Payment acceptance for retailers in a post-Brexit Europe
A very important piece of any omnichannel retailing strategy is the acceptance of payments across multiple points of interaction. Equally important is the need to accept different payment methods to correspond to consumers’ payment preferences. Following the referendum European retailers headquartered in the UK and in Europe are evaluating the implications of Brexit. Here we examine the implications for retailers accepting payments and the need to plan for the different scenarios that may play out. All the non-payments related topics, such as inflation, corporate tax and M&A activities are outside the scope of this article but are equally important to be evaluated.
For the cartophiles – a map can usually help
The European Economic Area (EEA) is the area which provides for the free movement of people, goods, services and capital within the European Single Market. The European Union’s wider framework is 31 member states as of 2016; that is 28 EU member states, as well as three of the four member states of the European Free Trade Association (EFTA – that is Iceland, Liechtenstein and Norway), whereas Switzerland, the fourth EFTA member, has not joined the EEA, but has a series of bilateral agreements with the EU which allow it to participate in the internal market. A cartophile is someone who likes maps, which I do, therefore, the following map illustrates the UK as a ‘third country’ status, which is one potential post-Brexit scenario. It is not the only potential post-Brexit scenario but it is the one that will create the biggest challenges for payment acceptance, therefore, useful for planning the worst case scenario. A ‘third country’ would be one that remains outside the single market and do not have freedom of movement with the EU.
Since the referendum (which was on 23rd June 2016) there has been considerable speculation across the “exit spectrum”, from a soft exit of the EU to a hard exit. The latest thinking is a hard exit which will mean that the UK would have a third country status. A less-hard exit, such as membership similar to Norway or Switzerland, where freedom of movement exists, would not please the 51.9% of the British public that voted for Brexit. This would have a colossal impact on the next general election, but let us avoid the political angles at this point. If a hard exit is the preferred route, it is important to remember that UK-regulated Payment and Financial Institutions could lose access to the European markets. Today, requirements for obtaining a license to conduct payment services are harmonized across the EU, and it is relatively easy to passport such a license from one EU country to another. This enables Payment and Financial Institutions with a UK license to access all of Europe. Eliminating this right would restrict UK-licensed institutions from pursuing business elsewhere in Europe without securing separate licenses. Examples of those that would be negatively impacted include UK-based cross-border acquirers and multi-national retailers using UK acquirers for pan-EU acquiring.
The UK has been a powerful voice in the European community and have enthusiastically, and sometimes aggressively, supported the harmonization of the financial service regulatory framework. Regulatory frameworks such as Single Euro Payments Area (SEPA) and Payment Service Directive (PSD) established standardization for payment services and competition within the payments marketplace. Another area of harmonization has been the capping of the card scheme interchange fees with the Interchange Fee Regulation (IFR). As a result of a hard exit, the UK will become separated from SEPA, PSD (which is in its second version – PSD2) and IFR. This degree of separation has yet to be fully understood, and the impact on retailers located in the UK or the EU could mean bad news or good news. There will be pros and cons each way. Retailers must plan for the worst case scenario.
The UK’s separation from the EU will be a complex process, causing political and economic changes for the UK and other countries. Triggering Article 50 by the end of March 2017 will be the firing gun for the UK to formally leave the EU by the end of March 2019. Retailers accepting consumer payments from across Europe after March 2019 will be impacted in many different ways. The cost of payment acceptance will be the crucial calculation which is directly or indirectly related to the following:
- The location of the retailer’s headquarters and its payment processing centre
- The location of the retailer’s consumers (mainly inside the UK or mainly outside the UK)
- The location of the payment service provider
- Interchange and how the payment networks (i.e. Visa and MasterCard) will interpret Brexit
- The license status of the retailer’s payment service provider(s)
- Protection of consumer data
More anxiety with non-payment related themes
The impact of Brexit on other matters, mainly non-payment related, is almost endless; including, corporation tax, recruitment of people, logistics, procurement of goods and services, consumer confidence, the value of the pound – especially when importing goods from Europe, China or the US. Furthermore, the falling value of the pound can lead to inflation. The possibility of trade tariffs with EU countries is another concern. Anti-money laundering (AML) legislation and customer due diligence (know your customer) are expected to remain in force because these are part of global regulations that all countries (inside and outside the EU) will implement. No impact from Brexit on these regulations.
