Interchange Litigation: summary of the three main economic issues

02nd March 2017
Contributor:
Callum Godwin
Callum Godwin
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The path to interchange reclaim is proving to be full of ups and downs for merchants. To date, we have seen 1 win, 1 loss and 3 settlements, leaving many merchants uncertain where their claim stands and whether they should even proceed.

After the most recent ruling – the loss of Arcadia & Ors. to Mastercard – it is now more important than ever to ensure the economic arguments presented during these court cases are as strong as they possibly can be. Visa and Mastercard are goliaths of the industry, so any challenge brought to them needs to be comprehensive. In this article, we take a look at the 3 main economic issues the schemes are likely to argue, and how to counter these arguments to achieve a favourable litigation outcome.

Number 1: Ancillary Restraint

The schemes will attempt to deliver the “ancillary restraint” counterfactual, the argument they would cease to exist in the absence of a MIF as issuers would migrate to another major scheme.

Number 2: System Output

In order to prove that the MIF qualifies for an exemption under Article 101(3), the schemes are likely to argue that the MIF is necessary for the delivery of the benefits of the card system.

Number 3: Baseline

The court may decide that merchants and issuers would have negotiated bilateral interchange fees (BIFs) in the absence of an illegal MIF, or that the MIF qualifies for an exemption.

Number 1: Ancillary Restraint

Also known as the “migration”, “death spiral”, “asymmetric” and “object necessity” argument. The schemes will attempt to deliver the “ancillary restraint” counterfactual, which is the argument that they would cease to exist in the absence of a MIF because card issuers would migrate to the other major card scheme.

This argument depends on the other card scheme being able to charge a MIF, which of course they would not be able to if their MIFs were also illegal. This ultimately comes down to whether or not the two card schemes are “materially identical”. In the Arcadia case, the judge determined that the burden of proof was on the merchants and they failed to adequately prove that Visa and MasterCard are materially identical.

In this case, it is necessary to quantify the level of gap between the schemes that would have prompted issuers to switch scheme, with the judge deciding that a differential of greater than 0.2% would have been sufficient for migration because of the large sums of money involved.

Number 2: System Output

In order to prove that the MIF qualifies for an exemption under Article 101(3), the schemes are likely to argue that the MIF is necessary for the delivery of the benefits of the card system.

For this, they are likely to use the system output argument. This argument states that the MIF allows issuers to offer consumers free banking and cardholder rewards, which in turn lead to higher levels of card spending, or higher “system output”, which benefits merchants. Therefore, there are network effects within the card system which means that merchants benefit from the MIF. In order to counter this, merchant claimants need to be able to demonstrate that issuers would still be in a position to offer and promote card products in the absence of a MIF.

Number 3: Baseline

The court may decide that merchants and issuers would have negotiated bilateral interchange fees (BIFs) in the absence of an illegal MIF, or that the MIF qualifies for an exemption. In both of these cases, it will be necessary to quantify this BIF or exemption in order to provide a baseline that determines a merchant claimant’s pay-out.

To do this, the court is likely to employ one of two main methodologies – the cost-plus method and the benefits-based method:

  1. The cost-plus method was used to quantify the BIF in the Sainsbury’s case. To do this, the judge used a 2005 issuer cost study provided for MasterCard to assess issuer costs and identified three legitimate issuer cost areas – processing, fraud and the free funding period. The outcome was that the negotiated BIF would have been 0.5% for UK credit cards, which is less than the actual MIF paid, so Sainsbury’s qualified for a pay-out.
  1. The benefits-based method was used to quantify the exemptible MIF in the Arcadia case. To do this, the judge quantified six main benefits that the MIF provided. These include the avoided cost of cash (quantified using the Tourist Test or MIT MIF method) and business stealing from merchants that don’t accept cards. The outcome was 1.01% for UK credit cards, which is more than the actual MIF paid and, as a result, there was no pay-out.

Merchants need to be familiar with both methodologies and need to be able to demonstrate that either would have resulted in a BIF or exemptible MIF far below what they actually paid.

Conclusion

Merchants are likely to encounter three key economic battlegrounds in cases against Mastercard – ancillary restraint, system output and the quantum baseline. In the Arcadia & Ors case, MasterCard was successful in all three of these areas and we believe this to be the main reason why the merchants’ case was unsuccessful. Therefore, in order to have a high chance of achieving a successful outcome, it is imperative that future merchant claimants develop robust responses to all three of these issues. For more information on interchange litigation please email Callum Godwin at cgodwin@cmspi.com

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