Credit cards regulation evolution

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Regulatory environment evolution and potential impacts for the payment eco-system

London, February 2015

Practice document


1

Contents

• Expected regulatory evolution

• Potential impacts of the new regulation for the

payment eco-system


2

The use of non-cash transactions has constantly increased during the last years, with Europe growing faster and having larger room for cash substitution then North America Number of Worldwide Non-Cash Transactions by Region (Billion), 2008–12

Source: World Payments Report 2014 RBS, Value Partners analysis

CAGR

Cash

Penetration

’08-’12

7.6%

19.3%

93%25.2%

11.0%

14.6% 92%

4.3% 77%

3.6% 54%111,2 113,1 116,6 124,0 127,9

11,7

15,319,4

23,3

28,8

11,8

13,6

16,4

19,5

23,9

2012

30.1

29.3

84.2

310.4

2011

33.5

32.5

87.6

334.3

2010

286.0

80.8

25.6

27.2

2009

269.4

77.2

23.8

26.3

2008

249.8

74.2

18.9

22.0

North America

(U.S. and Canada)

Europe

(Including Eurozone)

Latin America

Mature Asia-Pacific

CEMEA

Emerging Asia

Global

Focus of the document


3

2,5%

Within electronic payments card usage has shown the slowest growth in Europe and is still lagging behind as card usage share compared to other geographiesShare of cards in Payment services mix (%), 2008, 2011–2012

Source: World Payments Report 2014, Value Partners analysis

49%

78%

71%

81%

67%

43%42%39%

201220112008

North America

(U.S. and Canada)

Latin America

Mature Asia-Pacific

CEMEA

Emerging Asia 3,9%

5,5%

4,3%

3,7%

3,7%

Other

regions

Europe

Share of cards ’08-’12 growth


4

The card payments are managed following 2 main models: 4-party and 3-party schemes

4-party scheme 3-party scheme

Scheme

Model

Adopting Debit

Schemes

Adopting Credit

Schemes

• Transactions “On us” (the same bank is both Issuer and

Acquirer) follow the 3 corner model logic

• The schemes sells cards

directly to the cardholder and

rents POS to the merchant

Issuing

bank

Acquiring

bank

Merchant

Cardholder

Merchant

Cardholder


5

Issuing

bankAcquiring

bank

The key variables defining remuneration flows in the card payments eco-system between the players are MIF and MSC

When a client pays a product

by card to merchant, the

transaction flow can be

described in 4 steps:

a) Cardholder’s account is

debited for 100€ by Issuer

b) Issuer transfers 100€ to

Acquirer

c) Acquirer transfers 100€

minus merchant service

charge (composed mainly

of MIF, card scheme fees

and acquirer’s margin^)

d) Acquirer transfers MIF to

Issuer

e) Acquirer and issuer

transfer card scheme fees

f) The merchant pays

Merchant Service Charge

(MSC) to the acquirer

normally at the end of the

month

Illustrative scheme of the payment flowCase description

ILLUSTRATIVE - not on us transaction

100€ 100€ 98.5€

0.9€MIF*

ab

c

d

At the end, on 100 euro of transaction, merchant gets 98.5 €, issuer 0.9€, acquirer gets 0.5€ and

card schemes 0.1 €

a

b

c

d

Acquirer retains a

percentage (hp 0,5%=0,5€)

of the transaction as

acquiring margin

0.1€

Card Scheme

e

e

^ Clearing and settlement fees not considered because marginal

f

MerchantCardholder

MSC**f

Definitions of key variables

* Multilateral Interchange Fee (MIF) a fee that a merchant's bank (the "acquiring

bank") pays a customer's bank (the "issuing bank")

** Merchant Service Charge (MSC) a fee that a merchant pays to acquiring bank

for the service of being able to accept card payments


6

To boost the secular migration to electronic payments, European regulators are launching a series new requirements in Europe to further push card payments

Separation of

card schemes

and processing*

Steering rules /

Honour all cards

rules*

Co-badging and

choice of

application*

Fee unbundling

(MIF++

reporting)

Cross-border

acquiring

3-party

schemes:

fees and

surcharges*

• European regulators

have been actively

working on the Payment

Package (Payment

services Directive 2 and

MIF regulation), bringing

forward numerous

initiatives regarding both

Issuing and Acquiring

side

• The regulation focuses

on lowering cost of card

acceptance through

regulating interchange

fees and increasing

competition at the

network level

• Final version of the

regulation is expected to

be issued in the end of

H1 2015 and

enforcements to come in

the end of the 2015

• Processing to be separated from schemes’ managers in

order to promote healthy competition among processors

• Latest compromise: “separated accounting and organization”

Brief description

• The merchants will be able to steer customers to lower cost

payment method and limit card accepted to lower fee card

• Cards with the same MIF cannot be steered

• Prohibition of preventing co-badging with multiple brands and

allowance of the ability for customer to choose at POS

• No restrictions on POS application / terminals limiting the

choice

• The surcharge will be forbidden for 4-party schemes, while

will be allowed for other payment methods (AmEx, Diners, ...)

