## ftnea2021001 - Introduction ## Source details **Canonical URL:** [ftnea2021001 - Introduction](https://www.imf.org/-/media/files/publications/ftn063/2021/english/ftnea2021001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/ftn063/2021/english/ftnea2021001.pdf.md) - [Structured JSON version](/-/media/files/publications/ftn063/2021/english/ftnea2021001.pdf.json) --- ### Introduction: fintech as opportunity and challenge - Fintech presents unique opportunities for central banks to enhance core functions such as currency issuance and payment systems. - New technologies transforming the financial system include distributed ledger technology, new data analytics (artificial intelligence [AI] and machine learning), cloud computing, wider mobile access, and increased internet speed and bandwidth. - The COVID-19 pandemic plays an accelerating role in fintech adoption. - Private sector advances could lead to major components of national and international payment infrastructure being dominated by private firms and networks, potentially impairing central banks’ capability to deliver on monetary policy mandates and undermining their issuance monopoly for currency. - Key governance questions raised by fintech: - What is the impact of fintech on central bank mandates? - Are decision-making structures conducive to a sound response? - Will fintech affect autonomy? - How should central banks be transparent about, and accountable for, their response? - Purpose of the note: to discuss preliminary legal views on how central banks can best deal with the impact of fintech on their governance based on a review of central banks’ reactions to date. - There is no “one size fits all” approach; responses will vary by country and by the subset of fintech considered. - The main ideas of this note were discussed during the 6th High Level Forum on Central Bank Governance in Dubai on 23 January 2020. ### Central bank governance: concept and components - Governance defined as the ensemble of structures and arrangements by which an organization makes decisions in pursuit of its mandate. - “Central bank governance” comprises four constitutive and interrelated components: - (i) mandate — objectives (the “why”), functions (the “what”), and powers (the “how”); - (ii) decision-making structures; - (iii) autonomy; - (iv) transparency and accountability. - The mandate shapes the three other components, which interact with each other. - Main governance features are typically established in the organic “central bank law/act” (often interpreted considering corporate laws or principles of general application). ### The Mandate — Objectives, Functions, and Powers Objectives - Any central bank action on fintech must pursue legal objectives as established in central bank law. - Two legal questions: - Are fintech actions anchored in traditional objectives such as price and financial stability? Example: modernization of interbank payment systems is generally noncontroversial; issuance of central bank digital currency (CBDC) may be hard to justify solely by price and financial stability in some countries. - Will central bank laws be expanded with new, less traditional objectives to support innovation agendas, such as promoting financial inclusion, financial innovation, or fostering competition and open access to payment systems? - Examples of existing nontraditional objectives: - Monetary Authority of Singapore objective “to grow Singapore as an internationally competitive financial centre.” - Reserve Bank of Australia payment systems policy objectives include “promoting the efficiency of the payments system and ( . . . ) competition in the market for payment services.” - Monetary Authority of the Cayman Islands’ organic law modification to “recognize the desirability of facilitating innovation in financial services business” when performing regulatory and cooperative functions. - Recent Brazil Central Bank Autonomy Law includes the objective of promoting the efficiency of the financial system. - Trade-offs: more objectives increase complexity of trade-offs, especially without a clear hierarchy among objectives. Functions and Powers - Three legal questions for statutory functions and powers amid fintech: - (i) What are central banks expected or required to undertake to perform current functions? - (ii) Will fintech impose changes to the legal formulation of current functions and powers? - (iii) Is fintech likely to lead to novel central bank functions and powers? Currency Issuance - Fintech may majorly impact legal foundations of currency issuance. - Pressures include digital payment solutions, large technology companies issuing digital “money,” and issuance of CBDC by foreign central banks potentially causing “currency substitution.” - To ensure public access to central bank money, many central banks are considering CBDC issuance; legal basis depends on CBDC design features: - Token-based CBDC may require reform of currency issuance function and powers that today often are limited to banknotes and coins. - Account-based CBDC may require enhancing powers to offer central bank cash current accounts to the general public. - Footnote references: Auer, Cornelli, Frost (BIS Working Paper No. 880). Monetary Policy - Fintech will likely impact implementation rather than the legal wording of monetary policy, but may expose constraints in legal powers. - Typical legal wording: “The central bank shall formulate and implement monetary policy.” - Legal powers authorising financial transactions often restricted to banks (open market and credit operations), posing two challenges: - If fintech reduces the relevance of traditional monetary policy counterparties, effectiveness of monetary policy tools could be limited. Central banks could consider enlarging the category of monetary policy counterparties, potentially requiring central bank law reform to grant “guided flexibility” to determine eligible counterparties. - Some fintech firms may seek regulatory status (for example, as “bank”) to access monetary policy operations as a liquidity backstop despite not engaging in maturity transformation, possibly pushing central banks to review access policies and rules. - Central banks may also require explicit powers to charge interest on token-based CBDC. - Footnote references: Dabrowski; Bofinger; IMF Special Series on COVID-19. Payment System Soundness - Fintech could have a major impact on legal foundations of the payment system function. - Most central banks are tasked with promoting safety and efficiency of payment systems and can act as operator, catalyst, regulator, and overseer. - Payment system transformation through new digital means, service providers, and payment rails increases importance of safety and efficiency and tests limits of oversight scope and powers. - Central banks must review legal foundations of oversight responsibilities to ensure coverage of new payment systems, instruments, and firms. - When central banks modernize their own payment systems (digital IDs, expanding access to settlement accounts in central bank money to nonbank participants), they must ensure laws allow such actions. - When issuing CBDC to establish a more resilient and diverse