Apple Pay May Reignite War Over Durbin Amendment

WASHINGTON — Just months after the Supreme Court appeared to end the legal fight over swipe-fee rules, a new battle is brewing over the interplay between mobile payments like Apple Pay and the Durbin amendment.

At issue is the ease with which merchants can choose routing options that promise lower fees against the backdrop of rapidly changing technology.

The amendment, inserted by Sen. Richard Durbin, D-Ill., into the 2010 Dodd-Frank Act, requires issuers to give greater access to certain PIN networks and not just Visa and MasterCard. But merchants and some payments experts say that requirement is being violated because retailers have not been able to use the other networks in a variety of situations, including Near Field Communication and other contactless transactions like Apple Pay and online commerce.

"It's my view that Apple Pay is breaking the Fed's regulation," said Douglas Kantor, a partner at Steptoe & Johnson LLP who has represented merchants in the interchange fight.

Mark Horwedel, chief executive of the Merchant Advisory Group, said that "merchants, as a practical matter, don't have the options that Durbin affords them in all of these instances, including tokenized transactions with Apple Pay."

While the retailers blame banks, card networks and Apple for developing a system behind closed doors and refusing to provide certain details about it, others say merchants have been slow to adapt their technology to use additional card network options. Some PIN networks, including STAR and Fiserv's Accel, have already touted their capability to facilitate Apple Pay transactions.

"The problem is the merchants do not yet have a mechanism to see that alternative network despite the fact that that alternative network is associated with the" card, said Tim Sloane, vice president of payments innovation at Mercator Advisory Group.

Issues with how banks participating in Apple Pay comply with the Durbin provision add a new layer to the fight over swipe fee limits. The Dodd-Frank provision was a significant victory for merchants, but they later objected to the Federal Reserve Board's final rule implementing it, saying it did not go far enough. An ensuing legal battle ceased in January when the high court declined to hear the case.

The Durbin amendment essentially made two huge changes to how merchants pay processing fees. The centerpiece was requiring the Fed to cap debit interchange fees for issuers with more than $10 billion in assets. But the other main provision responded to concerns that major networks like Visa and MasterCard had a stranglehold on merchants' routing choices.

Under the law, as implemented by the Fed, issuers must enable cards so merchants can route a transaction through at least two unaffiliated networks. The typical scenario is through either one of the major signature networks or at least one of the PIN debit networks. Requiring the availability of the other networks was meant to foster competition in the setting of network fees.

But merchant advocates claim that the emergence of Apple Pay and other new technologies is allowing issuers to avoid offering the multiple routing choices. They assert that transactions carried out over a consumer's phone typically go straight to one of the major signature networks without the non-signature networks ever being a choice. While some PIN networks can be accessed via Apple Pay, retailers say Visa and MasterCard have not provided the technical information needed for merchants to utilize that function.

"When the transaction occurs over NFC, and the technical specifications that are needed to have the terminal be able to recognize the other networks that are available for that transaction … [have] not been made available, what happens is the merchant doesn't have a choice," said Kantor. "It goes over Visa or MasterCard."

Mallory Duncan, general counsel for the National Retail Federation, blamed the unavailability of the PIN networks in part on the major card networks, noting that they helped develop the tokenization system used to make Apple Pay transactions secure.

That system "essentially hides the other competitive networks from the merchants when a debit transaction is used," Duncan said. "The effect is that the competition, which the Durbin amendment required that the merchants be offered, is essentially blocked."

He said the difficulty retailers have faced in having multiple routing options is why many merchants have declined to accept Apple Pay, but he also faulted banks that are partnering with the new cell phone-based payments system.

Issuers have "agreed to put their cards onto this platform. They can't use the technology to circumvent the law," Duncan said. "When you're filing taxes, you're responsible for the law and you can't launder that obligation by filing taxes through your accountant."

The banking industry has stayed largely silent on merchant claims about Durbin compliance issues in new mobile payments channels. A number of financial services industry groups declined to comment for this story. (Neither Apple, Visa nor MasterCard responded to requests for comment.)

But some industry representatives said the merchants' argument is a leap.

One financial services attorney noted an appeals court already denied merchant claims that the Fed's routing rules were insufficient. Merchants had wanted the agency to require an option both for two unaffiliated PIN networks and two unaffiliated signature networks, but the rules only required one of each. Merchants did not even cite the routing provision in their Supreme Court petition, the attorney said.

