On the 28 June 2023 the EU Commission will release a bumper package of legislative proposals impacting financial services - PSD3, open finance and a legislative proposal for a digital euro. The Digital Euro proposal was expected in late May 2023 but is now expected to be published alongside these other financial services laws.The Digital euro proposal will support the EU agenda for digital finance and retail payments given its potential as another innovative and safe means of payment. The proposal follows public consultation by both the EU Commission (2022) and the European Central Bank (ECB) (2021)) and the investigative phase undertaken by the ECB that will determine the decision taken at the ECB Board in October this year.
The proposal will be for a Regulation[1] as opposed to a Directive[2], with the aim to “establish and regulate essential aspects of the digital euro as a new form of central bank money, which could be issued by the European Central Bank / Eurosystem alongside banknotes and coins”[3].
Below are some thoughts on the topics that may be or should be considered in the proposal and/or provided for in Level 2 mandates to the EBA.
- Legal Tender - a terms widely used but rarely understood. Within the EU, the legal tender status of EU bank notes and coin is enshrined in Article 128 TFEU. The EU framework for legal tender it set out in the Commission Recommendation on the scope and effect of legal tender of euro bank notes and coins [4]. The recommendation sought to establish, at an EU level certainty on the scope of legal tender status across the EU. To clarify the legal tender status of euro notes and coins, the Commission is expected to also publish a proposal for a Regulation that should also address the legal status of a digital euro. It would be practical for the digital euro will have the same legal tender status as notes and coins.
- Mandate – Article 128 of the Treaty on the Functioning of the European Union (TFEU) gives the ECB and eurozone central banks the power to issue euro notes and coins. It does not give a power to issue a digital form of EU money. The Eurosystem will need a mandate to issue a digital euro.
- Participants in Distribution of a Digital Euro – in the EU today central bank money in the hands of consumers (cash) is distributed by commercial banks. It is not possible for payment and e-money institutions to participate in the distribution of cash. The ECB has stated that it envisages non-bank firms, including both payment and e-money institutions, to participate in the distribution of a digital euro. This means that there will need to be a framework that allows non-bank firms access to central bank money and access to accounts held with a central bank.
- Participation in a Digital Euro payment system – payment and e-money institutions are not able to directly participate in the traditional EU payment systems that are designated for settlement finality, due to a restriction in the Settlement Finality Directive (SFD)[5]. As it stands, therefore, if the ECB wants payment and e-money institutions to participate in a digital euro payment system, then such a system could not at this time be designated as systemically important. It is expected that the proposal for PSD3 will address revision to the SFD, so if the stars align then it may be possible for a digital euro payment system to be designed for SFD and to allow for participation by payment and e-money firms.
- Settlement Finality - Settlement finality seeks to reduce the systemic risk associated with participation in payment systems, and the risk linked to the insolvency of a participant in such a system by specifying that transfer orders which enter the payment system are not reversible after a at a set point in time. In most jurisdictions, settlement finality applies to systemically important payment systems and to the participants in those payment systems.
A digital euro will settle instantly in risk free money. A digital euro payment does not create a risk of non-settlement arising from the insolvency of the commercial bank, because it is not a commercial bank liability. There are however two additional matters for consideration:
- How will settlement for offline transactions be addressed? The ECB is considering the use of tokens for offline payments so these could settle like cash, when ownership passes from one person to another.
- What provisions will be in place for how the ‘wallet’ or the digital euro in a ‘wallet’ are transferred from one provider to another in an insolvency situation?
- Authorisation - firms that participate in payment systems and have access to central money do so based on the regulatory authorisation that they hold (like a commercial bank). In addition to this, firms provide payment services based on the permissions that they hold for specific activities. The proposal will therefore need to address what more, if anything, will be added to authorisation requirements so that central banks are comfortable for non-bank firms to access central bank money and what new permissions may be needed for the provision of services in digital euro – for example, will distribution of digital euro be a regulated activity. We can only wait and see.
- Open Banking – given the synergy required between PSD3 and the digital euro proposal, one hopes there will be alignment on access to account requirements for open banking.
- Liability – a digital euro is a direct liability on a central bank (like cash). Today if you lose your cash, you do not go to the central bank to be made good. Unlike cash, a digital euro will be held in a ‘wallet’ provided by commercial bank or other provider, so if the digital euro is lost (due to a fraud or cyberattack) will the commercial bank be liable?
- Consumer protection – liability is if course also linked to consumer protection. PSD2 - and we assume PSD3 - will continue to provide protection for payments, fraud and unauthorised transactions. Other measures are also on the horizon for authorised push payment fraud[6]. These protections currently exist as wrappers around commercial bank money; how will they be provided for central bank money?
- Privacy – the ECB has taken the position that full anonymity is not possible or the preferred outcome with respect to transactions in digital euro. It also does not want access to consumer personal data, but it will be settling transactions made in digital euro. This preferred structure will need to have the appropriate data protection provisions in place to meet the both expectation of the ECB and the expectations of the consumers and general public who have placed privacy high on the list of attributes for a digital euro.,
- The legal relationships between the parties – this is a tricky one and will likely form the basis of how consumer protection and liability are ultimately structured. It will be important for there to be clarity on the legal nature of the tripartite relationship between the central bank, the intermediary, and the end user.
Countries across the globe are considering the issuance of a central bank digital currency (CBDC). The Digital Euro proposal when published will be read, commented on, and criticized. Whatever the final text it will set a benchmark for all countries that issue a CBDC.
I would like to thank Jannah Patchay for her thoughts on this blog.
About the Author
Nilixa is the founder of Payments Solved, a regulatory consultancy advising on the regulatory framework for CBDC, crypto assets, open banking, and payment services both in the UK and globally. Nilixa is a lawyer by training and an experienced regulatory expert with a Masters in European Competition Law and over 20 years of banking and payments experience gained from her time at Barclays, the Financial Conduct Authority, the European Banking Authority, and the Open Banking Implementation Entity. Nilixa is a member of the ECB Digital Euro Market Advisory Group and the European Payment Systems Market Expert Group. Nilixa works with industry, regulators, and legislators to drive changes in the financial services ecosystem for outcomes that support secure, transparent, and inclusive financial services. Nilixa is also a well-known public speaker, Chair of the Open Finance Association and a contributing member of the Digital Euro Association and the Digital Pound Foundation.
This article was prepared by the author/s. The views expressed in this article are the author’s own and do not necessarily reflect the views of the Digital Euro Association.
Footnotes
[1] A regulation is a binding legislative act. It must be applied in its entirety across the EU
[2]A directive is a legislative act that sets out a goal that all EU countries must achieve. However, it is up to the individual countries to devise their own laws on how to reach these goals.
[3] https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13392-A-digital-euro-for-the-EU_en
[4] A Recommendation is a non-binding EU Act.
[5] There is currently a sizeable lobbing effort for changes to the SFD
[6] In the Instant Payments Regulation