[Federal Register Volume 75, Number 248 (Tuesday, December 28, 2010)]
[Proposed Rules]
[Pages 81722-81763]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-32061]
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Part II
Federal Reserve System
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12 CFR Part 235
Debit Card Interchange Fees and Routing; Proposed Rule
Federal Register / Vol. 75 , No. 248 / Tuesday, December 28, 2010 /
Proposed Rules
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FEDERAL RESERVE SYSTEM
12 CFR Part 235
[Regulation II; Docket No. R-1404]
RIN 7100-AD63
Debit Card Interchange Fees and Routing
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Board is requesting public comment on proposed new
Regulation II, Debit Card Interchange Fees and Routing, which:
establishes standards for determining whether an interchange fee
received or charged by an issuer with respect to an electronic debit
transaction is reasonable and proportional to the cost incurred by the
issuer with respect to the transaction; and prohibits issuers and
networks from restricting the number of networks over which an
electronic debit transaction may be processed and from inhibiting the
ability of a merchant to direct the routing of an electronic debit
transaction to any network that may process such transactions. With
respect to the interchange fee standards, the Board is requesting
comment on two alternatives that would apply to covered issuers: an
issuer-specific standard with a safe harbor and a cap; or a cap
applicable to all such issuers. The proposed rule would additionally
prohibit circumvention or evasion of the interchange fee limitations
(under both alternatives) by preventing the issuer from receiving net
compensation from the network (excluding interchange fees passed
through the network). The Board also is requesting comment on possible
frameworks for an adjustment to interchange fees for fraud-prevention
costs. With respect to the debit-card routing rules, the Board is
requesting comment on two alternative rules prohibiting network
exclusivity: one alternative would require at least two unaffiliated
networks per debit card, and the other would require at least two
unaffiliated networks for each type of transaction authorization
method. Under both alternatives, the issuers and networks would be
prohibited from inhibiting a merchant's ability to direct the routing
of an electronic debit transaction over any network that may process
such transactions.
DATES: Comments must be submitted by February 22, 2011.
ADDRESSES: You may submit comments, identified by Docket No. R-1404 and
RIN No. 7100 AD63, by any of the following methods:
Agency Web site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal:http://www.regulations.gov. Follow the
instructions for submitting comments.
E-mail: [email protected]. Include the docket number
in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, NW.,
Washington, DC 20551.
All public comments are available from the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
information.
Public comments may also be viewed electronically or in paper in
Room MP-500 of the Board's Martin Building (20th and C Streets, NW.)
between 9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Dena Milligan, Attorney (202/452-
3900), Legal Division, David Mills, Manager and Economist (202/530-
6265), Division of Reserve Bank Operations & Payment Systems, Mark
Manuszak, Senior Economist (202/721-4509), Division of Research &
Statistics, or Ky Tran-Trong, Counsel (202/452-3667), Division of
Consumer & Community Affairs; for users of Telecommunications Device
for the Deaf (TDD) only, contact (202/263-4869); Board of Governors of
the Federal Reserve System, 20th and C Streets, NW., Washington, DC
20551.
SUPPLEMENTARY INFORMATION
Background
I. Section 1075 of the Dodd-Frank Act--Overview
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
``Dodd-Frank Act'') (Pub. L. 111-203, 124 Stat. 1376 (2010)) was
enacted on July 21, 2010. Section 1075 of the Dodd-Frank Act amends the
Electronic Fund Transfer Act (``EFTA'') (15 U.S.C. 1693 et seq.) by
adding a new section 920 regarding interchange transaction fees and
rules for payment card transactions.\1\
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\1\ Section 920 is codified in 15 U.S.C. 1693o-2. As discussed
in more detail below, interchange transaction fees (or ``interchange
fees'') are fees established by a payment card network, charged to
the merchant acquirer and received by the card issuer for its role
in transaction.
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EFTA Section 920 provides that, effective July 21, 2011, the amount
of any interchange transaction fee that an issuer receives or charges
with respect to an electronic debit transaction must be reasonable and
proportional to the cost incurred by the issuer with respect to the
transaction.\2\ That section authorizes the Board to prescribe
regulations regarding any interchange transaction fee that an issuer
may receive or charge with respect to an electronic debit transaction
and requires the Board to establish standards for assessing whether an
interchange transaction fee is reasonable and proportional to the cost
incurred by the issuer with respect to the transaction.
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\2\ Electronic debit transaction (or ``debit card transaction'')
means the use of a debit card, including a general-use prepaid card,
by a person as a form of payment in the United States.
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Under EFTA Section 920, the Board may allow for an adjustment to an
interchange transaction fee to account for an issuer's costs in
preventing fraud, provided the issuer complies with the standards to be
established by the Board relating to fraud-prevention activities. EFTA
Section 920 also authorizes the Board to prescribe regulations in order
to prevent circumvention or evasion of the restrictions on interchange
transaction fees, and specifically authorizes the Board to prescribe
regulations regarding any network fee to ensure that such a fee is not
used to directly or indirectly compensate an issuer and is not used to
circumvent or evade the restrictions on interchange transaction fees.
EFTA Section 920 exempts certain issuers and cards from the
restrictions on interchange transaction fees described above. The
restrictions on interchange transaction fees do not apply to issuers
that, together with affiliates, have assets of less than $10 billion.
The restrictions also do not apply to electronic debit transactions
made using two types of debit cards--debit cards provided pursuant to
government-administered payment programs and reloadable, general-use
prepaid cards not marketed or labeled as a gift card or certificate.
EFTA Section 920 provides, however, that beginning July 21, 2012, the
exemptions from the interchange transaction fee restrictions will not
apply for transactions made using debit cards provided pursuant to a
government-administered payment program or made using certain
reloadable, general-use prepaid cards if the cardholder may be charged
either an overdraft fee or a fee for the first
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withdrawal each month from ATMs in the issuer's designated ATM network.
In addition to rules regarding restrictions on interchange
transaction fees, EFTA Section 920 also requires the Board to prescribe
certain rules related to the routing of debit card transactions. First,
EFTA Section 920 requires the Board to prescribe rules that prohibit
issuers and payment card networks (``networks'') from restricting the
number of networks on which an electronic debit transaction may be
processed to one such network or two or more affiliated networks.
Second, that section requires the Board to prescribe rules prohibiting
issuers and networks from inhibiting the ability of any person that
accepts debit cards from directing the routing of electronic debit
transactions over any network that may process such transactions.
EFTA Section 920 requires the Board to establish interchange fee
standards and rules prohibiting circumvention or evasion no later than
April 21, 2011. These interchange transaction fee rules will become
effective on July 21, 2011. EFTA Section 920 requires the Board to
issue rules that prohibit network exclusivity arrangements and debit
card transaction routing restrictions no later than July 21, 2011, but
does not establish an effective date for these rules.
II. Overview of the Debit Card Industry
Over the past several decades, there have been significant changes
in the way consumers make payments in the United States. The use of
checks has been declining since the mid-1990s as checks (and most
likely some cash payments) are being replaced by electronic payments
(e.g., debit card payments, credit card payments, and automated
clearing house (ACH) payments). Debit card usage, in particular, has
increased markedly during that same period. After a long period of slow
growth during the 1980s and early 1990s, debit card transaction volume
began to grow very rapidly in the mid-1990s. Debit card payments have
grown more than any other form of electronic payment over the past
decade, increasing to 37.9 billion transactions in 2009. Debit cards
are accepted at about 8 million merchant locations in the United
States. In 2009, debit card transactions represented almost half of
total third-party debits to deposit accounts, while approximately 30
percent of total third-party debits to deposit accounts were made by
checks.\3\
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\3\ Third-party debits are those debits initiated to pay parties
other than the cardholder. These third-party debit numbers are
derived from the 2010 Federal Reserve Payments Study. The Study
reported that a total of 108.9 billion noncash payments were made in
2009, 35 percent of which were debit card payments. For purposes of
determining the proportion of noncash payments that were third-party
debits to accounts, ATM cash withdrawals and prepaid card
transactions are excluded from the calculation. A summary of the
2010 Federal Reserve Payments Study is available at http://www.frbservices.org/files/communications/pdf/press/2010_payments_study.pdf.
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In general, there are two types of debit card transactions: PIN
(personal identification number)-based and signature-based.\4\ The
infrastructure for PIN debit networks differs from that for signature
debit networks. PIN debit networks, which evolved from the ATM
networks, are single-message systems in which authorization and
clearing information is carried in one single message. Signature debit
networks, which leverage the credit card network infrastructure, are
dual-message systems, in which authorization information is carried in
one message and clearing information is carried in a separate message.
In the current environment, certain transactions cannot readily be
accommodated on PIN-based, single-message systems, such as transactions
for hotel stays or car rentals, where the exact amount of the
transaction is not known at the time of authorization. In addition, PIN
debit transactions generally are not accepted for Internet
transactions. Overall, roughly one-quarter of the merchant locations in
the United States that accept debit cards have the capability to accept
PIN-based debit transactions. According to the Board's survey of
covered card issuers, roughly 70 percent of debit cards outstanding
(including prepaid cards) support both PIN- and signature-based
transactions (87 percent, excluding prepaid cards).\5\
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\4\ Increasingly, however, cardholders authorize ``signature''
debit transactions without a signature and, sometimes, may authorize
a ``PIN'' debit transaction without a PIN. PIN-based and signature-
based debit also may be referred to as ``PIN debit'' and ``signature
debit.''
\5\ ``Covered issuers'' are those issuers that, together with
affiliates, have assets of $10 billion or more.
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Networks that process debit card transactions exhibit two main
organizational forms, often referred to as three-party and four-party
systems.\6\ The so-called four-party system is the model used for most
debit card transactions; the four parties are the cardholder, the
entity that issued the payment card to the cardholder (the issuer), the
merchant, and the merchant's bank (the acquirer or merchant
acquirer).\7\ The network coordinates the transmission of information
between the issuing and acquiring sides of the market (authorization
and clearing) and the interbank monetary transfers (settlement).\8\
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\6\ Industry participants sometimes refer to four-party systems
as ``open loop'' systems and three-party systems as ``closed loop''
systems.
\7\ Throughout this proposed rule, the term ``bank'' often is
used to refer to depository institutions.
\8\ The term ``four-party system'' is something of a misnomer
because the network is, in fact, a fifth party involved in a
transaction.
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In a typical three-party system, the network itself acts as both
issuer and acquirer. Thus, the three parties involved in a transaction
are the cardholder, the merchant, and the network. Three-party systems
are also referred to as ``closed,'' because the issuer and acquirer are
generally the same institution--they have, thus, tended to be closed to
outside participants. The three-party model is used for some prepaid
card transactions, but not for other debit card transactions.
In a typical four-party system transaction, the cardholder
initiates a purchase by providing his or her card or card information
to a merchant. In the case of PIN debit, the cardholder also enters a
PIN. An electronic authorization request for a specific dollar amount
and the cardholder's account information is sent from the merchant to
the acquirer to the network, which forwards the request to the card-
issuing institution.\9\ The issuer verifies, among other things, that
the cardholder's account has sufficient funds to cover the transaction
amount and that the card was not reported as lost or stolen. A message
authorizing (or declining) the transaction is returned to the merchant
via the reverse path.
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\9\ Specialized payment processors may carry out some functions
between the merchant and the network or between the network and the
issuer.
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The clearing of a debit card transaction is effected through the
authorization message (for PIN debit systems) or a subsequent message
(for signature debit systems). The issuer posts the debits to the
cardholders' accounts based on these clearing messages. The network
calculates and communicates to each issuer and acquirer its net debit
or credit position to settle the day's transactions. The interbank
settlement generally is effected through a settlement account at a
commercial bank, or through automated clearinghouse (ACH) transfers.
The acquirer credits the merchant for the value of its transactions,
less the merchant discount, as discussed below.
There are various fees associated with debit card transactions. The
interchange fee is set by the relevant network and paid by the merchant
acquirer to the issuer. Switch fees are charged by the network to
acquirers and issuers to compensate the network for its role in
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processing the transaction.\10\ The merchant acquirer charges the
merchant a merchant discount--the difference between the face value of
a transaction and the amount the merchant acquirer transfers to the
merchant-that includes the interchange fee, network switch fees charged
to the acquirer, other acquirer costs, and an acquirer markup. The
interchange fee typically comprises a large fraction of the merchant
discount for a card transaction.
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\10\ A variety of other network fees may be collected by the
network from the issuer or acquirer.
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When PIN debit networks were first introduced, some of them
structured interchange fees in a manner similar to ATM interchange
fees.\11\ For ATM card transactions, the cardholder's bank generally
pays the ATM operator an interchange fee to compensate the ATM operator
for the costs of deploying and maintaining the ATM and providing the
service. Similarly, some PIN debit networks initially structured
interchange fees to flow from the cardholder's bank to the merchant's
bank to compensate merchants for the costs of installing PIN terminals
and making necessary system changes to accept PIN debit at the point of
sale. In the mid-1990s, these PIN debit networks began to shift the
direction in which PIN debit interchange fees flowed. By the end of the
decade, all PIN debit interchange fees were paid by acquirers to card
issuers.\12\
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\11\ In the late 1970s, bank consortiums formed numerous
regional electronic funds transfer (``EFT'') networks to enable
their customers to withdraw funds from ATMs owned by a variety of
different banks. The EFT networks were first used to handle PIN
debit purchases at retailers in the early 1980s. It was not until
the mid-1990s, however, that PIN debit became a popular method of
payment for consumers to purchase goods and services at retail
stores.
\12\ Debit Card Directory (1995-1999). See also, Fukimo Hayashi,
Richard Sullivan, & Stuart E. Weiner, ``A Guide to the ATM and Debit
Card Industry'' (Federal Reserve Bank of Kansas City 2003).
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During the 1990s, most PIN debit networks employed fixed per-
transaction interchange fees. Beginning around 2000, many PIN debit
networks incorporated an ad valorem (i.e., percentage of the value of a
transaction) component to their interchange fees, with a cap on the
total amount of the fee for each transaction. In addition, PIN debit
networks expanded the number of interchange fee categories in their fee
schedules. For example, many networks created categories based on type
of merchant (e.g., supermarkets) and began to segregate merchants into
different categories based on transaction volume (e.g., transaction
tiers). Over the course of the 2000s, most PIN debit networks raised
the levels of fixed component fees, ad valorem fees, and caps on these
fees. By 2010, some networks had removed per-transaction caps on many
interchange fees.
In general, interchange fees for signature debit networks, like
those of credit card networks, combine an ad valorem component with a
fixed fee component. Unlike some PIN debit networks, the interchange
fees for signature debit networks generally do not include a per
transaction cap. Beginning in the early 1990s, signature debit networks
also began creating separate categories for merchants in certain market
segments (e.g., supermarkets and card-not-present transactions) \13\ to
gain increased acceptance in those markets. Until 2003, signature debit
interchange fees were generally around the same level as credit card
interchange fees and have generally been significantly higher than
those for PIN debit card transactions. PIN debit fees began to increase
in the early 2000s, while signature debit fees declined in late 2003
and early 2004.\14\ More recently, both PIN and signature debit fees
have increased, although PIN debit fees have increased at a faster
pace.
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\13\ Card-not-present transactions occur when the card is not
physically presented to the merchant at the time of authorization.
Examples include Internet, phone, and mail-order purchases.
\14\ This decline followed the settlement of litigation
surrounding signature debit cards. See In re: Visa Check/MasterMoney
Antitrust Litigation, 192 F.R.D. 68 (F.D.N.Y. 2000).
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In addition to setting the structure and level of interchange fees
and other fees to support network operations, each card network
specifies operating rules that govern the relationships between network
participants. Although the network rules explicitly govern the issuers
and acquirers, merchants and processors also may be required to comply
with the network rules or risk losing access to that network. Network
operating rules cover a broad range of activities, including merchant
card acceptance practices, technological specifications for cards and
terminals, risk management, and determination of transaction routing
when multiple networks are available for a given transaction.
III. Outreach and Information Collection
A. Summary of Outreach
Since enactment of the Dodd-Frank Act, Board staff has held
numerous meetings with debit card issuers, payment card networks,
merchant acquirers, merchants, industry trade associations, and
consumer groups. In general, those parties provided information
regarding electronic debit transactions, including processing flows for
electronic debit transactions, structures and levels of current
interchange transaction fees and other fees charged by the networks,
fraud-prevention activities performed by various parties to an
electronic debit transaction, fraud losses related to electronic debit
transactions, routing restrictions, card-issuing arrangements, and
incentive programs for both merchants and issuers. Interested parties
also provided written submissions.\15\
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\15\ The meeting summaries and written submissions are available
on the Regulatory Reform section of the Board's Web site, available
at http://www.federalreserve.gov/newsevents/reform_meetings.htm.
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B. Surveys
On September 13, 2010, the Board distributed three surveys to
industry participants (an issuer survey, a network survey, and a
merchant acquirer survey) designed to gather information to assist the
Board in developing this proposal. Industry participants, including
payment card networks, trade groups and individual firms from both the
banking industry and merchant community, commented on preliminary
versions of the issuer and network surveys, through both written
submissions and a series of drop-in calls. In response to the comments,
the two surveys were modified, as appropriate, and an additional survey
of merchant acquirers was developed.\16\
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\16\ Documentation and forms for the card issuer, payment card
network, and merchant acquirer surveys are respectively available at
http://www.federalreserve.gov/newsevents/files/card_issuer_survey_20100920.pdf, http://www.federalreserve.gov/newsevents/files/payment_card_network_survey_20100920.pdf, and http://www.federalreserve.gov/newsevents/files/merchant_acquirer_survey_20100920.pdf.
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The card issuer survey was distributed to 131 financial
organizations that, together with affiliates, have assets of $10
billion or more.\17\ The Board received 89
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responses to the survey. An additional 13 organizations informed the
Board that they do not have debit card programs. Three organizations
that issued a small number of cards declined to participate in the
survey. The Board did not receive any communication from the other 26
organizations. The network survey was distributed to the 14 networks
believed to process debit card transactions, all of which provided
responses. The merchant acquirer survey was distributed to the largest
nine merchant acquirers/processors, all of whom responded to the
survey.
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\17\ These institutions include bank and thrift holding
companies with assets of at least $10 billion; independent
commercial banks, thrifts, and credit unions with assets of at least
$10 billion; and FDIC-insured U.S. branches and agencies of foreign
banking organizations with worldwide assets of at least $10 billion.
Assets were computed using the Consolidated Financial Statements for
Bank Holding Companies (FR Y-9C; OMB No. 7100-0128), the
Consolidated Reports of Condition and Income (Call Reports) for
independent commercial banks (FFIEC 031 & 041; OMB No. 7100-0036)
and for U.S. branches and agencies of foreign banks (FFIEC 002; OMB
No. 7100-0032), the Thrift Financial Reports (OTS 1313; OMB No.
1550-0023) for Thrift Holding Companies and thrift institutions, and
the Credit Union Reports of Condition and Income (NCUA 5300/5300S;
OMB No. 3133-0004) for credit unions. The ownership structure of
banking organizations was established using the FFIEC's National
Information Center structure database.
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Information Requested and Summary Results
In general, the surveys requested information on signature debit,
PIN debit and prepaid card operations and, for each card type, the
costs associated with those card types, interchange fees and other fees
established by networks, fraud losses, fraud-prevention and data-
security activities, network exclusivity arrangements and debit-card
routing restrictions. The Board compiled the survey responses in a
central database, and reviewed the submissions for completeness,
consistency, and anomalous responses. As indicated above, the response
rates for the three surveys were high; however, some respondents were
not able to provide information on all data elements requested in the
surveys. For example, most respondents provided cost data at an
aggregate level, but some were unable to provide cost data at the level
of granularity requested in the surveys. In addition, there were
inconsistencies in some data that were reported within individual
responses and across responses. Therefore, each of the summary
statistics reported below may be based on a subset of the responses
received for each of the three surveys. The reporting period for each
survey was calendar year 2009, unless otherwise noted.
Card use. The networks reported that there were approximately 37.7
billion debit and prepaid card transactions in 2009, valued at over
$1.45 trillion, with an average value of $38.58 per
transaction.18 19 20 Responding issuers reported that, on
average, they had 174 million debit cards and 46 million prepaid cards
outstanding during 2009. Eighty-seven percent of debit cards and 25
percent of prepaid cards were enabled for use on both signature and PIN
networks. Four percent of debit cards and 74 percent of prepaid cards
were enabled for use on signature networks only. Finally, 9 percent of
debit cards and 1 percent of prepaid cards were enabled for use on PIN
networks only. Responding acquirers reported that 6.7 million merchant
locations were able to accept signature debit cards and 1.5 million
were able to accept PIN debit cards.\21\
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\18\ These data do not include ATM transactions. Responding
issuers accounted for approximately 60 percent of total debit and
prepaid card transactions in 2009. The acquirers surveyed handled
about 95 percent of these total transactions.
\19\ Of these 37.7 billion transactions, 22.5 billion were
signature debit transactions, with a total value of $837 billion and
an average value of $37.15 per transaction; 14.1 billion were PIN
debit transactions with a total value of $584 billion and an average
value of $41.34 per transaction; and 1.0 billion were prepaid card
transactions, with a total value of $33 billion and an average value
of $32.54 per transactions. Of the 37.7 billion transactions, 90
percent were card-present transactions. Eighty-six percent of
signature debit and 97 percent of PIN debit transactions were card-
present transactions.
\20\ The recently released 2010 Federal Reserve Payments Study
reported 6.0 billion prepaid card transactions in 2009, of which 1.3
billion were general purpose prepaid card transactions and 4.7
billion were private label prepaid card and electronic benefit
transfer card transactions that were not included in the Board
survey.
\21\ These numbers differ from the estimates that were otherwise
provided to the Board by major payment card networks, card issuers,
and merchant acquirers.
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Interchange fees. Networks reported that debit and prepaid
interchange fees totaled $16.2 billion in 2009.\22\ The average
interchange fee for all debit transactions was 44 cents per
transaction, or 1.14 percent of the transaction amount. The average
interchange fee for a signature debit transaction was 56 cents, or 1.53
percent of the transaction amount. The average interchange fee for a
PIN debit transaction was significantly lower than that of a signature
debit transaction, at 23 cents per transaction, or 0.56 percent of the
transaction amount. Prepaid card interchange fees were similar to those
of signature debit, averaging 50 cents per transaction, or 1.53 percent
of the transaction amount.\23\
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\22\ Of the $16.2 billion in interchange-fee revenue, $12.5
billion was for signature debit transactions, $3.2 billion was for
PIN debit transactions and $0.5 billion was for prepaid card
transactions. The responding issuers reported receiving $11.0
billion, or about 68 percent of total interchange fees.
\23\ The network survey also requested information on historical
interchange fees. Not all networks reported historical interchange
fees back to 1990. However, from 1990 to 2009, it appears that
interchange fees for signature debit transactions generally were
around 1.5 percent of transaction value. Based on other industry
resources, interchange fees on PIN debit transactions in the late
1990s were about 7 cents per transaction (Debit Card Directory,
1995-1999). Therefore, it appears that these fees rose significantly
during the 2000s.
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Processing costs. Issuers reported their per-transaction processing
costs, which are those costs related to authorization, clearance, and
settlement of a transaction.\24\ The median per-transaction total
processing cost for all types of debit and prepaid card transactions
was 11.9 cents.\25\ The median per-transaction variable processing cost
was 7.1 cents for all types of debit and prepaid card transactions.\26\
The median per-transaction network processing fees were 4.0 cents for
all types of debit and prepaid card transactions.\27\
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\24\ Unlike other statistics in this discussion, the Board
discusses cost information using percentiles within this Federal
Register Notice to avoid having summary measures distorted by
extreme values in the sample cost data.
\25\ By transaction type, the median total per-transaction
processing cost was 13.7 cents for signature debit, 7.9 cents for
PIN debit and 63.6 cents for prepaid cards.
\26\ By transaction type, the median variable per-transaction
processing cost was 6.7 cents for signature debit, 4.5 cents for PIN
debit, and 25.8 cents for prepaid cards.
\27\ By transaction type, the median per-transaction network
processing fees were 4.7 cents for signature debit, 2.1 cents for
PIN debit, and 6.9 cents for prepaid cards.
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Network fees. Networks reported charging two types of per-
transaction fees: processing and non-processing fees. Networks also
reported charging fees other than on a per-transaction basis. Networks
charged issuers a total of $2.3 billion in fees and charged acquirers a
total of $1.9 billion in fees. In general, the proportion of fees paid
by each party varied by network type. Aggregating these fees across all
debit and prepaid card transactions, the average network fee
attributable to each transaction was 6.5 cents for issuers and 5.0
cents for acquirers. The average network fee attributable to each
signature debit transaction was 8.4 cents for issuers and 5.7 cents for
acquirers. Thus, about 60 percent of signature debit network fees were
paid by issuers and 40 percent by acquirers. For PIN debit
transactions, the average network fee attributable to each transaction
was 2.7 cents for issuers and 3.7 cents for acquirers. Thus, about 42
percent of PIN debit network fees were paid by issuers and 58 percent
by acquirers. As noted above, these fees include per-transaction
processing fees and non-processing fees, as well as other fees. Based
on data reported by responding issuers, signature debit network
processing fees were 3.0 cents per transaction on average and PIN debit
network processing fees were 1.6[cent] per transaction on average.
Networks also reported providing discounts and incentives to
issuers and acquirers/merchants. Issuers were provided discounts and
incentives totaling $0.7 billion, or an average of 2.0 cents per
transaction, while acquirers
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were provided discounts and incentives of $0.3 billion, or an average
of 0.9 cents per transaction. Signature debit networks provided average
incentives and discounts of 2.6 cents per transaction to issuers and
1.2 cents per transaction to acquirers. Thus, 69 percent of signature
debit network incentives and discounts were provided to issuers and 31
percent to acquirers. PIN debit networks provided average incentives
and discounts of 0.7 cents per transaction to issuers and 0.5 cents per
transaction to acquirers. Thus, 61 percent of PIN debit network
incentives and discounts were provided to issuers and 39 percent to
acquirers.
Discounts and incentives effectively reduce the per-transaction
amount of network fees each party pays. After adjusting for discounts
and incentives, the average net network fee per transaction is 4.5
cents for issuers and 4.1 cents for acquirers.\28\ For signature debit
transactions, the average net network fee per transaction is 5.9 cents
for issuers and 4.5 cents for acquirers. Thus, 57 percent of net
network fees on signature networks were paid by issuers and 43 percent
by acquirers. For PIN debit networks, the average net network fee per
transaction is 1.9 cents for issuers and 3.2 cents for acquirers. Thus,
37 percent of net network fees on PIN debit networks were paid by
issuers and 63 percent by acquirers.
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\28\ Net network fees paid by issuers and acquirers were
calculated by subtracting incentives and discounts provided from
network fees paid.
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Fraud data. Survey responses on fraud occurrence, fraud losses, and
fraud-prevention and data-security costs are discussed in section IV of
this notice.
Exclusivity arrangements and routing restrictions. The surveys also
included a number of questions about exclusivity arrangements and
transaction routing procedures. Respondents reported that there are
arrangements, either rules-based or contractual, under which
transactions must be routed exclusively over specific networks or that
commit issuers to meet certain volume and dollar thresholds for
transactions on those networks. Respondents also reported that they
receive incentives under these arrangements, which for issuers take the
form lower network fees, signing bonuses, and marketing and development
funds. For acquirers, the incentives typically take the form of lower
network fees.
Summary of Proposal
Reasonable and proportional fees. The Board is requesting comment
on two alternative standards for determining whether the amount of an
interchange transaction fee is reasonable and proportional to the cost
incurred by the issuer with respect to the transaction. Alternative 1
adopts issuer-specific standards with a safe harbor and a cap. In
contrast, Alternative 2 adopts a cap that is applicable to all covered
issuers.
Under Alternative 1, an issuer could comply with the standard for
interchange fees by calculating its allowable costs and ensuring that,
unless it accepts the safe harbor as described below, it did not
receive any interchange fee in excess of its allowable costs through
any network. An issuer's allowable costs would be those costs that are
attributable to the issuer's role in authorization, clearance, and
settlement of the transaction and that vary with the number of
transactions sent to an issuer within a calendar year (variable costs).
The issuer's allowable costs incurred with respect to each transaction
would be the sum of the allowable costs of all electronic debit
transactions over a calendar year divided by the number of electronic
debit transactions on which the issuer received or charged an
interchange transaction fee in that year. The issuer-specific
determination in Alternative 1 would be subject to a cap on the amount
of any interchange fee an issuer could receive or charge, regardless of
the issuer's allowable cost calculation. The Board proposes to set this
cap at an initial level of 12 cents per transaction. Alternative 1 also
would permit an issuer to comply with the regulatory standard for
interchange fees by receiving or charging interchange fees that do not
exceed the safe harbor amount, in which case the issuer would not need
to determine its maximum interchange fee based on allowable costs. The
Board proposes to set the safe harbor amount at an initial level of 7
cents per transaction. Therefore, under Alternative 1, each payment
card network would have the option of setting interchange fees either
(1) at or below the safe harbor or (2) at an amount for each issuer
such that the interchange fee for that issuer does not exceed the
issuer's allowable costs, up to the cap.
Under Alternative 2, an issuer would comply with the standard for
interchange fees as long as it does not receive or charge a fee above
the cap, which would be set at an initial level of 12 cents per
transaction. Each payment card network would have to set interchange
fees such that issuers do not receive or charge any interchange fee in
excess of the cap.
Fraud-prevention adjustment. The Board's proposal requests comment
on two general approaches to the fraud-prevention adjustment framework
and asks several questions related to the two alternatives. One
approach focuses on implementation of major innovations that would
likely result in substantial reductions in total, industry-wide fraud
losses. The second approach focuses on reasonably necessary steps for
an issuer to maintain an effective fraud-prevention program, but would
not prescribe specific technologies that must be employed as part of
the program. At this time, the Board is not proposing a specific
adjustment to the amount of an interchange fee for an issuer's fraud-
prevention costs. After considering the comments received, the Board
expects to develop a specific proposal on the fraud adjustment for
public comment.
Exemptions. The Board's proposed rule exempts issuers that,
together with affiliates, have assets of less than $10 billion. The
Board's proposed rule also exempts electronic debit transactions made
using debit cards issued under government-administered programs or made
using certain reloadable prepaid cards. These exempt issuers or
transactions would not be subject to the interchange transaction fee
restrictions. The exemptions do not apply to the proposed rule's
provisions regarding network exclusivity and routing restrictions.
Prohibition on circumvention or evasion. In order to prevent
circumvention or evasion of the limits on the amount of interchange
fees that issuers receive from acquirers, the proposed rule would
prohibit an issuer from receiving net compensation from a network for
debit card transactions, excluding interchange transaction fees. For
example, the total amount of compensation provided by the network to
the issuer, such as per-transaction rebates, incentives or payments,
could not exceed the total amount of fees paid by the issuer to the
network.
Limitation on debit card restrictions. The Board is requesting
comment on two alternative approaches to implement the statute's
required rules that prohibit network exclusivity. Under Alternative A,
an issuer or payment card network may not restrict the number of
payment card networks over which an electronic debit transaction may be
carried to fewer than two unaffiliated networks. Under this
alternative, it would be sufficient for an issuer to issue a debit card
that can be processed over one signature-based network and one PIN-
based network, provided the networks are not affiliated. Under
[[Page 81727]]
Alternative B, an issuer or payment card network may not restrict the
number of payment card networks over which an electronic debit
transaction may be carried to less than two unaffiliated networks for
each method of authorization the cardholder may select. Under this
alternative, an issuer that used both signature- and PIN-based
authorization would have to enable its debit cards with two
unaffiliated signature-based networks and two unaffiliated PIN-based
networks.
Transaction routing. The Board proposes to prohibit issuers and
payment card networks from restricting the ability of a merchant to
direct the routing of electronic debit transactions over any of the
networks that an issuer has enabled to process the electronic debit
transactions. For example, issuers and payment card networks may not
set routing priorities that override a merchant's routing choice. The
merchant's choice, however, would be limited to those networks enabled
on a debit card.
