According to the Financial Stability Board (FSB), there is a consensus among major economies, such as the G20, to enhance cross-border payments. Providing faster, cheaper, and more transparent and inclusive cross-border payment services would be beneficial for citizens, businesses, and national economies. As the Bank for International Settlements (BIS) noted, the Covid-19 pandemic made global policymakers rethink the significance of optimizing global payment and settlement systems, leading some countries to further explore the possibility of developing cross-border central bank digital currencies (CBDCs). In response, China has sped up its own CBDC experiment – the digital yuan or digital renminbi (RMB) – by joining the “Multiple CBDC (m-CBDC) Bridge” project, whose other members are the Hong Kong Monetary Authority and the central banks of Thailand and the UAE.
For China, accelerating the cross-border use of CBDCs is critical to realizing the country’s long-term national strategy of the internationalization of RMB to compete with other major currencies in international payments. A paper from the International Monetary Fund (IMF) also stressed that “CBDCs…could reinforce the incentives behind currency substitution and currency internationalization.” However, the People’s Bank of China (PBOC) has legally defined retail-CBDCs (Digital Currency Electronic Payments or DCEP) as digital “fiat money,” meaning it is currently incapable of being freely exchanged beyond the country’s borders, which may severely restrict DCEP acceptance and application in both domestic and international contexts. This is of particular importance now, as China has been promoting the use of retail-CBDCs within its borders on a large scale. Accordingly, exploring the cross-border use of CBDCs has become urgent for the PBOC.
Facilitating the cross-border use of CBDCs is beneficial for the global economy, as it contributes to higher efficiency in international payment and settlement systems and boosts multilateral economic cooperation in neighboring countries and beyond. However, the potential financial risks and regulatory challenges should not be underestimated. As the second largest economy in the world, China should be cautious if and when it experiments with cross-border CBDCs and carefully consider the challenges, such as financial stability and regulatory compatibility.
In a recent paper, we point out three areas that are of major regulatory concern over the cross-border use of digital yuan that merit attention from the PBOC and financial authorities in other countries:
Reconciling the regulatory conflicts between enforcing anti-money laundering (AML) law and personal data & privacy protection law
The most common reason for AML fines on financial institutions is the failure to identify account ownership or to perform customer due diligence. This conclusion stems from our review of major jurisdictions’ latest enforcement cases, which include actions against Neelam Amand MSB (United Kingdom), BO HAI Bank Changchun Branch (China), OANDA Corporation (U.S.), Bank J. Safra Sarasin (Singapore), Bihar Awami Co-operative Bank (India), and Deutsche Bank-AG (South Africa). Considering the anonymous design of CBDCs, balancing AML compliance in cross-border CBDCs with the protection of personal-data privacy is a tricky task for regulators. Multi-party coordination is needed to address this issue, as the transactions will likely involve regulatory compliance and law enforcement across different jurisdictions. For example, Chinese laws have not yet recognized data protection as a fundamental human right – unlike the European Union (EU), which has done so under Article 52(1) of the Charter of Fundamental Rights of the EU. Thus, the permitted range of personal-data collection associated with a CBDC would differ across these two jurisdictions. Unlike the EU, China does not have a set of proportionality tests that ensure regulatory powers given to governments under a particular law do not restrict citizens’ fundamental rights. Therefore, controlled anonymity will be a likely feature of China’s CBDC, while anonymity vouchers have been newly introduced by the European Central Bank (ECB). Under the ECB’s proposal, anonymity vouchers will be regularly issued by the AML authority to allow users to anonymously transfer a limited amount of CBDC over a defined period of time to protect their privacy.
Maintaining financial stability: liquidity spillovers, balance-sheet reorganization, and interest rate floating
The two-tier distribution model divides Chinese DCEP activity between China’s domestic commercial banks and the overseas RMB business clearing banks. Both are susceptible to run-risks when there is a swift exchange of funds between deposit money (interest-bearing) and DCEP accounts (non-interest bearing). In response, commercial banks, both onshore and offshore, would prefer to reorganize their balance sheets by partly switching long-term RMB assets into short-term assets. In addition, the cross-border payment convenience of Chinese CBDCs and the stability of RMB might expose certain developing countries with delicate financial systems to the threat of currency substitution. Moreover, in the event of an overheated domestic economy caused by the large inflow of foreign money converted to RMB via DCEP, the People’s Bank of China may raise interest rates to address inflationary concerns.
In practice, however, the regular fluctuation of currency exchange rates and interest rates is determined by multiple factors that present either positive or negative correlation, which further complicates the problem. Such a challenge requires domestic commercial banks to closely watch the global trend of CBDC inflow and outflow when setting interests rate for their savings products and conducting other rate-sensitive businesses.
