Money, Payment Systems and the European Union: The Regulatory Challenges of Governance [1 ed.] 1443897957, 9781443897952

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Money, Payment Systems and the European Union: The Regulatory Challenges of Governance [1 ed.]
 1443897957, 9781443897952

Table of contents :
Table of Contents
Acknowledgements
Preface
Part I: Money and the Law of Payments
Chapter One
Chapter Two
Chapter Three
Part II: Money, Identity and Communities
Chapter Four
Chapter Five
Chapter Six
Part III: Money and the Central Banking
Chapter Seven
Chapter Eight
Chapter Nine
Chapter Ten
Conclusions
About the Authors

Citation preview

Money, Payment Systems and the European Union

Money, Payment Systems and the European Union The Regulatory Challenges of Governance Edited by

Gabriella Gimigliano

Money, Payment Systems and the European Union: The Regulatory Challenges of Governance Edited by Gabriella Gimigliano This book first published 2016 Cambridge Scholars Publishing Lady Stephenson Library, Newcastle upon Tyne, NE6 2PA, UK British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Copyright © 2016 by Gabriella Gimigliano and contributors All rights for this book reserved. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner. ISBN (10): 1-4438-9795-7 ISBN (13): 978-1-4438-9795-2

TABLE OF CONTENTS

Acknowledgements ................................................................................... vii Preface ...................................................................................................... viii The Governance of Money and Payment Systems within the European Union: Rationale and Aims of a Study Gabriella Gimigliano Part I: MONEY AND THE LAW OF PAYMENTS Chapter One ................................................................................................. 2 Sources of EU Payments Law Agnieszka Janczuk Chapter Two .............................................................................................. 25 The Lights and Shadows of the EU Law on Payment Transactions Gabriella Gimigliano Chapter Three ............................................................................................ 39 Regulation of Payments after the PSD: Is there still a Role for Domestic Law? Noah Vardi Part II: MONEY, IDENTITY AND COMMUNITIES Chapter Four .............................................................................................. 58 Money and Identity within the Framework of the European Union Celia de Anca Chapter Five .............................................................................................. 77 ‘Equal for Equal, Hand to Hand’: Comparing Islamic and Western Money Valentino Cattelan Chapter Six .............................................................................................. 102 Hayek and Bitcoins: Which Governance for an International Currency Andrea Borroni and Marco Seghesio

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Part III: MONEY AND THE CENTRAL BANKING Chapter Seven.......................................................................................... 130 Oversight of European Payment Systems: Operational Arrangements and Governance Marta Bozina Beros Chapter Eight ........................................................................................... 152 Financial Integration, Financial Stability and Collective Action Charilaos Mertzanis Chapter Nine............................................................................................ 185 “Chinese Walls” within the European Central Bank after the Establishment of the Single Supervisory Mechanism Christos V. Gortsos Chapter Ten ............................................................................................. 208 The Changing Nature of the Crisis and the Revival of the Lender of Last Resort in Europe Luigi Scipione Conclusions ............................................................................................. 231 Vittorio Santoro About the Authors ................................................................................... 237

ACKNOWLEDGEMENTS

I am grateful to the European Commission Jean Monnet Programme, Education and Culture DG, that sponsored my research granting the teaching module “Building up a Payment System for the European Union” (2013-2016) of which this book is part. I must thank the University of Siena and, above all, the Department of Business and Law, for the accommodation of the Jean Monnet project.

PREFACE THE GOVERNANCE OF MONEY AND PAYMENT SYSTEMS WITHIN THE EU: RATIONALE AND AIMS OF A STUDY GABRIELLA GIMIGLIANO

1. The Doctrinal Background Borrowing a definition statement from Mark Bevir (Bevir, 2012, p. 1), governance covers: All processes of governing whether undertaken by a government, market, or network, whether over a family, tribe, formal or informal organization, or territory, and whether through laws, norms, power, or language.

Theoretically speaking, governance refers to “all processes of social organization and social coordination”, while in empirical terms governance covers any “changing organizational practices within corporations, the public sector, and the global order”. Since the 1980s, studies on governance have emphasized how a hierarchical organization is not strictly necessary, and that markets and networks of players can also govern, coordinate and take decisions (Bevir, 2012, p. 3). When the term “governance” is associated with money, the mind goes directly to the traditional regulatory paradigm, i.e. the nation State-Central Banking-Currency, over which the nation State, as the sole holder of monetary sovereignty, exercises this power by means of the central bank within its territory and this is the only authority entitled to authorize to issue (and actually issue) coins and notes as legal currency, as well as managing monetary policy. No statutory definition of monetary sovereignty has been laid down, but the legal doctrine has produced several attempts at conceptualization.

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According to Rosa Maria Lastra (Lastra, 2015, p. 19), monetary sovereignty covers the power of: -

Establishing the money representing the legal tender for discharging monetary obligations Issuing coins and notes Exercising monetary policy by controlling the money supply and the interest rates Managing the exchange rate regime Imposing on capital and exchange controls Regulating and supervising the banking system taking part in the money creation process thanks to sight deposits Oversight of the proper functioning of payment systems

However, as Rosa Maria Lastra wrote, quoting Tullio Treves (Lastra, 2015, p. 14): ‘State’ sovereignty belongs to the area of fact and not to the area of law. Sovereignty as the stable and undisturbed exercise of power within a given territory is seen as a factual situation from whose existence international law draws consequences which are the rights and obligations of states.

The same holds true for monetary sovereignty. Indeed, over time, there has been a steady erosion of the nation states’ sovereignty, also in the area of monetary law. This process of erosion is still working from within and externally to the nation state, or, in other words, from upwards to downwards and vice versa. Moving from upwards to downwards, highly interconnected financial markets have urged the national competent authorities to improve the global level of coordination in terms of sharing regulatory standards, supervisory models, and risk-monitoring procedures. This is the experience of the Basel Committee on Banking Supervision, the Financial Stability Board, the Committee on Payments and Market Infrastructures, the Committee on the Global Financial System, and the International Association of Deposit Insurers, just to mention some of them. They all work under the umbrella of the Bank for International Settlements (BIS), an international organization serving central banks, aiming to foster monetary and financial stability. In addition, the International Monetary Fund (IMF) is almost the same as the BIS. The IMF was established in 1944 to set up a framework for economic cooperation in order to avoid repeating the competitive devaluations that had contributed to the Great

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Depression of the 1930s. The vocation of the IMF from this point of view is briefly explained on its website. Any regulatory standards established under the umbrella of BIS or IMF fall within the area of the self-regulation of the central banks. Such rules will impinge on the behaviour of central banks in their countries of origin and will become compulsory rules within the national legal systems when the European or domestic lawmaker converts them into formal acts. In the downwards-upwards direction, the concept of sovereignty is critically revised from the perspective of new and alternative means of payment. Indeed, the growth of e-commerce and mobile commerce has increased the demand for Internet-based means of payment across various jurisdictions, with lower costs for buyers and sellers, especially in the case of micro-payments, and high levels of payment security. In addition, there are also virtual currency schemes in place. They are regarded as a “digital representation of value” (ECB, 2015, p. 4), and represent forms of unregulated digital money, issued and controlled by their developers, but not necessarily interacting with the “real” world. Accordingly, the virtual currency schemes have no physical counterpart in legal tender status. In fact, not only is the issuer different from a financial intermediary, but it is also not subject to financial regulation and supervision, nor is it denominated in legal currencies (ECB, 2012, p. 3). Crypto-currency models may really foster new complementary currency projects. Far from being a uniform model, CCs (complementary currencies) represent projects with various guiding principles and general philosophies, but they have in common the fact, as Jerome Blanc points out, that (Blanc, 2012, p. 6): (…) Sovereignty, as well as profit motives do not respect what can be considered a series of major distinctive features of CCs: they are designed and implemented mostly by civil society, mostly locally and grassroots, and mostly in a democratic way, emphasizing the citizen’s appropriation and redefinition of money in a participative process.

Indeed, taking into account three institutionalized principles of behaviour – namely exchange, redistribution, and reciprocity – Blanc drew the differences between local currencies based upon territorial projects, community currencies based upon community projects, and complementary currencies based upon economic projects. While local currencies, in compliance with national sovereignty, attempt to strengthen territorial purposes such as the Argentinean provincial currencies, community

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currencies are strictly linked to a given community. In this event, the monetary system aims to achieve a “mutual” purpose, for example a social service, self-help, or environmental purpose. This is the case for time banks. Finally, Blanc highlighted monetary systems geared towards economic (but not-for-profit) purposes. Here, the guiding principle is represented by market exchange and, accordingly, the monetary system is set up to develop actions by not-for-profit organizations deemed to be of general interest. This type of CC is linked neither to a territory nor to community issues (Blanc, 2012, 7). The regulatory flows from downwards to upwards and the reverse cross the state-based monetary legal system. However, they are intertwined, as the legal theories of money tell us. Agreeing with the state theory of money, Mann argued that, being based on constitutional legal history, modern constitutional law, and the principle of nominalism, the state had a monopoly over currency, so only the chattels legally issued by the issuing state, denominated by reference to a unit of account and addressed as the universal means of exchange in the state of issue, could be considered to be money. This meant that there was no difference between legal tender and money. Any other means of payment, such as cheques, could discharge monetary obligations only by the consent of the creditor and debtor (Proctor, 2005, pp.15 ff.). Furthermore, the “societary” theory of money had a purely functional approach to money. This approach argued, as economists do, that the concept of money covers any means of payment recognized as such by society. Therefore, one can infer that monetary sovereignty is no longer vested in the state, but is shared out among the people (Proctor, 2005, pp. 23 - 25). Occupying the middle ground, there is the institutional theory of money. This approach is based on the legal experience of the euro as scriptural money, the importance given to the reduced role of coins and notes in modern trade, and the emphasis on the central bank’s task of controlling the process of money creation. The institutional theory argues that money is a credit towards a qualified debtor. Namely, money is defined as a direct or indirect claim against a central bank and this credit can be used by the people as a means of payment and a store of value. Therefore, it arises out of, and is controlled by, a central bank, as a way of preserving “its availability, functionality, and purchasing power” (Proctor, 2005, pp. 25 – 30).

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The above-outlined theories represent three pillars in the landscape of money theories and define the area upon which other legal approaches have been developed (for example: Lastra, 2015, Zimmermann, 2013, Proctor, 2005, p. 40; Santoro, 2001). Apart from agreeing on one or the other legal approach, all of them apply elements of lex monetae and lex contractus or, in other words, they reason on the right to regulate the monetary system in relation to the substantive law applicable to contractual obligations. This book investigates trends in governance concerning lex monetae and lex contractus within the European Union framework.

2. The European Union Framework The European Union is a feasible institutional context in which to investigate the development of the governance of money. Indeed, the EU, considered as a “unique economic and political partnership”,1 has not laid down a clear-cut definition of money, but the member states have been carrying on a varying transfer of sovereignty and, in particular, of monetary sovereignty. With regard to monetary sovereignty, there are different levels of regulatory actions. Firstly, money as a means of payment is the subject of a set of regulatory actions on scriptural money taken at Community law level since the 1980s in building up an internal (or single or common) market for payment services. The construction of the internal market falls within the so-called share competences, i.e. those areas of competence shared between the Union and the member state, where the Union is entitled to take any regulatory actions in compliance with the principle of subsidiarity and the principle of proportionality.2 The Treaty on the European Union (TEU) established the guiding principle and the leading values of the internal market project. Indeed, according to art. 3.2 TEU: The Union shall establish an internal market. It shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aimed at full employment and social progress, and a high level of protection and

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improvement of the quality of the environment. It shall promote scientific and technological advancement. It shall combat social exclusion and discrimination, and shall promote social justice and protection, equality between women and men, solidarity between generations, and protection of the rights of the child. It shall promote economic, social, and territorial cohesion, and solidarity among member states. It shall respect its rich cultural and linguistic diversity, and shall ensure that Europe's cultural heritage is safeguarded and enhanced.

Concerning the monetary legal system in terms of lex contractus, the European Union established in its primary rules that all restrictions on the movement of capital and on payments between the member states are prohibited. However, the freedom of capital and payment has long raised several legal uncertainties on the direct applicability and scope of such freedom. Perhaps this is the reason why the soft and compulsory legal acts issued to build up the internal market for payment services have mostly referred to freedom of establishment and freedom of services. The Union-based framework for payment services3 covers manifold aspects of money as a means of discharging monetary obligations, although it does not claim to be a comprehensive legal framework. In particular, the Unionbased framework deals with: -

The access and operation of the business of payment service provision The transparency obligations of professional providers The contracting rules in the provider-user relationships, both in single payment transactions and framework contracts The regulation of fund transfers and the management of money laundering risk Access to payment systems; 4 The exchange of information, and cooperation between national competent authorities

Accordingly, the EU legislative framework is made up of Commission recommendations and communications, regulations and directives of the EU Parliament and the Council, as well as the technical standards, guidelines, opinions and warnings issued by the European Banking Authority (EBA). To what extent can the EU law for payments impinge on existing national laws?

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Generally speaking, the Union-based framework attempts to achieve a compromise between the protection of users’ funds and data, the integrity and stability of payment systems, and the level playing field within the market. However, the full harmonization approach is coupled with some degrees of latitude for the self-regulation of providers and users in the contracting relationships and state-based regulatory initiatives. Finally, it is worth noting that the primary and secondary European laws make no mention of CCs. This seems to leave both topics to the market processes and to state-based initiatives. However, a careful investigation of the governance processes they are spurring on is necessary as long as the Union – namely, art. 3 TEU – claims to “work for the sustainable development of Europe based on (…) a highly competitive social market economy”, to “combat social exclusion and discrimination”, and to “respect its rich cultural (…) diversity”. Secondly, the establishment of the Euro-system wherein lex contractus and lex monetae meet. As the third stage of the monetary integration process that began with the Delors Report, the euro is recognized as the currency of economic and monetary union (art. 3.4, Treaty on the European Union or TEU), while art. 3 of the Treaty on the Functioning of the European Union (TFEU) established that the Union has, among other things, exclusive competence in the area of monetary policy for “the member states whose currency is the euro”, and this seems to counterbalance the very general statement of the above-mentioned TEU provision. The exercise of monetary policy in addition to the authorization and issuance of euro coins and notes, the conduct of foreign-exchange operations, the management of foreign reserves, and the oversight of payment systems, are entrusted to the European Central Bank (ECB) and the European System of Central Banks (ESCB). The EU Treaties also established a set of guiding principles and policy priorities to drive the performance of the ECB and ESCB in the pursuit of monetary governance. At the top of the list is the policy maintaining the stability of prices. Later on, they state that: Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives as laid down in Article 3 of the Treaty on European Union.

However, the idea of a Euro-system as a closed box in a bigger container for the governance of European monetary integration disappeared soon

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after its establishment. The first point of contact between them was established thanks to the SEPA project and, later on, followed by the financial and sovereign debt crises. Both of them have made the monetary integration process a highly complex picture. SEPA, or the Single Euro Payment Area, is a project launched by the EU Commission and promoted by the ECB to bridge the gap between the service levels of domestic and cross-border retail payment systems. This is a two-tier project and is, in fact, based on the EU institutional legislative initiatives and the work of the European Payment Council (EPC), made up of representatives of financial and banking intermediaries and their associations. There is a close relationship between these two components of the project. Both insist on the regulatory, business, and technical requirements of credit transfers, direct debits, and card-based payments in euros. However, while the guidelines, general principles, and rulebooks issued by the EPC are compulsory only for its members, the institutional acts are mandatory for euro and non-euro member states, but have different deadlines. Coming now to the financial and sovereign debt crises, these had the “merit” of addressing the drawbacks of the “asymmetries between monetary policy and fiscal policy, and between monetary policy and financial regulation, and supervision proved to be an inherent source of strain on EMU (…)” (Lastra, 2015, p. XIV). Once again, the events pointed to the weakness of the “economic” step of the European economic and monetary integration process (EMI). With regard to economic integration, TFEU art. 119 provides that the member states be committed to adopting “close cooperation” on economic policies. Economic integration, together with monetary integration, is to be carried out according to a set of guiding principles: -

“Stable prices, sound public finances and monetary conditions, and a sustainable balance of payments”5 “A spirit of solidarity between member states” where the Council can decide to provide appropriate measures for member states living in “severe difficulties” arising from the supply of certain products, especially energy. But the spirit of solidarity may also justify financial assistance to support a member state “seriously threatened by severe difficulties due to natural disasters or exceptional occurrences beyond its control”6

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-

-

-

-

The prohibition of overdraft facilities or other forms of credit facilities with the ECB or the national central banks in favour of public authorities (Union, national, or local authorities) “as shall the purchase directly from them by the European Central Bank or national central bank of debt instruments”7 The prohibition of any “privileged access” by Union institutions, national governments, or other public authorities to any measures “not based on prudential considerations”8 The no-bail-out clause: this means that the economic and monetary integration process does not provide the member states with mutual assistance for debts apart from the joint execution of special projects9 The commitment of member states to control “excessive government deficits”10

In the aftermath of the crisis, this book aims to analyse the main regulatory changes to the central banking governance of the European monetary system, paying specific attention to macro- and micro- prudential regulation and supervision, as well as lending of last resort activity. Finally, monetary governance is analyzed from a more traditional viewpoint: whether and how in the European Union the governance of central banking in the oversight of payment systems is changing. Indeed, recent studies have underlined how the structural changes in retail payment systems, open network communication and new business models may weaken the gatekeeping function of banks and central banks vis-à-vis users’ funds and data protection, as well as the money laundering risk.

3. About the book In the light of the rationale and the objectives previously outlined, this book is an interdisciplinary volume, examining money as a means of payment and a reserve of value within the framework of the European Union, with particular attention to community-based currencies. This volume is divided into three parts. Part I deals with the examination of money as a means of payment within the European Union legal framework. In particular, the volume underlines how the European policymaker has not yet made a clear-cut choice between the state, institutional, and societary theories of money. In reality,

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elements of each are brought together to build up an internal market for payment transactions,11 payment systems, and payment services. This part consists of three chapters. In Chapter 1, Agnieszka Janczuk examines the public and private sources of EU law for payments, focusing on the hybrid nature of this body of law. Following on, in Chapter 2, Gabriella Gimigliano analyzes the transparency rules, the authorization and supervision process for payment service providers, and, finally, the choice of a basic payment account able to meet the objective of financial inclusion as three main outcomes of the Union-based internal market for transferring funds. Lastly, in Chapter 3, Noah Vardi examines, with a critical eye, the impact of the EU legal framework for payment systems on the domestic private law provisions, questioning the residual role of some institutions. Part II of the book examines the concept of money against the backdrop of the regulatory experiences of community-based currencies and legal systems from a society-centred perspective. Two phenomena are at issue: the growth of CC projects providing both bricks-and-mortar and digital means of exchange, and that of Islamic communities within the European context. This part has three chapters. In Chapter 4, Celia de Anca examines the development of money as a means of identity, and investigates how money can contribute to building a common European identity or a community-based identity within EU cultural pluralism. In chapter 5, Valentino Cattelan analyzes the Islamic law of money in order to understand its legal and socio-economic rationale, as well as the process of accommodation within the contemporary financial system. Finally, in Chapter 6, Andrea Borroni and Marco Seghesio examine the legal issues raised by virtual currency schemes and above all the Bitcoin, reinterpreting and modernizing Hayek’s model. Part III is devoted to central banking and to traditional or “less traditional” tasks in the aftermath of the financial and sovereign debt crises. In Chapter 7, Marta Božina Beroš Beros analyzes the payment system oversight function and how the roles of the ECB and ESCB have changed thanks to the financial crisis so that the European level is now “taking precedence” over the national one.

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Chapter 8 is devoted to macro-prudential supervision. Charilaos Mertzanis focuses on the interrelations between financial integration, financial stability, and collective action in the aftermath of the financial crisis. Chapter 9 turns to micro-prudential stability within the European banking system. Christos Gortsos investigates the mechanism of “Chinese Walls” set up within the single supervisory mechanism to draw a clear distinction between the ECB’s new supervisory tasks and the exercise of monetary policy. Lastly, in Chapter 10, Luigi Scipione analyzes how the ECB performs the role of lender of last resort to support the banking and public sectors against any constraints arising from its statute. Conclusions are drawn by Vittorio Santoro, who gives an overview of the contributors’ positions, and offers a new and additional aspect of analysis, i.e. the role that choosing money as a unit of account can play in the discharging of monetary obligations within the payment service directive.12

References Bevir, M. 2012. Governance. A Very Short Introduction. Oxford: University Press. pp. 1-132. ECB. 2015. Virtual Currency Schemes – A Further Analysis. Frankfurt am Main. —. 2012. Virtual Currency Scheme. Frankfurt am Main. Lastra, R. M. 2015. International Financial and Monetary Law. 2nd Edition. OUP. Proctor, C. 2005. Mann on the Legal Aspect of Money. Oxford: Oxford University Press. Santoro,V. 2001. L’euro quale moneta scritturale. In: Banca Borsa Titoli di Credito (4). pp. 439 – 454.

Further Readings Lastra, R.M. 2012. The Evolution of the European Central Bank. Queen Mary University of London, School of Law. Legal Studies Research Paper no. 99. pp. 1-19. Porzio, M. 2007. Le imprese bancarie. Torino: Giappichelli. Van Empel, M. 2009. Retail Payments and the arduous road to SEPA. In: Common Market Law Review (46). pp. 921 – 940.

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Zimmermann, C.D. 2013. The Concept of Monetary Sovereignty Revisited. European Journal of International Law, 24(3). pp. 707-818.

Notes 1

This is a self-definition displayed on the European Union website. See art. 3 The concept of payment service is not defined in legislative acts. However, the Annex 5 TEU to Dir. 2015/2366/EU contains a closed list of activities regarded as payment services. 4 Payment system is defined as “a fund transfer system with formal and standardised arrangements and common rules for the processing, clearing and/or settlement of payment transactions” (art. 4, n. (7), dir. 2015/2366/EU) 5 See: Art. 119.3 TFEU. 6 See: Art. 122 TFEU. 7 See: Art. 123 TFEU. 8 See: Art. 124 TFEU. 9 See: Art. 125.1 TFEU. 10 See: Art. 126 TFEU. 11 Payment transaction is defined as “an act, initiated by the payer or on his behalf or by the payee, of placing, transferring, or withdrawing funds, irrespective of any underlying obligations between the payer and the payee” (art. 4, n. (5), dir. 2015/2366/EU). 12 The Payment Service Directive is Dir. 2007/64/EC of 13 November 2007, published in OJEU L 319/1 of 5.12.2007. 2



PART I: MONEY AND THE LAW OF PAYMENTS





CHAPTER ONE SOURCES OF EU PAYMENTS LAW AGNIESZKA JANCZUK-GORYWODA1

EU legislation recently expanded to cover an unprecedented scope of payments’ rules, colonizing areas that used to be in the private domain. This substantially diminished not only scope for national rules, but also room for privately-made rules. Participation in SEPA is no longer voluntary but mandated by EU law. In spite of this, the development of the SEPA framework contracts remains the sole responsibility of the European Payments Council, which is still a private association. Thus, EU payments law retains its hybrid character. This contribution will scrutinize the public and private sources of EU payments law. It will analyze the public-private hybrid character of EU payments law and explore its evolution towards federalization, uniformity, and publicity. It will conclude with observations concerning the legitimacy of such a hybrid system of law. Key Words: Sources of Law, Monetary Obligations, and Payment Systems

1. Introduction This chapter considers the different sources of EU payments law. The payments law of the EU is based upon and derives from formal EU law, national laws implementing EU directives, and privately made rules. The distinctive feature of the EU payments regime is its hybrid public-private nature. The public and private systems of rules - public in the form of European directives and regulations and private in the form of multilateral

 1

Assistant Professor, Tilburg University Law School; Research Coordinator, Tilburg Law and Economics Center (TILEC). Contact: [email protected]



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agreements among payment service providers - coexist and mutually shape the structure of the European payments system. The interdependence of the two modes of governance extends beyond mere complementarity; formal law and privately made rules become de facto, “integrated into a single system in which the functioning of each element is necessary for the successful operation of the other.” (Trubek & Trubek, 2006, p. 543) As a result, it is the combination of the two sets of rules that forms am EU governance system for payments, and they are so interwoven that neither the public nor private governance system can function without its counterpart. It is neither a public nor a private governance regime, but a truly hybrid one.

2. Money and Payment Systems Payment systems consist of payment instruments, applicable law, interbank procedures, common technical standards, and infrastructure. All these elements, combined together, ensure that money circulates in the economy (Bank for International Settlements, 2003, p. 38). Payment systems constitute a link between state money, private money, and credit. Their fundamental role lies in the fact that they transform money systems into credit systems (Janczuk-Gorywoda, 2015a). In monetary systems monetary obligations are discharged by transfers of money; that is, by means of final settlement. In comparison, in credit systems monetary obligations are discharged by means of credit; that is, by a promise to pay later (IOU) (Hawtrey, 1919). Banks’ ability to create money and credit is closely related to payment mechanisms. Payment systems enable circulation of monetary value without the need for the parties to the underlying transaction to physically transfer monetary objects. Monetary obligations are discharged through bookkeeping entries, whereby the bank account of the payer is debited, while the bank account of the payee is credited. When transfers of monetary value take place through bookkeeping entries, payments are processed without the need for coins and banknotes to leak outside the banking system. This allows the banking system to generate multiple deposit expansions (JanczukGorywoda, 2015a). To put it differently, these are payment systems that facilitate the creation of bank money. Well-functioning payment systems fulfill a strategic function in keeping deposits at par with currency. In contrast, malfunctioning payment systems can cause customers to withdraw currency from bank deposits more frequently, increasing the currency ratio



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and the expected deposit outflows. As a result, banks would have to limit their credit action and increase excess reserves (Mishkin, 2007, pp. 429431). The failures of payments infrastructure at Royal Bank of Scotland in 2012 prove that the operational risk in retail payment systems is very real and can put customers’ confidence in a bank or a banking system on trial (Goff and Palmer, 2012). The closure of Cypriot banks in March 2013 was due to a different reason, yet universal lack of access to bank deposits paralyzed the whole economy (Chaffin, 2013). The short story explained above tells us that sound and efficient payment systems are crucial for the smooth functioning of the economy.

3. Treaty Provisions As trade expands, it needs to be supported by a payment system of an adequate scale. Therefore, since the very beginning, the Treaty of Rome contained the principle of free movement of payments. The drafters of the Treaty of Rome were well aware that free circulation of payments within the internal market was essential for economic integration. Free movement of payments is not typically considered as one of the fundamental freedoms constituting the cornerstone of the EU internal market. However, the free movement of payments belonged to the basic freedoms established by the Treaty of Rome. The original Article 106 EC (repealed)2 required member states to liberalize “any payments connected with the movement of goods, services, or capital, and any transfers of capital and earnings, to the extent that the movement of goods, services, capital, and persons between member states has been liberalised pursuant to this Treaty.” What is more, it performed a special role, as it was considered to be ancillary to the other four freedoms. To be completed, any transaction in goods or services needs to be complemented by a corresponding payment. The same holds for movements of capital and labor. Thus, movements in the four “factors of production” could not be effectively liberalized without the corresponding liberalization of the payments’ movements. In the judgment of Luisi and Carbone 3 in 1984, the Court of Justice confirmed that freedom of payments supported the functioning of other transactions liberalized by the Treaty. The case concerned two Italian residents, Ms. Graziana Luisi and Mr. Giuseppe Carbone, who had been fined by the Italian Minister of the Treasury for having acquired more than the permitted amount of foreign currency to pay for medical treatment and



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various services as tourists in France and Germany. The Italian legislation then in force had set a maximum annual allowance for “exportation” of foreign currency for the purposes of tourism and medical treatment. Ms. Luisi and Mr. Carbone alleged that provisions limiting the means of payment in foreign currencies for the purposes of tourism and medical care were incompatible with EU law. The two cases were referred to the ECJ, which, among others, was asked whether the transfer of foreign currency for the purposes of tourism and travel intended for business, education, and medical treatment should be regarded as a current payment or as a movement of capital, in particular when banknotes are transferred physically. The difference between the movement of a current payment and of capital was crucial because under the capital movement’s directives then in force there was no requirement to liberalize the physical transfer of banknotes, however, Article 106 EC (repealed) did require that current payments in relation to other Treaty freedoms be liberalized (Usher, 2000, p. 11). The ECJ upheld the free circulation of payments and currencies in connection with tourism, medical treatment, education, or business. It confirmed that payments perform an ancillary function to other freedoms and hence whenever the monetary transfer “corresponds to an obligation to pay arising from a transaction involving the movement of goods or services” it may not be classified as a movement of capital.4 This view was confirmed in further cases that viewed restrictions on payment movements as restrictions on the free movement of goods (Usher, 2000, pp. 9-10). The ECJ also emphasized the autonomous character of the free movement of payments. In Luisi and Carbone, the ECJ drew a sharp line between current payments and capital movements, defining the former as “transfers of foreign exchange which constitute the consideration within the context of an underlying transaction”, and movements of capital as “financial operations essentially concerned with the investment of the funds in question rather than remuneration of a service.”5 The two freedoms were held to be different, and current payments were not subject to the limitations imposed on cross-border capital movements. Moreover, while the Treaty provisions on capital movements were not directly effective at that time, the ECJ confirmed that the then art. 106 EC (repealed), concerning free movement of payments, gave rise to rights enforceable by individuals in their national courts (Usher, 2000, pp. 7-8). As an autonomous freedom, payments’ movements in the EU followed their own pace and logic of liberalization (Usher, 2000, p. 12).



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Thus, the free movement of payments held a strong position of a directly effective fundamental Treaty freedom. Over the years it was relied on to remove various national provisions restricting circulation of payments across borders. Nevertheless, in the first three decades of the EU the Treaty provisions were only used to remove the obstacles to cross-border payments while no positive legislation was enacted.

4. Secondary Law: Before the Private Governance Removing obstacles to cross-border payments in the EU did not in itself improve the performance of cross-border payments. Legal frameworks for payments in the EU were fragmented along national borders. Both rules for inter-bank procedures, as well as rules governing the relationship between banks and their customers, were differentiated. This fragmentation created uncertainty as to the mutual rights and obligations of the parties involved in a payment transaction. Uncertainty was augmented by the fact that many member states lacked a comprehensive payments law. Instead, payments used to be governed by a patchwork of general contract law specified in case law, consumer protection rules, and private framework contracts governing particular types of payments. When the Single European Act of 1985 brought a new impetus for the internal market, the Commission placed harmonization of payments’ rules high on the agenda. It recognized that both inter-bank and bank-to-bank rules had to be harmonized. However, early on it decided that banks themselves were best placed to proceed with the harmonization of interbank rules, while the Commission would engage in the harmonization of bank-to-customer rules. Despite numerous declarations on the need for positive integration, the first piece of EU secondary law for retail payments was only enacted in 1997. Directive 5/97 on Cross-border Credit Transfers was, moreover, rather limited in scope. It was a minimum harmonization directive, which established transparency rules for the pricing of cross-border payment transfers, and rules regarding the time limits within which cross-border credit transfers should be executed. Directive 5/97 was the first important step towards the creation of the European payments law, however, its importance was undermined by largely diversified implementation by member states. What is more, the requirements of Directive 5/97 were far below the level of service practice for domestic payments.



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The introduction of the single currency in 1999 and the unification of monetary policy for members of the Eurozone was a game changer. The newly established ECB and the Euro-system were worried that the high costs and low efficiency of cross-border payments might undermine acceptance of the euro by European citizens (European Central Bank, 1999, p. 5 and 12). So, the Euro-system became more directly involved as “catalysts” for the integration of retail payments, and pushed banks to create “a single payment area” by the end of the transition period for the introduction of the euro, that is by January 1, 2002 (European Central Bank, 1999, p. 8 and 12). Likewise, the Commission intensified its pressure and listed integration of retail payment systems as being of “utmost urgency” among the measures that it considered necessary for the completion of the internal market for financial services in the 1999 Financial Services Action Plan (FSAP).6

4.1. Regulation 2560/2001 on cross-border payments in euros Dissatisfied with the lack of sufficient progress made by the banking industry, in 2000 the Commission proposed what was to become the first powerful piece of EU legislation for retail payments: Regulation 2560/2001 on cross-border payments in euros.7 Regulation 2560/2001 was a very slim piece of legislation. Its single most important provision stated that charges for comparable domestic and cross-border credit transfers in euros had to be equal.8 As it was a regulation, the obligation was directly applicable to all providers of credit transfers in the EU. In essence, Regulation 2560/2001 was not a piece of EU payments law, but rather a price regulation applicable to payments. Under Regulation 2560/2001, users of credit transfers across the EU had the right to receive the crossborder service at the same price as the domestic one. But apart from this, Regulation 2560/2001 did not contain any provisions making cross-border payments easier or more transparent. It also did not harmonize any payments rules. Regulation 2560/2001 entered into force despite the fact that the infrastructure, banks’ internal procedures, as well as inter-bank rules for cross-border payments, had not been modernized and were still to a large extent responsible for high costs of cross-border credit transfers. In essence, Regulation 2560/2001 shifted the cost of inefficient cross-border credit transfers onto the banking industry. 9 This regulatory move was intended to induce banks to finally create the internal market for payments. Nonetheless, cross-border payments represented only some 3% of the overall payments volume, so this in itself would not necessarily have



8

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induced banks to undertake the expenses related to the development of the transnational payments system. However, Regulation 2560/2001 was also perceived as a demonstration of the Commission’s power. The earlier regulatory threats were not very credible. In contrast, the speed of the legislative process for Regulation 2560/2001—which was less than a year—and the introduction of price regulation, sent a signal to the banking industry that the Commission could proceed with a more extensive regulation of payments. As a result, Regulation 2560/2001 prompted banks to act. In 2002, banks founded the European Payments Council (EPC) - a dedicated body for the European payments - and formulated the vision of the Single Euro Payments Area (SEPA). SEPA would become the private cornerstone of the hybrid public-private governance for EU payments, and will be discussed in the next section.

5. Private Governance for EU Payments Following the adoption of Regulation 2560/2001 in 2002, banks established the EPC as a European banking industry’s governance structure to realize the SEPA, which they defined as “an area where citizens, companies, and other economic actors will be able to make and receive payments in euros, within Europe… whether between or within national boundaries and under the same basic conditions, rights, and obligations, regardless of their location.” (European Payments Council, 2004, Section 3.2). The main purpose of the EPC has been to support and promote SEPA so that it can be achieved through self-regulation, and meet regulators and stakeholders’ expectations as efficiently as possible (European Payments Council, 2004, Section 2.2). Banks focused on three payment instruments: credit transfers, direct debits, and payment cards. The EPC has undertaken to ensure interoperability among payment service providers for cross-border payments. It elaborated uniform business rules and technical standards for two types of payment transactions: credit transfer and direct debit. These rules are contained in multilateral framework contracts (rulebooks) and have contractual force, as between participating payment service providers and as between payment service providers and the EPC.10 They regulate mutual rights and obligations of payment service providers with regards to SEPA payments.



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SEPA rulebooks represent a cornerstone of the integrated European payments system, but they are also not sufficient to achieve this goal. As just mentioned, the main objective of SEPA rulebooks is to secure interbank16 operability for cross-border payments, and they only harmonize rules governing relationships among payment service providers and other intermediaries. As a principle, the relationship between payment service providers and customers is not regulated by SEPA rulebooks. However, in order to secure automated processing of payments, certain rights and obligations of payment service providers towards payment service users need also be harmonized. This is where the public regulation steps in.

6. Secondary Law: After Private Governance 6.1. Payment Services Directive From the very start, the EPC insisted that privately made rules would not be sufficient to realize SEPA. The then existing patchwork of mandatory laws affecting payments in various member states would deprive privately made rules of effectiveness. Recognizing the concerns of the banking industry as valid, the Commission started work on “The New Legislative Framework” for payments as soon as the EPC began to develop SEPA rulebooks.17 In 2007 this New Legislative Framework was adopted as Directive 64/2007 on Payment Services in the Internal Market (PSD).11 The PSD represents a major achievement towards completion of financial integration within the EU, and in particular, in the integration of payments. The PSD aimed at rationalizing and simplifying the existing patchwork of European and national rules for payments, and providing the market with a single set of coherent legal rules. It combines the goal of enhanced market competition with that of high consumer protection. The PSD is a mix of public and private law provisions, mingling contract rules on payments and the prudential regime for payment institutions. The PSD consists of three building blocks. The first block creates authorization and a supervisory regime for payment institutions, the second block contains information requirements, and the third building block includes core rights and obligations of payment services providers and users. Reading the PSD, one can hardly see any reference to SEPA.12 However, a noticeable feature of the PSD is that its contractual rules deal mainly with the relationship between banks and their customers, with some limited



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provisions for the inter-bank sphere only.13 This approach contrasts with, for instance, the UNCITRAL Model Law on International Credit Transfers of 1992 (“Model Law”).14 The PSD was influenced by the Model Law (European Commission, 2002, p. 9), yet there are a number of differences between the two instruments. 15 In particular, the Model Law contains rather complex contract rules for the inter-bank sphere, whereas consumer protection is not its concern (Bollen, 2007). In contrast, the PSD was conceived as a primarily consumer protection law. The inter-bank sphere was, from the outset, meant to be harmonized by the EPC in its SEPA rulebooks. While this was a conscious choice by the EU legislator, it was also influenced by the fact that, within member states, bank-to-consumer rules were affected by national consumer protection laws of a mandatory nature, while inter-bank rules were mainly the domain of private framework contracts.

6.2. Regulation 924/2009 The SEPA rulebooks and the PSD represent a significant achievement for the creation of the European integrated payments’ system. However, soon after they entered into force, it became clear that they were not sufficient. SEPA rulebooks are private contracts and they become binding for those banks that sign “Adherence Agreements” in which they declare to be bound by SEPA rulebooks. The majority of banks in Europe quickly did exactly that. Yet, the Adherence Agreements only specify that participating banks would adhere to the SEPA rulebooks when sending or receiving SEPA payments; they did not oblige banks to actually offer SEPA payments, nor did they oblige them to cease using existing national payments. As migration to SEPA has been complex and expensive, it soon turned out that it would not happen voluntarily on a sufficient scale. Thus, early on, political discussion ensued over this key element that needed to be completed if the EU integrated payments’ system was to become reality. Political commitment to this regulatory goal prompted the EU institutions to adopt additional regulations supporting SEPA. First, in 2009 the EU adopted Regulation 924/2009 on cross-border payments intended to facilitate cross-border direct debits. 16 Regulation 924/2009 replaced the earlier Regulation 2560/2001 and extended the principle of equal charges to direct debits. Regulation 924/2009 states explicitly that its aim is to “facilitate the launch of the SEPA direct debit



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scheme”17 and “encourage the successful take-up of SEPA direct debits.”18 Regulation 924/2009 also supports SEPA direct debit through the introduction of the “reachability” requirement, which states that payment service providers that are reachable for national direct debit transactions in euros must also be reachable for direct debit transactions in euros initiated by a payee through a payment service provider located in any member state.19 Given that the use of direct debit is dependent upon the reachability of payers’ payment accounts, a critical issue for the success of SEPA direct debit is that all payers across the EU can be reached. SEPA rulebooks themselves provide for the reachability requirement (European Payments Council, 2006), but adherence to SEPA schemes is voluntary. In contrast, Regulation 924/2009 sets a mandatory requirement. Although the regulation does not introduce the obligation of being reachable for SEPA direct debits, without SEPA rulebooks this provision would be futile because no other infrastructure for cross-border direct debits in the EU exists. In this way, Regulation 924/2009 commanded a certain degree of SEPA implementation (Janczuk-Gorywoda, 2012).

6.3. Regulation 260/2012 While Regulation 924/2009 obligated banks in the EU to become “reachable” for SEPA direct debits, it did not mandate them to phase out legacy retail payment systems, and did not contain any obligations concerning SEPA credit transfer. In reality, while the majority of banks were ready to process SEPA payments if explicitly asked by their customer, the actual use of SEPA payments was very low. Such a scenario implied that many benefits of SEPA would not be realized. As a result, in 2012 the EU legislator adopted yet another regulation which de facto mandated transition to the SEPA schemes. First, Regulation 260/2012, establishing technical and business requirements for credit transfers and direct debits in euros, 20 toughened the “reachability” requirement by stating that payment service providers which are reachable for national credit transfers or national direct debits must be reachable “in accordance with the rules of a Union-wide payment scheme” for credit transfers or direct debits initiated in any member state.21 The only credit transfer and direct debit schemes which are “Union-wide” are the SEPA schemes,22 and because of network effects and the large costs involved in the establishment of a new scheme, it is unlikely that competitor schemes would emerge in the near future (Janczuk-Gorywoda, 2015).



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Chapter One

Second, Regulation 260/2012 introduced the principle of “interoperability”, which demands, among other matters, that only those payment schemes are used for credit transfers and direct debits whose participants “represent a majority of [payment service providers] within a majority of member states, and constitute a majority of [payment service providers] within the Union”.23 Again, the only credit transfer and direct debit schemes meeting this criterion are the SEPA schemes. With the recent Regulation 751/2015 on interchange fees for card-based payment transactions, 24 the EU further intensified its regulatory intervention in the retail payments industry. Regulation 751/2015 extends the scope of EU legislation, colonizing even more areas of inter-bank relationships that used to be governed by privately made rules. In contrast to the earlier regulations, however, Regulation 751/2015 focuses on card payments. In particular, it outlaws many of the provisions that for years have constituted the cornerstone of the international card schemes. The principles like “honour all cards” and “no surcharge” had been the subject of controversy on the side of competition authorities previously, however, until Regulation 751/2015, competition authorities always ultimately exempted them. Regulation 751/2015 represents a radical shift in this respect as it permanently, and for all payment card schemes, established rules that so far remained in the private sphere, with only targeted antitrust control. Combined with the introduction of technical standards in Regulation 260/2012, the EU law now substantially diminished not only scope for national rules but also room for privately-made rules.

7. Hybridity of EU Governance for Payments Ever since the state monopolized the issuance of money, it also took primary responsibility for the operation of payment systems. After all, payment systems support the stability of money and ensure that it circulates in the economy. Nevertheless, private payment systems have always operated alongside “state” payment systems, be it credit or debit cards, cheques, or letters of credit for international trade. The most significant feature of the new EU payments regime is that it is an intentionally designed public-private hybrid governance regime (JanczukGorywoda, 2012). Its hybridity is grounded on the fact that the objective behind the legal rules cannot be achieved by the sole application of law, but only when the two systems, public and private, are applied



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simultaneously and when they are aligned with each other. The two systems of rules, the public and the private one, “are integrated into a single system in which the functioning of each element is necessary for the successful operation of the other” (Trubek and Trubek, 2006, p. 543). This interdependence of the two regimes results from the allocation of tasks among them. Whereas the PSD mainly regulates the relationship between payment service providers and their customers, SEPA is mainly a set of inter-bank and processing rules, practices, and standards. The three layers (bank-to-customer, inter-bank, and processing) are highly dependent upon each other, and regulation of one layer affects the others (Uittenbogaard, 2007, p. 319). Suppose that a payment service provider has an obligation towards its customer to perform a payment transaction within a given amount of time (bank-to-customer sphere) - an example of an obligation imposed by the PSD. In order for the payment service provider to be in position to fulfill this obligation, adequate provisions must be included in the rules governing inter-bank relationships, as well as the processing sphere (clearing and settlement). In other words, provisions regulating mutual rights and responsibilities of payment service providers and any other entities involved in the processing of payment transactions affect the commitments that payment service providers can undertake towards their customers. It follows that regulation of inter-bank and processing layers of payments is critical for the payment products that payment service providers can offer to their customers. Accordingly, in order to achieve a coherent and complete regulation of payment transactions, certain elements must be regulated consistently in inter-bank and bank-to-customer sphere. It follows that in order for the pan-European payments system to function, all three layers of payment transactions must be harmonized. If rules regulating only one of these layers remained fragmented, it would be difficult to process and settle cross-border payment transactions. Because the EPC covers only interbank and processing layers of payment transactions, and the PSD, in turn, regulates only the bank-to-customer layer, only together they can facilitate the creation of a European payments system - the objective behind public and private rules.25 Hybridity can also be observed in the subsequent legal acts of the EU. The objectives pursued by Regulation 924/2009 can be achieved only in combination with SEPA, and, what is more, without SEPA they would be meaningless. Regulation 924/2009 introduces the obligation for payment



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service providers that are reachable for national direct debit transactions in euros to be reachable also for cross-border direct debit transactions in euros. As I have already pointed out above, the only cross-border direct debit service available in the EU is the SEPA one. Regulation 260/2012, in turn, even more explicitly pursues the regime for European payments as hybrid governance. Regulation 260/2012 states that: “An integrated market for electronic payments in euros, with no distinction between national and cross-border payments, is necessary for the proper functioning of the internal market”. 26 It recognizes that the objective of SEPA is to develop common Union-wide payment services,27 but states that self-regulatory efforts have proved insufficient to “drive forward concerted migration to Union-wide schemes.”28 As mentioned above, the result is that participation in the SEPA schemes is no longer voluntary, but mandated by EU law. In spite of this, the SEPA schemes retain their contractual character, and their development remains the sole responsibility of the EPC, which is still a private association. Thus, the SEPA schemes as such became a form of mandated private regulation. Simultaneously, EU payments law retains its hybrid character because in order to decode the full content of the new “euro-payments” both mutual rights and obligations of payment service providers towards each other, as well as mutual rights and obligations of payment service providers and payment service users - we need to analyze EU law and its implementation in member states, as well as the SEPA rulebooks, their implementation in individual states, and by individual payment service providers (Janczuk-Gorywoda, 2012). Still, the legislative developments discussed in this chapter gradually broadened the public element within EU payments law and scaled back the private one. Regulation 260/2012 has reduced the scope for private autonomy within the hybrid EU governance framework for payments by laying down technical requirements mandatory for all payment service providers in EU legislation. Prior to Regulation 260/2012, these technical requirements were specified in the SEPA Rulebooks and the EPC enjoyed full discretion to change them. With the adoption of Regulation 260/2012 the EU legislator took over this discretion from the EPC, as well as any other private payments scheme.



