Digital Assets Digest May edition

Federal Reserve: Financial Stability Report: May 2022

This report summarizes the Federal Reserve Board’s framework for assessing the resilience of the U.S. financial system. It features observations made by the Board in respect of cryptoassets.

Key points

• Stablecoins are vulnerable to runs, and the sector continues to grow rapidly.
• The stablecoin sector remains highly concentrated (the three largest stablecoin issuers—Tether, USD Coin, and Binance USD make up more than 80 percent of the total market value).
• Some cryptoassets have experienced extreme price volatility.
• The Federal Reserve like other central banks is looking at CBDCs, and in particular, how a CBDC can enhance domestic payments system and what risks to financial stability can be brought by CBDCs.

ECB: Speech by Fabio Panetta: Public money for the digital era: towards a digital euro

In this speech, Fabio Panetta, member of the ECB Board, reiterates some familiar messages in relation to the digital Euro and central bank digital currencies in general. He also refers to recent turbulence in the cryptoassets sector.

Notable points

• Certain segments of payments markets (e.g. card payments) are dominated by a few global players. The expansion of Big Techs could accentuate this trend.
• Recent developments in the cryptoassets sector suggest that it is an illusion to believe that private instruments can act as money if they cannot be converted at par into public money at all times.
• A digital Euro helps to maintain strategic autonomy and would accompany the ongoing digital transition in payments.
• Stablecoins are not risk-free and are vulnerable to runs.

FCA: CryptoSprint webpage

On 12 May 2022, the FCA published a webpage in respect of its CryptoSprint. The FCA's CryptoSprint, held on 10 and 11 May 2022, sought to examine how the cryptoassets sector could be regulated in the UK. The FCA states that it will share the outputs of the CryptoSprint in summer 2022.

ESMA: Final report on the European Commission mandate on certain aspects relating to retail investor protection

On 29 April 2022, ESMA issued a final report to the European Commission in respect of certain aspects relating to retail investor protection. This follows an earlier call for evidence from ESMA. ESMA states that input received included views on marketing practices of firms marketing complex products, as well as from non-regulated firms and specifically crypto-assets providers.

The recommendations include the following:

• addressing aggressive marketing communications; and

• addressing issues related to misleading marketing campaigns on social media and the use of online engagement practices, such as the use of gamification techniques by firms or third parties.

BIS (BCBS): Speech by Pablo Hernández de Cos: Computers and money: the work of the Basel Committee on cryptoassets

On 12 May 2022, BIS issued this speech by Pablo Hernández de Cos, Chair of the Basel Committee on Banking Supervision and Governor of the Bank of Spain, at the 36th AGM of ISDA. The speech focused on the Basel Committee's work on digitalisation, with a particular emphasis on cryptoassets.

Key points

• There is still some uncertainty as to how existing shortcomings associated with cryptoassets and DeFI can be better addressed within the existing financial architecture.
• Most cryptoassets today cannot be associated with terms such as "robustness" or "stability" and that is why there is so much energy being ploughed into CBDCs.
• The Basel Committee has found no fewer than 20 potential channels for banks, including in their capacity as lenders, issuers, providers of custody services or as market-maker to be exposed directly or indirectly to cryptoassets. This requires a forward looking approach to regulation and supervision.
• The Committee is finalising the process of reviewing the comments received on its recent consultation in relation to the prudential treatment of cryptoassets and plans to issue a further consultation paper soon.
• Design and calibration of prudential regulation should reflect level of knowledge when it comes to new asset classes, including the lack of historical data and ability to measure and mitigate risks.
• As there are unregulated areas of the financial system, including the emergence of a "shadow" crypto financial system, the appropriate response is to bring these areas within the relevant regulatory perimeter.

FSB: Speech by Klaas Knot: Diverse challenges, common threads: Preserving global financial stability today and tomorrow

In this speech, published on 11 May 2022, Klass Knot at the FSB provided an overview of challenges to financial stability posed by cryptoassets. Mr Knot refers to the FSB's recent update of its assessment of the financial stability implications of cryptoassets and the challenges associated with monitoring the sector, adding that recent events have supported the earlier stance. Mr Knot refers to the international nature of cryptoasset markets and points to the potential for regulatory gaps, fragmentation and arbitrage. He confirms that the FSB views policy work on cryptoassets is a priority for the FSB and that it will be taking forward work on the regulation and supervision of "unbacked" cryptoassets and "stablecoins". Mr Knot stressed the importance of collaboration between the FSB and standard-setting bodies such as the Financial Action Task Force.

