Bank of England rolls out new account model for wholesale payment systems to offer settlement funded in central bank money

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/april/bank-of-england-rolls-out-new-account-model-for-wholesale-payment-systems

The Bank of England has published a new Omnibus Accounts Access Policy. This provides for a novel account model under which payment system operators can offer their participants settlement funded in central bank money. The eligibility criteria restrict availability of the omnibus account to operators of wholesale payment systems recognised under the Banking Act 2009. This new offering is expected to support payment system innovation and is a welcome development for the fintech industry and more broadly.

Omnibus accounts – a new settlement model

The Bank of England has updated its website with a new Omnibus Accounts Access Policy. Under this policy, eligible payment system operators may open an omnibus account on behalf of their participants in the Bank’s Real-Time Gross Settlement (RTGS) system. This provides a new model for payment system operators to offer settlement services fully funded in central bank money.

Important benefits of the new structure identified by the Bank of England include that full funding in central bank money means participants bear reduced credit risk when holding funds and making payments, and that the payment system can offer greater flexibility in terms of intraday settlement as well as operation outside RTGS operating hours. This new offering will sit alongside existing models for settlement in central bank money, such as the real-time settlement model used for CHAPS (the Clearing House Automated Payment System) and various deferred net settlement arrangements. 

How does it work?

If a payment system operator holds its participants’ funds in an omnibus account in the Bank of England’s RTGS system, payment transactions can be settled between the participants in real-time simply by updating the participant balances in the payment system representing entitlements in the omnibus account. The transactions may be made between the participants acting on their own account or on behalf of their customers. The policy document sets out an illustrative example on page 5.

The Bank of England will pay interest on balances held overnight in the omnibus account at the base rate. This interest must be fully passed on to the relevant participants.

Eligibility

The policy sets out five eligibility requirements for opening an omnibus account, as summarised below:

  1. The sterling balances in the relevant payment system must always be fully funded with monies in the omnibus account. This must be maintained by processes that are supported by robust contingency arrangements and have clear risk management and governance arrangements.
  2. The entities that can hold an overnight entitlement (i.e. have beneficial ownership rights to funds in the account outside RTGS operating hours) in the account are restricted to participants in the Sterling Monetary Framework that hold reserves at the Bank of England and which are not subject to a target level of reserves. This would, for example, include banks and broker dealers but exclude central counterparty clearing houses (CCPs) for the time being. It remains to be seen whether other entities would be able to participate in the payment system if they only hold funds during RTGS operating hours.
  3. The payment system operator holding the account needs to have robust legal arrangements that protect both the participants and the Bank of England from legal risks and liability exposures. For example, the payment system operator must hold the account on trust on behalf of the participants, and the payment system must be designed under the Settlement Finality Regulations.
  4. The account holder must be an operator of a payment system that has been recognised under the Banking Act 2009. Such payment systems are regulated and supervised by the Bank of England. This requirement will limit the eligibility to payment systems of systemic importance or those that have the potential at launch to be systemic.
  5. Specific settlement services should not increase the risk to financial or monetary stability. The omnibus account model may not be the most suitable model for a given payment system to mitigate financial stability risks. If approved, the account will be granted for a particular set of settlement services, subject to modification from time to time with the approval or non-objection of the Bank.

The operator must also become a direct participant in CHAPS (in order to facilitate funding and de-funding of the account). As such, it will need to comply with the applicable CHAPS requirements.

Next steps/ other developments

Those interested in making an application can contact the Bank of England at rtgschapsaccess@bankofengland.co.uk

The Bank of England has also updated the section of its website relating to prefunding accounts in respect of certain retail systems. It notes that applications for such accounts must be made via Pay.UK.

Please do not hesitate to get in touch with any of our listed contacts if you would like to discuss any of these matters.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/april/bank-of-england-rolls-out-new-account-model-for-wholesale-payment-systems

In Ion Sciences, the English courts take a traditional approach to determining governing law and jurisdiction in a dispute relating to cryptoassets

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/march/the-english-courts-take-a-traditional-approach-to-determining-governing-law-and-jurisdiction

In a recent decision of the English Commercial Court, Mr Justice Butcher granted a proprietary injunction in respect of Bitcoin, recognising that it may amount to “property”. The judgment indicates that the English Courts are likely to treat questions of governing law or jurisdiction arising out of claims over cryptoassets in broadly the same way as other forms of property. 

Transfer of Bitcoin in the context of a crypto ICO fraud

In Ion Sciences vs Persons Unknown and Others (unreported) 21 December 2020 (Commercial Court), Ion Sciences and its sole director, Duncan Johns, were victims of alleged initial coin offering (ICO) fraud. They claimed to have been induced by persons unknown to transfer Bitcoin in the belief that they were investing in legitimate cryptocurrency products, but later discovered that the recipient was not legitimate.

Expert evidence suggested that the transferred Bitcoin or their traceable proceeds were deposited in accounts held by the Binance and Kraken cryptocurrency exchanges. Ion Sciences and Mr Johns therefore applied for (and were granted):

  • a proprietary injunction and a worldwide freezing order against persons unknown to preserve the transferred Bitcoin or their traceable proceeds and an ancillary disclosure order to identify the alleged fraudsters; and
  • disclosure orders aimed at the cryptocurrency exchanges in the form of a “Bankers Trust Order” (an order to disclose confidential documents to support a proprietary claim in fraud cases) and/or an order under CPR 25.1(g) to trace the transferred Bitcoin or their proceeds that were the subject of the proprietary injunction.

The judgment of Mr Justice Butcher on these applications touches on whether Bitcoin constitutes property, and how the courts should approach the questions of governing law and jurisdiction arising out of claims relating to cryptoassets; which we summarise as follows.

Cryptoassets as property

Consistent with the decision of the Commercial Court in AA v Persons Unknown [2019] EWHC 3556 (Comm), which adopted the reasoning of the UK Jurisdiction Task Force’s Legal Statement on Cryptoassets and Smart Contracts, Butcher J concluded that “there is at least a serious issue to be tried” that Bitcoin and other cryptoassets are property under English common law.

Governing law and jurisdiction for claims relating to cryptoassets

In England and Wales, jurisdiction for the claimants’ claims is based on valid service. The English courts can permit service on a defendant outside of the jurisdiction, such as on “persons unknown” provided that there is a good arguable case connecting the claim to the jurisdiction, that the claim has reasonable prospects of success and that the court is satisfied that England is the proper forum.

In assessing these factors, Butcher J held that there is at least a serious issue to be tried that English law should apply to the claimants’ claims given that England was the place where the damage occurred or because the relevant Bitcoin were located in England. In his judgment, Butcher J stated that a cryptoasset is situated in “the place where the person or company who owns it is domiciled.” He remarked that there are no decided cases in England on this question.

Butcher J held that the claimants could serve persons unknown outside of the jurisdiction. In coming to this conclusion, he considered the following factors, among others:

  • the representations to Mr Johns were made, and relied on, in England.
  • the account that funded the Bitcoin was English.
  • the assets were taken from the claimants’ control in England.
  • the computer used to purchase the cryptocurrency products was in England.
  • the relevant Bitcoin were located in England and Wales before their transfer.
Comment on the traditional approach

This judgment is further evidence that the English courts will recognise cryptoassets as “property”. However, the trickier question that Butcher J grappled with is: what is the right law to apply to claims relating to cryptoassets? Generally, this depends on the nature of the claim. The English courts have traditionally applied the law of the place where the damage occurred for tortious claims and the law where the property is located for proprietary claims.

Whether this is the right approach for cryptoassets is an open question; the judgment in Ion Sciences is an interim decision, rather than a final decision on the merits, but still gives a good indication of how courts will answer this question going forward.

As the Joint Taskforce’s Legal Statement recognised “there is very little reason to try to allocate a location to an asset which is specifically designed to have none because it is wholly decentralised”. Yet, in the absence of internationally coordinated legislation to come up with a new approach – a proposal made by the Joint Taskforce – the courts can only answer the question using the traditional approach.

As Professor Andrew Dickinson states in Cryptocurrencies in Public and Private Law (OUP 2019) – a text cited in the judgment – just because the courts are grappling with cryptoassets does not mean that there is any need to “panic and throw the existing toolbox away”. Therefore, unless dedicated legislation is enacted, it appears that the English Courts will continue to answer the question of governing law (and jurisdiction) of a cryptoasset in the same way they would with respect to any other property.

Read more

See our other coverage on this topic, including:

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/march/the-english-courts-take-a-traditional-approach-to-determining-governing-law-and-jurisdiction

Hong Kong extends international collaboration on CBDCs for cross-border payments

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/march/hong-kong-extends-international-collaboration-on-cbdcs-for-cross-border-payments

Hong Kong has one of the most advanced experiments for central-bank digital currencies (CBDCs) in cross-border payments and is expanding this project from just bilateral cross-border tests to tests involving multiple jurisdictions. The latest countries to join include the Peoples Republic of China and the United Arab Emirates.

Extension of the CBDC project for cross-border payments

The HKMA continues to make the areas of fintech and regtech a focus, and on in two recent press releases sets out the latest direction of travel on a key topic of interest: international cooperation on the use of CBDCs to facilitate cross-border payments.

Firstly, a joint statement has been issued announcing the extension of the Project Inthanon-LionRock (see our previous insight), the original project to explore the use of central bank digital currency (CBDC) for cross-border payments. The project was initially undertaken by the HKMA and the Bank of Thailand and included identifying pain points in cross-border payments and how to overcome them, and how to enhance the financial infrastructure for such payments.

Now in its second phase, the project will also involve the Central Bank of the United Arab Emirates (CBUAE) and the Digital Currency Institute of the People’s Bank of China (PBC DCI), and is being renamed the m-CBDC Bridge project. The Bank for International Settlements (BIS) is also taking part in the project.

Moving to proof-of-concept prototype

The joint statement notes that this latest phase will further explore the capabilities of distributed ledger technology (DLT), through developing a proof-of-concept (PoC) prototype, to facilitate real-time cross-border foreign exchange payment-versus-payment transactions in a multi-jurisdictional context and on a 24/7 basis.

