separating issuers from acquirers and profit limitations...
TRANSCRIPT
1
The Faculty of Law
The Zvi Meitar Center for Advanced Legal Studies
Separating Issuers from Acquirers
And Profit Limitations
In Payment Card Networks with Interchange Fees
By: Ori BarAm
Supervisor: Professor David Gilo
Thesis for the title "Doctor of Philosophy"
Submitted to the Senate of Tel Aviv University on August 3, 2017
2
פקולטה למשפטיםה
מרכז צבי מיתר ללימודי משפט מתקדם
פיצול סליקה והנפקה ומגבלות על רווחים
ברשתות כרטיסי חיוב עם עמלה צולבת
מאת: אורי ברעם דיויד גילה מנחה: פרופ'
חיבור לשם קבלת התואר "דוקטור לפילוסופיה"
2017 אוגוסטב 3יום אביב ב-הוגש לסנאט של אוניברסיטת תל
3
INDEX 1. INTRODUCTION .................................................................................................................................... 6
PART I - BACKGROUND ................................................................................................................................ 10
2. BASIC TERMS ................................................................................................................................... 10 2.1.THE CARDS .......................................................................................................................................... 10
Credit Cards ..................................................................................................................... 10 Bank Cards ..................................................................................................................... 11 Prepaid Cards ..................................................................................................................... 13
2.2.THE PARTIES ........................................................................................................................................ 14 Issuer ..................................................................................................................... 14 Acquirer ..................................................................................................................... 15 Merchants and Cardholders ..................................................................................................................... 17
2.3.THE FEES ............................................................................................................................................. 18 Cardholder Fee ..................................................................................................................... 18 The Merchant Service Fee (“MSF”) ....................................................................................... 19 The Interchange Fee ..................................................................................................................... 20 The Acquiring Fee ..................................................................................................................... 23
2.4. OPEN AND CLOSED NETWORKS .......................................................................................................... 23 “On-Us” Transactions ..................................................................................................................... 25 Price Level and Price Structure ..................................................................................... 25 The International Organizations ............................................................................................. 26
3. PAYMENT CARDS MARKET DATA ................................................................................................................................ 30 3.1.ISRAEL ........................................................................................................................................ 30 3.2.WORLDWIDE ......................................................................................................................................... 34
4. HISTORY OF PAYMENT CARDS AND INTERCHANGE FEES ........................................................................................... 38 4.1.HISTORICAL DEVELOPMENT OF OPEN NETWORKS ............................................................................. 41 4.2 HISTORY OF DEBIT CARDS AND ATMS ......................................................................................... 50 4.3.INTERIM SUMMARY ............................................................................................................................... 58
PART II - ECONOMIC ANALYSIS .................................................................................................................... 59
5. COSTS AND BENEFITS OF PAYMENT INSTRUMENTS ................................................................................................... 59 5.1.COSTS OF PAYMENT INSTRUMENTS ..................................................................................................... 60 5.2.BENEFITS OF PAYMENT INSTRUMENTS ................................................................................................ 66 5.3. CASH .................................................................................................................................................... 71 5.4.PAYMENT CARDS ................................................................................................................................. 74
Costs ..................................................................................................................... 74 Benefits ..................................................................................................................... 75
6. THE ECONOMIC MODELS ................................................................................................................................... 78 6.1.INTRODUCTION ..................................................................................................................................... 78 6.2. THE MODEL OF BAXTER - BALANCING COSTS .................................................................................................................... 81 6.3. INTERCHANGE FEE TO BALANCE DEMANDS ........................................................................................ 84 6.4.ROCHET & TIROLE – STRATEGIC CONSIDERATIONS ........................................................................... 87
The Restraining Role Of The Interchange Fee .................................................................... 96 Concern of Oversupply ..................................................................................................................... 98 Additional Developments And Criticism ................................................................................ 99
6.5 NEUTRALITY, SURCHARGE AND MERCHANT RESTRAINTS ............................................................ 103 The Literature In Favor Of NSR .................................................................................. 107 Other Models ................................................................................................................... 110
6.6. PAYMENT CARD COMPETITION .......................................................................................................... 119 Multihoming Analysis ................................................................................................................... 123 Multihoming Merchants And Singlehoming Customers .................................................... 125 Competition on Issuers ................................................................................................................... 132 Competition Between Open And Closed Networks ........................................................... 134
6.7. CARDHOLDER FEES AND REWARDS .................................................................................................. 137 6.8. DEBIT V. CREDIT ................................................................................................................................. 148 6.9. DETERMINATION OF THE OPTIMAL INTERCHANGE FEE ..................................................................... 155
Defining The Standard For Optimal Interchange Fees ..................................................... 158 Privately Optimal Interchange fee ........................................................................................ 159 Socially Optimal Interchange fee ......................................................................................... 163
4
Consumer Welfare Optimal Interchange Fee .................................................................... 167 7. THE SPECIAL FEATURES OF THE INTERCHANGE FEE .................................................................................................. 171
7.1. TWO-SIDED NETWORK PRODUCTS ................................................................................................... 171 Network Products ................................................................................................................... 171 Two-Sided Products ................................................................................................................... 174
7.2.EXTERNALITIES ................................................................................................................................... 175 Network Externality ................................................................................................................... 176 Usage Externality ................................................................................................................... 177
7.3.INTERCHANGE FEE AS A MECHANISM TO INTERNALIZE NETWORK EXTERNALITY ........................... 178 7.4. NEGATION OF THE NETWORK EXTERNALITY JUSTIFICATION ........................................................... 187 7.5. USAGE EXTERNALITY JUSTIFICATION ................................................................................................ 192
PART III – REGULATION AND LEGAL ANALYSIS ............................................................................................................. 200 8.REGULATION OF INTERCHANGE FEES AROUND THE WORLD .................................................................................... 200
8.1.ISRAEL ................................................................................................................................................ 200 Criticism Of The Cost-Based Methodology ........................................................................ 208 Regulation of Isracard ................................................................................................................... 215 Categories Of Interchange Fees .......................................................................................... 219 Debit Cards In Israel ................................................................................................................... 226 No Smart Acquiring (EMV) ................................................................................................................... 231 Market Concentration ................................................................................................................... 231 Single Routing Option ................................................................................................................... 233
8.2. EUROPE ........................................................................................................................................ 235 The Tourist Test ................................................................................................................... 244 Criticism Of The Tourist Test ................................................................................................ 246
8.3. UNITED STATES ............................................................................................................................ 248 Market Power ................................................................................................................... 250 Cost Coverage ................................................................................................................... 253 The interchange Fee As Internal Transfer .......................................................................... 254 Bilateral Agreements ................................................................................................................... 255 Issuers’ Extortion Position ................................................................................................................... 256 The Elimination Of Issuing Prohibitions .............................................................................. 258 Partial Cancellation Of The HAC Rule ................................................................................ 259 Interchange Fee Settlement ................................................................................................................... 261 The Durbin Amendment And Other Reforms ..................................................................... 262
Routing Reform ................................................................................................................... 267 Cancelation Of Merchant Restraints ................................................................................... 268 The Effects Of The Reform ................................................................................................... 269
8.4.AUSTRALIA .......................................................................................................................................... 271 8.5.ROMANIA ............................................................................................................................................ 276 8.6.NEW ZEALAND .................................................................................................................................... 277 8.7.OTHER COUNTRIES ............................................................................................................................. 279
9. THE RESTRICTIVE ARRANGEMENT – LEGAL ASSESSMENT ........................................................................................ 282 9.1. “BYLAWS” INTERCHANGE FEE ............................................................................................................ 288 9.2. ADAPTATION TO EXISTING INTERCHANGE FEE ................................................................................. 291
10. THE COMPETITIVE CONCERNS ................................................................................................................................. 293 10.1. PRICE INCREASE ................................................................................................................................ 293 10.2. CROSS-SUBSIDIZATION ...................................................................................................................... 294 10.3. OVERUSE AND OVER-ISSUANCE ....................................................................................................... 297
Over-Usage ................................................................................................................... 298 Over-Issuance Of Cards ................................................................................................................... 301
10.4. RAISING ENTRY BARRIERS ................................................................................................................ 302 11. WHY MERCHANTS DO NOT SURCHARGE ................................................................................................................ 303
11.1. UNCERTAINTY AS TO THE APPROPRIATE SURCHARGE .................................................................... 304 Surcharging The Difference Between Price And Benefits ............................................... 305 Surcharging The Difference Between Price And Costs .................................................... 306 Free Surcharging ................................................................................................................... 306
11.2. MERCHANT RESTRAINTS .................................................................................................................... 308 NSR ................................................................................................................... 309 HAC ................................................................................................................... 311
5
11.3 STRATEGIC CONSIDERATIONS ................................................................................................................. 313 11.4. SURCHARGING IS COSTLY ................................................................................................................. 314 11.5. PSYCHOLOGICAL REASONS ............................................................................................................... 315 11.6. SMALL COST DIFFERENCES DO NOT JUSTIFY SURCHARGES .......................................................... 316 11.7. OTHER REASONS ............................................................................................................................... 317
12. ALTERNATIVES TO THE INTERCHANGE FEE ............................................................................................................. 319 12.1. BILATERAL INTERCHANGE FEE .......................................................................................................... 319 12.2. ZERO INTERCHANGE FEE ................................................................................................................... 322 12.3. SPLIT .................................................................................................................................................. 324 12.4. MULTI-CARDS ..................................................................................................................................... 326
PART IV – NEW PROPOSALS ........................................................................................................................ 329
13. NOVELTY #1 – STRUCTURAL SEPARATION .............................................................................................................. 329 13.1. THE DE FACTO PREVALENCE OF THE NAWI RULE ......................................................................... 330
Israel ................................................................................................................... 330 Europe ................................................................................................................... 333 United States ................................................................................................................... 335 Other Countries ................................................................................................................... 336 NAWI Rule in the Bylaws of the International Organizations ........................................... 338
13.2.PROPOSAL TO SEPARATE ACQUIRERS FROM ISSUERS ..................................................................... 339 13.3.MITIGATING COMPETITIVE CONCERNS .............................................................................................. 353 13.4. DIVESTITURE AS PART OF REGULATION ........................................................................................... 357 13.5. DIVESTITURE AS AN ANTITRUST REMEDY ........................................................................................... 363 13.6. FINAL REMARKS .................................................................................................................................. 368
14. NOVELTY # 2 PROFIT LIMITATION ........................................................................................................................... 369 14.1.PAR CLEARANCE OF CHECKS ............................................................................................................ 370 14.2.PROFIT LIMITATION ............................................................................................................................. 374 14.3. PRECEDENTS ...................................................................................................................................... 385 14.4. ADDITIONAL REMARKS ....................................................................................................................... 389 14.5. RECIPROCAL RELATIONS BETWEEN MY PROPOSALS ....................................................................... 394
15. SUMMARY ................................................................................................................................. 395
6
1. Introduction
1. Payment cards, like cash and checks, are payment instruments. Payment instruments are not an
ordinary commodity, but rather an important production factor in the economy.1 Payment
instruments enable the execution of transactions and can be considered as the “plumbing” of
the economy.2 Enhancing the efficiency of payment instruments reduces transaction costs and
improves market performance.3
In the past, cash was the only way to preform transactions. As a result, many efficient
transactions never took place because of liquidity constraints. People often did not carry
substantial amounts of money. This situation incentivized the development of alternative
payment methods, particularly promissory notes and checks.4
2. During the second half of the twentieth century a new payment instrument evolved, the credit
card. Credit cards were a revolution in the field of payments. They enabled customers to pay
without the need for cash. Compared to checks and promissory notes, in which the risk of
default falls on the merchant (the beneficiary in the note), credit cards offered merchants
guaranteed payment, convenience, documentation, control and monitoring of transactions.
Credit cards enabled customers to purchase products and services with future money that they
did not yet possess at the time of the transaction.
3. Payment card networks have improved over the years and become more sophisticated.
Distribution of payment cards has grown worldwide, and a steep rise in usage has occurred.
As opposed to cash, which is a legal tender, produced and distributed by the state, there is no
obligation to accept payment cards, which are private payment instruments. No merchant is
obligated to accept them, and no customer is required to pay with them. To survive, payment
1 JACOB CHERTOF AND AMI TZADIK, CREDIT CARDS MARKET: ANALYSIS, REGULATION AND INTERNATIONAL
COMPARISON, KNESSET RESEARCH CENTER, at 1 (2010); Leo Van Hove, Central Banks and Payment Instruments: A
Serious Case of Schizophrenia, 66 COMMUNICATIONS & STRATEGIES 19, 19 (2007). 2 M. Charles Kahn & William Roberds, Why Pay? Introduction to Payment Economics, 18 J. FIN. INTERMEDIATION 1
(2009): "Payment systems are the plumbing of the economy"; Bank of Israel, Press Release, Speech of Governor Karnit
Flug in a Convention Money and Technology (March 26, 2014). 3 Iftekhar Hasan, Emmi Martikainen & Tuomas Takalo, Promoting Efficient Retail Payments in Europe, 20 Bank of
Finland Research Discussion Papers, at 1 (2014): “[A]s in the case of other infrastructures, the effects of more efficient
retail payment infrastructure are not limited to direct cost savings: there is evidence that such efficiency would also
yield indirect benefits by improving the supply chain, facilitating trade, boosting consumption, and enhancing bank
sector performance”. 4 For expansion see Alan S. Frankel, Monopoly and Competition in the Supply and Exchange of Money 66 ANTITRUST
L.J. 313 (1998); William F. Baxter, Bank Interchange of Transactional Paper: Legal and Economic Perspectives 26
J.L. ECON. 541 (1983).
7
cards had to reach a critical mass among both cardholders and merchants. Payment cards have
managed not only to survive, but also to thrive in this evolutionary process, by using their two-
sided network features. Payment card networks succeeded by extracting money from
merchants, who are considered less elastic (i.e., more eager to accept them), and by subsidizing
the adoption and usage of cards by the side with the higher elasticity, the cardholders.
Payment cards developed and gained market power without disruption for decades until
complaints about their high fees, particularly from merchants, invited scrutiny by regulators.
Authorities began to inspect the arrangements and the fees charged by payment card networks.
The main arrangement that regulators and competition authorities worldwide regulated was the
interchange fee that acquirers pay to issuers.
4. In every transaction made through a payment card, the merchant pays a fee to its acquirer. This
is the merchant service fee (“MSF”). The acquirer remits a major part of the MSF to the issuer
of the card, through which the transaction was performed. This is the interchange fee. The
interchange fee is the tool designed to deliver funds from the side of merchants to the side of
cardholders, but it also sets a floor for the MSF. Interchange fees alone account for billions of
dollars each year.
The interchange fee is a price which is set in a concerted agreement between issuers and
acquirers. As such, it falls under the category of a minimum price-fixing agreement between
competitors.5 Generally, antitrust regulators all over the world seek out and forbid minimum
price-fixing agreements between competitors. Nevertheless, payment cards have unique
features that entail different treatment under the law. Payment cards are two-sided network
products.6 The implication of their features yields a substantially different result compared to
other price fixing agreements.
Applying antitrust law to two-sided products, especially payment cards, as would be done to
“regular” products, can cause absurd consequences.7 To avoid such consequences, authorities
and regulators worldwide have approved interchange fees, even though they stem from
horizontal minimum price-fixing agreements between competitors.
5 Infra ch. 0. 6 Infra ch. 7. 7 Julian Wright, One-Sided Logic in Two-Sided Markets 3 REV. NETWORK ECON. 44 (2004); Jean-Charles Rochet &
Jean Tirole, Externalities and Regulation in Card Payment Systems 5 REV. NETWORK ECON. 1, at 1 (2006): "It is now
well-understood that the implementation of competition policy must be amended in order to reflect two-sidedness".
8
Acknowledgement of the special characteristics of payment cards is not the end of the story,
but rather its beginning. A distinction must be made between the “right” to charge an
interchange fee and the “rate” of that interchange fee.8 Even protection on basic rights is not
unlimited, all the more so the right to charge interchange fees does not mean that absolutely
any rate is legally protected. Even when the law accepts a restrictive arrangement, it may well
limit the size of it.9
Today, there appears to be a consensus that allowing payment card networks to privately
determine the rate of the interchange fee, results in a higher than optimal interchange fee.10 The
interchange fee is a cost for merchants. It is passed through to the prices of products and services
that merchants sell. Increase in the interchange fee causes a small but market-wide increase in
the final prices of goods. The interchange fee raises additional concerns.11
5. The consensus about the competitive concerns that the interchange fee raises disappears when
solutions to these concerns are considered. A wide variety of opinions and ideas exist as to the
best way to accomplish this. The topic is highly contentious.12
The simple approach suggests capping the interchange fee. In Europe, the cap is based on
demand features, primarily the alternative benefit to merchants from not having to accept cash
(avoided costs of cash or the "tourist test").13 In Israel, Australia and in the U.S. (for debit and
deferred debit cards), the cap is based on supply features, which are mainly the cost of the
payment guarantee and processing of transactions.14 Another approach to deal with the antitrust
concerns raised by the interchange is to allow merchants to surcharge card payments. This, in
8 Jean-Charles Rochet & Jean Tirole, Cooperation among Competitors: Some Economics of Payment Card
Associations, 33 RAND J. ECON. 549, 550 (2002): “Even if one accepts the existence of an interchange fee, one may still
be legitimately concerned that it might be set too high”. 9 For the difference between coverage and protection of rights in a different context, see HCJ 2194/06 Shinui Party v.
Head of Election Committee, para. 8 (Mar. 12, 2006). 10 Infra ¶ 395. 11 Infra ch. 10. 12 Wilko Bolt, Pricing, Competition and Innovation in Retail Payment Systems: A Brief Overview, 1 J. FIN. MARKET
INFRASTRUCTURE 73, 79 (2013): “While most economists agree – based on two-sided logic – that an interchange fee
may be necessary to balance the demands of consumers and merchants resulting in higher social welfare, the “right”
level of the fee remains a subject of debate”. See also ch. 8.3 for recent developments in interchange fee litigation in the
U.S.". 13 Infra ch. 8.2. 14 Infra chapters 8.1, 8.1.1 (Israel), 8.3.9 (U.S.), 8.4 (Australia).
9
theory, neutralizes the interchange fee.15 However, surcharging is not a common phenomenon
for reasons discussed below.16
6. My contribution to the burgeoning literature is to offer two independent ways to reduce, if not
eliminate, the antitrust concerns that the interchange fee raises. My first proposal is to separate
acquirers from issuers, and disconnect any interest of acquirers in the issuing side of payment
cards and vice versa. This proposal would eliminate the inherent conflict of interest of acquirers
that are also issuers, and enforce entrance of independent acquirers. Regulators and competition
authorities throughout the world try to enable such entrance but without success.17 My second
proposal is to condition approval of interchange fee on limitation of issuers' profits.18
Part I of this work is background. Chapter 2 explains the basic terms of the payment card
industry. Chapter 3 includes payment card market data. Chapter 4 describes the history of
interchange fee in credit, debit and prepaid transactions. Part II of the work is the economic
part. Chapter 5 introduces an analysis of the costs and benefits of payment instruments. Chapter
6 informally surveys relevant economic models, from the first model of Baxter, via the strategic
considerations of Rochet & Tirole, models of neutrality and surcharging, models of network
competition, models of the relations between rewards and cardholder fees, models of credit vs.
debit and models describing the determination of the optimal interchange fee. Chapter 7
explains the distinctive features of payment cards as a two-sided network product, and the
phenomena of network and usage externalities which entail the approval of interchange fee,
despite being a horizontal price fixing agreement between competitors. Part III is the legal part
of the work. Chapter 8 describes the existing regulation of the interchange fee in Israel and
around the world. Chapter 9 is a legal analysis of interchange fees. Chapter 10 explains the
competitive concerns interchange fee raises. Chapter 11 explains why merchants do not tend to
impose surcharges on expensive payment instruments. Chapter 12 investigates solutions to the
competitive concerns raised by the interchange fee. In part IV of the work I present my new
proposals. Chapter 13 presents my first innovation, i.e., separating issuers from acquirers.
Chapter 14 presents my second novelty, to limit profit of issuers who charge interchange fee.
Chapter 15 concludes the work.
15 Infra ch.6.5. 16 Infra ch.11. 17 Infra ch. 0. 18 Infra ch. 13.614.
10
It must be emphasized that my proposals are alternatives, and do not have to be implemented
together. The proposal to divest issuers from acquirers is a legislative proposal that would break
up the interchange fee from being a restrictive arrangement (apart from the minor joint
negotiation). The proposal to limit profits alleviates the competitive concerns from the
interchange fee. Each of the proposals suffices on its own.
Part I - Background
2. Basic Terms
2.1. The Cards
7. Israel's Payment Cards Law 5746 - 1986 defines a payment card as a plate or object for purchase
of assets (including services and rights). The common feature for all payment cards is that they
are all for reuse. Technology has made this definition anachronistic. A payment card can be
used in a completely virtual way, combined as software or hardware in smartphones or
electronic wallets.19
8. Common payment cards are plastic cards with a magnetic stripe that contains identification of
the cardholder and the issuer. There are few kinds of payment cards. The main difference
between them is the billing date of the cardholder, and the crediting date of the merchant.
Credit Cards
9. Credit cards are payment cards intended for purchase of assets without immediate payment.
Credit transactions enable cardholders to pay with money they are not carrying or even money
they do not yet have. A purchase with a credit card enables the cardholder to overcome liquidity
constraints.
In Israel, the main usage of credit cards is as deferred debit cards (known in the U.S. as charge
cards).20 The cardholder is charged for all purchases during a month, on a certain date in the
19 European Commission, Green Paper, Towards an Integrated European Market for Card, Internet and Mobile
Payments, at 1, COM (2011) 941 final (Jan. 11, 2012): “[T]he mass take-up of smart phones is changing the payments
landscape and is leading to new payment applications, for example electronic purses, replacing wallets and physical
cards, or virtual public transport tickets stored in a mobile phone”. 20 BANK OF ISRAEL, MARCHOT HATAHSLUMIM VEHASLIKA BEISRAEL, HASEFER HADOM (PAYMENT AND ACQUIRING
SYSTEMS IN ISRAEL, THE RED BOOK FOR 2014), at 29 (Nov. 8, 2015) (deferred debit is the most common card).
11
following month. Cardholders do not pay interest for the free funding period, which is, on
average, 17 days.21 Cardholders who defer payment are charged interest on their balance.22
10. Recent years have seen an increase in the dispersion of revolving cards. These are credit cards
on which the cardholder pays a monthly sum on part of the balance. The rest is postponed with
interest to later periods.23 In a revolving transaction, the merchant receives the sum of the
transaction in one payment. Thus, the issuer (and not the merchant), is the cardholder's credit
grantor.
11. Installment transactions are unique to Israel. These are credit transactions in which the
cardholder pays the sum of the transaction in monthly payments without interest. The merchant
also receives payment in the same monthly installments. Installment transactions are therefore
equivalent to as many regular transactions as the number of the installments. The merchant is
the one to extend credit to the cardholder in this kind of transaction.
Bank Cards
12. A bank card, as defined in the Payment Cards Law, enables the cardholder to purchase assets
by charging the account of the cardholder and correspondingly crediting the merchant’s
account. A bank card is a “pay-now” instrument. It immediately debits the related account and
credits the merchant’s account in the exact amount of the transaction. A transaction with a bank
card is similar to a transaction made with an ATM positioned at the cashier, in which the
cardholder withdraws the exact amount of the transaction and remits it immediately to the
merchant.
The law does not define “bank cards” properly because the main characteristic that
distinguishes a bank card from a credit card is not a “bank”, but rather the charge date. A better
definition is debit card.24
21 IAA, ISRAEL ANTITRUST AUTHORITY, HAGBARAT HAYEILUT VEHATAHARUT BETHUM KARTISEI HAHIUV
[ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR], FINAL REPORT, at 13, Antitrust
500680 (Sept. 8, 2014) (free funding period of 17 days on average). 22 Bank of Israel, THE RED BOOK, supra note 20; HAVAADA LEBHINAT TZIMZUM HASHIMUSH BEMEZUMAN BAMESHEK
HAISRAELI [THE COMMITTEE FOR EXAMINING REDUCTION OF CASH USAGE IN THE ISRAELI MARKET] (THE LOCKER
COMMITTEE), FINAL REPORT, at 48 (July 17, 2014); Sumit Agarwal et al., Regulating Consumer Financial Products:
Evidence from Credit Cards, at 5, SSRN eLibrary (Aug. 2014): “If an account holder pays off her purchase volume
completely, interest charges typically fall within a “grace period” and are not assessed by the bank. If the account holder
does not pay her balances in full, she is charged interest starting from the date of purchase”. 23 ISRACARD, 2014 ANNUAL REPORT, at 11, available at https://www.isracard.co.il/report/120021424.pdf . 24 BANK OF ISRAEL, RECOMMENDATIONS FOR ENHANCEMENT OF COMPETITION IN THE PAYMENT CARD SECTOR, FINAL
REPORT, at 9 (Feb. 2015); Santiago Carbo Valverde et al., Regulating Two-Sided Markets: An Empirical Investigation,
12
13. In Israel, debit card usage is negligible. Debit transactions amount to 1.4% of the volume of all
payment card transactions.25 The situation worldwide is opposite. Debit cards are widely used
in almost all countries.26 Even in the U.S., traditionally a "credit" nation, debit transactions
exceeded credit transactions.27
14. There are two main types of debit cards: signature debit and PIN debit. Only PIN debit
transactions are "pure" debit, in the sense that the transaction is completed immediately upon
payment. With signature debit transactions remittance to merchants occur after 1-3 days.28
The short delay of payment in signature debit makes signature debit a little riskier for issuers
than PIN debit transactions.29 PIN debit is a cheaper, faster and safer payment instrument than
at 19 (Fed. Res. Bank of Chicago Working Paper No. 09-11, 2009): "Debit cards allow consumers to access funds at
their financial institutions that are transferred to the merchants’ financial institutions and may be referred to as “pay
now” cards". 25 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 8. 26Infra ¶ 67. 27 Brad G. Hubbard, The Durbin Amendment, Two-Sided Markets, and Wealth Transfers: An Examination of
Unintended Consequences Three Years Later, at 11, SSRN (2013): “In the past decade, debits cards have been the
fastest growing payment method among noncash, retail, payment methods. Debit card usage was negligible in the early
nineties and represented 11.6 percent of all noncash payments by 2000. From 2000 to 2009, debit card usage grew by a
factor of 4.75… By 2009, debit cards ranked first in the total volume of noncash, retail payment methods, representing
35 percent of all payments... In 2003, for the first time, the aggregate dollar volume of Visa debit exceeded that of Visa
credit... Debit’s household penetration has also been extensive; in 1995 only 20 percent of households had debit cards;
by 2007, that number had increased to 71 percent. Perhaps most strikingly, in 2009, debit cards were used in 29.3
percent of all transactions, rendering them the most frequently used method of payment, eclipsing cash, credit cards,
and checks”. 28 FUMIKO HAYASHI ET AL., A GUIDE TO THE ATM AND DEBIT CARD INDUSTRY, Fed. Res. Bank of Kansas, at 8 (2003):
"[C]onsumer accounts are debited one or two days after the transaction".
Ron Borzekowski & Elizabeth k. Kiser, Consumers’ use of Debit Cards: Patterns, Preferences, and Price Response, 40
J. MONEY, CREDIT & BANK. 149 (2008); U.S. GOV'T ACCOUNTABILITY OFF., GAO-10-45, RISING INTERCHANGE FEES
HAVE INCREASED COSTS FOR MERCHANTS, BUT OPTIONS FOR REDUCING FEES POSE CHALLENGES, at 4 (2009); BANK OF
ISRAEL, THE RED BOOK, supra note 20 at 29 n. 37. 29 Robert M. Hunt, An Introduction to the Economics of Payment Card Networks, 2 REV. NETWORK ECON. 80, 83
(2003): "This delay creates some credit risk for the issuing bank because the cardholder may have insufficient funds in
her account at the time the transaction clears. So, unlike with ATM cards, banks offer signature debit cards only to
account holders that meet minimum credit standards".
13
signature debit.30 Also, empirical studies have found that fraud in signature debit is higher than
in PIN debit.31 All debit cards are less risky than credit cards.32
15. Until April 2016 Israel presented a distorted exception, as merchants were paid for debit
transactions after an average delay of 20 days (as if the transactions were deferred debit
transactions). Since April 1, 2016, this evil was corrected by Bank of Israel. Merchants are
credited for debit transactions within 1-3 days.33
16. Strictly speaking, signature debit cards are not “bank cards”, as defined in the Payment Cards
Law, because the cardholder is not debited immediately upon transaction. According to the
Law's precise definition, only PIN debit cards are bank cards. Signature debit cards are actually
accelerated charge cards.
In this work, I will use the term debit cards, as it is used in the literature, to describe signature
and PIN debit altogether, unless the context requires a distinction between them.
Prepaid Cards
17. Prepaid cards are also “a plate or object for reuse”. However, unlike debit or credit cards, in
which the cardholder pays after the transaction (credit) or in parallel with the transaction (debit),
with prepaid cards, the cardholder pays in advance.34 Prepaid cards can be used, like credit and
30 Fumiko Hayashi, The New Debit Card Regulations: Effects on Merchants, Consumers, and Payments System
Efficiency, 1 FRB KANSAS Q. REV. 89, 107 (2013): "PIN debit is less costly, more secure, and more preferred by
consumers than signature debit." Bank Of Israel, Chain of Transaction in Payment Card, at 43 (July 2016) 31 Board of Governors of the Fed. Res. System, Debit Card Interchange Fees and Routing, Final Rule, 77 Fed. Reg.
46258, 46261 (Aug. 3, 2012) (codified at 12 C.F.R. pt. 235): “Of the approximately $1.34 billion estimated industry-
wide fraud losses, about $1.11 billion of these losses arose from signature debit card transactions and about $181
million arose from PIN debit card transactions... on a per-dollar basis, signature debit fraud losses were approximately 4
times PIN debit fraud losses”;
FUMIKO HAYASHI ET AL., A GUIDE TO THE ATM AND DEBIT CARD INDUSTRY, 2006 UPDATE, at 21: "PIN debit
traditionally has been regarded as safer than signature debit, and three recent studies show that PIN debit has less fraud
than signature debit";
Oz Shy & Zhu Wang, Why do Payment Card Networks Charge Proportional Fees?, 101 AM. ECON. REV. 1575, 1577
(2011): "[D]ebit cards do not provide credit float and bear very small fraud risk, so there appears to be no cost basis for
charging proportional fees." 32 David A. Price & Zhu Wang, Why do Debit Card Networks Charge Percentage Fees?, footnote 3 (13-02 Fed. Res.
Bank of Richmond, 2013): “Fraud risk is much less for debit cards than for credit cards. According to industry studies,
the average net fraud loss to card issuers is 0.08 percent for credit card transactions, 0.05 percent for signature debit
card transactions, and 0.01 percent for PIN debit card transactions”. 33 Bank of Israel, Communication 2498-06-ח, Acquiring Payment Cards (Banking Proper Procedure, Instruction 472),
§13 (May 1, 2016). See also infra ¶ 18 and Ch. 8.1.4 (Debit Cards in Israel). 34 Mark Furletti, Prepaid Card Markets & Regulation, Fed. Res. Bank Phil., at 2 (2004): “Unlike credit cards, which
draw their value from a line of credit, or debit cards, which draw their value from a checking account, the value on a
prepaid card typically comes from money given to the card’s issuer (or a designee) prior to its use”;
Julia S. Cheney, Prepaid Cards: An Important Innovation in Financial Services, Fed. Res. Bank Phila. (2006): “Based
on a different business model than traditional credit and debit cards, prepaid cards require cardholders to “pay early” for
14
debit cards, for purchase of assets and also, like ATM cards, for withdrawal of money.35 Prepaid
cards are often used as a platform for specific purchases, such as transportation, restaurants,36
and gift cards.37 Prepaid cards are not linked to a bank account. The card itself is the account,
to which money is loaded. Purchases are limited to the amount that was (re)loaded into the card.
The definition in Article 1 to the Payment Cards Law explicitly states that usage of prepaid
cards cannot obligate the bank account of the cardholder.
18. A major anomaly in Israel with respect to debit and prepaid cards was that until April 2016,
interchange fee for debit and prepaid transactions was the same as the interchange fee for credit
transactions. The Israeli Antitrust Authority and Bank of Israel have taken steps to change this.38
On August 23, 2015 a Banking Decree finally ordered that interchange fee in debit and prepaid
transactions would be 0.3% (instead of 0.7% in credit transaction) effective April 1, 2016.39
2.2. The Parties
Issuer
19. An issuer is the financial institution that enters a contract with cardholders ("Cardholder
Agreement"). Cardholder agreement regularizes the terms of joinder and participation of a
cardholder in a payment card scheme.
The main responsibility of the issuer in the cardholder agreement is defined in Article 7 of the
Payment Cards Law. Issuer is liable to remit merchants the consideration for assets bought with
future purchases of goods and services as opposed to debit-card holders, who pay at the time the purchase is made, or
credit-card holders, who pay after the purchase has been made”. 35 Stephanie M. Wilshusen et al., Consumers’ use of Prepaid Cards: A Transaction-Based Analysis, at 6 (Fed. Res.
Bank of Phil. Discussion Paper 2012): "Most of the prepaid cards… are used for both cash withdrawals and purchases
of goods and services"; Fumiko Hayashi & Emily Cuddy, General Purpose Reloadable Prepaid Cards: Penetration,
use, Fees and Fraud Risks (FED. RES. BANK KANSAS, Feb. 2014). 36 Phillip Keitel, Federal Regulation of the Prepaid Card Industry: Costs, Benefits, and Changing Industry Dynamics,
at 27 (Conference Summary of the Payment Cards Center of the Fed. Res. Bank of Phil., April 8-9, 2010): “[P]repaid is
best viewed as a platform that supports a wide variety of products, each with a different business model”;
Phillip Keitel, A Prepaid Case Study: Ready Credit’s General-Purpose & Transit-Fare Programs (Fed. Res. Bank Phil.
Discussion Paper, 2012). 37 James McGrath, General-use Prepaid Cards: The Path to Gaining Mainstream Acceptance (Fed. Res. Bank Phil.,
2007). 38 For expansion see infra ch. 8.1.4 (Debit in Israel). 39 Banking Decree (Service to Customer) (Supervision on Service Issuer Gives Acquirer inConnection with Interchange
Acquiring of Debit Transactions) (Temporary Order), 2015 [(Tsav Habankaut (Sherut Lalakoach) (Pikuach al Sherut
Shenoten Manpik Lesolek Bekesher Leslika Tzolevet Shel Iskaot Hiuv Miadi) (Horaat Shaa) sec. 3, (2015)].
15
payment card it issued. The cardholder has a corresponding duty to pay the issuer for all
purchases made with the card.
20. In Israel, there are three issuers: Isracard, LeumiCard and C.A.L. These firms are bank
subsidiaries. Isracard is under the sole ownership of Bank Hapoalim. LeumiCard is under the
control of Bank Leumi (80%) and the Azrieli Group (20%).40 CAL is held jointly by Israel
Discount bank (72%) and First International bank of Israel (28%).41
In Israel, Isracard is the sole issuer and acquirer of American Express cards. Isracard is also the
only issuer of its proprietary brand cards that carry the name "Isracart". CAL is the sole issuer
of Diners Club cards in Israel. Isracard, LeumiCard and CAL are all issuers and acquirers of
Visa and MasterCard by virtue of licenses from those international organizations.
21. Most payment cards in Israel have been issued with the cooperation of the bank in which the
cardholder’s account is managed. However, during recent years, more cards are issued without
the cooperation of the bank in which the cardholder holds an account.42 Non-bank cards are
issued directly by one of the issuing firms (Leumicard, Isracard or CAL) or, more often, as a
cooperation of an issuer and a consumption club, such as big retailers e.g., Supersal, Lifestyle
for Super-Pharm customers, "Hever" for defense arms employers, "Members" for lawyers and
CPAs.43 The club operates as a marketing branch of the issuer. The club shares with the issuer
the income that the cards yield. Non-bank payment cards often offer rewards and rebates to
their holders. The merchant also enjoys higher loyalty of customers who possess cards issued
with its cooperation.44 In the U.S., many large retailers issue private cards that bypass the
payment card networks entirely.45
Acquirer
22. Acquirer is the financial institution that contracts with merchants (“The Merchant
Agreement”). The merchant agreement regulates the terms of joinder and participation of
40 LEUMICARD, 2014 ANNUAL REPORT, at 13 (2015). 41 CAL, 2014 ANNUAL REPORT, at 8 (2015). 42 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 ANNUAL REVIEW, at 28 (2016) (substantial increase in
issuance of non-bank cards in the last decade). See also infra ¶ 57. 43 ISRACARD, 2014 ANNUAL REPORT, at 11 (2015). 44 Comp/34.579 European Comm'n MasterCard Decision, para. 713 (Dec. 19, 2007): “By buying again at a shop the
customer typically gets rebates which are counted on the store cards. The shop in turn wins the loyalty (and often a
home address of the client to mail advertisements)”. 45 Steve Worthington, Affinity Credit Cards a Critical Review, 29 INT. J. RETAIL & DISTRIBUTION MANAGEMENT 485
(2001); Marc Bourreau & Marianne Verdier, Private Cards and the Bypass of Payment Systems by Merchants, 34 J.
BANK. FIN. 1798 (2010).
16
merchants in a payment card scheme. The Merchant Agreement regulates the commercial
relations between the acquirer and the merchant. The merchant agreement governs the way
merchants should act when accepting cards, e.g., identifying the cardholder, verifying signature,
passing the cards through magnetic stripes etc. The Merchant Agreement also stipulates the
duties of the acquirer, to pay the consideration for transactions acquired, minus the MSF.
Acquiring, as defined by the Israeli law, consists of remitting the consideration of a transaction
to the merchant against receiving it from the issuer.46 A merchant who wishes to accept payment
cards must contract with an acquirer, and install equipment and point of sale ("POS") terminal
suited to read payment cards. The acquirer is responsible to connect the cashiers of the merchant
to the infrastructure of the payment card network. The acquiring process involves processing
and routing transactions through the infrastructure of the payment card network, clearing and
settlement. Acquirers also provide merchants statements with information of their services.47
Acquiring can carry credit and fraud related risks, especially if the merchant does not perform
after being remitted. If a remitted merchant defaults and the cardholder cancels the transaction,
then acquirers assume the risk of chargeback (without being able to off-set against the
merchant). Chargeback disputes arise between issuers and acquirers without involvement of
cardholders or merchants.48 Generally, in chargeback disputes, acquirers are liable to
merchants' fraud and default whereas issuers are liable to cardholders' fraud and default.
Acquiring activities typically include underwriting merchants' applications including anti
money laundering and fraud checks; recruiting merchants; deployment of equipment, including
leasing or selling terminals and POSs; support and service to merchants; handling merchants'
46 Article 36(i) of the Banking Law (licensing) (1981) that was added in 2011. 47 Ann Kjos, The Merchant-Acquiring Side of the Payment Card Industry: Structure, Operations, and Challenges, at 3
(F.R.B Phil' Discussion Paper 2007): “[M]erchant acquirers generally perform four key functions: (1) signing up and
underwriting merchants to accept network-branded cards, (2) providing the means to authorize valid card transactions at
client merchant locations (3) facilitating the clearing and settlement of the transactions through the payment network,
and (4) providing other relevant information services, such as sending out statements”. 48 European Commission, Payment card chargeback when paying over Internet, at 3, MARKT/173/2000 (Jul. 12, 2000):
"Chargeback » is the technical term used by international card schemes to name the refunding process for a transaction
carried out by card following the violation of a rule. This process takes place between 2 members of the card scheme,
the issuer of the card and the acquirer (the merchant’s bank). The final customers of these 2 scheme members, the
cardholder for the issuer and the merchant for the acquirer, do not have any direct relationship in the chargeback
process."
17
accounts and chargebacks. Card networks monitor Acquirers' performance in areas such as
fraud and chargeback volumes. If parameters are breached, the acquirer can be fined.
23. Infrastructure of payment card network is comparable to roads. Communication and money
"travel" on this infrastructure. The infrastructure enables communication from the merchant's
POS to cardholders' accounts, and also allows remittance in the opposite direction. Acquirers
sometimes use outsourcing services offered by third parties, which are called "back-end" or
"back-office" acquirers.49
Often, an additional intermediary is situated between the acquirer and the merchant, a factoring
firm. Acquirers usually pay merchants once a month for credit and deferred debit transactions.
Factoring firms offer merchants the option to advance sums due in consideration for (factoring)
fee.50 For merchants, factoring firms make deferred transactions closer to debit, in return for a
larger MSF. In Israel, until April 2016, the delay in remittance of debit and prepaid
transactions,51 brought factoring firms to give their services also to debit and prepaid
transactions.
Merchants and Cardholders
24. Firms, individuals, institutions, shops, businesses, agencies and anyone who engages with an
acquirer in a Merchant Agreement to accept payment cards, will be referred to in this work as
"merchant". For example, as the state accepts payment cards for fines, taxes and other
mandatory payments, the state, in this sense, is a merchant. Landlords who receive rent via
payment cards are also considered merchants.
25. Consumers or customers that possess payment cards will be referred as “cardholders”. A
cardholder is defined by the holding of a payment card, without considering the level of usage.
49 Id. at 23: “It has become a common practice to outsource such back-office services as terminal deployment and setup,
underwriting, training, chargeback processing, fraud monitoring, customer services, and the point-of-sale help desk”.
Ramon P. Degennaro, Merchant Acquirers and Payment Card Processors: A Look Inside the Black Box, FRB ATLANTA
ECON. REV. (2006): “Some merchant acquirers perform the processing themselves; others resell the services of a third-
party processor. That is, they are merchant acquirers who resell front- and back-end processing services but do not provide
those services themselves. Most of the larger merchant acquirers also function as processors, but almost all of the smaller ones
are resellers”. 50 IAA, Press Release, Antitrust General Director Conditioned a Merger between Yatzil and CAL in Opening the
Factoring Markets, Antitrust 3018872 (2003); Adam J. Levitin, Priceless? The Social Costs of Credit Card Merchant
Restraints, at 7, SSRN (2008), available at http://ssrn.com/paper=973970 : “In all networks there is often an additional
party, the merchant service provider, that links the merchant and the acquirer". 51 Supra ¶ 18 and note 33.
18
2.3. The Fees
26. Issuers are connected to cardholders. Acquirers are connected to merchants. Issuers have no
direct relationship with merchants and acquirers have no direct relations with cardholders. The
income of issuers and acquirers stems from their contractual partners, with one exception – the
interchange fee.
Issuers charge a Cardholder Fee and acquirers charge a MSF. The MSF consists of two parts
– the acquirer fee and the interchange fee.
Cardholder Fee
27. The cardholder fee is the net amount a cardholder pays the issuer for the payment card, after
deduction of discounts, rewards and rebates. Typically, the cardholder fee consists of both fixed
and variable (negative) components.
The fixed component is usually a monthly payment. In Israel, following a reform in banking
fees,52 this payment is regarded as a banking fee, and is subject to regulation of the Governor
of the Bank of Israel.53 Not all cardholders pay a fix component. Issuers regularly exempt
cardholders, wholly or partially, from the fixed fee for an initial period, or against minimum
usage, which is measured either in number of transactions or in the amount spent.54
The variable fee is zero or negative. Cardholders do not pay for transactions. On the contrary,
the variable fee can be considered as negative for two reasons: the first is the free funding period
between the date of purchase and the future charge date, which exists in both credit and deferred
debit. The second reason is rewards to cardholders that usually increase with usage. This means
that issuers actually pay cardholders for usage. Rewards are mostly in the form of discounts,
flight mileage rewards, stars/points for future purchases, and sometimes even direct cash-
back.55
52 Amendment 12 to the Banking Law (Service to Customer), 1981 53 Banking Rules (service to customer) (fees), 2008 54 Tim Westrich & Malcolm Bush, Blindfolded into Debt: A Comparison of Credit Card Costs and Conditions at Banks
and Credit Unions, WOODSTOCK INST. (2005): "Introductory rates or “teaser rates” are promotional offers that keep one
or all of the credit card’s rates low, often at 0 percent, for a specified number of billing cycles". 55 Infra ch. 6.7; see also Oren Bar-Gill, Seduction by Plastic, 98 N.W.L.R. 1373, 1391 (2004): "In fact, when
considering the benefits or rewards programs associated with most credit cards, issuers are setting negative per
transaction fees.";
19
Both the positive fixed cardholder fee and negative transaction (variable) fee, affect the level
of usage by cardholders. The fixed fee is a lump sum. After payment of the fixed fee, the
cardholder sees only the benefits associated with extensive usage. These benefits grow with
usage and incentivize cardholders to use cards.56 Interchange fees play a vital role in this
inducement process, by funding it, as will be explained more extensively in this work.
28. Bank of Israel encourages customers to be aware of the fees they pay. As part of the Bank’s
efforts in this field it published on its web-site the official tariff of the cardholder fee and the
actual cardholder fee. The cardholder fee in practice is about half of the tariff, because of the
above explained "teaser rate" system of rebates and rewards.57 In this work, I use the term
“cardholder fee” as the actual fee, after the deduction of all rewards.
29. Apart from cardholder fees, issuers have other sources of income from their customers. They
charge interest on unpaid credit balances beyond the free funding period. This interest is usually
higher than the interest on bank loans,58 and is a main source of income to issuers.59 Another
source of income to issuers is interest charged on loans to the public, even to borrowers who
are not their cardholders, e.g., loans to purchase motor vehicles.60
The Merchant Service Fee (“MSF”)
30. The MSF is the price a merchant pays to the acquirer for transactions made with payment cards.
In the case of credit cards, the MSF is a percentage of the transaction (ad valorem). For example,
if the transaction sum is 100 and the MSF is 2%, the merchant receives 98 and the MSF is 2.
Jean-Charles Rochet & Jean Tirole, Must-Take Cards: Merchant Discounts and Avoided Costs, 9 J. EUR. ECON. ASS'N
462 (2011): "We allow Pb to be negative, in which case the cardholder receives a payment from his bank, in the form of
interest-free period, cash back bonuses or air miles awarded to the buyer every time he uses his card". 56 Infra ¶ 727. 57 Bank of Israel, Supervision of Banks, the Fee Reform, (Oct. 30, 2010) 58 ITAMAR MILRED, TEUR SHUK KARTISEI HASHRAI VENITUAH HAMIMSHAKIM BEIN HEVROT KARTISEI HASHRAI LEBEIN
HABANKIM (DESCRIPTION OF CREDIT CARD MARKET AND ANALYZING INTERFACES BETWEEN CREDIT CARD FIRMS AND
THE BANKS), THE KNESSET CENTER FOR RESEARCH AND INFORMATION, at 16 (Feb, 2014). Wilko Bolt & Sujit
Chakravorti, Digitization of Retail Payments (DNB Working Paper 270. 2010): "The empirical literature on credit cards
has suggested interest rate stickiness along with above market interest rates, although some have argued that the rate is
low compared with alternatives such as pawn shops."; Bank of Israel, the Supervision of Banks - Banking
Consumerism, Advantages and Disadvantages of Revolving Credit
http://www.boi.org.il/he/ConsumerInformation/ConsumerIssues/Pages/RevolvingCreditCard.aspx . 59 Infra ¶ 463. See also Steven Semeraro, Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who
Gains and Who Loses from Credit Card Payments? Theory and Calibrations, at 9 (2012): “[C]ardholders account for
well over half of the revenue that card-issuing banks earn. Approximately 70% of a typical card issuer’s revenue comes
from interest paid by cardholders for financed purchases";
United States v. Am. Express Co., 2015 U.S. Dist. Lexis 20114, at 36 (E.D.N.Y Feb. 19, 2015): "[I]nterest charged on
revolving balances… generate more than half… revenue". 60 LEUMICARD, 2014 ANNUAL REPORT, at 20; BANK OF ISRAEL, 2010 ANNUAL REPORT, at 121.
20
With debit cards, the MSF is sometimes fixed and sometimes ad valorem.61
The MSF is composed of two components. One of them is the interchange fee.
The Interchange Fee
31. A major part of the MSF collected by the acquirer does not remain with the acquirer. It is paid
by the acquirer to the issuer. This is the interchange fee.
By definition, the interchange fee is a payment that an acquirer of a transaction remits to the
issuer of the card used for the transaction when the acquirer and the issuer are not the same
institution.62 When the issuer and the acquirer are the same, the interchange fee is only notional,
and the transaction is called “On-Us”.63 The interchange fee is therefore another source of
income for issuers, in addition to cardholder fees and interest on credit and loans. As opposed
to the cardholder fee, which is a direct fee, the interchange fee is an indirect fee. Merchants pay
it, but they are not a party to the arrangement that sets it. Interchange fee is hidden for them as
undistinguished part of the MSF.
32. The Interchange fee makes up the bulk of the MSF. Although current regulation in some
countries has reduced interchange fees, it still makes up a major part of the MSF.64
61 Infra ¶ 33. For expansion see infra ch. 0. 62 REFORM OF CREDIT CARD SCHEMES IN AUSTRALIA, FINAL REFORMS AND REGULATION IMPACT STATEMENT, at 5
(RBA, 2002): “The interchange fee is the fee paid to the financial institution which issues the card (the “issuer”) by the
financial institution which provides services to the merchant (the “acquirer”) whenever the merchant accepts credit
cards for payment”. 63 Infra ch. 2.4.1. 64 Motion 34/01 Leumi v. Antitrust General Director, at 3 (Dec. 22, 2002) ; David Balto, The Problem of Interchange
Fees: Costs without Benefits? E.C.L.R 215 (2000): "[C]redit card interchange fees comprise over 90 per cent of the
merchant discount";
Price & Wang, Why do Debit Card Networks Charge Percentage Fees?, supra note 32: “Merchants that accept debit
cards pay fees known as merchant discounts, which are composed mainly of interchange fees paid to card issuers”;
Steve Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, 14 GEO. MASON L.REV 941
(2007): "Generally, in the Visa and MasterCard systems, the issuer receives about 75 percent of the total merchant
discount, leaving 25 percent for the acquiring bank";
Robin A. Prager et al., Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy
Issues, at 12 (F.R.B. Finance and Economics Discussion Series 23-09, 2009): "An interchange fee typically comprises a
large fraction of the merchant discount for a particular card transaction";
Alan S. Frankel & Allan L. Shampine, The Economic Effects of Interchange Fees, 73 ANTITRUST L.J. 627 (2006):
"Interchange fees establish the major component of acquirers’ marginal costs for processing transactions and account
for most of the fees paid by merchants to acquirers for processing credit card transactions—the “merchant discount”;
Fumiko Hayashi, A Puzzle of Card Payment Pricing: Why are Merchants Still Accepting Card Payments? 5Rev.
NETWORK ECON. 144 (2006): "Typically the interchange fee accounts for more than 75 percent of the merchant fee";
Tim Mead, Renee Courtois Haltom & Margaretta Blackwell, The Role of Interchange Fees on Debit and Credit Card
Transactions in the Payments System, 11-05 FED. RESERVE BANK OF RICHMOND (2011): “Each time a consumer makes
a purchase using a credit or debit card, the merchant is assessed fees associated with processing the transaction. The
21
33. Interchange fee in credit card transactions is ad valorem. Regarding debit transactions, the
interchange fee is sometimes proportional (ad valorem), sometimes fixed, and sometimes a
combination. In Israel and the E.U. interchange fee for all card transactions is proportional.65
In the U.S., since 2011, interchange fee for debit, prepaid and deferred debit is a fixed sum of
approximately 22 cents, uncorrelated to the transaction size, plus an additional 0.05% of the
transaction amount, for issuers who take certain steps of fraud prevention.66
Fixed interchange fee increases merchant resistance in small transactions, whereas a
proportional MSF increases merchant resistance to accept cards in large transactions.67 Shy &
Wang argue that acquirers prefer to charge proportional fees because it increases their profits.68
34. Worldwide, interchange fee for debit transactions is lower than that of credit. As mentioned
above, Israel presented a distortion, which was amended only on April 2016.69
In Israel, the interchange fee is determined in a Trio Agreement between the three acquirers and
issuers: Isracard, LeumiCard and CAL ("The Trio Agreement"). The first Trio Agreement was
signed in 2006, when Isracard joined a previous bilateral interchange agreement between CAL
and LeumiCard. According to the Trio Agreement, each of the three companies may acquire
MasterCard and Visa cards that each of them issues.70 Since 2012, all three firms may acquire
Isracard payment cards that only Isracard issues, and pay Isracard a similar interchange fee as
in Visa and MasterCard transactions.71
largest of those fees is the “interchange” fee, which is set by the card network that processes the transaction and is
ultimately paid to the bank that issued the card”; Bank of Israel, The Banking System in Israel, 2015 Annual Review, at
30, diagram #3 (2016). 65 Infra ¶ 34 (Israel), ¶ 576 (Visa Europe), ¶ 579 (MasterCard in Europe). 66 Infra ¶ 638. 67Ann Borestam & Heiko Schmiedel, Interchange Fees in Payment Cards, ECB Occasional Paper Series 131, at 22
(2011): "[A] fixed interchange fee that has to be paid by merchants has the potential to discourage the acceptance of
cards for payments of small amounts. On the other hand, an ad valorem fee for higher transaction values or for highly
taxed purchases such as petrol could result in the perception at the merchant that the merchant service charge to be paid
and the service offered are not connected to one another". 68 Shy & Wang, supra note 31 at 1585: “The card network earns higher profits by charging proportional fees compared
with fixed per-transaction fees”; Price & Wang, Why do Debit Card Networks Charge Percentage Fees?, supra note 32:
"[T]his type of fee structure, a linear ad valorem fee, maximizes profits for card networks by allowing price
discrimination."; See also Zhu Wang & Julian Wright, Ad-Valorem Platform Fees and Efficient Price Discrimination
(2012). 69 Supra ¶¶15, 18; for expansion see infra ch. 8.1.4 (Debit Cards In Israel). 70 Infra ¶ 493. 71 Infra ¶ 322.
22
Since July 2014, the interchange fee rate in Israel is 0.7%.72 There is a narrow exception for a
category of lower-rate interchange fee of 0.5% for the state and the Israeli Electric Company. I
will elaborate on the various categories of interchange fees in Chapter 8.1.3 infra.
35. The interchange fee is a “price” fixed by competitors. Isracard, LeumiCard and CAL are all in
competition with each other. They compete on the issuing side for cardholders. They compete
on the acquiring side for merchants. Since the interchange fee is a major part of the MSF, fixing
it means setting a minimum floor to the MSF. No acquirer can offer an MSF that is lower than
the interchange fee, if it does not want to suffer a loss.
Setting the MSF below the interchange fee would mean that the interchange fee the acquirer
pays, would be larger than all of the acquirer's income from that transaction. The acquirer would
necessarily lose money. Therefore, the interchange fee is a restrictive arrangement equivalent
to fixing a minimum price between competitors.73
36. When Isracard, LeumiCard and CAL negotiate the interchange fee, each of them wears two
hats, one in its role of issuer and the other in its role of acquirer. In a free negotiation between
a willing acquirer to a separate willing issuer, one might assume that acquirers would bargain,
attempting to reduce the price they pay. Such bargaining is in line with pro-competitive
principles of vertical arrangements, in which the interest of the buyer (acquirer) to pay low price
(interchange fee), merge with interest of consumers to pay low prices for final goods.74
However, this is not the case with interchange fees. The negotiation is a "self-negotiation"
between the payers (functioning as acquirers) and themselves as payees (functioning as issuers).
The outcome does not resemble the result of a free arm’s length negotiation.75 The buyer
(acquirer) willingly "gives up" and agrees to pay the issuer (i.e., to itself in another transaction),
a high interchange fee, which is ultimately passed through to the merchant via the MSF. The
acquirer knows that in another transaction, where it will function as the issuer, things will be
72 Infra ¶ 499. 73 For expansion see infra ch. 0. 74 See generally DAVID GILO & YOSSI SPIEGEL, VERTICAL RESTRAINTS, IN A LEGAL AND ECONOMIC ANALYSIS OF
ANTITRUST LAW 323, 327 (2008) (As long as the supplier is not a partner to the profits of the retailer through royalties
or fixed fees, the supplier prefers low prices for final consumers, to maximize number of transactions, i.e., purchases
from the supplier). 75 Comp/34.579 European Comm'n MasterCard Decision, supra note 44, para. 499: “[T]he setting of interchange fee
rates is not akin to a contentious process such as a price negotiation where opposing interests of buyers and sellers
meet”.
Case T-111/08 MasterCard v. Comm'n, para. 32( May 24, 2012): “[I]t was not in the acquiring banks’ interest to exert
any downward competitive pressure on the MIF since they benefit from it, directly or indirectly”.
For an amusing illustration, see Monty Python, Life of Brian, The Haggle, directed by Terry Jones (1979), http://www.youtube.com/watch?v=3n3LL338aGA.
23
the opposite, and the acquirer will be the party to receive the interchange fee, in its capacity as
an issuer.
The previous paragraph explains in short why the interchange fee is a restrictive arrangement,
and why privately set interchange fees (between issuers and acquirers) tend to be higher than
optimal.76
37. The overall income that the interchange fee yields is distributed according to the market share
of each issuer. Thus, even a large acquirer, which is a small issuer, enjoys the expansion of the
pie according to its share on the issuing side.77
The Acquiring Fee
38. The acquiring fee is the gap between the interchange fee and the MSF. This gap is the income
of the acquirer. The consideration for that fee is the acquiring services acquirers give to
merchants. The main services are remittance of transaction funds, connecting merchants to the
payment card network, and processing, authorizing and settling transactions.
39. In the past, acquiring services were performed manually. The product of card transactions was
paper slips, which the acquirer had to collect, process, authorize and remit their value to the
merchant, minus the MSF. Currently, the acquiring process is paperless and is provided by
electronic means. Generally, acquirers do not guarantee payments owed by cardholders to
merchants. Issuers incur the payment guarantee. Thus, as opposed to issuers’ cost of payment
guarantee, which is proportional to the transaction size, costs of supplying acquiring services
are generally fixed, and are not dependent on the sum of the transaction.
2.4. Open and Closed Networks
40. Open networks are payment systems in which there is multiplicity of acquirers and issuers. In
Israel, local networks of Visa and MasterCard are comprised of only three firms that operate
both on the issuing and acquiring sides. Internationally, networks like Visa and MasterCard
have thousands of issuers and acquirers. Any financial institution can join the network.78 There
are four parties to an open network: issuer, acquirer, cardholder and merchant. Therefore, open
76 For expansion see infra ch. 0 (interchange fee as a restrictive arrangement) and ch. 6.9.2 (why privately set
interchange fees are biased). 77 Infra ¶ 781. 78 Marc Rysman & Julian Wright, The Economics of Payment Cards, at 4 (2015): “The systems are open in the sense
that any bank or equivalent financial institution can join.”
24
networks are sometimes called "four-party" networks. Examples of open networks are Visa and
MasterCard.
41. Closed networks are payment systems in which the issuer and the acquirer are the same entity.
Closed networks are also known as "three-party" networks, because they involve only three
parties in each transaction: the payment system, which acts as sole issuer and acquirer,
cardholder and merchant.79 Closed networks set both the MSF to merchants and the cardholder
fee. A closed network that distinguishes in its accounts between issuing and acquiring costs
might attribute a notional interchange fee from the acquiring side to the issuing side, but the
interchange fee will remain notional. It is possible to think of the interchange fee in closed
networks as part of the MSF, which is allocated to the issuing side.80
Examples of closed networks in Israel are American Express and Diners Club.81 Until 2012
Isracard operated as a closed network. In 2012 Isracard was compelled, to open its network,
and let LeumiCard and CAL acquire its proprietary Isracard cards.82 In the U.S., American
Express and Diners sometimes give third parties licenses to issue their cards, in a structure that
resembles open networks.83
79Id. at 4 (2015): “Closed systems, or three-party systems, such as Discover and American Express typically issue cards
to consumers and acquire merchants to accept the card. They set fees to both sides, which largely consist of an annual
fee, an interest rate (for credit cards) and a rewards program for consumers, and a fee for merchants (termed the
merchant discount in the industry). A closed card platform can choose any structure of prices that it so desires between
cardholders and merchants.”;
EC INTERIM REPORT I PAYMENT CARDS SECTOR INQUIRY UNDER ARTICLE 17 REGULATION 1/2003 ON RETAIL
BANKING, at 88 (Apr. 12, 2006): “The industry generally distinguishes between “open” or “four-party” card payment
systems and “closed” or “three-party” card payment systems, where the scheme owner also engages in the financial
aspects of the payment card business by issuing cards and acquiring merchants. This is the case for American Express,
Citibank (Diners Club) and JCB, which (mainly) issue and acquire cards themselves. These systems are also referred to
as “proprietary” systems, as the scheme owner typically is the proprietor of the technical network used for routing,
switching, clearing and processing the transactions”. 80 Rysman & Wright, The Economics of Payment Cards, supra note 78, at 6: “[T]he closed system sets fees directly to
the consumer and merchant, and does not use an interchange fee. However, there is an implicit interchange fee.”;
Jean Tirole, Payment Card Regulation and the use of Economic Analysis in Antitrust, 4 Toulouse School Econ., at 18
(2011): “Three-party systems use an implicit interchange fee, defined as the difference between the merchant discount
and the acquiring cost”. 81 DAVID BOAZ, THE CREDIT CARD MARKET IN ISRAEL, GENERAL ANALYSIS, CONCLUSIONS AND RECOMMENDATIONS,
at 6 (Dec. 2009); IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL
REPORT), supra note 21, at 6 n. 16. 82 Infra ch. 8.1.2. 83 Prager et al., Interchange Fees and Payment Card Networks, supra note 64, at 35: “In recent years, both American
Express and Discover have begun to allow bank issuance of their respective brands’ credit cards.”;
Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 980: “American
Express and Discover now also issued credit cards nationally through banks”.
25
“On-Us” Transactions
42. In open networks, acquirer of a transaction and issuer of the card in which the transaction was
executed, are not necessarily the same, but occasionally they are the same entity. Transactions
in which the acquirer and the issuer is the same entity, are called “On-Us”.84 In “On-Us”
transactions, the acquirer (which is also the issuer) keeps all the MSF for itself. The interchange
fee in On-Us transactions is virtual, as in closed networks.
43. Statistically, as more issuers and acquirers participate in an open network, the probability that
a transaction is "On-Us" decreases. When numbers of issuers and acquirers in a network
increase, the occurrence of transactions with interchange fees is more frequent.
Price Level and Price Structure
44. Price Level is the total sum of the MSF and the cardholder fee in a card transaction. In this
work Pm stands for MSF (price for the merchant), and Pc stands for cardholder's fee. Issuers
collect Pc and acquirers collect Pm. The price level is therefore the sum Pm+Pc.
Price structure is the distribution of the price level between cardholders and merchants. The
price structure is the ratio between the price each side pays and the total price level. Formally,
if the price level is Pm+Pc then the price structure is Pm/ (Pc+Pm): Pc/ (Pc+Pm). For example, if the
MSF is Pm=5 and Pc is 1 then the price level is 6, and the price structure is 1:5. The merchant
pays 5/6 of the price and the cardholder pays 1/6.
45. The price structure is a concept that presents a major difference between ordinary products and
two-sided products like payment cards.85 In ordinary products the price level influences the
demand for the product. When the price increases, demand decreases, and vice versa. In two-
sided markets, a major additional factor that affects demands is the price structure between the
different customers who consume the asset.86
84 Visa core rules and visa product and service rules, at 758 (October 2014): “On-Us Transaction - A Transaction where
an individual Member, represented by one Visa Business ID (BID), both: ● Holds an issuing license and has issued the
Visa Card used in the Transaction ● Holds an acquiring license and acquired the corresponding Merchant volume". 85 For expansion on two sided products see infra ch. 7.1.2. 86 Id., see also ¶¶ 446-447.
26
46. Firms that operate in the payment card industry must determine not only the price level, but
also the price structure i.e., how much cardholders pay compared to merchants.87 The
interchange fee is a major component in this decision, as will be elaborated widely below.
The International Organizations
47. Branded cards carry the logo of international organizations such as Diners Club in closed
networks or Visa and MasterCard in open networks. The brand ascribes the card to the
international network of the organization, and thus expands the borders of acceptance to every
merchant around the globe that accepts that brand’s cards.
48. Visa and MasterCard both operated until about a decade ago as not-for-profit associations that
granted financial institutions licenses to issue and acquire cards. Legally, Visa and MasterCard
were joint ventures between competitors.88
Both Visa and MasterCard changed their structures and became public companies. In 2006,
MasterCard Inc. issued its shares on the New York Stock Exchange ("NYSE").89 In 2008, Visa
amalgamated its operations in the U.S. and Canada into a public company, Visa Inc., registered
in San Francisco and traded in New York.90 Visa Europe continued to operate as a not-for-profit
association, owned by its member banks. However, in November 2015 Visa Inc. acquired Visa
Europe for a total value of up to €21.2 billion.91 After their re-organization, both Visa and
MasterCard claimed that interchange fee is no longer a product of collusion, but a unilateral
decision. Their claims were rejected. The structural changes to a unilateral entity have not
allowed Visa or MasterCard to escape the scope of antitrust law with respect to interchange
fees.92
87 Jean-Charles Rochet & Jean Tirole, Platform Competition in Two-Sided Markets, 1 J. EUR. ECON. ASS'N 990 (2003):
"Under multi-sidedness, platforms must choose a price structure and not only a price level for their service". 88 United States v. Visa, 163 F. Supp. 2d 322 (S.D.N.Y 2001): "MasterCard and Visa are structured as open, joint
venture associations with members (primarily banks) that issue payment cards, acquire merchants who accept payment
cards, or both... They do not have stock, or shareholders; just members and membership interests… MasterCard and
Visa are operated as not-for-profit associations and are supported primarily by service and transaction fees paid by their
members". 89 MasterCard Corporate Overview http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjQ1MzZ8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1 90 http://corporate.visa.com/about-visa/our-business/visa-inc-and-visa-europe.shtml (last visited 5.7.15). 91 Visa Europe, Press Release, Visa Inc. to Acquire Visa Europe (Nov. 2, 2015) 92 See infra ¶ 690.
27
49. American Express was established in 1850. It is a public company traded in the NYSE.93 Diners
Club was purchased in 2008 by Discover Financial Services Inc., whose shares are also traded
on the NYSE. Before this merger, Discover operated a payment card network under the brand
name “Discover”.
50. The international organizations do not engage directly with either cardholders or merchants.
They grant licenses to financial institutions to issue and acquire payment cards that bear the
brand’s name.94 Both Visa and MasterCard have over 20,000 licensees worldwide, which are
permitted to issue and acquire their cards.95
Isracard, LeumiCard and CAL are licensees of Visa Europe to issue and acquire Visa cards,
and are also licensees of MasterCard Inc. to issue and acquire MasterCard cards.96 Licensees
are members of the international organizations. Their relations with the international
organizations are stipulated in the rules of the international organizations, to which sometimes
a direct and specific agreement is added. Generally, the international organizations do not
intervene in the commercial relations of members with their customers, i.e., cardholders and
merchants. The discretion to shape the commercial relations with merchants and cardholders is
determined by the licensees.97
51. International organizations operate infrastructure systems designed to process, route, connect
and authorize transactions between different members who are not directly linked, such as in
international transactions. Transactions between issuers and acquirers who are not from the
same country are executed via the international infrastructure of the organization that integrates
93 DAVID S. EVANS & RICHARD SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND
BORROWING, 13 (2d ed. 2005). 94 Ibid: "MasterCard does not actually issue cards to anyone nor does it sign up merchants itself. Its customers are
banks-some issue cards, some service merchants, and some do both". 95 EC, INTERIM REPORT, supra note 79, at 96: “Visa has over 21000 member banks worldwide and over 5000 members
in Europe. MasterCard reports approximately 25300 member banks worldwide." 96 Annual reports of Isracard for 2014, at 7, https://www.isracard.co.il/report/120021424.pdf LeumiCard Annual Report for 2014, at 12 https://www.leumi-card.co.il/he-il/GeneralPages/Documents/100331424.pdf CAL Annual Report for 2014, at 18. 97 Dennis W. Carlton & Alan S. Frankel, The Antitrust Economics of Credit Card Networks, 63 ANTITRUST L.J. 643
(1995): "Visa and MasterCard members collectively set rules on how they can communicate with each other and how
they can settle financial transactions. The members also collectively set membership rules and the interchange fee they
will charge each other. There are no collectively set rules on what merchant discount a merchant bank can charge. Nor
are there any rules on what a card-issuing bank can charge a customer for finance charges or annual fees, or on how
aggressive the banks can be in promotional activity to acquire new customers from other card-issuing banks or from the
general population.";
Christian Ahlborn, Howard H. Chang & David S. Evans, The Problem of Interchange Fee Analysis: Case without a
Cause? 2 PAYMENT CARD REV. 183, 187 (2004): "Members compete with each other for services to cardholders and
have total discretion in setting card fees and interest rates, as well as other parameters of their service; in the same way,
members compete for services to merchants for which they set their prices (merchant discounts)".
28
with the local infrastructure. In Israel, the sole infrastructure for routing local transactions
belongs to SHVA.98 In countries that do not have their own internal infrastructure, the
international organization itself also provides the internal infrastructure.99
52. The international organizations determine default interchange fees. The default interchange fee
applies unless agreed otherwise in a specific agreement.100 Therefore a cardholder that holds a
card issued by a bank in country A can purchase assets from a merchant in country B, whose
acquirer has no direct relations with the issuer.
53. Bylaws of the international organizations set rules that govern transactions. Those rules apply
by default unless issuers and acquirers decide otherwise. The rules shape the framework of card
transactions, such as the duty of the issuer to remit to the merchant (via the acquirer) the
consideration for transactions made by a holder of a card issued by the issuer.101 The bylaws
also set forth the duty of the acquirer, which is assigned to the merchant (in the merchant
agreement),102 to honor all cards that bear that brand’s name. This rule is called the “Honor All
Cards Rule” or in short: “HAC”.103 Another rule prohibits merchants from surcharging
customers that wish to pay with the brand’s card. This rule is called “No Surcharge Rule” or in
short: “NSR”.104 These rules apply by default unless determined otherwise. I will elaborate on
these merchant restraints in Chapter 11.2 below.
54. The international organizations provide additional services to their members, especially
regarding characteristic common to all members. The international organizations dictate
98 Infra ch. 8.1.7. 99 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 6 n.14. 100 U.S GOV'T ACCOUNTABILITY OFF., GAO-08-558, CREDIT AND DEBIT CARDS: FEDERAL ENTITIES ARE TAKING
ACTIONS TO LIMIT THEIR INTERCHANGE FEES, BUT ADDITIONAL REVENUE COLLECTION COST SAVINGS MAY EXIST, at 2
n.4 (2008): "The default interchange rates apply when there are no other interchange fee arrangements in place between
an issuer and an acquirer". 101 For example, article 7.3 of Visa International Operating Regulations Core Principles, available at http://corporate.visa.com/_media/visa-international-operating-regulations-core-principles.pdf determines: "Issuers are financially responsible for transactions that are accepted by the merchant as defined in the Visa
Operating Regulations, and properly processed by the acquirer”. See also supra ¶ 19. 102 Prager et al., Interchange Fees and Payment Card Networks, supra note 64, at 13: “Although contracts are written
only between the network and its issuers and acquirers, merchants and processors must also comply with the network
rules or risk losing access to that network”. 103 Visa International Operating Regulations Core Principles, supra note 101, Article 6.2: "Visa merchants may not
refuse to accept a Visa product that is properly presented for payment, for example, on the basis that the card is foreign-
issued, or co-branded with the merchant’s competitor's mark". See also Article 9.11 of MasterCard Merchant Rules
(Apr. 7 2006). 104 Visa International Operating Regulations Core Principles, Id. article 6.3: "Visa merchants agree to accept Visa cards
for payment of goods or services without charging any amount over the advertised price as a condition of Visa card
acceptance, unless local law requires that merchants be permitted to engage in such practice". See also article 9.12 of
MasterCard Merchant Rules.
29
uniform standards for the magnetic stripe on the card. They also set other measures to prevent
fraud, such as the EMV standard.105 Sometimes services are performed in the international
marketing and advertisement arena, like MasterCard's sponsorship of the European soccer
champions league.106
The Graph below depicts a payment card transaction in an open (four party) network. The
example presents purchase of an asset worth 100, an interchange fee of 1 % and a MSF of 1.3%.
Explanation
• The cardholder buys an asset for 100 (horizontal top arrow between
merchant and cardholder). The issuer charges the cardholder 100 (vertical
right arrow pointing downward). Actual charging can be before the
transaction (prepaid) or parallel to the transaction (debit) or after it (credit).
The issuer remits to the acquirer 99 and keeps 1 as interchange fee for itself
(lower horizontal arrow between issuer and acquirer). The acquirer remits
to the merchant 98.7, meaning that 1.3 is the MSF and 0.3 is the acquiring
fee (left vertical arrow between merchant and acquirer).
• If the scheme above were to depict a transaction in a closed network or an
On-Us transaction, the two rectangles of the issuer and acquirer would
unite to one. The interchange fee would then become notional.
105 Infra ch. 8.1.5. 106 Ahlborn et al., The Problem of Interchange Fee, supra note 97, at 187: “The co-operative (the Visa or MasterCard
organization) is responsible for managing aspects of the card system from which all members can benefit and which no
member could do on its own.”;
Prager et al., Interchange Fees and Payment Card Networks, supra note 64, at 13: “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”.
Merchant
cardholder
Issuer Acquirer
100P=
100
99 – issuer to acquirer
interchange fee=1 acquirer to issuer
98.7
0.3+1
MSF
30
• When there is no direct connection between the issuer and the acquirer,
such as in a tourist transaction, the horizontal arrow between them passes
through the switch and the infrastructure of the international organization
(not depicted in the graph).
3. Payment Cards Market Data
3.1. Israel
55. The number and the volume of card transactions in Israel are growing by an average rate of
more than 6% annually.107 About one third of the private consumption in Israel is made with
payment cards.108 The increase in card usage exceeds the growth in consumption, meaning that
some of the increase comes as a substitute for using cash and checks.109
56. The number of card transactions in Israel in 2015 was 1.1 billion, with a total volume of NIS
262 billion.110 Israeli cardholders use their cards for an average of 157 transactions per year
(2015).111 Average credit card transaction was of NIS 220 (2015).112 The average monthly
expense in credit cards was NIS 2,881 in 2015.113
The distribution by size and volume of transactions for the four quarters ending on June 30,
2016, is as follows:
Table 1 – Distribution of card payments by size (2015-2016)114
Number of transactions Volume of transactions (millions)
Up to NIS 50 407,623,371 10,178
NIS 50 to 100 264,398,672 19,492
NIS 100 to 200 234,781,912 34,106
NIS 200 to 500 210,519,621 63,845
NIS 500 to 1000 53,404,173 36,368
Over NIS 1000 38,969,938 98,718
Total 1,209,697,687 262,707
107 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 ANNUAL REVIEW, at 29 (2016); MILRED, supra note 58, at
7; Bank of Israel, THE RED BOOK, supra note 20, at 30 & 56. 108 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 3. 109 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 Annual Review, at 28 (2016); MILRED, supra note 58, at 1. 110 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 Annual Review, at 29 (2016); Bank of Israel, Data on
banks, Chapter J (10) – credit card information, table j-6, last update 21.8.16, available at
http://www.boi.org.il/he/BankingSupervision/Data/Pages/Tables.aspx?ChapterId=9 111 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 Annual Review, at 29 (2016); MILRED, supra note 58, at 2
(table 1). 112 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 Annual Review, at 29 (2016). 113Id. see also MILRED, supra note 58, at 7 (table 3). 114 Bank of Israel, Data on banks, Chapter J (10) – credit card information, table j-6
http://www.boi.org.il/he/BankingSupervision/Data/Pages/Tables.aspx?ChapterId=9
31
57. By the end of 2015 there were 7.6 million active payment cards in Israel (a card is considered
active if used at least once a quarter).115 In recent years the market share of non-bank cards has
increased. About 30% of cards are currently non-bank cards.116 CAL estimates that more than
90% of the adult population is holding payment cards. Average is two cards per adult.117
According to the Central Bureau of Statistics, 14% of cardholders hold 3 cards or more.118
The number of points of sale (POS) in which a payment card transaction can be executed has
increased more than 5% annually. In 2008, card payments could be performed at 99,793 points
of sale in Israel. By the end of 2014, the number of POSs jumped to 133,985 at about 70,000
card-accepting merchants.119 This means that most merchants who accept payment cards use a
single point of sale (POS). Large merchants usually have multiple points of sale.
58. Isracard is the Israel's largest payment card firm, with a combined market share of 45%
(including American Express (5%) and Isracart (15%)). CAL (including Diners Club (4%) and
Leumi Card possessed market shares of 27% and 28% respectively.120 The volumes of
transaction for each firm are shown at table 2.
Table 2 – transactions volume for (millions NIS, 2014)121
Volume of transactions %
LeumiCard 63,932 28
CAL 61,578 27
Isracard 100,916 45
Isracard, LeumiCard and CAL all issue and acquire both MasterCard and Visa cards. Isracard
used to operate its own proprietary card, "Isracart", as a closed network. In 2012 Isracard was
forced to "open" Isracart to cross-acquiring by LeumiCard and CAL.122 American Express (5%)
and Diners Club (4%) operate as closed networks. American Express is operated solely by
Isracard and Diners solely by CAL.123
115 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 ANNUAL REVIEW, at 28 (2016). 116 Ibid, see also Bank of Israel, Data on banks, Chapter J (10) – credit card information, table j-1 117 CAL, 2014 Annual Report, at 8. 118 Central Bureau of Statistics, Financial Literacy Survey: The Financial Situation of Israelis and how they Manage it
(Sept. 11, 2012), available at http://www.cbs.gov.il/reader/newhodaot/hodaa_template.html?hodaa=201225240 . 119 Bank of Israel, THE RED BOOK (2014), supra note 20, at 56 (table 6); THE COMMITTEE FOR REDUCING THE USE OF
CASH (LOCKER COMMITTEE), INTERIM REPORT, at 10 (may 2014); C.A.L Annual Report for 2014, at 8. 120 MILRED, supra note 58, at 7 (table 4). 121 2014 annual reports of the Israeli payment card firms. 122 Infra ch. 8.1.2 (Regulation of Isracard). 123 DAVID BOAZ, CREDIT CARD MARKET IN ISRAEL, GENERAL ANALYSIS, CONCLUSIONS AND RECOMMENDATIONS, at 6
(Dec. 2009)
32
59. By the end of 2014, LeumiCard had issued 2.359 million valid cards, of which 1.946 million
were active.124 CAL had issued 1.422 million valid cards, of which 1.212 million active
cards.125 Isracard had issued 3.638 million valid cards, of which 2.924 million were active.126
This is summarized by the table below:
Table 3 - number of cards (2014) in thousands
Number of valid cards Of which, number of active cards
LeumiCard 2,359 1,946
CAL 1,422 1,212
Isracard 3,368 2,924
Total 7,149 6,082
60. The payment card sector is very profitable, even relative to other profitable sectors in the
financial industry. Payment cards are responsible to a substantial part of the total profits of their
controlling banks. In 2012, the average ROE (return on equity) of the payment card firms was
20.8% (after correction due to over-payments to their controlling banks). This rate of return
was more than double the ROE in the financial sector, which was only 8.9%.127 Former Study
also found that the payment card sector yields more than double the rate of profits than the
average in the financial industry.128
61. The total income of the three payment card companies in 2014 exceeded NIS 4 billion, of which
almost NIS 1 billion was profit:
Table 4 –income, expenses and profit for 2015 (NIS millions)129
Total Income Total Expenses Profit
CAL 1,240 999 241
Leumi Card 1,052 796 258
Isracard (+Poalim express) 1,905 1,541 416
Total (all firms) 4,197 3,336 915
62. Out of the total income (NIS 4,197 million), the total income from cardholders was NIS1,619
million and from merchants NIS 1,919 million and together NIS 3,538 million. The remainder
is mainly interest on loans to cardholders and merchants. All three firms report that interest on
credit to cardholders is a growing source of income.130 The income of the issuing side (including
interchange fee) was NIS 3,106 million. The income of the acquiring side (after deducting the
124 LeumiCard 2014 Annual Report, at 15. 125 CAL Annual Report for 2014, at 13. 126 Isracard Annual Report for 2014, at 12. 127 MILRED, supra note 58, at 9 (table 9). 128 CHERTOF & TZADIK, supra note 1, at 11. 129 Bank of Israel, Data on banks, Chapter J (10) – credit card information, tables j-11, j-12, available at
http://www.boi.org.il/he/BankingSupervision/Data/Pages/Tables.aspx?ChapterId=9 130 CAL annual report, at 11 (2014); LeumiCard annual Report, at 17 (2014); Isracard annual Report, at 13 (2014).
33
interchange fees) was NIS 935 million.131 However, without deducting the interchange fees, the
MSF makes up the bulk of the income of the payment card companies. Despite reduction from
77% in 2005, still 65% of payment card firms' income in 2015 came from merchants.132 The
MSF in 2015 was approximately NIS 2.5 billion (NIS 2,420,000,000).133
The interchange fee (including the notional interchange fee in On-Us transactions) is a major
part of the MSF, as can be seen in the table below.
Table 5- MSF and interchange fee for 2014 (NIS millions)134
MSF Interchange fee135
CAL 587136 418
Leumi Card 596137 431
Isracard 1,376138 778
Total (all firms) 2,559 1627
63. The average annual cardholder fee in Israel for 2013 was NIS 81.6, with Isracard being the
cheapest (56.4 NIS), CAL being the most expensive (NIS 114), and LeumiCard close to the
average with an average annual cardholder fee of NIS 80.4. It is interesting to note that the
cardholder fee varies significantly according to the bank in which the cardholder manages her
account. Generally, cardholders who belong to Discount Bank or Bank Hapoalim or Bank
Leumi, pay more than cardholders who manage their accounts in other banks. The probable
reason is that the firms treat cardholders who manage their accounts in the controlling bank of
the issuer, as "captive" customers.139
131 Bank of Israel, Data on banks, TableX-13 consolidated income statements 2014-2015, available at
http://www.boi.org.il/he/BankingSupervision/Data/Pages/Tables.aspx?ChapterId=12 132 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 Annual Review, at 33, diagram 7 (2016). 133 Bank of Israel, Data on banks, table X-5 (last visited October 29, 2016) 134 Ibid and annual reports of the payment card companies for 2014. 135 Interchange fee out of the MSF, including notional interchange fee in on-us transactions. 136 Sheet L65 of C.A.L Annual Report for 2014, CAL Annual Report for 2014 137 Sheet L65 of LeumiCard Annual Report for 2014. LeumiCard 2014 Annual Report 138 Sheet L65 of Isracard and Hapoalim Express 2014 annual reports 139 MILRED, supra note 58, at 10-11 (table 10, diagrams 2-5).
34
3.2. Worldwide
64. The picture worldwide is not very different, and reveals that payment cards are flourishing
worldwide. Their adoption and usage are increasing yearly.140 A major difference between
Israel and the world is that worldwide debit cards are much more popular.141
According to Visa's 10-K (annual report for the year ending Sept. 2014), Visa is the largest
payments network, far ahead of its competitors:
Table 6 – world market shares142
Payments Volume ($ billions)
Number of transactions (billion)
Number of cards (million)
Visa 4,383 89.7 2,219
MasterCard 2,991 52.7 1,281
American Express 940 6.4 107
Discover 127 2.2 64
JCB 176 1.9 83
Diners Club 26 0.2 6
65. According to the 2015 Nilson Report, Visa has a worldwide market share of 58% ($112.1
billion). MasterCard has a market share of 26% ($51.52 billion). The world's third largest
payment card is Chinese UnionPay, with 10% market share. Union-Pay licensed LeumiCard to
acquire its cards beginning in 2015.143 American Express has a market share of 3%. The next
table illustrates these market shares:
Table 7 – Purchase Transaction Worldwide (billions, 2014)144
140 Wilko Bolt & Heiko Schmiedel, SEPA, Efficiency, and Payment Card Competition (DNB Working Paper 239/2009);
Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 67, at 8-9; RONALD J. MANN, CHARGING
AHEAD: THE GROWTH AND REGULATION OF PAYMENT CARD MARKETS, 52 (2006); Committee on Payment and
Settlement Systems, Statistics on Payment, Clearing and Settlement Systems in the CPSS Countries, (Sept. 2014)
http://www.bis.org/cpmi/publ/d120.pdf ; Market data can be also found at Ben Woolsey & Matt Schulz, Credit Card
Statistics, Industry Facts, Debt Statistics 2011, available at http://www.creditcards.com/credit-card-news/credit-card-industry-facts-personal-debt-statistics-1276.php; see also http://www.paymentssource.com ;
http://www.statista.com/topics/1598/debit-cards/ ; http://www.euromonitor.com/financial-cards-and-payments (Last visited Oct. 28, 2016). 141 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 8 (table); Andrew T. Ching & Fumiko Hayashi, Payment Card Rewards Programs and Consumer Payment
Choice, 34 J. BANK. FIN. 1773, 1773 (2010): "Most consumers in the United States already have both credit and debit
cards” 142 Visa Inc. Annual Report (Form 10-k) for the Fiscal Year Ended on Sept. 30, 2014, at 10
http://investor.visa.com/files/doc_downloads/annual%20meeting/2014/817762_BMK1.pdf 143 LeumiCard 2014 Annual Report, at 12. 144 http://www.nilsonreport.com/publication_chart_and_graphs_archive.php?1=1&year=2015
35
66. In 2013 Visa debit had a market share of 38.3%. Visa credit had a market share of 22.1%.
MasterCard debit had 12.4%. MasterCard credit had 14.4%, as illustrated below:
Table 8 – Market Shares Transactions by Types of Cards (2013)145
67. Debit is the fastest growing payment instrument. In the U.S., since 2005, debit transactions have
exceeded those of credit.146 The total value of debit card transactions was $1.8 trillion in 2011.147
The Nilson Report predicts that Visa credit will grow in the next years from $ 26.2 billion to $
66 billion, whereas Visa debit will grow from $42.6 billion to $114.1 billion. MasterCard credit
will grow from $17.5 billion to $43.1 billion, whereas MasterCard debit will grow from $10.7
billion to $47.8 billion:148
Table 9 – Predicted Growth in Transactions
145 http://www.nilsonreport.com/publication_chart_and_graphs_archive.php?1=1&year=2014 146 Kjos, The Merchant-Acquiring Side, supra note 47, at 16: “[T]he number of Visa and MasterCard offline debit
transactions exceeded the number of credit card transactions in 2005”. 147 Hayashi, The New Debit Card Regulations: Effects on Merchants, Consumers, and Payments System Efficiency,
supra note 30, at 114: "According to the Fed. Res. Board (2012), the total value of debit card transactions was $1.8
trillion in 2011". 148 Nilson Report, 2015.
36
68. Payment card transactions are used in Israel for about a third of total private consumption. This
puts Israel at a relatively high level of card usage. However, debit usage in Israel is negligible,
compared to credit cards. In Israel, debit consists only 1.4% of total card transaction. This is
contrary to its wide dispersion in other countries, as the Israeli Antitrust Authority has found.149
Table 10 – Overall payment card usage out of private consumption (left axis) and level of
debit usage out of all payment cards (right axis)
69. Among Visa and MasterCard credit and debit cards, the top issuers in 2013 by purchase volume
were all American banks: (1) Chase (2) Bank of America (3) Wells Fargo (4) Citi (5) Capital
One.150
149 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 8. 150 Nilson Report, 2013. See also: http://www.relbanks.com/rankings/top-credit-card-issuers ;
http://www.cnbc.com/id/36471668
37
70. The acquiring side is less concentrated. All acquirers are financial institutions that are also
issuers or connected by ownership bonds to issuers. First Data, which is a major acquirer, is
connected to Wells Fargo and several other banks.151 Vantiv, top international acquirer which is
a public company, is an affiliate of Fifth Third bank,152 a major payment card issuer.153 Other top
international acquirers are shown below:154
151 Kjos, The Merchant-Acquiring Side, supra note 47, at 15: “JP Morgan Chase’s merchant-acquiring business, Chase
Payment Solutions, Sun Trust, PNC, and Wells Fargo are a few of First Data’s partners”; First Data 2014 Annual
Report (10-K), at 16: “Under the alliance program, a bank or other institution form an alliance with us, either
contractually or through a separate legal entity.”; id. at 74: “A substantial portion of the Company’s business within the
Merchant Solutions and International segments is conducted through merchant alliances. Merchant alliances are
alliances between the Company and financial institutions. The formation of each of these alliances generally involves
the Company and the bank contributing contractual merchant relationships to the alliance and a cash payment from one
owner to the other to achieve the desired ownership percentage for each"; id. at 97: “The alliance acquires credit and
debit card transactions from merchants”; at 147: “Wells Fargo Merchant Services, LLC (the “Company”) is a joint
venture between First Data Merchant Services Corporation (“FDMS”) and Wells Fargo Bank, N.A. (“Wells Fargo”)...
The Company is engaged in processing and funds transfer related to the authorization, processing, and settlement of
credit and debit card transactions for merchants... The Company is operationally dependent on both FDMS and Wells
Fargo... The Company’s funding and settlement are primarily conducted through Wells Fargo. The majority of the bank
accounts used for daily operations are with Wells Fargo”. 152 Fifth Third Bank Affiliated Companies https://www.53.com/about/affiliated-companies/ 153 Fifth Third Bank > Home >Bank >Credit Cards https://www.53.com/personal-banking/credit-cards/ 154 Nilson Report, 2015 http://www.nilsonreport.com/publication_chart_and_graphs_archive.php?1=1&year=2015 . See
also
http://webcache.googleusercontent.com/search?q=cache:http://www.thestrawgroup.com/sites/default/files/downloads/T
SG-Directory-of-U.S.-Acquirers-Preview.pdf ; http://www.thestrawgroup.com/sites/default/files/downloads/TSG-
Directory-of-U.S.-Acquirers-Preview.pdf
38
71. Revenues from global credit card issuing are estimated to increase from $328 billion in 2011 to
$445 billion in 2016.155
4. History of Payment cards and Interchange Fees
72. The history of payment cards, as well as the history of money in general - coins, bills,
promissory notes and checks - albeit fascinating, exceeds the scope of this work.156 I will focus
on the historical aspects of the interchange fees that are relevant to this work.
All payment instruments must overcome a basic problem. They must be attractive to both
buyers and sellers. A payment instrument that is attractive to buyers, but which sellers do not
accept, is ultimately worthless, and vice versa. There must be a critical mass of both buyers and
sellers, who find it worthwhile to use a certain payment instrument, in order for it to become
viable. As for national currency, the law mandates that it be accepted as payment. This is the
foundation of its attractiveness to both buyers and sellers. Thus, the law prevents any lack of
attractiveness to the national currency. The Bank of Israel Law determines that the NIS is legal
tender in Israel according to its par value.157 Any buyer should be able to pay with legal tender
and any seller must accept the legal tender.
In the U.S., the Federal Reserve Act states that Federal Reserve notes shall be receivable by all
155 SRIKANTH VERMA & SATYANARAYANA REDDY, GLOBAL CREDIT CARD INDUSTRY: ISSUES AND CHALLENGES, at 22
(July 2014): "The revenues from global credit card issuing will increase from $328 billion in 2011 to $445 billion in
2016". 156 For expansion, Alan S. Frankel, Monopoly and Competition in the Supply and Exchange of Money 66 ANTITRUST
L.J. 313 (1998); William F. Baxter, Bank Interchange of Transactional Paper: Legal and Economic Perspectives 26
J.L. ECON. 541 (1983); EVANS & SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND
BORROWING, supra note 93. 157 Bank of Israel Law (2010), article 41(b)
39
banks, for all uses.158 However, this obligation is not imposed on private businesses, unless
there is a state law which says otherwise.159
73. Other payment instruments, which are not so lucky to have the law as their promoter, must fight
for their place in the payments arena to maintain viability and survive the evolutionary process
of competition.
Payment cards are private payment instruments. No seller or buyer is under any obligation to
accept, hold or use them. To be viable, payment cards must reach a critical mass and be
sufficiently attractive to both buyers and sellers. The simultaneous appeal to two target groups
of customers has been the key to the progress of all kinds of payment instruments since ancient
coins were minted, through promissory notes, bank notes and eventually, payment cards.160
74. Credit cards were the first kind of payment cards. They were developed in the U.S. in the middle
of the 20th century. Credit cards were actually a development of store credit that merchants
gave their trusted customers.161
In 1950, Diners Club presented the first closed (3-party) credit card payment network. Diners
Club contracted in issuing agreements with cardholders on one side, and in acquiring
agreements with merchants on the other side. The target cardholders were mostly affluent
customers. Merchants were mostly hotels and travel agencies. Diners Club cards were honored
by numerous merchants in the New York vicinity. Diners did not charge cardholder fee for an
initial period. After introductory period with zero cardholder fees, Diners Club charged a fixed
annual cardholder fee of a few dollars. Diners Club did not impose any per-transaction fee on
cardholders. Usage fee was zero. On the other side, merchants paid a MSF of 7%.162
158 Section 31 U.S.C. 5103, entitled "Legal tender" determines: "United States coins and currency (including Federal
reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public
charges, taxes, and dues; See also Board of Governors of the Federal Reserve System, available at
http://www.federalreserve.gov/faqs/currency_15197.htm : "The Act states that Federal Reserve notes "shall be
obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and
for all taxes, customs, and other public dues". 159 Board of Governors Fed. Reserve System, http://www.federalreserve.gov/faqs/currency_12772.htm: "There is,
however, no Federal statute mandating that a private business, a person, or an organization must accept currency or
coins as payment for goods or services. Private businesses are free to develop their own policies on whether to accept
cash unless there is a state law which says otherwise". 160 For expansion on two sided network products see infra ch. 7.1. 161 Baxter, Bank Interchange of Transactional Paper, supra note 156, at 572; Semeraro, Credit Cards Interchange
Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 965; "Merchants had long extended a month or two of
interest-free credit to their regular customers." 162 EVANS & SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND BORROWING, supra note 93,
at 54.
40
75. American Express entered the market in 1958. American Express too, derived the bulk of its
revenues and profits from merchants. That same year, Bank of America, which is the ancestor
of Visa, also began to operate a closed network.163
76. Cardholders of the first networks were required to pay for their purchases approximately one
month after the purchase.164 Cardholders, who paid their full balance on time, were effectively
being paid a sum which reflected the free funding period between the date of their purchases
and the date on which they actually paid for them. Cardholders who repaid their balance over
longer periods paid interest on the balance.165 Until today, worldwide, to attract new cardholders
and encourage card usage, most card schemes set a teaser price structure whereby cardholders
do not pay for the cards, especially for an initial period, and receive rewards for card usage.166
Among the main benefits cards yielded merchants were the payment guarantee (the issuer is
responsible to pay the merchant, even if the issuer cannot collect the money from the
cardholder),167 and the ability for merchants, who accepted credit cards, to expand sales at the
expense of their competitors. The reason was twofold: first, customers who bought assets from
a certain merchant did not need to purchase similar assets from competitors. Second, accepting
cards allowed merchants to make sales to illiquid customers, who but for the card, would not
have made those purchases, at least not at that time period.168
77. Cards reduced the risk of merchants from providing unsecured store-credit to customers.
Moreover, with the growth in trade and mobility, the number of occasional customers, who
sought to purchase with credit, increased. Merchants feared to grant credit to customers whom
they did not know. Guaranteed payment cards solved this problem for them. Cards acceptance
increased the proceeds of merchants who accepted them, at the expense of those who did not.
163Id. at 59. 164 Baxter, Bank Interchange of Transactional Paper, supra note 156, at 572. 165 David S. Evans & Richard Schmalensee, The Economics of Interchange Fees and their Regulation: An Overview,
Payments System Research Conferences 73, 80 (2005): "Then, as now, cardholders who paid their bills within a
specified amount of time (usually a bit less than a month) did not pay any fee for charging and in fact benefited from the
float. Those who financed their store card charges paid interest, of course". 166 Fumiko Hayashi, Payment Card Interchange Fees and Merchant Service Charges - an International Comparison, 1
LYDIAN PAYMENT J. 6 (2010), at 15-16; for expansion see infra ch. 6.7. 167 Infra ¶¶ 87-88, 489. 168 Sujit Chakravorti & Ted To, A Theory of Credit Cards, 25 INT'L J. INDUS. ORG. 583, 584 (2007): "Merchants benefit
from sales to illiquid consumers who would otherwise not be able to make purchases".
41
78. The MSF in the early days of the payment card networks stood at 5% to 10%.169 On the other
side, cardholders enjoyed a convenient means of payment, which saved them the need to carry
cash. Cards also released cardholders of liquidity constraints, so that they could pay with funds
that they did not yet possess at the time of the transaction.170
4.1. Historical Development of Open Networks
79. In my view, the development of open networks is not trivial. Theoretically antitrust authorities
could object to their creation. Open networks are actually cooperation between competitors that
includes an element of price fixing. Open networks involve cooperation between banks, which
generally ought to compete against each other. Instead, they agree to cooperate and acquire
cards issued by their rivals, or issue cards that are acquired by their rivals in consideration for
coordinated fees. This is not trivial.
80. Ironically, the main reason for this cooperation, which developed into contemporary open
systems such as Visa and MasterCard, was banking regulations. In the 1960s, U.S. banking
laws prohibited banks from acting outside their state of registry. Banks that desired to increase
the circulation of their cards beyond the borders of their state of registration, had to cooperate
with other banks, and grant issuing and acquiring franchises to rival banks. Franchisee banks
were entitled to acquire cards issued by their competitors, and issue cards that could be acquired
by competitors.171
81. Initially, bilateral franchise agreements stated that if the acquirer and the issuer were different
entities, then the acquirer had to remit the entire MSF to the issuer. This means that the
interchange fee was in fact equal to the MSF.172 The acquirer had no income, let alone profit.
However, in On-Us transaction (in which the acquirer and the issuer were the same
institution);173 the issuer/acquirer was entitled to bill and keep fees from both sides (the
169 Ahlborn et al., The Problem of Interchange Fee, supra note 97, at 192: “The original charge card systems in the
United States—American Express and Diners Club—charged merchant discounts in the range of 5-10 percent during
their first decade”. 170 For expansion of the costs and benefits of payment instruments see infra ch. 0. 171 Baxter, Bank Interchange of Transactional Paper, supra note 156; EVANS & SCHMALENSEE, PAYING WITH PLASTIC
THE DIGITAL REVOLUTION IN BUYING AND BORROWING, supra note 93, at 166. 172 Howard H. Chang, Interchange Fees in the Courts and Regulatory Authorities 1 PAYMENT CARD Rev. 13, 18 (2003):
"Under the franchise system, Bank of America did not set the fees charged to cardholders and merchants by its
licensees, so it, like the proprietary systems, needed an instrument to balance cardholder and merchant demand in its
system. It chose to require the acquirer to turn over the entire merchant discount to the issuer on a transaction where the
two banks were different. In other words, the implicit interchange fee under the Bank of America franchise system was
equal to the full amount of the merchant discount". 173 Supra ch. 2.4.1.
42
merchant and the cardholder) at its own discretion.
The idea at the basis of this price structure, in which the issuer received the entire income, was
to encourage issuers to distribute cards. The entire revenue from cards was divided solely to
issuers, according to their market share on the issuing side, completely ignoring market shares
on the acquiring side. This indeed encouraged the issuance of cards. In the U.S., credit cards
were massively issued and distributed for approximately two decades. Until 1970, U.S. banks
used to mail their customers active payment cards, without customers even requesting them.174
This conduct increased the proliferation of cards among cardholders, but it had a significant
disadvantage on the other side. Acquirers did not find the business of acquiring, by itself,
attractive, and had no incentive to become acquirers. They became acquirers as an accompanied
activity to the issuing business, and because most of the acquiring in the early days of payment
cards was in “On-Us” transactions.175
82. When the volume of interchange transactions (i.e., transactions in which the issuer and the
acquirer were different institutions, and interchange fee was paid) increased, the incentive for
acquirers to operate with zero MSF decreased. Acquirers had no direct benefit from providing
free services. They had only indirect benefit, derived from their role as issuers. This price
structure also encouraged scams by acquirers, whereby they did not report all of their
transactions.176 In the terminology of this work (although this terminology was created years
later), no acquirer internalized the benefits of its free operations to the network, but each
acquirer fully well internalized the costs incurred thereby.
83. In 1970, Bank of America converted the franchise system to an open network, an association
of acquirers and issuers owned by its members. This association later changed its name to
Visa.177 In 1966 a group of other banks set up another open system, which is the forerunner of
174 ALBERT FOER, ELECTRONIC PAYMENT SYSTEMS AND INTERCHANGE FEES: BREAKING THE LOG JAM ON SOLUTIONS
TO MARKET POWER, Am. Antitrust Institute (2010): “In their early years, before MasterCard and Visa had a substantial
share of merchants, some of their big banks attempted to build a cardholder base by mass mailing live credit cards to
consumers who had not even requested them. Congress put an end to this abuse when it enacted the Unsolicited Credit
Card Act in 1970”. 175 Chang, Interchange Fees in the Courts and Regulatory Authorities, supra note 172, at 13: “However, given that most
transactions in those days were “on-us” (the issuer was also the acquirer), a bank still had significant incentives to sign
up merchants, as it would keep the entire merchant discount for “on-us” transactions”. 176 Timothy J. Muris, Payment Card Regulation and the (MIS)Application of the Economics of Two-Sided Markets, 3
COLUM. BUS. L. REV. 515 (2005); Chang, Interchange Fees in the Courts, supra note 172, at 18. 177 Chang, ibid; Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 165, at 73:
“In 1970 the BankAmericard system was converted into a membership corporation, a multi-party system”.
43
MasterCard.178 Those early open networks encountered a problem, which spurred the
development of the interchange fee. When the acquirer presented a transaction voucher to the
issuer of the card, the issuer had to remit the transaction sum to the merchant, via the acquirer.
The remittance process involved costs and risks for the issuer. The risks were mainly insolvency
of the cardholder or fraud, which could frustrate the ability of issuers to collect the money they
had paid to the acquirers.
84. Issuers and acquirers had to make contracts to allocate the risks of the transaction between
themselves. The contracts had to determine arrangements for allocating the risks of insolvency,
misuse and fraud against cardholders or merchants. Materialization of those risks often meant
that the party assuming them would bear their costs with no indemnification. The consideration
for the party assuming the risks had also to be determined. This was the initial motivation
underlying early interchange fee agreements.179
85. Early interchange agreements were made by banks in their double capacity as issuers and
acquirers. At first, the agreements were bilateral. Two banks regulated the terms of the contract
between them. Bilateral agreements were suitable for small networks with few issuers and
acquirers. As the networks grew, they required an ever-larger number of bilateral agreements.180
n*(n-1)/2 is the formula for the number of agreements required to cover a network, where n is
the number of participants. As numbers of members grew, too many bilateral agreements were
required.
86. In addition, two major disadvantages characterized bilateral agreements in big networks. First,
multiplicity of issuers and acquirers meant high transaction costs. Second, multiplicity of
participants caused a practical problem whenever a transaction between issuer and acquirer with
no previous arrangement occurred. Terms of such transactions, in which the issuer and the
acquirer did not have a former agreement, had to be settled. This problem intensified when
networks expanded. Bilateral agreements simply could not cover all possible transactions in the
network. Thus, it became necessary to make general default rules at the association level, to be
178 EVANS & SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND BORROWING, supra note 93;
Avril McKean Dieser, Antitrust Implications of the Credit Card Interchange Fee and an International Survey, 17 LOY.
CONSUMER L. REV. 451 (2005). 179 David S. Evans, More than Money: The Development of a Competitive Electronic Payments Industry in the United
States, 2 PAYMENT CARD REV. 1 (2004). 180 Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 165, at 84: “[B]ilateral
negotiations were not a practical solution in systems with many banks.”; Frankel & Shampine, The Economic Effects of
Interchange Fees, supra note 64, at 641 n.41
44
applied in instances where there was no existing agreement. For this purpose, open networks
instituted bylaws that obligated all of their members unless determined otherwise.
87. Early bylaws determined, inter alia, a default multilateral interchange fee. The default rate was
to prevail, unless otherwise provided in a bilateral agreement. Other default rules regarded risks
of fraud or insolvency.
The basic rules that were formed in these early bylaws, including the interchange fee, are still
used by credit card networks to this day. The interchange fee is paid by acquirers to issuers.
Issuers assume the risk of the payment guarantee. The payment guarantee is the liability of the
issuer to pay the merchant, through the acquirer, the transaction funds, even if the issuer is
unable to collect the money from the cardholder.181
88. The main provisions that merchants had to meet, in order to be eligible for the payment
guarantee, were passing the cards through a designated reader device, and verifying the identity
of the cardholder. Verification was initially done by comparing signatures. Merchants who
upheld these terms were entitled to receive the transaction funds, even if the money was not
collected from the cardholder due to insolvency or fraud.182
89. The bylaws were set through negotiations among members. Members were banks that
participated on both the acquiring side and the issuing side.183 At the beginning, the networks
were not biased in favor of either issuers or acquirers.184 Later, the market power of issuers in
Visa and MasterCard networks increased more than that of acquirers. The interchange fee began
181 Margaret Guerin-Calvert & Janusz a. Ordover, Merchant Benefits and Public Policy Towards Interchange: An
Economic Assessment, 4 Rev. NETWORK ECON. 384, 401 (2005): “When a payment is made with the credit card, so long
as the merchant has followed the prescribed procedures, the card issuer, not the merchant, assumes the customer credit
risk and provides a mechanism for billing and collecting payments from the merchant’s customers.";
Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 64, at 660: “The payment guarantee” refers
to the fact that a merchant receives payment even if the cardholder never pays an outstanding balance or in the event of
cardholder fraud when the issuer authorized the transaction after the merchant followed proper procedures”;
EVANS & SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND BORROWING, supra note 93, at
153-54 (2nd ed. 2005). See also infra ¶ 489. 182 National Bancard Corp. (NaBanco) v. VISA 596 F. Supp. 1231, 1238 (1984): “[T]he issuer bank is ultimately
responsible for the sums due and owing from its cardholders, and thus, absent a breach of agreed procedure by the
merchant or merchant bank, the issuing bank bears the risk of default by the cardholder.”;
Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 165, at 83: “As long as an
acquirer’s merchant met certain terms, such as properly authorizing transactions and checking card numbers against a
list of known fraudulent accounts, it was guaranteed payment. If a transaction turned out to be fraudulent or a consumer
failed to pay, the issuer was responsible”. 183 Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 970: “In the
early days, most banks participated in both sides”. 184 Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 165.
45
to be determined according to the interest of issuers (even though they were also acquirers), or
directly by the networks (Visa and MasterCard) which favored the interest of issuers.185
90. It is interesting to note the excluding effect interchange fee had in extinction of competing
networks. Before Visa and MasterCard tilted in favor of issuers, some of the early networks,
which did not ultimately survive, had bylaws according to which, transactions were cleared by
issuers at par. Issuers remitted to acquirers all of the transactions' funds, meaning that the
interchange fee was zero.186 By contrast, Visa and MasterCard networks set positive and
relatively high rate of interchange fee. This caused issuing banks to cease issuing cards that did
not yield them an interchange fee, and to commence issuing cards of MasterCard and Visa that
did yield them an interchange fee. Thus, in evolutionary perspective, the interchange fee was a
mechanism that eradicated networks that operated without it. By contrast, in Europe, there are
local debit networks which were less exposed to competition from Visa and MasterCard, and
they continue to operate with zero interchange fees up to date.187
91. Initially the interchange fee was based on the estimated costs of the services that issuers
allegedly gave merchants. These included, apart from the payment guarantee, processing,
authorizing and clearing services. At that time, card transactions were executed using dedicated
"iron" POSs. The product of a transaction was a paper slip, a copy of which was given to the
cardholder. The paper slips that remained with the merchant eventually had to be converted to
money in the bank account of the merchant. Acquirers periodically collected the slips and
delivered them to the various issuers, whose cards they had acquired. Issuers would then
periodically remit to the acquirers the amounts of the slips, less the interchange fee, and charge
their customers, the cardholders, the due sums. In the networks’ early days, this process was
costly and included services that were labor-intensive and carried out mostly manually.
185 Infra note 1506. 186 EVANS & SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND BORROWING, supra note 93,
at 66: “Some of the regional cooperatives had initially exchanged at par so that the cardholder’s bank reimbursed the
merchant’s bank for the entire transaction and the cardholder’s bank didn’t get any of the merchant fees”. 187 Stewart E. Weiner & Julian Wright, Interchange Fees in various Countries: Developments and Determinants, 4 REV.
NETWORK ECON. 290 (2005); Comp/34.579 European Comm'n MasterCard Decision, supra note 44, paras. 562-608;
and at para. 751: “[S]everal payment schemes in the European Economic Area have successfully been operating without
a MIF for a long time. These Schemes have been established between 1979 and 1992 and they are not merely viable but
indeed successful.";
Peter Jones, The Uncomfortable Consequences of a Universal Multi-Lateral Interchange Fee (MIF) for Europe,
PAYMENT SYS. EUROPE, at 3 (2005): "[M]any schemes were established without interchange and still operate this way
today.";
Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 67, at 11: “In 2006 there were at least four
national card schemes that operated without an MIF, namely those in Denmark, Finland, Luxemburg and the
Netherlands”. See also infra n. 1446.
46
92. The consideration paid to the issuers for their services and risks they incurred was the
interchange fee. Early interchange fee rate was calculated according to the estimated costs of
issuers, their expenses, including the inherent risk of payment guarantee. The interchange fee
was essential, especially when direct channels of income, i.e., cardholder fees and interest on
credit, were low and yet undeveloped, so issuers did not have other significant sources of
revenue other than the interchange fee.
Historically, open credit card networks that did not have a positive interchange fee, did not
survive. They became extinct not because it was inherently unviable for an open network to
operate without an interchange fee, but because networks without interchange fees were less
attractive to issuers. Non-interchange-fee networks did not survive the Darwinian business
competition. Issuers preferred to issue cards that rewarded them interchange fee for every
usage, over cards that gave them nothing from usage, especially when cardholder fees and
interest on credit were degenerated revenue streams. The price structure in opened networks
that continued to operate, i.e., Visa and MasterCard, included interchange fee to the issuer.
93. The early Visa bylaws determined that, in any transaction in which the acquirer and the issuer
were not the same, the acquirer had to pay an interchange fee to the issuer at a rate of 1.95%.188
Determination of the MSF was left open to market forces, making it possible for acquirers to
earn profits from acquiring, by setting the MSF above the interchange fee.
A similar price structure also developed in closed systems (American Express and Diners Club)
that did not have an explicit interchange fee. Closed networks also revealed that it was best for
them to impose most of their costs on the merchant side.
Payment networks ultimately discovered that merchants had a greater willingness to pay for
cards than cardholders. Economically, merchants' elasticity of demand for cards is lower than
the demand elasticity of cardholders. Payment networks reacted by collecting most of their
revenue from merchants, the side with the more rigid demand. This is a basic and important
feature of two sided markets: the more-elastic side pays less and the less-elastic side with the
higher willingness to pay, bears most of the costs.189
188 EVANS & SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND BORROWING, supra note 93,
at 154; Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 165, at 74. 189 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 67, at 12-13: “The imbalance in the way
card schemes allocate costs and obtain their income is caused by the lower price elasticity on the merchants’ side... As
the elasticity of demand for merchants in card payments is lower than that for cardholders, the prices for merchants are
higher than the prices for cardholders.”;
47
The overall price level was lower in open systems than in closed systems.190 Both the MSF and
the cardholder fee charged by Visa and MasterCard were lower than that of American Express
and Diners Club. The lower fees gave the open networks a competitive advantage over closed
networks. The market share of Visa and MasterCard increased more than that of American
Express and Diners Club, due to higher penetration rates at the merchant side.191
94. As mentioned above, the interchange fee was initially based on an assessment of issuers’ costs.
However, growing dispersion increased market power of issuers. With it interchange fee began
to be determined based on demand factors.192 Due to their market power, payment networks
could charge interchange fees that were much higher than the issuers’ costs. The surplus of the
interchange fee above costs was used for two purposes. First, to rebate and reward cardholders,
and incentivize them to adopt and use cards even more. Second, as a source of profit for
issuers.193 The move from cost-based interchange fees to a demand-based interchange fees, is
in fact, a move from the realm of competition, where price is based on costs, to one of market
power of issuers.
95. Other contractual provisions in the early bylaws of open networks, helped to establish the
networks. The No Surcharge Rule ("NSR") prohibited merchants from charging more from
Nicole Jonker & Mirjam Plooij, Tourist Test Interchange Fees for Card Payments: Down Or Out? 1 J. FIN. MARKET
INFRASTRUCTURE 51, 54 (2013): “The assumption that merchants are relatively less price elastic compared with
consumers is commonly used as a rationale to justify that acquiring banks pay interchange fees to issuing banks, thus
raising merchant service fees for card payments and lowering consumer fees.”;
Ching & Hayashi, Payment Card Rewards, supra note 596, at 1775: “consumers are price sensitive”;
Steven Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, 14 STAN. J. L. BUS. &
FIN. 343, 356 (2009): “Long standing practice in credit card markets appears to confirm that cardholder demand is
considerably more elastic than merchant demand.”;
Bolt & Schmiedel, SEPA, Efficiency, and Payment Card Competition , supra note 140, at 8: “Typically, merchants are
less price elastic than cardholders, and often bear the full burden of joint payment cost."
Steven Semeraro, The Economic Benefits of Credit Card Merchant Restraints: A Response to Adam Levitin, TJSL Legal
Studies Research Paper no. 1357840, at 26 (2009): “[M]erchant demand for credit cards is less elastic than consumer
demand”. 190 For expansion on price level, see supra ch. 2.4.2. 191 Baxter, Bank Interchange of Transactional Paper, supra note 156, at 573; Ahlborn et al., The Problem of
Interchange Fee, supra note 97, at 192: “When the bank associations, Visa and MasterCard, entered the market and
introduced national credit card products in the mid-1960s in the United States, they wanted to expand well beyond the
traditional travel and entertainment sector. Not surprisingly, the merchant discounts for their products were much lower
than those of American Express and Diners Club. As a result, they were able to get many more merchants to sign up for
their cards.";
National Bancard Corp. (NaBanco) v. VISA 596 F. Supp. 1231, 1237 n. 8 (1984): “Annual fees [of American Express
and Diners Club – O.B] are normally much higher than those charged for the VISA or MasterCard”. 192 Chang, Interchange Fees in the Courts and Regulatory Authorities, supra note 172, at 18: “The fee was initially
based on costs but now depends significantly on demand factors as well”. 193 REPORT ON THE RETAIL BANKING SECTOR INQUIRY COMMISSION STAFF WORKING DOCUMENT ACCOMPANYING THE
COMMUNICATION FROM THE COMMISSION - SECTOR INQUIRY UNDER ART 17 OF REGULATION 1/2003 ON RETAIL
BANKING (FINAL REPORT) [COM(2007) 33 Final] SEC(2007)106, at 100, 122 (Jan 31, 2007). See also infra ¶ 97 and
note 208.
48
customers who paid with cards. The Honor All Cards Rule ("HAC") obligated merchants who
accepted cards of a particular brand (whether Visa or MasterCard), to accept all cards of this
brand, regardless the identity of the issuer.194 As a result, a MasterCard or a Visa card issued by
a small issuer is accepted with no discrimination by every merchant who accepts that card, all
over the world. These provisions helped the networks to increase proliferation worldwide.195
96. Until the 1980s cardholder fees were not common.196 In the U.S., the networks began to charge
cardholder fees as a result of the sharp increase in interest rates in the 1980s, which was
followed by legislation in several states that capped the interest rates banks could charge.
Capping the interest rates was approved by the U.S. Supreme Court in the Marquette
decision.197 The networks bypassed the interest-capping with the introduction of annual
cardholder fees.198 The Marquette decision also caused banks to move to states with fewer
interest-capping restrictions. This, in turn, led states to cancel interest-capping.199 Deregulation
during the 1990s eliminated these restrictions on interest. Again, issuers increased interest rates,
but this time, with their growing market power, they did so without giving up annual cardholder
fees.
97. The acquiring side is considered to be more competitive than the issuing side. The acquiring
business works on big volume but relatively small margins.200 Merchants are more sophisticated
customers (of acquirers) than cardholders (of issuers). This compels acquirers to act
competitively. Economies of scale exist on the acquiring side. Acquiring activities are
194 Supra ¶ 53. 195 Robert M. Hunt, An Introduction to the Economics of Payment Card Networks, 2 REV. NETWORK ECON. 80, 85
(2003): “The honor-all cards rule and the no-surcharge rule reduce the uncertainty consumers would otherwise face.
This was especially important in the late 1960s and 1970s, when the card associations were trying to build nationwide
acceptance of credit cards issued primarily by small banks”. 196 Baxter, Bank Interchange of Transactional Paper, supra note 156, at 579. 197 Marquette Nat'l Bank v. First of Omaha Service Corp. 439 U.S. 299 (1978). 198 Carlton & Frankel, The Antitrust Economics of Credit Card Networks, supra note 97, at 648 n. 12: “Annual fees
were first introduced in the early 1980s when market interest rates moved to record highs but credit card interest rates
were constrained by usury laws”;
Christopher C. DeMuth, The Case Against Credit Card Interest Rate Regulation, 3 YALE J. ON REG. 201 (1986);
Timothy J. Muris, Payment Card Regulation, supra note 176, at 545. 199 Oren Bar-Gill, Seduction by Plastic, 98 N.W. L. Rev. 1373, 1381-82 (2004). 200 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 64, at 633: “The U.S. acquiring market
is generally considered to be highly competitive”;
Jean-Charles Rochet & Jean Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations,
33 RAND J. ECON. 549, 549 (2002): “The acquiring side involves little product differentiation as well as low search
costs and is widely viewed as highly competitive.”;
Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321 (2008);
EU, Proposal for a Regulation on Interchange Fees for Card-Based Payment Transactions, COM (2013) 550, at 11
(July 24, 2013): “[A]cquiring markets tend to be more competitive than issuing markets”;
Ann Kjos, The Merchant-Acquiring Side of the Payment Card Industry: Structure, Operations, and Challenges, at 10
(F.R.B Phil' Discussion Paper 2007): "Unlike with competition for individual cardholders, acquirers have fewer ways to
differentiate their services to merchants; so price tends to be a dominant competitive factor".
49
homogeneous by nature, so competition is mainly reflected in prices, i.e., the MSF.201 In
competitive markets, the pass-through rate of inputs into final prices is high. Changes in the
interchange fee are translated into parallel changes in the MSF, meaning a pass-through rate
close to 100%.202
In Israel, when the interchange fee decreased, the Israel Antitrust Authority ("IAA") initially
found that only about half of the decrease was passed-through to merchants.203 However, a later
study by Bank of Israel found that all the decrease in the interchange fee was passed through to
merchants, i.e., 100% pass through from the interchange fee to the MSF.204 Thus, pass through
takes a few years until completion. The bank noted that the full pass through indicates increased
competition.205
98. The issuing side is relatively heterogeneous with diverse customers, many kinds of cards and
often transfer barriers between firms. Issuers enjoy three major revenue streams: (1) interchange
fees; (2) interest on credit and loans; (3) cardholder fees. The issuing side is considered less
competitive and more profitable than the acquiring side.206 The pass through rate on the issuing
side, from the interchange fees to cardholders, is lower than the pass through-rate on the
acquiring side.207 Studies estimated the pass through rate on the issuing side to be less than
201 Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, supra note 50, at 11: "Although the
acquiring market is dominated by only a few players, these players are highly competitive on price”;
Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 972 ; EVANS &
SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND BORROWING, supra note 93; Howard H.
Chang, Payment Card Industry Primer, 2 PAYMENT CARD REV. 29 (2004). 202 Hayashi, A Puzzle of Card Payment Pricing, supra note 64, at 144: "In the United States, acquirers completely pass
through the interchange fee to merchants.”; Motion 34/01 Leumi v. Antitrust General Director, para. 14 (Dec. 22,
2002); Marc Rysman & Julian Wright, The Economics of Payment Cards, at 28 (2015): "Studies of the regulatory
experiment in Australia in 2003, in which interchange fees were reduced by 40 basis points in 2003, suggest a roughly
100% pass through into lower merchant fees, but that cardholder fees (net of rewards and interest-free benefits) have
increased by a more modest amount". 203 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 7. 204 BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 ANNUAL REVIEW, at 27, 30 (2016). 205 Id. at 30. 206 Infra notes 370, 1480. 207 Michael L. Katz, What do we Know about Interchange Fees and what does it Mean for Public Policy? Commentary
on Evans and Schmalensee, FRB Kansas Payments Sys. Res. Conference 121, 132 (2005): "Industry wisdom is that
most of the weight is put on issuer profits, at least in the United States, and that acquirers generally pass through a
higher percentage of fee changes to their customers than do issuers.";
EU, Proposal for a Regulation on Interchange Fees, supra note 200, at 10: “Consumers already pay through the
incorporation of Interchange Fees (via the MSC) in the retail prices, and banks are less likely to pass on the benefits of
the Interchange Fees to their account holders than merchants to their clients, given the lower level of competition in the
banking sector and the current lack of consumer mobility in the field of retail banking. Hence the pass through by
merchants should be greater in any case than the pass through by banks”.
50
50%.208 This is in line with findings in the telephone industry, another two-sided-network
industry, in which the equivalent to the interchange fee is the "termination fee". Changes from
reducing the termination fee have been found not to be passed-through in full to calling
customers.209
4.2. History Of Debit Cards and ATMs
99. Historically, the first payment cards were credit cards, and the discussion above relates mainly
to them. Debit cards evolved in a different way. The historical development of debit cards is
important, especially since some debit card networks work with zero interchange fees.210 With
ATMs, the interchange fee is in the opposite direction, from acquirers to issuers.211
100. Debit cards are relatively new payment instruments. Debit expansion is related to its cost
effectiveness,212 but the beginning of debit is attached to the ATM networks. ATM networks
208 REPORT ON THE RETAIL BANKING SECTOR INQUIRY [COM(2007) 33 Final], supra note 193, at 101: "[A]n
econometric estimation controlling for other variables that may affect the fee per card level shows that if the
interchange fee increases by 1 Euro only 25 cents are passed on to consumers in lower fees.";
Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, supra note 50, at 9: "Currently about 45% of
the interchange fee goes to fund rewards programs". AMY DAWSON AND CARL HUGENER, A NEW BUSINESS MODEL FOR
CARD PAYMENTS (WayToHigh.com: Diamond Management and Technology Consultants, Inc.,2008), http://waytoohigh.wordpress.com/2008/07/18/a-new-business-model-for-card-payments-via-diamond-management-technology-consultants/2006 : "Paying for issuer rewards programs consumes about 44% of interchange costs, but
merchants get nothing out of these programs; they are competitive tools for issuers.";
Scott Schuh et al., Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations, at 29 (FRB of
Boston Public Policy Discussion Papers No. 10-03. 2010): "Thus, banks keep 65 percent of the revenues from
merchant fees, while consumers receive 35 percent in rewards". At 41 the writers argue that pass through rate out of
the interchange fee (as opposed to pass through rate out of the MSF), is 47%: “If we look at interchange fees instead of
merchant fees, subtracting 0.5 percent (acquiring banks' profit) from 2 percent we compute 35 percent times 4/3 ≈ 47
percent.”;
EU, Proposal for a Regulation on Interchange Fees, supra note 200, at 11: “[F]rom evidence in Australia, it seems that
retailers would benefit integrally (100%) from lower IFs – as acquiring markets tend to be more competitive than
issuing markets, whilst the potential increase in cardholder fees is limited to 30-40% of the amount of the interchange
fee decrease.”;
Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 64, 635 n. 28: “In the absence of perfect
competition and frictionless rebating, only a portion of interchange fee revenues are returned in this way to consumers.
Available evidence suggests that rebates, when offered, are lower than the associated interchange fee.”;
Fumiko Hayashi & Stuart E. Weiner, Interchange Fees in Australia the U.K and the United States: Matching Theory
and Practice, FRB KANSAS ECON. REV. 75, 95 (2006): “It does appear that pass through of interchange fees is 100
percent on the acquiring side, while on the issuing side it is less than 100 percent.”; see also infra note 590. 209 Wilko Bolt, Nicole Jonker & Mirjam Plooij, Tourist Test Or Tourist Trap? Unintended Consequences of Debit Card
Interchange Fee Regulation, DNB Working Paper 405, at 24 n.18 (2013): “Empirical evidence from another network
industry, i.e. the telephone industry, where termination rates were reduced as part of regulatory measures also point to
incomplete pass through of fee reductions to customers”. 210 Supra note 187. 211 David Balto, The Problem of Interchange Fees: Costs without Benefits? E.C.L.R 215, 218 (2000): “In the ATM
network environment, card-issuing banks pay ATM owners an interchange fee to compensate them for the costs of
deploying ATMs”; HAYASHI, A GUIDE TO THE ATM AND DEBIT CARD INDUSTRY, 2006 UPDATE, supra note 31. 212 Tim Mead, Renee Courtois Haltom & Margaretta Blackwell, The Role of Interchange Fees on Debit and Credit
Card Transactions in the Payments System, 11-05 FED. RESERVE BANK OF RICHMOND (2011): “The economics of this
expanding network was based on cost reduction (primarily for labor associated with customer checking and savings
accounts) rather than on revenue generation as in the credit card model”.
51
evolved as cheap and fast cash withdrawal systems, rather than payment networks. In the early
days of ATMs, a customer of bank A could not access her account and withdraw cash through
an ATM of bank B. In the late 1970s, banks began to connect their ATM networks, as a service
to their customers. This enabled a customer of a particular bank to withdraw cash from ATMs
of other banks in the network.213 ATM networks also allowed other banks to join. It was not
long until ATM networks integrated. This trend accelerated, and today most bank customers
can withdraw cash from any ATM worldwide. In Israel, the banks consolidated their own ATMs
through SHVA.214
101. The interchange fee in ATMs developed in the opposite direction of payment card interchange
fee. The ATM interchange fee is paid by the issuer (the bank where the account of the
withdrawing cardholder is managed) to the acquirer (the owner of the ATM). The history of
ATMs in the United States, which also applies to Israel, explains the reason for the reverse
interchange fee.
When ATM networks began to develop, ATM owners were not allowed to charge fees from
non-customers. This created a disincentive to install ATMs that served the general public.
Banks that enabled ATM withdrawals by non-customers, effectively gave a free service to
customers of other banks, and bore the associated costs and risks without any compensation.215
Interchange fee from issuer to the owner of the ATM served as consideration to ATM owners.
The interchange fee compensated ATM owners for the risks, especially fraud risks, from
providing cash to non-customers. The interchange fee thus enabled the growth of the ATM
network.216
102. In Israel, too, until the end of 2005, a price control order forbade ATM owners to charge fees
for withdrawals. As a result, the incentive to erect ATMs outside bank branches was low.217
213 FOER, ELECTRONIC PAYMENT SYSTEMS AND INTERCHANGE FEES, supra note 174: “In the late 1970s, banks began to
link their ATMs into networks that enabled each bank’s depositors to use not only his or her own bank’s ATMs to
withdraw cash but ATMs of all the banks linked in their bank’s network... and it wasn’t long before the banks in each
region figured out that it would be most convenient, and profitable, if they could offer their cardholders ATM access
anywhere in the country and then the world". 214 Infra ch. 8.1.7. 215 For expansion, James J. Mcandrews, Automated Teller Machine Network Pricing – A Review of the Literature, 2
REV. NETWORK ECON. 146 (2003). 216 Prager et al., Interchange Fees and Payment Card Networks, supra note 64, at 12 n. 22: “Automated teller machine
(ATM) networks are another example where interchange fees flow in the opposite direction (i.e., card issuing banks pay
interchange fees to ATM operators for each transaction). Historically, this arrangement arose because ATM networks
prohibited ATM operators from charging transaction fees (i.e., surcharges) to ATM users whose cards were issued by
other banks. Under this restriction, interchange fees encouraged deployment of network-connected ATMs by providing
a means for ATM operators to recover their costs". 217 Exemption with Conditions to Five Banks in re: SHVA, at 4, Antitrust 5001307 (Nov. 5, 2008).
52
Banks applied and received an exemption to a restrictive arrangement between them (as issuers
and ATM owners), whereby the bank that issued the card paid the owner of the ATM an
interchange fee of 20 cents (U.S.) per withdrawal.218
On December 13, 2005, Israel partially lifted its price controls on ATM withdrawal fees.
Owners of non-bank ATMs, and ATMs that are more than 500 meters from bank branches,
could charge fees for withdrawals.219 As a result, new players have entered the ATM market,
and a steep increase in the number of cash withdrawal points occurred, especially of non-banks
ATMs.220 This process also occurred in the U.S., when direct charges were permitted.
Incentives to install ATMs increased and the ATM market expanded.221
In my view, the deregulation should have been accompanied by a simultaneous reduction in the
ATM interchange fee, or even a complete cancellation of it. The interchange fee was originally
justified to encourage installment of ATMs, when withdrawal fees were forbidden, and ATM
owners could not recover costs. When the prohibition on direct withdrawal fee was canceled,
justification for ATM interchange fee was canceled with it. ATM owners can and do charge
direct fees for withdrawals. The anti-competitive effect of the unnecessary ATM interchange
fee is that issuers pass through the interchange fee they pay to their customers as foreign fees,
or in other ways that are not transparent. ATM interchange fee increases the price level of
banking services, but in a less transparent way than direct fees.
At the very least, the General Director should have examined the necessity of the interchange
fee for the viability of the ATM network, after the removal of the prohibition on withdrawal
fees, considering the flourishing channel of direct fees from withdrawers. This inspection
should have been a pre-condition to permit ATM interchange fee. Maintaining the interchange
218 Exemption to Five Banks - Interchange Fee in ATMs, Antitrust 3015632 (Oct. 8, 2002); Exemption with Conditions
to Five Banks in re: SHVA, Antitrust 5000714 (June 17, 2004). 219 Price Ordinance (Removal of Supervision on ATMs Withdrawal Fees) 2006. See also Exemption with Conditions to
Five Banks in re: SHVA, at 4, Antitrust 5001307 (Nov. 5, 2008); Exemption with Conditions to Five Banks in re:
SHVA, at 7, Antitrust 5001953 (May 22, 2012). 220 Exemption with Conditions to Five Banks in re: SHVA, at 4, Antitrust 5001307 (Nov. 5, 2008). 221 Osborn v. Visa Inc., 797 F.3d 1057, 1060 (D.C. Cir. 2015): "Until the mid-1990s, consumers who wished to
withdraw cash from their bank accounts generally could do so only by visiting a bank branch or a bank-operated ATM.
But states began to abolish various laws that had prohibited ATM operators from charging access fees directly to
cardholders. This created a financial incentive for nonbanks to enter the ATM market, and independent ATMs took root
accordingly".
53
fee should have been approved only if it was indispensable for ATM owners to operate without
interchange fees, despite charging direct fees, and to the minimal extent.222
103. In Australia, a pioneer country in regulating the interchange fee (as will be discussed below),223
since 2009 there has been no ATM interchange fee, but only direct charges for withdrawals.224
104. In the U.S, ATM interchange fee exist. A legal challenge against them failed, because of the
"indirect purchaser" doctrine.225 The Federal U.S. Supreme Court rule generally negates
indirect purchaser's standing.226 The interchange fee is interbank payment. Neither cardholders
nor merchants directly pay interchange fee in ATM transactions. Issuing banks pay it, and then
pass it to their customers, who are, in this sense "indirect purchasers". On this ground the action
was dismissed.227
In my opinion, this ruling is erroneous. The interchange fee is a restrictive arrangement of which
indirect payers (i.e., withdrawers) are injured. Unlike other inputs between buyer and seller, in
which the buyer bargains to pay less, and the seller bargains to charge more, ATM interchange
fee is a payment between banks that are payers and payees at the same time. They both have an
interest in increasing the interchange fee, and sharing the revenue according to their market
share as payees, i.e., as owners of ATMs. In their capacity as payees (ATM owners) they receive
interchange fee payments. In their role as payers (ATM card issuers), they pass the fee to their
customers, the withdrawers, e.g., as foreign fee. Antitrust injury is inflicted on withdrawers and
not issuers.
222 AT 491/98 Israel Electric Company v. Antitrust General Director, at 73 (March 22, 1999) (The Tribunal will not
approve a restrictive arrangement unless indispensable and proportional); AT 19545-04-10 Shovarei Bar v. Antitrust
General Director, at 8, 27 (Jan 24, 2012).
In Europe, indispensability is also one of the conditions for exemption, see Guidelines on the Applicability of Article
101 to Horizontal Co-Operation Agreements, O.J C 11/1, at 12 (Jan. 14, 2011): “[T]he restrictions must be
indispensable to the attainment of those objectives, that is to say, the efficiency gains”; Case T-111/08 MasterCard v.
Comm'n, para. 79 (May 24, 2012); C-382/12 P MasterCard v. European Commission, paras. 91, 107 (Sept. 11, 2014).
In the U.S. the requirement is that the restriction be reasonably necessary, see P. E. AREEDA & H. HOOVENKAMP, VII
ANTITRUST LAW 370 sec. 1505 (2d ed. 2003); FTC & DOJ, Antitrust Guidelines for Collaborations among
Competitors, para. 3.36(b) (Apr. 2000); ABA 1 ANTITRUST LAW DEVELOPMENTS 480 (7 ed. 2012). 223 Infra ch. 8.4. 224 Jocelyn Donze & Isabelle Dubec, ATM Direct Charging Reform: The Effect of Independent Deployers on Welfare,
10 REV. NETWORK ECON. 1 (2011): "Since March 2009, interchange fees and foreign fees have been removed and
replaced by a pricing scheme where ATM owners directly charge a fee to any cardholder who uses their ATMs.
Withdrawing money is free when the cardholder uses an ATM belonging to his or her own bank". Hugh Green,
Australia’s 2009 ATM Reforms: Transparency for Transparency’s Sake, 19 AGENDA 1 (2012). 225 In Re: ATM Fee Antitrust Litigation, 10-17354 LEXIS 14265 (C.A 9th Cir. 2012) 226 Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977). 227 Crayton v. Concord EFS, Inc. (In re ATM Fee Antitrust Litig.), 686 F.3d 741, 758 (9th Cir. Cal. 2012): "Plaintiffs
lack standing to seek damages for the alleged antitrust violations".
54
Nevertheless, the Ninth circuit dismissed the claim because the plaintiffs were allegedly
"indirect purchasers", and unfortunately certiorari was denied.228 However, injured withdrawers
are forever "indirect" purchasers, whereas "direct" purchasers are never injured and would
never sue. In fact, the banks, which are purportedly direct purchasers, are part of the
"conspiracy" (in their capacity as ATM owners). Even under the "indirect purchaser doctrine",
its co-conspirator exception should have been applied. Not for vain the Illinois Brick rule has
drawn consistent criticism.229 To demonstrate the absurdity, the court's reasoning would apply
even if the interchange fee were $100 per ATM withdrawal... The narrow interpretation of the
Ninth Circuit to the exceptions of Illinois Brick was indeed criticized.230
The indirect purchaser doctrine does not apply in Europe.231 In Israel, too, the indirect purchaser
rule is not applicable. Indirect purchasers in Israel have a cause of action for damages that were
passed on to them.232
105. Getting back to the history of debit cards, when ATM networks combined, their bank members
understood that it would be possible to use the networks’ infrastructure for actual payments and
not only cash withdrawals. From there, it was a short step to the introduction of debit card
228 Brennan v. Concord Efs, 2013 U.S. LEXIS 6750 (U.S., Oct. 7, 2013) 229 ANTITRUST MODERNIZATION COMMISSION, REPORT AND RECOMMENDATIONS 267-274 (2007).
available at http://govinfo.library.unt.edu/amc/report_recommendation/amc_final_report.pdf ; 2A PHILLIP E. AREEDA &
HERBERT HOVENKAMP, ANTITRUST LAW ¶ 346d-k (3d ed. 2007); Herbert Hovenkamp, Quantification of Harm in
Private Antitrust Actions in the United States (at 209 OECD POLICY ROUNDTABLE QUANTIFICATION OF HARM TO
COMPETITION BY NATIONAL COURTS AND COMPETITION AGENCIES DAF/COMP(2011)25): "The Illinois Brick rule was
based on two premises, both of which today seem quite questionable.”;
Maarten Pieter Schinkel, Jan Tuinstra & Jacob Rüggeberg, Illinois Walls: How Barring Indirect Purchaser Suits
Facilitates Collusion, (Amsterdam Ctr. for Law & Econ. Working Paper No. 2005-02, 2008);
Edmund H. Mantell, Denial of a Forum to Indirect-Purchaser Victims of Price Fixing Conspiracies: A Legal and
Economic Analysis of Illinois Brick, 2 PACE L. REV. 153, 217 n.157 (1982); Colin Graham Fraser, An Illinois Brick
Wall without Foundation: The “Price Paid” Rule and the Roadmap to Antitrust Immunity: “[T]he “cost-plus”
exception, expressly recognized by Hanover Shoe and Illinois Brick, applies where an indirect purchaser enters into a
contract with a direct purchaser for a fixed quantity and a fixed markup." see also Paper Sys. Inc. v. Nippon Paper
Indus. Co., Ltd., 281 F.3d 629, 631 (7th Cir. 2002). 230 Marrero-Rolón v. Autoridad De Energía Eléctrica De P.R., 2015 U.S. Dist. LEXIS 134211, 36-37 (D.P.R. Sept. 28,
2015): "I disagree that this case presents an "exception" to Illinois Brick rather than a fundamentally different factual
scenario... neither In re ATM Fee or Dickson explain who, if anyone, could sue for the overcharges alleged in each
case. For these reasons, I would not follow either case to the extent it conflicts with my analysis. See Laumann v. Nat'l
Hockey League, 907 F. Supp. 2d 465, 480-83 (S.D.N.Y. 2012) (declining to follow In re ATM Fee and holding that
where the "middlemen are alleged to be co-conspirators," the first purchasers outside of the conspiracy have standing to
sue)". 231 DIRECTIVE 2014/104/EU, On Certain Rules Governing Actions For Damages Under National Law For
Infringements Of The Competition Law Provisions, article 12 O.J L 349/1 (Dec. 5, 2014): “[C]ompensation of harm can
be claimed by anyone who suffered it”. 232 CA 2616/03 Isracard v. Howard Reis, 59(5) 701, 718 (2005); Opinion of the legal advisor to the government in CA
10538-02-13 Hatzlacha v. El-Al et al. (Sept. 7, 2014); CA (Center) 46010-07-11 Ophir Naor v. Tnuva, Paras. 37-44
(April 5, 2016); CA (Center) 53990-11-13 Hazlacha v. AU, at 30 (March 6, 2016); CA 41838-09-14 Weinstein v Mifalei
Yam Hamelach (29.1.17).
55
networks. A Debit transaction is routed through the ATM network. It is equivalent to a
withdrawal of the precise sum of the transaction from an ATM that is positioned at the cashier,
and immediately remitting the sum to the seller.
106. The proliferation of debit cards was rapid, due to the simple fact that all ATM cardholders are
automatically debit cardholders. Debit card networks therefore had to establish themselves only
on the merchant side. This was relatively easy to achieve. Debit networks could offer a lower
MSF because debit transactions are cheaper than credit transactions.233 In particular the cost of
the payment guarantee is lower in debit transactions compared to credit, because payment is
settled immediately. Risk of default by the cardholder is much smaller. With credit cards, the
payment guarantee is proportional, because the risk increases directly with the amount of the
transaction and the length of the credit period, which does not exist in debit.
Merchants that wanted to accept debit cards had to connect to the debit infrastructure which
was different than the credit infrastructure. Merchants also had to adjust their POSs for reading
and processing debit transactions. PIN debit POSs include smart terminals which identify the
cardholder by entering the PIN code, and not by signature.
To convince merchants to accept debit and make the required investment, early debit networks
offered a MSF low as 0% (i.e., acquiring at par value).234 Merchants had an incentive to invest
the initial lump sum and there-after enjoy a cheap payment instrument relative to credit cards.
107. After debit card circulation had grown to exceed critical mass and become viable, debit
networks began to charge a MSF of a few tens of cents per transaction (as opposed to the
proportional MSF applicable to credit card transactions). The MSF for debit reflects mainly the
processing and authorization costs. Those costs are not dependent on the sum of the transaction.
233 Infra ¶ 125. 234 David S. Evans, Robert E. Litan & Richard Schmalensee, Economic Analysis of the Effects of the Fed. Res. Board's
Proposed Debit Card Interchange Fee Regulations on Consumers and Small Businesses, (2011), available at
http://ssrn.com/abstract=1769887 : "The ATM networks were able to persuade merchants to install PIN pads at the
point-of-sale to route transactions through their systems by charging very low interchange fees in the 1990s.";
David S. Evans, The Antitrust Economics of Multi-Sided Markets, 20 YALE J. REG. 325 (2003); Ahlborn et al., The
Problem of Interchange Fee, supra note 97, at 192; Lloyd Constantine, Jeffrey I. Shinder & Kerin E. Coughlin, In Re
Visa Check/Mastermoney Antitrust Litigation: A Study of Market Failure in a Two-Sided Market, 2005 COLUM. BUS. L.
REV. 599, 609 (2005): “PIN debit also flourished because the regional networks priced it at par (i.e., merchants paid no
interchange fee), thus maximizing merchant incentives to install the PIN pads that they needed to accept PIN debit
transactions”.
56
In debit, the proportional cost is negligible; hence debit acquirers could offer fixed and not
proportional MSF.235
Since the debit networks in the U.S. developed from ATM networks, Visa and MasterCard were
initially not part of them. However, when the volume of debit transactions began to rise, Visa
and MasterCard did not sit idle. Visa acquired a debit network named Interlink, and MasterCard
developed its own debit network, Maestro.
Currently, there are more than 10 debit networks in the United States. The 4 largest (Interlink,
Pulse, Star, and NYCE) possess 90% market share.236
108. In my view, the actions taken by Visa after it purchased Interlink are a text-book example of
anti-competitive conduct which unfortunately succeeded, because of a lack of regulatory and
judicial awareness. Visa used the interchange fee to attract banks to issue visa debit. As opposed
to other debit networks that charged very low MSF, if any, Visa charged a relatively high MSF,
from which Visa transferred a major part to the issuing banks as interchange fee.
The interchange fee on Visa’s debit cards was higher than the interchange fee in cheaper PIN
debit networks. Visa offered issuing banks a higher interchange fee for issuing its signature
(and inferior) debit, instead rivals' PIN debit. Other networks could not match Visa's offer.
Visa's conduct was a decisive factor. The high income from Visa's interchange fees was an offer
that issuers could not refuse. Banks reduced issuance of other networks’ cheaper debit cards,
which did not reward them such a high interchange fee, and switched to issue Visa’s more
expensive debit. As a result, networks with low interchange fees were excluded, even though
from social welfare perspective, they were cheaper and more efficient. The market share of
Visa's Interlink increased and with it the MSF jumped from 20 cents per $100 transaction in
2002 to 90 cents in 2008.237
235 NACS v. Bd. of Governors of the Fed. Reserve Sys., 746 F.3d 474, 479 (D.C. Cir. 2014): “In contrast to credit card
fees, which generally represent a set percentage of the value of a transaction, debit card fees change little as price
increases. Thus, a bookstore might pay the same fees to sell a $25 hardcover that Mercedes would pay to sell a $75,000
car”. 236 Zhu Wang, Demand Externalities and Price Cap Regulation: Learning from the U.S. Debit Card Market, at 6 (FRB
Richmond Working Paper No. 13-06R. 2014): “Interlink, Star, Pulse and NYCE are the top four networks, together
holding 90 percent of the PIN debit market share. The largest PIN network, Interlink, is operated by Visa”. See also Shy
& Wang, Why do Payment Card Networks Charge Proportional Fees, Supra note 31, at 2 n. 6. 237 FOER, ELECTRONIC PAYMENT SYSTEMS AND INTERCHANGE FEES, supra note 174, at 18; Andrew Martin, How Visa,
using Card Fees, Dominates a Market, N. Y. Times, Jan. 4, 2010; M. Pierce Sandwith, The Dodd-Frank Wall Street
Reform and Consumer Protection Act: Debit Card Interchange Fees and the Durbin Amendment's Small Bank
Exemption, 16 N. C. BANKING INST. 223, 230-31 (2012).
57
Visa used signature debit and not PIN debit. Signature debit is not as fast as PIN debit, and is
more expensive. Signature debit is routed on the slower credit card network, as opposed to the
faster ATM network used by PIN debit.238 Signature debit is also less protected from fraud risks
than PIN debit.239
Visa thus paved the way for the market to move from the more efficient and cheap PIN debit
to the less efficient and more expensive signature debit.240 As I shall show, this is consistent
with the economic adage that bad money drives out good money.241
109. Later, a trend began in the United States whereby debit cards switched to proportional MSF,
probably for profit maximization.242 Debit interchange fee continued to increase gradually, and
apart from a temporary reduction in 2003, due to a class action settlement regarding the HAC
rule,243 debit card interchange fee was eventually reduced only after the U.S. Congress
intervened with a major reform, named the Durbin Amendment in the Dodd-Frank Law.244
110. Debit is a pure payment instrument. Debit cards are a substitute for cash.245 Debit card is also a
substitute for credit card, as long as the cardholder needs the card just as a payment instrument
(i.e., as a “transactor” and not as a “creditor”). Debit cards are not a substitute for deferred
payments or for those who need the inherent credit function in credit cards. Debit is also no
substitute for deferred checks. Therefore, debit is not an available option for consumers with
liquidity constraints. However, for customers who are pure transactors and need a payment
238 NACS v. Bd. of Governors of the Fed. Reserve Sys., 746 F.3d 474, 478 (D.C. Cir. 2014): “Signature networks
employ infrastructure used to process credit card payments, while PIN networks employ infrastructure used by ATMs...
PIN transactions are authorized and cleared simultaneously: because the cardholder generally enters her PIN
immediately after swiping her card, the authorization request doubles as the clearance message. Signature transactions
are first authorized and subsequently cleared: because the cardholder generally signs only after the issuer has approved
the transaction, the merchant must send a separate clearance message.”;
Shy & Wang, supra note 31, at 1576: “PIN debit cards are routed over the PIN debit networks, which used to charge
fixed per-transaction fees”. 239 Supra note 31. 240 Debit Card Interchange Fees and Routing, Final Rule, supra note 31, at 46262: “[T]he higher interchange revenue
for signature debit relative to PIN debit has encouraged issuers to promote the use of signature debit over PIN debit,
even though signature debit has substantially higher rates of fraud.”;
Balto, supra note 211, at 216: “[B]ecause of interchange fees the less efficient payment system prospered.”;
Borzekowski & Kiser, supra note 28, at 168; Sandwith, The Dodd-Frank Wall Street Reform, supra note 237, at 230;
Constantine, Shinder & Coughlin, In Re Visa Check/Mastermoney Antitrust Litigation: A Study of Market Failure in a
Two-Sided Market, supra note 234, at 605-10. 241 Infra ch. 7.2.2 and ¶ 435. 242 Supra n. 68. 243 Wal-Mart Stores, Inc. v. Visa U.S.A. Inc., 396 F.3d 96, 103 (2d Cir. N.Y. 2005): "The district court described the
Settlement as providing for, among other things… Lowering, by roughly one third, of the interchange rates on debit
products for the period from August 1, 2003, through December 31, 2003". For expansion on this case see infra ch.
8.3.7. 244 Infra ch. 8.3.9. 245 Infra note 952
58
instrument only to “pay” with, and of course for merchants, debit cards are cheaper, faster and
more efficient than credit cards.246
4.3. Interim Summary
111. The brief history description above shows how different payment networks evolved in diverse
ways, in terms of price structure and interchange fees, and as an answer to different supply and
demand pressures each payment system faced.
112. With Credit cards, networks were required to incentivize cardholders, the side with the higher
elasticity. Networks acted in creative ways to increase the distribution on the issuing side.
Merchants were willing to pay a high MSF, and needed fewer incentives for accepting cards.
Credit card networks developed by imposing most of the costs on the merchant side, and by
transferring interchange fees from acquirers to issuers in order to subsidize and incentivize
adoption and usage among cardholders.
With debit cards, the networks had to convince merchants to join, as the penetration at the
cardholders’ side was complete and automatic from the outset. Cardholders already had debit
cards - their ATM cards. Therefore, the price structure was tilted to attract merchants by
offering them a low MSF, and sometimes even an interchange fee of zero. Only when debit
networks matured and gained market power, did they raise the MSF for merchants.
With ATMs, the circumstances were the opposite and thus the interchange fee was reversed,
meaning from the issuer to the acquirer. The side that needed to be incentivized was the ATM
owners. Today, at least in countries that allow direct charges for withdrawals, interchange fees
in ATM transactions (not to mention interchange fees that are at the same level as that prior to
introduction of direct charges), is an anachronistic remnant of the period in which ATM owners
(acquirers) were not motivated to install ATMs, and had to be incentivized by collecting
interchange fees from issuers.
The historical evolution of interchange fees in payment networks demonstrates that interchange
fee is not an essential.247 Initially, credit card interchange fee was a tool to compensate issuers
246 For expansion on costs and benefits of payment cards see infra ch. 5.4. 247 Comp 29.373 Visa International — Multilateral Interchange Fee, O. J. L 318, 17, (July 24, 2002), http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32002D0914:EN:HTML "The Visa MIF is, on the admission of
Visa itself, not indispensable for the existence of the Visa system";
Comp/34.579 European Comm'n MasterCard Decision, supra note 44, para. 608; see also id. Para. 648: "The
MasterCard MIF is not objectively necessary for the operation of an open payment card scheme such as MasterCard's.";
59
for their costs. As networks gained market power, interchange fee was used for reducing
cardholder fee, and increasing rewards and profits, by exploiting the high willingness to pay on
the part of merchants. Also, in debit and ATMs interchange fee was used by the networks to
transfer money from the side that was more willing to pay to the side that needed inducement.
After networks gained market power they raised the interchange fee even more, and used its
proceeds as a source of profit.
Part II - Economic Analysis
5. Costs And Benefits Of Payment Instruments
113. There are several payment instruments in the market, of which the main ones are cash, checks
and payment cards. Payment cards include credit, deferred debit, prepaid and debit cards. New
payment instruments like Bitcoin and Pay-Pal have so far gained little market share, and are not
significant for this analysis.248 Pay-Pal is not an independent payment instrument, but rather an
add-on to the payment cards networks.
114. Interchange fees affect the level of payment card usage compared to other payment instruments.
In order to understand if it is indeed more efficient to increase the level of card usage, the
relative costs and benefits of payment instruments must be examined.
115. The costs and benefits of using a certain payment instrument are not limited to the payers and
payees. A positive correlation was found between usage of efficient payment instruments and
economic growth. For instance, electronic payment instruments, which are traceable, help to
suppress “black” or “shadow” economy, so their costs and benefits to society exceed those of
Case T-111/08 MasterCard v. Comm'n, para. 120 (May 24, 2012): “The Commission was legitimately able to conclude
that the MIF was not objectively necessary for the operation of the MasterCard system”. C-382/12 P MasterCard v.
European Commission, para. 113 (Sept. 11, 2014);
Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 971: "Success
does not establish that interchange fees are essential to an efficient card system.";
EU, Proposal for a Regulation on Interchange Fees, supra note 200, at 11: “In terms of viability, a debit card scheme
without any interchange fee seems to be perfectly viable from a commercial perspective without raising the costs of
current accounts for consumers. Denmark for example has a zero-interchange fee on its domestic debit scheme while an
average account holder pays current account fees well below the EU average. Similarly, in Switzerland the main debit
card network is Maestro (part of MasterCard) which has no MIF”. 248 Carlos Arango, Kim P. Huynh & Leonard Sabetti, Consumer Payment Choice: Merchant Card Acceptance Versus
Pricing Incentives, 55 J. BANK. FIN. 130, 139 (2015): “However, currently none of the platform-based digital currencies
are widely accepted”.
60
the parties to the transactions.249 This chapter will give a short summary of the costs and benefits
of payment instruments.
5.1. Costs of payment instruments
116. Like any other product or service, payment instruments also carry costs for their users.
Aggregate costs of payment instruments are substantial. Studies estimate that the total costs of
payment instruments amount to 1% (and, in some studies, even more) of the GDP.250
117. The main actors in the payment arena are the central bank, commercial banks, acquirers, issuers,
infrastructures owners, merchants (payees), customers (payers) and middle entities, such as
factoring firms. Every participant of a payment system incurs a private cost for using each
payment instrument (fees, time, labor, etc.). The costs can be summed up. The total of these
costs is the social cost of a payment instrument.251
249 Iftekhar Hasan, Emmi Martikainen & Tuomas Takalo, Promoting Efficient Retail Payments in Europe, 20 Bank of
Finland Research Discussion Papers, at 1: “[C]ash is an attractive method of paying in the shadow and underground
economies... Hence, the adoption of electronic payment methods might not only stimulate economic growth, but also
might provide a direct means to improve public finances for indebted European economies.”; Iftekhar Hasan, Tanya De
Renzis & Heiko Schmiedel, Retail Payments and the Real Economy, ECB Working Paper 1572 (Aug. 2013): “Using
data from across 27 European markets over the period 1995-2009, the results confirm that migration to efficient
electronic retail payments stimulates the overall economy, consumption and trade”. 250 David B. Humphrey, Retail Payments: New Contributions, Empirical Results, and Unanswered Questions, 34 J.
BANK. FIN. 1729, 1734 (2010): “In many of the most recent payment cost analyses, the full cost of a nation’s payment
system is somewhat less than 1% of GDP annually”.
Heiko Schmiedel, Gergana Kostova & Wiebe Ruttenberg, The Social and Private Costs of Retail Payment Instruments
A European Perspective, at 6, (137 ECB Occasional Paper Series, 2012): “The social costs of retail payment
instruments are substantial and amount to €45 billion, i.e. 0.96% of GDP for the sample of 13 participating EU
countries. When the sample results from the participating countries are extrapolated to 27 EU Member States, the social
costs of retail payment instruments are comparable to those of the sample countries, being close to 1% of GDP or €130
billion. These results are robust against the estimation method used”;
Wilko Bolt & Sujit Chakravorti, Digitization of Retail Payments, at 8 (DNB Working Paper 270. 2010): “Significant
real resources are required to provide payment services. Recent payment cost analyses have shown that the total cost of
a nation’s retail payment system may easily approach 1% of GDP annually (Humphrey, 2010). Even higher cost
estimates can be obtained depending on current payment composition and how much of bank branch and ATM network
costs are included as being essential for check deposit, cash withdrawal, and card issue and maintenance activity.”;
COMMISSION STAFF WORKING DOCUMENT - ANNEX TO THE PROPOSAL FOR A DIRECTIVE OF THE EUROPEAN
PARLIAMENT AND OF THE COUNCIL ON PAYMENT SERVICES IN THE INTERNAL MARKET - IMPACT ASSESSMENT,
SEC/2005/1535, at 2 (Dec. 1, 2005): "Studies estimate the cost impact of the payment system to society to as much as
2–3 % of GDP. Cash is the main cost driver and accounts for as much as 60–70 % of the total cost of the payment
system. Instead of efficient electronic payment services, for which the costs range between a few euro cents the cost per
transaction when paid for in cash ranges between EUR 0.30 to EUR 0.55.";
Soren Korsgaard, Paying for Payments Free Payments and Optimal Interchange Fees, 1682 ECB Working Paper, at 3
(2014): “Based on a joint microeconomic study conducted by central banks in 13 European countries, the European
Central Bank... estimates the real cost of producing payments to be almost 1.0 per cent of GDP on average.”;
Ewelina Sokołowska, Innovations in the Payment Card Market: The Case of Poland, ELECTRONIC COMMERCE
RESEARCH AND APPLICATIONS, at 2 (2015): “Printing, distribution, and cash controls were estimated to cost a developed
economy about 0.75% of annual gross domestic product (GDP), and an emerging economy 1–2%”. 251 Björn Segendorf & Thomas Jansson, The Cost of Consumer Payments in Sweden, at 8 (Sveriges Risbank Working
Paper 262. 2012): “When analysing the costs of an industry, one must make a distinction between private and social
61
118. There is no single methodology to calculate total cost of a payment instrument. Some studies
consider only direct costs that are invested in the production of payment instruments. Other
studies also consider indirect costs, such as the cost of time.252 Some costs, like overhead,
should be counted only partially, because they are shared with costs of other payment
instruments or other activities which are not related to payments. This makes the cost
calculation even more complicated.253
119. Another distinction should be made between private costs and social costs.254 For example,
suppose a customer withdraws cash from an ATM. The withdrawal fee is a private cost to the
customer, and income to the bank.255 However this fee is not necessarily connected to the cost
of real resources involved in this transaction, as part of the cost may embody profit. The cost
of deploying and maintaining the ATM is a real cost. The cost of the customer's time at the
queue to the ATM is an indirect cost (of cash).256 From a social point of view, labor, time and
resources invested in cash transactions should be included in the calculation of the costs of cash.
