Emerging Technologies Law PDF

EMERGING TECHNOLOGIES LAW 26/09 2 punti a domanda, 16 domande, solo slide, gruppi che presentano gli stessi argomenti. Inizio alle 9. How...

EMERGING TECHNOLOGIES LAW 26/09 2 punti a domanda, 16 domande, solo slide, gruppi che presentano gli stessi argomenti. Inizio alle 9. How new technologies are used in banking and nance, insurance. UNIT 1: PRINCIPLES OF BANKING FINANCIAL INTERMEDIATION Financial intermediation is a process whereby savings are channelled through intermediaries rather than directly. Financial intermediaries serve as middlemen between suppliers of capital (savers, investors, shareholders, policyholders…) and investors in real assets (borrowers of funds). Banks play a relevant role in nancial intermediation. It al allocation process that need to be conducted by nancial intermediations. The banks collets deposits, and then needs a pro table way to allocate these money. Storing money would not be pro table, that’s way banks make loans, to generate revenues. Banks mainly give loans to enterprises to support their needs and activities, and also to sovereign. For this reason banks are key players in nancial intermediation, especially in the European system, very focused on banks. This is di erent from the UK market, where enterprises typically issue equity instruments without the intermediation of banks. The advantages of nancial intermediation are: 1. Financial expertise (informational function): by acting professionally banks develop skills and expertises in what they do. This is important especially in the selection of borrowers for loans, which must be reliable to give money back at maturity. Capability to return money over time is a key element. Peer to peer landing platforms engage in activity equivalent to bank intermediation. Thought the platform the money are channeled to people in need from people who are available to give money. The risk of default might be considerably higher, you have investors that are not able to conduced checks and keep control. The bank is di erent because needs to be able to give money back even if the borrower hasn’t given money back yet. 2. Reduction in transaction costs (economies of scale by allowing savers to share the costs of security analysis): banks are able to lower their transactions considering the high amount of transactions they do everyday. 3. Risk diversi cation and portfolio diversi cation (insurance function): thanks to diversi cation you can reduce the risk, your asset portfolio will be more diversi ed and less risky. 4. Maturity transformation of short term liabilities into longer term assets (liquidity function): banks usually provide long term loans, banks deposits has high availability… , banks are able to transform …. Money creation system or …. to transform short term in long term. Example: Assets 100€ | Liability 90€ and 10€ Capital —> 11€ … insolvent. What if you have extended 100€ of loans and have 90€ of deposits…50€… you try to liquidate your assets, but they are illiquid, you might try to approach other banks to buy, but maybe at a lower price. … Emergency liquidity assistance: request to the central bank for liquidity. 5. Contribute to economic growth (link between nancial development and economic growth) TYPES OF BANKS The banking system comprises the network of institutions involved in di erent capacities in the provision of banking services. However, the word ‘bank’ is used to refer to many di erent types of institutions. A de nitions could be di erent if they come form the business or from the legal framework. The legal de nitions are important to understand which rules to apply. (1) General Public banks: Universal banks: Commercial banks: are those institutions which collect deposits … Credit institutions is the regulatory terminology to refer to commercial banks…. Investment banks: engage in investments advice, … (2) Higher-level institutions (not involved in direct contact with the general public): central banks, i.e. bankers and government banks, responsible for monetary policy and macroeconomic management of the monetary system; 1 ff fi fi fi fi fi fi fi ff fi fi ff fi fi fi fi fi ff ff  authorities which supervise other banks and check their probity, liquidity and solvency. COMMERCIAL VS INVESTMENT BANKS Financial rms typically channel funds from those who wish to save to those who need to borrow. There are di erent types of nancial rms: commercial banks, investment banks or securities rms, insurance companies, nance companies, investment companies (mutual funds, unit trusts), pension funds, hedge funds and others. Commercial banks (or banks) collect deposits from the public and grant loans and perform other activities such as payment services, asset custodianship, etc. The scope of permissible activities for commercial banks varies from country to country depending upon the laws and regulations. Universal banking is di erent from specialised banking. In recent years blurring of the frontiers between banks and other nancial institutions. They are called credit institutions in the EU and depositary institutions in the US. Investment banks/securities rms are nancial intermediaries that underwrite and facilitate the issuance of securities (stocks and bonds) and also promote the exchange of securities in the secondary markets. They are called MiFID rms or investment rms in the EU and broker-dealers in the US. Under a universal banking system, banks perform both commercial and investment banking functions. COMMERCIAL BANKS Banks are special because banking is crucial for the functioning of market economies. The activity of banking includes the provision of payments facilities, credit and capital to individuals, rms and the government. The traditional business of commercial banking involves: (1) accepting deposits, (2) lending, and (3) payment services. German model of ‘universal banking’ has spread around the world and in uenced the development of national banking systems in Europe and elsewhere. A ‘universal bank’ is a bank that accepts deposits and lends money, but it also carries out a large range of nancial activities, including investment services, property services and insurance services. In the UK and US, the regulation sets barriers limiting the ability of deposit taking institutions to perform securities-related activities. Not both. INVESTMENT BANKING An investment bank is typically a private legal entity (a company) that provides various nancial-related services to individuals, corporations, and governments. Services provided include: Raising capital Underwritting Agency services M&As Derivatives Securities Currencies Investment banks DO NOT take deposits (commercial banks DO) Ø Two main lines of business: v Sell Side: trading securities for cash or for other securities (e.g. facilitating transactions, market-making), or the promotion of securities (e.g. underwriting, research, etc.). v Buy Side: advice to institutions that buy investment services (HFs, PEFs, mutual funds, UCITSs, etc.) BANKING SYSTEM The role of the banking system is important in the process of ‘money creation’. Demand deposits (bank accounts) are the major part of the money supply. This characteristic of bank liabilities provides the rationale for many monetary and banking laws and regulations. The process of payment through the banking system involves several credit relationships, which require the establishment of an adequate degree of trust and availability of information. FRACTIONAL RESERVE SYSTEM Under a fractional reserve system, a commercial bank only holds a ‘fraction’ of its assets in the form of liquid assets: cash and reserves. The remaining assets are mostly loans. Commercial banks typically get funding from depositors through deposits which are withdraw-able on demand. By using deposits to extend loans they create money. The (potentially) most critical aspect is that such deposits (i. e. short -term liabilities) are used to extend loans (i. e. illiquid assets). This creates a maturity mismatch that can generate several issues. First come, rst serve. Domino e ect. The belief in a 2 fi ff ff fi fi fi fi fi fi fi fi fi fi fi fl fi ff fi  bank run is self -ful lling. Bank runs are costly. The inherent features of banking are also the source of its fragility. This make the system very vulnerable and fragile. Why banks issue illiquid assets ? Isn’t it risky? Because of the pro t the banks gains in giving loans, depositors pay interest. Banks consider that people usually do not withdraw their deposits all together. The interest rate banks pay to depositors is lower than the interest rate gained in giving loans. This di erence is the pro t. Illiquid assets are expected to be more pro table than... Extending loan might be more pro table for banks. EXPANSION OF BANK DEPOSITS