Separating Dodd-Frank’s Winners from Its Losers

The turbulent regulatory and legal atmosphere enveloping the U.S. payment card industry is blowing the industry into camps of winners, losers, and those in between. The biggest losers: Visa and MasterCard, large debit card issuers, and consumers. Winners: merchant-funded rewards networks and big merchants. Also likely to gain in the new, more-regulated era: chip-and-PIN cards. The automated clearing house, however, could be in for price increases.

Those are some of the predictions in a new Aite Group LLC report dubbed “The New Order: How Interchange Regulation Will Change the U.S. Payment Industry.” Report author Gwenn Bézard, research director at Boston-based Aite, assessed the combined effects of the so-called Durbin Amendment, which as part of the Dodd-Frank financial-reform law enacted in July will regulate debit card interchange, and the recent settlements by Visa Inc. and MasterCard Inc. with the U.S. Department of Justice and seven states that gives merchants more freedom to steer cardholders away from high-cost cards (Digital Transactions News, Oct. 4).

Bézard took a dozen industry sub-groups and rated their prospects zero, for negative; one, somewhat negative; two, mixed; three, mostly positive, and four, positive. Visa and MasterCard scored zeros for their loss of political clout and potential revenue losses as fee-generating debit transactions migrate from their PIN-debit networks (Interlink and Maestro, respectively) to the remaining regional electronic funds transfer networks. Dodd-Frank bans so-called exclusive affiliations in which a debit card offers only affiliated network choices, such as Visa for signature debit and Interlink for PIN transactions. In the future, each card must access at least one unaffiliated network. The dominant Visa/Interlink combo faces the biggest threat from this provision. On a related issue, the law bans networks and issuers from inhibiting merchants from routing transactions over their preferred network given the choices available on a given card.

Closely allied with big banks over the years, Visa and MasterCard suffered collateral damage when Congress passed Dodd-Frank, which for the first time interjects federal regulation into interchange rate-setting and other basic network operations and raises the specter of future credit card interchange regulation. “The payment business has been largely regulated by them [Visa and MasterCard],” Bézard tells Digital Transactions News. “It’s been a self-contained environment. That power to regulate interchange over the network is gone.”

Dodd-Frank charges the Federal Reserve Board with developing regulations to implement its various provisions. Industry observers expect the Fed to release draft rules within a month. Regulated debit card interchange will apply only to banks and credit unions with more than $10 billion in assets. That group, about 1% of all financial institutions, thus earned a zero in Aite’s forecast.

Big merchants earned a three, for mostly positive prospects. They’ll benefit from lower interchange costs. (Estimates of big issuers’ revenue losses range from 40% to 80% even though the Fed hasn’t shown its hand yet.) Large merchants also have the technological abilities to take advantage of the new transaction-routing provisions. It’s not a total victory, however, because merchants typically don’t know the actual cost of a transaction until settlement, not at authorization, Bézard notes.

The biggest winners in Aite’s view will be merchant-funded rewards providers, the only group to receive a four. These vendors arrange groups of merchants to provide discounts, points, or other rewards to the cardholders of client card issuers. They stand to gain as debit card issuers cut back on traditional, interchange-funded rewards programs. JPMorgan Chase & Co. has already announced it would end its debit card rewards program, the report notes. Vendors in this niche include Cardlytics, Affinity Solutions, Cartera Commerce, Vesdia, and DBG Loyalty.

Facing somewhat negative prospects are processors for card issuers, who will make less money off debit cards; traditional rewards providers; and small debit card issuers, who, though exempted from interchange regulation, could lose revenue if merchants use transaction routing and steering effectively. Groups with mixed prospects include small merchants, Discover Financial Services and American Express Co., alternative payment providers, and merchant acquirers.

And consumers? They haplessly rate a zero. “Banks won’t stand still and let their revenue drop, but will likely raise the direct cost of banking for consumers,” the report says. “In the meantime, merchants are unlikely to pass the totality of the cost savings onto consumers.”

Bézard also assessed the prospects for some other cogs in the payments machine. The outlook for so-called EMV, or chip-and-PIN, cards seems brighter now that Dodd-Frank orders the Fed to require issuers to reduce fraud. Though not invulnerable, EMV cards clearly are more fraud-resistant than magnetic-stripe cards. Thus, Aite predicts either the Fed or Visa and MasterCard will mandate their implementation in the U.S., the only major country not using or committed to converting to them.

The ACH, meanwhile, could be in line for higher prices as banks seek to compensate for lost interchange and overdraft-fee revenues, the latter of which now require consumer opt-in. The low-cost ACH network is an important part of many alternative-payment providers’ operational systems, including giant PayPal Inc. Banks for years have expressed concerns about the “quasi-free ride” the alternatives have received on the ACH, according to Aite. With other revenue sources stressed, a transaction’s ride on the ACH may soon cost more. “The ACH network stands as a prime candidate for pricing re-assessment,” the report says.