Perspectives on (Ca-)Libra #3: Why the Libra is not e-money (also: the history of e-money and stablecoins)
Quickly after the announcement of Libra, I, stated that Libra could not be viewed as e-money. Now has come the time to explain my earlier analysis (of June 2019) as to the regulatory qualification of Libra.
Libra is a privately issued and distributed digital and virtual ‘currency’, that is intended to function as a means of payment. It is not a true currency because its actual composition/counter value is a basket of fiat-currencies and financial instruments. It is not e-money as the Libra is not ‘monetary value’. The digital value qualifies as a financial instrument (a mini-participation in an open ended investment fund) and is used in an open source payment instrument, to be used for payment and acquiring. Both payments and securities legislation apply, as well as the relevant competition and consumer protection rules.
1- Definitions of e-money and term: monetary value
The reason why Libra, as a basket of a set of different currencies, cannot be considered e-money is that it doesn’t qualify as such as it is not monetary value under the definition. And to comprehend the definition we must understand that the European E-money directive has had a first version and that the European Central Bank was clear on its analysis. E-money is a fiat currency in a digital shape and is a form of monetary value that must be treated as such in terms of: reporting requirements for monetary aggregates, redeemability (at par), assurance that customer fiat money equivalent was kept safe etcetera.
The definition of e-money as monetary value reflects that all we could think of in the 1990s was digital tokens that one-on-one reflected the physical or existing scriptural account-money forms. This is particularly clear from the consideration 19 in the Opinion of the central bank on the first draft directives. What we can see here is a central bank ensuring that redeemability against the fiat currency is obliged, in combination with a definition of e-money which does not allow offering e-money at a discount.
“electronic money” shall mean monetary value as represented by a claim on the issuer which is:
(i) stored on an electronic device;
(ii) issued on receipt of funds of an amount not less in value than the monetary value issued;
(iii) accepted as means of payment by undertakings other than the issuer.
1. A bearer of electronic money may, during the period of validity, ask the issuer to redeem it at par value in coins and bank notes or by a transfer to an account free of charges other than those strictly necessary to carry out that operation.
To me it is obvious that e-money thus covers the 100% forms of convertible fiat currencies. We are talking the days that each digital player would seek maximum acceptance of the public of any new forms of payments. Introducing a non-fiat-related digital currency would be a direct nogo in terms of usability and trust. So everyone would seek a digital equivalent of the existing fiat currencies and that is exactly what the e-money directive regulates.
When the second e-money directive came in and was aligned with the EU payments directive, it changed some of the structure and definitions. The ECB opinion as to redeemability remained unchanged, so in essence the rule is still there. E-money means a one-on-one converted form of existing fiat money. It would otherwise not make sense to have all kinds of monetary statistics, redeemability etc in place.
We must understand that at that time we were nowhere near the existence of worldwide consumer platforms with such inherent power to dictate an alternate currency alongside fiat currencies. And the idea to do so would be silly as anyone seeking to have a working internet-based e-money system would use the fiat currency to piggy back on the unit-of-account feature to increase the adoption of his own homebrewed e-money product.
But now we do have a worldwide platform that tries to issue a Libra. Given the EU e-money directive, the only reason this Libra would qualify as e-money is when it would be a 100% EU currency backing the Libra. As this is not the case, the Libra will not qualify as e-money.
2. Should we adapt the EU definition for e-money then?
In theory one could argue that the e-money definition needs adjustment in order to allow the Libra basket of currencies to be regulated. But this doesn’t make sense from a financial instruments/securities perspective.
Whenever you dilute a 100% currency basket in the users own currency towards a different asset base, you reform the token at hand into a investment basket. The user is exposed to an additional form of currency and counterparty risk, which does not exist when using the 100% e-money form. Of course the issuer of the financial instrument can proclaim the new asset base to be stable. Or almost stable, but the rules of the financial instrument game are different. If you issue such combinations of assets, you must warn the user of risks, assess whether he/she may be up to the investment/risks that they are taking and so on.
