Payment System Regulator interim findings on the card acquiring market

“UK Card acquiring market is not working well for SME’s”

“The UK card acquiring market is not working well for SME’s” – thats the not so startling conclusion that the UK Payment Systems Regulator (“PSR”) reached this week in its interim report “Market Review into the supply of card-acquiring services”.  This is a shocking indictment of the services provided by the leading UK merchant acquirers by their own regulator but not a surprise to any market commentator or small business.

 

Background

The PSR investigation was kicked off back in 2018 with the objective of ensuring that the supply of card acquiring services is competitive and works in the interests of merchants, and ultimately consumers.  Concerns had previously been raised with the PSR that acquirers were holding onto savings arising from the  in 2015/16 and not passing these savings back to merchants thereby indicating a lack of competition in the market.

Their interim report concludes on the extensive work done to date which included telephone interviews with over 1,000 small and medium sized merchants and detailed analysis of fees charged to a sample of 40,000 merchants over a 5 year period by acquirers (WorldPay, Barclaycard, Global Payments, Elavon and Lloyds Cardnet).

 

Findings

The PSR’s findings are a tale of 2 halves.  For large merchants, with annual turnover >£50 million per year (who are predominately on interchange plus pricing) the PSR found that card acquiring services works well for them.  However for merchants with a card turnover < £50 million per year (small,  medium sized and the smaller end of the large merchant segment) the PSR found that the supply of card-acquiring services does not work well for them.

The proportion of UK merchants with turnover <£50m is 99.9% of all UK merchants!  So the card-acquiring market only works well for a measly 0.1% of merchants, ie the “big guys” – everyone else is paying over the odds!

The PSR’s main findings in detail for merchants with turnover <£50m per year :

  • They got little or no benefit from the EU interchange savings – these savings were retained by the acquirers.  Meanwhile the PSR estimated that the larger merchants received a benefit of c.£600 million per year from the EU interchange caps.  This was very evident as far back as 2016 – we saw countless examples of merchant fee increase letters where it was quite clear that acquirers were pocketing c.70% of the EU interchange savings.  For WorldPay alone, we estimated that this added c.£30 million per year to their profits.
  • No evidence of improved quality of service from acquirers – some acquirers told the PSR that an explanation for the lack of pass through to merchants of savings from the EU interchange caps was that they were investing these savings in improved services.  WorldPay certainly made a song and dance about this in its fee increase letters.  The PSR analysed performance metrics and found no evidence of improved services amongst acquirers.
  • New customers pay less than existing customers – a fairly obvious conclusion to anyone close to the industry and a prime reason merchants should shop around.  Interestingly the PSR did quantify an estimate of the additional amount existing customers pay and did conclude that this increases every year a merchant remains with the same acquirer :

Customer Time with SupplierRate
New0.65% - 1.8%
1yrnew +0.21%
2yrsnew +0.34%
>3yrsnew +0.47%

  • Merchants referred by ISO’s generally receive cheaper pricing then customers who go directly to an acquirer– again, self evident to anyone in the industry and something we’ve commented on a lot in the past.  If you are a merchant with card turnover <£50m there is utterly no reason to go directly to an acquirer – you get the same product and in our experience a superior service from an ISO.  You’re not taking any risk whatsoever – the ISO channel is the largest source of new merchants for acquirers accounting for 54% of all of their new business according to the PSR.
  • Acquirer and ISO pricing creates significant search costs for merchants because of the absence of published prices and the complexity of comparing prices.The PSR recognise there is only one price comparison website in the UK (ie this one – www.cardswitcher.co.uk).  We predominately partner with ISO’s because, not only are they better value for merchants, but also because acquirers flatly refuse to publish pricing publicly.  They will tell you its because of complexity but in reality it is because their existing customers would soon realise they are paying over the odds as the PSR has noted.
  • The indefinite duration of merchant contracts doesn’t provide a clear trigger point for merchants to think about searching for another provider and isn’t in merchants’ interests – this is one of the few points we are potentially in disagreement with the PSR on. We agree there isn’t a clear trigger point, however we’re not sure this isn’t in merchants’ interests.  Whilst the contracts should be fair and transparent, there is a certain responsibility merchants need to bear in understanding what they are signing up to and as long as this is clearly spelt out then we see no issue.
  • Terminal contracts with long initial terms of three to five years or that automatically renew for successive fixed terms represent a barrier to switching to a different provider – this is possibly the single largest complaint we hear from merchants and our blog comments are littered with feedback from merchants who have gone to cancel after 5 years only to find they’ve been automatically rolled over into a 2nd minimum contract term.  Numerous ISO’s use this tactic and it is grossly unfair – the capital cost of the terminal is entirely repaid within the first minimum term and the ISO suffers no loss from a merchant who terminates thereafter – indeed that would be seen as a highly profitable contract for the ISO.

