CAI0077

 

Written evidence submitted by the Payment Systems Regulator

 

Summary of response

The Payment Systems Regulator (PSR) is the UK’s - independent economic regulator of payments systems – the only dedicated payments systems regulator in the world. We regulate 40 billion payments worth over £92 trillion each year. The PSR’s objectives are to promote competition, innovation, and the interests of service users.

We are a member of the Crypto-Asset Taskforce (CATF) with the Financial Conduct Authority (FCA), Bank of England and HM Treasury (HMT) to shape the development of a UK risk-based, regulatory framework for crypto-assets – with our specific focus upon crypto-assets that are used for payments. As part of the recent draft Financial Services and Markets Bill 2022, currently before Parliament, the PSR will have a role in the regulation of Digital Settlement Assets e.g. stablecoins and other crypto-assets that can be used for payments.

We see opportunities for crypto-assets and distributed ledgers technology (DLT) in supporting financial services to be more efficient and cheaper, we expect the use of DLT to be deployed in a wider range of use-cases and welcome the competitive pressure and innovation that this represents. However, we do not expect to see digital currencies ‘replacing’ traditional currencies in the immediate future.

Nevertheless, as these opportunities arise, it is crucial that innovation and competition are balanced with strong safeguards to ensure the interests of all participants are protected. We welcome HM Treasury's approach to bring Digital Settlement Assets such as stablecoins within the payments perimeter.

The PSR supports the zero-carbon target. Any payment system, including any crypto-asset based system, should be working towards a zero-carbon target as soon as possible. We consider the inclusion of the specific net-zero duty applied to the PSR that is contained in the Financial Services and Markets Bill will assist in turning this from an aspiration into reality going forward.

Role and remit of the PSR in relation to crypto-assets

 

The PSR was established in 2013 and supports and promotes competition and innovation in payment systems. We also ensure payment systems are developed and operate in the best interests of its users, including appropriate protections for consumers.

 

The PSR has the following statutory objectives:

 

[Financial Services (Banking Reform) Act 2013 (FSBRA)]

 

The PSR’s role is to regulate payment systems. These systems span cash and cheques, though to card, bank transfers and prospective wholesale payments deploying distributed ledger technology. Payment systems are “designated” by HMT. At present, the designated payment systems under FSBRA are Faster Payments Scheme, Bacs, CHAPS, LINK, Mastercard, Visa Europe and Cheque and Credit/Image Clearing System; and most recently the Fnality Sterling System.

 

The PSR also regulates “participants” in designated payment systems. These participants are Operators of Payment Systems; any Infrastructure providers to that system; and any payment service providers (PSPs) in that system.

 

As part of the Financial Services and Markets Bill 2022, which is currently before Parliament, the PSR is included with respect to Digital Settlement Assets e.g. stablecoins and other crypto-assets. The Bill as introduced clarifies that HMT can designate a system that uses digital settlement assets that are transferred across it. The Bill also allows for different types of participants in those systems to be regulated, such as wallet providers and exchanges which are more commonly associated with those systems than in existing payment systems.

 

We work closely with our fellow regulators on a range of issues, including crypto assets, and have a statutory Memorandum of Understanding (MoU) in place between the Bank of England, the FCA, and the Prudential Regulation Authority (PRA). A summary of the complementary objectives and roles of each of the regulators, as it relates to payments and payment systems can be seen in the diagram below:

 

 

 

The PSR is also a concurrent competition regulator in relation to payment systems, alongside the Competition and Markets Authority (CMA) and can investigate abuses of dominant positions for example. We can conduct market studies and make market investigation references under the Enterprise Act 2002.

 

We are the lead authority for monitoring and enforcing the interchange fees under the Payment Card Interchange Fee Regulations (PCIFRs) 2015 2015. We are also the competent authority for alternative switching schemes under the Payment Accounts Regulations 2015. We are co-competent for some regulations within the Payment Service Regulations 2017.

 

We welcome this opportunity to respond to the Treasury Select Committee inquiry into crypto assets. Our submission focusses specifically those areas relevant to the PSR’s role and remit as the economic regulator of payment systems. We have responded to questions 1, 3, 4, 5, 6, 10, 11, 12, 13.

