Bank of England papers on new forms of digital money: our key takeaways

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/june/bank-of-england-papers-on-new-forms-of-digital-money-our-key-takeaways

The Bank of England has published its latest thinking on new forms of digital money, a.k.a. Central Bank Digital Currencies and stablecoins. Notably, the BoE’s latest modelling on the potential impact on credit conditions has not deterred the Bank from continuing to support digital money innovation. In the case of systemic stablecoins, it expects such arrangements to be subject to standards “equivalent to commercial bank money” and outlines four potential models for achieving that. The paper is open for feedback until 7 September 2021.

A busy month for the BoE’s innovation department

The Bank of England has had a busy month in matters of innovation. It recently published a discussion paper on new forms of digital money and a summary of responses to its March 2020 CBDC discussion paper (along with a number of related speeches). It has also, together with the Bank for International Settlements, launched the BIS Innovation Hub London.

So, what have we learnt from its latest messaging? A few key takeaways below.

The Bank’s modelling on the potential impact on credit conditions has not deterred the Bank from continuing to support digital money innovation

The potential risks that stablecoins and, in some cases, CBDCs pose to monetary and financial stability have been widely discussed. They include, among other things, the potential impact on commercial banks and the knock-on effect on funding the real economy. Whilst heavily caveated, the digital money paper reveals some BoE modelling which suggests that the long-term impact of new forms of digital money on lending rates and credit provision may be modest (though the impact on banks themselves, particularly in the short term, may be more significant).

More broadly, the papers suggest that the Bank’s current thinking is that it should be possible to manage risks to monetary and financial stability through well-designed measures. In the case of stablecoins, this includes (i) an appropriate regulatory framework that aligns with the Bank’s expectations; (ii) the use of transitional periods to assess the impact of any launch after the event; and (iii) initiatives to encourage more institutions to access the Bank’s liquidity facilities (as discussed further below).

CBDCs – no firm decisions yet, but commitment to deeper exploration driven by five key principles

The responses to the BoE’s March 2020 CBDC discussion paper revealed a broad range of views on most substantive issues concerning CBDC, including whether or not to issue one. Many felt that the BoE needed to set out the use case more clearly, and that this would ultimately drive answers to other questions. This is something that the Bank has clearly taken on board.

The Bank now plans to “deepen its exploration” into CBDC through a number of fora, including a Joint Taskforce with the government; a CBDC Engagement Forum; a CBDC Technology Forum; and its work with the Bank for International Settlements.

In doing so, it plans to follow five principles, which it has formulated based on areas of consensus in the responses.

1. Principle 1: Financial inclusion should be a prominent consideration in the design of any CBDC. For example, it should be broadly accessible and not replace cash.

2. Principle 2: A competitive CBDC ecosystem with a diverse set of participants will support innovation and offer the best chance to deliver the benefits of CBDC. Consistent with the “platform-model” proposed in the BoE’s original discussion paper, the BoE should provide only a minimum level of infrastructure, with the private sector taking a leading role in responding to the needs of end users. Interoperability between CBDC and other forms of money will likely be a key concern.

3. Principle 3: Due recognition should be given to the value of other payments innovations and their ability to deliver the benefits the BoE seeks. Notably, the BoE has to consider whether improvements to existing architecture as well as privately issued stablecoins (which may in some cases be implemented much faster than a CBDC) could negate the need for a CBDC.

4. Principle 4: CBDC should seek to protect users’ privacy. The BoE has confirmed that, subject to meeting objectives in relation to financial crime, CBDC should ensure a strong level of privacy.

5. Principle 5: While CBDC should “do no harm” to the BoE’s ability to deliver monetary and financial stability, opportunities to better meet the Bank’s objectives should also be considered. In other words, the BoE should consider what opportunities CBDC offers to support monetary and financial stability (for example, in implementing negative interest rates or quantitative easing) as well as for payments.

