Written evidence submitted by UK Finance
The inquiry will cover:
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UK Finance is the collective voice for the banking and finance industry. Representing more than 300 firms across the industry, we act to enhance competitiveness, support customers and facilitate innovation.
UK Finance welcomes the opportunity to respond to the Treasury Select Committee (TSC) call for evidence and inquiry into the crypto-asset industry. UK Finance are viewing this inquiry as an important opportunity to help improve future frameworks for regulating digital currencies and assets, including central bank digital currencies (CBDCs), stablecoins and wider cryptoassets. It is also important to begin the conversation around how Parliament scrutinises government and holds regulators to account on how the regulation of cryptoassets unfolds over time and so sets an important precedent.
Executive summary: Our members are supportive of a UK economy that supports the coexistence of different forms of money and a widening asset base in a way which supports consumers, businesses and financial institutions and ensures a long term innovative and thriving financial services ecosystem. The anticipated developments and changes surrounding cryptoassets and the application of their underlying technology represent a dynamic environment - the key question is how to develop a regulatory framework that is technologically neutral, supports innovation but regulates markets in a way which protects consumers and businesses. UK Finance and its members tend to think of the issues through the lens of stablecoins, CBDCs and wider cryptoassets.
Research does show that for the most part, trust and familiarity for businesses and consumers alike still have some way to go towards reaching ‘mainstream’ levels of trust in cryptocurrencies and their underlying technologies. It is worth also noting that with most mainstream consumers, they do not recognise the difference between cryptoassets, stablecoins and CBDCs and it remains to be seen how familiar they may be with these distinctions in future. Educational initiatives will play a key role in addressing this.
There are a broad range of views as to whether digital currencies such as stablecoin will replace traditional currencies. The cryptoassets market has developed substantially over the last few years and new types of digital money have emerged in response to both market and regulatory developments with many commentators seeing the application of cryptoasset technology at a significant moment in its development.
On specific categories of cryptoassets, our views are summarised as:
It does need to be articulated clearly what we want a CBDC to achieve long term and whether this could be better achieved from existing forms of money or alternative forms of appropriately regulated digital forms of money.
On a strategic basis, different forms of digital money will be more or less appropriate for various use cases and therefore these new forms of digital money will need to coexist and should therefore be considered as part of an overall important and developing regulatory landscape which can be adapted over time.
UK Finance response:
Post-Brexit, the competitiveness of the banking and finance sector is more vital than ever to the economic growth and prosperity of the UK. Banking, payments and related financial services support activity in every other part of economic life: holding and protecting money for customers, channelling savings into lending to households and businesses, providing payment services, facilitating market-based finance and providing a range of financial risk management tools for companies.
In recent years, payments has become a diverse and complex industry that is evolving at rapid speed. Payments not only provides the foundations for the wider economy but continue to innovate and drive changes in technology and society. The UK payments industry continues to lead the way and enhance how customers and businesses interact, with major changes underway in all parts of the industry. It is this intersection where substantial focus has arisen for newly emerging digital money, such as through stablecoins, CBDCs and through cryptoassets and their associated technology.
The provision of a stable currency to the UK market is a direct outcome of the Bank of England’s issuance of both wholesale central bank liabilities and liabilities held by UK consumers and businesses in the form of banknotes. Financial institutions which provide commercial bank money, and other forms of money to the UK economy also have an important part to play in ensuring the effective provision of money to the economy.
This commercial bank money is what facilitates lending to the whole economy and supports the UK economy. These activities, and the wider structure of legislation and regulatory activity that supports the issuance of pound sterling (GBP) to the UK economy, ensure that UK consumers and businesses have access to a currency that provides a reliable store of value, dependable medium of exchange and consistent unit of account, enabling them to make their financial decisions with confidence.
