Contents

Reserve Bank of Australia 2011. All rights reserved.

The contents of this publication shall not be reproduced, sold or distributed without the prior consent of the

Reserve Bank of Australia.

ISBN 978-0-9871488-0-3 (Online)

As part of the 2007/08 Review, the Board considered whether a modification to the Standards to allow schemes to limit the size of any surcharges imposed by merchants was necessary. This reflected concerns expressed through consultation that surcharging was being exploited by firms with market power.

Since then, there has been increasing evidence to suggest that it is now becoming more common for merchants to set surcharges at levels that are higher than average merchant service fees. The increasingly widespread nature of this practice has the potential to distort price signals to cardholders and to thereby reduce the effectiveness of the reforms.

This document sets out the Board’s analysis of current surcharging practices and some proposed changes that could be made to the no-surcharge Standards.

Section 2 sets out current merchant surcharging behaviour and consumers’ reaction to surcharging. Section 3 discusses recent

surcharging practices that have raised concerns,

while Section 4 sets out some proposed

modifications to the no-surcharge Standards to

address these concerns. Section 5 sets out the issues

for consultation and Section 6 provides details of the

next steps in the process.

The Payments System Board imposed the no surcharge

Standards – requiring the removal of nosurcharge

scheme rules – on the MasterCard and

Visa credit card systems effective from 1 January

2003 and the Visa Debit system effective from

1 January 2007. Other international card schemes

provided voluntary undertakings to remove their

equivalent rules. The removal of these rules has

allowed merchants to pass on the cost of credit card

and scheme debit card transactions to customers

benefits of the no-surcharge Standards have been

substantial, particularly in improving price signals

to cardholders about the relative costs of different

payment methods. The Board also noted that, in

time, the Standards might be expected to add to the

downward pressure on interchange fees.

As part of the 2007/08 Review, the Board considered

whether a modification to the Standards to allow

schemes to limit the size of any surcharges imposed

by merchants was necessary. This reflected concerns

expressed through consultation that surcharging

was being exploited by firms with market power.

The Board decided, however, that the isolated cases

of high surcharges, at that time, did not provide

sufficient grounds to allow the schemes to impose

restrictions on all merchants and hence limit their

Surcharging was slow to develop among merchants

in the first few years following the removal of no surcharge

rules. This likely reflected inertia on the

part of merchants and the strong expectation by

cardholders that no surcharges would apply, given

the history of these practices being prohibited.

In recent years, though, the rate of surcharging

appears to have grown significantly; data from East

& Partners’ semi-annual survey of the merchant

acquiring business suggest that 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).2 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)

In 2003, the Reserve Bank began implementing

reforms to the debit and credit card systems in

Australia. As part of these reforms, a number of

restrictions that had been placed on merchants by

the international card schemes were removed. One

such restriction was the no-surcharge rule, which

prevented merchants from surcharging for credit

card and scheme debit card transactions. These rules

had masked price signals to cardholders about the

relative costs of different payment methods. They

had also contributed to the subsidisation of credit

card users by all other customers, as merchants

would build the costs of accepting card payments

into the overall prices of their goods and services,

which were paid by all customers regardless of the

payment method they used. Finally, these rules

limited the ability of merchants to put downward

pressure on their merchant service fees and

interchange fees by threatening to charge the

customer for using a credit or scheme debit card.

The Reserve Bank imposed standards requiring the

removal of no-surcharge rules from 1 January 2003

in the MasterCard and Visa credit card systems

and from 1 January 2007 in the Visa Debit card

system.1 The American Express, Diners Club and

Debit MasterCard systems each provided voluntary

undertakings to remove their equivalent rules.

0

10

20

30

40

0

10

20

30

40

Per cent of surveyed merchants in June and December

% %

Source: East & Partners’ Merchant Acquiring & Cards Market program

2005 2006 2007 2008 2009

Small merchants

Very

small merchants

Large

merchants

Very large merchants

2010

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.

According to the East & Partners’ survey, average

surcharge levels have increased substantially over

the past few years (Graph 2.2). In December 2010, the

average surcharge for MasterCard credit cards was

1.8 per cent, for Visa it was 1.9 per cent, for American

Express it was 2.9 per cent, and for Diners Club it

was 4 per cent.3 These average surcharge levels are

around 1 percentage point higher than merchant

service fees for American Express, MasterCard

and Visa cards, and around 1.8 percentage points

higher for Diners Club cards.4 Surcharges also vary

substantially across different merchants; East &

Partners’ data indicate that around 10 per cent of

surcharging merchants apply a surcharge of 5 per

cent or more.

