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

Constantine & Partners 2 Constantine Cannon 2 C C The Future of Visa and MasterCard Major Issues Facing Visa and MasterCard –Internal cohesion –Merchant anger –Pressure from new competitors –Magnet for legal problems –Potential preference by large banks for different ownership structure

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

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

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

Constantine & Partners 6 Constantine Cannon 6 C C The Future of Visa and MasterCard Legal Problems Can be Sub-Divided into 3 Broad Categories –Membership rules –Merchant acceptance practices –Interchange

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

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

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

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

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

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

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

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

Constantine & Partners 15 Constantine & Partners Constantine Cannon 15 C C The Future of Visa and MasterCard The Final Frontier-Interchange

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

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

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

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

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

Constantine & Partners 21 Constantine & Partners Constantine Cannon 21 C C The Future of Visa and MasterCard Other Recent Significant National Investigations Of Interchange Spain Netherlands Poland Switzerland Italy Israel Sweden

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

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

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

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