Visa's flexible credential: A boon for the Capital One-Discover deal?

Andrew Harrer/Bloomberg

Decoupling the payment card from the funding source of a transaction via digital wallets could set off fresh competition between issuers. It could also be a favorable development for Capital One's proposed $35 billion deal to buy Discover Financial Services as regulators prepare to consider the deal's market impact, some observers say.

Developments at other payment companies bolster this argument. A new "flexible credential" technology Visa recently introduced echoes the pioneering approach of Curve, a U.K.-based fintech with a U.S. office, expanding payment card funding options by enabling users to pick any mode — debit, credit or installment loan — from any account to pay for items.

"Because Capital One will have its choice of routing transactions on the rails of Discover, Mastercard or Visa, it could benefit from Visa's flexible credentials by making it easier to offer merchants a choice for card network routing, along with other alternative funding options at the point of sale," said Richard Crone, a principal at Crone Consulting LLC.

That theory will be a tough sell for opponents of the merger, including Elizabeth Warren, D-Mass., and the nonprofit organization Americans for Financial Reform, which argues that the combination would narrow consumer choices by creating the largest U.S. credit card issuer, and through its market power enable Capital One to hike the fees it charges merchants.

Apart from the market effects of Visa's flexible credential, certain large banks have been quietly lobbying against the Capital One-Discover merger for months, according to Eric Grover, a principal with Intrepid Ventures. 

"The other goliath banks don't want the deal to go through because they'll face a more formidable competitor," Grover said, adding that Capital One's weight combined with Discover's Pulse debit network would almost certainly take market share from existing players. 

Capital One said it plans to move its debit card volume from Mastercard to the Discover Network if the merger is approved, while initially transitioning only a portion of existing Visa and Mastercard credit accounts cards to Discover's rails.

The Federal Reserve and the Office of the Comptroller of the Currency announced on May 14 a two-month extension of the public comment period for the proposed Capital One-Discover deal — now set for July 24 following a July 19 virtual public meeting.

The use of a virtual public meeting ensures that it will get the broadest possible input from all audiences for the high-profile deal, said equity analysts at TD Cowen, in a May 14 note to investors. TD Cowen is optimistic about the merger's chances of being approved during the first half of next year, and the analysts view the second extension of the comment window and widened access to the public as a positive sign.

"We continue to expect this deal will win approval, as long as Capital One is prepared to fight if the antitrust division tries to block it based on a narrow market definition," wrote Jeret Seiberg, a managing director at TD Cowen, adding that courts have become "more dubious" about defining markets where broad competition exists. 

The next big hurdle for the deal is a hearing examining its effect on the Community Reinvestment Act, which TD Cowen expects may occur in September or October.

In terms of consumer and merchant choice, the Capital One-Discover merger could perk up credit and debit card options for both sides, said David Shipper, a strategic advisor at Datos Insights. Since Discover doesn't have 100% U.S. retail acceptance, Capital One likely would come up with incentives to bring more merchants into the fold, Shipper said.

"Discover reaches about 99% of merchants, but it's not 100%. Capital One wants to reach those merchants, and I think if the merger goes through, there would be incentives so merchants would see lower card costs on the Capital One-Discover Network, or whatever they decide to call it," Shipper said.

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Rapid payments technology development is spurring competition between credit and debit card issuers in other ways, said Aaron McPherson, a principal at AFM Consulting.

"Visa's flexible credential is a defensive move, and particularly relevant in the context of open banking, growing peer-to-peer payment network volume and possible legislation requiring that merchants can choose which networks transactions are processed on," McPherson said, referring to the Credit Card Competition Act. 

That legislation is scheduled for a key vote in the U.S. Senate in October after it was reintroduced in the Senate and House last year. If the CCCA is enacted, the Federal Reserve would develop new rules requiring that merchants have the option to choose between two different card networks, with the goal of driving down credit card interchange fees merchants pay to banks. 

American Express and Discover would be most likely to benefit from increased credit card volume if the CCCA passes, observers say. But if the CCCA passes and the Capital One-Discover deal is approved, Discover would still lag far behind other card networks in its transaction volume, according to Grover. 

"Even with a massive increase in debit and credit transaction volume, Discover will still be a weak No. 4 payment card network behind Visa, Mastercard and American Express," he said.