payment system, central banks must ascertain issuance falls within legal mandate. - Example: Central Bank of Bahamas — Sand Dollar and the Central Bank of Bahamas Act, 2020: - Act conflates objectives and functions (Section 5(1)(h)). - “Currency” explicitly includes “electronic money” (Section 8(1)). - Act grants power to issue currency in the form of “electronic money” (Section 12(7)). - Act grants regulatory powers to prescribe “the framework under which electronic money issued by the Central Bank ( . . . ) may be held or used by the public” (Section 15). - Payment Systems Act, 2012 definition of “electronic money” and scope historically limited issuance to banks and trust companies; 2020 Act extended issuance to the central bank itself. - Establishment of innovation facilitators raises legal governance issues: - Type of facilitator depends on whether central bank has payment system oversight and/or micro-prudential function. - Innovation hubs are suited for central banks without such functions; regulatory sandboxes require central banks with such function(s). - Deployment of fintech “accelerators” can pose risks to financial autonomy, conflicts of interest, and regulatory capture; legal analysis required on powers to set up, participate in, and fund such accelerators. - Many central bank laws prohibit acquisition of equity stakes in commercial entities; hence many central banks offering accelerators prefer grants over equity participations. - Lender-of-Last-Resort (LOLR): - For central banks with explicit LOLR function/powers, legal formulations may need adjustment for fintech. - Many central banks do not have explicit legal LOLR function/powers. Payment System Oversight — legal forms and implications - Over recent decades, many central banks have seen strengthened payment system oversight mandates and explicit payment system objectives. - Most central banks now have explicit payment system functions and an increasing number have express powers (registration or licensing, inspection, regulation, sanctioning) shifting oversight from “soft law” to “hard law.” - Four legal forms of payment system oversight function and powers: - a broad function implemented through “soft law” powers; - a broad function implemented through “hard law” powers; - a narrow function implemented through “soft law” powers; - a narrow function implemented through “hard law” powers. - Definitions and implications: - A broad oversight function refers to “the payment system” as a whole, allowing flexible inclusion of infrastructures and firms under oversight, providing legal basis to bring new fintech firms under scope. - A narrow payment system function is limited to “payment systems” only (cash settlement infrastructures), potentially challenging extension of oversight to new fintech firms and products. - “Soft law” powers are flexible but moral suasion may be weaker vis-à-vis disruptive fintech firms than for traditional interbank infrastructures. - Broad “hard law” powers would cover fintech entrants; narrow “hard law” powers may not. - Argument: payment system oversight mandates established as a broad function combined with broad hard law powers help avoid under-regulation and regulatory arbitrage by fintech firms active in payments. - Legal risk: without a sound legal foundation, courts may overturn oversight frameworks (illustrated by ECJ decision annulling aspects of ECB’s oversight framework for central counterparty clearing for securities transactions; ECJ, UK et al v. ECB et al, C-T-496/11). ### Box 2 — Legal formulation of payment system oversight and innovation facilitators - Relying on general legal provisions has the advantage of flexibility. - Given the increased pace of financial innovation and the competition to attract talent and capital raging among major financial centers, there is a pressing urgency for regulators to better understand fintech innovations and the ensuing risks, while allowing for testing in a controlled risk environment. - Legal formulation and lender-of-last-resort (LOLR) access: - Typical legal formulation restricts LOLR lending to banks and other deposit-taking institutions; some fintech firms could acquire regulatory status that fits within one of those statutory categories to gain access. - Innovation facilitators developed by central banks and regulators: - Innovation hubs provide a dedicated point of contact for fintech firms to address competent authorities and provide nonbinding guidance and interpretation of the regulatory framework. - Regulatory sandboxes offer a controlled testing environment for new financial services, products, or business models. - Accelerators are arrangements that allow fintech providers to develop use cases that may be granted fund support and/or endorsement from the authorities. - Empirical findings on regulatory sandboxes: - Of the 73 sandboxes included in a recent World Bank Group Survey, 39 were either hosted exclusively by a central bank or co-hosted by a central bank in coordination with other regulatory agencies. - This said, sandboxes are expensive and complex to set up, and therefore not all sandboxes that were either announced or legislated are currently “live.” ### Box 3 — Innovation facilitators, statistics, cross-border collaboration, and novel powers - Overview and empirical snapshot: - Central bank-hosted sandboxes and innovation hubs are present across IMF membership (figure sources: IMF, European Supervisory Agencies, World Bank Group, CGAP, Columbia University; IMF staff for fintech officers and iLabs). - Fintech and central bank statistical function: - Fintech enables more efficient statistical functions through Big Data and AI, exploiting new data sources (for example, social networks, ecommerce, and the internet of things) and new techniques (for example, machine learning and text mining). - Legal issues when processing qualifying “personal data”: - compliance with complex data protection legal frameworks; - increased legal and reputational risks; - need to adjust decision-making structures and internal rules and procedures to ensure proper use of data. - Cross-border collaboration: - Motives: enhance effectiveness, achieve economies of scale, and reduce costs (example application: wholesale CBDC). - Forms: participation in working groups, bilateral arrangements, and multi-party structures. - Legal issues: - many central banks require a firm legal basis in their central bank law to enter into structural cross-border arrangements; - choice of legal instrument: while memoranda of understanding have been traditional, legally binding contracts may be more appropriate when a (larger) central bank provides fintech-related services against fees to other (smaller) central banks. - Novel functions and powers conferred by legislatures — examples: - Bank Negara Malaysia: primary function “to promote a sound, progressive and inclusive financial system” (Section 5(2)(f )). - Central Bank of the UAE organic law: function to “regulate, develop, oversee and maintain soundness of the Financial Infrastructure Systems in the State, including electronic payment systems, digital currency, and Stored Value Facilities” (Art. 4(g)). - National Bank of Ukraine organic