The missing legal framework for central bank digital currencies
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October 19, 2021 – Central banks around the world, including China, the United States and the United Kingdom, are actively considering adopting or creating their own central bank digital currency (CBDC). Geopolitical pressures are high, with China being far enough into testing that it plans to roll out this new currency to international visitors as early as the 2022 Winter Olympics in Beijing. Other countries, eager to embrace the “technological revolution”, are trying to be the first to adopt CBDCs. South Korea, Sweden, Cambodia, the Bahamas and Hong Kong are among the various countries with pilot programs. Jurisdictions such as the United States, the United Kingdom and the euro area are in the exploratory stage and risk being left behind if they do not act quickly.
CBDCs provide an opportunity for central banks to embrace the crypto revolution while retaining control of monetary policy by changing current frameworks and methods. CBDCs are not, and are not intended to be, just another electronic token that just happens to have been created by a central bank. Instead, they should be seen as their own kind of product, different in nature and under centralized control.
CBDCs benefit from some of the features of other crypto assets, including the ability to make instant transfers, or “delivery versus payment”, thereby reducing financial system risk by avoiding payment delays inherent in traditional fiat currency agreements. . Several central banks are already seeking to test these advantages for the international settlement of financial transactions. At the same time, the central bank’s element of control over CBDC’s issuance gives them a stability and predictability that is often lacking in crypto products.
Cryptocurrencies like Bitcoin are growing in popularity. Although China has banned these currencies, the situation is different elsewhere, with Bitcoin now being legal tender in El Salvador. However, for a currency controlled by a central bank, new devices will be necessary, the safety and financial soundness of which will have to be tested. The role of commercial banks and the traditional banking system could be affected. Respect for privacy is also taken into account, with centralized control and immutable recording of transactions raising sensitive questions relating to the collection and use of citizens’ data.
The most important concerns, however, are the law and regulations. Ideally, authorities would tackle, internationally, the critical unresolved issues of how to achieve clear legal and regulatory arrangements for CBDCs. However, there is currently no significant international agreement on these issues. The OECD and IOSCO have noted the lack of global consensus on the regulation of crypto tokens. There is a thoughtful discussion on how to regulate cryptocurrency issuers, and some countries, like Germany and Liechtenstein, are developing regulations for crypto trading. However, these national measures treat the issues in isolation, which is not the same as creating a global CBDC system that is functional and secure.
This leaves us with no agreement on what these forms of money really are and how they are regulated. Legal and regulatory systems can take very different views on how to deal with them, and the resulting confusion creates opacity and possible legal and regulatory challenges. Some countries may view the development of their own CBDCs as creating a competitive advantage over other countries, further undermining attempts for an agreed legal framework. As it stands, while a country may create a CBDC that operates within its current national legal regime – a task in itself – the inherent cross-border capabilities of CBDCs mean that a clear and international legal and regulatory channel has yet to be found. to enable their widespread adoption.
Fortunately, a lot can be accomplished under existing laws around the world. In the 1990s, the United States clarified the rules of the law of dematerialized securities. This provided clear rules for determining which system governed these securities, when the market shifted from paper to electronic form.
The result is a coherent global framework based on the location of the accounts in which the securities are held. A revised Article 8 of the Uniform Commercial Code facilitated the development and use of a system in which securities are held through one or more intermediaries, ultimately including a central depository such as the Depository Trust Company. (for most corporate securities) or the Federal Reserve (for US Treasury securities). A similar approach has been (though imperfectly) adopted in Europe and elsewhere, in a formulation known as Place de l’Approche Inter Intermediate Pertinent, or PRIMA; and PRIMA was largely provided for in the 2002 Hague Securities Convention.
The clarification of the applicable law has allowed the global conservation market to function safely. A New York bank may hold securities through a sub-custodian in Paris, for example, knowing that the interest that the New York bank holds in the asset on the books of the sub-custodian is subject to French law. This means that investors can cross civil and common law jurisdictions around the world, as there is an international understanding that the ownership of securities, and any treatment in the event of insolvency, will be determined solely by the law applicable to the intermediary who holds them.
CBDCs need similar legal certainty to be of great use to central banks or to interest traders and investors. Fortunately, it will be possible in some cases for the existing Article 8 and PRIMA regimes for securities to be used for CBDCs, particularly if CBDCs can be held in securities deposit accounts. As with dematerialized securities, the relevant legal provisions successfully address the main area of law that needs to be addressed: real estate law.
The successful implementation of this new arrangement will require central banks and financial regulators to adopt a three-pronged approach.
First, the central bank issuer should choose the law applicable to disputes regarding transactions in its CBDC. The temptation will be to design and implement a law that is based on political considerations, but which could prove to be counterproductive. Much of the success of a digital currency will be user-driven, meaning that any state control of commerce is likely to undermine trust and undermine the use of CBDCs, as users will embrace what works best for themselves.
For example, New York law or English law, which are already chosen as the laws governing financial trading contracts around the world, are both common law systems that have a proven track record of respecting intentions. parts and evolution to respond to new circumstances as they arise. Central bank issuers could choose this legal framework in order to build confidence in a successful business environment for their CBDC.
Second, the competent court must be chosen, which will generally be the same as the applicable law. The signatory countries of the 2005 Hague Convention (of which there are many, including the United Kingdom, the EU and Singapore) will recognize this choice of jurisdiction to settle disputes, as will the vast majority of national legal systems.
Third, if accounts are used, then property laws apply to the transfers in a manner that is generally based on the law of the jurisdiction of the intermediary where the seller’s account is located. This legal system should ensure that account details are updated once a judgment has been rendered by the selected jurisdiction on the validity of a transaction. In the event of insolvency, if CBDCs are transferred between parties and one party goes bankrupt, that party’s national court is usually responsible for determining which assets (or fractions of assets) belong to whom. In doing so, the starting point will be to look at the property rights registered on the account, governed by the legal regime governing the account.
Likewise, regulators divide their roles between those responsible for overseeing the seller, those who oversee the buyer, and those who regulate the company managing the securities account, with deference to one another.
This whole approach offers a practical option for the safe and widespread use of short-term CBDCs, avoiding having to persuade lawmakers and regulators around the world of the value of an unknown new system. Ancillary legal issues will of course still have to be explored. The central bank will want to control the money supply. It may also wish to have a central registry to determine ownership, although it is unlikely that it will have the administrative resources to maintain such a registry, especially given the in-depth anti-money laundering controls required in such a structure. . Instead, accounts could be held by local commercial banks, FinTech companies, or other vendors. A more sophisticated arrangement will likely be required for CBDC’s cross-border transactions, using existing custodial structures.
Building and relying on a system of bank deposit accounts can seem like going against the nature of crypto. However, resolving points of potential legal uncertainty and systemic risk, within the existing legal framework for conflict of laws, is a prerequisite for the future of CBDCs. Such an approach is essential if we are to ensure the safe international use of CBDCs, unleashing the benefits of central bank governance.
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