 

Responses

 

Q1: To what extent are crypto-assets when used as digital currencies (such as Stablecoin) likely to replace traditional currencies?

 

Summary

The UK has a well-developed set of payment instruments; that provide a convenient means of exchange, stable value, and a clear unit of account. Digital payments are increasingly more convenient for many people and businesses, such as with the growth of contactless card payments.

We welcome competition, including between different types of payment system. Competition can spur innovation and bring benefits to people and businesses making and receiving payments. However, new payment systems need to overcome several challenges to reach widespread use.

To date, digital currencies and crypto-assets that have emerged have not offered the same levels of stability or convenience for most use cases. We do not expect to see digital currencies ‘replacing’ traditional currencies in the immediate future.

Asset-backed stablecoins are the most likely form of crypto-asset to be accepted in payments and therefore could compete to replace traditional currencies for some payment use-cases. We consider that the volatility of other types of crypto-asset including other types of non-asset backed stablecoins means they are unlikely to be used as a widespread means of making payments, as such they are less likely to replace traditional currencies.

We expect the underlying technologies – notably the use of distributed ledgers – to be deployed in a wider range of use-cases and welcome the competitive pressure and innovation that this represents.

We remain committed to protecting consumers from harm e.g. fraud, and any stablecoin asset intended for use in payments is likely to need to address all these aspects of consumer protection to maintain sufficient trust in the system.

We also know from our work that many people continue to rely on cash in their day-to-day lives, do not benefit from good digital connectivity, and need payments to help them manage their tight budgets. We will continue our work to regulate the UK’s main cash machine network, so that there is good geographic availability of cash from free-to-use ATMs and our work in the Digital Payments Initiative.

Entry into the payment market

Establishing new forms of payment, and new payment systems, can be difficult, because of the need to establish wide acceptance of the payment method. Consumers already have access to payment methods that are convenient, fast, cost-free at point of use and largely secure. This makes it harder for any new payment type to achieve widespread use, without offering participants some form of advantage over existing payment systems.

The concept of starting small and building scale has not been seen to be effective in providing payment systems. Where payments systems have grown their user base over time, these systems have typically been integrated with pre-existing payment systems to get that widespread acceptance e.g. PayPal, ApplePay, GooglePay that use Faster Payments and card systems.    

Any new, widespread payment system would need to identify a significant benefit that it can deliver. There are clearly opportunities to do so by being more convenient, cost effective or safer than existing systems. Indeed, the emergence of the Fnality Sterling System as a new payment system illustrates that in respect of wholesale payments between large financial institutions.

It is not always the case that ubiquity and meeting new needs always leads to the uptake in a new payment method. Some other stimuli could also be needed to prove new use cases and to get more consumer and merchant adoption. For example, the Chinese CBDC (Central Bank Digital Currencies) trial to get uptake in which people were given CBDC that could be used for free or heavily subsidised public transport.

Leveraging pre-existing users of platforms or non-payment products

Some providers may be able to drive adoption, particularly if they already have a sufficiently large network of consumer or retailer relationships

For example, technology platforms may be able to make use of their existing large networks of users to introduce payment methods that have a greater chance of adoption. Facebook/Meta’s promotion of the Diem cryptocurrency (formerly Libra) was an attempt to make use of a broad user base for its existing services to then offer other services, in this case cryptocurrency distribution and acceptance. This is one way in which new entrants can overcome the challenges that are inherent in building a ‘network,’ and reach widespread adoption. We note that no provider has to date been able to take advantage of its wide network in this manner, in the UK.

Previously there have been examples of platforms providing payments products to send and receive payments to existing members of that platform. Typically, these products have been integrated with different payment systems such as Mastercard or Visa. Some examples include SnapChats SnapCash, Facebook & WhatsApp Pay. The majority of these have not had significant user interest in the UK, SnapCash and previous iterations of Facebook pay have been discontinued. Users of these platforms may not trust those providers in the same way they trust their bank or other financial providers. It may also seem to some users that these products are more of a novelty or that they have limited use cases such as person to person payments only. A Platform launching a digital currency may need to overcome these issues to gain wide-spread acceptance among its user-base.