law: function to “shape the development of modern electronic banking technologies (...); controlling the creation of ( . . . ) banking automation systems” (Art. 7.7). - Some central banks granted powers in nontraditional areas such as data management or digital ID to establish public digital infrastructure supporting fintech services. ### Decision-making structures, executive management, and oversight - Policy formulation bodies: - Boards and specialized bodies must have sufficient fintech understanding. - Options to secure fintech expertise: - legislate board composition to include fintech-knowledgeable members (may require legal changes); - rely on external fintech experts to participate in meetings; - establish a dedicated fintech body (advisory or, if granted real powers, require explicit legal basis and clarity on remit, membership, and hierarchy). - Executive management: - Must systematically monitor fintech developments and make organizational adjustments to increase responsiveness and agility. - Two common institutional responses: - creation of dedicated high-level fintech officer positions (examples: “chief fintech officer” at the Hong Kong Monetary Authority and Monetary Authority of Singapore; chief digital officer at the Magyar Nemzeti Bank; head of digitalization at the Bank of Finland); - establishment of iLabs or other dedicated fintech units. - Legal and governance considerations for high-level fintech officers: - clear lines of hierarchy and accountability (including vis-à-vis iLabs); - mitigate conflicts of interest and “revolving door” risks via robust internal Code of Conduct or Code of Ethics; - impact on fixed numbers of top executives and wider governance implications when creating new top-level roles. - iLabs and dedicated units: - trend: creation of dedicated fintech units, increased involvement of other departments (for example, statistics), and iLabs promoting cross-departmental innovation. - Oversight Boards should play a role in their set-up, given responsibility for strategy, structure approval, and financial oversight. - Due diligence and “fit and proper” style access criteria (not formal prudential requirements) are recommended when engaging with fintech entrepreneurs; procurement policies offer another oversight tool. - Oversight Board capabilities to bolster: - cyber resilience; - operational risk; - data management and AI issues; - under certain CBDC structures, AML/CFT compliance. - Data protection officer (DPO): - Laws could require central banks to appoint a DPO who must be independent and free from conflicts of interest. - Oversight Boards should be involved in DPO appointment and oversight, analogous to board roles with chief internal auditors. ### Autonomy, financial impacts, and institutional safeguards - Institutional and personal autonomy: - Fintech does not fundamentally change legal foundations for autonomy but can expose weaknesses (for example, government pressure to accommodate national digitalization agendas; weak incompatibility and ethics rules increasing conflict-of-interest risks). - Functional autonomy: - Fintech responses must preserve appropriate levels of functional autonomy across functions; monetary policy should retain the highest autonomy while other functions can tolerate more government involvement. - Political involvement in specific design choices for currency (for example, banknote images) is common and not inherently incompatible with monetary policy autonomy; careful division of labor is needed when designing CBDC. - Functional autonomy is supported by clear delineation of competencies between central banks and other regulatory agencies and legal arrangements requiring consultation on monetary and payment system matters. - Financial autonomy: - Mixed impacts on central bank financial solidity: - issuance of CBDC may stabilize or increase money in circulation and seigniorage, allowing central banks to build buffers to maintain a financially sound balance sheet (illustrative example in text). - Institutional governance and practical safeguards recommended: - consult central bank legal departments when creating new high-level fintech roles; - ensure clear hierarchy and remit when creating decision-making bodies with real powers; - Oversight Boards should ensure structural changes permit effective oversight of fintech outputs and pay attention to increased private-sector engagement; - implement “fit and proper” access criteria, procurement controls, and due diligence for engagements with fintech firms; - legislate or otherwise ensure appointment practices prioritize professional skills for board membership; consider requiring at least one member with fintech-related skills where appropriate; - establish internal procedures, controls, and qualified staffing for data use, AI governance, algorithm review, and data protection compliance. ### Transparency and Accountability - Transparency: - Central banks must be transparent about their response to, and use of, fintech and related processes and decisions; they should engage in open dialogue with internal and external stakeholders. - Specific transparency practices recommended: - Make eligibility requirements, procedures, rules, and outcomes for sandboxes and other innovation facilitators widely accessible. - Disclose the distribution of costs (between the central bank, users, banks, and merchants) for issuance of CBDC. - Communicate how insights from Big Data and AI are integrated into decision-making and how associated risks are mitigated (confidentiality protection, access rights, data governance). - Legal transparency instruments commonly present in central bank laws: - (i) issuance of an annual report on monetary, economic, and financial conditions and the central bank’s monetary policy; and - (ii) publication of audited annual financial statements. - Potential extensions related to fintech: - Annual reporting requirement could be extended to cover impact of fintech or digitalization on the economy and financial system and central bank reactions. - Chart of accounts may need adaptation for token-based CBDC to show separate lines under “currency in circulation” for banknotes (and coins) and CBDC. - International Financial Reporting Standards require disclosure of risk mitigation policies related to key balance sheet items, which may be relevant when a central bank embarks on a major fintech endeavor. - New and specific transparency demands: - Stakeholders may request explanations of decisions made with opaque algorithms and complex data; existing legal transparency requirements may or may not suffice. - Accountability: - Central banks must be held accountable for fintech-related actions as they are for other decisions; fintech may expand responsibilities and increase use of third-party providers. - Practical application of existing accountability arrangements will need adjustments rather than wholesale legal change. - When relying on third-party service providers (for example, cloud providers), contractual and legal arrangements must establish a clear division of responsibilities; central banks are likely to be held accountable for the choice of counterparties regardless of contracts. - Enlarged