FCA chief calls for EU to extend Brexit clearing exemption

By Samuel Wilkes | News | 16 September 2019

Bailey also urges EU to grant equivalence determinations for UK trading venues

Andrew Bailey. Photo: Bank of England

The chief executive of the UK Financial Conduct Authority, Andrew Bailey, has said the European Union needs to extend temporary permission for UK clearing houses beyond its planned expiry date of March 30, 2020, to prevent EU clearing members being denied access.

In December 2018, the European Commission adopted an act allowing EU clearing members to temporarily access UK central counterparties for a 12-month period, starting from the original Brexit date of March 2019, in the case of the UK leaving the bloc without a deal.

Although the UK and EU have agreed twice to delay the UK’s exit from the bloc, now scheduled for October 31, the temporary equivalence measures will still lapse on March 30, 2020.

Meanwhile, EU CCPs will be granted temporary permission from the Bank of England for a period of three years, starting from the moment the UK leaves the bloc.

The European Commission’s (EC) vice-president for financial services has said in a recent interview with the Financial Times that firms should prepare for the March 2020 date. But Bailey argued there is a need for the EU to extend temporary equivalence further to ensure there is no disruption.

“The EU authorities have mitigated material disruption to cleared derivatives markets by announcing temporary recognition and conditional equivalence decisions for the UK CCPs, and the regulatory framework for them,” said Bailey, speaking in London on September 16. “Though I should make clear that, with the elapsing of time, there will soon need to be agreement to renew this arrangement.”

Without greater clarity on the regulatory status of UK CCPs, the contracts that EU members clear with UK CCPs will need to be closed or transferred

Andrew Bailey, UK Financial Conduct Authority

If the EC does not extend temporary equivalence or grant it permanently to UK CCPs, the likes of LCH and LME will have to serve their EU clearing members with three-month cancellation notices, telling the firms they will be off-boarded from their service. The latest this can happen is December 29. Those clearing members would then have to undertake the mammoth task of closing out or transferring trillions of pounds worth of derivatives contracts from those CCPs to EU-authorised ones.

“Without greater clarity on the regulatory status of UK CCPs, the contracts that EU members clear with UK CCPs will need to be closed or transferred by them,” said Bailey. “So this process would need to be done by the end of this year, but it imposes significant costs on EU firms, as well as straining market capacity. Further action could therefore be necessary to prevent this. I also think the best solution is for the EU to grant permanent recognition of UK CCPs.”

Primacy of politics

Bailey’s speech was part of a broader pitch for the EU to make greater use of temporary equivalence measures and even to grant permanent equivalence decisions to the UK’s financial sector.

“We took the view that there should be wider use of temporary permission than is already the case – and [for] clearing… it needs to be extended,” he said.

On the sidelines of Bailey’s speech, a UK-based lawyer tells Central Banking sister title Risk.net that it would legally make sense for the EU to grant the UK equivalence, because the UK’s rulebook for clearing services will be a near-perfect replica of EU regulations. However, as clearing is viewed by some EU policy-makers as a jewel of the UK’s financial services sector, the EU may prefer to use equivalence as leverage that is perceived to strengthen its hand in Brexit negotiations with the UK.

“From a perfectly legal and technical standpoint, it makes sense for the EU to give UK CCPs equivalence, but they want to keep political pressure on the UK in their negotiations,” says the UK lawyer.

The lawyer does not believe the EC will grant any form of equivalence until after the current scheduled departure date of October 31, to see what the UK will actually do. The UK prime minister, Boris Johnson, has made clear that he wants to leave on October 31, either with an improved deal from the one negotiated by his predecessor, Theresa May, or without one.

“It will be the exact same situation as last year,” says the lawyer. “UK CCPs will have to serve notices of termination to EU clearing members around Christmas time unless the EU grants an extension. I don’t think we will hear from the EU until after October 31, when things are clearer on what will happen.”

Avoid double jeopardy

Bailey listed several other areas where he said it was necessary for the EU to grant equivalence to the UK, notably the measures to ensure the continuity of outstanding bilateral derivatives contracts between EU and UK firms, and the ability for EU firms to trade EU equities and certain over-the-counter derivatives on UK venues.

Without an equivalence determination for each other’s trading venues, EU and UK firms will only be able to trade instruments subject to their jurisdiction’s trading obligations – known as the share and derivatives trading obligations – on venues in their respective jurisdictions, or those in jurisdictions deemed equivalent by their home legislator.

UK CCPs will have to serve notices of termination to EU clearing members around Christmas time unless the EU grants an extension

A UK-based lawyer

As many of the OTC derivatives caught by the derivatives EU’s derivatives trading obligation are traded on UK venues, Bailey said the absence of an equivalence determination would mean splitting the liquidity pool currently available on them.

Due to UK trading venue operators establishing separate platforms in EU member states, the watchdog for the EC and EU, the European Securities and Markets Authority, has stated it does not see any evidence that EU firms will be unable to meet the EU’s derivatives trading obligation and so there is no urgent need for an equivalence determination.

