Key takeaways

• In MR22/1.9 'Market review of card scheme and processing fees: Interim report' the PSR has reached a provisional conclusion that the market for card schemes is not working well, and regulatory intervention may be appropriate.
• A key cause of the card scheme market operating inefficiently is the lack of effective competitive constraints. The market is dominated by Mastercard and Visa, who together account for 99% of UK debit and credit card payments by value.
• In respect of many of the services provided by Mastercard and Visa, there are no credible alternative service providers. Additionally, Mastercard and Visa have a significant advantage over any new entrants due to their entrenched market dominance.
• The lack of competition is reflected in recent economic developments in the card scheme market. The fees charged by Mastercard and Visa to card acquirers have increased by 30% in real terms over the last five years, with the total revenue of Mastercard and Visa more than doubling between 2017/18 and 2022/23. These fee increases currently cost UK businesses an additional £250 million per year and have not been accompanied by corresponding improvements in service.
• The potential remedies are not discussed in detail, but possibilities set out include:
  • requiring more detailed financial reporting from Mastercard and Visa;
  • improving transparency to enable merchants and acquirers to make better-informed decisions; and
  • placing obligations on Mastercard and Visa to explain, consult on, and document the reasons for price changes and the pricing of new services.

What’s next?

• The PSR has invited comments on its provisional findings and the content of the interim report by 30 July 2024.
• The final report is due to be published in Q4 2024.

Read on for a more detailed review of the interim report.

Background

The PSR published its final report MR18/1.8 'Market review into card-acquiring services: Final report' in November 2021, finding that fees paid by acquirers rose significantly between 2014 and 2018, and were continuing to increase. Building on MR18/1.8, the PSR announced its intention to conduct a market review of the card scheme and processing fee market, launching the review in October 2022 with the publication of MR22/1.2 'Market review of card scheme and processing fees: Final terms of reference'. In this, the PSR clarified that the focus would be on the scheme fees and processing fees charged by Mastercard and Visa, who together are responsible for 99% of debit and credit card payments in the UK.

Take a look at our previous Engage article for more on the background to the market review: ‘Card fees: UK Payment Systems Regulator publishes final terms of reference for two market reviews’.

Key points from the report

• Credit and debit cards are the most popular way to make retail payments. Consumer cards accounted for 85% of the total value of UK retail spending in 2022. With the decline of cash and growth in use of cards linked to digital wallets, the dominance of cards is set to continue. Mastercard and Visa facilitated around 99% of UK debit and credit card payments in 2022 and therefore were involved in payments constituting 84% of UK retail spending.
• The PSR has assessed the competitive constraints that card scheme operators face in relation to serving issuers and cardholders (the issuing side) and acquirers and merchants (the acquiring side). The competitive constraints have been found to be stronger on the issuing side than the acquiring side.

Constraints on the issuing side

• Constraints on the issuing side are largely due to direct competition between Mastercard and Visa over issuing portfolios. Issuers invite Mastercard and Visa to tender and negotiate bespoke contracts. The PSR observed that issuers are willing to switch card scheme, thereby encouraging the schemes to compete with each other on scheme fees and processing fees, as well as on the incentives and rebates the schemes offer to issuers.
• However, the benefits of competition on the issuing side are not spread equally amongst issuers due to differing levels of bargaining power vis-à-vis the card schemes. Larger issuers and issuers targeting more affluent consumers offer more desirable portfolios and so generate greater competition between Mastercard and Visa. Further, in some situations, there is non-price competition between Mastercard and Visa concerning the quality of service offered (e.g. Mastercard reported using its dispute resolution platform and innovative authentication solutions as non-price differentiation points).