As the use of digital payment methods continues to rise, it is critical that the UK considers how citizens access and use these digital services and, importantly, what changes may be required for the issuance of GBP to continue to meet these changing use cases. We are fully supportive of the investigation by the Bank of England and HM Treasury on the issuance of a CBDC for the UK, however encourage deeper cooperation with the industry on the evaluation of long-term implications of a potential CBDC and what this may mean for business models and the ability of banks to lend into the real economy. Foremost amongst these considerations are further details from HM Treasury and the Bank of England regarding the public policy objectives that a CBDC will fulfil for the UK economy over and above those outlined by G7 nations[1].
Many cryptoassets, including some stablecoins, have sought to utilise evolving DLT and we note there is continual technological development related to DLT with interlinkages in many other areas which we would encourage policymakers to be aware of. While UK Finance and its members tend to think of the issues through the lens of stablecoins, CBDCs and wider cryptoassets, it is worth noting wider technological developments, in particular in financial market infrastructures (FMIs) and financial institutions making use of DLT and embedding this technology into their business models and also the development of web 3.
When we write about web 3, we generally mean the blockchain-based web, which is fully decentralised, relying solely on its DLT and no centralising authority[2]. The development of web 3 is particularly important for the concept and progress of Decentralised Finance (DeFi) and whilst an exciting prospect, the potential of changing business models in financial services is still in its infancy and will take a number of years to be seen in any meaningful way that the average consumer or business would recognise across the sector.
Payment markets have historically tended to evolve slowly over time. People are creatures of habit, and this is no less true for the way that we pay for things than it is for other aspects of day-to-day life. In the last couple of years, the global Covid-19 pandemic and associated lockdowns have led to significant changes in patterns of payments in the UK. UK Finance’s Payments Market Report 2022 provides more detail on trends and forecasts in the UK payments market and is widely seen as the authoritative data source in this regard[3].
The pandemic led to changes in the types of payments that were used. People made greater use of digital payments. This led to the question of whether these observed changes in payment patterns will become permanent changes to people’s behaviour, or whether people’s payment preferences will return to pre-pandemic patterns as lockdown restrictions eased. The longer-term effects of the current cost-of-living crisis will be a development testing this assumption.
The UK’s underlying card and interbank infrastructures have proven resilient and adaptable to meeting the changing needs of consumers and businesses towards more digital interactions. This ranges from the innovative approaches to taking card payments among small merchants through to new forms of data rich interbank payments being developed by the UK’s investment in its New Payments Architecture (NPA). This poses a strategic question of cost and benefit balance for some applications of digital money and more debate is needed on this topic where we note there is a broad range of views when it relates to whether digital currencies such as stablecoin or other forms of cryptoassets will replace traditional currencies.
Our members are supportive of a UK economy that supports the coexistence of different forms of money and a widening asset base in a way which supports consumers, businesses and financial institutions and ensures a long term innovative and thriving financial services ecosystem. The anticipated developments and changes surrounding cryptoassets and the application of their underlying technology represent a dynamic environment - the key question is how to regulate this market in a way which unlocks innovation, but in a way that protects consumers and businesses.
A Bank of England Digital Currency could take many forms depending on its design, the level of access allowed to different types of market participants and its interoperability with other domestic and overseas payment systems. The fundamental question on CBDCs surround the balance between investment versus their intended application as they also raise important questions about the reshaping of our economy, financial systems, and the way in which people interact with money and payments which would have a wide impact not just on consumers, but on our financial markets. We note the substantive work undertaken by the House of Lords on a potential UK retail CBDC[4].
Below we consider two distinct models of Bank of England issued CBDC, a wholesale model and a retail model.
Wholesale CBDC
The main purpose of a wholesale CBDC (wCBDC) would be to improve the settlement speed and efficiency of transactions between financial institutions. Access would be limited to regulated financial intermediaries (banks and market infrastructures) with an account at the Bank of England, at least initially. Over time, access to wCBDC could be expanded to other firms, although this would raise prudential risk and other issues that policymakers should evaluate carefully. The principle of ‘same risk, same regulatory outcome’ would be a useful guide to follow in order to expand access gradually and safely.
