Libra: The Regulatory Challenges Facebook Ignored

The announcement on June 18 by Facebook of what it calls “a simple global currency and financial infrastructure that empowers billions of people” was sure to receive immediate attention. Facebook founder and CEO Mark Zuckerberg is now on a global “mission.”[1] However, the Libra White Paper is long on Libra’s technology and short on the regulatory challenges it faces around the world.

  • The diagnostic

The need for Libra is based on a diagnostic: People lack access to a global, open, instant, and low-cost way to move money. The project focuses on international payments.

Why is cross-border payment expensive? First, this is very different in emerging markets (e.g. remittances) than in developed countries (e.g. tourism). Second, if it is a question of business model, Libra might force a fee reduction by international payment providers like SWIFT.[2] If it is a technology problem, Libra will compete with other digital payment systems. If it is a regulatory issue, Libra cannot expect to avoid complying with regulations.

  • The solution

“Moving money around globally should be as easy and cost-effective as — and even more safe and secure than — sending a text message or sharing a photo, no matter where you live, what you do, or how much you earn,” according to the Libra White Paper.[3]

An international payment system requires a complex infrastructure and, more importantly, safe systems. It is a challenge, as participants around the world will be of various quality and capabilities.

Probably the most innovative aspect of Libra is its support by the Libra Reserve. “The assets in the Libra Reserve will be held by a geographically distributed network of custodians with investment-grade credit rating to provide both security and decentralization of the assets.”

  • The ambition

The ambition is gigantic. The aim of inclusion into the financial system for more people is laudable., Reaching the 1.7 billion people who lack access to banking services requires local infrastructure, such as electricity, telecommunications and internet access.

I wish those goals could be achieved in a stroke of Libra. The digital world is global, the currency world is national. Libra provides a technological solution to problems that are not mostly technological, but rather social-economic or political.

The Facebook challenge

Finance is about trust.

The fact that Facebook took this initiative represents a challenge in itself. Columbia Law School Professor Katarina Pistor recently summarized the risk. “After years of disregarding privacy, exploiting user data, and failing to control its platform, Facebook has now unveiled a cryptocurrency and payment system that could take down the entire global economy. Governments must intervene before a company that ‘moves fast and breaks things ends up breaking everything.”[4]

A couple of days later, Professor Eric Posner from the University of Chicago reiterated this idea: “Facebook, one of the world’s most distrusted companies, wants us to trust its new Libra cryptocurrency, which, it hopes, will be used by billions of people around the world. We shouldn’t. Libra will almost exactly replicate all the problems generated by Facebook’s social network.[5]

Many authorities around the world expressed skepticism on Facebook’s ability to respect privacy rules. Facebook will need to address this credibility gap.

What do we know about Libra?

  • Is it a currency or money?

There seems to be confusion – common as to many crypto assets – about the difference between money and currency. The strangest definition of Bitcoin came from the Bank of Finland, which considers it a commodity. Money is a means of exchange . It replaces barter.

A currency is a complex instrument: It is legal tender in the country that issues it, being issued by that country’s central bank. It carries the sovereign rights of that country’s government: There is a reason why the Federal Reserve and the U.S. Treasury appear on the dollar banknote. It is a liability of that country as well as an asset for the holder. A currency acts as an instrument of payment, a unit of account, and a store of value. In that sense, Libra is not a currency.

  • Pegged to a basket of currencies

No crypto assets are a currency, and neither will Libra be, because they lack the backing of a sovereign. Libra will be pegged to a basket of fiat currencies: the U.S. dollar, the Japanese Yen, the Euro, and the UK pound. While it is considered a stable coin because it will not fluctuate as a single currency, its value will constantly vary on the basis of the value and weight of the underlying currencies. The IMF Special Drawing Rights, a basket of currencies, never became a market instrument.

Furthermore, as we saw with crypto assets, supply and demand prevail. It is unclear whether the Libra Association will be able to keep the value of the Libra within the parameters of its basket of reference currencies. This might be a source of volatility.

  • Is it a crypto asset?

When Bitcoin started, it was not expected to be an instrument of reserve, but an instrument of payment. Both Libra and Bitcoin have no sovereign backing or public issuer. But, in contrast to Bitcoin, Libra is issued by a single entity: the Libra Association. The Bitcoin Foundation has a promotional purpose but is not issuing the coins.[6]

In contrast to Libra, Bitcoin and other crypto assets have no underlying asset. Their value varies based on supply and demand.

  • Payment system: “moving money around globally”

Money already moves around the world. The foreign exchange market alone, where currencies are converted, trades more than $5 trillion a day. By definition, Libra will not be a currency, and it will be not qualify as a national currency in any market where it trades. This implies that, other than Libra kept in a Libra wallet, most Libra will be converted into a fiat currency.

Money does not move around globally without being rooted in a specific country. For Libra to represent 1 percent of the foreign exchange market, it would need to trade $50 billion per day.

