Digital Assets Digest February edition

Mansion House Update: February 2022

On 10 February 2022, the Economic Secretary to the Treasury gave an update on steps the UK government has taken to deliver its vision for the future of financial services in the UK. The update contained a summary on work done in relation to technology and innovation and included: work done to advance measures that were committed to following the Kalifa Review of UK Fintech (e.g. obtaining funding to establish the Centre of Finance, Innovation and Technology); consultation on the regulatory regime concerning stablecoins, as well as a consultation concerning the financial promotions regime and cryptoassets; Public Policy Principles for Retail CBDCs; and the Payments Landscape Review response.

ESMA Speech: Keeping on track in an evolving digital world

In this speech ESMA Chair, Verena Ross, considers the impact of digitalisation on the financial services. Ms Ross argues that it is the job of regulators to consider the implications of new technology and innovations and decide which types will make a lasting impact. She notes that there are risks that come with the blurring of lines between regulated and unregulated products and calls for the benefits of digital technology to be harnessed to create a more inclusive, financial sector. She comments that digital platforms are serving as new venues for financial (and non-financial) products and that the fragmentation and complexity of the financial services value chain is being encouraged by entry of bigtech and fintech and refers to the ESAs February 2022 report on digital finance.

Ms Ross notes that consumers increasingly have easy access to complex and highly risky products, such as crypto-assets and that this can increase behavioural biases that they are subject to. She refers to the growing market capitalisation of cryptoassets and the lack of regulatory protections available to consumers, noting that ESAs issued a 2018 warning on cryptoassets and remain concerned about severe risks to consumers. Ms Ross confirms that until the EU Markets in Cryptoassets Regulation is agreed and in force, ESMA will be working with national supervisors to ensure information exchange in the authorising and supervising of new cryptoasset products and services.

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

On 9 February 2022, the Bank of England issued the latest minutes of the CBDC Technology Forum. The Forum noted the publication of the House of Lords Economic Affairs Committee report on CBDC. The Forum discussed different types of CDBC systems (account/token/hybrid), comparing the different ledger data structures across the range of design areas to ascertain advantages and disadvantages. A presentation was given by a Forum member which noted that CBDC pilot programs have experimented with two approaches to account-based settlement systems.

The Forum also looked at the issue of programmability, with the Forum introducing its understanding of programmable money, programmable payments and smart contracts.

IMF Speech: The Future of Money: Gearing up for Central Bank Digital Currency

In this speech, published to coincide with the publication of a report by the IMF on CBDCs, Kristalina Georgieva, IMF Managing Director, provides an overview of the development of CDBCs and argues that the industry is now in the phase of experimentation, having moved from conceptual discussions.

Key points

• A number of jurisdictions are making considerable progress in relation to the CBDC: the Sand dollar has been in circulation in the Bahamas for more than a year; Sweden’s Riksbank has developed a proof of concept and is exploring the technology and policy implications of CBDC; and China is making progress with the digital renminbi.

• There is no universal case for CBDCs because each economy is different.
•  Financial stability and privacy considerations are hugely important to the design of CBDCs. Central banks are committed to minimizing the impact of CBDCs on financial intermediation and credit provision. In the Bahamas, China, and the Eastern Caribbean Currency Union, limits were placed on holdings of CBDCs to prevent sudden outflows of bank deposits into CBDC.
• Introducing a CBDC is about finding the delicate balance between developments on the design front and on the policy front.

IMF: Behind the Scenes of Central Bank Digital Currency

This paper studies advanced CBDC projects in a number of jurisdictions. It looks at policy goals of the different jurisdictions, design features of the respective CBDC and operational models for CBDC (i.e. who issues and distributes CBDC and the respective roles of the central bank and the private sector). The paper also looks at legal foundations of CBDCs in the selected jurisdictions and examines the process of exploring and testing CBDC.

The report concludes that CBDC is still in its infancy, and that there are commonly identified obstacles. Issues raised by several jurisdictions include the nature of sustainable business models that will ensure cost recovery and provide sufficient incentives for private sector participation. The report states that choice of technology is also often highlighted, including the use cases and limits of DLT. The paper notes a new trend among some of the jurisdictions of a pragmatic view of technology.

EBA: Speech - Time for a paradigm shift in our approach to regulation and supervision?

