On Friday,
the European Banking Authority advised EU national financial regulators to "discourage" credit institutions (banks), payment institutions and e-money institutions from buying, holding or selling virtual currencies, based on over 70 risks that it says will require substantial regulation. The EBA says that should include bringing virtual currency exchanges which deal between virtual and actual currencies within the anti-money laundering regime.
Somewhat cryptically, the EBA concludes:
"Other things being equal, this immediate response will allow VC schemes to innovate and develop outside of the financial services sector, including the development of solutions that would satisfy regulatory demands of the kind specified above. The immediate response would also still allow financial institutions to maintain, for example, a current account relationship with businesses active in the field of VCs."
But there are many flaws in the EBA’s approach, and it undermines the EU’s potential as a home for financial services innovation. A lot more work should have
been done - and the EBA should have engaged with the market participants
publicly and constructively - before taking such disruptive action. Especially given that those
participants (including venture capitalists
and possibly financial institutions) should have a legitimate
expectation to be able to continue their lawful involvement, unless the
law is changed by the usual process.
The EBA concedes as much by saying that it
is too early to collect enough data to understand exactly what they are "shielding" financial institutions from:
"...the phenomenon of [virtual
currencies] being assessed has not existed for a sufficient amount of
time for there to be quantitative evidence available of the existing
risks, nor is this of the quality required for a robust ranking."
So what is the basis for intervening in this way now? Gut instinct?
There
is obvious duplication and overlap amongst the risks identified and
many “are similar, if not identical, to risks arising from conventional
financial services or products, such as payment services or investment
products”, as are the regulatory controls that are suggested for the
longer term. Key benefits of virtual currencies are also dismissed in
the context of the EU and Eurozone on the basis of regulations that are
yet to take effect.
Oddly,
the EBA points to a risk that
regulating virtual currencies more leniently will create an unequal
playing field that could result in service providers leaving fiat
currency markets in favour of their virtual cousins. Surely that risk is heightened
by denying financial institutions early access to virtual markets
altogether. Has the EBA learned nothing from the
rise of shadow banking?
Won't this breed weak regulated institutions? Won't entrepreneurs
simply operate outside the EU, leaving its institutions unable to capitalise on opportunities that virtual currencies might have brought?
And why would the EU want to discourage
borderless financial services while it's trying so hard to kickstart
cross-border commerce?
A requirement for fully comprehensive regulation cannot be the price of institutional participation in virtual currency markets. There is a flawed belief amongst Eurocrats that ‘vigorous regulation’ is a pre-condition for consumer trust,
as Paul Nemitz recently asserted. But that is not supported by the way in which the digital economy has evolved. Regulation can help build on existing trust, but cannot create trust where none existed before. This difference between the civil law and common law view of the role of regulation needs to be resolved in favour of a more acommodating EU approach to innovation and competition if the EU member states are to compete globally. For instance, the UK Cabinet Office convened a
workshop on financial innovation in October 2013, which featured a session on virtual currencies; and UK revenue officials were helpful in merely
clarifying their tax treatment of virtual currencies earlier this year. More recently,
the Financial Action Taskforce (FATF) was also much more circumspect in a report that was intended to “stimulate a discussion” on how to introduce risk-based anti-money laundering controls in the context of virtual currencies.
