Digital Assets Digest April 2022

BIS: Paper on CBDCs in emerging market economies

On 14 April 2022, BIS issued this document on CBDCs in emerging market economies, looking at issues such as: the main objectives of introducing CBDCs; the guiding principles of CBDC design and data governance; challenges of CBDCs for monetary policy, financial intermediation and financial stability; and the cross-border aspects of CBDCs. BIS argues that like their counterparts in advanced economies, central banks in emerging economies view achieving greater payment system efficiency as one of the objectives of CBDCs. However, emerging market economies place greater stress on financial inclusion and are more concerned about cyber security risks, bank disintermediation, and cross-border spillovers than advanced economies.

BIS: Insight: Central bank digital currencies - a new tool in the financial inclusion toolkit?

On 12 April 2022, BIS issued this document on central bank currencies and financial inclusion. The document draws on interviews with nine central banks with advanced work on CBDCs, as well as ongoing research and policy work at the BIS and World Bank. It presents findings in three main areas: existing barriers to financial inclusion that could be addressed with the introduction of a CBDC; CBDC design features that many jurisdictions view as critical to addressing these barriers; and the challenges foreseen, along with legal and regulatory changes needed for CBDC implementation. The article states that buy-in from all key stakeholders, including those currently not reached by formal financial services, must be achieved if CBDC issuance is to have the intended impact.

European Commission: EU Digital Finance Platform

On 8 April 2022, the European Commission announced the launch of a digital finance platform. The launch featured a panel discussion on innovation in finance in the EU and featured closing remarks by Verena Ross, Chair of ESMA.

Announced in the September 2020 EU Digital Finance Strategy (see our briefing), the EU Digital Finance Platform is intended to promote dialogue between innovative financial firms and supervisors. Its objectives include overcoming fragmentation and supporting the scaling up of digital financial services across the Single Market.

The EU Digital Finance Platform will initially consist of two main building blocks: an Observatory offering interactive features such as a Fintech Map; and a Gateway, which will serve as a single access point to supervisors, with information about national innovation hubs, regulatory sandboxes and licensing requirements.

European Parliament: Negotiating mandate agreed for proposed Regulation on information accompanying transfers of funds and certain cryptoassets

On 7 April 2022, the European Parliament published a press release confirming its negotiating mandate on the proposed Regulation on information accompanying transfers of funds and certain cryptoassets. The European Parliament also confirmed that it has agreed to start negotiations with the Council of the EU on the proposed Regulation. This follows the adoption of the report in March 2022.

European Commission: Consultation on a digital euro

On 5 April 2022, the European Commission issued a consultation paper on the digital euro. The European Commission sets out legislative steps that would need to be taken by EU bodies before a digital euro can be used as the single currency concurrently with euro banknotes and coins. The consultation covers: users’ needs and expectations for a digital euro; the digital euro’s role for the EU’s retail payments and the digital economy; making the digital euro available for retail use while continuing to safeguard the legal tender status of euro cash; and the digital euro’s impact on the financial sector and the financial stability.

EFR: Position paper on considerations for the design of a digital euro

On 4 April 2022, the European Financial Services Round Table (EFR), a body bringing together chairmen and chief executives of leading European banks and insurance companies, published a position paper on the digital Euro. The position paper calls the digital Euro a possible "game changer" but calls for caution and careful analysis.

Notable recommendations

• When analysing the reasons to offer a CBDC, central banks should take into account the idiosyncrasies and specific characteristics of each jurisdiction and each financial system and the needs that a CBDC would help to fulfil.
• CBDCs should be used for payments and not become a new form of investment or store of value.
• CBDCs should be integrated into broader services, enabling intermediaries to offer new value-added services. Access to CBDCs should be provided through supervised intermediaries that are best suited for providing end user services and adapting to evolving user needs.
• Central banks and legislators should provide legal certainty and a policy framework for the CBDC ecosystem.
• Participation of the private sector (banks and non-banks) in the development of concrete features and design options of a CBDC is crucial.

