By Leo Arzumanyan
Global Legal Law Firm
On February 20, 2024, Capital One Financial Corp. shook the financial landscape by announcing its ambitious plan to acquire its rival Discover Financial Services in a landmark $35.3 billion all-stock transaction (see investor.capitalone.com/news-releases/news-release-details/capital-one-acquire-discover).
This proposed merger, if approved by regulators, will herald the convergence of two giants in the credit card industry, promising significant implications for consumers, businesses and the broader financial and electronic payments ecosystem.
Capital One's bid to acquire Discover marks a pivotal moment in the realm of credit card companies. The amalgamation of these two industry powerhouses promises to create a formidable entity, potentially rivaling the dominance of Visa and Mastercard. With an expected closure in late 2024 or early 2025, the merger underscores Capital One's strategic vision to fortify its position in the market and challenge the status quo.
Despite the potential benefits touted by Capital One and Discover, such as an increase in competition and financial stability, concerns loom large regarding the implications of this merger (see www.reuters.com/markets/deals/capone-tells-regulators-discover-deal-will-boost-competition-stability-sources-2024-03-21/).
In a recent regulatory filing, Capital One argues that the merger will not harm credit card competition because the combined entity will account for roughly 13 percent of credit card purchasing volume, which Capital One reportedly claims is the best measure of credit card market share.
However, some government officials and consumer advocates argue to the contrary, fearing that reduced competition in an already-concentrated industry could pave the way for higher fees and interest rates for cardholders. On the other hand, proponents of the merger argue that it may usher in an era of enhanced credit card rewards, among other benefits not yet realized.
The impending regulatory scrutiny by entities such as the Federal Trade Commission and the Treasury Department's Office of the Comptroller of the Currency reflects the gravity of this proposed merger. Additionally, Capital One and Discover will have to deal with the Biden administration, which has placed M&A activity under strict scrutiny, with the Department of Justice issuing new guidelines in 2023 that take a tougher stance on deals in highly concentrated markets.
This legislative backdrop underscores the evolving regulatory landscape and the interplay between market dynamics and policy imperatives.
Central to the proposed merger between Capital One and Discover is the latter's operation of its own payment network. Discover's dual role as both a major credit issuer and a network provider holds profound implications for the payment ecosystem. By integrating Discover's payment network into its portfolio, Capital One stands poised to gain a significant foothold in the payment network arena, thereby challenging the established dominance of Visa and Mastercard.
This strategic move positions Capital One as a formidable player capable of leveraging its dual role to streamline payment processes, enhance operational efficiency and potentially reduce reliance on third-party payment networks. With the ability to directly control payment network rails, Capital One can unlock synergies, drive innovation, and offer enhanced value propositions to consumers and merchants alike.
Moreover, by consolidating its position as both a credit issuer and a network operator, Capital One stands to bolster its competitive edge, expand its market reach, and capitalize on emerging opportunities in the evolving payments landscape. As such, the merger between Capital One and Discover represents a pivotal moment in the evolution of payment network dynamics, with far-reaching implications for industry stakeholders and the broader financial ecosystem.
Notably, thanks to a unique loophole in the credit-card industry, Discover possesses the ability to offer consumers cash-back rewards on their debit cards, a privilege not extended to Visa and Mastercard.
This loophole stems from the 2010 Durbin Amendment, part of the Dodd-Frank reforms enacted after the financial crisis. The Durbin Amendment capped interchange fees on debit cards for large banks (see www.federalreserve.gov/supervisionreg/regiicg.htm), prompting banks to halt rewards for debit-card purchases due to squeezed profit margins.
However, the Durbin Amendment solely applies to open networks like Visa and Mastercard that collaborate with multiple banks, leaving proprietary networks like Discover and American Express unaffected.
As a result of the foregoing, Capital One could potentially issue rewards debit cards through Discover, making it more attractive to a wider range of customers. Additionally, the planned merger represents a rare instance of vertical integration within the U.S. payments industry. This integration offers direct connections to merchants and adds to fee income that would typically flow to entities like the Mastercard and Visa networks.
Given that Discover’s network operates independently of the debit interchange pricing rules established by the Durbin Amendment, Capital One (by virtue of the merger if it is approved) will set itself apart from third-party networks such as Mastercard and Visa. This distinction arises from Discover and American Express functioning as both card issuers and network operators, allowing them to engage directly with merchants. Discover's dual role as a credit card issuer and a payment network operator adds an intriguing dimension to the merger.
By integrating Discover's payment network into its arsenal, Capital One aims to challenge the duopoly of Visa and Mastercard. This move not only signals a shift in market dynamics but also holds the potential to redefine industry standards and reshape consumer preferences.
Finally, the proposed acquisition not only represents a significant strategic move within the financial sector but also carries profound implications in terms of market share and industry dominance. According to data from the U.S. Consumer Financial Protection Bureau, Visa held a commanding market share of 48 percent of credit cards in circulation by the end of 2021, while Mastercard accounted for approximately 36 percent (see www.consumerfinance.gov/data-research/research-reports/consumer-credit-card-market-2022/ ).
Discover and American Express jointly constituted the remaining 16 percent of credit cards. However, per GlobalData’s “Payment Card Analytics,” if regulators green light the merger, Capital One's acquisition of Discover would create a formidable entity boasting close to 191 million credit cards, surpassing JPMorgan Chase as the largest issuer in the country (see www.globaldata.com/newsletter/details/capital-one-and-discover-merger-will-displace-jpmorgan-chase-as-the-largest-credit-card-issuer-in-the-us_69418/).
This statistical prowess, coupled with Capital One's position as the second-largest issuer with 126.5 million credit cards and Discover's 64.5 million cards, underscores the seismic impact of this consolidation. These insights underscore the transformative potential of this merger, positioning Capital One as a formidable competitor capable of challenging the dominance of established players like Mastercard and Visa, while also enhancing its bargaining power in negotiations over interchange fees with merchants.
As the regulatory saga unfolds, the ultimate impact of the merger on consumers and businesses remains uncertain. However, it presents an opportune moment for stakeholders to assess their strategies and navigate potential disruptions. Whether it leads to a boon or a bane for consumers, the merger underscores Capital One's quest for market supremacy and sets the stage for a potential paradigm shift in the credit card industry.
While the Capital One-Discover merger holds the promise of reshaping the electronic payments industry, its ramifications extend far beyond the boardrooms. As stakeholders brace themselves for a new era of competition and innovation, initiative-taking engagement and informed decision-making will be key to navigating the evolving landscape of financial services.
Note: This article is for informational purposes only and does not constitute legal advice. Readers are encouraged to seek professional legal counsel regarding their specific circumstances. 
This article is for informational purposes only and does not constitute legal advice. Leo Arzumanyan Esq. is a corporate transactional attorney at Global Legal Law Firm, with expertise in a vast spectrum of transactional and compliance matters. An alumnus of the University of San Diego, School of Law, Arzumanyan has a proven track record of drafting, reviewing, revising and negotiating an extensive array of commercial contracts, including vendor, nondisclosure, employment, software-as-a-service, consulting and marketing agreements. Leveraging his prior in-house counsel background, Arzumanyan has also carved out a unique niche within the electronic payments industry as his transactional expertise now encompasses merchant processing, merchant banking and sponsorship, referral, independent sales office, and other related agency agreements. Contact him at larzumanyan@glrlegal.com.
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