UK PSR seeks input on proposed interchange fee cap

What are the key takeaways?

As of January 2021, the EU Interchange Fee Regulations (EU IFR) ceased to apply to cross-border transactions between the UK and EEA countries. As a result, Visa and Mastercard were able to increase their UK-EEA interchange fee for card-not-present transactions from 0.2% to 1.15% for consumer debit card transactions, and from 0.3% to 1.5% for consumer credit card transactions. 

In the final report, the PSR sets out its position that the card scheme market is not operating to the benefit of all participants because there is insufficient competition to drive down the fees set by Visa and Mastercard. Merchants and acquirers could exert pressure to drive down interchange fees, but this does not happen because:

• Acquirers pass on almost the entirety of the interchange fee to merchants, so have little economic incentive to challenge the card schemes as interchange fees apply equally to all acquirers (particularly as there is a business need to offer both Visa and Mastercard).
• The widespread use of Visa and Mastercard means merchants must accept them and lack any real negotiating power.

The PSR estimates that the increased fees cost UK businesses £150 - 200 million per year in 2022 and 2023, with 95% of the increase in the interchange fee being passed through to merchants. The PSR also finds a lack of corresponding service improvement, so concludes that the increased fees are harming market users and indicate suboptimal market operation. 

The only potential remedy deemed to be effective is a price cap. Whilst this would not solve the issue of the market operating poorly, it would protect service users from the negative effects. A two-stage approach is suggested, with an initial cap at the EU IFR level, and a second cap being introduced once further research has been conducted into the methodology and level of the cap. 

The consultation on the proposed remedy is open until 7 February 2025. 

Background to the report

The PSR has been concerned about the operation of the market for card-acquiring services for some time. This market review followed the PSR’s Market review into card-acquiring services (MR18/1.8), published in November 2021. A key finding of MR18/1.8 was that certain cross-border interchange fees had increased significantly since the Brexit transition period ended on 31 December 2020. At the end of the transition period, the EU IFR ceased to apply, which had capped interchange fees at 0.2% of the transaction value for transactions where the card is present, and 0.3% where the card is not present. By April 2022, the card schemes increased the interchange fees for UK-EEA card-not-present transactions to 1.15% for consumer debit cards, and 1.5% for consumer credit cards. 

In response to the fivefold increase in card-not-present interchange fees, the PSR launched a Market review of UK-EEA consumer cross-border interchange fees in October 2022. An interim market report (MR22/2.6) was published in December 2023, and a consultation paper (MR22/1.9) on the report was published in May 2024 (see our analysis here). The provisional conclusion in the interim report was that the card scheme market exhibits characteristics consistent with a lack of effective competition, with higher profit margins and poorer non-price outcomes for service users than would be expected in a well-operating, competitive market. Potential remedies proposed included (i) increasing competition to Visa and Mastercard through increasing the use of alternative payment methods, (ii) encouraging merchants to steer customers to other payment methods, (iii) changing the card scheme rules to enable UK acquirers to partner with EEA merchants so that UK-EEA transactions would be classified as domestic EEA transactions, and (iv) imposing a price cap for interchange fees. 

The final report largely confirmed the findings of the interim report, before determining the question of remedial approach left open in the interim report by concluding that a price cap is the only viable solution. 

Findings

The payments market

• Credit and debit cards are the payment methods most used by UK consumers, comprising 61% of total payments in the UK by volume in 2023. Of these card transactions, 3.6% were UK-EEA cross-border transactions. Visa and Mastercard together accounted for 99% of the volume and value of payments made with debit and credit cards issued in the UK. As Visa and Mastercard set a default interchange fee that acquirers pay to issuers, which the acquirers pass on to merchants in the merchant service charge (MSC), the MSC for almost all UK-EEA card transactions has increased fivefold.
• The increase in interchange fees cost UK acquirers an additional £150 million to £200 million per year in 2022 and 2023. Going forward, the PSR anticipates the extra costs to remain in this range.
• Acquirers passed an estimated 95% of the additional cost on to their merchants. The PSR has not estimated what proportion was then passed on to consumers, but the burden has been shared in the form of both higher prices and lower margins.

Lack of downward pressure on interchange fees

• There is a lack of competitive pressure in the interchange fee market. Competitive markets drive down prices for consumers (in this case, the merchants paying the MSC) as sellers (in this case, Visa and Mastercard) compete on price to increase their market share. The lack of such competitive pressure has led to the high interchange fees.
• The lack of downward pressure on interchange fees has three causes: 

1. The card scheme market is a duopoly dominated by Visa and Mastercard. The structure of the market is such that the PSR describes the two card schemes as having “must-take” status among merchants and acquirers, enabling them to act without effective constraints. Merchants and acquirers have very little leverage over the card schemes as the card market is such that they must offer Visa and Mastercard services to their clients; to do otherwise would lose them so much business it is not a real option – a fact known to Visa and Mastercard. 
2. Acquirers pass on almost all of the increase in interchange fees to the merchants they service, meaning they experience minimal financial effects and also have no incentive to seek lower interchange fees. Interchange fees apply to merchants uniformly so there is no price differentiation between them. 
3. Whilst merchants are permitted to steer customers to alternative payment methods, these are not sufficiently popular for this to have a significant effect. Further, merchants cannot be discerning about which types of card transactions they accept due to the card scheme’s “Honour All Cards” rule, which prohibits merchants who accept Visa or Mastercard cards for domestic payments from refusing to accept similar cards in a cross-border context.