Systemic stablecoin arrangements – broadly welcomed but need to meet standards equivalent to commercial bank money and traditional payment chains

Focus on systemic stablecoins

The digital money paper is primarily focused on stablecoins which are issued by private companies, denominated in sterling and have the potential to become widely used by households and non-financial businesses (i.e. gain systemic status). This is reflective of the government proposal to bring systemic stablecoins into the BoE’s regulatory remit.

The paper does acknowledge some of the potential challenges with developing different regimes for systemic and non-systemic stablecoins, including in relation to how firms might smoothly transition from one regime to the other as they grow (which is likely to be a key concern).

Stablecoins as a source of opportunity

Rather than discussing stablecoins purely in terms of risk-management, the BoE is quick to acknowledge the potential benefits that stablecoins could offer (eg in relation to efficiencies, competition, financial inclusion, data protection, resilience and enhanced functionality). Although it discusses the additional benefits that CBDCs could offer which privately-issued stablecoins could not (for example, in terms of public interest objectives), it does not seem to have reached any firm view as to whether a CBDC would necessarily be the preferable alternative.

Stablecoins as a store of wealth

The digital money paper highlights that stablecoins have the potential to offer both a new means of payment and a new way of storing wealth, and that the regulatory framework needs to support both functions. This is notable because the government’s recent consultation on stablecoins focused solely on payments. Likewise, the existing e-money regime (which the government has been considering for application to stablecoins) seeks to deter users from using e-money as a store of wealth by prohibiting interest payments.

Standards equivalent to those applied in traditional payment chains

The paper reiterates two expectations previously set out by the Bank’s Financial Policy Committee (FPC). The first expectation requires that payment chains that use stablecoins are regulated to standards equivalent to those applied to traditional payment chains and that firms in stablecoin-based systemic payment chains that are critical to their functioning are regulated accordingly.

Adding more colour to this, the BoE highlights that stablecoin arrangements can involve a fragmentation of functions (such as governance, issuance, redemption, reserve management, stabilisation, transfer of coins and interaction with users) across different entities, some of which may currently fall outside the regulatory perimeter. Given that any firm in the payment process could ultimately become a critical link in a systemically important payment chain, the Bank considers that it may be necessary to bring other entities within the scope of its regulation.

Standards equivalent to commercial bank money

The second FPC expectation requires that where stablecoins are used in systemic payment chains as money-like instruments they meet standards equivalent to those expected of commercial bank money. The BoE highlights four key features of the commercial bank regime for which equivalent protections would be needed:

1. A robust legal claim that allows for prompt redemption of the amount deposited

2. Capital requirements to lower the risk of insolvency

3. Liquidity requirements and support to ensure liquidity problems do not result in failure

4. A backstop to compensate depositors akin to the Financial Services Compensation Scheme and bank resolution arrangements

It also stresses that, unless a stablecoin is operating as a bank, the backing assets for stablecoins will need to cover the outstanding coin issuance at all times and robust reserve management will be a key requirement.

E-money not equivalent to commercial bank money

The paper echoes statements previously made by the Governor of the BoE in highlighting that the requirements applicable to e-money do not currently meet the FPC’s expectations. Whilst the use of e-money currently remains low, the BoE suggests that enhancements to the regime may be needed to address the potential for systemic risks arising in the future. Likewise, it indicates that this regime would not, as it currently stands, be suitable for regulating the types of systemic stablecoins it is concerned with.

Four potential regulatory models

The paper outlines four potential regulatory models which could be used to reflect the key features of the commercial bank regime. The differences centre around the assets that would be used to back the stablecoin issuer’s liabilities. In short, these are:

1. Bank model – i.e. the stablecoin issuer is subject to the current banking regime. Banks can choose to back their liabilities with (i) non-liquid assets like loans; (ii) liquid assets such as government bonds and certain corporate securities; and/or (iii) reserves held with a central bank.

