`[Federal Register Volume 75, Number 248 (Tuesday, December 28, 2010)]
[Proposed Rules]
[Pages 81722-81763]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-32061]



[[Page 81721]]

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Part II





Federal Reserve System





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12 CFR Part 235



Debit Card Interchange Fees and Routing; Proposed Rule

  Federal Register / Vol. 75 , No. 248 / Tuesday, December 28, 2010 / 
Proposed Rules  

[[Page 81722]]


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FEDERAL RESERVE SYSTEM

12 CFR Part 235

[Regulation II; Docket No. R-1404]
RIN 7100-AD63


Debit Card Interchange Fees and Routing

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Board is requesting public comment on proposed new 
Regulation II, Debit Card Interchange Fees and Routing, which: 
establishes standards for determining whether an interchange fee 
received or charged by an issuer with respect to an electronic debit 
transaction is reasonable and proportional to the cost incurred by the 
issuer with respect to the transaction; and prohibits issuers and 
networks from restricting the number of networks over which an 
electronic debit transaction may be processed and from inhibiting the 
ability of a merchant to direct the routing of an electronic debit 
transaction to any network that may process such transactions. With 
respect to the interchange fee standards, the Board is requesting 
comment on two alternatives that would apply to covered issuers: an 
issuer-specific standard with a safe harbor and a cap; or a cap 
applicable to all such issuers. The proposed rule would additionally 
prohibit circumvention or evasion of the interchange fee limitations 
(under both alternatives) by preventing the issuer from receiving net 
compensation from the network (excluding interchange fees passed 
through the network). The Board also is requesting comment on possible 
frameworks for an adjustment to interchange fees for fraud-prevention 
costs. With respect to the debit-card routing rules, the Board is 
requesting comment on two alternative rules prohibiting network 
exclusivity: one alternative would require at least two unaffiliated 
networks per debit card, and the other would require at least two 
unaffiliated networks for each type of transaction authorization 
method. Under both alternatives, the issuers and networks would be 
prohibited from inhibiting a merchant's ability to direct the routing 
of an electronic debit transaction over any network that may process 
such transactions.

DATES: Comments must be submitted by February 22, 2011.

ADDRESSES: You may submit comments, identified by Docket No. R-1404 and 
RIN No. 7100 AD63, by any of the following methods:
    Agency Web site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
    Federal eRulemaking Portal:http://www.regulations.gov. Follow the 
instructions for submitting comments.
    E-mail: [email protected]. Include the docket number 
in the subject line of the message.
    Fax: (202) 452-3819 or (202) 452-3102.
    Mail: Jennifer J. Johnson, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW., 
Washington, DC 20551.
    All public comments are available from the Board's Web site at 
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, your 
comments will not be edited to remove any identifying or contact 
information.
    Public comments may also be viewed electronically or in paper in 
Room MP-500 of the Board's Martin Building (20th and C Streets, NW.) 
between 9 a.m. and 5 p.m. on weekdays.

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, Mark 
Manuszak, Senior Economist (202/721-4509), Division of Research & 
Statistics, or Ky Tran-Trong, Counsel (202/452-3667), Division of 
Consumer & Community Affairs; 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

Background

I. Section 1075 of the Dodd-Frank Act--Overview

    The Dodd-Frank Wall Street Reform and Consumer Protection Act (the 
``Dodd-Frank Act'') (Pub. L. 111-203, 124 Stat. 1376 (2010)) 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.\1\
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    \1\ Section 920 is codified in 15 U.S.C. 1693o-2. As discussed 
in more detail below, interchange transaction fees (or ``interchange 
fees'') are fees established by a payment card network, charged to 
the merchant acquirer and received by the card issuer for its role 
in transaction.
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    EFTA Section 920 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.\2\ That section authorizes the Board to prescribe 
regulations regarding any interchange transaction fee that an issuer 
may receive or charge with respect to an electronic debit transaction 
and 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.
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    \2\ Electronic debit transaction (or ``debit card transaction'') 
means the use of a debit card, including a general-use prepaid card, 
by a person as a form of payment in the United States.
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    Under EFTA Section 920, the Board may allow for an adjustment to an 
interchange transaction fee to account for an issuer's costs in 
preventing fraud, provided the issuer complies with the standards to be 
established by the Board relating to fraud-prevention activities. EFTA 
Section 920 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 and is not used to 
circumvent or evade the restrictions on interchange transaction fees.
    EFTA Section 920 exempts 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 
government-administered payment programs and reloadable, general-use 
prepaid cards not marketed or labeled as a gift card or certificate. 
EFTA Section 920 provides, however, that beginning July 21, 2012, the 
exemptions from the interchange transaction fee restrictions will not 
apply for transactions made using debit cards provided pursuant to a 
government-administered payment program or made using certain 
reloadable, general-use prepaid cards if the cardholder may be charged 
either an overdraft fee or a fee for the first

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withdrawal each month from ATMs in the issuer's designated ATM network.
    In addition to rules regarding restrictions on interchange 
transaction fees, EFTA Section 920 also requires the Board to prescribe 
certain rules related to the routing of debit card transactions. First, 
EFTA Section 920 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.
    EFTA Section 920 requires the Board to establish interchange fee 
standards and rules prohibiting circumvention or evasion no later than 
April 21, 2011. These interchange transaction fee rules will become 
effective on July 21, 2011. EFTA Section 920 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 rules.

II. Overview of the Debit Card Industry

    Over the past several decades, there have been significant changes 
in the way consumers make payments in the United States. The use of 
checks 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 card usage, in particular, has 
increased markedly during that same period. After a long period of slow 
growth during the 1980s and early 1990s, debit card transaction volume 
began to grow very rapidly in the mid-1990s. 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 accepted at about 8 million merchant locations in the United 
States. In 2009, debit card transactions represented almost half of 
total third-party debits to deposit accounts, while approximately 30 
percent of total third-party debits to deposit accounts were made by 
checks.\3\
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    \3\ 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. A summary of the 
2010 Federal Reserve Payments Study is available at http://www.frbservices.org/files/communications/pdf/press/2010_payments_study.pdf.
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    In general, there are two types of debit card transactions: PIN 
(personal identification number)-based and signature-based.\4\ 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 one 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. 
In the current environment, certain transactions cannot readily be 
accommodated on PIN-based, single-message systems, such as transactions 
for hotel stays or car rentals, where the exact amount of the 
transaction is not known at the time of authorization. In addition, PIN 
debit transactions generally are not accepted for Internet 
transactions. Overall, roughly one-quarter of the merchant locations in 
the United States that accept debit cards have the capability to accept 
PIN-based debit transactions. According to the Board's survey of 
covered card issuers, roughly 70 percent of debit cards outstanding 
(including prepaid cards) support both PIN- and signature-based 
transactions (87 percent, excluding prepaid cards).\5\
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    \4\ 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.''
    \5\ ``Covered issuers'' are those issuers that, together with 
affiliates, have assets of $10 billion or more.
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    Networks that process debit card transactions exhibit two main 
organizational forms, often referred to as three-party and four-party 
systems.\6\ 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).\7\ The network coordinates the transmission of information 
between the issuing and acquiring sides of the market (authorization 
and clearing) and the interbank monetary transfers (settlement).\8\
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    \6\ Industry participants sometimes refer to four-party systems 
as ``open loop'' systems and three-party systems as ``closed loop'' 
systems.
    \7\ Throughout this proposed rule, the term ``bank'' often is 
used to refer to depository institutions.
    \8\ The term ``four-party system'' is something of a misnomer 
because the network is, in fact, a fifth party involved in a 
transaction.
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    In a typical three-party system, the network itself acts as both 
issuer and acquirer. Thus, the three parties involved in a transaction 
are the cardholder, the merchant, and the network. Three-party systems 
are also referred to as ``closed,'' because the issuer and acquirer are 
generally the same institution--they have, thus, tended to be closed to 
outside participants. The three-party model is used for some prepaid 
card transactions, but not for other debit card transactions.
    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 
and the cardholder's account information is sent from the merchant to 
the acquirer to the network, which forwards the request to the card-
issuing institution.\9\ 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 
authorizing (or declining) the transaction is returned to the merchant 
via the reverse path.
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    \9\ Specialized payment processors may carry out some functions 
between the merchant and the network or between the network and the 
issuer.
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    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 
cardholders' accounts based on these clearing messages. The network 
calculates and communicates to each issuer and acquirer its net debit 
or credit position to settle the day's transactions. The interbank 
settlement generally is effected through a settlement account at a 
commercial bank, or through automated clearinghouse (ACH) transfers. 
The acquirer credits the merchant for the value of its transactions, 
less the merchant discount, as discussed below.
    There are various fees associated with debit card transactions. The 
interchange fee is set by the relevant network and paid by the merchant 
acquirer to the issuer. Switch fees are charged by the network to 
acquirers and issuers to compensate the network for its role in

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processing the transaction.\10\ The merchant acquirer charges the 
merchant a merchant discount--the difference between the face value of 
a transaction and the amount the merchant 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.
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    \10\ A variety of other network fees may be collected by the 
network from the issuer or acquirer.
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    When PIN debit networks were first introduced, some of them 
structured interchange fees in a manner similar to ATM interchange 
fees.\11\ For ATM card 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, all PIN debit interchange fees were paid by acquirers to card 
issuers.\12\
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    \11\ 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.
    \12\ Debit Card Directory (1995-1999). See also, Fukimo Hayashi, 
Richard Sullivan, & Stuart E. Weiner, ``A Guide to the ATM and Debit 
Card Industry'' (Federal Reserve Bank of Kansas City 2003).
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    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 type 
of merchant (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 fixed component fees, ad valorem fees, and caps on these 
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, the 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) \13\ to 
gain increased acceptance in those markets. Until 2003, signature debit 
interchange fees were generally around the same level as credit card 
interchange fees and have generally been significantly higher than 
those for PIN debit card transactions. PIN debit fees began to increase 
in the early 2000s, while signature debit fees declined in late 2003 
and early 2004.\14\ More recently, both PIN and signature debit fees 
have increased, although PIN debit fees have increased at a faster 
pace.
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    \13\ 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.
    \14\ This decline followed the settlement of litigation 
surrounding signature debit cards. See In re: Visa Check/MasterMoney 
Antitrust Litigation, 192 F.R.D. 68 (F.D.N.Y. 2000).
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    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 the network rules explicitly govern the issuers 
and acquirers, merchants and processors also may be required to comply 
with the network 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.

III. Outreach and Information Collection

A. Summary of Outreach

    Since enactment of the Dodd-Frank Act, Board staff has held 
numerous meetings with debit card issuers, payment card networks, 
merchant acquirers, merchants, industry trade associations, and 
consumer groups. In general, those parties provided information 
regarding electronic debit transactions, including processing flows for 
electronic debit transactions, structures and levels of current 
interchange transaction fees and other fees charged by the networks, 
fraud-prevention activities performed by various parties to an 
electronic debit transaction, fraud losses related to electronic debit 
transactions, routing restrictions, card-issuing arrangements, and 
incentive programs for both merchants and issuers. Interested parties 
also provided written submissions.\15\
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    \15\ The meeting summaries and written submissions are available 
on the Regulatory Reform section of the Board's Web site, available 
at  http://www.federalreserve.gov/newsevents/reform_meetings.htm.
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B. Surveys

    On September 13, 2010, the Board distributed three surveys to 
industry participants (an issuer survey, a network survey, and a 
merchant acquirer survey) designed to gather information to assist the 
Board in developing this proposal. Industry participants, including 
payment card networks, trade groups and individual firms from both the 
banking industry and merchant community, commented on preliminary 
versions of the issuer and network surveys, through both written 
submissions and a series of drop-in calls. In response to the comments, 
the two surveys were modified, as appropriate, and an additional survey 
of merchant acquirers was developed.\16\
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    \16\ Documentation and forms for the card issuer, payment card 
network, and merchant acquirer surveys are respectively available at 
http://www.federalreserve.gov/newsevents/files/card_issuer_survey_20100920.pdf, http://www.federalreserve.gov/newsevents/files/payment_card_network_survey_20100920.pdf, and http://www.federalreserve.gov/newsevents/files/merchant_acquirer_survey_20100920.pdf.
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    The card issuer survey was distributed to 131 financial 
organizations that, together with affiliates, have assets of $10 
billion or more.\17\ The Board received 89

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responses to the survey. An additional 13 organizations informed the 
Board that they do not have debit card programs. Three organizations 
that issued a small number of cards declined to participate in the 
survey. The Board did not receive any communication from the other 26 
organizations. The network survey was distributed to the 14 networks 
believed to process debit card transactions, all of which provided 
responses. The merchant acquirer survey was distributed to the largest 
nine merchant acquirers/processors, all of whom responded to the 
survey.
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    \17\ These institutions include bank and thrift holding 
companies with assets of at least $10 billion; independent 
commercial banks, thrifts, and credit unions with assets of at least 
$10 billion; and FDIC-insured U.S. branches and agencies of foreign 
banking organizations with worldwide assets of at least $10 billion. 
Assets were computed 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.
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Information Requested and Summary Results
    In general, the surveys requested information on signature debit, 
PIN debit and prepaid card operations and, for each card type, the 
costs associated with those card types, interchange fees and other fees 
established by networks, fraud losses, fraud-prevention and data-
security activities, network exclusivity arrangements and debit-card 
routing restrictions. The Board compiled the survey responses in a 
central database, and reviewed the submissions for completeness, 
consistency, and anomalous responses. As indicated above, the response 
rates for the three surveys were high; however, some respondents were 
not able to provide information on all data elements requested in the 
surveys. For example, most respondents provided cost data at an 
aggregate level, but some were unable to provide cost data at the level 
of granularity requested in the surveys. In addition, there were 
inconsistencies in some data that were reported within individual 
responses and across responses. Therefore, each of the summary 
statistics reported below may be based on a subset of the responses 
received for each of the three surveys. The reporting period for each 
survey was calendar year 2009, unless otherwise noted.
    Card use. The networks reported that there were approximately 37.7 
billion debit and prepaid card transactions in 2009, valued at over 
$1.45 trillion, with an average value of $38.58 per 
transaction.18 19 20 Responding issuers reported that, on 
average, they had 174 million debit cards and 46 million prepaid cards 
outstanding during 2009. Eighty-seven percent of debit cards and 25 
percent of prepaid cards were enabled for use on both signature and PIN 
networks. Four percent of debit cards and 74 percent of prepaid cards 
were enabled for use on signature networks only. Finally, 9 percent of 
debit cards and 1 percent of prepaid cards were enabled for use on PIN 
networks only. Responding acquirers reported that 6.7 million merchant 
locations were able to accept signature debit cards and 1.5 million 
were able to accept PIN debit cards.\21\
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    \18\ These data do not include ATM transactions. Responding 
issuers accounted for approximately 60 percent of total debit and 
prepaid card transactions in 2009. The acquirers surveyed handled 
about 95 percent of these total transactions.
    \19\ Of these 37.7 billion transactions, 22.5 billion were 
signature debit transactions, with a total value of $837 billion and 
an average value of $37.15 per transaction; 14.1 billion were PIN 
debit transactions with a total value of $584 billion and an average 
value of $41.34 per transaction; and 1.0 billion were prepaid card 
transactions, with a total value of $33 billion and an average value 
of $32.54 per transactions. Of the 37.7 billion transactions, 90 
percent were card-present transactions. Eighty-six percent of 
signature debit and 97 percent of PIN debit transactions were card-
present transactions.
    \20\ The recently released 2010 Federal Reserve Payments Study 
reported 6.0 billion prepaid card transactions in 2009, of which 1.3 
billion were general purpose prepaid card transactions and 4.7 
billion were private label prepaid card and electronic benefit 
transfer card transactions that were not included in the Board 
survey.
    \21\ These numbers differ from the estimates that were otherwise 
provided to the Board by major payment card networks, card issuers, 
and merchant acquirers.
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    Interchange fees. Networks reported that debit and prepaid 
interchange fees totaled $16.2 billion in 2009.\22\ The average 
interchange fee for all debit transactions was 44 cents per 
transaction, or 1.14 percent of the transaction amount. The average 
interchange fee for a signature debit transaction was 56 cents, or 1.53 
percent of the transaction amount. The average interchange fee for a 
PIN debit transaction was significantly lower than that of a signature 
debit transaction, at 23 cents per transaction, or 0.56 percent of the 
transaction amount. Prepaid card interchange fees were similar to those 
of signature debit, averaging 50 cents per transaction, or 1.53 percent 
of the transaction amount.\23\
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    \22\ Of the $16.2 billion in 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 responding issuers reported receiving $11.0 
billion, or about 68 percent of total interchange fees.
    \23\ The network survey also requested information on historical 
interchange fees. Not all networks reported historical interchange 
fees back to 1990. However, from 1990 to 2009, it appears that 
interchange fees for signature debit transactions generally were 
around 1.5 percent of transaction value. Based on other industry 
resources, interchange fees on PIN debit transactions in the late 
1990s were about 7 cents per transaction (Debit Card Directory, 
1995-1999). Therefore, it appears that these fees rose significantly 
during the 2000s.
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    Processing costs. Issuers reported their per-transaction processing 
costs, which are those costs related to authorization, clearance, and 
settlement of a transaction.\24\ The median per-transaction total 
processing cost for all types of debit and prepaid card transactions 
was 11.9 cents.\25\ The median per-transaction variable processing cost 
was 7.1 cents for all types of debit and prepaid card transactions.\26\ 
The median per-transaction network processing fees were 4.0 cents for 
all types of debit and prepaid card transactions.\27\
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    \24\ Unlike other statistics in this discussion, the Board 
discusses cost information using percentiles within this Federal 
Register Notice to avoid having summary measures distorted by 
extreme values in the sample cost data.
    \25\ By transaction type, the median total per-transaction 
processing cost was 13.7 cents for signature debit, 7.9 cents for 
PIN debit and 63.6 cents for prepaid cards.
    \26\ By transaction type, the median variable per-transaction 
processing cost was 6.7 cents for signature debit, 4.5 cents for PIN 
debit, and 25.8 cents for prepaid cards.
    \27\ By transaction type, the median per-transaction network 
processing fees were 4.7 cents for signature debit, 2.1 cents for 
PIN debit, and 6.9 cents for prepaid cards.
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    Network fees. Networks reported charging two types of per-
transaction fees: processing and non-processing fees. Networks also 
reported charging fees other than on a per-transaction basis. Networks 
charged issuers a total of $2.3 billion in fees and charged acquirers a 
total of $1.9 billion in fees. In general, the proportion of fees paid 
by each party varied by network type. Aggregating these fees across all 
debit and prepaid card transactions, the average network fee 
attributable to each transaction was 6.5 cents for issuers and 5.0 
cents for acquirers. The average network fee attributable to each 
signature debit transaction was 8.4 cents for issuers and 5.7 cents for 
acquirers. Thus, about 60 percent of signature debit network fees were 
paid by issuers and 40 percent by acquirers. For PIN debit 
transactions, the average network fee attributable to each transaction 
was 2.7 cents for issuers and 3.7 cents for acquirers. Thus, about 42 
percent of PIN debit network fees were paid by issuers and 58 percent 
by acquirers. As noted above, these fees include per-transaction 
processing fees and non-processing fees, as well as other fees. Based 
on data reported by responding issuers, signature debit network 
processing fees were 3.0 cents per transaction on average and PIN debit 
network processing fees were 1.6[cent] per transaction on average.
    Networks also reported providing discounts and incentives to 
issuers and acquirers/merchants. Issuers were provided discounts and 
incentives totaling $0.7 billion, or an average of 2.0 cents per 
transaction, while acquirers

[[Page 81726]]

were provided discounts and incentives of $0.3 billion, or an average 
of 0.9 cents per transaction. Signature debit networks provided average 
incentives and discounts of 2.6 cents per transaction to issuers and 
1.2 cents per transaction to acquirers. Thus, 69 percent of signature 
debit network incentives and discounts were provided to issuers and 31 
percent to acquirers. PIN debit networks provided average incentives 
and discounts of 0.7 cents per transaction to issuers and 0.5 cents per 
transaction to acquirers. Thus, 61 percent of PIN debit network 
incentives and discounts were provided to issuers and 39 percent to 
acquirers.
    Discounts and incentives effectively reduce the per-transaction 
amount of network fees each party pays. After adjusting for discounts 
and incentives, the average net network fee per transaction is 4.5 
cents for issuers and 4.1 cents for acquirers.\28\ For signature debit 
transactions, the average net network fee per transaction is 5.9 cents 
for issuers and 4.5 cents for acquirers. Thus, 57 percent of net 
network fees on signature networks were paid by issuers and 43 percent 
by acquirers. For PIN debit networks, the average net network fee per 
transaction is 1.9 cents for issuers and 3.2 cents for acquirers. Thus, 
37 percent of net network fees on PIN debit networks were paid by 
issuers and 63 percent by acquirers.
---------------------------------------------------------------------------

    \28\ Net network fees paid by issuers and acquirers were 
calculated by subtracting incentives and discounts provided from 
network fees paid.
---------------------------------------------------------------------------

    Fraud data. Survey responses on fraud occurrence, fraud losses, and 
fraud-prevention and data-security costs are discussed in section IV of 
this notice.
    Exclusivity arrangements and routing restrictions. The surveys also 
included a number of questions about exclusivity arrangements and 
transaction routing procedures. Respondents reported that there are 
arrangements, either rules-based or contractual, under which 
transactions must be routed exclusively over specific networks or that 
commit issuers to meet certain volume and dollar thresholds for 
transactions on those networks. Respondents also reported that they 
receive incentives under these arrangements, which for issuers take the 
form lower network fees, signing bonuses, and marketing and development 
funds. For acquirers, the incentives typically take the form of lower 
network fees.
Summary of Proposal
    Reasonable and proportional fees. The Board is requesting 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. Alternative 1 
adopts issuer-specific standards with a safe harbor and a cap. In 
contrast, Alternative 2 adopts a cap that is applicable to all covered 
issuers.
    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 any interchange fee in excess of its allowable costs through 
any network. An issuer's allowable costs would be those costs that are 
attributable to the issuer's role in authorization, clearance, and 
settlement of the transaction and that 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 on the amount 
of any interchange fee an issuer could receive or charge, regardless of 
the issuer's allowable cost calculation. The Board proposes to set this 
cap at an initial level of 12 cents per transaction. 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, in which case the issuer would not need 
to determine its maximum interchange fee based on allowable costs. The 
Board proposes to set the safe harbor amount at an initial level of 7 
cents per transaction. Therefore, under Alternative 1, each payment 
card network would have the option of setting interchange fees either 
(1) at or below the safe harbor or (2) at an amount for each issuer 
such that the interchange fee for that issuer does not exceed the 
issuer's allowable costs, up to the cap.
    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.
    Fraud-prevention adjustment. The Board's proposal requests comment 
on two general approaches to the fraud-prevention adjustment framework 
and asks several questions related to the two alternatives. One 
approach focuses on implementation of major innovations that would 
likely result in substantial reductions in total, industry-wide fraud 
losses. The second approach focuses 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. At this time, the Board is not proposing a specific 
adjustment to the amount of an interchange fee for an issuer's fraud-
prevention costs. After considering the comments received, the Board 
expects to develop a specific proposal on the fraud adjustment for 
public comment.
    Exemptions. The Board's proposed rule exempts issuers that, 
together with affiliates, have assets of less than $10 billion. The 
Board's proposed rule also exempts electronic debit transactions made 
using debit cards issued under government-administered programs or made 
using certain reloadable prepaid cards. These exempt issuers or 
transactions would not be subject to the interchange transaction fee 
restrictions. The exemptions do not apply to the proposed rule's 
provisions regarding network exclusivity and routing restrictions.
    Prohibition on circumvention or evasion. In order to prevent 
circumvention or evasion of the limits on the amount of interchange 
fees that issuers receive from acquirers, the proposed rule would 
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.
    Limitation on debit card restrictions. The Board is requesting 
comment on two alternative approaches to implement 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 
carried 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

[[Page 81727]]

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 carried to less than two unaffiliated networks for 
each method of authorization the cardholder may select. Under this 
alternative, an issuer that used both signature- and PIN-based 
authorization would have to enable its debit cards with two 
unaffiliated signature-based networks and two unaffiliated PIN-based 
networks.
    Transaction routing. The Board proposes 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.
Scope of Rule
    In general, the Board's proposed rule covers debit card 
transactions (not otherwise exempt) that debit an account. The Board's 
proposed rule also covers both three-party and four-party systems. 
Throughout the proposal, the Board generally describes the interchange 
fee standards and the network exclusivity and routing rules in a manner 
that most readily applies to debit card transactions initiated at the 
point of sale for the purchase of goods and services and debit card 
transactions carried over four-party networks. The scope of the 
proposed rule, however, covers three-party networks and could cover ATM 
transactions and networks. The Board requests comment on the 
application of the proposed rule to ATM transactions and ATM networks, 
as well as to three-party networks.
    Coverage of ATM transactions and networks. The Board requests 
comment on whether ATM transactions and ATM networks should be included 
within the scope of the rule. Although the statute does not expressly 
include ATM transactions within its scope, EFTA Section 920's 
definitions of ``debit card,'' ``electronic debit transaction,'' and 
``payment card network'' could be read to bring ATM transactions within 
the coverage of the rule. Specifically, most ATM cards can be used to 
debit an asset account. It could also be argued that an ATM operator 
accepts the debit card as form of payment to carry out the transaction, 
so the ATM network could be covered by the statutory definition of a 
``payment card network.''
    Under EFTA Section 920(c)(8), the term ``interchange transaction 
fee'' is defined as a fee charged ``for the purpose of compensating an 
issuer.'' Traditionally, however, the interchange fee for ATM 
transactions is paid by the issuer and flows to the ATM operator. Thus, 
the proposed interchange transaction fee standards would not apply to 
ATM interchange fees and would not constrain the current level of such 
fees.\29\
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    \29\ The rule's interchange fee standard could become a 
constraint in the future if ATM interchange fees begin to flow in 
the same direction as point-of-sale debit card transactions, as was 
the case for interchange fees of certain PIN debit networks in the 
1990s.
---------------------------------------------------------------------------

    The network-exclusivity prohibition and routing provisions, 
however, would directly affect the operations of ATM networks if these 
provisions were applied to such networks. Issuers would be required to 
offer ATM cards that can be accepted on at least two unaffiliated 
networks, and the ATM operator would have the ability to choose the 
network through which transactions would be routed. As discussed below, 
in point-of-sale transactions, these provisions improve the ability of 
a merchant to select the network that minimizes its cost (particularly 
the cost associated with interchange fees) and otherwise provides the 
most advantageous terms. In the case of ATM transactions, however, the 
exclusivity and routing provisions would give the ATM operator, which 
is receiving the ATM interchange fee, the ability to select the network 
that maximizes that fee. Therefore, coverage of ATM networks under the 
rule may result in very different economic incentives than coverage of 
point-of-sale debit card networks.
    If ATM networks and ATM transactions are included within the scope 
of the rule, the Board requests comment on how to implement the network 
exclusivity provision. For example, if the Board requires two 
unaffiliated networks for each authorization method, should it 
explicitly require an issuer to ensure that ATM transactions may be 
routed over at least two unaffiliated networks? Should the Board state 
that one point-of-sale debit network and one ATM-only network would not 
satisfy the exclusivity prohibition under either proposed alternative? 
The Board also specifically requests comment on the effect of treating 
ATM transactions as ``electronic debit transactions'' under the rule on 
small issuers, as well as the cardholder benefit, if any, of such an 
approach.
    Coverage of three-party systems. The Board also requests comment on 
the appropriate application of the interchange fee standards to 
electronic debit transactions carried over three-party systems. In a 
three-party payment system, the payment card network typically serves 
both as the card issuer and the merchant acquirer for purposes of 
accepting payment on the network.\30\ In this system, there is no 
explicit interchange fee. Instead, the merchant directly pays a 
merchant discount to the network. The merchant discount typically is 
equivalent to the sum of the interchange fee, the network switch fee, 
other acquirer costs, and an acquirer markup that would typically be 
imposed in a four-party system.
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    \30\ In addition, under a three-party system, outside processors 
generally are not authorized by the network to acquire transactions 
from merchants. Although outside processors may provide some 
processing services to the merchant, the network is ultimately the 
acquirer for every transaction.
---------------------------------------------------------------------------

    Both the statutory and proposed definition of ``interchange 
transaction fee'' would cover the part of the merchant discount in a 
three-party system that is used to compensate the network for its role 
as issuer. If a three-party network apportioned its entire merchant 
discount to its roles as network or merchant acquirer, however, the 
interchange fee would, in effect, be zero. This outcome, coupled with 
the fact the statute does not restrict fees an acquirer charges a 
merchant, may present practical difficulties in limiting the amount of 
a merchant discount charged in a three-party network. The Board 
requests comment on the appropriate way to treat three-party networks 
and on any specific clarifications with respect to such fees that 
should be provided in the regulation.
    In addition, the Board requests comment on how the network 
exclusivity and routing provisions should be applied to three-party 
systems. If the limitations on payment card network restrictions under 
Sec.  235.7 were applied to a three-party system, debit cards issued by 
the network would be required to be capable of being routed through at 
least one unaffiliated payment card network in addition to the network 
issuing the card, and the network may not inhibit a merchant's ability 
to route a transaction to any other unaffiliated network(s) enabled on 
a debit card. For example, under Alternative A for the network 
exclusivity provisions, the payment card network would be required to 
add an unaffiliated network and arrange for the unaffiliated debit 
network to carry debit transactions, for ultimate routing

[[Page 81728]]

to the contracting network, which may result in more circuitous routing 
that would otherwise be the case. Under Alternative B, which requires 
at least two unaffiliated payment card networks for each method of 
authorization, the payment card network would be required to add at 
least one unaffiliated signature debit network for a signature-only 
debit card. In addition, if the debit card had PIN debit functionality, 
the card would also have to be accepted on at least two unaffiliated 
PIN debit networks.
    The Board recognizes that the nature of a three-party system could 
be significantly altered by any requirement to add one or more 
unaffiliated payment card networks capable of carrying electronic debit 
transactions involving the network's cards. Nonetheless, the statute 
does not provide any apparent basis for excluding three-party systems 
from the scope of the provisions of EFTA Section 920(b). The Board 
requests comment on all aspects of applying the proposed rule to three-
party payment systems, including on any available alternatives that 
could minimize the burden of compliance on such systems.

Section-by-Section Analysis

I. Sec. 235.1 Authority and purpose

    This section sets forth the authority and purpose for the proposed 
rule.

