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December 2010

Top Ten Developments in the Canadian Payments Industry in 2010

Over the past year the Canadian payments environment has undergone a period of dramatic change. Competition has intensified across most major segments of the industry, EMV migration has gained traction, technological innovation has resulted in new payment mechanisms being developed and rolled out, and regulatory scrutiny of the industry has increased. Here is our assessment of the top ten developments in the Canadian Payments Industry in 2010.

  1. Establishment of a ‘Voluntary’ Code of Conduct for the Credit and Debit Card Industry in Canada
    The final form of the voluntary Code of Conduct was tabled by the Minister of Finance, Jim Flaherty, on May 18, 2010, after more than a year of intense lobbying by the retail sector and other key players in the Canadian payments ecosystem. The major financial institutions involved in the Canadian payments industry were quick to publicly adopt the voluntary code for fear of it becoming compulsory, and to head off the possibility of more stringent direct regulation. Provision 6 of the Code prevents co-resident competing applications on the same debit card. One of the most important impacts of the Code has been to delay the entry and rollout of scheme debit (Visa and MasterCard) into the Canadian market, thereby giving Interac an extended period of monopoly protection.  The Code of Conduct came into effect in mid-August, 2010. It applies to payment card networks (i.e. credit and debit card networks), card issuers and acquirers.  The Financial Consumer Agency of Canada (FCAC) has responsibility for overseeing compliance with the Code.
  2. Payments System Review Task Force Established
    In June 2010, Finance Minister, Jim Flaherty, announced the formation of a Payments System Review Task Force “to help guide the evolution of the payments system in Canada”. While the Task Force’s mandate is fairly broad in that it addresses policy, innovation, regulatory structures, the competitive environment and security of the payments system, it marks the start of an era of increased regulatory oversight in the Canadian payments industry. The Task Force is scheduled to present recommendations to the Minister of Finance by the end of 2011.
  3. Interac’s Application to Convert to ‘For-Profit’ Status Declined
    Interac has been engaged in discussions with the Competition Bureau since 2007 in an effort to be allowed to operate as a for-profit organization. This was largely a response to the threat of increasing competition from Visa and MasterCard in the Canadian debit market. With Visa and MasterCard now publicly traded companies, they are no longer subject to similar levels of scrutiny by the Competition Bureau and are free to structure their businesses and pricing in any way that they choose, provided they do not breach the provisions of the Competition Act.  In February 2010, the Canadian Competition Commissioner declined to grant permission to convert to ‘for-profit’ status, but left the door open for further discussions should the situation change. This development was not surprising, given Interac’s near monopoly in the debit transaction market. A change in situation that would warrant a review of Interac’s status would imply that other debit card networks had gained a reasonable share of the market, and that Interac was no longer in a position to exercise market power or abuse its dominant position. Other aspects that Interac will have to address prior to gaining ‘for-profit’ status are changes to its governance, structure and funding.
  4. Contactless Rollout Gains Momentum
    The contactless market in Canada reached a critical mass of contactless cards and merchant acceptance terminals in 2010. More than 30 million contactless payment cards have been issued and there are in excess of 70,000 merchant acceptance terminals in place. Acceptance infrastructure rollout has been atypical in that it has been implemented in a ‘top-down’ manner, focusing on large merchants that have multiple checkout lanes and points-of-sale. MasterCard has the clear lead, having started its Canadian PayPass contactless initiative in 2007 (it originally showcased the technology in Canada in 2004). Most MasterCard issuers in Canada have started to issue PayPass cards.  Over the past year Visa’s payWave initiative also started to gain momentum and Visa issuers and acquirers have focused on playing catch-up. Interac conducted contactless trials in 2010 and has announced that it will be offering a contactless debit product – under the name Interac Flash – in 2011. While the number of acceptance terminals and cards is substantial and still growing rapidly, usage of contactless technology is still lagging. Most consumers are unaware of the fact that the cards issued to them have a contactless capability.
  5. Interac’s EMV Migration Deadlines Come into Effect