From a social perspective, the costs of a payment instrument combine only real resources
invested in it, without including profit or transfer payments which offset each other.257 Thus,
costs. Private costs are the costs that individual participants incur, while the latter are the total costs to society reflecting
the real use of resources in the whole production process”. 252 Allan Shampine, An Evaluation of the Social Costs of Payment Methods Literature, at 8 (SSRN Elibrary 2012):
“Many studies, using both marginal and average estimates, include the time spent by a cashier on a transaction
multiplied by an average wage rate as a resource cost”. 253 Olaf Gresvik & Harald Haare, Costs in the Norwegian Payment System, 4 Norges Bank Staff Memo, at 10 (2009):
“There is no clear-cut answer to which costs should be relevant in a social cost analysis. In our opinion, all direct
production or user costs should be included. When it comes to the indirect production costs, questions might arise. For
instance, it is often not obvious how to allocate indirect costs in a bank between payment operations and other activities
in a bank. Likely, and perhaps even more difficult, is the question of allocating overhead costs between the different
payment instruments”. 254 Fumiko Hayashi & William R. Keeton, Measuring the Costs of Retail Payment Methods, at 17 (Fed. Bank of Kansas
City Paper. 2012): “While social costs are appropriate for assessing payments efficiency, private costs can be useful for
other policy questions. For example, data on private costs can help determine why consumers prefer a particular
payment method or whether consumers are paying higher fees for a payment service than it costs the provider to
produce it”. 255 Jakub Górka, Payment Behaviour in Poland – The Benefits and Costs of Cash, Cards and Other Non-Cash Payment
Instruments, at 15 (Jan. 2012): “Social costs are calculated by extracting payment participants’ payment revenues (from
fees, tariffs) from their total private costs. Alternatively, the social cost is the sum of all internal costs made by the
relevant parties in the payment chain in order to carry out transactions. Private costs include all costs, including the fees
paid, borne by payment participants... Net social costs are social costs corrected for social benefits. They are derived
from private costs and benefits which exclude transfer payments, that is double counting of some items.";
Chris Stewart et al., The Evolution of Payment Costs in Australia, RBA Research Discussion Paper 14, at 6 (2014): “[A]
transaction fee paid by a merchant to its bank represents a transfer and a private cost to the merchant, but not a cost for
society as a whole”. 256 Hayashi & Keeton, Measuring the Costs of Retail Payment Methods, supra note 254, at 7: “Although the consumer
may not incur a monetary cost, the time spent carrying out the transaction is still treated as a labor resource cost,
because in theory, the time could have been spent in other productive ways”. 257 Bolt & Chakravorti, Digitization of Retail Payments, supra note 250, at 9: “[S]ocial cost refers to the total cost for
society net any monetary transfers between participants, and reflects the real cost of resources used in the production
and usage of payment services”.
62
the aggregate cost of a payment instrument differs from the sum of the individual costs for each
of its users. The former does not include transfer payments or profits, but only real resources.258
120. As with other products, costs of payment instruments can be divided into fixed and variable
costs.259 Payment cards are characterized by large fixed costs and relatively small variable
costs.260 Other payment instruments, like cash, are characterized oppositely, as variable costs
are more significant and the cost of payment increases with the size of the transaction.261 It costs
more to handle a large cash transaction than a small cash transaction, whereas for a debit
transaction, the amount has almost no influence on the cost, because the main costs are fixed
notwithstanding the size of the transaction.262 A credit transaction has a bigger variable cost,
because of the payment guarantee. A common baseline for comparison between costs must
therefore consider all costs of each payment instrument, both fixed and variable.263
258 Hayashi & Keeton, Measuring the Costs of Retail Payment Methods, supra note 254, at 7: “The social cost of a
payment instrument is the sum of the resource costs incurred by all parties in transactions using that instrument. This
cost is distinguished from the private cost of a payment instrument to an individual party. The latter cost includes not
only the resource costs incurred by an individual party to a payment transaction, but also the fees paid by that party to
other parties as part of the transaction. These fees are excluded from social costs because from society’s point of view,
the fees paid by one party to a transaction are offset by the fees received by another party.”;
Schmiedel, Kostova & Ruttenberg, The Social and Private Costs of Retail Payment Instruments, supra note 250, at 6:
“Private costs refer to all the costs incurred by the relevant individual parties in the payment chain. Social costs are the
costs to society, reflecting the use of resources in the production of payment services; that is, the total cost of production
excluding payments, e.g. fees, tariffs, etc., made to other participants in the payment chain. In this sense, social costs
measure the sum of the pure costs of producing payment instruments incurred by the different stakeholders in the
payments market". 259 Hayashi & Keeton, Measuring the Costs of Retail Payment Methods, supra note 254, at 8: “Fixed costs are those
incurred regardless of the number or value of payments, while variable costs are those that increase with the number or
value of payments. Fixed costs are generally associated with capital equipment, while variable costs are associated with
labor and raw materials.”;
EUROPEAN COMMISSION, SURVEY ON MERCHANTS' COSTS OF PROCESSING CASH AND CARD PAYMENTS FINAL RESULTS,
para. 6 (March 2015): “The total cost function of a given payment instrument is typically defined as the sum of fixed
costs, i.e. costs that do not vary with the number and value of payments with the payment instrument, and variable
costs. Variable costs can be of two types: costs that vary with the number of transactions (e.g. time of processing
payment at the cash counter) and costs that vary with the value of transactions (e.g. cost of delay in crediting the
incoming funds)”. 260 EVANS & SCHMALENSEE, THE INDUSTRIAL ORGANIZATION OF MARKETS WITH TWO-SIDED PLATFORMS, in ISSUES IN
COMPETITION LAW AND POLICY, at 679 (2008) available at
https://www.justice.gov/sites/default/files/atr/legacy/2006/12/13/219673_b.pdf : “[C]ard payment systems have to
maintain networks for authorizing and settling transactions for cardholders and merchants… The costs of developing,
establishing, and maintaining these networks are somewhat independent of volume”. 261 Dr Anikó Turján et al., Nothing is Free: A Survey of the Social Cost of the Main Payment Instruments in Hungary, at
6 (MNB Occasional Papers 93. 2011): “The share of variable costs is much higher in relation to cash and cash-based
payments... while the share of fixed costs is dominant for electronic payment instruments linked to payment accounts”.
Leo Van Hove, Central Banks and Payment Instruments: A Serious Case of Schizophrenia, 66 COMMUNICATIONS &
STRATEGIES 19, 25 (2007): “[O]ne additional cash payment would cost a minimum of EUR 0.11 - and this figure rises
considerably in accordance with the amount to be paid”. 262 Carl Schwartz et al., Payment Costs in Australia, at 124 (Conference Proceedings, Sydney, Nov. 29, 2007). 263 Hayashi, Measuring the Costs, supra note 258, at 8-9: “For questions involving the long-run efficiency of the
payments system, the appropriate measure of social costs is total cost, including both fixed and variable costs. For
example, electronic payment methods tend to require large investments in infrastructure, such as card-reading terminals
in stores and computer equipment in depository institutions and card networks. However, once that investment is in
63
121. A common cost methodology, which considers all costs, is the Long Run Incremental Cost -
“LRIC”. This was the methodology that was used in Israel to implement the methodology
decision.264 The idea is that in the long run, even fixed costs can be viewed as variable, because
of the ability of the firm to avoid them. The LRIC methodology thus enables comparison of all
costs of payment instruments, fixed and variable.
122. The average cost of a single transaction can be calculated as the total costs of the payment
instrument divided by the number of transactions. A more economic approach is to look at the
cost of the marginal transaction. For instance, the tourist test is based on a marginal
methodology, because it considers the avoided costs of cash in the marginal transaction. Indeed,
the European Commission considers only variable costs, and disregards fixed costs in the tourist
test calculation. The Commission's stance is that fixed costs, such as annual fees, are considered
only at the adoption stage of a payment instrument, whereas usage decision is based on variable
costs.265
123. A marginal or incremental approach is appropriate to investigate whether a payment instrument
is used too much or too little, because, by definition, the underlying question concentrates on
the marginal transaction. An average approach is appropriate to determine broader market-wide
effects of payment instruments.266
124. There are two main methods of estimating net costs of a payment instrument. One approach
counts the costs and revenues for the different participants (central banks, banks, merchants,
customers, infrastructures).267 This can be viewed as a macro approach. The other way to
place, the additional costs of processing transactions tend to be low. Thus, electronic payments may have low variable
social costs but high total social costs because of their high fixed costs. Cash payments, on the other hand, require
relatively small investment in infrastructure but large inputs of labor and raw materials to print, process, and safeguard
cash. As a result, these payments may have high variable social costs but low total social costs”. 264 Supra ¶¶ 495, 641. 265 EUROPEAN COMMISSION, SURVEY ON MERCHANTS' COSTS OF PROCESSING CASH AND CARD PAYMENTS FINAL
RESULTS, para. 8 (March 2015): “In the MIT MIF calculation, fixed costs should be excluded. As proposed by Rochet
and Tirole (2007), the test consists of considering the merchant's willingness to accept a card payment when a tourist,
i.e. a non-repeat customer with enough cash in the pocket, stands at the till ready to make a purchase. Thus, the fixed
costs (which are linked to the acceptance of the payment instrument) do not appear relevant in determining the
merchant's transactional benefits from card usage, and the calculation of the merchant indifference MIF level should be
based on variable costs only”. 266 Shampine, An Evaluation of the Social Costs of Payment Methods Literature, supra note 252, at 8: “[S]hould costs
be measured on a marginal or average basis? Both measures can be useful, but for different purposes. If one is
interested in determining whether there are significant externalities such that customers are “over-using” relatively high
cost payment methods, then a marginal approach may be appropriate. If one is interested in determining the potential
effects of a significant increase in usage of a payment method within a country, then an average approach may be
appropriate". 267 Segendorf & Jansson, The Cost of Consumer Payments in Sweden, supra note 251, at 6: “The first group, to which
our study belongs, uses a cost and revenue model in which both costs and revenues for major stakeholders (central
banks, banks, retailers, infrastructure providers, and sometimes consumers) are collected. The focus of these studies is
64
measure costs of payment instruments is called Activity Based Costing (“ABC”). This approach
disassembles all actions that are attributed to a payment transaction, and allocates the costs of
labor or real resource to each action.268 This is a micro approach. A caveat is that even within
the ABC method, there is wide amplitude of interpretations.269 For example, a cost analysis
which gives value to subjective criteria such as “time” is inconclusive by definition.
125. Payment cost studies have been conducted in various countries such as Netherlands,270
Sweden,271 Australia,272 Belgium,273 Norway,274 Hungary,275 and United States.276 There is also
literature that surveys these cost studies.277 There is only one emerging consensus: debit,
mainly on payments at the POS (point of sale); i.e. payments made by cash, debit- and credit card, checks and e-
money”. 268 Schmiedel, Kostova & Ruttenberg, The Social and Private Costs of Retail Payment Instruments, supra note 250, at
9: “ABC allocates the cost of the activities along the payment chain to the different payment products and services
within a bank”. 269 Shampine, An Evaluation of the Social Costs of Payment Methods Literature, supra note 252, at 6: “However, it
seems likely that ABC based point estimates are subject to significant uncertainty, and that differences in the precise
methodology used can lead to significantly different results”. 270 Hans Brits & Carlo Winder, Payments are no Free Lunch, 3 DNB Occasional Studies at 35, (2005): “Total social
costs involved with all POS payments in the Netherlands amount to 0.65% of GDP... the costs per pos
transaction average eur 0.35... . The credit card is the most expensive instrument, irrespective of the
transaction amount”. 271 Segendorf & Jansson, The Cost of Consumer Payments in Sweden, supra note 251, at 1: “The combined social cost
for these payments was 0.68 per cent of GDP. At the point of sale, cash is socially less costly than debit cards for
payments below EUR 1.88 (SEK 20) and credit cards below EUR 42.37 (SEK 450)”. 272 Stewart et al., The Evolution of Payment Costs in Australia, supra note 255, at 46: “[T]he costs involved in providing
payment services to households have fallen from 0.80 per cent of GDP in 2006 to 0.54 per cent of GDP in 2013.”; id. at
i: “The greater share of the overall cost is borne by merchants. The consumer undertaking a transaction typically pays a
small proportion of its cost; consumers face a similar cost for credit card payments as for debit card payments despite
the higher cost of credit cards to the economy”. 273 National Bank of Belgium, Costs, Advantages and Drawbacks of the various Means of Payment, NATIONAL BANK
OF BELGIUM ECON. REV. 41, 46 (2006): “The total macroeconomic costs associated with the use of the means of
payment are estimated at around 0.74 p.c. of Belgian GDP in 2003, which is a far from negligible figure”. 274 Gresvik & Haare, Costs in the Payment System, supra note 253 at 26: “The use of resources for payment and cash
services as a proportion of GDP is low (0.49 per cent). It is probably lower than ever before, and it is low in comparison
with other countries. The reasons for these low costs are low cash usage, high usage of the domestic debit card system
BankAxept, and widespread use of electronic payment services... The reason for the decrease in costs for the most
important payment services is a broad shift from manual to electronic services. The economies of scale associated with
producing electronic services have therefore been better realized”. 275 Turján et al., Nothing is Free: A Survey of the Social Cost of the Main Payment Instruments in Hungary, supra note
261, at 6: “[T]he social cost amounts to HUF 388 billion, i.e. 1.49% of GDP”. 276 Daniel D. Garcia Swartz, Robert W. Hahn & Anne Layne-Farrar, The Move Toward a Cashless Society: A Closer
Look at Payment Instrument Economics, 5 REV. NETWORK ECON. 175, 196 (2006): “[W]hen all key parties to a
transaction are considered and benefits are added, cash and checks are not as desirable as many earlier studies suggest.
In general, the shift toward a cashless society appears to improve economic welfare”;
Daniel D. Garcia Swartz, Robert W. Hahn & Anne Layne-Farrar, The Move Toward a Cashless Society: Calculating the
Costs and Benefits, 5 REV. NETWORK ECON. 199 (2006).
For criticism see of their work see Allan Shampine, Another Look at Payment Instrument Economics, 6 REV. NETWORK
ECON. 495 (2007).
For reply to the criticism see Daniel Garcia-Swarz, Robert W. Hahn & Anne Layne-Farrar, Further Thoughts on the
Cashless Society: A Reply to Dr. Shampine, 6 REV. NETWORK ECON. 509 (2007). 277 Shampine, An Evaluation of the Social Costs of Payment Methods Literature, supra note 252;
Turján et al., Nothing is Free: A Survey of the Social Cost of the Main Payment Instruments in Hungary, supra note
261, at 100; Górka, Payment Behaviour in Poland, supra note 255, at 15 ; Hayashi & Keeton, Measuring the Costs of
Retail Payment Methods, supra note 254, at 16.
65
especially PIN debit, is cheaper than credit. No other conclusive results have been found.278
Most studies also support the conclusion that, except for coin-size transactions (for which cash
is the cheapest payment instrument), debit is the cheapest payment instrument for society.279
Thus, shifting payments from cash (except for very low value transactions) and checks to
payment cards may result in net benefits for society as a whole.280
126. Studies also reveal that costs of cash tend to stay stable over time, whereas costs of electronic
money, such as payment cards, decline over time due to economies of scale and technology
improvements.281
278 Shampine, id. at 6: “Again, the differences between studies are striking. Some studies find little difference between
the payment methods, while others find enormous differences. Also, there is no agreement as to which payment method
has the lowest social cost. Seven of the twenty-one results find cash to be the least costly, twelve find PIN debit to be
the least costly, one finds credit to be the least costly, and one ranks payment cards generally as the least costly... If
there is any consensus to be found, it is that PIN debit is less costly than credit.”;
Górka, id. at 15: “[D]ebit card is always cheaper than the credit card.”;
Hayashi & Keeton, Measuring the Costs of Retail Payment Methods, supra note 254, at 1: “[A] number of central banks
have recently conducted comprehensive studies of the costs of retail payment methods. These studies have reached
some common conclusions, such as that debit cards are less costly than credit cards.”;
EUROPEAN COMMISSION, COMPETITION INTERIM REPORT I: PAYMENT CARDS, SECTOR INQUIRY UNDER ARTICLE 17
REGULATION 1/2003 ON RETAIL BANKING, at 11 (Apr.12, 2006): “The credit card is less attractive than the debit card,
irrespective of the transaction amount, as the credit card’s variable costs both for the execution of the transfer itself and
in relation to the size of the purchase are larger.”;
Nicole Jonker, Card Acceptance and Surcharging: The Role of Costs and Competition, 10 REV. NETWORK ECON. 1, 2
(2011): “Credit card payments turn out to be very costly”. 279 Harry Leinonen, Debit Card Interchange Fees Generally Lead to Cash-Promoting Cross-Subsidisation, at 8 BANK
OF FINLAND RESEARCH DISCUSSION PAPERS (2011): “According to payment cost studies done by central banks, cash is
generally efficient only for mini-size (coin-sized) purchases.”;
Górka, id. at 15: “cash is cheaper than debit cards in low value payments: up to EUR 11.63 in Netherlands, EUR 10.24
in Belgium, EUR 7.55 in Sweden, EUR 30.67 in Australia, about EUR 15 un Finland, about EUR 8 in Portugal; above
these thresholds a debit card is cheaper.”;
Segendorf & Jansson, The Cost of Consumer Payments in Sweden, supra note 251, at 5: “We found that for low-value
payments cash is more cost efficient than debit cards; the break-even point is estimated to be EUR 1.88 (SEK 20) and
for credit cards EUR 42.37 (SEK 450).”;
EC INTERIM REPORT, id. at 11: "Cash is more economical for purchases below a certain threshold.”;
Daniel Garcia-Swarz, Robert W. Hahn & Anne Layne-Farrar, Further Thoughts on the Cashless Society: A Reply to Dr.
Shampine, 6 REV. Network Econ. 509, 521 (2007): “[C]ash appears to be optimal at small transaction sizes. Fourth, as
the transaction size increases, a switching point is reached starting at which debit cards appear to become the socially
optimal payment instrument”. See also infra ¶143. 280 David Humphrey et al., What does it Cost to make a Payment? 2 REV. NETWORK ECON. 159 (2003): “As a general
rule of thumb, an electronic payment costs only from one-third to one-half as much as a paper-based payment. If a
country moves from a wholly paper-based payment system to close to an all electronic system, it may save 1% or more
of its GDP annually once the transition costs are absorbed.”;
Humphrey, Retail Payments: New Contributions, Empirical Results, and Unanswered Questions, supra note 250, at
1734: "In many of the most recent payment cost analyses, the full cost of a nation’s payment system is somewhat less
than 1% of GDP annually. Higher cost estimates can be obtained depending on current payment composition (as
electronic payments are only 1/3–1/ 2 the cost of paper-based instruments).";
Schmiedel, Kostova & Ruttenberg, The Social and Private Costs of Retail Payment Instruments, supra note 250, at 6. 281 Segendorf & Jansson, The Cost of Consumer Payments in Sweden, supra note 251, sec. 6: “Economies of scale are a
decisive factor for the social cost. The higher the number of transactions with a certain payment instrument, the lower
the unit cost tends to be.”;
Nicole Jonker, Card Acceptance and Surcharging: The Role of Costs and Competition, 10 REV. NETWORK ECON. 1, 2
(2011): “ Several cost studies reveal that for society as a whole, the cost of a debit card payment is often lower than the
cost of a cash payment, and that the costs of debit card transactions decrease over time due to economies of scale,
66
127. Most studies have also found that customers are not aware of the different costs of the payment
instruments they use. This is because customers often pay the same price for goods they buy,
irrespective of the payment instrument they use. Debit may generally be the cheapest payment
instrument, but many cardholders are not aware of that.282 Issuers benefit from this vagueness,
because they earn higher profits from the more expensive credit cards,283 but from an overall
welfare perspective, debit should be used more on account of (the more expensive) credit cards
and cash.284
128. Merchants derive benefits from switching to electronic money. Payment card networks
recognize this, and use their market power to extract these benefits from the merchant side, in
the form of higher fees, so that merchants end up paying a disproportionate share of the payment
costs.285 This distorts efficient decision making by merchants. The surplus they could derive
from card usage is extracted from them. All consumers bear the consequences because, as any
other cost, merchants' costs of payments instruments are passed through to consumers, in the
form of higher prices of products and services.
5.2. Benefits of payment instruments
129. Costs are only one side of the coin. To determine efficiency, benefits of payment instruments
should also be considered. A comparison between payment instruments must include benefits
and not only costs.286 Evans and Schmalensee give an example of cars with automatic
whereas the costs of cash payments are fairly stable. Credit card payments turn out to be very costly... In countries, such
as the Netherlands, where consumers mainly use cash and the debit card at the point-sale, a further substitution of cash
by debit card payments may bring considerable economic benefits for society as a whole”. 282 EC INTERIM REPORT, supra note 278, at 10: “[A]lmost no information about these relative costs is passed on to
consumers through price mechanisms. In the POS market, relative prices give no information to support a cost-efficient
choice between debit cards, credit cards and ATM withdrawals. Here, the debit card has a large cost advantage not
reflected in private variable fees”. 283 Górka, Payment Behaviour in Poland, supra note 255, at 16: “Credit cards are characterised by high resource costs,
but these cards also generate high profits for banks. This is the reason why they are promoted by credit institutions.
Direct debits, (electronically initiated) credit transfers and debit cards have the lowest social costs.”;
EC, INTERIM REPORT, id. at 11: “[A]ll means of payment except for cash distribution gives rise to net revenues for the
banks, where the most net revenue is generated by card payments (acquiring and issuing). Herefore, the non-transparent
price structure of payment instruments (with few exceptions consumers do not pay any variable fee and receive
insufficient price signals to make their choice) requires cross-subsidising between them”. 284 EC INTERIM REPORT, id. at 11: “From a welfare perspective, and given that user demand is price-elastic, a pricing
strategy based on variable costs would lead to greater use of debit cards, less use of credit cards and cash, and more use
of electronic credit transfers and direct debits”. 285 Wilko Bolt & Sujit Chakravorti, Economics of Payment Cards: A Status Report, 32 ECON. PERSPECTIVES 15, 18
(2008): “[S]hifting payments from cash and checks to payment cards results in net benefits for society as a whole, but
they also conclude that merchants may be paying a disproportionate share of the cost”. 286 Hayashi & Keeton, Measuring the Costs of Retail Payment Methods, supra note 254, at 5: “To determine whether
one retail payment method is more efficient than another, a central bank would need to know not only the costs to
society of using each payment method, but also the benefits”
67
transmissions, which are more expensive than cars with manual transmissions, but probably
yield more benefit to their buyers.287 The cost of a credit transaction is more expensive than of
debit, but a credit transaction allows the cardholder, the benefit of free funding period and the
benefit of advancing consumption ahead of payment. Credit card users, especially heavy users,
also enjoy bigger rewards.
130. Adding benefits to the calculation of comparing payment instruments complicates the
equation.288 It is impossible to know how one should value a shift in levels of utility across
individuals without making arbitrary assumptions.289 Apart from the general difficulty involved
in measuring utility, benefits from a payment instrument vary from person to person, from
merchant to merchant, and, even for the same person or the same merchant, the utility varies
over time.
For example, recent studies confirm that when people receive a large sum of cash, they tend to
dispose of it. They do not want to hang around with large sum in their wallet. The relative utility
of using a payment card versus cash changes for the same person, in comparison to other days,
in which she/he does not have so much cash. An attempt to steer those customers (who are
eager to get read of the cash) to pay with cards, even by bestowing rewards, may be futile.290
For merchants, the benefits of the payment guarantee may differ between transactions and
287 Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 1119, at 96: “There is
nothing unusual about a high-cost product driving out cheaper competition if the high-cost product is much better. U.S.
drivers generally prefer automatic to manual transmissions in their automobiles, for instance, even though automatic
transmissions cost more and are more expensive to maintain. Drivers seem to believe the difference in benefits
outweighs the difference in cost”. 288 Steven Semerraro, The Reverse Robin Hood Cross Subsidy Hypothesis: Do Credit Cards Systems Tax the Poor and
Reward the Rich?, 40 RUTGERS L.J. 419, 429 (2009). 289 KENNETH J. ARROW, SOCIAL CHOICE AND INDIVIDUAL VALUES, at 10-11 (2d ed. 1963): "Even if, for some reason,
we should admit the measurability of utility for an individual, there still remains the question of aggregating the
individual utilities. . . . In general there seems to be no method intrinsic to utility measurement which will make the
choices compatible. It requires a definite value judgment not derivable from individual sensations to make the utilities
of different individuals dimensionally compatible and still a further value judgment to aggregate them according to any
particular mathematical formula. If we look away from the mathematical aspects of the matter, it seems to make no
sense to add the utility of one individual, a psychic magnitude in his mind, with the utility of another individual”. 290 Fernando Alvarez & Francesco Lippi, Cash Burns: An Inventory Model with a Cash-Credit Choice, EIEF Working
Paper 02/15, at 1 (Feb. 2015): "[A]gents use cash for a purchase as long as they have any cash with them, but use credit
otherwise. Still, agents find it optimal to intermittently replenish their cash holdings, and so will use both cash and
credit... the agents in our model find that “cash burns” in their hands,"; id. at 25: "[T]he agent chooses whether to use
cash or credit purchase after purchase, a decision which turns out to depend on the amount of cash at hand. We find this
feature interesting because it makes contact with a body of recent evidence that the likelihood of using cash increases
with the level of cash holdings.";
Avner Bar-Ilan & Nancy Marion, Demand for Cash with Intra-Period Endogenous Consumption, 37 J. ECON.
DYNAMICS & CONTROL 2668, 2669 (2013): "[C]ash consumption depends positively on cash holdings. The rate of cash
consumption immediately after a cash withdrawal is greater than the consumption rate chosen at a lower cash level."; id.
at 2674: "[C]onsumption is positively correlated with the level of cash holdings"; id. at 2675: "[R]ecent empirical
studies support the positive correlation of cash position and the rate of cash consumption".
68
between customers. In some transactions, or for some customers, the risk of default is greater,
and this influences the utility from the payment guarantee.291
131. Despite of these difficulties payment economics requires quantifying the costs and benefits of
payment instruments. Especially if merchants differentiate the prices of the goods they sell
based on the payment instrument used, an economic evaluation must consider both the costs
and the benefits they yield. When merchants accept different payment instruments without
surcharging, a usage externality occurs. The cheaper payment instrument subsidizes the
expensive one.292 Again an economic assessment is required to estimate the size of this
externality.
132. The benefits a payment instrument yields its users, are also a function of its acceptance rate.293
A payment instrument that is not widely accepted among merchants will yield fewer benefits
to customers. A payment instrument that is not common among customers will not be attractive
to merchants.294 When both card and cash acceptance is ubiquitous, the importance of this
feature fades.295
133. Payment instruments carry inherent benefits to their users.296 For example, cash, by its nature,
assures anonymity and adherence to the budget constraint of the payer. Cash payers are more
in control of their balance, and are less exposed to debt.297 For consumers who wish to keep
their anonymity and monitor liquidity the inherent features of cash constitute a crucial
advantage.
291 Margaret Guerin-Calvert & Janusz a. Ordover, Merchant Benefits and Public Policy Towards Interchange: An
Economic Assessment, 4 REV. NETWORK ECON. 384, 386 (2005): “By accepting the credit card, the merchant gets the
benefit of prompt payment, while the card issuer bears the cardholder credit and fraud risk. It is not at all clear that these
complex bundles of benefits can be neatly converted into a “per transaction” benefit with a well-calibrated cost easily
assignable to the transaction”. 292 Infra ch. 7.2.2. See also ¶654. 293 Hayashi & Keeton, Measuring the Costs of Retail Payment Methods, supra note 254, at 6: “One reason a retail
payment method could yield higher benefits to end users than another is that the method is more widely accepted”. 294 Carlos Arango, Kim P. Huynh & Leonard Sabetti, Consumer Payment Choice: Merchant Card Acceptance Versus
Pricing Incentives, 55 J. BANK. FIN. 130, 131 (2015): “Consumers would not adopt and use a payment instrument if
they anticipated low acceptance by merchants, and merchants would not accept such instruments if consumers seldom
adopted and used them”. 295 For expansion see infra ch. 7.4 (negation of network externality). 296 See infra note 614. 297 Ulf von Kalckreuth et al., Using Cash to Monitor Liquidity – Implications for Payments, Currency Demand and
Withdrawal Behavior, at 25 (Deutsche Bundesbank Discussion Paper No. 22/2011. 2011): “Cash has the distinctive
feature that it contains memory – the amount spent and the remaining budget can easily be gathered by a glance into
one’s pocket. For some consumers, notably consumers who wish to monitor liquidity and for whom information
processing is relatively expensive, this feature of cash constitutes a crucial advantage of cash – these consumers use
cash because it is the payment instrument which provides the least costly way of keeping control.“;
Carlos Arango, Dylan Hogg and Alyssa Lee, Why is Cash (Still) so Entrenched?, at 12 (Bank of Canada Discussion
Paper 2. 2012): “[O]ther cash attributes, such as anonymity, also matter at the POS”.
69
Other consumers might value the inherent features of payment cards. Card transactions are
registered, and can be traceable. Development of online applications enables payers to pay
directly from their account and monitor the balance.298
134. Empirical studies found that liquidity constraint influences the payment choice. Illiquid
consumers resort to credit,299 but customers who have already used their credit line to the limit,
tend to use debit more often.300 Debit is used more than credit in small transactions. Debit is
more suited for repeating purchases in which the credit function is less important because of
the recurrence of the payment, e.g., gas stations or monthly utility bills. Credit is more often
used for large or irregular expenses.301
135. The direct users of a payment instrument are the merchant (payee) and the customer (payer).
Both of them are "consumers" of the payment instrument, and both of them are essential for the
transaction. Thus, the cost and benefits of a transaction must be considered from both sides of
the integrated customer i.e., the merchant and the customer.302 However, there is one major
asymmetry between merchants and consumers. In the ordinary case, the customer is the party
who chooses which payment instrument to pay with. Merchants can accept, refuse, surcharge
or try to steer the customer to another payment instrument, but eventually it is the customer
who is in charge of the payment method decision. The preferences of the customer are not
necessarily the same as the social preferences or the preferences of the merchant.
Studies that have investigated the choice of payment instruments of customers have revealed
different factors that influence the decision.
298 Hayashi & Keeton, Measuring the Costs of Retail Payment Methods, supra note 254, at 5: “[M]obile payment
methods may allow consumers to achieve much greater control over their finances and spending by allowing them to
check their account balances prior to making a payment”. 299 Ron Borzekowski & Elizabeth k. Kiser, Consumers’ use of Debit Cards: Patterns, Preferences, and Price Response,
40 J. MONEY, CREDIT & BANK. 149, 170 (2008): “[C]onsumers appear to have an underlying preference for spending
from liquidity, and may use credit to smooth consumption during periods of financial stress”. See also supra note 290. 300 Jonathan Zinman, Debit Or Credit?, 33 J. BANK. FIN. 358, 365 (2009). 301 John Simon, Kylie Smith & Tim West, Price Incentives and Consumer Payment Behaviour, 34 J. BANK. FIN. 1759,
1761 (2010): “ The share of payments made by debit cards is largest at petrol stations and supermarkets and credit
cards’ share of payments is largest for travel and insurance payments”. 302 OECD, POLICY ROUNDTABLES, COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS DAF/COMP 32, at 7
(2006): “In any transaction using a payment system both the purchaser (in this case, a cardholder) and the merchant are
consuming the services of the payment system; that is, both purchaser and merchant are consumers of payment systems.
When comparing costs and benefits of payment systems, the costs and benefits to the integrated purchaser-merchant
consumer should be considered”.
70
136. The price of a transaction for the customer is a significant explanatory variable of the choice of
a payment instrument. Customers do not like to pay extra for their purchases, i.e., transaction
fees deter.303 This is why Bank of Israel prohibited imposing transaction fees on debit.304
Surcharging has also been found to have a significant effect on usage, as it steers customers to
the cheaper payment instrument.305 Price incentives, like rewards and free funding period, were
also found to influence the payment behavior of customers.306
137. Convenience of handling the transaction and security have also been found to be significant
explanatory variables for choice of payment instruments.307 Ease of setup and of record keeping
affect adoption of payment instruments.308
138. Applying the findings of the cost studies clarifies why card companies have no incentive to
facilitate the use of debit. Credit cards are more expensive than debit cards for the integrated
customer, but they generate higher profits for the payment card firms.309 Merchants not only
303 Borzekowski & Kiser, supra note 299, at 170: “The fee charged by banks for PIN-based debit transactions does
appear to steer consumers away from PIN debit and toward signature debit. In addition, this fee also appears to dissuade
consumers from using debit cards at all: a fee that comprises less than 2% of the average purchase amount is associated
with a 12% reduction in the likelihood of using the card”. 304 Supra ¶ 550 (prohibition on debit line-fee or action-fee). 305 Wilko Bolt, Nikole Jonker & Corry Van Renselaar, Incentives at the Counter: An Empirical Analysis of Surcharging
Card Payments and Payment Behaviour in the Netherlands, 34 J. BANK. FIN. 1738 (2010): “[S]urcharging steers
consumers away from using debit cards towards cash”. 306 Simon, Smith & West, Price Incentives and Consumer Payment Behaviour, supra note 301, at 1771: “[P]rice
incentives, and loyalty programs in particular, can be influential when it comes to consumer decisions about which
payment instrument to use.”;
Santiago Carbo-Valverde & Jose Linares-Zegarra, How Effective are Rewards Programs in Promoting Payment Card
Usage? Empirical Evidence, 35 J. BANK. FIN. 3275, 3287 (2011): “[R]ewards programs can also significantly affect the
choice for cards relative to cash payments.”; Andrew T. Ching & Fumiko Hayashi, Payment Card Rewards Programs
and Consumer Payment Choice, 34 J. BANK. FIN. 1773 (2010). 307 Scott Schuh and Joanna Stavins, How Consumers Pay: Adoption and Use of Payments, at 3 (FRB of Boston working
paper 2-2012): “[C]onvenience, cost, and security affect payment use.”;
Borzekowski & Kiser, supra note 299, at 170: “Convenience is cited overwhelmingly as a main reason for using debit
cards.”;
Scott Schuh & Joanna Stavins, Why are (some) Consumers (Finally) Writing Fewer Checks? the Role of Payment
Characteristics, 34 J. BANK. FIN. 1745, 1747 (2010): "[P]ayment characteristics— especially convenience and cost—
are the most important determinants of payment use.";
Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 1253, at 12 n.9: “Recent studies have shown
that consumers are price sensitive.”;
Humphrey, Retail Payments: New Contributions, Empirical Results, and Unanswered Questions, supra note 250, at
1732: “[N]on-price characteristics of different payment instruments – especially convenience – have a significant
influence on consumer choice.”;
Gabriele Camera, Marco Casari & Stefania Bortolotti, An Experiment on Retail Payments Systems, ESI Working
Paper, at 2 (July 2015): “Convenience and reliability are among the suggested reasons for the growing popularity of
electronic payments in retail transactions”. 308 Scott Schuh and Joanna Stavins, How Consumers Pay: Adoption and Use of Payments, at 3 (FRB of Boston working
paper 2-2012): “[S]etup and record keeping are especially important in explaining adoption”. 309 For example, see Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1121, 653-54:
“[S]tudies have concluded that credit cards currently cost merchants substantially more than cash, checks, and PIN debit
card transactions on either a per-transaction or a per-dollar basis... For example, the purchase of a $1,000 item would
71
pay a higher MSF for credit card than for debit card, but are also being paid later. Debit is a
faster and cheaper payment instrument for customers, who do not need the credit function, but
only use the payment feature ("transactors"), but if merchants do not price differently
according to the cost of the payment instrument, debit cardholders are not aware of that. In
Israel, debit cards and credit cards are issued by the same three companies. For these three
firms, debit cards signify pure cannibalization of their credit card business.
139. From a nation’s efficiency point of view, the payment instrument to be used should be the one
that imposes the lowest cost on society for a given level of benefits.310 Transactors, who do not
need the credit function of the card and need the card only as a payment instrument for
transactions, should definitely use debit instead of credit. The additional benefit of the credit
function is redundant for transactors.311 When transactors pay with credit card, merchants
needlessly get paid later and in addition pay a higher MSF.
140. I will now highlight a few major costs and benefits of cash and cards.
5.3. Cash
141. The direct cost of producing cash lies entirely with the state. The state, through the central bank,
bears significant costs of printing, transporting, handling and securing cash, as well as costs of
labor and brick and mortar. On the other hand, the state earns seigniorage when it prints cash,
which is a cost to all users other than the state.312
142. Cash users may have to bear direct costs, such as withdrawal fees, to obtain cash. Fees create
income for banks, but are not real resources of production, and therefore are excluded from the
social costs of cash. Real resources devoted to cash, such as ATM deployment costs, safes,
cost a merchant $19.00 if paid with a credit card, but between $0.17 and $1.00 if paid by PIN-debit card (depending on
the size of the retailer), and $0.12 if paid by cash”. 310 Hayashi & Keeton, Measuring the Costs of Retail Payment Methods, supra note 254, at 3: "For a nation’s retail
payment system to be efficient, the payment methods used by consumers, businesses, and government entities should be
those that impose the lowest cost on society for a given level of benefits". 311 Simon, Smith & West, Price Incentives and Consumer Payment Behaviour, supra note 301, at 1763. 312 Tom Fish & Roy Whymark, How has Cash Usage Evolved in Recent Decades? What Might Drive Demand In The
Future?, 3 BANK OF ENGLAND Q. BULL., at 2-3 (2015): "As discussed above, a banknote that is sold by the Bank to the
commercial sector is paid for via an electronic funds transfer to the Bank. The Bank invests the funds received into an
interest-bearing asset, such as a government bond. The Bank therefore receives interest income from the assets, yet pays
no interest on the corresponding liability (the banknote). Once the costs of banknote production and issuance have been
deducted from this income, the net income earned — referred to as ‘seigniorage’ — is passed on to HM Treasury. This
amounted to £506 million in 2014–15.";
Górka, Payment Behaviour in Poland, supra note 255, at 19: “By issuing cash the central bank earns revenues called
seigniorage. Cash is the direct source of finance and non-interest bearing liability of the central bank... From the
perspective of all entities other than the central bank, seigniorage can be perceived as a quasi tax”.
72
alarms, armored vehicles, security guards, vaults, counterfeit-detection means and other
security devices (including the associated labor), are part of the social costs of cash. Cash users
also incur indirect costs to obtain cash, such as time at the bank or at the ATM. These are costs
of cash which are hard to quantify.313
143. Customers often find cash handy for use, simple and fast. Cash also enables the payer to "feel
the money" that is spent, and thus helps monitoring expenditures.314 Especially for small value
transactions, cash is perceived as a faster, cheaper, safer and more favorable payment
instrument.315 However, as technology improves, the costs of electronic money, such as
payment cards, decrease. At the same time the costs of labor and physical inputs associated
with cash increase. The transaction size below which cash is cheaper than cards constantly
declines. Recent studies in Europe have found that cash is cheapest only for coin-sized
transactions.316 Above that amount debit is more efficient.317
144. Cash is less dependent on technology, computers or electricity. Its survivability is higher. Cash
is a legal tender. Its acceptance is assured by law. Cash is used more often when customers'
313 Górka, id. at 17-18. 314 Arango, Hogg & Lee, Why Is Cash (Still) So Entrenched?supra note 297; Ulf von Kalckreuth et al., Using Cash to
Monitor Liquidity – Implications for Payments, Currency Demand and Withdrawal Behavior (Deutsche Bundesbank
Discussion Paper No. 22, 2011). 315 Carlos Arango, Kim P. Huynh & Leonard Sabetti, Consumer Payment Choice: Merchant Card Acceptance Versus
Pricing Incentives, 55 J. BANK. FIN. 130, 130 (2015): “Small value transactions, which typically form a substantial
share of payments in an economy, are overwhelmingly settled in cash”; id. at 139: “We find that consumers use cash
because it is easy to use and widely accepted.”;
Naoki Wakamori & Angelika Welte, Why do Shoppers use Cash? Evidence from Shopping Diary Data, at 33 (Bank of
Canada WP 2012-24. 2012): “[C]urrent cash usage is driven by demand-side factors – consumers prefer using cash, in
particular, for small-value transactions”. 316 Nicole Jonker, Social Costs of POS Payments in the Netherlands 2002–2012: Efficiency Gains from Increased Debit
Card Usage, 2 DNB Occasional Studies, at 32 (2013): “[T]he average variable social costs for cash payments increased
from EUR 0.18 to EUR 0.26 between 2002 and 2009, whereas the average variable social costs for a debit card payment
fell slightly from EUR 0.20 to EUR 0.17. Moreover, the results reveal that in 2009 the variable social costs for an
additional cash payment exceeded the variable social costs for an additional debit card payment for transaction sizes
above EUR 3.06. In 2002 the break-even point below which cash was more economical than the debit card was much
higher, i.e. EUR 11.63 (Brits and Winder, 2005). The downward shift of the break-even point is the result of both the
increase in the variable social costs per cash payment and the decrease in the variable social costs per debit card
payment. It seems likely that the actual break-even point was even lower than EUR 3.06.The variable social costs for
banks and retailers include fees paid to other companies, such as to the ACH, telecom companies, terminal providers for
debit card payments and cash-in-transit companies for cash payments. These companies fees are intended to cover both
their fixed and variable costs. Furthermore, these fees probably also included a profit margin. Therefore, in reality, the
variable costs of the services incurred by these companies were probably lower than the sum of their fees. Especially for
debit card payments, because fees make up a larger share of the variable costs for debit card than for cash payments. In
addition, it is likely that the break-even point has continued its decline since 2009, as IT developments have made
debit card payment processing even more efficient. Our findings for the Netherlands correspond very well with recent findings for Denmark and Sweden. Kaas Jacobsen and Molgaard Pedersen (2012) report EUR 3.90 in Denmark in 2009 as the break-even point between payments in cash and by domestic Dankort debit card, which closely matches our EUR 3.06. And also Sweden shows a considerable decline of the break-even point between cash and debit card payments between 2002 and 2009, from SEK 72/EUR 7.80 in 2002 (Bergman et al, 2007) to SEK 20/EUR 1.88 in 2009 (Segendorf and Jansson, 2012)”. 317 Supra note 279.
73
perceptions are that merchants do not accept cards. Cash is also a final and immediate payment
instrument.318
145. Private costs of cash include deposit and withdrawal fees. Cash exposes its users to risks such
as theft, robbery and counterfeiting, and requires security measures. Human error is also a risk
of handling cash exchanges.319 Cash involves risks of embezzlement and demands constant
counting, registration and monitoring. Other costs for cash users include foregone interest on
cash held.320
146. Indirect costs of cash to customers and merchants include, inter alia, time required to obtain
cash and extra time required for cash transactions at the counter. For merchants, this time is
translated into labor costs of employees and is somewhat easier to quantify than the value of
customers' time.
147. Cash has the advantage of anonymity that does not exist in electronic money.321 This advantage,
however, has a downside, as it facilitates the black economy.322 According to Visa, 21% of the
318 Arango, Hogg & Lee, Why Is Cash (Still) So Entrenched?supra note 297, at 2: “1. Cards are perceived by consumers
as not being widely accepted. Indeed, where cash, debit and credit are all accepted, consumers are 30 per cent less likely
to use cash. Cash use is especially high for transactions below $25, where perceived card acceptance is substantially
lower. 2. Cash has several characteristics that make it more appealing to consumers than other payment methods. In
particular, consumers prefer to use cash because they find it fast, cheap, safe against fraud and convenient for budget-
control purposes. Ease of use or speed, in particular, accounts for at least a third of the share of cash payments for
transactions below $25”; see also HAVAADA LEBHINAT TZIMZUM HASHIMUSH BEMEZUMAN BAMESHEK HAISRAELI
[THE COMMITTEE FOR EXAMINING REDUCTION OF CASH USAGE IN THE ISRAELI MARKET] (THE LOCKER COMMITTEE),
FINAL REPORT, at 38 (July 17, 2014). 319 Carlos Arango & Varya Taylor, Merchants’ Costs of Accepting Means of Payment: Is Cash the Least Costly? 2008
BANK OF CANADA REV. 15, 16 (2008): “However, cash exposes the merchant to the risk of theft, robbery, and
counterfeiting, as well as the risk of human error during the exchange. Security measures (e.g., surveillance cameras
and security guards), secure storage (vaults and cash registers), and investment in counterfeit-detection training are
necessary fixed costs associated with cash.”;
Fumiko Hayashi, The Economics of Payment Card Fee Structure: What is the Optimal Balance between Merchant Fee
and Payment Card Rewards?, at 6 (FRB of Kansas City Working Paper No. 08-06. 2008); Timothy J. Muris, Payment
Card Regulation, supra note 176, at 538: “[C]ash, for instance, imposes costs on retailers and consumers that electronic
payment systems do not. One example is the labor cost associated with counting cash and reconciling the cash register
drawer. As labor costs increase, the cost of cash payments to retailers becomes more expensive relative to electronic
payments. In addition, cash has a higher risk of theft and loss for both consumers and merchants (from employee
malfeasance). The costs associated with collecting and transporting cash safely, most notably armored cars, do not exist
for payment cards". 320 Steven Semeraro, Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who Gains and Who Loses
from Credit Card Payments? Theory and Calibrations, at 27 (2012) 321 Supra note 297. 322 Van Hove, Central Banks and Payment Instruments: A Serious Case of Schizophrenia, supra note 261, at 35: “One
of the great benefits of cash is its anonymity and untraceability. However, the downside is that it is precisely these
features that make cash so popular in the underground and criminal economy.”; Górka, Payment Behaviour in Poland,
supra note 255, at 14: “It turns out that almost 2/3 of Poles want to be anonymous at Points-Of-Sale… For others
anonymity is important because they work in a shadow economy.”; see also Hasan, Martikainen & Takalo, Promoting
Efficient Retail Payments in Europe, supra note 248; COMMITTEE FOR REDUCING THE USE OF CASH (LOCKER
COMMITTEE), FINAL REPORT, supra note 318.
74
GDP in Israel is not reported.323 This is an estimated black market of almost NIS 200 billion
annually. Card transactions combat black economy. Every card transaction is passed through
the network and is registered and traceable.324 In Israel a special committee was nominated for
this exact issue.325
148. The implication to our context is that cardholders who value anonymity, need to dispose of cash
or belong to the "cash economy", have strong cash preference at the time of the transaction.
Those customers might not be affected by steering attempts to other payment instruments, no
matter the level of rewards bestowed on them. Trying to steer those cash-lovers to card usage
would be futile, and expenditures on steering efforts would be spent for vain. Recent empirical
studies strengthen this conclusion with the finding that cash possessors tend to deplete the cash
they possess, and not use cards, until the cash is consumed.326
5.4. Payment Cards
Costs
149. Costs of producing payment cards are carried by the card networks. The networks cover their
costs with income from their customers, merchants and cardholders. The marginal cost of a
debit card transaction is relatively small. In Netherlands, merchants pay an average debit MSF
of 4.5 Eurocent on average.327 Even if the Netherlands is more competitive than other countries,
it is reasonable to assume that Dutch acquirers do not operate at a loss, so the Dutch costs of
acquiring must be lower than 4.5 Eurocent. Naturally, networks in other countries have different
cost, but nevertheless the Netherlands can serve as a benchmark for estimating the marginal
cost of a debit card transaction.
150. The main variable cost of a payment card transaction for merchants is the MSF. Other costs for
merchants are terminals and POS's equipment, hardware and software to read cards (fixed cost),
323 Dror Reich, Summary of Conference on Payment Cards, THEMARKER (Sept. 22. 2011). 324 Virag Ilona Blazsek, The 2009 Interchange Fee Decision of the Hungarian Competition Authority: A Comparative
Case Study, Central European University, at 10 (2010): “[P]ayment card industry can contribute to the fight against
hidden economy.”;
Hasan, Martikainen & Takalo, Promoting Efficient Retail Payments in Europe, supra note 248, at 14: "Furthermore,
there should be direct interventions that discourage cash use. For example, large value cash transactions should be made
void in the EU, and the European Central Bank should reassess the need to have 200 and 500 euro banknotes". 325 COMMITTEE FOR REDUCING THE USE OF CASH (LOCKER COMMITTEE), FINAL REPORT, supra note 318, see also supra
¶ 549. 326 Supra note 290. 327 Nicole Jonker, Card Acceptance and Surcharging: The Role of Costs and Competition, 10 REV. NETWORK ECON. 1,
20 (2011): “[T]he merchant service fee for debit card payments in the Netherlands averages about 4.5 eurocent, which
is low compared internationally”.
75
and chargebacks, costs of disputes, and costs of fraud not covered by the networks (variable
cost). The cost of cards for cardholders is the cardholder fee minus the rewards.
151. Cardholders and merchants also carry indirect costs of payment cards such as time in the bank
for filling forms and other paperwork. For the merchant time can be translated to labor costs.
Variable time costs of card may be low, especially if payments with cards are faster than
payment with cash. For example, card payers in gas stations do not have to go to the cashier.328
On the other hand, in very small transactions, leaving a coin on the counter is sometimes faster.
Benefits
152. Cards leave identity tracks and records of payment patterns. This allows merchants to
communicate with their card customers and offer them tailored offers.329 Similar to other
marketing activities, merchants incur costs providing such offers, and the benefit is shared by
both cardholders and merchants.330 Customers value payment card acceptance as an element of
quality service.
153. Debit resembles cash in that it limits consumers from overspending.331 This might be an
advantage for some consumers and a disadvantage for others. Credit cards (and deferred debit,
to a lesser degree); carry the benefit of expanding the budget constraint. Deferred debit is a
short-term credit with a grace period of zero interest. Deferred debit allows the cardholder to
concentrate monthly expenditures to a single payment day. Cardholders who pay their balance
in full every month enjoy an interest free period averaging half a month.332 However, deferred
debit might create an expenditure shock if purchases with the card are not monitored properly,
especially if the cardholder suffers a parallel income shock.
328 GAO-10-45, supra note 28, at 31: “[C]ustomers at gas stations and other retail stores often can pay for purchases
without necessarily interacting with an employee”. 329 id. at 30: “For example, if cardholders purchased particular items, their next billing statement would include offers
for additional discounts on future purchases at specific merchants that accept their card that also sell such items. The
networks reported that through their respective databases, they help merchants identify and better understand their
prospective, current, and lapsed customers and employ a variety of niche marketing approaches that ultimately serve to
increase sales”. 330 Shampine, An Evaluation of the Social Costs of Payment Methods Literature, supra note 252, at 8: “[E]lectronic
payment methods may allow merchants to more precisely track their customers’ identities and purchase patterns, and
potentially to obtain other data on the customer that might allow, say, targeted marketing. It seems as plausible to
include such a “benefit” as to include the “benefit” to cardholders of assistance with budgeting”. 331 M. Anthony Fusaro, Why do People use Debit Cards: Evidence from Checking Accounts, 51 Econ. Inquiry (2013). 332 GAO-10-45, supra note 28, at 4; IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD
SECTOR (FINAL REPORT), supra note 21, at 13.
76
154. Illiquid cardholders, who have preferences for purchases in the present, derive unique benefits
from credit cards. Credit cards offer purchase opportunities that do not exist neither with debit
nor cash nor deferred debit. Credit cards help to smooth consumption over time, and advance
consumption ahead of income.
155. For merchants, credit cards are a superior substitute to the more expensive, ancient and
unsecured "store credit". Credit cards enable merchants to extend credit to their customers,
without risk.333 Accepting credit cards may also expand revenue at the expense of rival
merchants who do not accept cards.
156. Payment cards yield another benefit for merchants. Studies have found that customers are
willing to pay more for the same product, when they pay with cards. The main reasons proffered
for this behavior are the lack of self-control and the vague feeling of the expenditure when made
by card. In addition, credit buyers were found to underestimate the true cost of interest on credit
purchases. The payment with a plastic card, and not with real notes, blunts the payment feeling,
and increases willingness to pay.334
157. Credit card acceptance might increase present sales not only at the expense of competing
merchants, but also at the expense of future acquisitions, both within other merchants and in
the same storehouse as well. However, the conventional wisdom is that accepting credit cards
does not increase the overall revenue of merchants, because credit cards do not increase
consumption on aggregate level.335
333 GAO-10-45, supra note 28, at 30: "Accepting credit cards also allows merchants to make sales on credit at a
generally lower cost than operating their own credit program". 334 Adam J. Levitin, The Antitrust Super Bowl: America's Payment Systems, No-Surcharges Rules And The Hidden
Costs Of Credit, 3 BERKELEY BUS. L.J. 265, 288 (2005): “Not only will consumers shift more of their purchases to
credit, but they will also make more purchases because they feel less constrained in credit spending than they do when
spending cash on hand. An MIT study found that when Sloan School of Management MBA students, a financially
savvy subject group, bid on sporting events tickets using either cash or credit, they were willing to place bids up to 64%
higher when bidding with credit than with cash... Credit cards distort consumers' cost benefit analysis and increase
consumers' willingness to pay for goods and to make purchases they otherwise would not. When purchasing with credit
cards, consumers will pay more to get the same goods and services or pay more to acquire goods and services of
marginal value to them.”;
Santiago Carbo-Valverde & Jose Linares-Zegarra, How Effective are Rewards Programs in Promoting Payment Card
Usage? Empirical Evidence, supra note 306, at 3275: “Most of these behavioral studies show significantly large and
positive effects of incentive programs for general purchases… studies with data on consumer transactions to compare
the spending of consumers who paid with credit cards with those who used cash or checks, and they find that the former
spend more”. 335 Sujit Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, 9 REV. NETWORK ECON. 1, 9
(2010): “In the long run, aggregate consumption over consumers’ lives may not differ because of access to credit, but
such access may increase consumers’ utility.";
Katz, What do we Know about Interchange Fees, supra note 207, at 128: “[B]y accepting particular payment cards, a
merchant may increase its sales but do so at the expense of rival merchants. Thus, the collective benefits of a
77
158. Other strands in the literature opine that credit cards can have an effect on aggregate
consumption. One strand takes the position that card acceptance might increase total
consumption. The second strand takes the opposite position: that card acceptance might
decrease total consumption.
159. According to the first strand, if the merchant’s net benefit from cards is higher than the MSF,
then card acceptance leads to cost savings for merchants. Cards save costs of cash. Credit
transactions save the avoided costs of expanding store credit. In addition, if merchants manage
to attract customers from their rivals because they accept cards, then fixed costs are allocated
between more sales, and this might decrease average costs and as a consequence, decrease retail
prices. This is likely to increase aggregate consumption.336 By the same logic, if payment cards
are more expensive than the alternative payment instrument, than prices tend to increase
because of card acceptance, and aggregate consumption decreases.337
160. The other strand does not concentrate on the effect of cards on merchants, but on the effect on
cardholders. Scholars of this strand argue that notwithstanding the price of cards to merchants,
credit cards seduce cardholders to purchase with what seems to be cheap credit, but is actually
expensive. The intrinsic “seduction by plastic”, unique to credit cards, increases the risk of
default.338 Especially when the debt is rolled into the following months, a larger share of income
merchant’s accepting payment cards may be much lower than the merchant’s individual benefits.”; see also infra note
404. 336 Steven Semeraro, Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who Gains and Who Loses
from Credit Card Payments? Theory and Calibrations, at 33 (2012): “If credit card use and rewards increase consumer
spending, it could effectively lower retail prices. Higher sales levels would enable retailers to spread their fixed costs
over greater sales volume. This cost spreading and savings would tend to reduce retail prices.”;
Jean-Charles Rochet & Julian Wright, Credit Card Interchange Fees, 34 J. BANKING FIN. 1788 (2010): ”Interestingly,
the equilibrium retail price may decrease in the interchange fee. A higher interchange fee shifts more transactions to
credit cards from store credit which could potentially outweigh the effect of a higher cost of accepting credit cards if
store credit is particularly costly to accept.”; Fumiko Hayashi, Do U.S Consumers really Benefit from Payment Card
Rewards? FRB KANSAS ECON. REV. 37, 61 n.25 (2009); Semerraro, The Reverse Robin Hood Cross Subsidy
Hypothesis: Do Credit Cards Systems Tax the Poor and Reward the Rich? Supra note 288. 337 Kahn & Roberds, Why Pay? Introduction to Payment Economics, supra note 2, at 16: “While there seems to be
widespread agreement that electronic forms of payment offer the potential for greater efficiency, card-based payments
in particular have in many cases remained more expensive (for merchants) than paper alternatives.”;
Scott Schuh et al., Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations, at 14 (FRB of
Boston Public Policy Discussion Papers No. 10-03. 2010): “The limited available data suggest that a reasonable, but
very rough, estimate of the per-dollar merchant effort of handling cash is ɛ=0.5 percent. Available data suggest that a
reasonable estimate of the merchant fee across all types of cards, weighted by card use, is µ = 2 percent.”; see also
Schmiedel, Kostova & Ruttenberg, The Social and Private Costs of Retail Payment Instruments, supra note 250, at 28;
Carl Schwartz et al., Payment Costs in Australia, table 11 at 117 (RBA and ACCC Publication for a Conference Held in
Sydney on Nov. 29, 2007). 338 John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee,
Payments Sys. Research Conference 231, 235-36 (2005): “Credit card spending, unlike most other forms of payment,
leads directly to debt, which is typically relatively expensive for the many who do not clear their balances in full within
the interest-free period. Of course, irrespective of the means of payment it uses, the change in a household’s net
indebtedness in any period is equal to its expenditure (including interest payments) less its income (including interest
78
is used for debt repayment. The temptation to consume at the expense of incurring future debt
often has a social and economic long-term negative impact.339 As a result the economy
experiences fewer savings and less purchasing power.340 Inter-temporal buying power of
consumers is reduced and aggregate consumption and consumer-welfare declines.341
6. The Economic Models
6.1. Introduction
161. This chapter discusses the economic theories and models with regard to interchange fees and
related issues. I do not expand on all aspects of the various models, but focus on issues
concerning the interchange fee.
162. The validity and usefulness of economic models depends highly on their underlying
assumptions.342 Changes in the assumptions may lead to different results.343 The main
differences between the models discussed here, due to the differing underlying assumptions,
are: (a) heterogeneity/homogeneity of merchants and cardholders; (b) strategic considerations
of merchants; (c) allowing surcharging compared to NSR; (d) type of cardholder fee
(fixed/proportional); (e) conditions of competition.344
income). But means of payment can nevertheless influence the evolution of the mix of the household’s net liability
position. In particular, it is natural to expect that encouragement (for example, via the interchange fee) of means of
payment that are conducive to particular kinds of debt (in other words, credit card debt) will tend to increase such debt”. 339 Oren Bar-Gill, Seduction by Plastic, 98 N.W. L. REV. 1373, 1403 (2004): “[M]ost consumers are not pure
transactors. As noted above, approximately three-quarters of credit-card holders borrow on their credit cards, and credit
card issuers make the bulk of their revenues from finance charges paid by these borrowers”. 340Id. at 1373; Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, supra note 50, at 52; Oren Bar-
Gill & Elizabeth Warren, Making Credit Safer, 157 U. PA. L. REV. 1, 46 (2008). 341 Hoze Linares-Zegarra & John O. S. Wilson, Risk Based Pricing in the Credit Card Industry: Evidence from US
Survey Data, at 2 (2012) http://ssrn.com/abstract=2141360: “[R]eliance on credit cards has led to an increase in
consumer indebtedness and a rise in personal bankruptcy.”; see also Levitin, Social Costs, ibid at 52; Vickers, supra
note 338, at 235-36; Fennee Chong, Credit Card Dues, Annual Summit on Business and Entrepreneurial Studies, 196,
201 (2011); Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 1135; Bar-Gill,
Seduction by Plastic, supra note 339; Tim Westrich & Malcolm Bush, Blindfolded into Debt: A Comparison of Credit
Card Costs and Conditions at Banks and Credit Unions, Woodstock Inst. (2005); Oren Bar-Gill & Ryan Bubb, Credit
Card Pricing: The Card Act and Beyond, 97 CORNELL L. REV. 967 (2012); IAA, ENHANCEMENT OF EFFICIENCY &
COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note 21, at 26.
For criticism of this approach see Daniel Garcia-Swarz, Robert W. Hahn & Anne Layne-Farrar, Further Thoughts on
the Cashless Society: A Reply to Dr. Shampine, 6 REV. NETWORK ECON. 509, 516-18 (2007). 342 Robin A. Prager et al., Interchange Fees and Payment Card Networks: Economics, Industry Developments, and
Policy Issues, at 21 (F.R.B. Finance and Economics Discussion Series 23-09, 2009): “The conclusions of the theoretical
literature vary substantially depending on the assumptions underlying the models”. 343 Fumiko Hayashi & Stuart E. Weiner, Interchange Fees in Australia the U.K and the United States: Matching Theory
and Practice, FRB KANSAS ECON. REV. 75, 80-86 (2006) (comparison table between results of models according to
their underlying assumptions). 344 Marc Rysman & Julian Wright, The Economics of Payment Cards, at 10 (2015): “Key differences across these
models are whether (i) they allow for merchants to be heterogenous, (ii) whether they allow for merchant
79
163. When assuming homogeneous merchants or cardholders, there will be always full acceptance
or full rejection – as all merchants or cardholders respond identically. Relaxing this assumption
and allowing heterogeneity enables partial acceptance or denial, and thus allows for over-usage
or under-usage of card transactions.345 Models also differ in the structure of fees and profits
(fixed or proportional fees/profits), the degree of network competition and competition between
payment instruments.346
164. I will concentrate on the models, where the underlying assumptions fit reality, i.e., models
assuming fixed annual cardholder fees, no per-transaction cardholder fees, rewards for card
usage (especially for heavy users), no surcharging and multihoming merchants. For the most
part I will assume ad-valorem MSF and interchange fees, although, in some countries, those
fees for debit are fixed per transaction, irrespective the size of the transaction.
165. The first model that explained the role of the interchange fee was created in 1983 by Professor
Baxter.347 It was an unrealistic but simple model, based on assumptions of perfect competition.
Despite its simplicity, the basic insights of the model remain useful until today. The
methodology that MasterCard presented to the European Commission to justify its interchange
fee was based on this model of Baxter.348 The methodology that was presented by the Visa
companies in Israel, i.e., the interchange fee as a tool to balance the alleged deficit of issuers,
was also largely based Baxter's model.349
internalization, (iii) whether cardholder pricing is restricted to usage pricing, fixed (or annual) fees or two-part tariffs
that combine both, and (iv) whether they allow for competing platforms”. 345 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 1253, at 18: “When heterogeneity is
considered, there can be an underuse or overuse of card payments from the point of view of the social planner. If that is
taken as given, the volume-maximising, the profit-maximising and the welfare-maximising interchange fees are not
equal.”;
Santiago Carbo Valverde et al., Regulating Two-Sided Markets: An Empirical Investigation, at 10 (Federal Reserve
Bank of Chicago Working Paper No. 09-11. 2009): “In reality, there is heterogeneity among consumers and merchants
regarding the level of benefits they derive from payment cards”; Luis Cabral, Market Power and Efficiency in Card
Payment Systems: A Comment, 5 REV. NETWORK ECON. 15, 19-21 (2005). 346 Sujit Chakravorti & Roberto Roson, Platform Competition in Two-Sided Markets: The Case of Payment Networks, 5
REV. NETWORK ECON. 118, 119-20, 128, 138 (2006). 347 Infra ch. 6.2. 348 Comp/34.579 European Comm'n MasterCard Decision, supra note 1027, para. 703: “The Baxter framework, on
which MasterCard relies...”. 349 AT 4630/01 Leumi v. General Director, at 6-11 (Aug. 31, 2006) ("The Methodology Decision"). See also supra ¶
488.
80
166. It took nearly two decades, until the early 2000s, before Baxter’s model was further developed
by Professor Schmalensee.350 Schmalensee explained the role of the interchange fee as a
balancing device between the demands of merchants and those of cardholders.351
167. Rochet & Tirole were the first to explain that even though a balancing device, the interchange
fee nevertheless raises competitive concerns.352 They were first to model the strategic
considerations of merchants, i.e., merchants' fear of losing customers, if merchants surcharge
or do not accept cards. Strategic considerations reduce the resistance of merchants to increases
in the interchange fee. Rochet & Tirole argued that because of these strategic considerations,
merchants are often willing to accept cards, even when high interchange fees cause the MSF to
be above the benefits merchants gain from cards. Nevertheless, they argued that interchange
fees may still be pro-competitive. This is because the interchange fee serves as a mechanism
that restrains market power of issuers, and solves a problem of under-usage of cards.353
168. Later models revised certain assumptions that characterized earlier models. I will review
models that discuss the neutrality of the interchange fee and implications of releasing the
NSR;354 models that discuss implications of network competition on interchange fees;355
models that discuss rewards (financed by interchange fees), which are bestowed on cardholders,
and the relations between rewards and cardholders fees;356 models that discuss the credit
function latent in credit cards but not in debit cards, and its implications on the interchange
fee,357 and models that tried to locate the optimal interchange fee.358 There is also literature
surveying the models.359
350 Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 1119, at 75: "In 1983,
William Baxter... published an important paper on the economic rationale for interchange fees. But after the NaBanco
decision, interchange fees faded from view in academic and policy circles and was a topic of interest mainly to industry
insiders. A few academic papers in the 1990s mentioned interchange fees, but for the most part, this topic languished in
obscurity until around the turn of this century”. 351 Richard Schmalensee, Payment Systems and Interchange Fees, 50 J. INDUS. ECON. 103 (2002); see also infra ch. 6.3. 352 Infra ch. 6.4. 353Id. 354 Infra ch.6.5. 355 Infra ch. 6.6. 356 Infra ch. 6.7. 357 Infra ch. 6.8. 358 Infra ch. 6.9 359 Sujit Chakravorti, Theory of Credit Card Networks: A Survey of the Literature, 2 REV. NETWORK ECON. 50 (2003);
Wilko Bolt & Sujit Chakravorti, Economics of Payment Cards: A Status Report, 32 ECON. PERSPECTIVES 15 (2008);
Jean Charles Rochet, The Theory of Interchange Fees: A Synthesis of Recent Contributions, 2 REV. NETWORK ECON. 97
(2003); Jean Charles Rochet, Competing Payment Systems: Key Insights from the Academic Literature (Paper Prepared
for the Payments System Review Conference, 2007); Chakravorti, Externalities in Payment Card Networks: Theory and
Evidence, supra note 335, at 9; Marianne Verdier, Interchange Fees in Payment Card Systems: A Survey of the
Literature, 25 J. ECON. SURVEYS 273 (2011) ; Richard Schmalensee, Interchange Fees: A Review of the Literature, 1
PAYMENT CARD ECON. REV. 25 (2003).
81
169. All models are based on the costs and benefits of the different payment instruments which I
explained above.
6.2. The model of Baxter - balancing costs
170. In 1983, in a pioneering article, Prof. William Baxter was the first to analyze an open system
of payment cards.360 He was the first to recognize that a payment card transaction is a two-sided
transaction that involves simultaneously two customers from two different groups – a
cardholder and a merchant: "A transaction is a two-sided arrangement".361 Baxter explained
that payment card networks must cover their costs through the fees they collect from both of
these groups. However, there is no requirement that cardholders pay the exact cost of issuance
and merchants pay the exact cost of acquiring. One side, in which the benefits exceed the cost,
can transfer an (interchange) fee to cover any uncovered costs, i.e., a “deficit”, of the other
side.362
171. Competitive equilibrium in “regular” products occurs when price equals marginal cost
(P=MC).363 In Baxter's model, the sum of the marginal costs of acquirers and issuers equals the
sum of cardholder fees and the MSF, i.e., the price level.364 Therefore:
Pm+Pc=Ci+Ca
Pc - price for customer, i.e., Cardholder fee,
Pm – price for the merchant, i.e. the MSF,
Ci – cost for the issuer,
Ca – cost for the acquirer.
Bc – net benefit to the customer from card transaction
Bm – net benefit to the merchant from card transaction
360 Rysman & Wright, The Economics of Payment Cards, supra note 344, at 22: “In an article that was well ahead of its
time, Baxter (1983) provided the first formal modeling of interchange fees”. 361 William F. Baxter, Bank Interchange of Transactional Paper: Legal and Economic Perspectives 26 J.L. ECON. 541,
548 (1983). 362Id. at 552. 363 DENNIS W. CARLTON & JEFFREY M. PERLOFF, MODERN INDUSTRIAL ORGANIZATION (4th ed. 2005): “[T]he optimal
(profit maximizing) production rule for a competitive firm is to expand its output until its marginal output, MC, equals
price, p.”;
Katz, What do we Know about Interchange Fees, supra note 207, at 127: "In a non-two-sided market, a rule that sets
price equal to marginal cost does define the unique efficient price.";
Semeraro, Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who Gains, supra note 336, at 64:
“In a typical one-sided market, an efficient price – one that will lead to an optimal consumption level – will generally
approximate the marginal cost of production plus the profit necessary to attract investment to the industry. This pricing
model is efficient because it maximizes short-run output consistently with the producer earning sufficient revenue to
continue providing the product or service”. 364 Baxter, Bank Interchange of Transactional Paper, supra note 361, at 553: “The sum of the two revenue streams
equals the sum of the two marginal cost streams”.
82
172. Baxter’s model can be illustrated with an example. The numbers in the example are taken from
the article of Schmalensee.365 The numbers are just an example, and could be replaced by any
other numbers that will bring different and even opposite results.
173. Suppose the cost of issuance is 2 (Ci=2), and the cost of acquiring is also 2 (Ca=2). Suppose
the benefit to a customer from a payment card is 1 (Bc=1), so 1 is the maximum cardholder fee
she/he is willing to pay (Pc=1). Lastly, let the benefit to the merchant (Bm), which is the
maximum MSF the merchant is willing to pay for card acceptance, be 5 (Bm=5).
The merchant’s willingness to pay reflects the net benefit to the merchant gained because the
transaction is not carried out with a different payment instrument. i.e., the total net benefit card
payment generates (for the merchant) in comparison to alternative payment instruments, as
discussed in the previous chapter. Thus, Bm=5 is the merchant’s net transaction benefit
reflecting the benefit from avoiding costs of alternative payment instruments (e.g., avoided
costs of cash), plus any additional benefit the merchant gains from card usage (e.g., expanding
sales to illiquid customers). In other words, if the transaction were paid for with another
payment instrument and not a payment card, the merchant would incur an additional cost of
Bm. Baxter referred to the real transaction benefit of the merchant (Bm), as an upper bound to
the MSF. Baxter did not recognize any strategic benefits of cards.
174. In this example, even though the card transaction generates a social aggregate surplus of 2
(Bm+Bc-Ci-Ca=5+1-2-2=6-4), the transaction will never take place. The cardholder is only
willing to pay the issuer a maximum cardholder fee of 1 (Pcmax=1 because Bc=1), which is less
than the minimal cardholder fee by which the issuer covers its costs (Ci=2).
175. An interchange fee of 1 (IF=1), from the acquirer to the issuer, changes the picture and enables
the transaction. There is no rule that the issuer’s costs be covered only by cardholders, e.g., in
the form of direct cardholder fee. If the acquirer would charge the merchant MSF=3 (or Pm=3),
of which the acquirer would remit 1 to the issuer as interchange fee (IF=1), and in addition the
issuer would charge a cardholder fee of 1 (Pc=1) which the cardholder is willing to pay, as
Bm=1, all costs would be covered. The merchant would pay the acquirer a MSF=3, of which 2
covers the acquirer’s cost, and the acquirer would transfer 1 to the issuer as an interchange fee
(IF=1). We get:
365 Schmalensee, Interchange Fees: A Review of the Literature, supra note 359.
83
Ca(2)= Pm(3)- IF(1)
And
Ci(2)=Pc(1)+IF (1)
176. If we add those equations, the interchange fee falls, and we get:
Ca+Ci=Pm+Pc=4
which means price level equals costs (P=MC), adjusted to a two-sided market. This is
equivalent to the competitive "one side" product equilibrium. The transaction, in this example,
generates a surplus of 2 for the merchant (Bm-Pm=5-3=2). The surplus is the result of efficient
card usage, i.e., the fact the transaction was performed with card and not with a more
expensive payment instrument.
177. Without an interchange fee, only if the benefit of the cardholder is 2 or more (Bc≥Ci) would
the transaction take place. This highlights the importance of the assumption of heterogeneity
among cardholders. When customers are homogeneous (and with no interchange fee), they will
either be cardholders, if their benefit is at least equal to the issuer’s costs (Bc≥2), or none of
them will be a cardholder if their homogeneous benefit from cards is less than the issuer’s costs
(Bc<2). But when customers are heterogeneous, even if their average benefit from cards is 1
(Bcavg=1), some customers will still become cardholders (those for whom Bc≥Ci=2 so they
agree to pay Pc≥2) without the need for an interchange fee.
178. Baxter enabled heterogeneity of both customers and merchants in his model. However, even
assuming heterogeneity, absent any subsidy from the merchant side, the price of payment cards
might be too expensive for enough customers (for whom Bc<Ci), so as to hold the network
atrophied. Indeed, customers for whom Bc≥2 would become cardholders, but if their number is
not big enough, the payment card network might not reach the critical mass necessary for it to
exist, or might operate in a degraded form with a too small a number of cardholders and
suboptimal card usage.
179. The above example is very simple, but it explains the role of the interchange fee as a balancing
device to cover costs of one side, using the surplus of the other side.
180. Baxter’s article was a breakthrough, but following its publication, with only few exceptions,366
interchange fee was ignored in literature for a long period. At the beginning of this century, a
366 Few worth noting exceptions are: Alan S. Frankel, Monopoly and Competition in the Supply and Exchange of Money
66 ANTITRUST L.J. 313 (1998); Carlton & Frankel, The Antitrust Economics of Credit Card Networks, supra note 97;
84
new wave of writing on the topic emerged, accompanied by an increase in worldwide regulatory
involvement.367 The new concern was the result of three main factors: (1) Payment card usage
increased sharply, and cards became common means of payment. (2) The interchange fee
became a significant expense for merchants. In the U.S., merchants’ representative argued
before a Congressional committee that the interchange fee was their second largest expense,
after wages,368 and that credit cards cost merchants much more than cash.369 Merchants in other
parts of the world also resented the fees they paid. (3) The payment card industry has abnormal
high profits with respect to the rest of the financial sector.370 In Europe, payment cards were
found responsible for approximately a quarter of the profits of the retail banking sector.371 These
factors renewed the focus on interchange fees.
6.3. Interchange Fee To Balance Demands
181. Baxter’s model assumed that issuers and acquirers operated under conditions of perfect
competition. In Baxter’s model, the interchange fee does not produce profits to issuers, but only
serves to cover costs, because there is no profit in perfect competition.
182. The assumptions of Baxter did not match real world conditions. Both the acquiring side and
even more so the issuing side, are extremely profitable.372 Payment cards networks definitely
David S. Evans & Richard Schmalensee, Economic Aspects of Payment Card Systems and Antitrust Policy Toward
Joint Ventures, 2 ANTITRUST L.J. 861 (1995). 367 See supra ch. 0 (worldwide regulation survey). 368 Credit Card Fair Fee Act of 2009: Hearing before the Committee on the Judiciary House of Representatives 111th
Cong. on H.R. 2695, Serial No. 111–101 at 33 (2010): "[I]t can clearly be seen that credit card fees are our second-
largest expense. Only labor costs us more";
Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J. MICROECONOMICS, at 206 (2013):
“Such fees are the second-highest expense for many businesses after labor costs, exceeding the price of health care
insurance for employees”. 369 GAO-10-45, supra note 28, at 31-32: “Credit card interchange fees result in credit card payments being more
expensive for them overall. For example, staff from one large retail chain told us that for a $100 transaction, a credit
card payment generally cost the company about 14 times as much to accept as cash. Other merchants reported that
transaction costs for credit cards were two to four times more than their transaction costs for cash”. 370 NICHOLAS ECONOMIDES, COMPETITION POLICY ISSUES IN THE CONSUMER PAYMENTS INDUSTRY, in MOVING
MONEY: THE FUTURE OF CONSUMER PAYMENT 113, 113 ( R. Litan & M. Baily eds., 2009): “Credit card networks have
high price-to-cost markups despite non dominant market shares. There is evidence of very significant markups of price
above cost, with total costs representing only 15 percent of revenue. It is highly unlikely that consumers receive from
card networks anything approaching the fee level charged to merchants. The implied profit rates are comparable to
those of Microsoft and Intel, which each have a dominant and almost monopoly market share”;
Westrich & Bush, Blindfolded into Debt: A Comparison of Credit Card Costs and Conditions at Banks and Credit
Unions, , supra note 341, at 4: “Credit card lending is one of the most profitable sectors in the financial services
industry, and many credit card banks have profits higher than such profitable companies as Microsoft and Wal-Mart”. 371 EC, INTERIM REPORT, supra note 278, at ii: “It is estimated that cards alone account for up to 25% of retail banking
profits”. 372 Ibid, see also supra ¶¶ 60, 96, 574.
85
possess market power.373 The next step that was made in order to adapt models to reality was
carried out by Professor Schmalensee.374
183. Schmalensee allowed for imperfect competition between both acquirers and issuers. Formally,
while the price level in Baxter equaled costs (Pm+Pc=Ci+Ca), in Schmalensee’s model issuers
and/or acquirers had a fixed profit margin (m=margin). This profit increased the price level:
Pm+Pc=Ci+Ca+m.
184. In Schmalensee’s model the interchange fee affects the price structure.375 There is an inverse
relationship (trade-off) between the MSF and the cardholder fee. The interchange fee is
responsible for this trade-off:
184.1 The higher the interchange fee, the higher the MSF and the lower the number of
merchants who accept cards. However, concurrently, the higher interchange fee
generates more cardholders, because the cardholder fee is lower due to the subsidy
from the interchange fee. The changes on each side depend on the price elasticity of
that side.
184.2 Conversely, the lower the interchange fee, the lower the MSF. Merchants' demand is
higher (low MSF) but cardholders’ demand decreases, because they have to pay a
higher cardholder fee.376
185. The interchange fee in Schmalensee’s model is a tool designed to balance the different demands
of each side, given the costs and margins of the network, in order to maximize the value of the
payment card network. The idea is to optimize through the interchange fee the attractiveness of
the network to both cardholders and merchants.377 In the model of Schmalensee, the fees on
each side (MSF or Pc) can rise as high as the merchant’s or the cardholder’s benefits (Bm or
Bc).
186. I will illustrate the difference between Schmalensee and Baxter in a simple example. Suppose
again that Ci=Ca=2; Bc=1, Bm=5. Baxter’s interchange fee is 1. With an interchange fee of 1,
issuers cover their deficit from the low willingness of cardholders to pay for cards (the deficit
373 Supra ch. 8.3.1. 374 Richard Schmalensee, Payment Systems and Interchange Fees, supra note 351. 375 Supra ch. 2.4.2 (price level and price structure). 376 Richard Schmalensee, Payment Systems and Interchange Fees, supra note 351, at 107. 377Id. at 118: “The interchange fee is not an ordinary market price; it is a balancing device for increasing the value of a
payment system by shifting costs between issuers and acquirers and thus shifting charges between consumers and
merchants."
86
is Ci-Pc=2-1=1). By contrast, Schmalensee’s interchange fee can be anywhere from 1 to 3
depending on the demand elasticities of cardholders and merchants, and on the degree of market
power of acquirers and issuers. As a result, the network could grow larger than in the model of
Baxter. For instance, if effect of an increase in the interchange fee above 1 is minimal on the
merchant side (i.e., only few merchants stop accepting cards), but the growth on the
cardholders’ side is significant when Pc<1, then a higher interchange fee than 1, which would
be used to induce usage (lower cardholder fee) would expand the network. Increase in the
interchange fee "sacrifices" some marginal merchants that would cease to accept cards, but on
the other side, there would be more cardholders who adopt and use their cards more often. When
the expansion on the cardholder side is bigger than the decline in the merchant side, the network
would increase with the interchange fee, until the expansion on the cardholder side (because of
the decrease in cardholder fees) would be offset in full by the loss from the merchant side
(because of the increase in the MSF).378
187. In the model of Schmalensee, the interchange fee can rise until the corresponding MSF equals
the merchant’s benefit (i.e. until Pm=Bm). Above that fee the merchant would stop accepting
cards and would accept other payment instruments (because they become cheaper than the net
benefit of cards). Using the numbers of the example above, the maximum interchange fee would
be 3, because then the MSF is 5 (2 is the cost of the acquirer, so the MSF is IF(3)+Ca(2)=5).
For any number above Pm= 5, the merchant would not accept cards.
188. Schmalensee acknowledged that the interchange fee that maximizes the profit of the network
is not necessarily the same interchange fee that maximizes social welfare.379 Schmalensee also
recognized that the interchange fee is a horizontal price-fixing agreement between competitors.
As such, it is a restrictive arrangement. Nevertheless, Schmalensee claimed that contrary to
price fixing that is intended to reduce output, the purpose of the interchange fee is to increase
output and welfare (including the welfare of issuers and acquirers).380 Therefore, according to
378 Jean Charles Rochet & Jean Tirole, Tying in Two-Sided Markets and the Honor all Cards Rule, 26 INT'L J. INDUS.
ORG. 1333, 1334 (2008): “The interchange fee must be high enough so as to induce consumers to use the card, but low
enough so as not to meet with merchant resistance”. 379 Richard Schmalensee, Payment Systems and Interchange Fees, supra note 351, at 106: “The privately optimal fee
may be above or below the socially optimal fee, and the difference does not turn on the level of market power”. For
expansion on the optimal interchange fee, see infra ch. 6.9. 380Id. at 118-19: “The first-order effect of fixing an ordinary price is to harm consumers by reducing output, while in a
non-extreme case, collective interchange fee determination maximizes output and Marshallian welfare in order to
maximize the system's private value to its owners”.
87
Schmalensee, a positive interchange fee is pro-competitive and desirable. As a result,
Schmalensee questioned the effectiveness of regulatory intervention in the interchange fees.381
189. As already noted, conclusions of models highly depend upon the underlying assumptions. In
the model of Schmalensee, issuers could not raise the MSF to a level higher than the merchant’s
benefit, because merchants would simply cease to honor cards. According to Schmalensee, that
resistance by merchants is a natural barrier against setting the interchange fee too high.
190. A decisive majority of merchants do accept payment cards. We might therefore conclude that,
according to revealed preferences and the model of Schmalensee, the MSF paid by merchants
does not exceed their net benefit from accepting cards, because otherwise merchants would not
agree to accept cards. However, revealed preferences do not show the entire picture and cannot
establish this conclusion. This was demonstrated by professors Rochet & Tirole.
6.4. Rochet & Tirole – Strategic Considerations
191. Schmalensee ignored a critical point, which was developed by Professors Rochet and 2014
Nobel Prize winner Jean Tirole,382 in a pioneering article.383 Most merchants cannot afford to
not accept payment cards.
192. Earlier models, before Rochet & Tirole, considered the net benefit of merchants (Bm) from
accepting cards as an upper bound for the MSF. The common assumption was that if the MSF
(Pm) exceeds the merchant’s benefit from a payment card (that is if Pm>Bm), then the merchant
will simply refuse to accept cards. This assumption overestimates the power of merchants.
Merchants weigh further considerations, beside the price they pay for cards. Those
considerations weaken their ability to oppose an increase in the MSF, even to a level above
Bm.384
193. These considerations were initially called by Rochet & Tirole "strategic" considerations.385
Strategic considerations force merchants to accept cards for fear that refusing to accept cards
will result in severe desertion of customers and significant loss of income.386 When customers
381Id. at 119 382 Mika Kato, Jean Tirole, Nobel Prize Winner, (Aug. 28, 2015). 383Jean-Charles Rochet & Jean Tirole, Cooperation among Competitors: Some Economics of Payment Card
Associations, 33 RAND J. ECON. 549, 549 (2002). 384Id. at 551. 385Id. at 558 (proposition 2): “The merchants' card acceptance policies exhibit strategic complementarity”. 386 Robert J. Shapiro & Jiwon Vellucci, The Costs of “Charging it” in America: Assessing the Economic Impact of
Interchange Fees for Credit Card and Debit Card Transactions, at 16 (2010): “[C]redit cards are so ubiquitous that
88
want to pay with cards but the merchant does not accept cards, the harm to the merchant is
expressed not only in the disappointment of the customer that must pay with a different payment
instrument. The disappointed customer might be upset enough to leave the merchant, if not at
that same purchase then at the next one, and transfer purchases to other merchants that do accept
cards. This concern compels merchants to pay a higher MSF than their transaction benefit
(Pm>Bm).
194. The loss to merchants from losing the entire transaction is generally much bigger than the
damage from a high MSF. Profits of transactions often reach tens of percent, while the MSF is
a few percent at most. Klein gives an example that when the profit from a transaction is 25%
and the MSF is 2%, compared to 1.5% cost of the alternative payment method, it is enough that
2% of customers abandon the refusing merchant, to render card refusal unprofitable.387
195. Rochet & Tirole quantified the size of the strategic considerations. They argued that it is equal
to the benefit of the average cardholder from payment with cards. Merchants internalize the
average benefit of cards to their customers who are cardholders.388 Merchants are willing to add
this average benefit to the MSF. In the example above where Bm=5; Bcavg=1, merchants are
willing to pay MSF=Pm=6, although their net benefit is only 5. They internalize the benefit of
the average cardholder.
196. In later articles, the strategic considerations were considered by Rochet & Tirole as a "quality
of service" feature.389 Merchants internalize the benefits of cards to cardholders, and are willing
merchants cannot apply market pressures to bring down their fees by withdrawing from the major networks, at least not
without jeopardizing their sales”. 387 Benjamin Klein et al., Competition in Two-Sided Markets: The Antitrust Economics of Payment Card Interchange
Fees, 73 ANTITRUST L.J. 571, 586 (2006): “[T]he average potential transaction fee savings from dropping the Visa
credit card would be about 50 basis points (the difference between the 2 percent cost of Visa credit and the average of
non-Visa payment methods of 1.5 percent). Assuming this potential cost savings and an average merchant gross margin
of approximately 25 percent, a merchant need only experience a 2 percent decrease in the sales that would have been
made with Visa credit cards (or 1 in 50 sales) for it not to be profitable for the merchant to drop acceptance of Visa
credit”; Alan S. Frankel, Towards a Competitive Card Payments Marketplace, RBA 29 (2007). 388 Rochet & Tirole, Cooperation among competitors, supra note 383, at 556: “In words a*, a is the level of the
interchange fee at which the net cost to the merchants is equal to the average cardholder benefit”; see also id. at 565: “In
the absence of unobserved heterogeneity among merchants, an increase in the interchange fee increases the usage of
payment cards, as long as the interchange fee does not exceed a threshold level at which merchants no longer accept
payment cards. At this threshold level, the net cost for merchants of accepting the card is equal to the average
cardholder benefit.”;
Jean-Charles Rochet & Jean Tirole, Must-Take Cards: Merchant Discounts and Avoided Costs, 9 J. EUR. ECON. ASS'N
462, 466 (2011); Fumiko Hayashi, A Puzzle of Card Payment Pricing: Why are Merchants Still Accepting Card
Payments?, 5 REV. NETWORK ECON. 144, 147-48 (2006): “Rochet and Tirole (2002), Guthrie and Wright (2003, 2006),
and Wright (2003b, 2004) have found that if merchants compete against each other, they accept cards as long as the
merchant fees do not exceed the sum of the merchant’s transactional benefits and the cardholder’s average net
transactional benefits from cards”. 389 Marc Rysman & Julian Wright, The Economics of Payment Cards, at 10 (2015): “Subsequent research (Farrell,
2006; Wright, 2010, 2012; Rochet and Tirole, 2011) has shown that merchant internalization is a much more general
89
to pay in order to improve their customers’ experience, as part of their services to attract clients,
even if the service itself is a ‘money-losing proposition’:
It might seem at first sight that, because of the merchants’ individual ability to turn
down the card, there could never be too many card payments by cardholders. This
reasoning however is incorrect as it misses the point that merchants accept cards
not solely for the convenience benefits (fraud protection, accounting facilities, time
savings at the counter relative to check payments, transaction enablement through
credit and float) that they derive from card usage, but also because card acceptance
makes their store more attractive to consumers. That is, merchants realize that card
acceptance is part of their quality of service (QoS) package and accordingly
internalize, at least in part, the cardholders’ net benefit from being able to use their
card. Put differently, merchants may be willing to accept cards even if doing
so is a money-losing proposition from a narrow accounting viewpoint that is
when the merchant discount exceeds the convenience benefit they themselves
derive from card usage.390
197. In another article, Rochet & Tirole further emphasized this aspect of accepting cards, even
though the MSF is higher than the transactional benefit. They argued that their conclusion holds
regardless of the degree of competition between merchants, i.e. whether merchants are
competitive or monopolistic.391 In a more recent article to which Tirole contributed, the
emphasis of the strategic considerations was on the “missed sales” that would occur if
merchants surcharge or do not accept cards.392
198. It is interesting to note that the approach of Rochet & Tirole negates the low category of
interchange fee in Israel, applied to transactions with the state, its agencies and the electric
company. Those merchants enjoy a lower category of interchange fee (0.5%).393 According to
Rochet & Tirole, those merchants, regardless of their market power, enjoy the higher quality of
phenomenon, holding in some cases even when merchants are monopolistic, Cournot competitors or perfectly
competitive. Simply put, when a merchant accepts cards it is improving the quality of the service it offers consumers,
the option of using cards for payment, and it is only natural this allows it to charge a higher price. The more surplus it
can offer consumers the more it is willing to incur a cost to do so”. 390 Jean-Charles Rochet & Jean Tirole, Externalities and Regulation in Card Payment Systems 5 REV. NETWORK ECON.
1, 3 (2006). 391 Rochet & Tirole, Must-Take Cards, supra note 388, at 463: “[R]etailers may be willing to accept cards even if the
fee they have to pay exceeds their convenience benefit for card payments. Accepting cards increases the retailer’s
quality of service by offering to his customers an additional payment option. This property holds whether retailers are
perfect competitors, Hotelling–Lerner–Salop competitors or even local monopolists. Thus it is not due to a hypothetical
prisoner's dilemma situation where retailers would accept cards only to steal business from each other”. 392 Hélène Bourguignon, Renato Gomes & Jean Tirole, Shrouded Transaction Costs, CEPR Discussion Paper no.
DP10171, at 3-4 (Sept. 2014): “[C]oncerns about missed sales induce merchants to perceive that they must take the
card... card refusal or a high surcharge may cause the merchant to lose business at the point of sale, a widespread
concern... A missed sale occurs when the customer is in the shop and eager to buy, but has a high inconvenience cost of
paying by cash, and is discouraged by either a high card surcharge or an outright rejection of the card.”; id. at 17: “As
our analysis reveals, concerns about missed sales are an important new rationale for the “must-take-card” argument. In
particular, the possibility of missed sales has been ignored in the card payment literature”. 393 Supra ch. 8.1.3.2 (merchants' categories).
90
service to their customers, as any other merchant. This is another reason to cast doubt on the
justification of a lower interchange fee to those merchants.394
199. Hayashi refines this point. She claims that monopolistic merchants, who enjoy inelastic
demand, are not exposed to strategic considerations. Only these merchants will not accept cards
bearing a MSF that exceeds their net transaction benefit from cards (Bm).395
200. According to Rochet & Tirole, cardholders recognize the improvement in quality of service
latent in card acceptance. Cardholders increase their purchases at merchants that provide this
enhanced service. Rochet & Tirole compare card acceptance to other services that merchants
grant their customers to improve their quality of service and to increase sales, such as free
parking, more cashiers or free packing services.396
201. Strategic considerations may not only cause merchants to accept cards. They compel merchants
to keep accepting cards after initial adoption. If after penetration of payment cards to a sector
which was historically reluctant to accept cards, merchants in that sector realize that the fee
they pay is higher than the net benefit they derive from cards, they might find it impossible to
go back to square one and cease to accept cards without suffering heavy loses. The risk is that
their competitors will not cease to accept cards, and thereby attract their angry cardholders.
An empirical example is found in the Israeli market. Gasoline stations in Israel have low
margins because their retail prices (selling prices to customers) and wholesale prices (buying
prices from refineries) are both regulated. For gas stations, every percent of profit is significant.
This sector was late to adopt cards. When finally it did, it was mainly because the low
interchange fee that was offered to gas stations (0.5% - lowest category). Gas stations accepted
the low fees and practically all gas stations turned to be card accepting. However, in 2010, when
the categories of interchange fees in Israel were unified, the interchange fee that gas stations
394 Supra ¶¶ 533 - 546 (criticism of categories). 395 Hayashi, A Puzzle of Card Payment Pricing, supra note 388, at 149: ”[O]nly monopoly merchants who are facing an
inelastic consumer demand may not accept cards if the fees exceed the merchant’s transactional benefits. In the other
three markets, merchants accept cards even when the fees exceed their transactional benefits. As previous studies found,
competing merchants accept cards for strategic reasons. Merchants initially hope that their card acceptance can lure
customers away from their rivals, but later on they accept cards to keep their current customers. Even monopoly
merchants accept cards when their transactional benefits are lower than the fees they pay if they face an elastic
consumer demand. They do so not because they have a strategic reason but because card acceptance shifts their
cardholder customers’ demand upward and thus brings in incremental sales." 396 Rochet & Tirole, Externalities and Regulation in Card Payment Systems, supra note 390, at 6: “From the merchant’s
viewpoint, card acceptance is one of many decisions that affect the store’s attractiveness. For example, hiring more
cashiers or offering convenient parking imply a direct loss for the merchant, but increase the quality of service
(especially to time-conscious consumers) and attracts more shoppers to the store”.
91
paid doubled from 0.5% to 1%.397 This caused a significant bite in their margins. The gas
stations filed suit against this increase, litigating all the way to the Supreme Court, without
success.398
The option of gas stations to cease acceptance of cards was not even considered. No single gas
station alone could stop accepting cards, although all found the new interchange fee excessive.
Of course, gas stations could not gather together and collectively decide to not accept cards, as
this would be a blatant restrictive arrangement. The result was that each gas station continued
to accept cards, although together they thought they were better off without them. This is a
classic example of the strategic considerations.
202. In my view strategic considerations is the correct definition to describe the pressure cards exert
on merchants. In competitive markets, services and products are sold at prices that are related
to costs of production. If merchants give their customers free parking or packing services, which
merchants buy at competitive prices, these can be viewed as improvements in the quality of
service by merchants to their customers. However, if merchants face cartelistic parking or
packing prices, they would probably not offer them to their customers for free, unless they are
forced to. These are exactly strategic considerations. If merchants are forced to purchase
services for their customers at cartel prices, then the purchase becomes strategic. It is not only
the improvement of service that merchants seek, but something else. As long as merchants must
take cards even though cards are a "money-losing proposition", as Rochet & Tirole suggest, the
correct comparison cannot be to quality improving services sold at competitive prices, which
merchants may (or may not) freely and unilaterally decide to grant. Merchants might find it
necessary to purchase free parking for their clients, but this in no way gives owners of parking
lots any legitimacy to coordinate prices, knowing merchants would still be forced to pay for
them.
203. Strategic considerations lead merchants to accept cards, despite a MSF that exceeds the net
benefit of the transaction (Pm> Bm). In the words of Vickers that were adopted by Rochet &
Tirole, cards are a "Must Take”.399
397 See ¶¶ 524.2, 155. 398 AT 601/06 Gas Companies Association v. Antitrust General Director (7.7.10); appeal denied in CivA 5529/10 Gas
Companies Association v. Antitrust General Director (12.8.10). 399 Rochet & Tirole, Must-Take Cards, supra note 388, at 462; Vickers, Public Policy and the Invisible Price:
Competition Law, Regulation and the Interchange Fee, supra note 338 at 234 : “Especially in a number of lines of
retail, it would be substantially detrimental to a retailer’s business not to accept at least the cards of the two main
schemes, above all because the retailer would otherwise risk losing profitable business to rival retailers. In short, there
is an element of must-take”.
92
When strategic considerations take place, the interchange fee is higher than without strategic
considerations.400 Strategic considerations force merchants to internalize the interests and
benefits of cardholders, in addition to the cardholders' own internalization of the benefits from
cards to themselves. This is a major asymmetry between merchants and cardholders.
Cardholders do not internalize the benefits merchants derive from cards. The result is that
strategic considerations of merchants actually reflect a double-representation of cardholders’
interests.401
204. In the model of Rochet & Tirole, accepting cards increases revenues of accepting merchants, at
the expense of competing merchants.402 However, in their model card acceptance does not
increase the total number of purchases. In their model, the number of transactions and their
volume is constant (and is equal to the product of the number of cardholders and the number
of merchants, because they assume each cardholder buys once at each merchant).403 This
assumption is consistent with the conventional wisdom that card acceptance does not increase
aggregate consumption, which is limited by budget constraint.404
400 Stewart E. Weiner & Julian Wright, Interchange Fees in various Countries: Developments and Determinants, 4 REV.
NETWORK ECON. 290, 313 (2005): “When merchants accept cards for strategic reasons, the interchange fee that
balances demands across cardholders and merchants so as to maximize card volume and profits for the members, will
be higher”. 401 Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, supra note 335, at 5: “A key
asymmetry is that merchants accept cards to attract business, in addition to any convenience or transactional benefits
they obtain. Even if cardholders and merchants play an otherwise symmetric role, this asymmetry causes a network
operator to over-represent the interests of cardholders — once in attracting additional card users and once in attracting
additional merchants who internalize their customers’ card benefits. This can result in merchants being charged more
(and cardholders less) than is efficient reflecting the over-representation of cardholders’ interests when merchants
accept cards to get more business.”;
Julian Wright, Why Payment Card Fees are Biased Against Retailers, 43 RAND J. ECON. 761, 773 (2012): “The bias
given in Proposition 5 reflects that buyers’ surplus from using cards gets counted twice in the determination of the
monopoly interchange fee -once from the platform extracting buyers’ surplus from using cards and once from the
platform extracting sellers’ surplus from accepting cards, given individual sellers already internalize the buyers’ surplus
from using cards when deciding how much to pay to accept cards”. 402 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note 383,
at 552: “A merchant's total benefit, and thus his decision whether to accept a card, then depends not only on his
technological benefit (fraud control, theft protection, speed of transaction, customer information collection, etc.), but
also on the product of the increase in demand due to system membership and its retail markup”. 403 Id. at 552. 404 Supra ¶ 157; Comp/34.579 European Comm'n MasterCard Decision, supra note 1027, para. 705; Andrea Amelio,
Antitrust Assessment of MIF and the Tourist Test, at 8 (Conference Proceeding, June 15, 2011): "[T]he benefits of
business stealing evaporate at an aggregate level"; MICHAEL L. KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA
II COMMISSIONED REPORT, at 19 Reserve Bank of Australia (2001): "First, an individual merchant’s benefits of card
acceptance arise only from sales transactions that would not have been made if the merchant did not accept cards.
Second, the merchants’ collective benefits may be zero because one merchant’s increased sales can come at the expense
of other merchants’ sales.";
Sujit Chakravorti & Roberto Roson, Platform Competition in Two-Sided Markets: The Case of Payment Networks,
supra note 346, at 139: "However, the aggregate welfare of merchants does not improve with business stealing because
net sales presumably remain constant.";
93
In the model of Rochet & Tirole, card acceptance increases the demand for products of
merchants that accept cards at the expense of their competitors who do not, but card acceptance
does not the affect total consumption. Card acceptance inflicts private benefits to card accepting
merchants without any raise in total revenue for merchants as a whole.
205. Rochet & Tirole quantified the size of the strategic considerations, i.e. the size in which Pm can
be larger than Bm, but merchants will still accept cards. They claimed that the size reflects what
merchants perceive as the benefit of the average cardholder from paying with a card and not
another payment instrument (Bcavg).405 For example, if there are three customers, and the net
benefit for them from card usage over other payment instruments is 1, 2, 3, respectively
(Bcavg=2), then the merchant will consent to pay a MSF as high as Bm+2, to ensure its average
customer will not be disappointed enough to leave to another merchant.
206. Wright notes that if the cardholder already paid the cardholder fee that corresponds to her/his
utility (Pc=Bc), then the strategic considerations actually double the ability of the network to
extract the cardholder’s surplus from cards – one time it is extracted from the cardholder as
cardholder fees; the second time from the merchant in the form of strategic considerations that
force the merchant to internalize the cardholder’s benefit, in addition to the merchant’s own
benefit.406
207. Rochet & Tirole were the first to model the phenomenon of interchange fees that are affected
by strategic considerations. Since then, courts and authorities have recognized the phenomenon
of honoring cards because of strategic considerations.407 The exact role of the interchange fee
Harry Leinonen, Debit Card Interchange Fees Generally Lead to Cash-Promoting Cross-Subsidisation, at 7 BANK OF
FINLAND RESEARCH DISCUSSION PAPERS (2011): "The instrument selection and palette will not affect the total volume
of payments made, which is determined by the budget constraints for consumption.”;
Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee, supra note 338,
at 235: “The interchange fee could conceivably affect the mix of demand, but aggregate demand remains constrained by
supply capacity”. 405 Supra ¶ 195. 406 Supra ¶ 203. 407 United States v. Visa, 163 F. Supp. 2d 322, 337 (S.D.N.Y 2001): “Some merchants, including large, prominent,
national retail chain stores, such as Target and Saks Fifth Avenue, believe that if they were to stop accepting Visa and
MasterCard general purpose cards they would lose significant sales. Consequently, these merchants believe they must
accept Visa and MasterCard, even in the face of very large price increases.”; see also id. at 341: “The reality is that Visa
and MasterCard are able to charge substantially different prices for those hundreds of thousands of merchants who must
take credit cards at any price because their customers insist on using those cards.”;
Comp/34.579 European Comm'n MasterCard Decision, supra note 1027, paras. 506, 705;
Julian Wright, The Determinants of Optimal Interchange Fees in Payment Systems, 52 J. INDUS. ECON. 1, 17 (2004):
“"Where merchants accept cards for strategic reasons (that is, to attract additional business), there will be some
merchants who accept cards even though the transactional benefits they obtain are less than the merchant fees they
pay.”;
94
in the presence of strategic considerations, in the basic model of Rochet & Tirole, with further
clarifications and developments made by them in later articles,408 would now be explained.
208. As in any model, also Rochet & Tirole have a number of simplifying assumptions. Their basic
model assumes a monopolistic card network, with numerous acquirers and issuers. They
assume that the volume of transactions is constant and merchants are homogeneous (in most of
the article). The acquirers are assumed to be competitive (no profits and full pass through rate
of the interchange fee to the MSF), but issuers do have a profit margin - m. The cardholder fee
is fixed per transaction. NSR rule applies (for most of the article). Cardholders are
heterogeneous in their net benefit from cards, compared to cash (because of differences in
accessibility of cardholders to cash).409 If the customer adopts a card and becomes a cardholder,
she always uses the card and not cash, unless the merchant refuses to accept cards.410
209. The condition for card adoption (and therefore, in the model of Rochet and Tirole, for usage
also) is Bc>Pc which means that net benefit from the card (Bc) should be bigger than the
cardholder fee (Pc). By definition the benefit of the marginal cardholder from her card
(Bcmarginal) is lower than the benefit of the average cardholder (Bc
avg). The marginal cardholder
might be thought of as the cardholder that has cash in her wallet, and is indifferent between
using cash or card.
210. Merchants internalize the benefit of the average cardholder.411 Merchants are willing to pay
MSF that is bigger than their net benefit (Bm) from cards, in the size of the strategic component
(Bcavg). The meaning of merchants' internalization is that merchants are compelled to pay
GAO-10-45, supra note 28, at 36: "[S]everal merchants told us that if they did not accept credit cards from Visa or
MasterCard, their sales would decrease and they would lose business to competitors that did accept those cards.”;
Credit Card Interchange Fees: Antitrust Concerns? Congress Senate Committee on Judiaciary, at 112 (Bill Douglass on
behalf of the National Association of Convenience Stores Before the U.S. Senate Committee on Judiaciary, July 19,
2006), at 112 (U.S. Government Printing Office, 2006): "I have to take these cards or I will go out of business. I have
no option. The comparison that fits is with the old AT&T – before the breakup. Visa and MasterCard's dominance is
very similar to the dominance of Ma Bell before the breakup of AT&T, and protestations by Visa and MasterCard that
merchants do not need to accept cards rings just as hollow as someone saying we could just choose not to have
telephone service. It simply ignores how business is done in this country. Accepting cards is necessary." 408 Jean-Charles Rochet & Jean Tirole, Platform Competition in Two-Sided Markets, 1 J. EUR. ECON. ASS'N 990 (2003);
Jean-Charles Rochet & Jean Tirole, An Economic Analysis of the Determination of Interchange Fees in Payment Card
Systems, 2 REV. NETWORK ECON. 69 (2003); Rochet & Tirole, Externalities and Regulation in Card Payment Systems,
supra note 390; Rochet & Tirole, Must-Take Cards, supra note 388; Jean Charles Rochet & Jean Tirole, Tying in Two-
Sided Markets and the Honor all Cards Rule, 26 INT'L J. INDUS. ORG. 1333 (2008); Jean Charles Rochet & Jean Tirole,
Two-Sided Markets: A Progress Report, 37 RAND J. ECON. 645 (2006) . 409 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note 383,
at 553: “[S]ome customers have easy access to cash or a low value of time for going to get cash before shopping." 410Id. at 552-53. 411 Supra ¶¶ 195, 205.
95
interchange fee higher than their net benefit (IF>Bm).412 When issuers have market power part
of the interchange fee (depends on the pass-through rate) is used to reward cardholders and
induce card usage, whereas the other part is used for issuers’ profits.
211. Formally, all merchants (because they are assumed to be homogeneous) agree to accept cards
as long as their transaction benefit, which is the sum of their net benefit plus the strategic benefit
(which is itself an estimation of the cardholder’s average benefit), is larger than the MSF. Thus
the merchants’ acceptance condition is:
1) Bm+Bcavg>Pm
212. From a social point of view, the condition of efficiency in a card transaction is that the
transaction generates benefits (to the merchant and the cardholder together, without strategic
considerations) that exceeds its costs to issuers (Ci) and acquirers (Ca).413 Thus the social
welfare condition dictates that net benefits (after deduction of the fees) should be bigger than
costs:
2) Bm+Bc≥Ci+Ca
or
Bc≥Ci+Ca-Bm
213. Cardholders use their cards as long as their benefit from paying with the card (Bc) is not lower
than the cardholder fee (Pc). Thus the condition for cardholders’ adoption (and in the model of
Rochet & Tirole also usage) is:
3) Bc ≥Pc
214. By definition of Bm, a merchant would prefer to pay a MSF sized Bm (Pm=Bm) and not a
smaller one, to avoid acceptance of cash. Merchants would prefer to finance all costs and
rewards up to Bm, as long as the cardholder indeed pays with the card, which is cheaper by
412 Julian Wright, Why Payment Card Fees are Biased Against Retailers, supra note 401, at 862: “Merchant
internalization is the property that when deciding whether to join a platform (e.g., whether to accept cards), sellers on
one side (known as merchants in the cards literature) take into account the benefits buyers on the other side get from
being able to interact with them on the platform (i.e., the benefits cardholders get from using cards including,
potentially, rewards and interest-free benefits that cardholders receive) given this allows sellers to charge a higher price
to buyers or to attract more business at the same price”. 413 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note 383,
at 551: “At the social optimum, the total benefit of the marginal transaction… is equal to its total cost”.
96
definition than cash, by the size of Bm. Otherwise the merchant “loses” Bm in each transaction
in which the customer pays with cash and not card. Merchants prefer to pay up to Pm=Bm,
provided this payment is required to steer cardholders to pay with cards, i.e., merchants are
willing to pay cardholder fee for cardholders, so the optimal cardholder fee would be:
4) Pc=Ci+Ca-Bm414
215. However, the sum of the fees in the model of Rochet & Tirole (Pm+Pc) is not equal to the costs
(Ci+Ca), as in Baxter's model, because in the model of Rochet & Tirole, issuers have markup
profit (m). Acquirers are assumed competitive in the model; thus their profit is zero. The
revenue from both sides equals the cost and the markup of issuers:
5) Pm+Pc=Ca+Ci+m
or
Pc=Ca+Ci+m-Pm
216. Now, substitute Pc from equation 4 in equation 5. We get:
6) Pm=Bm+m
217. In the model of Rochet & Tirole, merchants finance the profits of the issuers. This burden is
added to their transaction benefit, which is also extracted from them. Merchants would pay for
issuers' profit as long as the profit should not be bigger than the component of the strategic
considerations (Bcavg) (equation 1).415 Otherwise, if the profit is too big, even the strategic
considerations would not suffice, and merchant would give up cards (all merchants, as they are
homogeneous, so they either all accept or reject cards). The way merchants finance the profit
of issuers involves the interchange fee.
The Restraining Role Of The Interchange Fee
218. The interchange fee is the vehicle to shift money from merchants to issuers. However, when
issuers have market power, the pass through from merchants to issuers is not full. As issuers'
profits increase (i.e., as smaller is the pass-through rate from interchange fee to cardholders),
the amount of proceeds from merchants, delivered in the form of interchange fee to issuers,
414 See ¶ 340. See also Fumiko Hayashi, The Economics of Payment Cards Fee Structure: What Drives Payment Card
Rewards?, at 2 (FRB Of Kansas City Working paper 08-07. 2009): “According to the theoretical literature on payment
card fee structure, in most cases the most efficient cardholder fees would be the difference between the card network’s
costs for a card transaction and the merchant’s transactional benefit from the card transaction". 415 Infra, equation 7.
97
might not suffice to finance the costs and profit of issuers. Cardholder fees might also be
required to increase, in order to finance issuers' profits. If that were to happen, cardholder fees
would increase to the annoyance not only of cardholders, but of merchants also. This is because
demand of cardholders to cards would fall, and with it the number of card transactions. The
network would be impeded. There would be more cash transactions in which merchants suffer
"loss" of Bm.
In this respect the interchange fee restrains or offsets the market power of the issuers. The
interchange fee can be increased to lower cardholder fees and offset the market power of issuers.
219. In the model of Rochet & Tirole merchants agree to finance issuers’ profit, as long as issuers
do not exaggerate. Issuers' maximum profit must be smaller than the cardholders' average
benefit. Formally we see this if we substitute equation 6 in equation 1:
7) Bcavg>m
220. In the model of Rochet & Tirole, when equation 7 holds, the outcome is generally socially
efficient. Despite the fact that strategic considerations cause merchants to pay a fee that is in
excess of their benefit (equation 6: Pm=Bm+m=5+1=6), merchants receive compensation. Part
of the fee they pay is used to satiate issuers’ hunger for profits, but part is used for the merchants'
benefit – to induce card usage among cardholders. If it were not for the interchange fee, the
network was sub-optimal. Not enough customers would have paid with cards. Merchants would
have lost efficient card transactions to cash and suffer a cost of Bm in each cash transaction.
When part of the interchange fee induces card usage, marginal transactions are "saved" by the
interchange fee from being paid by cash.
221. Note that when equation 7 holds, even though merchants pay a fee that exceeds their net benefit
(Pm=Bm+Bcavg), the transaction as a whole is still efficient if its total net benefits are not smaller
than its total costs (Bm+Bc≥Ci+Ca, Equation 2).
222. In the model of Rochet & Tirole, the acquiring side has no gains, so the acquiring fee equals
acquirers’ costs. The MSF is the sum of the acquirer fee and the interchange fee (Pm=Ca+IF).
We can write equation 6 as a function of the interchange fee
8) Pm=Bm+m = Ca+IF
223. Substitute equation 4 in equation 8 and we get:
98
9) IF=Pm-Ca=Ci-Pc+m
224. For merchants the interchange fee is a “tax” added to acquirers’ costs (Pm=Ca+IF). For
cardholders the interchange fee is a subsidy deducted from issuers’ costs and profits (Pc=Ci+m-
IF).
225. From Equation 9, it is easy to notice that for any given costs (Ci, Ca) and profit (m), as the
interchange fee increases the cardholder fee (Pc) decreases and the MSF (Pm) increases. The
interchange fee balances the "issuers’ deficit" from Baxter’s model (Ci-Pc), if any, plus it
finances the profit of issuers (m). As issuers’ profit increase, a larger interchange fee is required
to satiate their hunger.
226. According to Rochet & Tirole, if it were not for the interchange fee, the burden of funding
issuers’ profit would fall on cardholders, and this would be an inferior situation because of sub-
optimal card usage.), vgacBexceed the m does not (profit is not too big ’As long as the issuers 416
increasing the interchange fee that is financed by merchants, in order to restrain the market
power of the issuers, is generally efficient.
227. In the model of Rochet & Tirole, an interchange fee higher than the merchant’s benefit, has two
positive functions: a. On the merchants’ side, it causes merchants to internalize the benefits that
cardholders derive from payment cards; b. and on the cardholders’ side, it avoids undersupply
of payment cards, which could result from issuers’ market power.417
Concern of Oversupply
228. Rochet & Tirole recognize that according to their model, the interchange fee may lead to the
opposite result, an over-supply rather than an undersupply. In their model, oversupply may exist
if the cardholder fee is reduced "too much" due to a large interchange fee. By definition, the
marginal cardholder has a lower benefit from cards than the average cardholder. The marginal
cardholder may be seen as the one who has cash in the wallet. Were it not for the interchange
fee, this marginal cardholder would have used cash (without being disappointed if the merchant
did not accept cards). Nevertheless, an interchange fee that weighs the interest of the average
cardholder, when applied to the marginal cardholder, causes the execution of transactions, in
416 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note 383,
at 559. 417Id. at 566: “The exploitation of the merchants' search for a competitive edge has two benefits from a social
viewpoint: on the merchant side, it forces merchants to internalize cardholders' convenience benefit, and on the
customer side, it offsets the underprovision of cards by issuers with market power”.
99
which the aggregate benefits to the merchant and the marginal cardholder is lower than the
aggregate fees. For example, when Bm=5 and Bcavg=1, it is still efficient if the merchant pays
6 and the cardholder pays 0 (Bm+Bc=6≥Pm+Pc=6). But in the case of a marginal cardholder,
for which Bc=0, then the transaction is not efficient (Pm+pc=6+0>Bm+Bc=5+0). It would have
been more efficient not to steer the marginal cardholder with high interchange fee, and let the
transaction be paid for with cash.
229. When the interchange fee is used to finance card usage of marginal customers, the result might
be oversupply and over usage of cards. Oversupply, in this sense, is the normal result that occurs
in every product that is priced too cheaply. If cards are priced too low, marginal cardholders
adopt and use cards that are financed by merchants.418 Rochet & Tirole also recognize that when
merchants over-internalize cardholders’ benefits, (i.e. attribute a bigger value to Bcavg than in
practice), the interchange fee is too high and inefficient from a social point of view.419
Additional Developments And Criticism
230. In the model of Rochet & Tirole cardholders pay only fixed transaction fees (which can be
negative because of rewards), and not annual fees. More recent models released this
assumption, and allowed two-part tariff of cardholder fees. The two-part tariff consists of
adoption (annual) fees and per transaction fees, which are for the most proportional and
negative, as a result of the free funding period and ad-valorem rewards.420
231. When cardholder fee is divided into annual fixed fee and small negative transaction fee, the
strategic considerations are even larger. They tilt the price structure even more to the detriment
of merchants and to the benefit of cardholders.421
The reason for this tilt is that when a customer decides to become a cardholder, the annual fixed
fee is a lump sum. Rewards that are partly financed by the interchange fee have a double effect:
first, the rewards increase usage among existing cardholders; and second, the rewards provide
418 Id. at 556: “[T]he higher the interchange fee, the lower the customer fee; and so customers with lower willingnesses
to pay for a card are induced to take a card when the interchange fee increases.” See also infra ¶ 723. 419Id. at 558. 420 Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, supra note 368; Sungbok Lee, The Effects of
Issuer Competition on the Credit Card Industry: A Case Study of the Two-Sided Market, (2010) available at
http://www.javanfish.com/file/The%20Effects%20of%20Issuer%20Competition%20On%20the%20Credit%20Card%2
0Industry_October2010.pdf 421 Rysman & Wright, The Economics of Payment Cards, supra note 389, at 3: “Merchant internalization can affect the
balancing act played by interchange fees, leading to more favorable terms to consumers and less favorable terms to
merchants than would be socially efficient.”
100
an incentive for adoption of cards by new joiners.422 Both existing and new cardholders are
therefore more eager to pay with cards. Thus, the two-part tariff of cardholder fees increases
the eagerness of cardholders to pay with cards for which they have already paid, and worsens
the internalization effect of merchants, i.e., their strategic considerations.
Formally, under fixed annual cardholder fees and per transaction (negative) fees, merchants are
exploited even more to (over) internalize the benefits of cardholders from card usage (Bcavg
increases).423
232. Suppose again that the net benefits of the merchant from cards is 5 (Bm=5), and that the average
benefit of the cardholder is 1 (Bcavg=1). Suppose again Ci=2; Ca=2. According to Equation 4,
the cardholder fees should be -1 (Ci+Ca-Bm). Thus the model yields negative cardholder fees
of -1 (rewards).
233. The profit condition from Equation 7 implies efficient merchant internalization if the profit is
no higher than 1 (Bcavg≥m). Suppose indeed m=1. From Equation 6 the MSF is 6
(Pm=Ci+Ca+m+Bca=6). Merchants have a benefit of 5, but they also internalize the average
cardholder benefit of 1 and are thus forced to pay 6. Rochet & Tirole justify this internalization
because the transaction is still socially beneficial. It adheres to Equation 2, as long as the
interchange fee lowers cardholder fees so that Pm+Pc is not bigger than Bm+Bc. When the
average cardholder is considered, the aggregate benefits are indeed 6 (Bm=5, Bca=1) whereas
Pm+Pc=6+(-1)=5.
234. However negative cardholder fee of -1 causes all cardholders for whom Bc>-1 to pay with
cards. Some of those cardholders (for whom Bc>0) would have paid with card even if the
interchange fee was lower. Merchants were exploited to over-internalize the benefit of their
marginal cardholders, and as a byproduct gave a windfall to the infra-marginal cardholders.
The negative cardholder fee is financed by an interchange fee of 4 (Pm=6=Ca+IF=2+4). The
422 Ozlem Bedre-Defolie et al., Pricing Payment Cards, supra note 368: “Financing card usage perks through higher
charges on merchants not only increases issuance of new cards but also fosters usage of existing cards." 423Id. at 27: “[M]erchants pay excessive transaction prices and cardholders pay inefficiently low card usage prices. We
demonstrate that the price structure distortion originates from an asymmetry between consumers and merchants:
consumers make two distinct decisions, card membership and card usage, at different information sets, whereas
merchants decide only on membership, i.e., whether to accept the scheme's cards or not.”
101
interchange fee is used to cover issuers’ costs (Ci=2); to finance rewards that lower cardholder
fees (rewards of 1); and to finance issuer’s profit (m=1).
235. On the merchants’ side - not only merchants are no longer indifferent to the means of payment,
but they strictly disfavor cards (Pm=6>Bm=5). Merchants, in this example, prefer other
payment instruments to a card. Their strategic considerations are used to exploit them.
236. On the cardholders' side, the part of the interchange fee that was used to lower cardholder fees
to minus 1 in the example, is redundant for all cardholders with positive benefit from cards
(Bc>0). They would have used cards anyway as they derive inherent benefit from cards. The
interchange fee indeed steers cardholders who “slightly” disfavor cards (their benefit from cards
is between -1 and zero, i.e. -1<Bc<0), but the price of steering them is too high. The price level
is 5 (6+(-1)=5) and the aggregate benefits, when marginal cardholders are considered, are less
than 5. Equation 2, therefore, does not hold.
237. In addition, because issuers have market power, the pass through to rewards is less than full.424
In the example above, issuers keep 1 as profit and pass through only 1 as rewards to cardholders,
whereas the price of goods would increase up to 2 in competitive markets. All customers suffer
from the price increase. Only some cardholders enjoy partial redeeming value:
Cardholders who strongly disfavor cards (Bc<-1) would not be steered to cards, even after the
high interchange fee turned their cardholder fee to be minus 1. They can be considered as "cash-
lovers".425 They suffer, with all other non-card customers, from the full price increase.
Cardholders with positive benefit from cards get redundant rewards (because they would have
paid with cards anyway) which do not fully compensate them for the price increase of goods.
As for merchants, were it not for strategic considerations, they would rather not accept cards at
all.
238. In a more recent article, Rochet & Tirole were more conservative about their original claim that
under certain conditions, interchange fee that is higher than Bm might be desired. They argued
that, at least under certain circumstances of maximizing short term consumer surplus (the
424 Rysman & Wright, The Economics of Payment Cards, supra note 389, at 17: “The possibility of less than 100% pass
through of interchange fees to cardholders is allowed in most existing models.” 425 Carlos Arango, Kim P. Huynh & Leonard Sabetti, Consumer Payment Choice: Merchant Card Acceptance Versus
Pricing Incentives, 55 J. BANK. FIN. 130, 131 (2015): “Our findings suggest that in a world with full merchant card
acceptance cash would still be used because of its non-pecuniary benefits such as ease of use, speed of transacting, and
anonymity”. See also supra ¶ 148.
102
“consumer” is the combination of merchant and cardholder), Bm should be an upper bound to
the interchange fee.426
239. In 2012, Julian Wright published an article in which he formalized my criticism above, that
contrary to Rochet & Tirole and to previous works of his own, the over-internalization effect
imposed on merchants is the reason for the biased price structure against merchants.427
240. Hayashi claims that the strategic considerations in practice may be much bigger than the benefit
to the average cardholder (Bcavg). Her claim is that the strategic considerations are not exhausted
in Bcavg. The strategic considerations may rise to a level almost as high as the merchant’s profit
from the transaction. As long as the merchant does not lose from the transaction, he is forced
to accept cards so as not to discourage customers.428 Merchants who fear that rejecting cards
may cause them to lose the transaction completely, are effectively extorted. Networks can
exploit their market power over merchants, to extract the surplus of merchants not only from
the payment instrument, but from the transaction itself.
241. Another criticism, which is more morally based, is that if issuers exploit their market power,
the response should be to fight this market power. The response should not be to accept high
interchange fee as inevitable so as to offset such market power. Interchange fee should not be
regarded as inevitable. Interchange fee is a horizontal minimum price fixing agreement between
competitors,429 which increases the prices of final goods in the market,430 and must operate
under a regulatory approval. Such approval can be conditioned.431 Recognizing as legitimate
426 Rochet & Tirole, Must-Take Cards, supra note 388, at 486: “A key result of this paper is thus that, with constant
issuer margins and homogenous merchants, a regulatory cap based on merchants’ avoided cost is legitimate when
competition authorities aim at maximizing short-term total user surplus”. 427 Julian Wright, Why Payment Card Fees are Biased Against Retailers, supra note 401, at 762: “I take a standard
model of a card platform facing elastic demand for cards on each side of the market (i.e., the same model considered by
Rochet and Tirole, 2011, in reaching their conclusion above) and show it actually implies an unambiguous bias against
retailers… Specifically, the interchange fee determined by the platform will be excessive. Reducing the amount
retailers pay and making cardholders pay more will, up to some point, raise welfare... Contrary to claims in
previous work on the topic (including some of my own), these strong results do not depend on the relative level of
cardholder and retailer benefits from different payment instruments. Nor do they rely on there being any revenue-
shifting role for interchange fees, in which it is argued the interchange fee shifts revenues to the cardholder side of the
business, as this is the side where the revenues are competed away less (although the bias continues to hold when
revenue shifting also arises). Rather, the results arise by exploiting the full implications of a phenomenon known
in the literature as merchant internalization.”. See also Rong Ding & Julian Wright, Payment Card Interchange Fees
and Price Discrimination (2015). 428 Hayashi, A Puzzle of Card Payment Pricing, supra note 388, at 172: “As long as the merchant fee does not exceed
the level that gives merchants negative profits, merchants may have no choice but to continue accepting cards”. 429 Infra ch. 0. 430 Infra ch. 10.1. 431 For the condition I propose see infra ch. 14 (profit limitation).
103
the “restraining” role of the interchange fee is analogous to subsidizing cartels as a counter
force to the harm they cause.432
242. An important condition for the basic model of Rochet & Tirole is that the NSR rule applies.
The NSR must apply in order to force merchants to internalize the benefits of cards to
cardholders. Application of NSR means that merchants cannot surcharge cardholders, even if
cards are expensive payment instruments. Other models, including those of Rochet & Tirole,
released the assumption of the NSR.
6.5. Neutrality, surcharge and merchant restraints
243. Carlton and Frankel were first to indicate the "neutrality" of the interchange fee.433 They argued
that if acquiring and issuing markets, as well as competition between merchants, satisfy the
conditions of a contestable market, the interchange fee has no real impact.
244. For example, if the interchange fee increases by 1, then the MSF increases by 1, and this spurs
the merchant to impose a surcharge of 1 on cardholders. However, at the same time the
cardholder fee decreases by 1, due to a reward received by the cardholder, which was financed
by the increase of 1 in the interchange fee (under assumption of full pass-through). The product
price for cardholders does not change. It is 1 higher but the cardholder received a reward of 1.
There is no real effect from the increase (or decrease) in the interchange fee. Despite the change
in the price structure, price level did not change. Product prices remain the same, as do the level
of card usage, the quantities sold and all other real economic variables. The interchange fee
would not affect the consumption or welfare of any party neither cardholders, nor issuers, nor
merchants nor acquirers.434
432 John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee,
Payments Sys. Research Conference 231, 237 (2005): “[T]he argument that the interchange fee should be raised in
order to subsidize imperfectly competitive issuers is unappealing. First, in so far as there is imperfect competition, it
should be addressed by pro-competitive measures, not rewarded by subsidy. (Pushed to an extreme, the
argument would favor subsidizing cartels.) Second, any subsidy has to be financed by, effectively, a tax on retail
purchases. It may be that some of the tax implied by a high interchange fee is recycled to card-paying consumers (for
instance, via the interest-free period and rewards for card use), but the recycling may well be imperfect and inefficient.
Moreover, there is usually no interest-free period for the many payers by credit card who do not routinely clear their
balances in full, and in the absence of frictionless surcharging, those paying other than by credit card get no tax
rebate at all. So besides the general unattractiveness of subsidizing imperfectly competitive firms, the effective tax to
finance the subsidy would seem likely itself to be inefficient and distorting.”; Alan S. Frankel, Towards a Competitive
Card Payments Marketplace, at 46 (RBA, 2007); Alan Frankel, Interchange in various Countries: Commentary on
Weiner and Wright, FRB Kansas 51, 54 (2005). 433 Dennis W. Carlton & Alan S. Frankel, The Antitrust Economics of Credit Card Networks, 63 ANTITRUST L.J. 643,
656-59 (1995). 434 Gans and King, The Neutrality of Interchange Fees in Payment Systems, 3 TOPICS IN ECON. ANALYSIS & POL'Y 1, at
5 (2003): "Neutrality requires that, while prices may change, real variables and payoffs do not"; id. at 9-10: "Note that
104
Under neutrality conditions, the interchange fee would also not be a source of profit for issuers.
All economic variables will remain the same no matter what interchange fees prevails:435
If issuers and merchants were perfectly competitive and there were no costs
associated with pricing differently according to payment method, then it is
possible that an interchange fee would have no economic effects. To explain,
suppose an interchange fee for credit card transactions is set at 5 percent of
the sale amount and neither merchants nor issuers incur any other payment
costs. Because pricing is assumed frictionless in this scenario, merchants
charge credit card customers 5 percent more than cash customers, and issuers
rebate 5 percent to those same credit customers. The interchange fee merely
circulates revenue from cardholders to merchants and back again in full to
cardholders—a result known as neutrality. Interchange fees have no
economic effects in this scenario, creating neither harm nor benefit; the net
position of merchants, cash customers, and credit card customers would not
vary with changes in interchange fees.436
245. When there are several means of payment, such as cash, checks and payment cards, neutrality
is maintained, despite the increase (or decrease) in interchange fees, if merchants are pricing
their products differentially, according to the cost of the payment instruments to them, i.e.,
conduct perfect surcharging policy. If merchants freely pass costs to customers, without any
transaction costs, and if merchants exactly reflect changes in the costs of the different payment
instruments in the final prices of goods, the interchange fee remains neutral.437 For non-card
payers the price would not change.
nominal variables, such as merchant prices and credit card fees, may alter as the interchange fee alters. Neutrality of the
fee only applies to real economic variables." 435 Wilko Bolt & Sujit Chakravorti, Economics of Payment Cards: A Status Report, 32 ECON. PERSPECTIVES 15, 20
(2008): “The interchange fee is said to be neutral if a change in the interchange fee does not change the quantity of
consumer purchases and the profit level of merchants and banks”;
Joshua S. Gans & Stephen P. King, Approaches to Regulating Interchange Fees in Payment Systems, 2 REV. NETWORK
ECON. 125, 134 (2003): “[W]hen there is frictionless surcharging, interchange fees may change the nominal prices and
fees in payment systems but not relative prices or real decisions being made”;
Gans & King, The Neutrality, id. at 9: “The interchange fee is neutral if for any other interchange fee, a′, there is an
equilibrium E′, such that all customers’ purchases, all banks’ profits and all merchants’ profits are the same under E and
E'.” 436 Alan S. Frankel & Allan L. Shampine, The Economic Effects of Interchange Fees, 73 ANTITRUST L.J. 627, 633
(2006); Dennis W. Carlton & Ralph A. Winter, Competition Policy and Regulation in Credit Card Markets: Insights
from Single-Sided Market Analysis, at 12 (2014): “Under these assumptions, the level of the interchange fee is
completely irrelevant”. 437 Rysman & Wright, The Economics of Payment Cards, supra note 389, at 14: “The main result in the literature with
regard to surcharging is known as neutrality. This says that the level of the interchange fee will be irrelevant for the
decisions of cardholders and merchants when merchants can set a surcharge for consumers who pay by card”.
105
246. When there are no transaction costs, surcharging under competitive conditions effectively turns
the two-sided market into standard "one-sided" market.438 Cardholders see one product price.
Interchange fee does not affect real economic variables, and neutrality is maintained.
247. In order to preserve neutrality, the cardholder fees should be imposed in the same way the MSF
is imposed. If the MSF is proportional, cardholder fees should be proportional or, alternatively,
both should be a fixed amount per transaction. Otherwise, the change in the price for merchants
will not be the same as the change in the price for cardholders.439
248. A development of the neutrality proposition was made by Professors Gans and King.440 They
showed that there is no need for the market to be contestable in order to preserve neutrality. It
is sufficient that merchants surcharge without transaction costs, and that in equilibrium, the
pass-through rate from the interchange fee to the prices of goods on the acquiring side, would
be identical to the pass-through rate on the issuing side, from the interchange fee to rewards.
This is enough for the price level to remain unchanged although price structure changes.441
For example, if the interchange fee increases by 1, and as a consequence the product price
increases by 0.6 (the acquirer absorbs 0.4, pass through rate of 60%), but the cardholder receives
a reward of 0.6 (the issuer keeps 0.4 as profit, pass through rate of 60%), then the product price
decreases for the cardholder due to the reward exactly in the same amount of the price increase
(0.6). Neutrality is maintained. The consumed quantities remain unchanged. This was explained
by Professor Katz more formally:
Rational consumers base their purchase and payment mechanism decisions
on p − r (p=price, r=rewards – O.B), the net cost to a consumer from making a card-
based purchase. Suppose a change in the interchange fee of da leads to
changes in p and r equal to dp and dr, respectively. Then the change in a
consumer’s net costs of a card-based transaction is dp − dr. Hence, if the rates
438 Hans Zenger, Perfect Surcharging and the Tourist Test Interchange Fee, 35 J. BANK. FIN. 2544, 2544 (2011):
"[P]erfect surcharging makes payment card markets one-sided."
Fumiko Hayashi, The Economics of Payment Card Fee Structure: Policy Considerations of Payment Card Rewards, at
11 (FRB of Kansas City Working Paper No. 08-08., 2008): “When per transaction costs and fees are fixed, the
merchants’ setting of different prices across payment methods changes the payment card market from two-sided to one-
sided. That is, the fee structure does not affect the number of card transactions any more”.
Rochet & Tirole, Two-Sided Markets: A Progress Report, supra note 408, at 665. 439 Julian Wright, Optimal Card Payment Systems, 47 EUR. ECON. REV. 587, 590 (2003). 440 Gans & King, The Neutrality of Interchange Fees, supra note 434. 441Id. at 11: “The interchange fee does not alter the degree of bank competition, and so bank fees will move to offset the
changes in the interchange fees… The changes in bank fees can and will completely offset the change in the interchange
fee… In this sense, the interchange fee is a redundant price. A credit card payment involves transfers from the customer
to three parties – the merchant, the issuer and the acquirer. But there are four prices [payments to merchants, payments
to issuers, payments to acquirers and the interchange fee]. If one of these prices is altered then the equilibrium values of
the other prices will change so there is no change in any real variable."
106
of change are equal (i.e., dp/da = dr/da), then changes in the interchange
fee have no effect on the net prices paid by consumers to make card-based
purchases442.
249. In equilibrium under neutrality conditions, when the interchange fee changes, prices adjust
themselves to the change, like the waterbed effect. The change in the price of the product is in
the same amount, but in the opposite direction of the cardholder fee. The total price of the
product for the cardholder is unchanged.443
250. The neutrality is based on the ability of merchants to signal their customers, or in economic
terms: to externalize on their customers, the real cost for the merchant, of each payment
instrument used by the customer.444 Customers may still prefer to pay with an expensive
payment instrument, if it yields benefit that justifies its higher price.445
251. Neutrality conditions bring customers to fully internalize all benefits and costs of each payment
instrument they use, not only for themselves but for the merchant also. Neutrality prevents a
customer from externalizing on merchants high costs of payment instrument, costly to the
merchant but cheap to the customer. Neutrality forces customers to acknowledge the full price
of payment cards for the integrated customer of payment card networks - customer and
merchant together.
252. According to the Coase Theorem, in the absence of transaction costs, surcharging should bring
efficient results.446 Customers internalize the aggregate cost of each payment instrument in their
wallet, not only for themselves, but for merchants also. Transactions between customers and
merchants will be efficient,447 even if customers choose to pay the surcharge. There is nothing
wrong with customers paying with an expensive payment instrument, if it produces benefits
442 MICHAEL L. KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA COMMISSIONED REPORT (Reserve Bank of
Australia, 2001); see also Amelio, supra note 404: “[I]f cost pass through of issuing and acquiring is not identical, MIF
influences the total fee level (issuing plus acquiring fee)";
Rochet & Tirole, Two-Sided Markets: A Progress Report, supra note 408, at 648: “Neutrality in payment systems. The
choice of an interchange fee paid by the merchant's bank, the acquirer, to the cardholder's bank, the issuer, is irrelevant
if the following conditions are jointly satisfied: First, issuers and acquirers pass through the corresponding charge (or
benefit) to the cardholder and the merchant. Second, the merchant can charge two different prices for goods or services
depending on whether the consumer pays by cash or by card; in other words, the payment system does not impose a no-
surcharge rule as a condition for the merchant to be affiliated with the system. Third, the merchant and the consumer
incur no transaction cost associated with a dual-price system”. 443 For expansion on the waterbed effect see Aaron Schiff, The "Waterbed" Effect and Price Regulation, 7 REV.
NETWORK ECON. 392 (2008). 444 Fumiko Hayashi, Discounts and Surcharges: Implications for Consumer Payment Choice, Payments Sys. Res.
Briefing FRB Kansas City, at 3 (2012): “Merchant surcharging enhances efficiency in the retail payments system by
improving price signals consumers face when making payments”. 445 Supra ¶ 129. 446 See Ronald Coase, The Problem of Social Costs, 3 J. L. & ECON. 1 (1960). 447 Rochet & Tirole, Two-Sided Markets: A Progress Report, supra note 408, at 665.
107
which are greater than the surcharge.448 Surcharging leads to informed choice of consumers
between different means of payment. Consumers pay with the payment instrument that is the
most cost effective to the customer and the merchant alike.449
253. Freedom to surcharge means that is does not pay for merchants to reject expensive payment
cards. The merchant would be better off surcharging than rejecting. After all, if cards are
expensive but merchants reflect this in prices, they do not need to reject cards. The demand for
cards and the level of usage would be determined by fully aware cardholders, who would
consider the full cost of their payment instrument.450
The Literature In Favor Of NSR
254. Although surcharging leads to neutrality, top economic scholars have defended the NSR and
argued in favor of this rule.
The main justification to the NSR is the argument that merchants are not able to recognize the
full benefits of payment instruments. Every merchant sees only its own costs and benefits. A
single merchant cannot internalize the benefits of payment card networks as a whole. Allowing
merchants to surcharge neutralizes the positive effects of the interchange fees that encourage
adoption and usage of efficient payment instruments such as cards. Allowing surcharges
reduces the network attractiveness. NSR is therefore required to keep the wholeness of payment
card networks.451
448 Supra ¶ 129. 449 Rochet & Tirole, Two-Sided Markets: A Progress Report, supra note 408, at 665: “The Coase theorem states that if
property rights are clearly established and tradeable, and if there are no transaction costs nor asymmetric information,
the outcome of the negotiation between two (or several) parties will be Pareto efficient, even in the presence of
externalities. Coase's (1960) view is that if outcomes are inefficient and nothing hinders bargaining, people will
negotiate their way to efficiency. Because, in the context of a buyer-seller interaction mediated by a platform, the gains
from trade between the two end-users depend on the price level but not its allocation, the latter has no impact on the
volume of transactions, the platform's profit, and social welfare in a Coasian world: markets are one-sided. The business
and public policy attention to price structure issues is then misguided”. 450Jean Charles Rochet, The Theory of Interchange Fees: A Synthesis of Recent Contributions, 2 REV. NETWORK ECON.
97, 106 (2003): “When sellers can costlessly surcharge, they never benefit from refusing card payments. The total
volume of card payments is then only determined by buyers’ demand… With perfect surcharging and in the absence of
transaction costs, volume only depends on the total price (pB + pS) for card services and not anymore on the price
structure. Similarly, the net margin of issuers… only depends on total price and total cost… The level of the interchange
fee ceases to play any role (neutrality)". 451 Rysman & Wright, The Economics of Payment Cards, supra note 389, at 15: “By extracting the usage value of cards
through surcharges, merchants make fewer consumers willing to hold cards in the first place. However, this externality
is not internalized by merchants when deciding whether to surcharge since they take the number of cardholders as given
(as each merchant is just one of the very many merchants that consumers have a chance of dealing with)”.
108
255. Proponents of NSR claim that this rule is the linchpin of payment card networks. Card networks
established even though the demand on one side (merchants) is less elastic than the other
(cardholders), because merchants’ higher willingness to pay for cards was reflected in uniform
prices. NSR guarantees a pricing structure, in which merchants pay more and cardholders pay
less, whereas surcharging destroys this essence.452 Surcharging causes under-provision of cards
and inefficiently too-low card level usage. Surcharging trims the optimal size of networks,
because surcharging – according to this line of argument –inefficiently reduces the number of
cardholders and their usage.453
256. Surcharging destroys the incentives of cardholders to join networks and use cards.454 In the
event of surcharging, marginal cardholders would not pay with cards. They might either choose
not to adopt a card from the outset, or even if they do adopt a card, they would use it less often.
Only cardholders with relatively high demand for cards would adopt and use cards in the
presence of surcharging.455
257. To the extent that cards are expensive payment instruments for merchants, relative to other
means of payment, surcharging indeed signals that costliness to cardholders, but at the same
time weakens the whole payment card network. NSR indeed intensifies negative usage
externality (the externality that is caused when a cardholder chooses to pay with a cheap
payment instrument for her, and externalizes on the merchant its expensive cost), but results in
a positive expansion of the payment card network (positive network externality).
452 Steven Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, 14 STAN. J. L. BUS.
& FIN. 343, 353 (2009): “Card systems must deal with two distinct customer bases, cardholders and merchants. Within
such a two-sided market, efficient fee-setting is likely to require charges above marginal cost to the customer set that is
less sensitive to price, i.e. has lower demand elasticity, and prices below marginal cost to the customers on the other
side. Assuming reasonably that merchant demand is less elastic than cardholder demand, a rule prohibiting
surcharges may enable the card systems to ensure an efficient pricing structure in which merchants pay more
than their marginal cost of service and cardholders pay less”. 453 Steven Semeraro, The Economic Benefits of Credit Card Merchant Restraints: A Response to Adam Levitin, TJSL
Legal Studies Research Paper no. 1357840, at 26 (2009): “Economists have long cautioned that eliminating these rules
could inefficiently reduce credit card use”. 454 Jean-Charles Rochet & Jean Tirole, An Economic Analysis of the Determination of Interchange Fees in Payment
Card Systems, 2 REV. NETWORK ECON. 69 (2003), at 76: “…when issuers have market power, banning the NDR would
result in a systematic underprovision of card services, while with the NDR in place, the interchange fee chosen by an
association can result in an efficient card usage. Similarly, Wright (2000) shows that when merchants have market
power and cardholders’ payments to issuers are not perfectly proportional to transactions, merchants are able to extract
consumer surplus from card usage, destroying incentives for holding payment cards”. 455 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note 383,
at 562: “Merchant price discrimination reduces the demand for payment cards. Issuers focus on the high end of the
market and no longer attract consumers who are not willing to pay much in the first place and who know that they will
face a second markup when paying with the card in the store. Put differently, the card surcharge in stores raises the
issuers' cost of providing cardholders with a given surplus of using the card and thus inhibits the diffusion of cards".
109
258. The support or opposition to the NSR in the literature is, therefore, dependent on the writer's
approach to the question of which is the more important externalization, network or usage (for
expansion on these externalities see infra chapter 7.2). For those who seek to solve usage
externalities, i.e. those seeking to prevent customers from externalizing on merchants high costs
of expensive payment instruments, surcharging should be allowed. This approach, at its
extreme, argues that giving a free hand to merchants to surcharge obviates the need for any
further regulatory intervention.456
For those who are primarily concerned with the size of networks, surcharging should be
prohibited, and NSR should be mandatory. This approach, at its extreme opines that surcharging
could destroy payment card networks. Cardholders would not want to pay any cardholder fees
if “in reward,” they receive cards that raise prices of goods for them. No rational customer
would want to pay for the honor of being a holder of a card that has no usage benefits but usage
costs. Consumers would waive being cardholders from the outset.457
This argument has been illustrated by example of a club that allows free entry for women, but
then charges them extra for drinks. The entrance fee is analogous to the decision whether to
adopt a card. Payment for a drink is analogous to card usage. The surcharge on drinks dissuades
from entering the club, even for free.458
However, this argument is based on a flawed assumption of a single network. If there are
competing card networks, of which only some bear high MSF, consumers might react to
surcharge by waiving expensive cards that are rightly surcharged. Indeed, the surcharged
network might incur losses, but those losses are not necessarily lost sales for the entire
card network, but rather sales that would happen with a cheaper card. Thus, network
competition mitigates the negative network externality of surcharging. Any negative
externality to one network can be offset by positive externality to the competing
network. This insight is especially important in restraining large networks such as
456 Gans & King, The Neutrality of Interchange Fees in Payment Systems, supra note 434, at 12: "[R]emoval of
restrictions is a sufficient condition to avoid any regulatory concerns about the setting of interchange fees”. 457 Julian Wright, Optimal Card Payment Systems, supra note 439, at 599: “Under surcharging, merchants will set a
price for using cards that at least extracts all the payment benefits that the marginal cardholder receives... Knowing this,
the cardholder… will never join the network in the first place, since joining entails a fixed fee F but provides no
usage benefits”. See also Rochet & Tirole, An Economic Analysis of the Determination of Interchange Fees in Payment
Card Systems, supra note 454, at 76. 458 Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, supra note 452, at 358.
110
MasterCard or Visa from arguing against surcharging in the presence of competing
smaller networks. Network externality tends to be larger for smaller networks as their
growth is exponential, so surcharging by large networks might spur smaller networks’
growth, and gains to the card network would likely offset private losses of mature
networks.459
Other Models
259. Under different assumptions than Wright, especially under the assumption of flexible demand
for goods (in Wright’s model, as in the model of Rochet & Tirole, demand for final goods is
rigid. Changes in fees do not affect aggregate consumption), Schwartz & Vincent arrived at
different conclusions. In the model of Schwartz & Vincent, the NSR increases the profits of the
network (they refer to a closed network), and impedes the profitability and welfare of merchants
and cash users.460
In their model, when the MSF increases under NSR, merchants raise the prices they charge all
customers. As a result cash payers subsidize cardholders.461 The effect of this subsidy increases
as the MSF increases. Even if cardholders receive back as rewards the entire surcharge they
pay, cash payers are still harmed.462 Decline in cardholder fees (even to a negative amount)
further increases the demand and usage of cards. As demand in the model of Schwartz and
Vincent is flexible, the decrease in cardholder fees has a greater effect than in the model of
Rochet & Tirole. In the model of Rochet & Tirole the fees have no effect on aggregate
consumption, which is constant. In the model of Schwartz and Vincent, consumption of
cardholders increases with the MSF and at the same time - with prices of products. However
the increase in prices of goods is larger than the decrease in cardholder fees, because issuers
have markups. Cash payers suffer from higher prices with no offsetting benefit, and their
459 The author thanks an anonymous referee for this paragraph. 460 Marius Schwartz & Daniel R. Vincent, The no Surcharge Rule and Card User Rebates: Vertical Control by a
Payment Network, 5 REV. NETWORK ECON. 72 (2006). 461Id. at 75: “NSR induces the merchant (in part) to raise its price to cash users. Holding other fees constant, this effect
induces a cross-subsidy from cash to cards”. 462Id. at 92: “If rebates are feasible the EPN grants them, benefiting itself and card users while harming cash users and
(weakly) the merchant”.
111
consumption declines. Merchants also suffer from less consumption due to their higher prices.
Especially cash payers absorb the full price increase.463
260. Sujit Chakravorti and William Emmons found that surcharging may promote welfare.464 In their
model surcharging reduces the negative effects of cross-subsidization, not between cash and
cards but between credit and debit.465 Credit is a more expensive payment instrument than
debit.466 Credit is used by customers with liquidity constraints whereas debit is used by
customers that need the card only as a payment instrument (transactors). NSR causes the cheap
payment instrument to subsidize the expensive payment instrument. Specifically in their model,
NSR causes debit payers to subsidize credit payers. Abolishing NSR makes creditors internalize
the costs of credit.
261. Zenger argues that with free surcharging and no transaction costs, networks set interchange fees
that brings the MSF to be equal to the maximum fee that passes the tourist test (Bm), in order
to make merchants indifferent between payment instruments.467 When the MSF=Bm,
merchants will not surcharge, because at that level of MSF the merchant is indifferent between
payment instruments, and has no reason to surcharge.468 The ability to surcharge restrains
networks from exploiting merchants' strategic considerations.
262. Semeraro is a proponent of NSR, but not HAC. He claims that cancellation of the NSR is a
risky step. Some merchants could not afford to surcharge because of the competitive conditions
in the relevant market in which they operate. Merchants that possess market power may
surcharge too much. Semeraro proposes to abolish the HAC but not the NSR, and split the two
big open networks (Visa and MasterCard) to several closed networks. According to Semeraro,
merchants should be able to reject expensive cards, but if merchants choose to accept a card,
they should not be allowed to surcharge it. Semeraro opines that competition would force
463Id. at 76: “[T]he [network] grants rebates to card users so as to boost their demand and raises its fee to merchants
knowing that they will absorb part of the increase, because under the NSR any price increase must apply equally to cash
users”. 464 Sujit Chakravorti & William R. Emmons, Who Pays for Credit Cards? 37 J. CONSUMER AFF. 208 (2003). 465 For expansion on credit as opposed to debit, see infra ch. 6.8. 466Supra ¶ 125. 467 Hans Zenger, Perfect Surcharging and the Tourist Test Interchange Fee, supra note 438, at 2546: “There is price-
coherence, because the interchange fee is set such that merchants are indifferent among payment instruments”. 468Id. at 2546: “[T]he tourist test mimics as a second-best mechanism the market outcome in the absence of transaction
costs that inhibit merchants from differentiating retail prices by means of payment”.
112
issuers that charge high MSF to lower their fees.469 As I will show in the next chapter,
competition does not necessarily bring to lower fees for merchants.
263. Economides finds that the degree of competition between merchants is a key factor to NSR
desirability. He suggests a market-by-market approach.470 When merchants have market power
they tend to absorb at least part of the increase in the MSF. Merchants with market power set
prices according to demand and not according to costs. Those merchants know that further
increase in the price of the products will impede their profit (otherwise they would have used
their market power and increase prices at the outset). So merchants with market power prefer
to absorb at least some of the price increase due to higher fees, and not fully surcharge. On the
other side cardholders enjoy decline in cardholder fees (due to rewards), and in addition suffer
less from price increase of goods, due to merchant’s partial absorption of MSF increase. Thus
when merchants have market power lifting the NSR is desirable, according to Economides.
In the model of Economides, when merchants are competitive or when their demand for cards
is elastic, free surcharging causes a full pass through from the interchange fee to final prices
and thus reduces welfare. Economides proposes to keep the NSR in competitive markets.471
264. In the model of Wright, under NSR, competitive merchants split between those who accept
cards and those who do not. The uniform prices of merchants that accept cards are higher than
of “cash only” merchants. The result is that card accepting merchants end up with cardholders
only as their customers.472 When merchants compete on prices (Bertrand competition) they end
469 Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, supra note 452, at 346:
“Although surcharging potentially could combat this market power, it would be an uncertain and risky response … an
alternative, less risky response that would focus directly on card system market power by relaxing the rule that requires
merchants to accept cards from every issuer on the network (the “honor-all-cards rules”)." 470 Nicholas Economides & David Henriques, To Surcharge Or Not to Surcharge? A Two-Sided Market Perspective of
the no-Surcharge Rule, at 9 (ECB Working Paper No. 1338, Oct. 2011): “We consider the pros and cons of forbidding
the NSR versus no regulatory intervention emphasizing that one size policy does not fit all markets, since, in general,
there are significant market power differences across goods and geographic markets within the same country.
According to our welfare results, regulators should take into account the merchant’s market power in the goods and
geographic markets and the extent of network effect and decide on the NSR on a market-by-market basis instead of
imposing a rule common to all markets”. 471Id. at 27-28: “In order to assure social desirability, the NSR has to be applies in markets whose merchants have
sufficiently high market power… Hence, under the NSR, in a market whose merchants have sufficiently high market
power, cardholders do not pay much more for their purchases while benefit from a discount on the membership fee. In
these cases, the NSR… partially corrects the opposite price distortion in the goods market due to merchant market
power… On the other hand, if the market for goods is highly competitive… the NSR will introduce a distortion…
making society worse off". 472 Julian Wright, Optimal Card Payment Systems, supra note 439, at 590: “Under the no-surcharge rule, some
merchants will accept card payments and charge more (assuming card payments are more expensive for merchants to
handle than cash), while others will only accept cash and charge less. Any firm that accepts both card and cash
payments is vulnerable to a competitor that undercuts its price and just accepts the low-cost cash customers".
113
up in the same situation whether NSR exists or not, i.e., in either case cash customers do not
purchase at card-accepting merchants.473
265. Hayashi sharpens the point that if allowed, merchants' decision whether to surcharge depends
on the competitive conditions in the relevant market. She claims that there are two kinds of
merchants with market power. Merchants who face elastic demand will be restrained from
surcharging, even if they have market power. Merchants with market power that face inelastic
demand, would not be restrained from surcharging.474
266. Bourguignon constructs a model in which the impact of surcharging depends on the level of the
MSF. If the MSF passes the tourist test or even lies just a little above Bm, allowing surcharging
reduces welfare, because then surcharging reduces the number of efficient card transactions. If
the MSF is higher than Bm, surcharging improves welfare as it restores proper payment
incentives and steers customers to cheaper payment instruments. When the MSF is very high
allowing merchants to surcharge improves welfare.475
267. Edelman & Wright claim that networks will always desire to impose NSR if they can do so, as
NSR increases the profits of the networks at the expense of consumer surplus.476 When NSR
applies, it is used to exploit merchants to pay a high MSF, of which part is used to subsidize
expensive cards that are over used.477
268. Korsgaard relaxes the assumption that surcharging neutralizes the interchange fee. He argues
that cardholders do not pay for transactions, with or without interchange fees.478 Surcharging
causes less card usage, which in turn makes the card network less attractive, so fewer merchants
473 Id. at 606: “Under Bertrand competition between merchants, both the card association and the regulator are
indifferent as to whether surcharges should be allowed or not. Bank profits and total surplus do not change when the no-
surcharge rule is lifted, regardless of the level of the interchange fee”. 474 Hayashi, A Puzzle of Card Payment Pricing, supra note 388; see also Wright, Optimal Card Payment Systems, supra
note 439, at 589: "In the case where merchants have local monopolies but are free to surcharge, we show they will do so
excessively, so as to extract surplus from inframarginal cardholders". 475 Bourguignon et al., Shrouded Transaction Costs, supra note 392, at 5: “[T]he welfare impact of card surcharges
depends on the level of the merchant fee; if the latter satisfies the tourist test or even lies reasonably above the
merchant’s convenience benefit, allowing card surcharge reduces welfare by excessively reducing card usage. For very
high merchant fees by contrast, allowing card surcharges improves welfare”. 476 Benjamin Edelman & Julian Wright, Price Coherence and Excessive Intermediation, at 31 (2014): “[A]n
intermediary always imposes price coherence if it has the ability to do so, as this increases its profit even though it also
lowers consumer surplus”. 477Id. at 32: "By offering benefits to buyers at no direct charge, intermediaries cause excessive usage of their services -
usage which then lets intermediaries extract significant fees from sellers, indeed beyond even the normal monopoly
fees". 478 Soren Korsgaard, Paying for Payments Free Payments and Optimal Interchange Fees, at 2 (1682 ECB Working
Paper, 2014): “payment services are often provided either for free or against periodical fees: Consumers’ marginal
cost is therefore zero, independent of interchange fees”;
114
accept cards. In his model, when the MSF is not regulated, the optimal response of issuers to
surcharging merchants, is to choose a lower interchange fee in the first place. This has a positive
impact from a welfare perspective. On the other hand, surcharging causes some consumers to
pay with cash, despite their initial card preference.479 Surcharging is thus a sort of a whip, used
to restrain issuers’ market power, at the price of sacrificing marginal cardholders who quit using
cards.
269. Empirical studies reinforce the conclusion that merchants with market power surcharge
excessively.480 Merchants with market power that surcharge cause double distortion. Not only
their level of supply is sub-optimal at the initial phase (because of their market power), but after
an increase in the MSF, they surcharge excessively, and under-provision worsens.481
Proponents of NSR hold that when this is the case, the NSR has a restraining role, similar to
the one of the interchange fee in the model of Rochet & Tirole, described in the previous
chapter. NSR reduces the under-provision of cards, and offsets the market power of issuers.482
In my view, if issuers abuse their market power, regulators should combat the abuse, and not
mitigate its harsh effect by imposing a NSR, which is a further restriction in the abused
market.483
270. In sum, surcharging inflicts positive usage externality at the cost of negative network
externality, whereas NSR does the opposite. Intent to limit oversupply of cards and impose
internalization of costs, would favor surcharging, whereas ambition to cure undersupply,
increase the size of the network and induce cross subsidy between payment instruments
supports NSR.