Scope of Rule
In general, the Board's proposed rule covers debit card
transactions (not otherwise exempt) that debit an account. The Board's
proposed rule also covers both three-party and four-party systems.
Throughout the proposal, the Board generally describes the interchange
fee standards and the network exclusivity and routing rules in a manner
that most readily applies to debit card transactions initiated at the
point of sale for the purchase of goods and services and debit card
transactions carried over four-party networks. The scope of the
proposed rule, however, covers three-party networks and could cover ATM
transactions and networks. The Board requests comment on the
application of the proposed rule to ATM transactions and ATM networks,
as well as to three-party networks.
Coverage of ATM transactions and networks. The Board requests
comment on whether ATM transactions and ATM networks should be included
within the scope of the rule. Although the statute does not expressly
include ATM transactions within its scope, EFTA Section 920's
definitions of ``debit card,'' ``electronic debit transaction,'' and
``payment card network'' could be read to bring ATM transactions within
the coverage of the rule. Specifically, most ATM cards can be used to
debit an asset account. It could also be argued that an ATM operator
accepts the debit card as form of payment to carry out the transaction,
so the ATM network could be covered by the statutory definition of a
``payment card network.''
Under EFTA Section 920(c)(8), the term ``interchange transaction
fee'' is defined as a fee charged ``for the purpose of compensating an
issuer.'' Traditionally, however, the interchange fee for ATM
transactions is paid by the issuer and flows to the ATM operator. Thus,
the proposed interchange transaction fee standards would not apply to
ATM interchange fees and would not constrain the current level of such
fees.\29\
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\29\ The rule's interchange fee standard could become a
constraint in the future if ATM interchange fees begin to flow in
the same direction as point-of-sale debit card transactions, as was
the case for interchange fees of certain PIN debit networks in the
1990s.
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The network-exclusivity prohibition and routing provisions,
however, would directly affect the operations of ATM networks if these
provisions were applied to such networks. Issuers would be required to
offer ATM cards that can be accepted on at least two unaffiliated
networks, and the ATM operator would have the ability to choose the
network through which transactions would be routed. As discussed below,
in point-of-sale transactions, these provisions improve the ability of
a merchant to select the network that minimizes its cost (particularly
the cost associated with interchange fees) and otherwise provides the
most advantageous terms. In the case of ATM transactions, however, the
exclusivity and routing provisions would give the ATM operator, which
is receiving the ATM interchange fee, the ability to select the network
that maximizes that fee. Therefore, coverage of ATM networks under the
rule may result in very different economic incentives than coverage of
point-of-sale debit card networks.
If ATM networks and ATM transactions are included within the scope
of the rule, the Board requests comment on how to implement the network
exclusivity provision. For example, if the Board requires two
unaffiliated networks for each authorization method, should it
explicitly require an issuer to ensure that ATM transactions may be
routed over at least two unaffiliated networks? Should the Board state
that one point-of-sale debit network and one ATM-only network would not
satisfy the exclusivity prohibition under either proposed alternative?
The Board also specifically requests comment on the effect of treating
ATM transactions as ``electronic debit transactions'' under the rule on
small issuers, as well as the cardholder benefit, if any, of such an
approach.
Coverage of three-party systems. The Board also requests comment on
the appropriate application of the interchange fee standards to
electronic debit transactions carried over three-party systems. In a
three-party payment system, the payment card network typically serves
both as the card issuer and the merchant acquirer for purposes of
accepting payment on the network.\30\ In this system, there is no
explicit interchange fee. Instead, the merchant directly pays a
merchant discount to the network. The merchant discount typically is
equivalent to the sum of the interchange fee, the network switch fee,
other acquirer costs, and an acquirer markup that would typically be
imposed in a four-party system.
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\30\ In addition, under a three-party system, outside processors
generally are not authorized by the network to acquire transactions
from merchants. Although outside processors may provide some
processing services to the merchant, the network is ultimately the
acquirer for every transaction.
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Both the statutory and proposed definition of ``interchange
transaction fee'' would cover the part of the merchant discount in a
three-party system that is used to compensate the network for its role
as issuer. If a three-party network apportioned its entire merchant
discount to its roles as network or merchant acquirer, however, the
interchange fee would, in effect, be zero. This outcome, coupled with
the fact the statute does not restrict fees an acquirer charges a
merchant, may present practical difficulties in limiting the amount of
a merchant discount charged in a three-party network. The Board
requests comment on the appropriate way to treat three-party networks
and on any specific clarifications with respect to such fees that
should be provided in the regulation.
In addition, the Board requests comment on how the network
exclusivity and routing provisions should be applied to three-party
systems. If the limitations on payment card network restrictions under
Sec. 235.7 were applied to a three-party system, debit cards issued by
the network would be required to be capable of being routed through at
least one unaffiliated payment card network in addition to the network
issuing the card, and the network may not inhibit a merchant's ability
to route a transaction to any other unaffiliated network(s) enabled on
a debit card. For example, under Alternative A for the network
exclusivity provisions, the payment card network would be required to
add an unaffiliated network and arrange for the unaffiliated debit
network to carry debit transactions, for ultimate routing
[[Page 81728]]
to the contracting network, which may result in more circuitous routing
that would otherwise be the case. Under Alternative B, which requires
at least two unaffiliated payment card networks for each method of
authorization, the payment card network would be required to add at
least one unaffiliated signature debit network for a signature-only
debit card. In addition, if the debit card had PIN debit functionality,
the card would also have to be accepted on at least two unaffiliated
PIN debit networks.
The Board recognizes that the nature of a three-party system could
be significantly altered by any requirement to add one or more
unaffiliated payment card networks capable of carrying electronic debit
transactions involving the network's cards. Nonetheless, the statute
does not provide any apparent basis for excluding three-party systems
from the scope of the provisions of EFTA Section 920(b). The Board
requests comment on all aspects of applying the proposed rule to three-
party payment systems, including on any available alternatives that
could minimize the burden of compliance on such systems.
Section-by-Section Analysis
I. Sec. 235.1 Authority and purpose
This section sets forth the authority and purpose for the proposed
rule.
II. Sec. 235.2 Definitions
The proposed rule provides definitions for many of the terms used
in the rule. As noted throughout this section, many of the definitions
follow the EFTA's definitions. The proposed rule also provides
definitions for terms not defined in EFTA Section 920. Some of these
definitions are based on existing statutory or regulatory definitions,
while others are based on terminology in the debit card industry. The
Board requests comment on all of the terms and definitions set out in
this section. In particular, the Board requests comment on any terms
used in the proposed rule that a commenter believes are not
sufficiently clear or defined.
A. Sec. 235.2(a) Account
EFTA Section 920(c) defines the term ``debit card'' in reference to
a card, or other payment code or device, that is used ``to debit an
asset account (regardless of the purpose for which the account is
established) * * *.'' That section, however, does not define the terms
``asset account'' or ``account.'' EFTA Section 903(2) defines the term
``account'' to mean ``a demand deposit, savings deposit, or other asset
account (other than an occasional or incidental credit balance in an
open end credit plan as defined in section 103(i) of [the EFTA]), as
described in regulations of the Board established primarily for
personal, family, or household purposes, but such term does not include
an account held by a financial institution pursuant to a bona fide
trust agreement.'' \31\
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\31\ 15 U.S.C. 1693a.
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Similar to EFTA Section 903(2), proposed Sec. 235.2(a) defines
``account'' to include a transaction account (which includes a demand
deposit), savings, or other asset account. The proposed definition,
however, differs from EFTA Section 903(2) because EFTA Section 920(c)
does not restrict the term debit card to those cards, or other payment
codes or devices, that debit accounts established for a particular
purpose. Accordingly, the proposed definition includes both an account
established primarily for personal, family, or household purposes and
an account established for business purposes. For the same reason, the
proposed definition of ``account'' includes an account held by a
financial institution under a bona fide trust arrangement. These
distinctions from the EFTA Section 903(2)'s definition are clarified in
proposed comment 2(a)-1.
The proposed definition of ``account'' is limited to accounts that
are located in the United States. The Board does not believe it is
appropriate to apply EFTA Section 920's limitations to foreign issuers
or accounts, absent a clear indication from Congress to do so.
B. Sec. 235.2(b) Acquirer
Proposed Sec. 235.2(b) defines the term ``acquirer.'' Within the
debit card industry, there are numerous models for acquiring
transactions from merchants, and the term ``acquirer'' may not always
be used to refer to the entity that holds a merchant's account. In some
acquiring relationships, an institution performs all the functions of
the acquirer (e.g., signing up and underwriting merchants, processing
payments, receiving and providing settlement for the merchants'
transactions, and other account maintenance). In other acquiring
relationships, an institution performs all the functions of the
acquirer except for settling the merchant's transactions with both the
merchant and the network.
The Board is proposing to limit the term ``acquirer'' to entities
that ``acquire'' (or buy) the electronic debit transactions from the
merchant. Proposed Sec. 235.2(b) defines ``acquirer'' as a person that
``contracts directly or indirectly with a merchant to receive and
provide settlement for the merchant's electronic debit transactions
over a payment card network.'' Proposed Sec. 235.2(b) limits the term
to those entities serving a financial institution function with respect
to the merchant, as distinguished from a processor function, by
stipulating that the entity ``receive and provide settlement for the
merchant's'' transactions. Proposed Sec. 235.2(b) also explicitly
excludes entities that solely process transactions for the merchant
from the term ``acquirer.''
Proposed Sec. 235.2(b), however, takes into consideration the fact
that the degree of involvement of the entity settling with the merchant
varies under different models by defining ``acquirer'' as a person that
``contracts directly or indirectly with a merchant.'' See proposed
comment 2(b)-1.
C. Sec. 235.2(c) Affiliate and Sec. 235.2(e) Control
Proposed Sec. Sec. 235.2(c) and (e) define the terms ``affiliate''
and ``control.'' EFTA Section 920(c)(1) defines the term ``affiliate''
as ``any company that controls, is controlled by, or is under common
control with another company.'' The proposed rule incorporates the
EFTA's definition of ``affiliate.''
Although the EFTA's definition of affiliate is premised on control,
the EFTA does not define that term. The Board is proposing to adopt a
definition of ``control'' that is consistent with definitions of that
term in other Board regulations.\32\
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\32\ See Regulation Y (Bank Holding Companies and Change in Bank
Control), 12 CFR 225.2(e)) and Regulation P (Privacy of Consumer
Financial Information), 12 CFR 216.3(g).
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D. Sec. 235.2(d) Cardholder
Proposed Sec. 235.2(d) defines the term ``cardholder'' as the
person to whom a debit card is issued. Proposed comment 2(d) clarifies
that if an issuer issues a debit card for use to debit a transaction,
savings, or other similar asset account, the cardholder usually will be
the account holder. In some cases, however, such as with a business
account, there may be multiple persons who have been issued debit cards
and are authorized to use those debit cards to debit the same account.
Each employee issued a card would be considered a cardholder. In the
case of a prepaid card, the cardholder is the person that purchased the
card or a person who received the card from the purchaser. See proposed
comment 2(d)-1.
[[Page 81729]]
F. Sec. 235.2(f) Debit Card and Sec. 235.2(i) General-Use Prepaid Card
Debit Card (Sec. 235.2 (f))
EFTA Section 920(c)(2) defines the term ``debit card'' as ``any
card, or other payment code or device, issued or approved for use
through a payment card network to debit an asset account (regardless of
the purpose for which the account is established), whether
authorization is based on signature, PIN, or other means.'' The term
includes a general-use prepaid card, as that term was previously
defined by the gift card provisions of the Credit Card Accountability,
Responsibility and Disclosure Act of 2009 (Credit Card Act).\33\ The
statute excludes paper checks from the definition of ``debit card.''
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\33\ See EFTA Section 915(a)(2)(A).
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Proposed Sec. 235.2(f) defines the term ``debit card'' and
generally tracks the definition set forth in EFTA Section 920. Thus,
proposed Sec. 235.2(f)(1) generally defines the term ``debit card'' as
``any card, or other payment code or device, issued or approved for use
through a payment card network to debit an account, regardless of
whether authorization is based on signature, personal identification
number (PIN), or other means.'' In addition, the term applies
regardless of whether the issuer holds the underlying account. This is
consistent with the statutory definition of ``debit card'' which does
not require that an issuer also hold the account debited by the card,
code, or device. Proposed Sec. 235.2(f)(2) further provides that
``debit card'' includes a ``general-use prepaid card.'' See proposed
comment 2(f)-4.
Proposed comment 2(f)-1 clarifies that the requirements of this
part generally apply to any card, or other payment code or device, even
if it is not issued in card form. That is, the rule applies even if a
physical card is not issued or if the device is issued with a form
factor other than a standard-sized card. For example, an account number
or code that could be used to access underlying funds in an account
would be considered a debit card under the rule (except when used to
initiate an ACH transaction). Similarly, the term ``debit card'' would
include a device with a chip or other embedded mechanism that links the
device to funds held in an account, such as a mobile phone or sticker
containing a contactless chip that enables the cardholder to debit an
account.
Proposed comments 2(f)-2 and -3 address deferred and decoupled
debit cards, two types of card products that the Board believes fall
within the statutory definition of ``debit card'' notwithstanding that
they may share both credit and debit card-like attributes. Under a
deferred debit arrangement, transactions are not immediately posted to
a cardholder's account when the card transaction is received by the
account-holding institution for settlement, but instead the funds in
the account are held and made unavailable for other transactions for a
specified period of time.\34\ Upon expiration of the time period, the
cardholder's account is debited for the amount of all transactions made
using the card which were submitted for settlement during that period.
For example, under some deferred debit arrangements involving consumer
brokerage accounts (whether held at the issuer or an affiliate), the
issuer agrees not to post the card transactions to the brokerage
account until the end of the month. Regardless of the time period
chosen by the issuer for deferring the posting of the transactions to
the cardholder's account, deferred debit cards would be considered
debit cards for purposes of the requirements of this part. Deferred
debit card arrangements do not refer to arrangements in which a
merchant defers presentment of multiple small dollar card payments, but
aggregates those payments into a single transaction for presentment, or
where a merchant requests placement of a hold on certain funds in an
account until the actual amount of the cardholder's transaction is
known. See proposed comment 2(f)-2.
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\34\ The issuer's ability to maintain the hold assumes that the
issuer has received a settlement record for the transaction within
the time period required under card network rules.
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Proposed comment 2(f)-3 addresses decoupled debit arrangements in
which the issuer is not the institution that holds the underlying
account that will be debited. That is, the issuer-cardholder
relationship is ``decoupled'' from the cardholder's relationship with
the institution holding the cardholder's account. In these ``decoupled
debit'' arrangements, transactions are not posted directly to the
cardholder's account when the transaction is presented for settlement
with the card issuer. Instead, the issuer must send an ACH debit
instruction to the account-holding institution in the amount of the
transaction in order to obtain the funds from the cardholder's account.
As noted above, the term ``debit card'' includes a card, or other
payment code or device, that debits an account, regardless of whether
the issuer holds the account. Accordingly, the Board believes it is
appropriate to treat decoupled debit cards as debit cards subject to
the requirements of this part.
Moreover, the Board understands that there may be incentives for
some issuers to design or offer products with ``credit-like'' features
in an effort to have such products fall outside the scope of the
interchange fee restrictions to be implemented by this rulemaking. For
example, an issuer may offer a product that would allow the cardholder
the option at the time of the transaction to choose when the
cardholder's account will be debited for the transaction. Any attempt
to classify such a product as a credit card is limited by the
prohibition against compulsory use under the EFTA and Regulation E.
Specifically, the EFTA and Regulation E provide that no person may
condition the extension of credit to a consumer on such consumer's
repayment by means of preauthorized electronic fund transfers.\35\
Thus, an issuer of a charge or credit card is prohibited from requiring
a consumer's repayment by preauthorized electronic fund transfers from
a deposit account held by the consumer as a condition of opening the
charge or credit card account. The Board solicits comment on whether
additional guidance is necessary to clarify that deferred and decoupled
debit, or any similar products, qualify as debit cards for purposes of
this rule.
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\35\ EFTA Section 913(1); 12 CFR 205.10(e)(1).
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The proposed rule also sets forth certain exclusions from the term
``debit card'' in Sec. 235.2(f)(3) to clarify the definition. Proposed
Sec. 235.2(f)(3)(i) clarifies that retail gift cards that can be used
only at a single merchant or affiliated group of merchants are not
subject to the requirements of this part. The Board believes that by
including an explicit reference to general-use prepaid cards in the
statutory definition of ``debit card,'' Congress did not intend the
interchange fee restrictions to apply to other types of prepaid cards
that are accepted only at a single merchant or an affiliated group of
merchants. These cards are generally used in a closed environment at a
limited number of locations and are not issued for general use. See
Sec. 235.7(a), discussed below.
Proposed comment 2(f)-5 clarifies that two or more merchants are
affiliated if they are related by either common ownership or common
corporate control. For purposes of the definition of ``debit card,''
the Board views franchisees to be under common corporate control if
they are subject to a common set of corporate policies or practices
under the terms of their franchise licenses. Accordingly, gift
[[Page 81730]]
cards that are redeemable solely at franchise locations would be
excluded from the definition of debit card for cards, or other payment
codes or devices, usable only at a single merchant or affiliated group
of merchants, from the definition of ``debit card.''
Proposed Sec. 235.2(f)(3)(ii) expands the statutory exclusion for
paper checks to exempt any ``check, draft, or similar paper instrument,
or electronic representation thereof'' from the definition of ``debit
card.'' This adjustment is proposed because in many cases paper checks
may be imaged and submitted electronically for presentment to the
paying bank. Proposed comment 2(f)-6 further clarifies that a check
that is provided as a source of information to initiate an ACH debit
transfer in an electronic check conversion transaction is not a debit
card.
Finally, proposed Sec. 235.2(f)(iii) would generally exclude ACH
transactions from the requirements of this part. Specifically, the
proposed exclusion provides that an account number is not a debit card
when used to initiate an ACH transaction from a person's account. The
Board believes that this exclusion is necessary to clarify that ACH
transactions initiated by a person's provision of a checking account
number are not ``electronic debit transactions'' for purposes of the
network exclusivity and routing provisions under Sec. 235.7. However,
this exclusion is not intended to cover a card, or other payment code
or device, that is used to directly or indirectly initiate an ACH debit
from a cardholder's account, for example, under a decoupled debit
arrangement.\36\ Proposed comment 2(f)-7 sets forth this guidance.
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\36\ However, a decoupled debit card issued by a merchant that
can be used only at that merchant or its affiliate(s) may qualify
for the separate exclusion under proposed Sec. 235.2(f)(3)(i).
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General-Use Prepaid Cards (Sec. 235.2(i))
The statutory definition of ``debit card'' includes a ``general-use
prepaid card'' as that term is defined under EFTA Section
915(a)(2)(A).\37\ Proposed Sec. 235.2(i) defines ``general-use prepaid
card'' as a card, or other payment code or device, that is (1) issued
on a prepaid basis in a specified amount, whether or not that amount
may be increased or reloaded, in exchange for payment; and (2)
redeemable upon presentation at multiple, unaffiliated merchants or
service providers for goods or services, or usable at ATMs.
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\37\ See EFTA Section 920(c)(2)(B).
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The proposed definition of ``general-use prepaid card'' generally
tracks the definition as it appears under EFTA Section 915(a)(2)(A),
with modifications to simplify and clarify the definition.\38\ For
example, the proposed rule refers to cards issued in a ``specified''
amount to capture a card, or other payment code or device, whether it
is issued in a predenominated amount or in an amount requested by a
cardholder in a particular transaction.
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\38\ See also 12 CFR 205.20(a)(3).
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The inclusion of general-use prepaid cards in the definition of
``debit card'' under EFTA Section 920(c)(2)(B) refers only to the term
``general-use prepaid card'' as it is defined in EFTA Section
915(a)(d)(A), and does not incorporate the separate exclusions to that
term that are set forth in the gift card provisions of the Credit Card
Act.\39\ Thus, for purposes of this proposed rule, the definition of
``general-use prepaid card'' would include the cards, or other payment
codes or devices, listed under EFTA Section 915(a)(2)(D) to the extent
they otherwise meet the definition of ``general-use prepaid card.''
\40\
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\39\ For example, under the gift card provisions of the Credit
Card Act, general-use prepaid cards do not include cards that are
not marketed to the general public or cards issued in paper form
only. See EFTA Section 915(a)(2)(D)(iv) and (v).
\40\ The Board further notes that had Congress intended to apply
the exclusions in EFTA Section 915(a)(2)(D) to the definition of
``general-use prepaid card'' for purposes of this rule, it would
have been unnecessary to separately create an exemption for certain
reloadable prepaid cards that are not marketed or labeled as a gift
card. See EFTA Section 920(a)(7)(ii).
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Proposed comment 2(i)-1 clarifies that a card, or other payment
code or device, is ``redeemable upon presentation at multiple,
unaffiliated merchants'' if, for example, the merchants agree, pursuant
to the rules of the payment network, to honor the card, or other
payment code or device, if it bears the mark, logo, or brand of a
payment network. (See, however, proposed comment 2(f)-5, discussed
above, clarifying that franchises subject to a common set of corporate
policies or practices are considered to be affiliated.)
Proposed comment 2(i)-2 provides that a mall gift card, which is
generally intended to be used or redeemed at participating retailers
located within the same shopping mall or in some cases, within the same
shopping district, would be considered a general-use prepaid card if it
is also network-branded, which would permit the card to be used at any
retailer that accepts that card brand, including retailers located
outside the mall.
In some cases, a group of unaffiliated merchants may jointly offer
a prepaid card that is only redeemable at the participating merchants.
For example, ``selective authorization'' cards may be offered to
encourage sales within a shopping mall or district or at merchants
located in the same resort. Selective authorization cards generally are
issued by a financial institution or member of a card network, rather
than a program sponsor as in the case of many retail gift card
programs. Transactions made using such cards are authorized and settled
over the payment card networks just like other general-use prepaid
cards. In addition, interchange transaction fees may be charged in
connection with these cards because they are processed over a payment
card network.
Selective authorization programs enable a merchant to offer gift
cards to its customers and ensure that card funds are spent only within
the participating merchant(s) without incurring the costs of setting up
a separate program. There may be little difference between these
programs and closed-loop retail gift card programs operated by a single
retailer, but for the fact that these cards are accepted at merchants
that are unaffiliated. However, requiring these selective authorization
cards to comply with the network exclusivity and routing restrictions
could be problematic and costly for the participating merchants with
little corresponding benefit. Accordingly, comment is requested on
whether a prepaid card that is accepted at a limited number of
unaffiliated participating merchants and does not carry a network brand
should also be considered a ``general-use prepaid card'' under the
rule.
G. Sec. 235.2(g) Designated automated teller machine network
(Designated ATM network)
EFTA Section 920(a)(7)(C) defines a ``designated automated teller
machine network'' as either (1) all ATMs identified in the name of the
issuer or (2) any network of ATMs identified by the issuer that
provides reasonable and convenient access to the issuer's customers.
Proposed Sec. 235.2(g) implements this definition substantially as set
forth in the statute.
The Board is also proposing to clarify the meaning of ``reasonable
and convenient access,'' as that term is used in Sec. 235.2(g)(2).
Proposed comment 2(g)-1 provides that an issuer provides reasonable and
convenient access, for example, if, for each person to whom a card is
issued, the issuer provides access to an ATM within the metropolitan
statistical area (MSA) in which the last known address of the person to
whom the card is issued is located, or if the address is not known,
[[Page 81731]]
where the card was first purchased or issued, in order to access an ATM
in the network. The purpose of this comment is to clarify that if an
issuer does not have its own network of proprietary ATMs, as provided
in Sec. 235.2(g)(1), that the network the issuer identifies as its
designated ATM network is one in which a person using a debit card can
access an ATM with relative ease. The Board believes that having to
travel a substantial distance from where the person is located, as
determined by the last known address of the person to whom the card is
issued, for an ATM in the network is neither reasonable nor convenient.
The MSA is a common, well-known way of defining a community.\41\
Therefore, the Board is proposing the MSA as a proxy for a reasonable
distance from the person's location.
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\41\ See U.S. Census Bureau for information on MSAs, available
at http://www.census.gov/population/www/metroareas/metroarea.html.
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Furthermore, because a debit card includes a general-use prepaid
card, for which the issuer may not have the address of the person using
the card, the proposed comment provides that the issuer may use the
location of where the card was first purchased or issued. The issuer of
a general-use prepaid card may not have address information because
either the person to whom the card is issued is not the ultimate user
of the card, such as in the case of a gift card, or the issuer does not
collect address information for the product. In these instances, the
only location known to the issuer is the place where the card was first
purchased or issued, and the issuer may assume that the person using
the card is located in that same area. The Board also requests comment
on whether additional clarification or guidance is needed for how an
issuer may identify a network of automated teller machines that
provides reasonable and convenient access to the issuer's cardholders.
H. Sec. 235.2(h) Electronic debit transaction
EFAT section 920(c)(5) defines the term ``electronic debit
transaction'' as ``a transaction in which a person uses a debit card.''
The Board's proposed definition in Sec. 235.2(h) adds two clarifying
provisions.
First, proposed Sec. 235.2(h) clarifies that the term ``electronic
debit transaction'' is a transaction in which a person uses a debit
card as ``a form of payment.'' The statute defines payment card
network, in part, as a network a person uses to accept a debit card as
a form of payment. For clarity, the Board proposes to incorporate that
requirement into the definition of electronic debit transaction.
Second, the statutory definition is silent as to whether use of the
debit card must occur within the United States. Proposed Sec. 235.2(h)
limits electronic debit transactions to those transactions where a
person uses a debit card for payment in the United States. The Board
found no indication in the statute that Congress meant to apply the
interchange provisions extraterritorially. Moreover, if a person uses a
debit card outside the United States, even if such use is to debit an
account located in the United States, the amount of the interchange
transaction fees the issuer may receive often is determined by the
network rules for cross-border transactions or the laws or regulations
of the country in which the merchant is located. Therefore, electronic
debit transactions subject to the proposed rule are those that occur at
a merchant located within the United States.
Proposed comment 2(h)-1 explains that the term ``electronic debit
transaction'' includes transactions in which a person uses a debit card
other than for the initial purchase of goods or services. For example,
after purchasing goods or services, a person may decide that such goods
and services are unwanted or defective. If permitted by agreement with
the merchant, that person may return the goods or cancel the services
and receive a credit using the same debit card used to make the
original purchase. Proposed Sec. 235.2(h) covers such transactions.
The Board understands, however, that issuers typically do not receive
interchange fees for these transactions. Proposed comment 2(h)-2
clarifies that transactions in which a person uses a debit card to
purchase goods or services and also receives cash back from the
merchant are electronic debit transactions.
I. Sec. 235.2(j) Interchange transaction fee
Proposed Sec. 235.2(j) generally incorporates the EFTA Section
920(c)(8)'s definition of ``interchange transaction fee'' that defines
the term as ``any fee established, charged or received by a payment
card network for the purpose of compensating an issuer for its
involvement in an electronic debit transaction.'' A payment card
network may determine interchange transaction fees according to a
schedule that is widely applicable, but also may permit bilateral
negotiation of fees between issuers and acquirers or merchants, as well
as specialized interchange transaction fee arrangements.
As discussed above, interchange transaction fees today are used to
reimburse issuers for their involvement in electronic debit
transactions by transferring value between acquirers and issuers. In
general, payment card networks establish the interchange transaction
fees, although the issuers are receiving the fees by reducing the
amount remitted for a particular transaction by the amount of that
transaction's interchange transaction fee. Therefore, the merchants or
acquirers are paying the amount of the interchange transaction fee. The
proposed definition, however, clarifies that interchange transaction
fees are paid by merchants or acquirers. See proposed comment 2(j)-1.
Proposed comment 2(j)-2 restates the rule that interchange fees are
limited to those fees established, charged or received by a payment
card network for the purpose of compensating the issuer, and not for
other purposes, such as to compensate the network for its services to
acquirers or issuers.
J. Sec. 235.2(k) Issuer
Proposed Sec. 235.2(k) incorporates the statute's definition of
``issuer'' that defines the term as ``any person who issues a debit
card or the agent of such person with respect to the card.'' Proposed
Sec. 235.2(k) follows the statutory definition, but removes the phrase
``or the agent of such person with respect to the card.'' Because
agents are, as a matter of law, held to the same restrictions with
respect to the agency relationship as their principals, the Board does
not believe that removing this clause will have a substantive effect.
Issuing a debit card is the process of providing a debit card to a
cardholder. The issuing process generally includes establishing a
direct contractual relationship with the cardholder with respect to the
card and providing the card directly or indirectly to the cardholder.
The debit card provided may or may not have the issuer's name on the
card. For example, a prepaid card may be issued by a bank that has
partnered with another entity (e.g., a retail store) and the other
entity's name may be on the prepaid card. Further, as discussed below,
the issuer is not necessarily the institution that holds the
cardholder's account that will be debited.
Similar to merchant-acquirer relationships, the issuer-cardholder
relationship varies. Proposed comments 2(k)-2 through 2(k)-5 clarify
which entity is the issuer in the most prevalent issuing arrangements.
In the simple four-party system, the financial
[[Page 81732]]
institution that holds the account is the issuer because that is the
institution that directly or indirectly provides the debit card to the
cardholder, holds the cardholder's account and has the direct
contractual relationship with the cardholder with respect to the card.
If the debit card is a prepaid card, the cardholder may receive the
card from a merchant or other person, and thus may not receive the card
directly from the issuing bank, which is the entity that holds the
account that pools together the funds for many prepaid cards. See
proposed comment 2(k)-2.
In contrast, in a three-party system, the network typically
provides the debit card or prepaid card directly to the cardholder or
through an agent. Generally, the network also has a direct contractual
relationship with the cardholder. Notwithstanding the other roles the
network may have with respect to the transaction, the network is
considered an issuer under proposed Sec. 235.2(k) because it provides
the card to the cardholder, and may also be the account-holding
institution. See proposed comment 2(k)-3.
A variation of the issuer relationship within the four-party and
three-party systems involves the licensing or assignment of Bank
Identification Numbers (BINs), which are numbers assigned to financial
institutions by the payment card networks for purposes of issuing
cards. Some members of payment card networks permit other entities that
are not members to issue debit cards using the member's BIN. The entity
permitting such use is referred to as the ``BIN sponsor.'' The entity
using the BIN sponsor's BIN (``affiliate member'') typically holds the
account of the cardholder and directly or indirectly provides the
cardholder with the debit card. The cardholder's direct relationship is
with the affiliate member. Proposed comment 2(k)-4.i and .ii describes
two circumstances involving BIN sponsorship arrangements and provides
guidance on the entity that would be considered to be the issuer in
those circumstances.
Another variant of the issuer relationship within the four-party
and three-party systems is the decoupled debit card arrangement. In a
decoupled debit card arrangement, a third-party service provider (which
may or may not be a financial institution) issues a debit card to the
cardholder and enters into a contractual relationship with the
cardholder with respect to the decoupled debit card. Therefore,
proposed comment 2(k)-5 clarifies that the entity directly or
indirectly providing the cardholder with the card is considered the
issuer under proposed Sec. 235.2(k).
Some issuers outsource to a third party some of the functions
associated with issuing cards and authorizing, clearing, and settling
debit card transactions. A third party that performs certain card-
issuance functions on behalf of an issuer would be subject to the same
restrictions as the issuer in the performance of those functions. An
issuer that outsources certain issuing functions retains the underlying
relationship with the cardholder and should retain responsibility for
complying with the rule's requirements as they pertain to issuers.
Therefore, the Board's proposed definition of ``issuer'' does not
include the phrase ``or agent of the issuer with respect to such
card.'' The Board requests comment on whether there are circumstances
in which an agent of an issuer also should be considered to be an
issuer within the rule's definition.
Proposed Sec. 235.2(k)'s definition of ``issuer'' applies
throughout this part, except for the provisions exempting small
issuers.\42\ For purposes of that exemption, EFTA Section 920 limits
the term ``issuer'' to the person holding the account that is debited
through the electronic debit transaction. For example, issuers of
decoupled debit cards are not considered issuers for purposes of the
small issuer exemption because they do not hold the account being
debited.