Asset-backed stablecoins and payments

Asset-backed stablecoins are the most likely form of crypto-asset to be accepted in payments and therefore compete to replace traditional currencies for some payment use-cases.

Some forms of asset-backed stablecoin have been designed to remove significant price volatility, and to avoid the transaction lags associated with previous generations of digital assets. Designers of these types of crypto-asset have set out to provide a form of digital asset that can substitute for traditional forms of money more effectively. There is reason to think that these types of assets may be useful in tackling some of the problems of cross-border payments. It also has the potential to be used by consumers and retailers to pay for goods and services.

However, even with stablecoin, challenges remain to widespread take-up and acceptance.

Payment acceptance is a two-sided market: payers must feel that enough payees accept a new method of payment for them to adopt it, and payees must feel that enough payers will choose the new method for them to accept it. If a large base of payees will accept a new form of payment, they may attempt to incentivise payers to adopt and choose the new method.

The impact of price volatility on crypto-assets being used for payments

We think the volatility of other types of crypto-asset including other types of non-asset backed stablecoins means they are unlikely to be used as a widespread means of making payments, as such they are less likely to replace traditional currencies.

Many crypto-assets, like Bitcoin, Ethereum and XRP, held by consumers are traded on open exchanges with prices set by market demand. This has led to significant volatility in prices and/or the risk that in certain circumstances the value of the assets will become volatile, even some seemingly fiat pegged tokens can become volatile as Terra Luna showed.

An additional factor is the extent to which crypto-assets are readily exchangeable, including in periods of financial distress. In addition, the design of some of these systems leads to operational bottlenecks with transaction and redemption speed, reducing their convenience and/or suitability for many widespread use-cases.

Any digital asset that is based on volatile, market-set, prices is unlikely ever to act as an effective substitute for traditional currencies in payments. Holders of digital assets that are appreciating in price are not incentivised to use those assets in exchange for goods or services. When digital assets depreciate in price, merchants are less likely to take the risk of accepting them. In addition, those that have slow transaction speeds will not be able to compete with existing systems that process significant flows of transactions within seconds.

We have seen Mastercard and Visa design products and services that allow crypto-assets to be used to pay for goods and services across their systems. This shows how a crypto asset could gain scale over time by integrating with another system that is already ubiquitous. However, at the point of sale crypto-assets in a linked wallet account are exchanged for fiat currency and that is then used to settle the payment. As such this is allowing holders of some crypto-assets to automatically sell them for fiat currency to pay for goods and services using a branded card. This is different from a system where the crypto-asset is used end-to-end with both the consumer and the merchant happy to accept it in payment.

Consumer protections

It is likely that consumers will consider the protections available to them, in respect of: how stable the value of the assets are during periods of financial distress; the purchase protections available; and the protections against fraud.

In respect of the first, consumers in the UK can generally rely on deposit protection when holding funds with a retail bank and are protected by the e-money regulations. Any stablecoin asset intended for use in payments is likely to need to address both forms of protection.

The main card schemes all offer customers protections when making purchases online and in-person, which go beyond the statutory minimum levels. For stablecoins to achieve widespread use, they would need to be deployed in a way that reflected some of these protections.

Any new system will also need to manage risks associated with authorised and unauthorised fraud. This is a significant challenge across payment systems today and is a focus for improvement in many of these systems. For example, the PSR has also been addressing the growing issue of authorised push payment scams (APP scams) that arise using Faster Payments. Similarly, the security in card payments has recently been enhanced through the introduction of Secure Customer Authentication.

Any stablecoin asset intended for use in payments is likely to need to address all these aspects of protection to maintain sufficient trust in the system.

Q3: What impact could the use of crypto-assets have on social inclusion?

Our work has considered issues of social inclusion and highlighted some of the barriers to greater use of digital payments. These include: the benefits of ‘tangible’ cash when managing daily spending; the relative ease of keeping to a budget when using cash; and the lack of a need for digital connectivity. We do not see that crypto-assets specifically have any material benefits to social inclusion.

