Since this article was published, there have been multiple new announcements relating to Britain’s reclassification as an inter-regional market. For a more comprehensive summary of announced fee changes, review our blog: Merchants Brace for Potential Five Fold Increase in Card Fees
The latest announcement means that an EU merchant selling to a UK consumer online will see their interchange fees rise from 0.2% to 1.15% for a debit transaction. For a credit transaction, the fees will increase even further from 0.3% to 1.5%, as shown in Figure 1. Interchange fees are paid by a merchant to the cardholder’s issuing bank and, for large merchants, can form 80% of the total cost of accepting card transactions.
The UK is a large e-commerce market for the EU; in 2019, the UK made up around 34% of Western Europe’s online shopping. Previously, these Mastercard transactions would have cost European merchants an estimated €3.93 million annually. From October 2021, CMSPI’s analysis suggests that those same transactions will cost merchants €20.48 million – an additional cost of €16.55 million.
Figure 1: Comparison of CNP interchange for EU merchants selling to the UK before and after
Modelling: What if Further Changes are Announced?
‘Card not present’ (CNP) Mastercard transactions by UK consumers form only a small subset of transactions to which this reclassification could apply. Firstly, the change could be extended in the opposite direction, meaning that UK merchants selling to EEA consumers online would face the 1.15% and 1.5% fees. There currently does not seem to be anything to stop this change being extended to Mastercard’s scheme fees, increasing them from approximately 0.197% to the inter-regional average of 0.77% (CMSPI estimates). By this point, CMSPI estimates that merchant costs would have risen by over €100 million annually. If Visa chose to follow suit, our data suggests that the combined impact figure for merchants could reach over than €340 million. Indeed, reports have suggested that many in the industry expect Visa to follow Mastercard’s decision. The graph below shows the estimated merchant impact of this progression. So far, merchants have only seen step 1.
Figure 2: Potential merchant impact of reclassifying UK-EEA transactions as ‘inter-regional’
European Merchants Worst
Hit Our simulations suggest that the impact of these changes for European merchants (around €202 million annually) would exceed the impact for UK merchants (approximately €138 million). Although the UK’s figure is higher at a national level, the changes are a lose-lose for merchants across the continent. The figure below shows the estimated cost for EEA merchants of a full reclassification by country. As expected, countries from which the UK imports significant amounts such as Germany and Italy are worst hit, with popular tourist destinations such as Spain and Portugal suffering from a potential reclassification of ‘card present’ transactions.
Figure 3: Merchant impact by country of total reclassification of UK-EEA fees
Gaps in Legislation
Introduced in 2015, the Interchange Fee Regulation is a piece of European Union legislation that sets a maximum level of interchange on domestic and intra-EEA consumer card transactions. The caps sit at 0.2% for debit and 0.3% for credit transactions. However, the IFR did not regulate inter-EEA transactions (i.e. those where the merchant is within the EEA and the consumer uses a card issued outside of the EEA). Instead, the EU secured additional agreements with Visa and Mastercard for these transactions from April 2019. Whilst the caps agreed for ‘card present’ transactions matched the domestic 0.2% and 0.3% rates, those for ‘card not present’ transactions were 1.15% and 1.5% – exactly the rates that UK consumers will now attract online. While the UK has retained the IFR as part of its exit from the EU, there is nothing to stop the schemes from reclassifying the UK as inter-regional in its transactions with EU merchants.
The IFR was a significant victory for merchants and consumers in Europe. That the announced changes are possible, however, shows that the problems posed by gaps in the legislation are more significant than anticipated. One clear example of this is scheme fees. Paid by a merchant to the card schemes via their acquirer, scheme fees are not included within the IFR. Our data suggests that successive scheme fee increases since 2015 have meant that over €1 billion of the €9.4 billion in annual savings expected from the IFR will no longer be seen by merchants. The Brexit reclassifications are particularly concerning in terms of scheme fees as inter-regional fees are much higher than those charged within the EU. The figures below offer the average scheme fees by region for the largest EU economies.
Figure 4: Average inter- and inter-regional scheme fees by country
Source: CMSPI estimates, note that these represent rates optimised using the CMSPI process, so may not reflect those of other retailers
This is to say nothing of interchange; another pattern that seems to be emerging is one in which interchange is increased on transactions – such as those on commercial cards – that were left unregulated by the IFR. CMSPI estimates that the 2020-2021 changes to Mastercard’s corporate prepaid interchange, for example, will cost retailers an additional €15.5 million every year. As such, although Brexit provides the schemes with an argument for further increasing fees, it does so against a backdrop of years of similar changes.
From October 2021, Mastercard will be increasing the interchange fees that European merchants must pay on CNP transactions to UK cardholders fivefold. CMSPI estimates that the announcement will cost merchants €16.55 million every year – a figure that could reach over €340 million if a similar reclassification is applied across the board. Of this total impact, European merchants would bear more than €200 million. This not only represents a barrier to trade, but the increase announced for October 2021 targets online merchants at a time when lockdowns across Europe have forced many to close their face-to-face operations.
That these changes – and the 13 other scheme fee increases since 2015 – are possible shows that the loopholes in Europe’s Interchange Fee Regulation are proving much more costly than anticipated. Strengthening the regulation – particularly by extending the ‘card present’ inter-regional commitments on interchange to the ‘card not present’ space – could limit the potential costs of Mastercard’s announcement. However, merchants continue to struggle with fees growing in both size and complexity, which only highlights the importance of optimisation.