Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 5 - Evidence, April 23, 2009
OTTAWA, Thursday, April 23, 2009
The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:30 a.m. to study on the credit and debit card systems in Canada and their relative rates and fees, in particular for businesses and consumers.
Senator Michael A. Meighen (Chair) in the chair.
[English]
The Chair: Good morning, ladies and gentlemen. I call the meeting of the Standing Senate Committee on Banking, Trade and Commerce to order.
[Translation]
This morning, we are studying issues related to the credit and debit card systems in Canada and their relative rates and fees, in particular, for businesses and consumers.
[English]
The committee was charged with undertaking this inquiry after the Senate adopted a motion put forward by Senator Ringuette to have this committee study this issue.
The first half of our meeting this morning will deal with matters relating to debit cards. Canadians are second only to Swedes in terms of per capita debit card transactions.
I am Michael Meighen, a senator from Ontario, and I have the honour of chairing this committee, together with the Deputy Chair, Senator Goldstein, from Quebec. Other senators will be introduced as they ask questions.
We are pleased to have with us, from the Interac Association, Mark O'Connell, President and Chief Executive Officer.
Please proceed with your opening statement.
Mark O'Connell, President and Chief Executive Officer, Interac Association: Good morning. Thank you for the opportunity to talk to you today about Interac; why Interac needs to evolve from its current structure; and why we see our viability as very important to Canadian merchants, consumers and the marketplace in general.
I have provided you with a deck of slides. Slide 2 indicates that without question, Canadians love Interac and Interac debit, its 24-7 convenience, its reliability and its security. However, there are many different perceptions about the Interac organization and just what we do.
In short, Interac is a successful Canadian world-class debit system. Interac Association, first formed in 1984, is responsible for the management and operations of that network. Our members are not only the banks. Our membership includes credit unions, other financial institutions, payment and technology companies, and we also have a merchant represented on our board. As a payment network, we do not issue payment cards or own or operate ABMs or point-of-sale terminals. Also, we do not charge fees to merchants or consumers.
Interac is Canada's only domestically run coast-to-coast debit payment network. We offer a suite of trusted payments solutions to consumers and merchants in both the physical and the online space. We are the only home- grown retail payment brand. Interac operates on a world-class efficient national payments infrastructure with leading edge security. We have the only payment product that clears and settles through the Canadian payment system. We are Canadians' preferred and leading payment option and Canadian merchants' lowest-cost option.
Slide 3 indicates that this is supported by a recent survey by the Bank of Canada. As you can see here, Interac debit is a low-cost payment option for merchants, even compared to cash.
Debit is the middle column in the chart. The fee noted of 12 cents on average is paid to a merchant's acquirer and not to Interac. On an Interac debit transaction we receive a switch fee from the acquirers and issuers to process the transaction.
The Chair: I am sorry to interrupt, Mr. O'Connell. Please explain switch fees and acquirers.
Mr. O'Connell: There are four constituents in the payments market. There is the issuer, who issues the card and takes care of the cardholder and the accounts.
The Chair: Can you give an example of the issuer?
Mr. O'Connell: Yes, the issuers are the financial institutions of Canada, which includes banks and credit unions.
An acquirer takes care of the other side. They have a contract with the merchant to provide various services for the merchant, including processing the transaction, taking care of their terminal needs and so forth. A merchant acquirer provides merchants with those terminal services.
Acquirers would be Moneris, which is a large one in the Canada market, and Global Payments and Paymentech. The Toronto-Dominion Bank has an acquirer, as does Desjardins.
Our switch fee is a flat 0.8-cent fee charged to the acquirer and the issuer in order for Interac to process the transaction through our Inter Member Network.
The Chair: Does the switch fee appear on this slide?
Mr. O'Connell: No, we are less than one cent of that 12-cent fee that is indicated as the payment processing fees in the Bank of Canada report.
Senator Moore: Just to clarify, that eight-tenths of one cent is paid to you by two parties?
Mr. O'Connell: Yes, the acquirer for the message that goes through the IMN from the merchant terminal to the issuer, and the issuer as well, in an equal fashion, for taking the authorization message back after the cardholder's account has been verified. We transport that to the merchant verifying that there are good funds for payment.
Senator Moore: You get 1.6 cents in each transaction?
Mr. O'Connell: Yes, but the acquirer, which is the merchant side, is only charged 0.8 of a cent.
Senator Goldstein: All of this is done electronically?
Mr. O'Connell: All of this is done electronically by the Inter Member Network, which we manage.
Moving on to slide 4, I would like to spend a moment discussing Interac Association. I would like to discuss how it is governed and why we need to change this structure, regardless of new competitors entering the market, but certainly spurred on by that factor.
Since 1996, Interac Association has operated under a consent order. The order has no termination date and can only be amended or terminated by a further order of the Competition Tribunal. The consent order is extremely detailed and confining. It prescribes how Interac Association is structured as an association, how it is governed and by whom, how it sets and collects fees, and even the voting levels required to approve many initiatives. In essence, it has frozen Interac Association in time.
I will continue by speaking about risks turning the association into an anachronism. When the consent order was negotiated and entered into, almost all payment networks throughout the world were structured as associations. Today, almost none are. Throughout the world, it has been recognized that associations tend to be slow and ponderous, moving at the pace of the slowest. They have difficulty reacting to a dynamically-changing marketplace, which certainly characterizes our world today. This is the essence of the problem that we face at Interac Association and key to our need to change.
While we try to move forward with our dysfunctional structure and its limitations, the Canadian marketplace is rapidly changing all around us. As you heard loud and clear yesterday, Visa Inc. and MasterCard Worldwide, the large U.S. based card companies, have entered the Canadian debit space with their debit products. These products operate just like Interac, debiting your bank account when you make a purchase using your bank card.
While we are shackled, these companies have the regulatory and structural flexibility, and financial resources that we do not have. They are well financed and have a great deal of experience taking on incumbent domestic debit networks while rapidly gaining market share at the expense of those domestic debit providers. They have done this most recently in the United States. We see similar strategies being employed here as they aggressively work to sign up issuers, acquirers and merchants.
Additionally, we heard yesterday that other new competitors, new products and new brands are emerging. New investments in chip technology are driving those in the payments industry to find new products and services that can provide greater value to consumers and merchants.
I have described why we need to change, but how do we want to evolve and how will that happen? Yes, we want to transition from a not-for-profit association model to a commercial model. We want the company to be governed independently from its participants. It would own and operate all existing and new services, and it would be operated as an independent commercial business.
Getting to this point involves a number of steps. As you are aware, we are in discussions with the Competition Bureau regarding the consent order, and those discussions are ongoing. Those discussions comprise the first step. Second, preserving Interac requires greater investment in the core infrastructure of the network and new product innovation. This means changes to the pricing system for Interac products in a manner that respects our strategy of being a low-cost provider.
Finally, on slide 7, there is a great deal of competition in the Canadian marketplace and we welcome additional competition. That is not the issue. The issue is that we need to have a level playing field. Interac needs to be allowed to operate under a more efficient and independent governance structure, and be able to operate on a commercial basis to bring capital investment into the network and product innovation to market. We also believe that transparency should be a hallmark of our debit system, where choice should be given to its users.
Interac competing with the Visas and the MasterCard's of the world does not mean that we will adopt their strategies. In fact, it is quite the contrary. From watching our counterparts and being counselled by them from around the world, adopting other companies' strategies has proven to be a no-win situation and strategy.
Interac will instead continue to operate true to its Canadian roots. We understand the price pressures that merchants currently face, particularly in this economic environment and these challenging times. One of the strategic advantages for Interac debit comes from being a low-cost payment option with per-transaction fee pricing. Any changes to the pricing structure will be mindful of these principles.
We will continue to seek to protect and enhance the Interac brand in the marketplace and the confidence that our stakeholders have in us. We will utilize our leadership position and our domestic knowledge of this market to deliver the right solutions, under the right business model, for our Canadian constituents.
However, given the forces at play, we must first change. If we do not — if we are not allowed to compete on a level playing field — Canada's only payment brand and network will be hobbled and will not be able to continue to offer Canadians the services that they demand and that they deserve.
The Chair: Thank you for a succinct and clear statement.
Senator Massicotte: Thank you for being with us this morning. I can easily understand why Interac's shareholders would want to become a for-profit organization. I can understand that part, but obviously, our interest is whether it is good for Canada, for your clients and consumers.
I understand the arguments on innovation, but I am having difficulty understanding how competitors, he Visas or MasterCard's of the United States, can come to Canada, and charge a lot more than the 19 cents per transaction. We see that figure in the Bank of Canada report. How can they become so dominant and why are you so concerned about them when their costs are so much higher, relative to credit cards and relative to their debit experience in the United States?
If you wish, I have a concern as expressed by OECD and so on, that the people paying the bill — the merchants, effectively — are not at the table. They do not have enough negotiating power to ensure the system is fair. If I could speculate, I would say no wonder Visa would do well in Canada because they will charge an interchange fee — they will charge higher fees. The financial institutions would love to get paid more money, so they will get prominent in the system but only because the merchants who pay the bill, who will have to pay more, are not at the table; they cannot say no. Obviously, customer is king.