3 East & Partners has attributed the sharp increase in surcharges

on Diners Club cards in December 2010 to the inclusion of several

merchants that surcharge aggressively.

by a merchant to the acquirer when a cardholder undertakes a transaction.

In the Board’s view, the benefits from the removal of

no-surcharge rules have been substantial, particularly

in improving the price signals cardholders face

when making payments. While merchants that

apply surcharges are becoming increasingly

commonplace, consumers appear to respond to

price signals by avoiding surcharges where possible.

According to the Bank’s 2010 Consumer Payments

Use Study, consumers paid a surcharge on just

5 per cent of their credit card transactions over the

one-week diary period, with this proportion little

changed from a similar study conducted in 2007

despite the greater prevalence of surcharging.5

These surcharges were found to be most

commonly paid in the holiday travel industry

(44 per cent of credit card transactions in that

industry). This possibly reflects the fact that for

this industry, online purchases are more common

than in other industries and credit cards provide

the most readily available means to undertake

online transactions. In addition, most hotel or car

rental bookings require a credit card as a form of

security deposit or ‘hold’ on funds to cover potential

damages, often resulting in customers paying the

final bill with the same card.

The Consumer Payments Use Study also provides

evidence on how consumers respond to price

signals from surcharging. The study specifically asked

consumers how they would react when faced with

various surcharging scenarios. Across the scenarios,

the results suggest that around 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. The results

5 As part of the Payments System Board’s Strategic Review of Innovation

in the Payments System, the Reserve Bank commissioned Roy

Morgan Research to conduct a study of payment patterns. The 1 241

individuals participating in the study were asked to record details of

every payment they made during one week, including whether they

paid a card surcharge on the payment. A report of the results of this

study will be available in June.

Per cent of transaction value in June and December

0.5

1.0

1.5

2.0

2.5

1.5

2.0

2.5

0.5

1.0

Source: East & Partners’ Merchant Acquiring & Cards Market program

2010

Average surcharge

% Larger merchants Smaller merchants %

Average merchant

service fee

2007 2008 2009 2010 2007 2008 2009

Average surcharge

Average merchant

service fee

also indicate that consumers respond to differential

surcharging: when faced with a surcharge that is

higher on one type of credit card than another,

only around 10 per cent of consumers indicated

that they would complete the transaction with the

card attracting the higher surcharge, while around

40 per cent indicated they would complete the

transaction with the card attracting the lower

surcharge.

The Board reviewed the no-surcharge Standards

as part of its broader review of the card payment

reforms in 2007/08. During consultations for this

Review, some industry participants expressed

concerns about surcharging being exploited by

merchants with market power. Reflecting these

concerns, the Board considered two broad options:

the removal of the no-surcharge Standards; and

the allowance of caps on the surcharge level. The

case for removing the no-surcharge Standards was

considered weak at that time given the substantial

benefits it had provided in improving price signals

to cardholders.

By contrast, the arguments for and against allowing

schemes to cap surcharges were considered to be

more finely balanced. On the one hand, a consumer

group, the card schemes and smaller financial

institutions had expressed concerns about some

cases of excessive surcharging; it was argued that a

cap could ensure that any surcharge set would be

in line with the cost to merchants of accepting a

particular card.

On the other hand, the Board assessed that caps

would limit the negotiating flexibility of merchants

who might agree to limit the amount of their

surcharge in exchange for a lower merchant service

fee. Weighing up these arguments, the Board

assessed that the isolated cases of high surcharges

did not provide sufficient grounds to restrict

surcharging for all merchants. Indeed, at that time,

survey data suggested that, on average, surcharges

were in line with merchant service fees, and the

isolated cases of considerably higher surcharges

were more likely a reflection of the market power of

the merchants concerned. In the latter case, a cap on

surcharges would have limited effect on the overall

prices of goods and services charged by such firms.