The joint statement also acknowledges the possibility of additional central banks and regions joining the project in the future, and underlines the importance of participating central banks evaluating the feasibility of the m-CBDC Bridge project for cross-border fund transfers, international trade settlement and capital market transactions.

Exchange of specific MOU with UAE

The second HKMA press release announced the exchange of a Memorandum of Understanding (MoU) with the CBUAE, to enhance collaboration on fintech between the two authorities, with a view to strengthening co-operation between the two jurisdictions in promoting innovative financial services and regulatory development. It is under this arrangement that the agreement was made that CBUAE would join the m-CBDB Bridge project.

This MoU is the latest HKMA fintech collaboration with an overseas regulator, following on from its 2019 fintech MoUs with Bank of Thailand and France’s Autorité de Contrôle Prudentiel et de Résolution.

What’s happening next?

CBDCs are one of the BIS’ six focus areas for this year, so more developments in this area are coming down the track. One to look out for is the BIS project exploring the creation of an international settlement platform onto which central banks would issue multiple wholesale CBDCs. This would then allow regulated banks and payment service providers to use the platform as a common settlement infrastructure for purchasing, exchanging and redeeming the various CBDCs.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/march/hong-kong-extends-international-collaboration-on-cbdcs-for-cross-border-payments

Kalifa Review of UK Fintech: 10 key takeaways

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/march/kalifa-review-of-uk-fintech-10-key-takeaways

Knowledge

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https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/march/kalifa-review-of-uk-fintech-10-key-takeaways

UK regulator seeks to get retail payments infrastructure upgrade back on track

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/february/uk-regulator-seeks-to-get-retail-payments-infrastructure-upgrade-back-on-track

The UK’s Payment Systems Regulator has launched a consultation on the New Payments Architecture programme. The NPA, which was first outlined in 2017, aims to improve the UK’s retail interbank payments infrastructure. Progress has, however, been slow, in part due to challenges in procuring a suitable provider. The PSR consultation seeks views on possible solutions to get the project back on track. 

What is the NPA?

The UK is in the process of renewing the clearing and settlement infrastructure for interbank retail payments. The idea is for the new infrastructure to enable increased participation, encourage greater innovation and competition, and improve resilience, among other things. The project is known as the New Payments Architecture (NPA) programme.

Pay.UK, the operator of the UK’s main retail payment systems, has been tasked with realising this vision. The process is being overseen by the Payment Systems Regulator (PSR) in collaboration with the Bank of England.

Challenges and delays

The NPA programme has faced several challenges and delays since its initial launch in 2017. Most recently, a key group of stakeholders raised concerns around costs, timescales and migration difficulties and recommended (among other things) that the ongoing competitive procurement process for a central infrastructure services provider be cancelled in favour of instructing the incumbent provider, Vocalink. In response, Pay.UK paused the procurement process and requested an exemption from its obligations to run a competitive procurement. The PSR rejected this request last month, citing concerns around fair competition and value for money.

The NPA experience illustrates some of the practical difficulties in modernising legacy infrastructure, a process that many incumbent players in the financial sector have had to grapple with.

PSR consultation

It is against this backdrop that the PSR has launched a consultation. The consultation paper acknowledges the challenges faced by Pay.UK and the need to tackle some of the risks posed by the programme. To that end, it is seeking stakeholder views on various remedies. 

In particular:

1. Scope of the procurement

The original plan was for the procurement contract to include core clearing and settlement services plus an additional set of common services to migrate both Faster Payments and Bacs transactions to the NPA. The PSR considers the complexity involved in providing all these services to be a key source of delay. It suggests the services to support Bacs migration could be carved out of the initial procurement contract, and that such services could be procured at a later stage or provided through market-led propositions.

2. Approach to procurement

Given the disruption to the procurement process over the last year, the PSR is seeking views on whether Pay.UK should continue with the current competitive procurement, start a new competitive procurement or directly negotiate with Vocalink without a competitive procurement. It acknowledges there are advantages and disadvantages to all three options.

3. Promoting competition and innovation

Following a call for input on the NPA last year, the PSR proposes a list of design principles it expects Pay.UK to follow. This includes, for example, ensuring that the central infrastructure has a “thin” collaborative infrastructure and a wide range of access options in order to encourage competition and innovation. 

It also proposes various measures and governance principles to mitigate against the risk of the central infrastructure service provider gaining a dominant position within the NPA ecosystem. 

4. Pricing

The PSR proposes that Pay.UK should have a role in setting the price levels for users. It notes that prices should be set using proportionate, objective and non-discriminatory criteria (in line with existing regulatory requirements) and proposes five additional pricing principles. Under these principles, prices would need to: (i) reflect efficiently incurred costs; (ii) incentivise utilisation of the NPA; (iii) foster competition in services to end users; (iv) be transparent and predictable; and (v) adapt to changing competitive conditions.

Next steps

The consultation paper sets out various specific questions for feedback.

In relation to the questions relating to the scope of, and approach to, procurement, stakeholders have until 19 March 2021 to respond. The PSR aims to provide its initial response in Q3 2021 and final decision in Q4 2021. The NPA procurement process will remain on hold in the meantime.

In relation to questions relating to competition, innovation and pricing, stakeholders have until 5 May 2021 to respond. These responses will inform a policy statement, expected to be published in Q4 2021.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/february/uk-regulator-seeks-to-get-retail-payments-infrastructure-upgrade-back-on-track

Luxembourg legislator paves the way for the issuance of dematerialised securities using distributed ledger technology

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/february/luxembourg-legislator-paves-the-way-for-the-issuance-of-dematerialised-securities

On 26 January 2021, a new Luxembourg law dated 22 January 2021 (the “2021 DLT Law”) entered into effect, amending the Luxembourg law of 6 April 2013 on dematerialised securities, and the law of 5 April 1993 on the financial sector.

The 2021 DLT Law introduces two changes, namely: (i) recognising the issuance of dematerialised securities using distributed ledger technology (including blockchain), and (ii) broadening the scope of entities allowed to act as account keeper for unlisted debt securities, by including any EU credit institution or investment firm, provided certain conditions are fulfilled.

1. Issuance of dematerialised securities using distributed ledger technology (DLT)

The 2021 DLT Law is a continuation of the previous effort to bring the Luxembourg legal framework in line with new technological developments and to promote innovation in the financial sector. 

The law of 1 March 2019 had already amended the Luxembourg law of 1 August 2001 on the circulation of securities, to clarify that securities account (i.e. the account that investors have at their bank, which reflects their ownership of the securities), for the circulation of fungible book-entry securities, may be kept by relying on distributed ledger technology.

The 2021 DLT Law completes the previous developments by enabling central account keepers and liquidation organisms to also keep issuance accounts (i.e. the record in which the issued securities are registered at the moment of the securities issue) with respect to dematerialised securities by relying on distributed ledger technology. Note that the 2021 DLT Law is technologically neutral and refers to secure electronic recording devices, including distributed registers or databases.

In other words, the Luxembourg legal framework now explicitly recognises the possibility to issue dematerialised securities in tokenised form, and to register the transfer of ownership of these securities using distributed ledger technology. Thus, the entire issuance and circulation process can occur in a DLT-based environment.

2. Enlarged scope of entities allowed to act as account keeper for unlisted debt securities

Before the 2021 DLT Law, the function of central account keeper was reserved to those Luxembourg regulated entities holding a specific authorisation to this effect.

Going forward, for unlisted debt securities, any EU credit institution or (MiFID) investment firm is allowed to carry out the function of account keeper, provided they comply with certain IT control and security requirements. In particular the relevant firms need to be able to:

  • Register the securities composing each issue in an issuance account;
  • Ensure the circulation of securities by transfer from one account to another;
  • Verify that the total amount of each issue and recorded in an issuance account is equal to the sum of the securities recorded in the securities accounts of their account holders; and
  • Exercise the rights attached to the securities recorded in the securities account.

This will ultimately enable issuers of debt securities governed by Luxembourg law to rely on a much broader range of account keepers, provided these comply with rules equivalent to those applying to authorised central account keepers, thereby creating a level playing field.

Note that the enlarged scope applies only to unlisted debt securities and hence for equity securities and listed debt securities the previous regime remains unchanged.

What’s happening next?

We expect additional market players to make use of the possibilities offered by the new law, and hence we are likely to see an increased interest in securities issuances via DLT for the year to come. We also expect this trend to spread to the investment funds world in Luxembourg, where more and more DLT-based distribution solutions begin to surface.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/february/luxembourg-legislator-paves-the-way-for-the-issuance-of-dematerialised-securities

Departure of OCC head could end a winning streak for crypto in US banking

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/february/departure-of-occ-head-could-end-a-winning-streak-for-crypto-in-us-banking

Brian Brooks has recently ended his term as Acting Comptroller of the Currency. A focus of his tenure had been broadening the ability of banks to engage in cryptocurrency activities and expanding the availability of federal charters to cryptocurrency businesses. His parting actions include approval of a charter conversion for a cryptocurrency bank, Anchorage Trust Company (Anchorage), and an interpretive letter clarifying the authority of national banks and federal savings associations to use independent node verification networks (INVNs) and stablecoins for payment activities. It remains to be seen whether the Office of the Comptroller of the Currency’s (OCC) crypto-friendly agenda will continue under the Biden administration.

The conditional cryptobank approval 

Prior to the OCC’s approval of a conversion to a federal charter, Anchorage was a non-depository trust company organized under South Dakota law. As a national trust bank, operating under the title of Anchorage Digital Bank, National Association, it is permitted to do business in all fifty states.

The OCC conditioned its approval on Anchorage limiting its business to trust operations and related activities. The OCC approval bars Anchorage from engaging in activities that would cause it to be a “bank” under the Bank Holding Company Act such as taking cash deposits. Anchorage must also enter into agreements with the OCC and Anchorage’s parent company, Anchor Labs, Inc. (Anchor Labs), establishing capital and liquidity requirements, obligations on the part of Anchor Labs to provide capital and liquidity support to Anchorage if and when necessary, and certain risk management expectations.