II. Sec. 235.2 Definitions

    The proposed rule provides definitions for many of the terms used 
in the rule. As noted throughout this section, many of the definitions 
follow the EFTA's definitions. The proposed rule also provides 
definitions for terms not defined in EFTA Section 920. Some of these 
definitions are based on existing statutory or regulatory definitions, 
while others are based on terminology in the debit card industry. The 
Board requests comment on all of the terms and definitions set out in 
this section. In particular, the Board requests comment on any terms 
used in the proposed rule that a commenter believes are not 
sufficiently clear or defined.
A. Sec. 235.2(a) Account
    EFTA Section 920(c) defines the term ``debit card'' in reference to 
a card, or other payment code or device, that is used ``to debit an 
asset account (regardless of the purpose for which the account is 
established) * * *.'' That section, however, does not define the terms 
``asset account'' or ``account.'' 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 end 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.'' \31\
---------------------------------------------------------------------------

    \31\ 15 U.S.C. 1693a.
---------------------------------------------------------------------------

    Similar to EFTA Section 903(2), proposed Sec.  235.2(a) defines 
``account'' to include a transaction account (which includes a demand 
deposit), savings, or other asset account. The proposed definition, 
however, differs from EFTA Section 903(2) because EFTA Section 920(c) 
does not restrict the term debit card to those cards, or other payment 
codes or devices, that debit accounts established for a particular 
purpose. Accordingly, the proposed definition includes both an account 
established primarily for personal, family, or household purposes and 
an account established for business purposes. For the same reason, the 
proposed definition of ``account'' includes an account held by a 
financial institution under a bona fide trust arrangement. These 
distinctions from the EFTA Section 903(2)'s definition are clarified in 
proposed comment 2(a)-1.
    The proposed definition of ``account'' is limited to accounts that 
are located in the United States. The Board does not believe it is 
appropriate to apply EFTA Section 920's limitations to foreign issuers 
or accounts, absent a clear indication from Congress to do so.
B. Sec. 235.2(b) Acquirer
    Proposed Sec.  235.2(b) defines the term ``acquirer.'' Within the 
debit card industry, there are numerous models for acquiring 
transactions from merchants, and the term ``acquirer'' may not always 
be used to refer to the entity that holds a merchant's account. In some 
acquiring relationships, an institution performs all the functions of 
the acquirer (e.g., signing up and underwriting merchants, processing 
payments, receiving and providing settlement for the merchants' 
transactions, and other account maintenance). In other acquiring 
relationships, an institution performs all the functions of the 
acquirer except for settling the merchant's transactions with both the 
merchant and the network.
    The Board is proposing to limit the term ``acquirer'' to entities 
that ``acquire'' (or buy) the electronic debit transactions from the 
merchant. Proposed Sec.  235.2(b) defines ``acquirer'' as a person that 
``contracts directly or indirectly with a merchant to receive and 
provide settlement for the merchant's electronic debit transactions 
over a payment card network.'' Proposed Sec.  235.2(b) limits the term 
to those entities serving a financial institution function with respect 
to the merchant, as distinguished from a processor function, by 
stipulating that the entity ``receive and provide settlement for the 
merchant's'' transactions. Proposed Sec.  235.2(b) also explicitly 
excludes entities that solely process transactions for the merchant 
from the term ``acquirer.''
    Proposed Sec.  235.2(b), however, takes into consideration the fact 
that the degree of involvement of the entity settling with the merchant 
varies under different models by defining ``acquirer'' as a person that 
``contracts directly or indirectly with a merchant.'' See proposed 
comment 2(b)-1.
C. Sec. 235.2(c) Affiliate and Sec.  235.2(e) Control
    Proposed Sec. Sec.  235.2(c) and (e) define the terms ``affiliate'' 
and ``control.'' EFTA Section 920(c)(1) defines the term ``affiliate'' 
as ``any company that controls, is controlled by, or is under common 
control with another company.'' The proposed rule incorporates the 
EFTA's definition of ``affiliate.''
    Although the EFTA's definition of affiliate is premised on control, 
the EFTA does not define that term. The Board is proposing to adopt a 
definition of ``control'' that is consistent with definitions of that 
term in other Board regulations.\32\
---------------------------------------------------------------------------

    \32\ 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).
---------------------------------------------------------------------------

D. Sec. 235.2(d) Cardholder
    Proposed Sec.  235.2(d) defines the term ``cardholder'' as the 
person to whom a debit card is issued. Proposed comment 2(d) clarifies 
that if an issuer issues a debit card for use to debit a transaction, 
savings, or other similar asset account, the cardholder usually will be 
the account holder. In some cases, however, such as with a business 
account, there may be multiple persons who have been issued debit cards 
and are authorized to use those debit cards to debit the same account. 
Each employee issued a card would be considered a cardholder. In the 
case of a prepaid card, the cardholder is the person that purchased the 
card or a person who received the card from the purchaser. See proposed 
comment 2(d)-1.

[[Page 81729]]

F. Sec. 235.2(f) Debit Card and Sec.  235.2(i) General-Use Prepaid Card

Debit Card (Sec.  235.2 (f))

    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.'' The term 
includes a general-use prepaid card, as that term was previously 
defined by the gift card provisions of the Credit Card Accountability, 
Responsibility and Disclosure Act of 2009 (Credit Card Act).\33\ The 
statute excludes paper checks from the definition of ``debit card.''
---------------------------------------------------------------------------

    \33\ See EFTA Section 915(a)(2)(A).
---------------------------------------------------------------------------

    Proposed Sec.  235.2(f) defines the term ``debit card'' and 
generally tracks the definition set forth in EFTA Section 920. Thus, 
proposed Sec.  235.2(f)(1) generally 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 account, regardless of 
whether authorization is based on signature, personal identification 
number (PIN), or other means.'' In addition, the term applies 
regardless of whether the issuer holds the underlying account. This is 
consistent with the statutory definition of ``debit card'' which does 
not require that an issuer also hold the account debited by the card, 
code, or device. Proposed Sec.  235.2(f)(2) further provides that 
``debit card'' includes a ``general-use prepaid card.'' See proposed 
comment 2(f)-4.
    Proposed comment 2(f)-1 clarifies that the requirements of this 
part generally apply to any card, or other payment code or device, even 
if it is not issued in card form. That is, the rule applies even if a 
physical card is not issued or if the device is issued with a form 
factor other than a standard-sized card. For example, an account number 
or code that could be used to access underlying funds in an account 
would be considered a debit card under the rule (except when used to 
initiate an ACH transaction). Similarly, the term ``debit card'' would 
include a device with a chip or other embedded mechanism that links the 
device to funds held in an account, such as a mobile phone or sticker 
containing a contactless chip that enables the cardholder to debit an 
account.
    Proposed comments 2(f)-2 and -3 address deferred and decoupled 
debit cards, two types of card products that the Board believes fall 
within the statutory definition of ``debit card'' notwithstanding that 
they may share both credit and debit card-like attributes. Under a 
deferred debit arrangement, transactions are not immediately posted to 
a cardholder's account when the card transaction is received by the 
account-holding institution for settlement, but instead the funds in 
the account are held and made unavailable for other transactions for a 
specified period of time.\34\ Upon expiration of the time period, the 
cardholder's account is debited for the amount of all transactions made 
using the card which were submitted for settlement during that period. 
For example, under some deferred debit arrangements involving consumer 
brokerage accounts (whether held at the issuer or an affiliate), the 
issuer agrees not to post the card transactions to the brokerage 
account until the end of the month. Regardless of the time period 
chosen by the issuer for deferring the posting of the transactions to 
the cardholder's account, deferred debit cards would be considered 
debit cards for purposes of the requirements of this part. Deferred 
debit card arrangements do not refer to arrangements in which a 
merchant defers presentment of multiple small dollar card payments, but 
aggregates those payments into a single transaction for presentment, or 
where a merchant requests placement of a hold on certain funds in an 
account until the actual amount of the cardholder's transaction is 
known. See proposed comment 2(f)-2.
---------------------------------------------------------------------------

    \34\ The issuer's ability to maintain the hold assumes that the 
issuer has received a settlement record for the transaction within 
the time period required under card network rules.
---------------------------------------------------------------------------

    Proposed comment 2(f)-3 addresses decoupled debit arrangements in 
which the issuer is not the institution that holds the underlying 
account that will be debited. That is, the issuer-cardholder 
relationship is ``decoupled'' from the cardholder's relationship with 
the institution holding the cardholder's account. In these ``decoupled 
debit'' arrangements, transactions are not posted directly to the 
cardholder's account when the transaction is presented for settlement 
with the card issuer. Instead, the issuer must send an ACH debit 
instruction to the account-holding institution in the amount of the 
transaction in order to obtain the funds from the cardholder's account. 
As noted above, the term ``debit card'' includes a card, or other 
payment code or device, that debits an account, regardless of whether 
the issuer holds the account. Accordingly, the Board believes it is 
appropriate to treat decoupled debit cards as debit cards subject to 
the requirements of this part.
    Moreover, the Board understands that there may be incentives for 
some issuers to design or offer products with ``credit-like'' features 
in an effort to have such products fall outside the scope of the 
interchange fee restrictions to be implemented by this rulemaking. For 
example, an issuer may offer a product that would allow the cardholder 
the option at the time of the transaction to choose when the 
cardholder's account will be debited for the transaction. Any attempt 
to classify such a product as a credit card is limited by the 
prohibition against compulsory use under the EFTA and Regulation E. 
Specifically, the EFTA and Regulation E provide that no person may 
condition the extension of credit to a consumer on such consumer's 
repayment by means of preauthorized electronic fund transfers.\35\ 
Thus, an issuer of a charge or credit card is prohibited from requiring 
a consumer's repayment by preauthorized electronic fund transfers from 
a deposit account held by the consumer as a condition of opening the 
charge or credit card account. The Board solicits comment on whether 
additional guidance is necessary to clarify that deferred and decoupled 
debit, or any similar products, qualify as debit cards for purposes of 
this rule.
---------------------------------------------------------------------------

    \35\ EFTA Section 913(1); 12 CFR 205.10(e)(1).
---------------------------------------------------------------------------

    The proposed rule also sets forth certain exclusions from the term 
``debit card'' in Sec.  235.2(f)(3) to clarify the definition. Proposed 
Sec.  235.2(f)(3)(i) clarifies that retail gift cards that can be used 
only at a single merchant or affiliated group of merchants are not 
subject to the requirements of this part. The Board believes that by 
including an explicit reference to general-use prepaid cards in the 
statutory definition of ``debit card,'' Congress did not intend the 
interchange fee restrictions to apply to other types of prepaid cards 
that are accepted only at a single merchant or an affiliated group of 
merchants. These cards are generally used in a closed environment at a 
limited number of locations and are not issued for general use. See 
Sec.  235.7(a), discussed below.
    Proposed comment 2(f)-5 clarifies that two or more merchants are 
affiliated if they are related by either common ownership or common 
corporate control. For purposes of the definition of ``debit card,'' 
the Board views franchisees 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. Accordingly, gift

[[Page 81730]]

cards that are redeemable solely at franchise locations would be 
excluded from the definition of debit card for cards, or other payment 
codes or devices, usable only at a single merchant or affiliated group 
of merchants, from the definition of ``debit card.''
    Proposed Sec.  235.2(f)(3)(ii) expands the statutory exclusion for 
paper checks to exempt any ``check, draft, or similar paper instrument, 
or electronic representation thereof'' from the definition of ``debit 
card.'' This adjustment is proposed because in many cases paper checks 
may be imaged and submitted electronically for presentment to the 
paying bank. Proposed comment 2(f)-6 further clarifies that a check 
that is provided as a source of information to initiate an ACH debit 
transfer in an electronic check conversion transaction is not a debit 
card.
    Finally, proposed Sec.  235.2(f)(iii) would generally exclude ACH 
transactions from the requirements of this part. Specifically, the 
proposed exclusion provides that an account number is not a debit card 
when used to initiate an ACH transaction from a person's account. The 
Board believes that this exclusion is necessary to clarify that ACH 
transactions initiated by a person's provision of a checking account 
number are not ``electronic debit transactions'' for purposes of the 
network exclusivity and routing provisions under Sec.  235.7. However, 
this exclusion is not intended to cover a card, or other payment code 
or device, that is used to directly or indirectly initiate an ACH debit 
from a cardholder's account, for example, under a decoupled debit 
arrangement.\36\ Proposed comment 2(f)-7 sets forth this guidance.
---------------------------------------------------------------------------

    \36\ However, a decoupled debit card issued by a merchant that 
can be used only at that merchant or its affiliate(s) may qualify 
for the separate exclusion under proposed Sec.  235.2(f)(3)(i).
---------------------------------------------------------------------------

General-Use Prepaid Cards (Sec.  235.2(i))

    The statutory definition of ``debit card'' includes a ``general-use 
prepaid card'' as that term is defined under EFTA Section 
915(a)(2)(A).\37\ Proposed Sec.  235.2(i) defines ``general-use prepaid 
card'' as 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.
---------------------------------------------------------------------------

    \37\ See EFTA Section 920(c)(2)(B).
---------------------------------------------------------------------------

    The proposed definition of ``general-use prepaid card'' generally 
tracks the definition as it appears under EFTA Section 915(a)(2)(A), 
with modifications to simplify and clarify the definition.\38\ For 
example, the proposed rule refers to cards issued in a ``specified'' 
amount to capture a card, or other payment code or device, whether it 
is issued in a predenominated amount or in an amount requested by a 
cardholder in a particular transaction.
---------------------------------------------------------------------------

    \38\ See also 12 CFR 205.20(a)(3).
---------------------------------------------------------------------------

    The inclusion of general-use prepaid cards in the definition of 
``debit card'' under EFTA Section 920(c)(2)(B) refers only to the term 
``general-use prepaid card'' as it is defined in EFTA Section 
915(a)(d)(A), and does not incorporate the separate exclusions to that 
term that are set forth in the gift card provisions of the Credit Card 
Act.\39\ Thus, for purposes of this proposed rule, the definition of 
``general-use prepaid card'' would include the cards, or other payment 
codes or devices, listed under EFTA Section 915(a)(2)(D) to the extent 
they otherwise meet the definition of ``general-use prepaid card.'' 
\40\
---------------------------------------------------------------------------

    \39\ For example, under the gift card provisions of the Credit 
Card Act, general-use prepaid cards do not include cards that are 
not marketed to the general public or cards issued in paper form 
only. See EFTA Section 915(a)(2)(D)(iv) and (v).
    \40\ The Board further notes that had Congress intended to apply 
the exclusions in EFTA Section 915(a)(2)(D) to the definition of 
``general-use prepaid card'' for purposes of this rule, it would 
have been unnecessary to separately create an exemption for certain 
reloadable prepaid cards that are not marketed or labeled as a gift 
card. See EFTA Section 920(a)(7)(ii).
---------------------------------------------------------------------------

    Proposed comment 2(i)-1 clarifies that a card, or other payment 
code or device, is ``redeemable upon presentation at multiple, 
unaffiliated merchants'' if, for example, the merchants agree, pursuant 
to the rules of the payment network, to honor the card, or other 
payment code or device, if it bears the mark, logo, or brand of a 
payment network. (See, however, proposed comment 2(f)-5, discussed 
above, clarifying that franchises subject to a common set of corporate 
policies or practices are considered to be affiliated.)
    Proposed comment 2(i)-2 provides that a mall gift card, which is 
generally intended to be used or redeemed at participating retailers 
located within the same shopping mall or in some cases, within the same 
shopping district, would be considered a general-use prepaid card if it 
is also network-branded, which would permit the card to be used at any 
retailer that accepts that card brand, including retailers located 
outside the mall.
    In some cases, a group of unaffiliated merchants may jointly offer 
a prepaid card that is only redeemable at the participating merchants. 
For example, ``selective authorization'' cards may be offered to 
encourage sales within a shopping mall or district or at merchants 
located in the same resort. Selective authorization cards generally are 
issued by a financial institution or member of a card network, rather 
than a program sponsor as in the case of many retail gift card 
programs. Transactions made using such cards are authorized and settled 
over the payment card networks just like other general-use prepaid 
cards. In addition, interchange transaction fees may be charged in 
connection with these cards because they are processed over a payment 
card network.
    Selective authorization programs enable a merchant to offer gift 
cards to its customers and ensure that card funds are spent only within 
the participating merchant(s) without incurring the costs of setting up 
a separate program. There may be little difference between these 
programs and closed-loop retail gift card programs operated by a single 
retailer, but for the fact that these cards are accepted at merchants 
that are unaffiliated. However, requiring these selective authorization 
cards to comply with the network exclusivity and routing restrictions 
could be problematic and costly for the participating merchants with 
little corresponding benefit. Accordingly, comment is requested on 
whether a prepaid card that is accepted at a limited number of 
unaffiliated participating merchants and does not carry a network brand 
should also be considered a ``general-use prepaid card'' under the 
rule.
G. Sec. 235.2(g) Designated automated teller machine network 
(Designated ATM network)
    EFTA Section 920(a)(7)(C) defines a ``designated automated teller 
machine network'' as either (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. 
Proposed Sec.  235.2(g) implements this definition substantially as set 
forth in the statute.
    The Board is also proposing to clarify the meaning of ``reasonable 
and convenient access,'' as that term is used in Sec.  235.2(g)(2). 
Proposed comment 2(g)-1 provides that an issuer provides reasonable and 
convenient access, for example, if, for each person to whom a card is 
issued, the issuer provides access to an 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,

[[Page 81731]]

where the card was first purchased or issued, in order to access an ATM 
in the network. The purpose of this comment is to clarify that if an 
issuer does not have its own network of proprietary ATMs, as provided 
in Sec.  235.2(g)(1), that the network the issuer identifies as its 
designated ATM network is one in which a person using a debit card can 
access an ATM with relative ease. The Board believes that having to 
travel a substantial distance from where the person is located, as 
determined by the last known address of the person to whom the card is 
issued, for an ATM in the network is neither reasonable nor convenient. 
The MSA is a common, well-known way of defining a community.\41\ 
Therefore, the Board is proposing the MSA as a proxy for a reasonable 
distance from the person's location.
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    \41\ See U.S. Census Bureau for information on MSAs, available 
at http://www.census.gov/population/www/metroareas/metroarea.html.
---------------------------------------------------------------------------

    Furthermore, because a debit card includes a general-use prepaid 
card, for which the issuer may not have the address of the person using 
the card, the proposed comment provides that the issuer may use the 
location of where the card was first purchased or issued. The issuer of 
a general-use prepaid card may not have address information because 
either the person to whom the card is issued is not the ultimate user 
of the card, such as in the case of a gift card, or the issuer does not 
collect address information for the product. In these instances, the 
only location known to the issuer is the place where the card was first 
purchased or issued, and the issuer may assume that the person using 
the card is located in that same area. The Board also requests comment 
on whether additional clarification or guidance is needed for how an 
issuer may identify a network of automated teller machines that 
provides reasonable and convenient access to the issuer's cardholders.
H. Sec. 235.2(h) Electronic debit transaction
    EFAT section 920(c)(5) defines the term ``electronic debit 
transaction'' as ``a transaction in which a person uses a debit card.'' 
The Board's proposed definition in Sec.  235.2(h) adds two clarifying 
provisions.
    First, proposed Sec.  235.2(h) clarifies that the term ``electronic 
debit transaction'' is a transaction in which a person uses a debit 
card as ``a form of payment.'' The statute defines payment card 
network, in part, as a network a person uses to accept a debit card as 
a form of payment. For clarity, the Board proposes to incorporate that 
requirement into the definition of electronic debit transaction.
    Second, the statutory definition is silent as to whether use of the 
debit card must occur within the United States. Proposed Sec.  235.2(h) 
limits electronic debit transactions to those transactions where a 
person uses a debit card for payment in the United States. The Board 
found no indication in the statute that Congress meant to apply the 
interchange provisions extraterritorially. Moreover, if a person uses a 
debit card outside the United States, even if such use is to debit an 
account located in the United States, the amount of the interchange 
transaction fees the issuer may receive often is determined by the 
network rules for cross-border transactions or the laws or regulations 
of the country in which the merchant is located. Therefore, electronic 
debit transactions subject to the proposed rule are those that occur at 
a merchant located within the United States.
    Proposed comment 2(h)-1 explains that the term ``electronic debit 
transaction'' includes transactions in which a person uses a debit card 
other than for the initial purchase of goods or services. For example, 
after purchasing goods or services, a person may decide that such goods 
and services are unwanted or defective. If permitted by agreement with 
the merchant, that person may return the goods or cancel the services 
and receive a credit using the same debit card used to make the 
original purchase. Proposed Sec.  235.2(h) covers such transactions. 
The Board understands, however, that issuers typically do not receive 
interchange fees for these transactions. Proposed comment 2(h)-2 
clarifies that transactions in which a person uses a debit card to 
purchase goods or services and also receives cash back from the 
merchant are electronic debit transactions.
I. Sec. 235.2(j) Interchange transaction fee
    Proposed Sec.  235.2(j) generally incorporates the EFTA Section 
920(c)(8)'s definition of ``interchange transaction fee'' that defines 
the term 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.'' A payment card 
network may determine interchange transaction fees according to a 
schedule that is widely applicable, but also may permit bilateral 
negotiation of fees between issuers and acquirers or merchants, as well 
as specialized interchange transaction fee arrangements.
    As discussed above, interchange transaction fees today are used to 
reimburse issuers for their involvement in electronic debit 
transactions by transferring value between acquirers and issuers. In 
general, payment card networks establish the interchange transaction 
fees, although the issuers are receiving the fees by reducing the 
amount remitted for a particular transaction by the amount of that 
transaction's interchange transaction fee. Therefore, the merchants or 
acquirers are paying the amount of the interchange transaction fee. The 
proposed definition, however, clarifies that interchange transaction 
fees are paid by merchants or acquirers. See proposed comment 2(j)-1.
    Proposed comment 2(j)-2 restates the rule that interchange fees are 
limited to those fees established, charged or received by a payment 
card network for the purpose of compensating the issuer, and not for 
other purposes, such as to compensate the network for its services to 
acquirers or issuers.
J. Sec. 235.2(k) Issuer
    Proposed Sec.  235.2(k) incorporates the statute's definition of 
``issuer'' that defines the term as ``any person who issues a debit 
card or the agent of such person with respect to the card.'' Proposed 
Sec.  235.2(k) follows the statutory definition, but removes the phrase 
``or the agent of such person with respect to the card.'' Because 
agents are, as a matter of law, held to the same restrictions with 
respect to the agency relationship as their principals, the Board does 
not believe that removing this clause will have a substantive effect.
    Issuing a debit card is the process of providing a debit card to a 
cardholder. The issuing process generally includes establishing a 
direct contractual relationship with the cardholder with respect to the 
card and providing the card directly or indirectly to the cardholder. 
The debit card provided may or may not have the issuer's name on the 
card. For example, a prepaid card may be issued by a bank that has 
partnered with another entity (e.g., a retail store) and the other 
entity's name may be on the prepaid card. Further, as discussed below, 
the issuer is not necessarily the institution that holds the 
cardholder's account that will be debited.
    Similar to merchant-acquirer relationships, the issuer-cardholder 
relationship varies. Proposed comments 2(k)-2 through 2(k)-5 clarify 
which entity is the issuer in the most prevalent issuing arrangements. 
In the simple four-party system, the financial

[[Page 81732]]

institution that holds the account is the issuer because that is the 
institution that directly or indirectly provides the debit card to the 
cardholder, holds the cardholder's account and has the direct 
contractual relationship with the cardholder with respect to the card. 
If the debit card is a prepaid card, the cardholder may receive the 
card from a merchant or other person, and thus may not receive the card 
directly from the issuing bank, which is the entity that holds the 
account that pools together the funds for many prepaid cards. See 
proposed comment 2(k)-2.
    In contrast, in a three-party system, the network typically 
provides the debit card or prepaid card directly to the cardholder or 
through an agent. Generally, the network also has a direct contractual 
relationship with the cardholder. Notwithstanding the other roles the 
network may have with respect to the transaction, the network is 
considered an issuer under proposed Sec.  235.2(k) because it provides 
the card to the cardholder, and may also be the account-holding 
institution. See proposed comment 2(k)-3.
    A variation of the issuer relationship within the four-party and 
three-party systems involves the licensing or assignment of Bank 
Identification Numbers (BINs), which are numbers assigned to financial 
institutions by the payment card networks for purposes of issuing 
cards. Some members of payment card networks permit other entities that 
are not members to issue debit cards using the member's BIN. The entity 
permitting such use is referred to as the ``BIN sponsor.'' The entity 
using the BIN sponsor's BIN (``affiliate member'') typically holds the 
account of the cardholder and directly or indirectly provides the 
cardholder with the debit card. The cardholder's direct relationship is 
with the affiliate member. Proposed comment 2(k)-4.i and .ii describes 
two circumstances involving BIN sponsorship arrangements and provides 
guidance on the entity that would be considered to be the issuer in 
those circumstances.
    Another variant of the issuer relationship within the four-party 
and three-party systems is the decoupled debit card arrangement. In a 
decoupled debit card arrangement, a third-party service provider (which 
may or may not be a financial institution) issues a debit card to the 
cardholder and enters into a contractual relationship with the 
cardholder with respect to the decoupled debit card. Therefore, 
proposed comment 2(k)-5 clarifies that the entity directly or 
indirectly providing the cardholder with the card is considered the 
issuer under proposed Sec.  235.2(k).
    Some issuers outsource to a third party some of the functions 
associated with issuing cards and authorizing, clearing, and settling 
debit card transactions. A third party that performs certain card-
issuance functions on behalf of an issuer would be subject to the same 
restrictions as the issuer in the performance of those functions. An 
issuer that outsources certain issuing functions retains the underlying 
relationship with the cardholder and should retain responsibility for 
complying with the rule's requirements as they pertain to issuers. 
Therefore, the Board's proposed definition of ``issuer'' does not 
include the phrase ``or agent of the issuer with respect to such 
card.'' The Board requests comment on whether there are circumstances 
in which an agent of an issuer also should be considered to be an 
issuer within the rule's definition.
    Proposed Sec.  235.2(k)'s definition of ``issuer'' applies 
throughout this part, except for the provisions exempting small 
issuers.\42\ For purposes of that exemption, EFTA Section 920 limits 
the term ``issuer'' to the person holding the account that is debited 
through the electronic debit transaction. For example, issuers of 
decoupled debit cards are not considered issuers for purposes of the 
small issuer exemption because they do not hold the account being 
debited.
---------------------------------------------------------------------------

    \42\ See discussion of proposed Sec.  235.5(a) in the section-
by-section analysis.
---------------------------------------------------------------------------

    The Board requests comment on all aspects of the issuer definition. 
The Board specifically requests comment on whether the appropriate 
entity is deemed to be the issuer in relation to the proposed examples.
L. Sec. 235.2(l) Merchant
    The statute does not define the term ``merchant.'' The term is used 
throughout the proposed rule, and the Board is proposing to define a 
merchant as a person that accepts a debit card as payment for goods or 
services.
M. Sec. 235.2(m) Payment card network
    EFTA Section 920(c)(11) defines the term ``payment card network'' 
as (1) 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 (2) 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. Proposed Sec.  235.2(m) 
follows this definition, with revisions for clarity.
    Under the proposed rule, a payment card network is generally 
defined as an ``entity that directly or indirectly provides the 
proprietary services, infrastructure, and software for authorization, 
clearance, and settlement of electronic debit transactions.'' Because 
the interchange fee restrictions and network exclusivity and merchant 
routing provisions of the Dodd-Frank Act do not apply to credit card 
transactions, the Board believes it is appropriate to exclude from the 
proposed definition the reference to credit cards in the statutory 
definition to avoid unnecessary confusion. No substantive change is 
intended. Likewise, the Board does not believe its necessary to state 
that a payment card network is an entity that a person uses in order to 
accept debit cards as a form of payment, because proposed Sec.  
235.2(h) defines the term ``electronic debit transaction,'' as use of a 
debit card ``as a form of payment.''
    In addition, the term ``payment card network,'' as defined in EFTA 
Section 920, could be interpreted broadly to include any entity that is 
involved in processing an electronic debit transaction, including the 
acquirer, third-party processor, payment gateway, or software vendor 
that programs the electronic terminal to accept and route debit card 
transactions. Each of these entities arguably provide ``services, 
infrastructure, and software'' that are necessary for authorizing, 
clearing, and settling electronic debit transactions. However, the 
Board does not believe that this is the best interpretation in light of 
the statute's objectives. Instead, the Board believes that the better 
interpretation is that in general, the term ``payment card network'' 
only applies to an entity that establishes the rules, standards, or 
guidelines that govern the rights and responsibilities of issuers and 
acquirers involved in processing debit card transactions through the 
payment system. Accordingly, proposed Sec.  235.2(m)(2) makes this 
clarification. The rules, standards, or guidelines may also govern the 
rights and responsibilities of participants other than issuers and 
acquirers. See proposed comment 2(m)-1.
    In certain cases, such as in a three-party system, the same entity 
may serve multiple roles, including that of the payment card network, 
the issuer, and the acquirer. Proposed comment 2(m)-1 clarifies that 
the term ``payment card network'' would also cover such entities to the 
extent that their rules, standards,

[[Page 81733]]

or guidelines also cover their activities in their role(s) of issuer 
and/or acquirer. Proposed comment 2(m)-1 further clarifies that the 
term ``payment card network'' would generally exclude acquirers, 
issuers, third-party processors, payment gateways, or other entities 
that may provide services, equipment, or software that may be used in 
authorizing, clearing, or settling electronic debit transactions, 
unless such entities also establish guidelines, rules, or procedures 
that govern the rights and obligations of issuers and acquirers 
involved in processing an electronic debit transactions through the 
network. For example, an acquirer is not considered to be a payment 
card network due to the fact that it establishes particular transaction 
format standards, rules, or guidelines that apply to electronic debit 
transactions submitted by a merchant that uses the acquirer's services, 
because such standards, rules, or guidelines would apply only to the 
merchant using the acquirer's services, and not to other entities that 
may also be involved in processing those transactions, such as the card 
issuer.
    The Board requests comment on whether other non-traditional or 
emerging payment systems would be covered by the statutory definition 
of ``payment card network.'' For example, consumers may use their 
mobile phone to send payments to third parties to purchase goods or 
services with the payment amount billed to their mobile phone account 
or debited directly from the consumer's bank account. In addition, 
consumers may use a third party payment intermediary, such as PayPal, 
to pay for Internet purchases, using the consumer's funds that may be 
held by the intermediary or in the consumer's account held at a 
different financial institution. In both examples, the system or 
network used to send the payment arguably provide the ``proprietary 
services, infrastructure, and software for authorization, clearance, 
and settlement of electronic debit transactions.'' Transactions 
involving these methods of payment typically are subject to rules and 
procedures established by the payment system. If such systems are not 
covered, the Board requests specific comment how it should 
appropriately distinguish these payment systems from traditional debit 
card payment systems that are subject to the rule.
N. Sec. 235.2(n) Person
    The term ``person'' is not defined in the EFTA. The proposed 
definition incorporates the definition of the term in existing Board 
regulations.\43\
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    \43\ Regulation Z (Truth in Lending Act), 12 CFR 226.2(a)(22); 
Regulation CC (Availability of Funds and Collections of Checks), 12 
CFR 229.2(yy);
---------------------------------------------------------------------------

O. Sec. 235.2(o) Processor
    EFTA Section 920 uses the term ``processor'' but does not define 
the term. Proposed Sec.  235.2(o) defines the term ``processor'' as a 
person that processes or routes electronic debit transactions for 
issuers, acquirers, or merchants.
P. Sec. 235.2(p) United States
    Proposed Sec.  235.2(p) defines the term ``United States.'' The 
proposed definition is modified from the EFTA's definition of 
``State.'' (15 U.S.C. 1693a(10)).

