Jamaica - Central Bank Regulatory Framework to Support ... · Central Bank Regulatory Framework to...

CentralBankRegulatoryFrameworktoSupportFinTech

inPaymentSystem

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13thConferenceofRegionalCentralBanksOperationsManagersTrinidadandTobago24th –26th April2018

NovelettePantonBankofJamaica

StatementsandopinionsexpressedhereinaresolelythoseofthespeakerandnotnecessarilythoseoftheBankofJamaica

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Outline

1. WhatisFintech?

2. PaymentSystemsFintechusecases

3. Definitions:• DLT• DigitalCurrency• Cryptocurrency

4. RegulatorytreatmentforFintech

5. Featuresofsandboxing

6. Sandboxingreportsinothercountries

7. BankofJamaica’sapproach

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Whatis‘FinTech’?

§ FinTech – Financial Technology

§ Broadly defined as rapid technological change or innovationapplied to financial services (Zetzsche, Buckley, Barberis &Arner, 2017)

§ A catchall term representing developments in the technologiesused to enable and support banking and financial servicesoften times in support of financial inclusion

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PaymentSystemUseCasesinFinTech

• UsesofFinTechinthepaymentsystems:• Posttradeoperations– DigitalLedgerTechnology

(DLT)tospeeduptradesettlement,specificallytheclearing,settlementandassetservicingcycle.• MoneyTransmission– (VirtualCurrency)• InnovativeLending– (P2P)

• SmartContracts– Selfexecutingdigitalcontractsconvertedtocodeusingblochain technologywithouttheserviceofanintermediary.• E.g.- DigitalLedgerTechnologyembeddedwithinsyndicatedloanstoreduceoperationalrisks,costsandtimeincurredinthevariousprocesses – BackOffice

• DLTcanbeusedtoachieverealtimecross-borderpaymentandsettlementOperations

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DefinitionsWhatisDLT?

• DLT(distributedledgertechnology,orblockchain)features:• Acontinuousand perpetualrecordofinformation;datainclude:

• Transactions• Contracts—somecanbeexecutedautomaticallybycontingenciesbeingmet

• Archive-typedata

• TherecordisheldinandcopiedinnumerousledgersthataremaintainedandupdatedbyoperatorsofnodesintheDLTnetwork

• Onlythosewithpermissionorrightstothedatacanuseitorgrantaccesstoothers

• Nodesarepointsofprocessingwhereinformationisexchangedandcompared

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DefinitionsThe“Rules”ofDLT

• Bydesign,thereisnocentraldatabaseorprocessingfacility• Allnodesareequal,hence,peer-to-peer

• Eachnewtransactionupdatestherecordaddingtothedata

• Thevectorofprocessingisforwardonly—”mistakes”requirea“next”transactiontomakeacorrection(i.e.,somebookkeepingrules)

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Takenfrom:DefiningFinTech:for2018andBeyond– RichardHeckinger 2018

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DefinitionsAWordRe-DigitalCurrencies?

• Digitalcurrency(digitalmoney,Cybercash)isapaymentmethodexistingonlyinelectronicform

• Digitalcurrencycanbetransferredbetweenentitiesandindividualswiththehelpoftechnologylikecomputers,smartphonesandtheinternet(Technopedia)

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• Mostofwhatisdeemedasmoney(e.g.,Euro,Dollars,Yen,Sterling)isindigitalform• Forexample,theU.S.economyis$18trillionperyear,yetitssupplyofnotesandcoinsincirculationisabout$1.6trillion(Heckinger,Richard2018)

• Mosttransactionsandbalancesareindigitalform• Paymentsofallkinds• Creditcards• Debitcards• Mobilephone• Moneycards

• DLTisbeingadoptedforusewithanydigitalcurrency

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• CentralbanksareinterestedinDLTforusewithexistingdigitalcurrencies• Paymentsystems• Supervisorydata

• CommercialbanksarestartingtouseDLT• Fortheirowndataprocessing• Collaboratively,creatingprivatenetworksforsettlingtransactions,netting,etc.,withorwithoutaprivatecryptocurrency

• Tosupporttheirowncryptocurrencyforusebycorrespondentsandcounterparties

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DefinitionsAWordRe- CryptoCurrencies?

