Debit Card Interchange Fees and Routing

Federal RegisterJul 20, 2011

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FEDERAL RESERVE SYSTEM

12 CFR Part 235

[Regulation II; Docket No. R-1404]

RIN 7100 AD 63

Debit Card Interchange Fees and Routing

AGENCY:

Board of Governors of the Federal Reserve System.

ACTION:

Final rule.

SUMMARY:

The Board is publishing a final rule, Regulation II, Debit Card Interchange Fees and Routing. This rule implements the provisions of Section 920 of the Electronic Fund Transfer Act, including standards for reasonable and proportional interchange transaction fees for electronic debit transactions, exemptions from the interchange transaction fee limitations, prohibitions on evasion and circumvention, prohibitions on payment card network exclusivity arrangements and routing restrictions for debit card transactions, and reporting requirements for debit card issuers and payment card networks. An interim final rule, with a request for comment, on standards for receiving a fraud-prevention adjustment to interchange transaction fees is published separately in the

Federal Register

DATES:

Effective date:

The final rule is effective October 1, 2011.

Compliance dates:

For § 235.7(a) the general compliance date is April 1, 2012, except as follows: Payment card networks must comply with §§ 235.7(a)(1) and (a)(3) on October 1, 2011. Issuers must comply with § 235.7(a) on April 1, 2013, with respect to debit cards that use transaction qualification or substantiation systems and general-use prepaid cards sold on or after April 1, 2013. Issuers must comply with § 235.7(a) with respect to reloadable general-use prepaid cards sold and reloaded prior to April 1, 2013 by May 1, 2013. Issuers must comply with § 235.7(a) with respect to reloadable general-use prepaid cards sold prior to April 1, 2013 and reloaded after April 1, 2013 within 30 days of the reloading.

FOR FURTHER INFORMATION CONTACT:

Dena Milligan, Attorney (202/452-3900), Legal Division, David Mills, Manager and Economist (202/530-6265), Division of Reserve Bank Operations & Payment Systems, or Mark Manuszak, Senior Economist (202/721-4509), Division of Research & Statistics; for users of Telecommunications Device for the Deaf (TDD) only, contact (202/263-4869); Board of Governors of the Federal Reserve System, 20th and C Streets, NW., Washington, DC 20551.

SUPPLEMENTARY INFORMATION:

I. Section 1075 of the Dodd-Frank Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted on July 21, 2010.

Section 1075 of the Dodd-Frank Act amends the Electronic Fund Transfer Act (“EFTA”) (15 U.S.C. 1693

et seq.

) by adding a new section 920 regarding interchange transaction fees and rules for payment card transactions.

Pub. L. 111-203, 124 Stat. 1376 (2010).

EFTA Section 920 is codified as 15 U.S.C. 1693o-2. As discussed in more detail below, EFTA Section 920(c)(8) defines “an interchange transaction fee” (or “interchange fee”) as any fee established, charged, or received by a payment card network for the purpose of compensating an issuer for its involvement in an electronic debit transaction.

EFTA Section 920(a)(2) provides that, effective July 21, 2011, the amount of any interchange transaction fee that an issuer receives or charges with respect to an electronic debit transaction must be reasonable and proportional to the cost incurred by the issuer with respect to the transaction.

Section 920(a)(3) requires the Board to establish standards for assessing whether an interchange transaction fee is reasonable and proportional to the cost incurred by the issuer with respect to the transaction.

Electronic debit transaction (or “debit card transaction”) is defined in EFTA Section 920(c)(5) as a transaction in which a person uses a debit card.

Under EFTA Section 920(a)(5), the Board may allow for an adjustment to an interchange transaction fee that is reasonably necessary to make allowance for costs incurred by the issuer in preventing fraud in relation to electronic debit transactions, provided the issuer complies with standards established by the Board relating to fraud prevention. Section 920(a)(8) also authorizes the Board to prescribe regulations in order to prevent circumvention or evasion of the restrictions on interchange transaction fees, and specifically authorizes the Board to prescribe regulations regarding any network fee to ensure that such a fee is not used to directly or indirectly compensate an issuer with respect to an electronic debit transaction and is not used to circumvent or evade the restrictions on interchange transaction fees.

EFTA Sections 920(a)(6) and (a)(7) exempt certain issuers and cards from the restrictions on interchange transaction fees described above. The restrictions on interchange transaction fees do not apply to issuers that, together with affiliates, have assets of less than $10 billion. The restrictions also do not apply to electronic debit transactions made using two types of debit cards—debit cards provided pursuant to certain government-administered payment programs and certain reloadable, general-use prepaid cards not marketed or labeled as a gift card or gift certificate. Section 920(a) provides, however, that beginning July 21, 2012, these two types of debit cards will not be exempt if the cardholder may be charged either an overdraft fee or a fee for the first withdrawal each month from automated teller machines (“ATMs”) in the issuer's designated ATM network.

In addition to rules regarding restrictions on interchange transaction fees, EFTA Section 920(b) requires the Board to prescribe rules related to the routing of debit card transactions. First, Section 920(b)(1) requires the Board to prescribe rules that prohibit issuers and payment card networks (“networks”) from restricting the number of networks on which an electronic debit transaction may be processed to one such network or two or more affiliated networks. Second, that section requires the Board to prescribe rules prohibiting issuers and networks from inhibiting the ability of any person that accepts debit cards from directing the routing of electronic debit transactions over any network that may process such transactions.

Section 920(a) requires the Board to establish interchange fee standards no later than April 21, 2011, and that section becomes effective on July 21, 2011. Section 920(b) requires the Board to issue rules that prohibit network exclusivity arrangements and debit card transaction routing restrictions no later than July 21, 2011, but does not establish an effective date for these provisions.

On December 28, 2010, the Board requested public comment on a proposed rule for implementing these provisions of the Dodd-Frank Act. As explained below, the Board received comments from more than 11,500 commenters regarding this proposal, including comments from issuers, payment card networks, merchants, consumers, consumer advocates, trade associations, and members of Congress. Prior to publishing its proposed rule, the Board also conducted a survey of issuers covered by EFTA Section 920 and of payment card networks to gather information regarding electronic debit transactions and related costs. Based on its review of the comments, the statutory provisions, the data available to the Board regarding costs, its understanding of the debit payment system, and other relevant information,

and for the reasons explained below, the Board has adopted this final rule. A companion interim final rule providing for a fraud-prevention adjustment to the interchange fee standards was also adopted, with a request for comment on the interim final rule.

See

companion interim final rule published separately in the

Federal Register

II. The Debit Card Industry

A. Overview of the Debit Card Industry

When introduced in the late 1960s and early 1970s, debit cards provided a new way for consumers to access funds in their deposit accounts, supplementing more traditional means such as checks and in-person withdrawals at bank branches.

Although initially debit cards were used to withdraw cash or perform other banking activities at ATMs, the system evolved to support payments made by consumers for the purchase of goods or services at merchants. Cardholders are also able to use their debit cards to get cash back at certain point-of-sale locations as part of the purchase transaction. Debit cards are generally issued by depository institutions to their deposit account holders.

Check use has been declining since the mid-1990s as checks (and most likely some cash payments) are being replaced by electronic payments (

e.g.,

debit card payments, credit card payments, and automated clearing house (ACH) payments).

Debit cards now play a prominent role in the U.S. payments system. Debit card payments have grown more than any other form of electronic payment over the past decade, increasing to 37.9 billion transactions in 2009.

Debit cards are used in 35 percent of noncash payment transactions, and have eclipsed checks as the most frequently used noncash payment method. Almost half of total third-party debits to deposit accounts are made using debit cards, compared to approximately 30 percent made by checks.

7 8

Debit cards are accepted at about 8 million merchant locations in the United States.

The numbers in this discussion are derived from the 2010 Federal Reserve Payments Study, available at

http://www.frbservices.org/files/communications/pdf/press/2010_payments_study.pdf.

Accordingly, these figures may vary from those discussed in connection with the Board's survey of covered issuers and payment card networks.

Third-party debits are those debits initiated to pay parties other than the cardholder. These third-party debit numbers are derived from the 2010 Federal Reserve Payments Study. The Study reported that a total of 108.9 billion noncash payments were made in 2009, 35 percent of which were debit card payments. For purposes of determining the proportion of noncash payments that were third-party debits to accounts, ATM cash withdrawals and prepaid card transactions are excluded from the calculation.

Board staff projects that debit card transactions will total about 50 billion in 2011.

A more recent innovation in card-based payments is the introduction of prepaid cards. Prepaid cards may or may not be reloadable and may be accepted broadly or restricted to purchases at particular merchants or for specific types of products. Prepaid card transaction volume is still low in comparison to other forms of electronic payments, such as debit cards, but is increasing rapidly. In particular, prepaid cards were used for 6 billion transactions in 2009, valued at $140 billion, with average annual growth rates of prepaid transaction volume and value of more than 20 percent between 2006 and 2009.

These prepaid numbers are based on the 2010 Federal Reserve Payments Study, which gathered information on both general-use and private-label prepaid cards. According to that study, of the reported 6.0 billion prepaid card transactions in 2009, 1.3 billion were general-use prepaid card transactions, valued at $40 billion, and 4.7 billion were private-label prepaid card and electronic benefit transfer (“EBT”) card transactions, valued at $90 billion. Combined, in 2009, debit and prepaid cards accounted for 43.9 billion transactions or 40 percent of noncash payment transactions. Debit and prepaid card transaction volume of 37.6 billion reported by networks in the Board's interchange survey differed from the transaction volume of 39.2 billion (excluding private-label prepaid and EBT card transactions) reported in the Federal Reserve Payments Study because some networks reported different volumes in the two surveys.

In general, there are two types of debit card authentication methods on which current systems are based: PIN (personal identification number) and signature.

The infrastructure for PIN debit networks differs from that for signature debit networks. PIN debit networks, which evolved from the ATM networks, are single-message systems in which authorization and clearing information is carried in a single message. Signature debit networks, which leverage the credit card network infrastructure, are dual-message systems, in which authorization information is carried in one message and clearing information is carried in a separate message.

Increasingly, however, cardholders authorize “signature” debit transactions without a signature and, sometimes, may authorize a “PIN” debit transaction without a PIN. PIN-based and signature-based debit also may be referred to as “PIN debit” and “signature debit.”

The authentication methods available for a given transaction generally depend on features of the consumer's card, the transaction, and the merchant's acceptance policy. According to the Board's survey of covered card issuers, more than 70 percent of debit cards outstanding (including prepaid cards) support both PIN- and signature-based transactions (88 percent, excluding prepaid cards).

In the current environment, however, certain transactions, such as transactions for hotel stays or car rentals, where the exact amount of the transaction is not known at the time of authorization, cannot readily be accommodated on PIN-based, single-message systems. In addition, PIN debit transactions generally are not currently accepted for Internet, telephone, and mail transactions. Overall, information collected by the Board indicates that roughly one-quarter of the merchant locations in the United States that accept debit cards have the capability to accept PIN-based debit transactions. Further, as discussed below in connection with § 235.2(m), new types of debit card transactions are emerging that are not “PIN-based” or “signature-based” as those terms traditionally have been used and use new cardholder authentication methods.

“Covered issuers” are those issuers that, together with affiliates, have assets of $10 billion or more.

Debit card transactions typically are processed over one of two types of systems, often referred to as three-party and four-party systems.

The so-called four-party system is the model used for most debit card transactions; the four parties are the cardholder, the entity that issued the payment card to the cardholder (the issuer), the merchant, and the merchant's bank (the acquirer or merchant acquirer).

The network receives transaction information and data from the acquiring side of the market, routes the information to the issuer of the card (authorization and clearing), and determines each side's daily net settlement positions for interbank monetary transfers.

Industry participants sometimes refer to four-party systems as “open loop” systems and three-party systems as “closed loop” systems.

Throughout this rule, the term “bank” may be used to refer to any depository institution.

The term “four-party system” is something of a misnomer because the network is, in fact, a fifth party involved in a transaction.

In a three-party system, one entity acts as issuer and system operator, and often as acquirer as well. Thus, the three parties involved in a transaction are the cardholder, the merchant, and the system operator. The three-party model is used for some prepaid card transactions, but currently is not used for other debit card transactions in which the cardholder is debiting his or her bank account.

In a typical four-party system transaction, the cardholder initiates a purchase by providing his or her card or card information to a merchant. In the case of PIN debit, the cardholder also

enters a PIN. An electronic authorization request for a specific dollar amount, along with the cardholder's account information, is sent from the merchant to the acquirer to the network, which sends the request to the appropriate card-issuing institution.

The issuer verifies, among other things, that the cardholder's account has sufficient funds to cover the transaction amount and that the card was not reported as lost or stolen. A message approving or declining the transaction is returned to the merchant via the reverse path, usually within seconds of the authorization request.

Specialized payment processors may carry out some functions between the merchant and the network or between the network and the issuer.

The clearing of a debit card transaction is effected through the authorization message (for PIN debit systems) or a subsequent message (for signature debit systems). The issuer posts the debits to the cardholder's account based on these clearing messages. Based on all clearing messages received in one day, the network calculates and communicates to each issuer and acquirer its net debit or credit position for settlement. The interbank settlement generally is effected through a settlement account at a commercial bank, or through ACH transfers. The acquirer credits the merchant's account for the value of its transactions, less the merchant discount, as discussed below. The timing of this crediting is determined by the merchant-acquirer agreement and/or ACH operator rules. In some circumstances, an acquirer that is also the issuer with respect to a particular transaction may authorize and settle that transaction internally.

Various fees are associated with debit card transactions. The interchange fee is set by the relevant network and paid by the acquirer to the issuer; the network accounts for the interchange fee in determining each issuer's and acquirer's net settlement position. Switch fees are charged by the network to acquirers and issuers to compensate the network for its role in processing the transaction.

The acquirer charges the merchant a merchant discount—the difference between the face value of a transaction and the amount the acquirer transfers to the merchant—that includes the interchange fee, network switch fees charged to the acquirer, other acquirer costs, and an acquirer markup. The interchange fee typically comprises a large fraction of the merchant discount for a card transaction.

A variety of other network fees, such as membership fees and licensing fees, may be collected by the network from the issuer or acquirer.

Merchant discounts generally follow two forms: interchange-plus pricing and blended. If an acquirer is charging an interchange-plus merchant discount, the acquirer passes through the exact amount of the interchange fee for each transaction. If an acquirer is charging a blended merchant discount, the acquirer charges the same discount regardless of the interchange fee that applies to each transaction.

When first introduced, some PIN debit networks structured interchange fees in a manner similar to ATM interchange fees.

For ATM transactions, the cardholder's bank generally pays the ATM operator an interchange fee to compensate the ATM operator for the costs of deploying and maintaining the ATM and providing the service. Similarly, some PIN debit networks initially structured interchange fees to flow from the cardholder's bank to the merchant's bank to compensate merchants for the costs of installing PIN terminals and making necessary system changes to accept PIN debit at the point of sale. In the mid-1990s, these PIN debit networks began to shift the direction in which PIN debit interchange fees flowed. By the end of the decade, interchange fees for all PIN debit transactions in the United States were paid by acquirers to card issuers.