On 9 February 2022, the EBA published a speech by Jose Manuel Campa, Chair of EBA. The speech considers the ESAs’ response to the European Commission call for advice on digital finance and related issues. It also sets out details of future EBA work relating to digital finance.

Mr Campa comments that there are alternative tools to be used in different circumstances and for achieving regulatory objectives, arguing that both activities and entities-based regulation and supervision play a role in mitigating specific types of risk. He cites the example of the EU Markets in Cryptoassets Regulation as an initiative encompassing both activities-based and entities-based regulation (whereby issuers who issue cryptoassets that are classified as "significant" will be subject to additional requirements, including governance and prudential requirements). He adds that a one-size fits all approach is neither proportionate nor effective in mitigating risks.

In relation to cryptoassets and decentralised finance, Mr Campa confirms that the EBA will develop templates that competent authorities can use to encourage a convergence in the monitoring of cryptoasset activities at the domestic level. He confirms that the EBA will continue to contribute to ongoing EU and international work streams on cryptoassets, including global stablecoins, and the prudential treatment of banks’ exposures to crypto-assets (the EBA expects a further BCBS consultation in 2022). In the area of artificial intelligence, the EBA will assess the public feedback received on the discussion paper on the use of Machine Learning for IRB models and will consider whether any additional measures should be taken in this regard.

European Parliament: Updated procedure file on proposed Regulation on pilot regime for market infrastructures based on DLT

On 8 February 2022, the European Parliament updated its procedure file concerning the proposed Regulation on a pilot regime for market infrastructures based on distributed ledger technology (DLT) to confirm that the Parliament will consider the proposed Regulation during its plenary session (to be held from 23 to 24 March 2022). In January 2022, the Economic and Monetary Affairs Committee's approved the text agreed at the first reading interinstitutional negotiations. The Council of the EU and the Parliament reached political agreement on the proposed Regulation in November 2021. The Commission adopted the proposed Regulation in September 2020 as part of its Digital Finance Strategy.

FCA speech on enhancing UK's capital markets

On 8 February 2022, the FCA published a speech by Sarah Pritchard, Executive Director, Markets, on enhancing the UK's capital markets. In the speech, Ms Prtichard speaks of the importance of the FCA having clear expectations and outcomes against which progress can be measured. She also notes the importance of partnering with industry, other regulators and government partners during the policy making and standard setting process. In the speech, Ms Pritchard refers to the ongoing transformation of the FCA and states that ongoing projects include making the regulatory sandbox permanent, and a robust approach to cryptoasset firms that need registration under the money laundering regime.

ESAs' response to European Commission call for advice on digital finance and related issues

On 7 February 2022, the European Supervisory Authorities published a report containing their response to the European Commission's February 2021 call for advice on digital finance and related issues.

The report notes the growth of digital platforms across the financial sector. The report states that the changing financial landscape brings opportunities and risks and that the ESAs will keep monitoring the application of innovative technologies in the EU financial sector as part of their ongoing work, including the appropriateness of the EU regulatory perimeter.
Recommendations include the following:

• Update current disclosure requirements in EU law as relevant to make them fit for the digital age and enhance consumer protection and conduct of business rules.
• Provide further guidance on the definition of cross-border services in a digital context and strengthen cross-border supervisory co-ordination. The ESAs recommend that the Commission consider the need to introduce further guidance on when a digital service is to be regarded as being provided in another Member State under sectoral legislations in the banking, payment, insurance and investment sectors and other areas of financial services (e.g. the provision of crypto-asset services).
• Take specific actions intended to promote a convergent approach to money-laundering and terrorism financing risks in a digital context.

CPMI: SWIFT GPI data and drivers of fast cross-border payments

On 9 February 2022, the Committee on Payments and Market infrastructures issued this summary article on SWIFT Global Payments Innovation. In 2020, the FSB and the CPMI agreed a roadmap on implementing building blocks for improving cross-border payments. The article states that the challenges concerning cross-border payments differ considerably between market segments and payment arrangements. For international payments via correspondent banking, the article notes that SWIFT has developed gpi4.

Key points

• Initiatives such as SWIFT gpi are improving the speed of cross-border payments, but obstacles remain to shortening the processing time to the levels observed for domestic payments.
• Prolonged processing times are largely driven by time spent at the beneficiary bank from when it receives the payment instruction until it credits the end customer's account.
• The timeline of a payment on SWIFT gpi can be split into three legs: the originator, inflight and beneficiary leg.
• The speed of cross-border payments on SWIFT gpi is generally high with a median processing time of less than two hours.
• Cross-border payments on SWIFT involve, on average, just over one intermediary between the originator and beneficiary banks.