There are some firms, however, that will be caught by both the EU and UK’s trading obligations, meaning they will not be able to trade on either UK or EU trading platforms without an equivalence determination.

The affected group includes the UK branches of EU firms – Deutsche Bank in London, for example – and UK firms executing on behalf of EU firms as part of an outsourcing arrangement.

The only option for those operations would be to trade on US trading venues that have been granted equivalence by both the EU and UK authorities.

“We will work with EU regulators to try to avoid firms being caught by both UK and EU derivatives trading obligations,” said Bailey. “We believe the right outcome will be for regulators to ensure – where there is a conflict of law – which rule firms should follow, and this would only work if EU regulators were able to do the same. It would be, in my view, a suboptimal outcome if the only place for them to comply with their regulatory obligations is to trade outside Europe as a whole, which is one consequence that could happen.”

This article first appeared in sister title Risk.net.

Lane stresses broad consensus on ECB policy

By Victor Mendez-Barreira | News | 16 September 2019

Comments come after criticism from German and Dutch central bank governors

Philip Lane

Most members of the European Central Bank governing council agreed lower inflation and growth warranted new measures at the latest policy meeting, said ECB chief economist, Philip Lane, today (September 16).

The remarks come after a handful of national central bank governors expressed reservations over the decision.

In a speech in London, Lane explained he is convinced the new stimulus announced on September 12 will have a significant effect, boosting investment and consumption in the eurozone. This in turn should help push inflation towards the ECB’s below, but close to, 2% annual target.

“In the governing council there was a high degree of consensus around the need to act,” said Lane. “The current situation is not satisfactory; that is the most important question.”

Last week, ECB president Mario Draghi unveiled a set of measures to boost inflation in the region. These included reducing the deposit rate by 10 basis points to –0.5%, and indefinitely resuming net asset purchases at a monthly rate of €20 billion ($22 billion).

On September 13, several members of the governing council publicly opposed the decision approved by the body. The president of the Netherlands Bank, Klaas Knot, said he considered the measures “disproportionate”.

“This broad package of measures, in particular restarting the APP [asset purchase programme], is disproportionate to the present economic conditions, and there are sound reasons to doubt its effectiveness,” said Knot.

Additionally, Deutsche Bundesbank president Jens Weidmann said the ECB action was “excessively large”.

However, Lane downplayed disagreements between policy-makers. “If you look around the world, this debate is everywhere about how to better tackle below-target inflation,” said the chief economist in a Q&A following his speech.

“It is natural that the same debate is taking place among members of the governing council; this is quite healthy. The discussions are serious, and various points of views are discussed, but at the end of the day a decision is made.”

Lane pointed out inflation expectations have drastically fallen since December 2018. During 2019, projected inflation for 2021 has decreased from 1.8% to 1.5%.

“When you have such a big movement you need to respond,” he said. “In my perspective, we are still far from a conventional framework. As a result, this is not a radical change of attitude. The fact that we have re-opened an existing programme is not a dramatic decision.”

Some officials and analysts argue that years of stimulus, including a total of €2.6 trillion in asset purchases since March 2015, will limit the effectiveness of new purchases. However, Lane argued internal research shows quantitative easing can still loosen financial conditions.

“They pass through to lower lending rates facing firms and households, stimulating investment and consumption,” said Lane. “Regarding the overall impact, we would not do it if it were insignificant in the data. We are convinced this will have a significant effect.”

Symmetrical target

Lane emphasised the ECB will implement a symmetrical inflation target, treating below-target inflation as equally problematic as above-target price growth.

With the new policy package, the ECB intends to show that “our determination to act when inflation falls short of our medium-term inflation aim is just as strong as our determination to act when inflation exceeds that aim”, said the chief economist. “Stating clearly our commitment to symmetry is important, since the formulation of our aim – ‘below, but close to, 2%’ – risks being misunderstood, particularly in an environment of falling inflation expectations.”

In order to limit the negative side effects of this ultra-loose stance on the banking system, the ECB introduced a two-tier system. This now exempts part of commercial banks’ excess liquidity holdings at the central bank from the payments required by a –0.5% deposit rate. Funds worth up to six times the ECB’s minimum requirement have a 0% rate applied to them.

“This system has been calibrated to strike a balance between, on the one hand, offsetting the direct cost of negative interest rates on bank profitability, thereby helping to sustain the pass-through of low policy rates to bank lending rates,” said Lane. “And on the other, preserving the positive contribution of negative rates to the accommodative stance of monetary policy and the continued sustained convergence of inflation to our aim.”

The role of fiscal policy

Last week, Draghi stressed eurozone countries with solid fiscal positions should increase public spending to boost growth and facilitate the convergence of inflation to target.

This added to the clash between ECB and German officials. Despite negative growth in the second quarter of the year, both the German government and the Bundesbank have said they do not think it necessary to increase public spending.