Constraints on the acquiring side

• On the acquiring side, three potential levels of constraint were identified, but the PSR determined that none are effective:
  • Acquirer-level constraints exist if acquirers can use alternative suppliers to provide merchants with access to card payments. This is ineffective as the lack of alternatives means that acquirers are forced to offer Mastercard and Visa acquiring services if they are to obtain and retain merchants as customers. Hence, acquirers can do little other than accept fee increases imposed by Mastercard and Visa.
  • Merchant-level constraints exist where merchants can negotiate down Mastercard or Visa prices or substitute card payments for alternative methods. This would put commercial pressure on Mastercard and Visa to reduce their card scheme and processing fees so that acquirers had lower costs to pass on to merchants. However, the market dominance of Mastercard and Visa negates this constraint as a material portion of consumers have demonstrated that they will choose a merchant that facilitates their preferred payment method (currently for most, a Mastercard or Visa card) and consumers are reluctant to incur the personal costs of switching to alternative payment methods.
  • Wallet-level constraints exist where operators of payment methods use alternative infrastructure to Mastercard’s or Visa’s payment rails. To be a wallet-level constraint, therefore, requires the wallet to support non-card payment methods, which is the case for e-money wallets and ‘buy now pay later’ solutions. Whilst these providers have an incentive to use payment methods with lower fees, such a small proportion of transactions are processed through these compared to Mastercard and Visa cards that they do not operate as an effective constraint.
• The PSR further noted that purchasing core scheme services is a condition of participation in a Mastercard or Visa card payment system and therefore an acquirer cannot source these from a competitor. Similarly, core processing services are only offered by Mastercard and Visa (although in theory they could be offered by other providers, this is not the case in the UK and there is no evidence of potential competitors seeking to provide core processing services).
• The above, coupled with the market practice of acquirers passing on scheme and processing fees to merchants in full, creates a situation of low competitive constraints on the card schemes, and limited incentives for other actors in the system to impose such constraints.

Market outcomes

• The developments in the card scheme market are consistent with the conclusion that there is a lack of competition in the market. As noted above, Mastercard and Visa have increased their fees significantly without making commensurate improvements in their service offering.
• The PSR also considers that Mastercard and Visa may have higher profit margins than would be expected in a competitive market. However, the lack of data on this means that the excess profit and level of harm caused cannot be quantified. Nonetheless, the PSR takes the view that such harm exists and is likely to be material.
• The PSR has also found that the market produces inadequate non-price outcomes. Pricing information is so opaque and complex that some large acquirers reported having to purchase consultancy services from the card schemes to understand their fees. Other reported issues included acquirers receiving insufficient notice of changes to fees, long delays in card schemes responding to queries, and problems accessing information through the card schemes’ online portals.

Potential remedies

• To address the issues identified, the PSR has proposed the following possible remedies:
  • More rigorous regulatory financial reporting: This would require the card schemes to provide the PSR with their UK financial information on an ongoing basis. The PSR would use this information to exercise greater oversight and conduct more thorough analysis of aspects such as profitability, although no detail on the information that might be requested has been provided.
  • Pricing methodology and governance: This would require Mastercard and Visa to make pricing decisions in a more formalised and consistent manner. It could also be expanded to require the card schemes to review their existing pricing.
  • Mandatory consultation and timely notification requirements: This would require Mastercard and Visa to consult acquirers about fee changes and report how acquirer feedback was taken into account when determining fees.
  • Complexity and transparency: This would require fees issued by the card schemes to be more detailed to enable recipients to understand the basis of fees, including whether they have been charged for optional services.
• The PSR is also considering implementing interim remedies pending the final decision on remedies, which will be made after a further consultation. The proposed interim remedies are (i) card schemes must consult acquirers and merchants before introducing or increasing fees, and (ii) card schemes must record the basis for their pricing decisions such that increases in fees can be shown to be due to an increase in costs.

Next steps

• The PSR has invited comments on its provisional findings and the content of the interim report by 30 July 2024.
• The final report is due to be published in Q4 2024.
• Whilst comments on the proposed remedies are welcomed, the PSR has stated that remedies will be subject to a further consultation after the final report is published.

If you would like to discuss any aspect of the interim report or card schemes and processing fees more broadly, please get in touch with one of the people listed above or your usual Hogan Lovells contact.