• Crypto-currency– anyformofcurrencythatusuallyexistsdigitally,andthathasnocentralissuingorregulatingauthority,butinsteadusesadecentralizedcryptographicallysecuredsystemtorecordtransactions,managetheissuanceofnewunitsandpreventcounterfeitingandfraudulenttransactions.(Merriam-WebsterDictionary)

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• Cryptocurrencieschallengedefinitionof“money”• Almostanyonecancreateone;verylowbarrierstoentry• Acceptance,trust,securityandcommitmentarebigquestions

• RecallthatMoney,istraditionallydefinedas• Mediumofexchange• Storeofvalue• Aunitofaccount

• Ofcourse,moneyiswhateverweagreeitis;• oftendefinedas“LegalTender”tocreatesomecertaintyofacceptance

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• Desirablecharacteristicsofmoney• Availablebutreasonablyscarce• Relativelystableinvalue• Noteasytocounterfeitordegrade• Transportable• Fungible

• Thereisusuallyacertainamountofseigneurage thataccruestothesovereign(i.e.,theissuer),

• Over1500cryptocurrencies(asofMarch2018)

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DefinitionsCryptocurrencyvis-avis

DigitalCurrency?

Cryptocurrenciesandvirtualcurrenciesarecategoriesofdigitalcurrencies.

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PaymentSystemUseCasesinFinTech

• Different types of firms providing services

• Tech firms

• Existing non-bank financial firms

• Entrants from other industries (telcos, retail)

• Non-firm networks (Bitcoin)

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RegulatoryTreatmentforFinTech - Risk

Issues and challenges with FinTech:• FinTech & digital currencies particularly, are usually notspecifically regulated and do not fit easily into the existingregulatory framework and structures.

• The online and ‘borderless’ nature of these technologies posea challenge for regulation and regulators.

• Also, regulation naturally imposes costs on payment systemproviders and their intermediaries. The flipside is that digitalcurrency providers may benefit from not being subject tothese costs.

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• Risks posed by Fintech• Data Security and Privacy

• New firms who may not be competent at protecting sensitive information

• New structures/processes that may be inherently harder to secure

• Tradeoff between security and functionality

• Consumer Protection• New firms or methods create different risks• UDA(A)P (Unfair, Deceptive Acts & Practices)• Disparate Impact• Thinly capitalized firms

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• Systemic Risk• Impact on payments system• Impact of asset backed securities• Loss of resilience• Competitive and Concentration• What if only one “bank” wins • What if all banks use the same

vendors

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RegulatoryTreatmentforFinTech -Approaches

• Severalapproacheshavebeentakentoregulationthisnewwaveoftechnology:1. Information/moralsuasion– Publicwarnings;Investor/buyer

information;Researchpapers2. Regulationofspecificentities– Limitedsetofregulationsfor

specifictypesofentity(e.g.thosethatenableinteractionbetweendigitalcurrenciesandtraditionalpaymentinstrumentsand/ortherealeconomy)(record-keeping,reporting,prudentialmeasures,AML/TF- Examples:UnitedStates,France,Canada,Singapore,Sweden

3. Interpretationofexistingregulations– Applicationofregulationbasedon“interpretation”ofhowexistingframework(e.g.taxlawtreatment)maybeappliedtodigitalcurrenciesordigitalcurrencyintermediaries

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RegulatoryTreatmentforFinTech -Approaches

• Thereareseveralapproachestotheregulationofthisnewwaveoftechnology:4. Overallregulation– Dedicatedregulation,coveringallthree

aspects(consumerprotection,prudential/organizationalrulesforstakeholders,andspecificoperatingrulesaspaymentsystems)

5. Prohibition – Abanonspecificservices.Banondigitalcurrencyacceptancebyretailers;Banondigitalcurrency-basedfinancialinstruments(Example:China&Belgium);Banondigitalcurrencyexchangers;BanonBitcointransactionsbetweenbanks(Example:China&Mexico).

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RiskstoRegulation?

• Risks posed by regulation

1. Regulation can be ineffective at preventing risks

2. Regulation is the risk

• Suppress innovation• Deny access• Stifle competition• Distort Markets

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RiskstoRegulation?• FINTECH – Why might regulation fail?

• Risks to effective regulation1. Poor Regulatory Structure

§ Forcing square pegs into round holes§ Too many (or too few) cooks in the kitchen

§ Fractured Regulatory Environment§ Not the right type of authority

2. Regulation Lagging Innovation• Takes a while to pass laws/promulgate regulations• Need to assess the issue before government acts• Compounding innovation• Innovation responds to regulatory impediments

(Life finds a way)

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RiskstoRegulation?