"I don't think this is an issue. The merchants keep bringing this up," said the attorney, who spoke on the condition of anonymity. "They lost on this issue in the circuit court, but they just keep trying to raise it."

The attorney said it is the merchant's choice to decide which technology suits their needs but that does not mean their routing options are limited. "The merchant may have decided to accept transactions in a way that only gives them one network. The merchant has opted to use an online technology where only one network is available. It doesn't mean that the issuer or the networks are precluding other types of transactions."

Steve Kenneally, a vice president for the American Bankers Association, said banks are not aware of compliance issues stemming from Apple Pay.

"If there were concerns that this was in conflict with the Durbin routing requirements we would do whatever we could to make sure we're in compliance," he said. "However, we have not heard of this concern from our members. Banks aren't skirting anything. We're interested in complying. We're also not interested in addressing a problem that doesn't exist."

But merchant advocates argued the Fed's rule specified that issuers provide options for at least two unaffiliated networks across multiple forms of technology. The rule said that requirement "applies to any supplemental device, such as a fob or token, or chip or application in a mobile phone, that is issued in connection with a plastic card, even if that plastic card fully complies with the rule."

"The Fed made it very clear that it was their intention that merchants were to have access to multiple [forms of] routing regardless of the configuration of the product," Duncan said.

Yet other payments experts suggested the lack of routing options on NFC-enabled services is not intentional but simply because various stakeholders have not yet upgraded their technology enough to be able to accept Apple Pay with multiple routing choices available.

"It follows the letter of the Durbin law but it might break the spirit of it," said Tom Noyes, a former Citigroup and Wachovia executive who now runs a startup called Commerce Signals.

While some PIN networks have been able to achieve functionality with Apple Pay, Noyes said others will likely follow suit. "Over the next six months, this shouldn't be an issue anymore. The other networks will be able to work with Visa and MasterCard to be able to make this work," he said.

Whether it is a clear legal violation or matter of needing technical upgrades, merchants have been surprised by higher network processing costs associated with using Apple Pay, observers said.

"For the merchants that signed up for Apple Pay, it's an unintended consequence that they had not anticipated because it actually increases the merchants' cost," said Richard Crone, founder of Crone Consulting. "They don't have the lowest cost routing options through the PIN networks available to them."

Meanwhile, the merchants' argument is complicated by the fact that some PIN debit networks — not affiliated with Visa or MasterCard — have promoted their functionality with Apple Pay. In a Sept. 9 announcement, for example, First Data said its "STAR Network will shine bright as the leading independent network accepting Apple Pay transactions." The company touted "integrated token services" that "support the safety of both online and point-of-sale transactions."

Fiserv announced a similar capability for its Accel debit network. On March 24, the company said it had completed its "first tokenized transactions" via the network.

Still, PIN debit network providers may also have concerns about the process for including them in Apple Pay.

Bob Woodbury, senior vice president and general manager at FIS Payments Networks, said while the company's NYCE Payments Network "currently supports Apple Pay for multiple clients," the launch of the service was "exclusionary."

"With the advent of the Durbin Amendment in 2012, launches of new payment technologies should consider that financial institutions are required to have at least two unaffiliated networks supporting the same technology," Woodbury said. "The exclusionary nature of the Apple Pay launch disadvantaged many Visa and MasterCard financial institution clients who participate in one of the domestic debit networks. These financial institutions are unable to launch their program until two of their network partners are supporting the tokenization technology."

Sloane said part of the burden of allowing merchants to access the independent networks falls on their acquiring banks. He said normally merchants can refer to a lookup table to identify alternative network options, but such tables are not yet available for networks with token services.

"It's taking time to implement. This is a gray area. It's really the acquirer that needs to get that routing information to the merchant," Sloane said.

But Kantor said part of the delay in making the PIN networks visible for routing NFC transactions is a lack of important information provided by Apple, Visa and MasterCard to be able to make the necessary upgrades.

The other PIN networks "can handle the transactions," but "it's that the way that Apple Pay is configured doesn't allow the merchant's processor to see what the other option is," he said. "It's not something that the networks … need to do. It's something that Apple Pay and Visa and MasterCard have to do. They have to tell everyone how to program things to make that secondary network possible to see."