479Id. at 4: "When fees are unregulated, permitting merchants to surcharge will lead banks to lower their fees, which is
positive from a welfare perspective. On the other hand, the surcharge itself causes some consumers to pay using cash,
even though they prefer card payments." 480 Nicole Jonker, Card Acceptance and Surcharging: The Role of Costs and Competition, 10 REV. NETWORK ECON. 1,
4 (2011): “[L]ocal monopolists ask a much higher surcharge fee than other surcharging merchants who face any
competition. This implies that monopolists more than other merchants employ the possibility to surcharge as a way to
extract any additional consumer surplus from card usage. These results are in line with the theoretical predictions by
Rochet and Tirole (2002), Wright (2003) and Hayashi (2006)”. 481 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note 383,
at 562: “In case of initial underprovision of cards…, the card surcharge aggravates this underprovision and therefore
reduces welfare”;
Wright, The Determinants of Optimal Interchange Fees in Payment Systems, supra note 407, at 24: “Where merchants
compete imperfectly… since under surcharging consumers will face all the costs of the card network (including
covering the issuers’ and acquirers’ margins), but only some of the benefits, there will be too little card usage”. 482 Rochet & Tirole, An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems, supra
note 877, at 76: "[W]e show in Rochet and Tirole (2002) that when issuers have market power, banning the NDR would
result in a systematic underprovision of card services." 483 Supra ¶ 241.
115
All models agree that the relative costs of payment instruments determine the efficiency of
surcharging. Under NSR, cheap payment instruments subsidize expensive payment
instruments.484 If, for merchants, cards are more expensive than other payment instruments,
surcharging helps customers realize this. NSR, as a rule of thumb, disfavors those who pay with
cheap payment instruments.485
271. It is important to note that many of the scholars that support NSR have acted on behalf of Visa
or MasterCard, while many supporters of surcharging have been involved in proceedings
against Visa or MasterCard: Professor Rochet gave expert opinion for the Israeli Visa
companies in the Israeli proceedings (AT 4630/01), and together with Professor Tirole, advised
Visa. Professor Schmalensee was Visa's expert against the U.S. government. Wright advised
visa and also received research funds from Visa. Evans, too, received funds from Visa. In
contrast, Frankel is the expert for the merchants in proceedings against Visa. Carlton was the
expert on behalf of the U.S. Government in the case against Visa. Katz was the expert for the
Reserve Bank of Australia. Oz Shy, who supports surcharging, submitted an expert opinion
against the position of the Visa companies in the Israeli proceeding.486
272. In my view surcharging should be permitted for the following reasons.
273. First, nowadays payment card networks are mature. They have established themselves in the
market. They have high penetration rates among merchants and cardholders both in Israel and
abroad. Cards are ubiquitous. There is no concern for networks’ wholeness and size. The
practical concern is usage externality caused by excessive fees.
In this situation, NSR needlessly neutralizes competition between payment instruments.487
Surcharging, on the other hand, is a lynchpin of healthy competition between payment
instruments.488 Surcharging fosters efficient choice of payment instruments.489 Surcharging
484 Mark Armstrong, Competition in Two-Sided Markets, 37 RAND J. ECON. 668, 676 (2006): "[T]he consequence of a
ban on price discrimination is that one group is made better off (the group that has the higher price with discriminatory
pricing) while the other group is made worse off".
485 Sujit Chakravorti, Theory of Credit Card Networks: A Survey of the Literature, 2 REV. NETWORK ECON. 50, 58
(2003): “[T]here is consensus that one-price policies harm non-card users when cards are more ‘costly’ for merchants to
accept than other payment alternatives”. 486 Scott Schuh et al., Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations, at 29 (FRB of
Boston Public Policy Discussion Papers No. 10-03. 2010). 487 Joseph Farrell, Efficiency and Competition between Payment Instruments, 5 REV. NETWORK ECON. 26, 28 (2006). 488 United States v. Am. Express Co. 2015 U.S. Dist. LEXIS 20114 (E.D.N.Y Feb. 19, 2015), at 187: “Steering is a
lynchpin to inter-network competition on the basis of price”. 489 Commission Staff Working Document - Annex to the Proposal for a Directive of the European Parliament and of the
Council on Payment Services in the Internal Market - Impact Assessment, sec. 48 (Dec. 1, 2005): “The overall social
cost of using payment services could be reduced if consumers and business selected the means of payments in a more
116
signals customers about the real cost of the payment instrument they are using. Under NSR
customers are unaware of these costs.490
274. NSR serves as a barrier to entry, because it prevents cheap payment instruments from standing
out.491 Only when customers internalize the real costs of their payment instruments, they would
choose the most cost effective instrument for the “combined” customer – the cardholder and
the merchant.492
For example, PIN debit cards are cheaper than credit cards.493 For PIN debit to successfully
enter the Israeli market, PIN debit must overcome the chicken and egg problem and reach a
critical mass.494 In my view it is essential that merchants should be able to signal their customers
about PIN debit low prices, by differentiating debit and credit prices. Distinguished (lower)
MSF for debit is how debit cards were established in the United States.495
Whereas the concern for the size of mature networks is gratuitous, the concern over their fees
is very real. Because the network externality concern is the main basis on which the NSR is
built, then with this argument gone, the entire justification for NSR falls also (“Cessante ratione
legis cessat ipsa lex”).496
275. Second, surcharging is not costless. Merchants who surcharge risk negative reactions from
customers. In addition they have to invest resources in applying different prices to same
products, according to the payment instrument.497 The default preference of merchants is to
keep price coherence and not to surcharge. Merchants surcharge only as a last resort. Merchants
should be permitted to cry out and signal their customers if excessive prices are imposed on
them.
rational way. When prices paid by users reflect the real cost value of the service, they provide an incentive for users to
select services that meet their needs at the lowest possible private and social cost. This promotes the efficiency of the
payment system. It is well documented in studies that cost-based pricing of payment services triggers customer
behaviour and the right price signals can drive customers to select more efficient payment services rather than less
efficient ones”. 490 Sungbok Lee, The Effects of Issuer Competition on the Credit Card Industry, supra note 420, at 16: “Under the no-
surcharge rule, the higher interchange fee followed by the lower customer fee increases demand for card purchases,
because the effective cost of a card payment service is not informed to consumers”. 491 United States v. Am. Express Co., 2015 U.S. Dist. Lexis 20114, at 199-200 (E.D.N.Y Feb. 19, 2015): “Notably,
Defendants do not strenuously dispute ... that such restrictions effectively raise a barrier to entry in the relevant market
for firms pursuing a low-price strategy”. 492 OECD, POLICY ROUNDTABLE, EXCESSIVE PRICES, at 7 DAF/COMP(2011)18. 493 Supra ¶ 125. 494 Infra ¶¶ 419 - 421. 495 Supra ¶¶ 105 - 106. 496 C.A 2299/99 Shfayer v. Diur Laole, 55(4) 213, 225 (2001). 497 Infra ch. 11.4.
117
Merchants that weigh strategic considerations are even more reluctant to surcharge.498 Such
merchants surcharge only when they have no choice, but to signal to their customers, about the
high cost of the payment instrument.
276. Merchants may err and surcharge too high or too low, but the consequences fall on them, similar
to any other mistake in pricing. If a merchant is ready to take the risk involved in surcharging,
there is no reason to ban the merchant from doing so, let alone when this ban is a restrictive
arrangement.499 There is no reason to negate the autonomy of merchants to dispatch messages
to their clients about the costs of payment instruments. Surcharging should be a prerogative of
the merchant, and the merchant should not be deprived of it.
277. Third, the mere potential for merchants to surcharge is by itself, a credible threat that enhances
merchants’ bargaining power. Merchants can restrain networks from imposing high fees and
exert downward pressure on fees, just by having a possibility to surcharge. Surcharging should
be a deterrence mechanism to balance biased price structure against merchants.500
278. Fourth, surcharging increases transparency. Permitting surcharges induces merchants and
consumers to learn more about the different costs of payment instruments. Merchants will be
incentivized to better examine the price they pay for each payment instrument they accept.
Competition between payment instruments becomes more effective, as cheaper payment
instruments can be advertised and promoted.501 Consumers would also become aware to the
costs of the payment instruments they possess.
498 Infra ch. 11.3. 499 See infra ¶ 750. 500 COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT, SWD(2013)288 Final, at 135 (July 24, 2013):
“[A]t least some merchants saw surcharging as a 'threat' they could use in negotiations with their acquirers in order to
decrease their MSCs.”;
Robin A. Prager et al., Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy
Issues, at 44 (F.R.B. Finance and Economics Discussion Series 23-09, 2009): “[E]ven the threat of surcharging may
improve the bargaining position of merchants as a whole, which could induce the networks to lower interchange fees.”;
Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, supra note 335, at 6: “Even if price
differentiation based on the payment instrument used is not common, the possibility to do so may enhance the
merchants’ bargaining power in negotiating their fees. Merchants can exert downward pressure on fees by having the
possibility to set instrument-contingent pricing.”;
Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321, 1355
(2008): “Ultimately, though, whether merchants would actually surcharge is irrelevant. The ability to surcharge would
give merchants negotiating leverage to gain lower fees, and with lower fees, there would be no need to surcharge". 501 NICHOLAS ECONOMIDES, COMPETITION POLICY ISSUES IN THE CONSUMER PAYMENTS INDUSTRY, in MOVING
MONEY: THE FUTURE OF CONSUMER PAYMENT 113, 119 ( R. Litan & M. Baily eds., 2009). For a different view on
transparency see Bourguignon et al., Shrouded Transaction Costs, supra note 392, at 5-6.
118
279. Fifth, nascent networks require interchange fees to lower cardholder fees and penetrate the
cardholder side. For them, NSR is a kind of infancy protection, which might be justified.
However, banning surcharges out of concern for the size of mature networks, when networks
are already in saturation, is ridiculous and unrelated to any legitimate fear.502
280. Sixth, the concern that some merchants will abuse their market power to surcharge excessively
ignores two points.
(a) If payment cards indeed yield net benefits to merchants, then excessive surcharging is
against their interest. If cards are more beneficial, surcharging steers customers to less attractive
payment instruments for the merchants, to the merchants’ detriment.
(b) According to Economides and Hayashi, most merchants with market power would tend not
to fully surcharge, because their prices are optimal for them at the outset.503
Nevertheless, if merchants (probably with market power and inelastic demand) abuse their
position and surcharge excessively, albeit taking the negative implications on themselves, a
specific ex-post rule to limit their surcharging opportunity might be considered. This is
preferable to an over-broad ex-ante NSR. In practice, regulators that are concerned about
excessive surcharges, avoid this situation by capping surcharges.504
281. Levitin suggested that in order to prevent excessive surcharges, merchants who surcharge
should be obligated to openly display the MSF they pay. Customers can then compare the
surcharge to the MSF. If networks know the MSF is to be openly displayed, this might also
restrain them from charging excessive fee from the outset. It would also neutralize negative
feelings of customers toward surcharges and refer them to blame the payment card firms.505
282. From all the above my conclusion is that unless abused, surcharging should be legitimate and
NSR should be prohibited.
502 Scott Schuh et al., An Economic Analysis of the 2011 Settlement between the Department of Justice and Credit Card
Networks, 8 J. COMPETITION L. ECON. 1, 25 (2012): "[T]he externality argument in favor of the no-surcharge rule is
most compelling in the case of an emerging payment network, where implicit subsidies may be needed to attract users
and establish the network. This argument may have little relevance in the case of a mature payment network, such as
credit cards in the United States”. 503 Supra ¶¶ 263, 265. 504 See, for example, the Australian experience, infra ¶ 663. 505 Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321
(2008)
119
Surcharging indeed restrains the market power of networks. However, the ability to surcharge
alone might not be sufficient to bring an efficient price level, let alone an efficient price
structure.506 In practice, most merchants do not surcharge, even when they are allowed to do
so. The reasons for that are discussed in chapter 11 below. The ability to surcharge is thus a
necessary but insufficient condition. The sufficiency of network competition to prevent
exploitation of the interchange fees will be explored now.
6.6. Payment Card Competition
283. In the 1990s, restaurants in Boston demanded that American Express reduce the MSF it charged
them, which was 3.25%. The conflict won the nickname “The Boston Fee Party”.507 Other
networks, such as Visa and MasterCard, took advantage of merchants' grievance. They offered
merchants cheaper MSF and gained market shares on account of American Express. Eventually
American Express had to reduce its MSF.508
The event led to the belief that competition between networks promotes efficient price level
and price structure, similar to the usual view that competition leads to an efficient equilibrium.
284. However, competition in two sided markets such as payment cards, differs from competition in
regular markets.509 There is an important asymmetry between cardholders and merchants that
heavily impacts payment card competition. The cardholder is the active side. The customer is
the one sitting on the driver’s sit and deciding with which payment instrument to pay.510
Merchants are passive in the sense they can accept or reject the payment instrument in which
the customer chooses to pay with, but they are not in a position to choose the payment
instrument themselves.
506 Edelman & Wright, Price Coherence and Excessive Intermediation, supra note 476, at 32: “In principle, this
neutrality need not hold. For example, menu costs or other frictions could inhibit pass through even if intermediaries are
not allowed to impose price coherence... and the benefits of banning price coherence may be overstated.” 507 The “Boston Tea Party” is one of the constitutive events in American independence history,
http://en.wikipedia.org/wiki/Boston_Tea_Party 508 DAVID S. EVANS & RICHARD SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND
BORROWING 185-88 (2d ed. 2005). 509 Julian Wright, One-Sided Logic in Two-Sided Markets 3 REV. NETWORK ECON. 44 (2004); Rochet & Tirole,
Externalities and Regulation in Card Payment Systems, supra note 390, at 1: "It is now well-understood that the
implementation of competition policy must be amended in order to reflect two-sidedness". 510 Farrell, Efficiency and Competition between Payment Instruments, supra note 487, at 26: “[M]ost observers believe
that cardholders are 'in the driver’s seat'.”;
Julian Wright, Why Payment Card Fees are Biased Against Retailers, supra note 401, at 3: “[W]hile consumers ignore
the benefits retailers get from accepting cards, the reverse is not true."; see also supra ¶ 135.
120
285. Two key terms in the terminology of payment card competition should be introduced:
“multihoming” and “singlehoming”.
Multihoming occurs when customers at one side of the market, choose to interact with more
than one platform. Cardholder's multihoming occurs if a cardholder belongs to more than one
payment card network (for example, American Express and Visa). Multihoming on the
merchant side occurs when merchants accept cards of more than one network.
Multihoming is a term drawn from the internet literature. The term was adopted by Rochet &
Tirole to the context of payment cards.511 Other examples of multihoming are buyers or sellers
contracting with a number of real estate agents; engagement of men or women with more than
one dating club; or interaction of readers or advertisers with several newspapers.
Singlehoming occurs when a person interacts only with one platform. Cardholders that have
only one card in their wallet are singlehoming, as are merchants that accept only one brand of
cards.512 Like multihoming, also singlehoming occurs in other multisided platforms. For
example, readers of newspapers often subscribe to only one newspaper; end-users usually
purchase only one game console. On the other side, game developers aspire to multihome, and
contract with many consoles, to disperse the games they develop.
Multihoming and singlehoming are important factors in determining the effects of competition
on both price level and price structure.513
286. Effect on price level - the conventional wisdom is that price level tends to be lower under
multihoming. This is the typical result of multiplicity of competitors, drawn from ordinary one-
511 Rochet & Tirole, Tying, supra note 408, at 1334: “The term “multi-homing” is borrowed from the Internet literature.
It refers to a situation where some users are members of several platforms. In the context of payment cards it means
either that consumers hold several cards (buyers' multi-homing) or that merchants accept several cards (sellers' multi-
homing);
Frederic Jenny, Competition Policy Issues in the Financial Services Sector: Regulation of the Interchange Fees in
Credit Card Systems, at 10 (Conference competition policy for regulated industries, Athens, Sept. 2008): "Multihoming
is a situation in which some agents, in one or both sides of a two sided market, adopt more than one platform, so that
interactions may occur through a series of alternative channels. A shop manager multihomes when several credit cards
are accepted for payment. A consumer multihomes when she owns several credit cards, among which to choose”.
Jean-Charles Rochet & Jean Tirole, Platform Competition in Two-Sided Markets, 1 J. EUR. ECON. ASS'N 990, 992
(2003). 512 Mark Armstrong, Competition in Two-Sided Markets, supra note 484, at 669: “When an agent chooses to use only
one platform, it has become common to say the agent is “single-homing.” When an agent uses several platforms, she is
said to “multi-home".” 513Id.; see also David S. Evans, The Antitrust Economics of Multi-Sided Markets, 20 YALE J. ON REG. 325, 346 (2003):
“Multihoming affects both the price level and the pricing structure”.
121
sided markets. Multihoming means that cardholders have several cards in their wallet and
merchants accept variety of cards. This increases the resistance of merchants to expensive
cards.514 Merchants' elasticity of demand is more elastic under multihoming. Customers can, at
least theoretically, switch to substitute networks, because they are already connected to them.
Refusal of a merchant to accept an expensive card, leads to less severe consequences when
cardholders are multihoming. The conventional wisdom opines that under multihoming,
networks must cut prices to merchants. Competition for merchants due to multihoming causes
prices to fall and lowers the price level.515
287. The conventional wisdom is based on symmetric pass through rates in the issuing and acquiring
sides, and concave demand curves.516 Under different (and, in my opinion, more realistic)
assumptions, especially when the pass through rate on the issuing side is lower than on the
acquiring side, due to market power of issuers, competition can raise price level, even when
cardholders are multihoming.517 As explained below, this occurs when A. Interchange fees rise
as a result of competition, in order to finance reduction in cardholder fees and rewards; B.
Demand of merchants is rigid, due to strategic considerations; C. Issuers keep some of the
revenue from the interchange fee to themselves as profit. The result is that cardholder fees
indeed decrease, but the increase in the MSF is larger than the decrease in cardholder fees.
Under such circumstances, competition can yield an increase in the price level (Pm+Pc).
Specifically, Pm might increase more than Pc decreases.
514 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note 383,
at 561: ”System competition increases merchant resistance”. 515 Rochet & Tirole, Platform Competition in Two-Sided Markets, supra note 511, at 1006: “The price level is lower for
associations with healthy competition among their members.”;
Chakravorti & Roson, Platform Competition in Two-Sided Markets: The Case of Payment Networks, supra note 346, at
129: “In our model, market competition reduces the total price, the sum of the consumer and merchant fees, and
increases merchant and consumer welfare.”;
David S. Evans, The Antitrust Economics of Multi-Sided Markets, 20 YALE J. ON REG. 325, 346 (2003): “[T]he price
level tends to be lower with multihoming because the availability of substitutes tends to put pressure on the multi-sided
firms to lower their prices.”;
Stewart E. Weiner & Julian Wright, Interchange Fees in various Countries: Developments and Determinants, 4 REV.
NETWORK ECON. 290, 313 (2005): “Greater inter-system competition should not increase the total fees charged across
both sides of the market.”;
Mark Armstrong & Julian Wright, Two-Sided Markets, Competitive Bottlenecks and Exclusive Contracts, 32 ECON.
THEORY 353, 359 (2007). 516 E. Glen Weyl, The Price Theory of Two-Sided Markets, at 7 (2009) available at http://ssrn.com/paper=1324317: “However when demand is log-convex on one side of the market… things can be entirely different... competition and
price controls may well raise the price level”. 517 Farrell, Efficiency and Competition between Payment Instruments, supra note 487 at 37: “[W]hereas one might
naturally think of interchange as primarily affecting fee structure, not fee level. Changes in the level of interchange will
affect only fee structure if pass through of those changes is symmetric on the acquiring and issuing sides”.
122
288. Impact on the price structure - Competition significantly affects the price structure.
Competition leads to a drop in the price on one side, in which the competition is fierce, and to
a rise in the price on the other side, where the competition is weaker. The interchange fee is a
major key in this competition.
289. Generally, if one side is singlehoming and the other side is multihoming, the strong competition
would be on the side which is singlehoming.518 In the extreme, the multihoming side will pay
monopoly prices, because the network has monopoly on access to its customers on the
singlehoming side.519
This is similar to the way a telecom operator enjoys a monopoly over the termination of calls
made to its subscribers. When cardholders are singlehoming each issuer can charge interchange
fees that reflect its market power.520 In the literature this situation is called "competitive
bottlenecks".521 Merchants cannot afford to refuse the only card that the cardholder carries,
especially if it is a common card.522
290. When merchants do not surcharge, a cardholder who can choose between different payment
instruments, would pay with the most beneficial instrument for herself.523 The crucial element
becomes recruiting cardholders.524
518 Marc Rysman, An Empirical Analysis of Payment Card Usage, 55 J. INDUS. ECON. 1, 9 (2007): "[W]hen one side of
a market multi-homes and one side singlehomes, competition between intermediaries is fierce on the side that
singlehomes and much lighter or even non-existent on the side that multi-homes". 519Rochet & Tirole, Externalities and Regulation in Card Payment Systems, supra note 390, at 8: “Intuitively, under
single-homing, each system holds a monopoly of access to its own cardholders.”;
Armstrong, Competition in Two-Sided Markets, 668, supra note 484, at 669: “[P]latforms have monopoly power over
providing access to their singlehoming customers for the multi-homing side. This monopoly power naturally leads to
high prices being charged to the multi-homing side, and there will be too few agents on this side being served from a
social point of view”; 520 Rochet & Tirole, Externalities, id. at 8: “Intuitively, under single-homing, each system holds a monopoly of access
to its own cardholders (in the same way each telecom operator enjoys a monopoly over the termination of calls made to
its subscribers). Thanks to this competitive bottleneck, it can “charge” a monopoly merchant discount”. 521 Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J. MICROECONOMICS 206, 221
(2013): “Assuming that consumers get only one card (single-home) and merchants multi-home, network competition
would fail to mitigate the distortion we describe… Intuitively, competition has a bias favoring the single-homing side,
since steering customers toward an exclusive relationship lets platforms extract monopoly rents from the multi-homing
side users (competitive bottleneck)”; Mark Armstrong & Julian Wright, Two-Sided Markets, Competitive Bottlenecks
and Exclusive Contracts, 32 ECON. THEORY 353 (2007). 522 Timothy J. Muris, Payment Card Regulation, supra note 176, at 522: ”Because most consumers do not carry all of
the major payment cards, refusing to accept a major card may cost the merchant substantial sales." 523 Wilko Bolt & Sujit Chakravorti, Consumer Choice and Merchant Acceptance of Payment Media (FRB of Chicago
Working Paper No. 2008-11. 2008): "However, when merchants are unable to price differentiate and post one price,
consumers do not face any price inducements in the store, and are assumed to opt for the instrument with the greatest
functionality”. 524 Prager et al., Interchange Fees and Payment Card Networks, supra note 500, at 22: “[N]etwork competition has
varying effects on interchange fees, depending crucially on the cardholding behavior of consumers”.
123
Multihoming Analysis
291. When merchants and cardholders multihome, merchants' resistance to expensive cards
increases, because cardholders carry more than one card in their wallet. Competition between
networks will be reflected in downward pressure on the MSF, which in turn will exert
downward pressure on the interchange fee.525
292. Reality reinforces theory in that there are merchants who do not accept American Express or
Diners cards, for which the MSF is more expensive than of Visa and MasterCard. These
merchants rely on customers' multihoming, i.e., cardholders would pay with another card, but
not abandon the merchant.526
293. When both sides are multihoming, even though the control is in the hands of the cardholder,
the merchant can steer the cardholder to the merchant's preferred payment instrument. The
merchant can use direct rewards or surcharge (if surcharging is permitted). Indeed, merchants
often provide discounts or other rebates for those who purchase with the preferable card for
them. 527
For example, Super-Pharm offers benefits to customers who purchase with Lifestyle cards that
are issued by Isracard in conjunction with Super-Pharm. Supersal offers similar discounts to its
525 Jean Tirole, Payment Card Regulation and the use of Economic Analysis in Antitrust, 4 TOULOUSE SCHOOL ECON.,
at 18 (2011): “System competition puts downward pressure on IFs only if individual cardholders hold cards on different
systems. Under full “multi-homing” merchants cannot be charged more than their net benefit.”;
Rochet & Tirole, Tying, supra note 408, at 1334: “[W]hen consumers hold multiple cards (multi-home), system
competition tilts the price structure toward lower merchant discounts and higher cardholder fees, because merchants
then have an incentive to turn down the card that is most expensive to them”.
Weiner & Wright, Interchange Fees in various Countries: Developments and Determinants, supra note 515. 526 Jenny, Competition Policy Issues, supra note 511, at 10: “When consumers hold several payment instruments,
platforms cannot charge merchants with excessive commissions, otherwise the merchants would not choose to be
affiliated with the platform. Merchants need not be affiliated with several platforms, because they know that consumers
can substitute one payment instrument for another. Best example is Visa which overtook American Express by charging
lower merchants fees”. 527 Sujit Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, 9 REV. NETWORK ECON. 1, 10
(2010), at 10: “If consumers carry multiple types of payment instruments, merchants may be able to steer them away
from more costly payment instruments.”;
Rochet & Tirole, Platform Competition in Two-Sided Markets, supra note 511, at 1001: “By undercutting the rival
platform, each platform thus induces some sellers (those with intermediate types) to stop multihoming, a strategy
known as steering.”;
Graeme Guthrie & Julian Wright, Competing Payment Schemes, 55 J. INDUS. ECON. 37, 38-39 (2007): “[I]f cardholders
always hold multiple cards, merchants can steer consumers to their preferred card network, meaning platform
competition will focus on attracting merchants to accept their cards exclusively. In this case, despite the additional
incentive merchants face to accept cards, platform competition can result in lower merchant fees and higher card fees
compared to those set by a single scheme.”; GAO-10-45, supra note 28, at 29-31.
124
loyalty Supersal cardholders. There are many more affinity cards. Merchants are using club-
cards to steer customers to the merchant's preferable payment instrument.
294. In Israel, when a merchant steers customers to pay with the merchant's preferable card, the
merchant does not pay a lower interchange fee. The Trio Agreement stipulates that an acquirer
may not charge merchants different fees for cards of the same brand, based on the identity of
the issuer. In addition, issuers may not discriminate between acquirers.528
In practice, however, there is revenue sharing between issuers and merchants that operate
affinity or club cards. The justification for the revenue sharing, which in practice equals a
reduced MSF (allegedly contrary to the Trio Agreement), is that such merchants act as a
marketing arm of the issuer. The bottom line is that merchants pay less for affinity cards.
295. Affinity cards encourage shopping in affiliated merchants, but they pose a trade-off for
merchants. A purchase with a loyalty card generates higher revenue but also higher costs.
Merchants must weigh the possible increase in sales against the required rewards associated
with their affinity cards. Merchants must also consider the increase in advertising costs and
marketing efforts, including ad-hoc campaigns with unaffiliated cards. Merchants must also
balance the loss of revenue associated with giving discounts to buyers who would have paid
with the merchant’s most preferred payment instrument even in the absence of a discount.
Merchants choose whether to invest in steering through affinity cards on the basis of these
conflicting considerations.529
296. However, even under multihoming, steering is only a passive and partial remedy for merchants.
Merchants will not necessarily steer and certainly not hasten to refuse expensive cards. An
effort of a merchant to steer, might encounter abandonment and not the desired steering. After
all, the merchant does not know in advance if the customer is multihoming or singlehoming,
528 AT 610/06 Leumi v. Antitrust General Director, (§ 5 of Annex B to the Motion to Approve a Restrictive
Arrangement), Antitrust 6652 (Oct. 30, 2006). 529 Worthington, supra note 45; Steven Semeraro, Assessing the Costs & Benefits of Credit Card Rewards: A Response
to Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations, at 32-33 (2012): “In short, if
merchants recognize that rewarding their customers helps expand their own businesses, similar programs should also be
a good way to expand the credit card business”;
Tamás Briglevics & Oz Shy, Why Don’t most Merchants use Price Discounts to Steer Consumer Payment Choice? 12-9
FRB BOSTON, at 21 (2012): “[T]he degree to which profit increases or decreases as a result of steering with price
discounts depends on both consumers’ responsiveness to price incentives and on the tradeoff between reductions in
payment processing costs and the loss of revenue associated with giving discounts to all buyers, including buyers who
would have paid with the merchant’s most preferred payment instrument even in the absence of a discount.”;
Sumit Agarwal et al., Why do Banks Reward their Customers to use their Credit Cards? (Fed. Res. Bank of Chicago
Working Paper No. 2010-19. 2010); see also infra ¶ 335.
125
and even if the customer is multihoming, she might be eager to pay with a specific card. To
avoid the risk, it is almost always profitable for the merchant to accept the less favorable
payment instrument. Profit from the transaction usually exceeds the cost difference of the
different payment instruments.530 Merchants are also aware that accepting cards, even
expensive cards, increases their own revenue at the expense of their competitors. For these and
for more reasons, explored more deeply in chapter 11 below, merchants do not tend to
surcharge, let alone refuse expensive cards, even under cardholders' multihoming.
297. Cardholders who multihome often have a preferred card. The fact that they are multihoming in
adoption does not mean they are multihoming in usage. In fact, most cardholders are
singlehoming in usage.531
Multihoming Merchants And Singlehoming Customers
298. When customers singlehome and merchants multihome, competition is focused on cardholders.
Conquering the cardholder means having monopoly access to her wallet.532 Demand elasticity
of merchants to cards becomes rigid. Competition for cardholders compels networks to offer
cardholders low fees, free funding period, and rewards. Cardholder fees decrease as competition
increases.533 A higher interchange fee is required to finance rewards.534 This exerts an upward
pressure on the MSF (and on final prices).535
530 Supra ¶ 194. 531 Infra notes 547-549. 532 Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J. MICROECONOMICS 206, 210
(2013): "If merchants accept the cards of multiple card networks (multi-home), competition increases the distortion
even further as networks try to woo cardholders back from their rivals by lowering their prices."
Fumiko Hayashi, The Economics of Payment Cards Fee Structure: What Drives Payment Card Rewards? at 7 (FRB Of
Kansas City Working paper 08-07, 2009): “When a cardholder holds only a single-branded card or has a strong
preference among cards (singlehoming), then each card network can set monopolistic merchant fees”. 533 Jean Charles Rochet & Jean Tirole, Two-Sided Markets: A Progress Report, 37 RAND J. ECON. 645, 660 (2006). 534 Prager et al., Interchange Fees and Payment Card Networks, supra note 500, at 4: “In general, competition among
payment networks is unlikely to exert downward pressure on interchange fees because the networks tend to focus their
competitive efforts on getting their card to be the favored card of a consumer. This objective is facilitated by having a
higher interchange fee that can be used to fund more attractive terms (e.g., lower fees and higher rewards) for the
consumer.”;
Guthrie & Wright, Competing Payment Schemes, supra note 527, at 59: “[C]ompetition between schemes can be the
cause of high interchange fees.” 535 Fumiko Hayashi, Network Competition and Merchant Discount Fees, at 32 (FRB of Kansas City, Payments System
Research Department, Working Paper 05-04. 2006): “Network can increase its net revenue by setting the cardholder fee
lower than its rival’s cardholder fee. Since lower cardholder fees likely make equilibrium merchant fees higher, the
results may emphasize that network competition does not necessarily lower merchant fees.”;
Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 436, at 650-51: “[N]etwork competition
may not reduce merchant fees.”;
ALBERT FOER, ELECTRONIC PAYMENT SYSTEMS AND INTERCHANGE FEES: BREAKING THE LOG JAM ON SOLUTIONS TO
MARKET POWER, Am. Antitrust Institute, at 6 (2010): “Ironically, the competition this creates between Visa and
MasterCard is not toward lower prices, but higher ones.”
126
299. The effect of competition versus monopoly is particularly evident on the cardholders’ side. If
there were just one monopoly network with many issuers and acquirers, it would set a monopoly
price on the cardholder side, in order to extract maximum consumer surplus. The monopoly
network would do the same on the merchant side, taking into consideration the interdependency
of the two sides.
Competition yields lower cardholder fees and higher MSF than a monopoly.536 Competition
forces networks to reduce cardholder fee from monopoly level. Competition is reflected in
lower cardholder fees and abundance of rewards bestowed on cardholders.537 Those rewards
are fueled and financed by higher interchange fees.538 Frankel cites publications and notices of
Visa and MasterCard officials, who explained recurring increases in the MSF by the need to
increase interchange fee in pursuit of cardholders.539
300. Nevertheless, the reduction of cardholder fees does not offset the increase in the price level,
due to issuers' higher costs under competition. Total issuers' costs are higher in competition
than in a monopoly. Issuers spend more in competition (than a monopolist), on advertising and
marketing efforts including rewards. The effect of such expenditures is only an internal shifting
between cards, with no effect on aggregate consumption or volume of transactions.540 Thus, the
price level is higher in competition than under a monopoly, even if pass through on the issuing
side is full (a far-fetched assumption), let alone when pass through to rewards is partial. From
a social perspective, this kind of competition on cardholders, fueled by the interchange fee (and
a corresponding MSF and price increase), is futile.
301. Cardholders' tendency to singlehome leads competition to inefficient price structure, biased in
favor of cardholders against merchants.541 Strong competition might reduce welfare more than
536 Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J. MICROECONOMICS 206, 222
(2013): “Hence, in equilibrium, cardholders pay too little and merchants pay too much.”; Hayashi, Network Competition
and Merchant Discount Fees, ibid. 537 Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, supra note 527, at 8: “As a general
finding, competing networks try to attract end-users who tend to singlehome, since attracting them determines which
network has the greater volume of business. Accordingly, the price structure is tilted in favor of end-users who
singlehome”. 538 Guthrie & Wright, Competing Payment Schemes, supra note 527, at 59: “[T]o the extent competing (heterogeneous)
merchants internalize their customers’ benefits from using cards and to the extent cardholders are at least as important
as merchants in determining which card will be adopted by both sides, system competition will generally drive
interchange fees higher.";
Carlos Arango, Kim P. Huynh & Leonard Sabetti, Consumer Payment Choice: Merchant Card Acceptance Versus
Pricing Incentives, 55 J. BANK. FIN. 130, 131 (2015): “Rewards in turn are funded through an interchange fee”. 539 Alan S. Frankel, Towards a Competitive Card Payments Marketplace, at 33-34 (RBA, 2007). 540 Infra ¶336; see also supra note 404 541 Jean-Charles Rochet & Jean Tirole, Two-Sided Markets: An Overview, at 35 (2004): "Platform competition does not
necessarily lead to an efficient price structure."; see also note 427 and accompanying text.
127
under monopolistic network.542 Hayashi and others go further and claim that when competition
causes issuers’ costs to rise, in order to finance rewards, then even if cardholders are
multihoming, the bleak result is an economy inferior to that without cards at all(!).543 This
542 Santiago Carbo Valverde et al., Regulating Two-Sided Markets: An Empirical Investigation, at 11 (Federal Reserve
Bank of Chicago Working Paper No. 09-11. 2009): “[N]etwork competition may yield a price structure that has a lower
social welfare than when there is only one network. If competition is too strong on the consumer side, the network may
extract too much from merchants resulting in higher than socially optimal interchange fees.”;
Fumiko Hayashi, Pricing and Welfare Implications of Payment Card Network Competition, at 6 (FRB of Kansas City,
Working Paper 06-03. 2006): “It is possible that equilibrium merchant fees under network competition are higher than
the merchant fee set by a monopoly network."; id. at 21: “[T]he social welfare is always lower under network
competition than under monopoly because providing rewards is costly.”;
Rochet, Competing Payment Systems: Key Insights from the Academic Literature, at 8 “[I]ntersystem competition is
completely ineffective when consumers hold a single card.”;
COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT ACCOMPANYING THE PROPOSAL FOR A DIRECTIVE ON
PAYMENT SERVICES, at 104, SWD(2013) 288 Final, (24.7.2013): “[C]ompetition between payment schemes may lead to
merchants being charged more and consumers less, which means higher interchange fee relative to what a single
scheme would set... competition between schemes is not necessarily more likely to yield a socially optimal interchange
fee than when card services are provided by a single network”. 543 Fumiko Hayashi, The Economics of Payment Card Fee Structure: Policy Considerations of Payment Card Rewards,
at 7-8 (FRB of Kansas City Working Paper No. 08-08. 2008): “[W]hen per transaction costs and fees are proportional to
the transaction value, even if all cardholders are multihoming, the equilibrium cardholder fee set by competing card
networks would unlikely be the most efficient; rather it would be less efficient than the cardholder fee set by a
monopoly network. This implies that competition among card networks potentially deteriorates social welfare. In fact,
the results suggest that when per transaction costs and fees are proportional to the transaction value, the equilibrium
social welfare would not just be lower than the maximum social welfare, but would also potentially be lower than the
social welfare without cards at all. Consumers as a whole and merchants would be worse off, compared with the
economy without cards. This may warrant public policy interventions”.
Fumiko Hayashi, Do U.S Consumers Really Benefit from Payment Card Rewards?, FRB Kansas Econ. REV. 37, 52
(2009): “If the current level of rewards is too high, then that level may not only offer less social welfare than zero
rewards, but it may also potentially offer less social welfare than making transactions without payment cards at all.
Rewards that exceed a certain level unlikely play a role of reducing the total costs to society... Further, additional
rewards may potentially increase total costs of transactions... A higher level of rewards may raise the merchant fees and
ultimately raise retail prices, which may increase the value of the transaction. Thus, a higher level of rewards may
require more real resources to society. If this additional resource cost is substantial, then social welfare with very
generous rewards may potentially be lower than social welfare without cards at all”.
Fumiko Hayashi, The Economics of Payment Cards Fee Structure: What Drives Payment Card Rewards?, at 13 (FRB
Of Kansas City Working paper 08-07. 2009): “[T]he theoretical models suggest that when per transaction costs and fees
are proportional to the transaction value, the equilibrium social welfare would potentially be lower than the social
welfare without cards at all. Consumers as a whole and merchants would be worse off, compared with the economy
without cards at all”.
Fumiko Hayashi, The Economics of Payment Card Fee Structure: What is the Optimal Balance between Merchant Fee
and Payment Card Rewards?, At 19-20 (FRB of Kansas City Working Paper No. 08-06. 2008): “When the merchant
fee is higher than the merchant transactional benefit from a card, then the product price set by the merchants is likely to
be higher, compared with the level of the product price in the economy where no card products are available. As a
result, consumers who use the alternative payment method would likely be worse off, compared with the economy
without cards. Some card using consumers, whose transactional benefit from a card is relatively low, would also likely
be worse off, due to the higher product price”.
Rong Ding & Julian Wright, Payment Card Interchange Fees and Price Discrimination, at 5 (2015): "Our paper also
relates to the recent work of Edelman and Wright (2015), who provide a setting in which a platform that imposes price
coherence ends up setting such high fees to merchants that the platform actually destroys consumer surplus; that is,
consumers would be better of without the platform. We show a similar result exists in our setting… card platform
contributes nothing to overall welfare despite being profitable… consumer surplus is reduced by the existence of the
card platform, reflecting that the platform raises retail prices… the extent of consumer surplus loss and harm to welfare
from leaving interchange fees unregulated may be so significant that they offset all the positive benefits that payment
cards provide.";
Wang Zhu, Market Structure and Payment Card Pricing: What Drives the Interchange? 28 INT'L J. INDUS. ORG. 86, 96
(2010): “At equilibrium, consumer rewards and total card transaction values increase with interchange fees, but
consumer surplus and merchant profits may not improve”.
128
conclusion is extreme but even most conservative scholars admit that payment card competition
expressed in excessive rewards might yield an inferior economy, a phenomenon that Rochet &
Tirole (and others) call "wasteful competition".544
302. Thus, in the payment cards sector, the conventional approach from ordinary markets, according
to which the ‘invisible hand’ of competition lowers prices and increases welfare, is reversed.
Contrary to the conventional wisdom, competition expressed in "reward wars", may actually
increase price level and worsen welfare.545
303. The situation of multihoming merchants and singlehoming customers is common. Merchants
are most often multihoming.546 In Israel, merchants generally accept a variety of payment cards.
Even merchants who do not accept American Express or Diners usually do accept Visa,
MasterCard and Isracard.
304. Regarding cardholders, the IAA found in 2005 that cardholders tend to singlehome.547 An
empirical research in Spain came to the same conclusion.548 Other studies found that even when
cardholders possess several cards, they tend to use only the card which gives them the maximum
benefits and rewards.549 Thus the empirical evidence supports singlehoming in usage, at least
544 Rochet & Tirole, Externalities and Regulation in Card Payment Systems, supra note 390, at 11: "wasteful
competition Suppose that issuers do not tacitly collude, but compete in ways that bring limited benefits to
consumers.28"; and in n. 28 which they refer to: "The large advertising expenditures mentioned by Farrell in the above
citation sometimes fall into this category.";
Steven Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, 14 STAN. J. L. BUS.
FIN. 343, 345-46 (2009): “Card issuers may then retain some revenue as supracompetitive profit and wastefully
compete some away in pursuit of highly profitable cardholders.”;
Jean Tirole, Payment Card Regulation and the use of Economic Analysis in Antitrust, supra note 525, at17: “If the
profits associated with cardholders’ installed base are dissipated through wasteful advertising expenditures to “acquire”
cardholders, profits should not enter social welfare calculations.”. 545Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, supra note 527, at 7-8: “Economic
theory suggests that competition generally reduces prices, increases output, and improves welfare. However, with two-
sided markets, network competition may yield an inefficient price structure… Unlike one-sided markets, competition
does not necessarily improve the balance of prices for two-sided markets.";
Santiago Carbo Valverde et al., Regulating Two-Sided Markets: An Empirical Investigation, at 11 (Federal Reserve
Bank of Chicago Working Paper No. 09-11. 2009): “"Standard economic theory suggests that competition would
increase consumer and merchant surplus. Some theoretical models predict that competition in a two-sided market
environment may worsen social welfare.”;
Fumiko Hayashi, The Economics of Payment Cards Fee Structure: What Drives Payment Card Rewards? 13 (FRB Of
Kansas City Working paper 08-07. 2009): “Thus, competition among card networks would likely increase the
equilibrium merchant fee and the level of payment card rewards”. 546 Valverde, id. at 11: “Merchants generally accept cards from multiple networks”. 547 Declaration on Isracard as Monopoly in Acquiring Isracart and MasterCard, at 13, Antitrust 5000034 (May 22,
2005) (finding that in only 3% of checking accounts in big banks who own a payment card firm, there are standing
orders to another payment card). 548 Santiago Carbo Valverde et al., Regulating Two-Sided Markets: An Empirical Investigation, at 11 (Federal Reserve
Bank of Chicago Working Paper No. 09-11. 2009): “Merchants generally accept cards from multiple networks and
consumers choose their preferred issuer and network”. 549 Marc Rysman, an Empirical Analysis of Payment Card Usage, 55 J. INDUS. ECON. L (2007) “[C]onsumers maintain
cards in multiple networks but tend to use only one network. That suggests that they have a preference for single-
129
for large part of purchases.
In this context there is a major difference between late and early models. In early models, there
was no distinction between possession and usage. Possession dictated usage.550 In practice,
however, singlehoming in usage might occur even if the cardholder is multihoming in adoption.
An unused card might be kept in the wallet for security reasons or only for certain specific
purchases.551
305. Hayashi found that if the share of multihoming cardholders is less than 20 percent, a network
can act towards merchants, as if the network is monopoly in supplying access to its
singlehoming cardholders.552
306. Competition for cardholders leads even small networks to exert market power over
merchants.553 Rochet & Tirole note that sometimes cardholders of a certain brand are perceived
as being more lucrative. Rochet & Tirole call them "Marquee Buyers".554 Where merchants
attach special importance to cardholders of a minor network, its small market share does not
lessen the market power that it can exert on merchants. This effect is even stronger in specific
sectors, like travel and entertainment, in which merchants are more dependent on those more
lucrative cardholders.555
homing but recognize that some purchases are valuable enough to warrant using a less-preferred network."; id. at 34:
"[V]ery few consumers multi-home in the sense that they place almost all of their spending on a single payment
network. However, about two-thirds of consumers maintain cards from different networks so they may switch to multi-
homing for relatively small benefits.”;
Arango et al., Consumer Payment Choice: Merchant Card Acceptance Versus Pricing Incentives, supra note 538, at
138: “Our results empirically confirm the role that rewards play as a coordination device, shifting the ranking of top-of-
the-wallet payment instruments and increasing the likelihood of single-homing in payments”. 550 Rochet & Tirole, Platform Competition in Two-Sided Markets, supra note 511; Fabio M. Manenti & Ernesto
Somma, Plastic Clashes: Competition among Closed and Open Systems in the Credit Card Industry, WPA Industrial
Organization, at 9 (2002): “[A]doption and usage decisions are equivalent and depends on the per transaction cost of
card usage”. In a later version from 2010, (Fabio M. Manenti and Ernesto Somma, Plastic Clashes: Competition Among
Closed and Open Payment Systems, at 9 (March 2010)), Manenti relaxed this assumption, and enabled adoption
decision to be independent of usage which is decided per transaction: “when individuals endorse a platform, they do not
know in advance how many transactions they will perform, and they take the adoption decision on a per transaction
basis”. 551 Rysman, supra note 549. 552 Hayashi, Network Competition and Merchant Discount Fees, supra note 535 at 31: "For most parameter values, if
the share of multihoming cardholders is less than 20 percent, networks can act as if they are monopolies". 553 Rysman & Wright, The Economics of Payment Cards, supra note 389, at 21: "Card networks have monopoly power
over access to those consumers to the extent that the consumers only want to use that form of payment (e.g. if
consumers single home). In that case, card platforms can theoretically have a type of “market power” with regard to
merchants even if the card platforms have relatively small market shares among consumers". 554 Rochet & Tirole, Platform Competition in Two-Sided Markets, supra note 511, at 1008: “[M]arquee buyers make the
platform more attractive for the sellers”. 555 The following facts findings from United States v. Am. Express Co., 2015 U.S. Dist. LEXIS 20114, at 130-32
(E.D.N.Y. Feb. 19, 2015), are worth noting, although the decision was reversed: “Similar "single-homing" behavior is
130
307. The degree of multihoming / singlehoming is indeed important to determine the effects of
competition. However, it is not conclusive. Several other factors are also influential.
308. The degree of competition between merchants affects the results of competition between
networks. Competitive merchants, who are driven by strategic considerations, are less resistant
to increases in the MSF than merchants with market power.556 Networks with categories of
interchange fees can bypass the resistance of merchants with market power, by offering them
lower category of fees. However, if there is only one level of interchange fee, then merchants
with market power serve as a barrier to attempts of networks to increase the interchange fee. In
this sense, ascribing the State its agencies and the Israeli Electric Company (the “marginal
consumer” of cards) to a low category of interchange fee in Israel, prevented a possible decrease
(that could occur without categories) for all other merchants.
309. Heterogeneity between merchants enables the networks to sacrifice marginal merchants,
when the price structure is tilted against them as a consequence of networks competition.
According to Guthrie & Wright, competition will have no effect on homogeneous merchants,
because when merchants are homogeneous, the worst result for them, monopolistic pricing, is
achieved anyway.557 Monopolistic network determines the interchange fee and the resulting
MSF at the maximum rate that merchants (all of them, because they are homogeneous) will still
accept cards. Higher costs to issuers, because of competition, cannot be subsidized by any
further increase of the MSF.
also observed among the approximately 10-20% of Amex cardholders who own or regularly carry only their Amex
cards... Amex's industry-leading corporate card program, for instance, drives a significant degree of insistent spending,
particularly at those T&E merchants that cater to the needs of business travelers... approximately 70% of Corporate
Card consumers are subject to some form of "mandation" policy, by which employers require the employee-cardholders
to use Amex cards for business expenses”;
Prager et al., Interchange Fees and Payment Card Networks, supra note 500, at 51 n. 113 (FRB Finance and Economics
Discussion Series 23-09. 2009): “A merchant’s tradeoff between costs and benefits of card acceptance implies that a
merchant will not necessarily choose to accept cards from the network with the lowest interchange fee. The benefits that
a merchant derives from card acceptance include both the transactional benefits (e.g., reduced handling costs or
increased certainty of payment, relative to other payment methods) and increased demand for its products. The
magnitude of the latter effect depends, in part, on the surplus that consumers derive from the use of a given network’s
card – the greater the consumer’s surplus from a card, the more likely he or she will be to choose a merchant based on
whether the merchant accepts that card. In general, consumer surplus from using a network’s card will be higher (e.g.,
rewards will be greater or fees will be lower) when the interchange fee is higher. Thus, when making its card
acceptance decision, a merchant will weigh the cost of the interchange fee (or, more precisely, the merchant discount)
against the benefit of increased final product demand generated by card acceptance”. 556 Hayashi, A Puzzle of Card Payment Pricing, supra note 388, at 171: “Merchant competition allows the network to
set higher merchant fees." 557 Guthrie & Wright, Competing Payment Schemes, supra note 527, at 51: “Whichever equilibrium is selected in
practice, competition between payment schemes can never increase the equilibrium interchange fee (when sellers obtain
identical benefits from accepting cards), reflecting that a single card scheme already sets interchange fees to the highest
possible level consistent with sellers’ accepting cards”.
131
However, when merchants are heterogeneous, competition drives up the costs of issuers. Issuers
cover their increased costs by further increases in the interchange fee. The MSF also increases
and the bias in the price structure against merchants intensifies. Heterogeneity means that
marginal merchants will drop out of the card network whenever the MSF increases. When
demand elasticity of merchants to cards is sufficiently rigid, network competition worsens their
position in comparison to a monopoly network.558
310. A fixed or ad valorem cardholder fee is relevant only when competition exists. Under a
monopoly network, there is no difference whether the cardholder fee is fixed or variable,
because a monopoly network can compute how to extract the same fees, anyway.559
Fixed cardholder fees primarily affect the degree of card adoption. Competition on cardholders,
when cardholder fee is fixed, may result in multihoming cardholders. Competition to encourage
cardholders to adopt cards causes lower (fixed) cardholder fees, and higher multihoming among
cardholders. Multihoming cardholders and fixed cardholder fees increase merchant resistance
and can correct the biased price structure against them.560
Ad valorem fees primarily influence the degree of usage.561 When cardholder fees include a
fixed positive component (such as a monthly or annual fee), and a variable negative price
(rewards), the cardholder is even more eager to use the card that gives the maximum benefits,
especially after paying the subscription fees.562 When benefits of cardholders from card usage
increase, strategic considerations of merchants intensify. Merchants' resistance weakens. Thus,
contrary to the initial model of Rochet & Tirole, in which cardholder fees were constant and
not correlated to usage, ad valorem (negative) variable fees are positively correlated to the level
558Id. at 58: “[W]ith seller heterogeneity, …competition between card schemes can increase interchange fees above the
level set by a single monopoly scheme. Competition can lead card schemes to set interchange fees too high for their
own good. In effect, each card scheme sets its interchange fee too high in an attempt to get buyers to switch to holding
its card exclusively, an effect which ends up reducing the total number of card transactions as fewer sellers accept
cards". See also ¶ 301. 559 Armstrong, Competition in Two-Sided Markets, 668, supra note 484, at 669: “The distinction between the two forms
of tariff only matters when there are competing platforms. When there is a monopoly platform… it makes no difference
if tariffs are levied on a lump-sum or per-transaction basis”. 560 Hayashi, What Drives Payment Card Rewards, supra note 545, at 12: “When all cardholders are multihoming (i.e.,
they are indifferent among cards as long as the cardholder fees are the same), the equilibrium cardholder fee depends on
whether per transaction costs and fees are fixed (Scenario I) or proportional to the transaction value (Scenario II). If the
former is the case, the competing card networks would set their cardholder fee at the most efficient level and their
merchant fee at the merchant’s transactional benefit. This is because oligopolistically competing merchants would only
accept the cards with the lower merchant fee”. 561 Joanna Stavins, Potential Effects of an Increase in Debit Card Fees (FRB of Boston Public Policy Briefs No. 11-03.
2011) "Fixed one-time fees are more likely to affect the adoption of a payment method, while per-transaction fees are
more likely to affect the use of payment methods". 562 Supra ¶ 230.
132
of usage.563 Competition on cardholders negatively exploits this correlation through anti-
competitive "reward wars" which likely result in "wasteful competition".
Competition on Issuers
311. Another ground for competition between networks is for issuers. In Israel this kind of
competition is degenerated, because banks own issuers. Leumi Bank would not issue cards
other than of Leumicard. It is unlikely that Hapoalim Bank would issue cards other than in
conjunction with Isracard. However this competition exists in a degenerated form, on
"independent” banks such as Mizrachi-Tfachot, Igud and Jerusalem bank.564 In other countries,
this competition is much more significant.
312. Interchange fees are the primary tool for a network that wishes to persuade a financial institution
to issue its cards. For the issuer bank, the interchange fee generates per transaction income.
Issuers have incentives to issue the card that gives them the highest income, i.e. the highest
interchange fee.565 Thus, competition between networks for issuers tends to increase the
interchange fee.566 A number of empirical studies from around the world have confirmed this
result:
563 Supra ¶ 204; see also Lee, The Effects of Issuer Competition on the Credit Card Industry: A Case Study of the Two-
Sided Market, supra note 420, at 16: “By assuming that the customer fee is a price per transaction, the model in this
paper derives that the interchange fee increases with competition, which is one of significantly different results from
those in Rochet and Tirole (2002)”. 564 See supra ¶¶ 560-562 for arrangement of issuers with independent banks in Israel. 565 Ann Borestam & Heiko Schmiedel, Interchange Fees in Payment Cards, ECB Occasional Paper Series 131, at 13
(2011): “Issuers’ decisions on which card to issue depend on the level of the interchange fee”. 566 EU, Proposal for a Regulation on Interchange Fees, supra note 1042, at 2: “Competition between card schemes
appears in practice to be largely aimed at convincing as many issuing payment service providers as possible to issue
their cards, which usually leads to higher rather than lower fees, in contrast with the usual price disciplining effect of
competition in a market economy”;
Frankel, Interchange in various Countries: Commentary on Weiner and Wright, supra note 432, at 56; “[T]he issuer has
an incentive to choose the network with the higher fee";
Benjamin Klein et al., Competition in Two-Sided Markets: The Antitrust Economics of Payment Card Interchange Fees,
73 ANTITRUST L.J. 571, 604 (2006): “[I]ncrease in interchange fees can be explained by the increased competition
between Visa and MasterCard for issuers.”;
Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 436, at 651: “Competition between card
brands is ineffective at constraining interchange fees because a network with lower fees gets fewer sales. If one network
were to set its interchange exactly at a theoretically efficient level while its rival offered a slightly higher interchange
fee, issuers would prefer the network with the higher fee unless the fee was so much higher that merchants refused that
brand.”;
Albert A. Foer, Our $48 Billion Credit Card Bill, N. Y TIMES, Apr. 20, 2010: “The result is that Visa and MasterCard
compete to deliver the highest returns to the banks rather than offer the lowest prices to consumers”;
Alberto Heimler, Payment Cards Pricing Patterns: The Role of Antitrust and Regulatory Authorities, SSRN (2010): “In
Europe most cardholders receive their cards from the financial institution where they have a checking account. The
bank is certainly not chosen with respect of the credit card it offers, so competition can hardly discipline banks with
respect to the pricing of payment systems. Furthermore, financial institutions often carry a number of cards (for
example Visa, MasterCard, or even American Express). Banks, however, tend to suggest one card to depositors. It is
true that consumers may ask for a different one, but they seldom do. The incentive of the issuing bank is to offer the
133
313. In the proceedings of the U.S government against MasterCard and Visa, the court ruled in 2003
that Visa and MasterCard could not prevent their member banks from issuing American Express
cards.567 After that ruling American Express began to grant issuing licenses to banks. American
Express offered higher (notional, because it is a closed network) interchange fee than Visa or
MasterCard. As a result, both MasterCard and Visa had to raise their interchange fees in order
to persuade banks to keep issuing their cards and not those of American Express.568 Also, as
described in the historical review (chapter 4), competition for debit issuers caused interchange
fees to rise.569 In the MasterCard Decision, the European Commission also determined that
competition between networks for issuers increases the interchange fee.570 Merchants bear the
direct consequences of such competition in the form of the higher MSF they must pay.
Merchants pass through to their consumers the price increase they suffer.571
314. An empirical study conducted by Weiner & Wright on interchange fees in various countries,
did not find significant correlation between issuers’ concentration and interchange fees.572 In
2015 Wright, this time with Rysman, was more decisive about this point and concluded that
competition between networks for issuers increases the interchange fee.573
315. In Israel, the Trio Agreement disabled competition between Visa and MasterCard for issuers.
The card companies - Isracard, LeumiCard or CAL - cannot offer individual issuers higher
interchange fees. The card firms bypass this limitation by offering issuing banks higher share
card with the highest interchange fee, not the lowest. So, since cardholders usually do not pay for their card, nor for the
use of it, competition can hardly discipline the behaviour of issuing banks. On the contrary, the high interchange fee
will drive out the low interchange fee card, and therefore interchange fees between competing networks will tend
to converge at the highest, not the lowest level. A further perverse result.";
Jean-Charles Rochet & Zhu Wang, Issuer Competition and the Credit Card Interchange Fee Puzzle, at 2 (2010): “We
show that the increasing concentration of large card issuers is indeed a main driving force of rising interchange fees and
consumer card rewards. As a result, large issuers’ profits increase whereas merchant profits and consumer welfare are
reduced”.
567 See supra ch. 8.3.6. 568 GAO-10-45, supra note 28, at 20-21; Robert J. Shapiro & Jiwon Vellucci, The Costs of “Charging it” in America:
Assessing the Economic Impact of Interchange Fees for Credit Card and Debit Card Transactions, (2010): “Following
a 2003 court ruling allowing banks that are members of VISA or MasterCard to also issue other credit cards, Visa and
MasterCard both moved to retain banks by introducing new cards with higher interchange fees”. 569 See ¶ 108. 570 Comp/34.579 European Comm'n MasterCard Decision, at 131-37 (Dec. 19, 2007), available at
http://ec.europa.eu/competition/antitrust/cases/dec_docs/34579/34579_1889_2.pdf. 571 Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 505, at 1341. 572 Weiner & Wright, Interchange Fees in various Countries: Developments and Determinants, supra note 515, at 315:
“[T]here is no obvious relationship between issuer market concentration and interchange fees across the sample of
countries considered”. 573 Rysman & Wright, The Economics of Payment Cards, supra note 389, at 13: “[I]ndividual issuers prefer a card
system that offers them a higher interchange fee... interchange fees increased due to the increasing ability of large
issuers to play one platform off against another in the U.S., which was the result of a shift towards a more equal
distribution of market shares among the top 5 issuers over the period and strong inter-system competition. Each of the
episodes in which interchange fees jumped up was associated with a battle to keep issuers”.
134
of the MSF, or even a few percent ownership in the card firm, in return for issuing minimum
quantities of cards.574
316. The Trio Agreement did enable competition between Isracard, Leumicard and CAL for
merchants. As a consequence both the interchange fee and the MSF decreased significantly.575
However, Israel is not an exception to the rule according to which payment card competition
increases interchange fees. Israel falls under the rule that regulation lowers interchange fees,
and as a consequence, also lowers the corresponding MSF. Without regulation, the interchange
fee in Israel would have probably remained on its initial level (almost 2%).
Competition Between Open And Closed Networks
317. Another notable field of competition which is affected by the interchange fee is competition
between open and closed networks.
318. Scholars have argued that regulating the interchange fee is a discrimination against open
networks as opposed to closed networks.576 The interchange fee in closed networks is virtual.
Closed networks determine only the cardholder fees and the MSF. American Express, for
instance, is effectively the sole acquirer and sole issuer of its own cards. It contracts with
merchants and unilaterally sets the MSF for them, and it also contracts with cardholders and
unilaterally sets the fees for them.577 There is no coordination between competitors in a closed
network, and the fees are not treated as restrictive arrangement.
319. The discrimination argument is that regulating interchange fee puts open networks in a
competitive disadvantage in comparison with closed networks. Closed networks can set the
MSF as high as they desire, and transfer part of the revenues to their cardholders as rewards,
with no regulatory scrutiny. On the other hand, open networks whose interchange fees are
monitored, are limited in the rewards they can offer cardholders, and payments they can offer
issuing banks. Cardholders of closed networks can receive greater rewards and pay lower
cardholder fees. If a closed network wishes to expand, it will be able to offer higher notional
574 Supra ch. 8.1.6. 575 Supra ¶ 97; see also Motion 34/01 Leumi v. Antitrust General Director, para. 4 (Dec. 22, 2002) (indicating that the
cross acquiring agreement caused a decrease of 20-35% in the MSF). 576 Jean Tirole, Payment Card Regulation and the use of Economic Analysis in Antitrust, 4 TOULOUSE SCHOOL ECON.
18 (2011): “Regulation has hitherto been misguided in that it favors closed, three-party systems over open, four-party
ones. There is absolutely no economic reason for treating the two asymmetrically”. 577 United States v. Am. Express Co., 2015 U.S. Dist. Lexis 20114, at 31 (E.D.N.Y Feb. 19, 2015): “American Express
operates a partially integrated "3-party" or "closed-loop" payment card system. In addition to operating its credit and
charge card network, American Express also acts as the card issuer and merchant acquirer for the vast majority of
transactions involving its cards”.
135
interchange fees (i.e., higher part of the MSF) to issuing banks and steer them to cooperate with
the closed network. The argument finishes at that cardholders will prefer higher rewarding cards
of closed networks that will supplant open networks.578
320. The MSF in closed networks is indeed higher than it is in open networks. Nevertheless, closed
networks not only do not dominate open networks, but their market share remains relatively
small. One reason for that is the regulation of the interchange fees. This lowers the MSF of
open network cards, and enables merchants to accept Visa and MasterCard, but reject (or
surcharge) closed networks, especially if cardholders are multihoming. As a consequence, cards
of closed networks are less accepted and less popular.
321. In my view, even if closed networks would supplant open networks, by charging high MSF,
this should not lead to deregulation of interchange fee, but rather to regulation of closed
networks. The law should not disregard high interchange fees in open networks, because of the
existence of a high MSF in closed networks. There should be no correction of evil by another
evil.579 If high prices supplant low prices, this is a market failure, and the cause for high prices
should be regulated.
322. Several options of regulating closed networks, in the event they abuse their position and charge
excessive MSF, are possible:
The first option is to obligate closed networks that gain large market share (by charging high
MSF), to "open" i.e., to let others to acquire their cards.580 In Israel, this authority is vested in
578 VISA'S RESPONSE TO THE RESERVE BANK OF AUSTRALIA AND AUSTRALIA COMPETITION AND CONSUMER
COMMISSION JOINT STUDY, at 1 (Visa International Service association,2001): “Any moves to regulate interchange for
open card systems such as VISA would provide a significant competitive advantage for closed credit card networks
such as American Express.”; see also id. at 22-23 (“Comparison with 3-party credit card systems”);
Benjamin Klein et al., Competition in Two-Sided Markets: The Antitrust Economics of Payment Card Interchange Fees,
73 ANTITRUST L.J. 571, 610 (2006): “[I]f an open-loop payment card system's default interchange fees are reduced by
regulation, these systems are placed at a competitive disadvantage relative to closed-loop systems.";
Fumiko Hayashi, The Economics of Payment Card Fee Structure: Policy Considerations of Payment Card Rewards, at
13 (FRB of Kansas City Working Paper No. 08-08. 2008): "[R]egulating the four-party schemes interchange fees gives
a competitive advantage to the three-party scheme networks and card issuing financial institutions would likely switch
their card brands from the four-party to the three-party schemes.”;
Richard Schmalensee, Payment Systems and Interchange Fees, 50 J. JNDUS. ECON. 103, 119 (2002): "[A]ny serious
restriction on collective interchange fee determination would have one clear effect: it would make it harder for the bank
card systems to compete effectively with American Express and other proprietary payment systems". 579 CA 189/66 Aziz Sasson v. Kedma, 20(3) 477 (1966) ; HCJ 637/89 Huka LeIsrael v. Minister of Finance, 46(1) 191,
203 (1991). 580 Frankel, Towards a Competitive Card Payments Marketplace, supra note 539, at 57: “If three-party card networks
did begin to take over the market and cause harm to the public, as MasterCard and Visa warn (or if MasterCard or Visa
themselves attempt to transform their structures by integrating directly into acquiring like American Express), then one
possible remedy is to simply prohibit the monopolisation of their respective acquiring markets through such vertical
control”.
136
the hands of the Banks’ Supervisor, after consultation with the Antirust General Director.581
The Banks’ Supervisor has used this authority to declare Isracard as a major acquirer, thus
obligating Isracard to allow CAL and Leumicard to acquire its cards. Isracard was compelled
to open its closed network and receive interchange fee that is effectively the same as the
interchange fee in the open networks of Visa and MasterCard.582
323. The second option to deal with a high MSF of closed networks is to monitor the MSF.583 The
MSF is not a restrictive arrangement. It is determined in bilateral negotiation between the
merchant and the acquirer. Nevertheless the MSF is a banking fee and banking fees are
regulated by central banks.584 In my view it is enough (and better) to prohibit price
discrimination in the MSF than to regulate its level. Regulators rightly avoid price control, and
use it as last resort.585 Prohibiting price discrimination would tie the bargaining power of large
merchants (such as the state and the Israel Electric Company for example), which enables them
to get low MSF, to the MSF of marginal merchants. The outcome would probably be one low
MSF.586 My proposal is subject to general principles of price discrimination. If different MSFs
reflect different costs or different risks, due, for example to distinctive characteristics of
merchants, then the MSF might and should reflect these differences.
324. The third way to regulate the MSF of closed networks is by declaring closed networks with
market power as monopolies in acquiring their cards. Section 30 of the Antitrust Law authorizes
the General Director to give instructions to a monopolist that poses a risk of substantial harm
to competition or to the public, regarding the measures it must take to prevent such harm. Thus,
the General Director may give a monopolist closed network instructions to lower the MSF, as
it intended to do with Isracard.587
325. Even with no regulation of the MSF in closed networks, the mere fact that the interchange fee
in open networks is reduced due to regulation, puts downward pressure on the MSF in closed
581 Banking Law (Licensing) 1981, sec. 36(13). 582 For expansion, see ch. 8.1.2. 583 Julian Wright, Why Payment Card Fees are Biased Against Retailers, 43 RAND J. ECON. 761, 775 (2012):
[R]egulating interchange fees... only deals with the bias in fee structure arising from four-party payment networks,
leaving three-party networks that avoid interchange fees to continue to set high merchant fees and high rewards to
cardholders if doing so gives them a competitive advantage... An alternative approach of directly imposing caps on
each network’s average merchant fees would avoid this problem, as it would apply across the board regardless of
whether card networks make use of competing acquirers or deal with retailers directly”. 584 Amendment 12 to the Banking Law (Service to Customer), 1981. 585 IAA, Opinion 1/17 Considerations of the General Director in Enforcing Excessive Pricing, Antitrust 501194 (Feb.
28, 2017). 586 See ¶¶ 541, 308. 587 See ¶ 514.
137
networks, in a way that might restrain the ability of closed networks to charge higher MSF.588
In Israel and in Australia, interchange fee regulation that caused the MSF in open networks to
decrease, caused a parallel reduction in the MSF of closed networks. Closed networks likely
lowered their MSF out of fear that merchants would stop accepting them. Especially
multihoming cardholders place merchants in a position of credible threat to do that.
6.7. Cardholder Fees and Rewards
326. The direct effect of the interchange fee is on price structure. The effect of the interchange fee
on price level is indirect and depends on the pass-through rates, both from acquirers to
merchants and from issuers to cardholders.589 This chapter explores the literature regarding the
effects of the interchange fee on cardholder fees and rewards.
327. The bigger the interchange fee, the more merchants pay and the less cardholders pay. The
interchange fee is a main source for financing rewards, bestowed by issuers upon
cardholders.590 Rewards decrease cardholder fee and generous reward plans may even cause
cardholder fee to be negative.
328. Cardholder fee is usually a combination of a fixed amount for a set period and zero or even
small negative variable fee. Rewards can be given with respect to either part of the cardholder
fee. Rewards can be given as a full or partial discount of annual fee, especially in the first period
588 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 436, at 664: “In fact, American Express
acknowledges that low interchange fees put downward pressure on its own merchant fees”. 589 Prager et al., Interchange Fees and Payment Card Networks, supra note 500, at 49: “Regulation of interchange fees
is also problematic because the key issue is the overall structure of fees across parties to a transaction, not the
interchange fee itself.”;
Julian Wright, The Determinants of Optimal Interchange Fees in Payment Systems, 52 J. INDUS. ECON. 1, 8 (2004):
“When an interchange fee is used to try to optimize the size of the network, it can have at best only a limited effect…
the main effect of a single interchange fee will be to get the right structure of fees between consumers and merchants,
while the overall level of fees (card fee plus merchant fee) will be pinned down by competition between members of the
card association, and between different payment systems.”;
Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, ESMT Working Paper 10-005 , at 6 (Aug. 11, 2010)
(draft - these sentences were omitted from the final version): “The interchange fee affects only the allocation of the total
user price between consumers and merchants whereas the first-best efficiency requires also a lower total price level due
to positive externalities between the two sides.”; id. at 31: “[R]egulating the interchange fee corrects only the distortion
in the price structure, but this is not enough to achieve full efficiency in the payment card industry, since efficiency
requires each user fee be discounted by the positive externality of that user on the rest of the industry, and one tool
(interchange fee) is not enough to achieve efficient usage on both sides”. 590 United States v. Am. Express Co., 2015 U.S. Dist. Lexis 20114, at 39 (E.D.N.Y Feb. 19, 2015): “[R]ewards are
generally funded through the interchange fee paid by the merchant that is passed through to the issuing bank.”;
Fumiko Hayashi, The Economics of Payment Card Fee Structure: What is the Optimal Balance between Merchant Fee
and Payment Card Rewards?, (FRB of Kansas City Working Paper No. 08-06. 2008): "Typically rewards are most
financed by the issuer's interchange fee revenue.";
Douglas Akers et al., Overview of Recent Developments in the Credit Card Industry, 17 FDIC Banking REV. 23, 29
(2005): “Card issuers are funding these increasingly popular reward programs through interchange fees”; See also supra
notes 208, 534; Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 505, at 1332.
138
after the issuance of the card. Varying rewards are expressed in discounts, points, gifts or cash-
back in a certain percentage of a given transaction or of the volume of transactions for a
period.591
329. Rewards have a particularly important role when networks are in their infancy. Rewards
encourage adoption and usage among cardholders.592 However, historically, networks did not
establish themselves as a result of rewards. What drove cards' growth were their inherent
benefits to merchants and cardholders, such as security, convenience and expansion of liquidity
constraint.593 Only years later, networks decided to do something more in order to stimulate
usage among cardholders, and began to provide rewards.594
330. In 1984, Diners was the first network to offer rewards, including accumulating airline miles.595
Since then credit card rewards have flourished, as have debit card rewards though to a lesser
degree.596 Especially in the U.S., card schemes are characterized by generous reward plans.597
U.S. credit card rewards are on average 1 percent of total purchases. Rewards in debit cards
591 Andrew T. Ching & Fumiko Hayashi, Payment Card Rewards Programs and Consumer Payment Choice, 34 J.
BANK. FIN. 1773, 1774 (2010): “[V]arious types of rewards are offered: airline miles, cash-back, discounts, gifts, etc.”;
Oren Bar-Gill & Ryan Bubb, Credit Card Pricing: The Card Act and Beyond, 97 Cornell L. REV. 967, 969 (2012):
“[C]redit card contracts commonly lure consumers with low short-term prices (e.g., no annual fees and zero-percent
introductory or teaser rates) and then impose high long-term prices (e.g., default interest rates and penalty fees)”. See
also supra ¶ 27. 592 Fumiko Hayashi, Do U.S Consumers really Benefit from Payment Card Rewards? FRB KANSAS ECON. REV. 37
(2009); Santiago Carbo-Valverde & Jose Linares-Zegarra, How Effective are Rewards Programs in Promoting Payment
Card Usage? Empirical Evidence, supra note 306. 593 For expansion on cards' benefits see supra ch. 5.4.2. 594 Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 505, at 1346: “When credit
cards first became widely available a quarter century ago, they provided merchants a significant boon by enabling
greater spending by masses of credit-constrained consumers. Now, however, growth in credit card usage is fueled by
affluent, non-credit-constrained consumers, seeking rewards points and frequent flier miles, rather than by credit-
constrained consumers, seeking the benefits of paying later for goods and services received now.”;
Hayashi, Do U.S Consumers really Benefit from Payment Card Rewards?, supra note 592, at 38-40. 595 GAO-10-45, supra note 28, at 26. 596 Andrew T. Ching & Fumiko Hayashi, Payment Card Rewards Programs and Consumer Payment Choice, 34 J.
BANK. FIN. 1773, 1774 (2010): “In the United States, credit card rewards have more than 25 years of history, while
debit card rewards are relatively new. All top 10 credit card issuers (whose aggregate market share is more than 80%)
provide rewards, according to their websites; while about one-third of depository institutions provide debit card
rewards”.
597 United States v. Am. Express Co., 2015 U.S. Dist. Lexis 20114, at 130-31 (E.D.N.Y Feb. 19, 2015): “Cardholder
insistence is derived from a variety of sources. First, and perhaps most importantly, cardholders are incentivized to use
their Amex cards by the robust rewards programs offered by the network. Enrollees in American Express's Membership
Rewards program, for example, receive points for purchases made with their Amex cards, and may then redeem those
points with Amex or one of its redemption partners for merchandise, gift cards, frequent flyer miles, statement credits,
or other goods and services... Cardholders who value the ability to earn points, miles, or cash rebates often centralize
their spending on their Amex cards to maximize these benefits”.
See also an internet site that compares rewards on card schemes: http://www.moneysavingexpert.com/credit-
cards/cashback-credit-cards
139
were, until recently, 0.25 percent on average.598 However, the Durbin reform, which reduced
interchange fees in debit cards, trimmed rewards on debit card programs.599
331. Studies found that rewards have a significant positive effect on the use of the card that carries
them, as long as the reward program exists.600 Credit card rewards encourage usage not only on
account of other non-rewarding credit cards but also with respect to cash and debit.601
332. Merchants bear the costs of rewards that are funded by the interchange fee, as an integral (and
invisible) part of the interchange fee, which itself is an integral (and invisible) part of the MSF.
As with all other costs, the cost of rewards is passed through to final prices, depending on the
pass-through rate, which itself depends on the degree of competition in the relevant market in
which the merchant operates.
333. Studies have found that rewards have psychological effects. Rewards cause cardholders to
spend more. This finding integrates with the conclusion of other behavioral studies, according
598 Hayashi, Do U.S Consumers really Benefit from Payment Card Rewards?, supra note 592, at 39. 599 Benjamin Kay, Mark D. Manuszak & Cindy M. Vojtech, Bank Profitability and Debit Card Interchange Regulation:
Bank Responses to the Durbin Amendment, at 16 (2014): “Following the enactment of Reg II, many banks ended debit
card rewards programs”; Wells Fargo Ends Debit Rewards Program Entirely, (Aug. 22, 2011); Stavins, Potential
Effects of an Increase in Debit Card Fees, supra note 561. 600 Liyuan Wei, Consumer Choice of Credit Cards, Usage and Retention (2015): “Once the card is chosen, the effects of
annual fee waiving policies on cardholder behavior are twofold: they encourage more usage thus retain customer longer
and at the same time make them terminate the service relationship when the fee is not waived.” 601 Carlos Arango, Kim P. Huynh & Leonard Sabetti, Consumer Payment Choice: Merchant Card Acceptance Versus
Pricing Incentives, 55 J. BANK. FIN. 130, 131 (2015): “Having a reward feature raises the likelihood of paying with
credit cards by a range of 3.6–12.8 percentage points for transactions of $25 and above at the expense of both debit card
and cash payments. We find that the intensive margin of rewards is inelastic; a 10 percent increase in rewards raises the
likelihood of paying with a credit card between 1.8 and 2.7 percent, depending on the transaction value and the type of
reward plan.”; id. at 138: “In our scenario analysis of universal acceptance of cards, consumers shift towards credit
cards rather than debit cards even at low transaction values, which is driven by the extensive margin of rewards... Our
analysis shows instead, that the presence of credit card rewards leads to substitution not only away from debit cards but
also cash, to varying degrees across the transaction value spectrum.”; id. at 139: “[T]he effects of credit card rewards
plans induce substitution away from not only cash but debit cards”.
Jens Uhlenbrock, Pricing and Regulation in Multi-Sided Markets - Implications for Payment Card Networks and Smart
Metering, at 53 (2012): “[R]eward programs seem to play an influential role when consumers make a choice for a
specific payment instrument… card networks offer reward programs to change overall perception and usage pattern”;
Santiago Carbo-Valverde & Jose Linares-Zegarra M., How Effective are Rewards Programs in Promoting Payment
Card Usage? Empirical Evidence, 35 J. BANK. FIN. 3275, 3287 (2011): “[W]e show that rewards programs can also
significantly affect the choice for cards relative to cash”;
John Simon, Kylie Smith & Tim West, Price Incentives and Consumer Payment Behaviour, 34 J. BANK. FIN. 1759,
1768 (2010): “Our model shows a strong relationship between participation in a loyalty program and the probability of
credit card use. The results indicate that the probability of a credit card holder using a credit card to make a payment is
23 percentage points lower for a base case cardholder that does not participate in a loyalty program, than a cardholder
that does have a loyalty program. The effect is reasonably large given that the predicted probability of our base case
person using a credit card is 45%. In other words, there is a 45% chance that a credit card holder with a loyalty program
(who is female, is a transactor and does not have a scheme debit card), spending $51–$60 at a retail store will use a
credit card to make the payment. This falls to a 22% chance if the same cardholder does not have a loyalty program.”;
Ching & Hayashi, Payment Card Rewards, supra note 596, at 1779: “[C]redit card reward dummy remains statistically
significant for all types of retail stores and the signature-debit reward dummy remains significant for all retail types but
fast food restaurants”.
140
to which, cardholders tend to spend more when they purchase with cards than when they
purchase with cash.602 However, this effect vanishes on aggregate level. Rewards do not expand
the budget constraint.603
334. Rewards increase the pressure on merchants to accept cards, even if the MSF is higher than the
net benefits cards yield.604 Merchants are aware that the cardholder is eager to use the card, in
order to gain fee reduction, airline points or a discounted toaster. Thus, the merchant finds it
difficult refusing a reward card, even if it bears a high MSF.605
335. Rewards are often given with the cooperation of merchants. A merchant that contracts with a
payment card firm, for provision of rewards to customers who pay with cards of that firm, gets
a private benefit such as exposure and advertisement that may result in more sales. However,
rewards carry a trade-off for the merchant. Providing the reward makes the card bearing it to
be the most expensive payment instrument for the merchant. At least some of the customers
would have purchased the goods with no need for rewards.606 On the other hand, some of these
buyers would not have bought at this merchant at the outset if it were not for the rewards.607
336. Rewards can be efficient if they induce a shift from costly payment instruments to more
efficient payment instruments.608 Unfortunately this is not the situation. The main impact of
rewards was found to be an inner transition between non rewarding cards to rewarding cards,
especially at more affluent levels of society.609 Elimination of rewards would thus have no
602 Supra ¶ 155. 603 Supra ¶ 157. 604 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note 383,
at 560: “When the interchange fee exceeds the issuer cost, variable pricing rewards the cardholder for using the card;
the cardholder is then even more upset when a shop turns down the card, as she loses the reward on top of the
convenience benefit. This of course is more than a theoretical possibility. Many Visa and MasterCard banks as well as
proprietary cards have introduced inducements for customers to use their card: cash-back bonuses (Discover), discounts
on products sold by affiliates, travel insurance, frequent-flyer mileage, and so forth.”;
John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee, Payments
Sys. Research Conference 231, 234 (2005): “If the interchange fee is so high that competition among issuers leads to
users getting rewards for card usage (for example, air miles or cash back), the cardholder is then even more upset when
a shop turns down a card, as she loses the reward on top of the convenience benefit… This reinforces the key point that
individual retailers' willingness to accept cards is not a good measure of overall retailer (or social) benefit from card
acceptance. The sum of the willingness of each retailer to accept can greatly exceed the aggregate benefit to retailers or
to economic welfare generally". 605 For expansion, see the strategic considerations of merchants – (chapter 7.4 above). See also ¶ 203 for why cards are
"must take". 606 Simon, Smith & West, Price Incentives and Consumer Payment Behaviour, supra note 601; Sumit Agarwal et al.,
Regulating Consumer Financial Products: Evidence from Credit Cards, at 5, SSRN (Aug. 2014). 607 Supra ¶¶ 293-295. 608 Ching & Hayashi, Payment Card Rewards, supra note 596, at 1773: "[R]ewards can reduce total costs to the
economy by inducing consumers to switch from a more costly payment method, such as checks, to a less costly
payment method, such as credit and debit cards". 609 GAO-10-45, supra note 28, at 33: “[R]ewards cards generally have been offered to higher-income cardholders. Such
cardholders might spend more than the average cardholder generally. Thus higher total spending on rewards cards by
141
impact, or only a slight impact on aggregate card usage (but price level would be lower).610
More perversive, rewards often steer debit cardholders who intend to pay with cheap debit cards
to expensive credit cards.611 When this effect materializes, rewards strictly worsen social
welfare.612
337. Apparently, most cardholders enjoy inherent benefits from using cards, which are not connected
to rewards, such as ease of use, security, monitoring and registration of costs and
convenience.613 Thus, most cardholders would not give up their card usage if cards carried no
rewards. Empirical studies confirmed that cardholders have inherent benefit from payment
cards. They will not give up using cards even if rewards were abolished.614
individual cardholders or increased ticket sizes for such cards may reflect only that those cardholders spend more in
general, and not represent additional sales that a merchant otherwise would not have received. Similarly, higher total
spending on rewards cards compared with spending on nonrewards cards could reflect that rewards cardholders tend to
consolidate their spending on fewer cards—sometimes onto a single card—in order to maximize their ability to earn
rewards. As a result, such cardholders may not be spending more overall but just limiting their payment methods.”;
Arango et al., Consumer Payment Choice: Merchant Card Acceptance Versus Pricing Incentives, supra note 601, at
130: “Ching and Hayashi (2010), Simon et al. (2010) and Carbó-Valverde and Linares-Zegarra (2011) find that the
introduction of credit card rewards has only a small impact on the use of cash”. 610 Ching & Hayashi, Payment Card Rewards, supra note 596, at 1774: “The results from the policy experiments of
removing rewards suggest that the majority of consumers who currently receive rewards on credit and/or debit
cards would continue to use those payment methods even if rewards were no longer offered.”;
Humphrey, Retail Payments: New Contributions, Empirical Results, and Unanswered Questions, supra note 250, at
1732: “[C]redit card reward programs make consumers much more likely to use their card than if there are no rewards.
However, if rewards were reduced or eliminated the effect on credit card market share would seem to be small.";
Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, supra note 50, at 18: “[T]he higher purchase
volume on rewards cards may be merely a reflection of the greater purchasing power of rewards card consumers
relative to regular card consumers and may have little or nothing to do with the rewards themselves”. 611 Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 505, at 1347: “It appears,
however, that rather than inducing consumers to make more and larger purchases, rewards merely induce
consumers to shift their consumption from non-credit-card payment systems and nonrewards credit cards to
rewards cards. In other words, rewards induce consumers to shift from low-cost to high-cost payment systems.”;
Alberto Heimler, Payment Cards Pricing Patterns: The Role of Antitrust and Regulatory Authorities, at 2 (SSRN,
2010): “[C]ard holders are not aware of the costs associated with using them and do not choose between alternatives
considering their total cost. They simply consider their private benefit, for example, the reward they receive at the end
of the year for using a certain type of card. As a result, the highest-reward /highest-cost, not the lowest-cost payment
instrument is chosen. Consequently, free market competition may result in the high-cost payment system being
preferred to its low-cost rivals”; Ching & Hayashi, Payment Card Rewards, supra note 596. 612 Wang Zhu, Market Structure and Payment Card Pricing: What Drives the Interchange?, 28 INT'L J. INDUS. ORG. 86,
96 (2010): “At equilibrium, consumer rewards and total card transaction values increase with interchange fees, but
consumer surplus and merchant profits may not improve.”; see also supra note 543. 613 Supra ch. 5.4.2 (cards' benefits). 614 Arango et al., Consumer Payment Choice: Merchant Card Acceptance Versus Pricing Incentives, supra note 601, at
139: “Our results suggest that in mature card payment markets like Canada, card users are quite inelastic to variations in
incentives. This result suggests that reductions in rewards may broaden merchant acceptance of electronic
payments while having minimal impact on market outcomes.”; see also supra note 610;
Humphrey, Retail Payments: New Contributions, Empirical Results, and Unanswered Questions, supra note 250, at
1732: "[I]f rewards were reduced or eliminated the effect on credit card market share would seem to be small.";
Ching & Hayashi, Payment Card Rewards, supra note 596, at 1783: “Some consumers may have improved their
perceptions toward payment cards after joining a rewards program, which induces them to use payment cards more
frequently. However, once they learned the cards’ features, their perception about payment cards, such as how fast the
card transactions are, whether the payment cards are easy to use, and whether the payment cards keep money and
accounts safe, would likely remain unchanged even if consumers no longer receive rewards".
142
338. Rewards lure present consumption on account of future debt. A study by Agarwal et al. found
that rewards increase the expense in the card that carries the rewards, by an average of $68, and
increase debt in that card by average of $115. Total spending and debt of those people did not
change. Thus, cardholders shift expenses to rewarding cards with no aggregate effect. They
conclude that rewards are a primary tool in competition between issuers, and not a tool to
increase usage in more efficient payment instruments.615
339. Baxter's original argument was that interchange fees should be transferred from one side to
finance uncovered costs of the other side. Today, interchange fee proceeds exceed uncovered
costs. When the interchange fee proceeds are used to finance rewards, the "covering costs"
argument falls.616
However, if cards yield positive benefit to merchants compared to other payment instruments,
then merchants would rather pay an MSF above costs and up to their benefit (Pm=Bm), in order
to steer customers to pay with card and not with another, more expensive, payment instrument.
Whenever the net benefit of the merchant from cards (Bm) is bigger than the total costs of the
transaction (Ci+Ca), then it is profitable for the merchant to pay an MSF up to Bm. In fact, even
if the merchant is paying all costs and an additional sum as rewards (the difference between its
benefit to costs, i.e., Bm-Ci-Ca), it is still profitable for the merchant to do so, as long as rewards
cause the receiving cardholder to shift and pay with the efficient payment instrument that saves
the merchant Bm.
340. Indeed, Rochet & Tirole,617 and other scholars after them,618 concluded that if the benefit of the
merchant is bigger than transaction costs, than optimal cardholder fee should be negative
(rewards), in an amount of the difference represented by (Pc=Ci+Ca-Bm),619 as stated in
615 Agarwal et al., Regulating Consumer Financial Products, supra note 606, at 18. 616 Avril McKean Dieser, Antitrust Implications of the Credit Card Interchange Fee and an International Survey, 17
LOY. CONSUMER L. REV. 451, 492 (2005): “If indeed Visa and MasterCard based their interchange fees on costs,
issuing banks could not likely afford to offer substantial rebates, frequent flyer miles, or attractive financing”. 617 Supra ¶ 214. 618 Wilko Bolt & Heiko Schmiedel, SEPA, Efficiency, and Payment Card Competition, at 20 (DNB Working Paper
239/2009); Fumiko Hayashi, The Economics of Payment Card Fee Structure: What is the Optimal Balance between
Merchant Fee and Payment Card Rewards?, at 12 (FRB of Kansas City Working Paper No. 08-06. 2008); Hayashi, Do
U.S Consumers really Benefit from Payment Card Rewards?, supra note 592, at 49: “When the Payment Service
providers' net joint cost is less than the merchant's transaction benefit, the most efficient cardholder fee is negative – in
other words, a reward”. 619 Fumiko Hayashi, The Economics of Payment Card Fee Structure: What is the Optimal Balance between Merchant
Fee and Payment Card Rewards?, at 21-22 (FRB of Kansas City Working Paper No. 08-06. 2008): “[I]n most cases the
most efficient cardholder fee is the difference between the card network’s costs of processing a card transaction and the
merchant transactional benefit from a card transaction. Therefore, in most cases, providing rewards to card-using
consumers is the most efficient only when the merchant transactional benefit from a card transaction exceeds the card
network’s costs”.
143
Equation 4 above.620 When this difference is positive (Ci+Ca-Bm>0), cardholder fees should
be positive, to cover a real "issuers' deficit". Hayashi claims, based on cost surveys, that the
benefit to merchants from payment cards does not exceed the costs. Therefore cardholder fees
should be positive, and merchants should not fund rewards.621
341. Let us turn back to the situation where the benefit of merchants is large enough to cover costs
and rewards (Bm>Ci+Ca). This can be the case if, for example, due to technological
improvements and scale economies, the cost of cards declines, and the benefit to merchants
from cards relative to other payment instruments is very high.622 For example assume that the
total costs of the transaction are 2 (Ci+Ca=2) and Bm=10. According to Rochet & Tirole and
others, the optimal cardholder fees should be negative, i.e. cardholders should receive (huge)
rewards. I will now illustrate, and with all due respect to those researchers, criticize this
position.
342. If the cardholder not only do not pay any cardholder fee, but in addition receives a reward of 6
(Pc=Ci+Ca-Bm=2+2-10=-6), the result, apart from a negative cardholder fee of -6, would be
an increase of 10 in the final prices of goods.623
Models that predict such result (that Pc should be Ci+Ca-Bm) ignore that most cardholders do
have positive benefit from cards, and therefore do not need rewards to encourage them to use
cards. Networks actually know this, and consequently extract positive cardholder fees from
most cardholders. In this situation the rewards paid by merchants are: (1) double extraction of
the cardholders’ surplus after it was already extracted from them in the form of cardholder
620 Supra ¶ 214. 621 Ching & Hayashi, supra note 596, at 1785: “[P]olicy implications of our results are rather straightforward for the
policy of disallowing card issuers to offer rewards.”;
Fumiko Hayashi, The Economics of Payment Cards Fee Structure: What Drives Payment Card Rewards?, (FRB Of
Kansas City Working paper 08-07. 2009): “Available empirical evidence suggests that in the United States the
merchant’s transactional benefit from a card transaction may not exceed the card network’s cost. This implies providing
rewards would unlikely be the most efficient.”; id. at 8: “[U]nless the merchant transactional benefit from a card
exceeds the card network’s costs of processing a card transaction, providing payment card rewards to consumers is less
efficient.”;
Hayashi, The Economics of Payment Card Fee Structure: Policy Considerations of Payment Card Rewards, supra note
578, at 8. 622 Supra ¶ 125. 623 Edelman & Wright, Price Coherence and Excessive Intermediation, supra note 476, at 31 (2014): “Indeed, many
readers of this paper probably enjoy credit card rebates and other benefits resulting from price coherence. Of course
consumers ultimately do pay the associated costs: In equilibrium, prices increase to cover sellers' costs of offering ‘free’
benefits.”;
Ching & Hayashi, Payment Card Rewards, supra note 596, at 1773: “[R]ewards may lead to higher card transaction
fees to merchants, which may cause higher prices for their goods and services. As a result, consumers, especially those
who do not use rewards cards, could be hurt by the higher retail prices.”; See also infra ch. 10.1 (the concern of price
increase due to high interchange fee).
144
fees;624 and (2) not required to steer cardholders, because most cardholders (except the
marginal) will pay with cards anyway.
Even in the unlikely event that the pass-through rate is full, then the high MSF merchants pay
causes final price of goods to increase, especially for those who do not enjoy card rewards. If
pass through is not full, then my criticism is even stronger. Merchants effectively fund issuers’
profit which is extracted from merchants under the pretext of rewards to cardholders. Indeed,
Schwartz and Vincent argue that rewards are a tool in the hands of networks to extract more
profit from the NSR.625
343. The distortion is even graver, as rewards are given to all cardholders, not only to the marginal
cardholders. Assuming cardholders do not pay per-transaction fees, and most of them derive
positive benefits from card usage, then most cardholders would pay with a card anyway.
Rewards for them are redundant.
Marginal cardholders who strictly prefer cash (or any payment instrument other than card),
might not suffice with the reward offered. We can formalize these anti-card customers as "cash
lovers", whose preference for the other payment instrument is bigger than the offered reward.626
Those cardholders would continue to pay with another payment instrument despite the reward.
Note that it is efficient that these cardholders will not be steered to pay with a payment card,
when their benefit from paying with a card is highly negative. (Formally, when Bc<Ci+Ca-Bm,
equation 2 in para 212 above does not hold).
In addition, every time merchants pay MSF=Bm (and even more, if the merchants weigh
strategic considerations), the attempt to steer is futile for "card lovers" who derive inherent
benefit from cards. Those cardholders would have used their card anyway. Thus, for both "card
lovers" and "cash lovers" (whose anti-card preference is bigger than the reward), rewards are
redundant.
Only cardholders with relatively small (but negative) benefit from cards, who intended to pay
with another payment instruments, but were steered to cards because of the rewards, are "true"
targets for rewards (if a cardholder has even slight positive card benefit, she/he pays by card
624 Supra ¶¶ 507,681, 203, 206. 625Id. at 81: “[R]ebates can be a pricing tactic designed to better exploit the power of the NSR”. 626 Supra ¶¶ 148, 237.
145
even with no rewards at all). This group of "small anti-card payers" is the only group which
might switch to cards because of the rewards. But if the number of consumers in this group is
small, then the price of steering them is way too high. The costs of steering are higher MSF for
all transactions, which inevitably cause higher prices of goods. It is more efficient to lower the
MSF, so it will not include rewards, and to let those customers pay with other payment
instruments.627
344. Under the assumption that most cardholders have positive benefit from cards (Bc>0), they
would use cards anyway. Those who have a strong preference for cash would not use cards
anyway (despite the rewards). Therefore rewards are an ineffective tool that costs too much and
drives up the prices of goods, with a very small redeeming value compared to the harm they
cause.
345. The aggregate effect of rewards is dependent on the number of cardholders in each group.
Without formalization we can say that the general effect of rewards on each group involved are:
346. "Heavy" card users – may derive private benefit from rewards but together as a group, they
also suffer from price increase, more than they benefit from rewards. Rewards offset the rise in
prices, which in itself is a result of the high interchange fee that funds the rewards. However,
unless pass through is full on the issuing side, the offset in rewards is not full, and rewards are
smaller than the "tax" they impose on merchants. In practice the pass-through rate of
interchange fees to rewards has been found to be less than half.628
It is indeed possible that in a certain month, a specific cardholder enjoys rewards that offset the
price increase for her. Individual cardholders enjoy 100% of any reward they receive, whereas
the rise in final prices is spread across the entire market. However, in the aggregate, rewards do
not compensate for the price increase they cause.629
All other parties strictly suffer from rewards:
347. For customers who do not enjoy rewards (or do not use cards), rewards raise the MSF and
as a result raise the final prices of goods, without any redeeming value. Cardholders, at least,
receive some redeeming value, even partial, in the form of rewards. This argument has a social
627 For a numerical example, see infra ¶ 477. 628 Supra note 208, and infra note 590. 629 Fumiko Hayashi, Do U.S Consumers really Benefit from Payment Card Rewards? FRB KANSAS ECON. REV. 37, 55
(2009).
146
touch, because most often customers who do not enjoy rewards belong to the weak class of
population.630
348. Marginal cardholders that were steered to pay by card only because of the rewards, and
otherwise would have paid with another payment instrument, would prefer that instead of
rewards, prices would be a little lower. These marginal cardholders can be seen as those who
have cash in their wallet, and intended to pay with cash anyway (a lower price), if not for the
rewards. This is why their benefit from cards is, by definition, marginal.
349. Merchants bear the costs of rewards that issuers bestow upon cardholders. Rewards exacerbate
the strategic considerations exerted on them. Rewards cause the interchange fee and the MSF
to rise. Merchants have no other choice but to pay the higher MSF, even (a) when it exceeds its
net benefit from cards; (b) when it finances rewards given to cardholders who would have paid
the merchant with card anyway; and (c) when rewards are offered in a futile attempt to steer
cardholders who pay with other payment instruments.
Merchants have no control over the pass-through rate. The merchant is not aware what part of
the high MSF issuers keep as profit. The merchant would have preferred that the MSF would
be lower, and the reward would be given directly to the customer (direct steering). Thus, instead
of recognizing to merchants the efficiency of cards, rewards turn merchants against cards.
350. Another distortion caused by rewards is that they cause the absurd result that merchants finance
their rivals. Take, for instance, the following example: Isracard gives its customers a reward –
a free meal at McDonald’s. The reward is inevitably funded by all merchants that accept
Isracard, including the competitors of McDonald's. Thus when Burger Ranch accepts cards
issued by Isracard, Burger Ranch pays for rewards offered at McDonald's. In the U.S. the
authorities recognized this absurdity, and determined that rewards that are funded by
interchange fee cause a subsidy of selected merchants by all other merchants, including their
competitors.631 Indeed, rewards are not to be included as eligible costs in the calculation of the
interchange fee both in Israel and in the U.S., but unfortunately, in practice, rewards do exist.
Interchange fee that is transferred to the issuing side, inevitably supports rewards.
630 Infra ch. 10.2 (cross subsidy effect of interchange fees). 631 Final Rule on Debit Card Interchange Fees, supra note 1155, at 128: “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)”.
147
351. In my view, rewards funded by the interchange fee, should be prohibited:
First, payment card networks reached maturity, and they do not need incentives. As explained
above, rewards are reflected in internal shifting between cards (sometimes from more efficient
payment instruments to more expensive reward cards), but the aggregate size of networks would
not be influenced from elimination of rewards.
352. Second, attempts to steer marginal customers to pay with cards, are socially too expensive.
Moreover, the social perversive results, in which affluent customers are funded by the weak,
should not be a product of rewards.
353. Third, apart from a small group of cardholders, most people would either use cards anyway or
not use them at all. It is preferable to waive attempts to steer them to cards through rewards.
354. Fourth, rewards are actually a sort of "bribe" given to cardholders for using their cards.632
Rewards are "prize" for shopping. They create cross subsidy for the rich (who consume a lot,
and thus earn many rewards) by the poor (who consume less, and are entitled to few rewards).633
Cards are first and foremost a means of payment. Just as the state does not give rewards to cash
users, payment card networks should not reward excessive consumption with cards.
355. Fifth, cardholders are more sensitive to their fixed cardholder fees, which cost them out of
pocket money, than to elimination of points, discounts, cash-back, presents and other kinds of
rewards, which do not cost them directly.634 If the interchange fee decreases, then issuers will
first tend to cancel wasteful rewards. An increase in cardholder fees is a step that is much more
prone to irritate cardholders. As long as their costs are covered, issuers, especially in
competition, would probably not raise cardholder fees.635 However, as the European
632 Joseph Farrell, Efficiency and Competition between Payment Instruments, 5 REV. NETWORK ECON. 26 (2006);
Frankel, Towards a Competitive Card Payments Marketplace, supra note 539, at 30: “The rebates and rewards funded
by interchange fees and offered to card users act like a systematic form of commercial bribery”. 633 Adam J. Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, at 68, SSRN (2008), available at
http://ssrn.com/paper=973970: “Ending rewards programs would end a highly regressive cross-subsidy among
consumers and an unfair externality imposed on merchants.”;
Simon, Smith & West, Price Incentives and Consumer Payment Behaviour, supra note 601, at 1766: [H]igher income
consumers may be more likely to hold a credit card with a loyalty program”;
Robert J. Shapiro & Jiwon Vellucci, The Costs of “Charging it” in America: Assessing the Economic Impact of
Interchange Fees for Credit Card and Debit Card Transactions, at 11 (2010): “[T]he interchange fee system creates
cross-subsidies in which consumers who don’t use credit cards or who cannot qualify for high-reward cards pay higher
prices to support not only the banks issuing the cards but also the rewards offered to other consumers”. For further
expansion see infra ch.10.2. 634 Infra ch. 11.5. 635 See infra ¶¶ 659 & 462- 468.
148
Commission stated, theoretical threat of increase in cardholder fee, should not thwart lowering
the interchange fee and prices of goods:
Even if cardholder fees increase – which is not a given…consumers are still
likely to benefit from lower interchange fees through lower retail prices, even
if retailers do not pass through 100% of the savings, and from new entry in
the payment market.636
356. Sixth, merchants that want to offer rewards to those who pay with preferable payment
instruments can do this directly, by negative surcharge (discounts) to those who pay with
preferred payment instruments. Inducing shopping by rewards can be done in ways other than
the payment instrument. Indeed, recent years have seen flourish of rewards that are not
connected to payment instruments, such as Groupon and its followers.
357. Seventh, the pretext of rewards is to induce adoption and usage of allegedly efficient payment
instruments. This pretext does not provide a basis for enriching issuers. In chapter 14, I expand
on my proposal with respect to this idea.
6.8. Debit v. Credit
358. Most of the discussion until now has been focused on the payment function of payment cards.
Some payment cards also fulfill another function – the provision of credit to cardholders for
purchases of goods. This function exists in credit and deferred debit cards, where payment is
deferred.637 Debit and prepaid cards are payment instruments only.
359. Credit cards provide additional benefits for merchants and cardholders, beyond being just a
payment instrument: (a) Credit enables merchants to make present sales that would not have
been done without credit, because of liquidity constraints of the cardholder; (b) Credit enables
merchants to make present sales that otherwise might not have occurred in the future in their
stores.638 (c) Credit card enables consumption prior to income; (d) Credit enables cardholders
not only to precede consumption but also to expand consumption, by using future money they
636 EU, Proposal for a Regulation on Interchange Fees, supra note 1042, at 12; David Balto, The Problem of
Interchange Fees: Costs without Benefits?, E.C.L.R 215, 223 (2000). 637 Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, supra note 527, at 2: “Credit cards
allow consumers to access lines of credit at their banks when making payments and can be thought of as “pay later”
cards because consumers pay the balance at a future date”. 638 Sujit Chakravorti & Ted To, A Theory of Credit Cards, 25 INT'L J. INDUS. ORG. 583, 584 (2007): “Merchants also
benefit from accepting credit cards. Merchants benefit from sales to illiquid consumers who would otherwise not be
able to make purchases”.
149
do not yet have at the date of acquisition;639 and (e) Credit increases the turnover of merchants
in the present at the expense of future sales at other merchants or even at the same merchant.
360. The benefits of merchants from credit are not reflected in aggregate increase in turnover over
time. The inter-temporal budget constraint of cardholders does not expand because they use
credit and not debit. On the contrary, the budget constraint for material goods decreases due to
pledging part of the future income for repayment of credit debt.640
361. Merchants are heterogeneous in the benefit they derive from making credit sales. The benefit
depends on the present preferences of merchants (i.e., the discount factor) and the intensity of
the strategic considerations of drawing customers away from competing merchants (as well as
from the merchant's own future sales).
362. Merchants who accept credit cards, and thus enjoy the benefit of expanding sales to illiquid
customers, find that this benefit does not come for free. Credit cards are more expensive
payment instrument than debit cards.641 The real costs of the transaction are larger. Especially
the risk of default, which is part of the payment guarantee, is larger. The longer the credit period,
the higher is the cost of the payment guarantee.642 This risk is usually reflected in a higher
interchange fee in credit cards.
363. When merchants charge one price for goods irrespective of the payment instrument used, then
cardholders who pay with debit subsidize the higher credit costs incurred by those who pay
with credit cards.643
In Israel, the Antitrust Tribunal specifically ordered in the Methodology Decision that
transactions, whose payment guarantee is significantly different, shall bear different
interchange fees.644 The payment card firms did not enact such fee differences, and continued
639 Ian Lee et al., Credit Where It’s due: How Payment Cards Benefit Canadian Merchants and Consumers, and how
Regulation can Harm Them, at 2 (Geo. Mason U. L. Econ. Res. Paper Series 13-58, Oct. 2013): “Debit cards offer
security, convenience, and a ready access to funds that benefits consumers and merchants alike. Credit cards provide all
these benefits and more, enabling consumers to spend money they don’t currently have in their bank accounts”. 640 Supra ¶ 159. 641 Supra ¶ 125. 642 Bolt & Schmiedel, SEPA, Efficiency, and Payment Card Competition , supra note 618, at 11. 643 Supra ¶ 270. See also Harry Leinonen, Debit Card Interchange Fees Generally Lead to Cash-Promoting Cross-
Subsidisation, at 32 BANK OF FINLAND RESEARCH DISCUSSION PAPERS (2011): “In a non-surcharging setup, debit cards
always cross-subsidise credit cards with delayed debit, because the payment function and payment costs are identical,
so some of the credit costs will be transferred to debit card users”. 644 AT 4630/01 Leumi v. General Director, para. 53 (Aug. 31, 2006) ("The Methodology Decision").
150
(until April 2016) to charge the same interchange fee for debit transactions.645 A class action is
pending on this issue (see ¶529).
364. Early scholars, who modeled payment cards, ignored the implications of the credit function on
the interchange fee. Their models related to interchange fees in all payment cards without
distinction. The interchange fee was assumed to be uniform for all payment cards. Later
scholars investigated both empirically and theoretically the inherent credit function that exists
only in credit cards and deferred debit transactions.646
365. Chakravorti and Emmons were the first to model the inherent credit function of credit cards,
without referring explicitly to interchange fees.647 In their model, credit cards are more
expensive than debit cards, but if the cardholder has a strong present value preference, then
cardholders with liquidity constraints, are willing to pay the extra cost involved in credit cards.
Credit card networks lure customers through initially low (even negative) fixed cardholder fees,
and earn profits by interest on the credit they provide to cardholders who wish to consume with
credit. Merchants also finance the expensive cost of credit cards in the MSF they pay.
In their model, merchants can surcharge to prevent cross-subsidization. When merchants
surcharge, only customers with liquidity constraints will use credit, and finance the higher costs
of credit card networks. Those who need cards just as a payment instrument (transactors) will
use cheaper payment instruments. If NSR applies, merchants that accept credit raise their
uniform prices. Customers that are liquid and do not need credit, are not shopping at those
expensive merchants, unless they are subsidized by rewards. This model distinguishes between
setup in which there are rewards and setup with no rewards. If there are no rewards, merchants
that accept credit cards attract only cardholders with liquidity constraint that are willing to pay
the higher prices of credit. If rewards exist, they are given both to liquidity constrained
cardholders, as well as to transactors that do not need them. Rewards make merchants who
accept credit cards, serve both transactors and creditors.
645 Supra ¶ 553. 646 Sujit Chakravorti & William R. Emmons, Who Pays for Credit Cards? 37 J. CONSUMER AFF. 208 (2003); Wilko
Bolt & Sujit Chakravorti, Consumer Choice and Merchant Acceptance of Payment Media (FRB of Chicago Working
Paper No. 2008-11. 2008); Chakravorti & To, A Theory of Credit Cards, supra note 638; Jean-Charles Rochet & Julian
Wright, Credit Card Interchange Fees, 34 J. BANK. FIN. 1788 (2010); Bolt & Schmiedel, SEPA, Efficiency, and
Payment Card Competition , supra note 618. 647 Chakravorti & Emmons, ibid.
151
366. Another model is of Chakravorti and To.648 They opine that if merchants have sufficiently high
margins from the goods they sell with respect to the MSF, then, as more cardholders with
liquidity constraints exist, the MSF that merchants are willing to pay increases. Merchants want
customers to purchase in the present, because a customer that purchases a non-consumable asset
will not acquire this asset again in the next period. A major development of their model points
to an intertemporal prisoner's dilemma:
367. From the perspective of merchants, greater dispersion of credit cards increases strategic
considerations. Merchants that do not accept credit cards are "punished", not only by customers
that abandon them in favor of other merchants, but also by current customers who will not come
back in future periods. In this respect, credit cards allow not only a business to draw customers
away from other merchants, but also drawing purchases from the next period to the present.649
368. Strategic considerations place each merchant in a prisoner's dilemma. If no other merchant
would accept credit cards, merchants on the whole will pay less and be better off. However, no
single merchant can afford to refuse cards, for fear of jeopardizing its income, if its competitors
will behave differently and accept credit cards. The greater the present value of sales to the
merchant, the greater is its dilemma. The result is that merchants end up accepting credit cards.
Their aggregate profit is lower than if they all would have refused credit cards. Issuers extract
a greater proportion of merchants’ surplus through higher MSF.650
369. Bolt and Chakravorti construct a model including cash, debit and credit. Merchants who accept
cards benefit from greater sales compared to a cash-only economy.651 They consider the case
when issuers can issue credit, debit or both. They assume that consumers participate in credit
card networks to insure themselves against inter alia, liquidity constraints. The network
determines the rate of the cardholder fees at the maximum price cardholders are willing to pay.
Merchants trade off increased sales when accepting cards, against higher fees. The MSF in
credit cards is always higher than the MSF in debit. They conclude that when the costs of credit
648 Chakravorti & To, A Theory of Credit Cards, supra note 638. 649Id. at 592: “[T]he acceptance of credit cards allows individual merchants to capture sales which might otherwise be
made by another merchant in the second period. Business stealing in our model occurs across industries and across
time”. 650Id. at 591-92: “This effect comes about because merchants face an externality much like that in the Prisoner's
Dilemma. As a group, merchants realize group acceptance of credit cards reduces second period profits… merchants
accept credit cards despite the fact that they are made worse off. One can also think of this externality as an
intertemporal business stealing effect”. 651 Bolt & Chakravorti, Consumer Choice and Merchant Acceptance of Payment Media, supra note 646.
152
cards are relatively low, issuers refrain from supplying debit cards and offer only credit cards.652
This conclusion is consistent with the situation in Israel, where the payment card firms offer
almost no debit cards. In their mode merchants prefer to surcharge, because by surcharging,
merchants can steer consumers to the low-cost payment instrument, i.e., debit (there are no
rewards in their model).653 The profit of the card network is bigger under NSR because when
merchants surcharge, consumers pay with debit which is less profitable, unless the consumers
are liquidity-constrained.654
370. Another model of Bolt et al. considers competition between debit and credit.655 The authors
assume that merchants accept either debit or credit, but not both. In equilibrium, only merchants
with high profit margins accept credit cards, since credit cards are more expensive.656 Debit
cards are linked to bank accounts, whereas credit cards have a prearranged grace period,
followed by an interest-carrying credit line on unpaid balances.657 They find that merchants tend
to accept more debit when default risk increases, despite an increase in the MSF of debit
(because the corresponding MSF of credit increases even more sharply), causing some
merchants to switch from credit to debit.658 In addition, if the interest rate is high, banks (which
are debit issuers) enjoy when their customers use credit cards. Banks benefit from the ‘free
funding’ period offered to credit cardholders, as the bank can earn interest on the balance that
remains in their account during this period.659
371. Rochet & Wright were the first to provide a model that relates specifically to the interchange
fees in credit cards.660 Models before them that examined the credit function of payment cards,
related to the MSF and not to the interchange fee. Rochet & Wright referred to the inherent
credit function in credit cards, as a cheaper and more efficient substitute to store credit. In their
model, credit cards are used for two types of transactions. The first type is convenient
652Id. at 2: “For relatively low credit card costs, the bank would refrain from supplying debit cards and only offer credit
card services”. 653Id. at 25. 654Id. at 26: “[C]onsumers pay a lower price when using their debit cards (pdc < pcc), they will use credit cards only
when they have not yet received their income”. 655 Bolt, Foote & Schmiedel, Consumer Credit and Payment Cards, (ECB Working Paper 1387, 2011). 656Id. at 32: “We assume that merchants singlehome; if they accept a card at all, it is either a debit or a credit card. In
equilibrium, only merchants with high profit margins accept credit cards, since these are more costly”. 657Id. at 12-13. 658Id. at 8: “[W]e find that debit merchant acceptance actually increases with the probability of default, despite an
increase in the merchant fee. This is because the credit card merchant fee responds more to the higher default risk,
causing some merchants to switch from credit cards to debit cards”. 659 Id. at 41-42: "The bank providing the debit card and current account actually benefits from consumers using credit
cards, if they have positive initial income. In effect the bank benefits from the ‘free credit’ period offered to the
consumer by the credit card network, as the bank can earn interest on the balance that remains in the current account
during this period”. 660 Rochet & Wright, Credit Card Interchange Fees, supra note 646.
153
transactions. Those are transactions performed by customers who use credit cards instead of
cash or debit cards ("Transactors"). The second type is credit transactions. In these transactions
the customer is illiquid, so if not for the credit function, the transaction would not be executed,
unless the merchant provided store credit of its own.
Store credit is more expensive, meaning that merchants can supply store credit themselves, but
at a higher cost than the cost of credit for credit cards schemes. Credit has no effect on aggregate
consumption.661 The use of credit may be required for big or impulsive purchases, or when the
credit function facilitates the execution of the transaction.662
372. In the model of Rochet and Wright, credit cards are a more expensive payment instrument than
debit cards. For that reason credit cards are less efficient for "ordinary" transactions.663
However, because credit card fees are higher, credit networks that maximize profit provide
rewards to entice cardholders to use credit cards. The result is that transactors (convenience
cardholders who do not need the credit function), use credit cards for ordinary purchases, even
though it is more efficient to use debit in these transactions. Credit networks set high
interchange fees, to fund rewards that fuel this excess usage. The more such cardholders there
are, who do not need the credit function but still use credit cards for ordinary transactions, the
worse is the effect of the (too-high) interchange fee on final prices.
On the other hand, the alternative to credit cards in the model is store credit. Store credit is even
less efficient, riskier and more expensive for the merchant than credit cards. High interchange
fees induce credit usage, by cardholders who do not internalize the high cost of credit cards to
merchants, but at the same time high interchange fees enable merchants to avoid store credit.
Customers who need the credit function, indeed use credit cards and not store credit. However,
this comes with a price. Transactors who do not need credit cards are lured to use them also.664
661 Id. at 1789: “The existence of store credit in our framework means credit cards will not have any effect on aggregate
consumption”. 662 Id. at 1788-89: “Credit purchases could capture a range of different types of purchases (such as unplanned purchases,
impulse purchases and large purchases) for which the consumer does not have the cash or funds immediately available
to complete the purchase or for purchases for which the deferment of payment facilitates the transaction. Thus, offering
credit allows an individual merchants to make sales that they otherwise would not make”. 663 Id. at 1789: “For ordinary purchases, we assume credit cards are inefficient compared to pure payment technologies
given we assume there are additional costs of transacting with credit cards”. 664 Ibid: “Since consumers do not internalize retailers’ cost savings from avoiding direct provision of credit and since
merchants cannot distinguish the type of consumer they face, there is also a case for setting a relatively high interchange
fee so that consumers who wish to rely on credit are induced to use credit cards when it is efficient for them to do so.
154
373. According to Rochet & Wright, in order to maximize consumer surplus (including cash buyers),
the required interchange fee must encourage credit card usage, at the price of over usage for
ordinary purchases. Rochet & Wright recognize that without regulation, interchange fee which
is determined by the network would be too high. They claim that capping privately determined
interchange fee will decrease it, and increase consumer surplus.665 They offer caps for the
interchange fee which brings it to a more efficient level than a privately determined interchange
fee. The lower bound is a cost-based interchange fee. The upper bound is an interchange fee
that passes a "mutatis mutandis" tourist test, i.e., an interchange fee that would cause the
merchant to be indifferent between accepting a card or providing store credit.666
Rochet & Wright claim that the higher benefits merchants derive from credit cards, justify the
adverse effect (customers using credit even when they do not need it).667 They also claim that
extraction of surplus from merchants, in order to induce more credit card usage, and to save
merchants from the need to provide inefficient store credit, is inevitable.
374. The stance of Rochet & Wright is that interchange fees should be higher than cost-based. This
is because the fee must be high enough to fund rewards that in turn, will increase card usage
and prevent store credit. They acknowledge that some customers do not need rewards, but as
merchants cannot distinguish them, there is no choice but to reward all cardholders. Given the
high benefits to merchants from cards, they opine that the outcome is still beneficial. The
alternative to store credit is inferior, and would decrease social welfare. They maintain that a
degree of overuse of credit cards is inevitable.668
In my opinion, if store credit is inferior to credit cards, the interchange fee does not have to be
high in order to persuade consumers to shift credit purchases to credit cards and not store credit.
The inherent benefits of cards and their superiority over store credit, are recognized by
cardholders without any need for interchange fee. Merchants can also easily and directly steer
credit consumers to cards, without resorting to high interchange fee for that.
For this reason, to maximize consumer surplus (including the surplus of cash customers) may require setting an
interchange fee which induces excessive usage of credit cards for ordinary purchases”. 665 Id. at 1793: “[L]owering interchange fees from the private maximum to at unambiguously raises consumer surplus”. 666 Id. at 1789: “[T]he cap should either be based on the issuers’ costs (to avoid excessive usage of cards for ordinary
purchases) or on merchants’ net avoided costs from not having to provide credit directly” 667 Id. 668 Id. at 1796: “Some excessive use of credit cards may be unavoidable given merchants cannot easily observe if credit
is needed or not by their customers”.
155
375. Other scholars also opine that merchants recognize the benefits of credit cards to customers
with liquidity constraints, and are willing to pay a higher price for them. Merchants indeed pay
more, but they also gain more.669 Credit might have benefits for some cardholders and
merchants that outweigh the extra costs.
376. I shall use the example of Evans & Schmalensee for my modest criticism. Competitive prices
are based on costs, whereas prices that reflect market power are based on demand. In my
opinion, in a competitive market, when better products, e.g. cars with automatic transmissions,
displace inferior products, the price of the former will still be based on the marginal cost of
production, and not on demand. “Better product” is not a magic word to move from the realm
of competition to the realm of market power, and extract all of the consumer surplus, let alone
in a restrictive arrangement. In addition, (poor) customers who prefer cheap manual
transmission cars should be able to purchase one without having to subsidize (rich) buyers of
automatic cars.
377. Further, in competitive markets, a more beneficial product will cost more than an inferior
product only if it is costlier to produce. Many new products replaced inferior products because
they were both more beneficial and cheaper. However, even if a better product costs more to
produce than an inferior product, in a competitive market the price difference should reflect the
difference in costs of production, and not the difference in the benefits they yield. The fact that
merchants derive benefits from credit cards is not a reason to extract that entire benefit from
them, and certainly not through a cartel that causes final prices to rise.
6.9. Determination of the Optimal Interchange Fee
378. One of the main goals of models that formalize the interchange fee is to determine what that
optimal interchange fee is. The optimal interchange fee should, in theory maximize the welfare
of all relevant participants.
Participants in card payments include in the demand side both cardholders and merchants. The
supply side includes issuers, acquirers and the network. Those are the direct participants, but
669 Julian Wright, Why do Merchants Accept Payment Cards? 9 REV. NETWORK ECON. 1, 2 (2010): "[P]ayment cards
such as credit cards increase consumers’ willingness to pay. As a result, merchants that accept payment cards also sell
more than otherwise identical merchants, and earn more profit."
Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, supra note 527, at 20: “[B]oth consumers
and merchants value credit extended by credit card issuers (along with other benefits such as security), and consumers
and merchants are willing to pay for it"; Bolt & Chakravorti, Consumer Choice and Merchant Acceptance of Payment
Media, supra note 646, at 4.
156
they are not the only parties whose welfare should be considered. Consumers who pay with
other payment instruments are also affected by the interchange fee. The state also participates
in the payment system arena.
379. The first problem is that “optimal” interchange fee in the eyes of one party can be the worst for
the other. The interchange fee has contradicting effects, on the welfare of each party:
380. Issuers – For issuers, interchange fee is a source of profit. Issuers would like the interchange
fee to be as high as possible. If issuers could push the fee above the merchant transactional
benefit, because of strategic considerations, they would gladly do so, until the point of merchant
refusal. If issuers could price-discriminate between merchants and charge different interchange
fees, according to each merchant's willingness to pay, they would also do that. Issuers would
also keep as large share of the interchange revenue as they can, and transfer to cardholders only
the necessary minimum to keep the volume of transactions from falling.670
381. Acquirers – For acquirers, the interchange fee is a cost. Acquirers presumably would like to
lower this cost as much as possible, but this does not happen in practice. The reason is that
acquirers are also issuers, or connected to issuers.671 This double function creates conflict of
interest for acquirers. Wearing their acquiring hat, they would like to reduce the interchange
fee in order to offer an attractive MSF to merchants. On the other hand, wearing their issuer
hat, they enjoy high interchange fees. Acquirers enjoy the proceeds from the interchange fees
according to each acquirer’s market share in its capacity as an issuer.
When the acquiring side is more competitive than the issuing side, the pass-through rate is
higher on the acquiring side. That solves the conflict of interests faced by acquirers (that are
also issuers), in favor of the issuing side. Acquirers will prefer a higher interchange fee that is
transferred to themselves, in their role as issuers, where it will be less competed away.672
670 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 436, at 634. 671 Supra ¶ 89 (interchange fee is determined by issuers). 672 Alan S. Frankel, Towards a Competitive Card Payments Marketplace, RBA 27, 37 (2007): “Whether or not banks
are primarily acquirers, primarily issuers, or have a more balanced credit card operation, they prefer high interchange
fees. The reason is that in their function as issuers, they will each receive those fees and pass only a portion of them
along to cardholders as rewards; as acquirers, they pass the full amount of the cost increase to their merchant
customers.”;
EC, INTERIM REPORT, supra note 278, at 70-71: “[H]igh interchange fees are a way to transfer profits to the side of the
scheme where they are least likely to be competed away.”;
Julian Wright, The Determinants of Optimal Interchange Fees in Payment Systems, 52 J. INDUS. ECON. 1, 12 (2004);
Rysman & Wright, The Economics of Payment Cards, supra note 389, at 27: "Schmalensee (2002) first pointed out that
if the interests of issuers and acquirers are not weighted equally in the determination of interchange fees, the
privately determined interchange fee will be affected by the desire to shift profit from one side of the system to
157
382. In On-Us transactions acquirers pay the interchange fee to themselves. This means that in On-
Us transactions, income for acquirers (i.e., the income from their role as issuers) directly
increases with the interchange fee. In countries where there are only few issuers and acquirers,
such as Israel, the market share of On-Us transactions is large. This further incentivizes a high
interchange fee for acquirers that are also issuers.
In addition, every acquirer knows that even if the merchant replaces it by another acquirer, it
will still earn the interchange fee from transactions, in its capacity as an issuer. Thus, high
interchange fee reduces the attractiveness of acquiring, and serves as an entry barrier. The result
is that especially in On-Us transactions, the considerations of acquirers are tilted to the issuing
side, meaning they favor high interchange fees.
383. Merchants – For merchants, the interchange fee is similar to a tax on payment cards. The
interchange fee is passed through the MSF to final prices of goods, thus causing a small increase
in final prices.673 Allegedly, the interchange fee also has a positive effect, because it increases
demand and usage of cards on account of less efficient payment instruments. But if the
interchange fee causes the MSF to be as high as the merchant’s benefit from cards (Bm), or
even higher because of strategic considerations, this positive effect is diminished and merchants
capture none of the benefits from cards.
384. Cardholders – Cardholders presumably benefit from the interchange fee. It lowers cardholder
fees and is a source for rewards. The size of the reduction is dependent on the pass-through rate
from the interchange fee to cardholder fee. What cardholders do not see is that at the same time
it benefits them, the interchange fee causes a small but wide price increase of final goods. In
the aggregate, pass through is full only on the acquiring side,674 so prices increase more than
cardholder fee decreases.675
385. Non-card payers – For non-card payers there are two options. When merchants do not
surcharge, an increase in the interchange fee causes a small but wide price increase for them,
the other. He focuses on the case of a monopoly issuer and monopoly acquirer, but the issuer's profit is given more
weight in determining the platform's interchange fee, thereby leading the platform to prefer a higher interchange fee
than otherwise would be the case. All else equal, this profit-shifting motive leads to a bias towards excessive
interchange fees compared to the socially optimal interchange fee”. 673 Infra ¶ 695 and note 1281. 674 Supra ¶ 97. 675 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 436, at 634: "As interchange fees
increase, merchants are likely to pass the additional costs on to all of their customers. Issuers, on the other hand,
generally do not fully rebate each increment in interchange fee revenue back to their cardholders". See also supra ¶¶
346-348, 714 and infra notes 684, 1311.
158
without any offsetting benefit, as only cardholders get the rewards. When merchants surcharge,
the interchange fee is neutral for non-cardholders.676
386. The state –The state has several roles. First, the state is also a major merchant.677 Second, as a
benevolent social planner, the state desires to induce the usage of efficient payment instruments.
Thus, the role of the interchange fee in inducing card usage integrates with the state's goals, as
long as card usage is indeed efficient.678 From this social point of view, when increasing the
interchange fee induces efficient card usage the state would support this increase. When
increase in the interchange fee makes card usage inferior to another payment instrument, the
state should oppose this increase. Third, the state is major player in the payment arena. The
state is a supplier of cash and bears the cost of production of cash. States usually encourage the
transfer to electronic money, which saves the cost of producing cash and support the fight
against black economy. The downside for the state is the loss of seigniorage.679
Defining The Standard For Optimal Interchange Fees
387. When talking about optimality, it is important to define the chosen standard which is to be
optimized by the interchange fee.
388. Economic models formalize definitions to the optimal interchange fee, that maximizes the
chosen standard. For payment card networks, issuers and acquirers, the chosen standard is
maximum profit. From a welfare perspective, the chosen standard which is to be maximized is
social welfare.680 For consumers, i.e., merchants and payers, the standard is consumer surplus
or consumer welfare. In order to find the interchange fee that maximizes the chosen standard,
the standard is defined in complicated formulas as a function of the interchange fee, and then
differentiated and equated to zero, to find the fee that maximizes first order conditions for
optimality.
676 For neutrality of the interchange fee see supra ch. 6.5. 677 See supra ¶ 24. See also U.S. GOV'T ACCOUNTABILITY OFF., GAO-08-558, FED. ENTITIES ARE TAKING ACTIONS TO
LIMIT THEIR INTERCHANGE FEES, BUT ADDITIONAL REVENUE COLLECTION COST SAVINGS MAY EXIST (2008). 678 For the condition to efficiency see supra ¶ 212, infra ¶ 399. 679 See supra ch. 5.3. 680 Hayashi, The Economics of Payment Card Fee Structure: What is the Optimal Balance between Merchant Fee and
Payment Card Rewards?, at 3 (FRB of Kansas City Working Paper No. 08-06. 2008): “Efficiency is often measured by
social welfare, which consists of welfares of all parties involved in the market. The most efficient card fee structure,
therefore, can be defined as the fee structure that maximizes social welfare of all parties involved in the payment card
market”.
159
389. I will explain the notion of the privately (profit maximizing) optimal interchange fee, then the
notion of the socially optimal interchange fee, and lastly the notion of consumer welfare
optimizing interchange fee.
Privately Optimal Interchange fee
390. Privately set interchange fee is the fee that an open network would choose in order to maximize
its profits.
When open networks determine the interchange fee, they must consider a trade-off. Increasing
the interchange fee enlarges cardholders demand and volume of transactions. At the same time
it reduces merchants demand for cards. As long as the positive effect on cardholders is stronger
than the negative effect on merchants, an increase in the interchange fee is profitable for the
network.
In other words, networks increase interchange fee until the point where a further marginal
increase in the volume of transactions (due to the larger cardholder demand although with fewer
merchants) that occurs when the interchange fee increases, is outweighed by the effect of
reduction in the volume of transactions due to desertion of merchants. At the optimum, any
increase in the profit per transaction (due to the higher interchange fee), is outweighed by the
reduction in the volume of transactions (due to desertion of merchants).
Increase in the interchange fee causes an increase in profit, for the network, from each
transaction with the remaining merchants. This effect is balanced at the optimum by the
reduction in the volume of transactions. When the effect of deserting merchants on volume of
transactions is stronger than the effect of a larger profit per transaction, an increase in the
interchange fee will no longer be profitable. As long as the positive “cardholder effect” is
stronger than the negative “merchant effect”, an increase in the interchange fee will be desired
by the network.681
681 Benjamin Klein et al., Competition in Two-Sided Markets: The Antitrust Economics of Payment Card Interchange
Fees 73 ANTITRUST L.J. 571, 582 (2006): “Profit-maximizing prices are determined such that the percentage change in
merchant acceptance from a small increase (or decrease) in P[M] is equal to the percentage change in cardholder use
from an equal decrease (or increase) in P[c]. The intuition behind this equation is simple: If these terms are not equal,
then the payment network can increase transaction volume and profits by changing relative prices between cardholders
and merchants while keeping the total transaction price the same.";
Julian Wright, The Determinants of Optimal Interchange Fees in Payment Systems, supra note 672, at 10: “[T]he output
maximizing interchange fee balances the increase in consumer demand for cards resulting from lower card fees (this has
to be multiplied by the proportion of merchants that accept cards to obtain the impact on total demand) with the
160
The profit maximizing interchange fee for the networks is achieved, when the profit per
transaction multiplied by the number of transactions is at its peak.682
391. A further fine tuning of the privately optimal interchange fee considers the distinction between
the output maximizing interchange fee and the profit maximizing interchange fee. This
distinction does not always occur. It depends on the pass-through rates of issuers and acquirers.
If pass through rates are identical then profit and volume maximum coincide.683
To see the effect of the pass-through rate, imagine a small increase in the interchange fee from
the output maximizing interchange fee. This increase leads, by definition, to fewer transactions.
But the increase in the interchange fee implies a higher profit per transaction. Specifically this
is the case if part of the revenue from the increased interchange fee is kept by issuers as profit
and the part which is passed-through to cardholders is less than the increase in revenue from
merchants on the acquiring side. In this situation, the network enjoys a bigger increase in profit
per transaction on the issuing side, than the decrease of profit in the acquiring side. The profit
maximizing interchange fee would be higher than the output maximizing interchange fee.
If the profit per transaction increases so that its aggregate effect outweighs the effect of the
reduction in the number of transactions, networks would prefer to sacrifice some transactions,
but earn higher profits for each remaining transaction. This implies that when the issuers' side
is less competitive than the acquirers' side, it is profitable for the network to increase the
interchange fee with fewer transactions. Proceeds are transferred to the issuers' side, where they
are less competed away.684
decrease in merchant demand for accepting cards resulting from higher merchant fees (this has to be multiplied by the
proportion of consumers that use cards to obtain the impact on total demand)”. 682 Julian Wright, The Determinants of Optimal Interchange Fees, id. at 11: “The joint profit maximizing interchange
fee involves a trade-off between maximizing the total number of card transactions and maximizing profit per
transaction”. 683 E. Glen Weyl, The Price Theory of Two-Sided Markets, at 2 (SSRN 2009): “This makes the rate at which the firm
passes these cross-subsidies on to consumers on the other side of the market crucial.”;
Rysman & Wright, The Economics of Payment Cards, supra note 389, at 9: “[T]hese two approaches (profit
maximization and volume maximization) become equivalent if issuers and acquirers pass through interchange fees
into their respective prices equally. In this case, when the interchange fee is changed, issuers' and acquirers'
aggregated profit will only change to the extent that the value or volume of card transactions will change. Therefore,
maximizing the value or volume of card transactions will be equivalent to maximizing the profit of issuers and
acquirers, thereby providing equivalence between these two approaches.”; id. at 27: "Without this asymmetry in pass
through rates, the card platform would maximize the profit of issuers and acquirers by setting an interchange fee to
maximize the volume of card transactions". 684 Ann Borestam & Heiko Schmiedel, Interchange Fees in Payment Cards, ECB Occasional Paper Series 131, at 15
(2011): “It has often been argued that the pass through of interchange fee income from issuers to cardholders takes
161
392. Early models did not find a systematic bias in the privately optimal interchange fee compared
to the socially optimum interchange fee.685 Later models sharply deviated from that conclusion.
When merchants have rigid demand for cards, and the interchange fee is privately set, there is
a bright line that directs the setting of the privately optimal interchange fee. The chosen
interchange fee is the one which makes the corresponding MSF to be on the maximum level in
which merchants still accept cards.686 If merchants weigh strategic considerations, the network
will exploit them to increase the interchange fee and the resulting MSF even more.687 The
network will than transfer to cardholders (as rewards or discounts from cardholder fees), the
minimal sum which is required to keep the volume of transactions from falling.688
393. Formally, when acquirers are competitive (their markup is zero), merchants fund all costs
(Ci+Ca) and profits of issuers (m). The interchange fee (IF) is transferred to the issuing side to
fund any difference between issuers' costs and cardholder fees (Ci-Pc) i.e., the so called "issuing
deficit" plus issuers’ profit.689 Formally:
place at a lower rate than the pass through of interchange fee costs from acquirers to merchants. With such an
asymmetric pass through, schemes have an incentive to use the interchange fee to affect the price structure of payment
card markets so as to maximise output. In addition, it would be commercially profitable for them to raise the
interchange fee to a higher level in order to shift revenues to the side of the market where the pass through is low
(issuing), while costs are shifted to the side of the market where the pass through is high (acquiring). In this way, they
can increase banks’ joint profit margins across issuing and acquiring, which allows rents to be extracted from
consumers. With such an asymmetric pass through, a reduction of the interchange fee must decrease the price level
across issuing and acquiring, because the original interchange fee set by the scheme could otherwise not have been
profit-maximising.”;
Julian Wright, The Determinants of Optimal Interchange Fees, supra note 681, at 12: “Whenever higher interchange
fees increase per-transaction profits to issuers more than they decrease per-transaction profits to acquirers... the profit
maximizing interchange fee will be higher than the interchange fee which maximizes output, with some transactions
being sacrificed in order to transfer per transaction profits to the side of the market where they will be competed away
less. Alternatively, if costs are passed through by the same amount on both sides of the market, then the output and
profit maximizing interchange fee will coincide". 685 Jean-Charles Rochet & Jean Tirole, An Economic Analysis of the Determination of Interchange Fees in Payment
Card Systems, 2 REV. NETWORK ECON. 69, 71 (2003): “[T]here is no reason to think that privately optimal IFs are
higher or lower than socially optimal ones.”; id. at 75: “although socially optimal and privately optimal IFs may
sometimes differ, there is no systematic bias between them. In specific environments, (linear demands, constant
margins) they actually coincide.”; Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment
Card Associations, supra note 383; Wright, The Determinants of Optimal Interchange Fees, ibid. 686 Jean-Charles Rochet & Jean Tirole, Must-Take Cards: Merchant Discounts and Avoided Costs, 9 J. EUR. ECON.
ASS'N 462, 473 (2011): “[W]hen there is a single association, when acquiring is perfectly competitive and when there is
no unobservable heterogeneity among retailers, the association sets the highest possible IF am that retailers accept.
am is always larger than the level aTUS that maximizes total user surplus (and thus consumer surplus)”. 687 Julian Wright, Why Payment Card Fees are Biased Against Retailers, 43 RAND J. ECON. 761 (2012). 688 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 436, at 672. 689 Rochet & Tirole, Must-Take Cards, supra note 686, at 472 (equation 15).
162
10) Pm=MSF=Ca+IF=Ci+Ca+m-Pc →
11) IF=Ci+m-Pc
394. When the interchange fee is privately set, the MSF can be higher than the merchant's benefit
(Pm>Bm) due to strategic considerations. Prices are high but networks are not sensitive to the
prices of goods, but only to their own profits. Welfare considerations of non-card payers are
also ignored by networks.690
395. Indeed, there is a consensus in literature that privately set interchange fee is too high from a
social point of view. Under realistic assumptions, the optimal interchange fee that would be set
by a benevolent social planner to maximize total welfare, is always lower than the privately set
interchange fee that networks would like to set in order to maximize their profit. Privately set
interchange fee is thus always above the socially optimal level.691
690 James J. Mcandrews & Zhu Wang, The Economics of Two-Sided Payment Card Markets: Pricing, Adoption and
Usage, at 23 (Fed. Res. Bank of Kansas City Research Working Paper 08-12. 2008): “What cause the fundamental
differences between the monopoly outcome and social optimum? The answer lies on their different objectives. The card
network makes its profit from providing card services, so it only cares about card users but not cash users. Moreover,
lowering card fees to consumers help inflate the value of card transactions, so the card network prefers high interchange
fees. As card service costs decline over time, the card network is able to further raise interchange fees to extract more
profits out of the system. In contrast, the social planner maximizes the consumer surplus, so it cares about both card
users and cash users”. 691 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 436, 672: “The mere ability to construct
a theoretical model in which it might be possible [emphasis in the original – O.B] for an omniscient and benevolent
social planner to fix an interchange fee in a way that improves upon a decentralized, competitive market, does not mean
that this is what banks do if given the unrestricted right to fix these prices—particularly when there is a clear and
plausible mechanism by which such price fixing, in fact, harms the public.”;
Julian Wright, Why Payment Card Fees are Biased Against Retailers, supra note 687, at 762: “I take a standard model
of a card platform facing elastic demand for cards on each side of the market (i.e., the same model considered by
Rochet and Tirole, 2011, in reaching their conclusion above) and show it actually implies an unambiguous bias
against retailers, even when there is no possibility of price discrimination on either side of the market. Specifically, the
interchange fee determined by the platform will be excessive. Reducing the amount retailers pay and making
cardholders pay more will, up to some point, raise welfare.”; id. at 768-69: "[T]he privately set interchange fee
strictly exceeds the interchange fees maximizing consumer surplus, total user surplus and welfare... Lowering
interchange fees from the privately set level unambiguously raises consumer surplus and total welfare.";
John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee, Payments
Sys. Research Conference 231, 238 (2005): “It follows from the points discussed above that the level of the interchange
fee that is best for the major credit card associations, and their members, could well be significantly in excess of the
level that best serves economic efficiency and overall consumer welfare.”;
Prager et al., Interchange Fees and Payment Card Networks, supra note 500, at 21-22: “In theory, privately-set
interchange fees can be too high or too low relative to the efficient interchange fee, depending on a number of factors.
However, the incentives underlying merchants’ card acceptance decisions in the theoretical models tend, all else
equal, to support interchange fees that are higher than the social optimum. In such a situation, merchant fees will
be inefficiently high and card use fees will be inefficiently low (or card rewards will be inefficiently high), leading to
excessive card use”;
Rong Ding & Julian Wright, Payment Card Interchange Fees and Price Discrimination, at 2, 3 (2015): “The two most
recent papers in this line of research (Bedre-Defolie and Calvano, 2013, and Wright, 2012) have both been able to
establish that a systematic upward bias in interchange fee arises under price coherence… we show that with some
degree of merchant internalization, a card platform will always set the weighted average interchange fee too high
compared to the socially optimal level of interchange fees.”;
163
396. The privately set interchange fee is higher than the socially optimal interchange fee for several
reasons. When pass through rate is not full on the issuing side, and assuming rigid demand of
merchants, increase in the interchange fee above social optimum would not reflect in significant
loss on the merchant side but would reflect is a significant higher profit from the issuing side.
Networks enjoy profits from a greater number of transactions within merchants that accept
cards.692 Cardholder fees are reduced and more cardholders join and use cards. Existing
cardholders also enjoy greater benefits, and increase their card expenditures. The networks
enjoy higher revenues from more transactions.693
397. A question may be posed, as to why networks determine the interchange fee but not the MSF.
First, interests of issuers are weighted more in networks. The interchange fee is issuers’ income,
whereas the MSF is acquirers’ income. Second, the issuing side is considered less
competitive,694 so revenues of the interchange fee that are shifted to the less competitive issuers’
side are less competed away.695 Third, the interchange fee is a latent fee, and thus it is easier to
hide profit through it, than an overt fee such as the MSF, which is more exposed to competition.
Fourth, contrary to the tolerant approach towards the interchange fee, MSF price fixing by
competitors would be considered a blatant hard-core price fixing cartel.
Socially Optimal Interchange fee
398. Most models recognize the tension between privately interchange fee that maximizes profits,
and the optimal interchange fee that maximizes social welfare.
James J. Mcandrews & Zhu Wang, The Economics of Two-Sided Payment Card Markets: Pricing, Adoption and Usage,
at 22 (Fed. Res. Bank of Kansas City Research Working Paper 08-12. 2008): “[U]nder the same parameterization, the
monopoly network charges a much higher interchange fee than the social planner”; id. at 25: “Lowering card fees
to consumers but raising them to merchants help inflate the card transaction value, so the card network prefers high
interchange fees... imposing a ceiling on interchange fees may improve consumer welfare”;
EC, INTERIM REPORT, supra note 278, at 70-71: “Our findings seem to confirm some recent theoretical predictions of
the two sided market literature, which suggest that privately optimal interchange fees may be too high, notably if
merchant fees increase with interchange fees but issuers do not pass the additional interchange fee revenue back to
cardholders. In this case, high interchange fees are a way to transfer profits to the side of the scheme where they are
least likely to be competed away.”;
Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J. MICROECONOMICS 206, 218 (2013):
“The privately optimal IF is higher than the socially optimal IF. Hence, in equilibrium, cardholders pay too little
and merchants pay too much per transaction.”;
Soren Korsgaard, Paying for Payments Free Payments and Optimal Interchange Fees, at 11 (1682 ECB Working Paper
2014): “Privately set fees exceed those set by the social planner, except in special cases”. 692 Dennis W. Carlton & Ralph A. Winter, Competition Policy and Regulation in Credit Card Markets: Insights from
Single-Sided Market Analysis, at 13 (2014). 693 Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J. MICROECONOMICS 206, 218
(2013): “Increasing the interchange fee above the socially optimal level attracts new cardholders because cardholders
fees are reduced; (2) Existing cardholders also enjoy greater rewards and increase their card expenditure; (3) Networks
can extract the higher utility of cards to cardholders through higher membership fee”. 694 Supra ¶ 98. 695 Supra ¶ 381.
164
However, social welfare of all parties cannot be achieved with one interchange fee, due to the
conflicting effects on merchants, cardholders and issuers.696 A higher interchange fee makes
cardholders and issuers better off, but merchants are worse off.697 Optimizing the utility of both
cardholders and merchants with one interchange fee is not possible.698
399. Thus, models look after a second-best solution, in which the interchange fee sets a fee structure
that induces as many efficient card transactions, in which the joint benefits from cards (Bm+Bc)
exceed costs (Ci+Ca). At the same time, the welfare maximizing fee should aim to be such that
whenever this condition is not met (i.e. when Bm+Bb<Ci+Ca), the transaction will be executed
with another payment instrument.699
Under the assumption that cost of supplying card transactions (the supply curve) is not
decreasing, and that demand curve for card transactions (aggregate utilities of cardholders and
696 Supra ¶¶ 380-386. 697 Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J. MICROECONOMICS 206, 222
(2013): “Merchants and cardholders have conflicting interests over the level of the interchange fee.”;
Marc Rysman & Julian Wright, The Economics of Payment Cards, at 24 (2015): “[W]elfare maximization requires a
trade-off between getting the price right on each side. Thus, for instance, in the presence of positive issuing and
acquiring markups, the welfare maximizing interchange fee will be complicated by the need to try to offset these
markups. Since the interchange fee acts as a transfer between the two sides, obviously reducing one markup will
exacerbate the other”. 698 Julian Wright, The Determinants of Optimal Interchange Fees, supra note 681, at 13: “In general, both conditions
cannot simultaneously be satisfied”.
Fumiko Hayashi, The Economics of Payment Card Fee Structure: What is the Optimal Balance between Merchant Fee
and Payment Card Rewards?, at 17-18 (FRB of Kansas City Working Paper No. 08-06. 2008): “The first best solution
violates merchant and/or card network’s incentive compatibility constraints: That means either merchants or card
networks or both make losses at the first best solution. The second best solution is, therefore, to maximize consumer
surplus subject to the incentive compatibility constraints of merchants and card networks”. 699 Julian Wright, The Determinants of Optimal Interchange Fees, id. at 13: “Welfare is maximized by setting a fee
structure so that as many transactions where joint transactional benefits (bB + bS) exceed joint costs (cI + cA) take place
using cards, and as many transactions where bB + bS < cI + cA take place using cash.”;
Rysman & Wright, The Economics of Payment Cards, supra note 697, at 23-24: "The welfare-maximizing interchange
fee involves a trade-off between getting the right price signal for consumers and getting the right price signal for
merchants. The right price for consumers is such that they use cards whenever the sum of their convenience benefits
from using cards and the average convenience benefits from merchants they purchase from with cards exceeds joint
costs. The right price for merchants is such that they accept cards whenever the sum of their convenience benefits from
accepting cards and the average convenience benefits of their card-paying customers exceeds joint costs. Except for
very special cases, these goals are conflicting and a single instrument (the interchange fee) cannot achieve both
conditions";
Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 684, at 17: "What is of key interest both in
terms of economic modelling and from a regulatory perspective is to determine whether the current interchange fee
patterns are socially optimal, i.e. whether the various payment instruments will be overused or underused relative to a
socially optimum outcome”.
165
merchants) is strictly declining, an equilibrium interchange fee should allegedly exist, in which
the benefits of the marginal card transaction equals its costs.700
400. The difference between the socially optimal interchange fee and the privately set interchange
fee is that social optimum cares about final prices of goods. From a social perspective the
presence of interchange fees does not alter the general rule that welfare is maximized when
prices of goods are set by their marginal costs of production (P=MC).701
Thus, the interchange fee that maximizes social welfare, considers, from the demand side, the
welfare of cardholders, merchants and non-card payers. From the supply side it considers the
welfare of issuers and acquirers. Under this standard, increasing the supplier’s surplus (issuers
and acquirers) at the expense of consumer surplus (merchants and customers) is not in itself an
inherent loss of welfare. What matters is the total surplus.
401. Social welfare generally dictates that networks should charge merchants no more than their
transaction benefit (Bm), with no exploitation of strategic considerations. According to the
conventional models, cardholders should pay the difference between Bm and costs (Pc=Ci+Ca-
Bm).702 Thus, the framework of Equations 10 & 11 (supra ¶ 393 מעלremain, but the different
standard which is to be optimized yields different results. Specifically the social welfare
interchange fee is lower than the privately set interchange fee, in order to prevent the price
increases of final goods. The socially optimal interchange fee (IFw) is lower than the privately
set interchange fee (IFp>IFw). The cardholder fee (Pc) that is negatively correlated to the
interchange fee, is bigger when social welfare is the standard, i.e. cardholders pay more or
issuers earn less, and merchants pay less. Prices of goods are lower under social welfare
optimum interchange fee.
402. Socially optimal interchange fee tolerates profits. As long as the condition for efficiency is kept,
i.e., the benefits of the transaction are higher than its costs plus the profit (i.e., as long as:
700 Prager et al., Interchange Fees and Payment Card Networks, supra note 500, at 18: “An efficient interchange fee
would lead to a socially optimal number of payment card transactions. That is, with an efficient interchange fee, a
payment card would be used in a transaction if and only if using the card would result in a non-negative change in total
surplus. Technically, the number of card transactions would be such that the marginal social benefit of the last card
transaction would be equal to its marginal social cost”. 701 DAVID GILO, CONTRACTS THAT RESTRICT COMPETITION, in 3 CONTRACTS 638 (Nili Cohen & Daniel Fridman eds.)
(increase or decrease in price above or under marginal cost leads to distortion that reflects in inefficient allocations of
resources). 702 Supra equation 4) in ¶ 214; Rochet & Tirole, Must-Take Cards: Merchant Discounts and Avoided Costs, supra note
686, at 469: “Social welfare is a single-peaked function of pB, and reaches its maximum at (7) pWB≡ c − bS. The first-
best price pWB makes the consumer perfectly internalize the externality associated with the decision of paying by card”.
166
Bm+Bc>Pc+Pm=Ci+Ca+m), there is nothing wrong, from a social point of view, with
networks' profit generated from interchange fees
403. Factors that must be quantified in order to calculate the optimal interchange fee include, inter
alia, demand elasticities, the split of costs between issuers and acquirers, the degree of
competition in the relevant markets, and other parameters required to delineate the demand and
supply curves.703 The calculation requires estimation of all costs and benefits of card services,
which are very difficult to define, let alone quantify.
For these reasons, although the principle for finding the optimal interchange fee may sound
simple, determination of a specific result is very difficult, and the formulas that delineate the
optimal interchange fees are complicated and dependent on many variables.704
404. To understand the notion of a socially optimal interchange fee, consider a small increase in the
interchange fee. As a result of the lower cardholder fee, there will be some additional card
demand. The surplus of new and existing cardholders will increase. The additional benefits of
cardholders from the increase in the interchange fee have to be weighed against the increase in
the MSF, which lowers merchants’ demand for cards, and causes an increase in final prices.
The additional benefits to the newly joining cardholders are relatively lower, as they are, by
definition, marginal cardholders, who did not want to use cards until the last increase in the
interchange fee. Thus, due to the fact that the additional benefit of marginal cardholders from
cards is strictly declining, at a certain point, which depends on the merchants' and cardholders'
elasticities of demand, the negative effects of increase in the MSF will outweigh the positive
benefits from the lower cardholder fees.705
703 Jean-Charles Rochet & Jean Tirole, An Economic Analysis of the Determination of Interchange Fees in Payment
Card Systems, 2 REV. NETWORK ECON. 69, 75 (2003): “Both socially optimal and privately optimal IFs have to take
several factors into account: the split of total costs between issuer and acquirer, the demand elasticities for both types of
users, and the intensity of competition in both the issuing and the acquiring markets”. 704 Prager et al., Interchange Fees and Payment Card Networks, supra note 500, at 18: “Even in the simplest case, the
efficient interchange fee can be difficult to determine. At a minimum, calculation of the efficient interchange fee
requires estimation of the demand curves for card services for heterogeneous consumers and merchants, in addition to
precise cost data for acquirers, issuers, merchants, and consumers.”; id. at 47: “Ideally, the regulator would want to set
the interchange fee equal to the efficient level (i.e., the level that internalizes externalities between the parties to a
transaction)... calculation of that fee requires knowledge of social costs and benefits that are difficult, if not impossible,
to measure accurately”. 705 Julian Wright, The Determinants of Optimal Interchange Fees, supra note 681, at 12-13: “To interpret the welfare
maximizing interchange fee, consider a small increase in the interchange fee. As a result of lower card fees there will be
some additional consumers who will now want to use cards for transactions whereas previously they did not... The
increase in surplus arising from the additional consumers who now want to use cards depends on the number of
merchants that accept cards (S) multiplied by the social benefits averaged over these additional transactions... On the
other hand, as a result of higher merchant fees, there will be some industries where merchants no longer want to accept
167
The socially optimal fee is reached when the additional marginal surplus from increasing the
interchange fee (all the new efficient transactions that now occur, in which joint benefits exceed
joint costs), is outweighed by the marginal loss from this same increase (efficient transactions
that do not occur with cards anymore, because of fewer participating merchants). Until this
point, total welfare (that includes issuers' profit) increases along with increases in the
interchange fee.
405. When considering total welfare, if pass through rate from the interchange fee to cardholders is
not full, then part of the revenue is extracted as issuers’ profits. This profit is added to the total
welfare calculation.706 If it were but for the profit of issuers, the MSF and final prices of goods
could be lower, and closer to cost (P=MC). This is the basis for the distinction between socially
optimal and the consumer welfare optimal interchange fee.
Consumer Welfare Optimal Interchange Fee
406. The socially optimal interchange fee maximizes efficient card transactions. Even if part of the
surplus from efficient card transactions finds its way as profit of issuers or acquirers, there is
nothing wrong with that, as long as the profit is a result of efficient transactions.
407. The social welfare standard is somewhat in contrast to the current standard of antitrust law,
which aims not to maximize social welfare, but to maximize consumer welfare.707 Under the
consumer welfare standard, the optimal interchange fee excludes the welfare of issuers and
acquirers.708 I can think of two main reasons to justify this exclusion in our context.
First, antitrust laws most often come into play, when competition is impeded at the outset
because of suppliers' market power. The general situation antitrust laws deal with is suppliers’
market power. Although not directly in the payment market, it is worth noting that in Israel the
initial market power of banks over households and small merchants, is undisputed and
supported by numerous studies.709
cards even though previously they did... The decrease in surplus arising from this fall in merchant acceptance depends
on the proportion of consumers that would have wanted to use cards at these merchants (D) multiplied by the social
benefits that would have arisen when averaged over these transactions”. 706 Rochet & Tirole, Must-Take Cards, supra note 686, at 470. 707 See supra note 943. 708 Rochet & Tirole, Must-Take Cards, supra note 686, at 486: “TUS {defined by them as total user surplus – O.B},
equal to cardholders’ plus merchants’ surplus, that is not including issuer markups”. 709 Determination According to Section 43(a)(1) of the Antitrust Law to Information Exchange between Banks, at 4-7
Antitrust 501411, (Apr. 26, 2009); BANK OF ISRAEL, ECONOMIC SURVEY, Chapter 2, 48 (March 18, 2013) available at
168
The second reason for emphasizing the consumer side in our context is suggested by Rochet &
Tirole. Consumers of the payment card networks, i.e., merchants and customers, have greater
utility from money than ultimate beneficiaries of the supply side i.e., the shareholders of the
issuers and the acquirers.710 Thus, expanding consumer surplus contributes greater value to
social welfare, even if it is at the expense of producer surplus. Indeed, some scholars recognized
that consumer welfare, and not total welfare, should be the standard which the interchange fee
should maximize.711
408. The distinction between an interchange fee that maximizes total welfare and an interchange fee
that maximizes consumer welfare, is that the latter includes only the welfare of merchants and
customers. Profit of issuers is not included under the consumer welfare standard. In fact, the
difference between the consumer welfare optimal interchange fee and the total welfare optimal
interchange fee, is the profit of issuers.712
409. The outcomes of models that subject the interchange fee to the consumer welfare standard are:
(1) final prices of goods should be equal to the marginal cost of production (including the cost
of the payment instrument) (P=MC); (2) the interchange fee cannot be used as a source of profit
https://www.boi.org.il/he/BankingSupervision/Survey/DocLib/chap2.pdf ; COMMITTEE FOR ENHANCEMENT OF
COMPETITION IN COMMON BANKING & FINANCIAL SERVICES (SHTRUM COMMITTEE) FINAL REPORT, at 10-9 , 34-30 (Sep
1, 2016). 710 Jean-Charles Rochet & Jean Tirole, Externalities and Regulation in Card Payment Systems, 5 REV. NETWORK ECON.
1, 11 (2006): "Should markups be part of social welfare?... the resulting supra-normal profits are either dissipated
through an “easy life” and inefficient production of card services, or go to wealthy shareholders whose marginal utility
of income is much lower than that of the average consumer. Then issuers’ markup should not be counted as part of
social welfare.”;
Rochet & Tirole, Must-Take Cards, supra note 686, at 477: “Focusing on the narrow notion of consumer surplus is
legitimate for a shortterm analysis as long as the welfare of shareholders is weighted much less heavily than that of
consumers.”; See also Ofer Groskoph, Paternalizm, Public Policy and Government Monopoly in the Gambling Market
(Paternalizm, Takanat Hatzibur Vehamonopol Hamemshalti Beshuk Hahimurim), 7 HAMISHPAT 9, 18 (2007) 711 Jean-Charles Rochet & Julian Wright, Credit Card Interchange Fees, 34 J. BANKING FIN. 1788, 1793 (2010): “[I]f
competition authorities aim at maximizing (short-run) consumer surplus... they will always find the privately optimal
interchange fee excessive.”;
Rochet & Tirole, Must-Take Cards, ibid at 486: “A key result of this paper is thus that, with constant issuer margins and
homogenous merchants, a regulatory cap based on merchants’ avoided cost is legitimate when competition authorities
aim at maximizing short-term total user surplus”;
Joseph Farrell, Efficiency and Competition between Payment Instruments, 5 REV. Network Econ. 26, 34 (2006): “While
this is in part a matter of judgment, it seems to me that if a payment instrument with a large market share avoids the
demand penalty of relatively high overall fees by loading its fees heavily on the merchant side, making usage attractive
to consumers in a way that it may well not be to the two-sided customer, and inflicting real negative externalities on
non-participating consumers and on rival payment instruments, then policy intervention to make it more likely that the
two-sided customer generally chooses the best available offer (as is usually automatic in a one-sided market) is well
worth exploring”. 712 Rochet & Tirole, Must-Take Cards, id. at 471: “[T]he wedge between the welfare-optimal IF, which remains equal to
aW = bS − cS + mB, and the TUS-maximizing IF, aTUS = bS − (cS + mS)”. m is the profit margin, which is added to the
total welfare interchange fee (aW) but deduced from the “total user surplus” interchange fee - aTUS".
169
for acquirers or issuers (m=0), and (3) the sum of the cardholder fee and the MSF (Pm+Pc)
should equal the network’s cost (Ci+Ca).713
410. Formally, the consumer optimum interchange fee (IFcw) is lower than the privately set
interchange fee (IFp) and the social welfare interchange fee, because instead of
11) IFtotal welfare=Ci+m-Pc
comes
12) IFconsumer welfare=Ci-Pc714
411. Note that if merchants surcharge and pass-through rate is full, the consumer welfare standard,
if applied only on cardholders (and not on cash payers), allows for rewards. However, under
NSR and whenever pass-through is not full - rewards inflate the price of goods, especially for
non-cardholders.715 This is why using consumer welfare as the standard, by itself, is not
sufficient to halt redundant rewards, unless the interest of non-card payers is also considered
and pass-through is full. i.e., no profit for issuers. In chapter 14 I expand this insight in my
innovation to limit profits of issuers.
