[Federal Register Volume 76, Number 139 (Wednesday, July 20, 2011)]
[Rules and Regulations]
[Pages 43394-43475]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-16861]
[[Page 43393]]
Vol. 76
Wednesday,
No. 139
July 20, 2011
Part II
Federal Reserve System
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12 CFR Part 235
Debit Card Interchange Fees and Routing; Final Rule
Federal Register / Vol. 76, No. 139 / Wednesday, July 20, 2011 /
Rules and Regulations
[[Page 43394]]
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FEDERAL RESERVE SYSTEM
12 CFR Part 235
[Regulation II; Docket No. R-1404]
RIN 7100 AD 63
Debit Card Interchange Fees and Routing
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule.
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SUMMARY: The Board is publishing a final rule, Regulation II, Debit
Card Interchange Fees and Routing. This rule implements the provisions
of Section 920 of the Electronic Fund Transfer Act, 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,
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. An
interim final rule, with a request for comment, on standards for
receiving a fraud-prevention adjustment to interchange transaction fees
is published separately in the Federal Register.
DATES: Effective date: The final rule is effective October 1, 2011.
Compliance dates: For Sec. 235.7(a) the general compliance date is
April 1, 2012, except as follows: Payment card networks must comply
with Sec. Sec. 235.7(a)(1) and (a)(3) on October 1, 2011. Issuers must
comply with Sec. 235.7(a) on April 1, 2013, with respect to debit
cards that use transaction qualification or substantiation systems and
general-use prepaid cards sold on or after April 1, 2013. Issuers must
comply with Sec. 235.7(a) with respect to reloadable general-use
prepaid cards sold and reloaded prior to April 1, 2013 by May 1, 2013.
Issuers must comply with Sec. 235.7(a) with respect to reloadable
general-use prepaid cards sold prior to April 1, 2013 and reloaded
after April 1, 2013 within 30 days of the reloading.
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, or Mark
Manuszak, Senior Economist (202/721-4509), Division of Research &
Statistics; 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:
I. Section 1075 of the Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
``Dodd-Frank Act'') was enacted on July 21, 2010.\1\ 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.\2\
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\1\ Pub. L. 111-203, 124 Stat. 1376 (2010).
\2\ EFTA Section 920 is codified as 15 U.S.C. 1693o-2. As
discussed in more detail below, EFTA Section 920(c)(8) defines ``an
interchange transaction fee'' (or ``interchange fee'') 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.
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EFTA Section 920(a)(2) 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.\3\ Section 920(a)(3) 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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\3\ Electronic debit transaction (or ``debit card transaction'')
is defined in EFTA Section 920(c)(5) as a transaction in which a
person uses a debit card.
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Under EFTA Section 920(a)(5), the Board may allow for an adjustment
to an interchange transaction fee that is reasonably necessary to make
allowance for costs incurred by the issuer in preventing fraud in
relation to electronic debit transactions, provided the issuer complies
with standards established by the Board relating to fraud prevention.
Section 920(a)(8) 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 with
respect to an electronic debit transaction and is not used to
circumvent or evade the restrictions on interchange transaction fees.
EFTA Sections 920(a)(6) and (a)(7) exempt 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 certain government-administered payment programs and
certain reloadable, general-use prepaid cards not marketed or labeled
as a gift card or gift certificate. Section 920(a) provides, however,
that beginning July 21, 2012, these two types of debit cards will not
be exempt if the cardholder may be charged either an overdraft fee or a
fee for the first withdrawal each month from automated teller machines
(``ATMs'') in the issuer's designated ATM network.
In addition to rules regarding restrictions on interchange
transaction fees, EFTA Section 920(b) requires the Board to prescribe
rules related to the routing of debit card transactions. First, Section
920(b)(1) 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.
Section 920(a) requires the Board to establish interchange fee
standards no later than April 21, 2011, and that section becomes
effective on July 21, 2011. Section 920(b) 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 provisions.
On December 28, 2010, the Board requested public comment on a
proposed rule for implementing these provisions of the Dodd-Frank Act.
As explained below, the Board received comments from more than 11,500
commenters regarding this proposal, including comments from issuers,
payment card networks, merchants, consumers, consumer advocates, trade
associations, and members of Congress. Prior to publishing its proposed
rule, the Board also conducted a survey of issuers covered by EFTA
Section 920 and of payment card networks to gather information
regarding electronic debit transactions and related costs. Based on its
review of the comments, the statutory provisions, the data available to
the Board regarding costs, its understanding of the debit payment
system, and other relevant information,
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and for the reasons explained below, the Board has adopted this final
rule. A companion interim final rule providing for a fraud-prevention
adjustment to the interchange fee standards was also adopted, with a
request for comment on the interim final rule.\4\
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\4\ See companion interim final rule published separately in the
Federal Register.
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II. The Debit Card Industry
A. Overview of the Debit Card Industry
When introduced in the late 1960s and early 1970s, debit cards
provided a new way for consumers to access funds in their deposit
accounts, supplementing more traditional means such as checks and in-
person withdrawals at bank branches.\5\ Although initially debit cards
were used to withdraw cash or perform other banking activities at ATMs,
the system evolved to support payments made by consumers for the
purchase of goods or services at merchants. Cardholders are also able
to use their debit cards to get cash back at certain point-of-sale
locations as part of the purchase transaction. Debit cards are
generally issued by depository institutions to their deposit account
holders.
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\5\ Check use 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).
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Debit cards now play a prominent role in the U.S. payments system.
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.\6\ Debit cards are used in 35 percent of noncash payment
transactions, and have eclipsed checks as the most frequently used
noncash payment method. Almost half of total third-party debits to
deposit accounts are made using debit cards, compared to approximately
30 percent made by checks.7 8 Debit cards are accepted at
about 8 million merchant locations in the United States.
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\6\ The numbers in this discussion are derived from the 2010
Federal Reserve Payments Study, available at http://www.frbservices.org/files/communications/pdf/press/2010_payments_study.pdf. Accordingly, these figures may vary from those discussed
in connection with the Board's survey of covered issuers and payment
card networks.
\7\ 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.
\8\ Board staff projects that debit card transactions will total
about 50 billion in 2011.
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A more recent innovation in card-based payments is the introduction
of prepaid cards. Prepaid cards may or may not be reloadable and may be
accepted broadly or restricted to purchases at particular merchants or
for specific types of products. Prepaid card transaction volume is
still low in comparison to other forms of electronic payments, such as
debit cards, but is increasing rapidly. In particular, prepaid cards
were used for 6 billion transactions in 2009, valued at $140 billion,
with average annual growth rates of prepaid transaction volume and
value of more than 20 percent between 2006 and 2009.\9\
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\9\ These prepaid numbers are based on the 2010 Federal Reserve
Payments Study, which gathered information on both general-use and
private-label prepaid cards. According to that study, of the
reported 6.0 billion prepaid card transactions in 2009, 1.3 billion
were general-use prepaid card transactions, valued at $40 billion,
and 4.7 billion were private-label prepaid card and electronic
benefit transfer (``EBT'') card transactions, valued at $90 billion.
Combined, in 2009, debit and prepaid cards accounted for 43.9
billion transactions or 40 percent of noncash payment transactions.
Debit and prepaid card transaction volume of 37.6 billion reported
by networks in the Board's interchange survey differed from the
transaction volume of 39.2 billion (excluding private-label prepaid
and EBT card transactions) reported in the Federal Reserve Payments
Study because some networks reported different volumes in the two
surveys.
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In general, there are two types of debit card authentication
methods on which current systems are based: PIN (personal
identification number) and signature.\10\ 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 a
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.
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\10\ 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.''
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The authentication methods available for a given transaction
generally depend on features of the consumer's card, the transaction,
and the merchant's acceptance policy. According to the Board's survey
of covered card issuers, more than 70 percent of debit cards
outstanding (including prepaid cards) support both PIN- and signature-
based transactions (88 percent, excluding prepaid cards).\11\ In the
current environment, however, certain transactions, such as
transactions for hotel stays or car rentals, where the exact amount of
the transaction is not known at the time of authorization, cannot
readily be accommodated on PIN-based, single-message systems. In
addition, PIN debit transactions generally are not currently accepted
for Internet, telephone, and mail transactions. Overall, information
collected by the Board indicates that roughly one-quarter of the
merchant locations in the United States that accept debit cards have
the capability to accept PIN-based debit transactions. Further, as
discussed below in connection with Sec. 235.2(m), new types of debit
card transactions are emerging that are not ``PIN-based'' or
``signature-based'' as those terms traditionally have been used and use
new cardholder authentication methods.
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\11\ ``Covered issuers'' are those issuers that, together with
affiliates, have assets of $10 billion or more.
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Debit card transactions typically are processed over one of two
types of systems, often referred to as three-party and four-party
systems.\12\ 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).\13\ The network receives transaction information and data
from the acquiring side of the market, routes the information to the
issuer of the card (authorization and clearing), and determines each
side's daily net settlement positions for interbank monetary
transfers.\14\
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\12\ Industry participants sometimes refer to four-party systems
as ``open loop'' systems and three-party systems as ``closed loop''
systems.
\13\ Throughout this rule, the term ``bank'' may be used to
refer to any depository institution.
\14\ 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 three-party system, one entity acts as issuer and system
operator, and often as acquirer as well. Thus, the three parties
involved in a transaction are the cardholder, the merchant, and the
system operator. The three-party model is used for some prepaid card
transactions, but currently is not used for other debit card
transactions in which the cardholder is debiting his or her bank
account.
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
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enters a PIN. An electronic authorization request for a specific dollar
amount, along with the cardholder's account information, is sent from
the merchant to the acquirer to the network, which sends the request to
the appropriate card-issuing institution.\15\ 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 approving or declining the transaction is
returned to the merchant via the reverse path, usually within seconds
of the authorization request.
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\15\ 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
cardholder's account based on these clearing messages. Based on all
clearing messages received in one day, the network calculates and
communicates to each issuer and acquirer its net debit or credit
position for settlement. The interbank settlement generally is effected
through a settlement account at a commercial bank, or through ACH
transfers. The acquirer credits the merchant's account for the value of
its transactions, less the merchant discount, as discussed below. The
timing of this crediting is determined by the merchant-acquirer
agreement and/or ACH operator rules. In some circumstances, an acquirer
that is also the issuer with respect to a particular transaction may
authorize and settle that transaction internally.
Various fees are associated with debit card transactions. The
interchange fee is set by the relevant network and paid by the acquirer
to the issuer; the network accounts for the interchange fee in
determining each issuer's and acquirer's net settlement position.
Switch fees are charged by the network to acquirers and issuers to
compensate the network for its role in processing the transaction.\16\
The acquirer charges the merchant a merchant discount--the difference
between the face value of a transaction and the amount the 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.\17\
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\16\ A variety of other network fees, such as membership fees
and licensing fees, may be collected by the network from the issuer
or acquirer.
\17\ Merchant discounts generally follow two forms: interchange-
plus pricing and blended. If an acquirer is charging an interchange-
plus merchant discount, the acquirer passes through the exact amount
of the interchange fee for each transaction. If an acquirer is
charging a blended merchant discount, the acquirer charges the same
discount regardless of the interchange fee that applies to each
transaction.
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When first introduced, some PIN debit networks structured
interchange fees in a manner similar to ATM interchange fees.\18\ For
ATM 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,
interchange fees for all PIN debit transactions in the United States
were paid by acquirers to card issuers.\19\
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\18\ 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.
\19\ Debit Card Directory (1995-1999). See also, Fumiko 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
merchant type (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 the fixed and ad valorem components of
fees, in addition to raising the caps on overall 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, 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) to gain
increased acceptance in those markets.\20\ Until 2003, interchange fee
levels for signature debit transactions were generally similar to those
for credit card transactions and significantly higher than those for
PIN debit card transactions. However, PIN debit fees began to increase
in the early 2000s, as noted above, while signature debit fees declined
in late 2003 and early 2004.\21\ More recently, both PIN and signature
debit fees have increased, although PIN debit fees have increased at a
faster pace.
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\20\ 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.
\21\ This decline followed the settlement of litigation
surrounding signature debit cards. See In re: Visa Check/MasterMoney
Antitrust Litigation, 192 F.R.D. 68 (E.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 network rules generally apply to issuers and
acquirers, merchants and processors also may be required to comply with
a network's 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.
B. Summary Information About Interchange Fees and Transaction Costs
In September 2010, the Board surveyed issuers that would be subject
to the interchange fee standards and payment card networks to gather
information to assist the Board in developing its proposed rule.\22\
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Preliminary summary information was provided in the Board's
proposal.\23\ An updated and more detailed summary of this information
is provided in ``2009 Interchange Revenue, Covered Issuer Costs, and
Covered Issuer and Merchant Fraud Losses Related to Debit Card
Transactions.'' \24\ What follows is a brief high-level summary of the
survey data responses on interchange fees, issuer costs, and merchant
and issuer fraud losses. The data results represent only covered
issuers and networks that responded to the survey.\25\
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\22\ The Board also surveyed the nine largest merchant
acquirers, all of which responded to the survey and provided
information on the number and volume of debit card transactions that
they processed, the number of merchants that accepted various types
of debit cards, fraud losses, fraud prevention activities and costs,
and exclusivity arrangements and routing procedures.
\23\ 75 FR 81724-26, 81740-42 (Dec. 28, 2010).
\24\ http://www.federalreserve.gov/paymentsystems/files/debitfees_costs.pdf.
\25\ Most respondents did not provide information for every data
element requested in the surveys. As discussed further below under
Sec. 235.3, when determining the interchange fee standard, the
Board considered only data from issuers that provided information
for each included cost.
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Card use. Payment card networks reported a total of approximately
37.6 billion debit (including prepaid) card purchase transactions in
2009, with an aggregate value of more than $1.4 trillion. Signature-
based transactions accounted for 22.5 billion or 60 percent of all
purchase transactions, and $837 billion or 59 percent of transaction
value. PIN-based debit transactions totaled 13.9 billion or 37 percent
of purchase transactions, and $555 billion or 39 percent of transaction
value. General-use prepaid card transactions represented 1.2 billion or
3 percent of purchase transactions and $38 billion or 3 percent of
purchase transaction value. The average value of all purchase
transactions was $38.03, with the average values of signature debit,
PIN debit, and prepaid card transactions being $37.15, $40.03, and
$31.47, respectively.
Interchange fees. Networks reported that debit card interchange
fees totaled $16.2 billion in 2009. Of this 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 average interchange fee for all debit card
transactions was 44 cents per transaction, or 1.15 percent of the
average transaction amount. The average interchange fee for signature
debit transactions was 56 cents, or 1.53 percent of the average
transaction amount. The average interchange fee for PIN debit
transactions was significantly lower, at 23 cents per transaction, or
0.58 percent of the average transaction amount. Prepaid card
interchange fees averaged 40 cents per transaction, or 1.28 percent of
the average transaction amount.\26\
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\26\ Some of these numbers differ from those published in the
Federal Register notice of proposed Regulation II (75 FR 81725 (Dec.
28, 2010)) because several networks subsequently submitted
corrections to previously provided data. In one instance, a network
corrected the number of prepaid transactions and PIN debit
transactions.
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Issuer processing costs. The Board's survey requested covered
issuers to report their total transaction processing costs, including
fixed and variable costs and network processing fees associated with
authorization, interbank clearing and settlement, and cardholder
account posting for routine purchase transactions and non-routine
transactions, such as chargebacks and errors. The median per-
transaction total processing cost across issuers for all types of debit
card transactions was 11 cents per transaction. The 80th percentile of
per-transaction total processing cost across issuers for all types of
debit card transactions was 19 cents.\27\
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\27\ For signature debit transactions, the median issuer per-
transaction cost was 13 cents and the 80th percentile was 21 cents.
For PIN debit transactions, the median and 80th percentile issuer
per-transaction costs were 8 cents and 14 cents, respectively. For
prepaid card transactions, they were 61 cents and $1.52,
respectively.
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Issuer fraud-prevention and data-security costs. The median issuer
cost for all debit card-related fraud-prevention activities (excluding
data-security costs, which were reported separately) was approximately
1.7 cents and the 80th percentile was 3.1 cents. The most commonly
reported fraud-prevention activity was transaction monitoring. The
median issuer cost for transaction monitoring was 0.7 cents, and the
80th percentile was 1.2 cents. The remaining costs related to a variety
of fraud-prevention activities, including research and development,
card activation systems, PIN customization, merchant blocking, and card
authentication systems; the per-transaction cost of each individual
activity was small, typically less than one-tenth of a cent. The median
total data-security cost reported by issuers was approximately 0.1
cents and the 80th percentile was 0.4 cents.
Network Fees and Incentives. The payment card networks reported
various network fees that they charge to issuers and acquirers. Total
network fees exceeded $4.1 billion. Networks charged issuers more than
$2.3 billion in fees and charged acquirers over $1.8 billion in fees.
Almost 76 percent of the total fees paid, or $3.1 billion, were charged
by signature debit networks. More than $3.4 billion, or 82 percent of
total fees paid, were assessed on a per-transaction basis. Networks
paid issuers almost $700 million and acquirers more than $300 million
in discounts and incentives. Of the total incentives or discounts paid
by networks, 81 percent were paid by signature networks.
Fraud losses. The Board estimates that industry-wide fraud losses
to all parties of a debit card transaction were approximately $1.34
billion in 2009. About $1.11 billion of these losses arose from
signature debit card transactions, about $181 million arose from PIN
debit card transactions, and almost $18 million arose from prepaid card
transactions.\28\ Across all transaction types, the median number of
purchase transactions that were fraudulent was about 3 of every 10,000
transactions. The medians for signature, PIN, and prepaid debit card
were 4, less than 1, and 1 of every 10,000 transactions, respectively.
The median loss per purchase transaction incurred by both issuers and
merchants was about 3 cents.\29\ The median fraud loss as a percent of
purchase transaction value was about 9 basis points. For issuers alone,
the median loss per purchase transaction was about 2 cents, and the
median fraud loss as a percent of purchase transaction value was
approximately 5 basis points.\30\
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\28\ Revisions in the data plus the inclusion of prepaid card
fraud have led to changes to some of the industry-wide fraud loss
estimates that were included in the proposal. 75 FR 81740-41 (Dec.
28, 2010). 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. The sum of debit card
program fraud losses will not equal the industry-wide fraud losses
due to different sample sizes and rounding.
\29\ Issuers charge back transactions to acquirers that, in
turn, typically pass on the chargeback value to the merchant.
\30\ For signature debit, the median loss per purchase
transaction to both issuers and merchants was 5 cents, and the
median fraud loss as a percentage of purchase transaction value was
about 12 basis points. This corresponds to a median fraud loss per
purchase transaction to issuers of 3 cents and a median fraud loss
as a percentage of purchase transaction value of 7 basis points. For
PIN debit, the median loss per purchase transaction to both issuers
and merchants was 1 cent and the median fraud loss as a percentage
of purchase transaction value was about 3 basis points. This
corresponds to a median fraud loss per purchase transaction to
issuers of 1 cent and a median fraud loss as a percentage of
purchase transaction value of 2 basis points. For prepaid, the
median loss per purchase transaction to both issuers and merchants
was 1 cent, and the median fraud loss as a percentage of purchase
transaction value was 3 basis points. This corresponds to a median
fraud loss per purchase transaction to issuers of 1 cent and a
median fraud loss as a percentage of purchase transaction value of 2
basis points.
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Across all types of transactions, 62 percent of reported fraud
losses were borne by issuers and 38 percent were borne by merchants.
The distribution of fraud losses between issuers and merchants differs
significantly based on
[[Page 43398]]
the cardholder authentication method used in a debit card transaction.
Issuers reported that nearly all the fraud losses associated with PIN
debit transactions (96 percent) were borne by issuers. By contrast,
reported fraud losses for signature debit and prepaid card transactions
were distributed more evenly between issuers and merchants.
Specifically, issuers and merchants bore 59 percent and 41 percent of
signature debit fraud losses, respectively. Issuers and merchants bore
67 percent and 33 percent of prepaid fraud losses, respectively.
Other debit card program costs. The issuer survey collected
information on other costs related to debit card programs, including
costs associated with card production and delivery, cardholder
inquiries, rewards and other incentives, research and development,
nonsufficient funds handling, and compliance. For each issuer that
reported these costs, the costs were averaged over the total number of
debit card transactions processed by the issuer. The median per
transaction cost of production and delivery of cards was 2 cents,
cardholder inquiries 3 cents, rewards and other incentives 2 cents,
research and development 1 cent, nonsufficient funds handling 1 cent,
and compliance less than 0.5 cents.
C. Comparison to Checking Transactions
1. Summary of Proposal and Comments
EFTA Section 920(a)(4)(A) requires the Board to consider, in
prescribing standards governing debit interchange fees, the functional
similarity between electronic debit transactions and checking
transactions that are required to clear at par within the Federal
Reserve System. As part of its proposal, the Board described both the
similarities and differences between electronic debit transactions and
checking transactions. The similarities noted by the Board included the
fact that both types of transactions result in a debit to an asset
account; both involve electronic processing and, increasingly, deposit;
both involve processing fees paid by merchants to banks and other
intermediaries; and both have similar settlement timeframes. The
differences noted by the Board included the closed nature of debit card
systems compared to the open check clearing and collection system; the
payment authorization that is an integral part of electronic debit card
transactions (but not check transactions), which guarantees that the
transaction will not be returned for insufficient funds or certain
other reasons (e.g., a closed account); processing and collection costs
incurred by the issuer (analogous to the payor's bank) for electronic
debit transactions but not for check; par clearance in the check
system; restricted routing choice in the debit card environment; and
the ability to reverse electronic debit transactions within the normal
processing system.\31\
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\31\ See 75 FR 81734 (Dec. 28, 2010) for a more detailed
comparison between checks and electronic debit transactions in the
Board's proposal.
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The Board considered the functional similarity between electronic
debit transactions and checks in determining which allowable costs to
include under its proposal. In part based on this comparison, the Board
proposed to include only those costs that are incurred with respect to
a particular transaction that are related to authorization, clearance,
and settlement of the transaction. The Board noted that a payor's bank
in a check transaction (analogous to the issuer in a debit card
transaction) would not recoup such costs from the payee's bank
(analogous to the merchant acquirer in a debit card transaction), but
that these were costs that EFTA Section 920(a) specifically directed
the Board to consider in setting standards governing interchange
transaction fees.
The Board received several comments from issuers, networks, and
merchants on the functional similarities and differences between
electronic debit transactions and check transactions, as well as
comments on how the Board should take those similarities and
differences into consideration. Merchants and their trade groups
suggested that the starting point for the comparison to checks should
be the cost savings that issuers receive from processing a debit card
transaction rather than a check.
By contrast, numerous issuers and networks asserted that the
Board's interchange fee standards should reflect not only the
similarities between checks and debit cards, but also the differences
between checks and debit cards. As a result, these commenters believed
that the comparison to checks would expand the scope of allowable
costs. Several issuers and networks argued that, by tying the amount of
an interchange fee to the cost of an electronic debit transaction,
Congress recognized that the debit card pricing system should be
different from the check pricing system. These commenters argued that
the Board should consider all costs that issuers incur for electronic
debit transactions, regardless of whether the payor's bank would be
able to recoup similar costs from the payee's bank in a check
transaction.
Many issuers and networks suggested that the Board's interchange
fee standards should account for the benefits merchants receive from
accepting debit cards instead of checks. The benefits of debit cards to
merchants that were cited include the payment guarantee; the avoidance
of fees and other costs of handling checks; \32\ faster availability of
funds; faster check-out at the point-of-sale; increased sales value and
volume; the ability to engage in certain types of transactions where
checks are not practical (e.g., Internet); and resolution of disputes
through network rules and mediation rather than through the legal
system.\33\
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\32\ Cited costs of checks included per-item and batch deposit
fees, check return fees, re-clearance fees, and an optional
guarantee service.
\33\ Some commenters argued that the benefits of debit cards
over checks are also benefits of debit cards over cash.
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Some issuer and network commenters suggested that the Board also
consider the benefits to consumers of using debit cards instead of
checks. Such benefits cited by the commenters included wide acceptance
of debit cards by merchants, ease of use, and speed of transactions.
More generally, some commenters noted that the increase in debit card
use and decline in check use are indicative of greater value from debit
cards to all parties. One network stated that interchange fee revenue
has given issuers an incentive to innovate, allowing them to provide to
merchants a product that is superior to checks.
One difference between electronic debit transactions and check
transactions that commenters highlighted is the payment guarantee for
electronic debit transactions. Numerous issuers and networks stated
that, unlike checks, debit card transactions are guaranteed by issuers
against insufficient funds in an account. These commenters stated that
a comparable service for checks costs merchants 1.5 percent of the
transaction value. Accordingly, several commenters argued that the
Board should compare merchants' debit card acceptance costs to the cost
of accepting a guaranteed check. Some commenters contended that failure
to compensate issuers for the payment guarantee could decrease its
availability.
The Board has considered the comments received and has revised its
analysis of the comparison of check and electronic debit transactions,
as set out below.
[[Page 43399]]
2. Comparison of Check and Electronic Debit Transactions
Typical check transaction.\34\ Checks can be collected, presented,
returned, and settled through an interbank system or through an
intrabank system, in the case of checks deposited and drawn on the same
bank (i.e., ``on-us'' checks). A typical check transaction is initiated
by the payor (such as a consumer) writing a check drawn on the bank
maintaining the payor's account to the order of a payee (such as a
merchant). The payee receives as a payment the signed check and
deposits the check with its bank for collection. The payee's bank has
several choices in directing the presentment of the check to the
payor's bank for payment. The payee's bank may (i) present the check
for payment directly to the payor's bank, (ii) use a check clearing
house, or (iii) use the services of an intermediate collecting bank,
such as a Federal Reserve Bank or another correspondent bank.\35\ Upon
presentment, the payor's bank settles with the presenting bank (either
the payee's bank or an intermediate collecting bank) for the amount of
the check and debits the amount of the check from the account of the
payor. In some cases, the payee's bank may also be the payor's bank, in
which case the bank settles the check internally.
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\34\ See the discussion above providing an overview of the debit
card industry for a description of the typical electronic debit
transaction.
\35\ Check clearing houses generally provide a facility or
mechanism for banks to exchange checks for collection and return.
The services provided by check clearing houses vary. Some merely
provide the capability to exchange checks. Others provide the
capability to exchange between banks in electronic form. A check
clearing house generally also facilitates settlement of the checks
exchanged through it.
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Functional similarities. There are a number of similarities between
check and debit card payments. Both are payment instructions that
result in a debit to the payor's account. Debit card payments are
processed electronically, which is increasingly true for checks as
well. For both check and debit card payments, merchants pay fees to
banks, processors, or intermediaries to process the payments. Interbank
settlement times are roughly similar for both payment types, with
payments typically settling between banks on the same day, or one day
after, the transaction is cleared. Settlement to the payee's account
typically occurs within one or two days after the payee deposits the
check or submits the debit card transaction to its bank.
Dissimilarities. As noted by many commenters, there are also
important functional differences between the check and debit card
payment systems. Some commenters argued that the debit card
authorization, clearance, and settlement infrastructure has no direct
corollary in the check system, and therefore, the comparison between
check and debit card payment systems is inappropriate. The Board notes
that EFTA Section 920(a)(4)(A) requires the Board to consider the
functional similarities between checking transactions and electronic
debit transactions. The Board recognizes that there are also important
differences between the two types of transactions, including those
discussed below.
Closed network versus open system. Debit card systems are
``closed'' systems (relative to check systems) in that both issuing and
acquiring banks must join a network in order to accept and make
payments. To accept debit cards, a merchant must select an acquirer and
make decisions as to the network(s) in which it will participate.
Issuers and acquirers that are members of a network must establish a
relationship with that network and agree to abide by that network's
rules. These network rules include network-defined chargeback and
liability allocation rules, network-defined processing and dispute
handling requirements, and network fee schedules.\36\
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\36\ In addition to the network rules, the EFTA establishes the
basic rights, liabilities, and responsibilities of consumers who use
electronic fund transfer services and of financial institutions that
offer these services.
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The merchant's choice with regard to routing a debit card
transaction is limited to the set of networks whose cards the merchant
accepts and that are also enabled to process a transaction on the
customer's card. Until the effective date of Regulation II, merchant
transaction routing may be further limited if the card issuer or a
network has designated network routing preferences on cards that are
enabled on multiple networks. These issuer or network routing
preferences may result in a transaction being routed to a network that
imposes a higher fee on the acquirer (and hence the merchant) than if
the payment were processed on another available network.
By contrast, the check system is an open system in which, as a
practical matter, 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 payee's bank (i.e., the merchant's
bank) need not join a network in order to collect a check. The rules
governing checks are established by generally uniform state laws (e.g.,
the Uniform Commercial Code), the Expedited Funds Availability Act, and
the Board's Regulation CC (12 CFR part 229). These laws and rules
provide a common legal framework for all check system participants. The
participants, however, may vary certain parts of those rules, such as
by arranging to accept or send electronic images in place of the paper
checks.
The routing of checks for collection is not limited in the same way
as the routing of electronic debit transactions. A payee's bank is free
to use its least costly option for collecting a check. Intermediary
collecting banks generally compete on the basis of price and funds
availability. Typically price and availability vary within an
intermediate collecting bank's service menu depending on the level of
processing the collecting bank is required to do (e.g., whether the
payee's bank sends checks in paper form or via electronic image) and
depending on the time of day the checks are received. If participants
agree to send electronic images instead of the paper checks, the
sending bank must have an agreement with the bank to which it is
sending the image.
Payment authorization and guarantee. Payment authorization is an
integral part of the processing of a transaction on a debit card
network. As part of the payment authorization process, at the start of
a transaction, a card issuer determines, among other things, whether
the card is valid and whether there are sufficient funds to cover the
payment. Several commenters (predominantly issuers and their trade
associations) emphasized that part of the approval includes a ``payment
guarantee,'' which refers to the issuers' agreement to fund a
transaction authorized by the issuer regardless of whether customer
funds are actually available at the time of the settlement of the
transaction, subject to certain predefined chargeback rights. These
commenters argued that the cost of this ``guarantee'' is a settlement
or authorization cost incurred by issuers when they pay acquirers funds
to settle the transaction and the cardholder has insufficient funds in
the account to cover the transaction. Many merchant commenters, as well
as issuers, stated that a debit card payment is provisional because the
transaction may be charged back in certain circumstances, such as when
it is later discovered that the transaction was not properly authorized
by the customer.
By contrast, payment authorization is not an inherent part of the
check collection process, and therefore the acceptance of a check by a
merchant for payment does not include any automatic ``guarantee'' that
the check
[[Page 43400]]
will be honored and the payment will be made. Merchants, however, can
purchase check verification and guarantee services from various third-
party service providers. These service providers offer varying levels
of check guarantee and verification services that are structured in
various ways. In a check ``guarantee'' service, a check guarantee
provider may verify whether currently outstanding returned checks are
associated with that payor or the checking account, as well as verify
open/closed account status and valid/invalid routing and account
numbers, although the service generally cannot verify the amount of
funds in the payor's account.\37\ If a check meets all of the guarantee
service's criteria (such as no known outstanding bad checks drawn by
the customer), the service authorizes acceptance by the merchant and
accepts the risk of loss on the check.\38\ If a check is subsequently
returned unpaid, the merchant will be reimbursed by the check guarantee
provider for the value of the returned check.
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\37\ Based on information available to the Board, a check
guarantee service requires extra steps at the time of a transaction
and is not integrated into check processing the same way that the
authorization and guarantee is integrated into the debit card
transaction. Each check is entered into the system by inputting the
check's MICR information on either a manual or automated basis. The
merchant also enters customer identification information, such as
the driver's license number. The guarantor then sends a return
message to the merchant.
\38\ The service provider may have exceptions to its guarantee
and these exceptions may vary across service providers.
---------------------------------------------------------------------------
The merchant pays a fee for the check guarantee service. Based on
available information, the Board understands that a check guarantee
provider typically charges the merchant a percentage of the face value
of all checks that are accepted, in addition to various other service
charges. The fee structures vary by the service provider and also can
vary by merchant type and perceived risk, but one commenter asserted
that check guarantee services typically charge between 1.0 percent and
1.5 percent of the face amount of the check and a 25 cent per-check
fee, as well as a monthly customer service fee.\39\
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\39\ See, e.g., Comment letter from American Bankers
Association, p. 7.
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Another service offered is a check ``verification'' product, which
does not include a guarantee. A check verification service may use
database searches similar to a check guarantee service to approve or
decline any given check transaction.\40\ The check verification
service, however, leaves the risk of an unpaid check with the merchant.
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\40\ Some check verification services also provide the merchant
with a reason for a decline, so the merchant can make a more
informed decision as to whether to accept the check on a customer-
by-customer basis. See http://www.ncms-inc.com/check-verification.aspx.
---------------------------------------------------------------------------
Various fees are charged for check verification services, and the
fee structure and levels can vary by service provider and merchant.
Based on information available to the Board, check verification
services may charge a per transaction fee of about 25 cents with a $20
monthly minimum and may charge a monthly service fee.\41\ Unlike the
check guarantee services, the check verification services do not appear
to also charge a fee based on the amount of the check.
---------------------------------------------------------------------------
\41\ See http://www.nobouncedchecks.com/SCAN-check.html
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Payment of processing and collection costs. In the check system,
payments clear at par. When a presenting bank (either the payee's bank
or an intermediary collecting bank) presents a check to the payor's
bank, the payor's bank pays, and the presenting bank receives, the face
value of the check (i.e., ``par clearing''). The presenting bank
typically does not pay a fee to the payor's bank in order to receive
settlement for the check. In addition, the payor's bank does not pay
fees to the presenting bank to receive check presentment unless the
payor's bank has agreed to pay a fee to receive presentment
electronically.\42\ The payee's bank and any subsequent collecting bank
incur costs to collect the check. A payor's bank incurs costs to be
able to accept presentment of the check, to determine whether or not to
pay the check, and to remit funds for settlement. One commenter
indicated that these costs exceeded debit card processing costs. The
payor's bank recoups some or all of these costs through fees it charges
to its customers or the interest it earns on the customer's balances.
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\42\ If both the presenting bank and the payor's bank have
voluntarily joined a check clearing house, they may pay fees to the
clearing house.
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By contrast, in the debit card system, the merchant does not
receive the full face value of the debit transaction. The merchant pays
fees to its acquirer in the form of a discount on the value of each
transaction for the services rendered in processing the transaction.
The acquirer, in turn, pays an interchange fee to the issuing bank on
each debit transaction, which is deducted from the amount of the debit
card transaction in the daily net settlement calculations. The acquirer
and issuer both pay fees to the network to process electronic debit
transactions. As discussed in more detail below, the issuer incurs
costs to authorize, clear, and settle debit card transactions, as well
as other costs related to debit card programs. Likewise, the acquirer
incurs costs to send authorization and clearing messages, as well as
for interbank settlement and crediting the merchant's account.
Payee deposit and availability. A debit card transaction is
initiated in an electronic format and sent electronically to the
acquiring bank; the proceeds are then deposited in the merchant's bank
account electronically and made available to the merchant in accordance
with the agreement between the merchant and its acquirer.
With respect to paper checks, the check must be physically accepted
by the merchant, and deposited in its bank and then sent through the
check clearing process to the payor's bank. The proceeds of a typical
check generally must be made available to the payee within one or two
business days of deposit.\43\ Banks may, and sometimes do, make check
deposits available for withdrawal faster than the law requires.
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\43\ See Regulation CC, 12 CFR part 229.
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Some merchants may take advantage of ``remote deposit capture''
services from their bank wherein a paper check is scanned to create an
electronic image that is sent to the merchant's bank electronically for
deposit.\44\ Remote deposit capture can decrease processing costs and
improve customers' access to their deposits.\45\ One commenter stated,
however, that although some merchants may use remote deposit capture,
many do not for a variety of reasons, including inconvenience, lack of
eligibility, and cost.\46\ Depository institutions charge a variety of
fees for remote deposit capture, which may vary by depository
institution and customer, but typically include a monthly service fee,
a per-item fee, equipment lease/purchase fee, and various other fees.
Some banks charge a monthly service fee and a fee for leasing the check
scanner, although a customer may purchase a scanner.\47\ A
[[Page 43401]]
bank also may charge a per-item fee and a client set-up fee.\48\
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\44\ Remote deposit capture was made practicable by the Check
Clearing for the 21st Century Act (Check 21 Act), codified at 12
U.S.C. 5001 note.
\45\ FFIEC, Risk Management of Remote Deposit Capture (Jan. 14,
2009). Certain risks, however, may be elevated with respect to
remote deposit capture when compared to paper checks. For example,
duplicate deposits, check alteration, and forged or missing
indorsements may be more difficult to detect in remote deposit
capture. Id. p.5.
\46\ The elevated fraud risk may cause some banks to offer
remote deposit capture only to creditworthy corporate customers with
appropriate back office and control environments.
\47\ FDIC Supervisory Insights (Summer 2009), available at
http://www.fdic.gov/regulations/examinations/supervisory/insights/sisum09/primer.html
\48\ See, e.g., http://www.firstbankak.com/home/bs/remotedepositcapture/rdc_faq#15.
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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, the payor's bank must initiate the
return by its ``midnight deadline,'' which is midnight of the banking
day after the check was presented to the payor's bank for payment.\49\
After the midnight deadline passes, the payor's bank can no longer
return the payment through the check payment system, although it may
have legal remedies, such as warranty claims, outside the check
collection system.\50\ Such legal remedies may be available, for
example, if a payor notifies its bank that the check was altered or
that the indorsements on the check were forged and does so reasonably
promptly if the payor's bank provides statements to the payor.\51\
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\49\ UCC 4-104(a)(10) (definition of ``midnight deadline'').
\50\ UCC 4-301 and 4-302. The payor's bank may have a warranty
claim for a forged indorsement or a material alteration, but, except
in limited circumstances, would not have a claim based on
insufficient funds or forged drawer's signature.
\51\ UCC 4-406.
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The debit card system provides a much longer time within which a
transaction may be reversed through the payment card network, as
opposed to warranty claims outside the payments system. Typically, the
time period for initiating resolution of a disputed transaction through
the network is around 60 days, but may be longer.\52\ Payment card
network rules permit certain disputed transactions to be resolved
through the payment card network. Specifically, if a transaction was
not authorized or is incorrect, payment card network rules generally
provide that, depending on the facts and circumstances, (1) the
transaction is guaranteed and the amount of the transaction must be
absorbed as a fraud loss by the issuer; or (2) the transaction can be
charged back to the merchant that accepted the electronic debit
transaction.\53\
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\52\ The Board's Regulation E (implementing other provisions of
the EFTA) states that a consumer has 60 days to dispute the
transaction as unauthorized or incorrect from the date that the
consumer's depository institution posts an electronic debit
transaction to the consumer's account and sends a statement to the
consumer. 12 CFR 205.11(b).
\53\ Morrison & Foerster comment letter, p.10.
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Acceptance by merchants and consumers. The use of debit cards by
consumers is increasing, while the use of checks is decreasing.\54\ The
increase of electronic payments and the decline of checks can be
attributed to technological and financial innovations that influence
the payment choices of consumers and businesses. Commenters
(predominantly issuers, networks, and consumers) provided other reasons
for these trends, such as ease and speed of the debit card transaction
and the fact that customers do not need to leave a physical copy of
their names and addresses with the merchant after a debit card
transaction, as they would with checks. Many issuer and network
commenters asserted that merchants also are increasingly accepting
debit cards because debit cards increase the amount of money consumers
spend at the point of sale.
---------------------------------------------------------------------------
\54\ Between 2006 and 2009, check transactions decreased by an
average of 7.1% annually and debit card transactions increased by an
average of 14.8% annually. See The 2010 Federal Reserve Payments
Study.
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In addition, debit transactions are used in many situations that do
not readily lend themselves to the use of checks, such as purchases
made over the Internet or telephone, online recurring payments, vending
machine transactions, self-service checkout purchases, and purchases at
automated gas pumps. Also, foreign checks are not nearly as widely
accepted by U.S. merchants as are debit cards issued by institutions in
foreign countries. Consumers generally may use their debit cards at
locations beyond their local area, regardless of the location of the
card issuer.
As required by EFTA Section 920(a)(4)(A), the Board has taken the
similarities between the functionality of electronic debit transactions
and check transactions into account in establishing the standards for
interchange fees under Section 920(a). The functional similarities
between these two types of transactions can be understood only by
considering the differences between them as well. Accordingly, the
Board has also, in fulfilling the mandate in Section 920(a)(4)(A) and
in the exercise of its discretion under Section 920(a), considered the
differences between these two types of transactions in establishing
standards for assessing whether interchange fees are reasonable and
proportional to cost, as discussed below in the interchange fee
standards section.
III. Summary of Proposal and Comments
A. Summary of Proposal
The Board requested 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. 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 through any network any interchange fee in
excess of the issuer's allowable costs. An issuer's allowable costs
would be those costs that both are attributable to the issuer's role in
authorization, clearance, and settlement of the transaction and 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 of 12
cents per transaction, regardless of the issuer's allowable cost
calculation. 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 of 7 cents
per transaction, in which case the issuer would not need to determine
its allowable costs.
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 amount.
The Board requested comment on two general approaches to the fraud-
prevention adjustment framework and asked several questions related to
the two alternatives. One approach focused on implementation of major
innovations that would likely result in substantial reductions in
total, industry-wide fraud losses. The second approach focused 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. The Board did not propose
a specific amount as an adjustment to the amount of an interchange fee
for an issuer's fraud-prevention costs.
As provided in EFTA Section 920, the Board proposed to exempt from
the interchange fee restrictions issuers that, together with
affiliates, have assets of less than $10 billion, and electronic
[[Page 43402]]
debit transactions made using either debit cards issued under certain
government-administered programs or certain reloadable prepaid cards.
In order to prevent circumvention or evasion of the limits on the
amount of interchange fee that issuers may receive or charge with
respect to electronic debit transactions, the Board proposed to
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.
The Board requested comment on two alternative approaches to
implementing 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 processed 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 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 processed to fewer than
two unaffiliated networks for each method of authentication the
cardholder may select. Under this alternative, an issuer that used both
signature- and PIN-based authentication would have to enable its debit
cards with two unaffiliated signature networks and two unaffiliated PIN
networks.
The Board proposed 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. In keeping
with EFTA Section 920, no exemption was provided from the network
exclusivity and routing provisions for small issuers or for debit cards
issued pursuant to certain government-administered programs or certain
reloadable general-use prepaid cards.
B. Summary of Comments
The Board received comments on the proposed rule from approximately
11,570 commenters. Of these commenters, approximately 7,080 were
depository institutions or represented depository institutions
(including trade groups, outside counsel, and consultants),
approximately 3,020 were merchants or represented merchants (including
trade groups, outside counsel, and consultants), 9 were payment card
networks, 23 were payment processors, approximately 1,340 were
individual consumers or represented consumer groups, 35 were members of
Congress or represented government agencies, and 54 were other
interested parties. Approximately 8,300 of the commenters submitted one
of 17 form letters, and one letter was submitted on behalf of over
1,600 merchant commenters.
1. Overview of Comments Received
Merchants, their trade groups, and some consumers supported the
Board's proposal and argued that the proposal would lower the current
interchange fees (the savings of which could be passed on to consumers
as lower retail prices), increase transparency in the system, and
increase competition by prohibiting exclusivity arrangements and
enabling merchant-routing choice. By contrast, issuers, their trade
groups, payment card networks, and some consumers opposed the proposal
for a range of reasons, including concern that it would decrease
revenue to issuing banks; result in increased cardholder fees or
decreased availability of debit card services; reduce benefits to
merchants when compared to other forms of payment; not provide a
workable exemption for small issuers; and stifle innovation in the
payment system, among other things.
Interchange fee standards. As between proposed Alternative 1 and
proposed Alternative 2, merchants supported the more issuer-specific
Alternative 1, arguing that issuer-specific fees would be a proxy for
fees in a competitive issuer market place and that many covered issuers
had per-transaction authorization, clearance, and settlement costs
significantly below the proposed 12-cent cap. Likewise, merchants
supported lowering the cap, some suggesting 4 cents (i.e., the average
per-transaction allowable costs across all transactions and issuers).
Merchants argued that the proposed cap would allow some issuers to
receive an interchange fee significantly higher than the proposed
allowable costs of authorization, clearance, and settlement. Merchants
overwhelmingly supported the Board's proposal to limit allowable costs
to the variable costs of authorization, clearance, and settlement.
Issuers and networks urged the Board to adopt a more flexible
approach to the standards by prescribing guidelines rather than a cap.
Issuers typically favored the stand-alone cap in Alternative 2 over
Alternative 1. Issuers suggested raising the safe harbor up to a level
that permits a ``substantial majority'' of issuers to avail themselves
of it. Issuers and networks supported raising the cap and safe harbor
by expanding the allowable cost base to include such costs as the
payment guarantee costs, fraud losses, network processing fees,
customer service costs, the costs of rewards, fixed costs, and a return
on investment.
Fraud-prevention adjustment. Although there was not agreement on
which approach to pursue, commenters generally agreed that the Board
should not mandate use of specific technologies. Merchants generally
favored the paradigm-shifting approach.\55\ By contrast, issuers of all
sizes and payment card networks preferred the non-prescriptive approach
that would allow issuers to have the flexibility to tailor their fraud-
prevention activities to address most effectively the risks they faced
and changing fraud patterns. Among commenters, there was a general
consensus that the fraud-prevention adjustment should be effective at
the same time as the interchange fee standard--either on July 21, 2011,
or at a later date as suggested by some commenters. This issue is
addressed in the companion notice adopting an interim final rule
providing a fraud-prevention adjustment.\56\
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\55\ Merchants proposed a framework where an issuer receives an
adjustment only if both the merchant and issuer use an eligible low-
fraud technology (i.e., one that reduces fraud losses below PIN
debit levels).
\56\ See companion interim final rule published separately in
the Federal Register.
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Exemptions. Many issuers were concerned that the exemptions, and in
particular the small-issuer exemption, would not be effective because
all networks might not institute a two-tier fee structure or might not
be able to implement such a structure by July 21, 2011. Additionally,
issuers argued that, even if networks institute a two-tier fee
structure, market forces and merchant routing choice would place
downward pressure on interchange fees over time. Some issuers suggested
the Board require that networks implement a two-tier fee structure.
Other commenters suggested the Board initially monitor
[[Page 43403]]
implementation of two-tier fee structures (perhaps by requiring
networks to report to the Board on whether and how they have
implemented an interchange fee differential).
Additionally, some issuers and prepaid industry commenters
supported exempting Health Savings Account (HSA), Flexible Spending
Account (FSA), Health Reimbursement Account (HRA), and Qualified
Transportation Benefit (QT) cards from the interchange fee standard
because they believe Congress did not intend to cover such cards. By
contrast, some merchant groups argued that HSA, FSA, HRA, or QT cards
do not qualify for the exemption for reloadable prepaid cards because
such cards typically are not reloadable and the funds are held in
employer accounts for the benefit of the employee or held by the
cardholder him or herself.
Circumvention and evasion. Issuers generally agreed that
circumvention or evasion should be determined on a case-by-case basis
based on the facts and circumstances. Issuers believed that the
proposed net compensation approach was overly broad because it
considered compensation for ``debit card-related activities,'' rather
than merely debit card transactions. Merchants, however, supported the
consideration of compensation for non-debit card programs when the
compensation is tied to debit card activities and chargebacks.
Merchants also urged the Board to prevent forms of circumvention or
evasion other than net compensation, such as increasing merchant
network fees concurrently with decreases in issuer network fees and
issuers' adjusting their products to avoid the final rule's interchange
fee limits.
Network exclusivity and routing provisions. Issuer and network
commenters preferred the proposal to require two unaffiliated networks
for processing without regard to the method of authentication
(Alternative A) because the commenters believed that Alternative A was
most consistent with the statutory language. These commenters also
argued that Alternative B, which would require at least two processing
alternatives for each authentication method, would impose significant
operational burdens with little consumer benefit. In particular,
issuers and networks asserted that Alternative B, when coupled with
merchant routing choice, would cause consumer confusion and/or decrease
consumer benefits. Moreover, these commenters asserted that Alternative
B could stifle innovation, as networks and issuers would have less
incentive to develop new authentication technologies, which they would
have to ensure could be implemented on at least two networks.
Merchants preferred Alternative B because they believed that
Alternative B is consistent with the statute and would provide the most
routing choice and the most market discipline on interchange and
network fees. They noted that, under Alternative A, once the consumer
has chosen the method of authentication, the merchant may not have a
choice over which network to route the transaction. Merchants also
believed that Alternative B would promote competition for signature
debit, whether from PIN networks or other new entrants.
Several commenters suggested that the Board invoke EFTA Section
904(c) to exempt small issuers and prepaid cards from the network
exclusivity and routing rules. Several prepaid issuers and a processor
commented that, if a prepaid card is not enabled for both signature and
PIN, such cards should not be required to have two signature networks,
which would require substantial operational restructuring by various
debit card participants to accomplish. Several issuers and prepaid
industry group commenters stated that because of restricted
functionality of HSA, FSA, HRA, and QT cards, such cards cannot be used
on a PIN network without significant cost and operational changes,
partly because satisfying certain Internal Revenue Service (IRS)
requirements is currently possible only over signature networks.
Additionally, commenters noted that enabling two signature networks may
not be operationally practical at this time.
Scope. The Board received comments on the application of the
proposed rule to three-party systems, ATM transactions, and emerging
payment technologies. The majority of commenters recognized that three-
party systems do not charge explicit interchange fees (rather, they
charge a merchant discount), but were concerned that exempting three-
party systems from the interchange fee standards would create an uneven
playing field. Even commenters favoring coverage of three-party systems
recognized, however, the circuitous routing that would result from
subjecting these systems to the network exclusivity and routing
provisions. A three-party system urged the Board to exempt such systems
from the exclusivity and routing provisions.
With respect to ATM transactions, almost all comments received on
the issue agreed that interchange fees on ATM transactions should not
be covered because they flow from the issuer to the ATM operator.
Although representatives of ATM operators supported applying the
network exclusivity and routing rules to ATM transactions, issuers and
networks opposed applying the network exclusivity and routing rules to
ATM transactions because of different economic incentives for ATM
transactions.
Issuer, network, and merchant commenters generally supported
including emerging payments technologies under both the interchange fee
standards and network exclusivity and routing rules so as to not create
an unfair benefit for emerging payments networks. Some networks and
issuers were concerned that applying the interchange fee restrictions
and network exclusivity and routing provisions to emerging payment
systems and means of authentication would stifle innovation, leading to
reduced competition in the payments market. Other commenters suggested
exempting emerging payment systems either during their pilot stage or
for a specified period after they begin processing transactions. Other
commenters were concerned that some ``emerging payments systems'' were
not truly emerging, and therefore exempting them would create an uneven
playing field.
2. Other General Comments
The Board received numerous comments that related to the proposed
rule and EFTA Section 920 more generally. Numerous commenters opposed
any government regulation of interchange fees (and prices generally)
and stated that the free market should determine interchange fee
levels. Some of these commenters argued that price and quality
competition in the debit card market currently is strong, as well as
transparent. These commenters believed that the government should
impose price controls only where a market is monopolized or is
otherwise demonstrably not functioning properly. Many of these
commenters stressed the potential negative or unintended consequences
of government price controls. Many commenters were further concerned
that government price controls would prevent lower-cost providers from
entering the market.
Numerous commenters requested that the Board either take more time
to consider the issue or not adopt interchange fee restrictions. These
commenters thought that further study and debate were needed because of
the lack of study and debate by Congress prior to passing EFTA Section
920. Several commenters stated that the Board should have conducted
hearings, debates, and impact analyses prior to
[[Page 43404]]
proposing a rule, and encouraged the Board to further study the issue
rather than adopting a final rule. One commenter did not believe the
statute provided the Board with sufficiently intelligible standards to
promulgate rules; rather, the commenter argued that several policy
judgments remained for Congress to make. Other commenters did not
believe that government intervention was required at this time. Rather,
a few commenters believed that market competition from alternative
payment forms (e.g., mobile) would put downward pressure on interchange
fees. Another commenter did not believe any interchange fee regulation
would be necessary if there were no network-imposed restraints on
merchant-customer interactions.\57\
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\57\ Other commenters suggested that the government supply
payment card network services or that the Board reform money
transmitter laws rather than regulating interchange fees.
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3. Consultation with Other Agencies
EFTA Section 920(a)(4)(C) directs the Board to consult, as
appropriate, with the Comptroller of the Currency, the Board of
Directors of the Federal Deposit Insurance Corporation, the Director of
the Office of Thrift Supervision, the National Credit Union
Administration Board, the Administrator of Small Business
Administration, and the Director of the Bureau of Consumer Financial
Protection in the development of the interchange fee standards. Board
staff consulted with the staff of these agencies throughout the
rulemaking process on all aspects of the proposed rule including the
interchange fee standards, the role of supervisors in determining
compliance with these standards, the small-issuer exemption, the
potential effects on consumers (both banked and unbanked) and merchants
(both small and large), the two proposed approaches to a fraud-
prevention adjustment, possible means of circumvention and evasion of
the interchange fee standards (through network fees, compensation,
change in account structure, or otherwise), and the possible impact of
the prohibitions against network exclusivity arrangements and routing
restrictions. Many of these agencies submitted formal comment letters,
raising many of the same issues addressed by other commenters and
discussed above.
IV. Summary of Final Rule
The Board has considered all comments received and has adopted
Regulation II (Debit Card Interchange Fees and Routing).