 

Actions the PSR is considering

  • Require all contracts for card-acquiring services to have an end date to encourage merchants to consider alternatives – we think this is of questionable benefit and do see some downside if it creates an administrative burden for merchants and acquirers.
  • Limit the length of terminal contracts, for example to 18 months to  align with the Consumer Credit Act 1974 – there are cost benefits to both merchants and terminal providers in having longer contracts – longer contract terms enable volume discounts making the annual cost lower for the merchant and the contract more valuable for the terminal provider.  This value then attracts more suppliers to the market and widens choice for the merchant.  Without the ability to offer longer term contracts, a number of smaller ISO’s would not be able to compete and merchant choice would be reduced which is contrary to the PSR objectives.  The real issue at present is a number of terminal providers circumvent the CCA74 through structuring terminal hire contracts as membership agreements or by using loosely connected sister companies to provide terminals.  Smaller unincorporated merchants for whom CCA74 permits them to exit hire contracts without penalty after 18 months are unable to do so because of this circumvention.  We think a better solution would be to stamp out these means of circumvention by requiring that all providers offer an 18 month terminal hire contract in addition to any other longer terms and that there are no penalties on exit from that 18 month contract no matter how it is structured.  Merchants can then knowingly choose between an 18 month contract which they know they can exit at no cost but which will be more expensive and a longer term contract which will be cheaper but will carry exit costs.  Those exit costs should be prominently published in a standard form. 
  • End terminal contracts that automatically renew for successive fixed terms – as noted above this is a significant issue that should be brought to an immediate end – all contracts should be on a rolling 30 day basis after the end of the initial term.  Not only should the PSR ban this for new contracts but it should also make this clause unenforceable in existing contracts.  This would not disadvantage terminal providers because the capital cost of a terminal is repaid within the initial minimum term.  ISO’s who enforce automatic renewal also tend to make it very difficult for merchants to terminate their contracts – the time window in which termination notices require to be served are narrow and are often finished before the merchant even thinks about termination, the form of termination is often onerous – ie registered post to a specific address which is different from any other address used by the provider and sometimes the identity of the terminal provider is different from the entity which the merchant has been dealing with, ie a sister company.
  • Link the contracts for card acquiring services to the terminal contract so that if the terms and conditions on the acquiring contract were changed and the merchant has grounds for termination then they can also terminate the terminal contract at no cost – acquirers frequently increase pricing, probably once a year for a significant proportion of their book – the PSR findings above clearly demonstrate that.  In just about all cases this does trigger a material contract change and enables the merchant to terminate, however as the PSR observes it only triggers a material change in the merchant acquiring contract.  Terminal hire contracts are separate and a change in pricing in the merchant acquiring contract is not grounds for termination of the terminal hire contract – such termination would still carry termination costs which can be sizeable and effectively nullify the merchants’ termination rights.  Linking the 2 contracts such that both are terminable is problematic,  Merchant acquirers are not in control of the interchange or card scheme fees passed to them by Visa/Mastercard and it would be grossly unfair for them to be forced to suffer loss on a terminal hire contract just because they are passing on price increases forced upon them.  For merchants who are into a rolling terminal hire contract, there is no issue – there is no loss on termination of the terminal hire contract thus linkage of the 2 contracts is fine.  For merchants still in the initial minimum term of the terminal hire contract, the capital value of the terminal is not yet repaid and thus the ability to terminate early does cause loss.  In a purely theoretical world, one solution might be to enable termination of both contracts if price increases are greater than those suffered by the acquirer.  The difficulty here is in policing and measuring the increases suffered – interchange is relatively straight forward but scheme fees are complex and how does one cater for indirect costs such as salaries, IT, etc?  Another solution might be to cap percentage increases unless the acquirer can clearly demonstrate to the PSR that its cost base has increased beyond that cap.  Another problem to consider is quite often the terminal provider and the acquirer are totally separate businesses – is it fair to penalise the terminal provider because of the actions of the acquirer?  Part of the issue stems form the non-transportability of card terminals – if you switch card providers then you need a new card terminal.  An alternative solution might be to enforce transferability of card terminals between acquirers such that an acquirer cannot refuse to provide acquiring services to a third party terminal.  This would require commonality of accreditation of terminal manufacturers and models but one would argue that acquirers operate to largely the same standards at present and thus this would not be difficult.  I confess some of the technical detail is beyond me but with today’s technology this does seem a viable option and one which would greatly benefit merchants.
  • Making comparison easier for merchants by requiring pricing information to be in an easily comparable format and enhancing/enabling tools to facilitate comparison yes.  Card acquiring is living in the dark ages and is decades behind comparable markets such as mobile phone pricing.  The problem lies squarely at the doors of the acquirers who deliberately over complicate pricing to preserve over-pricing of existing customers.  Uniformity of presentation and terminology together with a requirement to publicly disclose pricing will help.

 

Next Steps

This is just the PSR’s initial findings.  It is open to comment and then there will be a period of further investigation, a final report and a period of implementation for any findings/recommendations.  We could be several years away from anything above finally coming to market but at least the process has began and we would urge the PSR to accelerate where this is possible.

One disappointment is there is no clawback or windfall tax on acquirers who did not pass on savings arising from the EU interchange caps.  The PSR has concluded that SME’s didn’t see this benefit whilst their larger competitors did – grossly unfair.  Most of the actions above will impact ISO’s (and maybe rightly so) whilst the bigger sin of unfairly profiting from EU interchange caps was largely committed by acquirers.  Acquirers benefitted to the tune of £tens of million per year at the cost of UK SME’s and consumers.  Some acquirers used these increased profits to plump themselves up for enhanced stock market flotations or acquisition by overseas competitors adding £hundreds of millions to their valuations.  The PSR should consider how its powers could re-balance this injustice, for example forced divestments of the UK card acquiring businesses by UK banks or multi-national payment businesses who’s UK subsidiaries are now too insignificant to be anything other than a cash cow.

In the meantime, you can still learn from the PSR’s factual findings and reduce your costs of card acceptance :

  1. Shop around for card acceptance – existing customers are charged more than new customers.  FACT
  2. Use an ISO, they are generally cheaper than acquirers.  FACT
  3. Read your terminal hire contracts carefully.  Do not go with a provider who enforces a second minimum term
  4. Use a price comparison website to research pricing – the PSR recognise only one –  www.cardwitcher.co.uk.
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