As discussed in a previous blog, the Federal Reserve began seeking comments on proposed changes to Reg II of the Durbin Amendment in May. At that time, the Fed said that it felt the changes would be non-substantial and would not include more compliance obligations. Currently, the Fed bars issuers from restricting the number of unaffiliated networks for debit card transactions to fewer than two, including one signature network and one PIN network. The new proposal would make issuers responsible for ensuring that all transactions with US merchants can be routed across two unaffiliated networks.
While the Fed characterized this change as a simple clarification, it is anything but, as evidenced by the over 2,600 comments received. It is clear this issue is complex, substantial, and would increase compliance obligations.
We have sorted through the comments posted on the Fed's website and various government sites to summarize the key points for both sides of this argument.
- Issuer Compliance: One of the most significant areas of concern is how the proposal would significantly change the compliance obligation by replacing the word "enable" with "ensuring." This means that issuers must ensure their unaffiliated networks can support all transaction types across all US merchants, but there is still uncertainty around how far this goes. What if a merchant does not accept the alternative network? What if a merchant intentionally limits the routing options of its transactions due to valid business purposes? What if a mobile wallet only has one routing option? Issuers and networks clearly stated the compliance burden of this is not only significant, but also not feasible from an operations perspective. Networks like Visa warned that issuers could be held accountable for the actions of third parties such as merchants, merchant acquirers, merchant processors, and networks.
- Unintended Consequences: Associations and networks noted that, while there are PIN solutions merchants could use in the card-not-present (CNP) environment, merchants have mostly chosen not to adopt them for economic reasons. Instead, they're seeking support for riskier PINless transactions. There is uncertainty about whether issuers will be forced to accept certain transaction types to be compliant, such as high dollar amount transactions from less reliable merchants. Issuers selectively evaluate such transactions per their risk tolerances.
- Innovation Impacts: The Fed recommended some definitional changes, including exchanging the words "means of access" for "form factor," but it provided no definition. It is unclear if new forms of authentication and innovation could fall under the "means of access" definition and would be blocked unless two networks could support the service. This could put a significant damper on industry innovation and reduce competition.
- Smaller Issuer Exception/Fintech: The Clearing House Association and others expressed concern that larger fintechs have leveraged unregulated issuers in a way that has created an unfair interchange advantage. They are advocating for closing this loophole.
- Diverted Resources: NAFCU said in its response that clarifications would affect smaller issuers, expressing concern about the financial, fraud, and back-office impacts. The association said such issues would divert resources from other member-focused projects, thus negatively impacting consumers.
- Timing Concerns: Issuers, especially smaller financial institutions, said they would need time to enable changes, citing technology contingencies and back-office challenges. Some issuers want at least three to four years to comply.
- Change Needed: When Durbin was enacted, CNP transactions made up less than 10% of all transactions (though exponential growth had occurred and was projected to increase). Now that CNP transactions are roughly 20% of the mix, merchants believe they only have one network available due to issuer configurations. Merchants argue that clarifications should be implemented before the holiday season.
- Routing/Share Incentives: The Federal Trade Commission said financial incentives from networks like Visa and Mastercard created a pattern of issuer behavior that includes turning off competitive features like PINless. The FTC wants those incentives to be disallowed. As such arrangements often take the form of quantity discounts, it would be difficult to argue that networks should be prohibited from engaging in such financial arrangements.
- Means of Access/Authentication: Merchants raised concerns that networks could use authentication methods to limit access. They asked that issuers be barred from turning off authentication methods for the alternative network if the primary network has them turned on and the merchant wants to accept them, even if the unaffiliated network lacks the controls, sophistication, or capabilities of the primary network.
- Regulated Interchange: While they believe issuers costs have gone down by almost 50%, merchants noted that interchange stayed the same. While the Fed's data refutes the latter claim, the merchant community encourages the Fed to review regulated interchange.
The Bottom Line
This continues to be a top priority for issuers and merchants. We noted that the Federal Trade Commission and Justice Department weighed in on behalf of merchants and in support of the Fed's recommendations. While the Fed has not said when it plans to act, the general consensus is that the industry will hear something by mid-2022.
Reg II's clarification outcome could have significant impacts for financial institutions with some very troubling elements. SRM is hopeful that, with all the comments and the stated intent of not increasing issuers' compliance obligations, the outcome could be less problematic with more clarifications.
Many believe, at a minimum, the Fed is likely to bar issuers from opting out of PINless or CNP transactions with their unaffiliated networks. That said, issuers should actively engage their government relations areas and prioritize this issue at the local and national levels while working with their associations. They should monitor this closely and highlight this item during strategic planning. They should take inventory of existing relationships and evaluate this potential change's technological, operational, and financial implications.
Read part one of this blog, Durbin 2.0 | Creating Clarity or Confusion? or watch the recorded webinar for more on this topic from the team at SRM.
To discuss how this directly affects your financial institution, contact Keith Ash at Kash@srmcorp.com.