III. Sec. 235.3 Reasonable and proportional interchange transaction 
fees

    Proposed Sec.  235.3 sets forth standards for assessing whether the 
amount of any interchange transaction fee that an issuer receives or 
charges with respect to an electronic debit transaction is reasonable 
and proportional to the cost incurred by the issuer with respect to the 
transaction.
A. Statutory Considerations
1. Reasonable and Proportional to Cost
    As noted above, EFTA Section 920 requires the Board to establish 
standards for assessing whether the amount of any interchange 
transaction fee an issuer receives or charges with respect to an 
electronic debit transaction is reasonable and proportional to the cost 
incurred by the issuer with respect to the transaction. EFTA Section 
920 does not define ``reasonable'' or ``proportional.'' The Board has 
found only limited examples of other statutory uses of the terms 
``reasonable'' or ``proportional'' with respect to fees.\44\ One 
example is Section 149 of the Truth in Lending Act (TILA), which limits 
credit card penalty fees for violations of the cardholder agreement to 
fees that are reasonable and proportional to the violation. In 
implementing standards under TILA Section 149, the Board relied on the 
commonly accepted legal definition of ``reasonable'' (``fair, proper, 
or moderate'') and the commonly accepted definition of ``proportional'' 
(``corresponding in degree, size, or intensity'' or ``having the same 
or constant ratio'').\45\
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    \44\ Several public utility rate-setting statutes require ``just 
and reasonable'' rates. See, e.g., Natural Gas Act, 15 U.S.C. 717 et 
seq. In the public utility rate-setting context, a ``just and 
reasonable'' rate requires that the public utility be able ``to 
operate successfully, to maintain financial integrity, to attract 
capital, and to compensate its investors for the risk assumed.'' 
Duquense Light Co. v. Barash, 488 U.S. 299 (1989). The Board 
believes that the similarities between these statutes and Section 
920, however, are limited. Public utility rate-setting involves 
unique circumstances, none of which are present in the case of 
setting standards for interchange transaction fees. Issuers are 
unlike public utilities, which, in general, are required to make 
their services regularly available to the public. In addition, 
unlike in the case of public utilities where the utility's only 
source of revenue is the fees charged for the service or commodity, 
issuers have other sources, besides interchange fees, from which 
they can receive revenue to cover their costs of operations and earn 
a profit.
    \45\ See 75 FR 37526, 37531-32 (June 29, 2010), Black's Law 
Dictionary at 1272 (7th ed. 1999)(defining ``reasonable'') and 
Merriam Webster's Collegiate Dictionary at 936 (10th ed. 1995) 
(defining ``proportional'').
---------------------------------------------------------------------------

    Although the Board believes the previously relied upon definitions 
can inform this rulemaking, the Board notes that reasonableness and 
proportionality have different connotations in the context of 
interchange transaction fees than in the context of penalty fees. The 
TILA provision related to the reasonableness and proportionality of the 
fees charged when a violation of the account terms occurred. TILA 
required the Board to consider the costs incurred by issuers as a 
result of violations and other factors, including the need to deter 
violations. In considering whether an interchange fee is reasonable, 
the Board proposes to consider whether the fee is fair or proper in 
relation to both the individual issuer's costs as well as the costs 
incurred by other issuers. As discussed further below, the Board 
believes it may determine that certain fee levels are reasonable based 
on overall issuer cost experience, even if the individual issuer's 
costs are above (or below) that fee level.
    Similarly, in considering whether an interchange fee is 
proportional to the issuer's costs, the Board does not believe that 
proportionality must be interpreted to require identical cost-to-fee 
ratios for all covered issuers (although a constant cost-to-fee ratio 
would result from the issuer-specific standard discussed below for 
issuers with allowable costs below the cap). Rather, if the Board were 
to adopt a safe harbor or a fee cap (discussed further below) that it 
determined to be reasonable, the cost-to-fee ratio of any issuer that 
received fees at or below the safe harbor or cap would be deemed to 
meet the proportionality standard.
2. Considerations for Standards
    In EFTA Section 920, Congress set forth certain factors that the 
Board is required to consider when establishing standards for 
determining whether interchange transaction fees are reasonable and 
proportional to the cost

[[Page 81734]]

incurred by the issuer. Specifically, EFTA Section 920 requires the 
Board to (1) consider the functional similarity between electronic 
debit transactions and checks, which are required to clear at par 
through the Federal Reserve System and (2) distinguish between the 
incremental cost of authorization, clearance, and settlement of a 
particular transaction, which shall be considered, and other costs that 
are not specific to a particular transaction, which shall not be 
considered. Although Section 920 requires only the consideration of 
these factors, the Board believes that they are indicative of 
Congressional intent with respect to the implementation of Section 920, 
and therefore provide a useful measure for which costs should and 
should not be included in ``the cost incurred * * * with respect to the 
transaction.''
Similarities to Check
    There are a number of similarities between the debit card and check 
payment systems. Both are payment instruments that result in a debit to 
the payor's asset account. Debit card payments are processed 
electronically, and while historically check processing has been paper-
based, today virtually all checks are processed and collected 
electronically. Further, depository institutions have begun to offer 
their depositors remote deposit capture services to enable merchants to 
deposit their checks electronically. For both debit card and check 
payments, merchants pay fees to banks, processors, or intermediaries to 
process the payments. Settlement time frames are roughly similar for 
both payment types, with payments settling within one or two days of 
deposit.
    However, there are also differences between debit card and check 
payment systems.
    Open versus closed systems. Debit card networks are closed systems 
that both issuing and acquiring banks must join in order to accept and 
make payments. To accept debit card payments, issuing and acquiring 
banks must decide which debit card networks to join, establish a 
relationship with those networks, and agree to abide by those networks' 
rules. In contrast, the check system is an open system in which 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 merchant's bank need not join a network in order to 
collect a check.
    Payment authorization. Payment authorization is an integral part of 
the processing of a transaction on a debit card network. As part of the 
payment authorization process, a card issuer determines, among other 
things, whether the card is valid and whether there are sufficient 
funds to cover the payment. In contrast, payment authorization is not 
an inherent part of the check acceptance process, and therefore a 
merchant does not know whether the check will be returned unpaid at the 
time the merchant accepts the check. However, a merchant that wants to 
better manage its risks associated with unpaid checks can purchase 
value-added check verification and guarantee services from various 
third-party service providers.
    Processing and collection costs. In the check system, the payee's 
bank (which is analogous to the merchant-acquiring bank for debit 
cards) either incurs costs to present a check directly to the payor's 
bank (which is analogous to the card-issuing bank) or pays fees to 
intermediaries to collect and present the check to the payor's bank. In 
either case, the payor's bank does not incur fees to receive check 
presentments unless it has agreed to pay a fee to receive its 
presentments electronically. In debit card systems, the merchant-
acquiring and card-issuing banks both pay fees to the network to 
process payments for their respective customers.
    Par clearing. In the check system, payments clear at par. When a 
payee's bank presents a check to the payor's bank, the payor's bank 
pays and the payee's bank receives the face value of the check. As 
discussed above, a payee's bank may pay fees to an intermediary for 
check collection services; however, check payments are cleared and 
settled for the full face value of the checks. The payee's bank is not 
required to pay a fee to the payor's bank to receive the settlement for 
the full value of the checks presented. In contrast, in the debit card 
system, because interchange fees represent fees paid by the merchant-
acquiring bank to card-issuing banks, the merchant-acquiring bank 
receives less than the full value of debit card payments.
    Routing. In the check system, the payee's bank decides the avenue 
through which it collects checks. Checks can be presented directly to 
the payor's bank, collected through an intermediary for a fee, or 
exchanged through a clearing house.\46\ The decision is often based on 
the avenue that offers the lowest clearing cost. For a debit card 
payment, the merchant's choice with regard to routing is limited to the 
set of networks whose cards the merchant accepts and that are also 
available to process a transaction for its customer's card. Merchant 
payment routing may be further limited if the card issuer has 
designated routing preferences that must be honored when a customer 
presents a card that can be used for payment on multiple (typically 
PIN) networks. Such preferences may result in a transaction being 
routed to a network that imposes a higher fee on the merchant's bank 
(and hence the merchant) than if the payment were processed on another 
available network.
---------------------------------------------------------------------------

    \46\ For checks exchanged through a clearing house, both the 
payor's bank and the payee's bank must be members of or participate 
in the clearing house.
---------------------------------------------------------------------------

    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, a check must be returned by the 
``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, a payor's bank can no longer return the payment 
through the check payment system, although it may have legal remedies 
in the event of a dispute or financial loss.\47\ In contrast, in the 
debit card system, the time period within which a transaction may be 
reversed is not as limited. Typically, many disputes can be addressed 
through network chargeback processes without having to rely on legal 
remedies. These chargebacks and disputes can be handled through the 
network with procedures that are delineated in network rules.
---------------------------------------------------------------------------

    \47\ Uniform Commercial Code 4-301 and 4-302.
---------------------------------------------------------------------------

Activity Costs To Be Considered
    As noted above, the statute provides that, in establishing 
standards for assessing whether an interchange fee is reasonable and 
proportional to ``the cost incurred by the issuer with respect to the 
transaction,'' the Board shall consider the incremental cost of 
authorizing, clearing, and settling a particular transaction and shall 
not consider other costs that are not specific to a particular 
transaction.\48\ The statute is silent with respect to costs that are 
specific to a particular transaction other than incremental costs 
incurred by an issuer for authorizing, clearing, and settling the 
transaction.
---------------------------------------------------------------------------

    \48\ Sec. 920(a)(3).
---------------------------------------------------------------------------

    After considering several options for the costs that may be taken 
into account in setting interchange transaction fees (``allowable 
costs''), the Board proposes such costs be limited to those associated 
with authorization, clearing, and settlement of a transaction. This 
formulation includes only those costs

[[Page 81735]]

that are specifically mentioned for consideration in the statute. If an 
issuer outsources its authorization, clearance, and settlement 
activities, allowable costs would include fees paid to a processor for 
authorization, clearance, and settlement services.
    In the definition of allowable costs, the Board proposes to exclude 
network processing fees (i.e., switch fees) paid by issuers.\49\ Card 
issuers pay such fees to payment card networks for each transaction 
processed over those networks. Although these network fees typically 
are not associated with one specific component of authorization, 
clearance, or settlement of the transaction, a particular transaction 
cannot be authorized, cleared, and settled through a network unless the 
issuer pays its network processing fees. The Board proposes that 
network processing fees be excluded from allowable costs, because the 
Board recognizes that if network processing fees were included in 
allowable costs, acquirers (and, by extension, merchants) might be in 
the position of effectively paying all network fees associated with 
debit card transactions. That is, an acquirer would pay its own network 
processing fees directly to the network and would indirectly pay the 
issuer's network processing fees through the allowable costs included 
in the interchange fee standard.\50\
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    \49\ These fees do not include processing fees paid by an issuer 
to a network in its role as processor (i.e., a role equivalent to 
that of an issuer's third-party processor).
    \50\ Such an arrangement would be similar to traditional paper-
check processing where the payee's bank typically pays all of the 
processing costs, while the payor's bank typically pays no 
processing fees. However, this arrangement would be consistent with 
electronic check collection systems where both the payor's bank and 
payee's bank generally pay processing fees.
---------------------------------------------------------------------------

    The Board considered including other costs associated with a 
particular transaction that are not incurred by the issuer for its role 
in authorization, clearing, and settlement of that transaction. Such 
costs might include, for example, cardholder rewards that are paid by 
the issuer to the cardholder for each transaction. The Board does not 
view the costs of cardholder rewards programs as appropriate for 
consideration within the context of the statute. Other costs associated 
with a particular debit transaction might also include costs associated 
with providing customer service to cardholders for particular 
transactions, such as dealing with cardholder inquiries and complaints 
about a transaction. Given the statute's mandate to consider the 
functional similarities between debit transactions and check 
transactions, the Board proposes that allowable costs be limited to 
those that the statute specifically allows to be considered, and not be 
expanded to include additional costs that a payor's bank in a check 
transaction would not recoup through fees from the payee's bank.
    The Board requests comment on whether it should allow recovery 
through interchange fees of other costs of a particular transaction 
beyond authorization, clearing, and settlement costs. If so, the Board 
requests comment on what other costs of a particular transaction, 
including network fees paid by issuers for the processing of 
transactions, should be considered allowable costs. The Board also 
requests comment on any criteria that should be used to determine which 
other costs of a particular transaction should be allowable.
    The Board considered limiting the allowable costs to include only 
those costs associated with the process of authorizing a debit card 
transaction, because this option may be viewed as consistent with a 
comparison of the functional similarity of electronic debit 
transactions and check transactions. Among the most prominent 
differences between debit cards and checks is the existence of 
authorization for a debit card transaction where the deposit account 
balance is checked at the time of the transaction to ensure that the 
account has sufficient funds to cover the transaction amount. Clearing 
and settlement occur for both debit cards and checks, but for checks 
there is nothing analogous to an interchange fee to reimburse the 
issuer for the cost of clearing and settling a transaction. However, 
because the statute instructs the Board to also consider the costs of 
clearance and settlement, the Board proposes to include those costs. 
The Board requests comment on whether it should limit allowable costs 
to include only the costs of authorizing a debit card transaction.
Cost Measurement
    As noted above, the statute specifically requires consideration of 
the ``incremental'' cost of authorization, clearance, and settlement of 
a particular transaction. There is no single, generally-accepted 
definition of the term ``incremental cost.'' One commonly-used economic 
definition of ``incremental cost'' refers to the difference between the 
cost incurred by a firm if it produces a particular quantity of a good 
and the cost incurred by that firm if it does not produce the good at 
all.\51\ Other definitions of incremental cost consider the cost of 
producing some increment of output greater than a single unit but less 
than the entire production run. However, under any of these 
definitions, the increment of production is larger than the cost of any 
particular transaction (and, in the first definition, as large as the 
entire production run in the first case).\52\ As a result, the Board 
believes that these definitions of incremental cost do not 
appropriately reflect the incremental cost of a particular transaction 
to which the statute refers.
---------------------------------------------------------------------------

    \51\ Baumol, William J., John C. Panzar, and Robert D. Willig 
(1982), Contestable Markets and the Theory of Industry Structure. 
New York: Harcourt Brace Jovanovich. This definition involves any 
fixed or variable costs that are specific to the entire production 
run of the good and would be avoided if the good were not produced 
at all. Notably, this measurement excludes any common costs across 
goods that a firm produces, such as common fixed overhead costs, as 
those costs would still be incurred if production of the good of 
interest were ceased.
    \52\ Fundamentally, none of these definitions correspond to a 
per-transaction measure of incremental cost that could be applied to 
any particular transaction, regardless of the particular transaction 
used for such a definition.
---------------------------------------------------------------------------

    The Board proposes that the interchange fee standard allow for the 
inclusion of the per-transaction value of costs that vary with the 
number of transactions (i.e., average variable cost) within the 
reporting period. This cost calculation yields the cost of a typical or 
average transaction. This measure of per-transaction cost does not 
consider costs that are shared with other products of an issuer, such 
as common fixed or overhead costs, which would still be incurred in the 
absence of debit card transactions. For example, the Board does not 
believe that other costs of deposit accounts or, more generally, 
depository institutions, which cannot be attributable to debit card 
transactions, are appropriate to include in allowable costs. While a 
debit card program may not exist if certain costs are not incurred, 
such as account set-up costs or corporate overhead costs, it does not 
follow that those costs would be avoided in the absence of a debit card 
program.
    However, if variable costs of authorizing, clearing, and settling 
debit card transactions are shared with credit card operations, the 
Board believes that some portion of such costs should be allocated to 
debit card transactions. For example, these costs may be recorded 
jointly in internal cost accounting systems or not separated on third-
party processing invoices. These costs should be allocated to debit 
cards based on the proportion of debit card transactions to total card 
transactions.

[[Page 81736]]

    This measure would not consider costs that are common to all debit 
card transactions and could never be attributed to any particular 
transaction (i.e., fixed costs), even if those costs are specific to 
debit card transactions as a whole. Such fixed costs of production 
could not be avoided by ceasing production of any particular 
transaction (except perhaps the first).
    The Board recognizes that, by distinguishing variable costs from 
fixed costs, this standard imposes a burden on issuers by requiring 
issuers to segregate costs that vary with the number of transactions 
from those that are largely invariant to the number of transactions, 
within the reporting period. The Board also acknowledges that 
differences in cost accounting systems across depository institutions 
may complicate enforcement by supervisors. Finally, the Board 
recognizes that excluding fixed costs may prevent issuers from 
recovering through interchange fees some costs associated with debit 
card transactions. However, as noted above, the Board also recognizes 
that issuers have other sources, besides interchange fees, from which 
they can receive revenue to help cover the costs of debit card 
operations. Moreover, such costs are not recovered from the payee's 
bank in the case of check transactions.
    The Board also considered a cost measurement in terms of marginal 
cost or, in other words, the cost of an additional transaction. 
However, marginal cost can be different for each unit of output, and it 
is unclear which unit of output's cost should be considered, although 
often it is assumed to be the last unit. Notably, if marginal cost does 
not vary materially over the relevant volume range, then average 
variable cost will provide a close approximation to marginal cost for 
any particular transaction.\53\ In addition, average variable cost is 
more readily measurable than marginal cost for issuers and supervisors. 
Specifically, marginal cost for a given issuer cannot be calculated 
from cost accounting data; instead, it must be identified and estimated 
based on assumptions about costs that would have been incurred if an 
issuer's transaction volume had differed from that which actually 
occurred.\54\
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    \53\ In particular, if marginal cost is constant, then average 
variable cost equals marginal cost. More generally, average variable 
cost equals the average marginal cost across all transactions.
    \54\ See, Turvey, Ralph ``What are Marginal Costs and How to 
Estimate Them?'' University of Bath School of Management, Centre for 
the Study of Regulated Industries, Technical Paper 13(2000).
---------------------------------------------------------------------------

    The Board requests comment on whether it should include fixed costs 
in the cost measurement, or alternatively, whether costs should be 
limited to the marginal cost of a transaction. If the latter, the Board 
requests comment on how the marginal cost for that transaction should 
be measured.
B. Proposed Interchange Fee Standards
    The statute requires that 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.'' \55\ Proposed 
Sec.  235.3 sets forth two alternatives (referred to as ``Alternative 
1'' and ``Alternative 2'') for determining the level of the allowable 
interchange fee. Alternative 1 proposes an issuer-specific approach 
combined with a safe harbor and a cap. Under Alternative 1, an issuer 
may receive or charge interchange transaction fees at or below the safe 
harbor amount or based on a determination of its allowable costs, up to 
a cap. Alternative 2 proposes a stand-alone cap. The Board proposes to 
adopt only one of the alternatives and requests comment on each, as 
well as on any other alternatives that could be applied.
---------------------------------------------------------------------------

    \55\ See Sec. 920(a)(2) of the EFTA.
---------------------------------------------------------------------------

1. Alternative 1--Issuer-Specific up to a Cap, With a Safe Harbor
    Under Alternative 1, an issuer could comply with the regulatory 
standard for interchange fees by calculating allowable per-transaction 
cost, based on the allowable costs described by the Board, and ensuring 
that it did not receive an interchange fee for any transaction in 
excess of its allowable per-transaction cost. Proposed Sec.  235.3(c) 
sets forth an issuer's allowable costs. As discussed above, these are 
the issuer's costs that are attributable to its role in authorization, 
clearance, and settlement of electronic debit transactions and that 
vary, up to existing capacity limits within a reporting period, with 
the number of electronic debit transactions sent to the issuer. Network 
fees paid by the issuer are excluded from allowable costs. Proposed 
Sec.  235.3(b)(2) limits the amount of any interchange fee that an 
issuer may receive to no more than the allowable costs divided by the 
number of electronic debit transactions on which the issuer received or 
charged an interchange transaction fee in the calendar year.
    Alternative 1 also provides for a cap of 12 cents per transaction 
(proposed Sec.  235.3(b)(2)). An issuer could not receive an 
interchange fee above the cap regardless of its allowable cost 
calculation. In addition, Alternative 1 would deem any interchange fee 
at or below a safe harbor level of 7 cents per transaction to be in 
compliance with the regulatory standard (proposed Sec.  235.3(b)(1)), 
regardless of the issuer's allowable per-transaction cost.
    Under Alternative 1, each payment card network could set 
interchange fees for each issuer (1) at or below the safe harbor \56\ 
or (2) at a level for the issuer that would not exceed the issuer's 
allowable per-transaction costs up to the cap.\57\ A network would be 
permitted to set fees that vary with the value of the transaction (ad 
valorem fees), as long as the maximum amount of the interchange fee 
received by an issuer for any electronic debit transaction was not more 
than that issuer's maximum permissible interchange fee. A network would 
also be permitted to establish different interchange fees for different 
types of transactions (e.g., card-present and card-not-present) or 
types of merchants, as long as each of those fees satisfied the 
relevant limits of the standard. Each issuer's supervisor would verify 
that the amount of any interchange fee received by an issuer is, in 
fact, commensurate with the safe harbor, the issuer's allowable per-
transaction costs, or the cap, as appropriate. Each of the three 
elements of this alternative, the issuer-specific determination, the 
cap, and the safe harbor, are discussed in more detail below.
---------------------------------------------------------------------------

    \56\ This rule would not require a payment card network to set 
an interchange fee above the safe harbor. Whether a network would 
implement an issuer-specific interchange fee is the network's 
prerogative.
    \57\ Under this option, if a network planned to establish 
interchange fees on a per-issuer basis above the safe harbor, an 
issuer would report its maximum allowable interchange fee to the 
network.
---------------------------------------------------------------------------

Issuer-Specific Determination

    EFTA Section 920(a)(2) requires that ``the amount of any 
interchange transaction fee that an issuer may receive or charge * * * 
be reasonable and proportional to the cost incurred by the issuer with 
respect to the transaction.'' One reading of that provision is that the 
use of the definite article ``the'' in the second half of the standard 
suggests that the interchange fee limitation should be determined 
separately for each issuer and each transaction presented to that 
issuer. As discussed below, however, such an approach would be 
impractical and difficult to administer and enforce, and would 
introduce undesirable economic incentives.
    Measuring the allowable cost of each transaction would be highly 
impracticable due to the volume of

[[Page 81737]]

transactions and the fact that the cost of each transaction is likely 
not known when the interchange fee is charged. The Board believes that 
the average variable cost, as discussed above, provides a reasonable 
approximation of an issuer's per-transaction cost for its role in 
authorization, clearance, and settlement. The Board believes that a 
maximum interchange fee determined on an issuer-specific basis as 
provided in Alternative 1 is both reasonable, in that it reflects only 
those allowable costs identified by the Board (up to a cap, discussed 
further below), and is directly proportional to the issuer's actual 
costs.
    From an economic perspective, an issuer-specific determination 
directly links the compensation through interchange fees for each 
issuer to that issuer's specific costs. A major drawback of this 
approach is that it would not provide incentives for issuers to control 
their costs. In particular, an issuer that is eligible to recoup its 
costs under an issuer-specific determination with no cap would face no 
penalty for having high costs. Conversely, because a reduction in costs 
would lead to a reduction in an issuer's interchange fee, an issuer 
would receive no reward for reducing its costs (in the absence of a 
safe harbor). As a result, issuers would have no incentive to minimize 
their costs and may incur higher costs than they would otherwise. An 
issuer-specific determination might also encourage over-reporting of 
costs by an issuer because any inflation of the reported costs would be 
directly rewarded with a higher interchange fee for the issuer. Such 
undesirable incentive properties have generally led economists to 
advocate the abandonment of cost-of-service regulation in regulated 
industries in favor of approaches that yield better incentives to the 
regulated entities.\58\
---------------------------------------------------------------------------

    \58\ Joskow, Paul L. (2008), ``Incentive Regulation and its 
Application to Electricity Networks,'' Review of Network Economics, 
Vol. 7, Issue 4, pp. 547-60. Kahn, Alfred E. (1988), The Economics 
of Regulation: Principles and Institutions, Cambridge: MIT Press.
---------------------------------------------------------------------------

    An issuer-specific determination, on its own, would also place a 
significant implementation and administration burden on industry 
participants and supervisors. Each issuer would have to account for its 
costs in a manner that enables it to segregate allowable costs that 
could be recovered through the interchange fee from its other costs, 
tabulate those costs on an ongoing basis, and report them to the 
networks in which it participates. A network that set issuer-specific 
fees would need to incorporate such fees into its fee schedules, 
including the operational ability to distinguish among many different 
issuers in order to apply different rates to each of those issuers' 
transactions. The issuers' supervisors would need to evaluate each 
issuer's reported costs and verify that each issuer's interchange fees 
appropriately reflect those reported costs.

Cap

    To address, at least in part, the incentive problems discussed 
above with respect to a purely issuer-specific determination, the Board 
proposes to place a ceiling on the amount of any issuer-specific 
determination by specifying a cap of 12 cents per transaction. With an 
issuer-specific determination and a cap, the Board would deem any 
interchange fee that was equal to an issuer's allowable costs to be 
reasonable and proportional to the issuer's costs if it is at or below 
the cap.
    Some issuers that are subject to the interchange fee limitations 
have debit card programs with substantially higher per-transaction 
costs than others. These unusually high costs might be due to small 
programs targeted at high-net-worth customers or newer start-up 
programs that have not yet achieved economies of scale. In comparing 
reported per-transaction costs to current interchange transaction fee 
levels, the Board believes it is unlikely that these issuers currently 
are recovering their per-transaction costs through interchange 
transaction fees. The Board does not believe it is reasonable for the 
interchange fee to compensate an issuer for very high per-transaction 
costs. The Board believes that setting the cap at 12 cents per 
transaction will be sufficient to allow all but the highest-cost 
issuers discussed above to recover through interchange transaction fees 
the costs incurred for authorizing, clearing, and settling electronic 
debit transactions. The Board notes that even the highest-cost issuers 
have sources of revenue in addition to interchange fees, such as 
cardholder fees, to help cover their costs.
    A cap would eliminate some of the negative incentives of a purely 
issuer-specific determination. An issuer with costs above the cap would 
not receive interchange fees to cover those higher costs. As a result, 
a high-cost issuer would have an incentive to reduce its costs in order 
to avoid this penalty. The Board would re-examine the cap periodically 
(to coincide with the reporting requirements in proposed Sec.  235.8) 
to ensure that the cap continues to reflect a reasonable fee.
    To determine an appropriate value for a cap, the Board used data 
from responses to the card issuer survey described earlier. The Board 
used data on transaction volumes and the variable cost of 
authorization, clearing, and settlement (the allowable costs under an 
issuer-specific determination) to compute an issuer's per-transaction 
cost. These data were used to compute various summary measures of per-
transaction variable costs for issuers, generally. For this sample of 
issuers, the Board estimated that the per-transaction variable costs, 
averaged across all issuers, were approximately 13 cents per 
transaction. Average per-transaction variable costs were approximately 
4 cents per transaction when each issuer's costs are weighted by the 
number of its transactions.\59\ The 50th percentile of estimated per-
transaction variable costs was approximately 7 cents.
---------------------------------------------------------------------------

    \59\ This value corresponds to the aggregate per-transaction 
cost for all covered issuers.
---------------------------------------------------------------------------

    The Board proposes a cap of 12 cents per transaction because, while 
it significantly reduces interchange fees from current levels 
(approximately 44 cents per transaction, on average, based on the 
survey of payment card networks), it allows for the recovery of per-
transaction variable costs for a large majority of covered issuers 
(approximately 80 percent). The proposed cap does not differentiate 
between different types of electronic debit transactions (e.g., 
signature-based, PIN-based, or prepaid). From the survey results, the 
Board found some evidence of differences in allowable costs across 
signature and PIN debit transactions. In particular, the mean and 
median values of allowable costs for signature debit transactions were 
approximately 2 cents higher per transaction than the analogous figures 
for PIN debit transactions, while the 80th percentile was approximately 
1 cent higher per transaction for signature debit transactions. 
However, because these estimates are based on a sample of data, and 
because the variation among the individual issuers' costs was large, 
the ability to reliably infer a statistically significant difference 
from the data is limited. As a result, the Board does not propose to 
distinguish initially between the cap value for signature and PIN debit 
transactions, for either Alternative 1 or Alternative 2. For the same 
reasons, as described below, the Board does not propose to allow the 
safe harbor value to vary initially by authorization method. The Board 
requests comment on whether it should allow for such differences in the 
cap or safe harbor values.
    The Board notes that issuers reported higher costs for authorizing, 
clearing, and settling prepaid card transactions

[[Page 81738]]

(many of which are likely to be exempt from the interchange fee 
restrictions). The Board believes that issuers reported higher prepaid 
costs for one or more of the following reasons. First, many prepaid 
programs use stand-alone components, such as processing infrastructure, 
that are unable to exploit economies of scale that result from a large 
number of prepaid transactions or other debit card transactions. 
Second, because of the stand-alone components, all costs are allocated 
to prepaid card programs. Third, many prepaid issuers outsource almost 
all prepaid activity to third-party processors that include fixed costs 
and a mark-up in per-transaction fees. Finally, the cost data reported 
to the Board include information for both non-exempt and exempt cards. 
Exempt cards may have higher costs than non-exempt cards due to 
differences in the functionality of exempt cards, such as the need to 
verify the eligibility of transactions under certain government 
benefits programs. In light of the higher reported prepaid card costs, 
the Board specifically requests comment on whether the Board should 
initially have separate standards for debit card transactions and 
prepaid card transactions, and what those different standards should 
be.\60\
---------------------------------------------------------------------------

    \60\ The Board notes that prepaid cards do not currently have 
different interchange fees than other debit cards despite any 
potential differences in costs across the two types of cards.
---------------------------------------------------------------------------

Safe Harbor

    To further address the incentive and administrative burden problems 
discussed above, the Board proposes to provide a safe harbor for 
issuers as an alternative to the issuer-specific determination. 
Alternative 1 provides that, regardless of an issuer's per-transaction 
allowable cost, an interchange fee that is less than or equal to 7 
cents per transaction is deemed to be reasonable and proportional to 
the issuer's cost of the electronic debit transaction. Thus, issuers 
would have an incentive to reduce their per-transaction costs below the 
safe harbor.
    In determining the proposed safe harbor amount, the Board 
considered allowable issuer costs identified in responses to its card 
issuer survey. Using the issuer cost data described above, the Board 
proposes that 7 cents per transaction is an appropriate safe harbor 
value for the interchange fee. This value represents the approximate 
median in the distribution of estimated per-transaction variable costs. 
Like the cap discussed above, the Board proposes one safe harbor for 
all electronic debit transactions (i.e., signature, PIN and prepaid). 
The Board recognizes that issuers' costs may change over time, and the 
Board proposes to re-examine the safe harbor amount periodically in 
light of changing issuer costs.
    Overall, this approach reduces administrative burden on those 
issuers that choose to rely on the safe harbor, rather than determine 
their allowable costs, and allows issuers with costs above the safe 
harbor to receive an interchange fee directly linked to their costs, up 
to the level of the cap. At the same time, for an issuer with costs 
below the safe harbor value, this approach provides a reward for 
efficient production while also encouraging cost reductions to maximize 
the spread between the issuer's costs and the safe harbor value.
2. Alternative 2--Stand-Alone Cap
    Under Alternative 2, the Board would use information about issuer 
costs to determine an appropriate maximum interchange fee, or a cap, 
that would apply uniformly to all issuers. That is, each issuer could 
receive interchange fees up to the cap, regardless of that specific 
issuer's actual allowable costs. Alternative 2 provides that an 
interchange transaction fee is reasonable and proportional to an 
issuer's cost only if it is no more than 12 cents per transaction. As 
in Alternative 1, a network would be permitted to set fees that vary 
with the value of the transaction (ad valorem fees) or with the type of 
transaction or type of merchant, but only such that the maximum amount 
of the interchange fee for any transaction was not more than the cap of 
12 cents. The Board proposes the same cap of 12 cents per transaction 
in Alternative 2 as in Alternative 1 for the reasons stated in the 
discussion of Alternative 1. Each issuer's supervisor would verify that 
an issuer does not receive interchange revenue in excess of the cap. 
The Board recognizes that issuers' costs may change over time, and the 
Board proposes to conduct periodic surveys of covered issuers and re-
examine the cap amount periodically in light of changing issuer costs.
    As in Alternative 1, a stand-alone cap would encourage high-cost 
issuers to reduce their costs. In addition, an issuer with costs below 
the cap would receive a markup reflecting the spread between its costs 
and the cap value. Because the magnitude of the spread increases with 
the difference between the issuer's costs and the cap, all issuers, 
including low-cost issuers, would have an incentive to improve the 
efficiency of their operations. Finally, a cap reduces somewhat the 
incentive for an issuer to inflate its reported costs because no issuer 
would receive direct compensation for higher costs. These incentives 
have motivated authorities in other contexts to set price caps in many 
regulated industries, including, for example, the Reserve Bank of 
Australia in its intervention in the Australian credit and debit card 
markets.
    In comparison to Alternative 1, administration and implementation 
of this approach places less administrative burden on industry 
participants. Although the issuer would have to report its costs to the 
Board every two years in accordance with Sec.  235.8, an issuer would 
not have to calculate or report to the networks its maximum allowable 
interchange transaction fee. Similarly, a payment card network would 
not need to incorporate issuer-specific fees into its fee schedule, as 
the cap would apply uniformly to all covered issuers in that network.
3. Application of the Interchange Fee Standard
    Under both Alternative 1 and Alternative 2, the limitations on 
interchange fees would apply on a per-transaction basis. Under both 
alternatives, no electronic debit transaction presented to an issuer 
could carry an interchange fee that exceeds the interchange fee 
standard for that issuer.\61\ As noted above, supervisory review would 
be necessary to verify that an issuer does not receive interchange fee 
payments in excess of the maximum permitted by the rule.
---------------------------------------------------------------------------

    \61\ In no case does the standard prevent a network from setting 
interchange fees below the established amount. Instead, the standard 
describes the maximum appropriate interchange fee.
---------------------------------------------------------------------------