HM Treasury: Response to consultation on UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets

On 4 April 2022, the Government issued a response to its January 2021 consultation on cryptoasssets.

The Government confirms plans to focus the first phase of legislative changes on bringing stablecoins used as a means of payment into the UK’s regulatory perimeter, whilst noting that stablecoins are currently predominantly used to in trading and investment activities in unbacked cryptoassets, (as well as playing a critical function in decentralised finance applications). The Government is also planning to look at additional regulation of a broader set of cryptoasset activities, particularly as a means of investment in a second legislative phase (later in 2022), so as to respond to the increasing usage of wider cryptoassets. The Government will amend the existing legislation governing electronic money and payments (and other relevant legislation) at the earliest available opportunity, chiefly via amendments to the Electronic Money Regulations 2011 (SI 2011/99) and Payment Service Regulations 2017 (SI 2017/752). The Government also confirms that it will legislate to establish a financial market infrastructure (FMI) "Sandbox" that will enable firms to test Distributed Ledger Technology. A further consultation with industry in advance of the introduction of secondary legislation on the legislative framework of the Sandbox is planned.

The government has also published terms of reference for the Centre Finance, Innovation and Technology Steering Committee. The vision for CFIT was set out in the Kalifa Review, which recommended the creation of a new private sector-led organisation focused on driving forward financial innovation (see our briefing).

HM Treasury: Keynote Speech by John Glen, Economic Secretary to the Treasury, at the Innovate Finance Global Summit

On 4 April 2022, the Government published a speech by John Glen, Economic Secretary to the Treasury. The speech outlines plans in relation to digital assets. In the speech, Mr Glen referred to a two day FCA "CryptoSprint" in May 2022. Mr Glen also confirmed plans to establish a Cryptoasset Engagement Group, convening key figures from the regulatory authorities and industry, to advise the Government on issues facing the cryptoasset sector. Mr Glen also confirmed that the Government would be looking at disincentives that may be preventing UK fund managers from having cryptoassets in their portfolios.

FCA: Speech by Jessica Rusu, Chief Data, Information and Intelligence Officer: Building a digital regulator: how the FCA is riding the innovation wave

On 4 April 2022, the FCA issued a speech by Jessica Rusu, Chief Data, Information and Intelligence Officer at the Innovation Finance Global Summit 2022. In the speech, Ms Rasu notes that technological innovation has resulted in an explosion of data. Ms Rusu states that the FCA must foster innovation, be intelligence led and prepare for the future. Ms Rasu outlines the role that the new unified firm support service "Innovation Pathways" could play in promoting a regulatory environment for future innovation. She argues that the future CryptoSprint and APP Fraud TechSprints will help to support innovation. Ms Rasu notes that in response to recommendations from the Kalifa Review, the FCA committed to establishing a regulatory "scalebox" that supports firms focusing on scaling innovative technology. She notes that the FCA piloted "Early Oversight" and "High Growth Oversight" initiatives and that the FCA is currently reviewing the findings of the pilots and will be announcing next steps soon.

Bank of England: Speech by Victoria Cleland, Executive Director for Banking, Payments and Innovation: The road to enhanced payments

On 31 March 2022, the Bank of England published a speech by Executive Director for Banking, Payments and Innovation, Victoria Cleland. Ms Cleland described the role of the RTGS in maintaining stability and promoting innovation in the context of rapidly changing user needs and how collaboration between central banks and other stakeholders can deliver far-reaching benefits.

Ms Cleland noted that high-value payments form more than 90 percent of the value of electronic payments transmitted in the UK and that due to their value and their importance to financial stability, these payments often settle directly at central banks. She further explained that this means that central banks can have a strong impact on how these wholesale payments perform and evolve.

Ms Cleland noted that payments were the most active area of FinTech investment, making up a quarter of the total. Ms Cleland argued that aspects needed to encourage progress include: an innovative and forward-looking FinTech and financial sector; a resilient, accessible and functional public infrastructure that creates a platform for coordinated innovation; and international collaboration across the public and the private sectors to promote harmonisation and interoperability.