• The charges can be equal to or lower than the actual cost to

payee

• Acquirers will have to provide the details namely the acquirer

fees, interchange fees, and network fees separately

• By 1 January 2015, Visa has committed to allow cross-border

acquirers (residing in another country than the one where the

acquired merchant is based) to apply reduced interchange

fees of 0.3% for credit and 0.2% for debit transactions

Our understanding of main new regulatory initiatives in Europe, as of end of Feb 2015

Initia

tives

in Issuing

Initia

tives

in

Acquiring

MIF reduction

for consumer

debit and credit

transactions

• Interchange fees to be set at 30bps for credit and 20bps

for debit card transactions for all four-party schemes

• As of now 3-party schemes are excluded

Impacts on card schemes

3-party 4-party

Indirectly

Indirectly Indirectly

Directly

Indirectly

Directly

Indirectly

* Details in attachment

GNS

Focus of the next slides


7

EU commission regulation will impose MIF caps that will impact all of the players in the payment eco-system

Initiative and timing

•EU commission regulation

is expected to harmonize

and lower MIFs (0.3% for

credit and 0.2% for debit) on

all transactions by

September 2015 or

September 2016 (timeframe

is strictly related to ECON*

approval) in Europe**

• While in the short-term

only transaction by VISA

(thanks to cross-border

acquiring) will be impacted,

in 2016 both VISA and

MasterCard volumes on

consumer cards will have

lower MIFs applied

MIF

Card scheme

fees

Acquirer’s

margin

Expected effects on merchant service

charge (MSC)

ILLUSTRATIVE-

Credit transaction

* European Parliament Committee on Economic and Monetary Affairs

** EU 28

Source: European commission

0,9%

0,3%

0,1%

0,5%

1,5%

0,9%

0,1%

0,5%

AS-IS TO-BE

Issuing

bankAcquiring

bank

MerchantCardholder

Schemes

- 4-party

Players impacted in Payment

eco-system

AmEx

Loyalty programs


8

Contents

• Expected regulatory evolution

• Potential impacts of the new regulation for

the payment eco-system


9

Among the players involved the banks will be directly impacted on both acquiring and issuing side

• Merchant will benefit from lower MSC applied, due to MIF reduction

• Cardholders would have a mixed effect driven by two potential effects:

- Higher card usage due to increased acceptance by merchants

- Lower new card adoption due to potential higher card fees applied by banks (annual card fee + price

increase on additional services)

• 4-party card schemes are expected to have no specific effects, if not depending on increased /

decreased transacted volumes

• MasterCard could eventually benefit during the VISA CBA initiative, as banks will have the incentive to

issue MasterCard’s cards (in case MasterCard doesn’t lower CBA MIFs)

Card schemes

/ 4-party

/ 3-party

Cardholder

Merchant

Description

• AmEx will be indirectly impacted, both negatively - merchants will demand lower prices and positively

– lower prices will potentially push acceptance and cards issued

Issuing bank • After the EC initiative enforcement banks will face significant losses on issuing side

• In the short-term (till the end of 2015), if MasterCard does not follow VISA in CBA initiative, banks will

start to have limited impacts proportioned to adoption of CBA, with the speed of the revenue fall

depending on the strategies adopted by acquiring banks on CBA side

• Banks will implement alternative strategies to recover from losses

Acquiring

bank

• Acquiring banks which become cross-border acquirers could benefit from the MIF lowering, making

some extra-margin on the smaller merchants who are having less bargaining power and have less

awareness about regulation

Focus of the next slides

22

11

Impact

GNS

33

44

Positive

Negative

Uncertain

55

55

• Loyalty program’s impacts will largely depend on the loyalty partner type (financial vs. not financial),

with not financial partners not being impacted while financial partners’ impacts will depend on scheme

used and client base

Loyalty

programs


10

•European

regulator

considers this

situation

anticompetitive

•Coming

regulations are

changing the

“rules of the

game” eliminating

MIF barrier and

opening new

opportunities for

cross-border

acquiring

The new cross-border acquiring rules reshape European competitive framework for cross-border acquirers as lowered MIF levels will apply Acquiring