Not obliging Libra to have to do so would be creating an uneven playing field towards all kinds of other providers of financial instruments that equally seek to provide their financial services to customers via a similar asset package that can be bought in tiny portions. In addition, the monetary concerns involved in overissuance of the e-money product may go beyond the geography of the central banks involved as monetary authorities in the currency basket. Merely allowing a basket of currencies as backing for an e-money product would not be consistent with the ECB analysis on relevant monetary considerations and rules to ensure financial stability.
So, as stable as you may give your product a name or try to sell it to the public or regulators, all regulatory and market experts know that no currency basket will ever be stable. Effectively, suggesting the fact that it would be stable for the end-user would be mis-selling of the product, misleading the consumer and what have you. So name it stablecoin as you like, but it remains a risky participation in an investment fund/currency basket. And all rules under EU securities to such investments do apply. Meaning disclosure rules, but also rules as to who can trade/distribute this instrument. It will not at all be open to trade for everyone, without restrictions.
3. Does paying with Libra involve a payment instrument then?
Next up is the question what exactly qualifies as a payment instrument in the Libra setup. In my view the financial participation is a digital asset/financial instrument. And of course, if you wish, such an instrument could be used to pay. Rather than sending someone digital fiat currencies, the provision of the tradeable digital financial instrument would consist the payment. The payment with Libra would thereby be a payment in kind, as if I exchange a bread for a bottle of water.
So is there a payment instrument involved and where is it?
Next up is the question if we can see a payment instrument, a payment order and a payment transaction under the Payment Services Directive, leading to the placing, transferring or withdrawing of funds. I think the main idea in this respect is to take the intentions of Libra to serve as a worldwide payment system as a starting point. This means we will have to take a close look at the question if tools are provided to the user (yes) meaning those tools (wallets) may qualify as payment instruments, if they move funds, which are defined as:
banknotes and coins, scriptural money or electronic money as defined in point (2) of Article 2 of Directive 2009/110/EC;
If the Libra is not banknotes and coins nor eletronic money, we only have the wonder if it could qualify as scriptural money. But this is indeed where it becomes a bit complicated. As the ECB put it, when advising on the Payment Services Directive:
12.10 The term ‘scriptural money’ is used in the proposed directive without being defined, e.g. in Article 3(b), Article 4(8) of the proposed directive and paragraph 7 of the Annex to the proposed directive. It is suggested that a definition of scriptural money should be established (in the definitions article), bearing in mind that only central banks and credit institutions (which include e-money institutions) may hold such funds.
So we have two options. We could consider the Libra issued by Libra association to the Libra association members (who are all registered security companies, allowed to offer, trade and sell financial products to the public and each other) a form of scriptural money. This is not illogical, given the explicit intentions of the Libra association and it would require the regulatory flexibility to allow for a self issued unit of account / securities product to be viewed as a form of money.
The other option is of course to not view the Libra as scriptural money and not apply the Payment Services Directive to a payment instrument which has a worldwide scope and impact. Although this may sound illogical, it is not illogical at all. The apps and tools that are used to pass on the Libra to other consumers would still have to comply with all securities related regulations. Users would have to sign up, pass suitability tests, issuers, brokers and exchanges of the Libra would need to have their MIFID licenses and such, so the customer would still be protected.
The exercise does show however that the Libra association has had little consideration to the relevant EU requirements and definitions when choosing Switzerland as their jurisdiction. Their guess may have been that they might be able to convince the local regulator to bend the rules a little, but the choice of a currency basket (and financial instrument structure) effectively deters its worldwide inclusive use for cross-border payments. Alternatively, a choice for a single currency basket might work, which would make it regular e-money, to which the PSD and all kinds of KYC/AML rules apply. Yet, this would mean that there needs to be a single issuer in the business model, as the reselling of e-money is prohibited under the EU regulations.
