Finance Committee on May 26th, 2009

[The Co-Chair, Conservative, Michael Chong]

Good afternoon, everybody.

Good afternoon, everyone. Welcome to the joint meeting of the Standing Committee on Industry, Science and Technology and the Standing Committee on Finance.

I am here with my co-chair, Mr. Rajotte, who is the chair of the House of Commons Standing Committee on Finance. My name is Michael Chong, and I am the chair of the Standing Committee on Industry, Science and Technology.

Pursuant to Standing Order 108(2), we are studying credit card interchange fees and the debit payment system in Canada.

Today I am pleased to welcome two representatives of UseMyBank Services, Mr. Brian Crozier, co-founder of UseMyBank Services, responsible for global business development; and Mr. Joseph Iuso, who is the chief executive officer and also a co-founder of UseMyBank Services.

We're also pleased to welcome, from Moneris Solutions, Mr. Jim Baumgartner, president and chief executive officer; and Ms. Fern Glowinsky, senior vice-president, general counsel, and corporate secretary.

From TD Merchant Services, we're also pleased to welcome Mr. Jeff van Duynhoven, who is the president of that company.

Welcome to all.

You now have a chance to provide some opening remarks. We'll begin with UseMyBank Services.

[Brian Crozier, Co-founder, Global Business Development, UseMyBank Services]

Thank you.

We'd like to thank the committee for the opportunity to present our view, as a Canadian online payment service provider, of the online electronic transactions business in Canada.

My name is Brian Crozier. I'm in global business development for UseMyBank Services in Toronto. I've been in the online payment processing business for over 12 years. My business partner and CEO of UseMyBank, Joseph Iuso, has worked for major Canadian banks for over 20 years. Joseph has extensive knowledge of the technical capabilities of the Canadian banking system, as well as all aspects of security, transaction processing, the self-service arena of ATM POS terminals, as well as telephone and Internet banking.

UseMyBank is a Canadian online bank service provider for online merchants and billers. Our core technology provides an easy way for online merchants to transact in real time with their customers using online banking.

Consumers who use a merchant's online checkout may choose their online bank and make a purchase or pay a bill in real time. We launched our service in 2002 and have processed millions of transactions for Canadians, with a good funds rate of 99.99999%.

UseMyBank pioneered online payments several years ahead of the Canadian banking institutions. We were able to accomplish this by leveraging the existing online banking systems to perform real-time payments. We have since expanded our service to hundreds of banks across 10 countries. This real-world experience gives us at UseMyBank a global view of the best online payment practices, which we can share with committee members.

The business of making payments in Canada is largely controlled by a handful of financial institutions. Many believe this constitutes a monopoly that stifles competition, which is the very lifeblood of Canadian business. E-commerce is an important and growing part of the payment industry in Canada. Payments to online merchants and billers are now in the tens of billions of dollars, and many merchants and consumers would like to see more available choices when making these online payments.

There is very little competition in the Canadian payments market. There is a tradition of in-house sales of merchant services, with the largest payment processor, Moneris Solutions, being owned by two of the largest banks. Paymentech and Global Payment Systems have taken over the rest of the market where mergers were not allowed. So it's not difficult to understand why new independent businesses face an uphill battle to offer service.

Interac, Canada's near-monopoly debit network, as well as Visa and MasterCard, are in the business of processing online payments. We believe it's in our country's best interest to offer consumers a choice by having as many suppliers of online payment services in Canada as possible, thus ensuring the quality of service as well as fair market prices.

Since 1989, retailers in Canada have been accepting debit payments at point of sale terminals for pennies per transaction using Interac. In 2006, Interac launched Interac Online, charging merchants upwards of 2% or more per transaction.

Canadian online retailers and billers require a greater variety of options when accepting payments from their customers--more than the current four banks that Interac supplies. For example, the Canadian travel and airline business processes billions of dollars in transactions each year online. This industry currently finds itself between high credit card rates and Interac Online's position of placing them on a restricted list. These retailers are unable to accept direct payments from their customers using online banking.