A noteworthy use of wCBDC would be as infrastructure for payment settlement in DLT applications for securities markets. By allowing for delivery-versus-payment (DvP) transactions to take place fully on-chain, digital money such as a wCBDC could significantly expand the functionality available to firms using DLT. As the Government prepares to launch the first FMI Sandbox in 2023, this is an important consideration.
It is important to note that a wCBDC is not the only type of digital money that could achieve this functionality. Alternatives include appropriately regulated digital forms of money such as blockchain base deposits, tokenised deposits, synthetic CBDCs or properly regulated stablecoins.
Another potential use case of a wCBDC would be cross-border payments. Potential impacts include faster settlement speeds and lower operational costs and funding requirements, with likely downstream benefits for retail remittances and other cross-border payments. The extent of these benefits would significantly depend on the degree of interoperability between wCBDC systems in different jurisdictions. Again, other forms of digital money (including appropriately regulated privately issued forms) could also deliver greater speed and efficiency for cross-border payments.
Retail CBDC
The Bank of England and HM Treasury are currently considering whether the introduction of a UK retail CBDC would be beneficial for the UK economy and the continued integrity of pound sterling in light of increasing use of digital money. This decision could have significant impact on the way that the UK’s financial markets operate and the ways in which consumers and businesses make payments on a day-to-day basis.
While the Bank has not yet made a decision on whether to introduce a UK retail CBDC[5], the Bank and HM Treasury are currently considering the practical challenges of implementing and operating a UK retail CBDC, including the roles of the public and private sectors ahead of the proposed consultation in 2022 to help assess the case for a UK retail CBDC.
As the use of digital payment methods continues to rise, it is critical that the UK considers how citizens access and use these digital services and, importantly, what changes may be required for the issuance of GBP to continue to meet these changing use cases, for example the greater adoption of micropayments or the ability for consumers to have a ‘cash-like’ service that allows offline access. We are fully supportive of the investigation of the Bank of England and HM Treasury on the issuance of a CBDC for the UK.
There is still a large amount of work to be undertaken to fully understand how the issuance of a CBDC can resolve issues in the current use and access to GBP and whether these existing issues and problems with traditional currencies can even be solved by a CBDC.
There are risks to financial stability and the sources and cost of lending that we believe must be understood before deciding to proceed, including the provision of affordable lending by the mutual building society sector with its distinct operating and commercial model. Different business models will be impacted differently by these changes.
The biggest risk of disintermediation comes from the changing collateralisation approach for a CBDC and the reduced opportunities for banks and other Financial Institutions to provide loans and commercial bank money based on fractional reserve banking models. This could dramatically adjust the cost and sources of funding for unregulated and regulated lending activities – including business lending and consumer mortgages. This is explored in the Bank of England’s recent consultation on new forms of digital money and will be covered in more detail in an upcoming piece of work by UK Finance on credit creation and CBDCs.
On a strategic basis, it does need to be articulated clearly what we want a CBDC to achieve long term and whether this could be better achieved from existing forms of money or alternative forms of appropriately regulated digital forms of money. At the core of this question is whether we intend to replace or replicate existing systems like cards or Faster Payments and also the impacts this will have on the industry, merchants and consumers. This is a particularly pertinent question given the scale and nature of the UK’s investment in modernising interbank payments via the New Payments Architecture – a programme of delivery that will likely take a number of years to deploy.
The ‘safety’ element of digital money, if backed fully by liquid assets and most pronounced for a CBDC (as a central bank liability), together with the ease of transferring deposits from commercial banks to digital money, could pose a risk to financial stability by increasing the likelihood of commercial banks’ deposit outflow in a stress. As deposit growth becomes more cyclical, with depositors potentially moving their money into CBDC during a period of stress, in turn, this could increase the cyclicality of bank credit supply.