Ms Cleland confirmed that in Spring 2024, the BoE will introduce a new RTGS core settlement platform, designed to offer greater resilience and enhanced user functionality.

ECB: Speech by Fabio Panetta, Member of the Executive Board of the ECB

On 30 March 2022, the ECB published a speech by Fabio Panetta, member of the Executive Board of the ECB, concerning the digital euro. On the same day, the ECB published findings of focus groups held in relation to the digital Euro.

Key points

• The ECB has an idea of the views of prospective users of a digital euro, thanks to discussions with focus groups.
• Findings from the focus group suggest that, all merchants across the euro area – both in physical stores and online – would need to accept a digital euro.
• Participants in the focus groups would like to see a solution that would allow instant person-to-person payments, regardless of the platform used by the payers and payees.
• Analysis suggests that digital euro transaction data should not be visible to the Eurosystem – or any other central entity – beyond what is strictly needed to perform its functions.
• In a baseline scenario, a digital euro would provide people with a level of privacy equal to or higher than that of private digital solutions.

Investment Association (Engine): Report: Innovation in Investment Management: The current technological landscape, how to transform and unlock the opportunities

On 28 March 2022, the Investment Association issued a report by IA Engine on innovation in investment management. The IA Engine launched in October 2018 with the aim of encouraging the adoption of technology within investment management in response to the changing needs of consumers.

The report notes that in contrast to other sectors in the financial services, investment management sectors have been conservative in relation to financial innovation due to legacy infrastructure, culture, and processes. The report argues that the pandemic has highlighted the importance for firms of having more digital-ready experiences both for internals (advisers, portfolio managers) and clients.

The report also notes a marked increase in investment in the FinTech sector by investment managers, with 2021 seeing a record number of funding rounds involving investment managers.

The report argues that FinTech can also provide commercial opportunities for investment managers who wish to take a stake in their operations, adding that this can take many forms, ranging from cooperation on a platform’s development within the technology stack to full acquisition.

Responses to report: House of Lords (Economic Affairs Committee): Central bank digital currencies: a solution in search of a problem?

HM Treasury and BoE have issued responses to the House of Lords CBDC report, published earlier this year, which raised a number of questions about the feasibility of a CBDC (see February 2022 Digital Assets edition).

HM Treasury response

• The Government agrees that CBDCs pose a broad range of opportunities and risks, which require careful evaluation. The Government has established a Taskforce to consider these questions in depth and welcomes the Committee’s scrutiny of the Taskforce’s.
• While no decision has been taken on issuance in the UK, it is important that the UK develops an understanding of the desirability and viability of a domestic CBDC to ensure it is in a position to take an informed decision on how to proceed.
• CBDC system could have the potential to spur innovation and greater competition in domestic payments. A CBDC could improve the efficiency and cost of domestic transactions, providing a parallel payment method alongside retail payments systems, offering wider choice. However, the extent to which these benefits could be achieved by other means is being evaluated by the Taskforce.
• The Government will be carefully considering the role which CBDCs could play in increasing access to digital payments.

BoE response

• The BoEwill work with HMT to understand any legislative framework needed for implementing and operating a robust CBDC system in the UK.
• The BoE's assessment will be forward-looking, taking account of future payments needs in an economy and society that is increasingly digital, and where the pace of private payments innovation is rapid. The assessment will consider CBDC against both current payment options but will also consider the possible entrance of new forms of digital money such as stablecoins, and the emergence of possible new players in the payments landscape such as so-called "Big Techs".

European Commission: Speech by Mairead McGuiness at Conférence Europe des Services Bancaires et Financiers

On 25 March 2022, the European Commission issued a speech by EU Commissioner, Mairead McGuiness, touching on how the European Commission is responding to trends and challenges in the European Union.

Key issues

• Instant payments: The market take up of instant payment in the EU is currently too slow and the EU will be publishing legislation to accelerate things in the second half of 2022. The Commission is focusing on key areas such as: the ability of payment service providers to both send and receive instant credit transfers; preventing fraud or errors; and ensuring that instant payments is not a premium service available to just a few by introducing a pricing regime that balances all interests.
• Digital euro: The European Commission has been working with the ECB in relation to the digital euro and key areas that have been considered include: maintaining the privacy of users; incorporating the digital euro with private payment options; and operational resilience.