Through the Anchorage approval, Brooks achieved his stated goal of granting crypto companies a federal charter — just before stepping down as the OCC’s head.   The availability of a federal charter may be attractive to crypto companies because it allows them to avoid regulation by all fifty states.  While Anchorage is the first federally chartered crypto bank, it may not remain the only one for long as fellow start-ups BitPay and Paxos have also applied for federal charters through the OCC.

The interpretive letter

The interpretive letter clarifies that banks under the OCC’s supervision have the authority to utilize INVNs and stablecoins in their authorized payment activities. 

The OCC and courts have long recognized banks’ authority to conduct payment activities using new and evolving technologies. For example, the letter cites a 2002 OCC rule codifying the authority of national banks to offer electronically stored value (ESV) systems which noted that “the creation, sale, and redemption of [ESV] in exchange for dollars is part of the business of banking because it is the electronic equivalent of issuing circulating notes or other paper-based payment devices like travelers checks.” 

The OCC applied a similar analysis in the interpretive letter to conclude that banks may use INVNs and related stablecoins to conduct authorized payment activities. In the OCC’s view, stablecoins, ESV systems, debit cards, and checks are simply different means of carrying out the same function, and the technological differences among them are immaterial so long as the underlying activity is a permissible one. Similarly, banks may serve as nodes on INVNs because it is simply a new means of transmitting payment instructions and validating payments, both of which are permissible banking activities.

The OCC stressed that banks must remember to engage in these payment activities in a manner consistent with applicable law and safe and sound banking practices. The letter cites a statement of the President’s Working Group on Financial Markets, which noted that stablecoin arrangements “should have the capability to obtain and verify the identity of all transacting parties” and that they should have appropriate practices in place such as “a 1:1 reserve ratio and adequate financial resources to absorb losses and meet liquidity needs.”

Under the interpretive letter, banks must also continue to guard against potential money laundering activities and terrorist financing. The OCC recognized that banks already have significant experience with developing compliance programs to ensure compliance with the reporting and recordkeeping requirements of the Bank Secrecy Act, and to prevent the usage of their systems by bad actors to avoid the financial system or engage in other illicit activities. However, they may adapt and expand their compliance programs to address the risks associated with cryptocurrency transactions in particular.

The letter closes with a note that banks should consult with OCC supervisors prior to engaging in these payment activities, as appropriate.

Next steps

The OCC’s crypto-friendly actions under Brooks have been met with criticism from lawmakers and trade groups, including sharply worded letters from members of Congress, who wrote that they were not the OCC’s call to make unilaterally.  In a letter to then-President-Elect Joe Biden, the chair of the House Financial Services Committee requested that the new administration rescind all of the OCC’s crypto-related guidance.

Certain actions, like the granting of federal charters to crypto companies, may be more difficult to undo. However, given the new administration coming to power and Brooks’s departure, it is unclear whether the OCC will continue to push banking regulation in such a crypto-friendly direction. It will likely take a number of months after the nomination and confirmation of a new head of the OCC before it becomes clear how the agency will approach the crypto space going forward.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/february/departure-of-occ-head-could-end-a-winning-streak-for-crypto-in-us-banking

UK joins global trend by putting buy-now, pay-later under the regulatory spotlight

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/february/uk-joins-global-trend-by-putting-buy-now-pay-later-under-the-regulatory-spotlight

As more of us shop online, the option to “buy-now, pay-later” is surging in popularity. Providing this BNPL service to customers has not been a regulated activity in the UK but this is likely to change following a review of the unsecured credit market. This follows similar moves by other countries to tighten the regulatory scrutiny of BNPL as it becomes more popular.

Bringing BNPL within the regulatory net

The UK government has confirmed that it will legislate to bring currently unregulated, interest-free buy-now, pay-later services into the scope of regulation. This follows the publication of the Woolard review into change and innovation in the UK’s unsecured credit market.

The Woolard review recommends starting to regulate BNPL products “as a matter of urgency”. The report justifies the move to regulate by pointing to the potential for consumer harm e.g. the risk that some individuals will take on unaffordable levels of debt. The urgency is justified by the significant growth in the BNPL market.

Not an unexpected move

Our payments team covered BNPL on our latest monthly payments podcast where we discussed recent calls to regulate BNPL.

Although some BNPL firms already have a UK licence, providing BNPL services is not itself a regulated activity because it falls outside the scope of payment service and consumer credit rules.

In particular, loan agreements can be exempt from consumer credit regulation where they are interest-free and due to be repaid within 12 months. Given that most BNPL agreements provide for repayment within 4-6 weeks, this exemption has allowed many BNPL firms to provide their services without needing to seek an FCA licence. It is likely to be this exemption which is limited by future legislation.

Some BNPL firms operating in the UK, including some of the larger providers, are already authorised. Regulating BNPL would likely mean that other providers would have to seek FCA authorisation. There would also be more consistency across the market in terms of the application of affordability assessments and whether customer complaints can be referred to the Financial Ombudsman Service.

The global comparison

The UK is not alone in scrutinising BNPL. For example, the payment method is also popular in Sweden and Australia which are home to two of the biggest providers: Klarna and Clearpay (aka Afterpay) respectively. Both countries have also recently tightened restrictions in relation to BNPL offers.

Last year Sweden prohibited e-payments providers from presenting credit options before debit options. This is to avoid BNPL offers being presented as the default payment method – something which the Woolard report also flags as a concern. In Australia, BNPL firms will be subject to new design and distribution obligations later in 2021.

Why has BNPL become more popular?

According to the report, the BNPL market nearly quadrupled in size in 2020. 90% of BNPL transactions involve fashion and footwear but in total the report estimates that the total value of BNPL transactions last year amounted to £2.7bn.

The market was growing before the Covid-19 pandemic but has risen rapidly as lockdown restrictions have moved more spending online.

Balancing benefits and risks

Broadly speaking the benefits of the BNPL model are:

  • BNPL firms receive a fee from merchants in return for providing them with a new payment option to offer customers
  • Merchants hope to increase sales from this service, which may also be cheaper for them than other payment options
  • Customers get more flexibility about when and/or how they pay for their shopping online and interest-free credit

While acknowledging the benefits of BNPL, the report notes several concerns relating to the affordability of credit, the potential to create high levels of indebtedness, and varying approaches to late payment fees. Related to these are concerns about how BNPL offers are presented and promoted.

Background to the Woolard review

The Woolard review was commissioned by the FCA to explore how regulation should support the market for unsecured lending in the light of the pandemic, changing business models and growth in the BNPL market. The report makes 26 recommendations to the FCA.

What happens next?

The Treasury says that it will take this forward “as a matter of priority” and work with the FCA to assess the policy and legislative options for the government.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/february/uk-joins-global-trend-by-putting-buy-now-pay-later-under-the-regulatory-spotlight

UK plans to protect access to cash in 2021 and beyond

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/january/uk-plans-to-protect-access-to-cash-in-2021-and-beyond

How to ensure continued access to cash has been high on the regulatory agenda for several years. However, the Covid-19 pandemic has made the question more urgent. The UK Government is finalising its proposals for new legislation intended protect the sustainability of cash for the long term.

Cash crunch

The Covid-19 pandemic continues to accelerate pre-existing trends in cash usage as consumers increasingly switch to alternative payment methods. The figures available for 2020 show a significant year-on-year shift with the use of contactless and remote payments on the up and ATM usage going down.

Cash remains, however, an essential payment mechanism for many people and small businesses. In the UK over the last few years the regulators and Treasury have led several reviews, research projects and reports to understand better how people interact with cash.

Read Access to cash: The regulatory response to a tangible problem on our knowledge portal for an overview of the UK policymakers’ involvement in this area to date.

Adapting the infrastructure to lower cash volumes

As that note explains, the processes behind physical cash – such as production, delivery and distribution – were built for larger cash volumes. The more excess capacity there is in the cash system the more inefficient and costly it becomes, which has raised questions about the sustainability of the cash infrastructure.

To address this, the Treasury has created the Joint Authorities Cash Strategy (JACS) Group to bring together the Bank of England, Payment Systems Regulator and Financial Conduct Authority to oversee cash infrastructure across the UK. The JACS Group is tasked with ensuring that this infrastructure adapts so that it can continue to operate in a future environment of lower cash usage.

The JACS Group is also working with the Government to develop new legislation in this area. In its 2020 Budget the Government committed to bringing forward legislation to protect access to cash and the UK’s cash infrastructure.

Mapping ATMs

In the meantime, the regulators are continuing their own initiatives relating to cash usage.

Towards the end of 2020, the FCA and PSR released the findings from their collaboration with Bristol University on mapping access to cash. The results show that, although most consumers do have ATMs close to them, there is a noticeable urban-rural divide. The research also found a growth in the proportion of pay-to-use ATMs in deprived areas.

According to the paper, one avenue for further research would be to explore the “quality” of cash access. For example, whether expanding cashback to retail outlets would be effective in filling gaps in cash coverage. Currently cashback requires the customer to purchase an item to withdraw cash. Relaxing this rule may be part of the forthcoming legislation.  

Looking to the future – the battle between established and alternative payment methods

Cash is just one example of a diverse range of payment methods. Our Fintech Global Year in Review 2020 and Year to Come 2021 report predicts that the coming year will see competition in this area hot up as alternative payment methods battle for dominance.

In addition, as we have tracked in this blog, the Bank of England is among a group of central banks exploring the possibility of issuing their own digital currencies. Notably, in a recent speech, Chancellor Rishi Sunak highlighted that any CBDC in the UK would be “as a complement to cash” (as opposed to a replacement for cash).

This extract from a speech by Andy Haldane (Chief Economist at the Bank of England) sums up the likely cumulative outcome of these developments:

“If history is any guide, a co-evolutionary path is likely, with an eco-system of diverse and competing payments media and systems emerging, some wholesale, others retail, some private, others public. The technologies supporting these systems may also differ.”

Read more

For a summary of recent policy work in this area, read our note Access to cash: The regulatory response to a tangible problem.