Lost deposits could in part be replaced with increased wholesale funding of commercial banks – although this form of funding would be less ‘sticky’ and greater reliance on wholesale funding would increase the exposure of banks, and credit conditions, to refinancing risk and short-term volatility in market sentiment. The price of new funding would be more variable than today where a larger proportion of funding is via retail deposits, and therefore we could see more variable pricing of new lending across the economic cycle. In particular, this could affect differing business models such as newer retail banks or building societies that cannot access the wholesale markets as easily. There is also the question of whether all lost deposit funding could be replaced with wholesale sources.
Given the widespread importance of a CBDC, the impacts this could have on the financial services sector, the average consumer and the UK in an increasingly unsure international world, we believe it important that Parliament is regularly updated by government and takes a significant interest in the potential development of a UK CBDC.
UK Finance has worked with members throughout the first half of 2022 to understand how some of the key technical hurdles could be overcome by the market. Our members identified with us three areas that required particular investigation:
Please find a summary of these reports below:
Interoperability: In our paper investigating interoperability for a CBDC, we analysed a number of models that could support the level of technical interoperability for a CBDC with existing payment providers and institutions. Providing interoperability of a CBDC with other forms of money could drastically expand the availability of CBDC services and provide a clear pathway for broader market adoption.
Any model for a CBDC should carefully consider the infrastructure changes that may be necessary to support interoperability while ensuring the ongoing fungibility of pound sterling (GBP) between its different forms (i.e. notes, coins, Bank of England reserves, e-money, commercial bank money and, in future, any CBDC or stablecoin provided for the UK market).
Credit Creation: The potential impact of the launch of a CBDC, and any prudential regulation of stablecoin and crypto-asset products, could be significant to the UK economy. The Bank of England’s discussion paper on new forms of digital money suggested that in the region of 20% of existing commercial bank deposits could migrate into these new forms of money.
At the upper end of the Bank’s sensitivity analysis, they suggest that this migration could raise the cost of lending from the bank sector by 80 basis points (i.e. 0.80%). Subsequent analysis undertaken by UK Finance and its members suggests that this figure could be higher. Further, our initial analysis indicates that potential constraints on the ability of firms to replace lost deposits with wholesale funding, could materially reduce the amount of credit the industry is able to create for the UK market.
However, these conclusions remain provisional as the design of any CBDC, the expected migration of existing commercial bank deposits to new forms of digital money and any prudential requirements for other new forms of money have yet to be defined. Further, the Bank suggests that the non-bank financial sector could begin to provide a greater share of credit creation for the UK market. However, the Bank’s analysis does not elaborate on the precise mechanisms by which this would occur. As reliable data on the way in which the non-bank financial sector provides credit is limited, it is difficult to estimate the degree to which non-banks would be able to step in (including in a time of stress) and the resultant impact on the availability and cost of credit.
What remains clear is that the introduction of a CBDC, and other new forms of digital money, could have a significant impact on the current function of the UK economy. We believe that a joint public and private forum that is responsible for modelling the potential impact of the introduction of new forms of digital money should be created in order to reach a shared understanding of the potential impact of their introduction, this is something we have discussed in detail with the Bank of England.
Business Models: Our work investigating the potential business models of private providers of CBDC services highlighted a number of concerns for firms providing these services. Firstly, we considered that firms would need to provide a level of service that is as good as, if not better, than existing services provided by financial institutions.
This would have to cover issues such as consumer protection, fraud prevention and appropriate customer authentication. We further assume that, given a CBDC would be a liability of the central bank, income from net interest rate margin (the ability for firms to derive income from holding deposits by using them as collateral to make loans) would not be possible. This leaves firms providing CBDC services to investigate end-user and merchant charges, seeking public sector funding or cross-subsidising the cost of providing these services through data monetisation or cross-selling opportunities.
Given that any CBDC based product with similarity to current accounts will be competing with established account providing institutions, including the likes of e-money providers and challenger banks, it is not clear to some industry experts how a dedicated CBDC service provider would be able to create an effective business model, offering a compelling consumer proposition while covering the costs associated with competing in this market. As the design of any CBDC launched by the Bank of England becomes clearer, we expect that this will be considered in the future design. Additionally, as regulation around stablecoin initiatives becomes clearer, we expect that this will begin to clarify for the industry the commercial opportunities present for firms to offer these products to the market.
