[co-authors: Richard Jones, Ruth Fairhurst, and Trevor Dolan, Eversheds Sutherland (International) LLP Team]
Upcoming global developments for the payment sector
Payment sector on the horizon: What do I need to know?
1. Hong Kong: Launch of Phase 2 of the e-Hong Kong Dollar Pilot Programme
On September 23, 2024, the Hong Kong Monetary Authority (HKMA) announced the start of Phase 2 of the e-Hong Kong Dollar (e-HKD) Pilot Programme (now called ‘Project e-HKD+’) to explore innovative uses for digital money like e-HKD and tokenised deposits that can be used by individuals and businesses.
Under Phase 2, selected firms from different sectors will explore innovative use cases for digital money across three themes: settlement of tokenised assets, programmability, and offline payments. The HKMA has also set up an e-HKD Industry Forum allowing entities to discuss common issues and explore ways to adopt and implement digital money.
Impact: Phase 2 will help the HKMA understand the real-world challenges of creating and running a digital money ecosystem that includes both public and private digital currencies. Pilot participants will be able to access the e-HKD sandbox to accelerate prototyping, development and testing of use cases. The HKMA will work closely with the selected firms in the next year or so under Phase 2 – its aim will be to share the key learnings from Phase 2 with the public by the end of 2025.
2. Hong Kong: Launch of the Project Ensemble Sandbox
On August 28, 2024, the Hong Kong Monetary Authority (HKMA) announced the launch of the Project Ensemble Sandbox (Sandbox) to accelerate asset tokenisation. It has introduced four main themes of asset tokenisation use cases in the initial round of experimentation: fixed income and investment funds, liquidity management, green and sustainable finance, and trade and supply chain finance. Participating banks have linked their tokenised deposit platforms to the Sandbox, enabling them to experiment with interbank payment-versus-payment and delivery-versus-payment settlement.
As a crucial architect of Hong Kong’s financial market, the Securities and Futures Commission will be crafting a regulatory framework to ensure the sustainable growth of Hong Kong’s tokenised asset market. Globally, HKMA will also explore collaboration with BIS Innovation Hub Hong Kong Centre on various themes and engage the CBDC Expert Group to utilise their expertise in advancing the Sandbox.
Impact: The launch of the Sandbox will support Phase 2 of the e-HKD Pilot Programme as mentioned above. It is a significant step for HKMA and the industry in exploring real-world applications of tokenisation.
3. Singapore: Central bank partners with banks and tech firms on quantum security
On August 14, 2024, the Monetary Authority of Singapore (MAS) signed a Memorandum of Understanding (MoU) with banks and tech partners to strengthen the financial sector against cybersecurity threats from quantum computing.
This follows on from MAS’s commitment to allocate an additional S$100 million for quantum and AI technologies.
Under this MoU, MAS and the participants will conduct proof-of-concept trials using Quantum Key Distribution (QKD) technology to test its effectiveness in securing financial communications. The trials will test QKD to make sure it can detect if someone is eavesdropping on communication and prevent unauthorised access to the data, checking if QKD can provide a higher level of security for sensitive information.
The MoU also highlights the importance of sharing knowledge to help the financial sector get ready for quantum security solutions. The goal is to improve technical skills needed to implement and manage secure communications that are resistant to quantum computing threats.
Impact: Quantum computing could disrupt current encryption methods, posing a major cyber security threat. In response, MAS is supporting the adoption of quantum security technologies in financial services. The proof-of-concept trials will help MAS and financial firms understand QKD’s impact and address challenges early. These trials will also shape technology and cyber risk management policies for quantum-proofing financial systems.
4. European Central Bank’s speech on role of digital euro in EU payments
On September 23, 2024, the European Central Bank (ECB) released a speech given by a member of its Executive Board relating to an update on the status of the digital euro project. Other matters discussed were Europe’s dependence on foreign players for retail payments and the benefits of a digital euro.
Key highlights of the speech:
- The problem of foreign dominance in the European payment landscape can be addressed by creating a strong European digital payments system with the introduction of a digital euro.
