The OFT ruled that a collective agreement between members of MasterCard UK Members Forum, including most major banks, setting a multi-lateral interchange fee paid on virtually all purchases in the UK made using UK-issued MasterCard credit and charge cards between 1st March 2000 and 18th November 2004 restricted competition and infringed Article 81 of the EC Treaty and the Chapter I prohibition of the Competition Act.
The EC Treaty and the Competition Act 1998 both prohibit anti-competitive agreements. Article 81 of the EC Treaty and the Chapter I prohibition of the Competition Act apply to agreements which prevent, restrict or distort competition.
When a credit card is used, a small percentage of the purchase price is paid by the merchant to its bank. The merchant’s bank then pays a fee – the interchange fee – to the cardholder’s bank. In 2004, over 700 million purchase transactions were made in the UK using MasterCard cards with a total value of £42.7 billion. An interchange fee was charged on each of these transactions as a percentage of total transaction value.
MasterCard says this interchange fee is necessary, that it is the mechanism by which operators of the MasterCard system are able to balance the costs and revenues between the cardholder’s bank and the merchant’s bank. In particular, MasterCard argues that it allows the cardholder’s bank to recover a portion of its costs from the merchant, who is one of the principal beneficiaries of credit cards.
But the OFT says that the interchange fee agreement had adverse effects on competition within the MasterCard scheme and also in relation to other payment systems. It considers that the collective agreement deterred issuers of MasterCard cards and merchant acquirers of MasterCard transactions from competing by negotiating their own interchange fees, different from the MasterCard UK Members Forum's multi-lateral interchange fee – what it called the MMF MIF.
In turn, the OFT says this reduced competition between merchant acquirers because the MMF MIF – as a standard cost for merchant acquirers – directly affected the merchant service charges paid to merchant acquirers by retailers accepting MasterCard cards.
The OFT also found that the MMF MIF was used to recover 'extraneous costs' for services which were not necessary for the operation of the MasterCard scheme as a mechanism for transmitting payments, such as the costs of the interest-free periods provided by card issuers.
Recovering extraneous costs through the MMF MIF resulted in merchant acquirers paying a higher interchange fee to card issuers than if the MMF MIF had been used just to recover the costs of the payment transmission mechanism. This fee was passed on to retailers by the merchant acquirers through higher merchant service charges. Consumers, including those who do not use MasterCard cards, ultimately picked up the cost for the higher interchange fee through higher retail prices, it said.
It ruled that, as an increase in the standard costs faced by all merchant acquirers, the higher MMF MIF reduced the ability of merchant acquirers to compete on the amount of merchant service charges charged to retailers.
The inclusion of extraneous costs in the MMF MIF provided a large flow of revenue to card issuers and the incentive to induce customers to hold and use MasterCard cards, for example, through loyalty schemes, advertising and funding the provision of an interest-free period, according to the OFT. This distorted competition between the MasterCard scheme and alternative methods of payment such as debit cards, cheques or cash, it says. The recovery of extraneous costs through the MMF MIF also led to a distortion of competition between card issuers within the MasterCard scheme.
Sir John Vickers, OFT Chairman, said:
"The parties to this collective agreement set the interchange fee to derive revenues from retailers and their customers over and above the costs of providing the payment services. This unduly high interchange fee was like a tax on UK consumers."
MasterCard introduced new arrangements for setting the interchange fee on 18th November 2004. They currently apply to all UK MasterCard transactions. The OFT has concerns that under the new arrangements the interchange fee applying to UK transactions may still be set with reference to extraneous costs and used to recover these costs. The OFT expects to start an investigation into the new arrangements for setting the fallback interchange fee applying to UK MasterCard transactions unless this concern is addressed by MasterCard.
MasterCard expressed its "strong disagrement" with today's conclusions from the OFT. It denied infringing the Competition Act and the EC Treaty.
John Bushby, General Manager, MasterCard Northern Europe, said: “We’re very disappointed by the OFT’s decision after five and a half years of deliberations and all the detailed evidence we have provided to explain the need for MasterCard’s default interchange fees in the UK.”
Bushby added: “We have consistently shown not only that default interchange fees have paved the way for a large number of new entrants into the UK credit card business over the past decade, but also that the UK payment system is one of the most competitive in the world."
The OFT complained that the interchange includes funds to cover the interest free period, funds described by the OFT as “extraneous” costs. But Bushby argued that the interest free period "is in fact integral to the credit card system and it is highly valued both by retailers and cardholders”.
He continued:
“For the OFT to claim that the interchange fee agreement either reduced competition or disadvantaged consumers or retailers is simply wrong. Consumers benefit from greater choice as more retailers accept credit cards, and retailers of all sizes benefit as card usage expands. As such, today’s OFT ruling is bad news for both healthy competition and the economy.”
“Today’s ruling also fails to recognise that interchange fees have contributed to significant expansion in use of new technology and a considerably more sophisticated and secure means of payment, tightening up the way in which transactions are recorded, preventing fraud, and helping to place the UK at the forefront of the e-commerce drive. These vital benefits seem not to have been properly taken into consideration by the OFT.”
Regarding the OFT's suggestion that default interchange fees represent a "tax" on consumers, Bushby argues that every cost that a retailer has could likewise be called a "tax". "It’s another example of the hazards of trying to analyse the issue of interchange fees in isolation," he says. "Cards are a more efficient, more secure and more convenient means of payment than cash for both consumers and retailers, something today’s ruling fails to recognise."
MasterCard says it has always argued that reducing interchange fees by regulatory intervention will not make the costs of running the system disappear. It claims that the UK’s 30 million MasterCard cardholders would, under the circumstances the OFT seeks to impose, be compelled to pay a greater proportion of the costs of the system, to the ultimate detriment of cardholders and retailers.
Bushby continued:
“Consider what happened when the Reserve Bank of Australia forced MasterCard and other four-party payment systems to reduce interchange fees by nearly 50%: cardholder fees increased, card benefits (such as loyalty programs) were reduced, and retailers, so far as anyone can tell, pocketed the savings rather than passing them along to consumers in the form of lower prices. Worst of all, less efficient and more expensive three-party systems (such as American Express) have been able to increase their share of the business, since the Reserve Bank chose not to regulate them. MasterCard observes that the OFT’s decision today would, likewise, give three-party systems an unfair competitive advantage.”
MasterCard believes that the OFT decision, in addition to jeopardising competition will, if allowed to stand, lead to reduced services to cardholders and to an increase in cardholder fees and charges, and may even make it difficult for many consumers to get credit cards.
It suggests that, in the long run, even retailers will suffer from today’s decision. "Retailers are the primary beneficiaries of a healthy credit card industry, given the importance of credit cards in facilitating millions of consumer purchases and in increasing retailers’ sales," it said. "Anything that undermines the credit card business will, eventually, harm retailers."
MasterCard plans to appeal the OFT’s decision and says it will continue to work to defend the interests of its cardholders, retailers and members. It says it is confident that the OFT’s decision will ultimately be reversed.
As for the fact that MasterCard last year took over from its UK members the responsibility for setting default interchange fees, MasterCard said that, if the OFT challenges the current arrangements, MasterCard is equally confident that those arrangements would ultimately be vindicated.
The OFT is currently investigating an agreement between Visa members on the UK domestic multi-lateral interchange fee applying to Visa transactions. While the OFT stressed that today's decision makes findings only in relation to the MasterCard agreement, it commented: "where the OFT applies competition law to other interchange fee arrangements, it expects to do so in a consistent manner."