For the interchange fee standard (set forth in Sec. 235.3), the
final rule adopts a modified version of proposed Alternative 2 (stand-
alone cap) and provides that an issuer may not receive or charge an
interchange transaction fee in excess of the sum of a 21-cent base
component and 5 basis points of the transaction's value (the ad valorem
component). The interchange fee standard is based on certain costs
incurred by the issuer to effect an electronic debit transaction
(``allowable costs'' or ``included costs''). The standard is based on
data collected by the Board through its survey of covered issuers and
reflects comments received from many parties. Issuer costs that are
incurred to effect a transaction include the following costs related to
authorization, clearance, and settlement of a transaction: network
connectivity; software, hardware, equipment, and associated labor;
network processing fees; and transaction monitoring. Several other
costs that may be incurred in effecting a transaction, such as costs
related to customer inquiries and the costs related to rewards
programs, were not included for various reasons explained below. As
noted above, an allowance for fraud losses is also included as an
issuer cost incurred to effect a transaction. The Board did not include
other costs not incurred to effect a particular transaction. Issuer
costs that are not incurred in effecting a transaction include costs of
corporate overhead (such as senior executive compensation);
establishing the account relationship; card production and delivery;
marketing; research and development; and network membership fees.
With respect to the fraud-prevention adjustment, the interim final
rule (published separately in the Federal Register) adopts the more
general, less prescriptive approach to standards regarding the
eligibility of an issuer to receive the adjustment and sets the
adjustment at 1 cent per transaction.
The final rule prohibits circumvention and evasion of the
interchange fee standard, as well as an issuer receiving net
compensation from a payment card network.
The final rule exempts from the interchange fee standard issuers
that, together with affiliates, have assets less than $10 billion,
debit cards issued pursuant to certain government-administered
programs, and certain reloadable general-use prepaid cards. The final
rule provides that the Board will publish a list annually of
institutions above and below the small issuer exemption asset threshold
to facilitate the identification of exempt institutions. In addition,
the Board will annually collect and publish information regarding
interchange fees collected by networks and received by exempt and non-
exempt issuers and transactions to allow monitoring of the
effectiveness of the exemption for small issuers.
With respect to network exclusivity, the final rule adopts
Alternative A (i.e., two unaffiliated networks for each transaction).
The final rule also adopts the prohibitions on routing restrictions in
the proposed rule.
The final rule's definition of ``payment card network'' excludes
three-party systems because they are not payment card networks that
route transactions within the terms of the statute. The final rule's
definition of ``account'' excludes accounts established pursuant to
bona fide trust arrangements.
Various modifications throughout the rule were made in response to
comments and additional information available to the Board. The final
rule and the modifications adopted are explained more fully below.
Section-By-Section Analysis
I. Authority and Purpose
The Board proposed to set forth the authority and purpose of
Regulation II in Sec. 235.1. The Board received no comments on
proposed Sec. 235.1. The Board, however, made two revisions to that
section. First, the Board has revised the authority citation in
proposed Sec. 235.1(a) to reflect the section of the United States
Code in which EFTA Section 920 is codified. Second, the Board has
revised Sec. 235.1(b) to state that Regulation II also implements
standards for receiving a fraud-prevention adjustment.\58\
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\58\ See the companion interim final rule published separately
in the Federal Register.
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II. Definitions
A. Section 235.2(a)--Account
The Board proposed to define ``account'' to mean ``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.'' The proposed definition included
both consumer and business accounts, as well as accounts held pursuant
to a bona fide trust arrangement.
1. Summary of Comments
The Board received comments on its proposed definition of
``account'' related to the proposed inclusion of
[[Page 43405]]
business-purpose accounts and bona fide trust arrangements. A few
commenters suggested that the Board exclude business accounts from the
definition of ``account'' because the EFTA applies only to consumer
accounts. These commenters contended that the Board should not infer
congressional intent to include business debit cards from the
parenthetical in EFTA Section 920(c)(2) (definition of ``debit card''),
which states that the purpose of the account being debited is
irrelevant. In support of this argument, one commenter noted that
business accounts and consumer accounts differ both in the nature of
purchases and the account structure (e.g., business accounts may have
multiple employees on a single account). Other commenters stated that
the Board has not previously expanded the definition of ``account'' in
its Regulation E; these commenters saw no reason to expand the term's
scope at this time.\59\
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\59\ These commenters stated that the purpose of both the EFTA
and the Dodd-Frank Act was consumer protection and that including
business accounts under the scope of rule was contrary to the
purpose behind EFTA Section 920.
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A few commenters urged the Board to exclude bona fide trust
arrangements from the definition of ``account'' because EFTA Section
903(2) excludes bona fide trusts from the definition of ``account.''
These commenters asserted that a bona fide trust arrangement is not a
``purpose'' of the account; therefore, the parenthetical in Section
920(c)(2) does not affect the EFTA's general exclusion of bona fide
trust arrangements. Additionally, a few commenters expressed concern
that including bona fide trust arrangements in the definition of
``account'' could result in different treatment of health savings
accounts (HSAs) and other similar accounts that are structured as bona
fide trusts (proposed to be subject to the fee standards) and those
that are structured as reloadable, general-use prepaid cards (which
would be exempt), which could, a commenter contended, create confusion
for cards that access both types of HSAs and similar accounts. Finally,
one commenter suggested that payroll cards be excluded from the
definition of ``account.''
2. Analysis and Final Rule
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 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.'' \60\ Section
920(c)(2) of the EFTA, however, defines the term ``debit card'' to mean
a card that may be used ``to debit an asset account (regardless of the
purpose for which the account is established).* * *'' \61\ Some
commenters encouraged the Board to disregard the parenthetical in
Section 920(c)(2) as inconsistent with Section 903(2)'s definition that
applies throughout the EFTA. Doing so, however, would render the
parenthetical mere surplusage, contrary to principles of statutory
construction. The Board notes that Regulation E and this rule have
different scopes because Section 920 has differing definitions and
scope of coverage than the rest of the EFTA.
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\60\ 15 U.S.C. 1693a(2).
\61\ 15 U.S.C. 1693o-2(c)(2) (emphasis added).
---------------------------------------------------------------------------
The Board interprets the parenthetical as removing the limitation
in EFTA Section 903(2) that applies the ``account'' definition only to
accounts used for consumer purposes. Thus, the Board has adopted its
proposal to include accounts used for business purposes as ``accounts''
under Section 920. Accordingly, Sec. 235.2(a) will continue to include
transaction, savings, and other asset accounts, regardless of the
purpose for which the account was established.This definition of
``account'' is limited to this part and does not extend to other rules
that implement other provisions of the EFTA.
The Board agrees with the commenters that a trust is a type of
account structure rather than a purpose (such as a business purpose or
personal purpose) for which the account is held. Therefore, the Board
has revised its proposed definition of ``account'' to exclude bona fide
trusts, consistent with EFTA Section 903(2). For purposes of Regulation
E, the Board has stated that whether an agreement is a bona fide trust
agreement is a question of state or other applicable law.\62\ The Board
believes a similar approach is warranted under this rule. In general,
bona fide agreements or arrangements are those done in good faith and
not merely a device to evade a law.\63\ Accordingly, the Board has
revised the definition of ``account'' to exclude accounts held under
bona fide trust agreements that are excluded from the definition of
``account'' under EFTA Section 903(2) and rules prescribed thereunder.
The Board has added comment 2(a)-2 to clarify that whether a trust
arrangement is bona fide is a matter of state or other applicable law
and that accounts held under custodial agreements that qualify as
trusts under the Internal Revenue Code are considered to be held in
trust arrangements.
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\62\ 12 CFR part 205, Supplement I, par. 2(b)(2). An account
held under a custodial agreement that qualifies as a trust under the
Internal Revenue Code is considered to be a trust agreement for
purposes of Regulation E.
\63\ See, e.g., 44B Am. Jur. 2d. Interest and Usury Sec. 14.
---------------------------------------------------------------------------
With respect to excluding HSAs and similar accounts, many
commenters pointed to statements by members of Congress regarding their
intent that cards used in connection with flexible spending accounts
(FSAs), HSAs, and health reimbursement accounts (HRAs) not be subject
to either the interchange fee standards or the network exclusivity and
routing provisions.\64\ Other commenters stated that HSAs and other
similar accounts are not ``asset accounts,'' but are employer-sponsored
and administered arrangements under which employees have an unsecured
right to reimbursement for certain health-care-related purchases. The
commenters explained that the employer in such arrangements is not
required to keep funds for the reimbursements or to fund any specified
account. Some commenters stated that HSAs and other similar accounts
often are structured as bona fide trusts.
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\64\ See 156 Cong. Rec. S5927 (statements of Sen. Dodd) (2010);
156 Cong. Rec. H5225-26 (statements of Rep. Larson and Rep. Frank)
(2010).
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The language in EFTA Section 920 does not provide for any
exceptions to the section's provisions based on the purpose for which
an account was established; moreover, Section 920(c)(2) defines ``debit
card'' as including cards that may be used to debit an account
``regardless of the purposes for which the account was established.''
Therefore, the Board does not believe that the statute exempts debit
cards that access HSAs and other similar accounts solely because such
accounts are established for health care-related purposes. Such cards
and accounts, however, may be otherwise exempt from the Board's
interchange fee standards if they qualify for another exemption. For
example, as commenters noted, some HSAs and other similar accounts are
structured as bona fide trust arrangements. Cards that access these
HSAs would be exempt from the requirements of this part because they do
not access ``accounts,'' as the term is defined in Sec. 235.2(a). In
addition, some cards that access HSAs and other similar accounts are
structured like prepaid cards where funds are held in an omnibus
account (which is considered an ``account'' under Sec. 235.2(a)) and
the employee may
[[Page 43406]]
access the funds using a prepaid card. Provided these cards are
structured in such a way that qualifies them for the reloadable,
general-use prepaid card exemption in the statute, these cards used to
access HSAs and similar accounts will be exempt from the rule's
interchange fee standards. See discussion of Sec. 235.5(c). These
cards, however, will be subject to the rule's network exclusivity and
routing provisions. See discussion of delayed effective date related to
Sec. 235.7.
Finally, the Board has adopted a definition of ``account'' that
restricts the term to those accounts located in the United States. The
Board received no comment on this part of the proposal. The Board,
however, has made clarifying revisions to proposed comment 2(a)-2, now
designated as 2(a)-3.
B. Section 235.2(b)--Acquirer
The Board proposed to define ``acquirer'' to mean ``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.'' The Board proposed to exclude processors from the definition
of ``acquirer.'' The Board received one comment on the proposed
definition. This commenter supported a definition that limited
acquirers to those entities that move money, and excluded processors,
gateways, and independent sales organizations (``ISOs'').\65\
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\65\ A gateway is an entity that connects multiple networks.
Merchants may sign-up with a gateway to enable them to accept debit
cards and the gateway acts as a switch for the merchants to access
multiple networks. ISOs provide merchant- and cardholder-acquisition
services, including deploying point-of-sale (``POS'') terminals.
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The Board has determined to adopt Sec. 235.2(b) as proposed, but
has made minor revisions to proposed comment 2(b)-1 to clarify that an
acquirer settles for the transaction with the issuer, rather than with
the network itself. Although the network calculates net settlement
amounts for issuers and acquirers, settlement occurs between the issuer
and acquirer. The Board also revised comment 2(b)-1 to clarify that in
some circumstances, processors may be considered payment card networks.
See discussion of Sec. Sec. 235.2(m) and 235.2(o).
C. Section 235.2(c)--Affiliate
The Board proposed to define the term ``affiliate'' to mean ``any
company that controls, is controlled by, or is under common control
with another company.'' The proposed definition incorporated the
definition of ``affiliate'' in EFTA Section 920(c)(1). The term
``affiliate'' is relevant for two purposes in this part: determining
which issuers are considered ``small'' for purposes of the small-issuer
exemption, and determining which prepaid cards are considered
``general-use.'' \66\ In proposed comment 2(f)-5, the Board explained
that ``two or more merchants are affiliated if they are related by
either common ownership or by common corporate control,'' and that, for
purposes of this rule, the Board considered franchises 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.''
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\66\ Under EFTA Section 920(a)(6), an issuer is considered
``small'' if it, together with its affiliates, has assets of less
than $10 billion. 15 U.S.C. 1693o-2(a)(6). EFTA Section 920
incorporates the definition of ``general-use prepaid cards'' from
the Credit CARD Act of 2009, which defines ``general-use prepaid
cards'' as those cards that, among other things, are redeemable at
multiple, unaffiliated merchants. 15 U.S.C. 1693l-1(a)(2)(A).
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The Board received one comment suggesting that the Board use a
consistent definition of ``affiliate'' for both the small issuer
exemption and for general-use prepaid cards, expressing a preference
for the control test set forth in the proposed definition of
``control.'' This commenter expressed concern that requiring only
common ownership, and not common control, could result in the exclusion
of closed-loop cards accepted at merchants that are not truly
affiliated.
The Board has considered the comment and does not believe that
``affiliate'' is defined inconsistently in the small-issuer and
general-use prepaid card contexts. First, proposed comment 2(f)-5 is
consistent with the measure for ``control'' in proposed Sec.
235.2(e)(3): ``[t]he power to exercise, directly or indirectly, a
controlling influence over the management or policies of the company,
as the Board determines.'' Second, the acceptance of a ``closed-loop''
card is not sufficient to cause merchants to be affiliated as the term
is defined in this rule. For example, closed-loop cards may be accepted
at a group of merchants that are not subject to a common controlling
influence over their management and policies. Such cards are considered
``general-use prepaid cards'' (see discussion of Sec. 235.2(i)) and
would not be subject to the interchange fee standards if they satisfied
the criteria for exemption in Sec. 235.5(c). These closed-loop cards,
however, would not be excluded from the network exclusivity and routing
provisions as would cards accepted only at affiliated merchants. If the
merchants were affiliated, the prepaid card would not be considered
``general-use'' and would be excluded from Section 920's definition of
``debit card.''
Both the EFTA's definition and the proposed definition of
``affiliate'' were silent as to whether affiliated companies included
companies located outside the United States. One commenter suggested
that the term be limited to U.S. affiliates. The statutory language is
silent on this point, and the Board believes it is appropriate to
consider the total resources available to an issuer when determining
whether it is ``small.'' \67\ Accordingly, the Board has adopted the
definition of ``affiliate'' in proposed Sec. 235.2(c). The Board has
added language to comment 2(c)-1 to clarify that the term ``affiliate''
includes any U.S. and foreign affiliate.
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\67\ The Board considered the assets of both U.S. and non-U.S.
affiliates when determining which issuers to survey. The Board
computed assets 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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D. Section 235.2(d)--Cardholder
The Board proposed to define ``cardholder'' to mean ``the person to
whom a debit card is issued.'' The Board did not receive any comments
on the proposed definition of ``cardholder'' and has adopted Sec.
235.2(d) as proposed.
E. Section 235.2(e)--Control
The Board proposed to define ``control'' as it is defined in
existing Board regulations.\68\ The Board did not receive any comments
specifically on the proposed definition of ``control,'' although the
Board received comments on the definition of ``affiliate,'' discussed
above. The Board has adopted Sec. 235.2(e) as proposed.
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\68\ 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).
---------------------------------------------------------------------------
F. Section 235.2(f)--Debit card
1. Summary of Proposal and Comments
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,
[[Page 43407]]
or other means'' and as including general-use prepaid cards (as defined
in EFTA Section 915(a)(2)(A)) but excluding paper checks. The proposed
definition incorporated the statutory definition with some clarifying
changes.
The proposed definition of ``debit card'' had three parts. First,
the proposed definition included ``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.'' Second, the
proposed definition included ``any general-use prepaid card.'' \69\
Finally, the proposed definition excluded (1) any cards, or other
payment codes or devices, that are redeemable only at a single merchant
or an affiliated group of merchants; (2) checks, drafts, or similar
paper instruments, or electronic representations thereof; and (3)
account numbers when used to initiate an ACH transaction to debit a
person's account. Additionally, the proposed commentary explained that
the term ``debit card'' included deferred debit cards (where the
transaction is posted to the cardholder's account but not debited for a
specified period of time) and decoupled debit cards (where the issuer
does not hold the account being debited). The Board received several
comments about which cards, or other payment codes or devices, should
or should not be considered debit cards under this part. Many of these
comments related to the proposed commentary and are summarized and
analyzed below.
---------------------------------------------------------------------------
\69\ See discussion of Sec. 235.2(i) for a discussion of the
term ``general-use prepaid card.'' Comment 2(i)-7 explains that
store cards are not included in the term ``debit card'' under this
rule.
---------------------------------------------------------------------------
2. Card, or Other Payment Code or Device
Proposed comment 2(f)-1 explained that the phrase ``card, or other
payment code or device'' includes cards, codes, and devices in physical
and non-physical (i.e., electronic) form. The Board received three
comments regarding which ``payment codes'' should be included or
excluded from the definition of debit card. One issuer requested that
the Board clarify that ``payment code'' does not include one-time
passwords (or other numbers) generated for purposes of authenticating
the cardholder, provided such passwords/numbers are not used in lieu of
an account number. The Board does not believe that a one-time password
or other number used for purposes of authentication and in addition to
the card, or other payment code or device, is itself a ``payment code
or device.'' In that case, the passwords/numbers function like PINs or
signatures. Therefore, the Board has revised proposed comment 2(f)-1 to
clarify that cards, or other payment codes or devices, are not debit
cards if used for purposes of authenticating the cardholder and used in
addition to a card, or other payment code or device.
One commenter requested that the Board exclude account numbers from
the definition of debit card if the account numbers are used to access
underlying funds held in a pooled account, but where the underlying
funds do not move (i.e., the transaction is a general ledger entry). By
contrast, another commenter suggested that such use of account numbers
be included in the definition of debit card because the account numbers
are used to debit ``asset accounts.'' As discussed in greater detail
below in relation to Sec. 235.2(m), account numbers, or other payment
codes or devices, that are used only to initiate general ledger
transactions are not issued or approved for use through a payment card
network because the entity receiving the transaction information and
data is not routing the information to an unaffiliated entity.
Accordingly, even if the account number is used to debit an
``account,'' the account number is not a debit card because it was not
issued or approved for use through a payment card network.
3. Deferred Debit Cards
Proposed comment 2(f)-2 explained that deferred debit cards are
included within the proposed definition of ``debit card.'' Like other
debit cards, deferred debit cards can be used to initiate direct debits
to the cardholder's account, but the issuer may not debit the funds
until after a pre-arranged period of time (e.g., two weeks) after
posting the transaction to the cardholder's account. During this time
period, the funds typically are unavailable to the cardholder for other
purposes, although the cardholder may accrue interest on the funds
until the issuer debits the account.
The Board did not receive any comments opposed to including
deferred debit cards within its definition of ``debit card,'' but did
receive a few comments on the proposed deferral time period, as well as
comments seeking clarification as to which cards qualified as deferred
debit cards. Two commenters suggested that the Board exclude from the
definition of ``debit card'' any cards where settlement to the
cardholder's account is deferred 14 days or more after the transaction
because a 2003 network/merchant settlement treats such cards as charge
or credit cards.\70\ The Board has considered these comments and
determined not to revise proposed comment 2(f)-2 to limit deferred
debit cards to those cards where the issuer settles the transaction
with the cardholder within 14 days of the transaction.
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\70\ See MasterCard comment letter, Appendix C.
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The fact that the cardholder initiates transactions that debit an
account, as the term is defined in Sec. 235.2(a), is the
characteristic of deferred debit cards that distinguishes such cards
from charge cards and credit cards for purposes of EFTA Section 920. In
the case of charge cards and credit cards, the transactions post to
lines of credit rather than accounts. Excluding cards that debit an
account based on the time period within which the account is debited
creates significant potential for evasion and circumvention of Section
920's provisions, as implemented by this rule. The Board notes that the
EFTA and Regulation E limit the ability of an issuer to structure
deferred debit cards to be more like charge cards or credit cards. The
EFTA and Regulation E prohibit any person from conditioning the
extension of credit to a consumer on such consumer's repayment by means
of preauthorized electronic fund transfers.\71\
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\71\ 15 U.S.C. 1693k(1); 12 CFR 205.10(e)(1).
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Two commenters requested clarification as to the types of products
that qualify as ``deferred debit cards,'' particularly as to the
deferral period. Deferred debit cards may have different deferral
periods specified in the cardholder agreement; however, the deferral
period and when the hold is applied are not necessary to determining
whether a card is a ``debit card'' as defined in Sec. 235.2(f). The
Board has revised proposed comment 2(f)-2 to clarify that, in the case
of deferred debit cards, the issuer-cardholder agreement governs the
period of time for which the issuer will hold the funds in the
cardholder's account after the debit card transaction and before
debiting the cardholder's account.
The Board is not at this time providing more examples of debit
cards that are considered ``deferred debit cards.'' The deferred debit
cards of which the Board is aware use the framework described in
comment 2(f)-2. The Board is removing the proposed examples regarding
the timing of merchants sending electronic debit transactions to
acquirers as unnecessary
[[Page 43408]]
to describe whether a debit card is a deferred debit card.
4. Decoupled Debit Cards
Proposed comment 2(f)-3 explained that the term ``debit card''
included decoupled debit cards. As explained in the proposed comment,
decoupled debit cards are issued by an entity other than the entity
holding the cardholder's account, and the issuer settles for the
transaction with the acquirer and with the cardholder through an ACH
transaction that debits the cardholder's account.
The Board received a few comments opposed to including decoupled
debit cards under the rule's definition of ``debit card,'' and no
comments explicitly supporting their inclusion. One commenter contended
that including decoupled debit cards within the definition of ``debit
cards'' is inconsistent with the exclusion of ACH transactions, because
decoupled debit cards are used to initiate ACH debits to the account.
Other commenters suggested the Board exclude decoupled debit cards
issued by merchants because including them would be inconsistent with
statutory intent to reduce merchant debit card expense. One commenter
requested clarification as to the types of products that qualified as
``decoupled debit cards.'' Another commenter stated that treating the
location of the asset account as irrelevant for defining ``debit
card,'' but relevant for purposes of the small issuer exemption, is
inconsistent.
The Board has considered the comments received and has determined
to include decoupled debit cards that process transactions over payment
card networks within the definition of ``debit card'' as proposed with
minor clarifying revisions to the commentary. Cardholders use decoupled
debit cards to initiate debits to their accounts. The Board is aware of
two types of decoupled debit card transactions. The first type,
described in proposed comment 2(f)-3, is where the transaction is
processed over a payment card network, and the issuer settles the
transaction with the acquirer using the normal network procedures, but
settles with the cardholder via an ACH transaction. In this type of
transaction, the cardholder preauthorizes the ACH transaction, and the
issuer initiates the ACH transaction shortly after authorizing the
transaction and settling for the transaction with the acquirer through
the payment card network. The second type is a transaction initiated
with a card issued by the merchant, and the merchant's processor
initiates an ACH debit to the cardholder's account. This second type of
decoupled debit card transaction is processed solely through an ACH
operator and not through a payment card network. Decoupled debit cards
that are used to initiate ACH transactions at the point of sale that
are not processed over a payment card network for any part of the
transaction (i.e., the second type) are not debit cards under this
part.
By contrast, if the card holder initiates a decoupled debit card
transaction, part of which is processed over a payment card network,
the decoupled debit card is a debit card for purposes of this part.
Unlike decoupled debit cards that directly initiate ACH transactions,
merchants cannot distinguish these decoupled debit cards from other
debit card transactions that would be subject to interchange fees and
network rules. Accordingly, the Board does not believe it is
inconsistent to include in the definition of ``debit card'' decoupled
debit cards that initiate transactions processed over payment card
networks, while simultaneously excluding ACH transactions initiated at
the point of sale.
Inclusion of decoupled debit cards that initiate transactions
processed over payment card networks is consistent with the provisions
in EFTA Section 920, which are intended to reduce merchant costs of
accepting debit cards, even if merchants are the issuers of such cards
(although the Board believes that transactions initiated with merchant-
issued decoupled debit cards generally would be processed through the
ACH). Section 920 is designed to achieve cost-reduction through
limitations on interchange transaction fees and prohibitions on network
exclusivity and merchant routing restrictions, rather than by excluding
certain cards that may be lower-cost to merchant issuers.
In addition, any inconsistency between the requirement that an
issuer hold the account in order to be eligible for the small issuer
exemption and the lack of relevance for purposes of defining ``debit
card'' is statutory. Section 920(c)(9) defines the term ``issuer'' for
general purposes of the section as the person who issues the debit
card, or agent of such person. For purposes of the small issuer
exemption, Section 920(a)(6) limits the term ``issuer'' to the entity
holding the cardholder's account.
A few commenters requested that the Board provide more specific
examples of decoupled debit cards. The decoupled debit cards of which
the Board is aware use the framework described in comment 2(f)-3.
5. Hybrid Cards and Virtual Wallets
The Board requested comment on whether additional guidance was
necessary to clarify whether products with ``credit-like'' features are
considered debit cards for purposes of this rule. The Board noted that
if an issuer offers a product that allows the cardholder to choose at
the time of the transaction when the cardholder's account will be
debited for the transaction, any attempt to classify such a product as
a credit card would be limited by the prohibition against compulsory
use under the EFTA and Regulation E.
A few issuers, networks, and processors suggested that the Board
exclude cards used to access or obtain payment from a credit account
(i.e., cards subject to the Truth in Lending Act and Regulation Z),
regardless of whether the consumer chooses to repay the credit account
using an asset account. These commenters indicated that such cards
could include cards that enable the customer to pre-designate the types
of transactions to be paid from a preauthorized debit to the asset
account more frequently than the monthly billing cycle. Additionally,
these commenters urged the Board to distinguish between credit cards
that require repayment using preauthorized transfers and cards that
permit repayment using preauthorized transfers, stating that the latter
would not run afoul of the prohibition against compulsory use.
The Board is aware of two general categories of cards with both
credit- and debit-like features (so-called ``hybrid cards''). The first
category includes those cards, or other payment codes or devices, used
to initiate transactions that access and post to credit accounts, but
that the cardholder repays through a preauthorized debit to an asset
account. The second category of hybrid cards includes those cards, or
other payment codes or devices, that may be used to access multiple
accounts (including both credit and other accounts) (often referred to
as ``virtual wallets'' or ``mobile wallets''). Cards used to initiate
transactions that access and post to credit accounts are not considered
debit cards for purposes of this rule because such cards are not used
to debit an account, as the term is defined in Sec. 235.2(a). Further,
cards that access credit accounts are not considered debit cards
regardless of whether the cardholder pays the credit balance through
preauthorized transfers from an account.
For example, a card may be used to initiate transactions that
access and post
[[Page 43409]]
to credit accounts, but the issuer enables the cardholder to preselect
transactions for immediate repayment (or repayment prior to the monthly
billing cycle) from the cardholder's asset account. The issuer, then,
may initiate a preauthorized ACH debit to the cardholder's account in
the amount of the preselected transactions. Such products, due to their
classification as credit cards, may not condition the extension of
credit on a consumer's repayment by means of preauthorized electronic
fund transfers.\72\ An issuer may permit a cardholder to opt in to
preauthorization of some or all transactions made using the credit or
charge card. The Board, however, recognizes the potential for issuers
to restructure existing debit cards like these hybrid cards in order to
circumvent and evade this rule. Therefore, such cards will be
considered debit cards for purposes of this part if the issuer
conditions a cardholder's ability to preselect transactions for early
repayment on the cardholder maintaining an asset account at the issuer.
See comment 2(f)-4.ii.
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\72\ 15 U.S.C. 1693k(1); 12 CFR 205.10(e)(1).
---------------------------------------------------------------------------
The Board has added comment 2(f)-4.i to clarify that hybrid cards
that permit some transactions to be posted directly to an account as
defined in Sec. 235.2(a), rather than posting first to a credit
account, are considered debit cards for purposes of this part. Only
those transactions that post directly to the account, however, will be
considered electronic debit transactions.
The second category of hybrid cards consists of virtual or mobile
wallets, which store several different virtual cards that each accesses
a different account. The Board has added comment 2(f)-5 to clarify the
treatment of virtual wallets under this rule. As explained in the
commentary, the payment codes or devices (``virtual cards'') stored in
a virtual wallet may each access a different account, which may be
credit accounts or accounts as defined in Sec. 235.2(a). For example,
a mobile phone may store credentials (the payment codes) for accessing
four different accounts or lines of credit, which the cardholder can
view on the phone's screen. At the point of sale, the cardholder
selects which virtual card to use (e.g., by selecting the icon for the
issuer whose card the cardholder wishes to use). If at least one
virtual card within the virtual wallet may be used to debit an account
under Sec. 235.2(a), then that virtual card is a debit card for
purposes of this part, notwithstanding the fact that other cards in the
virtual wallet may not be debit cards for purposes of this part. The
entire virtual wallet is not considered to be the card, or other
payment code or device.
6. Checks and Similar Instruments
One commenter supported the Board's exclusion of electronic images
and representations of checks and similar instruments. The Board has
retained the exclusion in Sec. 235.2(f), as well as the exclusions for
checks, drafts, and similar instruments.
7. ACH Transactions
The Board received a few comments on its proposed exclusion of
account numbers when used to initiate an automated clearinghouse (ACH)
transaction to debit an account. One commenter thought the Board should
consider account numbers used to initiate ACH transactions to be
``payment codes'' in order to create a level playing field between
debit cards and ACH transactions. One issuer suggested that the Board
broaden the ACH exclusion to include intrabank transfers initiated
using an account number.
The Board has considered these comments and has determined that
account numbers used to initiate ACH transactions should be excluded
from the definition of ``debit card.'' An ACH transaction is processed
through an ACH operator, such as EPN or FedACH[supreg]. As explained
below in relation to Sec. 235.2(m), ACH operators are not ``payment
card networks'' under EFTA Section 920. Therefore, an account number
used to initiate an ACH transaction is not ``issued or approved'' for
use through a payment card network and, therefore, is not a ``debit
card'' for purposes of this rule. Payment information used to initiate
intrabank transactions using an account number are not processed
through either ACH operators or payment card networks and, therefore,
are not debit cards under EFTA Section 920.
Even if ACH transactions were subject to this part, they already
would comply with the provisions of this part. Currently, ACH operators
do not establish, and receiving and originating banks do not charge,
fees that are comparable to interchange fees. If a merchant were to use
the ACH to clear its customers' purchase transactions, its bank chooses
the ACH operator through which it will originate transactions.
The Board believes retaining an explicit exclusion from the
definition of ``debit card'' in Sec. 235.2(f) is unnecessary but has
retained commentary to explain the exclusion (proposed comment 2(f)-7
is now designated comment 2(f)-9). This comment is useful in
distinguishing decoupled debit cards (discussed above) from cardholder-
initiated ACH transactions. The Board has made minor revisions to the
proposed comment to clarify that an account number used to initiate an
ACH transaction is not a debit card where the person initiating the ACH
transaction is the same person whose account is being debited and to
clarify the distinction between decoupled debit cards and cardholder-
initiated ACH transactions.
G. Section 235.2(g)--Designated Automated Teller Machine (ATM) Network
Section 235.2(g) of the proposed rule incorporated the statutory
definition (EFTA Section 920(a)(7)(C)) of ``designated automated teller
machine network.'' The proposed definition included (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. The Board did not receive any comments on
the proposed definition, and Sec. 235.2(g) is adopted as proposed,
with the exception of minor technical changes.
The Board also proposed comment 2(g)-1 to clarify the meaning of
``reasonable and convenient access,'' as that term is used in Sec.
235.2(g)(2). Under proposed comment 2(g)-1, an issuer would provide
reasonable and convenient access, for example, if, for each person to
whom a card is issued, the issuer provided access to one 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, where the card was first purchased or issued.
Several consumer group commenters recommended that the Board delete
proposed comment 2(g)-1. These commenters noted that certain MSAs are
very large and that requiring only one ATM within the same MSA as a
cardholder's last known address (or, if unknown, the card's place of
purchase or issuance) could potentially be burdensome for certain
cardholders when an MSA covers a sizeable area. Another industry
commenter suggested that for a payroll card, an ATM available at a
cardholder's workplace should be considered to provide reasonable and
convenient access.
As discussed in the proposal, the proposed comment was intended to
ensure that cardholders do not have to travel a substantial distance
for ATM access. The Board agrees that certain MSAs are very large and,
for those MSAs, providing access to one ATM may not be reasonable or
convenient for
[[Page 43410]]
many cardholders. Moreover, a network that provides ATM access that is
reasonable and convenient to a cardholder's home or work address also
should be considered to provide reasonable and convenient for purposes
of Sec. 235.2(g)(2). Accordingly, the Board has adopted a revised
comment 2(g)-1 to provide that whether a network provides reasonable
and convenient access depends on the facts and circumstances, including
the distance between ATMs in the designated network and each
cardholder's last known home or work address or, if a home or work
address is not known, where the card was first issued.
H. Section 235.2(h)--Electronic Debit Transaction
EFTA Section 920(c)(5) defines ``electronic debit transaction'' as
``a transaction in which a person uses a debit card.'' The Board
proposed to define ``electronic debit transaction'' to mean ``the use
of a debit card by a person as a form of payment in the United States''
in order to incorporate the concept of ``payment'' already included in
the statutory definition of ``payment card network'' and to limit
application of the rule to domestic transactions.\73\ As discussed
above in relation to Sec. 235.2(f), some debit cards may be used to
access both accounts as defined in Sec. 235.2(a) and lines of credit.
The Board has revised the definition of ``electronic debit
transaction'' to specify that a transaction is an electronic debit
transaction only if the debit card is used to debit an account. The
Board has added comment 2(h)-1 to clarify that the account debited
could be, for example, the cardholder's asset account or the omnibus
account that holds the funds used to settle prepaid card transactions.
---------------------------------------------------------------------------
\73\ EFTA Section 920(c)(11) defines ``payment card network,''
in part, as an entity ``that a person uses in order to accept as a
form of payment a brand of debit card.'' See discussion related to
Sec. 235.2(q) (definition of ``United States'') regarding the
application of the rule to only domestic transactions.
---------------------------------------------------------------------------
A few commenters requested clarification on whether the rule would
apply to Internet transactions. Section 235.2(h) does not limit the
term ``electronic debit transaction'' to transactions initiated at
brick-and-mortar store locations; the term also includes purchases made
online or by telephone or mail. Accordingly, electronic debit card
transactions initiated over the Internet are within the scope of this
part.
One commenter suggested that the definition of ``electronic debit
transaction'' not be limited to use as a ``form of payment'' because
many POS networks also function as ATM networks. This commenter
suggested the Board expand the definition of ``electronic debit
transaction'' to include ATM transactions. For the reasons discussed
below in relation to Sec. 235.2(m), the Board is not revising its
proposed definition of ``electronic debit transaction'' to include ATM
transactions, but is adding comment 2(h)-2 to clarify that payment may
be made in exchange for goods or services, as a charitable
contribution, to satisfy an obligation, or for other purposes.
As explained in the proposed commentary, the term would include use
of a debit card for subsequent transactions connected with the initial
transaction and would include cash withdrawal at the point of sale
(provided the cardholder has also made a purchase). The Board has
revised proposed comment 2(h)-1 (now designated as comment 2(h)-3) to
clarify that a transaction, such as a return transaction, is an
electronic debit transaction if the transaction results in a debit to
the merchant's account and a credit to the cardholder's account.
The Board has also adopted its proposed comments clarifying that
``electronic debit transaction'' includes cash withdrawals at the point
of sale (comment 2(h)-4) and that transactions using a debit card at a
merchant located outside of the United States are not subject to this
rule (comment 2(h)-5), with minor conforming and clarifying changes.
I. Section 235.2(i)--General-Use Prepaid Card
EFTA Section 920(c)(2) defines the term ``debit card'' as including
``a general-use prepaid card, as that term is defined in section
915(a)(2)(A).'' EFTA Section 915(a)(2)(A), in turn, defines ``general-
use prepaid card'' as those cards, or other payment codes or devices,
that (1) are redeemable at multiple, unaffiliated merchants or service
providers, or ATMs; (2) issued in a requested amount, whether or not
such amount may be increased or reloaded; (3) purchased on a prepaid
basis; and (4) honored upon presentation for goods and services.\74\
The Board proposed to adopt the statutory definition with some
revisions. The Board proposed to define ``general-use prepaid card'' to
mean 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. The proposed definition
included cards that a group of unaffiliated merchants agrees to accept
via the rules of a payment card network and cards that a select group
of unaffiliated merchants agrees to accept, whether issued by a program
manager, financial institution, or network (referred to as ``selective
authorization cards''). The Board requested comment on whether
selective authorization cards that do not carry a network brand should
be included within the definition of ``general-use prepaid card.'' The
Board received several comments on its proposed definition, primarily
concerning the exclusions from the definition of ``general-use prepaid
card'' and selective authorization cards.
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\74\ 15 U.S.C. 1693l-1.
---------------------------------------------------------------------------
For the reasons discussed in relation to Sec. Sec. 235.2(h), (l),
and (m), ATM transactions are not electronic debit transactions for
purposes of this rule because cash withdrawals are not ``payments.''
Accordingly, the Board has revised the proposed definition to eliminate
the unnecessary reference to prepaid cards' usability at ATMs.
1. Credit CARD Act Exclusions
Several commenters urged the Board to incorporate the exclusions to
the definition of ``general-use prepaid card'' in the Credit CARD Act
of 2009 (CARD Act) into the definition of ``general-use prepaid card.''
These exclusions include telephone cards; cards not marketed or labeled
as gift cards; loyalty, award, or promotional gift cards; cards not
marketed to the general public; cards issued only in paper form; and
cards redeemable solely for admission to events or venues (or purchases
of goods and services at the events or venues) at a particular location
or affiliated locations.\75\
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\75\ 15 U.S.C. 1693l-1(a)(2)(D).
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The proposed definition generally tracked the definition of
``general-use prepaid card,'' set forth above, in EFTA Section
915(a)(2)(A). EFTA Section 915(a)(2)(D) enumerates exclusions from the
term ``general-use prepaid card'' as defined in Section 915(a)(2)(A).
In light of the explicit reference to Section 915(a)(2)(A) and the
absence of a reference to Section 915(a)(2)(D), the Board has
determined not to exclude the CARD Act's exclusions from the definition
of ``general-use prepaid card.'' \76\ Moreover, one of the
[[Page 43411]]
enumerated exclusions in Section 920(a)(7)(A)(ii) is for cards
``reloadable and not marketed or labeled as a gift card or gift
certificate.'' If such cards were already excluded from Section 920's
definition of ``debit card'' by virtue of their exclusion from the term
``general-use prepaid card'' in the CARD Act, Section
920(a)(7)(A)(ii)'s express exemption of such cards would be
superfluous. Therefore, the Board is adopting the definition of
``general-use prepaid card'' as proposed (with the exception of
removing the unnecessary ATM reference). The cards excluded from the
CARD Act's definition of general-use prepaid card may otherwise be
excluded from the definition of ``debit card'' (i.e., if they are not
redeemable at multiple, unaffiliated merchants) or exempt from the
interchange fee standards (e.g., if they are reloadable).
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\76\ The Board also notes that EFTA Section 920(c)(2) does not
refer to Section 915(a)(2) more broadly.
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2. Selective Authorization Cards
Several commenters requested that the Board exclude ``selective
authorization cards'' from the definition of ``general-use prepaid
cards.'' These commenters asserted that selective authorization cards
more closely resemble cards that are accepted at only one merchant or
affiliated merchants. Many of these commenters argued that selective
authorization cards provide consumers with more shopping options than
cards accepted at only one merchant, thus providing the consumer with
more protection in the event of a merchant's bankruptcy. Some
commenters suggested excluding only those cards that do not carry a
network brand.
The Board has considered the comments and has determined to include
selective authorization cards within the definition of ``general-use
prepaid card.'' Selective authorization cards provide benefits to the
merchants or business districts wishing to promote their business, as
well as to consumers wishing to mitigate their exposure in the event of
a merchant's bankruptcy. Nonetheless, one characteristic of general-use
prepaid cards is that they are redeemable at multiple, unaffiliated
merchants. Two or more merchants are affiliated if they are related
either by common ownership or by common corporate control.\77\ Two or
more merchants are not ``affiliated'' within the rule's meaning of the
term merely because they agree to accept the same selective
authorization card. Therefore, selective authorization cards are
redeemable at multiple, unaffiliated merchants. This is true regardless
of whether or not the card carries the mark, logo, or brand of a
network. In fact, the Board understands that transactions using some
selective authorization cards that do not display a network brand logo
on the card itself are processed over ``brands'' of payment card
networks, including the major networks or smaller networks.
Accordingly, there is not a basis for distinguishing network-branded
selective authorization cards from non-network branded selective
authorization cards.\78\ Selective authorization cards, however, like
other general-use prepaid cards, may not be subject to certain
provisions of this part. For example, if the selective authorization
card satisfies the requirements in Sec. 235.5(c) (e.g., the card is
reloadable and not marketed as a gift card), the card would not be
subject to the interchange fee standards.
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\77\ See the discussion on the definition of ``affiliate''
(Sec. 235.2(c)), above, in this notice.
\78\ For the same reason, the Board is revising its proposed
comment 2(i)-2 to clarify that a general-use prepaid card is not
required to display the network brand, mark, or logo in order to
come within the definition of ``general-use prepaid card.''
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Proposed comment 2(i)-2 explained that ``mall cards'' are
considered general-use prepaid cards because the cards are accepted at
multiple, unaffiliated merchants. The Board is aware, however, that
selective authorization cards are used outside the shopping mall
environment. Selected groups of merchants within the same business
district or located near a university also may accept selective
authorization cards. Accordingly, the Board has expanded the scope of
the proposed comment to include selective authorization cards used in
all contexts.
3. Other Comments
The Board received one comment requesting clarification as to
whether ``gift cards'' are included under the definition of ``general-
use prepaid cards.'' Prepaid gift cards that are redeemable at a single
merchant or a group of affiliated merchants are not included within the
definition of ``general-use prepaid cards.'' By contrast, if the gift
card is redeemable at multiple, unaffiliated merchants, then the gift
card is a ``general-use prepaid card.'' Gift cards that are general-use
prepaid cards are not exempt from the interchange fee standards.
J. Section 235.2(j)--Interchange Transaction Fee
1. Summary of Proposal and Comments
EFTA Section 920(c)(8) defines ``interchange transaction fee'' 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.'' The Board proposed to define
``interchange transaction fee'' to mean ``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.''
2. Paid by a Merchant or an Acquirer
The Board proposed to add the phrase ``and paid by a merchant or
acquirer'' as a clarification of current market practice.\79\ One
commenter expressed concern that, by adding ``and paid by a merchant or
acquirer'' to the statutory definition, the Board was opening up the
possibility that an acquirer would contract with a middleman to pay the
fee on the acquirer's behalf, which would result in circumvention or
evasion of the rule. The Board does not believe that the phrase would
enable such a practice. Under principles of agency (governed by state
law), if an acquirer contracts with a third party to pay an interchange
transaction fee on behalf of an acquirer, the fee is considered to be
paid by the acquirer and would be subject to the same restrictions as
if the fee were in fact paid by the acquirer. Although the Board
understands that, today, acquirers pay interchange transaction fees to
issuers through settlement effected by a payment card network (and then
pass the fee on to merchants), the Board has retained the proposed
addition, noting that the interchange transaction fee can be paid
either by a merchant or acquirer. The Board also has made minor
revisions to comment 2(j)-2 to clarify that the fees payment card
networks charge to acquirers for network services are not considered
``interchange transaction fees.''
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\79\ 75 FR 81722, 81731, and 81755 (Dec. 28, 2010).
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3. Established, Charged, or Received
Merchant commenters voiced concerns that issuers may attempt to
circumvent the interchange fee standards (applicable to those fees
``established, charged, or received'' by a network) by collectively
setting fees and imposing those collectively set fees on acquirers, and
ultimately merchants, through the networks' honor-all-cards rules. For
example, the largest issuers may collectively determine to charge
interchange transaction fees above the cap and effect this decision by
dictating to each network the agreed upon amount. The network, then,
would permit each issuer to charge that amount, and because merchants
would
[[Page 43412]]
be required to accept all the network's cards, merchants would pay the
amount determined by the issuers.
Section 920(c)(8) of the EFTA defines the term ``interchange
transaction fee'' to mean ``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.''
Accordingly, interchange transaction fees are not limited to those fees
set by payment card networks. The term also includes any fee set by an
issuer, but charged to acquirers (and effectively merchants) by virtue
of the network determining each participant's settlement position. In
determining each participant's settlement position, the network
``charges'' the fee, although the fee ultimately is received by the
issuer. An issuer, however, would be permitted to enter into
arrangements with individual merchants or groups of merchants to charge
fees, provided that any such fee is not established, charged, or
received by a payment card network. The Board has added paragraph 2(j)-
3 to the commentary to explain that fees set by an issuer, but charged
by a payment card network are considered interchange transaction fees
for purposes of this part. The Board plans to monitor whether
collective fee setting is occurring and whether it is necessary to
address collective fee setting or similar practices through the Board's
anti-circumvention and evasion authority.
One commenter urged the Board to adopt a definition of
``interchange transaction fee'' that covers both the fee flowing from
merchant to network and the fee flowing from network to issuer so as to
require that the two amounts be equal. This commenter was concerned
that, otherwise, networks with widespread acceptance would be able to
engage in price discrimination. Networks may charge lower fees to
acquirers than they pass through to the issuers in order to compete for
transaction volume in certain market segments, while charging higher
fees to acquirers than they are passing through to the issuers in other
market segments, although today these amounts are the same. The Board,
however, has determined not to revise its proposed definition of
``interchange transaction fee'' to cover both the fee flowing from
merchant to network and the fee flowing from network to issuer so as to
require that two amounts be equal. By statute, an interchange
transaction fee is a fee established, charged, or received by a payment
card network for the purpose of compensating an issuer and Section
920(a) limits the amount that the issuer may receive. By contrast,
Section 920(a) does not prohibit networks from charging other fees to
merchants or acquirers that are not passed to the issuer and does not
require that the network pass through to the issuer the same amount
charged to the acquirer. The Board plans to monitor whether networks
are charging other fees that are being passed to the issuer and
determine whether it is necessary to address network fees through the
Board's anti-circumvention and evasion authority.
K. Section 235.2(k)--Issuer
1. Summary of Proposal and Comments
EFTA Section 920(c)(9) defines the term ``issuer'' to mean ``any
person who issues a debit card, or credit card, or the agent of such
person with respect to such card.'' The Board proposed to define
``issuer'' to mean ``any person that issues a debit card.'' Proposed
comments 2(k)-2 through 2(k)-5 provided examples of which entity was
considered the issuer in a variety of debit card arrangements. As
described in the proposed commentary, the issuer in four-party systems
is the bank holding the cardholder's account, and the issuer in three-
party systems is the entity acting as issuer and system operator (and
typically acquirer as well). The issuer in debit card BIN-sponsor
arrangements is the bank holding the cardholder's account, and the
issuer in prepaid card BIN-sponsorship arrangements is the BIN sponsor
holding the omnibus account.\80\ Finally, the issuer of a decoupled
debit card is the entity providing the card to the cardholder, not the
bank holding the cardholder's account.
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\80\ As explained in the proposed commentary, payment card
networks assign Bank Identification Numbers (``BINs'') to member
institutions for purposes of issuing cards, authorization,
clearance, settlement, and other processes. In exchange for a fee or
other financial considerations, some member institutions permit
other entities to issue debit cards using the member-institution'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 are done for debit cards (including prepaid cards).
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The Board received several comments on its proposed definition of
``issuer,'' one of which generally supported the proposed definition.
Many of the comments received addressed the proposed removal of the
phrase ``or agent of such person'' from the statutory definition. Two
commenters suggested that Board exclude third-party agents as proposed,
because unlike credit cards, debit card issuers typically do not use
third-party agents. One commenter argued that the agent of an issuer
should only be considered the issuer when the agent has a level of
control such that the role of the issuer is subordinated to that of its
agent. A few other commenters requested that the Board clarify the
effect on the interchange fee restrictions of eliminating ``or agent of
the issuer'' and further study the issue.
The Board also received a few comments requesting clarification on
whether an issuer that outsources processing functions is responsible
for complying with the requirements, or whether the third-party
processor must comply with the requirements. One commenter specifically
expressed concern about a covered issuer being able to contract with a
small issuer for issuance of the card and having the small issuer
receive and pass back the higher interchange fees. The Board also
received a comment requesting clarification on which party is
considered the issuer under a variety of mobile payments arrangements.
2. Analysis and Final Rule
The Board has considered the comments and has determined to revise
its definition of ``issuer'' to clarify the meaning of ``issue.'' In
general, the proposed commentary explained which entity is the issuer
in terms of which entity has the underlying contractual agreement with
the cardholder. Although the underlying contractual agreement with the
cardholder is one of the defining characteristic of issuing debit
cards, the Board believes that it is clearer and more precise to
explain the underlying agreement in terms of authorizing the use of the
card to perform electronic debit transactions. The entity that
authorizes use of the card may also be the entity that arranges for the
cardholder to obtain the card. The revisions to the commentary describe
this component of issuing in terms of ``authorizing'' the cardholder to
use the card to perform electronic debit transactions, rather than the
more general term ``provide'' as proposed. Therefore, the identity of
the issuer is not determined by which entity performs issuer
processing, but rather by which entity authorized the cardholder to use
the card to perform electronic debit transactions.
The Board has revised comment 2(k)-1 to provide more guidance on
which entity is the issuer for purposes of this part. Comment 2(k)-1
explains that a person issues a debit card by authorizing a cardholder
to use the debit card to perform electronic debit transactions. That
person may provide the card directly or indirectly to the cardholder.
For example, a person may use a third-party processor to distribute
[[Page 43413]]
a plastic card to the cardholder, or may use a phone network or
manufacturer to distribute a chip or other device as part of a phone.
The entity that distributes the card, or other payment code or device,
is not the issuer with respect to the card unless that entity also is
the one authorizing the cardholder to use the card, or other payment
code or device, to perform electronic debit transactions.
Proposed comments 2(k)-2 and 2(k)-3 discussed the identity of the
issuer in four-party and three-party systems, respectively. In light of
the changes discussed below in relation to Sec. 235.2(m), which
clarify that three-party systems are not payment card networks for
purposes of this rule, the Board has deleted the proposed commentary
language that discusses three-party systems and is making other
clarifying changes for consistency in other commentary provisions. See
comment 2(k)-2.
Proposed comment 2(k)-4 described which entity was the issuer under
two different types of BIN-sponsor arrangements: the sponsored debit
card model and the prepaid card model. Proposed comment 2(k)-4.i stated
that the issuer in a sponsored debit card arrangement was the community
bank or credit union providing debit cards to its account holders using
a BIN of another institution (the ``BIN sponsor''). The Board has
revised the proposed comment to explain that the community bank or
credit union is an issuer if it authorizes its account holders to use
the debit cards to access funds through electronic debit transactions.
The community bank or credit union may provide debit cards directly or
indirectly (e.g., through its BIN sponsor) to cardholders. The BIN
sponsor is not considered the issuer for purposes of this part because
the BIN sponsor does not enter into an agreement with the cardholder
authorizing the cardholder to use the card to perform electronic debit
transactions to access funds. The Board also has revised the comment to
refer consistently to the ``bank or credit union'' throughout the
comment. See comment 2(k)-3.i.
Proposed comment 2(k)-4.ii stated that the issuer in the second
type of BIN-sponsor model--the prepaid card model--is the BIN sponsor
holding the funds underlying the prepaid cards. The Board has revised
the proposed comment to clarify that, under these arrangements, the BIN
sponsor typically uses a program manager to distribute cards to
cardholders, and the BIN sponsor typically holds the funds in an
omnibus or pooled account. Under these arrangements, either the BIN
sponsor or the program manager may track the amount of underlying funds
on each card. The revised comment explains that the BIN sponsor is the
issuer because it is the entity authorizing the cardholder to use the
card to perform electronic debit transactions to access the funds held
by the BIN sponsor and also has the contractual relationship with the
cardholder. See comment 2(k)-3.ii. The Board also has revised this
comment, as well as other comments, to refer to ``member institutions''
rather than ``member-financial institutions'' for consistency
throughout the commentary.
Proposed comment 2(k)-5 explained that the issuer with respect to
decoupled debit card arrangements is the entity that provides the debit
card to the cardholder and initiates a preauthorized ACH debit to the
cardholder's account at a separate institution. The Board has revised
proposed comment 2(k)-5 (now designated as 2(k)-4) to clarify that the
bank or other entity holding the cardholder's funds is not the entity
authorizing the cardholder to use the decoupled debit card to perform
electronic debit transactions. Rather, the bank or other entity holding
the cardholder's funds has authorized access to the funds through ACH
debits in general, but not specifically through the decoupled debit
card. The Board has deleted the statement in proposed comment 2(k)-5
that the account-holding institution does not have a relationship with
the cardholder with respect to the card because the statement is
unnecessary to explain the identity of the issuer of the card.
The Board has not provided examples in the commentary that are
specific to mobile devices and mobile payments. A mobile device, such
as a chip in or on a telephone or a software application on the
telephone, is one type of payment code or device that may be used to
access underlying funds. If the cardholder's bank authorizes the
cardholder to use a device connected with the phone and arranges for
the cardholder to obtain the device through the phone network or
manufacturer, or other party, the cardholder's bank is the issuer with
respect to the mobile device. By contrast, if the mobile device is more
like a decoupled debit card where the mobile device is used to initiate
debits to an account, but those debits settle through a preauthorized
ACH transaction, the cardholder's bank is not the issuer. Rather, the
entity that provided the mobile device to the cardholder to ultimately
access the underlying funds is the issuer. Depending on the debit card
arrangement, this entity may be either the phone network, phone
manufacturer, or other entity.