Canada's clearing and settlement system is among the most efficient in the world. The Canadian Payments Association operates national clearing and settlement systems for all cheques, wire transfers, direct deposits, pre-authorized debits, bill payments, point-of-sale debits, and online payments. Transactions that are charged to credit cards are not cleared through CPA systems, thus the CPA rules don't apply to them.

UseMyBank has met with the CPA to bring them a better understanding of the need for alternative forms of online payments and the benefit that such technology offers Canadian e-commerce. The rules ultimately drafted on this measure excluded not only UseMyBank but many other innovative companies from participating in the Canadian payment sector.

From its initial launch, UseMyBank has made every effort to be an active participant in the payment processing industry. Both in Canada and abroad, we have ensured that our goals and objectives are heard and understood at the regulatory and legislative levels of the financial banking industry.

This same scenario has been replayed time and time again with every group that has been charged with the responsibility of governing the Canadian payment industry. Sadly, innovations that could offer Canadian merchants safe and cost-effective ways to build their online business are being stifled, while other countries begin to surge ahead of us in this sector. We believe that the banking system in Canada should have regulations that foster competition and innovation, similar to the telecommunications industry today, which is enjoying more services and lower prices as a result of allowing more competition to enter a market that was once a monopoly.

In 2006, the Bank of Nova Scotia became a defendant in a case brought before the Competition Tribunal. It was alleged to have illegally reduced competition in the online debit payments market. The bank won the case, but the plaintiff, GPay, without the cooperation of the defendant and other Canadian banks, was unable to remain doing business. GPay was our payment processor for Canada at that time.

At one time, Canada was number one for consumer adoption and usage of ATMs, POS terminals, debit transactions, and online banking. We are no longer number one, as many of these other countries have surpassed us. Since 2000, the banking industry has not been as responsive to changing market conditions and expectations. Their policies and tactics have attempted to restrict the market by manipulating the rules and regulations through lobbying the CPA, the CBA, and other government agencies.

It is possible for Canada to regain its lead in the payments industry. However, it requires an environment that rewards entrepreneurs for creating the next big ideas and companies. We hope that the committee can help make this a more friendly and competitive market for online payment service providers and their millions of Canadian and global customers.

Thank you.

[The Co-Chair, Conservative, Michael Chong]

Thank you very much, Mr. Crozier.

We'll now hear from Moneris Solutions and, I believe, Mr. Baumgartner.

[Jim Baumgartner, President and Chief Executive Officer, Moneris Solutions]

Thank you very much.

Thank you for the invitation to speak to the committee regarding the study of the credit and debit card industry in Canada. We appreciate the opportunity to appear before you and share information with you in support of your study.

I'm Jim Baumgartner, president of CEO of Moneris Solutions, and with me here today is Fern Glowinsky, our senior vice-president and general counsel.

Moneris Solutions is a Canadian-based payment processor with operations in Canada as well as the U.S. Our head office is in Toronto, and we also have offices in Sackville, New Brunswick; Montreal; Calgary; Vancouver; and throughout the United States. We've been providing credit, debit, and gift card acceptance solutions to merchants in Canada and the U.S. since December 2000. We process for approximately 350,000 merchant locations in Canada and close to 65,000 merchants in the U.S.

Moneris is a joint investment of the Royal Bank of Canada and the Bank of Montreal. We distribute our products and services to the market directly through various sales channels. Moneris employs approximately 1,800 people, the vast majority of whom are right here in Canada.

As our role in the industry tends to be the least understood, I'll take a moment to briefly describe what we do. First, we enable merchants' acceptance of electronic payments by providing and supporting the cardholder facing solution, which may be a stand-alone device at the point of sale or enablement of a cash register, gas pump, kiosk, or even a website. Second, when a card is swiped--or inserted, in the chip context--we route that transaction and the authorization request through the payment brands to the card issuer. They send back an authorization message that we deliver to the merchant so the merchant knows that the customer is authorized by the issuing bank to complete the transaction. Once the transaction is authorized by the card issuer, the merchant will finalize the transaction with the cardholder and send us a settlement file that prompts us to settle funds into the merchant's bank account for that day's transaction activity.

