In the fifth and final part of a series on New Zealand's retail payment systems Gareth Vaughan lays out a roadmap for regulating the retail payments sector and outlines why this should be done

*This is the fifth and final article in a series, for context the previous four articles can be found here, here, here and here.  And the major political parties' positions on retail payments are detailed here.

By Gareth Vaughan

The overwhelming economic hit from the COVID-19 pandemic could and should finally push the Government into regulating retail payments, and whilst they're at it, open banking too.

Regulating retail payments would reduce costs for many small and medium sized businesses, for whom card acceptance fees can be the third highest cost of doing business after wages and rent. This should flow through to consumers, thus providing some stimulation to a COVID-19 ravaged economy.

This series has outlined how merchants pay hundreds of millions of dollars in merchant service fees to banks annually, and how credit card reward schemes tilt the playing field in favour of high income households over low income households. All the while the Visa and Mastercard interchange system entices banks towards its lucrative revenue streams and away from EFTPOS, which is cheaper and more cost efficient for merchants and ultimately consumers.

In a 2016 issues paper on New Zealand's retail payments system, the Ministry of Business, Innovation & Employment (MBIE) argued market dynamics suggested there was cause for concern in both the credit and debit card markets. MBIE estimated merchants had to increase their prices to consumers by about $187 million annually to fund rewards paid to some credit card users creating an annual "regressive cross-subsidy" of $59 million from low income to high income households.

Since 2016 commerce and consumer affairs ministers from both the National and Labour parties have waved the stick of regulation without actually following through. MBIE says since 2016 credit and debit interchange fees have decreased by between 8% and 14%. Is this enough to ward off regulation?

In my view it's not. And if there's a time to be bold it is now. On top of COVID-19 being a massive global public health crisis, the response required to thwart it - isolation - is wreaking massive economic upheaval. Given this the economy will require many adrenalin injections to stay alive, let alone get back on its feet. One of these should be bringing the bank-international card scheme retail payments party to an end. Hit the major banks, plus their Visa and Mastercard partners, in the pocket in the broader interests of NZ Inc.

Start with a cull of interchange

Interchange, a compounding deadweight on the economy that fattens bank profits, is a great place to start.

Interchange is a fee charged by the financial institution on one side of a payment transaction to the financial institution on the other side of the transaction. In the Byzantine world of interchange, each bank sets its own rates within a cap set by Visa and Mastercard. Interchange comprises the biggest part of merchant service fees which are set by banks. The Retail NZ diagram below details the components of merchant service fees.

As we heard in part two of this series, in 2018 the Australian Productivity Commission recommended a ban on card payment interchange fees. Note Australia is among dozens of countries that has already regulated interchange. NZ is not. Consequently merchant service fees are higher in NZ than Australia. Retail NZ's latest figures show weighted average merchant service fees of 1.1% of the consumer's purchase payment for contactless debt payments in NZ and just 0.6% in Australia. For credit NZ's at 1.5% and Australia 0.8%.

In the days of the internet, smartphones and instant communications, interchange is a relic from a pre-electronic payments era. To quote the Aussie Productivity Commission: "The case for interchange fees to fund reward programs or to redistribute benefits on a transactions basis from the merchant’s bank to the customer’s bank is feeble." 

And as the Reserve Bank of Australia (RBA) puts it: "The major card schemes are mature systems, and regulators in many countries have reached the judgement that their cards are ‘must take’ methods of payments – that is, that merchants have little choice but to accept their cards. In practice, with interchange fees being used to incentivise issuers [typically banks] to issue cards from a particular scheme and cardholders to use that card, the tendency has been for competition between mature card schemes to drive up interchange fees and costs to merchants, with adverse effects on the efficiency of the payments system."

The 2016 MBIE paper suggested considering whether the retail payment system, or a part of the system, should be treated like a utility. Absolutely it should. As the electricity and telecommunications sectors are. In those sectors greater access to the physical networks aims to increase competition, encourage innovation and lower prices.

Taking a cue from the CCCFA

Doing away with interchange still leaves the various other elements that make up merchant service fees, as detailed in the Retail NZ diagram above. An option here could be taking a cue from the Credit Contracts and Consumer Finance Act (CCCFA). Overseen by the Commerce Commission, the CCCFA is designed to ensure consumers are able to make informed choices, know what they're agreeing to, and are able to keep track of their debts. For lenders, the CCCFA requires them to act responsibly at all times.

And under consumer credit contracts, lenders are only permitted to recover their costs in the fees they charge customers where those costs are closely connected to the activity for which the fee is charged. For example, where costs are closely connected to the establishment of a loan or closely connected to a customer default. So here's an idea. Why not mandate that banks' merchant service fees are only allowed to recover their costs for the activity for which the fee is charged?

In part four of this series we looked at how 90% of debit cards issued in Australia are dual-network debit cards. These allow a payment to be processed via either Australian EFTPOS or one of the other debit schemes such as Mastercard or Visa. Australia also has a fledgling least-cost routing system in place. Through this merchants can choose to route contactless transactions via whichever of the two networks on the card costs them less to accept.

These are two further initiatives the NZ Government should look closely at. Perhaps, for example, NZ merchants could be able to choose to route payments through either Paymark's Online EFTPOS or a Visa/Mastercard network? Both enable contactless payments.