The purpose of removing no-surcharge rules

from the credit and scheme debit card systems

was to promote efficiency and competition in the

Australian payments system by providing merchants

the freedom to charge according to the means

of payment. The intent was that the Standards

would introduce normal market disciplines into

negotiations between merchants and acquirers

over merchant service fees and, to the extent that

merchants surcharge, improve price signals facing

consumers choosing between different payment

methods. This in turn would lead to a more efficient

allocation of resources in the payments system,

which is in the public interest. The Standards

therefore prevent scheme rules or any participant

in a scheme from prohibiting a merchant from

of that card. At the time, it was generally expected

that retail competition would ensure that merchants

would not exploit cardholders, who had the option

to turn to other payment instruments or go to other

stores.

As discussed above, there is evidence to suggest the

removal of no-surcharge rules has improved price

signals to cardholders and has thereby improved

efficiency in the payments system. Nevertheless,

in recent years, it has become apparent that

merchants have increasingly been adopting a

number of surcharging practices that have the

potential to distort price signals and thereby reduce

the effectiveness of the surcharging reforms. Two

practices are of particular concern to the Board:

‘excessive’ surcharging; and blended surcharging.

As discussed above, the available data indicate

that the margin by which the average surcharge is

above the average merchant service fee has been

increasing in recent years (Graph 2.2). There is also

some evidence to suggest that this margin tends

to be quite wide for some industries and payment

channels. These industries and channels also tend

to be the segments where a higher proportion of

transactions are surcharged. For example, data from

the 2010 Consumer Payments Use Study suggest

that the incidence of surcharging is much higher

for online purchases than those made in person;

respondents paid a credit card surcharge on around

18 per cent of transactions made online compared

with 4 per cent of those made in person. East &

Partners’ data suggest that surcharges paid for

online transactions also tend to be higher, at around

4 per cent of the purchase value, on average,

compared with around 2 per cent for merchants

with a physical presence. A related concern about

surcharging that has been expressed by both

industry participants and consumers is that there

may sometimes be a lack of genuine payment

alternatives where credit card surcharges are applied

to online payments.

While there is potentially a large variation in the card

acceptance costs faced by merchants, justifying

significant variation in surcharges, concern has

been expressed to the Bank that some merchants

may be using surcharging as an additional means

of generating revenue, rather than simply covering

the costs of card acceptance. A similar conclusion

A related issue is that there appear to be few, if

any, instances where merchants apply different

surcharges for different cards within a card scheme

(that is, ‘differential’ surcharging). Given that

premium/platinum cards typically are more costly

for merchants to accept than standard or gold

cards, we may expect that some merchants would

impose different surcharges on these different

card types. While it is ultimately the merchant’s

choice as to how they impose surcharges, this

outcome may, in part, be the result of the structure

of merchant pricing. Most merchants tend to pay

one blended merchant service fee to their acquirer

for a particular card scheme, with little knowledge

of how this blended fee depends on their particular

mix of card transactions. While many merchants

prefer this simple fee structure, it provides them

little information on the cost of acceptance for each

different card type; hence, they may be charging the

same rate for different cards simply because they do

not know how different cards affect their total cost

of card acceptance.

was reached in a report published by CHOICE in

November 2010, commissioned by the New South

Wales Department of Fair Trading.6

The second concern is an apparent increase in the

use of blended surcharging. This is where different

cards are surcharged at the same rate despite

significant differences in acceptance costs. For

instance, a merchant may apply the same surcharge

to American Express, Diners Club, MasterCard and

Visa cards even though the merchant’s acceptance

costs are likely to be higher for some cards than

others. Hence, a merchant may not be recovering all

its acceptance costs, or it may be recovering its costs

for some cards and more than its costs for others.

In some cases, these blended surcharges have been

encouraged by the higher-cost schemes. While some

merchants may prefer the simplicity of applying only

one blended surcharge across card schemes, this

practice dulls price signals to consumers about the

relative costs of different card systems.

November.

lowest cap that schemes rules could choose to

impose. That is, scheme rules may choose to impose

a cap at a higher level than that specified in the

Standards, or to not impose caps at all, but any cap

below the level specified would not be permitted.

This option has the appeal of being transparent

and easy for schemes and consumers to monitor

compliance. There is, however, the practical difficulty

of determining the appropriate level for the cap. If

the cap is set too high, merchants with market power

would be encouraged to set surcharges at the level

of the cap. If the cap is set too low, the ability of

merchants to put downward pressure on merchant

service fees and interchange fees would be limited.