2. HQLA model – the bank model is adapted so that the issuer is restricted to backing its liabilities with assets described in limbs (ii) and (iii) of the bank model. Capital, liquidity and backstop requirements could be calibrated to reflect the lower risks associated with these categories of backing assets.

3. Central bank liability reserve backing model – the bank model is adapted so that the issuer is restricted to backing its liabilities with assets described in limb (iii) of the bank model. This would be economically similar to a CBDC (but, importantly, not a direct central bank liability). Capital, liquidity and backstop requirements could be adjusted accordingly.

4. Deposit-backed model – liabilities are backed with deposits placed with commercial banks (acting as custodians). The custodian holds the deposits on trust for stablecoin customers in its reserve account or other highly liquid assets. The stablecoin issuer has no direct relationship with the central bank. This would share features with the current e-money regime, but with enhanced protections including a public backstop and appropriate capital and liquidity requirements.

Access to the Bank’s balance sheet

The model used would have implications for the use of the BoE’s balance sheet – for example, it may be appropriate for stablecoin issuers under the HQLA model to draw on central bank lending in order to access contingency liquidity in the event of severe market disruption, whereas this should not be necessary if the stablecoin issuer’s only assets are central bank liabilities.

Transitional periods and limits

As noted above, the BoE considers that transitional arrangements may be a useful tool in managing the potential impact of new stablecoins on monetary and financial stability risks. This includes, for example, the risk that the banking sector proves unprepared to withstand large outflows of deposits or that markets and non-banks are unable to fill any funding gaps that arise. Transitional arrangements could, for example, include limits on the use of, or access to, stablecoins during the transitional period. Such arrangements could also be maintained on a more long-term basis if necessary.

Next steps

The Bank’s discussion paper invites feedback on most of the issued raised, including the appropriate regulatory framework for stablecoins. Responses must be submitted by 7 September 2021.

As ever, please get in touch if you would like to discuss.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/june/bank-of-england-papers-on-new-forms-of-digital-money-our-key-takeaways

Global banking regulator outlines proposals for the prudential classification and treatment of cryptoassets

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/june/global-banking-regulator-outlines-proposals-for-the-prudential-classification-treatment-cryptoassets

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https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/june/global-banking-regulator-outlines-proposals-for-the-prudential-classification-treatment-cryptoassets

Hong Kong unveils its bold Fintech 2025 Strategy

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/june/hong-kong-unveils-its-bold-fintech-2025-strategy

The HKMA’s Chief Executive Eddie Yue has said that banks should be going ‘all-in’ with comprehensive fintech adoption in the next 4 years.

The comments were made in a speech unveiling the HKMA’s ‘Fintech 2025’ strategy, which touched on five main areas:

  1. All banks to go fintech, but the HKMA will digitalise too 
  2. Central Bank Digital Currencies for wholesale and retail too
  3. Next-generation data infrastructure
  4. Expanding the fintech-savvy workforce
  5. Funding and policies

For more details read our Hong Kong Financial Regulation alert.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/june/hong-kong-unveils-its-bold-fintech-2025-strategy

Hong Kong SAR: HKMA’s Fintech 2025 Strategy

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/june/hong-kong-sar-hkmas-fintech-2025-strategy

The HKMA’s Chief Executive Eddie Yue has said that banks should be going ‘all-in’ with comprehensive fintech adoption in the next 4 years.

The comments were made in a speech unveiling the HKMA’s ‘Fintech 2025’ strategy, which touched on five main areas:

1. All banks to go fintech, but the HKMA will digitalise too

Banks are encouraged to fully digitalise their operations, from front-end to back-end for 2025. The HKMA will perform Tech Baseline Assessments to review where banks are and what their plans are. The target is for banks to submit a Three Year Plan for technology adoption in Q4 2021, which the HKMA will then assess and benchmark against overseas peers.