The regulatory challenges

The announcement of the Libra project raised serious regulatory questions.

  • The U.S. House of Representatives’ Committee on Financial Services wrote to Facebook’s Mark Zuckerberg, Sheryl Sandberg, and the chief executive of Calibra, David Marcus, asking for a moratorium on the development of both Libra Coin itself and Facebook’s bespoke wallet, Calibra.[7]
  • Mark Carney, the governor of the Bank of England, declared he would meet Facebook’s ambitions “with an open mind” but not “an open door”.[8] The Bank of England, the UK Treasury, and the FCA are working together to assess Libra. [9]
  • Olivier Guersent, the European Commission official in charge of financial stability, said ahead of Libra’s unveiling that Facebook’s potential concentration of both personal and financial data needed attention from regulators.[10]
  • At the Bank for International Settlements (BIS), the banker of central banks, the first priority seems to be to accelerate the projects of central banks to issue digital Libra might therefore have to compete with digital currencies issued by central banks in fiat currencies.[11]
  • The Financial Stability Board (FSB), chaired by Randall Quarles of the Federal Reserve, sent a letter to the G20 members stating that “a wider use of new types of crypto assets for retail payment purposes would warrant close scrutiny by authorities to ensure that that they are subject to high standards of regulation. The FSB and standard-setting bodies will monitor risks very closely and in a coordinated fashion and consider additional multilateral responses as needed.”[12]

A G7 working group will also consider how to ensure proper controls against money-laundering, according to a letter from Bruno Le Maire, the French finance minister, and François Villeroy de Galhau, the governor of the Banque de France.[13]

The issues

  • Convertibility in fiat currencies

Whether it is acquired or sold to obtain fiat currencies, Libra, as a basket of currencies, will be fundamentally dependent on the ability to convert it into fiat currencies. That ability has to be built, currency by currency, and will be subject to the characteristics of each fiat currency, its convertibility, and foreign exchange rules and regulations.

That process will be tedious: Facebook should consider the currency constraints and foreign exchange management of each country. Each Libra will affect the foreign exchange reserves countries. The objective to reach the unbanked people around the world might be affected by this reality: Less developed countries do not dispose of foreign exchange reserves and often restrict the acquisition of a foreign currency (or Libra for that matter). They will not use their reserves to provide any form of convertibility to Libra.

  • Systemic risks

Crypto currencies don’t present a systemic risk, even after their value exceeded $1 trillion. Libra will therefore be an active component of the foreign exchange markets. The risks associated with the supply and demand of Libra are not insignificant and, should Libra be successful, could reach systemic proportions. One of the critical issues is that a wide circulation of Libra implies a robustness that comes from the system itself.  Central banks are not expected to intervene in a run on non-fiat currencies. The safety net that currencies and sovereign debt receive from central banks will not apply to Libra. It will be allowed to fail.

  • Money laundering

The history of crypto currencies has been plagued by money laundering, frauds, crypto exchange failures, and ICO bond defaults. Libra will enter a field where one of the first concerns of regulators will be to make sure that a new level of transparency is provided to reduce the risks of fraud.

  • Government bonds as collateral

The Libra Reserve’s investments in assets “are the major difference between it and many existing cryptocurrencies that lack such intrinsic value and hence have prices that fluctuate significantly based on expectations.”[14] The interest of those assets will be used to pay for the functioning of the system. In a way, the Libra Reserve functions as a central bank by covering the circulation of its currency with sovereign bonds from the U.S., Japan, the United Kingdom, and the Eurozone.

This is an asset management function doubled with multi-currency hedging.

  • The issue of separation from social media

The most scrutinized regulatory aspect will be the separation between Facebook as a social media company and Libra as a means of payment. The issues Facebook faced on privacy will reemerge in force. Among other things, the Libra Association will have to comply with regulations such as “know your customer” that require deep knowledge of customers, a serious weakness of Facebook.  Jamie Dimon raised these issues in a recent interview.[15] Also Sheila Bair reminds us that: “there will be no regulatory oversight of what Libra actually does with your money and no capital and liquidity requirements that you would typically find with a bank”.[16]

Impact on monetary policy

  • Liquidity

The impact of Libra on the ability of central banks to conduct monetary policy will be particularly felt in a general liquidity crisis. The open market policy does not apply to Libra denominated instruments.

It is important that the commitment to well-functioning markets be clearly spelled out. Why would taxpayer money be used to support Libra should there be a liquidity crunch that might erode or destroy the value of Libra?

  • Interest rates

Those who use the main tool of monetary policy, short-term interest rates, will not be able to ignore the trends in the development of Libra. However, the problem will only emerge if, in one or another country, a substantial amount of liquid assets is not held in the national currency. This might make converting Libra into fiat currencies more difficult.  Needless today, Libra will not bear interest and serve as an investment.