11

• Now cross-border acquiring occurs when

a card is issued in a different country from

the country where transaction occurs

•Cross-border acquirers (CBA) must apply

the Multilateral interchange fee (MIF) of

merchant’s countryO

• O since the MIF accounts generally for

~70-90% of the total Merchant Service

Charge (MSC), there is limited room for

competition on price

•For these reason, nowadays cross-border

acquiring rules limit the possibility for a

merchant to benefit from better conditions

offered by acquirers established outside of

the domestic market

“As-is” situation: cross-border acquiring

New CBA rules

•Cross-border acquiring will occur

whenever the acquirer manages the

transaction in a country different

from the country where the

transaction occurs

•Cross-border acquirers from 1/2015

will apply a reduced cross-border

fee (0.3% for credit and 0.2% for

debit transactions) for cross-border

transactions within European

Economic Area (EEA*)

• The cap of MIF for credit card

transactions at 0.3% after two years

will be applied also to domestic

transactions in ten Member States**

* EU 28 + Iceland, Liechtenstein, Norway

** Belgium, Hungary, Iceland, Ireland, Italy, Latvia, Luxembourg, Malta, the Netherlands and Sweden

Source: European Commission


11

Not becoming CBA in the short-term would result in potential loss of large clients and lack of competitiveness Acquiring

11

Strategy

options

• Bank adopts CBA and

switches its clients (if

requested) to CBA contracts

in order to preserve its

market share

Description

• Bank does not adopt CBA

and continues to run the

acquiring business as it is

run now (only domestic)

Defensive

• Bank adopts CBA,

converting all merchants to

CBA contracts and trying to

acquire new merchants

(clients of non-CBA banks) to

increase its market share

Aggressive

Impact on

Acquiring

• Immediate loss of

clients who

demand CBA and

related acquiring

revenues

(especially large

corporates)

• No impact, the

bank keeps its

clients base

• Gradual increase

of acquiring

revenues due to

market share

gained from CBA

services

Do nothing

Strategic

considerations

• Suboptimal

strategy given

maximum loss on

issuing ad

acquiring

• Becoming CBA is a

dominant strategy for

banks with relevant

acquiring market share,

as it will permit to:

- Avoid loss on large

corporates and other

clients demanding

CBA services

- Extract the potential

extra-margins (see

next slide)

• Both the options

outstand the

“do nothing”

strategy

• The choice

between the two

options depends

on the

comparison

between potential

benefits from

acquiring and

related losses

from issuing


12

Moreover becoming a CBA could permit to obtain some extra revenues in the short-term leveraging on less informed medium and small corporates

Expected impact on MSC in the

short-term

Merchant

cluster

Large

corporate

Medium

corporate

Small

corporate

ILLUSTRATIVE

•Large corporates are expected to

request immediately the MSC

adjustment due to their higher

knowledge of regulation

framework with consequent

savings on their costs

•The demand for lower MSC will

likely be extended to 3-party

schemes

•Without regulation intervention,

the MSC is expected case by

case to lower depending on

the ability of the merchant to

renegotiate the MSC

•Without regulation intervention,

the MSC is expected to remain

the same, due to low/none

knowledge of regulatory

evolution

ILLUSTRATIVE

ILLUSTRATIVE

• MIF cap reduction

will be around 40%-

60% of actual MIF, in

the short run price

decrease

incorporation will

probably depend on

merchant cluster due

to different bargaining

power and regulation

knowledge

• This will potentially

permit to CB

acquirers to extract

some extra-margin

from the business

Expected evidences

Full MIF

decrease

incorporated

However, in

the long run

MIF will tend

to be fully

incorporated

in Merchant

Service

Charge for

all merchant

clusters

0,9%

0,3%0,1%

0,5%

1,5%

0,9%

0,1%

0,5%

Decrease not

incorporated

As-is To-be

Acquirer

margin

MIF

Scheme

fees

As-is To-be

1,1%

0,3%0,1%

0,7%

1,5%

0,9%

0,1%

0,5%

MIF

decrease

partially

incorporated

As-is To-be

1,5%

0,3%0,1%

1,1%

1,5%

0,9%

0,1%

0,5%

Acquiring

Large merchants will demand to banks CBA service to lower their costs with

consequent pressure also to 3-party schemes in order to push down their costs

Acquirer

margin

MIF

Scheme

fees

Acquirer

margin

MIF

Scheme

fees

11


13

On the issuing side, in the long-term there will be a significant reduction in the revenue pool on MIF with a consequent shrink of bank’s profitability Issuing / 4-party