tabella 3/10 MAIN FEATURES OF THE BANKING SYSTEM Low cash to assets (liquidity). I.e. Maturity mismatch (short-term deposits withdraw-able on demand and longer term loans) Low capital to assets (leverage) Risky asset portfolio (it’s imbedded in the nature of long term loans, the reliability of a borrower might can over time) These features (asset-liability mismatch, low capitalization and risky asset portfolio) make the banking industry particularly vulnerable. A loss for the bank is if the borrower is not able to pay the loans back. This can create a bigger problem and make the bank insolvent. All this characteristics make banks fragile and vulnerable. RATIONALE FOR REGULATION Why is regulation necessary? Why is the nancial industry more heavily regulated than other industries? What is the speci c rationale for banking regulation? Why is governmental regulation put in place? RATIONALE FOR BANKING REGULATION The distinctive feature of the banker begins when he uses the money of others; as long as he uses his own money he is only a capitalist. Deposits are also part of the money supply. Their safeguard bene ts both depositors and the stability of the system. In times of bonanza nancial markets are a retreat from reality. In times of crises, nancial markets are a retreat from sanity. THEORIES OF REGULATION The PUBLIC INTEREST explanation of regulation lays down that regulation is supplied in response to the public’s demand for relief from inequitable or ine cient market practices. It focuses on consumer interests (Gardener). ‘PUBLIC CHOICE’ Theory – individuals when making public as well as private decisions are primarily motivated by private interests rather than the public interest. REGULATORY CAPTURE. The capture hypothesis asserts that regulation is demanded by interest groups attempting to promote their own interests. TYPES OF REGULATION Preventive vs protective Prescriptive rules vs general principles Prudential vs conduct of business REGULATION VS SUPERVISION Regulation: Establishment of rules, both acts of the legislator (Congress or Parliament) and statutory instruments or rules of the competent authorities. Rules may also be issued by private bankers’ associations. Soft law, too. 3 fi ff fi fi fi fi fi fi fi ffi fi fi  Supervision in a broad sense is a process with four stages or functions: 1. licensing 2. supervision stricto sensu 3. sanctioning, and, 4. crisis management (including LOLR, deposit insurance, resolution and insolvency proceedings). Also a distinction can be made between micro-prudential supervision and macro-prudential supervision. There are two instruments Regulations and Prohibitions. This terms are sometimes used as synonyms, but they are not. Regulations refers to rules, and the low making process, which might diverge from the institutional power decisions by the governments (…). Laws are adopted by the constitutional body with constitutional power, a regulator is an administrative authority that fa rispettare. Dark law binding and forcible, obliged to comply with those rules. Soft law rules are not binding, are adopted by body which do not ha legislative or regulative powers. Are not forcible. But some of them where transported in the bank legal framework where they have be adopted. … It ensuring that the recipient comply to certain rules, … , the ones who do not respect those rules will be punished thanks to the supervision mechanism... THE INTERACTION BETWEEN REGULATION AND SUPERVISION Even if often the terms ‘regulation’ and ‘supervision’ are used interchangeably, such concepts are very di erent. Still, the connection between regulation and supervision is tight, since supervision is meant to monitor whether a supervised person complies with the regulation. For example, at the licensing stage, the rules (i.e. regulation) determine the requirements that the authorising rm must meet and the supervisor (i.e. supervision) is meant to actually check if these requirements are met. This is the reason why often supervisors are also tasked with regulatory functions (Lastra 2015). KEY DEFINITIONS 1) Conduct of business regulation/supervision : conduct of business regulation and supervision relate to the interaction of nancial institutions with their customers in regulated nancial markets dealing with investments (Hudson 2013 ). 2) Macro -prudential regulation/supervision : macro -prudential regulation and supervision relate to the imbalances in the nancial system and the detection of systemic risks that can arise from such imbalances a ecting both nancial institutions and the economy. The focus is therefore on the safety of the nancial and economic system as a whole through the prevention of the creation of systemic risk. Systemic risk refers to the risk of breakdown of the entire nancial system , as opposed to breakdown of some of its individual components (Lastra 2013 ). 3) Micro -prudential (regulation/supervision) : micro -prudential regulation and supervision relate to the safety and soundness of individual nancial institutions as well as depositor/investor protection (Lastra 2013). MICRO VS MACRO-PRUDENTIAL SUPERVISION In the aftermath of the nancial crisis, a consensus emerged regarding the di erence between macro and micro prudential supervision. According to the House of Lords Report on the Future of EU Supervision and Regulation, ‘macro-prudential supervision is the analysis of trends and imbalances in the nancial system and the detection of systemic risks that these trends may pose to nancial institutions and the economy. The focus of macro-prudential supervision is the safety of the nancial and economic system as a whole – the prevention of the materialization of systemic risk. Micro-prudential supervision is the day-to-day supervision of individual nancial institutions. The focus of microprudential supervision is the safety and soundness of individual institutions and also consumer protection. The same or a separate supervisor can carry out these two functions. If di erent supervisors carry out these functions they must work together to provide mechanisms to counteract macro-prudential risks at a micro-prudential level’. Macro prudential supervision is analogous to the oversight of the forest, while micro prudential supervision is analogous to the oversight of individual trees (Lastra). THE NATURE OF MICRO-PRUDENTIAL SUPERVISION In a broad sense, micro-prudential supervision includes four stages: 1) authorisation or licensing, 2) supervision stricto sensu (Day-to-day supervision), 3) sanctioning, 4) crisis management (LOLR, resolution/ 4 ff fi fi fi ff fi fi fi fi ff fi fi fi fi fi ff fi  liquidation). In a narrow sense, supervision is oversight of the rms’ behaviour, risk monitoring and control, and enforcement. This exercise by de nition requires judgment, and therefore some degree of discretion. The Basel core principle No. 1 states: the primary objective of banking supervision is to promote the safety and soundness of banks and the banking system. If the banking supervisor is assigned broader responsibilities, these are subordinate to the primary objective and do not con ict with it. Note of caution: supervision is resource and personnel intensive, litigious, prone to reputational damage; a ‘thankless task’ in which failures are magni ed and successes are hidden. 31/10 1. AUTHORISATION PROCESS Licensing or authorisation is the rst step of the supervisory process. It is a lter aimed at having a safe and sound nancial system. However, entry barriers can be neither too lax nor too restrictive (Lastra, 2015). Typically, at this stage of the supervisory process, supervisors consider a number of elements relating to the authorising rm, such as: a) Conditions of the rm to obtain the authorisation (capital, management skills), b) list of activities that the rm wants to perform. Issues to be considered in the Law: Conditions to obtain a licence Scope of permissible activities Entry of foreign banks Banks/Industry/Commerce Legal form of the institution Authority to revoke a licence Forms of bank expansion Banking laws often require that the authorities give their approval (a licence in some cases, a registration procedure in some others) to various forms of bank expansion: branches, subsidiaries, joint ventures, take- overs and mergers. You have a ltering mechanism that ensure that every applicant meet all the requirements. 