    This approach generally follows the statutory provisions discussed 
above that refer to ``the'' issuer and ``the'' transaction. The Board 
recognizes, however, that this approach restricts flexibility in 
setting interchange fees to reflect differences in risk, among other 
things. If the interchange fee standard must hold strictly for all 
transactions, then an issuer would be unable to receive a higher 
interchange fee for relatively high-risk transactions offset by lower 
interchange fees on relatively low-risk transactions.
    The Board has identified two other potential methods for 
implementing the interchange fee standards and requests comment on 
each. The first approach would allow flexibility in interchange fees 
with respect to a particular issuer. Under this approach, the issuer 
could comply with the rule as long as it meets the interchange fee 
standard, on average, for all of its electronic debit

[[Page 81739]]

transactions over a particular network during a specified period. In 
other words, some interchange fees above the amount of the standard 
would be permitted as long as those were offset by other fees below the 
standard. The second approach would allow an issuer to comply with the 
rule with respect to transactions received over a particular network as 
long as, on average, over a specified period, all covered issuers on 
that network meet the fee standard given the network's mix of 
transactions. In other words, compliance with the interchange fee 
standard would be evaluated at the network level, rather than at the 
level of each individual issuer.
    Both of these approaches would provide flexibility in setting 
interchange fees to incorporate considerations such as differences in 
risk across transactions. However, both of these approaches would 
introduce the possibility that any particular set of fees, set ex ante 
given assumptions about an issuer's or a network's expected mix of 
transactions, would result in an average fee for the actual 
transactions experienced that exceeded the regulatory standard. 
Moreover, network and issuer efforts to manage transactions and fees to 
stay within established limits could become very complex. Therefore, if 
the Board were to adopt either of these approaches, it may also need to 
deem an issuer to be in compliance with the standard as long as the 
interchange fees were set based on the issuer's or the network's 
transaction mix over a previous, designated, period of time, regardless 
of the actual transaction experience during the time period the fee is 
in effect.
    The Board requests comment on whether either of these approaches is 
appropriate. If so, the Board requests comment about whether and how it 
should adopt standards with respect to a permissible amount of 
variation from the benchmark for any given interchange transaction fee.
4. Proposed Regulatory Language
    Proposed Sec.  235.3(a) restates the statutory requirement that the 
amount of any interchange transaction an issuer charges or receives 
with respect to a transaction must be reasonable and proportional to 
the cost incurred by the issuer with respect to the transaction. 
Proposed Sec.  235.3(a) is the same for both Alternatives 1 and 2.
    Alternative 1. Alternative 1 is contained in proposed Sec. Sec.  
235.3(b) through (e) of the alternative.
    Interchange fee determination. Proposed Sec.  235.3(b) sets forth 
the exclusive standards for determining whether the amount of any 
interchange fee is reasonable and proportional to the issuer's cost. 
Proposed Sec.  235.3(b) sets the safe harbor amount and the issuer-
specific approach, up to the cap, described above. Except during the 
transition period, the amount of any interchange fee must comply with 
the standards from October 1 of any given calendar year through 
September 30 of the following calendar year. See proposed comments 
3(b)-1 through -4.
    Proposed Sec.  235.3(c) sets forth an exclusive list of allowable 
costs for purposes of the issuer-specific approach. Specifically, as 
discussed above, an issuer may include only those costs that are 
attributable to the issuer's role in authorization, clearance, and 
settlement of the transaction. Proposed Sec.  235.3(c)(1) describes 
activities that comprise the issuer's role in authorization, clearance, 
and settlement and limits the types of costs that may be included to 
those that vary with the number of transactions sent to the issuer. 
Proposed Sec.  235.3(c)(2) specifies that fees charged by a payment 
card network with respect to an electronic debit transaction are not 
included in the allowable costs. See also proposed comment 3(c)-1.
    Proposed comment 3(c)-2 describes in more detail the issuer's role 
in authorization, clearance, and settlement of a transaction. Proposed 
comment 3(c)-2 also specifies the types of costs that an issuer is 
considered to incur for authorization, clearance, and settlement of a 
transaction. With respect to authorization, an issuer may include the 
costs of activities such as data processing, voice authorization 
inquiries and referral requests. See proposed comment 3(c)-2.i. With 
respect to clearance, proposed comments 3(c)-2.ii and 3(c)-2.iii 
clarify that an issuer's costs for clearance of routine and non-routine 
transactions include costs of data processing, to the extent the issuer 
incurs additional such costs for clearance. An issuer's clearance costs 
also include the costs of reconciling clearing message information, 
initiating the chargeback message, and data processing and 
reconciliation expenses specific to receiving representments and error 
adjustments. Finally, with respect to settlement, an issuer may include 
costs of interbank settlement through a net settlement service, ACH, or 
Fedwire[supreg] and the cost of posting the transactions to the 
cardholders' accounts. See proposed comment 3(c)-2.iv.
    Proposed Sec.  235.3(c)(1) limits allowable costs to those that 
vary with the number of electronic debit transactions sent to the 
issuer during a calendar year. Proposed comment 3(c)-3.i describes, and 
provides examples of, the distinction between allowable, variable costs 
(those costs that vary, up to existing capacity limits, with the number 
of transactions sent to the issuer over the calendar year) and 
unallowable, fixed costs (those costs that do not vary, up to existing 
capacity limits, with the number of transactions sent to the issuer 
over the calendar year).
    Proposed Sec.  235.3(c)(2) states that allowable costs do not 
include the fees an issuer pays to a network for processing 
transactions. Proposed comment 3(c)-3.ii clarifies that switch fees are 
an example of fees that are not an allowable cost. Proposed comment 
3(c)-3.ii further explains that fees an issuer pays to a network when 
the network acts as the issuer's third-party processor are allowable 
costs.
    As clarified in proposed comment 3(c)-3-iii, an issuer would not be 
permitted to include costs that are common to other products offered by 
the issuer, except insofar as those costs are allowable costs that are 
shared with other payment card products and vary with the number of 
debit transactions. Proposed comment 3(c)-3-iv clarifies that proposed 
Sec.  235.3(c) sets forth an exhaustive list of allowable costs, and 
provides examples of costs that may not be included, such as the costs 
of rewards programs. The Board requests comment on whether additional 
clarification of allowable costs is needed.
    Disclosure to payment card network. Each issuer must ensure that it 
is in compliance with proposed Sec.  235.3(a) by receiving or charging 
interchange transaction fees at or below the safe harbor amount or as 
determined by its allowable costs up to the cap. Because payment card 
networks, not issuers, establish interchange fees, issuers must provide 
networks with information sufficient to ensure the issuers' compliance. 
Proposed Sec.  235.3(d) requires an issuer to report the maximum amount 
of an interchange transaction fee it may receive or charge to a 
network, but only if the issuer will be receiving or charging an 
interchange fee above the safe harbor amount.
    In establishing the conditions for reporting, the Board recognizes 
that not all networks likely will establish individualized interchange 
transaction fees. If a network does not establish individualized 
interchange transaction fees above the safe harbor amount, the Board 
believes it is not necessary to require an issuer to report its maximum 
allowable interchange transaction fee to networks through which it 
receives

[[Page 81740]]

electronic debit transactions. See proposed comment 3(d)-1. The Board 
requests comment on whether this reporting requirement is necessary to 
enable networks to set issuer-specific interchange fees.
    The Board proposes that an issuer report its maximum allowable 
interchange fee to each payment card network through which it processes 
transactions by March 31 of each year (based on the costs of the 
previous calendar year) to ensure compliance with the standard 
beginning on October 1 of that same year. See proposed comment 3(d)-2. 
The Board specifically requests comment on whether prescribing the 
deadline by rule is necessary. If necessary, the Board requests comment 
on whether March 31 is an appropriate deadline or whether a different 
deadline is appropriate.
    Transition period. As noted above, the Board is proposing to allow 
three months after year-end for an issuer to determine and report its 
maximum allowable interchange transaction fee, if its payment card 
networks establish individualized interchange fees above the safe 
harbor amount. The new interchange fee standards will be effective July 
21, 2011, and are proposed to be based on 2009 costs. The Board 
believes that establishing new interchange fees based on calendar year 
2010 costs on September 30, 2011 (approximately two months after the 
effective date) will impose an unnecessary burden on issuers, payment 
card networks, and acquirers. Accordingly, the Board proposes to allow 
issuers to rely on calendar year 2009 costs until September 30, 2012. 
After that date, issuers must determine compliance based on calendar 
year 2011 costs.
    Alternative 2. Alternative 2 is contained in proposed Sec.  
235.3(b). That section prohibits an issuer from receiving or charging 
any interchange transaction fee greater than 12 cents. See proposed 
comment 3(b)-1 under Alternative 2.

IV. Section 235.4 Adjustment for Fraud-Prevention Costs

    Section 920(a)(5) of the statute provides that the Board may allow 
for an adjustment to the interchange fee amount received or charged by 
an issuer if (1) such adjustment is reasonably necessary to make 
allowance for costs incurred by the issuer in preventing fraud in 
relation to electronic debit card transactions involving that issuer, 
and (2) the issuer complies with fraud-prevention standards established 
by the Board.\62\ Those standards must be designed to ensure that any 
adjustment is limited to the issuer's fraud-prevention costs for 
electronic debit transactions; takes into account any fraud-related 
reimbursements received from consumers, merchants, or payment card 
networks in relation to electronic debit transactions involving the 
issuer; and requires issuers to take effective steps to reduce the 
occurrence of, and costs from, fraud in relation to electronic debit 
transactions, including through the development and implementation of 
cost-effective fraud-prevention technology.
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    \62\ In describing Section 1075 of the Dodd-Frank Act, Senator 
Durbin stated: ``Further, any fraud prevention cost adjustment would 
be made on an issuer-specific basis, as each issuer must 
individually demonstrates that it complies with the standards 
established by the Board, and as the adjustment would be limited to 
what is reasonably necessary to make allowance for fraud-prevention 
costs incurred by that particular issuer.'' 156 Cong. Rec. S5925 
(July 15, 2010).
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    In issuing the standards and prescribing regulations for the 
adjustment, the Board must consider (1) The nature, type, and 
occurrence of fraud in electronic debit transactions; (2) the extent to 
which the occurrence of fraud depends on whether the authorization in 
an electronic debit transaction is based on a signature, PIN, or other 
means; (3) the available and economical means by which fraud on 
electronic debit transactions may be reduced; (4) the fraud-prevention 
and data-security costs expended by each party involved in the 
electronic debit transactions (including consumers, persons who accept 
debit cards as a form of payment, financial institutions, retailers, 
and payment card networks); (5) the costs of fraudulent transactions 
absorbed by each party involved in such transactions (including 
consumers, persons who accept debit cards as a form of payment, 
financial institutions, retailers, and payment card networks); (6) the 
extent to which interchange transaction fees have in the past reduced 
or increased incentives for parties involved in electronic debit 
transactions to reduce fraud on such transactions; and (7) such other 
factors as the Board considers appropriate.
    For the reasons set forth below, the Board has not proposed 
specific regulatory provisions to implement an adjustment for fraud-
prevention costs to the interchange transaction fee. The Board, 
however, sets forth two approaches--a technology-specific approach and 
a non-prescriptive approach--to designing the adjustment framework and 
requests comment on several questions related to these approaches. The 
Board plans to consider the comments in developing a specific proposal 
for further public comment.

A. Background and Survey Results

    Although the statute authorizes the Board to allow an adjustment to 
an interchange fee for fraud-prevention costs, the statute does not 
define the term ``fraud.'' In considering whether to allow an 
adjustment, the Board believes that fraud in the debit card context 
should be defined as the use of a debit card (or information associated 
with a debit card) by a person, other than the cardholder, to obtain 
goods, services, or cash without authority for such use.\63\
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    \63\ This definition derives from the EFTA's definition of 
``unauthorized electronic fund transfer.'' 15 U.S.C. 1693a(11).
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    Two primary steps are involved in making fraudulent purchases using 
a debit card. The first is stealing the cardholder account data. The 
second is using the stolen card or account data to make the fraudulent 
transaction. A thief may steal the card or the account information in 
several ways. For example, a card may be lost or stolen, and a thief 
may simply use the card to make purchases. Alternatively, a thief could 
obtain card account data by breaching the data-security systems of any 
entity that maintains records of debit card data. A thief might use the 
card account data to create a counterfeit card. The stolen card or 
account data may also be used to make unauthorized card-not-present 
transactions via the Internet, phone, or mail-order purchases.
    As part of its survey of debit card issuers, payment card networks, 
and merchant acquirers, the Board gathered information about the 
nature, type, and occurrence of fraud in electronic debit transactions 
at the point of sale, and the losses due to fraudulent transactions 
absorbed by parties involved in such transactions.\64\ Respondents were 
asked to report this information separately for signature and PIN debit 
card programs.\65\ From the surveys, the Board estimates that industry-
wide fraud losses to all parties of a debit card transaction were 
approximately $1.36 billion in 2009.\66\ About $1.15 billion of these 
losses arose from signature debit

[[Page 81741]]

card transactions and about $200 million arose from PIN debit card 
transactions.\67\
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    \64\ Respondents were not asked to provide data on ATM fraud.
    \65\ For more information, see the previous discussion regarding 
the survey process.
    \66\ Industry-wide fraud losses were extrapolated from data 
reported in the issuer and network surveys. Of the 89 issuers who 
responded to the issuer survey, 38 issuers provided data on total 
fraud losses related to their electronic debit card transactions. 
These issuers reported $719 million in total fraud losses to all 
parties of card transactions and represented 53 percent of the total 
transactions reported by networks.
    \67\ 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.
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    The surveys also solicited information about respondents' fraud-
prevention and data-security activities and the costs of these 
activities. The surveys did not capture analogous activities and costs 
for merchants (or cardholders). The data presented below derive from 
the survey of debit card issuers, which has the most complete 
information about fraud losses.\68\ The data are estimates given the 
variability in reporting across issuers about fraud types, associated 
fraud losses, and fraud-prevention and data-security activities and 
costs.
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    \68\ Networks' information regarding fraud losses may not be as 
complete as that of issuers because fraud losses absorbed by the 
issuers would generally not flow through the networks as chargebacks 
and may not be fully reported to the networks. Acquirers would 
generally not have knowledge about issuer losses.
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    Issuers that provided data on total fraud losses relating to their 
electronic debit card transactions reported $719 million in total debit 
card fraud losses to all parties, averaging 0.041 percent of 
transaction volume and 9.4 basis points of transaction value. These 
fraud losses were generally associated with 10 different types of 
fraud. The most commonly reported fraud types were counterfeit card 
fraud, lost and stolen card fraud, and card-not-present fraud.
    Issuers reported that total signature and PIN debit card fraud 
losses to all parties averaged 13.1 and 3.5 basis points, respectively. 
This represents, on a per-dollar basis, signature debit fraud losses 
3.75 times PIN-debit fraud losses. These different fraud rates reflect, 
in part, differences in the ease of fraud associated with the two 
authorization methods. A signature debit card transaction requires 
information that is typically contained on the card itself in order for 
card and cardholder authentication to take place. Therefore, a thief 
only needs to steal information on the card in order to commit 
fraud.\69\ In contrast, a PIN debit card transaction requires not only 
information contained on the card itself, but also something only the 
cardholder should know, namely the PIN. In this case, a thief needs 
both the information on the card and the cardholder's PIN to commit 
fraud.
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    \69\ Among other things, information on the card includes the 
card number, the cardholder's name, and the cardholder's signature.
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    Signature debit card transactions exhibit a higher fraud rate than 
that of PIN debit card transactions. Debit cards used to make purchases 
over the Internet and in other card-not-present environments are routed 
almost exclusively over signature debit card networks.\70\ Although 
card-not-present transactions have a higher fraud rate than card-
present transactions, the average signature debit fraud loss for card-
present transactions is nonetheless more than 4 times that for PIN 
debit transactions.\71\
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    \70\ Although some recent innovations attempt to facilitate PIN 
entry for Internet transactions, use of these technologies is still 
very limited.
    \71\ This comparison is based on survey responses from those 
issuers that differentiated card-present and card-not-present fraud 
losses for both signature and PIN transactions. These respondents 
represent about half of the transaction volume reported by all 
issuer respondents. The ratio of card-present fraud losses for 
signature and PIN debit networks is not comparable to the ratio of 
total fraud losses noted above because they are based on different 
subsets of issuer respondents.
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    In terms of losses to the various parties in a transaction, almost 
all of the reported fraud losses associated with debit card 
transactions fall on the issuers and merchants. In particular, across 
all types of transactions, 57 percent of reported fraud losses were 
borne by issuers and 43 percent were borne by merchants. In contrast, 
most issuers reported that they offer zero or very limited liability to 
cardholders, in addition to regulatory protections already afforded to 
consumers, such that the fraud loss borne by cardholders is 
negligible.\72\ Payment card networks and merchant acquirers also 
reported very limited fraud losses for themselves.
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    \72\ The EFTA limits consumer liability for unauthorized 
electronic fund transfers. See 15 U.S.C. 1693g and 12 CFR 205.6.
---------------------------------------------------------------------------

    The distribution of fraud losses between issuers and merchants 
depends, in part, on the authorization method used in a debit card 
transaction. Issuers and payment card networks reported that nearly all 
the fraud losses associated with PIN debit card transactions (96 
percent) were borne by issuers. In contrast, reported fraud losses were 
distributed much more evenly between issuers and merchants for 
signature debit card transactions. Specifically, issuers and merchants 
bore 55 percent and 45 percent of signature debit fraud losses, 
respectively.
    In general, merchants are subject to greater liability for fraud in 
card-not-present transactions than in card-present transactions. As 
noted above, signature-based authorization is currently the primary 
means to perform such transactions. According to the survey data, 
merchants assume approximately 76 percent of signature debit card fraud 
for card-not-present transactions.
    Based on the card issuer survey data, issuers engage in a variety 
of fraud-prevention activities. Issuers identified approximately 130 
fraud-prevention activities and reported the costs associated with 
these activities as they relate to debit card transactions.\73\ Some of 
these activities were broadly related to fraud detection and included 
activities such as transaction monitoring and fraud risk scoring 
systems that may trigger an alert or call to the cardholder in order to 
confirm the legitimacy of a transaction. Issuers also reported a number 
of fraud mitigation activities, such as merchant-blocking and account-
blocking. Some issuers included costs related to customer servicing 
associated with fraudulent transactions and personnel costs for fraud 
investigation teams or other staffing costs. When all fraud-prevention 
activities reported by issuers are included, the overall amount spent 
by respondents was approximately 1.6 cents per transaction, which also 
corresponds to the median amount spent by those firms.
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    \73\ The Board does not believe that the issuers participated in 
130 unique fraud-prevention activities. Rather, the Board believes 
that the listed activities refer to many of the same activities 
under differing descriptions.
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    The survey also asked issuers to report their data-security 
activities and costs. Issuers identified approximately 50 data-security 
activities and reported the allocated costs to debit card programs.\74\ 
Many of these activities were associated with information and system 
security. For all data-security costs reported by issuers in the card 
issuer survey, the overall amount spent by respondents was 
approximately 0.2 cents per transaction, which corresponds to the 
median amount spent by those firms.\75\
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    \74\ Similar to the fraud-prevention information, the Board does 
not believe that issuers engaged in a total of 50 unique activities.
    \75\ On average, by transaction type, issuers incurred 2.2[cent] 
per signature-debit transaction for fraud-prevention and data-
security activities and 1.2[cent] per PIN-debit transaction. 
Similarly, networks incurred 0.7[cent] per signature-debit 
transaction for fraud-prevention and data-security activities and 
0.6[cent] per PIN-debit transaction. Finally, acquirers incurred 
0.4[cent] per signature-debit transaction for fraud-prevention and 
data-security activities and 0.3[cent] per PIN-debit transaction.
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    Merchants also have fraud-prevention and data-security costs, 
including costs related to compliance with payment card industry data-
security standards (PCI-DSS) and other tools to prevent fraud, such as 
address verification services or internally developed fraud screening 
models, particularly for card-not-present transactions.\76\ The Board's

[[Page 81742]]

surveys were not comprehensive enough to adequately capture merchant 
activities nor did they provide a way to determine whether issuers' 
fraud-prevention and data-security activities directly benefit 
merchants by reducing their debit card fraud losses.
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    \76\ The Payments Cards Industry (PCI) Security Standards 
Council was founded in 2006 by five card networks--Visa, Inc., 
MasterCard Worldwide, Discover Financial Services, American Express, 
and JCB International. These card brands share equally in the 
governance of the organization, which is responsible for the 
development and management of PCI Data Security Standards (PCI DSS). 
PCI DSS is a set of security standards that all payment system 
participants, including merchants and processors, are required to 
meet in order to participate in payment card systems.
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B. Board's Consideration of an Adjustment for Fraud-Prevention Costs
    As previously described, issuers, merchant acquirers, and networks 
listed a variety of fraud-prevention and data-security activities in 
their survey responses. In designing an adjustment framework for fraud-
prevention costs, the Board is considering how an adjustment should be 
implemented, what fraud-prevention costs such an adjustment should 
cover, and what standards the Board should prescribe for issuers to 
meet as a condition of receiving the adjustment.
    Technology-specific approach. One approach to an adjustment for 
fraud-prevention costs would be to allow issuers to recover costs 
incurred for implementing major innovations that would likely result in 
substantial reductions in fraud losses. This approach would establish 
technology-specific standards that an issuer must meet to be eligible 
to receive the adjustment to the interchange fee. Under this approach, 
the Board would identify the paradigm-shifting technology(ies) that 
would reduce debit card fraud in a cost-effective manner. The 
adjustment would be set to reimburse the issuer for some or all of the 
costs associated with implementing the new technology, perhaps up to a 
cap; therefore, covered issuers and the Board would need to estimate 
the costs of implementing the new technology in order to set the 
adjustment correctly. Industry representatives have highlighted several 
fraud-prevention technologies or activities, such as end-to-end 
encryption, tokenization, chip and PIN, and the use of dynamic data 
that they believe have the potential to substantially reduce fraud 
losses. These technologies are not broadly used in the United States at 
this time.\77\
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    \77\ The Board understands, however, that in countries with 
broad chip and PIN adoption, fraud levels are not necessarily lower 
than those experienced in the U.S. because fraud has migrated to 
less secure channels, for example to Internet transactions where PIN 
authentication is not yet a common option.
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    This approach to implementing the adjustment has the potential to 
spur implementation of major security enhancements in the debit card 
market that have not yet gained substantial market adoption. 
Specifically, the adjustment could serve as an incentive for debit card 
industry participants to coordinate in the adoption of technologies 
that the Board determines would be effective in reducing fraud losses. 
The drawback of adopting technology-specific standards is the risk that 
it would cause issuers to under-invest in other innovative new 
technologies, not included in the Board's standards, that may be more 
effective and less costly than those identified in the standards.
    Non-prescriptive approach. An alternative approach is to establish 
a more general standard that an issuer must meet to be eligible to 
receive an adjustment for fraud-prevention costs. Such a standard could 
require issuers to take steps reasonably necessary to maintain an 
effective fraud-prevention program but not prescribe specific 
technologies that must be employed as part of the program.\78\ This 
approach would ensure that the Board's standards give flexibility in 
responding to emerging and changing fraud risks.
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    \78\ For example, Section 615(e) of the Fair Credit Reporting 
Act requires a number of federal agencies to develop identity theft 
prevention guidelines and regulations. The implementing regulations 
require that covered institutions adopt an identity theft prevention 
program designed to identify, detect, and respond to relevant 
identity theft red flags, but does not require consideration of 
specific red flags or mandate the use of specific fraud-prevention 
solutions. Rather, the accompanying guidelines provide factors that 
institutions should ``consider.'' The supplement to the guidelines 
lists examples of red flags. See e.g., Regulation V (Fair Credit 
Reporting), 12 CFR 222.90(d).
---------------------------------------------------------------------------

    Under this approach, the adjustment would be set to reimburse the 
issuer for some or all of the costs of its current fraud-prevention and 
data-security activities and of research and development for new fraud-
prevention techniques, perhaps up to a cap. This approach would shift 
some or all of the issuers' ongoing fraud-prevention costs to 
merchants, even though many merchants already bear substantial card-
related fraud-prevention costs, particularly for signature debit 
transactions.\79\ Such a shift in cost provides issuers with additional 
incentives to invest in fraud-prevention measures. Financial 
institutions make investments today, however, to reduce the risk of 
fraud in non-card forms of payment, without reimbursement of those 
costs from the counterparty to the payment.
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    \79\ An issuer's fraud losses would not be considered a cost 
that would be considered in setting the fraud adjustment. EFTA 
limits any fraud adjustment to an amount that ``is reasonably 
necessary to make allowance for costs incurred by the issuer in 
preventing fraud in relation to electronic debit transactions * * 
*'' EFTA Section 920(a)(5)(A)(i) (emphasis added).
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Request for Comment
    The Board requests comment on how to implement an adjustment to 
interchange fees for fraud-prevention costs. In particular, the Board 
is interested in commenters' input on the following questions:
    1. Should the Board adopt technology-specific standards or non-
prescriptive standards that an issuer must meet in order to be eligible 
to receive an adjustment to its interchange fee? What are the benefits 
and drawbacks of each approach? Are there other approaches to 
establishing the adjustment standards that the Board should consider?
    2. If the Board adopts technology-specific standards, what 
technology or technologies should be required? What types of debit-card 
fraud would each technology be effective at substantially reducing? How 
should the Board assess the likely effectiveness of each fraud-
prevention technology and its cost effectiveness? How could the 
standards be developed to encourage innovation in future technologies 
that are not specifically mentioned?
    3. If the Board adopts non-prescriptive standards, how should they 
be set? What type of framework should be used to determine whether a 
fraud-prevention activity of an issuer is effective at reducing fraud 
and is cost-effective? Should the fraud-prevention activities that 
would be subject to reimbursement in the adjustment include activities 
that are not specific to debit-card transactions (or to card 
transactions more broadly)? For example, should know-your-customer due 
diligence performed at account opening be subject to reimbursement 
under the adjustment? If so, why? Are there industry-standard 
definitions for the types of fraud-prevention and data-security 
activities that could be reimbursed through the adjustment? How should 
the standard differ for signature- and PIN-based debit card programs?
    4. Should the Board consider adopting an adjustment for fraud-
prevention costs for only PIN-based debit card transactions, but not 
signature-based debit card transactions, at least for an initial 
adjustment, particularly given the lower incidence of fraud and lower 
chargeback rate for PIN-debit transactions? To what extent

[[Page 81743]]

would an adjustment applied to only PIN-based debit card transactions 
(1) satisfy the criteria set forth in the statute for establishing 
issuer fraud-prevention standards, and (2) give appropriate weight to 
the factors for consideration set forth in the statute? \80\
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    \80\ Some merchant representatives have advocated that the fraud 
adjustment not be used to perpetuate signature-based networks, which 
they believe are inherently less secure than PIN networks and for 
which they incur significantly more chargebacks. These merchants 
believe that, if the Board allows a fraud adjustment, it should be 
designed to steer the industry from signature debit to PIN debit, or 
possibly to other more secure means of authorizing transactions. As 
noted earlier, the survey data indicate that signature debit fraud 
losses are higher than PIN debit fraud losses and that merchants 
bear a very small proportion of loss associated with PIN debit 
transactions.
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    5. Should the adjustment include only the costs of fraud-prevention 
activities that benefit merchants by, for example, reducing fraud 
losses that would be eligible for chargeback to the merchants? If not, 
why should merchants bear the cost of activities that do not directly 
benefit them? If the adjustment were limited in this manner, is there a 
risk that networks would change their rules to make more types of 
fraudulent transactions subject to chargeback?
    6. To what extent, if at all, would issuers scale back their fraud-
prevention and data-security activities if the cost of those activities 
were not reimbursed through an adjustment to the interchange fee?
    7. How should allowable costs that would be recovered through an 
adjustment be measured? Do covered issuers' cost accounting systems 
track costs at a sufficiently detailed level to determine the costs 
associated with individual fraud-prevention or data-security 
activities? How would the Board determine the allowable costs for 
prospective investments in major new technologies?
    8. Should the Board adopt the same implementation approach for the 
adjustment that it adopts for the interchange fee standard, that is, 
either (1) an issuer-specific adjustment, with a safe harbor and cap, 
or (2) a cap?
    9. How frequently should the Board review and update, if necessary, 
the adjustment standards?
    10. EFTA Section 920 requires that, in setting the adjustment for 
fraud-prevention costs and the standards that an issuer must meet to be 
eligible to receive the adjustment, the Board should consider the 
fraud-prevention and data-security costs of each party to the 
transaction and the cost of fraudulent transactions absorbed by each 
party to the transaction. How should the Board factor these 
considerations into its rule? How can the Board effectively measure 
fraud-prevention and data-security costs of the 8 million merchants 
that accept debit cards in the United States?

V. Sec. 235.5 Exemptions

    EFTA Section 920(a) sets forth several exemptions to the 
applicability of the interchange fee restriction provisions. 
Specifically, the statute contains exemptions for small issuers as well 
as government-administered payment programs and certain reloadable 
prepaid cards.\81\ The Board proposes to implement these exemptions in 
Sec.  235.5, as discussed below.
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    \81\ EFTA Section 920(a)(6) and (7) (15 U.S.C. 1693r(a)(6) and 
7).
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    Under the proposed rule, an electronic debit transaction may 
qualify for more than one exemption. For example, an electronic debit 
transaction made using a debit card that has been provided to a person 
pursuant to a Federal, State, or local government-administered payment 
program may be issued by an issuer that, together with its affiliates, 
has assets of less than $10 billion as of the end of the previous 
calendar year. Proposed comment 5-1 clarifies that an issuer only needs 
to qualify for one of the exemptions in order to exempt an electronic 
debit transaction from the interchange provisions in Sec. Sec.  235.3, 
235.4, and 235.6 of the proposed rules. The proposed comment further 
clarifies that a payment card network establishing interchange fees 
need only satisfy itself that the issuer's transactions qualify for at 
least one of the exemptions in order to exempt the electronic debit 
transaction from the interchange fee restrictions.

A. Sec. 235.5(a) Exemption for Small Issuers

    Section 920(a)(6)(A) of the EFTA provides that EFTA Section 920(a) 
does not apply to any issuer that, together with its affiliates, has 
assets of less than $10 billion. For purposes of this provision, the 
term ``issuer'' is limited to the person holding the asset account that 
is debited through an electronic debit transaction.\82\
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    \82\ EFTA Section 920(a)(6)(B) (15 U.S.C. 1693r(a)(6)(B)). The 
Board notes that an issuer of decoupled debit cards, which are debit 
cards where the issuer is not the institution holding the consumer's 
asset account from which funds are debited when the card is used, 
would not qualify for the exemption under EFTA Section 920(a)(6)(A) 
given the definition of ``issuer'' under EFTA Section 920(a)(6)(B), 
regardless of the issuer's asset size.
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    Proposed Sec.  235.5(a)(1) combines the statutory language in EFTA 
Sections 920(a)(6)(A) and (B) to implement the exemption with some 
minor adjustments for clarity and consistency. Therefore, Sec.  
235.5(a)(1) provides that Sec. Sec.  235.3, 235.4, and 235.6 do not 
apply to an interchange transaction fee received or charged by an 
issuer with respect to an electronic debit transaction if (i) the 
issuer holds the account that is debited; and (ii) the issuer, together 
with its affiliates, has assets of less than $10 billion as of the end 
of the previous calendar year. Proposed comment 5(a)-1 clarifies that 
an issuer would qualify for this exemption if its total worldwide 
banking and nonbanking assets, including assets of affiliates, are less 
than $10 billion.
    For consistency, the proposed rule assesses an issuer's asset size 
for purposes of the small issuer exemption at a single point in time. 
Although the asset size of an issuer and its affiliates will fluctuate 
over time, for purposes of determining an issuer's eligibility for this 
exemption, the Board believes the relevant time for determining the 
asset size of the issuer and its affiliates for purposes of this 
exemption should be the end of the previous calendar year. The Board 
has used the calendar year-end time frame in other contexts for 
determining whether entities meet certain dollar thresholds.\83\
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    \83\ See, e.g., 12 CFR 203.2(e)(1)(i) and 12 CFR 228.20(u).
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    To the extent that a payment card network permits issuers meeting 
the small issuer exemption to receive higher interchange fees than 
allowed under Sec. Sec.  235.3 and 235.4, payment card networks, as 
well as merchant acquirers and processors, may need a process in place 
to identify such issuers. Thus, the Board requests comment on whether 
the rule should establish a consistent certification process and 
reporting period for an issuer to notify a payment card network and 
other parties that the issuer qualifies for the small issuer exemption. 
For example, the rule could require an issuer to notify the payment 
card network within 90 days of the end of the preceding calendar year 
in order to be eligible for an exemption for the next rate period. The 
Board also requests comment on whether it should permit payment card 
networks to develop their own processes for making this determination.