In the late 1970s, bank consortiums formed numerous regional electronic funds transfer (“EFT”) networks to enable their customers to withdraw funds from ATMs owned by a variety of different banks. The EFT networks were first used to handle PIN debit purchases at retailers in the early 1980s. It was not until the mid-1990s, however, that PIN debit became a popular method of payment for consumers to purchase goods and services at retail stores.

Debit Card Directory

(1995-1999).

See

also,

Fumiko Hayashi, Richard Sullivan, & Stuart E. Weiner, “A Guide to the ATM and Debit Card Industry” (Federal Reserve Bank of Kansas City 2003).

During the 1990s, most PIN debit networks employed fixed per-transaction interchange fees. Beginning around 2000, many PIN debit networks incorporated an

ad valorem (i.e.,

percentage of the value of a transaction) component to their interchange fees, with a cap on the total amount of the fee for each transaction. In addition, PIN debit networks expanded the number of interchange fee categories in their fee schedules. For example, many networks created categories based on merchant type (

e.g.,

supermarkets) and began to segregate merchants into different categories based on transaction volume (

e.g.,

transaction tiers). Over the course of the 2000s, most PIN debit networks raised the levels of the fixed and

ad valorem

components of fees, in addition to raising the caps on overall fees. By 2010, some networks had removed per-transaction caps on many interchange fees.

In general, interchange fees for signature debit networks, like those of credit card networks, combine an

ad valorem

component with a fixed fee component. Unlike some PIN debit networks, interchange fees for signature debit networks generally do not include a per-transaction cap. Beginning in the early 1990s, signature debit networks also began creating separate categories for merchants in certain market segments (

e.g.,

supermarkets and card-not-present transactions) to gain increased acceptance in those markets.

Until 2003, interchange fee levels for signature debit transactions were generally similar to those for credit card transactions and significantly higher than those for PIN debit card transactions. However, PIN debit fees began to increase in the early 2000s, as noted above, while signature debit fees declined in late 2003 and early 2004.

More recently, both PIN and signature debit fees have increased, although PIN debit fees have increased at a faster pace.

Card-not-present transactions occur when the card is not physically presented to the merchant at the time of authorization. Examples include Internet, phone, and mail-order purchases.

This decline followed the settlement of litigation surrounding signature debit cards.

See In re: Visa Check/MasterMoney Antitrust Litigation,

192 F.R.D. 68 (E.D.N.Y. 2000).

In addition to setting the structure and level of interchange fees and other fees to support network operations, each card network specifies operating rules that govern the relationships between network participants. Although network rules generally apply to issuers and acquirers, merchants and processors also may be required to comply with a network's rules or risk losing access to that network. Network operating rules cover a broad range of activities, including merchant card acceptance practices, technological specifications for cards and terminals, risk management, and determination of transaction routing when multiple networks are available for a given transaction.

B. Summary Information About Interchange Fees and Transaction Costs

In September 2010, the Board surveyed issuers that would be subject to the interchange fee standards and payment card networks to gather information to assist the Board in developing its proposed rule.

Preliminary summary information was provided in the Board's proposal.

An updated and more detailed summary of this information is provided in “2009 Interchange Revenue, Covered Issuer Costs, and Covered Issuer and Merchant Fraud Losses Related to Debit Card Transactions.”

What follows is a brief high-level summary of the survey data responses on interchange fees, issuer costs, and merchant and issuer fraud losses. The data results represent only covered issuers and networks that responded to the survey.

The Board also surveyed the nine largest merchant acquirers, all of which responded to the survey and provided information on the number and volume of debit card transactions that they processed, the number of merchants that accepted

various types of debit cards, fraud losses, fraud prevention activities and costs, and exclusivity arrangements and routing procedures.

75 FR 81724-26, 81740-42 (Dec. 28, 2010).

http://www.federalreserve.gov/paymentsystems/files/debitfees_costs.pdf

Most respondents did not provide information for every data element requested in the surveys. As discussed further below under § 235.3, when determining the interchange fee standard, the Board considered only data from issuers that provided information for each included cost.

Card use.

Payment card networks reported a total of approximately 37.6 billion debit (including prepaid) card purchase transactions in 2009, with an aggregate value of more than $1.4 trillion. Signature-based transactions accounted for 22.5 billion or 60 percent of all purchase transactions, and $837 billion or 59 percent of transaction value. PIN-based debit transactions totaled 13.9 billion or 37 percent of purchase transactions, and $555 billion or 39 percent of transaction value. General-use prepaid card transactions represented 1.2 billion or 3 percent of purchase transactions and $38 billion or 3 percent of purchase transaction value. The average value of all purchase transactions was $38.03, with the average values of signature debit, PIN debit, and prepaid card transactions being $37.15, $40.03, and $31.47, respectively.

Interchange fees.

Networks reported that debit card interchange fees totaled $16.2 billion in 2009. Of this interchange-fee revenue, $12.5 billion was for signature debit transactions, $3.2 billion was for PIN debit transactions, and $0.5 billion was for prepaid card transactions. The average interchange fee for all debit card transactions was 44 cents per transaction, or 1.15 percent of the average transaction amount. The average interchange fee for signature debit transactions was 56 cents, or 1.53 percent of the average transaction amount. The average interchange fee for PIN debit transactions was significantly lower, at 23 cents per transaction, or 0.58 percent of the average transaction amount. Prepaid card interchange fees averaged 40 cents per transaction, or 1.28 percent of the average transaction amount.

Some of these numbers differ from those published in the

Federal Register

notice of proposed Regulation II (75 FR 81725 (Dec. 28, 2010)) because several networks subsequently submitted corrections to previously provided data. In one instance, a network corrected the number of prepaid transactions and PIN debit transactions.

Issuer processing costs.

The Board's survey requested covered issuers to report their total transaction processing costs, including fixed and variable costs and network processing fees associated with authorization, interbank clearing and settlement, and cardholder account posting for routine purchase transactions and non-routine transactions, such as chargebacks and errors. The median per-transaction total processing cost across issuers for all types of debit card transactions was 11 cents per transaction. The 80th percentile of per-transaction total processing cost across issuers for all types of debit card transactions was 19 cents.

For signature debit transactions, the median issuer per-transaction cost was 13 cents and the 80th percentile was 21 cents. For PIN debit transactions, the median and 80th percentile issuer per-transaction costs were 8 cents and 14 cents, respectively. For prepaid card transactions, they were 61 cents and $1.52, respectively.

Issuer fraud-prevention and data-security costs.

The median issuer cost for all debit card-related fraud-prevention activities (excluding data-security costs, which were reported separately) was approximately 1.7 cents and the 80th percentile was 3.1 cents. The most commonly reported fraud-prevention activity was transaction monitoring. The median issuer cost for transaction monitoring was 0.7 cents, and the 80th percentile was 1.2 cents. The remaining costs related to a variety of fraud-prevention activities, including research and development, card activation systems, PIN customization, merchant blocking, and card authentication systems; the per-transaction cost of each individual activity was small, typically less than one-tenth of a cent. The median total data-security cost reported by issuers was approximately 0.1 cents and the 80th percentile was 0.4 cents.

Network Fees and Incentives.

The payment card networks reported various network fees that they charge to issuers and acquirers. Total network fees exceeded $4.1 billion. Networks charged issuers more than $2.3 billion in fees and charged acquirers over $1.8 billion in fees. Almost 76 percent of the total fees paid, or $3.1 billion, were charged by signature debit networks. More than $3.4 billion, or 82 percent of total fees paid, were assessed on a per-transaction basis. Networks paid issuers almost $700 million and acquirers more than $300 million in discounts and incentives. Of the total incentives or discounts paid by networks, 81 percent were paid by signature networks.

Fraud losses.

The Board estimates that industry-wide fraud losses to all parties of a debit card transaction were approximately $1.34 billion in 2009. About $1.11 billion of these losses arose from signature debit card transactions, about $181 million arose from PIN debit card transactions, and almost $18 million arose from prepaid card transactions.

Across all transaction types, the median number of purchase transactions that were fraudulent was about 3 of every 10,000 transactions. The medians for signature, PIN, and prepaid debit card were 4, less than 1, and 1 of every 10,000 transactions, respectively. The median loss per purchase transaction incurred by both issuers and merchants was about 3 cents.

The median fraud loss as a percent of purchase transaction value was about 9 basis points. For issuers alone, the median loss per purchase transaction was about 2 cents, and the median fraud loss as a percent of purchase transaction value was approximately 5 basis points.

Revisions in the data plus the inclusion of prepaid card fraud have led to changes to some of the industry-wide fraud loss estimates that were included in the proposal. 75 FR 81740-41 (Dec. 28, 2010). The higher losses for signature debit card transactions result from both a higher rate of fraud and higher transaction volume for signature debit card transactions. The sum of debit card program fraud losses will not equal the industry-wide fraud losses due to different sample sizes and rounding.

Issuers charge back transactions to acquirers that, in turn, typically pass on the chargeback value to the merchant.

For signature debit, the median loss per purchase transaction to both issuers and merchants was 5 cents, and the median fraud loss as a percentage of purchase transaction value was about 12 basis points. This corresponds to a median fraud loss per purchase transaction to issuers of 3 cents and a median fraud loss as a percentage of purchase transaction value of 7 basis points. For PIN debit, the median loss per purchase transaction to both issuers and merchants was 1 cent and the median fraud loss as a percentage of purchase transaction value was about 3 basis points. This corresponds to a median fraud loss per purchase transaction to issuers of 1 cent and a median fraud loss as a percentage of purchase transaction value of 2 basis points. For prepaid, the median loss per purchase transaction to both issuers and merchants was 1 cent, and the median fraud loss as a percentage of purchase transaction value was 3 basis points. This corresponds to a median fraud loss per purchase transaction to issuers of 1 cent and a median fraud loss as a percentage of purchase transaction value of 2 basis points.

Across all types of transactions, 62 percent of reported fraud losses were borne by issuers and 38 percent were borne by merchants. The distribution of fraud losses between issuers and merchants differs significantly based on

the cardholder authentication method used in a debit card transaction. Issuers reported that nearly all the fraud losses associated with PIN debit transactions (96 percent) were borne by issuers. By contrast, reported fraud losses for signature debit and prepaid card transactions were distributed more evenly between issuers and merchants. Specifically, issuers and merchants bore 59 percent and 41 percent of signature debit fraud losses, respectively. Issuers and merchants bore 67 percent and 33 percent of prepaid fraud losses, respectively.

Other debit card program costs.

The issuer survey collected information on other costs related to debit card programs, including costs associated with card production and delivery, cardholder inquiries, rewards and other incentives, research and development, nonsufficient funds handling, and compliance. For each issuer that reported these costs, the costs were averaged over the total number of debit card transactions processed by the issuer. The median per transaction cost of production and delivery of cards was 2 cents, cardholder inquiries 3 cents, rewards and other incentives 2 cents, research and development 1 cent, nonsufficient funds handling 1 cent, and compliance less than 0.5 cents.

C. Comparison to Checking Transactions

1. Summary of Proposal and Comments

EFTA Section 920(a)(4)(A) requires the Board to consider, in prescribing standards governing debit interchange fees, the functional similarity between electronic debit transactions and checking transactions that are required to clear at par within the Federal Reserve System. As part of its proposal, the Board described both the similarities and differences between electronic debit transactions and checking transactions. The similarities noted by the Board included the fact that both types of transactions result in a debit to an asset account; both involve electronic processing and, increasingly, deposit; both involve processing fees paid by merchants to banks and other intermediaries; and both have similar settlement timeframes. The differences noted by the Board included the closed nature of debit card systems compared to the open check clearing and collection system; the payment authorization that is an integral part of electronic debit card transactions (but not check transactions), which guarantees that the transaction will not be returned for insufficient funds or certain other reasons (

e.g.

, a closed account); processing and collection costs incurred by the issuer (analogous to the payor's bank) for electronic debit transactions but not for check; par clearance in the check system; restricted routing choice in the debit card environment; and the ability to reverse electronic debit transactions within the normal processing system.

See

75 FR 81734 (Dec. 28, 2010) for a more detailed comparison between checks and electronic debit transactions in the Board's proposal.

The Board considered the functional similarity between electronic debit transactions and checks in determining which allowable costs to include under its proposal. In part based on this comparison, the Board proposed to include only those costs that are incurred with respect to a particular transaction that are related to authorization, clearance, and settlement of the transaction. The Board noted that a payor's bank in a check transaction (analogous to the issuer in a debit card transaction) would not recoup such costs from the payee's bank (analogous to the merchant acquirer in a debit card transaction), but that these were costs that EFTA Section 920(a) specifically directed the Board to consider in setting standards governing interchange transaction fees.

The Board received several comments from issuers, networks, and merchants on the functional similarities and differences between electronic debit transactions and check transactions, as well as comments on how the Board should take those similarities and differences into consideration. Merchants and their trade groups suggested that the starting point for the comparison to checks should be the cost savings that issuers receive from processing a debit card transaction rather than a check.

By contrast, numerous issuers and networks asserted that the Board's interchange fee standards should reflect not only the similarities between checks and debit cards, but also the differences between checks and debit cards. As a result, these commenters believed that the comparison to checks would expand the scope of allowable costs. Several issuers and networks argued that, by tying the amount of an interchange fee to the cost of an electronic debit transaction, Congress recognized that the debit card pricing system should be different from the check pricing system. These commenters argued that the Board should consider all costs that issuers incur for electronic debit transactions, regardless of whether the payor's bank would be able to recoup similar costs from the payee's bank in a check transaction.

Many issuers and networks suggested that the Board's interchange fee standards should account for the benefits merchants receive from accepting debit cards instead of checks. The benefits of debit cards to merchants that were cited include the payment guarantee; the avoidance of fees and other costs of handling checks;

faster availability of funds; faster check-out at the point-of-sale; increased sales value and volume; the ability to engage in certain types of transactions where checks are not practical (

e.g.

, Internet); and resolution of disputes through network rules and mediation rather than through the legal system.

Cited costs of checks included per-item and batch deposit fees, check return fees, re-clearance fees, and an optional guarantee service.

Some commenters argued that the benefits of debit cards over checks are also benefits of debit cards over cash.

Some issuer and network commenters suggested that the Board also consider the benefits to consumers of using debit cards instead of checks. Such benefits cited by the commenters included wide acceptance of debit cards by merchants, ease of use, and speed of transactions. More generally, some commenters noted that the increase in debit card use and decline in check use are indicative of greater value from debit cards to all parties. One network stated that interchange fee revenue has given issuers an incentive to innovate, allowing them to provide to merchants a product that is superior to checks.

