Digital Innovation in Financial Services: Legal Challenges and Regulatory Policy Issues

by Phoebus Athanassiou

Overview

Consumer behaviour is rapidly trending towards the use of digital devices as instruments through which to transact day-to-day business. This original and timely book shows how this trend creates new opportunities not only for retail consumers but also for financial service providers, regulators and central banks. The author offers a comprehensive overview of these opportunities and their countervailing legal and regulatory challenges.

The author describes and analyses in unprecedented detail the application of digital financial innovation (FinTech), and some of its core manifestations, including virtual currencies, Blockchain and distributed ledger technologies to the delivery of financial services, in areas such as:

• – payments;
• – securities clearing and settlement;
• – central banking;
• – real-time access to financial information;
• – instant completion of core financial transactions;
• – data validation and reconciliation processes; and
• – digital contracting (smart contracts).

Also clarified are the legal and other barriers to be overcome – including cybersecurity and risks to privacy – before any widespread adoption of digital innovation in the highly regulated financial sector context can occur.

As an informed assessment of the legal merits and risks of technological innovation for financial service providers and central banks, and as a contribution to establishing a conceptual framework within which to analyse and better understand the applications of digital innovation to the financial sector, this practical work is bound to be welcomed by legal practitioners and legal scholars alike with an interest in financial services. Policymakers and regulators will also appreciate its guidance on how to temper the less benevolent aspects of FinTech with targeted, risk-focused regulation, so as to promote innovation and preserve the potential benefits for financial markets and their participants alike.

Product Details

ISBN-13:	9789041187819
Publisher:	Wolters Kluwer
Publication date:	02/08/2018
Series:	International Banking and Finance Law Series
Pages:	288
Product dimensions:	6.30(w) x 9.80(h) x 0.80(d)

Table of Contents

About the Author vii

Preface xvii

List of Abbreviations and Acronyms xix

Acknowledgements xxiii

Chapter 1 Introduction: Digital Innovation in Financial Services - An Overview of Risks, Benefits and Use Cases 1

§1.01 FinTech and Its Promises 2

[A] The Consumer Perspective 3

[B] The Financial Institutions' and Service Providers' Perspective 3

[C] The Regulators' and Supervisors' Perspective 6

§1.02 FinTech: Risks and Challenges 7

[A] Headline Consumer and Investor Risks 7

[B] Headline Risks for Financial Institutions and Service Providers 8

[C] Regulatory Challenges: Highlights 10

§1.03 Headline Use Cases of FinTech: An Introduction 11

[A] Clearing and Settlement of Payments 12

[B] Securities Issuance, Trading and Post-trading 13

[C] Information Sharing 14

§1.04 Final Remarks and Scope of This Study 14

Chapter 2 DLTs, Blockchain and Distributed Ledgers: Scope, Definitions and Headline Legal and Regulatory Issues 19

§2.01 DLTs and Blockchain: Definitions, Possible Areas of Application and Key Strengths 19

[A] Prefatory Remarks 20

[B] Blockchain: The Archetypal DLT 21

[C] DLTs: Strengths, Weaknesses and Practical Limitations 22

§2.02 Distributed Ledgers 25

[A] Ledgers and Their Significance for the Contemporary Financial System 25

[B] Financial Intermediaries and Their Function in Modern Financial Markets 26

[C] Distribution 27

[D] Consensus Protocols and Security Features 30

§2.03 Recapitulative Remarks 32

§2.04 DLTs and Distributed Ledgers: High-Level Legal and Regulatory Issues 33

[A] Why, How and When to Regulate and Supervise DLTs and Distributed Ledgers 34

[1] Why Regulate DLTs and Distributed Ledgers? 34

[2] How to Regulate DLTs and Distributed Ledgers? 36

[3] When to Regulate DLTs and Distributed Ledgers? 39

[B] Legal and Regulatory Implications of the Use of DLTs for the Holding of Funds, the Issuance and Holding of Securities and the Settlement of Payments and Securities Transfers 40

[1] Legal Status of Assets Issued and Transactions Performed in a DLT Environment 41

[2] Asset Identification, Issuance and Segregation 41

[3] Settlement Finality in a DLT Environment 44

[4] Conflict of Laws 46

[5] Insolvency Proceedings 48

[6] Access to Central Bank Accounts and Liquidity 48

[7] Compliance with Legal and Regulatory Requirements 49

[C] Protection of Transactional and Other Data in a DLT Environment 50

[D] Legal Limits to Decentralisation 51

§2.05 Closing Remarks 53

Chapter 3 Cash and Cash Alternatives as Retail Payment Media: State of Play and Scope for Digital Innovation-Driven Alternatives 55

§3.01 Traditional Payment Media and Rails; Strengths and Weaknesses 56

[A] Cash 56

[B] Account-Linked Credit and Debit Cards 60

[C] Electronic Fund Transfers (Credit Transfers and Direct Debits) 61

[D] E-Money 62

[E] Online Payment Platforms 65

§3.02 Alternative Payment Providers: Overview of Services, Regulatory Status and Legal Issues 67

[A] Apple Pay, Google Wallet and Venmo: Overview of Main Features 68

[B] APPs and Headline Legal Issues 69

§3.03 Concluding Remarks: What Scope for Innovation in Payments? 72

Chapter 4 Virtual Currencies as Retail Payment Media: Core Legal Issues 75

§4.01 Definitions and Introductory Remarks 76

[A] On Bitcoin and the Bitcoin Network 78

[B] How Payments Are Made in Bitcoin 80

[C] Virtual Currency Networks and Validation/Consensus Protocols 81

§4.02 Virtual Currencies and Underlying Technologies: An Overview of User Benefits and Risks 82