412. The consumer welfare optimal interchange fee considers both final prices of goods and efficient
card usage.
Card payments are optimal if they are more cost effective than other payment instruments.
Under the consumer welfare standard, the net benefit from card payments, should be passed-
through to customers, so prices of goods would sustain the basic principle of P=MC.
If cardholders are heterogeneous, marginal cardholders might not pay with cards, even if cards
are the most efficient payment instrument. In this situation a higher interchange fee than a cost-
based fee is required, to induce efficient card usage. Thus, the heterogeneity of cardholders is
a crucial factor in the determination of the social welfare optimal interchange fee.
713 Fumiko Hayashi, Do U.S. Consumers really benefit from Payment Card Rewards, FED. RES. BANK KAN., ECON.
REV. 37, 50 (2009); Hayashi, The Economics of Payment Card Fee Structure: What is the Optimal Balance between
Merchant Fee and Payment Card Rewards, supra note 698, at 18: “The maximum social welfare is more likely to be
achieved when the product prices for card-using consumers and for non-card-using consumers, respectively, are set at
the merchant’s marginal costs, and the sum of a cardholder fee and a merchant fee equals the card network’s cost.” 714 Rochet & Tirole, Must-Take Cards, supra note 686, at 470. 715 Supra ch. 6.7.
170
An interchange fee which is above costs is efficient only when it effectively steers cardholders
to pay with efficient cards, so merchants actually save costs of the alternative and more
expensive payment instrument, when steering succeeds. The trade-off is that rewarding
marginal cardholders comes along with rewarding all other cardholders who do not need
rewards. The interchange fee which funds those rewards is a cost to merchants. It lowers their
surplus from cards and is passed through to final prices. Non-card customers suffer from the
price increase, as well as cardholders who do not get rewards. Thus, in order for a steering
interchange fee to be efficient, the steering effect must outweigh all the negative effects it
simultaneously generates.
Optimal interchange fee should balance between price increase and efficient steering. As long
as merchants actually save costs when the interchange fee increases to shift the marginal
cardholders to pay with card, it is efficient to increase the interchange fee.
When the “price” to steer the marginal cardholder, i.e. when the rise in the MSF for all infra-
marginal cardholders has a stronger effect, the interchange fee should be lowered, until the point
where the "price increase" effect and the "steering" effect equalize.
413. Wright formalized a similar argument in an article which, in fact, conflicted with his own
previous works, and those of Rochet & Tirole.716 He claimed that it is sufficient for merchants
to internalize the utility of their marginal cardholders, to conclude that the privately set
interchange fee is biased against merchants, and too high compared to social optimum.717
414. The conclusion from the above is twofold. The exact numerical calculation of the optimal
interchange fee is probably not achievable with existing market data. However, few milestones
can be placed. On the 'number line'. The privately set interchange fee is the highest. The socially
optimal interchange fee is in the middle, and the consumer welfare optimal interchange fee is
the lowest (IFp>IFw>IFcw).
716 Julian Wright, Why Payment Card Fees are Biased Against Retailers, supra note 687, at 762. 717 Id. at 765: “The difference between the average and marginal user’s interaction benefit, which I call i’s inframarginal
surplus per interaction, is defined as vi(bi) = E(bi|bi ≥ bi) −bi . It plays a critical
role in the analysis that follows.”; id. at 769: “Therefore, it is only the difference between the average and marginal
seller surplus that drives a wedge between the profit-maximizing and welfare-maximizing interchange fee. This is the
key insight I exploit”.
171
7. The Special Features Of The Interchange Fee
415. Payment cards have unique characteristics that should allow for a different rule to be applied to
the interchange fee arrangement, as opposed to the prohibition which applies to other
arrangements of minimum price fixing between competitors. Payment cards are a two-sided
network product. The interchange fee enables internalization of externalities that exist in two-
sided network markets.
7.1. Two-Sided Network Products
Network Products
416. Payment cards are a network product. A network product is a product whose marginal benefit
for the user is influenced by the number of other users. The fax machine is a good example
of a network product. If there were only one user of fax machine, the device would be useless.
The costs of producing the first fax machines were much greater than the benefits they yielded.
As more people are able to receive and send faxes, the benefits from fax to the new (marginal)
users increase and the marginal cost decreases, due to the division of the initial high fixed costs
among many products.
417. Facebook is another example. The value to users increases as more people are connected to this
platform. The same logic applies to payment cards. If there were only a few people who used
cards, they would not be attractive. As the network increases and more cardholders and
merchants join, the value for the marginal user – be it a cardholder or a merchant – increases.718
418. However, it should be noted that even a network product may have a maximum size beyond
which the value falls. Generally, there is a no need for more than one fax machine per person.
Additional fax machines may even cause confusion. Number of individuals more or less limits
the optimal size of the fax network. Therefore, for accuracy, a network product is a product
718 David S. Evans, The Antitrust Economics of Two-Sided Markets, at 4-5, SSRN (2002): “A network effect arises
when the value that one user receives from a product increases with the number of other users of that product. A
modern, but already almost quaint example, is the fax machine”;
Howard H. Chang & David S. Evans, The Competitive Effects of the Collective Setting of Interchange Fees by Payment
Card Systems, 45 ANTITRUST BULL. 641 (2000); Dennis Carlton & S. Alan Frankel, Transaction Costs, Externalities,
and "Two Sided" Payment Markets, 2005 COLUM. BUS. L. REV. 617 (2005); AT 46791-03-14 El Rov v. General
Director, para. 30 (Dec. 4, 2014); Objection of the General Director to a Merger between Seebus and Millpas, Antitrust
5001982, at 6-8 (June 14, 2012).
172
whose value is rising, in a relevant range.719
In the relevant range, the network feature is characterized by an increase in demand as a function
of increase in quantity. This is a special feature of network product that does not exist with
ordinary products. Demand increases due to a double effect: 1. the joinder of new customers,
for whom the large network is more attractive, and 2. veteran customers get more benefits from
the network when it grows, so they are willing to pay more.720
419. High fixed costs are required to establish a network. A network product requires a critical mass
of users to survive. Only entities that manage to establish the network and overcome the
problem of critical mass can succeed. This is sometimes regarded as a “chicken and egg”
problem, i.e., choosing which side to develop first and reach a critical mass, in order to leverage
the attractiveness of the product to the other side.721
420. Typically there are not many competitors in network product markets. The feature of scale
economy enables only big players to enter and survive in network markets. The market structure
creates high barriers to entry. Indeed markets that are characterized as network-product markets
are often oligopolies by nature.722 In the extreme, the phenomenon of “the winner takes it all”
719 George L. Priest, Rethinking Antitrust Law in an Age of Network Industries, at 2 (John M. Olin Center for Studies in
Law, Economics, and Public Policy Research Paper No. 352, 2007): “The term “network effect” describes the
phenomenon according to which the value of participation in a network increases over some range as the number of
members of the network increases”. 720 GEORGE L. PRIEST, NETWORKS AND ANTITRUST ANALYSIS, in 1 ISSUES IN COMPETITION LAW AND POLICY 641
(ABA section of Antitrust Law, 2008): "As the scale of the network increases, demand increases, either by those
consumers considering joining the network—the aggregate network becomes more valuable—or by those consumers
who have already joined the network—the network they have joined becomes more valuable to them as more
consumers join". 721 Wilko Bolt, Retail Payments in the Netherlands: Facts and Theory,154 DE ECONOMIST 345, 353-54 (2006): "It is a
well-known phenomenon that new payment instruments first have to build some “critical mass” before end-users get
convinced of their use and convenience."; id. 354 n.9: "This is sometimes called the “chicken-and-egg” problem of
payment instruments.";
MICHAEL L. KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA II COMMISSIONED REPORT, at 14 (Reserve Bank of
Australia, 2001): “The chicken-and-egg problem arises when no consumer wants to join a network because too few
merchants accept the card, but additional merchants don’t want to join the network because too few consumers carry the
card”. 722 Robert M. Hunt, An Introduction to the Economics of Payment Card Networks, 2 REV. NETWORK ECON. 80, 84
(2003); David S. Evans, The Antitrust Economics of Multi-Sided Markets, 20 YALE J. ON REG. 325, 354 (2003): “In
practice, a relatively small number of firms tend to compete in multi-sided platform markets because of indirect
network effects on the demand side and fixed costs of establishing platforms”.
173
occurs in network markets.723 A well-known example of this is the struggle between the video
formats VHS and BETA which was finally won by the VHS format.724
421. Most often in network products, the marginal cost is larger than the marginal utility for the user
when the network is in its infancy. The opposite becomes the case as the network matures.
Marginal costs decline due to scale economies and marginal utility increases. In mature
networks, the marginal price that users pay and the marginal cost of production are relatively
law.725 The benefit users derive from a fully developed and powerful network is higher. For
example, imagine that only few people had to pay for the costs of a telephone network. The
costs for them would be enormous, and certainly greater than their benefits from the network.
When the network is in its infancy, the marginal cost is larger than the marginal utility, and this
is why networks find it difficult to establish. When a network already has millions of users, the
marginal cost of supplying the service to the additional customer is minimal, relative to the
utility derived from the network. The marginal customer enjoys a mature and powerful network,
with all of its benefits, immediately from the moment of accession.
422. It should be emphasized that the marginal cost of a network product does not necessarily
decline, even though it is possible that due to economies of scale, the costs of the marginal (e.g.,
card) transaction (e.g., for issuers and acquirers) actually decrease.726 In mature networks, even
if the marginal cost of production increases, the important thing is that the marginal utility is
greater and increasing faster, sometimes even in exponential growth, such as the exponential
growth of Facebook. The fact that the utility of the marginal customer is bigger than the costs
enables mature networks to create positive surplus through transactions.
723 David S. Evans, The Antitrust Economics of Two-Sided Markets, SSRN (2002); David S. Evans & Richard
Schmalansee, Failure to Launch: Critical Mass in Platform Businesses, 9 REV. NETWORK ECON. (2010): “With strong
network effects, new networks tend either to capture the entire market (e.g., Blu-Ray) or to fail completely (e.g., HD-
DVD)”. 724 WILLIAM H. PAGE & JOHN E. LOPATKA, NETWORK EXTERNALITIES, in 1 ENCYCLOPEDIA OF LAW AND ECONOMICS
952, 960 (1999). 725 Leo Van Hove, Central Banks and Payment Instruments: A Serious Case of Schizophrenia, 66 COMMUNICATIONS &
STRATEGIES 19, 21 (2007): “[W]hereas significant investment in infrastructure is needed to start a payments scheme,
the marginal cost of services produced over the existing infrastructure is typically relatively small”. 726 Wilko Bolt & Sujit Chakravorti, Digitization of Retail Payments, at 10 (DNB Working Paper 270. 2010): “As more
consumers and merchants adopt payment cards, providers of these products may benefit from economies of scale and
scope. Size and scalability are important in retail payment systems due to their relatively high capital intensity. In
general, electronic payment systems require considerable up-front investments in processing infrastructures, highly
secure telecommunication facilities and data storage, and apply complex operational standards and protocols. As a
consequence, unit cost should fall as payment volume increases (when appropriately corrected for changes in labor
and capital costs)”; Heiko Schmiedel, Gergana Kostova & Wiebe Ruttenberg, The Social and Private Costs of Retail
Payment Instruments A European Perspective, at 28-29 (137 ECB Occasional Paper Series, 2012).
174
Two-Sided Products
423. A second characteristic of payment cards (in addition to being a network product) is that they
are a two-sided product.727 A two-sided product is a product (or service) that is consumed by
two different groups of customers that engage in reciprocal interactions.728 The reciprocity is
expressed in that changing the price structure for each group, without changing the price level,
can affect the volume of transactions.729 Lowering the price on one side and increasing the price
on the other side, affects the volume of transactions. A two-sided product is a private case of a
multi-sided product, which is defined as a platform that enables the creation of value between
distinct groups of customers that are engaged in reciprocal interactions.730
424. The customers of payment card networks are simultaneously both merchants and cardholders.
To create a payment card transaction, the simultaneous cooperation of both a merchant that
accepts the card and a cardholder that uses the card is required.731 The reciprocity is based on
the network feature, which means that the value of the product for one consumer group
increases with the number of consumers in the other group. More cardholders make the network
727 For expansion, Armstrong, Competition in Two-Sided Markets, supra note 484, at 668; Evans, The Antitrust
Economics of Multi-Sided Markets, supra note 722; Julian Wright, One-Sided Logic in Two-Sided Markets 3 REV.
NETWORK ECON. 44 (2004); Marc Rysman, The Economics of Two-Sided Markets, 23 J. ECON. PERSPECTIVES 125
(2009); Massimo Motta & Helder Vasconcelos, Exclusionary Pricing in a Two-Sided Market, CEPR Discussion Paper
no. 9164 (Oct. 2012). 728 Prager et al., Interchange Fees and Payment Card Networks, supra note 500, at 14-15: “A two-sided market is a
market for the provision of a product whose value is realized only if a member of each of two distinct and
complementary sets of users simultaneously agrees to its use…. A payment card has value only if a merchant and the
merchant’s customer agree on its use to carry out a transaction”. 729 Jean Charles Rochet & Jean Tirole, Two-Sided Markets: A Progress Report, 37 RAND J. ECON. 645, 664-65 (2006):
“A market is two-sided if the platform can affect the volume of transactions by charging more to one side of the market
and reducing the price paid by the other side by an equal amount; in other words, the price structure matters, and
platforms must design it so as to bring both sides on board”;
Gonenc Gurkaynak et al., Multisided Markets and the Challenge of Incorporating Multisided Considerations into
Competition Law Analysis, J. ANTITRUST ENFORCEMENT 1, 4 (2016): "The pioneers of the multisided markets theory,
Rochet and Tirole, have provided a formal definition that focuses on the pricing structure. Based on their 2006 paper, ‘a
market is two-sided if the platform can affect the volume of transactions by charging more to one side of the market and
reducing the price paid by the other side by an equal amount. In other words, the price structure matters, and platforms
must design it so as to bring both sides on board’. Rochet and Tirole further narrow down the limits of two-sided
markets by providing a definition for one-sided markets. They suggest that ‘[t]he market is one-sided if the end-users
negotiate away the actual allocation of the burden (ie the Coase theorem applies)". 730 Andrei Hagiu & Julian Wright, Multi-Sided Platforms, at 7 (Harvard Business School Working Paper 12-024, 2011):
“Multi-sided platform (MSP): an organization that creates value primarily by enabling direct interactions between two
(or more) distinct types of affiliated customers”; Evans, The Antitrust Economics of Multi-Sided Markets, supra note
722. 731 Evans, The Antitrust Economics of Multi-Sided Markets, supra note 722, at 34: “Payment systems—cash, checks,
cards, and emerging e-pay systems—are viable only if both buyers and sellers use it.”;
Dennis W. Carlton & Ralph A. Winter, Competition Policy and Regulation in Credit Card Markets: Insights from
Single-Sided Market Analysis, section 3A (2014): “The credit card network is a two-sided market in the sense that both
cardholders/consumers and merchants must be attracted to the network. Neither side will join without sufficient
numbers of agents on the other side of the market”.
175
more attractive to merchants. More merchants accepting cards signify the attractiveness of the
network to cardholders. Therefore, most network products are also two-sided products.732
425. Other two-sided products include, inter alia, newspapers that require both advertisers and
readers; operating systems that face end-users on one side and developers of applications on
the other side; shopping malls that apply to businesses on one hand and to consumers on the
other; video game consoles targeting developers on one side and buyers of video games on the
other; brokers, auction houses and real estate agents, which serve as platforms for interactions
between one group of sellers and another group of buyers; dating clubs which turn to men and
women; and stock exchanges which interact with both buyers and sellers of securities.
Thus, payment cards are two-sided network products. In addition, payment cards have another
feature that affects the approval of the interchange fee.
7.2. Externalities
426. The main reason that the interchange fee deserves sanctioning, in spite of it being horizontal
minimum price fixing, is because the interchange fee is a mechanism for internalizing
externalities.733
427. Externality is a phenomenon which occurs when the cost of an agent’s action for herself is
significantly different from the social costs of that action.734 Actions of agent do not depend on
the full social costs of the action, but on the cost of the action to the agent. Therefore an agent
may act inefficiently, from a social point of view, in the presence of externalities. The classic
example is of a polluting factory which derives for its owner utility of 10, but inflicts
environmental damage of 100 on its neighborhood. The damage is dissipated equally among a
732 David S. Evans, The Antitrust Economics of Two-Sided Markets, supra note 723 at 4: “It turns out that most, if not
all, industries characterized by network effects—a subject of considerable economic theorizing since the mid 1980s—
are two-sided markets”. 733 For expansion on externalities see STEVEN SHAVELL, FOUNDATIONS OF ECONOMIC ANALYSIS OF LAW (2004);
DENNIS W. CARLTON & JEFFREY M. PERLOFF, MODERN INDUSTRIAL ORGANIZATION (3d ed. 2000); Rochet & Tirole,
Externalities and Regulation in Card Payment Systems, supra note 710; ANDREU MAS-COLELL ET AL., MICROECONOMIC
THEORY, Chapter 11 ( Oxford University Press, 1995); James M. Buchanan & William Craig Stubblebine, Externality,
29 ECONOMICA 371, 372 (1962). 734 Hayashi, Do U.S consumers, supra note 629, at 48: “An externality is the effect of one agent’s action on the benefits
or costs of another agent whose benefits or costs are not taken into account when an economic decision is made.”;
Carlton & Frankel, Transaction Costs, Externalities, and "Two Sided" Payment Markets, supra note 718, at 622:
“Externalities arise when the private cost facing a buyer or a seller differ significantly from the social cost.”;
Harrison J. McAvoy, Regulation Or Competition?: The Durbin Amendment, the Sherman Act, and Intervention in the
Card Payment Industry, 37 SETON HALL LEGISLATIVE J. (2013): “Externalities are defined as “indirect effects of
consumption or production activity”.
176
population of 1000 people.735 If there is no rule governing the situation and allocating
entitlements,736 the existence of transaction costs might frustrate enjoining the factory owner
from continuing to self-internalize the profit of 10 while externalizing the damage of 100 on
the local population. Payment cards exhibit two types of externalities: network and usage.737
Network Externality
428. Network externality – is the externality that is caused when cardholders or merchants take into
account only their private considerations, and as a result, do not join the network, even though
the aggregate benefit from their joinder would be larger than the costs.738 For example, without
interchange fees, when the cost of the issuer is 2 (Ci=2), but the utility the customer derives
from cards is 1 (Bc=1), the customer will not adopt a card. This presents a network externality
if the aggregate utility is in fact, big enough to make card adoption beneficial from a social
point of view (e.g., when Bm=5, Ci+Ca=4 so Bm+Bc=6>4=Ci+Ca). The fact that the
cardholder considers only her private considerations frustrates the efficient outcome.739
429. The focus of the network externality is the “to be or not to be” question, whether to be a
cardholder or a card accepting merchant, or not. The focus is on the initial joinder to the network
and adoption of cards. The concern of the network externality is on the critical mass of
cardholders and merchants, needed for the network to be viable on both sides and beyond that
- on the optimal size of the network.
430. Network externality is sometimes called membership externality.740 The effect of this
externality is on the initial decision whether (or not) to become a cardholder or a card-accepting
merchant.
735 For a similar example, KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA COMMISSIONED REPORT, supra note
721, at 15 . 736 For expansion, Guido Calabresi & Douglas Melamed, Property Rules, Liability Rules and Inalienability: One View
of the Cathedral, 85 HARV. L. REV. 1089 (1972). 737 Rochet & Tirole, Two-Sided Markets: A Progress Report, supra note729, at 647; Wilko Bolt, Retail Payments, supra
note 721, at 346: “[P]ayment networks give rise to strong usage and network externalities”. 738 Nicholas Economides & David Henriques, To Surcharge Or Not to Surcharge? A Two-Sided Market Perspective of
the no-Surcharge Rule (ECB Working Paper No. 1338. Oct. 2011). 739 PAGE & LOPATKA, NETWORK EXTERNALITIES, supra note 724, at 957: “In deciding whether to buy a network good,
the individual compares the price only with his private benefit, not the benefit that his purchase confers on other users.
Consequently, the equilibrium size of a physical network under perfect competition, with direct network externalities,
may be smaller than the social optimum”. 740 Rochet & Tirole, Two-Sided Markets: A Progress Report, supra note729, at 650; Hayashi, Do U.S Consumers, supra
note 629, at 48: “[M]embership externality, which is equivalent to the chicken and-egg problem”.
177
431. As shown by Baxter,741 without interchange fees, if the issuer's cost is bigger than the benefit
to the cardholder (Ci>Bc), even the minimal fee the issuer must offer (Pc=Ci) will not convince
the potential cardholder to join the network. The network will have a problem achieving critical
mass. If consumers are homogeneous, then it is possible that their utility from cards, exceeds
Ci and all of them (because they are homogeneous) will become cardholders. However it is also
possible that none of them will become a cardholder. Heterogeneity in demand for cards among
consumers means that there will be some who become cardholders (for whom Bc>Ci), but if
not, enough cardholders are willing to pay at least Pc=Ci, the network will operate in a degraded
form. Only consumers who are at the upper left of the demand curve might become cardholders.
432. The network externality arises because consumers consider only their private cost / benefit
calculations. Consumers have no reason to take into account the benefits to merchants or to
society when they consider whether or not to become cardholders. Whenever the private cost
exceeds the private benefit (Pc>Bc), the customer will not join the network. When private costs
exceed private benefits, a subsidy is required to persuade customers to join. Without this
subsidy, the size of the network is limited by the side with the smaller demand.
Usage Externality
433. The second externality in payment cards does not occur at the adoption stage but rather when
the cardholder uses the card. The usage externality - is not related to the size of the network,
but to the existence of other means of payment, and the various costs and benefits of each
payment instrument.
434. When a customer approaches the cashier with several payment instruments in her/his wallet
(check, cash, debit and credit), the customer will choose to pay with the instrument that is most
beneficial to her/him. The usage externality occurs when the chosen payment instrument is in
fact more expensive, especially for the merchant, but nevertheless, the cardholder chooses to
use it anyway. The cardholder externalizes on the merchants the expensive cost, and enjoys
(internalizes) the cheap cost or the other benefits the chosen payment instrument inflicted on
her/him.742
741 See supra ch. 6.2. 742 Hayashi, Optimal Balance, supra note 619, at 5: “Usage externality arises from usage decision. In a payment market,
consumers choose a payment method from a set of payment methods the merchant accepts. The consumer’s choice of
payment methods affects the merchant benefits/costs. However, the consumer’s private incentive typically does not
reflect the merchant benefits/costs”; Joseph Farrell, Efficiency and Competition between Payment Instruments, 5 REV.
NETWORK ECON. 26, 28 (2006).
178
435. Usage externality on a large scale creates a problem of adverse selection. The concern is that a
cheap payment instrument will not be able to provide usage incentives for its users
(cardholders), as the expensive payment instrument provides. The outcome might be that the
expensive payment instrument would exclude the cheap one, due to lack of attractiveness of the
latter among payers, and only expensive payment instruments will survive. Another name for
this phenomenon is “Gresham's Law of Payments”, which states that “bad money drives out
good money”.743
For example, if there are two bills in your wallet, one worn and the other brand new, you would
probably prefer to use the worn bill, before it will be torn apart while in your possession. The
merchant would also like to dispose of the bad bill first, and so the bad money drives out the
good money from circulation. Every user externalizes the risk of the torn bill on the next user.
This is a classic usage externality.
436. The difference between the two externalities is very important. The network externality affects
the adoption decision in the first place. It therefore affects the size of the network. The usage
externality affects the usage decision, and therefore affects the volume of transactions.
437. The interchange fee is a mechanism which internalizes both of these externalities. This is the
justification for sanctioning the interchange fee, despite its being a minimum price-fixing
arrangement between competitors. I shall explain now the role of the interchange fee in
internalizing the two externalities in payment cards, both network and usage.
7.3. Interchange Fee As a Mechanism To Internalize Network
Externality
438. In general, the surplus a consumer derives from consumption of a product, is the difference
between its price and the value to the consumer. The utility consumers derive from apparel or
743 Christian Von Wizsacker, Comments regarding "Reform of Credit Card Schemes in Australia II" Commissioned
Report, RBA (2002): “Gresham’s Law: bad coins drive out good coins. Traditionally, coins had a certain metallic value.
If the metallic value of different exemplars of the same denomination differed, the buyer preferred to pay with a bad
coin.”;
John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee, Payments
Sys. Research Conference 231, 235 (2005): “Just as our 16th century forbears would rather pay with a coin that had lost
1 per cent of its gold than a full one, so in the 21st century some of us may be tempted to pay by means that yield 1 per
cent rewards at the expense of the retailer than by ways that do not.”; Alan S. Frankel, Monopoly and Competition in
the Supply and Exchange of Money 66 ANTITRUST L.J. 313, 317 (1998); I. J. Macfarlane, Greshams Law of Payments,
RBA (Address to Australasian Institute of Banking and Finance Industry Forum), Sydney, 23 March 13 (2005). See
also infra note 1646.
179
a beverage or any other product or service - does not change, as a function of the number of
other people that use the product. On the contrary, sometimes consumers derive higher benefit
if fewer consumers buy the product. For example, apparel buyers might prefer to be unique.
439. In network products, customer's utility is positively correlated with the number of other
members in the network. As more merchants honor payment cards, and as more consumers
adopt cards, the individual cardholder or merchant derives higher utility from the bigger size of
the network.
440. The interchange fee is a tool which transfers surplus from the side with the higher demand to
the side with the lower demand. The interchange fee is a tool to expand the size of the network,
on the side that limits network’s growth, for the benefit of the two sides. Imagine for instance
two runners. The pace is determined by the slower runner. The interchange fee is similar to a
boost to this slower runner. The interchange fee induces the side with the less willingness to
pay. Wise utilization of the interchange fee can increase the size of the network not only to the
point of critical mass, where the network is viable, but above it, to its optimal size. On the other
hand, excessive interchange fees might cause market wide price increase together with
oversupply and excessive usage of cards.744
441. The history of credit cards reveals that cardholders' side was less willing to pay for cards (high
elasticity).745 Networks encouraged cardholders to join, through low cardholder fee (even
negative). The interchange fee was a major factor in encouraging cardholders to adopt cards.
The growth on the side of cardholders caused the network to be more attractive to merchants.
Growth on the merchants' side made the network more attractive to cardholders, and the cycle
continued.
442. History also provides an example of a payment instrument that did not manage to overcome
network externality. In the 1990s a revolutionary payment instrument was developed: the finger
(print). The company which developed this payment instrument was called “Pay by Touch”.746
All one had to do in order to pay was to place a finger on a biometric reader at the cashier,
instead of swiping a card through a POS device. The finger was the payment card, read just like
a card is read in a card reader device.
744 See infra ch. 10 for a discussion on the competitive concerns raised by interchange fee. See also supra ¶ 374. 745 Supra note189. 746 https://en.wikipedia.org/wiki/Pay_By_Touch
180
443. The finger print is probably more convenient and more secure than payment cards. It goes
without saying that this form of payment is safer, in terms of fraud and abuse. Nevertheless,
Pay By Touch never became viable. It failed to establish and reach a critical mass on the
merchant side. Had it been successful, it would have had automatic high penetration on
cardholders' side.747
444. The need to recruit critical mass on one side of the market, in order to attract critical mass on
the other side, is certainly not unique to payment cards. Dating clubs that do not have a critical
mass of subscribers from one gender, will not be attractive to the other gender, even if the entry
is free.748 Application developers will not develop applications for operating systems with few
end users, even if the source codes are provided free of charge, and vice versa, i.e., end users
will not find attractive operating systems with few applications. A newspaper that has no critical
mass of readers will not be attractive to advertisers, even if it distributed for free, and vice versa.
A mall without interesting shops will not attract customers, and vice versa. Real estate agents
with property for sale but with no buyers will not succeed, and vice versa.
445. The interchange fee has two effects on the payment card network, which are connected to the
network externality: a direct effect followed by an indirect effect.
Direct network effect is the ordinary effect that also exists in ordinary 'one-sided' products.
When the price of a (normal) product increases, its consumption decreases. The direct effect of
an increase in the interchange fee is an increase in the MSF and decrease in the cardholder fee.
This direct effect is expressed in fewer merchants and more cardholders in the network. But the
effects on each side are not of the same magnitude. The consensus is that merchants’ demand
is rigid and far less elastic than cardholders’ demand.749 Especially after merchants already
accept cards, they would find it almost impossible to cease accepting them.750 When this is the
case, an increase in the interchange fee will lead fewer merchants to abandon cards but many
cardholders to adopt them. As long as the effect on the cardholder side is stronger, the direct
effect of an increase in the interchange fee will therefore be expansion of the network.
747 DAVID S. EVANS & RICHARD SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND
BORROWING ch. 1 (2d ed. 2005). 748 Sebastian Voigt & Oliver Hinz, Network Effects in Two-Sided Markets: Why a 50/50 User Split is Not Necessarily
Revenue Optimal, at 29-30 (2015): “Users may derive positive cross-side network effects from the participation of the
other user group; for example, the more women are on a dating platform, the more attractive the service is for men”. 749 United States v. Am. Express Co., 2016 U.S. App. LEXIS 17502 (2d Cir. N.Y. Sept. 26, 2016): "Within the credit-
card industry, cardholders are generally less willing to pay to use a certain card than merchants are to accept that same
card, and thus a network may charge its cardholders a lower fee than it charges merchants."; For expansion see supra ¶¶
93, 441 and note 191. 750 Supra ¶ 201.
181
446. The Indirect network effect is the effect of an increase in demand of a side (e.g., merchants),
despite an increase in price for them. This is the most special feature of two sided products.
The increase in demand despite higher price, results from the increase in demand of the other
side (e.g., cardholders), due to the direct network effect, which makes the product/service more
attractive. This is certainly different and distinct from an ordinary "one-sided" product, in
which, ceteris paribus, an increase in price leads to a drop in demand, with no countervailing
effect. The indirect network effect characterizes other two-sided products as well, and is not
unique to payment cards.
For example, the benefit to merchants in a mall rises when more customers visit the mall. All
else being equal, it is possible that a merchant would prefer to pay higher rent, if part of it is
intended for marketing, advertising and promotions designated to increase the number of
customers.751
Another example is the increase in the utility for a gender in a dating club, as the number of
members from the other gender increases, even if the price goes up. Men, for example, may
prefer to pay higher subscription fee, if in return price for women falls and their number
increases, and vice versa. An increase in the number of men despite the rise in price for men is
a classic example of the indirect network effect.752
447. Spain exhibited an empirical example of indirect network effects. Following a regulatory
reform, the interchange fee in Spain decreased. As a result: (a) the MSF fell, and more
merchants began to honor payment cards (direct effect); (b) despite an increase in cardholder
fees (direct effect), the adoption of payment cards among cardholders increased (indirect effect,
caused by the larger merchant acceptance); and (c) total revenue from card fees increased,
despite a decrease in the revenue per transaction, because the aggregate increase in the volume
of transactions, outweighed the effect of the drop in revenue per transaction.753
448. The direct and indirect effects of the interchange fee on demand and supply can be described
as follows: interchange fees increase the cost to merchants (direct effect - the movement of the
751 See AT 46791-03-14 El Rov v. General Director, at 15 (Dec. 4, 2014) 752 Voigt & Hinz, Network Effects in Two-Sided Markets, supra note 748: “[P]ositive cross-side and negative same-side
network effects have a significant impact on the revenue generated per user”. 753 Santiago Carbo Valverde et al., Regulating Two-Sided Markets: An Empirical Investigation, at 8-9 (Federal Reserve
Bank of Chicago Working Paper No. 09-11. 2009). For criticism, David S. Evans & Abel M. Mateus, How Changes in
Payment Card Interchange Fees Affect Consumers Fees and Merchant Prices: An Economic Analysis with Applications
to the European Union, at 29-31 (2011) available at http://ssrn.com/abstract=1878735.
182
supply curve of cards for merchants up and left), and lowers the cardholder fees (movement of
the supply curve of cards for cardholders down and right), so the number of cardholders
increases.
The indirect network effect is reflected by an increase in demand of cards by merchants
(movement up and right of the demand curve of merchants), as cards become more attractive
for them because of increased cardholder usage, despite the increase in the MSF. This, in turn,
increases even more the attractiveness of cards to cardholders (movement up and right of the
demand curve of cards for cardholders). The indirect effects continue until convergence.754
449. The interchange fee creates an asymmetric price structure. One side (merchants) pays more than
the other. However, asymmetric pricing is a fundamental characteristic of two-sided products.
The platform exploits the rigid demand of one side to allocate more costs on this side and
transfer revenue to the other side, which has more elastic demand. Other two-sided products
are also characterized by asymmetric price structure. One side funds most of the costs:
Shopping malls do not charge customers, although customers entail high costs on shopping
malls. Malls even offer benefits to customers (which are equivalent to negative fees), in the
form of free parking or other kinds of discounts. Malls earn almost all of their income from
merchants.
Operating systems charge little from application developers, and sometimes even allow free
access to components of their operating systems. They collect most of their revenue from end-
users.755
Real estate agents, stock markets and auction houses charge different prices to each side, buyers
and sellers. At the extreme, one side pays nothing and the other side everything. For example,
real estate agents might implement this pricing structure to increase the supply of assets (charge
nothing from sellers) or the demand to assets (charge nothing from buyers).
Adobe distributes for free its Acrobat reader for PDF files, and charges payment for the Adobe
754 Janusz a. Ordover, Comments on Evans & Schmalensee’s “The Industrial Organization of Markets with Two-Sided
Platforms”, 3 COMPETITION POL'Y INT'L 181, 185 (2007): “An increase in price on one side above some initial level
reduces participation on that side and sets off a chain of adverse effects that bounce back and forth between the sides”. 755 EVANS & SCHMALENSEE, PAYING WITH PLASTIC, supra note 747, at 145.
183
writer.756
Newspaper readers generally do not fund all costs of content and production. Typically,
advertisers bear most of the costs.
450. As trivial as those examples may be for the reader up to this point, those who are not familiar
with two-sided network products, might mistakenly analyze the price structure of two-sided
products through the same lens used to analyze ordinary products, and arrive at different, even
absurd, conclusions (at least from the point of view of this work).757 I will give two examples:
451. In 2010, and again in 2014, two bills, which were aimed to restrict free distribution of
newspapers, made headlines in Israel.758 The 2014 bill even passed first reading (first stage of
legislation).759 In practice, this Bill is aimed to prevent further dissemination of the newspaper
“Israel Today”. This newspaper is distributed in the form of a radically asymmetrical price
structure: the paper is distributed for free to readers. It collects all of its revenues from
advertisers.
In my opinion, the bill demonstrated a fundamental lack of understanding for the need of a two-
sided product, such as a newspaper, to overcome the chicken and egg problem in order to reach
a critical mass of readers, and penetrate into a market with a dominant player (Yediot Ahronot).
In two-sided markets, it is common that charging even a small amount from one side (readers)
reduces the amount of readers dramatically.760 The price structure of 'Israel Today' is a
legitimate pricing of a two-sided product. Even a price of zero on one side (which is, of course,
below marginal cost), cannot be considered predatory.761 Predatory pricing in two-sided
products can be considered only if the price level (as opposed to the price structure),762 charged
from both sides together (readers and advertisers), is lower than the costs of the newspaper.
756 Id. at 8, 42, 139. 757 Julian Wright, One-Sided Logic in Two-Sided Markets 3 REV. NETWORK ECON. 44 (2004). 758 Proposal for a Law to Amend the Press Command (Restriction on Free Distribution of Newspaper with National
Circulation), (2010); Proposal, Law to Promote and Defend the Written Press in Israel, (2014)
www.knesset.gov.il/privatelaw/data/19/2464.rtf. 759 Divrei Haknesset 19, Sitting 177 at 46-62 (Nov. 12, 2014). 760 EVANS AND SCHMALENSEE, PAYING WITH PLASTIC, supra note 747, at 145. 761 Jenny, Competition Policy Issues, supra note 511, at 16: “In two sided markets, a price below marginal cost ( for
example a consumer fee equal to zero) does not necessarily indicates predation or cross subzidisation”. 762 Supra ch. 2.4.2 (price level and price structure).
184
Only then, and with the existence of a dominant market position, can commencement of a
predation examination be considered.763
452. Second, in 2008, a motion for certification of a class action against a night-club that charged
different entrance prices from men and women, was submitted to court.764 The claim asserted
that the night club discriminated against men on basis of gender, contrary to the law.765
As explained above, asymmetric pricing of a night club is designed to balance different
demands of men and women. It is a rightful distinction and not discrimination. The claim argued
for a narrow, literal interpretation of the law, which stands against its purposive
interpretation.766 Men may even encourage club owners to price asymmetrically (even though
men would pay more), when the result is a women/men ratio that yields higher utility for them.767
A night club is a two-sided product. It is not to be analyzed in the same manner as ordinary
product, in which price discrimination based on gender is prohibited.
The court dismissed the motion to approve the class action, but determined that the different
pricing was discriminatory.768 Another court also ruled that charging different entrance prices
to night-clubs for men and women is prohibited discrimination.769
In my opinion, these judgments did not pay enough attention to the balancing requirement of
different demands between men and women. The need to balance demands leads in my view to
the conclusion that this is not discrimination, but a permitted price distinction. A night club is
a two-sided product. Actions of club owner to reduce demand on one side and increase demand
on the other has should not be considered inappropriate discrimination. Courts should not look
through one-sided glasses at two-sided products.
763 Amelia Fletcher, Predatory Pricing in Two-Sided Markets: A Brief Comment, 3 COMPETITION POL'Y INTE'L 221, 223
(2007): “[P]redation can clearly occur where a platform prices its total service at a level that fails to cover its avoidable
costs of providing the total service, taking revenues from both sides of the market into account”; see also Ori BarAm &
Elad Man, The Other Side of the Newspaper, The 7th Eye (Dec. 15, 2012). 764 Ci.C Nadav Lahat v. Forum Production (Claim), (Nevo, Oct 30, 2008). 765 Prohibition of Discrimination in Products, Services and Entry to Places of Entertainment and Public Facilities Law,
2000. 766 For purposive interpretation see, for example, Civ. A. 105/92 Ram Engineering V. Nazereth Municipality, 47(5) 189,
(1993); HCJ 267/88 Reshet Kolel Haidra v. Court of Local Affairs, 43(3) 728, (1989); CA 2706/11 Sybil Germany v.
Harmatic, para. 45 (Sept. 4, 2015) (The meaning of legislation is determined by the purpose of it). For expansion see
AHRON BARAK, INTERPRETATION IN LAW - INTERPRETATION OF LEGISLATION (1993). 767 Voigt & Hinz, Network Effects in Two-Sided Markets, supra note 748. 768 Ci.C 5315/08 Nadav Lahat v. Forum Productions, (Dec. 26, 2011). 769 CiC 2786-06-12 Kobi Tzetzna v. Lord Bars Ltd, (July 16, 2014).
185
Nothing in the above should be construed to legitimize other sorts of unlawful discrimination
in clubs (like racism), which are invidious, regardless of whether they could be economically
justified from the two-sided prospective.
453. In 2011, the Supreme Court held that discrimination between men and women in an entrance
to a night club, based on age, is unlawful.770 In my view, it is of no importance if balancing the
demands is done by different pricing or by age hurdles. Reducing demand for one side to
balance demands, in a two sided product, is for the benefit of that side, and cannot be regarded
as discrimination against it.771
454. However, a clear distinction should be made between the legitimacy of asymmetric pricing of
a newspaper or a night club and the interchange fee.
In all of the two-sided products above, the owner of the platform chooses independently and
unilaterally, without consulting competitors, how to divide the price level between the two
sides. Mall owners choose unilaterally whether to charge or not to charge for parking. If mall
owners would have met and coordinated parking fees at malls, this would be an explicit cartel.
A newspaper chooses whether to charge or not to charge readers, and if so, how much. If
newspaper owners met to coordinate prices for readers, they would probably find themselves
on the defendants’ bench. A night club owner solely decides on the price structure between men
and women. If this decision would be made among competing club owners, it would be a blatant
restrictive arrangement.772
Regularly in two-sided products, the price structure determination is made without coordination
between competitors. The platform owner communicates directly with the two sides of
customers. Indeed regulation of interchange fee is not applicable to close (three-party) card
networks, in which the network connects directly with the two sides. On the other hand, open
card networks cannot avoid coordination. By definition, except “On-Us” transactions every
other transaction involves two competitors - an issuer and acquirer that are not the same. Thus,
while most two-sided products act as closed systems, where the owner contracts directly with
770 CA 8821/09 Pavel Prozianski v. Laila Tov Productions, (Nov. 16, 2011). 771 Ori BarAm, Note on Ruling 8821/09 Pavel Prozianski v. Laila Tov Productions, (Nevo, 2011). 772 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1280, at 636 n. 30: “However, decisions
not to charge differentially in such cases are typically made by independent, competing firms, not by all providers of,
e.g., parking lots”.
186
the two sides of customers and unilaterally sets the price structure, the interchange fee in open
card networks is a restrictive arrangement.773
455. A similar restrictive arrangement in two sided market is termination fees in
telecommunications. Communication networks are also a two-sided product. They have to
decide how much to charge the calling party and how much to charge the addressee side.
Termination fee is the payment that the calling network pays to the receiving network for
completion of a call (when the call is not "on-net" which is the parallel term for "On-Us" in
telecommunication networks).
Interchange fees and termination fees are both hidden from the payer. Both fees are set by
competitors wearing two different hats at the same time, when determining the termination fee.
The price (termination fee) they decide to pay, in their capacity as a calling network, is actually
paid to themselves, in their capacity as the addressee network. The negotiation to determine the
termination fee is thus a self-negotiation, which unsurprisingly yields high prices. The result is
increase in the price of calls.
Rochet & Tirole claim the need to compare the approach of the interchange fees and termination
fees ("Need for Consensus").774 Without regulation, there is a high possibility of market failure
that will result in termination fees being set on supra-competitive rates.775 Indeed, termination
fees, like interchange are under regulatory supervision.776
456. In Israel, one of the major consumer revolutions occurred, when termination fees dropped in
2011 due to a governmental reform. This enabled cellular operators to offer unlimited packages
for prices under NIS 50 per month, a fraction of the prices prior to the reform. Before the reform,
a mobile operator could not offer unlimited calls to its subscribers, because of the risk that they
would make lengthy calls to other networks, and expose it (the calling network) to enormous
termination (interchange) fees. The reform reduced termination fees (analogic to interchange
773 Harry Leinonen, Debit Card Interchange Fees Generally Lead to Cash-Promoting Cross-Subsidisation, at 8 BANK
OF FINLAND RESEARCH DISCUSSION PAPERS (2011): “Multilateral interchange fees (MIFs) in particular are set jointly by
the issuers, which can be viewed as a system of cartel-type anti-competitive agreements”. 774 Rochet & Tirole, Externalities and Regulation in Card Payment Systems, supra note 710, at 12. 775 Jean-Jacques Laffont, Patrick Rey & Jean Tirole, Network Competition I Overview and Nondiscriminatory Pricing,
29 RAND J. ECON. 1 (1998); David Gilo & Yossi Spiegel, Network Interconnection with Competitive Transit, 16 INFO.
ECON. POL'Y 439 (2004). 776 Communication Regulations (Bezeq and Transmissions) (Payments for Termination Fee), (2000). For expansion,
OECD, DEVELOPMENTS IN MOBILE TERMINATION (OECD Digital Economy Papers, no. 193, 2012); Commission
Recommendation on the Regulatory Treatment of Fixed and Mobile Termination Rates in the EU, supra note 866.
187
fees) to very low sums - few single agorot per minute. The risk (of the calling network) to pay
high termination fee became negligible, so networks could offer unlimited packages.
457. The conclusion is that from the network externality viewpoint, interchange fee is warranted to
balance demands and enlarge the size of networks, when networks are at their early stages, and
still must establish themselves in the market. This purpose does not apply to mature networks,
as will be explained now.
7.4. Negation Of The Network Externality Justification
458. The role of the interchange fee as a mechanism to internalize network effect is exhausted when
the network is mature and ubiquitous. When the network is universal, a higher interchange fee
does not contribute anymore to the size of the network.
The network effect might also be exhausted in other products. A club might be attractive only
up to a certain capacity. Too many fax machines will cause confusion and degrade the value of
fax machines for their users.
459. The justification of interchange fees, which is based on network externality, draws its vitality
from the need to expand the network. The need to solve the chicken and egg problem and reach
a critical mass and further, an optimal mass, is valid when absent the interchange fee (or with a
lower interchange fee), the network would act in a degraded form. The justification relies on
the assumption that without the required interchange fee, cardholder fees would exceed the
utility for enough cardholders, so as to render the network atrophied. The interchange fee,
according to the network rationalization, is required not only to keep the network from being
too small, but to bring it to optimal size. This argument applies well to nascent networks.
However, in mature networks this rationale is not valid.777
When cards are ubiquitous, scale and scope economies cause transaction's costs to decrease. At
the same time benefits to users from the large network are maximized on both sides. The
important thing is that in mature networks, the marginal benefit from the network, to users at
777 Dennis Carlton & S. Alan Frankel, Transaction Costs, Externalities, and "Two Sided" Payment Markets, supra note
718, at 639 : “Credit cards, however, have achieved widespread consumer adoption and almost universal acceptance
among major retailers. It therefore remains difficult to defend the present need for collective setting of interchange fees
on the grounds that the fees were necessary to launch the network decades earlier.”;
Vickers, supra note 743, at 236: “As to the desirability of using the interchange fee to tune the balance between card
acceptance and card holding/usage, it may well be that the case is stronger in nascent systems than in mature systems
with wide coverage”.
188
both sides, should be big enough for them to bear the cost, with no need for subsidy. In the
literature there is a consensus that when payment card networks reach maturity the network
effect is exhausted.778
460. Contrary to its initial intent, any attempt to justify an interchange fee on the grounds of the need
to internalize network effects, when applied to mature networks, may undermine the
justification.779 Mature networks can even suffer from congestion.780 Just like a problem of too
many men and women in a dance club, or too much advertising in a newspaper (which lowers
the attractiveness to readers), too-high interchange fees can also cause congestion and over-
supply of payment cards.781
461. Against the argument that current size of networks is large enough, so the network externality
justification for interchange fee is inapposite (at least not at the former levels), the payment
card firms have repeatedly claimed, in Australia, United States, Israel, Spain, and probably
elsewhere that reducing the interchange fee will ignite a process of a “death spiral” that would
destroy the network. The argument goes as follows: (1) a decrease in the interchange fee would
require a raise in the cardholder fees; (2) this would result in fewer cardholders; (3) cards would
778 Howard H. Chang, David S. Evans & Richard Schmalensee, Some Economic Principles for Guiding Antitrust Policy
Towards Joint Ventures (1997): “[J]ust as economies of scale or scope can be exhausted at some level of firm size or
output diversity, so too can the magnitude of network externalities decrease as a network increases in size and reach
zero at some point.”;
Jean Charles Rochet, The Theory of Interchange Fees: A Synthesis of Recent Contributions, 2 REV. NETWORK ECON.
97, 98 (2003): “This network externality becomes less and less important as the network matures, when virtually all
potential users have joined.”;
Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1280, at 655: “By its nature, a network
externality is likely to become less important (and a less persuasive justification) as a network matures… Visa and
MasterCard now operate the largest card payment systems and enjoy almost ubiquitous penetration among major
merchants. Thus, they probably have little continued need to overcome chicken-and-egg entry barriers.”;
Wang Zhu, Market Structure and Payment Card Pricing: What Drives the Interchange?, 28 INT'L J. INDUS. ORG. 86, 96
(2010): “[W]e model a mature card market where the extensive margin of card usage is less important.”;
Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321, 1388
(2008): “The network effects concern is simply inapplicable in the context of mature payment networks competing
against other mature payment networks.”;
Amelio, Antitrust Assessment of MIF and the Tourist Test, supra note 404, at 16: “If consumer adoption and usage of
payment instrument would be almost complete even without MIF, limited benefits can be achieved.”;
Hayashi, Optimal Balance, supra note 619, at 5: “Once the market matured, the positive feedback becomes almost
negligible. That means, additional cardholders do not influence merchant card acceptance and additional merchants do
not influence consumer cardholding”; KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA COMMISSIONED REPORT
supra note 735 at 14; Heimler, Payment Cards Pricing Patterns, supra note 611, at 8. 779 Dominique Forest & Vaigauskaite Dovile, EC Competition Policy in the Payments Area: New Developments in
MIFs for Cards and SEPA Direct Debit, 2 EC COMPETITION POL'Y NEWSL. 38, 40 (2009): “When a payment card
would reach universal usage in a market even without MIF, the need to promote the issuing of such a card in terms of
network effects would vanish”. 780 DAVID S. EVANS & RICHARD SCHMALANSEE, MARKETS WITH TWO-SIDED PLATFORMS, in 1 ISSUES IN COMPETITION
LAW AND POLICY 667 ( ABA Section of Antitrust Law ed., 2008): “At a given size, expanding the number of customers
on the platform can result in congestion that increases search and transaction costs”. 781 Infra ch. 10.3.
189
then be less attractive to merchants (the indirect network effect); (4) at the margin, merchants
will stop honoring cards; (5) this will in turn lead to a further reduction in demand for cards on
the cardholder side, and so forth; (6) This snowball effect will keep on going until the
demolition of the network, or at least until it will exist only in a degraded form.782
The death spiral prophecy was refuted empirically in Australia, Spain and Israel.783 Courts
found that despite the decline in interchange fees and increase in cardholder fees, there has not
been a drop on the cardholder side. On the contrary, the volume of purchases and the number
of active cards is increasing every year.784
462. Beyond the empirical refutation, the “snowball” argument is also theoretically unfounded, and
has no merit.
First, a drop in the interchange fee does not necessarily cause an increase in cardholder fee to
any positive sum, let alone inevitable abandonment by cardholders. When cardholder fees are
negative at the outset, because of rewards, an increase in cardholder fees will not necessarily
exclude cardholders from the networks. Cardholder fees might increase but still remain negative
or near zero. Issuers have other channels of income than interchange fees, such as interest on
credit, which is a main and growing source of income.785 The direct income from cardholders
might well suffice to keep cardholder fees low enough, so that the cardholder side will not be
harmed in the event of a drop in the interchange fee.786 Indeed, in Australia, even after the
reform substantially trimmed the interchange fee, cardholder fees remained negative.787
782 Supra ¶ 659. 783 Supra ¶¶ 660, 672, 447. 784 AT 4630/01 Leumi v. General Director, at 20 (Aug. 31, 2006) ("The Methodology Decision") (Yet, despite the
decline in interchange fees and raise in cardholder fees, the huge drop in willingness to hold cards did not occur. On the
contrary, the volume of purchases by households is increasing every year). See also supra ch. 3, and supra ¶¶ 658-659. 785 Supra ¶ 28. 786 Vickers, supra note 743, at 242: “[C]redit card issuers have substantial revenue streams other than the interchange
fee to finance the cost of funding the interest-free period, especially interest payments from the many who do not
routinely pay off their credit card balances in full.”;
Soren Korsgaard, Paying for Payments Free Payments and Optimal Interchange Fees, 1682 ECB Working Paper, at 2
(2014): “payment services are often provided either for free or against periodical fees: Consumers’ marginal cost is
therefore zero, independent of interchange fees”; id. at 5: “The countries which have historically operated payment
card schemes without interchange fees also happen to be those in which card usage is greatest”. 787 Macfarlane, Greshams Law, supra note 743, at 13: “Despite the cut in interchange fees to an average around 0.55 per
cent, issuers are still able to offer interest-free credit and rewards whose value averages around 0.6-0.7 per cent. Issuers
are able to do this partly due to the revenue they earn from annual fees and the interest earnings from those credit card
users who do not pay their bill by the due date. For many people, credit cards remain one of the very few services that
they are actually paid to use!”.
190
463. When direct income from cardholders is high enough, and given that the interchange fee is a
minimum price fixing agreement that cause an increase in final prices, there is no need for it to
further subsidize issuers. In Europe, it was found already in 2007 that most issuers do not need
the revenue from the interchange fee to be profitable:
It appears that 62% of all banks surveyed would still make profits with credit card
issuing even if they did not receive any interchange fee revenues at all. In 23 EU
Member States, at least one bank participating in the survey was able to make a
profit from issuing credit cards without interchange fees. This exercise seems to
partially invalidate explanations put forward by the industry that total system
output would suffer if issuing were not subsidised through the transfer of revenues
from acquirers. The aim of this analysis is not to argue in favour of a zero
interchange fee. However, in the light of the results, it is legitimate to question the
optimality of the current level of interchange fees in several countries.788
464. The conclusion of the European Commission from January 2007 that an interchange fee is
probably not required, when the pretext is the network size, is even more valid today. In recent
years, direct channels of income from cardholders to issuers (interest on credit, loans and
cardholder fees) only expanded, to well above their 2007 levels, accompanied by a parallel
reduction in transaction's costs.789
465. However, even if cardholder fees will rise to a low positive level, then, as explained above, in
mature networks, enough cardholders derive sufficient utility from cards so as not to abandon
the network. It is reasonable to assume that cardholders will cease carrying the second and third
cards in their wallet, but will keep at least one card. Giving up the extra card in the wallet cannot
be considered as a negative impact on the card network. If a cardholder gives up her Visa or
MasterCard or vice versa, there is indeed a negative effect on the abandoned network, but this
a zero sum game with no aggregate effect. This is not a matter for competition law that is
focusing on protecting competition, and not competitors.790
466. Another reason which renders the death-spiral argument inapplicable is that cardholder fee
cannot rise to unreasonable levels, because this is a regulated fee under the Banking rules.791 In
788 COMMISSION STAFF WORKING DOCUMENT ON RETAIL BANKING, at 157, SEC 2007 (0106) final (Jan. 31, 2007);
Pierre Bos, International Scrutiny of Payment Card Systems, 73 ANTITRUST L.J. 739, 751 (2006): "On the issue of
profitability, the main findings of the Commission's inquiry are:1. Profitability in card issuing is high and has been
sustained over time. 2. Profitability is higher for credit cards than for debit cards. 3. Even without interchange fees,
card issuing remains profitable". 789 Supra ch. 3, see also ¶¶ 28, 502595, 609, 126, 143. 790 Appeal 9/99 Amana v. Antitrust General Director, Antitrust 3013742, para. 17 (Feb. 21, 2002) (Antitrust laws
intended to avoid harm to competition, not competitors, and citing Brooke Group Ltd.v.Brown & Williamson Tobacco
Corp., 113 S.Ct. 2578, 2588 - 2589). 791 Supra ¶ 27.
191
practice due to rewards, cardholder fee, especially for "heavy" users, is much lower than the
ceiling allowed by the banking rules.792 Most probably, even in the unlikely event that
cardholder fee would increase, this would reflect in curtailing rewards (which is pro-
competitive!),793 and not an increase in fixed cardholder fee. It is reasonable to assume that
networks' size would not be impeded.
467. Leinonen has another explanation why reduction in the interchange fee will not lead to an
increase in cardholder fees. The costs of cash for banks are higher than the costs of payment
cards.794 Banks would not want to enlarge their costs by enabling cardholders to shift their
expenditures from cards to (expensive) cash (for banks). Thus, issuers (which are all banking
auxiliary corporations),795 would refrain from increasing cardholder fees.796
468. The logical fallacy in the “death spiral” argument is that the spiral or the snowball would stop.
The cycle argument is flawed. Even if the effect of a reduction in the interchange fee would be
negative on cardholders, this would not be the effect on merchants. It is very unlikely that
reduction in the interchange fee will result in abandonment of the network by merchants. The
direct effect on merchants from lowering the interchange fee is positive (more merchants accept
cards). It is reasonable to assume that the negative indirect effect on merchants (which would
occur in the unlikely event that the cardholder side would decline), would only offset but not
outweigh the direct effect. Theoretically, it is possible that indirect effect would outweigh the
direct effect. However, it is hard to assume that this is the case here. It is not plausible that a
decline in the interchange fee that means a lower MSF for merchants will result in fewer
merchants in the card network.797
469. Reduction of the interchange fee transfers competition from hidden grounds to direct channels,
in which prices are visible and competition is transparent. Already in 2000, Balto proposed to
792 Supra ¶ 28. 793 see supra ¶¶ 351-357. 794 See supra ch. 5.3 (costs of cash). 795 Supra note 1264. 796 Leinonen, Debit Card Interchange Fees, supra note 773, at 27: “Issuers often warn that cutting MIFs would result in
higher card fees and therefore in less use of cards and more use of cash. However, the outcome will probably be the
opposite, because if banks would promote the use of cash it would increase their overall costs due to more expensive
cash distribution”. 797 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1280, at 656: “Yet while a reduction in
interchange fees might well reduce the use of credit cards by some consumers in some transactions, it seems unlikely
that a reduction in merchant fees would be associated with a net decrease in the number of merchants accepting the
cards. This is particularly unlikely if, net of interchange fees, each card transaction costs merchants less on average than
alternative methods of payment—as suggested by the claimed usage externality justification.”; United States v. Am.
Express Co. LEXIS 20114, at 111 (E.D.N.Y Feb. 19, 2015).
192
reduce the interchange fee gradually, and monitor the effects, to ensure that the networks are
not harmed:
Card issuers and merchants will have to recover their costs internally. This may
mean higher direct costs for consumers for credit cards and debit cards. But again,
these prices will be transparent and in that fashion consumers can choose between
banks offering the lowest cost product and this will force banks to compete more
aggressively on these different cost factors. Ultimately it will force banks to
attempt to reduce the costs that are currently compensated by the interchange fee:
card issuance and risk of loss. This will provide even greater incentives for banks
to drive for efficiency.798
470. This proposal was revolutionary and ahead of its time. Today it seems logical as in mature card
networks, the argument that interchange fee is necessary to internalize network externalities is
flawed. I will examine now the second argument, which hinges the necessity of the interchange
fee on the usage externality.
7.5. Usage Externality Justification
471. Usage externality is caused due to the different costs and benefits of each payment
instrument.799 The usage externality is caused when the cardholder decides to pay with the most
beneficial payment instrument for her/him, even if it is an expensive payment instrument for
the merchant.
472. In Israel, merchants that accepted debit and prepaid cards were harmed, because the payment
card companies charged (contrary to the Methodology Decision), at least until April 2016,
unified MSF.800 Merchants could not enjoy the cheaper costs of debit and prepaid.
Credit card is a more expensive payment instrument than debit card, for merchants especially.801
PIN debit is an especially cheap payment instrument compared to credit cards.802 Efficiency
dictates that credit would be used only in transactions in which the credit function is needed.803
However, credit card firms grant cardholders a free funding period and bestow on cardholders
other rewards in order to steer them to pay with expensive credit cards and not cheap debit. The
result is that cardholders externalize high costs of their payment instrument on merchants, and
798 David Balto, The Problem of Interchange Fees: Costs without Benefits? E.C.L.R 215, 223 (2000). 799 For expansion see supra ch. 7.2.2 (Usage Externality). 800 Supra ch. 8.1.4. 801 Supra ¶ 125 802 Id. 803 Supra ch. 6.8 (Debit vs Credit).
193
enjoy (internalize) benefits their choice bestows upon themselves. An OECD report emphasized
this point:
Systems that yield the lowest costs to the group of purchaser/merchants may not
be the ones that purchasers will choose to use. For example, if PIN-based debit
cards are the minimum cost electronic payment instrument to the integrated
consumer, but non-PIN cards offer purchasers a small financial incentive for each
marginal use of the card, purchasers may choose the non-PIN card despite it being
much more expensive for the merchant and less secure. That is, purchasers will not
take into account the full costs of card use to the integrated payment system
"consumer". As a result, modest rewards to purchasers for use of a much higher
total cost payment system can lead purchasers to use the higher cost system much
more frequently than they would if the costs of different payment systems were
always reflected in the retail prices of goods.804
473. When usage externality occurs, a merchant can take steps to prevent it by making his customers
internalize the costs of the payment instrument they use. The merchant does this by surcharging,
discounting, rewarding or steering customers in any other way, to pay with the preferred method
for the merchant. Price discrimination neutralizes the usage externality. For example if the
“cheap money” costs the merchant 1 and the “expensive money” costs the merchant 2, then by
surcharging 1, the merchant eliminates the usage externality. The cardholder internalizes the
full costs of the expensive payment instrument.
In practice, surcharging is not a widespread phenomenon, as explained in chapter 11.
474. Proponents of the interchange fee as a solution to the usage externality claim that interchange
fee is a better alternative to surcharging.805 The internalization of the usage externality is
exhausted at the point in which the MSF reaches the indifference criterion. When the merchant
pays a MSF that is equal to the net benefit (Bm), the merchant becomes indifferent to the
payment method the customer pays with.806 However, when the MSF sustains the indifference
criterion, the merchant no longer has any "profit" from the fact the customer pays with the cheap
instrument. The entire surplus is extracted from the merchant through the MSF.
When the MSF is different than Bm, the merchant is not indifferent between cards and other
payment instruments. When the MSF is lower than Bm the merchant would prefer to pay an
additional fee to marginal cardholders who intend to pay with another payment instrument, and
804 OECD, POLICY ROUNDTABLE, EXCESSIVE PRICES, at 7 DAF/COMP(2011)18. 805 Hans Zenger, Perfect Surcharging and the Tourist Test Interchange Fee, 35 J. BANK. FIN. 2544, 2544 (2011). 806 Supra ch. 8.2.1.
194
steer them to pay with a card (the implied assumption is full pass through rate). When the MSF
exceeds Bm (Pm>Bm) e.g., because of exploitation of strategic considerations of merchants,
the usage externality is reversed ("Reverse Usage Externality"). The merchant prefers other
payment instrument, but is compelled to accept the card. Merchant pays for cards more than the
benefits cards yield. In this situation, when merchants do not surcharge, customers who pay
with other payment instruments (e.g., cash) are subsidizing the expensive payment instrument.
Farrell calls this: "negative externality".807
475. Theoretically an MSF=Bm could perfectly internalize usage externality. However, this requires
another condition – full pass through rate. When the pass through rate is not full, the usage
externality fails.808 The reason is that under the consumer welfare standard, interchange fee that
is not fully passed through, but is kept as profit, should not be eligible. Profits have nothing to
do with the need to internalize the usage externality or encouraging efficient usage of payment
instruments.809
476. But even under the unlikely assumption of full pass through, justification for interchange fee
which is under Bm is flawed, when most cardholders have enough utility from cards, or when
they suffice with a lower rate of interchange fee, for using their card. When this is the case,
interchange fee and the corresponding MSF should be lower than Bm.
For the majority of the infra-marginal cardholders, who derive inherent utility from cards, the
merchant does not need to pay a MSF which partly subsidizes them. Those cardholders would
pay with cards anyway, i.e., even with a lower interchange fee.
With regard to marginal cardholders, my argument is that merchants would rather pay a MSF
that is slightly lower, and give up the attempt to steer them (i.e., let them pay with a different
instrument). Merchants indeed "sacrifice" marginal cardholders, but in return save some of the
surplus from accepting cards in all transactions made with cards.
In this scenario, merchants are not indifferent but strictly prefer cards, because the MSF is
lower than Bm. The savings might be passed-through, depending on the pass through rate in
807 Farrell, supra note 742, at 38: “I think there is a good argument that the negative externality on non-card consumers
is more of a concern than the vertical externality between cardholder and merchant that the fee structure’s “balancing
role” resolves. Essentially this would be the view that participants in a complex venture should seek ways to solve their
internal problems without hurting outsiders". 808 Emilio Calvano, Note on the Economic Theory of Interchange, at 6 (Feb. 22, 2011). 809 For expansion, see my proposal, infra ch. 13.614.2.
195
the industry to which the merchant belongs, and be reflected in a decrease in the final prices of
goods. In other words, there is no reason to bring the merchant to the point of indifference, if
we are guaranteed to get the merchant (and his customers) to a better point. I will illustrate with
an example:
477. Suppose that there are 1000 cardholders. Each performs one transaction (total of 1000
transactions). Now, as opposed to models that assume uniform distribution of utility among
cardholders, suppose now, what I find to be a more realistic assumption (which calls for
empirical confirmation that I leave for future research), that the utility of the cardholders from
cards is distributed unevenly between 2 to minus 2 (-2<Bc<2) so that:
900 cardholders have a greater utility than minus 0.5 (Bc>-0.5) from card usage compared to
other means of payment. Meaning, they either have an inherent positive benefit from card
usage, or they need only a “small push” of a reward up to 0.5 in order to steer them to pay with
a card.
50 cardholders have a negative utility from cards which is between minus 0.5 to minus 1 (-
0.5<Bc<-1). That is, they will pay with a different instrument, unless they receive a subsidy of
0.5 to 1 to steer them to cards. A cardholder in this group may be someone who has a large sum
of cash, and wants to get rid of it, but if paying with a card offers a large enough discount or
rebate, this cardholder will be steered and pay with card.
50 cardholders have a strong negative utility from cards (Bc<-1) meaning they strongly prefer
to pay with another payment instrument. A cardholder in this group may be someone who wants
to make a discreet purchase or one who has “black” cash money, or someone who wants and to
dispose of large sum of cash she carries. It is possible to steer at least some of these cardholders,
but only if the reward is substantial (bigger than 1).
Suppose again that Ci+Ca=4 and Bm=5. MSF that meets the indifference criterion is by
definition 5. Under full pass through rate the interchange fee is 3 and the cardholder fee is minus
1 (Pc=Ci+Ca-Bm=4-5=-1).810
However, even under a full pass through rate, and certainly if the pass through rate is not full,
810 Supra ¶ 214 (Equation 4) and 223 (equation 9).
196
the merchant is better off if the MSF is less than the fee that meets the indifference criterion.
If the cardholder fee is not minus 1 but “only” minus 0.5, which is tantamount, under a full pass
through to MSF of Pm=4.5, interchange fee of IF=2.5, and Pc=-0.5 (instead of: MSF=5, IF=3,
Pc=-1 under the indifference criterion), then the merchant allegedly "loses" 250 from the 50
infra-marginal cardholders whose benefit is -0.5<Bc<-1, as they are not steered to pay with a
card (a loss of 5 in each transaction made with the alternative payment instrument that costs 5
more than a card).
The 50 marginal cardholders whose utility from cards is strongly negative (Bc<-1) continue to
pay with cash. They would do so anyway, even under a MSF=5 and Pc=-1, because their utility
from cards is smaller than -1. The shift from an interchange fee of 3 to an interchange fee of
2.5 does not affect them. It was futile with respect to them. They paid with cash before and
continue to do so.
The results of this example show that under a MSF=4.5 and not 5, merchants are better off.
Total consumer surplus of merchants and customers together is bigger than under the
indifference criterion. Indeed, the merchant “lost” 250 because 50 customers (who sustain -
0.5<Bc<-1) shifted to pay with the expensive payment instrument that costs the merchant 5
more than a card in each transaction. The loss would have been avoided, had those 50 paid by
card, and saved the merchant 250.
Nevertheless, merchants are better off. They saved 0.5 in the MSF (4.5 instead of 5) in the 900
other transactions that did take place with cards. Merchants payed Pm=4.5 and not Pm=5 in
900 transactions (total of 4,050), instead of paying Pm=5 in 950 transactions (total of 4,750).
Thus, the merchants saved 700. The sacrifice of 50 transactions cost the merchant 250. The
total surplus is therefore 450. Depending on the competitive conditions, some of the savings
will be transferred to a reduction in the final prices of goods in the market.
Another way to see this is when MSF=5, the merchant has zero surplus from accepting payment
instruments. The entire surplus from the 950 transactions that are made by cards (4750) is
extracted in the form of the MSF which is also 4750 (950x5=4,750). Under a MSF=4.5, the
merchant remains with surplus of 450 (surplus of 0.5 in 900 transactions=450).
197
478. When the MSF is lower, prices are lower. The conclusion drawn is that when enough
cardholders do not need an interchange fee to encourage them, a fee lower than the fee that
sustains the indifference criterion might be preferable from the joint consumers' (merchants and
customers) standpoint. This holds even though the internalization of the usage externality is
lower, as social welfare is also higher when prices are lower, quantities increase and marginal
customers, especially those who pay with other payment instruments, enjoy lower prices and
purchase goods they did not purchase before.
The numbers above are just an example. Other numbers will yield different results. The example
is just intended to demonstrate a situation which I believe reflects reality, that when
cardholders have sufficient benefit from cards, the usage externality is not a good pretext
for existing levels of interchange fee. This is especially true where interchange fee is based
on the indifference criterion (Europe). Inherent incentives to pay with cards already exist for
most cardholders with no need for interchange fees to encourage them.
The existence of enough cardholders with sufficient benefit from cards, is what might make an
interchange fee that is intended to overcome the usage externality for the marginal customer,
too expensive from a social (and of course, consumers') point of view.
479. A critical point is that even if we acknowledge the usage externality as a pretext for interchange
fee, the condition must be full pass through.811 If issuers claim they need the revenue of the
interchange fee to incentivize usage, then they cannot use it for their own profits. Those are
conflicting and even contradictory goals. Rochet & Tirole call issuers' profits, which are derived
from interchange fees, “cozy cartel”.812 My proposal is to forbid profits achieved through cozy
cartel.813
480. A full pass through rate is a necessary but not a sufficient condition for the efficiency of the
interchange fee. Another concern is that in order to justify collection of high interchange fees,
issuers who know they must use interchange fee proceeds in order to justify their initial
collection, would abuse them. Rochet & Tirole call the phenomenon in which issuers artificially
inflate their costs to justify high interchange fee “wasteful competition”.814 This occurs when
811 Alan S. Frankel, Towards a Competitive Card Payments Marketplace, RBA 27, 43 (2007): "The interchange fee
proceeds are (in this theoretical framework) rebated entirely to the cardholder customer". 812 Rochet & Tirole, Externalities and Regulation in Card Payment Systems, supra note 710, at 10-11. 813 Infra ch. 13.6. 814 Rochet & Tirole, Externalities, supra note 710, at 11: "Perhaps more complex is the case of wasteful competition.
Suppose that issuers do not tacitly collude, but compete in ways that bring limited benefits to consumers.";
198
issuers know that their revenues from the interchange fee hinges upon their costs (as, for
example, in Israel, where the fee is cost based). Issuers then make an effort to "waste" the
proceeds from the interchange fees.815
This concern might generally be attributed to inflating salaries, management and other costs,816
but in the payment cards sector the concern is more about futile marketing and advertising
expenses, which can be socially wasteful and a form of rent-seeking cost.817 This is true even
more definitely regarding issuers’ advertisements in a mature payment card markets.818
Abuse might take the form of futile expenditures such as wasteful marketing campaigns that do
not contribute to an increase in card usage. Frankel & Shampine give as an example, the vast
expenses of card firms on direct mail solicitation, where only a tiny percentage of customers
respond. They equate this to rent seeking costs spent in vain by a monopoly.819 Agarwal found
response rates to mail solicitation in mature payment card markets as negligible.820 Even worse,
those few who do respond to aggressive solicitations are significantly riskier customers. The
offers to which they respond to are inferior, i.e. they carry a higher interest rate on credit.821 Not
surprisingly, the risk of default among respondents to inferior mail solicitations is bigger.822
This, in turn, causes an adverse selection. Riskier cardholders respond to inferior solicitations
and default more. The interest on cards' credit increases for all cardholders. Customers with
high credit scores abandon the network. The network is compelled to increase interest rates,
because remaining cardholders are riskier. Again the customers with high credit scores
Alan Frankel, Interchange in various Countries: Commentary on Weiner and Wright, FRB Kansas 51, 52 (2005):
“[I]ssuer costs are endogenous to the level of the fees. In response to an increase in interchange fees, issuers will have
an incentive to spend more promoting their cards and enhancing their rebate programs”. 815 Supra note 544. 816 For expansion see infra ¶ 887. 817 ANTHONY J. DUKES, ADVERTISING AND COMPETITION, in ISSUES IN COMPETITION LAW AND POLICY 515 (ABA
Section of Antitrust Law, 2008). 818 DAVID S. EVANS & RICHARD SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND
BORROWING 123 (2d ed. 2005). 819 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1280, at 634: “Such competitive
responses (marketing efforts – O.B) may benefit consumers to some extent, but they can also reflect “rent-seeking”
costs symptomatic of excessive profits generated from interchange fees.”; Frankel, Interchange in various Countries:
Commentary on Weiner and Wright, supra note 814, at 56. 820 Sumit Agarwal et al., Regulating Consumer Financial Products: Evidence from Credit Cards, at 1, SSRN eLibrary
(Aug. 2014): “[I]n 2005, the response rate was 0.3%”. 821 Sumit Agarwal, Souphala Chomsisengphet & Chunlin Liu, The Importance of Adverse Selection in the Credit Card
Market: Evidence from Randomized Trials of Credit Card Solicitations, 42 J. MONEY, CREDIT & BANK. 743, 753
(2010): “[C]onsumers who responded to the lender’s credit card solicitations exhibit significantly higher credit risk
characteristics than those who did not respond”; Lawrence M. Ausubel, Adverse Selection in the Credit Card Market
(University of Maryland Working Paper 1999). 822 Agarwal et al., id. at 753: “[C]ardholders who responded to the inferior credit card offers are significantly more
likely to default”.
199
abandon, and so forth.823
In this setup there is no reason to allow the interchange fee to recruit and finance risky
cardholders (who from the outset derive low utility from cards), especially when the result is a
price increase for low-risk cardholders. In addition, switching from one card to the other due to
marketing efforts and rewards cannot be regarded as a legitimate purpose of the interchange
fee. It does not contribute to efficient card usage. On the contrary, it contributes to inefficient
card usage, as marketing efforts are funded by merchants’ money and cause price increase, from
which users of non-rewarding cards and cash payers suffer the most. Marketing efforts funded
by interchange fees cause an inversion of the usage internalization, or a “negative usage
externality”. Merchants are forced to take the expensive cards due to the eagerness of inflamed
cardholders.824
481. In addition, inflated interchange fee that is collected under the pretext of rewarding cardholders
causes a transfer of wealth from those who do not pay with rewarding cards (but nevertheless
still pay the higher prices of goods resulting from rewards) to those who enjoy the rewards.825
482. Therefore, a full pass through rate is a necessary but insufficient condition for approving the
interchange fee. Issuers should also bear the burden to show that the interchange fee was indeed
transferred to cardholders in order to encourage efficient usage of payment cards, and was not
abused in wasteful competition.826
823 Id;. see also Barry Scholnick et al., The Economics of Credit Cards, Debit Cards and ATMs: A Survey and some
New Evidence, 32 J. BANK. FIN. 1468, 1472 (2008). 824 Ann Borestam & Heiko Schmiedel, Interchange Fees in Payment Cards, ECB Occasional Paper Series 131, at 15
(2011): “When a payment is made with a high interchange fee card, cardholders impose a negative externality on the
merchant and, hence, all other purchasers. Cardholders are tempted to use more expensive payment cards, because their
high interchange fee is often reimbursed via low cardholder fees and reward programmes. In doing so, they do not take
into account the genuine costs of the payment, which is to a large extent borne by the merchant and other shoppers.
Rather than internalising positive externalities for merchants, excessive interchange fees therefore create negative
externalities”. 825 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1280, at 658: “In the credit card market,
moreover, switching, rebating, and marketing costs may dissipate much of the fee proceeds and permit issuers to retain
profits, and significant wealth transfers to card customers from other consumers may be problematic as a matter of
public policy.";
Jean Tirole, Payment Card Regulation and the use of Economic Analysis in Antitrust, 4 TOULOUSE SCHOOL ECON., at
17 (2011): “If the profits associated with cardholders’ installed base are dissipated through wasteful advertising
expenditures to “acquire” cardholders, profits should not enter social welfare calculations.”; For expansion see supra ¶¶
351357. 826 ECJ C-382/12 P Mastercard v. European Commission, paras. 90-92 (Sept. 11, 2014); Neelie Kroes, Introductory
Remarks At Press Conference, SPEECH/07/832 (Dec. 19, 2007): “It is not sufficient that a MIF simply increases the
sales volumes of a [credit card network] scheme to the sole benefit of the member banks. Rather, a MIF should
contribute to objective efficiencies such as to promote more efficient payment means to the detriment of less efficient
ones. Also, the proceeds from a MIF should not just increase bank’s revenues—they should be clearly dedicated to the
achievement of efficiencies”. See also supra notes 222, 247.
200
Part III – Regulation and Legal Analysis
8. Regulation Of Interchange Fees Around The World
483. The interchange fee is one of the restrictive arrangements with the largest financial impact in
the world.827 This has not gone unnoticed by various regulators, especially in light of complaints
from merchants, and the extremely high profit margins of the payment card industry. Thus, at
the same time payment systems have flourished, regulatory scrutiny also has increased. A
survey of the regulatory involvement in Israel and in some other countries is a useful
introduction to the next parts of this work.
8.1. Israel
484. Until 1998 there were no interchange fees in Israel for payment cards, simply because there
were no open payment card networks. Isracard was the only issuer and acquirer of MasterCard
and its proprietary brand, Isracart. Isracard is owned by Bank Hapoalim, which is one of the
two biggest banks in Israel. Leumi and Discount are the next two largest banks in Israel. CAL,
the only other payment card firm in Israel until 1998, was jointly controlled by Leumi and
Discount banks.828
Isracard and CAL issued cards, each to clients of their respective associated banks. Customers
of Leumi, Discount and their respective associated banks were issued Visa cards. Customers of
Hapoalim and its associates were issued either a local Isracart or the more lucrative global
MasterCard. Both Isracard and CAL operated as closed networks, meaning that each one was
the sole issuer (in cooperation with its associated banks) and acquirer of its cards.829
485. In 1998, AlphaCard entered the market, after receiving a license to issue and acquire Visa cards
from Visa Europe.830
In the same way described in the historical review of credit cards,831 so too happened when
Alpha entered the market. CAL and Alpha had to regularize the conditions of cross-acquiring
827 Adam J. Levitin, The Antitrust Super Bowl: America's Payment Systems, No-Surcharge Rules, and the Hidden Costs
of Credit, 3 BERKELEY BUS. L.J. 265 (2005). 828 David Gilo & Yossi Spiegel, The Credit Card Industry in Israel, 4 REV. NETWORK ECON. 266 (2005). 829Id. 830Id. 831 Supra ¶¶ 83, 84, 87.
201
whenever a Visa transaction took place, in which one of them was the issuer and the other was
the acquirer. Isracard continued to operate as a closed network.
Alpha and CAL signed a mutual cross-acquiring agreement that enabled each of them to acquire
cards issued by its rival. The cross-acquiring agreement included three categories of interchange
fees. In July 1998, the General Director exempted the agreement, on condition that a
methodology for calculating the interchange fee would be presented to him.832 The parties failed
to submit such methodology despite several deadline extensions.833 Hence, in his decision of
March 8, 2001, the General Director agreed to exempt the mutual acquiring agreement, only if
the parties (by that time Alpha Card ceased operations. Its current incarnation is LeumiCard),
would seek approval of the interchange fee from the Antitrust Tribunal.834 The General Director
continued to grant exemptions to the existence of the mutual cross-acquiring arrangement
between the Visa firms, but not to the interchange fee.835
486. On September 6, 2001, LeumiCard, CAL and their controlling banks, submitted to the Antitrust
Tribunal a motion for approval of the interchange fee.836 The Antitrust Tribunal granted a
temporary ex-parte approval that was extended to an interim approval.837 Until final judgement
in 2012, the interchange fee was approved by interim permits that were extended from time to
time according to Article 13 of the Restrictive Trade Practices Law. As for the interchange fee
itself, the Tribunal ruled that the hearing would be bifurcated. First, the methodology for
calculating the interchange fee would be determined.
487. It is interesting to note that the Visa firms included in their main motion to approve the
interchange fee, a request to maintain as privileged the annex that detailed the exact rates of the
interchange fees. The Antitrust Tribunal rightly rejected the request to privilege the exact rates
of the interchange fees.838 The interchange fee is paid by merchants who are not a party to the
832Exemption with Conditions to a Restrictive Arrangement between Alpha Card and Others, Antitrust 3007229 (July 7,
1998). See also Annex B2 to AT 4630/01 Leumi v. Antitrust General Director, (Publication 4630 in the Antitrust
Registry, Sept. 13, 2001). 833 Exemption with Conditions to Issuers and Acquirers in Visa Network, Antitrust 3009123 (May 18, 2000); Exemption
with Conditions to Issuers and Acquirers in Visa Network, Antitrust 3008373 (July 6, 2000). 834 Exemption with Conditions to a Restrictive Arrangement between Leumicard et al., Antitrust 3010373 (March 8,
2001). 835 Exemption with Conditions to a Restrictive Arrangement between CAL et. el., Antitrust 3014977 (July 22, 2002);
Exemption with Conditions to a Restrictive Arrangement between CAL et al., Antitrust 3015230 (Aug. 12, 2002);
Exemption with Conditions to a Restrictive Arrangement between CAL et al., Antitrust 3019786 (March 1, 2004);
Exemption with Conditions to a Restrictive Arrangement between CAL et al., Antitrust 5000444 (Feb. 19, 2006). 836 AT 4630/01 Leumi v. Antitrust General Director, Antitrust 4630 (Sept. 13, 2001). 837 Motion 34/01 Leumi v. Antitrust General Director (Dec. 22, 2002). 838 Article 120 to the Motion To Approve Restrictive Arrangement in AT 4630/01 Leumi v. General Director (Registry
Publication 4630); AT 4630/01 Leumicard v. Antitrust General Director, (Removal of Privileges), Antitrust 3015470
202
arrangement that determines it. Merchants cannot bargain and negotiate the rate of the
interchange fee. At the very least, this fee, which sets a floor to the MSF merchants must pay,
should be transparent to them. When the interchange fee is unknown, merchants cannot bargain
with the acquirers about the acquirer fee, which is the gap between the interchange fee and the
MSF.
There is no real justification to hide the particulars of the interchange fee, apart from the desire
of the payment card firms to hinder competition. Unfortunately in Europe, too, Visa’s
interchange fees were privileged until 2002.839 Also in the U.S., prior to 2009, merchants could
not see Visa and MasterCard rules, by which they were bound.840 However in recent years,
understanding the importance of transparency and full information to customers has caused a
change in the regulatory attitude. The interchange fee rates today are transparent and published
in Israel and around the world.841 Moreover, comparative studies are conducted on this topic.842
488. With respect to the interchange fee methodology, the position of the Visa firms was based on
what they called "the issuing deficit”. At the core of the Visa firms position was the idea that
the interchange fee should balance the deficit that is allegedly the result of subtracting the
(purportedly low) income issuers derive from cardholder fees and other issuers’ direct income
obtained from cardholders (Pc), from all of the issuing costs (Ci) – i.e., the interchange fee
should be based on Ci-Pc. The underlying assumption was that there is such a deficit (i.e.,
(Sept. 1, 2002); Antitrust, Press Release, Tribunal Refused to Privilege the Interchange Fee, Antitrust 3015423 (Sept. 3,
2002). 839 Press Release, Antitrust, Commission Exempts Multilateral Interchange Fees for Cross Border VISA Card
Payments, IP/02/1138 (July 24, 2002): "The levels of MIFs prior to these reductions cannot be revealed as they are
considered business secrets by Visa". 840 Prager et al., Interchange Fees and Payment Card Networks, supra note 64, at 13 n. 25: “Merchant groups have
frequently expressed concern that merchants themselves were not permitted to view the network operating rules by
which they were bound because they were not network members... In response to these concerns, Visa and MasterCard
have recently [As of February 2009] begun to make their rules available to merchants”. 841 Interchange in Israel is published on the IAA internet site - Antitrust, Press Release, The Antitrust Tribunal Approved
the Settlement between the General Director and the Credit Card Firms, Antitrust 5001903 (March 8, 2012).
Visa interchange fees in U.S: https://usa.visa.com/content/dam/VCOM/download/merchants/visa-usa-interchange-
reimbursement-fees-2016-april.pdf . MasterCard interchange fees in U.S.: http://www.mastercard.com/us/company/en/whatwedo/interchange/Country.html Interchange fees of Visa in Europe: https://www.visaeurope.com/media/images/intra%20visa%20europe%20non-
eea_09122015-73-17767.pdf MasterCard interchange fees in Europe: http://www.mastercard.com/us/company/en/whatwedo/interchange/Intra-EEA.html
290; , at 187 note supra, Interchange Fees in various Countries: Developments and DeterminantsWright, Weiner & 842
Fumiko Hayashi, Payment Card Interchange Fees and Merchant Service Charges - an International Comparison,
supra note 166, at 6; Terri Bradford & Fumiko Hayashi, Developments in Interchange Fees in the United States and
Abroad, FRB KANSAS PAYMENTS SYS. RES. BRIEFING (2008). Jakub Górka, Payment Behaviour in Poland – The
Benefits and Costs of Cash, Cards and Other Non-Cash Payment Instruments, at 8 (table showing interchange fees in
various countries) (Jan. 2012). Fumiko Hayashi, Public Authority Involvement in Payment Card Markets: Various
Countries, August 2013 Update, PAYMENTS SYS. RESEARCH DEPARTMENT OF THE FED. RES. BANK OF KANSAS CITY.
203
Ci>Pc), which the interchange fee is required to gap.843 The position of the Visa firms was that
1.8% interchange fee was required to cover that deficit. I will show below that this methodology
is, in fact, based on the model of Professor Baxter, though the firms themselves did not claim
that.844 In addition, I will claim in chapter 14, as one of my innovations, that permitting
interchange fee to cover any gap in issuers’ costs implies that if in fact there is no such gap, the
justification for interchange fee falls. But even if an “issuing deficit” does exist, under such
position interchange fee should cover it and not be used as a source of profit.
In support of their position, the Visa card firms initially attached an expert opinion by Professor
Rochet, who published, together with 2014 Nobel Prize winner, Professor Jean Tirole, some of
the most important articles in this field. Interestingly, in his academic articles (discussed
below)845 Professor Rochet has expressed a different opinion than that which he submitted to
the Antitrust Tribunal. Professor Rochet did not arrive in Israel to be cross examined, and his
expert opinion was withdrawn from the court file. The payment card firms submitted a
replacement expert opinion of Professor Fershtman.
Another interesting point was that the proposed methodology of the Visa firms in Israel ran
contrary to the consent of Visa Europe at the same time in proceedings before the European
Commission. In Israel the Visa firms opined that the interchange fee should be based on the
“issuing deficit”. In Europe Visa agreed to base the interchange fee on costs.846
489. The position of the General Director with respect to the methodology was that interchange fee
should be calculated according to three specific costs that reflect services issuers allegedly
provide to merchants (“Cost Methodology”).847 A number of retailers supported the General
Director’s position. At that time cost methodology was adopted in Australia and in Europe.848
Cost methodology is based on the premise that issuers provide specific services to merchants,
and the consideration for these services cannot be collected from cardholders. On the other
hand, merchants allegedly benefit from these services, and therefore should pay for them.849
Cost methodology excludes costs of acquirers from the interchange fee calculation. With
843 AT 4630/01 Leumi v. Antitrust General Director, at 9, Antitrust 5000592 (Aug. 31, 2006). 844 Infra ch. 6.2. 845 Infra ch. 6.4. 846 Infra ¶ 572. 847 AT 4630/01 Leumi v. Antitrust General Director, at 12, Antitrust 5000592 (Aug. 31, 2006). 848 Infra ¶ 572 (Europe) and Ch. 8.4 (Australia). 849 Prager et al., Interchange Fees and Payment Card Networks, supra note 64, at 47: “cost-based” fees in which the
regulated value of or cap on interchange fees is computed so as to reimburse card issuers for costs that they cannot
recover from card users without a substantial increase in card user fees”.
204
respect to issuers' costs, the cost-methodology includes as eligible only part of issuers’ costs
i.e., the part that is to be attributed to services issuers purportedly grant merchants.850
The position of the General Director was that the main cost of issuers, which is to be included
in the interchange fee, is the cost of Payment Guarantee. This is the cost related to issuer's
obligation to remit to the merchant, via the acquirer, transactions’ funds, even if the issuer
cannot collect the money from cardholders. The stance was that payment guarantee is the main
service issuers purportedly provide to merchants. Therefore merchants should pay for the cost
of this service.851
According to the opinion of the General Director, other services issuers purportedly provide
merchants, the costs thereof to be included in the interchange fee, were processing costs and
the cost of the free funding period.852
490. The cost of free funding is the cost associated with paying merchants before collecting from
cardholders.853 Regarding this cost, Frankel notes that its origin has an historic explanation,
which has nothing to do with services issuers purportedly provide to merchants. In the early
days of payment cards, the costs of processing transactions were relatively high and the interest
rate was relatively low. Acquirers adopted the custom of merchants, who preferred to save
themselves the trouble of calculating daily interest until the monthly payment was due. They
charged their customers once a month without interest. Interest was added only to unpaid
balance of customers who delayed payment over a month.854
850 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 67, at 32: “Not every cost that can be linked
with an operation of a payment card should be included in the interchange fee, and should thus be borne by merchants.
There had to exist a convincing direct relationship between a given activity and the benefits that merchants receive from
it”. 851 See supra note 181. 852 AT 4630/01 Leumi v. Antitrust General Director, at 12-15, Antitrust 5000592 (Aug. 31, 2006). 853 GAO-10-45, supra note 28, at 21: “Among the costs that issuers told us they incur in running their credit card
programs were costs related to preventing and address fraud and data breaches; write-offs for credit losses from
delinquent or defaulting cardholders; funding costs associated with paying the merchant before receiving payment
from the cardholder; paying for rewards and other cardholder benefits; and general operations, including the issuance
of cards and credit card bill statements”. 854 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 64, at 662: “The interest-free period
itself likely originated from the high costs of processing small credit transactions prior to the invention and general
adoption of computer technology. Merchants—particularly small merchants—offering credit to their customers would
have been faced with a difficult and expensive task if they sought routinely to charge interest during the period between
the purchase date and the statement date. At the same time, interest rates were usually relatively low, so it was more
sensible to wait until the statement date and then apply simple, easily computed interest (say, at 1 percent or 1.5 percent
per month) on the unpaid balance”.
205
491. The OECD raised another criticism regarding the crux of the free funding cost, imposed on
merchants according to cost-based methodology. Cardholders, and not merchants, are the actual
beneficiaries of the free funding period.855 Merchants do not enjoy from the cardholders' free
funding period. On the contrary, merchants should not pay but be paid for the delay for them.
Merchants would have preferred to get paid immediately. Therefore, cardholders, and not
merchants, should pay for the cost of free funding period. This approach was adopted in the
U.S.856 and Poland.857
492. The trial in Israel was conducted for five years during which several expert testimonies were
heard. In August 2006, the Antitrust Tribunal gave its decision (“The Methodology
Decision”).858 The Antitrust Tribunal rejected the "Issuing Deficit" methodology that was
suggested by the Visa Firms, and accepted the cost-based methodology. The Tribunal
determined three costs as eligible costs, which should be included in the calculation of the
interchange fee: (a): the cost of the payment guarantee; (b) the cost of authorization of
transactions; (c) the cost of the free funding period.859
493. In September 2006, short after the delivery of the Methodology Decision, Isracard (which until
then had operated a closed system, and was not an applicant in the proceedings, which involved
only the Visa firms), and the two visa companies, signed a multilateral trio acquiring agreement,
according to which, each firm of the three could acquire any Visa or MasterCard any of them
issued (“The Trio Agreement”).860
The Trio Agreement stipulated that the interchange fee was to be decreased during its operative
period (until 2013) from 1.25% to 0.875%. The Trio Agreement also determined a gradual
reduction in each of the prevailing categories of interchange fees, until unification of the
855 OECD, POLICY ROUNDTABLE COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS, at 26 DAF/COMP 32
(2006): “The supply of credit to holders of credit cards including the first fifty or so days is fundamentally not a
payment service supplied to retailers. Rather, it is a credit service supplied by credit card issuers to credit card holders”. 856 Infra ¶ 642. 857 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 67, at 33: “The funding of the interest-free
period was a service provided by the issuing bank to the credit card user. The TDC emphasised that there was no
evidence, neither theoretical nor empirical, that served to prove that this service led to a permanent increase in sales of
the merchant outlets, taken as a whole. The TDC also pointed out that the interest-free period, like the default
management, was closely linked to one of the most important sources of income for issuing banks, namely the high
interest rates charged for using credit cards outside the interest-free credit periods, and should therefore not be included
in the interchange fee”. 858 AT 4630/01 Leumi v. Antitrust General Director, Antitrust 5000592 (Aug. 31, 2006). 859Id. para. 55 860 AT 610/06 Leumi v. Antitrust General Director, (Motion to Approve a Restrictive Arrangement), Antitrust 6652
(Oct. 30, 2006)
206
categories (subject to exceptions, discussed below).861 Also, as a part of the Trio Agreement,
the firms established a joint interface and routing system, operated by SHVA.
The Trio Agreement opened the market for competition on the MSF merchants paid to
MasterCard, which operated until then as a closed network, i.e., as the sole acquirer of
MasterCard. The Trio Agreement also increased the number of acquirers in the Visa network
from two to three firms. The Trio Agreement initiated competition between the three firms for
providing acquiring services to merchants, on any Visa or MasterCard each of them issued. The
Trio Agreement provided that 18 months before its expiration, an expert would be appointed to
determine the appropriate interchange fee in the post-agreement period, according to the
methodology that would prevail at that time.
494. In October 2006, Leumi Card, Isracard and CAL together submitted to the Antitrust Tribunal a
motion to approve the Trio Agreement and the interchange fee contained therein.862 The
Tribunal refused to wait with nomination of an expert until 18 months before expiration of the
Trio Agreement. In November 2007, the Tribunal held that the General Director would appoint
an expert to determine the appropriate interchange fee in accordance with the Methodology
Decision.863 In January 2008, an expert was appointed (Dr. Yossi Bachar). The expert submitted
his interim report on January 1, 2009.864
495. In implementing the Methodology Decision, the expert used the LRIC (Long Run Incremental
Cost) methodology.865 This methodology has been used already in determining termination fees
in the phone industry,866 and was used in other payment cost studies also.867 In a LRIC model,
all costs become variable, and since it is assumed that all assets are replaced in the long run,
setting charges based on LRIC allows efficient recovery of costs. According to the LRIC
methodology, the expert took account of all costs of the payment card firms, both fixed and
variable, including the cost of capital, which is a virtual cost, as long as they were fully or
861 Infra ch. 8.1.3. 862 AT 610/06 Leumi v. General Director, (Motion to Approve a Restrictive Arrangement), supra note 648. 863 AT 610/06 Leumi v. General Director (Decision to Appoint an Expert), Antitrust 5000840 (11.11.07) 864 AT 610/06 Leumi v. General Director (Interim Expert Report on Calculation of the Interchange Fee) (Jan. 1, 2009). 865Id. at 27-30. 866 Commission Recommendation on the Regulatory Treatment of Fixed and Mobile Termination Rates in the EU, O.J.
L 124/67, para. 13 (may 7, 2009): “Taking account of the particular characteristics of call termination markets, the costs
of termination services should be calculated on the basis of forward-looking long-run incremental costs (LRIC). In a
LRIC model, all costs become variable, and since it is assumed that all assets are replaced in the long run, setting
charges based on LRIC allows efficient recovery of costs. LRIC models include only those costs which are caused by
the provision of a defined increment. An incremental cost approach which allocates only efficiently incurred costs that
would not be sustained if the service included in the increment was no longer produced (i.e. avoidable costs)”. 867 European Commission, Survey on Merchants' Costs of Processing Cash and Card Payments Final Results, para. 7,
(March 2015): “[T]he longer the time horizon, the more costs become variable”. See also infra ¶ 121.
207
partially qualifying costs, i.e., belonging to the cost of payment guarantee or the cost of
authorization.
With respect to the free-funding period cost, the expert determined that this cost does not exist
in Israel, as issuers in Israel do not remit transaction funds to merchants before issuers collect
those funds from cardholders.868
496. The absence of any free funding period in debit cards creates a further distortion in debit and
prepaid transactions in which issuers pay merchants 20 days (on average) after they collect the
sums due from cardholders.869 In deferred debit, assuming uniform distribution of card
purchases during the month, issuers collect transaction funds from cardholders 15 days after
the purchase (on average), so issuers pay merchants “only” 5 days (on average) after they
already collect the money. Thus, with debit and all the more so with prepaid cards, cardholders
actually grant free funding period to issuers. In Israel issuers enjoyed until April 2016 a free-
funding income from debit and prepaid cards.870 One way or the other, in Israel merchants are
certainly not funded by issuers but instead fund issuers and cardholders.
497. To determine what costs qualify for inclusion in the interchange fee, the expert divided the costs
of the payment card firms into three main groups:
497.1 Fully qualifying costs: those costs were entirely attributable to the payment
guarantee or the processing of transactions.
497.2 Fully unqualified costs: those costs were not attributable to payment guarantee or
to processing of transactions at all. Those costs include all acquiring costs and on the
issuing side, mainly marketing costs.
497.3 Partially qualifying costs: those costs are attributable in part to the payment
guarantee and processing of transactions, i.e., eligible costs, and in part to ineligible
costs. These costs were the problematic to attribute, because all three firms function
as issuers and acquirers, so some of their costs are bundled. Indeed, all countries in
which cost based methodology was adopted encountered this kind of difficulty in
separating and allocating the eligible issuing costs from the bundled joint costs of
868 AT 610/06 (Interim Expert Report), supra note 864, at 23-24. 869 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 25. 870 Supra ¶ 15.
208
issuing and acquiring. Partially qualifying costs included overhead, staff costs,
wages, payment to banks, cost of capital, administrative expenses and more. The
expert determined coefficients to allocate those partially qualifying costs to the
interchange fee.
498. In May 2011 the expert (whose role has subsequently been filled by Dr. Shlomi Parizat, when
Dr. Yossi Bachar was nominated to be Chairman of Bank Discount) submitted a final report to
the Tribunal. The final report fully adopted and implemented the interim report of Dr. Bachar.
According to this final report, the appropriate rate of the interchange fee, as determined by the
Methodology Decision, was 0.638%. At that time, the interchange fee was 0.975% according
to the Trio Agreement. On July 2011 the Antitrust Tribunal ordered a decrease in the
interchange fee to 0.875%, effective no later than November 1, 2011.871 In September 2011, the
payment card firms filed counter-opinions according to which, the interchange fee should be
higher than 0.638%.
499. In December 2011, the Antitrust General Director reached a settlement with the three payment
card firms, according to which, the interchange fee would decrease gradually to 0.7%, effective
from July 1, 2014 until the end of 2018.872 On March 7, 2012, the Antitrust Tribunal approved
the settlement, ending more than a decade of litigation.873
Criticism Of The Cost-Based Methodology
500. The total volume of purchases with payment cards in Israel in 2015 was more than NIS 250
billion.874 The interchange fee amounts to income of more than NIS 1.75 billion for the three
payment card companies (0.7% of the volume of transactions). The total costs of the three
payment card firms for 2015 (issuing plus acquiring) amounted to NIS 3.3 billion.875 Total
issuing costs in 2015 amounted to NIS 2.576 billion.876 Deducting 15% of the three firms'
artificial payments to their controlling banks, implies that the true total issuing costs amounts
to NIS 2.1 billion, of which the interchange fee alone covered more than NIS 1.75 Billion.877
871 AT 610/06 Leumi v. Antitrust General Director (Aug. 7, 2011); Antitrust, Press Release, Credit Card Firms Will
Decrease tomorrow the Average Interchange Fee to no More than 0.875%, Antitrust 5001868 (Oct. 31, 2011). 872 Antitrust, Press Release, General Director and the Credit Card Firms Reached a Dramatic Decrease in the
Interchange Fee and Extension of the Cross Acquiring Agreement Until 2018, Antitrust 5001886 (Dec. 28, 2011). The
settlement is published at the IAA's internet site:
http://www.antitrust.gov.il/files/7925/11_12_27_הסדר_סליקה_צולבת_מתוקן.pdf 873 AT 610/06 Leumi v. Antitrust General Director, Antitrust 500191 (March 7, 2012). 874 Supra ¶ 56. 875 Bank of Israel, Table J-11, Income Statements of the Payment Card Firms (last visited, Oct. 30, 2016). 876 Bank of Israel, Data on Payment Card Firms, Table J-13, Income Statements According to Activity Sectors for 2014. 877 MILRED, supra note 58, at 9. See also Table 5 supra ¶ 62.
209
In other words, under the pretext of receiving back “only” the costs of authorization and
payment guarantee, the 0.7% interchange fee assures the payment card firms that almost all of
their total issuing costs, and more than half of their total costs (including acquiring costs), are
to be returned to them within the framework of a cartel, and without any need for competition.
Vickers warned of a scenario in which the interchange fee would be used as a pretext for
covering all costs:
More generally, having regard to the fact that credit card systems provide payment
services jointly to retailers and to cardholders, it might be thought that there is a
distortion of competition in the acquiring market arising from the interchange fee,
at least if it effectively requires acquirers to charge retailers more than their fair
share of the costs of providing the payment services. But it is not obvious what
constitutes a fair share. So a related, but perhaps rather modest, view would be that
there is certainly a distortion of competition in the acquiring market arising from
the interchange fee if it effectively requires acquirers to charge retailers more than
all the costs of providing the payment services that are provided jointly to retailers
and cardholders.878
501. Fortunately the interchange fee in Israel does not exceed all costs of payment card firms, but it
already covers a substantial part of them. The Antitrust Tribunal did not intend that interchange
fee would evade competition between payment card firms. However, when most expenses are
returned through a cartel such as the interchange fee, which originally was intended to cover
only two costs (payment guarantee and authorization), this raises doubts whether the
interchange fee is not a disguise for what Rochet & Tirole named "cozy cartel".879 Current level
of interchange fee certainly raises doubts about the legitimacy of the fee's underlying
methodology.880
502. In my view, the concern for the future is even more serious. The interchange fee is a fraction.
The eligible costs are the numerator. The total volume of transactions is the denominator. Due
to technological innovations and the continuous increase in card usage, the numerator is
expected to decrease and the denominator is expected to increase, thus, the fraction, i.e., the
interchange fee, should decrease.881 Cost-based interchange fees, which are not adjusted to the
878 John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee,
PAYMENTS SYS. RESEARCH CONFERENCE 231, 241 (2005). 879 Jean-Charles Rochet & Jean Tirole, Externalities and Regulation in Card Payment Systems 5 REV. NETWORK ECON.
1, at 10-11 (2006). For expansion see infra ¶ 871. 880 REPORT ON THE RETAIL BANKING SECTOR INQUIRY [COM(2007) 33 Final], supra note 193, at 127: "[I]t is legitimate
to question the optimality of the current level of interchange fees in several countries". 881 Infra note 316.
210
decline of costs and the rise in volumes, are effectively a way to artificially inflate profits of
issuers. I hope this conclusion will be followed towards the end of the Trio Agreement in 2018.
503. Another way to look at this criticism is by examining other sources of issuers' income, i.e.,
interest and cardholder fees. A cost-based interchange fee ensures issuers a minimum income
floor, regardless of issuers' other incomes. When the "other" income is high enough, the
interchange fee automatically compels issuers to gain profit.
The implicit assumption underlying the cost-base methodology was that absent the interchange
fee, issuers would not be able to collect the eligible costs from cardholders.882 This assumption
is clearly refuted when in fact issuers are able to cover all of their costs with no need for
interchange fees, or with a need for only a fraction of the interchange fee. An empirical study
made by the European Commission in 2006 strengthens this criticism. The Commission found
that already in 2006, 62% of issuers did not need any interchange fee to cover all of their
costs.883 Since 2006 issuers' direct sources of income (especially interest) only expanded.
Interchange fee should not be used as a disguise for inflated profits under the pretext of covering
costs.884 In the last chapter of this work, I propose a development of this criticism. My proposal
is to impose profit limitations on issuers who collect interchange fees.
504. Besides criticizing the level of the interchange fee yielded by the cost methodology, there are
further practical and theoretical problems in the cost methodology, as adopted in Israel.
First, cost-based pricing has an inherent difficulty. It incentivizes issuers to inflate their
expenditures.885 Cost-based pricing that is calculated in accordance with accounting principles,
gives incentive for the controlled entity, to inflate the qualifying costs, loading them up with
overhead, and attributing costs to the qualifying components. It is not difficult to fool an outside
inspector, and make him assign to the interchange fee, artificially inflated costs that do not
honestly belong to the qualifying components. The main reason is asymmetric information. Full
information is available only to the regulated firm, which can manipulate its presentation to the
882 AT 4630/01 Leumi v. Antitrust General Director, at 7, Antitrust 5000592 (Aug. 31, 2006). 883 Infra ¶ 463. 884 Harry Leinonen, Debit Card Interchange Fees Generally Lead to Cash-Promoting Cross-Subsidisation, at 13 BANK
OF FINLAND RESEARCH DISCUSSION PAPERS (2011): “Issuers should not be able, according to the legislation principles
of competition, to cooperate in price setting so as to increase their profits”. 885 Alen Frankel, Interchange in various Countries: Commentary on Weiner and Wright, FRB KANSAS 51, 52 (2005):
“[I]ssuer costs are endogenous to the level of the fees. In response to an increase in interchange fees, issuers will have
an incentive to spend more promoting their cards and enhancing their rebate programs”.
211
outer supervisor.886 Indeed, cost-based interchange fee has been criticized by scholars.887
Australia and the European Commission abandoned cost-based pricing.888 The Supreme Court
of Israel has also criticized, in another context, the drawbacks of cost-based pricing.889 This is
the reason why cost-based pricing is usually not acceptable, especially when offered by
collaborating competitors.890 Firms that suspect their prices are to be based on costs may
deliberately operate inefficiently or artificially inflate their costs, resulting in higher prices and
higher profits to the collaborators.891
505. Second, cost-based pricing creates a moral hazard. A similar example of moral hazard is the
"tendency for the insurance plans to encourage behavior that increases the risk of insured
loss”.892 The interchange fee, as calculated in Israel, encourages moral hazard. It compensates
issuers for, inter alia, the materialized risks arising from their payment guarantee. Issuers can
act more riskily, knowing that the interchange fee is going to compensate them anyway for the
greater risk assumed.893 This can be compared to abandoning an insured asset, and externalizing
the risk on the insurer. The "insurers" of payment cards, who pay the premium (as part of the
886 MARK ARMSTRONG & DAVID E. M. SAPPINGTON, RECENT DEVELOPMENTS IN THE THEORY OF REGULATION IN 3
HANDBOOK OF INDUSTRIAL ORGANIZATION, 1560 (Ch. 27, Asymmetric Cost Information), at para. 2.3.1 (2007). 887Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 958: “Systems
attempting to regulate price based on costs have historically been plagued with practical problems even in industries
where theory would predict that optimal prices can be set based on cost. In credit card markets, there is reason to
believe that these practical problems would be just as bad… costs are too manipulable to serve as an objective means to
regulate price. In short, a firm has little incentive to cut cost if its revenue is tied directly to cost.";
Balto, supra note 211, at 219: “Antitrust courts and enforcement agencies rarely, if ever, accept promises that price
setting will be "cost based" as a reason to permit collective price fixing…decades of unsuccessful government
regulation has demonstrated, setting price based on cost often creates the wrong incentives for the market. If price is
based on cost, there may be insufficient incentive for the venture or its members to attempt to reduce costs, because
they know at the end of the day, all the costs will be recovered.”;
Benjamin Edelman & Julian Wright, Price Coherence and Excessive Intermediation, at 33(2014): “Direct oversight of
fees presents clear problems, most notably a regulator's difficulty in determining the “right" fee, a price-setting function
that is viewed as unduly intrusive in most markets”;
Don Cruickshank, Competition in UK Banking: A Report to the Chancellor of the Exchequer U.K. Stationery Office,
sec. 3.114 (2000); AVINASH DIXIT & BARRY NALEBUFF, GAME THEORY, 380-81 (Ilan Michal trans., Aliyat Hagag
Books, Hebrew ed., 2010) (It is easy for a firm which operates under cost based pricing to inflate costs); Benjamin
Edelman & Julian Wright, Price Coherence and Excessive Intermediation, at 33(2014): “Direct oversight of fees
presents clear problems, most notably a regulator's difficulty in determining the “right" fee, a price-setting function that
is viewed as unduly intrusive in most markets”. 888 Infra ch. 8.2 (Europe) and Ch. 8.4 (Australia). 889 C.A 449/85 General Attorney v. Gad Building Company, 43(1) 183, 192 (1989) (criticizing cost plus agreements for
their incentive to inflate costs). See also the Methodology Decision, supra note 882, para. 35. 890 Balto, supra note 211, at 215: “Antitrust courts and enforcement agencies rarely, if ever, accept promises that price
setting will be "cost based" as a reason to permit collective price fixing”. 891 Alan S. Frankel, Monopoly and Competition in the Supply and Exchange of Money 66 ANTITRUST L.J. 313, 342
(1998); Carlton & Frankel, The Antitrust Economics of Credit Card Networks, supra note 97, at 652-53. 892 Allard E. Dembe & Leslie I. Boden, Moral Hazard: A Question of Morality? 3 NEW SOLUTIONS 257 (2000). 893 Duncan B. Douglass, An Examination of the Fraud Liability Shift in Consumer Card-Based Payment Systems, FRB
Chicago 43, 46 (2009): “As it currently stands, the major card networks’ zero liability policies (and even the very low
deductibles payable by cardholders under public law) leave in place a significant risk of moral hazard that almost
certainly, at least at the margins, contributes to overall systemwide fraud losses”.
212
interchange fee), are the merchants, and ultimately the public. The insured parties are the
issuers, who can act recklessly in their credit offerings. Indeed issuers in Israel offer generous
credit lines. They know that proceeds from interchange fee would reimburse them for any loss.
Thus, merchants (and indirectly the public), compensate issuers for granting high credit to
cardholders.
The expert that was nominated to implement the Methodology Decision, acknowledged the
moral hazard, but argued that payment guarantee losses are fully qualifying costs, since the
payment card firms were not prepared in advance for his inspection of their costs, and therefore
did not deliberately inflate their credit lines in order to be repaid with a higher interchange
fee.894 In my view this reasoning is flawed. The interim report was based on 2007 costs. The
final report was based on 2009 costs. Thus the payment card firms had more than a year to
“prepare” their costs. The reasoning behind inclusion of actual losses in the interchange fee
does not hold. In Australia, while the cost based methodology was in force and in U.S today,
materialized fraud losses are excluded from the interchange fee.895 In my view, in Israel, credit
losses should likewise not be part of the interchange fee calculation, as issuers are already
reimbursed for this cost through the (high) interest they charge their cardholders on outstanding
credit.
506. In Israel moral hazard is a real concern. Issuers, especially non-bank issuers who have less
information than banks about the credit scoring of their cardholders, are very generous in the
unsecured credit lines they grant their cardholders, with no collateral. Banks, which are better
aware of the credit scoring of their customers, are reluctant to grant such generous credit lines
that non-bank issuers give out easily. The explanation for such risky credit is that issuers create
moral hazard and externalize the costs of default on merchants via the interchange fee.
507. Not only does the interchange fee reimburse issuers, but so does the interest from cardholders
earned on credit lines granted by issuers. Issuers get paid for the costs associated with this credit
two times: First through the interchange fee and second through the interest from cardholders.
It turns out that interchange fee double-compensates issuers. Indeed in U.S., the costs of
granting credit lines to cardholders are considered a service from issuers to their cardholders
894 AT 610/06 (Interim Expert Report), supra note 864, at 47. 895 REFORM OF CREDIT CARD SCHEMES IN AUSTRALIA, FINAL REFORMS AND REGULATION IMPACT STATEMENT, at 37
(RBA, 2002): “[T]he Reserve Bank has not been persuaded that other costs of clear benefit to cardholders, such as…
the cost of credit losses, should be included in the cost-based benchmark.”; Debit Card Interchange Fees and Routing,
Final Rule, supra note 31, at 46264: “[F]raud losses, including ATM losses... are not costs incurred to prevent
fraudulent electronic debit transactions and are excluded”.
213
and not to merchants. However, it should be noted that the costs which make up the core of the
payment guarantee, i.e., the actual default and fraud losses, are relatively small, and amount to
less than 0.1% (out of the 0.7% of the interchange fee in Israel).896
508. Unexpectedly, the biggest two components of the interchange fee in Israel are the cost of capital
and payments to the banks. These costs seem not to raise much attention in the literature. Quiet
as they are, they alone account for 0.4%, i.e., more than half of the interchange fee.897 In my
opinion these components should not have been included in the calculation of the interchange
fee.
The cost of capital is a virtual cost. It reflects the price of the capital that issuers must confine,
because of their open debt position to merchants. This cost imitates a virtual loss of interest (for
shareholders of issuers) on the confined capital. First, the cost of capital is only a theoretical
component and not an actual direct cost. The Methodology Decision specifically called for
counting only direct costs in the interchange fee calculation. Second, this cost is derived from
the credit function to cardholders. Merchants do not have benefit from the cost of capital that
is needed to guarantee credit given to cardholders. The cardholders are the direct beneficiaries
of this credit. The cost of capital is not a direct cost that issuers incur for the benefit of
merchants, as required for inclusion by the Methodology Decision.
509. In my view, "payments to banks" should also not be included in the calculation of the
interchange fee. Most payment cards are issued with the cooperation of the bank in which the
cardholder has an account. Banks grant their customers unsecured credit lines (overdraft).
Customers can use their credit lines in various ways. Customers can withdraw cash, write
checks or use their payment cards up to the limit of the credit line. The payment guarantee does
not add any significant risk beyond that which the bank incurs anyway. The credit function of
payment cards is one possible unsecured channel of credit line banks give their customers.898
Banks already bear the risks of clients that default. The fact that a cardholder choses to use the
credit line via a payment card, does not increase the risk of default to the bank more than if the
cardholder would have used the credit line by cash withdrawals or any other way.899
896 AT 610/06 (Final Report by Dr. Parizat); Fumiko Hayashi, Payment Card Interchange Fees and Merchant Service
Charges - an International Comparison, supra note 166, at 19-21. 897 AT 610/06 Leumi V. Antitrust General Director (Expert Opinion of Dr. Shlomi Parizat on the Calculation of the
Interchange Fee - Final Report) at 28, 35 (May 23, 2011). 898 For comparison, in U.S., payment guarantee is considered a service to cardholders and not to merchants, see ¶ 642. 899 Wilko Bolt et al., Consumer Credit and Payment Cards, at 28 (ECB Working Paper 1387, 2011).
214
510. Another criticism of the cost-based methodology is from a theoretical point of view. Cost-based
methodology is not founded on any economic model. There is a consensus in literature that
cost-based interchange fees cannot yield optimal outcome.900 Interchange fee is a balancing
mechanism and not a payment for service that bears a “price tag”.901 From a theoretical point
of view, the services that are purportedly paid for through the interchange fee are not given only
to merchants. They are given to all “customers” of payment cards as a whole, cardholders and
merchants. The processing and the authorization of transactions are not being made only for the
benefit of merchants. Cardholders also enjoy from these services. As explained above,
cardholders also enjoy from the payment guarantee and the free funding period.902
The cost-based methodology wrongly assumes a vertical structure of a production chain in
which issuers are at the top, acquirers are downstream and thereafter merchants and
cardholders.903 This approach ignores the fact that consumers, and not only merchants, are also
customers of issuers for card services. Therefore, allocation of costs to the issuing (or acquiring)
900 Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 165, at 102: “"A robust
conclusion of the economic literature on interchange fees and two-sided markets is that cost-based interchange fees are
generally not socially optimal… There is no basis in economic theory or fact for cost-based regulation of interchange
fees such as the regime adopted in Australia or by the European Commission.”;
Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 959: “Economists
have shown that, except by happenstance, the optimal interchange fee will be neither zero nor determinable by any
strictly cost-based measure.”;
Emilio Calvano, Note on the Economic Theory of Interchange (Feb. 22, 2011) : "[T]here is no economic basis for cost-
based regulation. That is, there is no reason to believe that cost-based regulation would improve social welfare relative
to market-set interchange fees.";
Julian Wright, Why Payment Card Fees are Biased Against Retailers, 43 RAND J. ECON. 761, 775 (2012): “There is
near unanimity among economists that setting interchange fees based on the costs faced by issuers, as has happened in
Australia (for credit cards) and in the United States (for debit cards) has no good theoretical basis.”;
Marc Rysman & Julian Wright, The Economics of Payment Cards, at 34 (2015): “The problem with this approach is it
is not supported by any economic theory. None of the existing models that work out optimal interchange fees (either
those maximizing welfare or consumer surplus) imply interchange fees based on issuers' costs will be optimal, or will
indeed increase welfare relative to unregulated fees. This is the consensus reached in surveys of the literature”;
Prager et al., Interchange Fees and Payment Card Networks, supra note 64, at 48 (2009): "More importantly, the
economic theory underlying the efficient interchange fee provides no rationale for either a strictly cost-based
interchange fee".
Joshua S. Gans & Stephen P. King, Approaches to Regulating Interchange Fees in Payment Systems, 2 REV. NETWORK
ECON. 125 (2003); Julian Wright, The Determinants of Optimal Interchange Fees in Payment Systems, 52 J. INDUS.
ECON. 1 (2004); 901 See ch. 7.3 (interchange fee as a mechanism to internalize network externality). 902 Supra ¶¶ 491, 507, 508, 681. 903 Jean Charles Rochet, The Interchange Fee Mysteries, Commentary on Evans and Schmalensee, Payments System
Research Conferences 139, 142 (2005): “Interchange fees should be based on some fraction of the issuer’s cost...
this view is based on a wrong “vertical” model where only the merchant benefits from the payment service”. Éva Keszy-Harmath et al., The Role of the Interchange Fee in Card Payment Systems, at 19 (MNB Occasional papers
96. 2012): “As pointed out by Rochet and Tirole, the cost based method implicitly assumes a vertical structure in which
issuer banks provide a type of intermediary service to acquirer banks, and the acquirer banks provide an end service to
merchants. In this structure, the interchange fee is a fee paid for a service. Rochet and Tirole argue that the vertical
approach, however, is faulty, as it neglects cardholders as consumers of the card service, that is, that the card market is a
two-sided market with network externalities on which the two types of consumer demand need to be balanced. Thus,
the interchange fee not only affects the marginal cost of merchants, but also cardholders and card use".
215
side only, is wrong, because costs are in fact shared by the two sides.904
For example, if the cost of printing a newspaper increases, then the cost increases for both
readers and advertisers. It would seem artificial to allocate this cost increase only to one side.
In the same manner, the salary of the CEO and the CFO of a payment card firm is common to
the issuing and acquiring side. It is artificial to allocate joint costs or even part of them, to one
of the sides.905
511. For completeness, it must be noted that there is an answer to the last criticism. The fact that
some costs are common to the two sides, and cannot be specifically allocated, does not mean
that it is not possible to estimate a reasonable allocation to each side. One way to allocate
common costs is by attaching coefficients to the common costs. For instance, one can think of
allocating the cost of printing a newspaper between advertisers and readers according to the
ratio between the costs of ink used for articles and the ink used for advertisements, or the ratio
between content area and advertisement area in the newspaper. The cost of the CEO can be
allocated by the ratio of time she dedicates to issuing activities compared to the time dedicated
to the acquiring activities. Overhead and indirect costs can be allocated according to number of
employers.906 Most of the work of the expert in Israel was to allocate eligible parts of common
costs to the interchange fee. The expert used coefficients to allocate the eligible part of common
costs.907
Regulation of Isracard
512. A major disadvantage of regulating payment cards via interchange fees is that closed networks
that do not have interchange fees, are excluded from the regulation.
513. Isracard (the company) is the sole owner of a local payment card, Isracart. Until 2012, Isracard
was the sole issuer and acquirer of Isracart. The market share of Isracart (the local card) was
904 Steven Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, 14 STAN. J. L. BUS.
& FIN. 343, 355 n. 58 (2009): “Although total costs are relevant, they cannot be neatly segregated between cardholders
and merchants. Most costs are jointly caused and the benefits produced largely overlap between the two customer
groups”. 905 David S. Evans, The Antitrust Economics of Multi-Sided Markets, 20 YALE J. ON REG. 325, 345 (2003): “It is well
recognized by economists that in multi-product businesses the allocation of joint costs to a particular product is arbitrary
and that there is no economic rationale behind any proposed formula for doing so... Price-marginal cost relationships for
one side do not have any economic meaning either”. 906 Górka, Payment Behaviour in Poland, supra note 842, at 20: “Direct costs and revenues are allocated using
transactional cost drivers (the number and value of payment transactions and data about overnight deposits). It is more
difficult to distribute indirect costs between particular payment instruments”. 907 AT 610/06 (Interim Expert Report), supra note 864, at 35.
216
less than 20% of all payment cards. Nevertheless as sole acquirer and issuer of Isracart cards,
Isracard had a monopoly of 100% market share in acquiring and issuing Isracart payment cards.
514. In 2005, the General Director used his authority to declare Isracard to be a monopoly in
acquiring Isracart cards. The General Director emphasized that the basis of the declaration was
that merchants could not refuse to accept Isracart cards, as other cards are no substitute when a
customer wants to pay with Isracart.908
American Express and Diners Club also operate in Israel as closed networks. Diners Club is a
closed network operated by CAL. American Express is a closed network operated by Isracard.
However, the market share of each of them is less than 5%. Merchants find it easier to reject
them than to refuse more popular card such as Isracart. In addition American Express and
Diners are often a second card whereas Isracart was often the only card of the cardholder, a
phenomenon called singlehoming.909 Therefore, American Express and Diners Card did not
present same concerns as Isracart, which was perceived as a "must take" card.910
However, no operative measures were taken against Isracard following the declaration. A
consent decree under Section 50 of the Antitrust Law was withdrawn by the General Director.911
515. The Trio Agreement from 2006 applied to Visa and MasterCard brands only. It did not apply
to Isracart, American Express and Diners Club. Issuing and acquiring Isracart continued to be
performed exclusively by Isracard, as a closed network. The Trio Agreement, however, limited
the autonomy of Isracard to charge any MSF for its Isracart brand. It determined that under
certain conditions Isracard must compare the MSF of Isracart to the MSF it charged for the
open MasterCard brand.912 No similar limitations were imposed on Diners Club or American
Express.
516. In August 2011, the Banking Law (Licensing) (Amendment No. 18), was enacted. This
amendment defines an issuer with a market share of 10% or more, as a "large-scale issuer". The
amendment applies to Isracart cards but not to American Express and Diners, because their
908 Declaration on Isracard as Monopoly in Acquiring Isracart and MasterCard, Antitrust 5000034 (May 22, 2005). 909 For expansion see ¶ 285 and ch. 6.6.2. 910 See ch. 6.4, especially ¶¶ 202-203. 911 AT 7011/02 Antitrust General Director v. Bank Hapoalim, Antitrust 5000874 (Aug. 14, 2006). 912 Article 2 of the Trio Agreement, in AT 610/06 Leumi v. Antitrust General Director, (Motion to Approve a Restrictive
Arrangement), Antitrust 6652 (Oct. 30, 2006).
217
market share is lower. The amendment provides that a "large-scale issuer" shall not
unreasonably refuse to contract with an acquirer for the purpose of cross-acquiring.913
517. In January 2012 the Banking Commissioner announced that Isracard, Leumi Card and CAL are
all large scale issuers.914 Isracard had to open its proprietary Isracart network to other acquirers.
Isracard demanded from LeumiCard and CAL royalties and additional fees on top of the
interchange fee, as a condition for permitting them to acquire Isracart brand cards. The General
Director temporarily exempted these fees,915 but after further inspection, allowed only a one-
time fixed license payment and an additional payment based on a percentage of Isracart
acquiring turnover, which was smaller than the payment that Isracard had demanded.916
Isracard did not accept the decision and submitted a motion to the Antitrust Tribunal, to approve
the additional fees. In March 2014 the Tribunal rejected Isracard’s motion.917 The Tribunal
based its ruling on several reasons: (a) the concern that additional fees may raise the floor of
the MSF to a higher level ("interchange fee plus the additional fees"), because acquirers would
align the MSF upwards, according to the highest interchange fee; (b) the concern that the
additional fees would raise Isracard’s rivals costs; (c) the concern that the additional payments
would act as entry barriers to new acquirers; and (d) the conclusion that the services Isracard
purportedly supplies for the additional fees are actually already included in the interchange fee.
518. In my opinion, the ruling of the Antitrust Tribunal is not only correct, but applying its logic,
should have even extend it to ban all additional fees Isracard demanded above the interchange
fee. First, the Tribunal’s reasoning about increasing the floor to the MSF and raising rivals’
costs applies equally to prohibiting any payments above the interchange fee, i.e., this reasoning
applies also to both the fixed payment and the percentage of turnover payment that Isracard is
allowed to collect.
Second, the Antitrust General Director found that the services of Isracard to its acquirers, as a
brand owner, were worth less than those of Visa and MasterCard. So under cost-based
methodology like the one applied in Israel, acquiring Isracard brand cards should be cheaper,
913 Article 36(13)(b) of the Banking Law (Licensing) 1981. 914 Directives of the Banks' Supervisor - Notice on Issuers with Large Scale of Activity (Dec. 20, 2011) available at
http://www.boi.org.il/he/NewsAndPublications/PressReleases/Pages/111220h.aspx . Directives of the Banks'
Supervisor - Notice on Issuers with Large Scale of Activity (Dec. 20, 2011) http://www.boi.org.il/he/NewsAndPublications/PressReleases/Pages/111220h.aspx 915 Exemption to Isracard, Leumicard and CAL, Antitrust 5001952 (May 14, 2012); Exemption to Isracard, Leumicard
and CAL, Antitrust, Antitrust 500207 (Aug. 8, 2012). 916 Exemption to Isracard, Leumicard and CAL, Antitrust 500226 (Sept. 13, 2012); IAA, ENHANCEMENT OF
EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note 21, at 11. 917 AT 11333-02-13 Isracard v. Antitrust General Director, Antitrust 500647 (Mar. 9, 2014).
218
and not more expensive than acquiring Visa or MasterCard cards.
Third, and perhaps most important, the entire purpose of the interchange fee is to be a
comprehensive payment from acquirer to issuer. Any additional payment that Isracard
demanded should have been part of the interchange fee, or not an eligible cost at all. In this
context, Article 5 of the European Regulation 2015/751 on Interchange Fees from May 2015
prohibits any circumvention of the interchange fee no matter how the parties design it.918
Applying this rule would have resulted in tossing all fees Isracard demanded which were on top
of the interchange fee.
519. Fourth, as the Tribunal noted, acquirers usually charge merchants one MSF for all cards, even
if some cards carry a larger MSF. This unification is called “blending”. Even if acquirers do not
blend, merchants do tend to blend. Merchants tend not to charge different prices to customers
who pay with a slightly more expensive payment instrument. I dedicated a chapter of this work
to explain this phenomenon.919
Blending prevents customers from internalizing that some cards are more expensive than others.
Blending leads to unification of prices for customers who pay with expensive and cheap
payment instruments. Blending leads to perversive cross-subsidization of expensive payment
cards by cheaper cards. Thus, under the logical assumption that merchants would not have
surcharged customers who pay with the more expensive (to merchants) Isracart, the effect of
the additional charges Isracard demanded, would have been (1) cross subsidy of Isracart by
other cards; (2) a small increase in goods' prices sold by merchants which accept Isracart. All
customers would have suffered from this increase, and not only those who pay with Isracart
cards. The Tribunal rightly rejected the demand of Isracard which is similar to imposing an
"Isracart Tax".920
918 EU Regulation 2015/751 on Interchange Fees for Card-Based Payment Transactions, O.J L 123/1, Article 5
(19.5.15): "Prohibition of circumvention… any agreed remuneration, including net compensation, with an equivalent
object or effect of the interchange fee, received by an issuer from the payment card scheme, acquirer or any other
intermediary in relation to payment transactions or related activities shall be treated as part of the interchange fee". See
also EU, Proposal for a Regulation on Interchange Fees, supra note 200, at 28: “[A]ny net compensation received by
an issuing bank from a payment card scheme in relation to payment transactions or related activities shall be treated as
part of the interchange fee”. See also id. at 23. 919 See ch. 11. 920 For expansion on the interchange fee as transaction tax see ¶¶ 224, 383, 695, 715, 783, 830.
219
520. In June 2012, in accordance with the Trio Agreement, and after Isracard was no longer the sole
acquirer of its proprietary Isracart brand, the General Director repealed the monopoly
declaration on Isracard.921
Categories Of Interchange Fees
521. Merchants are heterogeneous in the benefit they derive from cards. Some merchants are more
willing to accept cards than others. Card networks can therefore use their market power to price-
discriminate between merchants, according to the merchants’ varying willingness to pay.922
522. Categories of interchange fees can be set according to types of cards (premium cards may bear
higher interchange fees), types of transaction (credit interchange fee is higher than debit, with
Israel as a twisted exception until April 2016), and types of merchants (e.g., supermarket,
groceries or gas stations).923
523. Historically, payment cards firms divided merchants into categories of different interchange
fees, based on sectors of activities, types of cards and size of merchants. These categories
enabled the card networks to price discriminate and extract surplus from merchants with higher
demand for cards, without losing merchants with lower demand.
524. The Methodology Decision determined that subject to two exceptions, there should be no
interchange fee categories. The Tribunal noted that categories are equivalent to price
discrimination, which can impede competition if two competing merchants pay different
interchange fees.924
921 Annulment of Declaration on Isracart as a Monopoly, Antitrust 4538 (Jul. 3, 2012). 922 Rochet & Tirole, Externalities and Regulation in Card Payment Systems, supra note 879, at 7: “Card payment
systems, whether proprietary or not-for-profit, to some extent try to account for this heterogeneity and offer lower
interchange fees/merchant discounts to certain classes of merchants. Such price discrimination however is necessarily
limited. Merchants with more limited convenience benefits from cards have a relative preference for lower interchange
fees (a lower volume of card transactions) compared to those with higher convenience benefits. The former may
therefore object to an interchange fee policy that in part reflects the average merchant’s concerns”. 923 Robin A. Prager et al., Interchange Fees and Payment Card Networks: Economics, Industry Developments, and
Policy Issues, at 25 (F.R.B. Finance and Economics Discussion Series 23-09, 2009): “For many years, the interchange
fee for an individual card transaction at a given merchant has varied with transaction type (credit, signature debit, or
PIN debit) and purchase value. Interchange fees also vary across merchants according to merchant type (e.g.,
supermarket or gas station) and merchant sales volume, and the number of distinct merchant types listed in interchange
fee schedules continues to proliferate. Recently, Visa and MasterCard have introduced interchange fees that vary across
card programs, even for a given merchant type and sales volume”. 924 AT 4630/01 Leumi v. Antitrust General Director, para. 48 (Aug. 31, 2006).
220
Nevertheless, the Tribunal accepted the position of the Antitrust General Director, and allowed
categories of interchange fees under two exceptions:
524.1 Merchants, who allegedly do not benefit from the payment guarantee, should pay a
lower interchange fee.
524.2 Transactions in which the payment-guarantee is significantly different than that of
the unified category should have a different interchange fee. Lower interchange fee
should prevail in transactions in which the payment guarantee is significantly low,
and a higher interchange fee for transactions in which the payment guarantee is
significantly high.925
525. The Trio Agreement determined that effective July 1, 2010, the categories were to be unified,
except for merchants or transactions that qualify for a different interchange fee according to the
Methodology Decision.926
526. Worldwide there are different approaches towards categories, even within the same country.
The U.S. credit card market presents various interchange fee categories.927 MasterCard’s top
tier of interchange fee for its “world elite” cards is over 3.25%.928 As a rule of thumb, cards that
carry rewards are in a category of higher interchange fees.929 In Australia, the average
interchange fee is regulated but categories are allowed as long as the average does not exceed
the regulated fee. In the U.S., since Durbin Amendment, all debit card interchange fees of
regulated institutions are subject to the same cap. Categories are theoretically allowed but in
practice regulated institutions align the fee to the cap.930 The Durbin Amendment does not apply
925Id. Para. 53. 926 Annex A to the Trio Agreement, Antitrust 6652 (Oct. 30, 2006). 927 United States v. Am. Express Co., 2015 U.S. Dist. Lexis 20114, at 31 (E.D.N.Y Feb. 19, 2015): “[T]he interchange
rate charged on the Visa and MasterCard network varies along two axes: (1) the industry the merchant belongs to, and
(2) the actual card product used by the cardholder. MasterCard, for example, has more than 240 different interchange
rate categories, and Visa has more than 70 categories.”; Rong Ding & Julian Wright, Payment Card Interchange Fees
and Price Discrimination, at 2 (2015): “MasterCard, for instance, had 36 different interchange fee categories in 2014
for consumer credit cards transactions in the U.S. reflecting different types of merchants such as Airlines, Insurance,
Lodging and Auto-rental, Petroleum Base, Public Sector, Real-Estate, Restaurants, Supermarkets, and Utilities”. 928 MasterCard 2015–2016 U.S. Region Interchange Programs and Rates (last visit Oct. 30, 2016) http://www.mastercard.com/us/merchant/pdf/Merchant_Rates_April_2014.pdf 929 Adam J. Levitin, Priceless? the Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321, 1323
(2008): “Credit cards with rewards programs cost more for merchants to accept than cards without rewards”. Prager et
al., Interchange Fees and Payment Card Networks, supra note 923, at 26: “[I]nterchange fees associated with Visa’s
and MasterCard’s premium rewards cards are markedly higher than the interchange fees associated with their basic
credit cards”. 930 Rong Ding & Julian Wright, Payment Card Interchange Fees and Price Discrimination, at 5 (2015): “[I]n Australia,
policymakers have allowed platforms to set different credit card interchange fees subject to a cap on the average
interchange fee. In contrast, in the U.S., policymakers have required debit card interchange fees in all categories to be
subject to the same cap, thereby effectively ruling out discriminatory interchange fees”.
221
to issuers with turnover of less than $ 10 billion. As a result, in the United States there are two
tiers of interchange fees: one regulated, and one for exempted issuers, which is, not surprisingly,
higher.931 The European Interchange Fee Regulation from 2015 (Regulation 2015/751), allows
categories of interchange fees for debit transactions, as long as the average interchange fee is
kept on 0.2%, but forbids categories for credit transactions (which are capped at 0.3%).932
527. Getting back to Israel, the experts (Dr. Bachar followed by Dr. Parizat), who were nominated
to implement the Methodology Decision, specifically had to address the issue of categories.
Transaction Categories
528. With respect to transactions, the experts identified three kinds of transactions as candidates for
a different category of interchange fee: (a) non-paper transactions, in which the payment
guarantee is lower, because it does not cover fraud; (b) multiple payments transactions, in which
the payment guarantee is higher, because the issuer guarantees default risks of the cardholder
for as long as payments continue; (c) transactions acquired in smart POSs in which the payment
guarantee is theoretically lower because of better identification. Ultimately, only payments
transactions received a 0.05% higher interchange fee.933
529. It is interesting to note that the most obvious category of transactions in which the payment
guarantee is lower - debit and prepaid transactions, was not even considered as candidate for
lower interchange fee. The distortion is noticeable because the difference in payment guarantee
is more than 100% lower and not just 0.05% lower. Debit transactions evidently passed under
the radar of the experts and the IAA. The reasons for this ignorance would probably be clarified
in a pending class-action, the undersigned is involved with, claiming, inter alia that debit and
prepaid interchange fees in Israel should have been lower than that of credit, specifically in
light of the Methodology Decision.934
530. With respect to non-paper transactions, such as internet or telephone transactions, effective July
1, 2012 the interchange fee in these transactions is the same as in documented transactions.935
931 Sandwith, The Dodd-Frank Wall Street Reform, supra note 237, at 234-35, 240-41; Fumiko Hayashi, The New Debit
Card Regulations: Initial Effects on Networks and Banks, 4 FRB KANSAS CITY ECON' REV 79, 107 (2012): “Most card
networks have set two separate interchange fee schedules: one for regulated banks, conforming to the new caps on
interchange fees for those banks, and a separate one for exempt banks.”; Fumiko Hayashi, The New Debit Card
Regulations: Effects on Merchants, Consumers, and Payments System Efficiency, 1 FRB Kansas Q. REV. 89, 92 (2013). 932 Infra ¶ 584. 933 AT 610/06 (Interim Expert Report), supra note 864, at 67; AT 610/06 (Expert Opinion, Final Report), supra note
897, at 37. 934 Infra ¶ 553. 935 AT 610/06 Leumi V. Antitrust General Director, Antitrust 500191 (Mar. 7, 2012).
222
Until July 1, 2012 the interchange fee in those transactions was 0.15% higher.936 The payment
card firms claimed that higher fee is required because non-paper transactions are riskier. This
argument was flawed. According to the network rules, payment guarantee in non-paper
transactions is lower than in ordinary transactions, especially with regard to fraud.937 In U.S.
the court recognized this flaw as early as 2001.938 Unfortunately it took until 2012 for Israel to
recognize and correct this distortion.939
Merchant categories
531. As for categories of merchants who allegedly do not benefit from the payment guarantee, the
experts identified the state and its agencies as candidates to remain in a lower category of
0.5%.940
532. The payment card firms claimed that the Israel Electric Company (“IEC”) should also belong
to the category of lower interchange fees. The Antitrust Authority did not support this stance,
but was forced by the Antitrust Tribunal to accept the firms' position. As of July 2010, merchant
categories have been unified, except for the state, its agencies and the IEC.941
533. In my view, there should be no categories of merchant interchange fees. The fact that the
Methodology Decision determined “cost-based” interchange fee negates merchant categories
that are “benefit-based”, as this is contrary to the methodology. This conclusion should be
emphasized:
534. First, payment guarantee is same for all merchants. When a cardholder defaults, the payment
guarantee of the card's issuer covers all merchants at which the cardholders purchased.942
Therefore the state and the IEC should not be treated differently than any other merchant.
535. Second, the main goal of antitrust law is to maximize consumer welfare.943 Under this standard,
price discrimination is inferior to a competitive (cost based) pricing. In comparison to
936 AT 610/06 Leumi v. Antitrust General Director ¶ 17 (Aug. 7, 2011). 937 AT 610/06 (Expert Opinion, Final Report), supra note 897, at 38. 938 United States v. Visa U.S.A., 163 F. Supp. 2d 322, 341 (S.D.N.Y 2001): "Defendants rationalize this difference by
pointing to increased fraud in these merchant categories, but this explanation is belied by the fact that the Internet
merchant, not Visa/MasterCard or their member banks, bears virtually all the risk of loss from fraudulent transactions". 939 AT 610/06 Leumi V. Antitrust General Director, Antitrust 500191, para. 9 (Mar. 7, 2012); AT 601/06 Isracard v.
Antitrust General Director (Jul. 18, 2010). 940 AT 610/06 (Interim Expert Report), supra note 864, at 67. 941 AT 601/06 Isracard v. Antitrust General Director (July 18, 2010). 942 AT 610/06 (Expert Opinion, Final Report), supra note 897, at 37. 943 FTC, Press Release, Principles regarding Enforcement of FTC Act as a Competition Statute (Aug. 13, 2015): “The
promotion of consumer welfare is a cornerstone of the FTC’s antitrust enforcement”;
223
competitive outcome, price discrimination (i.e., categories) always reduces consumer-welfare.
The Tribunal held that an interchange fee which is based on direct costs, will lead to a
competitive result.944 By definition, competitive pricing and price discrimination cannot
coexist. The Former requires a uniform price that is equal to the marginal cost of production
(P=MC). The latter involves pricing above costs, and reducing consumer-welfare in comparison
to competitive pricing. Thus, under the antitrust standard for maximizing welfare, categories
should not have been allowed.
This criticism can have another angle. If the benefit from a product or a service is less than its
cost, it is efficient that the consumer will not buy the product or the service and there will be no
transaction. If, for example, the payment guarantee costs 0.7% of the transaction, then it is
efficient not to set an interchange fee for the state and the IEC at 0.5% (the level of the low
category). The approach of the Tribunal means that, absurdly, the state, its agencies and the
IEC receive a payment guarantee service that costs 0.7%, but pay only 0.5% for it. It is all the
more absurd because the 0.7% interchange fee in Israel is an average fee, so other merchants
could end up paying a little more, because the state and the IEC pay a little less. Merchants in
Israel actually subsidize the cost of the payment guarantee to the state, its agencies and the IEC.
This is unreasonable paternalism.
536. Third, the payment card firms tried to justify the categories by invoking the Ramsey Principle,
according to which, under certain conditions, price discrimination, (i.e. categories), may
BARAK ORBACH, THE GOALS OF ANTITRUST LAW IN PRACTICE, IN LEGAL AND ECONOMIC ANALYSIS OF ANTITRUST
LAW 63, 97 (Michal Gal & Menachem Perlman eds., 2008) (claiming competition enhances first and foremost
consumers, and citing Herbert Hovenkamp: “After thirty years, the debate over antitrust ideology has quieted. Most
now agree that the protection of consumer welfare should be the only goal of antitrust laws”);
COMPACT v. Metropolitan Government of Nashville & Davidson County, 594 F. Supp. 1567, 1572 (M.D. Tenn. 1984):
“[W]hile judicial pronouncements during the last fifty years have varied on the central policy intended by Congress in
its enactment of the Sherman Act, the current concensus among both courts and commentators embraces consumer
welfare as the objective served by enforcement of the antitrust laws.”;
Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 67, at 35: “The concept of consumers has been
further developed in the Commission’s Guidelines... where it is stated that the concept of consumers should encompass
all direct or indirect users of the product covered by the agreement, including producers that use the products as an
input, wholesalers, retailers and final consumers”;
OECD, POLICY ROUNDTABLE, EXCESSIVE PRICES, at 24 DAF/COMP(2011)18: “The concept of consumer harm has
been identified as the “intellectual cornerstone of competition policy”
See also Cr.A 4855/02 Borowitz v. State of Israel, 59 (6) 776, 861 (2005); SCL 4465/98 Tivol v. Shef Hayam, 56(1) 56,
80 (2001); HCJ 588/84 K.S.R Asbestos v. Chairman of Antitrust Council, 40(1) 29, 37 (1986); A.T 36014-12-10 Kaniel
v. IAA, para. 10 (June 10, 2012); Cf. Jean Charles Rochet, Competing Payment Systems: Key Insights from the
Academic Literature, at 7 (Paper Prepared for the Payments System Review Conference) (2007): “Farrell (2006) argues
that the target for a Competition Authority (as opposed to a regulator like the RBA) should be consumer surplus and not
social welfare.” 944 The Methodology Decision, AT 4630/01 Leumi v. Antitrust General Director, para. 33 (Aug. 31, 2006).
224
promote efficiency.945 They argued that interchange fee should reflect merchants' elasticity of
demand. i.e., merchants with rigid elasticity should pay more. The Tribunal rejected this
argument, but simultaneously accepted it for merchants who allegedly do not benefit from the
payment guarantee.946 It is not logical to accept and reject the same principle.947
Price discrimination might sometimes be efficient, but not in payment cards. Charging high
interchange fees from merchants with rigid demand is just another way for networks to use their
market power and exploit those merchants.948
Ramsey pricing argument was also rejected by the European Commission in the European
MasterCard Decision. There was no evidence in that case that issuers could not cover their fixed
costs without resorting to price discrimination. The mere fact that the interchange fee was used
to enhance card adoption and usage among cardholders was not accepted as a reason for
categories of interchange fees.949
537. Fourth, categories can be performed on the acquiring side via the MSF. The MSF is an overt
price. It is relatively easy for merchants to compare between different MSFs offered to them.
Discrimination in the interchange fee is more difficult to detect. Even if detected, it is
impossible for a merchant to dispute over it.950 If price discrimination is efficient it should be
in the revealed and transparent MSF, and not latent.
538. Fifth, merchants accept payment cards. They do not explicitly accept payment guarantee,
because there is no such product. Even assuming that the interchange fee should be based on
benefit, then such benefit should be with respect to the product as a whole, which is a payment
card. Benefits merchants gain from payment cards cannot be attributed only to the function of
payment guarantee, as a differentiated component. Benefit from payment guarantee cannot be
measured in isolation. It is part of a complete product, named a payment card.
945Id. para 53; See also Frank Ramsey, A Contribution to the Theory of Taxation, ECON. J. (1927); Hans Zenger,
Differentiated Interchange Fees, 115 Econ. Letters 276 (2012). 946 The Methodology Decision, AT 4630/01 Leumi v. Antitrust General Director, para. 33 (Aug. 31, 2006). 947 See, in another context, the minority opinion (not in this issue) of Additional Civil Appeal 6811/04 Menahel Mas
Shevach v. Shadmi (Manager of real estate Tax v. Shadmi), 63(1) 778, 819 (2009). 948 Alan Frankel, Interchange in various Countries: Commentary on Weiner and Wright, FRB KANSAS 51, 58 (2005).
But see also Rong Ding & Julian Wright, Payment Card Interchange Fees and Price Discrimination (2015). 949 Comp/34.579 European Comm'n MasterCard Decision, supra note 44. 950 Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321, 1333
(2008): “Because the interchange fee is an arrangement between the acquirer and the issuer, merchants cannot negotiate
the interchange rate”.
225
Even assuming types of merchants who do not derive benefits from payment guarantee, e.g.,
because their customers never default, they may well have high benefits from payment cards as
a whole. Accepting cards might save them labor, collection array and costs of handling cash.
Thus, these merchants, whose very existence is doubtful, should not be in a lower category.
539. Sixth, if low benefit from the payment guarantee is the criterion for belonging to a category of
low interchange fee, other merchants should be classified in the lower category. Universities,
for example, do not benefit from the payment guarantee. A student who does not pay tuition
will not be permitted to take exams, and will not receive a graduation certification. If a
university would not accept payment cards, it is unlikely that its revenues would decrease.
Students would probably not go to another academy, because the university they desire does
not accept cards. It follows that if benefit from the payment guarantee is the criterion for a low
interchange fee, other merchants, of which universities are just an example, should also be
added.
Moreover, universities may well derive substantial benefits from payment cards, as a product.
Cards are convenient, easy to accept by phone or on-line, and they save alternative costs of
other payment instruments.951 Universities are just an example. In 2010, Bezeq, the Israeli
monopoly in immobile telephones, filed a civil suit for a declaratory order that it should be
included in the lower category, because of the purported claim that it does not benefit from
payment guarantee. This suit was later withdrawn by Bezeq.
540. Seventh, ironically, there is a strong basis to believe that the state, in fact, is the entity which
benefits the most from payment cards. Payment cards, especially debit cards, are a substitute
for cash.952 Studies estimate that replacing paper money with cards can save the state up to 1%
of GDP.953 Switching to electronic money also supports fight against black economy.954 Thus
the state should subsidize cards, and not be subsidized by them.
541. Eighth, the state, its agencies and the IEC are powerful merchants. They have strong buying
power over the payment card firms. They are responsible for a substantial share of the payment
card transaction volume. Without price discrimination in the form of categories, all merchants
951 For expansion see infra ch. 0 (Costs and Benefits of Payment Instruments). 952 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 13; Carlos Arango, Kim P. Huynh & Leonard Sabetti, Consumer Payment Choice: Merchant Card Acceptance
Versus Pricing Incentives, 55 J. BANK. FIN. 130, 138 (2015): “Our results also show that debit cards are a closer
substitute to cash than credit cards, as in Borzekowski et al. (2008) and Koulayev et al. (2012)”. 953 Infra ¶ 127. 954 Infra ¶ 146.
226
and all consumers would have enjoyed any of their success in bargaining lower interchange
fees. Those powerful merchants are, in fact, the “marginal consumers”, who are positioned at
the intersection of the demand and supply curve. Marginal consumer is the one who pulls the
price down for all “infra-marginal” customers across the entire market. Isolating the marginal
consumer into a lower-fee category is what enabled the payment card firms to charge more
from the infra-marginal consumers.955
542. Ninth, separation of merchants into categories leads to one of two options, neither is desirable:
If the costs that make up the interchange fee are higher than 0.5%, then merchants, and
indirectly all consumers, subsidize the state, its agencies and the IEC. On the other hand, if
0.5% interchanges fee is profitable, then the expert was wrong, and notwithstanding categories
all merchants in Israel should pay less. Be what may, the current outcome is erroneous.
Debit Cards In Israel
543. The payment card market in Israel is degenerated, in terms of variety of cards and the
arrangements accompanying them. Debit card transactions are faster and cheaper than credit
transactions.956 Nevertheless, debit usage is rare. The degeneration is reflected firstly in the
volume of debit and prepaid cards, which is only about 1.5%.957
544. Debit and prepaid transactions in Israel, suffered until April 2016 from two distortions.
First, the interchange fee for debit and prepaid transactions in Israel was until April 2016 the
same as the interchange fee in deferred debit and credit transactions.958 The interchange fee in
Israel is cost-based. The payment guarantee is the main cost-driver of the interchange fee. The
payment guarantee in debit is significantly lower than in credit. According to the IAA, applying
the Methodology Decision on debit and prepaid transactions yields an interchange fee of
approx. 0.28% instead of 0.7%.959 Nevertheless, it took until April 2016 for the regulator to
955 Alex Chisholm, Speech given at the Regulatory Policy Institute Annual Conference (Sept. 10, 2014): "In any given
market you might have a mix of ‘engaged’ and 'Disengaged’ customers, who suffer from biases to different extents.
And if there is a sufficient number of engaged customers, and if firms cannot price-discriminate between the two
groups, then the actions of engaged customers can indirectly protect disengaged customers."; Cf. Ori BarAm & Elad
Man, Prohibit Price Discrimination [Leesor Al Aflayat Mehirim], THEMARKER, May 3, 2016; Ori BarAm & Elad Man,
One Price for Gas, Big Prize for Consumers, THEMARKER, Aug. 22, 2016. 956 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 12. See also infra ¶ 125. 957 IAA, id. at 8. 958 Banking Decree (Service to Customer) (Supervision on Service that an Issuer Gives Acquirer with Connection to
Interchange Acquiring of Debit Transactions) (Temporary Order), sec. 3 (2015). See also supra ¶ 18. 959 IAA DRAFT REPORT ON ENHANCEMENT OF EFFICIENCY AND COMPETITION IN PAYMENT CARDS, at 12 n. 29, Antitrust
500560 (Feb. 11, 2014).
227
differentiate the interchange fees.
The second twist was that until April 2016 merchants were remitted for debit and prepaid all
payment card transactions, after 20 days (on average) from transaction date. This delay was
outrageous, because the money was taken from the cardholder immediately (in debit), or even
before the transaction (prepaid).960
545. Three different regulators emphasized the distortions and recommended a debit reform.
The first to note was the IAA’s initiative. In 2012, following the conclusion of a Governmental
Committee examining the cost of living (Trachtenberg Committee), the IAA established a new
department, aimed in the promotion of competition - the Competitive Division.961 In February
2014, the Competitive Division published its first (draft) report. This report examined the lack
of competition in the payment card sector.962 The IAA noted the oligopolistic features of the
payment card market: (a) few competitors with stable market shares; (b) only half of the
decrease in the interchange fee was passed through to the MSF. This conclusion was
subsequently proved wrong. The pass through from the interchange fee to the MSF is 100%
(see para. 97); (c) almost no debit cards; (d) technological barriers to entry such as no
interoperability of SHVA for new acquirers.
The IAA noted that according to the Methodology Decision the interchange fee calculation for
debit should be about 0.28% and not 0.7%.963 The IAA emphasized the distortion in delaying
debit and prepaid funds for twenty days (on average). The IAA went even further and
recommended that in deferred debit transactions, payment would be remitted to merchants close
to the transaction. The IAA explained this recommendation in that the card firms have lower
funding costs than merchants.964 Twenty days delay in debit and prepaid remittance to
merchants seemed to the IAA as an obvious distortion. The IAA recommended promotion of
debit cards by, inter alia, reducing the interchange fee in debit transactions, and obligating
960 Supra ¶496. 961 IAA website, “about” tab, http://www.antitrust.gov.il/about/about1.aspx 962 IAA DRAFT REPORT, supra note 959. 963Id. at 12 n. 29. 964Id. at 23-25 (11.2.14); IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL
REPORT), supra note 21, at 27-28.
228
issuers to remit debit and prepaid funds to merchants (via acquirers) within two days of the
transaction, and not once per month.965
546. On September 11, 2014 the IAA published its final report. Again the report noted the high
concentration and the low competitiveness of the payment card market in Israel, and stressed
the need to enhance debit in Israel.966 The final report adopted the recommendations of the draft
report regarding (a) the low interchange fee that should prevail in debit and prepaid transactions,
and (b) the need to advance payments to merchants in these transactions.
In its final report, the IAA highlighted the advantages of debit and its desire to promote debit
cards in Israel. The IAA emphasized that debit cards operate with lower fees than credit cards,
and are cheaper, simpler and faster than credit cards. Debit systems are also a substitute for
cash, and they support combating “black economy”.967
The IAA indicated that low volume of debit transactions is derived from: (a) interchange fee
for debit transactions in Israel, was the same as for deferred debit transactions; (b) public
misperception that credit cards bear free credit, when in fact, they induce interest bearing
debt;968 (c) imposition of usage fees (action or line fee) on every debit transaction, which
diminishes cardholders’ incentive to use debit. This distortion was amended, and the fee was
canceled, on February 2015;969 (d) absence of any incentive for incumbent credit card firms to
develop debit card network, and by that cannibalize their profitable credit card business; (e)
absence of designated debit POSs at cashiers; (f) delay in remittance (20 days on average); (g)
absence of debit infrastructure.970
547. The IAA recommended that debit should be promoted both on the issuing side and on the
acquiring side. On the issuing side, the IAA recommended that issuers would be required to
offer debit cards to 90% of their active cardholders, and to effectively issue debit cards to 70%
of them, by the end of 2015. If issuers would not meet these targets, they would have to issue
965 Press Release, IAA Publishes Research on the Competition in Payment Cards, Antitrust 500561 (Feb. 12, 2014). 966 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 7, 8. 967Id. at 4, 12-14. 968 See infra ¶¶ 152, 159, 728 (the "seduction by plastic" phenomenon). 969 2015 Amendment to Banking Rules (Service to Customers) (Fees), 2008, effective Feb. 1, 2015. 970 Ibid, see also IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL
REPORT), supra note 21, at 13-20.
229
combined cards (i.e., cards that can be used as both debit and credit cards) starting in the middle
of 2016.971
548. On the acquiring side, the IAA recommended: (a) setting a lower interchange fee for debit;972
(b) require issuers to remit debit funds to merchants (via acquirers) within 1-3 days of the
transaction date;973 (c) require banks to identify debit transactions as such in statements to their
clients, and not charge any fee for debit usage,974 (d) abolish HAC rule and enable merchants
to freely choose to accept only cheap payment instruments (i.e., debit and not credit);975 (e)
remove technological barriers and require full interoperability of SHVA's infrastructures for
new acquirers;976 (f) enable debit transactions to be routed on both the ATM network and the
credit card network, (g) encourage merchants to install debit POSs.977
In July 2015, the World Bank awarded the IAA a commendation for its activities to enhance
competition in the Israeli payment card market.978
549. Second encouragement to debit came from a government initiative. In September 2013, the
government decided to take steps to minimize the use of cash, in order to fight black
economy.979 In April 2014, a ministerial Committee regarding the cost of living decided to take
steps to enhance debit usage.980 In May 2014, an interim report of a government committee
(Locker Committee) that was nominated to examine how to limit the use of cash, included
recommendations for promoting debit cards.981 The final report of this committee was
submitted in July 2014.982
The committee stressed that debit payments combat black economy, because transactions are
monitored and registered. The final report recommended, inter alia, authorizing the Antitrust
971Id. recommendation 7 at 24. 972Id. see also Memorandum, Antitrust Law (Amendment 16 - Determination of Interchange Fee), Antitrust 500777
(Aug. 10, 2014). 973 IAA, FINAL REPORT, id. at 24, recommendation 2. 974Id. recommendations 3 and 4. 975Id. 976Id. 977 Id at 25, 31. 978 IAA, Press Release, World Bank awarded commendation to the IAA for Debit Reform, Antitrust 500811 (July, 8,
2015). 979 Government Decision 749 from Sept. 17, 2013 available at http://www.pmo.gov.il/Secretary/GovDecisions/2013/Pages/govdec749.aspx 980 Decision 1551 of Ministers’ Comity on cost of living, ENHANCEMENT OF COMPETITION AND EFFICIENCY IN
PAYMENT CARDS, (Apr. 2014) 981 THE COMMITTEE FOR REDUCING THE USE OF CASH (LOCKER COMMITTEE), INTERIM REPORT, at 17 (May 2014). 982 HAVAADA LEBHINAT TZIMZUM HASHIMUSH BEMEZUMAN BAMESHEK HAISRAELI [THE COMMITTEE FOR EXAMINING
REDUCTION OF CASH USAGE IN THE ISRAELI MARKET] (THE LOCKER COMMITTEE), FINAL REPORT (July 17, 2014).