Revising the settlement rules: weakening financial intermediaries or strengthening central counterparty clearing
Unlike DCEPs, wholesale-CBDCs generally flow through financial intermediaries, with a major impact on the institutional settlement framework. In China’s interbank bond market – accounting for roughly 80 percent of the trading volume of its national bond market – the legal framework of settlement and clearing for qualified foreign investors is formed by multiple accounts and a tier. The PBOC, the Market Clearing House Co., Ltd. (hereafter referred to as Shanghai Clearing House), and commercial banks have collectively been granted statutory rights and duties to provide services of centralized registration, custody, clearing, and settlement. Technically speaking, using wholesale CBDCs in the financial markets allows foreign investors to complete the settlement process while bypassing any third parties as they will have a direct claim on the PBOC. The peer-to-peer mechanism of settlement and clearing could reduce the transactional costs for foreign investors, but it also weakens the status of financial intermediaries, especially traditional commercial banks. However, considering financial safety and stability, the PBOC is likely to preserve the role of Shanghai Clearing House as a central counterparty, and might even embed wholesale-CBDCs into the Clearing House system in the future.
|Steps||Key points||Relevant regulations in China|
|1||Foreign institutional investors shall first entrust a commercial bank as custodian to open foreign currency account or/and a special RMB deposit account.||Article 7 and 9 of Announcement No. 2  on the Administration of Domestic Securities and Futures Investment Funds of Foreign Institutional Investors; Article 11 of Order No. 1  ‘Interim Measures for the Administration of Mutual Bond Market Access between Hong Kong SAR and Mainland China.’|
|2||Foreign institutional investors shall open a fund money settlement account at Shanghai Clearing Exchange.||Article 3 of No. 52  ‘Operating Guidelines for Networking and Account Opening by Foreign Institutional Investors in the Interbank Market.’|
|3||Foreign institutional investors shall allow entrusted custodian to authorize Shanghai Clearing House to directly debit or credit the designated fund money settlement account.||Article 62 of Announcement No. 13  ‘Announcement of the Shanghai Clearing House on Operating Rules and Procedures for the Registration, Custody, Clearing and Settlement of Interbank Bond Market’; Article 12 of ‘Operating Guidelines for the Settlement of Bond Transactions’(2020 version).|
|4||Shanghai Clearing House becomes the main custodian with rights to intervene in and inherit rights and duties of money settlements for counterparties.||Rule 1.17 of Notice by the Shanghai Clearing House of Issuing the Manual of the Centralized Clearing Business in the Interbank Market (Seventh Edition).|
Table 1: The Settlement and Clearing Framework of China’s Inter-bank Bond Market for Qualified Foreign Investors
Any central bank issuing CBDCs for cross-border use should carefully consider relevant impacts on domestic and international financial markets. It requires governments and central banks, as the initiators of CBDCs, to accomplish multiple tasks: build a regulatory system that is beneficial for both the host and offshore users; negotiate bilateral agreements on CBDC transfers; conduct effective macro-prudential regulation; and revise the settlement framework for financial markets. Our paper suggests that building a compatible CBDC cross-border system could largely improve the efficiency of international financial infrastructure, which benefits global economic growth in the long-term. However, central banks and financial authorities across the world must work together to address discrepancies in technological standards and regulatory systems.
 FSB, “Enhancing Cross-border Payments: Stage 3 roadmap” (October 13, 2020), available at https://www.fsb.org/wp-content/uploads/P131020-1.pdf
 BIS, “Multiple CBDC (mCBDC) Bridge”, available at https://www.bis.org/about/bisih/topics/cbdc/mcbdc_bridge.htm
 IMF, “Digital Money Across Borders: Macro-Financial Implications” (October 19, 2020), available at https://www.imf.org/en/Publications/Policy-Papers/Issues/2020/10/17/Digital-Money-Across-Borders-Macro-Financial-Implications-49823
 ECB, “Exploring anonymity in central bank digital currencies” (December 2019), available at https://www.ecb.europa.eu/paym/intro/publications/pdf/ecb.mipinfocus191217.en.pdf
This post comes to us from Lerong Lu, a senior lecturer in law at The Dickson Poon School of Law at King’s College London, and Alice Lingsheng Zhang, a PhD candidate at the School of Law at Shanghai University of Finance and Economics. It is based on their recent article, “Could The Chinese Dragon Now Fly Beyond Borders? Contextualizing The Cross-Border Use Of China’s CBDC, Financial Risk, And Regulatory Design.” The article was presented at “The 4th International Forum on Computational Law: Data Governance and Legal Tech” on September 25-26, 2021, Tsinghua University, Beijing, and is available here. A version of this post also appears on the Oxford Business Law Blog, here.