FCA Board Meeting: 21 December 2021 -minutes

The FCA has published the minutes of the FCA board meeting on 21 December 2021. In the minutes, FCA CEO, Nikhil Rathi, briefs the board on a number of issues. A topic of discussion was also the proposed strategy for the FCA to play a more significant role in the regulation of cryptoassets. The board discussed the interaction of cryptoassets regulation with FCA’s objectives of consumer protection and market integrity. The regulation of decentralised financial activities was also discussed. The board discussed international regulatory cooperation. It was noted that the FCA's approach was limited by the current regulatory powers given to the FCA by Parliament.

Financial Markets Law Committee: Minutes – 9 December 2021

The Financial Markets Law Committee (FMLC) has published the minutes of a meeting held on 9 December 2021.

Among topics discussed were the legal issues concerning the adoption of distributed ledger technology by financial market infrastructures. The Committee noted that a number of initiatives and meetings (including a meeting with HM Treasury and the Bank of England) had been set up in this regard and that key stakeholders had been discussing commercial imperatives for the adoption of DLT and the legal and regulatory challenges. It was agreed that future developments in this area should be monitored.

BoE: Report: ISO 20022 Market Guidance: Guide for the corporate market sector

On 3 February 2022, the Bank of England published new guidance in relation to the implementation of ISO 20022. The Bank explains that the migration to the ISO 20022 messaging standard for CHAPS payments is one of its Real-Time Gross Settlement (RTGS) Renewal Programme. As a result, the BoE is issuing guidance setting out a standardised approach for all parties. This guidance mainly looks at corporates.

Notable findings

• There are clear opportunities to exploit additional information included with payment messages. Payment reconciliation and fraud detection and management are areas where integration with internal business processes offer significant potential business benefits.

• There is a need for consistency in implementation of ISO 20022 messaging, both across payment schemes and scheme participants. The Bank will continue to work collaboratively with Pay.UK, UK Finance and other groups to define potential market opportunities for market guidance.
• Initiatives such as open banking are creating further complexity in payments processing but this could be beneficial. There is some evidence of the emergence of services exploiting wider connectivity to allow added value services to be overlaid on core payment systems.

European Commission: Speech by Mairead McGuinness at European Supervisory Authorities high-level conference on financial education and literacy

On 3 February 2022, the European Commission published a speech by EU Commissioner, Mairead McGuinness, at the conference on financial education and literacy organised by the European Supervisory Authorities. In the speech, Ms McGuinness stresses the importance of financial literacy in an increasingly digital world, but adds that it cannot be used to weaken consumer protection. Ms McGuinness states that technology brings many opportunities, but also carries risks and that this is evident in the use of social media to promote cryptoassets. She refers to how the Commission is responding to changes in the financial landscape, citing the EU Markets in Cryptossets legislative proposal as an example. She states that such developments underscore the importance of a robust consumer protection regime. She argues that open finance is a part of the EU’s Digital Finance Strategy that could spark new, innovative products that are personalised to the individual consumer. She refers to the digital euro as an example of another initiative that could bring benefit to EU citizens and confirms that the ECB and the Commission are looking at number of issues concerning a digital euro.

House of Commons (Treasury Committee): Report: Economic Crime (HC 145)

On 2 February 2022, the House of Commons Treasury Committee issued a report on economic crime. The report looks at the effectiveness of measures taken to address economic crime since the Government’s Economic Crime Plan 2019-2022.

Key points

• The report welcomes plans to bring cryptoassets within financial promotions regime. The report also welcomes the work being done by the Advertising Standards Authority to protect consumers from misleading advertisements for cryptoassets.
• Criminals use cryptoassets to launder money, and press reports have indicated that new forms of cryptoassets can be particularly attractive because they are designed to be untraceable. Once acquired, cryptoassets can easily be exchanged, and the original source obscured.
• The report considers it unacceptable that, having introduced AML regulations for cryptoasset firms, there are considerable number of firms yet to be registered. The Government should ensure that there is proper consumer protection regulation across the whole cryptoasset industry.