Bank of England and Massachusetts Institute of Technology joint Central Bank Digital Currency collaboration

On 25 March 2022, the BoE issued a press release confirming that it will collaborate with MIT Media Lab’s Digital Currency Initiative team on a research project to explore potential technical challenges, trade-offs, opportunities and risks involved in designing a CBDC system. The collaboration forms part of the BoE's wider "research and exploration" into CBDC, and will be focused on exploration and experimentation of potential technology approaches.

IOSCO: Report on decentralized finance

On 24 March 2022, IOSCO issued a report on decentralised finance. IOSCO and its Fintech Network established the DeFi Working Group to focus on understanding the current state of the DeFi market, its typologies, and policy implications. According to IOSCO, in order to understand the regulatory implications of DeFi, it is necessary to look at DeFi ecosystem in total, its interrelationship with centralized cryptoasset trading platforms and service providers and traditional markets and activities. The report argues that a comprehensive understanding involves: identifying and analyzing the structural components of each type of DeFi financial product, service, arrangement and activity; identifying the aspects that may be “decentralized”; and identifying the roles of each of the components and participants involved at each of the different layers..

The report outlines products and services unique to DeFi, but finds that most of the new services which are emerging reproduce more traditional financial services and activities, albeit with weaker regulation and increased risks for investors. The report argues that DeFi often has central actors who often retain control (via distribution of “governance tokens”). The report also highlights the important role played by centralised trading platforms, who often face substantial conflicts of interest. In response to the report, IOSCO has also announced the establishment of a new task force.

PRA: Dear CEO letter on existing or planned exposure to cryptoassets

On the 24 March 2022 Sam Woods, CEO of the PRA, issued a follow up 'Dear CEO' letter discussing the regulator's approach to existing or planned exposure to cryptoassets in the context of increasing growth and innovation in the industry.

Whilst the scope of the letter is very broad given the spectrum of the term 'cryptoassets', it is focused on physical and derivative exposures to cryptoassets without an intrinsic value (e.g. Bitcoin, Ether) and other so-called stablecoins whose value is stapled to fiat currency and other forms of conventional financial assets.

The letter outlines a number of tangible measures that firms must take when gaining exposure to cryptoassets, and should be considered by firms in relation to risk management systems and capital adequacy calculations going forward

The letter has been published alongside related publications from the FCA, BoE and the Financial Policy Committee.

For more information, see Ashurst briefing.

Bank of England: Response to discussion paper on new forms of digital money

On 24 March 2022, the BoE published a paper reporting on responses it has received to its June 2021 discussion paper on new forms of digital money.

Key points

• Many agreed that digital money would provide benefits but noted that any publicly provided digital money should not replace cash.
• Most respondents considered that any private sector firm issuing or intermediating payments in new forms of digital money must comply with the regulatory frameworks on data protection.
• Respondents noted that interoperability between all forms of money, including new forms of digital money, was essential.

The BoE confirms it has not yet made a decision on any of the topics in the discussion paper but will continue its work in this area.

FPC: Summary and record: March 2022

On 24 March 2022, the BoE published the financial policy summary and record (FPSR) of the meetings of its Financial Policy Committee (FPC) on 9 and 18 March 2022.

The FPSR includes the FPC's assessment of cryptoassets and systemic stablecoins, with the FPC stating that while direct risks to UK financial stability from cryptoassets are currently limited, their rapid growth could present risks.

The FPC states that a systemic stablecoin issued by a non-bank without a resolution regime and deposit guarantee scheme could meet its expectations, as long as the BoE applies a regulatory framework designed to mitigate financial stability risks. A systemic stablecoin backed by a deposit with a commercial bank would, however, introduce undesirable financial stability risks.

FPC: Financial Stability in Focus: Cryptoassets and decentralised finance

On 24 March 2022, the FPC published a Financial Stability in Focus report on cryptoassets and DeFi.