2. SUPERVISION STRICTO SENSU On-going monitoring and oversight of the health of the banks and the banking system, in particular asset quality, capital adequacy, liquidity, management, internal controls and earnings. Enforcement: power given to supervisors to make sure rules are respected, if there is a bric it will be sanctioned. There are di erent types of sanctions. Risk monitoring and risk control. Supervision is exercised through an array of instruments. Supervisors make sure that rules are respected. INSTRUMENTS OF MICRO-PRUDENTIAL SUPERVISION The supervisors can do is work thanks to some instruments like: Reports and statistical requirements Ratings (CAMELS, private ratings) SREP – Supervisory Review Examination Process (1,2,3,4, F) On-site examinations (US, UK) or inspections (investigatory powers ECB/SSM) Internal audit, o -site examinations, consultations with senior management Independent external audit Others (disclosure, duciary duties) System of adequate loan classi cation (according to credit risk) Stress tests (exercises to try to predict how a nancial institution will do in case of a nancial crisis, how it react to nancial losses and so on) CAMEL The determination of the nancial condition, of the soundness of a bank is not an exact science. For banks, the rating system is commonly known as the CAMEL system, which has two principal elements. First, an assessment is made of ve critical aspects of an institution's operations and condition: Capital adequacy, 5 fi fi fi fi ff fi fi ff fi fi fi fi fi fi fi fi fi fi fl fi  Asset quality, Management, Earnings and Liquidity (thus, the acronym CAMEL), which are rated on a scale of 1 through 5, with 1 being the most favorable mark and 5 being the worse one. The second element combines the ve factor ratings into a composite rating. 3. SANCTIONING The success of banking legislation depends upon its e ective enforcement. Penalties for wrongdoing should be clearly spelt out in the law, their severity ‘graded’. ‘Institutional sanctions’ versus ‘personal sanctions’. Civil versus criminal penalties. Penalties cannot be applied for political considerations or for displeasure with bank management policies. Courts of Justice need to be independent to assess cases without political pressures. TYPES OF SANCTIONS Institutional sanctions (institution) Fines Cease and desist orders Closer supervision Restriction/s in activities Termination or suspension of deposit insurance Prompt corrective action Revocation of a bank licence Personal sanctions (management) Temporary or permanent inability to be a banker Fines Loss of job (management overhaul) Imprisonment In recent years (post-Enron scandal) increased attention is given to the duciary duties of directors, managers, and o cers. 4. BANK CRISIS MANAGEMENT Bank crisis management comprises an array of o cial and private responses that extends beyond the insolvency proceedings that are the only tool typically available to deal with corporate bankruptcy in other industries. As regards the o cial responses, when confronted with failed or failing banks, public authorities have at their disposal: (1) Lender of last resort role of the central bank (2) Deposit insurance schemes (3) Government policies of implicit protection of depositors, banks (the ‘too-big-to-fail doctrine’) or the payment system (4) Resolution vs insolvency (lex specialis vs lex generalis) (5) Early intervention and preventive measures, including enhanced supervision, living wills or rm speci c contingency planning MACRO-PRUDENTIAL SUPERVISION The 2007-09 global nancial crisis challenged many pre-existing conceptions about systemic risk. One of these is the so-called ‘composition fallacy’ which contends that the safety and soundness of any nancial system is the aggregate soundness of all its participating institutions. This fallacy assumed that if individual entities were robust, then the whole system would be resilient. This assumption proved to be misguided. Using an analogy with forest management, the safeguard of the health of the forest requires a di erent type of strategy than the safeguard of the health of each individual tree (Lastra). Inadequate systemic risk control was a feature of the 2007-2009 nancial crisis. And as a response ‘macroprudential’ is embraced now by nancial authorities in the EU, US, UK and all over the world. REGULATORY CHALLENGES The Basel Committee on Banking Supervision (BCBS) enhanced the scope of risk-based supervision in its Core Principles for E ective Banking Supervision. The new Core Principles have been widened in order to include: ‘the need for greater intensity and resources to deal e ectively with systemically important banks; 6 fi fi ffi fi ff ffi fi ffi ff ff fi fi ff fi fi  the importance of applying a system-wide, macro perspective to the micro-prudential supervision of banks to assist in identifying, analysing and taking pre-emptive action to address systemic risk; and the increasing focus on e ective crisis management, recovery and resolution measures in reducing both the probability and impact of a bank failure’. This system wide perspective is referred to as macro-prudential supervision. FINANCIAL STABILITY Financial stability is a broad and discretionary concept that refers to the safety and soundness of the nancial system, the smooth operation of the payment system and the resilience of the nancial system to withstand unforeseen shocks. In ‘negative terms’, nancial stability is the absence of instability/crisis. Financial stability, systemic risk/contagion control and sound banking are close and interconnected concepts. Systemic risk refers to the risk or probability of breakdown of the entire nancial system, as opposed to breakdowns in individual parts or components. But a widely accepted de nition is still missing. Systemic risks pose a threat to nancial stability. The GFC evidenced that these risks are not con ned to the banking system: they can also a ect insurance, securities and derivatives markets (e.g. AIG and Lehman Brothers). Systemic risks are not bounded by jurisdictional frontiers; they have a tendency to spread across geographical borders. The interconnectedness of nancial markets has rendered nancial stability as a ‘national, regional and international goal’. It is a global public good that ‘does not stop at national borders’. THE INSTRUMENTS OF MACRO-PRUDENTIAL SUPERVISION Countercyclical capital bu ers. Sectorial capital requirements. Leverage ratios. Provisioning. Liquidity bu ers. Loan to value and loan to income ratios/restrictions. LTV ratios measure how much you are borrowing versus how much the house is worth. E.g. a mortgage of £160,000 on a £200,000 house has a LTV ratio of 80% Margin requirements, use of central counterparties Disclosure requirements UNIT 2: PRINCIPLES OF FINTECH REGULATION FINTECH: LOOKING FOR A DEFINITION Fintech is the con uence of ‘ nance’ and ‘technology’: companies or innovations that employ new technologies to improve or innovate nancial services. Fintech developments concern all areas of the nancial sector: payments and nancial infrastructures, consumer and SME, lending, insurance, investment management, and venture nancing. Fintech innovations include: blockchain and DLTs, cryptoassets, cryptocurrencies and digital assets, CBDCs, stable coins and ICOs (to name a few). The main issue as to Fintech relates to if and how it should be regulated. Many jurisdictions claim to prefer a technology-neutral approach, thus the technology as such should not be regulated, the activity and the nancial intermediary should. Some preliminary concepts concerning nancial services regulation are key. PRELIMINARY CONCEPTS Focus on the regulation of nancial services provision (concerning securities), mainly from the investor protection perspective. Investor protection has a broad meaning and relates to each type of investor, from sophisticated and institutional investors to unsophisticated – retail investors. It looks at the risks faced by investors when they trade in securities as well as the mechanisms to mitigate such risks in order to make capital markets fair, e cient and transparent environments (market integrity). This is based on the importance of having an e cient nancial system for the economy. In the securities market, the main risk relates to abusive conducts. Investors who buy securities pay an amount of money in exchange of a mere promise to be repaid later or in exchange of a bunch of rights and obligations concerning a corporate entity. (You pay now money in return to a promise to receive something in the future, it not certain. What I can obtain depend on di erent elements, like the 7 fi fi fi ff ff fl ff fi fi fi fi fi fi ff fi fi ffi ffi fi fi ff fi fi fi fi fi  value of share, what businesses decide to give away to shareholders, what if the company goes bankrupt etc.) Objective of securities regulation is to protect investors from abusive practices. (Regulations de nitions are used here in di erent way but they all refer to regulations in general). Main tools : authorisations to perform reserved activities; conduct rules (telling intermediaries how to perform), duty to disclose information, sanctions. Financial services: activities, bene ts and satisfactions, connected with the sale of money, that o er to users and customers nancial-related value. Suppliers of nancial services: a) Banks, b) Insurance companies, c) Building societies; d) Credit card issuers; e) Collective investment schemes; f) Stock exchanges; g) Factoring and leasing companies; h) Securities rms, etc. Customers of nancial services: a) Retail customers, including a uent retail customers (Private Banking); b) Businesses from the private sector; c) Businesses from the public sector; d) Non-pro t organisations; e) Financial service providers (e.g., an insurance company must be insured with another insurer against contingencies). FINANCIAL ACTIVITIES 1. Banking - Exercised by banks. - Commercial banks take deposits from the public and make loans. Additionally, banks operate accounts, make transfers, pay standing orders and sell foreign currency. 