It is this considerable ignorance of relevant EU rules that has made it clear to me that Libra and Facebook will at no point in time be able to make their business model work. A brief visit to any innovation hub at any central bank would have made the above inconsistencies clear, but they apparently chose to ignore this. And the reason may be that the Swiss policy papers on stablecoins may have provided them with the impression that there was some leeway here. But even the relevant local supervisor has explained to them that both securities and payments legislation applies and that their business model will not work.
Then again, this is Facebook, pushing and moving so why could they have been so wrong in their assessment?
My hunch is that Facebook have applied a US centric approach to the whole regulatory debate on issuance of stablecoins and forgot how the regulatory regimes between EU and US differ. But for that I refer to the PS.
My main conclusion for now is: Libra does not qualify as e-money and the transfer of Libra might constitute a payment transfer, depending on the view one has with respect to the application of the word scriptural money under todays context.
February 5, 2020
PS. Regulatory regimes for stablecoins (US) and e-money (EU)
To put this in perspective for US readers, I want to shed a regulatory light onto the difference between stablecoins and e-money and the relevance of 1990s legislative landscapes in the US en Europe with respect to payments. The background against which the e-money directive was being developed here in Europe, was one in which — just as now — all over the world, people were thinking about the best forms of regulation of a new phenomenom: e-cash: electronic cash or Internet cash.
At that point in time I worked for the Dutch central bank and I investigated the difference between the existing regulatory regimes in Europe and in the US payments (see the American Law Review article here). And the big thing to take away here is that:
- the US had both banking supervision laws and money transmission laws,
- Europe did not have money transmission laws and only bank supervision regulation (somewhat harmonized under EU rules).
The consequence of this difference is that the US regulators had a clear money transmission framework that they could use, to apply to new forms of Internet payments and digital coins. In essence they all proclaimed new internet payment stuff to be some fort of money transmission, either by their design or by their nature. And thus: the regulation of those new forms of payment was easily done. No change in laws was required.
In Europe, there was no uniform payment legislation on a European scale. Different member states had different local rules on payments. We had to have a euro in place and many years of deliberation before we even ended up with a harmonised Payment Services Directive in 2007. So we had no payments legislation but we did have some form of e-cash begging to be regulated somehow. As the ECB had clearly outlined its concerns in this respect.
So the fierce debate in Europe was: should e-money be considered the functional equivalent of banking?
The main reasoning was: upon issuance of an e-money token of 1 euro, the issuer receives one euro of the public. This means attracting deposits from the public, which is part of the banking definition. Whereas central banks and Ministries of Finance felt this way, the Ministries of Economic Affairs succeeded in convincing them that an intermediate, light-weight banking regime should be set up. So we got an E-money Directive, creating EU license regimes for organisations that issue electronic money to the public, upon receipt of regular fiat money, which electronic money is then used for all sorts of payments.
The digital e-money had to be issued and redeemed at a 1 on 1 level (at par) and the e-money organisation had to safeguard the full reserve in a separate financial vehicle (or insurance arrangement). No license would be given if the safeguards weren’t in place, so this means that the European e-money regime boils down to a regulatory regime which safeguards e-money. Or, what most US people would view as stablecoins (digital tokens, to be issued, traded, sold and transacted on the basis of an at-par rule with the original fiat currency).
Now back to the US. Initially the US payments regulation thus seemed well suited to adapt to new technologies. The birth of the bitcoin and other currencies created an issue. In essence, the US regulators didn’t care to define a separate token or form of e-money into their payments regulation. They just stated that virtual currencies were a form of currencies and hence the money transmission regulations should be in place somehow.
Therefore Tether and TrueUSD are registered with the Fincen, but without the legal European safeguards in place to guarantuee the peg. Then again the New York bitlicense regime does have those safeguards, but it is clear that no US regime for stablecoins exists. We can see that the US now lags in regulatory terms. It has fragmented state laws on payments, where EU caught up with harmonised payments legislation and harmonised e-money legislation. And the European e-money regime is essentially the unified EU stablecoin regime for tokens that seek a 1–1 peg with a fiat currency.