Gareth Vaughan looks at what merchant service fee regulation may mean for loyalty & rewards schemes, surcharging, and buy now pay later service providers, and why

The Government's decision to regulate merchant service fees charged by banks to retailers and other businesses could have major implications for credit card loyalty and rewards schemes, surcharging by businesses, and buy now pay later service providers. Let's take a look at how and why that is.

Commerce and Consumer Affairs Minister David Clark has announced plans to regulate merchant service fees, following a Labour Party election promise last year to reduce fees small businesses pay their banks for accepting debit and credit cards.

Specifically the Government plans to enable the Commerce Commission to regulate interchange, bringing New Zealand in line with comparable countries such as Australia, which have regulated interchange for years.

Interchange is the biggest part of a broader merchant service fee charged by card issuing banks to their business customers. According to a government regulatory impact statement, interchange can be 70% to 80% of the merchant service fee. However, each bank sets its own interchange rates within a cap set by Visa and Mastercard, whose cards the banks issue.

Clark says interchange fees for credit card transactions will be capped at 0.8% of the transaction value, and interchange fees charged for online debit card transactions will be capped at 0.6%. This is in line with Australia. According to retail lobby group Retail NZ, small retail businesses can pay fees of more than 2% for credit transactions. Additionally many retailers remain on blended rates of more than 1.6% for all transactions including contactless debit.

Clark says contactless debit card interchange fees will stay at their current levels of 0.2% or less, and swiped and inserted debit transactions such as EFTPOS, will remain fees free for merchants.

Cross-subsidisation compounding inequities

So where do loyalty and rewards schemes such as Fly Buys and Airpoints fit in?

On top of regulating interchange, the government is considering additional options including limiting the extent of rewards and loyalty programmes. Why?

The regulatory impact statement sets out that individual consumers being incentivised to use higher cost payment methods isn't necessarily a problem for them given they receive benefits for higher costs.

"I.E. a consumer may be willing to pay a surcharge for the use of a credit card, in return for rewards points accrued from the use of that credit card. For individual consumers, the costs can be outweighed by the benefits when rewards and the provision of credit are factored in."

The problem is when consumer preferences for higher cost payment methods impose higher costs on merchants, who may then choose to recoup these by increasing prices on goods and services or surcharging.

"This is a problem because it means that all consumers pay the same higher prices even when they use lower cost payment methods. This results in a wealth transfer from the users of low cost payment options to users of high cost cards, likely to be on high incomes due to issuer rules or higher annual fees," the regulatory impact statement says.

"This perpetuates the economic inefficiency of the current retail payments system because it means that users of low cost payment methods essentially fund reward schemes for users of high cost payment methods, rather than matching up the costs and benefits of those different payment types to their users. This cross-subsidisation compounds the inequities within the retail payments system."

In 2016 the Ministry of Business, Innovation & Employment (MBIE) estimated merchants had to increase prices to all consumers by about $187 million annually to fund rewards paid to certain credit card users.

"Because of the way credit card reward schemes are structured, this leads to an annual regressive cross-subsidy of $59 million from low income to high income households. These costs are ongoing, so they add up over many years," MBIE said.

The regulatory impact statement notes that Visa and Mastercard debit and credit cards are increasingly providing consumers with greater functionality such as the ability to make online and contactless payments, and additional security features and rewards and loyalty programmes. However, they're also more costly.

"Product innovation has focused on scheme debit and credit cards [as opposed to EFTPOS cards] as the use of these cards generates greater revenue. Banks also use incentives to steer consumers to payment systems where they make the highest return. Issuing banks are relying on rewards and inducements to compete for customers as it generates greater revenue," the regulatory impact statement says.

Poor value

In a submission on a government issues paper on merchant service fee regulation, Consumer NZ says reward schemes and incentives deliver poor value for many shoppers.

"Our analysis of credit card reward schemes shows that they only benefit big spenders who use their card frequently and are able to pay off the balance in full each month. Low spenders, and those with interest bearing debt, don't benefit from rewards and are effectively subsidising high spenders," Consumer NZ says.