2. Securities - Exercised by securities rms. - Securities rms perform a variety of activities connected with securities, such as, underwriting, dealing, brokering. 3. Insurance - Exercised by insurance companies. Insurance is de ned as a nancial contract which transfers risk from the customer to the insurer. - The primary service the customer gets is a guarantee of payment on the occurrence of an accidental loss that is covered by the insurance policy. WHAT DO SECURITIES FIRMS DO? Securities rms: a) connect those looking for funding with those who seek to make an investment; b) facilitate the sales of securities, such as shares, bonds, (provision of underwriting); c) buy and sell securities as agents that is on customer’s behalf (securities brokering); d) buy and sell securities on their own account (securities dealing). Typically, securities rms do not take (insured) deposits. Since securities rms do not take deposits, how are they funded? 1) By borrowing in the wholesale market with other nancial instruments that are functionally similar to deposits (notably, repos or bonds). 2) By charging a fee for their services. Investment banks are perhaps the most important securities rms. They are called ‘broker dealers’ in the USA. WHAT ARE SECURITIES? Securities are tradable nancial assets. The de nition of what constitutes a nancial security varies according to the jurisdiction. In some jurisdictions, it refers only to listed and tradable equity and xed income investments. In other jurisdictions, like the UK, it includes nancial instruments that are close to equities and xed income, such as equity warrants, debentures, units in a vehicle such as a listed collective investment scheme and personal pension schemes. It also includes derivatives (as required under MiFID). In the US, a security is a tradable nancial asset of any kind, usually categorised as: 8 fi fi fi fi fi fi ff fi fi fi fi fi fi fi fi fi fi fi ffl fi fi fi fi fi fi ff 1) debt securities (bonds, debentures, banknotes); 2) equity securities; 3) derivatives (forwards, futures, options, swaps). DEBT SECURITIES These securities represent a debt owed by an entity to lenders. There are di erent types of debt securities such as bonds, debentures, commercial notes. These securities are di erent from each other in terms of maturity, collateral, and other characteristics. They are di erent from equity securities in the sense that debenture holders are creditors of the company, while equity shareholders are owners of the company. Debentures or corporate bonds are issued for a xed period, like any other debt. They have a longer maturity as compared to notes that have a shorter maturity. Like equity shareholders, debenture holders have certain rights. They are entitled to interest for the amount lent and repayment of entire principal at the time of maturity. A bond is a security that represents the debt of an issuer to an investor. When an investor buys a bond, he is lending a sum of money to the issuer. An issuer of bonds thus makes a commitment to repay capital plus interest. However, certain bonds known as "zero coupon bonds" do not pay interest during the life of the security. Subordinated bonds generally have very long (if not inde nite) duration, a restriction on the rights of investors to request early redemption and a limited ability for the issuer to request early redemption. The redemption of these securities is subordinated to the repayment of the other creditors. High Yield Bonds are speculative and have a rating that is lower than the investment grade threshold. They carry a coupon that is relatively high to re ect the higher level of risk. In the issue documentation, investor protection is through covenants that will, for example, limit or prohibit the issuer from carrying out certain types of transactions or making certain types of investment. Composite bonds allow an investor to have access to other nancial instruments, in particular, to shares through an initial investment in a bond. There exist di erent types of composite bonds, such as convertible bonds and exchangeable bonds. EQUITY SECURITIES A share is a security which represents a part of the capital of its issuer. Each holder of a share is a "shareholder". A shareholder is entitled to a share of the company's pro ts through the payment of an annual dividend, the amount of which is in proportion to the shareholder's holding in the company. The shareholder receives a dividend only if the income of the company allows it. Dividends are not guaranteed and a company can decide not to pay a dividend or to distribute only lesser amount. Holding an equity interest means contributing to the capital of the company. A share of a company represents a monetary value. This monetary value is the amount of capital you contribute to the company. Equity shareholders have certain rights and duties. They are entitled to the pro ts of the company. They can participate in the operations of the company by exercising their voting rights. However, if a company is incurring losses, equity shareholders get no return. In case of bankruptcy, they are on the losing end. They get paid for their contribution only after all obligations have been discharged. Sometimes, they may not get anything in return on their investment. DERIVATIVES Derivative securities are those securities whose value is derived from an underlying asset. These underlying assets can be bonds, shares, commodities, currencies or other assets. Ownership of a derivative does not mean ownership of an asset. Derivative securities are more sophisticated as compared to equity and debt securities. Their most common use is containing risk. Such risks can be currency uctuation risks, movements in index or commodities prices, adverse changes in rates of interest, weather, etc. There are several types of derivatives available in the market, in accordance with the needs of the customers. Broadly, derivatives can be classi ed as Options, Futures, Forwards, and Swaps. RETAIL FINANCIAL SECTOR AND WHOLESALE FINANCIAL SECTOR PRIMARY MARKET In the primary market investors buy securities directly from the company issuing them for the rst time. When a company publicly sells securities (e.g., shares and bonds) for the rst time, it does so on the primary market. The company o ering the securities (e.g. a car manufacturer) hires an investment bank to 9 ff fi fl fi ff fi ff fi ff fi fi ff fi fl fi  obtain commitments from large institutional investors to purchase the securities when rst o ered. Usually small and/or unsophisticated investors do not participate; priority is to sell all of the available securities in a short period of time to meet the required volume of sale. SECONDARY MARKET In the secondary market, securities are traded after the company has sold all the stocks and bonds o ered on the primary market (e.g., New York Stock Exchange, London Stock Exchange). Investors trade securities among themselves. Company that had initially issued the security is not a party to any sale between the two investors namely the securities rm acting as a broker and the investor who is the client of the securities rm. Anyone can purchase securities on the secondary market. An investor typically hires a securities rm to act as a broker. The price paid by the investor is no longer directly related to the initial price of the security as determined by the rst issuance. WHAT IS SECURITIES REGULATION? The ultimate goal of securities regulation is to obtain e cient nancial markets and thereby improve the allocation of resources to the economy. But how can this goal be reached? The role of securities regulation is to create and promote a competitive market for information traders. In this way nancial markets can function e ciently and hence they can provide e ective allocation of resources, thereby bene ting the real economy. Practically speaking, there are di erent mechanisms through which securities regulation seeks to pursue its goal. MARKET EFFICIENCY Market e ciency is said to depend on: 1) share price accuracy, and, 2) nancial liquidity. In other words, accurate shares price and liquidity make markets function e ciently. How is it possible to achieve accurate shares price and liquidity? The accuracy of shares prices depends on the public availability of information that can in uence the price. Liquidity depends on the willingness of market players to keep on trading in securities, which in turn allows potential sellers to sell and potential buyers to buy quickly and easily. THE POLICYMAKERS’ ROLE Policymakers have to decide who should perform the tasks of: 1) incorporating information into prices, and, 2) providing liquidity in trading. They can choose among di erent market participants, such as: a) insiders, b) information traders, c) liquidity traders, d) noise traders. There seems to be consensus on the fact that such tasks can be more e ciently performed by information traders. 