    The first slew of Interac’s EMV migration deadlines come into effect at midnight tonight. According to the Interac schedule, 90% of deposit-taking ABMs, 50% of white-label ABMs and 35% of POS terminals must be EMV compliant by December 31, 2010. Most of the bank-owned ABM’s have already been converted, whereas white-label ABMs are way behind schedule. In September, Interac offered the white-label ABM industry a compromise to either have 50% of their ABM’s converted by the deadline, or have 80% of ABM’s in high-risk locations converted. It is estimated that less than 20% of white-label ABM’s have been converted thus far. Organizations that are not compliant with Interac’s EMV migration schedule face sanctions and the risk of transactions being blocked. In September, Visa and MasterCard both postponed their EMV liability-shift dates from October 31, 2010 to 31 March, 2011.
  6. The First Competing Debit Application is Launched in Canada
    The Code of Conduct for the Credit and Debit Card Industry prevents competing debit applications appearing on the same card. In October 2010, CIBC launched a debit card that allows Interac debit transactions for domestic payments at points-of-sale, and Visa debit payments for international or online transactions. While some have suggested that the card is in contravention of the Code, the fact that the debit applications on the card do not compete, means that the card is compliant with the Code. In 2009, some debit transactions on Bank of Montreal transactions were routed through Maestro, which created a furor amongst merchants, and led to intense government lobbying to prevent preferential routing that did not default to Interac debit.
  7. First ‘Dual’ Card Issuers Appear in Canada
    The Competition Bureau of Canada has, historically, not allowed the same financial institution to issue both Visa and MasterCard credit cards, and the market developed as a ‘non-dual’ environment. In November 2008 the Canadian Competition Commissioner issued a ruling permitting duality in the Canadian market. Duality gained traction in 2010 with the Royal Bank of Canada, traditionally a Visa issuer, issuing a MasterCard WestJet World credit card. In June 2010, CIBC, also a Visa credit card issuer, announced that it would acquire CitiCards $2.1 billion MasterCard card portfolio, opening up a new mass market segment to CIBC and allowing the successful Petro-Canada loyalty program to be brought on board.  The deal closed on September 1, 2010. The CIBC Citibank deal is unlikely to have a major impact on Visa since an existing base of CitiCards is being brought into the CIBC fold. The RBC WestJet card, however, erodes Visa’s share directly since it cannibalizes the Visa base in a traditional Visa stronghold.
  8. Canadian Banks Launch Mobile Banking Applications for Smartphones
    The increasing usage of smartphones in Canada has stimulated the development of mobile banking applications by most of the large Canadian banks. CIBC was first to launch a mobile banking app for the popular iPhone, but others followed rapidly and most large banks now have mobile banking applications for the iPhone, Blackberry and Android platforms, with launch usually occurring in that order. While mobile banking applications provide an extension to the online banking services that are so popular with Canadians, most banks see it is a precursor to mobile payments. Once consumers are familiar with conducting financial transactions on a mobile device – and have developed a level of trust in mobile transactions – it will be easier to gain acceptance of payment applications.
  9. Tim Horton’s Decides to Accept Debit Cards
    The iconic Tim Horton’s chain of coffee shops finally succumbed to the onslaught of debit in November by agreeing to accept Interac debit payments at all of its outlets across Canada. The company first started accepting debit payments in western Canada in 2003, but was reluctant to roll this out to other stores for fear of increasing transaction times. Interestingly, Tim Horton’s was one of the first to accept MasterCard PayPass payments. While both Interac and Tim Horton’s have denied that the move has anything to do with Interac’s plans to rollout contactless payments in 2011, it is unlikely that the move to debit acceptance would have taken place without the prospect of contactless debit payments on the horizon.
  10. Competition Bureau Takes on Visa and MasterCard
    On December 15 the Canadian Competition Bureau announced that it will be challenging Visa and MasterCard’s ‘honour all cards’ rule and ‘no-surcharge’ rules, since it regards these as a demonstration of anticompetitive behaviour. The Bureau has submitted an application to the Competition Tribunal to have these, and other allegedly anti-competitive rules, struck down. The action is being brought under the price maintenance provisions of the Competition Act. According to independent legal commentary on the matter, it is believed that the action under the price maintenance provisions of the Act will be more effective than under abuse of dominance provisions since it does not require the Competition Bureau to prove that the two players are dominant and have abused their dominance by reducing competition.

