Following Covid-19, the message from the UK financial regulators regarding payments firms and payments innovation has stepped up. Recently, the Bank of England published a speech given by Christina Segal-Knowles (Executive Director, Financial Market Infrastructure Directorate) on 11 June in which she discussed the emerging themes and challenges for payments firms and payments innovation.
Highlights from the speech
- Covid-19 has accelerated the use by consumers of alternatives to cash (whether by card, app or other technology) – although cash remains important for some and the Bank of England supports the UK government’s policy of ensuring that cash remains accessible for those who need it.
- Cross-border e-commence is on the rise. There remain key challenges to improve the cost, speed and reduce other frictions associated with making international payments (including harmonising AML checks, agreeing targets, and improving (or introducing new) infrastructures).
- Innovation in the payments space has not fundamentally changed the four key methods of making payments, ie by card, electronic (bank-to-bank) transfer, cash or cheque. New apps provide a way to access those key methods (particularly card or electronic payments) rather than introducing an entirely new way to make payments. However, the rise of stablecoins as a solution to the volatility of earlier cryptoassets (such as Bitcoin) could change this.
- There are two key financial stability challenges for stablecoins:
- If a stablecoin is to operate like fiat currency, it must be as reliable as fiat currency – although regulation should be technology neutral (and, at least conceptually, stablecoins present the same risks to the economy as fiat currency payments chains), in many countries the regulatory framework would need to change to accommodate stablecoins.
- Ensuring the value of the stablecoin/instrument being transferred. Some stablecoins offer no legal claim for holders of the instrument (versus, for example, a bank note which is a promise by the central bank to pay the bearer) while other stablecoins propose backing by volatile instruments (eg with market and liquidity risk) – which is not appropriate if the stablecoin is to operate as an alternative to fiat currency.
- Finally, Ms Segal-Knowles discusses central bank digital currencies (CBDCs) and the ways in which CBDCs could address some of the concerns over financial stability as well as the challenges that CBDCs might pose for a central bank.
The direction of the speech is not surprising. It ties into the broader message emerging from both UK and global governments and regulators. Two key themes will be of particular interest to payments and cryptocurrency firms:
1. Increased regulatory focus on non-bank PSPs
The speech reinforces the approach of increased regulatory focus on payments (especially following Covid-19).
On 22 May, the FCA published a consultation on proposed guidance for non-bank payment service providers (PSPs) on the safeguarding rules under the Payment Services Regulations 2017 (PSRs) and Electronic Money Regulations 2011 (EMRs) (see our blog post). More recently on 4 June, the FCA announced a survey into the financial resilience of c. 13,000 firms (see our blog post).
Non-bank PSPs are assuming an increasingly important role in the lives of consumers and the mainstream economy without the same prudential requirements as banks. Given the current economic situation, it is not surprising that the FCA is focussing on the related issues of protecting customer funds and ensuring financial resilience.
Non-bank payments firms should continue to expect increased regulatory attention and supervisory action in these areas, particularly given the emphasis on payments in the FCA’s business plan (see our blog post).
2. The Bank of England’s work on CBDCs
The speech addresses the complex issues around the proper use of cryptoassets (in the form of stablecoins) in the financial system and whether cryptoassets – as an alternative to fiat currency – should be centralised or not. Although CBDCs could potentially provide a solution to the financial stability concerns identified for stablecoins in her speech, Ms Segal-Knowles also highlights some of the challenges for CBDCs, including the implications for how the financial system works (eg moving balances from commercial banks to CBDCs) and how monetary policy is developed and implemented.
For some, the cryptocurrency space is a race between stablecoins and CBDCs – but the reality is more complex. In her speech, Ms Segal-Knowles recognises that there are challenges for both alternatives and places an emphasis on finding the right solution for the economy. This approach should be welcomed. Innovators and central governments have complex issues to work through before cryptoassets of any form or CBDCs can be deployed more widely. See our recent commentary comparing stablecoins and CBDCs.
The speech and the wider market discussion follows the Bank of England’s recent discussion paper on CBDCs. One response to the Bank’s discussion paper, from the Institute of International Finance, also reinforces the need to focus on the potential cross-border implications of an internationally accessible CBDC (as well as the domestic use case). With trends in payments accelerating, the continued output from the Bank (especially following its discussion paper) is likely to be key in shaping the development and application of cryptoassets and CBDCs in the financial system and should be watched closely by firms in this space.