Source: ECB, VP benchmarking data, Value Partners analysis

22

ILLUSTRATIVE

•As estimated for a

pool of

benchmarked banks

after the EC law

enforcement the

bank will lose more

than half of its

revenues from MIF

•Overall issuing

revenues (including

card fees and

interests) are

expected to decline

of 24%* according

to our estimation

•Applying these

effects to estimate

revenue pool from

MIF reduction at

the national level

resulted in

approximately

€200Mln

Regulation impact on Issuing revenue pool

Revenue pool from MIF,

Pool of Italian banks, Base 100Card schemes

considered:

-5.1 (-43%)

-48.0 (-55%)

Revenue pool

reduction

Credit

Debit

To-be post-regulatory

implementation

46,9

40,0

6,8

2013

100,0

88,0

12,0

-53.1 (-53%)

* The MIF share on total Issuing revenues is 45% according to Value Partners benchmark study

The speed of the impacts on

VISA volumes will depend on

the adoption of CBA

initiative by acquiring banks

(see attachment for details)

• EU commission

regulation that will the

MIFs caps to 30bps for

credit and 20bps for

debit cards for VISA and

MasterCard consumer

cards transactions is

expected to heavily

impacts on the

profitability of the

Issuing business of the

bank

Estimation on italian issuing market


14

The ability to recover the profitability of the issuing business will depend on the business model in place ...

Issuing

management

model Description

• The bank has commercial relationship with clients and is the issuer of

the card with all connected liabilities

• In proprietary management model the bank tends to manage entire

Value Chain in-house, ...

• ... still some parts of Value Chain could be outsourced to third-party

provider (e.g. processing, customer care, ...)

• All the revenues are of the bank and costs are prevalently actively

managed

• The bank has commercial relationship with clients and is the issuer of

the card (the cards are issued under bank’s brand)

• Value Chain is managed by third party that offers to the bank white

labelling outsourcing

• The bank has the ability to define the product and connected services

with the consequent cost structure

Source: Value Partners benchmark data and analysis

Issuing management models and relative ability to act on revenues and costs

• As shown before the

revenue from issuing have

a certain effect of declining

in the long-term

• The impacts on net

profitability of the business

will mainly depend on:

- The ability to react on the

cost side of the business

–driven also by the cost

management model

- Possibility of new

strategies on revenue

side in order to replenish

the losses

22

Ability to act on ...

Revenues Costs

In-house

Player

example:

Hybrid

Player

example:

Outsourced

Player

example:

• The bank has commercial relationship with clients, but is not the issuer

of the card

• Entire Value Chain is managed by third party with the cards having its

branding (e.g. CartaSi) and limited control of the product offered and

the underling costs

• The bank receives a rebate on the revenues per card agreed in the

outsourcing model

Issuing / 4-party


15

... with more room for action on the revenue side where banks will be looking for alternative strategies

22

Description

•The banks will

face a

decrease in

revenues,

while having a

rigid cost

structure that

will put at risk

issuing bank’s

profitability

•To face the

issue banks

will take the

actions on the

revenue side

Increase card

fees

Card offer

restructuring

Commercial

Partnerships

Additional

services

offering

• The banks will be actively looking for additional revenue

streams in the card business, also through establishing

commercial partnerships with other players not impacted by

regulation

• Banks will sell additional card services (e.g. travel insurance,

...) in order to increase the revenue stream from card business

• On consumer side it will mean less free basic services and

expensive additional services (for 4-party schemes cards)

• Banks will try to strip the services in the basic cards linked to

current accounts in order to keep low the maintenance cost of

the card

• Banks will be less eager to engage in loyalty programs on

their cards (if not offered for free by loyalty program)

• Most of the banks are assumed to increase the card fees

transferring the loss of revenues to the customers

Strategy

Issuing / 4-party


16

The 4-party card schemes, including Amex GNS, will be impacted by the new regulation

33

Due to impacts from regulation ... ... core strategic initiatives

4-party schemes

•Many of the initiatives of Payment

Package (Payment services

Directive 2 and MIF regulation) will

have only indirect and potentially

uncertain effects

• Some initiatives regard directly 4-

party card schemes and will (if

validated in final version) produce

concrete operational impacts (e.g.

separation of card schemes and

processing, surcharges prohibition,

...)

•No matter how the regulatory

environment changes, some core

strategic initiatives will remain

among main priorities for 4-party

card schemes

Card-

holder

Mer-

chant

Issuer Acquirer

1

2 separate

entities?