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\42\ See discussion of proposed Sec. 235.5(a) in the section-
by-section analysis.
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The Board requests comment on all aspects of the issuer definition.
The Board specifically requests comment on whether the appropriate
entity is deemed to be the issuer in relation to the proposed examples.
L. Sec. 235.2(l) Merchant
The statute does not define the term ``merchant.'' The term is used
throughout the proposed rule, and the Board is proposing to define a
merchant as a person that accepts a debit card as payment for goods or
services.
M. Sec. 235.2(m) Payment card network
EFTA Section 920(c)(11) defines the term ``payment card network''
as (1) an entity that directly, or through licensed members,
processors, or agents, provides the proprietary services,
infrastructure, and software that route information and data to conduct
debit card or credit card transaction authorization, clearance, and
settlement, and (2) that a person uses in order to accept as a form of
payment a brand of debit card, credit card, or other device that may be
used to carry out debit or credit transactions. Proposed Sec. 235.2(m)
follows this definition, with revisions for clarity.
Under the proposed rule, a payment card network is generally
defined as an ``entity that directly or indirectly provides the
proprietary services, infrastructure, and software for authorization,
clearance, and settlement of electronic debit transactions.'' Because
the interchange fee restrictions and network exclusivity and merchant
routing provisions of the Dodd-Frank Act do not apply to credit card
transactions, the Board believes it is appropriate to exclude from the
proposed definition the reference to credit cards in the statutory
definition to avoid unnecessary confusion. No substantive change is
intended. Likewise, the Board does not believe its necessary to state
that a payment card network is an entity that a person uses in order to
accept debit cards as a form of payment, because proposed Sec.
235.2(h) defines the term ``electronic debit transaction,'' as use of a
debit card ``as a form of payment.''
In addition, the term ``payment card network,'' as defined in EFTA
Section 920, could be interpreted broadly to include any entity that is
involved in processing an electronic debit transaction, including the
acquirer, third-party processor, payment gateway, or software vendor
that programs the electronic terminal to accept and route debit card
transactions. Each of these entities arguably provide ``services,
infrastructure, and software'' that are necessary for authorizing,
clearing, and settling electronic debit transactions. However, the
Board does not believe that this is the best interpretation in light of
the statute's objectives. Instead, the Board believes that the better
interpretation is that in general, the term ``payment card network''
only applies to an entity that establishes the rules, standards, or
guidelines that govern the rights and responsibilities of issuers and
acquirers involved in processing debit card transactions through the
payment system. Accordingly, proposed Sec. 235.2(m)(2) makes this
clarification. The rules, standards, or guidelines may also govern the
rights and responsibilities of participants other than issuers and
acquirers. See proposed comment 2(m)-1.
In certain cases, such as in a three-party system, the same entity
may serve multiple roles, including that of the payment card network,
the issuer, and the acquirer. Proposed comment 2(m)-1 clarifies that
the term ``payment card network'' would also cover such entities to the
extent that their rules, standards,
[[Page 81733]]
or guidelines also cover their activities in their role(s) of issuer
and/or acquirer. Proposed comment 2(m)-1 further clarifies that the
term ``payment card network'' would generally exclude acquirers,
issuers, third-party processors, payment gateways, or other entities
that may provide services, equipment, or software that may be used in
authorizing, clearing, or settling electronic debit transactions,
unless such entities also establish guidelines, rules, or procedures
that govern the rights and obligations of issuers and acquirers
involved in processing an electronic debit transactions through the
network. For example, an acquirer is not considered to be a payment
card network due to the fact that it establishes particular transaction
format standards, rules, or guidelines that apply to electronic debit
transactions submitted by a merchant that uses the acquirer's services,
because such standards, rules, or guidelines would apply only to the
merchant using the acquirer's services, and not to other entities that
may also be involved in processing those transactions, such as the card
issuer.
The Board requests comment on whether other non-traditional or
emerging payment systems would be covered by the statutory definition
of ``payment card network.'' For example, consumers may use their
mobile phone to send payments to third parties to purchase goods or
services with the payment amount billed to their mobile phone account
or debited directly from the consumer's bank account. In addition,
consumers may use a third party payment intermediary, such as PayPal,
to pay for Internet purchases, using the consumer's funds that may be
held by the intermediary or in the consumer's account held at a
different financial institution. In both examples, the system or
network used to send the payment arguably provide the ``proprietary
services, infrastructure, and software for authorization, clearance,
and settlement of electronic debit transactions.'' Transactions
involving these methods of payment typically are subject to rules and
procedures established by the payment system. If such systems are not
covered, the Board requests specific comment how it should
appropriately distinguish these payment systems from traditional debit
card payment systems that are subject to the rule.
N. Sec. 235.2(n) Person
The term ``person'' is not defined in the EFTA. The proposed
definition incorporates the definition of the term in existing Board
regulations.\43\
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\43\ Regulation Z (Truth in Lending Act), 12 CFR 226.2(a)(22);
Regulation CC (Availability of Funds and Collections of Checks), 12
CFR 229.2(yy);
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O. Sec. 235.2(o) Processor
EFTA Section 920 uses the term ``processor'' but does not define
the term. Proposed Sec. 235.2(o) defines the term ``processor'' as a
person that processes or routes electronic debit transactions for
issuers, acquirers, or merchants.
P. Sec. 235.2(p) United States
Proposed Sec. 235.2(p) defines the term ``United States.'' The
proposed definition is modified from the EFTA's definition of
``State.'' (15 U.S.C. 1693a(10)).
III. Sec. 235.3 Reasonable and proportional interchange transaction
fees
Proposed Sec. 235.3 sets forth standards for assessing whether the
amount of any interchange transaction fee that an issuer receives or
charges with respect to an electronic debit transaction is reasonable
and proportional to the cost incurred by the issuer with respect to the
transaction.
A. Statutory Considerations
1. Reasonable and Proportional to Cost
As noted above, EFTA Section 920 requires the Board to establish
standards for assessing whether the amount of any interchange
transaction fee an issuer receives or charges with respect to an
electronic debit transaction is reasonable and proportional to the cost
incurred by the issuer with respect to the transaction. EFTA Section
920 does not define ``reasonable'' or ``proportional.'' The Board has
found only limited examples of other statutory uses of the terms
``reasonable'' or ``proportional'' with respect to fees.\44\ One
example is Section 149 of the Truth in Lending Act (TILA), which limits
credit card penalty fees for violations of the cardholder agreement to
fees that are reasonable and proportional to the violation. In
implementing standards under TILA Section 149, the Board relied on the
commonly accepted legal definition of ``reasonable'' (``fair, proper,
or moderate'') and the commonly accepted definition of ``proportional''
(``corresponding in degree, size, or intensity'' or ``having the same
or constant ratio'').\45\
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\44\ Several public utility rate-setting statutes require ``just
and reasonable'' rates. See, e.g., Natural Gas Act, 15 U.S.C. 717 et
seq. In the public utility rate-setting context, a ``just and
reasonable'' rate requires that the public utility be able ``to
operate successfully, to maintain financial integrity, to attract
capital, and to compensate its investors for the risk assumed.''
Duquense Light Co. v. Barash, 488 U.S. 299 (1989). The Board
believes that the similarities between these statutes and Section
920, however, are limited. Public utility rate-setting involves
unique circumstances, none of which are present in the case of
setting standards for interchange transaction fees. Issuers are
unlike public utilities, which, in general, are required to make
their services regularly available to the public. In addition,
unlike in the case of public utilities where the utility's only
source of revenue is the fees charged for the service or commodity,
issuers have other sources, besides interchange fees, from which
they can receive revenue to cover their costs of operations and earn
a profit.
\45\ See 75 FR 37526, 37531-32 (June 29, 2010), Black's Law
Dictionary at 1272 (7th ed. 1999)(defining ``reasonable'') and
Merriam Webster's Collegiate Dictionary at 936 (10th ed. 1995)
(defining ``proportional'').
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Although the Board believes the previously relied upon definitions
can inform this rulemaking, the Board notes that reasonableness and
proportionality have different connotations in the context of
interchange transaction fees than in the context of penalty fees. The
TILA provision related to the reasonableness and proportionality of the
fees charged when a violation of the account terms occurred. TILA
required the Board to consider the costs incurred by issuers as a
result of violations and other factors, including the need to deter
violations. In considering whether an interchange fee is reasonable,
the Board proposes to consider whether the fee is fair or proper in
relation to both the individual issuer's costs as well as the costs
incurred by other issuers. As discussed further below, the Board
believes it may determine that certain fee levels are reasonable based
on overall issuer cost experience, even if the individual issuer's
costs are above (or below) that fee level.
Similarly, in considering whether an interchange fee is
proportional to the issuer's costs, the Board does not believe that
proportionality must be interpreted to require identical cost-to-fee
ratios for all covered issuers (although a constant cost-to-fee ratio
would result from the issuer-specific standard discussed below for
issuers with allowable costs below the cap). Rather, if the Board were
to adopt a safe harbor or a fee cap (discussed further below) that it
determined to be reasonable, the cost-to-fee ratio of any issuer that
received fees at or below the safe harbor or cap would be deemed to
meet the proportionality standard.
2. Considerations for Standards
In EFTA Section 920, Congress set forth certain factors that the
Board is required to consider when establishing standards for
determining whether interchange transaction fees are reasonable and
proportional to the cost
[[Page 81734]]
incurred by the issuer. Specifically, EFTA Section 920 requires the
Board to (1) consider the functional similarity between electronic
debit transactions and checks, which are required to clear at par
through the Federal Reserve System and (2) distinguish between the
incremental cost of authorization, clearance, and settlement of a
particular transaction, which shall be considered, and other costs that
are not specific to a particular transaction, which shall not be
considered. Although Section 920 requires only the consideration of
these factors, the Board believes that they are indicative of
Congressional intent with respect to the implementation of Section 920,
and therefore provide a useful measure for which costs should and
should not be included in ``the cost incurred * * * with respect to the
transaction.''
Similarities to Check
There are a number of similarities between the debit card and check
payment systems. Both are payment instruments that result in a debit to
the payor's asset account. Debit card payments are processed
electronically, and while historically check processing has been paper-
based, today virtually all checks are processed and collected
electronically. Further, depository institutions have begun to offer
their depositors remote deposit capture services to enable merchants to
deposit their checks electronically. For both debit card and check
payments, merchants pay fees to banks, processors, or intermediaries to
process the payments. Settlement time frames are roughly similar for
both payment types, with payments settling within one or two days of
deposit.
However, there are also differences between debit card and check
payment systems.
Open versus closed systems. Debit card networks are closed systems
that both issuing and acquiring banks must join in order to accept and
make payments. To accept debit card payments, issuing and acquiring
banks must decide which debit card networks to join, establish a
relationship with those networks, and agree to abide by those networks'
rules. In contrast, the check system is an open system in which a
merchant simply needs a banking relationship through which it can
collect checks in order to be able to accept check payments from its
customers. The merchant's bank need not join a network in order to
collect a check.
Payment authorization. Payment authorization is an integral part of
the processing of a transaction on a debit card network. As part of the
payment authorization process, a card issuer determines, among other
things, whether the card is valid and whether there are sufficient
funds to cover the payment. In contrast, payment authorization is not
an inherent part of the check acceptance process, and therefore a
merchant does not know whether the check will be returned unpaid at the
time the merchant accepts the check. However, a merchant that wants to
better manage its risks associated with unpaid checks can purchase
value-added check verification and guarantee services from various
third-party service providers.
Processing and collection costs. In the check system, the payee's
bank (which is analogous to the merchant-acquiring bank for debit
cards) either incurs costs to present a check directly to the payor's
bank (which is analogous to the card-issuing bank) or pays fees to
intermediaries to collect and present the check to the payor's bank. In
either case, the payor's bank does not incur fees to receive check
presentments unless it has agreed to pay a fee to receive its
presentments electronically. In debit card systems, the merchant-
acquiring and card-issuing banks both pay fees to the network to
process payments for their respective customers.
Par clearing. In the check system, payments clear at par. When a
payee's bank presents a check to the payor's bank, the payor's bank
pays and the payee's bank receives the face value of the check. As
discussed above, a payee's bank may pay fees to an intermediary for
check collection services; however, check payments are cleared and
settled for the full face value of the checks. The payee's bank is not
required to pay a fee to the payor's bank to receive the settlement for
the full value of the checks presented. In contrast, in the debit card
system, because interchange fees represent fees paid by the merchant-
acquiring bank to card-issuing banks, the merchant-acquiring bank
receives less than the full value of debit card payments.
Routing. In the check system, the payee's bank decides the avenue
through which it collects checks. Checks can be presented directly to
the payor's bank, collected through an intermediary for a fee, or
exchanged through a clearing house.\46\ The decision is often based on
the avenue that offers the lowest clearing cost. For a debit card
payment, the merchant's choice with regard to routing is limited to the
set of networks whose cards the merchant accepts and that are also
available to process a transaction for its customer's card. Merchant
payment routing may be further limited if the card issuer has
designated routing preferences that must be honored when a customer
presents a card that can be used for payment on multiple (typically
PIN) networks. Such preferences may result in a transaction being
routed to a network that imposes a higher fee on the merchant's bank
(and hence the merchant) than if the payment were processed on another
available network.
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\46\ For checks exchanged through a clearing house, both the
payor's bank and the payee's bank must be members of or participate
in the clearing house.
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Ability to reverse transactions. In the check system, there is a
limited amount of time during which the payor's bank may return a check
to the payee's bank. Specifically, a check must be returned by the
``midnight deadline,'' which is midnight of the banking day after the
check was presented to the payor's bank for payment. After the midnight
deadline passes, a payor's bank can no longer return the payment
through the check payment system, although it may have legal remedies
in the event of a dispute or financial loss.\47\ In contrast, in the
debit card system, the time period within which a transaction may be
reversed is not as limited. Typically, many disputes can be addressed
through network chargeback processes without having to rely on legal
remedies. These chargebacks and disputes can be handled through the
network with procedures that are delineated in network rules.
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\47\ Uniform Commercial Code 4-301 and 4-302.
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Activity Costs To Be Considered
As noted above, the statute provides that, in establishing
standards for assessing whether an interchange fee is reasonable and
proportional to ``the cost incurred by the issuer with respect to the
transaction,'' the Board shall consider the incremental cost of
authorizing, clearing, and settling a particular transaction and shall
not consider other costs that are not specific to a particular
transaction.\48\ The statute is silent with respect to costs that are
specific to a particular transaction other than incremental costs
incurred by an issuer for authorizing, clearing, and settling the
transaction.
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\48\ Sec. 920(a)(3).
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After considering several options for the costs that may be taken
into account in setting interchange transaction fees (``allowable
costs''), the Board proposes such costs be limited to those associated
with authorization, clearing, and settlement of a transaction. This
formulation includes only those costs
[[Page 81735]]
that are specifically mentioned for consideration in the statute. If an
issuer outsources its authorization, clearance, and settlement
activities, allowable costs would include fees paid to a processor for
authorization, clearance, and settlement services.
In the definition of allowable costs, the Board proposes to exclude
network processing fees (i.e., switch fees) paid by issuers.\49\ Card
issuers pay such fees to payment card networks for each transaction
processed over those networks. Although these network fees typically
are not associated with one specific component of authorization,
clearance, or settlement of the transaction, a particular transaction
cannot be authorized, cleared, and settled through a network unless the
issuer pays its network processing fees. The Board proposes that
network processing fees be excluded from allowable costs, because the
Board recognizes that if network processing fees were included in
allowable costs, acquirers (and, by extension, merchants) might be in
the position of effectively paying all network fees associated with
debit card transactions. That is, an acquirer would pay its own network
processing fees directly to the network and would indirectly pay the
issuer's network processing fees through the allowable costs included
in the interchange fee standard.\50\
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\49\ These fees do not include processing fees paid by an issuer
to a network in its role as processor (i.e., a role equivalent to
that of an issuer's third-party processor).
\50\ Such an arrangement would be similar to traditional paper-
check processing where the payee's bank typically pays all of the
processing costs, while the payor's bank typically pays no
processing fees. However, this arrangement would be consistent with
electronic check collection systems where both the payor's bank and
payee's bank generally pay processing fees.
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The Board considered including other costs associated with a
particular transaction that are not incurred by the issuer for its role
in authorization, clearing, and settlement of that transaction. Such
costs might include, for example, cardholder rewards that are paid by
the issuer to the cardholder for each transaction. The Board does not
view the costs of cardholder rewards programs as appropriate for
consideration within the context of the statute. Other costs associated
with a particular debit transaction might also include costs associated
with providing customer service to cardholders for particular
transactions, such as dealing with cardholder inquiries and complaints
about a transaction. Given the statute's mandate to consider the
functional similarities between debit transactions and check
transactions, the Board proposes that allowable costs be limited to
those that the statute specifically allows to be considered, and not be
expanded to include additional costs that a payor's bank in a check
transaction would not recoup through fees from the payee's bank.
The Board requests comment on whether it should allow recovery
through interchange fees of other costs of a particular transaction
beyond authorization, clearing, and settlement costs. If so, the Board
requests comment on what other costs of a particular transaction,
including network fees paid by issuers for the processing of
transactions, should be considered allowable costs. The Board also
requests comment on any criteria that should be used to determine which
other costs of a particular transaction should be allowable.
The Board considered limiting the allowable costs to include only
those costs associated with the process of authorizing a debit card
transaction, because this option may be viewed as consistent with a
comparison of the functional similarity of electronic debit
transactions and check transactions. Among the most prominent
differences between debit cards and checks is the existence of
authorization for a debit card transaction where the deposit account
balance is checked at the time of the transaction to ensure that the
account has sufficient funds to cover the transaction amount. Clearing
and settlement occur for both debit cards and checks, but for checks
there is nothing analogous to an interchange fee to reimburse the
issuer for the cost of clearing and settling a transaction. However,
because the statute instructs the Board to also consider the costs of
clearance and settlement, the Board proposes to include those costs.
The Board requests comment on whether it should limit allowable costs
to include only the costs of authorizing a debit card transaction.
Cost Measurement
As noted above, the statute specifically requires consideration of
the ``incremental'' cost of authorization, clearance, and settlement of
a particular transaction. There is no single, generally-accepted
definition of the term ``incremental cost.'' One commonly-used economic
definition of ``incremental cost'' refers to the difference between the
cost incurred by a firm if it produces a particular quantity of a good
and the cost incurred by that firm if it does not produce the good at
all.\51\ Other definitions of incremental cost consider the cost of
producing some increment of output greater than a single unit but less
than the entire production run. However, under any of these
definitions, the increment of production is larger than the cost of any
particular transaction (and, in the first definition, as large as the
entire production run in the first case).\52\ As a result, the Board
believes that these definitions of incremental cost do not
appropriately reflect the incremental cost of a particular transaction
to which the statute refers.
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\51\ Baumol, William J., John C. Panzar, and Robert D. Willig
(1982), Contestable Markets and the Theory of Industry Structure.
New York: Harcourt Brace Jovanovich. This definition involves any
fixed or variable costs that are specific to the entire production
run of the good and would be avoided if the good were not produced
at all. Notably, this measurement excludes any common costs across
goods that a firm produces, such as common fixed overhead costs, as
those costs would still be incurred if production of the good of
interest were ceased.
\52\ Fundamentally, none of these definitions correspond to a
per-transaction measure of incremental cost that could be applied to
any particular transaction, regardless of the particular transaction
used for such a definition.
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The Board proposes that the interchange fee standard allow for the
inclusion of the per-transaction value of costs that vary with the
number of transactions (i.e., average variable cost) within the
reporting period. This cost calculation yields the cost of a typical or
average transaction. This measure of per-transaction cost does not
consider costs that are shared with other products of an issuer, such
as common fixed or overhead costs, which would still be incurred in the
absence of debit card transactions. For example, the Board does not
believe that other costs of deposit accounts or, more generally,
depository institutions, which cannot be attributable to debit card
transactions, are appropriate to include in allowable costs. While a
debit card program may not exist if certain costs are not incurred,
such as account set-up costs or corporate overhead costs, it does not
follow that those costs would be avoided in the absence of a debit card
program.
However, if variable costs of authorizing, clearing, and settling
debit card transactions are shared with credit card operations, the
Board believes that some portion of such costs should be allocated to
debit card transactions. For example, these costs may be recorded
jointly in internal cost accounting systems or not separated on third-
party processing invoices. These costs should be allocated to debit
cards based on the proportion of debit card transactions to total card
transactions.
[[Page 81736]]
This measure would not consider costs that are common to all debit
card transactions and could never be attributed to any particular
transaction (i.e., fixed costs), even if those costs are specific to
debit card transactions as a whole. Such fixed costs of production
could not be avoided by ceasing production of any particular
transaction (except perhaps the first).
The Board recognizes that, by distinguishing variable costs from
fixed costs, this standard imposes a burden on issuers by requiring
issuers to segregate costs that vary with the number of transactions
from those that are largely invariant to the number of transactions,
within the reporting period. The Board also acknowledges that
differences in cost accounting systems across depository institutions
may complicate enforcement by supervisors. Finally, the Board
recognizes that excluding fixed costs may prevent issuers from
recovering through interchange fees some costs associated with debit
card transactions. However, as noted above, the Board also recognizes
that issuers have other sources, besides interchange fees, from which
they can receive revenue to help cover the costs of debit card
operations. Moreover, such costs are not recovered from the payee's
bank in the case of check transactions.
The Board also considered a cost measurement in terms of marginal
cost or, in other words, the cost of an additional transaction.
However, marginal cost can be different for each unit of output, and it
is unclear which unit of output's cost should be considered, although
often it is assumed to be the last unit. Notably, if marginal cost does
not vary materially over the relevant volume range, then average
variable cost will provide a close approximation to marginal cost for
any particular transaction.\53\ In addition, average variable cost is
more readily measurable than marginal cost for issuers and supervisors.
Specifically, marginal cost for a given issuer cannot be calculated
from cost accounting data; instead, it must be identified and estimated
based on assumptions about costs that would have been incurred if an
issuer's transaction volume had differed from that which actually
occurred.\54\
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\53\ In particular, if marginal cost is constant, then average
variable cost equals marginal cost. More generally, average variable
cost equals the average marginal cost across all transactions.
\54\ See, Turvey, Ralph ``What are Marginal Costs and How to
Estimate Them?'' University of Bath School of Management, Centre for
the Study of Regulated Industries, Technical Paper 13(2000).
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The Board requests comment on whether it should include fixed costs
in the cost measurement, or alternatively, whether costs should be
limited to the marginal cost of a transaction. If the latter, the Board
requests comment on how the marginal cost for that transaction should
be measured.
B. Proposed Interchange Fee Standards
The statute requires that the amount of any interchange transaction
fee that an issuer receives or charges with respect to an electronic
debit transaction must be ``reasonable and proportional to the cost
incurred by the issuer with respect to the transaction.'' \55\ Proposed
Sec. 235.3 sets forth two alternatives (referred to as ``Alternative
1'' and ``Alternative 2'') for determining the level of the allowable
interchange fee. Alternative 1 proposes an issuer-specific approach
combined with a safe harbor and a cap. Under Alternative 1, an issuer
may receive or charge interchange transaction fees at or below the safe
harbor amount or based on a determination of its allowable costs, up to
a cap. Alternative 2 proposes a stand-alone cap. The Board proposes to
adopt only one of the alternatives and requests comment on each, as
well as on any other alternatives that could be applied.
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\55\ See Sec. 920(a)(2) of the EFTA.
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1. Alternative 1--Issuer-Specific up to a Cap, With a Safe Harbor
Under Alternative 1, an issuer could comply with the regulatory
standard for interchange fees by calculating allowable per-transaction
cost, based on the allowable costs described by the Board, and ensuring
that it did not receive an interchange fee for any transaction in
excess of its allowable per-transaction cost. Proposed Sec. 235.3(c)
sets forth an issuer's allowable costs. As discussed above, these are
the issuer's costs that are attributable to its role in authorization,
clearance, and settlement of electronic debit transactions and that
vary, up to existing capacity limits within a reporting period, with
the number of electronic debit transactions sent to the issuer. Network
fees paid by the issuer are excluded from allowable costs. Proposed
Sec. 235.3(b)(2) limits the amount of any interchange fee that an
issuer may receive to no more than the allowable costs divided by the
number of electronic debit transactions on which the issuer received or
charged an interchange transaction fee in the calendar year.
Alternative 1 also provides for a cap of 12 cents per transaction
(proposed Sec. 235.3(b)(2)). An issuer could not receive an
interchange fee above the cap regardless of its allowable cost
calculation. In addition, Alternative 1 would deem any interchange fee
at or below a safe harbor level of 7 cents per transaction to be in
compliance with the regulatory standard (proposed Sec. 235.3(b)(1)),
regardless of the issuer's allowable per-transaction cost.
Under Alternative 1, each payment card network could set
interchange fees for each issuer (1) at or below the safe harbor \56\
or (2) at a level for the issuer that would not exceed the issuer's
allowable per-transaction costs up to the cap.\57\ A network would be
permitted to set fees that vary with the value of the transaction (ad
valorem fees), as long as the maximum amount of the interchange fee
received by an issuer for any electronic debit transaction was not more
than that issuer's maximum permissible interchange fee. A network would
also be permitted to establish different interchange fees for different
types of transactions (e.g., card-present and card-not-present) or
types of merchants, as long as each of those fees satisfied the
relevant limits of the standard. Each issuer's supervisor would verify
that the amount of any interchange fee received by an issuer is, in
fact, commensurate with the safe harbor, the issuer's allowable per-
transaction costs, or the cap, as appropriate. Each of the three
elements of this alternative, the issuer-specific determination, the
cap, and the safe harbor, are discussed in more detail below.
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\56\ This rule would not require a payment card network to set
an interchange fee above the safe harbor. Whether a network would
implement an issuer-specific interchange fee is the network's
prerogative.
\57\ Under this option, if a network planned to establish
interchange fees on a per-issuer basis above the safe harbor, an
issuer would report its maximum allowable interchange fee to the
network.
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Issuer-Specific Determination
EFTA Section 920(a)(2) requires that ``the amount of any
interchange transaction fee that an issuer may receive or charge * * *
be reasonable and proportional to the cost incurred by the issuer with
respect to the transaction.'' One reading of that provision is that the
use of the definite article ``the'' in the second half of the standard
suggests that the interchange fee limitation should be determined
separately for each issuer and each transaction presented to that
issuer. As discussed below, however, such an approach would be
impractical and difficult to administer and enforce, and would
introduce undesirable economic incentives.
Measuring the allowable cost of each transaction would be highly
impracticable due to the volume of
[[Page 81737]]
transactions and the fact that the cost of each transaction is likely
not known when the interchange fee is charged. The Board believes that
the average variable cost, as discussed above, provides a reasonable
approximation of an issuer's per-transaction cost for its role in
authorization, clearance, and settlement. The Board believes that a
maximum interchange fee determined on an issuer-specific basis as
provided in Alternative 1 is both reasonable, in that it reflects only
those allowable costs identified by the Board (up to a cap, discussed
further below), and is directly proportional to the issuer's actual
costs.
From an economic perspective, an issuer-specific determination
directly links the compensation through interchange fees for each
issuer to that issuer's specific costs. A major drawback of this
approach is that it would not provide incentives for issuers to control
their costs. In particular, an issuer that is eligible to recoup its
costs under an issuer-specific determination with no cap would face no
penalty for having high costs. Conversely, because a reduction in costs
would lead to a reduction in an issuer's interchange fee, an issuer
would receive no reward for reducing its costs (in the absence of a
safe harbor). As a result, issuers would have no incentive to minimize
their costs and may incur higher costs than they would otherwise. An
issuer-specific determination might also encourage over-reporting of
costs by an issuer because any inflation of the reported costs would be
directly rewarded with a higher interchange fee for the issuer. Such
undesirable incentive properties have generally led economists to
advocate the abandonment of cost-of-service regulation in regulated
industries in favor of approaches that yield better incentives to the
regulated entities.\58\
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\58\ Joskow, Paul L. (2008), ``Incentive Regulation and its
Application to Electricity Networks,'' Review of Network Economics,
Vol. 7, Issue 4, pp. 547-60. Kahn, Alfred E. (1988), The Economics
of Regulation: Principles and Institutions, Cambridge: MIT Press.
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An issuer-specific determination, on its own, would also place a
significant implementation and administration burden on industry
participants and supervisors. Each issuer would have to account for its
costs in a manner that enables it to segregate allowable costs that
could be recovered through the interchange fee from its other costs,
tabulate those costs on an ongoing basis, and report them to the
networks in which it participates. A network that set issuer-specific
fees would need to incorporate such fees into its fee schedules,
including the operational ability to distinguish among many different
issuers in order to apply different rates to each of those issuers'
transactions. The issuers' supervisors would need to evaluate each
issuer's reported costs and verify that each issuer's interchange fees
appropriately reflect those reported costs.
Cap
To address, at least in part, the incentive problems discussed
above with respect to a purely issuer-specific determination, the Board
proposes to place a ceiling on the amount of any issuer-specific
determination by specifying a cap of 12 cents per transaction. With an
issuer-specific determination and a cap, the Board would deem any
interchange fee that was equal to an issuer's allowable costs to be
reasonable and proportional to the issuer's costs if it is at or below
the cap.
Some issuers that are subject to the interchange fee limitations
have debit card programs with substantially higher per-transaction
costs than others. These unusually high costs might be due to small
programs targeted at high-net-worth customers or newer start-up
programs that have not yet achieved economies of scale. In comparing
reported per-transaction costs to current interchange transaction fee
levels, the Board believes it is unlikely that these issuers currently
are recovering their per-transaction costs through interchange
transaction fees. The Board does not believe it is reasonable for the
interchange fee to compensate an issuer for very high per-transaction
costs. The Board believes that setting the cap at 12 cents per
transaction will be sufficient to allow all but the highest-cost
issuers discussed above to recover through interchange transaction fees
the costs incurred for authorizing, clearing, and settling electronic
debit transactions. The Board notes that even the highest-cost issuers
have sources of revenue in addition to interchange fees, such as
cardholder fees, to help cover their costs.
A cap would eliminate some of the negative incentives of a purely
issuer-specific determination. An issuer with costs above the cap would
not receive interchange fees to cover those higher costs. As a result,
a high-cost issuer would have an incentive to reduce its costs in order
to avoid this penalty. The Board would re-examine the cap periodically
(to coincide with the reporting requirements in proposed Sec. 235.8)
to ensure that the cap continues to reflect a reasonable fee.
To determine an appropriate value for a cap, the Board used data
from responses to the card issuer survey described earlier. The Board
used data on transaction volumes and the variable cost of
authorization, clearing, and settlement (the allowable costs under an
issuer-specific determination) to compute an issuer's per-transaction
cost. These data were used to compute various summary measures of per-
transaction variable costs for issuers, generally. For this sample of
issuers, the Board estimated that the per-transaction variable costs,
averaged across all issuers, were approximately 13 cents per
transaction. Average per-transaction variable costs were approximately
4 cents per transaction when each issuer's costs are weighted by the
number of its transactions.\59\ The 50th percentile of estimated per-
transaction variable costs was approximately 7 cents.
---------------------------------------------------------------------------
\59\ This value corresponds to the aggregate per-transaction
cost for all covered issuers.
---------------------------------------------------------------------------
The Board proposes a cap of 12 cents per transaction because, while
it significantly reduces interchange fees from current levels
(approximately 44 cents per transaction, on average, based on the
survey of payment card networks), it allows for the recovery of per-
transaction variable costs for a large majority of covered issuers
(approximately 80 percent). The proposed cap does not differentiate
between different types of electronic debit transactions (e.g.,
signature-based, PIN-based, or prepaid). From the survey results, the
Board found some evidence of differences in allowable costs across
signature and PIN debit transactions. In particular, the mean and
median values of allowable costs for signature debit transactions were
approximately 2 cents higher per transaction than the analogous figures
for PIN debit transactions, while the 80th percentile was approximately
1 cent higher per transaction for signature debit transactions.