FCA research published in 2021, estimates that 2.3 million adults now hold cryptoassets in some form[8]. It is widely acknowledged by industry that this figure is much larger and has grown significantly since. However, the key point regarding these types of cryptoassets is that they are largely seen as speculative investments or a gamble, and not a currency, and therefore rarely act as a means of payment or store of value, however, as noted there have been substantial developments related to cryptoassets over the last few years.
Research does show that for the most part, trust and familiarity for businesses and consumers alike still have some way to go towards reaching ‘mainstream’ levels of trust in cryptocurrencies and their underlying technologies[9]. It is worth also noting that with most mainstream consumers, they do not recognise the difference between cryptoassets, stablecoins and CBDCs and it remains to be seen how familiar they may be with these distinctions in future. Educational initiatives will play a key role in addressing this.
There are no official studies on the impact of cryptoassets on social inclusion. However there are a number of issues which sould be considered in more detail from a general perspective and in paralells with other inclusion issues such as understanding of how to use or buy cryptocurrencies, stablecoins, and/or CBDCs; what that means for the consumer in terms of level of protection, and their ability to initiate the transaction.
It is worth noting the recent finalisation of the Consumer Duty by the FCA, which means all customers are deemed as vulnerable, including where they have protected characteristics. This effectively translates to firms ensuring their products have inclusive design. In the application of digital services delivered through decentralised financial services, this could be easier said than done given that much of the underlying governance, controls and protocols are decentralised in nature.
Specifically on CBDCs, we note that the main driver and use case in many countries has been to improve access to financial services and banking. In the UK, 98% of UK adults had a day-to-day account in February 2020, that is an account they could use for day-to-day payments and transactions. We therefore do not see this can be materially changed by CBDCs.
Another risk in relation to ease of transfer could be if consumers increasingly move between commercial, regulated and unregulated forms of digital money; perhaps if the distinction between holding money as a medium of exchange and a store of value versus investing in speculative assets to generate a return becomes blurred for mainstream consumers. We could envisage a scenario where underlyingly complex decentralised finance tools enable such exchanges, presented in ways that appeal to retail users. If this scenario was to materialise, there would be risks to the control of the money supply in relation to money moving outside the supervisory view of UK regulators in addition to risks around customer protection.
On scams, the current problem is that UK consumers are being increasingly targeted by cryptoasset-related investment scams. These are sophisticated scams and are impacting both traditional financial services firms as well as new emerging business models like cryptoasset firms and exchanges. Given recent volatility in cryptoasset markets some of this activity has reduced but it still poses risk to consumers.
Long term, it is difficult to see how the industry will evolve, but if we factor in the possibility of a more decentralised internet through web 3 (remains to be confirmed) and the potential for increasing applications of DLT technology and in some quarters, the move to the metaverse, this could further divide the digital and non-digital consumers by widening the gap between understanding of the digital world given its potentially increasing complexity. Banking, access to cash and other inclusive strategies such as the Payment System Regulator (PSR’s) Digital Payments Initiative remain strongly rooted in the UK’s public policy and regulatory oversight and are enacted by the financial sector, these are important developments, but we expect increasing complexity as more forms of digital assets and money are introduced.
We are at a time of fundamental change for the regulatory landscape in the UK. Much of our regulation for financial services, but specifically payments, is EU-retained legislation. Through the Financial Services and Markets (FSM) Bill, we are seeing the introduction of the Future Regulatory Framework (FRF), which will fundamentally change the landscape and powers of the regulators and their ability to make changes as well as increased potential for regulatory arbitrage within the cryptoassets market, in particular.