Key points

• Where crypto technology is performing an equivalent economic function to one performed in the traditional financial sector, this should take place within existing regulatory arrangements, and the regulatory perimeter should be adapted as necessary to ensure an equivalent regulatory outcome.
• Enhanced regulatory and law enforcement frameworks, both domestically and at a global level, are needed to address developments in these markets and activities, and encourage sustainable innovation as well as maintain broader trust and integrity in the financial system.
• The FPC will continue to pay close attention to developments in cryptoassets and DeFi and will seek to ensure that the UK financial system is resilient to systemic risks that may arise.

European Parliament: Text of adopted ECON report on proposed Regulation on markets in cryptoassets

On 23 March 2022, the European Parliament published the text of the report adopted by its Economic and Monetary Affairs Committee (ECON) on the European Commission's legislative proposal for a Regulation on markets in cryptoassets. ECON voted to adopt the report on 14 March 2022.

CMA: Update on Open Banking implementation roadmap

On 23 March 2022, the Competition and Markets Authority (CMA) published a letter sent to the Open Banking Implementation Entity (OBIE) following an update from OBIE on the status of items in the Roadmap for the final stages of Open Banking implementation. The OBIE, which is funded by the nine largest retail banks, was established by the Order to implement Open Banking.

The letter notes the UK's nine largest current account providers have the following remaining items that require implementation: variable recurring payments (VRPs) for sweeping; consent and access dashboards as part of version 3.1.10 of the Open Banking standard; and delivery of the enhanced management information submission mechanism.

European Commission: Speech by Commissioner Mairead McGuinness at ALFI European Asset Management Conference 2022

This speech by EU Commissioner Mairead McGuiness, directed mostly at the asset management industry, touched on a number of issues including the EU Digital Finance package.

Points to note

• The Capital Markets Union is related to the EU's ambition for a digital Europe: a single market for capital in the EU will help asset managers direct financing towards digital innovators, wherever they are located. The digitalization of the financial sector can result in more choice and better access to financial products and services.
• The risk of scams and money laundering in cryptoasset markets could be addressed with regulation and transparency and EU MICA can go some way in responding to these threats.

ASA: Enforcement notice on misleading and socially irresponsible cryptocurrency advert

On 22 March 2022, the ASA issued an enforcement notice providing guidance about adverts for cryptocurrencies, crypto exchanges and adverts or promotions which otherwise involve the transfer, sale or supply of cryptocurrencies, targeted at UK consumers or that are targeted globally on behalf of UK-based advertisers. The ASA directs companies advertising cryptocurrencies to review their adverts to ensure compliance with the CAP Code. Companies are reminded that they must comply with the rules that adverts are not misleading or socially irresponsible

FSB: Report - FinTech and Market Structure in the COVID-19 Pandemic - Implications for financial stability

On 21 March 2022, the FSB issued a report on FinTech and market structures. This report examines whether the COVID-19 pandemic changed the ways in which individuals and firms engage with innovative financial service providers and traditional financial incumbents. Its main finding is that the pandemic has accelerated the trend toward digitalisation of retail financial services. The report outlines the types of actions authorities have taken during the pandemic that may impact market structure and the role of different firms in providing digital financial services.

Main points

• Comprehensive data on market shares of FinTechs, BigTechs and incumbent financial institutions in retail digital services is scarce. However, available proxies and insights from market participants suggest that BigTechs in particular have further expanded their footprint in financial services.
• The growth of BigTechs underscores the need to address data gaps that currently hamper the assessment of those firms’ financial risks and systemic importance. These data gaps make it difficult for authorities to decide whether and how to regulate BigTechs.
• The pandemic has had an uneven impact on FinTech firms depending on the nature and source of their funding. Many FinTech firms rely on investor funding, which initially declined during the pandemic. As a result, it was the larger, more established FinTech firms that performed well, while smaller, less well capitalised firms, many of which are not yet profitable, struggled.