European Commission: Targeted consultation on the review of PSD2

On 10 May 2022, the European Commission published a public consultation and a targeted consultation on PSD2, as well as a targeted consultation on open finance framework and data sharing. The Commission considers that both a public and a targeted consultation are important to collect the views of different stakeholders on the application of PSD2 market developments and the need for possible amendments. In its 2020 Digital Finance Strategy (see our briefing), the European Commission set data-driven finance as one of the priorities in its digital finance strategy and announced an open finance framework legislative proposal (see our briefing).

In the targeted consultation, the European Commission notes that the payment needs of payment service users have changed as a consequence of the continuing digitalisation of society and that new risks and challenges may have arisen as a result. The consultation asks whether payment transactions using cryptoassets should be added to the list of payment services in Annex I of PSD 2

EIOPA: Feedback statement: Discussion paper on blockchain and smart contracts in insurance

On 6 May 2022, EIOPA issued a discussion paper on the use of blockchain and smart contracts in insurance. This follows an April 2021 public consultation on a “Discussion paper on blockchain and smart contracts in insurance”.

Key points

• The use of blockchain and smart contract in the EU seems to be still in the early stages.
• Blockchain could reduce fraud, enable insurers, reinsurers, intermediaries and regulators to share data securely and in real time and give customers more control over their data, including access rights. Potential use cases include providing a proof that the customer has read the documents (e.g. pre-contractual documents under the Insurance Distribution Directive).
• The risks of Blockchain and smart contracts differ depending on the concrete use case and the contexts in which they are applied.
• MICA will particularly favour the evolution of insurance and banking investment products (e.g. Unit and Index-Linked life insurance products).
• Greater clarity and convergence is needed in relation to accounting definition of cryptoassets, the applicable accounting standards, the fair value of the asset and prudential treatment of cryptoassets.

FCA: Speech by Nikhil Rathi, Chief Executive: Learning from the last 30 years to face the next

On 5 May 2022, the FCA issued a speech by FCA CEO, Nikhil Rathi. The speech touched on the impact of digitalisation and cooperation between UK regulators in relation to digitalisation. Mr Rathi argues that developments in digitalisation have led the FCA to partner with the Competition and Markets Authority, the Information Commissioner’s Office and Ofcom to form the Digital Regulation Cooperation Forum (DRCF) (further details below). He adds that a key aspect will be building digital regulatory skills across all the major UK regulators. He refers to the recently published action plan (further details below) of the DRCF, which includes protecting children online from financial promotions concerning cryptoassets and notes that this is relevant for the FCA as it has noted increasingly younger participants in new financial products such as cryptoassets.

FMLC: Minutes: 7 April 2022

On 5 May 2022, the minutes of the April 2022 meeting of the FMLC were published. Among the issues discussed in the meeting was the regulation of cryptoassets. The CEO reported that, at a recent meeting of the FinTech Scoping Forum, attendees discussed HM Government’s Response to its October 2020 consultation on the regulatory perimeter and the financial promotions regime. Forum members recommended that the FMLC send a letter setting out concerns concerning legal certainty before the legislation amending the financial promotions regime is published.

EBA: Final Report on response to the non-bank lending request from the CfA on digital finance

On 4 May 2022, the EBA published a final report setting out its technical advice to the European Commission on non-bank lending, in response to a February 2021 call for advice on digital finance and related issues. The report looks at the risks and challenges posed by the increased provisions of lending by non-bank entities.

Notable findings

• FinTech has been increasing over the last years and the trends observed outside the EU show that BigTechs and other non-traditional operators have already developed and successfully rolled out business models for lending. The same applies to lending in the form of cryptoassets.
• Overall, some existing data suggest that cryptoasset lending activities in the EU are growing but are still limited in terms of observed volumes and values (report looks at different forms in which crypto-asset lending and borrowing activities can happen and activities such as "staking" and "crowdlending").
• Most dominant crypto-lending platforms and service providers are observed to be established outside the EU. Crypto-lending and staking activities are increasingly being undertaken and/or offered to customers by cryptoasset exchange services providers, who are broadening their activities by adding these new services to their exchange platforms.
• The EBA will continue to monitor the cryptoasset lending and borrowing activity in the EU, understanding the different forms and conditions under which the activities take place. In particular, it will consider the wider regulatory and policy implications of cryptoasset lending, chiefly implications of MICA. National competent authorities in EU Member States do not seem to have developed specific regulatory regimes covering cryptoasset lending, and the MICA proposal is not expected to cover these specific activities.