Mr. O'Connell: I will address first the notion why perhaps I, being proud in the custodian of Interac, should not be concerned with the penetration of Visa and MasterCard into the marketplace.
In almost every jurisdiction in the world, they have come in with those pricing models you have talked about and been able to rapidly take market share from domestic debit providers. The closest proxy I can give you speaks to both the speed at which it can happen and the magnitude: STAR Network is the closest proxy in the United States. Four and one-half years ago, they had close to 60 per cent market share of the debit market. They had a low-cost model and so forth. Visa debit at that time had 10 per cent. In four years, STAR Network has 24 per cent of the market and Visa has just over 50 per cent, I believe. If you combine signature debit, which we do not have in Canada, with PIN debit, Visa now controls over 70 per cent of the debit market in the United States, which has happened in the U.K., in Europe, in all markets around the world. Therefore, I think it would be unwise to ignore this threat. As we heard yesterday, they are here.
We need to have a table stake fundamental agreement that we have a multi-network environment. They are utilizing their strategies and pitching value propositions for the market to be unregulated and unfettered, while the Canadian option is confined and fettered. We have to recognize this Canadian gem, of which I am so proud. I took the job two years ago because I was not willing to let such a Canadian success story go quietly into the night as I have seen happen in debit markets all over the world. I have been in the payments business for 16 years.
You saw the aggressiveness of the strategies yesterday. We heard from Mr. Stanton about an initial pricing strategy to achieve merchant penetration. We heard that he is conducting business cases with select merchants to penetrate the market. I will not speculate on what exactly he means.
However, as a businessman, when someone says he is doing business cases with merchants, it means he is packaging value propositions, inducements and incentives to get those merchants to sign on to accept Maestro debit. This is at a time when merchants are particularly hurting.
What else did we hear? On the other side, we heard that Visa is here and we can go to their website to see their posted interchange rates on a percentage basis. They are offering interchange on the other side of the market. I believe Mr. Wilson said that the Canadian price they have introduced is drastically lower than the rest of the world.
Then Mr. Stanton said that there is a 0.5-cent switch fee. I believe he has the interchange fee set at zero. Do we actually think those two pricing situations would occur if Interac were not in this marketplace?
That is the risk. We have seen it all around the world. We talked to the merchants and the merchants association. The worst-case scenario for both merchants and consumers in this market is a duopoly of those two U.S. multinationals. That is why we need to change.
Senator Massicotte: You are making my point. Why are they successful? Are they delivering cheaper services than you can deliver to merchants?
Mr. O'Connell: They have the financial resources and the marketability to offer to both sides of the market, inducements and otherwise. They are allowed to do this unfettered, where I cannot.
Senator Massicotte: Can they do this at a cheaper cost? Success is a relative term. It is success for whom, to their shareholders or your shareholders? I can agree with that. Will the merchants and consumers benefit from that competition?
Mr. O'Connell: I believe they benefit from a strong Interac and that is why I want to change. I believe we have the low cost basis to continue to offer merchants the low cost option in the marketplace. Our success is riding on that fact.
Senator Massicotte: History will tell you, if we look at your charges versus other country's debit charges, they are significantly lower than other payment systems. That may be because are you not able to make a profit. If you look at the systems around the world and the many reports, I am concerned that the merchants do not have enough negotiating power. Wal-Mart may be the exception.
The financial institutions are pushing these cards. Obviously, if they get paid interchange fees, you will see proliferation of new debit cards. It will not be because merchants or consumers are winning, but because the financial institutions are winning. That is our concern.
Mr. O'Connell: I repeat that we have a lower cost basis. We will not be sponsoring Olympics and creating Bell labs with all the associated costs. We have a wide acceptance base and a large number of transactions in this country to protect. I believe that if we are allowed to compete on a level playing field, we can compete through our merchant and low cost strategies.
I agree with you. As I discussed before, the mistake that the STAR Network made and the lessons we learned from other countries is that when faced with competition, they abandoned that low cost merchant strategy. In the American market today, the average interchange is over $0.25 in all networks.
Senator Massicotte: You will not make that same mistake. Will you remain low cost and not charge interchange fees if you are allowed to be a for-profit company?
Mr. O'Connell: We cannot make that mistake because it is proven to be a no-win situation. Our success is based on merchant acceptance.
Senator Massicotte: You are saying every other country made that mistake. Is that not the greed principle, the profit principle? Why would your shareholders not agree to increase their profits in three years, five years or ten years if they can do so and the market permits? Are you suggesting legislation should prohibit you from doing so?
Mr. O'Connell: I am not. I am saying the very strategy and the viability of the organization are vested in a low cost business model that we have followed for the last 20 years. It is our only way to compete successfully against Visa and MasterCard. That has been proven throughout the world. We have the ability to do that given our costs.
Senator Massicotte: You are saying that we Canadians and legislators should have confidence in you and give you carte blanche because that principle will always be the best alternative for Canadians. That is a lot of hope.
Mr. O'Connell: The changes to the consent order are required because we cannot reorganize without those changes. Those changes are only in force if the association membership — 62 members, not only the banks — agree to strategies, pricing model agreements, et cetera. They must believe this outcome is what is needed to preserve Interac as opposed to what they currently enjoy. There are a number of checks and balances in that system.
Senator Gerstein: On slide 7, you say that you welcome new competition and you want to be able to act on a level playing field. If you are on a level playing field, you will either survive or you will not. It will be survival of the fittest.
The consent order of 1996 is what is keeping you from getting there. Please give us a little more insight. You have been with the association now for two years and you have referred to ongoing discussions. Where are you with these discussions? Do you see light at the end of the tunnel? Is it something you think can be concluded shortly?
What does that consent order restrict you to and how dose it restrict your activity? I assume it addresses governance issues in terms of the number of board members you have, majority rule, et cetera. Have you been frozen in time since 1996 in that you have not been able to invest? We hear from Visa and MasterCard that they invest in new items and technology.
Mr. O'Connell: On your first point about timing of discussions, as you would know, it is a complex and unique situation. The Competition Bureau, as protector of the public interest, takes its statutory duty very seriously, as it should. Therefore, our proposal is subjected to rigorous scrutiny.
In addition, changes in staffing at the senior levels of the bureau understandably elongate the time needed for education, analysis and eventual approval. I cannot comment on when that process will be complete. I can say unequivocally that there is a sense of urgency.
While we are going through these machinations, we have a lot of work to do. As I mentioned, we have to have a super majority of the association's 62 members agree that this is the new world that will ensure that Interac is healthy and viable and can promote a healthy debit system. You can imagine making agreements with 62 organizations.
While these machinations are going on in the market, we heard yesterday that Visa and MasterCard are signing up and selling, employing their strategies on both sides of the market. At some point in time, this gem of Canada called Interac will be at a severe competitive disadvantage from which it may not be able to recover.
You asked about the structure of the consent order. In 1996 the consent order was put in place, as I believe you heard from the Competition Bureau a few weeks ago, to promote access to a network that at that time, was the only ATM network in town. Networks were expensive, et cetera. It has done that job. We have 62 members connected into the network.
In 1996, most of the people here did not even know about the Internet. We are still operating under a structure from that time when all payments companies were associations. Today we are the only payment association remaining in North America.
The structure imposes its governance and its funding model, which are inextricably linked. First, the governance model is inefficient and ponderous with too many hands on the wheel. We are being governed by our customers. I do not know many governance texts that would talk about that as being an efficient structure.
Second, you cannot get away from the fact that all of the members around the governance table compete with each other and are competitors in the payments industry. There is now a multi-network environment in the industry. Visa and MasterCard are here. We are just trying to ensure that Interac remains a countervailing force in this market. How do we change our strategies to do that?
The governance structure is inefficient and makes it difficult to get agreement and react to the marketplace in a timely manner. The funding structure is basically an all-pay or no-pay model. In all institutions, funds can only be raised by switch fees set on an annual basis in a cost recovery model. Therefore, all constituents must be on the same page at the same time in the same budget cycle to get any investment into the network or a new product out the door. That has occurred. With the ATM rollout itself, everyone wanted to promote ATM usage, but how often does that happen in business today with the rapid pace of the world?
The facts speak for themselves. I am proud of this network. It is a world-class network. It was one of the first PIN debit networks in the world, and I know we can compete with the Visa and MasterCard if we have a distinct strategy from them. However, the last organic product that came out of Interac Association was Interac debit itself 15 years ago. That speaks for itself with respect to the ability of the organization to keep up with the changing times.
Senator Massicotte: What in your legal structure prohibited you from investing and doing more? Fifteen years ago you came out with the debit card and nothing else has come out since. What stopped you from being more innovative? We presume you are smart and confident. Why did you not do more? What in you governance structure prohibited you from researching and developing products?
Mr. O'Connell: The governance is onerous and inefficient because there are 14 disparate competitors. As I said, if they are not on the same page at the same time with the same budget cycle, because they are all levied a fee in an almost communistic fashion across the board, initiatives will not be funded at the right time.
Senator Massicotte: So their self-interest was not satisfied and that is why you were not innovative?
Mr. O'Connell: The consent order says that there is no research and development funding. You cannot raise any funds for the organization outside of an annual switch fee that has to be based on a cost recovery model.
Senator Massicotte: Why not increase it?