"In our 2019 banking satisfaction survey, we asked participants to rate the value they got from their credit card rewards. Only 31% thought they got 'very good' value from their rewards. Thirty-four percent thought they got poor value, or were neutral about the value they received."

"We also consider rewards and incentives lock consumers into higher cost credit cards, making them reluctant to switch. This reduces competition and allows incumbents to continue charging uncompetitive rates," adds Consumer NZ.

Regulating merchant surcharging is on the cards

So what about surcharging? A surcharge is an extra fee or charge added to the cost of a good or service, beyond the initially quoted price.

The Government is proposing to arm the Commerce Commission with "a package of tools." This includes the option of further price regulation such as the ability to regulate merchant surcharging.

Consumer NZ suggests surcharging should be regulated to ensure merchants can't charge more than the actual cost of accepting payment. It says overseas experience shows surcharge regulation has been required to provide consumer protection.

"In Australia, for example, excessive surcharges have been banned since 2017. Under Australian law, if a merchant's cost of accepting a Visa payment is 1.5%, consumers can only be charged 1.5% on payments made using a Visa. Further, if businesses want to set a single surcharge across multiple payment methods, the surcharge must be set at the level of the lowest cost method, not the average. We would like to see similar rules in New Zealand given the excessive surcharges that consumers face," Consumer NZ says.

Consumer NZ says it receives regular complaints about excessive surcharging.

"For example, we recently received a complaint about Jetstar's $5 credit card fee. Although $5 may not be considered excessive on a $200 flight, if booking a $40 flight, a $5 fee equates to a 12.5% surcharge. We also receive complaints about surcharges that were not disclosed upfront to the consumer and complaints about the inability to avoid surcharges when credit card payment is the only option."

Will the Government also cap buy now pay later merchant service fees?

Then there's the buy now pay later service providers who've been making significant inroads into the retail and credit sectors, especially among young female shoppers, in recent years. Two buy now pay later providers, Afterpay and Humm, submitted on the government's merchant service fee issues paper. Afterpay noted its merchant service fee is 4% of the transaction value, which is significantly higher than what banks typically charge.

Clark says he's looking at buy now pay later service providers. Retail NZ wants caps placed on fees charged by buy now pay later service providers, who like banks partner with Visa and Mastercard. Retail NZ notes buy now pay later services have zero cost to the consumer but very high cost to retailers.

Consumer NZ, meanwhile, is concerned about the lack of transparency in the costs involved with buy now pay later schemes.

"Buy now pay later schemes promote their schemes as 'free' to consumers when payments are made on time. However, there is a cost to merchants using these services and that cost is passed on to consumers through increased prices. Ultimately, the cost of these schemes is borne by all consumers, not just those who use the service. We consider this issue should be addressed," says Consumer NZ.

Humm, which is part of Flexigroup, says in its submission the regulation of interchange fees would see non-bank lenders such as Humm lose revenue affecting the viability of some products such as its open loop buy now pay later product.

"We cannot charge other credit fees as these must only be used for transaction specific cost recovery, which is something we take very seriously in our fee jurisdiction process. Banks however have considerably more scope to replicate these lost fees in several other ways," Humm says.

Humm also operates in Australia where interchange is regulated.

Meanwhile, Humm also notes it issues two rewards cards, the Flight Centre Mastercard and Farmers Mastercard, and offers cashbacks that reduce consumers' purchase costs.

"Rewards and inducements are significant factors that determine what payment method a consumer will select," Humm says.

"As a non-bank lender we need to be able to compete in such areas as offering reward points. We are unable to treat our products as 'loss leaders' as banks have the ability to do. Revenue we collect in interchange fees helps us fund customer benefits, innovation and ultimately better customer outcomes through more secure products, better customer experience and lower costs - as evident in the new products we are bringing to market."

Clark plans to introduce a Retail Payments Systems Bill to Parliament later this year.