To see our predictions for the year to come in fintech and payments, download your copy of our Fintech Global Year in Review 2020 and Year to Come 2021.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/january/uk-plans-to-protect-access-to-cash-in-2021-and-beyond

UK reveals plans to regulate stablecoins

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/january/uk-government-reveals-plans-to-regulate-stablecoins

The UK has set out its proposals on the regulation of cryptoassets for public comment. The UK’s proposals are narrower than the EU proposals launched last year, reflecting an intention to take a “staged and proportionate approach”. In particular, the UK proposes to regulate only “stable tokens used as a means of payment” initially. It is, however, inviting input in relation to opportunities and risks in other areas, including cryptoassets used for investment purposes and DLT in financial services and financial market infrastructures in particular. The consultation closes on 21 March 2021.

HMT Consultation and Call for Evidence

The UK has finally launched a long-awaited consultation and call for evidence on cryptoassets and stablecoins. 

The document reveals the government’s proposal to expand the regulatory perimeter to cover “stable tokens used as a means of payment”. The legislation would take the form of high-level principles, leaving it for financial regulators to specify detailed requirements through rules or codes of practice.

More broadly, the UK intends to take a “staged and proportionate approach” to cryptoasset regulation. As it deems the risks and opportunities in relation to stablecoins to be most urgent, the government has prioritised this area. It is not proposing to regulate further any other types of cryptoasset for now, except in relation to financial promotions (in relation to which it has already consulted and will report in due course). It is however seeking evidence in relation to cryptoassets used for investment purposes and the use of DLT in financial services and financial market infrastructures in particular, in order to inform its future proposals.

This approach stands in stark contrast to the European Commission’s legislative proposals which already include a comprehensive framework to regulate the entire crypto industry (MiCA) as well as a pilot regime for the creation and testing of digital security infrastructure. Underlying the UK approach is a desire to avoid applying “disproportionate or overly burdensome regulation to entities”, particularly where the financial stability risks are low.

Proposed regulatory framework for stable tokens

The proposal contemplates introducing two new categories of regulated token to supplement the FCA’s existing categories of “security tokens” and “e-money tokens”. These new categories, which broadly echo the taxonomy in MiCA, are (i) stable tokens whose value is linked to a single fiat currency; and (ii) stable tokens whose value is linked to assets other than a single currency (such as gold or multiple currencies).

The government anticipates that regulation would apply in relation to a long list of activities concerning such tokens. These include issuance, destruction, value stabilisation and reserve management, validation of transactions, facilitating access, settlement, custody and administration, executing transactions and fiat-token exchange. This list is intended to reflect the FSB’s recommendations in this area.

In determining its approach, the UK authorities will be considering how to align regulatory treatment with existing analogous frameworks. For instance, the government is contemplating whether stable tokens that are linked to a single fiat currency should be subject to the same requirements that apply to e-money tokens. However, it is mindful of the need to provide enhanced regulation for tokens with the potential to become systemically important, as well as a framework that is clear and appropriate to support innovation. The European Commission has had to grapple with similar issues in its drafting of MiCA. 

As well as proposing new regulatory treatment for stable tokens, the consultation paper helpfully outlines how the government envisages stable token payment systems will be regulated. Notably, it suggests that stable token arrangements which play a similar function to existing payments systems should be regulated in a similar way, even if that entails legislative clarification. This would mean that systems with the potential to reach systemic scale would be regulated by the Bank of England whilst others may fall within the remit of the Payment Systems Regulator. 

Given the decentralised and cross-border nature of stable tokens, UK authorities need to consider carefully how the proposed regulation will apply to firms located overseas. The proposal notes that the government is considering whether firms that actively market to UK consumers should be required to have a UK establishment and be authorised in the UK.

Call for Evidence

The final part of the document seeks views on a variety of questions in relation to cryptoassets used for investment purposes (including both unregulated tokens such as Bitcoin and regulated security tokens) as well as the use of DLT in financial services (including by regulated financial markets infrastructures and in Decentralised Finance). In particular, the government seems to be looking to develop its understanding around potential benefits and drawbacks to various types of innovation as well as potential regulatory barriers and unregulated risks.

Next steps

The consultation closes on 21 March 2021. Input received will feed into the government’s response, which will include more detail on how the proposed approach may be implemented in law. We can also expect further consultations from the relevant regulatory authorities in relation to the specific rules.

Please feel free to get in touch should you wish to discuss.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/january/uk-government-reveals-plans-to-regulate-stablecoins

Introducing our Fintech Global Year in Review 2020 & Year to Come 2021 and Technology Legal Outlook 2021

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/december/fintech-global-year-in-review-2020-year-to-come-2021-and-technology-legal-outlook-2021

As part of our annual Year in Review, Year to Come campaign, we have published two complementary end of year reports looking at global legal and regulatory developments in fintech and the broader tech sector.

Global Fintech Year in Review 2020 & Year to Come 2021

For the third year running we have published a Fintech Global Year in Review, Year to Come report.

This publication summarises key legal and regulatory developments in the fintech space and addresses global, EU and country specific developments for 16 jurisdictions. Our review covers the full breadth of the fintech legal spectrum, from the development of alternative payment models, stablecoins and central bank digital currencies, to the increasing regulatory burden on Fintechs and BigTechs, through to the latest trends in tech investments, funding, and the regulation of data. Looking at the year to come from a thematic perspective we have also identified 7 key predictions.

Visit our Fintech Global YIR,YTC 2021 landing page for our predictions, to download the publication and for more details of our global fintech key contacts and other fintech content.

Technology Legal Outlook 2021

For the second year running we have also produced a publication looking at broader themes affecting tech companies, digital markets and emerging tech.

After the seismic events of 2020, the new year offers new hope for tackling the Covid-19 pandemic, for economic recovery and for “building back better”. Technology and data will continue to have a critical role in all aspects of the global economy, and this will present opportunities and challenges for tech companies. Businesses will be the subject of increased scrutiny and will need to navigate a climate of heightening risk and increasing regulation of the digital economy.

In our Technology Legal Outlook 2021 we explore the key global trends that we believe will shape the legal outlook for businesses in 2021, exploring the macro-themes of: “The shifting global dynamic”, “Viewing the future through an ESG lens” and “Regulation and redress in the digital economy”.

Visit our Tech Outlook 2021 landing page for more details of our publication and tech-focused key contacts across our key practice areas and to download a copy of the report.

Broader Year in Review Year to Come Campaign

Visit our “The World in 2021” landing page to access the full suite of our Year in Review & Year to Come content – country-by-country and also by topic (using the “legal topic” filter).

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/december/fintech-global-year-in-review-2020-year-to-come-2021-and-technology-legal-outlook-2021

UK payments sector prepares for the end of the Brexit transition period

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/november/uk-payments-sector-prepares-for-the-end-of-the-brexit-transition-period

The Brexit transition period ends at 11pm UK time on 31 December 2020. From this point many payment providers will no longer have the right to provide regulated services from the UK into the EEA. As firms finalise their Brexit plans, the UK’s Financial Conduct Authority has repeated its warning to firms that customers should be treated fairly throughout the process.

What Brexit means for payments firms

The passport

EEA firms which are licensed to provide certain financial services in their home EEA State may provide these services throughout the EEA. This right is known as the financial services passport and covers payment services under the Payment Services Directive and the issuance of e-money under the Electronic Money Directive.

Loss of EEA-UK passporting rights

The UK left the EU (and, by extension, the EEA) at the end of January 2020 but then immediately entered a transition period. During this time, passporting between the UK and the rest of the EEA has still been possible. At the end of the year, however, the transition period ends and so too will any cross-Channel passport rights.

Temporary permission for EEA firms

As we discussed in our latest payments podcast, EEA payments firms which passport into the UK at the end of the transition period may participate in the UK’s temporary permissions regime. This regime treats those firms as if they were authorised in the UK for a temporary period. This is effectively a unilateral extension of the transition regime for these firms and allows them more time to prepare for the impact of Brexit, which may involve applying for UK authorisation. EEA firms that want to benefit from the temporary permissions regime must notify the FCA before 30 December 2020, if they have not done so already.

Preparing for life outside the EEA

There is no EEA-wide, or EEA national, equivalent of the UK temporary permissions regime. And so for UK payments firms the “cliff-edge” impact of the loss of EEA licence will be felt at the end of this year.

Some UK payments firms have responded by setting up an appropriately licensed entity in the EEA. This entity could then continue to provide payment services throughout the EEA post-Brexit. In many cases this has involved providing customers with new contracts to move them across to the EEA entity. In a recent speech, Nausicaa Delfas (FCA Executive Director of International) reiterated that the FCA expects all firms to treat customers fairly throughout the Brexit process.

Others intend to wind down their EEA operations. However, this also requires careful planning and customer communications. In a letter sent to payments firms earlier this year, the FCA warned that it would be a “poor outcome” if firms suddenly stopped servicing customers in the EEA.

The impact on UK payments regulation

Revocation of identification certificates

In a recent press release, the European Banking Authority has reminded firms that eIDAS certificates issued to UK third party payment service providers (TPPs) will be revoked at the end of this year. These certificates are used for identification purposes. TPPs rely on them to access customer account data and initiate payments, which are important elements of Open Banking.

Changes to UK Open Banking

In response, the FCA has amended identification requirements for TPPs under UK law. A recent FCA policy statement confirms that UK account servicing payment service providers (ASPSPs, which are often banks) must accept an alternative form of identification as long as it meets certain criteria.

ASPSPs need to start implementing the change in the rule in their systems and tell TPPs what alternative certificate they will accept. TPPs will need to seek alternative certificates which comply with the revised rules.

To give firms some more time to prepare, the FCA is allowing certificates which do not meet the revised requirements to be used in some cases for a temporary period. This arrangement will end on 30 June 2021.

Access to euro payments schemes

Ongoing participation

Electronic payments in euro rely on payments schemes known collectively as SEPA. Helpfully for UK payment providers, the European Payments Council has confirmed that the UK will continue to participate in the SEPA schemes after Brexit.

Changes to messaging

UK-based participants in SEPA will, however, need to update their processes to reflect their new role as non-EEA firms. Notably they must update their processes to reflect changes in the information they need to provide when operating via SEPA. Not including the additional information about their payment transactions could lead to those transactions being rejected.