An important component of our business model is merchant underwriting. We bear the risk when the merchant does not deliver the goods or services that have been paid for in advance--for example, when a cardholder purchases an airline ticket and the airline goes out of business prior to delivering the flight--and in the cases of merchant fraud and non-compliance with payment brand rules.

We also provide reporting to enable the merchant to monitor their transaction activity for the purposes of operational and financial reconciliation, as well as fraud monitoring.

Another important element of our service is exception item management. This includes the tracing of individual transactions and mediating on behalf of the merchant in the case of a transaction being disputed by a cardholder.

As a whole, these components are the payment processing value proposition. Payment processing is often the last interaction or final impression between the merchant and the consumer in the shopping experience, therefore it has to be instant, always on, and easy to operate. It is critical in enabling cashflow, and therefore the merchant must receive funds when and where they want them and have certainty of payment. The finality of payment feature in today's uncertain times removes an element of credit risk from the equation, as well as the risk in handling large amounts of cash.

The payment processor also plays a leading role in the integrity and evolution of electronic payment networks. With the introduction of enhanced verification technology such as chip, data security standards such as PCI, or new card entry modes such as contactless, the processor must upgrade its infrastructure. These are no small tasks. They're very capital-intensive and complex undertakings that have helped Canada maintain one of the most ubiquitous, secure, and successful networks in the entire world.

As an industry, we're subject to the increasing liabilities associated with potential data compromises. A number of recent high-profile breaches in the U.S. have highlighted the threats posed to the digital infrastructure. The reality is that the cost of compliance and ensuring security within the payment system is continually increasing as the threat of breaches and fraud continues to evolve.

The Canadian payment processing market is highly competitive. Most of North America's top processors actively market in Canada. Significant established players regularly enter the market. U.S.-based merchant processors now control a significant percentage of the Canadian market. In addition, there's a robust reseller industry that offers even more choice to merchants. Our industry is forced to compete on price and innovation to maintain our market position. And at this point in the evolution of the payment card industry, card acceptance is roughly equivalent to the growth in the retail economy. It is essentially a zero-sum game, requiring each industry participant to strive to be the most relevant to its merchants. We negotiate fees with merchants directly.

In terms of merchant acceptance of cards, merchants have a choice about acceptance, and they do so because of the significant value they receive from electronic payments, including avoiding the costs associated with handling cash, reporting and reconciliation, finality of payment, speed and throughput at the point of sale, and increasing customer satisfaction by offering their customers a payment method of choice.

There has been much discussion about interchange, and as you may know, it is the fee that's paid by the payment processors to the card issuers. In our pricing model, it is a component of our cost of goods sold. Payment processors do not set interchange rates; we are advised of them by the payment brands. Other components of our cost base include the assessment fees that are paid to the payment brands, as well as our operating infrastructure.

There has also been much discussion about the introduction of competing debit products in Canada. As payment enablers, we have to invest in the infrastructure to process new acceptance products from card issuers because we expect that at least some of our merchants will want to be able to accept the card their customer presents for payment. As a result, we must develop the technical acceptance capability, build business processes, commercialize, and inform and train the merchant. New products attract a greater compliance burden, greater wear and tear on our hardware, as well as additional risk and exception item management.

We hope our remarks have provided some helpful insights, and we look forward to answering your questions. Thank you again for the opportunity to be here.

[The Co-Chair, Conservative, Michael Chong]

Thank you, Mr. Baumgartner.

Finally, we'll hear from Mr. van Duynhoven.

[Jeff van Duynhoven, President, TD Merchant Services]

Thank you, Mr. Chair. I appreciate the opportunity to appear before you today on behalf of TD Merchant Services.