§4.03 Virtual Currency Regulation in the EU and the US: General Overview 84

[A] Virtual Currencies under EU Law 84

[1] Virtual Currencies and PSD2 85

[2] Virtual Currencies under EMD2, AMLD4, CSDR and MiFID 86

[3] Interim Conclusions 88

[B] US Federal Legal Framework: Highlights 89

§4.04 Virtual Currencies: Core Legal and Regulatory Issues 92

[A]tVirtual Currencies: Fundamental Legal Nature and Characterisation 92

[1] Virtual Currencies as 'Money' or 'Currency': Bitcoin and Beyond 93

[2] Virtual Currencies as Property Rights 98

[3] Virtual Currencies as Mere Contractual Rights or Securities 101

[4] Virtual Currency Networks and Exchanges as FMIs 103

[B] Virtual Currency Networks: Regulatory Competence, Regulatory Compliance and Substantive Law Issues 107

§4.05 Concluding Remarks on Virtual Currencies, and the Prospect of Their Use as Payment Media 110

Chapter 5 Use Cases of Digital Innovation in the Financial Services Field: DLT-Enabled Smart Contracts, Instant Payments and Their Legal Aspects 115

§5.01 'Smart Contracts': Working Definition, Link to DLTs and Practical Examples 117

[A] Smart Contracts: Working Definition 117

[B] Modus Operandi and Financial Sector-Specific Use Cases of Smart Contracts 118

§5.02 Benefits of DLT-Enabled Smart Contracts 121

§5.03 Legal Nature of Smart Contracts 122

[A] Introductory Remarks 123

[B] Smart Contracts and the 'Code Is Law' Doctrine 124

[C] Substantive Law Considerations 128

[1] Intention to Create Legal Relations 128

[2] Certainty of Contractual Terms 130

[3] External Enforceability 131

[4] Impact of the Electronic Creation of Smart Contracts on Then Validity 132

[5] Interim Concluding Remarks 134

§5.04 Smart Contracts: Legal Challenges, Practical Questions and Possible Solutions 135

§5.05 Concluding Remarks on Smart Contracts 138

§5.06 Legal Issues Specific to Instant (or Faster) Retail Cashless Payments and Link to FinTech 139

[A] Introductory Remarks 139

[B] Advantages and Legal Challenges of Instant Payments 142

[C] Closing Remarks on Instant Payments 146

Chapter 6 DLTs and Their Application in Securities Issuance, Clearing and Settlement: Risks, Benefits and Legal Challenges 149

§6.01 Life Cycle of a Typical Securities Trade and Features of the Contemporary Securities Markets' 'Consensus Through Reconciliation' Model 151

[A] Introductory Remarks 151

[B] What Possible Applications for DLTs? 154

§6.02 DLTs and Their Use in the Initial Issuance of Public Securities 155

[A] Issuance of Securities and the Pivotal Role of Securities Accounts 156

[B] Main Areas of Concern with the Use of DLT for the Issuance of Securities 158

[C] Concluding Remarks 161

§6.03 DLTs and Their Use in the Trading of Public Securities 162

§6.04 DLTs and Their Use in the Clearing and Settlement of Transactions over Public Securities 163

[A] Prefatory Remarks 163

[B] Intermediaries Active in the Clearing Stage of Securities Transactions and Their Future in a DLT Environment; Netting and Its Relevance to Various Asset Classes 165

[C] Shortening of the Settlement Cycle: Opportunities and Undesirable Consequences 167

[D] DLTs, DvP Settlement and Access to Central Bank Money 169

[E] DLTs and Settlement Finality 170

§6.05 Other Uses of DLTs in the Public Securities Markets: Challenges, Opportunities and Deployment Prerequisites 172

[A] DLTs and Regulatory Reporting 172

[B] DLTs, Shareholder Transparency and Asset Servicing 174

[C] DLTs and Their Use in Collateral Management Purposes 175

[D] DLTs, Data Privacy, Cyber-Security and AML/CTF 176

§6.06 Concluding Remarks and Regulatory Considerations 177

Chapter 7 Digital Innovation, Central Banks and Monetary Policy: The Case of Central Bank-Issued Digital Currencies 181

§7.01 Why Would Central Banks Consider Issuing CBDCs? 184

[A] CBDCs: Distinguishing Features and Types 185

[B] What Rationales for the Issuance of CBDCs? An Overview 188

[C] Interim Conclusions 193

§7.02 CBDCs: Features and Means of Distribution and Holding 194

[A] CBDC Features: A Non-exhaustive Overview 195

[B] Means of Distribution and Holding of CBDCs 197

[C] CBDC: What Use for DLTs? 199

[1] Rationale for the Use of DLTs for the Issuance of CBDCs and Processing of Transactions over Them 199

[2] What Type of Distributed Ledger for the Issuance and Distribution of CBDCs, and for the Validation and Processing of Transactions OVCT Them? 201

§7.03 Core Legal Issues Relative to the Issuance of CBDC 203

[A] Requirements to Be Fulfilled for CBDCs to Qualify as General Legal Tender 203

[1] General Remarks 203

[2] Euroarea-Specific Remarks 204

[B] Legal Finality of CBDC Transfers 206

[C] Legal Issues Specific to Particular Types of CBDC 207

[D] Other Regulatory Issues 210

§7.04 Possible Role of Central Banks in Facilitating Access of DLT Platforms to Central Bank Money for Settlement Purposes 210

[A] Access to Central Bank Money for Private DLT Payment Platforms 211

[B] Access to Central Bank Money for DLT Securities Platforms 212

Chapter 8 Epilogue: Financial Services in the Twenty-First Century - What Future for DLTs, Blockchain and Virtual Currencies? 215

Glossary of Key Terms 225

Bibliography 231

Table of Cases 251

Table of Legal Acts 253

Index 257