230
General Director to determine a different interchange fee for debit and fast remittance of debit
funds to merchants, in no more than three days.983
550. Third debit encouragement initiative came from Bank of Israel. In April 2014, the Bank
announced its intention to reduce the number of fees applying to payment cards.984 On February
1, 2015 an amendment to the Banking Rules (Service to Customers) (Fees), 2008 came into
force. Amendment to First Annex § 3 eliminated action fee (line-fee) on debit transactions. The
amendment also prohibited debit cardholder fee, for customers who already possess credit
cards, for 36 months from the issuance of the debit card.985
551. In February 2015 Bank of Israel promulgated a comprehensive report on payment cards
competition.986 The report recommended, inter alia: (a) to reduce interchange fees on debit
transactions; (b) expediting debit remittance to merchants, not later than 3 days from transaction
date; (c) obligate banks to offer their customers free debit cards; (d) educating the Israeli public
about debit advantages; (e) amending the Banking Law (Licensing), 1981, so as to enable
SHVA to serve acquirers that are not banks (i.e., repeal section 23 of the Banking Law
(Licensing) 1981);987 (f) ease equity demands from new debit acquirers.988
552. On June 30, 2015, Bank of Israel announced that the Governor of the Bank intended to declare
that debit interchange fee would be under the Bank’s supervision, and would be at a rate of
0.3% effective April 1, 2016. The reduced debit interchange fee indeed came into force on April
1, 2016 in a temporary order.989 The Bank also declared more steps to increase debit usage.
Beginning April 1, 2016, banks must offer free debit cards to all of their customers (if the
customer already has a credit card) or with a reduced cardholder fee (if the customer has no
previous payment card). Banks must remit merchants funds of debit transactions within 3 days,
983Id. at 17, 23. 984 Bank of Israel, Press Release, Announcement of Reduction in the Number of Payment Card Fees (Apr. 30, 2014), 985 Banking Rules (Service to Customer) (Fees), 2008, section 6(1) to part 6 of first Annex and section 2 to the second
Annex of Banking Rules (Service to Customer) (Fees), 2008. See also Israel Bank, Press Release, Fee Reduction in
Payment Cards (Feb. 1, 2015). 986 BANK OF ISRAEL, RECOMMENDATIONS FOR ENHANCEMENT OF COMPETITION IN THE PAYMENT CARD SECTOR, FINAL
REPORT (Feb. 2015) available at http://www.boi.org.il/he/BankingSupervision/Survey/Pages/paymentcards.aspx . 987 Infra ¶ 799.3. 988 Bank of Israel, Final Report, id.; IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD
SECTOR (FINAL REPORT), supra note 21, at 11, 16, 22. 989 Banking Decree (Service to Customer) (Pikuach al Sherut Shenoten Manpik Lesolek Bekesher Leslika Tzolevet Shel
Iskaot Hiuv Miadi) (Horaat Shaa), 2015 (Supervision on Service an Issuer Gives an Acquirer with Connection to
Interchange Acquiring of Debit Transactions) (Temporary Order), 2015.
231
and disclose details of each debit card transaction in an explicit way both to customers and
merchants.990
553. For completeness, I am involved in a pending class action which claims, inter alia that the
payment card firms were parties to two unauthorized restrictive arrangements: (a) the
interchange fees in debit and prepaid cards (b) delay of payments to merchants in debit and
prepaid transactions.991 As of the end of 2017 the suit is still pending.
No Smart Acquiring (EMV)
554. The payment card firms in Israel did not promote the use of smart cards. A smart card is a card
with an EMV (Europay MasterCard Visa technical standard) chip, installed on it. Upon
payment, the cardholder types her PIN number that is verified by the EMV chip. Smart card
transactions are less prone to fraud than signature transactions. According to the rules of the
international organizations, the risk of fraud falls on the issuer, but if fraud occurs at a POS that
was not modified to read smart cards, and had the POS been so modified, the fraud would have
been prevented, then the responsibility for the fraud is transferred to the acquirer.
555. The payment card firms were specifically exempted by the Antitrust General Director, and were
allowed to collaborate in order to erect an EMV interface.992 Despite the approval they did not
promote neither EMV issuing nor acquiring nor EMV compatible terminals.
556. In June 2015, the Bank of Israel published instructions according to which EMV issuing will
become mandatory by October 2015, and EMV acquiring will become mandatory by July
2016. POS terminals installed from July 2016 forward must be EMV compatible.993
Market Concentration
557. Another drawback of the payment market in Israel is its structural obstruction. The three
payment card companies in Israel are controlled by four commercial banks. LeumiCard by
990 Press Release, Bank of Israel Publishes Instructions for Assimilation of Debit Cards and Enhancement of
Competition in Payment Cards (30.6.15); Bank of Israel, Communication 2498-06-ח, Acquiring Payment Cards, sec. 13
(Banking Proper Procedure, Instruction 472), (May 1, 2016); Bank of Israel, Expansion of Debit Card Distribution,
Letter from the Banks' Supervisor, section 4 (June 29, 2015); Bank of Israel, Banking Proper Procedure, Payment
Cards, sections 17, 19 (Instruction 470) available at
http://www.boi.org.il/he/BankingSupervision/SupervisorsDirectives/DocLib/470.pdf. 991 Civil Case (Center) 43283-4-14 Hajbi v. Isracard et al. (Motion to Approve a Class Action) (April 28, 2014). 992 Exemption with Conditions to Isracard, Leumi Card and CAL, Antitrust 5000623 (May 30, 2006). 993 Press Release, Bank of Israel Publishes Instructions for Assimilation of Debit Cards and Enhancement of
Competition in Payment Cards (June 30, 2015).
232
Leumi, Isracard by Hapoalim, CAL by Discount and First International bank. The banks have
no interest in letting their subsidiaries compete with them for credit to cardholders.
558. Indeed, issuers offer attractive loans only to their non-bank cardholders. For this reason, inter
alia, Bills calling for divestiture of the payment card companies from their parent banks have
been submitted.994 These bills have not evolved into law. In 2016 the Shtrum committee
recommended again to divest the two bigger payment card companies, Isracart and LeumiCard
from their controlling banks.995 This time the committee’s recommendations were adopted.
However, until the end of 2017 such divestiture did not yet occur.
559. Cross-ownership and other cooperation between competitors also characterize the Israeli
payment card market.
CAL is jointly held by Bank Discount (72%) and First International Bank (28%).996 The joint
ownership of CAL by two competing banks can be considered as a restrictive arrangement for
itself. This was the opinion of the Antitrust General Director when CAL was jointly held by
Leumi and Discount.997 The IAA insisted that Leumi and Discount banks dissolve their joint
possession of CAL. Bank Discount bought out Bank Leumi, and the latter founded LeumiCard.
Probably the IAA is more tolerable to the current joint possession in CAL, than when CAL was
held by Bank Leumi, because the First International is smaller than Leumi.
560. The only other big bank in Israel that does not own a payment card firm is Mizrahi Tfachot
Bank.
Mizrahi Tfachot and Isracard are parties to a (restrictive) arrangement, according to which
Tfachot issues Isracard cards, in exchange for revenue sharing and an option to purchase
unknown number of shares in Isracard. This arrangement was not submitted for approval to the
IAA but it was advertised in the economic media.998
994 Banking Law (Licensing) Bill, Enhancement of Competition in the Credit Card Market, 2468/17/(2007) פ; Banking
Law (Licensing) Bill, Ownership of Issuing Undertakings /2475/17פ (2007); Banking Law (Licensing) Bill, Ownership
of Credit Card Issuers /157/18פ (2009); Banking Law (Licensing) Bill, Ownership of Credit Card Issuers /1066/19פ
(2013); Bill to Enhance Competition in Credit (Divestiture of Bank Ownership in Credit Card Firms) /2180/19פ (2014). 995 For further details on the Shtrum Committee, see infra ¶ 847. 996 Supra note 41. 997 David Gilo & Yossi Spiegel, The Credit Card Industry in Israel, 4 REV. NETWORK ECON. 266, 267 n. 3 (2005): " In
July 1998, the director of the IAA notified Bank Leumi and IDB that they should dissolve their joint ownership of CAL
by the end of 1999, otherwise he would open an investigation. The director’s claim was that the joint ownership was an
illegal restraint of trade under Section 2 of the Israeli Antitrust Act". 998 Eiran Peer, Isracard Will Issue to Customers of Mizrachi Tfachot Branded Credit Cards, GLOBES (Aug. 23, 2009)
233
Such arrangement enables Mizrachi Tefachot to enjoy benefits of being an issuer's stakeholder,
and dissuades it from entering the issuing arena as an independent competitor.
561. The last independent bank in Israel, Union Bank, has an issuing agreement with CAL, according
to which Union bank issues CAL cards, in return for revenue sharing, and an option to purchase
3% of CAL.999 This is approximately the market share of Union Bank in the general banking
sector. Thus, the agreement promises Union Bank its market share in the issuing side of the
payment card market, without the need to compete.
562. In my opinion, the above mentioned arrangements are restrictive arrangements that should not
have been approved. Had Mizrachi Tfachot and Union Banks not sign those issuing
arrangements, they could not afford not to offer cards to their clients. They would have had to
purchase licenses from the international organizations, MasterCard and Visa, in order to issue
cards to their customers. It is reasonable to expect that under such scenario Mizrachi Tfachot
and Union banks would have had to compete for cardholders and merchants.
The effect of these agreements is that instead of competing, Tfachot and Union Banks receive
assured profits from the payment card industry, proportional to their market share in the banking
industry.1000 Their income and profits from payment cards is fixed according to their market
share in the overall banking industry, without the need for competing independently. In my
opinion this is exactly the kind of passive investments between competitors that antitrust laws
should prevent.1001 In my view banks should not hold stakes in payment card firms of rival
banks.
Single Routing Option
563. Israel has only one routing infrastructure through which payment cards transactions are
processed - SHVA.1002 This situation may seem normal for Israelis that are used to the
999 Exemption for CAL, Diners Cards and Union Bank, Antitrust 5001695 (Dec. 1, 2010). 1000 See also Sivan Eizensco, The Little Fee that Produces Additional 700 Million NIS to Banks from Credit Cards, THE
MARKER, (27.4.14) available at http://www.themarker.com/markets/1.2306467. 1001 David Gilo, Passive Investments between Competitors in Israel, 35 MISHPATIM 1 (2005); David Gilo, The
Anticompetitive Effect of Passive Investment, 99 MICH. L. REV. 1 (2000). 1002 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
21, at 5.
234
concentrated banking sector, and are not aware of other possibilities, but many countries have
several routing infrastructures that compete against each other.
564. The Trio Agreement required the parties to establish an interface for acquiring and routing
payment card transactions. This interface was built and operated by “SHVA”, the company
which also operates the interbank ATM network infrastructure in Israel, and was the owner of
non-bank ATMs.
SHVA is a company owned by the banks, and as such it is cooperation between competitors in
the field of competition, which naturally raises competitive concerns. Therefore SHVA is a
restrictive arrangement by itself, which requires the approval of the Antitrust General Director
for its existence. Although SHVA was founded in the 1970s, it did not file for such approval
until 2002.1003
565. For a decade the General Director exempted SHVA, without requiring any structural
demands.1004 However, in 2012 the General Director conditioned the continuance of SHVA's
existence on several terms, one of which was to sell its ATMs.1005 Another condition was that
SHVA adapts its interface to accommodate new acquirers that want to connect to the payment
card network.1006 As of October 2017, SHVA had not yet adjusted its interface to be
interoperable with systems of new acquirers.
566. Remittance to merchants and access to accounts of non-bank cardholders are performed by
MASAV, an Automated Clearing House that operates interbank clearance in Israel. MASAV
is a sister firm of SHVA, owned by the banks, and similarly, by itself, a restrictive
arrangement.1007
1003 Exemption with Conditions in re: SHVA, Antitrust 4804 (June 18, 2002), (Sept. 17, 2002). 1004 Exemption with Conditions to Five Banks in re: SHVA, Antitrust 5000714 (June 17, 2004); Exemption with
Conditions to Five Banks in re: SHVA, Antitrust 5001307 (Nov. 5, 2008); Exemption with Conditions to Five Banks in
re: SHVA, Antitrust 5001953 (May 22, 2012). 1005 Exemption with Conditions to Five Banks in re: SHVA, Antitrust 500224 (Sept. 20, 2012); Exemption with
Conditions to Five Banks in re: SHVA (Feb. 9, 2014); Exemption with Conditions to Five Banks in re: SHVA, Antitrust
5669 (Nov. 19, 2014). 1006 Exemption with Conditions to Five Banks on the Matter of SHVA, Antitrust 500459 (Aug. 26, 2013); See also IAA,
ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note 21. 1007 Exemption with Conditions to Five Banks in re: MASSAV, Antitrust 3014681 (June 20, 2002); Exemption with
Conditions to Five Banks in re: MASSAV, Antitrust 5667 (June 17, 2004); Exemption with Conditions to Five Banks in
re: MASSAV, Antitrust 5001308 (Nov. 5, 2008); Exemption with Conditions to Five Banks in re: MASSAV, Antitrust
5001954 (May 22, 2012); Exemption with Conditions to Five Banks in re: MASSAV, Antitrust 500223 (Sept. 20, 2012);
Exemption with Conditions to Five Banks in re: MASSAV, Antitrust 500271 (Dec. 20, 2012); Exemption with
Conditions to Five Banks in re: MASSAV, Antitrust 500368 (March 20, 2013). See also Interim Expert Report of Y.
Bachar in A.T 610/06 Leumi v. Antitrust General Director, at 45 (1.1.09).
235
567. The result of the existence of a single infrastructure controlled by the banks is, not surprisingly,
the inability to access this infrastructure by new acquirers. Access to infrastructure is of course
essential for new acquirers.1008 Notwithstanding the undisputed difficulties in erecting
interoperable infrastructure systems, these issues could be already solved long ago had there
been an independent payment infrastructure in Israel.
568. SHVA and MASAV are prohibited from dividing profit to their shareholders (the banks). They
can gain profit but cannot distribute it to their controlling banks. The reason is to dissuade
SHVA and MASAV from charging high fees which could have been transferred to their
controlling banks as profit, while concurrently serving as an entry barrier to new entrants.1009
8.2. Europe
569. The history of payment card networks in Europe began early in the second half of the 20th
century. In those years, Diners and American Express, and later also Visa and MasterCard,
expanded outside the United States.
570. The European Commission first examined the rules of open networks in 1977. Ibanco, the
predecessor of Visa, submitted its operating rules and requested approval. The Commission did
not give formal approval, but announced in a comfort letter that Ibanco's operating rules did not
violate EU regulations.1010 Until the 1990s, payment cards were barely regulated in Europe.
571. In the 1990s merchant organizations complained against the interchange fee of Visa and
MasterCard. The complaints alleged that cross-border interchange fees were a restrictive
arrangement prohibited by the treaty on the functioning of the European Union (“TFEU”). This
led to an investigation of the payment card sector. In 1999, the commission sent a Statement of
Objections to visa. In August 2001, the European Commission published a decision in which it
1008 Leinonen, Debit Card Interchange Fees, supra note 884, at 28: “In order to promote efficiency in the payments
market authorities need to open the market to increased competition, which would imply requiring open access to
payment networks and interoperable standards from the processing technical point of view”. 1009 Exemption with Conditions in re: SHVA, Antitrust 4804 (June 18, 2002), (Sept. 17, 2002), Exemption with
Conditions in re: SHVA, Antitrust 4804, at 10 (June 18, 2002); Exemption with condition, in re: SHVA, antitrust
500459, at 7-8 (Aug. 26, 2013). 1010 COMP/29.373 − Visa International 2001/782/EC, paras. 1-2 (O.J. L 293 2001), http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32001D0782:EN:HTML : “On 31 January 1977 Ibanco Ltd,
since 1979 known as Visa International, notified various rules and regulations governing the Visa association and its
members to the Commission, applying for negative clearance or, in the alternative, an exemption under Article 81(3) of
the Treaty. (2) After having initially sent a comfort letter, on 29 April 1985 the Commission reopened the investigation
in the Visa case, following a complaint by the British Retail Consortium against the "multilateral interchange fee" in the
Visa International payment scheme, and the comfort letter was withdrawn on 4 December 1992.”; Éva Keszy-Harmath
et al., The Role of the Interchange Fee in Card Payment Systems, para. 5.1.1 (MNB Occasional papers 96. 2012).
236
found no grounds for action with respect to the NSR, the HAC and the “No Acquiring Without
Issuing” ("NAWI") rule. The commission noted that the interchange fee remained under
examination.1011
572. On July 24, 2002 the Commission exempted Visa’s interchange fee (“The Visa Decision”). The
Visa Decision was given with the consent of Visa, after Visa had made some changes and
reductions in the fees it charged merchants.1012
Visa agreed to reduce the level of its interchange fees in deferred debit and credit transactions
to an average of 0.7% in credit and €0.28 (regardless of the transaction’s amount) for debit
transactions. These were supposed to be upper bounds. The interchange fee could be lower if
three specific costs, which in the Commission's view corresponded to services provided by
issuers to merchants, yielded a lower interchange fee than 0.7% and €0.28. The services were:
(1) transaction processing costs; (2) Payment guarantee, which was defined as “the promise of
the cardholder's bank to honor payments made by cardholders, even those which turn out to be
fraudulent or for which the cardholder ultimately defaults, on condition that the retailer
undertakes all the necessary security checks”; (3) Free funding period, which was defined as
the time period until the cardholder must pay the card bill or roll over the debt to later months.
A rate of interest was applied to this period. The free funding period was considered by the
Commission to benefit merchants by stimulating additional sales.1013
These costs were similar to the eligible costs of the Methodology Decision in Israel that was
given few years later, as described above.
The Visa Decision also determined that Visa had to make a cost study, audited by an
independent accountant, to determine these costs. If the costs were found to be lower than the
caps, the interchange fees would have been lowered to match the costs. In practice, however,
in all of the five years in which the Visa Decision was in force, the audited costs Visa provided
always showed a result higher than 0.7% and €0.28, so the arbitrary caps prevailed. This, of
course, is no surprise given the criticisms of cost-based interchange fees explained earlier.1014
1011 COMP/29.373 − Visa International 2001/782/EC, O.J. L 293 (2001). 1012 Comp 29.373 Visa International — Multilateral Interchange Fee, O. J. L 318, (July 24, 2002), supra note 247. 1013 Ibid, see also Press Release, Antitrust, Commission Exempts Multilateral Interchange Fees for Cross Border VISA
Card Payments, IP/02/1138 (July 24, 2002). 1014 Supra ch. 8.1.1 especially ¶¶ 504-504.
237
573. An important determination that was included in the Visa Decision was that interchange fee is
not essential for the operation of the Visa network.1015 Nevertheless, the Commission opined
that interchange fee is not a restrictive arrangement by object (i.e., designed to harm
competition), because an interchange fee could increase the efficiency and stability of open
systems, as well as the relative competitiveness of open networks versus closed networks.1016
574. In 2006, the Commission published, after thorough research, an Interim Report on payment
cards. A main conclusion of the report was that networks tilt the price structure in favor of
cardholders, at the expense of merchants.1017
The report also noted that the issuing side was highly profitable. 62% of issuers were found to
be profitable just from cardholder fee and interest from credit to cardholders, thus diminishing
the need for interchange fees as a mean to cover costs.1018
575. After the exemption granted by the Visa Decision expired, on December 31, 2007, the
Commission informed Visa Europe, which had taken over responsibility from Visa
International for the network rules applicable in Europe, that it was renewing its investigation
regarding the interchange fees and regarding merchant restraints such as the NSR and the
HAC.1019 On April 3, 2009, the Commission sent Visa Europe a Statement of Objections, stating
that the interchange fee was an alleged violation of Articles 101 and 102 (previously Articles
81, 82) of the TFEU.1020
576. On May 28, 2010, Visa and the Commission reached a partial settlement. The settlement
included a reduction in Visa’s debit card interchange fee to a rate of 0.2%, and partial abolition
of the HAC rule.1021 The commitments of Visa were published in September 2010.1022 Soon
1015 Comp 29.373 Visa International — Multilateral Interchange Fee, supra note 247, para. 8.2.3: “The Visa MIF is, on
the admission of Visa itself, not indispensable for the existence of the Visa system”. 1016Id. para. 69: “However, the Commission does not consider the MIF agreement to be a restriction of competition by
object, since a MIF agreement in a four-party payment system such as that of Visa has as its objective to increase the
stability and efficiency of operation of that system…, and indirectly to strengthen competition between payment
systems by thus allowing four-party systems to compete more effectively with three-party systems”. 1017EC, INTERIM REPORT, supra note 79, at iii: “The preliminary results of the inquiry show a picture of market
fragmentation. While consumers clearly reap benefits from card payment networks in the EU, businesses do less so and
largely foot the bill”. 1018Id. at 76: “It appears that 62% of all banks surveyed would still make profits with credit card issuing even if they did
not receive any interchange fee revenues at all”. 1019 Europa, Press Release, Antitrust, Commission Initiates Formal Proceedings Against Visa Europe Limited,
MEMO/08/170 (Mar. 26, 2008). 1020 Press Release, Antitrust: Commission Sends Statement of Objections to Visa, MEMO/09/151, (Apr. 6, 2009). 1021 Notice no 1/2003 in Case COMP/39.398 — Visa MIF, O.J (C 138) 34 (May 28, 2010). 1022 Case Comp/39.398 - Visa Europe Commitments Offered To The European Commission Pursuant To Article 9 Of
Council Regulation (Ec) No 1/2003 (Sept. 10, 2010).
238
after, on December 8, 2010, the Commission announced the end of its investigation on the
agreed upon issues,1023 but credit card interchange fees and deferred debit interchange fees
remained under investigation. On July 31, 2012, after completion of the investigation, the
Commission sent Visa a supplementary statement of objection, stating the credit card
interchange fee was a restrictive arrangement.1024
577. Once again, Visa reached a settlement with the Commission. On May 14, 2013, the Commission
published a notice stating that it welcomed the proposal by Visa Europe to reduce its
interchange fee on cross-border credit card and deferred debit transactions to 0.3%. This
reduction applied also to ten European countries that followed the cross-border interchange
fee.1025 On February 26, 2014, the Commission announced that Visa’s proposal was binding,
and the cross-border interchange fee was to be reduced by January 2015, to 0.3% (on average).
The national interchange fees, in countries where Visa sets them, would be reduced to 0.3%
two years later. Visa also undertook to accede to merchants' requests to pay a MSF that is based
on the interchange fee (“interchange fee plus” MSF).1026
578. The proceedings of the European Commission against MasterCard advanced at a different pace.
In December 2007 the Commission published a comprehensive decision which declared the
cross-border interchange fee of MasterCard to be a restrictive arrangement.1027 This decision
repeated the 2002 conclusion of the Visa decision, and determined once again that the
interchange fee was not essential for the operation of an open network.1028 The Commission
1023 Commission Decision of 8.12.2010 relating to Proceedings Under Article 101 of the Treaty on the Functioning of
the European Union and Article 53 of the EEA Agreement (Case COMP/39.398 - Visa MIF), C(2010) 8760 final. See
also Summary of Commission Decision of 8 December 2010 Relating to a Proceeding Under Article 101 of the Treaty
on the Functioning of the European Union and Article 53 of the EEA Agreement (Case COMP/39.398 — VISA MIF),
C 79/8 (March 12, 2011). 1024 Press Release: Commission Sends Supplementary Statement of Objections to Visa, IP/2/871 (July 31, 2012). 1025 European Commission, Antitrust, Memo/13/431 Vice President Almunia Welcomes Visa Europe's Proposal to Cut
Inter-Bank Fees for Credit Cards (May 14, 2013); Commission Announcement in Case AT.39398 — VISA MIF O.J. C
168/22 (June 14, 2013). 1026 AT 39398 Visa - Commission Decision C(2014) 1199 Final (Feb. 26, 2014)
http://ec.europa.eu/competition/antitrust/cases/dec_docs/39398/39398_9728_3.pdf ; European Commission Press
Release, Antitrust, Commission Makes Visa Europe's Commitments to Cut Inter-Bank Fees and to Facilitate Cross-
Border Competition Legally Binding, IP/14/197 (Feb. 26, 2014); European Commission MEMO, Commission Makes
Visa Europe's Commitments Binding – Frequently Asked Questions (Feb. 26, 2014): “Visa Europe has offered to cap
the weighted average MIF for consumer credit card transactions at 30 basis points (bps), i.e. 0.30% per transaction for
all transactions where it sets the fee… Visa Europe commits: (i) to introduce a rule to make the prices paid by
merchants more transparent. Accordingly acquirers will be required to offer merchants merchant service charge
("MSC") pricing on a “MIF plus” basis. In other words, acquirers must, if requested, clearly break down in their
contracts and invoices the MSC into three components, namely the MIF, the acquirer fee and all the other applicable
payment system fees”. 1027 Comp/34.579 European Comm'n MasterCard Decision (Dec. 19, 2007), available at
http://ec.europa.eu/competition/antitrust/cases/dec_docs/34579/34579_1889_2.pdf . 1028Id. Paras. 648, 608: “A MIF is not objectively necessary for the co-operation of banks in an open payment card
scheme such as MasterCard's”.
239
explicitly highlighted the existence of successful open debit card networks, operating without
interchange fees.1029 MasterCard appealed this decision. The appeal was rejected in May 2012,
affirming the Commission’s arguments.1030 MasterCard appealed once again to the European
High Court of Justice (“ECJ”). In September 2014 the ECJ rejected MasterCard's appeal.1031
579. The ECJ determined once again that the interchange fee was not objectively necessary to the
functioning of MasterCard,1032 and that it sets a floor to the MSF. It upheld the lower court's
view that interchange fee has none of the redeeming objective advantages required by article
101(3) in order to be exempted. The ECJ rejected the argument that due to the HAC rule,
without interchange fee acquirers would be put at the mercy of issuers (i.e., issuers would be
allegedly able to extort any level of interchange fee, since acquirers must pay merchants
according to the Honor All Cards rule). The ECJ stated that as long as this is the argument for
interchange fee, it could be dealt in a more proportional and less anti-competitive manner, such
as prohibition on ex-post pricing by issuers.1033
1029Id. Paras. 562-608 and para. 751: “[S]everal payment schemes in the European Economic Area have successfully
been operating without a MIF for a long time. These Schemes have been established between 1979 and 1992 and they
are not merely viable but indeed successful."; EU, Proposal for a Regulation on Interchange Fees, supra note 200, at
10-11: “Denmark has one of the highest card usage rates in the EU at 216 transactions per capita with a zero-
Interchange Fee debit scheme. This is also true of international schemes: in Switzerland Maestro has no interchange fee
and is the main debit card system… In terms of viability, a debit card scheme without any interchange fee seems to be
perfectly viable from a commercial perspective without raising the costs of current accounts for consumers.”; Lukas
Repa, Agata Malczewska & Antonio Carlos Teixeira, Commission Prohibits MasterCard’s Multilateral Interchange
Fees for Cross-Border Card Payments in the EEA, COMPETITION POL'Y NEWSL., at 2 (Nov. 1, 2008): “A mechanism
such as a MIF that shifts profits between acquiring and issuing banks is not objectively necessary for the banks’
cooperation, as issuing and acquiring services can be remunerated directly by the respective consumer groups.
The decision demonstrates the viability of the MasterCard scheme in the absence of the crossborder MIF, amongst
others, by providing examples of five other domestic payment card schemes that operated for decades without any MIF
in Europe. These schemes are Pankkikortti in Finland, Bancomat in Luxembourg, Dankort in Denmark, PIN in the
Netherlands and BAX in Norway”. 1030 T-111/08 MasterCard v. Comm'n, (May 24, 2012) 1031 C-382/12 P MasterCard v. European Comm'n (Sept. 11, 2014). 1032Id. para. 113. 1033Id. para. 172: “[T]he Commission was fully entitled to conclude that ‘the possibility that some issuing banks might
hold up acquirers who are bound by the [Honour All Cards Rule] could be solved by a network rule that is less
restrictive of competition than MasterCard’s current solution that, by default, a certain level of interchange fees applies.
The alternative solution would be a rule that imposes a prohibition on ex post pricing on the banks in the absence of a
bilateral agreement between them”. See also Comp/34.579 European Comm'n MasterCard Decision, supra note 1027,
para. 554: "[T]he possibility that some issuing banks might hold up acquirers who are bound by the HACR could be
solved by a network rule that is less restrictive of competition than MasterCard’s current solution that, by default, a
certain level of interchange fees applies. The alternative solution would be a rule that imposes a prohibition on ex post
pricing on the banks in the absence of a bilateral agreement between them. The rule would oblige the creditor bank to
accept any payment validly entered into the system by a debtor bank while prohibiting each bank from charging the
other bank in the absence of a bilateral agreement on the level of such charges. That solution to “protect” acquirers if
issuers should indeed abuse their power under an HACR is less restrictive of competition than a MIF as it does not set a
minimum price level on either side of the scheme."; T-111/08 MasterCard v. Comm'n, paras. 95-97 (May 24, 2012). For
further details see infra ch. 8.3.5
240
580. In June 2008, while the appeal was pending, MasterCard announced that it was temporarily
ceasing to charge interchange fees in European cross-border transactions.1034 In April 2009,
MasterCard, with the consent of the Commission, announced a huge reduction of cross border
interchange fees, to an average of 0.3% on credit card transactions and 0.2% for debit cards
transactions. This was a significant reduction compared to the previous 1.9% interchange fee
for credit cards and 0.4% to 0.9% for debit cards.1035
581. The European Commission has been working intensively in recent years to turn Europe into a
single payment area (SEPA - Single Euro Payments Area). In this framework, the European
Parliament enacted Regulation 924/2009 and Regulation 260/2012.1036 It is interesting to note
developments in non-card interchange fees according to these Regulations.
Regulation 924/2009 established a default 8.8 Eurocent interchange fee on cross-border direct
payments between financial institutions in Europe until November 2012.1037 Regulation
260/2012 established, inter alia, zero interchange fees for direct payments, beginning
November 2012. Cross-border direct payments are defined as “national or cross-border
payment service for debiting a payer’s payment account, where a payment transaction is
initiated by the payee on the basis of the payer’s consent”.1038 The regulation allows charging
cost-based interchange fee for refused transactions. Beginning in November 2017 a zero
interchange fee will apply also to direct payments between national financial institutions.1039
582. With regard to payment card interchange fees, in January 2012 the European Commission
published a Green Paper entitled: "Towards An Integrated European Market for Cards, Mobile
Payments and Internet".1040 This document generated hundreds of responses from interested
1034 Press Release, Antitrust, Commission Notes MasterCard's Decision to Temporarily Repeal its Cross-Border
Multilateral Interchange Fees within the EEA, MEMO/08/397 (2008). 1035 Press Release, Commissioner Kroes Takes Note of MasterCard's Decision to Cut Cross-Border Multilateral
Interchange Fees (MIFs) and to Repeal Recent Scheme Fee Increases, IP/09/515 (April 1, 2009). 1036 Regulation 924/2009 on Cross-Border Payments, O. J. L 266/11 (Sept. 16, 2009); Regulation 260/2012 Establishing
Technical and Business Requirements for Credit Transfers and Direct Debits in Euro and Amending Regulation (EC)
no 924/2009, O.J. L 94/22 (March 14, 2012). 1037 Regulation 924/2009 on Cross-Border Payments, O. J. L 266/11, Article 6 (2009): “In the absence of any bilateral
agreement between the payment service providers of the payee and of the payer, a multilateral interchange fee of EUR
0,088, payable by the payment service provider of the payee to the payment service provider of the payer, shall apply
for each cross-border direct debit transaction executed before 1 November 2012, unless a lower multilateral interchange
fee has been agreed upon between the payment service providers concerned”. 1038 Regulation 260/2012, supra note 1036, Article 2 (definition) and article 8.1: “[N]o MIF per direct debit transaction
or other agreed remuneration with an equivalent object or effect shall apply to direct debit transactions”. 1039Id. Article 6.3. 1040 European Commission, Green Paper, Towards an Integrated European Market for Card, Internet and Mobile
Payments, COM (2011) 941 final (Jan. 11, 2012).
241
parties. The responses were summarized in a Feedback Statement.1041 In July 2013, the
European Commission published a comprehensive proposal for interchange fee regulation in
card-based payment transactions that summarized former years of work on this topic.1042
The proposal considered six scenarios for regulating interchange fee.1043 The commission
thoroughly analyzed each option. Its final recommendation was to cap the interchange fee and
cancel merchant restraints like the HAC rule.1044 The Proposal recommended a cross-border
interchange fee of 0.2% for debit cards and 0.3% for credit cards. These rates were to prevail
in the national systems two years later.1045
583. The interchange fee Proposal was accompanied by two additional detailed documents. The first
document was a new payment services directive proposal (PSD2), which, inter alia, enabled
non-bank acquirers to enter the market more easily and with fewer entry barriers. The PSD2
proposal recommended a relatively simple application process, easing equity and capital
1041 European Commission, Feedback Statement on European Commission Green Paper “Towards an Integrated
European Market for Card, Internet and Mobile Payments (June 27, 2012) available at
http://ec.europa.eu/internal_market/payments/cim/index_en.htm 1042 EU, Proposal for a Regulation on Interchange Fees for Card-Based Payment Transactions, COM/2013/550, (July
24, 2013), available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2013:0550:FIN:EN:PDF. 1043Id. at 8: “The impact assessment considers six scenarios for interchange fees: (i) No action from the Commission,
(ii) Regulating cross-border acquiring and the level of interchange fees for cross-border transactions, (iii) Mandating
Member States to set domestic IFs on the basis of a common methodology, (iv) Regulating a common, EU-wide
maximum level for interchange fees (a) whether the maximum interchange fee cap – of a different level for debit and
for credit cards- covers both debit and credit cards or just debit cards and (b) whether the IFs for debit card transactions
are to be forbidden altogether or just reduced to a low level, (v) Whether or not to exempt (normally more expensive)
commercial cards and cards issued by three party schemes from the regulation of interchange fees and (vi) regulating
Merchant Service Charges i.e. regulating the fees paid by the retailer to its acquiring bank”. 1044Id. at 8-9: “The assessment concludes that the most beneficial option appears to be a combination of: • a series of
measures to enhance effective market functioning including the limitation of the HACR and allowing merchants to
determine the choice of card brand at the point of sale for all cards and card-based transactions based on four party
scheme models; and • capping the level of interchange fees for cross-border transactions with consumer debit and credit
cards (in the first stage) and, in a second stage, capping the level of interchange fees also for domestic transactions with
consumer credit cards and consumer debit cards”. 1045Id. Articles 3 and 4 of the Proposal:
Article 3 Interchange fees for cross-border consumer debit or credit card transactions
1. With effect from two months after the entry into force of this Regulation, payment services providers shall not offer
or request for cross-border debit card transactions a per transaction interchange fee or other agreed remuneration with
an equivalent object or effect of more than 0,2 % of the value of the transaction.
2. With effect from two months after the entry into force of this Regulation, payment services providers shall not offer
or request for cross-border credit card transactions a per transaction interchange fee or other agreed remuneration with
an equivalent object or effect of more than 0,3 % of the value of the transaction.
Article 4 Interchange fees for all consumer debit or credit card transactions
3. With effect from two years after the entry into force of this Regulation, payment service providers shall not offer or
request a per transaction interchange fee or other agreed remuneration with an equivalent object or effect of more than
0,2 % of the value of the transaction for any debit card based transactions.
4. With effect from two years after the entry into force of this Regulation, payment service providers shall not offer or
request a per transaction interchange fee or other agreed remuneration with an equivalent object or effect of more than
0,3 % of the value of the transaction for any credit card based transactions.
242
demands and requiring interoperability of incumbent payment systems.1046 The second
document is an exhaustive impact assessment accompanying the interchange fee and the PSD2
proposals.1047
584. The interchange fee proposal was adopted by the European Parliament on April 29, 2015. The
Regulation was published in the Official Journal of the EU on May 19, 2015 (Regulation
2015/751).1048 Few articles are worth noting:
584.1 Article 3 determines the average interchange fee for debit transactions to be no more
than 0.2% until 2020. Thus, debit interchange fees can be higher or lower as long as
an average of no more than 0.2% is kept.1049
584.2 Article 4 sets a cap of 0.3% for credit card interchange fee.1050 Thus, credit card
interchange fee can be lower than 0.3%.
584.3 Article 5 prohibits circumvention of the interchange fee.1051
584.4 Article 8 presents an interesting idea, named “Co-badging and choice of payment
brand or payment application”. Co-Badging is defined in Article 2(31): "the inclusion
of two or more payment brands or payment applications of the same brand on the
same card-based payment instrument". Article 8 ensures that issuers cannot prevent
cardholders from co-badging their cards, e.g., using the same card as a credit and
debit card.
This article might be a useful to the IAA, if the payment card firms in Israel resist
issuing combined cards (cards that can be used either as credit or debit cards at the
cardholder's will).
1046 Proposal for a Directive on Payment Services (PSD2), Com (2013) 547 Final 2013/0264 (Cod) (July 24, 2013) 1047 Commission Staff Working Document Impact Assessment, SWD(2013) 288 Final, (July 24, 2013). 1048 Reg. (EU) 2015/751 of 29 April 2015 on Interchange Fees for Card-Based Payment Transactions, O.J L 123/1 (May
19, 2015). 1049Id. Article 3(3): "Until 9 December 2020, in relation to domestic debit card transactions, Member States may allow
payment service providers to apply a weighted average interchange fee of no more than the equivalent of 0,2 % of the
annual average transaction value of all domestic debit card transactions within each payment card scheme. Member
States may define a lower weighted average interchange fee cap applicable to all domestic debit card transactions". 1050 Ibid: "Payment service providers shall not offer or request a per transaction interchange fee of more than 0,3 % of
the value of the transaction for any credit card transaction. For domestic credit card transactions Member States may
define a lower per transaction interchange fee cap" 1051 Supra note 918.
243
584.5 Article 9 requires "unblending" of fees. Acquirers are required to offer merchants
different MSFs, if the interchange fee of one card is different from the interchange
fee of another card, unless the merchant requests blended MSF.1052
584.6 Article 10 deals with the HAC rule. There are two types of HAC rule. “Product tying
HAC rule", obligates merchants who accept one payment instruments (e.g., debit
cards) to accept all payment instruments of that brand (e.g., credit). “Issuers tying
HAC rule" obligates merchants who accept a certain payment instrument to accept
all payment instruments of this type regardless of the issuer.
The Regulation permitted "product HAC" but prohibited "issuers HAC".1053
Merchants that accept cheap debit cards can refuse to accept expensive credit cards.
On the other hand a merchant that accepts a debit or credit card issued by X bank
cannot refuse to accept a debit or credit card of that brand, issued by Y bank.1054
In my view, this rule is correct. Indeed, merchants should not discriminate between
issuers who do not demand different prices, but should be able to discriminate and
even reject cards that are costlier.
584.7 Article 11 cancels the NSR rule. Merchants in Europe are allowed to surcharge
customers who pay with expensive payment instruments. NSR Regularization is
completed in two other legislations. Article 52(3) of the Payment Services Directive
(PSD), determines that surcharging is subject to state authority, in order to promote
efficient payment methods.1055 About half of the countries in Europe have banned
1052 Id. Article 9: “Each acquirer shall offer and charge its payee merchant service charges individually specified for
different categories and different brands of payment cards with different interchange fee levels unless payees request
the acquirer, in writing, to charge blended merchant service charges”; See also EU, Proposal for a Regulation on
Interchange Fees, supra note 1042, at 29, Art. 9. 1053Id. Article 10, titled ‘Honour All Cards’ rule: "1. Payment card schemes and payment service providers shall not
apply any rule that obliges payees accepting a card- based payment instrument issued by one issuer also to accept other
card-based payment instruments issued within the framework of the same payment card scheme. 2.Paragraph 1 shall not
apply to consumer card-based payment instruments of the same brand and of the same category of prepaid card, debit
card or credit card subject to interchange fees under Chapter II of this Regulation". 1054 EU, Proposal for a Regulation on Interchange Fees, supra note 1042, at 24: “The Honour all Cards Rule is a
twofold obligation imposed by issuing payment services providers and payment card schemes on payees to, on the one
hand, accept all the cards of the same brand ('Honour all Products' - element), irrespective of the different costs of these
cards, and on the other hand irrespective of the individual issuing bank which has issued the card ('Honour all Issuers' –
element)... the 'Honour all Issuers' element of the Honour all Cards Rule is a justifiable rule... the 'Honour all Products'
element is essentially a tying practice”. See also id. article 10 at 30. 1055 Directive 2007/64/EC of the European Parliament and of the Council of 13 November 2007 on payment services in
the internal market OJ L319/1 (Dec. 5, 2007): “The payment service provider shall not prevent the payee from
requesting from the payer a charge or from offering him a reduction for the use of a given payment instrument.
244
surcharging.1056
The PSD2 Proposal from 2013 recommended limiting surcharges to the costs of the
payment instrument, and to prohibit merchants from surcharging payment
instruments in which interchange fees are regulated.1057 The proposal was adopted in
the Consumer Rights Directive. Article 19 of this directive determines that merchants
will not surcharge a payment instrument by an amount greater than its costs.1058
The Tourist Test
585. In Europe, the methodology used to examine appropriateness of the interchange fee, is no longer
a cost-based methodology. The Commission uses a methodology known as "the tourist test".
The tourist test tries to envisage the indifference point of the merchant between accepting cash
and cards, and is also known as the "Merchant Indifference Test".1059 The indifference criterion
was first denoted by Farrell.1060
586. The indifference test assesses the fee a merchant is willing to pay for a card, in order to avoid
costs of cash (time, deposit fees, security measures), but excluding other benefits merchants
derive from cards, such as increasing their turnover (this is why the test is pointed at a tourist
However, Member States may forbid or limit the right to request charges taking into account the need to encourage
competition and promote the use of efficient payment instruments”. 1056 Study on the impact of directive 2007/64/ec On payment services in the internal market And on the application of
regulation (ec) no 924/2009 on cross-border payments in the Community Contract market/2011/120/h3/st/op Final
report, sec. 24 (Feb. 2013): "Fourteen Member States representing about half of the EU Population have banned
altogether surcharging for the use of specific payment instruments”. 1057 Proposal for a Directive on Payment Services (PSD2), Com (2013) 547 Final 2013/0264 (Cod) (July 24, 2013),
Article 55(3) and (4): “The payment service provider shall not prevent the payee from requesting from the payer a
charge, offering him a reduction or otherwise steering him towards the use of a given payment instrument. Any charges
applied shall, however, not exceed the costs borne by the payee for the use the specific payment instrument.
(4) However, Member States shall ensure that the payee shall not request charges for the use of payment instruments for
which interchange fees are regulated under Regulation”. 1058 Directive 2011/83/EU on Consumer Rights, OJ L 304/64, Article 19 (Nov. 22, 2011): “Member States shall prohibit
traders from charging consumers, in respect of the use of a given means of payment, fees that exceed the cost borne by
the trader for the use of such means”. 1059 Marc Rysman & Julian Wright, The Economics of Payment Cards, at 23 n. 22 (2015): “[T]he associated merchant
fee would be set at the level to leave the merchant indifferent ex-post (i.e., at the point of sale) between whether
consumers use cards or the relevant alternative (e.g. cash). The latter principle is known as the "merchant indifference
criterion" (Farrell, 2006) or the "tourist test" (Rochet and Tirole, 2011)… The tourist test asks: does the interchange
fee lead to a merchant fee that would induce the merchant to turn down the card for a tourist who is known to
have the cash and is already at the store, assuming that the merchant has this discretion and will not see the tourist
again? The highest interchange fee that does not lead the merchant to turn down the cards in such circumstances
is the tourist test interchange fee.”; EU Interchange Fee Proposal, supra note 1042, at 15: “The 0.2% and 0.3% caps
envisaged are based on the so-called 'Merchant Indifference Test', which identifies the fee level a merchant would be
willing to pay if he were to compare the cost of the customer’s use of a payment card with those of non-card (cash)
payments.” See also id. at 8. 1060 Joseph Farrell, Efficiency and Competition between Payment Instruments, 5 REV. NETWORK ECON. 26 (2006).
245
that is already at the cashier and intends to pay with cash).1061 Maximum interchange fee that
corresponds to a MSF that makes a merchant indifferent between accepting card or cash (given
that cash also has its costs), is the tourist test interchange fee.1062
The indifference test relates to the MSF and not to the interchange fee. However, the tourist test
methodology is relevant to the interchange fee because of the direct correlation between the
interchange fee and the MSF. When the acquiring fee (the gap between the interchange fee and
the MSF), is constant, the maximum MSF that passes the tourist test relates to a specific
interchange fee.
587. The indifference-test methodology was based on empirical studies that the European
Commission conducted and which examined merchants' costs of accepting cash.1063 The tourist
test is not cost-based. Maximum MSF that passes the indifference test will be at the level of the
avoided costs of cash. The avoided costs of cash are equivalent to the benefit merchants derive
from not having to accept cash.1064 Thus, the tourist test is a utility-based test.1065
588. If the network sets the MSF at a higher level than the avoided costs of cash, the merchant might
decline a card transaction and prefer to accept cash, even though the real costs of cash are higher
1061 For expansion on costs and benefits of payment instruments see ch. 0. 1062 EU Interchange Fee Proposal, supra note 1042, at 22: “Those caps are based on the so-called 'Merchant
Indifference Test' developed in economic literature, which identifies the fee level a merchant would be willing to pay if
he were to compare the cost of the customer’s use of a payment card with those of non-card (cash) payments (taking
into account the fee for service paid to acquiring banks, i.e. the merchant service charge coming on top of the
interchange fee)”. 1063 Ibid at 16: "The figures were calculated on the basis of this test, using data gathered by four national central banks". 1064 Jean-Charles Rochet & Jean Tirole, Must-Take Cards: Merchant Discounts and Avoided Costs, 9 J. EUR. ECON.
ASS'N 462, 463 (2011): "This benchmark is not based on issuers’ costs, but on the retailer’s avoided-cost when a cash
(or check) payment is replaced by a card payment. The empirical counterpart of this benchmark, which we call the
tourist test, gives some operational content to the notion of must-take card: would the merchant want to refuse a card
payment when a non-repeat customer with enough cash in her pocket is about to pay at the cash register? Put
differently, the merchant discount passes the tourist test if and only if accepting the card does not increase the
merchant’s operating costs ". See also Jean-Charles Rochet & Julian Wright, Credit Card Interchange Fees, 34 J.
BANK. FIN. 1788, 1794 (2010); Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 67, at 18-19. 1065 Notice Published Pursuant to Article 27(4) of Council Regulation (EC) no 1/2003 in Case COMP/39.398 — Visa
MIF, 2010 O.J C-138/34, 35 (May 28, 2010): “Based on studies conducted by the central banks of several EEA
countries comparing the costs of cards with those of cash, the Commission is of the preliminary view that the MIF Visa
Europe has committed to apply to consumer immediate debit card transactions is in conformity with the ‘merchant
indifference methodology’ (or ‘tourist test’) developed in economic literature. The fee that meets this test (also referred
to as the balancing fee) is set at such a level that merchants are indifferent as to whether they receive a card or cash
payment. The balancing is such that merchants do not pay higher charges than the transactional benefit that the
card use generates for them. For instance, transactional benefits arise where card payments reduce merchants’
costs as compared to cash payments (e.g., because transportation and security expenses for cash are saved or check-
out times at cashier desks are reduced)”.
246
than the costs of cards. The merchant saves card costs, although from a social point of view it
could be better if the merchant accepted the card.1066
589. Interchange fee that passes the tourist test prevents issuers from exploiting strategic
considerations of merchants. Strategic considerations, elaborated in Chapter 6.4, cause
merchants to accept cards even when the cost (i.e., the MSF), is higher than the utility they
derive from cards. For example, the fear of losing customers compels merchants to pay MSF
that is higher than their net benefit.1067 A tourist test interchange fee caps the MSF on the net
benefit of the merchant from not having to accept cash (without strategic considerations).
Criticism Of The Tourist Test
590. Usually, the surplus of a transaction is divided between the seller and the buyer. However the
MSF, in which the merchant is indifferent whether to accept cards or cash, extracts the
merchant’s entire surplus from not accepting cash.1068
Tourist test interchange fee captures the merchant’s entire surplus from cards compared to cash.
Even if cards are cheaper, so merchants would have strictly preferred them (had they been
priced according to their cost), a tourist-test fee eliminates any such preferences. It compels the
merchant to be indifferent between cash and card.
The indifference test does not incentivize merchants to accept cards. It does not enable the
merchant to enjoy any savings from use of cards instead of cash, even under the assumption
that cards are a cheaper payment instrument than cash.
1066 Nicole Jonker & Mirjam Plooij, Tourist Test Interchange Fees for Card Payments: Down Or Out? 1 J. FIN.
MARKET INFRASTRUCTURE 51, 55 (2013): “[I]f the level of the interchange fee is set too high, and consequently the
acquiring fee, a merchant who accepts card payments may still decide to turn down a card payment of a nonrepeat
customer (“the tourist”) with both cash and cards in their wallet. That way, the merchant reduces their operating
costs. However, from a social point of view it would have been better if this nonrepeat customer had used their
card”. 1067 Dominique Forest & Vaigauskaite Dovile, EC Competition Policy in the Payments Area: New Developments in
MIFs for Cards and SEPA Direct Debit, 2 EC COMPETITION POL'Y NEWSL. 38, 39 (2009): “The tourist test provides a
reasonable benchmark for assessing a MIF level that generates benefits to merchants and final consumers. It determines
a MIF that allows the promotion of efficient payment instruments, while at the same time preventing the MIF from
exploiting business-stealing effects to the detriment of the merchants and their subsequent customers, which would lead
to an inefficient promotion of payment instruments that impose invisible costs on consumers”. 1068 Leinonen, Debit Card Interchange Fees, supra note 884, at 11: “The interchange according to the maximum Tourist
Test (MIFm0b) would transfer all net benefits from the acquiring/merchant side to the issuing/cardholder side. It can
therefore also be labelled the MIF resulting in merchant zero-level benefits”.
247
591. Second, the indifference test does not account for the heterogeneity of merchants. One
interchange fee can be efficient only if merchants are homogeneous.1069 However, some
merchants have larger costs of handling cash than others. Whenever merchants are
heterogeneous (in the utility they derive from cards), then even if the fee is calibrated to fit the
average benefit of merchants, marginal merchants pay more than their utility, in contradiction
to the underlying logic of the tourist test.1070 Whenever merchants are heterogeneous, the
indifference test, by definition, yields multiple fees, and not just one uniform fee.1071
592. Third, the tourist test requires detailed data on the differences between the costs and benefits of
both cash and cards. Quantification of the avoided costs of cash is difficult to estimate,1072 and
varies between merchants who are heterogeneous.1073 In addition, the data does not only vary
between merchants, but even between the same merchant over time.1074
593. Fourth, the indifference test requires additional supervision to ensure its effectiveness. The
economic justification to charge a utility based fee is to transfer to cardholders the gap between
the (purportedly high) avoided costs of cash and the (purportedly low) costs of cards, as
discounts, rewards and rebates, so as to encourage them to use cards instead of cash. The tourist
test does not allow markups to remain with issuers or acquirers as profit. Any such profit
indicates a failure of the tourist test.1075
594. Fifth, the tourist test determines an interchange fee which is based on negative utility and not
on cost – merchants’ benefits from the avoided costs of cash. Pricing that is based on demand
(benefits) and not on supply (costs), is actually a shift from realm of competition, where price
1069 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 67, at 19: "The tourist test is a reliable tool
in the case of constant issuer margins and homogeneous merchants (Rochet and Tirole (2011))”. 1070 Rochet & Tirole, Must-Take Cards, supra note 1064, at 486: “[M]erchants are heterogenous, and an IF that properly
guides cardholders’ decisions must reflect the average, not the marginal merchant benefit. This implies that the
merchants who benefit least from the card, say the large retailers, are likely to fail the tourist test at the social
optimum”. 1071 Richard Schmalensee, Interchange Fees, Market Failure, and Remedies (June 15, 2011), available at
https://www.competitionpolicyinternational.com/assets/Free/Schmalensee-transcriptupdate.pdf: "[T]he test is not
defined when merchants differ, when merchants have different net convenience benefits from card transactions."; H
Leinonen, Debit Card Interchange Fees, supra note 884, at 12: “The theoretical contributions do not indicate clearly
which parameters would be required for establishing the MIFopt or how market data should be collected for estimating
the parameters. This will be more difficult in practice, as neither cardholders nor merchants comprise a homogeneous
group of agents with identical benefit and cost structures”. 1072 For expansion on costs of payment instruments see infra ch. 5.1. 1073 Supra ¶ 591. 1074 Prager et al., Interchange Fees and Payment Card Networks, supra note 923, at 48: “[T]he tourist test requires
detailed information on transactional costs and benefits of cards and cash to merchants. These benefits and costs are
likely complex and may vary substantially across merchants as well as across types of transactions, even for a given
merchant”. 1075 Emilio Calvano, Action on Payment Cards (a Few) Insights from Theory, at 6 (June 15, 2011): "Whenever there is
an epsilon markup somewhere the TTIF fails."
248
is determined by costs (p=mc adjusted to our case: Pm+Pc=Ci+Ca),1076 to the world of market
power. This is problematic when done in a legally approved restrictive arrangement.
595. Sixth, costs of card transactions are constantly declining because of scale efficiencies and
technological improvements.1077 The cost of cash involves concreate inputs and labor which
become more expensive over time.1078 This means that the tourist test should increase with time.
The unfortunate implication is that progress and efficiency become a factor in price increases
instead of price reductions. This also reduces incentives of merchants to invest in smart
acquiring, because a tourist test fee implies they would not benefit from any cost savings.1079
596. Seventh, the tourist test ignores the inherent benefits of cardholders from cards.1080 If the benefit
to a cardholder from using her/his card is large enough, then the cardholder will use the card
(and not cash) anyway. When cardholders’ benefits from cards is sufficient, there is no need to
charge merchants a (high) MSF that extracts all of their utility from cards, in order to encourage
cardholders to use cards. Cardholders would use their cards anyway, even with a lower MSF,
and retail prices would be also lower.1081
8.3. United States
597. Until the end of the 1970s, interchange fees in U.S. payment card market were fixed by banks
who were members of the open networks, Visa and MasterCard. The banks were operating on
both sides of the networks as both issuers and acquirers.
1076 For expansion, see ¶ 171. 1077 See ¶¶ 143, 125. 1078 See ch. 0. 1079 Nicole Jonker & Mirjam Plooij, Tourist Test Interchange Fees for Card Payments: Down Or Out? 1 J. FIN.
MARKET INFRASTRUCTURE 51 (2013); Bolt, Pricing, Competition and Innovation in Retail Payment Systems: A Brief
Overview, supra note 12, at 73: “Due to large-scale effects, the average cost of a (debit) card transaction continues to
decrease, while the average cost of a cash payment is increasing. Applying the tourist test methodology would then
predict higher (future) interchange fees for payment cards, so as to maintain the indifference level between cash and
cards.”; Wilko Bolt, Nicole Jonker & Mirjam Plooij, Tourist Test or Tourist Trap?, supra note 209, at 25: “The main
drivers of the increase in Tourist Test MIF level are the rising costs for cash and declining costs for debit card payments
for merchants. Over time, scale and scope effects increase these cost differentials even further. If banks would base their
acquiring fees on the Tourist Test methodology for debit card payments, merchants are discouraged to invest in
acceptance and efficiency of debit card payments. The reason is that merchants would hardly benefit from any of the
efficiency gains that arise from increased debit card usage or improvements in the infrastructure for card payments, as
these are (partly) neutralized by rising acquiring fees. With merchants having less incentive to stimulate card payments,
the application of the Tourist Test could slow down the existing trend of increasing the use of debit cards. In a market
where the social costs of debit card payments are now lower than those of cash, this would mean that potential social
cost savings are not realized.”; Leinonen, Debit Card Interchange Fees, supra note 302, at 9: “[S]etting the interchange
fee close to the "tourist test level" would result in almost total elimination of the development incentive”. 1080 See infra note 614. 1081 For expansion see infra ch. 6.9.4 (Consumer Welfare Optimal Interchange Fee).
249
598. In 1979, NaBanco, a firm that served as an acquirers' processing agent, filed a suit against
Visa.1082 NaBanco was a back-office processor. It collected transaction slips for acquirers and
then presented them to issuers for payment to merchants. Issuers deducted the interchange fee
from the payments. NaBanco remitted to merchants funds it received from issuers, and shared
the MSF (minus the interchange fee that was deduced by the issuers) with the formal acquirers.
NaBanco therefore had a strong incentive to lower the interchange fee. The lower the
interchange fee the more profit could be retained by NaBanco.
However, all issuers to whom NaBanco applied demanded the same interchange fee, which was
the fee dictated by Visa or MasterCard organizations. Thus, in 1978, NaBanco filed a lawsuit
that challenged the interchange fee as a horizontal minimum price-fixing agreement. The claim
stated that the uniform interchange fee was a per-se price-fixing violation proscribed under
section 1 of the Sherman Act.
599. Visa submitted expert opinions explaining what today we would call the principles of a two-
sided market.1083 One of the experts was Professor Baxter, who later published the first major
article in this field.1084 Visa argued that contrary to a cartel that leads to lower output and higher
price than competitive equilibrium, the interchange fee was designated to increase output and
lower prices for cardholders.
600. The court accepted the position of Visa and dismissed the claim. The court held that Visa did
not possess significant market power,1085 because the relevant market included all payment
instruments, including cash and checks.1086 The court rejected the argument that interchange
fee was a per-se restrictive arrangement. It scrutinized and confirmed the legality of the
interchange fee under the rule of reason standard, as a necessary instrument for Visa to operate
efficiently.1087
601. The court's conclusion has been based on several foundations:
1082 National Bancard Corp. (NaBanco) v. VISA, 596 F. Supp. 1231 (S.D of Fla, LEXIS 23432 1984). 1083 For two-sided markets see infra ch. 7.1. 1084 For expansion on the model of Baxter see infra ch. 6.2. 1085 NaBanco, supra note 182, at 1251: “Consideration of the relevant market reveals that VISA has no significant
market power”. 1086Id. at 1257. 1087Id. at 1253: “Given this background of jurisprudence, the Court concludes that IRF should be analyzed under the
rule of reason because it is an agreement on the terms of interchange necessary for VISA to market its product and be
an effective competitor”.
250
601.1 Thorough calculation of the interchange fee that was presented to court, and was
based on costs, led the court to conclude that without interchange fee, issuers’ costs
could not be covered (i.e., cardholder fees and interest on credit, were not sufficient
for covering all costs of issuers), thus without interchange fee issuers would be in
"deficit".
601.2 The court conceptualized interchange fee as similar to internal payments that exist in
closed networks like American Express.
601.3 The court held that interchange fees would not be set too high, because most issuers
were also acquirers who, presumably, would object paying excessively high
interchange fees.
601.4 The number of acquirers and issuers was too large for bilateral agreements. Without
a default interchange fee, transactions in which an issuer has no prior agreement with
an acquirer could occur. In such cases issuers could supposedly, extort excessive ex-
post interchange fees for their consent to transfer transactions' funds to acquirers.1088
602. Before continuing, it should be noted that the arguments of NaBanco are no longer valid in light
of changed realities.
Market Power
603. Market power is the ability to raise prices significantly above the competitive level without
suffering losses from this increase.1089 In 2001, a U.S. federal court held in a governmental
proceeding (discussed below),1090 that contrary to the holding in NaBanco, both Visa and
MasterCard had market power.1091 The reasoning was that merchants could not resist increases
in the fees they pay, because of fear of desertion by customers. Merchants weigh “strategic
considerations” that cause them to accept cards even in the presence of market power. The court
noted that even though Visa and MasterCard raised their interchange fees significantly, they
1088Id. at 1261-62. But see an answer to the "extortion" argument infra ch. 8.3.5, 1089 United States v. Am. Express Co., 21 F. Supp. 3d 187, 195 (E.D.N.Y. 2014): “Market power is the ability to raise
price significantly above the competitive level "without losing all of one's business”. For a different definition see
United States v. Am. Express Co., 2016 U.S. App. LEXIS 17502 (2d Cir. N.Y. Sept. 26, 2016): "Market power is the
power to force a purchaser to do something that he would not do in a competitive market." Eastman Kodak, 504 U.S….
see also E. I. du Pont de Nemours & Co., 351 U.S. at 391 ("[Market] power is the power to control prices or exclude
competition.")." 1090 Infra ch. 8.3.6. 1091 United States v. Visa U.S.A., Inc., 163 F. Supp. 2d 322, 340 (S.D.N.Y. 2001); aff'd in United States v. Visa U.S.A.,
Inc., 344 F.3d 229, 239-240 (2d Cir. N.Y. 2003).
251
did not lose market share. This is a significant indicator of market power. Other indicators of
market power the court found were price discrimination between categories of merchants in the
MSF (as the ability to carry out price discrimination is also an indicator of market power),1092
and high barriers to entry. In the words of the court:
[Merchants] cannot refuse to accept Visa and MasterCard even in the face of
significant price increases because the cards are such preferred payment methods
that customers would choose not to shop at merchants who do not accept them. In
addition, both Visa and MasterCard have recently raised interchange rates charged
to merchants a number of times, without losing a single merchant customer as a
result... Defendants' ability to price discriminate also illustrates their market power.
Both Visa and MasterCard charge differing interchange fees based, in part, on the
degree to which a given merchant category needs to accept general purpose cards…
whether considered jointly or separately, the defendants have market power…
Furthermore, there are significant barriers to entry into the general purpose card
network services market.1093
Visa and MasterCard appealed this decision. Their appeal was denied, and the court held
again that they both have market power.1094
604. Market power in the field of payment cards is the ability to make a permanent and significant
increase in the price level, at least on one side (cardholders or merchants), without suffering a
loss from the price increase. This is in fact a SSNIP test, known for defining relevant markets,
adjusted for two-sided markets.1095 In the European MasterCard decision, the Commission
warned that like with ordinary products, SSNIP test may yield false results if at the initial stage
of the investigation, prices are already inflated because they reflect existing market power (a
situation known as the "Cellophane Fallacy").1096
605. In a more recent battle in the U.S. between the Department Of Justice and American Express
over anti-steering provisions in American Express contracts with merchants, the court ruled in
1092 OECD, POLICY ROUNDTABLE, COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS, at 9
DAF/COMP(2006)32: “[P]rice discrimination exists both for cards with large market shares and for cards with small
market shares… Some would interpret this price discrimination as an indication of market power". 1093 United States v. Visa U.S.A., Inc., 163 F. Supp. 2d 322, 339-40 (S.D.N.Y. 2001). 1094 United States v. Visa, 344 F .3d 229 (CA 2d Dist. 2003): "We agree with the district court's finding that Visa U.S.A.
and MasterCard, jointly and separately, have power within the market for network services.”; cert. denied, Visa U. S. A.,
Inc. v. United States, 543 U.S. 811 (2004). 1095 United States v. Am. Express Co., 2015 U.S. Dist. LEXIS 20114, 85-86 (E.D.N.Y. Feb. 19, 2015): “[A] relevant
product market is properly defined if a hypothetical profit-maximizing monopolist that is the only seller of the
product(s) included in the proposed market could profitably impose a small but significant and non-transitory price
increase ("SSNIP") - i.e., without losing so many sales to other products that its price became unprofitable. By contrast,
if buyers are able and inclined to switch away from the product(s) in numbers sufficient to render the SSNIP
unprofitable, the proposed market definition likely needs to be expanded.”; Erich Emch, Market Definition and Market
Power in Payment Card Networks, 5 REV. NETWORK ECON. 45 (2006); Lapo Filistrucchi, A SSNIP Test for Two-Sided
Markets: The Case of Media (NET Inst. Working Paper 08-34. 2008): "In a two-sided market as the payment cards one
the hypothetical monopolist should be thought of as raising the price level, adjusting optimally the price structure”. 1096 Comp/34.579 European Comm'n MasterCard Decision, supra note 1027, paras. 286-87.
252
February 2015 that American Express also has market power.1097 The market share of American
Express in the U.S. is second to Visa but higher than MasterCard.1098 However, American
Express appealed successfully. The Court of Appeals for the 2nd district ruled on September
2016 that American Express's power to raise the MSF is not sufficient to indicate market power.
According to the court of appeals Amex's anti-steering rules, designed to enable low cardholder
fees, do not indicate market power.1099 The U.S. Government applied for rehearing en-banc,
and the petition is pending (November 2016).1100
606. Price discrimination (i.e., categories), and very high profitability, in comparison to other sectors
of the financial sector, also imply that networks possess market power.1101 Moreover, market
power indicators appear also on cardholders' side. An increase in cardholder fees had not
reduced payment cards adoption or usage, as would be expected to occur when firms without
market power increase their prices.1102
607. Since NaBanco decision, tribunals in other countries have also determined that contrary to
NaBanco ruling, both Visa and MasterCard have market power, on both sides of the market. In
1097 Am. Express Co., supra note 1095: “[T]he court concludes that American Express does possess antitrust market
power in the GPCC card network services market sufficient to cause an adverse effect on competition. Specifically, the
court finds that Defendants enjoy significant market share in a highly concentrated market with high barriers to entry,
and are able to exercise uncommon leverage over their merchant-consumers due to the amplifying effect of cardholder
insistence and derived demand. In addition, American Express's ability to impose significant price increases during its
Value Recapture initiatives between 2005 and 2010 without any meaningful merchant attrition is compelling evidence
of Defendants' power in the network service market”. 1098 Ibid: “Today, American Express is the second largest GPCC card network when measured by charge volume. As of
2013, Amex accounted for 26.4% of general purpose credit and charge card purchase volume in the United States. It
trails only Visa's 45% market share, and is larger than both MasterCard (23.3%) and Discover (5.3%)”. 1099 United States v. Am. Express Co., 2016 U.S. App. LEXIS 17502 (2d Cir. N.Y. Sept. 26, 2016). 1100 United States v. Am. Express Co., Petition Of The United States And Plaintiff States For Panel Rehearing And
Rehearing En Banc, (Nov. 10, 2016) https://www.justice.gov/atr/case-document/file/910116/download 1101 NICHOLAS ECONOMIDES, COMPETITION POLICY ISSUES IN THE CONSUMER PAYMENTS INDUSTRY, in MOVING
MONEY: THE FUTURE OF CONSUMER PAYMENT 113, 114 ( R. Litan & M. Baily eds., 2009): “Both Visa and MasterCard
charge fees (primarily to merchants) that are significantly above costs—some report that total card costs are only 13 to
15 percent of the fees charged and that total fees are about $30 to $48 billion per year. This combination of fees that are
significantly above cost and high market shares suggests that current fees reflect market power”.
1102 AT 4630/01 Leumi v. General Director (Aug. 31, 2006) ("The Methodology Decision"), at 20: (despite increase in
cardholders’ fees adoption and usage increased). For the same effect in Spain, see Santiago Carbo Valverde et al.,
Regulating Two-Sided Markets: An Empirical Investigation, at 8 (FED. RES. BANK OF CHICAGO WP 09-11 2009):
“Spanish consumers increased their holdings of credit cards even when annual fees increased suggesting that the market
for credit cards had not reached its saturation point and consumers are willing to pay higher fees in exchange for greater
merchant acceptance”.
253
Europe,1103 in an OECD roundtable,1104 and in Israel,1105 the conclusions of the respective
Tribunals were that Visa and MasterCard have market power.
Cost Coverage
608. In NaBanco, the interchange fee was set according to the ratio between the average costs of
issuers (numerator) to the pecuniary volume of card transactions (denominator).1106 Interchange
fee at that rate covers total costs of issuers.
609. Regarding the numerator, costs have fallen dramatically over the years (causing the numerator
to decrease). Tremendous technological improvements in the payment industry have occurred
since NaBanco. Nowadays, processing, approval, authorization, clearance and payment phases
are all done electronically. At the time of NaBanco acquiring was done manually with
designated “irons” and paper slips that had to be manually collected and authorized. The process
was labor intensive and time consuming. Today, there is almost full digitization of the payment
process and manual acquiring has been replaced by cheaper and faster electronic process.
Economies of scale also have contributed to lower costs per transaction. Regarding the
denominator, volume of transactions has increased dramatically since NaBanco.1107
610. If the interchange fee was indeed purely a device for covering issuers’ costs, it should have
been reduced significantly since NaBanco.1108 In reality, however, the interchange fee in the
U.S., as a ratio between costs and volumes, has increased dramatically. It is obvious that U.S.
interchange fee is used not only for covering costs, as was the excuse in NaBanco. The
interchange fee in the U.S. is well above costs (supra note 1101). Without derogating from the
1103 EC, INTERIM REPORT, supra note 79, at 77: “[T]he high and persistent profit ratios found by this inquiry in
relatively mature markets, together with other evidence collected on entry barriers, suggest the existence and exercise of
market power in these markets”. 1104 OECD, ROUNDTABLE ON COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS, supra note 1092, at 8: "[I]t is
likely that payment systems do have market power towards merchants, even if a given payment system has a small
share of transactions, as long as the systems have broad acceptance". 1105 Monopoly Declaration on Isracart, supra note 908, at 11 (indications that the payment card firms have market
power over merchants). 1106 NaBanco, supra note 182 at 1262: “cost-based methodology using systemwide average costs ." 1107 Ann Kjos, The Merchant-Acquiring Side of the Payment Card Industry: Structure, Operations, and Challenges, at
11 (F.R.B Phil' Discussion Paper 2007): “Technological innovations, economies of scale, and low-risk business models
are characteristics that have helped shape the industry’s current structure". 1108 Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 974-75: "As
technology has improved and transaction volume soared, one might expect per transaction costs, and thus interchange
fees, to fall. Unlike the non-interchange fee portion of the merchant discount, however, between 1995 and 2005,
interchange fees rose more than 25 percent."; David B. Humphrey, Payment Scale Economies, Competition, and
Pricing (ECB Working Paper No. 1136. 2009) (Graphs showing how costs per transactions decreased over time), at 26:
“relating bank operating cost to point of sale and bill payment transaction volumes across 11 European countries over
1987-2004 suggests that a doubling of payment volume increases operating expenses by only around 27%, so average
payment costs could potentially fall by 37%”.
254
general criticism of cost-based interchange fees,1109 the "covering costs" excuse cited in
NaBanco, not only does not hold anymore, but has over the years evolved into a pretext for
profits.1110
The interchange Fee As Internal Transfer
611. In 2001, Ahlborn et al wrote:
"The interchange fee does not provide a source of profits to the co-operative or its
members. The co-operative itself does not receive the interchange fees; the fee is
simply a payment from acquirers to issuers".1111
612. With all due respect, this is not accurate. It is true that interchange fees are not directly
transferred to the international organizations like Visa or MasterCard. Nevertheless, contrary
to Ahlborn, interchange fee proceeds are transferred to issuers who are the owners of the
international organizations, and do serve as a major source of profit. Issuers control the
international organizations, and determine the interchange fee to maximize their profits.1112
613. The interchange fee is not an internal transfer payment. Interchange fees are paid by merchants
as part of their MSF, and are transferred to issuers via acquirers. This does not turn interchange
fee to be an internal payment. In fact, interchange fees inflate issuers’ income. As long as
acquirers are also connected directly or indirectly to the issuing side, acquirers also enjoy
interchange fee proceeds, according to their market share on the issuing side.1113 Even if a large
1109 Supra ch. 8.1.1(Criticism Of The Cost-Based Methodology). 1110 Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321,
1332-33 n. 22 (2008): "Whatever underlying theoretical basis now might be concocted in defense of the interchange
fee, the credit card issuers themselves see it as a method of funding rewards programs (and other costs), as well as an
independent profit center.";
Steven Semerraro, The Reverse Robin Hood Cross Subsidy Hypothesis: Do Credit Cards Systems Tax the Poor and
Reward the Rich? 40 RUTGERS L.J. 419, 423 (2009): "Interchange fees essentially tax merchants by requiring them to
pay card issuers a fee for the right to accept cards that exceeds the issuers’ cost (plus normal profit) of the service that
the merchants receive.";
For the same conclusion in Europe see EC, INTERIM REPORT, supra note 79, at 77: "[T]he above findings on the
profitability of payment card issuing cast doubt on the assumption that in the absence of interchange fees, issuers could
not recoup their costs from card-holders . . . seem[ingly] . . . confirm[ing] some recent theoretical predictions in the
literature on two-sided markets suggesting that privately optimal interchange fees may be too high, notably if merchant
fees increase with interchange fees but issuers do not pass the additional interchange fee revenue back to cardholders. In
this case, high interchange fees are a way to transfer rents to the side of the scheme where they are least likely to be
competed away". 1111 Christian Ahlborn, Howard H. Chang & David S. Evans, The Problem of Interchange Fee Analysis: Case without a
Cause? 2 PAYMENT CARD REV. 183, 194 (2004). 1112 David Balto, The Problem of Interchange Fees: Costs without Benefits? E.C.L.R 215, 221 (2000); see also infra ch.
6.9.2 (Privately set interchange fee by issuers) . 1113 Case T-111/08 MasterCard v. Comm'n, para. 254(May 24, 2012): “[t]he MIF remains a source of revenue for the
banks in so far as they also have an issuing business... the NAWIR (No Acquiring Without Issuing Rule) — which
obliged banks wishing to acquire transactions also to have a card issuing business, virtually all banks engaged in the
255
acquirer is only a small issuer, it enjoys a positive flow from the interchange fee, according to
its market share on the issuing side, while not “suffering" from the payment of the interchange
fee on the acquiring side, because it is passed through to merchants.1114 Thus, the reasoning in
NaBanco, viewing the interchange fee as an internal payment, cannot hold.
Bilateral Agreements
614. In NaBanco, the court held that it was not practical to cover the market with bilateral
agreements, because of the large number of issuers and acquirers. This argument is not
applicable in concentrated markets such as Israel, which has only three payment card firms.
Without the Trio Agreement only three agreements would have been required to cover the entire
market.1115 In addition, some scholars have argued that bilateral agreements are currently
applicable, because markets, on both sides, have become centralized, so only relatively small
number of agreements is needed to cover most of the market.1116
615. In my view, this argument from the NaBanco decision is still valid. Bilateral agreements are
not feasible. Transactions in which there are no prior agreement between the issuer and the
acquirer, e.g., tourists' transactions, would forever occur. Even if bilateral agreements were
feasible, bilateral interchange fee that would have been determined (in bilateral negotiations),
would not abate the competitive concerns. The problem is that as long as acquirers have
interests on the issuing side, the acquirer will forever agree to pay (in bilateral negotiation) high
acquiring business were also card issuers and benefited, to that extent, from the MIF.”; Comp/34.579 European
Comm'n MasterCard Decision, supra note 570, para. 385; see also supra ¶ 35, (n.75) ([T]he setting of interchange fee
rates is not akin to a contentious process such as a price negotiation where opposing interests of buyers and sellers
meet). See also ¶ 0104 , ¶ 613 (Even if a large acquirer is only a small issuer, it enjoys a positive flow from the
interchange fee, according to its market share on the issuing side, while not “suffering" from the payment of the
interchange fee on the acquiring side, because it is passed through to merchants); ¶ 615, ¶ 620, ¶ 692, ¶ 781, Infra note
1436. For my proposal with respect to this distortion, see infra ch. 0 (Structural Separation Between Issuers And
Acquirers) 1114 See also supra ¶¶ 35, 97. 1115 Supra ¶ 85. 1116 NICHOLAS ECONOMIDES, COMPETITION POLICY ISSUES IN THE CONSUMER PAYMENTS INDUSTRY, supra note 1101, at
122: "[T]here is significant concentration among acquirers, with 86 percent of all Visa and MasterCard volume
generated by the top ten acquiring banks. Similarly, 84 percent of this volume is generated by the top ten issuers.
Therefore ninety contracts generate 72 percent of all MasterCard and Visa volume."; Frankel & Shampine, The
Economic Effects of Interchange Fees, supra note 64, at 640-41 (2006): “The top ten acquirers account for about 86
percent of all MasterCard and Visa bank card dollar charge volume, while the top ten issuers account for 84 percent
of charge volume. No more than 90 contracts— not millions—would therefore be required to cover 72 percent of
all charge volume. Individual banks not interested in direct contracts with many other banks need only shop for a
single correspondent services contract. Particularly with modern data processing and communications technology,
such correspondent relationships can be quick and efficient”.
256
interchange fee, knowing that in its role as issuer, it will profit from this supra competitive fee.
This is true regardless the number of issuers or acquirers.1117
Issuers’ Extortion Position
616. The "hold-out" argument in favor of interchange fees was raised by Baxter and adopted in
NaBanco. According to this argument, in the absence of ex-ante agreement, and because of the
HAC rule that compels every merchant who accepts Visa or MasterCard, to accept all cards of
that brand (regardless of the issuer's identity), issuers have a strong upper hand and can extort
from acquirers ex-post monopolistic interchange fees.1118
The hold-out argument continues as follows: The extortion position of issuers could saddle not
only merchants but also cardholders, with constant uncertainty. In the absence of prior
agreement between the merchant’s acquirer and the cardholder’s issuer, merchants might totally
refuse to accept cards that might reveal ex-poste too costly (if the issuer extorts excessive
interchange fee). Cardholders in such case would always have to be prepared to pay with cash.
This would destroy one of the main advantages of payment card networks. If surcharging is
allowed, then merchants, who are compelled to pay high MSF, would pass through this high
price to cardholders. Cardholders again would have to be in constant alert, and be prepared to
pay with a different payment instrument. The value of cards would be diminished. The
interchange fee is thus required, according to this argument, to prevent this ex-post hold-out
position of issuers.1119
1117 For expansion see infra ch. 12.1 (Bilateral Interchange Fees). 1118 William F. Baxter, Bank Interchange of Transactional Paper: Legal and Economic Perspectives 26 J.L. ECON. 541,
577 (1983): “Accordingly, It is essential that the participants in a four-party payment system collectively adopt some
internal mechanism that prevents individual exploitation of the monopsony power endemic to such systems”. 1119 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, 33 RAND J.
ECON. 549, 550 (2002): “To see the benefits of a centrally determined interchange fee cum the honor-all-cards rule, it
suffices to envision the complexity of bilateral bargaining among thousands of banks as well as the cost for issuers
(respectively, merchants) of informing consumers about the set of merchants (respectively, banks) with whom an
agreement has been reached. The latter transactions costs could be avoided by keeping the honor-all-cards rule while
letting issuers and acquirers set their pairwise interchange fees. However, an individual issuer would then be able to
impose an arbitrarily high interchange fee, since the acquirer would then face the grim choice between accepting
this fee on a fraction of his payments and exiting the industry altogether. Individual issuers would become
bottlenecks, and their free riding would dissuade acquirers from entering the industry.”;
Marc Rysman & Julian Wright, The Economics of Payment Cards, at 18 (2015): “[I]t is difficult to combine the “honor
all cards” rule with bilateral interchange negotiation because it leads to a hold-up problem, in which a single issuer
might refuse to deal with acquirers unless they accept its demands for a particularly high interchange fee.”;
Prager et al., Interchange Fees and Payment Card Networks, supra note 923, at 19: “The logic is as follows: In the
absence of common terms of exchange between banks, each issuer could set its own interchange fee. However, an
honor-all-cards rule would require that every merchant that accepts a particular network brand and type of card (e.g.,
Visa credit card) accept every card with that brand and type, regardless of the level of the interchange fee set by the
issuer. As a result, an honor-all-cards rule with bilaterally negotiated interchange fees would introduce the possibility of
257
617. The hold-out argument (that without ex-ante interchange fee, issuers would be in an ex-post
extortion position towards acquirers with whom they have no prior agreement), is flawed for
two main reasons:
618. First, Legally, Article 7 of the Payment Card Law anchors the fundamental obligation of
issuers, to pay merchants for all transactions performed by the issuers’ cardholders. In other
legal systems issuers are also obliged to remit to merchants the sums due for purchases made
by their cardholders. This obligation is binding even if the acquirer does not agree to pay any
interchange fee to the issuer. Therefore, acquirers could also allegedly extort issuers.1120
619. Second, the hold-out argument assumes a default rule, under which issuers are entitled to
demand interchange whatsoever. This assumption is incorrect. There is no such binding default
rule. On the contrary, the default rule might just as well be that in the absence of advance
agreement, the issuer must remit to the acquirer the full sums due (i.e., default rule of zero
interchange fee). Under this default, which is no less plausible, an issuer would be prohibited
from requiring ex post interchange fee, unless acceptable by the acquirer.1121 This will put an
end to any holdout argument.
a “holdup problem”... That is, an individual issuing bank could demand very high interchange fees from acquiring
banks. The acquirers would then factor the high fees charged by this issuer into the merchant discounts that they charge
their merchants. A merchant, in turn, could avoid those fees only by rejecting all of a network’s cards of that type, in
which case card acceptance could be inefficiently low. A common interchange fee avoids this holdup problem.”;
David S. Evans & Richard Schmalensee, The Economics of Interchange Fees and their Regulation: An Overview,
Payments System Research Conferences, 73, 84 (2005): ”As long as an honor-all-cards rule is in effect, so that
merchants are required to accept all cards of a given brand, an acquirer is at a significant disadvantage in negotiations
with other issuing banks, since its merchant is required to accept their cards, but it has no guarantee of payment by the
card issuer.”;
Ahlborn et al., The Problem of Interchange Fee, supra note 1111, at 193: "[W]ithout agreement, issuing banks could
refuse to honour acquiring bank transactions and thereby “hold up” the acquiring banks for huge interchange fees.";
Benjamin Klein et al., Competition in Two-Sided Markets: The Antitrust Economics of Payment Card Interchange Fees,
73 ANTITRUST L.J. 571, 574 (2006): “Given an honor-all-cards rule, bilaterally negotiated interchange fees in the
absence of a default interchange fee would create an incentive for individual card issuers in an open-loop payment card
system to “hold up” acquirers by demanding arbitrarily high interchange fees on transactions made with their cards. In
particular, individual Visa and MasterCard issuers would have the incentive to take advantage of the fact that merchants
accepting Visa or MasterCard have agreed to honor-all-cards to make unreasonably high interchange fee demands. Such
demands would impose an externality on the entire payment card system, and eventually lead some merchants to drop
acceptance of the payment system's cards. A default interchange fee prevents such holdups by placing a cap on
interchange fees that can be bilaterally negotiated between individual issuers and individual acquirers in the Visa and
MasterCard payment systems”. 1120 John Simon, Payment Systems are Different: Shouldn’t their Regulation be Too?, 4 REV. NETWORK ECON. 364, 366
(2005): “[B]oth issuers and acquirers have hold-up power over any negotiations. This simultaneous hold-up power
means that, once established, it is difficult for interchange fees in a bilateral system to be reset as economic
circumstances change”. 1121 Alan S. Frankel & Allan L. Shampine, The Economic Effects of Interchange Fees, 73 ANTITRUST L.J. 627, 642
(2006); K. Craig Wildfang & Ryan W. Marth, The Persistence of Antitrust Controversy and Litigation in Credit Card
Networks, 73 ANTITRUST L.J. 675 (2006): "This argument, however, presumes that some interchange fee must be paid
for the network to function… For the hold-up problem to justify the collective setting of a fee, it is first necessary to
conclude that the transfer of some fee is necessary in the first place. The success of four-party networks that function
258
620. On July 2016 the British Competition Appeal Tribunal entered a long judgement in the case of
Sainsbury v. MasterCard.1122 The tribunal analyzed what would be the consequences of a
transaction made without a prior interchange fee agreement. It concluded that the extortion
argument is flawed. Due to the Honor All Cards rule, without prior arrangement, issuers would
have to remit to acquirers transactions' funds with no deduction:
"We do not consider that it would be open to an Issuing Bank simply
to deduct from its settlement obligation any amount that it saw fit.
Indeed, it is significant that the Commission described this in
paragraph 554 of its Decision (The European MasterCard Decision –
O.B) as an “abuse”, and that is exactly what it would be. According
to the MasterCard Scheme Rules, a deduction from the settlement
obligation must be authorized – and if it is not authorized, it cannot
be made… Absent a bilateral agreement between the Issuing Bank
and the Acquiring Bank, no deduction representing a charge for
interchange would be permissible in the no-MIF or zero MIF world"
(ibid paras. 149-151).
Thus, the hold-out problem is not issuers' potential extortion position, because acquirers are
able to offset such position. The problem of the interchange fee is that as long as acquirers are
also issuers, or connected through ownership to issuers, acquirers would gladly surrender in
any ex-ante or ex-post negotiation, and agree to pay a high interchange fee, knowing that they
themselves will receive the same interchange fee, in another transaction, in which they will be
the issuers.1123
621. Getting back to the history of payment cards, after the NaBanco decision was given (in 1984),
there was a lull of years, without any attempt to challenge the interchange fee. Other restrictive
arrangements in open networks were more successfully challenged.
The Elimination Of Issuing Prohibitions
622. In 1998, the U.S. Department of Justice filed a civil suit against Visa and MasterCard. The suit
challenged the legality of the bylaws of Visa and MasterCard, which had prohibited banks that
issued Visa and MasterCard, from also issuing the competing cards of rivals Discover and
effectively without interchange fees is inconsistent with such a conclusion."; Steven Semeraro, The Antitrust Economics
(and Law) of Surcharging Credit Card Transactions, 14 STAN. J. L. BUS. & FIN. 343, 381 n. 162 (2009); see also supra
¶ 579 (ECJ MasterCard Decision). 1122 Sainsbury’s supermarkets v. MasterCard, (July 14, 2016) http://www.catribunal.org.uk/237-9006/1241-5-7-15-T-Sainsburys-Supermarkets-Ltd.html 1123 Supra ¶ 35 (n.75), 104, 613. For my proposal to correct this distortion see infra ch. 0.
259
American Express.1124 Interestingly that same rule in the bylaws did not consider Visa and
MasterCard to be competitors, and therefore did not prohibit issuers of Visa from issuing
MasterCard, or vice versa…
623. In 2001, following the ruling that both Visa and MasterCard had market power,1125 the court
accepted the claim and prohibited Visa and MasterCard from preventing their members to issue
American Express or Discover cards.1126 Indeed, after the decision, American Express, which
operated until then as a closed system, began issuing cards through banks with whom it
partnered.1127
In 2007, The European Commission reached the same conclusion with respect to Visa's bylaws
that prevented Morgan Stanley Bank, issuer of Diners Cards, to be member of Visa.1128 In 2011,
the General Court affirmed this decision, opening doors for banks to be members of open
networks as well as closed networks.1129
Partial Cancellation Of The HAC Rule
624. In 1996, several class actions were filed against Visa and MasterCard, claiming that because of
the HAC rule, merchants were not allowed to accept only debit cards. In 2000, the court
certified, accepting plaintiffs' argument that the HAC rule is in fact a tying arrangement,
according to which cheap debit cards are tied to expensive credit cards, and although debit card
interchange fees should have been lower than credit card interchange fees, Visa and MasterCard
tied them together on the same level.1130 As a result a merchant that accepted cheaper Visa or
MasterCard debit cards was forced by the HAC rule to accept also more expensive credit cards.
1124 Commission Decision comp/d1/37860 Morgan Stanley / Visa International and Visa Europe, para. 17 (Oct. 3,
2007): "[O]n 4 December 1989, the Visa International Board of Directors adopted the following rule as an amendment
to Section 2.12b of the Visa International By-Laws:28 “… If permitted by applicable law, the Board (including
Regional Boards and Group Members) shall not accept for membership any Applicant which is deemed by the Board of
Directors to be a competitor of the corporation.”; United States v. Am. Express Co., LEXIS 20114 at 32-33 (E.D.N.Y
Feb. 19, 2015): “Visa and MasterCard maintained bylaws preventing their member banks from issuing credit cards on
competing networks, like Discover and American Express... these so-called "exclusionary rules" were removed
following the Department of Justice's successful antitrust enforcement action”. 1125 Supra ¶ 603. 1126 United Stated v. Visa U.S.A., Inc., 183 F. Supp. 2d 613 (S.D.N.Y 2001), aff'd, United States v. Visa, 344 F.3d 229
(2d Cir. 2003), Cert. denied Mastercard v. United States, 543 U.S. 811 2004. 1127 United States v. Am. Express Co., LEXIS 20114 at 33 (E.D.N.Y Feb. 19, 2015). 1128 Comp/d1/37860 Morgan Stanley / Visa International and Visa Europe, (Oct. 3, 2007) 1129 T‑461/07 Visa Europe Ltd v European Commission (Apr. 14, 2011). 1130 In re Visa Check/MasterMoney Antitrust Litig., 192 F.R.D. 68, 73 (E.D.N.Y. 2000): "In 1979, Visa and MasterCard
launched their off-line POS debit cards, VisaCheck and MasterMoney, respectively. Pursuant to the defendants' "honor
all cards" rule, any merchant accepting Visa or MasterCard credit cards was contractually obligated to accept
VisaCheck and MasterMoney as well. Also linked were the interchange fees: Visa and MasterCard set them for the off-
260
625. These claims were consolidated into what is known as the Wall-Mart case. The litigation
continued for several years. A notable interim decision by the court held that credit cards and
debit cards are separate markets.1131 Meanwhile, in the DOJ case it was determined that both
Visa and MasterCard have market power.1132
626. In 2003, a settlement was reached whereby Visa and MasterCard paid merchants, a then record
compensation of over $ 3 billion, and partially canceled the HAC.1133 The settlement permitted
merchants to split their decision regarding the acceptance of credit and debit. Merchants could
choose to accept only debit cards or only credit cards (or both) of either Visa or MasterCard.
However, the HAC rule within debit and within credit card networks was not cancelled.
Merchants who accepted debit card (or credit card) still had to honor all the cards of the same
type, even if they bear a higher MSF. For example, premium credit cards carry a higher MSF
than regular credit cards, but merchants who chose to accept regular credit cards, had to also
accept premium credit cards, and pay their higher MSF.1134 Therefore, the HAC, even in its
restricted form, provoked criticism among scholars. The main argument was that the historical
development of the HAC and the NSR rule reveals that they were intended to protect the
network and increase certainty of card acceptance when networks were nascent.1135 Merchant
line POS debit cards at the same level as for credit cards. This equivalence occurred notwithstanding the fact that credit
cards are much more expensive for banks (due to the risks inherent in extending credit) than are debit cards… Without
the tie to credit cards, the plaintiffs allege that "retailers would not pay these fixed, supra-competitive and extortionate
VisaCheck and MasterMoney rates."... Visa and MasterCard have undertaken a number of measures to "deceive"
retailers about the off-line POS debit cards. They designed them to be "visually and electronically indistinguishable"
from credit cards so that retailers would not even know they were accepting a different form of payment, and they set
the interchange fees at the same level for debit and credit so that retailers would not notice the difference when they
were billed."; aff'd in In re Visa Check/Mastermoney Antitrust Litig. v. Visa, United States, 280 F.3d 124, 131 (2d Cir.
N.Y. 2001): "Defendants have set the interchange fees for Visa Check and MasterMoney at or near the same level as the
interchange fees for their respective credit cards despite the fact that, according to plaintiffs, credit card transactions -
which rely on the extension of credit - involve far more risk. The interchange fees for competing on-line debit cards -
where the risk of non-payment is substantially eliminated - is far lower."; cert. denied: Visa U.S.A., Inc. v. Wal-Mart
Stores, 2002 U.S. LEXIS 4394 (U.S. June 10, 2002). 1131 In re Visa Check/Mastermoney Antitrust Litig., 2003 U.S. Dist. LEXIS 4965 (E.D.N.Y. Apr. 1, 2003): "Merchant
demand for credit card services is distinct from merchant demand for debit card services". 1132 Supra ¶603. 1133 In Re Visa Check/Mastermoney Antitrust Litig. 297 F. Supp. 2d 503 (E.D.N.Y 19.12.03). 1134 Wildfang & Marth, The Persistence of Antitrust Controversy and Litigation in Credit Card Networks, 675; see also
infra ¶ 755. 1135 Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321,
1328 (2008): “In the early days of credit cards, if consumers had been required to pay more at point of sale for using
cards, it is unlikely that credit cards would have become a mass-market product. No-surcharge rules allowed the card
networks to retain control over the perceived allocation of costs within the network and impose a cross subsidy on non-
cardholders so as to grow the network. Now, however, credit card networks are past the chicken-and-egg problem that
plagues new two-sided networks. Credit cards are now widely accepted by merchants and used by consumers. Credit
cards are an established product that does not need subsidization to thrive.”; See also United States v. Am. Express Co.
LEXIS 20114 (E.D.N.Y Feb. 19, 2015).
261
restraints were never intended to compel merchants to honor expensive cards against their will,
especially in mature networks and when cards are ubiquitous.1136
Interchange Fee Settlement
627. Since 2005, the interchange fee itself has again been under attack. In 2005 and 2006, dozens of
class actions challenging credit card interchange fees were filed, after interchange fees in the
U.S. reached very high levels relative to other countries. The lawsuits were consolidated into
the largest suit ever under the Sherman Act.1137
The plaintiffs alleged, inter alia that the interchange fee constituted prohibited horizontal price-
fixing, and that the justifications given in NaBanco allowing the interchange fee were no longer
valid. NSR rules were also challenged. The preliminary proceedings in the consolidated claim
were comprehensive and went on for years.1138
628. In July 2012 a proposed settlement agreement was submitted to the Court.1139 It provided, inter
alia: (a) Compensation to merchants of an estimated $7.25 billion (before reductions for opt-
outs); (b) Modifications to Visa and MasterCard NSR rules, so to permit merchants to surcharge
credit card transactions (Subject to few limitations, mentioned in Article 42 of the Visa
settlement and Article 55 of the MasterCard Settlement); (c) Obligations of Visa and
MasterCard to negotiate future interchange fees in good faith with merchant buying groups.1140
1136 Levitin, Priceless? The Economic Costs, id. at 1369: “[H]onor-all-card and no- differentiation rules have morphed
into a new role, which has nothing to do with network effects. Instead, these rules now allow all credit card networks to
lever new, more expensive product lines onto their existing merchant base."; id. at 1391: “The only reason for a
merchant to refuse to honor a particular card within a brand is because it is more expensive to accept than another of the
brand’s cards. The function served today by honor-all-cards rules is not ensuring the viability of a multi-issuer network,
but rather ensuring networks’ ability to issue high-cost cards... If the honor-all-cards rule was eliminated, merchants
would likely refuse to accept cards that had high interchange fees (and hence high merchant discount fees). This refusal
would create substantial market pressure on card issuers to stop issuing high interchange fee cards”. 1137 In re Payment Card Interchange Fee & Merchant Discount Antitrust Litigation, 398 F. Supp. 2d 1356 (J.P.M.L.
2005). See also Hearing before the S. Judiciary Comm., 109th Cong. 147 (2006) (Statement of Timothy J. Muris,
Former FTC Chairman): "[T]he largest private antitrust litigation in the hundred-plus year history of the Sherman Act". 1138 In re Payment Card Interchange Fee & Merchant Discount. Antitrust Litig., 986 F. Supp. 2d 207, 215 (E.D.N.Y.
2013): “This case has been extensively litigated for more than eight years. Discovery, which began in 2005, included
more than 400 depositions, the production and review of more than 80 million pages of documents, the exchange of 17
expert reports, and a full 32 days of expert deposition testimony”. 1139 In Re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation (Settlement Agreement), 05-MD-
1720 (E.D.N.Y 2012). 1140 In re Payment Card Interchange Fee & Merchant Discount. Antitrust Litig., 986 F. Supp. 2d 207, 217 (E.D.N.Y.
2013): “On July 13, 2012, the parties filed a Memorandum of Understanding attaching a document setting forth the
terms of the settlement... The proposed Settlement Agreement provides for, among other things:• The creation of two
cash funds totaling up to an estimated $7.25 billion (before reductions for opt-outs). • Visa and MasterCard rule
modifications to permit merchants to surcharge on Visa- or MasterCard-branded credit card transactions at both the
brand and product levels. • An obligation on the part of Visa and MasterCard to negotiate interchange fees in good faith
with merchant buying groups. • Authorization for merchants that operate multiple businesses under different "trade
262
On Dec. 13, 2013, the court granted final approval to the settlement, noting that: “The
settlement proceeds establish a guaranteed fund worth approximately $7.25 billion (before
reductions for opt-outs), the largest-ever cash settlement in an antitrust class action.”1141 In
January 2014, the court awarded Class Counsel Fees of $544.8 million and costs and expenses
of $27 million.1142
629. In my opinion, notwithstanding the huge amounts of compensation and attorney fees, the
settlement was insufficient. It did not resolve future interchange fees in a competitive manner.
In spite of the settlement, interchange fees in the U.S. are among the world's highest, and could
remain so. Many merchants have opted-out of the settlement, mainly because of absence future
regularization of the interchange fee.1143
630. Indeed, on June 30, 2016 the court of appeals held that plaintiffs were inadequately represented.
The appeal court vacated the district court's certification of the class action and reversed the
approval of the settlement.1144
The Durbin Amendment And Other Reforms
631. While the class action regarding credit cards proceeded, U.S. authorities initiated a
comprehensive debit reform, including deferred debit, in particular with respect to the
interchange fees.
632. In 2008, a bill was proposed to the Congress according to which, merchants could organize and
negotiate interchange fees collectively. The Bill also proposed to appoint a panel of judges that
would determine cost based "competitive" interchange fees that would prevail, if merchants and
names" or "banners" to accept Visa and/or MasterCard at fewer than all of its businesses. • The locking-in of the
reforms in the Durbin Amendment and the DOJ consent decree with Visa and MasterCard, even if those reforms are
repealed or otherwise undone”. 1141Id. at 229. 1142 In re Payment Card Interchange Fee & Merchant Discount. Antitrust Litig., 991 F. Supp. 2d 437, (E.D.N.Y. 2014) 1143 MarketWatch, Retail group opts out of Visa, MasterCard pact (Apr. 11, 2013) available at
http://www.marketwatch.com/story/retail-group-opts-out-of-visa-mastercard-pact-2013-04-11 : "They argue the
settlement will do little to keep the cost of interchange fees from rising and worry the deal grants overly broad releases
from future litigation to the defendants". 1144 In re Payment Card Interchange Fee & Merchant Discount. Antitrust Litig., 827 F.3d 223, 239-40 (2d Cir. 2016):
"The defendants never have to worry about future antitrust litigation based on their honor-all-cards rules and their
default interchange rules… we vacate the district court's certification of the class, reverse approval of the settlement,
and remand for further proceedings not inconsistent with this opinion".
263
issuers would not reach an agreement.1145 This Bill did not ripe to a final statute, but winds of
reform began to blow.
633. In May 2009, Congress passed the Credit Card Accountability Responsibility and Disclosure
Act (“The Card Act”), which concentrated on the commercial relations between issuers and
cardholders. The Card Act increased the duty of disclosure with respect to interest rates and
cardholder fees. The act also limited penalties for arrears, and increased the transparency of
commercial terms in contracts between issuers and cardholders.1146
In February 2010, Regulations known as Regulation Z (truth in lending), were published. Those
regulations were intended to implement the Card Act and ensure its compliance with existing
legislation.1147
634. The interchange fees in debit cards (including deferred debit) were addressed in a
comprehensive reform enacted in July 2010, known as The Dodd-Frank Wall Street Reform
and Consumer Protection Act.1148 Section 1075 of this act, known as the Durbin Amendment,
added Section 920 of the Electronic Fund Transfer Act.1149 The Durbin Amendment was
intended, inter alia, to increase competition and relieve merchants from high interchange fees,
while increasing transparency in the way in which interchange fees are set.1150
635. Section 1075(a) of the Durbin Amendment refers to interchange fees in debit (including
deferred debit) and prepaid cards. Subsection (2) provides that interchange fee will be
calculated based on reasonable costs:
1145 Credit Card Fair Fee Act of 2008 H.R 5546 110 Cong. 1146 Credit Card Accountability Responsibility and Disclosure Act, Public Law 111–24, (2009). See also Sumit Agarwal
et al., Regulating Consumer Financial Products: Evidence from Credit Cards, at 6-8 SSRN Elibrary (Aug. 2014). 1147 Truth in Lending; Unfair Or Deceptive Acts Or Practices; Final Rules, 75 Fed. Reg. 7658 Parts 226 & 227 (Feb.
22, 2010) http://edocket.access.gpo.gov/2010/pdf/2010-624.pdf ; Board of Governors of the Fed. Res. System, Press
Release, (March 3, 2010). For criticism see Oren Bar-Gill & Ryan Bubb, Credit Card Pricing: The Card Act and
Beyond, 97 CORNELL L. REV. 967 (2012). 1148 Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law Pub. L. 111-203, (2010) http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf 1149 Electronic Funds Transfer Act (EFTA), Pub. L. No. 95-630, 92 Stat. 3641 (1978). See also
Board of Governors of the Fed. Res. System, Compliance Guide to Small Entities (Aug. 2, 2013). 1150 Brad G. Hubbard, The Durbin Amendment, Two-Sided Markets, and Wealth Transfers: An Examination of
Unintended Consequences Three Years Later, at 3, SSRN (2013): “The Durbin Amendment had three major goals.
First, to relieve merchants from high interchange fees, which would, in turn, enable merchants to pass these cost savings
on to consumers, who would see lower retail prices. Second, to increase transparency in the way in which interchange
fees are set. Third, to increase competition among networks, such as Visa and MasterCard”.
264
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.
636. The amendment gave the Federal Reserve Board of Governors (the "Board”) the authority to
determine what constitutes reasonable costs. The Board’s discretion is limited by paragraph
4(B)(i), which instructs the Board to consider only incremental costs to issuers, with respect to
“authorization, clearance, or settlement” of the transaction provided:
[T]he incremental cost incurred by an issuer for the role of the issuer in the
authorization, clearance, or settlement of a particular electronic debit
transaction, which cost shall be considered… other costs incurred by an issuer
which are not specific to a particular electronic debit transaction, which costs shall
not be considered.
637. In December 2010, the Board promulgated draft regulations.1151 The draft regulations
recommended that debit issuers could charge an interchange fee which would be one of two
options: (a) a safe harbor of no more than a 7 cent interchange fee which would not be
scrutinized or; (b) an interchange fee of no more than 12 cents, subject to scrutiny of the costs'
compatibility to the Durbin Amendment. Both options posed a dramatic reduction compared to
the former 44-cent average interchange fee.1152
Had this draft been implemented in full, it would have reduced issuers' income significantly. It
is not surprising that Visa and MasterCard recruited leading experts who argued that if the draft
regulations were to be implemented, networks would be impeded and issuers would have to
raise cardholder fees. The networks' scenarios went on to conclude that the access of the
economically weak and disadvantaged population to bank accounts and debit cards would be
severely curtailed.1153 Some articles with these pessimistic forecasts addressed the European
market.1154
On the other hand, merchant organizations supported an even greater reduction in interchange
1151 Debit Card Interchange Fees and Routing, A Proposed Rule by the Federal Reserve System, 75 Fed. Reg. 81722,
(Dec. 28, 2010) available at http://edocket.access.gpo.gov/2010/pdf/2010-32061.pdf. 1152 Ibid at 81726 81736, 81738. 1153 David S. Evans, Howard H. Chang & Margaret M. Weichert, Economic Analysis of Claims in Support of the Durbin
Amendment to Regulate Debit Card Interchange Fees (2011) available at http://ssrn.com/paper=1843628 ;Martin Baily
& Robert E. Litan, Toward Reasonable Regulation of Debit Card Interchange Fees: The Case for Modifying the Fed.
Res. Board's December 16, 2010 Proposals (2011). 1154 David S. Evans & Abel M. Mateus, How Changes in Payment Card Interchange Fees Affect Consumers Fees and
Merchant Prices: An Economic Analysis with Applications to the European Union (2011) available at
http://ssrn.com/abstract=1878735.
265
fees than the one proposed in the draft. All in all, the Board received thousands of comments to
the draft, both in support and in opposition to further reductions in the interchange fee.
638. The Board conducted a comprehensive survey in which costs of processing and fraud
prevention by debit card issuers were investigated.1155 On June 29, 2011, after referring to all
comments, the Board promulgated final regulations (with respect to fraud prevention they were
only interim regulations), known as Regulation II, which became effective October 1, 2011.1156
Regulation II contains, besides a cap on debit card interchange fees, two more important
provisions: (1) a prohibition against NSR and HAC rules; and (2) routing reform.1157
The pressures exerted by the networks and their financial lobby evidently significantly
influenced the final regulations. The final rule increased the maximum interchange fee to 21
cents plus a variable component of 5 basis points (0.05%).1158 Issuers that met the requirements
of fraud prevention adjustments mentioned in Section 235.4 were allowed to add an additional
one cent to the interchange fee. This 1-cent fraud-prevention adjustment, which was initially
temporary, became permanent as of October 2012.1159
639. The U.S. current debit interchange fee is 21 cents plus 0.05% of the transaction plus 1 cent for
fraud prevention. Still, this cap reflects a 45% decrease from the previous average interchange
fee prior to the Durbin Amendment.1160
1155 Board of Governors of the Fed. Res. System, Final Rule on Debit Card Interchange Fees and Routing and Interim
Final Rule on Fraud Prevention Adjustment, 12 C.F.R Pt. 235, 76 Fed. Reg. 43,394, 43,433 (July 20, 2011) http://federalregister.gov/a/2011-16861 : “[T]he types of costs that form the basis for the interchange fee standard are
costs incurred for processing electronic debit transactions, chargebacks, and similar transactions, including network
processing fees and transactions monitoring costs; and fraud losses”. 1156 Ibid at 43,402 43,420 . 1157 Fumiko Hayashi, The New Debit Card Regulations: Initial Effects on Networks and Banks, 4 FRB KANSAS CITY
ECON. REV. 79, 88 (2012): “Regulation II contains three main provisions: a cap on debit card interchange fees, a
prohibition on network exclusivity arrangements, and a prohibition on routing restrictions for debit card transactions”. 1158 Final Rule on Fraud Prevention Adjustment, 76 Fed. Reg. 43,394 at 43467, Sec 235.3(b), available at
https://www.federalregister.gov/documents/2011/07/20/2011-16861/debit-card-interchange-fees-and-routing : “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.”; Sandwith, The Dodd-Frank Wall Street Reform, supra note 237, at
234: "To set the limitation on interchange fees in the final rule, the Fed conducted a survey of institutions covered by
the new interchange fee regulation to determine costs related to issuers' debit card programs. Based on the results of this
survey, the Fed rule limits interchange fees to a base fee of twenty-one cents per transaction plus five basis points of the
transaction's value. For eligible issuers, an additional cent per transaction can be added to cover fraud prevention costs.
The Fed's final rule became effective October 1, 2011”. 1159 77 Fed. Reg. 46279 (Aug. 3, 2012): “Under the final rule, if an issuer meets standards set forth by the Board, it may
receive or charge an adjustment of no more than 1 cent per transaction to any interchange transaction fee it receives or
charges.”; See also Federal Board of Governors of the Fed. Res. System, Press Release (July 27, 2012). 1160 Benjamin Kay, Mark D. Manuszak & Cindy M. Vojtech, Bank Profitability and Debit Card Interchange
Regulation: Bank Responses to the Durbin Amendment, at 9, (2014), available at
http://www.bostonfed.org/payments2014/papers/Cindy_M_Vojtech.pdf: “This cap implies a maximum interchange fee
of 24 cents for a $38 debit card transaction, a decline of 45 percent from the average value of 44 cents for the same
266
640. The Board specifically emphasized that the Durbin Amendment is applicable not only to debit
cards but also to deferred debit cards.1161
641. Both the U.S methodology and the Israeli methodology are cost based. However, the application
of the methodology in the U.S. is much more limiting.
In Israel, the nominated experts used a Long Run Incremental Cost (LRIC) method to attribute
costs to the interchange fee. In LRIC methodology, all variable and fixed costs are considered
as variable, because in the long run they could be avoidable. Thus, in Israel fixed costs, and not
only variable costs, are included in the interchange fee calculation.1162 The methodology
established in the United States is a modified “stand alone” methodology that takes into account
only direct incremental costs of the examined service.1163
642. Perhaps the most striking practical difference between the cost-based methodologies in Israel
and U.S. is that according to the U.S methodology, the cost of the payment guarantee is
practically not counted. The cost of payment guarantee is not associated with “authorization,
clearance, or settlement” of specific transactions. The reason provided in the commentary is
that: “[I]f an issuer approves the transaction knowing there are insufficient funds in the
account… the issuer incurs this cost as a service to its cardholders, and generally imposes fees
to recover the associated risk”.1164 Thus, in U.S., the payment guarantee is considered a service
given by issuers to cardholders. In Israel, according to the Methodology Decision, the payment
guarantee is considered a service to merchants.1165 The difference between U.S. and Israel can
be explained in the artificialness of attributing a specific cost to one side only in two-sided
markets.
transaction in 2009 prior to the Durbin Amendment.”; Kathleen A. McConnell, The Durbin Amendment's Interchange
Fee and Network Non-Exclusivity Provisions: Did the Federal Reserve Board Overstep its Boundaries? 18 N.C.
BANKING INST. 627, 651 (March 2014): “It is estimated that in 2012, the first full year after the regulation went into
effect, card issuing banks lost approximately $ 7.3 billion in interchange fee revenue.” 1161 Commentary on Board of Governors of the Fed. Res. System, Final Rule on Debit Card Interchange Fees and
Routing and Interim Final Rule on Fraud Prevention Adjustment, 12 C.F.R Pt. 235, at 315 (2011): “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... For example, under some
deferred debit card arrangements, the issuer may debit the consumer‘s account for all debit card 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”. 1162 Supra ¶¶ 495-499. 1163 76 FR 43393, supra note 1158, at 43404: “For the interchange fee standards (§ 235.3), the final rule adopts a
modified version of proposed Alternative 2 (stand-alone cap)” 1164 76 FR 43393, supra note 1158, at 43429. 1165 Supra ¶ 492.
267
Indeed, some of the specific costs, comprising the payment guarantee in Israel, are also
considered in the U.S, as being part of the fraud prevention costs. Nevertheless, in the U.S.,
fraud prevention costs amount to only 1 cent. Thus, the main cost drivers of payment guarantee
considered in the calculation of the interchange fee in Israel do not exist, or exist only
negligibly, in the U.S. interchange fee calculation.
643. Overhead is also a cost driver taken into consideration in the Israeli calculation of the
interchange fee, but not in the U.S. calculation, which is more limiting, because overheads
cannot be attributed to a specific transaction.1166
Routing Reform
644. Part (b) of Section 1075 of the Durbin Amendment, applies to all payment cards, including
credit cards.
Subsection 1 prohibits issuers from dictating to merchants how transactions should be
routed.1167 In the regulations this is interpreted as an obligation on issuers to offer merchants
(via acquirers) at least two routing options on unaffiliated networks’ infrastructure (i.e., Star
and Visa).1168 This provision may seem odd to Israelis, who live in a world of only one routing
option (SHVA).1169 As long as SHVA has no competitors, it is difficult to comprehend the
significance of the routing reform. Nevertheless, in the United States there are several routing
options, belonging to different networks.
645. The routing reform eliminated exclusive routing arrangements between issuers and networks
that were infrastructure owners. Prior to the reform, issuers could require merchants to route
1166 76 FR 43393, supra note 1158, at 43427: “The costs the Board did not consider in setting the standards include
costs associated with corporate overhead… these costs are not specific to any electronic debit transaction.”; Adam J.
Levitin, Interchange Regulation: Implications for Credit Unions (FILENE RESEARCH INSTITUTE, 2010): "The
amendment also provides that in its rule- making, the Fed shall only take into account issuers’ incremental costs for
debit transactions, thereby excluding sunk costs like overhead and marketing”. 1167 76 FR 43393, supra note 1158, at 43468 §235.7 : “(b) Limitation on payment card network restrictions )1(
Prohibitions against exclusivity arrangements (A) No exclusive network: The Board shall... prescribe regulations
providing that an issuer or payment card network shall not... restrict the number of payment card networks on which an
electronic debit transaction may be processed”. 1168 76 FR 43393, supra note 1158, at 43448: “[T]he final rule provides that the network exclusivity provision in §
235.7(a)(1) could be satisfied as long as an electronic debit transaction may be processed on at least two unaffiliated
payment card networks”. 1169 Supra ch. 8.1.7.
268
transactions on the issuer's preferable route, even though it was a more expensive route.1170
After the reform, control over the choice of route passed to merchants. Thus, networks who
want transactions to be routed on their infrastructures must compete and convince merchants to
choose them, by reducing the routing price.1171 Merchants can also choose to route signature
debit transactions through PIN debit infrastructures, which are cheaper and faster.1172 Post-
Durbin, merchants have at least two routing options, and competition has driven prices down.
Some scholars opine that routing is the biggest success of the reform.1173 Furthermore, Durbin
reinstalled the proper competitive incentives to choose the cheapest infrastructure.1174
Cancelation Of Merchant Restraints
646. Section 1075(b) of the Durbin Amendment is titled: "Limitation on Payment Card Network
Restriction". Subsection 1075(b)(2) states that “a payment card network shall not… inhibit the
ability of any person to provide a discount or in-kind incentive for payment by the use of cash,
checks, debit cards, or credit cards”.
This section completed a final judgment from July 20, 2011 that approved a consent decree,
reached in a civil suit the DOJ initiated against Visa and MasterCard, regarding NSR rules.1175
The litigation in the same proceeding against American Express resumed. On Feb. 19, 2015 the
1170 NACS v. Bd. of Governors of the Fed. Reserve Sys., 746 F.3d 474, 479 (D.C. Cir. 2014): “Issuers and networks
often entered into mutually beneficial agreements under which issuers required merchants to route transactions on
certain networks that generally charged high processing fees so long as those networks also set high interchange fees.
Many of these agreements were exclusive, meaning that issuers agreed to activate only one network or only networks
affiliated with one company”. 1171 Hayashi, The New Debit Card Regulations: Effects on Merchants, Consumers, and Payments System Efficiency,
supra note 30, at 98: "Before the regulations, PIN networks had an incentive to set their interchange fees at levels
higher than those of rival networks. By offering higher fee revenue to banks, the networks were able to generate more
transactions because transaction routing was controlled by the banks. But the merchants’ new control over routing has
changed PIN networks’ incentives. Now they seek to set their interchange fees lower than their rivals to attract more
transaction volume". 1172 Ibid: “Many merchants now avoid Visa’s Interlink network, the largest PIN network prior to the regulations, and
instead choose other PIN networks whenever possible. As a result, in terms of transaction volume, Interlink has lost
significant market share to other PIN networks such as Maestro, Pulse, and STAR. Through their new control over
routing, merchants’ emerging influence over the market shares held by different PIN networks is likely to increase
competition among PIN networks for merchants”. 1173 Hubbard, supra note 1150, at 15: “[T]he provision allows the merchant to direct the routing of the transaction from
among the networks chosen by the issuer, providing merchants the ability and incentive to choose the network with the
lowest fees”. For a different view, see Tom Brown, Re-Routing the Exclusivity and Routing Provisions of the Durbin
Amendment, LYDIAN PAYMENT J. (2011) 1174 Hubbard, supra note 1150, at 15: “[N]etworks (and merchants) now have an incentive to push consumers back to
PIN networks because of the lower cost they incur, rather than to signature networks, as they were doing pre-Durbin
due to the higher interchange fees generated”. 1175 United States v. Am. Express Co., 2011 U.S. Dist. LEXIS 78835 (E.D.N.Y. July 20, 2011) (approval of settlement
with Visa and MasterCard); Scott Schuh, Oz Shy, Joanna Stavins & Robert Triest, An Economic Analysis of the 2011
Settlement Between the Department of Justice and Credit Card Networks, 8 J. COMPETITION L. ECON., 1 (2012).
269
court ruled against American Express's NSR,1176 but in September 2016, a successful appeal
reversed the ruling.1177
647. The result of the combined legislative and judicial actions is the practical elimination of NSR
and HAC in Visa and MasterCard networks. Merchants that accept Visa or MasterCard (but not
American Express) can choose to surcharge cardholders who pay with them. Merchant
restraints still apply within a certain type of card. For example, a merchant who accepts without
surcharging Visa debit card issued by Chase Bank cannot surcharge Visa debit card issued by
HSBC.1178
648. Subsection (3) forbids payment card networks from inhibiting the ability of merchants to refuse
to accept credit cards for transactions valued under $10.00.1179
649. After the promulgation of the final regulations, merchant organizations sued the Board for the
significant increase it made in the interchange fee in the final rule compared to the draft. On
July 31, 2013 the Columbia District Court accepted their claim and vacated the interchange
transaction fee rule (12 C.F.R. § 235.3(b)) and the network non-exclusivity rule (12 C.F.R. §
235.7(a)(2)), on the ground that the Board exceeded its authority by inclusion of unqualified
costs.1180 The Board appealed. On March 21, 2014 the Court of Appeals reversed the District
Court and held that the board reasonably interpreted its authority.1181
The Effects Of The Reform
650. It is interesting to follow initial effects of the reform in the U.S.
The MSF in small value transactions have been raised (due to the transfer from proportional to
flat fee).1182 Except small value transactions, merchants have been the party benefitting the most
1176 United States v. Am. Express Co. LEXIS 20114 (E.D.N.Y Feb. 19, 2015). 1177 Supra ¶ 605. 1178 See also supra ¶ 584.6 (similar arrangement in Europe) and infra ¶ 755. 1179 15 U.S. Code § 1693o–2 - Reasonable fees and rules for payment card transactions, Pub. L. 114-38: “(3) Limitation
On Restrictions On Setting Transaction Minimums Or Maximums. ‘‘(a) IN GENERAL.A payment card network shall
not... inhibit the ability—
‘‘(i) of any person to set a minimum dollar value for the acceptance by that person of credit cards, to the extent that —
‘‘(I) such minimum dollar value does not differentiate between issuers or between payment card networks; and
‘‘(II) such minimum dollar value does not exceed $10.00” 1180 NACS v. Bd. of Governors of the Fed. Reserve Sys., 958 F. Supp. 2d 85, 115 (D.D.C. 2013). 1181 NACS v. Bd. of Governors of the Fed. Reserve Sys., 746 F.3d 474 (D.C. Cir. 2014). Cert. denied by NACS v. Bd. of
Governors of the Fed. Reserve Sys., 2015 U.S. LEXIS 731 (U.S., Jan. 20, 2015). 1182 Andrew R. Johnson, Fees on Cup of Coffee Raised From 8 Cent To 23 Cent, MasterCard, Visa Raising Small Debit
Buy Fees, MARKETWATCH (Sept. 22, 2011).
270
from the reform. Their MSF reduced substantially. It is doubtful whether the merchants' savings
from lower interchange fee and the resulting lower MSF have been passed through to
consumers. In competitive markets, there should be full pass through to final consumers.1183
Issuers' revenue has decreased by billions of dollars because of the reduced interchange fees.1184
651. Banks have threatened to make up for lost revenues by eliminating free checking accounts, or
by imposing usage fees on debit cards. For example, Bank of America announced that it will
begin to charge $5 per month for checking accounts.1185 The announcement provoked some
severe reactions, including that of Senator Durbin, who had initiated the reform.1186 Eventually,
competition plus fear of losing customers restrained banks.1187 Other banks, such as Wells
Fargo, announced a cutback in rewards it had bestowed on cardholders before the Durbin
Amendment.1188 In my view, curtailing cardholders' rewards, as opposed to raising cardholder
fee, is a pro-competitive outcome.1189
652. Another interesting result of the reform is that competition between debit and credit might
intensify. As explained above,1190 the U.S. reform applies to prepaid, debit and deferred debit
but not to credit transactions. The reform lowered the cost of debit to merchants, deepening the
gap between the price of (cheap) debit from which merchants enjoy, to expensive credit from
which issuers benefit. Sandwith found that as a result of the reform merchants hope consumers
use debit cards more often because of low interchange fees. On the opposing side banks hope
to push consumers to payment cards with higher fees. i.e., credit cards. Thus an unseen battle
1183 Fumiko Hayashi, The New Debit Card Regulations: Effects on Merchants, Consumers, and Payments System
Efficiency, 1 FRB KANSAS Q. REV. 89, 102 (2013). 1184 Kay et al., Bank Profitability and Debit Card Interchange Regulation, supra note 1160, at 5: “Reg II clearly led to
significant reductions in interchange income for treated banks.”; Wilko Bolt & David Humphrey, Competition in Bank-
Provided Payment Services, 1539 ECB Occasional Paper Series, at 7 (2013): “It has been suggested that this legislation
may reduce bank payment revenues from credit cards by $5.6 billion annually”. 1185 BoA to Instate $5 Monthly Fee for Debit Card Purchases, PYMNTS. COM (Sept. 29, 2011) 1186 Richard J. Durbin, Letter to Bank of America (Oct. 3, 2011) available at
http://durbin.senate.gov/public/index.cfm/files/serve?File_id=c57f9acb-7a87-4bb9-a2d0-211189c364d0. 1187 Bolt & Humphrey, Competition in Bank-Provided Payment Services, supra note 1184, at 7: “An effort by large
banks to explicitly price debit card use through a monthly fee, however, was not successful due to a consumer
backlash”; Tara Siegel Bernard, In Retreat, Bank of America Cancels Debit Card Fee, N. Y. TIMES (Nov. 1, 2011);
Sandwith, The Dodd-Frank Wall Street Reform, supra note 237, at 236-37, 241. 1188 Wells Fargo Ends Debit Rewards Program Entirely, PYMNTS. COM (Aug. 22, 2011) available at
http://pymnts.com/Wells-Fargo-Ends-Debit-Rewards-Program-Entirely/ ; Fumiko Hayashi, The New Debit Card
Regulations: Initial Effects on Networks and Banks, 4 FRB KANSAS CITY ECON. REV 79, 107 (2012): “After the new
rules removed the regulated banks’ incentive for promoting signature debit over PIN debit, the banks stopped offering
rewards programs”. 1189 See ¶ 351, see especially note 614. 1190 Supra ¶ 635.
271
between merchants and banks is emerging.1191 Another study has found that issuers were unable
to offset the lost interchange fee revenue on debit, neither by higher debit volumes nor by
shifting consumers to credit cards (that have unregulated fees), despite issuers’ desire to do
so.1192 Hayashi claims that the reform also prompted intrabrand platform competition between
debit networks, routed on competing infrastructures. Hayashi indicated that Visa's debit lost
market share to cheaper PIN debit networks.1193
Other commentators, most of them identified with the payment networks, have argued that the
long-term effects of the Durbin reform will cause an increase in cardholder fees and banking
account fees.1194 Empirical study by Kay et al found that regulated banks increased account fees
in response to the reform, but these increases were insufficient to mitigate lost interchange fee
income. Changes in account fees were able to offset roughly 30 percent of the lost interchange
fee income.1195
Others claim that more time is needed until the final effects of the reform will be clear.1196
8.4. Australia
653. Australia was a pioneer country in regulating the interchange fee. At the end of the last century
and the beginning of the recent one, the Federal Reserve Bank of Australia (“RBA”), conducted
a comprehensive reform in payment card interchange fees. Following the reform, the Australian
1191 Sandwith, The Dodd-Frank Wall Street Reform, supra note 237, at 238: “An unseen battle is emerging between
retailers that hope consumers use debit cards because of low interchange fees and banks hoping to push consumers to
payment cards with higher fees”. 1192 Kay et al., Bank Profitability and Debit Card Interchange Regulation, supra note 1160, at 5: “[T]reated banks have
been unable to offset the lost interchange income on debit cards by higher debit volumes or by shifting consumers to
credit cards that have unregulated fees”. 1193 Fumiko Hayashi, The New Debit Card Regulations: Initial Effects on Networks and Banks, 4 FRB KANSAS CITY
ECON. REV. 79, 107 (2012): “Apparent changes in market shares among debit card networks over the past two years
suggest that competition has risen among debit card networks. The decline of Visa’s market share, especially in the PIN
debit card market, is likely to be a sign of increased competition among the networks for merchants”. 1194 Todd Zywicki, Geoffrey A. Manne & Julian Morris, Price Controls on Payment Card Interchange Fees: The U.S.
Experience, ICLE (2014); David S. Evans, Howard Chang & Joyce Steven, The Impact of the U.S. Debit Card
Interchange Fee Regulation on Consumer Welfare: An Event Study Analysis, (University of Chicago, Institute for Law
and Economics Working Paper, 2013). 1195 Kay et al., Bank Profitability and Debit Card Interchange Regulation, supra note 1160, at 5: “[T]reated banks
increased their deposit fees in response to the regulation. While these increases are generally insufficient to mitigate all
of the lost interchange income, changes in deposit fees offset roughly 30 percent of the lost interchange income.”; see
also ibid at 30-31. 1196 Hayashi, The New Debit Card Regulations: Effects on Merchants, Consumers, and Payments System Efficiency,
supra note 30; Oz Shy, Measuring some Effects of the 2011 Debit Card Interchange Fee Reform, 32 CONTEMPORARY
ECON. POLICY 769 (2014).
272
interchange fee in credit cards was reduced to 0.5%.1197 At that time, this was one of the lowest
interchange fees in open systems.
654. The RBA identified the usage externality as the major problem of payment systems.1198
Different payment instruments have different costs, but customers are not aware of them. Usage
externality occurs when customers choose to pay with the most cost effective payment
instruments for them (i.e., for the cardholder), even if this is the costliest payment instrument
to the merchant. Customers externalize the expensive cost of usage on merchants and solely
internalize the benefit of the payment instrument. When customers pay with inferior payment
instruments from a social point of view, then the usage externality becomes a social problem,
and not only the merchants' problem.
655. The RBA found significant differences between the costs of credit cards and debit cards. The
cost of a $100 debit card transaction (total average costs of transaction to the acquirer and the
issuer), was estimated at 41 cents. The transaction price for cardholders was approximately 50
cents, meaning debit payments were priced at cost plus 9 cent profit. However, the total cost of
an average credit card transaction was found to be 2.01 Australian dollars, but the price for the
cardholder was found to be negative, because of rewards, ranging from 42 cents to $ 1.04 per
transaction.-It should be weighted with longterm price. -The negative price is only a short 1199
term effects such as goods' price increase (due to rewards) or inclination to enter debt.1200
Interchange fees were a significant component in the rewards granted to cardholders.
Merchants, in turn, bore the brunt of the costs. Merchants paid an averaged MSF of 1.8% of the
transaction. Thus, merchants actually subsidized the usage of expensive payment instruments,
especially for them (credit cards), to their detriment.1201
1197 RESERVE BANK OF AUSTRALIA, REFORM OF CREDIT CARD SCHEMES, FINAL REFORMS AND REGULATION (2002). 1198 See ch. 7.2.2 (Usage Externality). 1199 RESERVE BANK OF AUSTRALIA, REFORM OF CREDIT CARD SCHEMES, FINAL REFORMS AND REGULATION, at 4-5
(2002): “The price signals facing consumers choosing between different payment instruments do not promote efficient
resource use in Australia’s retail payments system... In many circumstances, a debit card is a close substitute for a credit
card, particularly for cardholders who do not have a cash constraint. Consumers using a debit card typically face a
transaction fee of around $0.50 per transaction (beyond a fee-free threshold) for accessing their own funds; this fee is
broadly in line with the average cost of providing debit card services ($0.41). Credit cardholders who settle their
account in full each month (known as “transactors”) pay no transaction fee, and may be paid in the form of loyalty
points, for using the funds of their financial institution. In these cases, the benefits from using a credit card can be as
much as $1.04 for an average size transaction of around $100, compared to the average cost of $2.01 to provide this
transaction.”; Philip Lowe, Reform of the Payments System (March, 2005)" :In the case of credit cards, many people
face per-transaction prices that are effectively negative; that is they get paid to use the card!". 1200 See ¶ 160. 1201 RESERVE BANK OF AUSTRALIA, REFORM OF CREDIT CARD SCHEMES, FINAL REFORMS AND REGULATION, at 8
(2002): “Credit card interchange fees play a pivotal role in determining the incentives for consumers to use, and
273
656. When evaluating net costs of a payment instruments, benefits should also be considered. Thus,
if credit cards were more beneficial to merchants than other (cheaper) payment instruments,
this could change the picture. The higher price for merchants could be worthy and profitable
for them. The RBA’s research found that the combined benefit to merchants and cardholders
from credit cards did not justify the difference in costs.1202
657. The RBA also found that interchange fee does not abide to ordinary rules of competition.
Multiplicity of competitors did not contribute to lower prices (reduction in the interchange fee),
but to an increase in the interchange fee. Below I dedicate a chapter to explain how, contrary to
ordinary products, competition in payment cards drives prices up (and not down).1203 In short,
competition for cardholders is fueled by interchange fee, which is a major source of rewards
and cardholder discounts. As competition intensifies, higher interchange fees are required. The
fee is imposed on merchants through the MSF, and causes price level to rise.
658. The Australian reform included a series of instructions, designed to reduce the interchange fee.
Other instructions were designed to enable merchants to surcharge customers who pay with
expensive payment instruments. The NSR was cancelled and merchants could charge more to
credit cardholders.1204
659. The open networks, particularly MasterCard, opposed the reform. Their major argument was
that reducing the interchange fee would lead payment card networks to a death spiral, that would
eventually destroy the open networks, and cause a transition to closed networks. The thrust of
the argument was: (1) reduction in the interchange fee would force issuers to compensate
themselves for the lost income by increase in cardholder fee; (2) raising cardholder fees would
merchants to accept, credit cards. Revenues from interchange fees allow credit card issuers effectively to “subsidise”
cardholders to use their credit cards, in the sense that they are charged less than the cost of the credit card payment
services they use (or are even offered rebates in the form of loyalty points). The burden of this subsidy falls initially on
merchants, but ultimately on the community as a whole”. 1202 Ibid at 30: “The Reserve Bank acknowledges the widespread acceptance of credit cards in Australia and the benefits
that they can provide to individual cardholders and merchants. At the same time, however, it is not persuaded by
arguments that allowing normal market mechanisms to operate more effectively in the Australian payments system is
against the community’s interest. It does not accept that continued growth in the use of credit cards at the expense of
alternative payment instruments necessarily adds to the community’s welfare. In particular, it remains of the view that
the benefits of credit cards to cardholders and merchants as a whole – in the form of a permanent increase in
sales or a reduction in transaction costs – are overstated. Other payment networks can also gain from being larger in
size and the mix of payment instruments in these circumstances ought to be one for consumers to decide in a
competitive market place, in response to efficient price signals. These conditions do not prevail in the retail payments
system in Australia”. 1203 Infra ch. 6.6. 1204 RESERVE BANK OF AUSTRALIA, REFORM OF CREDIT CARD SCHEMES, FINAL REFORMS AND REGULATION, at 46
(2002): “Neither the rules of the Scheme nor any participant in the Scheme shall prohibit a merchant from charging a
credit cardholder any fee or surcharge for a credit card transaction”.
274
lead to abandonment of cardholders; (3) this, in turn, would lead to an inevitable diminution in
the attractiveness of payment cards for merchants; (4) merchant would cease to accept cards,
(5) Next step would be an even greater abandonment of cards by cardholders and back again
through the cycle., a similar argumentalso maintained the Visa firms had ,IsraelIn 1205
according to which an interchange fee reduction would cause a “snowball” effect that would
destroy the network.1206
This "death spiral" or "snowball" argument was empirically refuted. After the reform, open
networks still continued to flourish. Adoption among cardholders and acceptance among
merchants actually increased.1207 Transactions' volumes also mounted. In Israel the snowball
effect was also similarly refuted empirically.1208 In Europe it was also concluded that even when
interchange fees were reduced, adoption, usage and acceptance of cards increased.1209
660. Theoretical analysis also reveals that "snowball effect" predictions are without merit. True,
interchange fee reduction may theoretically cause an increase in cardholder fees. Even so, if
cardholder fee had been negative due to rewards, an increase the in cardholder fee to a higher
(but still negative) level would probably not result in significant cardholder abandonment.
Moreover, in mature networks, cardholders have inherent positive benefits from cards, and they
would not easily give-up cards.1210 All the more so it is unlikely that in mature networks, a
reduction in the interchange fee, the direct effect of which would be a lower MSF, would result
in abandonment by merchants. The certain and direct effect of a reduction in the interchange
fee (and the corresponding MSF) should probably overshadow any (questionable) indirect
effect from increase in cardholder fee.1211
1205 MasterCard's Submission to the Reserve Bank of Australia, at 10-11 (2001). 1206 The Methodology Decision, supra note 1102, at 8. 1207 Santiago Carbo Valverde et al., Regulating Two-Sided Markets: An Empirical Investigation, at 12 (Federal Reserve
Bank of Chicago Working Paper No. 09-11. 2009); Robin A. Prager et al., Interchange Fees and Payment Card
Networks: Economics, Industry Developments, and Policy Issues, at 39 (F.R.B. Finance and Economics Discussion
Series 23-09, 2009); Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1121, at 665-70;
Fumiko Hayashi & Stuart E. Weiner, Interchange Fees in Australia the U.K and the United States: Matching Theory
and Practice, FRB KANSAS ECON. REV. 75 (2006); Alan S. Frankel, Towards a Competitive Card Payments
Marketplace, RBA 27 (2007). For another view see Howard Chang, David S. Evans & Daniel D. Garcia Swartz, The
Effect of Regulatory Intervention in Two-Sided Markets: An Assessment of Interchange-Fee Capping in Australia, 4
REV. NETWORK ECON. 328 (2005). 1208 The Methodology Decision, supra note 1102, at 8 (despite decline in the interchange fee, systems flourished). 1209 EU, Proposal for a Regulation on Interchange Fees, supra note 1042, at 10: “A decrease of high interchange fees in
most countries generally seems to be associated with a higher acceptance of cards, and it seems that in countries with
low interchange fees cards usage is higher”. 1210 For expansion on inherent benefits of payment cards to cardholders see ¶¶ 137, 145, 151, 152-154. 1211 See also infra ¶¶ 461-470 and note 797.
275
661. In 2008, the RBA evaluated its earlier reform. The RBA reported that the reform had increased
transparency, and consumers got better pricing signals about the true costs of the payment
instruments they used. Following the reassessment, the RBA announced that it would waive the
requirement to recalculate interchange fees, if market players would take steps to ensure that
interchange fees would not exceed 0.5% in credit card transactions and 12 cents in debit card
transactions.1212 The RBA continues to promulgate such waiver notices from time to time.1213
As a complementary step to deregulation, merchants can freely surcharge expensive payment
instruments.1214
662. Since the reform, the number of merchants that surcharge credit cards have increased.1215 The
interchange fee decreased and as a consequence, the MSF also decreased. Final prices of goods
possibly decreased, although not in a full pass through rate.1216 At the same time, there have
been reductions in cardholder rewards and increases in cardholder fees. However, as the initial
outset was high negative cardholder fees,1217 even the increase resulted in them being negative
or close to zero.1218
663. The Australian payment card firms complained that merchants were using the abolishment of
the NSR to surcharge excessively, i.e. more than is justified by the real costs of payment
1212 Media Release, RBA: Waiver of Requirement to Recalculate Interchange Fee Benchmark (Dec. 2008): “The
Reserve Bank waives the requirement to recalculate the cost-based measure and the common cost-based benchmark for
the 2009/10 year in the designated credit card systems”. 1213 RBA, Waiver of Requirement to Recalculate Interchange Fee Benchmark, March 2015: “The Reserve Bank waives
the requirement to recalculate the cost-based measure and the common cost-based benchmark for the 2015/16 year in
the designated credit card systems. The Bank previously waived the requirement for the 2009/10 and 2012/13 years. As
set out in the current standards, the benchmark of 0.50 per cent of transaction value calculated in September 2006 and
announced in media release 2006-08 will continue to apply until the next scheduled recalculation in the 2018/19 year...
The Reserve Bank waives the requirement to recalculate the benchmark for the 2015/16 year in the Visa Debit system.
The Bank previously waived the requirement for the 2009/10 and 2012/13 years. As set out in the current standards, the
benchmark of 12 cents per transaction calculated in September 2006 and announced in media release 2006-08 will
continue to apply until the next scheduled recalculation in the 2018/19 year". 1214 Reserve Bank of Australia, Conclusions of the 2007/08 Review (2008). 1215 Reserve Bank of Australia, REFORM OF AUSTRALIA’ S PAYMENTS SYSTEM, PRELIMINARY CONCLUSIONS OF THE
2007/08 REVIEW, 17 (2008): “Since the beginning of 2003, when the no-surcharge rule was removed, the number of
merchants surcharging has risen substantially”; RBA, REVIEW OF CARD SURCHARGING: A CONSULTATION DOCUMENT,
Reserve Bank of Australia at 2-3 (2011): “In recent years, though, the rate of surcharging appears to have grown
significantly... almost 30 per cent of merchants imposed a surcharge on at least one of the credit cards they accepted in
December 2010 (Graph 2.1). Surcharging appears to be more common among very large merchants (those with annual
turnover greater than $530 million), although around one-quarter of smaller merchants (those with annual turnover
between $1 million and $20 million) are also reported to impose surcharges. According to these data, most other
merchants are considering imposing surcharges, with only around 20 per cent of merchants having no surcharge plans”. 1216 United States v. Am. Express Co., LEXIS 20114, at 221 (E.D.N.Y Feb. 19, 2015): “[T]he RBA's report actually
supports the court's determination that lower discount rates resulting from removal of the NDPs will benefit consumers
as merchants translate some amount of their lower credit card costs into lower prices”. 1217 Supra ¶655. 1218 Reserve Bank of Australia, Reform of Australia's Payments System Issues for the 2007/08 Review, at 19-23 (2007);
Allan L. Shampine, Testing Interchange Fee Models using the Australian Experience (Proceedings of the Bank of
Canada Economics of Payments VI conference, at 21-22 (May 24, 2012).
276
instruments.1219 The RBA found these complaints justified. As a result, in March 2013, the
RBA published a new standard that limits the ability of merchants to surcharge. The changes
were aimed at improving the price signals consumers face when choosing a payment
instrument. The RBA allowed networks to limit surcharging by merchants to their reasonable
cost of acceptance. These costs include the MSF plus any additional expenses the merchant
carries in connection with acceptance of payment cards. Such expenses included, for example,
the costs of purchasing POS terminals, the costs of maintaining card acceptance infrastructure,
and the costs of other equipment required to accept card payments.1220
8.5. Romania
664. Similar to Israel, the national interchange fee in Romania is set by a single multilateral
agreement between issuers and acquirers that compose almost all (98%) of the market.1221 The
interchange fee in Romania was formerly set amongst the highest rates in Europe.1222 The EU
proceedings against Visa and MasterCard, in which the interchange fee was set at 0.2% (debit)
and 0.3% (credit), have been reflected in a Romanian announcement that the internal
interchange fees should not be higher than the international.1223
665. In my view, this conclusion also applies to Israel. There is no justification for the "local"
interchange fee (0.7%), to be hundreds of percent higher than the interchange fee paid to a
foreign European issuer for a tourist transaction (0.3% for credit; 0.2% for debit).
1219RBA, Reforms to Payment Card Surcharging, March 2013: “Although the Reserve Bank's surcharging reforms have
provided significant public benefit, the Reserve Bank has become concerned in recent years that some surcharging
practices have developed in a way that potentially distorts price signals. In particular, the Reserve Bank has been
concerned about cases where fees or surcharges appear to be well in excess of acceptance costs or where a single
‘blended’ surcharge is applied across several card schemes even though merchants' acceptance costs may be
significantly higher for some cards than others". 1220 RBA, ibid: “On 18 March 2013, a number of changes to the Reserve Bank's Standards relating to merchant
surcharging took effect. These changes are aimed at improving the price signals that consumers face when choosing the
payment method they use. The changes enable card schemes (such as American Express, Diners Club, MasterCard and
Visa) to limit surcharges and address cases where merchants are clearly surcharging at a higher level than is justified.
Merchants are nonetheless still able to fully recover their legitimate card acceptance costs.”; RBA, Guidance Note:
Interpretation of the Surcharging Standards (Nov. 2012). For a similar rule in Europe, supra note 1058. 1221 Anca-Iulia Gîrjob & Maria-Raluca Gîrbacea, The Impact of Interchange Fees on Merchants and Consumers, 2
ROMANIAN COMPETITION JOURNAL 83 (2013)
Gîrjob & Gîrbacea, id. at 87: “In Romania, according to the rules of the two cards systems, the interchange fee
applicable in the card payments national market is the result of a multilateral agreement between banks which hold
about 98 % of the national market”. 1222Id. at 85: “[I]n Romania the financial institutions set some of the highest rates for multilateral interchange fees”. 1223Id. at 89: “[A]ccording to the statements of Bogdan Chiriţoiu, the President of the Competition Council, at Antena 3,
on 06/01/2013, VISA has promised to the European Commission that it will reduce the fees to 0.3% because there is no
economic justification for the fact that an internal transaction in Romania costs more than a cross-border transaction”
see also ibid at 97: “As it was mentioned before the upper limits were established to 0.2% of the value of the transaction
for debit cards and 0.3% for credit cards. These measures will be applied in Romania also, because there is no
economical justification that an internal transaction costs more than a cross-border transaction”.
277
This reasoning is even stronger given that the interchange fee in Israel is based on cost
methodology. The costs of the payment guarantee in international transactions are higher than
in internal transactions, as international transactions (i.e., tourist transactions) are subject to
higher rates of fraud, default and misuse than local transactions. In addition, the costs of
processing and authorization of an international transaction demands more resources than those
of an internal transaction. Thus, international interchange fee should be higher and not lower
than the local. Therefore if in Europe Visa and MasterCard charge 0.2% (debit) and 0.3%
(credit) interchange fees, interchange fee in Israel should be lower, not higher.
666. This is all truer because the tourist test methodology is a utility methodology. The tourist test
methodology is based on the avoided costs of cash which are saved if using a card. The
underlying assumption is that the costs of using cards are less than the costs of using cash. Thus,
the tourist test is supposed to yield a higher interchange fee than a cost based interchange fee.
Thus, if the fee in a higher yielding methodology, such as in Europe, results in a lower fee than
the cost based Israeli interchange fee, the Israeli interchange fee is surely too high.
8.6. New Zealand
667. In 2006, New Zealand's Commerce Commission initiated proceedings against Visa,
MasterCard and 11 financial institutions for antitrust violations. The allegations were that the
interchange fees amounted to anti-competitive collusion.1224 In 2009, the government reached
a settlement with seven banks,1225 after separate settlements were previously reached with
MasterCard and Visa.1226 All settlement agreements are published online.1227
The settlement agreements canceled restraints that network rules imposed on merchants, such
1224 New Zealand Commerce Commission, Media Release, Commission Alleges Price-Fixing in Credit Card
Interchange Fees (Nov. 10, 2006). 1225 N.Z. Commerce Commission, Media Release, Credit Card Settlements Lower New Zealand Business Costs, (Oct. 5,
2009). 1226 N.Z. Commerce Commission, Media Release, Commerce Commission and Visa Reach Agreement to Settle Credit
Card Interchange Fee Proceedings (Aug. 12, 2009); Media Release, N.Z., Commerce Commission and MasterCard
Agree to Settle Credit Card Interchange Fee Proceedings (Aug. 24, 2009). 1227 New Zealand settlements are available at:
http://www.comcom.govt.nz/business-competition/enforcement-response-register-commerce/detail/665
278
as NSR and HAC, and included provisions intended to increase transparency, such as
publishing the various categories of interchange fees online.1228
668. The settlements also limited the ability of incumbent payment card firms to prevent new
acquirers from connecting to the network. Visa and MasterCard each agreed to allow new
acquirers to join the networks, provided they meet relevant criteria regarding security, financial
strength and risk avoidance.1229 In addition, Section 4.1.3 of the settlement agreements
specifically determines that: "New Zealand acquirers need not also be issuers, and vice
versa".1230
New Zealand further established that if an issuer and acquirer do not have an ex-ante agreement
with respect to interchange fees, issuers cannot demand ex-post interchange fees. Section 3.1.7
to the Settlements with Visa and MasterCard stipulates: "if there is neither an issuer rate nor a
bilaterally agreed rate notified to [MasterCard/Visa] that applies", then no interchange fee (zero
interchange fee) will be paid on that transaction.1231
669. At least from regulatory point of view, structural separation between issuers and acquirers is
feasible in New Zealand. Practically this separation never occurred for reasons explained in
chapter 13.1 below. Independent acquirers (i.e., acquirers which are not issuers), do not exist in
New Zealand.1232 Moreover, interchange fees in New Zealand can be over 2% which is among
the world's highest.1233
Just as in New Zealand, the Antitrust Tribunal in Israel also determined that new acquirers could
enter the market.1234 However, in Israel, too, there are no independent acquirers.
My innovation, discussed at chapter 0 below, is to turn to reality the desire of regulators which
1228 New Zealand Interchange Fees are available at http://www.westpac.co.nz/business/payment-solutions/pricing-and-
fees/ 1229 Articles 4.3, 4.1.4 to the Visa settlement, supra note .1227 1230 See also Peter R. Taylor, Cards and Payments Australasia (Payment Conference, Mar. 15, 2010): “Relevant for
specialist and self-acquirers, the schemes have confirmed that acquirers need not also be issuers and that applicants
need not be financial institutions”. 1231 Ibid: “[I]f an issuer does not stipulate or agree a fee with an acquirer, no interchange will be payable on that issuer’s
transaction."; Asia Pacific Banking ANF Finance, NZ uses market forces to bring card companies into line (May 21,
2010): "The manner in which interchange fees are now independently determined is unique to New Zealand –
significantly, if an issuer does not stipulate or agree a fee with an acquirer, no interchange will be payable on that
issuer’s transaction". 1232 Internal E-mails of the author with the Commerce Commission from Oct. 10 & 13, 2015. 1233 Infra ¶ 809. 1234 AT 610/06 Leumi v. Antitrust General Director, para. 3 (11.11.07).
279
was never fulfilled, of existence of independent acquirers. Moreover, my proposal is to give
such independent acquirers the bargaining power to determine the interchange fee they pay.
8.7. Other countries
670. There is literature reviewing worldwide regulation of interchange fees.1235 Several additional
countries are worth noting.
671. In Mexico, adoption and usage of payment cards were low, compared to other countries.1236
The Central Bank reached an agreement with the financial institutions to reduce the interchange
fees. As a consequence, the MSF decreased and the placement of POS devices accelerated.1237
672. In Spain, the regulator reduced credit card interchange fees from an average rate of 1.4% in
2006 to an average rate of 0.35% in 2009. The interchange fee for debit transactions decreased
from Euro 0.53 to Euro 0.35 per transaction. The methodology selected for calculating the
interchange fee was cost-based. The Spanish Authority determined that interchange fees should
reflect the variable cost of payment guarantee against fraud, and a fixed cost of processing
transactions.1238 The payment card firms threatened of "death spiral" which would destroy the
payment card network. In practice, adoption and usage of cards in Spain only increased after
the reform.1239
673. In Hungary, the Competition Authority decided in 2009 that acquirers and issuers of Visa and
MasterCard had been colluding as a cartel that had coordinated interchange fees from 1996 to
2008. The decision did not determine that interchange fee was per-se violation. The ruling was
1235 Fumiko Hayashi, Payment Card Interchange Fees and Merchant Service Charges - an International Comparison,
supra note 166; Stewart E. Weiner & Julian Wright, Interchange Fees in various Countries: Developments and
Determinants, 4 REV. NETWORK ECON. 290 (2005); Bradford & Hayashi, Developments in Interchange Fees in the
United States and Abroad, supra note 842; Fumiko Hayashi, Public Authority Involvement in Payment Card Markets:
Various Countries, August 2013 Update, PAYMENTS SYS. RESEARCH DEPARTMENT OF THE FED. RES. BANK OF KANSAS
CITY; Fumiko Hayashi & Jesse Leigh Maniff, Public Authority Involvement in Payment Card Markets: Various
Countries August 2014 Update, FRB KANSAS (Aug. 2014). 1236 José L. Negrín, The Regulation of Payment Cards: The Mexican Experience 4 Rev. NETWORK ECON. 243 (2005). 1237 Rachel L. Osband, Interchange Fee Reform in Mexico: A Bank Driven Approach, ANTITRUST BULL. (2009). 1238 Valverde, Empirical Investigation, supra note 1207, at 18: “Some TDC resolutions required the card networks to
only include two costs when setting domestic multilateral interchange fees (MIFs): a fixed cost for processing each
transaction and a variable ad valorem cost for the risk of fraud”. 1239 Infra ¶ 447.
280
against the unapproved coordination between Visa and MasterCard, which prevented
competition between acquirers of Visa and MasterCard for merchants.1240
674. The Hungarian Authority did not rule out the possibility that an interchange fee agreement
between issuers and acquirers of Visa and MasterCard (such as in Israel) might be efficient, but
it did determine that the specific interchange fee rate in Hungary was not proportional to the
competitive concerns it created, and that possible benefits from the interchange fee did not pass
through to merchants and cardholders. It seems that if approval had been sought (along the lines
of the motion to approve the Trio Agreement in Israel that also involves MasterCard and Visa),
the agreement would be thoroughly investigated and the conclusion may have been different,
i.e., the unapproved arrangement would have been sanctioned.1241
675. In 2010, a draft law that regulated, among other things, the interchange fee, and the maximum
MSF was proposed in Hungary. This draft did not evolve into legislation.1242
676. United Kingdom - in 2000, the central bank promulgated a detailed report known as the
Cruickshank Report.1243 This report argued that issuers inflate the interchange fee and use it as
a barrier to entry.1244 The report also determined that banks charge interchange fees that are
way over and above their costs.1245
677. Following the Cruickshank report, the Office of Fair Trading ("OFT"), today the Competition
and Markets Authority ("CMA"), began a long investigation. In 2005, the OFT issued a
comprehensive decision regarding MasterCard's interchange fees. The decision stated that
MasterCard cards are a relevant market; that both issuers and acquirers were parties to a
restrictive arrangement that took two forms: First, the interchange fee set a floor to the MSF. It
prevented issuers from charging lower interchange fees for MasterCard transactions, thus
1240 BACKGROUND REPORT OF THE HUNGARIAN COMPETITION AUTHORITY ABOUT THE UNIFORM AND COMMON
INTERCHANGE FEES SET BY BANKS IN HUNGARY (2009): "[T]here was no real chance for competition between Visa and
MasterCard and competition between the acquiring banks was also restricted". 1241Id. at 2: “The GVH does not contest that collective multilateral agreements may produce substantial efficiencies.
However, the GVH did not find any evidences proving that - mostly due to the distortion of competition resulting from
the common treatment of both card payment schemes – the restriction has only reached the reasonable necessary level
at any time, and that a due share of the benefits reached the cardholders and retailers". 1242 Éva Keszy-Harmath et al., The Role of the Interchange Fee in Card Payment Systems, at 71 (MNB Occasional
papers 96. 2012). 1243 DON CRUICKSHANK, COMPETITION IN UK BANKING: A REPORT TO THE CHANCELLOR OF THE EXCHEQUER U.K.
STATIONERY OFFICE (2000). 1244Id. at 3.97: “First, the schemes have strong incentives to inflate interchange fees above costs. Second, schemes have
incentives to use interchange fees to restrict new entry”. 1245Id. at 3.114: “The Review’s analysis of interchange arrangements for the three major card scheme operators leads to
concerns that interchange fees for credit cards and the Visa debit card scheme are substantially higher than can be
justified by legitimate cost recovery”.
281
preventing intrabrand competition that could otherwise arise between MasterCard’s issuers.
Second, the interchange fee included unjustified costs. It was further determined that the
interchange fee should be based on the payment guarantee and processing costs, but not on the
cost of the free funding period to cardholders.1246
678. This decision was suspended in 2006 for reasons of procedural discrimination of MasterCard
facing Visa. Thereafter, the OFT announced that it would again review interchange fees of
MasterCard and Visa.1247 In 2007, the OFT announced the expansion of the investigation to
also include debit card interchange fees.1248
679. Subsequently, the British investigation joined the European Commission proceedings against
MasterCard, in which Britain took the side of the Commission. After the European High Court
of Justice dismissed MasterCard’s appeal, and in light of the progress of the European
legislative procedures described above, the CMA decided not to conduct any further or separate
proceedings against Visa or MasterCard.1249 On May 2015 the CMA decided to close the
investigation.1250
680. Poland, in 2006, the competition authority determined that the interchange fee was a restrictive
arrangement that harms competition by setting a floor to the MSF. The Polish decision also
emphasized that competition between networks for issuers tends to increase the interchange fee,
because issuing banks are not willing to participate in a system that will not maximize their
profits, i.e., yield them the highest interchange fee. Thus competition for issuers actually
destroyed banks' incentives to introduce and issue cheaper payment instruments.1251 The Banks
successfully appealed to the Polish Court, and the decision was vacated. Thereafter, the Polish
Authority appealed to the Polish Supreme Court, which ruled in November 2013 in favor of the
1246 CA98/05/05 MasterCard UK Members Forum Limited, OFT (2005). 1247 Press Release, OFT to Refocus Credit Card Interchange Fees Work (Jun. 20, 2006). 1248 Press Releases, Statement regarding Expansion of OFT Investigation into Interchange Fees (Feb. 9, 2007). 1249 CMA Decides Not to Progress Interchange Fee Investigations at the Present Time (Nov. 4, 2014). 1250 CMA's statement regarding the decision to close its investigations of MasterCard's and Visa's interchange fee
arrangements on the grounds of administrative priority (May 2015); CMA Closes MasterCard and Visa Investigations
Following EU Regulation (May 6, 2015). 1251 Press Release, UOKIK, Decision On Determining The Interchange Fee In Visa And MasterCard Systems, at 2
(2007): “A potential consequence of the agreement on the interchange fee rates is also a hampered development of new
payment systems, which require participation of banks (e.g. as issuers) for their correct functioning. The banks may not
be willing to participate in a system that will not bring them profits comparable with the profit made on the collection of
the interchange fee on every transaction made with a card they issue. Consequently, even a more effective, lower cost
payment system may be hampered in its development, with detriment to innovation and consumers”. For expansion see
infra ch. 6.6.3 (Competition on Issuers).
282
Polish authority, and determined that an anti-competitive agreement had been concluded
between the banks.1252
681. The Polish Authority determined that the interchange fee should be based on costs. However,
in a sharp contrast to Israel, the payment guarantee was not accepted as one of the eligible costs.
The Polish Authority determined that the costs of the payment guarantee are covered by
cardholders via the interest they pay on their credit. This interest compensates issuers for the
entire payment guarantee. Thus, including this cost in the interchange fee would be double
compensation of the same cost. In addition the Polish Authority concluded that providing
payment guarantee causes issuers to be less careful in granting credit to higher-risk cardholders,
thus causing moral hazard.1253
682. In Italy, banks were fined in 2010 for illegal fixing of the interchange fees.1254
9. The Restrictive Arrangement – Legal Assessment
683. Section 2 of the Israeli Antitrust law determines:
2. Restrictive Arrangement
(a) A restrictive arrangement is an arrangement entered into by persons conducting
business, according to which at least one of the parties restricts itself in a manner
liable to eliminate or reduce the business competition between it and the other
1252 EU, Press Release, Poland: The Court of Competition and Consumer Protection Confirms UOKiK’s Decision on
Multilateral Interchange Fees (Nov. 2013). 1253 Ann Borestam & Heiko Schmiedel, Interchange Fees in Payment Cards, ECB Occasional Paper Series 131, at 32-
33 (2011): “The OCCP found that the costs of the payment guarantee were being paid twice: first, by cardholders to
their bank in the case of a lack of funds and, second, by merchants as part of the MIF. In addition, considering the
benefits arising from MIFs, banks might not pay sufficient attention to the “quality” of their customers, which could
contribute to increasing MIFs further”. 1254 AGCM, Annual Report, at 18 (2010): “MasterCard's coordinated setting of a specific Multilateral Interchange Fee
(MIF) for credit card transactions in Italy was classified as a competition-restricting agreement equivalent to the setting
of a joint and uniform minimum threshold for one of the price components for the corresponding payment service in the
absence of reasonable economic justifications... the Authority imposed over 6 million EUR of fines on the companies
involved”.
