A Closer Look at Visa’s and MasterCard’s Voluntary Agreement to Interchange Limits in Canada

January 2015
By: Myron Schwarcz and David Woynerowski

Following months of industry speculation, Visa and MasterCard officially announced voluntary reductions to interchange fees in Canada.  Beginning in April 2015, Visa and MasterCard will reduce the average net effective interchange rate on consumer credit card transactions by about 10% to 150 bps of the transaction amount, for a period of five years.  This would translate into an annual savings of approximately $500 million for Canadian merchants in fees paid to card issuers.

The voluntary actions to lower effective interchange rates were a product of almost a year of negotiations among the credit card networks, issuers, retailer associations, and the Canadian government, which has been a staunch advocate of lowering interchange fees specifically, and card usage costs generally. The announcements also significantly reduce the likelihood of stronger government intervention related to interchange. MasterCard explicitly noted in its press release that it wanted to reach a voluntary solution to avoid the unintended consequences of regulation experienced in other countries.

However, the consequences of the actions by Visa and MasterCard are predictable. Issuing banks will likely act to offset the revenue loss, which equates to over $15 per year for each active cardholder. We expect that, as occurred in other markets, credit card issuers will have to evaluate cardholder benefits, cardholder pricing, and their card network relationships. Further, there is disagreement between the networks and merchants regarding whether merchants will pass along the lower costs to consumers. The networks both alluded to other markets where it has been difficult to demonstrate that interchange regulation ultimately benefited the consumer, while merchants argue that their sectors are so competitive that excess margin is unsustainable. Regardless of the ultimate effect on consumer prices in Canada, unless the government intervenes, it’s likely that the interchange reduction will make credit cards less rewarding and / or more expensive for consumers.

Recently, both Visa and MasterCard released their revised interchange rates, which will be effective in April 2015. We have summarized the estimated changes for both networks in the nearby tables.

Figure 1: Visa Canada Interchange Reductions

fig1_-Visa-Canada-Interchange-ReductionsNote: *First Annapolis Consulting estimates.
Source: Visa Canada and First Annapolis Consulting research and analysis.

Figure 2: MasterCard Canada Interchange Reductions

fig2_-MasterCard-Canada-Interchange-ReductionsNote: *First Annapolis Consulting estimates.
Source: MasterCard Canada and First Annapolis Consulting research and analysis.

 Visa largely left its Rate Programs (merchant categories receiving the same rates) intact and decreased rates for smaller merchants by approximately 7.5%. However, its rates for all other segments including large merchants (at least $850MM in Visa sales) were reduced by only 2% to 3%. Visa’s changes were nearly identical across product types (no-rewards Classic cards through high-annual-fee Infinite Privilege cards). Also, Visa added Charitable Organizations and Social Service Organizations to its lowest interchange Rate Program which could result in 20-35% interchange reductions for impacted organizations.

MasterCard took the settlement as an opportunity to double the number of Rate Programs from six to 12.  Similar to Visa, smaller merchants (less than $400MM in MasterCard sales) generally received larger reductions than larger merchants. Unlike Visa, MasterCard’s changes varied by card / cardholder type. Rate changes were much lower for Premium High Spend (MasterCard World and World Elite) cards and Core (e.g., lower spend) cards than for High Spend (high spend, non-World / World Elite) cards. Among the new Rate Programs for Tier 1 merchants, Core and High Spend cards received much larger reductions than Premium High Spend cards. We believe that MasterCard took this approach to more evenly distribute the margin hit for issuers across products. Interchange contributes a much lower percentage of an issuer’s revenue on lower-spend products (e.g., low-rate cards, retail co-brands, and some no fee rewards cards) than it represents on high-spend products (e.g., travel rewards and cash back cards).

The new MasterCard Rate Programs will largely result in substantially reduced interchange rates for the affected merchants. For example, Tier 1 merchants (with more than $3 billion in MasterCard sales) will receive steeper reductions on Core and High Spend cards (same reduction on Premium High Spend Cards) than Tier 2 and Tier 3 merchants. Like Visa, MasterCard also targeted charitable organizations for large reductions and to be competitive with Visa, MasterCard introduced a Recurring Payments Rate Program, which should result in 20-30% rate reductions for affected merchants. Perhaps to curry favor with the Canadian Federation of Independent Businesses (CFIB), a powerful proponent of interchange reduction, MasterCard also introduced an Independent Everyday Spend Rate Program, directed at 24 small merchant categories ranging from limo drivers to dry cleaners, which reduces rates by upwards of 10% for qualifying merchants. The added Rate Programs and changes to Premium High Spend and Core cards make calculating an overall rate reduction difficult, but the rate cuts by MasterCard in the aggregate appear greater than Visa’s, suggesting that MasterCard’s current rates are higher than Visa’s.

Many months, or possibly years, will go by until the impact of the changes on networks, banks, merchants, and cardholders can be assessed. Already, a number of stakeholders have expressed concern that the agreement may not achieve all of the desired benefits. Visa mentioned in its press release that it reserves the right, at any time, to terminate or amend its agreement should Visa or its clients be disadvantaged. Similarly, Federal Finance Minister Joe Oliver stated that the government would rescind the voluntary commitments if they do not result in the reduction of card acceptance costs to merchants. We believe these changes will undoubtedly put pressure on the economics of co-branded credit card partnerships, although we doubt it will be significant enough to re-open most agreements.

These landmark announcements are another recent example of Ottawa playing an active role in the Canadian payments industry – a trend that appears likely to continue. Since 2010 the government has acted in favor of consumers (i.e., Credit Business Practices and Cost of Borrowing), banks and payment networks (NFC Mobile Payments Reference Model) and merchants (Code of Conduct, interchange reduction). Just one week after announcing the voluntary interchange reduction, the Wall Street Journal reported that the government may amend the Code of Conduct for the Credit and Debit Card Industry in Canada to expand merchants’ rights to selectively accept mobile forms of Visa / MasterCard-branded payments products.  As the payments industry continues its rapid evolution, it will be interesting to observe how the Canadian government balances the interests of all stakeholders in any future actions it may take.

For more information, please contact Myron Schwarcz, Senior Manager, member of the Deposit Access Practice, specializing in Debit and Prepaid, myron.schwarcz@firstannapolis.com; or David Woynerowski, Partner, specializing in Credit Card Issuing and initiatives in Canada,