3. Lack of Expertise or Resources• Different skill sets/tools needed• Staying up to date isn’t cheap• It isn’t your only job

4. Politics

• Politics can move slowly• What is popular isn’t always right• Special interests and regulatory capture

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RiskstoRegulation?Whatcanbedone?

•• Engagement• Experimentation• Reevaluation of current

regulation/regulatory structure• Revisiting regulation over time

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RegulatoryTreatmentforFinTech:Sandboxing

• The globally accepted strategy for dealing with FinTech is‘sandboxing’.

• Sandboxing is not new, simply put it’s a pilot project:• The word sandbox originally referred to the small box filled withsand where children play and experiment in a controlledenvironment.

• In the computer science world, a sandbox is a closed testingenvironment designed for experimenting safely with web orsoftware projects.

• In the FinTech world, it is a testing ground for new businessmodels and products that face unique relationships with currentregulation and regulatory institutions.

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FeaturesofaSandbox• Each country’s Regulatory Sandbox has unique features.• UK Sandbox Diagram:

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Sandbox:Features(1)

• Broadly speaking, each jurisdiction has a criteria for use, whichforms a part of the entry test:1. Scope of the applicant firm: Does it support the financial

ecosystem?2. Consumer benefit: Is there a benefit?3. Objective of testing: Why should it be tested here?4. Genuine innovation5. Applicant firm background research: What research have you

done?6. Testing plan: How do you plan to test your innovation?

• All of which are submitted to the regulators for approval.

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Sandbox:Features(2)

• Regulators then request applicant firms to assess their levelsof risk to see whether the product or service enhances:• market stability;• market transparency; or• a company‘s processes to protect clients, consumers,counterparties and the broader financial system.

• This helps determine the utility of the innovation within thesandbox, or whether it is already covered in existingregulation.

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Sandbox:Features(3)

• Regulators then act to:• Apply sectorial restrictions on the participant• Restrict the interaction with target customers (Example: HongKong Monetary Authority’s sandbox is open for services targeting“staff members or focus groups of selected customers”, while theMonetary Authority of Singapore (MAS) allows the applicant tochoose the type of customer, and the Australian Securities andInvestments Commission (ASIC) and the Mauritius InvestmentBoard deem services offered to retail and wholesale clientseligible).• The more that retail clients comprise the focus of the FinTech, themore restrictions regulators have imposed as the type of customershas to be appropriate to the tested products and to the exposedrisks.

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Sandbox:Features(4)

• Regulators then act to:

• Determine the time and size the firm is allowed to operate in theSandbox. For example:

• Duration: 6, 12 or 24 months + Extensions; or

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Sandbox:Features–MandatoryProvisions

• Of particular note are the mandatory provisions which formthe minimum requirements to access.1. licensing fees;2. an entity’s capital requirements;3. leadership requirements;4. credit rating and relative size;5. financial soundness;6. risk management;7. confidentiality of customer information;8. management’s fitness;9. handling of customers’ monies and assets by intermediaries;10. AML/CTF measures.

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11. audit requirement;12. know-your-client requirements;13. suitability requirements;14. dispute resolution requirements;15. certain disclosure and reporting requirements;16. the requirement to issue and distribute a prospectus

Each country determines which requirement(s) may be waivedfor participation.

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• Sandbox rules typically specify the grounds upon which towithdraw the privilege. Reasons for forced exit from thesandbox include:1. risks exceeding the benefits;2. non-compliance with laws or regulatory impositions; and3. the purpose of being in the sandbox not being achieved.

• Note: The true value lies in the substance of the sandbox,which is the extent to which it can promote beneficialinnovation based upon an in-depth knowledge exchangebetween innovator and regulator.

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Sandbox:CountriesThereareanumberofcountrieswithasandboxinoperation:1. UK2. HongKong3. Malaysia4. Singapore5. AbuDhabi6. Australia7. Mauritius8. Netherlands9. Indonesia10. Brunei-Darussalam11. Canada12. Thailand13. Bahrain14. Switzerland

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CountryReportsonSandbox:UnitedKingdom

• The sandbox is open to authorized firms, unauthorized firmsthat require authorization and technology businesses. Thesandbox seeks to provide firms with:a) The ability to test products and services in a controlled

environment;b) Reduced time-to-market at potentially lower cost;c) Support in identifying appropriate consumer protection

safeguards to build into new products and services;d) Access to finance.

• The sandbox also offers tools such as restricted authorization,individual guidance, waivers and no enforcement actionletters.