A permissible cap that is specified in the Standards

would also be unresponsive to competitive

pressures that might influence merchant service fees

over time.

The second and more flexible option is to modify

the no-surcharge Standards to allow scheme rules

to limit surcharges to an amount that is either

reasonably related, or equal, to the merchant’s cost

of card acceptance. Under the current Standards,

acquirers and merchants may come to an agreement

that the amount of the surcharge will be limited to

the costs of card acceptance. However, it is not clear

that this has been used in practice, as acquirers for the

four-party schemes have little incentive to impose

restrictions on their merchant clients in exchange

for reducing merchant service fees. Hence, this limit

may be more effectively implemented through

scheme rules.

Since the 2007/08 Review, there has been increased

evidence of adverse surcharging practices. The

Board, therefore, believes there may be a case for

varying the no-surcharge Standards. The Board

has identified two potential modifications to the

Standards: allowing scheme rules to impose caps on

surcharges; and providing clarification on differential

surcharging. These suggested modifications are

set out below. The possible need for disclosure of

merchant service fees is also discussed.

The Board believes that allowing some limit to be

placed on the level of surcharges could improve the

effectiveness of the reforms at relatively little cost,

particularly given that the practice of surcharging

is now well established. There are two possible

options the Board could take to implement such

a change: determine a specific permissible cap

that the schemes could impose; or allow scheme

rules to limit surcharges to an amount that is either

reasonably related, or equal, to the merchant’s cost

of card acceptance. Given that the Bank has no direct

influence over merchant pricing, either approach

would best be implemented by allowing schemes

to alter their rules to incorporate the cap.

Under the first option, the Board could determine

a specific permissible cap, possibly expressed

as a percentage of the transaction value, for the

designated MasterCard and Visa credit card systems,

and the Visa Debit system.7 This would be the

7 The American Express, Diners Club and Debit MasterCard systems

could modify their relevant voluntary undertakings accordingly.

to that cost. Allowing for a reasonable relationship

between surcharges and the cost of acceptance

implies some level of tolerance around any

surcharging cap. What constitutes ‘reasonable’ in

this case could be left unspecified. Alternatively, a

level of tolerance could be defined more precisely,

for instance in terms of basis points for credit cards.

The second proposed modification to the nosurcharge

Standards is to provide clarification on the

ability of merchants to surcharge differentially across

card types within a particular card scheme. However,

consideration needs to be given to the different

models of merchant pricing.

As mentioned in Section 3, the majority of merchants

receive a blended merchant service fee across all

cards of a particular scheme and most prefer this

simple fee structure. This blended merchant service

fee, in part, reflects the merchant’s expected mix of

card transactions as indicated by recent experience

or industry norms. Therefore, premium/platinum

card transactions, for example, do not explicitly cost

more than standard card transactions for a merchant

on a blended merchant service fee, but a sustained

increase in the proportion of premium/platinum

card transactions is likely to flow through to a higher

blended rate over time. Blended merchant service

fees, therefore, make it difficult for merchants to

assess the cost of accepting a particular card type

and to surcharge accordingly.

By contrast, some larger merchants receive

‘interchange-plus’ merchant pricing, where for each

transaction the merchant is charged the interchange

fee applying to that card or transaction type plus

the acquirer’s margin. A transaction made with a

premium/platinum card will, therefore, at many

merchants incur a higher merchant service fee than

a transaction on a standard card because premium/

platinum cards attract a higher interchange fee.

Reflecting this, the merchant may choose to signal

the different costs of acceptance for different

Under this second option, the Standards might

need to define the cost of card acceptance. The

widest definition of the cost of acceptance would

be the merchant service fee plus ‘other’ costs, such

as annual fees, terminal rentals or other transaction

fees. Determining what other costs should be

included, though, is not straightforward because of

the complexities of merchant pricing. One way to

limit the scope of the costs that can be included is to

only allow costs charged by the acquirer. However,

there are legitimate costs for processing card

transactions that are not necessarily charged by the

acquirer. For example, while some merchants rent

their terminals and incur terminal rental fees, others

invest directly in terminals themselves; if only costs

imposed by acquirers could be passed through,

merchants that rent their terminals from acquirers

could impose a higher surcharge. Also, in the case

of online payments, some merchants have their

card transactions processed by a payment gateway,

which is not necessarily the same as the merchant

acquirer. Therefore, any fee associated with

transaction processing by the third-party gateway

could not be passed through as a surcharge under

such arrangements. Another consideration is that

other costs cannot always be entirely attributed to a

particular card’s acceptance. For example, terminals

are used to process many types of payments and so

these costs would need to be apportioned across

payment methods appropriately.