One difference between electronic debit transactions and check transactions that commenters highlighted is the payment guarantee for electronic debit transactions. Numerous issuers and networks stated that, unlike checks, debit card transactions are guaranteed by issuers against insufficient funds in an account. These commenters stated that a comparable service for checks costs merchants 1.5 percent of the transaction value. Accordingly, several commenters argued that the Board should compare merchants' debit card acceptance costs to the cost of accepting a guaranteed check. Some commenters contended that failure to compensate issuers for the payment guarantee could decrease its availability.

The Board has considered the comments received and has revised its analysis of the comparison of check and electronic debit transactions, as set out below.

2. Comparison of Check and Electronic Debit Transactions

Typical check transaction.

Checks can be collected, presented, returned, and settled through an interbank system or through an intrabank system, in the case of checks deposited and drawn on the same bank (

i.e.,

“on-us” checks). A typical check transaction is initiated by the payor (such as a consumer) writing a check drawn on the bank maintaining the payor's account to the order of a payee (such as a merchant). The payee receives as a payment the signed check and deposits the check with its bank for collection. The payee's bank has several choices in directing the presentment of the check to the payor's bank for payment. The payee's bank may (i) present the check for payment directly to the payor's bank, (ii) use a check clearing house, or (iii) use the services of an intermediate collecting bank, such as a Federal Reserve Bank or another correspondent bank.

Upon presentment, the payor's bank settles with the presenting bank (either the payee's bank or an intermediate collecting bank) for the amount of the check and debits the amount of the check from the account of the payor. In some cases, the payee's bank may also be the payor's bank, in which case the bank settles the check internally.

See

the discussion above providing an overview of the debit card industry for a description of the typical electronic debit transaction.

Check clearing houses generally provide a facility or mechanism for banks to exchange checks for collection and return. The services provided by check clearing houses vary. Some merely provide the capability to exchange checks. Others provide the capability to exchange between banks in electronic form. A check clearing house generally also facilitates settlement of the checks exchanged through it.

Functional similarities.

There are a number of similarities between check and debit card payments. Both are payment instructions that result in a debit to the payor's account. Debit card payments are processed electronically, which is increasingly true for checks as well. For both check and debit card payments, merchants pay fees to banks, processors, or intermediaries to process the payments. Interbank settlement times are roughly similar for both payment types, with payments typically settling between banks on the same day, or one day after, the transaction is cleared. Settlement to the payee's account typically occurs within one or two days after the payee deposits the check or submits the debit card transaction to its bank.

Dissimilarities.

As noted by many commenters, there are also important functional differences between the check and debit card payment systems. Some commenters argued that the debit card authorization, clearance, and settlement infrastructure has no direct corollary in the check system, and therefore, the comparison between check and debit card payment systems is inappropriate. The Board notes that EFTA Section 920(a)(4)(A) requires the Board to consider the functional similarities between checking transactions and electronic debit transactions. The Board recognizes that there are also important differences between the two types of transactions, including those discussed below.

Closed network versus open system.

Debit card systems are “closed” systems (relative to check systems) in that both issuing and acquiring banks must join a network in order to accept and make payments. To accept debit cards, a merchant must select an acquirer and make decisions as to the network(s) in which it will participate. Issuers and acquirers that are members of a network must establish a relationship with that network and agree to abide by that network's rules. These network rules include network-defined chargeback and liability allocation rules, network-defined processing and dispute handling requirements, and network fee schedules.

In addition to the network rules, the EFTA establishes the basic rights, liabilities, and responsibilities of consumers who use electronic fund transfer services and of financial institutions that offer these services.

The merchant's choice with regard to routing a debit card transaction is limited to the set of networks whose cards the merchant accepts and that are also enabled to process a transaction on the customer's card. Until the effective date of Regulation II, merchant transaction routing may be further limited if the card issuer or a network has designated network routing preferences on cards that are enabled on multiple networks. These issuer or network routing preferences may result in a transaction being routed to a network that imposes a higher fee on the acquirer (and hence the merchant) than if the payment were processed on another available network.

By contrast, the check system is an open system in which, as a practical matter, a merchant simply needs a banking relationship through which it can collect checks in order to be able to accept check payments from its customers. The payee's bank (

i.e.

, the merchant's bank) need not join a network in order to collect a check. The rules governing checks are established by generally uniform state laws (

e.g.

, the Uniform Commercial Code), the Expedited Funds Availability Act, and the Board's Regulation CC (12 CFR part 229). These laws and rules provide a common legal framework for all check system participants. The participants, however, may vary certain parts of those rules, such as by arranging to accept or send electronic images in place of the paper checks.

The routing of checks for collection is not limited in the same way as the routing of electronic debit transactions. A payee's bank is free to use its least costly option for collecting a check. Intermediary collecting banks generally compete on the basis of price and funds availability. Typically price and availability vary within an intermediate collecting bank's service menu depending on the level of processing the collecting bank is required to do (

e.g.,

whether the payee's bank sends checks in paper form or via electronic image) and depending on the time of day the checks are received. If participants agree to send electronic images instead of the paper checks, the sending bank must have an agreement with the bank to which it is sending the image.

Payment authorization and guarantee.

Payment authorization is an integral part of the processing of a transaction on a debit card network. As part of the payment authorization process, at the start of a transaction, a card issuer determines, among other things, whether the card is valid and whether there are sufficient funds to cover the payment. Several commenters (predominantly issuers and their trade associations) emphasized that part of the approval includes a “payment guarantee,” which refers to the issuers' agreement to fund a transaction authorized by the issuer regardless of whether customer funds are actually available at the time of the settlement of the transaction, subject to certain predefined chargeback rights. These commenters argued that the cost of this “guarantee” is a settlement or authorization cost incurred by issuers when they pay acquirers funds to settle the transaction and the cardholder has insufficient funds in the account to cover the transaction. Many merchant commenters, as well as issuers, stated that a debit card payment is provisional because the transaction may be charged back in certain circumstances, such as when it is later discovered that the transaction was not properly authorized by the customer.

By contrast, payment authorization is not an inherent part of the check collection process, and therefore the acceptance of a check by a merchant for payment does not include any automatic “guarantee” that the check

will be honored and the payment will be made. Merchants, however, can purchase check verification and guarantee services from various third-party service providers. These service providers offer varying levels of check guarantee and verification services that are structured in various ways. In a check “guarantee” service, a check guarantee provider may verify whether currently outstanding returned checks are associated with that payor or the checking account, as well as verify open/closed account status and valid/invalid routing and account numbers, although the service generally cannot verify the amount of funds in the payor's account.

If a check meets all of the guarantee service's criteria (such as no known outstanding bad checks drawn by the customer), the service authorizes acceptance by the merchant and accepts the risk of loss on the check.

If a check is subsequently returned unpaid, the merchant will be reimbursed by the check guarantee provider for the value of the returned check.

Based on information available to the Board, a check guarantee service requires extra steps at the time of a transaction and is not integrated into check processing the same way that the authorization and guarantee is integrated into the debit card transaction. Each check is entered into the system by inputting the check's MICR information on either a manual or automated basis. The merchant also enters customer identification information, such as the driver's license number. The guarantor then sends a return message to the merchant.

The service provider may have exceptions to its guarantee and these exceptions may vary across service providers.

The merchant pays a fee for the check guarantee service. Based on available information, the Board understands that a check guarantee provider typically charges the merchant a percentage of the face value of all checks that are accepted, in addition to various other service charges. The fee structures vary by the service provider and also can vary by merchant type and perceived risk, but one commenter asserted that check guarantee services typically charge between 1.0 percent and 1.5 percent of the face amount of the check and a 25 cent per-check fee, as well as a monthly customer service fee.

See, e.g.,

Comment letter from American Bankers Association, p. 7.

Another service offered is a check “verification” product, which does not include a guarantee. A check verification service may use database searches similar to a check guarantee service to approve or decline any given check transaction.

The check verification service, however, leaves the risk of an unpaid check with the merchant.

Some check verification services also provide the merchant with a reason for a decline, so the merchant can make a more informed decision as to whether to accept the check on a customer-by-customer basis.

See http://www.ncms-inc.com/check-verification.aspx.

Various fees are charged for check verification services, and the fee structure and levels can vary by service provider and merchant. Based on information available to the Board, check verification services may charge a per transaction fee of about 25 cents with a $20 monthly minimum and may charge a monthly service fee.

Unlike the check guarantee services, the check verification services do not appear to also charge a fee based on the amount of the check.

See http://www.nobouncedchecks.com/SCAN-check.html

Payment of processing and collection costs.

In the check system, payments clear at par. When a presenting bank (either the payee's bank or an intermediary collecting bank) presents a check to the payor's bank, the payor's bank pays, and the presenting bank receives, the face value of the check (

i.e.,

“par clearing”). The presenting bank typically does not pay a fee to the payor's bank in order to receive settlement for the check. In addition, the payor's bank does not pay fees to the presenting bank to receive check presentment unless the payor's bank has agreed to pay a fee to receive presentment electronically.

The payee's bank and any subsequent collecting bank incur costs to collect the check. A payor's bank incurs costs to be able to accept presentment of the check, to determine whether or not to pay the check, and to remit funds for settlement. One commenter indicated that these costs exceeded debit card processing costs. The payor's bank recoups some or all of these costs through fees it charges to its customers or the interest it earns on the customer's balances.

If both the presenting bank and the payor's bank have voluntarily joined a check clearing house, they may pay fees to the clearing house.

By contrast, in the debit card system, the merchant does not receive the full face value of the debit transaction. The merchant pays fees to its acquirer in the form of a discount on the value of each transaction for the services rendered in processing the transaction. The acquirer, in turn, pays an interchange fee to the issuing bank on each debit transaction, which is deducted from the amount of the debit card transaction in the daily net settlement calculations. The acquirer and issuer both pay fees to the network to process electronic debit transactions. As discussed in more detail below, the issuer incurs costs to authorize, clear, and settle debit card transactions, as well as other costs related to debit card programs. Likewise, the acquirer incurs costs to send authorization and clearing messages, as well as for interbank settlement and crediting the merchant's account.

Payee deposit and availability.

A debit card transaction is initiated in an electronic format and sent electronically to the acquiring bank; the proceeds are then deposited in the merchant's bank account electronically and made available to the merchant in accordance with the agreement between the merchant and its acquirer.

With respect to paper checks, the check must be physically accepted by the merchant, and deposited in its bank and then sent through the check clearing process to the payor's bank. The proceeds of a typical check generally must be made available to the payee within one or two business days of deposit.

Banks may, and sometimes do, make check deposits available for withdrawal faster than the law requires.

See

Regulation CC, 12 CFR part 229.

Some merchants may take advantage of “remote deposit capture” services from their bank wherein a paper check is scanned to create an electronic image that is sent to the merchant's bank electronically for deposit.

Remote deposit capture can decrease processing costs and improve customers' access to their deposits.

One commenter stated, however, that although some merchants may use remote deposit capture, many do not for a variety of reasons, including inconvenience, lack of eligibility, and cost.

Depository institutions charge a variety of fees for remote deposit capture, which may vary by depository institution and customer, but typically include a monthly service fee, a per-item fee, equipment lease/purchase fee, and various other fees. Some banks charge a monthly service fee and a fee for leasing the check scanner, although a customer may purchase a scanner.

bank also may charge a per-item fee and a client set-up fee.

Remote deposit capture was made practicable by the Check Clearing for the 21st Century Act (Check 21 Act), codified at 12 U.S.C. 5001 note.

FFIEC,

Risk Management of Remote Deposit Capture

(Jan. 14, 2009). Certain risks, however, may be elevated with respect to remote deposit capture when compared to paper checks. For example, duplicate deposits, check alteration, and forged or missing indorsements may be more difficult to detect in remote deposit capture.

Id.

p.5.

The elevated fraud risk may cause some banks to offer remote deposit capture only to creditworthy corporate customers with appropriate back office and control environments.

FDIC Supervisory Insights (Summer 2009),

available at http://www.fdic.gov/regulations/examinations/supervisory/insights/sisum09/primer.html

See, e.g., http://www.firstbankak.com/home/bs/remotedepositcapture/rdc_faq#15.

Ability to reverse transactions.

In the check system, there is a limited amount of time during which the payor's bank may return a check to the payee's bank. Specifically, the payor's bank must initiate the return by its “midnight deadline,” which is midnight of the banking day after the check was presented to the payor's bank for payment.

After the midnight deadline passes, the payor's bank can no longer return the payment through the check payment system, although it may have legal remedies, such as warranty claims, outside the check collection system.

Such legal remedies may be available, for example, if a payor notifies its bank that the check was altered or that the indorsements on the check were forged and does so reasonably promptly if the payor's bank provides statements to the payor.

UCC 4-104(a)(10) (definition of “midnight deadline”).

UCC 4-301 and 4-302. The payor's bank may have a warranty claim for a forged indorsement or a material alteration, but, except in limited circumstances, would not have a claim based on insufficient funds or forged drawer's signature.

UCC 4-406.

The debit card system provides a much longer time within which a transaction may be reversed through the payment card network, as opposed to warranty claims outside the payments system. Typically, the time period for initiating resolution of a disputed transaction through the network is around 60 days, but may be longer.

Payment card network rules permit certain disputed transactions to be resolved through the payment card network. Specifically, if a transaction was not authorized or is incorrect, payment card network rules generally provide that, depending on the facts and circumstances, (1) the transaction is guaranteed and the amount of the transaction must be absorbed as a fraud loss by the issuer; or (2) the transaction can be charged back to the merchant that accepted the electronic debit transaction.

The Board's Regulation E (implementing other provisions of the EFTA) states that a consumer has 60 days to dispute the transaction as unauthorized or incorrect from the date that the consumer's depository institution posts an electronic debit transaction to the consumer's account and sends a statement to the consumer. 12 CFR 205.11(b).

Morrison & Foerster comment letter, p.10.

Acceptance by merchants and consumers.

The use of debit cards by consumers is increasing, while the use of checks is decreasing.

The increase of electronic payments and the decline of checks can be attributed to technological and financial innovations that influence the payment choices of consumers and businesses. Commenters (predominantly issuers, networks, and consumers) provided other reasons for these trends, such as ease and speed of the debit card transaction and the fact that customers do not need to leave a physical copy of their names and addresses with the merchant after a debit card transaction, as they would with checks. Many issuer and network commenters asserted that merchants also are increasingly accepting debit cards because debit cards increase the amount of money consumers spend at the point of sale.

Between 2006 and 2009, check transactions decreased by an average of 7.1% annually and debit card transactions increased by an average of 14.8% annually.

See

The 2010 Federal Reserve Payments Study.

In addition, debit transactions are used in many situations that do not readily lend themselves to the use of checks, such as purchases made over the Internet or telephone, online recurring payments, vending machine transactions, self-service checkout purchases, and purchases at automated gas pumps. Also, foreign checks are not nearly as widely accepted by U.S. merchants as are debit cards issued by institutions in foreign countries. Consumers generally may use their debit cards at locations beyond their local area, regardless of the location of the card issuer.

