v3 01/02/06 Analysis of European Debit Card MSC Differences TARJETAS DE PAGO Y TASAS DE INTERCAMBIO Madrid, 2 nd February 2006

Explaining Differing European MSC Levelsv3 01/02/06 2 Objectives Test the hypothesis: “That the level of debit MSC in any market is substantially linked to the maturity of its domestic EftPos payments infrastructure and the effectiveness of its national displacement strategy”. Specifically to:  Identify the sources of Merchant Service Charge (MSC) differences within Europe  Explore the relationship between Europe’s varied MSC levels and the level of debit usage  Identify potential causes of differences between national debit markets  Support PSE’s position that imposing a common European debit interchange could have unforeseen impacts, and that a lengthy convergence period would be required.

Explaining Differing European MSC Levelsv3 01/02/06 3 Scope and Methodology Scope:  Major EU Cards Markets (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Norway, Portugal, Spain, Switzerland, and the UK)  National data from Eastern European nations on historical and current card and cash usage was not yet regarded as sufficiently reliable, or comparable, to allow inclusion. StepLogic 1. A MSC simple normalisation approach Enables a more accurate comparison of MSCs across Western Europe 2. A simple Debit Cash Displacement (DCD) metric Links consumers’ propensity to use cash versus plastic cards at the Point of Sale (POS), to show the effectiveness of each nations cash displacement strategies. 3. The correlation of normalised debit MSCs with DCD Demonstrates the link between the level of MSC and the maturity of plastic cards payment infrastructure.

Explaining Differing European MSC Levelsv3 01/02/06 4 Headline European MSC Rates Current MSC Rates in Europe Acquired Volumes/ Values Cross Border Transactions Settlement/ Float Costs Terminal/ Merchant Support Costs HEADLINE MSC Rates NORMALISED MSC Rates Current Headline Rates are Currently Non-Comparable PSE Normalisation Approach

Explaining Differing European MSC Levelsv3 01/02/06 5 Rate Variation within the EU CountryTerminalsTerminal Maintenance TelecomsConsumablesSettlement Period Austria NNN Y T + 2 Belgium NNN Y T + 3 DenmarkNNNNT + 1 Finland NNN Y T + 6 France NN Y (60%) N T + 1 GermanyNNNNT + 3 Greece YYYY T + 3 Ireland NNN Y T + 1 Italy Y (25%) NN T + 1 Netherlands NNN Y T + 2 Norway----T + 2 Portugal Y (60%) Y (10%) Y (60%) T + 1 Spain YYYY T + 1 SwitzerlandNNNNT + 2 UK NN Y (50%) N T + 2 Source: PSE Surveys in 2002 and 2005 Substantial Variations Still Exist in the MSC Rate Structures

Explaining Differing European MSC Levelsv3 01/02/06 6 Impact of Normalisation Normalised MSC Rates in EuropeImpact of Normalisation Average MSCs drop by 5% following Normalisation, with Spanish Rates falling by 25%

Explaining Differing European MSC Levelsv3 01/02/06 7 Usage and Maturity Variation in the EU Wide range of Maturity Levels within the Western European Market for POS usage Total Value of Debit POS (per annum per capita) Volume of Debit POS Transactions (per annum per capita)

Explaining Differing European MSC Levelsv3 01/02/06 8 The Debit Cash Displacement Metric MetricLogic Debit POS expenditure value per capita per annum This indicates, for each national market, the value of domestic debit POS expenditure per capita per annum (debit has been used rather than credit due to the European propensity to use debit for domestic transactions – c.79% of plastic card transactions in Western Europe are debit). ATM Withdrawal value per capita per annum This indicates the total value of cash acquired from ATMs per capita per annum. Again, this is a proxy for cash spending based on the assumption that a high proportion of cash spent at merchants is acquired through the ATM

Explaining Differing European MSC Levelsv3 01/02/06 9 The DCD Metric in the EU CountryDCD Score (2005) Austria44% Belgium53% Denmark66% Finland49% France60% Germany19% Greece1% Ireland27% Italy35% Netherlands50% Norway69% Portugal40% Spain27% Switzerland66% UK55% DCD Scores Scores range from 1% to 69% Majority of countries have experienced increases in their DCD metrics over the past ten years, a reflection of their maturing debit card market

Explaining Differing European MSC Levelsv3 01/02/06 10 The MSC DCD Relationship The MSC DCD Relationship (2005) Data Points Correlation All Western European Markets-0.74 Western Europe, with no Germany or Ireland-0.88 Western Europe with no Greece-0.72 Analysis indicates a relationship between the DCD score and the level of MSCs

Explaining Differing European MSC Levelsv3 01/02/06 11 Answer to the most frequently asked question… “…this analysis proves the hypothesis that countries with very low or no MSCs have successful EftPOS strategies” Country comparisons show that this is not so:  Germany has a debit MSC of c.€0.3 but has one of the lowest card transactions per head of population per annum  France also has a debit MSC of c.€0.3 but has one of the highest card transactions per head of population per annum (also has high card/ bank accounting fees) The MSC Debit Usage Relationship (2005) …lower MSCs do not reflect successful cash displacement or EftPOS strategies

Explaining Differing European MSC Levelsv3 01/02/06 12 Characteristics of More Developed Card Markets Causal LinkCharacteristics of More Developed Card Markets National Consensus and Funding:  National consensus over the benefits of cash (and cheque) displacement  Strong and well funded interbank bodies  Worked closely with large merchants and merchant associations  Cohesive structure and a commercial frameworks Competition:  Merchants are more likely to have a greater choice of acquirers  Competition squeezes acquirer’s profit margins, reducing MSCs but also encouraging unbundling  Strong merchant pressure for banks to reduce or minimise rates Cardholder Perceptions and Incentives:  Issuers use share of card income (interchange revenues) to fund cardholder behaviour change campaigns.  Mature markets consumers no longer require further education or substantial incentives to encourage usage Merchant Perceptions and Benefits:  More successful in persuading merchants of the benefits of cards and in particularly the value of the funds guarantee  Persuaded merchants that they can achieve substantial benefits through improved customer service and cost savings through cash (and cheque) displacement

Explaining Differing European MSC Levelsv3 01/02/06 13 Characteristics of Less Developed Countries  Lack of a coherent national cash displacement strategy and strong central leadership. This results in a fragmented approach to EftPos.  Difficulty in building early support for debit card EftPos amongst the largest merchants and supermarkets.  Business models that vary substantially from those of successful countries, such as:  Three party structures which eliminate the use of an acquiring bank and operate without a MIF generating insufficient revenues to incentivise consumers and deliver merchant benefits.  Bundled MSC structures, complex MIF formulae and merchant contracts.  Fragmented and complex acquiring structures which result in multiple terminal placement, loss-making acquiring and insufficient funds to change consumer behaviour.  Strong consumer cultural propensity to use cash

Explaining Differing European MSC Levelsv3 01/02/06 14 Summary and Conclusions 1.There is a negative correlation between the simple DCD metric and the level of normalised debit MSC 2.These differences are necessary and that inappropriate intervention may have undesirable consequences on the development of domestic payment infrastructure. 3.If working effectively, card markets will converge over time around lower debit MSC levels as card payments displace cash usage. 4.Successful cash displacement strategies reflect clear national direction, strong competitive commercial frameworks, and good incentives to invest in infrastructures, change consumer behaviour and deliver merchant benefits.

Explaining Differing European MSC Levelsv3 01/02/06 15 Peter Jones Managing Director Chris Jones Senior Consultant +44 (0)