BIS: Working paper: Gaining momentum – Results of the 2021 BIS survey on central bank digital currencies

On 6 May 2022, BIS issued a working paper on the results of its survey on central bank digital currencies. BIS surveyed 81 central banks about CBDC work, as well as their motivations and their intentions regarding CBDC issuance.

Key findings

• Nine out of 10 central banks are exploring CBDCs, and more than half are now developing them or running concrete experiments. In particular, work on retail CBDCs has moved to more advanced stages.
• Globally, more than two thirds of central banks consider that they are likely to issue a retail CBDC in either the short or medium term.
• Work on wholesale CBDCs is increasingly driven by reasons related to cross-border payments efficiency.
• Most central banks in the survey still perceive the use of cryptocurrencies for payments to be trivial or limited to niche groups. However, the use of stablecoins is perceived to be lower than the use of other cryptocurrencies, and especially for cross-border payments.

FCA: Statement on the risks of investing in cryptoassets

On 11 May 2022, the FCA issued a statement reminding consumers about the risks of investing in cryptoassets. The statement refers to recent social media posts concerning cryptoassets and non-fungible tokens (NFTs) and states that there are no consumer protections or FSCS protection in relation to the purchase of cryptoassets and NFTs.

Those marketing cryptoassets are reminded of guidelines set out by the Advertising Standards Authority (ASA) and the FCA notes that the ASA has investigated multiple adverts for cryptocurrencies which did not make it clear that the product was not regulated or protected in the UK.

ISDA: Speech: ISDA AGM 2022: Day 1 Scott O'Malia Opening Remarks

ISDA has published the Opening Remarks of Scott O'Malia at ISDA's AGM. Mr O'Malia examines ISDA's role in bringing order to the crypto derivatives markets. The speech refers to a recent ISDA whitepaper on the accounting framework for digital assets and Mr O'Malia notes that ISDA has also raised concerns about what it perceives to be conservative capital treatment of crypto assets set out by the Basel Committee on Banking Supervision and how this would make it meaningful participation by banks difficult (i.e. ISDA considers the proposed 1,250% risk weight for certain crypto assets is excessive).

ISDA: White Paper: Accounting for Digital Assets: Key Considerations

ISDA has published this paper which is proposing that the framework for accounting for digital assets should allow for them to be accounted for at fair value. The paper examines at the accounting implications of recent investment in and use of digital assets, including, but not limited to, cryptocurrencies. The paper aims to identify and illustrate how digital assets are accounted for and reported. The paper categorizes digital assets into two groups: native digital assets that exist solely as a digital asset and do not represent any legal or proprietary interest in other assets; and asset-referencing digital assets that reference an underlying asset or right through a legal or operational mechanism. It argues that the type of digital asset will be a major factor in the accounting and financial reporting of the instrument under existing accounting rules.

PRA: Business Plan 2022/23

The PRA has published a Business Plan setting out proposed action in a number of areas, including cryptoassets sector. The PRA states that is monitoring the risks associated with ongoing digitalisation of financial services and the growth of crypto assets, the increasing use of artificial intelligence and machine learning, and developments in FinTech. The PRA confirms that it will continue to contribute to the BoE's work on cryptoassets, including oversight of the risks emerging from exposures in cryptoassets. The PRA will also ask firms to report their cryptoasset exposures, treatments and future investment plans. It confirms continued engagement with international partners, including at the Basel Committee on Banking Supervision, to establish a common, international framework for the treatment of cryptoasset exposures.

DIT: Speech by Anne-Marie Trevelyan MP: Opening remarks at City Week 2022

On 27 April 2022, a speech by Anne-Marie Trevelyan MP outlining the importance of the financial services sector for the UK and the growing importance of FinTech was published.

Key issues

• UK is the world’s largest financial services net exporter, Europe’s leading fintech hub, and a world-leading fundraising centre.
• Almost half of Europe’s Fintech unicorns were built in the UK.
• The Government is putting in a lot of effort to implement the recommendations of the Kalifa review.
• The Government and Innovate Finance launched the International FinTech Group, uniting industry and government to keep UK FinTechs at the forefront of the industry.
• The UK was the first European country to sign a Digital Economy Agreement with Singapore.

EBA: Response to call for advice on review of EU banking macro-prudential framework

On 29 April 2022, the EBA published its response to the call for advice from the European Commission concerning the Commission's review of the EU banking macro-prudential framework. The EBA states that it considers it premature to introduce new macro-economic tools to address the systemic risks arising from issues such as cryptoassets, given that there are currently international initiatives on these risks.