Mr. O'Connell: There is no ability, for example, to ask whether someone is ready to tackle this. Yesterday, the committee heard from Visa and MasterCard about innovations in the market.
Senator Massicotte: If it is so good for their economy, business and sales — and obviously Visa and MasterCard are making the same argument — why can you not sell people on that merit if other people can.
Mr. O'Connell: You can, but you need them all to be on the same page at the same time in the same budget cycle in the same year, and that does not often happen.
Senator Massicotte: Who on your 62-member board does not agree with that increase? Who does not see it in their self-interest to say yes to that question?
Mr. O'Connell: They are all competing and all have businesses.
Senator Massicotte: Like who?
Mr. O'Connell: There is no single person who does not agree with these initiatives. The board, the governance, is set up with these inherent flaws, which is why around the world you have seen abandonment of the association board structure. We are the last association in North America because these boards are known to be ponderous. They move at the pace of the slowest member because everyone has to be on board in such a uniform switch fee environment.
Senator Goldstein: Mr. O'Connell, I am having some difficulty understanding some of the things you said. It is clear from what you have described that the governance structures is archaic and that you have to make that change in order to have the decision-making process of the organization more fluid and readily adaptive to needs as they arise.
What I cannot understand is how the consumer will benefit from the increased cost of Interac services. You are asking the Competition Bureau to lift the prohibition against profit making. I understand lifting the impediments with respect to governance; I do not understand the lifting of impediments with respect to profit making.
How will that help you penetrate the market? How will that help you compete with Visa or MasterCard, and how will the consumer benefit from the fact that the merchant will have to pay more for your services?
Mr. O'Connell: It gets back to this network. The cost recovery model, by its very definition, means —
Senator Goldstein: I accept that cost recovery alone is not sufficient; you need money for research and development among other things, and that is fine.
Would you accept the proposition that there should be some limitation — recognizing that Visa and MasterCard do not have such a limitation — on the profitability of the enterprise after research and development?
I understand that the interests of the members of the association would not be friendly to such an approach. I am trying to find a way that Interac can continue to be a relatively low-cost service, rather than one that competes with the higher-cost services with the national and natural tendency to price similarly to the detriment of the consumer.
Mr. O'Connell: I am a proponent of competition in a free market. If we are allowed to compete on a level playing field, through competitive reasons and the need to maintain a distinct low-cost choice and flat fee transaction pricing to the merchant community, we will base that success. In addition, we need to provide a value proposition to the issuing side.
We will be governed by those competitive principles, which will continue to allow Interac to be a countervailing force in not only our pricing but also in the pricing of other networks. In respect of increased pricing around the world, this debit market will evolve with or with Interac changes. If Interac is not allowed to compete on an equal footing and maintain that countervailing force, then merchant and consumer costs will likely increase.
Senator Goldstein: You are pleading for survival of the Interac system, and everyone here accepts that because it is appropriate. I am worried about what happens, assuming that we want to encourage your survival. What would be the likely result of taking away all the impediments that the consent order presently puts in your path? Would Interac charge much the same as the rest of the competition — Visa and MasterCard —, which would be necessarily higher than Interac currently charges? Where is the consumer in all of this?
Mr. O'Connell: If we were to charge similar to or the same as Visa and MasterCard, which some other networks did that have failed, we would lose our competitive advantage in the market. Our competitive advantage is being the highest utility card, or the most widely accepted card. That is why for 20 years merchants have been a bastion of our strategy and success. If merchants begin to view and accept Interac, Visa and MasterCard as the same, then we lose the very foothold and the very cornerstone of our success.
Merchants value and respect the utility of our card because consumers can use it across the country. Issuers value and respect Interac, which is a strategic advantage for us. We want to provide a distinct choice from Visa and MasterCard.
Our sustainability is based on our differences. I am not talking about a lost-leader pricing or penetration pricing or others that we heard about yesterday. Rather, I am talking about our business model and organizational ethos for 20 years and that will be the basis of our success in the future. We will always be limited and governed by our difference from Visa and MasterCard.
Senator Oliver: Mr. O'Connell, I would like to ask about the consent order. I have heard you suggest that in the negotiations you would like to see it changed, altered or varied. I believe that what you would like to see is to have it removed completely. You keep saying that you want a level playing field with Visa and MasterCard. You have told us that they are not constrained by a consent order. If you want to have a level playing field, but you still have a consent order with conditions, then how can that be? Do you understand my question?
Mr. O'Connell: I cannot explain in detail because the discussions are ongoing. We need the ability to restructure.
Senator Oliver: You want to stop the association and become a commercial corporation.
Mr. O'Connell: We want to be governed independently from participants. The amended consent order would allow that to be carried out in an orderly fashion. As long as we are able to change those two hallmarks and promote transparency in this market, then we would have a level playing field.
Senator Oliver: You have said that the consent order deals with both governance and the funding model. Would your funding model have to change in order to have a level playing field with Visa and MasterCard?
Mr. O'Connell: Yes, it would have to change so that we have an ability to invest. We need a commercial business model, as opposed to the all-pay or no-pay switch fee model. We need to invest capital into the network, fraud services, new services and all the other things that Canadian merchants and consumers expect today and in the future. Yes, we are asking for the commercial funding model.
Senator Oliver: You are asking for Interac. What would you like to see, if anything, for Visa and MasterCard to ensure that they are on that same level playing field with changes in your consent order in terms of regulatory matters?
Mr. O'Connell: I am not a proponent of price regulation, certainly not protectionism, which speaks to restraint of trade issues, because it has unintended consequences. Important to Interac is transparency, and we will employ this strategy. A free market with Interac vested in its success on a low-cost-per-transaction-fee pricing model can create a healthy debit market into the future in Canada in a free market economy. However, a free market economy is based absolutely and fundamentally on transparency. The users of that system have to know what they are choosing, the cost to them and whether it is the best value proposition for them. For example, I would point to the merchants, in particular small- and medium-sized merchants. They need to understand their costs in any acceptance decisions. They need to know the distinct cost of Interac services versus the other two. Our success is based on that. We will be as transparent as we can be because we are a wholesaler in many respects. We will ensure that our simple costs are understood in the marketplace. It is important that other market acquirers and so forth are transparent as well. Small merchants can be presented with a bundled offering that includes a new chip terminal to accept Visa, MasterCard, debit and Interac. It costs $9.95 per month and sign here.
Senator Oliver: It is also important for the consumer to have transparency. Yesterday, I was trying to suggest to the witnesses that perhaps the consumer's monthly statement should show all of the fees so that informed decisions can be made by the consumer about what type of card or process they wish to use. They might decide to pay in cash if such a discount were offered. All of that information could be disclosed to the consumer who uses a card and has money debited from his or her bank account.
Mr. O'Connell: Transparency and choice are important for Interac's success. Our strategy will be so different that we want to ensure it is evident. If presented fairly, Canadian consumers will choose Interac, which has been a trusted brand for them for 20 years.
Senator Oliver: Right now, your cost is 0.19 cents and, if you get the changes that you want in your consent order and if you are then free to pursue technology, innovation and the development of new products, how much more do you think that cost will be to the user? How much will it increase from 0.19 cents?
Mr. O'Connell: Where are you getting the 0.19 cents?
Senator Oliver: It is at the beginning of your chart; the report done by the Bank of Canada.
Mr. O'Connell: I only have auspices over 0.8 cents of that.
Senator Oliver: I am on page 3 your chart; the report done by the Bank of Canada. The bottom number; what is the total number?
Mr. O'Connell: It is 0.19 cents but, if you look up the column, there is 0.7 of cost associated with tender time. That is the Bank of Canada doing mathematical calculation work with merchants on how long you are in the line — that sort of thing. That has nothing to do with us.
Regarding, the payment processing fee, we are less than 1-cent of that 12-cent number. The float must the overnight, just because this is a real-time payment system so there must be a float and that is 0.001. I can only comment on the 0.8 cent. That is the only part that represents Interac. The 12 cents comes into play for the merchant acquirer because they provide a number of services to the merchant.
Senator Oliver: How much will your fee go up if you get the changes in the order?
Mr. O'Connell: Pricing deliberations are ongoing so I cannot speak to specifics, as they are not complete. I can say we will respect our Canadian roots. Our strategy is vested in being the low-cost provider in the market by a distinct margin and we will continue to respect that strategy. That has been our success. We also respect that a flat-fee transaction price has been part of Interac's success. The independent board looking at the future pricing also respects those principles.
The Chair: If the negotiations with the Competition Bureau are successful from your standpoint, you say that you will be out there competing on a level playing field and able to succeed by maintaining your position, as I understood it, as the low-cost operator.
How can you do that other than by not offering so-called "bells and whistles" that many consumers seem to want, or by being a much more efficient operator than Visa and MasterCard? How do you maintain that low cost?
Mr. O'Connell: I do believe we are a more efficient operator. With the nature of the network, we already have a low- cost basis and have operated at cost-recovery basis since 1996.
As I said, the utility of the card is extremely important. We have almost ubiquitous acceptance from coast-to-coast with merchants. We respect and ensure our strategies. If we ensure they are able to see that Interac offers a distinct lower-cost choice, we can maintain that utility. That utility and the transaction base — we are talking about 3.6 billion transactions — is very important to the issuer side of the equation, who have their own itinerant costs, not the least of which is fraud at north of $100 million a year. Transferring that utility across that transaction base enables us to be that low-cost provider and not go into the realms of the Visa and MasterCard interchange rates.
