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Antitrust Assessment of MIF and the tourist test

Andrea Amelio*

European Commission

The Role and Regulation of Interchange Fees in European Payments CardsBruxelles, 15 June 2011

*The views expressed are those of the author and do not necessarily reflect those of DG COMP or the European Commission

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1. Introduction

– Historical overview

– Description of theory of harm

– Use of MIT to correct for the harm

– Caveats

– Conclusions

2. Historical overview

Visa I and Visa II decisions (2001/2002), MasterCard decision (2007), Visa decision (2010)

– MIFs are a restriction of competition between acquirers by effect because they have an inflationary effect on prices to merchants

– To comply with competition rules MIFs need to be justified by efficiencies that are passed on to consumers

MasterCard Decision:

– MIFs a restriction of competition, but not prohibited as a matter of principle as possibility of an efficiency justification explicitly accepted in the Decision

– Efficiency justification brought forward by MasterCard prior to the Decision rejected

– General allegations to efficiencies of payment card system as a whole are not sufficient

– Instead, concrete demonstration of efficiencies generated by MIFs and the benefits brought to merchants and their subsequent purchasers

MasterCard provisional settlement:– Based on “tourist test” at 0.3% (credit) and 0.2% (debit)– Data from national central bank studies– Additional transparency measures regarding the honour-all-cards rule (HACR), no-surcharge rule

(NSR), blending and exclusive dealing provisions

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2. Historical overview: VISA

Simultaneously: – MasterCard appeal of the 2007 decision in front of the Court of First

Instance– Study commissioned to obtain more precise data for a wider set of EU

countries

Visa SO in April 2009– April 2010 Visa offered commitments for immediate debit card

transactions– To reduce its MIFs for cross-border and domestic transactions in

nine countries to 0.20% – Measures to increase transparency and competition along the

same lines as MasterCard– Commission made commitments binding for four years in

December 2010– Investigation of Visa’s credit card transactions continues

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What harm can the MIF do?

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2. Interchange fees

MIF increases marginal cost of acquiring and decreases marginal cost of issuing

Hence, it tends to incentivize issuing of cards to the detriment of acquiring

Impact of the MIF:1. Price structure: allows to decide who pays what share for

payment service, merchants or cardholders – or rather how consumers pay for payment service: directly to their own banks or indirectly via higher prices to the merchant and the merchant’s bank

2. Price level: if cost pass-through of issuing and acquiring is not identical, MIF influences the total fee level (issuing plus acquiring fee)

2. Interchange fees

Basically the MIF simulates three-party schemes’ greater freedom in determining their prices across markets

In principle, there is nothing wrong with having asymmetric price structures in two-sided markets (advertising media, game consoles, …)

But there is one difference in payment card markets which is significant: on the merchant side, typically no price signals are transmitted because merchants normally do not (cannot) price discriminate according to the payment instrument used

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3. Relaxing Baxter’s assumptions

Baxter (1983) is first two-sided market analysis of payment networks

– banks can not influence overall price level but only the volume of transactions

– the output maximizing MIF level maximizes both total welfare and consumer welfare

Two strong assumptions of Baxter:1. Merchants reject cards if they do not benefit from them2. Banks are perfectly competitive

In reality, however, merchants’ willingness to pay for cards consists of two factors:

– Transactional benefits (e.g., immediate cost benefits compared to other means of payment)

– Business stealing (e.g., the competitive desire to accept cards to offer customers a good service)

However, second category does not constitute a genuine benefit to merchants overall, because the benefits of business stealing evaporate at an aggregate level

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3. Relaxing Baxter’s assumptions

Merchants are therefore reluctant to decline cards even if they impose additional cost, which allows banks to agree collectively high MIFs

As a result, card usage increases merchants’ marginal cost relative to other means of payment (recovered through increases in retail prices)

Instead of internalizing positive externalities, negative externalities are created

Cardholders are generally not aware of this and do not take this negative externality of card usage into account. Furthermore higher retail prices are born by all consumers (including cash users), not the individual card user

3. Relaxing Baxter’s assumptions

Banks thereby introduce hidden cost, crowding out usage of potentially cheaper payment instruments (eg, more use of credit cards vs. debit cards, even if the cardholder does not value the credit element, sponsored by higher MIF)

With imperfectly competitive banks, the cost pass-through of issuing and acquiring will generally not be identical

Australian experience: pass-through in acquiring full, pass-through in issuing less than full (imprecise estimates)

In this situation, increasing the MIF beyond the output maximizing level (at a profit maximizing level) pays off for banks:

It shifts revenues to issuing (where a part can be retained as profit), and shifts costs to acquiring (where they are passed on to merchants)

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“Optimal” MIFs:Is tourist test an appropriate test for

101(3)?

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4. The “tourist test” MIF

With competitive issuers, optimal fee makes merchants indifferent between payment instruments (see Wright, 2003):

Tourist test fee = merchants’ net transactional benefits (avoided cost of non-card payments)

If tourist test fee is positive, it incentivizes adoption and usage of an efficient payment instrument by consumers without creating hidden costs

Optimal MIF internalizes usage and membership externalities

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4. The “tourist test” MIF

In Rochet and Tirole (2007), tourist test fee is below profit-maximizing fee for banks (as business stealing among merchants is not exploited)

Relation to cost-based regulation: merchant benefit measured on the acquiring side (additional cost of non-card payments) rather than on the issuing side (issuing costs that “benefit” merchants), avoiding also issues of cost allocation across sides.

With imperfect competition (pass-through in issuing below 1):

consumer welfare tourist test fee total welfare

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4. The “tourist test” MIF

Tourist test fee weighs efficiency and consumer benefits

It provides a benchmark that focuses on the primary market failure (lack of price signals for final consumers on the merchant side)

Tourist test fee makes market one-sided (equivalent to perfect surcharging)

Tourist test fee is easier to measure than the precise consumer-welfare maximizing fee (measuring elasticities at all levels is very difficult)

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4. The “tourist test” MIF

Farrell (2006) (an economic advisor to the Australian MIF regulation) first recommended tourist test fee

Transactional benefits: exclude “additional spend”/business stealing (cancel out across merchants or across time)

Difference between debit and credit not obvious

From a legal point of view, tourist test fee provides a reasonable benchmark for applying Article 101(3): (i) contribution to improve economic growth, (ii) consumers receive a fair share, (iii) indispensable restriction, and (iv) eliminating competition in respect of a substantial part of the products in question

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5. Some caveats

Full adoption: If consumer adoption and usage of payment instrument would be almost complete even without MIF, limited benefits can be achieved

If payment instrument is almost free of charge even without MIF, further incentives may not be necessary

Hence, if adoption without MIF is wide and cardholder fees are low, it may be possible that consumers lose with tourist test fee compared to zero MIF

Less restrictive means of achieving efficiencies: in this case MIFs are not justified. For example, per transaction MIFs do not seem appropriate for direct debit as incentives can be provided directly by the merchant to the payer given the long-term relationship between them.

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Conclusion

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6. Conclusion

MIF might be used by payment card associations in an anticompetitive way to extract rents from consumers and push more expensive cards

However, if capped appropriately, MIF may generate efficiencies by promoting efficient payment instruments

Possible policy benchmark: do not allow MIF such that card payments would harm merchants (tourist test)

Additional cross-checks to make sure that the proclaimed benefits of the MIF can work in practice