What happens next?

Firms on both sides of the Channel are continuing to implement their Brexit plans. We have recently been helping clients stress-test their planning. Please get in touch if you would like to discuss.

Looking further ahead, both the EU and the UK are developing new regulatory policy for the payments sector. The EU has already set out its plans in its retail payments strategy, whilst the UK government is currently working through feedback received on its payments landscape review. We will continue to keep you updated on the latest developments in this blog.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/november/uk-payments-sector-prepares-for-the-end-of-the-brexit-transition-period

Spain passes a new law creating a fintech “Regulatory Sandbox”

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/november/spain-passes-a-new-law-creating-a-fintech-regulatory-sandbox

Spain has passed a new law relating to digital transformation of its financial system (pending publication in the Official Gazette in the next few days). The law introduces the highly anticipated regulatory sandbox: a testing space that can be used to try out technological innovation in financial services under special flexible rules. The aim is to curb costs and regulatory complexity, while ensuring supervision by regulators and due protection for the market.

Background

In July 2018, following the UK’s example, the Spanish government proposed a new law to boost technological innovation in the Spanish fintech sector. Following a public consultation and parliamentary debate, a draft bill on the “digital transformation of the financial system” has been approved by the Spanish Senate and passed into law (the DTFS Law) on 5 November 2020.

We summarise below the main aspects and features of this new law on the digital transformation of the financial system creating a regulatory sandbox.

Purpose

The stated aim of the sandbox is:

  • to create a controlled testing ground that enables technological innovations in the financial system to be put into practice, fully in line with the legal and regulatory framework, respecting in any event the principle of no discrimination, and
  • to give the relevant authorities and sponsors of technology-based innovations, of application in the financial system and for financial services customers, the tools to help them understand the implications of digital transformation. This aims at increasing efficiency, the quality of services and, particularly, security and protection against new fintech risks.

The sandbox will enable technological innovation projects developed by any individual or firm, including technology firms, financial institutions, credit servicers, representative associations, public or private centres of research or any other interested party (Sponsors) that are granted entry to carry out tests in a special regulatory environment.

Sandbox projects will not be subject to the specific legislation usually applicable to financial services. However, firms will be required to act in accordance with the DTFS Law and a protocol established between the relevant authorities and the Sponsor.

The sandbox is conceived as a temporary arrangement under which ‘tests’ can be carried out before a solution is rolled out ‘in the real world’.

Entrance and applicable rules
  • Applications: Applications are to be made electronically through a standard form to be published by Spain’s Secretariat General for the Treasury and International Finance (Secretaría General del Tesoro y Financiación Internacional). The relevant regulatory authorities by area will conduct a preliminary assessment for allowing the test.

    Applications (which can be submitted in English) must be accompanied by a supporting statement explaining the project and detailing compliance with the requirements mentioned below and, if accepted, how Sponsors plan to provide the required safeguards and protection set out in the DTFS Law.

    For applications to be accepted, propositions must be innovative, ‘sufficiently advanced’ and able to provide added value. Regulators will also consider the relevant project’s possible impact on the Spanish financial system.

  • Testing: When a proposition receives positive pre-assessment, a testing protocol will be entered into between the Sponsor and the relevant authority or authorities. This sets out the details of how the proposition works and the specific conditions under which it will be tested.

    The testing phase will be supervised by the relevant authority in the area (the Bank of Spain, the securities and markets regulator (CNMV) or pensions and insurance regulator (DGSFP)). Where projects are a success, sponsors will be able to get the necessary approvals, if needed, to bring them to market.

  • Participants: The DTFS Law states that each participant to a sandbox project must state their written informed consent to involvement in that testing. Participants must first be informed of the test and its possible risks and the rules on their withdrawal. All participants will have the right to stop taking part in a test at any time, without any entitlement to compensation for Sponsors.
  • Sponsor liability: Sponsors will have sole liability for any possible participant losses as a result of their participation in tests, where these result from breaches of the protocol, from risks not duly reported, or from any form of negligence or technical or human errors.
  • Guarantees for losses: The Sponsor must have sufficient financial guarantees, and this will be stated in the relevant protocol, to cover any losses for which it has to compensate participants, proportionate to the actual risk.
  • Supervision: The relevant regulatory authority must appoint one or more monitors of the tests that form the pilot project. Authorities and Sponsors are expected to remain in constant contact throughout tests. The supervisor can issue instructions for compliance with the protocol or the DTFS Law and insist on changes to protocols for tests to be carried out successfully.
  • Confidentiality: Safeguards on confidentiality may be included in protocols to protect Sponsor’s industrial and intellectual property.
  • Non-compliance: Tests will be discontinued if the DTFS Law or relevant protocol are not complied with. Individuals and businesses, as well as their directors or officers, who as a result of that non-compliance violate rules and regulations will be liable for the penalties under those rules and regulations.
Exiting the sandbox

The DTFS Law states that at the end of or during pilot projects according to the protocols, Sponsors can apply for authorisation to start the relevant activity, if they are not already authorised, or to extend it.

The DTFS Law allows fast-track authorisation for regulated activities where these will be mainly conducted through the technology and business model tests in the sandbox. This is provided that the authorising regulators consider that the testing allows a simplified analysis of whether the requirements under applicable legislation are met. Authorisation application times will be shortened and a proportionality rule be used.

Protocols must set out in the manner in which, if tests are satisfactory, firms will make the transition from the sandbox to ordinary business. Where this cannot be determined when the protocol is entered into, plans may be annexed to it subsequently.

Other aspects covered by the DTFS Law
  • Proportionality: The DTFS Law contains a general mandate for the relevant authorities to make use of the principle of proportionality when considering requirements that are subject to weighting.
  • Communication channels: It also establishes certain channels of communication with the relevant regulatory authorities to deal with queries concerning new applications, processes, products, business models and other matters related with technological innovation applied to financial services, including a system for written enquiries.
  • Coordination between public authorities: Finally, measures are set out so that the lessons learned from the propositions tested in the sandbox are passed up to the Spanish government and parliament, and for coordination between public authorities, so that these can be used to adapt regulations to new technological requirements.
Next

The sandbox is of interest to Fintech start-ups that want to launch new technology-based financial products and services in Spain, but also to well-established actors that want to use it as a step before bringing innovative projects to market. The application window for the first cohort of the regulatory sandbox is expected to open soon.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/november/spain-passes-a-new-law-creating-a-fintech-regulatory-sandbox

EU takes a step towards a Union-wide single market for crowdfunding

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/eu-takes-a-step-towards-a-union-wide-single-market-for-crowdfunding

Existing national rules for crowdfunding platforms differ across the European Union. This can get in the way of providing crowdfunding services across national borders. A new regulation aims to deliver a uniform framework for these service providers and introduce a straightforward passporting regime.

What has happened? 

The EU has introduced a Regulation on European crowdfunding service providers for business (CFR) and an accompanying Directive. This is a response to the largely different national rules across the Union which present an obstacle for the cross-border provision of crowdfunding services. The CFR introduces an EU-wide approach to crowdfunding, including new passporting rights.

Why is the CFR needed?

Crowdfunding represents an increasingly important type of alternative finance for start-ups and small and medium-sized enterprises, typically relying on small investments.

The CFR is part of the European Commission’s fintech action plan and digital finance strategy. The European Commission has previously identified that crowdfunding platforms do not always fall squarely in the EU regulatory framework and wants to ensure loan- and investment-based crowdfunding services are treated as regulated activities.

What does the CFR require?

The CFR sets rules for crowdfunding service providers (CFSPs) on, among other things:

  • Authorisation as CFSP and cross-border provision of crowdfunding services
  • Capital requirements
  • Outsourcing
  • Reporting
  • Entry knowledge test and simulation of the ability to bear loss
  • Pre-contractual reflection period
  • Key investment information sheet 
  • Market communications
How does the CFR impact existing crowdfunding platforms?

EU CFSPs which are in the scope of the CFR, including those that are already regulated under a national regime, must apply for a licence under the new regime. A transitional period for these firms means that the deadline for getting that licence is 10 November 2022.

What does the CFR cover?

The CFR applies to crowdfunding campaigns up to EUR 5 million over a 12-month period. Larger crowdfunding operations fall within the scope of the Prospectus Regulation and might trigger an authorisation requirement for the crowdfunding service provider under MiFID II.

What are the key points to note for crowdfunding service providers?
  • Judging application of the CFR: Crowdfunding platforms should start by working out if they fall within the scope of the CFR which covers broadly speaking loan- and investment-based crowdfunding services. They should also consider how they can track on an ongoing basis whether the funds they raise are within the threshold noted above.
  • Identifying relevant activities: The licensing procedure under the CFR does not impact other licensable activities. So if a CFSP were, for example, to provide payment services in connection with its crowdfunding services it may also need to be separately licensed as a payment service provider under the Payment Services Directive.
  • Operational build: The CFR imposes comprehensive requirements for all stages of the provision of crowdfunding services, starting with an entry assessment of the prospective non-sophisticated investor’s experience, through specific IT requirements regarding the buying and selling of loans and transferable securities for crowdfunding purposes, to reporting and recording obligations.
  • Investor assessments: Before giving prospective non-sophisticated investors full access to invest in crowdfunding projects on their platform, CFSPs will have to assess whether and which crowdfunding services offered are appropriate for these investors. This assessment includes requesting information about the investor’s experience, financial situation and basic understanding of risks involved, and should be reviewed every two years.
  • Key investment information sheet: CFSPs will be required to provide prospective investors with a key investment information sheet drawn up by the project owner for each crowdfunding offer. While the project owner is generally responsible for the information provided, it is the duty of the CFSP to ensure that the key investment information sheet is clear, correct and complete. In this respect, where an omission, mistake or inaccuracy is detected by the crowdfunding service provider, they should, under certain conditions, suspend or even cancel the crowdfunding offer.
What happens next?