However, because these estimates are based on a sample of data, and
because the variation among the individual issuers' costs was large,
the ability to reliably infer a statistically significant difference
from the data is limited. As a result, the Board does not propose to
distinguish initially between the cap value for signature and PIN debit
transactions, for either Alternative 1 or Alternative 2. For the same
reasons, as described below, the Board does not propose to allow the
safe harbor value to vary initially by authorization method. The Board
requests comment on whether it should allow for such differences in the
cap or safe harbor values.
The Board notes that issuers reported higher costs for authorizing,
clearing, and settling prepaid card transactions
[[Page 81738]]
(many of which are likely to be exempt from the interchange fee
restrictions). The Board believes that issuers reported higher prepaid
costs for one or more of the following reasons. First, many prepaid
programs use stand-alone components, such as processing infrastructure,
that are unable to exploit economies of scale that result from a large
number of prepaid transactions or other debit card transactions.
Second, because of the stand-alone components, all costs are allocated
to prepaid card programs. Third, many prepaid issuers outsource almost
all prepaid activity to third-party processors that include fixed costs
and a mark-up in per-transaction fees. Finally, the cost data reported
to the Board include information for both non-exempt and exempt cards.
Exempt cards may have higher costs than non-exempt cards due to
differences in the functionality of exempt cards, such as the need to
verify the eligibility of transactions under certain government
benefits programs. In light of the higher reported prepaid card costs,
the Board specifically requests comment on whether the Board should
initially have separate standards for debit card transactions and
prepaid card transactions, and what those different standards should
be.\60\
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\60\ The Board notes that prepaid cards do not currently have
different interchange fees than other debit cards despite any
potential differences in costs across the two types of cards.
---------------------------------------------------------------------------
Safe Harbor
To further address the incentive and administrative burden problems
discussed above, the Board proposes to provide a safe harbor for
issuers as an alternative to the issuer-specific determination.
Alternative 1 provides that, regardless of an issuer's per-transaction
allowable cost, an interchange fee that is less than or equal to 7
cents per transaction is deemed to be reasonable and proportional to
the issuer's cost of the electronic debit transaction. Thus, issuers
would have an incentive to reduce their per-transaction costs below the
safe harbor.
In determining the proposed safe harbor amount, the Board
considered allowable issuer costs identified in responses to its card
issuer survey. Using the issuer cost data described above, the Board
proposes that 7 cents per transaction is an appropriate safe harbor
value for the interchange fee. This value represents the approximate
median in the distribution of estimated per-transaction variable costs.
Like the cap discussed above, the Board proposes one safe harbor for
all electronic debit transactions (i.e., signature, PIN and prepaid).
The Board recognizes that issuers' costs may change over time, and the
Board proposes to re-examine the safe harbor amount periodically in
light of changing issuer costs.
Overall, this approach reduces administrative burden on those
issuers that choose to rely on the safe harbor, rather than determine
their allowable costs, and allows issuers with costs above the safe
harbor to receive an interchange fee directly linked to their costs, up
to the level of the cap. At the same time, for an issuer with costs
below the safe harbor value, this approach provides a reward for
efficient production while also encouraging cost reductions to maximize
the spread between the issuer's costs and the safe harbor value.
2. Alternative 2--Stand-Alone Cap
Under Alternative 2, the Board would use information about issuer
costs to determine an appropriate maximum interchange fee, or a cap,
that would apply uniformly to all issuers. That is, each issuer could
receive interchange fees up to the cap, regardless of that specific
issuer's actual allowable costs. Alternative 2 provides that an
interchange transaction fee is reasonable and proportional to an
issuer's cost only if it is no more than 12 cents per transaction. As
in Alternative 1, a network would be permitted to set fees that vary
with the value of the transaction (ad valorem fees) or with the type of
transaction or type of merchant, but only such that the maximum amount
of the interchange fee for any transaction was not more than the cap of
12 cents. The Board proposes the same cap of 12 cents per transaction
in Alternative 2 as in Alternative 1 for the reasons stated in the
discussion of Alternative 1. Each issuer's supervisor would verify that
an issuer does not receive interchange revenue in excess of the cap.
The Board recognizes that issuers' costs may change over time, and the
Board proposes to conduct periodic surveys of covered issuers and re-
examine the cap amount periodically in light of changing issuer costs.
As in Alternative 1, a stand-alone cap would encourage high-cost
issuers to reduce their costs. In addition, an issuer with costs below
the cap would receive a markup reflecting the spread between its costs
and the cap value. Because the magnitude of the spread increases with
the difference between the issuer's costs and the cap, all issuers,
including low-cost issuers, would have an incentive to improve the
efficiency of their operations. Finally, a cap reduces somewhat the
incentive for an issuer to inflate its reported costs because no issuer
would receive direct compensation for higher costs. These incentives
have motivated authorities in other contexts to set price caps in many
regulated industries, including, for example, the Reserve Bank of
Australia in its intervention in the Australian credit and debit card
markets.
In comparison to Alternative 1, administration and implementation
of this approach places less administrative burden on industry
participants. Although the issuer would have to report its costs to the
Board every two years in accordance with Sec. 235.8, an issuer would
not have to calculate or report to the networks its maximum allowable
interchange transaction fee. Similarly, a payment card network would
not need to incorporate issuer-specific fees into its fee schedule, as
the cap would apply uniformly to all covered issuers in that network.
3. Application of the Interchange Fee Standard
Under both Alternative 1 and Alternative 2, the limitations on
interchange fees would apply on a per-transaction basis. Under both
alternatives, no electronic debit transaction presented to an issuer
could carry an interchange fee that exceeds the interchange fee
standard for that issuer.\61\ As noted above, supervisory review would
be necessary to verify that an issuer does not receive interchange fee
payments in excess of the maximum permitted by the rule.
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\61\ In no case does the standard prevent a network from setting
interchange fees below the established amount. Instead, the standard
describes the maximum appropriate interchange fee.
---------------------------------------------------------------------------
This approach generally follows the statutory provisions discussed
above that refer to ``the'' issuer and ``the'' transaction. The Board
recognizes, however, that this approach restricts flexibility in
setting interchange fees to reflect differences in risk, among other
things. If the interchange fee standard must hold strictly for all
transactions, then an issuer would be unable to receive a higher
interchange fee for relatively high-risk transactions offset by lower
interchange fees on relatively low-risk transactions.
The Board has identified two other potential methods for
implementing the interchange fee standards and requests comment on
each. The first approach would allow flexibility in interchange fees
with respect to a particular issuer. Under this approach, the issuer
could comply with the rule as long as it meets the interchange fee
standard, on average, for all of its electronic debit
[[Page 81739]]
transactions over a particular network during a specified period. In
other words, some interchange fees above the amount of the standard
would be permitted as long as those were offset by other fees below the
standard. The second approach would allow an issuer to comply with the
rule with respect to transactions received over a particular network as
long as, on average, over a specified period, all covered issuers on
that network meet the fee standard given the network's mix of
transactions. In other words, compliance with the interchange fee
standard would be evaluated at the network level, rather than at the
level of each individual issuer.
Both of these approaches would provide flexibility in setting
interchange fees to incorporate considerations such as differences in
risk across transactions. However, both of these approaches would
introduce the possibility that any particular set of fees, set ex ante
given assumptions about an issuer's or a network's expected mix of
transactions, would result in an average fee for the actual
transactions experienced that exceeded the regulatory standard.
Moreover, network and issuer efforts to manage transactions and fees to
stay within established limits could become very complex. Therefore, if
the Board were to adopt either of these approaches, it may also need to
deem an issuer to be in compliance with the standard as long as the
interchange fees were set based on the issuer's or the network's
transaction mix over a previous, designated, period of time, regardless
of the actual transaction experience during the time period the fee is
in effect.
The Board requests comment on whether either of these approaches is
appropriate. If so, the Board requests comment about whether and how it
should adopt standards with respect to a permissible amount of
variation from the benchmark for any given interchange transaction fee.
4. Proposed Regulatory Language
Proposed Sec. 235.3(a) restates the statutory requirement that the
amount of any interchange transaction an issuer charges or receives
with respect to a transaction must be reasonable and proportional to
the cost incurred by the issuer with respect to the transaction.
Proposed Sec. 235.3(a) is the same for both Alternatives 1 and 2.
Alternative 1. Alternative 1 is contained in proposed Sec. Sec.
235.3(b) through (e) of the alternative.
Interchange fee determination. Proposed Sec. 235.3(b) sets forth
the exclusive standards for determining whether the amount of any
interchange fee is reasonable and proportional to the issuer's cost.
Proposed Sec. 235.3(b) sets the safe harbor amount and the issuer-
specific approach, up to the cap, described above. Except during the
transition period, the amount of any interchange fee must comply with
the standards from October 1 of any given calendar year through
September 30 of the following calendar year. See proposed comments
3(b)-1 through -4.
Proposed Sec. 235.3(c) sets forth an exclusive list of allowable
costs for purposes of the issuer-specific approach. Specifically, as
discussed above, an issuer may include only those costs that are
attributable to the issuer's role in authorization, clearance, and
settlement of the transaction. Proposed Sec. 235.3(c)(1) describes
activities that comprise the issuer's role in authorization, clearance,
and settlement and limits the types of costs that may be included to
those that vary with the number of transactions sent to the issuer.
Proposed Sec. 235.3(c)(2) specifies that fees charged by a payment
card network with respect to an electronic debit transaction are not
included in the allowable costs. See also proposed comment 3(c)-1.
Proposed comment 3(c)-2 describes in more detail the issuer's role
in authorization, clearance, and settlement of a transaction. Proposed
comment 3(c)-2 also specifies the types of costs that an issuer is
considered to incur for authorization, clearance, and settlement of a
transaction. With respect to authorization, an issuer may include the
costs of activities such as data processing, voice authorization
inquiries and referral requests. See proposed comment 3(c)-2.i. With
respect to clearance, proposed comments 3(c)-2.ii and 3(c)-2.iii
clarify that an issuer's costs for clearance of routine and non-routine
transactions include costs of data processing, to the extent the issuer
incurs additional such costs for clearance. An issuer's clearance costs
also include the costs of reconciling clearing message information,
initiating the chargeback message, and data processing and
reconciliation expenses specific to receiving representments and error
adjustments. Finally, with respect to settlement, an issuer may include
costs of interbank settlement through a net settlement service, ACH, or
Fedwire[supreg] and the cost of posting the transactions to the
cardholders' accounts. See proposed comment 3(c)-2.iv.
Proposed Sec. 235.3(c)(1) limits allowable costs to those that
vary with the number of electronic debit transactions sent to the
issuer during a calendar year. Proposed comment 3(c)-3.i describes, and
provides examples of, the distinction between allowable, variable costs
(those costs that vary, up to existing capacity limits, with the number
of transactions sent to the issuer over the calendar year) and
unallowable, fixed costs (those costs that do not vary, up to existing
capacity limits, with the number of transactions sent to the issuer
over the calendar year).
Proposed Sec. 235.3(c)(2) states that allowable costs do not
include the fees an issuer pays to a network for processing
transactions. Proposed comment 3(c)-3.ii clarifies that switch fees are
an example of fees that are not an allowable cost. Proposed comment
3(c)-3.ii further explains that fees an issuer pays to a network when
the network acts as the issuer's third-party processor are allowable
costs.
As clarified in proposed comment 3(c)-3-iii, an issuer would not be
permitted to include costs that are common to other products offered by
the issuer, except insofar as those costs are allowable costs that are
shared with other payment card products and vary with the number of
debit transactions. Proposed comment 3(c)-3-iv clarifies that proposed
Sec. 235.3(c) sets forth an exhaustive list of allowable costs, and
provides examples of costs that may not be included, such as the costs
of rewards programs. The Board requests comment on whether additional
clarification of allowable costs is needed.
Disclosure to payment card network. Each issuer must ensure that it
is in compliance with proposed Sec. 235.3(a) by receiving or charging
interchange transaction fees at or below the safe harbor amount or as
determined by its allowable costs up to the cap. Because payment card
networks, not issuers, establish interchange fees, issuers must provide
networks with information sufficient to ensure the issuers' compliance.
Proposed Sec. 235.3(d) requires an issuer to report the maximum amount
of an interchange transaction fee it may receive or charge to a
network, but only if the issuer will be receiving or charging an
interchange fee above the safe harbor amount.
In establishing the conditions for reporting, the Board recognizes
that not all networks likely will establish individualized interchange
transaction fees. If a network does not establish individualized
interchange transaction fees above the safe harbor amount, the Board
believes it is not necessary to require an issuer to report its maximum
allowable interchange transaction fee to networks through which it
receives
[[Page 81740]]
electronic debit transactions. See proposed comment 3(d)-1. The Board
requests comment on whether this reporting requirement is necessary to
enable networks to set issuer-specific interchange fees.
The Board proposes that an issuer report its maximum allowable
interchange fee to each payment card network through which it processes
transactions by March 31 of each year (based on the costs of the
previous calendar year) to ensure compliance with the standard
beginning on October 1 of that same year. See proposed comment 3(d)-2.
The Board specifically requests comment on whether prescribing the
deadline by rule is necessary. If necessary, the Board requests comment
on whether March 31 is an appropriate deadline or whether a different
deadline is appropriate.
Transition period. As noted above, the Board is proposing to allow
three months after year-end for an issuer to determine and report its
maximum allowable interchange transaction fee, if its payment card
networks establish individualized interchange fees above the safe
harbor amount. The new interchange fee standards will be effective July
21, 2011, and are proposed to be based on 2009 costs. The Board
believes that establishing new interchange fees based on calendar year
2010 costs on September 30, 2011 (approximately two months after the
effective date) will impose an unnecessary burden on issuers, payment
card networks, and acquirers. Accordingly, the Board proposes to allow
issuers to rely on calendar year 2009 costs until September 30, 2012.
After that date, issuers must determine compliance based on calendar
year 2011 costs.
Alternative 2. Alternative 2 is contained in proposed Sec.
235.3(b). That section prohibits an issuer from receiving or charging
any interchange transaction fee greater than 12 cents. See proposed
comment 3(b)-1 under Alternative 2.
IV. Section 235.4 Adjustment for Fraud-Prevention Costs
Section 920(a)(5) of the statute provides that the Board may allow
for an adjustment to the interchange fee amount received or charged by
an issuer if (1) such adjustment is reasonably necessary to make
allowance for costs incurred by the issuer in preventing fraud in
relation to electronic debit card transactions involving that issuer,
and (2) the issuer complies with fraud-prevention standards established
by the Board.\62\ Those standards must be designed to ensure that any
adjustment is limited to the issuer's fraud-prevention costs for
electronic debit transactions; takes into account any fraud-related
reimbursements received from consumers, merchants, or payment card
networks in relation to electronic debit transactions involving the
issuer; and requires issuers to take effective steps to reduce the
occurrence of, and costs from, fraud in relation to electronic debit
transactions, including through the development and implementation of
cost-effective fraud-prevention technology.
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\62\ In describing Section 1075 of the Dodd-Frank Act, Senator
Durbin stated: ``Further, any fraud prevention cost adjustment would
be made on an issuer-specific basis, as each issuer must
individually demonstrates that it complies with the standards
established by the Board, and as the adjustment would be limited to
what is reasonably necessary to make allowance for fraud-prevention
costs incurred by that particular issuer.'' 156 Cong. Rec. S5925
(July 15, 2010).
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In issuing the standards and prescribing regulations for the
adjustment, the Board must consider (1) The nature, type, and
occurrence of fraud in electronic debit transactions; (2) the extent to
which the occurrence of fraud depends on whether the authorization in
an electronic debit transaction is based on a signature, PIN, or other
means; (3) the available and economical means by which fraud on
electronic debit transactions may be reduced; (4) the fraud-prevention
and data-security costs expended by each party involved in the
electronic debit transactions (including consumers, persons who accept
debit cards as a form of payment, financial institutions, retailers,
and payment card networks); (5) the costs of fraudulent transactions
absorbed by each party involved in such transactions (including
consumers, persons who accept debit cards as a form of payment,
financial institutions, retailers, and payment card networks); (6) the
extent to which interchange transaction fees have in the past reduced
or increased incentives for parties involved in electronic debit
transactions to reduce fraud on such transactions; and (7) such other
factors as the Board considers appropriate.
For the reasons set forth below, the Board has not proposed
specific regulatory provisions to implement an adjustment for fraud-
prevention costs to the interchange transaction fee. The Board,
however, sets forth two approaches--a technology-specific approach and
a non-prescriptive approach--to designing the adjustment framework and
requests comment on several questions related to these approaches. The
Board plans to consider the comments in developing a specific proposal
for further public comment.
A. Background and Survey Results
Although the statute authorizes the Board to allow an adjustment to
an interchange fee for fraud-prevention costs, the statute does not
define the term ``fraud.'' In considering whether to allow an
adjustment, the Board believes that fraud in the debit card context
should be defined as the use of a debit card (or information associated
with a debit card) by a person, other than the cardholder, to obtain
goods, services, or cash without authority for such use.\63\
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\63\ This definition derives from the EFTA's definition of
``unauthorized electronic fund transfer.'' 15 U.S.C. 1693a(11).
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Two primary steps are involved in making fraudulent purchases using
a debit card. The first is stealing the cardholder account data. The
second is using the stolen card or account data to make the fraudulent
transaction. A thief may steal the card or the account information in
several ways. For example, a card may be lost or stolen, and a thief
may simply use the card to make purchases. Alternatively, a thief could
obtain card account data by breaching the data-security systems of any
entity that maintains records of debit card data. A thief might use the
card account data to create a counterfeit card. The stolen card or
account data may also be used to make unauthorized card-not-present
transactions via the Internet, phone, or mail-order purchases.
As part of its survey of debit card issuers, payment card networks,
and merchant acquirers, the Board gathered information about the
nature, type, and occurrence of fraud in electronic debit transactions
at the point of sale, and the losses due to fraudulent transactions
absorbed by parties involved in such transactions.\64\ Respondents were
asked to report this information separately for signature and PIN debit
card programs.\65\ From the surveys, the Board estimates that industry-
wide fraud losses to all parties of a debit card transaction were
approximately $1.36 billion in 2009.\66\ About $1.15 billion of these
losses arose from signature debit
[[Page 81741]]
card transactions and about $200 million arose from PIN debit card
transactions.\67\
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\64\ Respondents were not asked to provide data on ATM fraud.
\65\ For more information, see the previous discussion regarding
the survey process.
\66\ Industry-wide fraud losses were extrapolated from data
reported in the issuer and network surveys. Of the 89 issuers who
responded to the issuer survey, 38 issuers provided data on total
fraud losses related to their electronic debit card transactions.
These issuers reported $719 million in total fraud losses to all
parties of card transactions and represented 53 percent of the total
transactions reported by networks.
\67\ The higher losses for signature debit card transactions
result from both a higher rate of fraud and higher transaction
volume for signature debit card transactions.
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The surveys also solicited information about respondents' fraud-
prevention and data-security activities and the costs of these
activities. The surveys did not capture analogous activities and costs
for merchants (or cardholders). The data presented below derive from
the survey of debit card issuers, which has the most complete
information about fraud losses.\68\ The data are estimates given the
variability in reporting across issuers about fraud types, associated
fraud losses, and fraud-prevention and data-security activities and
costs.
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\68\ Networks' information regarding fraud losses may not be as
complete as that of issuers because fraud losses absorbed by the
issuers would generally not flow through the networks as chargebacks
and may not be fully reported to the networks. Acquirers would
generally not have knowledge about issuer losses.
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Issuers that provided data on total fraud losses relating to their
electronic debit card transactions reported $719 million in total debit
card fraud losses to all parties, averaging 0.041 percent of
transaction volume and 9.4 basis points of transaction value. These
fraud losses were generally associated with 10 different types of
fraud. The most commonly reported fraud types were counterfeit card
fraud, lost and stolen card fraud, and card-not-present fraud.
Issuers reported that total signature and PIN debit card fraud
losses to all parties averaged 13.1 and 3.5 basis points, respectively.
This represents, on a per-dollar basis, signature debit fraud losses
3.75 times PIN-debit fraud losses. These different fraud rates reflect,
in part, differences in the ease of fraud associated with the two
authorization methods. A signature debit card transaction requires
information that is typically contained on the card itself in order for
card and cardholder authentication to take place. Therefore, a thief
only needs to steal information on the card in order to commit
fraud.\69\ In contrast, a PIN debit card transaction requires not only
information contained on the card itself, but also something only the
cardholder should know, namely the PIN. In this case, a thief needs
both the information on the card and the cardholder's PIN to commit
fraud.
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\69\ Among other things, information on the card includes the
card number, the cardholder's name, and the cardholder's signature.
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Signature debit card transactions exhibit a higher fraud rate than
that of PIN debit card transactions. Debit cards used to make purchases
over the Internet and in other card-not-present environments are routed
almost exclusively over signature debit card networks.\70\ Although
card-not-present transactions have a higher fraud rate than card-
present transactions, the average signature debit fraud loss for card-
present transactions is nonetheless more than 4 times that for PIN
debit transactions.\71\
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\70\ Although some recent innovations attempt to facilitate PIN
entry for Internet transactions, use of these technologies is still
very limited.
\71\ This comparison is based on survey responses from those
issuers that differentiated card-present and card-not-present fraud
losses for both signature and PIN transactions. These respondents
represent about half of the transaction volume reported by all
issuer respondents. The ratio of card-present fraud losses for
signature and PIN debit networks is not comparable to the ratio of
total fraud losses noted above because they are based on different
subsets of issuer respondents.
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In terms of losses to the various parties in a transaction, almost
all of the reported fraud losses associated with debit card
transactions fall on the issuers and merchants. In particular, across
all types of transactions, 57 percent of reported fraud losses were
borne by issuers and 43 percent were borne by merchants. In contrast,
most issuers reported that they offer zero or very limited liability to
cardholders, in addition to regulatory protections already afforded to
consumers, such that the fraud loss borne by cardholders is
negligible.\72\ Payment card networks and merchant acquirers also
reported very limited fraud losses for themselves.
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\72\ The EFTA limits consumer liability for unauthorized
electronic fund transfers. See 15 U.S.C. 1693g and 12 CFR 205.6.
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The distribution of fraud losses between issuers and merchants
depends, in part, on the authorization method used in a debit card
transaction. Issuers and payment card networks reported that nearly all
the fraud losses associated with PIN debit card transactions (96
percent) were borne by issuers. In contrast, reported fraud losses were
distributed much more evenly between issuers and merchants for
signature debit card transactions. Specifically, issuers and merchants
bore 55 percent and 45 percent of signature debit fraud losses,
respectively.
In general, merchants are subject to greater liability for fraud in
card-not-present transactions than in card-present transactions. As
noted above, signature-based authorization is currently the primary
means to perform such transactions. According to the survey data,
merchants assume approximately 76 percent of signature debit card fraud
for card-not-present transactions.
Based on the card issuer survey data, issuers engage in a variety
of fraud-prevention activities. Issuers identified approximately 130
fraud-prevention activities and reported the costs associated with
these activities as they relate to debit card transactions.\73\ Some of
these activities were broadly related to fraud detection and included
activities such as transaction monitoring and fraud risk scoring
systems that may trigger an alert or call to the cardholder in order to
confirm the legitimacy of a transaction. Issuers also reported a number
of fraud mitigation activities, such as merchant-blocking and account-
blocking. Some issuers included costs related to customer servicing
associated with fraudulent transactions and personnel costs for fraud
investigation teams or other staffing costs. When all fraud-prevention
activities reported by issuers are included, the overall amount spent
by respondents was approximately 1.6 cents per transaction, which also
corresponds to the median amount spent by those firms.
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\73\ The Board does not believe that the issuers participated in
130 unique fraud-prevention activities. Rather, the Board believes
that the listed activities refer to many of the same activities
under differing descriptions.
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The survey also asked issuers to report their data-security
activities and costs. Issuers identified approximately 50 data-security
activities and reported the allocated costs to debit card programs.\74\
Many of these activities were associated with information and system
security. For all data-security costs reported by issuers in the card
issuer survey, the overall amount spent by respondents was
approximately 0.2 cents per transaction, which corresponds to the
median amount spent by those firms.\75\
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\74\ Similar to the fraud-prevention information, the Board does
not believe that issuers engaged in a total of 50 unique activities.
\75\ On average, by transaction type, issuers incurred 2.2[cent]
per signature-debit transaction for fraud-prevention and data-
security activities and 1.2[cent] per PIN-debit transaction.
Similarly, networks incurred 0.7[cent] per signature-debit
transaction for fraud-prevention and data-security activities and
0.6[cent] per PIN-debit transaction. Finally, acquirers incurred
0.4[cent] per signature-debit transaction for fraud-prevention and
data-security activities and 0.3[cent] per PIN-debit transaction.
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Merchants also have fraud-prevention and data-security costs,
including costs related to compliance with payment card industry data-
security standards (PCI-DSS) and other tools to prevent fraud, such as
address verification services or internally developed fraud screening
models, particularly for card-not-present transactions.\76\ The Board's
[[Page 81742]]
surveys were not comprehensive enough to adequately capture merchant
activities nor did they provide a way to determine whether issuers'
fraud-prevention and data-security activities directly benefit
merchants by reducing their debit card fraud losses.
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\76\ The Payments Cards Industry (PCI) Security Standards
Council was founded in 2006 by five card networks--Visa, Inc.,
MasterCard Worldwide, Discover Financial Services, American Express,
and JCB International. These card brands share equally in the
governance of the organization, which is responsible for the
development and management of PCI Data Security Standards (PCI DSS).
PCI DSS is a set of security standards that all payment system
participants, including merchants and processors, are required to
meet in order to participate in payment card systems.
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B. Board's Consideration of an Adjustment for Fraud-Prevention Costs
As previously described, issuers, merchant acquirers, and networks
listed a variety of fraud-prevention and data-security activities in
their survey responses. In designing an adjustment framework for fraud-
prevention costs, the Board is considering how an adjustment should be
implemented, what fraud-prevention costs such an adjustment should
cover, and what standards the Board should prescribe for issuers to
meet as a condition of receiving the adjustment.
Technology-specific approach. One approach to an adjustment for
fraud-prevention costs would be to allow issuers to recover costs
incurred for implementing major innovations that would likely result in
substantial reductions in fraud losses. This approach would establish
technology-specific standards that an issuer must meet to be eligible
to receive the adjustment to the interchange fee. Under this approach,
the Board would identify the paradigm-shifting technology(ies) that
would reduce debit card fraud in a cost-effective manner. The
adjustment would be set to reimburse the issuer for some or all of the
costs associated with implementing the new technology, perhaps up to a
cap; therefore, covered issuers and the Board would need to estimate
the costs of implementing the new technology in order to set the
adjustment correctly. Industry representatives have highlighted several
fraud-prevention technologies or activities, such as end-to-end
encryption, tokenization, chip and PIN, and the use of dynamic data
that they believe have the potential to substantially reduce fraud
losses. These technologies are not broadly used in the United States at
this time.\77\
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\77\ The Board understands, however, that in countries with
broad chip and PIN adoption, fraud levels are not necessarily lower
than those experienced in the U.S. because fraud has migrated to
less secure channels, for example to Internet transactions where PIN
authentication is not yet a common option.
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This approach to implementing the adjustment has the potential to
spur implementation of major security enhancements in the debit card
market that have not yet gained substantial market adoption.
Specifically, the adjustment could serve as an incentive for debit card
industry participants to coordinate in the adoption of technologies
that the Board determines would be effective in reducing fraud losses.
The drawback of adopting technology-specific standards is the risk that
it would cause issuers to under-invest in other innovative new
technologies, not included in the Board's standards, that may be more
effective and less costly than those identified in the standards.
Non-prescriptive approach. An alternative approach is to establish
a more general standard that an issuer must meet to be eligible to
receive an adjustment for fraud-prevention costs. Such a standard could
require issuers to take steps reasonably necessary to maintain an
effective fraud-prevention program but not prescribe specific
technologies that must be employed as part of the program.\78\ This
approach would ensure that the Board's standards give flexibility in
responding to emerging and changing fraud risks.
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\78\ For example, Section 615(e) of the Fair Credit Reporting
Act requires a number of federal agencies to develop identity theft
prevention guidelines and regulations. The implementing regulations
require that covered institutions adopt an identity theft prevention
program designed to identify, detect, and respond to relevant
identity theft red flags, but does not require consideration of
specific red flags or mandate the use of specific fraud-prevention
solutions. Rather, the accompanying guidelines provide factors that
institutions should ``consider.'' The supplement to the guidelines
lists examples of red flags. See e.g., Regulation V (Fair Credit
Reporting), 12 CFR 222.90(d).
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Under this approach, the adjustment would be set to reimburse the
issuer for some or all of the costs of its current fraud-prevention and
data-security activities and of research and development for new fraud-
prevention techniques, perhaps up to a cap. This approach would shift
some or all of the issuers' ongoing fraud-prevention costs to
merchants, even though many merchants already bear substantial card-
related fraud-prevention costs, particularly for signature debit
transactions.\79\ Such a shift in cost provides issuers with additional
incentives to invest in fraud-prevention measures. Financial
institutions make investments today, however, to reduce the risk of
fraud in non-card forms of payment, without reimbursement of those
costs from the counterparty to the payment.
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\79\ An issuer's fraud losses would not be considered a cost
that would be considered in setting the fraud adjustment. EFTA
limits any fraud adjustment to an amount that ``is reasonably
necessary to make allowance for costs incurred by the issuer in
preventing fraud in relation to electronic debit transactions * *
*'' EFTA Section 920(a)(5)(A)(i) (emphasis added).
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Request for Comment
The Board requests comment on how to implement an adjustment to
interchange fees for fraud-prevention costs. In particular, the Board
is interested in commenters' input on the following questions:
1. Should the Board adopt technology-specific standards or non-
prescriptive standards that an issuer must meet in order to be eligible
to receive an adjustment to its interchange fee? What are the benefits
and drawbacks of each approach? Are there other approaches to
establishing the adjustment standards that the Board should consider?
2. If the Board adopts technology-specific standards, what
technology or technologies should be required? What types of debit-card
fraud would each technology be effective at substantially reducing? How
should the Board assess the likely effectiveness of each fraud-
prevention technology and its cost effectiveness? How could the
standards be developed to encourage innovation in future technologies
that are not specifically mentioned?
3. If the Board adopts non-prescriptive standards, how should they
be set? What type of framework should be used to determine whether a
fraud-prevention activity of an issuer is effective at reducing fraud
and is cost-effective? Should the fraud-prevention activities that
would be subject to reimbursement in the adjustment include activities
that are not specific to debit-card transactions (or to card
transactions more broadly)? For example, should know-your-customer due
diligence performed at account opening be subject to reimbursement
under the adjustment? If so, why? Are there industry-standard
definitions for the types of fraud-prevention and data-security
activities that could be reimbursed through the adjustment? How should
the standard differ for signature- and PIN-based debit card programs?
4. Should the Board consider adopting an adjustment for fraud-
prevention costs for only PIN-based debit card transactions, but not
signature-based debit card transactions, at least for an initial
adjustment, particularly given the lower incidence of fraud and lower
chargeback rate for PIN-debit transactions? To what extent
[[Page 81743]]
would an adjustment applied to only PIN-based debit card transactions
(1) satisfy the criteria set forth in the statute for establishing
issuer fraud-prevention standards, and (2) give appropriate weight to
the factors for consideration set forth in the statute? \80\
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\80\ Some merchant representatives have advocated that the fraud
adjustment not be used to perpetuate signature-based networks, which
they believe are inherently less secure than PIN networks and for
which they incur significantly more chargebacks. These merchants
believe that, if the Board allows a fraud adjustment, it should be
designed to steer the industry from signature debit to PIN debit, or
possibly to other more secure means of authorizing transactions. As
noted earlier, the survey data indicate that signature debit fraud
losses are higher than PIN debit fraud losses and that merchants
bear a very small proportion of loss associated with PIN debit
transactions.