As required by EFTA Section 920(a)(4)(A), the Board has taken the similarities between the functionality of electronic debit transactions and check transactions into account in establishing the standards for interchange fees under Section 920(a). The functional similarities between these two types of transactions can be understood only by considering the differences between them as well. Accordingly, the Board has also, in fulfilling the mandate in Section 920(a)(4)(A) and in the exercise of its discretion under Section 920(a), considered the differences between these two types of transactions in establishing standards for assessing whether interchange fees are reasonable and proportional to cost, as discussed below in the interchange fee standards section.

III. Summary of Proposal and Comments

A. Summary of Proposal

The Board requested comment on two alternative standards for determining whether the amount of an interchange transaction fee is reasonable and proportional to the cost incurred by the issuer with respect to the transaction. Under Alternative 1, an issuer could comply with the standard for interchange fees by calculating its allowable costs and ensuring that, unless it accepts the safe harbor as described below, it did not receive through any network any interchange fee in excess of the issuer's allowable costs. An issuer's allowable costs would be those costs that both are attributable to the issuer's role in authorization, clearance, and settlement of the transaction and vary with the number of transactions sent to an issuer within a calendar year (variable costs). The issuer's allowable costs incurred with respect to each transaction would be the sum of the allowable costs of all electronic debit transactions over a calendar year divided by the number of electronic debit transactions on which the issuer received or charged an interchange transaction fee in that year. The issuer-specific determination in Alternative 1 would be subject to a cap of 12 cents per transaction, regardless of the issuer's allowable cost calculation. Alternative 1 also would permit an issuer to comply with the regulatory standard for interchange fees by receiving or charging interchange fees that do not exceed the safe harbor amount of 7 cents per transaction, in which case the issuer would not need to determine its allowable costs.

Under Alternative 2, an issuer would comply with the standard for interchange fees as long as it does not receive or charge a fee above the cap, which would be set at an initial level of 12 cents per transaction. Each payment card network would have to set interchange fees such that issuers do not receive or charge any interchange fee in excess of the cap amount.

The Board requested comment on two general approaches to the fraud-prevention adjustment framework and asked several questions related to the two alternatives. One approach focused on implementation of major innovations that would likely result in substantial reductions in total, industry-wide fraud losses. The second approach focused on reasonably necessary steps for an issuer to maintain an effective fraud-prevention program, but would not prescribe specific technologies that must be employed as part of the program. The Board did not propose a specific amount as an adjustment to the amount of an interchange fee for an issuer's fraud-prevention costs.

As provided in EFTA Section 920, the Board proposed to exempt from the interchange fee restrictions issuers that, together with affiliates, have assets of less than $10 billion, and electronic

debit transactions made using either debit cards issued under certain government-administered programs or certain reloadable prepaid cards.

In order to prevent circumvention or evasion of the limits on the amount of interchange fee that issuers may receive or charge with respect to electronic debit transactions, the Board proposed to prohibit an issuer from receiving net compensation from a network for debit card transactions, excluding interchange transaction fees. For example, the total amount of compensation provided by the network to the issuer, such as per-transaction rebates, incentives, or payments, could not exceed the total amount of fees paid by the issuer to the network.

The Board requested comment on two alternative approaches to implementing the statute's required rules that prohibit network exclusivity. Under Alternative A, an issuer or payment card network may not restrict the number of payment card networks over which an electronic debit transaction may be processed to fewer than two unaffiliated networks. Under this alternative, it would be sufficient for an issuer to issue a debit card that can be processed over one signature-based network and one PIN-based network, provided the networks are not affiliated. Under Alternative B, an issuer or payment card network may not restrict the number of payment card networks over which an electronic debit transaction may be processed to fewer than two unaffiliated networks for each method of authentication the cardholder may select. Under this alternative, an issuer that used both signature- and PIN-based authentication would have to enable its debit cards with two unaffiliated signature networks and two unaffiliated PIN networks.

The Board proposed to prohibit issuers and payment card networks from restricting the ability of a merchant to direct the routing of electronic debit transactions over any of the networks that an issuer has enabled to process the electronic debit transactions. For example, issuers and payment card networks may not set routing priorities that override a merchant's routing choice. The merchant's choice, however, would be limited to those networks enabled on a debit card. In keeping with EFTA Section 920, no exemption was provided from the network exclusivity and routing provisions for small issuers or for debit cards issued pursuant to certain government-administered programs or certain reloadable general-use prepaid cards.

B. Summary of Comments

The Board received comments on the proposed rule from approximately 11,570 commenters. Of these commenters, approximately 7,080 were depository institutions or represented depository institutions (including trade groups, outside counsel, and consultants), approximately 3,020 were merchants or represented merchants (including trade groups, outside counsel, and consultants), 9 were payment card networks, 23 were payment processors, approximately 1,340 were individual consumers or represented consumer groups, 35 were members of Congress or represented government agencies, and 54 were other interested parties. Approximately 8,300 of the commenters submitted one of 17 form letters, and one letter was submitted on behalf of over 1,600 merchant commenters.

1. Overview of Comments Received

Merchants, their trade groups, and some consumers supported the Board's proposal and argued that the proposal would lower the current interchange fees (the savings of which could be passed on to consumers as lower retail prices), increase transparency in the system, and increase competition by prohibiting exclusivity arrangements and enabling merchant-routing choice. By contrast, issuers, their trade groups, payment card networks, and some consumers opposed the proposal for a range of reasons, including concern that it would decrease revenue to issuing banks; result in increased cardholder fees or decreased availability of debit card services; reduce benefits to merchants when compared to other forms of payment; not provide a workable exemption for small issuers; and stifle innovation in the payment system, among other things.

Interchange fee standards.

As between proposed Alternative 1 and proposed Alternative 2, merchants supported the more issuer-specific Alternative 1, arguing that issuer-specific fees would be a proxy for fees in a competitive issuer market place and that many covered issuers had per-transaction authorization, clearance, and settlement costs significantly below the proposed 12-cent cap. Likewise, merchants supported lowering the cap, some suggesting 4 cents (

i.e.,

the average per-transaction allowable costs across all transactions and issuers). Merchants argued that the proposed cap would allow some issuers to receive an interchange fee significantly higher than the proposed allowable costs of authorization, clearance, and settlement. Merchants overwhelmingly supported the Board's proposal to limit allowable costs to the variable costs of authorization, clearance, and settlement.

Issuers and networks urged the Board to adopt a more flexible approach to the standards by prescribing guidelines rather than a cap. Issuers typically favored the stand-alone cap in Alternative 2 over Alternative 1. Issuers suggested raising the safe harbor up to a level that permits a “substantial majority” of issuers to avail themselves of it. Issuers and networks supported raising the cap and safe harbor by expanding the allowable cost base to include such costs as the payment guarantee costs, fraud losses, network processing fees, customer service costs, the costs of rewards, fixed costs, and a return on investment.

Fraud-prevention adjustment.

Although there was not agreement on which approach to pursue, commenters generally agreed that the Board should not mandate use of specific technologies. Merchants generally favored the paradigm-shifting approach.

By contrast, issuers of all sizes and payment card networks preferred the non-prescriptive approach that would allow issuers to have the flexibility to tailor their fraud-prevention activities to address most effectively the risks they faced and changing fraud patterns. Among commenters, there was a general consensus that the fraud-prevention adjustment should be effective at the same time as the interchange fee standard—either on July 21, 2011, or at a later date as suggested by some commenters. This issue is addressed in the companion notice adopting an interim final rule providing a fraud-prevention adjustment.

Merchants proposed a framework where an issuer receives an adjustment only if both the merchant and issuer use an eligible low-fraud technology (

i.e.,

one that reduces fraud losses below PIN debit levels).

See

companion interim final rule published separately in the

Federal Register.

Exemptions.

Many issuers were concerned that the exemptions, and in particular the small-issuer exemption, would not be effective because all networks might not institute a two-tier fee structure or might not be able to implement such a structure by July 21, 2011. Additionally, issuers argued that, even if networks institute a two-tier fee structure, market forces and merchant routing choice would place downward pressure on interchange fees over time. Some issuers suggested the Board require that networks implement a two-tier fee structure. Other commenters suggested the Board initially monitor

implementation of two-tier fee structures (perhaps by requiring networks to report to the Board on whether and how they have implemented an interchange fee differential).

Additionally, some issuers and prepaid industry commenters supported exempting Health Savings Account (HSA), Flexible Spending Account (FSA), Health Reimbursement Account (HRA), and Qualified Transportation Benefit (QT) cards from the interchange fee standard because they believe Congress did not intend to cover such cards. By contrast, some merchant groups argued that HSA, FSA, HRA, or QT cards do not qualify for the exemption for reloadable prepaid cards because such cards typically are not reloadable and the funds are held in employer accounts for the benefit of the employee or held by the cardholder him or herself.

Circumvention and evasion.

Issuers generally agreed that circumvention or evasion should be determined on a case-by-case basis based on the facts and circumstances. Issuers believed that the proposed net compensation approach was overly broad because it considered compensation for “debit card-related activities,” rather than merely debit card transactions. Merchants, however, supported the consideration of compensation for non-debit card programs when the compensation is tied to debit card activities and chargebacks. Merchants also urged the Board to prevent forms of circumvention or evasion other than net compensation, such as increasing merchant network fees concurrently with decreases in issuer network fees and issuers' adjusting their products to avoid the final rule's interchange fee limits.

Network exclusivity and routing provisions.

Issuer and network commenters preferred the proposal to require two unaffiliated networks for processing without regard to the method of authentication (Alternative A) because the commenters believed that Alternative A was most consistent with the statutory language. These commenters also argued that Alternative B, which would require at least two processing alternatives for each authentication method, would impose significant operational burdens with little consumer benefit. In particular, issuers and networks asserted that Alternative B, when coupled with merchant routing choice, would cause consumer confusion and/or decrease consumer benefits. Moreover, these commenters asserted that Alternative B could stifle innovation, as networks and issuers would have less incentive to develop new authentication technologies, which they would have to ensure could be implemented on at least two networks.

Merchants preferred Alternative B because they believed that Alternative B is consistent with the statute and would provide the most routing choice and the most market discipline on interchange and network fees. They noted that, under Alternative A, once the consumer has chosen the method of authentication, the merchant may not have a choice over which network to route the transaction. Merchants also believed that Alternative B would promote competition for signature debit, whether from PIN networks or other new entrants.

Several commenters suggested that the Board invoke EFTA Section 904(c) to exempt small issuers and prepaid cards from the network exclusivity and routing rules. Several prepaid issuers and a processor commented that, if a prepaid card is not enabled for both signature and PIN, such cards should not be required to have two signature networks, which would require substantial operational restructuring by various debit card participants to accomplish. Several issuers and prepaid industry group commenters stated that because of restricted functionality of HSA, FSA, HRA, and QT cards, such cards cannot be used on a PIN network without significant cost and operational changes, partly because satisfying certain Internal Revenue Service (IRS) requirements is currently possible only over signature networks. Additionally, commenters noted that enabling two signature networks may not be operationally practical at this time.

Scope.

The Board received comments on the application of the proposed rule to three-party systems, ATM transactions, and emerging payment technologies. The majority of commenters recognized that three-party systems do not charge explicit interchange fees (rather, they charge a merchant discount), but were concerned that exempting three-party systems from the interchange fee standards would create an uneven playing field. Even commenters favoring coverage of three-party systems recognized, however, the circuitous routing that would result from subjecting these systems to the network exclusivity and routing provisions. A three-party system urged the Board to exempt such systems from the exclusivity and routing provisions.

With respect to ATM transactions, almost all comments received on the issue agreed that interchange fees on ATM transactions should not be covered because they flow from the issuer to the ATM operator. Although representatives of ATM operators supported applying the network exclusivity and routing rules to ATM transactions, issuers and networks opposed applying the network exclusivity and routing rules to ATM transactions because of different economic incentives for ATM transactions.

Issuer, network, and merchant commenters generally supported including emerging payments technologies under both the interchange fee standards and network exclusivity and routing rules so as to not create an unfair benefit for emerging payments networks. Some networks and issuers were concerned that applying the interchange fee restrictions and network exclusivity and routing provisions to emerging payment systems and means of authentication would stifle innovation, leading to reduced competition in the payments market. Other commenters suggested exempting emerging payment systems either during their pilot stage or for a specified period after they begin processing transactions. Other commenters were concerned that some “emerging payments systems” were not truly emerging, and therefore exempting them would create an uneven playing field.

2. Other General Comments

The Board received numerous comments that related to the proposed rule and EFTA Section 920 more generally. Numerous commenters opposed any government regulation of interchange fees (and prices generally) and stated that the free market should determine interchange fee levels. Some of these commenters argued that price and quality competition in the debit card market currently is strong, as well as transparent. These commenters believed that the government should impose price controls only where a market is monopolized or is otherwise demonstrably not functioning properly. Many of these commenters stressed the potential negative or unintended consequences of government price controls. Many commenters were further concerned that government price controls would prevent lower-cost providers from entering the market.

Numerous commenters requested that the Board either take more time to consider the issue or not adopt interchange fee restrictions. These commenters thought that further study and debate were needed because of the lack of study and debate by Congress prior to passing EFTA Section 920. Several commenters stated that the Board should have conducted hearings, debates, and impact analyses prior to

proposing a rule, and encouraged the Board to further study the issue rather than adopting a final rule. One commenter did not believe the statute provided the Board with sufficiently intelligible standards to promulgate rules; rather, the commenter argued that several policy judgments remained for Congress to make. Other commenters did not believe that government intervention was required at this time. Rather, a few commenters believed that market competition from alternative payment forms (

e.g.,

mobile) would put downward pressure on interchange fees. Another commenter did not believe any interchange fee regulation would be necessary if there were no network-imposed restraints on merchant-customer interactions.

Other commenters suggested that the government supply payment card network services or that the Board reform money transmitter laws rather than regulating interchange fees.

3. Consultation with Other Agencies

EFTA Section 920(a)(4)(C) directs the Board to consult, as appropriate, with the Comptroller of the Currency, the Board of Directors of the Federal Deposit Insurance Corporation, the Director of the Office of Thrift Supervision, the National Credit Union Administration Board, the Administrator of Small Business Administration, and the Director of the Bureau of Consumer Financial Protection in the development of the interchange fee standards. Board staff consulted with the staff of these agencies throughout the rulemaking process on all aspects of the proposed rule including the interchange fee standards, the role of supervisors in determining compliance with these standards, the small-issuer exemption, the potential effects on consumers (both banked and unbanked) and merchants (both small and large), the two proposed approaches to a fraud-prevention adjustment, possible means of circumvention and evasion of the interchange fee standards (through network fees, compensation, change in account structure, or otherwise), and the possible impact of the prohibitions against network exclusivity arrangements and routing restrictions. Many of these agencies submitted formal comment letters, raising many of the same issues addressed by other commenters and discussed above.