The CFR and the accompanying directive start to apply from 10 November 2021. As noted above, existing CFSPs have an additional twelve months in which to apply for a licence under the new regime. Meanwhile, EBA and ESMA will develop the fourteen sets of regulatory and implementing standards provided for in the CFR.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/eu-takes-a-step-towards-a-union-wide-single-market-for-crowdfunding

FSB lays out global agenda on stablecoins and cross-border payments

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/fsb-lays-out-global-agenda-on-stablecoins-and-cross-border-payments

This month the Financial Stability Board presented G20 leaders with two reports which are likely to be instrumental in shaping the future of payments. One lays out a roadmap for enhancing cross-border payments whilst the other sets out recommendations for the regulation of global stablecoins. Both contemplate a busy agenda for both public and private stakeholders over the coming years.

FSB reports to the G20 

For the October 2020 meeting of the G20 finance ministers and central bank governors, the FSB has presented two reports of high significance for the global payments industry.

  1. Roadmap for enhancing cross-border payments

    The FSB laid out a roadmap for tackling inefficiencies in cross-border payments. These inefficiencies are a key challenge for the payments industry and a perceived driver behind new private money initiatives such as stablecoins. Addressing this issue is also a key pillar of the European Commission’s Retail Payments Strategy.

    The roadmap primarily focuses on areas of improvement for the existing payments ecosystem, but it does also touch on alternative payment arrangements, such as central bank digital currencies and stablecoins.

  2. Final report on the regulation, supervision and oversight of global stablecoins

    Following its consultation earlier this year, the FSB published its final report on global stablecoins. The recommendations outlined in the report have not changed substantially from those in the consultation paper (discussed in our previous blogpost). The report now also lays out a timetable for implementation.

Alongside these, the FSB also submitted reports on BigTech in finance in emerging markets and the use of supervisory and regulatory technology, among other things.

A detailed roadmap for cross-border payments

The FSB’s roadmap (which builds on previous work) seeks to establish “ambitious but achievable goals” by setting out five themes which are broken down into 19 building blocks comprising specific action points. The complexity is indicative of the fact that there is a multitude of issues affecting cross-border payments and no silver bullet to solve them. 

The five themes are outlined at a high level below.

  1. A joint public and private sector vision 

    This is a cornerstone for the project. It involves setting common targets to be agreed by relevant stakeholders and endorsed by the G20. To that end, a public consultation is due to be launched in May 2021. The FSB and other international standard-setters will also assess areas for improvement in the implementation of existing regulatory standards and look to develop new common standards for agreements relating to cross-border payment services.

  2. Coordinating regulatory, supervisory and oversight frameworks

    This area aims to improve regulatory alignment between jurisdictions. As part of this, the FSB is looking to promote a more consistent application of standards around anti-money laundering and combating the financing of terrorism (AML/CFT) and foster digital identity frameworks, both areas of focus under the European Commission’s Digital Finance and Retail Payments Strategies. 

  3. Improving existing payment infrastructures and arrangements 

    Operational inefficiencies in existing systems are seen as another key problem area. In particular, the FSB wants to facilitate adoption of payment-versus-payment mechanisms, widen access to systems, explore reciprocal liquidity arrangements across central banks, extend and align operating hours of key payment systems, and establish better links between payment systems. 

  4. Increasing data quality and straight-through processing by enhancing data and market practices

    Standardising data formats and protocols for data exchange is expected to improve transaction efficiency. The FSB hopes to harmonise technical standards for common message formats (such as ISO 20022) and APIs (application programming interfaces) for data exchange. It also wants to assess the scope for a unique global identifier that links to the account information in payment transactions.

  5. Exploring the potential role of new payment infrastructures and arrangements

    This workstream will examine the scope for new multilateral platforms, global stablecoin arrangements and CBDCs. The action points complement the objectives under the FSB’s global stablecoin report as well as the recent joint central bank report on CBDCs.

Next steps for global stablecoin regulation

From now until December 2021, international standard-setting bodies are tasked with amending and/or providing guidance to supplement existing standards in light of the FSB’s stablecoin report. For example:

  • The Financial Action Task Force (FATF) will be reviewing the implementation of its AML/CFT standards and considering whether any further updates are necessary.
  • The Basel Committee on Banking Supervision (BCBS) will continue to assess the appropriate prudential treatment for different types of cryptoasset and consult on any specific measures.
  • CPMI-IOSCO intend to provide more guidance on which factors should determine whether a stablecoin arrangement is systemically important and thus subject to its Principles for Financial Market Infrastructures (PFMI). They also plan to look at how systemically important stablecoins may comply with the PFMI (as a number of these principles pose challenges in this context) and whether there are any risks that are not appropriately addressed by the PFMI.

Meanwhile, national authorities are tasked with implementing the FSB recommendations and international standards in relation to both cross-border cooperation arrangements and their regulatory, supervisory and oversight frameworks.

The road ahead

Improving cross border payments and regulating global stablecoins are two important challenges for which international coordination is absolutely fundamental. These reports represent key milestones in the journey to tackle them, by establishing a global agenda. There now lies a long and busy road ahead through the implementation phase.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/fsb-lays-out-global-agenda-on-stablecoins-and-cross-border-payments

Lofty Ways to Leave your Fiver: Big Thoughts About Central Bank Digital Currencies

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/lofty-ways-to-leave-your-fiver-big-thoughts-about-central-bank-digital-currencies

Seven central banks and the BIS have released a report proposing a framework for domestic central bank digital currencies that complement existing forms of legal tender and support public policy objectives. Any decision to issue a CBDC (and on what basis) will be taken by each central bank individually, but the framework is intended to develop a common understanding in relation to design principles, from a technical and policy perspective. Meanwhile, the European Central Bank has launched a public consultation on a digital euro.

A new joint report

With the increasing popularity of non-cash payments and efforts made by private entities such as Facebook in connection with stablecoins, questions around the desirability and feasibility of central bank digital currencies (CBDC) are becoming increasingly pertinent. 

A group consisting of the Bank of Canada, European Central Bank, Bank of Japan, Sveriges Riksbank, Swiss National Bank, Bank of England, Board of Governors of the Federal Reserve and Bank for International Settlements has issued a report setting out guiding principles for and core features of CBDCs. 

The report emphasizes the role of a digital fiat as a complement to, rather than a substitute for, cash and the need for informed judgment balancing the need for innovation and efficiency in the relevant country’s payment system with broader public policy objectives, such as monetary or financial stability.

This comes just as the European Central Bank has launched a consultation on a digital euro.

Three guiding principles

A CBDC is a digital payment instrument, denominated in the national unit of account, that is a direct liability of the central bank. CBDCs may improve payments diversity, foster financial inclusion and support public privacy. At the same time, they may introduce certain risks, such as counterfeiting and cyber risk, fragmentation of payment systems and the risk of disintermediating banks or enabling destabilizing runs into central bank money.

In order to balance the potential benefits of CBDCs against their risks, the group highlighted the following as key principles:

  • Do no harm to monetary and financial stability
  • Coexistence with cash and other types of money in a flexible and innovative payment system
  • The promotion of broader innovation and efficiency.
Four core features

Based on these key principles, the group broadly agrees that any future CBDC system should be:

  • Resilient and secure to maintain operational integrity
  • Convenient and available at very low or no cost to end users
  • Underpinned by appropriate standards and a clear legal framework
  • Have an appropriate role for the private sector and promote competition and innovation.

The report also outlines more specific design features (for example, in relation to monetary controls, technical design, incentives, and trade-offs) requiring further consideration by each central bank.

No one-size-fits-all approach

The group highlighted that the design and issuance of a CBDC will need to be sovereign decisions based on an informed calculus of how certain risks, such as the potential for destabilizing runs into central bank money, may be managed through a combination of safeguards both in the design of the CBDC and general throughout the jurisdiction’s financial system policies.

The design of domestic CBDCs will need to be driven by each jurisdiction’s circumstances, such as its stage of economic development, its motivations and others, but would also have international implications requiring cooperation and coordination to prevent any negative spillovers and ensure any improvements necessary for seamless cross-border payments. 

At this stage, the focus is very much on exploring domestic use cases rather than improving cross-border payments. The Financial Stability Board is spearheading a separate initiative to consider the latter, which this group will contribute to.

The report’s guidelines are intentionally broad and the group notes that they may be incorporated in some fashion by an array of CBDC designs. While not simple, the report suggests that each jurisdiction’s design approach should take into account both the differences between jurisdictions and the need for harmonization and compatibility for cross-border transfers. 

Next steps

The group aims to continue exploring questions around CBDCs and its challenges, and continue domestic outreach to foster informed dialogue. Any decision to introduce a CBDC will be taken by each jurisdiction on its own timing.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/lofty-ways-to-leave-your-fiver-big-thoughts-about-central-bank-digital-currencies

EU proposal to tackle digital risks and build operational resilience in the financial sector

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/eu-proposal-to-tackle-digital-risks-and-build-operational-resilience-in-the-financial-sector

As technology firmly embeds itself into every aspect of financial services, policy makers are increasingly looking at the sector’s exposure to the risks of this digitalisation. One response from the European Commission is to beef up the EU’s rules on ICT risk via a Digital Operational Resilience Act. As well as imposing new rules on financial entities, DORA could see some technology providers subject to the scrutiny of the EU financial supervisors.

Introducing DORA

The draft Digital Operational Resilience Act is part of a suite of materials published under the European Commission’s new Digital Finance Strategy. The Strategy also includes a proposal to regulate the EU’s crypto industry and a pilot DLT sandbox.

As drafted, DORA has two distinct parts. The first applies to financial entities. The second is relevant to providers of technology services to those financial entities.

DORA explored: key points to note for financial entities

The first part of DORA applies to a very wide spectrum of EU “financial entities”, including banks, insurers, payment service providers, crypto-asset issuers and service providers, and crowdfunding service providers. Financial entities identified as “significant and cyber-mature” would be subject to the most onerous obligations.

