The Future of Visa and MasterCard

1. The Future of Visa and MasterCard The Future of Visa and MasterCard By Jeffrey I. Shinder Partner, Constantine Cannon New York City/Washington jshinder@constantinecannon.com Presentation to LAFFERTY INTERNATIONAL CARDS & PAYMENTS COUNCIL May 11, 2005

2. The Future of Visa and MasterCard • Major Issues Facing Visa and MasterCard • Internal cohesion • Merchant anger • Pressure from new competitors • Magnet for legal problems • Potential preference by large banks for different ownership structure

3. The Future of Visa and MasterCard • What U.S. Banks Like About The Associations • Full menu of products • Financial incentives (big banks) • High interchange products • Support for affinity/co-brand deals (monolines) • Sharing cost of investing in new products • Spending on brand (monolines)

4. The Future of Visa and MasterCard • Typical Complaints of U.S. Member/Owner Banks • Association brands compete with their own • Assessments and dues are used to benefit competitors • Visa and MasterCard associations are too bureaucratic and inflexible • Too many legal problems

5. The Future of Visa and MasterCard • Legal Problems • U.S. lawsuits • Australian Reserve Bank action • European Commission • U.K. Office of Fair Trading • Reviews of interchange by other states

6. The Future of Visa and MasterCard • Legal Problems Can be Sub-Divided into 3 Broad Categories • Membership rules • Merchant acceptance practices • Interchange

7. The Future of Visa and MasterCard • Membership Rules • U.S. Justice Department suit-resulted in • Invalidation of Visa by-law 2.10(e) and MasterCard Competitive Programs Policy • Key judicial findings, including Visa and MasterCard’s joint and individual market power • Private damages lawsuits from American Express and Morgan Stanley/Discover • Morgan Stanley challenge to Visa membership rules in Europe resulted in • August 2004 statement of objections by Commission

8. The Future of Visa and MasterCard • Merchant Acceptance Practices • Honor All Cards rules • U.S. Merchant Honor All Cards class action • EU examination of Honor All Cards rule • No-surcharge rule • Invalidated by Australian Reserve Bank • Merchant Dissatisfaction Continues • Interchange • Introduction of new premium card products in the U.S. • Chargeback rules and fines

9. The Future of Visa and MasterCard The U.S. Merchant Challenge to the Honor All Cards Rules • Basic Claims • Visa/MC Honor All Cards rules illegally tied debit card acceptance to credit card acceptance • Visa (alone and together with MC) used the tying arrangements to monopolize the debit market

10. The Future of Visa and MasterCard The U.S. Merchant Challenge to the Honor All Cards Rules • Visa/MasterCard Convinced Banks That Settlement Was Remote And Unnecessary • “I don’t think we should hold any delusions about it. The damage claimed theoretically exceeds a billion. The practice at issue is a fundamental business practice in both associations, the cost of adjusting that business practice is enormous . . . [S]ettlement discussions before the parties have flexed their muscles [at] summary judgment strikes me as probably a waste of the Court’s time.” (Visa’s Laurence Popofsky at June 26, 1997 hearing)

11. The Future of Visa and MasterCard • The Honor All Cards Rules – Why They Were Anticompetitive? HAC tying rules Forced merchant acceptance Supracompetitive interchange Banks favor signature debit Signature debit rewards Higher PIN debit interchange Signature debit steering materials PIN debit penalties Reduced incentives to install PIN pads Reduced PIN debit volume Reduced overall debit volume

12. The Future of Visa and MasterCard • The Court’s Summary Judgment Findings In The Merchant Class Action • Court denied all 11 of Visa/MC’s motions • Court granted 6 of the merchants’ motions • Debit and credit are distinct products • Existence of a credit card market • Visa has market power in credit • Existence of a tying arrangement • Evidence of a debit card market • These Findings Can Be Used In Future Cases • Interchange cases • Other tying cases (i.e. corporate cards)

13. The Settlement of the Merchant Case • Compensatory Relief • $3,050,000,000 over ten years • $846,000,000 in reduced interchange fees from Aug. 1 – Dec. 31, 2003 • Largest antitrust recovery in history (by more than 3x) • Largest federal class action settlement in history • Injunctive Relief • Abolishing the Honor All Cards tying rules • Mandatory visual and electronic identifiers for all debit cards by January 1, 2007 • No exclusive debit deals between Visa and banks for two years

