Libra must overcome regulatory challenges to become global currency

If successful, the Libra initiative promises to support frictionless cross-border trade, better access to financial services for the world's unbanked, and the development of innovative new services. However, it has the potential to disrupt incumbent business models and threaten stability in the market and is likely to draw significant scrutiny from regulators as a result.

The Libra currency

Plans for the creation of a new Libra blockchain and cryptocurrency were outlined last week by a series of major technology and payments companies.

Under the proposals, a new Libra blockchain would, in time, provide a decentralised, permissionless framework for the processing of payments and exchange of assets, including a new Libra cryptocurrency and remove many of the fees that currently apply to the processing of transactions.

The Libra cryptocurrency would be underpinned by a Libra reserve, which, the proposals said, would help regulate the value of the cryptocurrency in line with changes to the value of real-world assets so as to minimise volatility.

Facebook, Uber, eBay, PayPal, Visa and Mastercard are among the businesses that are behind the Libra initiative and they would become members of the Libra Association, which would be "an independent, not-for-profit membership organisation" responsible for governance of the Libra blockchain and Libra reserve.

The initial reaction of regulators

The Libra currency provides an opportunity to facilitate frictionless cross border payments that will occur more quickly than current payment methods and at potentially significantly reduced costs. If widely adopted this will have an impact on current cross border payment channels.

Global regulators will need to monitor the adoption and use of Libra currency closely. A strong uptake of the Libra currency could end up having a serious impact on existing financial services infrastructure with corresponding pressures on incumbent financial services businesses.

Depending on the impact, this could draw a strong regulatory response to ensure that it doesn’t undermine existing, regulated, financial services business and monetary or other financial policies. Ultimately that will likely mean countries look to bring Libra currency within some form of regulation.

This is something that regulators have already strongly hinted at.

In the US, one group of law makers have called for the Libra project to be put on temporary hold until they can investigate the proposals in more detail, while Bank of England governor Mark Carney, in an interview with the BBC, said Libra would be subject to "direct regulatory oversight".

Carney said: "If it's going to work it is going to be so important that [the Bank of England], the Fed (US Federal Reserve), the ECB (European Central Bank), the major central banks of the world would have direct regulatory oversight of the entity."

"The entity would not be Facebook," Carney said. "This would be a global public good so it would have to not be owned by Facebook or a group of technology companies but would have to be in a separate organisation that had direct regulatory oversight of ourselves, but also of the regulators such as the FCA here in the UK who are responsible for the oversight of anti-money laundering and counter terrorism finance – we don't want criminals and terrorists to be using this – and we want people's data to be protected; their privacy rights are hugely important."

"We have strong data protection and right to privacy rules here in the United Kingdom... People need to have the ability to retain the privacy of their data and transactions and still access the system if it does develop," he said.

Growth in the popularity of cryptoassets as a means of making payments, but also as a product in which to invest and as a tool for raising capital, has already spurred many financial regulators to review how the cryptoassets market is regulated. In some countries, like China, 'initial coin offerings' (ICOs) are banned, while other jurisdictions have taken a more liberal approach – such as Switzerland where the town of Zug has become somewhat of a global centre for crypto innovation.

In the UK, the FCA has already revised its guidance on cryptoasset regulation, and the government is in the process of considering legislative changes. Libra is likely to require a further rethink of the legislative and regulatory framework.

The challenges ahead for Libra

There are a range of issues that arise out of the Libra initiative which could hinder its bid for widespread adoption.

Identity checks

According to the Libra white paper, 1.7 billion people are unable to access bank accounts. One of the principal reasons for this is that they are unable to comply with the internationally agreed identity checks required to set up accounts. Account holders must have an address, a passport or other form of ID, and paper-form proof of residence, such as a utility bill. Despite the pseudonymity of accounts, in order to satisfy KYC/AML checks, Libra resellers may have to do the same.

Legal recourse

Libra is the first major example of the unbundling effect of blockchain banking.

In a normal banking scenario, a debt relationship exists between the bank and the customer, and it is always obvious to whom the customer should look for recourse if they are affected by a mistake or fraud. Libra, however, has built a complex and international financial architecture where users may be dealing with parties in any jurisdiction around the globe.

The blockchain will be owned by a Swiss company, operated by 100 validators around the world as a system of potentially millions of ledgers. The Libra currency will be distributed by a diverse array of different company types, and the Libra reserve, which will aim to preserve the currency’s value, will be distributed across an undecided group of global custodians. A customer affected by a mistake or fraud may not have legal recourse against any of these parties, and it is unclear into which regulatory jurisdiction each of them falls.

Prudential risk

It is unclear, so far, the extent to which Libra poses a prudential challenge. On the one hand, it is not a currency because its value is the duplication of existing assets – in this sense it is similar to electronic money as it exists within the EU. On the other hand, the Libra currency is backed by a synthetic mix of fiat currencies and other liquid assets, each of which may be affected by different monetary or other financial policies.

Regulators may be concerned that Libra will undermine important monetary policies such as inflation targets, and that it will produce tight coupling, and associated interconnectedness risk, between different asset classes and previously unrelated fiat currencies.

Regulatory differences

The resellers of Libra may fall within financial regulatory schemes in many parts of the world, but compliance burdens vary between jurisdictions. Because it won’t necessarily affect the customers they can reach, distributors who are located in, or operate from, low-regulation jurisdictions may have a competitive advantage as service providers. This presents a concentration risk, and may also precipitate the use of extraterritorial jurisdiction by the US, the EU and the UK in new and unusual ways.

Insurance

There are few details about the Libra reserve. The most important question is perhaps whether deposits will be insured. If only some of the reserve custodians have state-backed deposit insurance, Libra will have to think about concentration risks and how money is allocated to particular custodians.

Andrew Barber is an expert in financial services regulation at Pinsent Masons, the law firm behind Out-Law.