Friday, August 27, 2021
In separate letters to the Fed, the two agencies gave a thumbs up to a Fed proposal clarifying its rules on debit routing choice, but suggested the rules should explicitly prohibit “routing-based incentives.” “Eliminating routing-based incentive programs will make it less likely that issuers will search for ways to circumvent Regulation II,” the FTC wrote. The letter was signed by chiefs of the agency’s competition, economics and consumer protection bureaus.
Reg II is the rule set that carries out the dictates of the Durbin Amendment to the Dodd-Frank Act. The most notable component of the regulation caps debit interchange rates at 0.05 percent plus 22 cents for cards issued by financial institutions with $10 billion or more in assets. It applies to both card-present and card-not-present debit transactions.
The regulation also prohibits exclusivity arrangements between debit card issuers and networks, by mandating that at least two unaffiliated networks be made available to merchants for processing debit card payments.
In the 10 years since Reg II took effect debit card payments have taken off, tripling from 56.5 billion in 2012 to 86.4 billion in 2018, according to the Fed’s data. And for the last year and a half, CNP debit card payments have taken off, as consumers flocked to online shopping outlets. The PULSE EFT network, reported that CNP transactions rose 23 percent in 2020, and that CNP transactions now account for one in three debit card payments.
In tandem with this growth, regional EFT networks (think Shazam, PULSE, Star) have developed PINless debit technology. As the name implies, this technology supports processing debit cards through those networks without PINs. When used in an online environment, cardholders are authenticated using address verification service (AVS) and/or card verification values (CVV), as is the case with online credit card purchases. Contactless debit card payments can also be accommodated on these networks provided the EMV chips are programmed to support PINless debit.
The problem is that many debit cards are not programmed to support PINless debit, forcing merchants to process these transactions through the Visa and Mastercard networks. PULSE, for example, found that half of debit card issuers subject to Reg II had no payments using debit cards they issued processing through regional EFT networks. The DOJ said its analysis shows that the Visa and Mastercard networks, combined, process 75 percent of all debit card transactions and 90 percent of all online debit card payments.
Merchants have been so irate over the lack of choice in debit card routing that in 2020 they prevailed upon Sen. Dick Durbin, D-Ill., and author of the Durbin Amendment, to seek a federal investigation into whether the card brands and issuers are conspiring to keep merchants from processing debit card payments through the regional EFT networks.
The proposed change to the Fed’s Reg II – actually a change to the official commentary explaining the regulation’s dictates – seems to address Durbin’s concerns. It makes clear that the exclusivity rule applies to CNP as well as card-present debit transactions, and that issuers are responsible for making sure at least two unaffiliated networks are enabled on their cards to support merchant choice.
The Fed said its analysis indicates a “low prevalence” of CNP payments over single-message networks (i.e.: regional EFT networks) “may have occurred because issuers have not consistently enabled single-message networks for card-not-present transactions.”
The proposed change in commentary language “is not intended to impose new obligations with respect to card-not-present transactions, but rather to clarify the regulation’s applicability to those transactions,” the Fed staff wrote in the May request for comment. Public comments on the proposal were due earlier this month.
The FTC and DOJ delivered comment letters supporting the proposal, but said more needs to be done. The proposal “is one step among many that could be taken to address the lack of competitiveness in the debit card market,” DOJ antitrust attorneys wrote.
The FTC was more specific, requesting the Fed specifically prohibit networks from using routing-based incentives that inhibit merchant routing choice. “As experience with CNP transactions has demonstrated, it is difficult to predict in advance all the ways that issuers and networks might devise to inhibit merchant routing choice,” the FTC wrote.
Trade groups representing financial institutions, as well as some individual FIs strongly oppose the change. A comment letter signed by leaders of six trade groups (including the American Bankers Association, Consumer Bankers Association and the National Association of Federal Credit Unions), said the proposal calls for “distracting, expensive, time-consuming efforts to change our core network infrastructure.”
The 17-page letter also took a swipe at retailers. “The proposal is particularly surprising given that the primary beneficiaries of the Board’s action would be large multinational retailers that have experienced double-digit profitability increases during the pandemic, not small businesses,” it stated. The letter cited a New York Times report that better than two-thirds (68 percent) of all ecommerce sales are concentrated with just 10 large retailers, and its own estimates that major retailers would see a “windfall” of $27 billion over the next 10 years, at the expense of debit card issuers, if the proposed change in language were adopted.
The group also argued that the proposal could prove a windfall for identity thieves by forcing issuers “to accept services from networks that have not proven their ability to handle fraud security” for CNP payments.
The group asked the Fed to withdraw the proposal. If the Fed goes ahead with the proposed change, the FI groups requested it first make several changes, including specifying the exact transaction types that are covered and a four-year lead time to comply.
In its request for comment, the Fed also highlighted trends in debit card interchange. It found that interchange fees have remained relatively unchanged among issuers covered by the regulation at between 22 cents and 24 cents per transaction since the caps took effect. By contrast, average interchange collected by exempt FIs for dual-message transactions rose from 51 cents in 2011 to 54 cents in 2019. Debit card payments routed through single-message networks fell from 31 cents to 25 cents, the Fed reported.
Dual-message transactions are processed in two steps, and are commonly associated with signature authorization. Single-message transactions, more common to regional EFT networks, require PIN entry and issuer validation of the entered PIN. PINless debit technology was developed to replace PIN entry and issuer validation with other fraud mitigation techniques. Many regional EFT networks, however, also incorporate dual-message features. 
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