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Finally, Regulation 260/2012 also introduces a more aggressive regulation of the inter-bank sphere. It lays down a general prohibition against charging an MIF on a direct debit transaction.29 As an exception, MIF is allowed for rejected transactions, but only under strict conditions related to its economic justification and an increase in the scheme’s efficiency.30 The implementation of these criteria would be subject to monitoring and sanctions by the relevant European and national authorities.31 The hybridity of the new EU payments regime can be observed not only on its substantive plane, but also on the procedural one. In order for the payments system to work smoothly, the two systems of rules, public and private, need to be coordinated. SEPA rulebooks and the EU secondary payments legislation were formally developed as separate legal regimes in distinct rule-setting processes - private and public respectively. However, the hybrid public-private nature of the governance regime for European payments was intentionally designed, and the two categories of rulemakers have collaborated with each other, exerting substantial influence over “each other’s” rules (Janczuk, 2010; Janczuk-Gorywoda, 2012). Despite this collaboration, until recently, the EPC remained the major forum for the discussion of business rules and standards adopted in SEPA, and the only institution with formal decision-making powers in this respect. The EPC was established as a private club of banks and this mode of the EPC governance, which attracted strong criticism (JanczukGorywoda, 2012). Over time, the pressure built up for more openness and transparency. Although the EPC eventually opened up its decision-making process to non-bank stakeholders and increased transparency of its procedures, the changes came too late and fell short of expectations. Consequently, in 2010 the Commission and the ECB set up the SEPA Council, composed of a broad range of stakeholders, to discuss the further development of SEPA payments. The main goal of setting up that body was to ensure that SEPA meets the needs and expectations of all stakeholders. SEPA Council was an ad-hoc body without any formal decision-making powers regarding SEPA. It could only formulate nonbinding statements and appeals for the EPC. Nonetheless, due to the involvement of the Commission and the ECB, SEPA Council’s positions and statements were of high political salience and could not be ignored by the EPC. In December 2013, the SEPA Council was replaced by the European Retail Payments Board (ERPB), with the ECB in the driving seat. The ERPB’s composition is broader than that of the SEPA Council and also



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Chapter One

involves payment institutions and e-money industry. The ERPB is also more formal and has a broader mandate than the SEPA Council. In particular, the ERPB can identify strategic issues and work priorities, including standardization needs. The ERPB has been given an explicit mandate to develop recommendations for new standards for retail payments. Even though such recommendations would not automatically be incorporated into any payment schemes, they can be expected to be rather persuasive. In one of its first tasks to develop high-level principles for consumer no-refund direct debit, the ERPB explicitly asks the EU legislator to introduce appropriate changes in the Proposal for PSD 2.32 The establishment of the ERPB shows how the role of private rule making by the EPC was further reduced with the introduction of another element of hybrid governance. The evolution of the governance structure for SEPA mirrors the developments that took place on the substantive plane of EU payments law. Takeover of an ever-larger share of hybrid EU payments law by the EU public legislator was accompanied by the increased involvement of the public sector in the hybrid institutional framework for making SEPA rules. Thus, both at the substantive and the institutional plane, the scope of the private sphere has gradually shrunk, while the public expanded. The decision of the European legislator to collaborate with private actors in the creation of the European payments system can be explained by several rationalizations (Janczuk-Gorywoda, 2012). From the perspective of choosing the right regulatory approach, it seems that centralized and detailed legislation was seen as unsuitable for this policy domain. The operation of payments requires meticulous and sometimes very technical inter-bank rules, which, because of the high level of precision and technicality, are probably best elaborated by payment providers themselves. And indeed, in member states they have been mostly governed by multilateral contracts among banks. An attempt to elaborate inter-bank payments rules would probably also put too much strain on the EU’s limited capacity both to issue rules and to secure compliance with detailed legal rules. The task of regulating payments at European level has always been complicated due to the great differences among the systems of the various member states and the divergent use of various payment instruments. It was becoming even more complex due to increased prevalence of electronic systems. Securing the appropriate level of quality of payments rules was considered crucial. Informal delegation of rule-making authority



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to a private banking association was aimed at allowing this highly technical field to benefit from the expertise of sophisticated market participants. It was also intended to generate a new payment standard, overcoming existing fragmentation, and acceptable to all participants in the payments market. Finally, from the political economy perspective, securing the commitment of member states to develop a pan-European payments system might have been tricky. The still existing national payments systems are highly diversified, and agreeing on a uniform model inevitably generates winners and losers: participants in the payments industry from some member states face higher adaptation costs than from the others (Büthe and Mattli, 2011; Cafaggi and Pistor, 2014). A fierce battle over the uniform model could have been expected, as well as the subsequent opposition from the “losers”. Banks perceived Regulation 2560/2001 as a demonstration of the EU’s political power to develop EU-level rules for payments; they saw it as a tacit threat of further regulatory intervention in this field. However, it is not so certain that the EU would have been able to develop a complete regulatory regime for a European payments system without the collaboration of the banking industry. In fact, proposing Regulation 2560/2001 can be seen as a strategic move by the Commission. It was a very concise regulation, whose main objective was to introduce the principle of equal charges for cross-border and domestic payments. This was a straightforward proposal, and it was not particularly difficult to convince member states to agree on it. Had the Commission tried from the outset to propose a complete regulatory regime for a European payments system, this would have been much more difficult (Janczuk-Gorywoda, 2012). What is more, a general opposition from the payments industry could also have been expected. As already mentioned, in most member states, payments systems have been governed by some form of private regulation, mostly multilateral contracts managed by a national banking association with a different degree of public involvement. Enactment of a comprehensive European payments law would implicate a shift of regulatory power from private to public, and could have been expected to be opposed by the payments industry, and in particular by the powerful banks. Further, the need to adapt to new payments standards generates proportionally higher costs for smaller actors than for bigger ones. Accordingly, opposition to new European payments law could have also



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Chapter One

been expected from their side. As a matter of fact, small banks have argued against the adoption of Regulation 260/2012, which de facto makes the transition to SEPA mandatory.33 Informal delegation of rule-making authority to a private banking association was intended to win the support of the payments industry for the project of payments integration. Having elaborated SEPA rules, the majority of the banking industry strongly supported the PSD and further payments regulations, 34 especially as these legal acts were adequately coordinated with SEPA rulebooks. In this way, a harmonization project, which could have been expected to be met with a considerable opposition, was successfully pressed through. Nevertheless, what is striking is that European governance for payments is so much at odds with recent trends in European governance. Since the early 2000s, the EU has instigated a fundamental reform of its regulatory practices, turning to “better governance” as its regulatory strategy (Bailey, 2006; Kohler-Koch and Rittberger, 2006; Topan, 2002). Starting with the “White Paper on European Governance”,35 the European institutions have issued numerous documents declaring their commitment to the principles of transparency, openness, stakeholder involvement, accountability, coherence, and effectiveness in the European process.36 Many governance practices and institutions were reformed in this spirit (Everson, 2005, p. 181). In this context, the governance regime for payments stands out as a remainder of previous times. First, the governance regime of the EPC - the private rule-maker in this hybrid scenario - deviates, or at least deviated over the critical period of drafting the initial versions of the rulebooks, from the governance structures of the European and other established standardization bodies. More established standardization bodies have elaborated a fairly consistent set of “global principles of internal administrative law” (Schepel, 2005, p. 6). These principles include a balanced involvement of various stakeholders and acceptable level of transparency including public notice and comment (Schepel, 2005, p. 6). In contrast, the EPC was long a single-stakeholder body composed solely of industry players. What is more, it comprised only one category of industry players, first only banks then also other providers of payment services, in a market occupied by a variety of commercial interests. Although it finally opened its rule making process to other stakeholders, final decisions are still taken solely by payment service providers. Further, over the critical period of drafting the rulebooks, the operation of the EPC was largely non-transparent (Janczuk-



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Gorywoda, 2012). Thus, it is impossible to say, for instance, what was the relationship between technical and political decisions in its decisionmaking process, and whether some national or other interests did not exert too much weight. Second, also the interrelation between the public and private governance regimes transpires as rather obscure. While it could be argued that promulgation of the formal public legislation complementing SEPA by the European legislator in the official legislative process - thus not merely by an executive body - lends this governance regime its legitimacy, the ambiguous relationship of the European legislator towards SEPA, leaves us with a level of doubt. It is particularly troubling that the European legislator appears to be leaving the option for any of the private payments regimes that meet its legislative requirements to operate, while the fact is that only one payments regime meets these requirements - SEPA. On the other hand, it seems that the aim of Regulation 260/2012 was not only to increase migration to SEPA, but also to weaken the powers of the EPC. The involvement of rather detailed “technical requirements” in the Regulation means that the EPC or any other payment scheme is no longer free to develop technical rules of the rulebooks without restraint.

8. Conclusions Ever since the state monopolized the issuance of money, it also took primary responsibility for the operation of payment systems. As payment systems support the stability of money and ensure that it circulates in the economy, they have been perceived to be of great importance by the states. Nevertheless, private payment systems have always operated alongside the “state” payment systems, be it credit or debit cards, cheques, or letters of credit for international trade. The drafters of the Treaty of Rome were well aware that free circulation of payments within the internal market was essential for economic integration. Therefore, from the very beginning the Treaty of Rome contained the principle of free movement of payments. Still, EU payments law has not developed for more than four decades, and payments operated on a national basis. When the EU institutions finally pushed to develop an integrated EU payments regime, they opted to design it as a public-private hybrid governance regime. Its hybridity is grounded on the fact that the objective behind the legal rules cannot be achieved by the sole application of law,



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Chapter One

but only when the two systems, public and private, are applied simultaneously and when they are aligned with each other. The two systems of rules, the public and the private one, “are integrated into a single system in which the functioning of each element is necessary for the successful operation of the other” (Trubek and Trubek, 2006, p. 543). In order to decode the full content of the new “euro-payments” - both mutual rights and obligations of payment service providers towards each other, as well as mutual rights and obligations of payment service providers and payment service users - we need to analyze EU law and its implementation in member states, as well as the SEPA rulebooks, their implementation in individual states and by individual payment service providers. These are not only the sources of EU payments that are of hybrid character, but also its institutional regime. European payments law has been developed within a complex public-private governance system. The hybridity has ensured that public and private rule-makers have taken into account each other’s expectations, and that public and private rules are coordinated with each other. However, this hybrid public-private governance regime is not formalized, which has proved to compromise public control over private decision-making process. Although the EPC took into account many of the public actors’ suggestions, it resisted others. This sparked harsh criticism of the governance regime for EU payments and led to the expansion of the public sector in the hybrid institutional framework for making SEPA rules.

References Bailey, David J. 2006. Governance or the Crisis of Governmentality? Applying Critical State Theory at the European Level. In: Journal of European Public Policy, 13(1). 16-33. Bank for International Settlements. 2003. A Glossary of Terms Used in Payments and Settlement Systems. Bollen, R. 2007. European Regulation of Payment Services – Recent Developments and the Proposed Payment Services Directive – Part 2. In: Journal of International Banking Law and Regulation (22). 532. Büthe, T. and Mattli, W. 2011. The New Global Rulers: The Privatization of Regulation in the World Economy. Princeton: Princeton University Press. Cafaggi, F. and Janczuk, A. 2010. Private Regulation and Legal Integration: The European Example. In: Business and Politics, 12(3).



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http://www.degruyter.com/view/j/bap.2010.12.3/bap.2010.12.3.1320/b ap.2010.12.3.1320.xml Cafaggi, F. and Pistor, K. 2014. Regulatory Capabilities: A normative Framework for Assessing the Distributional Effects of Regulation. In: Regulation & Governance, 9(2), 95107. Chaffin, J. 2013, 26 March. Damage Ripples through Cypriot Economy, In: Financial Times. Egan, Michelle P. 2001. Constructing a European Market: Standards, Regulation, and Governance. Oxford: Oxford University Press. European Central Bank. 1999. Improving Cross-border Retail Payment Services: The Eurosystem’s View. Frankfurt am Main. European Commission. 2002. Working Document: A Possible Legal Framework for the Single Payment Area in the Internal Market. Brussels. —. 2010. Accompanying document to the proposal for a Regulation establishing technical requirements for credit transfers and direct debits in euros and amending Regulation (EC) No 924/2009 — Impact Assessment Brussels. European Payments Council. 2004. EPC Roadmap 2004-2010. —. 2006. Resolution: Reachability of all Scheme Participants in SEPA Credit Transfer and Direct Debit Schemes. Everson, M. 2005. Control of Executive Acts: The Procedural Solution. ‘Proportionality, State of the Art Decision-Making and Relevant Interests’. In: D. Curtin, A. E. Kellerman & S. Blockmans (eds.). The EU Constitution – The Best Way Forward?. The Hague: T.M.C. Asser Instituut. pp. 181-200. Goff, S. and Palmer, M. 2012, 25 July. Banking: Finance’s Fifth Column. In: Financial Times. Hawtrey, Ralph G. 1919. Currency and Credit. London and New York: Longmans, Green and Co. Janczuk, A. 2010. Single Payments Area in Europe. In: Columbia Journal of European Law, 16(2), pp. 321-335. Janczuk-Gorywoda, A. 2012. Public-Private Hybrid Governance for Electronic Payments in the European Union. In: German Law Journal, 13(12), pp. 1438-1458. —. 2015a. Public-private Hybridity of the Single Euro Payments Area and Its Legitimacy Challenge. —. 2015b. Evolution of EU Retail Payments Law. In: European Law Review, 40(6), pp. 858-876. Kohler-Koch, B. and Rittberger, B. 2006. ‘The Governance Turn’ in EU Studies. In: Journal of Common Market Studies (44). pp. 27-49.



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Mishkin, Frederic S. 2007. The Economics of Money, Banking, and Financial Markets. (Alternate edn ed.). Boston: Pearson Education. Pelkmans, J. 1987. The New Approach to Technical Harmonization and Standardization. In: Journal of Common Market Studies, 25(3), pp 249-269. Schepel, H. 2005. The Constitution of Private Governance: Product Standards in the Regulation of Integrating Markets. Oxford: Hart Publishing. Topan, A. 2002. The Resignation of the Santer-Commission: The Impact of ‘Trust’ and ‘Reputation’. In: European Integration online Papers, 6(14). http://eiop.or.at/eiop/texte/2002-014a.htm Trubek, David M. and Trubek, L.G. 2006. New Governance & Legal Regulation: Complementarity, Rivalry, and Transformation. In: Columbia Journal of European Law, 13(3), pp. 539-564. Uittenbogaard, R. 2007. Turkeys Voting for Christmas? How Selfregulation Makes the European Payments Market More Competitive. In: Journal of Payments Strategy & Systems (1). pp. 318. Usher, John A. 2000. The Law of Money and Financial Services in the EC (2nd ed.). Oxford: Oxford University Press.

Notes 

2

Art.106 EC remained in force until January 1, 1994. Luisi and Carbone v. Ministero del Tesoro (286/82 and 26/83) [1984] E.C.R. 377. 4 Luisi and Carbone, para.22 (emphasis added). 5 Luisi and Carbone, para.21. 6 Communication on Implementing the Framework for Financial Markets: Action Plan COM(1999) 232, p. 12. 7 Regulation 2560/2001 on cross-border payments in euro [2001] OJ L 344/13. 8 The scope of Regulation 2560/2001 was limited to transfer end electronic card transactions up to €12,500, and later increased up to €50,000; articles 1-3. 9 The Commission made it clear that “leveling up” would be unacceptable. 10 E.g. European Payments Council, SEPA Credit Transfer Scheme Rulebook, Version 6.0 Approved, Section 5.2 (Nov. 17, 2011), http://www.europeanpaymentscouncil.eu/knowledge_bank_detail.cfm?documents_ id=551 11 Directive 2007/64/EC of the European Parliament and of the Council of 13 November 2007 on Payment Services in the Internal Market Amending Directives 97/7/EC, 2002/65/EC, 2005/60/EC and 2006/48/EC and Repealing Directive 97/5/EC, 2007 O.J. (L 319), 1. 3





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12 Only on Recital 4 the PSD states that its aim is to “establish at Community level a modern and coherent legal framework for payment services, whether or not the services are compatible with the system resulting from the financial sector initiative for a SEPA, that is neutral so as to ensure a level playing field for all payment systems, in order to maintain consumer choice, which should mean a considerable step forward in terms of consumer costs, safety and efficiency, as compared with the present national systems”. 13 E.g. Article 69(1) PSD. 14 UNCITRAL Model Law on International Credit Transfers adopted by the United Nations Commission on International Trade Law (UNCITRAL) in 1992. 15 Of course, it cannot be disregarded that the Model Law regulated only credit transfer, whereas the PSD is intended also for other instruments, in particular direct debit and payment cards. 16 Regulation (EC) No 924/2009 of the European Parliament and of the Council of 16 September 2009 on Cross-border Payments in the Community and Repealing Regulation (EC) No 2560/2001, 2009 O.J. (L 266), 11 in particular at Recitals 2-5. 17 Recital 11. 18 Recital 12. 19 Regulation 924/2009, Article 8. 20 Regulation 260/2012 establishing technical and business requirements for credit transfers and direct debits in euro and amending Regulation (EC) No 924/2009 [2012] OJ L 94/22. 21 Reg. 260/2012, Article 3. 22 This is even recognized in the Impact Assessment to Regulation 260/2012; (European Commission, 2010, p. 35 and 37). 23 Reg. 260/2012, Article 4(1)(b). 24 Regulation 751/2015 on interchange fees for card-based payment transactions [2015] OJ L 123/1. 25 As a confirmation that the two sets of rules are factually interdependent, SEPA Rulebooks were modified after the PSD had been adopted in order to be compatible with it. What is more, SEPA Direct Debit Scheme Rulebook explicitly states that the implementation of the PSD is a prerequisite for the launch of the Scheme; see European Payments Council, SEPA Core Direct Debit Scheme Rulebook, Version 6.0 Approved, Section 1.8 (November 17, 2011), http://www.europeanpaymentscouncil.eu/knowledge_bank_detail.cfm?documents_ id=553. 26 Recital 1. 27 Recital 2. 28 Recital 5. 29 Regulation 260/2012, Article 8. 30 Regulation 260/2012, Article 8(2). 31 Regulation 260/2012, Articles 8(2) and 10.





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Proposal for a Directive on payment services in the internal market and amending Directives 2002/65/EC, 2013/36/EU and 2009/110/EC and repealing Directive 2007/64/EC COM(2013) 547 (final). 33 Even the key member of the EPC, the European Saving Banks Group, despite the official position of the EPC to support end-date for SEPA migration, used a vague language in its response to the Commission’s consultation on SEPA migration end-date and refrained from supporting it; responses available at http://circa.europa.eu/Public/irc/markt/markt_consultations/library?l=/financial_s ervices/sepa_migration_end-date&vm=detailed&sb=Title (last visited Aug. 31, 2012). 34 See responses to the Commission’s Consultation on possible end-date(s) for SEPA migration, id. 35 COM (2001) 428 final (July 25, 2001). 36 E.g. COM (2002) 278 final (June 5, 2002); COM (2002) 275 final (June 5, 2002) and in particular Interinstitutional Agreement on Better Law-making between European Parliament, the Council of the European Union and the Commission of the European Communities, 2003 O.J. (C 321), 1. For the list of key documents see http://ec.europa.eu/smart-regulation/better_regulation/key_docs_en.htm (last updated June 26, 2015).



CHAPTER TWO THE LIGHTS AND SHADOWS OF THE EU LAW ON PAYMENT TRANSACTIONS GABRIELLA GIMIGLIANO1

A long-standing process to harmonise national rules on the transfer of funds has been underway at European Union level since the nineteeneighties. This process aims to improve the proper functioning of the internal market for domestic and cross-border payment transactions, and is performed through soft and compulsory rules. It involves both institutional and private actors. This chapter looks at money as a means of payment and, after overviewing the EU law on payments, points to the lights and shadows in the payment service concept according to the directives on payment services in the internal market. Key Words: European Union, Payment Service, Money as a Means of Payment, Negative Scope, Electronic Money

1. Introduction The EU-based investigation relating to money as a means of payment, namely as the legal means of discharging monetary obligations, naturally leads us to think of the euro, being the legal tender of countries joining the Euro-system. However, there is an alternative regulatory path. Indeed, in the process of building up a single market for the Union, the European policymaker has developed a regulatory integration process for removing any legal and technical barriers to the free transfer of funds in view of

1

Lecturer in Business Law at the Department of Business and Law, University of Siena. Contact: [email protected]

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treating “cross-border” transactions like domestic ones in terms of speed, security, and ease of use. This process has a clear EU-based governance, even if it involves both public and private regulatory players. However, when the European lawmaker turns to the self-regulatory action of private players – as chapter one shows – it does so within a wider institutional umbrella. The paper argues that many steps further towards an EU-based concept of money as a means of payment have been taken, but a weak policy-making choice on the idea of money results in a weakening of the systematic consistency of the whole legal framework. The legal analysis presented here focuses on the concept of a “payment service”. This is very important because the provision of payment services is a regulated activity. This means an authorisation is needed to work as a payment service provider (PSP).1 In addition, the nature of the payment service provided (or to be provided) influences the supervisory requirements applied to payment institutions (PIs) in terms of initial capital and own funds, where PIs represent a type of PSP specialised in the provision of payment services and ancillary activities.2 Lastly, the idea of the payment service is conducive to defining the field of application of a Union-based framework for transparency, and the duties and obligations in the user-payment provider contract.3 The chapter is divided into a further three sections. After an overview of the EU law on payments (section 2), section 3 analyses the concept of money as an electronically based means of payment, and section 4 points to the differences between e-money and payment services, both paying close attention to 2015/2366/EU (the so-called PSD2) and 2007/64/EC directives (PSD). Lastly, drawing some conclusions, the paper addresses the lights and shadows emerging from legal analysis.

2. Overviewing EU Law for Payments EU law for payments has always pursued the integrity and stability of the financial market, the efficiency and affordability of payment systems, and the contestability of the relevant market, as well as users’ funds and data protection. To achieve the above-mentioned goals, the European lawmaker has traditionally applied an ex-ante regulatory approach. The development of

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e-money payment institutions may be regarded as a prominent example. When the phenomenon of pre-paid payment products began to spread throughout the European Union, the Community policy-maker took the legislative initiative and, in compliance with the ex-ante approach, the European Parliament and Council approved the 2000/46 and 2000/28 EC directives (Vereecken, 2000). According to the explanatory memorandum of the EU Commission Directives Proposal, the ex-ante approach is conducive to boosting users’ confidence in new means of payment, and in the proper functioning of the payment system and, at the same time, protecting the monetary policy of central banks against the risk of a runaway diffusion of private-based electronic money products. Recently, however, the preventive approach is apparently being replaced by a waitand-see approach. European Central Bank (ECB) studies on the bitcoin give us some interesting hints on this regulatory shift (ECB, 2015, p. 33). Since the nineteen-eighties, when the Single European Act and then the subsequent Maastricht Treaty laid down the legal basis for an Economic and Monetary Union (EMU), the European Commission began to issue a series of recommendations and communications to build up an internal market for payment systems. Initially, the Community-based framework mainly comprised soft laws, which referred to specific targets, mostly one payment instrument or another: above all, credit cards and credit transfers (COM 87/598/EEC; COM 88/590/EEC; Directive 97/5/EC; COM 97/489/EC). For the first time, the 1990 Commission Recommendation on “Making Payments in the Internal Market” provided an overview of the Community’s internal market programme. Indeed, the various means of payment are found in the general framework. The efficiency growth of cross-border retail payments is addressed as a leading policy priority to be pursued through active cooperation between the EU Commission and banking and financial operators, as well as a greater level of competition on the market for cross-border payment systems. During the late nineties, the regulatory process for internal market construction was coupled with the Single Euro Payment Area (SEPA) project. The SEPA project involved the financial and banking intermediaries, as well as their associations, in the process of establishing common business, regulatory, and technical standards for an array of means of payment,

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namely card-based payments, credit transfers, and direct debits. More recently, the project has extended to mobile payments too. The main purpose of this project is to bridge the gap between the levels of payment services in domestic and cross-border retail payment systems. Indeed, the principle of indifference regarding the country of origin of the (value) transfer order is stated as the leading principle. It is a matter of debate whether SEPA was proposed either as a Eurosystem or a Union-based project. Apart from initial regulatory intents, since 2001, the SEPA business and regulatory requirements for credit transfers and direct debts are de facto applied across the European Union, setting different deadlines for Euro and non-Euro countries. However, before PSD, the European law maker established neither a general framework for the professional provision of payment services, nor a set of straightforward legal definitions. As for the establishment of a dedicated general framework, PSD first and then PSD2 provided for regulatory access and stability requirements for the provision of payment service businesses, transparency rules for PSPs, and duties and obligations in contracting relationships between users and service providers. Moreover, since PSD, the European legal framework for payment services has laid down a set of basic legal concepts. However, as Maria Chiara Malaguti (Malaguti, 2009, p.22) argued, this operation partly suffers from a lack of conceptualisation. However, it also partly suffers from having to deal with a long-standing domestic tradition of civil and commercial law.4 Lastly, the construction of an internal market for retail payment services is being challenged by the two-sided nature of payment systems and by the phenomenon of financial exclusion or self-exclusion of large groups of society. The former has long been treated as a pure antitrust issue in the hands of the European Commission and the network of national antitrust authorities. The EU general principles for agreements, concerted practices, and decisions of associations of undertakings are applied. However, the persistent regulatory issues raised by the use of multilateral interchange fees in card-based payments has prompted the European lawmaker to enact a regulation to cap them in consumer payment transactions. This is the 2015/751/EU Regulation.

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On the international stage, the latter has been addressed as a policy priority and a regulatory concern. The Committee on Payment and Market Infrastructure and The World Trade Bank have jointly addressed the payment inclusion as a crucial means of financial inclusion. In their opinion, it is advisable to allow everyone access to at least one transaction account, meaning an account enabling the holder to make and receive payments and store monetary value (CPMI, 2015). In compliance with this study, the 2014/92/EU Directive establishes among its goals “a modern, socially inclusive economy”, and points to a “universal provision of payment services” as one of the regulatory means of achieving the stated objective.

3. Money, Payment Transactions, and Payment Services In the European Union framework, money as a means of payment encompasses euro (and non-euro) coins and notes, accepted as legal tender in countries joining the Eurosystem, and scriptural money. When the EU law refers to money as a means of payment, it covers the electronic transfer of funds, namely any transfer of funds that requires no manual intervention. Indeed, both PSD and PSD2 regulate payment services in the internal market, and they expressly exclude coins and notes, as well as paper-based value transfer from their scope.5 This does not mean that coins and notes on one hand, and cheques on the other, are no longer considered as means of payment within the EU framework. Rather, the European lawmaker has argued that they are supported sufficiently by their own regulatory framework. Consequently, the ongoing internal market process and its regulatory framework are committed to cover solely electronic transfers of funds. To this end, in my opinion, the European lawmaker is working on a legal framework based on an idea of money as a claim against the PSP, but the regulation seems to be mimicking the process of discharging monetary obligations in the act of handling coins and notes. To support this intuition there are at least three elements: a) both the concept of SEPA instant payments6 and PSD2 “acquiring of payment transactions”7 are laid down, irrespective of the underlying payment instruments, b) PSD2 provides transparency rules (Title III), and the rules on rights and obligations in the user-provider service relationship (Title IV) are applied also when a payment service is provided within the Union, when the providers of payer and payee (or the sole provider involved) are based in the Union, but the payment transaction is denominated by the

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parties in a currency not belonging to a member state8, and lastly, c) the list of payment service does not contain clearing and settlement services, which are technically needed to fulfil a bank-based payment transaction. In the end, European money as a means of payment is basically scriptural money, and the provider may be a bank, but may also be a non-bank or a non-financial legal entity. This depends on the nature of payment service provider involved. Accordingly, the concept of money becomes much more complex. It is based on a handful of strictly connected notions: payment instrument, payment transaction, payment order, and payment service, as well as the payment system. Moreover, money is no longer considered as a means of discharging monetary obligations because the existence of a monetary obligation to be fulfilled is no longer required. Coming to the basic, technical, and legal elements of money as a means of payment, “payment transactions” or, in other legislative acts, “electronic payments” cover “any acts, initiated by the payer on his behalf or by the payee, of placing, transferring, or withdrawing funds, irrespective of any underlying obligations between the payer and the payee”.9 How are transaction payments initiated? There is a user who issues a payment order (“an instruction by a payer or a payee to its payment service provider requesting the execution of a payment transaction”) using a payment instrument (“a personalised device(s) and/or set of procedures agreed between the payment service user and the payment service provider, and used in order to initiate a payment order”). The payment instruments are (credit or debit) cards and pre-paid cards, but also virtual instruments like pin codes, that allow users to access an organisation structure set up to receive and process the payment order to execute a transfer of funds (PSP’s organisation). This is the reason why any payment transactions need a “payment system”, namely “a fund transfer system with formal and standardised arrangements and common rules for the processing, clearing and/or settlement of payment transactions”.10 PSD and PSD2 draw a distinction between single payment transactions and payment transactions operated within a framework contract. In the former, the user and the service provider make an agreement upon which the provider undertakes to place, transfer, or withdraw funds against the remuneration of a price.

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Single payment transactions are occasional relationships between users and providers. On the other hand, a framework contract establishes a durable contracting relationship between user and provider. Indeed, a framework contract is defined as “a payment service contract which governs the future execution of individual and successive payment transactions and which may contain the obligation and conditions for setting up a payment account”. This legal definition hints at the distinction between a framework contract with or without a payment account, where a payment account is meant as “an account held in the name of one or more payment service users which is used for the execution of payment transactions”. Generally speaking, when a payment account service is set up, the service provider is entitled to transfer money value as well as to protect monetary value on behalf of the user with a view to carrying out payment transactions in the future. The concept of payment services is the result of operating a payment transaction. Neither PSD nor PSD2 have set out a concept of payment services. Rather, they have made a closed list in the enclosed annex.11 This list comprises payment transactions based and not-based on a payment account, and refers to the execution of direct debits, credit transfers, and card payments. Moreover, the idea of a payment service covers a line of credit extended by the PI in the view of a payment transaction based on one of the above-mentioned means of payment (n. 4 in the PSD2 Annex). Lastly, the list covers monetary remittance operations based on cash handed by a payer to a PSP, which remits the corresponding amount to either a PSP acting on behalf of the payee, or to the payee himself.12 In the PSD legislative process, the draft directive has given rise to some criticism from the ECB (ECB, 2006). Indeed, the opinion handed down by the ECB has emphasised the overlap between the provision of accountbased payment services coupled with the extension of a line of credit and banking activity. This is because not only were PIs able to issue payment instruments and transfer purchasing power, but they were also entitled to hold monetary values, namely to “keep funds for a longer period than necessary to finalise a payment transaction”, performing an economic function no different from that of deposits and other reimbursable funds. Therefore, the ECB proposed either to restrict the payment services, removing the extension of a line of credit and account-based payment transactions from the list, or imposing the obligation of segregation between PI funds and the funds of clients on one side and between the funds of each user on the other. The final text of PSD opted for the latter regulatory solution.

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PSD2 has slightly changed the list of payment services, and has laid down a concept of payment service encompassing preliminary or instrument steps, but it goes beyond and points to the transfer, safekeeping, or management of users’ data as payment services. In fact, PSD2 provides for “payment initiation services” and “account information services” as payment services. While the former is defined as a “service to initiate a payment order at the request of the payment service user with respect to a payment account held at another payment service provider”, the latter is termed as an “online service to provide consolidated information on one or more payment accounts held by the payment service user with either another payment service provider or with more than one payment service provider”. Neither of them provides the PI withholding clients’ funds and this, in turn, raises a doubt concerning the status of PIs as financial intermediaries specialised in provision of payment services. Indeed, it is important to recall that PSD and PSD2 apply a risk-based approach to PI statutes, based on the nature of the payment service to be provided: different payment services create different levels of risk and, consequently, different financial licensing requirements (especially in terms of initial capital and ongoing funds). This change in the regulatory attitude to the idea of payment services might be due to the greater attention paid to operational risks on the international stage.13 It has been underlined how open network communications and new business models may weaken the gatekeeping function vis-a-vis users’ funds and data protection, as well as increasing the money laundering risk (Weiner et al, 2007). Moreover, this change may have pro-competitive effects. In fact, it can remove some legal obstacles to allowing mobile and network operators to enter the common market. In the end, conceptually speaking, whenever the lawmaker moves from paper-based to electronic fund transfers, the payment service represents the latest evolution of money as a means of payment, and it implies the definite transfer of purchasing power to discharge a monetary obligation. While Goodhart states that money represents “(…) those assets whose transfer completes an economic transaction, leaving neither the seller nor a third party, who may have given credit to the buyer, with a further claim on the buyer” (Goodhart, 1989, p. 25), PSD2 has gone further.

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4. Payment Services and Electronic Money Electronic money (or e-money) has never been listed among the payment services. This implies that there is an intrinsic difference in the legal nature. However, in economic terms, e-money is a pre-paid payment product and it works as a means of payment. In fact, using e-money allows the holder to access money value placed at the e-money institution and, thanks to the issuer’s organisation, discharge a monetary obligation. Issuing its opinion on the proposal of 2000 e-money directives, the ECB has highlighted the difficulty of drawing a distinction between ELMIs and PIs because the difference between “payment services based on payment accounts and e-money payment services based on centralised accounts” seems unclear (ECB, 2008, § 3.2.). Moreover, in the opinion of the ECB (ECB, 2008, §5.3): Since payment transactions are not restricted to traditional means of payments, but also cover transfer and withdrawal of funds, this general definition of e-money would imply that traditional bank accounts, as well as payment accounts, could be considered as e-money. The ECB would therefore advise specifying that any funds received (by ELMIs) can only be used for the sole purpose of electronic transfer of funds from e-money holder to its payees.

However, it does not seem that the final definition of e-money wholly matches the ECB’s advice. Indeed, according to the new definition, emoney is an electronically or magnetically stored monetary value, which represents a claim on the issuer, and has been released on “receipt of funds for the purpose of making payment transactions as defined in point 5 of Article 4 of Directive 2007/64/EC, and which is accepted by a natural or legal person other than the electronic money issuer”. This means that emoney can be used for making final payments to payees, but also for operations of withdrawal and transfers of funds, irrespective of any underlying monetary obligations. However, to make a distinction with regard to banking deposits, the 2009 Directive forbids ELMIs from “granting interest or any other benefit unless those benefits are not related to the length of time during which the money holder holds electronic money”. Otherwise, the outstanding monetary value would become a saving product (Preamble 13). Additionally, the 2009 e-money directive provides for extending safeguarding requirements laid down by PSD for hybrid PIs to ELMIs in

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the issuance of e-money.14 This means that the funds received in exchange for electronic money must: (a) Not commingle the funds held on behalf of payment service users. (b) Either deposit the funds still held by the PI and “not yet transferred to another payment service provider by the end of the business day following the day when the funds have been received in a separate account in a credit institution” or invest them in “secure, liquid, low-risk assets as defined by the competent authorities of the home member state”. (c) Insulate such funds, in compliance with national laws, against the claims of the payment institution, especially in the event of insolvency: the funds placed in payment accounts must have legal, physical, and financial insulation against the claims of PI creditors and other payment service users. Alternatively, the funds placed on the payment account and still held by the PI may be covered by an insurance policy or other comparable guarantee from an insurance company or credit institution. Alternatively, for the purpose of meeting safeguarding requirements, the ELMIs can invest the funds received in exchange for e-money issued in secure, low-risk assets. The choice of safeguard method is left to the member states. Has the 2009 e-money Directive established a clear separation between payment services based on a payment account and e-money? This is hard to believe. Once the funds received by the ELMI are immediately exchanged for e-money, they can be used to carry out payment transactions according to the broad meaning mentioned above. Therefore, ELMIs are autonomously (i.e. without being authorised as PIs) entitled to provide a de facto payment account service. However, this does not mean that e-money is a payment service. Indeed, according to PSD and PSD2, the concept of e-money can be subsumed into the definition of “funds”, and not the list of payment services. In spite of the ECB advice, the revision of e-money directives has not clarified the differences between emoney and payment services, but has laid down the regulatory conditions for excluding ELMIs from exercising credit intermediation.

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6. Conclusions Drawing some conclusions, this analysis highlights the further steps taken towards an idea of money as a means of payment based on the idea of electronically-based fund transfers and account-based (payment) services. Additionally, the attempt to lay down a set of basic concepts - payment order, payment transactions, payment services, and so on – creates a common regulatory background and offers a strong challenge to the legal tradition of member states, regardless of whether they have a civil or common law background. The shadows lurking in the analysis cover what Maria Chiara Malaguti identifies as a lack of conceptualisation. Indeed, when, time after time, the European lawmaker attempts to find a palatable solution to align itself with advice coming from the Court of Justice or the ECB, no real consistency is achieved. This has occurred when drawing the differences between payment accounts and deposits and other repayable funds, as well as e-money and payment services.

References EC Commission. 1987. Commission Recommendation of 8 December 1987 on a European Code of Conduct relating to electronic payment. OJ L 365, 24/12/1987. pp. 372 – 376. —. 1988. Commission Recommendation of 17 November 1988 concerning payment systems, and i particular the relationship between cardholder and card issuer. OJ L 317, 24/11/1988. pp. 55 – 58. —. 1990. Discussion Paper. Making Payments in the Internal Market. COM (90) 447 final. Brussels, 26 September 1990. —. 1997. Commission Recommendation of 30 July 1997 concerning transactions by electronic payment instruments and in particular the relationship between issuer and holder. OJ L 208, 2/8/1997, pp. 52 – 58. EC Parliament and the Council. 1990. Directive 97/5/EC of 27 January 1997 on cross-border credit transfers. OJ L 43, 14/02/1997. pp. 25 – 30. EC Commission. 1987. Commission Recommendation of 8 December 1987 on a European Code of Conduct relating to electronic payment. OJ L 365, 24/12/1987. pp. 372 – 376.

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—. 1988. Commission Recommendation of 17 November 1988 concerning payment systems, and i particular the relationship between cardholder and card issuer. OJ L 317, 24/11/1988. pp. 55 – 58. —. 1990. Discussion Paper. Making Payments in the Internal Market. COM (90) 447 final. Brussels, 26 September 1990. —. 1990. Commission Recommendation of 14 february 1990 on the transparency of banking conditions relating to cross-border financial transactions. OJ L 67, 15/3/1990. pp. 39 – 43. —. 1997. Commission Recommendation of 30 July 1997 concerning transactions by electronic payment instruments and in particular the relationship between issuer and holder. OJ L 208, 2/8/1997, pp. 52 – 58. EC Parliament and the Council. 2000. Directives 2000/46/EC and 2000/28/EC of 18 September 2000. OJEC L 275 of 27.10.2000. —. 1990. Directive 97/5/EC of 27 January 1997 on cross-border credit transfers. OJ L 43, 14/02/1997. pp. 25 – 30. ECB. 2006. Opinion of the European Central Bank on a proposal for the directive on payment services in the internal market. OJEC C 109/10 of 9.5.2006. —. 2015. Virtual Currency Schemes – A Further Analysis. Frankfurt am Main: ECB. pp. 1 – 37. EU Parliament and the Council. 2007. Directive 2007/64/EC of 13 November 2007 on payment services in the internal market amending Directives 97/7/EC, 2002/65/EC, 2005/60/EC and 2006/48/EC and repealing Directive 97/5/EC. OJEU 5.12.2007, L 319/1. —. 2015. Directive EU/2015/2366 of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation EU/1093/2010, and repealing Directive 2007/64/EC. OJEU 23.12.2015 L 337/35. EU Regulation 2015/751 of the European Parliament and of the Council of 29 April 2015 on interchange fee for card-based payment transactions. Goodhart, C.A. 1989. The Development of Monetary Theory. In: Llevellyn, D.T. (ed). Reflections on Money. London: MacMillan Press. pp. 25 – 36. Malaguti, M.C. 2009. The Payment Services Directive. Pitfalls between the aquis communitaire and national implementation. ECRI Research Report, n. 9. Brussels: CEPS. pp. 1 – 32. Vereecken, M. 2000. Electronic money: EU Legislative Framework. In: European Business Law Review (November/December). pp. 417 – 434.

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Weiner et al. 2007. Nonbanks and Risk in Retail Payments. Frankfurt: Paper for presentation at the Joint ECB-Bank of England Conference on Payment Systems and Financial Stability, 12-13 November. pp. 140

Further Reading ECB.2000. Issues arising from the emergence of electronic money. In: ECB Montly Bulletin (November). pp. 49 - 60 Motti, C. 1998. Intermediari finanziari non bancari e industria dei pagamenti. In: Rispoli Farina, M. (ed). Studi sugli intermediari finanziari non bancari. Napoli: Jovene. pp. 49 – 81. Santoro, V. 2012. I servizi di pagamento. In: Ianus (6). pp. 7 – 42. —. 2008. I conti di pagamento degli istituti di pagamento. In: Giur. Comm. (5). pp. 855 – 867. Van Empel, M. 2009. Retail Payments and the Ardous Road to SEPA. Common Market Law Review (46). pp. 921 – 940. —. 2005. Retail Payments in the EU. Common Market law Review (42). pp. 1425 – 1444.

Notes 1

PSD and PSD2 produced a list of PSPs. These are credit institutions, electronic money institutions, payment institutions, post office giro institutions, the European Central Bank, and the national central banks. There are also Member states, regional and local authorities. The last two groups of PSPs are considered as such when they are “not acting in the capacity” as monetary authorities and public authorities respectively. See: Art. 1 PSD; Art. 1 PSD2. 2 Both PSD and PSD2 draw a distinction between pure and hybrid PIs. While the former PIs are authorised to provide payment services only, the latter PIs are financial legal entities other than PSPs or non-financial legal entities (such as supermarkets, telecoms or network service providers) authorised to operate payment service activities in addition to their core business. 3 See: Art. 2, PSD; Art. 2, PSD2. 4 See: Chapter 3 in this Volume. 5 See: Art. 3, letters (a), (f) and (g), PSD. 6 According to the ECB website, referrring to the Euro Retail Payment Board, instant payments are electronic retail payment solutions available 24/7/365 and resulting in the immediate or close-to-immediate interbank clearing of the transaction and crediting of the payee’s account with confirmation to the payer (within

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seconds of payment initiation). This is irrespective of the underlying payment instrument used (credit transfer, direct debit or payment card) and of the underlying arrangements for clearing (whether bilateral interbank clearing or clearing via infrastructures) and settlement (e.g. with guarantees or in real time) that make this possible. 7 See: art. 4 (44) PSD2. 8 See: art. 2, PSD2. More details in this Book: Santoro, Conclusions. 9 See: Art. 4, n. 5, PSD2. 10 See: Art. 4, n. 7, PSD2. 11 The rationale of a closed list seems to be that everything not included in the list is not considered to be a payment service and, therefore, PSD2 is not applied, while everything that is, directly or indirectly, subsumable within the list, is regarded as a payment service and PSD2 is automatically applied. However, both PSD and PSD2 lawmakers have slightly changed this regulatory approach in order to reduce the scope of the directive. The so-called “negative scope” clause points to a set of payment transactions not considered as payment services. This list of exclusion does not have a univocal explanation. 12 See: PSD2 Annex, n. 6. According to the PSD2 preamble (9), money remittance activities are carried out by supermarkets, merchants and other retailers offering bill-payment services. 13 In fact, the international supervisors have underlined that the greater complexity of payment systems is supposed to make the operational risks less easy to manipulate. They have increased the awareness of data security and fraud risks as well as counterfeit and malfunctioning risks This is the also the case for misuse of information, computer brakdown or processing slowdown, skimming or cloning cards, identity theft or illicit authentication. 14 Reference is made to Article 9, § (1) and (2), PSD.

CHAPTER THREE REGULATION OF PAYMENTS AFTER THE PSD: IS THERE STILL A ROLE FOR DOMESTIC LAW? NOAH VARDI1

The creation of EU payment systems has been fostered with the intent of overcoming barriers to swift and efficient transactions within the EU, given the absence of a legal framework in line with the advancement of economic integration. Whilst the result is a typical top to bottom imposition of harmonized rules, the genesis of EU legislation is heavily dependent on the adoption of bottom up rules, especially those elaborated and applied contractually by market operators. Hence, the discipline finally adopted by the EU legislator has introduced new (often highly technical) rules into domestic jurisdictions, which impact heavily on the institutions embodied in civil codes, to the extent that in many cases the traditional rules on payments have become residual and scarcely relevant from an economic point of view. Problems may however arise where a residual interaction between the new rules and the domestic private law provisions comes into play. Key Words: monetary obligation, payments and indirect regulatory effects

Introduction The grounds on which the European Union bases its regulation of payments and payment systems with the adoption of different legislative instruments is founded - to quote just some of the major policy issues - on

1

Associate Professor of Private Comparative Law, University of Roma Tre, Faculty of Law. Contact: [email protected]

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reasons of economic integration, on enhancement of competition, and on the will to provide a common legal framework. Various legal instruments have been adopted over recent years to further these goals in the area of payments, and many of these rules constitute almost inevitably - the result of a harmonization process based on the adoption of rules elaborated, accepted, and widely used by the market. The Payment Services Directive (PSD)1 is an example in which not only the origin, but also the allocation, of competences between the EU legislator and the market is clearly visible2: the legislator disciplines the interaction between service providers and users; the European Payments Council (i.e. the market) is in charge of regulating the relations between service providers (payment transactions carried out within a payment or securities settlement system between settlement agents, central counterparties, clearing houses, and/or central banks and other participants of the system) (Troiano, 2008, p. 42). Market based rules have thus been “imposed” onto domestic jurisdictions where the pre-existing regulation of payments has not been abrogated in toto, but rather has continued to coexist side by side with the new, often highly technical, provisions that are the result of the transposition of EU law. The role of domestic rules on payments in general may however still have a role to play, and not only a residual one. This may be the case if one examines for example the consequences of the EU legislator’s choice to discipline only the “abstract” contract between payment service providers and their service users, without entering into the underlying relation between the debtor and his creditor. Divergences may arise when considering for example issues related to performance and discharge of payments and liability arising therefrom: the Payment Services Directive only has provisions on execution of, and liability arising from, the payment service contract (and this choice is confirmed in the proposal of the so-called PSD2).3 Where, as is the case, the underlying pre-existing national rules on performance and discharge of a monetary obligation are still disciplined in divergent ways, discrepancies may occur with regard to the effects of the harmonized rules on domestic regulation. Is the lawful discharge of the debtor according to the payment service contract (regulated by the PSD), and according to the general rules on payments and monetary obligations, governed by the same requirements, or is something more (or less) required?