14. The Future of Visa and MasterCard Merchant Lawsuit-Long Term Fallout • Financial Implications Of Settlement • Visa settlement service fee • Visa and MasterCard “litigation” over settlement service fee • Greater Merchant Power And Cohesion • Special deals on debit interchange • Merchant steering • Growing merchant coordination • Diminished Association Power And Cohesion • Bank disenchantment with handling of merchant case and its settlement • Credit card issuers do not want to pay for debit card settlement • Debit card issuers dissatisfied with lower interchange fees

15. The Future of Visa and MasterCard The Final Frontier-Interchange

16. The Future of Visa and MasterCard The Final Frontier-Interchange Key Questions • Is It Necessary For Credit Card And Debit Card Networks To Function? • Is It Anti-Competitive? • Would Visa And MasterCard Survive In Their Current Form Without Interchange? • Would Changes In Association Ownership Structure Address Antitrust Issues Associated With Interchange?

17. The Future of Visa and MasterCard The Australian Review Of Interchange • October 2000 – Interchange Found To Be Above-Cost • August 2002 - RBA Announces Mandatory Reductions Of Interchange Rates • September 2003 – Visa/MasterCard Appeals Fail • October 2003 – Visa/MasterCard Credit Card Interchange Rates Fell By Half • Little discernible impact on volume • December 2003 – Australian Competition Authority Proposes Zero Interchange For Debit • Australian Competition tribunal overturns this proposal • February 2005 – RBA Proposes Reductions In Signature And PIN Debit Interchange

18. The Future of Visa and MasterCard The European Review of Interchange • January 1977 – Visa Enters European Market And Requests An Exemption From Certain EU Competition Laws • 1985 – EC Grants Visa A Comfort Letter • Retailer Complaints Regarding Interchange In 1992 (British Retail Consortium) And 1997 (Eurocommerce)

19. The Future of Visa and MasterCard The EU Challenges Visa/MasterCard Interchange • September 2000 – Preliminary Finding That Visa Interchange Is Price-Fixing • June 2001 – Visa Proposes To Lower Interchange Fee • July 2002 – EC Exempts Visa Interchange Fees In Response To Visa Proposal • Visa reduced interchange fees based on cost-based benchmarks • EC found that: • Interchange was anti-competitive • Bilateral arrangements were inefficient • October 2003- EC Sends Statement Of Objections To MasterCard Regarding Interchange • May 2004 – Visa And MasterCard Agree To Reduce Cross-Border Interchange

20. The Future of Visa and MasterCard The U.K. Review of Interchange • March 2000 - Cruickshank Report Is Released • No cost justification for interchange • September 2000 – British Retail Consortium files complaint • February 2003 – OFT Finding That MasterCard Common Interchange Fee Violates Competition Act • May 2003 – OFT Report Recognizes Both Pro-And Anti-Competitive Aspects Of Interchange • November 2004 – OFT Announces Formal Inquiry Into Visa Interchange Fees

21. The Future of Visa and MasterCard Other Recent Significant National Investigations Of Interchange • Spain • Netherlands • Poland • Switzerland • Italy • Israel • Sweden

22. The Future of Visa and MasterCard Is The U.S. Next? • Credit Card Interchange Survived Antitrust Challenge In The 1980s • Visa And MasterCard Extend Interchange To New Products, Including Debit Cards And Commercial Cards • Visa And MasterCard Have Since Abused Their Power To Collectively Fix Interchange Fees

23. The Future of Visa and MasterCard • Visa And MasterCard Have Abused The Power To Fix Interchange In The U.S. • Visa has raised its base credit card rate by 64% since 1990 • MasterCard has raised its base credit card rate by 49% since 1990 • These Increases Cannot Be Cost Justified • Fraud – down 67% since 1991 • Cost of funds – down 80% since 1989 • Increased economies of scale • Substantial increase in credit card volume since 1993 − Reduced hardware, processing and telecommunications • U.S. Rates Are Amongst The Highest In The World

24. The Future of Visa and MasterCard Is The U.S. Next? • The Federal Reserve Examines Interchange • Individual Merchant Cases • Merchant Class Action?

25. The Future of Visa and MasterCard • Cohesion Of Visa And MasterCard Associations In The U.S. • Potential divisions between banks • Large issuers • Monoline credit card issuers • Regional and smaller banks • Private label issuers • Hard core loyalists vs. banks that are hedging their bets