As explained in the proposal, as a matter of law, agents are held
to the same restrictions with respect to the agency relationships as
their principals. In other words, a third-party processor cannot act on
behalf of an issuer and receive higher interchange fees than are
permissible for the issuer to receive under this rule. For example, if
an issuer uses a third-party processor to authorize, clear, or settle
transactions on its behalf, the third-party processor may not receive
interchange fees in excess of the issuer's permissible amount.
Therefore, the Board does not believe that removing the clause ``or
agent of such person'' will have a substantive effect on either the
interchange fee restrictions or the network exclusivity and routing
provisions. In assessing compliance, any interchange transaction fee
received by the agent of the issuer will be deemed to be an interchange
transaction fee received by the issuer.
L. Section 235.2(l)--Merchant
EFTA Section 920 does not define the term ``merchant.'' \81\ The
Board proposed to define ``merchant'' to mean ``any person that accepts
debit cards as payment for goods or services.'' The Board did not
receive comments specifically on the proposed definition; however, a
few commenters suggested that ATM operators be included in the
definition of ``merchant.'' As discussed below in relation to Sec.
235.2(m), ATM operators do not accept payment in exchange for goods or
services. Rather, ATM operators facilitate cardholders' access to their
own funds. The Board has revised Sec. 235.2(l) so as to not limit the
purposes for which a person accepts payment to being in exchange for
goods or services. See Sec. 235.2(h) and comment 2(h)-2. This
expansion does not include ATM operators within the definition of
``merchant.''
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\81\ Section 920(c)(11)'s definition of ``payment card network''
refers to ``an entity * * * that a person uses in order to accept as
a form of payment a brand of debit card.''
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M. Section 235.2(m)--Payment Card Network
EFTA Section 920(c)(11) defines ``payment card network'' as ``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 that a person
uses in order to accept as a form of payment a brand of debit card,
credit card or
[[Page 43414]]
other device that may be used to carry out debit or credit
transactions.'' The Board proposed a modified version of the statutory
definition as defining the term ``payment card network'' to mean an
entity that (1) directly or indirectly provides the services,
infrastructure, and software for the 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. Proposed commentary 2(m)-1 further
explained the proposed criteria that only those entities that establish
rules governing issuers and acquirers be considered payment card
networks. The Board received several comments on its proposed
definition of ``payment card network.'' A few commenters generally
supported the Board's proposed definition.
A few commenters supported the Board's proposed exclusion of
issuers, acquirers, and processors from the definition of ``payment
card network.'' These commenters argued that including these entities
in the definition was beyond the intent of EFTA Section 920 and would
have unintended consequences. By contrast, other commenters argued that
the statutory definition of ``payment card network'' was broad enough
to include processors and gateways, among other entities. One commenter
suggested that the Board consider third-party intermediaries to be
``payment card networks'' if a network contracts with them to perform
functions traditionally performed by a network.
1. Standards, Rules, or Procedures Governing Issuers and Acquirers
One commenter expressed concern that adding the ``standards, rules,
or procedures'' criteria would reduce the Board's flexibility to cover
emerging payment systems under the rule. A few commenters also
suggested that the Board impose substantive requirements on the rules
that entities establish in order to be considered ``payment card
networks'' for purposes of this rule. In particular, these commenters
suggested the Board require the ``standards, rules, or procedures'' to
include consumer chargeback rights.
The Board has considered the comments received and has determined
to revise the final rule to eliminate the ``standards, rules, or
procedures'' criteria. This recognizes that processors and gateways may
be ``payment card networks'' with respect to electronic debit
transactions depending on their role (discussed below in connection
with this defined term). To be considered a payment card network for
purposes of this rule an entity must do more in relation to a
transaction than provide proprietary services, infrastructure, and
software to route the transaction information to conduct authorization,
clearance, and settlement. The Board continues to believe that an
entity that acts solely as an issuer, acquirer, or processor with
respect to an electronic debit transaction is not covered by the
definition of ``payment card network,'' because such entities do not
route information and data between an acquirer and an issuer with
respect to the transaction. In order to make this clear, the final rule
provides that an entity is considered a payment card network only if
the entity routes electronic debit transaction information and data
between an acquirer and issuer.\82\
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\82\ The Board is not adopting the guidelines, rules, or
procedures requirement and, therefore, it is not necessary to
address the comments regarding substantive requirements of such
standards, rules, or procedures.
---------------------------------------------------------------------------
Processors and gateways may take on different roles depending on
the transaction. For example, for a given transaction, an entity may
act as processor to both the acquirer and the issuer. The acquirer and
issuer may wish to bypass the network for such a transaction and may
themselves establish standards, rules, or procedures for so doing,
while relying on the processor or gateway to process the electronic
debit transaction and charge and pay fees between the acquirer and
issuer. In that case, the Board believes the processor is acting as a
payment card network and should be considered a ``payment card
network'' with respect to the transaction for purposes of the rule.
Accordingly, the Board has revised the commentary to the definition of
``payment card network'' to explain that an entity that acts as
processor between issuers and merchants without routing the transaction
through an intervening payment card network would be considered a
payment card network with respect to those transactions. See comment
2(m)-3.
Some emerging payment systems may resemble payment card networks,
while others may resemble acquirers or acquirer processors. Like
existing entities, if the emerging payment system routes transaction
information and data between acquirers and issuers, and not to an
intervening payment card network, the system will be considered a
payment card network for purposes of those transactions, provided the
entity satisfies the other criteria in Sec. 235.2(m). If a payment
card network contracts with another entity to perform network-like
functions on behalf of the payment card network, the other entity is
considered the agent of the payment card network.
2. Proprietary Services and Brands of Payment Cards
The proposal did not include the statutory text that a payment card
network provides ``proprietary'' services, infrastructure, and software
provided for authorization, clearance, and settlement and that those
services enable a person to accept ``a brand of debit card.'' The Board
received one comment suggesting the Board retain the statutory concept
that a payment card network provides ``proprietary'' services that a
person uses to accept ``a brand of debit card.'' In light of the other
transaction types that resemble electronic debit transactions (e.g.,
ACH transactions), specifically incorporating the concept of payment
card networks providing proprietary services that a person uses to
accept ``a brand of payment card'' (although not necessarily the brand
of the entity providing the services, infrastructure, and software) is
a meaningful way of distinguishing between the networks traditionally
thought of as ``payment card networks'' and other entities that provide
services, infrastructure, and software that provide debits and credits
to accounts on their own books. Accordingly, the final rule adopts the
more complete statutory language rather than the truncated proposed
language.
The proposed definition of ``debit card'' excluded account numbers
used to initiate an ACH transaction. As noted above in the discussion
of Sec. 235.2(f), retaining an explicit exclusion within the
definition of ``debit card'' is no longer necessary because an account
number used to initiate ACH transactions is not a ``brand'' of debit
card or other device, as the account number is not associated with a
``brand'' of ACH network. An ACH transaction is processed through an
ACH operator, either EPN or FedACH[supreg]. Merchants use account
numbers or other information to initiate a particular type of
transaction (i.e., ACH), but these account numbers are not ``brands''
of cards, or other payment codes or devices. Therefore, ACH operators
should not be considered ``payment card networks'' for purposes of the
rule. The Board has added comment 2(m)-4 that explains that ACH
operators are not considered ``payment card networks'' under this part.
[[Page 43415]]
3. Credit Cards
The Board proposed to remove the reference to ``credit cards'' from
the definition of ``payment card network'' as unnecessary in light of
the fact that the Board's rule would apply only to debit card-related
interchange fees and routing restrictions. One commenter suggested the
Board retain the references to ``credit card'' because removing the
reference would have an impact on the application of EFTA Sections
920(b)(2) and (b)(3), as well as for the application to hybrid credit-
debit cards. Removing the reference to ``credit card'' in the
definition of payment card network will not affect the application of
Section 920(b)(2) (discounts at the point of sale) or Section 920(b)(3)
(transaction minimums and maximums). Section 920(b)(2) is not dependent
on any Board rulemaking, and Section 920(b)(3) authorizes the Board to
increase the level of the minimum transaction value merchants may
impose. The Board, however, did not request comment on an increase and
is not at this time adopting provisions in this part pursuant to
Section 920(b)(3). If the Board determines to increase the minimum
dollar value in Section 920(b)(3), the Board at that time will consider
whether revisions to the definition of payment card network are
necessary for that purpose. Therefore, the Board has not retained the
statutory reference to ``credit card'' in the definition of payment
card network.
4. Routing Transaction Information and Three-Party Systems
The proposed definition of payment card network did not incorporate
the statutory concept of providing services, infrastructure, and
software ``to route information and data to conduct'' debit card
transactions. Rather, the Board proposed to shorten the definition to
include the provision of services, infrastructure, and software ``for''
authorization, clearance, and settlement. The Board did not receive
comments specifically on this proposed change from the definition in
EFTA Section 920(c)(11). The Board did, however, receive comments on
the inclusion of three-party systems within the scope of the rule.
a. Summary of Proposal
The Board proposed that its rule cover three-party systems as well
as four-party systems. The Board noted, however, the practical
difficulties in applying the interchange fee standards to three-party
systems, which charge only a merchant discount and no explicit
interchange fee. Specifically, a three-party system could apportion its
entire merchant discount to its role as network or acquirer, rendering
the interchange fee zero, in effect, and EFTA Section 920 does not
restrict fees an acquirer charges a merchant. Therefore, the Board
requested comment on the appropriate application of the interchange fee
standards to electronic debit transactions processed over three-party
systems.
In addition, the Board requested comment on how the network
exclusivity and routing provisions should be applied to three-party
systems, including alternatives that could minimize the compliance
burden on such systems. If those provisions were applied to a three-
party system, debit cards issued by the network must be capable of
routing transactions 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. The Board
recognized 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.
b. Summary of Comments
The Board received comments regarding the application of both the
interchange fee standards and the network exclusivity and routing
provisions to three-party systems. In general, almost all of these
comments recognized that three-party systems do not charge explicit
interchange fees, but many of the commenters (particularly issuers and
four-party systems) were concerned that exempting three-party systems
from the interchange fee standards would create an uneven playing
field. Some of these commenters were concerned that excluding three-
party systems would prompt current four-party systems to vertically
integrate and become three-party systems, which they believed could be
considered circumvention or evasion of the rule. Other commenters
recommended that, if covering three-party systems was not feasible, the
Board should at least examine whether excluding three-party systems
places four-party systems at a competitive disadvantage.
One commenter suggested the Board require three-party systems to
provide the Board with an allocation of the merchant discount that
explicitly identifies an ``interchange fee.'' Other commenters that
favored applying the interchange fee standards to three-party systems
also suggested that the Board prohibit a three-party system from
allocating fees away from the issuer side and to the acquirer side.
Other commenters suggested that the Board deem three-party systems to
be in compliance if the merchant discount charged by three-party
systems was similar to merchant discounts charged in four-party
systems.
Other issuers and three-party systems supported excluding three-
party systems from the interchange fee standards, noting that such
systems currently do not establish or charge a fee similar in concept
to an ``interchange fee.'' These commenters also stated that the Board
had no authority under EFTA Section 920 to regulate merchant discounts.
Moreover, some of these commenters claimed that developing a framework
and method for calculating an implicit merchant discount would be
unworkable and arbitrary. Commenters (including some representing
merchants) contended that three-party systems do not raise the same
centralized price-setting concerns as four-party systems because
merchants negotiate directly with the three-party system setting the
merchant discount.
With respect to the network exclusivity and routing provisions, the
Board received comments from issuers and networks, some of which
supported applying the provisions to three-party systems, whereas
others did not. Almost all of these commenters recognized the
circuitous routing that would result if three-party systems were
subject to the network exclusivity and routing provisions (because all
transactions on cards issued for three-party systems ultimately would
need to be routed back to the system operator/issuer for authorization,
clearance, and settlement), but, similar to the application of the
interchange fee standards, commenters believed that exempting three-
party systems would create an uneven playing field.\83\ By contrast,
several commenters supported excluding three-party systems from the
network exclusivity and routing provisions' coverage because, by
definition, three-party systems operate on a single ``network.''
Therefore, the commenters contended, application of the rules to three-
party systems would have a detrimental effect on the three-party
business model. One three-party
[[Page 43416]]
system stated that the Board should invoke EFTA Section 904(c) to
exempt three-party systems.\84\ This commenter asserted that three-
party systems do not ``restrict'' the networks over which an electronic
debit transaction may be processed ``by contract, requirement,
condition, penalty,'' or other similar method.\85\ Rather, according to
the commenter, the closed-loop characteristic is intrinsic to three-
party systems. The commenter concluded that the network exclusivity and
routing provisions were ambiguous as applied to three-party systems.
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\83\ If a three-party system were to enable its cards for
transaction processing over a second network, the authorization,
clearance, and settlement would be done by the three-party system.
Therefore, the transaction would go outside the system only to be
sent back to the system for authorization, clearance, and
settlement.
\84\ See discussion in connection with Sec. 235.5 regarding the
Board's authority under EFTA Section 904(c) as applied to this
rulemaking.
\85\ This commenter argued that the Board should interpret ``or
otherwise'' to mean by devices or mechanisms similar to those
specifically listed.
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The Board also received a few comments on its characterization of
three-party systems in its proposed rule. One commenter asserted that
the Board's characterization ignores the fact that some ``three-party
systems'' provide network and issuing functions but not acquiring
functions. This commenter suggested that the Board should characterize
three-party systems as those where the network is also the issuer,
regardless of whether the entity acquires transactions, because the
rules are primarily focused on network-issuer relationship. Similarly,
another commenter stated that ``three-party systems'' may have the
ability to route transactions outside the system, and that, in such
cases, the network exclusivity and routing provisions should apply to
the ``three-party system.'' A few commenters requested that the Board
provide more examples of three-party systems.
c. Analysis and Final Rule
In a three-party payment system, the same entity serves as the
issuer and system operator, and typically the acquirer.\86\ For debit
card transactions in three-party systems, the merchant sends the
authorization request, as well as any other information necessary to
settle a transaction, typically to one entity. By contrast to four-
party systems, the system operator that receives the transaction
information and data does not direct the information and data to
another party. Rather, that entity uses the transaction information and
data to approve or decline the transaction, as well as to settle the
transaction with both the merchant and the cardholder. If the three-
party system involves separate acquirers, the issuer/system operator
will remit funds to the acquirer through whatever settlement method the
parties agreed to.
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\86\ In addition, under a three-party system, outside processors
may provide some processing services to the merchant, but are not
authorized to acquire transactions. The other parties to a three-
party system are the cardholder and the merchant.
---------------------------------------------------------------------------
A merchant must send the transaction information and data to the
issuer (or issuer's processor) for authorization, as well as clearance
and settlement. In a four-party system, the information and data are
sent to a network that, in turn, sends the information and data to an
issuer (or the issuer's processor). Network entities in four-party
systems provide services, infrastructure, and software that receive
transaction information and data from the merchant side of the
transaction and send the information and data to the designated issuer.
By contrast, in a three-party system, a single entity operates the
system and holds the cardholder's account. Typically that entity holds
the merchant's account as well, but may permit other entities to
acquire transactions. Once the system operator receives the transaction
information and data, the operator does not send the information and
data on to another point. Rather, all authorization and settlement
decisions and actions occur within that entity. Therefore, three-party
systems provide services for merchants to send and receive transaction
information and data, but not to ``route'' transaction information and
data. Merchants are able to protect themselves from excessive fees in
three-party systems by negotiating directly with the issuer-system
operator, unlike in the case of four-party systems, where a network
intervenes between the issuer and merchant.
EFTA Section 920(c)(11) defines ``payment card network'' as ``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 * *
*'' \87\ The Board's proposal did not include the statutory text that a
payment card network provide the services, infrastructure, and software
that ``route information and data to conduct'' electronic debit
transaction authorization, clearance, and settlement. The statute does
not define the term ``route.'' The term ``route'' is commonly defined
as ``to send by a certain [or selected] route'' or ``to divert in a
specified direction.'' \88\ In other words, routing suggests
involvement other than merely receiving and using information and data;
specifically, routing suggests sending the information and data to
another point or destination.\89\ Connecting numerous different points,
in this case numerous merchants and issuers, is a fundamental element
of any network. The final rule modifies the proposal to incorporate
this statutory reference to routing in the definition of payment card
network.
---------------------------------------------------------------------------
\87\ EFTA Section 920(c)(11).
\88\ See, e.g., Webster's New World Dictionary and Thesaurus at
558 (2d ed. 2002); Merriam Webster's Collegiate Dictionary at 1021
(10th ed. 1993).
\89\ See discussion below in connection with Sec. 235.2(p).
---------------------------------------------------------------------------
Accordingly, three-party systems are not ``payment card networks''
for purposes of the rule because they do not ``provide[] the
proprietary services, infrastructure, and software that route
information and data to an issuer from an acquirer to conduct the
authorization, clearance, and settlement of electronic debit
transactions.'' \90\ Because three-party systems are not payment card
networks, they are not subject to the interchange fee standards (as
there is no payment card network establishing, charging, or receiving a
fee) or to the network exclusivity or routing provisions (as there is
no payment card network to which an issuer could restrict the
processing of transactions).\91\
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\90\ Transactions through three-party systems are similar to
other ``on-us'' transactions that can be authorized, cleared, and
settled using a book-entry rather than sending information to
another point.
\91\ Because three-party systems are not payment card networks
for purposes of this rule, it is not necessary to address the
comments regarding calculating an implicit interchange fee for
three-party systems.
---------------------------------------------------------------------------
The Board has made conforming changes to its proposed commentary.
First, the third sentence in proposed comment 2(m)-1 that stated that
three-party systems are considered payment card networks has been
removed. Second, commentary to explain the routing component of the
definition and the definition's application to three-party systems has
been added. Comment 2(m)-1 has been revised to state that an entity
that authorizes and settles an electronic debit transaction without
routing information to another entity generally is not considered a
payment card network. New comment 2(m)-2 has been added to explain that
three-party systems are not ``payment card networks'' for purposes of
the rule. Comment 2(m)-2 clarifies that ``routing'' transaction
information and data involves sending such information and data to an
entity other than the entity that initially receives the information
and data, and does not include merely receiving information and data.
See comment 2(p).
[[Page 43417]]
5. ATM Transactions and Networks
a. Summary of Proposal and Comments
The Board requested comment on whether ATM transactions and
networks should be included within the scope of the rule. The Board
also requested comment on how to implement the network exclusivity
provision if ATM transactions and networks are included within the
scope of the rule. The Board noted that the interchange fee standards
would not apply to ATM interchange fees, which currently flow from the
issuer to the ATM operator, and therefore do not meet the statutory
definition of ``interchange transaction fee.''
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. The proposal
explained that covering ATM networks under the rule may result in very
different economic incentives than coverage of point-of-sale debit card
networks because the party receiving the interchange fee would be able
to control the transaction routing.
The Board received comments in support of excluding ATM
transactions from the scope of the rule and in support of including ATM
transactions within the scope of the rule. Those commenters that
opposed including ATM transactions within the scope of the rule argued
that ATM withdrawals are not a payment for goods or services. Rather,
these commenters argued that the customer is accessing his or her own
funds. By contrast, commenters in support of including ATM transactions
within the scope of the rule asserted that ATM operators are
``merchants'' selling convenient access to cash and that ATM
transactions debit accounts.
Both the commenters in support of and opposed to including ATM
transactions supported the Board's interpretation that interchange fees
for ATM transactions would be excluded from the rule's coverage (even
if ATM transactions were otherwise included) because issuers do not
receive or charge interchange fees for ATM transactions. A few
commenters believed ATM transactions to be outside the scope of EFTA
Section 920 because merchants are not charged for ATM transactions.
Furthermore, commenters stated that, unlike for debit card
transactions, ATM networks currently have incentives to lower
interchange fees in the ATM industry in order to compete among issuers,
who are paying interchange fees. Commenters also contended that
applying the interchange fee standards to ATM interchange fees could
render ATM terminals cost-prohibitive, emphasizing the extent to which
ATM operators rely on interchange to cover operational costs. Moreover,
one commenter asserted that the Board did not have sufficient
information about ATM interchange fees and costs to set standards for
such interchange fees.
The commenters supporting application of the network exclusivity
and routing provisions to ATM transactions generally were ATM operators
or acquirers. These commenters argued that including ATM transactions
within the scope of the network exclusivity and routing provisions
would increase competition in the ATM industry and enable ATM operators
to route transactions to the network with the lowest network fees. More
generally, these commenters claimed that eliminating network
exclusivity and routing practices in the ATM industry would benefit
consumers through reduced ATM convenience fees, help small issuers
relying on nonbank ATMs, and ensure that cash remains a viable
alternative to debit cards. One commenter suggested that issuers be
able to satisfy any requirement for multiple networks by enabling debit
networks that also function as ATM networks.
By contrast, the commenters that opposed applying the network
exclusivity and routing provisions to ATM transactions were generally
issuers and payment card networks. These commenters argued that
including ATM transactions under the rule would enable the party
receiving the interchange fee to direct the routing of the transaction,
a practice prohibited by the network routing provisions in the point-
of-sale environment. Commenters also expressed concern that, if the
network exclusivity provision applied to ATM cards and networks, the
establishment of settlement arrangements with multiple networks would
create a large burden on issuers, which could result in higher consumer
fees. One issuer that was opposed to applying the network exclusivity
provisions to ATM cards argued that doing so was unnecessary because
many issuers currently have at least two unaffiliated network options
on their cards.\92\
---------------------------------------------------------------------------
\92\ The Board also received comments requesting that the Board
permit ATM operators to impose differential surcharges based on the
network the transaction is routed over. This suggestion is outside
the scope of the rule.
---------------------------------------------------------------------------
b. Analysis and Final Rule
The Board has considered the comments and has determined that ATM
transactions are not subject to either the interchange fee standards or
the network exclusivity and routing provisions. The statute does not
expressly include ATM transactions within its scope, but ATM cards,
similar to debit cards, are used to debit accounts, as the term is
defined in Sec. 235.2(a). The terms ``debit cards'' and ``electronic
debit transaction'' are both connected to EFTA Section 920(c)(11)'s
definition of ``payment card network,'' which is limited to those
networks a person uses to accept a debit card ``as a form of payment.''
``Payment'' generally is thought of as exchanging money for goods or
services or other purposes (e.g., satisfying an obligation or a making
a charitable contribution), rather than changing the form of a person's
money (e.g., from a balance in an account to cash).\93\ In an ATM
transaction, a person is using the card to access his or her money.
Similarly, a cardholder may use an ATM to transfer money from one
account to another. Withdrawing money from one's own account is not a
payment to an ATM operator in exchange for goods or services, to
satisfy an obligation, or for other purposes.\94\ Therefore, a network
providing only ATM services is not a payment card network.
Consequently, a card is not a ``debit card'' by virtue of its being
issued or approved for use through an ATM network, which, in turn,
means that the ATM transaction is not an ``electronic debit
transaction'' as those terms are defined in EFTA Section 920.
Therefore, ATM networks and transactions are not within the scope of
either the interchange fee standards or the network exclusivity and
routing provisions. The Board has added comment 2(m)-5, which clarifies
that ATM networks are not payment card networks for purposes of this
part.
---------------------------------------------------------------------------
\93\ See Black's Law Dictionary at 950 (abridged 8th Ed.);
Merriam Webster's Collegiate Dictionary at 963 (10th ed. 1993).
\94\ To the extent the cardholder is paying for the service of
being able to access his or her money, the amount paid for that
service is the convenience fee charged by the ATM operator.
---------------------------------------------------------------------------
One commenter suggested the Board address the treatment of ATM
transactions within the rule text. As discussed above in connection
with Sec. 235.2(h), the Board has not explicitly excluded
``transactions initiated at an automated teller machine (ATM),
including cash withdrawals and balance transfers initiated at an ATM''
in the definition of ``electronic debit transaction.''
[[Page 43418]]
Even if ATM transactions were included within the scope of the
rule, interchange fees received on ATM transactions are not
``interchange transaction fees'' as defined in EFTA Section 920(c)(8)
because ATM interchange fees do not compensate an issuer. Additionally,
applying the network exclusivity and routing provisions to ATM
transactions would provide incentives to the party directing the
routing to select the network that maximizes interchange fees, although
also one that minimizes network fees.
6. Non-traditional and Emerging Payments Systems
a. Summary of Proposal and Comments
The Board requested comment on whether non-traditional or emerging
payment systems should be covered by the definition of ``payment card
network.'' In its request for comment, the Board provided examples of
non-traditional or emerging payment systems, which included systems in
which a consumer uses a mobile phone to purchase goods or services with
the payment amount billed to the mobile phone account or debited
directly from the consumer's bank account, or systems such as PayPal,
in which a consumer may use a third-party payment intermediary and use
funds that may be held either by the intermediary or in the consumer's
account held at a different financial institution.\95\ The Board stated
that these non-traditional and emerging payment systems arguably
satisfied the proposed criteria for payment card networks, and
requested comment on how it would distinguish these payment systems
from traditional debit card payment systems in the event commenters
believed such non-traditional and emerging payment systems should not
be covered.
---------------------------------------------------------------------------
\95\ A few commenters stated that PayPal should no longer be
considered an ``emerging'' payment system due to its broad adoption
and that PayPal operates like a three-party system.
---------------------------------------------------------------------------
The Board received numerous comments on whether emerging payment
networks should be considered ``payment card networks'' under the rule,
and as groups, both issuers and networks were divided as to their
views. The Board received comments from issuers, networks, and
merchants that supported including emerging payment systems and more
generally, any entity that satisfied the criteria of a ``payment card
network'' under the proposed definition. These commenters argued that
excluding emerging payments technologies would create an unfair benefit
to the emerging payment systems.\96\ In addition, some commenters
believed that emerging payment systems should be built for multiple
routing options and that the Board should encourage the
interoperability of systems and technologies.
---------------------------------------------------------------------------
\96\ One of these commenters stated that asymmetric regulation
would distort innovation and market evolution.
---------------------------------------------------------------------------
The Board also received comments from networks, issuers, and
emerging payments technology providers that supported excluding
emerging payment systems from the definition of ``payment card
network.'' These commenters argued that including emerging payments
technologies would hinder development and innovation of new
technologies because networks, issuers, and other processors would be
less likely to innovate if they must share new technology with at least
one other network under the network exclusivity provisions. Commenters
asserted that inclusion often would not be practical because
alternative form factors initially may not be capable of being
processed on more than one unaffiliated network. Moreover, one
commenter asserted that innovation could be hindered if a competing
payment card network blocked adoption of technology by refusing to use
it, and thereby prevented the technology from being processed over more
than one network. One commenter further contended that such a barrier
would exacerbate the already significant barriers to entry in the
payments industry. A few of these commenters asserted that non-
traditional payment systems offer a competitive alternative to the
traditional payment card networks. One commenter argued that the
emerging payments technologies should be excluded because merchant
adoption of technology is voluntary. Another commenter suggested that
the Board initially exclude emerging payment systems, but continue to
monitor whether such systems continue to be ``emerging.''
A few commenters (typically merchants and emerging payment card
networks) suggested that emerging payment systems be subject to the
rule, but not while the emerging payment system is deployed on a
limited, pilot basis. Similarly, one commenter suggested that emerging
payment technologies be included, but that an issuer be able to rebut
the presumption of inclusion by demonstrating that processing over two
networks is not technologically possible or cannot be deployed in a
cost-effective manner.
b. Non-traditional Payment Systems
Non-traditional and emerging payment technologies generally fall
into three categories: those that facilitate payments but do not come
within the scope of the definition of ``payment card network,''
emerging devices or authentication methods used to access existing
payment card networks, and new payment card networks. In general, non-
traditional payment systems should not be excluded from coverage merely
because the payment systems are ``non-traditional.'' Excluding these
systems solely because they are ``non-traditional'' would not result in
a rule that is flexible to accommodate future developments in the
industry. Rather, the application of the rule to non-traditional
payment systems is determined by whether the characteristics of the
entity with respect to transactions make the entity a payment card
network, issuer, or acquirer as those terms are defined in the rule.
Some non-traditional payment systems perform functions similar to
traditional payment card networks, but are structured such that these
entities are not ``payment card networks'' as the term is defined in
the rule. For example, an entity may provide services that enable
merchants to accept payments from customers by permitting customers to
prefund accounts with the entity. Similar to prepaid cards, such
accounts could be prefunded with ACH transfers or by a debit or credit
card transaction that debits the customer's account at an issuer.
Later, a customer may use his or her account information to initiate a
debit to her account with the entity in order to pay the merchant for
goods or services. If the customer and merchant both hold accounts with
the entity, similar to three-party systems, the entity does not route
the transaction information and data. Rather, the entity uses the
information to make a debit entry to the customer's account and a
credit entry to the merchant's account. Therefore, an entity is not a
``payment card network'' for purposes of this rule when the entity does
not send the transaction information and data to another point and
instead merely makes book-keeping entries.
Like other three-party systems, a non-traditional payments system
that is not a ``payment card network'' with respect to some
transactions may be a payment card network, issuer, or acquirer with
respect to other transactions. For example, in addition to permitting
its customers to debit accounts to pay merchants that also have
accounts with the entity, the entity may issue debit
[[Page 43419]]
cards to account-holding customers or merchants that may be used
outside the entity/system and the transactions of which are processed
over four-party systems. Under these circumstances, the entity is an
issuer with respect to electronic debit transactions that are initiated
using the debit card. If the entity, together with its affiliates, has
assets of $10 billion or more, then the interchange fee restrictions
apply to the entity. The network exclusivity and routing provisions
will apply regardless of the entity's asset size.
c. Emerging Technologies That Access Existing Networks
Another category of emerging payments technology is new access
devices used to initiate debit card transactions processed over
existing payment card networks. For example, many networks have
approved the use of contactless devices to initiate transactions
processed over their networks. These contactless devices may be issued
as a separate card or included on or accessible through a mobile phone.
The Board received comments both supporting and opposing application of
the Board's rule to such new devices. The Board has considered the
comments and has determined that new or emerging access devices are
included within the scope of the proposed rule if they are issued or
approved for use through a payment card network and otherwise meet the
criteria for being a debit card as the term is defined in this rule
(e.g., the card, code, or device debits the cardholder's account or a
general-use prepaid card). New and emerging access devices are
discussed more fully in the context of Sec. 235.2(f)'s definition of
``debit card'' and the network exclusivity and routing provisions in
Sec. 235.7.
N. Section 235.2(n)--Person
The Board proposed to define ``person'' to mean ``a natural person
or an organization, including a corporation, government agency, estate,
trust, partnership, proprietorship, cooperative, or association.'' The
Board received no comments on its proposed definition of ``person'' and
has adopted the definition as proposed.
O. Section 235.2(o)--Processor
The Board proposed to define the term ``processor'' to mean ``a
person that processes or routes electronic debit transactions for
issuers, acquirers, or merchants.'' One commenter suggested that the
definition of processor be expanded to include processors that process
on behalf of ATM operators. The Board does not consider ATM operators
to be merchants for purposes of this rule. Additionally, ATM networks
and transactions are not ``payment card networks'' or ``electronic
debit transactions,'' respectively, for purposes of this rule.
Therefore, the Board has not expanded the definition of ``processor''
to include those processors that process on behalf of ATM operators.
The Board has adopted the definition of ``processor'' as proposed and
its associated commentary with minor clarifying revisions.
P. Section 235.2(p)--Route
The Board did not propose to define the term ``route.'' One
commenter suggested the Board define the term ``network routing'' to
mean ``the act of routing a transaction from the point of sale to point
of authorization,'' but to exclude from the meaning of ``network
routing'' any settlement or dispute handling functions unless the
network and the gateway is the same entity. The Board is unaware of
whether payment card networks currently permit entities to handle
settlement and disputes through different entities than those through
which the transaction was initially routed. Under Sec. 235.7 of the
final rule, such a rule would not be prohibited.
The Board is adding a definition of the term ``route'' in Sec.
235.2(p). EFTA Section 920 uses the term ``route'' in the definition of
``payment card network'' and requires the Board to prescribe
regulations that prohibit issuers and networks from inhibiting the
ability of merchants to ``direct the routing'' of electronic debit
transactions. EFTA Section 920 does not define ``route'' or
``routing.'' The Board also is not aware of other statutes that use
those terms in similar contexts.
As discussed above in connection with Sec. 235.2(m), the term
``route'' is commonly defined as ``to send by a certain [or selected]
route'' or ``to divert in a specified direction.'' \97\ In other words,
routing suggests involvement other than merely receiving and using
information and data; specifically, it involves sending the information
and data to another point or destination. These definitions apply to
the term ``route'' in the context of electronic debit transactions.
---------------------------------------------------------------------------
\97\ See, e.g., Webster's New World Dictionary and Thesaurus at
558 (2d ed. 2002); Merriam Webster's Collegiate Dictionary at 1021
(10th ed. 1993).
---------------------------------------------------------------------------
In a four-party system, when a merchant accepts a debit card as a
form of payment, the merchant sends the transaction information to its
acquirer or processor. The acquirer or processor uses the transaction
information to determine the network(s) over which it may send the
transaction. For example, for signature-based transactions, the
acquirer or processor looks to the first number in the BIN and directs
the transaction to the appropriate network. The network then directs
the transaction to the appropriate issuer. For PIN-based transactions,
the acquirer or processor usually compares the information received
from the merchant to ``BIN tables,'' which the acquirer or processor
uses to determine the networks over which transactions initiated by
cards with various BINs may be routed. The acquirer or processor then
sends the transaction over the appropriate network, which, in turn,
sends the information to the appropriate issuer. Each party that
receives the information must select the path the information will take
to reach the entity to which it is sending the information and data.
Therefore, the Board has defined the term ``route'' in Sec.
235.2(p) to mean ``to direct and send information and data to an
unaffiliated entity or to an affiliated entity acting on behalf of the
unaffiliated entity.'' Comment 2(p)-1 explains that the point to which
a party directs or sends the information may be a payment card network
or processor (if the entity directing or sending the information is an
acquirer), or an issuer or processor acting on behalf of the issuer (if
the entity directing and sending the information is a payment card
network). As a result, an entity does not route information and data if
the entity merely sends the information and data to affiliated book-
keeping entities within itself.
As stated in the discussion on the scope of this part, three-party
systems are not payment card networks because they do not ``route''
information to another point. Rather, a three-party system receives the
transaction information and processes the information internally in
order to authorize and settle the transaction.
Q. Section 235.2(q)--United States
The Board proposed to define ``United States'' to mean ``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.'' One network-commenter suggested
that the Board limit its definition of ``United States'' to the 50
states plus the District of Columbia in order to minimize the costs
associated with reprogramming. This commenter also noted that if the
Board includes U.S. territories, the Board should survey
[[Page 43420]]
issuers in those territories regarding their costs.\98\
---------------------------------------------------------------------------
\98\ Based on information available to the Board, the Board
distributed surveys to an institution that, together with its
affiliates, had assets of more than $10 billion and that filed one
of the following reports: 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),
the Reports of Assets and Liabilities of 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 Board proposed a definition of the term ``United States'' that
is consistent with the EFTA's definition of ``State.'' \99\ The
definition of ``account'' in Sec. 235.2(a) is limited to accounts that
are held in the United States and the definition of ``electronic debit
transaction'' to those transactions accepted as a form of payment in
the United States because the EFTA provides no indication (such as a
conflicts of law provision) that Congress intended for Section 920 to
apply to international transactions (i.e., those where the merchant or
account debited is located in a foreign country).\100\ Accordingly,
limiting the scope of this part to transactions initiated at United
States merchants to debit accounts in the United States avoids both
extraterritorial application of this part as well as conflicts of laws.
By contrast, including the Commonwealth of Puerto Rico and other
territories or possessions of the United States does not implicate the
same extraterritorial application concerns because the EFTA already
applies to these jurisdictions. Therefore, the Board has not revised
its definition of ``United States,'' now designated as Sec. 235.2(q).
---------------------------------------------------------------------------
\99\ 15 U.S.C. 1693a(10).
\100\ Interchange fees for electronic debit transactions
initiated in a foreign country also may be subject to restrictions
imposed by that country.
---------------------------------------------------------------------------
III. Section 235.3 Reasonable and Proportional Interchange Transaction
Fees
Section 235.3 sets forth a standard 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 for purposes of EFTA Section 920(a)(2). Under Sec.
235.3(b), an issuer may not charge or receive any interchange
transaction fee that exceeds the sum of 21 cents plus 5 basis points of
the transaction's value.
A. Summary of Proposal and Comments
The Board requested 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. Under proposed Alternative 1, an issuer
could comply with the standard for interchange fees by calculating its
allowable costs and receiving an interchange fee that does not exceed
its per-transaction allowable costs, up to a cap of 12 cents per
transaction. An issuer's allowable costs with respect to each
transaction would be the sum of those costs that are attributable to
the issuer's role in authorization, clearance, and settlement of an
electronic debit transaction and that vary with the number of
transactions sent to the issuer within a calendar year (variable costs)
divided by the number of electronic debit transactions on which the
issuer received or charged an interchange transaction fee during that
year (average variable cost). The proposal defined the issuer's role in
authorization, clearance, and settlement as receiving and processing
authorization requests (including voice authorization and referral
inquiries); receiving and processing presentments and representments;
initiating, receiving, and processing chargebacks, adjustments, and
similar transactions; transmitting and receiving funds for interbank
settlement; and posting electronic debit transactions to cardholders'
accounts. Alternative 1 also would permit an issuer to receive or
charge an interchange fee that does not exceed a safe harbor amount of
7 cents per transaction without demonstrating costs. Under Alternative
2, an issuer would comply with the standard for interchange fees as
long as it does not receive or charge an interchange fee in excess of
12 cents per transaction. All of the proposed amounts were based on
cost data for issuers responding to a Board survey in which those
issuers reported information related to their transaction costs.
The Board received numerous comments on all aspects of its proposed
interchange fee standards. Merchants and their trade groups
overwhelmingly supported adoption of the framework in Alternative 1
because that proposed standard would result in the greatest reduction
from the current interchange fees (the savings of which could
potentially be passed on to consumers as lower retail prices).\101\ A
few individual commenters supported the position of merchants and their
trade groups. Issuers, many consumers, and payment card networks, on
the other hand, opposed both proposed interchange fee standards for a
variety of reasons, arguing that the limits in the proposals were not
compelled by statute and expressing concerns that either of the
proposed alternatives would decrease revenue to issuing banks, result
in increased cardholder fees or decreased availability of debit card
services, reduce benefits to merchants when compared to other forms of
payment, and stifle innovation in the payment system, among other
things.
---------------------------------------------------------------------------
\101\ Several merchant-commenters stated that they saw no need
for any interchange fees and that debit card transactions should
clear at par like check transactions.
---------------------------------------------------------------------------
The Board received numerous comments, primarily from issuers and
networks, on its proposed interpretation of the meaning of
``reasonable'' and ``proportional'' to cost in Section 920(a)(2).\102\
Issuers and networks asserted that the Board was bound by, or at least
should look to, the jurisprudence surrounding the phrase, ``just and
reasonable,'' used in connection with ratemaking for public utilities
or other regulated entities. These commenters argued that, by referring
to fees that are ``reasonable'' and ``proportional'' to cost, Congress
intended the Board to follow ratemaking jurisprudence that requires
full recovery of costs (including depreciation) and a reasonable return
on the rate base (asserted by the commenters to be the entire debit
card program cost). These commenters argued that an interchange fee
standard must be adopted in accordance with the ratemaking
jurisprudence in order to avoid a violation of the takings prohibition
in the Fifth Amendment to the U.S. Constitution. Issuers and networks
believed that the failure to consider the recovery of all types of
costs plus a reasonable profit for all issuers (including those with
allowable costs above the level of the proposed cap), as well as the
Board's proposed consideration of an issuer's ability to recover costs
from consumers, were inconsistent with the ratemaking jurisprudence.
More generally, these issuers and networks objected to any cap that
would not permit each covered issuer to recover the entire amount of
its allowable costs.
---------------------------------------------------------------------------
\102\ In general, unlike issuers and networks, merchants and
their representatives did not comment in detail about the meaning of
the phrase ``reasonable'' and ``proportional'' to the cost.
---------------------------------------------------------------------------
[[Page 43421]]
By contrast, merchants and their trade groups argued that debit
cards are only one part of a checking account product, that issuers do
not need to obtain full cost recovery from merchants through
interchange fees, and that robust debit card markets exist in other
countries that have low or no interchange fees. Therefore, merchants
and their representatives supported the proposal to limit allowable
costs to a narrow group of costs associated mainly with authorization,
clearance, and settlement of a transaction and to establish a cap at a
level that does not permit 100 percent of covered issuers to recover
allowable costs through interchange fees.
Other issuers and networks suggested that the Board should not
follow the ratemaking jurisprudence because, unlike public utilities,
no natural monopoly exists for issuers, which eliminates the risks of
excessive profits and charges (as issuers do not have captive
customers). Some of these commenters suggested how the Board should
interpret the phrase ``reasonable and proportional to the cost incurred
by the issuer'' independent from ratemaking jurisprudence. Many of
these commenters read EFTA Section 920(a)(2) as requiring interchange
fees that are in ``reasonable proportion'' to the issuer's cost of the
transaction. Several issuers and networks contended that an interchange
fee was not ``reasonable'' unless the fee included profit or a mark-up
on cost. A few commenters argued that Congress demonstrated its intent
that issuers be permitted to receive or charge interchange transaction
fees that exceeded their costs by using the phrase ``proportional to''
rather than ``equal to.'' One commenter contended that the
``reasonableness'' of a fee should vary based on the scope of allowable
costs. For example, reasonableness may be a different standard when
compared to total cost than when compared to average variable cost.
Other commenters viewed reasonableness independently from
proportionality and suggested that the ``reasonableness'' of a fee take
into consideration the benefits (or value) of debit cards to consumers
and merchants (particularly through the analogy to checks).
Numerous issuers, networks, depository institution trade
organizations, and individuals objected to fee limits as inconsistent
with the directive that the Board establish ``standards for assessing''
whether the amount of an interchange fee is reasonable and proportional
to cost. These commenters objected to the establishment of both the
safe harbor and the cap because both involved numerical limits rather
than subjective or flexible standards for assessing whether a fee was
reasonable and proportional to cost. Few of these commenters provided
specific suggestions about structuring the more flexible standards
(other than eliminating the proposed cap). One issuer suggested that
the Board specify the allowable costs and then specify how interchange
fees may be structured to account for the variation in risk associated
with different types of transactions. This commenter suggested that the
Board specify how to determine a reasonable rate of return and that
each network could gather cost information from each covered issuer in
order to determine permissible interchange fees. A few commenters
suggested the Board follow the approach used in its Regulation Z to
interpret similar language in section 149 of the Truth in Lending Act
(TILA), which did not set specific numerical limits, but did include
safe harbor fee levels.\103\
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\103\ See 12 CFR 226.52(b)(1) (an issuer may impose a fee that
``represents a reasonable proportion of the total costs incurred by
the card issuer for that type of violation'').
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Merchants supported a cap as necessary to prevent interchange fees
from becoming excessively high, but objected to a safe harbor as
inconsistent with the statutory language, which they viewed as
requiring a connection to each issuer's specific costs. Some commenters
argued that a cap involves an arbitrary limit on interchange fees and
would be an unauthorized assessment of the reasonableness of the level
of costs rather than of interchange fees. Other commenters contended
that a single cap creates a variable relationship between interchange
fees and costs across issuers, rather than a uniform proportional
relationship.
A few commenters contended that the Board had no statutory basis
for considering incentives to reduce costs. These commenters argued
that issuers always have such incentives, and therefore a cap was not
necessary to create such incentives. A few commenters also argued that
any cap on cost recovery would ultimately reduce efficiency gains by
discouraging firms from investing capital needed to achieve efficiency
gains if those investments were not recovered under the cap.
One commenter argued that a cap was unnecessary in light of the
network exclusivity and routing restrictions and believed that a cap
would distort the market outcome of those provisions. By contrast, some
merchants did not believe that the network exclusivity and routing
provisions would result in significant downward pressure on interchange
fee levels under proposed Alternative A.
Many of the commenters opposed to a cap and/or safe harbor,
however, recognized the appeal of a cap or a safe harbor from the
perspective of transparency and administrative simplicity and stated
that a pure issuer-specific standard would be difficult to implement
operationally and difficult to enforce. Merchants and one acquirer/
processor acknowledged that having either a cap or a safe harbor would
make the interchange fee structure simpler for merchants to understand,
which could increase transparency and reduce operational risks. One
network asserted that an issuer-specific approach would result in
unpredictable interchange fees for merchants because merchants would
not know in advance the issuers of their customers' debit cards.
As between proposed Alternative 1 and 2, most issuers viewed
Alternative 2 as the better alternative due to its ease of compliance,
but preferred a higher cap. Other issuers supported a variant of
Alternative 1--issuer-specific standards with a higher safe harbor and
no cap. Issuers supported raising the cap and/or safe harbor to ensure
recovery of costs such as the payment ``guarantee,'' network processing
fees, customer service costs, rewards programs, fixed costs, and a
return on investment.\104\ A few issuers suggested that any inclusion
of the payment guarantee and fraud losses be done on an ad valorem
basis and vary by merchant type.
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\104\ Allowable costs are discussed in more detail later in this
section. Many issuers, both covered by and exempt from the
interchange fee standards, provided information in their comment
letters about their estimated costs of debit card transactions,
derived from internal accounting or industry studies. These costs
generally ranged from 14 cents per transaction to 63 cents per
transaction. A few commenters provided information about the cost
components of these estimates.
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Merchants and their representatives generally supported the more
issuer-specific Alternative 1 as most consistent with the statute and
reflective of the actual costs of most covered issuers, which they
asserted are significantly below both the proposed 12-cent cap and 7-
cent safe harbor.\105\ Some acquirers and merchant processors
acknowledged that Alternative 2 would be the easier alternative to
implement, but objected to a safe harbor as inconsistent with the
statute. Many of these commenters encouraged the Board
[[Page 43422]]
to revise any safe harbor to base it on the mean cost across
transactions rather than the median issuer cost in order to provide a
greater link between costs and fees for most transactions, as well as
greater incentives to lower costs. One commenter asserted that the
average-cost measurement is more ``economically meaningful'' than the
median. Most merchants objected to an ad valorem component.
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\105\ Several merchant commenters referenced a 2004 industry
study (STAR CHEK Direct Product Overview study; First Annapolis
Consulting) that found the per-transaction costs to be 0.33 cents
for PIN debit and 1.36 cents for signature debit, but the study was
not provided with the comments.
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B. Final Interchange Fee Standard
1. Description of Final Rule
The Board has considered all of the comments it has received and
has determined to adopt in the final rule a modified version of the
approach in proposed Alternative 2. Under the final rule, each issuer
could receive interchange fees that do not exceed the sum of the
permissible base component and the permissible ad valorem component.
The standard's base amount per transaction is 21 cents, which
corresponds to the per-transaction allowable cost, excluding fraud
losses, of the issuer at the 80th percentile, based on data collected
by the Board in a survey of covered issuers. The ad valorem amount is 5
basis points of the transaction's value, which corresponds to the
average per-transaction fraud losses of the median issuer, based on the
same survey data. Each issuer's supervisor is responsible for verifying
that an issuer does not receive interchange fee revenue in excess of
that permitted. See Sec. 235.9. The Board recognizes that issuers'
costs may change over time, and the Board anticipates that it will
periodically conduct surveys of covered issuers in order to reexamine
and potentially reset the fee standard.
2. Reasonable and Proportional to Cost
EFTA Section 920(a)(2) does not clearly require either transaction-
specific or issuer-specific standards. Section 920(a)(2) provides that
``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 transaction.'' Some commenters interpreted this language
as limiting the permissible interchange fee amount for a particular
issuer to a proportion of the allowable costs incurred by that issuer.
Other commenters interpreted this language as permitting the
permissible interchange fee amount to be set in accordance with the
allowable costs of the average issuer or an issuer at a reasonable
ranking among issuers. Nearly all commenters appear to believe the
language did not require computing the actual allowable cost of each
specific transaction; none argued for such a calculation. Instead,
commenters generally interpreted Section 920(a)(2) as referring to the
cost of an average electronic debit transaction or type of electronic
debit transaction (e.g., PIN vs. signature) or some other
categorization of the transaction (e.g., card-present vs. card-non-
present).
The two proposals offered for comment by the Board covered both
interpretations. Alternative 1 included an issuer-specific measurement
of costs and fees. Alternative 2 was based on the average costs
incurred by an issuer at the 80th percentile of allowable costs, based
on certain survey data. As noted above, after consideration of the
language and purpose of the statute and the practical results of
various interpretations of the statute, the Board is adopting in the
final rule a variant of the approach proposed as Alternative 2. Under
this approach, an issuer may not receive an interchange fee that
exceeds the sum of a base component, corresponding to the per-
transaction allowable costs of the issuer at the 80th percentile as
reported on the Board's survey, and an ad valorem component,
corresponding to the per-transaction fraud loss of the median issuer as
reported on the Board's survey.
As an initial matter, the Board believes this approach is
consistent with the language in Section 920(a)(2). Section 920(a)(2)
refers to ``an issuer'' and ``an electronic debit transaction;'' in
other words, to a representative issuer and transaction. Section
920(a)(2)'s subsequent use of ``the issuer'' and ``the transaction'' is
reasonably read as a reference back to the original representative use
of each term (i.e., an issuer receiving an interchange fee and a
transaction for which a fee is received). This reading fulfills the
purposes of the provision by allowing a standard to be set that ensures
that interchange transaction fees are reasonable and are proportional
to allowable costs without imposing undue compliance burdens on issuers
or networks. This approach also provides transparency to issuers,
networks, acquirers, merchants, and supervisors that will result in the
most effective monitoring and enforcement of compliance.
The Board considered an alternative interpretation of Section
920(a)(2) under which the section would require that each interchange
fee that a particular covered issuer receives be reasonable and
proportional to the cost incurred by that issuer for the particular
transaction for which the issuer is receiving the interchange fee. This
reading, however, would result in a statutory requirement that is
virtually impossible to implement. First, interchange fees are computed
at the time of the transaction, and an issuer's costs for a specific
transaction cannot be ascertained at the time the issuer receives the
interchange fee. The cost of each transaction varies based on a variety
of factors, including factors that may not be known to the issuer at
the time it charges or receives the interchange fee. For example, the
cost of network fees for a transaction may vary based on the volume of
transactions that the issuer processes through a given network. The
issuer cannot precisely control or know the volume of transactions at
any given moment when a particular transaction occurs, because that
volume depends largely on customer usage of their debit cards and
merchant routing decisions; for example, lower transaction volume may
result in higher network fees for each transaction.
Second, even assuming an issuer could calculate the cost of each
transaction, transaction-specific interchange fees would result in an
exceedingly complex matrix of interchange fees. Each issuer would be
required to provide each network with data reflecting that issuer's
actual cost per transaction, and each network would then be required to
ensure that no more than the allowable portion of these actual costs
would be covered by an interchange fee. These calculations would be
required for tens of billions of electronic debit transactions and a
large and growing number of covered issuers.\106\ This would introduce
tremendous complexity and administrative costs for issuers, networks,
acquirers, and merchants, as well as difficulty in monitoring and
enforcing compliance. Thus, interpreting Section 920(a)(2) as requiring
interchange fees to be calculated based on the cost of each transaction
for which an interchange fee is charged or received would be an absurd
result the Board does not believe Congress intended.\107\
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\106\ According to the Board's survey, there were 37.6 billion
electronic debit transactions in 2009. The Board sent the survey to
131 covered financial organizations (some of which represented
multiple affiliated issuers). The issuers responding to the survey,
which does not cover the universe of covered issuers, accounted for
about 60 percent of these transactions--roughly 22.6 billion
transactions.
\107\ In general, statutes should be interpreted to avoid an
absurd result. See Harrison v. Benchmark Elecs. Huntsville, Inc.,
593 F.3d 1206, 1212 (11th Cir. 2010).
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[[Page 43423]]
This impractical result is not compelled by the words of Section
920(a)(2). As explained above, Section 920(a)(2) may be reasonably read
to limit interchange fees based on the allowable costs for a
representative issuer in a representative electronic debit transaction.
Some commenters urged adoption of an interpretation of Section
920(a)(2) that focuses on the costs incurred by a specific issuer in
connection with a representative electronic debit transaction. This
view, however, does not represent a consistent reading of the words of
Section 920(a)(2). As noted above, Section 920(a)(2) refers to ``an
issuer'' and ``an electronic debit transaction'' when identifying the
amount of a fee that shall be restricted. Later, Section 920(a)(2)
refers to both the cost incurred by ``the issuer'' and the cost of
``the transaction.'' If ``the issuer'' in this second location is
interpreted not as a reference to the original representative issuer,
but instead as a reference to a specific issuer, then the same
interpretation would seem to be required by the identical and parallel
references to ``a transaction'' and ``the transaction'' in that same
sentence. As explained above, this leads to an extraordinarily complex
and burdensome result. Commenters recognized this in supporting an
interpretation of ``a transaction'' and ``the transaction'' as both
referring to a representative electronic debit transaction,
distinguishing electronic debit transactions and the costs related to
those transactions from the costs related to other types of
transactions, such as credit card transactions. In the same way, the
parallel use of the same construction in referencing ``an issuer'' and
``the issuer'' in the same sentence supports the interpretation of
those references as references to a representative issuer of debit
cards.
