Merchants have won a victory with a FederalCourt ruling this week that orders the Federal Reserve to revisittwo aspects of its interchange regulation, routing andinterchange rates, that will ultimately impact prepaid.
The court has ruled the Federal Reserve Board failed to follow thelegislative intent of the Durbin legislation, specifically dualrouting for all transaction types and limiting interchange costcalculations to only costs associated with the transaction.
The dual routing concept implied in this ruling is that everysignature debit card transaction should be supported over the twoexisting signature networks: Visa and MasterCard. This wouldchallenge existing business models in a way that defies any quickanalysis as, in our opinion, it would drive the industry in adirection that is completely unknown from several perspectivesincluding, but not limited to, business model, operationalgovernance, branding, and technological. It would suggest that allother available signature networks might become importantinstruments in the business model battles that are likely tofollow.
Relative to this ruling that require the Fed re-evaluate itsInterchange cap to assure that it reflects only transactionalcosts; any bad news that drops prepaid interchange for MasterCardand Visa is likely great news for American Express and Discoversince their networks are exempt from Durbin (as long as they arealso the issuer). If exempt networks can maintain higherinterchange, then they will be able to more easily maintain theexisting business models that are fueled by interchange.Conversely, prepaid programs that are primarily fueled byinterchange that exist on non-exempt networks could find theirinterchange revenue cut almost in half, to perhaps as low as 12cents.
It is important to note, however, that this ruling is based on afinding that the Fed must pay strict attention to the intent of theDurbin legislation. This is good in that prepaid has specific carveouts in that legislation (See below). These carve outs, however,may not entirely protect prepaid. It is possible that the networkswill adjust all their interchange tables when they take action toaddress any new Fed ruling. This is what occurred for the prepaidexempt programs in the last round. They didn’t drop to thenon-Exempt level across all categories, but overall prepaidinterchange was lower.
Of course, while Durbin exempts many prepaid programs from changesin interchange, no such exemption exists from dual routing – andprepaid is just a speck in the eye compared to the impact dualrouting issues might have on the much larger debit cardmarket.
So we find ourselves trying to prepare for a future which isunknown and with minimal facts at our disposal. Another hearing hasbeen scheduled for Aug. 14, and it is likely more positions andfacts will spill out as we approach and pass that date. Thesepositions and facts may not improve our ability to analyze thesituation much, but they will give us at least a few more datapoints to consider.
From the legislation:
”(7) EXEMPTION FOR GOVERNMENT-ADMINISTEREDPAYMENT
PROGRAMS AND RELOADABLE PREPAID CARDS.-
This is the language on the exemption from the legislation, not theregs.
”(A) IN GENERAL.-This subsection shall not apply to
an interchange transaction fee charged or received with
respect to an electronic debit transaction in which a person
uses-
”(i) a debit card or general-use prepaid card that
has been provided to a person pursuant to a Federal,
State or local government-administered payment program,
in which the person may only use the debit
card or general-use prepaid card to transfer or debit
funds, monetary value, or other assets that have been
provided pursuant to such program; or
”(ii) a plastic card, payment code, or device that
is-
”(I) linked to funds, monetary value, or assets
which are purchased or loaded on a prepaid basis;
”(II) not issued or approved for use to access
or debit any account held by or for the benefit
of the card holder (other than a subaccount or
other method of recording or tracking funds purchased
or loaded on the card on a prepaid basis);
”(III) redeemable at multiple, unaffiliated merchants
or service providers, or automated teller
machines;
H. R. 4173-696
”(IV) used to transfer or debit funds, monetary
value, or other assets; and
”(V) reloadable and not marketed or labeled
as a gift card or gift certificate.
”(B) EXCEPTION.-Notwithstanding subparagraph (A),
after the end of the 1-year period beginning on the effective
date provided in paragraph (9), this subsection shall apply
to an interchange transaction fee charged or received with
respect to an electronic debit transaction described in
subparagraph (A)(i) in which a person uses a generaluse
prepaid card, or an electronic debit transaction
described in subparagraph (A)(ii), if any of the following
fees may be charged to a person with respect to the card:
”(i) A fee for an overdraft, including a shortage
of funds or a transaction processed for an amount
exceeding the account balance.
”(ii) A fee imposed by the issuer for the first withdrawal
per month from an automated teller machine
that is part of the issuer’s designated automated teller
machine network.
”(C) DEFINITION.-For purposes of subparagraph (B),
the term ‘designated automated teller machine network’
means either-
”(i) all automated teller machines identified in the
name of the issuer; or
”(ii) any network of automated teller machines
identified by the issuer that provides reasonable and
convenient access to the issuer’s customers.
”(D) REPORTING.-Beginning 12 months after the date
of enactment of the Consumer Financial Protection Act
of 2010, the Board shall annually provide a report to the
Congress regarding –
”(i) the prevalence of the use of general-use prepaid
cards in Federal, State or local government-administered
payment programs; and
”(ii) the interchange transaction fees and cardholder
fees charged with respect to the use of such
general-use prepaid cards.
”(8) REGULATORY AUTHORITY OVER NETWORK FEES.-
”(A) IN GENERAL.-The Board may prescribe regulations,
pursuant to section 553 of title 5, United States
Code, regarding any network fee.
”(B) LIMITATION.-The authority under subparagraph
(A) to prescribe regulations shall be limited to regulations
to ensure that-
”(i) a network fee is not used to directly or
indirectly compensate an issuer with respect to an
electronic debit transaction; and
”(ii) a network fee is not used to circumvent or
evade the restrictions of this subsection andregulation