2

• If legal or organizational separation is required,

4 party Card Scheme Provider will have to face

some new challenges as a:

-New organization and separate accounting

systems, necessary to continue providing

services in the short run

-Separate legal entities, management and

decision making ability, necessary to set up

to guarantee services in the long-run

-Potential increase in operating costs in the

nearest future

• 4-party schemes will look to

further drive customers from

cash to electronic payments,

through:

- Investing in technology and

enhanced security standards

(also to justify the potential

increase in card fees that

banks might apply)

-Expand in the geographies

with still high share of cash

usage

- Innovate and bring new

products and services

(cardless payments, e-

commerce security, ...)

- Increase pricing

transparency towards

merchants to further push the

levels of acceptance

- Build new partnerships (e.g.

Apple pay)

AmEx cards on GNS

Card schemes

(4-party)

GNS


17

For AmEx (3 party card scheme) the impacts will be indirect and will produce double effect: decrease of revenues from MSC and potential gain in market share

44

• In case of American Express it

would be directly impacted only* by

initiative of permitting surcharge for

3-party schemes, while forbidding

the same for 4-party schemes

• The most relevant impact will

derive from indirect effects of MIF

lowering

•After MIF lowering the general

decrease of MSC is expected and

consequently merchants will

require lower prices to all operators

of card payments eco-system

• Several European countries have

already adjusted domestic MIF

levels closer to the levels of the new

MIF levels (e.g. Poland, Germany,

Hungary, ...) anticipating the above

mentioned effects

... on

average

MSC

... on

market

share

Expected indirect impacts* from MIF reduction ...

• Similar situation was verified in Australia, where

average MIF was reduced from 0.95 p.p. to 0.55 p.p

(42% reduction)

• As a consequence of this intervention AmEx has lost 41

bps in the 4 years to follow (aprox. 10 bps per year)

• Comparing to Italian market where the average

reduction of MIF** is expected to exceed 50% ...

• ... the expected annual margin reduction would be

around 10-15 bps per year (with a total impact on

marginality in 3 years of 30-45 bps)

• Given the lower cost for merchants to accept AmEx

cards there will be consequent benefits in terms of

acceptance

• On the other hand, banks will increase card fees, making

AmEx cards gaining competitiveness in terms of

pricing

• Given higher AmEx products marginality it will be

easier to establish partnerships with banks

• These factors will permit to boost the development of

the infrastructure and gain market share

Total

effect

++

==

• The net effect is uncertain and will depend on how

much market share AmEx will manage to gain

* Global Network Services (GNS) business is not considered in this assessment; ** Estimated on effective MIF revenue received by pool of major Italian issuers

Source: Reserve bank of Australia, industry reports,

Value Partners internal benchmark data and analysis


18

The merchants will certainly benefit from lower prices and more transparency, while the customers will have an uncertain impact

Impacts description

55

Cardholder

Merchant • Merchants will have a positive effect that will be driven mainly by Large

merchants that are more aware of regulation and have higher bargaining

power, demanding single counterpart for global servicing, more transparency and

lower prices

• In fact, not only will merchant see MSC reduction, but a series of other initiatives

will give merchants more transparency on the pricing from the banks ...

• ... and more rights to influence customer’s behaviour in order to lower their

price of acceptance

Overall impact

Positive

Positive

++

==

Negative

Uncertain

• The customers impact will significantly depend on the actions taken by the

issuing banks, that most likely are going to be negative for customers (card fee

increase, advanced services payable, ...)

• This will be contrasted by the general increase of acceptance due to lower

price to merchants and more rights

• The overall effect is uncertain


19

In a nutshell…

• The use of non-cash transactions has constantly increased during the last years, with Europe still

having larger room for cash substitution

• With regards to card usage Europe has shown the slowest growth compared to other geographies

and has the lowest share compared to other geographies

• European regulators have launched a series new requirements to push card payments through two

key initiatives impacting Multilateral Interchange Fee:

- Cross-border acquiring lower interchange fees

- MIF reduction for consumer debit and credit transactions

• The first initiative creates a new European competitive framework for cross-border acquirers and

forces relevant acquirers to become cross-border, as not doing so would result in potential loss of

large clients and lack of competitiveness, with a growing number of players looking to establish

dedicated to Acquiring Partnerships with specialized players (e.g Global Payment, First Data, O)

• In the long-term there will be a significant reduction in the revenue pool on the Issuing side with

banks that will implement alternative strategies to replenish the losses, including also thinking to

new partnership with the Card Schemes less impacted by the new regulation

• The new regulation will impact mainly the 4 Party Card Schemes from an operative point of view,

while 3 Party Card Schemes will be impacted mostly indirectly

• The merchants will be the winning players in this game due to lower prices and higher

transparency, while the effects on card users are uncertain


20

Thank you!


21

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Economy & Finance

Credit cards regulation evolution