Moreover, establishing issuer-specific interchange fee standards
would significantly increase the burden on supervisors to assess
compliance and make it impossible for networks, acquirers, and
merchants to know whether issuers were in compliance with the standards
under Section 920. Under any issuer-specific framework, each supervisor
would need to determine for each transaction whether an issuer is
receiving an interchange fee that does not exceed its allowable costs.
Further, in contrast to the adopted approach that includes a publicly
known maximum permissible fee, an issuer-specific approach would
introduce uncertainty for networks and merchants, neither of which
would know whether interchange fees received or charged by a given
issuer were in compliance with the statutory standard. In addition,
this approach would not create the incentive to reduce costs that is
created by an approach like Alternative 2.
Section 920(a)(2) raises a second definitional matter. Section
920(a)(2) requires that the amount of any interchange fee be
``reasonable'' and ``proportional to the cost incurred by the issuer,''
without defining either ``reasonable'' or ``proportional.'' Instead,
Section 920(a)(3) requires the Board to give meaning to those terms
through its standards. For purposes of establishing standards for
assessing whether the amount of any interchange fee is ``reasonable''
and ``proportional'' to cost, the Board has established a reasonable
limit on the highest amount of an interchange fee that an issuer may
receive and has based that limit on the average per-transaction
allowable costs incurred by issuers with respect to electronic debit
transactions.
This approach gives meaning and effect to both terms. The statute's
use of the term ``reasonable'' implies that, above some amount, an
interchange fee is not reasonable. The term ``reasonable'' commonly is
defined as meaning ``fair, proper, or moderate'' or ``not excessive,''
and what is ``reasonable'' generally depends on the facts and
circumstances.\108\ Section 920(a) does not specify whether
reasonableness is assessed from the merchant's or issuer's perspective
or from another perspective. The use of the term ``proportional''
requires a relationship between the interchange fee and costs incurred;
however, it does not require equality of fees and costs or demand that
the relationship be constant across all quantities. The term
``proportional'' has a variety of meanings, including ``forming a
relationship with other parts or quantities'' or ``corresponding in
degree, size, or intensity.''\109\ The final rule adopts a standard for
both terms: a cap that delineates a separation between a ``reasonable''
fee and a fee that is not reasonable; and a requirement that the
relationship between the amount of an interchange fee that may be
received by an issuer and the cost of the transaction be set by
reference to the allowable costs of electronic debit transactions.
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\108\ Black's Law Dictionary at 1272 (7th ed. 1999) (defining
``reasonable''); Webster's New World Dictionary & Thesaurus at 529
(2nd Ed. 2002) (defining ``reasonable'').
\109\ American Heritage Dictionary at 1049 (1976); Merriam
Webster's Collegiate Dictionary at 936 (10th ed. 1995) (defining
``proportional'').
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In establishing this standard, the Board rejected a more
mathematical interpretation of the word ``proportional'' that would
require a constant proportion between costs and fees. As explained
above, that reading is not required to give meaning to the term
``proportional'' in the statute. As interpreted by the Board, the term
eliminates quantities that do not have the required relationship--in
this case, excluding costs that are not related to electronic debit
transactions. Moreover, the term ``proportional'' is a meaningful and
descriptive alternative to ``equal to.'' In this way, Congress
indicated that interchange fees must have a relationship to related
costs, but need not be equal to those costs. Had Congress intended a
fixed proportion between an issuer's transaction cost and the amount of
an interchange fee, Congress could have required an interchange fee to
have a ``given proportion to,'' ``be equal to,'' or have a ``fixed
proportion to'' cost.
Several commenters suggested the Board follow an approach similar
to the rules prescribed under Section 149 of the Truth in Lending Act,
which uses language similar to EFTA Section 920(a)(2) and requires that
penalty fees assessed by credit card issuers be reasonable and
proportional to the omission with respect to, or violation of, the
cardholder agreement.\110\ Section 149 of TILA required the Board to
consider the costs incurred by issuers as a result of credit card
violations in addition to other factors, which included the need to
deter violations. Under the Board's TILA rule, a penalty fee is
reasonable and proportional to the omission or violation if the penalty
fee is a reasonable proportion of the creditor's total cost of
addressing that type of omission or violation for all consumers, which
ensures that no individual consumer bears an unreasonable or
disproportionate share of the creditor's costs of the type of
violation. That rule establishes a safe harbor for compliance with the
Board's standards, but does not establish a cap on the amount of
penalty fees.\111\
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\110\ 15 U.S.C. 1665d.
\111\ 12 CFR 226.52; 75 FR 37527 (June 29, 2010).
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The Board believes the context and usage of the terms
``reasonable'' and ``proportional'' in Section 149 of TILA and Section
920 of the EFTA allow for different approaches to effectuate the
specific purposes of each section. The reference in TILA incorporates a
subjective determination, relating to the proportionality of a fee to
the violations of a contract, while the reference in Section 920
relates to the proportionality of a fee to a numerical cost. In the
Board's TILA standards, ``a
[[Page 43424]]
reasonable proportion'' is based on a creditor's total cost of all
violations of that type, and is readily set based on the costs to the
creditor and monitored by supervisors, with variation across creditors
reinforcing competition to the benefit of consumers. In the case of
penalty fees regulated by TILA, the consumer paying the fee may stop
its relationship with the creditor charging the fee.
Although that approach may be permissible under Section 920, the
Board believes for the reasons discussed above that a single cap is a
more appropriate approach in the context of interchange fees. In
particular, practical implementation concerns, constraints on the data
currently available to the Board, lack of competition in interchange
fees, more effective and consistent monitoring, and other factors
justify a different approach than the interpretation under TILA.
Accordingly, the Board does not believe interpreting ``proportional
to'' the same way in both the interchange fee context and the credit
card penalty fee contexts is appropriate.
Based on the interpretations discussed above, the standard set in
the final rule assesses whether an interchange fee is reasonable and
proportional to costs by reference to certain average per-transaction
costs directly related to particular electronic debit transactions of
covered issuers. As explained below, in setting the cap, the Board
relied on data that were available to it through its survey, and the
Board included only certain issuer costs directly related to effecting
particular electronic debit transactions. The Board did not consider
any costs of processing credit card transactions, ACH transactions, or
other transactions that access a cardholder's account (but did consider
a pro rata portion of certain costs that are joint between debit cards
and credit cards, or between debit card and other transactions that
access a cardholder's account). Similarly, the Board did not consider
corporate overhead or other costs, whether or not related to debit
cards, that are not related to particular electronic debit transactions
(such as advertising and marketing costs for debit card programs). By
so limiting the considerations, the Board ensures that the amount of an
interchange fee is related to issuers' costs of effecting the
electronic debit transaction and not to other factors.
3. Cost Considerations
EFTA Section 920(a)(4)(A) requires the Board to consider the
``functional similarity'' between electronic debit transactions and
checking transactions that are required within the Federal Reserve
System to clear at par. Section 920(a)(4)(B) requires the Board to
distinguish between ``the incremental cost incurred by an issuer for
the role of the issuer in the authorization, clearance, or settlement
of a particular electronic debit transaction,'' and ``other costs
incurred by an issuer which are not specific to a particular electronic
debit transaction.'' The statute directs the Board to consider the
former costs in establishing an interchange fee standard, and prohibits
it from considering the latter costs. The Board interprets the
prohibition in Section 920(a)(4)(B)(ii) on considering certain costs as
prohibiting inclusion of these costs in the standards set under Section
920(a)(3), and not as a prohibition on the Board collecting information
about and determining the scope of these costs.
Beyond these instructions, as explained below, Section 920 does not
restrict the factors the Board may consider in establishing standards
for assessing whether interchange transaction fees are reasonable and
proportional to cost, such as costs that are specific to a particular
electronic debit transaction but are not incremental or are not related
to the issuer's role in authorization, clearance, and settlement. As
explained below, the Board carefully evaluated the costs that could be
considered under Section 920(a)(4) as well as the data available
regarding these costs in establishing a standard for determining
whether an interchange fee is reasonable and proportional to cost, and
did not include costs prohibited by Section 920(a)(4)(B)(ii) in
establishing the interchange fee standard.
a. Summary of proposal
The Board proposed standards for interchange fees that are based on
the per-transaction costs an issuer incurs only for authorization,
clearance, and settlement and that vary with the number of transactions
within the reporting period (i.e., average variable cost). The proposal
excluded network processing fees, as well as other costs not related to
authorization, clearance, and settlement that varied with the number of
transactions. The proposal also excluded all costs that did not vary
with changes in transaction volumes up to capacity limits within a
calendar year. See proposed comment 3(c)-3.i. Under the proposal, an
issuer could allocate a pro rata share of debit card costs included
among variable costs of authorization, clearance, and settlement that
were shared with credit card or other programs.
The Board based both of its fee standard alternatives on an
issuer's per-transaction variable costs of authorization, clearance,
and settlement. The regulatory text for Alternative 1, which
incorporated an issuer-specific cost component, included a detailed
description of allowable costs. Proposed Sec. 235.3(c)(1) described
the exclusive list of allowable costs as including the costs that are
attributable to receiving and processing authorization requests;
receiving and processing presentments and representments; initiating,
receiving, and processing chargebacks, adjustments, and similar
transactions; transmitting and receiving funds for interbank
settlement; and posting electronic debit transactions to cardholders'
accounts. Proposed Sec. 235.3(c)(2) stated that fees paid to a network
were not an allowable cost. Proposed comment 3(c)-2.i clarified that,
with respect to authorization, an issuer's allowable costs included
costs for activities such as data processing, voice authorization and
referral inquiries, and did not include the costs of pre-authorization
activities with the primary purpose of fraud prevention (e.g.,
transactions monitoring). Proposed comment 3(c)-2.ii explained that an
issuer's clearance costs included costs for activities such as data
processing and reconciling the clearing message. With respect to non-
routine transactions, proposed comment 3(c)-2.iii explained that an
issuer's costs included data processing to prepare and send the
chargeback, or other similar message and reconciliation expenses
specific to non-routine transactions, but allowable costs did not
include the costs of receiving cardholder inquiries about particular
transactions. Finally, proposed comment 3(c)-2.iv explained that an
issuer's settlement costs, for purposes of determining allowable costs,
included fees for settling through a net settlement service, ACH, or
Fedwire[supreg], as well as data processing costs incurred for account
posting.
b. Summary of comments
Merchants overwhelmingly supported the proposal to interpret the
first consideration in Section 920(a)(4)(B) as limiting allowable costs
to only the incremental costs of authorization, clearance, and
settlement. One merchant trade group expressed a preference for
including only authorization costs (noting that the statutory
requirement to ``consider'' other costs did not require ``inclusion''
of those costs in allowable costs), but concluded that including
clearance and
[[Page 43425]]
settlement costs would also be permissible in light of the statutory
mandate to consider those costs.
By contrast, issuers and networks advocated expanding the proposed
set of allowable costs, asserting that Section 920(a)(4)(B) does not
require that allowable costs be limited to the incremental costs of
authorization, clearance, and settlement of a particular transaction.
Issuers and networks suggested a variety of ways by which the Board
could expand the set of allowable costs, such as by including an
expanded definition of activities considered to be part of
authorization, clearance, and settlement; including more, or all, costs
that are specific to a particular transaction, but not incurred for
authorization, clearance, or settlement; including all costs associated
with a debit card program; and including all costs associated with
deposit accounts or general operations of the bank.\112\ As further
discussed below, many issuers suggested that other allowable costs
could include costs of computer equipment and other capital assets,
card production and delivery, customer service, statements, and
resolution of billing errors, as well as an allowance for profit.
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\112\ Several commenters encouraged the Board to view settlement
as not complete until after the period during which network rules
permit an issuer to charge back a transaction has ended. As
discussed in this section, adopting a specific definition of
``authorization,'' ``clearance'' or ``settlement'' is unnecessary.
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With respect to authorization, clearance, or settlement costs, many
commenters believed that the proposal improperly limited the costs of
authorization, clearance, and settlement to the costs of sending the
message and funds between parties to a transaction.\113\ In general,
commenters suggested expanding the interpretation of authorization
activities to include the costs of building, updating, and maintaining
databases of cardholder information and behavior patterns that are
necessary for determining whether the card and account are valid. In
addition, numerous issuers suggested including the cost of monitoring
transactions to determine whether a particular transaction is
fraudulent, which one network noted could involve establishing and
maintaining complex algorithms. (Transactions monitoring is discussed
separately below.) Many issuers suggested including the network
processing fees (e.g., switch fees) they pay for authorizing, clearing,
and settling each transaction. Another issuer suggested including, as
an authorization cost, the cost of PIN management, but did not
elaborate as to what that activity entailed. Numerous issuers suggested
that the final rule include the cost or value of the payment guarantee
as a cost of authorization. This feature is discussed separately below.
---------------------------------------------------------------------------
\113\ A few commenters suggested that the Board expand allowable
costs to include data processing costs of authorization, clearance,
and settlement. The proposal included these costs to the extent the
costs varied with the number of transactions sent to the issuer.
---------------------------------------------------------------------------
The Board received numerous comments on its proposed interpretation
of the incremental cost of a particular transaction. Merchants, as well
as a few other commenters, supported the use of average variable costs
(i.e., the average value of those costs that vary with the number of
transactions sent to an issuer within a calendar year). Issuers and
networks generally opposed this interpretation of the incremental cost
of a particular transaction, and several commenters offered alternative
definitions of ``incremental cost.'' Several commenters stated that
``incremental cost'' had a well-established meaning--the cost saved by
a service provider if it did not provide the service, or the cost
incurred to provide the service. Many issuers argued that the relevant
service was debit card programs and, based on this proposed definition,
suggested that all of the program's costs should be considered,
including customer service costs, the cost of statements, costs from
resolution of billing errors, card production and delivery, capital
costs, and an allowance for profit, as well as account set-up
costs.\114\
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\114\ These and similar costs are discussed in more detail later
in this section.
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Other commenters argued that the proposal arbitrarily limited the
period of time used for determining whether a given cost was
``incremental.'' One commenter suggested that incremental costs include
costs that varied over a multi-year period (e.g., 3-5 years). Still
others asserted that the costs of debit card transactions can vary
based on measures other than time, such as transaction volume (e.g.,
peak-load volumes); therefore, many in-house costs are variable with
changes in transaction volume larger than one transaction. Among the
costs commenters argued should be included because they vary over time
or over other measures are customer service costs; equipment and other
capital costs, labor costs, and overhead costs; network membership and
gateway fees; debit program administration costs, including marketing;
insurance costs; and research and development costs. These commenters
contended that excluding consideration of these costs would encourage
issuers to shift transaction processing to third-party processors that
would convert all costs into incremental costs that vary with the
number of transactions over the short term. Commenters argued that this
result would be less efficient in the long run and could lead to higher
interchange fees and customer costs. A few commenters argued that a
broader reading of incremental costs was necessary to ensure that a cap
would further general policy goals of efficiency and innovation, and
contended that many efficiency gains and innovations cannot be achieved
absent specific upfront investment. A few commenters argued that
considering a broader range of costs would minimize barriers to entry
and promote competition.
The Board also received numerous comments on the proposed
distinction between costs that are specific to a particular transaction
and costs that are not specific to a particular transaction for
purposes of the considerations in Section 920(a)(4)(B). Commenters
disagreed as to which costs were specific to a particular transaction
and which costs were not. A few commenters suggested that issuers be
permitted to recover certain transaction costs even if the cost is not
paid for, charged, or incurred on a per-transaction basis. Costs that
commenters suggested as being specific to a particular transaction
included costs incurred for chargebacks, transaction-specific customer
service inquiries, providing statements, providing rewards (and
associated rewards-program administration), and depreciation. One
commenter argued that any cost can be allocated to a specific
transaction, and therefore the statute does not resolve which costs are
specific to a transaction. Several commenters recognized that although
any cost could be allocated to any transaction, the relationship of a
cost to a particular electronic debit transaction varies.
In addition to the proposed interpretation of individual
provisions, the Board received numerous comments about how Section
920(a)(2) and the considerations in Section 920(a)(4)(B) should be
interpreted together. Some merchant commenters argued that the Board
should interpret Section 920(a)(4)(B)(ii) as prohibiting inclusion of
all costs that were not an incremental cost of authorization,
clearance, and settlement. Several other commenters asserted that
Section 920(a)(4)(B) is silent with respect to non-incremental costs
associated with authorization, clearance, and settlement. Specifically,
these commenters argued that Section 920(a)(4)(B)(i) addressed the
[[Page 43426]]
incremental costs of authorization, clearance, and settlement of a
particular transaction, Section 920(a)(4)(B)(ii) addressed costs that
are not specific to a particular transaction, but neither paragraph
addressed costs that were specific to a particular transaction but were
not an incremental cost of authorization, clearance, and settlement.
Other commenters argued that Section 920(a)(4)(B)(ii) excludes only
costs that are not specific to electronic debit transactions in
general, rather than costs that are not specific to a particular
electronic debit transaction. Several issuers and networks asserted
that Section 920(a)(4)(B) requires the Board only to ``consider'' some
costs and that the cost considerations are not binding in the
development of fee standards under Section 920(a)(2), which requires
that the amount of an interchange fee be reasonable and proportional to
``the cost incurred by the issuer with respect to the transaction.''
One depository institution trade group contended that there is no
indication of Congressional intent that issuers not be able to recover
all of the substantial costs incurred to provide debit card services.
c. Overview of Costs Considered Under the Final Rule
EFTA Section 920(a)(4)(B) requires the Board to distinguish between
two types of costs when establishing standards for determining whether
the amount of any interchange fee is reasonable and proportional to the
cost incurred with respect to the transaction. In particular, Section
920(a)(4)(B) requires the Board to distinguish between ``the
incremental cost incurred by an issuer for the issuer's role in
authorization, clearance, or settlement of a particular electronic
debit transaction,'' which costs the statute requires the Board to
consider, and ``other costs incurred by an issuer which are not
specific to a particular electronic debit transaction,'' which the
statute prohibits the Board from considering.
Section 920(a)(4)(B) does not define which types of costs are ``not
specific to a particular electronic debit transaction.'' Therefore, the
Board must define these costs. The Board had proposed to exclude from
allowable costs those costs that cannot be attributed to any identified
transaction (referred to as ``fixed costs'' in the proposal), even if
those costs were specific to effecting debit card transactions as a
whole.
Many commenters argued that this reading was not compelled by the
statute, excluded costs that could be considered under the statute, and
was an unworkable approach in practice. In particular, they argued that
identifying whether a particular cost would not be incurred but for one
particular transaction is an impractical approach to determining which
costs not to consider because of the very large number of transactions
many covered issuers process in a day or other time period. This volume
makes it virtually impossible to attribute the actual cost of the
activity (e.g., receiving messages) to one specific transaction.
Based on a consideration of these and other comments on the scope
of the prohibition in Section 920(a)(4)(B)(ii), the Board has revisited
its proposed interpretation of Section 920(a)(4)(B). The Board notes
that this section is ambiguous and may be read in several ways. An
interpretation that Section 920(a)(4)(B) prohibits consideration of all
costs that are not able to be specifically identified to a given
transaction would appear to exclude almost all costs related to
electronic debit transactions because very few costs could be
specifically assigned to a given transaction.\115\ Moreover, as many
commenters noted, operational constraints make the determination of
which in-house costs an issuer incurs in executing any particular
transaction virtually impossible in practice.
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\115\ Network switch fees and issuer-processor per-transaction
fees are among the few costs that could be assigned to individual
transactions.
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Section 920(a)(4)(B) has another straightforward interpretation
that is workable and gives important meaning to this section. This
reading would interpret costs that ``are not specific to a particular
electronic debit transaction,'' and therefore cannot be considered by
the Board, to mean those costs that are not incurred in the course of
effecting any electronic debit transaction. The statute allows the
Board to consider any cost that is not prohibited--i.e., any cost that
is incurred in the course of effecting an electronic debit transaction.
This interpretation would not require identification of the cost of a
given electronic debit transaction. In this way, the interpretation
gives life and meaning to the prohibition in Section 920(a)(4)(B)(ii)
without creating the tremendous burdens and practical absurdities
discussed by commenters and noted above. Examples of the costs the
Board is prohibited from considering are discussed below.
As noted above, there exist costs that are not encompassed in
either the set of costs the Board must consider under Section
920(a)(4)(B)(i), or the set of costs the Board may not consider under
Section 920(a)(4)(B)(ii). These costs, on which the statute is silent,
are those that are specific to a particular electronic debit
transaction but that are not incremental costs related to the issuer's
role in authorization, clearance, and settlement. Although Section
920(a) does not specifically instruct the Board on how these costs
should be considered in establishing the debit interchange fee
standard, the section does not prohibit their consideration. Indeed,
the requirement that one set of costs be considered and another set of
costs be excluded suggests that Congress left to the implementing
agency discretion to consider costs that fall into neither category to
the extent necessary and appropriate to fulfill the purposes of the
statute. Had Congress intended otherwise, it would have prohibited
consideration of all costs other than those required to be considered,
rather than simply prohibiting consideration of a particular set of
costs. Moreover, the statutory phrasing of the costs that must be
considered and of the costs that may not be considered leaves no doubt
that costs that are not within the category of prohibited costs and
that are not incremental costs of authorization, clearance, and
settlement may still be considered in establishing standards under
Section 920(a).\116\
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\116\ The reference in Section 920(a)(4)(B)(i) requiring
consideration of the incremental costs incurred in the
``authorization, clearance, or settlement of a particular
transaction'' and the reference in Section 920(a)(4)(B)(ii)
prohibiting consideration of costs that are ``not specific to a
particular electronic debit transaction,'' read together, recognize
that there may be costs that are specific to a particular electronic
debit transaction that are not incurred in the authorization,
clearance, or settlement of that transaction.
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In discussing the costs that the Board is required to consider
under Section 920(a)(B)(4)(i), the proposal noted that there is no
single generally-accepted definition of the ``incremental cost'' of a
particular unit of a service. As a result, the Board proposed to apply
a definition to this term. The Board proposed to consider a cost to be
an ``incremental cost * * * of a particular transaction'' for purposes
of Section 920(a)(4)(B)(i) if the cost varied with the number of
transactions sent to an issuer within a year.
Several commenters urged defining ``incremental cost'' as the
difference between the cost incurred by a firm if it produces a
particular quantity of a good and the cost incurred by the firm if it
does not produce the good at all.\117\ This definition would include
any fixed or variable costs that are specific to the
[[Page 43427]]
entire production run of the good and would be avoided if the good were
not produced at all. Another definition of ``incremental cost''
suggested by commenters was the cost of producing some increment of
output greater than a single unit but less than the entire production
run.\118\ The Board noted in the proposal these definitions do not
correspond to a per-transaction measure of incremental cost that could
be applied to any particular transaction.
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\117\ Baumol, William J., John C. Panzar, and Robert D. Willig
(1982), Contestable Markets and the Theory of Industry Structure.
New York: Harcourt Brace Jovanovich.
\118\ Another interpretation of ``incremental cost'' would be
marginal cost, often assumed to be, but not required to be, the
additional cost of the last unit produced. The proposal highlighted
the practical difficulties of measuring the marginal cost of a
transaction. The Board did not receive comments regarding the use of
marginal cost.
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Other commenters urged the Board to interpret ``incremental cost''
as differentiating between ``fixed'' and ``variable'' costs. Although
relying on the variable cost incurred by the issuer to authorize,
clear, and settle an electronic debit transaction is a way to interpret
the incremental cost of authorization, clearance, and settlement of a
particular transaction, the meanings of fixed costs and variable costs
depend on a variety of factors, and these concepts are difficult to
apply in practice. As asserted by many commenters, whether a cost
incurred by an issuer for authorization, clearance, and settlement of
transactions is thought of as ``fixed'' or ``variable'' depends on the
relevant time horizon and volume range. As applied to the proposed
interchange fee standards, the same type of cost may appear variable in
one year, but fixed in a different year. For example, if an increase in
the number of transactions processed from one year to the next requires
the acquisition of additional equipment in the second year, hardware
costs that would be considered fixed in the first year would be
variable in the second year.
Inconsistent treatment of the same type of cost would make tracking
costs for purposes of reporting exceedingly difficult for issuers. This
difficulty is compounded by the fact that, even if a clear line could
be drawn between an issuer's costs that are variable and those that are
fixed, issuers' cost-accounting systems are not generally set up to
differentiate between fixed and variable costs. Rather, cost-accounting
systems typically are used for internal management purposes, and
determining which part of total costs is variable and which is fixed
often requires a subjective judgment by the issuer. This fact could
result in significant variation across issuers as to which costs are
allowable and which are not.
Moreover, nearly any cost that could be defined as fixed if
incurred by an issuer that performs its transactions processing in-
house could be considered as variable if the issuer were to outsource
its debit card operations to a third-party processor that charged
issuers a per-transaction fee based on its entire cost, including both
fixed and variable costs. This makes enforcement of a distinction
between fixed and variable costs very difficult and potentially uneven.
Commenters argued that an issuer incurs costs to effect an
electronic debit transaction other than the variable authorization,
clearance, and settlement costs the Board originally proposed to
include as allowable costs. Specifically, issuers incur costs to
connect to the network and to purchase and operate the hardware and
software used for processing transactions, including associated labor
cost. As stated above, these costs are not readily placed in the
``variable'' or ``fixed'' categories because their categorization
depends on the relevant range of transactions and the time horizon.
However, no electronic debit transaction can occur without incurring
these costs, making them costs specific to each and every electronic
debit transaction.
Many complexities also exist in attempting to define costs that are
or are not ``incurred by an issuer for the role of the issuer in the
authorization, clearance, or settlement'' of an electronic debit
transaction under Section 920(a)(4)(B)(i). As noted above, many
commenters disputed the proposed definition of authorization,
clearance, and settlement as arbitrarily excluding costs related to
dispute settlement and account set-up because these costs are incurred
before or after the transaction has occurred. The Board considered
these comments and included additional costs to the extent described
below. The Board does not find it necessary to determine whether costs
are ``incremental,'' fixed or variable, or incurred in connection with
authorization, clearance, and settlement. Under the framework
established by the statute, all costs related to a particular
transaction may be considered, and some--the incremental costs incurred
by the issuer for its role in authorization, clearance, and
settlement--must be considered. In determining the interchange fee
standard, the Board considered the authorization, clearance, and
settlement costs described in the proposal for which data were
available. By considering all costs for which it had data other than
prohibited costs, the Board has complied with the statutory mandate not
to consider costs identified in Section 920(a)(4)(B)(ii), has fulfilled
the statutory mandate requiring consideration of the costs identified
in Section 920(a)(4)(B)(i), and has chosen to consider other costs
specific to particular electronic debit transactions to the extent
consistent with the purpose of the statute, in establishing its
standard required under Section 920(a)(3)(A).
d. Examples of Costs Not Included in Setting the Standard
On the basis described above, in establishing the standards for
implementation of Section 920(a)(2), the Board did not include in the
establishment of the interchange fee standard those costs that are not
specific to a particular electronic debit transactions.\119\ In
addition, the Board did not include certain costs that are specific to
a particular electronic debit transaction but are not incremental costs
incurred by the issuer for its role in the authorization, clearance,
and settlement of a particular transaction. The costs the Board did not
consider in setting the standards include costs associated with
corporate overhead or establishing and maintaining an account
relationship; general debit card program costs, such as card production
and delivery costs, marketing expenditures, and research and
development costs; and costs for non-sufficient funds handling.
Although the Board recognizes that all of these costs may in some way
be related to debit card programs and transactions, the Board believes
that many of these costs are not specific to a particular electronic
debit transaction within the meaning of the prohibition in Section
920(a)(4)(B)(ii) and therefore may not be considered by the Board. The
Board has also determined not to include the costs resulting from non-
sufficient funds, the costs of rewards programs, or costs of handling
cardholder inquiries for various reasons discussed below.
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\119\ The Board also did not include a level of profit or a rate
of return as an allowable cost in setting its standard. To the
extent profit is a ``cost,'' it is not one that is specific to a
particular transaction.
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Corporate overhead and account relationship costs. Corporate
overhead costs incurred by an issuer for its general business
operations are shared across all product lines of the issuer and are
not specific to a particular electronic debit transaction. In fact,
although a portion of these costs could relate to debit card programs,
these costs are not specific to any electronic debit transaction
because they are not incurred in the course of effecting electronic
debit transactions. Corporate
[[Page 43428]]
overhead costs include, but are not limited to, the costs of
compensation for executive management; the costs of support functions
such as legal, human resources, and internal audit; and the costs to
operate the issuer's branch network.
Some commenters recommended the final rule include the costs of
account set-up, including the costs of performing customer due
diligence, enrolling the customer in on-line banking, and acquiring
customers (e.g., through marketing). Costs that are incurred with
respect to the cardholder account relationship are not specific to any
electronic debit transaction. Once an account is established, an issuer
may incur ongoing costs of maintaining the account and customer
relationship, including costs of receiving and resolving certain
account-related customer inquiries, account-related regulatory
compliance cost (e.g., BSA/AML compliance, Regulation E compliance, and
FDIC insurance),\120\ and ATM-related costs. These costs are also not
incurred in the course of effecting an electronic debit transaction,
and, as with cardholder account costs, would be incurred even if the
customer engaged in no electronic debit transactions.
---------------------------------------------------------------------------
\120\ Federal, State, or local regulations that are not tied
directly to the debit card program include Bank Secrecy Act/anti-
money laundering (BSA/AML) regulations. Among other things, BSA/AML
requires banks to report suspicious activity that might signify
money laundering, tax evasion, or other criminal activities. 12
U.S.C. 1829b and 1951-1959; 31 U.S.C. 5311-5314, 5316-5332; 31 CFR
part 1010.
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Debit card program costs. Many issuers and networks suggested that
the final rule include all costs related to debit card programs. As
noted above, those commenters urged the Board to read Section
920(a)(4)(B)(ii) to exclude only those costs that are not related to
electronic debit transactions or the debit card program.
The Board's interpretation of the statute distinguishes between
costs incurred in effecting electronic debit transactions and broader
program costs. Card production and delivery costs were excluded because
they are not incurred in the course of effecting electronic debit
transactions. Although each debit card transaction uses a debit card or
information from the debit card, an issuer's card production and
delivery costs (e.g., creating plastic cards and alternate devices such
as key fobs, and mailing them to cardholders) are incurred without
regard to whether, how often, or in what way an electronic debit
transaction will occur. For example, a customer may never use the debit
card for an electronic debit transaction or may use the card only for
ATM transactions (which are not covered by this rule). A customer may
also use only the debit card number (as, for example, in Internet or
preauthorized recurring electronic debit transactions) and not the card
or alternate device provided by the issuer.
Excluding the cost of debit card production and delivery from the
interchange fee charged to the acquirer is consistent with another
requirement of Section 920(a). Section 920(a)(4)(A) requires the Board
to consider the functional similarity between electronic debit
transactions and check transactions. In the case of checks, the check-
writer or his bank typically bears the cost of producing and obtaining
blank checks.
An issuer's marketing costs and costs of research and development
to improve its debit card products and programs are not costs that are
specific to particular electronic debit transactions within the meaning
of the statute. Marketing costs could include, for example, the cost of
informing cardholders of the availability of optional debit card
products and services, and the cost of advertising campaigns for the
issuer's debit card program. Research and development costs could
include, for example, costs related to debit card enhancements, process
improvements, and debit card product development. In addition to not
being costs specific to effecting particular electronic debit
transactions, analogous costs incurred by a payor's bank for its check
service are not reimbursed by the payee's bank.
Debit card issuers also incur costs in order to comply with
Federal, state, or local regulations, including costs of providing
account statements. Although the costs of providing statements relate
to conducting electronic debit transactions generally, the statement
relates to the entire account relationship and the total number of all
types of transactions in the cardholder's account and is triggered by
the account relationship as opposed to any specific transaction.\121\
Moreover, analogous costs incurred by a payor's bank for its check
service are not reimbursed by the payee's bank.
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\121\ Some issuers argued that enabling a second, unaffiliated
network on a debit card was a ``compliance cost'' (created by this
rule). To the extent an issuer incurs costs related to enabling an
unaffiliated network that are otherwise considered to be incurred in
effecting an electronic debit transaction (e.g., network
connectivity costs to comply with Sec. 235.7), such costs would be
included as a basis for the interchange fee standard.
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As explained below, the Board considered and determined to include
network switch fees in establishing standards under Section 920(a).
However, the Board did not include the cost of network membership.
Although network membership is necessary in order to process
transactions over a particular network, membership fees are not
incurred each time a cardholder uses a debit card and, in fact, are
incurred for activities other than those related to particular
electronic debit transactions, such as marketing and research and
development.
Payment guarantee and non-sufficient funds handling. If an issuer
authorizes an electronic debit transaction, network rules typically
require the issuer to pay the transaction, subject to specific
chargeback rights provided by network rules. One aspect of the issuer's
obligation is the so-called ``payment guarantee,'' which refers to
network rules that specify that an issuer that authorizes a transaction
may not return that transaction for insufficient funds or an invalid
account. Several issuers and networks suggested including the cost of
providing the payment guarantee as an authorization or settlement cost.
Many of these commenters asserted that the payment guarantee that
issuers provide merchants for electronic debit transactions is one of
the primary differences between electronic debit transactions and
checking transactions.
Commenters both in favor of and opposed to including the cost of
the payment guarantee as an allowable cost stated that for check
transactions merchants are able to purchase check verification and
guarantee services. Commenters that supported including the cost of the
payment guarantee as an allowable cost suggested that the Board measure
the costs in terms of risk exposure, overdraft losses, or the value to
the merchant (by considering the price merchants pay for comparable
check verification and guarantee services). A few issuers asserted that
if they were not compensated for the payment guarantee, then they
should be permitted to return a transaction for insufficient
funds.\122\ More generally, some commenters noted that networks could
change existing chargeback rights if issuers were not reimbursed for
their costs incurred as part of the payment guarantee.
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\122\ A few issuers suggested that, if the payment guarantee
were not included in the base interchange fee, an issuer should be
able to charge separately for the guarantee. However, if an issuer
were to charge or receive a fee for a payment guarantee through a
network, then such a fee would be an interchange transaction fee for
purposes of this rule.
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By contrast, other commenters (predominantly merchants) opposed
including the cost of the payment
[[Page 43429]]
guarantee as an allowable cost because, for check transactions,
purchasing the verification or guarantee is optional and not required
in order to accept checks. Merchants also stated that network rules
permitted issuers to charge back transactions alleged to be fraudulent
and therefore, the commenters argued, the payment guarantee was not
really a guarantee. Some merchants also noted that they are constrained
from taking certain steps to minimize fraud because payment card
networks discourage merchants from checking the identification of the
cardholders in order to reduce inconvenience associated with use of the
card.
The Board has considered the comments received on payment
guarantees. The final rule does not include the payment-guarantee cost
(including non-sufficient funds handling) within the allowable costs.
Losses that result from the payment guarantee are incurred when an
issuer authorizes a transaction that overdraws the cardholder's
account. However, losses associated with a debit card payment guarantee
are largely within the issuer's control. An issuer is usually able to
decline transactions for which there are insufficient funds, whereupon
the merchant will not complete the transaction using the particular
debit card. When an issuer approves an authorization request, it
generally places a hold on the cardholder's funds pending settlement.
If an issuer approves the transaction knowing there are insufficient
funds in the account, or does not place a hold on funds underlying an
approved transaction, the issuer is choosing to incur any costs
incurred in obtaining funds from the cardholder. The issuer incurs this
cost as a service to its cardholders, and generally imposes fees to
recover the associated risk that a cardholder may fail to provide
subsequent funding for the transaction.\123\ Although some issuers
argued that the payment guarantee is analogous to check-guarantee
services for which the merchant pays, check guarantee services are
generally provided by firms that do not hold the customers' accounts.
Therefore, these guarantees are made based on less complete information
and the fees for these services reflect this incremental risk.
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\123\ There are some instances in which a transaction is not
cleared until after the authorization hold expires (generally after
three days), which may result in an overdraft that was not within
the control of the issuer. Although this represents a cost to the
issuer of the payment guarantee that is not caused by the issuer
knowingly authorizing a nonsufficient funds transaction, the data
are not available to separate these ``NSF'' costs from all other
``NSF'' costs.
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Cardholder rewards. Issuers offer rewards to customers in order to
promote use of the issuer's debit cards, and debit card networks
develop these rewards programs to be offered by issuers in order to
promote the use of the network's cards. The costs of the rewards and
associated program administration depend upon the level of rewards the
issuer deems desirable to effectively compete for account holders.
Although an issuer may give cardholders rewards for each transaction
(or value of transactions), this cost is a customer-relationship
program cost that the issuer chooses to incur. Thus, rewards costs are
more akin to marketing costs designed to attract customers to the
issuer and the network than to transaction costs incurred in the course
of effecting an electronic debit transaction.
Moreover, rewards programs often benefit a specific group of
merchants determined by the debit card network or issuer. Including
these costs in interchange fees that are charged to all merchants would
amount to a subsidization of selected merchants by all other merchants
that do not benefit from the rewards program (including competitor
merchants). Although payor's banks typically do not offer rewards
programs for the use of checks, an institution that chose to do so
would bear the associated costs and would not receive reimbursement for
these costs from the payee's bank. The Board has not included the costs
of rewards in establishing the fee standard.
Cardholder inquiries. Issuers incur costs for activities necessary
to receive and resolve cardholder inquiries before and after
transactions. Issuers and networks argued that the costs of handling
customer inquiries and disputes should be included because such costs
relate to a particular transaction. Moreover, issuers stated that not
including these costs would eliminate incentives for issuers to provide
anything but the minimum, legally mandated customer service.
Many costs related to cardholder inquiries do not relate to
specific transactions. Rather, they relate to balance inquiries,
reports of lost or stolen cards, requests for other replacement or
additional cards, inquiries about ancillary products and services, and
other non-transaction specific inquiries. In addition, issuers often
take the opportunity of a cardholder inquiry to engage in marketing
activities unrelated to any particular electronic debit transaction (or
to debit programs generally).
However, some customer service inquiries relate to particular
transactions. Fielding these inquiries is partly a cost of a service
required by regulatory and network rule requirements and partly a cost
of managing the customer relationship.
Payor's banks bear the costs associated with customer inquiries for
check transactions and do not receive reimbursement for these costs
from the payee's bank. Moreover, the cost data obtained by the Board in
response to its issuer survey does not allow for the separation of the
costs of cardholder inquiries related to specific transactions from the
costs of inquiries that do not related to particular transactions.
Thus, it is not currently possible to accurately separate out and
assess cost data for customer inquiries related solely to particular
debit transactions. Accordingly, the Board has not included the costs
of cardholder inquiries in establishing the fee standard.
e. Costs Included in Setting the Standard
The Board has included in its establishment of the interchange fee
standard the following types of costs from its issuer survey: total
transactions processing costs (including costs reported as fixed and
variable authorization, clearance, and settlement costs, network
processing fees (e.g., switch fees), and the costs of processing
chargebacks and other non-routine transactions), transactions
monitoring, and fraud losses. An issuer may use the same processing
platform for its debit card and credit card operations (or debit card
and ATM card operations) to take advantage of economies of scope and
scale. The costs of these activities and equipment are referred to as
``joint costs'' because they are shared. Joint costs between debit card
and credit card programs may include network connectivity used for
multiple card program activities; common hardware, software, and
associated labor that are shared across card programs; and customer
settlement applications used for all transaction account processing. In
these cases, in the Board's survey, costs (excluding fraud losses) were
allocated to electronic debit transactions on a pro rata basis. The
costs the Board included in establishing the fee standard are discussed
further below.
Transactions processing. In addition to the proposed allowable
costs described in relation to proposed Alternative 1, an issuer must
maintain and use network connectivity to effect each transaction
because the issuer must be able to receive the particular authorization
request, send the particular approval or denial message,
[[Page 43430]]
and receive the related clearing and settlement message. Likewise, an
issuer must maintain and use computer equipment that can process each
authorization request by checking for the validity of the card and
account, as well as checking and updating the amount of funds in an
account. The issuer must also employ staff to operate and maintain the
computer equipment involved in transaction processing. Each transaction
uses the equipment, hardware, software and associated labor, and no
particular transaction can occur without incurring these costs. Thus,
these costs are ``specific to a particular transaction.'' The most
reasonable way to measure and allocate these costs on a per-
transactions basis is by averaging these costs across the total number
of electronic debit transactions that use the resource.\124\
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\124\ The Board's survey data included the costs of loading
funds to prepaid cards as part of reported processing costs. The
Board does not believe these costs should be considered in
establishing the interchange fee standard because they are not
specific to a particular electronic debit transaction and are more
akin to deposit account costs, which have not been included in
setting the debit interchange fee standard. However, these costs
could not be separated from other processing costs that should be
included. Because reloadable prepaid cards transactions are a very
small proportion of total electronic debit transactions, the Board
believes this inclusion is immaterial and does not affect the
calculation of the overall cap amount. Future surveys will ask that
this cost not be included in reporting processing costs for
reloadable prepaid costs.
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Costs of chargebacks and other non-routine transactions.
Transactions are not limited to the initial purchase. An issuer may
initiate a chargeback transaction to reverse settlement with both the
acquirer and the cardholder, and an acquirer may present the
transaction again to the issuer if the acquirer believes the issuer is
not entitled to charge back the transaction.\125\ The proposal included
as allowable costs the costs of ``initiating, receiving, and processing
chargebacks, adjustments, and similar transactions'' and the costs of
``receiving and processing representments of electronic debit
transactions'' (but not the actual amount of the chargeback,
adjustment, or representment. Proposed comment 3(c)-2.iii stated that
an issuer's activities associated with non-routine transactions
included activities such as data processing to prepare and send the
chargeback message and reconciling the chargeback with the cardholder's
account, but excluded costs of receiving cardholder inquiries about
particular transactions. Several issuers suggested including costs of
processing chargebacks, other than the costs proposed (e.g., data
processing and sending the message), such as the costs of resolving
cardholder inquiries to determine whether the issuer has a chargeback
right. One consumer group encouraged including the cost of processing
chargebacks in allowable costs in order to encourage issuers to use
networks that provide chargeback rights to consumers.\126\ A few
merchants opposed including the costs of fraud-related chargebacks,
arguing such costs should be included as part of the fraud-prevention
adjustment, if at all.
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\125\ The circumstances under which an issuer may reverse a
transaction vary based on network rules and include an error in the
transaction information, duplicate processing, an unauthorized
transaction, and non-receipt of merchandise.
\126\ That commenter suggested that, under proposed Alternative
1, the Board should allow issuers to recover costs where the
merchant has gone out of business, and under proposed Alternative 2,
the Board should reduce the cap to 11 cents and allow issuers to
recover 1 cent for maintaining an effective debit card chargeback
program.
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Chargebacks and other non-routine transactions are separate
transactions that essentially unwind the initial transaction (see
discussion of the definition of ``electronic debit transaction,'' Sec.
235.2(h)). The associated costs of processing these transactions are
``specific to a particular transaction.'' The final rule considers the
costs of processing chargebacks and other non-routine transactions as a
basis for establishing the standard for interchange fees. As implied by
the discussion in a companion interim final rule, published separately
in the Federal Register, the costs of processing chargebacks are not
considered for purposes of the fraud-prevention adjustment; therefore,
including the issuer's cost of processing fraud-related chargebacks in
the interchange fee standard will not result in double-recovery.
Network processing fees. The Board received numerous comments on
the proposed exclusion of network processing fees (e.g., switch fees)
as a type of allowable cost. Many issuers and networks requested that
the Board include network processing fees because such fees are
directly related to the authorization, clearance, and settlement of a
transaction. One network asserted that excluding network processing
fees created an inconsistency if per-transaction fees paid to third
parties could be included as allowable costs. Merchants, by contrast,
overwhelmingly supported the exclusion of network processing fees
because, if such fees were included, merchants would be in the position
of paying all network fees for a transaction. One issuer contended that
if network processing fees were excluded, issuers should be permitted
to receive net compensation from the networks so that issuers could
realize the value to the networks of their cardholder base. This is
discussed further in the section related to circumvention and evasion.
The Board believes that network processing fees are both specific
to a particular transaction and incurred for the issuer's role in
authorization, clearance, and settlement. Network processing fees are
incurred by issuers in the course of effecting electronic debit
transactions, and the total amount of fees charged to an issuer is
determined by the amount of electronic debit transactions processed for
that issuer. The Board has included network processing fees in
determining the standard for interchange fees. Merchant-routing choice
may place downward pressure over time on the level of network fees
assessed to acquirers. To the extent that acquirers and merchants may
be in the position of directly paying all of their network fees as well
as paying the network fees of covered issuers through interchange fees,
such an arrangement would be similar to traditional paper-check
processing where the payee's bank (the corollary to the acquirer for
the merchant) typically pays all of the processing costs, while the
payor's bank (the corollary of the issuer in an electronic debit
transaction) typically pays no processing fees. The Board recognizes,
however, that in electronic check collection systems, both the payee's
bank and the payor's bank generally pay processing fees.
Transactions monitoring. The proposal excluded authorization-
related fraud-prevention costs from allowable costs in proposed Sec.
235.3. Numerous commenters (predominantly issuers) recommended
including costs of such fraud-prevention activities in the interchange
fee standard because the pre-authorization fraud-prevention activities
are integral to transaction authorization. These commenters suggested
that such costs could include the cost of enrolling in or maintaining
programs that monitor transactions prior to making the decision to
authorize the transaction. Merchants and a few other commenters opposed
including fraud-prevention costs in the interchange fee standard
because such costs are intended to be included through the fraud-
prevention adjustment.
Transactions monitoring systems assist in the authorization process
by providing information to the issuer before the issuer decides to
approve or decline the transaction. Issuers may monitor transactions
through the use of neural networks and fraud-risk scoring
[[Page 43431]]
systems. Transactions monitoring is as integral to the authorization
decision as confirming that a card is valid and authenticating the
cardholder. For example, an issuer may flag a transaction as suspicious
and decline the authorization request or require the merchant to verify
the transaction with the issuer before deciding whether to approve or
deny the transaction.
In comparison, the types of fraud-prevention activities considered
in connection with the fraud-prevention adjustment (discussed in an
interim final rule published separately in the Federal Register) are
those activities that prevent fraud with respect to transactions at
times other than when the issuer is effecting the transaction. The
issuer's cost of this type of action is not considered a cost of
authorization. For example, an issuer may send cardholders alerts after
authorizing a transaction or series of transactions to inquire about
suspicious activity. These subsequent alerts are intended to prevent
future fraudulent transactions and are not a cost of authorizing a
particular transaction. Any costs of those subsequent alerts are
considered in the fraud-prevention adjustment, but not as a basis for
the interchange fee standard. Similarly, the cost of research and
development of new authentication methods would be considered in the
fraud-prevention adjustment but would not be a cost that is specific to
a particular electronic debit transaction and therefore cannot be
considered in determining the fee standard.
Fraud losses. The proposal did not include fraud losses incurred
with respect to electronic debit transactions as an allowable cost.
Numerous merchants argued for this exclusion because they believed that
allowing issuers to pass fraud losses on to acquirers or merchants
through the interchange fee would largely eliminate the incentive for
issuers to take steps to minimize fraud losses, contrary to policy
goals of reducing the occurrence of, and losses from, fraudulent
electronic debit transactions. On the other hand, numerous issuers and
some networks supported including fraud losses as costs that are
specific to a particular transaction. These commenters argued that it
would be unreasonable for issuers to bear fraud losses without any
compensation from merchants because merchants receive benefits from
authorized debit card sales (including the payment guarantee) and are
in a unique position to prevent fraud losses by checking for cardholder
identification or signature, among other things. Moreover, these
commenters argued that excluding fraud losses from allowable costs
would encourage merchants to ignore possible fraudulent electronic
debit transactions. A few issuers also indicated that they incur
insurance costs against fraud losses, including paying a per-account
deductible.
Two issuers provided general suggestions for measuring the amount
of fraud losses that should be included in allowable costs. One issuer
suggested that fraud losses be reflected as a variable component in the
interchange fee standards because fraud losses increase with
transaction size. Another issuer suggested that interchange fees
reimburse an issuer for fraud losses based on the issuer's fraud levels
vis-[agrave]-vis industry fraud levels, but did not elaborate further
as to the precise formula to be used.
The Board has considered the comments received on fraud losses. The
final rule includes an allowance for fraud losses in determining the
interchange fee standard. For purposes of the final rule, fraud losses
are those losses incurred by the issuer, other than losses related to
nonsufficient funds, that are not recovered through chargebacks to
merchants or debits to or collections from customers.\127\
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\127\ The amount of the fraud-prevention adjustment permitted
under the accompanying interim final rule published separately in
the Federal Register does not include consideration of fraud losses.
The adjustment amount is based on fraud-prevention costs, rather
than fraud losses.
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Fraud losses are costs that are specific to a particular
transaction. The issuer's fraud losses are generally the result of the
authorization, clearance, and settlement of an apparently valid
transaction that the cardholder later identifies as fraudulent. An
issuer may experience losses for fraud that it cannot prevent and
cannot charge back to the acquirer or recoup from the cardholder.\128\
The most common types of fraud reported in the Board's survey were
counterfeit card fraud, lost and stolen card fraud, and card-not-
present fraud.\129\ Certain fraud and the related losses can be reduced
through actions by the merchants. Even if the merchant takes all
reasonable steps to verify the card user, however, the transaction may
nonetheless be fraudulent.
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\128\ Rules regarding chargeback rights and obligations vary
across payment card networks. Some networks have rules that prevent
an issuer for imposing any liability on the cardholder for
unauthorized transactions.
\129\ Counterfeit-card fraud is when a fraudster obtains
information about the card and creates a replica of the card.
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Permitting issuers to recover at least some fraud losses through
interchange fees is reasonable given that the source of fraud could be
any participant in an electronic debit transaction and that the exact
source of fraud often is unknown. Payment card network rules allocate
responsibility for fraudulent transactions, but this allocation does
not necessarily result in the loss ending up with the party that was in
the best position to prevent the fraud. For example, the loss may have
occurred from a data breach at a merchant or acquirer not involved in
the fraudulent transactions. Additionally, network rules that are vague
with respect to merchant requirements for authenticating a signature
may lead to fraud losses being borne by the issuer when the merchant
was in a position to compare the cardholder's signature with the
signature on the back of a card and prevent the fraud.
Allowing a portion of fraud losses to be recovered through
interchange fees will not eliminate the incentive for issuers to
monitor and prevent fraud. Issuers will continue to bear the cost of
some fraud losses and cardholders will continue to demand protection
against fraud.
The cost of a fraud loss varies with the amount of the transaction.
For example, an issuer takes on a greater risk when approving a $100
transaction than a $5 transaction because the amount of the potential
loss is greater. Therefore, fraud losses are best assessed through an
ad valorem component in the interchange fee standards.
C. Section 235.3 Interchange Fee Standards
EFTA Section 920(a)(3) requires the Board to establish ``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. The Board proposed that an
issuer must comply with its interchange fee standards, under both
proposed alternatives, on a per-transaction basis; that is, an issuer
could not receive any interchange fee that exceeds its maximum
permissible fee. The Board requested comment on two other applications
of the interchange fee standards: one that would permit an issuer to
comply with the fee standard, on average, for all of its electronic
debit transactions, and another that would evaluate compliance at a
network level and permit an issuer to comply with the fee standard if,
for a particular network, all covered issuers on that network received
the amount of the fee standard, on average, for all electronic debit
transactions over the network.
[[Page 43432]]
1. Standards for Assessing
A number of issuers argued that a cap on interchange fees was a
limit and not a ``standard for assessing'' whether interchange fees
were reasonable and proportional to costs. These commenters argued that
Section 920(a) requires more flexible guidelines.
The term ``standards'' generally means ``something established by
authority as a rule for the measure of quantity, quality, etc.'' or the
``rule or principle that is used as a basis for judgment.'' \130\ The
final rule sets the standard for the maximum permissible interchange
transaction fee that may be received by a covered issuer (i.e., a
transaction-level standard). If an interchange fee that an issuer
receives does not exceed the cap, the amount of the interchange fee is
reasonable and proportional to transaction cost. In this way, the cap
represents a standard; it is a ``rule for the measure of quantity'' and
``a basis for judgment.''
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\130\ Webster's New World Dictionary and Thesaurus 17 (2nd ed.
2002); Random House Webster's Unabridged Dictionary (2nd ed. 2001).
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The Board recognizes that providing a standard in the form of
general guidelines would provide networks with more flexibility in
setting interchange fees. The Board believes, however, that this
approach would be extremely difficult to implement and is not required
by the statute. Section 920(a) uniquely positions the Board to obtain
information regarding each covered issuer's costs and, thus, to
consider the transaction costs across all covered issuers in order to
determine the point at which interchange fees would no longer be
reasonable in light of allowable transaction costs. By contrast, a
payment card network does not process transactions for each covered
issuer and would receive information from only a subset of covered
issuers. Without a uniform numerical standard applicable to all
issuers, networks, and transactions (i.e., as adopted in this rule),
the definition of the highest reasonable fee could vary across issuers,
networks, and transactions. This would make enforcement of the statute
extremely difficult and burdensome for all parties and would encourage
issuers to choose a network based on the network's application of the
fee standards, rather than based on the services provided by the
network.