Germany enjoys a very solid fiscal position. It last recorded a budget deficit in 2013, and last year it recorded a budget surplus of 1.7% of GDP, or €58 billion.

Today, Lane repeated and expanded on Draghi’s message. “Our mandate is unconditional, I’m not saying that fiscal is the new monetary,” he said. “I am making the empirical case that the macroeconomic environment depends on fiscal policies. Under these conditions, if you are facing a slowdown and you have fiscal space, you should use it.”

Regulators meet in Basel to grill stablecoin backers

By Daniel Hinge | News | 16 September 2019

Conference convened by G7 stablecoins group included Libra Association, Fnality and JP Morgan

The Bank for International Settlements

The Libra Association struck a conciliatory note today (September 16), as its officials met with central bankers and regulators in Basel to discuss issues posed by the rise of “stablecoins”.

“Our goal is a stable, secure, low-cost payment system that can expand access and improve financial services for billions of people,” said a spokesperson for the Libra Association in an emailed statement. “We are committed to ongoing engagement with central banks and financial regulators as we work toward that goal.” 

The organisation behind libra has drawn a mix of scepticism and invective from regulators and lawmakers concerned about the significant market power the Facebook-backed currency could wield. Members of the US Congress slammed the plan as “delusional” at a hearing in July.

Many were unimpressed by statements at libra’s launch in June that implied the stablecoin’s backers were willing to lobby hard as they sought to “shape a regulatory environment that encourages technological innovation”.

Central bankers were quick to respond, with plans laid just a day after libra’s launch for a G7 group to investigate stablecoins, chaired by the European Central Bank’s Benoît Cœuré.

Some, such as Bank of England governor Mark Carney, have hinted at an openness to stablecoins, but all regulators have warned the backers of stablecoins they must be prepared to meet full regulations before coming to market.

Today, the Libra Association spokesperson stressed the “constructive dialogue” with policy-makers at the event, which was hosted by the BIS and convened by the G7 group.

Regulators stressed the importance of this dialogue. “A key part of assessing new initiatives is to understand the details,” said Agustín Carstens, general manager of the BIS. “When such initiatives cross national borders, it’s important for regulators to co-ordinate and come to a common understanding.”

However, a statement from Cœuré indicated the continued caution expressed by regulators: “As a new technology, stablecoins are largely untested, especially on the scale required to run a global payment system. They give rise to a number of serious risks related to public policy priorities. The bar for regulatory approval will be high.”

Representatives from the Libra Association appeared alongside officials from Fnality, a consortium of global banks that have developed a “utility settlement coin” (USC), and from JP Morgan, which has been testing its own stablecoin, called the JPM coin.

While libra is designed to be backed by an unspecified basket of global currencies, JPM coin is backed by the US dollar and five separate USCs, which are each backed by the currencies of their national central banks: Canadian dollars, euros, pounds, US dollar and yen. Fnality says its aim is to create infrastructure for global payments based on blockchain.

The Basel event included a Q&A with representatives of the three organisations, and discussions of issues around anti-money laundering, data privacy, competition and tax compliance, as well as any potential impact on price and financial stability.

BIS paper: DLT opens possibility of ‘embedded supervision’

By Central Banking Newsdesk | Research | 16 September 2019

Distributed ledger data would be useful for supervision, but must be trustworthy, author says

Rather than trying to fit crypto assets into existing regulation, new technology could be used to oversee distributed ledger-based products, new research argues.

But the author also says a means needs to be found of ensuring data is trustworthy.

Raphael Auer, author of the Bank for International Settlements’ working paper, says distributed ledger technology (DLT) could allow for “embedded supervision”. It would be possible to monitor compliance automatically, simply by reading the market’s ledger, and cryptographic tools could be used to ensure confidentiality.

The issue, he warns, is that the data structure of DLT is based on economic consensus. Rather than a central intermediary that guarantees settlement finality, DLT requires agreement among market players, which Auer says could lead to collusion to reverse transactions and mislead supervisors.

Auer proposes a solution whereby any third party tasked with verifying transactions stands to lose a set amount of “verification capital” if any existing transactions are ever voided.

If the cost is set high enough, no market participant will ever find it profitable to bribe the verifiers into reversing the transaction history. Then supervisors will be able to trust the data contained in the ledger.

Zimbabwean rates hit 70% as inflation remains in triple digits

By Central Banking Newsdesk | News | 16 September 2019

Central bank attributes rapid price rises to restructuring of the economy

John Mangudya

The Reserve Bank of Zimbabwe has made a further major rate hike, having already pushed up the policy rate sharply in June to tackle surging inflation.

On September 13, governor John Mangudya unveiled a 20 percentage-point hike, bringing the overnight bank rate to 70%. In June, the RBZ hiked the rate from 15% to 50%.

Since Zimbabwe abandoned its increasingly untenable dollar peg in February, the national currency has fallen sharply, contributing to a rapid rise in inflation.