IV. Summary of Final Rule

The Board has considered all comments received and has adopted Regulation II (Debit Card Interchange Fees and Routing).

For the interchange fee standard (set forth in § 235.3), the final rule adopts a modified version of proposed Alternative 2 (stand-alone cap) and provides that an issuer may not receive or charge an interchange transaction fee in excess of the sum of a 21-cent base component and 5 basis points of the transaction's value (the

valorem

component). The interchange fee standard is based on certain costs incurred by the issuer to effect an electronic debit transaction (“allowable costs” or “included costs”). The standard is based on data collected by the Board through its survey of covered issuers and reflects comments received from many parties. Issuer costs that are incurred to effect a transaction include the following costs related to authorization, clearance, and settlement of a transaction: network connectivity; software, hardware, equipment, and associated labor; network processing fees; and transaction monitoring. Several other costs that may be incurred in effecting a transaction, such as costs related to customer inquiries and the costs related to rewards programs, were not included for various reasons explained below. As noted above, an allowance for fraud losses is also included as an issuer cost incurred to effect a transaction. The Board did not include other costs not incurred to effect a particular transaction. Issuer costs that are not incurred in effecting a transaction include costs of corporate overhead (such as senior executive compensation); establishing the account relationship; card production and delivery; marketing; research and development; and network membership fees.

With respect to the fraud-prevention adjustment, the interim final rule (published separately in the

Federal Register

) adopts the more general, less prescriptive approach to standards regarding the eligibility of an issuer to receive the adjustment and sets the adjustment at 1 cent per transaction.

The final rule prohibits circumvention and evasion of the interchange fee standard, as well as an issuer receiving net compensation from a payment card network.

The final rule exempts from the interchange fee standard issuers that, together with affiliates, have assets less than $10 billion, debit cards issued pursuant to certain government-administered programs, and certain reloadable general-use prepaid cards. The final rule provides that the Board will publish a list annually of institutions above and below the small issuer exemption asset threshold to facilitate the identification of exempt institutions. In addition, the Board will annually collect and publish information regarding interchange fees collected by networks and received by exempt and non-exempt issuers and transactions to allow monitoring of the effectiveness of the exemption for small issuers.

With respect to network exclusivity, the final rule adopts Alternative A (

i.e.,

two unaffiliated networks for each transaction). The final rule also adopts the prohibitions on routing restrictions in the proposed rule.

The final rule's definition of “payment card network” excludes three-party systems because they are not payment card networks that route transactions within the terms of the statute. The final rule's definition of “account” excludes accounts established pursuant to

bona fide

trust arrangements.

Various modifications throughout the rule were made in response to comments and additional information available to the Board. The final rule and the modifications adopted are explained more fully below.

Section-By-Section Analysis

I. Authority and Purpose

The Board proposed to set forth the authority and purpose of Regulation II in § 235.1. The Board received no comments on proposed § 235.1. The Board, however, made two revisions to that section. First, the Board has revised the authority citation in proposed § 235.1(a) to reflect the section of the United States Code in which EFTA Section 920 is codified. Second, the Board has revised § 235.1(b) to state that Regulation II also implements standards for receiving a fraud-prevention adjustment.

See

the companion interim final rule published separately in the

Federal Register.

II. Definitions

A. Section 235.2(a)—Account

The Board proposed to define “account” to mean “a transaction, savings, or other asset account (other than an occasional or incidental credit balance in a credit plan) established for any purpose and that is located in the United States.” The proposed definition included both consumer and business accounts, as well as accounts held pursuant to a

bona fide

trust arrangement.

1. Summary of Comments

The Board received comments on its proposed definition of “account” related to the proposed inclusion of

business-purpose accounts and

bona fide

trust arrangements. A few commenters suggested that the Board exclude business accounts from the definition of “account” because the EFTA applies only to consumer accounts. These commenters contended that the Board should not infer congressional intent to include business debit cards from the parenthetical in EFTA Section 920(c)(2) (definition of “debit card”), which states that the purpose of the account being debited is irrelevant. In support of this argument, one commenter noted that business accounts and consumer accounts differ both in the nature of purchases and the account structure (

e.g.,

business accounts may have multiple employees on a single account). Other commenters stated that the Board has not previously expanded the definition of “account” in its Regulation E; these commenters saw no reason to expand the term's scope at this time.

These commenters stated that the purpose of both the EFTA and the Dodd-Frank Act was consumer protection and that including business accounts under the scope of rule was contrary to the purpose behind EFTA Section 920.

A few commenters urged the Board to exclude

bona fide

trust arrangements from the definition of “account” because EFTA Section 903(2) excludes

bona fide

trusts from the definition of “account.” These commenters asserted that a

bona fide

trust arrangement is not a “purpose” of the account; therefore, the parenthetical in Section 920(c)(2) does not affect the EFTA's general exclusion of

bona fide

trust arrangements. Additionally, a few commenters expressed concern that including

bona fide

trust arrangements in the definition of “account” could result in different treatment of health savings accounts (HSAs) and other similar accounts that are structured as

bona fide

trusts (proposed to be subject to the fee standards) and those that are structured as reloadable, general-use prepaid cards (which would be exempt), which could, a commenter contended, create confusion for cards that access both types of HSAs and similar accounts. Finally, one commenter suggested that payroll cards be excluded from the definition of “account.”

2. Analysis and Final Rule

EFTA Section 903(2) defines the term “account” to mean “a demand deposit, savings, deposit, or other asset account (other than an occasional or incidental credit balance in an open credit plan as defined in section 103(i) of [the EFTA]), as described in regulations of the Board, established primarily for personal, family, or household purposes, but such term does not include an account held by a financial institution pursuant to a

bona fide

trust agreement.”

Section 920(c)(2) of the EFTA, however, defines the term “debit card” to mean a card that may be used “to debit an asset account

(regardless of the purpose for which the account is established

)

.* * *”

Some commenters encouraged the Board to disregard the parenthetical in Section 920(c)(2) as inconsistent with Section 903(2)'s definition that applies throughout the EFTA. Doing so, however, would render the parenthetical mere surplusage, contrary to principles of statutory construction. The Board notes that Regulation E and this rule have different scopes because Section 920 has differing definitions and scope of coverage than the rest of the EFTA.

15 U.S.C. 1693a(2).

15 U.S.C. 1693o-2(c)(2) (emphasis added).

The Board interprets the parenthetical as removing the limitation in EFTA Section 903(2) that applies the “account” definition only to accounts used for consumer purposes. Thus, the Board has adopted its proposal to include accounts used for business purposes as “accounts” under Section 920. Accordingly, § 235.2(a) will continue to include transaction, savings, and other asset accounts, regardless of the purpose for which the account was established.This definition of “account” is limited to this part and does not extend to other rules that implement other provisions of the EFTA.

The Board agrees with the commenters that a trust is a type of account structure rather than a purpose (such as a business purpose or personal purpose) for which the account is held. Therefore, the Board has revised its proposed definition of “account” to exclude

bona fide

trusts, consistent with EFTA Section 903(2). For purposes of Regulation E, the Board has stated that whether an agreement is a

bona fide

trust agreement is a question of state or other applicable law.

The Board believes a similar approach is warranted under this rule. In general,

bona fide

agreements or arrangements are those done in good faith and not merely a device to evade a law.

Accordingly, the Board has revised the definition of “account” to exclude accounts held under

bona

fide

trust agreements that are excluded from the definition of “account” under EFTA Section 903(2) and rules prescribed thereunder. The Board has added comment 2(a)-2 to clarify that whether a trust arrangement is

bona fide

is a matter of state or other applicable law and that accounts held under custodial agreements that qualify as trusts under the Internal Revenue Code are considered to be held in trust arrangements.

12 CFR part 205, Supplement I, par. 2(b)(2). An account held under a custodial agreement that qualifies as a trust under the Internal Revenue Code is considered to be a trust agreement for purposes of Regulation E.

See, e.g.,

44B Am. Jur. 2d. Interest and Usury § 14.

With respect to excluding HSAs and similar accounts, many commenters pointed to statements by members of Congress regarding their intent that cards used in connection with flexible spending accounts (FSAs), HSAs, and health reimbursement accounts (HRAs) not be subject to either the interchange fee standards or the network exclusivity and routing provisions.

Other commenters stated that HSAs and other similar accounts are not “asset accounts,” but are employer-sponsored and administered arrangements under which employees have an unsecured right to reimbursement for certain health-care-related purchases. The commenters explained that the employer in such arrangements is not required to keep funds for the reimbursements or to fund any specified account. Some commenters stated that HSAs and other similar accounts often are structured as

bona fide

trusts.

See

156 Cong. Rec. S5927 (statements of Sen. Dodd) (2010); 156 Cong. Rec. H5225-26 (statements of Rep. Larson and Rep. Frank) (2010).

The language in EFTA Section 920 does not provide for any exceptions to the section's provisions based on the purpose for which an account was established; moreover, Section 920(c)(2) defines “debit card” as including cards that may be used to debit an account “regardless of the purposes for which the account was established.” Therefore, the Board does not believe that the statute exempts debit cards that access HSAs and other similar accounts solely because such accounts are established for health care-related purposes. Such cards and accounts, however, may be otherwise exempt from the Board's interchange fee standards if they qualify for another exemption. For example, as commenters noted, some HSAs and other similar accounts are structured as

bona fide

trust arrangements. Cards that access these HSAs would be exempt from the requirements of this part because they do not access “accounts,” as the term is defined in § 235.2(a). In addition, some cards that access HSAs and other similar accounts are structured like prepaid cards where funds are held in an omnibus account (which is considered an “account” under § 235.2(a)) and the employee may

access the funds using a prepaid card. Provided these cards are structured in such a way that qualifies them for the reloadable, general-use prepaid card exemption in the statute, these cards used to access HSAs and similar accounts will be exempt from the rule's interchange fee standards.

See

discussion of § 235.5(c). These cards, however, will be subject to the rule's network exclusivity and routing provisions.

See

discussion of delayed effective date related to § 235.7.

Finally, the Board has adopted a definition of “account” that restricts the term to those accounts located in the United States. The Board received no comment on this part of the proposal. The Board, however, has made clarifying revisions to proposed comment 2(a)-2, now designated as 2(a)-3.

B. Section 235.2(b)—Acquirer

The Board proposed to define “acquirer” to mean “a person that contracts directly or indirectly with a merchant to provide settlement for the merchant's electronic debit transactions over a payment card network.” The Board proposed to exclude processors from the definition of “acquirer.” The Board received one comment on the proposed definition. This commenter supported a definition that limited acquirers to those entities that move money, and excluded processors, gateways, and independent sales organizations (“ISOs”).

A gateway is an entity that connects multiple networks. Merchants may sign-up with a gateway to enable them to accept debit cards and the gateway acts as a switch for the merchants to access multiple networks. ISOs provide merchant- and cardholder-acquisition services, including deploying point-of-sale (“POS”) terminals.

The Board has determined to adopt § 235.2(b) as proposed, but has made minor revisions to proposed comment 2(b)-1 to clarify that an acquirer settles for the transaction with the issuer, rather than with the network itself. Although the network calculates net settlement amounts for issuers and acquirers, settlement occurs between the issuer and acquirer. The Board also revised comment 2(b)-1 to clarify that in some circumstances, processors may be considered payment card networks.

See

discussion of §§ 235.2(m) and 235.2(o).

C. Section 235.2(c)—Affiliate

The Board proposed to define the term “affiliate” to mean “any company that controls, is controlled by, or is under common control with another company.” The proposed definition incorporated the definition of “affiliate” in EFTA Section 920(c)(1). The term “affiliate” is relevant for two purposes in this part: determining which issuers are considered “small” for purposes of the small-issuer exemption, and determining which prepaid cards are considered “general-use.”

In proposed comment 2(f)-5, the Board explained that “two or more merchants are affiliated if they are related by either common ownership or by common corporate control,” and that, for purposes of this rule, the Board considered franchises to be under common corporate control “if they are subject to a common set of corporate policies or practices under the terms of their franchise licenses.”

Under EFTA Section 920(a)(6), an issuer is considered “small” if it, together with its affiliates, has assets of less than $10 billion. 15 U.S.C. 1693o-2(a)(6). EFTA Section 920 incorporates the definition of “general-use prepaid cards” from the Credit CARD Act of 2009, which defines “general-use prepaid cards” as those cards that, among other things, are redeemable at multiple, unaffiliated merchants. 15 U.S.C. 1693l-1(a)(2)(A).

The Board received one comment suggesting that the Board use a consistent definition of “affiliate” for both the small issuer exemption and for general-use prepaid cards, expressing a preference for the control test set forth in the proposed definition of “control.” This commenter expressed concern that requiring only common ownership, and not common control, could result in the exclusion of closed-loop cards accepted at merchants that are not truly affiliated.

The Board has considered the comment and does not believe that “affiliate” is defined inconsistently in the small-issuer and general-use prepaid card contexts. First, proposed comment 2(f)-5 is consistent with the measure for “control” in proposed § 235.2(e)(3): “[t]he power to exercise, directly or indirectly, a controlling influence over the management or policies of the company, as the Board determines.” Second, the acceptance of a “closed-loop” card is not sufficient to cause merchants to be affiliated as the term is defined in this rule. For example, closed-loop cards may be accepted at a group of merchants that are not subject to a common controlling influence over their management and policies. Such cards are considered “general-use prepaid cards” (

see

discussion of § 235.2(i)) and would not be subject to the interchange fee standards if they satisfied the criteria for exemption in § 235.5(c). These closed-loop cards, however, would not be excluded from the network exclusivity and routing provisions as would cards accepted only at affiliated merchants. If the merchants were affiliated, the prepaid card would not be considered “general-use” and would be excluded from Section 920's definition of “debit card.”

Both the EFTA's definition and the proposed definition of “affiliate” were silent as to whether affiliated companies included companies located outside the United States. One commenter suggested that the term be limited to U.S. affiliates. The statutory language is silent on this point, and the Board believes it is appropriate to consider the total resources available to an issuer when determining whether it is “small.”

Accordingly, the Board has adopted the definition of “affiliate” in proposed § 235.2(c). The Board has added language to comment 2(c)-1 to clarify that the term “affiliate” includes any U.S. and foreign affiliate.

The Board considered the assets of both U.S. and non-U.S. affiliates when determining which issuers to survey. The Board computed assets using the Consolidated Financial Statements for Bank Holding Companies (FR Y-9C; OMB No. 7100-0128), the Consolidated Reports of Condition and Income (Call Reports) for independent commercial banks (FFIEC 031 & 041; OMB No. 7100-0036) and for U.S. branches and agencies of foreign banks (FFIEC 002; OMB No. 7100-0032), the Thrift Financial Reports (OTS 1313; OMB No. 1550-0023) for thrift holding companies and thrift institutions, and the Credit Union Reports of Condition and Income (NCUA 5300/5300S; OMB No. 3133-0004) for credit unions. The ownership structure of banking organizations was established using the FFIEC's National Information Center structure database.

