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Credit Card - Operations

. Canadian Imperial Bank of Commerce v. Canada

In Canadian Imperial Bank of Commerce v. Canada (Fed CA, 2021) the Federal Court of Appeal, as part of a decision as to when a bank is subject to GST/HST in it's credit card operations, sets out an interesting and useful description of a typical credit card operation:
B. A typical Visa transaction

[15] A typical transaction using a Visa credit card and the Visa payment system involves the cardholder, who uses a Visa credit card to pay for goods or services; the merchant, which accepts the Visa credit card as payment; the issuer (here CIBC), which issued the Visa credit card to the cardholder and provides the cardholder with credit; the acquirer, which entered into an agreement with the merchant to accept Visa credit cards as payment; and Visa, as operator of the Visa payment system.

[16] When the cardholder presents the Visa credit card to the merchant as payment, an authorization request is sent electronically from the merchant to the acquirer, and almost simultaneously from the acquirer to Visa and from Visa to the issuer. The issuer (or, in some cases, a third party to which the issuer has outsourced the approval function) checks the cardholder’s available credit, and returns either an approve or a decline message to Visa. The message is transmitted almost simultaneously from Visa to the acquirer and from the acquirer to the merchant. The authorization process takes but a second or two, and Visa processes approximately 65,000 transactions per second.

[17] If the purchase transaction is authorized and completed, the merchant transmits a transaction record to the acquirer, ordinarily as part of a file transmitted daily with records of other transactions. The acquirer then sends it to Visa, which sorts the records by issuer, and advises each issuer of the net daily settlement amount payable. This comprises the amounts charged on the Visa credit card less interchange fees (fees payable by the acquirer to the issuer) and chargebacks (amounts reflecting the issuer’s reversal of a transaction – for example, for fraud). The issuer then sends the net settlement amount to Visa by paying it into the settlement bank account Visa has designated (in this case, an account with Scotiabank). Visa then pays out of this account to each acquirer the settlement amount the acquirer is owed. Each acquirer in turn pays each of its merchants the net amount the merchant is owed, taking account of fees payable. Finally, the issuer includes the amount payable by the cardholder on the cardholder’s monthly statement, and collects payment, plus any applicable interest, from the cardholder.

[18] Where an acquirer disputes a chargeback, the dispute is subject to rules and a dispute-resolution process established by Visa. Visa will also sometimes stand in to authorize transactions on an as-needed basis when the system of an issuer (or third party processor) is temporarily non-operational. These stand-in authorizations are subject to parameters communicated to Visa by the issuer.

C. Risks and indemnities

[19] Under the Visa rules, Visa is exposed to a variety of risks. One of these is settlement risk. Visa indemnifies its customers for any settlement loss suffered as the result of another customer’s failure to fund its daily settlement obligations. Visa may indemnify customers on this basis even where a transaction is not processed on the Visa system.

[20] In its annual report (Form 10-K) for 2009 filed with the United States Securities and Exchange Commission (Public Appeal Book, Vol. III, Tab K4, p. 964), Visa explains that "“[t]his indemnification creates settlement risk for [it] due to the difference in timing between the date of the payment transaction and the date of subsequent payment. The term and amount of the indemnification are unlimited.”" It goes on to state that concurrent settlement failures by customers, or systemic operational failures that last more than one day, could expose it to significant losses and materially affect its financial condition.

[21] To manage its exposure to settlement risk, Visa maintains a credit risk policy that contains credit standards and risk control measures. These include regular evaluation of customers to which it has significant exposure, and a variety of potential remedial actions up to and including terminating the right of participation in the system.

[22] According to the notes to its 2009 financial statements, Visa’s estimated maximum settlement risk exposure as of September 30, 2009 was approximately US$41.8 billion, of which US$3.7 billion was covered by collateral. As of the same date, the estimated probability-weighted fair value of the settlement risk guarantee was less than US$1 million. The evidence in the Tax Court was that Visa Canada has never had to make any payments on the settlement indemnity, and that Visa Inc. has incurred no material loss related to settlement risk in recent years.

[23] Other risks to which Visa is exposed are sovereign risk, foreign exchange risk, and merchant risk. Sovereign risk is the risk from operating in countries whose financial institutions are of questionable solvency. Foreign exchange risk arises from settling in multiple currencies, which in turn requires maintaining a large foreign exchange position all over the world.

[24] Merchant risk is the risk that, after the cardholder has made a valid purchase using a Visa credit card, the merchant will become insolvent and fail to provide the purchased goods or services. In these circumstances, Visa would indemnify the cardholder by not charging the issuer for the goods or services. For this reason, Visa’s risk management division actively monitors financially distressed merchants, consults with their acquirers, and may require the acquirers to post collateral. There was evidence before the Tax Court that concern about merchant risk, including the need for indemnification, was the main reason why Visa and its competitor MasterCard started up: their systems relieved individual issuers from the need to assess and monitor the credit-worthiness of merchants who were unknown to the issuer and might be located anywhere in the world. Like the settlement risk indemnity, Visa also provides this indemnity even in cases where the transaction is not processed on its system.

[25] While under the Visa rules it is the issuer or acquirer, and not Visa, that bears responsibility for fraud risk, Visa analyzes and responds to fraudulent transaction activity on an ongoing basis. Issuers and acquirers must agree to follow Visa-specified anti-fraud requirements and controls.

D. Benefits to CIBC

[26] Participation in the Visa payment network provides CIBC with a variety of benefits, in addition to the indemnities and controls just discussed.

[27] One obvious benefit is that CIBC earns revenue from its Visa credit card business. It does so in three principal ways. First, it earns net interest income to the extent that the interest it charges customers who do not pay their monthly credit card bills exceeds its cost of funding these receivables. Second, it earns interchange fees from acquirers, based on a percentage of purchases made with CIBC-issued Visa credit cards. Visa establishes default interchange rates, which CIBC has adopted, though CIBC is (like other issuers) free to negotiate its own rates. The third source of revenue is the annual fees charged to cardholders.

[28] Apart from serving as a source of revenue, the Visa payment system benefits CIBC by making it possible for merchants to trust that they will always be paid for goods and services charged to a Visa credit card. Absent this trust, merchants would not accept, and CIBC’s customers would not be able to use, Visa credit cards in payment for goods or services. The Visa rules also protect CIBC, through the chargeback mechanism, from having to fund purchases of goods and services that the merchant fails to provide.

[29] CIBC and other issuers also derive benefits from the Visa brand, which leads cardholders to trust and recognize the utility of the card and the ability to use it around the world.


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