There is likely to be a revival in overseas investors as the weaker pound makes British companies more affordable. The Australian retail giant Wesfarmers recently acquired British DIY chain Homebase for £340 million following the approval by the shareholders of Homebase owner the Home Retail Group. True, this was before the Brexit vote but it could be indicative of further foreign investment in UK’s high street. After the Brexit vote we have seen Steinhoff acquire Poundland for £597m and AMC acquire Odeon cinemas (for £921m). Perhaps we could see Lidl buying Morrisons!
Payment Acceptance Optimization
When optimising payment acceptance, retailers will examine their commercial relationships with their acquirers and payment service providers. Edgar, Dunn & Company (EDC) uses a sophisticated tool called CoPA, the “cost of payment acceptance”. CoPA is able to run different scenarios for retailers to determine which is the best configuration for payment acceptance – using the payment transaction traffic, where it was processed, where the transaction originated and at what fee – the model is able to optimize the acquiring arrangement for the retailer. The intention of the cap on interchange fees is to redistribute revenue from issuing banks to retailers and on to consumers. The European Commission’s goal is effectively to pass cost savings to retailers and consumers. EDC has estimated that interchange fees are around £2.6 billion per annum in the UK. According to the British Retail Consortium (BRC) interchange fee caps of 20 basis points for debit cards and 30 for credit cards could save UK retailers £480m million each year. The UK government is clear that retailers are expected to pass these savings onto consumers in the form of lower prices. It is far too soon to say whether this has been the case but in a post-Brexit UK the interchange caps could be set lower, higher or removed. The UK will not be bound to comply with the EU defined interchange caps. The EU will review these caps on 9th June 2019 which is around the same time when the UK is likely to be entirely disengaged from the EU.
There is an expectation that the costs of payment acceptance for cross-border inter-regional transactions will increase. In a hard exit scenario, the UK domestic Interchange Fee Regulation (IFR) which is linked to the European regulations that caps interchange can be amended or re-written. The most likely challengers of continuing with the capped interchange would the major international card issuers of Visa and MasterCard. What is important is that retailers must ask themselves three key questions:
- Where is the location of my headquarters and its payment processing centre?
- Where are my consumers located – mainly inside the UK or mainly outside the UK?
- Where is my acquirer located?
The answers to these three questions will help to decide the degree of the impact of Brexit and this can be summarised in the following decision table:
Using the answer to the first question, the location of your retailer’s headquarters, to select the suitable column in decision table above the next key driver is the answer to the second question, where are your consumers located. The answer to this second question will always override the third question, where is the retailer’s acquirer located. French consumers, for example, using credit and debit cards issued by French banks and making purchases on a UK retailer’s website or in-store, which are acquired by a UK acquirer will have a Brexit impact. In this example, it is advisable that the retailer ought to identify a corrective action plan. If the majority of the UK retailer’s consumers are located outside the UK, the corrective action plan will have to bring into question the location of the retailer’s headquarters and its payment processing arrangements, and so on.
A corrective action plan is likely to involve several different options that will be determined based on the outcome of the decision table above. This could include changing your current acquirer, splitting some of your payment traffic between two or more acquirers, or migrating your payment processing centre to another location. Several options will be identified each will be individual and designed for your business. They will be prioritised and using the CoPA model different business growth or business reduction scenarios will be tested to determine which is the best option for your business. Merging retailers or retailers offloading parts of its sales channel will also result in different corrective action plan options to be tested.