4/12 INFORMATION TRADERS Information traders operate in a highly competitive environment, which is not the case for insiders who operate in a quasi-monopolistic environment. Information traders can exploit economies of scale and scope in collecting and assessing both general market and rm-speci c information. Information traders cannot manipulate business decisions or take advantage of timing when using rm-speci c information. For all these reasons, information traders are deemed to be the best market participants with regard to incorporating information into prices and providing liquidity in trading. For the same reasons, the rationale for securities regulation is mainly to protect the interests of information traders on the grounds that their activity is of paramount importance for having in place e ective markets. Information traders are the agents who render markets e cient. Their function is even more important when markets are ine cient. This is why securities regulation is meant to protect them. By de nition, they are not insiders, so they do not have access to inside information. However, they typically devote resources to gathering and analysing information, that then is used as a rational basis for their investments. There are two groups of information traders: a) sophisticated professional investors and b) analysts. 10 fi ff ff ffi fl fi ffi fi ffi fi fi fi fi ffi fi ff ffi ff ffi fi fi fi fi fi ff ff fi ffi  Sophisticated professional investors —> Sophisticated professional investors comprise a wide range of institutional investors. These are money managers, and other market professional players. They rely, to varying degrees, on some sort of nancial or business analytical products as a basis for their investment decisions. Analysts —> 3 subgroups: sell-side analysts, buy-side analysts, independent analysts. Sell-side analysts are employed by investment banks to evaluate certain stocks. They disclose their analytical work to the market for free, and do not attempt to pro t by trading on their valuations. This is essentially a service to the clients of the investment bank and aims at attracting investors and rms to the investment bank. Buy-side analysts are employed by large institutional investors, such as mutual funds, hedge funds and pension funds, to manage investment portfolios. These analysts keep their analytical products con dential and pro t through trading based on discrepancies between their valuation and the market price. In performing their work, buy-side analysts use the analytical products of the sell-side analysts as one source of information among the other sources they use. Independent analysts are not associated with an investment bank and produce analytical products which they sell to their clients through some method of subscription to their service. PRICING PROCESS Information traders detect discrepancies between value and price based on the information they possess. They then trade to capture the value of their informational advantage. When they observe an undervaluation, they buy, thereby raising the price; conversely, when they spot overvaluation they sell, thereby causing the price to drop. Because price changes are always assessed against some calculated value, a trade is triggered when the price change is not justi ed by currently known information. The accuracy of stock prices depends on the ability of information traders to counter the actions of noise traders and to price newly disclosed information. The more information traders can counter price-value discrepancies caused by noise traders or by newly disclosed information, the more e cient the market is. A perfectly e cient equilibrium, however, is unattainable. Securities regulations in a nutshell: Securities regulation typically seeks to reach its goal by employing a number of legal mechanisms. The most e ective ones are a) disclosure duties, b) restrictions on fraud and manipulation, c) restrictions on insider trading. These tools, indeed, are supposed to provide information traders with the protection they need to properly perform their functions. More speci cally, a) disclosure duties reduce information gathering costs, b) restrictions on fraud and manipulation reduce costs of verifying the credibility of information, c) restrictions on insider trading protect information traders from the competition of insiders that can bene t from the knowledge of inside information FINTECH AND BANKING Fintech creates the possibility of banking services being o ered without banks. Fintech rms can create intermediary solutions by-passing banks and nancial institutions (P2P lending conducted on P2P lending platforms is an example). P2P = peer to peer landing platforms. Such platforms are not de ned nor regulated as banks; this allows them to o er competitive market conditions. Pros no intermediary involved. parties to agree the lending conditions. more access to nance for borrowers Cons: creditworthiness di cult to determine. higher risk of default. going forward potential systemic risks OPEN BANKING Open banking refers to new possibilities for non-banks to o er banking-like services, mainly payments. New rules request banks to give access (upon depositor’s consent) to third parties to their 11 fi ffi fi ff fi ffi fi fi ff fi ff fi ff fi fi ffi fi fi fi customers’ account records. Competition enhancement rational (banks market monopoly). On this basis, such third parties can then o er services, including payment services. Such third parties need to be authorised by the regulator. This process will bring more competition to the detriment of banks DISTRIBUTED LEDGER TECHNOLOGY (DLT) DLT refers to a novel and fast-evolving approach to recording and sharing data across multiple data stores (or ledgers). This technology allows for transactions and data to be recorded, shared, and synchronized across a distributed network of di erent network participants, i.e. a distributed database (or register or ledger). Distributed ledgers (DLs) are a speci c implementation of the broader category of ‘shared ledgers’, which are simply de ned as a shared record of data across di erent parties. A shared ledger can be a single ledger with layered permissions or a distributed ledger, which consists of multiple ledgers maintained by a distributed network of nodes. DLTs are categorized as permissioned or permissionless, depending on whether or not network participants (nodes) need permission from any entity to make changes to the ledger and as public or private depending on whether the ledgers can be accessed by anyone or only by the participating nodes in the network. Nodes are network participants in a distributed ledger network. BLOCKCHAIN A ‘blockchain’ is a particular type of data structure used in some distributed ledgers which stores and transmits data in packages called ‘blocks’ that are connected to each other in a digital ‘chain’. Blockchains employ cryptographic and algorithmic methods to record and synchronize data across a network in an immutable manner. Blockchain-based DLT was rst applied as the underlying technology of the cryptocurrency Bitcoin. It has a variety of potential applications beyond the narrow realm of digital currencies and cryptocurrencies. DIGITAL CURRENCIES AND CRYPTOCURRENCIES Digital currencies are digital representations of value that are denominated in their own unit of account, distinct from e-money, which is simply a digital payment mechanism, representing and denominated in at money. Non- at digital currencies: 1) are not backed by any underlying asset, have zero intrinsic value, and do not represent a liability on any institution, 2) are exchanged through distributed ledgers absent trust between partners and absent central record-keeping, 3) as a result of the above two