AURORA PROJECT – WRITTEN EVIDENCE (CDC0007)
CENTRAL BANK DIGITAL CURRENCIES INQUIRY
1. The Aurora Project, a growing team of individuals with strong connections with the City of London and the UK finance industry welcomes this Economic Affairs Lords Select Committee inquiry into Central Bank Digital Currencies (CBDCs).
2. However, after watching the Committee’s 12th October oral evidence session, we feel we should note that the existential risk of CBDCs to the City of London, or indeed the global role of the City of London (as opposed to the Bank of England), was unfortunately not brought to the Committee’s attention by the experts providing the oral evidence.
3. In summary, we therefore feel it is critical for the Committee to note as part of its evidence gathering:
Q1. What are the main issues driving central banks to explore CBDCs?
4. Technology developments that sit behind CBDCs mean that for the first time in a generation reform of the complex, expensive, rent seeking frameworks currently used by wholesale and retail payment rails can be comprehensively recast in favour of much lower costs, much greater capital efficiency and the prospect of significantly improved regulation.
5. In addition, central banks are also reacting to the perceived threat from cryptocurrencies, such as Bitcoin or one of the 100’s of other cryptocurrencies, or Stablecoins, such as Facebook’s Diem. This is a reaction to retail payments occurring outside the central banks’ jurisdiction and control; and it might explain why some central banks seem fixated on Retail CBDCs. Other countries though, such as China and France, see the national strategic advantage that the technology behind CBDCs can bring to wholesale payments and the wider benefits this would bring.
Q2. What are the main benefits and risks of a CBDC?
6. As a charge on the balance sheet of the issuing central bank the principal benefit of a CBDC is settlement finality, this coupled with lower costs, reduced capital requirements and greater regulatory transparency together with some particularly attractive tax collection and micro-payment features means that a CBDC becomes truly the payment rails for the digital age. Given the technology used to deliver a CBDC, the overall system becomes much more resilient and robust. The nature of a CBDC also means that the expensive need for reconciliation between ledgers can be dispensed with.
7. The principal risks of a CBDC lie in the ‘vested interests’ that would be disintermediated by its adoption. As these interests are currently at the heart of the current system it is to be expected that their reluctance to embrace change could prevent the nation fully benefitting from this advance in technology.
8. Further risks in relation privacy and security are dealt with in the answer to Q4
Q3. Could the proposed benefits of a CBDC be achieved through improvements to existing payment systems?
9. With regard to wholesale transactions, the answer is No. A Wholesale CBDC is an intrinsic technological improvement and by extension faster and cheaper, as well as requiring less capital for its users. Current Western finance is built on a spaghetti of payment systems. New technology can consolidate all of them onto one platform.
10. For Retail CBDCs then this is a more complex questions as existing payment systems using immediate (faster) payments, Open Banking and common international standards can improve the costs and speed of our current card-based payments systems. However, for new types of payments such as atomised payments for fractional penny pricing in areas such as road pricing or digital rights, a low-cost, low friction Retail CBDC linked to a consumer digital wallet would be needed.
Q4. How should the Bank of England and HM Treasury address concerns over privacy and traceability of payments when exploring CBDC design?
11. This is a Retail CBDC implementation issue and not relevant to Wholesale CBDC implementations.
Wholesale payments, which account for about 98% of all payments by value in the UK, do not raise any privacy concerns. They are after all, simply a credit and debit item across the ledgers of the central bank. Like any bank there is transparency as to the payor and the payee.
12. For a Retail CBDC privacy and payment traceability goes beyond binary choices of anonymity or full disclosure and system designers have a range of choices around the type of information to keep private or trace and who to keep it private from. Choices which are not the sole purview of a central bank and would need to be defined in consultation with other stakeholders, within a strong legal framework and parliamentary overview.
Q5. What effects might a CBDC have on the financial sector? And Q6. What effect might a CBDC have on competition and innovation in the payments and fintech sectors?
13. A CBDC issued and administered by the BoE is absolutely essential to secure the position of London as a wholesale financial centre. A CBDC would be used as collateral at various stages of the clearing and settlement cycle which London currently dominates. It would mean that expensive reconciliations could be dispensed with. It would enable real-time regulation as opposed to the current ex post system and it would lead inexorably to an increase in innovation, volume, and competition as there would be the possibility of replacing bank reserves with CBDC.
14. There would therefore be huge advantage if a Wholesale CBDC was implemented within a short timeframe (see Figure 1) but irreversible degradation of national revenues from the City of London if a Wholesale CBDC is not implemented at pace (see Figure 2).
Figure 1. Benefits of a Wholesale CBDC as a foundation for a Retail CBDC
Figure 2. What the UK Loses without a Wholesale CBDC
Q7. How might a CBDC affect monetary policy?
15. A Wholesale CBDC would supplement bank reserves in the transmission of monetary policy, reducing reliance on bank lending. It would have to be remunerated at or close to the policy rate, since the fact that banks could arbitrage reserves and CBDC would prevent a more divergent rate from holding. Combining a remunerated CBDC deposit or lending facility with a slightly divergent opposite for bank reserves would potentially control the policy rate in a manner similar to the Fed's standing repo-ONRRP combination, potentially allowing the Bank to unwind QE purchases safely. The CBDC rate would also be an obvious replacement for Libor.
16. Over time, CBDC could replace bank reserves. This would call into question the primacy of banks in the financial system and force the Bank of England to reconsider the role of "bank rate". However, since the advent of QE, monetary policy transmission has aimed to influence wider market behaviour, rather than bank lending. Adopting CBDC as the primary transmission mechanism could potentially enable central banks to exercise more control over a market in which collateral prices are increasingly the driving force and non-banks of growing importance.