New Canadian Wireless Entrants lash out at Incumbents

At the Mobile Monday Toronto meeting held on December 6, senior executives of Wind Mobile and Public Mobile sketched the emerging Canadian wireless environment and lashed out at incumbents for their anticompetitive behaviour. The new entrants to the Canadian wireless market were represented by Anthony Lacavera, Chairman of Wind Mobile, and Alex Krstajic, CEO of Public Mobile. In a panel session chaired by Jeff Mucci, Publisher of RCR Wireless, Lacavera and Krstajic highlighted the impact that new wireless entrants have had on the mobile market in Canada.

 Prior to entry, they said, unlimited plans were “unheard of” in Canada, but are now offered by most operators. Service pricing has decreased as a result of competition, and the large wireless carriers have launched competitive offerings. Incumbents have also tried to bolster their position in the marketplace by having subscribers sign lengthy wireless contracts – in most cases up to three years – in an effort to prevent erosion of their subscriber base. Lacavera commented that the contract cancellation penalties are particularly harsh in Canada, and that mobile service agreements are more onerous than most car lease agreements. The key reasons why subscribers are prepared to sign these contracts are that incumbents subsidize phones, and they also offer some of the most sought after handsets, including the iPhone.

Krstajic noted that Rogers’ launch of of the low-end brand, chart, was a blunder of note on a number of levels. Firstly, it cannibalizes Rogers’ own profits. Secondly, the brand chose to differentiate itself on a false claim of having the fewest dropped calls – a move that has recently seen Rogers fined $10 million by the Competition Bureau for false advertising. Krstajic’s prediction is that “a senior executive from Rogers will lose their job over this within the next year”.

Anticompetitive antics

Both executives were most vocal on the anticompetitive behaviour that they claimed was being practised by incumbents. Kristajic noted that, while tower sharing was mandated by government almost three years ago, not a single tower has been shared by incumbents. One of the strategies followed by incumbents has been to populate their towers with inactive antennas in anticipation of applications by new entrants, on the basis that they are building out their capacity in preparation for future demand. This allows them to assert that their towers are not able to take any additional antennas at any reasonable height on the tower (increased height equates to increased coverage). Furthermore, they then maintain that that some of the towers have reached the maximum stress limits and that placement of new antennas on the towers will require the applicant to pay for rebuilding the tower to handle the increased load. Lacavera and Kristajic called on the CRTC and policy-makers to prevent this kind of anticompetitive behaviour and enforce tower sharing on reasonable and competitive terms.

Lacavera and Krstajic admitted, in response to a question from the floor, that their organizations didn’t share any towers with each other. Lacavera commented, somewhat sheepishly, that this is an area “where we should definitely do more”.

The issue of future 700 MHhz spectrum auctions also drew fire. Krstajic said that the questions of “set asides” for new entrants was being determined by Industry Canada, and commented that the full allocation should be set aside so that incumbents were not allowed to bid. He refuted claims by incumbents that they urgently needed spectrum for future network development and suggested that incumbents are hoarding it. He accused Bell and Rogers of being “spectrum squatters”. He quipped, rather humorously, that “Bell, Rogers and Telus have all been breast-fed until the age of twelve on spectrum! They're obese on it!”

However, both incumbents and new entrants believe that it is unlikely that the full allocation of 700 MHz would be set aside for new entrants. The executives representing the new entrants suggested, in recognition of this, that incumbents wanted to accelerate the 700 MHz spectrum auction process since they realized that new entrants were still busy investing in and building out their networks – leaving little financial capacity for engaging in a further round of expensive spectrum auctions.

The mobile industry has been participating in discussions with, among other entities, the Payment System Review Task Force, in order to advance the mobile payments and mobile commerce agenda. Krstajic commented that this was not an immediate area of concern for Public Mobile since it was not, at this stage, of great importance to their blue-collar target market. Lacavera stated that this was yet another area where incumbents, in consort with the large banks, were trying to dominate and limit the role that new entrants could play.

When asked when Wind Mobile would be offering the iPhone, Lacavera pointed out that the Advanced Wireless Spectrum (AWS) that Wind offers services on differs from the bands used by incumbent mobile operators, and that Wind did not yet have the volume that would make it attractive for handset manufacturers, including Apple, to supply them. However, he said T-Mobile’s use of the same AWS spectrum in the USA, and their plans to offer the iPhone, would result in Apple supplying to this market, and hence Wind was likely to offer these devices at some stage in the future.

While all Canadian carriers were invited to participate in the panel discussion, only Wind and Public Mobile accepted.