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5. Should the adjustment include only the costs of fraud-prevention
activities that benefit merchants by, for example, reducing fraud
losses that would be eligible for chargeback to the merchants? If not,
why should merchants bear the cost of activities that do not directly
benefit them? If the adjustment were limited in this manner, is there a
risk that networks would change their rules to make more types of
fraudulent transactions subject to chargeback?
6. To what extent, if at all, would issuers scale back their fraud-
prevention and data-security activities if the cost of those activities
were not reimbursed through an adjustment to the interchange fee?
7. How should allowable costs that would be recovered through an
adjustment be measured? Do covered issuers' cost accounting systems
track costs at a sufficiently detailed level to determine the costs
associated with individual fraud-prevention or data-security
activities? How would the Board determine the allowable costs for
prospective investments in major new technologies?
8. Should the Board adopt the same implementation approach for the
adjustment that it adopts for the interchange fee standard, that is,
either (1) an issuer-specific adjustment, with a safe harbor and cap,
or (2) a cap?
9. How frequently should the Board review and update, if necessary,
the adjustment standards?
10. EFTA Section 920 requires that, in setting the adjustment for
fraud-prevention costs and the standards that an issuer must meet to be
eligible to receive the adjustment, the Board should consider the
fraud-prevention and data-security costs of each party to the
transaction and the cost of fraudulent transactions absorbed by each
party to the transaction. How should the Board factor these
considerations into its rule? How can the Board effectively measure
fraud-prevention and data-security costs of the 8 million merchants
that accept debit cards in the United States?
V. Sec. 235.5 Exemptions
EFTA Section 920(a) sets forth several exemptions to the
applicability of the interchange fee restriction provisions.
Specifically, the statute contains exemptions for small issuers as well
as government-administered payment programs and certain reloadable
prepaid cards.\81\ The Board proposes to implement these exemptions in
Sec. 235.5, as discussed below.
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\81\ EFTA Section 920(a)(6) and (7) (15 U.S.C. 1693r(a)(6) and
7).
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Under the proposed rule, an electronic debit transaction may
qualify for more than one exemption. For example, an electronic debit
transaction made using a debit card that has been provided to a person
pursuant to a Federal, State, or local government-administered payment
program may be issued by an issuer that, together with its affiliates,
has assets of less than $10 billion as of the end of the previous
calendar year. Proposed comment 5-1 clarifies that an issuer only needs
to qualify for one of the exemptions in order to exempt an electronic
debit transaction from the interchange provisions in Sec. Sec. 235.3,
235.4, and 235.6 of the proposed rules. The proposed comment further
clarifies that a payment card network establishing interchange fees
need only satisfy itself that the issuer's transactions qualify for at
least one of the exemptions in order to exempt the electronic debit
transaction from the interchange fee restrictions.
A. Sec. 235.5(a) Exemption for Small Issuers
Section 920(a)(6)(A) of the EFTA provides that EFTA Section 920(a)
does not apply to any issuer that, together with its affiliates, has
assets of less than $10 billion. For purposes of this provision, the
term ``issuer'' is limited to the person holding the asset account that
is debited through an electronic debit transaction.\82\
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\82\ EFTA Section 920(a)(6)(B) (15 U.S.C. 1693r(a)(6)(B)). The
Board notes that an issuer of decoupled debit cards, which are debit
cards where the issuer is not the institution holding the consumer's
asset account from which funds are debited when the card is used,
would not qualify for the exemption under EFTA Section 920(a)(6)(A)
given the definition of ``issuer'' under EFTA Section 920(a)(6)(B),
regardless of the issuer's asset size.
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Proposed Sec. 235.5(a)(1) combines the statutory language in EFTA
Sections 920(a)(6)(A) and (B) to implement the exemption with some
minor adjustments for clarity and consistency. Therefore, Sec.
235.5(a)(1) provides that Sec. Sec. 235.3, 235.4, and 235.6 do not
apply to an interchange transaction fee received or charged by an
issuer with respect to an electronic debit transaction if (i) the
issuer holds the account that is debited; and (ii) the issuer, together
with its affiliates, has assets of less than $10 billion as of the end
of the previous calendar year. Proposed comment 5(a)-1 clarifies that
an issuer would qualify for this exemption if its total worldwide
banking and nonbanking assets, including assets of affiliates, are less
than $10 billion.
For consistency, the proposed rule assesses an issuer's asset size
for purposes of the small issuer exemption at a single point in time.
Although the asset size of an issuer and its affiliates will fluctuate
over time, for purposes of determining an issuer's eligibility for this
exemption, the Board believes the relevant time for determining the
asset size of the issuer and its affiliates for purposes of this
exemption should be the end of the previous calendar year. The Board
has used the calendar year-end time frame in other contexts for
determining whether entities meet certain dollar thresholds.\83\
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\83\ See, e.g., 12 CFR 203.2(e)(1)(i) and 12 CFR 228.20(u).
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To the extent that a payment card network permits issuers meeting
the small issuer exemption to receive higher interchange fees than
allowed under Sec. Sec. 235.3 and 235.4, payment card networks, as
well as merchant acquirers and processors, may need a process in place
to identify such issuers. Thus, the Board requests comment on whether
the rule should establish a consistent certification process and
reporting period for an issuer to notify a payment card network and
other parties that the issuer qualifies for the small issuer exemption.
For example, the rule could require an issuer to notify the payment
card network within 90 days of the end of the preceding calendar year
in order to be eligible for an exemption for the next rate period. The
Board also requests comment on whether it should permit payment card
networks to develop their own processes for making this determination.
B. Sec. 235.5(b) Exemption for Government-Administered Programs
Under EFTA Section 920(a)(7)(A)(i), an interchange transaction fee
charged or received with respect to an electronic debit transaction
made using a debit or general-use prepaid card that has been provided
to a person pursuant to a
[[Page 81744]]
Federal, State, or local government-administered payment program is
generally exempt from the interchange fee restrictions. However, the
exemption applies as long as a person may only use the debit or
general-use prepaid card to transfer or debit funds, monetary value, or
other assets that have been provided pursuant to such program. The
Board proposes to implement this provision in Sec. 235.5(b)(1) with
minor non-substantive changes to the statutory language.
Proposed comment 5(b)-1 clarifies the meaning of a government-
administered program. The proposed comment states that a program is
considered government-administered regardless of whether a Federal,
State, or local government agency operates the program or outsources
some or all functions to service providers that act on behalf of the
government agency. The Board understands that for many government-
administered programs, the government agency outsources the
administration of the card program to third parties. The proposed
comment makes clear that a government-administered program will still
be deemed government-administered regardless of the government agency's
choice to use a third party for any and all aspects of the program.
Furthermore, proposed comment 5(b)-1 provides that a program may be
government-administered even if a Federal, State, or local government
agency is not the source of funds for the program it administers. For
example, the Board understands that for child support programs, a
Federal, State, or local government agency is not the source of funds,
but such programs are nevertheless administered by State governments.
As such, the Board believes that cards distributed in connection with
such programs would fall under the exemption.
The Board notes that Section 1075(b) of the Dodd-Frank Act amends
the Food and Nutrition Act of 2008, the Farm Security and Rural
Investment Act of 2002, and the Child Nutrition of 1966 to clarify that
the electronic benefit transfer or reimbursement systems established
under these acts are not subject to EFTA Section 920. These amendments
are consistent with the exemption under EFTA Section 920(a)(7)(i).
Because proposed Sec. 235.5(b)(1), which implements EFTA Section
920(a)(7)(i), covers these and other government-administered systems,
neither the proposed regulation nor commentary specifically references
such programs.
Payment card networks that allow issuers to charge higher
interchange fees than permitted under Sec. Sec. 235.3 and 235.4 for
transactions made using a debit card that meets the exemption for
government-administered payment programs will need a means to identify
the card accounts that meet the exemption. As with the small issuer
exemption in Sec. 235.5(a), the Board requests comment on whether it
should establish a certification process or whether it should permit
payment card networks to develop their own processes.
The operational aspects of certifying on an account-by-account
basis may be more complex than certifying on an issuer-by-issuer basis.
Therefore, if the Board is to establish a certification process, the
Board requests comment on how to structure this process, including the
time periods for reporting and what information may be needed to
identify accounts to which the exemption applies. For example, the
Board understands that certain cards issued under a government-
administered payment program may be distinguished by the BIN or BIN
range.
C. Sec. 235.5(c) Exemption for Certain Reloadable Prepaid Cards
EFTA Section 920(a)(7)(A)(ii) establishes an exemption for an
interchange transaction fee charged or received with respect to an
electronic debit transaction for a plastic card, or other payment code
or device, that is: (i) Linked to funds, monetary value, or assets
purchased or loaded on a prepaid basis; (ii) not issued or approved for
use to access or debit any account held by or for the benefit of the
cardholder (other than a subaccount or other method of recording or
tracking funds purchased or loaded on the card on a prepaid basis);
(iii) redeemable at multiple, unaffiliated merchants or service
providers, or automated teller machines; (iv) used to transfer or debit
funds, monetary value, or other assets; and (v) reloadable and not
marketed or labeled as a gift card or gift certificate.
For clarity, the proposed rule refers to ``general-use prepaid
card,'' which incorporates certain of the conditions for obtaining the
exemption in EFTA Section 920(a)(7)(A)(ii). See proposed Sec.
235.2(i). Proposed Sec. 235.5(c)(1) thus implements the remaining
conditions concerning the ability of the card to be used to access an
account held by or for the benefit of the cardholder (other than a
subaccount or other method of recording or tracking funds purchased or
loaded on the card on a prepaid basis) and whether the card is
reloadable and not marketed or labeled as a gift card or gift
certificate.
Typically, issuers structure prepaid card programs so that the
funds underlying each prepaid card in the program are held in an
omnibus account, and the amount attributable to each prepaid card is
tracked by establishing subaccounts or by other recordkeeping means.
However, certain issuers structure prepaid card programs differently
such that the funds underlying each card are attributed to separate
accounts established by the issuer.
The condition in EFTA Section 920(a)(7)(A)(ii)(II) makes clear that
an exempt card may not be issued or approved for use to access or debit
an account held by or for the benefit of the cardholder (other than a
subaccount or other method recording or tracking funds purchased or
loaded on the card on a prepaid basis). Therefore, issuers that
structure prepaid card programs such that the funds underlying each
card are attributed to separate accounts do not qualify for the
exemption based on the conditions set forth under the statute. These
issuers may argue that there is little difference between their prepaid
programs and others that are constructed so that the funds are part of
an omnibus account. However, an argument can be made that prepaid cards
that access separate accounts are not significantly different from
debit cards that access demand deposit accounts, which are covered by
the interchange fee restrictions in EFTA Section 920(a). The Board's
proposal is based on the view that prepaid cards where the underlying
funds are held in separate accounts do not qualify for the exemption.
Reloadable and Not Marketed or Labeled as a Gift Card or Gift
Certificate
The Board has previously defined and clarified the meaning of
``reloadable and not marketed or labeled as a gift card or gift
certificate'' in the context of a rule restricting the fees and
expiration dates for gift cards under 12 CFR 205.20 (``Gift Card
Rule''). In order to maintain consistency, the Board proposes to import
commentary related to the meaning of reloadable and not marketed or
labeled as a gift card or gift certificate from the Gift Card Rule.
Proposed comment 5(c)-1 provides that a general-use prepaid card is
``reloadable'' if the terms and conditions of the agreement permit
funds to be added to the general-use prepaid card after the initial
purchase or issuance. The comment further states that a general-use
prepaid card is not ``reloadable'' merely because the issuer or
processor is technically able to add functionality that would otherwise
[[Page 81745]]
enable the general-use prepaid card to be reloaded. The comment is
similar to comment 20(b)(2)-1 under the Gift Card Rule.
Proposed comment 5(c)-2, which has been adapted from comment
20(b)(2)-2 under the Gift Card Rule, clarifies the meaning of the term
``marketed or labeled as a gift card or gift certificate.'' The
proposed comment provides that the term means directly or indirectly
offering, advertising, or otherwise suggesting the potential use of a
general-use prepaid card as a gift for another person. The proposed
comment also states that whether the exclusion applies does not depend
on the type of entity that is making the promotional message.
Therefore, under the proposed comment, a general-use prepaid card is
deemed to be marketed or labeled as a gift card or gift certificate if
anyone (other than the consumer-purchaser of the card), including the
issuer, the retailer, the program manager that may distribute the card,
or the payment network on which a card is used, promotes the use of the
card as a gift card or gift certificate.\84\
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\84\ As the Board discussed in connection with the issuance of
the Gift Card Rule, a card is not deemed to be marketed or labeled
as a gift card or gift certificate as a result of actions by the
consumer-purchaser. For example, if the purchaser gives the card to
another consumer as a ``gift,'' or if the primary cardholder
contacts the issuer and requests a secondary card to be given to
another person for his or her use, such actions do not cause the
card to be marketed as a gift card or gift certificate.
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The proposed comment also states that a certificate or card could
be deemed to be marketed or labeled as a gift card or gift certificate
even if it is primarily marketed for another purpose. Thus, for
example, a reloadable network-branded card would be considered to be
marketed or labeled as a gift card or gift certificate even if the
issuer principally advertises the card as a less costly alternative to
a bank account but promotes the card in a television, radio, newspaper,
or Internet advertisement, or on signage as ``the perfect gift'' during
the holiday season. Proposed comment 5(c)-2 further clarifies that the
mere mention that gift cards or gift certificates are available in an
advertisement or on a sign that also indicates the availability of
exempted general-use prepaid cards does not by itself cause the
general-use prepaid card to be marketed as a gift card or a gift
certificate.
The Board also proposes examples of what the term ``marketed or
labeled as a gift card or gift certificate'' includes and does not
include in proposed comment 5(c)-3; these examples are similar to those
in comment 20(b)(2)-3 under the Gift Card Rule. Thus, under the
proposed comment, examples of marketing or labeling as a gift card or
gift certificate include displaying the word ``gift'' or ``present,''
displaying a holiday or congratulatory message, and incorporating gift-
giving or celebratory imagery or motifs on the card, certificate or
accompanying material, such as documentation, packaging and promotional
displays. See proposed comment 5(c)-3.i.
The proposed comment further states that a general-use prepaid card
is not marketed or labeled as a gift card or gift certificate if the
issuer, seller, or other person represents that the card can be used as
a substitute for a checking, savings, or deposit account, as a
budgetary tool, or to cover emergency expenses. Similarly, the proposed
comment provides that a card is not marketed as a gift card or gift
certificate if it is promoted as a substitute for travelers checks or
cash for personal use, or promoted as a means of paying for a
consumer's health-related expenses. See proposed comment 5(c)-3.ii.
As the Board discussed in connection with the issuance of the Gift
Card Rule, there are several different models for how prepaid cards may
be distributed from issuers to consumers.\85\ These models vary in the
amount of control the issuer has in terms of how these products may be
marketed to consumers. Therefore, an issuer that does not intend to
market a particular general-use prepaid card as a gift card or gift
certificate could find its intent thwarted by the manner in which a
retailer displays the card in its retail outlets.
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\85\ See 75 FR 16580 at 16594 (April 1, 2010).
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The Board issued comment 20(b)(2)-4 under the Gift Card Rule to
address these issues. Specifically, comment 20(b)(2)-4 provides that a
product is not marketed or labeled as a gift card or gift certificate
if persons subject to the Gift Card Rule, including issuers, program
managers, and retailers, maintain policies and procedures reasonably
designed to avoid such marketing. Such policies and procedures may
include contractual provisions prohibiting a card, or other payment
code or device, from being marketed or labeled as a gift card or gift
certificate; merchandising guidelines or plans regarding how the
product must be displayed in a retail outlet; and controls to regularly
monitor or otherwise verify that the card, or other payment code or
device, is not being marketed as a gift card or gift certificate. The
comment further states that whether a person has marketed a reloadable
card, or other payment code or device, as a gift card or gift
certificate will depend on the facts and circumstances, including
whether a reasonable consumer would be led to believe that the card, or
other payment code or device, is a gift card or gift certificate. The
comment also included examples. The Board is proposing a similar
comment 5(c)-4 to address issues related to maintaining proper policies
and procedures to prevent a general-use prepaid card from being
marketed as a gift card or gift certificate. Proposed comment 5(c)-4
also contains similar examples as set forth in comment 20(b)(2)-4 under
the Gift Card Rule.
Proposed comment 5(c)-5 provides guidance relating to online sales
of gift cards that is substantially the same as in comment 20(b)(2)-5
under the Gift Card Rule. As discussed in connection with the issuance
of the Gift Card Rule, the Board believes that a Web site's display of
a banner advertisement or a graphic on its home page that prominently
displays ``Gift Cards,'' ``Gift Giving,'' or similar language without
mention of other available products, or inclusion of the terms ``gift
card'' or ``gift certificate'' in its web address, creates the same
potential for consumer confusion as a sign stating ``Gift Cards'' at
the top of a prepaid card display. Because a consumer acting reasonably
under these circumstances may be led to believe that all prepaid
products sold on the Web site are gift cards or gift certificates, the
Web site is deemed to have marketed all such products, including any
general-purpose reloadable cards that may be sold on the Web site, as
gift cards or gift certificates. Proposed comment 5(c)-5 provides that
products sold by such Web sites would not be eligible for the
exemption.
Certification
As with the exemption for government-administered payment programs,
payment card networks, as well as merchant acquirers and processors,
will need a process to identify accounts accessed by reloadable
general-use prepaid cards that are not marketed or labeled as a gift
card or gift certificate if such networks permit issuers of such
accounts to charge interchange fees in excess of the amount permitted
under Sec. Sec. 235.3 and 235.4. The Board seeks comment on whether it
should establish a certification process for the reloadable prepaid
cards exemption or whether it should permit payment card networks to
develop their own processes. The Board also requests comment on how it
should structure the certification process if it were to establish a
process, including the time
[[Page 81746]]
periods for reporting and what information may be needed to identify
accounts to which the exemption applies.
Temporary Cards Issued in Connection With a General-Purpose Reloadable
Card
As the Board discussed in connection with the Gift Card Rule, some
general-purpose reloadable cards may be sold initially as a temporary
non-reloadable card. These cards are usually marketed as an alternative
to a bank account (or account substitute). After the card is purchased,
the cardholder may call the issuer to register the card. Once the
issuer has obtained the cardholder's personal information, a new
personalized, reloadable card is sent to the cardholder to replace the
temporary card.
The Board decided to permit temporary non-reloadable cards issued
solely in connection with a general-purpose reloadable card to be
treated as general-purpose reloadable cards under the Gift Card Rule
despite the fact that such cards are not reloadable. As it discussed in
connection with the Gift Card Rule, the Board was concerned that
covering temporary non-reloadable cards under the Gift Card Rule would
create regulatory incentives that would unduly restrict issuers'
ability to address potential fraud. Some issuers issue temporary cards
in non-reloadable form to encourage consumers to register the card and
provide customer identification information for Bank Secrecy Act
purposes. A rule that provides that the exemption is only available if
the temporary card is reloadable would therefore limit issuers' options
without a corresponding benefit.\86\
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\86\ See 75 FR 16580 at 16596 (April 1, 2010).
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For similar reasons, the Board is proposing that interchange fees
charged or received with respect to transactions using a temporary non-
reloadable card issued solely in connection with a general-purpose
reloadable card would also qualify for the exemption under EFTA Section
920(a)(7)(A)(ii), provided such cards are not marketed or labeled as a
gift card or gift certificate. Therefore, proposed Sec. 235.5(c)(2)
provides that the term ``reloadable'' also includes a temporary non-
reloadable card if it is issued solely in connection with a reloadable
general-use prepaid card. Proposed comment 5(c)-6, similar to comment
20(b)(2)-6 under the Gift Card Rule, provides additional guidance
regarding temporary non-reloadable cards issued solely in connection
with a general-purpose reloadable card.
D. Sec. 235.5(d) Exception
EFTA Section 920(a)(7)(B) provides that after the end of the one-
year period beginning on the effective date of the statute, the
exemptions available under EFTA Sections 920(a)(7)(A)(i) and (ii)
become subject to an exception. The statute provides that the
exemptions are not available if any of the following fees may be
charged to a person with respect to the card: (i) An overdraft fee,
including a shortage of funds or a transaction processed for an amount
exceeding the account balance; and (ii) a fee charged by the issuer for
the first withdrawal per month from an ATM that is part of the issuer's
designated ATM network. The Board proposes to implement this exception
to the exemptions in Sec. 235.5(d), substantially as presented in the
statute with one minor clarification.
Specifically, the Board proposes to clarify that the fee described
in Sec. 235.5(d)(1) does not include a fee or charge charged for
transferring funds from another asset account to cover a shortfall in
the account accessed by the card. Such a fee is not an ``overdraft''
fee because the cardholder has a means of covering a shortfall in the
account connected to the card with funds transferred from another asset
account, and the fee is charged for making such a transfer.
VI. Sec. 235.6 Prohibition on Circumvention or Evasion
EFTA Section 920 contains two separate grants of authority to the
Board to address circumvention or evasion of the restrictions on
interchange transaction fees. First, EFTA Section 920(a)(8) authorizes
the Board to prescribe rules to ensure that network fees are not used
``to directly or indirectly compensate an issuer with respect to an
electronic debit transaction'' and ``to circumvent or evade'' the
interchange transaction fee restrictions under the statute and this
proposed rule.\87\ In addition, EFTA Section 920(a)(1) provides the
Board authority to prescribe rules to prevent other forms of
circumvention or evasion. Pursuant to both of these authorities, the
Board is proposing to prohibit circumvention or evasion of the
interchange transaction fee restrictions in Sec. Sec. 235.3 and 235.4.
Circumvention or evasion would occur under the proposed rule if an
issuer receives net compensation from a payment card network, not
considering interchange transaction fees received from acquirers.
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\87\ Under EFTA Section 920(a)(1), a network fee is defined as
``any fee charged and received by a payment card network with
respect to an electronic debit transaction, other than an
interchange transaction fee.''
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Payment card networks charge network participants a variety of fees
in connection with electronic debit transactions. On the issuer side,
fees charged by the network include access fees for connectivity and
fees for authorizing, clearing, and settling debit card transactions
through the network.\88\ Issuers also pay fees to the network for the
costs of administering the network, such as service fees for supporting
the network infrastructure, and membership and licensing fees. In
addition, a network may charge fees to issuers for optional services,
such as for transaction routing and processing services provided by the
network or its affiliates or for fraud detection and risk mitigation
services.
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\88\ Network fees associated with authorizing, clearing, and
settling debit card transactions are not included in the allowable
costs under the interchange standard.
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On the acquirer and merchant side, a network similarly charges fees
for accessing the network, as well as fees for authorizing, clearing,
and settling debit card transactions through the network. Likewise,
networks charge network administration fees, membership or merchant
acceptance fees, and licensing or member registration fees on acquirers
and/or merchants. There are also fees for various optional services
offered by the network to acquirers or merchants, including fees for
fraud detection and risk mitigation services. For a closed-loop or
three-party payment network, network fees are bundled into the merchant
discount rate charged by the network in its capacity as the merchant
acquirer.
A fee charged by the network can be assessed as a flat fee or on a
per transaction basis, and may also vary based on transaction size,
transaction type or other network-established criteria. While
interchange fee rates generally do not vary across issuers or acquirers
for the same types of debit card transactions, fees charged by the
network are often set on an issuer-by-issuer or merchant-by-merchant
basis. For example, issuers and merchants may be given individualized
discounts relative to a published network fee or rate based on their
transaction volume increases.
In addition to discounts, issuers and merchants may receive
incentive payments or rebates from a network. These incentives may
include upfront payments to encourage issuers to shift some or all of
their debit card volume to the network, such as signing bonuses
[[Page 81747]]
upon contract execution or renewal. Such payments may help issuers
defray the conversion cost of issuing new cards or of marketing the
network brand. In addition, issuers may receive incentive payments upon
reaching or exceeding debit card transaction, percentage share, or
dollar volume threshold amounts.
Discounts and incentives enable networks to compete for business
among issuers and merchants. Among other things, these pricing tools
help networks attract new issuers and retain existing issuers, as well
as expand merchant acceptance to increase the attractiveness of the
network brand. Discounts and incentives also help the network to
encourage specific processing behavior, such as the use of enhanced
authorization methods or the deployment of additional merchant
terminals.
There are a number of factors that a network may consider in
calibrating the appropriate level of network fees, discounts, and
incentives in order to achieve network objectives. However, EFTA
Section 920(a) authorizes the Board to prescribe rules to ensure that
such pricing mechanisms are not used to circumvent or evade the
interchange transaction fee restrictions. This authority is both
specific with respect to the use of network fees under EFTA Section
920(a)(8), as well as general with respect to the Board's
implementation of the interchange transaction fee restrictions under
EFTA Section 920(a)(1).
As an initial matter, the Board notes that the statute does not
directly regulate the amount of network fees that a network may charge
for any of its services. Thus, the proposed rule does not seek to set
or establish the level of network fees that a network may permissibly
impose on any network participant for its services. Instead, the
proposed rule is intended to ensure that network fees, discounts, and
incentives do not, in effect, circumvent the interchange transaction
fee restrictions. Accordingly, proposed Sec. 235.6 contains a general
prohibition against circumventing or evading the interchange
transaction fee restrictions in Sec. Sec. 235.3 and 235.4. In
addition, proposed Sec. 235.6 would expressly prohibit an issuer from
receiving net compensation from a payment card network with respect to
electronic debit transactions. The Board believes that such
compensation would effectively serve as a transfer to issuers in excess
of the amount of interchange transaction fee revenue allowed under the
standards in Sec. Sec. 235.3 and 235.4.
The Board also considered whether increases in fees charged by the
network on merchants or acquirers coupled with corresponding decreases
in fees charged by the network on issuers should also be considered
circumvention or evasion of the interchange fee standards in Sec. Sec.
235.3 and 235.4. For example, following the effective date of this
rule, a network might increase network switch fees charged to
merchants, acquirers, or processors while decreasing switch fees paid
by issuers for the same types of electronic debit transactions. Under
these circumstances, the increase in network processing fees charged to
merchants is arguably ``passed through'' to issuers through
corresponding decreases in processing fees paid by issuers.
The Board recognizes that such decreases in issuer fees could have
the effect of offsetting reductions in interchange transaction fee
revenue that will occur under the proposed restrictions in Sec. Sec.
235.3 and 235.4. Nonetheless, the Board believes that such
circumstances would not necessarily indicate circumvention or evasion
of the interchange transaction fee restrictions because, absent net
payments to the issuer from the network, an issuer would not receive
net compensation from the network for electronic debit transactions.
Moreover, the Board is concerned that prohibiting such shifts in the
allocation of network fees would effectively lock in the current
distribution of network fees between issuers and merchants, thereby
constraining the ability of networks to adjust their own sources of
revenue in response to changing market conditions. The Board requests
comment on the proposed approach, as well as on any other approaches
that may be necessary and appropriate to address concerns about
circumvention or evasion of the interchange fee standards.
Proposed comment 6-1 provides that any finding of circumvention or
evasion of the interchange transaction fee restrictions will depend on
the relevant facts or circumstances. The proposed comment also provides
an example of a circumstance indicating circumvention or evasion. In
the example, circumvention or evasion occurs if the total amount of
payments or incentives received by an issuer from a payment card
network during a calendar year in connection with electronic debit
transactions, excluding interchange transaction fees that are passed
through to the issuer by the network, exceeds the total of all fees
paid by the issuer to the network for electronic debit transactions
during that year. In this circumstance, an issuer impermissibly
receives net compensation from the payment card network in addition to
the interchange transaction fees permitted under Sec. Sec. 235.3 and
234.4. See proposed comment 6-1.i.
Proposed comment 6-1.ii clarifies that payments or incentives paid
by a payment card network include, but are not limited to, marketing
incentives, payments or rebates for meeting or exceeding a specific
transaction volume, percentage share or dollar amount of transactions
processed, or other fixed payments for debit card related activities.
Payments or incentives paid by a payment card network to an issuer do
not include any interchange transaction fees that are passed through to
the issuer by the network. Incentives paid by a payment card network
also do not include funds received by an issuer from a payment card
network as a result of chargebacks or violations of network rules or
requirements by a third party. The proposed comment further clarifies
that fees paid by an issuer to a payment card network include, but are
not limited to, network processing, or switch, fees paid for each
transaction, as well as fees charged to issuers that are not particular
to a transaction, such as membership or licensing fees and network
administration fees. Fees paid by an issuer could also include fees for
optional services provided by the network.
Proposed comment 6-2 provides examples of circumstances that do not
evade or circumvent the interchange transaction fee restrictions. In
the first proposed example, an issuer receives an additional incentive
payment from the network as a result of increased debit card
transaction volume over the network during a particular year. However,
because of the additional debit card activity, the aggregate switch
fees paid by the issuer to the network also increase. Assuming the
total amount of fees paid by the issuer to the network continues to
exceed the total amount of incentive payments received by the issuer
from the network during that calendar year, no circumvention or evasion
of the interchange transaction fee restrictions has occurred. See
proposed comment 6-2.i.
In the second example, an issuer receives a rate reduction for
network processing fees due to an increase in debit card transactions
during a calendar year that reduces the total amount of network
processing fees paid by the issuer during the year. However, the total
amount of all fees paid to the network by the issuer continues to
exceed the total amount of incentive payments received by the issuer
from the network. Under these circumstances, the issuer does not
circumvent or evade the interchange
[[Page 81748]]
transaction fee restrictions. See proposed comment 6-2.ii.
Proposed comment 6-3 clarifies that the prohibition in Sec. 235.6
against circumventing or evading the interchange transaction fee
restrictions does not apply to issuers or products that qualify for an
exemption under Sec. 235.5. Thus, for example, Sec. 235.6 does not
apply to an issuer with consolidated assets below $10 billion holding
the account that is debited in an electronic debit transaction.
Comment is requested regarding how the rule should address signing
bonuses that a network may provide to attract new issuers or to retain
existing issuers upon the execution of a new agreement between the
network and the issuer. Such bonuses arguably do not circumvent or
evade the interchange transaction fee restrictions because they do not
serve to compensate issuers for electronic debit transactions that have
been processed over the network. Moreover, if such payments were
considered in assessing whether network-provided incentives during a
calendar year impermissibly exceeded the fees paid by an issuer during
that year, it could constrain a network's ability to grow the network
and achieve greater network efficiencies by potentially removing a
significant tool for attracting new issuers. However, if such signing
bonuses are not taken into account in determining whether an issuer
receives net compensation for electronic debit transactions, a network
could provide significant upfront incentive payments during the first
year of a contract or space out incentive payments over several years
to offset the limitations on interchange transaction fees that could be
received by the issuer over the course of the contract.
The Board also requests comment on all aspects of the proposed
prohibition against circumvention or evasion, including whether the
rule should provide any additional examples to illustrate the
prohibition against circumvention or evasion of the interchange
transaction fee restrictions.
VII. Sec. 235.7 Limitations on Payment Card Restrictions
EFTA Section 920(b) sets forth provisions limiting the ability of
issuers and payment card networks to restrict merchants and other
persons from establishing the terms and conditions under which they may
accept payment cards. For example, EFTA Section 920(b) prohibits an
issuer or payment card network from establishing rules that prevent
merchants from offering discounts based on the method of payment
tendered. In addition, the statute prohibits an issuer or payment card
network from establishing rules preventing merchants from setting
minimum and maximum transaction amounts for accepting credit cards.
These two statutory provisions are self-executing and are not subject
to the Board's rulemaking authority.\89\
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\89\ The Board may, however, increase from $10 the minimum value
amount that a merchant may set for credit card acceptance. EFTA
Section 920(b)(3)(B).
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However, the Board is directed to prescribe implementing
regulations with respect to two additional limitations set forth in the
statute. First, the Board must issue rules prohibiting an issuer or
payment card network from restricting the number of payment card
networks on which an electronic debit transaction may be processed
(network exclusivity restrictions).\90\ Second, the Board must issue
rules that prohibit an issuer or payment card network from directly or
indirectly inhibiting any person that accepts debit cards for payment
from directing the routing of an electronic debit transaction through
any network that may process that transaction (merchant routing
restrictions).\91\ Proposed Sec. 235.7 implements these additional
limitations on payment card network restrictions.