Payment systems are obviously a complex topic, but I'm happy to do what I can to help explain the process and explicitly the role that a merchant acquirer plays within that system. In the simplest sense, as acquirers, we provide our customers with point-of-sale payment devices, the hardware that sits on the counter in a store, and we process payments on behalf of the retailer.

Major merchant acquirers, or payment processors, including TD Merchant Services, Moneris, Global Payments, Chase Paymentech, and Desjardins, provide essentially the same set of payment capabilities to merchants, but we compete with each other primarily based on two things: the quality of service we provide and the price we charge that merchant.

TD is the only Canadian bank that currently operates a merchant acquiring business. The reason for this is quite simple. We believe it is a relationship business and we appreciate having a direct relationship with retailers and business owners across Canada. In fact, more than 85% of my clients are also clients and customers of TD Canada Trust, illustrating this relationship aspect for us.

In terms of pricing, as the committee knows, interchange rates are set by the payment network companies—Visa and MasterCard—and they both make these rates available via their websites. Both have stated their intention to enter the debit market in Canada and have communicated the interchange rates associated with accepting those debit cards. Acquirers take these interchange rates, determine our own additional direct costs, and then develop a comprehensive fee structure that we present to merchants. The cost of interchange is by far the largest component of the merchant discount rate.

In the past, we presented costs to merchants via a simple, often all-in merchant discount rate—that is, the all-in cost a merchant would pay per transaction process. This was feasible as the interchange rate structure was simple at the time. The payment networks have since changed their interchange rate structures to a more complex model that has different rates for consumer, premium, and business cards, as well as for online or other card-not-present transactions. As a consequence, acquirers also revisited pricing approaches to merchants.

TD Merchant Services completed this task in time for the introduction of Visa interchange rates in April 2008, and this was a significant effort and was completed at considerable cost to my business.

This committee has heard testimony to date regarding transparency on the part of acquirers. As part of our submission to today's hearing, we provided the committee with samples of notification letters that we sent to clients to illustrate the approach we take to articulate any change in the merchant's processing costs. I'd like to highlight to the committee, as well, that these letters are from 2007 and 2008, before Parliament began its studies on this matter. Quite simply, it's the way we do business.

As illustrated in these letters, we introduced new fees or changes to current fees arising from the interchange rate structures made by Visa, and we provided appropriate examples to ensure that merchants understood the impact of these changes. At TD Merchant Services, we are proud to provide our merchants with what we believe is a clear and transparent statement of their monthly activity.

I've shared a sample of this statement with the committee and have highlighted the Visa discount rate adjustment box, which lists the number and dollar amount of all transactions for which a rate in excess of the merchant discount rate has been applied. This section of our statement also clearly identifies the type of card used—for example, an Infinite card or a commercial card—in plain English, not via the use of codes or other more obscure terminology. This section also identifies the increase in the rate associated with the processing of these transactions and the sum of the additional charges for each card type processed by that merchant.

To reiterate, I know some organizations have complained that there is a lack of transparency at some points in the payment process. From my perspective, I believe that clients of TD Merchant Services have a clear picture of the fees they are paying for the transactions we process on their behalf. In fact, delivering quality service and communicating with customers in a clear and transparent manner is a key tenet for both TD Merchant Services and the entire TD Bank Financial Group.

As an acquirer, TD will continue to bring the latest payment options to our merchants. However, as these options are introduced, history would suggest that in order to be viable, any innovation needs to create value for all stakeholders in the payment value chain, whether they be issuers, consumers, merchants, or acquirers, as without the acceptance of all of the parties involved, these innovations are likely to fail.

As change evolves, we will continue to consult with our customers, presenting new options to determine whether they are of interest to them, as well as educating and training their staff on how to use the new technologies. Throughout this process, we will continue to communicate clearly so that merchants know exactly what they're paying for and that they're getting value for their money. As payment processes continue to develop over time, TD Merchant Services will not change our strategy of offering customer-focused, price-competitive, high-quality services to our clients in a transparent manner.

Thank you, Mr. Chair. I'd be pleased to answer questions.

[The Co-Chair, Conservative, James Rajotte]

Thank you, Mr. van Duynhoven.