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The European Court of Justice has already had to face this type of issue in a case in which it was called to identify, with the scope of ascertaining the timeliness of the payment, the exact “moment” in which a payment is “executed” when paying through a bank transfer4 (thus ruling on a conflict between pre-existing general domestic rules and partially harmonized regulation of EU origin). Given the absence of a direct regulation of domestic rules on these points, it seems that the only possible harmonization will be an indirect one. The effects would be twofold. The first is ensuring a harmonized interpretation of different domestic rules, by imposing an EU-oriented construction of the pre-existing discipline of payments, monetary obligations, and banking contracts, even where a payment system is not directly involved. The second is introducing indirect regulatory effects,5 which are likely to emerge from the need for service providers to abide by new rules on performance and liability, with the result of selecting and allowing only the most efficient undertakings to survive on the market (now extended to a European scale).

1. Payment Transactions in the PSD Legislation on payment systems and payment services in many member states before the adoption of an EU regulation was often piecemeal in nature, with a prevalence of rules developed by the private banking sector (often under surveillance of central banks). Furthermore, not all member states had exhaustive rules on payments made through transfers and with the aid of service providers (Troiano, 2008, p. 43).6 Areas requiring a common European legislative intervention were identified in the rules for credit transfers, direct debit transfers, and payments through cards on the one side; and in the creation of harmonized rules and adequate structures for the carrying out of so-called ancillary functions (i.e. clearing and settlement), thus also ensuring the creation of a competitive market for these services, on the other. The PSD, partially in line with these needs, is an example of full harmonization; national legislators may not discipline the subject matter covered by the Directive (not even by offering heightened protection to users). The only non-mandatory rules of the Directive concern the options for service providers, who may decide to grant more favourable terms to payment service users7. Some norms however may be derogated if the

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parties are not consumers or micro enterprises8 (and this policy seems to be confirmed in the proposal for the PSD2).9 Furthermore, the creation of a general discipline for all payment services (regardless of the quality of the providers), already defined as an effort of the EU legislator towards an Allgemeiner Teil for payments (Troiano, 2008, p. 46; Mancini, 2008, p. 1171), moves in the direction of introducing a general private law regulation for payments, which substitutes the piecemeal rules that were, so far, sector-specific to banking laws. One of the innovative choices made by the EU legislator with the PSD was that of introducing, for the first time, a unitary discipline for credit and direct debit transfers10. A closer look at the rules on performance and discharge of the obligation reveals however that they are only apparently unified. Whilst the Directive imposes unified rules on receipt (Article 64 PSD) and refusal (Article 65 PSD) of payment orders, the difference in regulation emerges on the moment of irrevocability of a payment order (Article 66 PSD): the different moments in which a payment order may no longer be revoked (respectively Article 66, paragraph 1, and Article 66, paragraph 2, PSD) correspond to the two different hypotheses of a credit transfer and a direct debit transfer (in which the proposal for the PSD2 has included payments initiated by a payments initiation service provider) (Troiano, 2008, p. 48-49).11 The same differentiation is found in the regulation of the payment service provider’s liability (Article 75 PSD), whose extent varies according to whether payment is initiated by the payer (Article 75, paragraph 1, PSD), and therefore constitutes a credit transfer, or whether payment is initiated by the payee (Article 75, paragraph 2, PSD), and is therefore a direct debit transfer. The payment service provider of the payer (in the case of a credit transfer, or a “payment initiated by the payer” according to the wording of Article 75 PSD) will be liable not only for the correct transmission of the order, but also for the correct execution of the order, and this liability will extend not only to the payer, but also to the payee through his service provider (unless he can prove to both that the payee’s payment service provider received the amount of the payment, in which case the liability towards the payee will lie with the payee’s payment service provider (Article 75, paragraph 1, PSD)).

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Where payment is initiated by the payee/creditor (debit transfer) his payment service provider will only be liable for the correct transmission of the order and the liability for non-execution or defective execution of the payment will lie with the payer’s (debtor) payment service provider, (only) towards his own user (the payer) (Article 75, paragraph 2, PSD). The payee in such a case, unless he can prove his own service provider’s liability for defective transmission of the payment order or for not having credited the funds to his account, shall have no direct action against the payer’s payment service provider (Troiano, 2008, p. 50). The liability scheme set out by Article 75 PSD can thus be summarized with the rule that each service provider is liable towards his own service user for the leg of the transfer under its control (Sciarrone Alibrandi, 2008, p. 71). As highlighted above, it should also be noted that the theoretically unified approach to the discipline of payments (given the extension beyond retail payments so as to comprise large transfers) actually introduces nonetheless an important distinction that in part nullifies the unitary goals: the above mentioned mandatory or non-mandatory nature of the discipline according to the subjective consumer/non-consumer distinction (where only consumers enjoy protection against less favourable terms). Another issue that is related to the dual regime laid down by article 75 of the PSD, and that is particularly meaningful in assessing the indirect effects of the European regulation of payment services on domestic legislation, concerns the moment of discharge of the debtor’s obligation towards his creditor. Whilst national legislations identify different moments and places in which a monetary obligation is discharged (i.e. distinction between portable and querable obligations), or different rules on partial execution, the same legislations do not always discipline the hypothesis in which such an obligation is discharged by means of a payment made through a payment system (even though the use of such means is increasingly common). With reference to the first issue, that of time and place of payment for example, when payment is performed through a bank transfer, the debated issues traditionally concern the actual “domicile” of the creditor in case of a portable obligation (i.e. when a payment is made through a bank account), but also the exact moment of performance, and the consequences

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as far as the risk of non–execution is concerned in case of the so-called Schickschuld. These issues have been indirectly raised in the ECJ judgement clarifying “late” payments according to Directive 2000/35/EC on combating late payments in commercial transactions.12 The PSD does not contain specific provisions on timeliness of payment: liability, according to the wording of Article 75, arises in case of “nonexecution or defective execution”, with the ensuing differentiated regime according to whether the payment is a credit transfer or a direct debit transfer, as examined above. On this specific point, the proposal for PSD2 introduces the specific hypothesis of liability for late execution of payment (article 80 Proposal PSD2) and further provides that in such a case, “the payee’s payment service provider shall ensure […] that the credit value date for the payee’s payment account is no later than the date the amount should have been value dated in case of correct execution”. While the consequence of delay is thus taken into account, there is still no reference to the moment in time in which discharge takes place (whether payment is timely or late). As for the issue of partial performance of a monetary obligation, these rules will become relevant in a bank transfer in the hypothesis in which a payment, for example, is made through a transfer, and the charges/commission of the transfer are directly subtracted from the sum that is credited. Finally, with reference to the last issue, concerning payments made using payment instruments other than cash, a few examples of national rules on lawful means for discharging a payment obligation show that alongside provisions imposing only the tender of currency (such as can be found in Italian, French, Spanish, Polish, and Portuguese codes for example, though some of these have been interpreted in an evolving manner), (Sciarrone Alibrandi, 1997, p. 23; Santoro, 2005, p. 65; Inzitari, 2007, p. 13, p. 137; Inzitari, 1983, p. 49)13 other legislators have introduced norms allowing alternative means for the discharge.14 The equivalence of payment in cash or through bank transfers (unless there is an express refusal made by the creditor) has been either imposed by law, or has been the result of case law ruling on the “social” or “commercial” acceptance and equivalence between the two means of payment.15 The issue of the interchangeability and legal parity between tender of cash and payment through a payment service provider (and thus discharge of

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the debtor by tendering bank money en lieu of cash) seems to be accepted not only by most scholarly considerations on the subject, but also seems to be the preferred solution in different European harmonization projects.16 As can be clearly inferred, these issues are not secondary and may hamper some of the harmonisation goals underlying the creation of a common market for payment services. Furthermore, they remain open since there has been relatively little European case law on the subject. A different, though connected, set of issues that have been the object of ECJ case law concerns the qualification of “payment instruments” under national law and under the PSD, with ensuing impact on the extent of contractual freedom in imposing charges for their use.17

2. Indirect regulation of national rules? A closer analysis of the notion of “payment” as it is conceived in EU legislation on payment services reveals, not surprisingly, that the underlying debt that originates the payment obligation is expressly excluded from regulation (De Stasio, 2013, p. 56). 18 The policy choice to only deal with the contractual aspects of the payment service made by the EU legislator is quite comprehensible, considering the problematic issues that are involved once the underlying debt or “monetary obligation” of a payment are taken into account. These include questions on the admissibility of legal means of payment other than cash; on refusability by the creditor of certain means of payment tendered by the creditor; on the contrary problem of the imposition of certain means of payment for transactions above a certain sum (typically driven by the ratio of avoiding money laundering and of allowing a traceability of transactions of significant sums for scope of taxation). The controversy around these issues is demonstrated by the scholarly debates and abundant, and often contrasted, case law to which they have given rise within national legal systems, and has thus led to reasonable doubts regarding the possibility of imagining a uniform discipline of these aspects of monetary obligations at EU level. Furthermore, the “abstract” nature of the payment transfer is also justified by needs such as certainty of transactions, efficiency of transactions (a single transfer that discharges multiple underlying obligations), protection of credit (De Stasio, 2013, p. 61).

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As can be clearly inferred, the way in which liability for non-performance of the payment service contract is regulated by Article 75 PSD (in which each service provider is liable de facto only towards his user), provides further confirmation of compatibility only with an abstract nature of the payment, where discharge of the underlying obligation is left out of the harmonized rules. Some authors have even compared the discipline of the payment transfer to that of a contract of carriage (De Stasio, 2013, p. 59). More specifically, with reference to the underlying obligation, to the extent that one can speak of the transfer of bank money and thus of abstract availability of credited funds (rather than of payment of money through tender of chattels) as a lawful means of performance and discharge of a monetary obligation (as case law and scholarship, in those systems where legislative reform has not intervened specifically on the point, tend to admit),19 a monetary obligation may well be discharged through a payment transfer. The open issue remains determining the moment when this occurs. An indirect regulatory effect may be inferred on this point. Although the PSD (and its reception) do not deal with the exact moment of discharge, they may however lead to an interpretation that is oriented towards the PSD’s harmonisation goals and that tries to fill the legislative gap on the moment of discharge of the underlying obligation (Sciarrone Alibrandi, 2008, 63). According to this construction, the moment of discharge is identified with the moment in which the funds reach the payee’s payment service provider, not in the later moment in which the latter credits the funds to the payee’s account. This conclusion is reached by reading the provisions of the PSD on the object of the “execution” of a payment transaction;20; on the reciprocal duties arising through clearing and settlement between the PSP of the payer and of the payee (considered as the moment in which the payment is executed); and on the meaning given to accreditation of the funds to the payee’s account (Sciarrone Alibrandi, Dellarosa, 2011, 207). The provisions in the proposal for PSD2 are sketched along the same lines.21 This also seems the most “efficient” reading of the PSD, since it allocates the risk for non-performance on each party only for the leg of the payment that is under his/her sphere of control. A conclusion in this sense may also be indirectly inferred from the ECJ Telekom case of 2008, where, although discharge is affirmed as occurring at the moment of “receipt” and thus accreditation on the beneficiary’s account, there is also express “exoneration” from liability for causes that do not depend on the debtor’s

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conduct (thus implying that the debtor should calculate execution times in order to avoid delay, but shall not be held liable for other cases of defective execution/non-execution, which are not under his area of control). The need to continue to refer to an indirect harmonizatory effect on the issue of performance also derives from a missed opportunity for clarification and definition that was not taken at the moment of transposition of the PSD into the national legislation of member states. A brief overview of the relevant transposition measures adopted in some member states shows that there has indeed generally been a conformed implementation (sometimes even literal) of the rules observed above on irrevocability and liability. However, the policy choice of a strict adherence to the PSD (that undeniably does not deal with monetary obligations) has entailed that national legislators have neither confirmed nor struck down interpretative trends strongly supported by case law and scholarly doctrine. For example, in those systems where an equivalence between payment through tender of cash and payment through other means has not yet been legislatively affirmed (i.e. Italy), the transposition of a general discipline on payment services could have been an opportunity to bring the law in line with commercial practice (Sciarrone Alibrandi, Dellarosa, 2011, p. 270). Furthermore, the effects of a hiatus between the transposition of the abstract discipline of performance of the payments service contract and the general domestic rules on non-performance of a monetary obligation can be highlighted by a few examples that refer to the measure of liability in case of non-performance. The Italian decreto legislativo n.11 of 27.1.2010 transposing the PSD for instance introduces several nuances of non-performance, which include defective execution and non-execution. These are followed by a duality of remedies, including the possibility that the payer (i.e. in a defective execution, such as a late transfer) gives up his right to a refund from his defaulting payment service provider, and keeps the payment order in place22 (an option most likely grounded in a principle of conservation of defective transfers where the payer may have no interest in voiding the entire transaction).23 The discipline of the payment service contract thus

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includes hypothesis of breach and partial breach of the contract that entail different consequences from those present in domestic rules on performance. Furthermore, the Italian transposition speaks of the right to a refund in case of non-execution of the payment transfer, and not to a right to compensation (Sciarrone Alibrandi, Dellarosa, 2011, p. 252). While the typical damages (i.e. interests, service costs etc.) are recoverable in addition to the refund ex Article 25, paragraph 8 of the d.lgs n. 11/2010, nothing is stated as to the recoverability in terms of compensation of any “further damages” foreseen by Article 1224 of the civil code as a general rule on non-performance of monetary obligations. A different policy choice was made both by the French and the German legislator, who, in the implementation of the PSD,24 on the one hand transposed almost literally the discipline on liability contained in Article 75 of the PSD, but on the other hand have not introduced general rules on liability, thus remanding to the discipline contained in the respective civil codes. Article L-133-22 of the Code monétaire and financier for example sets out the liabilities of the payments service providers without reference to proof; the article must therefore be read in conjunction with the second subparagraph of Article 1315 of the Code civil, according to which a person who claims to be released must substantiate the payment which has produced the termination of this obligation and therefore, the liability attached to it.25 As for the German transposition, liability of the payment service providers must be derived from the general rules of the BGB (i.e. § 280 BGB on damages for breach of duty, which applies in the case envisaged by Article 75, paragraph 2, section 3, PSD). Also, the norm allowing to determine the recovery of additional financial compensation if the law applicable to the contract so allows, ex Article 76 of the PSD has not been expressly transposed, but given the absence of a legislative prohibition to do so, it may be inferred that under the general principle of private autonomy the parties may so decide. It should be noted however, with reference to liability, that §675y, section 5, BGB, which transposed article 75, paragraph 1, section 4, PSD on the duty of the payment service provider to make immediate efforts to trace the non-executed or definitively executed payment transaction and to inform the payer, does not impose a heightened degree of obligation on the

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PSP; indeed, the duty to trace and inform must not be carried out “immediately”. This different degree of the duty has been highlighted by the Conformity Assessment carried out by the EU institutions on the transposition of the PSD, which has noted that it is not a simple case of linguistic inaccuracy, but rather a precise choice of the legislator that normally distinguishes the degree of obligation by qualifying as “immediate” certain duties, while not qualifying others. The assessment has considered this as a partial non-conformity of the German law on “a central aspect in the system of liability pursuant to the Directive” as, in such a case, claims for compensation may rise and the issue of whether information was given in time or not is crucial.26 A different degree of liability (be it even only a question of intensity) could nullify the indirect harmonization and regulatory effects highlighted above; in this case a disincentive to an efficient functioning of providers could affect the cross-border competition between payment service undertakings.

3. A few considerations on the reach, so far, of EU legislation on payment services and its implementation The PSD seems to have achieved only part of its harmonization goals. Some of the issues highlighted by observers and operators have been taken into account in the Proposal for the PSD2 (which also constitutes a means to implement the Digital Agenda and the Commission Green Paper “Towards an integrated European market for card, internet, and mobile payments”). There are however a few major areas, as far as substantive law is concerned, in which legislative intervention may still be required. The first relates to the regulation of the monetary obligation underlying the abstract transfer made through the payment service contract and that may be affected by rules on discharge of the payment and liability of payment service providers. As highlighted above, there are some controversial issues, including the exact moment in which the debtor (that uses a payment service) is discharged, and the relation between remedies in case of non-execution of the payment service contract and remedies for nonperformance of the underlying monetary obligation (Sciarrone Alibrandi and Dellarosa, 2011, p. 270) (i.e. entity and type of compensation recoverable) that remain uncertain; and this is notwithstanding the PSD and its implementation in national systems (the Italian example is meaningful on this point).

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The scepticism and difficulties surrounding the laying down of a “general discipline of obligations” is too well known to be dwelt on further, and is likely to be at the origin of the choice of the EU legislator. The efforts of harmonization, rather than on general principles, have focused on sector specific contractual rules (a policy not new in the area of contract law). In the absence of binding legislation on the point however, some leeway may have been left, allowing indirect regulation to find its way. With reference to the moment of discharge of the debtor, for example, if one accepts thesis according to which the “execution” of the payment order (and thus indirectly the discharge of the obligation) occurs with the transfer to the payment service provider of the beneficiary (and not at the moment in which the latter transfers the funds to his own user), it follows that the payer/debtor will be discharged in the moment in which his payment service provider transfers the order to the payee’s/creditor’s provider. The hypothesis is confirmed by the rules on liability, according to which each payment service provider is only liable towards his own user for its own leg of the payment transfer (Sciarrone and Dellarosa, 2011, 270). Should the payer’s payment service provider be held directly liable towards the payee, one could construct the payer’s liability as also extending to the moment of accreditation of the funds. The allocation of liability for this last leg of the payment (accreditation of the received funds onto the payee’s account) on the provider of the payee, instead, means that the payee will have an incentive to choose an efficient provider in order to avoid the risk of not receiving the accreditation of funds transferred to his institution. This mechanism of apportionment of liability between the two payment service providers as far as the moment of execution is concerned could (or should) trigger an efficient selection process on behalf of users, favouring reliable service providers on both sides. This ensues inter alia from the fact that each party can more easily exert control and choice over its own service provider: which also happens to be liable for non-performance on its respective leg of the payment. Another issue that is related to the allocation of liability between payment services and the indirect regulation it can lead to is the right to obtain a refund in case liability, which is assessed under Article 75 PSD. The Directive provides for a refund “without undue delay” (art. 75 PSD) without stating more; the extent of liability and its effectiveness also depend on the speed with which a remedy can be obtained27. In the

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absence of compulsory harmonization on the point (the wording of the PSD allows different implementation rules and leaves a gap in legal certainty), the “efficiency” of a payment service provider may inter alia be measured by the timeliness with which a refund/remedy is executed. Another major area in which notwithstanding incomplete harmonization of substantive law through the PSD, an indirect spill over effect on domestic rules may be envisioned, regards a possible redefinition of banking contracts (especially when taken into account in relation to a payment service contract). The PSD, as highlighted earlier, aims at creating a set of “general rules” on payments that will apply whenever a payment is tendered through the service of an intermediary. It can be questioned whether the rules contained in the PSD package should extend to other payment services (maybe not even yet envisaged) offered by banking contracts and that are not included in the tripartite division of credit transfers, direct debit transfers, and payment through cards. Should the rules examined above on execution, irrevocability, and liability, for example, be applied to other banking services? In these cases, can private autonomy derogate the general rules without the mandatory restriction set down in favour of users who qualify as consumers? To what extent should all banking services be interpreted in conformity to the rules resulting from the PSD? The indirect harmonisation effect quoted above may induce a similar “EU-oriented” (or rather “PSD-oriented”) interpretation of other banking contracts, or of future atypical contracts involving payments through an intermediary.

References De Stasio, V. 2013. Operazioni di pagamento non autorizzate e restituzioni. Milan: EDUCatt Inzitari, B. 2007. L’adempimento dell’obbligazione pecuniaria nella società contemporanea: tramonto della carta moneta e attribuzione pecuniaria per trasferimento della moneta scritturale, in: Banca, borsa e titoli di credito, 2. p. 133. —. 1983, La moneta. In: Galgano, F. (Dir.). Trattato di diritto commerciale e diritto pubblico economia.Padua: Cedam Mancini, M. 2008. Il sistema dei pagamenti e la banca centrale. In: Galanti, E. (ed.). Diritto delle banche e degli intermediari finanziari. Padua: Cedam

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Santoro, V. 2005. L’efficacia solutoria dei pagamenti tramite intermediari. In: Carriero, G. and Santoro, V. (eds.), Il diritto del sistema dei pagamenti. Milan: Giuffrè. Sciarrone Alibrandi, A. 2008. L’adempimento dell’obbligazione pecuniaria tra diritto vivente e portata regolatoria indiretta della Payment Services Directive 2007/64/CE. In: Mancini, M. and Perassi, M. (Eds.) Il nuovo quadro normativo comunitario dei servizi di pagamento. Prime riflessioni. Banca d’Italia, Quaderni di Ricerca Giuridica, n. 63. Rome: Banca d’Italia —. 1997. L’interposizione della banca nell’adempimento dell’obbligazione pecuniaria, Milan: Giuffrè Sciarrone Alibrandi, A. and, Dellarosa, E. 2011. Commento all’Art. 25. In: Mancini, M., Rispoli Farina, M., Santoro, V, Sciarrone Alibrandi, A., Troiano, O., (eds.). La nuova disciplina dei servizi di pagamento. Turin: Giappichelli. Troiano, O. 2008. La nuova disciplina privatistica comunitaria dei servizi di pagamento: realizzazioni e problemi della Single Euro Payments Area (SEPA). In: Mancini, M. and Perassi, M. (eds.) Il nuovo quadro normativo comunitario dei servizi di pagamento. Prime riflessioni. Banca d’Italia, Quaderni di Ricerca Giuridica, n. 63. Rome: Banca d’Italia.

Notes 1

Directive 2007/64/EC of 13.11.2007 See Art. 3 para. h, PSD 3 Proposal for a Directive of the European Parliament and of the Council on payment services in the internal market, [final compromise text], 2 June 2015, (available at http://data.consilium.europa.eu/doc/document/ST-9336-2015INIT/en/pdf), [hereinafter Proposal PSD2] 4 ECJ 3 April 2008, C-306/06 Telekom Gmbh v. Deutsche Telekom AG. 5 The expression is of A. SCIARRONE ALIBRANDI. 6 Market made rules flourished especially after the introduction in the 1980’s of electronic platforms and instruments for payments. The payments market was basically divided between wholesale payments on one side, regulated through the TARGET and subsequent TARGET2 platforms, and the market for retail payments, still fragmented and subject to country specific services and costs on the other side. The removal of the fragmentation of the market for retail payments became one of the aims of the EU which endorsed a self-regulatory approach of the banking industry. The European banking industry in the payments sector responded with the creation in 2002 of the European Payments Council, an 2

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executive organism representing it; the institution of the Council was approved by the European Central Bank, the SECB and the Commission, with the scope, inter alia, of creating the SEPA (a self-regulatory inter-bank standardization project for a Single Euro Payments Area) by 2010. 7 Art. 86 (3) PSD. 8 I.e. ex Art. 51 PSD: Art. 52, par.1, PSD (charges applicable); Art. 54, par. 2, PSD (form of consent and presumption of unauthorized transaction); Art. 59 PSD (evidence on authentication and execution of payment transactions); Arts. 61-63 PSD (all on liability for unauthorized payment transactions and refunds procedures); Art. 66 PSD (irrevocability of payment order); Art. 75 PSD (nonexecution or defective execution). 9 See Art. 54 of the Proposal PSD2. 10 Previous EU legislation was tailored specifically on the different types of payments (credit transfers, direct debit transfers, payment by cards). 11 See Art.71, paragraph 2, Proposal PSD2. In the latter case (a direct debit transfer) the proper wording of the Directive(s) should have been “direct payment authorization” or “payment instruction” or “direct debit instruction” rather than revocability of the “order of payment”. 12 See European Court of Justice, 3 April 2008, C-306/06 Telekom Gmbh v. Deutsche Telekom AG on time of performance (Directive 2000/35): “the decisive point for the assessment of whether, in a commercial transaction, payment may be regarded as having been made in time, thus excluding the possibility of the debt giving rise to the charging of interest for late payment within the meaning of that provision, is the date on which the sum due is credited to the account of the creditor”; however the debtor must not be held liable for delays for which he is not responsible. In other words, Directive 2000/35 itself excludes interest for late payment in cases where the late payment is not the result of the debtor’s conduct, as he has diligently taken into account the periods normally necessary for execution of a bank transfer”. The bottom line of this judgment seems to be that the debtor must calculate the risk of delay at least as far as his leg of payment is concerned. 13 In Italian law for example, the legislative rule, ex Art. 1277 codice civile according to which a monetary obligation is discharged (only) by tendering currency, has been interpreted by scholarship and case law in what has been defined as an evolutionary construction which admits the interposition of service providers and the transfer of scriptural money, en lieu of cash, as a lawful means of discharge of a monetary obligation: see also the ruling by the Corte di Cassazione S.U., n.26617/2007. Similar rules imposing payment by tender in cash can be found in Portugal (Art. 550 codigo civil), Spain (Art. 1170 codigo civil), Poland (Art. 358, par. 1, civil code), France (Art. 1895 code civil). 14 I.e. The Dutch civil code in art 6:112 NBW allows payment in a “common currency” in the country where the payment is made, and Art.6:114 states that “1.When the creditor has a bank account suitable for bank-giro payments in the

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country where the payment must or may be made, then the debtor may pay his debt by transferring the indebted amount to that bank account, unless the creditor has validly excluded a payment to that account - 2. In the event of the previous paragraph the payment is made at the moment on which the bank account of the creditor is credited”. In Belgium the arête royal of 10 November 1967, n. 56 imposes that all businessmen must open a bank or postal account for their payments and that payments above a threshold sum between businessmen must be made through bank transfers. In France loi 22 October 1940, Art.1 (modified by loi 23 December 1988, n. 1149) states the same obligation of payment by cheque or bank transfer or credit card payment for obligations above a certain threshold. 15 See e.g. the judgement of the Spanish Tribunal Supremo, 18 June 1948; in UK, Court of Appeal, 23rd May 1974, Tenax v. The Brimnes, [1974, EWCA Civ 15]; the German BGH, 13 March 1953, in NJW 1953, p. 897. 16 See Art. III 2:108 of the DCFR on Method of payment: “(1)Payment of money due may be made by any method used in the ordinary course of business”; Art. 86 Code europeén des contrats. See also Art. 6.1.7 of the UNIDROIT principles. 17 See European Court of Justice, 9 April 2014, Case C-616/11, T-Mobile Austria GmbH v Verein für Konsumenteninformation. 18 See inter alia Art. 4, para. 5, PSD. 19 See above, note n.11. 20 See the interpretation resulting from Article 64 PSD on receipt of payment orders and Article 66 PSD on irrevocability of payment orders. 21 See i.e. Articles 69 and 71 PSD2 22 Art. 25, par.3, d.lgs n.11/2010. 23 The disposition could also be read under the light of the trend of a concern for “systemic stability” highlighted with reference to the revocability/irrevocability of orders. 24 Respectively contained in France, in Art. L133-1 to L133-27 of the Code monétaire and financier as modified by the Ordonnance n. 2009-866; in Germany, in §§ 675a to 676c of the BGB (on obligations for the performing of a payment service, liability of PSPs and duty to provide information as well as termination of a payment service contract) as modified by the Gesetz zur Umsetzung der Verbraucherkreditrichtlinie, des zivilrechtlichen Teils der Zahlungsdiensterichtlinie sowie zur Neuordnung der Vorschriften uber das Widerrufs- und Ruckgaberecht von 29.Juli 2009. 25 See Conformity Assessment of Directive 2007/64/EC- France, Final Report, August 2001, available at: http://ec.europa.eu/internal_market/payments/docs/framework/transposition/france _en.pdf (last consulted November 2014). 26 See Conformity Assessment of Directive 2007/64/EC- Germany, Final Report, August 2011, available at:

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http://ec.europa.eu/internal_market/payments/docs/framework/transposition/germa ny_en.pdf (last consulted November 2014). 27 See Report from the Commission to the European Parliament and the Council on the application of Directive 2007/64/EC and on Regulation 924/2009, [COM (2013) 549 final], p. 8.

PART II: MONEY, IDENTITY AND COMMUNITIES

CHAPTER FOUR MONEY AND IDENTITY WITHIN THE FRAMEWORK OF THE EUROPEAN UNION CELIA DE ANCA1

Money has traditionally been agreed to perform three functions: to give value to tradable goods, to be a means of payment, and to be a reserve of value. However there is an important fourth value, which is “providing a sense of belonging”, or identity money. The establishment of the European central banks over the course of the 19th century was in parallel with the creation of European nationalisms, by which countries look for unifying elements to bond a society, whether through a national constitution, a national language, or a national currency, including national symbols in the newly issued banknotes. In the challenges ahead for European integration, the attachment of a community-based culture of money with an emotional sense of belonging is often neglected but constitutes a relevant factor to the future of Europe. This chapter builds on the idea of money and identity in Europe, with particular emphasis on emerging community-based complementary currencies, as well as new ideas on commodity-based currencies to try to understand how money can contribute to creating community, whether through a common European identity or a community-based identity within EU cultural pluralism. Key Words: Money, Community and Identity 1

Professor of Islamic Finance and Organizational Behaviour; Director of Diversity Center IE Business School, Madrid. Contact: [email protected]

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1. Introduction: money in the European context Money: a commodity accepted by general consent as a medium of economic exchange. It is the medium in which price values are expressed, as currency, it circulates anonymously from person to person and country to country, thus facilitating trade, and it is the principal measure of wealth. (Encyclopaedia Britannica, 2015) Based on the Encyclopaedia Britannica definition, we can explore whether the euro meets these criteria. There is an agreement among the citizens of the 19 member states with the single currency that the euro is a means of payment. We also use it as a unit of account to measure goods and services traded between our nations. Finally, the euro is used to store value, allowing us to save our surpluses in our euro-denominated bank accounts. In fact, these three functions have been performed by the euro with greater efficiency than the old national European currencies: we can trade in euros among a larger number of people than with our former individual European currencies, it is a more efficient unit of account for a greater number of goods and services, and, as a store of value, the euro provides greater stability for our savings. However, the euro has not been as efficient in providing something that the old national currencies once gave European citizens, which is a sense of belonging, or a “national identity”. Nonetheless, the lack of a strong emotional attachment to the euro or to the EU’s economic institutions has not prevented Europe from enjoying its longest period of economic stability in history. The success of Europe and its emergence as a soft power after World War II was due to three main aspects (Fernandez, 2015): 1. Political: Europe managed to find a communitarian method of resolving long-standing conflicts and supra-national decisionmaking rules, based on the principle of social cohesion and nondiscrimination. 2. Economic: Growing integration has taken place, based on a social market economy. 3. Ideological: The success of Europe has been due in part to a common ideology based on the humanistic principles of the Renaissance, coupled with a Christian Democrat consensus.

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During the second half of the 20th century the lack of a strong European identity did not seem to be a problem. However, in the 21st century, the lack of a common identity bond has emerged as a problem on a par with other challenges, among them: -

-

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The economic success of Germany has changed the traditional balance of power in Europe and has undermined other powerful states. The lack of a strong central European government means political power remains with national governments, raising the question of whether the EU can continue working with a common secretariat made up of 28 governments lacking a common defence or foreign policy. Economically, Europe struggles with globalization and the loss of its position as a leading technological power.

But the most difficult challenge for Europe today probably comes from the ideological disintegration brought about by growing demand from local nationalism. The question is whether we need a common European identity within the plurality of the peoples that make up the EU, and if so, whether this could be created, and then what the role of its currency might be. Our purpose here is thus twofold: to explore how money can contribute to creating a sense of community and thus identity; and how plural this identity could be. In other words, whether it is possible to create a monetary system for a multi-identity European society.

2. National currencies in the construction of national identity: the rise of the peseta as an example of national construction through a currency The establishment of the European currencies during the course of the 19th century, exemplified by the franc in 1795 or the pound in 1826, emerges in parallel with the creation of European nationalisms. The newly created nation states looked for unifying elements to bond their societies. The creation of national currencies was an important step in the creation of national identities, together with the establishment of a constitution or an official language. Particularly relevant was the introduction of national symbols on newly issued banknotes.

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To illustrate the creation of national identity through the monetary system, we can analyze the case of Spain. The rise of Spanish nationalism took place during the period from 1833 to 1868 (Horta, 2016), specifically as part of the Liberal economic reforms conducted during the reign of Queen Isabel II. One of the main goals of the Liberals was to establish national institutions that would overcome past territorial differences and develop a national identity distinct from other European nations. The first step in this process was the creation of a well-defined homogenous market (Antón, 1997, p. 149). This required the unification of the financial system, the creation of a central bank, and the introduction of the decimal system. These reforms also led to the organization of a new fiscal system in 1845, along with private initiatives among industrialists and financiers (González Antón, 1997, pp. 462-463). Thanks to these economic reforms, the state was able to tackle much of the chaos inherited from the previous period, giving the population the hope of stability and a common future. The peseta constituted a fundamental step in the construction of the national market and thus of a national identity. In 1856 the peseta was finally adopted by the newly created Central Bank of Spain,1 the Banco de España, which, in 1874, was given the monopoly on issuing coins and bank notes. Monetary union came in 1868, when the peseta became the only legal tender in Spain, eliminating all other currencies in use at the time (escudos, reales, and maravedies). After the establishment of the peseta, bank notes, coins, and stamps were created bearing the symbols of the Spanish nation such as kings, queens, and other political and cultural icons (Álvarez Junco, 2001, p. 564). The peseta remained the only legal national currency in Spain until the arrival of the euro in 2002. When the peseta was finally replaced by the euro, some Spaniards were unhappy, not just because of the difficulties of working out the price of goods in a new currency or the increase in prices, but also because many people had formed an emotional attachment to the peseta, and with its disappearance they saw part of their Spanish identity vanish. Perhaps they were right, because if the launch of the peseta marked the beginning of Spanish nationalism, its replacement by the euro marked the beginning of a new, uncertain era for many people.

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Fear of losing their national identity is arguably one of the reasons why the Danish were reluctant to abandon the krone, even though the currency is pegged to the euro, and thus effectively part of the single currency although Denmark has no say in the European Central Bank’s (ECB) decisions regarding the euro.

3. Identity and Community: The Emergence of Community-based Finance. 3.1. What is identity? The word “identity” comes from the Latin idem, meaning same, and entis, meaning entity. Therefore it is the process of becoming identical to some entity. This process can have two directions: I might decide consciously or unconsciously that I belong to a certain group, and thus identify with it, meaning that I follow certain patterns of behavior in order to conform to the group; equally, the process can be outside of me because “they” (those in the outside world) have decided to categorize me within a certain group, which implies a certain pattern of behavior people expect me to conform to, but which nevertheless I may or may not identify with. Social identity, and in particular group identification, has been widely studied in management literature, pioneered by Tajfel (Tajfel, 1972). Social identification appears to derive from the concept of group identification (Tolman, 1943) and could be defined as “the perception of oneness with, or belongingness to, some human aggregate” (Ashforth, 1989). This led Turner (1984) to propose the existence of a “psychological group,” which is perceived as a collection of people who share the same social identification or who define themselves in terms of the same social category membership. A member of a psychological group does not need to interact with, or like, other members of the group, or be liked and accepted by them. The individual seems to reify or credit the group with a psychological reality apart from his or her relationships with its members. Whether from the fields of sociology, anthropology, or psychology, scholars tend to agree on the basic premise that identity constitutes a process that has some of the following features (Jenkins, 2008, p 120): -

Identification is rooted in basic and generic human processes; it is part of the specific nature of our species.

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Personal identity, which differentiates the unique self from all other selves, is different from social identity, which is the internalization of collective identifications. The identification process reflects the interplay between identification of similarity and difference. Group membership is meaningful to individuals because it confers social identity and permits self-evaluation.

Everyday life would be impossible without classificatory systems. Symbolization permits the necessary abstractions for individuals and collectivities, and for relationships between them, thus it is the constitutional basis of the notion of society.

3.2. Community Community it is not an intellectual invention, it is a powerful everyday notion in terms of which people organize their lives, understand the places and settlements in which they live, and the quality of their relationships (Jenkins, 2008, p.133).

Community, following Jenkins, is among the most important sources of collective identification. In addition to regulating our everyday lives, it provides us with a strong emotional component. Community makes us feel good, as Bauman states: Community feels good because of the meanings of the word “community” conveys— all of them promising pleasures, and more often than not the kinds of pleasures we would like to experience but seem to miss. (Bauman, 2001,2008, p 1.)

3.3. From national identity to community, the role of money and finance in community construction At the end of the 1980s, sociologist Michel Maffesoli used the term tribe to illustrate a significant shift in society underway since the European Enlightenment, from one built around the individual to a world populated by “affective communities”. This new form of “being together” was labeled sociality, in which the person (persona), instead of having a function, plays a role. In these new identities, individuals seek to transcend their individualities by playing a role in open and free tribes that provide them with temporary identification. The micro-groups that dominate the landscape were described by Maffesoli not as residuals of former traditional

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social life, but as the key social fact of the experience in everyday living, a new way of living everyday life based on a communal, as opposed to an individual, basis. A few decades later, Bauman discussed these new forms of temporary communities that no longer provide a permanent space in which to act, but instead exist for a short time and then disappear as soon as the task is finished. He labeled these new groups liquid communities (Bauman, 2001). Another scholar who has dealt with new forms of community identification is Manuel Castell (Castell, 1997). In Castell’s analysis, the power of identity within the new e-networks is a key driving force. He identifies three forms of identities. The first are legitimizing identities, provided by institutions such as the state, political parties, unions, the Church, or the patriarchal state. These forms of identity have largely lost their cohesive capacity, leading to the appearance of resistance identities, which are imposed from above and built around traditional values such as God, nation, and family, or can be built around proactive social movements like feminism or environmentalism. The second form of identity has since been replaced by project identities, whereby individuals link their personal projects together with others for a common good. These projected identities are one result of the emerging forms of relationships enabled by new information and communication technologies, creating network societies. According to Castells, these networks allow for a new kind of social relationship characterized by collective behavior, rather than a collective sense of belonging. In the three cases, it is now a question of individuals choosing identities that they consciously want to be a part of and contribute to. The fact that this new form of “togetherness” is a product of decision and not of necessity is what makes it so rewarding to participate in. These communities of the network society, unlike those of the 1960s, are much more about sharing ideas and projects than sharing feelings - i.e., feeling well is fine and desirable, but it is not the primary objective for joining. More than two decades on, the collective energy the French thinker saw emerging is now developing at full speed, driven by new information technology systems. As societies progress toward greater communitarian affiliation, there is a clear movement of individuals from their groups of

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origin towards those they aspire to belong to and in which, without having to reject their identities of origin, they can also play out new identities of their choice. The collective energy of a new paradigm - whether labeled project identities, aspirational identities, or liquid identities - represents a form of temporary engagement to a group that is bound together by a common interest, and that uses the differences between its members to collaborate, co-create, or execute other kinds of joint action within a collaborative economy. Shared action is the driving force behind collaborative economics. According to Von Mises (Von Mises, 1949) the central issue in traditional economies is action as an individualistic application of human reason to select the best means of satisfying individual ends. In a complementary way, the collaborative economy could be defined as the joint application of human reason to select the best means of satisfying the collective ends of the group. Collaborative economics is defined by two complementary factors: the collaborative nature of needs (ends) and means. To qualify as collaborative, an activity must satisfy a shared need within a group. For example, car sharing is a response to a shared need for transportation. The sharing economy implies a collective use of need-oriented means within the group in order to satisfy a previous need. Recent examples of this are online crowdfunding, the establishment of complementary currencies. Community finance is a fundamental element in the collaborative economy, defined as a form of cash-flow that channels the financial resources of the savers of a community into the wellbeing of that community via economic activities, which members of the community believe should be undertaken and therefore willingly support with their savings. Community finance is perceived as another form of community-based behavior, others being collaborative consumption, collaborative work, cocreation, and co-production. Members sometimes want to belong to one or many communities at the same time, some made up of values, some geographically based, and others linked by consumption habits. Complex IT open systems composed of many inter-connected communities can work at community level while being open and global. Community finance includes a number of initiatives such as ethical banking, credit unions, micro finance, mutual organizations, Islamic

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finance co-ooperative com mpanies, and otther financingg traditions. What W these have in com mmon is a bellief that the fiinancial instituution, regardlless of its size, is theree to serve the community c on n a local or gloobal level.

4. Community--based com mplementarry currenciies Some monettary experts, such s as Lietaeer (Lietaer 20001) suggest th hat money is the reasoon why old forms f of com mmunity bondding were lo ost, while recognizing that, paradoxxically, moneey can also bee a way to help h build communities. Lietaer arguues that comm munity is linked to the ideaa of reciprociity in gift exchanges. ““Community derives from the two Latinn roots: cum, meaning among eachh other, and muunus, meaning g the gift, or tthe correspond ding verb munere to ggive. Thus, “community “ means m to givee among eacch other”. (Lietaer, 20001, p.182) Following that definitioon, when no on-reciprocal monetary exchanges e replace gift exchanges, communities break down. One of the examples c used by thiis thinker is the breakdow wn of traditioonal societies in Latin America or Africa in thee wake of Eu uropean colonnial expansion n and the imposition oof non-reciproocal money monetary m exchaanges. Some economic e theorists arggue that the monetization n of all trannsactions is a sign of economic ddevelopment because they y can be recoorded in the national statistical syystem. Thus, Lietaer indiicates that it is precisely in more

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developed economies where the process of community decay is the highest (Lietaer, 2001. p 186). As we saw in the previous section, the creation of Europe’s nation states and the emergence of national currencies that allowed for non-reciprocal monetary exchanges marked the emergence of the modern state, with the corresponding contract between the individual and the state. With the appearance of this social contract, the individual no longer needs the protection of the community. Nation states are thus based on individuals, not on communities, with monetary systems that reflect this relationship. The decline of the nation state has created a renewed need for community. Lietaer, one of the defenders of complementary currencies as a way to solve existing monetary challenges, argues that community-based currencies, for example, can help rebuild communities, since these forms of currencies, as opposed to national ones, are not based on scarcity or competition. “They are creating new wealth while solving social problems without taxation or regulation. They are empowering self-organizing communities, while increasing overall economic and social stability. Finally, they enable the creation of very necessary social capital without attaching the established capital formation process” (Lietaer, 2001, p.186). As its name suggests, the idea behind a complementary currency is not to provide an alternative to a country’s monetary system, but simply another payment option. Other systems to facilitate the exchange of goods and services can also function alongside the national currency. Complementary currencies depend on a strong sense of identity within the communities that agree to use them. Unlike regular money, complementary currencies cannot be used for accumulating wealth or contributing toward an individual’s savings, due to their tendency to oxidation, (Gisbert, 2010, p. 93) and the gradual nominal value decrease of the currency, which penalized the holder for keeping it out of the market. Complementary currencies help build communities, strengthening ties among members, encouraging exchanges within the community, creating jobs, and increasing local liquidity. Members of communities that have created complementary currencies say they have perceived an improvement in the local economic wellbeing. Complementary currencies also strengthen the local and regional economy, since the currency is only accepted within them, thus fostering the development of local and regional produce and discouraging imports of external goods (Yasuyuki Hirota,

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2013). As Lietaer points out, these complementary systems can help to balance economies and society (Lietaer. 2001, p. 146 – 147). Some pioneering complementary currencies, such as the WIR, date back to the early 1930s, but these were mainly isolated experiments, and it is only in recent decades that we have seen the emergence of complementary currencies as part of a broad-based movement, with some estimates suggesting that, between 1983 and 2014, more than 4,500 consolidated complementary currencies have been created worldwide. The WIR Cooperative Bank was founded in 1934 in Basel, Switzerland by Werner Zimmermann and 16 colleagues. Wir is the abbreviation of Wirtschaftsring-Genossenschaft (which roughly translates as “mutual economic support circle” and also means “we” in German (Lietaer, 2001. p 168). Initially the scope of the bank was limited to SMEs, but in 2000 was extended to other private clients, with the bank offering some of its products in regular Swiss francs (CHF). That said, it remains primarily focused on SMEs and the Swiss middle classes, as stated on its web page: “Nous déployons nos activités en Suisse en faveur de la classe moyenne, dont nous voulons être à partenaire digne de confiance, depuis notre création en tant que coopérative en 1934 (Banque WIR, 2015).” Among the advantages for members is being able to use the currency with other members (who numbered around 60,000 in 2015). Members can also borrow in the WIR currency (CHW) or in a combination of CHF and CHW. This combination means it can offer more competitive rates of interest than the market (since the CHW money is issued by the cooperative). CHW deposits do not give interest and have parity with the CHF, to which the CHW can be converted under certain conditions. At the end of 2014, the bank had provided loans worth a total of 848.4 billion in CHW (equivalent to €885.4 billion) In addition to these advantages for its members, some analysts have pointed out that the WIR system can also benefit the economy because of its anti-cyclical behavior (Stodder, 2000, p. 7-9). For example, as unemployment rises, more companies join the WIR system. Also, at times of economic stagnation there is a larger number of transactions in CHW. There is an increase in CHW transactions when SMEs have surplus cash.

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Encouraged by the pioneering experience of WIR, many other such social currency initiatives have developed around the globe, some of them focusing less on SMEs and the middle classes and more on the deprived, helping them to join the formal economy. Rather than complementary currencies, these are usually referred to as social currencies, (Primavera, 1999, p.3). Social currencies have been created throughout Latin America, many of them playing an important role in regional economic development. One of the most successful of these initiatives is the Banco Palmas in Brazil. Banco Palmas was established in 1998 in a deprived area near the city of Fortaleza. The initiative has since generated more than 1,000 jobs, and been copied by some 50 other communities that make up a network (Instituto Banco Palmas, 2015). The bank was developed by the Associaçao dos Moradores do Conjunto Palmeiras (Association of Residents of Conjunto Palmeiras), which has a population of around 30,000, to provide an alternative to the micro-credit lines offered by the regular banks, to help foster local production and consumption, as well as to generate employment. Banco Palmas developed its own currency, the palma, pegged to the real at a rate of one to one. The palma is accepted by 240 local producers and retailers and has established itself as a viable alternative, parallel currency. The palma is also helping business creation by providing loans in reales (R$) and palmas. Among the financial services offered by the Banco Palmas are (Instituto Banco Palmas, 2015): -

Local social currency Credit for financing solidarity enterprises Credit for personal and family consumption without interest Popular Solidarity credit card Opening account and account statements Deposits Invoice reception (water, electricity, telephone etc.) Subsidies and pension payments Cash withdrawals with or without credit card

The palma circulates freely in local shops, which tend to give discounts to businesses and producers to encourage the use of the currency.

