Libra is a new global digital currency backed by Facebook and some of the biggest players in financial services and tech, due for launch in 2020. It offers international money transfers for 1.7 billion people without bank accounts.
Libra at a glance
• Libra faces a number of legal and regulatory hurdles including the complex patchwork of international financial services regulation.
• Data privacy will be a thorny issue as Libra will have to ensure compliance with global data protection requirements.
• Tax authorities are likely to take an interest in who is using and accepting Libra.
• Libra faces a range of political difficulties - in the US, for example, there are calls for a break up of big tech and the power that it wields and there are international calls for central bank oversight.
Libra is a “stablecoin” and so, unlike Bitcoin, for example, will be linked to a reserve of underlying stable assets to maintain its value. However, getting a project of this global reach and magnitude off the ground gives rise to a range of regulatory, legal, practical and political challenges.
Facebook has incorporated a regulated subsidiary, Calibra, to manage the financial services it will provide in relation to Libra with the stated aim of keeping individuals’ financial and social data separate. Calibra’s first product is a digital wallet allowing consumers to hold and spend Libra, although there is no restriction on other firms creating competitor wallets.
It is quite clear that Libra is not solely intended as a financial inclusion tool. The list of founding members of the Libra Association includes many businesses with plenty of affluent tech-savvy customers and Libra has obvious potential to become a global currency with worldwide acceptance.
One of the regulatory mazes Libra will need to navigate is the complex patchwork of international regulatory frameworks governing financial services.
In the US, a key issue will be whether Libra will be treated as a security and, consequently, subject to US securities laws and the jurisdiction of the Securities and Exchange Commission (SEC).
Libra also potentially triggers US money transmission and commodities regulatory regimes, among others. As to commodities law, to the extent Libra is considered a virtual currency, the US Commodity Futures Trading Commission could potentially assert the right to police fraud and manipulative conduct.
In the EU - The establishment of the Libra Reserve pool of assets which provide backing for Libra has the hallmarks of a collective investment undertaking or scheme. The issuance of, and intermediaries providing services with respect to Libra to EU customers will need to be mindful of fund and investment services legislation as well as regulations governing the authorisation of intermediaries and trading venues, fund marketing and securities offers, the distribution of packaged products to retail investors, securitisation (at least if there is some element of subordination of the claims of the holders of investment tokens on the asset pool) and market abuse. Furthermore, the EU payment services framework may also be relevant given that Libra’s explicit function is to enable users to meet their obligations arising from transactions, as will the EU electronic money rules if Libra gives its holders claims on an issuer in exchange for the receipt of funds.
As Libra is intended to act as a global currency, regulatory constraints across the globe will be relevant. For example, some countries such as China have introduced a cryptocurrency prohibition, some, such as Germany, have extended existing financial services legislation to bring even true cryptocurrencies such as Bitcoin in scope whereas other jurisdictions such as Malta and Gibraltar have developed bespoke cryptocurrency regimes, each of which will need to be traversed. The global picture is a patchwork which is notoriously difficult to navigate but, that said, there are movements afoot which might help to develop a harmonised approach. France’s central bank governor Francois Villeroy de Galhau, for example, has announced that the G7 has set up a task force led by European Central Bank board member Benoit Coeure to assess stablecoins like Libra and how they fit within existing regulatory frameworks
Many other regulatory questions arise, such as how will financial crime regulations apply to transactions involving Libra (and to whom)? How and how frequently will the costs, income and assets of the Libra Reserve be calculated and reconciled against outstanding Libra, will this be published, and how frequently? What contractual and transparency requirements – such as the need for a written agreement, and statements of transactions, to be provided on paper or in a durable medium – apply to intermediaries providing services relating to Libra and can these be discharged in practice? Will Libra users benefit from government insurance or deposit guarantee schemes in respect of their Libra holdings or in respect of services provided to them relating to Libra by professional providers? From an institutional perspective, what is the regulatory capital or liquidity treatment of banks or other regulated financial institutions holding or trading in Libra and are entities with limited charters permitted to hold Libra at all? What is the liquidity treatment of banks or other regulated financial institutions acting as custodians of the Libra Reserve asset pool?
One further regulatory question concerns data privacy. The data and data flows relating to Libra, Libra transactions and Libra users will be numerous, cross-border and rich in nature, making for a heady mix of challenge and opportunity in a post-GDPR world. Building the system to ensure current and future compliance with global data protection requirements will be critical, and regulators have already voiced concerns on this front given Facebook’s recent past.
One such question is as to the legal nature of Libra – a broader question which continues to challenge the cryptocurrency market. This is particularly important for Libra, however, because of the asset-backing. Its legal characterisation will determine whether the holders of Libra or authorised resellers have any legal claims in respect of the Libra Reserve assets, the law governing those claims and the jurisdiction for enforcing those claims and how holders and resellers are protected against future changes in the arrangements governing Libra or a failure of the Libra Association or the custodians of the Libra Reserve assets.
