(July 23, 2010) In a year when Congress is beefing up regulation of the financial system, merchant-acquiring executives not surprisingly view the tightening regulatory environment as the key challenge facing their industry in 2010 and 2011, according to a new study from Boston-based Aite Group LLC. Sixty-one percent of executives Aite researchers interviewed at the Electronic Transactions Association annual conference in April viewed regulations, including the card networks’ Payment Card Industry data-security standard (PCI), as the top challenge facing the acquiring industry.

Executives also view regulatory and compliance issues as the number-one trend shaping the industry, Aite Group says. PCI matters are weighing heavily on merchant acquirers, which must keep up with PCI mandates as well as ensure their approximately 6 million small merchants comply.

The average cost of PCI compliance for small, so-called Level 4 merchants—including network scans, communications costs and customer-service calls—was $55 per merchant account annually, according to the executives surveyed. Forty-five percent of executives said they spent less than $50 annually, while 18% said they spent more than $75. Thirty-six percent spent between $50 and $75 a year. Most independent sales organizations and acquirers, however, turned the cost into revenue by charging PCI-compliance fees directly to merchants, Aite found.

When asked about the effectiveness of methods used to ensure compliance with the PCI standards, about two-thirds of the 18 executives said that merchant self-assessments were “not effective” or only “slightly effective.” Only 6% viewed the self-assessments as “effective” or “highly effective.”

While the card networks assess fines in the wake of data breaches, a strong majority of executives (82%) said that the most effective approach to PCI compliance would be to ensure that products sold to merchants and service provided by valued-added resellers be PCI-compliant. “Acquirers clearly prefer to drive PCI compliance into product-suites use and away from merchant assessments,” Aite’s report says.

Nearly two-thirds of the executives said end-to-end encryption of card data during the transaction process would be a technological solution to a significant portion of PCI’s requirements for protecting personal information. Sixty-three percent said end-to-end encryption would be “effective” or “very effective.”

In addition to the PCI standard, the industry is having difficulty in coping with regulatory “interference,” such as a coming federal mandate that acquirers report merchant revenues to the Internal Revenue Service and the capping of debit interchange, according to the report.

Earlier this week, President Obama signed the Dodd-Frank Wall Street Reform Act of 2010, which mandates that the Federal Reserve Board set debit card interchange fees at levels that are “reasonable and proportional.” Some major banks, including Bank of America Corp., are expecting huge cuts in interchange revenues as a result (Digital Transactions News, July 19). Another provision says the Fed should consider that debit cards have “functional similarity” to checks, which trade at par. Some observers say that could result in zero interchange on debit card transactions. While interchange flows to issuers, its regulation could reduce consumer usage of debit cards, which would affect acquirers’ income. The new law also allows merchants to more easily steer credit and debit card payments to cash and checks and set minimum and maximum transaction limits for cards.

Further complicating matters for acquirers are state mandates, such as a Vermont bill which allows merchants to set minimum or maximum transaction amounts without being fined by networks and acquirers.

Compliance with new legislation will be costly for merchant acquirers, Aite says. For example, reporting merchant financial activity to the IRS will require more back-office work by acquirers, representing a cost that will be passed on to merchants.

While merchant-acquiring executives viewed increased regulation as their major challenge, 50% stated that economic factors ranked as the industry’s second leading issue. The respondents cited the current economic situation, the slow recovery of consumer spending, the margin compression felt throughout the industry, and acquirers’ difficulty in accessing capital.

Sixty-three percent of the executives cited technology as their third most important challenge, including mobile and radio-frequency identification (RFID) technology.