Constantine Partners Constantine Cannon Partners The Future of

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

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • Major Issues Facing Visa and Master. Card – – – Internal cohesion Merchant anger Pressure from new competitors Magnet for legal problems Potential preference by large banks for different ownership structure 22

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • 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) 33

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • Typical Complaints of U. S. Member/Owner Banks – Association brands compete with their own – Assessments and dues are used to benefit competitors – Visa and Master. Card associations are too bureaucratic and inflexible – Too many legal problems 44

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • Legal Problems – U. S. lawsuits – Australian Reserve Bank action – European Commission – U. K. Office of Fair Trading – Reviews of interchange by other states 55

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • Legal Problems Can be Sub-Divided into 3 Broad Categories – Membership rules – Merchant acceptance practices – Interchange 66

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • Membership Rules – U. S. Justice Department suit-resulted in • Invalidation of Visa by-law 2. 10(e) and Master. Card Competitive Programs Policy • Key judicial findings, including Visa and Master. Card’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 77

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • 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 88

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card 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 99

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card The U. S. Merchant Challenge to the Honor All Cards Rules • Visa/Master. Card 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) 10 10

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • 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 11 11

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • 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 ü Debit and credit are distinct products ü Existence of a credit card market ü Visa has market power in credit ü Existence of a tying arrangement ü Evidence of a debit card market • These Findings Can Be Used In Future Cases – Interchange cases – Other tying cases (i. e. corporate cards) 12 12

Constantine & Partners Constantine Cannon & Partners CC The Settlement of the Merchant Case • Compensatory Relief – $3, 050, 000 over ten years – $846, 000 in reduced interchange fees from Aug. 1 – Dec. 31, 2003 – Largest antitrust recovery in history (by more than 3 x) – 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 13 13

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card Merchant Lawsuit-Long Term Fallout • Financial Implications Of Settlement – Visa settlement service fee – Visa and Master. Card “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 14 14

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card The Final Frontier-Interchange 15 15

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card 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 Master. Card Survive In Their Current Form Without Interchange? • Would Changes In Association Ownership Structure Address Antitrust Issues Associated With Interchange? 16 16

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card 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/Master. Card Appeals Fail • October 2003 – Visa/Master. Card 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 17 17

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card 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) 18 18

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card The EU Challenges Visa/Master. Card 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 Master. Card Regarding Interchange • May 2004 – Visa And Master. Card Agree To Reduce Cross. Border Interchange 19 19

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card 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 Master. Card 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 20 20

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card Other Recent Significant National Investigations Of Interchange • • Spain Netherlands Poland Switzerland Italy Israel Sweden 21 21

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

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • Visa And Master. Card Have Abused The Power To Fix Interchange In The U. S. – Visa has raised its base credit card rate by 64% since 1990 – Master. Card 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 23 23

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card Is The U. S. Next? • The Federal Reserve Examines Interchange • Individual Merchant Cases • Merchant Class Action? 24 24

Constantine & Partners Constantine Cannon & Partners CC The Future of Visa and Master. Card • Cohesion Of Visa And Master. Card 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 25 25