  • Central Bank Digital Currencies (CBDC)

The issuance of digital currencies by central banks is a work in progress. Quietly, under BIS, central banks are seeking to digitalize their currencies. Let’s make one thing clear: A CBDC is not another currency. It is an existing currency in digital form. BIS writes: “CBDC is potentially a new form of digital central bank money that can be distinguished from reserves or settlement balances held by commercial banks at central banks.“[17] Libra creates new momentum for CBDC.

The work is just beginning

Money will not be privatized.

There should be no doubt that the sovereign control of currency will not be transferred to private entities. In the case of Libra, regulators and central banks have decided to coordinate their policies, which is good news. Also, banks will not passively watch Libra replace their role in payment systems.

Facebook has chosen to present its initiative by focusing on its technology. The regulatory and social-political part of the challenge is yet to be spelled out. This is what the Libra announcement achieved: It mobilized the financial services world and will force the authorities to ensure a regulatory framework for these assets.

Libra is not a revolutionary technology. It is a new way of approaching international payment systems. Social, economic, and financial factors rather than technological sophistication will make or break this initiative. Libra has the potential to improve international payments in a number of ways, but it will hardly be an alternative to fiat currencies.

ENDNOTES

[1] https://libra.org/en-US/white-paper/#introduction

[2] https://www.swift.com/

[3] https://libra.org/en-US/white-paper/#introducing-libra

[4] https://www.project-syndicate.org/commentary/facebook-libra-must-be-stopped-by-katharina-pistor-2019-06

[5] https://www.theatlantic.com/ideas/archive/2019/06/dont-trust-libra-facebooks-new-cryptocurrency/592450/

[6] https://bitcoinfoundation.org/

[7] https://www.forbes.com/sites/francescoppola/2019/07/02/congressional-committee-calls-for-a-moratorium-on-facebooks-libra-project/#46495c103cd6

[8] https://www.ft.com/content/541918d8-92b5-11e9-b7ea-60e35ef678d2

[9] https://finance.yahoo.com/news/facebook-libra-fca-treasury-bank-of-england-andrew-bailey-cryptocurrency-112408816.html

[10] https://www.ft.com/content/14e3b778-92af-11e9-b7ea-60e35ef678d2

[11] https://www.ft.com/content/5535fb3a-91ea-11e9-b7ea-60e35ef678d2

[12] https://www.fsb.org/2019/06/fsb-chairs-letter-to-g20-leaders-meeting-in-osaka/

[13] https://www.reuters.com/article/us-facebook-crypto-france/france-creates-g7-cryptocurrency-task-force-as-facebooks-libra-unsettles-governments-idUSKCN1TM0SO

[14] https://libra.org/en-US/white-paper/#the-libra-currency-and-reserve

[15] https://finance.yahoo.com/news/jp-morgan-ceo-jamie-dimon-has-questions-about-facebooks-cryptocurrency-libra-150525210.html

[16] Sheila Bair (July 8, 2019), ‘Why the Fed should oversee Facebook’s Libra’, https://finance.yahoo.com/news/fed-libra-sheila-bair-160930832.html

[17]https://www.bis.org/cpmi/publ/d174.pdf

This post comes to us from Georges Ugeux, chairman and CEO of Galileo Global Advisors and former group executive vice president of the New York Stock Exchange. He teaches international banking and finance and a reading class on Brexit at Columbia Law School.

1 Comment

  1. Meyer Eisenberg

    What is missing from the very interesting “regulatory
    challenges” discussed in George Ugeux’s recent post
    in the Blue Sky Blog, is any reference to the securities
    regulatory issues relating to cybercurrency offerings.
    Changing the nomenclature from “account” to “wallet”
    and “redemptions” to “mining” does not resolve the
    questions raised by the SEC of, eg, why are not IPO’s
    offerings of interests in cyber tokens securities, subject to the registration requirements of Sec.5 of the 1933
    Act and the antifraud provisions of both the ’33 and ’34
    Acts? Are the platforms for transactions in cyber currencies not unregistered exchanges and the sales
    organizations broker dealers? Is the pool backing the Libra, along with the pool of the “coins”, not an unregistered investment company and their managers. investment advisers subject to the Advisers Act? This is not to dismiss the important bank regulatory issues
    raised in the Ugeux comments, just adding to the scope
    of relevant issues which need to be addressed by the
    sponsors of these interests and their counsel and by the bank, securities and commodities regulators who are
    charged with enforcing existing statutes.It is also a
    caution to Congressional committees not to jump aboard a moving train before they know where it is headed…Experience with cyber tokens is littered with
    problems that need to be addressed before the yellow
    caution light is turned to green…Why are the sponsors of these interests so opposed to full disclosure of risks?
    There is an array of fair exemptions available..under
    the securities laws…Why are the sponsors so dead set
    against using them? The “white papers” that have been
    touted as adequate disclosure are often drowned in
    hype, just as drug ads for clear skin or arthritis zip
    through disclosures of serious side effects. Right now the light is dark amber…serious caution is warranted
    on both fronts-banking and securities /commodities…

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