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Any producer, shopkeeper, or entrepreneur that is registered in the community bank can exchange the social currency for the national currency if he or she needs to buy something or make a payment in the wider economy, and the social currency is backed by the Banco do Brasil for this purpose (de Melo, 2015). In the wake of the 2008 financial crisis, complementary currencies have emerged throughout Europe to foster local economic transactions, among the best known of which is the Brixton pound.

4.1. The Brixton pound The Brixton pound, created in London’s Brixton neighborhood, first appeared in paper form in September 2009. Two years later, the electronic B£ pay-by-text platform was launched. The Brixton pound is not legal tender, and for that reason does not constitute a promise to pay the bearer, however it is accepted by 250 businesses in the district, and council employees can take part of their salary, on a voluntary basis, in electronic Brixton pounds, while all trade performed with the currency is subject to income, business, and sales taxes. It has the appearance of regular money and seems to behave as such, the difference with pound sterling being that it is community-based, as illustrated by the Brixton pound supporters’ slogan, “The Brixton pound creates community pride”! (Brixton Pound, 2015) The Brixton pound is designed to be used to buy goods and services, and would lose its value if used to store value instead of being circulated as widely as possible. An essential part of its value is that it provides a sense of belonging: the people who use it feel themselves to be one of the tribe, a tribe that lives in an area described on the Brixton pound website as: …a diverse local economy with a vibrant high street and local market, a history of strong community spirit, a rich mix of culture and backgrounds, vestiges of revolution, activism, change, dynamic people, and attracting the avant-garde. (Brixton Pound, 2015)

The concept of tribal identity helps explain why these community-based complementary currencies are emerging, and why they are so well used by local people. As the nation state declines, the tribe becomes stronger, and so adopts, as the state did before it, a currency that includes the symbols of the community and its shared identity.

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5. Is a Monetary System for a Multi-Identity Society Possible in Europe? 5.1. How culturally sensitive is Europe’s monetary system? Community financing and the new forms of complementary currencies developed in most European countries represent two fundamental things: 1. A new sense of identity based on a sense of community that the state can no longer provide. 2. A system to overcome scarce liquidity. In principle, as their names suggest, these complementary currencies do not seek to replace the national or supra-national monetary system, which is seen by many people as no longer sensitive to their needs. The ongoing economic crisis has helped create a movement of European citizens looking for new, ethical money relationships. This has raised a number of questions: -

Could a different financial system foster a different society? Do the present financial systems have any ethical basis? Could religion provide an ethical basis? How can a financial system support the economic development of a community? Could a new financial system be established based on nonspeculative formulas and without usury? Could a collaborative system be more profitable than a system based on competition? Is growth always necessary and do countries need to base growth on debt?

Most of these questions relate to a general criticism of the European monetary system, in particular to three of its basic elements: 1. It was created through fiat, and thus on debt. 2. It is backed by banks in return for interest. 3. It is based on a legal currency issued by the ECB.

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For many Euuropean citizeens, these threee elements arre the basis off an unfair social system m. Equally, thhey are seen as culturally insensitive, as a interest lies at the coore of the systtem. Interest has traditionally been banned by most religgions, which highlights h how it explloits those most in need. Similarly, it is seen as paarasitical, taking from m the communnity, rather thaan giving to iit. Interest alsso creates instability, bbecause it inteerrupts the flo ow of money; and finally, because b it attempts to control timee, against the will of Godd, particularly y through practices succh as speculattion and gamb bling (See tablle below).

In the wakee of the finanncial crisis fu urther argumeents against th he use of interest ratess have joined traditional relligious ones, aamong them: -

Intereest rates drivee the growth im mperative Upward redistribuution of wealtth (increasingg the gap betw ween rich and ppoor) Errorrs in assigningg risks and liab bilities Sociaal erosion Acceelerated growtth of monetary y wealth and ddebt

Opposition to an interestt-based financcial system inn Europe has seen the growth of a movement to find alternativ ves. In part, thiss movement has h been led by Europe’s Muslim com mmunities, based on Isslam’s ban onn interest and speculation iin finance. In n London

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alone there are now more than 22 fully Islamic banks, along with some 18 law firms supplying Islamic financial services. Outside the Muslim community, a successful interest-free initiative is the Swedish JAK Members Bank (JAK Medlemsbank, 2015). JAK (an acronym of Jord Arbete Kapital in Swedish, or Land Labour Capital) is based on an idea that originated in Denmark in 1931. As of November 2011, JAK had around 38,000 members, who are each allowed one share in the bank, giving them voting rights and a role in its policies and management decisions. As with Islamic banks, JAK does not charge or pay interest on any of its loans. Instead, JAK members accrue points for saving, and use them to apply for a loan. The bank uses a simple accounting rule to ensure its own sustainability: each member who wishes to take out a loan must save money first. To see how this works in practice, consider a true story. An entrepreneur in the small community of Skatteungby – some 300 kilometers from Stockholm, asked the JAK Bank for a loan to open a shop. Although he was responsible for paying back the loan, the project was able to go ahead because he enjoyed the support of individuals within the community who wanted the shop. Enough people in his local community made a deposit from their personal savings into the account to finance the shop, complying with the rules that JAK requires for granting a loan. In this scheme, the bank takes the risk, and responsibility for repayment is the entrepreneur’s, while the community foregoes the potential gain in interest in their deposits in exchange for having a muchneeded shop. Like Islamic banks, JAK is a powerful alternative to the financial system for communities that do not want interest to be part of their financial daily transactions. Free-interest banking and community-based initiatives complement the mainstream system.

5.2. Can a monetary system be created for a multi-identity society in Europe? The need for community–based financial initiatives, together with some of the intrinsic problems in the current monetary system, poses a difficult

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challenge foor the EU: can a new mo oney system for a new Europe E be created? Until we finnd a new wayy to exchange goods and services that does not require conssumers to get themselves t in nto debt, a systtem that woulld give all Europeans a sense of pride p and ideentity, for maany experts, the most reasonable aapproach is too find a way for coexistennce between a unified supra-nationnal system, guaranteeing g cohesion at the macro-level and multiple com mmunity-baseed systems ab ble to providee a sense of belonging b and access tto credit, partiicularly in these difficult tim mes, as this illustration shows: Commu unity based mu ultiple system ms

Eu- based payment system m

The challennge facing thhe EU’s finaancial authorrities will bee how to facilitate theese new emerrging commun nity-based mooney systems with the legal framew works they need to operate.

6. Final Th houghts The sense oof identity Euuropeans migh ht once have felt with theeir nation state is arguuably waning; but it has nott generally beeen replaced by b a sense of belongingg to the instituutions of the EU, E which aree seen by man ny people as distant annd abstract. At the samee time, our neeed to belong g to a commuunity to which h we can contribute aand participatee is as great as a ever. It is nnot surprising therefore

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that money can play a role in providing that sense of belonging, particularly at this moment of transition. Emotional attachment to community-based money systems is a largely neglected area of study, but one that will play an important role in the future of Europe.

References Álvarez Junco, J. 2002. Mater Dolorosa. La idea de España en el siglo XIX. Madrid: Taurus-Santillana Ashforth, Blake E., and Mael, F. 1989. Social Identity Theory and the Organization, In: Academy of Management Review, 14 (1). pp. 20-39. Banque WIR. 2015. Accessed December 10 http://www.wir.ch/fr/labanque-wir/. Bauman, Z. 2008. Community. Seeking Safety in an Insecure World. 7 th ed. Cambridge: Polity Press. Brixton Pound. 2015. Accessed December 10 http://brixtonpound.org/ Castells, M. 2000. The Rise of the Network Society, In: The Information Age: Economy, Society and Culture. Vol. I (2). Cambridge, MA; Oxford, UK: Blackwell. —. 2004. The Power of Identity. In: The Information Age: Economy, Society and Culture. Vol. II. 2nd ed. Cambridge, MA; Oxford, UK: Blackwell. de Melo Neto Segundo, João J. 2015. Community Banks – Microcredit & Social Currencies The case of Brazil. Accessed December, 20th http://web.archive.org/web/20130720100112/http://www.banquepalmas.fr /IMG/pdf/Community_Banks_-_Microcredit_The_Case_of_Brazil_.pdf Cortés G., F. J. 2010. Finanzas éticas: banca ética, microfinanzas y monedas sociales. La Hidra de Lerna: Madrid. Encyclopaedia Britannica. 2015. Money. Acessed December 7th http://www.britannica.com/topic/money. Fernandez, F. 2015. Conference at the BBVA Open Mind 19 11. González, Anton L. 1997. España y las Españas, Madrid, Alianza Editorial. Gisbert, Quero J. 2010. Vivir sin empleo, Los libros del lince, Barcelona. Horta, M. J. øSPANYOL MøLLøYETÇøLøöø (1808-1870). Kökenleri, ideolojisi ve ulusal simgeler. Pp. 149. (forthcoming). Instituto Banco Palmas. Accessed December 20. http://www.institutobancopalmas.org/ JAK Medlemsbank. 2015. Accessed December 20

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https://www.jak.se/international Jenkings, R. 2008. Social identity. 3rd ed. New York: Routledge. Lietaer, B. 2001. The future of Money , Century London. Maffesoli, M. 1988. Le temps des tribus: le déclin de l’individualisme dans les sociétés de masse. Paris: Méridiens Klincksieck. Primavera, H., Covas, H. y de Sanzo, C. 1998. “Reinventando el mercado La experiencia de la Red Global de Trueque en Argentina”. Accessed December 10 2015. http://redlases.files.wordpress.com/2008/02/es1998_reinventando_el_ mercado_libro3_hp.pdf Tajfel, H. 1972. La catégorisation sociale. In : S. Moscovici (ed). Introduction à la psychologie sociale (Vol. 1). Paris : Larousse Tolman, E.C. 1943. Identification and the Post-war world. In: Journal of Abnormal and Social Psychology (38). pp. 141-148. Turner, J.C. 1984. Social Identification and Psychological Group Formation. In: Tajfel, H. (ed.). The Social Dimension: European Developments in Social Psychology, 2 vols. Cambridge: Cambridge University Press: II. pp.518-538. Stodder, J. 2000. Reciprocal Exchange Networks: Implications for Macroeconomic Stability. Accessed December 10 2015. http://www.complementarycurrency.org/ccLibrary/materials/reciprocal _exchange_networks.pdf last entered December 10 2015. p. 7 – 9 Yasuyuki, H. 2014. Monedas sociales y complementarias (MSCs): Experiencias, su papel en la economía social, estrategias, marketing y políticas públicas. Working Paper Universitat de València.

Notes 1

Created from the Banco de San Carlos, founded in 1782 by the King Carlos III and finally taking the name Banco de España.

CHAPTER FIVE “EQUAL FOR EQUAL, HAND TO HAND”: COMPARING ISLAMIC AND WESTERN MONEY VALENTINO CATTELAN1

“Equal for equal, hand to hand” is a well-known hadith regarding money transactions. The Islamic law of money, prohibiting any quantitative inequality, as well as uncertainty, in commercial transactions, raises fundamental issues for all the components of the contemporary financial system stemming from conventional capitalism, from the banking sector to the insurance segment, and payment standards. Considering this, the chapter aims at investigating the “identity” of “Islamic money”, moving from its legal and socio-economic nature to the challenges related to the accommodation of Islamic finance in the contemporary financial system. In this direction, open issues related to the plural dimensions of contemporary capitalism will also be taken into consideration, dealing with aspects of credit history, comparative law, and socio-economics (with regard to the categories of “community” – Gemeinschaft – and “society” – Gesellschaft) from an interdisciplinary perspective. Final considerations will also comment on the current dynamics of convergence between Islamic and conventional finance within the sharing economy. Keywords: Islamic law, money, socio-economics, capitalism

1

Lecturer in Islamic Economics and Finance, Department of Political and Social Sciences, University of Florence, Italy. Contact: [email protected]

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1. Introduction. Islam, money, and the contemporary financial system [Exchange] gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, like for like, equal for equal, hand to hand. If the [exchanged] articles belong to different genera, then sell them as you wish, provided that the transaction is hand-to-hand.

Numerous accounts of the Sunna1 report hadith on the exchange of currencies and other denominated articles, whose nature, being susceptible of riba, can easily lead to usurious transactions. The passage reported above is merely representative of the multiplicity of caveats that can be found in the literature of fiqh (“Islamic jurisprudence”), warning Muslim believers “not to devour usury” for the sake of their spiritual salvation (as the Holy Quran dictates at Q. III:130). In fact, besides scriptural sources, the prohibition of riba has been the object of a broad hermeneutical study along the centuries in the treaties of fiqh, of which a rich illustration can be found in Saleh (1992). The ban of riba (as the prohibition of any kind of interest or illicit increase, in a much broader sense than that of usury) constitutes the most striking aspect of the rise of Islamic banking and finance, occurred from the 1970s onwards, as “an assertion of religious law in the area of commercial life, where secularism rules almost unquestioned throughout the rest of the world” (Vogel and Hayes, 1998, p. 19). Thus, while interestbased transactions, from conventional banking loans to the variety of debt products currently sold in the international market, appear “natural” elements of the conventional financial system (I would say “inherent” in its functioning), Islamic finance promotes an alternative model of intermediation, whose characteristics certainly represent a challenge to contemporary capitalism. In fact, apart from the prohibition of riba, further peculiarities differentiate the Islamic conception of money from the conventional system: more precisely, the rejection of gharar, i.e. of any element of the contract causing potential damage (ghabn) due to a want of knowledge (jahl) either of the price or the subject-matter; as well as the ban of maysir, i.e. of any aleatory purposes underlying the conclusion of the transaction. Generally speaking, if the prohibition of riba implies a quantitative equilibrium between the counter-values, those of gharar and maysir, leading to the dismissal of any element of speculation or gambling, reflect the necessity

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of a qualitative equilibrium, in terms of full disclosure and risk-sharing in trade (Cattelan, 2009). Without any doubt, the Islamic law of money, prohibiting any quantitative inequality as well as uncertainty in commercial transactions, raises fundamental issues for all the components of the contemporary financial system stemming from conventional capitalism, from the banking sector (being the remuneration through interest on deposits not admissible) to the insurance segment (since insurance is intrinsically an aleatory contract, thus banned due to gharar) and payment standards (the legitimacy of credit cards, for instance, is still under debate in Islamic finance, due to the postponement of the balance, causing the rise of riba). Considering all this, the present text intends to investigate the “identity” of “Islamic money”, moving from its legal and socio-economic nature (§ 2) to the challenges related to the accommodation of Islamic finance in the contemporary financial system (§ 3). In this direction, assuming that money is not only a means of exchange but also a ‘social relation’ (Ingham, 1996) and a ‘place’ of meaning (Maurer, 2005), the study highlights how the nature and function of money in Islam cannot be fully understood unless its principles are embedded with a credit economy founded on mutual trust and cooperation. Since “Islamic money” (either as purchasing or investing power) relates both to the “life of goods” (hayat al-amwal) and of “human beings” (hayat al-nufus), the prohibitions of riba, gharar and maysir implicitly foster a “trade community” where the market is conceived as a locus of partnership and sharing of resources (§ 2). Within this frame, the text will later compare the logic of “community” (Gemeinschaft) that belongs to Islamic finance to that of “society” (Gesellschaft) of Western modern capitalism, drawing from this comparison relevant questions on the compatibility of the two models. In the light of the specific identity of “Islamic money” in comparison to “Western money”, the text will argue that current regulatory policies should recognize the peculiar socio-economics of Islamic finance as complementary to that of the conventional financial system. Accordingly, their possible reconciliation should focus on instruments of project finance, microfinance, as well as crowdfunding, within the rise of the sharing economy, to nourish the full potential of “Islamic money” in relation to the “community of credit” that it embraces (§ 3).

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To conclude, some final considerations will comment on the current dynamics of convergence that can be found between Islamic finance mechanisms and the new frontiers of contemporary capitalism that the sharing economy is currently depicting, moving from the “otherhood” of modern ethics to the “brotherhood” of personal interactions in the market economy (§ 4).

2. “Islamic money” and the market as a community of trade 2.1. Locating “Islamic money” within its cultural context: some preliminary references to Quranic sources, and a little clue from Aristotle When dealing with the Islamic conception of money in comparison to the conventional, one strong hermeneutical concern is needed. Otherwise, the transfer of some cultural assumptions underlying the latter may have the unintended effect to undermine a coherent comprehension of the rationales of the former. In this regard, it is usually assumed that the functioning of the religiousbased market of Islamic finance suffers from a wide range of operative restrictions, due to the ethical constraints deriving from the prohibitions of riba and the other limitations on commercial transactions that have been previously mentioned. But, while this interpretation seems to me to be excessively affected by an interest-based conceptualization that belongs to “Western money”, it is, in reverse, by contextualizing those prohibitions within their own cultural background that “Islamic money” can find better explanation. To this objective, in order to recognize the specific paradigm that fosters Islamic capitalism (Cattelan, 2013a), a preliminarily reference to the Quranic sources from which the principles of Islamic economics and finance are derived can certainly be helpful. In this regard, the prohibition of riba can be found in four suras (“chapters”) of the Holy Quran, among which the most extended passage is in Q. II: 275-281. Its meaning can be summarized in the light of ayat (“evidence”, “sign”, i.e. “verse”) number 275 as follows: Those who devour usury will not stand, except as stands one whom the Evil One by his touch hath driven to madness. That is because they say:

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“Trade is like usury”, but Allah hath permitted trade, and forbidden usury. Those who, after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (the offence) are Companions of the Fire: they will abide therein (for ever).

Other relevant passages can be found at Q. III: 130 (“ye who believe! Devour not usury [...]”), Q. IV: 161 and Q. XXX:392. Also the Sunna reports the condemnation of any riba transaction3, which is to say of any commerce determining an “unlawful gain derived from the quantitative inequality of the counter-values… [in] the exchange of two or more species… which belong to the same genus…”, (Saleh, 1992, p. 16). Hence, all monetary loans are potentially ribawwi transactions (from which, the usual translation of riba as “interest”). Further provisions are provided by scriptural sources also on gharar and maysir, whose meaning, as already seen, can be linked to the need for a qualitative equilibrium as a condition of the validity of the contract4. As previously noted, gharar indicates any “danger of loss” that can derive from an unwanted uncertainty of which a counter-party can take advantage, to the damage of the other (the Arabic root gh-r-r meaning “to deceive”, or “to mislead”)5. While the term gharar does not appear in the Quran, the Sunna reports that the Prophet Muhammad, due to the fear of gharar: Forbade the sale of an escaped slave of animal, the sale of a bird in the air or a fish in the water, the sale of what the vendor is not in a position to deliver, […] the sale of a young still unborn when the mother is not part of the sale, the sale of milk in the udders… (Saleh, 1992, p. 106)

The prohibition of any speculation or betting finds an explicit rule at Q. V: 90-91 with regard to maysir, a complex game of chance played at the time of the Prophet, and interpreted as referred to any form of gambling, in general: O ye who believe! Intoxicants and gambling [maysir as a game of chance], (dedication) of stones, and (divination) of arrows, are an abomination - of Satan handiwork: eschew such (abomination), that ye may prosper. Satan’s plan is (but) to excite enmity and hatred between you, with intoxicants and gambling, and hinder you from prayer: will ye not then abstain?

After reading these passages regarding commercial transactions and, in particular, monetary exchanges in Islam, one can easily jump to the

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conclusion that complying with Shari‘ah (the “right Path” for Muslim believers) would be detrimental to market interactions, due to excessive limitations on economic freedom. But, to a certain extent, this opinion comes from such a deep-rooted acquaintance with a market system where interest and speculation have been considered licit from the end of the Middle Ages onwards and are now so embedded in the dominant capitalist model (and its “remarkable story of risk”: Bernstein, 1996) that any potential alternative is perceived as a “challenge” to its “natural/social order”: in Greek language, to its nomos. In actual fact, since the very beginning, Islam had a positive view toward commerce. The point is confirmed by historical research on the broad development of commercial partnerships in medieval Islam (especially in the forms of mudaraba: Udovitch, 1970), and finds support in the life of the Prophet as a model of behavior for any Muslim. Mohammed himself had begun his adult life as a merchant, and no Islamic thinker ever treated the honest pursuit of profit as itself intrinsically immoral or inimical to faith. Neither did the prohibitions against usury [i.e. riba] – which for the most part were scrupulously enforced, even in the case of commercial loans – in any case mitigate against the growth of commerce, or even the development of complex credit instruments (Graeber, 2012, p. 275).

While the issue of the observance of the prohibition of riba in medieval Islam is still a contentious topic of debate, especially with regard to the nature of “legal devices” (hiyal, sing. hila) in the interaction between theory and practice6, it is undeniable that not only did the Muslim Middle Age experience a complex system of commercial partnerships, but also an exceptional development of credit instruments, from the sakk, “check” (pl. sukuk) and ruq‘a (“credit note”), to the suftaja (“letter of credit”, “bill of exchange”) and hawala (“assignment of debt”) (Ray, 1997). How would one explain this apparent contradiction between the seemingly restrictive system (in the light of the current conventional financial market) and the flourishing of these credit and commercial institutions? A sensible reply to this question requires an investigation into the conception of money in Islam at the intersection between legal prohibitions, commercial practice, and theoretical elaboration from a multi- and inter-disciplinary perspective, by recognizing that, far from being a neutral medium of exchange, money deeply shapes social interactions. It is precisely in this sense that Aristotle, in his Nicomachean

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Ethics, underlines the etymological correspondence in Greek language between “money” (nomisma) and “law” as “natural/social order” (nomos), both embodying the notion of an ordered existence of a social group as the “standards” for exchanges and social relations established by common agreement. There must… be one standard by which all commodities are measured… money has become by convention a sort of representative of common need [chreia, “demand”]; and this is why it has the name “money” [nomisma, “currency”] – since it exists not by nature but by “law” [nomos, “custom, usage, law, natural/social order”] (NE, Book V, 1133a 29-30).

Embracing Aristotle’s clue on the nature of money as equivalent to the natural/social order of things, thus affecting both the ordered exchange of goods and the existence of a given community in the light of the rulings provided by Shari‘ah, the next two paragraphs will focus on the idea of money in Islam, moving from its “causes” (2.2) to the sociological impact that its specific conceptualization can have on the trade system (2.3).

2.2. In-between the “life of goods” and the “life of human beings”: Aristotle’s four causes and “Islamic money” Both in Physics and in Metaphysics, Aristotle explains that there are four fundamental types of answer to the question of “why” things change. These “reasons” relate to the nature and functions of things, and are known in the philosophical tradition as the “four Aristotelian causes”, namely: -

-

The material cause, that is to say the substance, the material from which something is composed (e.g. the bronze of a statue); The formal cause, as the model, the essence of that thing (the shape of the statue); The efficient cause, which is the source, the origin of something, i.e. the factor determining its nature and its qualities (the sculptor who carved the statue); The final cause, as the end, the purpose, the function toward which the thing is directed (the statue was made to embellish a garden).

Although it goes beyond the objectives of this work to explore the philosophical background and outcomes of Aristotle’s classification, this taxonomy can certainly be helpful for summarizing the Islamic conception of money, as can be derived from the treatises of classical Islamic law

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(dating back to II-VII hijra/VIII-XIII century A.D.), representing the conceptual reference for the current practice of Islamic finance. Accordingly, the following sub-sections will summarize the “identity” of “Islamic money” in the light of Aristotle’s four causes, aiming in this way at a brief (while sufficiently appropriate) description of money in compliance with Quranic sources. 2.2.1. The substance of money: gold, silver, and modern paper money The classical legal scholars of Islam identified two materials as money par excellence: gold (dahab) and silver (fidda). Their “substantial” aptitude for being money was so deep-rooted that, either minted or not in form of coins (see also next section), they were conceived as the “fundaments” (usul) (here in the sense of Aristotle’s material cause) of prices, holding the intrinsic nature of being “price” (thamaniyya), i.e. “medium” of exchange. This does not mean that the usage of other types of (non-precious) materials in the alloy of money was rigorously prohibited: on the contrary, Muslim civilization experienced the widespread employ of copper as money, whose thamaniyya (i.e., the quality of being prices) was recognized by legal scholars on the ground of “human convention” (istilah). Thus, copper coins were produced by the Umayyad (661-750 A.D.) and the Abbasid caliphate (750-1258 A.D.) until the 19th century. On that point, Brunschvig remarks that if gold and silver were money by nature, copper represented it by agreement (1967, p. 141), showing how Islamic scholarship implicitly adhered to Aristotle’s concept of money from the Nicomachean Ethics, as previously quoted. This observation can support the admission of paper money in the contemporary economies of Muslim countries as a Shari‘ah-compliant means of exchange (rejecting some radical views that would claim the necessary use of gold and silver), provided that the employ of paper money derives from widespread social/political agreement, and the regulatory framework carefully oversees inflation and all other elements directly involved in the control over riba factors (in this sense, for instance, see Siegfried, 2001, pp. 327-331).

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2.2.2. The form of money: coins as fungible good (dayn) As previously said, gold and silver, as precious materials, are money by nature: as a universally accepted means of exchange, either by weight (muratala) or by number (mubadala) of pieces, both are recognized as the standard medium of representation of the price (thaman), the value (athman, qiyam) of all other things7. Of course, in the social dimension of medieval Islam, money appeared commonly in the form (formal cause) of coins, whose denomination varied in relation to their substance: thus, besides the golden dinar and the silver dirham, money by agreement was also the copper fulus8. While the issue of the conversion rate between these forms of currencies (whose values changed both in time and space) and the problem of their exchange by number or by weight were debated by classical scholarship for a long time (a precise outline of these problems can be found in Brunschvig, 1967), any form of money was characterized by Muslim scholars as dayn, being coins, by definition, fungible and substitutable to one another. The qualification of the “legal essence” (Aristotle’s formal cause) of coins as dayn (lit. “debt”, “credit”, located over the legal personality of the person, dhimma) implied, among many other legal consequences (Cattelan, 2013b), the necessary application of the prohibition of riba (as emerging also from the hadith reported at the beginning of this paper with regard to gold and silver). In a nutshell, any monetary exchange had to be seen as a potential ribawwi transaction, with all the deriving restrictions that have been mentioned above. 2.2.3. The price (thaman) as efficient cause (‘illa) of money A point of agreement can be found among all the treaties of classical Islamic jurisprudence: the efficient cause (in Arabic, ‘illa) of money, the “reason” for which money exists, is to be the “value” (qima) of other things in the form of “price” (thaman, qiyam). In this sense, as already remarked, money (especially gold and silver) holds the intrinsic nature of being “price” (thamaniyya), “medium” of exchange: money is the “root” (asl) of prices, or (according to other sources) “the prices par excellence” (al-athman al-mutlaqa).

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Significantly, both gold and silver are also metaphorically defined as “the life of goods” (hayat al-amwal), in the same way in which food is “the life of living beings, of people” (hayat al-nufus) (Brunschvig, 1967, p. 117): in other words, their functional role in market exchanges is comparable to anything nourishing the good health of human beings (see also next section). Subsequently, as standard representative of prices, either by nature (dinar and dirham) or by consent of people (fulus), money cannot be deemed to have value per se (when it is not acquired for its intrinsic value, as for gold and other precious metals): on the contrary, as the “value of other things”, it is commonly accepted as being easily convertible into the goods that people ultimately intend to buy (Siegfried, 2001, p. 324). In other words, the intrinsic ratio underlying the existence of money in a civil society, its thamaniyya, lies in its proactive usage in the market as a medium of exchange, realizing in the circulation of properties the ultimate purpose of its nature. 2.2.4. The purpose of money: giving life to goods as food gives life to human beings Hence, among the four Aristotelian causes that can outline the nature of money in Islam, the most revealing element is properly related to the purpose, the end (final cause) of money in the market as an instrument to promote trade, nourishing the “life of goods” (hayat al-amwal) as food sustains the “life of people” (hayat al-nufus). The mercantile society that flourished in medieval Islam through the development of a variety of commercial institutions and credit instruments (Udovitch, 1970; Ray, 1997) found its cornerstone in the fundamental conception of money not as a means per se of personal enrichment (against which the prohibition of riba is directly addressed), but either as “purchasing power” for consumption (i.e. as “price” in exchanged countervalue in a sale) or “investing power” for the production of things (that is to say, as “capital” to be invested in the purchase of commodities for an enterprise). In a nutshell, it is the promotion of the market as a locus of common welfare (thus of profit- and risk-sharing) that enlightens the “identity” of “Islamic money” and can fully explain its legal principles and socioeconomic rationales. From this perspective the Quranic decree forbidding riba, usually read in a restrictive sense (Q. II: 125: “… Allah hath

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permitted trade and forbidden usury”), can display its affirmative stance in promoting trade activities as the foundation of any market relation, looking at economic actors as participants in a common enterprise of welfare, in the light of the principles of the sacred Shari‘ah. And it is from this pro-active role of the human being as God’s agent in the marketplace that the principles of profit- and risk-sharing can display the socioeconomics of “Islamic money”, as the next paragraph will outline.

2.3. The market as a common venture of profit- and risksharing In conclusion, which kind of market does “Islamic money” foster as a place of social interaction (Ingham, 1996) and meaning (Maurer, 2005)? Which socio-economic environment promotes the “reasons” (i.e. the four Aristotelian causes) underlying its nature and functions? The usage of (1) gold, silver, copper, or paper money, (2) in form of dinar, dirham, or fulus as (3) representative par excellence of prices (4) in order to nourish trade, while avoiding any illicit return (riba, gharar or maysir) reflects a deep-rooted conception of the marketplace as the outcome of an “economy of trust” that “operates largely without state mechanisms of enforcement…, [and where] a significant part of the value of a promissory notes [the ruq‘a, as well as the other institutes previously mentioned] is indeed the good name of the signature” (Graeber, 2012, p. 277). An “economy of trust” that is founded, in other terms, on the centrality of the person and of inter-personal networks which can mainly develop at a local and community level (on some parallelisms between “Islamic money” and the rationales supporting “alternative currencies” at a local level significant considerations can be found in Maurer, 2005). Far away from the anonymity and impersonality of the economic actor operating in the Western contemporary market, the coherent employ of “Islamic money” (here intended as nomisma in the Greek sense, both as a means of exchange and of human interaction) implies the development of a network of social relations in the form of a “community” of trade and credit (a Gemeinschaft in socio-economic terminology: see § 3). Within this “community” it is the centrality of the person, his own reputation as “personal credit” (the dhimma as legal personality) that “backs” his debt (dayn) and the exchange of goods through an economy of mutual trust, oriented towards criteria of profit-oriented cooperation and the sharing of resources, whose practices are governed by a logic which is specific to its own cultural context.

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In summary, it is through the socio-type of Gemeinschaft (as this text will argue in § 3) that the fundamental peculiarities of “Islamic money” can find their most appropriate explanation either as exchange counter-value for consumption or capital for production, whose inherent quality (‘illa) of being the price (thaman), the equivalent (qiyam) of goods is deeply connected to the promotion of the market as a common enterprise of social welfare. Accordingly, the law of Islam governing money (in brief, the prohibitions of riba, gharar, and maysir), as well as the centrality of the real economy and the principles of profit- and risk-sharing9 can properly disclose their potential for social development in the light of a “community of trade and credit” gathering consumers, merchants, and bankers in a common venture of welfare promotion. This can explain why there is no historical evidence that the Islamic law governing money (in particular the prohibition of interest as riba) represented an obstacle to the flourishing of the merchant society of medieval Islam (Udovitch, 1970). On the contrary, a list of commercial institutions and credit instruments, as well as the conceptualization of money as a means of exchange either by nature or by agreement reflect the image of a market society where personal reputation, a trust network, and mutual cooperation were the foundations of economic interactions. In this sense, the sources show an advanced credit economy in medieval Islam. -

-

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Based on the exchange of goods through a variety of credit transactions (e.g. murabaha, mark-up sale; bay‘ al-salam, immediate payment for future delivery) and instruments (e.g. hawala, transfer of debt as a means of payment; suftaja, letter of credit; ruq‘a, promissory note; sakk, credit document) (Ray, 1997); As well as the widespread use of commercial partnerships (mudaraba; musharaka), credit partnerships (sharika al-wujuh, where the capital consisted of goods bought on credit and borrowed money), and even “partnerships of good reputation” (sharika almafalis) where merchants had no capital at all, and borrowed money only by their good name in their business circles (Graeber, 2012, p. 276; see also Udovitch, 1967); Moreover, dealing with the distinction between the material cause of money in relation to the intrinsic value of money by nature (gold and silver) and the face value of coins by convention (fulus), legal scholars pointed out that, while with foreigners in international trade only gold and silver should have been accepted as money

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(being the “others” outside the community of trade and its criteria of mutual trust), within the social circle of this community, fulus could have been accepted as money without restrictions, due to the “reputation” of the people involved in the business “backing” the exchange of goods or the invested capital (Siegfried, 2001, p. 326). Moving from “Islamic money” to the socio-economics of “Western money” in modern and contemporary capitalism, the next section of the article will raise fundamental doubts on the compatibility between the models of intermediation underlying Islamic finance and the modern financial system (3.1). At any rate, sensible suggestions will be advanced for an appropriate accommodation of Islamic finance in the contemporary global market, in the light of the trade and credit community that its socioeconomics embraces (3.2).

3. Accommodating “Islamic money” in the society of contemporary capitalism Without any doubt, the social reality of the medieval trade in Islam, with its commercial institutions and credit instruments, does not match the current functioning of financial markets for a multiplicity of reasons. Nominal values have substituted tangible products and the interest-based conception of money is so deeply embedded in financial transactions that the shift towards a riba-free market looks like an explicit challenge to contemporary capitalism. At any rate, if one looks at the history of Western capitalism from a much broader perspective, from the legitimacy of interest in the Middle Ages to the “society of debt” that is currently dominating the financial system, the rise of Islamic finance as a complementary model of credit intermediation can actually be welcomed as a factor of pluralism in economic relations (thus contributing to diversification, social inclusion, and multiculturalism) rather than as a challenge to “Western money” (in this sense, Cattelan, 2013d). To this aim, in order to “open” the market to “financial pluralism” (Cattelan, 2013d), the assumption of Western capitalism as a unique paradigm for financial intermediation should be preliminarily rectified, through the study of the historical and cultural background of the contemporary financial market (3.1). Only after that, the investigation can concentrate on the search for specific strategies to accommodate Islamic

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finance in the dominant interest-based system, without depriving it of its community-oriented dimension (3.2).

3.1. The socio-types of “community” (Gemeinschaft) and “society” (Gesellschaft) as respective backgrounds of Islamic and conventional finance The socio-economic distance between “Islamic” and “Western money” can be effectively described with reference, respectively, to types of “community” (Gemeinschaft) and “society” (Gesellschaft), as originally conceptualized by Tönnies (1887). As this work has previously highlighted (see 2.3), the Islamic principles governing money, the centrality given to the real economy, as well as to criteria of profit- and risk-sharing, lead “Islamic money” to a “community of trade and credit” that gathers together consumers, merchants, and bankers in a common economic venture. This profit and risk-sharing model embraces the socio-type of Gemeinschaft, where the moral principles of Islamic finance (Asutay, 2013) reflect a logic of mutual trust and cooperation aimed at a fair distribution of resources among all market participants. In reverse, from the XIII century onwards, in the Western world this “community” has been replaced by the “society” (Gesellschaft) of modern capitalism, dominated by a logic of exchange that has been progressively detached from human relations. The birth of modern capitalism and the peculiar connotations belonging to “Western money” can be found in the new identity of a market where the development of economic life led to the admissibility of financial loans through the acceptance of interest as a means of remuneration of the capital. The Christian Church itself, as remarkably described by French historian Jacques Le Goff (1986 and 2010), contributed to this radical change by reconceptualizing biblical precepts and moving from usury as sin to credit management as work: hence, the distinction between the “evil” of the usurer and the “good” of the banker, the “offence” of usury and the “licit” of interest defined a turning point (probably a cultural revolution) that formed the basis for modern capitalism. Of course, another four centuries were needed for the consolidation of the new Gesellschaft founding “Western money”, through the essential contributions by Martin Luther and his Protestant Reform, as well as by the doctrinal elaboration of John Calvin (Weber, 1905), but the embryonic nature of the contemporary

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financial system was already defined in the late Christian Middle Ages. In this regard, Nelson (1949) underlines the extent to which, by the removal of the prohibition of interest, in modern capitalism, “all are ‘brothers’ in being equally ‘others’”: in other terms, embracing the modern spirit of impersonality, Western money has leveled qualitative differences between things, as well as between people. Subsequently, this anthropology of money has paved the way from the personal relations of Gemeinschaft (as embedded in “Muslim money”) to the impersonal structure of Gesellschaft, leading to the paradigm of “universal otherhood” that dominates contemporary financial markets. Within this anthropology (Maurer, 2006)10, the notion of “credit” was soon radically transformed into the de-personalized and de-materialized economy of “nominal values”, where “credit-based honesty [cast] two incongruent textualities (personal reputation, impersonal paper) into discursive reciprocity” (Sherman, 1997). Derived from the Latin credere (to believe or to trust) and originally a reference to the quality of the person who could be trusted, the word [credit] now served to endow the untrustworthy thing – the loan – with the qualities of the person who could be trusted. Buttressed by the personal word of an individual and public acknowledgment of that bond, credit acquired substance, and only when trust failed would a borrower be obliged to pledge his plate or jewels… (Howell, 2010, p. 28).

It is easy to recognize in this extract a list of terms (credit, reputation, the trustworthy person, the untrustworthy thing) that have previously been employed to characterize the “community of trade and credit” (Gemeinschaft) underpinning “Islamic money”. But in the “society” (Gesellschaft) of “Western money”, as deeply embedded in the contemporary mechanisms of conventional finance, the “quality of the person who could be trusted” has been radically replaced by the loan as an “untrustworthy thing”. As a result, the ultimate expression of the Western “society of credit”, conventional finance, has witnessed the transformation of commercial banking into consumerfocused “financial services” organizations, whose activity focuses on money as a “product” rather than a “social relation”, sustaining the consumption of things rather than the production of social value (Langley, 2014). Thus, unexpectedly, the “society of credit” has finally turned into a “society of debt” deteriorated by the excessive commoditization of money.

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Only by recognizing this dichotomy of Gemeinschaft/Gesellschaft can the mechanisms of real exchange and participation of Islamic finance, with their logic of mutual trust and cooperation (see § 2), find a coherent reassertion in contemporary economy, replacing the opposition between “Islamic” and “Western money” with the search for a fruitful outcome (if any) between their reciprocal interactions.

3.2. “Western” and “Islamic money” reconciled? A community-based approach to the credit economy Considering the alternative conceptualization of money in Islamic and Western capitalism, respectively in terms of Gemeinschaft and Gesellschaft, it comes as no surprise that current attempts of accommodation of Islamic finance in the conventional system have raised many points of dissatisfaction, with a widespread criticism of the practice of Islamic economics11. Certainly, the rise of Islamic finance in a system dominated by the logic of Western capitalism has implicitly determined a high level of hybridization, as well as a departure from the strict rules of classical Islamic law (ElGamal, 2006; Bälz, 2008). At any rate, the actual challenge of integration between conventional and Islamic finance should not be seen exclusively in legal terms: on the contrary it is the substantial dimension of the socio-economics of “Muslim money”, as previously outlined, on which strategic policies of reconciliation should focus, looking at Islamic finance as a complementary (rather than alternative) model of intermediation nourished by the sociotype of Gemeinschaft. Accordingly, it is precisely by referring to the “community of trade and credit” underlying “Islamic money” (see § 2), with rationales of mutuality comparable to projects of “local currencies” (Maurer, 2005), that a list of operative instruments can be mentioned, embracing a conception of money (nomisma), whose legal principles (nomos)12 are entwined with a credit economy founded on profit- and risk-sharing. To the objective of reconciling the distinct socio-economics of Western and Islamic capitalism, attention should be given, for instance, to the areas of (1) project financing; (2) microfinance; and (3) crowd-funding.

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3.2.1. Project financing Project financing, as a model for supporting the development of local infrastructures, fosters a “community of interests” among capital providers, managers, final beneficiaries, and consumers. A general definition of project finance is: The financing of an economic unit in which the lenders look initially to the cash flows from operation of that economic unit [usually in the form of the so-called Special Project Vehicle, SPV] for repayment of the project loan and to those cash flows and other assets comprising the economic unit as collateral for the loan (McMillen, 2001, p. 1186).

As can be easily noted, the rationales of Islamic finance, especially those related to the primacy of the real economy and the principles of profit- and risk-sharing, are easily met by a project financing structure, where the cash flows will repay the initial investment of the capital provider and remunerate the work of the developer of the economic unit. In fact, both contractual forms of mudaraba or musharaka are easily applicable to project financing, while, with regard to multi-lateral investments, Islamic finance does not differentiate from the conventional one in the appraisal process, with variations limited to the legal structures to be implemented. In this sense, it is significant to note how the socio-economics of Gemeinschaft, which may appear at a first glance relegated to a premodern model of commercial business, becomes, on the contrary, extremely effective in the event of multi-lateral plans of project financing. 3.2.2. Microfinance Objectives of local development have been pursued through numerous initiatives of microcredit and microfinance in the last decades. Being embedded in the social structure of local communities, it is clear that these initiatives also comply with the logic of Gemeinschaft belonging to “Islamic money”. In this regard, it has been noted that: Islamic microfinance represents the confluence of two rapidly growing industries: microfinance and Islamic finance. It has the potential to not only respond to unmet demand, but also to combine the Islamic social principles of caring for the less fortunate with microfinance’s power to provide financial access to the poor. Unlocking this potential could be the key to providing financial access to millions of Muslim poor who

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In fact, the issue of interest-based microcredit can be easily overcome by satisfying consumers’ basic needs through contracts of sale (murabaha), or leasing (ijara), or by participating in a small business enterprise through mudaraba. As a result, Islamic microfinance can be primarily beneficial to small and medium businesses, also in the light of women’s empowerment, where micro-investment projects match aspects of social endorsement and personal self-determination. 3.2.3. Crowdfounding and the sharing economy The exceptional growth of the digital economy in the last decade has fostered the popularity of crowdfunding to promote initiatives of micro and project finance that perfectly match the logic of trade and credit community (Gemeinschaft) underpinning “Islamic money”. To a certain extent, it can be said that all the pioneering instruments of the “sharing economy” embrace a logic of “community” (through elements of cooperative agency, participation in business networks, peer-to-peer lending, consumption, and production) that appear particularly functional to the reconciliation between conventional and Islamic finance (see also the conclusions of this article). Focusing here on crowd-funding as the most significant example among these instruments, it has been correctly remarked that: Crowdfunding complements the principles of Islamic finance and how Muslim nations can benefit from building a Sharia compliant crowdfunding ecosystem. Such an ecosystem would build strong relationships among people, promote the socially responsible distribution of wealth, and encourage risk sharing in economic transactions to reduce the risk to any one party. All core elements of both Islamic finance and crowdfunding (Crowdfund Capital Advisors, 2012).

This promising match between Islamic finance and crowd-funding has already emerged through two internet-based platforms, Shekra and Yomken13 (Taha and Macias, 2014), the former is the winner of the Islamic Economy Award as the best SME Development Provider in 2013 (Global Islamic Economy Summit, Dubai), as well as the Ethical Finance Initiative Award in the same event.

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Indirectly, the success of this initiative shows the promising potential linked to the intersection between “Islamic money” and the sharing economy, as well as the emergence of mutable patterns in contemporary capitalism, marking a shift from traditional parameters of “otherhood” to innovative principles of “brotherhood” in trade and credit relations.

4. Conclusions: Money, the “other” and the “brother” By exploring the identity of Islamic money as resulting from the elaboration of the classical scholarship of fiqh, this contribution has highlighted: -

-

On the one side, how the conception of money in Islam cannot be fully understood, and practiced, unless Islamic legal principles are entwined with a trade and credit economy founded on mutual trust and cooperation (§ 2); And, on the other side, how the rationales of Islamic and conventional finance reflect the divergent socio-types of “community” (Gemeinschaft) and “society” (Gesellschaft), whose possible reconciliation requires strategic models of partnerships (e.g. project finance) and local investments (e.g. microfinance and crowdfunding ) (§ 3).

As these pages have remarked, the comparison between Islamic and Western capitalism should not move from a dogma of incompatibility. On the contrary, a reconciliation between the identities of conventional and Islamic finance can be pursued by focusing on their respective socioeconomics, and recognizing the deep interconnection between social order (nomos) and money (nomisma) in the market, as suggested by Aristotle (NE, Book V, 1133a 29-30). It is within this frame that further opportunities of interaction between “Western” and “Islamic money” can be found by looking at the changing identity that global capitalism is experiencing through the rise of the sharing economy, and how much the “diversity” of Islamic finance can be reconciled within this identity in evolution. If the basic assumptions of “Western money”, as shaped through the rationales of Gesellschaft (e.g. individualism, impersonality, commoditization of money, competition) are being currently replaced by pioneering models of collaborative and sharing economy that remind the logic of

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Gemeinschaft (eg. crowd funding, microfinance, capital venture, and social lending) (for a general outlook, see Chase, 2015, and Kramer, 2015), new opportunities for the implementation of “Islamic money” can be linked to the changing boundaries of global capitalism in the digital economy. Paraphrasing Nelson (1949), it is still too early to claim that a “universal brotherhood” between Western and Islamic capitalism will soon re-invent market institutions, from the otherhood of (self-)interest to the brotherhood of (community-)participation, but mutable frontiers of social economics are certainly appearing in the landscape of the global financial system. In the end, the proper accommodation of Islamic finance in this emerging landscape will also be measured in the light of the capability to nourish the potential of the cooperative economy, re-affirming the value of human interactions over the blind logic of exchange that has dominated modern capitalism.

References The quotations of the Holy Quran are taken from Yusuf Ali, A. 1975. An English Interpretation of the Holy Qur’an with Full Arabic Text. Lahore: Ashraf Press. The sura is specified in Roman numbers; the ayat (“evidence”, “sign”: that is to say, one of the “verses” into which the sura is divided) in Arab numbers (to give an example: Q. IX:51, 51st ayat of the 9th sura). Aristotle. The Nicomachean Ethics [Transl. by A.K. Thomson; revised by H. Tredennick; introduction and further readings by J. Barnes: 2004]. London: Penguin Books. Asutay, M. 2008. Islamic banking and finance: social failure. New Horizon, 169(1-3), Oct.-Dec. London: IIBI. —. 2013. Islamic moral economy as the foundation of Islamic finance. In: Cattelan, V. (ed.). Islamic Finance in Europe: Towards a Plural Financial System. Cheltenham, UK, and Northampton, USA: Edward Elgar Publishing. pp. 55-68. Bälz, K. 2008. Sharia risk? How Islamic finance has transformed Islamic contract law. Occasional Publications 9. Cambridge, USA: Islamic Legal Studies Program, Harvard Law School. Bernstein, P.L. 1996. Against the Gods: The Remarkable Story of Risk. New York, US, and Chichester, UK: John Wiley & Sons.