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\90\ See EFTA Section 920(b)(1)(A).
\91\ See EFTA Section 920(b)(1)(B).
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The statutory exemptions for small issuers, government-administered
payment cards, and certain reloadable prepaid cards under EFTA Section
920 apply only to the restrictions on interchange transaction fees in
EFTA Section 920(a). See proposed Sec. 235.5, discussed above. Thus,
these exemptions do not apply to the limitations on payment card
network restrictions under EFTA Section 920(b), including the
prohibitions on network exclusivity arrangements and merchant routing
restrictions implemented in proposed Sec. 235.7. See proposed comment
7-1.
A. Sec. 235.7(a) Prohibition on Network Exclusivity
EFTA Section 920(b)(1)(A) directs the Board to prescribe rules
prohibiting an issuer or a payment card network from directly or
indirectly restricting, through any agent, processor, or licensed
member of a payment card network, the number of payment card networks
on which an electronic debit transaction may be processed to fewer than
two unaffiliated payment card networks. Proposed Sec. 235.7(a)
implements the new requirement.
In recent years, payment card networks have increasingly offered
issuers financial incentives in exchange for committing a substantial
portion of their debit card transaction volume to the network. For
example, some issuers may agree to shift some or all of their debit
card transaction volume to the network in exchange for higher incentive
payments (such as volume-based payments or marketing support) or
volume-based discounts on network fees charged to the issuer. In many
cases, issuers have agreed to make the payment card network, or
affiliated networks, the exclusive network(s) associated with the
issuer's debit cards. For example, some issuers have agreed to restrict
their cards' signature debit functionality to a single signature debit
network and PIN debit functionality to the PIN debit network that is
affiliated with the signature debit network. Certain signature debit
network rules also prohibit issuers of debit cards carrying the
signature network brand from offering other signature debit networks or
certain competing PIN debit networks on the same card. See proposed
comments 7(a)-1 and -2 describing the terms PIN and signature debit.
Some issuers also negotiate or enroll in ``exclusivity
arrangements'' with payment card networks for other business purposes.
For example, an issuer may want to shift a substantial portion or all
of its debit card volume to a particular network to reduce core
processing costs through economies of scale; to control fraud and
enhance data security by limiting the points for potential compromise;
or to eliminate or reduce the membership and compliance costs
associated with connecting to multiple networks.
From the merchant perspective, the availability of multiple card
networks on a debit card is attractive because it gives merchants the
flexibility to route transactions over the network that will result in
the lowest cost to the merchant. This flexibility may promote direct
price competition among the debit card networks that are enabled on the
debit card. Thus, debit card network exclusivity arrangements limit
merchants' ability to route transactions over lower-cost networks and
may reduce price competition.
From the cardholder perspective, however, requiring multiple
payment card networks could have adverse effects. In particular, such a
requirement could limit the cardholder's ability to obtain certain card
benefits. For example, a cardholder may receive zero liability
protection or enhanced chargeback rights only if a transaction is
carried over a specific card network. Similarly, insurance benefits for
certain types of transactions or purchases or the
[[Page 81749]]
ability to receive text alerts regarding possible fraudulent activity
may be tied to the use of a specific network.\92\ Requiring multiple
unaffiliated payment card networks, coupled with a merchant's ability
to route electronic debit transactions over any of the networks, could
reduce the ability of a cardholder to control, and perhaps even to
know, over which network a transaction would be routed. Consequently,
such a requirement could reduce the likelihood that the cardholder
would be able to obtain benefits that are specific to a particular card
network. Moreover, it may be challenging for issuers or networks to
explain to the cardholders that they will receive certain benefits only
if a merchant chooses to route their transaction over that particular
network.
---------------------------------------------------------------------------
\92\ These benefits are often provided for transactions routed
over signature debit networks; they are less commonly available for
PIN-debit transactions.
---------------------------------------------------------------------------
In the proposed rule, the Board requests comment on two alternative
approaches for implementing the restrictions on debit card network
exclusivity. The first alternative (Alternative A) would require a
debit card to have at least two unaffiliated payment card networks
available for processing an electronic debit transaction. Under this
alternative, an issuer could comply, for example, by having one payment
card network available for signature debit transactions and a second,
unaffiliated payment card network available for PIN debit transactions.
The second alternative (Alternative B) would require a debit card to
have at least two unaffiliated payment card networks available for
processing an electronic debit transaction for each method of
authorization available to the cardholder. For example, a debit card
that can be used for both signature and PIN debit transactions would be
required to offer at least two unaffiliated signature debit payment
card networks and at least two unaffiliated PIN debit payment card
networks.
Alternative A
EFTA Section 920(b)(1)(A) provides that an issuer and payment card
network do not violate the prohibition against network exclusivity
arrangements as long as the number of payment card networks on which an
electronic debit transaction may be processed is not limited to less
than two unaffiliated payment card networks. Nothing in EFTA Section
920(b)(1)(A) specifically requires that there must be two unaffiliated
payment card networks available to the merchant once the method of
debit card authorization has been determined. In other words, the
statute does not expressly require issuers to offer multiple
unaffiliated signature and multiple unaffiliated PIN debit card network
choices on each card.
In addition, requiring multiple unaffiliated payment card networks
on a debit card for each method of card authorization could potentially
limit the development and innovation of new authorization methods.
Although PIN and signature are the primary methods of debit card
transaction authorization today, new authentication measures involving
biometrics or other technologies may, in the future, be more effective
in reducing fraud. However, an issuer may be unable to implement these
new methods of card authorization if the rule requires that such
transactions be capable of being processed on multiple unaffiliated
networks. Moreover, the Board understands that enabling the ability to
process a debit card transaction over multiple signature debit networks
may not be feasible in the near term. Specifically, enabling multiple
signature debit networks on a debit card could require the replacement
or reprogramming of millions of merchant terminals as well as
substantial changes to software and hardware for networks, issuers,
acquirers, and processors in order to build the necessary systems
capability to support multiple signature debit networks for a
particular debit card transaction.
Finally, the Board recognizes that small debit card issuers could
be disproportionately affected by a requirement to have multiple
networks for each method of debit card authorization. See proposed
comment 7(a)-7, discussed below. Alternative A would minimize the
overall compliance costs for these issuers.
For these reasons, Alternative A would provide that the network
exclusivity prohibition could be satisfied as long as an electronic
debit transaction may be processed on at least two unaffiliated payment
card networks. See Sec. 235.7(a)(1) (Alternative A). Proposed comment
7(a)-3 under Alternative A clarifies that Alternative A does not
require an issuer to have multiple, unaffiliated networks available for
each method of cardholder authorization. Under Alternative A, it would
be sufficient, for example, for an issuer to issue a debit card that
operates on one signature-based card network and on one PIN-based card
network, as long as the two card networks are not affiliated.
Alternatively, an issuer could issue a debit card that operates on two
or more unaffiliated signature-based card networks, but is not enabled
for PIN debit transactions, or that operates on two or more
unaffiliated PIN-based card networks, but is not enabled for signature
debit transactions.
Alternative B
The Board also recognizes that the effectiveness of the rule
promoting network competition could be limited in some circumstances if
an issuer can satisfy the requirement simply by having one payment card
network for signature debit transactions and a second unaffiliated
payment card network for PIN debit transactions. In particular, the
Board understands that only about 2 million of the 8 million merchant
locations in the United States that accept debit cards have the
capability to accept PIN debit transactions. Thus, in those locations
that accept only signature debit, potentially under Alternative A only
a single payment card network would be available to process electronic
debit transactions.
In addition, PIN debit functionality generally is not available in
certain merchant categories or for certain types of transactions. For
example, the Board understands that PIN debit typically cannot be used
for hotel stays or car rentals for which a merchant obtains an
authorization for an estimated transaction amount, but the actual
transaction amount is not known until later, when the cardholder checks
out of the hotel or returns the rental car. Because PIN debit
transactions are single-message transactions that combine the
authorization and clearing instructions, the Board understands that it
is currently not feasible to use PIN debit in circumstances where the
final transaction amount differs from the authorized transaction
amount. PIN debit is also not currently available for Internet purchase
transactions in most cases. Thus, for these transaction types, the
unavailability of PIN debit as an alternative method of authorization
effectively means that only a single card network would be available to
process an electronic debit transaction if Alternative A is adopted in
the final rule.
Finally, the Board notes that Alternative A could limit the
effectiveness of the separate prohibition on merchant routing
restrictions under new EFTA Section 920(b)(1)(B), discussed below, if
an issuer elected to enable only one signature debit network and one
unaffiliated PIN network on a particular debit card. This is because
once the cardholder has authorized the
[[Page 81750]]
transaction using either a signature or PIN entry, the merchant would
have only a single network available for routing the transaction.
Under Alternative B, an issuer or payment card network would be
prohibited from directly or indirectly restricting the number of
payment card networks on which an electronic debit transaction may be
processed to less than two unaffiliated networks ``for each method of
authorization that may be used by the cardholder.'' This means that an
issuer would not comply with the proposed rule for a signature and PIN-
enabled debit card unless there were at least two unaffiliated
signature debit networks and at least two unaffiliated PIN debit
networks enabled on the card.
Proposed comment 7(a)-3 under Alternative B clarifies that under
this alternative, each electronic debit transaction, regardless of the
method of authorization, must be able to be processed on at least two
unaffiliated payment card networks. For example, if a cardholder
authorizes an electronic debit transaction using a signature, that
transaction must be capable of being processed on at least two
unaffiliated signature-based payment card networks. Similarly, if a
cardholder authorizes an electronic debit transaction using a PIN, that
transaction must be capable of being processed on at least two
unaffiliated PIN-based payment card networks. This comment would also
clarify that the use of contactless or radio-frequency identification
(RFID) technology would not constitute a separate method of
authorization as the Board understands that such transactions are
generally processed over either a signature debit network or a PIN
debit network.
The Board requests comment on both proposed alternatives for
implementing the prohibition on network exclusivity arrangements under
EFTA Section 920(b)(1)(A). Comment is requested on the cost and
benefits of each alternative, including for issuers, merchants,
cardholders, and the payments system overall. In particular, the Board
requests comment on the cost of requiring multiple payment card
networks for signature-based debit card transactions, and the time
frame necessary to implement such a requirement.
Proposed Sec. 235.7(a)(2) describes three circumstances in which
an issuer or payment card network would not satisfy the general
requirement to have at least two unaffiliated payment networks on which
an electronic debit transaction may be processed, regardless of which
of the alternatives is adopted.
First, proposed Sec. 235.7(a)(2)(i) addresses payment card
networks that operate in a limited geographic acceptance area.
Specifically, the proposed rule provides that adding an unaffiliated
payment card network that is not accepted throughout the United States
would not satisfy the requirement to have at least two unaffiliated
payment card networks enabled on a debit card. For example, an issuer
could not comply with the network exclusivity provision by having a
second unaffiliated payment card network that is accepted in only a
limited geographic region of the country. However, an issuer would be
in compliance with proposed Sec. 235.7(a)(1) if, for example, the
debit card operates on one national network and multiple geographically
limited networks that are unaffiliated with the first network and that,
taken together, provide nationwide coverage. Proposed comment 7(a)-4.i
provides an example to illustrate the provision regarding limited
geographic acceptance networks. The proposed comment also clarifies
that a payment card network is considered to have sufficient geographic
reach even though there may be limited areas in the United States that
it does not serve. For example, a national network that has no merchant
acceptance in Guam or American Samoa may nonetheless meet the
geographic reach requirement.
The Board requests comment on the impact of the proposed approach
to networks with limited geographic acceptance on the viability of
regional payment card networks, and whether other approaches may be
appropriate, including, but not limited to, requiring that a particular
debit card be accepted on at least two unaffiliated payment card
networks (under either alternative) in States where cardholders
generally use the card. If the Board permitted a regional network by
itself to satisfy the requirement, what standard should be used for
determining whether that network provides sufficient coverage for the
issuer's cardholders' transactions? The Board also requests comment on
the potential impact, and particularly the cost impact, on small
issuers from adding multiple payment card networks in order to ensure
that a debit card is accepted on a nationwide basis on at least two
unaffiliated payment card networks.
Second, proposed Sec. 235.7(a)(2)(ii) provides that adding an
unaffiliated payment card network that is accepted only at a limited
number of merchant locations or for limited merchant types or
transaction types would not comply with the requirement to have at
least two unaffiliated payment card networks on a debit card. For
example, an issuer could not solely add as an unaffiliated payment card
network, a network that is only accepted at a limited category of
merchants (for example, at a particular supermarket chain or at
merchants located in a particular shopping mall). See proposed comment
7(a)-4.ii. The Board requests comment on whether additional guidance
regarding networks that have limited merchant acceptance is necessary.
Third, the proposed rule would prohibit a payment card network from
restricting or otherwise limiting an issuer's ability to contract with
any other payment card network that may process an electronic debit
transaction involving the issuer's debit cards. See proposed Sec.
235.7(a)(2)(iii). Proposed comment 7(a)-5 provides examples of
prohibited restrictions on an issuer's ability to contract with other
payment card networks. For example, a payment card network would be
prohibited from limiting or otherwise restricting, by rule, contract,
or otherwise, the other payment card networks that may be enabled on a
particular debit card, such as by expressly prohibiting an issuer from
offering certain specified payment card networks on the debit card or
by limiting the payment card networks that may be offered on a card to
specified networks. See proposed comment 7(a)-5.i.
Proposed Sec. 235.7(a)(2)(iii) would also prohibit network rules
or guidelines that allow only that network's (or its affiliated
network's) brand, mark, or logo to be displayed on a particular debit
card, or that otherwise limit the number or location of network brands,
marks, or logos that may appear on the debit card. See proposed comment
7(a)-5.ii. Such rules or guidelines may inhibit an issuer's ability to
add other payment card networks to a debit card, particularly if the
other networks also require that their brand, mark, or logo appear on a
debit card in order for a card to be offered on that network.
Proposed comment 7(a)-6 provides, however, that nothing in the rule
requires that a debit card identify the brand, mark, or logo of each
payment card network over which an electronic debit transaction may be
processed. For example, a debit card that operates on two or more
different unaffiliated payment card networks need not bear the brand,
mark, or logo for each card network. The Board believes that this
flexibility is necessary to facilitate an issuer's ability to add (or
remove) payment card networks to a debit card without being required to
incur the additional costs associated with the
[[Page 81751]]
reissuance of debit cards as networks are added (or removed).
Proposed Sec. 235.7(a) does not expressly prohibit debit card
issuers from committing to a certain volume, percentage share, or
dollar amount of transactions to be processed over a particular
network. However, these volume, percentage share, or dollar amount
commitments could only be given effect through issuer or payment card
network priorities that direct how a particular debit card transaction
should be routed by a merchant. As discussed below under proposed Sec.
235.7(b), these issuer or payment card network routing priorities would
be prohibited by the proposed limitations on merchant routing
restrictions. The Board requests comment on whether it is necessary to
address volume, percentage share, or dollar amount requirements in the
exclusivity provisions, and whether other types of arrangements should
be addressed under the rule.
Proposed comment 7(a)-7 clarifies that the requirements of Sec.
235.7(a) apply equally to voluntary arrangements in which a debit card
issuer participates exclusively in a single payment card network or
affiliated group of payment card networks by choice, rather than due to
a specific network rule or contractual commitment. For example,
although an issuer may prefer to offer a single payment card network
(or the network's affiliates) on its debit cards to reduce its
processing costs or for operational simplicity, the statute's
exclusivity provisions do not allow that. Thus, the proposed comment
clarifies that all issuers must issue cards enabled with at least two
unaffiliated payment card networks, even if the issuer is not subject
to any rule of, or contract, arrangement, or any other agreement with,
a payment card network requiring that all or a specified minimum
percentage of electronic debit transactions be processed on the network
or its affiliated networks.
Proposed comment 7(a)-8 clarifies that the network exclusivity rule
does not prevent an issuer from including an affiliated payment card
network among the networks that may process an electronic debit
transaction for a particular debit card, as long as at least two of the
networks that accept the card are unaffiliated. The proposed comment
under Alternative A clarifies that an issuer is permitted to offer
debit cards that operate on both a signature debit network as well as
an affiliated PIN debit network, as long as at least one other payment
card network that is unaffiliated with either the signature or PIN
debit networks also accepts the card. The Board is also proposing a
corresponding comment that would apply to Alternative B.
Proposed Sec. 235.7(a)(3) addresses circumstances where previously
unaffiliated payment card networks subsequently become affiliated as a
result of a merger or acquisition. Under these circumstances, an issuer
that issues cards with only the two previously unaffiliated networks
enabled would no longer comply with Sec. 235.7(a)(1) until the issuer
is able to add an additional unaffiliated payment card network to the
debit card. The proposed rule requires issuers in these circumstances
to add an additional unaffiliated debit card network no later than 90
days after the date on which the prior unaffiliated payment card
networks become affiliated. The Board requests comment on whether 90
days provides sufficient time for issuers to negotiate new agreements
and add connectivity with the additional networks in order to comply
with the rule.
Additional Requests for Comment
The Board understands that some institutions may wish to issue a
card, or other payment code or device, that meets the proposed
definition of ``debit card,'' but that may be capable of being
processed using only a single authorization method. For example, a key
fob or mobile phone embedded with a contactless chip may be able to be
processed only as a signature debit transaction or only on certain
networks. Under the proposed rule (under either alternative), the
issuer would be required to add at least a second unaffiliated
signature debit network to the device to comply with the requirements
of Sec. 235.7(a). The Board requests comment on whether this could
inhibit the development of these devices in the future and what steps,
if any, the Board should take to avoid any such impediments to
innovation.
As noted above under proposed comment 7-1, the statutory exemptions
for small issuers, government-administered payment cards, and certain
reloadable prepaid cards do not apply to the limitations on payment
card network restrictions under EFTA Section 920(b). Thus, for example,
government-administered payment cards and reloadable prepaid cards,
including health care and other employee benefit cards, would be
subject to the prohibition on the use of exclusive networks under EFTA
Section 920(b)(1). The Board understands that in many cases, issuers do
not permit PIN functionality on prepaid cards in order to prevent cash
access in response to potential money laundering or other regulatory
concerns. In addition, in the case of debit cards issued in connection
with health flexible spending accounts and health reimbursement
accounts, Internal Revenue Service (IRS) rules require the use of
certain sophisticated technology at the point-of-sale to ensure that
the eligibility of a medical expense claim can be substantiated at the
time of the transaction. However, PIN-debit networks may not currently
offer the functionality or capability to support the required
technology. Thus, applying the network exclusivity prohibition to these
health benefit cards in particular could require an issuer or plan
administrator to add a second signature debit network to comply with
IRS regulations if PIN networks do not add the necessary functionality
to comply with those regulations. The Board requests comment on any
alternatives, consistent with EFTA Section 920, that could minimize the
impact of the proposed requirements on these prepaid products.
B. Sec. 235.7(b) Prohibition on Merchant Routing Restrictions
EFTA Section 920(b)(1)(B) requires the Board to prescribe rules
prohibiting an issuer or payment card network from directly or
indirectly ``inhibit[ing] the ability of any person that accepts debit
cards for payments to direct the routing of electronic debit
transactions for processing over any payment card network that may
process such transactions.'' The Board is proposing to implement this
restriction in Sec. 235.7(b). Specifically, proposed Sec. 235.7(b)
would prohibit both issuers and payment card networks from inhibiting,
directly, or through any agent, processor, or licensed member of the
network, by contract, requirement, condition, penalty, or otherwise, a
merchant's ability to route electronic debit transactions over any
payment card network that may process such transactions.
In practice, this means that merchants, not issuers or networks,
must be able to designate preferences for the routing of transactions,
and that the merchant's preference must take priority over the issuer's
or network's preference. The rules of certain PIN debit payment card
networks today require merchants to route PIN debit transactions based
on the card issuer's designated preferences. This is the case even
where multiple PIN debit networks are available to process a particular
debit card transaction. In other cases, the PIN debit network itself
may require, by rule or contract, that the particular PIN debit
transaction be
[[Page 81752]]
routed over that network when there are multiple PIN networks
available.\93\ Such rules or requirements prevent merchants from
applying their own preferences with respect to routing the particular
debit card transaction to the PIN debit network that will result in the
lowest cost to the merchant. Neither of these practices would be
permitted under the proposed rule.
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\93\ These issuer- or network-directed priority rules are
generally unnecessary for signature debit networks as there is only
a single payment card network available for processing a signature
debit transaction.
---------------------------------------------------------------------------
The Board does not interpret EFTA Section 920(b)(1)(B) to grant a
person that accepts debit cards the ability to process an electronic
debit transaction over any payment card network of the person's
choosing. Rather, the Board interprets the phrase ``any payment card
network that may process such transactions'' to mean that a merchant's
choice is limited to the payment card networks that have been enabled
on a particular debit card. Moreover, allowing merchants to route
transactions over any network, regardless of the networks enabled on
the debit card, would render superfluous the requirement to have at
least two unaffiliated payment cards enabled on a particular debit
card. Accordingly, proposed comment 7(b)-1 clarifies that the
prohibition on merchant routing restrictions applies solely to the
payment card networks on which an electronic debit transaction may be
processed with respect to a particular debit card.
Proposed comment 7(b)-2 provides examples of issuer or payment card
network practices that would inhibit a merchant's ability to direct the
routing of an electronic debit transaction in violation of Sec.
235.7(b). Although routing generally refers to sending the transaction
information to the issuer, the Board notes that the statute broadly
directs the Board to prescribe the rules that prohibit issuer or
payment card network practices that ``inhibit'' a person's ability to
direct the routing of the transaction. Accordingly, the Board believes
it is appropriate also to address certain practices that may affect the
network choices available to the merchant at the time the transaction
is processed.
The first example addresses issuer or card network rules or
requirements that prohibit a merchant from ``steering,'' or encouraging
or discouraging, a cardholder's use of a particular method of debit
card authorization. For example, merchants may want to encourage
cardholders to authorize a debit card transaction by entering their
PIN, rather than by providing a signature, if PIN debit carries a lower
interchange rate than signature debit. Under proposed Sec. 235.7(b)
and comment 7(b)-2.i, merchants may not be inhibited from encouraging
the use of PIN debit by, for example, setting PIN debit as a default
payment method or blocking the use of signature debit altogether.
The second example of a prohibited routing restriction is network
rules or issuer designated priorities that direct the processing of an
electronic debit transaction over a specified payment card network or
its affiliated networks. See proposed comment 7(b)-2.ii. Thus, for
example, if multiple networks are available to process a particular
debit transaction, neither the issuer nor the networks could specify
the network over which a merchant would be required to route the
transaction. Nothing in proposed comment 7(b)-2.ii, however, is
intended to prevent an issuer or payment card network from designating
a default network for routing an electronic debit transaction in the
event a merchant or its acquirer or processor does not indicate a
routing preference. In addition, proposed comment 7(b)-2.ii does not
prohibit an issuer or payment card network from directing that an
electronic debit transaction be processed over a particular network if
required to do so by state law. See, e.g., Iowa Code Sec. 527.5.
As noted above, if issuer- or network-directed priorities are
prohibited, issuers will, as a practical matter, be unable to guarantee
or otherwise agree to commit a specified volume, percentage share, or
dollar amount of debit card transactions to a particular debit card
network. Accordingly, the Board believes it is unnecessary to
separately address volume, percentage share, or dollar amount
commitments of debit card transactions as prohibited forms of network
exclusivity arrangements under proposed Sec. 235.7(a).
Under the third example, a payment card network could not require a
particular method of debit card authorization based on the type of
access device provided by the cardholder. See proposed comment 7(b)-
2.iii. For example, a payment card network would be prohibited from
requiring that an electronic debit transaction that is initiated using
``contactless'' or radio frequency identification device (RFID)
technology may only be processed over a signature debit network. The
Board requests comment on whether there are other circumstances that
the commentary should include as examples of prohibited routing
restrictions.
Although proposed Sec. 235.7 provides merchants control over how
an electronic debit transaction is routed to the issuer, the proposed
rule does not impose a requirement that a merchant be able to select
the payment card network over which to route or direct a particular
electronic debit transaction in real time, that is, at the time of the
transaction. The Board believes that requiring real-time merchant
routing decision-making could be operationally infeasible and cost-
prohibitive in the short term as it would require systematic
programming changes and equipment upgrades. Today, for example,
transaction routing is relatively straightforward once the cardholder
has chosen to authorize a debit card transaction using his or her PIN.
Once the PIN is entered, card information for the transaction is
transmitted to the merchant's acquirer or processor and the transaction
is then generally routed over a pre-determined network based upon
issuer or payment network routing priorities for that card. Under
proposed Sec. 235.7(b), however, issuer and network routing priorities
would no longer be permitted, except under limited circumstances. See
proposed comment 7(b)-2.ii, discussed above. Instead, merchants would
be free to make the routing decision. Although merchant-directed
routing tables administered by the acquirer or processor could be
somewhat more complex than issuer-directed routing tables given the
larger number of merchants, such a system could still be administered
in the straightforward manner they are administered today with the
routing decisions determined in advance for a particular merchant.
Accordingly, proposed comment 7(b)-3 provides that it is sufficient for
a merchant and its acquirer or processor to agree to a pre-determined
set of routing choices that apply to all electronic debit transactions
that are processed by the acquirer on behalf of the merchant.
C. Effective Date
Although EFTA Section 920 requires that the restrictions on the
amount of interchange transaction fees become effective on July 21,
2011, the statute does not specify an effective date for the separate
provisions on network exclusivity and merchant routing restrictions. As
discussed above, the new provisions provide that at least two
unaffiliated payment card networks must be available for processing any
electronic debit transaction, and prohibit issuers and payment card
[[Page 81753]]
networks from inhibiting merchants from directing how electronic debit
transactions may be routed based upon the available choices. In order
to implement these new requirements, certain system changes will be
required. For example, before a debit card may be enabled for an
additional payment card network, connectivity will have to be
established with the new network and internal processing systems
upgraded to support that network. In some cases, new cards may have to
be issued to cardholders. Acquirers and processors will have to be
notified of the new network assignments for each debit card program and
their routing tables updated for each issuer and card program. Payment
card networks will have to ensure that they have sufficient processing
capacity to support any necessary changes.
If Alternative B is adopted in the final rule and multiple
signature debit networks are required for each debit card, the Board
anticipates that significantly more time will be needed to enable
issuers and networks to comply with the rule. The Board requests
comment on a potential effective date of October 1, 2011, for the
provisions under Sec. 235.7 if the Board were to adopt Alternative A
under the network exclusivity provisions, or alternatively, an
effective date of January 1, 2013 if Alternative B were adopted in the
final rule.
The Board requests comment on all aspects of implementing the
proposed limitations on network exclusivity and merchant routing
restrictions under Sec. 235.7, including the specific changes that
will be required and the entities affected. The Board also requests
comment on other, less burdensome alternatives that may be available to
carry out the proposed restrictions under Sec. 235.7 to reduce the
necessary cost and implementation time period.
Sec. 235.8 Reporting Requirements
Section 920 authorizes the Board to collect from issuers and
payment card networks information that is necessary to carry out the
provisions of this section and requires the Board to publish, if
appropriate, summary information about costs and interchange
transaction fees every two years. Summary information from information
collections conducted prior to this proposed rulemaking is discussed
above. The Board anticipates using forms derived from the Interchange
Transaction Fee Surveys (FR 3062; OMB No. 7100), but with a narrower
scope, for purposes of these proposed reporting requirements.\94\ At
this time, however, the Board is not publishing specific forms for
comment. The Board does not anticipate requiring the first report to be
submitted before March 31, 2012. Prior to that time, the Board will
provide an opportunity for comment on the specific reporting forms and
reporting burden. The Board, however, is seeking comment on the
reporting requirements as laid out generally in proposed Sec. 235.8.
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\94\ Copies of the survey forms are available on the Board's Web
site at http://www.federalreserve.gov/newsevents/reform_meetings.htm.
---------------------------------------------------------------------------
Consistent with the statutory information collection authority, the
Board proposes to require issuers that are subject to Sec. Sec. 235.3
and 235.4 and payment card networks to submit reports to the Board.
Each entity required to submit a report would submit the form
prescribed by the Board. The forms would request information regarding
costs incurred with respect to electronic debit transactions,
interchange transaction fees, network fees, and fraud-prevention costs.
Similar to the surveys conducted in connection with this proposed
rulemaking, the Board may publish summary or aggregate information.
The Board proposes that each entity would be required to report
biennially, consistent with the Board's statutory publication
requirement. The Board anticipates that circumstances may develop that
require more frequent reporting. Accordingly, under proposed Sec.
235.8(c), the Board reserves the discretion to require more frequent
reporting.
For the years an entity is required to report, the Board proposes
that such entity must submit the report to the Board by March 31 of
that year. The Board believes that permitting three months following
the end of the calendar-year reporting period provides a reasonable
time to determine the costs that need to be reported and complete the
report. The Board is requesting comment on whether the three-month time
frame is appropriate.
Proposed Sec. 235.8(e) would require entities that are required to
report under this section to retain records of reports submitted to the
Board for five years. Further, such entities would be required to make
each report available upon request to the Board or the entity's primary
supervisors. The Board believes that the record retention requirement
will facilitate administrative enforcement.
Sec. 235.9 Administrative Enforcement
The interchange transaction fee requirements and the network
exclusivity and routing rules are enforced under EFTA Section 918 (15
U.S.C. 1693o), which sets forth the administrative agencies that
enforce the requirements of the EFTA. Unlike other provisions in the
EFTA, the requirements of Section 920 are not subject to EFTA Section
916 (civil liability) and Section 917 (criminal liability). Further,
the Dodd-Frank Act amends the current administrative enforcement
provision of the EFTA. Therefore, proposed Sec. 235.9 sets forth the
administrative enforcement agencies under EFTA Section 918 as amended
by the Dodd-Frank Act.
Form of Comment Letters
Comment letters should refer to Docket No. R-1404 and, when
possible, should use a standard typeface with a font size of 10 or 12;
this will enable the Board to convert text submitted in paper form to
machine-readable form through electronic scanning, and will facilitate
automated retrieval of comments for review. Comments may be mailed
electronically to [email protected].
Solicitation of Comments Regarding Use of ``Plain Language''
Section 772 of the Gramm-Leach-Bliley Act of 1999 (12 U.S.C. 4809)
requires the Board to use ``plain language'' in all proposed and final
rules published after January 1, 2000. The Board invites comment on
whether the proposed rule is clearly stated and effectively organized,
and how the Board might make the text of the rule easier to understand.
Paperwork Reduction Act
In accordance with the Paperwork Reduction Act (PRA) of 1995 (44
U.S.C. 3506; 5 CFR part 1320 Appendix A.1), the Board reviewed this
proposed rule under the authority delegated to the Board by the Office
of Management and Budget. The Board will conduct an analysis under the
Paperwork Reduction Act and seek public comment when it develops
surveys to obtain information under Sec. 235.8. Any additional burden
associated with the reporting requirement in proposed Sec. 235.3(d)
(under Alternative 1) for issuers that wish to receive an interchange
fee in excess of the safe harbor is considered negligible. Thus no new
collections of information pursuant to the PRA are contained in the
proposed rule.
[[Page 81754]]
Regulatory Flexibility Act
In accordance with Section 3(a) of the Regulatory Flexibility Act,
5 U.S.C. 601 et. seq. (RFA), the Board is publishing an initial
regulatory flexibility analysis for the proposed new Regulation II
(Debit Card Interchange Fees and Routing). The RFA requires an agency
to provide an initial regulatory flexibility analysis with the proposed
rule or to certify that the proposed rule will not have a significant
economic impact on a substantial number of small entities. The Board
welcomes comment on all aspects of the initial regulatory flexibility
analysis. A final regulatory flexibility analysis will be conducted
after consideration of comments received during the public comment
period.
1. Statement of the objectives of the proposal. As required by
Section 920 of the EFTA (15 U.S.C. 1693r), the Board is proposing new
Regulation II to establish standards for assessing whether an
interchange transaction fee received or charged by an issuer (and
charged to the merchant or acquirer) is reasonable and proportional to
the cost incurred by the issuer with respect to the transaction.