characteristics, they do not rely on speci c institutional arrangements or intermediaries for peer-to-peer exchanges. Cryptocurrencies are a subset of digital currencies that rely on cryptographic techniques to achieve consensus, for example Bitcoin and ether. A token is a representation of a digital asset. It typically does not have intrinsic value, but it is linked to an underlying asset, which could be anything of value. BITCOIN Bitcoin is a cryptocurrency created in 2009 by Satoshi Nakamoto. He developed a blockchain allowing individuals to access the blockchain to trade bitcoins without involvement of nancial institutions The value of bitcoin (like gold) depends on demand and supply, but the supply is limited as bitcoins must be mined in a complex virtual system and up to a certain amount. Bitcoins have become popular, and many have bought them on unregulated exchanges. The price has been very volatile, but many consider it as an alternative store of value. Accordingly, it is more similar to a commodity than to a currency. FINANCIAL INSTITUTIONS AND CRYPTOS Financial institutions have been o ering digital currency services. Derivatives with bitcoin as underlying asset (bitcoin future contracts) can be traded on the Chicago commodity markets. Other derivative contracts to speculate or hedge against bitcoin price movements are o ered by some US banks. CENTRAL BANK DIGITAL CURRENCIES Wholesale CBDC (WCBDC) would be accessible only to nancial institutions. A WCBDC would have to be issued on a permissioned rather than a public blockchain. It would also have to be remunerated to keep reserves and the WCBDC at par. The main motive for issuing a WCBDC could be to promote nancial innovation and to lower transactions costs using a blockchain. Retail CBDC (RCBDC) would be accessible to the general public, including nancial institutions. A RCBDC would not necessarily use the blockchain and would most likely involve intermediaries. The motives for issuing a RCBDC could be to supply the public with a digitalised monetary instrument without any liquidity or credit risks, easy to access and cheap to use. As the issuance of one sort of CBDC could be dissociated from the other, there could thus be one, two or no CBDC(s). A CBDC would be created or 12 fi fi ff ff fi fi fi ff ff fi fi ff fi fi fi  destroyed only by the central bank and would be issued and exchanged at par with other forms of central bank money (banknotes and reserves). ICOs AND TOKENS Tokens issued in the context of ICOs are the result of a transaction carried out by an “issuer”, generally in connection with the collection of nancial resources: something close to the issue of traditional securities, through an o ering on the market. An ICO is an innovative way of raising money from the public, using so- called coins or tokens and can also be called an initial token o ering or token sale. In an ICO, a business or individual issues coins or tokens and puts them for sale in exchange for at currencies, such as the Euro, or more often virtual currencies, e.g. Bitcoin or Ether. Typically, an ICO is preceded by a “white paper” which serves purposes very loosely, and broadly, similar to those of a prospectus in an IPO. UNIT 3: DISTRIBUTED LEDGER TECHNOLOGY (DLT) DISTRIBUTED LEDGER TECHNOLOGY (DLT) DTL is the term used to refer to those technologies that allow a common ledger to be shared across networks of computers. It is class of technologies which support the distributed recording of encrypted data. It is a technology allowing a network of independent and often geographically dispersed computers to update, share and keep a de nitive record of data (e.g. information, transactions) in a common decentralised database in a peer-to-peer way, without the need for a central authority y (CSSF 2022). Consensus mechanism to validate the transactions added to the ledger Nodes must reach a consensus amongst each other to validate new data entries by following a set of prede ned rules. Consensus mechanism is speci ed in the algorithm that de nes the distributed ledger. Consensus mechanism can vary depending on the nature, goal and underlying asset of the technology. Aim of the consensus mechanism is to determine whether a new transaction on the DLT is legitimate or not. In an environment without a central authority, consensus mechanism prevents the network from being hacked or misused and allows for trust in a non-trusted environment. With DLT being originally used for cryptocurrencies, consensus was the solution against double- spending. Cryptography means to guarantee the immutability, non-repudiation and authorisation of transactions. Immutability: Once a transaction has been validated by the nodes and added to the DLT, it can no longer be retroactively changed. Non-repudiation: participants of the DLT cannot deny the authenticity of the transaction accepted in the DLT. Purpose of non-repudiation is to collect, maintain, provide, and verify the undeniable evidence about transactions between participating actors. Authorisation: asymmetric cryptography is used to provide users with public and private key pairs. Each transaction is signed to be acknowledged as valid during the nodes’ validation process and to prove that the transaction has been initiated by the authorised user. TYPES OF DLT Comparing blockchain and distributed ledger technologies based on key attributes such as data access, transaction submission, transaction validation, consensus mechanisms, data structure, and examples. 1) Access Data (“Read” Data) Public: anyone can access the data without restrictions. Private: data access is controlled and may require permissions 2) Submit Transactions Unrestricted: in public systems, anyone can submit transactions. Restricted or Unrestricted: in private 13 fi ff fi fi fi fi ff fi  systems, submitting transactions may be either fully open or require permissions, depending on the setup. 3) Validate Transactions (“Write” Data) Permission-less: in public systems, anyone can participate in validating transactions without special permissions. Semi-Permissioned: some level of permissions is required, allowing a controlled group to validate transactions. Permissioned: in private systems, only speci c, authorised participants are allowed to validate transactions. 4) Consensus Proof-based: public systems typically use consensus mechanisms like Proof of Work (PoW) or Proof of Stake (PoS) to ensure integrity and security. BFT-based & Others: private and semi-permissioned systems often use Byzantine Fault Tolerance (BFT) and related mechanisms like Practical BFT (PBFT), Federated Byzantine Agreement (FBA), or PoS. 5) Data Structure Blockchain: both public and semi-permissioned systems generally rely on blockchain technology to maintain a sequential, immutable ledger of transactions. Non-Blockchain: some private systems may use alternative data structures that are not blockchain-based. Examples: Public: Bitcoin and Ethereum are examples of public, permission-less blockchains. Semi-Permissioned: Stellar operates in a semi-permissioned manner. Private: Quorum and Hyperledger are permissioned blockchain frameworks, while Corda is a private distributed ledger platform that does not use traditional blockchain structures. This comparison highlights the trade-o s between decentralisation, transparency, and control in di erent distributed ledger setups. Public blockchains prioritise openness and decentralisation, while private systems focus on control and tailored functionalities for enterprise use cases. ACCESS RIGHTS 1. PUBLIC VS PRIVATE Distributed ledgers are often categorised as public or private depending on who can access the ledger. By default, public ledgers are typically open to anyone whereas private ledgers are only accessible to authorised users. 2. UNRESTRICTED VS RESTRICTED It is also possible to restrict further the access rights of a participant on an individual basis, for instance by authorising only to read the ledger. With regards to creation rights, a ledger is said restricted when a speci c access right is required to create transactions in the ledger or unrestricted when any user of the private ledger can submit transactions for inclusion in the ledger. VALIDATION RIGHTS 3. PERMISSIONED VS PERMISSION-LESS In permission-less ledgers, anyone can join the network as a validator node and validate transactions. The validators do not know each other. Permissioned ledgers rely on transaction validators who are identi ed and authorised to act as such and who trust each other. Usually, public ledgers i.e. for which anyone can join the network and access the ledger are also unrestricted (anyone can submit a transaction) and permission-less (anyone can validate / verify transactions). Private ledgers i.e. for which only authorised users can join the network/access the ledger may be unrestricted (all users authorised to access the private ledger can submit a transaction) or restricted (only a subset of authorised users can submit a transaction) and are permissioned (only a subset of authorised users can validate transactions). CONSENSUS METHODS In a permission-less distributed ledger, anyone can join the network so the risk of bad behaviour from a participant is higher. In order to validate transactions over a network of untrusted participants, “proof- based” consensus methods are generally used (Proof-of-Work). 