HM Treasury: Summary of meeting: HM Treasury and Financial Conduct Authority Regulatory Perimeter Meeting - December 2021

On 18 March 2022, the record of the meeting between the CEO of the FCA and the Economic Secretary to the Treasury (EST), held in December 2021 to discuss the FCA's Perimeter Report, was published. Items discussed included cryptoassets.

Cryptoassets

• The EST noted that it will be important to keep up the pace of progress on key cryptoassets measures, including proposals to bring cryptoassets into financial promotions regulation.
• The FCA provided an update on the FCA’s work to register cryptoasset firms under AML regulations. The FCA and HM Treasury agreed that the UK needs to create a regulatory environment for cryptoassets in which firms can innovate responsibly, while crucially maintaining high regulatory standards and managing financial crime risks so that people can use new technologies reliably and safely. The FCA and HM Treasury noted the cross-border dimensions of regulation in this area were and welcomed international cooperation on these topics.

FIA: Article: Crypto regulation comes under the spotlight at Boca

The FIA published this article on 17 March 2022 reporting on the annual International Derivatives Industry Conference. Regulators in the US and EU discussed the supervision of cryptoassets in their jurisdictions. Klaus Löber, chair of the CCP Supervisory Committee at ESMA, discussed the EU's Markets in Crypto Assets Regulation. There was a discussion relating to the Executive Order (see briefing here) issued by US President, Joe Biden. It was noted that although the SEC regulates digital assets where they are deemed to be securities and the CFTC regulates derivatives based on digital assets, neither agency has sufficient authority to regulate spot trading in all digital assets.

ESAs: Statement on the risks of cryptoassets

On 17 March 2022, the ESAs issued a warning to consumers stating that many cryptoassets are highly risky and speculative, and are not suited for most retail customers to invest in or use as a means of payment or exchange. The ESAs set out a list of questions consumers should ask themselves if they are considering buying cryptoassets or related products and services. They also provide brief explanations of what they perceive to be the key risks including: extreme price movements; misleading marketing; absence of protection; product complexity; market manipulation; lack of price transparency and low liquidity; and fraud.

The ESAs note growing consumer activity and interest in cryptoassets, including virtual currencies and the emergence of new types of cryptoassets and related products that claim to generate high or fast returns (or both). These include NFTs, derivatives with cryptoassets as underlying, unit-linked life insurance policies with cryptoassets as underlying and decentralised finance applications.

FIA: Opening remarks of Walt Lukken, President and CEO of FIA: Crypto derivatives -"Same activity, same risk, same regulation"

On 15 March 2022, the FIA published this speech by Walt Lukken, President and CEO of FIA in relation to crypto derivatives.

Key issues

• The global derivatives industry cannot ignore digital assets. Cryptocurrencies are not a fad – and neither are related crypto derivatives products.
• Volume in global crypto derivatives hit $3 trillion dollars in January and accounted for more than 60 per cent of all trading in digital assets.
• Several major crypto exchanges have purchased regulated futures exchanges, identifying derivatives markets and its regulatory framework as strategically important.
• The crypto space keeps attracting capital.
• FIA understands concerns related to decentralised finance and the cryptoasset sector in general. Addressing these concerns will involve considering the risk management and customer protection aspects.

Bank of England: Minutes of the CBDC Technology Forum - March 2022

On 12 March 2022, the Bank of England issued the latest minutes for its CBDC Technology Forum.

Key actions

• BIS introduced the London Centre of their Innovation Hub (launched in June 2021) and also presented the latest approved project, Project Rosalind. The project aims to design an API prototype for retail CBDC, along with a set of API standards, and a sandbox exposing a "skeleton" of the API.
• There was some discussion of interoperability of CBDC, as well as convertibility and the BoE outlined assumptions, namely that CBDC interoperability with payment schemes would be required. The capability to perform offline payments was noted as critical for a section of the UK population with limited access to internet connectivity.
• The BOE raised the issue of financial exclusion and how CBDC could help mitigate financial exclusion. A presentation was given on the main drivers of exclusion and possible CBDC features that could be implemented to mitigate these risks.