• For some very large merchants, there are alternatives to paying the increased interchange fees. Sufficiently large merchants can negotiate lower interchange fees with the card schemes, and for merchants with large enough value sales it is economically viable to relocate to the EEA and avoid cross-border transactions entirely. However, both of these options apply to a tiny minority of merchants.  
• Aside from their own profit-maximising interests, the only interests the card schemes took into consideration were those of the issuing banks, who benefit from higher interchange fees and to whom the card schemes wished to remain attractive in their two-supplier market. This exerts an upward pressure on interchange fees which, with no countervailing downward pressure, has caused fees to increase.

The PSR considers the new fees to be “unduly high”

The card schemes argued to the PSR that the new interchange fees were more appropriate than those in place before January 2021. 

This argument was rejected by the PSR on the basis that:

• Neither Visa nor Mastercard conducted any analysis to establish that increases were required. The rates adopted were chosen to align with those used for transactions between EEA countries and the rest of the world, set in 2019. The considerations in setting these rates were not the same as those which should have been taken into account for UK-EEA transactions, which have characteristics more similar to EEA-EEA transactions as the UK remained a member of the Single Euro Payments Area after Brexit so retains access to the cross-border payments infrastructure. 
• The card schemes argued that the higher levels of interchange fees still left card-not-present transactions less expensive than alternative payment methods (and so should be even higher than the rates set during 2021). The PSR rejected this analysis on the basis that some of the comparators are not genuine alternatives (e.g. Apple Pay), and others had costs that were, at least in part, directly related to fees imposed by Visa and Mastercard (e.g. PayPal Digital Wallet). The PSR’s own methodology indicated that interchange fees had been raised unduly high.
• The PSR also rejected arguments from the card schemes that the increased fees were necessary to incentivise more fraud protection, as there has been no evidence of the fee money being invested this way, or evidence that fraud levels have reduced since the fees were raised.
• There was no evidence that the pre-January 2021 levels had any detrimental impact on service users. As the schemes have not provided any reason to think that operational costs have changed since Brexit, the new rates are significantly above the costs card issuers incur for UK-EEA card-not-present transactions.

The PSR therefore took the view that the only reason for the increase in interchange fees was the removal of the cap imposed by the EU IFR. Further, the increase did not improve the operation of the market by reducing fraud, fostering innovation or improving services. As such, the increased interchange fee levels are unduly high. 

It should be noted that the PSR has not conducted its own analysis to determine an appropriate level for interchange fees, nor has the regulator given any indication that this work will be undertaken. 

Proposed Remedies

In response to its findings that constraints on Visa and Mastercard are lacking, leading to the market not functioning well and causing harm to service users, the PSR has concluded that the only effective remedy would be a price cap. 

The arguments that have led to this conclusion are:

• A price cap would ensure that the unduly high cross-border interchange fees are reduced, alleviating (some of) the burden placed on merchants and consumers.
• As there have been no market benefits to the card schemes unilaterally increasing the interchange fees, there would similarly be no detriment to service users if the card schemes were forced to reduce these fees.
• The market dominance of Visa and Mastercard makes it very difficult to implement effective measures to promote competition.

The PSR proposes a two-stage intervention. The first stage would be a time-limited cap at the same level as the EU IFR (0.2% for card-not-present consumer debit transactions and 0.3% for card-not-present consumer credit transactions). During the first stage, the PSR would establish a methodology and conduct analysis to determine where the UK should set its interchange fee cap, which would be implemented at the end of the first stage. 

Next steps

Alongside the final report, the PSR has published a consultation paper seeking stakeholder feedback on:

• Whether a two-stage price cap is appropriate – in particular, any evidence as to the likely impact on investment, innovation and consumer protection.
• The proposal for the stage one cap, including setting it at EU IFR levels.
• The considerations that have informed the PSRs views, draft cost-benefit analysis, and draft direction (included in CP24/14).

A list of ten detailed questions can be found on pages 60-61 of CP24/14. 

Should the PSR decide to implement its two-stage proposed remedy, it will launch a consultation on developing a methodology for calculating the stage two price cap. 

The consultation closes to comments at 5pm on 7 February 2025. If you would like to discuss submitting a comment, or any aspect of the final report, card schemes and processing fees more broadly, please get in touch with one of the people listed above or your usual Hogan Lovells contact.

Authored by Dan Park.