B. Sec. 235.5(b) Exemption for Government-Administered Programs

    Under EFTA Section 920(a)(7)(A)(i), an interchange transaction fee 
charged or received with respect to an electronic debit transaction 
made using a debit or general-use prepaid card that has been provided 
to a person pursuant to a

[[Page 81744]]

Federal, State, or local government-administered payment program is 
generally exempt from the interchange fee restrictions. However, the 
exemption applies as long as a person may only use the debit or 
general-use prepaid card to transfer or debit funds, monetary value, or 
other assets that have been provided pursuant to such program. The 
Board proposes to implement this provision in Sec.  235.5(b)(1) with 
minor non-substantive changes to the statutory language.
    Proposed comment 5(b)-1 clarifies the meaning of a government-
administered program. The proposed comment states that a program is 
considered government-administered regardless of whether a Federal, 
State, or local government agency operates the program or outsources 
some or all functions to service providers that act on behalf of the 
government agency. The Board understands that for many government-
administered programs, the government agency outsources the 
administration of the card program to third parties. The proposed 
comment makes clear that a government-administered program will still 
be deemed government-administered regardless of the government agency's 
choice to use a third party for any and all aspects of the program.
    Furthermore, proposed comment 5(b)-1 provides that a program may be 
government-administered even if a Federal, State, or local government 
agency is not the source of funds for the program it administers. For 
example, the Board understands that for child support programs, a 
Federal, State, or local government agency is not the source of funds, 
but such programs are nevertheless administered by State governments. 
As such, the Board believes that cards distributed in connection with 
such programs would fall under the exemption.
    The Board notes that Section 1075(b) of the Dodd-Frank Act amends 
the Food and Nutrition Act of 2008, the Farm Security and Rural 
Investment Act of 2002, and the Child Nutrition of 1966 to clarify that 
the electronic benefit transfer or reimbursement systems established 
under these acts are not subject to EFTA Section 920. These amendments 
are consistent with the exemption under EFTA Section 920(a)(7)(i). 
Because proposed Sec.  235.5(b)(1), which implements EFTA Section 
920(a)(7)(i), covers these and other government-administered systems, 
neither the proposed regulation nor commentary specifically references 
such programs.
    Payment card networks that allow issuers to charge higher 
interchange fees than permitted under Sec. Sec.  235.3 and 235.4 for 
transactions made using a debit card that meets the exemption for 
government-administered payment programs will need a means to identify 
the card accounts that meet the exemption. As with the small issuer 
exemption in Sec.  235.5(a), the Board requests comment on whether it 
should establish a certification process or whether it should permit 
payment card networks to develop their own processes.
    The operational aspects of certifying on an account-by-account 
basis may be more complex than certifying on an issuer-by-issuer basis. 
Therefore, if the Board is to establish a certification process, the 
Board requests comment on how to structure this process, including the 
time periods for reporting and what information may be needed to 
identify accounts to which the exemption applies. For example, the 
Board understands that certain cards issued under a government-
administered payment program may be distinguished by the BIN or BIN 
range.

C. Sec. 235.5(c) Exemption for Certain Reloadable Prepaid Cards

    EFTA Section 920(a)(7)(A)(ii) establishes an exemption for an 
interchange transaction fee charged or received with respect to an 
electronic debit transaction for a plastic card, or other payment code 
or device, that is: (i) Linked to funds, monetary value, or assets 
purchased or loaded on a prepaid basis; (ii) not issued or approved for 
use to access or debit any account held by or for the benefit of the 
cardholder (other than a subaccount or other method of recording or 
tracking funds purchased or loaded on the card on a prepaid basis); 
(iii) redeemable at multiple, unaffiliated merchants or service 
providers, or automated teller machines; (iv) used to transfer or debit 
funds, monetary value, or other assets; and (v) reloadable and not 
marketed or labeled as a gift card or gift certificate.
    For clarity, the proposed rule refers to ``general-use prepaid 
card,'' which incorporates certain of the conditions for obtaining the 
exemption in EFTA Section 920(a)(7)(A)(ii). See proposed Sec.  
235.2(i). Proposed Sec.  235.5(c)(1) thus implements the remaining 
conditions concerning the ability of the card to be used to access an 
account held by or for the benefit of the cardholder (other than a 
subaccount or other method of recording or tracking funds purchased or 
loaded on the card on a prepaid basis) and whether the card is 
reloadable and not marketed or labeled as a gift card or gift 
certificate.
    Typically, issuers structure prepaid card programs so that the 
funds underlying each prepaid card in the program are held in an 
omnibus account, and the amount attributable to each prepaid card is 
tracked by establishing subaccounts or by other recordkeeping means. 
However, certain issuers structure prepaid card programs differently 
such that the funds underlying each card are attributed to separate 
accounts established by the issuer.
    The condition in EFTA Section 920(a)(7)(A)(ii)(II) makes clear that 
an exempt card may not be issued or approved for use to access or debit 
an account held by or for the benefit of the cardholder (other than a 
subaccount or other method recording or tracking funds purchased or 
loaded on the card on a prepaid basis). Therefore, issuers that 
structure prepaid card programs such that the funds underlying each 
card are attributed to separate accounts do not qualify for the 
exemption based on the conditions set forth under the statute. These 
issuers may argue that there is little difference between their prepaid 
programs and others that are constructed so that the funds are part of 
an omnibus account. However, an argument can be made that prepaid cards 
that access separate accounts are not significantly different from 
debit cards that access demand deposit accounts, which are covered by 
the interchange fee restrictions in EFTA Section 920(a). The Board's 
proposal is based on the view that prepaid cards where the underlying 
funds are held in separate accounts do not qualify for the exemption.
Reloadable and Not Marketed or Labeled as a Gift Card or Gift 
Certificate
    The Board has previously defined and clarified the meaning of 
``reloadable and not marketed or labeled as a gift card or gift 
certificate'' in the context of a rule restricting the fees and 
expiration dates for gift cards under 12 CFR 205.20 (``Gift Card 
Rule''). In order to maintain consistency, the Board proposes to import 
commentary related to the meaning of reloadable and not marketed or 
labeled as a gift card or gift certificate from the Gift Card Rule.
    Proposed comment 5(c)-1 provides that a general-use prepaid card is 
``reloadable'' if the terms and conditions of the agreement permit 
funds to be added to the general-use prepaid card after the initial 
purchase or issuance. The comment further states that a general-use 
prepaid card is not ``reloadable'' merely because the issuer or 
processor is technically able to add functionality that would otherwise

[[Page 81745]]

enable the general-use prepaid card to be reloaded. The comment is 
similar to comment 20(b)(2)-1 under the Gift Card Rule.
    Proposed comment 5(c)-2, which has been adapted from comment 
20(b)(2)-2 under the Gift Card Rule, clarifies the meaning of the term 
``marketed or labeled as a gift card or gift certificate.'' The 
proposed comment provides that the term means directly or indirectly 
offering, advertising, or otherwise suggesting the potential use of a 
general-use prepaid card as a gift for another person. The proposed 
comment also states that whether the exclusion applies does not depend 
on the type of entity that is making the promotional message. 
Therefore, under the proposed comment, a general-use prepaid card is 
deemed to be marketed or labeled as a gift card or gift certificate if 
anyone (other than the consumer-purchaser of the card), including the 
issuer, the retailer, the program manager that may distribute the card, 
or the payment network on which a card is used, promotes the use of the 
card as a gift card or gift certificate.\84\
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    \84\ As the Board discussed in connection with the issuance of 
the Gift Card Rule, a card is not deemed to be marketed or labeled 
as a gift card or gift certificate as a result of actions by the 
consumer-purchaser. For example, if the purchaser gives the card to 
another consumer as a ``gift,'' or if the primary cardholder 
contacts the issuer and requests a secondary card to be given to 
another person for his or her use, such actions do not cause the 
card to be marketed as a gift card or gift certificate.
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    The proposed comment also states that a certificate or card could 
be deemed to be marketed or labeled as a gift card or gift certificate 
even if it is primarily marketed for another purpose. Thus, for 
example, a reloadable network-branded card would be considered to be 
marketed or labeled as a gift card or gift certificate even if the 
issuer principally advertises the card as a less costly alternative to 
a bank account but promotes the card in a television, radio, newspaper, 
or Internet advertisement, or on signage as ``the perfect gift'' during 
the holiday season. Proposed comment 5(c)-2 further clarifies that the 
mere mention that gift cards or gift certificates are available in an 
advertisement or on a sign that also indicates the availability of 
exempted general-use prepaid cards does not by itself cause the 
general-use prepaid card to be marketed as a gift card or a gift 
certificate.
    The Board also proposes examples of what the term ``marketed or 
labeled as a gift card or gift certificate'' includes and does not 
include in proposed comment 5(c)-3; these examples are similar to those 
in comment 20(b)(2)-3 under the Gift Card Rule. Thus, under the 
proposed comment, examples of marketing or labeling as a gift card or 
gift certificate include displaying the word ``gift'' or ``present,'' 
displaying a holiday or congratulatory message, and incorporating gift-
giving or celebratory imagery or motifs on the card, certificate or 
accompanying material, such as documentation, packaging and promotional 
displays. See proposed comment 5(c)-3.i.
    The proposed comment further states that a general-use prepaid card 
is not marketed or labeled as a gift card or gift certificate if the 
issuer, seller, or other person represents that the card can be used as 
a substitute for a checking, savings, or deposit account, as a 
budgetary tool, or to cover emergency expenses. Similarly, the proposed 
comment provides that a card is not marketed as a gift card or gift 
certificate if it is promoted as a substitute for travelers checks or 
cash for personal use, or promoted as a means of paying for a 
consumer's health-related expenses. See proposed comment 5(c)-3.ii.
    As the Board discussed in connection with the issuance of the Gift 
Card Rule, there are several different models for how prepaid cards may 
be distributed from issuers to consumers.\85\ These models vary in the 
amount of control the issuer has in terms of how these products may be 
marketed to consumers. Therefore, an issuer that does not intend to 
market a particular general-use prepaid card as a gift card or gift 
certificate could find its intent thwarted by the manner in which a 
retailer displays the card in its retail outlets.
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    \85\ See 75 FR 16580 at 16594 (April 1, 2010).
---------------------------------------------------------------------------

    The Board issued comment 20(b)(2)-4 under the Gift Card Rule to 
address these issues. Specifically, comment 20(b)(2)-4 provides that a 
product is not marketed or labeled as a gift card or gift certificate 
if persons subject to the Gift Card Rule, including issuers, program 
managers, and retailers, maintain policies and procedures reasonably 
designed to avoid such marketing. Such policies and procedures may 
include contractual provisions prohibiting a card, or other payment 
code or device, from being marketed or labeled as a gift card or gift 
certificate; merchandising guidelines or plans regarding how the 
product must be displayed in a retail outlet; and controls to regularly 
monitor or otherwise verify that the card, or other payment code or 
device, is not being marketed as a gift card or gift certificate. The 
comment further states that whether a person has marketed a reloadable 
card, or other payment code or device, as a gift card or gift 
certificate will depend on the facts and circumstances, including 
whether a reasonable consumer would be led to believe that the card, or 
other payment code or device, is a gift card or gift certificate. The 
comment also included examples. The Board is proposing a similar 
comment 5(c)-4 to address issues related to maintaining proper policies 
and procedures to prevent a general-use prepaid card from being 
marketed as a gift card or gift certificate. Proposed comment 5(c)-4 
also contains similar examples as set forth in comment 20(b)(2)-4 under 
the Gift Card Rule.
    Proposed comment 5(c)-5 provides guidance relating to online sales 
of gift cards that is substantially the same as in comment 20(b)(2)-5 
under the Gift Card Rule. As discussed in connection with the issuance 
of the Gift Card Rule, the Board believes that a Web site's display of 
a banner advertisement or a graphic on its home page that prominently 
displays ``Gift Cards,'' ``Gift Giving,'' or similar language without 
mention of other available products, or inclusion of the terms ``gift 
card'' or ``gift certificate'' in its web address, creates the same 
potential for consumer confusion as a sign stating ``Gift Cards'' at 
the top of a prepaid card display. Because a consumer acting reasonably 
under these circumstances may be led to believe that all prepaid 
products sold on the Web site are gift cards or gift certificates, the 
Web site is deemed to have marketed all such products, including any 
general-purpose reloadable cards that may be sold on the Web site, as 
gift cards or gift certificates. Proposed comment 5(c)-5 provides that 
products sold by such Web sites would not be eligible for the 
exemption.
Certification
    As with the exemption for government-administered payment programs, 
payment card networks, as well as merchant acquirers and processors, 
will need a process to identify accounts accessed by reloadable 
general-use prepaid cards that are not marketed or labeled as a gift 
card or gift certificate if such networks permit issuers of such 
accounts to charge interchange fees in excess of the amount permitted 
under Sec. Sec.  235.3 and 235.4. The Board seeks comment on whether it 
should establish a certification process for the reloadable prepaid 
cards exemption or whether it should permit payment card networks to 
develop their own processes. The Board also requests comment on how it 
should structure the certification process if it were to establish a 
process, including the time

[[Page 81746]]

periods for reporting and what information may be needed to identify 
accounts to which the exemption applies.
Temporary Cards Issued in Connection With a General-Purpose Reloadable 
Card
    As the Board discussed in connection with the Gift Card Rule, some 
general-purpose reloadable cards may be sold initially as a temporary 
non-reloadable card. These cards are usually marketed as an alternative 
to a bank account (or account substitute). After the card is purchased, 
the cardholder may call the issuer to register the card. Once the 
issuer has obtained the cardholder's personal information, a new 
personalized, reloadable card is sent to the cardholder to replace the 
temporary card.
    The Board decided to permit temporary non-reloadable cards issued 
solely in connection with a general-purpose reloadable card to be 
treated as general-purpose reloadable cards under the Gift Card Rule 
despite the fact that such cards are not reloadable. As it discussed in 
connection with the Gift Card Rule, the Board was concerned that 
covering temporary non-reloadable cards under the Gift Card Rule would 
create regulatory incentives that would unduly restrict issuers' 
ability to address potential fraud. Some issuers issue temporary cards 
in non-reloadable form to encourage consumers to register the card and 
provide customer identification information for Bank Secrecy Act 
purposes. A rule that provides that the exemption is only available if 
the temporary card is reloadable would therefore limit issuers' options 
without a corresponding benefit.\86\
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    \86\ See 75 FR 16580 at 16596 (April 1, 2010).
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    For similar reasons, the Board is proposing that interchange fees 
charged or received with respect to transactions using a temporary non-
reloadable card issued solely in connection with a general-purpose 
reloadable card would also qualify for the exemption under EFTA Section 
920(a)(7)(A)(ii), provided such cards are not marketed or labeled as a 
gift card or gift certificate. Therefore, proposed Sec.  235.5(c)(2) 
provides that the term ``reloadable'' also includes a temporary non-
reloadable card if it is issued solely in connection with a reloadable 
general-use prepaid card. Proposed comment 5(c)-6, similar to comment 
20(b)(2)-6 under the Gift Card Rule, provides additional guidance 
regarding temporary non-reloadable cards issued solely in connection 
with a general-purpose reloadable card.

D. Sec. 235.5(d) Exception

    EFTA Section 920(a)(7)(B) provides that after the end of the one-
year period beginning on the effective date of the statute, the 
exemptions available under EFTA Sections 920(a)(7)(A)(i) and (ii) 
become subject to an exception. The statute provides that the 
exemptions are not available if any of the following fees may be 
charged to a person with respect to the card: (i) An overdraft fee, 
including a shortage of funds or a transaction processed for an amount 
exceeding the account balance; and (ii) a fee charged by the issuer for 
the first withdrawal per month from an ATM that is part of the issuer's 
designated ATM network. The Board proposes to implement this exception 
to the exemptions in Sec.  235.5(d), substantially as presented in the 
statute with one minor clarification.
    Specifically, the Board proposes to clarify that the fee described 
in Sec.  235.5(d)(1) does not include a fee or charge charged for 
transferring funds from another asset account to cover a shortfall in 
the account accessed by the card. Such a fee is not an ``overdraft'' 
fee because the cardholder has a means of covering a shortfall in the 
account connected to the card with funds transferred from another asset 
account, and the fee is charged for making such a transfer.

VI. Sec. 235.6 Prohibition on Circumvention or Evasion

    EFTA Section 920 contains two separate grants of authority to the 
Board to address circumvention or evasion of the restrictions on 
interchange transaction fees. First, EFTA Section 920(a)(8) authorizes 
the Board to prescribe rules to ensure that network fees are not used 
``to directly or indirectly compensate an issuer with respect to an 
electronic debit transaction'' and ``to circumvent or evade'' the 
interchange transaction fee restrictions under the statute and this 
proposed rule.\87\ In addition, EFTA Section 920(a)(1) provides the 
Board authority to prescribe rules to prevent other forms of 
circumvention or evasion. Pursuant to both of these authorities, the 
Board is proposing to prohibit circumvention or evasion of the 
interchange transaction fee restrictions in Sec. Sec.  235.3 and 235.4. 
Circumvention or evasion would occur under the proposed rule if an 
issuer receives net compensation from a payment card network, not 
considering interchange transaction fees received from acquirers.
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    \87\ Under EFTA Section 920(a)(1), a network fee is defined as 
``any fee charged and received by a payment card network with 
respect to an electronic debit transaction, other than an 
interchange transaction fee.''
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    Payment card networks charge network participants a variety of fees 
in connection with electronic debit transactions. On the issuer side, 
fees charged by the network include access fees for connectivity and 
fees for authorizing, clearing, and settling debit card transactions 
through the network.\88\ Issuers also pay fees to the network for the 
costs of administering the network, such as service fees for supporting 
the network infrastructure, and membership and licensing fees. In 
addition, a network may charge fees to issuers for optional services, 
such as for transaction routing and processing services provided by the 
network or its affiliates or for fraud detection and risk mitigation 
services.
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    \88\ Network fees associated with authorizing, clearing, and 
settling debit card transactions are not included in the allowable 
costs under the interchange standard.
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    On the acquirer and merchant side, a network similarly charges fees 
for accessing the network, as well as fees for authorizing, clearing, 
and settling debit card transactions through the network. Likewise, 
networks charge network administration fees, membership or merchant 
acceptance fees, and licensing or member registration fees on acquirers 
and/or merchants. There are also fees for various optional services 
offered by the network to acquirers or merchants, including fees for 
fraud detection and risk mitigation services. For a closed-loop or 
three-party payment network, network fees are bundled into the merchant 
discount rate charged by the network in its capacity as the merchant 
acquirer.
    A fee charged by the network can be assessed as a flat fee or on a 
per transaction basis, and may also vary based on transaction size, 
transaction type or other network-established criteria. While 
interchange fee rates generally do not vary across issuers or acquirers 
for the same types of debit card transactions, fees charged by the 
network are often set on an issuer-by-issuer or merchant-by-merchant 
basis. For example, issuers and merchants may be given individualized 
discounts relative to a published network fee or rate based on their 
transaction volume increases.
    In addition to discounts, issuers and merchants may receive 
incentive payments or rebates from a network. These incentives may 
include upfront payments to encourage issuers to shift some or all of 
their debit card volume to the network, such as signing bonuses

[[Page 81747]]

upon contract execution or renewal. Such payments may help issuers 
defray the conversion cost of issuing new cards or of marketing the 
network brand. In addition, issuers may receive incentive payments upon 
reaching or exceeding debit card transaction, percentage share, or 
dollar volume threshold amounts.
    Discounts and incentives enable networks to compete for business 
among issuers and merchants. Among other things, these pricing tools 
help networks attract new issuers and retain existing issuers, as well 
as expand merchant acceptance to increase the attractiveness of the 
network brand. Discounts and incentives also help the network to 
encourage specific processing behavior, such as the use of enhanced 
authorization methods or the deployment of additional merchant 
terminals.
    There are a number of factors that a network may consider in 
calibrating the appropriate level of network fees, discounts, and 
incentives in order to achieve network objectives. However, EFTA 
Section 920(a) authorizes the Board to prescribe rules to ensure that 
such pricing mechanisms are not used to circumvent or evade the 
interchange transaction fee restrictions. This authority is both 
specific with respect to the use of network fees under EFTA Section 
920(a)(8), as well as general with respect to the Board's 
implementation of the interchange transaction fee restrictions under 
EFTA Section 920(a)(1).
    As an initial matter, the Board notes that the statute does not 
directly regulate the amount of network fees that a network may charge 
for any of its services. Thus, the proposed rule does not seek to set 
or establish the level of network fees that a network may permissibly 
impose on any network participant for its services. Instead, the 
proposed rule is intended to ensure that network fees, discounts, and 
incentives do not, in effect, circumvent the interchange transaction 
fee restrictions. Accordingly, proposed Sec.  235.6 contains a general 
prohibition against circumventing or evading the interchange 
transaction fee restrictions in Sec. Sec.  235.3 and 235.4. In 
addition, proposed Sec.  235.6 would expressly prohibit an issuer from 
receiving net compensation from a payment card network with respect to 
electronic debit transactions. The Board believes that such 
compensation would effectively serve as a transfer to issuers in excess 
of the amount of interchange transaction fee revenue allowed under the 
standards in Sec. Sec.  235.3 and 235.4.
    The Board also considered whether increases in fees charged by the 
network on merchants or acquirers coupled with corresponding decreases 
in fees charged by the network on issuers should also be considered 
circumvention or evasion of the interchange fee standards in Sec. Sec.  
235.3 and 235.4. For example, following the effective date of this 
rule, a network might increase network switch fees charged to 
merchants, acquirers, or processors while decreasing switch fees paid 
by issuers for the same types of electronic debit transactions. Under 
these circumstances, the increase in network processing fees charged to 
merchants is arguably ``passed through'' to issuers through 
corresponding decreases in processing fees paid by issuers.
    The Board recognizes that such decreases in issuer fees could have 
the effect of offsetting reductions in interchange transaction fee 
revenue that will occur under the proposed restrictions in Sec. Sec.  
235.3 and 235.4. Nonetheless, the Board believes that such 
circumstances would not necessarily indicate circumvention or evasion 
of the interchange transaction fee restrictions because, absent net 
payments to the issuer from the network, an issuer would not receive 
net compensation from the network for electronic debit transactions. 
Moreover, the Board is concerned that prohibiting such shifts in the 
allocation of network fees would effectively lock in the current 
distribution of network fees between issuers and merchants, thereby 
constraining the ability of networks to adjust their own sources of 
revenue in response to changing market conditions. The Board requests 
comment on the proposed approach, as well as on any other approaches 
that may be necessary and appropriate to address concerns about 
circumvention or evasion of the interchange fee standards.
    Proposed comment 6-1 provides that any finding of circumvention or 
evasion of the interchange transaction fee restrictions will depend on 
the relevant facts or circumstances. The proposed comment also provides 
an example of a circumstance indicating circumvention or evasion. In 
the example, circumvention or evasion occurs if the total amount of 
payments or incentives received by an issuer from a payment card 
network during a calendar year in connection with electronic debit 
transactions, excluding interchange transaction fees that are passed 
through to the issuer by the network, exceeds the total of all fees 
paid by the issuer to the network for electronic debit transactions 
during that year. In this circumstance, an issuer impermissibly 
receives net compensation from the payment card network in addition to 
the interchange transaction fees permitted under Sec. Sec.  235.3 and 
234.4. See proposed comment 6-1.i.
    Proposed comment 6-1.ii clarifies that payments or incentives paid 
by a payment card network include, but are not limited to, marketing 
incentives, payments or rebates for meeting or exceeding a specific 
transaction volume, percentage share or dollar amount of transactions 
processed, or other fixed payments for debit card related activities. 
Payments or incentives paid by a payment card network to an issuer do 
not include any interchange transaction fees that are passed through to 
the issuer by the network. Incentives paid by a payment card network 
also do not include funds received by an issuer from a payment card 
network as a result of chargebacks or violations of network rules or 
requirements by a third party. The proposed comment further clarifies 
that fees paid by an issuer to a payment card network include, but are 
not limited to, network processing, or switch, fees paid for each 
transaction, as well as fees charged to issuers that are not particular 
to a transaction, such as membership or licensing fees and network 
administration fees. Fees paid by an issuer could also include fees for 
optional services provided by the network.
    Proposed comment 6-2 provides examples of circumstances that do not 
evade or circumvent the interchange transaction fee restrictions. In 
the first proposed example, an issuer receives an additional incentive 
payment from the network as a result of increased debit card 
transaction volume over the network during a particular year. However, 
because of the additional debit card activity, the aggregate switch 
fees paid by the issuer to the network also increase. Assuming the 
total amount of fees paid by the issuer to the network continues to 
exceed the total amount of incentive payments received by the issuer 
from the network during that calendar year, no circumvention or evasion 
of the interchange transaction fee restrictions has occurred. See 
proposed comment 6-2.i.
    In the second example, an issuer receives a rate reduction for 
network processing fees due to an increase in debit card transactions 
during a calendar year that reduces the total amount of network 
processing fees paid by the issuer during the year. However, the total 
amount of all fees paid to the network by the issuer continues to 
exceed the total amount of incentive payments received by the issuer 
from the network. Under these circumstances, the issuer does not 
circumvent or evade the interchange

[[Page 81748]]

transaction fee restrictions. See proposed comment 6-2.ii.
    Proposed comment 6-3 clarifies that the prohibition in Sec.  235.6 
against circumventing or evading the interchange transaction fee 
restrictions does not apply to issuers or products that qualify for an 
exemption under Sec.  235.5. Thus, for example, Sec.  235.6 does not 
apply to an issuer with consolidated assets below $10 billion holding 
the account that is debited in an electronic debit transaction.
    Comment is requested regarding how the rule should address signing 
bonuses that a network may provide to attract new issuers or to retain 
existing issuers upon the execution of a new agreement between the 
network and the issuer. Such bonuses arguably do not circumvent or 
evade the interchange transaction fee restrictions because they do not 
serve to compensate issuers for electronic debit transactions that have 
been processed over the network. Moreover, if such payments were 
considered in assessing whether network-provided incentives during a 
calendar year impermissibly exceeded the fees paid by an issuer during 
that year, it could constrain a network's ability to grow the network 
and achieve greater network efficiencies by potentially removing a 
significant tool for attracting new issuers. However, if such signing 
bonuses are not taken into account in determining whether an issuer 
receives net compensation for electronic debit transactions, a network 
could provide significant upfront incentive payments during the first 
year of a contract or space out incentive payments over several years 
to offset the limitations on interchange transaction fees that could be 
received by the issuer over the course of the contract.
    The Board also requests comment on all aspects of the proposed 
prohibition against circumvention or evasion, including whether the 
rule should provide any additional examples to illustrate the 
prohibition against circumvention or evasion of the interchange 
transaction fee restrictions.

VII. Sec. 235.7 Limitations on Payment Card Restrictions

    EFTA Section 920(b) sets forth provisions limiting the ability of 
issuers and payment card networks to restrict merchants and other 
persons from establishing the terms and conditions under which they may 
accept payment cards. For example, EFTA Section 920(b) prohibits an 
issuer or payment card network from establishing rules that prevent 
merchants from offering discounts based on the method of payment 
tendered. In addition, the statute prohibits an issuer or payment card 
network from establishing rules preventing merchants from setting 
minimum and maximum transaction amounts for accepting credit cards. 
These two statutory provisions are self-executing and are not subject 
to the Board's rulemaking authority.\89\
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    \89\ The Board may, however, increase from $10 the minimum value 
amount that a merchant may set for credit card acceptance. EFTA 
Section 920(b)(3)(B).
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    However, the Board is directed to prescribe implementing 
regulations with respect to two additional limitations set forth in the 
statute. First, the Board must issue rules prohibiting an issuer or 
payment card network from restricting the number of payment card 
networks on which an electronic debit transaction may be processed 
(network exclusivity restrictions).\90\ Second, the Board must issue 
rules that prohibit an issuer or payment card network from directly or 
indirectly inhibiting any person that accepts debit cards for payment 
from directing the routing of an electronic debit transaction through 
any network that may process that transaction (merchant routing 
restrictions).\91\ Proposed Sec.  235.7 implements these additional 
limitations on payment card network restrictions.
---------------------------------------------------------------------------

    \90\ See EFTA Section 920(b)(1)(A).
    \91\ See EFTA Section 920(b)(1)(B).
---------------------------------------------------------------------------

    The statutory exemptions for small issuers, government-administered 
payment cards, and certain reloadable prepaid cards under EFTA Section 
920 apply only to the restrictions on interchange transaction fees in 
EFTA Section 920(a). See proposed Sec.  235.5, discussed above. Thus, 
these exemptions do not apply to the limitations on payment card 
network restrictions under EFTA Section 920(b), including the 
prohibitions on network exclusivity arrangements and merchant routing 
restrictions implemented in proposed Sec.  235.7. See proposed comment 
7-1.