Digital Regulation Co-operation Forum: Annual report and workplan for 2022/23

On 28 April 2022, the Digital Regulation Co-operation Forum (DRCF) published its annual report and its workplan for 2022/23. Work will focus on three areas: coherence between regimes; collaboration on projects; and capability building across regulators.

The DRCF annual report for 2021/22 sets out the DRCF's work in relation to the following priority areas: responding strategically to industry and technological developments; developing joined-up regulatory approaches; and building shared skills and capabilities.

The Competition and Markets Authority (CMA), Ofcom, the FCA and the ICO are members of the DRCF, which was established to support regulatory co-ordination in digital markets, and co-operation on areas of mutual importance.

Council of EU: Comparison table in trialogue negotiating positions on proposed Regulation on information accompanying transfers of funds and certain cryptoassets

On 21 April 2022, the Council of the EU published a note (8293/22) from the General Secretariat to the Delegations with a three-column table to commence trialogues. It contains negotiating positions taken by the European Commission, the Council and the European Parliament on the proposed Regulation on information accompanying transfers of funds and certain cryptoassets.

The Council agreed its negotiating mandate in December 2021.

FSB: Progress update to G20 finance leaders and central bank governors: April 2022

On 20 April 2022, the FSB published a letter sent by Klaas Knot, FSB Chair, to the G20 finance ministers and central bank governors.

Key issues

• Crypto-asset markets are fast evolving and could reach a point where they represent a threat to global financial stability due to their scale, structural vulnerabilities and increasing interconnectedness with the traditional financial system.
• The FSB is taking forward, in collaboration with standard-setting bodies, work on the regulation and supervision of "unbacked" crypto-assets and "stablecoins". The FSB will keep the G20 updated on the FSB’s work on crypto-assets, reflecting the ambitions set out in the February G20 communique.
• The FSB is continuing to coordinate the work to advance the G20 cross-border payments roadmap. This work will provide the platform for the action and investment needed, by both the private and public sector, to meet the targets for improving cross-border payments that G20 members committed to in October 2022.

AIMA: Guidance on Digital Asset Custody

On 27 April 2022, AIMA announced that it had issued guidance on digital asset custody for institutional investors. The guide provides industry guidance on sound practices and key considerations around due diligence for institutional investors in relation to custody of digital assets. It is intended to be a jurisdiction-neutral guide and has been primarily designed for institutional investors who are seeking the services of a digital asset custodian.

House of Commons (Treasury Committee): Eighth Special Report of Session 2021–22: Economic Crime: responses to the Committee’s Eleventh Report (HC 1261)

The Treasury Committee has published responses to its report on fraud, scams and economic crime. The report contained a number of recommendations for UK regulators and the Government. The responses received to the report from HM Treasury, the FCA and the Payment Systems Regulator and summarises their plans in relation to the regulation of the cryptoassets sector.

ECB: Call for expression of interest for digital euro front-end prototyping

On 28 April 2022, the ECB announced a call for expression of interest for payment service providers, banks and other relevant companies to join an exercise to develop prototype user interfaces The ECB has also published an application questionnaire.

The digital euro investigation phase is moving forward with an exercise to explore user interface solutions for making payments with digital euro. The ECB confirms that the prototyping exercise will begin with an information session in June 2022 to discuss specific expectations for the project, including use cases.

ECB: Speech by Fabio Panetta: For a few cryptos more: the Wild West of crypto finance

On 25 April 2022, the ECB issued a speech by ECB member Fabio Panetta concerning the crypto assets sector.

Interesting points

• Policymakers should ensure that crypto-assets should be used within clear, regulated boundaries and for purposes that add value to society and that sovereign money is fit for the digital age.
• The market is highly concentrated: retail investors hold less than 10 bitcoins own one-tenth of bitcoin supply, while professional investors and high-net-worth individuals hold almost two-third.
• Fear of missing out and social media is leading to many investing without understanding what they are investing in.
• Big payment networks have stepped up their support services for crypto-assets and intermediaries are seeing a significant increase in retail holdings.
• The launch of the first bitcoin exchange-traded fund in the United States in October 2021 is a sign of increased institutional activity in these assets.
• There is an increase in participation of high-net-worth investors, financial advisors and family offices in terms of investment in cryptoassets.
• Linkages between cryptoassets and wider financial system are still limited but policy makers need to consider how a sudden surge in redemptions by stablecoin holders could lead to instability in various market segments.
• Progress is needed in the following areas: holding crypto-assets to the same standards as the rest of the financial system; strengthening public disclosure and regulatory reporting; transparency requirements and standards of conduct to be followed by professional operators in order to protect unexperienced retail cryptoasset investors.