Scenario planning will involve other factors
How interchange is capped in the EU and in the UK will require scenario planning and using the table above to determine the answers to questions 1, 2 and 3 will be the start of the planning process. Scenario planning or contingency planning is a structured methodology for EDC to work with retailers to think about the future and plan any necessary corrective action plans. One scenario we have been testing is how the pound has experienced a devaluation and what may be the case for the next few years. This will impact the Merchant Service Charge (MSC) that retailers pay their acquirers. The fixed element of scheme fees is charged in euros, while some inter-regional interchange line items are charged in dollars. Therefore, a depreciation of the pound would increase interchange and scheme fees for retailers located in the UK (the first question in the decision table above). EDC has found that the UK’s booming online gaming sector is very concerned about these currency fluctuations. They are also concerned about the fact that many of their consumers are outside the UK. If interchange increased, then cross-border transactions will increase their total CoPA.
How Visa and MasterCard interpret Brexit has yet to be seen and whether they regard the UK as part of their definition of the European region or outside. Debit and credit cards issued outside the UK but within the EU region may now be classified as international cards in the UK since leaving the EU would most likely mean leaving the EEA (the hard exist scenario). The card networks could classify transactions between the EU and the UK as inter-regional with higher scheme fees – good for UK issuers, bad for UK retailers. Interchange fees for international transactions are significantly higher than for intra-regional (EU) transactions since the interchange caps are no longer applicable. This will particularly affect the travel and entertainment (T&E) sector since they process large volumes of international transactions. Online gaming retailers and airlines will also have to assess their payment acceptance arrangements.
As we can see on the decision table above any non-British and non-EU retailer will have zero or a very low impact. They may even benefit from a weaker pound in terms of being able to have their investments go further. This will be good for Walmart with ASDA which mainly serves British consumers, and having a UK acquirer will not result in a significant Brexit impact. For Amazon’s UK business there is a lower concern unless they process their EU based consumers through the UK acquirer.
The view from the FCA
The UK was a key supporter of the IFR during negotiations and supported a swift implementation and flexibility on interchange fee caps so that the UK could choose caps to suit its own market. Ireland, on the other hand, decided to adopt the 20 basis points cap for debit cards but then lower it to 10 basis points. Poland, Spain and Netherlands are also considering going off-piste; so much for harmonization in Europe. Outside the EU the UK could abandon the interchange rate caps and allow for free market economics to prevail. Visa and MasterCard will have to assess this very closely with the UK’s Financial Conduct Authority (FCA) and the Payment Systems Regulator (PSR). The FCA and PSR could maintain the caps irrespective of Brexit. Officially, Andrew Bailey, Chief Executive of the FCA has stated that “our objective of ensuring healthy competition in UK financial markets is supported by cross-border trade in these financial services.”
In other words, all of the FCA rules and regulations continue to be applied regardless whether they originated from the EU or not. As most of them originated in the EU, including the PSD, PSD2, IFR, EMD2 and the PAD (Payment Account Directive) and General Data Protection Regulation (GDPR) will all be in force for some time. It is worth noting that GDPR is a regulation and not a Directive and therefore it doesn’t require national legislation to be passed by the UK government. GDPR is due to be implemented May 2018 (about 12 months before the UK exit is completed). As for the PSD2, the official word from the FCA is that it has started and it will be finished. It does not make sense to stop the PSD2 juggernaut now it is underway and gathered full steam. Many of the established institutions have already started to prepare for PSD2 and there are just as many start-ups and Fintech companies based in the UK wishing to take advantage of the PSD2 provisions. It does not make sense for the FCA to put the brakes on now.
Should retailers act now or later?
If you are a UK based retailer dealing with mainly UK customers from a single store or 600 stores up and down the country, you should have very little Brexit scenario planning to conduct to optimise your payment acceptance arrangements. The Brexit implications will be small. However, if you have lots of cross-border traffic, your UK based payment service provider has passported across the EU to serve your European customers, or you may have a Pan-European footprint, you need to start scenario planning now. After you have established your contingency plan, making changes to your PSP or your acquirer or even re-locating your processing centre could take 12 to 24 months. It is more than a technological challenge, it will involve strategy, personnel, commercial, and legal – right across the entire payment acceptance value chain in your business. Act now, don’t leave it until March 2019.
Authors: Mark Beresford with contributions from Volker Schloenvoigt on the merchant acquirer’s point of view