Given the difficulties involved in determining the

appropriate scope for other costs, a more transparent

and consistent alternative is to define the cost of

acceptance as, simply, the merchant service fee.

While it may be somewhat restrictive for some

merchants, it may be the most straightforward way

to address the concerns of excessive surcharging

while still providing appropriate price signals to

consumers.

Another consideration under this more flexible

option is whether surcharges should be capped

at a level equal to the defined cost of acceptance,

or whether they need only be ‘reasonably related’

merchant’s cost of acceptance for each different

card type if it is requested by the merchant. At the

same time, the Standards could require acquirers to

pass on information about the weighted-average

merchant service fee for those merchants on

‘interchange-plus’ arrangements.

The Board has also considered whether there is a

case to promote the disclosure of merchant service

fees. The disclosure of surcharges by merchants

Australian Competition and Consumer Commission,

and the Australian Securities and Investments

Commission.8 The additional disclosure of

merchant service fees by merchants would provide

consumers with information about the cost of

card acceptance, against which the reasonableness

of any surcharge could be assessed. Alternatively, the

Bank could collect and publish more detailed data

on merchant service fees, such as the range and

average of these fees across merchant categories for

each card scheme. The Board is seeking the views of

interested parties on the merits of these approaches

to disclosure.

for_business.pdf/$file/news_for_business.pdf.

card types by imposing card-specific surcharges.

Alternatively, they may choose to surcharge one rate

across all cards of a particular scheme. If surcharging

were tied to acceptance costs, such merchants

would need to calculate (or be provided with) their

own weighted-average (blended) merchant service

fee for each card scheme they accept.

Considering these different models of merchant

pricing, for efficiency reasons revised Standards

should ensure that scheme rules capping surcharges

are not imposed in a way that prevents a merchant

from surcharging differentially across cards within a

card scheme if they have the capacity to do so. The

Board is seeking views on the ways merchants may

retain the flexibility to apply differential surcharging

in conjunction with a possible surcharging cap. For

example, one option might be to clarify in the nosurcharge

Standards that scheme rules capping

surcharging cannot prohibit merchants applying a

surcharge that is either:

or

scheme.

In order to enable merchants to differentially

surcharge, revisions to the Standards could also

require acquirers to pass on information about the

a surcharge that is either a blended rate for each

card scheme or the cost of accepting each card

to allow for differential surcharging?

vi. Should the no-surcharge Standards require

acquirers to pass on information about the

merchant’s cost of acceptance for each different

card type if it is requested by the merchant? And,

for those on ‘interchange-plus’ pricing, should

the no-surcharge Standards require acquirers

to pass on information about the weightedaverage

merchant service fee if it is requested by

the merchant?

vii. Is there a case for disclosure of the cost of card

acceptance by merchants? Or, would it be

sufficient for the Bank to collect and publish

more detailed data on merchant service fees,

such as the range and average of merchant

service fees across merchant categories for each

card scheme?

Reflecting the discussion in the previous section, the

Board is seeking input from interested parties on the

following issues:

i. Is there a case for modifying the Standards to

allow schemes to limit surcharges?

ii. Is a surcharge cap best implemented by the

Board setting a transparent and specific

permissible cap that is specified in the

Standards, and may then be imposed in scheme

rules? Or, should the Standards allow scheme

rules to limit surcharges to an amount that

is either reasonably related, or equal, to each

particular merchant’s cost of card acceptance?

iii. Should there be some level of tolerance allowed

around any surcharge cap?

iv. Is the merchant service fee an appropriate

measure of the cost of card acceptance (that can

be applied consistently across all merchants)?

v. Should the no-surcharge Standards clarify that,

notwithstanding any surcharging cap, scheme

rules cannot prohibit merchants from applying

The Board’s proposals set out in this document are preliminary, and the Bank is now seeking submissions from interested parties on these proposals and the issues for consultation, as set out in this document.

Formal written submissions by no later than 20 July are welcome and should be sent to:

Head of Payments Policy Department

Reserve Bank of Australia

GPO Box 3947

Sydney NSW 2001