This will allow the HKMA to identify fintech business areas or technology types which may be underdeveloped, and would benefit from HKMA support. The HKMA continues to “walk the talk” by digitalising its supervision of banks through the use of advanced technologies.

2. Central Bank Digital Currencies for wholesale and retail too

CBDCs are an area in which the HKMA has been busy carrying out research. A new study will begin on e-HKD to understand its use cases, benefits, and related risks, and the HKMA will also continue to collaborate with the People’s Bank of China in supporting the technical testing of e-CNY in Hong Kong for cross-boundary payments for both domestic and mainland residents.

3. Next-generation data infrastructure

New data infrastructure that the HKMA will be working on includes the Commercial Data Interchange, digital corporate identity, and DLT-based credit data sharing platform.

4. Expanding the fintech-savvy workforce

The HKMA is working with the private sector and with universities to increase internship programs in fintech areas, as well as launching a new fintech module for the Enhanced Competency Framework to raise the professional competencies of existing banking practitioners.

5. Funding and policies

Recognising that encouraging banks will stimulate innovation, the HKMA will also be looking at funding and policies. For example, the HKMA is exploring the possibility of providing funding support to qualified fintech projects in the Fintech Supervisory Sandbox, as well as working with the private sector to offer further types of support.

HKMA support for banks

The HKMA is providing support to banks as part of this strategy to ensure a wide and consistent fintech implementation. This support comes in the form of initiatives that are more traditionally supervisory focused, such as future supervisory guidance to facilitate the uptake of novel technologies and the publication of a “Regtech Adoption Practice Guides” series to address how regtech solutions can be applied to cloud computing, blockchain and anti-money laundering surveillance.

However, the promise of steps such as analysing where there are lacunas in banks’ technological implementation, upskilling the workforce and working on projects with the assistance of the private sector along with additional funding, has the potential to make the changes at a deeper level which allow for more sustainable change, rather than simply placing additional requirements on banks and expecting them to catch-up.

Impact for the region

While some of the details are yet to be published, the unveiling of this strategy demonstrates that the HKMA believes in the importance of fintech as a key growth engine in the financial services in Hong Kong, and as a way to deliver fair and efficient financial services in Hong Kong. This should therefore mean that there is an increased drive to  implement fintech solutions in the banking industry in Hong Kong in the coming years.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/june/hong-kong-sar-hkmas-fintech-2025-strategy

UK insurtech slips out of the sandbox

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/may/uk-insurtech-slips-out-of-the-sandbox

The Kalifa review into the UK fintech sector praised the “instrumental role” of the regulatory sandbox in supporting innovation. But the proportion of insurtechs taking part in the FCA’s sandbox has fallen steadily over the last five years. Kalifa-inspired recommendations could see this trend change course.

Insurtech and the regulator

Playing in the sandbox

The Financial Conduct Authority launched its regulatory sandbox in 2016. Insurtechs have participated in every cohort of the FCA regulatory sandbox since. But, as this chart shows, the proportion of insurtech solutions has declined steadily over the last five years.

Insurtech chart 

 

Under the radar

2016 also saw the most recent public intervention from the FCA on the crossover between insurance and technology. FCA Feedback Statement 16/5 looked at the use of Big Data in retail general insurance. The paper concluded that Big Data was “broadly having a positive impact on consumer outcomes”.

Back then the FCA hinted at potential further work. For example the FCA wondered whether increased risk segmentation caused by Big Data could lead to reduced access to insurance products for some groups eg higher risk customers. But there had not been any further policy developments in this area, until recently.

Insurtech back on the agenda?

There are two signs which suggest that attention might turn back to insurtech. The first is another FCA feedback statement. The second is the regulator’s response to the Kalifa report.

Open to change

FCA Feedback Statement 21/7 explores how Open Banking could be applied to other areas of financial services, including insurance products (see also our previous blogpost which explains Open Banking). “Open Finance” would be based on the principle that customers can share their data held with one provider with third party providers in a secure way. If Open Finance follows the Open Banking model, insurers and other financial services firms could be required to share customer data.