A. Sec. 235.7(a) Prohibition on Network Exclusivity

    EFTA Section 920(b)(1)(A) directs the Board to prescribe rules 
prohibiting an issuer or a payment card network from directly or 
indirectly restricting, through any agent, processor, or licensed 
member of a payment card network, the number of payment card networks 
on which an electronic debit transaction may be processed to fewer than 
two unaffiliated payment card networks. Proposed Sec.  235.7(a) 
implements the new requirement.
    In recent years, payment card networks have increasingly offered 
issuers financial incentives in exchange for committing a substantial 
portion of their debit card transaction volume to the network. For 
example, some issuers may agree to shift some or all of their debit 
card transaction volume to the network in exchange for higher incentive 
payments (such as volume-based payments or marketing support) or 
volume-based discounts on network fees charged to the issuer. In many 
cases, issuers have agreed to make the payment card network, or 
affiliated networks, the exclusive network(s) associated with the 
issuer's debit cards. For example, some issuers have agreed to restrict 
their cards' signature debit functionality to a single signature debit 
network and PIN debit functionality to the PIN debit network that is 
affiliated with the signature debit network. Certain signature debit 
network rules also prohibit issuers of debit cards carrying the 
signature network brand from offering other signature debit networks or 
certain competing PIN debit networks on the same card. See proposed 
comments 7(a)-1 and -2 describing the terms PIN and signature debit.
    Some issuers also negotiate or enroll in ``exclusivity 
arrangements'' with payment card networks for other business purposes. 
For example, an issuer may want to shift a substantial portion or all 
of its debit card volume to a particular network to reduce core 
processing costs through economies of scale; to control fraud and 
enhance data security by limiting the points for potential compromise; 
or to eliminate or reduce the membership and compliance costs 
associated with connecting to multiple networks.
    From the merchant perspective, the availability of multiple card 
networks on a debit card is attractive because it gives merchants the 
flexibility to route transactions over the network that will result in 
the lowest cost to the merchant. This flexibility may promote direct 
price competition among the debit card networks that are enabled on the 
debit card. Thus, debit card network exclusivity arrangements limit 
merchants' ability to route transactions over lower-cost networks and 
may reduce price competition.
    From the cardholder perspective, however, requiring multiple 
payment card networks could have adverse effects. In particular, such a 
requirement could limit the cardholder's ability to obtain certain card 
benefits. For example, a cardholder may receive zero liability 
protection or enhanced chargeback rights only if a transaction is 
carried over a specific card network. Similarly, insurance benefits for 
certain types of transactions or purchases or the

[[Page 81749]]

ability to receive text alerts regarding possible fraudulent activity 
may be tied to the use of a specific network.\92\ Requiring multiple 
unaffiliated payment card networks, coupled with a merchant's ability 
to route electronic debit transactions over any of the networks, could 
reduce the ability of a cardholder to control, and perhaps even to 
know, over which network a transaction would be routed. Consequently, 
such a requirement could reduce the likelihood that the cardholder 
would be able to obtain benefits that are specific to a particular card 
network. Moreover, it may be challenging for issuers or networks to 
explain to the cardholders that they will receive certain benefits only 
if a merchant chooses to route their transaction over that particular 
network.
---------------------------------------------------------------------------

    \92\ These benefits are often provided for transactions routed 
over signature debit networks; they are less commonly available for 
PIN-debit transactions.
---------------------------------------------------------------------------

    In the proposed rule, the Board requests comment on two alternative 
approaches for implementing the restrictions on debit card network 
exclusivity. The first alternative (Alternative A) would require a 
debit card to have at least two unaffiliated payment card networks 
available for processing an electronic debit transaction. Under this 
alternative, an issuer could comply, for example, by having one payment 
card network available for signature debit transactions and a second, 
unaffiliated payment card network available for PIN debit transactions. 
The second alternative (Alternative B) would require a debit card to 
have at least two unaffiliated payment card networks available for 
processing an electronic debit transaction for each method of 
authorization available to the cardholder. For example, a debit card 
that can be used for both signature and PIN debit transactions would be 
required to offer at least two unaffiliated signature debit payment 
card networks and at least two unaffiliated PIN debit payment card 
networks.
Alternative A
    EFTA Section 920(b)(1)(A) provides that an issuer and payment card 
network do not violate the prohibition against network exclusivity 
arrangements as long as the number of payment card networks on which an 
electronic debit transaction may be processed is not limited to less 
than two unaffiliated payment card networks. Nothing in EFTA Section 
920(b)(1)(A) specifically requires that there must be two unaffiliated 
payment card networks available to the merchant once the method of 
debit card authorization has been determined. In other words, the 
statute does not expressly require issuers to offer multiple 
unaffiliated signature and multiple unaffiliated PIN debit card network 
choices on each card.
    In addition, requiring multiple unaffiliated payment card networks 
on a debit card for each method of card authorization could potentially 
limit the development and innovation of new authorization methods. 
Although PIN and signature are the primary methods of debit card 
transaction authorization today, new authentication measures involving 
biometrics or other technologies may, in the future, be more effective 
in reducing fraud. However, an issuer may be unable to implement these 
new methods of card authorization if the rule requires that such 
transactions be capable of being processed on multiple unaffiliated 
networks. Moreover, the Board understands that enabling the ability to 
process a debit card transaction over multiple signature debit networks 
may not be feasible in the near term. Specifically, enabling multiple 
signature debit networks on a debit card could require the replacement 
or reprogramming of millions of merchant terminals as well as 
substantial changes to software and hardware for networks, issuers, 
acquirers, and processors in order to build the necessary systems 
capability to support multiple signature debit networks for a 
particular debit card transaction.
    Finally, the Board recognizes that small debit card issuers could 
be disproportionately affected by a requirement to have multiple 
networks for each method of debit card authorization. See proposed 
comment 7(a)-7, discussed below. Alternative A would minimize the 
overall compliance costs for these issuers.
    For these reasons, Alternative A would provide that the network 
exclusivity prohibition could be satisfied as long as an electronic 
debit transaction may be processed on at least two unaffiliated payment 
card networks. See Sec.  235.7(a)(1) (Alternative A). Proposed comment 
7(a)-3 under Alternative A clarifies that Alternative A does not 
require an issuer to have multiple, unaffiliated networks available for 
each method of cardholder authorization. Under Alternative A, it would 
be sufficient, for example, for an issuer to issue a debit card that 
operates on one signature-based card network and on one PIN-based card 
network, as long as the two card networks are not affiliated. 
Alternatively, an issuer could issue a debit card that operates on two 
or more unaffiliated signature-based card networks, but is not enabled 
for PIN debit transactions, or that operates on two or more 
unaffiliated PIN-based card networks, but is not enabled for signature 
debit transactions.
Alternative B
    The Board also recognizes that the effectiveness of the rule 
promoting network competition could be limited in some circumstances if 
an issuer can satisfy the requirement simply by having one payment card 
network for signature debit transactions and a second unaffiliated 
payment card network for PIN debit transactions. In particular, the 
Board understands that only about 2 million of the 8 million merchant 
locations in the United States that accept debit cards have the 
capability to accept PIN debit transactions. Thus, in those locations 
that accept only signature debit, potentially under Alternative A only 
a single payment card network would be available to process electronic 
debit transactions.
    In addition, PIN debit functionality generally is not available in 
certain merchant categories or for certain types of transactions. For 
example, the Board understands that PIN debit typically cannot be used 
for hotel stays or car rentals for which a merchant obtains an 
authorization for an estimated transaction amount, but the actual 
transaction amount is not known until later, when the cardholder checks 
out of the hotel or returns the rental car. Because PIN debit 
transactions are single-message transactions that combine the 
authorization and clearing instructions, the Board understands that it 
is currently not feasible to use PIN debit in circumstances where the 
final transaction amount differs from the authorized transaction 
amount. PIN debit is also not currently available for Internet purchase 
transactions in most cases. Thus, for these transaction types, the 
unavailability of PIN debit as an alternative method of authorization 
effectively means that only a single card network would be available to 
process an electronic debit transaction if Alternative A is adopted in 
the final rule.
    Finally, the Board notes that Alternative A could limit the 
effectiveness of the separate prohibition on merchant routing 
restrictions under new EFTA Section 920(b)(1)(B), discussed below, if 
an issuer elected to enable only one signature debit network and one 
unaffiliated PIN network on a particular debit card. This is because 
once the cardholder has authorized the

[[Page 81750]]

transaction using either a signature or PIN entry, the merchant would 
have only a single network available for routing the transaction.
    Under Alternative B, an issuer or payment card network would be 
prohibited from directly or indirectly restricting the number of 
payment card networks on which an electronic debit transaction may be 
processed to less than two unaffiliated networks ``for each method of 
authorization that may be used by the cardholder.'' This means that an 
issuer would not comply with the proposed rule for a signature and PIN-
enabled debit card unless there were at least two unaffiliated 
signature debit networks and at least two unaffiliated PIN debit 
networks enabled on the card.
    Proposed comment 7(a)-3 under Alternative B clarifies that under 
this alternative, each electronic debit transaction, regardless of the 
method of authorization, must be able to be processed on at least two 
unaffiliated payment card networks. For example, if a cardholder 
authorizes an electronic debit transaction using a signature, that 
transaction must be capable of being processed on at least two 
unaffiliated signature-based payment card networks. Similarly, if a 
cardholder authorizes an electronic debit transaction using a PIN, that 
transaction must be capable of being processed on at least two 
unaffiliated PIN-based payment card networks. This comment would also 
clarify that the use of contactless or radio-frequency identification 
(RFID) technology would not constitute a separate method of 
authorization as the Board understands that such transactions are 
generally processed over either a signature debit network or a PIN 
debit network.
    The Board requests comment on both proposed alternatives for 
implementing the prohibition on network exclusivity arrangements under 
EFTA Section 920(b)(1)(A). Comment is requested on the cost and 
benefits of each alternative, including for issuers, merchants, 
cardholders, and the payments system overall. In particular, the Board 
requests comment on the cost of requiring multiple payment card 
networks for signature-based debit card transactions, and the time 
frame necessary to implement such a requirement.
    Proposed Sec.  235.7(a)(2) describes three circumstances in which 
an issuer or payment card network would not satisfy the general 
requirement to have at least two unaffiliated payment networks on which 
an electronic debit transaction may be processed, regardless of which 
of the alternatives is adopted.
    First, proposed Sec.  235.7(a)(2)(i) addresses payment card 
networks that operate in a limited geographic acceptance area. 
Specifically, the proposed rule provides that adding an unaffiliated 
payment card network that is not accepted throughout the United States 
would not satisfy the requirement to have at least two unaffiliated 
payment card networks enabled on a debit card. For example, an issuer 
could not comply with the network exclusivity provision by having a 
second unaffiliated payment card network that is accepted in only a 
limited geographic region of the country. However, an issuer would be 
in compliance with proposed Sec.  235.7(a)(1) if, for example, the 
debit card operates on one national network and multiple geographically 
limited networks that are unaffiliated with the first network and that, 
taken together, provide nationwide coverage. Proposed comment 7(a)-4.i 
provides an example to illustrate the provision regarding limited 
geographic acceptance networks. The proposed comment also clarifies 
that a payment card network is considered to have sufficient geographic 
reach even though there may be limited areas in the United States that 
it does not serve. For example, a national network that has no merchant 
acceptance in Guam or American Samoa may nonetheless meet the 
geographic reach requirement.
    The Board requests comment on the impact of the proposed approach 
to networks with limited geographic acceptance on the viability of 
regional payment card networks, and whether other approaches may be 
appropriate, including, but not limited to, requiring that a particular 
debit card be accepted on at least two unaffiliated payment card 
networks (under either alternative) in States where cardholders 
generally use the card. If the Board permitted a regional network by 
itself to satisfy the requirement, what standard should be used for 
determining whether that network provides sufficient coverage for the 
issuer's cardholders' transactions? The Board also requests comment on 
the potential impact, and particularly the cost impact, on small 
issuers from adding multiple payment card networks in order to ensure 
that a debit card is accepted on a nationwide basis on at least two 
unaffiliated payment card networks.
    Second, proposed Sec.  235.7(a)(2)(ii) provides that adding an 
unaffiliated payment card network that is accepted only at a limited 
number of merchant locations or for limited merchant types or 
transaction types would not comply with the requirement to have at 
least two unaffiliated payment card networks on a debit card. For 
example, an issuer could not solely add as an unaffiliated payment card 
network, a network that is only accepted at a limited category of 
merchants (for example, at a particular supermarket chain or at 
merchants located in a particular shopping mall). See proposed comment 
7(a)-4.ii. The Board requests comment on whether additional guidance 
regarding networks that have limited merchant acceptance is necessary.
    Third, the proposed rule would prohibit a payment card network from 
restricting or otherwise limiting an issuer's ability to contract with 
any other payment card network that may process an electronic debit 
transaction involving the issuer's debit cards. See proposed Sec.  
235.7(a)(2)(iii). Proposed comment 7(a)-5 provides examples of 
prohibited restrictions on an issuer's ability to contract with other 
payment card networks. For example, a payment card network would be 
prohibited from limiting or otherwise restricting, by rule, contract, 
or otherwise, the other payment card networks that may be enabled on a 
particular debit card, such as by expressly prohibiting an issuer from 
offering certain specified payment card networks on the debit card or 
by limiting the payment card networks that may be offered on a card to 
specified networks. See proposed comment 7(a)-5.i.
    Proposed Sec.  235.7(a)(2)(iii) would also prohibit network rules 
or guidelines that allow only that network's (or its affiliated 
network's) brand, mark, or logo to be displayed on a particular debit 
card, or that otherwise limit the number or location of network brands, 
marks, or logos that may appear on the debit card. See proposed comment 
7(a)-5.ii. Such rules or guidelines may inhibit an issuer's ability to 
add other payment card networks to a debit card, particularly if the 
other networks also require that their brand, mark, or logo appear on a 
debit card in order for a card to be offered on that network.
    Proposed comment 7(a)-6 provides, however, that nothing in the rule 
requires that a debit card identify the brand, mark, or logo of each 
payment card network over which an electronic debit transaction may be 
processed. For example, a debit card that operates on two or more 
different unaffiliated payment card networks need not bear the brand, 
mark, or logo for each card network. The Board believes that this 
flexibility is necessary to facilitate an issuer's ability to add (or 
remove) payment card networks to a debit card without being required to 
incur the additional costs associated with the

[[Page 81751]]

reissuance of debit cards as networks are added (or removed).
    Proposed Sec.  235.7(a) does not expressly prohibit debit card 
issuers from committing to a certain volume, percentage share, or 
dollar amount of transactions to be processed over a particular 
network. However, these volume, percentage share, or dollar amount 
commitments could only be given effect through issuer or payment card 
network priorities that direct how a particular debit card transaction 
should be routed by a merchant. As discussed below under proposed Sec.  
235.7(b), these issuer or payment card network routing priorities would 
be prohibited by the proposed limitations on merchant routing 
restrictions. The Board requests comment on whether it is necessary to 
address volume, percentage share, or dollar amount requirements in the 
exclusivity provisions, and whether other types of arrangements should 
be addressed under the rule.
    Proposed comment 7(a)-7 clarifies that the requirements of Sec.  
235.7(a) apply equally to voluntary arrangements in which a debit card 
issuer participates exclusively in a single payment card network or 
affiliated group of payment card networks by choice, rather than due to 
a specific network rule or contractual commitment. For example, 
although an issuer may prefer to offer a single payment card network 
(or the network's affiliates) on its debit cards to reduce its 
processing costs or for operational simplicity, the statute's 
exclusivity provisions do not allow that. Thus, the proposed comment 
clarifies that all issuers must issue cards enabled with at least two 
unaffiliated payment card networks, even if the issuer is not subject 
to any rule of, or contract, arrangement, or any other agreement with, 
a payment card network requiring that all or a specified minimum 
percentage of electronic debit transactions be processed on the network 
or its affiliated networks.
    Proposed comment 7(a)-8 clarifies that the network exclusivity rule 
does not prevent an issuer from including an affiliated payment card 
network among the networks that may process an electronic debit 
transaction for a particular debit card, as long as at least two of the 
networks that accept the card are unaffiliated. The proposed comment 
under Alternative A clarifies that an issuer is permitted to offer 
debit cards that operate on both a signature debit network as well as 
an affiliated PIN debit network, as long as at least one other payment 
card network that is unaffiliated with either the signature or PIN 
debit networks also accepts the card. The Board is also proposing a 
corresponding comment that would apply to Alternative B.
    Proposed Sec.  235.7(a)(3) addresses circumstances where previously 
unaffiliated payment card networks subsequently become affiliated as a 
result of a merger or acquisition. Under these circumstances, an issuer 
that issues cards with only the two previously unaffiliated networks 
enabled would no longer comply with Sec.  235.7(a)(1) until the issuer 
is able to add an additional unaffiliated payment card network to the 
debit card. The proposed rule requires issuers in these circumstances 
to add an additional unaffiliated debit card network no later than 90 
days after the date on which the prior unaffiliated payment card 
networks become affiliated. The Board requests comment on whether 90 
days provides sufficient time for issuers to negotiate new agreements 
and add connectivity with the additional networks in order to comply 
with the rule.
Additional Requests for Comment
    The Board understands that some institutions may wish to issue a 
card, or other payment code or device, that meets the proposed 
definition of ``debit card,'' but that may be capable of being 
processed using only a single authorization method. For example, a key 
fob or mobile phone embedded with a contactless chip may be able to be 
processed only as a signature debit transaction or only on certain 
networks. Under the proposed rule (under either alternative), the 
issuer would be required to add at least a second unaffiliated 
signature debit network to the device to comply with the requirements 
of Sec.  235.7(a). The Board requests comment on whether this could 
inhibit the development of these devices in the future and what steps, 
if any, the Board should take to avoid any such impediments to 
innovation.
    As noted above under proposed comment 7-1, the statutory exemptions 
for small issuers, government-administered payment cards, and certain 
reloadable prepaid cards do not apply to the limitations on payment 
card network restrictions under EFTA Section 920(b). Thus, for example, 
government-administered payment cards and reloadable prepaid cards, 
including health care and other employee benefit cards, would be 
subject to the prohibition on the use of exclusive networks under EFTA 
Section 920(b)(1). The Board understands that in many cases, issuers do 
not permit PIN functionality on prepaid cards in order to prevent cash 
access in response to potential money laundering or other regulatory 
concerns. In addition, in the case of debit cards issued in connection 
with health flexible spending accounts and health reimbursement 
accounts, Internal Revenue Service (IRS) rules require the use of 
certain sophisticated technology at the point-of-sale to ensure that 
the eligibility of a medical expense claim can be substantiated at the 
time of the transaction. However, PIN-debit networks may not currently 
offer the functionality or capability to support the required 
technology. Thus, applying the network exclusivity prohibition to these 
health benefit cards in particular could require an issuer or plan 
administrator to add a second signature debit network to comply with 
IRS regulations if PIN networks do not add the necessary functionality 
to comply with those regulations. The Board requests comment on any 
alternatives, consistent with EFTA Section 920, that could minimize the 
impact of the proposed requirements on these prepaid products.

B. Sec. 235.7(b) Prohibition on Merchant Routing Restrictions

    EFTA Section 920(b)(1)(B) requires the Board to prescribe rules 
prohibiting an issuer or payment card network from directly or 
indirectly ``inhibit[ing] the ability of any person that accepts debit 
cards for payments to direct the routing of electronic debit 
transactions for processing over any payment card network that may 
process such transactions.'' The Board is proposing to implement this 
restriction in Sec.  235.7(b). Specifically, proposed Sec.  235.7(b) 
would prohibit both issuers and payment card networks from inhibiting, 
directly, or through any agent, processor, or licensed member of the 
network, by contract, requirement, condition, penalty, or otherwise, a 
merchant's ability to route electronic debit transactions over any 
payment card network that may process such transactions.
    In practice, this means that merchants, not issuers or networks, 
must be able to designate preferences for the routing of transactions, 
and that the merchant's preference must take priority over the issuer's 
or network's preference. The rules of certain PIN debit payment card 
networks today require merchants to route PIN debit transactions based 
on the card issuer's designated preferences. This is the case even 
where multiple PIN debit networks are available to process a particular 
debit card transaction. In other cases, the PIN debit network itself 
may require, by rule or contract, that the particular PIN debit 
transaction be

[[Page 81752]]

routed over that network when there are multiple PIN networks 
available.\93\ Such rules or requirements prevent merchants from 
applying their own preferences with respect to routing the particular 
debit card transaction to the PIN debit network that will result in the 
lowest cost to the merchant. Neither of these practices would be 
permitted under the proposed rule.
---------------------------------------------------------------------------

    \93\ These issuer- or network-directed priority rules are 
generally unnecessary for signature debit networks as there is only 
a single payment card network available for processing a signature 
debit transaction.
---------------------------------------------------------------------------

    The Board does not interpret EFTA Section 920(b)(1)(B) to grant a 
person that accepts debit cards the ability to process an electronic 
debit transaction over any payment card network of the person's 
choosing. Rather, the Board interprets the phrase ``any payment card 
network that may process such transactions'' to mean that a merchant's 
choice is limited to the payment card networks that have been enabled 
on a particular debit card. Moreover, allowing merchants to route 
transactions over any network, regardless of the networks enabled on 
the debit card, would render superfluous the requirement to have at 
least two unaffiliated payment cards enabled on a particular debit 
card. Accordingly, proposed comment 7(b)-1 clarifies that the 
prohibition on merchant routing restrictions applies solely to the 
payment card networks on which an electronic debit transaction may be 
processed with respect to a particular debit card.
    Proposed comment 7(b)-2 provides examples of issuer or payment card 
network practices that would inhibit a merchant's ability to direct the 
routing of an electronic debit transaction in violation of Sec.  
235.7(b). Although routing generally refers to sending the transaction 
information to the issuer, the Board notes that the statute broadly 
directs the Board to prescribe the rules that prohibit issuer or 
payment card network practices that ``inhibit'' a person's ability to 
direct the routing of the transaction. Accordingly, the Board believes 
it is appropriate also to address certain practices that may affect the 
network choices available to the merchant at the time the transaction 
is processed.
    The first example addresses issuer or card network rules or 
requirements that prohibit a merchant from ``steering,'' or encouraging 
or discouraging, a cardholder's use of a particular method of debit 
card authorization. For example, merchants may want to encourage 
cardholders to authorize a debit card transaction by entering their 
PIN, rather than by providing a signature, if PIN debit carries a lower 
interchange rate than signature debit. Under proposed Sec.  235.7(b) 
and comment 7(b)-2.i, merchants may not be inhibited from encouraging 
the use of PIN debit by, for example, setting PIN debit as a default 
payment method or blocking the use of signature debit altogether.
    The second example of a prohibited routing restriction is network 
rules or issuer designated priorities that direct the processing of an 
electronic debit transaction over a specified payment card network or 
its affiliated networks. See proposed comment 7(b)-2.ii. Thus, for 
example, if multiple networks are available to process a particular 
debit transaction, neither the issuer nor the networks could specify 
the network over which a merchant would be required to route the 
transaction. Nothing in proposed comment 7(b)-2.ii, however, is 
intended to prevent an issuer or payment card network from designating 
a default network for routing an electronic debit transaction in the 
event a merchant or its acquirer or processor does not indicate a 
routing preference. In addition, proposed comment 7(b)-2.ii does not 
prohibit an issuer or payment card network from directing that an 
electronic debit transaction be processed over a particular network if 
required to do so by state law. See, e.g., Iowa Code Sec. 527.5.
    As noted above, if issuer- or network-directed priorities are 
prohibited, issuers will, as a practical matter, be unable to guarantee 
or otherwise agree to commit a specified volume, percentage share, or 
dollar amount of debit card transactions to a particular debit card 
network. Accordingly, the Board believes it is unnecessary to 
separately address volume, percentage share, or dollar amount 
commitments of debit card transactions as prohibited forms of network 
exclusivity arrangements under proposed Sec.  235.7(a).
    Under the third example, a payment card network could not require a 
particular method of debit card authorization based on the type of 
access device provided by the cardholder. See proposed comment 7(b)-
2.iii. For example, a payment card network would be prohibited from 
requiring that an electronic debit transaction that is initiated using 
``contactless'' or radio frequency identification device (RFID) 
technology may only be processed over a signature debit network. The 
Board requests comment on whether there are other circumstances that 
the commentary should include as examples of prohibited routing 
restrictions.
    Although proposed Sec.  235.7 provides merchants control over how 
an electronic debit transaction is routed to the issuer, the proposed 
rule does not impose a requirement that a merchant be able to select 
the payment card network over which to route or direct a particular 
electronic debit transaction in real time, that is, at the time of the 
transaction. The Board believes that requiring real-time merchant 
routing decision-making could be operationally infeasible and cost-
prohibitive in the short term as it would require systematic 
programming changes and equipment upgrades. Today, for example, 
transaction routing is relatively straightforward once the cardholder 
has chosen to authorize a debit card transaction using his or her PIN. 
Once the PIN is entered, card information for the transaction is 
transmitted to the merchant's acquirer or processor and the transaction 
is then generally routed over a pre-determined network based upon 
issuer or payment network routing priorities for that card. Under 
proposed Sec.  235.7(b), however, issuer and network routing priorities 
would no longer be permitted, except under limited circumstances. See 
proposed comment 7(b)-2.ii, discussed above. Instead, merchants would 
be free to make the routing decision. Although merchant-directed 
routing tables administered by the acquirer or processor could be 
somewhat more complex than issuer-directed routing tables given the 
larger number of merchants, such a system could still be administered 
in the straightforward manner they are administered today with the 
routing decisions determined in advance for a particular merchant. 
Accordingly, proposed comment 7(b)-3 provides that it is sufficient for 
a merchant and its acquirer or processor to agree to a pre-determined 
set of routing choices that apply to all electronic debit transactions 
that are processed by the acquirer on behalf of the merchant.

C. Effective Date

    Although EFTA Section 920 requires that the restrictions on the 
amount of interchange transaction fees become effective on July 21, 
2011, the statute does not specify an effective date for the separate 
provisions on network exclusivity and merchant routing restrictions. As 
discussed above, the new provisions provide that at least two 
unaffiliated payment card networks must be available for processing any 
electronic debit transaction, and prohibit issuers and payment card

[[Page 81753]]

networks from inhibiting merchants from directing how electronic debit 
transactions may be routed based upon the available choices. In order 
to implement these new requirements, certain system changes will be 
required. For example, before a debit card may be enabled for an 
additional payment card network, connectivity will have to be 
established with the new network and internal processing systems 
upgraded to support that network. In some cases, new cards may have to 
be issued to cardholders. Acquirers and processors will have to be 
notified of the new network assignments for each debit card program and 
their routing tables updated for each issuer and card program. Payment 
card networks will have to ensure that they have sufficient processing 
capacity to support any necessary changes.
    If Alternative B is adopted in the final rule and multiple 
signature debit networks are required for each debit card, the Board 
anticipates that significantly more time will be needed to enable 
issuers and networks to comply with the rule. The Board requests 
comment on a potential effective date of October 1, 2011, for the 
provisions under Sec.  235.7 if the Board were to adopt Alternative A 
under the network exclusivity provisions, or alternatively, an 
effective date of January 1, 2013 if Alternative B were adopted in the 
final rule.
    The Board requests comment on all aspects of implementing the 
proposed limitations on network exclusivity and merchant routing 
restrictions under Sec.  235.7, including the specific changes that 
will be required and the entities affected. The Board also requests 
comment on other, less burdensome alternatives that may be available to 
carry out the proposed restrictions under Sec.  235.7 to reduce the 
necessary cost and implementation time period.
Sec. 235.8 Reporting Requirements
    Section 920 authorizes the Board to collect from issuers and 
payment card networks information that is necessary to carry out the 
provisions of this section and requires the Board to publish, if 
appropriate, summary information about costs and interchange 
transaction fees every two years. Summary information from information 
collections conducted prior to this proposed rulemaking is discussed 
above. The Board anticipates using forms derived from the Interchange 
Transaction Fee Surveys (FR 3062; OMB No. 7100), but with a narrower 
scope, for purposes of these proposed reporting requirements.\94\ At 
this time, however, the Board is not publishing specific forms for 
comment. The Board does not anticipate requiring the first report to be 
submitted before March 31, 2012. Prior to that time, the Board will 
provide an opportunity for comment on the specific reporting forms and 
reporting burden. The Board, however, is seeking comment on the 
reporting requirements as laid out generally in proposed Sec.  235.8.
---------------------------------------------------------------------------

    \94\ Copies of the survey forms are available on the Board's Web 
site at http://www.federalreserve.gov/newsevents/reform_meetings.htm.
---------------------------------------------------------------------------

    Consistent with the statutory information collection authority, the 
Board proposes to require issuers that are subject to Sec. Sec.  235.3 
and 235.4 and payment card networks to submit reports to the Board. 
Each entity required to submit a report would submit the form 
prescribed by the Board. The forms would request information regarding 
costs incurred with respect to electronic debit transactions, 
interchange transaction fees, network fees, and fraud-prevention costs. 
Similar to the surveys conducted in connection with this proposed 
rulemaking, the Board may publish summary or aggregate information.
    The Board proposes that each entity would be required to report 
biennially, consistent with the Board's statutory publication 
requirement. The Board anticipates that circumstances may develop that 
require more frequent reporting. Accordingly, under proposed Sec.  
235.8(c), the Board reserves the discretion to require more frequent 
reporting.
    For the years an entity is required to report, the Board proposes 
that such entity must submit the report to the Board by March 31 of 
that year. The Board believes that permitting three months following 
the end of the calendar-year reporting period provides a reasonable 
time to determine the costs that need to be reported and complete the 
report. The Board is requesting comment on whether the three-month time 
frame is appropriate.
    Proposed Sec.  235.8(e) would require entities that are required to 
report under this section to retain records of reports submitted to the 
Board for five years. Further, such entities would be required to make 
each report available upon request to the Board or the entity's primary 
supervisors. The Board believes that the record retention requirement 
will facilitate administrative enforcement.
Sec. 235.9 Administrative Enforcement
    The interchange transaction fee requirements and the network 
exclusivity and routing rules are enforced under EFTA Section 918 (15 
U.S.C. 1693o), which sets forth the administrative agencies that 
enforce the requirements of the EFTA. Unlike other provisions in the 
EFTA, the requirements of Section 920 are not subject to EFTA Section 
916 (civil liability) and Section 917 (criminal liability). Further, 
the Dodd-Frank Act amends the current administrative enforcement 
provision of the EFTA. Therefore, proposed Sec.  235.9 sets forth the 
administrative enforcement agencies under EFTA Section 918 as amended 
by the Dodd-Frank Act.
Form of Comment Letters
    Comment letters should refer to Docket No. R-1404 and, when 
possible, should use a standard typeface with a font size of 10 or 12; 
this will enable the Board to convert text submitted in paper form to 
machine-readable form through electronic scanning, and will facilitate 
automated retrieval of comments for review. Comments may be mailed 
electronically to [email protected].
Solicitation of Comments Regarding Use of ``Plain Language''
    Section 772 of the Gramm-Leach-Bliley Act of 1999 (12 U.S.C. 4809) 
requires the Board to use ``plain language'' in all proposed and final 
rules published after January 1, 2000. The Board invites comment on 
whether the proposed rule is clearly stated and effectively organized, 
and how the Board might make the text of the rule easier to understand.
Paperwork Reduction Act
    In accordance with the Paperwork Reduction Act (PRA) of 1995 (44 
U.S.C. 3506; 5 CFR part 1320 Appendix A.1), the Board reviewed this 
proposed rule under the authority delegated to the Board by the Office 
of Management and Budget. The Board will conduct an analysis under the 
Paperwork Reduction Act and seek public comment when it develops 
surveys to obtain information under Sec.  235.8. Any additional burden 
associated with the reporting requirement in proposed Sec.  235.3(d) 
(under Alternative 1) for issuers that wish to receive an interchange 
fee in excess of the safe harbor is considered negligible. Thus no new 
collections of information pursuant to the PRA are contained in the 
proposed rule.

[[Page 81754]]

Regulatory Flexibility Act
    In accordance with Section 3(a) of the Regulatory Flexibility Act, 
5 U.S.C. 601 et. seq. (RFA), the Board is publishing an initial 
regulatory flexibility analysis for the proposed new Regulation II 
(Debit Card Interchange Fees and Routing). The RFA requires an agency 
to provide an initial regulatory flexibility analysis with the proposed 
rule or to certify that the proposed rule will not have a significant 
economic impact on a substantial number of small entities. The Board 
welcomes comment on all aspects of the initial regulatory flexibility 
analysis. A final regulatory flexibility analysis will be conducted 
after consideration of comments received during the public comment 
period.
    1. Statement of the objectives of the proposal. As required by 
Section 920 of the EFTA (15 U.S.C. 1693r), the Board is proposing new 
Regulation II to establish standards for assessing whether an 
interchange transaction fee received or charged by an issuer (and 
charged to the merchant or acquirer) is reasonable and proportional to 
the cost incurred by the issuer with respect to the transaction. 
Additionally, proposed new Regulation II prohibits issuers and payment 
card networks from both restricting the number of payment card networks 
over which an electronic debit transaction may be processed and 
inhibiting the ability of a merchant to direct the routing of an 
electronic debit transaction over a particular payment card network.
    2. Small entities affected by the proposal. This proposal may have 
an effect predominantly on two types of small entities--financial 
institutions that either issue debit cards or acquire transactions from 
merchants and the merchants themselves. A financial institution 
generally is considered small if it has assets of $175 million or 
less.\95\ Based on 2010 Call Report data, approximately 11,000 
depository institutions had total domestic assets of $175 million or 
less. Of this number, however, it is unknown how many of these 
institutions issue debit cards. Whether a merchant is a small entity is 
determined by the asset size or the number of employees.\96\ Of the 8 
million merchant locations that accept debit cards, the number of 
merchants that are considered small entities is unknown.
---------------------------------------------------------------------------

    \95\ U.S. Small Business Administration, Table of Small Business 
Size Standards Matched to North American Industry Classification 
System Codes, available at http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_sstd_tablepdf.pdf.
    \96\ Id.
---------------------------------------------------------------------------

    3. Compliance requirements. With respect to the limitations on 
interchange transaction fees, the Board's proposed rule does not affect 
most such entities directly.\97\ In accordance with Section 920 of the 
EFTA, the Board's proposed rule exempts from the limitations on 
interchange transaction fees all issuers that, together with 
affiliates, have assets of less than $10 billion. The Board's proposed 
rule does not require payment card networks to distinguish between 
issuers with assets of more than $10 billion and smaller issuers. If a 
payment card network decides to distinguish between large and small 
issuers, a payment card network may require a smaller issuer to submit 
information to it. The proposed rule, however, does not impose 
reporting requirements on smaller issuers. As discussed in other 
sections of the preamble, the proposed interchange transaction fee 
standards are expected to reduce the amount of interchange transaction 
fees charged to merchants and acquirers. Accordingly, the Board expects 
any economic impact on small merchants and acquirers to be positive.
---------------------------------------------------------------------------

    \97\ There may be some small financial institutions that have 
very large affiliates such that the institution does not qualify for 
the small issuer exemption.
---------------------------------------------------------------------------

    The proposed rule prohibiting network exclusivity arrangements may 
affect small financial institutions that issue debit cards if such 
institutions do not currently comply with the Board's proposed 
standards. Under one alternative, a small issuer, like other issuers, 
would be required to have at least two unaffiliated payment card 
networks on each debit card it issues. If the issuer does not do so 
already, it would be required to add an additional network. This 
process may require making a decision as to which additional network to 
put on a card, establishing a connection to the new network, or 
updating internal processes and procedures. Under the second 
alternative, a small issuer, like all issuers, would be required to 
issue debit cards with at least two unaffiliated networks for each 
method of authorization a cardholder could select. The actions that may 
be necessary to add additional networks under the second alternative 
are the same as those under the first alternative. An issuer, however, 
would incur greater costs as the number of networks it adds increases. 
In contrast, like all merchants that accept debit cards, smaller 
merchants will be provided with greater routing choice. Therefore, the 
smaller merchants will be able to route electronic debit transactions 
over the lowest-cost path. Accordingly, the Board expects any economic 
impact on merchants to be positive.
    4. Other Federal rules. The Board believes that no Federal rules 
duplicate, overlap, or conflict with proposed Regulation II.
    5. Significant alternatives to the proposed rule. As discussed 
above, the Board has requested comment on the impact of the network 
exclusivity and routing alternatives (the provisions of the proposal 
that apply to small issuers) on small entities and has solicited 
comment on any approaches, other than the proposed alternatives, that 
would reduce the burden on all entities, including small issuers. The 
Board welcomes comment on any significant alternatives that would 
minimize the impact of the proposal on small entities.