central bank functions (for example, direct issuance of CBDC to the general public) will require accountability for customer due diligence and AML/CFT compliance. - Decision-making based on AI and Big Data: - Central banks remain responsible; AI cannot permit abdication of responsibility. - Accountability should cover analytical tools and data sources used in decision-making. - Personal data protection: - Data protection laws may impose complex data management obligations. - Central banks will be accountable to data subjects and must allocate accountability to decision-making bodies for processing of personal data. ### Legal framework implications and concluding recommendations - Fintech can significantly affect legal foundations of central bank governance, but "fundamental changes to those foundations are not likely to be required." - Key legal pressure points identified: - Profit retention rules if central bank seigniorage increases significantly. - Budgetary legal limitations may be strained by fintech-related expenses. - Central banks should be cautious when granting funds to fintech firms as an “accelerator” role, since this is essentially a fiscal task. - CBDC issuance trade-offs and risks: - Issuing CBDC may be very costly and cause significant side-effects, including increased LOLR financing to banks witnessing a shift from deposits to CBDC. - Transparency and accountability adjustments will be needed to cover fintech, data, and AI governance. - Observed responses: - Central banks and political authorities have strengthened legal mandates and created new decision-making bodies or positions in response to fintech. - No “one size fits all” solution; responses depend on each central bank’s mandate and legal-institutional setup. - Recommendation on legal reform: - Central bank law reform should aim for sufficient agility and be technology-neutral where possible. - Consider open legal categories and well-designed “catch all” provisions. ### Box 4 — Ten Legal Steps a Central Bank Must Take to Prepare its Governance for a World of Fintech - 1. Objectives — Align fintech policy objectives with current statutory objectives of the central bank. - 2. Functions and Powers — Review execution of statutory functions in a digitalized world and whether legal powers permit necessary actions. - 3. Data Use — Establish robust governance structures, internal rules, and procedures to ensure data processing conforms with applicable laws and rules. - 4. Cross-Border Collaboration — Review legal basis for inter-central bank collaboration arrangements and document them in appropriate legal instruments. - 5. Oversight Board — Review eligibility criteria for Oversight Board members to ensure strong technical skill sets and legal authorization for specialized sub-committees or mandate/composition adjustments. - 6. Senior Fintech Executives — Consult legal department when creating fintech-focused senior executive roles to preserve chain of command, accountability, and avoid conflicts of interest. - 7. Autonomy — Design central bank fintech actions to maintain appropriate levels of functional autonomy across relevant functions. - 8. Transparency — Assess legal framework for general and financial transparency to determine which fintech-related issues to report and under which modalities. - 9. Accountability — Review legal framework to ensure accountability for fintech actions, with special attention to data and AI governance. - 10. Code of Ethics — Review the effectiveness of the central bank’s Code of Conduct/Ethics regarding high-level executives and staff dealing with fintech firms. *The Impact of Fintech on Central Bank Governance: Key Legal Issues — Introduction (FTNEA2021001). International Monetary Fund | August 2021.* ### Introduction ### ftnea2021001 - Introduction ### Introduction: fintech as opportunity and challenge - Fintech presents unique opportunities for central banks to enhance core functions such as currency issuance and payment systems. - New technologies transforming the financial system include distributed ledger technology, new data analytics (artificial intelligence [AI] and machine learning), cloud computing, wider mobile access, and increased internet speed and bandwidth. - The COVID-19 pandemic plays an accelerating role in fintech adoption. - Private sector advances could lead to major components of national and international payment infrastructure being dominated by private firms and networks, potentially impairing central banks’ capability to deliver on monetary policy mandates and undermining their issuance monopoly for currency. - Key governance questions raised by fintech: - What is the impact of fintech on central bank mandates? - Are decision-making structures conducive to a sound response? - Will fintech affect autonomy? - How should central banks be transparent about, and accountable for, their response? - Purpose of the note: to discuss preliminary legal views on how central banks can best deal with the impact of fintech on their governance based on a review of central banks’ reactions to date. - There is no “one size fits all” approach; responses will vary by country and by the subset of fintech considered. *The main ideas of this note were discussed during the 6th High Level Forum on Central Bank Governance in Dubai on 23 January 2020, co-organized by the IMF and Hawkamah, the Institute for Corporate Governance. The note has benefitted from comments from IMF staff and Anthony Beaves, Kerry Beaumont, Marie Bessala, Carine Chartouni, Cristiano Cozer, Giorgi Dzigualishvili, Christopher Hunt, Masaru Itatani, Christoph Keller, Manuel Monteagudo, Mohammed Nyaoga, Catherine Parr, Onenne Partsch, Kemar Richards, Steve Thomas, Chia Yi Tan, Marcela Tapia, Maria del Carmen Urquiza, Luis Urrutia, Kristof Van Nuffel, Paul Yuen, and Chiara Zilioli.* ### Central bank governance: concept and components - Governance defined as the ensemble of structures and arrangements by which an organization makes decisions in pursuit of its mandate. - “Central bank governance” comprises four constitutive and interrelated components: - (i) mandate — objectives (the “why”), functions (the “what”), and powers (the “how”); - (ii) decision-making structures; - (iii) autonomy; - (iv) transparency and accountability. - The mandate shapes the three other components, which interact with each other. - Main governance features are typically established in the organic “central bank law/act” (often interpreted considering corporate laws or principles of general application). ### The Mandate — Objectives, Functions, and Powers Objectives - Any central bank action on fintech must pursue legal objectives as established in central bank law. - Two legal questions: - Are fintech actions anchored in traditional objectives such as price and financial stability? Example: modernization of interbank payment systems is generally noncontroversial; issuance of central bank digital currency (CBDC) may be hard to justify solely by price and financial stability in some countries. - Will central bank laws be expanded with new, less traditional objectives to support innovation agendas, such as promoting financial inclusion, financial innovation, or