Setting a uniform standard of the maximum permissible interchange
transaction fee that may be received by a covered issuer is also the
most practical and least burdensome approach in the context of a
complex and dynamic system that handles large and growing volumes of
transactions. As many commenters recognized, more general cost-based
standards (including proposed Alternative 1) would place a significant
burden on industry participants and supervisors.
In addition to meeting the words and purpose of the statute, the
final rule's standard provides the proper economic incentives for
issuers to improve their efficiency. The final rule provides each
issuer an incentive to reduce its per-transaction costs below the level
of the cap. The Board will use the data collection authority provided
in Section 920(a) to regularly collect data on the costs incurred by
issuers in connection with electronic debit transactions and, over
time, will adjust the standards based on reported costs, if
appropriate. Lower costs should result in a lower interchange fee cap
as issuers become more efficient.
2. Transaction-Level Standard
In general, merchants, a few payment card networks, and acquirers
(as well as other types of commenters) opposed both an issuer- and
network-averaging approach in favor of a transaction-level approach.
Merchants contended that averaging would enable the continuation of
price discrimination against merchants, and Internet merchants in
particular. A few of these commenters stated that averaging was
inconsistent with the language of the statute because it permits
consideration of non-cost factors in the interchange fee determination.
Commenters opposed to averaging also argued that it would impose a
substantial administrative burden on issuers, payment card networks,
acquirers, and regulators. Additionally, a few commenters were
concerned that averaging likely would result in statutory violations
because predicting the transaction mix ex ante is exceedingly
difficult, and issuers would be unable to control whether they met the
target average because merchants would control routing. Another
commenter was concerned that, under a network-averaging approach, the
largest issuers on a network would receive higher interchange fees than
smaller issuers. One issuer suggested that the safe harbor be an
average effective rate that approximates current fee levels in order to
avoid injecting significant risk into the payment system. This issuer
suggested that the Board consider adjusting the safe harbor no sooner
than one year after the exclusivity and routing rules go into effect,
which should provide the Board time to evaluate whether routing rules
are increasing competition.
A few commenters supported an issuer-averaging approach, including
one issuer that suggested that the safe harbor be an average of all of
an issuer's interchange fees across all networks. One network contended
that permitting network averaging was necessary to provide meaningful
flexibility in setting interchange fees, would provide incentives for
fraud prevention, and would account for cost and risk variation across
transactions. One network suggested that network averaging could be
combined with a transaction-level upper boundary. The commenters in
favor of a network-averaging approach suggested that networks would
demonstrate compliance through regular reporting, and any issuers
participating in those networks would be deemed to be in compliance. If
a network exceeds the standard amount, the commenter suggested that the
Board could either permit variation or require corrective actions.
The Board has determined to adopt neither an issuer-averaging nor a
network-averaging standard. An issuer-averaging approach, where the
only requirement is that an issuer, on average, receive an interchange
fee that does not exceed the cap, would be significantly less
burdensome from an enforcement perspective, but would be less likely to
produce actual compliance. Issuers and networks would be unlikely to
accurately predict an issuer's transaction mix ex ante because of
fluctuation in cardholders' shopping patterns and merchant routing
choice, and therefore may not be able to exactly meet an issuer
average. Moreover, such an approach would be less transparent than a
transaction-level standard because each party would be unable to
determine whether a given interchange fee complied with the standard.
Similarly, although a network-averaging approach to the standard would
provide networks with more flexibility to vary the amounts of
interchange transaction fees by merchant type and transaction type, an
individual issuer's compliance would depend on the amounts of
interchange transaction fees received by other issuers on the network.
3. Determining the Interchange Fee Standard
The Board surveyed institutions expected to be covered by the
interchange fee standards to determine their costs relating to debit
card programs, among other things. As discussed above, there is no
industry standard for cost-accounting systems because institutions use
cost-accounting
[[Page 43433]]
systems predominantly for internal management purposes. In recognition
of this, the survey contained instructions regarding the types of costs
a responding issuer should report and the types of costs a responding
issuer should exclude entirely from its survey responses. Issuers also
were asked to provide information on the number of purchase and other
electronic debit transactions (such as returns and
chargebacks).131 132
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\131\ In a purchase transaction, value is transferred from the
cardholder to the merchant in exchange for goods and services. In a
return transaction, the merchant reverses a purchase transaction
(due, for example, to the return of goods by the cardholder), and
value is transferred from the merchant to the cardholder.
\132\ Although the response rates for the surveys were high,
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 detail requested in the surveys.
In addition, inconsistencies existed in some reported data within
individual responses and across responses. Where possible, minor
problems (e.g., adding components to determine the total or removing
minus signs) were resolved, but responses with major problems (e.g.,
failing to provide critical transaction volume information) were not
used.
---------------------------------------------------------------------------
Responding issuers were instructed to exclude corporate overhead
costs or any other overhead costs for activities that are not directly
related to the issuer's debit card program. If the responding issuer
incurred overhead costs directly related to activity in a card program,
the issuer could allocate those costs to card program activity.
Similarly, if an issuer incurred costs for an activity that was jointly
attributable to electronic debit transactions and another program (such
as credit cards), the issuer was instructed to allocate the costs of
that activity across the programs on a pro rata basis. Issuers were
instructed to include the depreciation or amortization of capital
expenditures. Throughout the survey instructions, issuers were directed
not to include costs that were not tied to debit card programs.
With respect to costs incurred for debit card program activity, the
survey requested cost information for the total costs of several
activities that were not included as part of authorization, clearance,
or settlement: Card production and delivery; cardholder inquiries;
rewards, incentives, and affinity-partnerships; network membership;
research and development; and compliance.\133\ Survey respondents were
instructed not to include the costs for these activities in any other
cost category, which allowed isolation of these cost categories and
prevented double-counting of costs. For the reasons stated above, costs
for these activities were not considered as the basis for the
interchange fee standard.
---------------------------------------------------------------------------
\133\ Issuers were instructed to put information regarding these
costs in Section IV of the Card Issuer Survey.
---------------------------------------------------------------------------
As discussed in more detail above, the types of costs that form the
basis for the interchange fee standard are costs incurred for
processing electronic debit transactions,\134\ chargebacks, and similar
transactions, including network processing fees and transactions
monitoring costs; and fraud losses. Each of these categories was
reported separately. With respect to transaction processing, issuers
were instructed to include the total costs associated with providing
authorization for transactions (including data processing, connectivity
expenses, voice authorization inquiries, and referral inquiries);
clearing and settlement (including receiving, verifying, reconciling,
settling transactions with other financial institutions, and posting
transactions to cardholder's accounts); and processing chargebacks and
other erroneous transactions. Issuers were instructed to separately
report network processing fees and their cost for transactions
monitoring prior to authorization.\135\ Issuers were asked to report
costs directly attributable to PIN debit, signature debit, and prepaid
card programs.
---------------------------------------------------------------------------
\134\ These transactions included purchase and return
transactions, authorizations without value transfer, denials, and
funds loads to prepaid cards.
\135\ Issuers were instructed to report these costs, except for
transactions monitoring, in Section III of the Card Issuer Survey.
Issuers were instructed to report all of their fraud-prevention
activities and the total costs incurred for each activity in Section
V of the Card Issuer Survey. The most commonly reported activity was
transactions monitoring.
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These data were used to compute an average per-transaction cost for
each issuer that reported costs for authorization, clearance and
settlement, network fees, and transactions monitoring based on the
number of routine purchase transactions.\136\ For each such issuer, the
total of these costs was computed and divided by the total number of
purchase transactions sent to the issuer for authorization during 2009.
The data from the Board's survey showed that these average per-
transaction costs reported by covered issuers ranged from 3 cents to 66
cents per transaction.\137\ The Board used this range as a starting
point for setting standards for the base component. Within this range,
the Board ranked the average per-transaction allowable cost from the
lowest- to highest-cost issuer.
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\136\ The number of respondents varies across the cost-
categories because not all issuers were able to break out certain
cost information. For example, a number of prepaid card issuers
reported that they did not know the specific costs associated with
their prepaid card program. In some cases those issuers provided
more complete data for their signature and PIN programs. In those
cases, the issuer's signature and PIN purchase transactions and
costs are included, but their prepaid purchase transactions and
costs are excluded.
\137\ One merchant group stated that the cost estimates in the
Board's survey contained an upward bias due to the inclusion of
higher-cost prepaid cards (many of which would be excluded). Unlike
other debit cards, issuers may not have information on which prepaid
cards are exempt because an exemption may be determined by factors
in the program manager's or merchant's control (such as whether the
card is marketed or labeled as a gift card). Accordingly, the survey
did not instruct issuers to differentiate between exempt and non-
exempt prepaid cards when reporting data.
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The distribution of issuer costs in the survey is quite skewed,
with the distribution concentrated in the range of costs below the 80th
percentile, and a scattered set of institutions with significantly
higher costs above this point. Below the 80th percentile, the
difference between the per-transaction allowable costs of adjacently-
ranked issuers is small. For example, among issuers whose costs are
between the 20th and the 80th percentiles, the largest cost difference
over a 5-percentile range of the distribution (e.g., from the 60th to
65th percentile) is about 3 cents. Above the 80th percentile, however,
the distribution shows a marked discontinuity, with per-transaction
allowable costs varying more significantly across issuers of similar
rank. Between the 80th and 85th percentiles, the difference in costs is
about 20 cents. The average per-transaction cost of the issuers above
the 80th percentile is 49 cents, more than double the level of the cap,
and greater than the average interchange fee level recorded in the
survey. It appears that some of these higher-cost issuers may face
unique circumstances regarding their overall business orientation; for
example, some of the issuers with high reported costs appear to be
organizations whose commercial banking operations (and associated debit
card programs) are small relative to their overall operations. The
Board therefore does not believe that setting interchange fee standards
to accommodate these higher-cost issuers would be reasonable or
proportional to the overall cost experience of the substantial majority
of covered issuers. Moreover, the Board does not believe that it is
consistent with the statutory purpose to permit networks to set
interchange fees in order to accommodate 100 percent of the average
per-transaction cost of the highest-cost issuers.
Based on a review of the survey data and public comments, and for
the
[[Page 43434]]
reasons explained above, the final rule establishes a standard that
caps the base component of any interchange fee at 21 cents per
transaction, which corresponds to the 80th percentile issuer's average
per-transaction included costs.
Fraud losses vary by the value of the transaction and, thus, were
considered separately. Issuers were asked to report fraud losses--the
total value of fraudulent transactions less any amounts recovered from
acquirers, cardholders, or other parties. For issuers that reported net
fraud losses, total net fraud losses were divided by the total value of
purchase transactions.\138\ The Board's survey indicated that the
average per-transaction fraud loss, measured in basis points (bps),
varied among responding issuers and ranged from 0.86 bps to 19.64 bps.
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\138\ Issuers were instructed to report information related to
fraud losses in Section VI of the Card Issuer Survey. Issuers that
reported net fraud losses were not limited to those issuers that
reported cost information necessary to calculate the base
interchange fee component.
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The Board has determined that it is appropriate to include an
allowance for fraud losses in the interchange fee standard, capped at
approximately the median of reported issuer fraud losses (5 bps). Using
the median figure recognizes that, as explained above, fraud losses can
result from the actions or inaction of merchants as well as issuers,
and will provide incentives for both issuers and merchants to take
appropriate steps to reduce fraud losses, since each group will incur
some costs for these losses.
Issuers that incur the included costs at a level below the
interchange fee standard cap (the sum of 21 cents and 5 bps multiplied
by the value of the transaction) may retain the difference between
their costs and the cap. The cap, however, will result in some issuers
not fully recovering their average per-transaction cost through
interchange fees. Some commenters argued that this result is
inconsistent with ratemaking in other contexts in which rates enable
regulated entities to recover costs plus a reasonable profit. The Board
has considered the comments and, for the reasons explained above,
believes that the similarities between the statutes governing rates for
public utilities and other regulated entities and Section 920 are
limited. In summary, EFTA Section 920(a) does not use the term ``just
and reasonable'' that is typically used in public utility rate-setting
statutes.\139\ Congress is well aware of this term of art and would
have used that phrase had it intended the Board to consider other
ratemaking jurisprudence. In addition, public utility rate-setting
involves unique circumstances, none of which is present in the case of
setting standards for interchange transaction fees. Issuers are unlike
public utilities and similarly regulated entities, which typically are
required to provide the regulated service to the public or are
otherwise restricted from discontinuing provision of the regulated
service. In addition, unlike in the case of public utilities and
similar entities where the entity's only source of revenue for the
service or commodity is the regulated rate, Section 920 regulates only
the fees issuers receive from the merchant side of the transaction, not
from all sources.\140\
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\139\ See, e.g., Natural Gas Act, 15 U.S.C. 717 et seq. Duquense
Light Co. v. Barash, 488 U.S. 299 (1989).
\140\ Several commenters pointed to Brooks-Scanlon Co. v. R.R.
Comm'n of La., 251 U.S. 396 (1920), in support of the proposition
that the Board should not consider an issuer's ability to receive
revenue by charging cardholders fees. The Board believes that there
is a material difference between looking to revenue from a separate
but commonly-owned business (as was the case in Brooks-Scanlon) and
looking to revenue from the same service. See Baltimore & Ohio
Railroad v. U.S., 345 U.S. 146, 150 (1953).
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4. Uniform Interchange Fee Standard
Section 235.3(a) applies to all electronic debit transactions not
otherwise exempt from the rule, and the maximum permissible interchange
fee is the same irrespective of the network over which the transaction
is processed, the type of debit card, and the method of cardholder
authentication. To determine amounts that would be proportional to
cost, the Board considered the average per-transaction allowable costs
of issuers for signature-based debit, PIN-based debit, and prepaid card
transactions.
a. Summary of Proposal and Comments
Under both proposed alternatives, the maximum permissible
interchange fee would be the same irrespective of card type, network,
or cardholder authentication method. The Board noted that issuers
reported higher allowable costs for prepaid cards and requested comment
on whether it should have separate standards for prepaid card
transactions.
Several issuers, networks, merchants, and their trade groups
opposed setting different standards (particularly the cap) for PIN-
based and signature-based debit card transactions for a variety of
reasons, including to avoid any possible discrimination between PIN-
based and signature-based networks and to reduce operational
complexity. Some of these commenters stated that authentication methods
will likely expand beyond PIN and signature and that accounting for all
types of authentication methods would further increase operational
complexity of standards that differentiate by authentication method.
Moreover, interchange fee standards that differentiate by
authentication method may impede the introduction of new and innovative
authentication methods. Some merchant commenters believed one uniform
interchange fee standard would drive the marketplace to PIN-based
transactions, which the merchants asserted was ``the lowest cost, most
secure, and best functioning'' method. One merchant commenter contended
that having one cap would eliminate circumvention and evasion concerns.
Other commenters supported having different standards for PIN-based
and signature-based transactions because of different risks and costs
associated with each type of transaction. These commenters contended
that having one cap would decrease incentives for merchants to use, or
become enabled to use, PIN-based transactions (especially in light of
the expense of PIN pads). Additionally, some commenters believed a
single cap would unfairly affect issuers that process predominantly
signature transactions and would result in an issuer recovering a
different portion of its costs from year to year depending on its
transaction mix.
Several commenters that are active participants in the prepaid
industry encouraged the Board to adopt a separate fee standard for
prepaid cards in light of the higher costs. Other commenters suggested
the Board allow for variation in interchange fees among different types
of prepaid cards, because the costs of authorization, clearance, and
settlement vary depending upon the type of prepaid card (e.g., a non-
reloadable general-use prepaid card and a health savings account
prepaid card).
b. Analysis of Comments and Final Rule
Electronic debit transactions are processed over numerous different
networks with numerous different pricing structures and participation
rules and requirements, and each network's pricing, rules, and
requirements vary by type of transaction. Signature networks may have
higher switch fees than PIN networks, and within those groups, switch
fees vary by network. Similarly, each network may have different rules
related to charging back fraudulent transactions, and the rules vary by
type of transaction (e.g., card-present and PIN-based). Moreover, new
card types and transaction types are developing due to innovation in
the payment card industry.
[[Page 43435]]
Accordingly, if the standard were to differentiate between
signature-based networks and PIN-based networks and were to recognize
differentiation across all networks (i.e., a network-specific standard)
and transaction types (e.g., card-present and card-not present), the
resulting interchange fee standard would require issuers to track their
costs (including fraud losses and switch fees) by network and
transaction type in order to submit information to the Board. This
level of detail would impose larger reporting burden on issuers, as
well as a burden on supervisors, to ensure that an issuer was receiving
the appropriate interchange fee revenue from each network for each
transaction type.
As discussed above, the final rule accounts for variation in the
cost incurred by an issuer in effecting an electronic debit transaction
by considering the costs of all types of electronic debit transactions
across all issuers responding to the Board's survey. By treating
allowable costs that are likely to vary based on network and/or
transaction type (e.g., network fees and fraud losses) the same--on an
average basis for any given transaction regardless of the network, card
type, or transaction type--the final rule avoids providing incentives
for issuers to steer consumers to use higher-cost networks, cards, and
transaction types.
Several merchants suggested that the same interchange fee standard
should apply across merchant types, transaction types, and transaction
size, arguing that current variation in interchange fees is due to
market power rather than true variation in costs or transaction risks
(which, they asserted is accounted for through chargeback rules).\141\
By contrast, several issuers suggested that the final rule should allow
networks to set interchange fees based on transaction risk. These
commenters asserted that fraud losses vary with transaction size,
transaction type, and merchant location.
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\141\ For example, some merchants stated that card-not-present
merchants are experiencing increasingly low rates of fraud
(primarily due to the merchants' own investments in fraud
prevention), but are subject to higher interchange rates and
chargeback rates.
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Merchants suggested that the Board establish different standards
for small-ticket sales (under $5) because the proposed cap likely would
result in higher interchange fees than merchants currently are paying
on those transactions. Other merchants thought that variation in
transaction risk should be addressed in the fraud-prevention
adjustment, if addressed anywhere, and noted that fraud risk exists for
both card-present and card-not-present transactions.
For the reasons stated above, the final rule permits an ad valorem
component such that the total amount of an interchange transaction fee
does not exceed the sum of the 21-cent base component and 5 basis
points of the transaction value (plus the fraud-prevention adjustment,
if applicable). Networks are not prohibited from varying the amount of
either interchange fee component by transaction type, transaction
value, or merchant type, provided the interchange fee for any
transaction not exceed the maximum permissible amounts in Sec.
235.3(b) (plus the fraud-prevention adjustment, if the issuer is
eligible to receive the adjustment). See comment 3(b)-2. The
flexibility to vary the amounts of interchange fee components below the
cap enables networks to establish interchange fees that reflect
variation in transaction risk and to account for other factors that
affect a network's ability to increase its transaction volume.
IV. Section 235.5 Exemptions \142\
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\142\ The companion interim final rule published separately in
the Federal Register adds Sec. 235.4 (Fraud-prevention adjustment).
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The proposed exemptions to the applicability of the interchange fee
standard in Sec. 235.5 implement the exemptions set forth in EFTA
Section 920(a) for small issuers, government-administered payment
programs, and certain reloadable prepaid cards.\143\
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\143\ EFTA Section 920(a)(6) and (7).
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Because an electronic debit transaction may qualify for more than
one exemption, the Board proposed comment 5-1 to clarify that an issuer
need qualify for only 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 clarified that a payment card network establishing
interchange fees need only satisfy itself that the issuer's transaction
qualifies for at least one of the exemptions in order to exempt the
electronic debit transaction from the interchange fee restrictions. The
Board did not receive any comment on the clarification, and the
substance of comment 5-1 has been adopted as proposed with
modifications to conform the language of the comment to other
revisions.
The Board has adopted new comment 5-2 to provide that payment card
networks that plan to allow issuers to receive interchange fees higher
than those permitted under Sec. Sec. 235.3 and 235.4 pursuant to one
of the exemptions in Sec. 235.5 must develop their own processes for
identifying issuers and products eligible for such exemptions. As
discussed in more detail below with respect to each of the exemptions
in Sec. 235.5, the Board believes payment card networks are in the
best position to develop processes for identifying issuers and products
eligible for the various exemptions. However, to assist payment card
networks in determining which of the issuers participating in their
networks are subject to the rule's interchange fee standards, the Board
will publish lists annually of institutions above and below the small
issuer exemption asset threshold.
A. Section 235.5(a) Exemption for Small Issuers
EFTA Section 920(a)(6)(A) provides an exemption from EFTA Section
920(a) for any issuer that, together with its affiliates, has assets of
less than $10 billion. EFTA Section 920(a)(6)(B) limits the term
``issuer'' for purposes of this exemption to the person holding the
asset account that is debited through an electronic debit
transaction.\144\
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\144\ EFTA Section 920(a)(6)(B). The Board noted in its
supplementary information to its proposed rule that an issuer of
decoupled debit cards, which 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) implemented EFTA Sections 920(a)(6)(A) and
(B) by providing 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 clarified 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. Furthermore, consistent with other Board rules, the Board
proposed to designate the end of the calendar year to measure the
assets of an issuer and its affiliates.\145\
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\145\ See, e.g., 12 CFR 203.2(e)(1)(i) and 12 CFR 228.20(u).
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The Board received numerous comments from a variety of commenters,
including large and small issuers, merchants, consumer groups, members
of Congress, and other financial institution regulatory agencies
expressing concern that the small issuer
[[Page 43436]]
exemption would not be effective in practice.\146\ Many issuer
commenters stated that they did not believe that payment card networks
would implement two-tier fee structures (i.e., different fee structures
for covered issuers and exempt issuers). Other issuer commenters stated
that although networks may attempt to implement two-tier fee
structures, market forces and merchant routing choice will erode the
differences between the two fee structures until there is only one
interchange fee that all issuers may charge or very little variation
between the two fees. Some of these commenters expressed concern that
if small issuers were required to accept the same interchange fees as
covered issuers, small issuers' debit card programs might not be
sustainable and that these issuers could be forced to severely limit or
abolish these programs.
---------------------------------------------------------------------------
\146\ Although these comments focused on the effectiveness of
the small issuer exemption, the other exemptions (i.e., debit cards
issued pursuant to certain government payment programs and certain
general-use prepaid cards) raise similar concerns.
---------------------------------------------------------------------------
Many issuer commenters also requested that the Board mandate that
payment card networks implement two-tier fee structures. Several issuer
commenters stated that even if payment card networks were to institute
two-tier fee structures, they believe merchants would pressure
customers or steer customers through discounts to use another form of
payment or refuse exempt cards or cards issued by exempt issuers.
By contrast, merchant commenters also noted that they believe
networks have an incentive to institute two-tier fee structures to
attract and retain the business of exempt issuers and issuers of exempt
products. In addition, merchant commenters, some consumer group
commenters, and a member of Congress stated that they do not believe
merchants would risk alienating customers by refusing to accept certain
cards or discriminating against the use of certain cards through, for
example, the use of differential pricing.
The Board's final rule provides exemptions from the interchange fee
standards in accordance with EFTA Sections 920(a)(6) and (7). The EFTA
does not provide the Board with specific authority to require networks
to implement these exemptions in any particular way. The Board notes,
however, that payment card networks that collectively process more than
80 percent of debit card volume have indicated that they plan to
implement two-tier fee structures.
The Board is taking several steps, including using the data
collection authority provided in EFTA Section 920(a)(3)(B), to allow
the Board to monitor and report to Congress on the effectiveness of the
exemption for small issuers. First, the Board plans to publish annually
lists of institutions above and below the small issuer exemption asset
threshold to assist payment card networks in determining which of the
issuers participating in their networks are subject to the rule's
interchange fee standards.\147\ Second, the Board plans to survey
payment card networks annually and publish annually a list of the
average interchange fees each network provides to its covered issuers
and to its exempt issuers. This list should enable issuers, including
small issuers, and Congress to more readily understand whether the
provisions of EFTA Section 920 and the implementing rule, including the
small issuer exemption, are having a meaningful effect.
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\147\ The lists will be posted on the Board's public Web site.
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With respect to comments on discrimination by merchants, Section
920(b)(2) prohibits payment card networks from inhibiting the ability
of any person to provide a discount or in-kind incentive for payment by
the use of debit cards to the extent that the discount or in-kind
incentive does not differentiate on the basis of the issuer or the
payment card network. Section 920(b)(4)(A) further provides that no
provision of Section 920(b) shall be construed to authorize any person
to discriminate between debit cards within a payment card network on
the basis of the issuer of the debit card.
Moreover, the Board understands that many payment card networks
have rules that require merchants to accept all cards of that payment
product type within that network, regardless of issuer. Merchants also
would likely face negative consequences by refusing to accept a
particular issuer's debit card. Unlike credit cards, where customers
may have cards from more than one issuer, customers are more likely to
have only one debit card. A merchant refusing a customer's particular
debit card could cause the customer to use a credit card, a potentially
more expensive form of payment for the merchant. Alternatively, the
merchant may lose the sale if the customer does not have enough cash or
another payment method that would be acceptable to the merchant.
The Board also received several other comments on this exemption.
Some issuer commenters and a financial regulatory agency urged the
Board to extend the exemption for small issuers to the network
exclusivity and routing provisions of Sec. 235.7. Although EFTA
Section 920(a)(6) provides that small issuers are exempt from the
provisions of EFTA Section 920(a) concerning the interchange fee
standards, the statute does not extend the exemption to the network
exclusivity and routing provisions of EFTA Section 920(b). Some
commenters urged the Board to use the exception authority under EFTA
Section 904(c) to extend the exemption. The Dodd Frank Act removes this
authority from the Board as of July 21, 2011, however.
A payment card network suggested that in assessing whether an
issuer qualifies for the exemption in Sec. 235.5(a), only U.S. assets
should be considered. EFTA Section 920(a)(6) does not specify that the
exemption should be based on U.S. assets only and nothing in the
purpose or structure of EFTA Section 920 or in practical operation
indicates that the provision should not apply to issuers with large
foreign operations that also operate in the U.S. Indeed, applying the
statute to apply to worldwide assets would be consistent with the
principle of national treatment of foreign firms operating in the U.S.
Therefore, the Board believes that this measurement should be based on
worldwide assets.
The final rule also clarifies whether trust assets should be
considered in determining whether an issuer's assets fall below the $10
billion exemption threshold. Trust assets under management are not
considered assets of the issuer or its affiliates, and are not
reflected on the issuer's or affiliate's balance sheet. Therefore,
comment 5(a)-1 states that an issuer qualifies for the small issuer
exemption if its total worldwide banking and nonbanking assets,
including assets of affiliates, other than trust assets under
management, are less than $10 billion.
In the supplementary information to its proposed rule, the Board
noted that to the extent payment card networks plan to permit issuers
meeting the small issuer exemption to receive higher interchange fees
than allowed under Sec. Sec. 235.3 and 235.4, such networks should
establish a process to identify small issuers and to provide
information to acquirers and merchant processors to enable them to
determine what interchange fee applies to each issuer. The Board
requested comment on whether the rule should establish a 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.
[[Page 43437]]
Payment card network commenters suggested that a Board-developed
process would ensure that there is consistent treatment across the
industry and requested that the Board annually publish a list of exempt
and non-exempt issuers based on asset size. A merchant trade group and
several processors suggested that the Board develop a certification
process for small issuers to notify the Board and the payment card
networks within 90 days of the end of the preceding calendar year that
they qualify for the exemption. A merchant trade group commenter also
expressed concerns with networks solely managing the exemption process.
Another processor commenter suggested that the payment card networks
should manage the certification process but that the Board should
establish the reporting period for consistency.
The Board plans to publish annually lists of institutions above and
below the small issuer exemption asset threshold and those for which
the Board is unable to make a determination, due to incomplete or
unreliable affiliate data.\148\ There may exist a small number of
debit-card issuers that do not appear on any of these lists.\149\ The
Board will compile these lists based on data in the Board's
possession.\150\ These lists, based on assets as of December 31, 2010,
will be posted on the Board's Web site. The Board has redesignated
proposed Sec. 235.5(a) as Sec. 235.5(a)(1) and adopting Sec.
235.5(a)(2) to provide that a person may rely on these Board-published
lists to determine whether an issuer, together with its affiliates, has
assets of less than $10 billion as of the end of a calendar year. To
the extent that an issuer qualifies for the small issuer exemption but
is not included on the Board's list of exempt institutions, payment
card networks may institute their own processes for such issuers to
certify their eligibility for the exemption to the networks. See
comment 5-2.
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\148\ The Board has insufficient data to determine whether every
issuer, together with its affiliates, has assets above or below $10
billion; e.g., the Board may not have data on affiliates of
industrial loan companies with assets below $10 billion.
\149\ The lists, for example, would not include depository
institutions without regulatory financial data reported as of the
report date, depository institutions without federal insurance, and
issuers that are not depository institutions.
\150\ The Board's sources of data to compile these lists
include: 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), the Consolidated Reports on
Condition and Income (Call Reports) for Edge and agreement
corporations (FR 2886b; OMB No. 7100-0086), the Reports of Assets
and Liabilities of 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, the Credit Union Reports of Condition and
Income (NCUA 5300/5300S; OMB No. 3133-0004) for credit unions, and
the Corporate Credit Union Monthly Call Report (NCUA 5310; OMB No.
3133-0067) for corporate credit unions.
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From year to year, issuers that are exempt may become covered
issuers based on changes in assets and affiliates. The Board has added
Sec. 235.5(a)(3) (and comment 5(a)-2) to provide that, if an issuer no
longer qualifies for the small issuer exemption as of the end of a
calendar year because at that time it, together with its affiliates,
has assets of $10 billion or more, the newly covered issuer must begin
complying with the interchange fee standards (Sec. 235.3), the fraud-
prevention standards (Sec. 235.4) (to the extent the issuer wishes to
receive a fraud-prevention adjustment), and the provisions prohibiting
circumvention, evasion, and net compensation (Sec. 235.6) no later
than July 1 of the following year. This date provides time for issuers
and networks to determine the applicability of the exemption and
implement any necessary system updates to enable compliance.
B. Section 235.5(b) Exemption for Government-Administered Programs
EFTA Section 920(a)(7)(A)(i) provides an exemption for 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 Federal, State,
or local government-administered payment program, in which the person
may use the debit or general-use prepaid card only to transfer or debit
funds, monetary value, or other assets that have been provided pursuant
to such program. The Board proposed to implement this provision in
Sec. 235.5(b) with minor non-substantive changes to the statutory
language.\151\ A merchant trade group commenter suggested that the
exemption for government-administered payment programs should be
temporary. The statute does not place an expiration date for the
exemption unless certain limited conditions are met. The final rule
follows the statute.
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\151\ As the Board discussed in its proposed rule, 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, and covered by, the exemption under EFTA Section 920(a)(7)(i).
---------------------------------------------------------------------------
Issuer commenters asked the Board to expand the exemption for
government-administered payment programs to the network exclusivity
provisions in Sec. 235.7. Although the statute exempts government-
administered payment programs from the interchange fee standards, it
does not provide an exemption from the network exclusivity provisions
for these programs, or specific authority for the Board to grant an
exemption from these provisions. Thus, the Board has not exempted
government-administered payment programs from the provisions of Sec.
235.7.
Commenters requested that the Board provide further clarification
on application of the exemption for government-administered payment
programs. One depository institution trade group suggested that the
exemption for government-administered payment programs be extended to
``multi-purse'' cards where a debit or general-use prepaid card may
access funds other than funds provided by a government-administered
payment program. The Board believes the statute is clear in stating
that the exemption is available for debit or general-use prepaid cards
in which a person may use such card only to transfer or debit funds,
monetary, value or other assets that have been provided pursuant to a
government-administered payment program. Therefore, the Board has not
made the suggested change.
Another commenter requested that the Board clarify that the
government-administered payment programs include programs in which
funds are paid to a consumer by government agencies, such as jury-duty
fees that are funded to a prepaid card, and programs administered by
tribal systems. Jury-duty programs administered by Federal, State or
local governments, including the courts, appear clearly covered by the
exemption in EFTA Section 920(a)(7) to the extent they meet the other
requirements of that section. The Board has not attempted to list every
type of government program that qualifies for this exemption and has
instead retained the general language in the statute.
With respect to programs administered by tribal governments, the
Board notes that the statute refers to ``Federal, State, or local
government-administered programs.'' Tribal governments do not appear to
be either ``Federal'' or ``State'' governments. However, unlike other
statutes that the Board has implemented by rule,\152\ EFTA Section 920
does not limit ``local'' governments to political subdivisions of
Federal or State governments. Therefore, the Board believes that the
term ``local'' government would include a tribal
[[Page 43438]]
government and that government-administered payment programs would
include programs administered by tribal governments. The Board has
added a sentence to comment 5(b)-1 to clarify this interpretation.
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\152\ See, e.g., the Expedited Funds Availability Act (12 U.S.C.
4001(24)) and provisions regarding NOW accounts in 12 U.S.C.
1832(a).
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A merchant trade group commented that it does not believe that
HSAs, FSAs, or HRAs are government-administered payment programs.
Certain cards that access HSAs, FSAs, and HRAs may qualify for
exemptions under Sec. 235.5 depending on how the account is
structured. To the extent such accounts are offered in connection with
a person's employment and administered by or on behalf of a government
employer, the Board believes such accounts may be considered
government-administered payment programs. However, a plain reading of
the statute indicates that HSAs, FSAs, and HRAs administered for non-
governmental entities or individuals by or on behalf of a non-
government employer are not ``government-administered payment
programs,'' which is the language used by the statute.
The Board proposed comment 5(b)-1 to clarify the meaning of a
``government-administered program.'' The proposed comment provided that
a program is considered government-administered regardless of whether a
Federal, State, or local government agency operates the program itself
or outsources some or all functions to service providers that act on
behalf of the government agency. The proposed comment 5(b)-1 also
stated 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. The Board did not receive comment on proposed
comment 5(b)-1, which is adopted as proposed, with minor non-
substantive wording changes for clarity.
The Board also requested comment on whether it should establish a
process by which cards that qualify for the government-administered
payment program exemption could be identified and information related
to such cards relayed to payment card networks. Such a process could
assist networks in establishing a two-tier interchange fee structure
that allows issuers to receive higher interchange fees than permitted
under Sec. Sec. 235.3 and 235.4 for transactions made using debit
cards and general-use prepaid cards issued pursuant to government-
administered payment programs. Unlike the process for identifying small
issuers that qualify for the exemption in Sec. 235.5(a), commenters
were split on whether they thought the Board should develop the process
for identifying cards that qualify for the government-administered
payment programs exemption. While a Board-established system could
provide consistency in the process, the Board acknowledges that
identifying and certifying card programs is complex and that the Board
may not be in the best position to specify this process. Furthermore,
as one payment card network noted, hundreds of new card programs are
introduced each year, and Board involvement in the process could delay
the timely introduction of these programs. The Board understands that
payment card networks generally have a process currently in place to
review and approve new card programs, and that determining whether such
products would meet the exemption requirements could be built into
existing procedures.
For these reasons, the Board believes that payment card networks
should have the flexibility to design their own systems for identifying
cards that are issued pursuant to a Federal, State, or local
government-administered payment program. Therefore, the final rule does
not specify the process for identifying these cards, and as provided in
comment 5-2, discussed above, the Board expects that payment card
networks will have a process for ensuring that only qualifying card
programs take advantage of this exemption.
C. Section 235.5(c) Exemption for Certain Reloadable Prepaid Cards
EFTA Section 920(a)(7)(A)(ii) contains an exemption from the debit
interchange fee standards for certain qualifying reloadable, non-gift
prepaid cards. The Board proposed to implement the exemption set forth
in EFTA Section 920(a)(7)(A)(ii) in Sec. 235.5(c)(1) and in the
proposed definition of the term ``general-use prepaid card'' in Sec.
235.2(i). Specifically, EFTA Section 920(a)(7)(A)(ii) provides an
exemption for an interchange transaction fee charged or received with
respect to an electronic debit transaction for a plastic card, 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.
The Board received several comments regarding this exemption.
Commenters expressed concern that issuers may try to restructure
accounts in order to qualify for the exemption under EFTA Section
920(a)(7)(A)(ii). One merchant trade group suggested that the Board
limit the exemption to cards that are reloadable by means other than
ACH transfer or a check drawn upon an asset account. A processor
commented that the exemption promotes form-over-substance manipulation
of debit card programs because certain reloadable prepaid cards are
virtually identical in function to debit cards. For example, a
reloadable card would function nearly in the same manner as a debit
card if the funds underlying the card may be accessed by check, ACH, or
wire transfer, in addition to by use of the prepaid card.
The Board believes that reloadable cards that provide access to the
funds underlying the card through check, ACH, wire transfer or other
method (unless these other means of access were used solely for a one-
time cash-out of the remaining balance on the card) would not meet the
requirement in Section 920(a)(7)(A)(ii)(II) that the card not be issued
or approved for use to access or debit any account held by or for the
benefit of the cardholder (other than certain sub-accounts). If funds
underlying the card may be accessed by the customer using alternate
payment methods, the customer would have access to an account held by
the customer or for the customer's benefit.
The Board has added new Sec. 235.5(c)(1)(iii) to clarify that the
exemption for a general-use prepaid card applies only if the card is
the only means to access the funds underlying the card, except when all
remaining funds are provided to the cardholder in a single transaction.
Thus, transactions using prepaid cards that provide regular access to
funds underlying the card through check or ACH would be subject to the
interchange fee restrictions.
Comment 6(a)-2 provides examples of activities that may warrant
additional supervisory scrutiny to determine whether there has been
circumvention or evasion of the interchange fee standard. For example,
additional supervisory scrutiny may be warranted if an issuer replaces
its debit cards with prepaid cards that are linked to its customers'
transaction accounts and funds swept from the transaction accounts to
the prepaid accounts as needed to cover transactions made.
The Board also received many comments on the interpretation of the
[[Page 43439]]
condition that the exemption in proposed Sec. 235.5(c)(1) is available
only if a card is 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). An issuer and a merchant group
noted that FDIC pass-through insurance is only available for omnibus
accounts for which the individual participants can be identified by the
accountholder. Based on this observation, a merchant group stated that
if funds are accorded FDIC coverage, then the account is considered to
be held ``for the benefit of the cardholder,'' and an electronic debit
transaction made using a card that accesses such funds should not be
eligible for the exemption under Sec. 235.5(c)(1).
EFTA Section 920(a)(7)(A)(ii) exempts a general-use prepaid card
only if it is 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). The parenthetical indicates
that if the ``account held * * * for the benefit of the cardholder'' is
actually a subaccount or other method of recording or tracking funds
purchased or loaded on the card on a prepaid basis, the general-use
prepaid card is not considered to access an account held by or for the
benefit of the cardholder for purposes of determining whether the
general-use prepaid card is exempt. General-use prepaid cards that
access funds in an omnibus account that are identifiable to the
cardholder by virtue of a subaccount (and thus are eligible for FDIC
pass-through insurance) are not considered general-use prepaid cards
that are issued or approved for use to access or debit an account held
by or for the benefit of the cardholder and thus may still qualify for
the exemption in Sec. 235.5(c)(1).
Commenters also requested that the Board make a clearer distinction
between account and subaccount. In response, the Board is adopting new
comment 5(c)-1 to draw a distinction between an ``account'' and a
``subaccount.'' Comment 5(c)-1 states that a subaccount is an account
within an account, opened in the name of an agent, nominee, or
custodian for the benefit of two or more cardholders, where the
transactions and balances of individual cardholders are tracked in such
subaccounts. An account that is opened solely in the name of a single
cardholder is not a subaccount. This clarification is consistent with
the way the Board understands subaccounts are structured for most
prepaid card programs.
1. Reloadable and Not Marketed or Labeled as a Gift Card or Gift
Certificate
The Board proposed to import commentary related to the meaning of
reloadable and not marketed or labeled as a gift card or gift
certificate from 12 CFR 205.20 (``Gift Card Rule''), in which the Board
had previously defined and clarified the meaning of ``reloadable and
not marketed or labeled as a gift card or gift certificate.''
Specifically, proposed comment 5(c)-1, providing guidance on when a
general-use prepaid card is ``reloadable,'' was adapted from comment
20(b)(2)-1 under the Gift Card Rule. Proposed comment 5(c)-2, which was
adapted from comment 20(b)(2)-2 under the Gift Card Rule, clarified the
meaning of the term ``marketed or labeled as a gift card or gift
certificate.'' Proposed comment 5(c)-3 provided examples of what the
term ``marketed or labeled as a gift card or gift certificate''
includes and does not include that are identical to the examples in
comment 20(b)(2)-3 under the Gift Card Rule. Proposed comment 5(c)-4,
which addressed 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, was adapted from 20(b)(2)-4 under the
Gift Card Rule. Finally, proposed comment 5(c)-5, which provided
guidance relating to online sales of gift cards, was substantially the
same as comment 20(b)(2)-5 under the Gift Card Rule.
The Board received few comments on proposed comments 5(c)-1 through
5(c)-5. One issuer expressed concerns that the commentary, taken
together, is too prescriptive. The Board believes that the detail is
necessary to provide issuers with sufficient guidance to determine
whether a prepaid card is considered to be reloadable and not marketed
or labeled as a gift card or gift certificate. Furthermore, the Board
believes it is important to maintain consistency with the Gift Card
Rule in interpretation of what is meant by ``reloadable and not
marketed or labeled as a gift card or gift certificate.'' Issuers and
other parties that are involved in the distribution and sale of prepaid
cards are required to make these determinations with respect to the
Gift Card Rule, and consistent interpretation across the two rules
should reduce confusion and compliance burden.
One merchant group commented that they did not believe HSAs, FSAs,
or HRAs qualified for the exemption in Sec. 235.5(c)(1) because they
believe that cards accessing HSAs, FSAs, and HRAs are not freely
reloadable and may only be reloaded during designated times. The
statute does not require that, to qualify for the exemption, a card be
reloadable on a continuous basis, only that the card be reloadable and
not marketed as a gift card. Accordingly, the final rule has not been
changed to require that a card be continuously reloadable to qualify
for the exemption for reloadable cards. Therefore, the Board is
adopting proposed comment 5(c)-1 as comment 5(c)-2 with minor changes
to clarify this point. The Board is adopting proposed comments 5(c)-2
through 5(c)-5 without change as comments 5(c)-3 through 5(c)-6.
2. Certification
The Board requested comment on whether it should establish a
process to identify accounts accessed by cards eligible for the
reloadable prepaid cards exemption or whether it should permit payment
card networks to develop their own processes. Comments received on the
process for identifying accounts for the reloadable prepaid card
exemption were similar to the comments received on the process for
identifying accounts for the government-administered payment programs
exemption. For the reasons discussed above with respect to the
government-administered payment program exemption, the Board believes
that the process should be developed and administered by the payment
card networks. See comment 5-2. Identifying accounts is a complex
process that the payment card networks may be better situated to
administer. Furthermore, the Board is concerned that a Board-
administered process could unnecessarily delay the introduction of new
card programs.
3. Temporary Cards Issued in Connection With a General-Purpose
Reloadable Card
Proposed Sec. 235.5(c)(2) provided that the term ``reloadable''
includes a temporary non-reloadable card if it is issued solely in
connection with a reloadable general-use prepaid card. As the Board
discussed in its proposal, this treatment of temporary cards issued in
connection with a general-purpose reloadable card is consistent with
its treatment under the Gift Card Rule. 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. The Board
did not receive comment on the proposed Sec. 235.5(c)(2), which is
adopted
[[Page 43440]]
as proposed. There were also no comments on proposed comment 5(c)-6,
which is adopted as comment 5(c)-7 without change.
4. Cards Accessing HSAs, FSAs, and HRAs and Qualified Transportation
Benefits
Many issuer commenters urged the Board to exempt cards accessing
HSAs, FSAs, or HRAs from the interchange fee restrictions as well as
the network exclusivity and routing provisions. These commenters also
suggested that cards accessing qualified transportation benefits should
be exempt. In support of their views, these commenters cited statements
from certain members of Congress indicating their belief that cards
accessing these types of accounts should be exempt from these
provisions.
The statute does not provide an exemption for cards accessing HSAs,
FSAs, or HRAs or qualified transportation benefits. Some of these cards
may nonetheless fall outside the definitions that establish the scope
of coverage of EFTA Section 920. For example, Sec. 235.2(a)(2), which
defines ``account,'' does not cover accounts held under a bona fide
trust agreement. The Board understands that some health-related
accounts are established as bona fide trust accounts. Therefore, to the
extent an account is established as a bona fide trust account,
electronic debit transactions using a card that accesses such an
account would not be covered by the provisions of this part.
For HSAs, FSAs, or HRAs or qualified transportation benefits that
are not established as bona fide trust accounts, cards accessing such
accounts may still meet one of the exemptions under Sec. 235.5 from
the interchange fee restrictions, depending on how the account is
structured and the issuer of the card. The Board addressed specific
comments related to whether electronic debit transactions made using
cards that access HSAs, FSAs, and HRAs qualify for the various
exemptions from the interchange fee restrictions in the supplementary
information to Sec. 235.5(b) and (c) above.
In addition, a number of commenters agreed that issuers face
significant complications in complying with the network exclusivity
provisions with respect to certain health care and employee benefit
cards under current government rules governing these programs. As
discussed further in the supplementary information related to Sec.
235.7(c)(3) and comment 7(c)-1, the Board is providing a delayed
effective date for electronic debit transactions using debit cards that
use point-of-sale transaction qualification or substantiation systems
for verifying the eligibility of purchased goods or services to provide
issuers of such cards additional time to identify and implement
approaches to comply with the rule's network exclusivity provisions.
D. Section 235.5(d) Exception
EFTA Section 920(a)(7)(B) provides that the exemptions available
under EFTA Sections 920(a)(7)(A)(i) and (ii) terminate after the end of
the one-year period beginning on the effective date of the statute if
either of the following fees may be charged: a fee for an overdraft,
including a shortage of funds or a transaction processed for an amount
exceeding the balance; or a fee imposed by the issuer for the first
withdrawal per month from an ATM that is part of the issuer's
designated ATM network. Proposed Sec. 235.5(d) implemented this
section by providing that the exemptions in Sec. Sec. 235.5(b) and (c)
are not available for 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: (i) 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 imposed for transferring funds from another asset account
to cover a shortfall in the account accessed by the card; or (ii) a fee
imposed 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.\153\ The Board's proposal clarified
that the fee described in Sec. 235.5(d)(1) does not include a fee or
charge imposed 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. The Board has determined to adopt Sec. 235.5(d) as proposed,
but is making some revisions to the commentary as discussed below.
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\153\ Section 235.2(g) defines the term ``designated automated
teller machine (ATM) network.''
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Several industry commenters suggested the Board clarify the
proposed exception. One prepaid card processor requested that the Board
make clear that an issuer with its own proprietary ATM network, which
identifies the issuer's name and does not charge a fee for the first
ATM withdrawal in a calendar month, does not lose the exemption because
the cards it issues also have access to a nonproprietary ATM network
that charges fees. Proposed Sec. 235.5(d)(2) provides that the
exemptions are not available if a fee is imposed by the issuer for the
first withdrawal per calendar month from an ATM that is part of the
issuer's designated ATM network. Therefore, a fee may be charged for a
withdrawal from an ATM outside of the issuer's designated ATM network
without the issuer losing the exemption. The Board has adopted comment
5(d)-1 to clarify this point by providing that an electronic debit card
transaction may still qualify for the exemption under Sec. Sec.
235.5(b) or (c) with a respect to a card for which a fee may be imposed
for a withdrawal from an ATM that is outside of the issuer's designated
ATM network as long as the card complies with the condition set forth
in Sec. 235.5(d)(2) for withdrawals within the issuer's designated ATM
network.
An issuer requested that the Board clarify that the condition in
Sec. 235.5(d)(2) regarding ATM fees would not apply to cards that do
not have ATM access. A card that does not have ATM access will not be
subject to any fees for withdrawals from an ATM; therefore, such a card
would not lose the exemption on the basis of Sec. 235.5(d)(2). The
Board has added a sentence to comment 5(d)-1 to clarify this point.
The Board also received a comment from a prepaid card processor
suggesting that the Board provide alternatives for issuers without
their own proprietary ATM network to meet the condition set forth in
Sec. 235.5(d)(2) by entering into an arrangement with either (i) a
nonproprietary network where a fee will not be charged for the first
ATM withdrawal in a calendar month; or (ii) a local bank, bank agent,
or retail seller to allow for in-branch or in-store free cash
withdrawal per calendar month using the card, regardless of whether any
ATMs are available for use. With respect to the first suggested
alternative, the Board notes that an issuer's ``designated ATM
network'' is defined in Sec. 235.2(g) as including either a network in
the name of the issuer or any network of ATMs identified by the issuer
that provides reasonable and convenient access to the issuer's
customers. As a result, the definition already contemplates the
possibility of an issuer entering into an arrangement with a
nonproprietary ATM network. With respect to the second suggested
alternative, tellers, bank agents, and point-of-sale terminals are not
considered ATMs and cannot
[[Page 43441]]
comprise an ATM network. If the card can be used to access ATMs with an
issuer's designated ATM network, then in order for the card to qualify
for the general-use prepaid exemption after July 21, 2012, a fee cannot
be imposed by the issuer for the first withdrawal per calendar month
from an ATM that is part of the issuer's designated ATM network,
irrespective of whether a cardholder can obtain fee-free cash
withdrawals from a branch or a retail store.
A prepaid card trade group suggested that the Board permit issuers
to meet the condition in Sec. 235.5(d)(2) by providing a credit to the
cardholder within the month that a fee for withdrawal from an ATM is
imposed. Although a cardholder in this scenario would be reimbursed the
fee, and thus have a fee-free ATM withdrawal, there may be other
negative consequences to the cardholder that would not occur if the fee
for the ATM withdrawal had not initially been imposed. For example, the
imposition of such a fee could cause a subsequent transaction to be
declined or returned. The fact that the fee is later reimbursed does
not reverse the negative consequence of the fee being imposed in the
first place. Therefore, the final rule does not permit issuers to meet
the condition in Sec. 235.5(d)(2) by imposing the fee and providing a
subsequent credit.
Finally, consumer groups were supportive of the conditions in Sec.
235.5(d) and thought the conditions provided important consumer
protections. However, they believed the Board should require additional
protections, including extending the other provisions of Regulation E,
such as error resolution and periodic statement requirements, to
general-use prepaid cards, and preventing any form of credit that
automatically triggers repayment of funds deposited on a general-use
prepaid card. The Board believes that these suggestions fall outside
the scope of this rulemaking and will not address these issues in this
final rule.
V. Section 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)(1) provides
the Board with general authority to prescribe rules to prevent
circumvention or evasion of the interchange fee standards under EFTA
Section 920(a). In addition, EFTA Section 920(a)(8) authorizes the
Board to prescribe rules regarding any network fees, but such authority
is limited to regulations to ensure that a network fee (i) ``is not
used to directly or indirectly compensate an issuer with respect to''
an electronic debit transaction; and (ii) ``is not used to circumvent
or evade'' the interchange transaction fee restrictions under EFTA
Section 920(a) and this rule.\154\ Under EFTA Section 920(a)(8)(B),
using a network fee to directly or indirectly compensate an issuer with
respect to an electronic debit transaction is a separate prohibition
from using a network fee to circumvent or evade the interchange fee
standards. The proposed rule contained a general prohibition against
circumventing or evading the interchange transaction fee restrictions,
as well as a statement that circumvention or evasion occurs if an
issuer receives net compensation from a payment card network with
respect to electronic debit transactions.
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\154\ 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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The final rule adopts the proposed rule's general prohibition of
circumvention or evasion. Comment 6(a)-1 clarifies that the
determination of circumvention or evasion will be based on the
particular facts and circumstances. The final rule also prohibits an
issuer from receiving net compensation from a payment card network,
excluding interchange transaction fees received from acquirers. The
commentary to the final rule includes examples of situations that do
not involve net compensation, but may nevertheless warrant additional
supervisory scrutiny to determine whether circumvention or evasion
exists. Finally, the final rule clarifies the time period over which
net compensation will be measured.
A. Overview of Network Fees, Discounts, and Incentives
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 (i.e., switch fees). 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.
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 to 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.
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. Issuers and
merchants may be given individualized discounts by a network relative
to its published network fee based on their transaction volume.
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 upon
contract execution. 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
from 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 networks to encourage
specific processing behavior, such as the use of enhanced authorization
methods or the deployment of additional merchant terminals.
B. Section 235.6(a) Prohibition of Circumvention or Evasion
A payment card network may consider a number of factors in
calibrating the appropriate level of network fees, discounts, and
incentives in order to achieve network objectives. EFTA Section 920(a)
does not directly regulate the fees that a network may charge for any
of its services. Thus, the final rule does not seek to set or establish
the amount, type, or level of
[[Page 43442]]
network fees that a network may permissibly impose on any network
participant for its services. However, the statute authorizes the Board
to prescribe rules to prevent circumvention or evasion of the
interchange transaction fee standards. This authority is both general
with respect to the Board's implementation of the interchange
transaction fee standards under EFTA Section 920(a)(1), as well as
specific with respect to the use of network fees under EFTA Section
920(a)(8)(B)(ii).
Under the proposed rule, Sec. 235.6(a) set out a general
prohibition against circumventing or evading the interchange
transaction fee standards in Sec. Sec. 235.3 and 235.4. In addition,
proposed Sec. 235.6 expressly prohibited, as an example of
circumvention or evasion of the interchange transaction fee standards,
an issuer from receiving net compensation from a payment card network
with respect to electronic debit transactions because such compensation
could effectively serve as a transfer to issuers that may be in excess
of the amount of interchange transaction fee revenue allowed under the
standards in Sec. Sec. 235.3 and 235.4.