D. Section 235.2(d)—Cardholder

The Board proposed to define “cardholder” to mean “the person to whom a debit card is issued.” The Board did not receive any comments on the proposed definition of “cardholder” and has adopted § 235.2(d) as proposed.

E. Section 235.2(e)—Control

The Board proposed to define “control” as it is defined in existing Board regulations.

The Board did not receive any comments specifically on the proposed definition of “control,” although the Board received comments on the definition of “affiliate,” discussed above. The Board has adopted § 235.2(e) as proposed.

See

Regulation Y (Bank Holding Companies and Change in Bank Control), 12 CFR 225.2(e) and Regulation P (Privacy of Consumer Financial Information), 12 CFR 216.3(g).

F. Section 235.2(f)—Debit card

1. Summary of Proposal and Comments

EFTA Section 920(c)(2) defines the term “debit card” as “any card, or other payment code or device, issued or approved for use through a payment card network to debit an asset account (regardless of the purpose for which the account is established), whether authorization is based on signature, PIN,

or other means” and as including general-use prepaid cards (as defined in EFTA Section 915(a)(2)(A)) but excluding paper checks. The proposed definition incorporated the statutory definition with some clarifying changes.

The proposed definition of “debit card” had three parts. First, the proposed definition included “any card, or other payment code or device, issued or approved for use through a payment card network to debit an account, regardless of whether authorization is based on signature, personal identification number (PIN), or other means, and regardless of whether the issuer holds the account.” Second, the proposed definition included “any general-use prepaid card.”

Finally, the proposed definition excluded (1) any cards, or other payment codes or devices, that are redeemable only at a single merchant or an affiliated group of merchants; (2) checks, drafts, or similar paper instruments, or electronic representations thereof; and (3) account numbers when used to initiate an ACH transaction to debit a person's account. Additionally, the proposed commentary explained that the term “debit card” included deferred debit cards (where the transaction is posted to the cardholder's account but not debited for a specified period of time) and decoupled debit cards (where the issuer does not hold the account being debited). The Board received several comments about which cards, or other payment codes or devices, should or should not be considered debit cards under this part. Many of these comments related to the proposed commentary and are summarized and analyzed below.

See discussion of § 235.2(i) for a discussion of the term “general-use prepaid card.” Comment 2(i)-7 explains that store cards are not included in the term “debit card” under this rule.

2. Card, or Other Payment Code or Device

Proposed comment 2(f)-1 explained that the phrase “card, or other payment code or device” includes cards, codes, and devices in physical and non-physical (

i.e.,

electronic) form. The Board received three comments regarding which “payment codes” should be included or excluded from the definition of debit card. One issuer requested that the Board clarify that “payment code” does not include one-time passwords (or other numbers) generated for purposes of authenticating the cardholder, provided such passwords/numbers are not used in lieu of an account number. The Board does not believe that a one-time password or other number used for purposes of authentication and in addition to the card, or other payment code or device, is itself a “payment code or device.” In that case, the passwords/numbers function like PINs or signatures. Therefore, the Board has revised proposed comment 2(f)-1 to clarify that cards, or other payment codes or devices, are not debit cards if used for purposes of authenticating the cardholder and used in addition to a card, or other payment code or device.

One commenter requested that the Board exclude account numbers from the definition of debit card if the account numbers are used to access underlying funds held in a pooled account, but where the underlying funds do not move (

i.e.,

the transaction is a general ledger entry). By contrast, another commenter suggested that such use of account numbers be included in the definition of debit card because the account numbers are used to debit “asset accounts.” As discussed in greater detail below in relation to § 235.2(m), account numbers, or other payment codes or devices, that are used only to initiate general ledger transactions are not issued or approved for use through a payment card network because the entity receiving the transaction information and data is not routing the information to an unaffiliated entity. Accordingly, even if the account number is used to debit an “account,” the account number is not a debit card because it was not issued or approved for use through a payment card network.

3. Deferred Debit Cards

Proposed comment 2(f)-2 explained that deferred debit cards are included within the proposed definition of “debit card.” Like other debit cards, deferred debit cards can be used to initiate direct debits to the cardholder's account, but the issuer may not debit the funds until after a pre-arranged period of time (

e.g.,

two weeks) after posting the transaction to the cardholder's account. During this time period, the funds typically are unavailable to the cardholder for other purposes, although the cardholder may accrue interest on the funds until the issuer debits the account.

The Board did not receive any comments opposed to including deferred debit cards within its definition of “debit card,” but did receive a few comments on the proposed deferral time period, as well as comments seeking clarification as to which cards qualified as deferred debit cards. Two commenters suggested that the Board exclude from the definition of “debit card” any cards where settlement to the cardholder's account is deferred 14 days or more after the transaction because a 2003 network/merchant settlement treats such cards as charge or credit cards.

The Board has considered these comments and determined not to revise proposed comment 2(f)-2 to limit deferred debit cards to those cards where the issuer settles the transaction with the cardholder within 14 days of the transaction.

See

MasterCard comment letter, Appendix C.

The fact that the cardholder initiates transactions that debit an account, as the term is defined in § 235.2(a), is the characteristic of deferred debit cards that distinguishes such cards from charge cards and credit cards for purposes of EFTA Section 920. In the case of charge cards and credit cards, the transactions post to lines of credit rather than accounts. Excluding cards that debit an account based on the time period within which the account is debited creates significant potential for evasion and circumvention of Section 920's provisions, as implemented by this rule. The Board notes that the EFTA and Regulation E limit the ability of an issuer to structure deferred debit cards to be more like charge cards or credit cards. The EFTA and Regulation E prohibit any person from conditioning the extension of credit to a consumer on such consumer's repayment by means of preauthorized electronic fund transfers.

15 U.S.C. 1693k(1); 12 CFR 205.10(e)(1).

Two commenters requested clarification as to the types of products that qualify as “deferred debit cards,” particularly as to the deferral period. Deferred debit cards may have different deferral periods specified in the cardholder agreement; however, the deferral period and when the hold is applied are not necessary to determining whether a card is a “debit card” as defined in § 235.2(f). The Board has revised proposed comment 2(f)-2 to clarify that, in the case of deferred debit cards, the issuer-cardholder agreement governs the period of time for which the issuer will hold the funds in the cardholder's account after the debit card transaction and before debiting the cardholder's account.

The Board is not at this time providing more examples of debit cards that are considered “deferred debit cards.” The deferred debit cards of which the Board is aware use the framework described in comment 2(f)-2. The Board is removing the proposed examples regarding the timing of merchants sending electronic debit transactions to acquirers as unnecessary

to describe whether a debit card is a deferred debit card.

4. Decoupled Debit Cards

Proposed comment 2(f)-3 explained that the term “debit card” included decoupled debit cards. As explained in the proposed comment, decoupled debit cards are issued by an entity other than the entity holding the cardholder's account, and the issuer settles for the transaction with the acquirer and with the cardholder through an ACH transaction that debits the cardholder's account.

The Board received a few comments opposed to including decoupled debit cards under the rule's definition of “debit card,” and no comments explicitly supporting their inclusion. One commenter contended that including decoupled debit cards within the definition of “debit cards” is inconsistent with the exclusion of ACH transactions, because decoupled debit cards are used to initiate ACH debits to the account. Other commenters suggested the Board exclude decoupled debit cards issued by merchants because including them would be inconsistent with statutory intent to reduce merchant debit card expense. One commenter requested clarification as to the types of products that qualified as “decoupled debit cards.” Another commenter stated that treating the location of the asset account as irrelevant for defining “debit card,” but relevant for purposes of the small issuer exemption, is inconsistent.

The Board has considered the comments received and has determined to include decoupled debit cards that process transactions over payment card networks within the definition of “debit card” as proposed with minor clarifying revisions to the commentary. Cardholders use decoupled debit cards to initiate debits to their accounts. The Board is aware of two types of decoupled debit card transactions. The first type, described in proposed comment 2(f)-3, is where the transaction is processed over a payment card network, and the issuer settles the transaction with the acquirer using the normal network procedures, but settles with the cardholder via an ACH transaction. In this type of transaction, the cardholder preauthorizes the ACH transaction, and the issuer initiates the ACH transaction shortly after authorizing the transaction and settling for the transaction with the acquirer through the payment card network. The second type is a transaction initiated with a card issued by the merchant, and the merchant's processor initiates an ACH debit to the cardholder's account. This second type of decoupled debit card transaction is processed solely through an ACH operator and not through a payment card network. Decoupled debit cards that are used to initiate ACH transactions at the point of sale that are not processed over a payment card network for any part of the transaction (

i.e.,

the second type) are not debit cards under this part.

By contrast, if the card holder initiates a decoupled debit card transaction, part of which is processed over a payment card network, the decoupled debit card is a debit card for purposes of this part. Unlike decoupled debit cards that directly initiate ACH transactions, merchants cannot distinguish these decoupled debit cards from other debit card transactions that would be subject to interchange fees and network rules. Accordingly, the Board does not believe it is inconsistent to include in the definition of “debit card” decoupled debit cards that initiate transactions processed over payment card networks, while simultaneously excluding ACH transactions initiated at the point of sale.

Inclusion of decoupled debit cards that initiate transactions processed over payment card networks is consistent with the provisions in EFTA Section 920, which are intended to reduce merchant costs of accepting debit cards, even if merchants are the issuers of such cards (although the Board believes that transactions initiated with merchant-issued decoupled debit cards generally would be processed through the ACH). Section 920 is designed to achieve cost-reduction through limitations on interchange transaction fees and prohibitions on network exclusivity and merchant routing restrictions, rather than by excluding certain cards that may be lower-cost to merchant issuers.

In addition, any inconsistency between the requirement that an issuer hold the account in order to be eligible for the small issuer exemption and the lack of relevance for purposes of defining “debit card” is statutory. Section 920(c)(9) defines the term “issuer” for general purposes of the section as the person who issues the debit card, or agent of such person. For purposes of the small issuer exemption, Section 920(a)(6) limits the term “issuer” to the entity holding the cardholder's account.

A few commenters requested that the Board provide more specific examples of decoupled debit cards. The decoupled debit cards of which the Board is aware use the framework described in comment 2(f)-3.

5. Hybrid Cards and Virtual Wallets

The Board requested comment on whether additional guidance was necessary to clarify whether products with “credit-like” features are considered debit cards for purposes of this rule. The Board noted that if an issuer offers a product that allows the cardholder to choose at the time of the transaction when the cardholder's account will be debited for the transaction, any attempt to classify such a product as a credit card would be limited by the prohibition against compulsory use under the EFTA and Regulation E.

A few issuers, networks, and processors suggested that the Board exclude cards used to access or obtain payment from a credit account (

i.e.,

cards subject to the Truth in Lending Act and Regulation Z), regardless of whether the consumer chooses to repay the credit account using an asset account. These commenters indicated that such cards could include cards that enable the customer to pre-designate the types of transactions to be paid from a preauthorized debit to the asset account more frequently than the monthly billing cycle. Additionally, these commenters urged the Board to distinguish between credit cards that require repayment using preauthorized transfers and cards that permit repayment using preauthorized transfers, stating that the latter would not run afoul of the prohibition against compulsory use.

The Board is aware of two general categories of cards with both credit- and debit-like features (so-called “hybrid cards”). The first category includes those cards, or other payment codes or devices, used to initiate transactions that access and post to credit accounts, but that the cardholder repays through a preauthorized debit to an asset account. The second category of hybrid cards includes those cards, or other payment codes or devices, that may be used to access multiple accounts (including both credit and other accounts) (often referred to as “virtual wallets” or “mobile wallets”). Cards used to initiate transactions that access and post to credit accounts are not considered debit cards for purposes of this rule because such cards are not used to debit an account, as the term is defined in § 235.2(a). Further, cards that access credit accounts are not considered debit cards regardless of whether the cardholder pays the credit balance through preauthorized transfers from an account.

For example, a card may be used to initiate transactions that access and post

to credit accounts, but the issuer enables the cardholder to preselect transactions for immediate repayment (or repayment prior to the monthly billing cycle) from the cardholder's asset account. The issuer, then, may initiate a preauthorized ACH debit to the cardholder's account in the amount of the preselected transactions. Such products, due to their classification as credit cards, may not condition the extension of credit on a consumer's repayment by means of preauthorized electronic fund transfers.

An issuer may permit a cardholder to opt in to preauthorization of some or all transactions made using the credit or charge card. The Board, however, recognizes the potential for issuers to restructure existing debit cards like these hybrid cards in order to circumvent and evade this rule. Therefore, such cards will be considered debit cards for purposes of this part if the issuer conditions a cardholder's ability to preselect transactions for early repayment on the cardholder maintaining an asset account at the issuer.

See

comment 2(f)-4.ii.

15 U.S.C. 1693k(1); 12 CFR 205.10(e)(1).

The Board has added comment 2(f)-4.i to clarify that hybrid cards that permit some transactions to be posted directly to an account as defined in § 235.2(a), rather than posting first to a credit account, are considered debit cards for purposes of this part. Only those transactions that post directly to the account, however, will be considered electronic debit transactions.

The second category of hybrid cards consists of virtual or mobile wallets, which store several different virtual cards that each accesses a different account. The Board has added comment 2(f)-5 to clarify the treatment of virtual wallets under this rule. As explained in the commentary, the payment codes or devices (“virtual cards”) stored in a virtual wallet may each access a different account, which may be credit accounts or accounts as defined in § 235.2(a). For example, a mobile phone may store credentials (the payment codes) for accessing four different accounts or lines of credit, which the cardholder can view on the phone's screen. At the point of sale, the cardholder selects which virtual card to use (

e.g.,

by selecting the icon for the issuer whose card the cardholder wishes to use). If at least one virtual card within the virtual wallet may be used to debit an account under § 235.2(a), then that virtual card is a debit card for purposes of this part, notwithstanding the fact that other cards in the virtual wallet may not be debit cards for purposes of this part. The entire virtual wallet is not considered to be the card, or other payment code or device.

6. Checks and Similar Instruments

One commenter supported the Board's exclusion of electronic images and representations of checks and similar instruments. The Board has retained the exclusion in § 235.2(f), as well as the exclusions for checks, drafts, and similar instruments.

7. ACH Transactions

The Board received a few comments on its proposed exclusion of account numbers when used to initiate an automated clearinghouse (ACH) transaction to debit an account. One commenter thought the Board should consider account numbers used to initiate ACH transactions to be “payment codes” in order to create a level playing field between debit cards and ACH transactions. One issuer suggested that the Board broaden the ACH exclusion to include intrabank transfers initiated using an account number.