14 ff fi fi fi ff  In public blockchain, participants validating transactions, also known as miners, are rewarded for contributing to the validation process. A de ned number of tokens or cryptocurrencies are created with each new block of transactions and are rewarded to the miners. It acts as an incentive mechanism to attract miners in securing the network. As Proof-of-Work has some known drawbacks (i.e it requires a large amount of computing power), new generation of public blockchains are arising and are based on Proof of Stake (PoS). In PoS based public blockchains, owners of the blockchain- native virtual currency can put some of their currencies at stake to participate in the consensus. Permissioned distributed ledgers are typically based on byzantine fault tolerance methods to generate the consensus between the participants. As the participants are identi ed and have been authorised to participate in the network, consensus methods requiring fewer computing resources can be used to reach an agreement on what they believe is the correct data to be added in the ledger. As a result, it generally o ers better performance in terms of transaction processing than the permission-less distributed ledgers. BLOCKCHAIN: A blockchain is a particular type of data structure used in some DLTs. Blockchains transmits and stores data in “blocks”, and connects these blocks to each other in a “chain”, using (a set of) cryptographic techniques in order to form a tamper-resistant chain of transaction blocks. Thus, blockchain creates a continuously growing data structure – to which data can only be appended and from which existing data cannot be removed – those functions as a distributed ledger. This is why the blockchain is often used in public ledger as a way to maintain the integrity/immutability of the ledger in an untrusted environment. Every blockchain is a distributed ledger, but not every distributed ledger uses blockchain technology to run its system. New generation of blockchains (e.g. Polkadot) come with a more advanced and complex topology. There is a main chain which is only dedicated to validating the transactions and storing the proofs of the validations. Other blockchains (shards or parachains) based on the same technology are connected to the main chain and are dedicated to application purpose. This topology allows a better scalability and more advanced features (like privacy on public blockchain). ROLES & RESPONSIBILITIES IN A DLT DLT Developer = responsible for developing the application code that enables the functioning of the DLT. updates the application code xes issues or bugs to ensure the smooth operation of the DLT provides services directly to the Solution Provider, who incorporates the developed DLT into business solutions. Infrastructure Service Provider = provides and manages the infrastructure (e.g., cloud services, servers, networks) on which the DLT operates. operates and maintains the technical infrastructure. ensures the DLT runs reliably on its platform o ers services to the Solution Provider, supporting the implementation of DLT-based solutions. Solution Provider = designs and develops the business software solutions that are based on the DLT framework. codes the business applications that use the DLT implements features and functionalities tailored to business needs provides services to both the Users (businesses or organisations using the solution) and End-Users (the nal consumers of the services). User = utilizes the software solutions developed by the Solution Provider to o er services to the End-User. inputs data into the software optionally secures sensitive credentials (e.g., passwords, private keys). engages with the Solution Provider to access and use the business software. 15 fi fi ff ff fi ff fi  End-User = nal consumer who accesses the services enabled by the software provided by the User. inputs data into the software (e.g., completing transactions or forms) interacts with the solution to receive services. accesses services indirectly via the User. Summary of Relationships DLT Developer → Solution Provider: Develops and updates DLT. Infrastructure Provider → Solution Provider: Supplies and maintains infrastructure. Solution Provider → User/End-User: Delivers business solutions based on DLT. User → End-User: Provides services enabled by the solution. The roles are not mutually exclusive. An entity could cumulate the role of solution provider and infrastructure service provider. There can also be multiple providers for the same role: in a typical distributed environment, there are multiple nodes operated by various infrastructure service providers. Also, an entity could cumulate the role of infrastructure service provider by running a node and the role of a user by using the software based on the distributed ledger it stores on its node. FUND DISTRIBUTION PLATFORM A DLT-based distribution platform allows the tokenisation of investment funds in which investors can subscribe and redeem their fund shares through a web or mobile application. The DLT distribution platform allows a direct access to the management company’s products for the investors. The use of a DLT can reduce time-consuming tasks such as reconciliation with automation, reduce the intermediation costs between investors and management companies, mutualise costs amongst the fund distribution participants, increase the resiliency of the platform and o er better transparency of transactions. An investor account would be assimilated to a wallet on a DLT and the funds he is investing in would be tokens stored in this wallet. Subscriptions and redemptions could be submitted directly by the investors in a digitalised way. The investor would be authenticated and would validate transactions through cryptographic means. Processing of these subscriptions and redemptions in funds would be automated with the help of smart contracts. History of the transactions would be immutable and accessible to authorised parties. A company o ers a platform on which fund shares are tokenised and where investors can buy them directly. On the other hand, management companies have the possibility to issue tokenised funds on this platform. The platform is powered by smart contracts running on a permissioned Quorum DLT. Quorum nodes are hosted in the Cloud and operated by the company developing the fund distribution platform. In this example, the DLT designer is Consensys (developer of the Quorum DLT). The company developing the fund distribution platform has the roles of solution provider and ISP (e.g nodes provider), the users are management companies issuing their funds on this platform and the end- users are the investors. 5/12 UNIT 4: INITIAL COIN OFFERINGS (ICOs) The expression ‘Initial Coin O ering’ initially only referred to issues of crypto- currencies (e.g., Bitcoin, Ethereum). Today it is used to identify any o ering of tokens which do not necessarily represent a crypto- currency, yet embed various rights and can be purchased against payment either in at currency or crypto- currency Most ICOs are issued for the funding of an activity/project. Tokens may be issued by companies, natural persons or networks of product developers. Often, the company’s business activity is merely in the phase of being planned (more or less organised start-ups), and the production of goods/services is scheduled to start after the end of funding. An Initial Coin O ering is similar to an Initial Public O ering as both aim at raising capital from the public (undetermined number of investors) and involve a set of activities aimed at promoting/advertising the o ering itself. Compared to conventional o erings of nancial instruments, ICOs are characterised by the following: use of blockchain technology, which allows to disinter-mediate the typical capital markets infrastructure (e.g., custodian banks, underwriters, secondary markets). 