Month-on-month inflation rose from 4.4% in March to a peak of 39% in June, though it moderated somewhat to 21% in July. The latest year-on-year figure, for June, puts inflation at 175.5%.

Mangudya said the inflation resulted largely from the lingering effects of past monetisation of the fiscal deficit, and from the “ongoing and necessary correction of long decades of mispricing”.

Since depegging, the official rate for the Zimbabwean dollar against the US dollar has dropped 81%, from 2.5 to 13.2. At the same time, a host of government-administered price caps and subsidies have been abandoned, setting off inflation in key goods, such as fuel and electricity.

The central bank acknowledges there remains a gap between official and black market exchange rates, though it says this is narrowing. One monitoring website puts the black market rate at Z$16 per US dollar.

Mangudya stressed that the difficult process of adjustment would prove transitory, and “inflationary pressures begin to recede” as the pass-through of the weaker exchange rate fades and domestic prices “re-align”.

The central bank says it will no longer monetise the fiscal deficit, which it calls a “precondition for a stable exchange rate and inflation”.

Monetary policy committee

In a further sign of a movement towards a more conventional approach to policy-making, the Zimbabwean government has said future policy decisions will be made by a monetary policy committee.

The committee comprises Mangudya and both deputy governors, Kupukile Mlambo and Jesiman Chipika. They are joined by six other members: Kumbirai Katsande, Ashok Chakravarti, Douglas Munatsi, Marjorie Ngwenya, Eddie Cross and Theresa Moyo.

The RBZ says it will be “transparent” in its monetary policy “in order to anchor inflation expectations”. It promises to improve its communication “with relevant stakeholders” and promote a “two-way feedback mechanism”.

Bank of Israel proposes measures to stabilise social security system

By Central Banking Newsdesk | Research | 16 September 2019

Benefit payments set to rise faster than GDP in the coming decades, warns central bank

The Bank of Israel has proposed measures to safeguard the long-term stability of Israel’s social security system, known as ‘national insurance’.

In a new long-term forecast for the system, published on September 15, the central bank says payments will likely grow faster than GDP over the coming decades. This is due to the “ageing of the population and the rapid growth expected by the National Insurance Institute in the number of disability allowance recipients”.

The research estimates that without action, in 2050 a cashflow gap will emerge between total benefit payments and the financing sources allocated to national insurance.

In order to prevent this imbalance, the central bank proposes a set of measures. One would be indexing the benefits to the average wage in the economy, rather than to inflation.

Another option is to raise the retirement age for women, in line with a framework proposed by the Ministry of Finance in June. The government could also limit the growth in the number of disability allowance claimants, the central bank says. If stabilised at 3.9% of the population, compared with 3.5% today and the long-term forecast of 5%, the fiscal burden will be more manageable.

Depending on the options implemented, within the current expenditure framework the Bank of Israel expects insurance benefit costs to range from 7–8% of GDP, compared with the current rate of 6.8% of GDP.

Central banks are ‘riders on the storm’, say Jordà and Taylor

By Central Banking Newsdesk | Research | 16 September 2019

Central banks control less than half the overall variation in interest rates, authors find

Central banks have only limited control over the domestic interest rate, despite it being a core policy lever that most use to set monetary policy, new research finds.

In Riders on the storm, Òscar Jordà and Alan Taylor say central banks are forced to navigate through the economy’s “stormy waters”, and must pay attention to “local currents” as well as “underlying, yet powerful, global disturbances”.

They set out to empirically examine how factors outside central banks’ control affect interest rates. The issue is important today as a synchronised response to the global downturn in 2008 has given way to more varied policy settings, and therefore spillovers, they note.

The authors build an empirical model of the natural rate of interest, which helps them assess to what extent monetary policy is shaped by long-run trends that are largely beyond central banks’ control.

They find that over the past 50 years, the majority of short-term rate variation has been driven by long-term changes in the natural rate, with “less than half” from changes in the stance of policy.

“In a financially integrated world where capital can move freely across borders with increasing ease, central banks should tack in response to local conditions while at the same time observing the drift of economic currents,” Jordà and Taylor say.

Overseeing China’s payments revolution

By Alice Shen | Feature | 16 September 2019

PBoC has tried to strike balance between bigtech innovation and reining in risks

In mid-2018, the Chinese authorities sharply tightened their regulation of payment firms, seemingly bringing to an end an ‘easy money’ era, while also restricting the ability of third-party payment providers to profit from earning interest on client funds. The shift in stance came after years of loose oversight that facilitated explosive growth in the country’s payment system. While technology firms such as Alipay and WeChat Pay have helped China leapfrog card-based payment systems by using digital wallets and QR codes, Chinese regulators became worried that major tech companies running payment services could disrupt or pose threats to the country’s financial stability.