The FRF gives the UK greater flexibility to be able to regulate cryptoassets in a neat and helpful way, but the regulation of cryptoassets and particularly activities like custodying these assets and decentralised finance needs substantial thought
Much of the change we’re seeing is being undertaken in a patchwork way with industry often being pulled in different and competing directions by regulators, one example relates to the proposed additional powers of the Bank of England in the cryptoasset space for systemic providers, and while we are supportive of systemic chains being appropriately regulated, this landscape could become more complicated, particularly where it overlaps with the FCA.
Without crystal clear transparency on roles, responsibilities and priorities, this landscape could become further confusing. The development of the UK’s regulatory coordination merits further discussion in this space, and engagement on the mandate and direction of regulatory bodies to achieve the opportunities presented, whilst mitigating the risks, would be welcome.
We do also have concerns regarding the technical skills and level of knowledge of regulators in this space given the emerging complexity.
This is why we are of the view that overall, there is a need for a fundamental look at how the UK will best work in future and how all of government, regulators and industry transform the industry and public authorities toward a regulatory framework that supports innovation. Most importantly, the UK needs to avoid an overly domestic approach to regulation in this space.
We support the principle of ‘same risk, same regulatory outcome.’ Any standards and regulatory decisions should take into consideration the role of different participants in the digital currency ecosystem and how their risks may vary to that of a typical bank. For example, a stablecoin issuer will carry different risks to that of a wallet operator, a wallet operator may or may not engage in lending activities. Within these categories there will also be varying levels of risk presented. These considerations will need to be reflected in the evolving regulatory regime.
Significant delays or confusing messages on the government and regulators' vision on crypto and digital assets would have an impact for the UK, considering the pace of innovation and the highly competitive nature of the industry and other jurisdictions who are very actively promoting this technology.
UK Finance is currently undertaking work with our members on the potential future application of NFTs within financial services, the use cases they might provide and the risks and opportunities they present. We envisage this will be published in October 2022 and will keep the committee updated.
DLT could have potential applications across financial services. Many firms have invested substantially in DLT by either embedding the technology in their business models or adopting assets or methods that use them widely. Some generalised examples of benefits of application are listed below:
Overall, DLT could help to reduce transaction costs in a broad range of financial services products, benefiting investors as well as market integrity and financial stability. The government has recognised this potential and is legislating to enable HM Treasury to create Financial Market Infrastructure (FMI) Sandboxes to test new technologies, including DLT.
Please refer to the more detailed answer regarding whether the government and regulators are suitably equipped to grasp the opportunities presented by crypto-assets.
UK Finance has not worked extensively on the tax system or implications regarding cryptoassets, but we will work closely with the government in future as they begin to look in more detail at the tax system and the implementation of international rules such as those from the OECD. As a broad point we note that the system does need to be inclusive of cryptoassets.
UK Finance are of the view that greater transparency of some types of cryptoasset transactions could reduce costs on the financial sector by supporting tracing of cryptoassets and thereby helping to deter criminal abuse, including high volumes of cryptoasset investment scams against our members’ customers. DLT-based tools already in the market should be used to help with the tracing of transactions and through our membership we are seeing practical cases of cryptoasset firms and traditional financial services firms working together to combat money laundering, scams and fraud which is a positive step in ensuring a more coordinated approach in protecting customers. UK Finance is also supporting this type of cross-sector understanding and collaboration through hosting presentations and roundtables on economic crime risk management
Economic crime is an issue pervasive in all sectors of the economy and so we need to consider a rounded approach which takes a system-wide approach to economic crime risks applying the principle of ‘same risk, same regulatory outcome’ in a technologically neutral way.
We welcome the principle of new anti-money laundering and counter-terrorist financing (AML/CFT) regulations requiring the cryptoasset sector to provide information about the originator and beneficiary of transactions (aka the Travel Rule), in line with international standards set by the Financial Action Task Force (FATF).