Additionally, proposed new Regulation II prohibits issuers and payment
card networks from both restricting the number of payment card networks
over which an electronic debit transaction may be processed and
inhibiting the ability of a merchant to direct the routing of an
electronic debit transaction over a particular payment card network.
2. Small entities affected by the proposal. This proposal may have
an effect predominantly on two types of small entities--financial
institutions that either issue debit cards or acquire transactions from
merchants and the merchants themselves. A financial institution
generally is considered small if it has assets of $175 million or
less.\95\ Based on 2010 Call Report data, approximately 11,000
depository institutions had total domestic assets of $175 million or
less. Of this number, however, it is unknown how many of these
institutions issue debit cards. Whether a merchant is a small entity is
determined by the asset size or the number of employees.\96\ Of the 8
million merchant locations that accept debit cards, the number of
merchants that are considered small entities is unknown.
---------------------------------------------------------------------------
\95\ U.S. Small Business Administration, Table of Small Business
Size Standards Matched to North American Industry Classification
System Codes, available at http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_sstd_tablepdf.pdf.
\96\ Id.
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3. Compliance requirements. With respect to the limitations on
interchange transaction fees, the Board's proposed rule does not affect
most such entities directly.\97\ In accordance with Section 920 of the
EFTA, the Board's proposed rule exempts from the limitations on
interchange transaction fees all issuers that, together with
affiliates, have assets of less than $10 billion. The Board's proposed
rule does not require payment card networks to distinguish between
issuers with assets of more than $10 billion and smaller issuers. If a
payment card network decides to distinguish between large and small
issuers, a payment card network may require a smaller issuer to submit
information to it. The proposed rule, however, does not impose
reporting requirements on smaller issuers. As discussed in other
sections of the preamble, the proposed interchange transaction fee
standards are expected to reduce the amount of interchange transaction
fees charged to merchants and acquirers. Accordingly, the Board expects
any economic impact on small merchants and acquirers to be positive.
---------------------------------------------------------------------------
\97\ There may be some small financial institutions that have
very large affiliates such that the institution does not qualify for
the small issuer exemption.
---------------------------------------------------------------------------
The proposed rule prohibiting network exclusivity arrangements may
affect small financial institutions that issue debit cards if such
institutions do not currently comply with the Board's proposed
standards. Under one alternative, a small issuer, like other issuers,
would be required to have at least two unaffiliated payment card
networks on each debit card it issues. If the issuer does not do so
already, it would be required to add an additional network. This
process may require making a decision as to which additional network to
put on a card, establishing a connection to the new network, or
updating internal processes and procedures. Under the second
alternative, a small issuer, like all issuers, would be required to
issue debit cards with at least two unaffiliated networks for each
method of authorization a cardholder could select. The actions that may
be necessary to add additional networks under the second alternative
are the same as those under the first alternative. An issuer, however,
would incur greater costs as the number of networks it adds increases.
In contrast, like all merchants that accept debit cards, smaller
merchants will be provided with greater routing choice. Therefore, the
smaller merchants will be able to route electronic debit transactions
over the lowest-cost path. Accordingly, the Board expects any economic
impact on merchants to be positive.
4. Other Federal rules. The Board believes that no Federal rules
duplicate, overlap, or conflict with proposed Regulation II.
5. Significant alternatives to the proposed rule. As discussed
above, the Board has requested comment on the impact of the network
exclusivity and routing alternatives (the provisions of the proposal
that apply to small issuers) on small entities and has solicited
comment on any approaches, other than the proposed alternatives, that
would reduce the burden on all entities, including small issuers. The
Board welcomes comment on any significant alternatives that would
minimize the impact of the proposal on small entities.
List of Subjects in 12 CFR Part 235
Electronic debit transactions, interchange transaction fees, and
debit card routing.
Authority and Issuance
For the reasons set forth in the preamble, the Board is proposing
to add new 12 CFR part 235 to read as follows:
PART 235--DEBIT CARD INTERCHANGE FEES AND ROUTING
Sec.
235.1 Authority and purpose.
235.2 Definitions.
235.3 Reasonable and proportional interchange transaction fees.
235.4 [Reserved]
235.5 Exemptions.
235.6 Prohibition on circumvention or evasion.
235.7 Limitations on payment card restrictions.
235.8 Reporting requirements.
235.9 Administrative enforcement.
Appendix A--Official Board Commentary on Regulation II
Authority: 15 U.S.C. 1693r.
Sec. 235.1 Authority and purpose.
(a) Authority. This part is issued by the Board of Governors of the
Federal Reserve System (Board) under section 920 of the Electronic Fund
Transfer Act (EFTA) (15 U.S.C. 1693r, as added by section 1075 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law
111-203, 124 Stat. 1376 (2010)).
(b) Purpose. This part implements the provisions of section 920 of
the EFTA, including standards for reasonable and proportional
interchange transaction fees for electronic debit transactions,
exemptions from the interchange transaction fee limitations,
prohibitions on evasion and circumvention,
[[Page 81755]]
prohibitions on payment card network exclusivity arrangements and
routing restrictions for debit card transactions, and reporting
requirements for debit card issuers and payment card networks.
Sec. 235.2 Definitions.
(a) Account means a transaction, savings, or other asset account
(other than an occasional or incidental credit balance in a credit
plan) established for any purpose and that is located in the United
States.
(b) Acquirer means a person that contracts directly or indirectly
with a merchant to provide settlement for the merchant's electronic
debit transactions over a payment card network. An acquirer does not
include an institution that acts only as a processor for the services
it provides to the merchant.
(c) Affiliate means any company that controls, is controlled by, or
is under common control with another company.
(d) Cardholder means the person to whom a debit card is issued.
(e) Control of a company means--
(1) Ownership, control, or power to vote 25 percent or more of the
outstanding shares of any class of voting security of the company,
directly or indirectly, or acting through one or more other persons;
(2) Control in any manner over the election of a majority of the
directors, trustees, or general partners (or individuals exercising
similar functions) of the company; or
(3) The power to exercise, directly or indirectly, a controlling
influence over the management or policies of the company, as the Board
determines.
(f) Debit card. (1) Means any card, or other payment code or
device, issued or approved for use through a payment card network to
debit an account, regardless of whether authorization is based on
signature, personal identification number (PIN), or other means, and
regardless of whether the issuer holds the account, and
(2) Includes any general-use prepaid card.
(3) The term ``debit card'' does not include--
(i) Any card, or other payment code or device, that is redeemable
upon presentation at only a single merchant or an affiliated group of
merchants for goods or services;
(ii) A check, draft, or similar paper instrument, or an electronic
representation thereof; or
(iii) An account number, when used to initiate an ACH transaction
to debit a person's account.
(g) Designated automated teller machine (ATM) network means
either--
(1) All automated teller machines identified in the name of the
issuer; or
(2) Any network of automated teller machines identified by the
issuer that provides reasonable and convenient access to the issuer's
customers.
(h) Electronic debit transaction means the use of a debit card by a
person as a form of payment in the United States.
(i) General-use prepaid card means a card, or other payment code or
device, that is--
(1) Issued on a prepaid basis, whether or not that amount may be
increased or reloaded, in exchange for payment; and
(2) Redeemable upon presentation at multiple, unaffiliated
merchants for goods or services, or usable at automated teller
machines.
(j) Interchange transaction fee means any fee established, charged,
or received by a payment card network and paid by a merchant or
acquirer for the purpose of compensating an issuer for its involvement
in an electronic debit transaction.
(k) Issuer means any person that issues a debit card.
(l) Merchant means any person that accepts debit cards as payment
for goods or services.
(m) Payment card network means an entity that--
(1) Directly or indirectly provides the services, infrastructure,
and software for authorization, clearance, and settlement of electronic
debit transactions; and
(2) Establishes the standards, rules, or procedures that govern the
rights and obligations of issuers and acquirers involved in processing
electronic debit transactions through the network.
(n) Person means a natural person or an organization, including a
corporation, government agency, estate, trust, partnership,
proprietorship, cooperative, or association.
(o) Processor means a person that processes or routes electronic
debit transactions for issuers, acquirers, or merchants.
(p) United States means the States, territories, and possessions of
the United States, the District of Columbia, the Commonwealth of Puerto
Rico, or any political subdivision of any of the foregoing.
Sec. 235.3 Reasonable and proportional interchange transaction fees.
(a) In general. The amount of any interchange transaction fee that
an issuer may receive or charge with respect to an electronic debit
transaction shall be reasonable and proportional to the cost incurred
by the issuer with respect to the electronic debit transaction.
Alternative 1 (Issuer-Specific Standard With Safe Harbor and Cap):
(b) Determination of reasonable and proportional fees. Except as
provided in paragraph (e) of this section, an issuer complies with the
requirements of paragraph (a) of this section only if, during an
implementation period of October 1 of any calendar year through
September 30 of the following calendar year, each interchange
transaction fee it receives or charges is no more than the greater of--
(1) Seven cents per transaction; or
(2) The costs described in paragraph (c) of this section incurred
by the issuer with respect to electronic debit transactions during the
calendar year preceding the start of the implementation period, divided
by the number of electronic debit transactions on which the issuer
charged or received an interchange transaction fee during that calendar
year, but no higher than twelve cents per transaction.
(c) Allowable costs. For purposes of paragraph (b) of this section,
the costs incurred by an issuer for electronic debit transactions--
(1) Are only those costs that vary with the number of transactions
sent to the issuer and that are attributable to--
(i) Receiving and processing requests for authorization of
electronic debit transactions;
(ii) Receiving and processing presentments and representments of
electronic debit transactions;
(iii) Initiating, receiving, and processing chargebacks,
adjustments, and similar transactions with respect to electronic debit
transactions; and
(iv) Transmitting or receiving funds for interbank settlement of
electronic debit transactions; and posting electronic debit
transactions to cardholder accounts; and
(2) Do not include fees charged by a payment card network with
respect to an electronic debit transaction.
(d) Disclosure to payment card network. If, during an
implementation period of October 1 of any given calendar year through
September 30 of the following calendar year, an issuer subject to this
section will receive or charge an interchange transaction fee in excess
of seven cents per transaction under paragraph (b)(2) of this section,
the issuer must report, by March 31 of the same calendar year as the
start of the implementation period, to each payment card network
through which its electronic debit transactions may be routed the
amount of any interchange transaction fee it may receive or charge
under paragraph (b)(2).
(e) Transition. From July 21, 2011 through September 30, 2012, an
issuer complies with the requirements of paragraph (a) of this section
if any
[[Page 81756]]
interchange transaction fee it receives or charges is no more than the
greater of--
(1) Seven cents per transaction; or
(2) The costs described in subsection (c) of this section incurred
by the issuer for electronic debit transactions during the 2009
calendar year, divided by the number of electronic debit transactions
on which the issuer received or charged an interchange transaction fee
during the 2009 calendar year, but no higher than twelve cents per
transaction.
Alternative 2 (Cap):
(b) Determination of reasonable and proportional fees. An issuer
complies with the requirements of paragraph (a) of this section only if
each interchange transaction fee received or charged by the issuer for
an electronic debit transaction is no more than twelve cents per
transaction.
Sec. 235.4 [Reserved]
Sec. 235.5 Exemptions.
(a) Exemption for small issuers. Sections 235.3, 235.4, and 235.6
do not apply to an interchange transaction fee received or charged by
an issuer with respect to an electronic debit transaction if--
(1) The issuer holds the account that is debited; and
(2) The issuer, together with its affiliates, has assets of less
than $10 billion as of the end of the previous calendar year.
(b) Exemption for government-administered programs. Except as
provided in paragraph (d) of this section, Sec. Sec. 235.3, 235.4, and
235.6 do not apply to an interchange transaction fee received or
charged by an issuer with respect to an electronic debit transaction
if--
(1) The electronic debit transaction is made using a debit card
that has been provided to a person pursuant to a Federal, State, or
local government-administered payment program; and
(2) The cardholder may use the debit card only to transfer or debit
funds, monetary value, or other assets that have been provided pursuant
to such program.
(c) Exemption for certain reloadable prepaid cards. (1) In general.
Except as provided in paragraph (d) of this section, Sec. Sec. 235.3,
235.4, and 235.6 do not apply to an interchange transaction fee
received or charged by an issuer with respect to an electronic debit
transaction if the electronic debit transaction is made using a
general-use prepaid card that is--
(i) Not issued or approved for use to access or debit any account
held by or for the benefit of the cardholder (other than a subaccount
or other method of recording or tracking funds purchased or loaded on
the card on a prepaid basis); and
(ii) Reloadable and not marketed or labeled as a gift card or gift
certificate.
(2) Temporary cards. For purposes of this paragraph (c), the term
``reloadable'' includes a temporary non-reloadable card issued solely
in connection with a reloadable general-use prepaid card.
(d) Exception. The exemptions in paragraphs (b) and (c) of this
section do not apply to any interchange transaction fee received or
charged by an issuer on or after July 21, 2012 with respect to an
electronic debit transaction if any of the following fees may be
charged to a cardholder with respect to the card--
(1) A fee or charge for an overdraft, including a shortage of funds
or a transaction processed for an amount exceeding the account balance,
unless the fee or charge is charged for transferring funds from another
asset account to cover a shortfall in the account accessed by the card;
or
(2) A fee charged by the issuer for the first withdrawal per
calendar month from an automated teller machine that is part of the
issuer's designated automated teller machine network.
Sec. 235.6 Prohibition on circumvention or evasion.
(a) Prohibition on circumvention or evasion. No person shall
circumvent or evade the interchange transaction fee restrictions in
Sec. Sec. 235.3 and 235.4. Circumvention or evasion of the interchange
fee restrictions under Sec. Sec. 235.3 and 235.4 occurs if an issuer
receives net compensation from a payment card network with respect to
electronic debit transactions.
Sec. 235.7 Limitations on payment card restrictions.
(a) Prohibition on network exclusivity. (1) In general.
Alternative A: An issuer or payment card network shall not directly
or through any agent, processor, or licensed member of a payment card
network, by contract, requirement, condition, penalty, or otherwise,
restrict the number of payment card networks on which an electronic
debit transaction may be processed to less than two unaffiliated
networks.
Alternative B: An issuer or payment card network shall not directly
or through any agent, processor, or licensed member of a payment card
network, by contract, requirement, condition, penalty, or otherwise,
restrict the number of payment card networks on which an electronic
debit transaction may be processed to less than two unaffiliated
networks for each method of authorization that may be used by the
cardholder.
(2) Prohibited exclusivity arrangements. For purposes of paragraph
(a)(1) of this section, an issuer or payment card network does not
satisfy the requirement to have at least two unaffiliated payment card
networks on which an electronic debit transaction may be processed if--
(i) The unaffiliated network(s) that is added to satisfy the
requirements of this paragraph does not operate throughout the United
States, unless the debit card is accepted on a nationwide basis on at
least two unaffiliated payment card networks when the network(s) with
limited geographic acceptance is combined with one or more other
unaffiliated payment card networks that also accept the card.
(ii) The unaffiliated network(s) that is added to satisfy the
requirements of this paragraph is accepted only at a small number of
merchant locations or at limited types of merchants; or
(iii) The payment card network restricts or otherwise limits an
issuer's ability to contract with any other payment card network that
may process an electronic debit transaction involving the issuer's
debit cards.
(3) Subsequent affiliation. If unaffiliated payment card networks
become affiliated as a result of a merger or acquisition such that an
issuer is no longer in compliance with this paragraph (a), the issuer
must add an unaffiliated payment card network through which electronic
debit transactions on the relevant debit card may be processed no later
than 90 days after the date on which the prior unaffiliated payment
card networks become affiliated.
(b) Prohibition on routing restrictions. An issuer or payment card
network shall not, directly or through any agent, processor, or
licensed member of the network, by contract, requirement, condition,
penalty, or otherwise, inhibit the ability of any person that accepts
or honors debit cards for payments to direct the routing of electronic
debit transactions for processing over any payment card network that
may process such transactions.
Sec. 235.8 Reporting requirements.
(a) Entities required to report. Each issuer that is not otherwise
exempt from the requirements of this part under Sec. 235.5(a) and each
payment card network shall file a report with the Board in accordance
with this section.
(b) Report. Each entity required to file a report with the Board
shall submit data in a form prescribed by the Board for that entity.
Data required to be
[[Page 81757]]
reported may include, but is not limited to, data regarding costs
incurred with respect to an electronic debit transaction, interchange
transaction fees, network fees, fraud-prevention and data-security
costs, and fraud losses.
(c) Timing. (1) Each entity shall submit the data in a form
prescribed by the Board biennially.
(2) Each entity shall submit the report to the Board by March 31 of
the year the entity is required to report.
(3) The first report shall be submitted to the Board by March 31,
2012.
(d) Disclosure. The Board may, in its discretion, disclose
aggregate or summary information reported under this section.
Sec. 235.9 Administrative enforcement.
(a)(1) Compliance with the requirements of this part shall be
enforced under--
(i) Section 8 of the Federal Deposit Insurance Act, by the
appropriate Federal banking agency, as defined in section 3(q) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(q)), with respect to--
(A) National banks, federal savings associations, and federal
branches and federal agencies of foreign banks;
(B) Member banks of the Federal Reserve System (other than national
banks), branches and agencies of foreign banks (other than Federal
branches, Federal Agencies, and insured state branches of foreign
banks), commercial lending companies owned or controlled by foreign
banks, and organizations operating under section 25 or 25A of the
Federal Reserve Act;
(C) Banks and state savings associations insured by the Federal
Deposit Insurance Corporation (other than members of the Federal
Reserve System), and insured state branches of foreign banks;
(ii) The Federal Credit Union Act (12 U.S.C. 1751 et seq.), by the
Administrator of the National Credit Union Administration (National
Credit Union Administration Board) with respect to any federal credit
union;
(iii) The Federal Aviation Act of 1958 (49 U.S.C. 40101 et seq.),
by the Secretary of Transportation, with respect to any air carrier or
foreign air carrier subject to that Act; and
(iv) The Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.),
by the Securities and Exchange Commission, with respect to any broker
or dealer subject to that Act.
(2) The terms used in paragraph (a)(1) of this section that are not
defined in this part or otherwise defined in section 3(s) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(s)) shall have the
meaning given to them in section 1(b) of the International Banking Act
of 1978 (12 U.S.C. 3101).
(b) Additional powers. (1) For the purpose of the exercise by any
agency referred to in paragraphs (a)(1)(i) through (iv) of this section
of its power under any statute referred to in those paragraphs, a
violation of this part is deemed to be a violation of a requirement
imposed under that statute.
(2) In addition to its powers under any provision of law
specifically referred to in paragraphs (a)(1)(i) through (iv) of this
section, each of the agencies referred to in those paragraphs may
exercise, for the purpose of enforcing compliance under this part, any
other authority conferred on it by law.
(c) Enforcement authority of Federal Trade Commission. Except to
the extent that enforcement of the requirements imposed under this
title is specifically granted to another government agency under
paragraphs (a)(1)(i) through (iv) of this section, and subject to
subtitle B of the Consumer Financial Protection Act of 2010, the
Federal Trade Commission has the authority to enforce such
requirements. For the purpose of the exercise by the Federal Trade
Commission of its functions and powers under the Federal Trade
Commission Act, a violation of this part shall be deemed a violation of
a requirement imposed under the Federal Trade Commission Act. All of
the functions and powers of the Federal Trade Commission under the
Federal Trade Commission Act are available to the Federal Trade
Commission to enforce compliance by any person subject to the
jurisdiction of the Federal Trade Commission with the requirements of
this part, regardless of whether that person is engaged in commerce or
meets any other jurisdictional tests under the Federal Trade Commission
Act.
Appendix A--Official Board Commentary on Regulation II
Introduction
The following commentary to Regulation II (12 CFR part 235)
provides background material to explain the Board's intent in
adopting a particular part of the regulation. The commentary also
provides examples to aid in understanding how a particular
requirement is to work.
Sec. 235.2 Definitions
2(a) Account
1. Types of accounts. The term ``account'' includes accounts
held by any person, including consumer accounts (i.e., those
established primarily for personal, family or household purposes)
and business accounts. Therefore, the limitations on interchange
transaction fees and the prohibitions on network exclusivity
arrangements and routing restrictions apply to all electronic debit
transactions, regardless of whether the transaction involves a debit
card issued primarily for personal, family, or household purposes or
a business-purpose debit card. For example, an issuer of a business-
purpose debit card is subject to the restrictions on interchange
transaction fees and is also prohibited from restricting the number
of payment card networks on which an electronic debit transaction
may be processed under Sec. 235.7. The term ``account'' also
includes bona fide trust arrangements.
2. Account located in the United States. This part applies only
to electronic debit transactions that are initiated to debit (or
credit in the case of returned goods or cancelled services) an
account located in the United States. If a cardholder uses a debit
card to debit an account held at a bank outside the United States,
then the electronic debit transaction is not subject to this part.
2(b) Acquirer
1. In general. The term ``acquirer'' includes only the
institution that contracts, directly or indirectly, with a merchant
to provide settlement for the merchant's electronic debit
transactions over a payment card network (referred to as acquiring
the merchant's electronic debit transactions). In some acquiring
relationships, an institution provides processing services to the
merchant and is a licensed member of the payment card network, but
does not settle the transactions with the merchant (by crediting the
merchant's account) or the network. These institutions are not
``acquirers'' because they do not provide credit for transactions or
settle to the merchant's transactions with the merchant. These
institutions that only process or route transactions are considered
processors for purposes of this part (See Sec. 235.2(o) and
commentary thereto).
2(c) Affiliate
1. Types of entities. The term ``affiliate'' includes both bank
and nonbank affiliates.
2. Other affiliates. For commentary on whether merchants are
affiliated, see comment 2(f)-5.
2(d) Cardholder
1. Scope. In the case of debit cards that access funds in
transaction, savings, or other similar asset accounts, ``the person
to whom a card is issued'' is the person or persons holding the
account. If the account is a business account, multiple employees
(or other persons associated with the business) may have debit cards
that can access the account. Each employee that has a debit card
that can access the account is a cardholder. In the case of a
prepaid card, the cardholder generally is either the purchaser of
the card or a person to whom the purchaser gave the card, such as a
gift recipient.
2(e) Control [Reserved]
2(f) Debit Card
1. Card, or other payment code or device. The term ``debit
card'' as defined in Sec. 235.2(f) applies to any card, or other
payment code or device, even if it is not issued in a physical form.
Debit cards include, for example, an account number or code that can
[[Page 81758]]
be used to access underlying funds. See, however, Sec.
235.2(f)(3)(iii). Similarly, the term ``debit card'' includes a
device with a chip or other embedded mechanism that links the device
to funds stored in an account, such as a mobile phone or sticker
containing a contactless chip that enables an account to be debited.
2. Deferred debit cards. The term ``debit card'' includes a
card, or other payment code or device, that is used in connection
with deferred debit card arrangements in which transactions are not
immediately posted to and funds are not debited from the underlying
transaction, savings, or other asset account upon settlement of the
transaction. Instead, the funds in the account are held and made
unavailable for other transactions for a specified period of time.
After the expiration of the applicable time period, the cardholder's
account is debited for the value of all transactions made using the
card that have been submitted to the issuer for settlement during
that time period. For example, under some deferred debit card
arrangements, the issuer may debit the consumer's account for all
debit card transactions that occurred during a particular month at
the end of the month. Regardless of the time period chosen by the
issuer, a card, or other payment code or device, that is used in
connection with a deferred debit arrangement is considered a debit
card for purposes of the requirements of this part. Deferred debit
card arrangements do not refer to arrangements in which a merchant
defers presentment of multiple small-dollar card payments, but
aggregates those payments into a single transaction for presentment,
or where a merchant requests placement of a hold on funds in an
account until the actual amount of the cardholder's transaction is
known and submitted for settlement.
3. Decoupled debit cards. Decoupled debit cards are issued by an
entity other than the financial institution holding the cardholder's
account. In a decoupled debit arrangement, transactions that are
authorized by the card issuer settle against the cardholder's
account held by an entity other than the issuer via a subsequent ACH
debit to that account. Because the term ``debit card'' applies to
any card, or other payment code or device, that is issued or
approved for use through a payment card network to debit an account,
regardless of whether the issuer holds the account, decoupled debit
cards are debit cards for purposes of this subpart.
4. General-use prepaid card. The term ``debit card'' includes
general-use prepaid cards. See Sec. 235.2(i) and related commentary
for information on general-use prepaid cards.
5. Store cards. The term ``debit card'' does not include prepaid
cards that may be used at a single merchant or affiliated merchants.
Two or more merchants are affiliated if they are related by either
common ownership or by common corporate control. For purposes of the
``debit card'' definition, the Board would view franchisees to be
under common corporate control if they are subject to a common set
of corporate policies or practices under the terms of their
franchise licenses.
6. Checks, drafts, and similar instruments. The term ``debit
card'' does not include a check, draft, or similar paper instrument
or a transaction in which the check is used as a source of
information to initiate an electronic payment. For example, if an
account holder provides a check to buy goods or services and the
merchant takes the account number and routing number information
from the MICR line at the bottom of a check to initiate an ACH debit
transfer from the cardholder's account, the check is not a debit
card, and such a transaction is not considered an electronic debit
transaction. Likewise, the term ``debit card'' does not include an
electronic representation of a check, draft, or similar paper
instrument.
7. ACH transactions. The term ``debit card'' does not include an
account number when it is used by a person to initiate an ACH
transaction that debits the person's account. For example, if an
account holder buys goods or services over the Internet using an
account number and routing number to initiate an ACH debit, the
account number is not a debit card, and such a transaction is not
considered an electronic debit transaction. However, the use of a
card to purchase goods or services that debits the cardholder's
account by means of a subsequent ACH debit initiated by the card
issuer to the cardholder's account, as in the case of a decoupled
debit card arrangement, involves the use of a debit card for
purposes of this part.
2(g) Designated Automated Teller Machine (ATM) Network
1. Reasonable and convenient access clarified. Under Sec.
235.2(g)(2), a designated automated teller machine network includes
any network of automated teller machines identified by the issuer
that provides reasonable and convenient access to the issuer's
cardholders. An issuer provides reasonable and convenient access,
for example, if, for each person to whom a card is issued, the
network provides access to an automated teller machine in the
network within the metropolitan statistical area of the person's
last known address, or if the address is not known, where the card
was first issued.
2(h) Electronic Debit Transaction
1. Subsequent transactions. The term ``electronic debit
transaction'' includes both the cardholder's use of a debit card for
the initial purchase of goods or services and any subsequent use by
the cardholder of the debit card in connection with the initial
purchase of goods or services. For example, the term ``electronic
debit transaction'' includes using the debit card to return
merchandise or cancel a service that then results in a credit to the
account initially debited to pay for the merchandise or service.
2. Cash withdrawal at the point of sale. The term ``electronic
debit transaction'' includes a transaction in which a cardholder
uses the debit card both to purchase goods or services and to
withdraw cash (known as a ``cashback transaction'').
3. Geographic limitation. This regulation applies only to
electronic debit transactions that are initiated at a merchant
located in the United States. If a cardholder uses a debit card at a
merchant located outside the United States to debit an account held
at a U.S. bank or a U.S. branch of a foreign bank, the electronic
debit transaction is not subject to this part.
2(i) General-Use Prepaid Card
1. Redeemable upon presentation at multiple, unaffiliated
merchants. A card, or other payment code or other device, is
redeemable upon presentation at multiple, unaffiliated merchants if
such merchants agree to honor the card, or other payment code or
device, if, for example, it bears the mark, logo, or brand of a
payment card network, pursuant to the rules of the payment network.
2. Mall cards. Mall cards that are generally intended to be used
or redeemed for goods or services at participating retailers within
a shopping mall are considered general-use prepaid cards if they
carry the mark, logo, or brand of a payment card network and can be
used at any retailer that accepts that card brand, including
retailers located outside of the mall.
2(j) Interchange Transaction Fee
1. In general. Generally, the payment card network is the entity
that establishes and charges the interchange transaction fee to the
merchants or acquirers. The merchants or acquirers then pay to the
issuers any interchange transaction fee established and charged by
the network. Therefore, issuers are considered to receive
interchange transaction fees from merchants or acquirers.
2. Compensating an issuer. The term ``interchange transaction
fee'' is limited to those fees that a payment card network
establishes, charges, or receives to compensate the issuer for its
role in the transaction. (See Sec. 235.3(c) and commentary thereto
for a description of an issuer's role in the transaction). In
contrast, a payment card network may charge issuers and acquirers
fees for sending transaction information to the network for clearing
and settlement. Such fees are not interchange transaction fees
because the payment card network is charging and receiving the fee
as compensation for its role in clearing and settling.
2(k) Issuer
1. In general. The term ``issuer'' means any person that issues
a debit card. The following examples illustrate the entity that is
the issuer under various card program arrangements. For purposes of
determining whether an issuer is exempted under Sec. 235.5(a),
however, the term issuer is limited to the entity that holds the
account being debited.
2. Four-party systems. In a four-party system, the cardholder
receives the card directly or indirectly (e.g., through the bank's
agent) from the account holding bank and has a direct contractual
relationship with its bank with respect to the card. In this system,
the cardholder's bank is the issuer.
3. Three-party systems. In a three-party system, the network
typically provides the card, either directly or indirectly, to the
cardholder and holds the cardholder's account. Accordingly, the
network is also the issuer with respect to the card. In most cases,
the network also has a contractual relationship with the cardholder.
4. BIN-sponsor arrangements. Payment card networks assign
member-financial
[[Page 81759]]
institutions Bank Identification Numbers (BINs) for purposes of
issuing cards, authorizing, clearing, settling, and other processes.
In exchange for a fee or other financial considerations, some
members of payment card networks permit other entities to issue
debit cards using the member's BIN. The entity permitting the use of
its BIN is referred to as the ``BIN sponsor'' and the entity that
uses the BIN to issue cards is often referred to as the ``affiliate
member.'' BIN sponsor arrangements can take at least two different
models:
i. Sponsored debit card model. In some cases, a community bank
or credit union may provide debit cards to its account holders
through a BIN sponsor arrangement with a member institution. In
general, the bank or credit union will provide, directly or
indirectly, debit cards to its account holders. The bank or credit
union's name typically will appear on the debit card. The bank or
credit union also holds the underlying account that is debited and
has the primary relationship with the cardholder. Under these
circumstances, the bank or credit union is the issuer for purposes
of this part. If that affiliate member, together with its
affiliates, has assets of less than $10 billion, then that bank or
credit union is exempt from the interchange transaction fee
restrictions. Although the bank or credit union issues cards through
the BIN sponsors, the BIN sponsor does not have the direct
relationship with the cardholder, and therefore is not the issuer.
ii. Prepaid card model. A member institution may also serve as
the BIN sponsor for a prepaid card program. Under these
arrangements, the BIN-sponsoring institution generally holds the
funds for the prepaid card program in a pooled account, although the
prepaid card program manager may keep track of the underlying funds
for each individual prepaid card through subaccounts. While the
cardholder may receive the card directly from the program manager or
at a retailer, the cardholder's relationship is generally with the
bank holding the funds in the pooled account. This bank typically is
also the BIN sponsor. Accordingly, under these circumstances, the
BIN sponsor, or the bank holding the pooled account, is the issuer.
5. Decoupled debit cards. In the case of decoupled debit cards,
an entity other than the entity holding the cardholder's account
directly or indirectly provides the debit card to the cardholder and
has a direct relationship with the cardholder. The account-holding
institution does not have a relationship with the cardholder with
respect to the decoupled debit card. Under these circumstances, the
entity providing the debit card, and not the account-holding
institution, is considered the issuer. If the issuer of a decoupled
debit card, together with its affiliates, has assets of less than
$10 billion, the issuer is not exempt under Sec. 235.5(a) because
it is not the entity holding the account to be debited.