China’s growth in mobile payments during the past five years is remarkable. Annual transaction volumes reached $40 trillion (277 trillion yuan) in 2018, according to a report released by the People’s Bank of China (PBoC).1 At the same time, transactions via nonbank third-party payment networks represented three-quarters of the total, or $30 trillion, up 45% on the corresponding figure for 2017. Alipay – run by China’s biggest online marketplace, Alibaba – controls 54% of the digital payment market share. And WeChat Pay, a unit of Tencent, which operates inside China’s ubiquitous ‘super-app’ WeChat, holds a 39% share, according to Chinese consulting firm Analysys.2

The way China has regulated its booming mobile payments, especially ‘bigtech’, nonbank payment providers, may offer valuable lessons as payment revolutions take place in other countries – potentially including cross-border options such as Facebook’s proposed stablecoin, libra.

Push for technical innovation

A series of PBoC rulings in 2017 and 2018 have stopped bigtech payment operators profiting from interest income earned by depositing customers’ surplus payment funds. Instead, surplus payment funds now need to be placed with the PBoC and secure no interest in return – it had previously mandated that only certain percentages needed to be held with the central bank (see table A). As a result, more than 1 trillion yuan was deposited in reserve with the central bank by the end of last year, according to estimates by Yang Weixiao, an analyst with Bank of China International. The PBoC asked payment companies to deposit 100% of customer funds with the central bank by January 2019.

While holding reserves at the central bank should make the system more secure, it could hurt innovation in the sector, particularly for smaller companies.

“To keep 100% of customer funds in reserve will spell the end for small payment firms, as they rely on the interest income,” says Wang Pengbo, an analyst with Analysys.

“But it won’t impact big players too much, since interest income represents only a smaller part of their revenue. The harsher regulation suggests that the central bank expects more innovation, such as data service and customer behaviour analysis, from these payment companies, rather than interest arbitrage.”

What makes Alipay and WeChat Pay different from some other mobile payment services is that they also function like a digital wallet. The wallet is generally funded either by transfer from another digital wallet, or directly by linking a bank account and transmitting funds. Payments can be made using funds already in the wallet, or from linked bank debit cards or credit cards.

What makes Alipay and WeChat Pay different from some other mobile payment services is that they also function like a digital wallet

Before the new rules came into force, third-party payment companies were allowed to invest customer funds that were left in their digital wallets. Even if payment firms did not actively invest the funds, they could deposit the money in interest-bearing accounts at commercial banks. For example, Alipay had put customers’ provision funds into a special account with the Industrial and Commercial Bank of China (ICBC) – one of the big four state-owned banks – since 2005, the firm claimed. The payment network was originally set up in 2003 to facilitate transactions made on Alibaba’s e-commerce site, Taobao, much as with PayPal and eBay.

Hong Kong-listed Tencent earned 4.6 billion yuan in interest income in 2018, up from 3.9 billion yuan in the previous year. While interest income also increased in 2018, it accounted for a smaller portion of Tencent’s total revenue – 1.5%, compared with 1.7% in 2017. Interest income also includes returns from companies’ own cash deposited with commercial banks.

The share of interest income could decline further in 2019, after the PBoC ordered payment firms to hold all customer funds in reserve at the central bank starting from this January – although the regulation had been widely expected.

“Alipay has already completed the necessary work to meet the reserve requirement, and has never relied on reserve funds as a source of income,” says a company spokesperson, without specifying whether customer funds had generated interest income before the new rules had kicked in.

People’s Bank of China

Ant Financial, the finance affiliate of e-commerce giant Alibaba, does not publish figures of customer funds, and nor does Tencent. But judging from market shares, Alipay has around 490 billion yuan in customer funds, while WeChat Pay has 400 billion yuan.

An Alipay spokesperson says such as estimate is not reliable, as most customers choose to put their funds into Yu’e Bao, a wealth management platform embedded in Alipay’s mobile payment application. Roughly translated as ‘spare cash treasures’, Yu’e Bao provides an annualised 2.3% return by investing funds in the money markets. Funds in Yu’e Bao can also be used to make payments directly, just like money in the digital wallet’s balance. Besides investing in the money markets, customers can also choose to buy wealth management products via Alipay to speculate on higher risk/return products.

“Since Alipay introduced Yu’e Bao in 2013, people seldom leave the funds in balance. They would transfer it to Yu’e Bao and earn interest income on the money,” the Alipay spokesperson tells Central Banking.

Both Alipay and WeChat Pay declined to disclose the amount of funds held in balance and in reserves in accordance with the PBoC rules on provisions. But the estimate of 400 billion yuan for WeChat Pay was described as conservative, according to one person with knowledge of China’s payment industry. Yet the new rules will not represent a “major setback for the big two”, as payments are “strategic” for “the big tech giants”, says the official, who estimated the new rules would cost the tech firms “a few billion yuan a year”.

Managing risks

China began to issue regulatory guidelines for payment companies in 2010, when the PBoC published a set of rules targeting nonbank payment providers. But the pace and detail of new regulations accelerated in recent years, says Yang Tao, a researcher with the National Institution for Finance & Development at the Chinese Academy of Social Sciences.