There is some way to go yet before Open Finance takes off in the UK. But the idea – along with similar proposals in the EU – suggests that insurtech providers using data to improve customer outcomes will have the wind at their back.

Kalifa-inspired changes to sandbox

Separate to this policy work on Open Finance, the FCA is also making changes to its regulatory sandbox. The sandbox is a controlled environment for firms to test innovative products with real consumers. The FCA has confirmed it plans to pick up a couple of recommendations made by the Kalifa review into UK fintech to improve how the sandbox works.

  • First, it will move away from the current “cohort” system to one that allows applications year-round. This is likely to see participant numbers increase across the board, including insurtechs.
  • Second, it plans to open a new “regulatory nursery” to provide more support as firms scale. This will be of interest to those insurtechs which have already graduated from the sandbox but still want to engage with regulators as they develop new products.
What happens next?

The FCA is due to release more detail about changes to its sandbox by autumn 2021. On Open Finance, the FCA says that it plans to support the Government’s policy work in this area and help industry-led development of common standards.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/may/uk-insurtech-slips-out-of-the-sandbox

Open season: EU explores opening up data access in insurance sector

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/may/eu-explores-opening-up-data-access-in-insurance-sector

With the roll-out of PSD2 complete, the EU’s fledgling open banking ecosystem will continue its shake-up of the sector in the coming years. Unlike banking, the insurance sector has – so far, at least – played a bit-part in the “open” finance revolution. This may be about to change, however, as the EU considers access to and sharing of insurance-related data.

Instigating innovation in insurance

Earlier in 2021 the EU’s insurance supervisor, EIOPA, released a discussion paper on Open insurance: accessing and sharing insurance-related data. The paper looks at the potential opening of value chains across the sector. In other words, whether insurance data should be accessible by and shareable with third parties to:

  • augment policyholder rights; and
  • facilitate innovation in products and services. 

Instead of viewing open insurance through a narrow lens of mandatory data sharing based on explicit customer consent (something akin to PSD2), EIOPA is setting its sights wider. The paper suggests “open insurance” covers, in broad terms, access to and sharing of insurance-related data – personal and non-personal – typically via application programming interfaces (APIs).

This broader definition of open insurance captures information sharing across the market – from insurers and intermediaries to outsourcing and IoT providers. It also covers data sharing that is not directly visible to customers, for example as part of back office processing. EIOPA further suggests that open insurance can be looked at from three overlapping angles:

Chart 1

A design for life (and non-life)

EIOPA’s paper describes a number of high-level aims for open insurance, many of which chime with open banking and open finance more generally: from fostering innovation and improving customer outcomes to increasing transparency and strengthening supervision.

The paper also suggests five specific areas to consider as part of creating a “sound open insurance framework”. Of these, data protection and digital ethics is a particularly delicate area for the sector to navigate. The breadth, nature and sensitivity of information that can be revealed through disseminating insurance data – including detail on a person’s health, sexuality and political views – is likely to be unlike (in nature) and eclipse (in quantity) that held in other areas of financial services.

The paper goes on to begin sketching out the potential benefits and risks of open insurance for customers, firms and supervisors (summarised below), providing an indication of what a future framework will encompass:

Chart 2

Looking ahead – what next for open insurance

EIOPA recognises that open insurance is not at a standing start. Most national regulators in the EU have work underway in their jurisdictions already, not to mention the work being undertaken by the likes of the OPIN open insurance think tank.

Despite this, progress is patchy across the industry (and between EU countries). For example, while there are good examples of open insurance being used to improve claims management, pricing and underwriting in particular, the paper also shows that the majority of national regulators have no plans to adopt open insurance solutions for supervision in the near future.