The Board has considered these comments and has determined that account numbers used to initiate ACH transactions should be excluded from the definition of “debit card.” An ACH transaction is processed through an ACH operator, such as EPN or FedACH®. As explained below in relation to § 235.2(m), ACH operators are not “payment card networks” under EFTA Section 920. Therefore, an account number used to initiate an ACH transaction is not “issued or approved” for use through a payment card network and, therefore, is not a “debit card” for purposes of this rule. Payment information used to initiate intrabank transactions using an account number are not processed through either ACH operators or payment card networks and, therefore, are not debit cards under EFTA Section 920.

Even if ACH transactions were subject to this part, they already would comply with the provisions of this part. Currently, ACH operators do not establish, and receiving and originating banks do not charge, fees that are comparable to interchange fees. If a merchant were to use the ACH to clear its customers' purchase transactions, its bank chooses the ACH operator through which it will originate transactions.

The Board believes retaining an explicit exclusion from the definition of “debit card” in § 235.2(f) is unnecessary but has retained commentary to explain the exclusion (proposed comment 2(f)-7 is now designated comment 2(f)-9). This comment is useful in distinguishing decoupled debit cards (discussed above) from cardholder-initiated ACH transactions. The Board has made minor revisions to the proposed comment to clarify that an account number used to initiate an ACH transaction is not a debit card where the person initiating the ACH transaction is the same person whose account is being debited and to clarify the distinction between decoupled debit cards and cardholder-initiated ACH transactions.

G. Section 235.2(g)—Designated Automated Teller Machine (ATM) Network

Section 235.2(g) of the proposed rule incorporated the statutory definition (EFTA Section 920(a)(7)(C)) of “designated automated teller machine network.” The proposed definition included (1) all ATMs identified in the name of the issuer; or (2) any network of ATMs identified by the issuer that provides reasonable and convenient access to the issuer's customers. The Board did not receive any comments on the proposed definition, and § 235.2(g) is adopted as proposed, with the exception of minor technical changes.

The Board also proposed comment 2(g)-1 to clarify the meaning of “reasonable and convenient access,” as that term is used in § 235.2(g)(2). Under proposed comment 2(g)-1, an issuer would provide reasonable and convenient access, for example, if, for each person to whom a card is issued, the issuer provided access to one ATM within the metropolitan statistical area (MSA) in which the last known address of the person to whom the card is issued is located or, if the address is not known, where the card was first purchased or issued.

Several consumer group commenters recommended that the Board delete proposed comment 2(g)-1. These commenters noted that certain MSAs are very large and that requiring only one ATM within the same MSA as a cardholder's last known address (or, if unknown, the card's place of purchase or issuance) could potentially be burdensome for certain cardholders when an MSA covers a sizeable area. Another industry commenter suggested that for a payroll card, an ATM available at a cardholder's workplace should be considered to provide reasonable and convenient access.

As discussed in the proposal, the proposed comment was intended to ensure that cardholders do not have to travel a substantial distance for ATM access. The Board agrees that certain MSAs are very large and, for those MSAs, providing access to one ATM may not be reasonable or convenient for

many cardholders. Moreover, a network that provides ATM access that is reasonable and convenient to a cardholder's home or work address also should be considered to provide reasonable and convenient for purposes of § 235.2(g)(2). Accordingly, the Board has adopted a revised comment 2(g)-1 to provide that whether a network provides reasonable and convenient access depends on the facts and circumstances, including the distance between ATMs in the designated network and each cardholder's last known home or work address or, if a home or work address is not known, where the card was first issued.

H. Section 235.2(h)—Electronic Debit Transaction

EFTA Section 920(c)(5) defines “electronic debit transaction” as “a transaction in which a person uses a debit card.” The Board proposed to define “electronic debit transaction” to mean “the use of a debit card by a person as a form of payment in the United States” in order to incorporate the concept of “payment” already included in the statutory definition of “payment card network” and to limit application of the rule to domestic transactions.

As discussed above in relation to § 235.2(f), some debit cards may be used to access both accounts as defined in § 235.2(a) and lines of credit. The Board has revised the definition of “electronic debit transaction” to specify that a transaction is an electronic debit transaction only if the debit card is used to debit an account. The Board has added comment 2(h)-1 to clarify that the account debited could be, for example, the cardholder's asset account or the omnibus account that holds the funds used to settle prepaid card transactions.

EFTA Section 920(c)(11) defines “payment card network,” in part, as an entity “that a person uses in order to accept as a form of payment a brand of debit card.” See discussion related to § 235.2(q) (definition of “United States”) regarding the application of the rule to only domestic transactions.

A few commenters requested clarification on whether the rule would apply to Internet transactions. Section 235.2(h) does not limit the term “electronic debit transaction” to transactions initiated at brick-and-mortar store locations; the term also includes purchases made online or by telephone or mail. Accordingly, electronic debit card transactions initiated over the Internet are within the scope of this part.

One commenter suggested that the definition of “electronic debit transaction” not be limited to use as a “form of payment” because many POS networks also function as ATM networks. This commenter suggested the Board expand the definition of “electronic debit transaction” to include ATM transactions. For the reasons discussed below in relation to § 235.2(m), the Board is not revising its proposed definition of “electronic debit transaction” to include ATM transactions, but is adding comment 2(h)-2 to clarify that payment may be made in exchange for goods or services, as a charitable contribution, to satisfy an obligation, or for other purposes.

As explained in the proposed commentary, the term would include use of a debit card for subsequent transactions connected with the initial transaction and would include cash withdrawal at the point of sale (provided the cardholder has also made a purchase). The Board has revised proposed comment 2(h)-1 (now designated as comment 2(h)-3) to clarify that a transaction, such as a return transaction, is an electronic debit transaction if the transaction results in a debit to the merchant's account and a credit to the cardholder's account.

The Board has also adopted its proposed comments clarifying that “electronic debit transaction” includes cash withdrawals at the point of sale (comment 2(h)-4) and that transactions using a debit card at a merchant located outside of the United States are not subject to this rule (comment 2(h)-5), with minor conforming and clarifying changes.

I. Section 235.2(i)—General-Use Prepaid Card

EFTA Section 920(c)(2) defines the term “debit card” as including “a general-use prepaid card, as that term is defined in section 915(a)(2)(A).” EFTA Section 915(a)(2)(A), in turn, defines “general-use prepaid card” as those cards, or other payment codes or devices, that (1) are redeemable at multiple, unaffiliated merchants or service providers, or ATMs; (2) issued in a requested amount, whether or not such amount may be increased or reloaded; (3) purchased on a prepaid basis; and (4) honored upon presentation for goods and services.

The Board proposed to adopt the statutory definition with some revisions. The Board proposed to define “general-use prepaid card” to mean a card, or other payment code or device that is (1) issued on a prepaid basis in a specified amount, whether or not that amount may be increased or reloaded, in exchange for payment; and (2) redeemable upon presentation at multiple, unaffiliated merchants or service providers for goods or services, or usable at ATMs. The proposed definition included cards that a group of unaffiliated merchants agrees to accept via the rules of a payment card network and cards that a select group of unaffiliated merchants agrees to accept, whether issued by a program manager, financial institution, or network (referred to as “selective authorization cards”). The Board requested comment on whether selective authorization cards that do not carry a network brand should be included within the definition of “general-use prepaid card.” The Board received several comments on its proposed definition, primarily concerning the exclusions from the definition of “general-use prepaid card” and selective authorization cards.

15 U.S.C. 1693l-1.

For the reasons discussed in relation to §§ 235.2(h), (l), and (m), ATM transactions are not electronic debit transactions for purposes of this rule because cash withdrawals are not “payments.” Accordingly, the Board has revised the proposed definition to eliminate the unnecessary reference to prepaid cards' usability at ATMs.

1. Credit CARD Act Exclusions

Several commenters urged the Board to incorporate the exclusions to the definition of “general-use prepaid card” in the Credit CARD Act of 2009 (CARD Act) into the definition of “general-use prepaid card.” These exclusions include telephone cards; cards not marketed or labeled as gift cards; loyalty, award, or promotional gift cards; cards not marketed to the general public; cards issued only in paper form; and cards redeemable solely for admission to events or venues (or purchases of goods and services at the events or venues) at a particular location or affiliated locations.

15 U.S.C. 1693l-1(a)(2)(D).

The proposed definition generally tracked the definition of “general-use prepaid card,” set forth above, in EFTA Section 915(a)(2)(A). EFTA Section 915(a)(2)(D) enumerates exclusions from the term “general-use prepaid card” as defined in Section 915(a)(2)(A). In light of the explicit reference to Section 915(a)(2)(A) and the absence of a reference to Section 915(a)(2)(D), the Board has determined not to exclude the CARD Act's exclusions from the definition of “general-use prepaid card.”

Moreover, one of the

enumerated exclusions in Section 920(a)(7)(A)(ii) is for cards “reloadable and not marketed or labeled as a gift card or gift certificate.” If such cards were already excluded from Section 920's definition of “debit card” by virtue of their exclusion from the term “general-use prepaid card” in the CARD Act, Section 920(a)(7)(A)(ii)'s express exemption of such cards would be superfluous. Therefore, the Board is adopting the definition of “general-use prepaid card” as proposed (with the exception of removing the unnecessary ATM reference). The cards excluded from the CARD Act's definition of general-use prepaid card may otherwise be excluded from the definition of “debit card” (

i.e.,

if they are not redeemable at multiple, unaffiliated merchants) or exempt from the interchange fee standards (

e.g.,

if they are reloadable).

The Board also notes that EFTA Section 920(c)(2) does not refer to Section 915(a)(2) more broadly.

2. Selective Authorization Cards

Several commenters requested that the Board exclude “selective authorization cards” from the definition of “general-use prepaid cards.” These commenters asserted that selective authorization cards more closely resemble cards that are accepted at only one merchant or affiliated merchants. Many of these commenters argued that selective authorization cards provide consumers with more shopping options than cards accepted at only one merchant, thus providing the consumer with more protection in the event of a merchant's bankruptcy. Some commenters suggested excluding only those cards that do not carry a network brand.

The Board has considered the comments and has determined to include selective authorization cards within the definition of “general-use prepaid card.” Selective authorization cards provide benefits to the merchants or business districts wishing to promote their business, as well as to consumers wishing to mitigate their exposure in the event of a merchant's bankruptcy. Nonetheless, one characteristic of general-use prepaid cards is that they are redeemable at multiple, unaffiliated merchants. Two or more merchants are affiliated if they are related either by common ownership or by common corporate control.

Two or more merchants are not “affiliated” within the rule's meaning of the term merely because they agree to accept the same selective authorization card. Therefore, selective authorization cards are redeemable at multiple, unaffiliated merchants. This is true regardless of whether or not the card carries the mark, logo, or brand of a network. In fact, the Board understands that transactions using some selective authorization cards that do not display a network brand logo on the card itself are processed over “brands” of payment card networks, including the major networks or smaller networks. Accordingly, there is not a basis for distinguishing network-branded selective authorization cards from non-network branded selective authorization cards.

Selective authorization cards, however, like other general-use prepaid cards, may not be subject to certain provisions of this part. For example, if the selective authorization card satisfies the requirements in § 235.5(c) (

e.g.,

the card is reloadable and not marketed as a gift card), the card would not be subject to the interchange fee standards.

See the discussion on the definition of “affiliate” (§ 235.2(c)), above, in this notice.

For the same reason, the Board is revising its proposed comment 2(i)-2 to clarify that a general-use prepaid card is not required to display the network brand, mark, or logo in order to come within the definition of “general-use prepaid card.”

Proposed comment 2(i)-2 explained that “mall cards” are considered general-use prepaid cards because the cards are accepted at multiple, unaffiliated merchants. The Board is aware, however, that selective authorization cards are used outside the shopping mall environment. Selected groups of merchants within the same business district or located near a university also may accept selective authorization cards. Accordingly, the Board has expanded the scope of the proposed comment to include selective authorization cards used in all contexts.

3. Other Comments

The Board received one comment requesting clarification as to whether “gift cards” are included under the definition of “general-use prepaid cards.” Prepaid gift cards that are redeemable at a single merchant or a group of affiliated merchants are not included within the definition of “general-use prepaid cards.” By contrast, if the gift card is redeemable at multiple, unaffiliated merchants, then the gift card is a “general-use prepaid card.” Gift cards that are general-use prepaid cards are not exempt from the interchange fee standards.

J. Section 235.2(j)—Interchange Transaction Fee

1. Summary of Proposal and Comments

EFTA Section 920(c)(8) defines “interchange transaction fee” as “any fee established, charged, or received by a payment card network for the purpose of compensating an issuer for its involvement in an electronic debit transaction.” The Board proposed to define “interchange transaction fee” to mean “any fee established, charged, or received by a payment card network and paid by a merchant or acquirer for the purpose of compensating an issuer for its involvement in an electronic debit transaction.”

2. Paid by a Merchant or an Acquirer

The Board proposed to add the phrase “and paid by a merchant or acquirer” as a clarification of current market practice.

One commenter expressed concern that, by adding “and paid by a merchant or acquirer” to the statutory definition, the Board was opening up the possibility that an acquirer would contract with a middleman to pay the fee on the acquirer's behalf, which would result in circumvention or evasion of the rule. The Board does not believe that the phrase would enable such a practice. Under principles of agency (governed by state law), if an acquirer contracts with a third party to pay an interchange transaction fee on behalf of an acquirer, the fee is considered to be paid by the acquirer and would be subject to the same restrictions as if the fee were in fact paid by the acquirer. Although the Board understands that, today, acquirers pay interchange transaction fees to issuers through settlement effected by a payment card network (and then pass the fee on to merchants), the Board has retained the proposed addition, noting that the interchange transaction fee can be paid either by a merchant or acquirer. The Board also has made minor revisions to comment 2(j)-2 to clarify that the fees payment card networks charge to acquirers for network services are not considered “interchange transaction fees.”

75 FR 81722, 81731, and 81755 (Dec. 28, 2010).

3. Established, Charged, or Received

Merchant commenters voiced concerns that issuers may attempt to circumvent the interchange fee standards (applicable to those fees “established, charged, or received” by a network) by collectively setting fees and imposing those collectively set fees on acquirers, and ultimately merchants, through the networks' honor-all-cards rules. For example, the largest issuers may collectively determine to charge interchange transaction fees above the cap and effect this decision by dictating to each network the agreed upon amount. The network, then, would permit each issuer to charge that amount, and because merchants would

be required to accept all the network's cards, merchants would pay the amount determined by the issuers.