“To make sure customers’ provision funds are secure is the priority when monitoring payment companies,” the PBoC said in a Q&A statement after an inspection of nonbank payment firms in 2016.3 “Putting the provision funds in reserve with the central bank or designated commercial banks could help us monitor liquidity risks of payment firms.”

Before the reserve requirement rule was put in place, each payment company on average opened 13 accounts for clients’ provision funds, with the highest number being 70, the PBoC said. Commercial banks would compete for the deposits from payment companies with contracts of different interest rates and tenors.

Efficiency and safety of the payment and clearing system have always been like a seesaw, and it is not easy to balance the trade-off

Yang Tao, National Institution for Finance & Development

The central bank found four problems with how payment companies managed the provision funds in a 2015 survey: depositing funds with unqualified banks; failure to transfer funds to a dedicated account by the end of day; the lack of an independent external auditor; and embezzlement.4

As the PBoC detailed regulation for payment companies, Zhejiang Yi Shi Enterprise Management Services became the first firm to lose its payment licence. Throughout 2015 and 2016, around 30 payment firms – most of which were prepaid card issuers – received punishments from the central bank, says Yang. And in 2018, the central bank issued a number of fines (see table B).

“Efficiency and safety of the payment and clearing system have always been like a seesaw, and it is not easy to balance the trade-off,” Yang tells Central Banking. “In China, regulators have had more tolerance and policy support for innovative technologies and businesses, which had helped the explosive growth of mobile payments, as well as a mixed bag of players in the industry.”

But China’s retail payment system is now well developed, and it is time for tighter regulation to reduce risks, adds Yang.

To force payment firms to improve their businesses’ compliance, the PBoC directed an industry trade body, the Payment & Clearing Association of China, to set up a clearing house dedicated to settle online payments in August 2017. The new clearing house, NetsUnion Clearing Corporation, was set up to help regulators improve oversight of the China’s online payment market, the company said.

“A clear boundary will be drawn between online payments and clearing services, forcing payment firms to improve the compliance of their businesses and offer better protection to consumers,” wrote NetsUnion chief executive Dong Junfeng in Caixin in 2017. “It is a key step towards ensuring the healthy development of the payment markets and the security of the financial markets.”5

Since this March, Alipay has worked with NetsUnion on cross-border payments and clearing, according to PBoC-affiliated Financial News.

Competition ahead

As China’s ubiquitous QR-based mobile payment system has developed with little reliance on the Chinese banking system, the country’s traditional players, such as banks and state-owned UnionPay, have struggled to keep up.

“This caught banks relatively flat-footed as their own payment initiatives [have centred] around the traditional magnetic striped card, UnionPay,” says Aaron Klein, policy director of the centre on regulation and markets at the Brookings Institution. “It also caught Chinese government officials and regulators somewhat by surprise.”

China’s QR-based mobile payment system is now ubiquitous

Founded in 2002, UnionPay is a payment card network supported by the PBoC and the Chinese government. As the only interbank network in China, it powers the payments and transfers via the point-of-sale (POS) network. Its payment initiatives, including contactless payment methods, similar to Visa’s payWave, have relied on traditional bank cards, while UnionPay’s mobile QuickPass – similar to Apple Pay – needs POS machines.

Major reasons for the adoption of mobile payments centring around Alipay and WeChat Pay were the ubiquity of smartphones, ease of transactions and distaste for fees, says Klein.

China’s payment firms are now turning to overseas markets as the domestic market matures. UnionPay, Alipay and WeChat Pay are all targeting areas where Chinese tourists are visiting. And UnionPay has made some breakthroughs in nations where the other two have stumbled.

In July, UnionPay was granted a payment system operator licence by the Nepal Rastra Bank, the Himalayan nation’s central bank. It was the first payment licence held by a foreign company in Nepal.

Earlier in May, the Nepalese central bank temporarily banned the use of Chinese mobile payment services, including Alipay and WeChat Pay, as well as unauthorised POS machines, citing misuse of foreign exchange.

Alipay may now operate in the country, as it is working with a local partner, Himalayan Bank. But neither Alipay nor WeChat Pay has obtained a payment licence in Nepal.

Tighter regulations and fiercer competition in China’s domestic market has prompted payment companies – both privately owned tech firms and state-owned enterprises – to expand internationally. Central banks in these markets will need to balance the trade-off between efficiency and safety, as competition between payment firms continues.


1. See: https://tinyurl.com/y6shhwq7.

2. See: https://tinyurl.com/y5s98t2k.

3. See: https://tinyurl.com/y5bls3v2.

4. See: https://tinyurl.com/y4dbtnnu.

5. Dong Junfeng, ‘Five things you need to know about China’s first online-payment clearinghouse’ in Caixin, July 6, 2017.