283
parties to the arrangement, or any of them, or between it and a person not party to
the arrangement. (b) Without derogating from the generality of the provisions of subsection (a), an
arrangement involving a restraint relating to one of the following issues shall be
deemed to be a restrictive arrangement:
(1) The price to be demanded, offered or paid;
(2) The profit to be obtained;
(3) Division of all or part of the market, according to the location of the business
or according to the persons or type of persons with whom business is to be
conducted;
(4) The quantity, quality or type of assets or services in the business.
684. A Restrictive Arrangement under Section 2(a) of the Antitrust Law has four elements: A.
arrangement; B. between persons conducting business; C. binding restriction; D. probability of
harm to competition.1255
685. When an arrangement that sustains the first three elements involves one of the matters set out
in section 2(b), a private occurrence of the general definition in section 2(a) exists.1256 When
any of the four situations that are mentioned in section 2(b) occurs, there is a conclusive
presumption (presumption juris et de jure) that the fourth element, harm to competition, exists.
The fourth element does not need to be proven. It is sufficient to prove the first three
elements.1257
686. Since installing a vertical block exemption in June 2013, the conclusive presumptions do not
apply to vertical restraints and horizontal maximum resale price restrictions (RPM
Maximum).1258 The application of the per-se rule to horizontal agreements only was reinforced
1255 Cr.A 5672/05 Tagar v. State of Israel, para. 44 (Oct. 21, 2007) (English version available at the IAA web site).
http://www.antitrust.gov.il/subject/199/item/33368.aspx : “The definition of a cartel in the Antitrust Law includes four
elements: (1) the existence of an arrangement, (2) that the arrangement be “between persons who engage in business”;
(3) that the arrangement impose a restraint on at least one of the parties thereto; and (4) its interest lies in the essence of
the restraint appearing in the arrangement”. SCL 4465/98 Tivol v. Shef Hayam, 56(1) 56, 95-96 (2001); Cr.A 4855/02
State of Israel v. Borowitz, 59(6) 776, para. 78 (2005); CrA 7829/03 State of Israel v. Ariel, 60(2) 120, 137 (2005); CrA
5823/14 Supersal v. State of Israel, para. 32 (Aug. 10, 2015).
1256 CrA 2560/08 State of Israel v. Yaron Wol, at 36 (July 6, 2009); MICHAL GAL, RESTRICTIVE ARRANGEMENT -
ELEMENTS OF THE PROHIBITION, IN LEGAL AND ECONOMIC ANALYSIS OF ANTITRUST LAW, 193, 272 ( Michal Gal &
Menachem Perlman eds., 2008).
1257 CrA 2560/08 State of Israel v. Wol, supra note 1256, at 35 (Section 2(b) determines formal test, based on the per-se
rule, in which the prosecution is exempted from proving harm); SCL 4465/98 Tivol v. Shef Hayam, 56(1) 56, 97 (2001);
CrA 7829/03 State of Israel v. Ariel, supra note 1255, para. 16; CrA 5823/14 Supersal v. State of Israel, supra note
1255, at 66-67.
1258 Antitrust Rules (Block exemption for non-horizontal and certain price restrictions agreements) 2013. For expansion
see CA 6233/02 Akastel v. Kalma Vi, 48(2) 635, 647, (2004); David Gilo, Is it Appropriate to Break Antitrust Dam and
Block the Flood in Ad-Hoc Fences, 27(3) Iunei Mishpat 751 (2004); Memorandum, Antitrust Law (Amendment 9),
2005; David Gilo, Restriction that Harms Competition between the Beneficiary and its Competitors, 28 Iunei Mishpat
517 (2005); CrC 1274/00 State of Israel v. Mudgal (12.3.10).
284
in August 2015 by the Supreme Court.1259 However, the interchange fee is clearly horizontal
price fixing between competitors, so the conclusive presumption applies.1260
687. The arrangement which determines the interchange fee includes all the elements of the
definition of restrictive arrangement. There is certainly no doubt about the first three elements:
688. The interchange fee is determined in a mutual acquiring arrangement. In Israel, it is the Trio
Agreement, which is a written agreement between competitors. The interchange fee
arrangement surely falls under the broad definition of the term "arrangement" in section 2 of
the Antitrust Law, which has been interpreted broadly in the case law, so as to include even a
wink or a nod of the head.1261
689. Issuers, acquirers and the banks that are parties to the Trio Agreement are, of course, persons
conducting business.1262 A person, according to Israeli Law, includes a firm.1263 All of the
payment card firms in Israel are not only “conducting business” entities, but banking auxiliary
corporations by definition.1264
690. Even when the interchange fee is determined by the international organization as an allegedly
unilateral act, it is still considered a restrictive arrangement between the members thereto.
MasterCard claimed, after its IPO that decisions about fees that were considered before the IPO
as joint decisions between competitors should be regarded after the IPO as unilateral decisions
of a single entity.1265 The European Commission rejected this claim. It stated that the
1259 CrA 5823/14 Supersal v. State of Israel, supra note 1255, at 73 (Generally, vertical restraints will be inspected
under section 2(a)and not 2(b) to the antitrust law). 1260 CrA 5672/08 Tagar v. State of Israel, at 27 (Oct. 21, 2007) (Question of the fourth element, harm to competition,
does not arise when agreement is horizontal under sec. 2(b)). 1261 CrA 4855/02 Borowitz, supra note 1255, at para. 79 (English version): “When we come forth to interpret the term
“arrangement” in view of the aforementioned intent of the antitrust laws, obviously the way in which the parties
expressed their consent to the cartel arrangement matters little. A cartel arrangement concluded orally or by a wink or
a nod of the head by one of the parties is no less liable to harm competition than a cartel created in writing with the
parties’ express consent. As stated above, the cartel need not even be legally binding to be considered an arrangement
under the Antitrust Law”; CrA 1042/03 Mezerples v. State of Israel, 58(1) 721, 728 (2003); CrA 5823/14 Supersal v.
State of Israel, supra note 1255, para. 32; Civ.C 396/87 Kisin v. PetrolGas, Dinim (1990). 1262 CrA 4855/02 Borowitz, supra note 1255 para. 81: “The term “persons” in the definition of a cartel
undoubtedly refers to corporations as well... A more complex question is what the expression “engage in business”...
The broad interpretation of the expression “engage in business”... [is] the correct one... The intent behind the
requirement that the arrangement must be concluded between “persons who engage in business” is not to distinguish
between different areas of business but to distinguish between businesses and non-business entities such as consumer
organizations or the State in its governmental function.”; CA 2768/90 PetrolGas v. State of Israel, 46 (3) 599, 604
(1992); Cr.C 366/99 State of Israel v. Ehud Svirsky, at 23 (Feb. 21, 2002); Determination According to Section 43(a)(1)
of the Antitrust Law to Information Exchange between Banks, Antitrust 501411, at 53 (26.4.09). 1263 Interpretation Law, 1981, sec. 4; Interpretation Command [new version], sec. 1. 1264 Banking Law (Licensing), 1981, Sec. 1. 1265 MacDonald A. Duncan, What MasterCard’s IPO Means for Merchant Suit, AM. BANKER (June 9, 2006).
285
interchange fee is still a restrictive agreement between all members in the MasterCard
organization.1266 The European Court of Appeals rejected once again MasterCard’s position
and affirmed the Commission’s ruling.1267 The European Court of Justice rejected MasterCard’s
second appeal, and upheld the conclusion that, even after the IPO, the interchange fee is a
restrictive arrangement between the banks that issue and acquire MasterCard cards.1268 This
conclusion is in line with other decisions that determined that the interchange fee is an
agreement between competitors, or a decision of an association of competitors that restricts
competition by fixing prices.1269
691. With respect to the restriction element, the interchange fee agreement binds all issuers and
acquirers that are parties to it, to pay (or be paid) the exact rate agreed upon in the arrangement.
The parties waive discretion to agree that any acquirer will pay or any issuer will receive a
different interchange fee. All acquirers and issuers lose their business autonomy in this area.
Therefore the restriction element subsists.1270
692. The final element is the potential of harm to competition, unless the arrangement falls under
one of the conclusive presumptions (per-se rule). The interchange fee arrangement is a
horizontal minimum price-fixing which falls under the conclusive presumption of section
2(b)(1). The interchange fee is the exact price the acquirer pays to the issuer. The essence of
the interchange fee is to provide an arrangement, in which issuers determine the price they (in
their role as acquirers) will pay to themselves, in their role as issuers. Indeed, the general rule
is that a price that is fixed between a seller and a buyer is not regarded as restrictive
arrangement, otherwise every arrangement which includes the price as one of its terms, would
be deemed a restrictive arrangement.1271 However, the double role of issuers and acquirers, as
1266 Comp/34.579 European Comm'n MasterCard Decision, supra note 570, paras 350-367. 1267 T-111/08 MasterCard v. Comm'n, paras.238-60 (May 24, 2012). 1268 C-382/12 P MasterCard v. European Commission, paras. 62-77 (Sept. 11, 2014); id. at para. 76: “[T]he appellants
cannot maintain that a body such as MasterCard cannot be classified as an association of undertakings when adopting
decisions relating to the MIF, since it is apparent… that, when those decisions are taken, those undertakings intend or at
least agree to coordinate their conduct by means of those decisions…”. 1269 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 684, at 30-31: “[T]he setting of a
multilateral interchange fee seems generally to be considered an agreement between competitors, or a decision of an
association of competitors, that restricts competition by fixing prices”. 1270 Cr.A 4855/02 State of Israel v. Borowitz, 59(6) 776, para. 87 (2005): “A restraint that would be deemed constitutive
of a cartel is one that narrows the latitude that one who engages in business enjoys... be this by forbidding him/her to do
something (e.g., contacting to a given population of clients) or by requiring him/her to act in a certain way only (e.g., to
sell his/her products only at some agreed-upon price); Moshe Boronovsky, On the Elements of the Restriction and its
Object - New and Not New, 5 Mechkarei Mishpat 125, 127, 132 (1987); CrC 1274/00 State of Israel v. Mudgal, at 92
(March 12, 2010). 1271 AA 6464/03 Real Estate Appraisers BAR v Department of Justice, 58(3) 293, 308-10 (2004); Board of Trade v.
United States, 246 U.S. 231, 238 (U.S. 1918): "Every agreement concerning trade, every regulation of trade, restrains.
To bind, to restrain, is of their very essence. The true test of legality is whether the restraint imposed is such as merely
286
payers and payees at the same time, introduces a price fixing element into the interchange fee
arrangement. Interchange fee is not a price determined at arm's length negotiation but through
a self-dealing process.1272
693. Section 2(b)(1) is satisfied even if the restriction simply “regards” the price. There is no need
for the restriction to set the exact price, as is the case here.1273 Therefore the interchange fee
clearly falls under Section 2(b)(1) of the Antitrust Law, and there is a conclusive presumption
of its anti-competitive potential.
694. In addition to Section 2(b)(1), a simple competitive analysis reveals that the interchange fee has
a potential to harm competition, and therefore also falls under Section 2(a), which requires only
potential competitive harm as an element.1274 This is in line with the European Law, which
also satisfies with potential harm, and does not require proof of actual harm.1275 The potential
for competitive harm is what turns an arrangement to be restrictive under a rule of reason
analysis.
695. Price increase –The interchange fee is determined in an arrangement between acquirers and
issuers that are supposed to compete with each other. Cooperation between competitors
naturally raises fears of competitive harm.1276 This is especially true when the cooperation
between competitors relates to prices. The interchange fee is a major component of the MSF.1277
Coordinating the interchange fee is equivalent to fixing a floor to the MSF.1278 An acquirer
regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition";
White Motor Co. v. United States, 372 U.S. 253, 261 (U.S. 1963); COMPACT v. Metropolitan Government of Nashville
& Davidson County, 594 F. Supp. 1567, 1572 (M.D. Tenn. 1984); National Bancard Corp. (NaBanco) v. VISA 596 F.
Supp. 1231 (1984); Am. Needle, Inc. v. NFL, 130 S. Ct. 2201, 2217 (U.S. 2010). 1272 Supra ¶¶ 35 (n.75), 104, 613. 1273Cr.C 209/96 State of Israel v. Ohalecha Yaacov, at 54 (Aug. 4, 2002) 1274 CrA 7829/03 State of Israel v. Ariel 60(2) 120, 138 (2005) (The last element of potential harm does not penetrate to
the definition of restrictive arrangement a consequential element of actual harm, potential harm is enough); Cr.C 167/03
State of Israel v. Mordechai Cohen, para. 8 (Feb. 7, 2007). 1275 C‑8/08 T-Mobile Netherlands BV v Raad Van Bestuur Van De Nederlandse Mededingingsautoriteit, para. 31 (June
4, 2009): "[I]n order for a concerted practice to be regarded as having an anti‑competitive object, it is sufficient that it
has the potential to have a negative impact on competition. In other words, the concerted practice must simply be
capable in an individual case, having regard to the specific legal and economic context, of resulting in the prevention,
restriction or distortion of competition within the common market. Whether and to what extent, in fact, such anti-
competitive effects result can only be of relevance for determining the amount of any fine and assessing any claim for
damages". 1276 General Director's Opinion and Guidelines, Opinion 1/08 Cooperation among Institutional Investors with Regard to
Changing the Terms of Corporate Bonds, Antitrust 5001318 , at 4 (Nov. 25, 2008) (Cooperation between competitors
can limit the competition in the area in which they cooperate and can spill over into other activities in which they
compete with each other, actually or potentially); Rochet & Tirole, Cooperation among Competitors: Some Economics
of Payment Card Associations, supra note 383, at 549: “At a general level, agreements among competitors can be
anticompetitive”. 1277 See supra ¶ 31. 1278 MILRED, supra note 58 (The interchange fee is a floor to the MSF); Comp/34.579 European Comm'n MasterCard
Decision, supra note 570, para. 435; Aff'd T-111/08 MasterCard v. Comm'n, para. 163 (May 24, 2012): “It is
287
cannot offer merchants a MSF that is lower than the interchange fee.1279 If the MSF were lower
than the interchange fee, then the acquirer would have to pay the issuer more than then whole
of its revenue, and the acquirer would necessarily lose money in every transaction (except for
"On-Us" transactions).
696. The interchange fee is an input for the acquirer. Acquirers have no choice but to pass through
the interchange fee to the MSF. The exact pass through rate from the interchange fee to the
MSF depends on the degree of competition in the acquiring market. The higher the interchange
fee, the higher the floor, i.e., the minimum MSF acquirers are forced to charge merchants. Thus,
the MSF is a kind of sales tax merchants pay on card purchases.1280 As with any tax, merchants
pass it along to the prices of products and services they sell. The exact pass through rate from
the MSF to prices of products and services depends on the degree of competition in the relevant
market.1281
697. Thus, the effect of the interchange fee is a small but market wide increase in all prices of goods
which are bought with cards. Concern for a market-wide price increase, even a small one, is
sufficient to sustain any rule of reason analysis and especially the fourth element in the
definition of "restrictive arrangement" under section 2(a) of the Antitrust Law: potential harm
to competition.1282 In the next chapter I elaborate on the concern for price increase and other
competitive harms stemming from the interchange fee.
To sum, interchange fee is a horizontal price fixing agreement between competitors - issuers
and acquirers who are supposed to compete with each other. The direct effect of the interchange
apparent… that ‘the [MIF of the MasterCard payment organization] sets a floor to MSCs for both small and large
merchants”. Aff'd C-382/12 P MasterCard v. European Commission, para. 193 (Sept. 11, 2014); Comp 29.373 Visa
International — Multilateral Interchange Fee, supra note 247, para. 7.5.2: “The MIF therefore effectively imposes a
floor to the MSC”. 1279 Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, supra n 633, at 10: “The merchant
discount fee is always the interchange fee plus an additional percentage taken by the acquirer bank”. 1280 Alan S. Frankel & Allan L. Shampine, The Economic Effects of Interchange Fees, 73 ANTITRUST L.J. 627, 671
(2006): "An interchange fee… acts much like a sales tax, but it is privately imposed and collected by banks, not the
government. It significantly and arbitrarily raises prices based not on technologically and competitively determined
costs, but through a collective process". 1281 Harrison J. McAvoy, Regulation Or Competition?: The Durbin Amendment, the Sherman Act, and Intervention in
the Card Payment Industry, 37 SETON HALL LEGISLATIVE J. 17 (2013): “[M]erchants are charged an interchange fee up
front on every transaction that is processed, that charge is inevitably incorporated into each individual merchant’s cost
calculation, similar to overhead or cost of goods sold. If a merchant is in a competitive market, the merchant will have
to raise its prices to maintain the same profit margin it would have without a transaction fee. This phenomenon is
known as a pass through and is evidenced by pass through rates. In the case of sales tax, economists have found there is
a pass through rate of one hundred percent or greater. Therefore, there is a strong inference that the interchange fee is
essentially passed on to the unassuming consumer. Indeed, merchants estimated that the average household paid $427
towards interchange in 2008”. 1282 Supra note 1274.
288
fee is to coordinate a minimum floor to the MSF. Thus the interchange fee falls under both
alternatives of section 2 of the Antitrust Law.
9.1. “Bylaws” Interchange Fee
698. In Israel the interchange fee is set in the Trio Agreement which is a territorial agreement
concerning the three card firms in Israel. Whenever there is no previous agreement between an
issuer and an acquirer, a default interchange fee prevails. Assume a tourist pays in Israel with
a payment card that was issued abroad by a foreign issuer, who has no acquiring agreement
with the Israeli acquirer. The Trio Agreement does not apply. A default interchange fee that is
set by the international organization, is the fee that applies.1283
A default interchange fee prevents coordination problems that allegedly could appear without
it, as explained in chapter 8.3.5 above. However, even when set as a default by the international
organizations, the interchange fee does not escape from being considered a restrictive
arrangement.
699. When open networks evolved, default rules such as the HAC were required to persuade issuers
and acquirers to join the networks with confidence.1284 As completion to the HAC rule networks
determined default interchange fees.1285 Without default rules, acquirers could refuse to acquire
cards of issuers that did not assure them in advance remittance of transaction funds. Issuers
would not have let acquirers, whom they did not have previous interchange agreements with,
to acquire their cards. The schemes argued that default interchange fees were required to
prevent situations in which in the absence of prior agreement, issuers could extort acquirers, or
be extorted by them.1286
1283 EC, INTERIM REPORT, supra note 278, at 19: “[W]here banks neither bilaterally nor multilaterally agree on the level
of domestic interchange fees, multilaterally set cross-border interchange fees will apply by default to domestic
payment card transactions as well… The effect of the “fallback” interchange fee system appears to be that in the
absence of an agreement between member banks, there will always be an interchange fee that acquirers pay to issuers,
whether a multilaterally agreed default rate at local level or a multilaterally agreed cross-border fee; this excludes the
possibility that acquirers pay no interchange fees to issuers”. 1284 For HAC rule see supra ¶¶ 53, 95, 586584.6 and ch. 11.2.2. 1285 See, for example, Rules 8.2-8.4 of MasterCard Rules. Rule 8.3 confirms the subordination of the default rule: "[I]t
being understood that all such fees set by the Corporation apply only if there is no applicable bilateral interchange fee or
service fee agreement between two Customers in place". https://www.mastercard.com/us/merchant/pdf/BM-
Entire_Manual_public.pdf 1286 Supra ¶ 52 (The international organizations determine default interchange fees. The default interchange fee applies
unless agreed otherwise in a specific agreement); ¶53 (HAC and NSR apply by default unless a superior rule determines
otherwise); ¶ 86 (due to multiplicity of issuers and acquirers bilateral agreements could not cover all possible
transactions. It became necessary to make general default rules at the association level, to be applied in instances where
there was no existing agreement); ¶ 87 (bylaws determined, inter alia, a default interchange fee to prevail, unless
otherwise provided in a bilateral agreement); ¶ 619 (the hold-out argument assumes a default rule, under which issuers
289
Today cards are ubiquitous, but issuers still disseminate payment cards to their customers under
the same default rules (but not necessarily the same rates) they themselves created when
networks began to develop. Default interchange fees are subject to any contract or regulation
that determines otherwise.1287An issuer is prohibited from requiring ex-post interchange fee
other than the default, unless previously agreed otherwise with the acquirer. Default interchange
fees apply to all members in open networks in the bylaws of the international organizations.
700. Bylaws create a contract between the members of the organization.1288 Determination of the
interchange fee through bylaws dictated by the international organization, Visa or MasterCard,
is similar to a provision in a contract to which all parties to the bylaws are bound. Therefore,
rules set forth in bylaws, or any other kind of organization rules that contain provisions which
might possibly harm competition, are a restrictive arrangement.
701. In addition, any rule, or even a recommendation, by a trade association, which is liable to
eliminate or reduce business competition, is considered a restrictive arrangement, according to
section 5 of the Antitrust Law.1289
An international organization like Visa or MasterCard, which is comprised of competing
members, can be regarded as a trade association. A "trade association" is defined in section 1
are entitled to demand interchange whatsoever. This assumption is incorrect. There is no such binding default rule. On
the contrary, the default rule might just as well be that in the absence of advance agreement, the issuer must remit to the
acquirer the full sums due i.e., default rule of a zero interchange fee. Under this default, which is no less plausible, an
issuer would be prohibited from requiring ex post interchange fee, unless acceptable by the acquirer. This will put an
end to any holdout argument); ¶ 698 (the same argument may be applied vice versa. Default interchange fee also
prevents holdout situations by acquirers, who could demand transactions funds from issuers, without offering to pay the
issuers any interchange fee, knowing that issuers are obligated by contract or by law, to remit merchants for purchases
of the issuers' cardholders). 1287 U.S GOV'T ACCOUNTABILITY OFFICE, GAO-08-558, CREDIT AND DEBIT CARDS: FEDERAL ENTITIES ARE TAKING
ACTIONS TO LIMIT THEIR INTERCHANGE FEES, BUT ADDITIONAL REVENUE COLLECTION COST SAVINGS MAY EXIST, at 2
n.4 (2008): "The default interchange rates apply when there are no other interchange fee arrangements in place between
an issuer and an acquirer". 1288 See, by syllogism, Sec. 17 of the Company Law (1999); see also CA 524/88 Pri Haemek v. Sde Yaacov, 45(4) 529,
542 (1991). 1289 Section 5 of the Antitrust Law titled: Determination of a Course of Action by a Trade Association, states: “A
course of action determined by a trade association for its members or some of them, which is liable to eliminate or
reduce business competition among them, or such course of action which the trade association recommended to them,
shall be deemed to be a restrictive arrangement as defined in Section 2, and the trade association and any member acting
in accordance with such course of action shall be deemed to be party to a restrictive arrangement”. For expansion:
Determination According to Section 43(a)(2) - Course of Action of Private Hospitals is a Restrictive Arrangement,
(Nevo, Dec. 31, 2007); Appeal 2/89 Moetzet Hamovilim v. Antitrust General Director, Antitrust 3001546 (1991); C.C
(T-A) 1617/93 Volkan v. Igud Hamusachim, 1994 (3) 274 (1994); Exemption According to Section 14 - Arrangement
between Members of the Israeli Bar Association, Antitrust 5000697 (2004); Exemption for Members of the Israeli Bar
Association - Campaign "Apartment from Contractor", Antitrust 5000052 (2004); Determination - Course of Action of
Travel Agents, 3001432 Antitrust (1997); Decision regarding Actors Association, Antitrust 3003746 (1994); Exemption
to Insurance Companies Union, Dissemination of Research about Earthquakes Damages, Antitrust 3001359 (1996).
290
of the Antitrust Law as: “a body of persons, whether or not incorporated, all or some of whose
purposes involve the promotion of the business interests of its members”. Members of the
organizations are payment card firms and their controlling banks. The organizations certainly
act for the promotion of the business interests of their members. Thus, the international
organizations Visa and MasterCard can be regarded as trade associations, as defined in the
Antitrust Law.
702. An interchange fee that is determined by trade associations can be seen as a "course of action",
which is deemed to be a restrictive arrangement. The interchange fee is a price constraint that
all parties to the association adhere to. It therefore falls under the conclusive presumptions of
section 2, which also applies in section 5. When a section 5 course of action involves one of the
matters set forth in Section 2(b), the conclusive presumption regarding the potential harm to
competition exists with respect to that "course of action".1290 In the matter of the Israeli
insurance cartel, in all three instances, courts ruled that section 5 broadens Section 2, and is not
intended to narrow the scope of section 2.1291
703. The purpose of Article 5 of the Antitrust Law is to prevent trade associations from imposing
restrictive arrangements disguised as unilateral decisions or recommendations of the
association.1292
MasterCard claimed before the European Commission that following its IPO, interchange fees
should be considered as a unilateral determination, and not a restrictive arrangement between
association of undertakings. The Commission rejected this argument on the grounds that
interchange fee, which is allegedly determined “unilaterally” by MasterCard as one
organization, is actually determined by all the financial institutions together that make up
MasterCard. The General Court and the Court of Justice of the European Union, to which
1290 Determination According to Section 43 of the Antitrust Law Regarding a Course of Action between Real Estate
Appraisers - Dissemination of a Minimum Tariff, Antitrust 3006353 (1995); Exemption to Restrictive Arrangement
between Members of the Bar Association - "Operation Will", Antitrust 5000697 (2004). 1291 Cr.C 417/97 State of Israel v. Haphenix, Dinim, para. 203 (Dec. 18, 2001); Cr.A 4855/02 Borowitz v. State of Israel,
59 (6) 776, 879 (2005); SCL 5189/05 Ayalon v. State of Israel, at 19-20 (Apr. 23, 2006). 1292 Cr. A 4855/02 Borowitz, ibid at 879: “The purpose of Section 5 of the Antitrust Law, in our view, is to cope with a
situation in which unrestrained competition in a given industry has been harmed by the action of a business association
that issues its members with “recommendations” to which they adjust their behavior.”;
Cr.C 4016-06-12 State of Israel v. Ezra Shoam, (Feb. 23, 2014); Exemption with Conditions to "Choices" Foundation,
Antitrust 5001365, part 4.3 (Feb. 15, 2009).
291
MasterCard appealed, affirmed. Both courts ruled that even after the IPO, the interchange fee
is determined in practice by all MasterCard members, and not as a unilateral decision.1293
704. Therefore, an interchange fee that is a product of a bylaw or a trade association rule is also a
restrictive arrangement that sets the price floor for the MSF.
9.2. Adaptation To Existing Interchange Fee
705. An issuer or acquirer that adheres to an interchange fee arrangement that was set by third parties
is deemed to be seen as a direct party to the restrictive arrangement of the interchange fee.
Section 6 of the Antitrust Law, titled "Adaptation to a Restrictive Arrangement", states:
A person conducting business and aware of the existence of a restrictive
arrangement, who adapts his actions to such arrangement, in whole or in part, shall
be deemed to be party to such arrangement.
706. Therefore, even if an issuer or acquirer was not a party to the initial Trio Agreement or any
other (default) arrangement which sets the interchange fee, once that issuer or acquirer is aware
of the interchange fee restrictive arrangement and "only" adheres to it, this issuer or acquirer is
deemed to be a party to the restrictive arrangement of the interchange fee.1294
The conclusion is that the interchange fee arrangement is a restrictive arrangement whether
according to section 2, 5 or 6 of the Antitrust Law.
707. However, the fact that the interchange fee is a restrictive arrangement is not the end of the story,
but rather its beginning. Under the Antitrust Law, even a horizontal restrictive arrangement that
falls under the conclusive presumptions of section 2(b) can obtain legitimacy and be
approved.1295 Approval can be granted either by exemption from the General Director under
section 14; or a temporary permit from the court under section 13; or the Antitrust Tribunal's
approval under section 9; or compliance to a block exemption installed under section 15A of
the Antitrust Law.
1293 Supra ¶ 690. 1294 CrA 2929/02 State of Israel v. Svirsky, 57(3) 135, 144 (2003); Cr.C 377/04 State of Israel v. Yaron Wol, para. 37
(July 3, 2007) (Passive party to a restrictive arrangement who adopted it without being a side to its creation – is a side to
a restrictive arrangement). 1295 CrA 5672/05 Tagar v. State of Israel, para. 48 (Oct. 21, 2007): “[T]he Israeli judicial system allows for the
possibility of sanctioning a cartel. A cartel may be sanctioned by securing the approval of Antitrust Court or by
obtaining immunity from the General Director from the need to seek the court’s approval”;
AT 13/93 Adanim Bank v. Consumer Council, at 10 (Jan 27, 1997) (The Tribunal is permitted, and even must, consider
sanctioning a restrictive arrangement, whether of section 2(a) or 2(b), according to the conditions by law).
292
708. Indeed, there are many situations in which cooperation between competitors is recognized as
legitimate, despite the inherent competitive concerns. Cooperation between competitors has
been approved with respect to inter alia, standard settings,1296 joint activities versus government
agencies,1297 actions within trade unions,1298 joint negotiations,1299 self-regulation of an entire
industry,1300 and in other instances.
709. Approval of restrictive arrangements between competitors was granted even in explicit areas of
Section 2(b).1301 This includes cases of horizontal price fixing. For example, a restrictive
arrangement among competitors regarding price-fixing is sanctioned in the selling of copyright
licenses by copyright management organizations.1302 Collective determination of termination
fees in telecommunications is also an approved price-fixing arrangement between competitors
that is similar in many ways to the interchange fees.1303
The question is, therefore, not whether the interchange fee is a restrictive arrangement, since
clearly it is. The question is whether the interchange fee is worthy of sanctioning, and if so,
under what conditions. Ostensibly, the answer has to be negative, for even the most liberal
competition authorities prohibit outright minimum price fixing between competitors.1304 The
prohibition against minimum price fixing between competitors is the keystone of Antitrust
Law.1305 Minimum price fixing leads to higher prices, lower outputs and diminution of
1296 Opinion 3/14 regarding Trade Associations and their Activities, Antitrust 500682, paras. 8, 44-46 (Sept. 24, 2014);
Exemption to Israeli Harbours, Antitrust 5001292, at 8-9 (Oct. 12, 2008); Guidelines on the Applicability of Article 101
to Horizontal Co-Operation Agreements, O.J C 11/1, at 55 (Jan. 14, 2011); ABA SECTION OF ANTITRUST LAW,
HANDBOOK ON THE ANTITRUST ASPECTS OF STANDARDS SETTING, at 24 (2004): “Many standards are created through
the formal collaboration of industry participants and include a variety of different types of standards”. 1297 Opinion 3/14 regarding Trade Associations and their Activities, paras. 34-39; Opinion 1/00 Cooperation between
Competitors Versus Governmental Authorities, Antitrust 3007119 (Feb. 6, 2000). 1298 Exemption regarding the “Choices Foundation”, supra note 1292; Exemption to Insurance Companies Union,
Antitrust 5001658 (2010).
1299 Exemption to Agreement between the Israel Hotels Association and its Members regarding Joint Negotiation with
Copyright Management Cooperation, Nevo (Oct. 16, 2002). 1300 AT 508/04 Taagid Haisuf v. Adam Teva Vadin, (Sept. 13, 2005); Exemption with Conditions to T.M.I.R, Antitrust
5001799 (June 30, 2011). 1301 For example, Exemption to Veolia and Tahel for Cooperation in Bids, Antitrust 5000999 (July 1, 2008); Exemption
regarding Common Holidays in Private Kinder Gardens, Antitrust 5001534 (Dec. 22, 2009). 1302 AT 3574/00 Music Federation v. Antitrust General Director (Apr. 29, 2004; Broadcast Music v. CBS, 441 U.S. 1
1979). 1303 Infra ¶ 455. 1304 CrA 2560/08 State of Israel v. Yaron Wol, at 80 (July 6, 2009) (Horizontal Price Fixing is the reason for antitrust
laws from the outset and citing United States v. Socony-Vacuum Oil Co. 310 U.S. 150 (1940) “combination formed for
the purpose and with the effect of raising, depressing, fixing, pegging, or stabilizing the price of a commodity in
interstate or foreign commerce is illegal per se”). 1305 Carlton & Frankel, The Antitrust Economics of Credit Card Networks, supra note 433, at 644: “One standard reason
given for why certain joint conduct among competitors should be treated as illegal per se, whether or not the
participants collectively have market power, is that some activities (such as naked price-fixing) are deemed so unlikely
to have redeeming efficiency effects that it is simpler and less costly in the long run simply to ban those activities”.
293
aggregate welfare, with particular harm to consumer welfare.
Despite all the factors weighing against it, the interchange fee has unique "redeeming" qualities
that call for different treatment from ordinary price-fixing rules, and indeed justify its approval
(though with conditions) all over the world. As explained in chapter 7, payment cards are a two-
sided network product. The interchange fee is a balancing mechanism to internalize network
and usage externalities. When interchange fee proceeds are used to cover costs and induce
efficient usage of cards, then interchange fee is justified, albeit being a minimum price fixing.
Only when the interchange fee rate exceeds its legitimate goals, the excessive part can be
considered illegitimate and to raise competitive concerns.
10. The Competitive Concerns
710. An arrangement is restrictive under Section 2(a) of the Antitrust Law, if it has the potential to
cause competitive harm. The potential for competitive harm is also what turns an arrangement
to be restrictive under a rule of reason analysis. Excessive interchange fee is liable to cause at
least three competitive harms.
10.1. Price Increase
711. The annual turnover of payment cards in Israel is above NIS 250 billion.1306 Every thousandth
of the interchange fee is equivalent to more than NIS 250 million collected annually. Merchants
pass through this input to final prices. The pass through rate is a function of the degree of
competition in the relevant market. The more the market is competitive, the larger is the pass
through rate. A rise in the interchange fee reflects in a small but market-wide price increase for
all customers.1307
712. The concern of increase in prices is intensified under common assumptions of rigid card
demand among merchants (mainly because of strategic considerations), and issuers that possess
market power. Under such assumptions the interchange fee is a tool to extract surplus from
1306 Supra ¶ 56. 1307 EU, Proposal for a Regulation on Interchange Fees, supra note 1042, at 2: “[H]igh Interchange Fees paid by
merchants result in higher final prices for goods and services, which are paid by all consumers.”; Robert J. Shapiro &
Jiwon Vellucci, The Costs of “Charging it” in America: Assessing the Economic Impact of Interchange Fees for Credit
Card and Debit Card Transactions, at 2 (2010): “[I]nterchange fees add approximately 1 to 3 percent to the price of
virtually everything”; id. at 11: “Since the largest direct effect of interchange fees is the higher prices that merchants
have to charge, and the credit card networks forbid price differentiation based on how a consumer pays for a good or
service, all consumers bear this cost whether or not they use credit cards”.
294
merchants and remit it to the issuers’ side where it is less competed away.1308 Issuers keep part
of the revenue as profit, and reward cardholders the minimum that is necessary to keep them as
active users.1309 When the pass through rate on the issuing side is not full, issuers keep part of
interchange fee as profit, allegedly strengthening the need for interchange fee, but in fact
inflating it and using it as a profit source.1310 On the merchant side the interchange fee is raised
to the maximum level merchants can absorb.1311 The result is a price increase of goods.
713. The greater the inherent benefits from card usage cardholders have, the fewer rewards are
needed to keep the level of card usage from falling. The interchange fee is used as a tool to
exploit merchants for issuers' profit, at the cost of economy-wide price increases.1312
714. The concern of a rise in prices exists even if we assume full pass through. This assumption is
far from reflecting reality, but even under it, the interchange fee that maximizes the volume of
transactions, causes a rise in prices that has no redeeming value for all those who do not pay
with cards, or for those cardholders who do not enjoy rewards.1313
10.2. Cross-Subsidization
715. The claim that whoever pays by other payment instruments subsidizes card users, was first
raised by Carlton & Frankel in 1995, and then several times thereafter.1314 The thrust of the
argument is that since the interchange fee is a percentage of the sales, it can be viewed as a kind
of tax imposed on merchants. Merchants pass this tax on to all of their customers. Cardholders
receive a partial refund in the form of rewards, whereas other payers receive nothing and
1308 Supra note 1110.
Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1280, at 634. 1310 Julian Wright, The Determinants of Optimal Interchange Fees, supra note 681, at 25: “Privately optimal
interchange fees may be too high if merchant fees increase with interchange fees but issuers do not rebate the additional
interchange fee revenue back to cardholders.”;
Vickers, supra note 743, at 234: “[I]f rebates to cardholders move less than one-for-one with the interchange fee, raising
the interchange fee will tend to increase the aggregate profit of the banks. In that case, the banks would have a natural
commercial incentive to achieve and maintain high interchange fees”. See also supra ¶¶392-396. 1311 See supra ¶392 and note 686. 1312 GAO-10-45, supra note 28, at 27-28. 1313 Farrell, supra note 742, at 29: “The shift [in the interchange fee – O.B] instead just encourages cardholders to use
CARD rather than CASH, partly by lowering the full price to cardholders of buying the good using CARD, and partly
by raising the full price of doing so using CASH". 1314 Levitin, Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV.
1321, 1356 (2008); Comp/34.579 European Comm'n MasterCard Decision, supra note 570, para. 707; Shapiro &
Vellucci, supra note 1307, at 11; Sujit Chakravorti, Theory of Credit Card Networks: A Survey of the Literature, 2 REV.
NETWORK ECON. 50, 64 (2003): “Economic models generally find that cash users subsidize card users when the cost to
merchants is greater than the benefits received”.
295
effectively fund the full tax. Even with no rewards (let alone with them) payers with cheap
payment instruments subsidize cardholders:
Interchange fees can be viewed as a way to raise costs to merchants who then pass
those costs on to cash and credit customers alike by charging the same higher price
to both. Cash customers are essentially being taxed to finance credit customers
because the interchange fees eventually flow back to the card-issuing banks that
will be forced by competition to give back at least part of the interchange fees in
the form of rebates or lower fees to their credit card customers.1315
716. When cards are more expensive for merchants than other payment instruments, but merchants
do not surcharge, those who pay with the cheap payment instrument subsidize those who pay
with the expensive payment instrument. All customers pay the same price, but those who pay
with cheap payment instruments could pay less, if they did not have to subsidize the expensive
payment instrument.1316
Cross-subsidization between payment instruments occurs only if merchants do not surcharge.
Surcharging neutralizes the interchange fee and eliminates cross subsidization.1317
717. Cross subsidy occurs if and only if cards are more expensive than other payment instruments,
causing negative usage externality.1318 The higher the interchange fee is, the higher is the risk
of negative usage externality, and that cards are in fact subsidized by other payment
instruments.1319 If cards are in fact cheaper than cash (Pcards<Pcash), and merchants do not
surcharge, then cash payers subsidize card payers.1320
1315 Carlton & Frankel, The Antitrust Economics of Credit Card Networks, supra note 433, at 660-61. 1316 MICHAEL L. KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA II COMMISSIONED REPORT, at 41 (Reserve Bank
of Australia, 2001): "When card-based transactions are more costly to merchants than are non-card-based transactions,
non-card users are hurt by card use because merchants have incentives to raise retail prices to reflect their higher costs”;
Steven Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, 14 STAN. J. L. BUS.
FIN. 343, 350 (2009); JACOB CHERTOF AND AMI TZADIK, CREDIT CARDS MARKET: ANALYSIS, REGULATION AND
INTERNATIONAL COMPARISON, KNESSET RESEARCH CENTER, at 6 (2010). 1317 Supra ch. 6.5. 1318 Supra ¶ 474. 1319 Leinonen, Debit Card Interchange Fees, supra note 773, at 16: “The higher the MIF, the larger the cross-subsidy
for cash”. 1320 Leo Van Hove, Cost-Based Pricing of Payment Instruments: The State of the Debate, 152 DE ECONOMIST 79 (2004)
(Arguing that cash users subsidize card users); James J. Mcandrews & Zhu Wang, The Economics of Two-Sided
Payment Card Markets: Pricing, Adoption and Usage, at 25 (Fed. Res. Bank of Kansas City Research Working Paper
08-12. 2008): “[C]ash users are “subsidized” by card users”; Christian Ahlborn, Howard H. Chang & David S. Evans,
The Problem of Interchange Fee Analysis: Case without a Cause? 2 PAYMENT CARD REV. 183, 196 (2004): “Cash and
checks have been subsidized by the government and in some countries these subsidies continue. Moreover, in many
countries consumers do not pay the direct cost of using cash and checks and therefore tend to use them too much…
banks do not usually charge people for taking cash out at a bank branch counter or on their ATM card on the bank’s
ATMs, even though the bank incurs corresponding costs. Likewise, many customers get free checks. Card customers
therefore may subsidise cash and check customers at the banks”.
296
718. The argument that cardholders are subsidized by cash payers, if true, has a social implication.
The most lucrative and expensive cards for merchants are less widespread among financially
weaker populations who tend to use cash or cheap cards.1321 In this situation, if merchants do
not surcharge, the weaker sectors finance the stronger sectors. An OECD report stated:
To the extent that retail prices are uniform for purchasers who use payment
mechanisms with different costs, the users of the high-cost payment mechanisms
are likely receiving benefits akin to a cross-subsidy from users of the low-costs
payment systems. That is, the users of the high cost payment mechanisms would
pay less than they would were they charged for the full cost of using their payment
system and the users of the low-cost payment mechanism would pay more than
they would in the absence of the high-cost payment mechanism. This pattern of
support may have perverse income distribution effects because the users of low
cost payment systems are more likely to be low income than the users of high-cost
payment systems.1322
719. In the U.S., a study by Hayashi & Stavins found that affluent population is more likely to use
credit cards and the weaker population is more likely to use debit.1323 This implies that when
merchants do not surcharge, lower-income debit users subsidize wealthy credit users. Schuh et
al. found that on average, each household that uses credit cards receives each year hundreds of
dollars from those who pay with other payment instruments (cash and debit cards), and that the
highest-income households receive $750 every year from lower-income households.1324
1321Adam J. Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, at 43, SSRN (2008), available at
http://ssrn.com/paper=973970; Scott Schuh et al., Who Gains and Who Loses from Credit Card Payments? Theory and
Calibrations, at 6 (FRB of Boston Public Policy Discussion Papers No. 10-03. 2010): “The literature has found a
positive relationship between income and credit card adoption”. 1322 OECD, POLICY ROUNDTABLES COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS DAF/COMP 32, at 9
(2006). See also Levitin, Social Costs, id. at 18: “[C]onsumers holding rewards cards tend to be more affluent than
those holding regular cards, both because of targeted card issuer marketing and the greater financial sophistication
associated with more affluent consumers”; EU, Proposal for a Regulation on Interchange Fees, supra note 1042, at 3:
“The result of the collectively agreed fees and transparency reducing measures is that banks are not made to compete on
this element of their fees, which leads to higher retail prices to consumers, including those who do not pay with a card
or who pay with low fee cards. In fact, the latter consumers are subsidising the use by other often wealthier
consumers of more expensive means of payment through higher retail prices.”; Frankel & Shampine, The
Economic Effects of Interchange Fees, supra note 1280, at 633 n. 19. 1323 Fumiko Hayashi & Joanna Stavins, Effects of Credit Scores on Consumer Payment Choice, FRB Boston Discussion
Paper no. 12-1, at 27 (2012): “[C]onsumers with higher credit scores are less likely to use debit cards and more likely to
use credit cards. We estimate the effect of credit scores on both adoption and use of debit and credit, and find that even
when controlling for several variables that affect payment behavior, higher credit score indicates a higher probability of
holding a credit card, and a lower probability of holding a debit card”. 1324 Schuh et al., Who Gains and Who Loses from Credit Card Payments?, supra note 1321, at 1: “On average, each
cash-using household pays $149 to card-using households and each card-using household receives $1,133 from cash
users every year. Because credit card spending and rewards are positively correlated with household income, the
payment instrument transfer also induces a regressive transfer from low-income to high-income households in general.
On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or
less annually) pays $21 and the highest-income household ($150,000 or more annually) receives $750 every year". For
criticism: Steven Semeraro, Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who Gains and
Who Loses from Credit Card Payments? Theory and Calibrations, (2012).
297
Another study confirmed the finding of cross-subsidies in gas stations and groceries.1325 In
Australia, cross-subsidy of payment instruments with similar social implications was also
found.1326
720. Cross subsidy is not only between cash and card customers, but also between debit and credit
cardholders, and between 'light' payment card users who do not receive rewards, and heavy
users for whom some prices are lower due to rewards. All cardholders participate in the costs
of providing rewards such as flight points, because goods’ prices go up for everyone.
Nevertheless only heavy users enjoy the advantages of free flights.
721. Cross-subsidy between payment instruments is not only reflected in harm to customers of the
cheap payment instrument. It also causes harm to competition between payment instruments,
by raising rivals' costs. When merchants do not surcharge, the cost of the expensive payment
instrument blends with the costs of the cheap payment instrument. Lack of segregation raises
the price of the cheap payment instrument and reduces its attractiveness.1327
10.3. Overuse And Over-Issuance
722. The interchange fee raises concerns of over-issuance and overuse of payment cards. This is
actually a concern for a quantitative distortion in the market of payment instruments.
723. An interchange fee internalizes externalities. When the fee encourages adoption of cards, it
internalizes network externality. When the fee encourages efficient usage, it internalizes usage
externality. However, even network products have an optimal size.1328 When interchange fee
causes cardholder fees to be zero, or even negative, and bestowing rewards encourages even
1325 Efraim Berkovich, Card Rewards and Cross-Subsidization in the Gasoline and Grocery Markets, 11 REV.
NETWORK ECON. 1 (2012). 1326 Philip Lowe, Reform of the Payments System, at 14 (March, 2005): “It is, of course, true that the credit card reforms
have not affected everyone equally. Those that benefited most from the previous arrangements were those who used
credit cards heavily and paid off the balance before the due date. More often than not these people tended to be those
on high incomes. The reforms have undoubtedly made credit cards relatively less attractive for these people. It is easy
to forget, however, that the benefit that these people were receiving, and are still receiving, is paid for by someone else;
in particular, those who predominantly use cash or debit cards to make their payments. These people were effectively
paying higher prices for their goods and services than would otherwise have been the case, to pay for the subsidies to
credit card users. Not only is this inefficient, but it means that people on lower incomes were often effectively
subsidizing those on higher incomes”. 1327 Farrell, supra note 742, at 31: “In this way CARD’s seemingly internal choice of fee structure can in effect raise
rivals’ costs, or more precisely lower the joint surplus achieved by trade using payment-instrument rivals”.
AT 11333-02-13 Isracard v. Antitrust General Director, para. 36 Antitrust 500647 (March 9, 2014). 1328 Supra ¶ 418.
298
more adoption and usage, then, as in any other product that is priced too low with respect to its
cost, there will be over-consumption of that product.1329
724. A distinction should be made between (1) over-issuance or over-supply that increases the
overall number of cards, and (2) over-usage of cards that increases the volume of (too many)
transactions.
Over-Usage
725. Once a payment instrument is more expensive, then seemingly all transactions made with it can
be considered over-usage from a social point of view. Therefore, as noted by Evans &
Schmalensee, the issue of over-usage should consider also the benefits and not only the
costs.1330 Also, the relative costs between payment instruments differ, depending on the value
of the transaction. Cash, for instance, is considered a cheap payment instrument for small
payments but expensive for large payments.1331
726. Payment cards may benefit merchants in such a way that it would be profitable for them to pay
more, in order to expand the volume of transactions being made with cards. The credit function,
which does not exist in cash and debit, enables a merchant to make more present sales at the
expense of its rivals and at the expense of future sales.1332 A merchant might prefer to pay a
higher fee for a credit transaction in which the cardholder needs the credit function. Such a
transaction made with credit should not be considered over-usage of credit.
This argument does not hold when the customer is liquid and does not need the credit function,
but nevertheless uses an expensive credit card. The use of expensive credit card is redundant
1329 Supra ¶ 229; see also KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA, supra note 1316, para. 98: “In the
presence of no-surcharge rules, setting relatively high interchange fees can promote inefficiently high levels of credit
and charge card usage”.
Rochet & Tirole, Externalities and Regulation in Card Payment Systems, supra note 710, at 12: “[T]he market
distortion, if any, must come from an excessive number and usage of cards.”; id. n. 33: “Or from an excessive use of
high-cost payment systems to the detriment of lower-cost ones.”;
Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J. MICROECONOMICS 206, 207 (2013):
“[T]he profit maximizing price structure (so the interchange fee) oversubsidizes card usage at the expense of charging
inefficiently high fees to merchants”;
Oren Bar-Gill, Seduction by Plastic, 98 N.W. L. REV. 1373, 1414 (2004): ”In addition, the absence of annual and per-
transaction fees implies that consumers will obtain too many credit cards and use these cards excessively for transacting
purposes (e.g., for $1 transactions)”;
REPORT OF THE INTER-MINISTRY COMMITTEE FOR INSPECTION OF MARKET FAILURES IN THE CREDIT CARD MARKET,
MINISTRY OF FINANCE, ACCOUNTANT GENERAL (BOAZ REPORT), at 25 (2007). 1330 David S. Evans & Richard Schmalensee, The Economics of Interchange Fees and their Regulation: An Overview,
Payments System Research Conferences 73, 96 (2005). 1331 Supra note 279. 1332 Supra ¶¶ 359-361.
299
for transactors, certainly from social point of view (and of course from the merchant’s point of
view). In terms of efficiency between payment instruments, paying with a credit card in such a
transaction is over-usage.
727. In the model of Rochet & Tirole that relates to all payment cards in general, over-usage occurs
when merchants over-internalize the benefits of cardholders. Marginal cardholders are steered
to pay with cards because of the interchange fee, although they could pay with cash. The higher
fee is not necessary for them to make the purchase. It only steers them to pay with the expensive
card instead of cheap payment instrument that they carry anyway (otherwise they would not be
defined marginal).1333
In the model of Rochet & Wright that relates to debit cards versus credit cards, over-usage
occurs when consumers who need the card only as a payment instrument (over-)use expensive
credit cards in transactions that could be made with cheaper debit cards.1334
In the models of Rochet & Tirole and Rochet & Wright, over-usage occurs as a result of a price
reduction to cardholders (because of high interchange fee), which leads to over-usage of cards
in general (Rochet & Tirole) or over usage of credit cards in “ordinary” transactions (Rochet
and Wright). High subsidies bestowed upon cardholders cause them to overuse cards.
In the model of Bedre-Defolie, over-usage occurs because of the two-part tariff of fixed annual
cardholder fees, and then a zero or even negative fee for transaction. This two-part tariff
encourages cardholders to use cards as much as they can, once they have joined the network.
Merchants can only choose to accept or reject cards. Once cardholders pay annual fee, they do
not further internalize the cost of usage. They are eager to use cards. The result is over-usage.
The interchange fee supports this over-usage, because it increases rewards that in turn cause the
over-usage.1335
1333 Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations, supra note
383, at 559.
1334 Jean-Charles Rochet & Julian Wright, Credit Card Interchange Fees, 34 J. BANK. FIN. 1788, 1789 (2010): “For
ordinary purchases, we assume credit cards are inefficient given we assume there are additional costs of transacting
with credit cards. As a result, card networks which maximize profit by maximizing the number of card transactions
have an incentive to encourage over-usage of credit cards by convenience users (even when these consumers do not
need the credit facility) provided merchants still accept such credit card transactions. A card network does this by
setting interchange fees high enough to induce issuers to offer rewards and cash back bonuses (equivalent to negative
fees)”. 1335 Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, supra note 1329, at 218: “In our model there is
overusage in the sense that, in equilibrium, the proportion of buyers who choose to pay by card at an affiliated merchant
is always inefficiently high”.
300
728. Over-usage exists whenever cardholder uses the card, even though the cardholder would have
used a more efficient payment instrument, if the interchange fee were not as high. Over usage
of credit relative to debit occurs, whenever transactors are steered to expensive credit because
of the interchange fee. This causes over-usage of credit and distorts competition between credit
and debit.
729. Another kind of over-usage occurs because of the weak willpower of some cardholders, who
are seduced to pay with credit cards and fall to indebtedness. This over usage is the result of the
“seduction by plastic” and insufficient control on budget constraint.1336 Although this kind of
over-usage should be attributed to the weak nature of cardholders, and cannot be regarded as
over-usage of cards with respect to other payment instruments, the interchange fee is still a
major contributor to it. There is a causal connection between the interchange fee and the
indebtedness of cardholders.
Indeed the interchange fee should not be responsible for all over-usage that is the result of the
“seduction by plastic”, as part of it would occur even if there were no interchange fee at all. It
is the result of the poor inclination of cardholders, who get confused by the seemingly painless
plastic.
However, interchange fee does contribute to default of cardholders, when this default is a result
of issuers' enticements - funded by the interchange fee (especially in the form of rewards and
rebates that are conditioned upon consumption thresholds) - that urge excessive card usage.
730. To conclude, over-usage occurs when: (1) interchange fee is too high and causes negative usage
externality; (2) when debit cardholders use credit when they are transactors; (3) when
cardholders default due to transactions they would have not done at all, if it were not for the
interchange fee.
1336 Supra ¶ 152. See also Adam J. Levitin, The Antitrust Super Bowl: America's Payment Systems, No-Surcharges
Rules And The Hidden Costs Of Credit, 3 BERKELEY BUS. L.J. 265, 288 (2005): “Not only will consumers shift more of
their purchases to credit, but they will also make more purchases because they feel less constrained in credit spending
than they do when spending cash on hand… Credit cards distort consumers' cost benefit analysis and increase
consumers' willingness to pay for goods and to make purchases they otherwise would not. When purchasing with credit
cards, consumers will pay more to get the same goods and services or pay more to acquire goods and services of
marginal value to them".
301
Over-Issuance Of Cards
731. Payment card firms directly and aggressively market payment cards to the general public.
Marketing efforts are done virtually everywhere: in shopping centers, supermarkets, duty-free
stores, terminals, over the phone, and, of course, inside banks. Marketers try to insert more and
more cards to our wallets. The fixed cost of new cards is almost always zero for an initial period.
In addition the enticement efforts contain promises for rebates, if using the card above a certain
threshold.
However, there are no free lunches. The cost of these marketing efforts must be covered. The
remaining channel of income to issuers, when direct channel of income from cardholders is
blocked, is the interchange fee. It is merchants, ultimately, who finance, through the interchange
fee, the cost of issuers in marketing cards, including expensive cards which usage is to the
detriment of merchants. Absurdly, merchants can find themselves subsidizing the marketing
efforts of their rivals.1337
732. When most customers already have one card in their wallet, issuing the second and third card
does not have any significant social benefit that the first card did not have. This is all the more
the case when the costs of funding the activities related to the issuance of the second and third
card, are not borne by the cardholder, who receive the new card for free. Card-accepting
merchants are the ones who cover at least part of the issuance costs, via the interchange fee.
Merchants then pass through their costs to their customers in increased final prices.
From a social point of view, issuing redundant cards, does not contribute to welfare and is an
example of the “wasteful competition” discussed above.1338
733. Over issuance occurs when interchange fee funds issuing additional and redundant cards from
a social point of view. The costs fall on all merchants directly, and on final prices of goods
indirectly, without conferring redeeming benefits. "Issuing wars" distort efficient allocation of
resources, and result in too many cards held by cardholders who do not internalize the true cost
of the new card in their wallet.
1337 Supra ¶ 350 and n. 631. 1338 Supra ¶¶ 301, 480, supra notes 544, 814, infra ¶ 889.
302
734. There is one positive side to over-issuance. Cardholders with several cards expand the number
of cardholders who multihome. This, in turn, improves of competition between networks.1339
Multihoming of cardholders increases the elasticity of demand of merchants, and enables them
to refuse expensive cards.1340 Unfortunately, empirical studies found that even under
multihoming in adoption, cardholders tend to singlehome in usage.1341 Thus, positive effect of
over issuance does not offset the negative affect, but only alleviates it.
10.4. Raising Entry Barriers
735. The interchange fee creates a classic chicken and egg problem. Interchange fee is a minimum
threshold income for issuers. New and cheap payment instruments would find it almost
impossible to convince incumbent issuers to waive high interchange fees and issue cards that
bear a lower interchange fee.1342 The European Commission emphasized this point:
Effects on market entry
Interchange fees also restrict market entry as their revenues for issuing payment
service providers function as a minimum threshold to convince issuing payment
service providers to issue payment cards or other payment instruments, such as
online and mobile payment solutions, offered by new entrants... new entrants
would have to offer interchange fees at least comparable to those prevailing in each
market they want to enter. This has an impact on the viability of their business
model i.e. affecting potential economies of scale and scope. This also explains why
in a number of Member States, national (normally cheaper) card schemes have
tended to disappear. The entry barriers interchange fees thus created for online and
mobile payment solutions also result in less innovation.1343
736. This problem worsens because new issuer would need an interchange fee for an initial start-up
period, to establish on the consumer side. New issuer would have to persuade cardholders to
join its network and use it, on account of competing payment instruments. Thus, a new network
would need high interchange fee for the warranted purpose of reducing cardholder fees and
incentivizing usage. The higher the interchange fee a new payment instrument would have to
allocate for satisfying incumbent banks, and convince them to issue its cards - the higher is the
entry barrier created by the interchange fee.
1339 Supra ch. 6.6. 1340 Christian Von Wizsacker, Comments regarding "Reform of Credit Card Schemes in Australia, supra note 743, at
12: “The more cards the purchaser carries around the lower is the pressure on merchants to accept additional payment
systems… merchants can become more selective in the choice of cards which they accept”. 1341 Supra ¶¶ 303-304, 331 note 600 (rewards have a significant positive effect on the use of the card that carries them,
only as long as the reward program exists). 1342 Supra ¶ 419. 1343 EU, Proposal for a Regulation on Interchange Fees, supra note 1042, at 3.
303
11. Why Merchants Do Not Surcharge
737. The competitive concerns that were mentioned above can be eliminated, or at least be
substantially reduced, if merchants surcharge expensive payment instruments.1344 By
surcharging, merchants can signal their customers that the cost of a payment instrument they
use is higher for the merchant.1345 Empirical studies in the Netherlands and Australia have found
that surcharging indeed steers up to 50% of those who intended to pay with the surcharged
payment instrument.1346
Schuh reports that when Ikea U.K. began to surcharge 70 pence to credit card transactions, 37%
of credit transactions switched to debit, and the credit volume fell by 15%.1347 Other studies
have also found positive effects of surcharging.1348 Another Australian study found that only
4% of card transactions were surcharged, meaning cardholders find ways to avoid surcharges.
Customers who pay the surcharge are likely to place high value on rewards.1349
738. The notion of surcharging, if fully implemented, is that the merchant will have a menu of prices,
which he will submit to its customers, according to the net cost of each payment instrument.
The choice of the customer as to which payment instrument to use, will internalize the full costs
1344 Supra note 456. 1345 Alan S. Frankel & Allan L. Shampine, The Economic Effects of Interchange Fees, 73 ANTITRUST L.J. 627, 648
(2006). 1346 Wilko Bolt, Nikole Jonker & Corry Van Renselaar, Incentives at the Counter: An Empirical Analysis of
Surcharging Card Payments and Payment Behaviour in the Netherlands, 34 J. BANK. FIN. 1738, 1740 (2010): "This
finding suggests that consumers are indeed steered towards the use of cash by retailers who apply debit card
surcharges… Around two-thirds indicate that, faced with such a debit card surcharge, they prefer to pay with cash...
These results suggest that consumers do react to payment fees and adapt their payment behaviour accordingly."; see
also ibid , 1741 note 10;
RBA, REVIEW OF CARD SURCHARGING: A CONSULTATION DOCUMENT, Reserve Bank of Australia, at 3 (2011):
“[A]round half of consumers that hold a credit card will seek to avoid paying a surcharge by either using a different
payment method that does not attract a surcharge (debit card or cash) or going to another store”
Nicole Jonker, Card Acceptance and Surcharging: The Role of Costs and Competition, 10 REV. NETWORK ECON. 1
(2011). 1347 Scott Schuh et al., An Economic Analysis of the 2011 Settlement between the Department of Justice and Credit Card
Networks, 8 J. COMPETITION L. ECON. 1, 23 (2012). 1348 David B. Humphrey, Retail Payments: New Contributions, Empirical Results, and Unanswered Questions, 34 J.
BANK. FIN. 1729, 1734 (2010): “[F]or the Netherlands using 2006 data where merchants are permitted to surcharge
debit card use and consumer and retailer survey data indicate a substitution to cash at merchants that impose a
surcharge”. 1349 Crystal Ossolinski, Tai Lam and David Emery, The Changing Way We Pay: Trends in Consumer Payments, at 43
(RBA Discussion Paper 2014-05): "Despite the strong growth in card use and online retail sales between 2010 and
2013, the frequency of surcharges was stable at around 4 per cent of card payments, indicating that individuals were
typically able to use alternative methods of payment if they were not willing to pay the surcharge. Furthermore, there is
evidence that consumers who pay surcharges are more likely to place a value on rewards programs than those who do
not pay surcharges".
304
of the chosen payment instrument on the merchant.1350
In practice, surcharging is not a common phenomenon.1351 Merchants tend to price uniformly.
Frankel named this phenomenon: “price coherence”.1352 The reasons why merchants tend not
to surcharge will be described now.
11.1. Uncertainty As To The Appropriate Surcharge
739. How much should be the surcharge? There is no clear answer. The surcharge should not be the
full amount of the MSF, for there are some benefits of card acceptance which the merchant
would agree to pay for. The convenience benefits of the merchants from card use should
theoretically be deducted from the MSF.1353
To find the “right” surcharge, the merchant should first identify the MSF it pays (Pm) for each
card. In Israel, the MSF for a specific merchant is the same for all cards from the same brand.
Cards in other countries, even within the same brand, may carry different MSFs. Premium cards
(that provide greater rewards to cardholders) carry a higher MSF.1354 The cards themselves do
not carry any indication of the MSF that is charged on them. Merchants themselves are not
always aware of the MSF that each card bears.1355
740. Identifying the MSF is a first and necessary stage in the calculation of the surcharge. After
identifying the MSF, the merchant needs to reduce the part of it that reflects the 'right' MSF for
1350 Robin A. Prager et al., Interchange Fees and Payment Card Networks: Economics, Industry Developments, and
Policy Issues, at 44 (F.R.B. Finance and Economics Discussion Series 23-09, 2009): “When choosing a payment
method, a consumer would face a menu of prices and would take into account both the price differentials and his or her
own private benefits and costs associated with different payment methods”. 1351 Zenger, Perfect Surcharging, supra note 805, at 2544: ”[S]urcharging very rarely occurs in practice.”; Marc
Rysman & Julian Wright, The Economics of Payment Cards, at 12 (2015); Commission Staff Working Document
Impact Assessment, SWD(2013) 288 Final, at 131-34 (24.7.2013), (Tables showing only few percent of surcharging
merchants in Europe). 1352 Alan S. Frankel, Monopoly and Competition in the Supply and Exchange of Money 66 ANTITRUST L.J. 313, 316
(1998). 1353 Hélène Bourguignon, Renato Gomes & Jean Tirole, Shrouded Transaction Costs, at 42, CEPR Discussion Paper no.
DP10171 (Sept. 2014): “If surcharging is to be allowed, the optimal cap is equal to the merchant fee minus the
merchant’s convenience benefit from card payments”. 1354 United States v. Am. Express Co., 2015 U.S. Dist. LEXIS 20114, 39-40 (E.D.N.Y. Feb. 19, 2015): “[I]t is more
expensive for merchants to accept high-rewards Visa and MasterCard cards when compared to more basic cards on the
same networks”. 1355 Oz Shy & Joanna Stavins, Merchant Steering of Consumer Payment Choice: Lessons Learned from Consumer
Surveys, 13-1 FRB Boston, at 5 (2013): “Merchants… currently lack complete information on the exact merchant
discount fees for their customers’ credit cards”.
305
the merchant, and surcharge only the difference. This seemingly simple step has no less than
three options.
Surcharging The Difference Between Price And Benefits
741. A merchant might want to surcharge the difference between the MSF and the benefits of the
card to the merchant.1356
When considering the price of cards, the merchant might want to add to the MSF other costs,
such as payments for infrastructure, point of sale devices, chargebacks, refunds, payments for
services from intermediaries who provide equipment, fraud detection, processing, factoring and
discounting services.1357
The net benefits a merchant derives from accepting a payment card, in comparison to another
payment instrument is Bm. If the MSF (and possible additional costs) is higher than Bm in the
amount of S1 (S for surcharge), the first option is to set a surcharge of S1 for cardholders who
pay with that card. It is easy see that S1 is a rather amorphous term. It is certainly not easy to
calculate.
The models of Rochet & Tirole and the model of Wright exhibit a private case, in which Pm is
the same size of the merchant’s benefit (Bm), plus cardholders’ average benefit (Bca). Thus the
'right' surcharge according to them should be S1=Bca. The term Bca for itself is amorphous. It is
the perceived benefit of the average cardholder in the merchant's view.
The effects of a surcharge in the size of Bca are that cardholders with an average benefit of Bca
and greater, will continue to pay with cards, while cardholders with transaction benefit that is
below Bca, will be deterred by the surcharge, and pay with another payment instrument.1358
1356 Bourguignon et al., Shrouded Transaction Costs, supra note 1353; Fumiko Hayashi, The Economics of Payment
Card Fee Structure: Policy Considerations of Payment Card Rewards, at 12 (FRB of Kansas City Working Paper No.
08-08. 2008); Rochet & Tirole, Cooperation among Competitors: Some Economics of Payment Card Associations,
supra note 383, at 562. 1357 Bourguignon et al., id, at 2 n. 4: “[I]n the UK surcharge regulation, the attributable costs can include direct costs
beyond the merchant service charge, such as point of sale devices, risk management, charges for reversing or refunding
a payment, or payments for services from intermediaries who provide equipment, fraud detection and processing
services for card payments”. 1358 Julian Wright, The Determinants of Optimal Interchange Fees, supra note 681, at 8.
306
742. To implement this exact surcharge the merchants must know exact card prices and benefits, as
well as estimate the average benefit of cardholders. This is not an easy task.
Surcharging The Difference Between Price And Costs
743. Levitin posits another option. If the perceived costs of the transaction in the merchant's view
are C, but the merchant is required to pay MSF which is higher than C (Pm=C+S2), the
merchant may surcharge S2.1359 In this scenario, the surcharge is the difference between the
MSF and what the merchant thinks is the cost of the transaction, or what the merchant perceives
the cost should have been in a competitive outset (when Pm=C).1360
744. In order to calculate the surcharge in this method (S2), the merchant is required to estimate the
costs of the payment card network, and attribute the part of them that in the opinion of the
merchant should be carried by the merchant. Estimation of these costs, such as processing costs,
authorization cost, and, if the merchant is generous, also the cost of payment guarantee is a
formidable task, as authorities in U.S., Europe, Australia, and Israel have discovered.1361 Exact
estimation is probably not within the reach of the merchant. Indeed Levitin was criticized for
this suggestion.1362
Free Surcharging
745. Another approach to setting the surcharge opines that the accurate size of the surcharge is not
of primary importance. The role of the surcharge is merely to signal to cardholders, which
payment instrument is expensive. Any effective signaling suffices. Neither prior knowledge nor
calculation of costs and benefits of the various payment instruments are necessary. The
surcharge should only signal, not even necessarily accurately, that a certain payment instrument
is more expensive than the other.1363
The criticism of this approach states that it is in fact very important to calculate the exact size
of the surcharge. Excessive surcharging might impede the network by over-deterring
1359 Adam J. Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321,
1335 (2008). 1360 id. 1361 Supra 495-499, for expansion see supra ch. 0. 1362 Steven Semeraro, The Economic Benefits of Credit Card Merchant Restraints: A Response to Adam Levitin, TJSL
Legal Studies Research Paper no. 1357840, at 32 (2009). 1363 Prager et al., Interchange Fees and Payment Card Networks, supra note 1350, at 44: “[Surcharge] does not require
a great deal of information about costs and benefits accruing to the various parties in a transaction; rather, it relies upon
market forces to yield retail prices that reflect those costs and benefits”.
307
cardholders. Excessive surcharging would eliminate efficient card transactions, and might be
used as a way to exert market power by merchants.1364 On the other hand, a too-low surcharge
fails to signal the real cost of the payment instrument being surcharged.
746. The theoretical concerns about excessive surcharging, when merchants can surcharge without
limitations, were found to exist in practice. The Australian central bank found in 2011 that
merchants tend to surcharge excessively, and not distinguish between cards bearing low and
high MSF.1365 Therefore in 2013 it permitted the networks to limit surcharges to "the reasonable
cost of acceptance".1366
According to a study for the Dutch market, merchants often surcharged up to 4 times the
MSF.1367 The issue was resolved by the European commission in Directive 2011/83/EU on
consumer rights.1368 Article 19 states that "Member States shall prohibit traders from charging
consumers, in respect of the use of a given means of payment, fees that exceed the cost borne
by the trader for the use of such means". The provision limits surcharging to the actual cost of
a payment instrument to the merchant.1369 A similar rule, limiting surcharging to costs, has been
applied in United Kingdom since August 2015.1370
Such limitations are still higher than the economic surcharge. Economically, the benefit of the
merchant, or at least the cost, should be deducted from the MSF. Nevertheless, in my view, as
a general rule, surcharging should be unlimited. Merchants prefer not to surcharge unless costs
1364 Julian Wright, Optimal Card Payment Systems, 47 EUR. ECON. REV. 587, 594 (2003): "When surcharging is
allowed, merchants with monopoly power will exploit their power by setting a price to extract surplus from
inframarginal cardholders.";
Rysman & Wright, The Economics of Payment Cards, supra note 1351, at 34: "[I]n reality, merchants will not
surcharge perfectly, with some merchants not surcharging at all and others surcharging excessively in order to extract
fees from consumers with high demand, or perhaps with little information. Allowing surcharging is therefore, at best,
only going to partially solve the problem. In other words, allowing surcharging may be a relatively weak way to address
the concern of inflated interchange fees and may have other unintended consequences". 1365 RBA, REVIEW OF CARD SURCHARGING: A CONSULTATION DOCUMENT, Reserve Bank of Australia at 2-3 (2011). 1366 RBA, REFORMS TO PAYMENT CARD SURCHARGING (March 2013): “The Standards now allow card scheme rules to
limit a merchant's surcharge to ‘the reasonable cost of acceptance’, which includes – but is not limited to – the merchant
service fee that the merchant pays to its financial institution. The Standards therefore continue to ensure that merchants
have the freedom to impose surcharges on the cards they accept, and that they can fully recover their acceptance costs.”;
see also Supra ¶ 663. 1367Bolt & Chakravorti, Digitization of Retail Payments, supra note 726, at 25-26: “[M]erchants may surcharge up to
four times their fee”. 1368 Directive 2011/83/EU on Consumer Rights, OJ L 304/64, Article 19 (Nov. 22, 2011): “Member States shall prohibit
traders from charging consumers, in respect of the use of a given means of payment, fees that exceed the cost borne by
the trader for the use of such means”; see also supra ¶ 584.7. 1369 COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT, SWD(2013) 288 Final, at 136 (July 24, 2013). 1370 United Kingdom, Department for Business Innovation and Skills, Guidance on the Consumer Rights (Payment
Surcharges) Regulations, at 5 (Aug. 2015): “The Regulations: • Ban traders from charging consumers more than the
direct cost borne by them as a result of the consumer using a given means of payment”.
308
are significantly higher than benefits. If this is the case, then merchants should be able not only
to signal but also to deter consumers from using expensive payment instruments. Merchants
that abuse their discretion to surcharge, should be treated specifically, and be capped in their
ability to surcharge. After all, merchants have benefits from cards. If they surcharge excessively
they would punish themselves. It is for the market forces to settle the equilibrium.1371
11.2. Merchant Restraints
747. A second reason why surcharge is not common is the presence of restraints on merchants,
sometimes by law but most often by covenants in merchants' agreements with acquirers.
Networks avoid surcharging by imposing restraints that prohibit merchants from discriminating
against those who pay with cards, compared to other customers ("Merchant Restraints").
The main merchant restraints are the no surcharge rule (“NSR”) which prevents discrimination
against cards, and the honor all cards rule (“HAC”) that obligates merchants to honor all cards
of the same brand.1372 The rules complement each other. If not for the HAC, a merchant could
refuse to accept the cards of certain issuers. If not for the NSR, a merchant could bypass the
HAC by honoring the card but surcharging astronomically, which is the equivalent of refusal.
748. NSR works in favor of costly payment instruments. For consumers, NSR equalizes the price of
the expensive instrument to that of the cheapest. Under NSR, merchants mostly set prices which
are based on the price of the expensive payment instrument, to prevent any loss on transactions
performed with it.1373
NSR also serves as a barrier to entry, and prevents the spread of cheap and innovative payment
instruments. Where NSR applies, the merchant cannot offer its customers a discount for using
the cheap instrument. For example, NSR can neutralize the merchant ability to signal its
customers that PIN debit is cheap, and hinder the penetration of PIN debit.1374
1371 Supra ¶¶ 272-281. 1372 Supra ¶ 53. For economic models regarding the NSR see supra 6.5. 1373 Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 1359, at 1358: “No-
surcharge rules equalize the price at the point of sale between all payment systems. This equalization accrues to the
benefit of costlier payment systems, particularly credit cards, because they are able to impose a cost externality on the
merchant who either absorbs it or passes it along to the consumers of other payment systems. Essentially, no-surcharge
rules increase the price of all other payment systems to match the price of credit cards”. 1374 Id. at 1358: “[F]or consumers who use credit cards only to transact, and not for their credit function (including
float), PIN-based debit cards offer the same convenience, but are cheaper and securer. For pure transacting, PIN debit is
309
749. The HAC rule works on two levels. First, the rule requires a merchant who accepts a particular
brand, e.g., Visa, to accept all cards of that brand, regardless of the identity of the issuer.
Second, the rule requires the merchant to accept all of the brand’s products (debit, credit,
prepaid, premium etc.).1375 HAC is a tying arrangement. Once a merchant accepts one kind of
a brand's cards, HAC rule ties all cards of that brand to the merchant.1376
The HAC rule assists in penetration of new types of payment instruments, bearing an existing
brand name. By leveraging the brand name, acceptance of new products, immediately upon
entering the market, is maximal.1377
750. NSR and HAC both prevent the autonomy of merchants to freely price cards NSR ties the price
of expensive instruments to that of cheap. HAC ties products and brands. NSR is contrary to
the principle whereby competitive prices should reflect costs.1378 Therefore, NSR and HAC are
restrictive arrangements.1379 It has been debated in the literature if these rules are prohibited per
se,1380 or should be analyzed under the rule of reason.1381 Under the broad definition of the
Israeli law there is no doubt that they are restrictive arrangements:
NSR
751. In Israel merchant restraints fall under the broad definition of Article 2 of the Antitrust Law.1382
Already by 1993, the Antitrust General Director determined that NSR is a price restraint that
a superior payment system. The use of PIN-debit, however, may well be limited by the no-surcharge rule advantages
given to credit cards”. 1375 NICHOLAS ECONOMIDES, COMPETITION POLICY ISSUES IN THE CONSUMER PAYMENTS INDUSTRY, in MOVING
MONEY: THE FUTURE OF CONSUMER PAYMENT 113, 119-20 ( R. Litan & M. Baily eds., 2009): “There were two aspects
of this rule. First, if a merchant accepted a certain type of card (say, Visa debit) issued by one bank (say, Citibank), he
was required to accept the same type of card (in this case, Visa debit) issued by another bank. The rule also imposed the
requirement that a merchant accept any other Visa products (such as Visa credit cards) if he accepted one (such as a
Visa debit card)”. See also supra ¶ 584.6. 1376 Jean Charles Rochet & Jean Tirole, Tying in Two-Sided Markets and the Honor all Cards Rule, 26 INT'L J. INDUS.
ORG. 1333 (2008). 1377 Sujit Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, 9 REV. NETWORK ECON. 1, 19
(2010): “Such a rule enables a card network to innovate by producing different products that when introduced will have
a large base of merchants that accept them. The introduction of payroll cards, a type of prepaid card, is an example of an
innovation that leverages a card network’s existing infrastructure”. 1378 Alberto Heimler, Payment Cards Pricing Patterns: The Role of Antitrust and Regulatory Authorities, at 8-9 (SSRN,
2010): “[T]he unfortunate impact of such rules is that they create a situation in which merchant costs differ according to
the payment instrument chosen, but prices that consumers pay do not reflect these cost differences. This mandatory
price coherence is inconsistent with the general principle that, in a market system, prices should be free to reflect costs”. 1379 NICHOLAS ECONOMIDES, COMPETITION POLICY ISSUES IN THE CONSUMER PAYMENTS INDUSTRY, supra note 1375, at
119; Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 1373, at 1400-02. 1380 Levitin, id. at 1399; Frankel, Towards, supra note 811, at 54. 1381 Semeraro, The Economic Benefits of Credit Card Merchant Restraints: A Response to Adam Levitin, , supra note
1362, at 33; Semeraro, The Antitrust Economics (and Law) of Surcharging, supra note 1316, at 376-82. 1382 Supra ch. 0.
310
falls into the conclusive presumption of section 2(b)(1)1383.
Under the current approach, NSR does not fall under section 2(b) of the Antitrust Law
(conclusive presumptions do not apply to vertical restraints).1384 However, NSR falls within
section 2(a) of the Antitrust Law. NSR is an arrangement between undertakings conducting
business. The effects of merchant restraints raise significant competitive concerns. Both NSR
and HAC might have anti-competitive effects, if they sustain “Gresham's law”,1385 i.e., cause
bad (expensive) money to supplant good (cheap) money.1386 Moreover, NSR can cause prices
to adjust, fully or partially, to the price of the expensive payment instrument. If this risk
materializes then NSR causes a small but wide price increase of all products and services that
can be purchased with the expensive payment instrument. Small but market wide price increase
is a clear example of competitive harm that falls under section 2(a) of Restrictive Trade
Practices Law.
Surprisingly, the final report of the Antitrust Authority on enhancement of efficiency and
competition in the payment card sector noted that some payment card firms in Israel impose
merchant restraints such as NSR.1387 This is surprising because no approval was requested from
the IAA for this clear restrictive arrangement that was already declared a per-se violation in
1993. It is not clear how the IAA can reconcile with unapproved NSR after it was already
declared illegal.
752. In Australia, NSR was canceled in the reform of 2002. As explained above, in 2013 the RBA
allowed networks to limit surcharges to "the reasonable cost of acceptance".1388
In European Union countries, about half allow surcharging (Estonia, Finland, Germany,
Ireland, Malta, Netherlands, Poland, Slovakia, Slovenia, Spain, United Kingdom) and half
1383 Decision of the Antitrust General Director According to section 43 of the Restrictive Practices Law Regarding
Isracard, Antitrust 3006076 (1993); BANK OF ISRAEL, RECOMMENDATIONS FOR ENHANCEMENT OF COMPETITION IN THE
PAYMENT CARD SECTOR, FINAL REPORT, para. 15.5 at 36 (Feb. 2015). 1384 Supra ¶ 686. 1385 Supra ¶ 435. 1386 OECD, POLICY ROUNDTABLES COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS DAF/COMP 32, at 8
(2006): “[C]ertain rules have the effect of limiting the retailer's ability to influence the choice of payment mechanism by
the customer. These rules can make merchants less sensitive to merchant fees, by making their demand for card services
more inelastic. The rules also limit the ability of merchants to negotiate for lower rates. Certain of these rules appear to
have largely anti-competitive”. 1387 IAA, ISRAEL ANTITRUST AUTHORITY, HAGBARAT HAYEILUT VEHATAHARUT BETHUM KARTISEI HAHIUV
[ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR], FINAL REPORT, Antitrust 500680
(Sept. 8, 2014) 1388 Supra ¶ 746.
311
prohibit it (Austria, Bulgaria, Cyprus, Czech Republic, France, Greece, Hungary, Italy, Latvia,
Lithuania, Luxembourg, Portugal, Romania, Sweden). Denmark permits surcharging credit but
bans it on debit.1389 Switzerland abolished NSR.1390 Surcharging, where permitted, is limited to
acceptance costs.1391 The 2015 Interchange Fee Directive prohibits surcharging in payment
instruments of which the interchange fee is regulated.1392
753. In the United States the NSR was practically canceled in the Durbin Amendment and the DOJ
proceedings.1393 However, surcharging was prohibited in some states, including California and
New York, by legislation.1394 This prohibition was recently held unconstitutional. In 2017, the
Supreme Court ruled that New York’s NSR limited merchants’ freedom of speech, which is
protected by the First Amendment, and remanded for the Court of Appeals to analyze the NSR
as a speech regulation.1395 In January 2018, the 9th District held that California’s NSR violates
the First Amendment (but only as applied to plaintiffs), because it prevents merchants from
conveying their customers the true cost of credit card usage.1396 I can only humbly concur and
note these rulings fit my view, as explained supra in ¶ 275.
HAC
754. In Israel, there is no difference in the MSF of cards within a specific brand. In general, the MSF
of American Express and Diners is higher than the MSF of Visa and MasterCard; but within a
brand itself, the MSF for all cards is the same.
Therefore, the HAC rule, which is meant to tie expensive cards to the acceptance of cheap cards,
1389 COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT, SWD(2013) 288 Final, at 131 (July, 24, 2013). 1390 OECD, POLICY ROUNDTABLES, COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS DAF/COMP 32, at 32
(2006); Heimler, Payment Cards Pricing Patterns, supra note 1378, sec. 3.1; Hayashi, Policy Considerations, supra
note 1356, at 11. 1391 Supra ¶ 746. 1392 Regulation (Eu) 2015/751 Of The European Parliament And Of The Council of 29 April 2015 on Interchange Fees
for Card-Based Payment Transactions, O.J L 123/1, para. 36 (May 19, 2015): “In situations where the payee steers the
payer towards the use of a specific payment instrument, no charges should be requested by the payee from the payer for
the use of payment instruments of which interchange fees are regulated within the scope of this Regulation”. 1393 Supra ch. 8.3.11. 1394 Hélène Bourguignon, Renato Gomes & Jean Tirole, Shrouded Transaction Costs, at 2 n. 2, CEPR Discussion Paper no.
DP10171 (Sept. 2014): “[S]ince January 2013, merchants in the United States are permitted to impose a surcharge on consumers
when they use a credit card, except in states with laws prohibiting surcharging, such as California, New York and Massachusetts”. 1395 Expressions Hair Design v. Schneiderman, 137 S. Ct. 1144 (Mar. 29, 2017). 1396 Italian Colors Rest. v. Becerra, 878 F.3d 1165, 1177 (9th Cir. Jan 3. 2018): “[t]he higher cost is a result of credit
card fees, and referring to the price differential as a discount prevents retailers from accurately conveying that causal
relationship… Section 1748.1 prevents retailer… from communicating with [their customers] in an effective and
informative manner" about the cost of credit card usage and why credit card customers are charged more than cash
users.”
312
does not have practical significance in Israel. However, HAC applies in Israel as part of the
bylaws of the international organizations.1397
755. The HAC was abolished in Europe for "product tying", i.e., merchants can refuse to accept
expensive cards. However, merchants cannot refuse to accept cards of a certain issuer, if they
accept the same card when issued by another issuer.1398
In the U.S, HAC rule was partially canceled in 2003, following a settlement in the Wall-mart
class action.1399 According to the settlement, merchants can accept debit but refuse credit, or
vice versa. The HAC rule still applies within credit or debit cards, which means that if a
merchant chooses to accept credit (or debit) it must accept all cards of that type, including
premium cards with higher MSF. Therefore, it was claimed that the residual HAC rule that still
exists is anti-competitive.1400
756. Empirical studies in countries that canceled the NSR found that networks expanded; refuting
the claim that NSR is necessary to maintain the size of the network.1401 The effects of
eliminating NSR are discernible only after a period of years. Australia, in which the NSR was
abolished in the reform of 2002, experienced a steady increase over time in surcharges. As of
2012, about 40% of large merchants, and 20% of small businesses, surcharged.1402 In Europe,
surcharging is less common and ranges from 1% in Finland to 14% in Ireland and U.K.1403
757. To sum up, merchant restraints are a sufficient reason that explains why merchants do not
surcharge. Nevertheless, canceling merchant restraints is a necessary but insufficient condition
for merchants to surcharge. For even in the absence of merchant restraints, the majority of
merchants adhere to price coherence. Merchant restraints cannot fully explain why merchants
do not surcharge. The reasons for price coherence are latent in other factors.
1397 Section 6.2 of Visa International Operating Regulations Core Principles, titled “Honoring all Visa cards" states:
"Visa merchants may not refuse to accept a Visa product that is properly presented for payment”. 1398 Supra ¶ 584.6. 1399 Supra ¶ 625. 1400 Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, supra note 1321. See also supra ¶626,
note 1178. 1401 Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 1373, at 1389: “Recent
experience shows that credit card networks have profited and grown in the absence of no-surcharge rules."; United
States v. Am. Express Co. LEXIS 20114 (E.D.N.Y Feb. 19, 2015); For the claim NSR is necessary see supra ¶ 461. For
a contrary opinion that the expansion of networks was a result of economic growth, see Chang et al. supra note 1207. 1402 RBA, REVIEW OF CARD SURCHARGING: A CONSULTATION DOCUMENT, supra note 1365, at 2; COMMISSION STAFF
WORKING DOCUMENT IMPACT ASSESSMENT, SWD(2013) 288 Final, at 193 (July 24, 2013): “[S]urcharging was slow to
develop among merchants, by the end of 2010 almost 30 per cent of merchants imposed surcharges on credit card
products”. 1403 Id. at 132 (July 24, 2013) (table 35 – proportion of merchants that surcharge, by country).
313
11.3. Strategic Considerations
758. A main reason why merchants do not surcharge is their concern to not deter their customers and
their fear of losing business.
When cardholders, who are eager to pay with cards, find that they have to pay a surcharge, they
may shop elsewhere, if not for the current transaction, then for future ones. Accepting cards is
an important service that merchants provide. Merchants that surcharge, while their competitors
do not, risk loss of transactions and income.1404
759. Merchants that decide to surcharge extract higher profit from infra-marginal customers, who
still use cards. The downside for surcharging merchants is that they sacrifice marginal
cardholders, who switch to other payment instruments (in the good scenario) or worst - quit
purchasing at that merchant.
Loss of profit from a transaction is usually greater than any MSF, and is certainly greater than
that part of the MSF which a merchant might decide to surcharge.1405 It is sufficient that just a
small fraction of customers abandon the surcharging merchant to render surcharging as not
profitable.1406 In fact, these are the same strategic considerations that prevent merchants from
refusing to accept cards in the first place.1407 If surcharging leads to a fall in sales merchants
would probably refrain from it.1408
760. Nevertheless, the magnitude of strategic considerations is weaker when it comes to surcharging.
Before a merchant refuses to accept cards at all, the merchant would likely resort to surcharge.
If a merchant accepts cards when NSR applies (even if it is because of strategic considerations),
the merchant will probably continue to accept cards when NSR is lifted. At the most the
merchant would surcharge.1409
1404 Chakravorti & To, A Theory of Credit Cards, supra note 638, at 586: “Why merchants do not differentiate between
credit and cash purchases is a difficult question to answer. It may simply be the case that faced with a higher price for
credit purchases, consumers may choose to purchase elsewhere rather than pay a higher price". 1405 Supra ¶ 194. 1406 COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT, SWD(2013) 288 Final, at 135 (July 24, 2013):
“[M]ost merchants, in particular in the traditional retail sector, were reluctant to adopt them [surcharging – O.B], mostly
because of fears of losing customers to competition”. 1407 Supra ch. 6.4. (Rochet & Tirole – Strategic Considerations) 1408 Jonker, Card acceptance and surcharging: the role of costs and competition, supra note 1346, at 7. 1409 Chakravorti & To, A Theory of Credit Cards, supra note 638, at 586.
314
761. For cardholders, surcharging leads to less negative feelings and less deterrence than total
rejection, so the intensity of strategic considerations that prevent a merchant from refusing to
honor cards is weaker when it comes to surcharging.
A situation, in which merchants do not surcharge because of strategic considerations, is similar
to the familiar prisoner's dilemma. Each merchant separately chooses not to surcharge, because
of fear of losing customers to its competitors. The result is that merchants fail to surcharge. If
all merchants could unite, a decision to surcharge would have put them all in a better
position.1410 Thus, strategic considerations are a good reason for why merchants do not
surcharge.1411
11.4. Surcharging Is Costly
762. Another reason why merchants do not surcharge, even if they can, is that surcharging has its
costs. These costs demand the allocation of special resources, and might be too expensive to
implement.1412
The merchant has to identify the exact surcharge it wishes to collect. Surcharging too little will
not suffice, while surcharging too much might deter more than the merchant wanted. Any
attempt to surcharge requires investment of resources to identify the proper amount.1413
Costs of surcharging include, inter alia, advertising and informing customers about the
existence of the surcharges;1414 allocation of additional human resources and salaries for
employees that are involved in the process of tagging different prices to products and services,
as well as responses to inquiries of customers seeking the best payment instrument to pay with,
1410 OECD POLICY ROUNDTABLES, COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS, supra note 1390, at 55:
“[M]erchants face a prisoners dilemma: they may have a preference for differential pricing, but individual merchants
are unlikely to introduce differential pricing, because it will irritate some customers and lead to customer loss”. 1411 Rong Ding, Merchant Internalization Revisited, 125 ECON. LETTERS 347 (2014): “[W]hen merchants set a single
price regardless of how consumers pay, merchants also accept cards for strategic reasons, even if their transactional
benefit of doing so is lower than the merchant fee they face. This has been used to explain why merchant fees may be
set too high”. 1412 John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee,
Payments Sys. Research Conference 231, 238 (2005): "[S]urcharging is by no means costless for retailers”. Tamás
Briglevics & Oz Shy, Why Don’t most Merchants use Price Discounts to Steer Consumer Payment Choice?, 12-9 Frb
Boston, at 20-21 (2012). 1413 Supra ch. 11.1. 1414 Briglevics & Shy, supra note 1412, at 20-21 (2012). Steven Semeraro, The Antitrust Economics (and Law) of
Surcharging Credit Card Transactions, 14 STAN. J. L. BUS. FIN. 343, 360 (2009): “Programming systems and training
employees to implement such a scheme would be a costly endeavor with uncertain returns”.
315
and inquiring about prices. Technology improvements might reduce the cost of surcharging,
but not eliminate it.
763. Another cost of surcharging is notional. It occurs whenever merchants give a price discount to
those who pay with a preferred payment instrument. Customers, who would have purchased
with the favored payment instrument anyway, even absent the discount, still enjoy the discount.
The merchant loses revenue because these customers pay a discounted price instead of full
price.1415
The costlier it is for the merchant to apply the surcharge, the less likely the merchant will choose
to surcharge in the first place.
11.5. Psychological Reasons
764. In the U.S., the Cash Discount Act permits merchants to give discounts for use of cash.1416 This
act led some commentators to argue that cash discounts are equivalent to surcharging cards, so
in reality, nothing prevents merchants from differential pricing.1417
765. Other scholars have explained, based on cognitive psychological theories that there is a
difference between a cash discount and surcharging. While surcharging cards is perceived as a
penalty for cardholders, who might shy away from merchants who surcharge, cardholders have
less hard-feeling if somebody else (who pays with cash) gets a discount. The reason for this lies
in what is known as the "endowment effect". People place a higher value on money they are
losing (paying a surcharge) than on money of the same amount that they have not earned (cash
discount to somebody else).1418
1415 Shy & Stavins, Merchant Steering of consumer payment choice, supra note 1355, at 5: “[O]ffering buyers price
discounts on cash and debit transactions may not be profitable to merchants because cash and debit price discounts
reduce revenues from consumers who would use these lower-cost payment methods even in the absence of price
discounts”. 1416 For expansion see Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, supra note 1373, at
1380. 1417 Benjamin Klein et al., Competition in Two-Sided Markets: The Antitrust Economics of Payment Card Interchange
Fees, 73 ANTITRUST L.J. 571, 610 (2006): "A discount for cash and checks is analytically equivalent to a surcharge for
credit". 1418 Scott Schuh et al., Economic Analysis of the 2011 Settlement between the Department of Justice and Credit Card
Networks, 8 J. COMPETITION L. ECON. 1, 22 (2012): “[I]f consumers must pay a surcharge for credit card transactions,
they view the surcharge as a loss and are less likely to use a credit card, whereas if they are offered a discount for using
cash or debit, they view the discount as a gain”.
Adam J. Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, at 48, SSRN (2008), available at
http://ssrn.com/paper=973970: “The endowment effect is a cognitive bias toward preferring assets one currently
possesses more than equivalent assets one does not have”.
316
766. Another cognitive bias is known as the "framing effect". According to the framing effect, the
way things are presented affects the way they are perceived, even if things are identical.1419 A
cash discount is perceived as profit by those who pay cash, but eager cardholders are generally
not offended that cash payers receive the discounts. On the other hand, a surcharge is perceived
as a pecuniary punishment, and cardholders are irritated when merchants surcharge.
767. The official price, where a cash discount is given, is the higher price. The official price at
surcharging merchants is the lower price. Surcharging merchants risk loss of business, when
angry cardholders reveal they have to pay more than the official price. On the other hand,
cardholders are not offended when they pay the price they prepared for, and somebody else
(cash payers) gets discount.1420 Thus, merchants who want to avoid negative feelings from their
card paying customers, tend to avoid surcharging.
11.6. Small Cost Differences Do Not Justify Surcharges
768. The MSF is a few percent at most. Merchants, who want their surcharge to reflect the exact cost
difference between payment instruments, should surcharge less than the MSF, because the
merchants do derive some benefits from cards.1421
It has been argued that merchants routinely ignore small differentials in costs and pass them on
to all of their customers. Making customers internalize small cost differences is not cost
effective. Merchants prefer to give improved services for free to all customers, so the financial
burden is divided between all customers, even though only some customers use the services.
Merchants simply prefer to not deal with minor cost differences, and this is the reason they do
not bother to surcharge.1422
1419 Levitin, id. at 22; Levitin, The Antitrust Super Bowl, supra note 1336, at 280; Adam J. Levitin, Priceless? The
Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321, 1350 (2008) (points at footnote 93 to the
works of Amos Tversky & Nobel prize winner Daniel Kahneman about Rational Choice and the Framing of Decisions) 1420 Levitin, The Antitrust Super Bowl, supra note 1336, at 308-09. 1421 Supra ch. 11.1. 1422 DAVID S. EVANS & RICHARD SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND
BORROWING 131 (2d ed. 2005); David S. Evans, Viewpoint: Bank Interchange Fees Balance Dual Demand, AM.
BANKER, Jan. 26, 2001: “All customers end up paying higher prices as a result of retailers offering parking, tailoring,
escalators, convenient store hours, gift-wrapping, and many other amenities that are used by only some customers.
Retailers don't try to charge for each of these services. So, just as with cards, some consumers pay higher retail prices
without getting the benefit of these freebies”.
Benjamin Klein et al., Competition in Two-Sided Markets: The Antitrust Economics of Payment Card Interchange Fees,
supra note 1417, at 617: “It is common for merchants to incur costs for various services that do not benefit all
customers to the same extent without passing on these differential costs to the particular consumers using the services.
For example, merchants frequently offer without charge a number of amenities that only some customers use, including
parking, gift wrapping, extended store hours, and delivery. Another obvious example is the practice of restaurants to
offer free coffee refills. This presumably creates a usage externality by consumers of multiple cups of coffee and an
317
For example, customers who arrive by bus to a shopping mall, share the costs of free parking
merchants pay for customers who arrive by car; customers who buy clothes already in just the
right size for them, fund the payment for free tailoring services the merchant provides to
customers who buy clothes that require adjustment; customers who do not use gift wrapping
services in a shop that gives this service subsidize other customers' use of this service.
769. Nevertheless, there is a significant distinction between the interchange fee and other small
differences such as the examples given above. The interchange fee is a horizontal restrictive
arrangement between competitors. Other subsidies, if any, result from unilateral decision of
merchants.1423 Therefore subsidy between payment instruments is a matter of antitrust concern,
while other subsidies are not. For example, if all owners of parking lots fixed parking fees for
shoppers, it would constitute a cartel that would very much interest antitrust authorities.1424
11.7. Other Reasons
770. Fear of a being a side to a restrictive arrangement. Merchants may fear that if they all
surcharge at the same rate, it will be perceived as a cartel. This is particularly true for competing
merchants. Evans and Schmalensee describe an incident in Denmark where merchants
surcharged a sum of 0.55 Danish Krona, and the competition authority started to investigate if
the uniform surcharge was a restrictive arrangement.1425
771. Regulation that requires price-marking. If regulation requires merchants to mark prices on
their products, the meaning of surcharging is a multiplicity of price tags. Otherwise, the price
at the cashier might not be the one marked on the product, and merchants can find themselves
in violation of the law.1426 To avoid the need of a multiplicity of price tags merchants simply
waive the surcharge, due to the relative costs and resources involved.
In my opinion, price-marking obligation actually applies only to legal tender. Cash is legal
excess coffee consumption inefficiency can be said to exist. However, such so-called cross-subsidization between
consumers is common throughout the economy and is imposed by firms without any market power.”;
Steven Semeraro, Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who Gains and Who Loses
from Credit Card Payments? Theory and Calibrations, at 54-56 (2012). 1423 Supra ¶ 454. 1424 Supra note 772. 1425 Evans & Schmalensee, The Economics of Interchange Fees and their Regulation, supra note 1330, at 93 n. 59. 1426 Levitin, Priceless? The Social Costs of Credit Card Merchant Restraints, supra note 1418, at 25: “A policy
implementing credit card surcharging or cash discounting would inevitably raise consumer protection issues related to
misleading advertising and inadequate or unclear price disclosure”.
318
tender, but payment cards are not. So, even where regulation requires merchants to mark prices,
there is no duty to mark card prices. Merchants can inform customers about their surcharging
policies in different ways such as advertisements, signs and placards.
772. Lack of knowledge. Some merchants are simply not aware of the fact that they are allowed to
surcharge, give discounts or price-differentiate in other ways. According to Levitin, 3% of
Swedish merchants mentioned the lack of such knowledge as a reason for not surcharging.1427
773. Unique benefits from cards. Some merchants receive special benefits from cards. These
merchants are not good candidates for surcharging. A few non-exhaustive examples are:
773.1 Merchants who operate in a high-risk environment of robberies, theft, or
embezzlement might prefer cards, whose revenue is more difficult to steal;
773.2 Merchants who enjoy cards more than others, such as merchants who sell high value
goods with high profit margins (e.g., jewelry). Cash is not a realistic option for most
of their customers, and checks are risky. In addition, these merchants do not mind
paying a high MSF, as the MSF is minor compared to the profit margin. Such
merchants may have a strong preference for cards.1428
773.3 Merchants who operate online or by phone may find it harder to accept other payment
instruments, and might be willing to pay a high MSF for payment cards without
surcharging. Alternative payment instruments for such merchants such as Pay-Pal or
Bitcoin, which are not as popular as cards, might be even more expensive.1429
All of these merchants can be viewed in contrast to the marginal merchant. They are located
in the upper left edge of the demand curve. Their consumer surplus from cards is high, so it is
unlikely for them to surcharge.
774. Cards might not be more expensive. The underlying assumption when analyzing why
merchants do not surcharge is that the MSF exceeds the benefit from cards. If this assumption
1427 Levitin, The Antitrust Super Bowl, supra note 1336, at 310. 1428 Nicole Jonker, Card Acceptance and Surcharging: The Role of Costs and Competition, 10 REV. Network Econ. 1, 7
(2011): “Merchants selling many or high value products are expected to opt for uniform prices and to be against
surcharging on card payments. For them unit transaction costs fall once they accept card payments”. 1429 Levitin, Priceless? The Economic Costs of Credit Card Merchant Restraints, 55 UCLA L. REV. 1321, 1352 (2008).
319
is not true, then merchants are unlikely to surcharge cards in the first place. They would prefer
instead to surcharge cash or checks.1430
775. In my opinion as we move towards a cashless society the benefits to merchants from cards
increase in comparison to cash and checks. With the addition of all the factors above, merchants
simply prefer not to surcharge cards that yield them benefits. If surcharging is not the cure, are
there any other solutions to the competitive concerns raised by the interchange fee? I will survey
now other alternatives besides surcharging, to the competitive concerns the interchange fee
raises.
12. Alternatives To The Interchange Fee
776. The European commission claims that the interchange fee can be replaced by a rule which is
less restrictive. This stance was affirmed by the European High Court of Justice.1431 Following
are suggested alternatives that have been raised in the literature.
12.1. Bilateral Interchange Fee
777. Some scholars have suggested that there is no need for multilateral interchange fees. Each issuer
can contract bilaterally with each acquirer that acquires cards issued by the issuer. The terms of
the contract of each pair, including the interchange fee, can be set bilaterally.1432
778. One problem with bilateral interchange fees is that full coverage of the market with ex-ante
bilateral interchange fees is not feasible. In a multi-national payment system like Visa or
MasterCard, there are thousands of issuers and acquirers spread all over the world. Ex-ante
contracts between each issuer and acquirer are not practical, and even if they were, transaction
1430 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1345, at 647-48: “[A] merchant could
charge more for cash sales than for credit card sales if the latter saved significant costs”.
Dennis Carlton & S. Alan Frankel, Transaction Costs, Externalities, and "Two Sided" Payment Markets, 2005 COLUM.
BUS. L. REV. 617, 638 (2005): “Suppose Baxter is correct in contending that interchange fees are required to enable
merchants to charge a lower effective price to credit card customers. In such a case, merchants would not require a no-
surcharge rule-a rule preventing merchants from charging a higher price for credit cards because absent transaction
costs, merchants would want to charge a lower, not higher, price to credit card customers”. 1431 Supra note 1033. 1432 NICHOLAS ECONOMIDES, COMPETITION POLICY ISSUES IN THE CONSUMER PAYMENTS INDUSTRY, IN MOVING
MONEY: THE FUTURE OF CONSUMER PAYMENT 113, 122 (R. Litan & M. Baily eds., 2009): “To reduce the interchange
fee, I propose that the network no longer set the maximum interchange fee. Let it instead be determined in bilateral
negotiations between an issuer and an acquirer, starting from a zero fee basis (par)”.
David Balto, The Problem of Interchange Fees: Costs without Benefits?, E.C.L.R 215, 219 (2000): “What of the
transaction costs argument? First, in countries where there are relatively few firms in a market the savings in
transactions costs will not be substantial and the argument can not support interchange fees. Secondly, even where there
are a larger number of firms there may be greater opportunity for interchange fees to be replaced by bilateral
negotiations”.
320
costs would be huge.1433
Proponents of the bilateral interchange fee have a counterargument. The aggregate market share
of the main issuers and acquirers covers most of the market. Interchange fee in the bulk of
transactions can be achieved through a relatively small number of agreements. A default
interchange fee would be required for the residual market share which is not covered by bilateral
agreements. The international organization might determine this default fee. Another option is
that small issuers and acquirers join one of the main bilateral agreements.1434
This counterargument is not convincing. Dozens of agreements are still required even when the
number of issuers and acquirers is relatively small. Number of required agreements is n*(n-1)/2
where n is the number of firms. There is no need for hundreds or thousands of firms in order to
make transaction costs prohibitively high.1435
779. In addition, bilateral agreements are doomed to fail covering all transactions. Even if most
issuers and acquirers will connect bilaterally, a transaction in which there is no prior contract
between an acquirer and the issuer will surely occur. Full coverage of all transactions in a
country with many issuers and acquirers is problematic, and certainly the worldwide market
cannot be covered through bilateral agreements.
780. Theoretically, Israel could be a very good candidate for bilateral agreements. Only three
bilateral agreements would be required to replace the Trio Agreement and cover the internal
market. International transactions such as tourist transactions would nevertheless, still require
a default interchange fee.
However, in my view, even when the number of issuers and acquirers is small, and bilateral
agreements are feasible, bilateral fees agreements do not abate the competitive concerns.
The concern that interchange fee, which would be the product of every bilateral agreement
separately, would still be set at a higher than optimal level, exists even when it is set by pairs
of issuers and acquirers. The inherent problem of the interchange fee remains all the more in
1433 Supra ¶¶ 85-86; see also Robert M. Hunt, An Introduction to the Economics of Payment Card Networks, 2 REV.
NETWORK ECON. 80, 85 (2003): "Setting the fee at the network level eliminates costs associated with bargaining
between individual card issuers and acquirers and uncertainty about the actual costs of a card transaction". 1434 Supra ¶ 614. 1435 Prager et al., Interchange Fees and Payment Card Networks, supra note 1350, at 46: “However, in a country with
thousands of banks, the number of bilateral arrangements required in a four-party system could be prohibitively high”.
321
bilateral agreements also: as long as the acquirer has an interest on the issuing side, the acquirer
will agree to pay - in a bilateral agreement - a high interchange fee, knowing that in its role as
issuer, it will earn from this high fee. The bilateral negotiation is artificial. The amount the
acquirer pays is borne by its customers, the merchants, but the profit it retains from the
interchange fee on the issuing side remains with the pair of issuers / acquirers.
This would be the case even if the market consisted of only two firms, as long as both of them
operated in issuance and acquiring. As more issuers and acquirers join, bilateral agreements
between each pair would still result in as high as possible a fee.
781. Contrary to early scholars, interchange fee is not a transfer fee from acquirers to issuers. It is a
source of revenue and profit from merchants to issuers. Interchange fees increase the revenue
and profits of issuers.
It is wrong to assume that if firms have a small market share on the issuing side and a large
market share on the acquiring side, these firms would demand to pay (in bilateral and
multilateral negotiations) low interchange fees. The right way to look at this is that no acquirer
“suffers” from having to pay an interchange fee, because this fee is not borne by it but by its
merchant customers. On the other hand, all firms enjoy the interchange fee, according to their
market share on the issuing side.1436 Interchange fee inflates the profit pie for all issuers. Even
small issuers enjoy a larger share of the larger pie, according to their market share on the issuing
side.1437
For example if there is one firm which has a 10% market share in issuing and another that has
a 90% market share, and they negotiate the interchange fee bilaterally, then it is incorrect to
assume that the 10% firm will try to lower the interchange fee it pays in 90% of the transactions
it acquires. It is correct, instead, to assume that both firms enjoy an increase in the interchange
fee according to their market shares in the issuing side. One firm enjoys 10% of any increase
in the revenue pie and the other enjoys 90%. They both have incentives to increase the pie.
782. Moreover, as I have showed above, competition for cardholders motivates issuers not to settle
for low interchange fee, even in bilateral agreements. Low interchange fee limits its receiver
1436 T-111/08 MasterCard v. Comm'n, para 254 (May 24, 2012): "[V]irtually all banks engaged in the acquiring
business were also card issuers and benefited, to that extent, from the MIF.”; Comp/34.579 European Comm'n
MasterCard Decision, supra note 570, para. 385. 1437 Supra ¶ 35.
322
from offering attractive cards.1438 No issuer has any incentive to ask for a lower interchange fee
than its competitors. On the contrary, a higher interchange fee would enable the issuer to offer
more rewards to its cardholders. Therefore, bilateral negotiations will not yield more
competitive interchange fees than multilateral interchange fee.1439 On the contrary – it would
be a race upwards. Without cutting the connection between issuers and acquirers, as I propose
in chapter 0, even a default interchange fee of zero but permitting the interchange fee to be set
bilaterally, will yield higher than optimal interchange fees.
783. Another reason which in my view negates bilateral agreements is that the interchange fee
imposes a tax on card transactions. Taxes should be at an even rate for all. There is no reason
to let issuers with higher bargaining power to extract a higher interchange fee in bilateral
agreements. However, variety of interchange fees is exactly the result of using bilateral
agreements.
12.2. Zero Interchange Fee
784. Some scholars have suggested banning interchange fees. The idea is that clearance of
transactions would be made at par, like checks.1440 King & Maddock even propose to set the
MSF on zero.1441 The European commission also considers banning interchange fees, especially
for debit, as an option.1442
785. The discussion on banning interchange fees fascinatingly resembles trials that took place about
100 years ago in the United States, regarding the interchange fees in checks (see supra 865).
Before the 20th century, clearance of checks in the U.S. was not at par, as we are used today.
Par clearance was performed only at the counter of the issuing bank. Whenever a check was
presented for withdrawal not at the counter of the issuing bank, the acquiring bank (in which
1438 Supra ¶ 298. 1439 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1345, at 642: “it is not clear that
collectively set interchange fees resolve the problem, rather than transferring the exercise of market power from the
individual issuer to the network comprised of issuers. To that extent, bilateral negotiations may not be any less practical
than collectively set interchange fees”. 1440 See Alan S. Frankel, Monopoly and Competition in the Supply and Exchange of Money 66 ANTITRUST L.J. 313, 336
(1998): “Baxter's argument that a zero exchange charge is inefficient is inconsistent with the results of universal par
collection of checks”;
Leinonen, Debit Card Interchange Fees, supra note 773, at 9: “This paper concludes that maintaining a zero
interchange fee and increasing the cost transparency would promote both competition and efficiency in retail payments,
as compared to a situation with high positive interchange fees.”; Balto, supra note 1432, 223 (2000). 1441 Stephen King & Rodney Maddock, Direct Charging of Card Fees (Monash University Working Paper, May 2017) 1442 COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT, SWD(2013) 288 Final, at 184 (24.7.2013): “The
option of banning IFs for debit cards is considered as it appears that a debit card without any IF would be viable from a
commercial perspective without necessarily raising the costs of current accounts”. See also id. at 185, sub-option 15.2
ans at 190 sub-option 15.4.
323
the check was presented), had to pay interchange fee to assignees of the issuing bank, for taking
the check and presenting it at the counter of the issuing bank. In olden times checks were
actually transferred in carriages to the issuing banks. The interchange fee was negotiated
bilaterally. Rural banks therefore had (market) power to charge higher interchange fees.1443
The development of clearinghouses enabled checks to be cleared, at many places and not only
at the counters of the issuing banks. Clearinghouses also had multilateral interchange fees. As
the market became more elaborate interchange fee declined, until eventually the Federal Bank
intervened and forced the final stage to a zero interchange fee. Some banks opposed this, which
led to bitter check interchange fee trials. Checks today are all alike cleared at par.1444
786. The check trials inspire my second innovation, as they resemble the proceedings we experience
today, a century later, with respect to interchange fees in payment cards. The banks complained
then, as they threaten now, that eliminating interchange fees would impede their stability. This
did not happen with checks, and the banking system operates successfully at par, with no
interchange fees and with costs borne on the direct sides to the checks, the payer and the
payee.1445
787. However, absolute negation of interchange fee – in the form of zero interchange fee - is not
necessarily the right methodological solution. Indeed, under a zero interchange fee, there is no
restrictive arrangement, but theoretically this can have a negative effect on networks, especially
nascent networks. When a new issuer tries to penetrate the market, this issuer will need an
interchange fee to lower its cardholder fees and establish a critical mass of cardholders.
In mature networks a rule of zero interchange fee, is appealing, provided that cardholders have
sufficient benefits from card usage (Bc≥0), and issuers are able to cover their costs and profits
1443 For expansion see infra ch. 14.1. 1444 Id. 1445 ALBERT FOER, ELECTRONIC PAYMENT SYSTEMS AND INTERCHANGE FEES: BREAKING THE LOG JAM ON SOLUTIONS
TO MARKET POWER, Am. Antitrust Institute, at 21 (2010): “There is a long history in this country relating to so-called
check “exchange fees” that in the past made the use of checks difficult and expensive. Supra-competitive check
exchange fees, imposed on merchants by some banks with market power interfered with commerce, so Congress
authorized the Fed. Res. at the time of its formation to abolish them and provide a system for all checks to exchange at
par – the system with which we are all familiar today. Although some bankers at that time loudly complained, the
usefulness of checks as a means of payment was not destroyed as a result of the system of par collection put into
operation by the Fed. On the contrary, more than eight decades after the Fed began its efforts to ‘impose’ par collection,
checking accounts now are offered by virtually all financial institutions, whether they are net payers or net recipients in
the check settlement process . . . . Costs imposed by customers drawing checks or depositing checks, including costs
associated with membership in and use of clearinghouses, are recovered through fees charged directly to those
customers”.
324
from the direct channels of cardholders' income. Zero interchange fee is a simple rule and cost
effective to implement, provided the network is not impeded. In fact, payment card networks
with zero interchange fees, manage to operate successfully.1446
788. Zero interchange fees would encourage transparency, minimize cross-subsidization between
payment instruments, and force issuers and acquirers to charge fees in a transparent manner.1447
Zero interchange fee is in line with zero termination fee, known as "bill and keep" in
telecommunications,1448 all the more if we accept the "need for consensus" approach in
termination fee and interchange fee, as Rochet & Tirole suggest.1449 Zero interchange fees
would also have a positive effect by reducing "wasteful competition" (i.e., redundant rewards)
or "cozy cartels" (using the interchange fee as a disguise for profits).1450
A caveat is that any attempt to lower the interchange fee towards zero should be done
gradually.1451 As Balto warned, the effects on reduction in the interchange fee on networks
should be examined step by step.1452
12.3. Split
789. Semeraro raised the idea that big issuers should operate as closed networks (without interchange
fees) and acquire their own cards only. In the U.S., the closed networks which would be created
according to his suggestion consist of Citibank, Chase, Bank of America, Capital One and Wells
Fargo.1453 Small issuers may be allowed to cooperate in a multilateral cross-acquiring
1446 Comp/34.579 European Comm'n MasterCard Decision, supra note 570, paras. 562-608; and at para. 751: “[S]everal
payment schemes in the European Economic Area have successfully been operating without a MIF for a long time.
These Schemes have been established between 1979 and 1992 and they are not merely viable but indeed successful.";
Proposal for a Regulation on Interchange Fees for Card-Based Payment Transactions, EXPLANATORY MEMORANDUM,
COM(2013)550 Final 2013/0265 (Cod), at 10-11(Aug. 5, 2013): “Denmark has one of the highest card usage rates in
the EU at 216 transactions per capita with a zero-Interchange Fee debit scheme. This is also true of international
schemes: in Switzerland Maestro has no interchange fee and is the main debit card system… In terms of viability, a
debit card scheme without any IF seems to be perfectly viable from a commercial perspective without raising the costs
of current accounts for consumers”. See also supra n. 187. 1447 Leinonen, Debit Card Interchange Fees, supra note 773, at 27: “[F]rom the competition point of view, there is
another interesting MIF level, that is, the zero-level. With MIFs set to zero, the acquiring side will set charges
independently of the issuing side and card transactions would therefore be processed at par in the payment networks.
At-par acquiring would create pressure for more transparent cardholder pricing and would reduce cross subsidization
effects”. 1448 Patrick DeGraba, Efficient Inter-Carrier Compensation for Competing Networks when Customers Share the Value
of a Call, (2002): "I concentrate on bill and keep, not because a zero inter-carrier compensation rate is likely to give rise
to theoretically optimal usage levels, but because the optimal rate may be very close to zero… Thus, as a policy matter,
society may be better off accepting the small usage distortions of bill and keep". 1449 Supra ¶455 1450 Supra ¶ 479. 1451 AT 4630/01 Leumi v. General Director, para. 46 (Aug. 31, 2006) ("The Methodology Decision"). 1452 Supra ¶ 469. 1453 Steven Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, 14 STAN. J. L.
BUS. & FIN. 343, 380 n. 159 (2009).
325
agreement and charge interchange fees. The idea is to increase the number of payment platforms
and to create platform competition, so merchants could choose to accept cards of cheap
networks, and reject cards of expensive networks.
Technology today is advanced enough to enable merchants to multihome easily. One POS is
capable to process cards of several networks. In the past, multihoming forced merchants to have
different acquiring equipment for each network. Today one terminal can connect with several
platforms at low cost and on a common single infrastructure. This makes the proposal
technologically feasible.
However, split requires separate contractual relationship between each acquirer and all
merchants. Although technologically possible, split is only a partial alternative to a multilateral
interchange fee. Similar to the problem of bilateral arrangements, despite large transaction
costs, full market coverage would not be achieved. For example, split is not an alternative for
international transactions. It cannot be expected from each issuer worldwide to connect with
each merchant. International transactions would still have to be performed under default
interchange fees set by the networks, so even under a split, the networks will include
interchange fees.
790. Semeraro argues that splitting open networks into closed networks would enlarge the number
of competing players, with no need for new entrants. Big issuers would enjoy economies of
scale which would enable them to offer merchants a low MSF. Inefficient issuers would be
unable to compete, consistent with competition law.1454 Competition would push the entire
market towards competitive fees.1455
However, platform competition in payment card networks, especially when cardholders tend to
single home, creates distorted equilibrium. Cardholder fees are reduced to negative (rewards).
Merchant fund all costs.1456 Nothing prevents this grim result here. In addition, under a split
regime, each issuer is a monopoly regarding the acquiring of its cards. When there are only a
few players, split actually means an oligopoly regime. Large issuers would be able to use their
market power to charge higher MSF, and not lower.1457 Empirical results, at least in Israel,
1454 See, e.g., Freeman v. San Diego Ass’n of Realtors, 322 F.3d 1133, 1154 (9th Cir. 2003). 1455 Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, supra note 1453, at 379-
82; Semeraro, Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 997-1000. 1456 Supra ch. 6.6.2. 1457 Supra ch. 6.6.3.
326
confirm that under split, MSFs were actually higher. Until AlphaCard emerged, the market was
split between Isracard and CAL. Only when AlphaCard entered the market and the Visa card
firms started to operate as an open network, the MSF sharply decreased.1458
Semeraro is actually proposing competition between closed networks. But in closed networks
the fees are higher. Isracard was declared a monopoly when it was the only acquirer of its
proprietary cards, because of the high MSF it charged, even though it was in competition with
the Visa companies. Diners and American Express each charge a high MSF.
12.4. Multi-Cards
791. Frankel proposed an interesting idea of combining Semeraro's split with multihoming
cardholders (and merchants), thus placing the merchant (instead of the customer) in the driver's
seat.1459 The idea is letting the merchant, and not the cardholder, to choose the network through
which the transaction would be processed. Competition becomes for merchants, with lower
MSF. The proposal is to require networks to issue “multi-cards”.
The idea is that a cardholder would not have to carry separate cards. Her/his cards are going to
be unified to one "multi-card". The merchant would choose the routing option, including the
interchange fee, unless the cardholder demands otherwise, but then the merchant can surcharge.
Multi-cards bear the logos of several networks, e.g., MasterCard and Visa, and must be
interoperable with several networks simultaneously. Multi-cards enable competition between
several networks on the same card. The side that was previously exploited, i.e., the merchant,
is given the bargaining power. Merchants could then choose the cheapest network and route the
transaction through it, by using the interoperability feature of multi-bugging cards.1460
1458 C.A 2616/03 Isracard v Howard Rice, 59(5), 701 (2006); AT 4630/01 Leumi v. General Director, at 31 (Aug. 31,
2006) ("The Methodology Decision"). 1459 Compare supra ¶ 284. 1460 Fumiko Hayashi, The Economics of Payment Card Fee Structure: Policy Considerations of Payment Card
Rewards, at 9 (FRB of Kansas City Working Paper No. 08-08. 2008): “[M]andating a single card to carry multiple card
networks may allow merchants to influence their customers’ payment choice toward less expensive payment methods
for the merchants.”;
Éva Keszy-Harmath et al., The Role of the Interchange Fee in Card Payment Systems, at 21 (MNB Occasional papers
96, 2012): “[I]f payment cards would be so-called multi-branded cards. In this case, merchants and their acquirer banks
would freely choose the network (brand) they wish to use for the settlement of a given transaction, and the payable
interchange fee would be set by the network (card company) conducting the given settlement.”; Frankel, Towards,
supra note 811, at 35: “[I]t is possible that a merchant could still accept many or all card transactions, irrespective of
brand, using one network – if cards were interoperable across networks and issuers accepted transactions presented to
them which originated over any network”.
327
792. Prager notes that multi-cards exist in the U.S PIN debit market.1461 Prager explains that multi-
cards developed due to geographical limitations of PIN debit networks. When geographical
coverage of individual PIN debit networks was limited, multi-cards, i.e., ascription of the card
to several networks, enabled the card to be accepted by more merchants. When networks
expanded their geographical coverage, multi-cards enabled merchants to choose the cheapest
routing option between the card's brands. This increased competition between networks.
As explained in chapter 8.3.10, a major reform in the Durbin Amendment was the "routing
reform". Issuers must offer merchants (via acquirers) at least two routing options on unaffiliated
networks’ infrastructure (for expansion see supra 644). The routing reform eliminated
exclusive routing arrangements between issuers and networks that were infrastructure owners
(supra 644645). In Israel, the Shtrum committee also considered erection of another routing
option.1462 However, until today (March 2018) this initiative was not developed.
Contrary to the debit market, in the U.S. credit card market the situation is opposite. Credit
cards networks prohibit issuers from assimilating into one card multi brands.1463
793. This idea of multi-cards was adopted in Europe in the Green Paper from 2012.1464 Article 8 of
the European Interchange fee Directive from September 2015, not only permits but also
encourages multi cards. The Article prohibits networks' rules that prevent co-badging.1465
1461 Prager et al., Interchange Fees and Payment Card Networks, supra note 1350, at 27: “[T]he differential between
PIN and signature debit interchange fees may reflect more intense competition among PIN debit networks due to the
presence of multiple brands on a given card. In the early days of PIN debit, each network covered a fairly small
geographic area, and many banks sought to offer their customers wider merchant acceptance of their PIN debit cards by
“multi-bugging” the cards (i.e., issuing cards that bore the logos of and could be used on multiple PIN networks). Over
time, individual networks expanded their geographic coverage through a combination of mergers and organic growth,
and in some cases, networks’ geographic regions began to overlap one another. In this environment, merchant acquirers
or their processors could often choose which one of the networks whose brands appeared on a card would carry the
transaction. Merchants generally prefer that their acquirers route PIN debit transactions over the network with the
lowest interchange fee, resulting in direct price competition among PIN debit networks. 1462 Supra note 709, at 64 note 64. 1463 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1345, at 644: “Under network rules,
banks may not issue credit cards carrying both the MasterCard and Visa (or other) branded networks”. 1464 European Commission, Green Paper, Towards an Integrated European Market for Card, Internet and Mobile
Payments, at 9 para. 4.1.3, COM (2011) 941 final (Jan. 11, 2012): “Co-badging combines different payment brands on
the same card or device. Nowadays, the most promising way for new entrant schemes to access the market could be to
convince issuing PSPs to co-badge their payment cards that carry an existing (international) scheme’s brand with the
new entrant’s brand. This would allow consumers to choose between brands when paying (provided the merchant
accepts both brands), taking into consideration possible bonuses from their issuing PSP (air miles, etc.) and the possible
incentives from the merchant (surcharging, rebating, steering).”; See also EU, Proposal for a Regulation on Interchange
Fees, supra note 1042, Article 8. 1465 Regulation (EU) 2015/751 of 29 April 2015 on Interchange Fees for Card-Based Payment Transactions, O.J L
123/1, Article 8.1 (19.5.15): “Any payment card scheme rules and rules in licensing agreements or measures of
equivalent effect that hinder or prevent an issuer from co-badging two or more different payment brands or payment
applications on a card-based payment instrument shall be prohibited”.
328
Customers may require co-badging of two or more different payment brands on one card,
provided that such a service is offered by the issuer.1466 Sections 3-5 of the Article 8 prohibit
issuers or networks or infrastructures from discriminating between the different payment
instruments that a multi-card combines. The most interesting section of Article 8 is the last,
section 6. It actually transfers the power to choose the payment instrument from the customer
to the merchant, unless the customer objects:
6. Payment card schemes, issuers, acquirers, processing entities and other technical
service providers shall not insert automatic mechanisms, software or devices on
the payment instrument or at equipment applied at the point of sale which limit the
choice of payment brand or payment application, or both, by the payer or the
payee when using a co-badged payment instrument. Payees shall retain the option of installing automatic mechanisms in the equipment
used at the point of sale which make a priority selection of a particular payment
brand or payment application but payees shall not prevent the payer from
overriding such an automatic priority selection made by the payee in its equipment
for the categories of cards or related payment instruments accepted by the
payee.1467
794. It is interesting to see, if in coming years, multi cards will become wide-spread, if merchants
will install technologies that automatically choose the cheapest payment instrument which the
card incorporates, if issuers will fight back by offering rewards to expensive cards, or if they
will cooperate by offering low interchange fees. If the analogy to checks holds, the increasing
options of merchants might push interchange fees downwards.1468
795. In my view, multi-card is a competitive idea, but which is facing high obstacles. Cardholders
do not have incentives to search for a “second” issuer, let alone a cheap issuer, that would be a
co-issuer of another issuer’s card. This is the interest of merchants, not cardholders. Issuers also
would not encourage multi-cards. Thus, no competitive force promotes their dispersion. In
addition, issuers do not tend to issue cards that do not carry sufficient interchange fees for them,
1466 id. Article 8.2: “[C]onsumer may require two or more different payment brands on a card-based payment instrument
provided that such a service is offered by the payment service provider”. 1467 Id. 1468 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1345, at 643: “The key factor that led
to the competitive elimination of interchange fees in currency and check markets was the ability of merchants and their
banks to choose the method used to transport financial claims back to the issuing bank for redemption. The ability of
acquirers to use competing transportation systems (and correspondent banks) led issuers to abandon their interchange
fees altogether and join par collection clearinghouses. If merchants, who typically must pay interchange fees today, had
the ability to choose the payment network over which to process the transaction (and issuers for legal or competitive
reasons continued to participate in multiple networks), the competitive result might be a par collection system, or at the
very least a system with significantly lower interchange fees. Just as an issuer tends to have an incentive to choose a
network with a higher interchange fee in the current system, a merchant would have an incentive to choose a lower
interchange fee if it had a choice. It is the lack of real competition and choice for those paying the fees that leads
networks to charge merchants (and therefore their customers) relatively high interchange fees in the current system”.
329
and I do not think that the option to issue on a multi-card would change this. I hope to be wrong
and see that multi-cards thrive.
Part IV – New Proposals
13. Novelty #1 – Structural Separation
796. Thus far I have tried to shed light on every aspect of the interchange fee: origin, history,
theoretical models, competitive justifications, concerns and alternatives. Now it is the time to
introduce two novelties that in my view, if adopted, will reduce substantially the enormous
regulatory resources invested in the supervision of the interchange fee.
My first proposal is to require dissolution, in mature networks, between issuers and acquirers.
Financial institutions will have to choose whether to operate on the issuing side or on the
acquiring side (but not on both).
797. Historically, networks evolved in a way that acquirers were always issuers.1469 This structure
was formally anchored in the bylaws of Visa and MasterCard, in the “No Acquiring Without
Issuing” (“NAWI”) rule. The networks claimed the rule was intended to promote the
development of the networks and make it more attractive to merchants, by encouraging card
issuing side.1470 The NAWI rule prevented networks’ members from operating only in acquiring
activity.1471 The NAWI rule stipulated that before becoming acquirers, banks had to issue a
minimum number of cards.1472
1469 Comp/34.579 European Comm'n MasterCard Decision, supra note 570, para. 461: “Acquiring banks are typically
also Issuers for historic reasons518”; and at note 518: “MasterCard used to oblige acquirers to issue cards, as well, until
the abolution of the so-called “No acquiring without issuing rule” in 2005. This is why today most acquirers also issue
cards”. 1470 Pierre Bos, International Scrutiny of Payment Card Systems, 73 ANTITRUST L.J. 739, 746 (2006): "Visa claimed the
rule was intended to promote the development of the card system by encouraging card issuing, which it claimed would
make the system more attractive for merchants."; see also infra note 1494. 1471 COMP/29.373 − Visa International 2001/782/EC, para 18, O. J. L 293 (2001): "Although according to the Visa
rules, principal members are formally obliged to issue cards and to acquire merchants, in practice Visa does not oblige
its members to acquire. However, if they want to acquire merchants for card acceptance, before starting acquiring
activities in a particular country the member has to issue a reasonable number of cards";
Ann Borestam & Heiko Schmiedel, Interchange Fees in Payment Cards, ECB Occasional Paper Series 131, at 25
(2011): “The “no acquiring without issuing” rule, if applicable, prevents members of schemes from pursuing only
acquiring activity, as members are also required to be active in card issuance”. 1472 Fumiko Hayashi & Stuart E. Weiner, Interchange Fees in Australia the U.K and the United States: Matching
Theory and Practice, FRB KANSAS ECON. REV. 75, 77 (2006): “Net issuer rules require merchant acquiring banks to
issue a minimum level of cards in order to participate on the acquiring side of the market”.
330
798. Since the beginning of the 2000s the NAWI rule was canceled in most jurisdictions.
Nevertheless, although this rule is de-jure not valid anymore, de-facto it still prevails. My
proposal is to make the cancelation of the NAWI rule mandatory and binding, and not only a
mere possibility which de-facto does not exist. The reasons for the continuance of the NAWI
rule (although in a more delicate way), despite its explicit cancelation, is a good introduction to
my proposal.
13.1. The De Facto Prevalence Of The NAWI Rule
Israel
799. In Israel, in November 2007 the Antitrust Tribunal held that independent acquirers (i.e.,
acquirers that are not related to the issuing side) could join the networks.1473 This would seem
to overcome any NAWI rule, but jumping to this conclusion is erroneous, since independent
acquirers do not exist in Israel. There are three main reasons for that, as explained herein:
799.1 First, according to the Israeli Banking Law, acquirers need a banking license from
the Banking Commissioner.1474 Activities of acquirers involve the administration of
merchants’ accounts and the provision of credit to merchants. Pursuant to banking
laws, this suffices for requiring acquirers to obtain a license from the Bank of Israel.
On December 31, 2013 Bank of Israel published a draft process for receiving an
acquiring license.1475 The draft was amended several times.1476 In May 2016, Bank
of Israel promulgated Instruction 472 regarding acquiring payment cards.1477 The
process to receive acquiring license is purportedly designed for non-bank acquirers
as well. Initial high equity demand and capital adequacy that only banks possess,
were modified to accommodate non-bank entrants.1478 However, the requirements of
the central bank still include, inter alia, high financial strength, reporting duties, high
security and information technology standards, limitations on fields of operation,
limitations on control block and on holdings above 5% of shares. In addition, a new
1473 AT 610/06 Leumi v. Antitrust General Director, Antitrust 5000840, sec. 3 (Nov. 11, 2007); See also supra ¶ 669. 1474 Section 36(10) and (11) of the Banking Law (licensing) 1981 1475 Bank of Israel, Process of Receiving Acquirer's License, (Dec. 31, 2013). 1476 See, e.g., Bank of Israel, Draft for Comments, Process for Granting Acquiring License, (Dec. 17, 2015). 1477 Bank of Israel, Communication 2498-06-ח, Acquiring Payment Cards (Banking Proper Procedure, Instruction 472),
(May 1, 2016). 1478 Bank of Israel, Draft Process for Acquiring License, supra note 1476, sec.3.2.
331
acquirer must collect transactions through EMV terminals, which can accept
contactless transactions, even though most merchants in Israel do not use such
terminals.
The result is that no non-bank acquirer received an acquiring license. Firms that
operate on the acquiring side, and provide part or all of the acquiring services, must
ultimately 'hide' behind a bank that has an acquiring license and acts as the official
acquirer.1479
799.2 The primary preference of banks is to operate on the issuing side, which is much
more profitable, mainly because of the interchange fee.1480 The issuing side would
remain more profitable, whether payment card companies are bank-controlled or
separated from banks (due to the expected divestiture of Leumi-Card and Isracard
from their controlling banks1481), mainly because the windfall of interchange fees to
the issuing side automatically tilts the profit of the issuing side to be higher than the
profit of the acquiring side, regardless of issuers' or acquirers' ownership. For
example, in Israel, the interchange fee in 2016 yielded income of almost NIS 2
Billion to the issuing side, out of NIS 2.9 billion in total, as opposed to only NIS 0.95
billion of fee income to the acquiring side.1482 In addition, interest income from
cardholders is a bigger source of income than interest from merchants (NIS 480
million compared to NIS 70 million in 2016).1483 Other factors that cause the
1479 Ann Kjos, The Merchant-Acquiring Side of the Payment Card Industry: Structure, Operations, and Challenges, at 8
(F.R.B Phil' Discussion Paper 2007): “[D]espite the sometimes complex chain of service providers, they are always
linked by contracts to the network member bank”. 1480 EC, INTERIM REPORT, supra note 278, at iv: "For both debit and credit cards, issuing is significantly more profitable
than acquiring. Although this general finding was to be anticipated, the difference in relative profitability is striking.";
Barbara Pacheco & Richard Sullivan, Interchange Fees in Credit and Debit Card Markets: What Role for Public
Authorities?, 1 FED. RES. BANK KANSAS ECON. REV. 87 (2006): "[I]n the United States, most agree that networks place
greater emphasis on issuer profits than acquirer profits and that acquirers pass along more of any changes in fees to their
customers compared to issuers."; aee also id. at 76: “The issuing of credit cards is very profitable”; Semeraro, Credit
Cards Interchange Fees: Three Decades of Antitrust Uncertainty, supra note 64, at 973; DAVID S. EVANS & RICHARD
SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND BORROWING 16, 215, 237 (2d ed.
2005); See also supra ¶ 96 (issuing is more profitable than the acquiring side), ¶ 89 (interchange fees are determined
according to the interests of issuers, even though they are also acquirers, or directly by the networks (Visa and
MasterCard) which favor the interests of issuers); and infra note1506 (acquirer banks get fewer votes in the Visa and
MasterCard associations than issuing banks, and there is far less balance or representation of the interests of merchants
in the setting of the interchange fee)”. 1481 Section 11b(b) to the Bankin Law (licensing) amendment 23 (2017). See also infra ¶ 847. 1482 Bank of Israel, Information on the banking system, chapter J payment cards, Tables x-3.1, x-3.2, x-13, available at http://www.boi.org.il/he/BankingSupervision/Data/Pages/DataTable.aspx?Chapter=%D7%A4%D7%A8%D7%A7+%D7%99%27+-
+%D7%9B%D7%A8%D7%98%D7%99%D7%A1%D7%99+%D7%90%D7%A9%D7%A8%D7%90%D7%99&Years=2012-2016 (last entry July 24, 2017). 1483 Id.
332
acquiring side to be more competitive is homogeneity and sophisticated customers,
compared to the issuing market.1484 Bottom line is that the issuing side is much more
attractive and profitable than the acquiring side.1485
799.3 Second, until 2017, section 23 of the Banking Law (licensing) (1981), determined
that an infrastructure firm, such as SHVA, could grant its services only to banks. This
requirement constituted a major entry barrier for non-bank independent acquirers,
which could not get access to the payment card infrastructure. Both the Antitrust
Authority and Bank of Israel noted that section 23 was an obstacle to entry of
independent acquirers.1486 Europe1487 and the U.S.1488 faced similar entry barriers.
Acquiring licenses and permissions to access the payment infrastructures were
traditionally granted only to financial institutions.
Apparently, Section 23 of the Banking Law was not at the focus of the Antitrust
Authority until 2014. In 2012 the Antitrust Authority approved the existence and
operation of SHVA, by noting that according to the above mentioned Tribunal
decision (dated November 2007), independent acquirers could supposedly enter the
market, but the Antitrust Authority did not mention section 23 of the Banking Law
1484 Supra ¶ 97. 1485 See also supra ¶ 98. 1486 IAA, ENHANCEMENT OF EFFICIENCY & COMPETITION IN THE PAYMENT CARD SECTOR (FINAL REPORT), supra note
1387, at 11; BANK OF ISRAEL, RECOMMENDATIONS FOR ENHANCEMENT OF COMPETITION IN THE PAYMENT CARD
SECTOR, FINAL REPORT, at 41 (Feb. 2015). 1487 REPORT ON THE RETAIL BANKING SECTOR INQUIRY [COM(2007) 33 Final], supra note 193, para. 18: “Access and
governance arrangements - 18. In international networks (Visa and MasterCard), as well as in national card payment
systems in Belgium, Denmark, Finland, France, Hungary, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain,
membership rules reserve the right of issuing and acquiring to credit and/or financial institutions, or to an entity
under direct control of such institutions. While it could be argued that this pre-condition is justified for supervisory
or financial stability reasons, it limits participation of merchants and processors in issuing and acquiring, hence
undermining the intra-network competition in these countries. Similar concerns appear with respect to access to
infrastructures . In Ireland, the Netherlands and Portugal the national system rules require the local presence of a foreign
entrant, by means of establishment of a local branch and/or a subsidiary. This requirement increases the costs of foreign
entry, which may limit the intra-network competition”; see also id. para. 26: “The ‘need to be a bank’ requirement:
Most clearing systems admit only banks. This scrutiny may help guaranteeing financial stability but could hinder the
entry of non-bank players in payment systems, in particular if there were other efficient ways to ensure the financial
reliability.”;
EC, INTERIM REPORT, supra note 278, at V: “Some payment system membership requirements may hinder non-banks
from domestic acquiring and new entrants from cross-border acquiring. Rules which may constitute barriers include
requirements to be a financial institution and to have a local establishment. About half of the domestic card
payment systems in the EU require issuers and acquirers to be financial institutions. Some systems also require banks to
establish a physical presence”. 1488 Andrew Kahr, Why Allow Only Banks to Issue Credit Cards? AM. BANKER, Aug. 22, 2012
http://www.americanbanker.com/bankthink/why-allow-only-banks-to-issue-credit-cards-1052029-1.html : “For years,
federal deposit insurance has been a prerequisite for issuing credit cards... Visa and MasterCard have permitted
credit card issuance on their networks only by institutions with federal deposit insurance from the FDIC or
NCUA”.
333
that thwarted this.1489 Eventually the outdated Section 23 was amended, as the
Antitrust Authority and Bank of Israel have recommended,1490 in the Banking Law
(licensing) amendment #23 (2017), that added section 23(b). This amendment curbed
the exclusivity of infrastructure firm that operates a payment system. According to
the amendment such firm can grant its services to every person.
799.4 Third, MasterCard and Visa grant acquiring licenses only to licensed financial
entities.1491 As already explained, the license demand poses a regulatory entry barrier
for non-banks, and thus for independent acquirers. Until today (October 2016) only
banks are licensees. The primary interest of licensee banks is to operate on the more
profitable issuing side. Even if interchange fees would reduce, it is reasonable to
assume that the issuing side would remain more attractive as it is considered less
competitive.1492
800. The three obstacles mentioned above reduced the possibility of independent acquirers to
operate. However, after the amendment of section 23 to the Banking Law (Licensing(, it is
feasible that a non-bank acquirer would manage to obtain an acquiring license. Under the
current situation, in which all acquirers are also issuers, a new entry would not be enough, as
this would be the exception and not the rule. All other acquirers would still be issuers. The
determination of the interchange fee would remain in the hands of acquirers which are also
issuers. Therefore, as explained below, my proposal is not only to obligate acquirers to be
independent, but also to give independent acquirers, and only them, the bargaining power to
determine the interchange fee they pay.1493
Europe
801. In Europe, the NAWI rule was initially cleared in 2001 by the European Commission.1494 In the
following years the commission reexamined its position. Before the commission promulgated
1489 Exemption with Conditions to Five Banks in re: SHVA, text near n. 11, Antitrust 5001953 (May 22, 2012). 1490 Supra note 1486. 1491 European Financial Services Advisory Group (EFSAG), Acquiring License, 2016, available at
http://www.mybankinglicense.com/bank-formation-services/acquiring-license/: " In order to obtain an acquiring
license, you will first need to go through the bank license application process";
EVANS & SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND BORROWING, supra note
1480, at 9: “MasterCard and Visa only allow financial institutions that belong to its network to enter into contracts with
merchants”. 1492 Supra ¶ 98 (issuing is less competitive and more profitable), ¶ 799.2 and note 1480 (issuing is significantly more
profitable than acquiring; interchange fees are determined according to the interests of issuers). 1493 See infra ¶ 832. 1494 COMP/29.373 − Visa International 2001/782/EC, para. 65, O. J. L 293 (2001): "However, the obligation to issue
cards may be said to promote the development of the Visa card system by ensuring a large card base, and thereby
334
a new decision, the networks took preventive steps, and in 2005 the NAWI rule was canceled
by both Visa and MasterCard.1495 Thus, in Europe, acquirers, in theory, do not have to be
issuers. No rule obligates issuers to be acquirers or acquirers to be issuers, neither in the Visa
nor MasterCard networks.
802. The Payment Services Directive proposal (PSD2) from 2013 intended, inter alia, to lower entry
barriers for independent acquirers.1496 The PSD2 proposal recommended a relatively simple
application process, easing equity and capital demands and requiring interoperability of
incumbent payment systems.1497Article 6 of the Interchange Fee Regulation from 2015
(2015/751), prohibits, inter alia, national restrictions on independent acquirers.1498 In domestic
payment card networks, acquirers do not have to be issuers.1499
However, in practice most banks are both issuers and acquirers.1500 Moreover, banks limit
concentration of operations on one side. For example, in the case of Groupement des cartes
making the system more attractive for merchants. The no acquiring without issuing rule does not in itself create
significant barriers to entry on the acquiring market" 1495 Lukas Repa, MasterCard and VISA Modify Network Rules and Increase Transparency of Cross-Border Interchange
Fees, 2 ANTITRUST COMPETITION POL'Y NEWSL. 57, 58 (2005): “Both MasterCard and VISA also repealed the so called
‘No Acquiring Without Issuing’ (‘NAWI’) Rule, which obliged their acquiring banks to issue a substantial number of
payment cards before starting to acquire merchants for card acceptance. Merchant acquirers are therefore no longer
obliged to issue cards in the Visa or MasterCard systems”.
Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 1471, at 25: “Visa Europe used to have this
rule, which had been cleared by the EU Commission as not being harmful to competition. However, it was abolished in
January 2005. MasterCard, too, used to have this rule for credit cards, but it was likewise abolished in January 2005”. 1496 Supra ¶ 583, 1497 Proposal for a Directive on Payment Services (PSD2), at para. 23 (Com (2013) 547 Final 2013/0264, July 24,
2013): "The requirements for the payment institutions should reflect the fact that payment institutions engage in more
specialised and limited activities, thus generating risks that are narrower and easier to monitor and control than
those that arise across the broader spectrum of activities of credit institutions"; Article 6 to the proposal: "Initial
Capital… (a)where the payment institution provides only [Money remittance] …, its capital shall at no time be less than
EUR 20000; (b) where the payment institution provides [access to payment accounts provided by a payment service
provider who is not the account servicing payment service provider] its capital shall at no time be less than EUR 50000;
(c) where the payment institution provides any of the [residual payment services – O.B], its capital shall at no time be
less than EUR 125000; See also Article 29 (Access to Payment Systems): "Member States shall ensure that the rules on
access of authorised or registered payment service providers that are legal persons to payment systems shall be
objective, non-discriminatory and proportionate and that those rules do not inhibit access more than is necessary to
safeguard against specific risks such as settlement risk, operational risk and business risk and to protect the financial
and operational stability of the payment system. Annex III Legislative Financial Statement… Specific objective(s):
"Develop an EU-wide market for electronic payments, which will… Address standardisation and interoperability
gaps for card, internet and mobile payments. Eliminate hurdles for competition, in particular for card and internet
payments… Ensure a consistent application of the legislative framework (PSD) and align the practical operation of the
licensing and supervisory rules for payment services across Member States". 1498 EU Regulation 2015/751 on Interchange Fees for Card-Based Payment Transactions, O.J L 123/1, Article 6 (May
19, 2015): "Any territorial restrictions… for issuing payment cards or acquiring card-based payment transactions shall be
prohibited". 1499 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 1471, at 26: "No national scheme has a “no
acquiring without issuing” rule"; Stewart E. Weiner & Julian Wright, Interchange Fees in various Countries:
Developments and Determinants, 4 REV. NETWORK ECON. 290, 298 (2005). 1500 Borestam & Schmiedel, id. at 26: "In practice, however, despite there being no compulsion, most banks are issuers
and acquirers at the same time".
335
bancaires ("CB"), the European High Court of Justice ("HCJ") upheld an appeal of CB against
the annulment of a "mechanism for regulating the acquiring function" (‘MERFA’) which,
according to CB, was aimed to encourage members that are issuers more than acquirers to
expand their acquiring activities. MERFA levied fees on members whose ratio of acquiring
activities to issuing activities was less than 0.5.1501 The General Court annulled this mechanism
as a restriction by object, but the HCJ upheld the appeal and referred the case back to the
General Court on the ground that indirect network effects between issuance and acquiring in
two-sided markets do not support "per-se" analysis.1502 The result is that in Europe as well,
there are no independent acquirers, let alone independent acquirers who determine the
interchange fee they pay.
United States
803. In the U.S., in theory, acquirers that are not issuers can allegedly exist. Networks Bylaws
demand that the participants in the networks of Visa and MasterCard be financial
institutions,1503 but there is no pre-demand such as the NAWI rule, to issue cards. However, in
practice, acquirers are part of financial conglomerates that include banks. Acquirers are either
1501 C‑67/13 P Groupement Des Cartes Bancaires (CB) v European Commission, para 4 (Sep 11, 2014). 1502 Ibid paras. 73-74: "[I]n a card payment system that is by nature two-sided… issuing and acquisition activities are
‘essential’ to one another and to the operation of that system… Having therefore found… ‘interactions’ between the
issuing and acquisition activities of a payment system and that those activities produced ‘indirect network effects’, since
the extent of merchants’ acceptance of cards and the number of cards in circulation each affects the other, the General
Court could not, without erring in law, conclude that the measures at issue had as their object the restriction of
competition within the meaning of Article 81(1) EC". 1503 Visa inc. bylaws, Article 2, available at
https://www.sec.gov/Archives/edgar/data/1403161/000119312507140569/dex1016.htm: "Eligibility. Application for
membership in the Corporation may be made by any organization which is… (a) a financial institution eligible for
federal deposit or share insurance" (or related entities);
MasterCard bylaws, http://www.sec.gov/Archives/edgar/data/1141391/000119312505223344/dex32b.htm, Article 1
entitled Membership: "The following are eligible to become Class A Members or Affiliate Members of this
Corporation: (a)… any corporation or other organization that is a financial institution";
Kay, Manuszak & Vojtech, Bank Profitability and Debit Card Interchange Regulation: Bank Responses to the Durbin
Amendment, at 10 n. 14 (2014): “Technically, network rules require participants in card networks to be depository
institutions. Firms such as First Data enter into sponsorship agreements with banks in which those banks outsource
many or all of the acquiring functions to the sponsored processor.”;
Prager et al., Interchange Fees and Payment Card Networks, supra note 1350, at 33 n. 72: “First Data is not technically
a merchant acquirer. The payment card networks require that a merchant acquirer be a member of the respective
network. To qualify for membership, a firm must be an insured depository institution. First Data is granted access to the
respective networks by sponsoring banks”.
Ramon P. Degennaro, Merchant Acquirers and Payment Card Processors: A Look Inside the Black Box, FRB ATLANTA
ECON. REV. at 31 (2006): “Only a bank may join Visa or MasterCard; as a result, many merchant acquirers and
processors form an alliance or partnership with a sponsoring bank”.
336
banks or bank affiliates.1504 The result is that acquirers in the U.S. are strongly influenced by
the interests of the issuing side.
804. The interchange fee in the U.S. is determined at the network level,1505 in which issuers have the
decisive role.1506 The outcome is that interchange fee in U.S., is determined by entities that have
an interest in raising it as high as possible.1507 No independent acquirers, let alone independent
acquirers that determine the interchange fee they pay, exist in the U.S.
Other Countries
805. Australia was a pioneering country in analyzing the NAWI rule, which was abolished in the
reform of 2002. The networks claimed that the NAWI rule is necessary to foster the "balanced
development" of the credit cards schemes, and to prevent free-riding of acquirers on the
network.1508 The RBA noted that this justification could have some merits when networks were
at their infancy, but not in mature networks.1509
1504 Supra ¶ 70 (Acquirers are financial institutions that are also issuers or connected by ownership bonds to issuers);
Prager et al., Interchange Fees and Payment Card Networks, supra note 1350, at 85 table 4. 1505 Rule 9.1.1.3 of Visa Product and Service Rules, available at https://usa.visa.com/dam/VCOM/download/about-
visa/15-April-2015-Visa-Rules-Public.pdf :
"Interchange Reimbursement Fees are determined by Visa and provided on Visa’s published
fee schedule"; Rule 8.3 to MasterCard rules, available at https://www.mastercard.com/us/merchant/pdf/BM-
Entire_Manual_public.pdf : "The Corporation has the right to establish default interchange fees and default service
fees" 1506 Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1345, at 652 : “Merchants have little
say in the setting of interchange fees, and acquirer banks get systematically fewer votes in the Visa and MasterCard
associations than issuing banks”;
Balto, supra note 1432, at 215: “[T]here is now generally far less balance or representation of the interests of merchants
in the setting of the interchange fee”;
Richard Schmalensee, Payment Systems and Interchange Fees, 50 J. INDUS. ECON. 103, 105 (2002): “In the U.S., banks’
voting power in the Visa and MasterCard associations is more sensitive to issuing volume than to acquiring
volume.”;
Price & Wang, Why do Debit Card Networks Charge Percentage Fees?, supra note 32: “Interchange fees are set by
card networks on behalf of their issuers.”;
KENNETH A. POSNER, CLASH OF TITANS: RETAILERS, CARD ISSUERS AND INTERCHANGE (Industry Report: Morgan
Stanley,2006): "One side of the market (i.e., card issuers) owns the payment network and controls the board of
directors";
Hayashi & Weiner, Interchange Fees in Australia the U.K and the United States, supra note 1472, at 95: “[n]etwork
objectives are likely to be weighted more heavily toward issuers than acquirers in the United States. One reason is
that even the largest nonbank acquirers do not have voting power in association networks... A second reason is that
large bank acquirers are typically large issuers as well”. 1507 Balto, supra note 1432, at 221: “Since most banks now participate primarily in card issuing, they have far greater
incentives to increase the fee as much as possible and extract the highest revenue from merchants and consumers”. 1508 RBA, REFORM OF CREDIT CARD SCHEMES IN AUSTRALIA: CONSULTATION DOCUMENT, at 104 (Dec. 2001): "The
justification… is that that such restrictions are necessary to foster the "balanced development" of the credit cards
schemes... "net issuer" rules are needed because specialist acquirers will attempt to "free ride" on the efforts of issuers; a
scheme's business interests will be better promoted if all members are "typically substantial issuers and acquirers"
(emphasis in the original). 1509 id. at 105 and 106.
337
806. Another pretext of the networks was that without the NAWI rule, independent acquirers would
have little interest to promote the credit card network. The RBA rejected this argument. It noted
that acquirers have interests to acquire cards of all networks.1510 The RBA also rejected the
argument that the NAWI rule was necessary to prevent a situation in which interchange fees
may be "too low". The RBA stated that:
[T]he justifications for ‘net issuer’ rules in credit card schemes do not outweigh
their anti-competitive impact on the acquiring market... Whatever contribution ‘net
issuer’ rules might have made to their early development, the designated credit
card schemes are well-established in Australia and the rules now mainly serve to
increase acquiring costs for new scheme members and entrench the market
power of incumbents. From the public interest viewpoint, the consequence is that
merchant service fees are higher than they might otherwise be, the market is not
contestable by specialist acquirers that might have new skills and efficiencies to
offer and incentives for innovation and cost reduction are likely to be dampened...
The Reserve Bank has therefore concluded that ‘net issuer’ rules are not in
the public interest and should be abolished1511.
807. Acquiring might be desirable by technological firms, already engaged in back office acquiring
and with sufficient financial resources, or by factoring firms, or by other firms that want to enter
the acquiring side only. "Issuing only" might be desired by small banks or by financial entities
that are already connected to pecuniary accounts of their clients, but do not possess the required
technology for acquiring. For such a firm, the NAWI rule is an upright entry barrier, as it forces
entrance to the two sides of the market instead of one side. Thus, repealing the NAWI rule
should have encouraged entrance of such firms. However, as of 2016, no independent acquirers
entered the Australian payment market. The Australian Payments Clearing Association includes
about 100 members, all banks or financial entities related to banks.1512
808. New-Zealand is another good example of a regime that formally has no NAWI rule, but in
which the NAWI rule prevails in practice. In 2009, the Commerce Commission reached
settlement agreements with MasterCard and Visa. The agreements stipulated that independent
acquirers could technically join the networks based on financial strength, security and
prudential criteria. Section 4.1.3 of the settlement agreements specifically determines that:
"New Zealand acquirers need not also be issuers, and vice versa".1513
1510 Ibid: "acquirers have a clear interst in promoting any scheme for which they acquire, since without transactions they
earn no revenue". 1511 RBA, REFORM OF CREDIT CARD SCHEMES IN AUSTRALIA: CONSULTATION DOCUMENT, at 107 (Dec. 2001). 1512 APCA (AUSTRALIAN PAYMENTS CLEARING ASSOCIATION) ANNUAL REVIEW 2015, at 26, available at
http://www.apca.com.au/docs/default-source/annual-reviews/apca-annual-review-2015.pdf . 1513 The settlements are available at:
http://www.comcom.govt.nz/business-competition/enforcement-response-register-commerce/detail/665
338
809. Section 3.1.7 of the Settlements with Visa and MasterCard stipulates: "if there is neither an
issuer rate nor a bilaterally agreed rate notified to [MasterCard/Visa] that applies" then no
interchange fee (zero interchange fee) will be paid on that transaction.1514 However, the problem
I emphasized throughout this work is that as long as acquirers remain issuers, they gladly
consent to pay high interchange fees to themselves in another transaction (or to themselves in
the same transaction, if it is an “On-Us” transaction).1515 Indeed, until today, no independent
acquirer has entered the market in New-Zealand. The interchange fees in New Zealand for
MasterCard can be as high as 2.35%.1516 Visa interchange fees are up to 2.3%.1517
NAWI Rule in the Bylaws of the International Organizations
810. The default rule of MasterCard and Visa is still a NAWI rule, rephrased more carefully, and
subject to modifications in regulated territories. For example, rule 3.1 of MasterCard bylaws
entitled: "Obligation to Issue MasterCard Cards" determines: "Each Principal and
Association Licensed to use the MasterCard Marks, together with its Sponsored Affiliates, must
have issued and outstanding a reasonable number of MasterCard Cards based on such criteria
as the Corporation may deem appropriate from time to time. NOTE Modifications to this Rule
appear in the “Asia/Pacific Region,” “Europe Region,” “Latin America and the
Caribbean Region,” “Middle East/Africa Region,” and “United States Region” chapters”
(emphasis in the original – O.B.).1518 Needless to say, that in the absence of territorial
modification, if the primary obligation of members is to issue cards, then acquirers will always
be former issuers, i.e., a NAWI rule.
Visa Settlement, sec. 4.1.1: "Visa participation is, and will remain, open to all New Zealand entities, including financial
institutions and other entities, on application to Visa". sec 4.1.2: "Applications will be considered by Visa applying
criteria which are directed solely to confirming that the applicant has the capability (for example, capital / financial
strength, systems, risk practices – that is, credit, fraud and operational risk), operational readiness and skills to provide
intended services without undue credit, reputational or other risks to Visa". The settlement with MasterCard is similar;
Peter R. Taylor, Cards and Payments Australasia (Payment Conference, Mar. 15, 2010): “Relevant for specialist and
self-acquirers, the schemes have confirmed that acquirers need not also be issuers and that applicants need not be
financial institutions”. See also supra ¶ 669. 1514 See also Peter R. Taylor, ibid: “[I]f an issuer does not stipulate or agree a fee with an acquirer, no interchange will
be payable on that issuer’s transaction; Asia Pacific Banking ANF Finance, NZ uses market forces to bring card
companies into line (May 21, 2010): "The manner in which interchange fees are now independently determined is
unique to New Zealand – significantly, if an issuer does not stipulate or agree a fee with an acquirer, no interchange will
be payable on that issuer’s transaction". 1515 For “on-us” transactions see supra ch. 2.4.1. 1516 MasterCard interchange fees in New Zealand, available at http://www.mastercard.com/nz/merchants/interchange-
fees.html 1517 Visa interchange fees in New Zealand, available at http://www.visa.co.nz/aboutvisa/interchange/interchange.shtml 1518 Rule 3.1 of MasterCard Rules, (Dec. 2014), available at http://www.mastercard.com/us/merchant/pdf/BM-Entire_Manual_public.pdf
339
811. As surveyed above, even in places where the NAWI rule was abolished, there are no
independent acquirers, let alone independent acquirers that participate in the determination of
the interchange fee they pay.