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• Participants have used the sandbox to test a range of businessmodels involving different technologies including onlineplatforms, biometrics etc. However, distributed ledgertechnology (DLT) has been the most popular technology (some17 different propositions).

• The Financial Conduct Authority (FCA) reports that it hashelped reduce the time and cost of getting new, innovative,ideas to market.

• In addition, the sandbox has helped FinTech firms gain accessto finance – according to the FCA, at least 40% of firms in thefirst cohort received investment either during or followingsandbox testing.

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• The FCA also identifies challenges encountered by somesandbox participants, in particular, the difficulties in obtainingkey banking services, particularly firms wishing to leverage DLTto become payment institutions, or electronic moneyinstitutions.

• The FCA concludes that the sandbox was the right step in theright direction.

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BankofJamaica’sApproach

• TheBankofJamaicahasbegunitsFinTechregulatoryjourneycommencingwith:

1. PublicAwarenessStatement;2. FintechSurvey;3. SettingupSandboxArrangement;and4. ProvideinformationonapplicationsreceivedbyBankof

Jamaica.

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ApplicationAssessment

andReporting

SandboxDevelopmentCollaborationBuilding

Awareness

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BankofJamaica’sApproach:PublicAwarenessStatement

• BankofJamaica’spublicawarenessstatementadvisesthepublic:• VirtualcurrenciesarenotlegaltenderinJamaica;

• BankofJamaicadoesnotregulateorsupervisevirtualcurrencies;

• BankofJamaicahasnotauthorizedanyentitytooperateavirtualcurrencyplatform.

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BankofJamaica’sApproach:Survey

• The Bank of Jamaica chairs and is represented at theCARICOM FinTech Work Group and recently participated in asurvey on digital currency.

• CARICOM Fintech Work Group fosters collaboration, buildcapacity and information sharing among CaribbeanCountries.

• Our response to the recent survey on digital currencyshared information on Jamaica’s experience with digital inthe categories of:• The legal and regulatory framework;• Information on proposals;• Issues and challenges faced when dealing with digital currency.

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BankofJamaica’sApproach:Sandbox

InsettinguptheBankofJamaicasandboxarrangementsthefollowingtenstepprocesswasimplemented:1. ApprovalofsandboxfromSeniorManagement2. Developgovernancearrangements3. SetupanInternalFintechWorkGroupforassessments4. DraftedGuidelinesforSandbox5. Developmentofoperationalproceduresforassessment6. Authorizationforpilotingofapplications7. Pilotassessment8. ApprovalorrevocationofFinTechapplicants9. Publishapprovedentities10. Reportonsandboxapplicantsandapprovedproducts

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BankofJamaica’sApproach:ApplicantsReceived

To-date the Bank of Jamaica received proposals and requests forclarification, position and information on FinTech. Some of theapplications received by the Bank of Jamaica include:1. Cryptocurrency2. CentralBankDigitalCurrency3. DigitalJamaicaDollarandDigitalWallet4. DigitalCurrencyExchange5. SecuritiesBlockchain Platform6. CryptocurrencyTrading7. KYCDatabase8. TokenIssuance

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ACKNOWLEDGEMENT

THIS DISCUSSION BENEFITTED FROM PRESENTATIONS MADE AT THE SEMINAR: “FINTECH OPPORTUNITIES AND CHALLENGES IN PAYMENT SYSTEMS”

CENTRAL BANKING TRAINING SERIES WINDSOR 2018 – CUMBERLAND LODGE WINDSOR

IN PARTICULAR:FINTECH: RISK AND REGULATIONBRIAN KNIGHTSENIOR RESEARCH FELLOWMERCAUTUS CENTREGEORGE MASON UNIVERSITY

DEFINING FINTECH: FOR 2018 AND BEYONDRICHARD HECKINGERVICE PRESIDENT & SENIOR POLICY ADVISOR, FINANCIAL MARKETS GROUP, FEDERALRESERVE BANK OF CHICAGO (RETIRED)

NEW APPROACHES IN UNDERSTANDING AND SUPERVISING DIGITALCURRENCIESCORDELIA KAFETZHEAD, FINTECH HUB,BANK OF ENGLAND

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FINALE

Thankyouforparticipating.

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44NovelettePantonBankofJamaicaNethersolePlaceKingstonJamaicanovelette.panton@boj.org.jm

13th ConferenceofRegionalCentralBanksOperationsManagersTrinidadandTobago24th – 26th April2018

Jamaica - Central Bank Regulatory Framework to Support ... · Central Bank Regulatory Framework to...

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