List of Subjects in 12 CFR Part 235

    Electronic debit transactions, interchange transaction fees, and 
debit card routing.

Authority and Issuance

    For the reasons set forth in the preamble, the Board is proposing 
to add new 12 CFR part 235 to read as follows:

PART 235--DEBIT CARD INTERCHANGE FEES AND ROUTING

Sec.
235.1 Authority and purpose.
235.2 Definitions.
235.3 Reasonable and proportional interchange transaction fees.
235.4 [Reserved]
235.5 Exemptions.
235.6 Prohibition on circumvention or evasion.
235.7 Limitations on payment card restrictions.
235.8 Reporting requirements.
235.9 Administrative enforcement.

Appendix A--Official Board Commentary on Regulation II

    Authority:  15 U.S.C. 1693r.


Sec.  235.1  Authority and purpose.

    (a) Authority. This part is issued by the Board of Governors of the 
Federal Reserve System (Board) under section 920 of the Electronic Fund 
Transfer Act (EFTA) (15 U.S.C. 1693r, as added by section 1075 of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 
111-203, 124 Stat. 1376 (2010)).
    (b) Purpose. This part implements the provisions of section 920 of 
the EFTA, 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,

[[Page 81755]]

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.


Sec.  235.2  Definitions.

    (a) Account means 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.
    (b) Acquirer means 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. An acquirer does not 
include an institution that acts only as a processor for the services 
it provides to the merchant.
    (c) Affiliate means any company that controls, is controlled by, or 
is under common control with another company.
    (d) Cardholder means the person to whom a debit card is issued.
    (e) Control of a company means--
    (1) Ownership, control, or power to vote 25 percent or more of the 
outstanding shares of any class of voting security of the company, 
directly or indirectly, or acting through one or more other persons;
    (2) Control in any manner over the election of a majority of the 
directors, trustees, or general partners (or individuals exercising 
similar functions) of the company; or
    (3) The power to exercise, directly or indirectly, a controlling 
influence over the management or policies of the company, as the Board 
determines.
    (f) Debit card. (1) Means 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, and
    (2) Includes any general-use prepaid card.
    (3) The term ``debit card'' does not include--
    (i) Any card, or other payment code or device, that is redeemable 
upon presentation at only a single merchant or an affiliated group of 
merchants for goods or services;
    (ii) A check, draft, or similar paper instrument, or an electronic 
representation thereof; or
    (iii) An account number, when used to initiate an ACH transaction 
to debit a person's account.
    (g) Designated automated teller machine (ATM) network means 
either--
    (1) All automated teller machines identified in the name of the 
issuer; or
    (2) Any network of automated teller machines identified by the 
issuer that provides reasonable and convenient access to the issuer's 
customers.
    (h) Electronic debit transaction means the use of a debit card by a 
person as a form of payment in the United States.
    (i) General-use prepaid card means a card, or other payment code or 
device, that is--
    (1) Issued on a prepaid basis, whether or not that amount may be 
increased or reloaded, in exchange for payment; and
    (2) Redeemable upon presentation at multiple, unaffiliated 
merchants for goods or services, or usable at automated teller 
machines.
    (j) Interchange transaction fee means 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.
    (k) Issuer means any person that issues a debit card.
    (l) Merchant means any person that accepts debit cards as payment 
for goods or services.
    (m) Payment card network means an entity that--
    (1) Directly or indirectly provides the services, infrastructure, 
and software for 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.
    (n) Person means a natural person or an organization, including a 
corporation, government agency, estate, trust, partnership, 
proprietorship, cooperative, or association.
    (o) Processor means a person that processes or routes electronic 
debit transactions for issuers, acquirers, or merchants.
    (p) United States means the States, territories, and possessions of 
the United States, the District of Columbia, the Commonwealth of Puerto 
Rico, or any political subdivision of any of the foregoing.


Sec.  235.3  Reasonable and proportional interchange transaction fees.

    (a) In general. The amount of any interchange transaction fee that 
an issuer may receive or charge with respect to an electronic debit 
transaction shall be reasonable and proportional to the cost incurred 
by the issuer with respect to the electronic debit transaction.
    Alternative 1 (Issuer-Specific Standard With Safe Harbor and Cap):
    (b) Determination of reasonable and proportional fees. Except as 
provided in paragraph (e) of this section, an issuer complies with the 
requirements of paragraph (a) of this section only if, during an 
implementation period of October 1 of any calendar year through 
September 30 of the following calendar year, each interchange 
transaction fee it receives or charges is no more than the greater of--
    (1) Seven cents per transaction; or
    (2) The costs described in paragraph (c) of this section incurred 
by the issuer with respect to electronic debit transactions during the 
calendar year preceding the start of the implementation period, divided 
by the number of electronic debit transactions on which the issuer 
charged or received an interchange transaction fee during that calendar 
year, but no higher than twelve cents per transaction.
    (c) Allowable costs. For purposes of paragraph (b) of this section, 
the costs incurred by an issuer for electronic debit transactions--
    (1) Are only those costs that vary with the number of transactions 
sent to the issuer and that are attributable to--
    (i) Receiving and processing requests for authorization of 
electronic debit transactions;
    (ii) Receiving and processing presentments and representments of 
electronic debit transactions;
    (iii) Initiating, receiving, and processing chargebacks, 
adjustments, and similar transactions with respect to electronic debit 
transactions; and
    (iv) Transmitting or receiving funds for interbank settlement of 
electronic debit transactions; and posting electronic debit 
transactions to cardholder accounts; and
    (2) Do not include fees charged by a payment card network with 
respect to an electronic debit transaction.
    (d) Disclosure to payment card network. If, during an 
implementation period of October 1 of any given calendar year through 
September 30 of the following calendar year, an issuer subject to this 
section will receive or charge an interchange transaction fee in excess 
of seven cents per transaction under paragraph (b)(2) of this section, 
the issuer must report, by March 31 of the same calendar year as the 
start of the implementation period, to each payment card network 
through which its electronic debit transactions may be routed the 
amount of any interchange transaction fee it may receive or charge 
under paragraph (b)(2).
    (e) Transition. From July 21, 2011 through September 30, 2012, an 
issuer complies with the requirements of paragraph (a) of this section 
if any

[[Page 81756]]

interchange transaction fee it receives or charges is no more than the 
greater of--
    (1) Seven cents per transaction; or
    (2) The costs described in subsection (c) of this section incurred 
by the issuer for electronic debit transactions during the 2009 
calendar year, divided by the number of electronic debit transactions 
on which the issuer received or charged an interchange transaction fee 
during the 2009 calendar year, but no higher than twelve cents per 
transaction.
    Alternative 2 (Cap):
    (b) Determination of reasonable and proportional fees. An issuer 
complies with the requirements of paragraph (a) of this section only if 
each interchange transaction fee received or charged by the issuer for 
an electronic debit transaction is no more than twelve cents per 
transaction.


Sec.  235.4  [Reserved]


Sec.  235.5  Exemptions.

    (a) Exemption for small issuers. Sections 235.3, 235.4, and 235.6 
do not apply to an interchange transaction fee received or charged by 
an issuer with respect to an electronic debit transaction if--
    (1) The issuer holds the account that is debited; and
    (2) The issuer, together with its affiliates, has assets of less 
than $10 billion as of the end of the previous calendar year.
    (b) Exemption for government-administered programs. Except as 
provided in paragraph (d) of this section, Sec. Sec.  235.3, 235.4, and 
235.6 do not apply to an interchange transaction fee received or 
charged by an issuer with respect to an electronic debit transaction 
if--
    (1) The electronic debit transaction is made using a debit card 
that has been provided to a person pursuant to a Federal, State, or 
local government-administered payment program; and
    (2) The cardholder may use the debit card only to transfer or debit 
funds, monetary value, or other assets that have been provided pursuant 
to such program.
    (c) Exemption for certain reloadable prepaid cards. (1) In general. 
Except as provided in paragraph (d) of this section, Sec. Sec.  235.3, 
235.4, and 235.6 do not apply to an interchange transaction fee 
received or charged by an issuer with respect to an electronic debit 
transaction if the electronic debit transaction is made using a 
general-use prepaid card that is--
    (i) Not issued or approved for use to access or debit any account 
held by or for the benefit of the cardholder (other than a subaccount 
or other method of recording or tracking funds purchased or loaded on 
the card on a prepaid basis); and
    (ii) Reloadable and not marketed or labeled as a gift card or gift 
certificate.
    (2) Temporary cards. For purposes of this paragraph (c), the term 
``reloadable'' includes a temporary non-reloadable card issued solely 
in connection with a reloadable general-use prepaid card.
    (d) Exception. The exemptions in paragraphs (b) and (c) of this 
section do not apply to any interchange transaction fee received or 
charged by an issuer on or after July 21, 2012 with respect to an 
electronic debit transaction if any of the following fees may be 
charged to a cardholder with respect to the card--
    (1) A fee or charge for an overdraft, including a shortage of funds 
or a transaction processed for an amount exceeding the account balance, 
unless the fee or charge is charged for transferring funds from another 
asset account to cover a shortfall in the account accessed by the card; 
or
    (2) A fee charged by the issuer for the first withdrawal per 
calendar month from an automated teller machine that is part of the 
issuer's designated automated teller machine network.


Sec.  235.6  Prohibition on circumvention or evasion.

    (a) Prohibition on circumvention or evasion. No person shall 
circumvent or evade the interchange transaction fee restrictions in 
Sec. Sec.  235.3 and 235.4. Circumvention or evasion of the interchange 
fee restrictions under Sec. Sec.  235.3 and 235.4 occurs if an issuer 
receives net compensation from a payment card network with respect to 
electronic debit transactions.


Sec.  235.7  Limitations on payment card restrictions.

    (a) Prohibition on network exclusivity. (1) In general.
    Alternative A: An issuer or payment card network shall not directly 
or through any agent, processor, or licensed member of a payment card 
network, by contract, requirement, condition, penalty, or otherwise, 
restrict the number of payment card networks on which an electronic 
debit transaction may be processed to less than two unaffiliated 
networks.
    Alternative B: An issuer or payment card network shall not directly 
or through any agent, processor, or licensed member of a payment card 
network, by contract, requirement, condition, penalty, or otherwise, 
restrict the number of payment card networks on which an electronic 
debit transaction may be processed to less than two unaffiliated 
networks for each method of authorization that may be used by the 
cardholder.
    (2) Prohibited exclusivity arrangements. For purposes of paragraph 
(a)(1) of this section, an issuer or payment card network does not 
satisfy the requirement to have at least two unaffiliated payment card 
networks on which an electronic debit transaction may be processed if--
    (i) The unaffiliated network(s) that is added to satisfy the 
requirements of this paragraph does not operate throughout the United 
States, unless the debit card is accepted on a nationwide basis on at 
least two unaffiliated payment card networks when the network(s) with 
limited geographic acceptance is combined with one or more other 
unaffiliated payment card networks that also accept the card.
    (ii) The unaffiliated network(s) that is added to satisfy the 
requirements of this paragraph is accepted only at a small number of 
merchant locations or at limited types of merchants; or
    (iii) The payment card network restricts or otherwise limits an 
issuer's ability to contract with any other payment card network that 
may process an electronic debit transaction involving the issuer's 
debit cards.
    (3) Subsequent affiliation. If unaffiliated payment card networks 
become affiliated as a result of a merger or acquisition such that an 
issuer is no longer in compliance with this paragraph (a), the issuer 
must add an unaffiliated payment card network through which electronic 
debit transactions on the relevant debit card may be processed no later 
than 90 days after the date on which the prior unaffiliated payment 
card networks become affiliated.
    (b) Prohibition on routing restrictions. An issuer or payment card 
network shall not, directly or through any agent, processor, or 
licensed member of the network, by contract, requirement, condition, 
penalty, or otherwise, inhibit the ability of any person that accepts 
or honors debit cards for payments to direct the routing of electronic 
debit transactions for processing over any payment card network that 
may process such transactions.


Sec.  235.8  Reporting requirements.

    (a) Entities required to report. Each issuer that is not otherwise 
exempt from the requirements of this part under Sec.  235.5(a) and each 
payment card network shall file a report with the Board in accordance 
with this section.
    (b) Report. Each entity required to file a report with the Board 
shall submit data in a form prescribed by the Board for that entity. 
Data required to be

[[Page 81757]]

reported may include, but is not limited to, data regarding costs 
incurred with respect to an electronic debit transaction, interchange 
transaction fees, network fees, fraud-prevention and data-security 
costs, and fraud losses.
    (c) Timing. (1) Each entity shall submit the data in a form 
prescribed by the Board biennially.
    (2) Each entity shall submit the report to the Board by March 31 of 
the year the entity is required to report.
    (3) The first report shall be submitted to the Board by March 31, 
2012.
    (d) Disclosure. The Board may, in its discretion, disclose 
aggregate or summary information reported under this section.


Sec.  235.9  Administrative enforcement.

    (a)(1) Compliance with the requirements of this part shall be 
enforced under--
    (i) Section 8 of the Federal Deposit Insurance Act, by the 
appropriate Federal banking agency, as defined in section 3(q) of the 
Federal Deposit Insurance Act (12 U.S.C. 1813(q)), with respect to--
    (A) National banks, federal savings associations, and federal 
branches and federal agencies of foreign banks;
    (B) Member banks of the Federal Reserve System (other than national 
banks), branches and agencies of foreign banks (other than Federal 
branches, Federal Agencies, and insured state branches of foreign 
banks), commercial lending companies owned or controlled by foreign 
banks, and organizations operating under section 25 or 25A of the 
Federal Reserve Act;
    (C) Banks and state savings associations insured by the Federal 
Deposit Insurance Corporation (other than members of the Federal 
Reserve System), and insured state branches of foreign banks;
    (ii) The Federal Credit Union Act (12 U.S.C. 1751 et seq.), by the 
Administrator of the National Credit Union Administration (National 
Credit Union Administration Board) with respect to any federal credit 
union;
    (iii) The Federal Aviation Act of 1958 (49 U.S.C. 40101 et seq.), 
by the Secretary of Transportation, with respect to any air carrier or 
foreign air carrier subject to that Act; and
    (iv) The Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.), 
by the Securities and Exchange Commission, with respect to any broker 
or dealer subject to that Act.
    (2) The terms used in paragraph (a)(1) of this section that are not 
defined in this part or otherwise defined in section 3(s) of the 
Federal Deposit Insurance Act (12 U.S.C. 1813(s)) shall have the 
meaning given to them in section 1(b) of the International Banking Act 
of 1978 (12 U.S.C. 3101).
    (b) Additional powers. (1) For the purpose of the exercise by any 
agency referred to in paragraphs (a)(1)(i) through (iv) of this section 
of its power under any statute referred to in those paragraphs, a 
violation of this part is deemed to be a violation of a requirement 
imposed under that statute.
    (2) In addition to its powers under any provision of law 
specifically referred to in paragraphs (a)(1)(i) through (iv) of this 
section, each of the agencies referred to in those paragraphs may 
exercise, for the purpose of enforcing compliance under this part, any 
other authority conferred on it by law.
    (c) Enforcement authority of Federal Trade Commission. Except to 
the extent that enforcement of the requirements imposed under this 
title is specifically granted to another government agency under 
paragraphs (a)(1)(i) through (iv) of this section, and subject to 
subtitle B of the Consumer Financial Protection Act of 2010, the 
Federal Trade Commission has the authority to enforce such 
requirements. For the purpose of the exercise by the Federal Trade 
Commission of its functions and powers under the Federal Trade 
Commission Act, a violation of this part shall be deemed a violation of 
a requirement imposed under the Federal Trade Commission Act. All of 
the functions and powers of the Federal Trade Commission under the 
Federal Trade Commission Act are available to the Federal Trade 
Commission to enforce compliance by any person subject to the 
jurisdiction of the Federal Trade Commission with the requirements of 
this part, regardless of whether that person is engaged in commerce or 
meets any other jurisdictional tests under the Federal Trade Commission 
Act.

Appendix A--Official Board Commentary on Regulation II

Introduction

    The following commentary to Regulation II (12 CFR part 235) 
provides background material to explain the Board's intent in 
adopting a particular part of the regulation. The commentary also 
provides examples to aid in understanding how a particular 
requirement is to work.

Sec. 235.2 Definitions

2(a) Account

    1. Types of accounts. The term ``account'' includes accounts 
held by any person, including consumer accounts (i.e., those 
established primarily for personal, family or household purposes) 
and business accounts. Therefore, the limitations on interchange 
transaction fees and the prohibitions on network exclusivity 
arrangements and routing restrictions apply to all electronic debit 
transactions, regardless of whether the transaction involves a debit 
card issued primarily for personal, family, or household purposes or 
a business-purpose debit card. For example, an issuer of a business-
purpose debit card is subject to the restrictions on interchange 
transaction fees and is also prohibited from restricting the number 
of payment card networks on which an electronic debit transaction 
may be processed under Sec.  235.7. The term ``account'' also 
includes bona fide trust arrangements.
    2. Account located in the United States. This part applies only 
to electronic debit transactions that are initiated to debit (or 
credit in the case of returned goods or cancelled services) an 
account located in the United States. If a cardholder uses a debit 
card to debit an account held at a bank outside the United States, 
then the electronic debit transaction is not subject to this part.

2(b) Acquirer

    1. In general. The term ``acquirer'' includes only the 
institution that contracts, directly or indirectly, with a merchant 
to provide settlement for the merchant's electronic debit 
transactions over a payment card network (referred to as acquiring 
the merchant's electronic debit transactions). In some acquiring 
relationships, an institution provides processing services to the 
merchant and is a licensed member of the payment card network, but 
does not settle the transactions with the merchant (by crediting the 
merchant's account) or the network. These institutions are not 
``acquirers'' because they do not provide credit for transactions or 
settle to the merchant's transactions with the merchant. These 
institutions that only process or route transactions are considered 
processors for purposes of this part (See Sec.  235.2(o) and 
commentary thereto).

2(c) Affiliate

    1. Types of entities. The term ``affiliate'' includes both bank 
and nonbank affiliates.
    2. Other affiliates. For commentary on whether merchants are 
affiliated, see comment 2(f)-5.

2(d) Cardholder

    1. Scope. In the case of debit cards that access funds in 
transaction, savings, or other similar asset accounts, ``the person 
to whom a card is issued'' is the person or persons holding the 
account. If the account is a business account, multiple employees 
(or other persons associated with the business) may have debit cards 
that can access the account. Each employee that has a debit card 
that can access the account is a cardholder. In the case of a 
prepaid card, the cardholder generally is either the purchaser of 
the card or a person to whom the purchaser gave the card, such as a 
gift recipient.

2(e) Control [Reserved]

2(f) Debit Card

    1. Card, or other payment code or device. The term ``debit 
card'' as defined in Sec.  235.2(f) applies to any card, or other 
payment code or device, even if it is not issued in a physical form. 
Debit cards include, for example, an account number or code that can

[[Page 81758]]

be used to access underlying funds. See, however, Sec.  
235.2(f)(3)(iii). Similarly, the term ``debit card'' includes a 
device with a chip or other embedded mechanism that links the device 
to funds stored in an account, such as a mobile phone or sticker 
containing a contactless chip that enables an account to be debited.
    2. Deferred debit cards. The term ``debit card'' includes a 
card, or other payment code or device, that is used in connection 
with deferred debit card arrangements in which transactions are not 
immediately posted to and funds are not debited from the underlying 
transaction, savings, or other asset account upon settlement of the 
transaction. Instead, the funds in the account are held and made 
unavailable for other transactions for a specified period of time. 
After the expiration of the applicable time period, the cardholder's 
account is debited for the value of all transactions made using the 
card that have been submitted to the issuer for settlement during 
that time period. For example, under some deferred debit card 
arrangements, the issuer may debit the consumer's account for all 
debit card transactions that occurred during a particular month at 
the end of the month. Regardless of the time period chosen by the 
issuer, a card, or other payment code or device, that is used in 
connection with a deferred debit arrangement is considered a debit 
card for purposes of the requirements of this part. Deferred debit 
card arrangements do not refer to arrangements in which a merchant 
defers presentment of multiple small-dollar card payments, but 
aggregates those payments into a single transaction for presentment, 
or where a merchant requests placement of a hold on funds in an 
account until the actual amount of the cardholder's transaction is 
known and submitted for settlement.
    3. Decoupled debit cards. Decoupled debit cards are issued by an 
entity other than the financial institution holding the cardholder's 
account. In a decoupled debit arrangement, transactions that are 
authorized by the card issuer settle against the cardholder's 
account held by an entity other than the issuer via a subsequent ACH 
debit to that account. Because the term ``debit card'' applies to 
any card, or other payment code or device, that is issued or 
approved for use through a payment card network to debit an account, 
regardless of whether the issuer holds the account, decoupled debit 
cards are debit cards for purposes of this subpart.
    4. General-use prepaid card. The term ``debit card'' includes 
general-use prepaid cards. See Sec.  235.2(i) and related commentary 
for information on general-use prepaid cards.
    5. Store cards. The term ``debit card'' does not include prepaid 
cards that may be used at a single merchant or affiliated merchants. 
Two or more merchants are affiliated if they are related by either 
common ownership or by common corporate control. For purposes of the 
``debit card'' definition, the Board would view franchisees 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.
    6. Checks, drafts, and similar instruments. The term ``debit 
card'' does not include a check, draft, or similar paper instrument 
or a transaction in which the check is used as a source of 
information to initiate an electronic payment. For example, if an 
account holder provides a check to buy goods or services and the 
merchant takes the account number and routing number information 
from the MICR line at the bottom of a check to initiate an ACH debit 
transfer from the cardholder's account, the check is not a debit 
card, and such a transaction is not considered an electronic debit 
transaction. Likewise, the term ``debit card'' does not include an 
electronic representation of a check, draft, or similar paper 
instrument.
    7. ACH transactions. The term ``debit card'' does not include an 
account number when it is used by a person to initiate an ACH 
transaction that debits the person's account. For example, if an 
account holder buys goods or services over the Internet using an 
account number and routing number to initiate an ACH debit, the 
account number is not a debit card, and such a transaction is not 
considered an electronic debit transaction. However, the use of a 
card to purchase goods or services that debits the cardholder's 
account by means of a subsequent ACH debit initiated by the card 
issuer to the cardholder's account, as in the case of a decoupled 
debit card arrangement, involves the use of a debit card for 
purposes of this part.

2(g) Designated Automated Teller Machine (ATM) Network

    1. Reasonable and convenient access clarified. Under Sec.  
235.2(g)(2), a designated automated teller machine network includes 
any network of automated teller machines identified by the issuer 
that provides reasonable and convenient access to the issuer's 
cardholders. An issuer provides reasonable and convenient access, 
for example, if, for each person to whom a card is issued, the 
network provides access to an automated teller machine in the 
network within the metropolitan statistical area of the person's 
last known address, or if the address is not known, where the card 
was first issued.

2(h) Electronic Debit Transaction

    1. Subsequent transactions. The term ``electronic debit 
transaction'' includes both the cardholder's use of a debit card for 
the initial purchase of goods or services and any subsequent use by 
the cardholder of the debit card in connection with the initial 
purchase of goods or services. For example, the term ``electronic 
debit transaction'' includes using the debit card to return 
merchandise or cancel a service that then results in a credit to the 
account initially debited to pay for the merchandise or service.
    2. Cash withdrawal at the point of sale. The term ``electronic 
debit transaction'' includes a transaction in which a cardholder 
uses the debit card both to purchase goods or services and to 
withdraw cash (known as a ``cashback transaction'').
    3. Geographic limitation. This regulation applies only to 
electronic debit transactions that are initiated at a merchant 
located in the United States. If a cardholder uses a debit card at a 
merchant located outside the United States to debit an account held 
at a U.S. bank or a U.S. branch of a foreign bank, the electronic 
debit transaction is not subject to this part.

2(i) General-Use Prepaid Card

    1. Redeemable upon presentation at multiple, unaffiliated 
merchants. A card, or other payment code or other device, is 
redeemable upon presentation at multiple, unaffiliated merchants if 
such merchants agree to honor the card, or other payment code or 
device, if, for example, it bears the mark, logo, or brand of a 
payment card network, pursuant to the rules of the payment network.
    2. Mall cards. Mall cards that are generally intended to be used 
or redeemed for goods or services at participating retailers within 
a shopping mall are considered general-use prepaid cards if they 
carry the mark, logo, or brand of a payment card network and can be 
used at any retailer that accepts that card brand, including 
retailers located outside of the mall.

2(j) Interchange Transaction Fee

    1. In general. Generally, the payment card network is the entity 
that establishes and charges the interchange transaction fee to the 
merchants or acquirers. The merchants or acquirers then pay to the 
issuers any interchange transaction fee established and charged by 
the network. Therefore, issuers are considered to receive 
interchange transaction fees from merchants or acquirers.
    2. Compensating an issuer. The term ``interchange transaction 
fee'' is limited to those fees that a payment card network 
establishes, charges, or receives to compensate the issuer for its 
role in the transaction. (See Sec.  235.3(c) and commentary thereto 
for a description of an issuer's role in the transaction). In 
contrast, a payment card network may charge issuers and acquirers 
fees for sending transaction information to the network for clearing 
and settlement. Such fees are not interchange transaction fees 
because the payment card network is charging and receiving the fee 
as compensation for its role in clearing and settling.

2(k) Issuer

    1. In general. The term ``issuer'' means any person that issues 
a debit card. The following examples illustrate the entity that is 
the issuer under various card program arrangements. For purposes of 
determining whether an issuer is exempted under Sec.  235.5(a), 
however, the term issuer is limited to the entity that holds the 
account being debited.
    2. Four-party systems. In a four-party system, the cardholder 
receives the card directly or indirectly (e.g., through the bank's 
agent) from the account holding bank and has a direct contractual 
relationship with its bank with respect to the card. In this system, 
the cardholder's bank is the issuer.
    3. Three-party systems. In a three-party system, the network 
typically provides the card, either directly or indirectly, to the 
cardholder and holds the cardholder's account. Accordingly, the 
network is also the issuer with respect to the card. In most cases, 
the network also has a contractual relationship with the cardholder.
    4. BIN-sponsor arrangements. Payment card networks assign 
member-financial

[[Page 81759]]

institutions Bank Identification Numbers (BINs) for purposes of 
issuing cards, authorizing, clearing, settling, and other processes. 
In exchange for a fee or other financial considerations, some 
members of payment card networks permit other entities to issue 
debit cards using the member'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 can take at least two different 
models:
    i. Sponsored debit card model. In some cases, a community bank 
or credit union may provide debit cards to its account holders 
through a BIN sponsor arrangement with a member institution. In 
general, the bank or credit union will provide, directly or 
indirectly, debit cards to its account holders. The bank or credit 
union's name typically will appear on the debit card. The bank or 
credit union also holds the underlying account that is debited and 
has the primary relationship with the cardholder. Under these 
circumstances, the bank or credit union is the issuer for purposes 
of this part. If that affiliate member, together with its 
affiliates, has assets of less than $10 billion, then that bank or 
credit union is exempt from the interchange transaction fee 
restrictions. Although the bank or credit union issues cards through 
the BIN sponsors, the BIN sponsor does not have the direct 
relationship with the cardholder, and therefore is not the issuer.
    ii. Prepaid card model. A member institution may also serve as 
the BIN sponsor for a prepaid card program. Under these 
arrangements, the BIN-sponsoring institution generally holds the 
funds for the prepaid card program in a pooled account, although the 
prepaid card program manager may keep track of the underlying funds 
for each individual prepaid card through subaccounts. While the 
cardholder may receive the card directly from the program manager or 
at a retailer, the cardholder's relationship is generally with the 
bank holding the funds in the pooled account. This bank typically is 
also the BIN sponsor. Accordingly, under these circumstances, the 
BIN sponsor, or the bank holding the pooled account, is the issuer.
    5. Decoupled debit cards. In the case of decoupled debit cards, 
an entity other than the entity holding the cardholder's account 
directly or indirectly provides the debit card to the cardholder and 
has a direct relationship with the cardholder. The account-holding 
institution does not have a relationship with the cardholder with 
respect to the decoupled debit card. Under these circumstances, the 
entity providing the debit card, and not the account-holding 
institution, is considered the issuer. If the issuer of a decoupled 
debit card, together with its affiliates, has assets of less than 
$10 billion, the issuer is not exempt under Sec.  235.5(a) because 
it is not the entity holding the account to be debited.

2(l) Merchant [Reserved]

2(m) Payment Card Network

    1. Scope of definition. The term ``payment card network'' 
generally includes only those entities that establish guidelines, 
rules, or procedures that govern the rights and obligations of, at a 
minimum, issuers and acquirers involved in processing electronic 
debit transactions through the network. Such guidelines, rules, or 
procedures may also govern the rights and obligations of merchants, 
processors, or cardholders in addition to issuers and acquirers. The 
term ``payment card network'' includes an entity that serves in the 
multiple roles of payment card network and issuer and/or acquirer, 
such as in the case of a three-party system, to the extent that the 
entity's guidelines, rules, or procedures also cover its activities 
in its role(s) as issuer or acquirer. Acquirers, issuers, third-
party processors, payment gateways, or other entities that may 
provide services, equipment, or software that may be used in 
authorizing, clearing, or settling electronic debit transactions are 
generally excluded from the term ``payment card network,'' unless 
such entities also establish guidelines, rules, or procedures that 
govern the rights and obligations of issuers and acquirers involved 
in processing an electronic debit transaction through the network. 
For example, an acquirer is not considered to be a payment card 
network solely due to the fact that it establishes particular 
transaction format standards, rules, or guidelines that apply to 
electronic debit transactions submitted by merchants using the 
acquirer's services, because such standards, rules, or guidelines 
apply only to merchants that use its services, and not to other 
entities that are involved in processing those transactions, such as 
the card issuer.

2(n) Person [Reserved]

2(o) Processor

    1. Distinction from acquirers. Although a processor may perform 
all transaction-processing functions for a merchant or acquirer, a 
processor is not the entity that acquires (that is, settles with the 
merchant for) the transactions. The entity that acquires electronic 
debit transactions is the entity that is responsible to other 
parties to the electronic debit transaction for the amount of the 
transaction.
    2. Issuers. An issuer may use a third party to perform services 
related to authorization, clearance, and settlement of transactions. 
The third party is the issuer's processor.