House of Commons: Answer to written questions: Treasury

In this Q&A, John Glen, Economic Secretary to the Chancellor the Exchequer responds to a question posed by Labour MP, Tulip Siddiq, on the total cost of creating the Royal Mint non-fungible token. Mr Glen confirms that work on the NFT is at an exploratory phase and costs are not separately identifiable.

FCA: Speech by Nikhil Rathi: Critical issues in financial regulation: The FCA's perspective

On 26 April 2022, the FCA issued a speech by Nikhil Rathi This speech covered a number of areas including innovation and the cryptoassets market.

Key points

• FCA "sandbox", has been copied and now serves as a blueprint for over 40 regulators globally.It has supported the growth and innovation of over 50 blockchain firms. The FCA aims to build on this via its Early and High Growth Oversight scheme.
• Innovate Finance say the UK represented nearly half of all European fintech investment last year.
• The FCA welcomes the Government’s recent announcement of a flexible approach to regulation so that the FCA can proportionately deal with any risks that emerge and for the FCA to have new powers over the promotion and marketing of high-risk assets such as crypto.  
• Most adults do not know that crypto is not regulated by the FCA, apart from rules concerning money laundering. Clarity is needed around future Financial Services Compensation Scheme (FSCS) coverage for investment losses from crypto, even when advised. 
• Policymaker cooperation is needed in respect of offshore providers of cryptoasset services (firms that the FCA rejects can still service UK customers from offshore)

HM Treasury: Speech by John Glen MP: Keynote Speech at a German Economic Council event in Berlin

On 28 April 2022, HM Treasury issued this speech given by John Glen, Economic Secretary to the Treasury.

Key points

• The UK government wants the UK to be a global hub for cryptoasset and a top global location for starting and scaling crypto-companies.
• The UK is keen to take a leading role in harnessing the potential of blockchain and supporting the development of a world-best crypto ecosystem.

BIS: Speech by Agustín Carstens: CBDCs for the People

On 18 April 2022, BIS issued this speech in relation to CBDCs. The speech looks at the interaction between financial inclusion and CBDCs. Specifically, the speech looks at how CBDCs can be designed and implemented to ensure that "unbanked" people have access to essential financial services.

Key points

• Financial inclusion starts, but does not end, with the ability to make and receive payments; central banks have largely met this need by providing the most inclusive form of money: cash.
• Due to the widespread adoption of digital and mobile technologies, the payments landscape is changing. Cash transactions are declining, and there is a shift toward digital activity. Regulators must work together to close the widening divide.
• CDBCs could offer an opportunity to overcome some barriers facing the unbanked.
• Both fast payment systems and CBDCs can encourage competing providers to offer new services, lower costs, and, ultimately, broaden access
• Any CBDC rollout must be accompanied by policy reforms and safeguards to address potential difficulties and risks, such as low levels of financial and digital literacy, and operational challenges, including cybersecurity.

ECB: Annual Report 2021

On 28 April 2022, the ECB issued its annual report. In the report, the ECB noted progress made in 2021 with respect to regulatory reform and also notes the resilience of financial system in withstanding the COVID-19 pandemic but notes that work needs to be done in developing regulations for the cryptoassers sector.

Key issues

• In response to digital transformation, new regulatory requirements and changing user demands, the Eurosystem has been reviewing and renewing existing market infrastructures, policies and strategies, as well as exploring new technologies, digital currencies and developments in crypto-assets.
• The ECB proposed strengthening certain requirements in the Markets in Crypto-assets Regulation.
• The ECB adopted seven opinions on EU proposals concerning innovations in the fields of digital finance.

BIS: G20 TechSprint 2022

On 25 April 2022, BIS announced the launch of the third G20 TechSprint Initiative. This year's TechSprint will focus on solving technology challenges related to wholesale and retail central bank digital currencies (CBDCs).

Key challenges identified in this year's TechSprint include:

• building effective and robust means to issue, distribute and transfer CBDCs;
• enabling financial inclusion: CBDCs also offer an opportunity to deepen financial inclusion and to overcome barriers facing the unbanked and underbanked;
• improving interoperability: CBDCs can help to improve and enable connections; and
• linkages in payment systems, enhancing connectivity and interoperability.