Bank of England sets out its stall for assessing payments innovation

Started by TimeshareTalk, November 15, 2019, 15:22:31

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Payment systems have an important, although sometimes overlooked, role in the broader UK financial system. Facebook's proposal to launch a digital currency for retail payments within its network has prompted regulators to consider their approach to innovation in the payments sector more generally. At a recent meeting of its Financial Policy Committee, the Bank of England suggests how these innovations should be assessed.

Three principles for ensuring payment systems support financial stability

In the record of its latest quarterly meeting, the FPC welcomes the exploration of alternative ways to improve cross-border and domestic payments. However, ensuring new solutions support financial stability is a key concern. And so, the FPC has agreed the following three principles for assessing how regulation should respond to fast-moving developments in the payments sector.

Principle 1 - financial stability risk is more important than legal form Firstly, according to the FPC, regulation should reflect the financial stability risk, rather than the legal form, of payments activities. In other words, the same level of risk should attract the same level of regulation. The FPC's concern is that use of innovative forms of payment (such as digital assets) could become widespread but not necessarily subject to the same level of regulatory oversight as prevailing payment methods (such as debit cards). The FPC reiterated the point that innovative structures are making it increasingly important to apply regulation based on functions undertaken rather than merely the type of entity involved. See also our blogpost on Protecting the financial system as the market changes.

Principle 2 - every link in the payment chain should be resilient Secondly, the FPC calls for end-to-end operational and financial resilience across payment chains. Payment chains typically connect payers and payees via multiple payment services firms, payment systems and other financial market infrastructure. Their length and complexity have been increased by new technology and new market participants. The FPC is concerned that, when it comes to resilience, these chains are only as strong as their weakest link. For example, it notes that: "The resilience of the proposed Libra system would rely on the stability of not just the core elements of the Libra Association and Libra Reserve but also the associated critical activities conducted by other firms in the Libra ecosystem such as validators, exchanges or wallet providers". Operational resilience is a regulatory priority and the UK regulators, including the Bank of England, are going to propose new rules and guidance for financial institutions shortly. Read our publication on Building the UK financial sector's operational resilience for more.

Principle 3 - data should be made available so that risks can be monitored and addressed Finally, according to the FPC, sufficient information about payments activities should be made available. Their concern is that supervisors may be blindsided to risks that could emerge from innovative payment systems. With more data, there is more chance of identifying risks to financial stability and addressing them appropriately.
The potential systemic importance of Libra

In the FPC's view, Libra has the potential to become a systemically important payment system. This means it would need to meet the highest standards of resilience and be subject to appropriate supervisory oversight.

The FPC stressed that the terms of engagement for innovations such as Libra must be adopted in advance of any launch. This echoes comments previously made by Mark Carney on Libra - see also our blogpost on Paving the road for a diversity of payment options.

What is the Financial Policy Committee?

The Bank of England's Financial Policy Committee looks out for risks in the financial system. As well as payments, its latest meeting considered Brexit, the UK-China trade war, the liquidity of some investment funds and LIBOR transition.

Next steps

The Treasury is leading a review of the payments landscape which includes looking at its resilience and how regulation can keep pace with innovation. The FPC suggests that its principles could inform any assessment of current payments regulation in that review.

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