The obligations which DORA would impose on “financial entities” include:

  • ICT risk management: Financial entities would be required to create and maintain a sound, comprehensive and well-documented ICT risk management framework. This must include a dedicated and comprehensive business continuity policy, disaster recovery plans and a communications policy. Alongside this framework, financial entities would have to use and maintain ICT systems that meet certain requirements, identify all sources of ICT risk on a continuous basis, design and implement security and threat-prevention measures, and promptly detect anomalous activities.
  • Incident reporting: DORA would require financial entities to establish and implement a robust ICT-related incident management process and to put in place early warning indicators. Financial entities would have to classify ICT-related incidents according to prescribed criteria to be developed by a Joint Committee of the European Supervisory Authorities (ESAs) and report “major” ICT-related incidents to their national regulator.
  • Information sharing: DORA would allow financial entities to exchange cyber-threat information and intelligence, provided this exchange is, amongst other things, aimed at enhancing digital operational resilience.
  • ICT third-party risk: DORA would prescribe certain strict content requirements for contracts between financial entities and ICT third-party service providers, including the circumstances in which such contracts must be terminated.

Many aspects of the draft rules are similar to the UK’s proposals for building operational resilience in financial services.

Impact on ICT third-party service providers

DORA is not limited to regulated firms in the financial sector. The second part of DORA would impact businesses which provide ICT services to those financial entities. This is in part to respond to fears of concentration risk i.e. where many financial services firms rely on a handful of technology providers.

As drafted, DORA would allow the ESAs to designate certain service providers – including providers of cloud computing services, software, and data analytics – as being “critical” to the functioning of the financial sector.

One of the ESAs would then be appointed as Lead Overseer for every critical third-party ICT service provider. That ESA would monitor whether the ICT service provider has in place comprehensive, sound and effective rules, procedures and mechanisms to manage the ICT risks which it may pose to financial entities.

The Lead Overseer would have an unrestricted right to access all information that is necessary to carry out its duties, including all relevant business and operational documents, contracts and policies. The Lead Overseer would also be granted powers to conduct on-site inspections of any premises of critical ICT third-party service providers.

Critical ICT third-party service providers would be expected to cooperate “in good faith” with the Lead Overseer. If they fail to comply, the Lead Overseer may impose daily fines for up to six months of 1% of the average daily worldwide turnover of the critical ICT third-party service provider in the preceding business year.

The ESAs would also charge oversight fees to critical ICT third-party service providers. The amount of a fees charged will cover all administrative costs of oversight and be “proportionate” to the turnover of the critical ICT third-party service provider.

What happens next?

The proposal is now going through the EU’s ordinary legislative procedure. The aim is to have the three regulations in the Digital Finance Package in full effect by 2024. Please get in touch if you have any questions.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/eu-proposal-to-tackle-digital-risks-and-build-operational-resilience-in-the-financial-sector

The EU’s proposed pilot regime for digital security infrastructure: a game-changer for security tokens?

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/the-eu-proposed-pilot-regime-for-digital-security-infrastructure-a-game-changer-for-security-tokens

The European Commission has proposed a pilot regime to enable regulated institutions to develop DLT-based infrastructure for the trading, custody and settlement of securities. The proposed regime allows for operators to request exemptions from certain regulatory requirements that have previously been identified as obstacles to such development. For the security token market, which has thus far failed to thrive, this could potentially be a game-changer.

Pilot regime for DLT-based market infrastructures 

As part of the European Commission’s Digital Finance Strategy, it has proposed a pilot regime for market infrastructures based on distributed ledger technology (DLT). This would pave the way for certain regulated institutions to develop and test DLT-based infrastructure for the trading, custody and settlement of securities. In this post, we discuss the rationale for, and key features of, the proposed regime.

Regulatory uncertainty as a barrier to development

The potential advantages and use cases for adopting DLT in securities markets have been expounded for several years now, including by a number of regulatory authorities. Cited benefits include a trusted common data source, enhanced resilience, improved transparency and traceability and the potential for automation (with all the efficiencies that that may bring, such as the streamlining of settlement processes). 

Yet, to date there remains very little use of DLT in the regulated financial markets and, as a result, the security token market has failed to thrive. Regulatory uncertainty is often seen as one of the key reasons behind this lack of development, as highlighted in the European Commission’s ROFIEG report

The options considered

The Commission identified three options to tackle these concerns.

  • non-binding guidance on the applicability of EU financial regulation to security tokens and DLT;
  • targeted amendments to EU financial regulation; and
  • a pilot regime for the creation and testing of DLT-based market infrastructure.

It is proposing to start with the pilot regime. The idea is that experimentation will help identify all relevant regulatory obstacles and inform more permanent amendments or guidance.

Key features of the proposed pilot regime

Eligibility

 Under the proposed regime:

  • authorised investment firms and market operators would be eligible to apply to operate a DLT multilateral trading facility (DLT MTF); and
  • authorised Central Securities Depositories (CSDs) would be eligible to apply for permission to operate DLT securities settlement system (DLT SSS).

Permission to participate

Applications are to be made to the relevant national authority for the applicant. The national authority is required to consult with the European Securities and Markets Authority (ESMA) as part of the decision-making process. Permission granted by that authority would allow the DLT market infrastructure to provide their services across the EU.

Requirements and relaxations for operation

The Regulation sets out the basic requirements for operation, which are similar to those for the equivalent traditional market infrastructures. However, applicants may apply for exemptions from certain requirements that may be problematic in the context of distributed systems, subject to the attached conditions. 

For example, investment firms and market operators may ask to be able to admit to trading DLT transferable securities that are not recorded in a CSD (in accordance with the Central Securities Depositories Regulation) but instead recorded on the DLT MTF’s distributed ledger. This request may be granted by the national authority subject to the DLT MTF meeting certain conditions, relating to factors such as record-keeping, custody arrangements and settlement mechanics (including settlement finality).

Similarly, under an accompanying proposal to amend MiFID II, DLT MTFs are able to request a temporary derogation from obligations to hold securities on an intermediated basis. This would allow them to offer direct access to retail investors, as many distributed networks seek to do. This is subject to conditions in relation to factors such as investor protection and AML/CTF safeguards.

The pilot regime also imposes additional requirements on operators, in order to address the novel forms of risk raised by the use of DLT – for example, in relation to disclosures, cyber-security and custody arrangements.

Eligible securities

Only transferable securities that meet the following conditions may be admitted to trading on a DLT MTF and recorded by a CSD operating a DLT SSS:

  • shares, the issuer of which has a market capitalisation or a tentative capitalisation of less than EUR200m; or
  • convertible bonds, covered bonds, corporate bonds, other public bonds and other bonds, with an issuance size of less than EUR500m.

Sovereign bonds are not permitted.

There is also a limit on the total market value of DLT transferable securities that can be recorded by a CSD or, if applicable, investment firm/ market operator, which is set at EUR2.5bn.

What happens after the pilot period?

After a five-year period (at the latest), ESMA will produce a detailed report on the pilot regime to the Commission. On the basis of this the Commission will decide:

  • whether the pilot regime should be maintained as is or amended;
  • whether the regime should be extended to new categories of financial instruments;
  • whether targeted amendments to EU legislation should be considered; and/or 
  • whether the pilot regime should be terminated.
Next steps

The proposal is now going through the EU’s ordinary legislative procedure. The aim is to have the three regulations in the Digital Finance Package in full effect by 2024. In the meantime, eligible parties may wish to consider working towards an application. Should you need any advice in this regard please do not hesitate to get in touch.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/the-eu-proposed-pilot-regime-for-digital-security-infrastructure-a-game-changer-for-security-tokens

The EU’s proposal to regulate the crypto industry: what, how and when?

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/the-eus-proposal-to-regulate-the-crypto-industry-what-how-and-when

The European Commission has proposed a comprehensive new regime to regulate the crypto-asset industry. The proposal imposes disclosure and authorisation requirements on crypto-asset issuers and service providers which serve European markets. It also impacts other market participants as well as potential acquirers of certain institutions in the industry. Market players across the globe will need to consider if and how this could affect their business models and structures in the run-up to adoption. 

Regulation on Markets in Crypto-assets (MiCA)

Last week, the European Commission launched a bold new Digital Finance Strategy, as outlined in our previous blogpost. In this post, we explore the EC’s proposal for a regulation on markets in crypto-assets, a law which, if enacted, would have highly significant consequences for the crypto industry. 

Plugging the gap

As markets in crypto-assets have evolved, authorities across the world have been prompted to consider whether there are unintentional gaps in existing regulatory frameworks that ought to be closed. A lack of legal certainty has also been seen as a barrier to safe innovation in digital finance. EU authorities have been further concerned that differing national responses may lead to fragmentation within the single market.

MiCA is the Commission’s answer to these issues, and has been developed off the back of a public consultation. It seeks to establish a harmonised EU regime for the regulation of crypto-assets. 

The intention is for the new regime to be directly applicable in all EU member states, replacing existing national frameworks applicable to crypto-assets. This will inevitably raise questions for some national regulators in relation to the transition process and the treatment of entities approved under existing regimes. 

Scope

The draft regulation casts a wide net, defining the term “crypto-asset” very broadly as “a digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology”. However, it seeks to avoid regulatory overlap (at an EU-level) by carving out crypto-assets that are otherwise regulated as financial instruments, e-money, deposits, structured deposits or securitisations.

In relation to in-scope crypto-assets, it covers:

  • the regulation of crypto-assets to be offered to the public or admitted to trading on a trading platform in the EU
  • the regulation of crypto-asset service providers
  • a market abuse regime for crypto-assets admitted to trading on a trading platform operated by a crypto-asset service provider
  • a mechanism for the oversight of material acquisitions in respect of issuers of asset-referenced tokens (as defined below) and crypto-asset service providers.
Crypto-asset issuances

Three new categories

MiCA establishes separate frameworks in respect of three distinct categories of crypto-assets: e-money tokens, asset-referenced tokens and other crypto-assets. Issuers of crypto-assets that meet the criteria under the applicable regime will be permitted to offer those crypto-assets to the public or admit them to trading anywhere in the EU. Conversely, anyone across the globe issuing crypto-assets that could be subscribed for in the EU may be subject to these requirements.

E-money tokens

The e-money token regime is intended to capture tokens that commercially function as electronic money but are structured in a way that they are not caught under the existing Electronic Money Directive. The drafters have sought to include equivalent requirements in order to avoid regulatory arbitrage between the two regimes. The new regime also seeks to cater for token-specific risks as well as the possibility of systemically important issuances, which are not addressed under the EMD.