In 2020, we carried out consumer research which considered how vulnerable and low-income groups adapt to and perceive different payments. We discovered that vulnerable and low-income groups are less likely to be aware of or to have used newer payment methods. This is particularly true of consumers with low internet usage and low levels of confidence online. Our research highlighted that there is a general feeling among this section of the population that newer payment methods are less secure and more susceptible to payment fraud. Interestingly, this highlighted that there is little appetite to learn more about newer payment methods, with most reporting that they are more comfortable with the payment methods they already know and use.

There are several initiatives we are undertaking to examine inclusion issues using existing payment technology; through improvements to how existing payments work (e.g. pre-paid cards, developments in how recurring payments are made), unlocking the potential of Open Banking, which has the potential to give greater control to customers over when and how they make account-to-account payments, and developments such as Request to Pay.

We do think that more can be done to address exclusion from digital payments. For further details we would like to address your attention to the work of the PSR in the Digital Payments Initiative which we would be delighted to discuss with you further going forward[1].

Q4: Are the Government and regulators suitably equipped to grasp the opportunities presented by crypto-assets, whilst at the same time mitigating against the risks?

The current regulatory approach with responsibilities split between the FCA, Bank and PSR works effectively, as it allows each regulator to focus on specific challenges and specialisms.

As the independent economic regulator our focus is on payment systems. We seek to create the right environment for competition and innovation in payment systems. We are focused on the interests of the people and businesses that use payment systems.

We have powers to:

We should ensure that this model can apply equally well to new payment technologies as it does to those today. It is our current view that the FSBRA framework is appropriate for the introduction of Digital Settlement Assets e.g. stablecoins and other crypto-assets that can be used for payments. This framework would allow the PSR to use our range of powers to deliver against our statutory duties and take a proportionate risk-based approach to our regulatory policy making. We are working with government to make sure that the definitions and statutory construction allows new technologies to be regulated as payment systems in this way and will continue to work with government to ensure we have the appropriate tools to address any issues that could arise.

While it is not a crypto-asset based system, HMT have recently designated the Fnality Sterling System for regulation by the PSR; this system uses Distributed Ledger Technology which is often associated with crypto-assets. The Fnality Sterling System has also been recognised for regulation by the Bank: which allows us to demonstrate how we can work together to regulate a system that shares some technologies with crypto-asset and stablecoin systems.

The Financial Services and Markets Bill in conjunction with the HMT’s proposals contained in the Payments Perimeter consultation will provide a solid footing for us to address the risks and opportunities presented by crypto assets as payments going forward.

However, it is worth noting that at present there are no large-scale GBP stablecoin issuers in the UK, and therefore no designated stable coin or crypto asset systems. Worldwide, where stablecoins have a large issuance, they are not being used widely for payments.

Q5: What opportunities and risks could the use of crypto-assets—including Non-Fungible Tokens—pose for individuals, the economy, and the workings of both the public and private sectors?

New crypto-asset and DLT technologies in payments could provide benefits such as robust resilience; reduction in costs, increased efficiency. This means that the use of appropriate payments crypto-assets could provide improvements for both retail and wholesale markets, and the public and private sector.

In respect of crypto-assets to be used in payments this could include new methods of payment for goods and services, greater levels of automation (e.g. Smart contracts), and potential for improvements in areas such as international / cross-border payments.

The types of risks that could arise in crypto-asset payments are consistent with those we see in other payment systems such as the need for systems to be developed with users in mind so ensuring adequate consumer protection; appropriate consideration is given to what happens when things go wrong; adequate access to the system; and ensuring the market remains competitive, avoiding issues associated with near-monopoly supply.

We should ensure that the existing regulatory model applies equally well to new payment technologies as it does to those today.

We do not think non-fungible tokens have a payments-use case. They are, by definition, non-fungible and so not suitable for widespread payment use cases. Their value is also unlikely to be sufficiently stable to support such widespread payment uses.

 

Q6: How can distributed ledger technology be applied in the financial services sector?

 

Digital Ledger Technology (DLT) as a technology has wider implications than crypto-assets. However, a lot of the DLT technology is often directly linked to how Bitcoin is set up and operates because it was the first decentralised crypto-asset.

 

DLT is already used to improve resilience within some organisations, where having multiple distributed copies of ledgers across a network and across different locations means that in the event of a technical issue operations are impacted less, if at all. This can also be the same for payment systems where multiple ledgers remove some of the risks associated with centralised systems.