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Brunschvig, R. 1967. Conceptions monétaires chez les juristes musulmans (VIII-XIII siècles). Arabica, 14(2). pp. 113-143. Cattelan, V. 2009. From the concept of haqq to the prohibitions of riba, gharar and maysir in Islamic finance. International Journal of Monetary Economics and Finance, 2(3/4). pp. 384-397. —. 2013a. Shari‘ah economics as autonomous paradigm: theoretical approach and operative outcomes. Journal of Islamic Perspective on Science, Technology and Society, 1(1). pp. 3-11. —. 2013b. Property (mal) and credit relations in Islamic law: an explanation of dayn and the function of legal personality (dhimma). Arab Law Quarterly, 27(2). pp. 189-202. —. 2013c. A glimpse through the veil of Maya: Islamic finance and its truths on property rights. In: Cattelan, V. (ed.). Islamic Finance in Europe: Towards a Plural Financial System. Cheltenham, UK, and Northampton, USA: Edward Elgar Publishing. pp. 32-51. —. 2013d. Conclusions. Towards a plural financial system. In: Cattelan, V. (ed.). Islamic Finance in Europe: Towards a Plural Financial System. Cheltenham, UK, and Northampton, USA: Edward Elgar Publishing. pp. 228-234. Chase, R. 2015. Peers Inc.: How People and Platform are Inventing the Collaborative Economy and Re-Inventing Capitalism. New York, US: PublicAffairs. Crowdfund Capital Advisors. 2012. Sharia Compliant Crowdfunding – Creating a Crowdfunding Ecosystem for the Muslim World. Available at: http://crowdfundingcapitaladvisors.com/resources (Last accessed October, 2015). El-Gamal, M.A. 2006. Islamic Finance. Law, Economics, and Practice. Cambridge: Cambridge University Press. Graeber, D. 2012 (paperback; 1st ed. in hardcover, 2011). Debt: The First 5,000 Years. Brooklyn, NY: Melville House Publishing. Horii, S. 2002. Reconsideration of legal devices (hiyal) in Islamic jurisprudence: the Hanafis and their “exits”(makharij). Islamic Law and Society, 9(3). pp. 312-357. Howell, M.C. 2010. Commerce Before Capitalism in Europe, 1300-1600. Cambridge: Cambridge University Press. Ingham, G. 1996. Money is a social relation. Review of Social Economy (Special Issues on Critical Realism), 54(4). pp. 507-529. Karim, N., Tarazi, M., and Reille, X. 2008. Islamic Microfinance: an Emerging Market Niche. Focus Note no. 49. Washington, US: CGAP.

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Khan, M.A. 2013. What is Wrong with Islamic Economics? Analysing the Present State and Future Agenda. Cheltenham, UK, and Northampton, USA: Edward Elgar Publishing. Kramer, B. 2015. Shareology: How Sharing is Powering the Human Economy. New York: Morgan James Publishing. Langley, P. 2014. Consuming credit. Consumption Markets & Culture, 17(5). pp. 417-428. Le Goff, J. 1986. La Bourse et le Vie. Economie et Religion au Moyen Age. Paris: Hachette. —. 2010. Le Moyen Age et l’Argent. Essai d’Anthropologie Historique. Paris: Perrin. Maurer, B. 2005. Mutual Life, Limited: Islamic Banking, Alternative Currencies, Lateral Reason. Princeton, N.J., and Oxford, UK: Princeton University Press. —. 2006. The anthropology of money. Annual Review of Anthropology, 35. pp. 15-36. McMillen, M.J.T. 2001. Islamic shari‘ah-compliant project finance: collateral security and finance structure case studies. Fordham International Law Journal, 24. pp. 1184-1263. Nelson, B.N. 1949. The Idea of Usury. From Tribal Brotherhood to Universal Otherhood. Princeton: Princeton University Press. Ray, N.D. 1997. The medieval Islamic system of credit and banking: legal and historical considerations. Arab Law Quarterly, 12(1). pp. 43-90. Saleh, N.A. 1992 (II ed.; I ed. 1986). Unlawful Gain and Legitimate Profit in Islamic Law. London: Graham & Trotman. Schacht, J. 1982 (paperback; 1st ed. hardcover 1964). An Introduction to Islamic Law. Oxford, UK: Clarendon Press. Sherman, S. 1997. Promises, promises: credit as contested metaphor in early capitalist discourse. Modern Philology, 94(3). pp. 327-349. Siegfried, N.A. 2001. Concepts of paper money in Islamic legal thought. Arab Law Quarterly, 16(4). pp. 319-332. Taha, T., and Macias, I. 2014. Crowdfunding and Islamic finance: a good match?. In: Atbani, F.M., and Trullols, C. (eds). Social Impact Finance. New York, US, and Hampshire, UK: IE Business Publishing and Palgrave MacMillan. pp. 113-125. Tönnies, F. 1887. Gemeinschaft und Gesellschaft. Leipzig: Fues’s Verlag. Udovitch, A.L. 1967. Credit as a means of investment in medieval Islamic trade. Journal of the American Oriental Society, 87(3). pp. 260-264. —. 1970. Partnership and Profit in Medieval Islam. Princeton: Princeton University Press.

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Vogel, F.E., and Hayes, S.L. 1998. Islamic Law and Finance. Religion, Risk and Return. The Hague, London and Boston: Kluwer Law International. Weber, M. 1905. Die Protestantische Ethik und der Geist des Kapitalismus. Germany.

Further readings Aristotle. Physics [Transl. by R. Waterfield; ed. by D. Bostock: 2008]. Oxford World’s Classics. Oxford, UK: Oxford University Press. Aristotle. The Metaphysics [Transl. by H. Lawson-Tancred: 1999]. London: Penguin’s Books. Ayub, M. 2007. Understanding Islamic Finance. Chichester, UK: John Wiley & Sons. Cattelan, V. 2014. In the Name of God: managing risk in Islamic finance. Eabh Working Papers Series, 14-07. Available at: http://www.eabh.info/publications. (Last accessed October, 2015). Çizakça, M. 2011. Islamic Capitalism and Finance. Origins, Evolution and the Future. Cheltenham, UK, and Northampton, USA: Edward Elgar Publishing. Ercanbrack, J. 2015. The Transformation of Islamic Law in Global Financial Markets. Cambridge: Cambridge University Press. Hassan, M. K., and Mahlknecht, M. (eds). 2011. Islamic Capital Markets: Products and Strategies. Chichester, UK: John Wiley & Sons. Iqbal, M., and Llewellyn, D.T. (eds). 2002. Islamic Banking and Finance: New Perspective on Profit-Sharing and Risk. Cheltenham, UK, and Northampton, USA: Edward Elgar Publishing. Mallat, C. 2000. Commercial law in the Middle East: between classical transactions and modern business. The American Journal of Comparative Law, 48. pp. 81-141. TheBanker. 2013. Top Islamic Financial Institutions. Special Report. London: Financial Times Ltd. Tripp, C. 2006. Islam and the Moral Economy. The Challenge of Capitalism. Cambridge: Cambridge University Press. Warde, I. 2000. Islamic Finance in the Global Economy. Edinburgh: Edinburgh University Press.

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Notes * Transliteration note: please consider that in the transliteration from Arabic into English graphical forms have been simplified (e.g. riba instead of ribƗ; Shari‘ah in the place of šarƯ‘ah; haqq in the place of ‫ۊ‬aqq; and so on). I am confident that the stylistic choice to simplify the text will not deprive the Arabic reader from an immediate understanding of the terminology in use, while making the spelling less intricate for the non-Arabic audience. 1

The Sunna collects the deeds and sayings of the Prophet Muhammad. This tradition constitutes one of the four primary sources of the law of Islam, next to the Holy Quran, the “consensus” (ijma) over a certain interpretation of the scriptural texts and the “analogy” (qiyas) as hermeneutical tool of investigation of God’s Will. 2 Q. III:130: “ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may really prosper”; Q. IV:161: “That they took usury, though they were forbidden; and that they devoured men’s substance wrongfully; - We have prepared for those among them who reject Faith a grievous punishment”; Q:XXX:39: “That which ye lay out for increase through the property of (other) people, will have no increase with Allah: but that which ye lay out for charity, seeking the countenance of Allah (with increase): it these who will get a recompense multiplied”. 3 As far as the Sunna is concerned, it is reported that the Prophet said: “[Exchange] gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, like for like, equal for equal, hand to hand. If the [exchanged] articles belong to different genera, then sell them as you wish, provided that the transaction is hand to hand” (see hadith opening this research work); “Riba is of seventy-three types. The least of them is like a man having sexual intercourse with his mother”; “The Messenger of God cursed the one who consumes riba, the one who makes it be consumed, its inscribed, its two witnesses”. 4 For an interpretation of the prohibitions of riba, gharar and maysir in connection to the conceptualization of the haqq, “right”, in Islam, please refer to Cattelan (2009). 5 From which gharar as “(undesirable) risk”, “hazard”, “jeopardy”, “peril”. Tadlis (“cheating in trade”) and ghabn (“fraud”, “deception”) are among the categories of gharar. 6 “The customary commercial law was brought into agreement with the theory of shari‘a by the hiyal (sing. hila) or ‘legal devices’, which were often legal fictions. The hiyal… can be described, in short, as the use of legal means for extra-legal ends, ends that could not, whether they themselves were legal or illegal be achieved directly with the means provided by the shari‘a. […] For instance, the Koran prohibits interest, and this religious prohibition was strong enough to make popular opinion unwilling to transgress it openly and directly, while at the same time there was an imperative demand for the giving and taking of interest in

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commercial life. In order to satisfy this need, and at the same time to observe the letter of the religious prohibition, a number of devices were developed […]” (Schacht, 1982, pp. 78-9). On the open debate over the nature of hiyal, see also Horii (2002). 7 On the point, Brunschvig remarks how classical Islamic scholars recognize a fundamental similarity between minted and not-minted precious metals. “À leurs yeux…, les métaux précieux n’expriment pas seulement, ils constituent les valeurs et les prix; il sont, de par leur inaltérabilité foncière, la référence fixe… des valeurs pour tous les biens variables et périssables” (1967, p. 141). 8 A term that was a corruption of follis, a Roman and later Byzantine copper coin. The word fulus is still used in modern spoken Arabic for money. 9 With regard to these rationales as cornerstone of the logic underlying Islamic finance see Cattelan (2013c). 10 In the abstract of his article, Maurer (2006) emphasizes “money’s social roles and meanings as well as its pragmatics in different modalities of exchange and circulation”. His work shows “modern money’s distinctive qualities of commensuration, abstraction, quantification, and reification. It also addresses recent work that seeks to understand the social, semiotic, and performative dimensions of finance”. 11 For being contaminated by Western secular values and underestimating the moral components embedded in Islamic legal principles: see, for instance, Asutay (2008) and Khan (2013). 12 The reference is to the clue given by Aristotle on the nature of money, as reported at the end of § 2.1. 13 See respectively http://www.shekra.com and http://yomken.com.

CHAPTER SIX HAYEK AND BITCOINS: WHICH GOVERNANCE FOR AN INTERNATIONAL CURRENCY? ANDREA BORRONI1 AND MARCO SEGHESIO2

After an introduction about crypto-currencies and the differences between them and national currencies, the authors will examine the legal problems posed by crypto-currencies and in particular Bitcoins, whose nature is decentralised, transnational, and, at least originally, immune from the control of public authorities. Mutatis mutandis, crypto-currencies share some common features with the system envisaged by Hayek in his “The Denationalization of Money”, wherein the Nobel laureate argues that: “There is no justification in history for the existing position of a government monopoly of issuing money. It has never been proposed on the grounds that government will give us better money than anybody else could” (Hayek, 1978, pp. 116-117). As a result, he proposed that banks should be allowed to issue money. In his opinion, this system would be preferable to the traditional one, because, under certain conditions – namely that money be asset backed – it 1

Tenured researcher and adj. prof. in Private Comparative Law at the Second University of Naples, Jean Monnet Department of Political Sciences. Contact: [email protected] 2 Contract professor within the Erasmus+ project Legal Information Technology Community – LITC, coordinated by the Danubius University of Galati, Romania. Contact: marc[email protected] Even if this article is the result of common thoughts and reflections, paragraphs 1, 3, and 4 have been authored by Marco Seghesio while paragraphs 2 and 5 have been authored by Andrea Borroni.

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would lead to more efficient and stable currencies, and it would create a state of healthy competition between money-issuing banks, resulting in positive economic returns throughout the system. But this would not result in the complete removal of the state from the domain of currency. In fact, while it is true that the market would be left, for the most part, in charge of regulating and policing the phenomenon, Hayek concedes that there would still be room for government intervention, for new “rules of law [would be] needed to provide an appropriate legal framework within which the new banking practices could successfully develop” (Hayek, 1990, p. 129). The authors agree, holding that there are aspects that cannot successfully be regulated from within and, so, the intervention of a regulator from without continues to be necessary; in particular, government vigilance would still be required to prevent market abuses and anti-competitive practices. As a result, the authors argue it is not possible to completely remove public authorities from the equation. That is what has happened in practice with Bitcoins. In fact, although the reactions from countries have been disorganised and fragmented – only Brazil and Canada have, so far, regulated crypto-currencies directly – even the countries that have failed to regulate them have had to contend with the issues caused by Bitcoins. Consequently, even those countries have had to come up with alternative means of dealing with them, for instance by adapting existing rules, or having public agencies step up to the plate, or, as Hayek also theorised, resorting to courts as the last possible safety valve. On the other hand, it has been supranational organizations that have taken the lead in analysing, and proposing solutions to the issues posed by crypto-currencies. In particular, the Organisation for Economic Cooperation and Development (OECD), and the European Banking Authority (EBA) have shown interest in the topic and have published interviews, issued reports, and drafted opinions. Their involvement should not be surprising, however, because the idea of a supranational or stateless currency would be particularly useful for transnational commerce and transactions; in this perspective, the desire to come up with a uniform regulation at the international level is not novel, but has, historically, been the driving force behind the creation harmonised

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rules on various subjects, such as international transport, the sale of goods, cheques, bills of exchange, and promissory notes. According to the authors, in conclusion, national governments should not stand in the way of progress, and neither should they try to harness these efforts towards harmonisation, but rather they ought to intervene lightly, simply facilitating this trend. This is, in fact, the safest approach to draft an efficient regulation that does not calcify the flexible and free nature of cryptocurrencies, thereby damaging their best feature. In this way, it is possible to reinterpret and modernise Hayek’s model, while, at the same time, softening the potential dangerous consequences of an approach where states play no role. Key words: payment system, Bitcoin, OECD, EBA, governance, Hayek

1. Introduction The 2008 global financial crisis and its aftermath have resulted in a generalised loss of trust in regulators, banks, and other financial institutions, and this may have helped pave the way for a more widespread acceptance of alternative means of payment, such as crypto-currencies, because of their decentralised and transnational nature, and, at least originally, the fact they are supposed to be immune from the control of public authorities. This shift toward alternative and innovative means of payment and storage of money is favoured by the advancement in technology deemed to be panacea of all the problems. However, crypto-currencies do also drawbacks, which can create problems for governments, consumers and companies, for they may make it easier for ill-intentioned persons to engage in frauds, money laundering and terrorism financing. This paper aims at analysing crypto-currencies, and the differences between them and national currencies, examining the legal problems posed, in particular, by Bitcoins, and also highlighting how cryptocurrencies are reminiscent of Hayek’s proposals in “The Denationalization of Money”, where he proposed that banks should be allowed to issue money, on the premise that: “There is no justification in history for the existing position of a government monopoly of issuing money. It has

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never been proposed on the ground that government will give us better money than anybody else could” (Hayek, 1978, pp. 116-117). So, after the analysis of the tenets of the Austrian economist, the possible alternative governance models will be examined, taking in critical consideration the role played by supranational organizations that have taken the lead in analysing and proposing solutions to the issues posed by crypto-currencies. Their involvement should not surprise, however, because the idea of a supranational or stateless currency would be particularly useful for transnational commerce and transactions; in this perspective, the desire to come up with a uniform regulation on an international level is not novel, but has, historically, been the driving force behind the creation harmonised rules on various subjects, such as international transport, the sale of goods, and cheques, bills of exchange, and promissory notes. In their conclusions, the authors will then propose that national governments should not stand in the way of progress, and neither should they try to harness these efforts towards harmonisation, but rather they ought to intervene lightly, simply facilitating this trend. This is, in fact, the safest approach to draft an efficient regulation that does not calcify the flexible and free nature of crypto-currencies, thereby damaging their best feature. In this way, this essay tries to reinterpret and modernise Hayek’s model, while, at the same time, softening the potentially dangerous consequences of an approach where states play no role.

2. The new frontier of money: crypto-currencies and Bitcoins The advent of the Internet had the effect of remodelling many aspects of our lives, including the domain of economics and finance, allowing for less expensive and more efficient commercial transactions, while prompting a new conceptualization of money, switching it from paper money to credit money which could easily be transferred via the Internet (Plassaras, 2013, p. 377). This has resulted in gradual ‘adjustments’ to the concept of money, so that it could best fit the new social and economic circumstances, a process

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which has been tremendously expedited over the last few decades by the technological achievements of the ITC domain. One of the innovations in this field has been the development of cryptocurrencies or virtual currencies, which are “a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a FC [Fiat Currency], but is accepted by natural or legal persons as a means of payment and can be transferred, stored, or traded electronically” (EBA, 2014, p. 5). Bitcoins represent the ultimate and successful outcome of a number of (failed) attempts, beginning in the 1990s, to create an online, decentralized, and stateless ‘currency’, and they have been described as a “masterpiece of technology” (Doguet, 2013, p. 1119), with the peculiarity of being a purely market-based crypto-currency (Iwamura, Kitamura & Matsumoto, 2014, p. 12). In 2009, Satoshi Nakamoto (a pseudonymous hacker or a group of hackers) published a paper on the internet, where he delineated a system consisting of a network of computers running a special software that enabled each machine (called ‘miner’) to solve specific algorithms and be consequently awarded Bitcoins (Farmer, 2014, p. 85); he was successful in concretely implementing such a project and, thus, Bitcoins saw the light of day1. To commemorate his inventiveness, the smallest unit of Bitcoin, the Satoshi, was named after him. One Bitcoin contains 100 million Satoshis (Merril - Linch, 2013, p. 4). Unlike conventional commodity-backed currencies, Bitcoins are not backed by any commodity or assets and therefore cannot be redeemed for goods and services (De Filippi, 2014, p. 3). Furthermore, Bitcoins are not denominated in an existing currency and so the price of each Bitcoin is independently determined by the market, and there is no fixed exchange rate between them and conventional currencies, even if it is possible to convert traditional currency into Bitcoins at the going exchange rate on broker platforms, such as Coinbase (Bollen, 2013, p. 271). And, historically, their price has been quite volatile2. Blundell – Wignall attributes “part of the reason for this to the fact that there is no clear intrinsic value or agreed valuation method, and certainly no Bitcoin central bank prepared to intervene to make the price more stable, which would violate the fixed supply element” (Blundell-Wignall, 2014, p. 7).

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In practice, Bitcoins are private digital ‘resources’ that can be traded online via an established peer-to-peer network. However, even though Bitcoins are digital, “every individual bitcoin is unique and can only be held by one entity at any given time” (Doherty, 2014, p. 37). And, besides, the number of Bitcoins which may be mined is finite, because technical limitations make it impossible to produce more than 21 million3 – of which the current supply accounts for 27%, or twelve million (Merrill – Linch, 2014) – and, in addition to that, technical measures have been set up that “make finding [Bitcoins] dynamically more difficult if they are found to quickly” (Blundell – Wignall, 2014, p. 8). Once a Bitcoin has been mined or purchased, it becomes “similar to a computer file that can be visualized as a coin on a desktop” (Wallace, 2011), within a virtual wallet, and transferred as easily as e-mails via the Internet. Security protocols embedded in the online Bitcoin network provide users with the necessary protection against (many types of) fraud; at the same time ensuring the system’s proper functioning. One of these stratagems consists in employing an offline storage service (so-called, “cold storage”) that allows customers to transfer the Bitcoins from the storage facility to a user’s online purse (also through mobile devices). In particular, the Bitcoin network relies on the principles of cryptography to process and validate transfers of Bitcoins: each user in fact has one public and one private key, that is to say “alphanumeric strings based on sophisticated encryption: random numbers and letters are derived from public keys by the application of a “hash” function” (Blundell – Wignall, 2014, p. 8). During Bitcoins transactions, a token is transferred from one public address to another; however, for it to be spent again, it is first necessary to decrypt it using a private key. Each transaction on this network is recorded on a decentralised public ledger, called “blockchain”, that is visible to all computers on the Bitcoin network, but which does not reveal the identity of the parties involved in any individual transaction, because each user's identity is encrypted (Farmer, 2014, p. 89-90).4 This public ledger verifies that a user transferring Bitcoins has in fact transferred the specified amount to the user receiving that amount of Bitcoins. In short, this peer-to-peer network serves a twofold purpose: mining Bitcoins, and recording Bitcoin transactions. Hence, the entire network keeps track of all transactions,5 as if it were a huge public ledger6.

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It is miners who verify new transactions; in this, they act “like a historian logging and verifying new transactions in the public ledger.” In exchange for this activity they are compensated with additional Bitcoins. However, only “the first miner to compute the proof gets paid, while the rest get nothing and have to start over on a new block” (Merril - Linch, 2014, conclusion). To maximise their profits, miners are encouraged to form guilds in order to rely on more computer power. So far, so good. Yet, the buzz surrounding Bitcoins is ‘justified’ by a noteworthy peculiarity of the system, namely that it was expressly designed to function without any interference or control by a third party (be it either a bank or a credit card company) or a central issuing authority, which could manipulate the system7; in light of this, some have gone as far as suggesting that “currency [. . .] is exactly like religion. It's based entirely on faith” (Yeomans, 1999). Given the architecture of the Bitcoin system, individuals engage in transactions with each other directly, without any intermediary and, in some cases, even anonymously, without a third party’s oversight (Plassaras, 2014). This feature constitutes the main and revolutionary innovation of Bitcoins, for it “removes the need for a trusted third party and the intermediary cost associated” (Blundell – Wignall, 2014, p. 8); however this technology is not without drawbacks because it has a scalability problem “related to the computing power required to recalculate the history of all transactions […], a problem which grows larger the more widespread the use of Bitcoins” (Blundell – Wignall, 2014, p. 8). This problem will have to somehow be solved, but it is not yet clear how to go about it; other crypto-currencies, however, rely on a different protocol, called the Ripple protocol, which solves this problem (Blundell – Wignall, 2014, p. 15). As a matter of fact, all ‘crypto-currencies’, like Bitcoins, may “have the potential to challenge government supervision of monetary policy by the disruption of current payment systems and the avoidance of existing regulatory schemes” (Middlebrook – Hughes, 2014, p. 814). The block chain technology is spread around and is also used by other crypto-currencies with autonomous devices and approaches (such as,

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Litecoin, Dogecoin, NXT, BitShares, and Ethereum) and “other protocols are built on top of the Bitcoin Block Chain to do new interesting things, like tokens being identified with specific assets for trading purposes (Coloured Coins, Mastercoin, and Counterparty)” (Blundell – Wignall, 2014, p. 12).8. Furthermore, since such ‘currencies’ offer the possibility to carry out transactions anonymously, they could be employed not only for licit privacy reasons, but also to accomplish unlawful (and even despicable) activities9, such as, for instance, the well-known Silk Road case.10 Then again, Blundell – Wignall correctly identifies a paradox, in that “[t]he more successful the crypto currencies become at fraud, money laundering, and/or the undermining of the tax system, the greater will be the incentive for the government to use its plenary powers to abandon its hitherto ‘light-touch’ in dealing with the crypto-currency phenomenon.” (Blundell-Wignall, 2014, p. 15). And it also has to be pointed out that, as Posner correctly remarked, despite their reputation, Bitcoins are not anonymous, but rather pseudonymous, for all parties are identified by a unique Bitcoin address (Goldman - Sachs, 2014, p. 4). And, as demonstrated by recent history, government agencies, such as the American NSA, have proven able to successfully track a person’s activities online, regardless of the use of any form of sophisticated cryptography on his part. Other problems posed by crypto-currencies include a high price volatility, and a risk of electronic thefts and unenforceable breaches of contract, causing serious losses to consumers and companies. In relation to this issue, the EBA has actually identified about 70 risks linked to the use of crypto-currencies, dividing them into five categories: “risks to users; risks to other market participants; risks to financial integrity; risks to payment systems in FCs; and risks to regulators” (EBA, 2014, p. 21). Among these, they include, for instance, the possibility that consumers will incur losses if their accounts are hacked, if their identification credentials are stolen, or if the crypto-currencies they have saved experience a drop in value; while companies run the risk of not having the Bitcoins they accepted reimbursed, or of not being able to spend them in turn (EBA, 2014, p. 21 ff.)11.

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However, a large part of the risks identified by the EBA applies to traditional transfer methods as well. And, in particular, the so-called risks to regulators are specious because it is not regulators who are actually exposed to them, but rather the consumers and the market in its entirety; in fact, unless said regulation is particularly capricious, a hypothetical lawsuit would be destined to failure because regulators are entitled to discretion, and policy is generally not reviewable by courts. According to the authors, the real risk faced by the regulators, if anything, is that of legislative obsolescence due to technological advancements. Concerning the nature of Bitcoins, most proponents of this cryptocurrency draw a parallel between the aforementioned evolution of money and the creation of Bitcoins. In particular, they argue that Bitcoins have been launched into the market as if they were one among several commodities available to users, and owing to their scarcity and ease of circulation, they have gained in value and, consequently, they may evolve into a form of money if the majority of market participants eventually acknowledge their benefits (Howden, 2015, pp. 742-743)12. The main shortcoming of this argument, however, lies in the fact that people already have a medium of payment and exchange, that is, traditional currencies; hence, Bitcoins could at best constitute an alternative or a competing monetary system. However, either way, at this point in time, Bitcoins can hardly be considered money, for they constitute “a difficult medium of exchange and a poor unit of account and a store of value” (Howden, 2015, p. 743)13. In this perspective, gold was considered a good form of currency, because “it does not decay, it can be easily divided into smaller pieces, it is heavy but not so heavy that you cannot carry it around, at least for ordinary purchases, and you can detect impurities in it. Those are the things that make gold a useful store of value and, at times, a currency, and that has nothing to do with its intrinsic value” (Goldman – Sachs, 2014, p. 5). And, for the most part, Bitcoins lack these features. Anyway, they are also unlikely to ever become legal tender because of “a certain government monopoly within the payments system” (Blundell – Wingnall, 2014, p. 12), namely the duty imposed on all subjects to pay taxes, which can only be paid using a currency recognised as legal tender.

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As a result, according to Blundell – Wignnall’s shareable opinion, “[n]o matter how acceptable Bitcoins are amongst its enthusiasts, it can in no way impact the ability of the government to conduct monetary policy, because everyone, at the end of the day, has to pay their taxes”, and it is improbable that governments should ever accept Bitcoins as legal tender, for, if they did, they would “lose control of the money supply and interest rates” (Blundell – Wignnall, 2014, p. 12). Regardless Bitcoins have been relatively successful for “micropayments and crowdfunding , but also payments related to the online sale of illicit goods […], or subversive actions against oppressive regimes like Iran and Russia” (Brito, Shadab & Castillo, 2014, p. 152), owing to the fact that transaction costs are much lower, as opposed to the traditional methods of payment14, in addition to the fact that such transactions can be completed more quickly than traditional wire transfers (Brito, Shadab & Castillo, 2014, p. 151), and that Bitcoin transactions may help circumvent attempts at censorship15. However, the low transaction costs should not be taken for granted, “as miners of popular decentralised VCs such as Bitcoins currently tend to be compensated by both transaction fees and a share in recently mined VC units. It is reasonable to assume that, as the number of newly issued VC units decreases over time, miners will have to rely more on transaction fees to recoup their investment of processing power” (EBA, 2014, p. 16). And, at least within the Single Euro Payment Area (SEPA), even the swiftness of transfers is not comparatively that much better than traditional transfer methods (EBA, 2014, p. 16). And, additionally, concerns have been voiced as to the vulnerability of the system, and the need to improve cyber-security, so as to avoid any breach or violation of users’ accounts. Moreover, the degree of vulnerability of the system is further enhanced by the fact that Bitcoin transactions do not occur at the same time16 (Sirila, 2014, p. 30). The period of time between the payment and the receipt of such payment depends, in fact, on the mining activity17. The non-simultaneous occurrence of Bitcoin payments may lead to so-called ‘double spending’18: since such transactions are not completed in real time, fraudulent Bitcoin users may employ the same Bitcoin to purchase two different goods or pay two different people, splitting, in so doing, one Bitcoin transaction into two (which is named ‘fork transaction’).

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For the moment, though, “Bitcoin is not a reality; it is an expectation […]a start-up currency” or, rectius, “[f]or now, Bitcoin is not a currency; it is an exchange network. Like a financial asset, a future or a derivative. Unlike legal tender currencies, no one is forced to accept it as a method of payment. It is not dissimilar to a barter coupon” (Lacalle, 2014, p. 156). It is however important to keep Bitcoins as a currency separated from Bitcoins as a technology, because, regardless of the issues caused by virtual currencies, “a trust-less transfer and ledger technology is separable from the idea of a crypto-currency, and it is potentially very useful for future competition in the financial system” (Blundell – Wigndall, 2014, p. 17).

3. Hayek's lesson on denationalisation of currency and the seeds of private money In his Denationalization of Money, Hayek argued in favour of depriving governments of their monopoly on the issuance of money and of their power of making any money legal tender for all existing debts, “because governments have invariably and inevitably grossly abused that power throughout the whole of history, and thereby gravely disturbed the selfsteering mechanism of the market” (Hayek, 1978, pp. 116-117). And also because he maintained that: “As soon as one succeeds in freeing oneself of the universally but tacitly accepted creed that a country must be supplied by its government with its own distinctive and exclusive currency, all sorts of interesting questions arise which have never been examined” (Hayek, 1990, p. 13). In the first instance, he proposed that European countries – possibly along with their North-American counterparts – should sign an international instrument, removing all legal obstacles to the free circulation of currency among them, and permitting the free exercise of the banking business on the part of any financial institution legally operating within the territory of one of them. This would result in the termination of any form of exchange regulation, the recognition to citizens and companies of the right to choose what currency to use in their transactions, and the chance for banks to easily open new branch offices abroad (Hayek, 1990, p. 23). After all, according to the scholar, government monopoly on the issuance of money had by then outlasted its usefulness. In fact, it may once have been useful, when “one of the main problems was to teach large numbers the art of calculating in money”, (Hayek, 1990, p. 27) and “the

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genuineness of metallic money could be ascertained only by a difficult process of assaying, for which the ordinary person had neither the skill nor the equipment” (Hayek, 1990, p. 27), and when having only one currency “greatly assisted comparison of prices, and therefore the growth of competition and the market” (Hayek, 1990, p. 27), but, for Hayek, those times were long gone. Nowadays, doing away with the government monopoly would force central banks, facing competition from other central banks, to be reliable and responsible, because, if a central bank decided to start dishonestly fiddling with its own currency, the market would stop using that currency in favour of another. This, in turn, would result in governments being pressured into “keep[ing] the value of their currencies tolerably stable” (Hayek, 1990, p. 27). For Hayek, such a system was preferable to adopting a uniform currency throughout the European Union, a proposal which, at the time, was first being discussed because a uniform currency would only worsen the traditional problems connected to government monopoly, since “a single international currency is not better but worse than a national currency if it is not better run” (Hayek, 1990, p. 25), because the negative effects of the bad choices made by a corrupt country would ripple through the system, also affecting the other, more virtuous, countries. In addition, Hayek’s approach would also allow citizens and corporations to experience first-hand, and grow accustomed to, the advantages of reducing government monopoly on the issuance of money, as a stepping stone towards doing away with it completely (Hayek, 1990, pp. 23-24). Furthermore, allowing for the free circulation of currencies would deprive governments of the ability of depreciating their own currency, a harmful tactic occasionally adopted by countries to protect their market at the common market’s expense. This change, however, will not come easy, because reformists would have to overcome the resistance put up by governments unwilling to give up their right to seigniorage. After all, as history shows, “some of the early foundations of banks at Amsterdam and elsewhere arose from attempts by merchants to secure for themselves a stable money, but rising absolutism soon suppressed all such efforts to create a non-governmental currency, [ protecting instead] the rise of banks issuing notes in terms of the official government money” (Hayek, 1990, p. 38).

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On the other hand, it is reported that in China, a hundred years ago, paper money was commonly accepted as money, even though it was not technically legal tender (Hayek, 1990, p. 38). Hayek then explains how, if he were a Swiss joint stock bank, he would go about creating a new, stateless currency, he calls “ducat”: he would issue “non-interest bearing certificates of note” (Hayek, 1990, p. 46) expressed in ducats, assuming the obligation of exchanging them back into a traditional currency upon request. He would then regulate the issuance of new currency in a way that would keep its purchasing power as stable as possible, so that “their real value would be kept approximately constant” (Hayek, 1990, p. 46). Furthermore, to allow for exchanges, the value of the ducat would be linked to a commodity reserve standard, possibly “a collection of raw material prices” (Hayek, 1990, p. 48). As a result, unlike traditional currencies, the ducat would not depreciate in real terms, and “the demand for the stable currency would rapidly increase, and competing enterprises offering similar but differently-named units would soon emerge” (Hayek, 1990, p. 47), creating healthy competition among issuing institutions, which would force them to keep their respective currencies stable, for failure to do so would quickly lead to their closing down. In this, the existence of competing money-issuing institutions would serve the public best because “with such a continuing demand depending on success in keeping the value of the currency constant, one could trust the issuing hanks to make every effort to achieve this better than would any monopolist who runs no risk by depreciating his money” (Hayek, 1990, p. 52). Consequently, according to Hayek, consumers and companies would have access to money of higher qualities. The entire system would also rely on the press to be vigilant and watchful to prevent abuses from market players. And, for the cases where the market should prove incapable of preventing abuses, the courts could serve as a safety valve, intervening to restore the system to its normal state. A corollary of this reform is that Central Banks would become obsolete (Hayek, 1990, p. 105).

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And even the other functions generally discharged by them could be fulfilled by these commercial institutions, including serving as the “lender of last resort” or as “holder of the ultimate reserve”. According to Hayek, currently, central banks are needed because commercial institutions incur liabilities that they have to pay “in a unit of currency which some other bank has the sole right to issue, thus in effect creating money redeemable in terms of another money. This, as we shall still have to consider, is indeed the chief cause of the instability of the existing credit system, and through it of the wide fluctuations in all economic activity. Without the central bank's (or the government's) monopoly of issuing money, and the legal tender provisions of the law, there would be no justification whatsoever for the banks to rely for their solvency on the cash being provided by another body” (Hayek, 1990, p. 106). However, while the new currency would have to be commodity-backed to insure its stability, Hayek argues that it would be undesirable, expensive, and impractical, to force money-issuing institution to keep these commodities stored at all times, as “[c]onvertibility is a safeguard necessary to impose upon a monopolist, but unnecessary with competing suppliers who cannot maintain themselves in the business unless they provide money at least as advantageous to the user as anybody else” (Hayek, 1990, p. 120). Still, there would be room for government intervention even in this system because new “rules of law [would be] needed to provide an appropriate legal framework within which the new banking practices could successfully develop” (Hayek, 1990, p. 129). To sum up, according to the Nobel laureate, what was required was “not the construction of a new system, but the prompt removal of all the legal obstacles which have for two thousand years blocked the way for an evolution which is bound to throw up beneficial results that we cannot now foresee” (Hayek, 1990, p. 134).

4. The governance of Bitcoins: An open issue Countries faced with their citizens’ use of Bitcoins and the resulting problems it caused, have had to decide whether and how to react, and have adopted wildly different approaches that can be summarized as follows: most have done nothing (e.g., Italy), others have tried to adapt existing

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legal institutions (e.g. the USA), few have chosen to regulate Bitcoins only for tax purposes (e.g., Germany), and fewer still have imposed new rules (e.g., Canada, Brazil, and Australia), some even getting as far as banning them outright (e.g., Russia and Vietnam) (Borroni, 2016, Ianus; Borroni, 2016, Palgrave-McMillan). However, even the countries that have failed to regulate them have had to contend with the issues caused by Bitcoins. Consequently, even those have had to come up with alternative means of dealing with them, for instance by adapting existing rules, or having public agencies step up to the plate, or, as Hayek also theorised, resorting to courts as the last possible safety valve. It cannot be denied, though, that crypto-currencies need to be regulated in order to protect consumers and to avoid market-distorting operations. On the other hand, for such a regulation to be effective, it cannot come from single countries acting individually, but it has to rely on cooperation between governments, aimed at crafting a common and uniform framework of rules. It is for this reason that it is interesting to analyze the suggestions made by the supranational organizations that have studied the issue. One such institution was the OECD, which, in its concluding comments, recommends “A general ban on any form of use of crypto-currencies in the clearing system between banks and the central bank – to ensure that the monetary system is not undermined” (Blundell – Wignall, 2014, p. 17), while at the same time suggesting that the technology behind the cryptocurrencies, i.e. “trust-less transfer and ledger technology”, should be preserved for its potential “for future competition in the financial system” (Ibid.). In addition, however, they argue that such a system should be subjected to different registration requirements, which would make it possible for the appropriate authorities to protect consumers and avoid tax evasion and money laundering (Ibid.). In addition, they advocate for “balance sheet reporting and income statements for all networks and other appropriate regulations” (Ibid.), and for the requirement that “[s]ome amount of capital should be held by exchanges on the balance sheet (perhaps in the form of legal tender)” (Ibid.).

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And finally, they are also in favour of requiring “[s]ome form of backing for crypto-currencies […] such as gold” (Ibid.). To sum up, they desire to “encourage technologies that improve competition in the payments system, and to ensure that the use of cryptocurrencies removes anonymity where money transmission is concerned (to avoid the darker aspects of Bitcoin use), and to meet minimum requirements for consumer protection” (Ibid.). The EBA’s recommendations, on the other hand, are more thorough. In fact, the EBA’s report first identifies a series of risks arising from the use of Bitcoins, and then proposes a short-term regulatory approach and a long-term strategy, which will “require a substantial body of regulation, some components of which are untested” (EBA, 2014, p. 5). In the short run, they suggest that credit institutions, payment institutions, and e-money institutions should be discouraged from “buying, holding, or selling [virtual currencies]” (EBA, 2014, p. 5), in addition to extending to currency exchanges the duty to run the anti-money laundering and counter-terrorism checks provided for in the EU Anti-Money Laundering Directive, in order to prevent the use of Bitcoins for illicit purposes, and to level the playing field between financial institutions offering services in the area of virtual currencies and the ones offering the same services in the area of traditional currencies. Such an approach has its limits, however, as the report itself acknowledges, in that “[t]his immediate response will ‘shield’ regulated financial services from VC schemes, and will mitigate those risks that arise from the interaction between VC schemes and regulated financial services. It would not mitigate those risks that arise within, or between, VC schemes themselves” (EBA, 2014, pp. 5-6). In the long run, however, the EBA proposes a series of far-reaching reforms. First of all, they argue, a “scheme-governance authority” needs to be created, that is to say a “non-governmental entity that establishes and governs the rules for the use of a particular VC scheme” (EBA, 2014, p. 39). Similar in concept to the European Central Bank, this authority would be accountable to national regulators, and currency exchanges would, in turn, be accountable to it. It would make sure then that currency exchanges comply with the various anti-money laundering and counter-terrorism requirements imposed by EU law.

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In addition, since the possibility for parties to a Bitcoin transaction to remain anonymous can facilitate the use of crypto-currencies for illicit purposes, the EBA suggests that, at least within the European Union, all financial institutions interacting with traditional currencies should be forced to incorporate themselves in a member state “as a legal person that has standing to sue and be sued” (EBA, 2014, p. 40), and to comply with “customer due diligence (CDD) requirements” (Ibid.), collecting the personal information of Bitcoin users required to make determinations as to “the customer's risk in terms of likeliness to commit money laundering, terrorist finance, or identity theft” (Ibid.), tracing the various Bitcoins transactions, and exchanging these data with the scheme-governance authority and other financial institutions whenever needed. Furthermore, to prevent abuses of trust, members of the schemegovernance authority and individual involved with the various market exchanges and financial institutions involved in Bitcoin transactions would have to comply with “fitness and probity standards” (Ibid.), aimed at insuring their competence, professionalism, and integrity (Ibid.). But that it is not all. According to the EBA, institutions “that hold VC units on behalf of others” (EBA, 2014, p. 41) should be subject to capital requirements to be held in a fiat currency, and the scheme governance authority would have to be tasked with ensuring that institutions holding crypto-currency possess secure IT systems to prevent hacking of their clients’ accounts. Finally, in the event that, despite appropriate technological countermeasures, hackers managed to complete unauthorised transactions, “market participants involved in the transfer of funds” (EBA, 2014, p. 42) should be obliged to refund the defrauded party. Applying these recommendations would probably be the kiss of death for crypto-currencies, because they would end up neutralising the two main features that make them competitive, namely pseudonymity and low transaction costs. After all, when a consumer consciously makes use of a payment system that costs less, while offering fewer guarantees, he knows that he faces more risks, but deems that, all things considered, they are acceptable. Not to mention that, as history shows, states, through their investigative agencies, such as the American NSA, are already capable of investigating a person’s activities online. In light of this, these reforms do appear excessive and overreaching.

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Then again, there are already institutions that offer high guarantees of competence, professionalism, integrity, and consumer protection. They are called banks, or financial and credit institutions at large. It would be wrong to expect that institutions whose strengths and weaknesses are by design different should be subjected to the same (or largely similar) regulations. What is curious, however, is that the EBA, after proposing that currency exchanges be subjected to rules that are broadly comparable to those to which banks and financial credit institutions are subjected, still cautions against “drawing similarities between existing payment and paymentrelated services, and some VC-based services” (EBA, 2014, p. 44). In fact, they go as far as warning that “[d]eclaring some actors as falling into the remit of a specific national or EU law may therefore lend credibility to these actors and, by implication, to VC schemes themselves that may not necessarily be warranted” (Ibid.). In short, the EBA wishes to avoid crypto-currencies being legitimised by way of analogy, even though they themselves apply the same patterns when trying to describe them, and to propose a way to regulate them. On the other hand, Posner, quoted in the Goldman Sachs report on Bitcoin, is very pessimistic, saying that while Bitcoins are an “interesting technological innovation”, he fears that “this technology will ultimately be domesticated by firms and governments” (Goldman – Sachs, 2014, p 5). And it cannot be overlooked that, albeit still in a rudimentary form, the Bitcoin community has already set up a governance structure, the Bitcoin Foundation. This body, founded by seven influential individuals involved in the development of the crypto-currency and registered under U.S. law as a 501c charity in Washington, D.C., is governed by a seven-person board of directors. These seven seats are apportioned on the basis of membership class: three directors are elected by individual members, another three by corporate members, and the seventh, originally reserved to the founding members, is now a representative of international chapters. To serve on the board, members have to be in good standing, conduct business openly using their real identity, and pass a background check for felony convictions (Trautman, 2014, p. 74).

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According to Kroll, Davey, and Felten, the various issues requiring governance include “threats from actual adversaries; the need for a change in the minimum transaction size; protocol instabilities; and the resolution of inevitable software bugs and accidents such as the conflict between version 0.7 and 0.8 during March 2013” (Kroll, Davey and Felten, 2013, p. 15).

And they argue, with the establishment of the Bitcoin Foundation, a form of governance has emerged in the realm of Bitcoins, and “that it will take the form of the governance of an open source project (in the sense that leaders cannot take actions contrary to the interests and will of the community without naturally losing legitimacy), and that the emergence of formal governance structures will ultimately subject Bitcoin itself (and not merely particular players) to influence by government regulators around the world” (Trautman, 2014, p. 78).

5. Concluding remarks At the present time, in spite of the existence of the Bitcoin Foundation, Bitcoins are still largely unregulated. Then again, this state of things is hardly unprecedented: as Posner correctly points out: “There is a long history of unregulated currencies. Gold has been an unregulated currency at various times and in various places. In prison camps, cigarettes have served as currency. In the United States in the 19th Century, in some states, the currency was basically unregulated; people would set up banks that issued bank notes that circulated” (Goldman – Sachs, 2014, p. 5). Even so, regardless of historical precedent, nowadays, to have an entity capable of exercising control over the money supply is certainly desirable, in that it allows for the possibility “to navigate and minimize or avoid economic problems like recessions or, maybe, asset bubbles” (Goldman – Sachs, 2014, p. 4). And, in fact, at the moment, despite its lack of a proper central bank, the Bitcoin network does have a way of controlling the money supply, for “[t]he people who maintain [it] can change the money supply through a majoritarian process” (Goldman – Sachs, 2014, p. 4).