fostering competition and open access to payment systems? - Examples of existing nontraditional objectives: - Monetary Authority of Singapore objective “to grow Singapore as an internationally competitive financial centre.” - Reserve Bank of Australia payment systems policy objectives include “promoting the efficiency of the payments system and ( . . . ) competition in the market for payment services.” - Monetary Authority of the Cayman Islands’ organic law modification to “recognize the desirability of facilitating innovation in financial services business” when performing regulatory and cooperative functions. - Recent Brazil Central Bank Autonomy Law includes the objective of promoting the efficiency of the financial system. - Trade-offs: more objectives increase complexity of trade-offs, especially without a clear hierarchy among objectives. Functions and Powers - Three legal questions for statutory functions and powers amid fintech: - (i) What are central banks expected or required to undertake to perform current functions? - (ii) Will fintech impose changes to the legal formulation of current functions and powers? - (iii) Is fintech likely to lead to novel central bank functions and powers? Currency Issuance - Fintech may majorly impact legal foundations of currency issuance. - Pressures include digital payment solutions, large technology companies issuing digital “money,” and issuance of CBDC by foreign central banks potentially causing “currency substitution.” - To ensure public access to central bank money, many central banks are considering CBDC issuance; legal basis depends on CBDC design features: - Token-based CBDC may require reform of currency issuance function and powers that today often are limited to banknotes and coins. - Account-based CBDC may require enhancing powers to offer central bank cash current accounts to the general public. - Footnote references: Auer, Cornelli, Frost (BIS Working Paper No. 880). Monetary Policy - Fintech will likely impact implementation rather than the legal wording of monetary policy, but may expose constraints in legal powers. - Typical legal wording: “The central bank shall formulate and implement monetary policy.” - Legal powers authorising financial transactions often restricted to banks (open market and credit operations), posing two challenges: - If fintech reduces the relevance of traditional monetary policy counterparties, effectiveness of monetary policy tools could be limited. Central banks could consider enlarging the category of monetary policy counterparties, potentially requiring central bank law reform to grant “guided flexibility” to determine eligible counterparties. - Some fintech firms may seek regulatory status (for example, as “bank”) to access monetary policy operations as a liquidity backstop despite not engaging in maturity transformation, possibly pushing central banks to review access policies and rules. - Central banks may also require explicit powers to charge interest on token-based CBDC. - Footnote references: Dabrowski; Bofinger; IMF Special Series on COVID-19. Payment System Soundness - Fintech could have a major impact on legal foundations of the payment system function. - Most central banks are tasked with promoting safety and efficiency of payment systems and can act as operator, catalyst, regulator, and overseer. - Payment system transformation through new digital means, service providers, and payment rails increases importance of safety and efficiency and tests limits of oversight scope and powers. - Central banks must review legal foundations of oversight responsibilities to ensure coverage of new payment systems, instruments, and firms. - When central banks modernize their own payment systems (digital IDs, expanding access to settlement accounts in central bank money to nonbank participants), they must ensure laws allow such actions. - When issuing CBDC to establish a more resilient and diverse payment system, central banks must ascertain issuance falls within legal mandate. - Example: Central Bank of Bahamas — Sand Dollar and the Central Bank of Bahamas Act, 2020: - Act conflates objectives and functions (Section 5(1)(h)). - “Currency” explicitly includes “electronic money” (Section 8(1)). - Act grants power to issue currency in the form of “electronic money” (Section 12(7)). - Act grants regulatory powers to prescribe “the framework under which electronic money issued by the Central Bank ( . . . ) may be held or used by the public” (Section 15). - Payment Systems Act, 2012 definition of “electronic money” and scope historically limited issuance to banks and trust companies; 2020 Act extended issuance to the central bank itself. - Establishment of innovation facilitators raises legal governance issues: - Type of facilitator depends on whether central bank has payment system oversight and/or micro-prudential function. - Innovation hubs are suited for central banks without such functions; regulatory sandboxes require central banks with such function(s). - Deployment of fintech “accelerators” can pose risks to financial autonomy, conflicts of interest, and regulatory capture; legal analysis required on powers to set up, participate in, and fund such accelerators. - Many central bank laws prohibit acquisition of equity stakes in commercial entities; hence many central banks offering accelerators prefer grants over equity participations. - Lender-of-Last-Resort (LOLR): - For central banks with explicit LOLR function/powers, legal formulations may need adjustment for fintech. - Many central banks do not have explicit legal LOLR function/powers. Payment System Oversight — legal forms and implications - Over recent decades, many central banks have seen strengthened payment system oversight mandates and explicit payment system objectives. - Most central banks now have explicit payment system functions and an increasing number have express powers (registration or licensing, inspection, regulation, sanctioning) shifting oversight from “soft law” to “hard law.” - Four legal forms of payment system oversight function and powers: - a broad function implemented through “soft law” powers; - a broad function implemented through “hard law” powers; - a narrow function implemented through “soft law” powers; - a narrow function implemented through “hard law” powers. - Definitions and implications: - A broad oversight function refers to “the payment system” as a whole, allowing flexible inclusion of infrastructures and firms under oversight, providing legal basis to bring new fintech firms under scope. - A narrow payment system function is limited to “payment systems” only (cash settlement infrastructures), potentially challenging extension of oversight to new fintech firms and products. - “Soft law” powers are flexible but moral suasion may be weaker vis-à-vis disruptive fintech firms than for traditional interbank infrastructures. - Broad “hard law” powers would cover fintech entrants; narrow “hard law” powers may not. - Argument: payment system oversight mandates established as a broad function combined with broad hard law powers help avoid under-regulation and regulatory arbitrage by fintech firms active in payments. - Legal risk: without a sound legal foundation, courts may overturn oversight frameworks (illustrated by ECJ decision annulling aspects of ECB’s oversight framework for central counterparty clearing for securities transactions; ECJ, UK et al v. ECB et al, C-T-496/11). *The Impact of Fintech on Central Bank Governance: Key Legal Issues — Introduction (FTNEA2021001). International Monetary Fund | August 2021.