What we do note is that international convergence of the application of these rules is currently lacking, in the UK the government has chosen to implement a rule which permits lower levels of information to accompany intra-UK transfers, whereas in other jurisdictions they have chosen to take a differing approach. We believe it is crucial that the approach taken allows for a standardised process across jurisdictions, as divergent regulation is inherently part of the risk profile for cryptoassets and therefore it is important greater consistency is encouraged. We note the Egmont Group of national Financial Intelligence Units (FIUs) 2018 Typology of Virtual Currencies reported that national FIUs have identified challenges associated with inconsistency of national regulation. We also note the Joint Money Laundering Intelligence Taskforce (JMLIT) conducted a late 2018 study of scenarios for evolution of threat of criminal abuse of cryptoassets, identifying international regulatory consistency as key drivers for the threat.
In addition to recent AML/CFT regulations, we consider that the government should use the National Risk Assessment process to ensure that emerging forms of crypto assets presenting ML/TF risk are brought within scope of AML/CFT regulation. We also consider that the government should use the forthcoming Economic Crime Bill to clearly bring all forms of crypto assets and crypto asset providers within scope of civil forfeiture powers, but again, thought needs to be given regarding how this is applied in practice.
There needs to be greater thought given to compensation of identifiable victims, as per issues we see in other types of payments or financial services. Legal powers to investigate, freeze and forfeit cryptoassets (whether in a digital form or a fiat currency form) should be considered along with other Proceeds of Crime Act (‘POCA’) powers for the seizure of assets. The vast majority of firms in the market are very cooperative with authorities, but for a small few, greater consequences are needed for businesses that do not reasonably act to prevent their services being used by criminals, and/or do not respond in a reasonable manner to regulator and law enforcement requests to support the investigation and forfeiture of assets. Consideration should be given to slow down or temporarily block transactions to certain cryptoasset providers where there are good grounds to do so.
It remains to be seen whether the right balance has been struck by government and regulators in this area. What we do note is that the government’s stated aim of becoming a global cryptoasset hub does not necessarily match with the tone we have historically seen from regulators in their intervention in the market, particularly around AML and financial promotions, though we broadly welcome those initiatives, the tone of the regulator has been more on the more cautious side. More recently, their tone has become more positive and constructive, which is welcome.
Where the government has taken steps to regulate, particularly in the space of stablecoins used as a means of payment, it has done so by extending existing regulation. In this space, we are supportive of this approach as it is done in a way consistent with the principle of ‘same risk, same regulatory outcome’. However, we note some of the proposals regarding systemic regulation, whilst necessary, require sufficient transparency and calibration of objectives in the Bank of England’s approach.
Regarding the wider cryptoassets space, we see substantial value in DLT technology and cryptoassets and are also supportive of a wider regulatory regime for cryptoassets. We acknowledge the regulation of wider cryptoassets is desirable to ensure consumer protection and certainty for firms investing in that space. However, regulation in this space needs careful thought and we expect to work closely with government and regulators in striking the right balance. We see the secondary objectives introduced on international competitiveness through the FRF as being key drivers in obtaining the right balance between protection and innovation by regulators.
We are currently working on a thought leadership report on a potential future regulatory approach for cryptoassets and will share this with regulators, the government and Parliament once available.
More practically, as is the case with any complicated area which fraudsters can target, we are seeing crypto assets being exploited to defraud victims of their funds, as such this is an important area of consumer harm for our members. We see public uncertainty over legitimate investments as an important driver of significant consumer harm through authorised push payment (APP) fraud. We have therefore welcomed new FCA financial promotion rules for high-risk investments, including crypto assets, but remain cautious on how this will be practically implemented by the FCA.
During the Covid-19 pandemic, fraudsters exploited many individuals heightened financial insecurities, particularly in the context of record low interest rates, to entice victims into fraudulent investment opportunities.
In 2021, this led to more than £171.7 million lost to investment scams in their totality (so not all of which are related to crypto), which is an increase of 57 per cent from 2020. These investment scams affected over 12,000 victims. The nature of these scams means there are often life-changing sums involved in individual cases. For example, while investment scams accounted for only six per cent of the total number of APP frauds in 2020, they accounted for 29 per cent of the total value of all APP frauds. More detail on fraud and scams can be found in UK Finance’s annual Fraud the Facts[10].