The paradox is that although theoretically independent acquirers can exist, on a practical level
only banks can be independent acquirers, but no bank wants to be only an acquirer. Thus, even
under regimes that permit independent acquirers to operate, this independency is not
implemented in practice, and acquirers remain issuers or tied to issuers.1519
13.2. Proposal to Separate Acquirers from Issuers
812. To solve the inherent conflict of interest that causes acquirers to “surrender” to issuers and agree
to pay high interchange fees, I suggest mandating a structural dissolution between issuers and
acquirers. My suggestion is to prohibit acquirers from having any interest on the issuing side,
and to provide independent acquirers the bargaining power to determine the interchange fee
they pay.
813. Separating issuers from acquirers is actually a mandatory implementation of the decisions to
cancel the NAWI rule. The ambition of regulators who canceled the NAWI rule, to reduce
interchange fees and remove entry barriers, was never fulfilled. The cancelation of the NAWI
rule was aimed to facilitate the entrance of independent acquirers, who could determine the
interchange fee they pay. However, this never occurred. The pervasive conflict of interest into
which acquirers are inherently trapped in, did not vanish, due to the existing connections
between issuers and acquirers. Thus, the divestiture I propose fulfills the legislative purpose
behind the cancelation of the NAWI rule that was thwarted in practice.
814. The interchange fee, according to my suggestion, would be determined in an annual single
multilateral process between independent acquirers on one side and independent issuers on the
other side. In the absence of consent, the default interchange fee would be zero. When issuers'
considerations are weighed in the determination of the interchange fee, the interchange fee is
inflated, because this suits the interest of acquirers which are also issuers to be paid as much as
possible, in their role as issuers. Under my proposal, the determination of the interchange fee
1519 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 1471, at 25: “No national scheme has a “no
acquiring without issuing” rule. In practice, however, despite there being no compulsion, most banks are issuers
and acquirers at the same time”.
DAVID S. EVANS & RICHARD SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND
BORROWING 250 (2d ed. 2005): "[O]nly bank members of Visa and MasterCard can formally be acquirers".
340
would cease to be a self-dealing process. The paying party, i.e., the acquirer, would no longer
be at an inherent conflict of interest, resulting from its interest as a payee, i.e., an issuer.
The simplicity of the proposal stems from the fact that when independent acquirers that are not
connected to the issuing side, and do not have any interest other than as payers, determine the
interchange fee they pay, and the default in the case of no consent is zero, the interchange fee
itself ceases to be a restrictive arrangement! The only reason the interchange fee would still be
considered restrictive arrangement, would be in case the determination process involves joint
negotiation of competing acquirers from one side and competing issuers from the other,
However, joint negotiation is a familiar restrictive arrangement, which can be relatively easy
treated.1520 In addition, even the joint negotiation can be avoided, as explained in para. 823
below.
815. My proposal starts with a default interchange fee of zero. The idea of imposing zero interchange
fees is not novel and has been suggested before.1521 However, the fact that a default interchange
fee is required does not, for itself, mean that it should be zero. Indeed, networks set positive
interchange fees as default. I do not adopt the idea of zero interchange fees as a target, but as a
starting point, acknowledging the special features of the interchange fee discussed widely in
this work.1522 Zero interchange fee as a target ignores the two-sided features of payment cards.
Zero interchange fee might not be sufficient when the issuing side requires encouragement to
cover issuers' costs including incentives to cardholders. Therefore, what I propose is not a
target of zero interchange fee, but a default of zero interchange fee.
Starting from zero, independent acquirers may agree to increase the interchange fee they pay.
The idea is that if acquirers would be independent, and as such would determine the interchange
fee they pay, they would collectively internalize the network and usage externalities.1523 They
would consent to an increase in the interchange fee, only if the increase would confer benefits
to each of them individually and all of them as a group.
The acquiring market is considered to be competitive with full pass through rates.1524
1520 Infra ¶ 823. 1521 Supra ch. 12.2 (zero interchange fee). See also ¶ 809 (In New Zealand, the settlements state that if no previously
determined interchange fee exist, then no interchange fee will be paid on that transaction); ¶ 668 (issuers cannot demand
ex-post interchange fees). 1522 Supra ch. 7 (The Special Feaures of the Interchange Fee). 1523 Supra ch. 7.2 1524 Supra ¶97; see also BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 ANNUAL REVIEW, at 27, 30 (2016).
341
Competitiveness means that each acquirer desires to maximize its volume of transactions.1525
The main mean in this competition is the lowest MSF an acquirer can offer. The consumer
welfare optimal interchange fee also aims to maximize efficient transactions subject to lowest
fees.1526
Interchange fee is an input for acquirers. Generally, every buyer wants to buy inputs at the
lowest price possible. Acquirers would consent to a raise in the interchange fee, only if the
higher price contributes to increasing their volume of transactions, because of indirect network
effect of the two-sided market. When this occurs, then paying higher interchange fee increases
the volume of transactions not only for each acquirer individually but also for all of them as a
group. As a byproduct, under the assumption that card transactions are efficient when the
interchange fee is not excessive, interchange fee would be raised only if this contributes to the
consumer welfare.1527
816. A supplementary rule must prohibit any circumvention of the interchange fee. As explained
above, Article 5 of the European Regulation 2015/751 on Interchange Fees from May 2015
prohibits any circumvention of the interchange fee no matter how the parties design it.1528 This
rule forbids any payments from acquirers to issuers other than the interchange fee. This rule
should be supplemented by a prohibition of payments also from issuers to acquirers, aiming to
"bribe" acquirers to consent to higher interchange fees. Any such side deal should be prohibited
and declared a punishable violation. The voting process should be under a rule of fiduciary duty
towards the acquirers' group.
817. The whip for issuers in the case of no consent would be zero interchange fee. This would give
independent acquirers the bargaining power in the negotiation. Issuers would have to convince
acquirers that raising the interchange fee would benefit the acquirers. This could be done only
if the interchange fee would indeed be used to expand volume of transactions and acquirers'
turnover in a manner revealed to the acquirers, and in an amount that would overcome the
increase in the fee acquirers pay. Otherwise, acquirers would prefer to pay less (they
determine!) and save money in each transaction.
1525 214. Ann Kjos, The Merchant-Acquiring Side of the Payment Card Industry: Structure, Operations, and Challenges,
at 9 (FRB Philadelphia Discussion Paper 2007): “Data processing is, at its heart, a scale-oriented business wherein size
and volumes drive profitability… Acquiring quickly became recognized as a volume business.”; See also Supra ¶97. 1526 Supra ch. 6.9.4; infra ¶858. 1527 Supra ch. 6.9.4; see also ¶¶ 36, 406 1528 Supra ¶¶ 518 and 584.3.
342
818. Acquirers would agree to pay interchange fee, only to the extent it increases the volume of
transactions, in a manner that outweighs the increase in the transaction price for each of them.
Just like the example of a dating club, in which one gender agrees to pay more if he or she gets
a higher benefit,1529 acquirers would agree to pay a higher interchange fee, when it deems
profitable for them, due to higher volumes of card usage genuinely derived by the interchange
fee. Acquirers are best positioned to weigh the effects of interchange fees on the volume of
transactions, because they are side to these transactions.
819. As explained in Chapter 6.9.4 (socially optimal interchange fee), from a consumer welfare point
of view, which includes merchants and all customers (cash and card payers alike), the optimal
interchange fee maximizes efficient card transactions, subject to the condition that final prices
of goods should be equal to the cost of production. Independent acquirers (as opposed to
acquirers that are also issuers), would pursue this aim as a by-product, because their interest
would become like those of final consumers.1530 Independent acquirers would like to set the
interchange fee on the lowest level, because it is an input for them, unless they acknowledge its
special features as an internalization mechanism which induces more efficient card transactions.
i.e., to boost usage.
Acquirers do not weigh the impact of their decisions on other payment instruments such as cash
and checks. If my proposal expands card usage, this should reflect a decline in the usage of cash
and checks. Such move is efficient, only if payment cards are cheaper and more efficient than
cash and checks. The empirical studies support such a move. Except small coin-size
transactions, for which cash is most efficient, payment card, especially debit, is the most
efficient payment instrument.1531 Actually interchange fee which is higher than optimal, is the
main cause for "inverse usage externality", which distorts efficient usage of payment
instruments, because it inflates the MSF, i.e., the price of card transactions.1532 Thus, reducing
the interchange fee would lower the price of card transactions with respect to cash and checks,
and under the assumption that cards are more efficient, enhanced usage of cards on account of
(expensive) cash and checks, is another benefit of my proposal.
1529 Supra ¶ 452 (in two sided markets, contrary to "one-sided" markets, customers might actually prefer to pay more,
because of the indirect market effect on the other side, which benefits them). 1530 See supra note 74. 1531 Supra ¶¶ 125 and 143. 1532 See supra ¶¶ 257, 480, 717, 730.
343
820. Acquirers would not consent to an increase in the interchange fee which is a tool for issuers'
profits or redundant rewards. Even in the unlikely event of full pass through from interchange
fee to rewards, acquirers would probably not agree to pay interchange fee which is used for
rewards that do not induce more card transactions (but cause cardholder fees to be negative).
Under the assumption that cardholders derive sufficient inherent benefits from cards, they
would use cards anyway. When rewards are given to cardholders who would use their cards
anyway, the effect of rewards is mainly to inflate the MSF (and final prices of goods), and shift
usage from cheap non-rewarding cards to cards that offer the rewards, which are more
expensive.1533 Acquirers would not agree to pay for such unnecessary rewards, because such
rewards for them are reflected in a higher price they pay with no redeeming value. Under my
proposal, the competitive pressures on the acquiring side would not be distorted anymore.
Acquirers' interest to maximize their profit would align with their interest to purchase their main
input, the interchange fee, at the lowest price.
821. Under the Honor All Cards rule, if independent acquirers would not agree with issuers on the
rate of the interchange fee, cross transactions (i.e., transactions in which the acquirer and the
issuer are different entities), would still be executed, under the default interchange fee. Visa
and MasterCard acquirers cannot refuse to acquire cards bearing the logo of Visa or
MasterCard, even if there is no prior agreement regarding the interchange fee. Issuers must
remit to acquirers all transactions' funds, even if no interchange fee is paid at all.1534 As
explained above, the "extortion" argument, according to which acquirers "must" allegedly pay
issuers interchange fee that suffices the issuers, is flawed.1535 Thus, Split, as explained in
Chapter 12.3 above, would not occur.1536
822. Issuers might try to resort to the default interchange fees of the international organizations, in
order to avoid zero interchange fees.1537 However, the interchange fees that are set in the bylaws
of international organizations, are just a restrictive arrangement as any other bilateral or
multilateral interchange fee.1538 Thus any bylaws' interchange fee would also be subject to the
default zero interchange fee rule of my proposal, unless independent acquirers in that territory
1533 Supra ¶¶ 236 - 237, 343. 1534 See e.g., section 1.7.6 of Visa Core Rules, titled Settlement
https://usa.visa.com/dam/VCOM/download/about-visa/15-April-2015-Visa-Rules-Public.pdf :
"An Issuer must pay the Acquirer the amount due for a Transaction occurring with the use of a valid Card. This includes
Transactions resulting from geographically restricted Card use outside the country of issuance." 1535 Supra ch. 8.3.5 and ¶ 579. 1536 Supra ch. 11.2.2. See also Sainsbury’s supermarkets v. MasterCard, paras. 143, 149-51 (July 14, 2016) 1537 For default interchange fees set by the international organizations see supra ¶¶ 52, 698 and note 1283. 1538 Supra ch. 9.1 (Bylaws interchange fee).
344
determine otherwise. Indeed, the bylaws of the international organizations subject themselves
to any territorial rule that determines otherwise.1539
823. I offer two mechanisms of setting the interchange fee. The first mechanism is collective
bargaining. The second mechanism is an on-line tender process. Each of them has its pros and
cons discussed below.
According to the first mechanism the interchange fee would be determined in a periodic (e.g.,
annual) meeting between representatives of independent acquirers from one side and issuers’
representatives from the other side.
Each acquirer and issuer would have the right to send a representative to this periodic meeting.
This authority can be delegated to a third party, general counsel, board member, external lawyer
or an outer agent.1540 Due to the importance of the interchange fee, the representatives would
most probably come with a prior position regarding the desired interchange fee, discussed with
their board.
The idea is to enable issuers’ representatives to persuade independent acquirers’
representatives, in the necessity of a positive interchange fee. Issuers should be permitted to
present their costs and their cardholders’ incomes, to convince acquirers that a certain rate of
interchange fee is necessary and would be beneficial to the acquirers. The default, in case of no
consent, would be zero.
After consummation of the negotiation, independent acquirers would vote. The negotiation
process should yield one interchange fee for every kind of card transactions (credit, debit,
prepaid etc.). The chosen interchange fee would obligate also acquirers that are not present.
The second mechanism I propose is a periodic (e.g., annually) electronic tender. On the
appointed time each acquirer would vote on-line for the chosen interchange fee (e.g., 0.1% for
credit, 0.05% for debit). The tender process should be secured against integrity or
confidentiality violations and other computer threats.1541
1539 Supra ¶ 53; see also supra note 1287. 1540 See infra ¶ 839 for antitrust benefits of delegation of the joint negotiation to third parties. 1541 For expansion on E-Tenders threats see Martin Betts, Peter Black, Sharon Christensen, Ed Dawson, Rong Du,
William Duncan, Ernest Foo, Juan González Nieto, Security, legal and risk issues relating to e-tendering, at 19 (2006);
345
Prior to submitting the electronic bids issuers would be permitted to meet acquirers, and to
persuade acquirers in the necessity of a positive interchange fee. This mechanism is no different
from any negotiation between a supplier and a purchaser, which can include meetings and
presentations, except for the price which ordinarily is a product of consent and here it would be
determined solely by the buyer (the acquirers). Exchange of information between acquirers
prior to voting should be permitted, to increase transparency and elaborate the competitive
process. The competitive concerns of information exchange, which in this case are aimed to
lower the interchange fee, do not seem to appear here, as discussed in para. 835 below.
The default mechanism would be electronic voting. However, issuers or acquirers above a
threshold, should be able to summon a meeting, (i.e., the first mechanism), in order to present
market wide innovations or other information relevant to the determination of the interchange
fee.
In both mechanisms, the basic rule should be one vote for each acquirer. Although acquirers
are not identical, I believe their preferences about the interchange fee would be the same. Their
vote would probably be unanimous. After all, interchange fee is a major input for independent
acquirers so each of them would like to pay as little as possible. I cannot see how the benefits
interchange fee might inflict, which is the only reason an acquirer would vote for a positive
interchange fee, would affect one acquirer in a different manner than the other. The effect of
the interchange fee is probably identical across the board. In the absence of extraneous
considerations, it is difficult to see any conflict of interest between acquirers.
In case there are disparities among independent acquirers, which result from genuine
divergence in their subjective evaluations of the interchange fee, a decision rule is required.
The first decision rule I propose is an average rule. Mathematically, this rule would approximate
the chosen interchange fee to be closest to the collective choice of all acquirers as a group.
However, if there are significant differences between acquirers, the rule can vary according to
Larry O'Connell, Electronic Tendering: Recognising a More Effective Use of Information Communications Technology
in the Irish Construction Industry, Masters dissertation. Dublin Institute of Technology (2010).
346
the relative weight of each acquirer. For example, if one acquirer has a market share of 90%
and its vote is for an interchange fee of 0.1% and the other acquirer has 10% market share and
its vote is for an interchange fee of 0.3% the interchange fee according to a weighted average
is not 0.2% but 0.12%.
I propose to use relative weights only if there are significant differences between acquirers,
such as in market shares or in merchant sectors of operation (e.g., one acquirer contracts with
Walmart size merchants and the other with small groceries). As explained in para. 97 above,
economies of scale exist on the acquiring side. Acquiring business is homogeneous by its
nature, and acquirers’ profit is derived from large volume of transactions, thus “niche” acquirers
are not expected to be viable. In addition, interchange fee is an input for niche acquirers just as
for large merchants’ acquirers. It is reasonable to assume that even niche acquirers would not
prefer different interchange fee than “general” acquirers. However, if significant disparities do
exist among acquirers then weighted average according to market share is appropriate.
Generally, voting can be biased due to manipulation or strategic considerations of voters.1542
Specifically, determination of the interchange fee based on average (or weighted average) can
be distorted due to extreme voting. For example, if 4 acquirers vote for interchange fee of 0.1%
but the fifth acquirer votes for 5%, an average rule would be distorted upwards. To prevent this
deviation, I suggest an alternative decision rule. In cases of extreme votes, which would be
defined as votes in which the gaps are larger than a threshold (e.g., 0.15% gap between the low
and high interchange fee) the decision rule would be automatically converted to be determined
by the median and not by the average.
A median rule eliminates distortions from genuine disparities. In addition, a median rule
alleviates, from the outset, distortions from strategic voting. If, for example, an acquirer wants
0.15% interchange fee, and it is aware of its peers’ intention to vote for 0.1% interchange fee,
that acquirer may deliberately vote higher than its preference, e.g., 0.3%. A median rule
eliminates extreme votes. Thus, a median rule, albeit not entirely strategy proof (because
strategic voting is possible within the threshold), reduces ex-ante incentives to vote
1542 For expansion see Jonathan Levin and Barry Nalebuff, An Introduction to Vote-Counting Schemes, 9 J. ECON.
PERSPECTIVES 3 (1995); David Easley and Jon Kleinberg, Voting in 735 NETWORKS, CROWDS, AND MARKETS:
REASONING ABOUT A HIGHLY CONNECTED WORLD (2010).
347
strategically.1543 The vote of an acquirer who wants its voice to be considered, would be closer
to its real preferences, to avoid a disparity which would activate the median rule.
A combination of the average and median rule is also a possibility. For example, the LIBOR
interest rate is an average of the 50% middle bids after elimination of the 25% lower and 25%
upper bids. Such rule can be plausible in case there are large number of acquirers.
824. My proposal contains joint negotiation between competitors on each side. Actually, this would
be the only reason for the interchange fee still being a restrictive arrangement. However, the
competitive concerns of joint negotiation are familiar,1544 and can be mitigated in our case, as
discussed below. In addition, under the current situation this cooperation exists anyway in a
graver form.
As explained by the European Commission "Joint purchasing arrangements usually aim at the
creation of buying power which can lead to lower prices or better quality products or services
for consumers".1545 Indeed, creation of independent acquirers' buying power aimed to lower the
interchange fee and the resulting MSF is the motivation for the structural separation from the
outset.
In the next sub-chapter (Ch. 13.3) I explain why competitive concerns from acquirers’
collective actions do not seem to appear here. In short, under both mechanisms, given that the
default rule is zero, no buying market power that is not conferred to acquirers anyway, arises.
Second, all acquirers in a territory would be able to participate and be subject to the chosen
interchange fee. Thus, the usual concern that competitors who do not participate in the process,
would be in an inferior position, does not arise. Third, because acquiring market is considered
competitive, any savings from lower interchange fee are expected to pass through downstream
to merchants and consumers.1546
1543 Alex Gershkov, Benny Moldovanu and Xianwen Shi, Optimal Voting Rules, at 2 (2016) : “It is well known that,
under complete information, single-peaked preferences and simple majority, the “sophisticated” equilibrium outcome
(reached by backward induction) of the successive voting procedures (and of many other binary voting schemes) is the
Condorcet winner, i.e., the alternative preferred by the median voter”.”; see also VINCENT CONITZER AND TOBY
WALSH, Barriers to Manipulation in Voting, in 127 HANDBOOK OF COMPUTATIONAL SOCIAL CHOICE (Cambridge
2016). 1544 See infra ch. 13.4 (mitigating competitive concerns). See also Stephen P. King, Collective Bargaining By Business:
Economic And Legal Implications, 36 UNSW L. J. 107 (2013); David E. Feller, A General Theory of the Collective
Bargaining Agreement, 61 CAL. L. REV. 663 (1973); Camilo Rubiano, Collective Bargaining and Competition Law: A
Comparative Study on the Media, Arts and Entertainment Sectors, (July 2013); Jonathan C. Tyras, Collective
Bargaining and Antitrust After Brown v. Pro Football, Inc., 1 PENN J. BUS. L. 297 (1998). 1545 Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal
co-operation agreements, para. 194 (2011). See also infra ¶ 841. 1546 For competitive concerns from joint purchasing agreements see the European Guidelines, ibid paras 200-216.
348
Most importantly is that the interchange fee itself, as a minimum price fixing between
competitors, who are simultaneously its buyers and sellers, would cease to exist. The outcome
of the determination process would be a single market wide interchange fee for each kind of
card transactions (i.e., credit, debit, prepaid).
825. In 2008 a Bill was proposed to the U.S. Congress (H.R. 5546, the Credit Card Fair Fee Act of
2008, hereafter: "the Bill").1547 The Bill was aimed to "correct an imbalance that currently
exists between credit card companies on one side and merchants and consumers on the other".
The bill attempted to achieve this goal "[B]y giving a limited antitrust exemption to merchants
so they can negotiate with the credit card companies for interchange fee rates and rules".1548
The Bill, which was never enacted to a final law, defined a 'Voluntarily negotiated access
agreement' as an agreement negotiated between merchants and payment card networks
representatives, to set the terms and fees of card transactions.1549
826. My proposal resembles the Bill, in the sense of setting of the interchange fee, as an outcome of
an exempted negotiation between representatives of competitors. A major difference between
the Bill and my proposal is of course the identity of the side to negotiate the interchange fee it
pays. In the Bill it was merchants. In my proposal it is independent acquirers. In my view,
independent acquirers are a better party than merchants to negotiate interchange fee.
First and foremost, the interchange fee is a mechanism to internalize usage and network
externalities. It is naive to think merchants would internalize the benefits of interchange fees,
as an internalizing mechanism in two-sided markets, on a market wide scale, in a manner that
acquirers would do. Merchants are simply not capable of internalizing network and usage
externalities of the entire market. They would probably not agree to pay interchange fee at all.
Merchants are not able to weigh the two-sided features of payment cards, because contrary to
acquirers, each merchant internalizes the costs to itself, but cannot internalize the benefits to
the industry as a whole from a positive interchange fee. Most probably merchants' vote would
be always zero interchange fee.
1547 H.R 5546 110th Cong. (2008) Credit Card Fair Fee Act ("The Bill"). 1548 H.R Report 110-913 CREDIT CARD FAIR FEE ACT OF 2008, at 4-5 (Oct 3, 2008). 1549 § 2(a)(18) of the Bill: "Voluntarily negotiated access agreement'' means an executed agreement voluntarily
negotiated between 1 or more providers of a single covered electronic payment system and 1 or more merchants that
sets the rates and terms pursuant to which the 1 or more merchants can access that covered electronic payment system
to accept credit cards and/or debit cards from consumers for payment of goods and services, and receive payment for
such goods and services".
349
Acceptance of payment instruments "costs" money for merchants.1550 Merchants are
supposedly in a better position than acquirers to appreciate the effects of the MSF they pay on
other payment instruments, such as checks and cash. For example, the tourist test envisages
how much a merchant is willing to pay, to divert a non-repeating cash payer to cards.1551 There
is a good reason to assume that interchange fee under my proposal would be lower than that of
the tourist test, meaning merchants would derive benefits from accepting cards and no other
(more expensive) payment instrument (under the tourist test merchants are indifferent). The
reason is that the net benefit of merchants from a card transaction, is higher than the cost of the
transaction. Independent acquirers with bargaining power would probably not pay issuers any
positive interchange fee, unless required to expand volume of transactions. This interchange
fee is, by definition, lower than the interchange fee that reflects merchants' benefits from
accepting card and not cash or check. Thus, my proposal enables merchants to enjoy the net
benefits of accepting cards, even though the acquirers and not the merchants determine the
interchange fee.
Acquirers also consider the benefit for themselves, but contrary to merchants, and especially if
the negotiation encompasses all acquirers as a group, their considerations and decisions are
made on a market-wide basis. Acquirers, as opposed to merchants, can see the benefits of a
positive interchange fee, from a bird's eye which covers all the market. Acquirers are capable
of internalizing that payment cards are two-sided network products. The network and usage
externalities can be internalized by acquirers, based on aggregate volume of transactions which
they acquire. Independent acquirers would weigh the profit from the volume of transactions
they process against their costs in each transaction. Their aim to maximize profits supports a
positive interchange fee, if and only if this fee is indeed used to expand the volume of
transactions to their benefit. Thus, independent acquirers (and not merchants) should be the
negotiating party to determine the interchange fee. Merchants would never be able to consider
the effect of the interchange fee they pay on the payment card industry as a whole, whereas
acquirers inherently can.
827. Second, the competitive concerns raised from cooperation between competing merchants are
far more serious than the concerns stemming from the same cooperation between competing
1550 See supra ch. 0 (Costs and Benefits of payment instruments), especially ¶¶ 156 and 159. 1551 See supra ch. 8.2.1for the tourist test. See also ¶¶ 666 and 261.
350
acquirers. Indeed, the Department of Justice warned that the ability of merchants to jointly
negotiate, and agree upon fees and terms could lead to a collusion, spillover effects and
exchange of confidential information between competing merchants.1552
My second mechanism, of online voting, does not contain collective bargaining at all. As
explained in section 823 above and also in Chapter 13.3 below,1553 even under the first
mechanism, those concerns are alleviated when the joint negotiation is performed by acquirers
(in short, towards issuers, not the joint bargaining confers market power but the default rule of
zero; among acquirers there is no concern, because all acquirers participate in the cooperation
and no acquirer is left in an inferior position;1554 towards merchants the concern is mitigated
because of the competitiveness of the acquiring market that compels acquirers to offer cost-
based MSF).
828. Another difference is the default interchange fee in the event of no consent. Initially, the Bill
proposed a panel of three administrative judges to determine the interchange fee,1555 whereas
the fallback interchange fee according to my proposal is zero. The proposal to set the default
interchange fee by three judges was heavily criticized. The Department of Justice explained and
emphasized in an open letter the disadvantages of "panel of judges".1556 In response, the Bill
was amended, and supervision of the Department of Justice replaced the three panel judges.1557
However, this supervision is also not a solution in the case of no consent.
1552 Letter from Keith B. Nelson, Principal Deputy Assistant Attorney General to the Judiciary Committy, (June 23,
2008): "[T]he ability of merchants (and issuers) to discuss, jointly negotiate, and agree upon fees and terms with one
network could lead to an implicit understanding on what fees and terms to accept from other networks, including
networks not encompassed by this legislation. Such a spillover effect would diminish, not enhance, competition
between payment card networks". 1553 See specially Infra ¶¶ 837 - 840. 1554 Infra ¶ 830. 1555 H.R 5546 110th Cong. (2008), at 24: "If the parties cannot agree voluntarily to such terms and conditions, then the
parties are subject to an administrative procedure before a three judge panel that will determine the rates and terms for a
three year period. The three-judge panel will be selected and administered by the Department of Justice’s Antitrust
Division and the Federal Trade Commission". 1556 Letter from Keith B. Nelson, Principal Deputy Assistant Attorney General to the Judiciary Committee, (June 23,
2008) available at https://www.icba.org/files/ICBASites/PDFs/DOJResponsetoSmithLetter6-23-08.pdf : "The
Department does not support the creation of a regulatory panel to set rates and terms of access. Generally, regulation
should be confined to the fewest areas possible, and even then should be narrowly tailored to address a clearly
demonstrated market failure. Notwithstanding the best of intentions and goals, the regulator will be imperfect in its
attempt to replicate the terms that would be reached in a competitive market. Moreover, a panel of regulators cannot
replicate the flexibility that is found in the free market". 1557 House of Representatives H.R. Report 110-913 CREDIT CARD FAIR FEE ACT OF 2008, at 25 (Accompany H.R. 5546
110th Congress,2008) https://www.congress.gov/110/crpt/hrpt913/CRPT-110hrpt913.pdf : "Chairman Conyers
attempted to address these concerns by eliminating the three-judge panel and replacing it with DOJ oversight over the
negotiations".
351
829. Another major difference between the Bill and my proposal is that the Bill did not limit the
joint negotiation to interchange fees. Merchants could discuss all "rates and terms of access to
payment systems".1558 Practically, this meant that the MSF (and other rates and terms) could
also be determined by collective bargaining. My proposal concerns only the interchange fee. In
my opinion, if the acquiring market is reasonably competitive (rather than monopolized or
suffers from another market failure), the gap between the interchange fee and the MSF should
not be determined in a collective bargaining.
The acquiring market world-wide is considered competitive with pass through rate close to
100%.1559 Thus there is no justification to forgo the setting of the MSF in a competitive manner.
In addition, even if interference in the MSF were warranted, and in my view it is not, it would
better be done through a non-discrimination rule than by price control.1560 The acquiring gap
between the interchange fee and the MSF is transparent, and when the acquiring market is
competitive it should be left open for competition.
830. The Bill did not obligate all merchants to participate in the joint negotiation. Thus, external
merchants could purportedly be disadvantaged if they did not take part in the negotiation. They
could find themselves ex-poste alone, against arbitrary high demands that their rivals, who
participated in the collective determination, would not face. Indeed, usually, the motivation for
allowing all players in a market to participate in a joint negotiation, is to prevent discrimination
against any player who is left outside the joint negotiation. The conventional concern is that
non-participating firms would not be able to reach the favorable terms reached in the collective
bargaining. My proposal does not suffer from this drawback. On the contrary, the motivation
behind obligating all (independent) acquirers to participate is opposite – to prevent external
acquirers' free riding. Due to the default of zero interchange fee, acquirers that would not
participate in the collective bargaining, would allegedly be put in a better and not a worse
position. Applying the chosen interchange fee on all acquirers in a territory, is the only way to
prevent free-riding by acquirers, who would not participate in the determination of the
interchange fee, and then refuse to pay.
1558 Sec. 2(b) of the Bill, titled: "limited antitrust immunity for negotiation 15 of access rates and terms to covered
electronic 16 payment systems" stated, in the relevant part: "[A]ny providers of a single covered electronic payment
system and any merchants may jointly negotiate and agree upon the rates and terms for access to the covered electronic
payment system". 1559 Supra ¶ 97 1560 See supra ¶¶ 524, 535-538, 541, 323, 830 and notes 922, 955.
352
Issuers would not be able to charge non-participating acquirers more than the agreed upon
interchange fee. Actually, it is in the interest of issuers that all acquirers participate in the
determination of the interchange fee, thus preventing extortion by residual acquirers. However,
acquirers could try to limit the access of non-participating acquirers to the infrastructure of the
network. Thus, obligating all acquirers to participate in the interchange fee determination
prevents possible foreclosure of acquirers, and further supports that all acquirers should
participate in the setting of the interchange fee.1561
Interchange fee is equivalent to "transaction tax" on acquirers. Taxes should be imposed
equally. It is only fair that all competing acquirers in the market pay the same interchange fee,
just like it is fair to demand that competing rivals pay same tax rates. This means that a local
agreement like the Trio Agreement in Israel is indeed desirable. If this were not the case, then
an individual acquirer might not agree to pay any interchange fee, relying (and free-riding) on
other acquirers to pay the interchange fees that are required to incentivize optimal usage, from
which it will enjoy the benefits without incurring the costs. There is no justification for tax
discrimination among acquirers.1562
831. My proposal for a single interchange fee is with respect to each type of transaction. Debit card
transactions are different from credit card transactions which are different from prepaid
transactions.1563 Cheaper, faster and safer transactions should be awarded lower interchange
fees. In each category of transactions, independent acquirers should be able to choose different
interchange fees, which reflect the different costs and benefits of each type of transaction.1564
Thus, the rule should be one interchange fee for each type of transactions (credit; debit; prepaid
etc.). As explained in Chapter 8.1.3.2 above, I hold the opinion there should be no merchant
categories of interchange fees. This was also the proposal of the Bill.1565
832. A transition period for the divestiture should be granted. However, when several independent
acquirers enter the market, my proposal is to validate the proposal. Independent acquirers will
1561 Compare Guidelines on the Applicability of Article 101 to Horizontal Co-Operation Agreements, O.J C 11/1 §203
(Jan. 14, 2011): "Buying power of the parties to the joint purchasing arrangement could be used to foreclose competing
purchasers by limiting their access to efficient suppliers. This is most likely if there are a limited number of suppliers
and there are barriers to entry on the supply side of the upstream market". 1562 Supra ¶ 783 ([T]he interchange fee imposes a tax on card transactions. Taxes should be at an even rate). 1563 Supra ch. 6.8 (Debit v. Credit). 1564 Supra ch. 0. 1565 H.R. 5546 - Summary, 110th Cong. 2d sess. (2008), https://www.congress.gov/bill/110th-congress/house-bill/5546 :
"Requires the rates and terms of a voluntarily negotiated access agreement to be the same for all merchants and
participating providers, regardless of their respective category or volume of transactions".
353
have the bargaining power to determine the interchange fee. Their determination would obligate
acquirers which remain attached to issuers, until all acquirers become independent. Acquirers
that would not qualify for the independency demand, would not be able to participate in the
interchange fee determination process, but they would be bound to pay the agreed upon
interchange fee.
833. For avoidance of constitutional doubts, my proposal should be anchored in a primary rule,1566
i.e., a statute and not secondary legislation or regulations.1567 In my view, the legal classification
for my proposal should be in an amendment to the Banking law (licensing), 1981. A sub section
should be added (possibly to §36), that enforces an "AWI rule", i.e., an Acquiring Without
Issuing rule. The law should stipulate that an acquirer cannot be issuer, or have direct or indirect
possessions at issuing activity. The determination process (on-line tender or periodical
meeting), should be regularized in an ordinance or secondary legislation
834. An exception should be made for nascent and small issuers, or for new and efficient kind of
transactions which require incentives at the payers' side.1568 Issuers at the take-off stage should
be able to demand a higher interchange fee for a limited period. New kinds of efficient
transactions should also be encouraged. This should enable new entrants or modern
technologies to grow, reward their users and establish a critical mass.
13.3. Mitigating Competitive Concerns
835. Collaboration among competitors for joint purchase of a main input, such as the interchange
fee, has potential to raise competitive concerns.
Under both mechanisms (on-line voting and periodic meeting), competing acquirers can
exchange information with respect to the interchange fee they would choose. Exchange of
information that is meant to be kept confidential removes the normal uncertainty concerning
1566 For expansion on primary rules see H.L.A. HART, THE CONCEPT OF LAW (Oxford, 1961). 1567 For the importance (and stronger validity) of arrangements made through primary rules, see HCJ 3267/97
Rubinshtein v. Minister of Defense, 52(5) 481, (1998) (Exemption of orthodox Jews from the army must be anchored in
a statute); but cf. HCJ 4491/13 Merkaz Academy Lemishpat Veasakim v. Government of Israel (July 2, 2014) (Gas
exportation policy can be determined by the government). 1568 Borestam & Schmiedel, Interchange Fees in Payment Cards, supra note 1471, at 25: "This rule [the NAWI rule –
O.B] can contribute to the initial take-off of a scheme, since card payments take place on a two-sided market, where
both issuers and acquirers are needed. The “no acquiring without issuing” rule therefore ensures a certain balance
between the issuing and acquiring activities within each bank". See also Supra ¶ 526 (Durbin Amendment does not
apply to small financial institutions).
354
the actions of the competitor providing the information.1569 Information exchange can be anti-
competitive, if it is liable to restrict competition.1570 However, here, the interchange fee is not
supposed to be confidential and the exchange of information between acquirers is aimed at
lowering the interchange fee, to the benefit of consumers. Exchange of information between
issuers cannot have restrictive effects, because under the default of zero, issuers do not have
market power. Thus, exchange of information cannot facilitate any collusion. On the contrary,
it contributes to informed decision-making based on full information.
836. The information exchange is part of a collective bargaining. Even if the result of collective
bargaining is cost savings to acquirers, then in order to justify such collective bargaining, the
benefits of the collective bargaining should be passed-on to the merchants and their
customers.1571 The acquiring side is considered competitive with full pass through rate, so any
reduction in costs would be passed to merchants. However, my proposal is guaranteed to
improve the market even if its consequences would not fully pass downstream to final
consumers, let alone if the cost savings would be passed-on to them.
1569 Commission Decision 92/157/EEC (UK Agricultural Tractor Registration Exchange), paragraph 43, Feb. 17, 1992:
“Uncertainty would lead the firms to compete more strongly than if they knew exactly how much of a response was
necessary to meet competition”. This decision was confirmed in the first instance - Case T-35/92, John Deere Ltd. v.
Comm'n, 1994 E.C.R II-00957, and appeal: Case C-7/95 and C-8/95 John Deere Ltd. v. Comm'n, 1998 E.C.R. I-3111. 1570 C 286/13 P Dole Food v. Comm'n, para. 121 (19.3.15): “[E]xchange of information between competitors is liable to
be incompatible with the competition rules if it reduces or removes the degree of uncertainty as to the operation of the
market in question, with the result that competition between undertakings is restricted”. 1571 Federal Trade Commission and the U.S. Department of Justice, Antitrust Guidelines for Collaborations among
Competitors, para. 3.2 (Apr. 2000): "The mere coordination of decisions on price… is not integration, and cost savings
without integration are not a basis for avoiding per se condemnation. The integration must be of a type that plausibly
would generate procompetitive benefits cognizable under the efficiencies analysis… Such procompetitive benefits may
enhance the participants’ ability or incentives to compete and thus may offset an agreement’s anticompetitive
tendencies";
ABA 1 ANTITRUST LAW DEVELOPMENTS 469 (7th ed. 2012): "Courts have invalidated joint purchasing arrangements
where the arrangement had no did not (mistake in the original – O.B) produce efficiencies from the cooperative activity
and functioned simply as a buyer's cartel".
For Europe, Guidelines on the Applicability of Article 101 to Horizontal Co-Operation Agreements, O.J C 11/1, para.
201 (Jan. 14, 2011): "If downstream competitors purchase a significant part of their products together, their incentives
for price competition on the selling market or markets may be considerably reduced. If the parties have a significant
degree of market power (which does not necessarily amount to dominance) on the selling market or markets, the lower
purchase prices achieved by the joint purchasing arrangement are likely not to be passed on to consumers"; Ibid paras.
213-14: "Joint purchasing arrangements may lead to a collusive outcome if they facilitate the coordination of the
parties’ behaviour on the selling market. This can be the case if the parties achieve a high degree of commonality of
costs through joint purchasing, provided the parties have market power and the market characteristics are conducive to
coordination.
214.Restrictive effects on competition are more likely if the parties to the joint purchasing arrangement have a
significant proportion of their variable costs in the relevant downstream market in common. This is, for instance, the
case if retailers, which are active in the same relevant retail market or markets, jointly purchase a significant amount of
the products they offer for resale. It may also be the case if competing manufacturers and sellers of a final product
jointly purchase a high proportion of their input together".
For Israel, see Decision Not to Exempt a Joint Negotiation Arrangement between Physician Union and Health Insurers,
Antitrust 501009 (Jul. 13, 2016).
355
837. First, the setting of the interchange fee is done in cooperation anyway. My proposal should be
compared to the but-for world, in which acquirers (which are also issuers) collectively bargain
for the interchange fee. Thus, I do not propose a collaboration which does not exist regardless
of my proposal. Moreover, currently, not only do acquirers (which are issuers at the same time)
jointly negotiate interchange fees, but acquirers frequently participate in unions or trade
associations.1572 From this point of view, the collaboration I propose does not increase the level
of cooperation or concentration that already exists anyway. The innovation is not to eliminate
an ongoing cooperation but to purify it. The collective bargaining should be clean of the self-
dealing element and the inherent conflict of interest that severely taints the current setting of
the interchange fee. The usual concern from competitors who determine prices is that they
would fix prices to the detriment of their customers. Here, the whole essence of the collective
bargaining is its aim to lower prices, to the benefit of consumers. Cost savings are guaranteed,
because independent acquirers would not agree to pay interchange fee, unless they realize it is
for their benefit.
838. Second, because the acquiring market is considered competitive, it is reasonable to assume that
cost savings would be translated into lower MSF and lower prices, at least in the long run.1573
Cost savings from reduced interchange fee would be passed through to downstream merchants
and their customers. This is exactly the kind of efficiencies recognized in collective bargaining
and joint purchasing.1574 However, the efficiencies are only the side effect of the main idea at
the base of the proposal, which is to solve the distortion that leads to inflated interchange fee,
by purifying its determination process from the self-dealing element.
Even if the acquiring market were not competitive, structural separation would make entrance
easier, and increase the level of competition. Instead of entering two sides (issuing and
acquiring), entrance to the acquiring side is subject to less demands (e.g., lower equity) and is
lower entry barriers. The acquiring market would become more contestable, at least in the long
1572 See e.g., Western States Acquiring Association https://www.westernstatesacquirers.com/index.php ; The UK Card
Association http://www.theukcardsassociation.org.uk/retailer_resources/ ; Australia Payment Clearing Association
http://www.apca.com.au/ 1573 Cf. Guidelines on the Applicability of Article 101 to Horizontal Co-Operation Agreements, O.J C 11/1 §217
(14.1.11): "Efficiency gains 217. Joint purchasing arrangements can give rise to significant efficiency gains. In
particular, they can lead to cost savings such as lower purchase prices or reduced transaction, transportation and storage
costs, thereby facilitating economies of scale. Moreover, joint purchasing arrangements may give rise to qualitative
efficiency gains by leading suppliers to innovate and introduce new or improved products on the markets". 1574 Federal Trade Commission and the U.S. Department of Justice, Antitrust Guidelines for Collaborations among
Competitors, para. 3.36 (Apr. 2000): "competitor collaboration may enable firms to offer goods or services that are
cheaper… such collaboration-generated efficiencies may enhance competition by permitting two or more ineffective
(e.g., high cost) participants to become more effective, lower cost competitors".
356
run. In Israel, when termination fees (the equivalent of interchange fees in telecommunications)
decreased, new entrants (Golan, Hot-Mobile and several virtual operators) could enter the
market and offer attractive rates to consumers, which they could not offer under a regime of
high termination fees. This, in turn, caused a huge reduction in mobile fees. Similar entrance of
independent acquirers is expected to occur here, if interchange fee is reduced and entrance to
one side would become feasible.
839. Third, there are common remedies to alleviate "traditional" concerns of collective bargaining,
such as collusion and information exchange. For example, each acquirer can be required to
delegate a third-party representative, such as its lawyer or an outer agent, for conducting the
negotiation.1575 The negotiation meetings can be recorded and monitored. Spillover effects can
be minimized, because no sensitive information (except the agreed upon rate of the interchange
fee) would be dispersed among acquirers.1576
840. Fourth, the collective negotiation process should be subject to a detailed exemption, which
should stress the terms and conditions of the negotiation process.1577 Strictly followed, this
would immunize acquirers from antitrust liability. The immunity should be limited to
negotiating the interchange fee. This is even a narrower immunity than the one suggested in the
1575 ABA 1 ANTITRUST LAW DEVELOPMENTS, 471 (7 ed. 2012): "[A]ntitrust risk is reduced where negotiations are
conducted on behalf of the cooperative by an independent employee or agent who is not an employee of any of the
participants"; Federal Trade Commission and the U.S. Department of Justice, Antitrust Guidelines for Collaborations
among Competitors, para. 3.31(a), para. 3.34(e) (Apr. 2000): "A buying collaboration might use an independent third
party to handle negotiations in which its participants’ input requirements or other competitively sensitive information
could be revealed. In general, it is less likely that the collaboration will facilitate collusion on competitively sensitive
variables if appropriate safeguards governing information sharing are in place";
Guidelines on the Applicability of Article 101 to Horizontal Co-Operation Agreements, id. para. 215 (Jan 14, 2011):
"Spill-over effects from the exchange of commercially sensitive information can, for example, be minimised where data
is collated by a joint purchasing arrangement which does not pass on the information to the parties thereto". For Israel,
see Exemption to Gas Companies (Sonol, Delek, Dor) for Collective Bargaining and Joint Purchase of Jet Fuel
Insurance Policy, Antitrust 500526, (Dec. 24, 2013) 1576 Guidelines on the Applicability of Article 101 to Horizontal Co-Operation Agreements, id. para. 215 (Jan. 14,
2011): "Spill-over effects from the exchange of commercially sensitive information can, for example, be minimised
where data is collated by a joint purchasing arrangement which does not pass on the information to the parties thereto". 1577 Compare to the Bill, H.R. 5546 - Summary, 110th Cong. 2d Sess. sess., (2008)
https://www.congress.gov/bill/110th-congress/house-bill/5546 : "Requires the negotiating parties to file with the
Antitrust Division of the Department of Justice a schedule for negotiations within one month following enactment of
this Act. Directs the Antitrust Division to issue such a schedule, and inform the negotiating parties, if they fail to file a
schedule before the deadline… Requires a representative of the Antitrust Division to attend all negotiation sessions
conducted under the authority of this Act… Requires the negotiating parties to file jointly with the Antitrust Division
any voluntarily negotiated access agreement that affects any market in the United States or elsewhere, including the
various components of the interchange fee, and a description of how access fees that merchants pay are allocated among
financial institutions and how they are spent".
357
U.S. Bill, which permitted negotiation under immunity of all "terms and rates" of access to
payment systems.1578
841. Fifth, collective bargaining of the interchange fee (only) by independent acquirers, is less
restrictive than joint purchasing arrangements in which competitors not only negotiate, but also
jointly purchase assets. However, even joint purchasing agreements can be recognized as pro-
competitive, if they lead to cost savings which are passed-on downstream.1579 Joint purchase
arrangements are recognized as legal even when they encompass large market shares, in
pharmaceutical,1580 copyrights,1581 and, of course, in the current setting of the interchange fee.
Remembering that "Cooperation is the norm in network industries",1582 joint negotiation of the
interchange fee by independent acquirers, which is a less restrictive arrangement than joint
purchasing, would probably result in lower costs for acquirers. Savings would most probably
diffuse downstream.
13.4. Divestiture As Part Of Regulation
842. Structural separation raises constitutional questions, specifically the question of
proportionality.1583 This chapter deals with these concerns.
1578 Section 2(b) to the Bill, titled "Limited Antitrust Immunity For Negotiation Of Access Rates And Terms To
Covered Electronic Payment Systems", stated: "[N]otwithstanding any provision of the antitrust laws, in negotiating
access rates and terms any providers of a single covered electronic payment system and any merchants may jointly
negotiate and agree upon the rates and terms for access to the covered electronic payment system, including through the
use of common agents that represent either providers of a single covered electronic payment system or merchants on a
non-exclusive basis". 1579 Northwest Wholesale Stationers, Inc. v. Pacific Stationery & Printing Co., 472 U.S. 284, 296 (U.S. 1985); Instant
Delivery Corp. v. City Stores Co., 284 F. Supp. 941 (E.D. Pa. 1968); Federal Trade Commission and the U.S.
Department of Justice, Antitrust Guidelines for Collaborations among Competitors, para. 3.31(a) (Apr. 2000): "Buying
Collaborations. Competitor collaborations may involve agreements jointly to purchase necessary inputs. Many such
agreements do not raise antitrust concerns and indeed may be procompetitive. Purchasing collaborations, for example,
may enable participants to centralize ordering, to combine warehousing or distribution functions more efficiently, or to
achieve other efficiencies". 1580 N. Jackson Pharm., Inc. v. Caremark RX, Inc. 385 F. Supp. 2d 740 (N.D. 2005); see also Statements of Antitrust
Enforcement Policy in Health Care, Issued by the U.S. Department of Justice and the Federal Trade Commission,
statement #7 (August 1996). For a joint purchasing arrangement of medical equipment between hospitals in Israel, see
Sarel Logistics Sollutions and Products for Advanced Medicine Ltd. http://www.sarel.co.il/eng/ 1581 For U.S., see Broadcast Music v. CBS, 441 U.S. 1, 23 (1979). In Israel - AT 3574/00 Music Federation v.
Antitrust General Director (29.4.04). 1582 ABA 1 ANTITRUST LAW DEVELOPMENTS 472 (7 ed. 2012). 1583 For expansion see HCJ 1661/05 Local Council Hof Aza v the Knesset, 59(2) 481, (2005); SCL 1333/02 Local
Zoning Committee v Judith Horoviz, 58(6) 289, (2004).
358
Regulation often involves structural reforms. A salient example is divestitures that occurred in
electricity and telecommunication networks.1584 Divestiture was used in numerous occasions to
reorganize a market that was controlled by incumbent monopolies, even though the incumbent
has not been engaged in unlawful trade practices.1585 In many countries, networks that were
operated by incumbent monopolies were forced to unbundle and separate their activities.1586
The terminology for divestiture of incumbents through regulatory reforms is sometimes treated
in literature as a "regulatory taking".1587
843. The power to obligate divestiture, as part of regulatory reforms, stems from the sovereign
authority of the state to regulate economic activities, especially in vital areas.1588 There is a
consensus in the literature that the state may force structural changes in regulated industries as
part of reforms it conducts. The main conflict in literature regards the extent of compensation.
Sidak & Spulber compared structural reforms, in which firms are deprived of their assets, to
takings. They argued for generous compensation.1589 The approach of most commentators is
1584 Cf. Lina Rainiene, Functional and Structural Separation Models, TAIEX Workshop on Regulatory Framework,
Belgrade, at 27-39 (April 2010); David Havyatt , Why Vertical Structural Separation is in the Interests of Incumbent
Telcos, and Why they don’t See it, http://www.havyatt.com.au/docs/wps/TJA1.pdf . 1585 United States v. AT&T Co. 552 F. Supp. 131 (D.D.C. 1982); Standard Oil Co. v. United States, 221 U.S. 1 (1911);
United States v. Aluminum Co. of America, 148 F.2d 416, 429 (2d Cir. N.Y. 1945): “In several decisions the Supreme
Court has decreed the dissolution of such combinations, although they had engaged in no unlawful trade
practices”; United States v. E. I. Du Pont De Nemours & Co. 366 U.S. 316, 329-31 (1961): “Divestiture or dissolution
has traditionally been the remedy for Sherman Act violations whose heart is intercorporate combination and control
Divestiture has been called the most important of antitrust remedies. It is simple, relatively easy to administer, and
sure". P. E. AREEDA, III ANTITRUST LAW, 147; United States v. Grinnell Corp., 384 U.S. 563, 577 (U.S. 1966):
“adequate relief in a monopolization case should put an end to the combination and deprive the defendants of any of the
benefits of the illegal conduct, and break up or render impotent the monopoly power found to be in violation of the
Act". For Europe see Reg. (EC) no 1/2003 on the Implementation of the Rules on Competition Laid Down in Articles
81 and 82 of the Treaty, Art. 7 (Dec. 16, 2002). 1586J. GREGORY SIDAK & DANIEL F. SPULBER, DEREGULATORY TAKINGS AND THE REGULATORY CONTRACT, 47 (1998):
"Deregulation of networks industries often is accompanied by regulatory policies requiring the incumbent utility to
provide "open access" to its transmission facilities. Deregulation in electricity and communication has been
accompanied by regulations aimed at vertical divestiture or separation of vertically integrated activities of
incumbent utilities." 1587Susan Rose-Ackerman & Jim Rossi, Disentangling Deregulatory Takings, 86 VIR. L. REV. 1435, 1438 (2000):
"Any commercial enterprise is subject to changes in the state's tax and regulatory laws, but these risks loom especially
large for infrastructure industries.";
Daniel F. Spulber & Christopher F. Yoo, Antitrust, the Internet, and the Economics of Networks, at 23 (Faculty
Scholarship Series. Paper 583, 2013): "One of the most common remedies sought during antitrust litigation in
network industries is structural separation. For example, the 1956 consent decree settling the second major case
against AT&T abandoned the government’s initial request for divestiture of AT&T’s equipment subsidiary, opting
instead to restrict AT&T to furnishing common carrier communications services. The 1982 court order that broke up
AT&T required that the local telephone services that remained monopolized be structurally separated from the portions
of the business in which competition had become possible: long distance, telephone equipment, and “information
services” that combined transmission with data processing. More recently, the federal government initially asked the
court hearing the case against Microsoft to require the company to spin off its applications businesses into a separate
subsidiary";
SHARON YADIN, REGULATION: ADMINISTRATIVE LAW IN THE AGE OF REGULATORY CONTRACTS (2016). 1588 See e.g., Verizon Communs., Inc. v. FCC, 535 U.S. 467 (2002). 1589 J. GREGORY SIDAK & DANIEL F. SPULBER, DEREGULATORY TAKINGS AND THE REGULATORY CONTRACT (1998)
359
less generous. The main argument is that structural changes, which are actually a by-product of
removing structural barriers to competition, are not an action that the public should pay for.1590
This argument seems to be even more valid when the divestiture is aimed in breaking a
restrictive arrangement, as the right to be a party to a restrictive arrangement, let alone price-
fixing, is not a vested right, which deserves compensation when taken.1591
From this point of view, my proposal is much less dramatic than it may initially seem. The
controversial question of compensation, which accompanies regulatory reforms that involve
takings, does not arise in this case. My proposal is not a "taking" of the acquiring business. It
is ending a price fixing restrictive arrangement, which the parties have no vested right to be part
of in the first place. Thus, the setup for structural separation is more favorable from the outset
than in other dissolutions in which the deprived incumbent did not commit any wrong.
844. Previous divestitures can be useful precedents. In Israel, a divestiture that was also meant to
eliminate inherent conflict of interests, occurred in 2005. The Bachar Reform ordered the
divestiture of provident funds from the banks that owned them. Banks operated in multiple
roles, and were subject to inherent conflict of interest.1592 The main concern was that banks use
their customers' funds for channels of investment they had interest in, even if those were less
attractive than competing channels of investment. However, possession of provident funds by
banks does not raise such grave conflict of interest, and is not per-se illegal. First, the mere
possession of provident fund is not an illegal price fixing. Second, the purported conflict of
interest the Bachar committee dealt with, could be solved with less drastic measures, e.g.,
forbidding or limiting banks from investing in channels they have interest in.
Third, if banks invest in inferior channels, competition could correct this bias. The Bachar
reform was aimed to stop banks' priority in channels they had interest in. But if investments of
banks were biased towards unprofitable (own) investment channels, interbank competition
could strengthen, and correct this inherent conflict of interest. This cannot be said on the
1590 __________ Herbert Hovenkamp, The Taking Clause and Improvident Regulatory Bargains, 108 YALE L.J. 801
(1999); Oliver E. Williamson, Deregulatory Takings and Breach of the Regulatory Contract: Some Precautions, 71 N.
Y.U. L. REV. 1007 (1996); Jim Rossi, The Irony of Deregulatory Takings, 197 TEX. L. REV. 77 (1998). 1591 AT 3276/99 Arutzei Zahav v. Association of Movie Directors, Sec. 36, (July 6, 2000); AT 3574/00 Music
Federation v. Antitrust General Director, Sec. 100 (Apr. 29, 2004); AT 19545-04-10 Shovarei Bar v. Antitrust General
Director, sec. 49 (Jan. 24, 2012) (no person has a vested right to be a party to a restrictive arrangement). 1592 INTER-MINISTERIAL COMMITTEE REPORT (BACHAR REPORT), STRUCTURAL REFORM IN THE CAPITAL MARKET,
Executive Summary, at 5 (Sept. 2004):" The broad range of activities in which Israel's banks engage, creates material
conflicts of interest between their own business interests and their customers’ interests."; id. at 9: "Against the
background of concentration and conflicts of interest, we propose that banks will not be permitted to hold any interest at
all in a company that manages a provident or mutual fund"; Law for Advancement of Competition and Reduction of
Concentration and Conflicts of Interests in the Capital Markets in Israel (2005).
360
interchange fee. No self-correcting mechanism can fix the inherent conflict of interest, which
results from issuers and acquirers being the same entities. To the contrary, as explained in
chapter 6.6 above, competition, which is usually a market self-correcting mechanism, does not
work well in two-sided markets such as payment cards. As competition intensifies, it inflates
and not reduces the interchange fee, which serves as a source for profits and wasteful
competition. Thus, the conclusions of the Bachar Reform, which justified divestiture in the
banking sector, hold even more with respect to my proposal.
845. Another divestiture in the Israeli market occurred, when Amendment 11 to the Banking Law
(Licensing) 1981 implemented the Brodet Report, and prohibited banks to possess more than
20% in industrial corporation. This reform forced banks to sell their holdings in major
corporations.1593
In 2013, the Law for Advancement of Competition and Reduction in Concentration was
enacted.1594 This law went even further, in order to implement recommendations of a
governmental committee appointed to offer steps to increase the competitiveness of the Israeli
market.1595 The Law prohibited pyramidal holdings of more than two levels in public
companies.1596 This was intended to prevent leveraged control over complicated structures of
companies through relatively minor investment.1597 In addition the law mandated structural
separation between significant financial and non-financial firms.1598 This structural separation
was also explained in the inherent conflict of interest of single economic units, which included
financial and non-financial entities, to lend or to invest in the same economic unit.1599 However,
the same arguments which were raised against the divestiture of the Bachar reform are valid
here. The conflict of interest is not inherent, and it could potentially be solved through the
"invisible hand" of competition or by less restrictive means than divestiture. Thus, my proposal
is certainly proportional when compared to the divestiture of the Law for Advancement of
Competition and Reduction in Concentration.
1593 Proposal for Banking Law (Licensing) 1981 (Amendment 11), Bills 2352, at 662, 663, 667 (March 11, 1996);
Banking Law (Licensing), Sec. 11, (1981). 1594 Law for Advancement of Competition and Reduction in Concentration (2013). 1595 Proposal for a Law for Advancement of Competition and Reduction in Concentration, Government Bills 706, 1084
(Jul. 9, 2012); COMMITTEE ON INCREASING COMPETITIVENESS IN THE ECONOMY [HAVAADA LEHAGBARAT
HATAHARUTIUT BAMESHEK] FINAL REPORT (2012)
http://mof.gov.il/Committees/PreviouslyCommittees/Pages/CompetitivenessCommittee.aspx . 1596 Law for Advancement of Competition and Reduction in Concentration, Sec. 21 (2013). 1597 Committee on Increasing Competitiveness in the Economy, supra note 1595, at 10. 1598 Law for Advancement of Competition and Reduction in Concentration, Chapter D (2013). 1599 COMMITTEE ON INCREASING COMPETITIVENESS IN THE ECONOMY, DRAFT RECOMMENDATIONS at 13-14, 20 (2011).
361
846. Separation of financial and non-financial holding took place in other countries. The arguments
were different from the reasoning in Israel. The economic crisis of 2008 caused numerous
financial institutions to collapse. Huge state aid and guarantees were required to stabilize the
financial markets. Desire to limit the effects of banks' breakdown on the economy, i.e., the "too
big to fail" narrative, was the main reasoning for structural separation.1600
In United Kingdom, the Vickers Report recommended "ring fencing" i.e., separation of banking
activities, especially between retail and investment activities.1601 In the U.S., Section 619 of the
Dodd–Frank Wall Street Reform and Consumer Protection Act, 2010 added a new section 13
to the Bank Holding Company Act, commonly referred to as the ‘Volcker Rule’. This rule
prohibited banking entities from engaging in proprietary trading and from having certain
relationships with a hedge fund or private equity fund.1602 Prior to the Volcker Rule, banks
invested heavily in these areas.
In the E.U., the Liikanen report recommended structural reforms to strengthen the financial
stability of the banking sector. The first recommendation was separation of proprietary trading
and other high-risk trading from commercial banks.1603 Another report for the G20 leaders also
concluded that separation of financial activities through prohibitions such as ‘ring-fencing’
promote financial stability by reducing systemic risks.1604 These structural separations were
more drastic than my proposal.
1600 Adrian Blundell-Wignall, Paul Atkinson & Caroline Roulet, Bank Business Models and the Separation Issue, 2
OECD J. FIN. MARKET TRENDS, at 9 (2013): "Following the 2008 crisis, the OECD Secretariat was amongst the first to
propose separation as necessary for the future stability of the financial system. It proposes a nonoperating holding
company (NOHC) structure for banks that require separation". 1601 INDEPENDENT COMMISSION ON BANKING FINAL REPORT RECOMMENDATIONS (VICKERS REPORT), at 9 (Sept. 2011):
"A number of UK banks combine domestic retail services with global wholesale and investment banking operations.
Both sets of activities are economically valuable while both also entail risks – for example, relating to residential
property values in the case of retail banking. Their unstructured combination does, however, give rise to public policy
concerns, which structural reform proposals – notably forms of separation between retail banking and
wholesale/investment banking – seek to address". For explanation on ring fencing, id. at 11. 1602 Pub. L. No. 111-203; Dodd–Frank Act § 619; 12 U.S.C. § 1851; see also STUDY & RECOMMENDATIONS ON
PROHIBITIONS ON PROPRIETARY TRADING & CERTAIN RELATIONSHIPS WITH HEDGE FUNDS & PRIVATE EQUITY FUNDS;
FINANCIAL STABILITY OVERSIGHT COUNCIL (January 2011). 1603 HIGH-LEVEL EXPERT GROUP ON REFORMING THE STRUCTURE OF THE EU BANKING SECTOR (LIIKANEN REPORT), at
III (Oct. 2012): " [P]roprietary trading and other significant trading activities should be assigned to a separate legal
entity if the activities to be separated amount to a significant share of a bank's business. This would ensure that trading
activities beyond the threshold are carried out on a stand-alone basis and separate from the deposit bank. As a
consequence, deposits, and the explicit and implicit guarantee they carry, would no longer directly support risky trading
activities". Cf. Proposal for a Regulation Of The European Parliament And Of The Council on Structural Measures
Improving the Resilience of EU Credit Institutions COM/2014/043 Final - 2014/0020 (COD), (2014). 1604 STRUCTURAL BANKING REFORMS CROSS-BORDER CONSISTENCIES AND GLOBAL FINANCIAL STABILITY
IMPLICATIONS REPORT TO G20 LEADERS FOR THE NOVEMBER 2014 SUMMIT FINANCIAL STABILITY BOARD, 1-2 (Oct. 27,
2014).
362
Entities that hold and operate financial and non-financial assets, or financial entities which
invest their own money (nostro) in considerably risky activities, do not raise inherent
competitive concerns, such as entities that hold and operate issuing and acquiring activities.
Stability issues could be solved with less drastic remedies than structural separation, such as
limitations on holdings and limitations on financial risk-ratios. If stability concerns, which are
not inherent, justify structural separation, then inherent conflict of interest, which raises
undoubted concerns of general price increase in the market,1605 should in my view justify
structural separation.
847. Another support for my proposal can be found at the recent report, dated September 2016, of
the Committee for Enhancement of Competition in Common Banking & Financial Services
(Shtrum Committee). The main recommendation of this committee was to divest Leumi-Card
and Isracard from their controlling banks (Leumi & Poalim respectively). The Shtrum
Committee actually adopted previous proposals to divest payment card companies from their
controlling banks.1606 The purpose of Shtrum's Committee divestiture proposal was to induce
entrance of new competitors, the buyers of these firms, to the financial market. The report did
not address constitutional considerations. The report just noted in one paragraph, without
elaboration, that its recommendation to divest payment card firms from their controlling banks
is proportional.1607 However, the desire to elaborate competition in the banking sector does not
imply that the incumbents (Leumi and Hapoalim banks in this case) did anything wrong. In
fact, they did not breach any law neither were they parties to a restrictive arrangement.
Nevertheless, the Shtrum Committee, in line with previous proposals, recommended divestiture
of the payment card companies from their parent banks. These recommendations were partly
anchored into section 11b of the Banking Law (Licensing), amendment 23 (2017). The
amendment determines that big banks, i.e., Leumi and Hapoalim, would not control firms
engaged in issuing or acquiring of payment cards. In comparison to these recommendations my
proposal is even more proportional and a fortiori less drastic.
Another advantage of separating acquirers from issuers and not payment card companies from
their controlling banks is that even if separated from banks, acquirers who are also issuers would
remain in inherent conflict of interest that would cause them to agree to pay high interchange
1605 Supra ch. 10.1 (interchange fee raises competitive concerns of market wide price increase). 1606 For prior Bills aiming for this divestiture see supra ¶ 558. 1607 COMMITTEE FOR ENHANCEMENT OF COMPETITION IN COMMON BANKING & FINANCIAL SERVICES (SHTRUM
COMMITTEE) FINAL REPORT, at 56 (Sep 1, 2016).
363
fee to themselves as issuers. My suggestion aims at preventing this inherent conflict of interest,
which would remain even if LeumiCard and Isracard would be divested from Leumi and
Hapoalim banks respectively. My proposal applies whether payment card firms would become
separated from their controlling banks, or not.
13.5. Divestiture as an antitrust remedy
848. Divestiture might indeed be an important part of structural reforms. Divestiture is one of the
most important antitrust remedies.1608 Divestiture is the "most drastic, but most effective"
antitrust remedy.1609 Mergers are a primary arena in which divestitures occur.1610 It is worthy
to analyze my proposal also considering this traditional remedy.
849. Divestiture is a remedy aimed to restore or preserve competition.1611 Merger remedy rules that
include divestiture are well recognized and commonly used.1612 When a merger eliminates a
competitor, divestiture seeks to restore the lost competitor and preserve the competitiveness of
1608 Schine Chain Theatres, Inc. v. United States, 334 U.S. 110, 128-129 (U.S. 1948): "Divestiture or dissolution must
take account of the present and future conditions in the particular industry as well as past violations. It serves several
functions: (1) It puts an end to the combination or conspiracy when that is itself the violation. (2) It deprives the
antitrust defendants of the benefits of their conspiracy. [*129] (3) It is designed to break up or render impotent the
monopoly power which violates the Act. See United States v. Crescent Amusement Co., supra, pp. 188-190; United
States v. Griffith, ante, p. 100.";
See also AT 103/09 Antitrust General Director v. Tnuva (Dec. 28, 2009) (Consent Decree to a dissolution of a milk
plant, Machlavot Ramat Hagolan, held by major competitors). 1609 United States v. E. I. du Pont de Nemours & Co., 366 U.S. 316, 326. 1610 IVO VAN BAEL & JEAN-FRANCOIS BELLIS, COMPETITION LAW OF THE EUROPEAN COMMUNITY 779 (5th ed. 2010):
"[I]n the vast majority of [merger – O.B] cases, competition concerns have been addressed by means of divestment". 1611 DOJ Antitrust Division Policy Guide To Merger Remedies, at 3 (June 2011);
United States v. E. I. du Pont de Nemours & Co., 366 U.S. 316, 326 (U.S. 1961): "The key to the whole question of an
antitrust remedy is of course the discovery of measures effective to restore competition";
Opinion 2/11: Guidelines on Remedies to Mergers that Raise Concerns of Significant Harm to Competition, Antitrust
5001804, at 7 (July 18, 2011);
DOJ Antitrust Division Policy Guide to Merger Remedies, at 7 (Jun. 2011): "The goal of a divestiture is to ensure that
the purchaser possesses both the means and the incentive to effectively preserve competition";
Europe, Commission Notice On Remedies Acceptable Under Council Regulation, para. 22: "Where a proposed
concentration threatens to significantly impede effective competition the most effective way to maintain effective
competition, apart from prohibition, is to create the conditions for the emergence of a new competitive entity".
British Merger Remedies: Competition Commission Guidelines, para. 2.5;
Canadian Merger Remedies para 12(i): "Divestitures seek to: (i) preserve competition through the sale of asset(s) to a
new market participant";
French Merger Guideline, para. 528: "When seeking adequate remedies, the Autorité de la concurrence gives priority to
structural remedies that are intended to preserve effective competition through divestitures of activities or of certain
assets to an appropriate buyer that is likely to exert actual competitive constraint, or through the elimination of capitalist
ties between competitors". 1612 U.S. DOJ Policy Guide To Merger Remedies (June 2011); British Competition Commission, Merger Remedies:
Competition Commission Guidelines, November 2008; Europe, Commission Notice On Remedies Acceptable Under
Council Regulation (Ec) No 139/2004 And Under Commission Regulation (Ec) No 802/2004 (2008/C 267/01);
Australian Competition And Consumer Commission, Merger Guidelines (Nov. 2008); France, Autorite de la
concurrence, Merger Control Guidelines; Canada Competition Bureau, Information Bulletin On Merger Remedies In
Canada (Sept. 22, 2006).
364
the market.1613 To see that my proposal is in line with merger remedies, the main principles of
divestiture in the merger remedies should be recalled:
850. First, to be aligned with constitutional principles, divestiture must address the competitive
concern and be proportionate.1614 As explained in the previous part, this condition is satisfied
in our case. In comparison to the distortions the interchange fee creates, especially the concern
for price increase and the inherent conflict of interest, my proposal is proportional and
constitutional. Moreover, the divestiture in our context is aimed to correct consequences of
horizontal price fixing between competitors, which is a per-se violation, and not merely a
merger, which is not prohibited per-se. Justification for divestiture in our context, is even
stronger than in the merger context.
851. Second, as a structural remedy, divestiture is preferable to behavioral remedies. The latter
requires ongoing supervision and is not as effective as structural remedies.1615 Divestiture, in
principal, does not require ongoing monitoring.1616 Indeed divestiture would end the
interchange fee from being a restrictive arrangement. Only the collective bargaining would
remain to be supervised, but as explained, this is a relatively minor concern.
852. Third, divested assets should include all parts of a viable business. An effective divestiture
must include all the assets, physical and intangible, necessary for the purchaser to compete
1613 British Merger Remedies: Competition Commission Guidelines, paras. 2.5 (Nov. 2008); see also id., 3.1: "[A]
divestiture seeks to remedy an SLC [substantial lessening of competition – O.B] by either creating a new source of
competition through disposal of a business or set of assets to a new market participant". 1614 C-202/06 P Cementbouw Handel & Industrie BV v Commission, para. 54 (Dec. 18, 2007): "[W]hen reviewing the
proportionality of conditions or obligations which the Commission may... impose on the parties to a concentration…
those conditions and those obligations are proportionate to and would entirely eliminate the competition problem that
has been identified".
See also IAA Merger Remedies Guideline, para 15;
British Merger Remedies: Competition Commission Guidelines, para. 1.9 (Nov. 2008): "In order to be reasonable and
proportionate the CC will seek to select the least costly remedy, or package of remedies, that it considers will be
effective. If the CC is choosing between two remedies which it considers will be equally effective, it will select the
remedy that imposes the least cost or that is least restrictive. The CC will seek to ensure, as outlined in paragraph 1.12,
that no remedy is disproportionate in relation to the SLC and its adverse effects.";
New Zealand Merger guidelines, Appendix 3 at para. 17 (Nov. 2008): "[T]he divestiture remedy should be
proportionate to the competition concerns or detriments and be effective in restoring or maintaining competition". 1615 British Merger Remedies: Competition Commission Guidelines, at 6 (Nov. 2008): "Restoring this process of rivalry
through remedies that re-establish the structure of the market expected in the absence of the merger (so-called structural
remedies such as divestitures) should be expected to address the adverse effects at source. Such remedies are normally
preferable to measures that seek to regulate the ongoing behaviour of the relevant parties (so-called behavioural
remedies such as price caps, supply commitments or restrictions on use of long term contracts) as these are unlikely to
deal with an SLC and its adverse effects as comprehensively as structural remedies and may result in distortions
compared with a competitive market outcome". 1616 British Merger guidelines, para. 2.6: "Divestitures will generally not require detailed monitoring following
implementation".
365
effectively.1617 Divestiture is applicable when the divested asset is viable as an independent
business.1618 Acquiring is definitely a stand-alone, viable and profitable business.1619 Acquiring
activities that are to be separated are relatively easy to identify. The rights and liabilities of
acquirers towards merchants are distinguished from rights and liabilities of issuers towards
cardholders. Assets of acquirers are relatively easy to allocate to a purchaser as an ongoing
business. Creating independent acquirers, preserves the competitive ability of acquirers,
without the distortion that causes acquirers to agree to pay high interchange fees to themselves
in their role as issuers.
In fact, my proposal lacks divestiture's difficulty known as "composition risks", which is the
concern, that the scope of the divestiture package may not be appropriately configured to allow
a suitable purchaser to operate effectively.1620 Acquiring is a stand-alone, identified, viable and
profitable business.
1617 DOJ Antitrust Division Policy Guide to Merger Remedies, at 7 (Jun. 2011): "First and foremost, to ensure an
effective structural remedy, any divestiture must include all the assets, physical and intangible, necessary for the
purchaser to compete effectively… The goal of a divestiture is to ensure that the purchaser possesses both the means
and the incentive to effectively preserve competition"; see also id. at 8: "The divestiture assets must be substantial
enough to enable the purchaser to effectively preserve competition… the Division often will insist on the divestiture of
an existing business entity that already has demonstrated its ability to compete in the relevant market".
European Commission Notice on Remedies Acceptable Under Council Regulation (EC), para. 23: "The divested
activities must consist of a viable business that, if operated by a suitable purchaser, can compete effectively"; id. para
30: "The business to be divested has to be viable as such" ¶ 35: "[N]ormally the divestiture of an existing viable stand-
alone business is required";
British Merger guidelines, paras. 3.6-3.9:" In identifying a divestiture package, the CC will take, as its starting point,
divestiture of all or part of the acquired business… the CC will normally seek to identify the smallest viable, stand-
alone business that can compete successfully on an ongoing basis and that includes all the relevant operations pertinent
to the area of competitive overlap… The CC will generally prefer divestiture of an existing business that can compete
effectively on a stand-alone basis independently of the merger parties";
Canada Merger Remedies, para 15: "A divestiture of a standalone operating business(es) means that the whole of one of
the merging parties’ overlapping businesses is to be divested. This includes all necessary management, personnel,
manufacturing and distribution facilities, retail locations, individual products or product lines, intellectual property (e.g.
including patents or brands), administrative functions, supply arrangements, customer contracts, government and
regulatory approvals, leases, and other components of an operating business";
French Merger Guideline para. 528: "For a divestiture to be able to effectively remedy anticompetitive effects, it is
indispensable that the divested activity should be viable and competitive". 1618 IVO VAN BAEL & JEAN-FRANCOIS BELLIS, COMPETITION LAW OF THE EUROPEAN COMMUNITY 778 (5th ed. 2010):
"[D]ivested activities must consist of a viable business that can compete effectively";
Opinion 2/11: Guidelines on Remedies to Mergers that Raise Concerns of Significant Harm to Competition, Antitrust
5001804, at 8 (Jul. 18, 2011); DOJ Antitrust Division Policy Guide to Merger Remedies, at 11-12 (Jun. 2011). 1619 RESERVE BANK OF AUSTRALIA, REFORM OF CREDIT CARD SCHEMES IN AUSTRALIA: A CONSULTATION DOCUMENT,
sec. 4.2 (December 2001): "Credit card issuing and acquiring are currently very profitable activities in Australia…
provision of credit card services generates revenues well above average costs, especially for financial institutions which
are both significant card issuers and acquirers. The margins are particularly wide in credit card acquiring (Table 4.1).";
IAA, FINAL REPORT ON ENHANCEMENT OF COMPETITION IN PAYMENT CARDS, at 6-7, Antitrust 500680 (Sept. 8, 2014).
See also supra ¶¶ 60, 97, 574, supra note 788. 1620 New Zealand merger Guidelines at Appendix 3 p. 64: "Each of the key aspects of the divestiture may be susceptible
to a number of risks such as: • composition risks—the scope of the divestiture package may not be appropriately
configured (or sufficiently wide, say, in product range) to attract a suitable purchaser or allow a suitable purchaser to
operate effectively".
366
853. Fourth, the purchaser is required to be independent of and unconnected to the parties.1621
Purchasers of divested assets should not be linked or associated to sellers, as such links may
compromise purchaser’s ability to compete, or soften competition between the buyer and the
seller.1622 Indeed, this is the crux of my proposal. Divested assets should be sold to an
independent purchaser who would operate the acquiring business, and shall not be connected
in any way to the selling side.
854. Fifth, the customary condition in the guidelines is that divested assets would be sold only to
capable purchasers with appropriate financial resources and expertise.1623 This goes without
saying in my proposal. Acquiring is a financial activity that requires a license under the Banking
Law. Independent acquirers must be entities with financial strength and verified corporate
governance. Indeed, independent acquirers are deemed to stand up to any merger guidelines
capability demands.
1621 European Commission Notice on Remedies Acceptable Under Council Regulation (EC), paras. 47- 48: "The
intended effect of the divestiture will only be achieved if and once the business is transferred to a suitable purchaser in
whose hands it will become an active competitive force in the market... 48. The standard purchaser requirements are the
following: — the purchaser is required to be independent of and unconnected to the parties".
Opinion 2/11: Guidelines on Remedies to Mergers that Raise Concerns of Significant Harm to Competition, Antitrust
5001804, para 22 (July 18, 2011);
DOJ Antitrust Division Policy Guide to Merger Remedies, at 28 (Jun. 2011);
British Merger Remedies: Competition Commission Guidelines, para. 3.15 (Nov. 2008): "The identity and capability of
a purchaser will be of major importance in ensuring the success of a divestiture remedy... The CC will wish to satisfy
itself that a prospective purchaser is independent of the merger parties… (a) Independence—The purchaser should have
no significant connection to the merger parties that may compromise the purchaser’s incentives to compete… for
example, an equity interest, shared directors, reciprocal trading relationships or continuing financial assistance".
Australian ACCC Merger Guidelines, Appendix 3, at 64 (2008): "As a general rule, divestiture undertakings aim to
ensure that the ultimate purchaser of the divestiture assets will be a viable, long-term, independent and effective
competitor… purchasers should be independent of the merged firm and possess the necessary expertise, experience and
resources to be an effective long-term competitor in the market";
Canada, Competition Bureau, Information Bulletin on Merger Remedies in Canada, para. 13 (Sept. 22, 2006): "[T]he
buyer must be independent and have both the ability and intention to be an effective competitor in the relevant
market(s)."; id. para. 58: "[T]he buyer must be independent (i.e., at arm’s length) from the vendor";
New Zealand, Commerce Commission, Mergers and Acquisitions: Divestment Remedies Guidelines, para 4.19 (Jun.
2010): "Examples of attributes that may make a buyer acceptable are: it is independent of the merged entity". 1622 British Merger Guidelines, para. 3.18: A purchaser should not have continuing links with the merger
parties after divestiture that may compromise the purchaser’s incentives to compete with these parties. 1623 British Merger Guidelines para. 3.15(b): "Capability—The purchaser must have access to appropriate financial
resources, expertise and assets to enable the divested business to be an effective competitor in the market. This access
should be sufficient to enable the divestiture package to continue to develop as an effective competitor";
Canada Merger Remedies: "An acceptable buyer must have both the ability and incentive to compete, so that
competition will be preserved in the relevant market(s). The buyer must operate independently of the merged entity in
all aspects of competition, even if various means of support (e.g. supply arrangements and other forms of technical
assistance) are part of the remedy package for a transitional period of time";
French Merger Guideline para. 535: "A divestiture is only efficient if the buyer is suitable, i.e. if: the buyer is
independent of the parties, in capitalistic as well as in contractual terms; it must have the adequate competence and
financial capacity in order to develop the activity and efficiently compete with the merging parties";
367
855. Sixth, "purchaser risk", which is the risk that: "a suitable purchaser may not be available",1624
and which is a regular concern in divestitures, would probably not arise here. Independent
entities that currently operate back-office acquiring are perfect candidates to be acquirers. They
have the financial strength, the technology, the know-how and the proper corporate governance.
In fact, current back-office factoring and processing firms, such as Gama, already applied for
an acquiring license.1625 Other international firms that currently operate back-office acquiring,
such as Gemalto, Verifone, Credorax, TSYS1626 and more, are also perfect candidates to
become independent acquirers.
The acquiring side is also attractive to credit suppliers, as it can easily be expanded for loans to
merchants. Thus, purchasing acquiring activity might be attractive for smaller banks, which are
not involved in issuing (such as Jerusalem or Igud banks in Israel), and for other financial
entities such as pension funds or insurance companies. Those entities might want to expand
their activities and become acquirers, alone or in a joint venture with current back-office
acquirers. Thus, in my view, purchaser risks do not arise.
856. Seventh, another difficulty of divestiture in merger context, which does not arise here, is known
as "asset risk". This concern is that the competitive capability of a divestiture package may
deteriorate significantly before completion of a divestment.1627 The reason this concern does
not arise here is pinned to the unique features of two-sided markets. Because each transaction
requires issuer and acquirer, harm to the acquiring (or issuing) side before selling it would first
and foremost damage the issuing (or acquiring) sellers. Any deterioration of one side would
reflect in worsening the other side and is equivalent to a deterioration of the network as a whole.
857. As with post-merger divestitures, the buyer should have full access to infrastructures. Presently,
acquirers have full access to the payment card infrastructure. This must remain with
independent acquirers. Otherwise, incumbent issuers can use the necessity of access to
1624 NIGEL PARR ET AL., UK MERGER CONTROL: LAW AND PRACTICE §9.104 (2nd ed. 2005): "The second risk factor
highlighted by the commission is that a suitable purchaser for the business to be divested may not be available". See
also New Zealand merger Guidelines, Appendix 3 at 64. 1625 Tomer Varon, Gama on its Way to Become Fourth Competitor in the Credit Market, Calcalist (Aug. 8, 2015). 1626 See their websites for description of their acquiring capabilities: http://www.gemalto.com/ ;
http://www.verifone.com/ ; https://www.credorax.com/ ; http://tsys.com/solutions-services/acquiring-services/ . 1627 British Merger Guidelines para. 3.3(c): "Asset risks—these are risks that the competitive capability of a divestiture
package will deteriorate before completion of divestiture, for example through loss of customers or key members of
staff". See also New Zealand merger Guidelines, Appendix 3 at 64.
368
infrastructure (in which they sometimes control, like in Israel via SHVA and MASAV) as an
entry barrier.1628
13.6. Final remarks
858. Interchange fee that would be determined by independent acquirers, would eliminate the self-
dealing mechanism that distorts its setting. Such an interchange fee would not for itself be a
restrictive arrangement. Given the default of zero, the probable result is that the interchange fee
would be close to the optimal interchange fee from the consumer welfare standard, i.e., the
lowest fee that will maximize the volume of efficient transactions.1629 If acquirers would not
have any ownership interest on the issuing side, they would not agree to pay any interchange
fee that is used to finance issuers’ profits (cozy cartels) or “wasteful competition”.1630
859. The direct effect of lowering the interchange fee reflects significant cost savings and a possible
small but market-wide price reduction of final goods. In Israel, every 0.1% decrease in
interchange fees is tantamount to more than NIS 260 million annual savings for merchants.1631
Merchants who operate in competitive markets are likely to pass through their savings to final
prices, at least in the long run. However, even in the absence of significant pass through, as
Rochet & Tirole explain, from allocative efficiency point of view, it is more efficient if cost-
savings stay with merchants than delivered to issuers.1632 Indeed, the consumer welfare standard
is comprised of merchants and consumers (and not issuers and acquirers). The consumer
welfare standard is satisfied if the surplus of merchants expands, even with no pass through to
final prices, as merchants are the consumers, let alone if competitive constraints compel pass
through to final prices of goods.1633
860. The cost savings of not having to monitor and scrutinize the interchange fee level are
substantial. Enormous resources are invested today by regulators, such as Courts, Tribunals,
1628 British Merger Guidelines para. 3.18: "[P]urchasers may require access to key inputs or services at appropriate
terms from the merger parties". 1629 Supra ch. 6.9.4 (Conumer Welfare Optimal Interchange Fee). 1630 Supra ¶ 299 (Competition for cardholders might yield lower cardholder fees and higher MSF than under a
monopoly, a phenomenon that is sometimes referred to as "wasteful competition"); ¶ 479 (Rochet & Tirole call issuers'
profits, which are derived from interchange fees, “cozy cartel”); ¶ 301, ¶ 480 notes 544, 814, 826 (the phenomenon in
which issuers artificially inflate their costs to justify high interchange fee is called “wasteful competition"), ¶ 732, ¶ 788
(Zero interchange fees would have a positive effect by reducing "wasteful competition" (i.e., redundant rewards) or
"cozy cartels" (using the interchange fee as a disguise for profits)). 1631 Supra ¶ 89. 1632 Supra ¶ 407 (Consumers of the payment card networks, i.e., merchants and customers, have greater utility from
money than ultimate beneficiaries of the supply side i.e., the shareholders of the issuers and the acquirers. Thus,
expanding consumer surplus contributes greater value to social welfare, even if it is at the expense of producer surplus). 1633 Supra ch. 6.9.4 (Consumer Welfare Optimal Interchange Fee)
369
competition authorities and central banks, in supervising the levels of the interchange fees.
Despite the enormous efforts and resources, current regulation which is aimed at capping the
interchange fee, mostly cost-base caps, yields poor results.1634 Significant portion of those costs
might be substantially reduced. Considering the huge profit margins of issuers, and their
growing channels of direct income from interest and cardholder fees, my suggestion, even if
implemented, would not have a substantial effect on their stability. Both the acquiring and the
issuing sides would probably remain highly profitable.1635 However, as with any reform,
monitoring the stability of the payment card networks and their participants after the divestiture
is warranted.
14. Novelty # 2 Profit Limitation
861. My first innovation, discussed above, is a regulatory initiative that should be anchored in a
primary law, to bring about a structural reform in payment card networks. Structural separation
would “break” the interchange fee from being a restrictive arrangement of price fixing. The
innovation discussed in this chapter is an alternative and independent proposal. It may be
implemented alone. It is a regulatory policy aimed at incentivizing issuers to give up
interchange fees. It sets a standard that imitates the consumer-welfare socially optimal
interchange fee, i.e., maximizing efficient card transactions subject to keeping prices of goods
equal to their cost of production. Profit limitation does not “break” the interchange fee from
being a restrictive arrangement, but rather eliminates the competitive concerns and neutralizes
the negative consequences of interchange fee, i.e., price increase of goods and negative usage
externality. Profit limitation may be applied by a regulator or a tribunal, as a condition for
permitting an interchange fee arrangement. In countries where interchange fee is not regulated,
implementation of my proposal is more challenging. It requires an authority - i.e., a regulator
or another enforcer - that is empowered to initiate proceedings, after a former arrangement has
crossed scrutiny and even got approval. Such authority is not trivial and might require
anchorage in primary or secondary legislation.
That being said, regulators usually have sua sponte power (and duty) to scrutinize from time to
time restrictive arrangements, even those that were formerly approved. Regulators are often
obligated by rules of the administrative law, to weigh and consider if existing regulation is still
1634See supra ch. 8.1.1 (Criticism Of The Cost-Based Methodology); ch. 8.2.2 (Criticism Of The Tourist Test). 1635 Supra ¶¶ 60, 96, 503, 574 and note 370.
370
beneficial to the public when considering time passage and circumstantial changes.1636
For example, under rule of reason and self-assessment analysis, some countries currently do
not regulate the interchange fee. However, this does not imply that interchange fee (which to
remind, is a minimum price fixing between competitors), is immunized from future regulatory
intervention. Imagine interchange fee in the U.S. jumps to 17%. Regulators would certainly not
sit idle and be barred from intervention. Lack of intervention in self-assessment regimes does
not immune the interchange fee from future intervention, if it is abused. If a regulator would be
convinced by my proposal that current approach (e.g., of no interference or capping fee level)
harms the public, but capping profit confers benefits, such regulator may have powers to initiate
proceedings and resume interference in the interchange fee setting.
My proposal is inspired by the policy of the U.S Federal Reserve System from over a century
ago that caused banks to give up interchange fees in checks.1637
14.1. Par Clearance of Checks
862. Since ancient times, issuers of money charged exchange fees for acquiring "their" money.
Frankel explains, that: "Market power in modern electronic payment systems… arises from the
same fundamental economic source as the market power once available only to emperors and
kings who issued coins stamped from precious metals".1638 First interchange fees were actually
seigniorage, i.e., fees that mints (belonged to the king) charged for exchanging "gold bullions
presented by merchants in exchange for gold coins."1639 Bullions were not redeemed (i.e., -
1636 AT 508/04 Taagid Haisuf v. Adam Teva Vadin, para. 14 (Sept. 13, 2005); CA 2063/16 Glik v. Israeli Police, para.
30 (Jan 19, 2017); HCJ 986/05 Peled v. Tel-Aviv Municipality, para. 14 (Apr. 13, 2005).
See also State Oil Co. v. Khan, 522 U.S. 3, 20 (1997): "In the area of antitrust law, there is a competing interest, well-
represented in this Court's decisions, in recognizing and adapting to changed circumstances and the lessons of
accumulated experience."; Maislin Indus., U.S. v. Primary Steel, 497 U.S. 116, 122 n.4 (1990): "[i]t would be . . . well
within this agency's authority (and indeed duty) to reinterpret the Interstate Commerce Act, based on upon experience
gained and changing circumstances." See also 19 U.S.C.S. § 1675(b) (Review upon information or request): "Whenever
the administering authority… receives information concerning… changed circumstances sufficient to warrant a review
of such determination, it shall conduct such a review". Subsection (c) determines a duty to conduct an additional five-
year review". 1637 William F. Baxter, Bank Interchange of Transactional Paper: Legal and Economic Perspectives 26 J.L. ECON. 541,
566 (1983): "[T]he practices and rules of the Federal Reserve Board, which the legislation created, eventually tipped the
balance in for of par clearance in the United States." See also supra ¶ 785. 1638 Alan S. Frankel, Monopoly and Competition in the Supply and Exchange of Money 66 ANTITRUST L.J. 313, 314
(1998). 1639 Ibid at 315.
371
acquired) at their PAR value, because of the seigniorage, i.e., the (interchange) fee merchants
had to pay to the mints.
In the U.S., bank notes were the first commercial paper money in circulation. "[B]ank notes
were promises by state chartered banks to remit to bearers on demand the stated amount in
specie (gold)."1640 The issuer bank was required to redeem notes at par if they were presented
physically over the counter at the issuing bank.1641 Bank notes were two-sided products.
Merchants wanted to accept only common payment instruments. Consumers wanted to pay only
with payment instruments that were widely accepted. Banks that wanted to convince merchants
and consumers to hold and accept bank notes they issued, had to find effortless ways for settling
them.1642 Banks entered bilateral agreements with other banks, for mutual acquiring of their
bank notes, in exchange for an (interchange) fee from the acquirer to the issuer. Bank notes
interchange fees reflected the saved shipping costs from not having to travel to the issuing bank
for redemption at the counter, and the travel back with specie.
As volume of transactions grew, banks formed the first clearing houses. Banks that belonged
to clearing houses could acquire at par, bank-notes of all other banks that belonged to the
clearing house. However, some rural banks did not join the clearing houses. They exploited
their (market) power from being located in remote areas to charge high interchange fees for
non-counter redemption of their notes.1643 On the other hand, notes of those non-par rural banks
circulated at par, because merchants tend to "price coherence" i.e., merchants did not surcharge
customers who paid with non-par bank notes bearing high interchange fees.1644 Absurdly, those
(expensive) notes were the most circulated, thus excluding cheaper bank notes.1645 The reason
was that neither merchants nor consumers wanted to be stuck with notes bearing high
interchange fees, thus fulfilling Gresham's Law – bad money drives out good money.1646
1640 Ibid at 320. 1641 Ibid at 322. 1642 Supra ¶72. 1643 Frankel, Monopoly and Competition in the Supply and Exchange of Money, supra note 1638, at 322 – 325. See also
DAVID S. EVANS & RICHARD SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION IN BUYING AND
BORROWING chapter 2 (2d ed. 2005); Baxter, supra note 1637 . 1644 For reasons why merchants do not surcharge see supra ch. 11. 1645 Baxter, Bank Interchange of Transactional Paper, supra note 1637, at 557: "[I]nferior country bank notes of
uncertain value tended to drive sounder city bank notes out of circulation." 1646 Frankel, Monopoly and Competition in the Supply and Exchange of Money, supra note 1638, at 325-326: "Some
banks refused to participate in clearinghouse arrangements. In particular, rural banks lacking local competition found
that they could profit by imposing exchange charges on notes sent for redemption by city banks in the region. As the
general practice of par acceptance grew, it made less sense for merchants to slow down their transactions by going to
the trouble of identifying which notes incurred exchange charges and how much... Just as clipped and debased coins
tended to drive out coins of full gold content and value, nonpar bank notes tended to displace par notes circulating in the
372
863. Checks gradually replaced bank notes. As with bank notes, banks that issued checks preferred
not to impose costs on the drawer (their customer) but on the receiver, often a distant merchant.
Except when checks were presented at the counter of the issuing bank, acquiring checks entailed
payment of interchange fee from the acquiring bank to the issuing bank. The interchange fee
reflected the cost saving for the payee, of not having to travel to the counter of the issuing bank
and return with specie. Increase in circulation of checks caused merchants not to bother with
surcharging. Hence goods were sold at the same price to check payers, albeit accepting
merchants had to pay interchange fees for redeeming them. As with bank notes, clearing houses
for checks, in which checks of members were cleared at par, were established. But many rural
banks did not join clearing houses, and enjoyed interchange fees imposed on banks with which
they had bilateral acquiring agreements.1647 However, the ultimate payer was the customer of
the acquiring bank, most often the merchant. Thus, just like ancient bullions or former bank
notes, acquiring checks of rural banks which were not members of the clearinghouses, entailed
payment of interchange fee to the issuing bank.1648
864. On that background the Federal Reserve System, created in 1913, was empowered to establish
a par collection system.1649 The Federal Reserve Act "provided that the Federal Reserve Board
would establish a check clearance system throughout the United States."1650 The federal
clearance system operated on national scale and cleared checks of member banks at par. The
federal clearing system gradually supplanted banks' clearing houses. The Federal Reserve
enticed banks to join its nation-wide (and par) clearing system, by enabling members to acquire
checks drawn on non-members banks, that were forwarded by a member bank to the clearing
system.1651 Nevertheless, thousands of banks still remained off the par list, i.e., demanded
interchange fees for non-counter clearance.1652 The next move of the Federal Reserve in order
to force non-member banks to waive interchange fees, was to collect and suddenly present at
the counter, checks of refusers banks:
[In 1919, the Federal Reserve] began to accept for clearance items drawn on
nonpar banks and then to demand that they be paid at par. If that request was
cities. This illustrates a second way to restate Gresham's Law: Restatement #2: Expensive forms of money tend to
displace the inexpensive". 1647 Baxter, Bank Interchange of Transactional Paper, supra note 1637, at 563-64. 1648 Id. at 565. 1649 Frankel, Monopoly and Competition in the Supply and Exchange of Money, supra note 1638, at 335: "The Federal
Reserve System, established by the Federal Reserve Act of 1913, was empowered to establish a general system of par
collection for all member banks". 1650Baxter, Bank Interchange of Transactional Paper, supra note 1637, at 567. 1651 Id. at 567-68. 1652 Id. at 569
373
refused, as it often was, the local reserve bank gathered up the checks of the nonpar
banks and presented them at the bank's premises ("at the window"), demanding
payment in full in currency. This tactic proved to be very powerful… The batch
presentation of checks in the manner described often required more currency then
the bank had in its vault; yet if payment in full was not made, the checks could be
returned to the depositor dishonored, placing the drawee bank in violation of its
contractual obligations to its customer. Through this tactic the Fed succeeded in
forcing many recalcitrant banks onto the par list".1653
865. The legality of this practice was supported by the Federal Supreme Court. Judge Brandeis, who
delivered the opinion, held:
Country banks are not entitled to protection against legitimate competition. Their
loss here shown is of the kind or which business concerns are commonly subjected
when improved facilities are introduced by others, or a more efficient competitor
enters the field. It is damnum absque injuria.1654
866. The Federal Reserve never prohibited interchange fees in checks. It wisely managed to persuade
(or one might say coerce) banks to voluntarily give up interchange fees, by offering carrot to
par banks and a stick to nonpar banks. The practices of the federal bank were an important mean
to achieve a nationwide par clearing system.1655
867. Back to the future of payment cards, my idea is to persuade issuers to give up interchange fees,
by offering them a carrot if they do so and a stick if they do not. Interchange fees are a product
of arrangements that require regulatory approval. An approval can be conditioned. My proposal
is to impose a condition on any approval of interchange fee arrangement, which issuers would
prefer to refrain from, unless the interchange fee is indeed essential to cover costs or to
genuinely reward cardholders (which is also a “marketing” cost). Issuers have two channels of
income. Direct channel from cardholders and the interchange fee from merchants. The latter is
the sole income of issuers from merchants, and cannot be circumvented.1656 The carrot to issuers
that would agree to waive interchange fees, and be satisfied with the direct channel of income
from the cardholder side, would be no regulation on their rate of return, i.e., their profitability.
The condition, i.e., the stick, in the case issuers decide to continue charging interchange fees,
is to impose limitation on their profit. Given that the reasoning for interchange fee is not to be
a source of profit, but only to cover uncovered costs and to genuinely reward cardholders, the
1653 Id. at 570. 1654 American Bank & Trust Company V. Federal Reserve Bank of Atlanta, 262 U.S. 643, 648 (1923) 1655 Baxter, Bank Interchange of Transactional Paper, supra note 1637, at 570; Evans & Schmalensee, The Economics
of Interchange Fees and their Regulation, supra note 1330, at 91: “The check system in the US is run by the Fed. Res.,
which essentially forced banks early in the last century to exchange checks at par—that is, to have a zero interchange
fee in the checking system”. 1656 Supra note 918 and accompanying text.
374
condition would lead to an efficient result. Issuers would not charge interchange fee, unless
used for its legitimate purposes.
14.2. Profit Limitation
868. The basis to my proposal is that interchange fee is justified only by necessity to internalize
usage or network externalities. The argument is either that interchange fee is required to
reimburse issuers for uncovered costs, and to enable expansion of the network (the network
justification);1657 or to induce efficient usage by passing proceeds of the interchange fee (above
transaction cost) to cardholders, as discounts or rewards, and by that incentivize efficient card
usage (the usage justification).1658 Come what may, under both justifications for interchange
fees, it is not meant to be a source of profit:
868.1 When the interchange fee is required to cover costs of transaction, then by definition
it cannot be a source of profit;
868.2 When the interchange fee is required to reward cardholders (which is also a kind of
cost), then also by definition it cannot be a source of profit;
869. When the interchange fee is used either to cover costs or to induce expansion of the network or
efficient card usage, using it as a source of profit causes it to fail its cause. If part of the
interchange fee is retained as issuers' profit, merchants could enjoy the same level of usage with
a lower MSF.1659 Any part of the interchange fee that is used as a source of profit cannot, by
definition, cover costs or induce efficient usage. It would have been better, from a social point
of view and under consumer welfare standard, if this part of the interchange fee would not be
granted a license, not be collected in the first place, and prices in the market would be a little
lower.1660 Simply put, interchange fee cannot serve as profit source under the pretext of
1657 Supra ¶¶ 488, 174-175. 1658 Ann Borestam & Heiko Schmiedel, Interchange Fees in Payment Cards, ECB Occasional Paper Series 131, at 30
(2011): "[I]nterchange fee is an indispensable income source for issuing banks, allowing them both to cover the costs
related to their card operations and to avoid charging cardholders."; see also ibid at 48, 53. for expansion, see supra ch.
6.7 (Cardholder fees and rewards). 1659 Supra note 1075 (In the terminology of Rochet & Tirole, under the consumer welfare standard, using interchange as
a source of profit causes it to fail the tourist test. Merchants would agree to pay interchange fee that is used to steer a
tourist to pay with efficient card because merchants derive benefit from steering to efficient payment instruments.
However, interchange fee that is used as a source of profit for issuers causes price increase and thus fails the tourist test.
Merchants (or consumers) derive no benefit from such profit). 1660 For expansion on price increase due to the interchange fee, see supra ch. 10.1. See supra ch. 10 for competitive
concerns raised by interchange fees in general.
375
internalizing usage and network externality. The unique features of the interchange fee which
justify its initial approval, do not include profit as part of the justification.1661
However, issuers earn profits from the interchange fee, contrary to its declared purpose. Worse,
they do it under regulatory approval. Payment card firms earn average rate of return that is more
than twice the customary rate of return in the financial industry.1662 In practice, as opposed to
the opinion of early scholars, interchange fee is not neutral,1663 but a major source of profit for
issuers.1664 This is not a predestination. Interchange fee can and should be approved, subject to
conditions that would ensure it is not used contrary to its declared goals. It is warranted to
prohibit issuers from abusing the purposes underlying the interchange fee, which they
themselves claimed that interchange fee is required for.
870. Indeed, competition authorities and regulators find it legitimate to condition approval of
restrictive arrangements in general and interchange fees specifically, in terms aimed to prevent
abuse.1665 Until today, regulators conditioned the approval of the interchange fee by capping its
level.1666 Scholars, regulators and competition authorities, attempted to combat the competitive
concerns by capping the level of the interchange fee.1667 No previous work proposed to combat
the market power of issuers by limiting their profits. My proposal is to condition the approval
of the interchange fee by capping it from being a source of profit.
1661 For expansion on the special features of the interchange fee that justify its approval, see supra ch. 7. For a legal
analysis, which (of course) do not contain profits as a basis for the interchange fee approval, see supra ch. 0. 1662 Supra ¶¶ 60, 96; see also supra notes 127, 370, 371, 1480, 1619.
See also EUROPE ECONOMICS, THE ECONOMIC IMPACT OF INTERCHANGE FEE REGULATION IN THE UK FINAL REPORT, at
52 (June 28, 2013): "[C]ompared to most other commercial bank activities credit cards still remain more profitable than
these.";
GAO-10-45, RISING INTERCHANGE FEES HAVE INCREASED COSTS FOR MERCHANTS, BUT OPTIONS FOR REDUCING FEES
POSE CHALLENGES, at 1 (2009): "Issuers, particularly smaller issuers such as community banks and credit unions, report
relying on interchange fees as a significant source of revenue for their credit card operations, and analyses by banking
regulators indicate such operations traditionally have been among the most profitable types of activities for large
banks." 1663 For neutrality of interchange fee, see supra ¶103. For negation of the neutrality see supra ch. 8.3.3. 1664 Balto, supra note 1432, at 221; Frankel & Shampine, The Economic Effects of Interchange Fees, supra note 1345,
at 634 n. 23. See also Thomas A. Durkin, Gregory Elliehausen & Todd J. Zywicki, An Assessment of Behavioral Law
and Economics Contentions and what we Know Empirically about Credit Card use by Consumers, at 38 (George
Mason Law & Econ. Research Paper no. 14-46, 2014): "[I]n every year after 1991, except 1998, revenue from
interchange actually exceeded net income after taxes (net profit) for the industry as a whole. Consequently, it seems
difficult to contend that interchange is not a “major” source of revenue".
See also supra ¶¶ 60, 96, 182. 1665 For an extensive survey see supra ch. 0 (Regulation of interchange fees around the world). 1666 Supra ¶ 373 (Rochet & Wright claim that capping privately determined interchange fee will decrease it, and
increase consumer surplus) .In Europe, the cap is based on demand features, primarily the alternative benefit to
merchants from not having to accept cash (avoided costs of cash or the "tourist test"), supra ch. 8.2). In Israel, Australia
and in the U.S. (for debit and deferred debit cards), the cap is based on supply features, which are mainly the cost of the
payment guarantee and the processing of transactions, see supra ch. 8.1, 8.1.1 (Israel), 8.3.9 (U.S.), 8.4 (Australia). 1667 Id.
376
To be clear, my proposal is to limit total issuers' profits from all sources, to a modest rate of
return. I do not propose to limit only profit from interchange fee, as there is no such profit.
Interchange fee proceeds mix and merge with proceeds from other channels of issuers' income,
and cannot be segregated.
If issuers are also acquirers the profits from the two-sided merge. According to my proposal,
issuers would not be able to claim that they use the entire proceeds from interchange fee to
cover costs and to reduce cardholder fees, but simultaneously use other channels of income,
such as cardholder fees or interest, for profit. This would be a forbidden wisecrack. As long as
issuers are also acquirers, then the profit limitation should apply to all of their activities, i.e.,
profit from issuing and acquiring should be limited.
Applying for interchange fee should be a last resort, after exhausting all other channels of
income available for issuers. Applying for interchange fee, but simultaneously gaining profits
from other channels of income (e.g., from the acquiring side or from cardholder fees or from
interest on credit to cardholders or merchants), is contradictory. If issuers' income apart from
interchange fee is high enough to cover costs and to allow a prosperous cardholder side, let
alone make profits, this pulls the rug under the justifications for interchange fee. Only if other
channels of income do not suffice, then the interchange fee excuses are recruited (to cover
uncovered costs and reward cardholders).
My proposal stems directly from asymmetric pricing, which is a basic feature in two-sided
markets. In two-sided markets, before resorting to price fixing, one side should finance the
other.1668 If issuers and acquirers are not separated, profits from the acquiring side should be
recruited to finance pecuniary demands of the issuing side, before resorting to interchange fees.
For example, a newspaper cannot claim it does not earn enough from readers, as an excuse for
fixing the prices of advertisements with other newspapers. In the same manner, shopping malls
cannot fix parking fees, to cover purported "deficit" on the customer side. Two sided platforms
must use their proceeds from the two sides to cover their costs, exactly the way they use their
proceeds from the two sides to make profits. Asymmetric pricing is a fundamental feature of
two sided platforms, which also applies to payment cards.
1668 Supra ¶¶ 449-454.
377
In Israel, each payment card firm is a separate legal entity. Each payment card firm operates a
payment card business as its sole activity, and is a distinguished profit center for its
shareholders. Hence in Israel, there is no problem for immediate application of my proposal. In
the unlikely event that payment card firms are not unified as separate legal entities, or at least
as separate profit centers, it is still possible to delineate their cost and income,1669 and assure
that if they charge interchange fee, their profit would be limited. Payment card business is a
distinguished field of operation, different from other financial activities, and its costs and
income can be isolated effortlessly. Thus, even in the unlikely event that issuers are not separate
entities, my proposal can be easily implemented. However, for facilitation of the proposal it
would be simpler to require issuers to unite into a distinguished form of association.
My proposal can be illustrated in the following example. Assume beggars need a license to beg
for alms, and this license is conditioned in that the beggar does not have other income. If he
does have other income he must use it and he is not entitled for a license to beg. A beggar that
drives to his luxurious house in a fancy car abuses his license and probably is not entitled for
license from the outset. The idea is that interchange fee should not be double compensation.
The observation point should be comprehensive. All sources of income should be considered
and recruited, before granting a license that depends on the need to cover costs.
871. Baxter's interchange fee was a mean to cover "issuers' deficit", and not a tool for profit.1670
Rochet & Tirole explained that in addition to cost coverage, interchange fee can stimulate
efficient usage of cards. They referred to market power of issuers as a cause for raising the
interchange fee, in order to offset the unfortunate results of that market power, which allegedly
causes sub-usage of cards. Thus, even according to Rochet & Tirole, the profit-part of the
interchange fee was an unpleasant consequence of issuers' market power, and not a justification
to its initial approval. To combat such an unpleasant result, Rochet & Tirole proposed that under
the consumer welfare standard, profit from interchange fee should not be counted in the
interchange fee calculation.1671 Otherwise, Rochet & Tirole explained, profit of issuers who do
not compete but enjoy the "easy life" created by the interchange fee, is tantamount to a “cozy
cartel”:
Cozy cartel: In this first view, issuers’ markup stems from tacit collusion among
large issuers protected from effective entry by barriers to entry. Furthermore, the
1669 See, e.g., ¶ 463 (The European Commission calculated the profitability of payment card activities of banks). 1670 For expansion, supra ch. 6.2. (Baxter model of balancing costs). See also ¶ 339. 1671 For expansion, supra ch. 6.4 (The model of Rochet & Tirole).
378
resulting supra-normal profits are either dissipated through an “easy life” and
inefficient production of card services, or go to wealthy shareholders whose
marginal utility of income is much lower than that of the average consumer. Then
issuers’ markup should not be counted as part of social welfare.1672
872. The proposal of Rochet & Tirole (under consumer welfare standard), was to ignore issuers'
profit in calculating the level of interchange fee ("markup should not be counted"), and to cap
the level of the interchange fee, so it would not account for issuers profit. They did not propose
to limit profitability of issuers as I do.
Vickers also argued that the initial market power of issuers should not be contemplated with.
He argued that allowing issuers to earn profits from interchange fee, which is collected in order
to satiate hunger for profits, is tantamount to subsidizing cartels.1673 Vickers also did not
propose to limit profits but to cap the level of the interchange fee, as did Rochet & Tirole.
Indeed, regulators all over the world cap the level of the interchange fee.
However, capping the level is often arbitrary, because the chosen level does not purport to be
optimization of any welfare standard. A cap assures issuers a certain amount of money, without
considering other sources of income.1674 Under my proposal the interchange fee can be larger
or smaller than any percentage or cap. What is important under my proposal is not the amount
of money collected by the interchange fee, but the designation of the proceeds. Interchange fee
cannot be a source for double compensation but collected only for justified causes, i.e., covering
uncovered costs or rewards to induce efficient usage, but not for profits.
My proposal is actually a solution to the problem of finding the optimal interchange fee, with
no need to solve the incredibly sophisticated equations of the economic models which attempted
to depict the optimal interchange fee. My solution is not mathematical but rather a principal
1672 Jean-Charles Rochet & Jean Tirole, Externalities and Regulation in Card Payment Systems, 5 REV. NETWORK
ECON. 1, 11 (2006); See also Steven Semeraro, The Antitrust Economics (and Law) of Surcharging Credit Card
Transactions, 14 STAN. J. L. BUS. FIN. 343, 345-46 (2009): “Card issuers may then retain some revenue as
supracompetitive profit and wastefully compete some away in pursuit of highly profitable cardholders.”;
Jean Tirole, Payment Card Regulation and the use of Economic Analysis in Antitrust, supra note 951, at17: “If the
profits associated with cardholders’ installed base are dissipated through wasteful advertising expenditures to “acquire”
cardholders, profits should not enter social welfare calculations.”.
see also supra notes 708,710,1676. 1673 John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the Interchange Fee,
Payments Sys. Research Conference 231, 235 (2005); Alan S. Frankel, Towards a Competitive Card Payments
Marketplace, RBA 27, 46 (2007); Alan Frankel, Interchange in various Countries: Commentary on Weiner and Wright,
FRB Kansas 51, 54 (2005). 1674 Supra ¶ 510 especially notes 900 and 905.
379
that is guaranteed to bring interchange fee to the optimum. Prohibiting interchange fee from
being a source of profit would compel it to its legitimate original boundaries, and no more.
873. Consumer welfare standard is the standard to be maximized under current view of antitrust
law.1675 Under consumer welfare standard, optimal interchange fee excludes profit of issuers
and acquirers.1676 Of course issuers and acquirers can earn unlimited and unregulated profits,
but not through a cartel. It is legitimate to demand that profits would not stem from the
restrictive arrangement of the interchange fee, but from the transparent competitive arenas they
compete in.
Optimization of consumer welfare does not derive a specific level of interchange fee. There is
no formula that yields an exact rate of optimal interchange fee, which is used solely for
legitimate purposes, and that can be translated to a level of interchange fee.1677 However, the
true economic condition for maximizing consumer welfare does imply that the optimal
interchange fee is the one which issuers earn zero profits from, and prices of goods are set
according to costs.1678
My proposal imitates the economic condition for optimal interchange fee according to the
consumer welfare standard. The idea is to permit issuers to charge interchange fee in one
1675 Supra note 943; see also supra ch. 6.9.4. 1676 Jean-Charles Rochet & Jean Tirole, Must-Take Cards: Merchant Discounts and Avoided Costs, 9 J. EUR. ECON.
ASS'N 462, 486 (2011): “TUS, equal to cardholders’ plus merchants’ surplus, that is not including issuer markups”. For
a further expansion see supra ¶¶ 408-410. See also Rochet & Tirole, Externalities and Regulation in Card Payment
Systems, supra note 710, at 10-11; Marc Rysman & Julian Wright, The Economics of Payment Cards, at 34-35 (2015):
"[T]he Baxter interchange fee does have some grounding in economic theory. In some standard theoretical settings, it
corresponds to the socially optimal interchange fee absent issuer margins. And, with positive issuer margins, it can
be justified either as providing a lower bound for the socially optimal interchange fee or being the interchange fee
which maximizes total user surplus (or consumer surplus). Rochet and Tirole (2011) have developed a related
alternative to the Baxter interchange fee in terms of a merchant indifference test, which they called the tourist-test (as
discussed in Section 4). It implies the same interchange fee as Baxter's except that it is lower than Baxter's to the extent
acquirers make positive margins. The European Commission is proposing to use this tourist-test interchange fee to
determine the regulatory cap". id. at 35: “Whether this approach is considered a reasonable benchmark depends on
whether one thinks total welfare or consumer surplus is the relevant objective. To the extent that issuers obtain positive
margins, a welfare standard would require an interchange fee above the Baxter level in order to offset these margins.
Thus, a Baxter interchange fee would be a lower bound to the desired interchange fee. Some policy-makers and
economists have criticized a welfare standard arguing it would be equivalent to subsidizing a monopolist in order to
reduce its price to cost (see Vickers, 2005 in particular), certainly an unusual government intervention. If one rejects
the welfare standard in favor of consumer surplus, then the Baxter interchange fee remains the theoretically
relevant standard even in the presence of issuer margins. Note that if regulators adopt a consumer-surplus standard,
then in case there are any acquiring margins, these should also not be used to decrease interchange fees (by a symmetric
argument), which is one reason why the Baxter interchange fee might be preferred over interchange fees based on
merchant indifference". 1677 Supra ¶ 510 especially notes 900 and 905. 1678 Supra ch. 6.9.4. See also Rochet & Tirole, Must-Take Cards, ibid at 469: "The maximum interchange fee that
passes the tourist test, aT , thus corresponds to the socially optimal IF when banks are perfectly competitive (m = 0)…
When issuers have market power (m > 0), the socially optimal interchange fee does not pass the tourist test ".
380
condition: issuers would be forbidden to earn profits above a modest rate of return, which would
reflect the rate of return on risk-free investments.
874. The reason for a risk-free rate of return is that interchange fees makes issuing a risk-free
business activity. Interchange fee is a (restrictive) arrangement which ensures full cost
coverage. The implied stance at the base of the interchange fee is that it should be a source of
income for uncovered costs, and not a source for double compensation (i.e., profit), in a manner
of a cartel. A numerical demonstration might visualize.
The interchange fee in Israel yields an income of almost NIS 2 billion (0.7% of more than NIS
270 billion turnover).1679 This amount alone covers almost all issuers' standardized costs – NIS
2.5 billion (total issuers' costs are approximately NIS 2.8 billion,1680 but they should be reduced
and amended because of inflated payments to issuers' controlling banks).1681 Hence, almost all
of issuers costs are covered by the interchange fee. In addition, issuers receive a 'windfall' of
approximately NIS 1.4 billion from cardholder fees and interest.1682 In this situation there is
almost nothing to compete on! This situation reminds of Vickers warning about the distortion
in the merchant side, when under the pretext of cost coverage, income of issuers from
interchange fee alone is larger than all costs.1683 Indeed, in Europe it was found already in 2007
that most issuers remain profitable without resorting to interchange fees.1684
Even in the case interchange fee alone does not cover all of issuers' costs, the residual is easily
covered with cardholder fees and interest from cardholders, which accrued with the interchange
fee, "compels" issuers to profit.1685 When issuers are also acquirers, all their income from the
acquiring side should also be recruited before resorting to price fixing. After all, the interchange
fee is a minimum price fixing arrangement.1686
1679 Bank of Israel, ongoing information on bank corporations, table X-6 (last updated June 4, 2017)
http://www.boi.org.il/he/BankingSupervision/Data/Pages/Tables.aspx?ChapterId=9 1680 Bank of Israel, annual information on the banking system, payment cards, Table X-13 (last entry July 26, 2017). http://www.boi.org.il/he/BankingSupervision/Data/Pages/DataTable.aspx?Chapter=%D7%A4%D7%A8%D7%A7+%D7%99%27+-
+%D7%9B%D7%A8%D7%98%D7%99%D7%A1%D7%99+%D7%90%D7%A9%D7%A8%D7%90%D7%99&Years=2012-2016 1681 ITAMAR MILRED, TEUR SHUK KARTISEI HASHRAI VENITUAH HAMIMSHAKIM BEIN HEVROT KARTISEI HASHRAI
LEBEIN HABANKIM (DESCRIPTION OF CREDIT CARD MARKET AND ANALYZING INTERFACES BETWEEN CREDIT CARD
FIRMS AND THE BANKS), THE KNESSET CENTER FOR RESEARCH AND INFORMATION, at 9 (Feb, 2014)
https://www.knesset.gov.il/mmm/data/pdf/m03356.pdf ; JACOB CHERTOF AND AMI TZADIK, CREDIT CARDS MARKET:
ANALYSIS, REGULATION AND INTERNATIONAL COMPARISON, KNESSET RESEARCH CENTER, at 11 (2010)
http://www.knesset.gov.il/mmm/data/pdf/m02668.pdf. 1682 Supra note 1680. 1683 Supra ¶¶ 500-501. 1684 Supra ¶¶ 574 (note 1018), 463. 1685 See e.g., supra ¶¶ 500 - 501 (interchange fee amounts to all or almost all of issuers' costs) 1686 Supra ch. 9 (Legal assessment of the interchange fee).
381
If issuers claim they need revenues from the interchange fee to cover costs or to subsidize
cardholders, then they cannot, at the same time, use it as a source for their own profits. Issuers
can never lose if all their costs are deemed to be covered through a protected and authorized
cartel. Interchange fee, which under the pretext of cost coverage and rewards becomes a source
of profit, turns card issuance into a risk-free business.
The essence of the interchange fee is to cover issuers' uncovered costs and induce cardholders'
usage. But when proceeds from interchange fee are higher than any "deficit" (i.e., uncovered
costs), then the interchange fee forces issuers to profit.1687 This profit is riskless.
875. The legal authority of regulators to limit profit stems from the fact that these profits result from
horizontal minimum price fixing arrangement among competitors.1688 The law in various legal
jurisdictions around the globe tolerates the interchange fee, even though it is a per-se price
fixing,1689 because of its special features as a mechanism to internalize network and usage
externalities.1690 However, recognition in the necessity of interchange fee is not a carte-blanche
to charge any rate of it. There is a difference between the essence of a right to its coverage. For
example, freedom of speech does not permit exposure of state secrets. Indeed, regulators and
Tribunals do condition approval of price arrangements in terms.1691 Any part of a price fixing
agreement, that is approved under the pretext of internalizing network and usage externalities,
but which in fact serves as a profit source, is an abuse. It is certainly not indispensable and does
not confer benefits to the public.1692 Only when direct channels of income are not sufficient,
interchange fee may be reasonable or indispensable. Nevertheless, even under this scenario,
interchange fee ceases to fulfill its legitimate purpose if used for generating profits. Thus,
authorities are entitled to limit interchange fees arrangements to their declared purposes and no
more, because those (i.e., cost coverage and genuine rewards) are the only reasonable,
indispensable and legitimate justifications to interchange fees.
876. A major difference between my proposal and the current cap/ level regulation is that capping
interchange fee level would not prevent it from being a source of profit, whenever the regulated
1687 See supra ¶¶ 500, 503, 574, 463, supra note 208 1688 For expanded legal analysis see supra ch. 9. 1689 For expansion see Supra ch. 8. 1690 For expansion on the special features of the interchange fee as a mechanism to internalize network and usage
externalities, see supra ch. 7. 1691 MICHAEL L. KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA II COMMISSIONED REPORT, paras 97-98 (Aug.
2001); see also supra ¶ 709; supra note 222. 1692 Supra note 826.
382
level plus additional income yield higher proceeds than the costs the interchange fee was
allegedly aimed to cover. Apparently, this is the situation worldwide, as can be seen in the
prosperous bottom line of issuers' financial reports all over the world. The caps are apparently
too high, a familiar weakness of price caps.1693 My proposal, however, prohibits profits, and
caps the level of the interchange fee, not on a number but on the standard which consumer
welfare dictates. My proposal is in line with the literature that emphasized that profits should
be ignored.
Similar to the practices of the Federal Reserve from a century ago,1694 the condition I propose
would take the edge off issuers' desire to apply for interchange fee higher than essential to cover
costs including rewards, especially when issuers' other channels of income, i.e., direct income
from cardholders (cardholder fees and interest on credit), are profitable enough.
877. Rochet & Tirole reconcile with interchange fee which derives profits to issuers, because the
part of the interchange fee which issuers are kind enough to pass through to cardholders as
rewards, incentivize efficient card usage. Economists do not always bother with normative
questions. A jurist, however, may and should pose doubts, if profit which is a result of initial
market power of issuers, is undeniable. The conclusion might be that such a market power
should not be contemplated with in the first place.
In my view, the argument according to which it is allegedly efficient that interchange fees
should be raised to offset market power of issuers, as raised by Rochet & Tirole to justify
interchange fee which is a source of profit, contrary to its initial economic justification, is
analogous to a situation in which one would say it is efficient that merchants pay protection to
the organized crime. Even under the assumption that paying for protection is economically
efficient under the circumstances of the (market) power of the organized crime, normatively we
must not accept protection phenomena in the first place, and we should enforce "no protection"
law as a better and more efficient solution.
Economically speaking, if a gun is attached to your temple it is efficient to pay protection.
However, normatively it is more efficient to have a rule that prohibits protection payments than
1693 Catherine Liston, Price-Cap versus Rate-of-Return Regulation, 5 J. Regulatory Econ. 25, 28 (1993): “[w]hen there
is considerable uncertainty about cost fluctuations, the regulator may have to set the cap on prices so high that transfers
of surplus to consumers are eliminated (Schmalensee 1989).” 1694 Supra ch. 14.1.
383
allowing them. The analogy is that we should not tolerate a situation whereby merchants are
being forced to pay interchange fee to offset issuers' market power, reflected in interchange fee
being a source of profit. Let alone so when the interchange fee is a restrictive arrangement that
must be approved by regulators. Regulators should prohibit interchange fees from being a
source of profit from the outset.
878. Given the competitive concerns raised by the interchange fee, especially the concern for a small
but market-wide price increase,1695 issuers should not be able to claim they need interchange
fee for reimbursement of uncovered costs, or to induce efficient card usage (the only two
acceptable justifications for charging interchange fees), but in practice use interchange fee
proceeds as a source for profit. On the other hand, if interchange fee is indeed required for
covering costs or to induce usage, then issuers do not expect to make any profit from it anyway.
Hence, restricting issuers' profitability does not frustrate any legitimate expectation issuers
could possibly have.
Under my proposal, issuers would be able to charge interchange fees, only to the extent
proceeds are used to cover costs of issuers which are not covered by other channels of issuers'
income. Any difference above costs would have to be remitted to cardholders as reduction in
cardholder fees. This would substantially reduce the attractiveness of interchange fees for
issuers' shareholders. The possibility of giving up interchange fees and be able to earn unlimited
profits from the direct channel, i.e., the cardholder side, would turn to be more appealing for
issuers.
879. It is interesting to note that the position of the Israeli Visa firms which was supported by an
expert opinion of Professor Rochet, in the Israeli proceedings (AT 4630/01), was that the
interchange fee is required to cover an "issuing deficit" plus reasonable profit.1696 This is
actually what I propose, with the reservation that reasonable profit is, in our case, a risk-free
return. In fact, the profits achieved by the Israeli payment cards in practice, since they submitted
their stance to the Antitrust Tribunal in AT 4630/01, far exceeds any reasonable profit they
could ask for. In other words, the denial of their stance was, paradoxically, in their favor. They
earned much more under the cost methodology.
My slight change in the profit standard (risk free interest instead of reasonable profit), cannot
1695 Supra ch. 10.1. 1696 Supra ¶ 488.
384
eliminate the fact, that my proposal is in line with the Visa firms claims before the Israeli
Antitrust Tribunal. Both me and the Visa firms claim that only issuers' "deficit" plus a certain
rate of return, should be acknowledged as legitimate interchange fee. This is Baxter’s
interchange fee,1697 achieved with a simple condition and almost no regulation.
880. Payment card firms are (usually large) financial institutions. Their books are mostly open to the
public and profits are published and cannot be concealed. If an issuer that collects interchange
fee shows profit, this profit is detectable, and can easily be disgorged to offset the interchange
fee for the next period. On the other hand, capping the level of the interchange fee is
complicated and demands vast resources, as can be learned from the experience of Israel,
Europe, U.S. and other countries. Moreover, even after this heavy investment there is no
assurance for optimization.1698 Thus, to detect profit, no deep accounting is required, as opposed
to setting a cap.
881. Under my proposal issuers, who would gain profits above the risk-free permitted rate of return
in a certain period, would have to reduce the interchange fee they charge in the following period,
to offset the illegal profit. Disgorgement, and even penalties and other remedies, should be
available if offset does not occur. What is more important is that no dividends can be distributed
to shareholders if there is no profit. I suspect shareholders would not agree to give up profits.
They would probably waive interchange fees altogether before giving up dividends.
There is no difference between keeping proceeds from interchange fees as profits (which should
be banned), or using interchange fees for covering costs (purportedly permitted aim), while
simultaneously using other income as profits. This latter situation should be also banned. Issuers
who charge interchange fee declare they operate a deficit business, that they need a price fixing
restrictive arrangement to survive, and that they are not entitled to profit. It is only legitimate
to demand that they should not be allowed to earn more than a modest risk-free rate of return.
Reducing profits obtained through interchange fee would lower costs of acquirers. The
acquiring side is considered competitive, thus savings would be passed through to merchants
in the form of a lower MSF.1699 Merchants are expected to pass through any lower MSF to final
prices, as a function of competition in the relevant markets. But even if merchants do not pass
through their savings to consumers, merchants are the “consumer” of payment cards and it
1697 Supra ch. 6.2. 1698 Supra ch. 8.1.1 (Criticism Of The Cost-Based Methodology). 1699 Supra ¶97; see also supra note 208.
385
suffices, in terms of efficiency, to expand their surplus.1700 In addition, reduction in the MSF is
expected to expand the merchant side (direct effect) and make cards more attractive to
consumers (indirect network effect).1701
882. To conclude, my proposal identifies the point, above which there is no justification to charge
interchange fee, and sets the cap there, without the need to stipulate a specific rate, number or
a formula, but by using a simple principle. The principle is that interchange fee cannot be
regarded as legitimate any more when it is above costs, and when its proceeds are not returned
to cardholders in full to induce efficient usage. My proposal yields optimal interchange fee
under the consumer welfare standard.
An exception should be made for nascent issuers, or for new and efficient kind of transactions
which require incentives at the payers' side. New issuers at the take-off stage should be able to
earn profits for a limited initial period. This would encourage entrance. In addition, to induce
innovations, new kinds of transactions or technologies should also be encouraged, by allowing
a higher rate of return on specific investments. This should encourage new entrants or modern
technologies to enter.
883. My proposal offers a second option for issuers. Issuers may waive interchange fees entirely,
and no limitations should be imposed on their profits. I believe that most issuers have sufficient
income from direct channels, i.e., cardholder fees and interest on credit.1702 They would waive
interchange fees entirely and prefer to operate without profit limits. In this sense my proposal
resembles the incentive taken by the Federal Reserve Bank in the U.S., about a century ago,
which was aimed to eliminate interchange fees in checks.1703
14.3. Precedents
884. My proposal is not unprecedented. Profitability (or rate of return) regulation is recognized in
markets with natural monopolies.1704 Profit limitation is also found in public utilities which are
traditionally regulated, such as health-care, financial institutions, energy, gas, water, electricity,
1700 Supra ch. 6.9.4. 1701 Supra ¶¶ 446-448. 1702 Supra ¶ 463. 1703 Supra ch. 14.1 and ¶ 785. 1704 See Richard A. Posner, Natural Monopoly and its Regulation, 21 STAN. L. Rev. 548 (1969).
386
construction and telecommunication.1705 In Israel, Nesher, a monopoly cement supplier is
restricted to 12% profit on its working capital.1706
The framework of rate-of-return regulation of public utilities fits my proposal. Payment systems
are the infrastructure of commerce and are often called the “plumbing” of economy (see supra
n. 2). Mature payment systems possess market power towards their customers (supra ¶¶ 603 -
607), which resemble the market power of public utilities towards their customers. Both face
rigid demand, high entry barriers and lack of close substitutes. However, there is a major
difference between rate-of-return regulation on public utilities and my proposal, which renders
my proposal even more plausible. Public utilities are not illegal by their nature. Their regulation
creates tension between their constitutional rights and public needs, although the constitutional
defense is not high.1707 Issuers, on the other hand, do not have a vested right nor a constitutional
protection to enjoy a minimum price fixing arrangement. Thus, limiting issuers’ rate-of-return
is inherently less intrusive. After all, issuers cannot claim they are deprived of a right to make
profit from an arrangement which was approved at the first place, only to cover costs. Such
right does not exist.
Rate-of-return regulation on public utilities in the U.S. began in the 19th century and since then
has been repeatedly approved by the Supreme Court.1708 The main principle under rate-of-return
regulation is that earnings should be "equal to that generally being made… in other business
1705 David M Newbery, Rate-of-return regulation versus price regulation for public utilities, 1 (Cambridge 1997):
"Public utility regulation arose naturally in the nineteenth century for gas, water, rail, telegraph, and later, electricity and
telephony". 1706 The supervision is derived from sec.12(b) of Control of Commodities and Services Law, 1985 and "Suari Formula",
see Ministry of Economy and Industry, Cement Regulation, available at
http://economy.gov.il/Industry/Industry_and_Environment/Chemical_Industry/Pages/CementImports.aspx 1707 Duquesne Light Co. v. Barasch, 488 U.S. 299, 307 (1989): “The Constitution protects utilities from being limited to
a charge for their property serving the public which is so "unjust" as to be confiscatory.”; Verizon Communs., Inc. v.
FCC, 535 U.S. 467, 484 (2002): "Rates which enable the company to operate successfully, to maintain its financial
integrity, to attract capital, and to compensate its investors for the risks assumed certainly cannot be condemned as
invalid, even though they might produce only a meager return on the so-called 'fair value' rate base.”; See also FPC v.
Nat. Gas Pipeline Co., 315 U.S. 575, 585-86 (1942); Federal Power Com. v. Hope Natural Gas Co., 320 U.S. 591, 605
(1944); cf. Covington & lexington tpk. Rd. Co. V. Sandford, 164 U.S. 578, 597 (1896): “[i]f a corporation cannot
maintain such a highway and earn dividends for stockholders, it is a misfortune for it and them which the Constitution
does not require to be remedied by imposing unjust burdens upon the public”; P.R. Tel. Co. v. Telecomms. Regulatory
Bd. of P.R., 665 F.3d 309, 324 (1st Cir. 2011): “All that is protected against, in a constitutional sense, is that the rates
fixed by the Commission be higher than a confiscatory level... the 'lowest reasonable rate' is one which is not
confiscatory in the constitutional sense... rates can be regulated so long as they are not so 'unjust' as to be confiscatory”. 1708See, inter alia, Smyth v. Ames, 169 U.S. 466, 515 (1898); Covington & lexington tpk. Rd. Co. V. Sandford, 164 U.S.
578, 597 (1896); Mo. ex rel. Sw. Bell Tel. Co. v. Pub. Serv. Com., 262 U.S. 276 (1923); FPC v. Nat. Gas Pipeline Co.,
315 U.S. 575, 585-86 (1942); Federal Power Com. v. Hope Natural Gas Co., 320 U.S. 591, 605 (1944); Duquesne
Light Co. v. Barasch, 488 U.S. 299, 307 (1989).
387
undertakings which are attended by corresponding risks and uncertainties."1709 In our context,
as I explained above, other businesses which are to be compared to, are risk-free investments.
Issuers, which are forever guaranteed to cover all costs, are effectively operating without risk,
and risk-free investment is thus the proper standard to equate. Any higher rate of return causes
the interchange fee to fail its declared goals, and should be considered as abuse, just like a
public utility would - in the absence of regulation - abuse it market power by charging supra-
competitive prices.1710
For completeness it should be noted, that current approach of rate regulation which is applied
to some public utilities in the U.S., at least in the telecommunication sector, deviates from the
traditional rate-of-return methodology, and is based on a total element long-run incremental
cost methodology (TELRIC). Allegedly TELRIC methodology does not account for the rate of
return.1711 However, the cost of capital, which is another name for a rate of return, is
included.1712
885. SHVA and MASAV, the infrastructure firms of the payment industry in Israel,1713 are not
allowed to divide profits. They can earn, but not distribute, their profit.1714 This condition
continues to apply to SHVA1715 and MASAV until today.1716 SHVA and MASAV are both
1709 Permian Basin Area Rate Cases, 390 U.S. 747, 806, 88 S. Ct. 1344, 1380 (1968) 1710 P.R. Tel. Co. v. Telecomms. Regulatory Bd. of P.R., 665 F.3d 309, 316 (2011): “In order to prevent monopoly power
from leading to exorbitant prices, legislatures and administrative agencies became involved in setting the rates utilities
could charge consumers”; see also Consol. Edison Co. v. Pub. Serv. Comm'n, 447 U.S. 530, 553 (1980). 1711 Verizon Communs., Inc. v. FCC, 535 U.S. 467, 493 (2002) :In setting these rates, the state commissions are,
however, subject to that important limitation previously unknown to utility regulation: the rate must be "determined
without reference to a rate-of-return or other rate-based proceeding."; P.R. Tel. Co. v. Telecomms. Regulatory Bd. of
P.R., 665 F.3d 309, 316-17 (2011): “the FCC's TELRIC methodology -- which presumes a "forward-looking," "most
efficient," and "lowest cost" hypothetical network in the local market… represents a significant break from traditional
rate-setting models.”; See also Verizon Communs., Inc. v. FCC. At 489: “While the Act is like its predecessors in tying
the methodology to the objectives of "just and reasonable" and nondiscriminatory rates, 47 U.S.C. § 252 (d)(1), it is
radically unlike all previous statutes in providing that rates be set "without reference to a rate-of-return or other rate
based proceeding " § 252(d)(1)(A)(i). The Act thus appears to be an explicit disavowal of the familiar public-utility
model of rate regulation (whether in its fair-value or cost-of-service incarnations) presumably still being applied by
many States for retail sales… in favor of novel rate setting designed to give aspiring competitors every possible
incentive to enter local retail telephone markets, short of confiscating the incumbents' property.”; also id. At note 31. 1712 Id., at 496: “The TELRIC of an element has three components, the operating expenses, the depreciation cost, and
the appropriate risk-adjusted cost of capital." 1713 Supra ch. 8.1.7. 1714 Exemption with Conditions in re: SHVA, at 10 Antitrust 4804 (June 18, 2002); Exemption with Conditions in re:
SHVA, Antitrust 500549 (Sept 17, 2002). 1715 Exemption with Conditions to Five Banks in re: SHVA, Antitrust 5001307 (Condition 2) (Nov. 5, 2008); Exemption
with Conditions to Five Banks in re: SHVA, Antitrust 5001953 (May 22, 2012); Exemption with Conditions to Five
Banks in re: SHVA, Antitrust 500224 (Sept. 20, 2012); Exemption with Conditions to SHVA, Antitrust 500369 (March
20, 2013); Exemption with Conditions to SHVA, Antitrust 500393 (1.5.13); Exemption with Conditions to Five Banks in
re: SHVA, Antitrust 500459 (Aug. 26, 2013). 1716 Exemption with Conditions to Five Banks in re: MASSAV, Antitrust 3014681, at 5 (condition 2) (June 20, 2002);
Exemption with Conditions to Five Banks in re: MASSAV, Antitrust 5001308 (Nov. 5, 2008); Exemption with
388
owned and controlled solely by their customers, which are the big banks. When the banks
negotiate prices with SHVA and MASAV, they have two inherent conflicts of interest:
885.1 In the role as customers (payers) the banks want to pay as little as possible. In their
role as SHVA or MASAV (payees) they have an interest to increase fees to the
maximum.
885.2 In addition, banks can use inflated payments to SHVA and MASAV as an entry
barrier. If SHVA and MASAV charge high fees, banks would be harmed as payers,
but at the same time inflated fees raise entry barriers for new competitors, which
would like to use the infrastructures of SHVA and MASAV. For the banks that own
SHVA and MASAV it is worthy to sacrifice expenditures, and let SHVA and
MASAV inflate prices, in order to raise entry barriers.
Banks that own SHVA and MASAV might expect that accrued profits in SHVA and MASAV
would eventually be transferred to them. As long as this does not happen, the profit limitation
imposed on SHVA and MASAV resembles my proposal, as it weakens part of the incentives
of SHVA and MASAV to inflate prices. However, the profit limitation on SHVA and MASAV
does not alleviate the second conflict of interest (inflated rates as an entry barrier).
My proposal does not suffer from such drawbacks. Under my proposal issuers cannot earn
profits (above a modest rate), all the more so issuers cannot accumulate undivided profits as
SHVA and MASAV can. As opposed to the owners of SHVA and MASAV, which derive
benefits from inflated rates even if profits cannot be distributed, issuers' owners do not have
any latent benefits from interchange fees that would mean no profit for them.
886. In the U.S., the Patient Protection and Affordable Care Act requires insurance companies to
spend at least 80% to 85% of premium dollars on medical care. Insurance companies that fail
to meet this standard are required to provide a rebate to their customers.1717 This is very similar
Conditions to Five Banks in re: MASSAV, Antitrust 5001954, at 6 (May 22, 2012); Exemption with Conditions to Five
Banks in re: MASSAV, Antitrust 500368 (March 20, 2013). 1717 Richard A. Epstein & Paula M. Stannard, Constitutional Ratemaking and the Affordable Care Act: A New Source of
Vulnerability, 38 AM. J. L. & MED 243, 259 (2012): "[T]he ACA requires that health insurance issuers… spend at least
eighty percent of premium revenue, and that health insurance issuers in the large group market spend at least eighty-five
percent of premium revenue on medical claims or clinical services, and healthcare quality activities. If they do not, they
are required to refund the difference to enrollees on an annual basis.";
The Center for Consumer Information & Insurance Oversight, Medical Loss Ratio,
https://www.cms.gov/CCIIO/Programs-and-Initiatives/Health-Insurance-Market-Reforms/Medical-Loss-Ratio.html :
"MLR requires insurance companies to spend at least 80% or 85% of premium dollars on medical care, with the review
provisions imposing tighter limits on health insurance rate increases. If they fail to meet these standards, the insurance
companies will be required to provide a rebate to their customers starting in 2012".
389
to limiting profits on medical insurance schemes to 15% or 20% of gross income.
My proposal is less intrusive because health insurers are not parties to any restrictive
arrangements and each insurer does not possess a monopoly position.1718 Therefore, the
arguments against imposing profit limitations are stronger against health insurers. Albeit this
criticism, profit limitations have been imposed on health insurers. This renders my proposal, to
limit profits on parties to a price fixing restrictive arrangement, even more plausible.
14.4. Additional Remarks
887. Supervision and regulation of the interchange fee exist worldwide anyway.1719 My proposal
does not interfere with business practices that were previously unregulated. On the contrary,
capping the level of the interchange fee is far more complicated than my proposal. Capping the
level requires a methodology to determine the cap, and then a calculation which implements
the methodology. Both stages consume vast regulatory resources, as shown in the survey of the
international regulation in chapter 8 above. My proposal consumes far less resources in
comparison to the extremely high regulatory efforts required to assess the information and to
calculate the "right" level of interchange fee.
888. My proposal bypasses the regulatory weakness known as "Regulatory lag” i.e., the period of
delay between the determination of the rate by regulators and the time it is applied.1720 For
example, the level of the interchange fee in Israel until 2018 was calculated on the basis of costs
and volumes of 2007-2009. The Antitrust General Director and the experts on his behalf had to
examine all issuers' costs, select their eligible part, quantify them and compute the numerator
and denominator of the fraction which comprise the interchange fee. This took years and
demanded vast resources.1721 When the "right" fee was finally calculated, it was already
outdated. Technology improvements and other innovations reduce costs (numerator reduction)
and at the same time volume of transaction increases annually (denominator increase).
Interchange fee, if calculated today in Israel, should probably be lower than the existing
0.7%,1722 which amounts to almost NIS 2 billion, as the volume of transactions in Israel
1718 Epstein & Stannard, id. 1719 Supra ch. 0. 1720 E.g., Richard A. Posner, Natural Monopoly and its Regulation, 21 STAN. L. REV. 548, 594 (1969): "[I]n the
considerable intervals of “regulatory lag” the profits of the regulated firm will pierce the ceiling imposed by the
regulatory agency if, as has frequently been the case in the regulated industries in recent years, costs are falling rapidly". 1721 Supra ¶¶ 0488 -499. 1722 Supra ¶ 502.
390
exceeded NIS 260 billion in 2016.1723 I pointed to the ridiculous results of this in paras. 500-
503 above.
My proposal skips this difficulty. Increase in turnovers (denominator) or improvements in the
cost structure of payment card firms (numerator), which make the interchange fee a profit
source, are immediately detectable. Profits sticks-out from financial reports, and cannot be
concealed, especially in large financial firms, as explained in the next paragraph.
Implementation of the profit limitation can be done automatically by offset in the following
period. Any profit above a small rate of return, would be illegal, and thus automatically
deducted from the interchange fee in the next period.1724 I hope my proposal could be applied
when the current Trio Arrangement approval in Israel period ends (in 2018), so the limitation
on payment card companies in their next cross acquiring agreement would be a profit limitation
instead of a "level limitation".
889. Profit limitations can often be bypassed by inflating expenditures.1725 This concern was also
expressed by Rochet & Tirole. They recognized that interchange fee could be a source of profit
for issuers in a "cozy cartel" manner.1726 However, they also discussed second situation, in
which profits are dissipated as redundant expenditures and rewards, a situation they call
"wasteful competition":
Perhaps more complex is the case of wasteful competition. Suppose that issuers do
not tacitly collude, but compete in ways that bring limited benefits to consumers.
Then, if one cannot directly confront the source of wasteful competition, indeed it
seems reasonable not to account for issuer profits.1727
Rochet & Tirole agree that if the situation is of "wasteful competition" then just like in the
"cozy cartel" situation: "[I]t seems reasonable not to account for issuer profits". My proposal
fulfills this ambition, as it does not account for issuers' profit.
With respect to the crux of the "wasteful competition" argument, controlling shareholders of
issuers would gain nothing from inflating costs or bestowing redundant rewards on cardholders.
This is a good enough reason for not adopting a strategy of inflated costs and redundant rewards.
1723 Supra ch. 3.1 (payment card market data). 1724 Supra ¶ 887. 1725 Posner, Natural Monopoly and its Regulation, supra note 1728, at 601. 1726 Supra ¶¶ 479, 871. 1727 Rochet & Tirole, Externalities and Regulation in Card Payment Systems, supra note 1672, at 11; Jean Tirole,
Payment Card Regulation and the use of Economic Analysis in Antitrust, 4 TOULOUSE SCHOOL ECON., at 17 (2011): “If
the profits associated with cardholders’ installed base are dissipated through wasteful advertising expenditures to
“acquire” cardholders, profits should not enter social welfare calculations”.
391
In addition, the ability to dissipate costs and conceal profits in large scale is limited, for the
following reasons:
Payment card firms have well established bookkeeping that reveal their profits. Payment card
firms are not Mom-and-Pop stores, in which profits could be disguised as salaries or
management fees. Payment card firms are financial institutions whose shareholders are not their
managers. Those firms are not managed as small sized firms in which there is a mixture of
ownership and control. As Posner noted, in large financial institutions such as payment card
firms, wisecracks aimed to conceal profits cannot be substantial:
Most important, in a corporation with annual revenues of hundreds of millions of
dollars, the amounts diverted by management to its own use (whether directly or
in perquisites) above reasonable compensation are not likely to be substantial in
relation to the corporation's sales or even profits.1728
890. Inflating expenditures is not an attractive option for issuers, and thus would not frustrate my
proposal, for several additional reasons:
First, shareholders of issuers would gain nothing from any attempt to conceal profits as
expenditures (wasteful competition). Shareholders of issuers would definitely not sit aside if all
profits above a modest rate of return would evaporate for them, and there would be a sanction
of disgorgement of any profit and a strict prohibition on distribution of profits. They would
probably prefer to waive interchange fee from the outset.
Second, if the MSF rise, due to inflated expenditures (that must be returned to cardholders),
merchants might resort to surcharging, or refuse to accept the card carrying high rewards.
Third, rewards cause marginal cardholders (with less utility from cards) to adopt and use cards.
This, in turn, causes increase in the merchants' resistance to high fees.1729 Thus, following an
increase in (redundant) rewards (that is financed through interchange fees) merchants would be
less willing to accept expensive cards and more willing to surcharge them.1730
Fourth, even a substantial number multiplied by zero, is zeroed. If the rate of return is very
small, as risk-free rate of return is, multiplying it by a larger rate base such as inflated volume
1728 Richard A. Posner, Natural Monopoly and its Regulation, 21 STAN. L. REV. 548, 575 (1969). 1729 Supra ¶ 404. 1730 Rysman & Wright, The Economics of Payment Cards, supra note 1676, at 11: "The reason merchants are still
somewhat sensitive to changes in the fee structure and less likely to accept cards when interchange fees are higher, is
due to the following additional effect. Facing higher rewards, some consumers will start using cards that previously did
not. These consumers therefore have a benefit of using cards that is lower than the average consumer. Thus, the mix of
consumers shifts towards those with lower values of using cards. Given that merchants also internalize the benefit their
customers get from using cards, merchants will be less likely to accept cards following an increase in interchange fees".
392
of transactions driven by rewards would still be small and unattractive.
Fifth, rewards bestowed on cardholders increase volume of transactions, but not profit.
Calculation of permittable profit could be made by multiplying the risk free rate-of-return by a
base that is not sensitive to the volume of transactions and thus does not include rewards.1731
For example, permittable profit could be calculated by multiplying the rate of return in the
working capital. In Israel, profitability of payment card firms was measured by ROE – return
on equity (supra ¶ 60). This is in line with the idea of Rochet and Tirole, not to account for
issuers’ profit which is a result of wasteful competition. Thus, if the rate-base is not dependent
on volume, even if rewards increase volume of transaction, they would not increase profit. The
incentive to inflate rewards is curtailed at the outset.
Sixth, wasteful competition occurs when rewards are too high and cardholder fees become
negative. But before rewards turn cardholder fees to negative, cardholder fees should pass
through zero point. Zero cardholder fees, as opposed to negative cardholder fees (rewards),
raises less competitive concerns of usage externality.1732 The more probable result, if my
proposal would be implemented, is that issuers would give up interchange fee, so that the
massive rewards bestowed on cardholders, which are effectively bribes for shopping, would be
reduced.1733 Curtailing rewards is a pro-competitive outcome.1734
Seventh, in mature networks the network-effect of rewards is exhausted (see ¶ 336). Rewards
are set at an equilibrium level. Thus, opening “reward wars” would probably not be reflected
in larger market shares but mainly in a higher MSF, with no aggregate effect on the network.
In addition, wars must be financed, and higher MSF is funded by annoying merchants. This
poses a significant risk for an individual issuer who considers opening a reward war. Because
marginal utility of the newly attracted cardholders is small (marginal), an issuer that rewards
excessively risks surcharging or even total rejection of its cards by merchants. Lastly, when
issuers would know that the “prize” for conquering an additional market share, is only a tiny
rate of return, and considering the risks involved, they would probably be dissuaded from
engagement in excessive rewards from the outset.
Eight, the concern for excessive rewards is not unique to my proposal. Rewards are an
1731 Catherine Liston, Price-Cap versus Rate-of-Return Regulation, 5 J. Regulatory Econ. 25, 26 (1993): “Rate of return
regulation: Under ROR regulation, the regulator typically determines a revenue requirement based on a firm's
accounting costs during a test year. Such accounting costs incorporate operating costs, taxes, allowances for
depreciation, and allowed returns. The allowed return is a "reasonable" rate (an estimate of the cost of capital to the
firm) multiplied by a rate base which includes the undepreciated portion of investments relevant to regulated
operations, valued on a historical expenditure basis.” See also infra ¶ 892. 1732 Supra ¶¶ 651, 351 - 357. 1733 See supra ¶¶ 889 - 890. 1734 Supra ¶¶ 343 - 357; for further expansion see ch. 6.7.
393
expenditure and as such, the concern for their inflation exists also under cost-based fee. In the
unlikely event issuers engage in wasteful competition, and bestow excessive rewards, although
gaining nothing from this, and the factors above do not restrain these redundant rewards, the
solution should be to limit rewards, a suggestion that has already been made in literature.1735
891. Another criticism of rate regulation is the difficulty to calculate the "proper" rate. Posner claims
that "[T]he determination of a “fair rate of return” on equity capital presents formidable
difficulties".1736 However, the main point of my proposal is not to hit a specific target, i.e., an
exact rate. The rate of return should not be an accurate number, which is a result of complicated
calculations. The rate of return should enable issuers to operate a viable risk-free business. For
issuers that are used to current profit ratios, any rate of return which reflects risk-free
investment, even on the high side, would be much lower than the profit rates issuers are used
to, and very unattractive. Issuers would probably prefer to waive interchange fees entirely and
be free to earn unlimited profits.
892. Posner claims that profit limitation ensures non-efficient monopoly a promised rate of return
without "materially increasing the penalty for failing to minimize costs."1737 However, this
criticism may be right only if the regulated profit is too high, so regulation stimulates
inefficiency without penalty. My proposal for a modest risk-free rate of return cannot, by
definition, be too high as the range of permitted profits rates are the lowest in the market (return
on risk free investments).
I do not purport to determine in this work the exact risk-free profitability which is to prevail
under my proposal. However, as a preliminary thought, the rate of return should be based on a
low benchmark such as the LIBOR (London Interbank Offered Rate) or the interest on U.S.
Treasury bills. A normal rate-of-return in the industry, e.g., the weighted average cost of capital
(WACC) does not fit, because it embodies a risk which does not exist for issuers that collect
interchange fee. I propose to calculate the maximum profitability by multiplying the risk-free
rate of return and a base rate. The base rate could be working capital or volume of transactions,
or equity (ROE), or any other base. The IAA General Director proposed other indices, i.e.,
ROCE or TIRR which can measure profitability, based on the company's performances, as
1735 Supra ch. 6.7 and ¶ 340. 1736 Posner, Natural Monopoly and its Regulation, supra note 1728, at 594. 1737 Ibid at 599.
394
reflected in its financial statements.1738 I leave the determination of the accurate profitability
limitation for future research.
893. It has been argued that leaving profit margin to issuers will contribute to innovation, research
and development.1739 This argument, however, cannot be accepted as an excuse for a supra-
competitive interchange fee. Innovation is indeed important, but it should not be financed by a
cartel, let alone a cartel that derives its justification from spurious needs. In addition, to the
extent innovation is in the acquiring side, then if high profits are required to finance it, the
argument supports lower interchange fees.1740 Verdier gives an example where, in order to
finance innovation in the acquiring side of the British market (smart card readers), the
interchange fee had to be reduced.1741 Lastly, innovation costs are recognized and eligible costs.
As long as R&D expenses are not abused, interchange fee proceeds can finance them. My
proposal does not purport to limit innovation.
14.5. Reciprocal Relations Between My Proposals
894. My proposals are not complementarities. The proposal to divest issuers from acquirers is a
legislative proposal that would break up the interchange fee from being a restrictive
arrangement (apart from the minor joint negotiation). The proposal to limit profits alleviates
the competitive concerns from the interchange fee. Each of the proposals suffices on its own.
1738 Public Statement 1/17: The Antitrust Director General's Considerations In Enforcing The Prohibition Against
Unfairly High Prices (Feb. 28, 2017) http://www.antitrust.gov.il/eng/subject/177/item/34609.aspx : “[t]wo types of
indices standard for this are ROCE, which represents the yield created by the company's assets and which is calculated
by dividing the company's profits, excluding financing expenses, by the total active capital at a particular point in time;
and IRR or TIRR, which are the yield brought in by total anticipated cash flow as a result of the company's future
activity, capitalized to the relevant point in time, to zero.” 1739 See Marc Bourreau & Marianne Verdier, Cooperative and Noncooperative R&D in Two-Sided Markets, 13 REV.
Network Econ. 175 (2014); Aghion Philippe et al., Competition and Innovation: An Inverted-U Relationship, 120 Q. J.
ECON. 701 (2005). 1740 Marianne Verdier, Interchange Fees and Incentives to Invest in Payment Card Systems, 28 INT'L J. INDUS. ORG.
539, 540 (2010): "When the Acquirer's contribution to investments is high, and when the consumers benefit more from
investments than the merchants, the Acquirer's investments may decrease with the interchange fee. Hence, in this case,
the payment platform may increase banks' joint profit by lowering the interchange fee to provide the Acquirer with
incentives to invest in quality, as this impacts the cardholders' demand positively";
Marc Bourreau & Marianne Verdier, Interchange Fees and Innovation in Payment Systems, SSRN Elibrary, at 33 (Oct.
8, 2013): "[W]hen there are strong adoption externalities, innovation is stronger with a zero interchange fee.
Otherwise, if adoption externalities are of a lower magnitude, the interchange fee that maximizes innovation is strictly
greater than zero. Cooperation does not stimulate innovation but, on the contrary, reduces quality investment. When
there are strong adoption externalities, this negative effect of cooperation is magnified with a higher interchange fee.
Our results have several policy implications. First, the interchange fee cannot be considered as an instrument that
increases the benefits of cooperation for innovation in retail payment systems. Second, when merchants have fixed costs
of adopting innovations and when consumers do not pay transaction fees, positive interchange fees benefit consumer
adoption only in specific circumstances; that is, when the degree of externality is low". 1741 Marianne Verdier, Interchange Fees and Incentives to Invest in Payment Card Systems, supra note 1740, at 549.
395
895. However, the proposals do not contradict one another. The proposal to limit profits of issuers
integrates with the proposal for structural separation in an unexpected manner. Divestiture
softens the consequences of profit limitations for the payment card firms. If issuers and
acquirers are not separated, then applying my proposal to issuers, which are also acquirers,
means that those firms would not be able to earn profits at all, neither from acquiring nor from
issuing (above a modest rate of return).
A company that includes issuing and acquiring activities should use its income from any side
to cover any uncovered costs of the other side, before resorting to price fixing with
competitors.1742 Thus, imposing profit limitation on separated issuers is a more lenient
limitation than imposing profit limitation on issuers which are also acquirers.
15. Summary
896. In this work I tried to explore every angle of interchange fees, and to shed light on its mysteries
and complexities. I began with basic terms and market data to acquaint the reader with the topic.
Then I surveyed the historical development of interchange fees in credit card open networks,
as opposed to the interchange fee in debit cards and ATMs.
The main factor that affected the creation of positive interchange fees in credit cards were the
higher merchants' demand for cards. This high willingness to pay was exploited by allocating
most costs on them, and using interchange fee as a vehicle to induce demand among
cardholders. With debit cards, the networks had to induce merchants to join, and accordingly
the interchange fees tilted to the merchants' favor, with zero interchange fees at the extreme. In
both networks, what started as cost-based interchange fees evolved into demand-based
interchange fees when networks gained market power.
897. I continued with a survey of the legal proceedings and regulation of the interchange fees in
Israel, Europe, United States, Australia and other selected countries. I included in this survey,
inter alia, references to categories of interchange fees and the discrimination debate between
open and closed networks. Next, I explained the cost and benefits of payment instruments on
which the economic models are based upon. I discussed the basic model of Baxter, the
development in the model of Schmalensee, the strategic considerations of Rochet & Tirole,
1742 Supra ¶ 870.
396
models of neutrality, competition, rewards, credit versus debit, and models that discussed the
optimal interchange fee.
898. A legal assessment of the interchange fee led to the conclusion that it is a minimum price fixing
agreement between competitors, which theoretically should have been banned by competition
authorities worldwide. However, the unique features of the interchange fee, as a mechanism to
internalize network and usage externalities in payment cards, which are two-sided network
market, led to a different result. Interchange fees are sanctioned worldwide despite the
competitive concerns they raise. After summarizing the competitive concerns, I examined
possible alternatives to the interchange fees, and why merchants do not surcharge. I concluded
with two proposals which, in my view, would make unnecessary much of the resources invested
under the current regime in supervising this area. First, I offer to separate issuers from acquirers.
Second, I offer to impose profit limitations on issuers which charge interchange fee, in order to
induce them to waive charging interchange fees.
899. Structural separation between issuers and acquirers would accomplish the vision of the
legislators and regulators who canceled the NAWI rule. Their intention was to enable the
entrance of independent acquirers. However, no regulator went far enough to obligate such a
proposed structural change. My proposal enforces the desire of competition authorities to
promote independent acquirers (which was the original intent behind the cancellation of the
NAWI rule). This intent was de-facto frustrated, as no independent acquirers who determine
the interchange fee they pay entered the payment system arena. Thus, my proposal fulfills the
legally desirable outcome that has not been achieved.