Proposed comment 6-1 further clarified that any finding of
circumvention or evasion of the interchange transaction fee standards
will depend on the relevant facts or circumstances. Proposed comment 6-
1.i. provided an example of net compensation occurring in violation of
the prohibition on circumvention or evasion when an issuer receives
payments or incentives in connection with electronic debit transactions
that exceed the total amount of fees paid by the issuer to the network
for such transactions. The proposed comment also included examples of
payments or incentives and fees that would be included in the net
compensation determination, as well as those that would not be
included. Among the payments or incentives that would be considered in
the net compensation analysis were payments or rebates to issuers for
meeting or exceeding certain transaction volume or dollar amount
thresholds, as well as marketing incentives and other fixed payments
for ``debit card activities.''
Issuers and depository institution trade associations generally
commented that the proposed rule appropriately limited the scope of the
net compensation analysis to payments made ``with respect to electronic
debit transactions.'' However, these commenters further stated that the
proposed commentary interpreting the rule exceeded the scope of the
statutory prohibition on circumvention or evasion in EFTA Section
920(a)(8) by also considering payments for ``debit card-related
activities.'' In the view of these commenters, the only payments that
should be considered in the net compensation analysis are payments to
an issuer for its role in an electronic debit transaction, or more
precisely, payments that vary with the number or volume of debit card
transactions processed on the network. Accordingly, issuers asserted
that payments made by networks to issuers for other debit card-related
purposes, such as for marketing or to encourage investment in network
infrastructure, should be excluded from the net compensation analysis.
Several issuer commenters further expressed the view that inclusion of
payments that were not tied to debit card volume would unnecessarily
inhibit a network's ability to attract issuers, promote investment in
the network, or provide incentives for desirable issuer behavior, such
as enhancing data security procedures.
Merchant commenters and a member of Congress stated that the
proposed rule was overly narrow in scope in limiting circumvention or
evasion to circumstances in which an issuer receives net compensation
from a network in connection with electronic debit transactions. These
commenters urged the Board to clarify that net compensation is not the
exclusive test for circumvention by, for example, including general
anti-circumvention language in the rule. According to merchant
commenters, such general anti-circumvention language would address
attempts by networks and issuers to adjust their pricing policies or
restructure their products to avoid being subject to the standards set
forth in the rule. Merchants also recommended that the Board
specifically include an enforcement mechanism to address occurrences of
circumvention or evasion.
The final rule adopts the general prohibition on circumvention or
evasion of the interchange transaction fee standards in Sec. Sec.
235.3 and 235.4, substantially as proposed. Comment 6-1, as in proposed
comment 6-3, clarifies that the prohibition in Sec. 235.6 against
circumventing or evading the interchange transaction fee standards 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. The final rule adopts the
comment as proposed, redesignated as comment 6-1.
Comment 6(a)-1 is modified from the language in the proposed
commentary to state more explicitly that circumvention or evasion may
include, but is not limited to, circumstances in which an issuer
receives net compensation from a payment card network with respect to
electronic debit transactions or other debit card related activity.
Although the proposal established a per se circumstance in which
circumvention or evasion of the interchange transaction fee standards
occurs (i.e., when an issuer receives net compensation with respect to
electronic debit card transactions), the Board did not intend to limit
potential findings of circumvention or evasion to such circumstances.
Rather, as stated in the supplementary information to the proposed
rule, Sec. 235.6 establishes a ``general prohibition against
circumventing or evading the interchange transaction fee standards in
Sec. Sec. 235.3 and 235.4.'' \155\ This concept is made more explicit
in the final rule by separating the prohibition against circumvention
and evasion and the prohibition against net compensation into different
subsections. Comment 6(a)-1 to the final rule retains the provision in
the proposed commentary stating that a finding of circumvention or
evasion ``will depend on all relevant facts and circumstances.''
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\155\ See 75 FR at 81747 (Dec. 28, 2010) (emphasis added).
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In the proposal, the Board requested comment on whether increases
in fees charged by the network to merchants or acquirers coupled with
corresponding decreases in fees charged by the network to 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.
Issuers and payment card networks generally commented that the rule
should not address the level of network processing fees regardless of
any changes to the proportion of such fees as applied to issuers and
merchants. These commenters asserted that EFTA Section 920 is only
intended to address the level of interchange transaction fees and
therefore the statute does not
[[Page 43443]]
regulate the structure or amount of non-interchange fees set by
networks, including network processing fees. Merchant commenters,
however, stated that decreases in network processing fees charged to
issuers and increases in network processing fees charged to merchants
or acquirers could easily compensate issuers for reductions in the
level of interchange transaction fees in circumvention of the
interchange transaction fee standard. Merchants thus urged the Board to
cap the level of network fees at current levels until the proposed
network exclusivity and routing provisions were fully implemented (in
particular, Alternative B) to allow merchants the ability to discipline
network fees through their routing choices. Merchants also urged the
Board to carefully monitor the networks' operating rules for any
changes that shift liability from issuers to merchants as a way to make
up for lost income from interchange.
Although the Board recognizes that decreases in issuer fees paid to
the network could have the effect of offsetting reductions in
interchange transaction fee revenue that will occur under the
interchange transaction fee standards in Sec. Sec. 235.3 and 235.4,
the Board continues to believe that such circumstances would not
necessarily indicate circumvention or evasion of the interchange
transaction fee standards. Moreover, the Board is concerned that an
outright prohibition on 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. Such a prohibition may preclude a network from
adopting a fee structure similar to that used by a competing network
that obtained a larger proportion of its fees from the merchant side of
the transaction. Finally, to the extent that networks alter fees for
issuers that are incorporated into the interchange fee standard, the
permissible interchange fee under the standards will adjust to reflect
those fee changes. Accordingly, the final rule does not treat shifts in
the relative proportion of network processing fees paid by issuers and
merchants as a per se indication of circumvention or evasion of the
interchange transaction fee standards. Instead, as discussed above,
individual determinations of circumvention or evasion would depend of
the particular facts and circumstances.
New comment 6(a)-2.i thus states that increases in network fees
charged to merchants or acquirers and decreases in network fees charged
to issuers do not by themselves constitute circumvention or evasion of
the interchange transaction fee standards; however, such action may
warrant additional supervisory scrutiny to determine whether the facts
and circumstances constitute circumvention or evasion.\156\ New comment
6(a)-2.ii includes another example based on merchant comments regarding
issuers adjusting their products to avoid the final rule's interchange
fee limits. The comment describes a situation where an issuer replaces
its debit cards with prepaid cards that are exempt from the interchange
fee standards of Sec. Sec. 235.3 and 235.4. The exempt cards are
linked to its customers' transaction accounts and funds are swept from
the transaction accounts to the prepaid accounts as needed to cover
transactions made. Although this situation may not constitute per se
circumvention or evasion, it warrants additional supervisory scrutiny
to determine whether the facts and circumstances constitute
circumvention or evasion.
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\156\ Merchants also commented that in permitting networks to
raise their network fees for merchants or to decrease them for
issuers (or both) so long as net compensation is not provided, the
Board contradicted its own reasoning for excluding network fees as
an allowable cost that can be recovered through the interchange
transaction fee standards, that is, to prevent merchants from having
to pay all processing fees. As discussed above, however, the final
rule permits network processing fees incurred by issuers to be
recovered through the interchange transaction fee standards as such
costs are incurred to effect an electronic debit card transaction.
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C. Section 235.6(b) Prohibition of Net Compensation
The final rule sets out a prohibition against net compensation in
Sec. 235.6(b). The description of net compensation contained in
proposed comment 6-1.i has been moved to Sec. 235.6(b) of the final
rule's regulatory text. As in the proposed comment, an issuer has
received net compensation from a payment card network if the total
amount of payments or incentives received by the issuer from the
payment card network during a calendar year in connection with
electronic debit transactions or other debit card-related activity,
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 or other debit card
related activity during that calendar year.
The Board notes that the prohibition in EFTA Section
920(a)(8)(B)(i) is not limited to direct compensation to an issuer with
respect to electronic debit transactions, but also applies to
circumstances in which network fees are used to ``indirectly''
compensate an issuer with respect to such transactions. Moreover, EFTA
Section 920(a)(8)(B)(ii) also includes general authority to ensure that
network fees are not used to circumvent or evade the interchange
transaction fee standards of the rule. Pursuant to these statutory
authorities, the Board believes that the net compensation determination
should take into consideration any payments or incentives paid by a
network to an issuer for debit card-related activities. In particular,
the Board believes that limiting the payments or incentives to payments
that are directly related to the number or volume of debit card
transactions on the network would potentially create a significant
loophole as networks could respond by providing sizable non-volume
based incentive payments to an issuer for debit card activities to
offset the reduced revenue from the limitations on interchange
transaction fees in Sec. Sec. 235.3 and 235.4. Accordingly, Sec.
235.6(b) in the final rule states that payments and incentives paid to
an issuer by a network, and fees paid by an issuer to a network ``with
respect to electronic debit transactions or debit card-related
activities,'' are not limited to volume-based or transaction-specific
payments, incentives, or fees, but also include other payments,
incentives, or fees related to an issuer's provision of debit card
services. Such payments could include, for example, bonuses to convert
an issuer's card base to a new signature network, or marketing
incentives. Comment 6(b)-2 to the final rule provides guidance on the
payments or incentives paid by a payment card network that could be
considered in determining whether an issuer has received net
compensation. Consistent with the proposal, comment 6(b)-2.i states
that 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
payments for debit card-related activities.
As noted above, signing bonuses are used as a network tool for
encouraging issuers to shift debit card volume to a network, and for
maintaining existing card volume on the network. For example, an
initial upfront payment from a network may serve to compensate the
issuer for its costs in converting its card base to a new signature
debit network. Signing bonuses may also offset the issuer's
[[Page 43444]]
costs in upgrading its internal processing systems and establishing
connectivity to the new network. In its proposal, the Board requested
comment on whether signing bonuses should also be considered as
payments or incentives paid by a network to an issuer for purposes of
the net compensation determination.
Issuer commenters generally responded with similar arguments made
in connection with the treatment of debit card-related payments
unrelated to transaction volume, stating that such bonuses should not
be included in the determination because they do not compensate an
issuer for the number or volume of transactions processed on a network.
One payment card network expressed concern that including signing
bonuses in the net compensation determination could reduce a network's
ability to compete with another payment card network that also offered
products or services unrelated to their operation of the network at a
discount. This network stated that if the final rule curtailed
networks' ability to offer signing bonuses by including them in the net
compensation calculation, operators of networks that did not offer
additional products or services would be left at a competitive
disadvantage in their ability to compete for debit card business.
Some issuers observed that initial upfront payments and incentives
were likely to exceed the fees charged to the issuer for the first
year. For example, a network may provide a new issuer an incentive to
participate in the network to offset the issuer's costs to reissue
cards, promote the new network brand to cardholders, and establish
network connectivity. In this regard, because of the potential size of
signing bonuses in relation to fees paid by an issuer on a year-to-year
basis, several issuers and one payment card network urged the Board to
clarify that signing bonuses would be eligible for pro rata treatment
over the term of the contract.
Merchants, two payment card networks, and a processor with an
affiliated payment card network, by contrast, believed that signing
bonuses should be included in the net compensation determination. Some
of these commenters expressed the view that excluding signing bonuses
could undermine the entire net compensation approach because networks
could create packages with signing bonuses, funded by imposing
increased network fee on merchants, without violating the rule.
Comment 6(b)-2.i clarifies that the determination of whether net
compensation exists must also take into account signing bonuses paid by
a network to an issuer to retain or attract the issuer's debit card
portfolio. Just as marketing incentives and other non-volume based
payments for debit card-related activities could be used by a network
to compensate an issuer for the issuer's role in electronic debit
transactions above and beyond the limits permitted under Sec. Sec.
235.3 and 235.4, the Board believes that signing bonuses could
similarly be used as a mechanism to generate payments to an issuer in
excess of the amount permitted under Sec. Sec. 235.3 and 235.4, absent
inclusion in the net compensation calculation. However, as further
provided in comment 6(b)-2.ii, the Board agrees that it would be
appropriate to allocate such bonuses over the life of the debit card
contract in calculating the payments or incentives paid by a network to
an issuer. To the extent an issuer receives signing bonuses for its
entire card portfolio, including for the issuer's credit card business,
an appropriate portion of such bonuses should be allocated to the
issuer's debit card business based on the proportion of the cards or
transactions that are debit cards or electronic debit transactions, as
appropriate to the situation, for purposes of the net compensation
determination.
Comment 6(b)-2.iii lists types of payments or incentives that need
not be included in the total payments or incentives paid by a network
to an issuer for purposes of the net compensation analysis. Among other
payments that may be received from a network, issuers may exclude any
interchange transaction fees that are passed through to the issuer by
the network. The comment also clarifies that incentives paid by a
payment card network do not include funds received by an issuer from a
payment card network as a result of chargebacks or fines paid by
merchants or acquirers for violations of network rules. In response to
issuer comments, the commentary also clarifies that settlements or
recoveries from merchants or acquirers to offset the costs of
fraudulent transactions or a data security breach do not constitute
payments or incentives paid by a payment card network.
The proposed commentary also stated that fees paid by an issuer
could include fees for optional services provided by the network. See
proposed comment 6-2.ii. Merchants expressed concern that the proposed
approach created a loophole that could permit networks to increase the
incentives paid to issuers without providing net compensation if fees
paid to a network included fees paid to a third-party processor
affiliated with the network. In such case, an issuer would be permitted
to recover those costs from merchants and acquirers through the
interchange fee standard to the extent such costs were related to the
authorization, clearing, or settlement of electronic debit
transactions. If those recoverable costs were also included in the net
compensation test, however, such processing costs could increase the
amount of incentives that could be transferred by the network to the
issuer. The network could then fund the additional incentives by
increasing the network fees paid by merchants or acquirers.
Merchant commenters proposed two different approaches to address
their concerns. First, they stated that the Board could limit the
recoverable costs through the interchange fee standards to a
processor's actual costs of authorizing, clearing, and settling an
electronic debit transaction where debit card processing is outsourced
to the third-party processor. Issuers, however, generally do not have
knowledge of their processors' actual costs. Alternatively, these
commenters recommended that the final rule exclude fees paid by an
issuer for third-party processing from the total amount of fees paid to
a network for purposes of the net compensation determination.
The Board agrees that the proposed approach could enable networks
to substantially increase the incentives paid to issuers without
violating the net compensation test and has determined that the test
should be based on fees that are not incorporated into the interchange
fee standard. Therefore, the Board has excluded from the net
compensation test fees for issuer-processor services paid by an issuer
to a network or network affiliate. For similar reasons, the Board has
excluded network processing, or switch, fees from the net compensation
calculation because under the final rule such fees are also
incorporated in the interchange fee standard.
New comment 6(b)-3 incorporates the proposed guidance describing
the examples of fees paid by an issuer to a payment card network for
purposes of the net compensation determination. Accordingly, the
comment provides that fees paid by an issuer to a payment card network
include, but are not limited to, network membership or licensing fees,
and network administration fees. Fees paid by an issuer could also
include fees for optional services provided by the network, such as
risk management services.
Comment 6(b)-4 provides an example of circumstances that do not
constitute
[[Page 43445]]
net compensation to the issuer. In the 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
calendar year. During the same period, however, the total network fees
the issuer pays the payment card network with respect to electronic
debit transactions also increase so that 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. Under these circumstances, the issuer does not receive
net compensation from the network for electronic debit transactions.
See comment 6(b)-4.i.
A few large issuers and a payment card network commented that the
prohibition against circumventing or evading the interchange
transaction fee standards should apply only to contractual arrangements
between a payment card network and an issuer that are entered into on
or after the date of enactment of the Dodd-Frank Act, July 21, 2010.
The Board does not believe that such arrangements should be
grandfathered, but the date on which such arrangements are entered into
would be included in the facts and circumstances analysis for
circumvention or evasion. Such arrangements would, however, be subject
to the prohibition against net compensation.
D. Additional Uses of Circumvention or Evasion Authority
As discussed above under Sec. 235.5, trade associations
representing small issuers, including credit unions, and one federal
banking agency urged the Board to use its circumvention or evasion
authority to ensure that the small issuer exemption in EFTA Section
920(a)(6) from the interchange transaction fee standards is given
effect by the networks. In particular, these commenters were concerned
that absent an express requirement on networks to adopt higher tiers of
interchange fees for exempt issuers, such issuers would experience a
significant reduction in interchange fee revenue, notwithstanding the
exemption.
The Board notes that Section 920(a) imposes restrictions on the
interchange fees that issuers may charge or receive and requires the
Board to set standards regarding those fees--it does not confer
authority on the Board to regulate the activities of networks (other
than regarding the use of network fees to compensate issuers or to
circumvent the interchange fee standards) or to require merchants to
pay any particular level of fees. Moreover, although the statute
provides an exemption from the interchange transaction fee standards
for issuers with less than $10 billion in consolidated assets, the
statute neither imposes an affirmative duty on networks to implement
different interchange transaction fee rates for covered and non-covered
issuers, nor requires merchants to pay a particular level of
interchange fee revenue that may be collected by an exempt issuer.
Thus, the Board does not believe that the circumvention or evasion
authority confers authority on the Board to require networks to take
specific actions to implement the small issuer exception (which do not
involve the use of network fees) or merchants to pay higher interchange
fees to small issuers.
As discussed above, however, the final rule relies on specific
authority granted in Section 920(a)(3)(B) to collect and publish
information from issuers and networks to separately require networks to
report to the Board the interchange revenue and related debit card
volumes for exempt and covered issuers. The Board intends to publish on
an annual basis the average interchange revenue received by covered and
exempt issuers by network. The Board anticipates that greater
transparency regarding network interchange policies will facilitate
issuers' ability to more easily choose the networks that best serve
their individual requirements, including the level of interchange
transaction fees that apply to issuers on the network.
VI. Section 235.7 Limitations on Payment Card Restrictions
EFTA Section 920(b)(1) directs the Board to prescribe regulations
with respect to two limitations set out in the statute regarding
transaction processing. First, the Board must prescribe regulations
prohibiting an issuer or payment card network from restricting the
number of payment card networks on which an electronic debit
transaction may be processed to fewer than two unaffiliated networks
(network exclusivity restrictions).\157\ Second, the Board must
prescribe regulations 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).\158\ Section 235.7 implements these
limitations on payment card network restrictions.
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\157\ See EFTA Section 920(b)(1)(A).
\158\ See EFTA Section 920(b)(1)(B).
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EFTA Sections 920(b)(2) and (3) impose certain limits on the
ability of payment card networks to restrict merchants and other
persons in establishing the terms and conditions under which they may
accept payment cards. Specifically, EFTA Section 920(b)(2) prohibits a
payment card network from establishing rules that prevent merchants
from offering discounts or in-kind incentives based on the method of
payment tendered to the extent that such discounts or incentives do not
differentiate on the basis of the issuer or payment card network. In
addition, EFTA Section 920(b)(3) prohibits a payment card network from
establishing rules that prevent merchants from setting minimum
transaction amounts for accepting credit cards to the extent that such
minimums do not differentiate between issuers and payment card
networks. These two statutory provisions are self-executing and are not
subject to the Board's rulemaking authority.\159\
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\159\ 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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EFTA Section 920(b) does not provide a statutory exemption for
small issuers, government-administered payment cards, or covered
reloadable prepaid cards. Thus, the exemptions in section 235.5 of the
rule do not extend to the prohibitions on network exclusivity
arrangements and merchant routing restrictions under EFTA Section
920(b) implemented in Sec. 235.7. See comment 7-1. As discussed below,
however, the final rule provides a delayed effective date for certain
types of debit cards to allow issuers to address significant
technological or operational impediments to an issuer's ability to
comply with the network exclusivity and routing provisions of the rule.
A. Section 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 through any agent, processor, or licensed member of a
payment card network, restricting the number of payment card networks
on which an electronic debit transaction may be processed to fewer than
two unaffiliated payment card networks. Section 235.7(a) implements the
new requirement and prohibits an issuer or payment card network from
restricting the number of payment card networks on which an electronic
debit transaction
[[Page 43446]]
may be processed to fewer than two unaffiliated networks, regardless of
the method of authentication.
Currently, issuers, or in some cases, networks, control the
merchant routing of electronic debit transactions. For example, for PIN
debit transactions, current network rules typically allow issuers to
specify routing priorities among the networks enabled on their
cards.\160\ These issuer-determined routing priorities require a
transaction to be performed using an issuer's preferred network, even
if a merchant may prefer to perform the transaction over a lower-cost
network that is available for the transaction. Moreover, issuers can
influence routing by limiting the networks enabled on their cards. For
example, certain issuers have agreed to make a payment card network, or
group of affiliated networks, the exclusive network(s) associated with
the issuer's debit cards in exchange for certain benefits.\161\ In
particular, some issuers have agreed to restrict their cards' signature
debit functionality to a single signature debit network and their PIN
debit functionality to the PIN debit network that is affiliated with
the signature debit network. Finally, at least one commenter raised
concerns that certain signature debit network rules could be
interpreted to prohibit issuers of debit cards carrying the signature
network brand from enabling other signature debit networks or certain
competing PIN debit networks on the same card. Issuers and merchants,
however, have different incentives regarding the routing of
transactions, as described below.
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\160\ In other cases, a PIN debit network itself may require, by
rule or contract, that PIN debit transactions be routed over that
network when multiple PIN networks are available. These issuer- or
network-directed priority rules are generally unnecessary for
signature debit networks as there is typically only a single payment
card network available per card for processing a signature debit
transaction.
\161\ Some issuers also negotiate or enroll in ``exclusivity
arrangements'' with payment card networks for other business
purposes. For example, an issuer may want to limit its participation
to one network (or two affiliated networks) to reduce the membership
and compliance costs associated with connecting to multiple
networks.
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Issuers may have a number of reasons to prefer that a particular
payment card network carry their transactions. First, to the extent
that interchange fees vary across networks, issuers would typically
prefer the network with the highest interchange fee, all else equal.
Second, in recent years, payment card networks have increasingly
offered issuers other financial incentives in exchange for directing a
substantial portion of their debit card transaction volume to their
respective networks. For example, some issuers may agree to shift some
or all of their debit card transaction volume to a 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.
From the merchant perspective, the availability of multiple card
networks for processing debit card transactions and the elimination of
routing restrictions are attractive because they give merchants the
flexibility to route transactions over the network that will result in
the lowest cost to the merchant, such as through the network with the
lowest interchange fee. This flexibility may promote direct price
competition for merchants among the debit card networks that are
enabled on the debit card. Accordingly, restrictions on this choice,
such as network exclusivity arrangements, limit merchants' ability to
route transactions over lower-cost networks and may reduce network
price competition.
From the cardholder perspective, however, requiring that merchants
have the ability to choose among multiple payment card networks enabled
on debit cards--particularly multiple signature debit 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 processed over a specific card network.
Similarly, insurance benefits for certain types of transactions or
purchases or the ability to receive text alerts regarding possible
fraudulent activity may be tied to the use of a specific network.\162\
Requiring multiple unaffiliated payment card networks, coupled with a
merchant's ability to route electronic debit transactions over any of
those networks, could reduce the ability of a cardholder to control the
network over which 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 market a
benefit to cardholders if the issuer has to inform cardholders that
they will receive certain benefits only if a merchant chooses to route
their transaction over that particular network. On the other hand,
cardholders and consumers generally may benefit to the degree that
routing choice for merchants results in lower debit interchange fees
with savings that are passed on to consumers in the form of lower
prices for goods and services.
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\162\ These benefits are often provided for transactions routed
over signature debit networks; they are less commonly available for
PIN debit transactions.
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1. Proposed Rule
In the proposed rule, the Board requested 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 by, for example, 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 authentication 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. The second alternative recognized in part
that PIN debit is not currently available for a significant number of
merchants, either because they do not accept PIN debit or because PIN
debit is not generally feasible in some retail environments, such as
for Internet transactions, or transactions such as hotel stays and car
rentals, where the final amount of the transaction cannot be determined
at the time a transaction is authorized.
In the comments received, support for the two alternative
approaches was divided primarily along issuer and merchant
perspectives, with issuers strongly in support of Alternative A and
merchants strongly in support of Alternative B. Payment card networks
also favored Alternative A, while the one consumer group commenting on
the issue favored Alternative B.
2. Comments Received
Issuers and networks stated that Alternative A as proposed fully
satisfies the text and intent of the network exclusivity restrictions
in EFTA Section 920(b)(1)(A). Issuers and networks further asserted
that the approach taken in proposed Alternative B is unsupported by the
statute, which does not distinguish between transactions by
[[Page 43447]]
the method of cardholder authentication. Issuers and networks also
noted that Alternative A would be far less disruptive to the payment
system because many institutions are already in compliance with
Alternative A and support multiple unaffiliated PIN networks.
By contrast, issuers and networks expressed significant concern
about the operational cost and burden of implementing Alternative B,
which in their view is not currently feasible because it would require
enabling multiple signature networks on a card. In particular, issuers,
networks, and card processors noted several changes that would be
required in order to implement Alternative B. Among these changes,
these commenters stated that merchants, acquirers, issuer processors,
and issuers would have to replace routing logic to ensure that
authorization, settlement, dispute processing, and fraud reporting
records for electronic debit transactions are routed to the network
selected by the merchant, instead of basing the logic on the first
digit of the account number or card BIN. These commenters also
suggested that point-of-sale terminals would have to be re-programmed
or replaced to ensure that transactions can be routed to the
appropriate network. Issuers also cited the expense of negotiating
contracts with and participating in additional networks, including the
costs of complying with multiple network rules, in order to comply with
Alternative B, a burden that could be particularly onerous for smaller
issuers. Moreover, several issuers contended that under the proposed
interchange fee standards, they would be unable to recover the full
costs of their current programs, much less the additional costs
required to comply with Alternative B.
Issuers and networks also expressed concern that Alternative B
would discourage investment and innovation in new authentication
technologies. For example, these commenters argued that networks and
issuers may have less incentive to develop and deploy new methods of
authentication if they are required to share that technology with other
parties to ensure that the new authentication method could be used on
multiple unaffiliated networks.
Several issuers asserted that in many cases where PIN debit is
unavailable, it is due to a merchant's choice not to offer PIN debit.
These issuers also cited the development of alternative technologies
that could facilitate the use of PIN debit in additional retail
environments, including Internet transactions.
Finally, many issuers stated their belief that Alternative B is
more likely to cause consumer confusion and potentially frustrate
consumer choice to the extent that certain cardholder benefits, such as
zero liability, enhanced chargeback rights, rewards, or insurance, are
tied to the use of a particular network. In their view, Alternative B,
with the potential of requiring four networks on a debit card, would
make it less likely that a cardholder would receive those benefits if a
merchant opted to route a transaction over a different network.
Merchants strongly urged the Board to adopt Alternative B to
require debit cards to carry at least two unaffiliated networks for
each method of authentication in order to create network competition
for every transaction. Merchants argued that Alternative B would give
them the ability to discipline the level of network processing fees by
routing transactions to the lowest cost network. A consumer group
commenter agreed that Alternative B was more likely to lead to greater
competition between networks through lower transaction fees and better
services, which would in turn benefit consumers through lower prices
for goods and services.
Merchant commenters described a number of situations in which
Alternative B would provide merchants with greater routing choice.
These commenters observed that certain retail environments, such as
Internet transactions, cannot readily accept PIN debit under current
technology. These commenters further argued that, in other cases,
certain types of debit cards may not be suited for PIN debit, such as
health care cards that require specialized transaction qualification or
substantiation systems that currently operate only on signature debit
networks. In each of these circumstances, a merchant would not have any
routing options under Alternative A. Merchants also noted that under
Alternative A, even where both signature and PIN debit are available, a
merchant's routing choice would be limited to a single network once the
consumer has selected his or her authentication method. Merchants thus
asserted that Alternative B was most consistent with statutory purpose
because it would not limit merchant routing choice either by the way a
transaction is authorized or by the type of transaction.
Finally, merchant commenters believed that Alternative B was more
likely to foster new entrants offering signature debit to increase
market competition. These commenters also predicted that new PIN debit
networks would enter the market if Alternative B were adopted. Merchant
commenters thus rejected issuer assertions regarding the operational
burden associated with Alternative B, arguing that existing
infrastructure already in place to support multiple PIN networks could
be leveraged to also support multiple signature debit networks.
3. Section 235.7(a)(1)--General Rule
The final rule adopts Alternative A (at least two unaffiliated
payment card networks) with respect to the network exclusivity
provisions. The Board believes that Alternative A is most consistent
with EFTA Section 920(b)(1)(A), which 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 fewer than two unaffiliated payment card networks. The plain
language of the statute does not require that there be two unaffiliated
payment card networks available to the merchant for each method of
authentication. 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.
The Board has also considered the compliance burden presented by
the two alternative approaches and the benefits to consumers of each
approach. The Board understands that many issuers, particularly small
issuers, are already in compliance with Alternative A, as they may
already have multiple unaffiliated PIN networks enabled on their debit
cards, or a signature network and an unaffiliated PIN network. Thus,
Alternative A would minimize the compliance burden on institutions,
particularly small issuers that might otherwise be adversely affected
by a requirement to have multiple networks for each method of debit
card authentication. Alternative A would also present less logistical
burden on the payment system overall as it would require little if any
re-programming of routing logic by issuers, networks, issuer
processors, and acquirers.
From the consumer perspective, as noted above, requiring multiple
payment card networks could limit the cardholder's ability to obtain
card benefits that are tied to a particular network, such as zero
liability protection or the ability to receive text alerts regarding
possible fraud. Moreover, explaining the circumstances under which a
cardholder may receive
[[Page 43448]]
those benefits could be challenging for issuers, regardless of the
alternative approach taken in the final rule. The Board believes that
Alternative A would result in less consumer confusion than might
otherwise result under Alternative B.
The Board acknowledges that Alternative A provides merchants fewer
routing options with respect to certain electronic debit transactions
compared to Alternative B. Nonetheless, under Alternative A, merchants
that currently accept PIN debit would have routing choice with respect
to PIN debit transactions in many cases where an issuer chooses to
participate in multiple PIN debit networks. Moreover, the Board notes
that EFTA Section 920(b)(1)(A) prohibits an ``issuer or payment card
network'' from restricting the number of payment card networks on which
an electronic debit transaction may be processed. To the extent a
merchant has chosen not to accept PIN debit, the merchant, and not the
issuer or the payment card network, has restricted the available
choices for routing an electronic debit transaction under Alternative
A. Similarly, where a consumer selects signature or PIN debit as the
method of payment, the consumer, and not the issuer or the payment card
network, has restricted the available routing choices.
The Board further understands that there exist emerging PIN debit
products and technologies that would allow PIN debit to be used in
additional retail environments where PIN debit is not generally
offered, such as for online purchases. Some billers and at least one
online merchant accept transactions that are routed over PIN debit
networks, without requiring the cardholder to provide his or her
PIN.\163\ The Board anticipates that the elimination of network and
issuer-based routing restrictions may further promote innovation to
facilitate the use of PIN debit in additional retail environments. See
discussion in relation to Sec. 235.7(b).
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\163\ A large online merchant is currently processing some
online customer payments as PIN-less debit transactions. See http://www.amazon.com/gp/help/customer/display.html/ref=hp_518224_pinless?ie=UTF8&nodeId=518224&#pinless
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Finally, the Board is persuaded that Alternative B and its
requirement to enable multiple unaffiliated payment card networks on a
debit card for each method of card authentication could potentially
limit the development and introduction of new authentication methods.
Although PIN and signature are the primary methods of debit card
transaction authentication today, new authentication measures involving
biometrics or other technologies may, in the future, be more effective
in reducing fraud. An issuer, however, may be unable to implement these
new methods of card authentication if the rule requires that such
transactions be capable of being processed on multiple unaffiliated
networks offering the new authentication method.
Thus, for the foregoing reasons, the final rule provides that the
network exclusivity provision in Sec. 235.7(a)(1) is satisfied as long
as an electronic debit transaction may be processed on at least two
unaffiliated payment card networks. Comment 7(a)-1 clarifies that Sec.
235.7(a)(1) does not require an issuer to have multiple, unaffiliated
networks available for each method of cardholder authentication. Under
the final rule, 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.
4. Section 235.7(a)(2)-(3) Permitted And Prohibited Arrangements
Proposed Sec. 235.7(a)(2) described 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. The proposed provision generally
described circumstances in which a payment card network that is added
to a debit card would not satisfy the network exclusivity provisions in
Sec. 235.7(a)(1) due to geographic or merchant coverage restrictions.
See proposed Sec. Sec. 235.7(a)(2)(i) and (ii). The proposal also
prohibited, as an impermissible exclusivity arrangement, contractual
restrictions or limitations set by a payment card network on an
issuer's ability to contract with another payment card network. See
proposed Sec. 235.7(a)(2)(iii).
The final rule generally adopts the proposed provisions with
modifications and adjustments in response to comments. Section
235.7(a)(3) of the final rule describes prohibited exclusivity
arrangements by networks. Proposed Sec. 235.7(a)(2)(i) provided that
an issuer would not satisfy the requirement to have at least two
unaffiliated payment card networks enabled on a debit card by adding a
payment card network that is not accepted on a nationwide basis. Thus,
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. The
proposal further provided, however, that an issuer could comply 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. The Board also requested comment on the
impact of the proposed approach on the viability of regional payment
card networks and on small issuers that are more likely to use regional
networks for their debit cards.
Several issuers objected to the proposed condition that a payment
card network operate on a nationwide basis, asserting that the rule
should permit issuers broad discretion to select unaffiliated networks
that serve their market areas and cardholder needs, and that a network
with coast-to-coast coverage may not be appropriate for all issuers.
Issuers and a few networks expressed concern that smaller regional
networks would be affected adversely if the nationwide coverage
requirement were adopted, because the requirement would reduce
competition between large and small networks. A few issuers commented
that small issuers that currently use regional networks would incur
additional costs to add nationwide PIN networks under the proposed
rule, but would receive little benefit as most of their card
transactions currently take place within their network's geographic
coverage area. Moreover, commenters argued that requiring nationwide
coverage would effectively prevent the establishment of new networks,
which historically have started in small geographic markets.
Issuers and networks suggested a number of alternative approaches
to the proposed rule, including providing that a network must have
general acceptance availability within the cardholder's area of
residence; allowing a network to be added as long as is it accepted at
the nation's largest retailers; and providing that a regional network
must establish network connectivity or reciprocal arrangements with
other networks that would allow a card to have nationwide coverage by
routing transactions to the regional network via a gateway arrangement.
A few issuers and one regional network suggested a coverage test under
which a certain percentage of a debit card's transactions must take
[[Page 43449]]
place within a network's geographic coverage area.
Merchants generally argued that a network with limited geographic
acceptance would not comply with the statute because there would be
portions of the United States where merchants would not have a viable
second debit network option. Merchants further argued that an issuer
could add other regional networks such that the networks would
collectively provide merchants the ability to route an electronic debit
transaction over at least two unaffiliated payment card networks
throughout most of the country. In that regard, merchants disagreed
that the proposed rule would reduce the viability of regional networks,
contending that such networks would likely gain volume if they are
enabled on additional debit cards to comply with the rule.
The final rule in Sec. 235.7(a)(2) describes the necessary
conditions to satisfy the requirement to have at least two unaffiliated
payment card networks available for processing an electronic debit
transaction under Sec. 235.7(a)(1).\164\ As in the proposal, under the
final rule, an issuer may satisfy the network exclusivity provisions of
Sec. 235.7(a)(1) if an electronic debit transaction may be processed
on at least two unaffiliated payment card networks that operate
throughout the United States. Debit cards that operate on at least two
nationwide payment card networks would most effectively provide
merchants routing choice regardless of where a cardholder uses the
card.
---------------------------------------------------------------------------
\164\ For clarity, the final rule describes the geographic
coverage and other requirements for payment card networks that would
satisfy the network exclusivity provisions through positive
requirements, instead of describing payment card networks that would
not satisfy the rule.
---------------------------------------------------------------------------
The Board does not believe, however, that a payment card network
operating on a nationwide basis should be the sole means by which an
issuer could satisfy the network exclusivity provisions. An overly
restrictive nationwide coverage requirement may reduce network choice
for issuers, with little benefit to merchants, particularly where the
vast majority of debit card transactions by an issuer's cardholders may
take place within the network's geographic coverage area. Accordingly,
the final rule provides additional flexibility for issuers by
permitting an issuer to comply with the network exclusivity provisions
by enabling on its debit cards a network that does not, by rule or
policy, restrict the operation of the network to a limited geographic
area, specific merchant, or particular type of merchant or transaction,
and that has taken steps reasonably designed to enable the network to
be able to process the electronic debit transactions that the network
reasonably expects will be routed to it, based on projected transaction
volume. A smaller network could be used to help satisfy an issuer's
requirement to enable two unaffiliated networks if the network was
willing to expand its coverage in response to increased merchant demand
for access to its network, and the smaller network meets the other
requirements of Sec. 235.7(a) for a permitted arrangement. If,
however, the network's policy or practice was to limit such expansion,
it would not qualify as one of the two unaffiliated networks. See
comment 7(a)-2.i.
Proposed Sec. 235.7(a)(2)(ii) provided that adding an unaffiliated
payment card network that is accepted only at a small number of
merchant locations or for limited merchant 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 accepted only 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.
Merchant comments supported the proposed prohibition on limited
merchant coverage networks. Issuers and networks did not object to
proposed Sec. 235.7(a)(2)(ii). The final rule adopts a prohibition on
networks that are limited to particular merchants or merchant types as
part of the necessary conditions set out in Sec. 235.7(a)(2) and
expands the prohibition to include networks that are limited to
particular transaction types. Proposed comment 7(a)-4.ii is also
adopted, and is redesignated as comment 7(a)-2.ii in the final rule.
Section 235.7(a)(2) of the final rule also provides that a payment
card network that has not taken steps reasonably designed to enable the
network to process the electronic debit transactions that the network
reasonably expects will be routed to it would not count towards the
issuer's requirement to have at least two unaffiliated payment card
networks on which an electronic debit transaction may be processed. The
new prohibition responds to merchant comments that expressed concern
that issuers may respond to the network exclusivity provisions by
adding small, capacity-constrained networks with the expectation that
such networks would not have the capacity to handle their additional
volume such that transactions would default to a larger payment card
network on the card. The Board agrees that such arrangements would not
meet the intent to provide merchants with routing choice in those cases
where a network does not take steps reasonably designed to enable the
network to meet reasonably foreseeable demand for processing
transactions given the number of cards enabled for processing over the
network and the general usage patterns of the cardholders. The new
prohibition is not intended, however, to address the rare circumstances
where a network may be off-line for technical reasons and an electronic
debit transaction is processed on a different payment card network on a
stand-by basis or where volume is unexpected. See comment 7(a)-2.iii.
Proposed Sec. 235.7(a)(2)(iii) prohibited 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. Proposed comment
7(a)-5 provided examples of prohibited restrictions on an issuer's
ability to contract with other payment card networks, including network
rules or guidelines that limited the number or location of network
brands, marks, or logos that may appear on a debit card. See proposed
comment 7(a)-5.ii. The prohibition on payment card network restrictions
on an issuer's ability to contract with other networks is adopted with
certain revisions for clarity and is redesignated as Sec.
235.7(a)(3)(i). See also comment 7(a)-3.
Depository institutions trade associations commented that the
proposed network contracting prohibition was overbroad and
impermissibly prohibited all arrangements between networks and issuers
that in any way restrict the networks made available on a debit card
for processing a transaction. In their view, the provision as proposed
would prohibit an issuer from agreeing to limit the number of networks
enabled on its debit cards to no more than two networks per method of
authentication even if such restriction would not violate either
Alternative A or B. One issuer urged the Board to clarify that the
proposed provision is directed at rules-based, blanket prohibitions
against an issuer enabling a competing network.
The examples in proposed comment 7(a)-5 elicited several comments
from two payment card networks expressing concern that the proposed
examples conflicted with established principles in trademark law. In
particular, these commenters argued that the example of network rules
limiting the number or
[[Page 43450]]
location of network brands, marks, or logos in comment 7(a)-5.ii would
impermissibly restrict their ability to protect their investment in
their marks or brands and their ability to limit consumer confusion.
These networks also urged the Board to clarify that the proposed
prohibition is not intended to change the card design and related
security requirements that networks may apply to their payment card
products, such as size and location requirements for the network logo,
card account number, and expiration date, as well as the location of
the magnetic stripe and card verification number. One processor
affiliated with a payment card network urged the Board to include safe
harbor language in the final rule to ensure that a payment card network
could not assert a trademark infringement or other claim against an
acquirer or network for routing transactions on that network's branded
card through competing networks enabled on the card in order to prevent
merchants from exercising routing choice as intended under EFTA Section
920(b)(1)(B).
The final rule adopts the prohibition on payment card network
restrictions or limitations on an issuer's ability to contract with
other payment card networks that may process an electronic debit
transaction generally as proposed with certain revisions in Sec.
235.7(a)(3). Specifically, Sec. 235.7(a)(3) provides that, for
purposes of the network exclusivity provisions in Sec. 235.7(a)(1), a
payment card network may not restrict or otherwise limit 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. Thus, for example, the rule prohibits a network from limiting or
otherwise restricting, by rule, contract, or otherwise, the other
payment card networks that may be enabled on a particular debit card.
See comment 7(a)-3.i. The rule would also prohibit a network from
specifying the other payment card networks that may be enabled on a
particular debit card in order to comply with Sec. 235.7(a)(1).
Comment 7(a)-3.i includes as an example of a prohibited rule or
contract any express prohibition on an issuer's ability to offer
certain specified payment card networks on the debit card or any
requirement that only certain specified networks may be offered on the
card.
Comment 7(a)-3.ii clarifies that Sec. 235.7(a)(3) 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 ability of brands,
marks, or logos of other payment card networks to appear on the debit
card. Without this prohibition, network rules could 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. Comment 7(a)-3.ii is revised from the proposed comment,
which would have listed, as an example of a prohibited network
restriction on an issuer's ability to contract with other networks, any
limits on the number or location of network brands, marks, or logos
that may appear on the card. In the final rule, only contract
provisions limiting the ability of one or more network brands, marks,
or logos to appear on the debit card are expressly prohibited, as such
restrictions could prevent a consumer from knowing the networks that
are enabled on a debit card. Thus, the rule is not intended to restrict
networks from imposing branding, card-design, or security requirements
on their cards to promote brand recognition and consistency across
payment card types or to limit consumer confusion as long as such
requirements do not effectively limit the ability of other payment card
networks to appear on the debit card, such as when multiple signature
networks require their logo to appear in the same location on the card.
The final rule does not, however, otherwise address other trademark-
related issues raised by commenters as such issues are outside the
scope of the rule.
Notwithstanding the examples in comment 7(a)-3, comment 7(a)-4 in
the final rule clarifies that nothing in the rule requires that a debit
card display the brand, mark, or logo of each payment card network over
which an electronic debit transaction may be processed. For example,
the rule does not require a debit card that operates on two or more
different unaffiliated payment card networks to 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 reissuance of debit cards as
networks are added (or removed). The Board received one comment
supporting comment 7(a)-6 as proposed and it is adopted without
substantive change, redesignated as comment 7(a)-4 in the final rule.
In its proposal, the Board requested comment as to whether it was
necessary to address in the rule a payment card network's ability to
require an issuer to commit a certain volume, percentage share, or
dollar amount of transactions over the network given that volume,
percentage share, or dollar amount commitments generally 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. The Board noted in the proposal, however, that such issuer or
payment card network routing priorities could be prohibited by the
proposed limitations on merchant routing restrictions.
Issuers and one card processor agreed that the merchant routing
provisions in proposed Sec. 235.7(b) would make explicit rules
relating to volume, percentage share, or dollar amount commitments
unnecessary given that merchants would be able to choose the payment
card network for processing a transaction. Merchants, however, believed
that if the Board were to adopt Alternative A with respect to the
network exclusivity provisions, it should prohibit a network's ability
to impose volume, percentage share, or dollar amount commitments
notwithstanding the routing provisions in Sec. 235.7(b). According to
these merchant commenters, if routing options were reduced to a single
signature debit and a single PIN debit option, networks and issuers
would continue to be able to reasonably predict and influence signature
debit volumes.
Under the final rule, the issuer's ability to influence volume,
percentage share, or dollar amount of transactions that are processed
through any particular network will be significantly reduced, given
that merchant routing preferences will take priority over issuer and
network routing preferences (see discussion of Sec. 235.7(b) below).
In addition, as discussed above, any network that issuers add to debit
cards to fulfill the requirement for two unaffiliated networks in Sec.
235.7(a)(1) must meet the requirements of Sec. 235.7(a)(2). The Board
recognizes that issuers may be able to use incentives to influence
cardholders to use a particular authentication method (signature or
PIN) at the point of sale. At the same time, however, merchants may
also steer consumers toward a particular authentication method through,
for example, default settings on transaction terminals or discounts for
choosing certain payment methods. Given the issuer's limited ability to
control volume, percentage share, or dollar amount of transactions over
a particular network, the Board has determined not to address this
issue in the final rule.
[[Page 43451]]
A few issuers and two payment card networks opposed the prefatory
language in proposed Sec. 235.7(a)(2) interpreting EFTA Section
920(b)(1)(A)'s prohibition on network exclusivity arrangements as
requiring a debit card ``to have at least two unaffiliated payment card
networks on which an electronic debit transaction may be processed.''
These commenters argued that EFTA Section 920(b)(1)(A) should only be
read as a prohibition on ``restricting'' the number of payment card
networks on which an electronic debit transaction may be processed to
fewer than two unaffiliated payment card networks. In their view, the
statute does not mandate a minimum number of payment card networks to
be enabled on a debit card as long as an issuer or a payment card
network does not affirmatively create any impediments to the addition
of unaffiliated payment card networks on a debit card. Thus, these
commenters argued that the statute does not prohibit voluntary
arrangements by an issuer to limit the number of payment card networks
on a card.
EFTA Section 920(b)(1)(A) states that ``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 fewer than
two unaffiliated payment card networks. Thus, by its terms, the
statute's prohibition on exclusivity arrangements is not limited to
those that are mandated or otherwise required by a payment card
network. In the Board's view, individual issuer decisions to limit the
number of payment card networks enabled on a debit card to a single
network or affiliated networks are also prohibited as a ``direct''
restriction on the number of such networks in violation of the statute.
The Board believes that to conclude otherwise would enable an issuer to
eliminate merchant routing choice for electronic debit transactions
with respect to its cards, contrary to the overall purpose of EFTA
Section 920(b). Accordingly, the final rule adopts the substance of
proposed comment 7(a)-7 and prohibits voluntary exclusivity
arrangements with respect to debit cards (now designated as comment
7(a)-5). The final comment 7(a)-5 provides that the network exclusivity
provision in Sec. 235.7(a) requires that debit cards must be 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.
Comment 7(a)-6 (designated 7(a)-8 in the proposal) 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
Board proposed two different versions of comment 7(a)-6 based on the
appropriate network exclusivity alternative. No comments were received
under either version and the final rule adopts the Alternative A
version of the comment as proposed. The final comment 7(a)-6 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.
5. Section 235.7(a)(4) Subsequent Affiliation
Proposed Sec. 235.7(a)(3) addressed 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 Board requested comment regarding whether 90 days after
the date on which the prior unaffiliated payment card networks become
affiliated provides sufficient time for issuers to add a new
unaffiliated network in order to comply with the rule.
Several issuers and one processor stated that the proposed 90-day
window for adding a new network in the event of a payment network
merger was too short. Some issuers suggested a transition period of at
least one year, while one large issuer suggested 24 months from the
date the merger closes.
The final rule (Sec. 235.7(a)(4)) requires issuers to add an
additional unaffiliated payment card network to a debit card within six
months after the date of a merger or acquisition that causes the
previously unaffiliated payment card networks enabled on a debit card
to become affiliated. Based on its outreach, the Board understands that
adding an additional PIN network to a debit card can be accomplished in
a relatively short period of time, particularly in circumstances in
which an issuer uses a processor that is already connected to several
PIN debit networks. The additional period of time in the final rule
provides issuers more time if necessary to negotiate new agreements and
establish connectivity with the new network.
6. Applicability to All Form Factors
New comment 7(a)-7 addresses the applicability of the network
exclusivity provisions with respect to cards, codes, or devices that
may be issued in a form factor other than a card. The Board requested
comment on how to apply the network exclusivity provisions to such
cards, codes, or devices given that they may be capable of being
processed using only a single authentication method. For example, a
transaction using a mobile phone embedded with a contactless chip may
be able to be processed only as a signature debit transaction or only
on certain networks. The Board noted that 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 thus
requested comment on the effect of the network exclusivity provisions
in Sec. 235.7(a) on the development of these devices in the future.
Some issuers, processors, and networks commented that requiring new
payment devices or methods to be processed by multiple networks would
inhibit the development of these innovations. They further asserted
that it was unnecessary for the Board's rule to cover new form factors
given that merchant adoption and acceptance of these innovations is
voluntary. One payment card network argued that a consumer's decision
to use an alternative form factor in a transaction was analogous to a
cardholder's election to initiate an electronic debit transaction by
signature or PIN debit at the point of sale. As an alternative
approach, one processor urged the Board to clarify that alternative
form factors would be compliant if they are associated with a
``companion card'' that is compliant, even if the alternative form
factor itself may only be used to initiate transactions over a single
network.
Merchants and one payment card network, by contrast, urged the
Board to require the addition of a second unaffiliated network for any
payment code or device, including cards with contactless features. In
their view,
[[Page 43452]]
current limitations restricting the use of contactless devices on a
network have been attributable to a desire to limit competition from
PIN networks rather than technological issues presented by the PIN
networks.
The Board believes the statute is clear that the network
exclusivity provisions apply to electronic debit transactions involving
any device that meets the definition of ``debit card'' under EFTA
Section 920(c)(2). Accordingly, comment 7(a)-7 of the final rule
provides that the network exclusivity provisions in Sec. 235.7(a)
apply to all ``debit cards,'' as that term is defined in EFTA Section
920(c)(2), regardless of whether the debit card is issued in card form
or in the form of another ``payment code or device.'' The final comment
thus clarifies that all debit cards must be accepted on at least two
unaffiliated payment card networks on which an electronic debit
transaction may be processed. Moreover, this is the case even if a
supplemental debit card is issued in connection with a card, code, or
other device that fully complies with the rule.
B. Section 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 who 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 implementing this restriction
in Sec. 235.7(b).
As noted above, the rules of certain PIN debit payment card
networks currently require PIN debit transactions to be routed based on
the card issuer's designated preferences when 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 routed over that
network when multiple PIN networks are available.\165\ 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. EFTA
Section 920(b)(1)(B) prohibits these practices. As a result, in
practice, this means that merchants, not issuers or networks, will be
able to direct the routing of transactions.
---------------------------------------------------------------------------
\165\ 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.
---------------------------------------------------------------------------
Proposed Sec. 235.7(b) prohibited 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. Issuers commented generally that the routing provision
would likely frustrate consumer choice and their ability to receive
cardholder benefits, such as zero liability and enhanced chargeback
rights, which are unique to a particular network. Issuers also
expressed concern that the routing provisions would make it difficult
for them to explain to their customers the circumstances under which
they would or would not receive such issuer-specific benefits. Issuers
and one payment card network urged the Board to require merchants to
continue to honor consumer choice for routing of the electronic debit
transaction or, at a minimum, to require merchants to inform
cardholders of the network that will carry the transaction before the
transaction is consummated to minimize consumer confusion regarding the
network that will process the transaction. By contrast, merchants
strongly supported the proposed provision.
Section 235.7(b), which tracks the language of the EFTA Section
920(b)(1)(B), is adopted as proposed. The final rule does not include
any requirement on merchants to disclose the network selected to
process a particular electronic debit transaction as some commenters
suggested. EFTA Section 920(b) does not impose such a requirement, and
the Board believes that issues regarding merchant card acceptance
practices are best left to the individual network-merchant
relationship.
In the proposal, the Board did 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 interpreted 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. Accordingly, the Board
proposed comment 7(b)-1 to clarify 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.
Issuers and networks agreed with the proposed comment providing
that a merchant's routing choices should apply only with respect to the
networks that the issuer has enabled to process transactions for the
card. By contrast, comments of some merchants and a payments processor
stated that the plain language of the statute indicated that Congress
intended merchants to be able to process electronic debit transactions
over any payment card network that may process such transactions. In
these commenters' view, had Congress intended to limit the routing
choice mandate to the payment card networks enabled by the issuer on a
particular debit card, it could have done so by statute.
The Board continues to believe that the appropriate reading of the
routing provisions in EFTA Section 920(b)(1)(B) limits merchant routing
choice to the card networks that an issuer has chosen to enable on a
cardholder's card. In particular, the Board notes that allowing
merchants to route transactions over any network, regardless of the
networks enabled on the debit card, would render superfluous the
requirement in EFTA Section 920(b)(1)(A) that electronic debit
transactions have the ability to be processed over at least two
unaffiliated networks. Also, the issuer (or its processor) must be
connected to a network for that network to be able to route the
transaction information and data, and the issuer must have an agreement
with the network to settle transactions cleared over that network.
Accordingly, comment 7(b)-1 is adopted as proposed with some revisions
to clarify that the rule does not permit a merchant to route the
transaction over a network that the issuer did not enable to process
transactions using that debit card.
Proposed comment 7(b)-2 provided 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). The proposed comment addressed both practices relating to the
sending of transaction information to the issuer and certain practices
that may affect the network choices available to the merchant at the
time the transaction is processed. The final commentary adopts the
examples in 7(b)-2 generally as proposed with certain adjustments for
clarity.