The key features of the regime are summarised in the table below.

E-money tokens*
MeaningA type of crypto-asset the main purpose of which is to be used as a means of exchange and that purports to maintain a stable value by referring to the value of a fiat currency that is legal tender
Required form of issuerLegal entity established in the EU
AuthorisationIssuer must be authorised as a credit institution or electronic money institution
WhitepaperWhitepaper must meet all relevant mandatory disclosure requirements set out in MiCA and be notified to the competent authority at least 20 working days before publication
Ongoing obligationsIssuer must comply with all ongoing requirements applicable to electronic money institutions
Claim on issuer/ redemption rightsToken holders must be provided with a direct claim on the issuer and the issuer must redeem at any time and at par value the monetary value of the tokens
Prohibition on interestIssuers are prohibited from paying interest or any other benefit related to the length of time during which the token is held
Significant issuancesAdditional prudential requirements apply to tokens that are deemed “significant” by the European Banking Authority (by reference to pre-defined criteria).
*Note: these are subject to certain exemptions (e.g. for de minimis issuances and issuances to qualified investors).
Asset-referenced tokens

The asset-referenced token regime broadly applies to tokens stabilised by currencies, commodities and/or crypto-assets, with the exception of a single currency. This regime (which would likely have applied in relation to the original Libra proposal) is intended to be the most stringent of the three, given the potentially heightened risks posed by these types of instrument in relation to market integrity, financial stability and monetary policy. 

The key features of the regime are summarised in the table below.

Asset-referenced tokens*
MeaningA type of crypto-asset that purports to maintain a stable value by referring to the value of several fiat currencies that are legal tender, one or several commodities or one or several crypto-assets, or a combination of such assets
Required form of issuerLegal entity established in the EU
AuthorisationIssuer must be authorised as an asset-referenced token issuer under MiCA or as a credit institution
WhitepaperWhitepaper must meet all relevant mandatory disclosure requirements set out in MiCA and be approved by home state authority in authorisation process
Ongoing obligationsExtensive ongoing obligations including around conduct, disclosure, complaints-handling, conflicts of interests, governance, own funds, management of reserve assets and orderly wind-down.
Claim on issuer/ redemption rightsNo outright requirement for a direct claim or redemption right against the issuer or reserve. However, issuers that do not grant such rights are required to put in place mechanisms to ensure the liquidity of the tokens.
Prohibition on interestIssuers are prohibited from paying interest or any other benefit related to the length of time during which the token is held
Significant issuancesAdditional prudential requirements apply to tokens that are deemed “significant” by the European Banking Authority (by reference to pre-defined criteria).
*Note: these are subject to certain exemptions (e.g. for de minimis issuances and issuances to qualified investors).

 

Other crypto-assets 

This regime is intended to be a catch-all, to cover all crypto-asset issuances that are not covered by other regimes. The approach provides for a degree of regulatory oversight and control without burdening authorities with having to approve every issuer or issuance in advance.

Other crypto-assets*
MeaningCrypto-assets other than e-money tokens and asset-referenced tokens
Required form of issuerLegal entity (established anywhere)
AuthorisationN/A
WhitepaperWhitepaper must meet all relevant mandatory disclosure requirements set out in MiCA and be notified to the competent authority at least 20 working days before publication
Ongoing obligationsLimited ongoing obligations, including in relation to conduct, conflicts of interest and cyber-security
Claim on issuer/ redemption rightsN/A
Prohibition on interestN/A
Significant issuancesN/A
*Note: these are subject to certain exemptions (e.g. for de minimis issuances and issuances to qualified investors).
 
Crypto-asset service providers

New authorisation requirement

MiCA requires anyone seeking to provide crypto-asset services in the EU (for example, in relation to custody, trading, exchange, brokerage, promotion or advice) to have been authorised in an EU member state for the services it wishes to undertake. For this purpose, it needs to establish a registered office in that state. An authorisation provided by one EU member will be valid across the EU. 

Authorised service providers must comply with a list of general requirements as well as the additional specific requirements applicable to the particular services they provide.

General requirements

The general requirements relate to:

  • Conduct – e.g. obligations to act honestly, fairly and professionally and in the best interests of their clients.
  • Prudential safeguards – in the form of own funds or insurance.
  • Organisational requirements – including requirements around ownership, personnel, resilience, cyber-security, record-keeping and monitoring of market-abuse.
  • Safeguarding of both crypto-assets and funds – these requirements seek to limit the ways in which crypto-asset service providers can deploy the crypto-assets and funds they hold on behalf of their clients.
  • Complaints handling procedure – e.g. there must be effective and transparent procedures for the prompt, fair and consistent handling of complaints.
  • Management of conflicts of interest – this includes conflicts between the service provider and its shareholders, its managers and employees or its clients as well as conflicts between clients.
  • Outsourcing – e.g. authorised service providers may not outsource any of their regulatory responsibilities.

Service-specific requirements

Additional service-specific requirements apply in relation to each of the following services:

  • Custody and administration of crypto-assets on behalf of third parties
  • Operation of a trading platform for crypto-assets
  • Exchange of crypto-assets (against fiat or crypto)
  • Execution of orders for crypto-assets on behalf of third parties
  • Placing of crypto-assets
  • Reception and transmission of orders on behalf of third parties
  • Advice on crypto-assets

AML/CTF

Crypto-asset service providers will also need to be mindful that their authorisations may be withdrawn if they fail to comply with national implementations of EU legislation in respect of money laundering or terrorist financing. 

Market abuse regime

MiCA also seeks to establish market abuse rules for crypto-asset markets. Under the proposal, crypto-assets that are admitted to trading on a crypto-asset trading platform that is operated by a crypto-asset service provider would be subject to the new rules. The rules include requirements relating to the disclosure of inside information as well as prohibitions on insider dealing, unlawful disclosures of inside information and market manipulation.

Acquisition-review mechanisms

Finally, it is worth noting that the proposed regime also includes mechanisms by which national authorities can review and control direct or indirect acquisitions of capital or voting rights in issuers of asset-referenced tokens and crypto-asset service providers. 

Potential acquisitions that meet the relevant thresholds (starting from 10% or more of capital or voting rights) must be notified to the supervising national authority, which will have around 60 working days to assess the proposal and determine whether to oppose it. This period may be extended if the authority requires further information. 

Notification of disposals of capital or voting rights may also be required in certain circumstances, namely where such disposals bring the relevant entity’s holding below the relevant thresholds.

Next steps

The proposal is now going through the EU’s ordinary legislative procedure. The aim is to have the three regulations in the Digital Finance Package in full effect by 2024. In the meantime, many market participants will want to consider the impact of the proposal on their business models and structures. 

Meanwhile, the UK government has committed to consult on the UK’s approach to cryptoasset regulation, including stablecoins, later this year. It remains to be seen to what extent the UK’s approach will follow the EU’s.

Should you need any advice on any of these matters please do not hesitate to get in touch

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/october/the-eus-proposal-to-regulate-the-crypto-industry-what-how-and-when

UK payments regulator proposes three new measures to promote competition in the SME card-acquiring market

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/september/uk-payments-regulator-proposes-three-new-measures-to-promote-competition

The UK’s Payment Systems Regulator has published an interim report on its review into the supply of card-acquiring services and is consulting on its findings and proposed remedies. Notably, it has suggested three new measures to help small and medium sized merchants benefit from competitive pricing for acquiring services. These include restrictions around the contracts for card-acquiring services and point-of-sale terminals as well as measures to facilitate price comparison. The consultation closes in December.

Market review into the supply of card-acquiring services

The UK’s Payment Systems Regulator is undertaking a market review into the supply of card-acquiring services, i.e. services which merchants buy in order to accept card payments. Among other things, it considered the competitiveness of the market and the impact of the Interchange Fee Regulation on the aggregate fees charged to merchants. 

The PSR has now published its interim report, which concludes that:

  • The market works well for the largest merchants with an annual card turnover above £50m. This accounted for around 77% of the overall value of transactions in 2018.
  • It works less well for small and medium merchants. Whilst new service providers have entered the SME market, there remain certain barriers to merchants switching providers and/or negotiating better deals.

The report proposes new measures to tackle those barriers, as discussed below. 

Who are the providers of card-acquiring services?

The report distinguishes between two categories of card-acquiring service providers:

  • acquirers (which are directly licensed by the card schemes); and
  • payment facilitators (a growing group of intermediaries which access the card systems via acquirers).  

It identifies that the five largest acquirers are Barclaycard, Elavon, Global Payments, Lloyds Bank Cardnet and Worldpay and the largest payment facilitators are PayPal, Square and SumUp. 

It identifies that ISOs (Independent Sales Organisations) are also an important channel for onboarding smaller merchants. ISOs do not provide card-acquiring services themselves, but instead sell services on behalf of acquirers.

Proposed new measures

The PSR is considering the following measures to help smaller merchants benefit from competitively priced card-acquiring services.

  • Requiring contracts for card-acquiring services to have an end date. This is designed to encourage merchants to shop around more regularly. It would not apply to contracts with large merchants with an annual card turnover above £50 million.
  • Measures to prevent POS (point of sale) terminal contracts from acting as a barrier to switching service providers. This may include term limits on POS terminal contracts, restrictions on auto-renewals for successive fixed terms, and measures to link the contracts for card-acquiring services and POS terminals where they are sold together as a package. 
  • Measures to make it easier for merchants to research and compare prices. For example, requiring acquirers and ISOs to provide pricing information in an easily comparable format.
The view from the EU

The European Commission has also been monitoring this market and recently published its report on the application of the Interchange Fee Regulation. It concluded that “major positive results” had been achieved through the IFR including reduced merchants’ charges, but also flagged that further data-gathering and monitoring would be required in some areas. See our previous blogpost for more.

What happens next?

The interim report is open for public consultation until 8 December 2020 and is due to be finalised in 2021. Once final, the PSR expects to carry out more detailed work to determine the most effective way to design and implement any new measures.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2020/september/uk-payments-regulator-proposes-three-new-measures-to-promote-competition