On 3 September 2020, Andrew Bailey, the Governor of the Bank of England, delivered a speech to the Brookings Institution regarding innovation in payments, setting out his view that innovations need to be underpinned by an appropriate regulatory framework to be suitable for use on a wider scale. In his view, stablecoins have the potential to be suitable for widespread use, but must meet the standards of other regulated payments to maintain consumer protection and promote consumer confidence.

Support for Regulated Innovation

Mr Bailey highlighted that traditional forms of payment, such as cash and cheques, have become less popular in recent times.  Society is becoming more cashless – digital payments were becoming more frequent prior to the pandemic, but the impact of COVID-19 has caused the volume to drop further: in April 2020, cash withdrawals were 60% lower than the year prior, and in July 2020, 40% lower. As society moves away from traditional cash as fiat money, focus has shifted to recent payment innovations, particularly digital payment methods.

Mr Bailey praised innovation in the payments space as being in the public interest. However, this innovation must be underpinned by regulatory frameworks to support the public interest and protect consumers, reflecting “the financial stability risk, rather than the legal or technological form of payment activities”.

Moreover, innovation must be suitable for its intended purpose in payments. For example, innovation taking the form of commercial money issued by private providers is only suitable for wide scale use in the UK if it is effectively indistinguishable from cash fiat money – that is, if it is denominating in sterling and convertible at par on demand. Some innovations in the payment space are not suited to these purposes. For example, while cryptoassets such as bitcoin may have an extrinsic value, they have no connection to money and their value may wildly fluctuate; in Mr Bailey’s view, this makes them unsuited to use in payments because they lack the required certainty of value. 

Setting Standards for Stablecoins

However, Mr Bailey considered stablecoins to be more promising as a method of payment than traditional cryptoassets, because, as the name implies, these can offer greater stability than other forms of cryptoassets. Stablecoins can also offer increased convenience, as it may be possible to integrate the assets with other technologies, such as social media platforms or retail services. Global stablecoins in particular may reduce frictions in payments by increasing speed and lowering cost.

Importantly, if stablecoins are to be suitable for widespread use in the payments space, “they must have equivalent standards to those that are in place today for other forms of payment types and the forms of money transferred through them” to ensure that they are safe, resilient and that consumers can use them with confidence. Therefore, it is important that regulators set standards early on to ensure that innovations can develop with confidence; because existing standards may not easily apply, minimum international standards for stablecoins should be established.

Stablecoins intending to launch with sterling-based activities in the UK are expected to first meet relevant domestic standards and be appropriately regulated. Moreover, the Prudential Regulation Authority will strongly consider the need for a UK-incorporated entity if a sterling retail stablecoin wishes to operate on a widespread basis in the UK, noting that similar requirements are already in place for banks with material retail banking operations in the UK.

Global stablecoins are more challenging to regulate, due to their cross-border nature – they may be denominated in multiple currencies, intended for use in cross-border transactions, with users based in multiple jurisdictions – and a global regulatory response, rounded in internationally agreed standards, is therefore necessary. This will require coordination between regulators to ensure that gaps in coverage and opportunities for regulatory arbitrage do not emerge.

Sketching the Shape of Future Regulation

While Mr Bailey fell short of expressly stating that the Bank of England would be developing a regulatory framework for stablecoins, firms developing stablecoins should bear in mind Mr Bailey’s view that regulatory standards for stablecoins should match those currently in place for other forms of payments. This means that:

  • any coin developed should be able to be converted at par into fiat money on demand, as this is a key to ensuring that payment users have confidence in the token as a method of payment;
  • there must be clear rules and protections for the payment recipient and for the consumer if the entity that issued the coin fails, with a legal claim for coin-holders. The effect of this is that merchants and consumers will not need to scrutinise individual coin issuers as they will be protected from any potential collapse or problem; and
  • regulatory coverage must be robust, and the coin must not fall into the gaps between regulatory regimes. For example, stablecoins intending to operate in the retail space must adhere to the same standards applying to backing instruments held on a bank’s balance sheet, because “low risk is not the same as no risk”.

This article was originally posted on the Blockchain blog.

Sue McLean
Author

Sue McLean is a partner in Baker McKenzie's Technology practice in London. Sue advises clients on a wide range of technology matters, including outsourcing, cloud computing, technology procurement, licensing and distribution, digital and disruptive technologies including AI and blockchain. Sue has significant experience in advising clients in the financial services sector and is a member of the firm's FinTech group.

Author

Kim is a Knowledge Lawyer within the Financial Services Regulatory group at Baker McKenzie. Her expertise covers both contentious and non-contentious regulatory matters across a wide range of sectors. She is particularly interested in issues relating to investigations and enforcement, vulnerable customers, regulatory reform and change, and the impact of Brexit on financial services regulation.

Author

Ben Thatcher is a trainee in the Financial Services Regulatory group at Baker McKenzie.