- The Single Currency Package, ensuring wide acceptance of cash and paving the way for a digital euro, will benefit European citizens, banks, and merchants.
- The project preparation phase will take several years to ensure all banks and merchants can adopt the digital euro.
The ECB is mid-way through its preparation phase of the digital euro project with one more year to go. One of its key focus areas is to develop a methodology to determine the maximum number of digital euro a person could hold at any one time (exact holding limits are yet to be determined). It is also working on a rulebook setting out rules and standards to ensure a consistent user experience across the euro area.
Impact: Swift action and coordination between legislators and the central bank are needed to maintain Europe’s leadership in digital currencies. The ECB has committed to work with stakeholders and offer technical support to ensure the digital euro strengthens financial sovereignty and benefits citizens. Banks will be significantly impacted by the introduction of the digital euro. Among other things, they can expect to integrate it into their payment processes and offer consumers the opportunity to buy digital euros.
5. Research findings on consumer demand for central bank digital currency
On September 18, 2024, the European Central Bank (ECB) published a bulletin examining consumer demand for central bank digital currency (CBDC) as a payment method. The bulletin explores factors that could potentially increase demand for CBDCs.
Some key findings are:
- Consumers might initially favour traditional payment methods over CBDCs. However, if CBDCs are designed to meet consumers’ specific needs, their adoption could increase significantly. Increasing public awareness about CBDCs and leveraging network effects (where the value of the currency increases as more people use it) could further boost demand for CBDCs. A well-designed CBDC that meets consumer needs is likely to see higher adoption and regular use.
- Central banks are exploring and developing CBDCs alongside traditional cash. This is in response to the decline in cash usage and the rise of digital payment methods.
- Introducing a new payment method involves costs for consumers, not just in terms of money but also the effort, time, and adjustments needed to adapt. Many consumers prefer familiar, less complex payment methods like cash and cards.
Impact: We anticipate that the development of CBDCs will be a slow and gradual process, requiring time to fully address consumer demands. Various models of CBDCs are being tested worldwide, each at different stages of piloting. This diversity in adoption indicates that interest in digital currencies continues to grow.
6. Firms and Bank for International Settlements to explore tokenisation for improving wholesale cross-border payments
On September 16, 2024, the Bank for International Settlements selected over forty private sector firms to join Project Agorá, which aims to test how tokenised deposits can be combined with wholesale cross-border payments to simplify payments and cross-border payments. The selected private sector firms include many large banks and non-banks.
Project Agorá aims to improve efficiency by allowing all participants to complete steps like anti-money laundering and information checks at the same time as using smart contracts. Cost efficiency and speed are the goals, expected to be achieved by eliminating repetitive financial integrity checks.
Impact: The project’s lessons may pave the way for new financial market infrastructure for cross-border payments using new technology. BIS Innovation Hub projects are experimental, and so the impact and outcomes remain unpredictable and unknown. A project report, expected by the end of 2025, will detail the prototype’s design, testing process, and analyse legal and regulatory issues across seven jurisdictions.
7. Report on cyber resilience of central bank digital currency ecosystem
On August 27, 2024, the International Monetary Fund (IMF) issued a report on the cyber resilience of central bank digital currency (CBDC) ecosystems. The report discusses the safety and stability of CBDC, and the difficulties involved in creating a cyber-resilient CBDC ecosystem. This ecosystem would include new technologies like distributed ledgers, digital wallets, smart contracts, and various technology options to support offline functionalities.
The report suggests that central banks can enhance CBDC data use by implementing strong accountability, transparency, and privacy-by-design principles, including privacy-enhancing technology.
Impact: The report points out that commitment to implementing a CBDC allows central banks to upgrade outdated IT systems with future-proof technologies like quantum-resistant cryptography, air-gapped data centers, mutable tokens, secure hardware, secure coding, and enhanced identity and access controls. Other priorities such as effective project management and ongoing staff training are also essential for successful CBDC development and deployment. The report concludes that while technologies like distributed ledgers, digital wallets, and smart contracts offer promising benefits for transaction efficiency and capabilities, they also bring complex security challenges. Current experiments have not yet provided enough insights to create specific frameworks for resilient CBDC designs. But current initiatives (such as Project Sela) show promise and will be used to inform future updates.