16 ff fi ff ff ff ff fi ff ff ff fi  means of payment used for the transaction settlement, as payments for purchasing tokens are often made in crypto currencies (e.g., Ethereum, Bitcoin) instead of at currency. they are advertised and promoted via the World Wide Web, which allows promotion and funding at a cross-border level, with no territorial constraints either for the issuer or the promoter. publication of a so-called ‘white paper’ in place of a prospectus, describing the main characteristics of the investment scheme and the object of the o ering. TOKENS vs FINANCIAL INSTRUMENTS Some types of tokens may qualify as nancial instruments or, as nancial products; this is the case for investment tokens or security-like tokens. Other tokens present a variable mix of characteristics and are therefore called ‘hybrid tokens’; these are the most di cult to qualify in the light of the current regulatory framework. These tokens may have a remarkable nancial content, in addition to being placed to retail investors via public o erings. Utility tokens: grant some sort of access or right(s) to use a company’s ecosystem, goods or services. may also provide holders with governance rights in the issuing company, such as the right to vote for updates in the functional structure and otherwise shape the future of issuing entities. often resemble the pre-payment of license fees or crowdfunding sales on websites such as Kickstarter. a utility token falling into these schemes is not usually considered a traditional security or nancial product: its aim is not to create future cash ows but rather enable functional use of a blockchain-based ecosystem. Security- nancial-investments tokens: are tied to an underlying asset and represent a fractional ownership of the overall value of the asset, albeit not of the asset itself (e.g. a rm, real estate or collectibles). o er rights to future pro ts and are typically treated under nancial regulatory regimes as nancial products, securities, nancial instruments, derivatives or collective investment schemes. Currency-payment tokens: (in their pure form) ful l the economic criteria of money, which are to serve as a means of exchange, storage of value, and unit of account. famously represented by Bitcoin, currency tokens have lately grown more diverse and now include stable coins like Libra. UNIT 5: CENTRAL BANK DIGITAL CURRENCIES CBDC is digital money issued by a central bank and is conceivable in both retail and wholesale form. Retail CBDC, or sometimes general purpose CBDC, refers to CBDC that can be held and used by individuals. Wholesale CBDCs are available only to a selected set of nancial institutions. Central banks are increasingly pondering whether to issue their own digital currencies to the general public, so-called retail central bank digital currency (CBDC). The majority of IMF member countries are actively evaluating CBDCs, with only a few having issued CBDCs or undertaken extensive pilots or tests. Jurisdiction on CBDC is already in advanced stage: a CBDC is already issued: Central Bank of The Bahamas (CBOB). a pilot CBDC has been or is being tested involving actual households and rms: People’s Bank of China (PBOC), Eastern Caribbean Central Bank (ECCB), and Banco Central de Uruguay (BCDU). a CBDC project has been brought onto the country’s political agenda and is being analysed by government or parliamentary bodies outside of the central bank: Sveriges Riksbank. the central bank has carried out a CBDC project and decided against issuing a CBDC for the time being: Bank of Canada (BOC). POLICY GOALS OF CDBC PROJECTS Financial Inclusion —> common policy goal for CBDC projects. Financial inclusion entails access to appropriate and a ordable nancial services and is associated with poverty reduction worldwide. Despite signi cant progress, large parts of the world’s population remain nancially underserved. 17 ff fi fi ff fi ff fi fi fi fi fi fl ff fi ffi fi fi fi fi fi fi fi fi  Increasing nancial inclusion has many challenges, including access to digital technology: CBDC could potentially facilitate nancial inclusion by increasing access to digital payments and thus serving as a gateway to wider access to nancial services. Most of the six jurisdictions in this survey identify nancial inclusion as a top policy goal. Access to payments —> helping facilitate payments among the population is an important objective for central banks in most countries. Even countries with high levels of nancial inclusion can still face access to payments challenges. Some central banks are concerned that private payment service providers might not nd extending services to all parts of the population pro table, and that a declining use of cash will exacerbate the problem. Some jurisdictions are therefore exploring if a CBDC could help achieve or safeguard universal access to payments. Access to payments may encounter multiple hurdles, including shortage of cash, rms’ refusal to accept cash, and lack of or recurring disturbances of digital infrastructure. In the Bahamas, for example, the island geography creates di culties in both distributing cash and extending digital infrastructure. In countries in which cash usage is dwindling, access to payment is also a key concern. Some segments of the population still rely on, or prefer, making cash payments, but may run into limitations. One of the Riksbank’s top priority goals for the e-krona project is to ensure broad access to payments in the years ahead (the elderly and groups with certain disabilities). Making payments more e cient —> in countries where cash and check use is high operational costs are elevated. In some countries existing digital payments are also relatively expensive. CBDC is therefore a potential policy tool to o er digital forms of payments that are cheaper to operate. the non-pro t nature of central banks means that they could potentially o er low-cost payments as a public good, potentially subject to the need to eventually recover costs. The Bahamas and the ECCU are high-cost jurisdictions for both physical and existing digital payments. In the Bahamas, an important additional consideration has been the high cost for government agencies to make cash-based payments to citizens who lack bank accounts. There are plans to integrate government agencies in the Sand Dollar network to support digital government payments to individuals to lower this cost. Ensuring the resilience of payments —> ensuring the ability to pay and extending government transfers to individuals under severe circumstances is important for all jurisdictions, but the urgency of this policy goal is especially high in disaster-prone nations. For the Bahamas and the ECCU, resilience is considered a key policy goal. Both consist of islands in a region where natural disasters are frequent. Destruction of physical, nancial infrastructure and impediments to shipping cash are immediate concerns. In the Bahamas, a hurricane in 2019 precipitated the start of the Sand Dollar pilot in the same year to facilitate assistance payments to and within a icted areas. Likewise, the ECCB accelerated the expansion of its DCash pilot to areas a ected by a volcano eruption in St. Vincent and the Grenadines in 2021. Countries with a highly digitalised payment sector are concerned about disruption to digital services and concentration risks where there are only a few large operators. In China, for example, the mobile payment market is dominated by two rms, AliPay and TenPay/WeChat Pay. The PBOC has expressed concern that the failure of such rms could have serious consequences to the Chinese payments system. One of the crucial policy goals expressed by the PBOC is for the e-CNY to function as a backup to existing digital payment solutions. Reducing illicit use of money —> some features of cash, including anonymity and the lack of an audit trail, make it attractive for illicit transactions (for example, tax evasion, money laundering, and terrorist nancing). CBDC could potentially reduce this problem. At this point, however, only the Bahamas has reduction of the illicit use of money as a top policy objective for its CBDC. The background to this objective is an ongoing campaign to strengthen the Anti-Money Laundering / Combating Financing of Terrorism (AML/CTF). Monetary sovereignty —> while currency substitution has long been a risk facing countries, it is possible that new forms of digital currency might have a competitive advantage relative to older forms of currencies. If a su ciently large portion of a country’s population adopts a foreign digital currency or a global stable- coin, the ability of the country to carry out several crucial central bank functions might be impaired, such as monetary policy and lender of last resort. The BOC has stated that serious consideration of a CBDC might be triggered if monetary sovereignty were to become an issue—say if Canadians began adopting a non- Canadian digital currency or stable-coin. Likewise, the PBOC has said that one motivation for investigating CBDC was to secure monetary sovereignty in a digital future. 18 fi fi ffi fi fi fi fi fi ff ff ffi fi fi