2(l) Merchant [Reserved]
2(m) Payment Card Network
1. Scope of definition. The term ``payment card network''
generally includes only those entities that establish guidelines,
rules, or procedures that govern the rights and obligations of, at a
minimum, issuers and acquirers involved in processing electronic
debit transactions through the network. Such guidelines, rules, or
procedures may also govern the rights and obligations of merchants,
processors, or cardholders in addition to issuers and acquirers. The
term ``payment card network'' includes an entity that serves in the
multiple roles of payment card network and issuer and/or acquirer,
such as in the case of a three-party system, to the extent that the
entity's guidelines, rules, or procedures also cover its activities
in its role(s) as issuer or acquirer. Acquirers, issuers, third-
party processors, payment gateways, or other entities that may
provide services, equipment, or software that may be used in
authorizing, clearing, or settling electronic debit transactions are
generally excluded from the term ``payment card network,'' unless
such entities also establish guidelines, rules, or procedures that
govern the rights and obligations of issuers and acquirers involved
in processing an electronic debit transaction through the network.
For example, an acquirer is not considered to be a payment card
network solely due to the fact that it establishes particular
transaction format standards, rules, or guidelines that apply to
electronic debit transactions submitted by merchants using the
acquirer's services, because such standards, rules, or guidelines
apply only to merchants that use its services, and not to other
entities that are involved in processing those transactions, such as
the card issuer.
2(n) Person [Reserved]
2(o) Processor
1. Distinction from acquirers. Although a processor may perform
all transaction-processing functions for a merchant or acquirer, a
processor is not the entity that acquires (that is, settles with the
merchant for) the transactions. The entity that acquires electronic
debit transactions is the entity that is responsible to other
parties to the electronic debit transaction for the amount of the
transaction.
2. Issuers. An issuer may use a third party to perform services
related to authorization, clearance, and settlement of transactions.
The third party is the issuer's processor.
2(p) United States [Reserved]
Sec. 235.3 Reasonable and Proportional Interchange Transaction Fees
Alternative 1 (Issuer-Specific Standard With Safe Harbor and
Cap):
3(a) [Reserved]
3(b) Determination of Reasonable and Proportional Fees
1. Two options. An issuer may comply with Sec. 235.3(a) in two
ways: (1) an issuer may elect to receive or charge an interchange
transaction fee that is no more than the amount in Sec.
235.3(b)(1), known as the ``safe harbor,'' or (2) an issuer may
determine the maximum interchange transaction fee it may receive or
charge using the cost-based approach in Sec. 235.3(b)(2) (See Sec.
235.3(c) and related commentary). An issuer complies with Sec.
235.3(a) if it receives an interchange transaction fee in an amount
at or below the safe harbor even if the maximum interchange
transaction fee that the issuer is able to receive or charge under
Sec. 235.3(b)(2) is less than the safe harbor.
2. Safe harbor. An issuer that receives or charges interchange
fees at or below the amount in Sec. 235.3(b)(1) (known as the
``safe harbor'') is not required to compute an interchange fee
transaction amount under Sec. 235.3(b)(2). An issuer that receives
or charges an interchange transaction fee in an amount at or below
the safe harbor, however, must comply the reporting requirements in
Sec. 235.8.
3. Cap. An issuer that determines the maximum interchange
transaction fee that it may receive or charge under the cost-based
approach in Sec. 235.3(b)(2) may not receive or charge an
interchange transaction fee above the maximum amount allowable under
Sec. 235.3(b)(2), known as the ``cap,'' even if its costs are above
the cap. In contrast, if an issuer calculates that it has allowable
per-transaction costs that are lower than the cap, that issuer may
not receive or charge an interchange transaction fee higher than the
amount determined using the formula in Sec. 235.3(b)(2) or the safe
harbor amount, whichever is greater.
4. Variation among interchange fees. A network is permitted to
set fees that vary with the value of the transaction (ad valorem
fees), as long as the maximum amount of the interchange fee received
by an issuer for any electronic debit transaction was not more than
that issuer's maximum permissible interchange fee. A network is
permitted to establish different interchange fees for different
types of transactions (e.g., card-present and card-not-present) or
different types of merchants, as long as each of those fees
satisfied the relevant limits of the standard.
3(c) Issuer Costs
1. In general. Section 235.3(c) sets forth the allowable costs
that an issuer may include when calculating its interchange
transaction fee under Sec. 235.3(b)(2). These costs are those that
are attributable to the authorization, clearance, and settlement of
electronic debit transactions. Section 235.3(c)(1) further limits
the costs in Sec. Sec. 235.3(c)(1)(i) through (c)(1)(iv) to those
that vary with the number of transactions sent to the issuer.
2. Activities. Section 235.3(c)(1) limits the allowable costs
that an issuer may include when calculating its interchange
transaction fee to the variable costs associated with its role in
authorization, clearance, and settlement of electronic debit
transactions.
i. Issuer's role in authorization. Section 235.3(c)(1)(i)
describes an issuer's role in the authorization process. The
authorization process begins when the cardholder presents a debit
card or otherwise provides the card information to the merchant to
purchase goods or services and ends when the merchant receives
notice that the issuer either has approved or denied the
transaction. In both four-party and three-party systems, the issuer
receives the request for authorization of the electronic debit
transaction. In a four-party system, the approval request is sent to
the issuer via the acquirer and payment card network (and any
[[Page 81760]]
processors that the acquirer or issuer may use). In a three-party
system, the payment card network is both the issuer and the acquirer
and therefore the approval request travels through fewer parties. In
both systems, the issuer decides whether to approve or deny the
electronic debit transaction based on several factors, such as the
availability of funds in the cardholder's account. Once the issuer
approves or denies the transaction, it sends the approval or denial
back through the payment card network and acquirer (and any
processors) to the merchant. Section 235.3(c)(1)(i)'s authorization
activities include activities such as data processing, voice
authorization inquiries, and referral inquiries. An issuer generally
performs separate activities with the primary purpose of fraud-
prevention in connection with authorization. Those separate
activities are not considered to be part of an issuer's role in
authorization under Sec. 235.3(c)(1).
ii. Issuer's role in clearance. Section 235.3(c)(1)(ii)
describes the issuer's role in the clearance process. Clearance is
the process of submitting a record of an electronic debit
transaction for payment. In PIN debit (or single-message) networks,
the authorization message also generally serves as the clearance of
the transaction. In signature debit (or dual-message) networks, the
acquirer sends the clearance message through the network to the
issuer following the completion of the purchase by the cardholder,
as specified in payment card network rules. Section
235.3(c)(1)(ii)'s signature-debit clearance activities include
activities such as data processing and reconciling clearing message
information.
iii. Non-routine transactions. In some instances, an issuer may
decide to reverse settlement for an electronic debit transaction,
pursuant to payment card network rules. This reversal is known as a
``chargeback.'' The issuer's role in the clearance process includes
the process of initiating the chargeback. After the acquirer
receives a chargeback, the acquirer may decide to represent the
transaction, pursuant to the network rules. The issuer's role in the
clearance process also includes receiving and processing
representments. Finally, after the initial clearance process, an
acquirer may determine that the transaction record contained an
error. For example, the transaction record may reflect an incorrect
transaction amount or may be a duplicate of a previous transaction.
The issuer's role in the clearance of a transaction also includes
receiving and processing adjustments. Accordingly, Sec.
235.3(c)(1)(iii)'s non-routine clearance activities include
activities such as data processing to prepare and send the
chargeback message through the network, and reconciliation expenses
specific to receiving representments and error adjustments, such as
posting a credit to a cardholder's account. An issuer's clearance
costs do not include the costs of receiving cardholder inquiries
about particular transactions.
iv. Issuer's role in settlement. Issuers have two roles in
settlement of electronic debit transactions: Interbank settlement
and settlement with the cardholders. Interbank settlement is the
process of transferring funds between issuers and acquirers.
Typically, each day a payment card network will collect all
transactions sent for clearing and will determine the net amount
owed by each issuer and acquirer, after deducting interchange
transaction fees and other fees. The issuer (unless it is also a
large merchant acquirer) will generally be in a net debit position
and will transmit funds for interbank settlement. Issuers settle the
electronic debit transactions with their cardholders by posting the
transactions to the cardholder accounts. Section 235.3(c)(1)(iv)'s
settlement costs include the fees for settlement through a net
settlement service, ACH, or Fedwire [reg], and data processing costs
for posting transactions to the cardholders' accounts.
3. Issuer's costs.
i. Variable costs vs. fixed costs. Variable costs that are
attributable to authorizing, clearing, and settling electronic debit
transactions can be considered in determining an issuer's
permissible interchange transaction fee. For example, the portion of
an issuer's data-processing costs that vary based on the number of
authorization requests is a variable cost. If an issuer uses a
third-party processor or other agent for all of its authorization,
clearance, and settlement activities, then any per-transaction fee
the third-party processor charges is a variable cost for the issuer.
In contrast, fixed costs are those costs that do not vary with
changes in output up to existing capacity limits within a calendar
year. For example, an issuer may pay a fixed fee to connect to a
network in order to process transactions. The connectivity fee is a
fixed cost.
ii. Network fees excluded. Per-transaction fees (e.g., switch
fees) paid to the network in its role as network for purposes of
authorization, clearance, and settlement are not an allowable cost.
A payment card network may offer optional authorization, clearance,
and settlement services to an issuer. In this case, although the
network is charging fees to the issuer, the network is not doing so
in its role as a network. Rather, these fees are considered fees an
issuer pays to a processor. Therefore, fees charged by a network for
its role as a third-party processor may be included in an issuer's
allowable costs, provided they otherwise are permissible to include
under Sec. 235.3(c)(1).
iii. Common costs excluded. Common costs, which are not
attributable to authorization, clearance, and settlement, are not
allowable costs. For example, an issuer may not allocate a portion
of its overhead costs (e.g., the costs of its facilities or its
human resources and legal staff) for the purpose of calculating its
permissible interchange transaction fee. Similarly, the costs of
operating a branch office are common to all banking activities,
including the debit card program, and therefore are not allowable
costs.
iv. Costs of other activities excluded. Section 235.3(c) sets
forth an exclusive list of costs that an issuer may include when
determining the amount of an interchange transaction fee it may
receive or charge with respect to an electronic debit transaction.
Therefore, an issuer may not include those costs that are not
incurred for the activities listed in Sec. Sec. 235.3(c)(1)(i)
through (iv). In addition, as discussed earlier, fixed costs, even
if incurred for activities related to authorization, clearance, or
settlement of debit card transactions, may not be included. Fraud
losses, the cost of fraud-prevention activities, and the cost of
rewards programs are not includable as allowable costs.
3(d) Disclosure to payment card network
1. No differentiation. A payment card network may, but is not
required to, differentiate among issuers subject to Sec. 235.3 when
setting interchange transaction fees. If a payment card network
chooses to set the interchange transaction fee for all issuers that
are subject to the interchange fee standards at or below the safe
harbor amount, it is not necessary for issuers to report to the
payment card network through which it receives electronic debit
transactions the maximum amount of any interchange transaction fee
it may receive or charge.
2. Differentiation. If a payment card network differentiates
among issuers when setting interchange transaction fees, any issuer
that is subject to the interchange fee standards receives or charges
interchange transaction fees above the safe harbor must report the
maximum amount of any interchange transaction fee it may receive or
charge to the payment card network. An issuer must report such
amount by March 31 of each calendar year for which it will be
receiving an interchange transaction fee above the safe harbor
(effective October 1 of the calendar year). An issuer need not
submit its detailed cost information to the payment card networks.
Alternative 2 (Cap):
3(a) [Reserved]
3(b) Determining reasonable and proportional fees
1. Variation among interchange fees. A network is permitted to
set fees that vary with the value of the transaction (ad valorem
fees), as long as the maximum amount of the interchange fee received
by an issuer for any electronic debit transaction was not more than
that issuer's maximum permissible interchange fee. A network is
permitted to establish different interchange fees for different
types of transactions (e.g., card-present and card-not-present) or
types of merchants, as long as each of those fees satisfied the
relevant limits of the standard.
Sec. 235.4 [Reserved]
Sec. 235.5 Exemptions for certain electronic debit transactions.
Sec. 235.5 In general
1. Eligibility for multiple exemptions. An electronic debit
transaction may qualify for one or more exemptions. For example, a
debit card that has been provided to a person pursuant to a Federal,
State, or local government-administered payment program may be
issued by an entity that, together with its affiliates, has assets
of less than $10 billion as of the end of the previous calendar
year. In this case, the electronic debit transaction made using that
card may qualify
[[Page 81761]]
for the exemption under Sec. 235.5(a) for small issuers or for the
exemption under Sec. 235.5(b) for government-administered payment
programs. A payment card network establishing interchange fees for
transactions that qualify for more than one exemption need only
satisfy itself that the issuer's transactions qualify for at least
one of the exemptions in order to exempt the electronic debit
transaction from the interchange fee restrictions.
5(a) Exemption for small issuers
1. Asset size determination. An issuer would qualify for the
small-issuer exemption if its total worldwide banking and nonbanking
assets, including assets of affiliates, are less than $10 billion.
5(b) Exemption for government-administered payment programs
1. Government-administered payment program. Electronic debit
transactions made using a debit card issued pursuant to a
government-administered payment program generally are exempt from
the interchange fee restrictions. A program is considered
government-administered regardless of whether a Federal, State, or
local government agency operates the program or outsources some or
all functions to third parties. In addition, a program may be
government-administered even if a Federal, State, or local
government agency is not the source of funds for the program it
administers. For example, child support programs are government-
administered programs even though a Federal, State, or local
government agency is not the source of funds.
5(c) Exemption for certain reloadable prepaid cards
1. Reloadable. Electronic debit transactions made using certain
reloadable general-use prepaid cards are exempt from the interchange
fee restrictions. A general-use prepaid card is ``reloadable'' if
the terms and conditions of the agreement permit funds to be added
to the general-use prepaid card after the initial purchase or
issuance. A general-use prepaid card is not ``reloadable'' merely
because the issuer or processor is technically able to add
functionality that would otherwise enable the general-use prepaid
card to be reloaded.
2. Marketed or labeled as a gift card or gift certificate.
Electronic debit transactions made using a reloadable general-use
prepaid card are not exempt from the interchange fee restrictions if
the card is marketed or labeled as a gift card or gift certificate.
The term ``marketed or labeled as a gift card or gift certificate''
means directly or indirectly offering, advertising or otherwise
suggesting the potential use of a general-use prepaid card as a gift
for another person. Whether the exclusion applies generally does not
depend on the type of entity that makes the promotional message. For
example, a card may be marketed or labeled as a gift card or gift
certificate if anyone (other than the purchaser of the card),
including the issuer, the retailer, the program manager that may
distribute the card, or the payment network on which a card is used,
promotes the use of the card as a gift card or gift certificate. A
general-use prepaid card is marketed or labeled as a gift card or
gift certificate even if it is only occasionally marketed as a gift
card or gift certificate. For example, a network-branded general
purpose reloadable card would be marketed or labeled as a gift card
or gift certificate if the issuer principally advertises the card as
a less costly alternative to a bank account but promotes the card in
a television, radio, newspaper, or Internet advertisement, or on
signage as ``the perfect gift'' during the holiday season.
The mere mention of the availability of gift cards or gift
certificates in an advertisement or on a sign that also indicates
the availability of exempted general-use prepaid cards does not by
itself cause the general-use prepaid card to be marketed as a gift
card or a gift certificate. For example, the posting of a sign in a
store that refers to the availability of gift cards does not by
itself constitute the marketing of otherwise exempted general-use
prepaid cards that may also be sold in the store along with gift
cards or gift certificates, provided that a person acting reasonably
under the circumstances would not be led to believe that the sign
applies to all cards sold in the store. (See, however, comment 5(c)-
4.ii.)
3. Examples of marketed or labeled as a gift card or gift
certificate.
i. The following are examples of marketed or labeled as a gift
card or gift certificate:
A. Using the word ``gift'' or ``present'' on a card or
accompanying material, including documentation, packaging and
promotional displays;
B. Representing or suggesting that a card can be given to
another person, for example, as a ``token of appreciation'' or a
``stocking stuffer,'' or displaying a congratulatory message on the
card or accompanying material;
C. Incorporating gift-giving or celebratory imagery or motifs,
such as a bow, ribbon, wrapped present, candle, or a holiday or
congratulatory message, on a card, accompanying documentation, or
promotional material;
ii. The term does not include the following:
A. Representing that a card can be used as a substitute for a
checking, savings, or deposit account;
B. Representing that a card can be used to pay for a consumer's
health-related expenses--for example, a card tied to a health
savings account;
C. Representing that a card can be used as a substitute for
travelers checks or cash;
D. Representing that a card can be used as a budgetary tool, for
example, by teenagers, or to cover emergency expenses.
4. Reasonable policies and procedures to avoid marketing as a
gift card. The exemption for a general-use prepaid card that is
reloadable and not marketed or labeled as a gift card or gift
certificate in Sec. 235.5(c) applies if a reloadable general-use
prepaid card is not marketed or labeled as a gift card or gift
certificate and if persons involved in the distribution or sale of
the card, including issuers, program managers, and retailers,
maintain policies and procedures reasonably designed to avoid such
marketing. Such policies and procedures may include contractual
provisions prohibiting a reloadable general-use prepaid card from
being marketed or labeled as a gift card or gift certificate,
merchandising guidelines or plans regarding how the product must be
displayed in a retail outlet, and controls to regularly monitor or
otherwise verify that the general-use prepaid card is not being
marketed as a gift card. Whether a general-use prepaid card has been
marketed as a gift card or gift certificate will depend on the facts
and circumstances, including whether a reasonable person would be
led to believe that the general-use prepaid card is a gift card or
gift certificate. The following examples illustrate the application
of Sec. 235.5(c):
i. An issuer or program manager of prepaid cards agrees to sell
general-purpose reloadable cards through a retailer. The contract
between the issuer or program manager and the retailer establishes
the terms and conditions under which the cards may be sold and
marketed at the retailer. The terms and conditions prohibit the
general-purpose reloadable cards from being marketed as a gift card
or gift certificate, and require policies and procedures to
regularly monitor or otherwise verify that the cards are not being
marketed as such. The issuer or program manager sets up one
promotional display at the retailer for gift cards and another
physically separated display for exempted products under Sec.
235.5(c), including general-purpose reloadable cards, such that a
reasonable person would not believe that the exempted cards are gift
cards. The exemption in Sec. 235.5(c) applies because policies and
procedures reasonably designed to avoid the marketing of the
general-purpose reloadable cards as gift cards or gift certificates
are maintained, even if a retail clerk inadvertently stocks or a
consumer inadvertently places a general-purpose reloadable card on
the gift card display.
ii. Same facts as in same facts as in comment 5(c)-4.i, except
that the issuer or program manager sets up a single promotional
display at the retailer on which a variety of prepaid cards are
sold, including store gift cards and general-purpose reloadable
cards. A sign stating ``Gift Cards'' appears prominently at the top
of the display. The exemption in Sec. 235.5(c) does not apply with
respect to the general-purpose reloadable cards because policies and
procedures reasonably designed to avoid the marketing of exempted
cards as gift cards or gift certificates are not maintained.
iii. Same facts as in same facts as in comment 5(c)-4.i, except
that the issuer or program manager sets up a single promotional
multi-sided display at the retailer on which a variety of prepaid
card products, including store gift cards and general-purpose
reloadable cards are sold. Gift cards are segregated from exempted
cards, with gift cards on one side of the display and exempted cards
on a different side of a display. Signs of equal prominence at the
top of each side of the display clearly differentiate between gift
cards and the other types of prepaid cards that are available for
sale. The retailer does not use any more conspicuous signage
suggesting the general availability of gift cards, such as a large
sign stating ``Gift Cards'' at the top of the display or located
near the display. The exemption in Sec. 235.5(c) applies because
policies and
[[Page 81762]]
procedures reasonably designed to avoid the marketing of the
general-purpose reloadable cards as gift cards or gift certificates
are maintained, even if a retail clerk inadvertently stocks or a
consumer inadvertently places a general-purpose reloadable card on
the gift card display.
iv. Same facts as in same facts as in comment 5(c)-4.i,, except
that the retailer sells a variety of prepaid card products,
including store gift cards and general-purpose reloadable cards,
arranged side-by-side in the same checkout lane. The retailer does
not affirmatively indicate or represent that gift cards are
available, such as by displaying any signage or other indicia at the
checkout lane suggesting the general availability of gift cards. The
exemption in Sec. 235.5(c) applies because policies and procedures
reasonably designed to avoid marketing the general-purpose
reloadable cards as gift cards or gift certificates are maintained.
5. On-line sales of prepaid cards. Some Web sites may
prominently advertise or promote the availability of gift cards or
gift certificates in a manner that suggests to a consumer that the
Web site exclusively sells gift cards or gift certificates. For
example, a Web site may display a banner advertisement or a graphic
on the home page that prominently states ``Gift Cards,'' ``Gift
Giving,'' or similar language without mention of other available
products, or use a web address that includes only a reference to
gift cards or gift certificates in the address. In such a case, a
consumer acting reasonably under the circumstances could be led to
believe that all prepaid products sold on the Web site are gift
cards or gift certificates. Under these facts, the Web site has
marketed all such products as gift cards or gift certificates, and
the exemption in Sec. 235.5(c) does not apply to any products sold
on the Web site.
6. Temporary non-reloadable cards issued in connection with a
general-purpose reloadable card. Certain general-purpose prepaid
cards that are typically marketed as an account substitute initially
may be sold or issued in the form of a temporary non-reloadable
card. After the card is purchased, the card holder is typically
required to call the issuer to register the card and to provide
identifying information in order to obtain a reloadable replacement
card. In most cases, the temporary non-reloadable card can be used
for purchases until the replacement reloadable card arrives and is
activated by the cardholder. Because the temporary non-reloadable
card may only be obtained in connection with the reloadable card,
the exemption in Sec. 235.5(c) applies as long as the card is not
marketed as a gift card or gift certificate.
Sec. 235.6 Prohibition on Circumvention or Evasion
1. Illustration of circumvention or evasion. A finding of
evasion or circumvention will depend on all relevant facts and
circumstances.
i. Example. Circumvention or evasion of the interchange
transaction fee restrictions is indicated in the following example:
The total amount of payments or incentives received by an issuer
from a payment card network during a calendar year in connection
with electronic debit transactions, other than interchange
transaction fees passed through to the issuer by the network,
exceeds the total amount of all fees paid by the issuer to the
network for electronic debit transactions during that year.
ii. Incentives or fees considered. Payments or incentives paid
by a payment card network could include, but are not limited to,
marketing incentives, payments or rebates for meeting or exceeding a
specific transaction volume, percentage share or dollar amount of
transactions processed, or other fixed payments for debit card
related activities. Incentives or payments made by a payment card
network do not include interchange transaction fees that are passed
through to the issuer by the network. In addition, funds received by
an issuer from a payment card network as a result of chargebacks or
violations of network rules or requirements by a third party do not
constitute incentives or payments made by a payment card network.
Fees paid by an issuer to a payment card network include, but are
not limited to network processing, or switch fees, membership or
licensing fees, network administration fees, and fees for optional
services provided by the network.
2. Examples of circumstances not involving circumvention or
evasion. The following examples illustrate circumstances that would
not indicate circumvention or evasion of the interchange transaction
fee restrictions in Sec. Sec. 235.3 and 235.4:
i. Because of an increase in debit card transactions that are
processed through a payment card network during a calendar year, an
issuer receives an additional volume-based incentive payment from
the network for that year. Over the same period, however, the total
network processing fees the issuer pays the payment card network
with respect to debit card transactions also increase so that the
total amount of fees paid by the issuer to the network continue to
exceed payments or incentives paid by the network to the issuer.
Under these circumstances, the issuer does not receive any net
compensation from the network for electronic debit transactions, and
thus, no circumvention or evasion of the interchange transaction fee
restrictions has occurred.
ii. Because of an increase in debit card transactions that are
processed through a payment card network during a calendar year, an
issuer receives a rate reduction for network processing fees that
reduces the total amount of network processing fees paid by the
issuer during the year. However, the total amount of all fees paid
to the network by the issuer for debit card transactions continues
to exceed the total amount of payments or incentives received by the
issuer from the network for such transactions. Under these
circumstances, the issuer does not receive any net compensation from
the network for electronic debit transactions and thus, no
circumvention or evasion of the interchange transaction fee
restrictions has occurred.
3. No applicability to exempt issuers or electronic debit
transactions. The prohibition against circumventing or evading the
interchange transaction fee restrictions does not apply to issuers
or electronic debit transactions that qualify for an exemption under
Sec. 235.5 from the interchange transaction fee restrictions.
Sec. 235.7 Limitations on Payment Card Restrictions
1. Application of small issuer, government-administered payment
program, and reloadable card exemptions to payment card network
restrictions. The exemptions under Sec. 235.5 for small issuers,
cards issued pursuant to government-administered payment programs,
and certain reloadable prepaid cards do not apply to the limitations
on payment card network restrictions. For example, an issuer of
debit cards for government-administered payment programs, while
exempt from the restrictions on interchange transaction fees, is
subject to the requirement that electronic debit transactions made
using such cards must be capable of being processed on at least two
unaffiliated payment card networks and to the prohibition on
inhibiting a merchant's ability determine the routing for electronic
debit transactions.
7(a) Prohibition on Network Exclusivity
1. Personal Identification Number (PIN) debit. The term ``PIN
debit'' refers to a cardholder's use of a personal identification
number, or PIN, to authorize a debit card transaction. Payment card
networks that process debit card transactions that are typically
authorized by means of a cardholder's entry of a PIN are referred to
as ``PIN'' or ``PIN-based'' (or single message) debit networks.
2. Signature debit. The term ``signature debit'' generally
refers to a cardholder's use of a signature to authorize a debit
card transaction. Payment card networks that process debit card
transactions that are typically authorized by means of a
cardholder's signature are referred to as ``signature'' or
``signature-based'' debit (or dual message) networks.
Alternative A (Two unaffiliated networks)
3. Scope of restriction. Section 235.7(a) does not require an
issuer to have multiple, unaffiliated networks available for each
method of cardholder authorization. For example, it is sufficient
for an issuer to issue a debit card that operates on one signature-
based card network and on one PIN-based card network, as long as the
two card networks are not affiliated. Alternatively, an issuer may
issue a debit card that is accepted on two unaffiliated signature-
based card networks or on two unaffiliated PIN-based card networks.
Alternative B (Two unaffiliated networks for each authorization method)
3. Scope of restriction. Section 235.7(a) provides that each
electronic debit transaction, regardless of the method of
authorization used by the cardholder, must be able to be processed
on at least two unaffiliated payment card networks. For example, if
a cardholder authorizes an electronic debit transaction using a
signature, that transaction must be capable of being processed on at
least two unaffiliated signature-based payment card networks.
Similarly, if a consumer authorizes an
[[Page 81763]]
electronic debit transaction using a PIN, that transaction must be
capable of being processed on at least two unaffiliated PIN-based
payment card networks. The use of alternative technologies, such as
contactless or radio-frequency identification (RFID), to authorize a
transaction does not constitute a separate method of authorization
because such transactions are generally processed over either a
signature debit network or a PIN debit network.
4. Examples of limited geographic or merchant acceptance
networks. Section 235.7(a) requires that a payment card network (or
combination of payment card networks) meet geographic and merchant
acceptance requirements to satisfy the rule. The following are
examples of payment card networks that would not meet the geographic
or merchant acceptance tests:
i. A payment card network that operates in only a limited region
of the United States would not meet the geographic test, unless one
or more other unaffiliated payment card network(s) are also enabled
on the card, such that the combined geographic coverage of networks
permits the card to be accepted on at least two unaffiliated payment
card networks for any geographic area in the United States. For
example, an issuer may not issue a debit card that is enabled solely
on one payment card network that is accepted nationwide and another
unaffiliated payment card network that operates only in the Midwest
United States. In such case, the issuer would also be required to
add one or more unaffiliated payment card networks that would
generally enable transactions involving the card to be processed on
at least two unaffiliated payment card networks in almost all of the
rest of the country. A payment card network is considered to have
sufficient geographic reach even though there may be limited areas
in the United States that it does not serve. For example, a national
network that has no merchant acceptance in Guam or American Samoa
would nonetheless meet the geographic reach requirement.
ii. A payment card network that is accepted only at a limited
category of merchants (for example, at a particular grocery store
chain or at merchants located in a particular shopping mall).
5. Examples of prohibited restrictions on an issuer's ability to
contract. The following are examples of prohibited network
restrictions on an issuer's ability to contract with other payment
card networks:
i. Network rules or contract provisions limiting or otherwise
restricting the other payment card networks that may be enabled on a
particular debit card.
ii. Network rules or guidelines that allow only that network's
brand, mark, or logo to be displayed on a particular debit card or
that otherwise limit the number, or location, of network brands,
marks, or logos that may appear on the debit card.
6. Network logos or symbols on card not required. Section
235.7(a) does not require that a debit card identify the brand,
mark, or logo of each payment card network over which an electronic
debit transaction may be processed. For example, a debit card that
is enabled for two or more unaffiliated payment card networks need
not bear the logos or symbols for each card network.
7. Voluntary exclusivity arrangements prohibited. Section
235.7(a) requires the issuance of debit cards that are enabled on at
least two unaffiliated payment card networks in all cases, even if
the issuer is not subject to any rule of, or contract, arrangement
or other agreement with, a payment card network requiring that all
or a specified minimum percentage of electronic debit transactions
be processed on the network or its affiliated networks.
Alternative A Only (Two unaffiliated networks)
8. Affiliated payment card networks. Section 235.7(a) does not
prohibit an issuer from including an affiliated payment card network
among the networks that may process an electronic debit transaction
with respect to a particular debit card, as long as at least two of
the networks that are enabled on the card are unaffiliated. For
example, an issuer may offer debit cards that are accepted on a
payment card network for signature debit transactions and in an
affiliated payment card network for PIN debit transactions as long
as those debit cards may also be accepted on another unaffiliated
payment card network.
Alternative B Only (Two unaffiliated networks for each authorization
method)
8. Affiliated payment card networks. Section 235.7(a) does not
prohibit an issuer from including an affiliated payment card network
among the networks that may process an electronic debit transaction
for a particular debit card, as long as, for each method of
authorization, at least two of the networks that are enabled on the
card are unaffiliated. For example, an issuer may offer debit cards
that are accepted on a payment card network for signature debit
transactions and on an affiliated payment network for PIN debit
transactions as long as those debit cards may also be accepted on a
second signature debit network and a second PIN debit network, both
of which are unaffiliated with the first network.
7(b) Prohibition on Routing Restrictions
1. Relationship to the network exclusivity restrictions. The
prohibition on routing restrictions applies solely to the payment
card networks on which an electronic debit transaction may be
processed for a particular debit card. Thus, an issuer or payment
card network is prohibited from inhibiting a merchant's ability to
route or direct the transaction over any of the payment card
networks that the issuer has enabled to process an electronic debit
transaction for that particular debit card.
2. Examples of prohibited merchant restrictions. The following
are examples of issuer or network practices that would inhibit a
merchant's ability to direct the routing of an electronic debit
transaction that are prohibited under Sec. 235.7(b):
i. Prohibiting a merchant from encouraging or discouraging a
cardholder's use of a particular method of debit card authorization,
such as rules prohibiting merchants from favoring a cardholder's use
of PIN debit over signature debit, or from discouraging the
cardholder's use of signature debit.
ii. Establishing network rules or designating issuer priorities
directing the processing of an electronic debit transaction on a
specified payment card network or its affiliated networks, except as
a default rule in the event the merchant, or its acquirer or
processor, does not designate a routing preference, or if required
by state law.
iii. Requiring a specific method of debit card authorization
based on the type of access device provided by to the cardholder by
the issuer, such as requiring the use of signature debit if the
consumer provides a contactless debit card.
3. Real-time routing decision not required. Section 235.7(b)
does not require that the merchant have the ability to select the
payment card network over which to route or direct a particular
electronic debit transaction at the time of the transaction.
Instead, the merchant and its acquirer may agree to a pre-determined
set of routing choices that apply to all electronic debit
transactions that are processed by the acquirer on behalf of the
merchant.
By order of the Board of Governors of the Federal Reserve
System, December 16, 2010.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 2010-32061 Filed 12-27-10; 8:45 am]
BILLING CODE 6210-01-P