* ### Box 2. The Legal Formulation of the Central Bank’s Payment System Oversight Mandate ### Box 2. The Legal Formulation of the Central Bank’s Payment System Oversight Mandate ### Overview - Relying on general legal provisions has the advantage of flexibility. - Given the increased pace of financial innovation and the competition to attract talent and capital raging among major financial centers, there is a pressing urgency for regulators to better understand fintech innovations and the ensuing risks, while allowing for testing in a controlled risk environment. - A further complication is that the financial services industry is heavily regulated. ### Legal formulation and lender-of-last-resort (LOLR) access - For those central banks with such explicit legal function and/or powers, it will be necessary to analyze their legal formulation against the backdrop of the policy needs arising out of fintech. - Typically, that legal formulation restricts LOLR lending to banks and other deposit-taking institutions. - As discussed in the context of monetary policy, some fintech firms could acquire a regulatory status that fits within one of those statutory categories to gain access. ### Innovation facilitators developed by central banks and regulators - This led central banks and other regulators to develop three types of “facilitators” to advance innovation in their jurisdictions. - Innovation hubs provide a dedicated point of contact for fintech firms to address competent authorities and provide nonbinding guidance and interpretation of the regulatory framework. - Regulatory sandboxes offer a controlled testing environment for new financial services, products, or business models. - Accelerators are arrangements that allow fintech providers to develop use cases that may be granted fund support and/or endorsement from the authorities. ### Empirical findings on regulatory sandboxes - Of the 73 sandboxes included in a recent World Bank Group Survey, 39 were either hosted exclusively by a central bank or co-hosted by a central bank in coordination with other regulatory agencies. - This said, sandboxes are expensive and complex to set up, and therefore not all sandboxes that were either announced or legislated are currently “live.” *FINTECH NOTES — International Monetary Fund | August 2021* ### Box 3. Innovation Facilitators in Central Banks ### Box 3. Innovation Facilitators in Central Banks ### Overview and empirical snapshot - Box Figure 3.1 provides an overview of central bank-hosted sandboxes and innovation hubs among IMF membership (figure source: IMF, European Supervisory Agencies, World Bank Group, Consultative Group to Assist the Poor (CGAP), and Columbia University). - Figure 3 summarizes the presence of dedicated fintech officers and iLabs in central banks, distinguishing: Chief Financial Officer, Chief Digitalization Officer, Executives with explicit technology mandate, and iLabs (figure source: IMF staff). ### Fintech and central bank statistical function - Fintech enables more efficient statistical functions through Big Data and AI, exploiting new data sources (for example, social networks, ecommerce, and the internet of things) and new techniques (for example, machine learning and text mining). - Legal issues to address when processing qualifying “personal data”: - compliance with complex data protection legal frameworks; - increased legal and reputational risks; - need to adjust decision-making structures and internal rules and procedures to ensure proper use of data. ### Cross-border collaboration - Motives: enhance effectiveness, achieve economies of scale, and reduce costs (example application: wholesale CBDC). - Forms: participation in working groups, bilateral arrangements, and multi-party structures. - Legal issues: - many central banks require a firm legal basis in their central bank law to enter into structural cross-border arrangements; - choice of legal instrument: while memoranda of understanding have been traditional, legally binding contracts may be more appropriate when a (larger) central bank provides fintech-related services against fees to other (smaller) central banks. ### Novel functions and powers conferred by legislatures - Examples of fintech-related statutory functions: - Bank Negara Malaysia: primary function “to promote a sound, progressive and inclusive financial system” (Section 5(2)(f )) — “progressive and inclusivity” provide a broad legal basis for fintech initiatives. - Central Bank of the UAE organic law: function to “regulate, develop, oversee and maintain soundness of the Financial Infrastructure Systems in the State, including electronic payment systems, digital currency, and Stored Value Facilities” (Art. 4(g)). - National Bank of Ukraine organic law: function to “shape the development of modern electronic banking technologies (...); controlling the creation of ( . . . ) banking automation systems” (Art. 7.7). - Some central banks have been granted powers in nontraditional areas such as data management or digital ID to establish public digital infrastructure supporting fintech services. - Expectation that other jurisdictions may follow, including developing digital ID or signature systems and maintaining digital records for the financial sector. ### Decision-making structures: policy formulation, executive management, oversight - Policy formulation bodies - Boards (Boards of Directors, Executive Boards), specialized bodies (Monetary Policy Committees, Payment System Boards) must have sufficient fintech understanding. - Options to secure fintech expertise: - legislate board composition to include fintech-knowledgeable members (may require legal changes); - rely on external fintech experts to participate in meetings; - establish a dedicated fintech body (advisory or, if granted real powers, require explicit legal basis and clarity on remit, membership, and hierarchy). - Executive management - Executive management must systematically monitor fintech developments and make organizational adjustments to increase responsiveness and agility. - Two common institutional responses: - creation of dedicated high-level fintech officer positions (examples: “chief fintech officer” at the Hong Kong Monetary Authority and Monetary Authority of Singapore; chief digital officer at the Magyar Nemzeti Bank; head of digitalization at the Bank of Finland); - establishment of iLabs or other dedicated fintech units. - Legal and governance considerations for high-level fintech officers: - clear lines of hierarchy and accountability (including vis-à-vis iLabs); - mitigate conflicts of interest and “revolving door” risks via robust internal Code of Conduct or Code of Ethics; - impact on fixed numbers of top executives (for example, if deputy-governor slots are fixed) and wider governance implications when creating