Section 920(c)(8) of the EFTA defines the term “interchange transaction fee” to mean “any fee established, charged, or received by a payment card network * * * for the purpose of compensating an issuer for its involvement in an electronic debit transaction.” Accordingly, interchange transaction fees are not limited to those fees set by payment card networks. The term also includes any fee set by an issuer, but charged

to acquirers (and effectively merchants) by virtue of the network determining each participant's settlement position. In determining each participant's settlement position, the network “charges” the fee, although the fee ultimately is received by the issuer. An issuer, however, would be permitted to enter into arrangements with individual merchants or groups of merchants to charge fees, provided that any such fee is not established, charged, or received by a payment card network. The Board has added paragraph 2(j)-3 to the commentary to explain that fees set by an issuer, but charged by a payment card network are considered interchange transaction fees for purposes of this part. The Board plans to monitor whether collective fee setting is occurring and whether it is necessary to address collective fee setting or similar practices through the Board's anti-circumvention and evasion authority.

One commenter urged the Board to adopt a definition of “interchange transaction fee” that covers both the fee flowing from merchant to network and the fee flowing from network to issuer so as to require that the two amounts be equal. This commenter was concerned that, otherwise, networks with widespread acceptance would be able to engage in price discrimination. Networks may charge lower fees to acquirers than they pass through to the issuers in order to compete for transaction volume in certain market segments, while charging higher fees to acquirers than they are passing through to the issuers in other market segments, although today these amounts are the same. The Board, however, has determined not to revise its proposed definition of “interchange transaction fee” to cover both the fee flowing from merchant to network and the fee flowing from network to issuer so as to require that two amounts be equal. By statute, an interchange transaction fee is a fee established, charged, or received by a payment card network for the purpose of compensating an issuer and Section 920(a) limits the amount that the issuer may receive. By contrast, Section 920(a) does not prohibit networks from charging other fees to merchants or acquirers that are not passed to the issuer and does not require that the network pass through to the issuer the same amount charged to the acquirer. The Board plans to monitor whether networks are charging other fees that are being passed to the issuer and determine whether it is necessary to address network fees through the Board's anti-circumvention and evasion authority.

K. Section 235.2(k)—Issuer

1. Summary of Proposal and Comments

EFTA Section 920(c)(9) defines the term “issuer” to mean “any person who issues a debit card, or credit card, or the agent of such person with respect to such card.” The Board proposed to define “issuer” to mean “any person that issues a debit card.” Proposed comments 2(k)-2 through 2(k)-5 provided examples of which entity was considered the issuer in a variety of debit card arrangements. As described in the proposed commentary, the issuer in four-party systems is the bank holding the cardholder's account, and the issuer in three-party systems is the entity acting as issuer and system operator (and typically acquirer as well). The issuer in debit card BIN-sponsor arrangements is the bank holding the cardholder's account, and the issuer in prepaid card BIN-sponsorship arrangements is the BIN sponsor holding the omnibus account.

Finally, the issuer of a decoupled debit card is the entity providing the card to the cardholder, not the bank holding the cardholder's account.

As explained in the proposed commentary, payment card networks assign Bank Identification Numbers (“BINs”) to member institutions for purposes of issuing cards, authorization, clearance, settlement, and other processes. In exchange for a fee or other financial considerations, some member institutions permit other entities to issue debit cards using the member-institution's BIN. The entity permitting the use of its BIN is referred to as the “BIN sponsor” and the entity that uses the BIN to issue cards is often referred to as the “affiliate member.” BIN-sponsor arrangements are done for debit cards (including prepaid cards).

The Board received several comments on its proposed definition of “issuer,” one of which generally supported the proposed definition. Many of the comments received addressed the proposed removal of the phrase “or agent of such person” from the statutory definition. Two commenters suggested that Board exclude third-party agents as proposed, because unlike credit cards, debit card issuers typically do not use third-party agents. One commenter argued that the agent of an issuer should only be considered the issuer when the agent has a level of control such that the role of the issuer is subordinated to that of its agent. A few other commenters requested that the Board clarify the effect on the interchange fee restrictions of eliminating “or agent of the issuer” and further study the issue.

The Board also received a few comments requesting clarification on whether an issuer that outsources processing functions is responsible for complying with the requirements, or whether the third-party processor must comply with the requirements. One commenter specifically expressed concern about a covered issuer being able to contract with a small issuer for issuance of the card and having the small issuer receive and pass back the higher interchange fees. The Board also received a comment requesting clarification on which party is considered the issuer under a variety of mobile payments arrangements.

2. Analysis and Final Rule

The Board has considered the comments and has determined to revise its definition of “issuer” to clarify the meaning of “issue.” In general, the proposed commentary explained which entity is the issuer in terms of which entity has the underlying contractual agreement with the cardholder. Although the underlying contractual agreement with the cardholder is one of the defining characteristic of issuing debit cards, the Board believes that it is clearer and more precise to explain the underlying agreement in terms of authorizing the use of the card to perform electronic debit transactions. The entity that authorizes use of the card may also be the entity that arranges for the cardholder to obtain the card. The revisions to the commentary describe this component of issuing in terms of “authorizing” the cardholder to use the card to perform electronic debit transactions, rather than the more general term “provide” as proposed. Therefore, the identity of the issuer is not determined by which entity performs issuer processing, but rather by which entity authorized the cardholder to use the card to perform electronic debit transactions.

The Board has revised comment 2(k)-1 to provide more guidance on which entity is the issuer for purposes of this part. Comment 2(k)-1 explains that a person issues a debit card by authorizing a cardholder to use the debit card to perform electronic debit transactions. That person may provide the card directly or indirectly to the cardholder. For example, a person may use a third-party processor to distribute

a plastic card to the cardholder, or may use a phone network or manufacturer to distribute a chip or other device as part of a phone. The entity that distributes the card, or other payment code or device, is not the issuer with respect to the card unless that entity also is the one authorizing the cardholder to use the card, or other payment code or device, to perform electronic debit transactions.

Proposed comments 2(k)-2 and 2(k)-3 discussed the identity of the issuer in four-party and three-party systems, respectively. In light of the changes discussed below in relation to § 235.2(m), which clarify that three-party systems are not payment card networks for purposes of this rule, the Board has deleted the proposed commentary language that discusses three-party systems and is making other clarifying changes for consistency in other commentary provisions.

See

comment 2(k)-2.

Proposed comment 2(k)-4 described which entity was the issuer under two different types of BIN-sponsor arrangements: the sponsored debit card model and the prepaid card model. Proposed comment 2(k)-4.i stated that the issuer in a sponsored debit card arrangement was the community bank or credit union providing debit cards to its account holders using a BIN of another institution (the “BIN sponsor”). The Board has revised the proposed comment to explain that the community bank or credit union is an issuer if it authorizes its account holders to use the debit cards to access funds through electronic debit transactions. The community bank or credit union may provide debit cards directly or indirectly (

e.g.,

through its BIN sponsor) to cardholders. The BIN sponsor is not considered the issuer for purposes of this part because the BIN sponsor does not enter into an agreement with the cardholder authorizing the cardholder to use the card to perform electronic debit transactions to access funds. The Board also has revised the comment to refer consistently to the “bank or credit union” throughout the comment.

See

comment 2(k)-3.i.

Proposed comment 2(k)-4.ii stated that the issuer in the second type of BIN-sponsor model—the prepaid card model—is the BIN sponsor holding the funds underlying the prepaid cards. The Board has revised the proposed comment to clarify that, under these arrangements, the BIN sponsor typically uses a program manager to distribute cards to cardholders, and the BIN sponsor typically holds the funds in an omnibus or pooled account. Under these arrangements, either the BIN sponsor or the program manager may track the amount of underlying funds on each card. The revised comment explains that the BIN sponsor is the issuer because it is the entity authorizing the cardholder to use the card to perform electronic debit transactions to access the funds held by the BIN sponsor and also has the contractual relationship with the cardholder.

See

comment 2(k)-3.ii. The Board also has revised this comment, as well as other comments, to refer to “member institutions” rather than “member-financial institutions” for consistency throughout the commentary.

Proposed comment 2(k)-5 explained that the issuer with respect to decoupled debit card arrangements is the entity that provides the debit card to the cardholder and initiates a preauthorized ACH debit to the cardholder's account at a separate institution. The Board has revised proposed comment 2(k)-5 (now designated as 2(k)-4) to clarify that the bank or other entity holding the cardholder's funds is not the entity authorizing the cardholder to use the decoupled debit card to perform electronic debit transactions. Rather, the bank or other entity holding the cardholder's funds has authorized access to the funds through ACH debits in general, but not specifically through the decoupled debit card. The Board has deleted the statement in proposed comment 2(k)-5 that the account-holding institution does not have a relationship with the cardholder with respect to the card because the statement is unnecessary to explain the identity of the issuer of the card.

The Board has not provided examples in the commentary that are specific to mobile devices and mobile payments. A mobile device, such as a chip in or on a telephone or a software application on the telephone, is one type of payment code or device that may be used to access underlying funds. If the cardholder's bank authorizes the cardholder to use a device connected with the phone and arranges for the cardholder to obtain the device through the phone network or manufacturer, or other party, the cardholder's bank is the issuer with respect to the mobile device. By contrast, if the mobile device is more like a decoupled debit card where the mobile device is used to initiate debits to an account, but those debits settle through a preauthorized ACH transaction, the cardholder's bank is not the issuer. Rather, the entity that provided the mobile device to the cardholder to ultimately access the underlying funds is the issuer. Depending on the debit card arrangement, this entity may be either the phone network, phone manufacturer, or other entity.

As explained in the proposal, as a matter of law, agents are held to the same restrictions with respect to the agency relationships as their principals. In other words, a third-party processor cannot act on behalf of an issuer and receive higher interchange fees than are permissible for the issuer to receive under this rule. For example, if an issuer uses a third-party processor to authorize, clear, or settle transactions on its behalf, the third-party processor may not receive interchange fees in excess of the issuer's permissible amount. Therefore, the Board does not believe that removing the clause “or agent of such person” will have a substantive effect on either the interchange fee restrictions or the network exclusivity and routing provisions. In assessing compliance, any interchange transaction fee received by the agent of the issuer will be deemed to be an interchange transaction fee received by the issuer.

L. Section 235.2(l)—Merchant

EFTA Section 920 does not define the term “merchant.”

The Board proposed to define “merchant” to mean “any person that accepts debit cards as payment for goods or services.” The Board did not receive comments specifically on the proposed definition; however, a few commenters suggested that ATM operators be included in the definition of “merchant.” As discussed below in relation to § 235.2(m), ATM operators do not accept payment in exchange for goods or services. Rather, ATM operators facilitate cardholders' access to their own funds. The Board has revised § 235.2(l) so as to not limit the purposes for which a person accepts payment to being in exchange for goods or services.

See

§ 235.2(h) and comment 2(h)-2. This expansion does not include ATM operators within the definition of “merchant.”

Section 920(c)(11)'s definition of “payment card network” refers to “an entity * * * that a person uses in order to accept as a form of payment a brand of debit card.”

M. Section 235.2(m)—Payment Card Network

EFTA Section 920(c)(11) defines “payment card network” as “an entity that directly, or through licensed members, processors or agents, provides the proprietary services, infrastructure, and software that route information and data to conduct debit card or credit card transaction authorization, clearance, and settlement, and that a person uses in order to accept as a form of payment a brand of debit card, credit card or

other device that may be used to carry out debit or credit transactions.” The Board proposed a modified version of the statutory definition as defining the term “payment card network” to mean an entity that (1) directly or indirectly provides the services, infrastructure, and software for the authorization, clearance, and settlement of electronic debit transactions and (2) establishes the standards, rules, or procedures that govern the rights and obligations of issuers and acquirers involved in processing electronic debit transactions through the network. Proposed commentary 2(m)-1 further explained the proposed criteria that only those entities that establish rules governing issuers and acquirers be considered payment card networks. The Board received several comments on its proposed definition of “payment card network.” A few commenters generally supported the Board's proposed definition.

A few commenters supported the Board's proposed exclusion of issuers, acquirers, and processors from the definition of “payment card network.” These commenters argued that including these entities in the definition was beyond the intent of EFTA Section 920 and would have unintended consequences. By contrast, other commenters argued that the statutory definition of “payment card network” was broad enough to include processors and gateways, among other entities. One commenter suggested that the Board consider third-party intermediaries to be “payment card networks” if a network contracts with them to perform functions traditionally performed by a network.

1. Standards, Rules, or Procedures Governing Issuers and Acquirers

One commenter expressed concern that adding the “standards, rules, or procedures” criteria would reduce the Board's flexibility to cover emerging payment systems under the rule. A few commenters also suggested that the Board impose substantive requirements on the rules that entities establish in order to be considered “payment card networks” for purposes of this rule. In particular, these commenters suggested the Board require the “standards, rules, or procedures” to include consumer chargeback rights.

The Board has considered the comments received and has determined to revise the final rule to eliminate the “standards, rules, or procedures” criteria. This recognizes that processors and gateways may be “payment card networks” with respect to electronic debit transactions depending on their role (discussed below in connection with this defined term). To be considered a payment card network for purposes of this rule an entity must do more in relation to a transaction than provide proprietary services, infrastructure, and software to route the transaction information to conduct authorization, clearance, and settlement. The Board continues to believe that an entity that acts solely as an issuer, acquirer, or processor with respect to an electronic debit transaction is not covered by the definition of “payment card network,” because such entities do not route information and data between an acquirer and an issuer with respect to the transaction. In order to make this clear, the final rule provides that an entity is considered a payment card network only if the entity routes electronic debit transaction information and data between an acquirer and issuer.

The Board is not adopting the guidelines, rules, or procedures requirement and, therefore, it is not necessary to address the comments regarding substantive requirements of such standards, rules, or procedures.

Processors and gateways may take on different roles depending on the transaction. For example, for a given transaction, an entity may act as processor to both the acquirer and the issuer. The acquirer and issuer may wish to bypass the network for such a transaction and may themselves establish standards, rules, or procedures for so doing, while relying on the processor or gateway to process the electronic debit transaction and charge and pay fees between the acquirer and issuer. In that case, the Board believes the processor is acting as a payment card network and should be considered a “payment card network” with respect to the transaction for purposes of the rule. Accordingly, the Board has revised the commentary to the definition of “payment card network” to explain that an entity that acts as processor between issuers and merchants without routing the transaction through an intervening payment card network would be considered a payment card network with respect to those transactions.

See

comment 2(m)-3.

Some emerging payment systems may resemble payment card networks, while others may resemble acquirers or acquirer processors. Like existing entities, if the emerging payment system routes transaction information and data between acquirers and issuers, and not to an intervening payment card network, the system will be considered a payment card network for purposes of those transactions, provided the entity satisfies the other criteria in § 235.2(m). If a payment card network contracts with another entity to perform network-like functions on behalf of the payment card network, the other entity is considered the agent of the payment card network.

2. Proprietary Services and Brands of Payment Cards

The proposal did not include the statutory text that a payment card network provides “proprietary” services, infrastructure, and software provided for authorization, clearance, and settlement and that those services enable a person to accept “a brand of debit card.” The Board received one comment suggesting the Board retain the statutory concept that a payment card network provides “proprietary” services that

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