The first example of an impermissible restriction on a merchant
under proposed comment 7(b)-2 addressed issuer or card network rules or
[[Page 43453]]
requirements that prohibit a merchant from ``steering,'' or encouraging
or discouraging, a cardholder's use of a particular method of debit
card authentication. See proposed comment 7(b)-2.i. For example,
merchants may want to encourage cardholders to authorize a debit card
transaction by entering their PIN, rather than by providing a
signature, because PIN debit carries a lower risk of fraud than
signature debit. Merchants supported the proposed example in comment
7(b)-2.i, stating that any rules that prohibit steering or that could
inhibit merchants' ability to steer--including anti-discrimination or
no-surcharge rules--should be invalidated by Sec. 235.7(b).
A payment card network and a few issuers opposed the Board's
statement in the supplementary information that, under the proposed
example, merchants would be permitted to block a consumer's choice of
signature debit. These commenters expressed concern that if merchants
were permitted to block the use of signature debit, consumers could be
misled about which payment networks' cards the merchant accepted. In
addition, issuer and payment card network commenters stated that
allowing merchants to block signature debit would take away consumers'
ability to limit exposure of their PIN if they wanted to use their
debit card.
This example is adopted as proposed. As discussed above under Sec.
235.7(a), an issuer may comply with the network exclusivity provisions
by enabling a debit card with a single signature debit network and a
single unaffiliated PIN debit network. For such cards, a merchant can
influence routing choice by, for example, determining whether a debit
card is PIN-enabled and, if it is, prompting the cardholder to input
his or her PIN, rather than asking the consumer whether the transaction
is ``debit'' or ``credit.''
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 comment 7(b)-2.ii.) Thus, for example, if
multiple networks were 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 (or be required to avoid in routing the transaction).
Nothing in 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,
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.\166\ Although one
commenter urged the Board to preempt state laws that mandate the
routing of electronic debit transactions to prevent networks or other
parties from securing favorable state laws requiring routing to a
particular network, the final rule does not adopt the recommendation
because state laws do not constitute issuer or network restrictions on
merchant routing that are prohibited by the statute. Proposed comment
7(b)-2.ii is adopted as proposed, with the clarification that issuer
and network practices that direct the processing of a transaction away
from a specified network or its affiliates is prohibited.
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\166\ See, e.g., Iowa Code Sec. 527.5.
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Under the third example, a payment card network could not require a
specific payment card network based on the type of access device
provided by the cardholder. See 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 be processed
over only a signature debit network. The Board received one comment
from a processor that supported the example. The Board is adopting the
example with a revision to clarify that the example applies to payment
card networks rather than authentication methods.
New comment 7(b)-3 clarifies that the prohibition on merchant
routing restrictions does not prohibit a payment card network from
offering payments or incentives to merchants to encourage the merchant
to route electronic debit card transactions to that network for
processing. The Board believes that a payment card network does not
impermissibly ``inhibit'' the merchant's ability to route transactions
over any available networks within the scope of the prohibition in EFTA
Section 920(b)(1)(B) by offering such incentives because it is the
merchant itself that has voluntarily chosen to direct electronic debit
transactions over a particular network in exchange for consideration
from the network.
Although proposed Sec. 235.7(b) provides merchants control over
how an electronic debit transaction is routed to the issuer, the
proposed rule did not require that a merchant make network routing
decisions on a transaction-by-transaction basis. As stated in the
supplementary information in the proposal, such a requirement may
necessitate systematic programming changes and equipment upgrades, may
be operationally infeasible and cost-prohibitive in the near term, and
is not needed to carry out the purpose of these provisions.\167\
Instead, under comment 7(b)-3 as proposed, it is sufficient to allow a
merchant to designate network routing decisions in a routing table in
advance for its transactions, similar to the way that issuer-directed
priorities are established today. Alternatively, a merchant could
delegate to its acquirer or processor the decision of how to route
transactions.
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\167\ See 75 FR 81752 (Dec. 28, 2010).
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One processor supported the proposed comment and urged the Board to
further clarify that allowing more complex routing logic beyond network
choice, such as basing a routing decision on the transaction amount,
would be discretionary. Merchants did not oppose the proposed comment,
but urged the Board to mandate that merchants be given additional
information, including access to the BIN tables and the effective
weighted average interchange rates that are applicable to each
merchant, at no cost, to facilitate merchants' ability to determine
which networks are lower cost for purposes of directing routing.
Proposed comment 7(b)-3 is adopted with minor wording changes and
redesignated as comment 7(b)-4 to the final rule. The comment clarifies
that Sec. 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.
Thus, under the comment to the final rule, it would be 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 or processor on behalf of the merchant,
or for the merchant to delegate the routing decisions to its acquirer
or processor. The final rule does not specify criteria regarding the
routing choices that must be provided to a merchant by its acquirer or
processor because the Board believes such determinations are best left
to the individual merchant's arrangement with its acquirer or
processor. The final rule also does not require networks to make BIN
tables or merchant-specific effective average interchange rates
available to merchants as such a requirement is outside the
[[Page 43454]]
scope of the statute. Nonetheless, the Board notes that, pursuant to
EFTA Section 920(a)(3)(B), the Board intends to periodically publish
the average interchange fee, by network, received by issuers, which may
provide merchants information regarding relative interchange rates
across networks.
One issuer commented that the Board should clarify that the payment
card network that a merchant uses to process the initial purchase
transaction for goods or services must also be used by the merchant for
processing subsequent transactions related to the original purchase
transaction. The Board has added new comment 7(b)-5 to clarify that the
rule does not supersede any network rule that requires the charge-back
or return of a transaction to be processed over the same network as the
original transaction.
C. Section 235.7(c) Effective Date
The network exclusivity rules in Sec. 235.7(a) are generally
effective and compliance is mandatory on April 1, 2012, with respect to
issuers. With respect to payment card networks, however, the compliance
date for the provisions in Sec. Sec. 235.7(a)(1) and (a)(3) is October
1, 2011. In addition, as described below, the compliance date is
delayed until April 1, 2013 for certain cards that use transaction
qualification or substantiation systems. Non-reloadable general-use
prepaid cards sold on or after April 1, 2013, must comply with the
rule. Non-reloadable general-use prepaid cards sold prior to April 1,
2013, are not subject to the rule. Reloadable general-use prepaid cards
sold on or after April 1, 2013, must comply with the rule. With respect
to reloadable general-use prepaid cards sold and reloaded prior to
April 1, 2013, the compliance date is May 1, 2013. With respect to
reloadable general-use prepaid cards sold prior to April 1, 2013, and
reloaded after April 1, 2013, the compliance date is 30 days after the
date of reloading.
The merchant routing provisions of Sec. 235.7(b) are effective on
October 1, 2011. However, issuers and payment card networks may
voluntarily comply with these rules prior to these dates.
1. Section 235.7(c)(1) and (c)(2)--General Rule and Effective Date for
Payment Card Networks
The statute does not specify an effective date for the EFTA Section
920(b) provisions on network exclusivity and merchant routing
restrictions. The Board requested comment on the appropriate
implementation time for the network exclusivity and routing provisions
given the different proposed alternatives under Sec. 235.7(a).
Specifically, the Board requested 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.
Recognizing that Alternative B would require significantly more time to
comply with the rule, the Board requested comment on an effective date
of January 1, 2013, if Alternative B were adopted in the final rule.
Several issuers stated that the proposed effective dates did not
allow sufficient time for compliance under either proposed alternative.
With respect to Alternative A, issuers and some payment card networks
requested longer lead times, generally until 2012 or 2013. Many such
commenters observed that a significant number of issuers will be trying
to add unaffiliated payment card networks at the same time to comply
with the network exclusivity provisions in Sec. 235.7(a).
Consequently, these commenters were concerned that simultaneous efforts
by numerous issuers will create a bottleneck at each network with
respect to negotiating new membership agreements with the respective
networks. These commenters urged the Board to provide additional time
for compliance to allow for an orderly transition. Issuer commenters
also noted that time would be needed for establishing connectivity with
new payment card networks and for upgrading internal processing systems
to support those networks. Some issuers, networks, and processors noted
that the proposed time periods were also unrealistic from acquirers'
perspective as they must implement the ability for individual merchants
to designate customized transaction routing rules. Finally, networks
and processors urged the Board to time any effective dates to coincide
with regularly scheduled industry-wide changes.
By contrast, merchants, although recommending the adoption of
Alternative B, urged the Board, if it adopted Alternative A, to make it
effective promptly in order to void ``exclusivity'' deals currently in
place. Merchants also expressed the view that there was little reason
issuers could not comply with Alternative A for all debit cards by
October 1, 2011, given that 70 percent of debit cards already have dual
functionality. Merchants also stated that Alternative A would not
require issuers to reissue cards to meet the proposed timeframe, and
that issuers could easily establish the necessary connectivity through
their processors during that time. A member of Congress also commented
that the proposed time periods for the alternatives were appropriate.
As discussed above, the final rule adopts Alternative A with
respect to the network exclusivity provisions in Sec. 235.7(a). Thus,
an issuer generally could comply with the rule by enabling a signature
debit network and an unaffiliated PIN debit network on its debit cards
for processing an electronic debit transaction. Based on comments
received and the Board's own outreach and analysis, the final rule in
Sec. 235.7(c)(1) states that, except as otherwise provided, the
network exclusivity provisions in Sec. 235.7(a) are effective for
issuers on April 1, 2012.
Many issuers are already in compliance with the network exclusivity
provisions in Sec. 235.7(a) because they have multiple unaffiliated
PIN networks enabled on their debit cards. Based on the Board's
outreach, the Board understands that adding an additional PIN network
can generally be accomplished in a matter of months where an issuer
connects to a network through an issuer processor that has already
established connectivity with other PIN networks. Thus, the Board
believes that, in most cases, issuers would be able to comply with
Alternative A by the October 1, 2011, date originally proposed.
Nonetheless, to relieve the burden on issuers that may need more time
to negotiate new agreements with networks, establish connectivity, and
revise their internal processing systems to support the new networks,
the final rule provides an additional six months to April 1, 2012, for
compliance with the network exclusivity provisions in Sec. 235.7(a).
The Board believes that issuers should have the opportunity to
begin to comply with Sec. 235.7(a) in advance of the effective date,
irrespective of any existing network rules that would prohibit them
from adding an additional network to their debit cards. Therefore, in
new Sec. 235.7(c)(2), the Board is making the provisions of Sec.
235.7(a) that are applicable to payment card networks effective on
October 1, 2011. Accordingly, as of that date, a network may not
enforce a rule that restricts the ability of an issuer to add a network
to comply with Sec. 235.7(a).
The final rule maintains the October 1, 2011, effective date for
the merchant routing provisions in Sec. 235.7(b). The earlier
effective date is intended to allow merchants and acquirers to
implement and exercise the new routing authority as soon as issuers
make additional networks available on their debit cards. Thus, for
transactions made using cards of issuers that comply with
[[Page 43455]]
the network exclusivity provisions in Sec. 235.7(a) prior to April 1,
2012, merchants will be able to take advantage of the new routing
flexibility, assuming their acquirers update the BIN tables to reflect
the new routing priorities preferred by the merchants.
2. Sections 235.7(c)(3) and (c)(4) Delayed Compliance Date for Certain
Debit Cards
The final rule also establishes a delayed compliance date for the
network exclusivity provisions in Sec. 235.7(a) in limited
circumstances for certain types of debit cards that present
technological or other operational impediments to an issuer's ability
to comply with the rule. Although EFTA Section 920(b) does not provide
the Board authority to exempt such debit cards from the network
exclusivity provisions, the Board believes it is appropriate to
establish a delayed compliance date of April 1, 2013, to allow issuers
additional time to develop technological solutions to enable compliance
with the rule. The effective date for the merchant routing provisions
in Sec. 235.7(b) would not be delayed for these cards to allow
merchants to exercise routing choice once alternative networks are made
available.
In the proposal, the Board noted that certain debit cards issued in
connection with health flexible spending accounts and health
reimbursement accounts are required by Internal Revenue Service (IRS)
rules to use certain technologies at the point of sale to ensure that
the eligibility of a medical expense claim can be substantiated at the
time of the transaction. The Board further stated its understanding,
however, that PIN debit networks may not currently offer the
functionality or capability to support the required technology. The
Board recognized therefore that 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 were unable to add the
necessary functionality to comply with those regulations. The Board
requested comment on the appropriate treatment of these products with
respect to the network exclusivity provisions in Sec. 235.7(a).
Issuers and program administrators of health spending cards
generally asserted that Congress did not intend to cover healthcare and
employee benefit cards under any of the provisions in EFTA Section 920,
even though the statute did not include a specific statutory exemption
for such products. These commenters noted that the Inventory
Information Approval System (IIAS) required by the IRS for auto-
substantiating medical expenses for eligibility is not currently
supported by the PIN networks. Thus, commenters expressed concern that
the significant costs associated with either adding a second signature
network or developing PIN network support for the IIAS could limit the
viability of such card programs and cause employers and plan
administrators to return to the inefficient system of using paper
receipts to verify the eligibility of transactions. Commenters thus
urged the Board to exempt cards linked to such health spending accounts
from the network exclusivity and routing provisions.
Similar requests for exemption were made by commenters with respect
to other employee benefit cards, such as cards used to provide transit
benefits, which also require the use of specialized transaction
qualification systems for verifying the eligibility of tax-exempt
expenses. For transit cards in particular, commenters also stated that
the time required to enter a PIN ran counter to the processing-speed
objective of the transit authorities.
Although EFTA Section 920 does not grant the Board authority to
exempt cards linked to health spending accounts or other types of debit
cards from the network exclusivity and routing provisions, the Board
has determined there is good cause to delay the effective date of the
network exclusivity provisions in Sec. 235.7(a) to April 1, 2013 for
debit cards that use point-of-sale transaction qualification or
substantiation systems, such as the IIAS, to verify the eligibility of
purchased goods or services in connection with health care and employee
benefit accounts in accordance with IRS rules. See Sec. 235.7(c)(3).
The Board believes it is necessary to provide a longer compliance
period for these cards to give PIN networks time to develop the
capability to handle transactions using these cards or to give industry
participants time to modify the manner in which signature debit routing
is determined, so that these cards can be enabled on multiple signature
debit networks.
Comment 7(c)-1 provides examples of debit cards that may qualify
for the delayed effective date in connection with certain health care
or employee benefit accounts. The comment clarifies that the delayed
effective date for certain health care or employee benefit cards also
applies to debit cards linked to health savings accounts that use
transaction substantiation or qualification authorization systems at
the point of sale, even if IRS rules do not require the use of such
systems in connection with verifying the eligibility of expenses
purchased with such cards. Although not specifically required by IRS
rules, the Board understands that in virtually all cases health savings
account cards use the same IIAS systems as do health flexible spending
accounts and health reimbursement account cards to reduce the
administrative burden for cardholders associated with sending in paper
receipts for substantiating health-related expenses.
Several issuers and card program managers urged the Board to exempt
non-reloadable gift cards from the network exclusivity provisions.
These commenters noted that single-load prepaid cards typically run
only on the signature debit networks, and that such products would be
adversely affected by a requirement to enable or support PIN debit
transactions. In particular, these commenters stated that the addition
of a PIN debit network could require the consumer to call a service
center to activate the card and obtain the PIN. By contrast, signature-
only prepaid cards can be activated at the point of sale, and used
immediately thereafter by the consumer. Commenters also stated that PIN
access was unnecessary for single load cards that typically are
depleted over a short period of time, and often after a single use.
Other issuer commenters urged the Board to exempt more broadly
prepaid cards that are designed to only support a single method of
authentication by a cardholder, whether such cards were reloadable or
not. These commenters stated that many prepaid card programs do not
have PIN capability in order to limit cash access by cardholders due to
potential money laundering and other regulatory concerns. One
depository institution trade association stated that for reloadable
prepaid cards, the network exclusivity provisions should only apply to
cards sold after October 1, 2013, to allow issuers to manage down their
existing card inventories.
The Board believes it is appropriate to establish various delayed
compliance dates for general-use prepaid cards to allow issuers time to
develop the ability to enable cardholders to use PIN debit networks for
prepaid card transactions or to give industry participants time to
modify the manner in which signature debit transaction routing is
determined, so that these cards can be enabled on multiple signature
debit networks. Accordingly, the effective date for non-reloadable
general-use prepaid cards is April 1, 2013. Non-reloadable general-use
prepaid cards sold prior to the
[[Page 43456]]
effective date are not subject to the requirements of Sec. 235.7(a).
The additional time is intended to allow issuers to draw down existing
card inventories, as well as to modify systems or develop solutions in
order to comply with Sec. 235.7(a). As noted above, single-load cards
typically are depleted over a short period of time, and often after a
single use. Instituting a PIN program for such cards in the short term
would not seem to be beneficial as the cardholder would be unlikely to
use the PIN option. Issuers of non-reloadable general-use prepaid cards
commonly may not have the customer identification information that
would be necessary to mail or otherwise provide the cardholder with PIN
information. An alternate solution for non-reloadable cards is to add a
second signature network, similar to prepaid cards with substantiation
requirements. The delayed effective date provides issuers and payment
card networks additional lead time before all prepaid cards must be
capable of supporting more than one network for processing electronic
debit transactions. Moreover, many of these cards already have been
sold to customers and may be active through that date, and the issuer
likely does not have the customer identification information necessary
to provide the cardholder with a PIN. Application of these provisions
to cards that have already been sold to customers who may not be known
to the issuers may create difficulties for the issuers, as well as
potential difficulties for the cardholders.
With respect to reloadable general-use prepaid cards, the effective
date is April 1, 2013 (or later, in some circumstances), and all
reloadable general-use prepaid cards sold on or after April 1, 2013,
must be in compliance. Reloadable general-use prepaid cards share many
of the problems as non-reloadable cards. However, PIN technology
appears more prevalent with reloadable prepaid cards than with non-
reloadable cards. The Board, therefore, anticipates that issuers of
reloadable general-use prepaid cards are more likely to add an
unaffiliated PIN network than another signature network to fulfill
their obligations under Sec. 235.7(a). Although cardholders of
reloadable prepaid cards may be provided a PIN at activation, commonly
the issuer does not obtain customer identification information until
the card is reloaded. Thus, for cards sold before April 1, 2013, an
issuer may not have the ability to provide the cardholder with a PIN
(if a PIN network is enabled) until the card is reloaded and the issuer
obtains the necessary customer identification information to contact
the cardholder. Accordingly, reloadable general-use prepaid cards sold
prior to April 1, 2013, are not subject to Sec. 235.7(a) unless and
until they are reloaded. With respect to reloadable general-use prepaid
cards that are sold and reloaded prior to April 1, 2013, the effective
date is May 1, 2013. With respect to reloadable general-use prepaid
cards sold prior to April 1, 2013, and reloaded after April 1, 2013,
the effective date is 30 days after the date of reloading. The 30-day
period is intended to ensure that issuers have sufficient time to
provide card holders with information on the additional network, such
as a PIN, after obtaining the necessary information to contact the card
holder.
The final rule does not delay the effective date for the network
exclusivity provisions for debit cards that are approved or issued for
use on alternative or emerging payment card networks that do not
require a cardholder's use of a signature or entry of a PIN to
authenticate an electronic debit transaction. Issuers were divided
regarding whether the network exclusivity and routing provisions should
be applied to emerging payment systems. Payment card networks
commenting on the issue were similarly divided on the issue.
Those commenters requesting exemptions from the network exclusivity
and routing provisions expressed concern that the application of the
rule would stifle innovation and reduce competition in the payments
market. For example, commenters requesting an exemption for cards used
on emerging payment systems stated that competing networks could refuse
to add the emerging network's debit cards to limit competition. These
commenters suggested that an exemption for emerging payment systems
would encourage investment in innovation and provide sufficient time
for the nascent systems to conduct pilots and achieve scale. Merchants
commenting on the issue agreed that it would be reasonable to permit
new systems to undertake pilot programs until such time as they achieve
critical mass.
By contrast, commenters that supported applying the network
exclusivity and routing provisions to emerging payment systems stated
that the rule should be equally applied to all networks to prevent an
unlevel playing field. One such commenter stated that the Board's rule
should apply based on whether an emerging payment system qualifies as a
debit card or payment card network, regardless of whether it describes
itself as a non-traditional or emerging network.
The purpose of the network exclusivity and routing provisions in
EFTA Section 920(b) is to provide merchants with enhanced routing
choice with respect to the networks available for processing an
electronic debit transaction. In this regard, more, not fewer, networks
would be desirable. As new technologies are being developed, the
developers should take into consideration the provisions of EFTA
Section 920(b). The Board believes that emerging payments technologies
that meet the definition of ``debit card'' in the statute should not be
subject to delayed effective dates for the network exclusivity and
routing provisions.
VII. Section 235.8 Reporting Requirements and Record Retention
A. Summary of Proposal and Comments
The Board proposed to require issuers that are subject to
Sec. Sec. 235.3 and 235.4 and payment card networks to submit reports
every two years, or more frequently as required, to the Board. Under
the proposal, each entity required to submit a report must do so in a
form prescribed by the Board and must provide information regarding
costs incurred with respect to electronic debit transactions,
interchange transaction fees, network fees, fraud-prevention costs,
fraud losses, and any other information requested by the Board. The
Board proposed that it would publish, in its discretion, summary or
aggregate information from these reports. The Board proposed that each
entity required to submit the report to the Board by March 31 of the
year the entity is required to report. Finally, the Board requested
comment on a requirement that each entity required to report retain
records of reports submitted to the Board for five years. Such entities
also would be required to make each report available upon request to
the Board or the entity's primary supervisors.
The Board received a few comments on the proposed reporting
requirements. Some issuers commented that requiring issuers to report
interchange fee revenue was duplicative, and therefore unnecessary,
because networks already maintain records of each issuer's interchange
fee revenue. A few commenters suggested the Board survey all interested
stakeholders, including small issuers, merchants of all sizes, and
consumers to determine the impact of the restrictions on them. One
commenter suggested the Board establish a process for affected entities
to inform the Board of significant
[[Page 43457]]
changes to previously reported processing costs and other information.
The Board received one comment regarding the frequency of reporting
in proposed Sec. 235.8(c). One merchant commenter asserted that the
word ``bi-annual'' in EFTA section 920(a)(3)(B) mandated reporting
twice a year, whereas the Board proposed to require reporting
biennially, or every two years. This commenter supported the more
frequent, twice-a-year reporting in order to provide interested parties
more visibility into the costs and fees received by issuer.
B. Analysis and Final Rule
EFTA Section 920(a)(3)(B) authorizes the Board to collect from
issuers and payment card networks information that is necessary to
carry out the provisions of Section 920(a). In addition, Section
920(a)(3)(B) requires the Board, in issuing rules on interchange fee
standards and on at least a ``bi-annual'' basis thereafter, to publish
summary or aggregate information about costs and interchange
transaction fees as the Board considers appropriate and in the public
interest. As summarized above in the debit card industry overview
section of this notice, the Board has collected information from
issuers and networks, as well as acquirers, and is publishing summary
information about debit card transactions, processing costs,
interchange fees, network fees, fraud-prevention costs, and fraud
losses in connection with this final rule. More detailed summary
information is available on the Board's Web site.\168\
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\168\ http://www.federalreserve.gov/paymentsystems/files/debitfees_costs.pdf.
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1. Section 235.8(a) Entities Required To Report
The Board has considered the comments regarding the entities from
which the Board should collect information and has determined to adopt
Sec. 235.8(a) as proposed--limiting those entities required to report
to issuers that are not otherwise exempt under Sec. 235.5(a) and
payment card networks, consistent with EFTA Section 920(a)(3). There
are several other interested types of parties to debit card
transactions, including, but not limited to, exempt issuers, acquirers,
merchants, and cardholders. These other interested parties may or may
not be able to provide information regarding costs, fees, fraud losses,
volumes, and values associated with debit card transactions. However,
EFTA Section 920 does not confer authority on the Board to compel all
of these parties to provide information to the Board. EFTA Section
920(a)(3) authorizes the Board to require only issuers and payment card
networks (and only as necessary to carry out the provisions of EFTA
Section 920(a)) to provide information; this authority does not extend
to merchants, cardholders, or others. Moreover, the Board is mindful of
the large reporting burden that could be imposed on exempt entities
through a request that those entities isolate and track various debit
card costs. The Board will continue to consider what, if any,
additional information could be useful in assessing the effects of its
final rule and how such information could be obtained with minimal
burden on the relevant parties.
2. Section 235.8(b) Report
Proposed Sec. 235.8(b) set forth a non-exhaustive list of the
information the Board may require entities to report, but did not
specify which entities would be required to report which types of
information. As stated in the proposal, the Board anticipates using
forms derived from the Interchange Transaction Fee Surveys (FR 3062;
OMB No. 7100).\169\ At this time, the Board is not specifying the
information that issuers and networks will be required to submit.
Section 235.8(b)'s list of possible information required to be reported
is intended to illustrate the kind of information the Board will
require. The Board is making revisions to proposed Sec. 235.8(b) to
include information about transaction value, volume, and type, in part
because the Board plans to request information from networks to monitor
the extent to which they have adopted a two-tier interchange fee
structure.\170\ The Board intends to request comment on the reporting
forms prior to the first report. At that time, the Board will consider
whether collecting interchange fee revenue from both issuers and
networks is necessary. Except for the revisions discussed in this
paragraph, the Board is adopting Sec. 235.8(b) as proposed.
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\169\ Copies of the survey forms are available on the Board's
Web site at http://www.federalreserve.gov/newsevents/reform_meetings.htm.
\170\ See discussion, above, in relation to Sec. 235.5.
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3. Section 235.8(c) Record Retention
The Board requested comment on a requirement that each entity
required to report must retain records of reports submitted to the
Board for five years. Such entities also would be required to make each
report available upon request to the Board or the entity's primary
supervisors. The Board did not receive comments on this provision.
Including a requirement that an issuer retain records to evidence
compliance with the regulation is important to ensure that supervisory
agencies have the information required to enforce the rule and to
determine whether the entity has circumvented or evaded the interchange
fee standard. However, specifying the precise form in which such
evidence must be maintained is unnecessary. The issuer and its primary
supervisor can determine in what form records must be retained to
demonstrate compliance, so long as the information is retrievable and
useable by the agencies.
To minimize the burden on issuers to retain information after the
issuer's supervisor has examined the issuer for compliance, the Board
is adopting Sec. 235.8(c) to require issuers to retain records that
demonstrate compliance with the requirements of part 235 for not less
than five years after the end of the calendar year in which the
electronic debit transaction occurred. For example, for an electronic
debit transaction that occurred on March 1, 2012, an issuer must
maintain records demonstrating compliance with the requirements of this
part through December 31, 2017. The issuer's primary regulator,
however, may determine that a longer record retention period is
warranted. See Sec. 235.9. Section 235.8(c)(2) sets forth an exception
to the general rule--if an issuer receives actual notice that it is
subject to an investigation by an enforcement agency, the issuer shall
retain the records until final disposition of the matter unless an
earlier time is allowed by court or agency order.
4. Submission Timeframe and Frequency
The Board proposed to require issuers that are subject to
Sec. Sec. 235.3 and 235.4 and payment card networks to submit reports
to the Board every two years. The Board requested comment, under
proposed Sec. 235.8(c), on reserving discretion to require more
frequent reporting. The Board proposed that entities required to report
submit the report to the Board by March 31 of the year they are
required to report in order to provide a reasonable time to compile the
data necessary to complete the report.
The Board did not receive comments explicitly regarding the
submission timeframe of required reporting, but did receive a few
comments on a similar provision--issuer submission of cost information
to networks under proposed Alternative 1. In relation to that
provision, commenters, although not necessarily supporting Board-
required certification, supported a March 31 deadline for submission if
adopted by the Board. The Board, however, has
[[Page 43458]]
determined not to mandate a specific date in the regulatory text in
order to retain flexibility to adjust the reporting deadline or the
reporting period to provide an appropriate period of time for
institutions to respond. Accordingly, the Board is not adopting in its
final rule proposed Sec. 235.8(c). Rather, similar to other reports
the Board requires to be filed, the instructions to the report will
indicate when the report is due.
The Board also expects initially to require different reporting
frequencies for issuers and payment card networks. As discussed above
in relation to Sec. 235.5, the Board plans to gather information from
networks regarding their interchange fee structures on an annual basis
and from covered issuers regarding their costs every two years.
The statute requires the Board to disclose aggregate or summary
information concerning costs and fees on at least a biannual basis.
``Biannual'' can mean either twice a year or every two years.\171\ The
Board believes it is appropriate to interpret ``biannual'' as meaning
every two years in the context of the statute's disclosure provision,
given the substantial reporting burden involved in collecting the
issuer cost data. More frequent reporting by networks or issuers may be
warranted in the future, depending on what the data collected and other
industry practices reveal. Accordingly, the Board is not specifying the
frequency of required reporting in the regulatory text in order to
retain flexibility. Similar to other reporting forms, the Board plans
to indicate with publication of the form the frequency with which
entities are required to report.
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\171\ See Merriam-Webster's Collegiate Dictionary (10th edition)
defining ``biannual'' as meaning ``twice a year'' or ``biennial,''
which in turn is defined as occurring every two years.
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Additionally, the Board is deleting proposed Sec. 235.8(d), which
stated that the Board may, in its discretion, disclose aggregate or
summary information reported. This provision was a restatement of the
Board's statutory authority to disclose such information under EFTA
Section 920(a)(3) and is not necessary.
VIII. Section 235.9 Administrative Enforcement
EFTA Section 920(d) provides that the requirements of EFTA Section
920 may be enforced by the relevant Federal administrative agencies in
accordance with EFTA Section 918. Proposed Sec. 235.9 set forth the
agencies that may enforce compliance with part 235. The Board received
no comments explicitly on proposed Sec. 235.9, but received comments
from some merchants urging the Board to require ex post verification by
supervisors of issuer compliance with the fee standards and to
enumerate penalties for failure to comply.\172\ Any penalties for non-
compliance are subject to the discretion of an issuer's or a network's
primary supervisor. Accordingly, the Board has not set forth penalties
for non-compliance with this part. The Board received no other comments
on proposed Sec. 235.9 and has determined to adopt Sec. 235.9 as
proposed.
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\172\ The Board received one comment suggesting a mechanism for
enforcing compliance with a proposed network-average interchange fee
approach. The Board has determined not to adopt a network-average
approach to the interchange fee standards and, therefore, need not
address the suggested approach to enforcement.
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IX. Section 235.10 Effective Date
Except as provided in Sec. 235.7 (discussed above), the provisions
of this final rule are effective and compliance is mandatory beginning
October 1, 2011.\173\ Issuers may voluntarily comply with these
provisions prior to that date.
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\173\ Section 235.4 and accompanying definitions, which are
added by the interim final rule published separately in the Federal
Register, also are effective on October 1, 2011.
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The Board proposed that the interchange fee standards would be
effective on July 21, 2011, coinciding with the effective date of EFTA
Section 920(a) (set forth in EFTA Section 920(a)(9)). The Board
received numerous comments regarding the effective date of the
interchange fee standards, many of which urged the Board to delay the
rule's effective date.
Several issuers and networks expressed concern that the proposed
effective date would not allow sufficient time to make necessary system
changes, under either of the proposed fee standard alternatives. For
example, one processor stated that, currently, there is no interchange-
fee data field transmitted with the transaction data at the time the
acquirer or processor makes the routing decision. This commenter
contended that networks should be responsible for identifying the
specific interchange fee category to ensure merchants have interchange
fee information available at the time of the routing decision. Many of
these commenters suggested a phased-in approach of the new standards to
mitigate the impact of the standards on market participants. A few
issuers and networks suggested that the Board deem current interchange
rates to comply with the ``reasonable and proportional'' requirement
for some period of time until the industry can implement new standards
(i.e., one to two years). A few issuers suggested the Board, in
addition to adopting a rule with a higher safe harbor and/or cap, study
the impact of both the interchange fee standards and exclusivity and
routing provisions prior to adjusting the safe harbor and/or cap.
Numerous issuers and networks contended that an issuer-specific
standard would take longer to implement than a cap because networks and
issuers would need to time to calculate their allowable costs and
networks would need time to establish a process for obtaining this
information, to write and implement new network rules, and to work with
issuers, acquirers, processors, and merchants to implement the new
interchange fee structure. A few commenters suggested specific
compliance dates if the Board implemented proposed Alternative 2. The
earliest suggested date was April 2012. More commonly, commenters
suggested an effective date of one year from publication, with other
commenters suggesting that implementation could not be accomplished
until well after July 2013. One issuer suggested that July 2013 would
permit networks to develop two-tier interchange fee structures.
Irrespective of the actual effective date, one commenter suggested a
mid-month effective date for changes to the interchange fees to align
with current network processes designed to reduce the financial risk of
month-end and quarter-end processing.
The Dodd-Frank Act does not specifically provide an effective date
for the Board's rules implementing EFTA Section 920(a). The Board is
directed to issue final regulations within nine months of the Dodd-
Frank Act's enactment, and EFTA Section 920(a) is effective one year
after enactment, indicating that Congress intended at least a three-
month implementation period before the interchange fee standards become
effective. Moreover, the final rule requires significant changes to
existing interchange fee practices and systems changes by issuers and
payment card networks. An October 1 effective date also coincides with
the normal schedule for many network releases of systems changes.
Additionally, the Congressional Review Act dictates that the Board's
final rule--as a major rule--cannot be enforced until the end of a 60-
day Congressional review period following transmission of the final
rule to Congress.\174\ For these reasons, the Board believes that an
October 1, 2011 effective date balances Congress's directions of prompt
effectiveness and sufficient time for
[[Page 43459]]
congressional review and for issuers and payment networks to bring
their systems and practices into compliance. The effective date for the
provisions implementing the routing and exclusivity requirements of
EFTA Section 920(b) are discussed above in connection with the
explanation of the requirements of Sec. 235.7.
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\174\ See 5 U.S.C. 801.
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Effects of the Rule on Various Parties
I. Overview of Comments Received
Comments from issuers, merchants, payment card networks, and
consumers addressed the benefits and drawbacks of the current system,
the impact of EFTA Section 920 and the effect of the Board's proposed
rule on various parties and on the current system overall, and
alternatives to the proposed rule. Numerous commenters (primarily
issuers, networks, and some consumer representatives) stated that the
current interchange fee system has resulted in the development of a
payment system that provides significant benefits for merchants,
consumers, and issuers. Many of these commenters stated that merchants
should pay for the benefits they receive from accepting debit cards,
which they said included cost savings relative to accepting cash,
checks, or credit cards; faster check-out at the point of sale; higher
consumer spending; guaranteed payment; avoiding liability for most
fraudulent transactions; faster settlement; secure online transactions;
and less time and money spent on collections, billing, and other
administrative matters. Other commenters stated that the debit card
system enables small merchants to compete with larger merchants.
Merchant commenters, by contrast, objected to the current
interchange fee system, noting that although transactions processing
costs have fallen substantially, interchange fees have not. These
commenters also noted that merchants often do not know at the time of
purchase the amount of the interchange fee that will be assessed on a
transaction. In addition, many merchants objected to networks setting
interchange fees centrally for all participating issuers, noting that
these centrally determined fees bear no relation to the costs of
individual issuers.
Merchant commenters explained that high interchange fees force them
either to accept lower gross margins, raise prices charged to their
customers, or reduce other costs. These commenters stated that, as a
practical matter, they cannot discontinue acceptance of debit cards
because of their widespread adoption by consumers. By contrast,
numerous non-merchant commenters asserted that merchants that are
unhappy with current interchange fee levels could stop accepting debit
cards as a form of payment or could negotiate with networks and
acquirers for lower interchange fees and merchant discounts. Some of
these commenters noted that merchants are able to offer cash discounts
in order to encourage payment by other means. Some merchant commenters,
however, stated that offering cash discounts was impractical.\175\
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\175\ Several merchant commenters also objected to certain other
practices, such as processors offering low rates for an introductory
period only, imposing hidden fees, and delaying availability of
funds by an extra day if the merchant routes the transaction through
a PIN-debit network. One merchant commenter stated that because EFTA
Section 920(b)(2) does not restrict the ability of a payment card
network to prohibit differential pricing on the basis of the network
used, networks would not have sufficient incentives to reduce fees
borne by merchants.
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Numerous commenters recognized that consumers benefit from debit
cards. Specifically, these commenters asserted that debit cards provide
consumers with a widely accepted payment method, increased security (by
reducing fraud liability and the risk associated with carrying cash),
and increased convenience (by reducing the need to carry cash). Several
of these commenters stated that the current interchange fee system
benefits consumers through lower fees for accounts and banking
services, as well as rewards for debit card purchases. By contrast,
several merchants stated that consumers pay higher retail prices as a
result of merchants passing on the cost of interchange fees.
Commenters also stated that issuers receive benefits from debit
cards, including interchange fee revenue. Several commenters stated
that issuers use interchange revenue to cover operating costs and
offset fraud losses. Other commenters noted additional benefits that
debit cards provide for issuers. For example, these commenters asserted
that debit cards provide a means for issuers to establish an account
relationship with customers, to reduce the need for issuers to hold
cash (and to maintain expensive brick-and-mortar branches in order to
facilitate withdrawals), and to experience cost savings from processing
fewer checks. By contrast, one issuer stated that debit card
transactions are more expensive to process than checks due to
processing fees, cost of inquiries and disputes, and fraud losses.
Numerous commenters asserted that the Board's proposed rule would
have adverse, unintended consequences on issuers, consumers, payment
card networks, and the payment system more generally. A few commenters
asserted that the Board's proposed rule would negatively impact small
merchants as well. Many of these commenters stated that the Board's
proposed rule should have included a competitive-impact analysis
required by EFTA Section 904(a) that was performed in accordance with
the Board's competitive-impact analysis bulletin.
II. Effects on Consumers
A. Comments Received
A number of commenters, primarily issuers and networks, asserted
that consumers would be harmed by the proposed rule, contrary to the
statutory intent. They predicted that the substantial reduction in
interchange fee revenue resulting from the proposed rule would lead
card issuers to raise fees charged to deposit account customers, reduce
benefits for users of debit cards (e.g., rewards or liability
protections), not authorize the use of debit cards for high-risk or
high-value transactions, or restrict or eliminate the issuance of debit
cards. These commenters argued that low income consumers would likely
experience the greatest harm, as they would be unable or unwilling to
incur the higher costs associated with maintaining deposit accounts,
and may consequently be forced out of the banking system.
At the same time, these commenters asserted that consumers would
not experience any benefits from lower interchange fees because they
expect that merchants would not reduce prices charged to consumers,
given that there is no statutory requirement for them to do so.\176\
They viewed the reduction in interchange fees as a transfer of revenue
from card-issuing banks to merchants, with no benefit flowing to
consumers.
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\176\ In support of their contentions, these commenters pointed
to the experience of other countries with regulating interchange
fees, most notably Australia and Canada. Issuers and some consumers
asserted that interchange fee regulation in other countries
demonstrates that merchants will not pass on savings to consumers at
the point of sale and that issuers will increase per-transaction
fees or other account fees.
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In addition, some commenters argued that the exclusivity and
routing provisions would adversely affect consumers by eliminating the
ability of cardholders to ensure that a transaction was routed over a
network that provides certain benefits to its cardholders. In
particular, these commenters noted that certain cardholder benefits,
such as zero liability, enhanced chargeback rights, rewards, or
insurance, are often tied to the use of a particular network. In their
[[Page 43460]]
view, requiring unaffiliated networks on a card with merchant control
of routing would make it less likely that a cardholder would receive
those benefits if a merchant opted to route a transaction over the
merchant's preferred network.
Other commenters, primarily merchants and some consumer groups,
asserted that consumers would benefit from the proposed rule. Several
commenters indicated that, currently, the cost of interchange fees is
being passed on to consumers through higher retail prices, and
therefore consumers would benefit from a reduction in the interchange
fees. They argued that merchants would have no choice but to pass on
their cost savings to consumers, given the competitive environment in
which they operate. They further argued that low income consumers, who
are currently less likely to use debit cards, would experience the
greatest benefits from lower prices at the point of sale. Some
commenters suggested that lower interchange fees could enable merchants
to enhance their operations through, for example, more stores or
improved customer service, which would benefit consumers. In addition,
they questioned the claim that lower interchange fees would lead to
higher account fees for deposit customers, noting that over the past
decade both interchange fees and other bank fees have increased
sharply.
B. Analysis
The ultimate net effect of the final rule on consumers will depend
on the behavior of various participants in the debit card networks. A
reduction in interchange fees would likely lead to a decrease in
merchants' costs of debit card acceptance, which could be passed on to
consumers in the form of lower prices. Merchants operating in highly
competitive markets with low margins are likely to pass the bulk of
these savings on to consumers, while merchants operating in less
competitive markets may retain a greater portion of the savings. Thus,
other things equal, the Board expects the rule to result in some
reduction in prices for goods and services faced by consumers.\177\
However, if issuers encourage consumers to shift from debit cards to
credit cards, which are more costly to merchants, overall merchant
costs could rise, despite a reduction in the cost of accepting debit
cards, and these higher costs could be passed on to consumers. If
merchants continue their current practice of not varying their prices
with the form of payment, any benefits associated with price
reductions, or costs associated with price increases, would likely
accrue to all consumers, regardless of whether they use debit cards. In
addition, lower debit card interchange fees would likely provide
merchants that currently do not accept debit cards with a greater
economic incentive to do so, which may benefit consumers by increasing
their ability to use debit cards.
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\177\ It is not practical, however, to measure the extent to
which lower interchange fees translate into lower merchant prices,
because of the many other factors that also influence those prices.
Australia has the longest experience with government limits on
interchange fees. Although the Reserve Bank of Australia
acknowledges the difficulties involved in measuring the effect of
the interchange fee reductions on merchant prices, it has stated
that it is confident that savings are passed through to consumers,
given that in a competitive market, changes in merchants' costs are
generally reflected in the prices that merchants charge. See http://www.rba.gov.au/payments-system/reforms/review-card-reforms/review-0708-pre-conclusions/index.html.
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At the same time, covered issuers are likely to implement some
changes in response to the reduction in interchange fee revenue. They
may seek alternative sources of revenue, including higher fees from
debit card users or deposit account customers more generally, or may
reduce or eliminate debit card rewards programs. In addition, card
issuers may look for opportunities to reduce operating costs, which
could involve reducing benefits associated with deposit accounts or
debit cards.
Finally, the exclusivity and routing provisions of the final rule
may limit the ability of cardholders to determine the network over
which a transaction is routed and, thus, may limit their ability to
ensure that they receive benefits associated with certain networks.
Currently, however, consumers are typically unaware of the network used
to route PIN debit transactions in situations where multiple PIN
networks are enabled on their cards. Therefore, the effect on consumers
of merchant routing decisions in such situations may be minimal.
Moreover, under the final rule, which does not require multiple
unaffiliated networks for each method of authentication, consumers may
still be able to influence transaction routing through their choice of
authentication method.
Thus, the effect of the rule on any individual consumer will depend
on a variety of factors, including the consumer's current payment
behavior (e.g., cash user or debit card user), changes in the
consumer's payment behavior, the competitiveness of the merchants from
which the consumer makes purchases, changes in merchant payment method
acceptance, and changes in the behavior of banks.
III. Effects on Issuers
A. Comments Received
Numerous commenters discussed the anticipated effect of the
proposed rule on covered and exempt issuers; some commenters predicted
that any adverse impact would be minimal, whereas other commenters
predicted that the adverse impact would be far more severe. More
specifically, merchant commenters believed that reducing interchange
fees would not have a significant adverse impact on issuers' profits
(noting that issuers were profitable before they received interchange
revenue); they also questioned claims that issuers would reduce debit
card issuance, because they believe debit cards are a lower-cost means
of access to deposit account funds compared with checks.
Numerous issuer commenters stated that the proposed rule's
substantial reduction in interchange fee revenue would adversely affect
debit card programs. Many of these issuers stated that debit cards have
become an essential tool for consumers; therefore, not offering debit
cards is not an option. Issuers were concerned that a substantial drop
in interchange fees would adversely affect their financial condition
and raise safety and soundness concerns. A few issuers noted that the
proposed rule's adverse impact would be particularly burdensome in
light of the recent financial crisis and recent regulatory changes,
including the repeal of the prohibition on paying interest on demand
deposits, limitations on overdraft fees, and increases in deposit
insurance fund premiums. Specifically, these issuers were concerned
that they would be unable to earn sufficient revenue to attract capital
and continue to invest in fraud prevention, processing, and other
technologies.
Numerous issuers indicated that, if the Board adopted its proposal,
they may impose or raise debit card or other account fees, decrease
cardholder rewards and other benefits including interest, decrease the
availability of debit cards and other banking services (by, for
example, imposing debit card transaction size limits), or reduce the
scale of their operations. Some consumer group commenters argued that,
because covered issuers would simply raise other fees to make up for
lost interchange revenue, the proposed rule would have little or no
effect on covered issuers. Some issuer commenters asserted, however,
that they would not be able to recoup all of the lost interchange fee
revenue through other customer fees, and therefore
[[Page 43461]]
would need to scale back their debit card programs. One issuer claimed
that the combination of higher customer fees and reduced program
benefits would put covered issuers at a competitive disadvantage
relative to exempt issuers.
Numerous commenters (predominantly issuers) noted that interchange
fee revenue currently is used to offset fraud losses absorbed by
issuers, particularly those related to signature debit transactions.
Several of these commenters asserted that most of the losses result
from action (or lack of action) on the merchant side of transactions.
Merchant commenters, by contrast, believed it was unfair for merchants
to pay for fraud losses that could be avoided through use of PIN debit
transactions. In addition, merchants argued that issuer incentives to
card holders to choose signature debit over PIN debit would be
diminished if fraud losses were not compensated through interchange
fees. In general, however, commenters disagreed on the allocation of
fraud losses between merchants/acquirers and issuers.\178\
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\178\ For example, some issuers assert they cannot charge back
some fraudulent transactions even when a merchant does not follow
network rules. Other commenters assert that it is difficult for
merchants to prove they followed correct procedures, and therefore
merchants bear much of the loss.
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As provided by the statute, issuers with consolidated assets of
less than $10 billion are exempt from the rule's interchange fee
standards, but not from the network exclusivity and routing provisions.
Some commenters, primarily issuers and smaller networks, argued that
issuers that are exempt from the interchange fee standards would be
harmed by the proposed rule because either (i) the exemption would not
be effective, and exempt issuers would face reductions in interchange
fees that are similar to those required for covered issuers; or (ii)
the exemption would be effective, and merchants would discriminate
against the higher-cost cards issued by exempt banks. These commenters
believed that the exemption might not be effective because networks are
not required to establish separate interchange fee schedules for exempt
and covered issuers. Furthermore, they asserted that even if networks
did establish separate schedules, market forces would put downward
pressure on exempt issuers' interchange fees. In part, these commenters
argued that this downward pressure on interchange fees would result
from the prohibition on network exclusivity and routing restrictions,
which would allow merchants to route transactions over networks with
lower interchange fees. In addition, some of these commenters expressed
concern that the proposed rule's requirement for at least two
unaffiliated networks on a card would result in increased costs for
issuers that are exempt from the interchange fee standards. Some
commenters asserted that the harm to small issuers might be sufficient
to cause some of them to fail. Some exempt issuers stated that they did
not believe they would be able to replace lost revenue as readily as
covered issuers because they have less diversified product lines than
covered issuers.
Merchant commenters argued that issuers that are exempt from the
interchange fee standards would not be harmed by the proposed rule.
They argued that the exemption would be effective, noting that several
networks have already indicated their intent to establish separate
interchange fee schedules for covered and exempt issuers. They also
dismissed the idea that merchants might discriminate against exempt
issuers' cards, arguing that (i) merchants cannot practically implement
such discriminatory practices and have an incentive to avoid alienating
customers who hold cards issued by exempt issuers, and (ii) networks
have rules requiring a merchant that accepts any of a network's debit
cards to accept all of that network's debit cards, regardless of
issuer.
B. Analysis
It is not clear how covered issuers will respond to the reduction
in interchange revenue. Experience in other countries has shown that
the extent of debit card usage is not necessarily related to the level
of interchange revenue received by issuers.\179\ Issuers may need to
provide debit cards on attractive terms in order to attract and retain
consumer transaction account balances. Covered issuers may offset some
or all lost interchange fee revenue through a combination of customer
fee increases (although competitive forces may limit their practical
ability to do so), reductions in debit card rewards programs, and cost
reductions.
---------------------------------------------------------------------------
\179\ In Canada, for example, debit card usage is widespread,
despite the absence of an interchange fee.
---------------------------------------------------------------------------
It is difficult to predict the market response to the rule, and
thus the likely overall effect of the rule on exempt issuers. Both the
statute and the final rule permit, but do not require, networks to
establish higher interchange fees for exempt issuers than would be
allowable for covered issuers. Networks that collectively process about
80 percent of debit card volume have indicated that they will establish
two separate interchange fee schedules when the rule goes into effect.
These plans likely reflect the incentives networks have to attract and
retain small issuers, which the Board estimates account for roughly 30
percent of debit card transaction volume. Networks will likely review
the appropriateness of their interchange fee structures and levels over
time as the competitive landscape continues to evolve.
To the extent that two-tier pricing is adopted by the networks, the
Board believes that it is unlikely that merchants would discriminate
against exempt issuers' cards. First, it would not appear to be in a
merchant's interest to steer customers away from using an exempt
issuer's debit card, because the cardholder will often not have a
payment option that is more attractive to the merchant. Although some
merchants have been known to steer customers who present a high-cost
credit card to a lower-cost credit card, they have been able to do so
because consumers often carry multiple credit cards. That is generally
not the case with debit cards; consumers typically have only one
checking account and hence one debit card. Merchants would have no
incentive to steer customers to pay by credit card, because credit card
payments generally involve a higher cost to merchants than do debit
card payments. Moreover, given that fewer and fewer consumers carry
checks or large amounts of cash, merchants risk losing the sale
entirely if they attempt to steer customers away from exempt issuers'
debit cards and towards non-card methods of payment.
In addition, as noted by some commenters, network rules prohibit
such discrimination. For example, the honor-all-cards rules of the
networks require a merchant that accepts a network's debit cards to
accept all of that network's debit cards, regardless of the issuer.
Moreover, although EFTA Section 920(b)(2) provides that a payment card
network cannot restrict merchant discounts across methods of payment,
it does not limit a network's ability to prohibit discounts on the
basis of the issuer.
The network exclusivity and routing provisions, however, which by
statute apply to issuers that are exempt from the interchange fee
standards, may lead to higher costs for some exempt issuers. Moreover,
these provisions could put some downward pressure on interchange fees
overall if merchants are able to route transactions over lower-
[[Page 43462]]
cost networks. The ultimate effect of any downward pressure on
interchange fees due to the network exclusivity and routing provisions
depends on the industry response once those provisions are in effect.
Thus, it is possible that, even with two-tier interchange fee
schedules, some issuers that are exempt from the interchange fee
standard may receive less interchange revenue than they would have
absent the rule. The Board expects, however, that even if interchange
fee revenue received by small issuers declines, it will remain above
the level they would have received if they were not exempt from the
interchange fee standard.
As discussed above, the Board is taking several steps to mitigate
any adverse effect on small issuers. First, it will publish lists of
institutions that fall above and below the small issuer exemption asset
threshold, to assist payment card networks in determining which of the
issuers participating in their networks are subject to the rule's
interchange fee standards, and plans to update these lists annually. In
addition, the Board plans to survey payment card issuers annually and
publish a list of the average interchange fee that each network
provides to its covered issuers and to its exempt issuers.\180\ This
list should enable issuers, including small issuers, to more readily
compare the interchange revenue they would receive from each network.
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\180\ Under EFTA Section 920(a)(3)(B), the Board may require any
issuer or payment card network to provide the Board with such
information as may be necessary to carry out the provisions of EFTA
Section 920(a).
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IV. Effects on Merchants
A. Comments Received
Some commenters, primarily issuers and networks, expected that
merchants would benefit from the rule, as they would face lower costs
associated with debit card acceptance and would not pass these savings
on to consumers. In addition, they argued that the exclusivity and
routing provisions, which give merchants the ability to direct their
transactions over the lower-cost network, may further benefit
merchants. However, some of these commenters argued that small and
medium-sized merchants may be harmed, as their acquirers would not
necessarily pass on the benefits of lower interchange fees to them,
whereas large merchants, which have more bargaining power in dealing
with their acquirers, would benefit from lower interchange fees and
would thereby gain a competitive advantage relative to smaller
merchants.
Merchants generally expected the proposed rule to result in
significant merchant cost savings, which, they argued, could be the
difference between staying in business and going out of business.
Merchant commenters supported the proposed rule's cost-based
interchange fees and indicated that the rule would increase competition
among payment card networks, improve pricing transparency, and increase
innovations by merchants. Merchants also noted that cost savings could
translate into increased hiring, more stores, or other enhancements,
such as improved customer service. However, one merchant group was
concerned that merchants with a high proportion of small-ticket
transactions may stop accepting debit cards because the interchange
fees for these types of transactions could increase under the proposed
rule.
A few commenters were skeptical that competition from the network
routing provisions would place material downward pressure on
interchange fees. Some commenters expect issuers to promote use of
credit cards over debit cards, which could result in higher costs for
merchants due to higher credit card interchange fees.
