The payments industry will see operational changes throughout its value chain. Here we highlight the
operational changes we expect to see at acquirers, banks, merchants, and networks.
Banks and acquirers would have to re-formulate and re-write their risk and underwriting policies to consider not just the TSR but many other industry-specific laws. These changes will materially impact acquirers’ operations.
Beginning with underwriting, acquirers would now be required to complete substantially increased due diligence of every potential new merchant. All acquirers would likely revise their risk policy and underwriting operations to include stricter evaluation of each merchant’s business model and its compliance with all applicable laws. For example, the up-front diligence requirement (per Visa and MasterCard guidance) of a “detailed business description” might be replaced by a required site visit to the merchant’s call center or operating location or the requirement that underwriters scrutinize or audit every business. Acquirers today do not have the level of knowledge and experience necessary to support this level of due diligence. It is our expectation that acquirers would be required to build new capabilities or use third parties with knowledge of specific industries to perform initial and ongoing due diligence.
Diligence would now need to include merchants’ operations to ensure compliance with laws and regulations not monitored by acquirers today such as the TSR and other laws specific to each industry served by the acquirer. This due diligence may need to include periodic audits and investigations into business contacts, contacting and surveying the merchants’ customers, and mystery shopping.
This would require highly skilled and experienced staff, which will be costly and result in expenses being passed on to merchants and, ultimately, to consumers in the form of higher prices. Today, the average time from receipt of merchant application to approval is one day. The time to underwrite a merchant application would significantly increase even if an acquirer chooses not to service telemarketing or other card-not-present merchants. We can easily see the time to underwrite a merchant increasing by 300% to 500% and the cost increasing in a similar fashion.
Operational consequences would not stop in the underwriting back-office. Sales staffs would need to be informed and educated about underwriting requirements. Portfolio managers would likely need to examine their existing books of business for examples of merchants that might now fall under the new policies. Numerous legal businesses across the U.S. may be displaced from the payments system and forced to accept only cash and checks.
Ongoing risk management would face similar, additional operational requirements to reconfirm the diligence done during the initial underwriting process. Ongoing “triggers” would need to be updated to include merchants that may not meet Visa and MasterCard definitions for high chargeback merchants as well as merchants that may now be in violation of any number of federal, state, or local laws. In short, acquirers would need to work through a process of revising their pre-existing risk policies, operations, and procedures, which would have a ripple effect through the rest of their businesses, increasing overall time and cost to underwrite an account.
Merchants would be required to make operational changes if the FTC continues with its current actions. Today, only a very small percentage of merchants are required to post reserves in order to process credit card transactions. With few exceptions in high-risk verticals, virtually all accounts across the industry are unsecured. The FTC’s proposed actions would likely change that and make it more difficult for merchants to gain access to the electronic payment system. Today, most merchants in the U.S. are paid credit card receipts one to two business days after transactions are processed. Other countries take up to thirty days to pay the merchant. Acquirers in the U.S. would likely want to hold merchant funds longer as a risk mitigation strategy, which will impact the cash flow of merchants, especially small businesses that have limited access to credit. These factors would impact small business cash flow and borrowing needs.
In addition to potentially being required to post collateral and suffering from delayed settlement, merchants may be subject to invasion of their business privacy by their merchant processors as merchant processors will need to audit the business to validate compliance with laws. This will impact businesses that incur the costs of the audit and distraction of their key personnel.
In response to FTC actions, the Card Networks will likely implement more restrictive rules and penalties. First, this could entail higher capital requirements to achieve the principal acquirer status needed to be an acquiring member bank. Alternatively, additional capital could be required to process merchants in certain industries that are considered higher risk. “Higher risk” in this sense would not be based on traditional risk models and experience, but rather defined as the potential for government actions, fines, and penalties.The Card Networks may also restrict acquirers from serving certain industry verticals, require collateral to protect the payments system, or implement higher pricing at the network level.
The FTC’s Potential Impact on the Merchant Acquiring Industry Prepared for the Electronic Transactions Association
First Annapolis Consulting, Inc.
July 15, 2014