Part four also looked at how NZ's oligopoly banks - ANZ NZ, ASB, BNZ and Westpac NZ - are majority owners of Payments NZ and what this means. Currently Payments NZ is overseeing the slow development of open banking and real time payments in NZ. This is perverse. Both open banking and real time payments have the potential to enable competitors to eat into bank and card scheme revenues. Allowing a bank controlled company to run this is akin to letting turkeys decide whether to have Christmas or not. The Government must step in.

The idea behind open banking is it will give customers greater access to and control over their own banking data, and require banks to give competing third parties access to their systems.  In December Commerce and Consumer Affairs Minister Kris Faafoi showed signs of losing patience with an industry-led roll-out of open banking, saying he had asked government officials to look into creating a Consumer Data Right. This would establish a legislative framework for the sharing of consumer data in designated sectors.

Australia is launching a Consumer Data Right regime overseen by the Australian Competition and Consumer Commission, with open banking expected to initially apply to the parents of NZ's big four banks - ANZ, Commonwealth Bank, National Australia Bank and Westpac - from July this year.

Real time payments could negate the need for payments terminals and interchange, boosting payments from smartphones for example. Australia's New Payments Platform (NPP) processes payments 24 hours a day, seven days a week, 365 days a year. Its mutual owners include the parents of NZ's big four banks and the RBA. NPP has faced challenges since launching in 2018. In December, for example, RBA Governor Philip Lowe criticised banks for failing to fully embrace it and threatened penalties. But that's still well ahead of where NZ's at.

Too big to fail

As detailed in part two, the Financial Markets Infrastructures (FMI) Bill is currently before Parliament's Finance and Expenditure Select Committee. One of the things the FMI Bill proposes is providing the regulators with oversight of rules and a full suite of crisis management powers for FMIs considered to be systemically important. 

To date neither the Reserve Bank nor the Government are suggesting Visa and Mastercard should be deemed, or designated, systemically important. Visa doesn't want to be, arguing unlike wholesale payment systems, retail payment systems don't pose systemic risk because their failure would not threaten the solvency or liquidity of the overall system.

However in Australia the RBA formally "designated" Visa and Mastercard's credit card schemes as payments systems as long ago as 2001. Visa's debit card scheme was designated in 2004, with Mastercard providing a voluntary undertaking to comply with the standards applying to Visa debit.  That made them subject to RBA regulation in the first step in establishing standards and access regimes for a payment system to deal with public interest issues. 

Here in NZ, given their scale, the failure of the Visa or Mastercard systems would cause major disruption to the country's payments. Thus they are systemically important and should be designated as such.

What about tax?

Given the billions of dollars our government is borrowing to help fight the massive economic impact of the COVID-19 pandemic, it's highly likely working New Zealanders will be paying more tax. So why shouldn't multi-nationals pay their share? Currently Visa and Mastercard don't.

We don't know how much revenue Visa and Mastercard generate in NZ. They won't say, and they don't file any financial results here. But we do know that in a NZ context they must be generating very significant sums. Clipping the ticket on billions of transactions through their networks, and booking the likes of service revenue, data processing revenue, international transaction revenue, plus charging licence fees for the use of their brands and account holder services, must add up.

In part one we looked at how Visa and Mastercard's NZ revenues are run through Singapore where their most recent financial statements show income tax rates of 5.1% and 2.2%, respectively. That's well below Singapore's standard 17% corporate tax rate due to sweetheart deals.

The question is, is it possible to tax them on the actual economic activity they carry out in NZ? With no tangible product, good or service, this would probably have to be via some form of transaction tax. Tax specialist and interest.co.nz contributor Terry Baucher suggests if it's to work a transactions tax would need to be applied globally because of the cross-jurisdiction arbitrage opportunities if some countries don't apply it.

Globalisation and the digital economy have proven a formidable challenge for international taxation as the likes of Facebook, Google, Apple and Uber have also demonstrated. International tax rules are inadequate when it comes to addressing the lack of tangible borders characterising the digital economy. Thus a company with little physical presence in NZ but with a significant digital presence such as Visa or Mastercard, is not liable for taxation. 

Perhaps the economic fallout from the COVID-19 pandemic will herald renewed global co-operation in changing this. Or perhaps it won't.

Visa and Mastercard's NZ transactions are processed in Singapore with the revenue earned from this booked in Singapore. In a recent submission to the RBA eftpos Payments Australia pointed out Malaysia, Canada, South Africa, Mexico, Turkey, Nigeria, Morocco, Thailand, Singapore, Saudi Arabia and Russia require onshore processing to enable regulatory supervision for the resiliency of their payment systems. This is another option the NZ government could look at, even if the onshore processing was ultimately done through a kiwi cloud computing provider.

A boost in a time of need

Through this series I've compared and contrasted NZ's retail payments oversight with Australia's. I've done this because that's both where the parents of our big four banks call home, and another market where Visa and Mastercard are strong. The Aussies don't have everything right. But they are in significantly better shape than NZ.

The concept of this series was cooked up shortly before Christmas. Thanks to COVID-19, the world has changed enormously since then. But the fundamentals of the NZ retail payments market remain the same. The major banks and non taxpaying international card schemes are having a field day, ultimately at the expense of small businesses and the consumer.

Hopefully Faafoi can take the ideas presented here, and potentially others, to his officials to formulate a plan to present to Finance Minister Grant Robertson. It could both bring in new tax revenue, and provide a much needed boost for small and medium-sized businesses in their hour of need.

*This article was first published in our email for paying subscribers early on Wednesday morning. See here for more details and how to subscribe.