Q8. How might a CBDC change the Bank of England’s role and responsibilities?
17. A CBDC would enable the BoE to become a ‘real time regulator’. The BoE would be able to witness stresses in the financial system like Northern Rock and RBS many months before they became critical through the CBDC allow the BoE to see ‘where’ the assets and commercial stresses were.
18. Our view is that in due course a limited Retail CBDC would offer benefits to the UK. We see this as being provisioned through and alongside the existing banking system, without fundamental change to roles and responsibilities, to support new retail business cases around, for instance, lower cost atomised payments, e.g., road use charging as fuel duty decreases, digital use charging, etc., or to support financial inclusion through the provision of digital wallets where individuals cannot access the current banking system.
Q9. How should HM Treasury and the Bank of England engage with the public on the research and development of a CBDC?
19. HMT and the BoE does not need to engage with the public on this matter if their focus is on launching a wholesale service, covering 98% of all payments made between less than 5000 BoE account holders, because it is effectively a closed loop. The experience gained from running this service will then inform the next steps for engaging with the public. Regrettably the BoE, by choosing to engage with the public at this time is very exposed to the suggestion that they are putting the metaphorical cart before the horse.
20. HM Treasury and the Bank of England should therefore be engaging with the relevant wholesale stakeholders across Westminster, the City of London, and the private sector to sponsor a project that is proactively progressing a wholesale first CBDC strategy - to protect the interests of the UK economy and lay the foundations for a Retail CBDC that supplements the existing banking sector.
Q10. How might CBDCs affect the economic foreign policies or geopolitical influence of different countries and economic areas? Are there implications for the effectiveness of economic sanctions?
21. There are two main areas of advantage one country will gain over another:
22. First, strategic advantage will be conferred to any country that can leverage a Wholesale CBDC capturing financial market-share and associated money flow data. That country will also enjoy increased tax revenues matched to the equal tax degradation of countries from which it has taken financial market share.
23. As a leading financial market, the faster settlement and cheaper fees offered by a competing CBDC platform will attract trade away from the City of London, impacting revenue collected by HM Treasury, and reducing the UKs geopolitical influence as that of other countries rises.
24. In this respect, the UK has more to lose than nearly all other countries and is a prime target both for the EU (who would want to demonstrate the cost of leaving the EU by the dismantling of the City of London) and China (who would want to entice market participants from London to Shanghai and Hong Kong). It is increasingly likely that unless the UK hugely accelerates the plan and implementation of a Wholesale CBDC then the City of London will be targeted by financial centres utilising a national Wholesale CBDC.
25. With regard any impact for the effectiveness of economic sanctions, unless a country is a part of the international CBDC landscape it cannot control the levers that impose economic sanctions and will be reliant of the goodwill of other countries in monitoring and sanctioning international money flows. If other countries launch a Wholesale CBDC ahead of the UK / US, and that Wholesale CBDC attracts (due to being greatly less expensive less capital intensive and faster to transact) large volume of transactions, the country who 'own' that Wholesale CBDC will not need to use the current Western controlled financial infrastructure – or can offer its own Wholesale CBDC as a replacement to whichever countries it chooses. The ability to enforce sanctions through control of international money flows will be drastically reduced.
26. Secondly, there already exists an equally insidious example of the UK use of an international Retail CBDC, in the form of the mobile application HungryPanda, which enables members of the UK Chinese diaspora to order and pay for Chinese food using the Chinese Renminbi CBDC and has a UK office in Birmingham. If this model is expanded, it would allow any country with a CBDC to offer the capability for services and payment in another country to be enabled in a way that would totally circumvent the latter country's ability to collect tax. Even if the tax authorities wanted to collect the tax, they would need access to the foreign Central Bank records in order to investigate, records very unlikely to be supplied without a price.
27. The Aurora Project is a growing team that includes UK Fintech entrepreneurs, central market infrastructure specialists, payment system architects, city executives and other specialist personnel all of whom have strong connections with the City of London and the UK finance industry (both at a wholesale and retail level). Members also include individuals who have backgrounds in security and geo-politics. This team were a major contributor to a submission to the TIGGR report chaired by Sir Iain Duncan Smith MP, and the recommendation to consider the enactment of a Wholesale CBDC as soon as possible.
28. The mission of the Aurora Project is to raise awareness and explain the ‘once in a generation’ opportunity, highlight the severe cost of doing nothing, and support the UK government to enable the UK to realise a multi-decade strategic advantage (using the expertise available within the City of London as support).
29. The Aurora Project includes:
Frances Coppola - is a world expert on commercial and central banking. After 17 years working in banking and IT she now writes and speaks on banking, finance, and monetary economics.
Professor Daniel Hodson - Chairman, The CityUnited Project; formerly Gresham Professor of Commerce, CEO of LIFFE, Deputy CEO and FD of Nationwide BS, NED of The London Clearing House, Master Mercer, Chairman of Berry Palmer and Lyle Holdings plc, and Chairman of Winchester University.
Peter Randall - serves as an independent non-executive director in the City of London. He founded Chi-X Europe in 2005 and is widely credited with transforming European equity trading and settlement.
Peter Seymour - is a retail payments, regulation, and policy expert; formerly head of government services for the UK payments clearing house VocaLink he currently advises and trains regulators in the payments and telecom sectors and is an advisor to the APPG on Open Banking and Payments.
18 October 2021