900. The proposal to limit issuers profit if they charge interchange fee, is a tool to cause them to
waive interchange fees. In case the fee is charged, my proposal approximates the interchange
fee to the optimal fee according to the consumer welfare standard. This standard dictates that
profits of issuers should not be accounted for in the interchange fee, and this is my proposal.
901. An assumption in the background of my proposal calls for further empirical research. I presume
that the decisive majority of cardholders have a positive benefit from payment cards. This
positive benefit warrants sufficient card usage even without exogenous incentives such as the
interchange fee,1743 and this justifies a default of zero interchange fee. When cardholders derive
sufficient benefits from cards, the networks would not be jeopardized and high level of card
1743 Supra note 189 and note 610 (the majority of consumers who currently receive rewards on credit and/or debit cards
would continue to use those payment methods even if rewards were no longer offered).
397
usage can still be achieved even with very low interchange fees (and with the additional benefit
of low prices of goods). This assumption calls for further empirical research which I hope to
conduct in the future. An empirical study may confirm that cardholders' willingness to pay for
cards is high enough to sustain an independent issuing system, with little or no need for
subsidization from the merchant side.
902. Further empirical research is required to investigate at which level of the MSF, merchants
would start surcharging and cease accepting cards. My null hypothesis is that merchants would
not reject (or surcharge) cards, even if the MSF is well above their net benefits (i.e., the tourist
test) let alone the cost-based interchange fee. If this is verified, it would demonstrate the market
power of networks (as well as the mismatch of the tourist test), and would render my proposals
to evade such market power even more plausible.
-----------------The end------------------------
398
Bibliography
1. LITERATURE ................................................................................................................................. 398 2. U.S. CASES ................................................................................................................................. 416 3. U.S. AUTHORITIES ................................................................................................................................. 417 4. FOREIGN AUTHORITIES ....................................................................................................................................... 418 5. INTERNATIONAL CASES ................................................................................................................................. 422 6. PAYMENT CARD DATA ................................................................................................................................. 423 7. HEBREW LEGISLATION ................................................................................................................................. 424 8. HEBREW LITERATURE ................................................................................................................................. 426 9. HEBREW CASES ................................................................................................................................. 426 10. ANTITRUST GENERAL DIRECTOR DECISIONS ........................................................................................................... 429 11. MISCELLANEOUS ................................................................................................................................. 431 12. HEBREW MISCELLANEOUS ....................................................................................................................................... 431
1. Literature
1. ABA, ANTITRUST LAW DEVELOPMENTS (7 ed. 2012).
2. ABA SECTION OF ANTITRUST LAW, HANDBOOK ON THE ANTITRUST ASPECTS OF STANDARDS
SETTING (2004).
3. Sumit Agarwal et al., Why do Banks Reward their Customers to use their Credit Cards?,
(Federal Reserve Bank of Chicago Working Paper No. 2010-19. 2010).
4. Sumit Agarwal, Souphala Chomsisengphet & Chunlin Liu, The Importance of Adverse
Selection in the Credit Card Market: Evidence from Randomized Trials of Credit Card
Solicitations, 42 J. MONEY, CREDIT & BANK. 743 (2010).
5. Sumit Agarwal et al., Regulating Consumer Financial Products: Evidence from Credit Cards,
SSRN Elibrary (Aug. 2014).
6. Christian Ahlborn, Howard H. Chang & David S. Evans, The Problem of Interchange Fee
Analysis: Case without a Cause? 2 PAYMENT CARD REV. 183 (2004).
7. Niati Ahuja, Interchange Fees and Credit Card Issuing: An Empirical Investigation
(Preliminary Working Paper 2008).
8. Douglas Akers et al., Overview of Recent Developments in the Credit Card Industry, 17 FDIC
BANKING REV. 23 (2005).
9. Fernando Alvarez & Francesco Lippi, Cash Burns: An Inventory Model with a Cash-Credit
Choice, (EIEF Working Paper 02/15).
10. Andrea Amelio, Antitrust Assessment of MIF and the Tourist Test (Conference Proceeding ,
June 15, 2011).
11. Carlos Arango et al., Why is Cash (Still) so Entrenched?, (Bank of Canada Discussion Paper 2.
2012).
12. Carlos Arango, Kim P. Huynh & Leonard Sabetti, Consumer Payment Choice: Merchant Card
Acceptance Versus Pricing Incentives, 55 J. BANK. FIN. 130 (2015).
13. Carlos Arango & Varya Taylor, Merchants’ Costs of Accepting Means of Payment: Is Cash the
Least Costly? BANK OF CANADA REV. 15 (2008).
14. Guerino Ardizzi, Card Versus Cash: Empirical Evidence of the Impact of Payment Card
Interchange Fees on End Users’ Choice of Payment Methods, 1 J. FIN. INTERMEDIATION 73
(2013).
15. P. E. AREEDA, III ANTITRUST LAW, 147.
399
16. P. E. AREEDA & H. HOOVENKAMP, VII ANTITRUST LAW 370 ¶ 1505 (2d ed. 2003).
17. Mark Armstrong, Competition in Two-Sided Markets, 37 RAND J. ECON. 668 (2006).
18. Mark Armstrong & Julian Wright, Two-Sided Markets, Competitive Bottlenecks and Exclusive
Contracts, 32 ECO. THEORY 353 (2007).
19. MARK ARMSTRONG & DAVID E. M. SAPPINGTON, RECENT DEVELOPMENTS IN THE THEORY OF
REGULATION IN 3 HANDBOOK OF INDUSTRIAL ORGANIZATION, ch. 27 (Asymmetric Cost
Information) (2007).
20. KENNETH J. ARROW, SOCIAL CHOICE AND INDIVIDUAL VALUES (2d ed. 1963).
21. Maria Aspan, New B of A Fee may Hasten Debit's Demise, Am. Banker, Sept. 29 2011, http://www.americanbanker.com/issues/176_190/bank-of-america-debit-card-fees-interchange-1042682-1.html.
22. Lawrence M. Ausubel, Adverse Selection in the Credit Card Market (University of Maryland
Working Paper 1999).
23. STRUCTURAL REFORM IN THE CAPITAL MARKET INTER-MINISTERIAL COMMITTEE REPORT
(BACHAR REPORT) (Sept. 2004).
24. Martin Baily & Robert E. Litan, Toward Reasonable Regulation of Debit Card Interchange
Fees: The Case for Modifying the Federal Reserve Board's December 16, 2010 Proposals
(2011), available at http://ideas.repec.org/p/reg/wpaper/642.html.
25. David Balto, The Problem of Interchange Fees: Costs without Benefits? E.C.L.R 215 (2000).
26. Oren Bar-Gill, Seduction by Plastic, 98 N.W.L.R. 1373 (2004).
27. Oren Bar-Gill & Ryan Bubb, Credit Card Pricing: The Card Act and Beyond, 97 CORNELL L.
Rev. 967 (2012).
28. Oren Bar-Gill & Elizabeth Warren, Making Credit Safer, 157 U. PA. L. REV. 1 (2008).
29. Avner Bar-Ilan & Nancy Marion, Demand for Cash with Intra-Period Endogenous
Consumption, 37 J. ECON. DYNAMICS & CONTROL 2668 (2013).
30. William F. Baxter, Bank Interchange of Transactional Paper: Legal and Economic
Perspectives, 26 J. L. ECON. 541 (1983).
31. Ozlem Bedre-Defolie & Emilio Calvano, Pricing Payment Cards, 5 AM. ECON. J.
MICROECONOMICS 206 (2013).
32. Mats A. Bergman, Two-Sided Network Effects, Bank Interchange Fees, and the Allocation of
Fixed Costs (Sveriges Riksbank Working Paper Series No. 185. 2005).
33. Mats Bergman et al., The Costs of Paying – Private and Social Costs of Cash and Card
Payments (Sveriges Riksbank Working Paper No 212. 2007).
34. Efraim Berkovich, Card Rewards and Cross-Subsidization in the Gasoline and Grocery
Markets, 11 REV. NETWORK ECON. 1 (2012).
35. Tara Siegel Bernard, In Retreat, Bank of America Cancels Debit Card Fee, N.Y. TIMES, Nov.
1, 2011.
36. Martin Betts, Peter Black, Sharon Christensen, Ed Dawson, Rong Du, William Duncan, Ernest
Foo, Juan González Nieto, Security, legal and risk issues relating to e-tendering, at 19 (2006)
37. Virag Ilona Blazsek, The 2009 Interchange Fee Decision of the Hungarian Competition
Authority: A Comparative Case Study (Central European University 2010).
38. Adrian Blundell-Wignall, Paul Atkinson & Caroline Roulet, Bank Business Models and the
Separation Issue, 2 OECD J. FIN. MARKET TRENDS (2013).
400
39. DAVID BOAZ, CREDIT CARD MARKET IN ISRAEL, GENERAL ANALYSIS, CONCLUSIONS AND
RECOMMENDATIONS (Dec. 2009).
40. Wilko Bolt, Retail Payment Systems: Competition, Innovation, and Implications, DNB
Working Paper 362 (Dec. 2012).
41. ———. , Pricing, Competition and Innovation in Retail Payment Systems: A Brief Overview, 1
J. FIN. MARKET INFRASTRUCTURE 73 (2013).
42. ———. , The Role and Regulation of Interchange Fees in European Payments Cards
(Presentation in Conference entitled “The Role and Regulation of Interchange Fees in European
Payment Cards” held in Brussels. June 15, 2011.
43. Wilko Bolt & Sujit Chakravorti, Digitization of Retail Payments (DNB Working Paper 270.
2010).
44. ———. , A Review of Payment Card Economics (Aug. 15 2010) http://pymnts.com/a-review-of-payment-card-economics/.
45. ———. , Consumer Choice and Merchant Acceptance of Payment Media (FRB of Chicago
Working Paper No. 2008-11. 2008).
46. ———. , Economics of Payment Cards: A Status Report, 32 ECON. PERSPECTIVES 15 (2008).
47. Wilko Bolt et al., Consumer Credit and Payment Cards (ECB Working Paper 1387. 2011).
48. Wilko Bolt & David Humphrey, Competition in Bank-Provided Payment Services, 1539 ECB
Occasional Paper Series (2013).
49. Wilko Bolt, Nicole Jonker & Mirjam Plooij, Tourist Test Or Tourist Trap? Unintended
Consequences of Debit Card Interchange Fee Regulation, DNB Working Paper 405 (2013).
50. Wilko Bolt & Heiko Schmiedel, SEPA, EFFICIENCY, AND PAYMENT CARD COMPETITION (DNB
Working Paper 239/2009).
51. Wilko Bolt, Retail Payments in the Netherlands: Facts and Theory, 154 DE ECONOMIST 345
(2006).
52. Wilko Bolt, Nikole Jonker & corry Van Renselaar, Incentives at the Counter: An Empirical
Analysis of Surcharging Card Payments and Payment Behaviour in the Netherlands, 34 J.
BANK. FIN. 1738 (2010).
53. Ann Borestam & Heiko Schmiedel, Interchange Fees in Payment Cards, ECB Occasional
Paper Series 131 (2011).
54. Ron Borzekowski & Elizabeth k. Kiser, Consumers’ use of Debit Cards: Patterns, Preferences,
and Price Response, 40 J. MONEY, CREDIT & BANK. 149 (2008).
55. Pierre Bos, International Scrutiny of Payment Card Systems, 73 ANTITRUST L.J. 739 (2006).
56. Hélène Bourguignon, Renato Gomes & Jean Tirole, Shrouded Transaction Costs, CEPR
Discussion Paper no. DP10171 (Sept. 2014).
57. Marc Bourreau & Marianne Verdier, Interchange Fees and Innovation In Payment Systems,
SSRN (Oct. 8, 2013).
58. ———. , Private Cards and the Bypass of Payment Systems by Merchants, 34 J. BANK. FIN.
1798 (2010).
59. _______. , Cooperative and Noncooperative R&D in Two-Sided Markets, 13 REV. NETWORK
ECON. 175 (2014).
60. ———. , Cooperation Models for the Development of Mobile Payment Solutions, 1 LYDIAN
PAYMENT J. 23 (2010).
401
61. Terri Bradford & Fumiko Hayashi, Developments in Interchange Fees in the United States and
Abroad (FRB Kansas Payments Sys. Res. Briefing, 2008).
62. Tamás Briglevics & Oz Shy, Why Don’t most Merchants use Price Discounts to Steer
Consumer Payment Choice?, (12-9 FRB Boston, 2012).
63. Hans Brits & Carlo Winder, Payments are no Free Lunch, 3 DNB Occasional Studies (2005).
64. Tom Brown, Re-Routing the Exclusivity and Routing Provisions of the Durbin Amendment,
LYDIAN PAYMENT J. (2011).
65. Luis Cabral, Market Power and Efficiency in Card Payment Systems: A Comment, 5 REV.
NETWORK ECON. 15 (2005).
66. Guido Calabresi & Douglas Melamed, Property Rules, Liability Rules and Inalienability: One
View of the Cathedral, 85 HARV. L. REV. 1089 (1972).
67. Emilio Calvano, Note on the Economic Theory of Interchange (Market Platform Dynamics,
2011).
68. ———. , Action on Payment Cards (A Few) Insights from Theory (Conference Proceeding, 15
June, 2011).
69. Gabriele Camera, Marco Casari & Stefania Bortolotti, An Experiment on Retail Payments
Systems, ESI Working Paper (Jul. 2015).
70. Santiago Carbo Valverde et al., Regulating Two-Sided Markets: An Empirical Investigation
(Federal Reserve Bank of Chicago Working Paper No. 09-11. 2009).
71. Santiago Carbo-Valverde & Jose Linares-Zegarra M., How Effective are Rewards Programs in
Promoting Payment Card Usage? Empirical Evidence, 35 J. BANK. FIN. 3275 (2011).
72. Dennis W. Carlton & Alan S. Frankel, The Antitrust Economics of Credit Card Networks, 63
ANTITRUST L.J. 643 (1995).
73. DENNIS W. CARLTON & JEFFREY M. PERLOFF, MODERN INDUSTRIAL ORGANIZATION (3d ed.
2000).
74. Dennis W. Carlton & Ralph A. Winter, Competition Policy and Regulation in Credit Card
Markets: Insights from Single-Sided Market Analysis (2014).
75. ———. , Vertical Restraints in Two-Sided Markets: Credit Card No Surcharge Rules
(Presentation), (Jul 5, 2015).
76. Dennis Carlton & S. Alan Frankel, Transaction Costs, Externalities, and "Two Sided" Payment
Markets, 2005 COLUM. BUS. L. REV. 617 (2005).
77. Sujit Chakravorti, Externalities in Payment Card Networks: Theory and Evidence, 9 REV.
NETWORK ECON. 1 (2010).
78. ———. , Theory of Credit Card Networks: A Survey of the Literature, 2 REV. NETWORK ECON.
50 (2003).
79. Sujit Chakravorti & William R. Emmons, Who Pays for Credit Cards? 37 J. CONSUMER AFF.
208 (2003).
80. Sujit Chakravorti & Roberto Roson, Platform Competition in Two-Sided Markets: The Case of
Payment Networks, 5 REV. NETWORK ECON. 118 (2006).
81. Sujit Chakravorti & Alpa Shah, Underlying Incentives in Credit Card Networks, 48 ANTITRUST
BULL. 53 (2003).
82. Sujit Chakravorti & Ted To, A Theory of Credit Cards, 25 INT'L J. INDUS. ORG. 583 (2007).
402
83. Howard H. Chang, Payment Card Industry Primer, 2 PAYMENT CARD REV. 29 (2004).
84. ———. , Interchange Fees in the Courts and Regulatory Authorities 1 PAYMENT CARD REV.
13 (2003).
85. Howard H. Chang & David S. Evans, The Competitive Effects of the Collective Setting of
Interchange Fees by Payment Card Systems, 45 ANTITRUST BULL. 641 (2000).
86. Howard H. Chang, David S. Evans & Richard Schmalensee, Some Economic Principles for
Guiding Antitrust Policy Towards Joint Ventures (1997).
87. Howard Chang, David S. Evans & Daniel D. Garcia Swartz, The Effect of Regulatory
Intervention in Two-Sided Markets: An Assessment of Interchange-Fee Capping in Australia, 4
REV. NETWORK ECON. 328 (2005).
88. Julia S. Cheney, Prepaid Cards: An Important Innovation in Financial Services, Fed. Res.
Bank Phila. (2006).
89. JACOB CHERTOF AND AMI TZADIK, CREDIT CARDS MARKET: ANALYSIS, REGULATION AND
INTERNATIONAL COMPARISON, Knesset Research Center (2010).
90. Andrew T. Ching & Fumiko Hayashi, Payment Card Rewards Programs and Consumer
Payment Choice, 34 J. BANK. FIN. 1773 (2010).
91. Alex Chisholm, Speech given at the Regulatory Policy Institute Annual Conference (Sept. 10,
2014).
92. Fennee Chong, Credit Card Dues, Annual Summit on Business and Entrepreneurial Studies,
196 (2011)
93. Ronald Coase, The Problem of Social Costs, 3 J. L. & ECON. 1 (1960).
94. VINCENT CONITZER AND TOBY WALSH, Barriers to Manipulation in Voting in 127 HANDBOOK
OF COMPUTATIONAL SOCIAL CHOICE (Cambridge 2016)
95. Lloyd Constantine, Jeffrey I. Shinder & Kerin E. Coughlin, In Re Visa Check/Mastermoney
Antitrust Litigation: A Study of Market Failure in a Two-Sided Market, 2005 COLUM. BUS. L.
REV. 599 (2005).
96. Don Cruickshank, Competition in UK Banking: A Report to the Chancellor of the Exchequer
U.K. Stationery Office (2000).
97. Amy Dawson and Carl Hugener, A New Business Model for Card Payments (WayToHigh.com:
Diamond Management and Technology Consultants, Inc., 2008), http://waytoohigh.wordpress.com/2008/07/18/a-new-business-model-for-card-payments-via-diamond-management-technology-consultants/.
98. Ramon P. Degennaro, Merchant Acquirers and Payment Card Processors: A Look Inside the
Black Box (FRB ATLANTA ECON. REV., 2006).
99. Patrick DeGraba, Efficient Inter-Carrier Compensation for Competing Networks when
Customers Share the Value of a Call (2002).
100. Allard E. Dembe & Leslie I. Boden, Moral Hazard: A Question of Morality? 3 NEW
SOLUTIONS 257 (2000).
101. Christopher C. DeMuth, The Case Against Credit Card Interest Rate Regulation, 3 YALE J.
REG. 201 (1986).
102. Weisman L. Dennis, Optimal Price Allocations in Two-Sided Markets, 9 REV. NETWORK ECON.
1 (2010).
403
103. Avril McKean Dieser, Antitrust Implications of the Credit Card Interchange Fee and an
International Survey, 17 LOY. CONSUMER L. REV. 451 (2005).
104. Rong Ding, Merchant Internalization Revisited, 125 ECON. LETTERS 347 (2014).
105. Rong Ding & Julian Wright, Payment Card Interchange Fees and Price Discrimination (2015).
106. Jocelyn Donze & Isabelle Dubec, Article 3, ATM Direct Charging Reform: The Effect of
Independent Deployers on Welfare, 10 REV. NETWORK ECON. 1 (2011).
107. Duncan B. Douglass, An Examination of the Fraud Liability Shift in Consumer Card-Based
Payment Systems, FRB Chicago 43 (2009).
108. ANTHONY J. DUKES, ADVERTISING AND COMPETITION, in ISSUES IN COMPETITION LAW AND
POLICY 515 (ABA Section of Antitrust Law, 2008).
109. MacDonald A. Duncan, What MasterCard’s IPO Means for Merchant Suit, AM. BANKER (June
9, 2006).
110. Richard J. Durbin, Letter to Bank of America (Oct. 3, 2011) http://durbin.senate.gov/public/index.cfm/files/serve?File_id=c57f9acb-7a87-4bb9-a2d0-211189c364d0.
111. Thomas A. Durkin, Gregory Elliehausen & Todd J. Zywicki, An Assessment of Behavioral Law
and Economics Contentions and what we Know Empirically about Credit Card use by
Consumers, George Mason Law & Econ. Research Paper no. 14-46 (2014).
112. David Easley and Jon Kleinberg, Voting, in 735 NETWORKS, CROWDS, AND MARKETS:
REASONING ABOUT A HIGHLY CONNECTED WORLD (2010).
113. NICHOLAS ECONOMIDES, COMPETITION POLICY ISSUES IN THE CONSUMER PAYMENTS INDUSTRY,
in MOVING MONEY: THE FUTURE OF CONSUMER PAYMENT 113 (R. Litan & M. Baily eds.,
2009).
114. Nicholas Economides & David Henriques, To Surcharge Or Not to Surcharge? A Two-Sided
Market Perspective of the no-Surcharge Rule (ECB Working Paper No. 1338, Oct. 2011).
115. Benjamin Edelman & Julian Wright, Price Coherence and Excessive Intermediation, (2014).
116. Erich Emch, Market Definition and Market Power in Payment Card Networks, 5 REV.
NETWORK ECON. 45 (2006).
117. Richard A. Epstein & Paula M. Stannard, Constitutional Ratemaking and the Affordable Care
Act: A New Source of Vulnerability, 38 AM. J. L. & MED 243 (2012).
118. EUROPE ECONOMICS, THE ECONOMIC IMPACT OF INTERCHANGE FEE REGULATION IN THE UK, Final
Report, (June 28, 2013).
119. David S. Evans, The Antitrust Economics of Multi-Sided Markets, 20 YALE J. ON REG. 325
(2003).
120. ———. , The Antitrust Economics of Two-Sided Markets, SSRN (2002).
121. ———. Viewpoint: Bank Interchange Fees Balance Dual Demand, AM. BANKER (Jan. 26,
2001).
122. David S. Evans, Howard H. Chang & Margaret M. Weichert, Economic Analysis of Claims in
Support of the Durbin Amendment to Regulate Debit Card Interchange Fees, SSRN (2011).
123. David S. Evans, Robert E. Litan & Richard Schmalensee, Economic Analysis of the Effects of
the Federal Reserve Board's Proposed Debit Card Interchange Fee Regulations on Consumers
and Small Businesses (2011) available at http://ssrn.com/abstract=1769887.
404
124. David S. Evans & Abel M. Mateus, How Changes in Payment Card Interchange Fees Affect
Consumers Fees and Merchant Prices: An Economic Analysis with Applications to the
European Union, SSRN (2011) available at http://ssrn.com/abstract=1878735.
125. David S. Evans & Richard Schmalansee, Failure to Launch: Critical Mass in Platform
Businesses, 9 REV. NETWORK ECON. (2010).
126. ———. , MARKETS WITH TWO-SIDED PLATFORMS, in 1 ISSUES IN COMPETITION LAW AND
POLICY 667 (ABA Section of Antitrust Law 2008).
127. ______. , The Economics of Interchange Fees and their Regulation: An Overview, Payments
System Research Conferences 73 (2005).
128. ———. , Economic Aspects of Payment Card Systems and Antitrust Policy Toward Joint
Ventures, 2 ANTITRUST L.J. 861 (1995).
129. David S. Evans, Howard Chang & Joyce Steven, The Impact of the U.S. Debit Card
Interchange Fee Regulation on Consumer Welfare: An Event Study Analysis, University of
Chicago, Institute for Law and Economics Working Paper (2013).
130. DAVID S. EVANS & RICHARD SCHMALENSEE, PAYING WITH PLASTIC THE DIGITAL REVOLUTION
IN BUYING AND BORROWING (2d ed. 2005).
131. David S. Evans, More than Money: The Development of a Competitive Electronic Payments
Industry in the United States, 2 PAYMENT CARD REV. 1 (2004).
132. Joseph Farrell, Efficiency and Competition between Payment Instruments, 5 REV. NETWORK
ECON. 26 (2006).
133. David E. Feller, A General Theory of the Collective Bargaining Agreement, 61 Cal. L.REV. 663
(1973).
134. Lapo Filistrucchi, A SSNIP Test for Two-Sided Markets: The Case of Media (NET Inst.
Working Paper 08-34, 2008).
135. Tom Fish & Roy Whymark, How has Cash Usage Evolved in Recent Decades? What Might
Drive Demand in the Future? 3 BANK OF ENGLAND Q. BULL. (2015).
136. Amelia Fletcher, Predatory Pricing in Two-Sided Markets: A Brief Comment, 3 COMPETITION
POL'Y INTE'L 221 (2007).
137. Albert Foer, Electronic Payment Systems and Interchange Fees: Breaking the Log Jam on
Solutions to Market Power, American Antitrust Institute (2010).
138. Albert A. Foer, Our $48 Billion Credit Card Bill, N.Y TIMES (Apr. 20, 2010).
139. Dominique Forest & Vaigauskaite Dovile, EC Competition Policy in the Payments Area: New
Developments in MIFs for Cards and SEPA Direct Debit, 2 EC COMPETITION POL'Y NEWSL. 38
(2009).
140. Alan S. Frankel, Towards a Competitive Card Payments Marketplace, RBA 27 (2007).
141. ———. , Monopoly and Competition in the Supply and Exchange of Money 66 ANTITRUST L.J.
313 (1998).
142. ———. , Interchange in various Countries: Commentary on Weiner and Wright, FRB Kansas
51 (2005).
143. Alan S. Frankel & Allan L. Shampine, The Economic Effects of Interchange Fees, 73
ANTITRUST L.J. 627 (2006).
144. Colin Graham Fraser, An Illinois Brick Wall without Foundation: The “Price Paid” Rule and
the Roadmap to Antitrust Immunity (2013).
405
145. Mark Furletti, Prepaid Card Markets & Regulation, Fed. Res. Bank Phila. (2004).
146. M. Anthony Fusaro, Why do People use Debit Cards: Evidence from Checking Accounts, 51
ECON. INQUIRY (2013).
147. Joshua S. Gans & Stephen P. King, Approaches to Regulating Interchange Fees in Payment
Systems, 2 REV. NETWORK ECON. 125 (2003).
148. ———. , The Neutrality of Interchange Fees in Payment Systems, 3 TOPICS ECON. ANALYSIS &
POL'Y 1 (2003).
149. Stephen King & Rodney Maddock, Direct Charging of Card Fees (Monash University
Working Paper, May 2017)
150. Daniel D. Garcia Swartz, Robert W. Hahn & Anne Layne-Farrar, The Move Toward a Cashless
Society: A Closer Look at Payment Instrument Economics, 5 REV. NETWORK ECON. 175
(2006).
151. ———. , The Move Toward a Cashless Society: Calculating the Costs and Benefits, 5 REV.
NETWORK ECON. 199 (2006).
152. Daniel Garcia-Swarz, Robert W. Hahn & Anne Layne-Farrar, Further Thoughts on the
Cashless Society: A Reply to Dr. Shampine, 6 REV. NETWORK ECON. 509 (2007).
153. Alex Gershkov, Benny Moldovanu and Xianwen Shi, Optimal Voting Rules (2016)
154. David Gilo, The Anticompetitive Effect of Passive Investment, 99 MICH. L. REV. 1 (2000).
155. David Gilo & Yossi Spiegel, The Credit Card Industry in Israel, 4 REV. NETWORK ECON. 266
(2005).
156. ——. , Network Interconnection with Competitive Transit, 16 INFO. ECON. POL'Y 439 (2004).
157. ——. , VERTICAL RESTRAINTS, in A LEGAL AND ECONOMIC ANALYSIS OF ANTITRUST LAW 323
(Michal Gal and Menahem Perlman eds., 2008)
158. Anca-Iulia Gîrjob & Maria-Raluca Gîrbacea, The Impact of Interchange Fees on Merchants
and Consumers, 2 ROMANIAN COMPETITION J. 83 (2013).
159. Jakub Gorka, Payment Behaviour in Poland – the Benefits and Costs of Cash, Cards and Other
Non-Cash Payment Instruments (Draft), (2012).
160. Hugh Green, Australia’s 2009 ATM Reforms: Transparency for Transparency’s Sake, 19
AGENDA 1 (2012).
161. Olaf Gresvik & Harald Haare, Costs in the Norwegian Payment System, 4 Norges Bank Staff
Memo (2009).
162. ———. , Costs in the Payment System, 80 NORGES BANK ECON. BULLETIN 16 (2009).
163. Margaret Guerin-Calvert & Janusz a. Ordover, Merchant Benefits and Public Policy Towards
Interchange: An Economic Assessment, 4 REV. NETWORK ECON. 384 (2005).
164. Gonenc Gurkaynak et al., Multisided Markets and the Challenge of Incorporating Multisided
Considerations into Competition Law Analysis, J. ANTITRUST ENFORCEMENT 1 (2016).
165. Graeme Guthrie & Julian Wright, Competing Payment Schemes, 55 J. INDUS. ECON. 37 (2007).
166. Andrei Hagiu & Julian Wright, Multi-Sided Platforms (2011).
167. H. L. A. HART, THE CONCEPT OF LAW (1961).
168. Iftekhar Hasan, Tanya De Renzis & Heiko Schmiedel, Retail Payments and the Real Economy,
ECB Working Paper 1572 (Aug. 2013).
406
169. Iftekhar Hasan, Emmi Martikainen & Tuomas Takalo, Promoting Efficient Retail Payments in
Europe, 20 Bank of Finland Research Discussion Papers (2014).
170. David Havyatt , Why Vertical Structural Separation is in the Interests of Incumbent Telcos, and
Why they don’t See it, available at http://www.havyatt.com.au/docs/wps/TJA1.pdf.
171. Fumiko Hayashi, The New Debit Card Regulations: Effects on Merchants, Consumers, and
Payments System Efficiency, 1 FRB KANSAS Q. REV. 89 (2013).
172. ———. , Discounts and Surcharges: Implications for Consumer Payment Choice, Payments
Sys. Research Briefing FRB Kansas City (2012).
173. ———. , The New Debit Card Regulations: Initial Effects on Networks and Banks, 4 FRB
KANSAS CITY ECON. REV 79 (2012).
174. ———. , Do U.S Consumers really Benefit from Payment Card Rewards? FRB KANSAS ECON.
REV. 37 (2009).
175. ———. , The Economics of Payment Cards Fee Structure: What Drives Payment Card
Rewards? (FRB Of Kansas City Working paper 08-07, 2009).
176. ———. , The Economics of Payment Card Fee Structure: Policy Considerations of Payment
Card Rewards (FRB of Kansas City Working Paper No. 08-08, 2008).
177. ———. , The Economics of Payment Card Fee Structure: What is the Optimal Balance
between Merchant Fee and Payment Card Rewards? (FRB of Kansas City Working Paper No.
08-06. 2008).
178. ———. , Network Competition and Merchant Discount Fees (FRB Kansas City, Payments
System Research Department Working Paper 05-04, 2006).
179. ———. , Pricing and Welfare Implications of Payment Card Network Competition (FRB
Kansas City Working Paper 06-03, 2006).
180. ———. , A Puzzle of Card Payment Pricing: Why are Merchants Still Accepting Card
Payments? 5 REV. NETWORK ECON. 144 (2006).
181. ———. , Public Authority Involvement in Payment Card Markets: Various Countries August
2013 Update (Payments Sys. Research Department of the Fed. Res. Bank of Kansas City).
182. Fumiko Hayashi & Emily Cuddy, General Purpose Reloadable Prepaid Cards: Penetration,
Use, Fees and Fraud Risks, FRB Kansas (Feb. 2014).
183. Fumiko Hayashi & William R. Keeton, Measuring the Costs of Retail Payment Methods (Fed.
Bank of Kansas City Paper, 2012).
184. Fumiko Hayashi & Jesse Leigh Maniff, Public Authority Involvement in Payment Card
Markets: Various Countries August 2014 Update (FRB Kansas, Aug. 2014).
185. Fumiko Hayashi & Joanna Stavins, Effects of Credit Scores on Consumer Payment Choice,
FRB Boston Discussion Paper 12-1 (2012).
186. Fumiko Hayashi et al., A Guide to the ATM and Debit Card Industry 2006 Update (Payment
System Research Department FRB of Kansas City ed.
187. Fumiko Hayashi, Richard Sullivan and Stuart E. Weiner, A Guide to the ATM and Debit Card
Industry (Federal Reserve Bank of Kansas, 2003).
188. Fumiko Hayashi & Stuart E. Weiner, Interchange Fees in Australia the U.K and the United
States: Matching Theory and Practice, FRB KANSAS ECON. REV. 75 (2006).
189. Fumiko Hayashi, Payment Card Interchange Fees and Merchant Service Charges - an
International Comparison, 1 LYDIAN PAYMENT J. 6 (2010).
407
190. Alberto Heimler, Payment Cards Pricing Patterns: The Role of Antitrust and Regulatory
Authorities, SSRN (2010) available at http://ssrn.com/abstract=1574292.
191. ———. , The Economics of Card Payments (Conference Proceeding June 15, 2011).
192. Herbert Hovenkamp, Quantification of Harm in Private Antitrust Actions in the United States
(OECD POLICY ROUNDTABLE QUANTIFICATION OF HARM 209 DAF/COMP(2011)25)
193. ——. , The Taking Clause and Improvident Regulatory Bargains, 108 YALE L.J. 801 (1999).
194. Brad G. Hubbard, The Durbin Amendment, Two-Sided Markets, and Wealth Transfers: An
Examination of Unintended Consequences Three Years Later, SSRN (2013).
195. David B. Humphrey, Retail Payments: New Contributions, Empirical Results, and Unanswered
Questions, 34 J. BANK. FIN. 1729 (2010).
196. ———. , Payment Scale Economies, Competition, and Pricing (ECB Working Paper No. 1136,
2009).
197. David B. Humphrey, Moshe Kim & Bent Vale, Realizing the Gains from Electronic Payments:
Costs, Pricing, and Payment Choice, 33 J. MONEY, CREDIT & BANK. 216 (2001).
198. David Humphrey et al., What does it Cost to make a Payment? 2 REV. NETWORK ECON. 159
(2003).
199. Robert M. Hunt, An Introduction to the Economics of Payment Card Networks, 2 REV.
NETWORK ECON. 80 (2003).
200. Frederic Jenny, Competition Policy Issues in the Financial Services Sector: Regulation of the
Interchange Fees in Credit Card Systems (Conference Proceeding, 2008).
201. Ginger Zhe Jin & Marc Rysman, Platform Pricing at Sports Card Conventions (NBER
Working Paper 17959, 2012).
202. Andrew R. Johnson, Fees on Cup of Coffee Raised From 8 Cent to 23 Cent, MasterCard, Visa
Raising Small Debit Buy Fees, Marketwatch (Sept. 22, 2011).
203. Peter Jones, Will Europe’s Acquiring Market be Dominated by Non Banks? (2009).
204. ———. , The Uncomfortable Consequences of a Universal Multi-Lateral Interchange Fee
(MIF) for Europe, Payment Sys. Europe (2005).
205. Nicole Jonker, Social Costs of POS Payments in the Netherlands 2002–2012: Efficiency Gains
from Increased Debit Card Usage, 2 DNB Occasional Studies (2013).
206. ———. , Card Acceptance and Surcharging: The Role of Costs and Competition, 10 REV.
NETWORK ECON. (2011).
207. Nicole Jonker & Mirjam Plooij, Tourist Test Interchange Fees for Card Payments: Down Or
Out? 1 J. FIN. MARKET INFRASTRUCTURE 51 (2013).
208. M. Charles Kahn & William Roberds, Why Pay? Introduction to Payment Economics, 18 J.
FIN. INTERMEDIATION 1 (2009).
209. Andrew Kahr, Why Allow Only Banks to Issue Credit Cards? AM. BANKER (Aug. 22, 2012).
210. Ulf von Kalckreuth et al., Using Cash to Monitor Liquidity – Implications for Payments,
Currency Demand and Withdrawal Behavior (Deutsche Bundesbank Discussion Paper
22/2011).
211. Mika Kato, Jean Tirole, Nobel Prize Winner (Aug. 28, 2015).
408
212. Michael L. Katz, What do we Know about Interchange Fees and what does it Mean for Public
Policy? Commentary on Evans and Schmalensee, FRB Kansas Payments Sys. Res. Conference
121 (2005).
213. MICHAEL L. KATZ, REFORM OF CREDIT CARDS SCHEMES IN AUSTRALIA COMMISSIONED REPORT
(Reserve Bank of Australia, 2001).
214. BENJAMIN Kay, Mark D. Manuszak & Cindy M. Vojtech, Bank Profitability and Debit Card
Interchange Regulation: Bank Responses to the Durbin Amendment (2014).
215. Phillip Keitel, A Prepaid Case Study: Ready Credit’s General-Purpose & Transit-Fare
Programs (Fed. Reserve Bank of Phil. Discussion Paper. 2012).
216. ———. , Federal Regulation of the Prepaid Card Industry: Costs, Benefits, and Changing
Industry Dynamics (Conference Summary Payment Cards Center Fed. Res. Bank of
Philadelphia, 2010).
217. Éva Keszy-Harmath et al., The Role of the Interchange Fee in Card Payment Systems (MNB
Occasional papers 96, 2012).
218. Ann Kjos, The Merchant-Acquiring Side of the Payment Card Industry: Structure, Operations,
and Challenges (FRB of Philadelphia Discussion Paper 2007).
219. Benjamin Klein et al., Competition in Two-Sided Markets: The Antitrust Economics of Payment
Card Interchange Fees, 73 ANTITRUST L.J. 571 (2006).
220. Soren Korsgaard, Paying for Payments Free Payments and Optimal Interchange Fees, 1682
ECB Working Paper (2014).
221. Jean-Jacques Laffont, Patrick Rey & Jean Tirole, Network Competition 1. Overview and
Nondiscriminatory Pricing, 29 RAND J. ECON. 1 (1998).
222. Ian Lee et al., Credit Where It’s due: How Payment Cards Benefit Canadian Merchants and
Consumers, and how Regulation can Harm them, George Mason University Law and
Economics Research Paper Series 13-58 (Oct. 2013).
223. Sungbok Lee, The Effects of Issuer Competition on the Credit Card Industry: A Case Study of
the Two-Sided Market, (2010) available at http://www.javanfish.com/file/The%20Effects%20of%20Issuer%20Competition%20On%20the%20Credit%20Card%20Industry_October2010.pdf.
224. Harry Leinonen, Debit Card Interchange Fees Generally Lead to Cash-Promoting Cross-
Subsidisation (Bank of Finland Research Discussion Papers, 2011).
225. Jonathan Levin and Barry Nalebuff, An Introduction to Vote-Counting Schemes, 9 J. ECON.
PERSPECTIVES 3 (1995)
226. Adam J. Levitin, Interchange Regulation: Implications for Credit Unions, (Filene Research
Institute, 2010).
227. ———. , Priceless? the Econommic Costs of Credit Card Merchant Restraints, 55 UCLA L.
REV. 1321 (2008).
228. ———. , The Antitrust Super Bowl: America's Payment Systems, no-Surcharge Rules, and the
Hidden Costs of Credit, 3 BERKELEY BUS. L.J. 265 (2005).
229. Adam J. Levitin, Priceless? the Social Costs of Credit Card Merchant Restraints, SSRN
(2008).
230. HIGH-LEVEL EXPERT GROUP ON REFORMING THE STRUCTURE OF THE EU BANKING SECTOR
(LIIKANEN REPORT), (Oct. 2012)
409
231. Hoze Linares-Zegarra & John O. S. Wilson, Risk Based Pricing in the Credit Card Industry:
Evidence from US Survey Data (2012) http://ssrn.com/abstract=2141360.
232. Catherine Liston, Price-Cap versus Rate-of-Return Regulation, 5 J. Regulatory Econ. 25, 28
(1993).
233. Philip Lowe, Reform of the Payments System (Visa International Australia and New Zealand
Member Forum, March. 2005).
234. James M. Lyon, The Interchange Fee Debate: Issues and Economics, FRB Minneapolis (June
1, 2006).
235. I. J. Macfarlane, Greshams Law of Payments, (Address to Australasian Institute of Banking and
Finance Industry Forum, 2005) available at http://www.bis.org/review/r050323l.pdf.
236. Ronald J. Mann, Charging Ahead: The Growth and Regulation of Payment Card Markets
(2006).
237. Fabio M. Manenti & Ernesto Somma, Plastic Clashes: Competition among Closed and Open
Systems in the Credit Card Industry (2002)
238. Fabio M. Manenti & Ernesto Somma, Plastic Clashes: Competition among Closed and Open
Systems in the Credit Card Industry (2010).
239. Andrew Martin, How Visa, using Card Fees, Dominates a Market, N.Y. TIMES (Jan. 4, 2010).
240. ANDREU MAS-COLELL ET AL., MICROECONOMIC THEORY, (Oxford 1995).
241. JAMES J. Mcandrews, Automated Teller Machine Network Pricing – A Review of the Literature,
2 REV. NETWORK ECON. 146 (2003).
242. James J. Mcandrews & Zhu Wang, The Economics of Two-Sided Payment Card Markets:
Pricing, Adoption and Usage (Fed. Res. Bank of Kansas City Working Paper 2008).
243. Harrison J. McAvoy, Regulation Or Competition?: The Durbin Amendment, the Sherman Act,
and Intervention in the Card Payment Industry, 37 SETON HALL LEGISLATIVE J. (2013).
244. Kathleen A. McConnell, The Durbin Amendment's Interchange Fee and Network Non-
Exclusivity Provisions: Did the Federal Reserve Board Overstep its Boundaries? 18 N.C.
BANKING INST. 627 (March 2014).
245. James McGrath, General-use Prepaid Cards: The Path to Gaining Mainstream Acceptance,
Fed. Res, Bank Philadelphia (2007).
246. Tim Mead, Renee Courtois Haltom & Margaretta Blackwell, The Role of Interchange Fees on
Debit and Credit Card Transactions in the Payments System, 11-05 Fed. Reserve Bank of
Richmond (2011).
247. Massimo Motta & Helder Vasconcelos, Exclusionary Pricing in a Two-Sided Market, CEPR
Discussion Paper 9164 (Oct. 2012).
248. Timothy J. Muris, Payment Card Regulation and the (MIS)Application of the Economics of
Two-Sided Markets, 3 COLUM. BUS. L. REV. 515 (2005).
249. NECG, Visa's Response to the Reserve Bank of Australia and Australia Competition and
Consumer Commission Joint Study (2001).
250. José L. Negrín, The Regulation of Payment Cards: The Mexican Experience, 4 REV. NETWORK
ECON. 243 (2005).
251. David M Newbery, Rate-of-return regulation versus price regulation for public utilities
(Cambridge 1997)
410
252. Larry O'Connell, Electronic Tendering: Recognising a More Effective Use of Information
Communications Technology in the Irish Construction Industry, Masters dissertation. Dublin
Institute of Technology (2010)
253. OFFICE OF FAIR TRADING, INVESTIGATION INTO INTERCHANGE FEES (2012) available at http://webarchive.nationalarchives.gov.uk/20140402142426/http://www.oft.gov.uk/OFTwork/competition-act-and-cartels/ca98-current/interchange-fees
254. BARAK ORBACH, THE GOALS OF ANTITRUST LAW IN PRACTICE, IN LEGAL AND ECONOMIC
ANALYSIS OF ANTITRUST LAW 63 (Michal Gal & Menachem Perlman eds., 2008).
255. Janusz a. Ordover, Comments on Evans & Schmalensee’s “The Industrial Organization of
Markets with Two-Sided Platforms”, 3 Competition Pol'y Int'l 181 (2007).
256. Rachel L. Osband, Interchange Fee Reform in Mexico: A Bank Driven Approach, ANTITRUST
BULL. (2009).
257. Crystal Ossolinski, Tai Lam & David Emery, The Changing Way we Pay: Trends in Consumer
Payments, RBA Australia Research Discussion Paper (2014).
258. Barbara Pacheco & Richard Sullivan, Interchange Fees in Credit and Debit Card Markets:
What Role for Public Authorities? 1 FED. RES. BANK KANSAS ECON. REV. 87 (2006).
259. WILLIAM H. PAGE & JOHN E. LOPATKA, NETWORK EXTERNALITIES, in 1 ENCYCLOPEDIA OF
LAW AND ECONOMICS 952 (B. Bouckaert & G. Ed De Geest eds., 1999).
260. NIGEL PARR ET AL., UK MERGER CONTROL: LAW AND PRACTICE (2nd ed. 2005).
261. Craig T. Peters, Bargaining Power and the Effects of Joint Negotiation: The "Recapture Effect"
(Sept. 2014).
262. Aghion Philippe et al., Competition and Innovation: An Inverted-U Relationship, 120 Q. J.
ECON. 701 (2005).
263. KENNETH A. POSNER, CLASH OF TITANS: RETAILERS, CARD ISSUERS AND INTERCHANGE, INDUS.
REPORT (Morgan Stanley, 2006).
264. Richard A. Posner, Natural Monopoly and its Regulation, 21 STAN. L. REV. 548 (1969).
265. Robin A. Prager et al., Interchange Fees and Payment Card Networks: Economics, Industry
Developments, and Policy Issues (FRB Fin. and Econ. Discussion Series 23-09. 2009).
266. David A. Price & Zhu Wang, Why do Debit Card Networks Charge Percentage Fees? 13-02
Fed. Reserve Bank of Richmond (2013).
267. GEORGE L. PRIEST, NETWORKS AND ANTITRUST ANALYSIS, in 1 ISSUES IN COMPETITION LAW
AND POLICY 641 (ABA section of Antitrust Law 2008).
268. ———. , Rethinking Antitrust Law in an Age of Network Industries (John M. Olin Research
Paper 352, 2007).
269. Lina Rainiene, Functional and Structural Separation Models, TAIEX Workshop on Regulatory
Framework, Belgrade (April 2010).
270. Frank Ramsey, A Contribution to the Theory of Taxation, ECON. J. (1927).
271. Lukas Repa, MasterCard and VISA Modify Network Rules and Increase Antitrust
Transparency of Cross-Border Interchange Fees, 2 COMPETITION POL'Y NEWSL. 57 (2005).
272. Lukas Repa, Agata Malczewska & Antonio Carlos Teixeira, Commission Prohibits
MasterCard’s Multilateral Interchange Fees for Cross-Border Card Payments in the EEA,
COMPETITION POL'Y NEWSL. (Nov. 1, 2008).
411
273. Jean Charles Rochet, Competing Payment Systems: Key Insights from the Academic Literature
(RBA Paper Prepared for the Payments System Review Conference, 2007).
274. ———. , The Interchange Fee Mysteries, Commentary on Evans and Schmalensee
(Conference on Payments Systems, 2005).
275. ———. , The Theory of Interchange Fees: A Synthesis of Recent Contributions, 2 REV.
NETWORK ECON. 97 (2003).
276. Jean Charles Rochet & Jean Tirole, Two-Sided Markets: A Progress Report, 37 RAND J. ECON.
645 (2006).
277. ———. , Externalities and Regulation in Card Payment Systems 5 REV. NETWORK ECON. 1
(2006).
278. ———. , Two-Sided Markets: An Overview (2004).
279. ———. , An Economic Analysis of the Determination of Interchange Fees in Payment Card
Systems, 2 REV. NETWORK ECON. 69 (2003).
280. ———. , Platform Competition in Two-Sided Markets, 1 J. EUR. ECON. ASS'N 990 (2003).
281. ———. , Cooperation among Competitors: Some Economics of Payment Card Associations,
33 RAND J. ECON. 549 (2002).
282. ———. , Must-Take Cards: Merchant Discounts and Avoided Costs, 9 J. EUR. ECON. ASS'N
462 (2011).
283. ———. , Tying in Two-Sided Markets and the Honor all Cards Rule, 26 Int'l j. Indus. Org.
1333 (2008).
284. Jean-Charles Rochet & Zhu Wang, Issuer Competition and the Credit Card Interchange Fee
Puzzle, (2010).
285. Jean-Charles Rochet & Julian Wright, Credit Card Interchange Fees, 34 J. BANKING FIN. 1788
(2010).
286. Susan Rose-Ackerman & Jim Rossi, Disentangling Deregulatory Takings, 86 VIR. L. REV.
1435 (2000).
287. Jim Rossi, The Irony of Deregulatory Takings, 197 TEX. L. REV. 77 (1998).
288. Camilo Rubiano, Collective Bargaining and Competition Law: A Comparative Study on the
Media, Arts and Entertainment Sectors (July 2013).
289. Michael H. Ryan, Structural Separation: A Prerequisite for Effective Telecoms Competition?
E.C.L.R 241 (2003).
290. Marc Rysman, The Economics of Two-Sided Markets, 23 J. ECON. PERSPECTIVES 125 (2009).
291. ———. , An Empirical Analysis of Payment Card Usage, 55 J. INDUS. ECON. 1 (2007).
292. Marc Rysman & Julian Wright, The Economics of Payment Cards, 13 REV. NETWORK ECON.
303 (2015).
293. M. Pierce Sandwith, The Dodd-Frank Wall Street Reform and Consumer Protection Act: Debit
Card Interchange Fees and the Durbin Amendment's Small Bank Exemption, 16 N.C. BANKING
INST. 223 (2012).
294. Aaron Schiff, The "Waterbed" Effect and Price Regulation, 7 REV. NETWORK ECON. 392
(2008).
295. Richard Schmalensee, Payment Systems and Interchange Fees, 50 J. INDUS. ECON. 103 (2002).
412
296. ———. , Interchange Fees, Market Failure, and Remedies (Presentation in Conference “The
Role and Regulation of Interchange Fees in European Payment Cards”, 2011) available at https://www.competitionpolicyinternational.com/assets/Free/Schmalensee-transcriptupdate.pdf.
297. ———. , Interchange Fees: A Review of the Literature, 1 PAYMENT CARD ECON. REV. 25
(2003).
298. Heiko Schmiedel, Gergana Kostova & Wiebe Ruttenberg, The Social and Private Costs of
Retail Payment Instruments A European Perspective, 137 ECB Occasional Paper Series (2012).
299. Barry Scholnick et al., The Economics of Credit Cards, Debit Cards and ATMs: A Survey and
some New Evidence, 32 J. BANK. FIN. 1468 (2008).
300. Scott Schuh et al., Who Gains and Who Loses from Credit Card Payments? Theory and
Calibrations (FRB of Boston Public Policy Discussion Papers No. 10-03, 2010).
301. ———. , An Economic Analysis of the 2011 Settlement between the Department of Justice and
Credit Card Networks, 8 J. COMPETITION L. ECON. 1 (2012).
302. Scott Schuh & Joanna Stavins, How Consumers Pay: Adoption and use of Payments (FRB of
Boston Working Paper, 2012).
303. ———. , Why Are (Some) Consumers (Finally) Writing Fewer Checks? The Role
of Payment Characteristics, 34 J. BANK. FIN. 1745 (2010).
304. Carl Schwartz et al., Payment Costs in Australia (RBA and ACCC Publication for a
Conference Held in Sydney on Nov. 29, 2007).
305. Marius Schwartz & Daniel R. Vincent, The No Surcharge Rule and Card User Rebates:
Vertical Control by a Payment Network, 5 REV. NETWORK ECON. 72 (2006).
306. Björn Segendorf & Thomas Jansson, The Cost of Consumer Payments in Sweden (Sveriges
Risbank Working Paper 262, 2012).
307. Steven Semeraro, Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who
Gains and Who Loses from Credit Card Payments? Theory and Calibrations (2012).
308. ———. , The Antitrust Economics (and Law) of Surcharging Credit Card Transactions, 14
STAN. J. L. BUS. & FIN. 343 (2009).
309. ———. , Credit Cards Interchange Fees: Three Decades of Antitrust Uncertainty, 14 GEO.
MASON L. REV. 941 (2007).
310. ———. , The Economic Benefits of Credit Card Merchant Restraints: A Response to Adam
Levitin, TJSL Legal Studies Research Paper 1357840 (2009).
311. ———. , The Reverse Robin Hood Cross Subsidy Hypothesis: Do Credit Cards Systems Tax
the Poor and Reward the Rich? 40 RUTGERS L. J. 419 (2009).
312. Allan Shampine, An Evaluation of the Social Costs of Payment Methods Literature, SSRN
(2012).
313. ———. , Another Look at Payment Instrument Economics, 6 REV. NETWORK ECON. 495
(2007).
314. ———. , Testing Interchange Fee Models using the Australian Experience (Bank of Canada
Economics of Payments VI conference, May 24, 2012).
315. Robert J. Shapiro & Jiwon Vellucci, The Costs of “Charging it” in America: Assessing the
Economic Impact of Interchange Fees for Credit Card and Debit Card Transactions (2010).
316. STEVEN SHAVELL, FOUNDATIONS OF ECONOMIC ANALYSIS OF LAW (2004).
413
317. COMMITTEE FOR ENHANCEMENT OF COMPETITION IN COMMON BANKING & FINANCIAL
SERVICES (SHTRUM COMMITTEE) FINAL REPORT (Sep 1, 2016)
318. Oz Shy, Measuring some Effects of the 2011 Debit Card Interchange Fee Reform, 32
CONTEMPORARY ECON. POL'Y 769 (2014).
319. Oz Shy & Joanna Stavins, Merchant Steering of Consumer Payment Choice: Lessons Learned
from Consumer Surveys, 13-1 FRB Boston (2013).
320. Oz Shy & Zhu Wang, Why do Payment Card Networks Charge Proportional Fees? 101 AM.
ECON. REV. 1575 (2011).
321. J. GREGORY SIDAK & DANIEL F. SPULBER, DEREGULATORY TAKINGS AND THE REGULATORY
CONTRACT (1998).
322. John Simon, Payment Systems are Different: Shouldn’t their Regulation be Too? 4 REV.
NETWORK ECON. 364 (2005).
323. John Simon, Kylie Smith & Tim West, Price Incentives and Consumer Payment Behaviour, 34
J. BANK. FIN. 1759 (2010).
324. Ewelina Sokołowska, Innovations in the Payment Card Market: The Case of Poland
(Electronic Commerce Research and Applications, 2015).
325. Daniel F. Spulber & Christopher F. Yoo, Antitrust, The Internet, and the Economics of
Networks, Faculty Scholarship Series Paper 583 (2013).
326. Joanna Stavins, Potential Effects of an Increase in Debit Card Fees (FRB of Boston Public
Policy Briefs No. 11-03, 2011).
327. Chris Stewart et al., The Evolution of Payment Costs in Australia, RBA Research Discussion
Paper 14 (2014).
328. STRUCTURAL BANKING REFORMS CROSS-BORDER CONSISTENCIES AND GLOBAL FINANCIAL
STABILITY IMPLICATIONS, Report to G20 Leaders for the November 2014 Summit Financial
Stability Board (Oct. 27, 2014).
329. Peter R. Taylor, Cards and Payments Australasia, Payment Conference 2010.
http://www.comcom.govt.nz/cards-and-payments-australasia-2010-conference-15-march-2010/.
330. Jean Tirole, Payment Card Regulation and the use of Economic Analysis in Antitrust, 4
TOULOUSE SCHOOL ECON. (2011).
331. Dr Anikó Turján et al., Nothing is Free: A Survey of the Social Cost of the Main Payment
Instruments in Hungary (93 MNB Occasional Papers 2011).
332. Jonathan C. Tyras, Collective Bargaining and Antitrust After Brown v. Pro Football, Inc, 1
PENN. J. BUS. L. 297 (1998).
333. Jens Uhlenbrock, Pricing and Regulation in Multi-Sided Markets - Implications for Payment
Card Networks and Smart Metering (2012).
334. United States Senate Committee on Judiciary, Credit Card Interchange Fee: Antitrust
Concerns? (2006).
335. Tommaso Valletti, Platform Regulation in Other Industries: Lessons from Telecoms
(Conference Presentation, The Role and Regulation of Interchange Fees in European Payment
Cards, Brussels. June 15, 2011).
336. IVO VAN BAEL & JEAN-FRANCOIS BELLIS, COMPETITION LAW OF THE EUROPEAN COMMUNITY
(5ed. 2010).
414
337. Leo Van Hove, Central Banks and Payment Instruments: A Serious Case of Schizophrenia, 66
COMMUNICATIONS & STRATEGIES 19 (2007).
338. ———. , Cost-Based Pricing of Payment Instruments: The State of the Debate, 152 DE
ECONOMIST 79 (2004).
339. Marianne Verdier, Interchange Fees in Payment Card Systems: A Survey of the Literature, 25
J. ECON. SURVEYS 273 (2011).
340. ———. , Interchange Fees and Incentives to Invest in Payment Card Systems, 28 INT'L J.
INDUS. ORG. 539 (2010).
341. Srikanth Verma & Satyanarayana Reddy, Global Credit Card Industry: Issues and Challenges,
(Jul. 2014) available at http://dawn-svims.in/wp-content/uploads/2014/12/4-Global-Credit-Card-Industry-Issues-and-Challenges.pdf .
342. John Vickers, Public Policy and the Invisible Price: Competition Law, Regulation and the
Interchange Fee, Payments Systems Research Conference 231 (2005).
343. U.K. INDEPENDENT COMMISSION ON BANKING FINAL REPORT RECOMMENDATIONS (VICKERS
REPORT), (Sept. 2011).
344. Sebastian Voigt & Oliver Hinz, Network Effects in Two-Sided Markets: Why a 50/50 User Split
is Not Necessarily Revenue Optimal, (2015).
345. Christian Von Wizsacker, Comments regarding "Reform of Credit Card Schemes in Australia
II" Commissioned Report by Professor Michael L. Katz (2002) available at http://www.rba.gov.au/payments-system/reforms/cc-schemes/consult-doc-responses/mastercard-0302-2.pdf.
346. Kevin Wack, Retailers Sue Fed Over Interchange Rule, AM. BANKER (Nov. 22, 2011).
347. Naoki Wakamori & Angelika Welte, Why do Shoppers use Cash? Evidence from Shopping
Diary Data (Bank of Canada WP 24-2012).
348. Zhu Wang, Demand Externalities and Price Cap Regulation: Learning from the U.S. Debit
Card Market (FRB Richmond Working Paper 2014).
349. Zhu Wang & Julian Wright, Ad-Valorem Platform Fees and Efficient Price Discrimination
(2012).
350. Liyuan Wei, Consumer Choice of Credit Cards, Usage and Retention (2015) available at
http://kuleuvencongres.be/EMAC2015/w/papers/ggkljel-fgmjhm-fm3vx8ou.pdf.
351. Stewart E. Weiner & Julian Wright, Interchange Fees in various Countries: Developments and
Determinants, 4 REV. NETWORK ECON. 290 (2005).
352. Tim Westrich & Malcolm Bush, Blindfolded into Debt: A Comparison of Credit Card Costs
and Conditions at Banks and Credit Unions, WOODSTOCK INST. (2005) available at
http://www.fdic.gov/news/conferences/affordable/woodstock2.pdf.
353. E. Glen Weyl, The Price Theory of Two-Sided Markets, SSRN (2009).
354. ———. , A Price Theory of Multi-Sided Platforms, 100 AM. ECON. REV. 1642 (2010).
355. ———. , Double Marginalization in Two-Sided Markets, SSRN (2008).
356. K. Craig Wildfang & Ryan W. Marth, The Persistence of Antitrust Controversy and Litigation
in Credit Card Networks, 73 ANTITRUST L.J. 675 (2006).
357. Oliver E. Williamson, Deregulatory Takings and Breach of the Regulatory Contract: Some
Precautions, 71 N.Y.U. L. REV. 1007 (1996).
415
358. Stephanie M. Wilshusen et al., Consumers’ use of Prepaid Cards: A Transaction-Based
Analysis (Federal Reserve Bank of Philadelphia discussion paper 2012).
359. Steve Worthington, Affinity Credit Cards a Critical Review, 29 INT. J. RETAIL & DISTRIBUTION
MANAGEMENT 485 (2001).
360. Julian Wright, Why Payment Card Fees Are Biased Against Retailers, 43 RAND J. ECON. 761
(2012).
361. ———. , Why do Merchants Accept Payment Cards? 9 REV. NETWORK ECON. 1 (2010).
362. ———. , The Determinants of Optimal Interchange Fees in Payment Systems, 52 J. INDUS.
ECON. 1 (2004).
363. ———. , One-Sided Logic in Two-Sided Markets 3 REV. NETWORK ECON. 44 (2004).
364. ———. , Optimal Card Payment Systems, 47 EUR. ECON. REV. 587 (2003).
365. ———. , Pricing in Debit and Credit Card Schemes, ECON. LETTERS (2003).
366. SHARON YADIN, REGULATION: ADMINISTRATIVE LAW IN THE AGE OF REGULATORY CONTRACTS
(2016)
367. Hans Zenger, Differentiated Interchange Fees, 115 ECON. LETTERS 276 (2012).
368. ———. , Perfect Surcharging and the Tourist Test Interchange Fee, 35 J. BANK. FIN. 2544
(2011).
369. Wang Zhu, Market Structure and Payment Card Pricing: What Drives the Interchange?, 28
INT'L J. INDUS. ORG. 86 (2010).
370. Jonathan Zinman, Debit Or Credit?, 33 J. BANK. FIN. 358 (2009).
371. Todd Zywicki, Will Congress Take another Swipe at Credit Cards? WALL ST. J. (Jan. 5, 2010).
372. Todd Zywicki, Geoffrey A. Manne & Julian Morris, Price Controls on Payment Card
Interchange Fees: The U.S. Experience (2014) available at
http://www.laweconcenter.org/images/articles/icledurbin2014.pdf .
416
2. U.S. Cases
1. United States v. Am. Express Co., 2016 U.S. App. LEXIS 17502 (2d Cir. N.Y. Sept. 26, 2016).
2. Brennan v. Concord Efs, U.S. LEXIS 6750 (U.S. Oct. 7, 2013).
3. United States v. Am. Express Co., 21 F. Supp. 3d 187 (E.D.N.Y May 7, 2014).
4. United States v. Am. Express Co., 2011 U.S. Dist. LEXIS 78835 (E.D.N.Y July 20, 2011).
5. United States v. Am. Express Co., 2015 U.S. Dist. Lexis 20114 (E.D.N.Y Feb. 19, 2015).
6. United States v. Am. Express, (April 30, 2015) http://www.justice.gov/file/485716/download.
7. Osborn v. Visa Inc., 797 F.3d 1057 (D.C. Cir. 2015).
8. In Re Payment Card Interchange Fee & Merchant Discount Antitrust Litig., 991 F. Supp. 2d
437 (E.D.N.Y. 2014).
9. NACS v. Bd. of Governors of the Fed. Reserve Sys., 746 F.3d 474 (D.C. Cir. 2014).
10. In Re Payment Card Interchange Fee & Merchant Discount Antitrust Litig., 986 F. Supp. 2d
207 (E.D.N.Y 2013).
11. NACS v. Bd. of Governors of the Fed. Reserve Sys., 958 F. Supp. 2d 85 115 (D.D.C. 2013).
12. In Re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation (Settlement
Agreement), 05-MD-1720 (E.D.N.Y 2012).
13. In Re: ATM Fee Antitrust Litigation, 10-17354 LEXIS 14265 (C.A 9th cir. 2012).
14. In Re Payment Card Interchange Fee & Merchant Discount Antitrust Litig., 05-MD-1720
(E.D.N.Y 2008).
15. In Re Payment Card Interchange Fee & Merchant Discount. Antitrust Litig., U.S. Dist. LEXIS
104439 (E.D.N.Y 2008).
16. In Re Payment Card Interchange Fee & Merchant Discount Antitrust Litig., 398 F. Supp . 2d
1356 (J.P.M.L 2005).
17. N. Jackson Pharm., Inc. v. Caremark RX, Inc., 385 F. Supp. 2d 740 (N.D. 2005).
18. Wal-Mart v. Visa U.S.A., 396 F .3d 96 U.S. Ct. of Appeals 2nd cir. (2005).
19. Mastercard v. United States, 543 U.S. 811 (2004).
20. Verizon Communs., Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, (2004).
21. United States v. Visa, 344 F .3d 229 (CA 2d Dist. 2003).
22. Verizon Communs., Inc. v. FCC, 535 U.S. 467 (2002).
23. United Stated v. Visa U.S.A., Inc., 183 F. Supp. 2d 613 (S.D.N.Y 2001).
24. United States v. Visa, 163 F. Supp. 2d 322 (S.D.N.Y 2001).
25. In Re Visa Check/MasterMoney Antitrust Litig., 192 F.R.D. 68 (2000).
26. National Bancard Corp. (NaBanco) v. VISA, 596 F. Supp. 1231 (S.D of Fla, LEXIS 23432
1984).
27. United States v. AT&T Co., 552 F. Supp. 131 (D.D.C. 1982).
28. Broadcast Music v. CBS, 441 U.S. 1 (1979).
29. Marquette Nat'l Bank v. First of Omaha Service Corp., 439 U.S. 299 (1978).
417
30. Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977).
31. United States v. Grinnell Corp., 384 U.S. 563 (1966).
32. United States v. E. I. Du Pont De Nemours & Co., 366 U.S. 316 (1961).
33. United States v. Aluminum Co. of America, 148 F. 2d 416 (2d Cir. N.Y. 1945).
34. United States v. Socony-Vacuum Oil Co., 310 U.S. 150 (1940).
35. American Bank & Trust Company V. Federal Reserve Bank of Atlanta, 262 U.S. 643 (1923).
36. Standard Oil Co. v. United States, 221 U.S. 1 (1911).
37. In Re Visa Check/Mastermoney Antitrust Litig., 297 F. Supp. 2d 503 (E.D.N.Y 2003).
38. In Re Visa Check/Mastermoney Antitrust Litig. 2003 U.S. Dist. LEXIS 4965 (E.D.N.Y 2003).
39. Am. Needle, Inc. v. NFL, 130 S. Ct. 2201, 2217 (U.S. 2010).
40. Board of Trade v. United States, 246 U.S. 231, 238 (U.S. 1918).
41. Compact v. Metropolitan Government of Nashville & Davidson County, 594 F. Supp. 1567
(M.D. Tenn. 1984).
42. In Re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation (Settlement
Agreement), 05-MD-1720 (E.D.N.Y 2012).
43. Instant Delivery Corp. v. City Stores Co., 284 F. Supp. 941 (E.D. Pa. 1968).
44. Marrero-Rolón v. Autoridad De Energía Eléctrica, U.S. Dist. LEXIS 134211(Sept. 28, 2015).
45. White Motor Co. v. United States, 372 U.S. 253 (U.S. 1963).
46. Expressions Hair Design v. Schneiderman, 137 S. Ct. 1144 (Mar. 29, 2017).
47. Italian Colors Rest. v. Becerra, 878 F.3d 1165 (9th Cir. Jan 3. 2018).
48. State Oil Co. v. Khan, 522 U.S. 3 (1997)
49. Maislin Indus., U.S. v. Primary Steel, 497 U.S. 116 (1990)
50. Duquesne Light Co. v. Barasch, 488 U.S. 299 (1989)
51. FPC v. Nat. Gas Pipeline Co., 315 U.S. 575 (1942).
52. Federal Power Com. v. Hope Natural Gas Co., 320 U.S. 591(1944)
53. Covington & lexington tpk. Rd. Co. V. Sandford, 164 U.S. 578 (1896)
54. P.R. Tel. Co. v. Telecomms. Regulatory Bd. of P.R., 665 F.3d 309 (1st Cir. 2011)
55. Smyth v. Ames, 169 U.S. 466, 515 (1898)
56. Mo. ex rel. Sw. Bell Tel. Co. v. Pub. Serv. Com., 262 U.S. 276 (1923)
57. Permian Basin Area Rate Cases, 390 U.S. 747, 806, 88 S. Ct. 1344 (1968)
58. Consol. Edison Co. v. Pub. Serv. Comm'n, 447 U.S. 530 (1980)
3. U.S. Authorities
1. ANTITRUST MODERNIZATION COMMISSION, REPORT AND RECOMMENDATIONS 267-269 (2007).
2. BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, COMPLIANCE GUIDE TO SMALL
ENTITIES (Aug. 2, 2013) http://www.federalreserve.gov/bankinforeg/regiicg.htm.
418
3. Board of Governors of the Federal Reserve System, Final Rule on Debit Card Interchange Fees
and Routing and Interim Final Rule on Fraud Prevention Adjustment, 12 C.F.R pt. 235, (2011).
4. Board of Governors of the Federal Reserve System, Debit Card Interchange Fees and Routing,
Final Rule, 77 Fed. Reg. 150 § 46258 (Aug. 3, 2012).
5. Credit Card Accountability Responsibility and Disclosure Act, Pub. L. 111–24, (2009).
6. Credit Card Fair Fee Act of 2009: Hearing before the Committee on the Judiciary House of
Representatives 111th Cong. on H.R. 2695, 111–101 (April 28, 2010).
7. Debit Card Interchange Fees and Routing, 75 Fed. Reg. § 81722, (2010).
8. Department of Justice, Antitrust Division Policy Guide to Merger Remedies, (Jun. 2011).
9. Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law Pub. L. 111-203,
(2010).
10. FEDERAL TRADE COMMISSION AND DEPARTMENT OF JUSTICE, ANTITRUST GUIDELINES FOR
COLLABORATIONS AMONG COMPETITORS (2000).
11. Hearing before the S. Judiciary Comm., 109th Cong. 147 (2006) (Statement of Timothy J.
Muris, Former FTC Chairman).
12. H.R 5546 110th Cong. (2008).
13. H.R. 5244, 110th Cong. (2008).
14. H.R. 5546 Summary , 110th Cong. (2008).
15. H.R. 110-913 (2008).
16. FINANCIAL STABILITY OVERSIGHT COUNCIL, STUDY & RECOMMENDATIONS ON PROHIBITIONS
ON PROPRIETARY TRADING & CERTAIN RELATIONSHIPS WITH HEDGE FUNDS & PRIVATE
EQUITY FUNDS (2011).
17. FTC, Press Release, FTC Issues Statement of Principles regarding Enforcement of FTC Act as
a Competition Statute (Aug. 13, 2015).
18. Justice News, Justice Department Sues American Express, MasterCard and Visa to Eliminate
Rules Restricting Price Competition; Reaches Settlement with Visa and MasterCard (Oct. 4,
2010).
19. Statements of Antitrust Enforcement Policy in Health Care, Issued by the U.S. Department of
Justice and the Federal Trade Commission August 1996 .
20. Truth in Lending; Unfair Or Deceptive Acts Or Practices; Final Rules, 75 Fed. Reg. 7658 pts.
226 & 227 (Feb. 22, 2010).
21. U.S. GOV'T ACCOUNTABILITY OFF., GAO-08-558, FEDERAL ENTITIES ARE TAKING ACTIONS TO
LIMIT THEIR INTERCHANGE FEES, BUT ADDITIONAL REVENUE COLLECTION COST SAVINGS MAY
EXIST (2008).
22. U.S. GOV'T ACCOUNTABILITY OFF., GAO-10-45, RISING INTERCHANGE FEES HAVE INCREASED
COSTS FOR MERCHANTS, BUT OPTIONS FOR REDUCING FEES POSE CHALLENGES (2009).
23. 19 U.S.C.S. § 1675(b)
4. Foreign Authorities
1. AUSTRALIAN COMPETITION AND CONSUMER COMMISSION, MERGER GUIDELINES (Nov. 2008).
2. Belgium, National Bank, Costs, Advantages and Drawbacks of the various Means of Payment,
NATIONAL BANK OF BELGIUM ECON. REV. 41 (2006).
419
3. Canada Credit Card and Debit Card Systems, Senate Committee on Banking (2009)
http://www.parl.gc.ca/Content/SEN/Committee/402/bank/rep/rep04Jun09-e.pdf.
4. CANADA, CODE OF CONDUCT FOR THE CREDIT AND DEBIT CARD INDUSTRY (2010)
5. CANADA COMPETITION BUREAU, INFORMATION BULLETIN ON MERGER REMEDIES IN CANADA
(Sept. 22, 2006).
6. CANADA, DEPARTMENT OF FINANCE, NEWS RELEASE 2009-109, DRAFT CODE OF CONDUCT FOR
THE CREDIT AND DEBIT CARD INDUSTRY IN CANADA (2009).
7. EUROPEAN COMMISSION, ANNOUNCEMENT IN CASE AT.39398 — VISA MIF (2013/C 168/07),
(June 14, 2013) .
8. ———. , Directive 2007/64/EC of the European Parliament and of the Council of 13
November 2007 on Payment Services in the Internal Market O J L319/1 (5 Dec., 2007).
9. ———. , Directive 2011/83/EU on Consumer Rights, OJ L 304/64 (Nov. 22, 2011).
10. ———. , FEEDBACK STATEMENT ON EUROPEAN COMMISSION GREEN PAPER “TOWARDS AN
INTEGRATED EUROPEAN MARKET FOR CARD, INTERNET AND MOBILE PAYMENTS (June 27, 2012)
available at http://ec.europa.eu/internal_market/payments/cim/index_en.htm
11. ———. , Guidelines on the Applicability of Article 101 to Horizontal Co-Operation
Agreements, O.J (C 11) 1 (Jan. 14, 2011 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52011XC0114(04)&from=EN
12. ———. , GREEN PAPER TOWARDS AN INTEGRATED EUROPEAN MARKET FOR CARD, INTERNET
AND MOBILE PAYMENTS COM(2011) 941 final.
13. ———. , INTERIM REPORT I PAYMENT CARDS SECTOR INQUIRY UNDER ARTICLE 17
REGULATION 1/2003 ON RETAIL BANKING (Apr. 12, 2006).
14. ———. , MEMO ANTITRUST: COMMISSION MAKES VISA EUROPE'S COMMITMENTS BINDING –
FREQUENTLY ASKED QUESTIONS (Feb. 26, 2014).
15. ———. , MEMO/13/431 VICE PRESIDENT ALMUNIA WELCOMES VISA EUROPE'S PROPOSAL TO
CUT INTER-BANK FEES FOR CREDIT CARDS (May 14, 2013).
16. ———. , Memo/08/170 COMMISSION INITIATES FORMAL PROCEEDINGS AGAINST VISA EUROPE
LIMITED, (Mar. 26, 2008) http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/170&format=HTML&aged=0&language=EN&guiLanguage=en
17. ———. , Neelie Kroes, Commission Prohibits MasterCard's Intra-EEA Multilateral
Interchange Fees, Introductory Remarks at Press Conference SPEECH/07/832 (Dec. 19, 2007).
18. ———. , Notice on Remedies Acceptable Under Council Regulation (EC) no 139/2004 and
Under Commission Regulation (EC) no 802/2004 (2008/C 267/01), .
19. ———. , NOTICE IN CASE COMP/39.398 — VISA MIF, 2010 O.J. (C 138) 34 (May 28, 2010) http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:138:0034:0036:EN:PDF
20. ———. , PRESS RELEASE, ANTITRUST, COMMISSION EXEMPTS MULTILATERAL INTERCHANGE
FEES FOR CROSS BORDER VISA CARD PAYMENTS IP/02/1138 (July 24, 2002).
21. ———. , PRESS RELEASE, EUROPA, ANTITRUST: COMMISSION SENDS STATEMENT OF
OBJECTIONS TO VISA MEMO/09/151 (Apr. 6, 2009).
22. ———. , PRESS RELEASE: COMMISSION SENDS SUPPLEMENTARY STATEMENT OF OBJECTIONS
TO VISA, IP/2/871 (Jul. 31, 2012).
420
23. ———. , PRESS RELEASE, POLAND: THE COURT OF COMPETITION AND CONSUMER PROTECTION
CONFIRMS UOKIK’S DECISION ON MULTILATERAL INTERCHANGE FEES (Nov. 2013)
http://ec.europa.eu/competition/ecn/brief/05_2013/courtfees_pl.pdf.
24. ———. , PRESS RELEASE, ANTITRUST, COMMISSION NOTES MASTERCARD'S DECISION TO
TEMPORARILY REPEAL ITS CROSS-BORDER MULTILATERAL INTERCHANGE FEES WITHIN THE
EEA, MEMO/08/397 (2008),.
25. ———. , PRESS RELEASE, ANTITRUST: COMMISSION PROHIBITS MASTERCARD'S INTRA-EEA
MULTILATERAL INTERCHANGE FEES IP/07/1959 (Dec.19, 2007).
26. ———. , PRESS RELEASE, ANTITRUST, COMMISSION MAKES VISA EUROPE'S COMMITMENTS TO
CUT INTER-BANK FEES AND TO FACILITATE CROSS-BORDER COMPETITION LEGALLY BINDING
IP/14/197 (Feb. 26, 2014) http://europa.eu/rapid/press-release_IP-14-197_en.htm.
27. ———. , PRESS RELEASE, COMMISSIONER KROES TAKES NOTE OF MASTERCARD'S DECISION TO
CUT CROSS-BORDER MULTILATERAL INTERCHANGE FEES (MIFS) AND TO REPEAL RECENT
SCHEME FEE INCREASES, IP/09/515 (Apr. 1, 2009), available at
http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/515.
28. ———. , PRESS RELEASE ANTITRUST, COMMISSION WELCOMES GENERAL COURT JUDGMENT IN
MASTERCARD CASE (May 26, 2012).
29. ———. , Proposal for a Regulation on Interchange Fees for Card-Based Payment Transactions,
COM(2013)550 (July 24, 2013).
30. ———. , Proposal for a Regulation on Interchange Fees for Card-Based Payment Transactions,
EXPLANATORY MEMORANDUM, COM(2013) 550 Final 2013/0265 (Cod) (Aug. 5, 2013).
31. ———. , Proposal for a Regulation Of The European Parliament and of the Council on
Structural Measures Improving the Resilience of EU Credit Institutions COM/2014/043 Final -
2014/0020 (COD).
32. ———. , Proposal for a Directive on Payment Services (PSD2), Com (2013) 547 Final
2013/0264 (July 24, 2013) http://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:52013PC0547.
33. ———. , Regulation 924/2009 on Cross-Border Payments, O. J. (l 266) 11 (2009).
34. ———. , Reg. 1/2003 on the Implementation of the Rules on Competition Laid Down in
Articles 81 and 82 of the Treaty (Dec. 16, 2002).
35. ———. , Regulation 2015/751 on Interchange Fees for Card-Based Payment Transactions, O.J
(L 123) 1 (May 19, 2015).
36. ———. , Regulation 260/2012 Establishing Technical and Business Requirements for Credit
Transfers and Direct Debits in Euro and Amending Regulation (EC) no 924/2009, O.J. (L 94)
22 (March 14, 2012).
37. ———. , Recommendation on the Regulatory Treatment of Fixed and Mobile Termination
Rates in the EU, O.J. L 124/67 (may 7, 2009), .
38. ———. , REPORT ON THE RETAIL BANKING SECTOR INQUIRY COMMISSION STAFF WORKING
DOCUMENT - SECTOR INQUIRY UNDER ART 17 OF REGULATION 1/2003 ON RETAIL BANKING
(FINAL REPORT) [COM(2007) 33 Final] SEC(2007) 106 (Jan 31, 2007).
39. ———. , SECTOR INQUIRY UNDER ARTICLE 17 OF REGULATION (EC) NO 1/2003 ON RETAIL
BANKING (FINAL REPORT){SEC(2007) 106} (Jan. 31, 2007).
421
40. ———. , STUDY ON THE IMPACT OF DIRECTIVE 2007/64/EC ON PAYMENT SERVICES IN THE
INTERNAL MARKET AND ON THE APPLICATION OF REGULATION (EC) NO 924/2009 ON CROSS-
BORDER PAYMENTS IN THE COMMUNITY, FINAL REPORT (Feb. 2013).
41. ———. , SURVEY ON MERCHANTS' COSTS OF PROCESSING CASH AND CARD PAYMENTS FINAL
RESULTS (March 2015).
42. ———. , FINAL REPORT OF THE HEARING OFFICER COMMITMENTS DECISION VISA MIF, 2011
O.J (C 79) 4.
43. ———. , Working Document - Accompanying the Communication from the Commission -
Sector Inquiry Under Article 17 of Regulation (EC) no 1/2003 on Retail Banking
SEC/2007/0106FIN (Dec. 1, 2005).
44. ———. , Working Document - Annex to the Proposal for a Directive of the European
Parliament and of the Council on Payment Services in the Internal Market - Impact
Assessment, SEC/2005/1535 (Dec. 1, 2005).
45. ———. , Working Document Impact Assessment, SWD(2013) 288 Final (July 24, 2013).
46. ______., Payment card chargeback when paying over Internet MARKT/173/2000 (Jul. 12, 2000).
47. FRANCE, AUTORITE DE LA CONCURRENCE, MERGER CONTROL GUIDELINES
48. HUNGARIAN COMPETITION AUTHORITY, PRESS RELEASE, ANTICOMPETITIVE UNIFORM
INTERCHANGE FEES (Sept. 24, 2009) available at
http://www.gvh.hu/gvh/alpha?do=2&pg=133&st=2&m5_doc=6071.
49. ITALY, AUTORITA GARANTE DELLA CONCORRENZA E DEL MERCATO, ANNUAL REPORT (2010).
50. NEW ZEALAND COMMERCE COMMISSION, MEDIA RELEASE, COMMISSION ALLEGES PRICE-
FIXING IN CREDIT CARD INTERCHANGE FEES (Nov. 10,
2006) http://www.comcom.govt.nz/media-releases/detail/2006/commissionallegespricefixingincred/.
51. ———. , MEDIA RELEASE, COMMERCE COMMISSION AND VISA REACH AGREEMENT TO SETTLE
CREDIT CARD INTERCHANGE FEE PROCEEDINGS (Aug. 12, 2009)
52. ———. , MEDIA RELEASE, COMMERCE COMMISSION AND MASTERCARD AGREE TO SETTLE
CREDIT CARD INTERCHANGE FEE PROCEEDINGS, (AUG. 24, 2009).
53. ———. , MEDIA RELEASE, CREDIT CARD SETTLEMENTS LOWER NEW ZEALAND BUSINESS
COSTS (Oct. 5, 2009) available at http://www.comcom.govt.nz/media-releases/detail/2009/creditcardsettlementslowernewzeala/.
54. ———. , MERGER GUIDELINES (Nov. 2008)
55. ———. , MERGERS AND ACQUISITIONS: DIVESTMENT REMEDIES GUIDELINES (Jun. 2010).
56. OECD, DEVELOPMENTS IN MOBILE TERMINATION, OECD Digital Econ. Papers, no. 193 (2012).
57. ———. , ROUNDTABLE EXCESSIVE PRICES, DAF/comp(2011)18.
58. ———. , POLICY ROUNDTABLES COMPETITION AND EFFICIENT USAGE OF PAYMENT CARDS,
DAF/COMP 32, 2006.
59. POLAND, PRESS RELEASE, UOKIK, DECISION ON DETERMINING THE INTERCHANGE FEE IN VISA
AND MASTERCARD SYSTEMS (2007).
60. POLAND, UOKIK, PRESS RELEASE, UNLAWFUL PRACTICES OF BANKS (Jan 4, 2007).
61. POLAND, PRESS RELEASE, INTERCHANGE FEE – UOKIK WINS (Apr. 23, 2010).
422
62. RESERVE BANK OF AUSTRALIA, MEDIA RELEASE, WAIVER OF REQUIREMENT TO RECALCULATE
INTERCHANGE FEE BENCHMARK (2008).
63. ———. , REFORM OF AUSTRALIA’ S PAYMENTS SYSTEM, PRELIMINARY CONCLUSIONS OF THE
2007/08 REVIEW (2008).
64. ———. , CONCLUSIONS OF THE 2007/08 REVIEW (2008).
65. ———. WAIVER OF REQUIREMENT TO RECALCULATE INTERCHANGE FEE BENCHMARK
(March 2015)
66. ———. REFORM OF CREDIT CARD SCHEMES IN AUSTRALIA: CONSULTATION DOCUMENT
(Dec.2001).
67. ———. REVIEW OF CARD SURCHARGING: A CONSULTATION DOCUMENT RESERVE BANK OF
AUSTRALIA (2011),.
68. ———. , REFORMS TO PAYMENT CARD SURCHARGING, March 2013 .
69. ———. , REFORM OF AUSTRALIA'S PAYMENTS SYSTEM ISSUES FOR THE 2007/08 REVIEW
(2007), http://www.rba.gov.au/payments-system/reforms/review-card-reforms/pdf/review-0708-issues.pdf.
70. ———. , REFORM OF CREDIT CARD SCHEMES IN AUSTRALIA, FINAL REFORMS AND
REGULATION IMPACT STATEMENT (2002).
71. UNITED KINGDOM, MERGER REMEDIES: COMPETITION COMMISSION GUIDELINES (Nov. 2008).
72. UNITED KINGDOM, PRESS RELEASE, STATEMENT REGARDING EXPANSION OF OFT
INVESTIGATION INTO INTERCHANGE FEES (Feb, 9 2007).
73. UNITED KINGDOM, PRESS RELEASE, OFT TO REFOCUS CREDIT CARD INTERCHANGE FEES
WORK (2006).
74. UNITED KINGDOM, CMA DECIDES NOT TO PROGRESS INTERCHANGE FEE INVESTIGATIONS AT
THE PRESENT TIME (Nov. 4, 2014).
75. UNITED KINGDOM, CMA CLOSES MASTERCARD AND VISA INVESTIGATIONS FOLLOWING EU
REGULATION (May 6, 2015).
76. UNITED KINGDOM, STATEMENT REGARDING THE CMA'S DECISION TO CLOSE ITS
INVESTIGATIONS OF MASTERCARD'S AND VISA'S INTERCHANGE FEE ARRANGEMENTS ON THE
GROUNDS OF ADMINISTRATIVE PRIORITY (May 2015).
77. UNITED KINGDOM, DEPARTMENT FOR BUSINESS INNOVATION AND SKILLS, GUIDANCE ON THE
CONSUMER RIGHTS (PAYMENT SURCHARGES) REGULATIONS (Aug. 2015).
78. United States, Center for Consumer Information & Insurance Oversight, Medical Loss
Ratio, https://www.cms.gov/CCIIO/Programs-and-Initiatives/Health-Insurance-Market-Reforms/Medical-Loss-Ratio.html.
5. International Cases
1. Canada, CT-201O-0IO Commissioner of Competition Vs. Visa Canada and Mastercard
International, (2010)
2. Sainsbury’s supermarkets v. MasterCard (July 14, 2016) http://www.catribunal.org.uk/237-9006/1241-5-7-15-T-Sainsburys-Supermarkets-Ltd.html
3. European Commission Decision COMP/29.373 − Visa International 2001/782/EC, O.J. (L
293) 24 (Nov. 10, 2001)
423
4. ———. , COMP 29.373 Visa International — Multilateral Interchange Fee, O.J L 318 (Jul. 24,
2002), http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32002D0914:EN:HTML.
5. ———. , COMP/d1/37860 Morgan Stanley / Visa International and Visa Europe (Oct. 3,
2007), http://ec.europa.eu/competition/antitrust/cases/dec_docs/37860/37860_629_1.pdf.
6. ———. , COMP 34.579 European Commission MasterCard Decision (Dec. 19, 2007)
http://ec.europa.eu/competition/antitrust/cases/dec_docs/34579/34579_1889_2.pdf.
7. ———. , COMP/39.398 - Visa Europe commitments Offered to the European Commission
Pursuant to Article 9 of Council Regulation (Ec) no 1/2003 (Sept. 10, 2010)
http://ec.europa.eu/competition/antitrust/cases/dec_docs/39398/39398_6186_3.pdf.
8. ———. , COMP/39.398 — VISA MIF, Summary of Commission Decision of 8 December
2010, C 79/8 (March 12, 2011) http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2011:079:0008:0009:EN:PDF.
9. ———. , COMP/39.398 - Visa MIF, C(2010) 8760 final (Dec. 8, 2010)
http://ec.europa.eu/competition/antitrust/cases/dec_docs/39398/39398_6930_6.pdf.
10. ———. , Decision 92/157/EEC (UK Agricultural Tractor Registration Exchange), paragraph
43, Feb. 17, 1992:
11. AT 39398 Visa C(2014) 1199 Final (Feb. 26, 2014).
12. Case T-35/92, John Deere Ltd. v. Comm'n, 1994 E.C.R II-00957
13. Europe, Court Of Justice, C-67/13 P Groupement Des Cartes Bancaires (CB) v European
Commission (Sep 11, 2014), http://curia.europa.eu/juris/liste.jsf?num=C-67/13&language=en#
14. ———. , C-382/12 P MasterCard v. European Commission (11.9.14).
15. ———. , C-202/06 P Cementbouw Handel & Industrie BV v Commission (Dec. 18, 2007).
16. ———. , C-8/08 T-Mobile Netherlands BV v Raad Van Bestuur Van De Nederlandse
Mededingingsautoriteit, (June 4, 2009).
17. ———. , Case C-7/95 and C-8/95 John Deere Ltd. v. Comm'n, 1998 E.C.R. I-3111
18. ———. , C 286/13 P Dole Food v. Comm'n, para. 121 (19.3.15)
19. Europe, Court of First Instance, T-461/07 Visa Europe Ltd v European Commission (Apr. 14,
2011)
20. ———. , T-111/08 MasterCard v. Comm'n (May 24, 2012).
21. Hungary, Background Report of the Hungarian Competition Authority about the Uniform and
Common Interchange Fees Set by Banks in Hungary, (2009),
http://www.gvh.hu/domain2/files/modules/module25/10769E8D7015B1618.pdf.
22. United Kingdom, CA98/05/05 MasterCard UK Members Forum Limited (2005)
6. Payment card data
1. Bank of Israel, Table J-11, Income Statements of the Payment Card Firms (last visited, Oct. 30,
2016).
2. Bank of Israel, Data on banks, TableX-13 consolidated income statements 2014-2015, available
at http://www.boi.org.il/he/BankingSupervision/Data/Pages/Tables.aspx?ChapterId=12
3. Bank of Israel, Data on Payment Card Firms, Table J-13, Income Statements According to
Activity Sectors for 2014.
424
4. CreditCards.com, Credit Card Statistics http://www.creditcards.com/credit-card-news/credit-card-industry-facts-personal-debt-statistics-1276.php
5. MasterCard Rules (Dec. 2014) http://www.mastercard.com/us/merchant/pdf/BM-Entire_Manual_public.pdf.
6. New Zealand Interchange Fees, 2015 http://www.westpac.co.nz/business/payment-solutions/pricing-and-fees/.
7. First Data Annual Report (10-K) (2014).
8. Interchange Fees of MasterCard https://www.mastercard.us/en-us/about-mastercard/what-we-do/interchange.html
9. MasterCard Merchant Rules (2016) https://www.mastercard.com/ca/merchant/en/getstarted/rules.html
10. Data on Visa (from its Website) http://corporate.visa.com/about-visa/our-business/visa-inc-and-visa-europe.shtml.
11. MasterCard Corporate Overview, http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjQ1MzZ8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1.
12. Mastercard Worldwide, Benefits of Payment Cards to Consumers
http://www.mastercard.com/us/company/en/docs/Benefits_of_Payment_Cards_to_Consumers.pdf.
13. Mastercard Worldwide, Benefits of Payment Cards to Merchants http://www.mastercard.com/us/company/en/docs/Benefits_of_Payment_Cards_to_Merchants.pdf
14. U.S. Visa Interchange Fees http://usa.visa.com/merchants/operations/interchange_rates.html.
15. Visa International Operating Regulations Core Principles
http://usa.visa.com/download/merchants/visa-international-operating-regulations-core.pdf.
16. Visa, Europe, Interchange Fees
http://www.visaeurope.com/en/about_us/what_we_do/fees_and_interchange/interchange_fees.aspx.
17. Visa Inc. Annual Report (Form 10-k) Sept. 30, 2014.
18. Committee on Payment and Settlement Systems, Statistics on Payment, Clearing and
Settlement Systems in the CPSS Countries, (Sept. 2014)
http://www.bis.org/cpmi/publ/d120.pdf .
7. Hebrew Legislation
1. Bank of Israel, Process of Receiving Acquirer's License (Dec. 31, 2013).
2. Bank of Israel Law, 2010.
3. Communication Regulations (Bezeq and Transmissions) (Payments for Termination
Fee), 2000.
4. Payment Cards Law, 1986.
5. Amendment 12 to the Banking Law (Service to Customer), 1981.
6. Banking Law (Licensing), 1981.
7. Divrei Haknesset 19, Sitting 177 at 46-62 (Nov. 12, 2014).
425
8. Draft Bill Amending the Banking Law (Licensing) 1981 (Amendment 11), HH 2352 (Mar. 11,
1996).
9. Draft Bill for Enhancement of Competition and Reduction in Concentration Law, HH (Gov)
No. 706 p. 1084 (July 9, 2012).
10. Draft Bill to Promote and Defend the Written Press in Israel, 2014
www.knesset.gov.il/privatelaw/data/19/2464.rtf.
11. Draft Bill to Amend the Press Command (Restriction on Free Distribution of Newspaper with
National Circulation), 2010 http://www.knesset.gov.il/privatelaw/data/18/2196.rtf.
12. Draft Bill to amend the Banking Law (Licensing) - Enhancement of Competition in the Credit
Card Market, 2007 /2468/17פ ,
13. Draft Bill to amend the Banking Law (Licensing) - Ownership of Credit Card Issuers, 2009
157/18פ/ .
14. Draft Bill to amend the Banking Law (Licensing) - Ownership of Credit Card Issuers, 2013
. 1066/19פ/
15. Draft Bill to amend the Banking Law (Licensing) - Ownership of Issuing Undertakings, 2007
2475/17פ/ .
16. Draft Bill to Enhance Competition in Credit (Divestiture of Bank Ownership in Credit Card
Firms), 2014 /2180/19פ .
17. Bank of Israel, Banking Proper Procedure, Payment Cards (Instruction 470)
http://www.boi.org.il/he/BankingSupervision/SupervisorsDirectives/DocLib/470.pdf.
18. Banking Decree (Service to Customer) (Supervision on Service that an Issuer Grants an
Acquirer with Connection to Interchange Acquiring of Debit Transactions) (Temporary Order),
2015.
19. Banking Law (Licensing), 1981.
20. Banking Rules (Service to Customer) (Fees), 2008.
21. Directives of the Banks' Supervisor - Notice on Issuers with Large Scale of Activity (Dec. 20,
2011) http://www.boi.org.il/he/NewsAndPublications/PressReleases/Pages/111220h.aspx.
22. Government Decision 749, Sept. 17, 2013
http://www.pmo.gov.il/Secretary/GovDecisions/2013/Pages/govdec749.aspx.
23. Interpretation Command [New Version].
24. Interpretation Law, 1981.
25. Law for Enhancement of Competition and Reduction of Concentration and Conflicts of
Interests in the Capital Markets in Israel (Legislation Amendments), 2005.
26. Law for Advancement of Competition and Reduction in Concentration (Hok Lekidum
Hataharut Vezimzum Harikuziut), 2013.
27. Memorandum, Antitrust Law (Amendment 9), 2005 http://www.antitrust.gov.il/law.htm.
28. Memorandum, Antitrust Law (Amendment 16 - Determination of Interchange Fee), Antitrust
500777 (Aug. 10, 2014).
29. Opinion 2/11: Guidelines on Remedies to Mergers that Raise Concerns of Significant Harm to
Competition, Antitrust 5001804 (July 18, 2011).
30. Price Ordinance (Removal of Supervision on ATMs Withdrawal Fees), 2006.
426
31. Prohibition of Discrimination in Products, Services and Entry to Places of Entertainment and
Public Facilities Law, 2000.
32. Supervision of Commodities and Services Order (Partial Removal of Supervision of Fee for
Cash Withdrawals through ATMs), 2006, KT 6452 p. 328
http://www.knesset.gov.il/laws/data/regulation/6452/6452.pdf.
8. Hebrew Literature
1. AHRON BARAK, INTERPRETRATION IN LAW - INTERPRETRATION OF LEGISLATION (1993).
2. ______, Prohibit Price Discrimination [Lesor Al Aflayat Mehirim], THEMARKER (May 3,
2016).
3. ——— , The Other Side of the Newspaper, THE 7TH EYE (Dec. 15, 2012).
4. Moshe Boronovsky, On the Elements of the Restriction and its Object - New and Not New, 5
MECHKAREI MISHPAT 125 (1987).
5. AVINASH DIXIT & BARRY NALEBUFF, GAME THEORY (Ilan Michal trans., Aliyat Hagag Books
2010).
6. MICHAL GAL, RESTRICTIVE ARRANGEMENT - ELEMENTS OF THE PROHIBITION, IN LEGAL AND
ECONOMIC ANALYSIS OF ANTITRUST LAW 193 (Michal Gal & Menachem Perlman eds., 2008).
7. David Gilo, Passive Investments between Competitors in Israel, 35 MISHPATIM 1 (2005).
8. ———. , Restriction that Harms Competition between the Beneficiary and its Competitors, 28
IUNEI MISHPAT 517 (2005).
9. ———. , Is it Appropriate to Break Antitrust Dam and Block the Flood in Ad-Hok
Fences, 27(3) IUNEI MISHPAT 751 (2004).
10. ———. , CONTRACTS THAT RESTRICT COMPETITION, in 3 CONTRACTS 638 (Nili Cohen &
Daniel Fridman eds).
11. Ofer Groskoph, Paternalizm, Public Policy and Government Monopoly in the Gambling
Market, 7 HAMISHPAT 9 (2007).
12. ITAMAR MILRED, DESCRIPTION OF CREDIT CARDS MARKET AND ANALYZING INTERFACES
BETWEEN CREDIT CARD FIRMS AND THE BANKS, (The Knesset Center for Research and
Information, Feb, 2014).
13. Dror Reich, Summary of Conference on Payment Cards, THEMARKER (Sept. 22, 2011).
9. Hebrew Cases
1. AT 610/06 Leumi Et Al. v. Antitrust General Director (Opinion of the General Director), (Oct.
7, 2007).
2. Supplement Civil Litigation (SCL) 6811/04 Menahel Mas Shevach v Naftali Shadmi, PD 61(1)
778 (2009).
3. Cr.C 167/03 State of Israel v. Mordechai Cohen (Feb. 7, 2007).
4. AT 3276/99 Arutzei Zahav v. Association of Movie Directors (July 6, 2000).
5. CA 2706/11 Sybil Germany v. Harmatic (Sept. 4, 2015).
427
6. Ci.C 5315/08 Nadav Lahat v. Forum Production (Claim) (Oct. 30, 2008).
7. Ci.C 5315/08 Nadav Lahat v. Forum Productions, (Dec. 26, 2011).
8. Cr.C (Jerusalem) 377/04 State of Israel v. Yaron Wol (July 3, 2007).
9. AT 3574/00 Music Federation v. Antitrust General Director, (April 29, 2004).
10. AT 103/09 Antitrust General Director v. Tnuva (Dec. 28, 2009).
11. AT 13/93 Adanim Bank v. Consumer Council (Jan. 27, 1997).
12. SCL 5189/05 Ayalon v. State of Israel (Apr. 23, 2006).
13. Cr.C 4016-06-12 State of Israel v. Ezra Shoam (Feb. 23, 2014).
14. Motion 34/01 Leumi v. Antitrust General Director (Dec. 22, 2002).
15. Appeal 9/99 Amana v. Antitrust General Director, Antitrust 3013742 (Feb. 21, 2002).
16. C.A 2616/03 Isracard v Howard Rice, PD 59(5), 701 (2006).
17. CrA 7829/03 State of Israel v. Ariel, PD 60(2) 120 (2005).
18. HCJ 1661/05 Local Council Hof Aza v the Knesset, PD 59(2) 481 (2005).
19. AA 6464/03 Real Estate Appraisers BAR v Department of Justice, PD 58(3) 293 (2004).
20. CA 6233/02 Akastel v. Kalma Vi, PD 48(2) 635 , (2004).
21. SCL 1333/02 Local Zoning Committee v Judith Horoviz, PD 58(6) 289, (2004).
22. CrA 1042/03 Mezerples v. State of Israel, PD 58(1) 721, (2003).
23. Cr.C 366/99 State of Israel v. Ehud Svirsky (Feb. 21, 2002).
24. C.A 2299/99 Shfayer v. Diur Laole, PD 55(4) 213, (2001).
25. Cr.C 417/97 State of Israel v. Haphenix (Dec. 18, 2001).
26. HCJ 3267/97 Rubinshtein v. Minister of Defense, PD 52(5) 481, (1998).
27. Civil. C. (T-A) 1617/93 Volkan v. Igud Hamusachim, PDM 1994 (3) 274 (1994).
28. Civ. A. 105/92 Ram Engineering V. Nazereth Municipality, PD 47(5) 189, (1993).
29. CA 2768/90 PetrolGas v. State of Israel, PD 46 (3) 599 (1992).
30. Appeal 2/89 Moetzet Hamovilim v. Antitrust General Director, Antitrust 3001546 (1991).
31. Civ. A. 524/88 Pri Haemek v. Sde Yaacov, PD 45(4) 529 (1991).
32. Civ.C. 396/87 Kisin v. PetrolGas, Dinim (1990).
33. HCJ 267/88 Reshet Kolel Haidra v. Court of Local Affairs, PD 43(3) 728, (1989).
34. Ci.C. 2786-06-12 Kobi Tzetzna v. Lord Bars Ltd (July 16, 2014).
35. Civ. Ap. 8821/09 Pavel Prozianski v. Laila Tov Productions (Nov. 16, 2011).
36. AT 508/04 Taagid Haisuf v. Adam Teva Vadin, (Sept. 13, 2005).
37. CA 2063/16 Glik v. Israeli Police, (Jan 19, 2017).
38. HCJ 986/05 Peled v. Tel-Aviv Municipality, para. 14 (Apr. 13, 2005).
39. A.T 36014-12-10 Kaniel v. Antitrust Authority (June 10, 2012).
40. A.T 601/06 Isracard v. Antitrust General Director (July 18, 2010).
41. AT 11333-02-13 Isracard v. Antitrust General Director, Antitrust 500647 (Mar. 9, 2014).
428
42. AT 19545-04-10 Shovarei Bar v. Antitrust General Director (Jan. 24, 2012).
43. AT 4630/01 Leumi v. Antitrust General Director (Application), Antitrust 4630 (Sept. 13, 2001).
44. AT 4630/01 Leumi v. Antitrust General Director, Antitrust 5000592 (Aug. 31, 2006).
45. AT 4630/01 Leumicard v. Antitrust General Director, (Removal of Privileges), Antitrust
3015470 (Sept. 1, 2002).
46. AT 46791-03-14 El Rov v. General Director, (Dec. 4, 2014).
47. AT 491/98 Israel Electric Company v. Antitrust General Director (Mar. 22, 1999).
48. AT 601/06 Gas Companies Association V. Antitrust General Director (July 7, 2010).
49. AT 610/06 Leumi v. Antitrust General Director (Aug. 7, 2011).
50. AT 610/06 Leumi v. Antitrust General Director (Decision to Appoint an Expert), Antitrust
5000840 (Nov. 11, 2007).
51. AT 610/06 Leumi V. Antitrust General Director (Final Report of Shlomi Parizat) (May 23,
2011).
52. AT 610/06 Leumi v. Antitrust General Director (Interim Report of Yossi Bachar) (Jan. 1,
2009).
53. AT 610/06 Leumi v. Antitrust General Director, (Application), Antitrust 6652 (Oct. 30, 2006).
54. AT 610/06 Leumi V. Antitrust General Director, Antitrust 500191 (Mar 7, 2012).
55. AT 7011/02 Antitrust General Director v. Bank Hapoalim, Antitrust 5000874 (Aug. 14, 2006).
56. Civ. Ap. 449/85 General Attorney v. Gad Building Company, PD 43(1) 183 (1989).
57. Civ. C. (Center) 43283-4-14 Hajbi v. Isracart Et al. (Motion to Approve a Class Action) (Apr.
28, 2014).
58. Civ. C. (Center) 46010-07-11 Ophir Naor v. Tnuva, (April 5, 2016).
59. Civ. C. (Center) 53990-11-13 Hazlacha v. AU et al., (March 6, 2016).
60. Civ. C. (Center) 41838-09-14 Weinstein v Mifalei Yam Hamelach (29.1.17)
61. Civ. Ap. 5529/10 Gas Companies Association v. Antitrust General Director (Aug. 12, 2010).
62. Cr. Ap. 4855/02 Borowitz v. State of Israel, PD 59 (6) 776 (2005).
63. Cr. C. 209/96 State of Israel v. Ohalecha Yaacov (Aug. 4, 2002).
64. Cr. Ap. 2560/08 State of Israel v. Yaron Wol (Jul. 6, 2009).
65. Cr. Ap. 2929/02 State of Israel v. Svirsky, PD 57(3) 135.
66. Cr. Ap. 5672/08 Tagar v. State of Israel (Oct. 21, 2010).
67. Cr. Ap. 5823/14 Supersal v. State of Israel (Aug. 10, 2015).
68. Cr. C. 1274/00 State of Israel v. Mudgal (Mar. 12, 2010).
69. HCJ 2194/06 Shinui Party v. Head of Election Commity (Mar. 12, 2006).
70. HCJ 4491/13 Merkaz Academy Lemishpat Veasakim v. Government of Israel (July 2, 2014).
71. HCJ 588/84 K.S.R Asbestos v. Chairman of Antitrust Council, PD 40(1) 29 (1986).
72. SCL 4465/98 Tivol v. Shef Hayam, PD 56(1) 56 (2001).
429
10. Antitrust General Director Decisions
1. Exemption to Gas Companies (Sonol, Delek, Dor) for Collective Bargaining and Joint
Purchase of Jet Fuel Insurance Policy, Antitrust 500526 (Dec. 24, 2013).
2. Exemption to Visa Issuers and Acquirers, Antitrust 3008827 (Aug. 24, 2000).
3. Opinion 1/14 Prohibition on Excessive Prices by a Monopoly, 500603 Antitrust (Apr. 9, 2014).
4. Opinion 1/00 Cooperation between Competitors versus Governmental Authorities, Antitrust
3007119 (Feb. 6, 2000).
5. Determination According to Section 43(a)(2) - Course of Action of Private Hospitals is a
Restrictive Arrangement, (Dec. 31, 2007).
6. Exemption with Conditions to T.M.I.R, Antitrust 5001799 (June 30, 2011).
7. Determination According to Section 43(a)(1) of the Antitrust Law to Information Exchange
between Banks, Antitrust 501411 (Apr. 26, 2009).
8. General Director's Guidelines, Opinion 1/08 Cooperation among Institutional Investors with
Regard to Changing the Terms of Corporate Bonds, Antitrust 5001318 (Nov. 25, 2008).
9. Opinion 3/14 Trade Associations and their Activities, Antitrust 500682 (Sept. 24, 2014).
10. Exemption for Common Holidays in Private Kinder Gardens, Antitrust 5001534 (Dec. 22,
2009).
11. Exemption to Insurance Companies Union, Antitrust 5001658 (2010).
12. Exemption to Arrangement between Members of the Israeli Bar Association, Antitrust 5000697
(2004).
13. Exemption for Members of the Israeli Bar Association - Campaign "Apartment from
Contractor", Antitrust 5000052 (2004).
14. Exemption to Restrictive Arrangement between Members of the Bar Association - "Operation
Will", Antitrust 5000697 (2004).
15. Exemption with Conditions to SHVA, 500369 Antitrust (20.3.13).
16. Determination - Course of Action of Travel Agents, 3001432 Antitrust (1997).
17. Exemption to Insurance Companies Union, Dissemination of Research about Earthquakes
Damages, 3001359 Antitrust (1996).
18. Determination According to Section 43 of the Antitrust Law regarding a Course of Action
between Real Estate Appraisers - Dissemination of a Minimum Tariff, Antitrust 3006353
(1995).
19. Decision regarding Actors Association, Antitrust 3003746 (1994).
20. Determination - Restrictive Arrangement regarding Isracard, Antitrust 3006076 (1993).
21. Exemption to Agreement between the Israel Hotels Association and its Members regarding
Joint Negotiation with Copyright Management Corporations (Oct. 16, 2002).
22. Exemption with Conditions to "Choices" Foundation, Antitrust 5001365 (Feb. 15, 2009).
23. Objection of the General Director to a Merger between Seebus and Millpas, Antitrust 5001982
(June 14, 2012).
24. Exemption to Israeli Harbors, Antitrust 5001292 (Oct. 12, 2008).
25. Exemption to Veolia and Tahel for Bids' Cooperation, Antitrust 5000999 (July 1, 2008).
430
26. Exemption with Conditions to SHVA, Antitrust 500393 (May 1, 2013).
27. Annulment of Declaration on Isracart as a Monopoly, Antitrust 4538 (July 3, 2012).
28. Decision Not to Exempt a Joint Negotiation Arrangement between Physician Union and Health
Insurers, Antitrust 501009 (Jul. 13, 2016).
29. Declaration on Isracard as Monopoly in Acquiring Isracart and MasterCard, Antitrust
5000034 (May 22, 2005).
30. Exemption to Restrictive Agreement between CAL, Diners Cards and Union Bank, Antitrust
5001695 (Dec. 1, 2010).
31. Exemption to 5 Banks - Interchange Fee in ATMs, Antitrust 3015632 (Oct. 8, 2002).
32. Exemption to Isracard, Leumicard and CAL, Antitrust 5001952 (May 14, 2012).
33. Exemption to Isracard, Leumicard and CAL, Antitrust 500207 (Aug. 8, 2012) .
34. Exemption to Isracard, Leumicard and CAL, Antitrust 500226 (Sept. 13, 2012).
35. Exemption with Conditions to 5 Banks in re: SHVA, Antitrust 5000714 (June 17, 2004).
36. Exemption with Conditions in re: SHVA, Antitrust 4804 (June 18, 2002), (Sept. 17, 2002).
37. Exemption with Conditions to 5 Banks in re: MASSAV, Antitrust 3014681 (June 20, 2002).
38. Exemption with Conditions to 5 Banks in re: MASSAV, Antitrust 5001308 (Nov. 5, 2008).
39. Exemption with Conditions to 5 Banks in re: MASSAV, Antitrust 5001954 (May 22, 2012).
40. Exemption with Conditions to 5 Banks in re: MASSAV, Antitrust 500271 (Dec. 20, 2012).
41. Exemption with Conditions to 5 Banks in re: MASSAV, Antitrust 500368 (Mar. 20, 2013).
42. Exemption with Conditions to 5 Banks in re: MASSAV, Antitrust 5667 (June 17, 2004).
43. Exemption with Conditions to 5 Banks in re: SHVA, Antitrust 5669 (Nov. 19, 2014).
44. Exemption with Conditions to 5 Banks in re: MASSAV, Antitrust 500223 (Sept. 20, 2012).
45. Exemption with Conditions to 5 Banks in re: SHVA, (Feb. 9, 2014).
46. Exemption with Conditions to 5 Banks in re: SHVA, Antitrust 5001307 (Nov. 5, 2008).
47. Exemption with Conditions to 5 Banks in re: SHVA, Antitrust 5001953 (May 22, 2012).
48. Exemption with Conditions to 5 Banks in re: SHVA, Antitrust 500224 (Sept. 20, 2012).
49. Exemption with Conditions to 5 Banks in re: SHVA, Antitrust 500459 (Aug. 26, 2013).
50. Exemption with Conditions to a Restrictive Arrangement between CAL et al., Antitrust
3014977 (July 22, 2002) .
51. Exemption with Conditions to a Restrictive Arrangement between CAL et al., Antitrust
3015230 (Aug. 12, 2002).
52. Exemption with Conditions to a Restrictive Arrangement between CAL et al., Antitrust
3019786 (March 1, 2004).
53. Exemption with Conditions to a Restrictive Arrangement between CAL et al., Antitrust
5000444 (Feb. 19, 2006).
54. Exemption with Conditions to a Restrictive Arrangement between Leumicard et al., Antitrust
3010373 (Mar 8, 2001).
55. Exemption with Conditions to a Restrictive Arrangement between Alpha Card et al., Antitrust
3007229 (July 7, 1998).
431
56. Exemption with Conditions to Issuers and Acquirers in Visa Network, Antitrust 3009123 (May
18, 2000).
57. Exemption with Conditions to Issuers and Acquirers in Visa Network, Antitrust 3008373 (July
6, 2000).
58. Exemption with Conditions to the Isracard, LeumiCard and CAL, Antitrust 5000623 (May 30,
2006).
11. Miscellaneous
1. Visa core rules and visa product and service rules (April 15, 2015) https://usa.visa.com/dam/VCOM/download/about-visa/15-April-2015-Visa-Rules-Public.pdf
2. Letter from Keith B. Nelson, Principal Deputy Assistant Attorney General to the Judiciary
Committee (June 23, 2008).
3. Credit Card Interchange Fees: Antitrust Concerns? Congress Senate Committee on Judiciary
(U.S. Government Printing Office, 2006).
4. Visa Europe, Press Release, Visa Inc. to Acquire Visa Europe (Nov. 2, 2015)
https://www.visaeurope.com/newsroom/news/vi-to-acquire-ve.
5. APCA (Australian Payments Clearing Association), Annual Review 2015.
6. Boston Tea Party Historical Society, http://www.boston-tea-party.org/.
7. Monty Python - Life of Brian - the Haggle, Comedy Film, Directed by Terry Jones (1979)
http://www.youtube.com/watch?v=3n3LL338aGA.
8. BoA to Instate $5 Monthly Fee for Debit Card Purchases, Pymnts. Com (Sept. 29, 2011)
available at http://pymnts.com/BoA-to-Instate-5-Monthly-Fee-for-Debit-Card-Purchases.
9. Wells Fargo Ends Debit Rewards Program Entirely, PYMNTS. COM (Aug. 22, 2011) available
at http://pymnts.com/Wells-Fargo-Ends-Debit-Rewards-Program-Entirely/
10. THE European PAYMENTS COUNCIL, PRESS RELEASE, EPC LAUNCHES THE TWO SEPA DIRECT
DEBIT SCHEMES IN NOVEMBER 2009, (Apr. 1 2009), available at http://www.europeanpaymentscouncil.eu/knowledge_bank_download.cfm?file=EPC109-09%20%20Press%20Release%20Launch%20SEPA%20Direct%20Debit%202009-04-01.pdf.
11. Pressure on B of A Mounts as Rivals Ditch Debit Fees, AM. BANKER, Nov. 1, 2011.
12. MasterCard International, MasterCard's Submission to the Reserve Bank of Australia, (2001) http://www.rba.gov.au/payments-system/reforms/cc-schemes/iii-submissions-vol2/o1-mastercard-final.pdf.
13. U.S. Payment Card Interchange Fee Settlement Website
https://www.paymentcardsettlement.com/en.
12. Hebrew Miscellaneous
1. Ori BarAm, Note on Ruling 8821/09 Pavel Prozianski v. Laila Tov Productions, Nevo (2011).
2. Ori BarAm & Elad Man, One Price for Gas, Big Prize for Consumers, THEMARKER (Aug. 22,
2016).
3. Bank of Israel, Supervision of Banks, The Fee Reform (Oct. 30, 2010).
4. Bank of Israel, Communication 2498-06-ח, Acquiring Payment Cards, Banking Proper
Procedure, Instruction 472 (May 1, 2016).
432
5. Bank of Israel, Chain of Transaction in Payment Card, (July 2016).
6. Bank of Israel, Press Release, Reduction of Payment Card Fees (Feb. 1, 2015).
7. Bank of Israel, Draft for Comments, Process for Granting Acquiring License (Dec. 17, 2015).
8. BANK OF ISRAEL, PRESS RELEASE, SPEECH OF KARNIT FLUG, GOVERNOR OF BANK OF ISRAEL IN
A CONVENTION MOONEY AND TECHNOLOGY (March 26, 2014).
9. BANK OF ISRAEL, THE BANKING SYSTEM IN ISRAEL, 2015 ANNUAL REVIEW (2016).
10. BANK OF ISRAEL, PAYMENT AND ACQUIRING SYSTEMS IN ISRAEL (THE RED BOOK) (2013).
11. BANK OF ISRAEL, PAYMENT AND ACQUIRING SYSTEMS IN ISRAEL (THE RED BOOK) (2014).
12. COMMITTEE ON INCREASING COMPETITIVENESS IN THE ECONOMY (SHANI COMMITTEE) FINAL
REPORT (2012).
13. REPORT OF INTER-MINISTRY COMMITTEE FOR INVESTIGATING MARKET FAILURES IN CREDIT
CARD MARKET, Ministry of Finance Accounting General, (2007).
14. REPORT OF THE INTER-MINISTRY COMMITTEE FOR INSPECTION OF MARKET FAILURES IN THE CREDIT
CARD MARKET, Ministry of Finance, accountant General (2007).
15. BANK OF ISRAEL, ECONOMIC SURVEY (March 18, 2013).
16. Central Bureau of Statistics, Financial Literacy Survey: Financial Situation of Israelis (Sept. 11,
2012).
17. ANTITRUST, PRESS RELEASE, THE CREDIT CARD FIRMS WILL DECREASE TOMORROW THE
AVERAGE INTERCHANGE FEE TO NO MORE THAN 0.875%, Antitrust 5001868 (Oct. 31, 2010).
18. ANTITRUST, PRESS RELEASE, FOLLOWING APPROVAL OF THE ACQUIRING SETTLEMENT, REPEAL
OF THE MONOPOLY DECLARATION ON ISRACARD, Antitrust 5001977 (June 17, 2012).
19. ANTITRUST, PRESS RELEASE, THE ANTITRUST TRIBUNAL APPROVED THE SETTLEMENT BETWEEN
THE GENERAL DIRECTOR AND THE CREDIT CARD FIRMS, Antitrust 5001903 (March 8, 2012).
20. ANTITRUST, PRESS RELEASE, THE GENERAL DIRECTOR CONDITIONED A MERGER BETWEEN
YATZIL AND CAL IN OPENING THE FACTORING MARKETS FOR COMPETITION, Antitrust 3018872
(2003).
21. ANTITRUST, PRESS RELEASE, TRIBUNAL REJECTED THE VISA FIRMS' MOTION FOR PRIVILEGE,
Antitrust 3015423 (Sept. 3, 2002).
22. ANTITRUST, PRESS RELEASE, THE GENERAL DIRECTOR AND THE CREDIT CARD FIRMS REACHED
AN AGREEMENT REGARDING A DRAMATIC INTERCHANGE FEE DECREASE AND EXTENSION OF
THE CROSS ACQUIRING AGREEMENT UNTIL 2018, Antitrust 5001886 (Dec. 28, 2011).
23. Bank of Israel, Expansion of Debit Card Distribution, Letter from the Banks' Supervisor (June
29, 2015).
24. BANK OF ISRAEL, PRESS RELEASE, ANNOUNCEMENT OF REDUCTION IN THE NUMBER OF
PAYMENT CARD FEES (Apr. 30, 2014), .
25. BANK OF ISRAEL, RECOMMENDATIONS FOR ENHANCEMENT OF COMPETITION IN PAYMENT
CARDS, FINAL REPORT (Feb. 2015).
26. Bank of Israel, the Supervision of Banks - Banking Consumerism, Advantages and
Disadvantages of Revolving Credit
27. THE COMMITTEE FOR REDUCING THE USE OF CASH (LOCKER COMMITTEE), FINAL REPORT (July
17. 2014).
433
28. THE COMMITTEE FOR REDUCING THE USE OF CASH (LOCKER COMMITTEE), INTERIM REPORT
(May 2014).
29. Decision 1551 of Ministers’ Committee on Cost of Living Regarding the Enhancement of
Competition and Efficiency in Payment Cards (Apr. 2014).
30. Draft Recommendations, Committee for Increasing Competitiveness in the Economy.
31. Globes, Isracard Will Issue Payment Cards to Customers of Mizrachi Tfachot Branded Credit
Cards (Aug. 23, 2009).
32. ISRAEL ANTITRUST AUTHORITY DRAFT REPORT ON ENHANCEMENT OF EFFICIENCY AND
COMPETITION IN PAYMENT CARDS, Antitrust 500560 (Feb. 11, 2014).
33. ———. , FINAL REPORT ON ENHANCEMENT OF COMPETITION IN PAYMENT CARDS, Antitrust
500680 (Sept. 8, 2014).
34. ______. , Opinion 1/17 CONSIDERATIONS OF THE GENERAL DIRECTOR IN ENFORCING EXCESSIVE
PRICING, Antitrust 501194 (Feb. 28, 2017)..
35. ______. , PRESS RELEASE, WORLD BANK AWARDED COMMENDATION TO THE IAA FOR DEBIT
REFORM, Antitrust 500811 (July 8, 2015).
36. ______. , PRESS RELEASE, BANK OF ISRAEL PUBLISHES INSTRUCTIONS FOR ASSIMILATION OF
DEBIT CARDS AND ENHANCEMENT OF COMPETITION IN PAYMENT CARDS (June 30, 2015).
37. ______. , PRESS RELEASE, IAA PUBLISHES A RESEARCH ON COMPETITION IN PAYMENT CARDS,
Antitrust 500561 (Feb. 12, 2014).
38. Sivan Eizensco, The Little Fee that Produces Additional 700 Million NIS to Banks from Credit
Cards, THEMARKER (Apr. 27, 2014).
39. Tomer Varon, Gama on its Way to Become Fourth Competitor in the Credit
Market, CALCALIST (Aug. 5, 2015).
434
תקציר עבודת דוקטורט בנושא:
הפרדה מבנית בין סולקים ומנפיקים,
והצעה להגבלת רווחיות
במערכות תשלומים עם עמלה צולבת
מוגש על ידי אורי ברעם
435
מציע שני חידושים שאימוצם עשוי להביא לעמלה צולבת תחרותית, דבר שמשמעו חיסכון של מיליארדי אני .1
למשק הישראלי וטריליארדי דולר למשק העולמי; לירידה קטנה אך רוחבית וכלל משקית של כלל מחירי ₪
ומות ובמשאבים המוצרים והשירותים; לשימוש יעיל בכרטיסי חיוב. כל זאת תוך הפחתה ניכרת בעלויות העצ
האדירים שמושקעים כיום על ידי רגולטורים, טריבונלים ורשויות תחרות למיניהן ברחבי העולם בפיקוח על
העמלה הצולבת בכרטיסי חיוב.
עמלה צולבת היא התשלום שמשלמים סולקים של כרטיסי חיוב למנפיקים של כרטיסי חיוב במערכות .2
, שבהן הסולק של העסקה הוא לא בהכרח המנפיק של כרטיס תשלומים "פתוחות" )כמו ויזה ומסטרכארד(
החיוב עמו בוצעה העסקה.
בשנה. ברחבי ₪ בישראל בלבד, סכום העמלה הצולבת שסולקים משלמים למנפיקים מתקרב לשני מיליארד .3
העולם גובים מנפיקים מידי שנה עמלה צולבת בסדר גודל של טריליארדי דולרים.
ולק את "עמלת הסליקה", שאותה הסולק שומר לעצמו. סולקים גובים מבתי עסק לעמלה הצולבת מוסיף הס .4
"עמלת בית עסק", שהינה התשלום שמשלם בית עסק עבור כיבוד כרטיסי חיוב. עמלת בית עסק מורכבת
מהעמלה הצולבת )שמועברת למנפיק( בתוספת עמלת הסליקה )המרווח של הסולק(. העמלה הצולבת היא
לת בית העסק. ככל שהעמלה הצולבת גבוהה יותר, כך עמלת בית העסק תהיה גבוהה יותר. מרכיב עיקרי בעמ
עבור בתי עסק, עמלת בית העסק היא תשומה. בתי עסק מגלגלים תשומה זו, ככל תשומה אחרת, על מחירי .5
רוחבי, המוצרים והשירותים שהם מוכרים. על כן ככל שהעמלה הצולבת גבוהה יותר, כך עולים באופן קטן אך
כלל המחירים בבתי עסק שמכבדים כרטיסי חיוב.
העמלה הצולבת היא הסדר כובל לתיאום מחיר מינימום לעמלת בית עסק. הסיבה העיקרית לכך שעמלה .6
צולבת היא הסדר כובל הינה שמי שמשלם אותה )למשל בישראל, לאומי קארד, ישראכרט וכ.א.ל בכובען
לום )ישראכרט, לאומי קארד וכ.א.ל בכובען כמנפיקים(. הסולקים כסולקים(, הוא גם הצד שמקבל את התש
מגלגלים את העמלה הצולבת על לקוחותיהם, בתי העסק, כחלק מעמלת בית העסק. צד ההנפקה פחות תחרותי
ומנפיקים לא מעבירים את כל התקבולים מהעמלה הצולבת ללקוחותיהם, מחזיקי כרטיסי חיוב )להלן:
נהנים מהעמלה הצולבת שהינה עבורם מקור רווח משמעותי. חלוקת ההכנסות "(. המנפיקיםמחזיקים"
מהעמלה הצולבת נקבעת לפי נתחי השוק בצד ההנפקה. כתוצאה מדרך קביעתה המערבת "מסחר עצמי",
העמלה הצולבת לא נקבעת על שיעור תחרותי שהיה שורר אילו המו"מ לקביעתה היה מתנהל בין קונה )סולק(
וכר )מנפיק( מרצון. הסולקים )המשלמים את העמלה( נהנים ממנה בכובעם כמנפיקים, ולכן הם מרצון לבין מ
"מוותרים" במו"מ, ומסכימים לשלם מחיר הגבוה מהמחיר התחרותי.
עולמי בקרב רגולטורים, מלומדים, -בשל ניגוד עניינים מובנה זה בקביעת העמלה הצולבת, קיים קונצנזוס כלל
שהינם גם מנפיקים שפט ורשויות, שעמלה צולבת הנקבעת במשא ומתן חופשי בין סולקיםטריבונלים, בתי מ
תהיה "מנופחת" וגבוהה מזו האופטימלית. כאמור, עמלה צולבת גבוהה גורמת לעליית מחירים קטנה אך
ת רוחבית במשק, ודי בכך כדי לסווג את ההסדר לקביעתה כהסדר כובל. מעבר לכך, עמלה צולבת גבוהה גורמ
לסבסוד צולב בין אמצעי תשלום ולשימוש יתר באמצעי תשלום פחות יעילים על חשבון אמצעי תשלום יעילים
יותר, וגם מטעם זה ההסדר לקביעתה עולה כדי הסדר כובל.
ברגיל, דיני ההגבלים העסקיים של כל המדינות המתוקנות אוסרים מכל וכל על הסדרים כובלים לתיאום .7
העסקיים. אף על פי כן, העמלה איסור זה הוא מאבני היסוד של דיני ההגבלים תחרים.מחירי מינימום בין מ
436
הצולבת היא הסדר כובל לתיאום מחיר מינימום בין סולקים ומנפיקים מתחרים, אשר זכה לאישור בכל
צדדי. למוצרי רשת דו -המדינות בעולם. הטעם לכך הינו שמערכות של כרטיסי חיוב הן בגדר מוצר רשת דו
צדדים יש מאפיינים מיוחדים, שמצדיקים החלת דין שונה מזה הנוהג במוצרים "רגילים". במערכות של
כרטיסי חיוב קיימות תופעות של החצנות, שאותה עמלה צולבת יעילה יכולה להפנים.
החצנה אחת שקיימת במערכות תשלומים של כרטיסי חיוב היא החצנת רשת. זו ההחצנה שנגרמת כאשר רשת
רטיסי החיוב קטנה מהגודל האופטימלי שלה, בגלל שהביקוש לכרטיסי חיוב בצד אחד )למשל בקרב כ
מחזיקים(, נמוך מהביקוש בצד שני )למשל בקרב בתי עסק(. כאשר הנכונות של הציבור לשלם עבור כרטיסי
צולבת יכולה חיוב נמוכה, אך בקרב בתי עסק יש נכונות גבוהה מספיק לשלם עבור כרטיסי חיוב, העמלה ה
להפנים את חוסר הסימטריה הגורם להחצנת רשת, על ידי העברת כסף מהצד שבו הביקוש גבוה יותר לצד
שבו הביקוש נמוך יותר, ולסייע בכך לגידול יעיל של הרשת.
החצנה שניה שקיימת במערכות כרטיסי חיוב ושאותה עמלה צולבת יעילה יכולה להפנים, היא החצנת שימוש.
צנה שנגרמת כאשר המחזיקה, בקופה, משתמשת באמצעי תשלום יקר ולא יעיל חברתית )למשל מזומן זו ההח
או שיק( ולא באמצעי תשלום זול ויעיל )למשל כרטיסי חיוב מיידי(, רק בגלל שהמחזיקה / המשלמת היא זו
בורה( אפילו שמקבלת את ההחלטה באיזה אמצעי תשלום לשלם, ויותר נוח לה לשלם באמצעי תשלום זול )ע
אם מבחינה חברתית זהו אמצעי תשלום יקר ולא יעיל. בעבודה מוקדש פרק לעלויות ולתועלות של אמצעי
התשלום. הממצאים האמפירים מעלים שכרטיסי חיוב )במיוחד כרטיס חיוב מיידי( הינו אמצעי תשלום יעיל
הן מזומן הוא אמצעי התשלום הזול וזול יותר מתשלום במזומן ובשיקים )למעט עסקאות ב"סכומי מטבע", שב
ביותר(. עמלה צולבת מפנימה את החצנת השימוש אם בלעדי העמלה הצולבת לא יהא מספיק שימוש באמצעי
התשלום היעיל )לדוגמה, עסקאות שיעיל לעשותן בכרטיס חיוב יתבצעו באמצעי תשלום נחות(. עמלה צולבת
ודד שימוש יעיל בכרטיסי חיוב, יכולה להפנים את החצנת שמועברת לצד ההנפקה על מנת להוזיל עלויות ולע
השימוש, ולתרום לשימוש יעיל באמצעי תשלום.
לפיו, כסף רע דוחק Gresham’s Law Of Payments))הנו "חוק גרישם" של החצנת שימוש כינוי אחר לתופעה
שני שטרות, האחד בלוי כםכך למשל, אם יש בארנק .Bad Money Drives Out The Good -מהמחזור כסף טוב
תעדיפו להשתמש בשטר הבלוי לפני השטר החדש, פן יקרע השטר הבלוי כשהוא ברשותכם. –והשני חדש
ידי המשלם שממהר להיפטר ממנו, וכך הלאה, והכסף הרע העלות היקרה של טיפול בשטר דהוי, מוחצנת על
.דוחק את הטוב מהמחזור
עולה שהעמלה הצולבת היא מצד אחד הסדר כובל לתיאום מחירי מינימום בין מתחרים שברגיל מן המקובץ .8
אסור מכל וכל על ידי דיני התחרות ברחבי העולם. מצד שני ובד בבד עמלה צולבת היא אמצעי יעיל להפנמת
ילה. ואכן, החצנות הקיימות במוצרי רשת דו צדדים. לפיכך רמה מסויימת של עמלה צולבת יכולה להיות יע
משאבים אדירים מושקעים ברחבי העולם על ידי רגולטורים, בנקים מרכזיים, טריבונלים תחרותיים, בתי
משפט ורשויות נוספות, כדי לאשר עמלה צולבת אך בו זמנית לזהות את שיעורה ה"נכון" ולפקח שהיא לא
גבוהה מידי מעוררת. כמבואר תהיה גבוהה מידי. בעבודה מוקדש פרק לחששות התחרותיים שעמלה צולבת
כבר לעיל, עמלה צולבת גבוהה מידי גורמת לעליית מחירים קטנה אך רוחבית בכלל המשק. שנית, עמלה צולבת
גבוהה מידי גורמת לסבסוד צולב בין אמצעי תשלום. במקום שהעמלה הצולבת תסייע להגדיל שימוש יעיל של
רמת לתשלום יתר באמצעי תשלום יקרים על חשבון אמצעי אמצעי תשלום זולים, כשהיא גבוהה מידי היא גו
תשלום זולים.
437
בתחום של כרטיסי חיוב, היד הנעלמה של התחרות לא פועלת כהלכה. בניגוד למוצר רגיל שאותו הצרכן לא .9
יקנה, אם העלות שלו גבוהה מהתועלת שהוא מניב, בתי עסק חוששים לסרב לקבל כרטיסי חיוב, אף אם
עמלת בית העסק( גבוהה מהתועלת שיש לבית העסק מקבלת כרטיס חיוב לעומת אמצעי תשלום עלותם )כלומר
אחר. החשש העיקרי של בתי עסק הינו מנטישת לקוחות שלא ירצו לרכוש מוצרים ושירותים בבית עסק שלא
פעה זו ( בגין קבלת כרטיסי חיוב. תוsurchargeמכבד כרטיסי חיוב, או אפילו ש"רק" גובה תוספת תשלום )
"שיקולים אסטרטגיים" של בתי עסק. השיקולים האסטרטגיים מוחרפים Rochet & Tiroleכונתה על ידי
בשל תחרות בין רשתות כרטיסי חיוב על ליבם של מחזיקים. כאשר מחזיקים עושים שימוש עיקרי בכרטיס
הממומנות ולו -ת ( אזי תחרות בין רשתות מתבטאת בהרעפת הטבוsinglehomingאחד )תופעה המכונה
על מחזיקים. להיטות מחזיקים לשלם בכרטיסי חיוב נושאי הטבות -בחלקן על ידי העמלה הצולבת
)הממומנות על ידי עמלה צולבת( מעצימה עוד יותר את הקושי של בתי עסק לסרב לקבל כרטיסים )תופעה
, תחרות המתודלקת על ידי עמלה (. וכך, במקום שתחרות תוריד מחיריםmust take cards -שכונתה בספרות
צולבת, גורמת לעליית מחירים.
ברחבי העולם קיימים מספר מודלים של פיקוח על העמלה הצולבת )בעבודה מוקדש פרק שלם לרגולציה .10
(. לפי cost methodologyברחבי העולם(. מתודולוגיה רווחת לקביעת העמלה הצולבת היא לפי עלויות )
צולבת נקבעת בהתאם לעלויות ספציפיות של שירותים שמנפיקים כביכול מעניקים מתודולוגיה זו, העמלה ה
לסולקים. מתודולוגיה נוספת, בה עשתה שימוש הנציבות האירופית, היא לקבוע את העמלה הצולבת על שיעור
שיביא את עמלת בית העסק לנקודה שבה בית העסק יהא אדיש בין קבלת מזומן מלקוח מזדמן )תייר( לבין
(. the tourist testבלת כרטיס חיוב )ק
בעוד שביסודה של מתודולוגית העלויות לא עומד מודל כלכלי כלשהו, ביסוד המתודולוגיה המבוססת על מבחן
התייר עומדים מודלים כלכליים שהוצעו על ידי פרופסורים לכלכלה ידועי שם )בעבודה מוקדש פרק רחב
ות )עלויות ומבחן התייר( דורשות השקעת משאבים ניכרת לצורך למודלים הכלכליים(. שתי המתודולוגי
קביעת העמלה הצולבת ה"נכונה" על פיהן. על שתי המתודלוגיות נמתחה ביקורת, הנסקרת בעבודה בהרחבה,
ולפיה אין ביכולתן להביא את העמלה הצולבת לשיעור אופטימלי. הצעה נוספת שהוצעה כדרך לנטרל את
( ממי אשר משלם באמצעי surchargeהיא מתן אפשרות לבתי עסק לגבות תוספת )השפעת העמלה הצולבת
תשלום יקרים. ואולם תשלום דיפרנציאלי על בתי עסק אינו תמיד ישים ואינו שכיח )בעבודה מוקדש פרק שלם
לסיבות לכך(.
רכזי להפקת כשלון הפיקוח על העמלה הצולבת בא לידי ביטוי בכך שבפועל, העמלה הצולבת משמשת ככלי מ .11
Cozyבשם Rochet & Tiroleרווחי עתק עבור מנפיקים, בניגוד מוחלט למטרותיה. תופעה זו כונתה על ידי
Cartel הצידוקים המקוריים ביסוד אישורה מלכתחילה של העמלה הצולבת לא כללו הפקת רווח, אלא כיסוי .
בכרטיסי חיוב. חברות כרטיסי החיוב עלויות הנפקה שלא מכוסות על ידי המחזיקים ועידוד שימוש יעיל
מציגות שיעורי תשואה החורגים באופן משמעותי בגובהם מהמקובל בתעשיית הפיננסים, כאשר העמלה
הצולבת היא סיבה מרכזית לכך, וזאת בניגוד מוחלט לנימוקים לאישורה.
בת לרמה תחרותית, עבודת הדוקטורט שלי מציעה שני חידושים מהפכניים, שיישומם יביא את העמלה הצול .12
תוך ייתור כמעט מוחלט של הצורך בפיקוח על העמלה הצולבת.
438
ההצעה הראשונה היא לחייב הפרדה מבנית בין סולקים לבין מנפיקים. גופים פיננסים ייצטרכו לבחור אם .13
לפעול בצד הסליקה או בצד ההנפקה, אך לא בשניהם. העמלה הצולבת תיקבע במשא ומתן תקופתי בין
)הצד המשלם( עצמאיים לבין מנפיקים בלתי קשורים לסולקים. ברירת המחדל בהעדר הסכמה תהיה סולקים
עמלה צולבת אפס. חידוש זה, לו ייושם, יביא לכך שהעמלה הצולבת תפסיק להיות הסדר כובל לתיאום
פיקים מחירים. ההסדר הכובל השיורי שיוותר יהיה משא ומתן משותף בין מתחרים )סולקים מצד אחד ומנ
בלתי קשורים לסולקים מהצד השני(. משא ומתן משותף הינו הסדר כובל "מינורי" שניתן לשליטה. חששות
ממשא ומתן משותף מופגים במיוחד ביחס למנפיקים, אשר לכאורה המו"מ המשותף שלהם בעייתי יותר, כי
)דביט, קרדיט, פריפייד( ברירת המחדל היא אפס. כוח המיקוח לקביעת העמלה הצולבת בכל סוג של עסקאות
יועבר לידי סולקים עצמאיים, שהם הצד המשלם את העמלה הצולבת. ככל שלעמלה הצולבת יש יתרונות
בהפנמת החצנת רשת ובהפנמת החצנת השימוש, הסולקים הם הגוף שיפנים זאת באורח מיטבי, כי הם צד
צולבת רק אם התשלום יביא לגידול לכל העסקאות בכרטיסי חיוב. סולקים עצמאיים יסכימו לשלם עמלה
במחזור העסקאות באופן שימקסם את רווחיהם.
צדדי אחר. מועדוני הכרויות הם מוצר דו צדדי הפונה בעת ובעונה -דוגמה לאמור ניתן למצוא בשוק רשת דו
הביקוש אחת לנשים ולגברים. נניח שתחת תמחור ראשוני כלשהו לגברים ולנשים, יש צד אחד )למשל גברים( ש
שלו גדול מהביקוש של הצד השני )הנשים( לשירותיו של מועדון ההיכרויות. במצב שכזה יש במועדון
ההיכרויות עודף גברים על נשים, באופן שגורם למועדון להיות לא אטרקטיבי ולא יעיל לשני הצדדים. על מנת
גדול מספיק )גברים/ סולקים(, להגדיל את מספר התועלת מהפלטפורמה לשני הצדדים עשוי הצד שבו הביקוש
, על מנת שחלק מהתשלום יועבר לצורך סבסוד המחירים הנגבים מבני המגדר יותרלהסכים מרצונו לשלם
השני )הוזלת התשלום לנשים / מחזיקים(. כלומר, אם נעניק לגברים )סולקים( את כוח המיקוח, הם עשויים
"רגילים", שבהם הרוכש לעולם יעדיף לשלם פחות(, אם כקבוצה להחליט לשלם יותר )הפוך מהמצב בשווקים
כתוצאה מכך תגדל הכמות בצד השני )הפנמת החצנת הרשת( ויגדל מספר האינטרקציות היעילות )הפנמת
החצנת השימוש(.
. כל חיסכון 100%-צד הסליקה נחשבת לתחרותי, ושיעור הגלגול בו מעמלה צולבת לעמלת בית עסק מתקרב ל .14
צולבת אמור להיות מגולגל, בשיעור מעבר מלא, אל בתי עסק. בתי עסק צפויים להעביר את שיושג בעמלה ה
החיסכון ללקוחותיהם, וזאת כתלות בשיעור המעבר של חיסכון בתשומות אל המחירים הסופיים בשווקים
לה הרלוונטיים. החשוב הוא שהפרדה מבנית תגדע מהשורש את ניגוד העניינים המובנה שביסוד קביעת העמ
הצולבת הנוכחית. כיום, בכל העולם, העמלה הצולבת נקבעת על ידי מנפיקים, שהם הצד שמקבל את התשלום.
אין אפוא פלא שהעמלה הצולבת נקבעת פעם אחר פעם ובמדינה אחר מדינה על שיעורים גבוהים
גורדי זה, מהאופטימום, המאפשרים למנפיקים באותה מדינה להפיק ממנה רווחי עתק. הצעתי גודעת קשר
ומנתקת בכך את העמלה הצולבת מהיותה הסדר כובל לתיאום מחירים.
תפגע ברווחיהן. לכן נקבעו -כמו זו המוצעת על ידי –רשתות כרטיסי החיוב היו ערות לכך שהפרדה מבנית .15
NAWIבתקנונים שלהן כלל האוסר על סולקים להיות עצמאיים, ומחייב סולקים להיות קודם כל מנפיקים )
– No acquiring without issuingעם השנים נפסל במקומות רבים כלל ה .)- NAWI ,על ידי רשויות
רגולטורים וטריבונלים שיפוטיים, באופן המאפשר, תיאורטית, את קיומם של סולקים עצמאיים כפי שאני
עצמאיים, בפועל מציע. ואולם, בפועל, על אף שתיאורטית מתיר הדין במדינות רבות את קיומם של סולקים
לא נכנסו לשווקים סולקים עצמאיים אשר קובעים את שיעור העמלה הצולבת שאותה הם משלמים. העמלה
AWI ,Acquiringהצולבת ממשיכה להיקבע על ידי מנפיקים. הצעתי היא למעשה לקבוע כלל מחייב של
439
without issuingטורים ושל רשויות תחרות ברחבי , ולעגן זאת בחוק. בכך תוגשם השאיפה )שסוכלה( של רגול
, אך מטרתם סוכלה כי בפועל לא קיימים סולקים NAWI -העולם, אשר הביאו אמנם לביטולו של כלל ה
היה תנאי הכרחי אך בלתי NAWI -עצמאיים שקובעים את העמלה הצולבת שהם משלמים. ביטולו של כלל ה
מספיק לפתרון הבעיות שמעוררת העמלה הצולבת. התנאי הנוסף הוא שסולקים עצמאיים אכן ייכנסו לשוק
והם אלה שיקבעו את העמלה הצולבת שהם משלמים. זאת לא אירע בפועל. החידוש שאני מציע יגשים זאת.
רשויות תחרות, טריבונלים ורגולטורים שעליהם החידוש השני שאני מציע הינו כלי רגולטורי, שיכול לשמש .16
הוטלה המשימה הקשה של קביעת שיעור העמלה הצולבת ה"ראוי". חידוש זה מתאים לאימוץ על ידי בנק
ישראל, שיושב כיום על המדוכה במטרה לקבוע את שיעור העמלה הצולבת שיחול בישראל עם תום ההסדר
שוטה והיא למעשה ה"פתרון" של העמלה הצולבת האופטימלית . ההצעה היא פ2018הנוכחי המסתיים בשנת
על פי המודלים הכלכליים, כשהסטנדרט לאופטימליות הינו רווחת הצרכן. במקרה של כרטיסי חיוב,
האופטימום על פי סטנדרט רווחת הצרכן הינו מקסום העודף המצרפי של בתי עסק מצד אחד, והצרכנים )לא
ומן, שיקים ואמצעי תשלום אחרים( מצד שני. מוצרים דו צדדיים כמו כרטיסי רק מחזיקים אלא גם משלמי מז
חיוב פונים בעת ובעונה אחת לשני קהלי יעד ששניהם יחד הם בגדר הצרכן של המוצר הדו צדדי. זאת בדומה
לכך שקוראי עיתונים ומפרסמים הם הצרכן המשולב של עיתונות, ובדומה לכך שבעלי עסקים וציבור הלקוחות
המבקרים הם הצרכן המשולב של מרכזי קניות.
ההצעה שלי תיאלץ את העמלה הצולבת להתכנס למטרותיה החוקיות בלבד, ולא מעבר לכך. אני מציע להתנות
אישור לגביית עמלה צולבת באיסור על מנפיקים להפיק רווחים מעבר לרווח מינימלי על השקעת חסרת סיכון.
לבת לכיסוי עלויות, לרבות עלויות המועברות במלואן לצד המחזיקים כדי מנפיקים יוכלו לגבות עמלה צו
לעודד שימוש יעיל בכרטיסים, ואולם לא אגורה מעבר לכך. כלומר, מנפיקים לא יוכלו להפיק רווח מהעמלה
הצולבת.
וחי מנפיקים מנפיקים יוכלו להפיק רווחים ללא מגבלה, אם יוותרו על גביית עמלה צולבת לחלוטין. ואולם, רו
שיעדיפו לגבות עמלה צולבת יוגבלו. ככל שהרווח של מנפיקים בתקופה כלשהי יהיה גבוה יותר מרווחיות על
השקעה חסרת סיכון, אותם מנפיקים ייאלצו להפחית בתקופה שלאחר מהן את העמלה הצולבת שהם גובים,
באופן שיקזז את הרווח הלא חוקי.
למנפיקים )ליתר דיוק, לבעלי המניות של המנפיקים(, ממצב שבו עמלה הצעתי מעקרת את התועלת שיש
צולבת גבוהה ו"מנופחת" מורעפת ביתר על מחזיקים כהטבות סרק מופלגות, שמעודדות שימוש מוגזם ולא
. מנפיקים הם Wasteful Competitionבשם Rochet & Tiroleיעיל בכרטיסי חיוב, תופעה שכונתה על ידי
ים שיש להם בעלים שמצפים לרווח. בעלי מניות של מנפיקים לא יפיקו שום רווח מעמלה צולבת גופים פיננסי
גבוהה שמועברת למחזיקים כהטבות. בנוסף, הרעפת הטבות סרק היא בעלת תופעות שליליות שעליהן אני
נוספות עומד בעבודה, ושבעטין כבר הוצע בעבר להגביל את העמלה הצולבת מלשמש מקור להטבות. טכניקות
להסוואת רווחים, כמו דמי ניהול, הוצאות סרק ומשכורות מנופחות, אינן ישימות כשמדובר על גופים פיננסים
כמו מנפיקים.
אם תאומץ הצעתי הדבר "ייאלץ" את העמלה הצולבת להיות אופטימלית, וזאת על פי הסטנדרט המקובל .17
חד כאשר דיני ההגבלים העסקיים מתמודדים עם בדיני הגבלים עסקיים שהנו מקסום רווחת הצרכן. כך במיו
שווקים שבהם במצב המוצא, עודף היצרן כבר מנופח בשל הגבל עסקי כלשהו, כבענייננו. נימוק נוסף לסטנדרט
440
ולפיו הערך השולי של כסף עבור הצרכן של כרטיסי חיוב )בתי Rochet & Tiroleשל רווחת הצרכן ניתן על ידי
ר מהערך השולי של הכסף עבור בעלי מניות של חברות כרטיסי חיוב. עסק והציבור( גבוה יות
תחת הסטנדרט של מקסום עודף הצרכן, עמלה צולבת אופטימלית היא זו שממקסמת עסקאות יעילות, תחת
(. התנאי מתקיים כאשר עמלה צולבת p=mcאילוץ שרמת המחירים של הטובין במשק תיקבע על פי עלויות )
ויות מנפיקים שלא מכוסות ממקור אחר )כגון דמי מחזיק או ריבית(. כאשר העמלה משמשת לכיסוי על
הצולבת משמשת לצורך עידוד שימוש בכרטיסי חיוב, שהינה המטרה הלגיטימית השניה בגינה הותרה גביית
עמלה צולבת ברחבי העולם מלכתחילה, אזי היא עשויה להפנים החצנת שימוש )ההחצנה שנגרמת כאשר
בקופה מעדיפה לשלם באמצעי תשלום יקר במקום באמצעי תשלום זול, כי האמצעי היקר הוא זול הלקוחה
עבורה(. ואולם, גם כאן, התנאי הוא שהעמלה הצולבת אכן תשמש לייעודה ותועבר למחזיקים כהטבות /
נקודות / הנחות וכיו"ב.
רים. הצידוק לאישורה הלכתחילי היה נזכור שעמלה צולבת היא הסדר כובל לתיאום מחירי מינימום בין מתח
לצורך עידוד שימוש יעיל בכרטיסים ותרומה לגידול יעיל של הרשת )הפנמת ההחצנות(. ואולם, הפקת רווח
אינה מטרה לגיטימית, בין תחת עמלה צולבת לכיסוי עלויות ובין תחת עמלה צולבת לעידוד שימוש וגידול יעיל
ות המורעפות על מחזיקים, לא יכול להיות תירוץ לרווח. לכן לא ייתכן של הרשת. כיסוי עלויות, לרבות הטב
שעמלה צולבת שמיועדת לכיסוי עלויות תשמש כמקור לרווח.
רשתות כרטיסי חיוב הן שוק בוגר שהגיע לדרגת חדירה מלאה. הצורך בעמלה צולבת להפנים את החצנת .18
צולבת תתרום להפנמה יעילה של אמצעי הרשת מוצה על פי רוב. באשר להחצנת השימוש, במקום שעמלה
תשלום על ידי הסטת לקוחות לשלם בכרטיסי חיוב זולים ויעילים, עמלה צולבת גבוהה יחד עם שיקולים
אסטרטגיים של בתי עסק שמונעים מהם לסרב לקבל כרטיסים, גורמים להחצנת שימוש הפוכה, בה בתי עסק
אמצעי תשלום זולים. ואולם, אפילו אם יש מקום לעמלה נאלצים לכבד כרטיסי חיוב יקרים עבורם, חלף
צולבת לצורך גידול נוסף של הרשת )הפנמה של החצנת רשת( או לצורך עידוד נוסף של שימוש בכרטיסים
)הפנמת החצנת שימוש(, ייעודה הלגיטימי של העמלה הצולבת, קרי כיסוי עלויות, עידוד שימוש יעיל בכרטיסי
, אינו כולל ואינו יכול לאפשר הפקת רווחים ממנה. חיוב או שניהם גם יחד
כיום, העמלה הצולבת היא כלי אשר במקום לשמש לכיסוי עלויות ולעודד שימוש יעיל בכרטיסים, "מאלץ" .19
את חברות כרטיסי החיוב לרווח. בכך חורגת העמלה הצולבת מהצידוקים לאישורה. התקבולים מהעמלה
בשנה. סכום זה מכסה לבדו, כמעט את כל עלויות ההנפקה ₪ מיליארד הצולבת לבדה מגיעים לכמעט שני
המתוקננות של מנפיקים בישראל. במצב שכזה, אין על מה להתחרות. כל, או כמעט כל, עלויות המנפיקים
( בזרם windfallמכוסים באמצעות העמלה הצולבת, כאשר בנוסף זוכים מנפיקים, בבחינת מתת חינם )
, כי מרבית 2006תי של דמי מחזיק וריבית על אשראי. באירופה נבחן ונמצא עוד בשנת הכנסות נוסף ומשמעו
המנפיקים כלל לא זקוקים לעמלה צולבת כדי לכסות את עלויותיהם ולהיות רווחיים. הנציבות האירופית
לבת ציינה כי הממצא מטיל ספק בנחיצות של עמלה צולבת. ואולם, כאמור, אף אם שיעור מסוים של עמלה צו
הוא חיוני ופרו תחרותי, אין שיעור זה מיועד לצרכי רווח אלא לכיסוי עלויות )כולל הטבות לעידוד שימוש יעיל
בכרטיסי חיוב(.
כמובן שאין להטיל על גופים עסקיים שום מגבלה על השגת רווחים בצורה חוקית. ואולם עמלה צולבת היא .20
ות קנויה להיות צד להסדר כובל שכזה. רווחים המושגים הסדר כובל לתיאום מחירי מינימום. אין לאדם זכ
441
אשר מלכתחילה קיבל אישור רק בשל הצורך לכיסוי עלויות או לעודד שימוש -מהסדר כובל לתיאום מחירים
מוצדק, ראוי וצריך להגביל. -יעיל )אך כמובן שלא לצורך הפקת רווחים(
מנפיקים הם גם סולקים, אזי הגבלת הרווחיות תחול על חברות יחס הגומלין בין שני החידושים הינו שכל עוד .21
כרטיסי החיוב בשני הצדדים. אסור יהיה לחברת כרטיסי חיוב להרוויח מעל ומעבר לתשואה על השקעה חסרת
סיכון. אם חברת כרטיסי חיוב מפיקה רווחים בצד הסליקה, עליה להעבירם לצד ההנפקה לפני שהיא מבקשת
מלה צולבת שהינה הסדר כובל לתיאום מחירים. העמלה הצולבת לא נועדה להיות פיצוי היתר רגולטורי לע
( על עלויות שנגבות בפועל ממחזיקים או מבתי עסק, אלא רק לכסות עלויות double compensationכפול )
חיוב(. שלא כוסו בגבייה ישירה ממחזיקים או מבתי עסק )לרבות עלויות שנועדו לתמרץ שימוש יעיל בכרטיסי
על חברות כרטיסי החיוב לעשות שימוש בכל מקורות הכנסתן מכרטיסי חיוב, לפני שהן מבקשות ומקבלות
היתר רגולטורי לבצע קרטל בחסות הדין. הסדר כובל כמו העמלה הצולבת צריך לקבל אישור רק כשהוא חיוני,
ת המשמשת לצורך הפקת רווחים מידתי ובלעדיו לא ניתן להגשים את מטרתו החוקית של ההסדר. עמלה צולב
חורגת ממבחן זה, היא אינה מידתית ולו רק בשל עליית המחירים לה היא גורמת, ועל כן החלק הלא מידתי
שלה, קרי הרווח, אינו ראוי לאישור. זו היא בדיוק הצעתי.
וד במערכות אני מסביר מושגי יס 2העבודה כוללת את הפרקים הבאים. הפרק הראשון הינו פרק מבוא. בפרק .22
אני סוקר את 4מובאים נתונים על מערכות כרטיסי חיוב בישראל ובעולם. בפרק 3של כרטיסי חיוב. בפרק
סוקר בעין 5. פרק prepaidההיסטוריה של העמלה הצולבת בכרטיסי אשראי, כרטיסי חיוב מיידי וכרטיסי
ר את העלויות והתועלות של אמצעי מסבי 6ביקורתית את הרגולציה של העמלה הצולבת ברחבי העולם. פרק
סוקר את המודלים הכלכליים הקשורים לעמלה הצולבת וכולל תשעה פרקי משנה החל 7התשלום. פרק
, מודלים של ניטרליות Rochet & Tirole, השיקולים האסטרטגיים של Baxterמהמודל הראשון של
(neutrality of the interchange feeוגביית תוספת, מודלים ) של תחרות בין רשתות, מודלים שדנים ביחס
בין דמי מחזיק להטבות, מודלים שדנו בעמלה הצולבת של כרטיסי אשראי לעומת זו של כרטיסי חיוב מיידי
(debit v credit .ומודלים שהתחקו אחר העמלה הצולבת האופטימלית ,)
יר את המאפיינים הייחודיים של מסב 9הוא ניתוח משפטי של העמלה הצולבת כהסדר כובל. פרק 8פרק
כרטיסי חיוב כמוצר רשת דו צדדי, בעטיים מאושרת העמלה הצולבת בכל העולם חרף היותה הסדר כובל
מסביר את החששות התחרותיים 10)החצנת הרשת והחצנת השימוש, והפנמתן על ידי העמלה הצולבת(. פרק
וטים שלא לגבות תוספת ממי אשר משלם באמצעי מסביר מדוע בתי עסק נ 11שמעוררת העמלה הצולבת. פרק
מציג את החידוש 13מציג אלטרנטיבות לעמלה הצולבת ולחששות שהיא מעוררת. פרק 12תשלום יקרים. פרק
מסכם. 15מציג את החידוש של הגבלת הרווחיות. פרק 14של ההפרדה המבנית. פרק
-סוף תקציר -
442
The Faculty of Law
The Zvi Meitar Center for Advanced Legal Studies
Separating Issuers from Acquirers
And Profit Limitations
In Payment Card Networks with Interchange Fees
By: Ori BarAm
Supervisor: Professor David Gilo
Thesis for the title "Doctor of Philosophy"
Submitted to the Senate of Tel Aviv University on 3 August, 2017
443
פקולטה למשפטיםה
מרכז צבי מיתר ללימודי משפט מתקדם
פיצול סליקה והנפקה ומגבלות על רווחים
ברשתות כרטיסי חיוב עם עמלה צולבת
מאת: אורי ברעם דיויד גילה מנחה: פרופ' "דוקטור לפילוסופיה"חיבור לשם קבלת התואר
2017 באוגוסט 3יום אביב ב-הוגש לסנאט של אוניברסיטת תל