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This would allow the operators of the Bitcoin network to act, if needed, to preserve the value of their crypto-currency, preventing it from depreciating in real terms, and keeping it appealing for customers and the market. Still, regardless of these forms of internal governance, there are aspects that cannot successfully be regulated from within and, so, the intervention of a regulator from without continues to be necessary. In particular, as Hayek conceded, “rules of law [would be] needed to provide an appropriate legal framework within which the new banking practices could successfully develop” (Hayek, 1990, p. 129). In addition to that, vigilance would still be required to prevent market abuses and anti-competitive practices, and to protect consumers’ basic rights. However, while it is not possible to completely remove public authorities from the equation, Bitcoins’ nature as a stateless currency has to be taken into consideration, because it makes them particularly useful for transnational commerce and transactions. Consequently, such a transnational dimension entails that regulation and vigilance from individual governments would probably bear little fruit. What is actually needed, instead, is a systematic approach at the supranational level. This should not surprise, though: in this perspective, the desire to come up with a uniform regulation at the international level is not novel, but has, historically, been the driving force behind the creation of harmonised rules on various subjects, such as international transport, the sale of goods, cheques, bills of exchange, and promissory notes. Consequently, according to the authors, national governments should not stand in the way of progress, and neither should they try to harness these efforts towards harmonisation, but rather they ought to intervene lightly, simply facilitating this trend. This is, in fact, the safest approach to draft an efficient regulation that does not calcify the flexible and free nature of crypto-currencies, thereby damaging their best feature. And, as one of the authors, Borroni, argued in his Bitcoins: Regulatory Patterns, the International Monetary Fund would be among the best

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candidates to propose such a regulation, in light of its primary purpose, namely “to ensure the stability of the international monetary system - the system of exchange rates and international payments that enables countries (and their citizens) to transact with each other. The fund's mandate was updated in 2012 to include all macroeconomic and financial sector issues that bear on global stability” (see the website www.imf.org). Not to mention that among its original aims there was the promotion of exchange stability and, above all, “the establishment of a multilateral system of payments” (id.)19. Alternatively, another approach might be a round table of all stakeholders, including representatives of the various national governments, and, possibly, of the most influential market players and consumer organizations, and of the Bitcoin Foundation, organised under the aegis of an international organisation, and aimed at setting up the basic legal framework within which a code of best practice could then be drafted. These proposals, of course, assume that national governments do not feel that their exclusive seigniorage rights, arising from their monopoly on the issuance of money, are threatened. In fact, when it comes to Bitcoins, “[s]eigniorage is currently accruing to the “miners” of Bitcoins who have the fastest CPUs” (Merril - Linch, 2013, p. 6). And, should this start to actually affect governments’ seigniorage rights, they are likely to start cracking down on Bitcoins. But even in that event, Bitcoins could still have a positive impact. In fact, even if they were outlawed outright, the technology behind them could still be salvaged and adapted to transfers of fiat currency, thereby making transaction costs lower for those transactions, and benefitting all involved. In conclusion, regardless of their future in terms of regulation, Bitcoins have already left their mark and, however national government may choose to act, Bitcoins’ legacy is, in all probability, here to stay.

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References Amicorum, Liber and Zamboni Garavelli, Paolo. 2005. Legal Aspects of the ESCB. Frankfurt Am Main: ECB. Blundell-Wignall, A. 2014. The Bitcoin Question: Currency versus Trustless Transfer Technology. OECD Working Papers on Finance, Insurance and Private Pensions, No. 37, OECD Publishing. Bollen, R. 2013. The Legal Status Of Online Currencies, Are Bitcoins The Future?. www.ato.gov.au. Borroni, A. Submitted for publication. Bitcoins: Regulatory Patterns. Journal of International Banking Law and Regulation. —. 2016. Bitcoins, a New Frontier of Money? Review of the Business and Law Department of the University of Siena, Special Issue “Building up an EU-based Payment System”. Ianus. —. 2016. A Fuzzy Set In The Legal Domain: Bitcoins According To U.S. Legal Formants, Palgrave-McMillan. —. 2014. A Sharia-compliant Payment System Within the Western World, Review of the Business and Law Department of the University of Siena, Special Issue “Building up an EU-based Payment System”. Ianus. Pp. 67-110. Brito, J., Shadab, H. & Castillo, A. 2014. Bitcoin Financial Regultaion: Securities, Derivaties, Prediction Markets and Gambling. 16 Colum. Sci. & Tech. L. Rev., pp. 144 - 221. De Filippi, P. 2014. Bitcoin: A Regulatory Nightmare To A Libertarian Dream. Internet Policy Review. pp. 1-12. Doguet, J.J. 2013. The Nature of the Form: Legal and Regulatory Issues Surrounding the Bitcoin Digital Currency System. Louisiana Law Review pp. 1119 -1212. Doherty, C. 2014. Bitcoin and Bankruptcy - Understanding the Newest Potential Commodity. American Bankruptcy Institute Journal. pp. 3840. EBA/Op/2014/08 4 July 2014 EBA Opinion on ‘virtual currencies’, https://www.eba.europa.eu/documents/10180/657547/EBA-Op-201408+Opinion+on+Virtual+Currencies.pdf. Farmer Jr, P.H. 2014. Speculative Tech: The Bitcoin Legal Quagmire & the Need for Legal Innovation. 9 J. Bus. & Tech. L., pp. 85 – 106. Hayek, F. 1990. Denationalisation of Money: The Argument Refined (An Analysis of the Theory and Practice of Concurrent Currencies Series). THIRD EDITION, Published by THE INSTITUTE OF ECONOMIC AFFAIRS. Hobart Special Paper 70. London: Institute of Economic Affairs.

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—. 1978. Denationalisation of Money. Second edition. THIRD EDITION, Published by THE INSTITUTE OF ECONOMIC AFFAIRS, 1990 Howden, E. 2015. The Crypto-currency Conundrum: Regulating an Uncertain Future. 29 Emory Int'l L. Rev., pp. 741 – 798. Iwamura, M., Kitamura, Y. & Matsumoto, T. 2014. Is Bitcoin the Only Cryptocurrency in the Town?. Economics of Cryptocurrency and Friedrich A. Hayek 12 (Hitotsubashi University Institute of Economic Research Working Paper, Feb. 28, 2014), available at http://ssrn.com/abstract=2405790. Kien-Meng Ly, M. 2014. Coining Bitcoin's "Legal-Bits": Examining The Regulatory Framework For Bitcoin And Virtual Currencies. 27 Harv. J. Law & Tec., pp. 587-607. Kroll, J. A. 2013. The Economics Of Bitcoin Mining, Or Bitcoin In The Presence Of Adversaries. Princeton University. Lacalle, D. 2014. Life in the Financial Markets: How They Really Work And Why They Matter To You. John Wiley & Sons. London. Merrill - Lynch Bank of America. 2013. Bitcoin: a first assessment. www.ciphrex.com. Middlebrook, S.T. & Hughes, S.J. 2014. Regulating Cryptocurrencies In The United States: Current Issues And Future Directions. Wm. Mitchell L. Rev., pp. 813-848. Nakamoto, S. 2009. A peer-to-peer Electronic Cash System. available at http://www.Bitcoin.org/Bitcoin.pdf. Plassaras, N. A. 2013. Regulating Digital Currencies: Bringing Bitcoin within the Reach of the IMF. 14 Chi. J. Int'l L., pp. 377 - 406. Sirila, D. 2014. The Pleasures and Perils of new money in old pockets: MpESA and Bitcoin in Kenia. Harvard law school. LLm Thesis. Trautman, L. 2014. Virtual Currencies Bitcoin & What Now After Liberty Reserve, Silk Road, and Mt. Gox?. 20 RICH. J.L. & TECH. 1-108. Available at http://jolt.richmond.edu/v20i4/article13.pdf. Velde, F. R. 2013. Bitcoin: A Primer. The Federal Reserve Bank of Chicago. Number 317. Available at http://www.chicagofed.org/digital_assets/publications/chicago_fed_lett er/2013/cfldecember2013_317.pdf. Wallace, B. 2011. The Rise and Fall of Bitcoin. Wired Magazine. http://www.wired.com/2011/11/mf_Bitcoin/ Yeomans, M. 1999. The Quest for a Global E-Currency. CNN. (Sept. 28, 1999), http://articles.cnn.com/1999-09-28/tech/9909_28_global.e.currency.idg _1_credit-card-debit-global-internet-project/3

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Yin, S. 2011. Which Bitcoin Exchange Can You Trust?. PCMAG. http://www.pcmag.com/article2/0,2817,2387279,00.asp, Kroll, J. Davey, I. and Felten, E. 2013. The Economics of Bitcoin Mining, or Bitcoin in the Presence of Adversaries. The Twelfth Workshop on the Economics of Information Security (WEIS 2013) Washington, DC, June 11-12, 2013. http://www.econinfosec.org/archive/weis2013/papers/KrollDaveyFelte nWEIS2013.pdf.

Notes 1

For a detailed description of the system’s design, see Nakamoto’s original paper (Nakamoto, 2009). 2 Such volatility may be illustrated by Bitcoins’ price trend: starting from around 100 dollars in 2014, it then sky-rocketed to 1100 dollars at the end of the year, only to plummet to 500 dollars at the beginning of 2014. 3 The automatically limited number of Bitcoins is directly generated by the system itself: at the beginning, miners received 50 Bitcoins for every proper block, but “as the computational problems become more difficult and the number of transactions increases, the payouts are cut in half (Velde, 2013, p. 29)”. Blocks are added at a rate of six times per hour and every 210,000 blocks the payout is cut in half and this results precisely “in a pre-determined Bitcoin limit of twenty one million (Velde, 2013, p. 29)”. It has been estimated that the total amount of Bitcoin in circulation will reach the cap in 2140. 4 In that regard, Bitcoins afford more privacy than all other forms of payment to date, in that all transactions recorded as transactions between public keys, rather than between named users. 5 Bitcoins can be mined or acquired from another user by “using exchanges to purchase them with traditional currencies, or to be connected directly with an individual for trading.” (Wallace, 2014). 6 Each Bitcoin is essentially “a chain of digital signatures which, when decoded, provide the entire transactional history of the Bitcoin”. (Middlebrook – Hughes, 2014, p. 813). 7 Even though no authority has control over the network, “the sheer size of the network of miners helps to prevent unauthorized manipulation or implantation of data in the system”. Along with this security and the “ability of exchanges to pinpoint and correct abnormalities in Bitcoin trading”, the Bitcoin network appears to be safer than other traditional systems (Yin, 2011, in Farmer, 2014, p. 90). 8 However, the digital currency market has been described as a “winner takes all” market, “whereby as Bitcoin becomes more popular and is easy to use, consumers will have much less incentive to experiment with an alternative currency with similar features”. (Merrill-Linch, 2013, p. 5). In other words, as Bitcoin becomes

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more popular, competitors will face higher barriers to entry, making it less likely they will be successful in supplanting Bitcoin’s market share. 9 Specifically, the anonymity connected to virtual currencies facilitate a number of various crimes, making the systems of such currencies, profitable marketplaces for: assassins, attacks on businesses, children exploitation (including pornography), corporate espionage, counterfeit currencies, drugs, fake IDs and passports, investment and financial frauds, sexual exploitation, stolen credit cards and credit card numbers, and weapons. (Trautman, 2014, p. 1). 10 Silk Road was a rather famous online marketplace for drugs, erotica, fake IDs, and other illegal goods. In October 2013, the FBI shut down the website and arrested the owner, William Ulbricht; and, according to the reports, by the end of the same month, U.S. government authorities “had seized more than 33.6 million USD worth of Bitcoins belonging to Ulbricht.” (Kien-Meng, 2014, p. 587). A second example of alleged misdeed involving Bitcoins was the asset seizure of Mt. Gox. The latter was one of the largest Bitcoin exchange worldwide, and the U.S. authorities seized its assets in May 2013 on the basis of suspicions that Mt. Gox did not have an appropriate license to engage in money transfer services according to the provisions of the FinCEN guidance document on virtual currencies. Following the asset seizure, in February 2014, Mt. Gox shut down its website and filed for bankruptcy “after losing approximately 750,000 of its customers' Bitcoins following a security breach”. (Trautman, 2014, pp. 13-14). 11 For example, the EBA opinion underlines that “[c]riminals are able to launder proceeds of crime because they can deposit and transfer VCs anonymously […] because they can deposit and transfer VCs globally, rapidly and irrevocably” or that “PSPs that provide services in FC as well as VC fail to meet their contractual obligations as payment system participants due to liquidity exposures in their VC operations.” (EBA, 2014, 23 ff.). 12 Before 1970, Western countries relied on currencies which were backed by their reserves of gold or silver. This system was aimed at preventing States from indiscriminately increasing the amount of money circulating. During the twentieth century, all countries abandoned the so-called gold standard (the US being the last one during the 1970s) and, as a result, “most currencies today are known as fiat money - in other words, currency that a government has declared legal tender despite the fact that it has no intrinsic value or backing by any reserves.” (Howden, 2015, pp. 742-743). 13 Currency is defined as “a coin, government note, or bank note that circulates as a medium of exchange, unit of account, and store of value.” (Swartz, 2014, pp. 329330). Swartz, however, harbours doubts that Bitcoins can successfully function as such. In particular, he maintains Bitcoins are a poor medium of exchange, in that the amount of transactions involving them occurring every day is minimal, the process of acquiring and spending Bitcoins is complicated and cumbersome, and the mining process requires significant computing effort. In addition, according to him, Bitcoins’ high volatility and the decreasing supply may end up encouraging

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hoarding. Furthermore, Bitcoins are also a poor unit of account, for, owing to their constituting features, they offer unreliable price information and make it difficult for users to compare the respective value of goods, not to mention that the large size of one Bitcoin is too large for practical use. Finally, Bitcoins are also a poor store of value, because of their very high volatility, and the fact they are frequently targeted by thieves. (Swartz, 2014, pp. 329-330). On the other hand, there are those who believe that Bitcoin can be described as money. As a medium of exchange, their essential advantage is to avoid the costs of transaction imposed on the exchange of currencies thanks to the fact that they are ‘universal’ currencies inherently “designed to be used transnationally via the Internet”. (Plassaras, 2014). As unit of account and measure of relative worth, given the complexity of Bitcoin’s production process, coupled with its scarcity, Bitcoins shall be regarded as “intrinsically and intuitively valuable”. As a store of value, since Bitcoin is not influenced by the policies adopted by governments, its worth depends exclusively on the market; for this reason, the issuers of digital currencies, like Bitcoin, commit to making their currencies the most stable and reliable as possible, for only thus can they succeed in becoming a store of value and concurrently attracting investments. Iwamura, Kitamura & Matzumoto, 2014). 14 “While credit card networks charge merchants fees in the range of 3 to 4 percent of the total amount of a transaction, and the average cost of international remittances is 8.5 percent, a Bitcoin transaction can cost less than 1 percent.” (Brito, Shadab & Castillo, 2014, p. 151). 15 The authors mention Wikileak’s case, where PayPal was able to freeze Wikileak’s account, thereby stopping donations. When it comes to Bitcoins, on the other hand, nobody has the power to freeze anybody else’s account. (Brito, Shadab & Castillo, 2014, p. 151). 16 For a thorough analysis of the double spending process, see (Kroll et al., 2013). 17 The more miners exist within the system, the faster a transaction is decoded. The problem however lies in the fact that mining is expensive, and since the value of Bitcoins is subject to wide price fluctuations, miners may not have enough incentives to mine, and this may slow down the overall system. (Sirila, 2014, p. 15). 18 However, according to Bitcoin’s developer, the system’s inner structure offers a solution to the problem of double-spending (which generally affects all monetary systems and is commonly tackled through the activity of a central authority or mint). In short, a user transfers his Bitcoins (each of which is a chain of digital signatures) to another user “by digitally signing a hash of the previous transaction and the public key of the next owner and adding these to the end of the coin. A payee can verify the signatures to verify the chain of ownership.” (Iwamura, Kitumura &Matsumoto, 2014). Hence, the solution that the Bitcoin system suggests to the double-spending problem consists in relying on “a timestamp procedure on a peer to peer basis”: each block of Bitcoins transactions contains the cryptographic hash of the preceding block enabling therefore anyone to verify

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whether the previous block has been modified. (Iwamura, Kitumura &Matsumoto, 2014). 19 For the possible problems posed by this approach, see Borroni, A. Submitted for pubblication. Bitcoins: Regulatory Patterns. Journal of International Banking Law and Regulation.

PART III: MONEY AND THE CENTRAL BANKING

CHAPTER SEVEN OVERSIGHT OF EUROPEAN PAYMENT SYSTEMS: OPERATIONAL ARRANGEMENTS AND GOVERNANCE MARTA BOŽINA BEROŠ1

While the regulatory initiative in respect of payment systems rests with European political institutions, the task of monitoring regulatory compliance, i.e. oversight, falls in the domain of the ESCB and the ECB. Operationally, the ESCB’s competences are executed in line with the principle of decentralization, and are governed by a multi-tier and multilevel framework with complex layers of national and EU responsibilities. Against this background, this chapter analyzes the progress in the Euro-system’s oversight competences in light of recent post-crisis reforms. Particular emphasis is placed on the evolution of the ECB’s statutory powers in the field of oversight and its implications on the policy capacity and responsibilities of other actors involved in this regulatory activity. Namely, in the post-crisis environment, European actors representing the supranational layer are taking precedence in respect of national authorities in governance arrangements. Henceforth, it is interesting to assess how this development has been reflected in the governance framework for the oversight of payment systems, as well as on the competences and responsibilities of specific actors. Key words: Payment System, oversight, Euro-system, Governance

1

Assistant Professor, Faculty of Economics and Tourism, Juraj Dobrila University of Pula. Contact: [email protected]

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1. Introduction A resilient financial system depends on the stability and efficacy of its core components: financial institutions, markets, and payment infrastructures. The latter, usually referred to as payment systems or simply – payments, facilitates transactions among financial actors contributing in this way to the effective mobilization and allocation of resources. Given the important role that payments perform in the transmission of monetary policy, in preserving financial stability, and in maintaining public confidence in the single currency, the Euro-system is assigned with specific operative and oversight competences in this sector as one of its basic functions. At the same time, the core owners and operators of payment systems remain primarily responsible for ensuring the safety and soundness of their infrastructures (ECB, 2015, p. 5). This decentralized approach to the management and supervision of payments, underpinned by shared responsibilities among stakeholders, involved on a national and EU level, form the main framework for the governance of payment system oversight in the EU. This chapter sets out to provide a comprehensive insight to this framework and its legal, economic, and institutional arrangements. In this respect the purpose of the chapter is twofold: primarily, it analyzes the Euro-system’s competences in the supervision of payment systems. We point out that in the chapter we use the term “supervision”, although European regulations and other documents refer exclusively to “oversight”. The reason for this is that the broader meaning of the term “supervision” comprises several functions: licensing (or authorization), supervision strictu sensu (or oversight), sanctioning and crisis management. Since oversight does fall within the scope of supervision in the chapter we use the two terms interchangeably. Secondly, the chapter discusses governance of the oversight of large-value and retail payments by examining the policy capacity and allocation of roles of actors involved in this regulatory activity. The main motive for our examination comes from the fact that, more recently, supranational actors have taken precedence in respect of national authorities in the regulatory governance of the financial sector. This trend has most notably been translated to the governance of prudential supervision in the Euro-system. Our assumption is that the trend was also translated to the supervision of payment systems. Thus, it is interesting to determine how this trend has manifested in the area of payments (e.g. legal

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instrument) and how it then affected competences of the EU and member states in the area. Can we argue that the European layer has really taken precedence in the governance of oversight post-crisis? At this point some observations have to be made regarding the scope, research methods and design. As for the scope of the chapter, we discuss exclusively the “Euro-system” by which we understand the ECB and national central banks (NCBs) of those member states that have adopted the single currency. As a term the Euro-system was introduced by the Lisbon Treaty in order to designate the central banking system of the euro area (European Parliament, 2013, p. 9). Secondly, we limit our analysis to the general concept of payment systems, meaning that we do not discuss specific payment instruments. In addition we do not mention clearing and settlement infrastructures of securities transactions. The main research method is qualitative, descriptive analysis of legal documents, policy papers and official texts related to payment systems’ oversight. Henceforth, the arguments and observations proposed are qualitative and conceptual in nature, and mainly address strengths and weaknesses of the current regulatory and institutional framework governing supervision of payment systems. The chapter proceeds as follows: after the introductory remarks, section two gives a succinct overview of payment systems in the EU, their scope and operative set up. Section three presents the main regulatory and institutional frameworks for the oversight of European payment systems. In that section we also discuss the economic rationale of the Euro-system’s involvement in the field, as well as the legal basis for the exercise of its competences. Section four presents how the Euro-system’s decentralized supervision of payments is governed in practice. Finally, section five concludes.

2. Payment Systems in the EU The narrower definition of payment systems states that these are: “ …set(s) of instruments, intermediaries, rules, procedures, processes, and interbank funds transfer systems which facilitate the circulation of money in a country or currency area” (Kokkola, 2010, p. 25). Given their contribution to the everyday transfer of proprietary titles and settlement of obligations between parties, it is clear that a salient feature of sound payment systems is the support of an appropriate legal framework. Henceforth, there is a codependency in the development of payment systems and their jurisdiction, meaning that key components of the payment infrastructure accommodate

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national economic requirements in line with provisions and limits stipulated by law. As a result, payment systems around the world differ in their nature and the manner in which they perform their functions. This is also true in the case of the EU, where payment systems were developed according to the juridical tradition and economic requirements of individual member states. Consequently, at the beginning of financial integration, payment systems did not suit the needs of the internal market or the possibility of handling transactions of a single currency. Nevertheless, from the outset of the Single Market project, European policymakers were more engaged with the micro-prudential regulation of the main financial actors (e.g. banks) and their cross-border operations, while financial transactions and their operative infrastructure were largely left to national regulatory autonomy. But the deepening of financial integration, the pressures of legal risks associated with cross-border transactions, and the prospect of monetary unification steered European policymakers towards payment systems, with the aim of achieving greater legal and operative convergence between member states’ infrastructures. As a result, in the late 1990s the EU embarked on a substantive overhaul of the legal environment and operational framework for payments. The key catalyst to the integration of interbank and retail payment systems in the EU was the introduction of the single currency in 1999. Following this event, the Euro-system’s competences in the field of payment systems have evolved, together with the widening of monetary integration: geographically and with respect to institutions or infrastructures. This evolution also comes as a response to national developments – less legal in nature (thanks to maximum harmonization in this regulatory area) and more economic and “market-dependent”. The EU’s efforts to harmonize the legal framework and consolidate the infrastructure for payments have been particularly prominent in largevalue payment systems. In this segment the creation of the TransEuropean Automated Real-time Gross Settlement Express Transfer system (TARGET) consolidated RTGS systems of euro area countries, centralized the settlement of central bank operations, cross-border and domestic interbank transfers, and other large-value payments in euros (ECB, 2007, p. 12). Before the introduction of TARGET, LVP systems in the future euro area operated in their respective national currencies via correspondent banking. The single currency changed these governing principles, allowing for cross-border payments within the euro area to be treated as payments within an individual country (Kokkola, 2010, p. 177). In the late 2000s

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TARGET went through a major improvement of its technical structure, allowing the Euro-system to transition to the system’s next generation – the TARGET2. Today, TARGET2 is the core system for all payments and settlements in euros, used not only for banks’ liquidity management, but also for the settlement operations of many ancillary systems (e.g. RPS) (Kokkola, 2010, p. 179)1. The Euro-system owns and operates the RTGS system for the euro, as this is key to the successful implementation of the common monetary policy and to the functioning of the single money market in the Euro area. And as owner and operator of TARGET2, the Euro-system has been assigned with oversight responsibilities that we detail in the following sections. With respect to retail payment systems, we can argue that central banks in this segment typically act as providers of market solutions (Wellink, Chapple and Meier, 2002, p. 12). As they are not infrastructure-providers, the role of central banks is less relevant in this segment, and it is not surprising then that the Euro-system has no direct supervisory competences over national retail payments. Over the years the segment of retail payments remained centered on national payment instruments and systems. Although this arrangement is adequate for domestic payments, it does not suit cross-border, retail transactions in the euro area, as it lowers the level of service provided while increasing the complexity of transaction processing. This is clearly a challenge for the European banking industry, since bank clients (citizens, enterprises, public authorities, etc.) have an immediate interest in the possibility of making euro payments throughout Europe from a single bank account they hold. Moreover, the integration of retail payments is imperative for the completion of the Single Market. Consequently, the main catalyst of integration came from the industry itself, in the form of the Single Euro Payments Area proposal (SEPA) in the early 2000s, which was then launched in 2008 (Kokkola, 2010, p. 192). The project set out to integrate all electronic payments across the Euro area, and in 2014 SEPA has become fully operational in all Euro area countries2. Although a self-regulatory initiative in its beginnings, SEPA’s evolution to a Union-wide policy was greatly endorsed by the European Commission and the ECB, whose regulatory initiatives and networks of interinstitutional collaboration (as well as that with the banking industry) provided for the development of a comprehensive legal framework3. In respect of RPSs, oversight competences are assigned primarily to the NCBs where the system is legally incorporated. The Euro-system

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acknowledges the important role RPSs perform in the functioning of the internal market, and for that it exerts some sort of “indirect” oversight or governance through expertise, which in practice consists of: 1) Providing guidance to market participants – the Euro-system’s network with the private sector and other public authorities allow it to act as a catalyst for market efficiency. 2) Supporting the development of SEPA and the use of SEPA payments – the Euro-system encourages the adoption of SEPA instruments by big senders and receivers of payments in the private and public sector. 3) Fostering coordination of communication of all stakeholders of RPSs4. Through the years the Euro-system has adopted standards, methodologies, and regulations aimed at improving oversight quality of retail payments at a member state level. Such were the 2003 “oversight standards for euro retail payment systems”, which categorized RPS in line with the 2001 “core principles for systemically important payment systems” set by the BIS Committee on Payment and Settlement Systems, as: i) systemically important – which fulfill all core principles, ii) prominently important – which fulfill select core principles, and iii) other systems – which fulfill principles defined by competent NCBs (ECB, 2011). A more recent example is the 2014 “Revised Oversight Framework for Retail Payment Systems”, a revision along the lines of the ECB’s 2014 Regulation on systemically important payment systems, and the 2012 Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commission (CPSS-IOSCO) principles for financial market infrastructures (PFMIs).

3. Oversight of European payment systems A safe and efficient payment system is fundamental for everyday economic and financial market activities. It is also essential for the conduct of monetary policy and maintenance of financial stability (ECB, 2010, p. 16). Therefore, supervision of payment systems is typically a central bank competence. As monetary authorities, their responsibility to preserve payment system soundness is crucial, given their objectives of monetary and financial stability. Moreover, as public authorities, central banks safeguard the public confidence in money, and since this confidence depends on the ability of transmitting payments across the system

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smoothly, their focus on payment systems is to be expected. Against all of these facts we may argue that Euro-system’s oversight competences in respect of payment systems derive from its central banking nature (i.e. the Euro-system as the central banking system of the Euro area). Following the logic that one of the key elements in central bank responsibility for the currency is fostering efficiency and safety of payment infrastructures, the ESCB and ECB have been given an explicit mandate in the field of payment systems, and allocated the roles of regulators, owners/operators and “overseers”. These mandates are not mutually exclusive, but complement each other in their rationale. The Euro-system executes its oversight competences through the ECB, in close cooperation with competent national authorities – predominantly NCBs. The rationale for this decentralized approach to oversight is purely economic. Namely, risks taken by financial institutions in one of the national payment systems may adversely affect overall financial stability in the EU. And national supervisors are best suited to assess such riskiness of business. In this respect, the Euro-system exercises a complementary approach to promoting safety and efficiency through its: 1) Operational role, derived from its role of owner and operator of a system (large-value payment system) where its immediate interest in the system’s safety and efficiency is derived from. 2) Conduct of oversight activities, in order to be reassured that all systems – be it privately owned or run by the ESCB – are sound and efficient. 3) Facilitator of policy changes, market adaptations and networking among actors (i.e. the Euro-system as catalyst), especially with respect to improving the overall efficiency of the Euro area market infrastructure.  Although the Euro-system’s oversight has become more formalized during the last two decades and has gradually expanded its scope, its enforcement has predominantly relied on moral suasion and the acceptance of ECB’s expert advice by national authorities. It was only in July 2014 that the ECB opted for a more radical take to its “advisory role” by exercising its statutory entitlement to issue regulations in the field of large value and retail payments for the first time in the Euro-system’s monetary history (and which we discuss in the following paragraphs).

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3.1. Economic rationale and legal basis of the Euro-system’s involvement The Euro-system’s competences in respect of oversight are enshrined in the primary sources of EU law. They are laid down in the Treaty on the Functioning of the EU (Art. 127(2)) and the subsequent Protocol on the Statute of the ESCB and of the ECB annexed to it (Art. 3 and 22). It is interesting to note however that the Maastricht Treaty doesn’t mention the term “oversight” explicitly. The reason for this elusiveness may be found in the broader historical context of the Treaty’s signing in 1992, when the delineation between supranational oversight (payments) and national supervision (banking) as separate regulatory functions was only emerging. Moreover, at the time when this legal framework was set, payment systems, both large value and retail ones, had not gained today’s size and systemic relevance. Article 127(2) of the Treaty on the Functioning of the EU determines the basic task of “promoting the smooth functioning of payment systems” as part of ESCB and the ECB’s primary objective, which is the maintenance of price stability. The mandate relates also to the Euro-system’s interest in the smooth functioning of securities clearing and settlement systems. It is through regulatory activities or, more precisely, oversight, that the Euro-system and the ECB ensure the proper functioning of payment systems and the smooth flow of financial assets. Often the oversight and operative functions overlap since the Euro-system acts both as operator and supervisor of payment systems5. In order to carry out these tasks successfully, the Statute of the ESCB and of the ECB assigns them an unambiguous regulatory role (Art. 22): “The ECB and NCBs may provide facilities, and the ECB may make regulations, to ensure efficient and sound clearing and payment systems within the Community and with other countries.” From this, two aspects of the ESCB’s general task may be discerned: (i) the imposition on the ECB and NCBs to perform not only the traditional task of payments’ facilitators but also of overseers, and (ii) the ECB’s regulatory competences in respect of payments, although restricted to euro area countries. This gives statutory powers to the ECB in pursuing oversight objectives, which is material for the confidence of payment system participants, as well as for public confidence in the common currency. In this, the Treaty assigns regulatory powers to the ECB (as the carrier of legal personality) necessary to secure the aforementioned goals. Basically, these regulatory powers entail two different kinds of ECB legislation (ECB, 2007, p. 14): i) legal acts with

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external effect, with addressees beyond the NCBs, which take the form of regulations (as the most binding type), decisions, recommendations, and opinions, and ii) legal acts with internal effect addressed exclusively to the euro area NCBs (and the ECB) which take the form of guidelines, instructions, etc. Until recently there has been no need for the ECB to issue specific oversight regulations, which indicates that all oversight activities were performed in a cooperative manner with overseen entities. It is also worth noting that, in addition to the supranational laws and regulations, the legal basis of oversight extends to national legislation as well. The principle of decentralized oversight stipulates that the enforcement of common policy stances is entrusted to the NCB of the country where the system is legally incorporated. This means that NCBs may act as lead supervisors when necessary, but also promote “information networking”. In the three-step process of oversight, the leading role is assigned to the “local” authority in respect of the system supervised. The Euro-system’s logic is that collection and assessment of information is best exercised by authorities in the proximity of the entity overseen. This is easily determined in systems with a clear national anchor, but in those where there is no “lead authority” established by national legislation, the body entrusted with oversight responsibility is the NCB of the country where the system is legally incorporated6. In executing this task, the NCB has to attain to a very strict prudent policy, making sure to maintain the oversight interests and expertise of the ECB, as well as of other NCBs in the euro area. The ECB ensures the enforcement of common prudential standards throughout the euro area, either by regulations as the most binding and centralizing legal instrument (according to Art. 22 of the Statute), or by guidelines. In certain circumstances, enforcement may be effected through legal instruments available to NCBs. Each NCB then reports to the Governing Council of the ECB on its assessments and results of conducted activities with the aim of facilitating transparency and consistent implementation of oversight standards across countries.

3.2. The common oversight policy The fact that the Euro-system’s supervisory competences are limited to payment systems that process the euro does not limit the variety of risks the system has to mitigate. Under certain conditions these risks may become systemic with imbalances, threatening not only payments but also other components of the financial system. Furthermore, delays in

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payments do not affect only transaction participants, but third parties as well, as they can become exposed to externalities through securities settlement or payments finality. This is why the Euro-system minimizes systemic risks and other externalities, with oversight as a specific form of public intervention. Henceforth, oversight fosters right incentives for participants and involved financial actors. The most detailed description of the Euro-system’s oversight role is given in the “Euro-system oversight policy framework” (ECB, 2011). In the document, the Euro-system defines oversight of payments as a central bank function whereby the objectives of safety and efficiency are promoted by monitoring existing and planned systems, and assessing them against predetermined objectives. The policy framework describes the rationale of the Euro-system’s involvement and the scope of its oversight function. It also details the conducted oversight activities, the policy capacity, and allocation of roles within the Euro-system, as well as the manner of cross-border cooperation in the field. While the common policy framework for oversight is determined on a supranational level, it can be complemented with national policies where necessary. Against this conceptual background, the Euro-system develops its oversight policy and determines its aims, objectives, and scope. The overarching aim is the safety and efficiency of payments. This is then translated into narrower objectives, namely the: (i) maintenance of systemic stability, (ii) promotion of operative efficiency, (iii) support of public confidence in payment systems, instruments, and the common currency, as well as (iv) safeguarding of the transmission channel for monetary policy7. In order to achieve its objectives, the Euro-system has developed and adopted numerous supervisory principles and standards. In practice this task is performed by the Governing Council, which articulates a common policy stance in circumstances where the smooth functioning of payments may be undermined (e.g. un-level playing field for market participants, propagation of systemic risk). Clear and straightforward standards and recommendations ensure a harmonized and systematic oversight of payments. They are all largely based on soft-law recommendations set by international institutions, such as the Committee of Payment and Settlement Systems. By adapting and specifying these international standards for the euro area context, the Euro-system ensures that the standards and recommendations take into account the specificities of the Euro area (ECB, 2011, p. 4). Henceforth, the enforcement of common

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supervisory standards is further ensured through ECB regulations and guidelines (Art. 22 of the Statute). In addition, terms of reference for the assessment of oversight activities minimize possible inconsistencies in implementation (IMF, 2013, p. 19). As for the oversight methodology, the Euro-system relies on several principles. First, it abides by very high transparency standards, since through transparency the Euro-system demonstrates the consistency of its approach to oversight, and provides a benchmark for the effectiveness of its policies. In addition, transparency is a prerequisite of policy accountability (as is the case with central bank governance in general). Second, the Euro-system consistently separates its oversight and operational functions in its internal organization (this is also mirrored by the NCBs) in order to minimize the potential for conflicts of interest. Third, the Euro-system’s oversight policy ensures a “level playing field” for all systems, meaning that in its implementation there is no difference of treatment between privately or publicly/EU-owned systems. In fact the same policy requirements and standards are applied to all payment systems, irrespective of whether they are publicly or privately owned/operated. The Euro-system’s oversight method is based upon three-steps (ECB, 2011, p. 7): 1) Collecting of relevant information by using a wide range of information sources, including bilateral contracts with system counterparties, reports on system activity, and other relevant documentation. It also relies on statistical information on payment systems. This is why the quality of collected information benefits from close coordination with NCBs.  2) Assessment of collected information against predetermined standards either as part of regular or ad hoc assessment activities. Regular assessments can concern the entire system and all relevant standards, or it can specifically target a defined group of standards. Ad hoc assessments are carried out when a system’s operator initiates change in its procedures or governance arrangements. In addition, the Euro-system conducts a risk-based assessment, through which it identifies systems and risks with greater systemic relevance.  3) Inducing change based on the results of assessments made. As already mentioned, until July 2014, the Euro-system incentivized change in market participants exclusively by moral suasion and

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public influence. From that date the ECB took a more formalistic approach to its catalyst role by executing its right to issue regulations in the area of payments.  Irrespective of the concrete oversight method conducted, effective cooperation with the entities subject to supervision is of utmost importance to the Euro-system. Since its approach to supervision is decentralized, the close coordination between competent authorities is a prerequisite of a consistent application of common standards. During the years, oversight became more formalized, but the activity still depends on the acceptance of the ECB as “expert authority” by system participants. The ECB does have a leading role in implementing policy standards and in overseeing individual infrastructures, but it is a responsibility shared with NCBs of the euro area (ECB, 2010, p. 284). Finally, the Euro-system has a leading role in coordinating crisis management, for which it has established a crisis-communication framework comprising all competent authorities within the Euro-system.

4. Governance of oversight activities Payment systems are traditionally conducted through the banking system, which is why it is often difficult to disentangle oversight from prudential supervision. In the EU the latter still remains as a national competence for the larger part (Lastra, 1999, p. 6). However, the Treaty and the Statute do establish such dissociation with legal consequences for governance arrangements of payments’ oversight and for the policy capacity of actors involved8. We have already stated that the Treaty on the EU and the annexed protocol on the Statute of the ESCB and the ECB constitute the framework of primary community legislation that govern the Euro-system in respect of supervision of payment systems. The Treaty envisaged the ESCB as a model of multi-tier governance. The ECB is an institutional embodiment of multi-level governance, with its subsets of member states engaged in task-specific cooperation.9 This governance arrangement represents the basis for the efficient execution of various tasks entrusted to the Euro-system, including the oversight of payments as well. As the ESCB itself has no legal personality, its governance model relies on the legal capacity of the ECB and NCBs. As a task conferred to the ESCB, the ECB retains the ultimate responsibility when carrying out oversight activities. Still, the ECB’s policy capacity as regards the oversight of payment system is weaker than in other areas (e.g. monetary policy), because of this complex division of institutional responsibilities between

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the ECB and its national counterparts. This is also partly due to the wording of the specific provisions in the Treaty and the Statute that award the Euro-system with a broad mandate in the field of payment systems (i.e. the Euro-system as operator, oversight authority, and initiator of regulatory developments). The governance structure of the ESCB has three-layers (European Parliament, 2013, p. 11): 1) European layer, where tasks conferred to the ESCB are carried out either by the ECB or by NCBs. In the latter case the ECB acts as direct supervisor, issuing legally binding guidelines and decisions, in order to monitor and harmonize the NCBs in their performance. 2) European/national layer, where NCBs act as independent authorities but under the supervision of the ECB. 3) National layer, where the NCBs act in full legal autonomy and with own responsibility and liability in carrying out tasks other than those specified by the Statute. However, the ECB’s Governing Council may take a 2/3 vote and veto the NCB’s activity if it deems it to interfere with the objectives and tasks of the ECB (Art. 14.4. of the Statute). It is worth noting that even in this layer, the ECB, through its Governing Council, still retains the right to interfere with the NCBs decisions. Overall, the “lead role” in governance matters is predominantly conferred to the European level, but with a horizontal interplay between different member states and their task-specific cooperation. The Euro-system’s oversight activities in respect of payment systems make no exception, as they are governed by a combination of the first two layers characterized by a strong principle of decentralization in favor of NCBs of the euro area.10 At the same time, the decision whether the ECB acts or the NCBs under the ECB’s supervision lies with the decision-making bodies of the ECB (European Parliament, 2013, p. 5). When executing oversight activities for LVPs, in accordance to the principle of decentralization, the NCBs of the euro area have to assure strict compliance with ECB’s guidelines and instructions (Art. 14.3. of the Statute). In order to ensure regulatory compliance, the Governing Council of the ECB can start infringement procedures at the European Court of Justice against NCBs11. It may also veto an NCB’s activity if it finds that it interferes with the tasks and objectives of the ESCB (Art. 14.4. of the Statute)12.

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Due to recent post-crisis developments the ECB’s right to impose sanctions on national competent authorities (i.e. NCBs) extends to all segments of payments. Namely, in 2014, the regulation on oversight requirements for systemically important payment systems (SIPIS) entered into force, covering LVPS and RPSs in order to ensure efficient risk management and appropriate governance of SIPIS13. This was the first time the ECB has made use of its regulatory powers in the field of oversight, moving away from its traditional moral suasion and expert guidance, and placing greater leverage on the European layer in oversight governance. The regulation provides stricter oversight standards and empowers the ECB to impose corrective measures and sanctions in case of non-adherence. Competent authorities, i.e. Euro-system central banks with primary oversight responsibility, still retain the right to impose corrective measures, but the ECB has to be informed of such actions without delay. In addition, the ECB has the right to impose independent or parallel corrective measures and sanctions (Art. 1, 22(4) and (5), 23, ECB/2014/28).

4.1. Policy capacity of main actors In a broader sense, policy capacity refers to the power an entity has to supervise the implementation of public policies in specific fields (Quaglia, 2008, 6). In the Euro-system, the execution of supervisory tasks is divided by the principle of decentralization between the EU level – the ECB and the national level – the NCBs. Operationally, this role of the ECB is executed through shared responsibilities with the NCBs. Decentralization implies that the ECB may have recourse to the NCBs to carry out specific supervisory assignments to the extent deemed possible and appropriate. This also implies that the NCBs, as significant actors in the Euro-system have to interact in different ways. In this multi-level governance, the NCBs act in dual capacity within the ESCB: (1) as operational agencies in carrying out tasks delegated to the EU-level (or the ESCB), and (2) as national actors in performing non-ESCB functions. Their oversight responsibilities and competences in respect of national payment systems are part of the former capacity. Such decentralized supervision is rather unusual from the perspective of recent regulatory developments in the euro area, where competencies are being centralized within the ECB. However, in respect of payments, this arrangement contributes to the overall strategy of risk reduction in the financial system. Namely, as financial stability may be affected by risks borne by credit institutions that carry out various roles in payment systems, it was only appropriate to complement the

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common oversight policy at the Euro-system level with national contributions. The leading role in this decentralized arrangement of oversight is entrusted to the ECB de facto, but its success depends crucially from timely and responsive cooperation with NCBs14. This cooperation extends to the international level by networking with central banks of non-member states and international securities regulators on issues related to global payment infrastructures (e.g. Continuous Linked System) in addition to the EU level. As for the governance of cooperation among EU authorities, the Euro-system has concluded Memoranda of Understanding with national prudential (i.e. banking) supervisors. Although these are not legally binding documents, they do stipulate principles and procedures of regulatory cooperation in respect of payments (ECB, 2010, p. 290)15. In this respect the Memoranda primarily focus on information-sharing and cooperation in large-value payment systems, but also on the maintenance of the framework for the safety and soundness of payment systems overall. It is worth noting that cooperation arrangements differ depending on the overseen entity. Their common feature is that there is always a lead supervisor in charge of organizing and administering the oversight activities. As a result, the NCBs and other competent authorities participate actively – to a various degree, in this process by exchanging information, periodical, or ad hoc assessment of the system and by conducting mutual consultation before implementing the common oversight policy or taking any oversight action that can adversely affect the overseen entity (IMF, 2013, p. 35).

4.2. Allocation of roles In the area of LVPS, the Euro-system has the most prominent oversight role. Namely, for all large-value payments, the Euro-system has the exclusive oversight mandate. These systems form the backbone of the euro area market infrastructure and every LVPS is subject to very detailed oversight scrutiny given their high systemic relevance. The well-known TARGET2 system is owned/operated by the Euro-system while the EURO1 (or EBA CLEARING the LVPS in euros) and the Continuous Linked Settlement system (settling euro transactions globally, outside the euro area) owned/operated privately. The Euro-system is entrusted with oversight competences in respect of every one of these systems except for the CLS16, with expert contributions from NCBs.

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The ECB considers every LVPS settling euro transactions to be systemically important, owning to the value of individual transactions and the crucial role of the system for financial stability and the transmission channel of monetary policy. In this context, the ECB’s oversight framework is based on the CPSS Core Principles for Systemically Important Payment Systems (SIPS) adopted by the Governing Council in 2001. In 2006 these core principles have been complemented with the provisions of the Business Continuity Oversight Expectations. Finally, Article 127(4) of the Treaty and Art. 4 of the Statute stipulate that any oversight policy or action that an NCB proposes to pursue at national level has to be coordinated with the ECB. This means that the ECB has to be consulted in regard of national rules imposed to payment systems. Systemic relevance is not typically associated with retail payments, and thus their significance is traditionally linked with the “public perception” of the euro. This is why, as a rule, oversight of retail payments fall under the competences of NCBs. However, in the last decade, some of these systems have substantially increased their transaction value and operating size, signaling that disruptions in these systems may trigger cascading effects. This is why, in respect to retail payments with systemic or prominent importance, the ECB has primary oversight capacity, meaning that general policy lines for oversight are defined at the European level. Such are the 2012 oversight requirements for links of retail payment systems operating in the euro area, whose provisions focus on their safety and efficiency.17 Henceforth, even in the area of retail payments, the scope of the ECB’s role has widened recently.

5. Concluding remarks Payment systems in the EU bear major public importance as malfunctions stemming from payments can potentially affect public confidence in the currency, undermine the stability of the financial markets and trigger system-wide instabilities. It is not surprising then that, alongside banking prudential regulation, oversight of payment systems constitutes a prerequisite of financial stability. Oversight is concerned with infrastructure soundness and effectiveness, meaning that its success depends from timely regulatory responses that adequately complement market developments. This chapter suggests that the recent conceptual imperative in the postcrisis governance of the European financial sector – with “more Europe” and vertical centralization, which has transformed the oversight of European financial infrastructures, but this transformation has been

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probably less mainstream than those which have developed in other financial segments under greater public scrutiny (most notably, the banking sector). This is partly due to the “operative” nature of payment systems, which consist mostly of market platforms and procedures, and where regulatory paradigms certainly matter, but primary emphasis is placed on the micro-level meaning of the consistent monitoring of regulatory compliance by competent authorities. The legal framework of the Euro-system’s oversight comprises the Treaty on the Functioning of the EU, in which the basic task of promoting sound payment systems is enshrined, the annexed Protocol on the Statute of the ESCB and of the ECB, and the Euro-system oversight policy framework. These documents determine the scope of oversight, actors’ policy capacity and the allocation of roles within the Euro-system in oversight matters. The economic rationale for this regulatory mandate of the Euro-system derives from the policy capacity of its main stakeholders – the central banks (ECB and NCBs respectively). As monetary authorities the responsibility of central banks to maintain the efficiency of payment systems is crucial, given the twin objectives of monetary and financial stability. Moreover, central banks safeguard the public confidence in money, and since this confidence depends on the ability of transmitting payments across the system smoothly, their focus on payment systems is to be expected. In the Euro-system the execution of oversight is decentralized, meaning that, in practice, regulatory tasks and responsibilities are divided between the EU level – the ECB, and the national level – the NCBs. Decentralization implies that the ECB may have recourse to the NCBs to carry out specific supervisory assignments to the extent deemed possible and appropriate. This decentralized approach to oversight respects the concept of the ESCB as envisaged by the Treaty – a model of multi-level and multi-tier governance, where the “lead role” is conferred to the supranational level, while the basis rests on the horizontal interplay between national actors in the form of task-specific cooperation. Within the scope of its oversight competences, the ECB is awarded with unambiguous regulatory power (The Statute, Art. 22). In practice this means that the ECB can pursue oversight objectives by means of direct regulatory intervention in payment systems. Both the Treaty and the Statute do not limit the ECB’s power to a specific payment’s area (large value or retail), nor do they link its execution to issues of systemicrelevance exclusively (Kokkola, 2010, p. 311). Recently the ECB did recur

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to direct regulatory intervention in the area of payments for the first time in its history, and adopted the regulation on systemically important payment systems in 2014. With this, the European layer in the ESCB’s governance model has become more prominent in oversight matters (in respect to both LVPs and RPSs). Another prospective challenge is the Euro-system’s financial stability role, as defined by Article 3.3 of the Statute. The ESCB has been entrusted an explicit mandate in contributing to the smooth conduct of policies pursued by the competent authorities relating to the stability of the financial system. Until present, the Euro-system’s oversight competence in respect of payments has been effectively structured and organized. But with new regulatory responsibilities, such as the centralization of supervisory expertise at the ECB level as part of the banking union, the Euro-system’s role of owner and overseer of payments will have to be better delineated. In this respect two key elements are crucial for the future evolution of the Euro-system’s oversight role: 1) Confirmation of a more robust legal basis for the ECB’s oversight responsibility for systemically important infrastructures in the euro area, especially those with substantial cross-border activity. 2) The empowerment of the ECB to issue and impose legally binding oversight measures – the Euro-system is relying ever more on its regulatory powers. Expectedly, the ECB will continue to develop new EU legislation addressed to financial market infrastructures, especially in respect of SEPA’s recent full launch. Overall, the Euro-system’s current oversight framework is undoubtedly comprehensive. Partly this is due to its conceptual basis formed by a widerange policy with established standards, through which the Euro-system manages to cover a broad range of payment infrastructures and service providers in the euro area. The system will evolve over years with respect to its organization and governance. The NCBs are likely to remain as key policy interlocutors and operative actors, while governance of oversight will arguably favor the European layer through a more occurring use of the ECB’s regulatory powers in payment systems. Such developments are likely to affect both large value and retail payments. This prospect has already been confirmed with respect to large value payment systems where the European layer of governance gained more leverage with the 2014 ECB regulation, focusing for now on systemically important payment systems. As for retail payment systems, they are likely

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to experience a greater degree of centralization. With SEPA’s full launch in 2014 and the intensification of the integration process among retail infrastructures, a stronger coordination of national oversight arrangements, as well as increased common oversight activities, will become imperative. And since SEPA wishes to extend to the European Economic Area, even countries outside the euro area will gradually transition to a more ‘SEPAfriendly’ legal environment, meaning that the influence of the ECB’s policy-making will likely extend beyond the limits of the euro area.