To the move the dial in a sector that is ripe for an “open” revolution, there needs to be a cross-industry effort to deliver effective API-driven interoperability and standardisation, backed by a coherent regulatory framework. As well improving the mechanics of the industry – from distribution frameworks to supervision – this could also put the insurance sector in a better place to respond to market trends (such as telematics or “black box”) cover, and usage-based insurance more generally, which is expected to grow significantly in the coming years.

EIOPA is currently analysing the responses to its discussion paper which will help inform its ongoing work on digitisation and input into the EU’s wider Digital Finance Strategy.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/may/eu-explores-opening-up-data-access-in-insurance-sector

UK to take forward Kalifa recommendations to boost fintech sector

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/april/uk-to-take-forward-kalifa-recommendations-to-boost-fintech-sector

Chancellor Rishi Sunak has unveiled some of the Government’s plans for supporting the UK fintech sector and ensuring that the UK remains “at the cutting edge of digitalising financial services”. These include setting up new sandboxes and a taskforce to explore creating a UK central bank digital currency.

Picking up from Kalifa

Last year the Government commissioned an independent review into the fintech sector. The outcome of the Kalifa Review was a detailed report, published in February 2021, which made wide-ranging recommendations aimed at ensuring the UK retains its position as a global leader in fintech. Speaking at Fintech Week, the UK Chancellor has now indicated which of those recommendations are going to be taken forward, with more details to follow.

Fintech-specific proposals

New sandboxes

Building on the success of the FCA’s regulatory sandbox, the Government has announced plans for no fewer than three new “boxes”.

  • A new “scale box” – led by the FCA – to support firms beyond the initial start-up stage. Several of the recommendations from the Kalifa Review were aimed at this stage of development.
  • A second phase of the Digital Sandbox – led by the FCA – which will focus on tackling sustainability and climate change-related challenges. The first phase, which is currently being piloted, is looking at issues arising from Covid-19.
  • A new DLT sandbox – delivered by HM Treasury, working with the Bank of England and FCA – for exploring how to use distributed ledger technology to improve financial market infrastructure. This echoes similar EU plans for a DLT-specific sandbox.

Taskforce on CBDCs

A new taskforce comprising HM Treasury and the Bank of England will explore creating a UK central bank digital currency. This work follows the Bank of England’s discussion paper on CBDCs for retail use.

No decision has yet been made on whether to introduce a CBDC in the UK but the taskforce will explore the potential opportunities and risks for doing so and evaluate different design features. It will also be responsible for monitoring international CBDC developments.

The views of technical experts and key stakeholders, including financial institutions and consumers, will be sought via two external engagement groups: the CBDC Technology Forum and the CBDC Engagement Forum.

In a sign of the investment being put into exploring CBDCs, the Bank of England has announced that it will establish a new division to lead its work in this area. The new CBDC Unit will be overseen by Deputy Governor for Financial Stability, Jon Cunliffe.

Other proposals

The Chancellor has backed the Kalifa recommendation for an industry-led Centre for Finance, Innovation and Technology. The idea is that CFIT would work closely with regional hubs to support fintech growth across the UK.

The Chancellor also mentioned the Bank of England’s new policy for omnibus accounts. This is intended to support faster settlement of wholesale payments using central bank money. Separately HM Treasury is due to release its plans for improving the UK’s payments infrastructure following a call for input in 2020.

Other reforms in the pipeline

As well as initiatives from the Kalifa Review, the Chancellor has said that proposals from a recent review of the UK’s listings rules will be taken forward. This includes consulting on the UK’s prospectus regime in summer 2021 and convening a group of experts to look at how rights issues could be made more efficient.

The Chancellor has also announced plans to consult on a series of reforms to the UK capital markets regime in summer 2021. The consultation will include proposals to remove the share trading obligation and double volume cap from the UK MiFID framework.

Visit our future regulatory framework webpage for more on the Government’s programme of work to shape the future of financial services regulation in the UK.

https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/april/uk-to-take-forward-kalifa-recommendations-to-boost-fintech-sector

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