Senator Ringuette: Mr. O'Connell, you are a very nice person but, regardless of that, I do not think I believe in your strategic plan. I will tell you why.
Visa and MasterCard have some of the deepest pockets in the world to penetrate the Canadian market. They can out-cut your pricing for the next 10 years until there is no more air in your organization, and that is the reality. There are 32 million potential debit cardholders in Canada and, once they get 70 per cent of the market — like they have done in the U.S. — they will command the market and command the prices, both for the consumers and for the business community.
You do not have those deep pockets. You cannot increase your price enough to build up a reserve to have those deep pockets. Your partners, the Canadian banks, issue your Interac cards and you will not be able to provide them the amount of money that Visa and MasterCard will promise them to sign exclusive debit contracts with them.
This is so clear. As you said, this is probably the scenario that has happened in all the other countries where Visa and MasterCard have attacked the domestic debit market. In regards to a level playing field, unless you have $10 billion today in your back pocket, for the next 10 years, to do the "ground battle" with them, you are out of the game. I am sorry but that is exactly how I see it.
Mr. O'Connell: I beg to differ, obviously, but thank you for the nice comment. I understand it is a daunting challenge. However, there are a couple of things I would say: First, these companies with deep pockets are public companies with internal rate of return and so forth. Today, they are investing into this market of 30 million people. However, every dollar in Purchase, New York or Foster City is looked at and sent. It is asked where the best place for that dollar to return. That is in terms of the types of returns that we are seeing from Visa and MasterCard in their public statements.
Regarding our partnership with the merchant community, I believe that the merchants are savvy enough to recognize short-term inducements, incentives and unsustainable initial pricing.
I believe that given a value proposition that is low cost — which we have — and a relationship with them for the past 15 years, I believe that we can maintain. We do not need buckets of money. We have a low cost to offer and I think we have a transparent system. Merchants understand we will not be ratcheting up prices on them every few quarters. I believe our merchant strategy is viable.
Remember, if that merchant strategy is viable, if agree you do not need to be dumping matching short-term inducements, Visa and MasterCard will be able to gain some merchants. However, there are half a million merchants in the market. On the issuing side, I believe they do see the strategic value of Interac.
My board is working toward restructuring. Regarding the utility: When the Visa card is only working at two out of 10 merchants, how can you turn over your card base?
Senator Ringuette: I will move on because we certainly disagree on this point.
Yesterday, Visa and MasterCard said that their debit cards were the only ones that could be used to make online purchases. On page 9, I see that you have an Interac online service. Therefore, you provide online purchases with the Interac card.
Mr. O'Connell: We do. We have a service in production that allows Canadians to purchase online to use their own money in their bank accounts.
Senator Ringuette: What is the fee for that service?
Mr. O'Connell: Arguably, it is a more secure option because our service does not have consumers giving card data and exchanging financial information with the merchants. As we have seen from T.J. Maxx and Winners, et cetera, that information can be compromised.
Interac Online is an independent Canadian entrepreneurial company developed to service email money transfers. These services were not developed organically from the association. We have a leading edge solution that allows Canadians to pay for items and services online with their own money. We have not been able to properly market or launch this service. That is another fact in testimony to the need to change our governance and the ability to utilize our own funds in the best interests of the organization.
Senator Ringuette: Are your merchant fees for these online purchases based on a transaction fee or on a percentage of sales?
Mr. O'Connell: They are both. This is the only service within the Interac brand that has both models. For example, there is a flat fee with caps for education and government. There is a percentage fee in the Interac Online service.
Senator Ringuette: When you state that you want to change your pricing, do you want to change your pricing to the same as your pricing for online purchases to include both a transaction fee and a percentage?
Mr. O'Connell: No, the principles for the new Interac are around a low-cost provider. We realize that the principle for the organization is flat-fee transaction based pricing. While I cannot speak to specifics, the deliberations are to respect that for all our services going forward.
Senator Ringuette: Debit cards and credit cards use the same chip. Yesterday, Visa told us that they own that technology and that they were lending it to the banking community. What will you do when their agreement with the banking community removes your privilege to put a chip on a debit card?
Mr. O'Connell: To be clear, they do not own the chip. I believe he was referring to the EMV standard upon which the chip is based. EMV stands for Europay MasterCard Visa. It was developed in Europe as a global specification standard upon which applications are put on the chip. That standard was conveyed as a worldwide open standard and I hope that continues to be the case.
Senator Moore: Can you explain the EMV again?
Mr. O'Connell: EMV is the standard specification upon which the chip and rules governing it are built.
Senator Moore: Do you mean the information in the chip? What standard applies to what?
Mr. O'Connell: It is to the rules and specifications around the chips.
Senator Moore: Do you mean its content, use, or both?
Mr. O'Connell: Both. Although not content in terms of what applications sit on top of it. It is simply the rules that govern how the chip operates, somewhat like a computer operating system, not the applications on the chip. It is a standard to ensure that all terminals and the chip can communicate with each other. It is the language of the chip, if you will.
Senator Moore: Senator Oliver asked about the money that Interac receives on transactions listed in the chart on page 3. You said earlier that you get 1.6 cents per transaction; that is eight-tenths of one cent each way for the debit card transaction.
What about the credit card transactions? That chart shows 73 cents. How much of that do you get?
Mr. O'Connell: None, Interac is a debit only network.
Senator Moore: Is the switching fee on debit cards only?
Mr. O'Connell: Yes.
Senator Moore: You expressed frustration at not being able to seek an increase in fees due to the interests of the owners who are all competitors. It looks like a classic conflict of interest situation. Does an increase in fees require a majority board decision or does it have to be unanimous? What does the consent order say about that situation?
Mr. O'Connell: It prescribes different requirements for different decisions, which shows how confining and detailed the consent order is. It lays out different types of initiatives and approval requirements.
Senator Moore: In the instance of a possible fee increase, does it require a majority or unanimous decision? Is that not the key element?
Mr. O'Connell: You bring up an interesting point that the consent order does not have to do with pricing. It is about governance and a funding model. The consent order allows for interchange today. Interchange can be increased from its current rate of zero with a simple majority vote of the board.
I think that is testimony to the board in going forward and allowing us to propose a restructuring initiative that this is not about interchange. That would not fix the problem. That can be done today. It has not. Instead, we have taken a path of restructuring that will create a strong and viable Interac.
Senator Moore: I heard you say that. However, you have not answered my question.
If the board was meeting today to consider the switch fee and the possibility of increasing it, does that decision have to be made by the board unanimously or by a simple majority of 50 per cent plus one?
Mr. O'Connell: They cannot meet. The budget is on a cost-recovery basis. Therefore, it is deliberated and sent once per year.
Senator Moore: We have done all that. Now, we hire a gentleman and to keep going, we have to increase it by a penny.
Mr. O'Connell: Each year there is a vote and the majority sets the annual switch fee on a cost-recovery basis.
Senator Moore: It is on a majority basis. Is there anything in the consent order that prevents Interac today as a not- for-profit association from being sold?
Mr. O'Connell: I believe so, yes.
Senator Moore: Under the new corporate structure, could that be removed?
Mr. O'Connell: It is in the mandate of the Competition Bureau to ensure that any changes to the consent order and to the structure of Interac are done to ensure there is open and proper competition. They would take care of that in their mandate.
Senator Moore: I understand. The consent order contains a provision that says the association cannot be sold.
Mr. O'Connell: An association is unsellable by its very construct. It is not even a clause in the order. An association is not even a legal entity. It is a membership, a bylaw and a memorandum of association.
Senator Moore: What about its assets? Could they be sold under the current order?
Mr. O'Connell: They are the property of the membership. No, it cannot.
Senator Moore: But under the new structure they could?
Mr. O'Connell: On a commercial basis?
Senator Moore: Yes. That is part of what you are trying to do, is it not?
Mr. O'Connell: There are a number of options for investment on a commercial basis, and those are well down the road with what we need to do. That has not been established.
Senator Moore: I am thinking of Senator Ringuette's concern about your survival. It is possible that you would cease to exist if you received the right from the Competition Bureau to make the desired changes. It is possible that your board of directors would respond to offers to sell. That is my concern.
The Chair: Mr. O'Connell, thank you very much for coming this morning. We appreciate your evidence. It has been helpful to us.
[Translation]
The second part of our meeting this morning will give us an overview of the issues related to the credit and debit card systems from the merchant's perspective.
[English]
We welcome today witnesses from the merchant community. From the Retail Council of Canada we have Diane Brisebois, President and Chief Executive Officer. From Giant Tiger Stores Limited we have Greg Farrell, Executive Vice-President and Chief Financial Officer. From the Canadian Council of Grocery Distributors we have David Wilkes, Senior Vice-President. From Sobeys Inc., we have Paul Jewer, Senior Vice-President Finance and Treasurer.
Welcome. We are glad to have you with us.
Please proceed with your opening statements.
