The Truth Behind Scheme Fees: Evidence from the Payment Systems Regulator’s New Working Paper
On the 30th of June 2023, the UK’s Payment Systems Regulator published a working paper on recent changes to card scheme and processing fees.1 This latest phase of their market review comes as merchants around the world call for action on rising card fees, and its findings could have implications for regulators globally.
Why the focus on scheme fees?
Scheme (or ‘network’) fees form one component of the Merchant Service Charge businesses pay to accept every card payment. The PSR separates these fees into ‘processing’ and ‘scheme’ elements, both of which are paid to card schemes like Visa and Mastercard for their services.2
While these fees are charged to both issuing banks and merchant acquirers, acquirers typically pass their share onto merchants.3 Evidence from markets like the U.S. shows that acquirer scheme fees can be significantly larger than issuer scheme fees.4
Unlike interchange fees, scheme and processing fees are largely unregulated globally. They are also incredibly complex, and constantly changing; between 2015 and 2021, CMSPI estimates that increases to scheme and processing fees have amounted to €1.46 billion in additional annual costs to European merchants. That’s without considering any overcharges and billing errors merchants may experience during the process of pass-through from acquirers.
These fee increases have meant that all eyes are on the UK as its regulators scrutinise the competitiveness of scheme and processing fees.
1 - Mandatory fees are the most lucrative
The PSR’s working paper contains analysis of approximately 40 changes to scheme and processing fees from Visa and Mastercard since 2017.5 These do not constitute every fee change across the period - just those expected to have the largest impact on the schemes’ revenues in the UK.
While some fees are charged based on the actions a merchant takes or the services they choose to access, many are mandatory (i.e. are automatically charged when the scheme is used). As Figures 1 and 2 (below) show, those fee changes with the greatest impact on Visa and Mastercard’s revenue were those that merchants had no choice but to accept.
Visa’s international fees are a well-known example of these mandatory fees. Between 2018 and 2021, the PSR notes that the International Service Assessment Fee - charged on Card Not Present international transactions – increased from 10 to 55 basis points. The International Acquiring fee also saw a 15 basis point increase in 2017 (charged on both Card Present and Card Not Present international transactions), and was extended to apply to transactions between the UK and EEA in 2021 (although at lower levels).6 Referred to by Visa as ‘core fees’, such mandatory charges are “not associated with any optional service, but with the service that is the use of the Visa card scheme”.7
Figure 1. Revenue impact of selected Mastercard fees by optionality (GBP million)
Source: PSR
Figure 2. Revenue impact of selected Visa fees by optionality (GBP million)
Source: PSR
2 - Merchants bear the brunt of fee changes
Card schemes compete to appear on the cards that banks issue. Merchant advocates have long argued that this creates an incentive for them to charge lower scheme fees to issuing banks than to merchants, who must increasingly accept card payments as a necessary part of doing business.
For both schemes, the PSR’s analysis found that most revenue from fee increases came from the acquiring (and therefore the merchant) side. In the case of Visa, 14 of the 15 changes affected acquirers – including all changes to mandatory fees. Only six fee changes affected issuers, and only one of those changes was mandatory.8 In fact, changes on the issuer side led to an aggregate reduction in fee revenue to the scheme when considering those changes for which the impact could be split.9 For merchants, these higher scheme fees arguably have the same effect as a larger interchange bill, in spite of regulation of the latter.
3 - Merchants don’t always know what they’re paying for
Two of the most common questions posed by CMSPI’s merchant partners are how fee increases are justified, and whether they are tied to additional value to the merchant’s business. According to the PSR, this increased service value is one of the most common explanations the schemes offer for fee increases in their internal documentation.10 However, the regulator noted that in most cases “the documents do not include any quantitative estimate of this value”.11 This is particularly true with mandatory fees, which are typically not associated with a specific service but with participation in the scheme itself.12
The PSR also found that engagement with customers generally occurs only when a fee change has already been approved, and even those services provided free of charge today may attract fees once merchants have become dependent on them:
“An acquirer told us that the card schemes typically ‘offer services first free of charge to allow for the market to adapt. At a later point in time, the payment networks introduce pricing and require payment for those service.’” – Payment Systems Regulator13
4 – Even regulation can drive fee increases
Not all scheme fees are mandatory; some relate to value-added services the schemes offer, such as fraud prevention products.