We have an hour and a half for questions and comments and we use both official languages so some MPs will ask questions in French and some in English.

So without further ado, we'll commence with Madam Coady.

[Siobhan Coady, Liberal, St. John's South—Mount Pearl, NL]

Thank you very much.

Thank you for your very clear presentations this afternoon. I appreciate the time you've taken to present to this joint committee.

I have a series of questions I'd like to go through, so brevity would be asked, if you don't mind, just because there's such a lengthy list of questions.

I'm going to start with the credit card side of life and ask a couple of questions. Did you have any influence on the interchange fees at all? When Visa and MasterCard were making changes to the interchange fees--I think I know the answer, but I want to hear it from you--did you have any influence?

[Jim Baumgartner]

From our perspective, no.

[Jeff van Duynhoven]

I would say the same, no, not at all.

[Siobhan Coady, Liberal, St. John's South—Mount Pearl, NL]

When the changes were made to the interchange fees--I think TD has already indicated that they also changed their pricing model to merchants at the same time--did you see any increase being paid to you because of the changes in the interchange fees and then your change in pricing models?

Did you change your pricing model, Moneris?

[Jim Baumgartner]

Yes, we did.

[Siobhan Coady, Liberal, St. John's South—Mount Pearl, NL]

At the same time?

[Jim Baumgartner]

Yes, as the more complex interchange structure was introduced, we did change our pricing structure in response to that. I can tell you that overall from when we started the company--the first full year was 2001--to 2008, the difference between what we were charged in interchange and assessments and what we charge our merchants has come down. So what we call our gross spread in basis points has come down from 2001 to 2008.

[Jeff van Duynhoven]

In terms of the interchange rates?

[Siobhan Coady, Liberal, St. John's South—Mount Pearl, NL]

And your change in pricing model, how did that affect your business?

[Jeff van Duynhoven]

As I said, when the interchange changed from two rates to 21 on the Visa side, we had to look at our pricing. Some merchants did see increases, but others saw decreases as well, depending on which industry they were in, the types of cards they process, and how they process those cards. So we had customers who moved both ways.

[Siobhan Coady, Liberal, St. John's South—Mount Pearl, NL]

Would you say there was one particular industry that was affected more than others?

[Jeff van Duynhoven]

More from a transaction size, so those industries that had a higher transaction size benefited and those that had a low transaction size, like quick-service restaurants and those sorts of things, saw the biggest price increases.

[Siobhan Coady, Liberal, St. John's South—Mount Pearl, NL]

Would you say there's a big impact to your businesses on the premium card introduction in terms of price, negative or positive, any impact at all?

[Jim Baumgartner]

Well, it required a significant investment in infrastructure. Our system was not capable of handling the complex interchange structure that was traditionally more common in the U.S. When that was introduced here, it required an investment in the tens of millions of dollars to be able to handle that.

[Siobhan Coady, Liberal, St. John's South—Mount Pearl, NL]

Do you think the merchants bore any of that cost, or do you feel you bore most of it?

[Jim Baumgartner]

I'd say a combination of both, quite frankly. As I mentioned before, our spreads have come down since we started and so we definitely have borne some of it, but the merchants are paying more as well, and there's no doubt about it.

[Siobhan Coady, Liberal, St. John's South—Mount Pearl, NL]

In the interest of time, I want to move to the debit card side of things. There are a few questions I want to talk about. First of all, could you explain priority routing? Are you aware of priority routing?

[Jim Baumgartner]

On the debit side? Sure, I can, and I'll try to be brief. Cut me off if I'm not brief enough.

Priority routing refers to a practice where, if you had an Interac card today, and let's say Maestro was added to the card, the instructions from the issuers would be to route this through Maestro as opposed to an Interac transaction. The card brands have taken different approaches on this. Visa, more recently, has said that they're going to allow consumers to choose. MasterCard is asking the banks to indicate where they would like their customers' transactions routed through. So they've taken different approaches, as they will do occasionally.