8. Update to maximum reimbursement limit for authorised push payment scams
On October 2, 2024, the Payment Systems Regulator (PSR) issued its full policy statement confirming its decision to reduce the maximum reimbursement limit for victims of Authorised Push Payment (APP) scams, effective from October 7, 2024. The maximum reimbursement limit for Faster Payments will be £85,000, down from the original limit of £415,000.
- Consumers with APP scam claims over £85,000 can still complain to their payment service providers (PSPs) and, if unsatisfied, escalate to the Financial Ombudsman Service (FOS) or courts. The FOS can apply higher award limits for other complaints, such as those under the Consumer Duty.
The Bank of England (BoE), managing CHAPS, has also set a maximum claim limit of £85,000 for CHAPS APP scams. This decision considers feedback and aims to benefit both industry and consumers by maintaining consistent limits. The BoE is committed to reviewing this limit within 12 months.
Impact: The industry has generally considered the APP scams reimbursement rules to be controversial. The PSR’s last-minute decision to lower the reimbursement limit from £415,000 to £85,000 has eased some tension, but concerns remain about the financial burdens. If they have not done so already, firms must update their communication correspondence referring to the new maximum limit. The PSR points out that the £85,000 limit, compared to £415,000, still incentivizes PSPs to prevent APP fraud and invest in anti-fraud measures. The PSR will keep the new limit under review.
9. Changes made to the safeguarding regime for payments and e-money firms
On September 25, 2024, the Financial Conduct Authority (FCA) issued a consultation on its proposed changes to how payments and e-money firms safeguard customer funds.
The current rules for safeguarding are detailed in the Payment Services Regulations 2017 and the Electronic Money Regulations 2011 and are bolstered by guidance issued by the FCA. The FCA wants to address weaknesses in the current approach and ensure that customer money is safe.
The consultation proposes the following changes:
- The introduction of interim rules with an aim to enhance the existing safeguarding rules (including imposing additional record-keeping, reporting and monitoring requirements); and
- End state rules which will move the safeguarding regime towards a statutory trust-based regime, much the same as the client money regime contained in the FCA’s Client Assets Sourcebook.
Impact: The consultation closes on December 17, 2024. The FCA plans to publish its final interim rules with an accompanying policy statement within the first six months of 2025. After this, firms will have six months to implement the new interim rules. Firms should start planning and making necessary structural changes now to be ready to meet these new requirements. Read our briefing for more information.
10. Bank regulators warn of third-party deposit risks
On July 24, 2024, federal bank regulatory agencies reminded banks of potential risks associated with third-party arrangements to deliver bank products and services. They support innovation but highlight concerns related to safety, compliance, and consumer protection.
- They point out that many banks increasingly partner with third parties to offer deposit products and services, such as checking and savings accounts, to customers. These partnerships help banks increase revenue, gather more deposits, expand their reach, and leverage new technologies. In these arrangements, third parties often manage records, process payments, and ensure regulatory compliance. Despite outsourcing these tasks, banks remain responsible for complying with all relevant laws and regulations.
- The agencies set out examples of effective risk management practices when managing third-party arrangements. Banks should, among other things:
- implement clear policies, procedures, and internal controls to manage risks;
- identify and analyze risks for each third-party arrangement to ensure controls are effective;
- understand the management information systems used by third parties;
- have risk-based plans to address potential third-party disruptions; and
- set limits and strategies for concentration, diversification, liquidity risk, and capital adequacy.
Impact: The number and complexity of these third-party arrangements have grown, making banks more dependent on these partnerships. Banks can expect further risk management and compliance oversight from federal regulators as they continue to stress the importance of managing associated risks. Although the agencies’ statement is not legally binding, it reflects current regulatory views and will likely influence future supervisory examinations. Banks should consider these recommendations, document their compliance efforts, and follow binding regulations.
Co-authored by Kirath Bharya, supported by Jonathan Botham (Knowledge).
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