new top-level roles. - iLabs and dedicated units - trend: creation of dedicated fintech units, increased involvement of other departments (for example, statistics) leveraging AI and machine learning, and iLabs promoting cross-departmental innovation. - Oversight Boards should play a role in their set-up, given their responsibility for strategy, structure approval, and financial oversight. - Due diligence and “fit and proper” style access criteria (not formal prudential requirements) are recommended when engaging with fintech entrepreneurs and private-sector counterparts; procurement policies offer another oversight tool. - Oversight - Oversight Boards must bolster capabilities in: - cyber resilience; - operational risk; - data management and AI issues; - under certain CBDC structures, AML/CFT compliance. - Legal questions for Boards: - how to ensure boards have sufficiently knowledgeable human capital (skill diversity can be legislated though rare; an intermediate solution is to require at least one member with necessary skills); - whether the law allows the Board to adjust remits and composition of committees or establish specialized sub-committees (for example, a “Fintech Committee”); - adoption of internal legal instruments for AI and data management, including: - internal procedures to mitigate inherent limitations of data (for example, documentation requirements for data sourced from third parties); - internal controls for decision-making processes using AI (for example, procedures when an error is found in an algorithm); - availability of qualified staff to monitor and periodically review algorithms. - Data protection officer (DPO) - laws could require central banks to appoint a DPO who must be independent and free from conflicts of interest (especially relative to IT, human resources, and executive management); - Oversight Boards should be involved in DPO appointment and oversight, analogous to board roles with chief internal auditors. ### Autonomy implications - Institutional and personal autonomy - Fintech does not fundamentally change legal foundations for autonomy but can expose weaknesses (for example, government pressure to accommodate national digitalization agendas; weak incompatibility and ethics rules increasing conflict-of-interest risks). - Functional autonomy - Fintech responses must preserve appropriate levels of functional autonomy across functions; monetary policy should retain the highest autonomy while other functions (for example, fiscal agent, exchange control implementation) can tolerate more government involvement. - Currency issuance example: political involvement in specific design choices (for example, banknote images) is common and not inherently incompatible with monetary policy autonomy; careful division of labor is needed when designing CBDC. - Functional autonomy is supported by: - clear delineation of competencies between central banks and other regulatory agencies (for example, competition and data protection agencies); - legal arrangements to ensure other agencies do not excessively hinder central bank mandates and to require consultation on monetary and payment system matters to promote coherence and mitigate leakages. - Financial autonomy - Mixed impacts on central bank financial solidity: - issuance of CBDC may stabilize or increase money in circulation and seigniorage, allowing central banks to build buffers to maintain a financially sound balance sheet (illustrative example in text). ### Institutional governance and practical safeguards - Governance safeguards recommended across areas: - consult central bank legal departments when creating new high-level fintech roles to preserve governance safeguards; - ensure clear hierarchy and remit when creating decision-making bodies with real powers; - Oversight Boards should ensure structural changes permit effective oversight of fintech outputs and pay attention to increased private-sector engagement; - implement “fit and proper” access criteria, procurement controls, and due diligence for engagements with fintech firms; - legislate or otherwise ensure appointment practices prioritize professional skills for board membership; consider requiring at least one member with fintech-related skills where appropriate; - establish internal procedures, controls, and qualified staffing for data use, AI governance, algorithm review, and data protection compliance. *Source: Box 3. Innovation Facilitators in Central Banks, as published in the provided IMF content.* ### 2019. On mandatory consultation of the minister, see for example, ### THE IMpaCT OF FINTECH ON CENTral BaNk GOvErNaNCE: kEy lEGal ISSuES ### Legal framework implications - Fintech can significantly affect legal foundations of central bank governance, but "fundamental changes to those foundations are not likely to be required." - Key legal pressure points identified: - Profit retention rules if central bank seigniorage increases significantly. - Budgetary legal limitations may be strained by fintech-related expenses. - Central banks should be cautious when granting funds to fintech firms as an “accelerator” role, since this is essentially a fiscal task. - CBDC issuance trade-offs and risks: - Issuing CBDC may be very costly and cause significant side-effects, including increased LOLR financing to banks witnessing a shift from deposits to CBDC (either to smoothen the adjustment in balance sheet structure or in the context of a “bank run”). - From a legal perspective, current frameworks “may not need to be fundamentally changed,” but existing issues could come to the fore and require attention. ### Transparency - Central banks must be transparent about their response to, and use of, fintech and related processes and decisions; they should engage in open dialogue with internal and external stakeholders. - Specific transparency practices recommended: - Make eligibility requirements, procedures, rules, and outcomes for sandboxes and other innovation facilitators widely accessible. - Disclose the distribution of costs (between the central bank, users, banks, and merchants) for issuance of CBDC. - Communicate how insights from Big Data and AI are integrated into decision-making and how associated risks are mitigated (confidentiality protection, access rights, data governance). - Legal transparency instruments commonly present in central bank laws: - (i) issuance of an annual report on monetary, economic, and financial conditions and the central bank’s monetary policy; and - (ii) publication of audited annual financial statements. - Potential extensions related to fintech: - Annual reporting requirement could be extended to cover impact of fintech or digitalization on the economy and financial system and central bank reactions. - Chart of accounts may need adaptation for token-based CBDC to show separate lines under “currency in circulation” for banknotes (and coins) and CBDC. - International Financial Reporting Standards require disclosure of risk mitigation policies related to key balance sheet items, which may be relevant when a central bank embarks on a major fintech endeavor. - The IMF’s Central Bank Transparency Code is relevant across its five pillars (governance, policies, operations, outcomes, and official relationships). - New and specific transparency demands: - Stakeholders may request explanations of decisions made with opaque algorithms and complex data; existing legal transparency requirements may or may not suffice. ### Accountability - Central banks must be held accountable for fintech-related actions as they are for other decisions; fintech may expand responsibilities and increase use of third-party providers. - Practical application of existing accountability arrangements will need adjustments rather than wholesale legal change. - When relying on third-party service providers (for example, cloud providers), contractual and legal arrangements must establish a clear division of responsibilities; central banks are likely to be held accountable for the choice of counterparties regardless of contracts. - Example cited: recent data breach in a third-party file sharing software by the Reserve Bank of New Zealand. - Enlarged central bank functions (for example, direct issuance of CBDC to the general public) will require accountability for customer due diligence and AML/CFT compliance. - Decision-making based on AI and Big Data: - Central banks remain responsible; AI cannot permit abdication of responsibility. - Accountability should cover analytical tools and data sources used in decision-making. - Personal data protection: - Data protection laws may impose complex data management obligations. - Central banks will be accountable to data subjects and must allocate accountability to decision-making bodies for processing of personal data. ### Conclusion — salient aspects and implications - Salient aspects where fintech will be particularly relevant: - Mandate impacts in three areas: - Reconsider adequacy of legal formulation of currency issuance and payment systems functions and powers. - In some instances, fintech may lead to new statutory objectives, functions, and powers, requiring management of trade-offs. - Fintech offers opportunities to perform traditional functions (for example, statistics) more effectively, though Big Data and AI raise novel legal challenges. - Decision-making structures: - Policy formulation bodies and Oversight Board should have sufficient fintech skills; legal steps can bridge gaps. - Executive management can create chief digital officer positions and iLabs, but these must fit within existing governance legal frameworks. - Autonomy: - Fintech will not fundamentally alter legal foundations for institutional, personal, and financial autonomy, but could expose weaknesses, especially in functional autonomy. - The government’s role in designing CBDC will be an important legal issue to delineate roles and responsibilities. - Transparency: - Most legal arrangements are flexible enough to report on fintech policies, though some provisions may be overly constraining. - Transparent reporting on total amount of CBDC in circulation and use of AI and Big Data will require a sound legal basis. - Accountability: - Primary legal arrangements are unlikely to change, but practical application must adjust to fintech, including through secondary legal instruments. - Data and AI governance and Codes of Ethics and Conduct are crucial to regulate contacts between central bank officials and fintech firms. - Observed responses: - Central banks and political authorities have strengthened legal mandates and created new decision-making bodies or positions in response to fintech. - No “one size fits all” solution; responses depend on each central bank’s mandate and legal-institutional setup. - Recommendation on legal reform: - Central bank law reform should aim for sufficient agility and be technology-neutral where possible. - Consider open legal categories and well-designed “catch all” provisions. ### Box 4 — Ten Legal Steps a Central Bank Must Take to Prepare its Governance for a World of Fintech - 1. Objectives — Align fintech policy objectives with current statutory objectives of the central bank. - 2. Functions and Powers — Review execution of statutory functions in a digitalized world and whether legal powers permit necessary actions. - 3. Data Use — Establish robust governance structures, internal rules, and procedures to ensure data processing conforms with applicable laws and rules. - 4. Cross-Border Collaboration — Review legal basis for inter-central bank collaboration arrangements and document them in appropriate legal instruments. - 5. Oversight Board — Review eligibility criteria for Oversight Board members to ensure strong technical skill sets and legal authorization for specialized sub-committees or mandate/composition adjustments. - 6. Senior Fintech Executives — Consult legal department when creating fintech-focused senior executive roles to preserve chain of command, accountability, and avoid conflicts of interest. - 7. Autonomy — Design central bank fintech actions to maintain appropriate levels of functional autonomy across relevant functions. - 8. Transparency — Assess legal framework for general and financial transparency to determine which fintech-related issues to report and under which modalities. - 9. Accountability — Review legal framework to ensure accountability for fintech actions, with special attention to data and AI governance. - 10. Code of Ethics — Review the effectiveness of the central bank’s Code of Conduct/Ethics regarding high-level executives and staff dealing with fintech firms. ### Annexes (selected inventories) - Annex 1. Breakdown of the Innovation Facilitators Per Central Bank — lists country, status, type, and central bank (examples include: Bahrain Live Sandbox Central Bank of Bahrain; Austria Live Innovation Hub Oesterreichische Nationalbank; China Live Sandbox PBoC; India Live Sandbox Reserve Bank of India; Singapore Live Sandbox MAS; Global sandbox Live Sandbox Includes MAS, HKMA, Central Bank of Bahrain). - Annex 2. List of Central Bank iLabs — selected entries include: - South African Reserve Bank — Innovation lab: “To practically explore the feasibility, desirability, and appropriateness of CBDC as an electronic legal ender” - Reserve Bank of Australia — Innovation Lab: “Facilitate new ideas and new ways of thinking within our Bank’s Departments and explore those areas through research and experimentation. Research the case for, and implications of, CBDCs” - Central Bank of Bahrain — FinbHub 973: “To create a collaborative ecosystem in the fintech sector by establishing a gateway for investment opportunities in the region, while fostering innovation and supporting integration between financial institutions and fintech startups.” - Banque de France — Le Lab: “Le Lab brings together a specialist team of 12 to harness new technologies and integrate them into the institution’s processes. It is helping to bring AI and advanced data analytics to the central bank’s work.” - Banco Central do Brasil — Laboratory of Financial and Technological Innovations: “Foster research and innovation in the financial industry and in the supervision and regulation thereof.” *International Monetary Fund | August 2021 — Excerpts from ftnea2021001* --- _Source: https://www.imf.org/-/media/files/publications/ftn063/2021/english/ftnea2021001.pdf_