IS US TAKING ON THE CREDIT CARD CARTEL?

China toughened up regulation of big tech which led to a strong reaction in markets. There are signs that US regulation is beginning to affect markets too.

The Chinese regulators attack on Chinese big tech has lead to a 40% fall in the value of Hang Seng Tech Index, with larger falls in areas such as online education, and fan based media businesses. The Biden administration also made a number of anti-trust moves against big tech, but unlike in China with no noticeable effect.

For many market commentators, the divergent paths of Chinese and US tech has become a Rorschach test. Some see an over powerful Chinese Communist Party crushing all other centres of power. Some see an over powerful US corporate sector that can easily avoid any regulation or tax. For me, as with all extreme views, the truth lies somewhere in between. The US has very powerful regulatory apparatus, but from the Reagan years onwards their power has been capped and reduced through judicial and political action. President Biden is beginning to reverse that process and there are signs that change is beginning to bite.

In May of this year, the FTC proposed a rule change on how debit cards were used. Details can be found on the “Federal Register - Debit Card Interchange and Routing”. In essence, when a debit card is used to pay in person, rules were enforced to allow a merchant the choice of which network to route a payment. However, when the person paying is not present (i.e. an online transaction) these rules were not enforced. That is debit card companies faced less competition in the much faster growing online payment market. Since the rule change, the dominant debit card payment system companies, Visa and Mastercard have underperformed the market.

Payment systems regulatory problems are probably only beginning, with FTC Head Lina Khan vocally opposing the Supreme Court decision in Ohio v American Express which endorsed the ability of the payment systems (Visa, Mastercard, American Express) to set up rules making it difficult to impossible for retailers to direct customers to cheaper systems. Khan proposes legislation to override the Supreme Court decision in this case.

Changes in US regulation are particularly important for Visa and Mastercard. Visa and Mastercard are suffering from the same problems, but Visa present their financial data in a clearer format, so will use only their data below. Despite the growth of e-commerce globally, Visa has become more reliant on the US for profits in recent years.

This is driven in part by falling volumes in Asia Pacific. These falling volumes occurred before Covid-19, and probably reflect the much more competitive nature of payment systems in Asia.

This growing reliance on the US contains some substantial risks for Visa and Mastercard. Paypal has been constantly reducing its take rate to drive growth, implying there is some pricing pressure within the payment system.

Even more problematic for Visa and Mastercard is that they acted as a middleman between millions of consumers, and thousands of businesses. This made the cost of setting up a competing payment system prohibitive. However, the dominance of Amazon, which also has a direct relationship between businesses and consumers, means this dominance is being eroded. The recent announcement that Amazon will no long accept Visa credit cards in the UK is sign of that shifting power. 10 years ago, I would suggest that such a mixed outlook should lead to a derating for these stocks, but like most of corporate America, Visa and Mastercard are large buyers of their own shares.

With US investment grade corporate debt yielding 2% against US inflation of 5%, it is hard to argue with share buybacks, but should bond markets ever demand a positive real interest rates again, buying back shares at the current valuation of 17 times revenue may not be seen as the best use of shareholder funds.