References Amicorum, Liber and Zamboni Garavelli, Paolo. 2005. Legal Aspects of the ESCB. Frankfurt Am Main: ECB. Bank for International Settlements. 2012. Payment, clearing and settlement systems in the Euro area. CPSS-Red book. Committee on Payment and Settlement Systems. 2012. Principles for financial market infrastructures. Basel: Bank for International Settlements – Technical Committee of the International Organization of Securities Commissions. Consolidated version of the Treaty on the Functioning of the European Union OJ C 326, Brussels 26.10.2012. European Central Bank. 2007. Blue Book. Payment and securities settlement systems in the European Union – Euro Area countries. Frankfurt am Main: ECB. —. 2011. Euro-system Oversight Policy Framework. Frankfurt am Main: ECB. —. 2012. Oversight expectations for links between retail payment systems (draft). Frankfurt am Main: ECB. —. 2014. Revised Oversight Framework For Retail Payment Systems. Available at: https://www.ecb.europa.eu/press/pr/date/2014/html/pr140821.en.html —. 2015. Euro-system oversight report 2014. Frankfurt Am Main: ECB. ECB Regulation (EC) No. 2157/1999 of 23 September 1999 on the powers of the European Central Bank to impose sanctions (ECB/1999/4), OJ L264/21, Brussels 12.10.1999. European Parliament. 2013. Limits and opportunities for the ECB in the multi-tier governance. DG for Internal Policies – Policy Department C: citizens’ rights and constitutional affairs. Committee on Constitutional Affairs. PE 474.398. International Monetary Fund. 2014. European Union: Detailed Assessment of implementation of the European Central Bank observance of the

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CPSS-IOSCO responsibilities of authorities for financial market infrastructures. IMF Country Report No. 14/35. Lastra, Rosa M. 1999. The division of responsibilities between the ECB and the NCBs within the ESCB. In: Louis, Jean-Victor and Bronkhorst, Hajo. The Euro and European Integration. Bruxelles: Peter Lang. pp. 199-216. —. 2012. The Evolution of the European Central Bank. Queen Mary University of London, School of Law. Legal Studies Research Paper No. 99/2012. Kokkola, T. (ed). 2010. The Payment System. Payments, Securities and Derivatives, and the role of the Euro-system. Frankfurt Am Main: ECB. Marks, G. 1993. Structural policy and multilevel governance in the EC. In: Cafruny, A. and Rosenthal, G. (eds). The State of the European Community: The Maastricht Debate and Beyond. Boulder, Colorado: Lynne Rienner. pp. 391-411. Protocol (No 4) on the Statute of the European System of Central Banks and of the European Central Bank, OJ C 326, Brussels 26.10.2012. Quaglia, L. 2008. Central Banking Governance in the European Union: A Comparative Analysis. Abingdon: Routledge. Regulation of the European Central Bank (EU) No 795/2014 of 3 July 2014 on oversight requirements for systemically important payment systems (ECB/2014/28). OJ L217/16. Brussels 23.7.2014. Regulation of the European Parliament and of the Council of 26 February 2014 amending Regulation 260/2012 as regards the migration to Union-wide credit transfers and direct debits (Text with EEA relevance). OJ L 84/1. Brussels 20.3.2014. Regulation of the European Parliament and of the Council of 14 March 2012 establishing technical and business requirements for credit transfers and direct debits in euro and amending Regulation (EC) No 924/2009 (Text with EEA relevance). OJ L 94. Brussels 30.3.2012. Wellink, N., Chapple, B., Meier, P. 2002. The role of national central banks within the ESCB: The example of De Nederlandsche Bank. Available at: http://econwpa.repec.org/eps/mac/papers/0207/0207006 .pdf (Last accessed October, 2, 2015)

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Notes 1

At this point it is important to note that TARGET2 is not the only European LVP system, as there are other privately owned systems operating inside or outside the Euro area. One of the most important is the EURO1 system, which is a EU-wide, net settlement system that processes both interbank and commercial payments, and that is privately owned and operated by the European Banking Association (EBA). Since the introduction of the single currency, other systems have been set up outside Euro area countries for the processing of Euro-payments. In 1999 the Euro Swiss Interbank Clearing (euroSIC) launched, operating in Swiss francs. This system settles customer payments and interbank transactions. In 2002 an additional system was established, settling large-value payments in foreign currencies – the Continuous Linked Settlement (CLS) system. Another interesting system is the Euro CHATS established in Hong Kong in 2003, which is a RTGS operating in Euro and functioning in parallel with RTGS systems operating in Hong Kong and US dollars. See more on this in Kokkola, 2010. 2 Similarly to the segment of LVP, SEPA is just one of the systems covering the whole of the Euro area (albeit, the most important!). Other RPS that are open to all banks are EBA’s STEP1 and STEP2, which were created as a complement to the EURO1. The first handles retail and commercial payments of EURO1 participants, while the second operates as the first pan-European automated clearinghouse for bulk payments in Euro. See more on this in Kokkola, 2010. 3 Some of the recent regulatory milestones in the project are: Regulation (EU) No 260/2012 of the European Parliament and of the Council of 14 March 2012 establishing technical and business requirements for credit transfers and direct debits in euro and amending Regulation (EC) No 924/2009; and finally Regulation (EU) of the European Parliament and of the Council of 26 February 2014 amending Regulation (EU) No 260/2012 as regards the migration to Union-wide credit transfers and direct debits. 4 See more on this at: https://www.ecb.europa.eu/paym/retpaym/governance/html/index.en.html Accessed 30, August 2015. 5 In this way the ESCB assumed responsibility for the system that has the greates significance for monetary policy and systemic stability, the large. 6 However, in these circumstances the Governing Council of the ECB has the possibility of delegating this task directly to the ECB. The Governing Council has executed this right in the case of the EBA Clearing Company (operating EURO1, STEP1 and STEP2) as well as for the TARGET2. In respect of the latter system, the ECB also draws on the NCBs’ oversight of local features. 7 Other objectives commonly pursued in supervision of payments, such as antimoney laundering, consumer and data protection, fall outside the Euro-system’s supervisory scope and are therefore pursued by national authorities and other institutions. Although the Euro-system can act as catalyst or facilitator devloping

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policies that actively support the pursuit of these “auxilliary” objectives by competent authorities. 8 “Policy capacity” refers to the steering of actions of public actors in defining the content and supervising the implementation of public policies in specific fields of activity. It also refers to the interaction with other public and private actors at the (inter) national level (Quaglia, 2010, p. 6). 9 Multi-level governance refers to vertical policy-making and decision-making involving supranational and national bodies (Marks, 1993, p. 402). By focusing on the supranational level, multi-tier governance describes the horizontal interplay between different member states and their task-specific cooperation (European Parliament, 2013, p. 6). 10 In both cases the ultimate decision regarding which layer takes the lead role in a specific situation rests on the European layer and the ECB’s decision-making bodies. 11 Art. 35(6) of the Statute. 12 At the same time this subordination of NCBs requires that they participate in decision-making. Hence, the governors of all Euro area NCBs, together with members of the Executive Board of the ECB, constitute the Governing Council (Art. 283(1) of the Treaty). (European Parliament, 2013, p. 9). 13 The ECB has four SIPIS to date – two in the segment of LVPS (TARGET2 and EURO1) and two in the segment of RPSs (STEP2-T and CORE). 14 This role was particularly relevant during the acute phase of shared in close cooperation among NCBs determined the Euro-system’s ability to swiftly address sources of instabilities. 15 The one with direct implications to the division of responsibilities in oversight procedures is the MoU on cooperation between payment system overseers and banking supervisors in Stage Three of the EMU, adopted in 2001. 16 In the case of CLS, run by the CLS Bank International in New York (US) the Federal Reserve System has primary supervisory responsibility, as stipulated under the provisions of a cooperative oversight framework. The Euro-system has participant status in this arrangement, alongside those NCBs that belong to the G10. Still, the Euro-system retains primary responsibility for supervising Euro settlements in the CLS in close cooperation with NCBs. 17 Links of payment systems are sets of legal and operational arrangements that facilitate the transfer of funds and the settlement of obligations between subjects participating in different RPSs, established in the same or in different jurisdictions (ECB, 2012, p. 1). These links between RPSs have grown constantly during the years as the SEPA project advanced. The objective of this regulation is to allow proper management of risks stemming from links between RPSs by means of more stringent oversight activities carried out by NCBs.

CHAPTER EIGHT FINANCIAL INTEGRATION, FINANCIAL STABILITY AND COLLECTIVE ACTION CHARILAOS MERTZANIS1

The goal of this chapter is to offer a broad overview of the link between financial integration, financial stability, and collective action. The recent financial crisis raised questions concerning the usefulness and effectiveness of macro-prudential policy exercised at the national level, whereas financial instability is a global problem. Financial stability must be understood as a public good, so that national supervisors align their policy for the benefit of all participants in the market. Collective action is therefore required through a proper international mechanism of coordination. Key words: financial regulation, stability, collective action, Europe

1. Introduction The global financial crisis and the complex nature of the financial stability goal have revived interest in collective action to ensure that policy makers will not suffer the economic consequences of financial market failure. However, since the 2009 G-20 summits in London and Pittsburgh promised global cooperation to eliminate the apparent misdeeds of financial markets, interest in collective action has waned considerably. The state of global cooperation has fallen victim to neglect for predictable reasons. First, acting to serve their self-interests, countries most affected 1

Associate professor, Dept. of Management, The American University in Cairo. Contact: [email protected]

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by the crisis intervened almost simultaneously, thereby giving the impression of coordinated global action on the fiscal front. The variety and intensity of fiscal stimulus programs, as well as fiscal consolidation policies enacted around the globe, differed considerably (IMF, 2010). Many economies in Asia and other emerging markets did not always feel the need to join in, which allowed them somewhat to 'free-ride', thereby helping them soften the internal consequences of the global downturn. In Europe, the flawed design of financial policy has resulted in a subsequent deep sovereign debt crisis that highlighted the serious problem of collective action both before and after the crisis. Politicians carefully reverted by assigning the technical task of redesigning the world's financial system to unelected officials, typically central banks and financial regulators. The failure of collective action, resulting from built-in incentives for group members to engage in free-riding when the group is working to provide public goods, was long pointed out (Olson, 1965), but recently has reemerged by the global crisis. The failure of both the G-20 to take decisive steps in raising public confidence on market institutions and the IMF to persuade key members that they have a shared interest in absorbing the costs of dealing with the consequences of incoherent and profligate fiscal restructuring in Europe, are demonstrations of modern collective action problems. In this chapter certain aspects of financial integration and financial stability are discussed, and their cross-border implications are drawn for collective action in financial services regulation and supervision in the EU and globally. It is argued that financial stability must be understood as a commonly shared public good, and that achieving global financial stability is a goal beyond reasonable doubt. In what follows, section 2 analyzes the interaction between monetary stability and financial stability policy. Section 3 analyzes the relationship between macro-prudential policy and financial stability by taking account of increasing global financial interconnectedness. Section 4 focuses on the European Union (EU) and highlights the existence of both internal and cross-border externalities among member states, which raise serious collective action problems. Section 5 shows that the process of EU financial integration has given rise to a financial stability trilemma, which shows the impossibility of simultaneously achieving EU financial integration and EU-wide financial stability, given national macro-prudential policies. Section 6 analyzes the important implications for collective action of the division between home vs. host regulation and supervision conflict on a global scale. Section 7

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shows that there is a modern mismatch between global portfolio investment diversification and domestic financial deepening, which raises new collective action challenges. Section 8 points to some important manifestations of collective action problems and provides directions for their resolution. Finally, section 9 concludes the paper.

2. Monetary stability and financial stability The recent financial crisis has shown that monetary stability and financial stability are closely intertwined. Monetary policy decisions affect financial behavior and vice versa. Asset price developments, monetary policy, and prudential policy are interconnected, both domestically and globally. On the one hand, monetary policy decisions play a significant role in either exacerbating or suppressing financial cycles. Persistently low interest rates have encouraged financial institutions and market participants to take levels of risk that they would not have otherwise assumed (Altunbus et al., 2008). The undisputed impact of monetary policy actions on risk-taking behavior of financial institutions has raised the question of whether monetary policy-makers should adjust the policy rate so as to accommodate the smooth operation of financial markets. On the other hand, changes in asset prices can directly impact upon the level of nominal variables targeted by central banks through a number of channels. Rising asset prices can increase household wealth; provide more collateral for mortgages; reduce the need for precautionary saving; stimulate firms’ expenditure through better access to finance, which may lead to inflationary pressures; and contribute to the build-up of financial and real imbalances which, even if they do not directly impinge on price stability, might indirectly pose serious risks for macroeconomic stability. Thus, monitoring of asset prices is an important task of monetary policy. The question then arises as to how asset price monitoring should be best integrated within monetary policy strategy. A financial stability-minded conduct of monetary policy needs to be aware that during periods of asset price inflation there is usually an interaction between the financial and real sector activity, which leads to credit and investment booms and long periods of economic expansion. The increase in the value of assets tends to reduce the perception of risk, while risk is quietly building up, and makes available more collateral for the growth of external financing to the private sector, raising investment and consumption expenditure. At the same time, if the increase in the value of assets is perceived to be of a permanent nature, expenditure is continuously expanded through the traditional

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wealth effect. As long as the boom in asset prices continues, the ensuing optimism for higher future returns sustains this self-reinforcing process. Although these developments may be driven by fundamentals at first, the interaction between credit and asset markets may generate asset-price misalignments, lead to high private indebtedness, over-investment, and, ultimately, serious financial and real imbalances. In the event of an unfavorable market shock or a sudden asset price reversal, these risks could materialize, causing a severe economic contraction with important disruptive effects in the financial and real sectors of the economy. In general, the larger the build-up of private debt and the greater the distortions in the allocation of capital during the economic boom, the higher the risks and potential disruptions. In order to mitigate the negative impact of these disruptions, central banks are led to loosen monetary conditions to counter the recessive and deflationary consequences for the economy of a sudden and sharp contraction of asset prices. However, views on how this should be done differ: some focus only on the direct impact of asset price volatility on monetary targets, others argue for an early identification of misalignments during the boom phase with a view to taking preventive action beyond what strictly concerns monetary policy goals, while others advocate a more intermediate and flexible intervention (Bean et al., 2010). The first approach relies on a pessimistic stance on whether central banks are able to detect early enough a departure of asset values from their fundamentals (Bernanke and Gertler, 2001). Even if misalignments could actually be identified in a timely manner, the ability of central banks to affect the bubble is questioned. Any preventive action would therefore be difficult to explain to the public, as it would require a substantial deviation from monetary policy goals. This may entail significant reputation costs for the central bank. In addition, lags in the transmission of monetary policy to the economy could also lead to undesired effects. For instance, if the bubble was about to burst, a tighter monetary policy could aggravate the recessionary impulses of the correction in asset prices, instead of moderating the effects of the upswing phase. At the extreme, the damage to the wider economy from higher interest rates may outweigh the benefits of taming the financial cycle. The second approach recommends a more flexible framework under which central banks should try to identify and respond to price misalignments in order to improve macroeconomic performance (Cecchetti et al., 2003).

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Asset prices should not be directly targeted and, more importantly, the reaction of monetary policy should never be mechanical; it should always depend on the nature of the underlying shocks. If asset prices were driven by changes in fundamentals alone, say a productivity shock, a monetary reaction would never be useful. However, if asset prices were driven by other factors as well, a tighter monetary policy during the upswing phase would offset the impact of the bubble on investment and consumption, and would contribute to greater macroeconomic stability. Notwithstanding the ability of central banks to timely detect asset-price bubbles and intervene to reduce their destabilizing effects, some judgment is inevitable. The third approach takes the previous approaches to be partly true. Dealing with asset price developments when making monetary policy decisions merits a pragmatic and flexible approach. While in normal conditions monetary policy should focus on changes in nominal target forecasts, in exceptional occasions central banks have enough signals to conclude that significant risks are stemming from broad financial developments. In these situations monetary policy may have to pay more attention to this other information and respond directly to it, even if inflation deviates from its objective in the short-term (Issing, 2003). For example, observed financial imbalances are found to contain useful information about subsequent banking crises, output loss, and inflation beyond the traditional two-year policy horizons (Borio and Lowe, 2004). This approach is also consistent with the idea that monetary policy should act not only on the basis of a central target scenario, but also by considering the distribution of risks around the most probable outlook. In this sense, abrupt corrections in asset prices are a clear example of a shock with a low probability of occurring but with significant macroeconomic implications if it actually occurs. Arguably, the more one believes in an active monetary response to financial distress, the less likely one would be to support micro- and macro-prudential instruments that work by affecting the financial system as a whole, and vice versa. This does not mean that such a belief would be inconsistent with more focused uses of prudential policy, such as dealing with bubbles confined to a single sector, such as real estate. But this does mean that the right and undisputed post-crisis restructuring of the overall regulatory architecture at the national level regarding responsibility among the central bank, the macro-prudential regulator, and the micro-prudential regulator will not be an easy task, or a success. Further, this also means that at the global level the mix of monetary policy actions and prudential policy actions among different jurisdictions nay differ considerably to

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achieve the coordination required for containing the global repercussions of financial distress that are caused somewhere around the globe.

3. Macro-prudential policy, interconnectedness, and financial stability The recent financial crisis has shown that the sole combination of macroeconomic policy and micro-prudential supervisory policy is insufficient to contain systemic risk in the financial sector. Systemic risk builds up quietly during periods of macroeconomic tranquility, while the asset side of financial institution balance sheets expands. Following some external shock, systemic risk materializes, causing feedback loops between the financial system and the real economy. For these reasons, systemic risk cannot be contained by a sole microprudential approach to supervision, aiming at ensuring the safety and soundness of individual financial institutions. Instead, a macro-prudential approach to supervision of the financial system as a whole is needed, to contain systemic risk and thereby the frequency and severity of financial crises. Further, macro-prudential policies are needed to contain monetary policy and the implications of excessive leverage for financial stability. These policies need to be implemented both at the national level, when accommodative monetary policy causes excessive increases in domestic asset prices and credit, and at the global level, when changes in the monetary stance cause spillovers into global financial markets that may compromise financial stability. Thus, macro-prudential policy frameworks need to be put in place across all interconnected national jurisdictions. These policy frameworks need to allow for action in both the cyclical (time) dimension and the structural (cross-sectional) dimension. Cyclical policies need to focus on the risks emanating from potentially excessive credit growth and the build-up of leverage in the upswing of the financial cycle, and to build buffers that cushion the impact of adverse financial conditions when the financial cycle turns. Structural policies need to focus on risks from increased interconnectedness within the financial system, and to mitigate the consequences from a failure of institutions that have become too big to fail. The effectiveness of macro-prudential policy faces several challenges. An important challenge is that macro-prudential policy is subject to inherent conflicts and biases that favor insufficient action or inaction (IMF, 2011;

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Nier, 2011). The root cause of these conflicts and biases is the macroprudential policy asymmetry: on the one hand, the benefit of macroprudential action accrues over time and is difficult to measure with certainty; on the other hand, the cost of this action is often felt immediately by financial institutions and market participants. This makes the choice of proper macro-prudential policy action difficult to make in terms of timing, direction, and size so as to achieve the goal of systemic stability in different jurisdictions. The resulting conflict and bias is often amplified by political pressure and regulatory capture, as well as the lack of coordination and clarity regarding sharing of intervention responsibility. Another important challenge is that the extent of interaction effects between the financial and real sectors of the economy, as well as among the financial systems in different jurisdictions, is amplified by the degree of interconnectedness of institutions and markets within and between the financial systems. Over the past three decades, global financial interconnectedness has increased remarkably. Rapid financial globalization has facilitated cross-border flows of capital in the form of lending and investing that have led to an enormous increase in the value of external assets and liabilities of nations as a share of GDP (IMF, 2013). This heightened cross-border financial activity reflects an expanded and complex role of modern global financial institutions, a greater share of foreign assets in financial institutions’ balance sheets, and a proliferation of branches and subsidiaries around the globe. Global financial interconnectedness has facilitated global financial integration. Both have created considerable opportunities and serious challenges (Aziz and Shin, 2013). On the one hand, global financial integration and provision of financial services has brought substantial benefits, such as improved allocation of capital, and expanded opportunities for risk-sharing and risk diversification. The cross-border provision of financial services has fostered competition, more efficient intermediation of savings, and greater access to finance. On the other hand, the increased financial integration has contributed to the build-up of risks in both cyclical and structural forms. Global financial institutions can transmit global liquidity conditions across countries, thereby contributing to global financial cycles. In so doing, financial institutions can collectively become overexposed to risks during the upswing of the credit cycle, and subsequently become overly risk-averse during credit contraction phases caused by adverse shocks.

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Given global interconnectedness, the failure of global systemically important financial institutions can send contagious shockwaves across national borders and lead to a seizing up of liquidity in key financial markets, with strong adverse effects on the provision of credit to the real economy, even in countries where the system was not overtly exposed to risks. Moreover, global interconnectedness not only transmits the impulse, but also complicates both the ex-ante assessment and mitigation of systemic risk at the national and global levels. National policy-makers are likely only to have partial information on the build-up of systemic risks at the national and global levels, making it difficult for each policy-maker individually to properly assess these risks.

4. European financial integration, interconnectedness, and externalities The interaction between monetary policy, macro-prudential policy, and financial stability under conditions of financial interconnectedness takes on a special significance for the European Union (EU). The Maastricht Treaty has separated monetary policy from financial stability supervision. Monetary policy responsibility rests with the European Central Bank (ECB), while financial stability supervision responsibility rests mainly with national member states, with a secondary role for the European System of Central Banks (ESCB). Further, prudential supervision in the EU is based on the principles of home member state control and mutual recognition. A financial institution is thus authorized and supervised in its home member state, and can offer ‘passported’ cross-border services throughout the EU, without additional supervision. The host member state has to recognize supervision from the home member state supervisors. Finally, the organization of crisis management in the EU assumes that both the costs and instruments of crisis resolution are born and available at the national level. The instruments adhere more to private sector solutions than public intervention (e.g. bailout). Given national supervisory authority, decision-making in managing failure of an individual financial institution and its branches rests with the home member state supervisors. However, it is the responsibility of the host member state supervisors to monitor the stability of their financial system. Moreover, the home member state taxpayer may not be prepared to pay for cross-border spillover effects of an institution’s failure elsewhere in the EU. The issue of home vs. host member state control has a direct bearing on financial stability, especially in the EU. There are two arguments in favor

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of home member state control. First, it promotes the effectiveness of supervision, as the home supervisor is able to make a group-wide assessment of the risk profile and of the required capital adequacy of financial institutions (based on consolidated supervision techniques). The EU has adopted the Directive on Financial Conglomerates, which introduces a single coordinator, located in the home member state, who is responsible for group-wide supervision of financial conglomerates. Second, home member state control promotes the efficiency of supervision, as financial institutions are not confronted with different supervisors, which could otherwise result in duplication of efforts and a higher regulatory burden. Home member state control is applicable to financial institutions that offer cross-border services to other EU member states or establish branches in them. However, financial institutions also operate through subsidiaries (separate legal entities) in other member states, for reasons of taxation and limited liability (Dermine 2003). These subsidiaries are separately licensed and supervised by the host member state supervisors (de jure control). The scope for control by host countries of these subsidiaries is limited in practice, as key decisions are often taken by the parent company in the home member state and the financial health of the subsidiary is closely linked (via intra-group transactions and/or joint branding) to the well-being of the financial group as a whole. The effective control of large financial groups is primarily in the hands of the consolidated supervisor in the home member state (de facto control). While home member state control may be useful for the effectiveness and efficiency of prudential supervision, home member state supervisors are not responsible for financial stability in host countries (Mayes and Vesala, 2000). Increasing integration within the EU can give rise to cross-border spillover effects or externalities. This means that the failure of a financial institution in one member state may cause problems in other member states. Therefore, it is questionable whether home member state control for supervision and host member state responsibility for financial stability are sustainable in an integrating European market. This structure of EU financial supervision is encouraging contagion and creating externality effects. Indeed, under current arrangements, EU national supervisors are not well placed to manage a crisis involving crossborder financial institutions, for they cannot adequately assess crossborder bank soundness and systemic risk (Prati and Schinasi, 1999). The sharing of responsibility between home and host supervisors has not been uniformly successful among the Group of Ten Countries (G-10). Further, the growing size and complexity of the EU interbank transactions network creates interconnected exposures capable of transmitting financial failures

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across Europe in a domino-like fashion (Favero et al., 2000). Moreover, during crisis management, the possibility of a conflict of interest between home and host supervisors looms vividly (Vives, 2001). The national central bank and prudential supervisors will only take into account the consequences of an institution’s failure in their domestic market, rather than considering its EU-wide repercussions, adjusting accordingly the provision of liquidity. Finally, national arrangements tend to underestimate the externalities inherent in the cross-border business of financial institutions (Freixas, 2003). Thus, following an institution’s failure, the contribution of capital will be insufficient, and the failed institution may not be bailed out. There is a public good dimension of collective bailout of a failed institution, and lack of cooperation between national supervisors will lead to under-provision of public goods, that is, to an insufficient level of bailouts. Overall, at the presence of contagion and cross-border externalities, effective financial supervision and stability in the EU is difficult to achieve. Under the current EU arrangements, two types of cross-border contagion risk occur following a financial shock. The first type of contagion risk materializes when financial shock causes the institution itself to fail. In this case, given the degree of financial interconnectedness, problems spread from the institution to its foreign branches and subsidiaries. The effect is stronger in countries whose domestic financial system is dominated by foreign banking groups. The second type of contagion risk materializes when the failure of an institution is transmitted to other institutions due to direct financial linkages between them, causing systemic risk (De Bandt and Hartmann, 2002). The latter spreads through two main channels: (a) the real or financial exposure ‘domino’ effect resulting from direct exposures in the interbank markets and/or the payment systems; and (b) the (asymmetric) information effect, which causes contagious cash withdrawals (bank runs) when depositors are imperfectly informed about the type and importance of shock hitting banks and the latter’s exposure to other banks. Thus, on the one hand, the failure of one or several financial institutions will cause a severe shock to the financial system as a whole because of mutual exposures. If the extent of cross-border interbank exposures is high, problems in a financial institution will not only cause internal problems, but also spread to otherwise sound financial institutions in other member states (Allen and Gale, 2000). On the other hand, imperfectly informed depositors will panic and engage in contagious cash withdrawals throughout the system. The effective management of the systemic consequences of uniformed depositors can benefit from distinguishing among three potential causes of

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systemic events related to asymmetric information and expectations (De Bandt and Hartmann, 2002). The first is the extent of revelation of new information to the public about the health of financial institutions; the second is the release of a ‘noisy signal’ to the public about the health of financial institutions; and the third is the release of a signal which coordinates the expectations of the public, but is not actually related to the health of institutions. Moreover, under the current EU arrangements, the impact of a financial shock is associated with inherent system externalities, the role of which can be understood by distinguishing between general liquidity and institution-specific effects (Goodhart, 2000; Schoenmaker, 2003). General liquidity effects can be mitigated by the ECB through the provision of liquidity in the market, without a specific need to obtain detailed national supervisory information on individual institutions. Institution-specific effects can be mitigated where national central banks obtain detailed information on the position of the respective institution (e.g. the availability of sufficient collateral) before granting emergency liquidity assistance. To contain the negative effects of contagion and externalities, more centralized coordination mechanisms must be explored. The ECB should assume a more ambitious role in crisis management. Central institutional authority is needed to implement measures necessary for the control of interbank exposures coupled with market discipline and prompt corrective action against failing financial institutions. The EU consensus, that private sector solutions are preferable whilst public sector solutions should be considered only when the social benefits (in terms of preventing a wider banking crisis) exceed the costs of a bailout, should also be carefully reconsidered.

5. European financial integration and the financial stability trilemma Despite contentions that public intervention may have adverse effects on incentives of market participants (moral hazard) and may lead to inflexible restrictions of financial institution activity, an unregulated financial system would be unstable and prone to systemic crises, requiring the intervention of a non-profit central bank that acts as the lender of last resort in times of crisis (Goodhart, 1988). Moreover, maintaining the momentum of financial integration in the EU and globally so as to reap its benefits, inter

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alia through the freedom of establishment, requires the continuous provision of financial services. But, to maintain direct control over systemically important operations of large, globally diversified financial institutions and interconnected markets through local control and ringfencing of operations conflicts with the need to preserve global reputation and the tendency of institutions to have centralized supervision of risk and capital at the group level and decentralized risk management within local business lines (Kuritzikes, Schuermann and Weiner, 2003). Finally, maintaining national direct control of domestic institutions and markets is today a fundamental element of national financial policies, state sovereignty perceptions, and pride. Under these circumstances, a financial stability trilemma exists in the EU, which says that the policy-makers cannot at the same time ensure the stability of the whole financial system, maintain the level of advanced financial integration, and have prudential supervision policy exercised at the national level (Thygesen, 2003; Schoenmaker, 2008). Following an external shock, national financial stability policies over cross-border financial institutions in the EU are inadequate to maintain financial stability at the EU level and globally. In the global level, while policy on monetary stability is commonly advanced by national central banks largely based on inflation targeting supported by well-developed forecasting models, policy on financial stability is less so. In the Eurozone, the ECB has made steps towards becoming the provider of liquidity to the financial system (general lender of last resort) in order to stabilize markets. But, even within the Eurozone, individual institution lender of last resort support and possible recapitalization are still in the realm of national central banks and finance ministers. At the EU level, the coordination problem becomes more severe, as the ECB policy mix must be coordinated with the policy mix of the non-Eurozone member state central banks. Overall, as cross-border integrating financial institutions and interconnected markets have emerged subject to national financial stability control, following an external shock, a stable EU-wide financial system cannot be maintained. The financial stability trilemma is related to the traditional monetary policy trilemma, which says that a fixed exchange rate, free mobility of capital, and independence in national monetary policy cannot be achieved at the same time (Mundell, 1963). However, the financial stability trilemma is more difficult to understand because of the lack of a clear and agreed definition of financial stability in relation to systemic risk (De Bandt and Hartmann, 2002; Goodhart, Sunirand and Tsomocos, 2006).

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Financial stability is closely related to systemic risk. There are several definitions of systemic risk (Group of Ten, 2001; De Bandt and Hartmann, 2002; ECB, 2006). However, all these definitions distinguish three dimensions of an interconnected financial system: institutions, markets, and infrastructures. This allows the analysis of each dimension separately, although in practice all dimensions are interconnected (e.g. the recent problems on the interbank market are related to worries about the liquidity and solvency of the financial institutions operating in that market). The definitions of financial stability effectively mean the capacity of financial markets to clear financial imbalances without major disruptions, and of financial institutions to provide financial services without major disruptions. Financial system integration is better understood by reference to the various market segments of the financial system: money markets, bond market, equity markets. In the EU, the degree of integration in money markets and bond markets is very high, the equity markets show clear signs of increasing, and in the interbank and capital market, related activities of financial institutions are also increasing, while retail banking activities remain fragmented (ECB, 2008b). Cross-border penetration of banking in the EU, defined as the assets of financial institutions from other EU member states as a percentage of the country’s total banking assets, has increased from 11 percent in 1995 to 19 percent in 2006, but very unevenly across the EU member states (De Haan, Oosterloo and Schoenmaker, 2009). Thus, financial institutions are also becoming more integrated within the EU. In particular, large, systemically important financial institutions have sizeable cross-border activities. Moreover, cross-border penetration of trade and post-trade infrastructures is documented. Several cross-border mergers among exchanges and link-ups among settlement depositories have taken place in Europe during the last few years as a result of competition and different business organization models (UK Competition Commission, 2005). A number of regional, global, and diversified trade and post-trade infrastructures have emerged, the operation of which is characterized by the following links: opportunistic mutual alliances, whether through cross-membership or trading volume development through the concentration of liquidity; electronic trading; increasing competition; and irrelevance of location (IFSE). They all contribute to the interconnection of trading and markets. Finally, the prime central bank instrument to manage a financial crisis is the provision of liquidity to the markets (general lender of last resort) and to individual institutions (individual lender of last resort). Public funds

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may also be needed to resolve a crisis. The prime ministry of finance instrument is the recapitalization of individual institutions in difficulties. In times of distress, there is an ex-post decision to be made whether to intervene and provide liquidity to gridlocked interbank markets (in addition to a decision for refinancing or liquidating a financial institution in financial distress). The choice to intervene or not depends on the costs and benefits of each action. The benefits include those associated with maintaining financial stability and avoiding market freeze and contagion. The direct costs are associated with moral hazard and bailout spending. In any case, private sector solutions are possible and the central bank can play the role of both a broker and a lender of last resort (general or individual). In a multi-country setting, interconnected interbank markets may be provided liquidity by different central banks and treasuries (e.g. in the EU29 there is the ECB and the central banks on the non-Eurozone countries). A sufficient contribution from the different central banks in times of distress may or may not be forthcoming (Freixas, 2003). Improvised cooperation applies, as different central banks and national treasuries have to meet to find out how much they are ready to contribute to the interconnected interbank market financing. If the overall amount they are willing to contribute is larger than the cost, market liquidity is enhanced, and vice versa. This game has multiple equilibria, in the sense that no individual central bank or national treasury is ready to finance the provision of liquidity to the market by itself, without guidance as to which equilibrium is chosen, since it depends on externalities falling outside the home central bank or treasury, which are therefore not accounted for. Assuming that the individual central bank or national treasury accruing the highest social benefits of liquidity provision is the home central bank or treasury, the latter may not be willing or prepared to cover the costs of market liquidity provision in its entirety. The problem becomes more severe for large markets operating under a small individual central bank or national treasury, where the ensuing fiscal cost is disproportionately high (Dermine, 2000). This means that when financial integration increases, nationally driven macro-prudential policy will not produce a stable financial system as a whole. Cross-border market difficulties will rise, even when it is optimal to provide liquidity to maintain financial stability. The required collective liquidity provision shows why improvised co-operation (ex-post negotiations) may lead to under-provision of necessary liquidity in times

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of distress. Collective decision-making by a group of individual central banks or national treasuries means that the provision of shared financial stability public goods may result in an equilibrium that is sub-optimal from a common market perspective, even though each individual central bank or national treasury views its own decision as optimal and has no incentive to change its resource allocation decision if other central banks or countries maintain theirs (Eatwell and Taylor, 2000; Schinasi, 2007; Goodhart and Schoenmaker, 2008). The incentive for co-ordination is strong when cross-border market activities are non-negligible (e.g. large mergers among national EU stock exchanges). The public good property of financial stability is illustrated by the following episodes. First, in the recent crisis, there were severe problems in the wholesale interbank markets. The ECB acted as a general lender of last resort, providing short-term funds to deficit financial institutions, and absorbing funds from surplus financial institutions, as well as providing liquidity through open market operations. The ECB’s policy was successful in stabilizing the euro-area interbank market. But markets were not stabilized at the EU-wide level. The ECB and the Bank of England followed different policies and did not coordinate. Fearful of overreliance on central bank funds by financial institutions (moral hazard), the Bank of England did not provide extra liquidity. The major UK retail financial institutions obtained liquidity through their affiliates in the euro-area, and did not experience funding problems. So these financial institutions could ‘free ride’ on the generous provision of liquidity by the ECB. But national UK financial institutions, like Northern Rock, had no access to the euroarea liquidity, and were left with the illiquid UK interbank market. Second, the 1987 US stock market crash showed the vulnerability of the trading infrastructure systems, as they were not capable of processing a sudden large increase in the volume of transactions. Uncertainty about information caused a withdrawal of investors from the market. Margin calls increased and market liquidity declined as securities traders drew down cash reserves to meet margin calls. The Federal Reserve intervened by providing liquidity support through massive open market operations and encouraging financial institutions to extend liquidity to securities traders. The extension of credit was key to traders’ ability to meet settlement obligations and continue operations (Brimmer, 1989). But, if a similar equity market crash were to occur in the EU, the ECB could step in to provide general liquidity support to Eurozone equity markets only. Unless, an ECB-consistent policy is followed by the UK central bank, given London’s position as a financial centre of Europe, as well as other non-Eurozone central banks, EU-wide financial stability might not be

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maintained. The financial stability trilemma could be overcome by implementing a closer coordination (common standards and procedures) among central banks and countries in a common market, and subsequently higher control - agreement for exercising policymaking, surveillance, and enforcement responsibilities by supranational policy-maker (Eatwell and Taylor, 2000).

6. The home versus host supervision conflict on a global scale It is widely shared that any effort to effectively maintain financial stability must be global. Global problems require global solutions brought about by global governance institutions, such as the Financial Stability Board (FSB). However, global policy-makers now cover a more diverse group of countries, economies, financial systems, and cultures, with a broader set of perspectives and starting points than before. The G-20 is more heterogeneous than the G7, and therefore any goal of achieving a single rulebook is a much more formidable task, since it requires both agreeing to a common approach to regulation, which is now complex and politically vested, and having national electorates willing to accept prescriptions determined by others (Persaud, 2010). This heterogeneity is associated with different views regarding financial stability strategy. On the one hand, US policy-makers and academics maintain a strong belief in the efficiency of markets, so the core problem highlighted by the crisis was that financial institutions had become too big to fail and that if they were smaller, they could have been allowed to fail without large taxpayer bail-outs. Financial institutions grew too big and complex as a result of their ability to convince the regulators that big is efficient. Thus, depending upon the measure of relative size used, the policy way forward is to limit the size of financial institutions, limit their business activities, and improve winding up rules. Big financial institutions are likely to face additional capital adequacy requirements, so the separation of riskier investment activities from lending and borrowing activities (Volker rule) is an obvious direction of reform. On the other hand, Europe is a strong advocate of counter-cyclical capital charges, since it believes that markets are myopic and crashes happen because markets get it wrong. So, reform in Europe is market-taming, involving banning speculation in certain economically sensitive products, such as commodities and credits, and limiting short selling. Asia holds a more diverse view, where the central idea is that it would be wrong to play too

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much with regulation. Since Basle II has been just implemented, it may be undesirable to move swiftly to Basle III. Thus, overall, the issue of whether efficient regulations should be based on global or local rules becomes important again, and the home-host divide of regulatory/supervisory authority takes on a new significance. It seems that the goal of global regulation would rather be to foster institutions that help integrate diversity, than impose a one-size-fits-all approach. This challenge is more powerful in common currency/market areas, such as the European Union. The rationale for a common global rulebook rests on the following arguments. First, to avoid reduction of capital inflows, it is better that big global financial institutions open up local branches and not separate subsidiaries in each country with separate capital and assets. Secondly, to minimize regulatory arbitrage, it is better to have common rules. Thirdly, to maintain a consistent view of enterprise-wide risk, it is better to assign financial institution supervision in the home country, which knows the mother enterprise. Fourth, to avoid financial protectionism and encourage foreign penetration of domestic markets (and thus market integration), it is better to align or scrap host country regulations. Fifth, to minimize the inadequacy of local supervisory experience, it is better to have financial activities of a large financial institution in a small country regulated by able and sophisticated regulators back home. Overall, setting up local subsidiaries with locally ring-fenced capital and assets is considerably more expensive and inefficient than having a single regulator with single reporting and accounting, and passing capital around the branches wherever it is needed most. Large global financial institutions campaigned for home country regulation and, within the general context of liberalization and globalization, succeeded in persuading regulators that this was a good idea. However persuasive these arguments for home country regulation may be, the recent crisis has cast doubt on their effectiveness from a financial stability perspective. Having common prudential rules across countries experiencing different phases of the boom-or-bust cycle creates perverse pressure on market incentives and capital flows. In boom countries, common capital adequacy levels are too low relative to the apparent profit opportunities, and increasing lending appears more profitable when it should appear more risky. In recessive countries, common capital adequacy requirements make lending unprofitable relative to other countries, thereby reducing lending where it would be safe in the long-run.

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Thus, rulebook homogeneity on a global scale will rather exacerbate financial instability. One-size-fits-all capital adequacy requirements are pro-cyclical (Brunnermeier et al., 2009). The policy question from a financial stability perspective is when lending mistakes are made in the boom precipitating an asset price bubble, which follows different stages and intensity in different countries, who is best placed to detect that and appropriately respond? The host- or the home-country supervisor? If financial institutions in country A are financing a property bubble in country B, is the country B regulator better placed to respond, or is the country A regulator better able to weigh up what the right amount of aggregate lending should be in country B? Moreover, what happens if country A, for competitive reasons, practices domestic “light touch” application of global rules, which it now irrationally applies, as a home supervisor, to country B? Similar concerns carry over, mutatis mutandis, to markets. Markets may be thought of as being more or less opaque and complex, affecting in different degrees the interaction between liquidity and default. The changing market conditions and the direction and extent of market supervision will affect the identification of a financial institution as systemically important or not, thereby causing regulatory arbitrage and risk shifting. It is a matter of further investigation whether the well-known dictum: “banks are global in life but national in death” can be extended to markets too. From a global financial stability perspective, the regulatory emphasis should shift from the host- vs. home-country supervisory authority distinction to facilitating the free flow of information so as to support the national (rather than global) monitoring of globally systemic developments, analyzing this information to provide lessons of good and bad practice, and potentially assessing performance vs. certain global standards; policing undesirable financial protectionism through global peer review of domestic action; aligning regulation of cross-border market infrastructure (commodities, forex, derivatives); and promoting a convergence of principles and a consolidation of instruments that would maintain local control but also enhance transparency and predictability in regulation that would support competitive cross-border activity (Persaud, 2010).

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In the EU specifically, national taxpayers are called to support a single financial market operating under a (almost) single rulebook. Taxpayers remain national, but European politicians want to enshrine a single financial space. The EU strives to behave like a single host member state regulator, with a single systemic risk council (ESRB) and a collective body of regulations with a stronger convergence of principle and instruments across member states than otherwise. The battle lines are drawn between those who want more Europe and those who want less, driven by politics, or nationalism, or other reasons. Perversely, in this situation, the “less Europe” option would actually do more to underpin the single European currency (by forcing heterogeneous rules) than the “more Europe” option. At the absence of a sufficiently large and flexible central fiscal authority in the EU that could make the necessary offsetting adjustments, any benefits of the common currency will be far outweighed by the costs (in the form of bubbles and crashes) that would arise from the differential adverse impact on credit expansion of different real interest rates among the member states. In this context, an additional policy instrument that operates at the national level would strengthen the integrity of the common currency. But this greater national independence is automatically seen as implying less integration. So, financial integration means more homogeneity of rules, which may cause perverse policy reaction by national member states at different phases of the business cycle, thereby intensifying financial instability.