 

We are also starting to see DLT emerge as an underlying technology in certain payment systems, for example Ripple provides the basis for international transfers either by using its system to message between correspondent banks on its system or by simultaneously buying and selling its XRP asset between two different currency pairs. Another prominent example of DLT usage is within the designs of the Fnality Sterling System.

 

Fnality Sterling was recently designated and recognised for regulation by both the PSR and Bank of England, respectively. In Fnality, participants send ‘central bank’ money into Fnality’s Omnibus account at the bank of England. Based on this ‘deposit’ Fnality increase the level of holdings on the ledger, which is distributed among the nodes (participants) in the system. Transactions are then recorded through ledger movements. At any time, the amount of money on the ledger will be the same as in the omnibus account and participants can draw down funds and receive their money back or else increase their holdings. While this is different from a Token system such as Ethereum, Ripple or Bitcoin, its developers are seeking to demonstrate that it has resilience and efficiency gains to it.

 

Q10: Is the Government striking the right balance between regulating crypto-assets to provide adequate protection for consumers and businesses and not stifling innovation?

Both the opportunity through more diverse payment systems and the utilisation of some of the technology (e.g. DLT) if implemented well, provides for greater resilience and greater efficiencies. This can lead to different products and services as well as levels of automation and innovation. More products and services provide more choice for businesses and consumers. It can also lead to greater competition within the payments market which can lead to other benefits e.g. improved service quality, lower fees.    

We consider that appropriate, risk-based regulation is a principal factor for ensuring that the correct balance is struck between promoting this competition and innovation and protecting consumers and businesses. We consider that it would be appropriate to ensure that crypto-based payment systems are subject to the same risk-based regulation that existing systems are subject to by the PSR (see our response above at question 4).

Q11: Could regulation benefit crypto-asset start-ups by improving consumer trust and resilience?

We can expect that consumers and businesses would have greater trust and confidence in an authorised and regulated crypto-asset.

Regulation can address risks to consumers and businesses by requiring standards are met, with consequences for those that do not meet them. In addition, regulation can be used to address emerging threats such as the potential for fraud to migrate from Cards, FPS (Faster Payment Scheme) and CHAPS to a new payment system such as a crypto based system.

Regulators can also help by promoting innovation. For example, the FCA regulatory sandbox and tech sprints, and providers having access to Payment Specialist Advisors to gain insight and experience, to understand regulations and risks and to test products ahead of commercial launch.

Q12: How are Governments and regulators in other countries approaching crypto-assets, and what lessons can the UK learn from overseas?

Internationally, jurisdictions are adopting different approaches. Payment ecosystems have developed in different ways and therefore the relative risks and benefits to crypto-assets for individual jurisdictions will vary.

We can learn from others, as well as recognising the characteristics of the UK payments ecosystem and how crypto-assets would impact it. The UK has a significantly high proportion of individuals with a bank account and a debit card. Smart phone usage is also high with the prevalent way consumers access bank accounts via banking apps. The UK is also a world leader in Open Banking, and the Payment Initiation Services through Open banking is also likely to lead to new products and services for consumers. This is different to many markets that have been looking at crypto-assets and CBDCs to leapfrog the issue of a large unbanked population or where financial products have lacked investment and innovation.

We have also been and remain close to developments in the US and Europe and will continue to monitor developments more widely.

Q13: The environmental and resource intensity of using crypto-asset technology.

The PSR supports the zero-carbon target. We are aware of the issues associated with crypto-assets that use the proof of work consensus mechanism; the largest one of which is Bitcoin.

Any UK payment system, including any crypto-asset based system, should be working towards a zero-carbon target as soon as possible. We consider the inclusion of the specific net-zero duty applied to the PSR that is contained in the Financial Services and Markets Bill will assist in turning this from an aspiration into reality going forward.

 

September 2022

 

[1] See PSR Panel Digital Payments Initiative Report here: https://www.psr.org.uk/publications/general/psr-panel-s-digital-payments-initiative-report/ and the PSR’s response here: https://www.psr.org.uk/publications/general/psr-response-to-digital-payments-initiative-report/