This is a trend seen across the economy but includes an increasing number of crypto investment scams. We are seeing high volumes of crypto investment scams against our members’ retail customers, with an increasingly strong link between misleading crypto adverts and APP fraud.
UK Finance are of the view that regulation will benefit cryptoasset start-ups by ensuring that consumers can recognise that firms they may be dealing with are regulated and will increase trust in a market in which research suggests it is currently relatively low[11].
The challenge will be ensuring appropriate, practical and proportionate regulation where protocols or varying types of finance are decentralised and therefore whether traditional financial services rules can be applied. However, our view is that regulation in this space is not only beneficial, but essential to improving consumer trust and ensuring cryptoasset firms are robust and resilient, provided this is done on the principle of ‘same risk, same regulatory outcome’ and in a technologically neutral way.
There is a substantial amount of cooperation around the approach to cryptoassets, stablecoins and CBDCs on the global stage, we particularly see interventions from the Financial Stability Board (FSB) and CPMI IOSCO on stablecoins, the FSB and IOSCO on cryptoassets and the Bank for International Settlements (BIS), G7 and G20 on CBDCs. The UK regulators currently take a leading role in these forums.
Globally, we would observe that most central banks investigating issuing a CBDC, plan to deliver a CBDC that will be of most benefit to their economies:
We see global opportunities for the UK economy in our participation in global CBDC initiatives to facilitate enhanced cross-border payments and we would encourage the Bank and HMT to ensure that interoperability and cooperation with other key jurisdictions is a key driver and feature of their continued exploration of a CBDC, whether retail or wholesale.
For cryptoassets, many commentators point to Switzerland as a good example of where crypto regulation is very friendly and open. The Swiss regulator FINMA has taken a more proactive approach to engaging with crypto firms than the FCA, however we do see the FCA’s approach beginning to change, and we would encourage cooperation with Switzerland where the UK is able to, and the negotiation of a Mutual Recognition Agreement (MRA)[12] may provide a good place to start here.
The environmental impact and intensity of some of the protocols used in cryptoasset technology, such as Proof of Work (PoW) is well and widely noted. UK Finance is a longstanding proponent of climate responsibility being brought into the mainstream of the management and supervision of banking and finance and see cryptoassets as no different to this. We are beginning work on our assessment of the implications of the technology for environmental and resource intensity.
September 2022
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[1] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1025235/G7_Public_Policy_Principles_for_Retail_CBDC_FINAL.pdf
[3] https://www.ukfinance.org.uk/policy-and-guidance/reports-and-publications/uk-payment-markets-2022
[4] https://www.parliament.uk/business/lords/media-centre/house-of-lords-media-notices/2022/january-2022/central-bank-digital-currencies-a-solution-in-search-of-a-problem/
[5] https://questions-statements.parliament.uk/written-statements/detail/2021-11-09/hcws381
[6] https://www.ukfinance.org.uk/policy-and-guidance/reports-and-publications/designing-interoperability-potential-uk-cbdc
[7] https://www.ukfinance.org.uk/policy-and-guidance/reports-and-publications/commercial-models-potential-uk-retail-cbdc
[8] https://www.fca.org.uk/news/press-releases/fca-research-reveals-increase-cryptoasset-ownership
[9] https://www.checkout.com/campaigns/demystifying-crypto?utm_campaign=gl_crypto_report&utm_medium=content&utm_source=blog
[10]https://www.ukfinance.org.uk/policy-and-guidance/reports-and-publications/annual-fraud-report-2022
[11] https://www.checkout.com/campaigns/demystifying-crypto?utm_campaign=gl_crypto_report&utm_medium=content&utm_source=blog
[12] https://www.gov.uk/government/news/uk-and-switzerland-to-deepen-cooperation-on-financial-services