Dutch governor attacks ECB’s new stimulus

By Victor Mendez-Barreira | News | 13 September 2019

Klaas Knot says rate cut and QE is “disproportionate to present economic conditions”

The president of the Netherlands Bank, Klaas Knot, has sharply criticised the stimulus package approved by the European Central Bank earlier this week, especially the resumption of quantitative easing.

After the meeting of the ECB governing council in September 11–12, president Mario Draghi announced the first rate cut since March 2016, and a new round of net asset purchases in a bid to boost inflation.

The ECB reduced the deposit rate by 10 basis points to –0.5%, and said it will start an open-ended quantitative easing (QE) programme amounting to €20 billlion ($22 billion) per month.

In a rare public statement posted on the DNB’s website today (September 13), Knot said: “This broad package of measures, in particular restarting the APP [asset purchase programme], is disproportionate to the present economic conditions, and there are sound reasons to doubt its effectiveness.”

As this article went to press, Reuters reported that Deutsche Bundesbank president Jens Weidmann also criticised the ECB package as “excessively large” in an interview with German tabloid Bild. Only a day earlier, Bild had compared Draghi to Count Dracula – as was ‘sucking the blood’ of German savers.

The comments reinforce opposition to resuming net asset purchases expressed by other members of the governing council in the weeks leading up to the meeting. Both Weidmann and the German member of the ECB’s executive board, Sabine Lautenschläger, said they opposed re-starting QE in interviews in August.

“The question is whether new measures are necessary based on our inflation outlook, particularly if side-effects grow and effectiveness diminishes,” Weidmann told the German weekly Frankfurter Allgemeine Sonntagszeitung. “You know that I am particularly cautious about government bond purchases.”

Lautenschläger said asset purchases would only be justified in a bid to stave off deflation in the eurozone.

“In my opinion, based on the current data, it is much too early for a huge package,” she said. “And I am still convinced that the asset purchase programme is the ultima ratio,” she added.

The new governor of the National Bank of Austria, Robert Holzmann, confirmed the disagreement among governing council members in an interview today with Bloomberg. “It was a pushback, but it was a constructive one in which one tries to come up with a common solution but not everybody agreed with,” he said.

“It was essentially about the question how effective will further monetary easing in its various areas be. Is it something where we started to reach the end, or is there still effectiveness in it?” he added.

Some observers say the situation is unusual. “It is surprising the criticism about these measures is becoming rather widespread, with Dutch, German and Austrian officials publicly criticising an ECB policy decision,” says René Smits, professor of the Law of Economic and Monetary Union at the University of Amsterdam. “I don’t recall a press release such as the one published today by the Netherlands Bank.”

“The level of confrontation was probably higher in 2012 after Draghi unveiled outright monetary transactions, and Weidmann testified before the German constitutional court against the programme,” says Smits. “This amounted to siding with the opponents in judicial proceedings.”

Voting system

The ECB’s governing council has 25 members, comprising six executive board members and the 19 governors of the national central banks included in the eurozone. When Lithuania joined the group in January 2015, pushing the number of governors over 18, the ECB introduced a rotating vote system. This is required by the European Union treaties, says the ECB on its website.

The six executive board members have permanent voting rights, but four out of 19 governors relinquish their right on a monthly basis. As a result, 21 officials take part in the one-person one-vote system, with the president holding a casting vote. As a result, every policy decision requires the support of 11 members.

Those opposed to the easing measures championed by Draghi still clearly fall short of that number, and no policy decision has yet been controversial enough to require formal voting. Decisions are typically taken on the basis of consensus, or near-consensus.

Indeed, in the press conference after the meeting Draghi said, “the consensus was so broad that there was no need to take a vote”. Nonetheless, he acknowledged a diversity of views in relation to the APP.

Asked in the interview whether he thought governing council members viewed the easing package as a mistake in hindsight, Holzmann said: “I’m sure this idea crossed the mind of some people; it definitely crossed my mind.”

QE infinity?

In addition to the rate cut and the resumption of asset purchases, analysts highlight the open-ended nature of asset purchases and the new wording of the policy statement.

The ECB’s governing council agreed to add a strong easing bias to its policy statement. “This different forward guidance is state-dependent, and no longer date-dependent,” said Draghi.

The council said it expects QE “to run for as long as necessary to reinforce the accommodative impact of our policy rates, and to end shortly before we start raising the key ECB interest rates”.

This new link between asset purchases, interest rates and on-target inflation leads some observers and policy-makers to think QE is here to stay.

Until its last policy meeting, the ECB set a time horizon for interest rate levels. For instance, on July 25, it said it expected “rates to remain at their present or lower levels at least through the first half of 2020”.

But the ECB expects rates to remain at present levels or lower “until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within our projection horizon,” said Draghi. “And such convergence has been consistently reflected in underlying inflation dynamics.”

Knot rejected the underlying assumption behind the package that the ECB must do whatever it takes to reach the inflation target. “The economic slowdown means it is unavoidable that it will take longer before the ECB reaches its inflation aim of below but close to 2%, but this is not to say this aim is completely out of reach,” he said. “The only observation is currently that the inflation outlook lags behind the ECB’s aim.”