[Translation]
Diane J. Brisebois, President and Chief Executive Officer, Retail Council of Canada: Mr. Chair, on behalf of the coalition and my colleagues, I would like to thank the senate committee for giving us the opportunity to present the merchant perspective on payment systems in Canada.
[English]
The issue before the committee is serious and growing for Canadian merchants and the customers we serve. We are grateful that this committee has taken the lead on it.
Following our testimony and that of other witnesses, we hope that the committee will recognize the need for the government to act.
David Wilkes, Senior Vice-President, Canadian Council of Grocery Distributors: The Stop Sticking It To Us coalition came together in 2008 and represents over 200,000 business, the majority being small independent businesses in retail, hospitality, food services, restaurants and other service sectors.
Our coalition members serve customers in every community from coast to coast to coast. They are extremely concerned with rapidly rising credit card merchant fees and impending new debit card schemes that will be introduced by Visa and MasterCard.
At the heart of the issue is Visa and MasterCard's duopoly representing 94 per cent of the credit card market in Canada. They have the market power to force very high fees for their services, as seen in recent months, and both merchants and consumers are paying the price.
With respect to debit card services, the coalition's concerns are that the impending issuance of debit cards by Visa and MasterCard will drive up the cost of debit transactions.
Make no mistake about it: Even credit card company executives view the fees we have talked about as a cash cow.
As I have on slide 5, allow me to quote from the former vice-president and assistant general counsel for Visa International and Visa U.S.A. as follows:
Issuers began to view the interchange reimbursement fee not as a revenue allocation mechanism to ensure success of the system, but as a demand-driven pricing scheme to collect as much revenue from merchants as the market would bear.
You heard yesterday from MasterCard the definitive statement that "consumers don't pay interchange."
Allow me to remind the committee what it heard from Mouvement Desjardins, which is both an issuer and an acquirer. This quote is on slide 6. "Consumers always end up on the hook for all costs associated with the payment of services."
Ms. Brisebois: As committee members know, the coalition is not opposed to credit cards. They are convenient, a secure means of payments for the most part, and liked by consumers. As customer-focused businesses, merchants must accept the customers' choice of method of payment. Merchants also understand that this service does not come for free.
However, as the chart shows, in reality the fees bear only a tenuous relationship to the processing costs, which account for only 13 per cent of the interchange cost.
How is this kind of mark-up possible? It is because of the absence of real competition.
[Translation]
Of course, we support the Competition Bureau's investigation.
[English]
We are gratified by the Competition Bureau's recent announcement of its investigation for abuse of dominance. We see strong evidence of this market malfunctioning as both players introduce similar fee schedules and tit-for-tat increases, and aggressively promote the proliferation of premium credit cards.
Economics 101 tells us that competition leads to price reduction, but this is not the case in the credit card market. The credit card companies have no direct relationship with consumers. Instead, they compete only for the business of financial institutions, which they do by offering high returns to issuers with other peoples' money.
This is a complete reversal of the normal effects of competition. The harder they compete, the higher the fees.
The best way to look at how Visa and MasterCard set their interchange fees is to think of it, not as competition, but as an auction, paid with money extracted from the merchants and, ultimately, from consumers.
The quote from Dr. Phillip Lowe, Assistant Governor of the Reserve Bank of Australia, says it all, ". . . competition between these schemes creates upward — not downward — pressure on these fees."
Merchants have no choice but to accept their cards, if that is the method of payment a consumer decides to use. That is the reality.
As noted by Mr. Vickers, Chairman, Office of Fair Trading, during an international payments policy conference, ". . . there is an element of `must-take'."
Merchants used to be able to negotiate with issuers as part of a bundled package of financial services. However, the outsourcing of acquirer programs has stripped away even this ability. Therefore, if merchants cannot negotiate on their own, can they do this collectively, as senators have asked during these hearings?
As a representative of RCC, we pioneered a program to help merchants negotiate low rates. In recent years, however, we have lost that ability, even with the large volume of business our collective members represent.
Visa and MasterCard rates are posted and non-negotiable. The acquirers are intermediaries and they pass it on to us.
At this point, I would ask Mr. Farrell to talk about the extent of the problem.
Greg Farrell, Executive Vice-President and Chief Financial Officer, Giant Tiger Stores Limited: Over the past 18 months, merchants have seen double-digit fee increases. We are a discount retailer selling basic grocery items and a mix of other necessities. We have experienced fee increases of over 30 per cent compared to a year ago. These increases are coming at the worst economic time, when retailers are cutting margins and lowering their costs just to survive.
Our 30 per cent fee increase is a result of two factors: We have been faced with a fee increase, a rate increase to process, and we have been faced with a shift from standard cards to premium cards.
The use of premium cards in our stores is telling. I repeat; we are a discount retailer, primarily serving low- and middle-income consumers, not the high spenders described as the target markets by MasterCard and Visa yesterday.
Remarkably, the use of premium cards in our stores has gone from under 0.7 per cent of our credit card sales one year ago to over 35 per cent of our credit card sales today.
The Chair: That is in one year?
Mr. Farrell: Yes, one year. That is a 50-fold increase in one year.
If these increased premium card costs were offset by these cardholders purchasing more — as suggested yesterday — that would be one thing. However, that is not the case. In fact, credit card usage in our stores has gone down slightly over that same time period.
The Chair: Are you talking about the number of transactions, or their value?
Mr. Farrell: I am speaking of dollar value of transactions.
Senator Oliver: Has debit card usage gone up?
Mr. Farrell: It is close but there is a slight increase. You would expect a significant increase but we experienced a slight decrease in the same period.
We are paying far higher fees for no increase in the rate of credit card use.
Paul Jewer, Senior Vice-President Finance and Treasurer, Sobeys Inc.: What choice do merchants have on acceptance of these higher-fee cards? In a word: None. We are required by Visa and MasterCard's "honour all cards" rule to take all of their credit card offerings.
Plus, it is hard to refuse a legitimate payment method chosen by our consumer, especially since that consumer is probably unaware of the detrimental impact on us, the merchant, and of the inevitable boomerang effect in higher consumer prices.
Even if merchants were to be allowed to decline such higher-fee cards, it would be next to impossible for one of our thousands of cashiers to identify them at point of sale from among 200-plus credit card products. Also, it would be very difficult for our cashiers to explain to the customer why their particular card is not accepted. This same practical concern will likely exist for debit cards in the future.
The significant cost increases are particularly dire for the grocery business. The grocery industry is extremely competitive, with very thin margins. Many grocery and pharmacy purchases are quite small in value, so even a few cents difference in acceptance charges has a significant impact. Any upward price pressure is inevitably passed on to consumers, as there is little that can be absorbed by grocers if they are to remain in business.
After all in, the grocery business is a business, where profit margins are barely larger than the interchange fee on infinite and premium cards. As food is a necessity rather than a discretionary spending item, we all need to be concerned about the impact of higher costs on consumers, especially those with low and modest incomes.
Mr. Wilkes: What is the solution? The coalition believes that transactions costs charged to retailers, whether credit or debit should reflect the true cost of processing, as is the case in Australia. The reasonable costs should be allowed, plus a fair return on involvement for the card companies. However, interchange fees should be capped at that level.
How does Australia's system work? The details are provided in our submission but the highlights are as follows: The entire fee-setting process of the card organizations is transparent for all stakeholders. A common benchmark has been established on allowable costs. The result in Australia is that interchange is capped at 0.5 per cent, or 50 basis points, producing a merchant discount rate of less than 1 per cent.
We do refer extensively to the Australian model, but, as you can see from the chart on page 19, it is not the only country to act. The European Union has moved to a cost-plus model on cross-border transactions, and multiple jurisdictions are working to address the problem. The world is moving on with this. We must not be left behind.
MasterCard and Visa have criticized Australia's system and, indeed, did so again yesterday, variously suggesting adverse impact on consumers or innovation. However, the respected industry trade newsletter, Lafferty Cards Insider, sees it is otherwise, noting that, "Despite the enforced changes, issuers have adapted well and the industry remains in a solid position: profit margins remain strong."
There is a trend toward low cost, no-frills credit cards but reward schemes and innovation remain part of the market.
Ms. Brisebois: The coalition understands that Canada is unique and that considerable analysis is needed to produce a regime that is appropriate for Canadian circumstances. However, it is urgent that Canada gets on with this task. We urge the committee to recommend that government develop a system of oversight to ensure fair pricing and competitive behaviour by the two card companies.
The Minister of Finance has the power to designate and, therefore, regulate payments systems in this country. Obviously, options for consideration are detailed in our submission.
That is the picture on the credit card market: Rising charges for questionable valuable added. However, now they are eyeing the debit card market, as well.
Canada's online debit card payment system is one of the most successful globally. Representatives from some of Canada's largest financial institutions have said this in their testimony to the committee.
Visa and MasterCard have said that they will be bringing their debit products to Canada starting this year. It should be understood that Visa and MasterCard operate outside our payment system legislation and outside CPA responsibilities. This is a critical moment in the development of financial services in this country.
Visa and MasterCard argued yesterday that allowing their debit products in Canada will simply provide more competition. However, this would be the same form of competition that Canada now experiences on the credit card side: An auction for issuers' business by increasing payment costs for all.