2(p) United States [Reserved]

Sec. 235.3 Reasonable and Proportional Interchange Transaction Fees

    Alternative 1 (Issuer-Specific Standard With Safe Harbor and 
Cap):

3(a) [Reserved]

3(b) Determination of Reasonable and Proportional Fees

    1. Two options. An issuer may comply with Sec.  235.3(a) in two 
ways: (1) an issuer may elect to receive or charge an interchange 
transaction fee that is no more than the amount in Sec.  
235.3(b)(1), known as the ``safe harbor,'' or (2) an issuer may 
determine the maximum interchange transaction fee it may receive or 
charge using the cost-based approach in Sec.  235.3(b)(2) (See Sec.  
235.3(c) and related commentary). An issuer complies with Sec.  
235.3(a) if it receives an interchange transaction fee in an amount 
at or below the safe harbor even if the maximum interchange 
transaction fee that the issuer is able to receive or charge under 
Sec.  235.3(b)(2) is less than the safe harbor.
    2. Safe harbor. An issuer that receives or charges interchange 
fees at or below the amount in Sec.  235.3(b)(1) (known as the 
``safe harbor'') is not required to compute an interchange fee 
transaction amount under Sec.  235.3(b)(2). An issuer that receives 
or charges an interchange transaction fee in an amount at or below 
the safe harbor, however, must comply the reporting requirements in 
Sec.  235.8.
    3. Cap. An issuer that determines the maximum interchange 
transaction fee that it may receive or charge under the cost-based 
approach in Sec.  235.3(b)(2) may not receive or charge an 
interchange transaction fee above the maximum amount allowable under 
Sec.  235.3(b)(2), known as the ``cap,'' even if its costs are above 
the cap. In contrast, if an issuer calculates that it has allowable 
per-transaction costs that are lower than the cap, that issuer may 
not receive or charge an interchange transaction fee higher than the 
amount determined using the formula in Sec.  235.3(b)(2) or the safe 
harbor amount, whichever is greater.
    4. Variation among interchange fees. A network is permitted to 
set fees that vary with the value of the transaction (ad valorem 
fees), as long as the maximum amount of the interchange fee received 
by an issuer for any electronic debit transaction was not more than 
that issuer's maximum permissible interchange fee. A network is 
permitted to establish different interchange fees for different 
types of transactions (e.g., card-present and card-not-present) or 
different types of merchants, as long as each of those fees 
satisfied the relevant limits of the standard.

3(c) Issuer Costs

    1. In general. Section 235.3(c) sets forth the allowable costs 
that an issuer may include when calculating its interchange 
transaction fee under Sec.  235.3(b)(2). These costs are those that 
are attributable to the authorization, clearance, and settlement of 
electronic debit transactions. Section 235.3(c)(1) further limits 
the costs in Sec. Sec.  235.3(c)(1)(i) through (c)(1)(iv) to those 
that vary with the number of transactions sent to the issuer.
    2. Activities. Section 235.3(c)(1) limits the allowable costs 
that an issuer may include when calculating its interchange 
transaction fee to the variable costs associated with its role in 
authorization, clearance, and settlement of electronic debit 
transactions.
    i. Issuer's role in authorization. Section 235.3(c)(1)(i) 
describes an issuer's role in the authorization process. The 
authorization process begins when the cardholder presents a debit 
card or otherwise provides the card information to the merchant to 
purchase goods or services and ends when the merchant receives 
notice that the issuer either has approved or denied the 
transaction. In both four-party and three-party systems, the issuer 
receives the request for authorization of the electronic debit 
transaction. In a four-party system, the approval request is sent to 
the issuer via the acquirer and payment card network (and any

[[Page 81760]]

processors that the acquirer or issuer may use). In a three-party 
system, the payment card network is both the issuer and the acquirer 
and therefore the approval request travels through fewer parties. In 
both systems, the issuer decides whether to approve or deny the 
electronic debit transaction based on several factors, such as the 
availability of funds in the cardholder's account. Once the issuer 
approves or denies the transaction, it sends the approval or denial 
back through the payment card network and acquirer (and any 
processors) to the merchant. Section 235.3(c)(1)(i)'s authorization 
activities include activities such as data processing, voice 
authorization inquiries, and referral inquiries. An issuer generally 
performs separate activities with the primary purpose of fraud-
prevention in connection with authorization. Those separate 
activities are not considered to be part of an issuer's role in 
authorization under Sec.  235.3(c)(1).
    ii. Issuer's role in clearance. Section 235.3(c)(1)(ii) 
describes the issuer's role in the clearance process. Clearance is 
the process of submitting a record of an electronic debit 
transaction for payment. In PIN debit (or single-message) networks, 
the authorization message also generally serves as the clearance of 
the transaction. In signature debit (or dual-message) networks, the 
acquirer sends the clearance message through the network to the 
issuer following the completion of the purchase by the cardholder, 
as specified in payment card network rules. Section 
235.3(c)(1)(ii)'s signature-debit clearance activities include 
activities such as data processing and reconciling clearing message 
information.
    iii. Non-routine transactions. In some instances, an issuer may 
decide to reverse settlement for an electronic debit transaction, 
pursuant to payment card network rules. This reversal is known as a 
``chargeback.'' The issuer's role in the clearance process includes 
the process of initiating the chargeback. After the acquirer 
receives a chargeback, the acquirer may decide to represent the 
transaction, pursuant to the network rules. The issuer's role in the 
clearance process also includes receiving and processing 
representments. Finally, after the initial clearance process, an 
acquirer may determine that the transaction record contained an 
error. For example, the transaction record may reflect an incorrect 
transaction amount or may be a duplicate of a previous transaction. 
The issuer's role in the clearance of a transaction also includes 
receiving and processing adjustments. Accordingly, Sec.  
235.3(c)(1)(iii)'s non-routine clearance activities include 
activities such as data processing to prepare and send the 
chargeback message through the network, and reconciliation expenses 
specific to receiving representments and error adjustments, such as 
posting a credit to a cardholder's account. An issuer's clearance 
costs do not include the costs of receiving cardholder inquiries 
about particular transactions.
    iv. Issuer's role in settlement. Issuers have two roles in 
settlement of electronic debit transactions: Interbank settlement 
and settlement with the cardholders. Interbank settlement is the 
process of transferring funds between issuers and acquirers. 
Typically, each day a payment card network will collect all 
transactions sent for clearing and will determine the net amount 
owed by each issuer and acquirer, after deducting interchange 
transaction fees and other fees. The issuer (unless it is also a 
large merchant acquirer) will generally be in a net debit position 
and will transmit funds for interbank settlement. Issuers settle the 
electronic debit transactions with their cardholders by posting the 
transactions to the cardholder accounts. Section 235.3(c)(1)(iv)'s 
settlement costs include the fees for settlement through a net 
settlement service, ACH, or Fedwire [reg], and data processing costs 
for posting transactions to the cardholders' accounts.
    3. Issuer's costs.
    i. Variable costs vs. fixed costs. Variable costs that are 
attributable to authorizing, clearing, and settling electronic debit 
transactions can be considered in determining an issuer's 
permissible interchange transaction fee. For example, the portion of 
an issuer's data-processing costs that vary based on the number of 
authorization requests is a variable cost. If an issuer uses a 
third-party processor or other agent for all of its authorization, 
clearance, and settlement activities, then any per-transaction fee 
the third-party processor charges is a variable cost for the issuer. 
In contrast, fixed costs are those costs that do not vary with 
changes in output up to existing capacity limits within a calendar 
year. For example, an issuer may pay a fixed fee to connect to a 
network in order to process transactions. The connectivity fee is a 
fixed cost.
    ii. Network fees excluded. Per-transaction fees (e.g., switch 
fees) paid to the network in its role as network for purposes of 
authorization, clearance, and settlement are not an allowable cost. 
A payment card network may offer optional authorization, clearance, 
and settlement services to an issuer. In this case, although the 
network is charging fees to the issuer, the network is not doing so 
in its role as a network. Rather, these fees are considered fees an 
issuer pays to a processor. Therefore, fees charged by a network for 
its role as a third-party processor may be included in an issuer's 
allowable costs, provided they otherwise are permissible to include 
under Sec.  235.3(c)(1).
    iii. Common costs excluded. Common costs, which are not 
attributable to authorization, clearance, and settlement, are not 
allowable costs. For example, an issuer may not allocate a portion 
of its overhead costs (e.g., the costs of its facilities or its 
human resources and legal staff) for the purpose of calculating its 
permissible interchange transaction fee. Similarly, the costs of 
operating a branch office are common to all banking activities, 
including the debit card program, and therefore are not allowable 
costs.
    iv. Costs of other activities excluded. Section 235.3(c) sets 
forth an exclusive list of costs that an issuer may include when 
determining the amount of an interchange transaction fee it may 
receive or charge with respect to an electronic debit transaction. 
Therefore, an issuer may not include those costs that are not 
incurred for the activities listed in Sec. Sec.  235.3(c)(1)(i) 
through (iv). In addition, as discussed earlier, fixed costs, even 
if incurred for activities related to authorization, clearance, or 
settlement of debit card transactions, may not be included. Fraud 
losses, the cost of fraud-prevention activities, and the cost of 
rewards programs are not includable as allowable costs.

3(d) Disclosure to payment card network

    1. No differentiation. A payment card network may, but is not 
required to, differentiate among issuers subject to Sec.  235.3 when 
setting interchange transaction fees. If a payment card network 
chooses to set the interchange transaction fee for all issuers that 
are subject to the interchange fee standards at or below the safe 
harbor amount, it is not necessary for issuers to report to the 
payment card network through which it receives electronic debit 
transactions the maximum amount of any interchange transaction fee 
it may receive or charge.
    2. Differentiation. If a payment card network differentiates 
among issuers when setting interchange transaction fees, any issuer 
that is subject to the interchange fee standards receives or charges 
interchange transaction fees above the safe harbor must report the 
maximum amount of any interchange transaction fee it may receive or 
charge to the payment card network. An issuer must report such 
amount by March 31 of each calendar year for which it will be 
receiving an interchange transaction fee above the safe harbor 
(effective October 1 of the calendar year). An issuer need not 
submit its detailed cost information to the payment card networks.

Alternative 2 (Cap):

3(a) [Reserved]

3(b) Determining reasonable and proportional fees

    1. Variation among interchange fees. A network is permitted to 
set fees that vary with the value of the transaction (ad valorem 
fees), as long as the maximum amount of the interchange fee received 
by an issuer for any electronic debit transaction was not more than 
that issuer's maximum permissible interchange fee. A network is 
permitted to establish different interchange fees for different 
types of transactions (e.g., card-present and card-not-present) or 
types of merchants, as long as each of those fees satisfied the 
relevant limits of the standard.

Sec. 235.4 [Reserved]

Sec. 235.5 Exemptions for certain electronic debit transactions.

Sec.  235.5 In general

    1. Eligibility for multiple exemptions. An electronic debit 
transaction may qualify for one or more exemptions. For example, a 
debit card that has been provided to a person pursuant to a Federal, 
State, or local government-administered payment program may be 
issued by an entity that, together with its affiliates, has assets 
of less than $10 billion as of the end of the previous calendar 
year. In this case, the electronic debit transaction made using that 
card may qualify

[[Page 81761]]

for the exemption under Sec.  235.5(a) for small issuers or for the 
exemption under Sec.  235.5(b) for government-administered payment 
programs. A payment card network establishing interchange fees for 
transactions that qualify for more than one exemption need only 
satisfy itself that the issuer's transactions qualify for at least 
one of the exemptions in order to exempt the electronic debit 
transaction from the interchange fee restrictions.

5(a) Exemption for small issuers

    1. Asset size determination. An issuer would qualify for the 
small-issuer exemption if its total worldwide banking and nonbanking 
assets, including assets of affiliates, are less than $10 billion.

5(b) Exemption for government-administered payment programs

    1. Government-administered payment program. Electronic debit 
transactions made using a debit card issued pursuant to a 
government-administered payment program generally are exempt from 
the interchange fee restrictions. A program is considered 
government-administered regardless of whether a Federal, State, or 
local government agency operates the program or outsources some or 
all functions to third parties. In addition, a program may be 
government-administered even if a Federal, State, or local 
government agency is not the source of funds for the program it 
administers. For example, child support programs are government-
administered programs even though a Federal, State, or local 
government agency is not the source of funds.

5(c) Exemption for certain reloadable prepaid cards

    1. Reloadable. Electronic debit transactions made using certain 
reloadable general-use prepaid cards are exempt from the interchange 
fee restrictions. A general-use prepaid card is ``reloadable'' if 
the terms and conditions of the agreement permit funds to be added 
to the general-use prepaid card after the initial purchase or 
issuance. A general-use prepaid card is not ``reloadable'' merely 
because the issuer or processor is technically able to add 
functionality that would otherwise enable the general-use prepaid 
card to be reloaded.
    2. Marketed or labeled as a gift card or gift certificate. 
Electronic debit transactions made using a reloadable general-use 
prepaid card are not exempt from the interchange fee restrictions if 
the card is marketed or labeled as a gift card or gift certificate. 
The term ``marketed or labeled as a gift card or gift certificate'' 
means directly or indirectly offering, advertising or otherwise 
suggesting the potential use of a general-use prepaid card as a gift 
for another person. Whether the exclusion applies generally does not 
depend on the type of entity that makes the promotional message. For 
example, a card may be marketed or labeled as a gift card or gift 
certificate if anyone (other than the purchaser of the card), 
including the issuer, the retailer, the program manager that may 
distribute the card, or the payment network on which a card is used, 
promotes the use of the card as a gift card or gift certificate. A 
general-use prepaid card is marketed or labeled as a gift card or 
gift certificate even if it is only occasionally marketed as a gift 
card or gift certificate. For example, a network-branded general 
purpose reloadable card would be marketed or labeled as a gift card 
or gift certificate if the issuer principally advertises the card as 
a less costly alternative to a bank account but promotes the card in 
a television, radio, newspaper, or Internet advertisement, or on 
signage as ``the perfect gift'' during the holiday season.
    The mere mention of the availability of gift cards or gift 
certificates in an advertisement or on a sign that also indicates 
the availability of exempted general-use prepaid cards does not by 
itself cause the general-use prepaid card to be marketed as a gift 
card or a gift certificate. For example, the posting of a sign in a 
store that refers to the availability of gift cards does not by 
itself constitute the marketing of otherwise exempted general-use 
prepaid cards that may also be sold in the store along with gift 
cards or gift certificates, provided that a person acting reasonably 
under the circumstances would not be led to believe that the sign 
applies to all cards sold in the store. (See, however, comment 5(c)-
4.ii.)
    3. Examples of marketed or labeled as a gift card or gift 
certificate.
    i. The following are examples of marketed or labeled as a gift 
card or gift certificate:
    A. Using the word ``gift'' or ``present'' on a card or 
accompanying material, including documentation, packaging and 
promotional displays;
    B. Representing or suggesting that a card can be given to 
another person, for example, as a ``token of appreciation'' or a 
``stocking stuffer,'' or displaying a congratulatory message on the 
card or accompanying material;
    C. Incorporating gift-giving or celebratory imagery or motifs, 
such as a bow, ribbon, wrapped present, candle, or a holiday or 
congratulatory message, on a card, accompanying documentation, or 
promotional material;
    ii. The term does not include the following:
    A. Representing that a card can be used as a substitute for a 
checking, savings, or deposit account;
    B. Representing that a card can be used to pay for a consumer's 
health-related expenses--for example, a card tied to a health 
savings account;
    C. Representing that a card can be used as a substitute for 
travelers checks or cash;
    D. Representing that a card can be used as a budgetary tool, for 
example, by teenagers, or to cover emergency expenses.
    4. Reasonable policies and procedures to avoid marketing as a 
gift card. The exemption for a general-use prepaid card that is 
reloadable and not marketed or labeled as a gift card or gift 
certificate in Sec.  235.5(c) applies if a reloadable general-use 
prepaid card is not marketed or labeled as a gift card or gift 
certificate and if persons involved in the distribution or sale of 
the card, including issuers, program managers, and retailers, 
maintain policies and procedures reasonably designed to avoid such 
marketing. Such policies and procedures may include contractual 
provisions prohibiting a reloadable general-use prepaid card from 
being marketed or labeled as a gift card or gift certificate, 
merchandising guidelines or plans regarding how the product must be 
displayed in a retail outlet, and controls to regularly monitor or 
otherwise verify that the general-use prepaid card is not being 
marketed as a gift card. Whether a general-use prepaid card has been 
marketed as a gift card or gift certificate will depend on the facts 
and circumstances, including whether a reasonable person would be 
led to believe that the general-use prepaid card is a gift card or 
gift certificate. The following examples illustrate the application 
of Sec.  235.5(c):
    i. An issuer or program manager of prepaid cards agrees to sell 
general-purpose reloadable cards through a retailer. The contract 
between the issuer or program manager and the retailer establishes 
the terms and conditions under which the cards may be sold and 
marketed at the retailer. The terms and conditions prohibit the 
general-purpose reloadable cards from being marketed as a gift card 
or gift certificate, and require policies and procedures to 
regularly monitor or otherwise verify that the cards are not being 
marketed as such. The issuer or program manager sets up one 
promotional display at the retailer for gift cards and another 
physically separated display for exempted products under Sec.  
235.5(c), including general-purpose reloadable cards, such that a 
reasonable person would not believe that the exempted cards are gift 
cards. The exemption in Sec.  235.5(c) applies because policies and 
procedures reasonably designed to avoid the marketing of the 
general-purpose reloadable cards as gift cards or gift certificates 
are maintained, even if a retail clerk inadvertently stocks or a 
consumer inadvertently places a general-purpose reloadable card on 
the gift card display.
    ii. Same facts as in same facts as in comment 5(c)-4.i, except 
that the issuer or program manager sets up a single promotional 
display at the retailer on which a variety of prepaid cards are 
sold, including store gift cards and general-purpose reloadable 
cards. A sign stating ``Gift Cards'' appears prominently at the top 
of the display. The exemption in Sec.  235.5(c) does not apply with 
respect to the general-purpose reloadable cards because policies and 
procedures reasonably designed to avoid the marketing of exempted 
cards as gift cards or gift certificates are not maintained.
    iii. Same facts as in same facts as in comment 5(c)-4.i, except 
that the issuer or program manager sets up a single promotional 
multi-sided display at the retailer on which a variety of prepaid 
card products, including store gift cards and general-purpose 
reloadable cards are sold. Gift cards are segregated from exempted 
cards, with gift cards on one side of the display and exempted cards 
on a different side of a display. Signs of equal prominence at the 
top of each side of the display clearly differentiate between gift 
cards and the other types of prepaid cards that are available for 
sale. The retailer does not use any more conspicuous signage 
suggesting the general availability of gift cards, such as a large 
sign stating ``Gift Cards'' at the top of the display or located 
near the display. The exemption in Sec.  235.5(c) applies because 
policies and

[[Page 81762]]

procedures reasonably designed to avoid the marketing of the 
general-purpose reloadable cards as gift cards or gift certificates 
are maintained, even if a retail clerk inadvertently stocks or a 
consumer inadvertently places a general-purpose reloadable card on 
the gift card display.
    iv. Same facts as in same facts as in comment 5(c)-4.i,, except 
that the retailer sells a variety of prepaid card products, 
including store gift cards and general-purpose reloadable cards, 
arranged side-by-side in the same checkout lane. The retailer does 
not affirmatively indicate or represent that gift cards are 
available, such as by displaying any signage or other indicia at the 
checkout lane suggesting the general availability of gift cards. The 
exemption in Sec.  235.5(c) applies because policies and procedures 
reasonably designed to avoid marketing the general-purpose 
reloadable cards as gift cards or gift certificates are maintained.
    5. On-line sales of prepaid cards. Some Web sites may 
prominently advertise or promote the availability of gift cards or 
gift certificates in a manner that suggests to a consumer that the 
Web site exclusively sells gift cards or gift certificates. For 
example, a Web site may display a banner advertisement or a graphic 
on the home page that prominently states ``Gift Cards,'' ``Gift 
Giving,'' or similar language without mention of other available 
products, or use a web address that includes only a reference to 
gift cards or gift certificates in the address. In such a case, a 
consumer acting reasonably under the circumstances could be led to 
believe that all prepaid products sold on the Web site are gift 
cards or gift certificates. Under these facts, the Web site has 
marketed all such products as gift cards or gift certificates, and 
the exemption in Sec.  235.5(c) does not apply to any products sold 
on the Web site.
    6. Temporary non-reloadable cards issued in connection with a 
general-purpose reloadable card. Certain general-purpose prepaid 
cards that are typically marketed as an account substitute initially 
may be sold or issued in the form of a temporary non-reloadable 
card. After the card is purchased, the card holder is typically 
required to call the issuer to register the card and to provide 
identifying information in order to obtain a reloadable replacement 
card. In most cases, the temporary non-reloadable card can be used 
for purchases until the replacement reloadable card arrives and is 
activated by the cardholder. Because the temporary non-reloadable 
card may only be obtained in connection with the reloadable card, 
the exemption in Sec.  235.5(c) applies as long as the card is not 
marketed as a gift card or gift certificate.

Sec. 235.6 Prohibition on Circumvention or Evasion

    1. Illustration of circumvention or evasion. A finding of 
evasion or circumvention will depend on all relevant facts and 
circumstances.
    i. Example. Circumvention or evasion of the interchange 
transaction fee restrictions is indicated in the following example: 
The total amount of payments or incentives received by an issuer 
from a payment card network during a calendar year in connection 
with electronic debit transactions, other than interchange 
transaction fees passed through to the issuer by the network, 
exceeds the total amount of all fees paid by the issuer to the 
network for electronic debit transactions during that year.
    ii. Incentives or fees considered. Payments or incentives paid 
by a payment card network could include, but are not limited to, 
marketing incentives, payments or rebates for meeting or exceeding a 
specific transaction volume, percentage share or dollar amount of 
transactions processed, or other fixed payments for debit card 
related activities. Incentives or payments made by a payment card 
network do not include interchange transaction fees that are passed 
through to the issuer by the network. In addition, funds received by 
an issuer from a payment card network as a result of chargebacks or 
violations of network rules or requirements by a third party do not 
constitute incentives or payments made by a payment card network. 
Fees paid by an issuer to a payment card network include, but are 
not limited to network processing, or switch fees, membership or 
licensing fees, network administration fees, and fees for optional 
services provided by the network.
    2. Examples of circumstances not involving circumvention or 
evasion. The following examples illustrate circumstances that would 
not indicate circumvention or evasion of the interchange transaction 
fee restrictions in Sec. Sec.  235.3 and 235.4:
    i. Because of an increase in debit card transactions that are 
processed through a payment card network during a calendar year, an 
issuer receives an additional volume-based incentive payment from 
the network for that year. Over the same period, however, the total 
network processing fees the issuer pays the payment card network 
with respect to debit card transactions also increase so that the 
total amount of fees paid by the issuer to the network continue to 
exceed payments or incentives paid by the network to the issuer. 
Under these circumstances, the issuer does not receive any net 
compensation from the network for electronic debit transactions, and 
thus, no circumvention or evasion of the interchange transaction fee 
restrictions has occurred.
    ii. Because of an increase in debit card transactions that are 
processed through a payment card network during a calendar year, an 
issuer receives a rate reduction for network processing fees that 
reduces the total amount of network processing fees paid by the 
issuer during the year. However, the total amount of all fees paid 
to the network by the issuer for debit card transactions continues 
to exceed the total amount of payments or incentives received by the 
issuer from the network for such transactions. Under these 
circumstances, the issuer does not receive any net compensation from 
the network for electronic debit transactions and thus, no 
circumvention or evasion of the interchange transaction fee 
restrictions has occurred.
    3. No applicability to exempt issuers or electronic debit 
transactions. The prohibition against circumventing or evading the 
interchange transaction fee restrictions does not apply to issuers 
or electronic debit transactions that qualify for an exemption under 
Sec.  235.5 from the interchange transaction fee restrictions.

Sec. 235.7 Limitations on Payment Card Restrictions

    1. Application of small issuer, government-administered payment 
program, and reloadable card exemptions to payment card network 
restrictions. The exemptions under Sec.  235.5 for small issuers, 
cards issued pursuant to government-administered payment programs, 
and certain reloadable prepaid cards do not apply to the limitations 
on payment card network restrictions. For example, an issuer of 
debit cards for government-administered payment programs, while 
exempt from the restrictions on interchange transaction fees, is 
subject to the requirement that electronic debit transactions made 
using such cards must be capable of being processed on at least two 
unaffiliated payment card networks and to the prohibition on 
inhibiting a merchant's ability determine the routing for electronic 
debit transactions.

7(a) Prohibition on Network Exclusivity

    1. Personal Identification Number (PIN) debit. The term ``PIN 
debit'' refers to a cardholder's use of a personal identification 
number, or PIN, to authorize a debit card transaction. Payment card 
networks that process debit card transactions that are typically 
authorized by means of a cardholder's entry of a PIN are referred to 
as ``PIN'' or ``PIN-based'' (or single message) debit networks.
    2. Signature debit. The term ``signature debit'' generally 
refers to a cardholder's use of a signature to authorize a debit 
card transaction. Payment card networks that process debit card 
transactions that are typically authorized by means of a 
cardholder's signature are referred to as ``signature'' or 
``signature-based'' debit (or dual message) networks.

Alternative A (Two unaffiliated networks)

    3. Scope of restriction. Section 235.7(a) does not require an 
issuer to have multiple, unaffiliated networks available for each 
method of cardholder authorization. For example, it is sufficient 
for an issuer to issue a debit card that operates on one signature-
based card network and on one PIN-based card network, as long as the 
two card networks are not affiliated. Alternatively, an issuer may 
issue a debit card that is accepted on two unaffiliated signature-
based card networks or on two unaffiliated PIN-based card networks.

Alternative B (Two unaffiliated networks for each authorization method)

    3. Scope of restriction. Section 235.7(a) provides that each 
electronic debit transaction, regardless of the method of 
authorization used by the cardholder, must be able to be processed 
on at least two unaffiliated payment card networks. For example, if 
a cardholder authorizes an electronic debit transaction using a 
signature, that transaction must be capable of being processed on at 
least two unaffiliated signature-based payment card networks. 
Similarly, if a consumer authorizes an

[[Page 81763]]

electronic debit transaction using a PIN, that transaction must be 
capable of being processed on at least two unaffiliated PIN-based 
payment card networks. The use of alternative technologies, such as 
contactless or radio-frequency identification (RFID), to authorize a 
transaction does not constitute a separate method of authorization 
because such transactions are generally processed over either a 
signature debit network or a PIN debit network.
    4. Examples of limited geographic or merchant acceptance 
networks. Section 235.7(a) requires that a payment card network (or 
combination of payment card networks) meet geographic and merchant 
acceptance requirements to satisfy the rule. The following are 
examples of payment card networks that would not meet the geographic 
or merchant acceptance tests:
    i. A payment card network that operates in only a limited region 
of the United States would not meet the geographic test, unless one 
or more other unaffiliated payment card network(s) are also enabled 
on the card, such that the combined geographic coverage of networks 
permits the card to be accepted on at least two unaffiliated payment 
card networks for any geographic area in the United States. For 
example, an issuer may not issue a debit card that is enabled solely 
on one payment card network that is accepted nationwide and another 
unaffiliated payment card network that operates only in the Midwest 
United States. In such case, the issuer would also be required to 
add one or more unaffiliated payment card networks that would 
generally enable transactions involving the card to be processed on 
at least two unaffiliated payment card networks in almost all of the 
rest of the country. A payment card network is considered to have 
sufficient geographic reach even though there may be limited areas 
in the United States that it does not serve. For example, a national 
network that has no merchant acceptance in Guam or American Samoa 
would nonetheless meet the geographic reach requirement.
    ii. A payment card network that is accepted only at a limited 
category of merchants (for example, at a particular grocery store 
chain or at merchants located in a particular shopping mall).
    5. Examples of prohibited restrictions on an issuer's ability to 
contract. The following are examples of prohibited network 
restrictions on an issuer's ability to contract with other payment 
card networks:
    i. Network rules or contract provisions limiting or otherwise 
restricting the other payment card networks that may be enabled on a 
particular debit card.
    ii. Network rules or guidelines that allow only that network's 
brand, mark, or logo to be displayed on a particular debit card or 
that otherwise limit the number, or location, of network brands, 
marks, or logos that may appear on the debit card.
    6. Network logos or symbols on card not required. Section 
235.7(a) does not require that a debit card identify the brand, 
mark, or logo of each payment card network over which an electronic 
debit transaction may be processed. For example, a debit card that 
is enabled for two or more unaffiliated payment card networks need 
not bear the logos or symbols for each card network.
    7. Voluntary exclusivity arrangements prohibited. Section 
235.7(a) requires the issuance of debit cards that are enabled on at 
least two unaffiliated payment card networks in all cases, even if 
the issuer is not subject to any rule of, or contract, arrangement 
or other agreement with, a payment card network requiring that all 
or a specified minimum percentage of electronic debit transactions 
be processed on the network or its affiliated networks.

Alternative A Only (Two unaffiliated networks)

    8. Affiliated payment card networks. Section 235.7(a) does not 
prohibit an issuer from including an affiliated payment card network 
among the networks that may process an electronic debit transaction 
with respect to a particular debit card, as long as at least two of 
the networks that are enabled on the card are unaffiliated. For 
example, an issuer may offer debit cards that are accepted on a 
payment card network for signature debit transactions and in an 
affiliated payment card network for PIN debit transactions as long 
as those debit cards may also be accepted on another unaffiliated 
payment card network.

Alternative B Only (Two unaffiliated networks for each authorization 
method)

    8. Affiliated payment card networks. Section 235.7(a) does not 
prohibit an issuer from including an affiliated payment card network 
among the networks that may process an electronic debit transaction 
for a particular debit card, as long as, for each method of 
authorization, at least two of the networks that are enabled on the 
card are unaffiliated. For example, an issuer may offer debit cards 
that are accepted on a payment card network for signature debit 
transactions and on an affiliated payment network for PIN debit 
transactions as long as those debit cards may also be accepted on a 
second signature debit network and a second PIN debit network, both 
of which are unaffiliated with the first network.

7(b) Prohibition on Routing Restrictions

    1. Relationship to the network exclusivity restrictions. The 
prohibition on routing restrictions applies solely to the payment 
card networks on which an electronic debit transaction may be 
processed for a particular debit card. Thus, an issuer or payment 
card network is prohibited from inhibiting a merchant's ability to 
route or direct the transaction over any of the payment card 
networks that the issuer has enabled to process an electronic debit 
transaction for that particular debit card.
    2. Examples of prohibited merchant restrictions. The following 
are examples of issuer or network practices that would inhibit a 
merchant's ability to direct the routing of an electronic debit 
transaction that are prohibited under Sec.  235.7(b):
    i. Prohibiting a merchant from encouraging or discouraging a 
cardholder's use of a particular method of debit card authorization, 
such as rules prohibiting merchants from favoring a cardholder's use 
of PIN debit over signature debit, or from discouraging the 
cardholder's use of signature debit.
    ii. Establishing network rules or designating issuer priorities 
directing the processing of an electronic debit transaction on a 
specified payment card network or its affiliated networks, except as 
a default rule in the event the merchant, or its acquirer or 
processor, does not designate a routing preference, or if required 
by state law.
    iii. Requiring a specific method of debit card authorization 
based on the type of access device provided by to the cardholder by 
the issuer, such as requiring the use of signature debit if the 
consumer provides a contactless debit card.
    3. Real-time routing decision not required. Section 235.7(b) 
does not require that the merchant have the ability to select the 
payment card network over which to route or direct a particular 
electronic debit transaction at the time of the transaction. 
Instead, the merchant and its acquirer may agree to a pre-determined 
set of routing choices that apply to all electronic debit 
transactions that are processed by the acquirer on behalf of the 
merchant.

    By order of the Board of Governors of the Federal Reserve 
System, December 16, 2010.
Jennifer J. Johnson,
Secretary of the Board.

[FR Doc. 2010-32061 Filed 12-27-10; 8:45 am]
BILLING CODE 6210-01-P`