B. Analysis
As noted above, merchants that operate in highly competitive
markets with low margins are likely to pass on most or all of the
interchange cost savings to their customers in the form of lower prices
or improved service; by contrast, merchants that operate in less
competitive markets may retain a greater portion of the interchange fee
savings. The merchant-acquiring business, broadly speaking, is
competitive; therefore, the Board believes that acquirers would pass on
the savings from lower interchange fees to their merchant customers,
regardless of merchant size. Consequently, the Board does not believe
that the rule would adversely affect small and medium-sized
merchants.\181\ Although it is possible that merchants with a large
proportion of small-ticket transactions may experience an increase in
total interchange fees, the rule does not require networks to raise the
current interchange fees for very-small-value transactions.
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\181\ Certain small and medium-sized merchants that have entered
into long-term contracts with independent resellers of payment card
services may experience some delay before realizing lower
transaction costs.
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V. Effects on Other Parties
A. Comments Received
Many issuer and network commenters stated that the proposed rule's
reduction in interchange fee revenue would adversely affect payment
card networks, as well as the payment system more generally.\182\ These
commenters stated that the proposed interchange fee levels would erode
the current beneficial characteristics of debit cards and stifle future
innovation in the debit card industry (including the introduction of
alternative payment systems). These commenters also stated that the
proposal would lead to fewer payment options for consumers because
issuers would stop offering debit cards (leading to increased reliance
on cash and checks), promote the use of credit cards, or both.
Promoting the use of credit cards, these commenters asserted, would
adversely affect consumers because credit cards do not have the same
debt-management characteristics as debit cards. Other commenters
asserted that increased reliance on cash and checks would result in
greater money laundering and tax compliance risks. By contrast, several
merchants stated that a reduction in interchange fees would benefit the
payment system by increasing merchant acceptance of debit cards (which
have beneficial debt management characteristics).
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\182\ Some issuer and network commenters believe that
interchange fee restrictions are unfair because financial
institutions and networks invested in building the current network
infrastructure. In contrast, some merchant commenters asserted that
issuers and networks have already been more than compensated for
historical investment in the debit card system. Another commenter
stated that reduced interchange fee revenues would increase the cost
of leasing point-of-sale terminals.
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B. Analysis
The effect of the rule on payment card networks and the payment
system more generally will depend on the market responses to the rule
by the various payment system participants. Based on experiences in
other countries that have adopted interchange fee regulations, the
Board does not expect a significant shift away from debit card payments
or any meaningful degradation of the integrity of the payment system.
The provisions prohibiting network exclusivity and routing restrictions
could spur competition among payment card networks, which may have an
overall positive effect on payment system efficiency.
EFTA 904(a) Economic Analysis
I. Statutory Requirement
Section 904(a)(2) of the EFTA requires the Board to prepare an
economic
[[Page 43463]]
analysis of the impact of the regulation that considers the costs and
benefits to financial institutions, consumers, and other users of
electronic fund transfers. The analysis must address the extent to
which additional paperwork would be required, the effect upon
competition in the provision of electronic fund transfer services among
large and small financial institutions, and the availability of such
services to different classes of consumers, particularly low income
consumers.
II. Cost/Benefit Analysis
The Section-by-Section Analysis above, as well as the Final
Regulatory Flexibility Analysis and Paperwork Reduction Act analysis
below, contain a more detailed discussion of the costs and benefits of
various aspects of the proposal. This discussion is incorporated by
reference in this section.
As required by Section 920 of the EFTA (15 U.S.C. 1693o-2), the
final rule, which the Board is implementing in Regulation II,
establishes standards for assessing whether an interchange transaction
fee received or charged by an issuer (and charged to the acquirer) is
reasonable and proportional to the cost incurred by the issuer with
respect to the transaction. Specifically, the final rule provides that
an issuer may not receive or charge an interchange transaction fee in
excess of the sum of a 21-cent base component and 5 basis points of the
transaction's value (the ad valorem component).
Certain issuers and products are exempt from the interchange fee
restrictions, including small issuers that, together with their
affiliates, have less than $10 billion in assets; certain cards
accessing government-administered payment programs; and certain
reloadable general-use prepaid cards that are not marketed or labeled
as a gift certificate or gift card. Payment card networks may, but are
not required to, differentiate between interchange fees received by
covered issuers and products versus exempt issuers and products.
Regulation II also prohibits issuers and payment card networks from
both restricting the number of payment card networks over which an
electronic debit transaction may be processed to fewer than two
unaffiliated networks and inhibiting the ability of a merchant to
direct the routing of an electronic debit transaction over any payment
card network that may process such transactions. Under the final rule,
issuers are required to have at least two unaffiliated payment card
networks for each debit card they issue.
A. Additional Paperwork
Under the final rule, issuers that do not qualify for the small
issuer exemption would be required to provide cost data to the Board.
Covered issuers would also be required to retain records that
demonstrate compliance with the requirements of Regulation II for not
less than five years after the end of the calendar year in which the
electronic debit transaction occurred. If an issuer receives actual
notice that it is subject to an investigation by an enforcement agency,
the issuer must retain the records until final disposition of the
matter.
In addition, under the Interim Final Rule, published separately in
the Federal Register, issuers are required to develop, implement, and
update policies and procedures reasonably designed to (i) identify and
prevent fraudulent electronic debit transactions; (ii) monitor the
incidence of, reimbursements received for, and losses incurred from
fraudulent electronic debit transactions; (iii) respond appropriately
to suspicious electronic debit transactions so as to limit the fraud
losses that may occur and prevent the occurrence of future fraudulent
electronic debit transactions; and (iv) secure debit card and
cardholder data. If an issuer meets these standards and wishes to
receive the adjustment, it must certify its eligibility to receive the
fraud-prevention adjustment to the payment card networks in which the
issuer participates.
For smaller institutions that are not required to submit cost
information to the Board under Regulation II, the regulation does not
impose any reporting requirements. However, it is possible small
issuers may have reporting requirements to payment card networks to
certify their exempt status. As discussed above, for those networks
that choose to implement a two-tier interchange fee structure that
provides different interchange rates to larger issuers and exempt small
issuers, the Board plans to publish annually lists of institutions
above and below the small issuer exemption asset threshold. If a
payment card network decides to distinguish between large and small
issuers, small issuers that are not on the Board's list of institutions
that, together with their affiliates, have less than $10 billion in
assets may need to provide information to the network in order to take
advantage of the exempt fee structure.
B. Competition in the Provision of Services Among Financial
Institutions
As discussed in ``Effects of the rule on various parties'' above,
numerous commenters discussed the anticipated effect of the proposed
rule on covered and exempt issuers. The Board understands that payment
card networks that together process about 80 percent of debit card
transaction volume have indicated their intent to establish two-tier
interchange fee structures. To the extent payment card networks do not
establish different interchange fee schedules for exempt and covered
issuers, exempt issuers that participate in these networks will
experience a decline in their interchange transaction fees, for
transactions routed over these networks, similar in magnitude to that
experienced by covered issuers. If exempt issuers have higher costs for
debit card transactions than do covered issuers, this decline in
interchange revenue may necessitate a larger adjustment of fees or
other account terms by exempt issuers than by covered issuers. In
addition, if exempt issuers typically offer narrower product or service
lines than covered issuers, as suggested by some issuer commenters,
then exempt issuers may adjust fees and account terms that are closely
tied to their debit card operations or deposit accounts, whereas
covered issuers may also modify fees and terms for other complementary
or substitute products, such as credit cards, offered by those issuers.
Under a scenario in which some networks do not establish different
interchange fee schedules for exempt and covered issuers, resulting
disparate changes in account fees or terms might cause a shift of
deposit customers from exempt to covered issuers.
To the extent payment card networks do establish two-tier fee
structures, covered issuers will likely experience a greater decline in
their interchange revenue compared to exempt issuers. In such a
situation, covered issuers may need to adjust fees and account terms in
response to the lower interchange revenue, whereas exempt issuers may
not. Under this scenario, consumers may shift their purchases of some
financial services from covered issuers to exempt issuers in response
to changes in fees and account terms at covered issuers. However,
covered issuers with diversified product lines may look to retain
customers by promoting alternative products not covered by the
interchange fee standards, such as credit cards.
Regardless of whether or not networks establish two-tier fee
structures, the competitive effects of any changes in
[[Page 43464]]
fees or account terms across covered and exempt issuers due to a
decline in interchange revenue will depend on the degree of
substitution between small, exempt issuers and large, covered issuers.
If the cross-price elasticity between exempt and covered issuers is
large, then substantial shifts in market share may occur in response to
disproportionate changes in fees and account terms by exempt versus
covered issuers. Conversely, if substitution between exempt and covered
issuers is low, then any changes in fees and account terms by exempt
versus covered issuers may generate small shifts in market shares
across exempt and covered issuers.
As the previous analysis suggests, the effect on competition among
large and small financial institutions will depend on a number of
factors, including the extent to which payment card networks implement
and retain two-tier fee structures, the differentials in fees across
tiers in such structures, the product and service lines offered by
large and small financial institutions, and the substitutability of
products and services across large and small financial institutions. As
noted above, the Board understands that most debit card networks have
indicated that they intend to implement two-tier fee structures;
however, these are not binding commitments, and the level of
interchange fees that will prevail in such systems is currently not
known and will depend on market responses. Prior economic research
suggests that competition between large and small depository
institutions is weaker than competition within either group of
institutions, likely because these institutions serve different
customer bases.\183\ For example, large institutions have tended to
attract customers who desire expansive branch and ATM networks and a
wide variety of financial instruments; by contrast, smaller
institutions often market themselves as offering more individualized,
relationship-based service and customer support to consumers and small
businesses. This evidence suggests that substitution effects in
response to changes in fees or account terms are stronger between
depository institutions of similar sizes than across depository
institutions of different sizes.
---------------------------------------------------------------------------
\183\ See, e.g., Robert Adams, Kenneth Brevoort, and Elizabeth
Kiser, ``Who Competes with Whom? The Case of Depository
Institutions,'' Journal of Industrial Economics, March 2007, v. 55,
iss. 1, pp. 141-67; Andrew M. Cohen and Michael J. Mazzeo, ``Market
Structure and Competition among Retail Depository Institutions,''
Review of Economics and Statistics, February 2007, v. 89, iss. 1,
pp. 60-74; and Timothy H. Hannan and Robin A. Prager, ``The
Profitability of Small Single-Market Banks in an Era of Multi-market
Banking,'' Journal of Banking and Finance, February 2009, v. 33,
iss. 2, pp. 263-71.
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III. Availability of Services to Different Classes of Consumers
``Effects of the rule on various parties'' above discussed the
comments the Board received regarding the effect the Board's proposed
regulation may have on consumers. Furthermore, as discussed in
``Effects of the rule on various parties'', the ultimate net effect of
the final rule on consumers will depend on the behavior of various
participants in the debit card networks. Specifically, the effect of
the rule on any individual consumer will depend on a variety of
factors, including the consumer's current payment behavior (e.g., cash
user or debit card user), changes in the consumer's payment behavior,
the competitiveness of the merchants from which the consumer makes
purchases, changes in merchant payment method acceptance, and changes
in the behavior of banks.
For low income consumers, to the extent that fees and other account
terms become less attractive as a result of the rule, some low income
consumers may be unwilling or unable to obtain debit cards and related
deposit accounts. Similarly, less attractive fees and account terms may
cause certain low income consumers who previously held debit cards and
deposit accounts to substitute away from those products. At the same
time, however, low income consumers who currently use cash for
purchases may face lower prices at the point of sale if retailers that
they frequent set lower prices to reflect lower costs of debit card
transactions. Therefore, the net effect on low income consumers will
depend on various factors, including each consumer's payment and
purchase behavior, as well as market responses to the rule.
IV. Conclusion
EFTA Section 904(a)(3) states that: ``to the extent practicable,
the Board shall demonstrate that the consumer protections of the
proposed regulations outweigh the compliance costs imposed upon
consumers and financial institutions.'' Based on the analysis above and
in the Section-by-Section Analysis, the Board cannot, at this time,
determine whether the benefits to consumers exceed the possible costs
to financial institutions. As discussed above and in ``Effects of the
rule on various parties,'' the overall effects of the final rule on
financial institutions and on consumers are dependent on a variety of
factors, and the Board cannot predict the market response to the final
rule.
Final Regulatory Flexibility Analysis
An initial regulatory flexibility analysis (IRFA) was included in
the proposal in accordance with Section 3(a) of the Regulatory
Flexibility Act, 5 U.S.C. 601 et seq. (RFA). In the IRFA, the Board
requested comments on all aspects of the IRFA, and, in particular,
comments on the network exclusivity and routing alternatives (the
provisions of the proposal that apply to small issuers). The Board also
requested comments on any approaches, other than the proposed
alternatives, that would reduce the burden on all entities, including
small issuers. Finally, the Board requested comments on any significant
alternatives that would minimize the impact of the proposal on small
entities.
The RFA requires an agency to prepare a final regulatory
flexibility analysis (FRFA) unless the agency certifies that the rule
will not, if promulgated, have a significant economic impact on a
substantial number of small entities. Although it is difficult to
quantify the analysis at this point, the Board believes that the rule,
if promulgated, may have a significant economic impact on a substantial
number of small entities and, accordingly, the Board has prepared the
following FRFA pursuant to the RFA.
1. Statement of the need for, and objectives of, the final rule. As
required by EFTA Section 920, the Board is adopting new Regulation II
to establish standards for assessing whether an interchange transaction
fee received or charged by an issuer is reasonable and proportional to
the cost incurred by the issuer with respect to the transaction.
Additionally, also as required by EFTA Section 920, 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 to less than two unaffiliated networks and
inhibiting the ability of a merchant to direct the routing of an
electronic debit transaction over a particular payment card network
that may process such transactions.
2. Summary of significant issues raised by public comments in
response to the Board's IRFA, the Board's assessment of such issues,
and a statement of any changes made as a result of such comments. The
Board received several comments on the IRFA. Some commenters contended
that the IRFA should include an analysis of the effect of the proposed
rule on small entities, including small merchants and small business
debit card holders, as well as a study of the disparate impact
[[Page 43465]]
of the rule on smaller and larger businesses. One commenter also
suggested that the IRFA should consider the effect on small businesses
that receive financial services from small banks. Some commenters
suggested that the Board's RFA analysis should take into consideration
the effect of the rule on consumers, especially consumer debit card
holders and lower income individuals. Another commenter argued that the
IRFA was not reasonably complete because the cost survey on which the
Board based its proposal did not consider small issuers. As noted above
in the sections on ``Effects on Various Parties'' and the ``EFTA 904(a)
Economic Analysis,'' the overall effects of the final rule on exempt
issuers, small merchants, consumers, and other parties are dependent on
a variety of factors, and the Board cannot predict the market response
to the final rule.
In addition, numerous commenters discussed the proposed rule's
impact on small entities, particularly small issuers. As discussed in
more detail in the Section-by-Section Analysis, EFTA Section
920(a)(6)(A) provides an exemption from the interchange fee
restrictions under EFTA Section 920(a) for any issuer that, together
with its affiliates, has assets of less than $10 billion. Consequently,
the provisions related to the interchange fee restrictions in the final
rule do not directly impact small issuers. Commenters, however, were
concerned that the small issuer exemption would not be effective in
practice if payment card networks do not implement two-tier fee
structures. As discussed above in this notice, trade associations
representing small issuers, including credit unions, and one federal
banking agency urged the Board to use its circumvention or evasion
authority to ensure that the small issuer exemption in EFTA Section
920(a)(6) from the interchange transaction fee restrictions is given
effect by the networks. In particular, these commenters were concerned
that absent an express requirement on networks to adopt higher tiers of
interchange fees for exempt issuers, such issuers would experience a
significant reduction in interchange fee revenue, notwithstanding the
exemption.
Although the statute provides an exemption from the interchange
transaction fee restrictions for issuers with less than $10 billion in
consolidated assets, the statute neither imposes an affirmative duty on
networks to implement different interchange transaction fee rates for
covered and exempt issuers, nor guarantees a particular level of
interchange fee revenue that may be collected by an exempt issuer. As
noted above, however, the Board is taking steps to respond to this
issue in two ways. First, the Board plans to survey payment card
issuers and networks annually and publish annually a list of the
average interchange fees each network provides to its covered issuers
and to its exempt issuers. This information will provide for more
transparency for issuers, including small issuers, to more readily
compare the interchange revenue they would receive from each network.
Second, to facilitate a network's implementation of a two-tier fee
structure, the Board will also compile annual lists of institutions
above and below the small issuer exemption asset threshold. Payment
card networks and issuers may then rely on such lists to determine
which issuers qualify for the small issuer exemption. Issuers not
appearing on the list of issuers that, together with their affiliates,
have less than $10 billion in assets may still be required by payment
card networks in which they participate to notify the networks that
they qualify for the small issuer exemption. The Board believes the
publication of the lists will greatly reduce the administrative burden
associated with identifying small issuers that qualify for the
exemption.
With respect to the network exclusivity and routing provisions,
some commenters suggested that the Board exempt small issuers from
these requirements. As explained above in the Section-by-Section
Analysis, the statute does not provide an exemption for small issuers
for these provisions. In addition, the exemption authority in EFTA
Section 904(c) is transferred to the Consumer Financial Protection
Bureau on July 21, 2011.
The Board has discretion, however, in setting the compliance date
for these provisions. In designating April 1, 2012, as the date by
which most issuers must comply with the network exclusivity provisions
and October 1, 2011, as the date by which issuers must comply with the
routing provisions, the Board has taken into account the concerns of
issuers of all sizes. The technological options available for issuers
generally will be the same for all issuers, regardless of asset size.
Furthermore, as discussed in more detail in the Section-by-Section
Analysis, certain debit cards have a delayed effective date, and
issuers of such cards do not have to comply with the network
exclusivity provisions for these cards until April 1, 2013.
3. Description and estimate of small entities affected by the final
rule. This final rule will apply to small financial institutions that
issue debit cards. A financial institution generally is considered
small if it has assets of $175 million or less.\184\ Based on 2010 Call
Report data, approximately 11,000 depository institutions had total
domestic assets of $175 million or less. The large majority of these
institutions issue debit cards.
---------------------------------------------------------------------------
\184\ 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.
---------------------------------------------------------------------------
The sections above on ``Effects on Various Parties'' and the ``EFTA
904(a) Economic Analysis'' provide a more detailed discussion of the
direct and indirect impact of the rule on various parties.
4. Projected reporting, recordkeeping, and other compliance
requirements. With respect to the limitations on interchange
transaction fees, the Board's final rule does not impose compliance
requirements on small issuers.\185\ In accordance with EFTA Section 920
the Board's 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 final rule does not,
however, require payment card networks to distinguish between issuers
with assets of $10 billion or more and smaller issuers in setting
interchange rates. If a payment card network decides to distinguish
between large and small issuers, small issuers that are not on the
Board's list of institutions that, together with their affiliates, have
less than $10 billion in assets may need to provide information to the
network in order to take advantage of the exempt fee structure.
---------------------------------------------------------------------------
\185\ 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 final rule prohibiting network exclusivity arrangements will
affect small financial institutions that issue debit cards if such
institutions do not currently comply with the final rule's standards.
Under the final rule, a small issuer, like other issuers, would be
required to have at least two unaffiliated payment card networks for
each debit card it issues. If the issuer does not have at least two
unaffiliated payment card networks for each debit card it issues, it
would be required to add an additional network. This process may
require making a decision as to which additional network to add to the
debit card, establishing a connection to the new network, and updating
internal processes and procedures.
[[Page 43466]]
5. Steps taken to minimize the economic impact on small entities;
significant alternatives. In its proposed rule, the Board requested
comment on the impact of the prohibition on network exclusivity and
routing restrictions on small entities and solicited comment on any
approaches, other than the proposed alternatives, that would reduce the
burden on all entities, including small issuers. The Board received
comment suggesting that small issuers should be exempt from the network
exclusivity and routing provisions. However, as noted above in the
Section-by-Section Analysis, EFTA Section 920 does not provide for this
exemption, and the Board does not have authority to adopt an exemption
for small issuers from these provisions. As noted above, the Board will
publish lists of institutions above and below the small issuer
exemption asset threshold to facilitate the implementation of two-tier
interchange fee structures by payment card networks. In addition, the
Board plans to publish annually information regarding the average
interchange fees received by exempt issuers and covered issuers in each
payment card network; this information may assist exempt issuers in
determining the networks in which they wish to participate.
The factual, policy, and legal reasons for selecting the
alternatives adopted in the final rule regarding each provision of the
rule are discussed above in the Section-by-Section Analysis regarding
each such provision. In addition, the reasons for rejecting other
significant alternatives to the final rule considered by the Board are
discussed in those sections as well.
Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (PRA) (44
U.S.C. 3501-3521; 5 CFR Part 1320 Appendix A.1), the Board reviewed
this final rule under the authority delegated to the Board by the
Office of Management and Budget. As mentioned in the preamble, the
Board is seeking comment, via an interim final rulemaking, on the
provisions required under Sec. 235.4 for the fraud-prevention
adjustment, published separately in the Federal Register. No
collections of information pursuant to the PRA are contained in this
final rule. Once the Board develops a survey to obtain information
under Sec. 235.8, containing recordkeeping and reporting requirements,
staff will conduct an analysis under the PRA and seek public comment in
the Federal Register.
Use of ``Plain Language''
Section 722 of the Gramm-Leach-Bliley Act of 1999 (12 U.S.C. 4809)
requires the Board to use ``plain language'' in all final rules
published after January 1, 2000. The Board has sought to present this
final rule in a simple and straightforward manner. The Board received
no comments on whether the proposed rule was clearly stated and
effectively organized, or on how the Board might make the text of the
rule easier to understand.
Text of Final Rule
List of Subjects in 12 CFR Part 235
Banks, banking, Debit card routing, Electronic debit transactions,
and Interchange transaction fees.
Authority and Issuance
For the reasons set forth in the preamble, the Board amends Title
12, Chapter II of the Code of Federal Regulations by adding a new 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 fees.
235.4 [Reserved]
235.5 Exemptions.
235.6 Prohibition on circumvention, evasion, or net compensation.
235.7 Limitation on payment card restrictions.
235.8 Reporting requirements and record retention.
235.9 Administrative enforcement.
235.10 Effective and compliance dates.
Appendix A to Part 235--Official Board Commentary on Regulation II
Authority: 15 U.S.C. 1693o-2.
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. 1693o-2, 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,
standards for receiving a fraud-prevention adjustment to interchange
transaction fees, exemptions from the interchange transaction fee
limitations, prohibitions on evasion and circumvention, 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.
For purposes of this part:
(a) Account (1) 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; and
(2) Does not include an account held under a bona fide trust
agreement that is excluded by section 903(2) of the Electronic Fund
Transfer Act and rules prescribed thereunder.
(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 a person 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; and
(3) 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; or
(ii) A check, draft, or similar paper instrument, or an electronic
representation thereof.
(g) Designated automated teller machine (ATM) network means
either--
[[Page 43467]]
(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.
(h) Electronic debit transaction (1) Means the use of a debit card
by a person as a form of payment in the United States to initiate a
debit to an account, and
(2) Does not include transactions initiated at an ATM, including
cash withdrawals and balance transfers initiated at an ATM.
(i) General-use prepaid card means 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 for goods or services.
(j) Interchange transaction fee means any fee established, charged,
or received by a payment card network and paid by a merchant or an
acquirer for the purpose of compensating an issuer for its involvement
in an electronic debit transaction.
(k) Issuer means any person that authorizes the use of a debit card
to perform an electronic debit transaction.
(l) Merchant means any person that accepts debit cards as payment.
(m) Payment card network means an entity that--
(1) Directly or indirectly provides the proprietary services,
infrastructure, and software that route information and data to an
issuer from an acquirer to conduct the authorization, clearance, and
settlement of electronic debit transactions; and
(2) A merchant uses in order to accept as a form of payment a brand
of debit card or other device that may be used to carry out electronic
debit transactions.
(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) Route means to direct and send information and data to an
unaffiliated entity or to an affiliated entity acting on behalf of an
unaffiliated entity.
(q) 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.
(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 the sum of--
(1) 21 cents and;
(2) 5 basis points multiplied by the value of the transaction.
Sec. 235.4 [Reserved]
Sec. 235.5 Exemptions.
(a) Exemption for small issuers. (1) In general. Except as provided
in paragraph (a)(3) 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--
(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 calendar year preceding the date
of the electronic debit transaction.
(2) Determination of issuer asset size. A person may rely on lists
published by the Board to determine whether an issuer, together with
its affiliates, has assets of less than $10 billion as of the end of
the calendar year preceding the date of the electronic debit
transaction.
(3) Change in status. If an issuer qualifies for the exemption in
paragraph (a)(1) in a particular calendar year, but, as of the end of
that calendar year no longer qualifies for the exemption because at
that time it, together with its affiliates, has assets of $10 billion
or more, the issuer must begin complying with Sec. Sec. 235.3, 235.4,
and 235.6 no later than July 1 of the succeeding 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 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);
(ii) Reloadable and not marketed or labeled as a gift card or gift
certificate; and
(iii) The only means of access to the underlying funds, except when
all remaining funds are provided to the cardholder in a single
transaction.
(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 imposed for transferring funds from another
asset account to cover a shortfall in the account accessed by the card;
or
(2) A fee imposed by the issuer for the first withdrawal per
calendar month from an ATM that is part of the issuer's designated ATM
network.
Sec. 235.6 Prohibition on circumvention, evasion, and net
compensation.
(a) Prohibition of circumvention or evasion. No person shall
circumvent or evade the interchange transaction fee restrictions in
Sec. Sec. 235.3 and 235.4.
(b) Prohibition of net compensation. An issuer may not receive net
compensation from a payment card network with respect to electronic
debit transactions or debit card-related activities within a calendar
year. Net compensation occurs when the total amount of payments or
incentives received by an issuer from a payment
[[Page 43468]]
card network with respect to electronic debit transactions or debit
card-related activities, other than interchange transaction fees passed
through to the issuer by the network, during a calendar year exceeds
the total amount of all fees paid by the issuer to the network with
respect to electronic debit transactions or debit card-related
activities during that calendar year. Payments and incentives paid by a
network to an issuer, and fees paid by an issuer to a network, with
respect to electronic debit transactions or debit card related
activities are not limited to volume-based or transaction-specific
payments, incentives, or fees, but also include other payments,
incentives or fees related to an issuer's provision of debit card
services.
Sec. 235.7 Limitations on payment card restrictions.
(a) Prohibition on network exclusivity--(1) In general. 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.
(2) Permitted arrangements. An issuer satisfies the requirements of
paragraph (a)(1) of this section only if the issuer allows an
electronic debit transaction to be processed on at least two
unaffiliated payment card networks, each of which does not, by rule or
policy, restrict the operation of the network to a limited geographic
area, specific merchant, or particular type of merchant or transaction,
and each of which has taken steps reasonably designed to enable the
network to process the electronic debit transactions that the network
would reasonably expect will be routed to it, based on expected
transaction volume.
(3) Prohibited exclusivity arrangements by networks. For purposes
of paragraph (a)(1) of this section, a payment card network may not
restrict or otherwise limit 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.
(4) 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 paragraph (a) of this section,
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 six months after the date on which the
previously unaffiliated payment card networks consummate the
affiliation.
(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.
(c) Compliance dates--(1) General. Except as otherwise provided in
paragraphs (c)(2), (c)(3), and (c)(4) of this section, the compliance
date of paragraph (a) of this section is April 1, 2012.
(2) Restrictions by payment card networks. The compliance date of
paragraphs (a)(1) and (a)(3) of this section for payment card networks
is October 1, 2011.
(3) Debit cards that use transaction qualification or
substantiation systems. Issuers shall comply with the requirements of
paragraph (a) of this section by April 1, 2013, for electronic debit
transactions using debit cards that use point-of-sale transaction
qualification or substantiation systems for verifying the eligibility
of purchased goods or services.
(4) General-use prepaid cards. Issuers shall comply with the
requirements of paragraph (a) of this section with respect to general-
use prepaid cards as set out below.
(i) With respect to non-reloadable general-use prepaid cards, the
compliance date is April 1, 2013. Non-reloadable general-use prepaid
cards sold prior to April 1, 2013 are not subject to paragraph (a) of
this section.
(ii) With respect to reloadable general-use prepaid cards, the
compliance date is April 1, 2013. Reloadable general-use prepaid cards
sold prior to April 1, 2013 are not subject to paragraph (a) of this
section unless and until they are reloaded, in which case the following
compliance dates apply:
(A) With respect to reloadable general-use prepaid cards sold and
reloaded prior to April 1, 2013, the compliance date is May 1, 2013.
(B) With respect to reloadable general-use prepaid cards sold prior
to April 1, 2013, and reloaded on or after April 1, 2013, the
compliance date is 30 days after the date of reloading.
Sec. 235.8 Reporting requirements and record retention.
(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 reported may include, but may not be limited to,
data regarding costs incurred with respect to an electronic debit
transaction, interchange transaction fees, network fees, fraud-
prevention costs, fraud losses, and transaction value, volume, and
type.
(c) Record retention. (1) An issuer subject to this part shall
retain evidence of compliance with the requirements imposed by this
part for a period of not less than five years after the end of the
calendar year in which the electronic debit transaction occurred.
(2) Any person subject to this part having actual notice that it is
the subject of an investigation or an enforcement proceeding by its
enforcement agency shall retain the records that pertain to the
investigation, action, or proceeding until final disposition of the
matter unless an earlier time is allowed by court or agency order.
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
[[Page 43469]]
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 (a)(1)(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 (a)(1)(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 (a)(1)(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.
Sec. 235.10 Effective and compliance dates.
Except as provided in Sec. 235.7, this part becomes effective and
compliance is mandatory on October 1, 2011.
Appendix A to Part 235--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.
Section 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
for business purposes. 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.
2. Bona fide trusts. This part does not define the term bona
fide trust agreement; therefore, institutions must look to state or
other applicable law for interpretation. An account held under a
custodial agreement that qualifies as a trust under the Internal
Revenue Code, such as an individual retirement account, is
considered to be held under a trust agreement for purposes of this
part.
3. Account located in the United States. This part applies only
to electronic debit transactions that are initiated to debit (or
credit, for example, 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 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 with the issuer. These institutions are not
``acquirers'' because they do not provide credit to the merchant for
the transactions or settle the merchant's transactions with the
issuer. These institutions are considered processors and in some
circumstances may be considered payment card networks for purposes
of this part (See Sec. Sec. 235.2(m), 235.2(o), and commentary
thereto).
2(c) Affiliate
1. Types of entities. The term ``affiliate'' includes any bank
and nonbank affiliates located in the United States or a foreign
country.
2. Other affiliates. For commentary on whether merchants are
affiliated, see comment 2(f)-7.
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'' generally will be the named 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
be used to access funds in an account to make Internet purchases.
Similarly, the term ``debit card'' includes a device with a chip or
other embedded mechanism, such as a mobile phone or sticker
containing a contactless chip that links the device to funds stored
in an account, and enables an account to be debited. The term
``debit card,'' however, does not include a one-time password or
other code if such password or code is used for the purposes of
authenticating the cardholder and is used in addition to another
card, or other payment code or device, rather than as the payment
code or device.
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 typically are held
and made unavailable for other transactions for a period of time
specified in the issuer-cardholder agreement. After the expiration
of the 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
[[Page 43470]]
transactions that occurred during a particular month at the end of
the month. Regardless of the time period between the transaction and
account posting, 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.
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, generally via a
subsequent ACH debit to that account. The term ``debit card''
includes 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 the issuer holds the account. Therefore,
decoupled debit cards are debit cards for purposes of this part.
4. Hybrid cards.
i. Some cards, or other payment codes or devices, may have both
credit- and debit-like features (``hybrid cards''). For example,
these cards may enable a cardholder to access a line of credit, but
select certain transactions for immediate repayment (i.e., prior to
the end of a billing cycle) via a debit to the cardholder's account,
as the term is defined in Sec. 235.2(a), held either with the
issuer or at another institution. If a card permits a cardholder to
initiate transactions that debit an account or funds underlying a
prepaid card, the card is considered a debit card for purposes of
this part. Not all transactions initiated by such a hybrid card,
however, are electronic debit transactions. Rather, only those
transactions that debit an account as defined in this part or funds
underlying a prepaid card are electronic debit transactions. If the
transaction posts to a line of credit, then the transaction is a
credit transaction.
ii. If an issuer conditions the availability of a credit or
charge card that permits pre-authorized repayment of some or all
transactions on the cardholder maintaining an account at the issuer,
such a card is considered a debit card for purposes of this part.
5. Virtual wallets. A virtual wallet is a device (e.g., a mobile
phone) that stores several different payment codes or devices
(``virtual cards'') that access different accounts, funds underlying
the card, or lines of credit. At the point of sale, the cardholder
may select from the virtual wallet the virtual card he or she wishes
to use for payment. The virtual card that the cardholder uses for
payment is considered a debit card under this part if the virtual
card that initiates a transaction meets the definition of debit
card, notwithstanding the fact that other cards in the wallet may
not be debit cards.
6. 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.
7. 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, franchisees are considered 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.
8. 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.
9. 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 that 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 that is settled 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 ATM network includes any network of ATMs
identified by the issuer that provides reasonable and convenient
access to the issuer's cardholders. Whether a network provides
reasonable and convenient access depends on the facts and
circumstances, including the distance between ATMs in the designated
network and each cardholder's last known home or work address, or if
a home or work address is not known, where the card was first
issued.
2(h) Electronic Debit Transaction
1. Debit an account. The term ``electronic debit transaction''
includes the use of a card to debit an account. The account debited
could be, for example, the cardholder's asset account or the account
that holds the funds used to settle prepaid card transactions.
2. Form of payment. The term ``electronic debit transaction''
includes the use of a card as a form of payment that may be made in
exchange for goods or services, as a charitable contribution, to
satisfy an obligation (e.g., tax liability), or for other purposes.
3. Subsequent transactions. The term ``electronic debit
transaction'' includes both the cardholder's use of a debit card for
the initial payment and any subsequent use by the cardholder of the
debit card in connection with the initial payment. For example, the
term ``electronic debit transaction'' includes using the debit card
to return merchandise or cancel a service that then results in a
debit to the merchant's account and a credit to the cardholder's
account.
4. 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 make a purchase and to withdraw cash
(known as a ``cash-back transaction'').
5. 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
in the United States, 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 prepaid card is redeemable upon presentation at
multiple, unaffiliated merchants if such merchants agree to honor
the card.
2. Selective authorization cards. Selective authorization cards,
(e.g., mall cards) are generally intended to be used or redeemed for
goods or services at participating retailers within a shopping mall
or other limited geographic area. Selective authorization cards are
considered general-use prepaid cards, regardless of whether they
carry the mark, logo, or brand of a payment card network, if they
are redeemable at multiple, unaffiliated merchants.
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
acquirers or merchants. The acquirers then pay to the issuers any
interchange transaction fee established and charged by the network.
Acquirers typically pass the interchange transaction fee through to
merchant-customers.
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 electronic debit transaction. By contrast, payment card
networks generally charge issuers and acquirers fees for services
the network performs. Such fees are not interchange transaction fees
because the payment card network is charging and receiving the fee
as compensation for services it provides.
3. Established, charged, or received. Interchange transaction
fees are not limited to those fees for which a payment card network
sets the value. A fee that compensates an issuer is an interchange
transaction fee if the fee is set by the issuer but charged to
acquirers by virtue of the network determining each participant's
net settlement position.
2(k) Issuer
1. In general. A person issues a debit card by authorizing the
use of debit card by a
[[Page 43471]]
cardholder to perform electronic debit transactions. That person may
provide the card directly to the cardholder or indirectly by using a
third party (such as a processor, or a telephone network or
manufacturer) to provide the card, or other payment code or device,
to the cardholder. 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. Traditional debit card arrangements. In a traditional debit
card arrangement, the bank or other entity holds the cardholder's
funds and authorizes the cardholder to use the debit card to access
those funds through electronic debit transactions, and the
cardholder receives the card directly or indirectly (e.g., through
an agent) from the bank or other entity that holds the funds (except
for decoupled debit cards, discussed below). In this system, the
bank or entity holding the cardholder's funds is the issuer.
3. BIN-sponsor arrangements. Payment card networks assign Bank
Identification Numbers (BINs) to member-institutions 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 follow 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 authorize its account holders
to use debit cards to perform electronic debit transactions that
access funds in accounts at the bank or credit union. The bank or
credit union's name typically will appear on the debit card. The
bank or credit union may directly or indirectly provide the cards to
cardholders. Under these circumstances, the bank or credit union is
the issuer for purposes of this part. If that bank or credit union,
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 may
distribute cards through the BIN sponsors, the BIN sponsor does not
enter into the agreement with the cardholder that authorizes the
cardholder to use the card to perform electronic debit transactions
that access funds in the account at the bank or credit union, and
therefore the BIN sponsor 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, a program manager distributes prepaid cards to the
cardholders and the BIN-sponsoring institution generally holds the
funds for the prepaid card program in an omnibus or pooled account.
Either the BIN sponsor or 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 BIN sponsor
authorizes the cardholder to use the card to perform electronic
debit transactions that access the funds in the pooled account and
the cardholder's relationship generally is with the BIN sponsor.
Accordingly, under these circumstances, the BIN sponsor, or the bank
holding the pooled account, is the issuer.
4. Decoupled debit cards. In the case of decoupled debit cards,
an entity other than the bank holding the cardholder's account
enters into a relationship with the cardholder authorizing the use
of the card to perform electronic debit transactions. The entity
authorizing the use of the card to perform electronic debit
transaction typically arranges for the card to be provided directly
or indirectly to the cardholder and has a direct relationship with
the cardholder with respect to the card. The bank holding the
cardholder's account has agreed generally to permit ACH debits to
the account, but has not authorized the use of the debit card to
access the funds through electronic debit transactions. Under these
circumstances, the entity authorizing the use of the debit card, and
not the account-holding institution, is considered the issuer. An
issuer of a decoupled debit card is not exempt under Sec. 235.5(a),
even if, together with its affiliates, it has assets of less than
$10 billion, because it is not the entity holding the account to be
debited.
2(l) Merchant [Reserved]
2(m) Payment Card Network
1. In general. An entity is a considered a payment card network
with respect to an electronic debit transaction for purposes of this
rule if it routes information and data to the issuer from the
acquirer to conduct authorization, clearance, and settlement of the
electronic debit transaction. By contrast, if an entity receives
transaction information and data from a merchant and authorizes and
settles the transaction without routing the information and data to
another entity (i.e., the issuer or the issuer's processor) for
authorization, clearance, or settlement, that entity is not
considered a payment card network with respect to the electronic
debit transaction.
2. Three-party systems. In the case of a three-party system,
electronic debit transactions are processed by an entity that acts
as system operator and issuer, and may also act as the acquirer. The
entity acting as system operator and issuer that receives the
transaction information from the merchant or acquirer also holds the
cardholder's funds. Therefore, rather than directing the transaction
information to a separate issuer, the entity authorizes and settles
the transaction based on the information received from the merchant.
As these entities do not connect (or ``network'') multiple issuers
and do not route information to conduct the transaction, they are
not ``payment card networks'' with respect to these transactions.
3. Processors as payment card networks. A processor is
considered a payment card network if, in addition to acting as
processor for an acquirer and issuer, the processor routes
transaction information and data received from a merchant or the
merchant's acquirer to an issuer. For example, if a merchant uses a
processor in order to accept any, some, or all brands of debit cards
and the processor routes transaction information and data to the
issuer or issuer's processor, the merchant's processor is considered
a payment card network with respect to the electronic debit
transaction. If the processor establishes, charges, or receives a
fee for the purpose of compensating an issuer, that fee is
considered an interchange transaction fee for purposes of this part.
4. Automated clearing house (ACH) operators. An ACH operator is
not considered a payment card network for purposes of this part.
While an ACH operator processes transactions that debit an account
and provides for interbank clearing and settlement of such
transactions, a person does not use the ACH system to accept as a
form of payment a brand of debit card.
5. ATM networks. An ATM network is not considered a payment card
network for purposes of this part. While ATM networks process
transactions that debit an account and provide for interbank
clearing and settlement of such transactions, a cash withdrawal from
an ATM is not a payment because there is no exchange of money for
goods or services, or payment made as a charitable contribution, to
satisfy an obligation (e.g., tax liability), or for other purposes.
2(n) Person [Reserved]
2(o) Processor
1. Distinction from acquirers. A processor may perform all
transaction-processing functions for a merchant or acquirer, but if
it does not acquire (that is, settle with the merchant for the
transactions), it is not an acquirer. The entity that acquirers
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. A processor may perform services related to
authorization, clearance, and settlement of transactions for an
issuer without being considered to be an issuer for purposes of this
part.
2(p) Route
1. An entity routes information if it both directs and sends the
information to an unaffiliated entity (or affiliated entity acting
on behalf of the unaffiliated entity). This other entity may be a
payment card network or processor (if the entity directing and
sending the information is a merchant or an acquirer) or an issuer
or processor (if the entity directing and sending the information is
a payment card network).
[[Page 43472]]
2(q) United States [Reserved]
Section 235.3 Reasonable and Proportional Interchange Transaction Fees
3(a) [Reserved]
3(b) Determining Reasonable and Proportional Fees
1. Two components. The standard for the maximum permissible
interchange transaction fee that an issuer may receive consists of
two components: a base component that does not vary with a
transaction's value and an ad valorem component. The amount of any
interchange transaction fee received or charged by an issuer may not
exceed the sum of the maximum permissible amounts of each component
and any fraud-prevention adjustment the issuer is permitted to
receive under Sec. 235.4 of this part.
2. Variation in interchange fees. An issuer is permitted to
charge or receive, and a network is permitted to establish,
interchange transaction fees that vary in their base component and
ad valorem component based on, for example, the type of transaction
or merchant, provided the amount of any interchange transaction fee
for any transaction does not exceed the sum of the maximum
permissible base component of 21 cents and 5 basis points of the
value of the transaction.
3. Example. For a $39 transaction, the maximum permissible
interchange transaction fee is 22.95 cents (21 cents plus 5 basis
points of $39). A payment card network may, for example, establish
an interchange transaction fee of 22 cents without any ad valorem
component.
Section 235.4 [Reserved]
Section 235.5 Exemptions for Certain Electronic Debit Transactions
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 preceding calendar
year. In this case, an electronic debit transaction made using that
card may qualify 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.
2. Certification process. Payment card networks that plan to
allow issuers to receive higher interchange fees than permitted
under Sec. Sec. 235.3 and 235.4 pursuant to one of the exemptions
in Sec. 235.5 could develop their own processes for identifying
issuers and products eligible for such exemptions. Section
235.5(a)(2) permits payment card networks to rely on lists published
by the Board to help determine eligibility for the small issuer
exemption set forth in Sec. 235.5(a)(1).
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, other than trust assets
under management, are less than $10 billion, as of December 31 of
the preceding calendar year.
2. Change in status. If an exempt issuer becomes covered based
on its and its affiliates assets at the end of a calendar year, that
issuer must begin complying with the interchange fee standards
(Sec. 235.3), the fraud-prevention adjustment standards (to the
extent the issuer wishes to receive a fraud-prevention adjustment)
(Sec. 235.4), and the provisions prohibiting circumvention,
evasion, and net compensation (Sec. 235.6) no later than July 1.
5(b) Exemption for Government-Administered Payment Programs
1. Government-administered payment program. 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 so long as the program is
operated on behalf of the government agency. 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. A tribal government is
considered a local government for purposes of this exemption.
5(c) Exemption for Certain Reloadable Prepaid Cards
1. Subaccount clarified. A subaccount is an account within an
account, opened in the name of an agent, nominee, or custodian for
the benefit of two or more cardholders, where the transactions and
balances of individual cardholders are tracked in such subaccounts.
An account that is opened solely in the name of a single cardholder
is not a subaccount.
2. Reloadable. 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 at any time 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.
3. Marketed or labeled as a gift card or gift certificate. i.
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.
ii. 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.)
4. 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.
5. 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
[[Page 43473]]
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 comment 5(c)-5.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 comment 5(c)-5.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 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 comment 5(c)-5.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.
6. 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.
7. Temporary non-reloadable cards issued in connection with a
general-use 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 cardholder 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 so long as the card is not
marketed as a gift card or gift certificate.
5(d) Exception
1. Additional ATM access. Some debit cards may be used to
withdraw cash from ATMs that are not part of the issuer's designated
ATM network. An electronic debit card transaction may still qualify
for the exemption under Sec. Sec. 235.5(b) or (c) with a respect to
a card for which a fee may be imposed for a withdrawal from an ATM
that is outside of the issuer's designated ATM network as long as
the card complies with the condition set forth in Sec. 235.5(d)(2)
for withdrawals within the issuer's designated ATM network. The
condition with respect to ATM fees does not apply to cards that do
not provide ATM access.
Section 235.6 Prohibition on Circumvention, Evasion, and Net
Compensation
1. No applicability to exempt issuers or electronic debit
transactions. The prohibition against circumventing or evading the
interchange transaction fee restrictions or against net compensation
does not apply to issuers or electronic debit transactions that
qualify for an exemption under Sec. 235.5 from the interchange
transaction fee restrictions.
6(a) Prohibition of Circumvention or Evasion
1. Finding of circumvention or evasion. A finding of evasion or
circumvention will depend on all relevant facts and circumstances.
Although net compensation may be one form of circumvention or
evasion prohibited under Sec. 235.6(a), it is not the only form.
2. Examples of circumstances that may constitute circumvention
or evasion.
The following examples do not constitute per se circumvention or
evasion, but may warrant additional supervisory scrutiny to
determine whether the totality of the facts and circumstances
constitute circumvention or evasion:
i. A payment card network decreases network processing fees paid
by issuers for electronic debit transactions by 50 percent and
increases the network processing fees charged to merchants or
acquirers with respect to electronic debit transactions by a similar
amount. Because the requirements of this subpart do not restrict or
otherwise establish the amount of fees that a network may charge for
its services, the increase in network fees charged to merchants or
acquirers and decrease in fees charged to issuers is not a per se
circumvention or evasion of the interchange transaction fee
standards, but may warrant additional supervisory scrutiny to
determine whether the facts and circumstances constitute
circumvention or evasion.
ii. An issuer replaces its debit cards with prepaid cards that
are exempt from the interchange limits of Sec. Sec. 235.3 and
235.4. The exempt prepaid cards are linked to its customers'
transaction accounts and funds are swept from the transaction
accounts to the prepaid accounts as needed to cover transactions
made. Again, this arrangement is not per se circumvention or
evasion, but may warrant additional supervisory scrutiny to
determine whether the facts and circumstances constitute
circumvention or evasion.
[[Page 43474]]
6(b) Prohibition of Net Compensation
1. Net compensation. Net compensation to an issuer through the
use of network fees is prohibited.
2. Consideration of payments or incentives provided by the
network in net compensation determination.
i. For purposes of the net compensation determination, payments
or incentives paid by a payment card network to an issuer with
respect to electronic debit transactions or debit card related
activities 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 payments for debit card related
activities. For example, signing bonuses paid by a network to an
issuer for the issuer's debit card portfolio would also be included
in the total amount of payments or incentives received by an issuer
from a payment card network with respect to electronic debit
transactions. A signing bonus for an entire card portfolio,
including credit cards, may be allocated to the issuer's debit card
business based on the proportion of the cards or transactions that
are debit cards or electronic debit transactions, as appropriate to
the situation, for purposes of the net compensation determination.
ii. Incentives paid by the network with respect to multiple-year
contracts may be allocated over the life of the contract.
iii. For purposes of the net compensation determination,
payments or incentives paid by a payment card network with respect
to electronic debit transactions or debit card-related activities do
not include interchange transaction fees that are passed through to
the issuer by the network, or discounts or rebates provided by the
network or an affiliate of the network for issuer-processor
services. In addition, funds received by an issuer from a payment
card network as a result of chargebacks, fines paid by merchants or
acquirers for violations of network rules, or settlements or
recoveries from merchants or acquirers to offset the costs of
fraudulent transactions or a data security breach do not constitute
incentives or payments made by a payment card network.
3. Consideration of fees paid by an issuer in net compensation
determination.
i. For purposes of the net compensation determination, fees paid
by an issuer to a payment card network with respect to electronic
debit transactions or debit card related activities include, but are
not limited to, membership or licensing fees, network administration
fees, and fees for optional network services, such as risk
management services.
ii. For purposes of the net compensation determination, fees
paid by an issuer to a payment card network with respect to
electronic debit transactions or debit card-related activities do
not include network processing fees (such as switch fees and network
connectivity fees) or fees paid to an issuer processor affiliated
with the network for authorizing, clearing, or settling an
electronic debit transaction.
4. Example of circumstances not involving net compensation to
the issuer. The following example illustrates circumstances that
would not indicate net compensation by the payment card network to
the issuer:
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 period. Over the same period, however, the
total network fees (other than 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 incentive payments by the network to the
issuer. Under these circumstances, the issuer does not receive net
compensation from the network for electronic debit transactions or
debit card related activities.
Section 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, debit cards for
government-administered payment programs, although exempt from the
restrictions on interchange transaction fees, are 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 to determine the routing for electronic debit
transactions.
7(a) Prohibition on Network Exclusivity
1. Scope of restriction. Section 235.7(a) requires a debit card
subject to the regulation to be enabled on at least two unaffiliated
payment card networks. This paragraph does not, however, require an
issuer to have two or more unaffiliated networks available for each
method of cardholder authentication. 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.
See also, comment 7(a)-7.
2. Permitted networks. i. A smaller payment card network could
be used to help satisfy the requirement that an issuer enable two
unaffiliated networks if the network was willing to expand its
coverage in response to increased merchant demand for access to its
network and it meets the other requirements for a permitted
arrangement, including taking steps reasonably designed to enable it
to process the electronic debit transactions that it would
reasonably expect to be routed to it. If, however, the network's
policy or practice is to limit such expansion, it would not qualify
as one of the two unaffiliated networks.
ii. A payment card network that is accepted only at a limited
category of merchants (such as a particular grocery store chain,
merchants located in a particular shopping mall, or a single class
of merchants, such as grocery stores or gas stations) would not
satisfy the rule.
iii. One of the steps a network can take to form a reasonable
expectation of transaction volume is to consider factors such as the
number of cards expected to be issued that are enabled on the
network and expected card usage patterns.
3. Examples of prohibited network 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, or network rules or contract provisions that
specify the other networks that may be enabled on a particular debit
card.
ii. 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 ability of
brands, marks, or logos of other payment card networks to appear on
the debit card.
4. Network logos or symbols on card not required. Section
235.7(a) does not require that a debit card display the brand, mark,
or logo of each payment card network over which an electronic debit
transaction may be processed. For example, this rule does not
require a debit card that is enabled for two or more unaffiliated
payment card networks to bear the brand, mark, or logo for each card
network.
5. 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, even if the issuer is
not subject to any rule of, or contract 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.
6. 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 on 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.
7. Application of rule regardless of form factor. The network
exclusivity provisions in Sec. 235.7(a) require that all debit
cards be enabled on at least two unaffiliated payment card networks
for electronic debit transactions, regardless of whether the debit
card is issued in card form. This applies to any supplemental
device, such as a fob or token, or chip or application in a mobile
[[Page 43475]]
phone, that is issued in connection with a plastic card, even if
that plastic card fully complies with the rule.
7(b) Prohibition on Routing Restrictions
1. Relationship to the network exclusivity restrictions. An
issuer or payment card network is prohibited from inhibiting a
merchant's ability to route or direct an electronic debit
transaction over any of the payment card networks that the issuer
has enabled to process an electronic debit transaction for that
particular debit card. This rule does not permit a merchant to route
the transaction over a network that the issuer did not enable to
process transactions using that 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, or
directing the processing of the transaction away from a specified
network or its affiliates, 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 payment card network based on the type
of access device provided to the cardholder by the issuer.
3. Merchant payments not prohibited. A payment card network does
not restrict a merchant's ability to route transactions over
available payment card networks in violation of Sec. 235.7(b) by
offering payments or other incentives to encourage the merchant to
route electronic debit card transactions to the network for
processing.
4. Real-time routing decision not required. A merchant need not
make network routing decisions on a transaction-by-transaction
basis. A merchant and its acquirer or processor may agree to a pre-
determined set of routing choices that apply to all electronic debit
transactions that are processed by the acquirer or processor on
behalf of the merchant.
5. No effect on network rules governing the routing of
subsequent transactions. Section 235.7 does not supersede a network
rule that requires a chargeback or return of an electronic debit
transaction to be processed on the same network that processed the
original transaction.
7(c) Effective Date
1. Health care and employee benefit cards. Section 235.7(c)(1)
delays the effective date of the network exclusivity provisions for
certain debit cards issued in connection with a health care or
employee benefit account to the extent such cards use (even if not
required) transaction substantiation or qualification authorization
systems at point of sale to verify that the card is only used for
eligible goods and services for purposes of qualifying for favorable
tax treatment under Internal Revenue Code requirements. Debit cards
that may qualify for the delayed effective date include, but may not
be limited to, cards issued in connection with flexible spending
accounts established under section 125 of the Internal Revenue Code
for health care related expenses and health reimbursement accounts
established under section 105 of the Internal Revenue Code.
Section 235.8 Reporting Requirements and Record Retention
[Reserved]
Section 235.9 Administrative Enforcement
[Reserved]
Section 235.10 Effective and Compliance Dates
[Reserved]
By order of the Board of Governors of the Federal Reserve
System, June 30, 2011.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 2011-16861 Filed 7-19-11; 8:45 am]
BILLING CODE 6210-01-P