According to an early estimate by the official statistical agency Eurostat, prices rose year-on-year by 1% in August, unchanged from July.

“This is worrying, but it does not imply that restarting a far-reaching measure such as the APP is the appropriate instrument,” Knot said.

This new policy framework may limit the options of the new ECB president Christine Lagarde, who is due to take over from Draghi on November 1.

“I hope we are not locked in; I hope there will be room for it to be discussed in the future,” Holzmann told Bloomberg. “My take is that [Lagarde] comes from a different environment, has a different way of acting. I don’t think she is a weak person who would say ‘I’m locked in, I’m not allowed to do anything.’”

He added: “My take is as things change, also this forward guidance and the policy may change. Not tomorrow – not after tomorrow – but I wouldn’t think it is now there for the next decade.”

Book notes: Narrative Economics, by Robert Shiller

By Charles Goodhart | Review | 13 September 2019

The book is good fun to read but some elements are a little disappointing, says Charles Goodhart

Narrative Economics by Robert Shiller

Robert Shiller, Narrative economics: how stories go viral & drive major economic events, Princeton University, 2019, 377 pages

This book must have been rather fun to write. It is based on the progressive digitisation of (often much earlier) newspapers and books, in this case done mainly by ProQuest News & Newspapers and by Google Trends and Ngrams, which allows the author to check the frequency with which a word or phrase gets repeated in the relevant press, or in books. What Shiller documents is that certain macroeconomic words/phrases from time to time become wildly popular, (or “go viral”, a phrase that he overuses), far beyond the range of those with an academic or practical interest in the subject. Then, after a time, quicker for newspapers than for books, interest in such concepts wanes. Shiller likens this process to the epidemic of a contagious disease, a reasonable analogy, but again somewhat overdone, since there is no immediate analogue to the recovery/death mechanism that eventually halts a disease epidemic.

He chooses some 11 such examples of an economic concept becoming of widespread public interest. Nine of these come in Part III of the book, chapters 10–18, which form the backbone of the work, and covering such narratives as machinery and AI displacing labour (Luddism); bubbles and busts in the housing and stock markets; supposed evil business and trade union behaviour; the gold standard vs bimetallism; panic versus confidence; and frugality versus conspicuous consumption. The other two popular concepts that he covers, in the opening part of the book are bitcoin and the Laffer curve, chapters one and five.

The book is also good fun to read. It is full of amusing and apposite quotations, and interesting detail. Shiller demonstrates that a concept or phrase is much more likely to take a grip on the public imagination (i.e. ‘go viral’) if it is uttered by, or attributed to, a celebrity and that the celebrity would often be picking up a phrase already used by someone else, less well known. Thus Bryan’s “crucify mankind on a cross of gold” was a steal from a congressman called McCall, page 167, and Franklin D Roosevelt’s line about “the only thing we have to fear is fear itself” had several precedents, page 128. 

Other details that caught my eye included the fact that, rather akin to bitcoin, there was an attempt to use earlier technology to fashion a new whizzy form of money in the guise of electric dollars, representing units of energy, (page 193). Again, I was struck by his statement on page 190, that in the 1930s depression in the US there was a “forced deportation (then called repatriation) of a million workers of Mexican origin. The goal was to free up jobs for ‘real’ Americans”.

While Shiller is a generally good historian, there are a few nitpicking slips. Firstly, there were signs of financial panic at the outbreak of WWI (page 238). Also, he is far too credulous about the role of JP Morgan in the 1907 crisis, page 117. Rather than using his own money, his role was to oversee the distribution of $130 million sent up to New York by the secretary of the Treasury, LM Shaw. Narratives can be wrong as well as popular, which he does admit on page 96.

Shiller is, of course, exactly right to see the learning process as most often deriving from social intercourse, rather than individual, independent ratiocination. The theory that “people are consistent optimisers of a sensible utility function using all available information, with rational expectations”, page 277, and with no time constraints on such a learning process, is clearly bonkers, as he clearly states. Yet, that said, I found his attempt to relate the emergence of such popular economic narratives to wider macro-economic developments to be disappointing. He fails to justify his “key proposition of this book that economic fluctuations are substantially driven by contagion of oversimplified and easily transmitted variants of economic narratives”, page 26.

Instead, “it is difficult to predict which narrative will eventually have economic impact”, page 58, and their “timing is unpredictable”, so “when it comes to predicting economic events, one becomes painfully aware that there is no exact science to understanding the impact of narratives on the economy”, page 271. So, having started with the claim that such popular narratives are of major importance, he ends, in chapter 19, with a plea that better data and more research might in future show this to be true. 

Also, there is no discussion of the common identification problem, whereby public interest in an asset, e.g. bitcoin, housing, equities, is largely driven by its apparent trend rise, as much, or more, than the same rise is reinforced by the widening interest in it. With two-way causation, it is harder to identify what drives what.