In addition, the legal nature of Libra will determine how ownership can be transferred, whether security may be granted over Libra (and, if so, how), whether Libra can be stolen and how it may be retrieved (and who has the better claim in any dispute). It may also affect whether acquisitions of goods and services made using Libra are protected under, for example, consumer protection measures (perhaps they will if it is a sale but not if it is a barter). It is a fundamental question with far-reaching consequences.
The liability framework for Libra will also be complex – it is multi-actor and multilayered. Unpicking this, if and when the system does not work as parties intend will, no doubt, keep litigators busy for years to come and, what is more, the questions will be unprecedented – questions such as who should be liable for bugs in open source code which has been used by parties transacting in different jurisdictions where there is no single party with overall responsibility for governance of the Libra Blockchain? Will a claim in respect of a failure to transfer Libra be a debt or a claim for damages and will a judgment be made in Libra or in a fiat currency?
Libra’s high profile and its potential for wide adoption means that tax authorities are unlikely to be content to rely on voluntary compliance. We expect the Libra Association to be required to report on its users’ transactions to tax authorities, either under existing domestic and international frameworks, a semi-voluntary scheme (like Airbnb’s agreement with the Danish tax authority) or specific new rules. Tax is therefore likely to become far more of an issue for both consumers using Libra and businesses accepting Libra
For example, if there is any time lag between consumers acquiring Libra and spending it, then any gain or loss will fall under applicable capital gains tax rules. While exemptions may apply, computing a user’s liability over the course of a tax year (on potentially hundreds of transactions) will be practically difficult.
Authorised resellers and other businesses accepting Libra will suffer two taxable events: first, upon receiving Libra from consumers (i.e. “normal” tax on trading profits, which would have happened if they had received fiat currency); and second, upon either converting Libra back to fiat assets or spending the Libra with another Libra-accepting business (profit/loss/gain on the “disposal” of Libra). This means those businesses will be subject to real uncertainty and potentially higher costs.
In Romania, we may expect that the tax authorities will have a close look at a potential tax payable on Libra-related transactions, to the extent these will fall under the Romanian legal fiscal provisions which already provide since January 2019 that gains from transfers of virtual currencies are taxable (or other relevant fiscal regualtions which Romania may adopt for this purpose).
Given the global footprint, size and dominance of Facebook, policy issues abound.
First, Libra heralds another major foray by big techs into financial services.
The disintermediation of banks from payments and payment system access seems to be inexorable and has precedent in China where over half of transactions now take place using third-party payment providers such as WeChat and AliPay. In fact, over half a trillion transactions were processed using the platforms of these two tech giants last year (around 1.7 billion transactions a day). The power that big techs apparently wield has its critics and, increasingly, particularly in the US, there have been calls for a break up of big tech. The launch of Libra will add fuel to this particular fire.
If, for example, Libra were indeed to become a global payment system enabling payments across geographies, Mark Carney, Governor of the Bank of England, indicated that central bank oversight would be necessary. He said: “If it’s going to work, it would be so important that ourselves, the Fed (Federal Reserve), the ECB, the major central banks of the world would have direct regulatory oversight of the entity”.
The National Bank of Romania recently reinstated its reservations with respect to the future of crypocurrencies, generally, because there are still numerous unknown aspects, although of course fintechs and blockchain technologies will restructure the future of financial-banking markets, especially through the streamline of payment systems.
The potential influence of big techs in the area of payments has also been recognised by international bodies. The Bank of International Settlements, for example, in its Annual Economic Report noted that “in some settings, such as the payment system, big techs have the potential to loom large very quickly as systemically relevant financial institutions”.
Another political discussion that will play out will be the potential for ‘dollarisation’. The accessibility and perceived security and stability of Libra and other stablecoins could mean that, increasingly, users of financial services are willing to transact in foreign currency, particularly in countries with weak domestic currencies (so-called ‘dollarisation’). Libra could facilitate this and bodies, including the IMF, are concerned that dollarisation could mean countries will lose monetary policy control, financial systems become more exposed to foreign exchange rate shocks, while central banks are constrained in providing liquidity. Ultimately, dollarisation can act as a restraint on financial development and long-term growth.
Another policy question which will no doubt be raised in connection with Libra’s structure, is the potential systemic impact of large-scale flows into and out of the Libra Reserve fund if Libra grows in scale. Flows out of conventional bank deposits and into Libra could adversely affect banks, for example by reducing the amount that they are able to lend, and distort government bond markets. Conversely, a ‘run’ on Libra leading to large-scale sales of Libra Reserve fund assets could lead to disorderly government bond markets. In addition, disruptions to the mechanisms for reconversions of Libra into fiat assets would not only potentially trigger a run but also potentially present wider consumer and systemic issues.
A Clifford Chance analysis; local input from Raluca Coman, Senior Associate Clifford Chance Badea