However, the close relationship between these services and regulatory standards that merchants must meet can blur this distinction. For example, the PSR notes that Mastercard’s AAV validation solution changed from an opt-in to an opt-out in September 2019 as AVV validation became required under the revised Payment Services Directive (PSD2), even though the service is available from other providers.14 Similarly, the opt-in fees with the largest revenue impact to the schemes related to 3D Secure15 – EMVCo’s solution for meeting the Strong Customer Authentication requirements of PSD2 online.
CMSPI has also observed the introduction of scheme fees for the use of SCA exemptions, such that merchants could face new fees regardless of the strategy they use to meet the requirements of PSD2. The European Banking Authority acknowledged this in its response to the European Commission’s review of PSD2, noting that any new Directive should “clarify explicitly that the application of SCA should be considered as a corrective and preventive measure, thus being free of charge.16
Such fees can result in additional costs for merchants seeking to comply with security requirements (see Figure 3 below), and that is even without considering the difficulties of opting out from a service - especially likely for smaller merchants who may lack the necessary expertise or resources.
Figure 3: The implementation of PSD2 has led to higher costs for merchants.
Figure 3. Weighted average response to the question “Please indicate to which extent you (dis)agree with the following statements: The implementation of PSD2 has led to higher costs for merchants.” in the targeted consultation on the review of the revised payment services Directive (PSD2). Source: CMSPI analysis of consultation responses.
5 - Alternative Payment Methods aren’t the answer - yet
Another justification identified for fee changes in the working paper is competition. Visa, for example, explains its Everyday Spend programme – which has protected certain sectors such as supermarkets from the impact of some historical scheme fee changes in the UK – with reference to competition from alternative payment methods.17
However, whilst the schemes may reference competition from alternative forms of payment in their documentation, the PSR notes that these constraints have not prevented substantial increases to mandatory fees in the cases analysed.18
The effect may be more pronounced too as the UK, unlike many of its European neighbours, lacks a national card scheme to compete with Visa and Mastercard’s rails.
So, for merchants, while looking outside of cards to drive competition between payment methods is still a worthwhile strategy in the long-run, it alone isn’t enough to solve the problem today.
What the findings mean for businesses
The PSR’s working paper highlights a challenge that merchants know all too well: regular, substantial changes to fees often come with little public justification or consultation, and commonly have to be accepted as a consequence of doing business.
While PSR’s findings are a step forward in generating transparency, many businesses can’t afford to wait for regulatory intervention. With that in mind, there are some steps you can take now to ease the pressure:
- Exercise your rights – If a service is not mandatory, make sure you have thoroughly analysed the business case for its usage and worked with your acquiring partner to opt in or out.
- Audit your fees – Even those fees that are ‘pass-through’. CMSPI often observes significant discrepancies from one acquirer to another, with mischarges leaving many merchants paying more than required by the latest fee change(s).
- Advocate – The PSR are calling for comments through the 11th of August, and it is only with merchant participation that regulators can become equipped with the necessary information to benefit merchants and consumers alike.
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Sources:
- https://www.psr.org.uk/publications/market-reviews/mr22-1-6-recent-changes-to-scheme-and-processing-fees-working-paper/
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Note: The ‘processing’ fees referred to throughout are not to be confused with fees for acquiring services, referred to as processing fees in some jurisdictions.
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See Section 4.4 of the Study on the Application of the Interchange Fee Regulation: https://ec.europa.eu/competition/publications/reports/kd0120161enn.pdf
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https://www.federalreserve.gov/paymentsystems/files/debitfees_costs_2019.pdf
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Paragraph 1.3. https://www.psr.org.uk/publications/market-reviews/mr22-1-6-recent-changes-to-scheme-and-processing-fees-working-paper/
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See Box 3: Changes to Visa’s international fees. https://www.psr.org.uk/publications/market-reviews/mr22-1-6-recent-changes-to-scheme-and-processing-fees-working-paper/
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Paragraph 4.50. https://www.psr.org.uk/publications/market-reviews/mr22-1-6-recent-changes-to-scheme-and-processing-fees-working-paper/
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Paragraph 4.60. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 4.62. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 5.10. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 5.10. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 4.7. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 5.13. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 4.11. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 4.13. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 4.75. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf
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Paragraph 4.71. https://www.psr.org.uk/media/2zsbl3k1/mr22-1-6-recent-changes-to-scheme-and-processing-fees-public-june-2023.pdf