BIS: BIS Innovation Hub to focus on CBDC, payments, DeFi and green finance in 2022 work programme

This press release sets out the work programme for BIS Innovation Hub (BISIH), confirming that in 2022, the BISIH will launch new projects into central bank digital currencies, next generation payments systems and decentralised finance. The press release states that the 2022/2023 work programme builds on the experience gained during the BISIH's first two years of operation and the completion of the first projects of the BISIH. The press release states that there will be a second BIS Innovation Summit, “Money, Technology, and Innovation” to be held on March 22-23. The press release notes that (BISIH) in London was opened in 2021 in partnership with the Bank of England and that the London Centre’s first projects will consider how individuals and businesses can benefit from the development of CBDCs and next generation financial market infrastructures.

BIS: Speech by Agustín Carstens, General Manager of the BIS: Digital currencies and the soul of money

This speech by Agustín Carstens, General Manager of the BIS, sets out three developments that can undermine money's essence as a public good and looks at three possible scenarios:

• In the first secnario, big tech stablecoins compete with national currencies and against each other, fragmenting the monetary system;
• The second scenario envisages decentralisation, replacing institutions with distributed ledger technology in a shared network based on the growth of decentralised finance, or "DeFi"; and
• In a third scenario, incumbent financial institutions, big techs and new innovative entrants compete in an open marketplace that guarantees interoperability, building on central bank public goods.

Mr Carstens notes that DeFi space has been used primarily for speculative activities and that the absence of controls such as know-your-customer and anti-money laundering rules could impact DeFi's growth. He states that a parallel financial system is emerging, revolving around two elements: automated, self-executing protocols, or "smart contracts; and stablecoins.

House of Commons: Answer to a written question – rules governing cryptoassets

This update contains a response by John Glen, Economic Secretary to the Treasury to query raised by a Labour MP in relation to Mr Glen's assessment of the adequacy of current rules and regulations governing the buying and selling of cryptocurrencies in the UK. Mr Glen summarises the work of the UK Cryptoassets Taskforce and the publication of papers concerning the regulation of cryptoassets in January 2022 by HM Treasury.

BIS (FSI) Insight: Gatekeeping the gatekeepers: when big techs and fintechs own banks – benefits, risks and policy options

On 21 January 2022, BIS published this paper. The paper looks at the advantages and disadvantages of extending banking licences to tech firms and considers selected jurisdictions’ authorisation criteria. Key points include: over the past decade, the rapid growth of the digital economy, together with technological innovations, has led big techs and fintechs to enter the financial services sphere; while technology firms initially offered financial services without the need for or interest in a banking licence, several big techs and fintechs have recently obtained a bank charter; although tech firms that operate licensed bank(s) are now a worldwide phenomenon, they are prevalent in jurisdictions that have supervisory mandates that include financial inclusion and/or competition (Asia, and in particular China, is home to the largest number of big techs that operate with a banking licence); authorities impose a range of financial and non-financial requirements as a precondition for tech firms to operate a licensed bank; when establishing licensing requirements, authorities should consider risks posed by tech firms; and the question of whether to allow tech firms to operate with a banking licence has the potential to permanently alter the landscape of national banking systems.

FCA: Strengthening our financial promotion rules for high risk investments, including cryptoassets" (CP 22/2)

On 19 January 2022, the FCA published its consultation paper "Strengthening our financial promotion rules for high risk investments, including cryptoassets" (CP 22/2). The FCA is proposing to introduce a tripartite classification for investments which will see "qualifying cryptoassets" classified as Restricted Mass Market Investments (RMMI). As a result, cryptoassets will be subject to the restricted financial promotions regime, including prohibitions on inducements, new frictions in the customer trading journey and limits on the types of consumer that can be targeted by financial promotions.

For more information see our briefing here.

HM Treasury: Changes to cryptoasset financial promotions regime

On 18 January 2022, HM Treasury confirmed that financial promotions regime governing cryptoassets will be reformed, in line with its July 2020 proposals. As a result, all cryptoasset promotions will have to be issued or approved by an authorised firm. The new rules aim to increase consumer protection to ensure that cryptoasset advertisements are fair, clear and not misleading.

The Government confirms that it intends to introduce a transitional period of approximately six months to allow for the finalisation of the amendments to the FPO and the complementary FCA rules.

For more information see our briefing here.