Further, they plan to provide acquirers with incentives so that their debit product receives priority routing at the point of sale. This will be matched by aggressive distribution of these cards by issuers. We only need to look to the U.S. to see how the two card companies suppressed efficient debit card services similar to Interac.
Fees have since skyrocketed and now include both flat fees and ad valorem rates. Senator Ringuette gave a U.S. example yesterday of a $7 plus fee on a $500 transaction. In Canada under Visa's published debit rates, that would cost $3.90. Compare that with the 12 cents or so that would be paid through our current debit system. Visa debit would be 30 times more expensive than what we have now today.
We ask the committee to consider the following: Why should the debit fee bear any relation to the size of the transaction at the point of sale? If the money is transferred from a customer's account to the issuer in real time, and is clearly not a loan or credit advance, how can Visa and MasterCard justify charging a percentage fee? The answer is simple: Currently they can and they are unregulated.
It is odd that Canada would contemplate moving to an unregulated, U.S.-style system, given that those who are familiar with the U.S. system have expressed admiration for the Interac that we utilize today.
Mr. Wilkes: When we are looking for a solution, we believe that if Visa and MasterCard are allowed to operate their debit business in Canada, they should operate under the Canadian rules such as those that exist for Interac through the Canadian Payments Association. Fees should relate to the actual cost processing cost plus a reasonable rate of return with no room for percentage charges. In short, we need a Canadian system — one that provides a secure, successful and affordable debit card system.
We are aware of the changes to the consent orders for Interac that the previous witness detailed. We appreciate that some changes might be appropriate. We are concerned that Interac might desire eventually interchange or a substantial increase in order to compete with Visa and MasterCard.
We continue to support a flat-fee structure that reflects actual transaction costs, oversight, transparency and accountability. This recommendation should apply to all debit schemes in this country.
Ms. Brisebois: In closing, the coalition has proposed practical solutions that reflect the uniqueness of our market and that can be implemented to better serve and protect the hundreds of thousands of businesses and Canadian consumers from coast to coast to coast. There is often an air of resignation about rising fees and charges from banks and credit card companies. It is as though there are so many of them that there is no way for consumers to fight back. There is a way to fight back, and we look to this committee and to these hearings as a viable first step in this regard.
These fees are not the "third inevitability" in life, as they say, along with death and taxes. The government has the tools to wrestle with this problem and to come up with solutions. Again, we appreciate this committee's leadership in this area, and we urge you to seize the opportunity to bring forth recommendations for concrete action.
[Translation]
The Chair: Ms. Brisebois, I would like to congratulate you on your presentation and those of your colleagues. It is not always easy to present an issue clearly and logically when a number of parties are involved, and all of you did just that.
[English]
If the debit card market were to evolve as you have suggested, do you think that Interac could survive? I refer to Senator Ringuette's question to the previous witness in which she suggested that Interac would have a devil of a time facing up to the deep pockets of Visa and MasterCard. Do you think that, as Mr. O'Connell said, if they were to maintain a lower cost model, merchants would opt for their service rather than for the service that offers all the bells and whistles?
Mr. Wilkes: We believe there should be a level playing field. Regardless of who is offering the debit instrument in the marketplace — Interac, Visa, MasterCard or some unforeseen party — it must be based on the Canadian solutions that is currently servicing customers as well: Ensure that you are in compliance with the Canadian Payments Act. The Canadian Payments Association governs all debit card transactions and we believe that should continue.
As Ms. Brisebois said, money is being transferred from a customer's account to the merchant's account. It should be a flat fee. There is no change in the cost regardless of the amount transferred. As such, we believe that a flat-fee reflecting the actual cost of transaction is the right fee. Certainly, we would not support a percentage fee. Under those conditions, we believe competition will flourish and should be allowed to flourish.
Ms. Brisebois: The reality is that we are talking about merchants as much as about consumers. It is the consumer who will decide which product to use in the store. The consumer might not know whether that product will carry a flat rate fee or a percentage fee. It is usually based on the incentives provided for the consumer to use the card. Therein is the issue and problem because the merchants are in the middle with no negotiating power. We have seen that in retail segments. We service low and mid level income families where the premium cards have gone from zero to close to 40 per cent. That tells you there is little control in relation to what the merchant can do. It is extremely important for us to look at regulation to try to ensure that there is a level playing field for merchants as well. I hope that I have answered the question.
The Chair: Mr. Farrell, do you think that the increase for premium cards to 40 per cent can be explained in whole or in part by an absence of financial literacy? Do the consumers receive the card in the mail and not realize what it might entail?
Mr. Farrell: My wife and I receive credit cards in the mail with no explanation. We have no idea. I have an idea but the typical consumer would not have. I was out with friends the other night at a table of 10 people and no one understood that.
Ms. Brisebois: It is interesting that regardless whether the consumer is informed, and we agree that the consumer is not informed, these premium cards allow issuers to issue premium cards to affluent Canadians. If I am not mistaken, in the last 12 months all of us have been going through difficult time with the recession. I am trying to figure out how Visa and MasterCard can justify the following: in the last 12-18 months, the percentage of affluent Canadians has gone from 2 per cent to 30 per cent. The fact is that these cards are given out like candy on Halloween night. Visa and MasterCard might say that their interchange fees have not changed or that they have gone down, but they are not issuing cards that carry the interchange fee. That is why we see the cards appearing in all the stores. In the U.S. and in other parts of the world within one to two years we might all have premium cards. MasterCard has announced that it is introducing a super premium card — a frightening thought. Their statements about the fees being lower are misleading.
Senator Goldstein: Thank you for helping us today. You have held up the Australian model as something that we should be considering. We have heard testimony and we have all seen studies that have said the diminution of the interchange fees has had no effect on consumers.
If that is correct, then why are we talking about the possibility of interfering in what ought to be a free market in Canada?
Mr. Jewer: As I mentioned earlier, in the grocery industry, we compete in a very competitive market, to the extent that lower costs are the reality for grocers. Grocers would have no choice but to ultimately pass some of those savings on to consumers because if one grocer did not, surely, in a competitive market, one of the other grocers would.
Senator Goldstein: Why did that not happen in Australia?
Mr. Jewer: I cannot speak to the Australian example.
Ms. Brisebois: While those statements were made yesterday, none of the witnesses offered proof that the prices did not go down. Just looking at a percentage decrease and then assuming that no other external elements would affect the price of goods, would be incorrect.
We need to assume that the retail market in Australia is very competitive in that, in fact, the prices were adjusted. To look just at that element as something that would affect a price would be incorrect. There is the cost of gas, for example, and many other elements, but you can be assured that in a retail environment you have thousands of businesses competing against each other, which always results in more competitive pricing.
[Translation]
Senator Massicotte: Yesterday, the MasterCard representatives told us that the Retail Council of Canada would not agree to meet with them. Is that true?
Ms. Brisebois: I was hoping that someone would ask about that. As Canada's retail association, we have repeatedly invited MasterCard to meet with us. Over the past five years, we have organized meetings with Visa, MasterCard, Interac and others.
[English]
Let me just add that if, as Mr. Stanton mentioned yesterday, it simply meant that I should pick up the phone and speak to him to resolve the issue, I can assure you we would not be sitting here asking you to consider moving forward with recommendations on legislation. It is not the case. There is a sense of frustration, however. It should be on the record that Retail Council of Canada has been invited on an annual basis to sit on their merchant payments committee, so we have been very active. I was a bit surprised.
[Translation]
Senator Massicotte: On page 2 of your presentation, you quote Broox-Peterson, the former vice-president. When he made that very significant statement, was he still an officer at Visa, or had he already left the company?
Ms. Brisebois: If I am not mistaken, it was after he left. I think he made the comment during similar consultations in the U.S.
Senator Massicotte: Let us now talk about Interac. I understand your recommendations; they are pretty clear. Do you agree with Mr. O'Connell? I have read the consent orders. They allow for investments in research and development because Interac operates on a cost-recovery basis. Without contradicting Senator Moore's question, the majority of the 14-member board will sign off on all of the decisions.
I have trouble with the governance argument. Do you agree that if Interac keeps the same rules while Visa and MasterCard are allowed into the Canadian market without having to follow those rules, it is very likely that Interac will disappear, especially if its interchange fees are high as you said in the beginning? That is the fundamental problem. As a result, they will be more popular than Interac.
Do you agree that there would be an imbalance if we left Interac as it is and allowed the others into the Canadian market without any specific rules?
Ms. Brisebois: Absolutely. If we leave the Interac organization as it is today, with the consent order rules, it would always be at a disadvantage, even if it can invest. It is not because of Interac or its structure, but mostly because of those on its board of directors.
As you mentioned earlier, if we offered you 20 cents instead of five for Interac, the choice would be clear. It is the people on Interac's board of directors who make that decision.
Senator Massicotte: Most of the Interac Association's 62 members are almost exclusively financial institutions. There are no major merchants in its membership, if I am not mistaken?
Ms. Brisebois: There is a major merchant, but at the end of the day, it is the financial institutions that decide whether or not to put a certain logo on their card. As far as the council, merchants and the community we represent are concerned, there is no doubt that if there are significant benefits for, say, three banks, they could very well choose to have a MasterCard, Visa or debit card without Interac or any other service.
