“I am firmly of the view that the technology revolution will hit – indeed, is hitting – finance in the way that it has hit other sectors of the economy. It strikes me that, for banks (as the incumbents), payments innovation is both a first-tier opportunity (given the potential benefits for them and their customers of additional payments functionality) and a first-tier threat (given the risk of disintermediation by new players). That in my view demands urgent action.”

(Sarah Breeden, Bank of England Deputy Governor, Financial Stability)

On 15 April 2024, Sarah Breeden, Bank of England Deputy Governor of Financial Stability, delivered a speech on ‘Modernising the trains and rails of UK payments’ at the Innovate Finance Global Summit 2024. Below are some key takeaways from the speech.

Innovation in money and payments

• The Bank’s approach to payments regulation aims to strike a balance between trust and safety – including monetary and financial stability - on the one hand and supporting innovation on the other.
• It is increasingly focused on innovation in wholesale payments and the importance of payments innovation by banks and plans to publish a discussion paper on these areas this summer to draw on input and collaboration from the private sector. This will complement the work that the Bank has been doing on stablecoin regulation and retail central bank digital currency (CBDC). It will also support HM Treasury’s work on a National Payments Vision.
• ‘Tokenisation’ (ie distributed ledger technology (DLT) and the potential for atomic settlement and programmability, as developed in cryptoasset markets) has the potential to enhance both retail payments and wholesale payments and settlement.

Retail innovation: Stablecoins

• Commenting on the proposals in the Bank’s November 2023 discussion paper on a regulatory regime for stablecoins used at systemic scale in retail payments, Ms Breeden emphasised that ‘business models wanting to offer a systemic means of payment and earn revenues from maturity and liquidity transformation should be regulated as banks’.
• She acknowledged feedback to the discussion paper arguing that the proposed requirements would challenge stablecoin issuers’ business models and so might effectively prohibit use of stablecoins at systemic scale. The Bank is planning to consult further on a draft rulebook, guided by the principle of “same risk, same regulatory outcome”.

Retail innovation: CBDC

• There was further confirmation that the Bank has not taken any decision on whether or not to issue a digital pound. Work over the next two years or so will focus on making a ‘robust and objective assessment of potential benefits and costs’. This will include looking at operational and technical feasibility. The Bank will continue to engage widely with external stakeholders.
• Key factors in any decision to proceed with a retail CBDC will be the nature and scale of innovation in other forms of retail money - particularly commercial bank money - as well as how the Bank’s own wholesale payments infrastructure might evolve in support.

Wholesale innovation: Settlement

• As the regulator of financial market infrastructure (FMI), the Bank is proactively encouraging firms to explore tokenisation technologies given their potential to drive greater speed and efficiency in post-trade financial market processes.
• There was reference to the work on establishing the Digital Securities Sandbox as ‘a means to test and then embed durable and safe innovation’. During the five years of the Sandbox, the Bank, the FCA and HM Treasury plan to learn from firms’ activity and, subject to that, create a new permanent regulatory regime for the trading and settlement of digital securities.

Wholesale innovation: Payments

• The Bank consider that there is a tail risk from too much wholesale settlement taking place in privately issued money. By contrast, Ms Breeden described the settlement of wholesale transactions in central bank money as akin to ‘an anchor of confidence and stability’ in times of stress.
• Given the Bank’s low risk appetite for a significant shift away from settlement in central bank money, it needs to ensure that its wholesale payments infrastructure keeps up with changes in trading, payments and securities settlement technology.
• While significant progress on the Bank’s renewal programme for the UK’s RTGS system has already been made, it is increasingly focused on how best to develop its wholesale infrastructure to support the settlement of tokenised transactions (such as those that will take place in the Digital Securities Sandbox) in central bank money.
• The Bank has already established a new ‘omnibus’ account in the current RTGS system to allow private sector payment systems using DLT to offer settlement in a tokenised representation of central bank money.
• It is also exploring with the industry the benefits of extending the renewed RTGS system in future to offer synchronised settlement in a variety of assets (part of its Future Roadmap for RTGS). This would be done by linking the traditional centralised RTGS ledger to other ledgers, including those using DLT. Ms Breeden explained that this ‘atomic settlement’, with the simultaneous movement of money and assets on different ledgers, ‘can effectively extend Delivery versus Payment or Payment versus Payment to a greater range of use cases’. In 2023 the Bank undertook a project with the BIS Innovation Hub to explore how such synchronisation might work in practice to improve the house purchase process. Some other central banks are going a step further, to experiment with tokenising central bank money, ie creating wholesale CBDCs. The Bank wants to look into how these different models for central bank infrastructure compare, including any important differences in the payment use cases they can support.
• Ms Breeden points out that developments in wholesale payments will also be relevant to the Bank’s exploration of a retail CBDC; both could help in bolstering the future uniformity of money in the UK.

Payments innovation by banks: Call to urgent action

• As commercial bank deposits currently support the vast majority of retail payments in the UK, the Bank wants to encourage more thinking around and – most importantly - action by banks in relation to payments innovation. Specifically, this thinking and action need to tackle how tokenisation could be applied to bank deposits to enhance their functionality across the full range of retail payments use cases, as well as what interbank payment rails would be needed to support this. Ms Breeden emphasises that payments innovation presents both a first-tier opportunity (in terms of enhanced payments functionality) and a first-tier threat (of disintermediation by new entrants).
• By way of an example of related work that will help the Bank in supporting banks to innovate in the payments space, Ms Breeden cites the recently launched Project Agorá. Here, the Bank, BIS, six other central banks and the private sector will explore how tokenised commercial bank deposits could be integrated with tokenised wholesale central bank money to enhance payments efficiency and functionality, including for cross-border payments. Such international projects - the G20 Roadmap for enhancing cross-border payments being another example - also help the Bank to understand the implications for the international monetary system if digital money leads to more frictionless cross-border money holdings and payment flows.

What’s next?

• As mentioned above, the Bank will publish a discussion paper on innovation in wholesale payments and the importance of payments innovation by banks in summer 2024.
• Legislative proposals for stablecoins as well as crypto staking, exchange and custody will be issued by June or July 2024.
• HM Treasury is due to publish a National Payments Vision by mid-late July / the summer Parliamentary recess 2024.
• For more on the UK regulators’ work to date on stablecoin regulation, take a look at our Engage article here.
• This Engage article considers the Bank of England and HM Treasury’s January 2025 consultation response on a UK retail CBDC (digital pound).
• Our Engage article ‘UK: 10 things to note about the FCA and Bank of England Digital Securities Sandbox consultation’ looks at the latest developments relating to the Digital Securities Sandbox.
• For details of the recommendations in the November 2023 Future of Payments Review report – which included the recommendation for a National Payments Vision – see this Engage article.

Comments from the Hogan Lovells team:

We are about to see real change in respect of payments and the payment systems for both retail and wholesale use cases. The Bank has indicated an ambitious time frame for the next steps with draft legislation for stablecoins expected in June/July and the wholesale package over the summer. This will bring stablecoins and payments made with stablecoins within the regulatory perimeter and will have a significant impact on the market.

We are closely monitoring and analysing the potential impact of developments in payments regulation. If you would like to discuss how the changes might affect your business, please get in touch with one of the people listed above or your usual Hogan Lovells contact.