[English]
With respect to routing, if you are making a deal, and it is an exclusive card, and that card is used in the store, the storeowner will not know but the priority routing will be for, let us say, Visa debit, the most expensive and not the less expensive. There should be rules for all three schemes, as was mentioned earlier.
Senator Massicotte: I am trying to understand this issue, and I will tell you the other side of the story. Looking at credit card use, the average cost is 1.75 percentage points per use, or close to that. From the testimony we have heard, it seems that the brand names, namely, Visa and MasterCard, are getting 15 to 20 basis points for their processing and their brand name. It looks like the acquirers are getting probably close to 25 or 30 basis points. If that information is accurate, you have 55 or 60 basis points used, and the rest, let us say 1.1 per cent, is going to the financial institution, the issuer per se. The argument they are making is that there are many financial institution issuers and hundreds of credit card choices. I do not know why consumers do not always choose the best one, but they are obviously influenced by the rewards.
If the presumption is that most of the piece is going to the financial issuers and that there is a lot of competition, one could make the argument that the markets will work. The issuers will deliver the best product and best value, and, therefore, competition is somewhere in the system. The concern around the world, though, is there not a lot of competition between the Visas and MasterCards, and that is a world problem.
There is also a debate about whether there is enough competition among the acquirers because there are only two or three, owned by financial institutions. Can you make a comment as to what is wrong with that big picture and tell me why there is still an issue?
Mr. Wilkes: It is the way the competition is working. It is inverse competition. Indeed, the credit card companies are competing for the business of the financial institutions. They are competing for them by offering higher and higher return rates, so they are competing with other people's money.
If someone offers a 1.2 per cent return and someone else offers 1.4 per cent to the institutions, they will take the higher return. Premium cards are an example of that. As they are issued to the customers and used in our coalition members' stores, we pay that higher fee as a return to the financial institutions. There is competition, but economics 101 does not describe this competition; it is inverse. It is going up. That is why, without the ability for the competitive market to work, you need a government to do what competition is not doing.
Senator Massicotte: I agree with the statement Ms. Brisebois made earlier. There is a fundamental problem whereby the people who decide which credit card to issue are not at the table. The merchants are not there and seem to want the power to negotiate a better deal. They are the ones paying it, but they do not decide which one the consumer uses. Inherently, that is a big problem.
Let us do that analysis. The brand names, obviously, give higher interchange rates for getting a lot of card distribution and effectively making more money. They make a lot of money. Do not forget that they are only making 20 basis points. The financial institutions are the ones making a lot of money through this negative incentive program.
Why is there not enough competition on that side to ensure it goes back not necessarily to the consumer of the product but somehow to their card users?
Ms. Brisebois: There is no incentive. We have jokingly said, "If you can get the gig, get it," because in fact you have this entity that is paying an unregulated hidden fee. The financial institutions are issuing banks. They are not looking at the merchant as the customer. The customer is the person carrying the card and the merchant is seen as a flow- through. Because of the way the system is built, you charge whatever the market can bear.
Senator Massicotte: Let me try again. If the financial issuer has a higher interchange rate — it is the same question all the time — and it goes up higher and they all have access to a higher premium card and all the banks and caisse populaires of this world, why not offer more incentives, more rewards if you wish, or lower interest rates on the card to take advantage of the higher revenues they get and effectively it is competition at that level?
Mr. Wilkes: They do but they are doing so with other people's money.
Ms. Brisebois: It is very profitable and because they do not need to. In fact, senator, I think we obviously have a different definition of competition. The financial institutions are taking advantage of much higher interchange fees, for example, through the issuance of premium cards. They do differentiate themselves in the market by offering different types of loyalty programs and other bells and whistles.
At this point in time, it seems to be working and there is no incentive for them to offer a lower-priced product or there has been no demand or they have not been forced to. I do not feel as if we have answered your question.
The Chair: Is it not true that one Canadian chartered bank at least has maintained its own card for the very reason that it wishes to keep a close relationship with merchant customers? It follows that if the merchant is using that bank's card, the merchant is likely to do other business with that bank.
Ms. Brisebois: You are suggesting that there is a bank that not only issues a card but also acts as the acquirer and owns the relationship with the merchant. There is no question that in that case, and I think that was one of the witnesses who appeared before the committee, they would tend to be more sensitive to their clients' needs, and in this case they would be the merchants. There would be an incentive there.
The Chair: I was pointing out that there was at least one example.
Senator Oliver: I have a question for Mr. Farrell and Mr. Jewer. You said that you as merchants are powerless to have a say and to be involved in the process of negotiating the fees and so on. We are here as a Senate committee as public policy-makers. I would like you to help us and give us some information as to what types of things you think the public policy-makers should be doing to ensure that you have some say and that you could be brought to the table.
Mr. Farrell: Yesterday, I believe in both presentations, they kept referring to a merchant choice; and as you pointed out, we really do not have choice. They control 94 per cent of the market. There is one Visa; there is one MasterCard and our consumer wants to use them. We just need a say in negotiations. Before they became public entities, there was a negotiation and that was with the processor.
Senator Oliver: What should we be looking at now?
Mr. Farrell: It is to go back to some regulation so there is no abuse of power. Right now we must accept credit cards. They will keep coming, increase after increase after increase like we have seen over the last 18 months. I do not see it slowing down. We ask for it to be regulated with a return on investment for their cost of offering that service. The margins that they have been experiencing are a lot different than the margins that we as retailers have been experiencing over the last 18 months.
Mr. Jewer: In our case, obviously with our scale, we typically would have significant negotiating power. What we have not been able to do, obviously evidenced by the numbers we shared with you today, despite that scale, is have any success in preventing the significant increases that have been passed on to us over the course of the last year. We propose intervention and we look to this committee and to government to determine what that appropriate public policy intervention would be.
Senator Oliver: A number of people have referred to hidden fees, and our chairman raised the question about financial literacy for which there was a partial answer. There is a strong feeling that most consumers are not informed, particularly about these premium cards. What do you as retailers and people on the ground feel would be a good way to have this disclosure so that the consumers in particular could be more informed about the choices they have and about the costs? What do you recommend?
Ms. Brisebois: Senator Oliver, we had this discussion and we all agreed that it would be important to ensure that we provide much more information to consumers. As our submission notes, we believe that the financial institutions, as well as Visa and MasterCard, should be providing transparent information to consumers.
The perfect example is the premium cards. People get new cards, and when they call, they find out their old card was cancelled and they can no longer use it. They are not told the kind of cost that card carries. Also the point is that a well- educated consumer can properly use a credit card. It is not a question of not being able to use credit; it is about understanding how to use it. While you can educate consumers, you still could have a situation where all those cards would carry a 3 per cent interchange fee at the merchant level. This is something that I am not sure can be dealt with via education because there is no oversight or regulations in relation to our payment system in Canada.
Education itself is extremely important for consumers and for them to understand how to use these payment methods, but it would not solve the issue of no competition in the interchange market with the fee continuing to rise. As we indicated in our submission, it is not just the merchant who pays, but the customer pays as well.
Senator Oliver: The Interac Association told us they are constrained by a consent order and they have been trying to negotiate it now for some time. They say they do not have a level playing field. What are some of the things you would like to see? Let us assume Interac can get reasonable changes in the consent order. What would you want to see to continue to level the playing field as between Interac and Visa and MasterCard?
Ms. Brisebois: As stated in the submission, we believe that the three — Visa, MasterCard and Interac — should provide services under the same rules. There should be a flat rate both on credit and debit and importantly that the fees charged to merchants have a correlation between the services provided.
That is why we have mentioned the Australian model. Let us be clear. We are not suggesting we should embrace the Australian model. It is a good example and we should look at the Australian model. We believe we are unique and that there should be a Canadian model, but for debit, we are saying there is a fabulous system today. It may need a bit of innovation, it may need to change; but it is cost effective; it is trusted; it is the second-most-used debit system in the world.
Senator Oliver: They are now losing market share.
Ms. Brisebois: What is bizarre is they will lose market share because someone else is coming in and charging more. That is not competition.
Senator Ringuette: Could you offer a comment on a response we heard yesterday that a merchant might be able to advertise a discount to his or her customers if those customers choose to pay for items with cash?
Mr. Farrell: In theory, we are allowed to offer such a discount. Practically speaking, it is close to impossible. What you would end up doing in the retail environment is pitting one consumer against another consumer. Second, we would be relying upon one of our thousand plus cashiers to make that determination and calculation at the point of sale, and from a technological perspective, that is not an easy task. That is a major issue. We thought about it, but it is not practical.
Mr. Jewer: I agree with those comments. Obviously, in the face of the significant fee increases we have seen, we have explored a number of options. It is one of the options that we continue to explore, but the challenges that Mr. Farrell has identified are significant in trying to implement that kind of model.
Senator Ringuette: You must admit that you are also playing the role of government tax collectors; you are collecting sales tax that you have to remit to the Government of Canada. From my perspective, it is not fair that you have to pay an interchange fee when you accept credit cards that include the amount of sales tax that you collect for the Government of Canada and the provincial government. In actuality, you are paying a fee to the system in order to collect taxes that go to at least two levels of government.
In your numerous dealings with the government, have you addressed that concern and issue? You are working for the government and you are paying additional costs to the credit card companies who are working for the Government of Canada and the government of whichever province?
Mr. Wilkes: I would not argue with the logic. I personally have not made that particular argument. I thank you for making it for us. It reinforces some of the arguments we have been making as to the type of model and system we need in order to ensure that, ultimately, all of those costs, including those costs that you described, are paid by one person, the consumer.
The consumer not only pays for those costs; they pay for the entirety of costs relating to premium cards. Even if you are not a premium card user, the inflationary impact of what you have described is paid for by all consumers. Whether it is paying percentage fees on tax collecting or the percentage of premium cards on the market or any other costs associated, it has one impact, and that impact is on all consumers, not just those that use the particular vehicle.
Senator Ringuette: Do you not find it bizarre that at the same time the Government of Canada reduces its GST tax rate, at that opportune moment, these credit card companies increase by about the same amount. At the end of the invoice, the consumer does not see that much change in their costs.
Ms. Brisebois: It is interesting, Senator Ringuette, that you mention that. In fact, if you look at some of the statistical information we have provided, you are exactly correct.
The stimulus that the government provided is barely still in existence now if you look at the number of premium cards that have entered the market and the impact that those premium cards have had on the cost of goods. We have watched a reduction in GST that has been passed on to consumers basically almost disappear over the last 18 months. There is absolutely no question about that.
Senator Moore: Mr. Farrell, in response to Senator Oliver, you said that we in the past could negotiate, but since Visa and MasterCard have become publicly traded companies, you can no longer do that. Can you tell us about that? What was the relationship? How did it work, and what is it today?
Mr. Farrell: We still have the same relationship. The relationship among the card brands, the issuer, the processor and the merchant all remain the same.
What has happened is a timing issue, in that it seems that all the fee increases started since then. Our deal with our processor is on a cost plus arrangement, so you negotiate the lowest possible cost and anything that comes down from MasterCard or Visa flows directly through to the retailer. The acquirers charge now published rates that are not negotiable.
Senator Moore: Not negotiable. They set the tax and that is it?
Mr. Farrell: That is it.
Ms. Brisebois: MasterCard has announced a new fee on foreign cards, so if someone from Buffalo shops in Canada, the Canadian merchant processing that card will now pay a new fee, which is called a foreign card fee. That is passed down directly to the merchant.
Senator Moore: Even if it is a debit card?
Ms. Brisebois: No. At this point we are talking about credit cards.
Senator Moore: In an ideal world, what would your organization want to see? Would we like to see a debit card with a flat fee?
Ms. Brisebois: We would like to see a debit card with a flat fee, but we would also like to see some regulations around the payment system that ensures transparency, oversight and correlation between the flat fee charged and the service provided.
If you see a flat fee at 8 cents, that sounds really reasonable today, as we heard yesterday with MasterCard. What stops them from that flat fee becoming a dollar in a couple of years from now?
If there is not in fact a correlation between the service provided and the fee charged, regardless if it is a flat fee or a percentage, it does not make any difference.
Senator Moore: This is the intervention that Mr. Jewer suggested in response to Senator Oliver; he wants some kind of an intervention.
Ms. Brisebois: Yes. It is simply because it is a reversed definition of competition in the world of Visa and MasterCard.
Senator Moore: I just want to get this on the record. I think what Senator Ringuette was asking is that in a transaction where you are paying a percentage, you are paying a percentage on the total of the transaction including the taxes. Is that right?
Mr. Jewer: Yes.
Mr. Farrell: With respect to our concerns, every argument comes down to the fact that it is the merchant's choice; we have a choice to accept or not to accept. However, we do not have a choice. It is the consumer that makes that choice, and as retailers, consumers are king. We have no choice.
Our concern is Visa and MasterCard, as they have done with the INFINITE card, will now just throw their debit onto the same card and send it out in the mail. Consumers will take their other debit card and realize they do not have to carry two cards anymore. They will throw the other card in the garbage. When they come to our store and we say sorry, we are not accepting that, we just lost our customer. We cannot afford that, and we have no choice in this situation.
Ms. Brisebois: Another scenario is what happened in the U.K., and I think it was mentioned yesterday by some of your witnesses. They will be striking deals with their merchants. Merchants are competitive, so if they feel they can get a very low fee for a period of time and they live in a world of very slim margins, they may take advantage of it. What happens is that the merchant then is helping MasterCard build market share. Once that happens, the merchant renegotiates and, lo and behold, those fees no longer exist. We have seen it in the U.K. and the United States. It happens everywhere. It is that $10 billion that is not in your back pocket. That is exactly what will happen.
Senator Gerstein: I suspect the one thing we could all agree with around this table is that retailing has never been easy. I am fascinated by the fact that you are looking towards regulation in this situation. I am old enough to remember when the Retail Council of Canada was looking for deregulation, particularly when it came to store hours. There actually was a time when the only night that stores were open was Thursday night. I wonder if some retailers might not be longing for shorter hours today and no Sunday shopping.
I am interested in the fact that you are looking at Australia as the model for which you would like to see some regulation. My understanding is that the results out of Australia are somewhat mixed. There is a school of thought that says that costs have, in fact, gone up; retail prices have not gone down. Why are you so committed that we should look at this model?
Ms. Brisebois: We need to be clear. We are not saying we should be adopting the Australian model. In fact, in our submission we are talking about other jurisdictions that have also put regulations in place. They may not have used the Australian model as we know it, but they have looked at the Australian model.
The Australian model is basically showing, and proving, that in fact the credit card and debit card market can still be profitable with a cap. They have done so. There is no doubt about that. The reserve bank is on record. Experts in the card association business are on record stating that.
Mr. Stanton from MasterCard mentioned that one of the mistakes Australia made was not to include American Express, for example. We should be looking at what these other jurisdictions have done. If the committee supports this model, it could allow us to understand why it is important to set regulations around the fees charged to merchants and to develop a model that fits our unique Canadian experience.
Mr. Wilkes: I think Ms. Brisebois would agree that it is the principles and the approach. We have said it a number of times: Ensure transaction costs reflect the actual costs, plus a reasonable return; ensure there is transparency, speaking a bit to consumer education; and ensure there is a benchmark to understand what real transaction costs should be so you do not get that artificial flat rate of $2.
We are not saying to take Australia and plant it in Canada. We have reiterated many times that we need a Canadian system that works for the Canadian economy. We believe — and that is why we use the word "model" with Australia — that it has the right principles.
Mr. Jewer: Senator Gerstein, we do not take asking for increased regulation lightly. It is a very difficult decision that is only reflective of the difficult situation we found ourselves in with the significant cost increases.
The Chair: I think we can also all agree that regulation is an imperfect science and sometimes you get unintended effects. I think we all would agree that in most scenarios, the market, generally speaking, is the best regulator.
One of the problems seems to be that I, as a customer, am really only interested in the bells and whistles. If I am interested in air travel and I will get three times the number of points, I want that card. If, on the other hand, when this card came to me unsolicited through the mail, it said, "By the way, your annual fee for this card will be $500," that might deter me, might it not? Is there any opportunity for differentiating premium cards from non-premium cards at that end of the spectrum?
Ms. Brisebois: Before I ask Mr. Jewer to answer that question, let me comment on your comment about less regulation.
I think we would all agree that because of the financial institutions in this country being highly regulated, that we can sit comfortably and look at what has happened in the United States, in a very unregulated environment, and sometimes agree that regulation is good. It may not apply to all situations, but in the financial market, we have gone through difficult times and we have experienced what works and what does not work. We suggest that in Canada the banking regulations have worked, and we are suggesting that we should be expanding those regulations to ensure that we protect the payment system. I will let Mr. Jewer talk about the premium cards.
The Chair: It is not an all-or-nothing situation.
Ms. Brisebois: No, it is not; I agree.
Mr. Jewer: The lack of transparency has made it very difficult to try to educate consumers on this issue. As Mr. Farrell mentioned earlier, as a retailer, we do not want to be in the business of pitting our consumers against our other consumers. Some consumers in our stores pay a significantly lower cost, or cause us to incur a significantly lower cost than other consumers in our store, and those consumers are not directly bearing the impact of their choice of payment.
Mr. Wilkes: Right now, the rewards and benefits you are talking about are paid for by everyone, so the highest-cost card transaction fees are paid for by all of Mr. Farrell's customers and all of Mr. Jewer's customers. If, in the scenario you suggested, there was the choice, the transparency, the decision that, yes, I will pay whatever in order to reap those particular awards, or maybe get university payments at a lower cost, that is where I think innovation and competition should flourish, in the open, with the decision made by the person who is receiving the benefits, not behind the scenes with everyone's money.
Ms. Brisebois: If you choose to pay $100 versus $500, that is a relationship that you have with your financial institution, so you are paying as a consumer. Then you have to ask yourself why, then, the merchant is paying more when you are using that card, because you have already paid for the privilege of using that card.
The Chair: When I am using that $500 card.
Ms. Brisebois: If you have a standard card, that is fine, but if you are paying for a premium card — and that is what we are seeing in the credit card market — you are paying for that privilege, and that relationship is between you and your bank, and it should not be paid by the merchant.
The Chair: We could continue this discussion, with great benefit to us all, for a long time. Senator Massicotte will do that just after I adjourn the meeting. Thank you for coming.
(The committee adjourned.)