7. Global portfolio diversification versus domestic financial deepening Global financial market liberalization and integration has led global capital markets in a race. On the one hand, younger and smaller capital markets are widening and deepening in order to improve domestic financial intermediation. On the other, global investors in developed markets are diversifying their portfolios in order to boost competitive returns and spread risk. As a result, the absorptive capacity of high-return, capitalimporting countries is being confronted with the distributive capacity of low-return, capital-exporting countries. Any mismatch between the rate at which global flows of capital are distributed and absorbed may spill over globally. The mismatch problem may become more severe over time, as either capital market deepening in capital-importing markets, or capital diversification in capital-exporting economies may gain the upper hand in the race (most likely the latter). The implications of this dynamic for global financial stability are potentially very important. Reducing these

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spillovers and containing their cumulative dynamic is a serious concern for global financial stability policy (Haldane, 2011). If capital markets operated efficiently, these global portfolio flows need not cause persistent fluctuations in capital-importing countries’ credit and asset markets, and asset market spillovers would not persist. Thus, substantial portfolio diversification by capital-exporting country investors risks causing ever greater fluctuations for capital-importing countries. The mismatch may be more intense within common currency areas (e.g. the Eurozone, with weaker and stronger member states), where the cost of capital flows is lower and their speed is higher. That may provide fresh ground for the debate on appropriate policy on capital liberalization and capital restrictions within both common currency areas and globally. In the last decade, gross portfolio equity inflows to capital-importing countries has surged as investors in search for yield moved out of slow growth capital-exporting countries into high growth capital-importing countries. Gross equity inflows to some capital-importing countries were too large relative to domestic market capitalization, and the resulting indigestion problem caused ballooning behavior in those markets’ asset prices (Reinhart and Rogoff, 2008). The higher the size and speed of capital inflows into capital-importing countries, the larger the size and speed of asset price crash in those countries, from a sudden reversal of these inflows (IMF, 2011). To the extent that global portfolio reallocation by capital-exporting countries outpaced the growth in financial deepening of capital-importing countries, large and mounting financial fluctuations resulted, which prompted some capital-importing countries to introduce protective capital flow restrictions and macro-prudential policies. Despite rising significantly in absolute terms, financial globalization has not closed the gap between capital-exporting and capital-importing countries and, moreover, has raised new challenges. It is known that global investment portfolios exhibit a severe home-bias puzzle, in the sense that selected portfolio compositions are much more heavily skewed towards home market securities than would be implied by conventional asset pricing models (French and Poterba, 1991; Forbes, 2010). However, observed aggregate patterns reveal two important new trends that add to the home bias puzzle. The first is a private-sector portfolio allocation from capital exporting to capital importing countries, which has reduced “homebias” for their portfolio securities. The second is the accumulation of official foreign exchange reserves by capital-importing countries, in particular since 2005 (estimated at $10 trillion by end-2010), which caused

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a reverse capital outflow from capital importing to capital exporting countries, thus exhibiting instead a “foreign bias” for debt securities (Prasad, Rajan and Subramanian, 2007) and real estate. From a global financial stability policy perspective, the main concern is the future course of the mismatch between the rate at which global flows of capital are distributed and absorbed. This course is far from straightforward, and depends on economic development in both capitalexporting and capital-importing countries. The impact of this capital-flow mismatch, in turn, is the outcome of two factors: first, the extent of homebias of global portfolio diversification, grounded on legal restrictions (including capital controls and weak property rights) and information asymmetries between home and host countries (Gehrig, 1993); and, second, the intensity of the positive, two-way relationship between financial deepening and economic growth (Levine, 2005). The strength and complex interaction of these two forces determine global capital flows, which are associated with three different patterns: first, a tendency towards increased diversification among capital-exporting country investors, causing a capital outflow substitution effect; second, a similar tendency among capital-importing country investors, but from a higher base, causing a countervailing capital outflow substitution effect; and, third, a change in the composition of the global market portfolio as capitalimporting countries account for a larger slice of the pie – a capital flow income effect. By combining these three counteracting forces, the emerging pattern of global capital flows and therefore the potential mismatch could be approximated, along with its implications for financial stability policy, within common currency areas and globally. The dynamic of global capital flows and the associated mismatch problem is real and increasing, creating favorable conditions for financial instability (Haldane, 2011). This may result in rising difficulties of some capitalimporting countries (within common currency areas and globally) to cope with the requirements of a balanced current account, or lead to a stall in alleviating the mismatch problem, or even getting off the cart. More than just the future stability of the global financial system is at risk. The problem raises serious macro-prudential coordination policy issues that would be unthinkable just a few years ago. These questions may be particularly important for large, converging, but still politically and structurally diversified, common markets (EU-27), and even more homogeneous common currency areas (Eurozone).

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The following questions need to be answered. First, should capital restrictions by capital-importing countries be allowed as a last resort, once conventional macroeconomic policies are exhausted? How should capital flows be coordinated so as to play a supporting role in all seasons in averting excessive capital surges and counteracting fluctuations in financial activity? In the EU specifically, can such policies be implemented in light of the current host vs. home market supervision and other common rulebook policies currently in effect? Second, are capital flow restrictions better conceived as a temporary or permanent measure? While temporary measures might better reflect the need to respond with exceptional interventions only in exceptional circumstances, establishing capital restrictions within a pre-agreed framework might improve the credibility and predictability of these measures among global investors. Third, should all capital flows (foreign direct investment vs. portfolio flows vs. banking flows) be prudentially treated in the same manner, given that different sources and types of capital behave differently during capital upswings and downturns (IMF, 2011)? Fourth, what might be the precise scope and roles of capital restrictions and macro-prudential policy, and how can the two be effectively reconciled given divergent views on their significance and usefulness? Fifth, with a view to enhancing effective financial intermediation in capital-importing countries, what are the respective scope and roles of capital restrictions and financial market deepening as responses to the mismatch problem? Should the intervention focus on transparency or market infrastructure, so as to reduce market frictions and therefore contain the potential asset market spillover costs of the mismatch problem, or would this make things worse by intensifying homogeneity in behavior? Finally, what supranational policy-makers should be provided to tackle the mismatch problem? This raises a set of key questions about global financial governance (Eatwell and Taylor, 2000; IMF, 2011). Are global financial network externalities sufficiently large to justify global imposition of rule? And how much driver discretion should instead be left to national states that ultimately may bear the costs of the mismatch problem? These questions clearly highlight the role of coordinated action on a global scale.

8. Financial stability and collective action: problems and intervention National policy-makers find it harder to jointly implement globally effective macro-prudential actions aimed at global financial stability, while mitigating costs and distortions to efficient financial intermediation

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at home. In a globally interconnected world, macro-prudential policy effectiveness is complicated by collective action problems that arise when policy is conducted at the national level, but financial activity occurs, and risk materializes, at the global level. This may cause either too much or too little, premature or delayed, macro-prudential action, resulting in either undue economic contraction or the reinforcement of conflicts and biases at the national level. In a globally interconnected world, collective action problems are likely to remain pervasive, and strong mechanisms will be needed to counter these problems. These problems can assume the following forms requiring collective action (Vinals and Nier, 2014): imposition of substantial cross-border trade and finance costs due to externalities; perverse contraction and expansion of cross-border credit; migration of financial activity and race-to-the-bottom implications; complex group structures can complicate risk assessment and effectiveness of risk mitigation for home and host supervisors; and inadequate recapitalization of ailing financial institutions. Each of these issues is briefly discussed below.

8.1. Trade and finance spillovers Inadequate or improper macro-prudential action in one country is associated with negative externalities in other countries, resulting in diminished opportunities for trade and contagious financial spillovers that may cause recession. In this case, there will overall be “too little” macroprudential action relative to the jointly welfare maximizing level (Gaspar and Shinasi, 2010). This global collective action problem compounds a deeper lack of action at the national level, where macro-prudential policy is subject to a strong bias favoring inaction, or insufficiently timely and forceful action as risks are building up (IMF, 2011). This requires the establishment of strong institutional frameworks across all relevant interconnected jurisdictions, so that the policy-makers are incentivized and enabled to take appropriate action. National macro-prudential frameworks need to specify clear objectives, accountability requirements, appropriate size and distribution of legal power, and the proper assignment of the macro-prudential mandate to those agencies that have the incentives to take action. Since the establishment of a global supervisory authority is not currently a feasible option, strong national macro-prudential mandates need to be subsequently implemented through IMF involvement, and the provision of advice on establishing appropriate institutional structures for macro-prudential policy through its surveillance of systemic risks, its Financial Sector Assessment Program (FSAP), and its technical assistance

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(e.g. IMF, 2012a). Further, the Basel Committee stepped up efforts to guide countries in monitoring excessive increases in the ratio of credit-toGDP and in introducing countercyclical capital buffers in response. The carrying out of in-depth assessment of systemic risks requires taking full account of macroeconomic imbalances and other trends that could have a bearing on systemic risks. The IMF’s surveillance of national macroprudential policies can strengthen national macro-prudential policy-makers in the face of opposition from the financial industry, and justify their intervention to take potentially unpopular risk mitigating action.

8.2. Business cycles and credit constraints During the business cycle over time, national macro-prudential policies to contain risk from a rapid build-up of domestic credit can be partly nullified by an increase in the share of credit provided across-borders through the activities of foreign global banks. This cross-border arbitrage can occur through direct lending by foreign global banks to domestic borrowers, domestic lending by foreign branches, as well as a rescheduling of loans, whereby credit is originated by subsidiaries, but then booked on the balance sheet of the parent institution. Such credit leakage effects can be substantial for both emerging and advanced countries. For instance, in the UK almost a third of the reduction in credit growth that could be achieved from increases in capital requirements on regulated banks is nullified by an increase in credit by foreign branches that are subject only to foreign home country regulatory requirements (Aiyar et al., 2012). Global leakage effects call for collective action in the form of reciprocity in the conduct of macro-prudential policy, so that all national policy-makers impose equivalent macro-prudential limitations on financial exposure to a given country. A lack of reciprocity weakens the effectiveness of macro-prudential policies for several reasons. First, the home country may not have yet established the equivalent macroprudential tools being applied by the host country. Second, for a home country, whose financial exposure to the host country’s financial system is only a small share of the total exposure at home, or when domestic credit and profits are subdued, there may be little urgency to impose limitations on cross-border financial exposure, even though such (relatively small) exposure may constitute a sizable share of the total credit provided in the host member state. There is a risk then that those countries that want to impose tighter macro-prudential policy, but whose efforts are nullified by increases in cross-border credit, will resort to the imposition of more distortive measures, such as the imposition of capital controls, to stop the

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inflow of credit. This collective action problem can only be dealt with through formal global mechanisms. The Basel Accord on reciprocity in the imposition of the Basel III countercyclical capital buffer is an important development. This accord stipulates that when the capital buffer is activated in a particular country, all participating countries must apply the same buffer to exposure into that particular country. However, the implementation effectiveness of reciprocity still remains untested (in the EU it is explicitly set at 2.5 per cent), and certainly more such global agreements are needed on the implementation of other macro-prudential policy tools, such as target increases in capital requirements on exposures to specific economic sectors. The recommendations issued by the European Systemic Risk Board (ESRB) that call for reciprocity across the European Union in the imposition of measures to address foreign exchange risks are important developments, but they are not binding.

8.3. Regulatory arbitrage and race to the bottom Cross-section macro-prudential policies to strengthen the resilience of systemically important financial institutions are subject to a race to the bottom among national policy-makers. The latter may want to increase the resilience of domestic systemically important institutions through the imposition of capital and liquidity buffers. However, domestic may respond by relocating their headquarters or parts of their financial activity into other countries, causing a reduction of employment and tax revenue for the domestic economy. This can lead to a race to the bottom in the application of macro-prudential policies among national policy-makers, as well as to greater concentration of risky activities in less strictly regulated jurisdictions (Acharya, 2003; Karolyi and Taboada, 2013). Indeed, the race to the bottom played a major role in driving financial deregulation in the period before the crisis, especially among the global financial centers, and contributed in drawing risk concentrations into lightly regulated jurisdictions, such as Iceland, Ireland, and Cyprus, each of which subsequently required global support. Similarly, this collective action problem can only be dealt with through formal global mechanisms. In this regard, an important recent advance has been the determination by the FSB of capital buffers for a set of global systemically important financial institutions. Further, the Basel Committee issued guidance for national policy-makers to assess capital surcharges for domestic systemically important banks in an attempt to achieve some degree of consistency in approach. Even so, such guidance leaves considerable room for national

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discretion in the application of a framework for dealing with risks from systemically important institutions and infrastructures.

8.4. Complex corporate groups and risk assessment Complex financial group structures pose additional difficulties in the assessment and mitigation of systemic risk. First, if a complex group maintains affiliates in many countries engaging in diverse financial activities, it is hard for any national policy-maker to fully assess the risks that are bundled within the group. Further, depending on the regulatory architecture between home and host countries, it is hard to decide on appropriate national policy-maker intervention to address these risks. Second, if a complex financial group maintains minimal activity in its home country headquarters and maximal activity through its systemically important affiliates in the host countries, the host countries’ supervisors will then fear that the macro-prudential limitations imposed on the group may not fully reflect the true systemic impact that a failure of the affiliates may have on them. This, in turn, could lead the host country supervisors to take action to ring-fence these affiliates, causing a potential loss of efficiency in the management of assets and liabilities for the group as a whole. Third, the transmission outcomes of macro-prudential action taken by the home country may have undesirable consequences for the host country. For instance, if the home country supervisor imposes capital or liquidity constraints on the group as a whole, the latter may be forced to implement excessive deleveraging of its affiliates in the host countries. This may be a particular problem in cases where the measures imposed by the home country are taken too late in the global financial cycle, so as deleveraging has already been going on in some host countries, as well as where the domestic affiliates of the foreign group make up a significant share of the total credit provision in the host countries. These problems are difficult to resolve and call for collective action through multilateral and regional mechanisms. Examples are the ESRB and the colleges of supervisors in the EU that can facilitate information exchange among regulatory policy-makers, and foster recognition and understanding of home-host interdependencies and adverse spillover effects. An additional example of an ad-hoc nature is the “Vienna initiative” that was set up to encourage cooperative solutions that helped avoid excessive deleveraging in central and eastern European countries in the wake of the global financial crisis. Further, global initiatives to enhance the resolution regime of ailing systemically important financial institutions can facilitate global

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financial stability globalization.

whilst

maintaining

the

benefits

of

financial

8.5. Recapitalization of distressed institutions Collective action challenges arise with respect not only to ex-ante containing financial instability, but also to ex-post resolving the resulting problems. The costs of resolving a financial crisis can be large in terms of national GDP. The resolution of banking failures can be either a private or a public sector solution. The use of public money is proclaimed only when the social benefits (in the form of preventing a wider banking crisis) exceed the costs of recapitalization via taxpayers’ money. In the European context, this is an especially important issue as the process of decisionmaking regarding recapitalization should take into consideration both national and cross-border externalities (Schoenmaker and Oosterloo 2005). In a multi-country setting, the costs of recapitalization can be shared between countries. However, ex-post negotiations on burden sharing can lead to an under-provision of recapitalization (Freixas, 2003). Countries have an incentive to understate their share of the problem in order to have a smaller share of the costs. In the EU arrangements, this leaves the largest country, typically the home member state, with the decision of whether to shoulder the recapitalization cost on its own or to let the financial institution fail and be liquidated. National policy-makers (central banks and finance ministries) have a mandate for financial stability in their national financial system. They may be reluctant to provide liquidity or solvency support for solving problems in other EU member states, and thus not take into account cross-border externalities caused by financial institutions under their jurisdiction (Schoenmaker and Oosterloo 2005). Financial problems occurring in one country can affect the health of the financial system in other countries, either when the institution itself fails, causing a collapse of its foreign affiliates, or when the failure of an institution is transmitted to other institutions because of explicit financial linkages between institutions. In either case, the credit capacity of both home and host member states may be constrained. Current EU national arrangements do not incorporate these cross-border externalities, and may therefore lead to a coordination failure in crisis management. Typically, before public money is considered, private-sector solutions are explored. When public solutions are considered, no individual member state seems ready to finance the recapitalization by itself. Obviously, if left to national discretion alone, the recapitalization policy is inefficient, as financial institutions will almost never be

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recapitalized. The fact that in most cases the financial institution is allowed to fail is explained by the fact that part of the externalities fall outside the home member state, and therefore they are undervalued. Although the home member state will have the highest social benefits of the recapitalization, it may not be prepared to meet the costs of recapitalizing a failing bank in its entirety. The problem becomes more severe for large banks in small member states. The cost relative to the fiscal budget may be too large for them, so the home member state simply cannot bear the full burden alone (Dermine, 2000). Thus, collective recapitalization (and financial stability) has a public-good dimension and therefore, in a multi-country setting, improvised cooperation (ex-post negotiations) will lead to under-provision of public goods - that is, to an insufficient level of recapitalization (Freixas, 2003; Schinasi, 2007). The provision of the shared financial stability public good results in an equilibrium that is suboptimal from an EU-wide perspective, even though each member state views its own decision as optimal and has no incentive to change its resource allocation decision if other member states maintain theirs. More specifically, countries choose a level of the public good that is inferior relative to the socially optimal level for European financial stability. To avoid an insufficient level of recapitalization, more centralized coordination mechanisms need to be established. While a global jurisdiction does not exist, the EU member states can extend the jurisdiction to a supranational European level in order to incorporate the social benefits in other member states in the decision-making. The key for solving the problem is the appropriate design of the sharing burden. The key needs to reflect the shared financial stability benefits. On the one hand, if financial stability is seen as a truly public good that affects all participating member states, then a European fund could be established to shoulder the burden of a recapitalization, in which all member states contribute according to their relative share. Alternatively, the ECB can issue bonds to set up a general fund and to use its seigniorage to finance the annual costs (interest payment and write-down) of the fund (Goodhart and Schoenmaker, 2006). This solution violates the bailout restrictions of the Maastricht Treaty and can only provide an intermediary solution. While a central bank can create unlimited amounts of liquidity, its capacity to absorb losses is limited to its capital. To give the ECB a credible role in rescue (individual lender of last resort or recapitalization), its capital needs to be explicitly underwritten by national governments. Instead, the EU could use its own bank, the European Investment Bank (EIB), to set up a recapitalization fund without ex-ante contributions, as long as revenues are nationally invested, since this would only raise the measured fiscal deficit,

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while changing nothing real. During a crisis, bonds are issued by the EIB to finance the recapitalization. This would cover the full nominal value needed for the rescue. The annual servicing costs of the bonds would be paid by the governments. First, interest on the outstanding bonds (flow) is paid out of the fund. Second, any loss on the bonds (stock) is also paid out of the fund. This is a sinking fund for the amortization of losses. Each participating country would pay into the fund, as and when needed. On the other hand, if financial stability is narrowly seen as a public good only in those member states where a failing institution is doing business, the burden of recapitalization can be financed directly by the involved member states, according to some key reflecting the spread of the business of the failing bank. The geographic segmentation of activities of global firms can be approximated by proper indicators, such as relative assets, income, and employees (Sullivan, 1994).

9. Conclusion In a globally integrated world, macro-prudential policy is subject to collective action problems. The manifestation of these problems is associated with considerable mismatches in the size, timing, and direction of macro-prudential policy exercised at the national level. In the EU these problems are associated with significant internal and cross-border externalities among member states, largely thanks to the flawed design in its current financial architecture. As a result, uncoordinated action results EU-wide and global financial stability as a public good are to be attained at sub-optimal levels. Collective action problems tend to exacerbate the deeper lack of action at the national level, that arises from uncertainty over the benefits of macro-prudential action, lobbying, and political pressure. Given these trends, a financial trilemma emerges which shows the impossibility of simultaneously achieving global financial integration and global financial stability, given national macro-prudential policies. Thus either countries throughout the globe, and particularly in common currency areas (e.g. Eurozone) or common markets (EU-29), choose to abide by their own national macro-prudential policies at the expense of global financial instability and retarded financial integration, or they have to participate in a collective action effort to tackle these problems simultaneously. However, if the goal is to be achieved, financial stability must be seen as a public good, thereby raising global awareness of its importance for national welfare. The large costs worldwide of mitigating past the recent financial crises must be viewed as a convincing reason for that. If the benefits of financial integration are to be developed and shared,

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countries must establish and strengthen cooperative mechanisms that effectively address collective action problems, so as to ensure global financial stability. Establishing strong national macro-prudential mandates is an important first step, providing national central banks and prudential supervisors with the incentives and tools to intervene to maintain financial stability. As a second step, national mandates need to be complemented and coordinated by global agreements and guidance by global standard setters, such as the FSB and the Basel Committee, and global surveillance of risks and national macro-prudential policy responses, to achieve the common public good. Deeper regional cooperation is also needed for regions that are highly integrated financially, such as the European Union. Developing adequate and effective collective action on a global scale is no small task. Formidable problems exist that need to be understood and tackled. But achieving global financial stability is a goal beyond reasonable doubt.

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Gehrig, T. (1993). “An Information Based Explanation of the Domestic Bias in International Equity Investment”, Scandinavian Journal of Economics, No 95(1), 97-109. Goodhart, C. A. E. (1988). The Evolution of Central Banks. Cambridge, MA: MIT Press. Goodhart, C. A. E. and Schoenmaker, D. (2008). “Fiscal Burden Sharing in Cross-Border Banking Crises”, International Journal of Central Banking, No 4, 141-165. Goodhart, C. A. E. and Tsomocos, D. (2009). “Liquidity, default and market regulation”, VoX Research, 12 November. Goodhart, C. A. E., Sunirand, P. and Tsomocos, D. (2006). “A Model to Analyze Financial Fragility”, Economic Theory, No 27, 107-142. Haldane, A. (2011a). “The Big Fish Small Pond problem”. Speech, Bank of England, April. —. (2011b). “The Race to Zero”. Speech, Bank of England, Speech, July. —. (2011c). “Global Imbalances in Retrospect and Prospect”. Speech, Bank of England, December. Issing, O. (2003). "Introductory statement”, ECB Workshop: Asset Prices and Monetary Policy, ECB, Frankfurt, December. Karolyi, G. A. and Taboada, A. G. (2013). "Regulatory arbitrage and cross-border bank acquisitions: is it really a race to the bottom?", Cornell University, mimeo. Kuritzikes, A., Schuermann, T. and Weiner, S. (2003). “Risk Management and Capital Adequacy in Financial Conglomerates”, In R. Herring and R. Litan (Eds) Brookings-Wharton Papers on Financial Services: 2003. Washington DC: Brookings Institution Mayes, D. and Vesala, J. (2000). “On the Problems of Home Country Control”, Current Politics and Economics of Europe, No 10, 1-26. Mundell, R. (1963). “Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates. Canadian Journal of Economics, No 29, 475-485. Nier, E. W. (2011). "Macroprudential policy - taxonomy and challenges", National Institute Economic Review, No. 216, April. Nier, E. W., Osioski, J., Jácome, L. I. and Madrid, P. (2011). "Institutional models for macroprudential policy", IMF, Staff Discussion Note, No. 11/18, and Working Paper, No. 11/250, Washington DC. Olson, M. (1965). The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge, MA: Harvard University Press. Persaud, A. (2010). “The locus of financial regulation: home versus host”, ADB Institute, mimeo.

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Prasad, E., Rajan, R. and Subramanian, A. (2007). “The Paradox of Capital”, Finance and Development, No 44, 1. Reinhart, C. M. and Rogoff, K. S. (2008). “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises”, NBER Working Paper No 13882. Schinasi, G. (2007). “Resolving EU Financial-Stability Challenges: Is a Decentralized Decision-Making Approach Efficient?”, Unpublished manuscript. Schoenmaker, D. (2005). “Central Banks and Financial Authorities in Europe: What Prospects?” In D. Masciandaro (Eds) The Handbook of Central Banking and Financial Authorities in Europe, Cheltenham: Edward Elgar. —. (2008). “The Trilemma of Financial Stability”, VU University Amsterdam, Working Paper, September. Schoenmaker, D. and Oosterloo, S. (2005). “Financial Supervision in an Integrating Europe: Measuring Cross-Border Externalities”, International Finance, No 8, 1-27. Schoenmaker, D. and Oosterloo, S. (2008). “Financial Supervision in Europe: A Proposal for a New Architecture”. In L. Jonung, C. Walkner and M. Watson (Eds) Building the Financial Foundations of the EuroExperiences and Challenges. London: Routledge. Sullivan, D. (1994). “Measuring the degree of internationalization of a firm”. Journal of International Business Studies, No 25 (2), 325-42 The Group of Ten, (2001). Consolidation in the Financial Sector. Bank for International Settlements. Basle. The International Monetary Fund, (2008). “Containing Systemic Risks and Restoring Financial Soundness”, Global Financial Stability Report, World Economic and Financial Surveys, April. —. (2011). "Macroprudential policy: an organizing framework", Washington, DC. —. (2013). "Key aspects of macroprudential policy", Washington DC. Thygesen, N. (2003). “Comments on The Political Economy of Financial Harmonisation in Europe'. In J. Kremers, D. Schoenmaker and P. Wierts (Eds) Financial Supervision in Europe, Cheltenham: Edward Elgar.

CHAPTER NINE “CHINESE WALLS” WITHIN THE EUROPEAN CENTRAL BANK AFTER THE ESTABLISHMENT OF THE SINGLE SUPERVISORY MECHANISM CHRISTOS V. GORTSOS1

This article analyses the provisions laid down in secondary EU law with regards to the creation of “Chinese walls” within the European Central Bank (ECB) after the establishment of the Single Supervisory Mechanism (SSM), in order to ensure that it carries its new specific supervisory tasks separately from its tasks relating to the definition and implementation of the single monetary policy and its other tasks. It is structured in three (3) sections: Section 1 provides an overview of the main features of the basic legal act governing the SSM, notably Council regulation (EU) no. 1024/2013, a classification of the ECB tasks, as currently in force, and the rationale underlying the adoption of the principle of separation between the ECB’s supervisory and other tasks. This is followed by section 2, which examines the general provisions of the regulatory framework governing the “Chinese walls” within the ECB. Finally, section 3 deals in particular with the mediation panel, which was established by virtue of Article 25 of the above-mentioned Council regulation. Keywords: ECB, SSM, SSMR, Chinese walls, separation of supervisory and monetary tasks, professional secrecy, ECB's Confidentiality Regime, ECB's mediation panel, reputational risk

1

Professor of Public Economic Law, Law School, National and Kapodistrian University of Athens. Contact: [email protected]

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1. General considerations 1.1 The main features of the SSM Regulation (a) Council Regulation (EU) No 1024/2013 “conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions” (SSMR) is the main legal source of the SSM, one of the three (3) main pillars of the European Banking Union (EBU).1 Taking into account that the political decision was to make use of the existing EU Treaties, the legal basis of the SSMR is Article 127(6) of the Treaty on the Functioning of the European Union (TFEU) - repeated in Article 25.2 of the Statute of the European System of Central Banks and of the ECB (the Statute) - which contains an enabling clause (known as the “sleeping beauty clause”).2 (b) The SSMR confers on the ECB specific tasks “concerning policies relating to the prudential supervision of credit institutions” (a phrase taken over verbatim from Article 127(6) TFEU) with a view to: x Contributing to the safety and soundness of credit institutions and the stability of the financial system3 within the EU and each member state, which is the main objective of the ECB under the SSMR, and x Preventing regulatory arbitrage, fully taking into account and caring for the unity and integrity of the internal market (a duty with which it was assigned) based on equal treatment of credit institutions (Article 1, first-subparagraph). This ECB objective is different from the primary objective of the European System of Central Banks (the ESCB) under the TFEU, i.e. maintaining price stability (TFEU, Article 127(1), first sentence, inter alia) (Smits, 1997, pp. 184-187, and Louis, 2009, pp. 150-151).4 This aspect is the main subject of this study, since the eventuality of conflicts of interest arising from the ECB concurrently pursuing these two objectives was the reason behind the introduction of “Chinese walls”, separating its monetary and supervisory functions in accordance with Article 25 SSMR.

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1.2 A classification of the ECB’s tasks In light of the above, as of 4 November 2014 the scope of the ECB’s tasks has been significantly broadened, since its tasks consist of the following (for a summary see Table 1 below): (a)

The first group comprises the ECB’s basic tasks set out in Article 127(2) TFEU (under the primary objective of pursuing the maintenance of price stability, carried out through the ESCB), i.e. the definition and implementation of the euro area monetary policy,5 the conduct of foreign-exchange operations consistent with the provisions of Article 219 TFEU, the holding and management of member states’ official foreign reserves, and the promotion of the smooth operation of payment systems (Smits, 1997, pp 193-202, Louis, 2009, pp 152-162, and Lastra and Louis, 2013, pp 79-81).

(b) The second group contains the other (non-basic) ECB tasks set out in the TFEU, such as: x The exclusive right to authorise the issue of banknotes denominated in euros according to Article 128(1) TFEU, and the approval of the volume of euro coins issued by member states (Article 128(2) TFEU), x The contribution to the smooth conduct of policies pursued by the (national) competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system according to Article 127(5) TFEU (Smits, 1997, pp. 338355), and x The collection of statistical information according to Article 5 of the Statute (Smits, 1997, pp. 202-221, Louis, 2009, pp. 162-173, and Lastra and Louis, 2013, pp. 81-95). (c)

The third group consists of the specific tasks conferred on the ECB under Article 2 of Council Regulation (EU) No 1096/2010 (based on Article 127(6) TFEU as well). These tasks concern the macroprudential oversight of the EU financial system in the context of the functioning of the European Systemic Risk Board (ESRB) established by Regulation (EU) No 1092/2010 of the European Parliament and of the Council of 24 November 2010, which is one of the components of the European System of Financial Supervision (the ESFS) (Tridimas, 2011, pp. 801-803, Gortsos, 2011, and Thiele, 2014, pp. 494-519).

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(d) Finally, the fourth group comprises the specific tasks conferred on the ECB under the SSMR concerning micro-prudential supervision, within the SSM, of certain types of financial firms, and predominantly credit institutions. On the contrary, the ECB is not a lender of last resort, even within the euro area, since emergency liquidity assistance (ELA) is provided, according to the ECB governing council, by the national central banks of the member states whose currency is the euro (Gortsos, 2015b). TABLE 1 The current tasks conferred upon the ECB Implementation in Category of ECB tasks

Legal basis

euro area member states

member states with a derogation

Art. 127(2) TFEU

Yes

No

x Issue of euro banknotes

Art.128(1) TFEU

Yes

No

x Contribution to the smooth conduct of policies pursued by the (national) competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system

Art.127(5) TFEU

No

No

1. Basic tasks x Definition and implementation of the euro area’s monetary policy x Conduct of foreign exchange operations consistent with the provisions of Article 219 TFEU x Holding and management of member states’ official foreign reserves x Promotion of the smooth operation of payment systems 2. Other tasks, e.g.:

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x Collection of statistical information Statute, Article 5 Yes

Yes

3. Specific tasks on the macroprudential oversight of the EU financial system

Council Regulation (EU) No 1096/2010 (based on Art. 127(6) TFEU)

Yes

Yes

4. Specific tasks on the microprudential supervision over credit institutions, financial holding companies, and mixed financial holding companies

Council Regulation (EU) No 1024/2013 (based on Art. 127(6) TFEU)

Yes

Under the conditions of the “close cooperation” procedure

1.3 The rationale for the creation of “Chinese walls” (a) Although the safeguarding of financial stability has historically been a major objective of central banks and the micro-prudential supervision over credit institutions a main task of several thereof, an ever increasing number of countries around the world have assigned this supervision since the 1980s to independent authorities other than the central bank (Herring and Carmassi, 2008, Central Bank Governance Group, 2011).6 The rationale behind this development was that the exercise of supervisory powers by the central bank might give rise to conflicts of interest that would undermine the efficient achievement of its monetary policy objectives (not least in terms of maintaining price stability).7 (b) However, this trend has tended to be reversed in the aftermath of the recent (2007-2009) international financial crisis as a result of the relevant failures attributed to independent supervisory authorities in many states all over the world (Davies and Green, 2010, pp. 187-213). In addition to the Bank of England, since 1 April 2013,8 the ECB has now become another striking example of this trend. Nevertheless, the creation of “Chinese walls” within the central bank is an essential element to ensure the adequate separation of its monetary policy and other tasks from its (new) supervisory tasks.

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2. The regulatory framework governing the “Chinese walls” within the ECB: general provisions 2.1 The provisions of the SSM Regulation 2.1.1 The rules (a) The principle of separation of monetary policy and micro-prudential supervisory tasks of the ECB (due to the difference of their objectives as already mentioned), by creating “Chinese walls” within it, is established in recital 65 SSMR. It reads as follows: The ECB is responsible for carrying out monetary policy functions with a view to maintaining price stability in accordance with Article 127(1) TFEU. The exercise of supervisory tasks has the objective of protecting the safety and soundness of credit institutions and the stability of the financial system. They should therefore be carried out in full separation, in order to avoid conflicts of interests, and to ensure that each function is exercised in accordance with the applicable objectives. The ECB should be able to ensure that the governing council operates in a completely differentiated manner as regards monetary and supervisory functions. Such differentiation should at least include strictly separated meetings and agendas.

(b) In this respect, Article 25 SSMR lays down the following two (2) rules: (ba) When carrying out the specific supervisory tasks conferred upon it by the SSM Regulation, the ECB must “pursue exclusively the objectives set therein” in accordance with Article 1 (first subparagraph). (bb) The ECB must also carry out these tasks “separately” from both its tasks relating to the definition and implementation of the single monetary policy (in accordance with Article 127(2), first indent TFEU) and its other tasks. In particular: (i) The specific supervisory tasks should neither interfere with, nor be determined by, its tasks relating to monetary policy. They should also not interfere with its tasks in relation to the ESRB, or any other tasks. For the sake of accountability, the ECB must report to the European Parliament and to the Council with regard to its compliance with this provision.

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(ii) The tasks should not alter the on-going monitoring of the solvency of its monetary policy counterparties (European Central Bank, 2011, pp. 96-97). (iii) Finally, the staff involved in carrying out these tasks must be organisationally separate from, and subject to, separate reporting lines from the staff involved in carrying out other tasks conferred on the ECB. Recital 66 states on this: Organisational separation of staff should concern all services needed for independent monetary policy purposes, and should ensure that the exercise of the tasks conferred by this Regulation is fully subject to democratic accountability and oversight as provided for by this Regulation. The staff involved in carrying out the tasks conferred on the ECB by this Regulation should report to the Chair of the supervisory board.

(c) It is also worth mentioning that Article 3 of the Code of Conduct for the members of the supervisory board on “separation from the monetary policy function” provides that members of the supervisory board and other participants in its meetings must respect the separation of the ECB’s specific tasks concerning policies relating to micro-prudential supervision from its tasks relating to monetary policy, as well as other tasks, and comply with internal ECB rules on this separation adopted pursuant to Article 25(3) SSMR. In the performance of their tasks, these persons must take into account the objectives set by the SSMR, and not interfere with other ECB tasks (Gortsos, 2015a, pp. 252-254). 2.1.2 Compliance with the rules In order to comply with these two rules, the ECB was required to adopt and make public any necessary internal rules, including rules regarding professional secrecy and information exchanges between the two functional areas (SSMR, Article 25(3)). The relevant rules are set out in the ECB Decision 2014/723/EU of 17 September 2014 “on the implementation of separation between the monetary and supervision functions of the European Central Bank” (ECB/2014/39, pp 57-62) In addition, it should establish a “mediation panel” (SSRM, Article 25(5), first sentence). The ECB should also ensure that the operation of the governing council is completely differentiated as regards monetary and supervisory functions (including strictly separated meetings and agendas) (SSRM, Article 25(4)).

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In this respect, Article 13l, paragraphs 1-4, of the ECB Rules of Procedure provides for the following: (a) The governing council meetings regarding the supervisory tasks must take place separately from the regular governing council meetings and have separate agendas. (b) On a proposal from the supervisory board, the executive board must draw up a provisional agenda and send it, together with the relevant documents prepared by the supervisory board, to the members of the governing council and other authorised participants at least eight (8) days before the relevant meeting. In cases of emergency the executive board must act appropriately having regard to the circumstances. (c) The governing council must consult with the governors of the national central banks of the non-area participating member states before objecting to any draft decision prepared by the supervisory board that is addressed to the national competent authorities in respect of credit institutions established in such member states. The same applies where the concerned national competent authorities inform the governing council of their reasoned disagreement with such a draft decision of the supervisory board. (d) Finally, in principle, the general provisions pertaining to governing council meetings laid down in Articles 2-5a of the ECB Rules of Procedure apply also to governing council meetings as far as ECB’s supervisory tasks are concerned.

2.2 The provisions of the ECB Decision 2014/723/EU on the implementation of separation between the monetary and supervision functions 2.2.1 General aspects of the ECB Decision The ECB Decision 2014/723/EU “on the implementation of separation between the monetary and supervision functions of the European Central Bank” (ECB/2014/39) was adopted on 17 September 2014 by virtue of Article 25(1)-(3) SSMR, and entered into force on 18 October 2014 (ECB Decision 2014/723/EU, Article 9). It sets out the arrangements complying with the requirement to separate the ECB’s monetary policy function from its supervisory function (together referred to as “the policy functions”), in particular with respect to professional secrecy and the exchange of information between the two policy functions (ECB Decision 2014/723/EU, Article 1 (1)). Moreover, Article 1 states that the ECB’s

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specific supervisory tasks and the on-going monitoring of the financial soundness and solvency of the Euro-system’s monetary policy counterparties must be articulated in a way that does not lead to distorting the finality of either of these functions (ECB Decision 2014/723/EU, Article 1 (2) fourth sentence).9 2.2.2 Organisational separation The organisational separation of monetary policy and supervisory functions is based on four rules laid down in Article 3 of the ECB Decision 2014/723/EU: (a) The ECB must maintain autonomous decision-making procedures for its monetary policy and supervisory functions. (b) All work units of the ECB must be placed under the managing direction of the executive board, whose competence in respect of the ECB’s internal structure and the staff of the ECB must encompass the supervisory tasks. (c) ECB staff involved in carrying out supervisory tasks must be organisationally separated from the staff involved in carrying out other tasks conferred on the ECB. This staff must report to the executive board in respect of organisational, human resources, and administrative issues, but must be subject to functional reporting to the chair and the vice chair of the supervisory board. (d) Exceptionally, the ECB may establish shared services providing support to the monetary policy and the supervisory function in order to ensure that the exercise of these support functions is not duplicated. Such services must not be subject to Article 6 as regards any information exchanges by them with the relevant policy functions. 2.2.3 Professional secrecy Professional secrecy is governed by Article 4 of this ECB decision, providing for the following rules, which do not prevent the ECB’s supervisory function from exchanging information with other EU or national authorities in line with applicable EU law: (a) Members of the supervisory board, the steering committee and any substructures established by the supervisory board, ECB staff, and staff seconded by participating member states carrying out supervisory duties, are required not to disclose any information

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covered by the obligation of professional secrecy, and are subject to the “ECB’s confidentiality regime”, even after their duties have ceased.10 The annex of the decision contains an excerpt from this confidentiality regime, which provides the following: (i) All documents created by the ECB must be assigned one of the five security classifications listed in Table 2 below. (ii) Documents received from parties outside the ECB are to be handled in accordance with the classification label on the document. If that document does not have a classification label, or the classification is assessed by the recipient as being too low, the document must be relabelled, with an appropriate ECB classification level clearly indicated at least on the first page. The classification should only be downgraded with the written permission of the originating organisation. TABLE 2 Security classifications of ECB documents ECB-SECRET

Access within the ECB limited to those with a strict “need to know”, approved by an ECB senior manager of the originating business area, or above.

ECB-CONFIDENTIAL

Access within the ECB limited to those with a “need to know” broad enough to enable staff to access information relevant to their tasks and take over tasks from colleagues with minimal delay.

ECB-RESTRICTED

Can be made accessible to ECB staff and, if appropriate, ESCB staff with a legitimate interest.

ECB-UNRESTRICTED

Can be made accessible to all ECB staff and, if appropriate, ESCB staff.

ECB-PUBLIC

Authorised to be made available to the general public.

(b) In addition, persons having access to data covered by EU legislation imposing an obligation of secrecy must also be subject to such legislation. The ECB must subject individuals providing any service (directly or indirectly, permanently or occasionally) related to the

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discharge of supervisory duties to equivalent professional secrecy requirements by means of contractual arrangements. (c) Applicable to the above-mentioned persons are the rules on professional secrecy contained in Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on “Access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms (...)” (the CRD IV). In particular, confidential information received in the course of their duties may be disclosed only in summary or aggregate form, in such a way that individual credit institutions cannot be identified, without prejudice to cases covered by criminal law. Nevertheless, if a credit institution has been declared insolvent or is being compulsorily wound up, confidential information not concerning third parties involved in attempts to rescue it may be disclosed, but only in civil or commercial proceedings. 2.2.4 Access to information between policy functions and classification (a) Article 5 lays down the following general principles for access to information between policy functions and classification. In particular (ECB Decision 2014/723/EU, Article 5(1)-(2)): (i) Information may be exchanged between the policy functions only if this is permitted under relevant EU law and notwithstanding Article 4 on professional secrecy. (ii) Information, except “raw data”11 which must be classified separately, must be classified in accordance with the ECB’s confidentiality regime by the ECB policy function owning the information. (iii) The exchange of confidential information between the two policy functions must be subject to the governance and procedural rules set out for this purpose, and a “need to know” requirement,12 to be demonstrated by the requesting ECB policy function. (b) Unless otherwise stated in the ECB Decision 2014/723/EU, access to confidential information by the supervisory or monetary policy function from the respective other policy function must be determined by the ECB policy function owning the information in accordance with the ECB’s confidentiality regime. In case of conflict between the two ECB policy functions, this access must be determined by the executive board, in compliance with the principle of separation. Consistency of decisions on

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access rights and adequate recording of such decisions must be ensured (ECB Decision 2014/723/EU, Article 5(3)). 2.2.5 Exchange of confidential information (a) Article 6 (ECB Decision 2014/723/EU) deals with the exchange of confidential information between the two policy functions.13 The rules adopted in this respect are the following: (i) The ECB’s policy functions must disclose confidential information in the form of non-anonymised common reporting (COREP) and financial reporting (FINREP) data,14 as well as other raw data to the respective other ECB policy functions upon request on a “need-toknow basis”, subject to executive board approval. The ECB’s supervisory function must disclose confidential information in the form of anonymised COREP and FINREP data to the monetary policy function upon request on a need-to-know basis (in both cases under reservation of other EU law provisions). (ii) The ECB’s policy functions must not disclose confidential information containing assessments or policy recommendations to the respective other policy function, except upon request on a needto-know basis, and ensuring that each policy function is exercised in accordance with the applicable objectives, and where such disclosure has been expressly authorised by the executive board. On the other hand, they may disclose confidential aggregated information containing neither individual banking information nor policy-sensitive information related to the preparation of decisions to the respective other policy function upon request on a need to know basis, and ensuring that each policy function is exercised under the applicable objectives. (iii) Analysis of any received confidential information must be conducted autonomously by the receiving policy function in accordance with its objective, and any subsequent decision must be taken solely on this basis. (b) According to Article 7 (ECB Decision 2014/723/EU), the exchange of information involving personal data must be subject to applicable EU law on the protection of individuals with regard to the processing of personal data and on the free movement of such data.

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(c) Finally, Article 8 (ECB Decision 2014/723/EU) provides that, notwithstanding Article 6, in an emergency situation as defined in Article 114 CRD IV,15 an ECB policy function must communicate, without delay, confidential information to the respective other policy function, if that information is relevant for the exercise of its tasks in respect of the particular emergency at hand.

3. In particular: the mediation panel 3.1 The provisions of the SSM Regulation The rationale for the creation of the mediation panel as one of the new bodies set up within the ECB is laid down in recital 73 SSMR: With a view to ensuring separation between monetary policy and supervisory tasks, the ECB should be required to create a mediation panel. The setting up of the panel, and in particular its composition, should ensure that it resolves differences of views in a balanced way, in the interest of the Union as a whole.

According to Article 25(5) SSMR, the task of this panel is the resolution of differences of views on the part of national competent authorities of interested participating member states regarding an objection of the governing council to a draft decision by the supervisory board (SSMR, Article 25(5) second sentence). The ECB should adopt and make public a regulation setting up the mediation panel and its rules of procedure (SSMR, Article 25(5) fourth sentence). The relevant ECB Regulation (EU) No 673/2014 was adopted on 2 June 2014, entered into force on 20 June 2014 Procedure (SSMR, Article 25(5) third sentence, and ECB Regulation 673/2014, Article 13), supplements the ECB Rules of Procedure ECB Regulation 673/2014, Article 1, first sentence),16 and is presented just below.

3.2 The provisions of the ECB Regulation (EU) No 673/2014 3.2.1Membership and internal organisation As just mentioned, the mediation panel is composed of one member per participating member state (ECB Regulation 673/2014, Article 3(1)). Its chair is the vice-chair of the supervisory board, who is not a member in their own right (ECB Regulation 673/2014, Article 3(2), and recital 4). The members are appointed by each participating member state from

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among the members of the governing council and the supervisory board, the chair having to facilitate the achievement of an adequate balance. Their mandate expires when they cease to be members of the body from which they were appointed, and they must act in the interest of the EU as a whole (ECB Regulation 673/2014, Article 4). Specific rules govern meeting attendance, organisation, and voting arrangements (ECB Regulation 673/2014, Articles 5-7). 3.2.2 Mediation 3.2.2.1 Request for mediation (a) A mediation is kick-started when the national competent authority of a participating member state is concerned by and has different views regarding an objection by the governing council to a draft decision of the supervisory board (Gortsos, 2015a, pp. 240-254). Such an objection may be subject to mediation only once (ECB Regulation 673/2014, Article 8(3)). In such a case, the following procedure applies: (i) The national competent authority concerned must submit to the supervisory board’s secretariat a notice requesting mediation in order to resolve differences, with a view to ensuring separation between monetary policy and supervisory tasks. This notice must be submitted within five (5) working days from receipt of the reasoned objection by the governing council, identify that objection, and include a statement on the reasons for requesting mediation. The secretariat must notify the supervisory board members (ECB Regulation 673/2014, Article 8(1)). (ii) Any other national competent authority of a participating member state concerned by and having different views regarding the same objection may give a separate notice requesting mediation, or join an existing request for mediation, within five working days of the notification of the first request for mediation, and state that it has a different view (ECB Regulation 673/2014, Article 8(2)). (iii) The secretariat of the supervisory board must then file the notice requesting mediation with the secretariat of the governing council, within ten working days from receipt of the objection by the governing council, annexing to the notice both the relevant draft decision of the supervisory board, and the relevant objection by the governing council. The notice must also be communicated to the governing council and supervisory board members (ECB Regulation 673/2014, Article 8(5)).

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(b) The above provisions are without prejudice to the procedure according to which a non-euro area participating member state (which is not represented in the supervisory board) notifies the ECB of its reasoned disagreement with an objection of the governing council to a draft decision of the supervisory board under Article 7(7) SSMR (Gortsos, 2015a, pp. 189-190). In particular, if the competent authority of such a member state notifies the ECB of its reasoned disagreement pursuant to Article 7(7), it may not request mediation on the same objection (ECB Regulation 673/2014, Article 8(4), and ECB Rules of Procedure, Article 13g(4)). Vice versa, if such a competent authority has requested a mediation regarding an objection by the governing council and then notifies the ECB of its reasoned disagreement with the same objection according to Article 7(7), the request for mediation is deemed withdrawn (ECB Regulation 673/2014, Article 8(6)). Accordingly, the procedure under Article 7(7) prevails as lex specialis. 3.2.2.2 The Case Committee (a) Once a notice requesting mediation is filed with the secretariat of the governing council, the chair of the mediation panel must immediately forward it to its members. For each duly filed notice requesting mediation, the panel must set up a case committee within five working days of the filing, and inform the mediation panel members of its composition (ECB Regulation 673/2014, Article 9(1)-(2)). (b) The case committee is composed of the chair of the mediation panel acting as its chair, and four other members appointed by the mediation panel from among its members. The mediation panel must aim to achieve a balance between governing council and supervisory board members. The case committee may not include the member appointed by the participating member state whose competent authority has expressed different views pursuant to Article 8(1) of the ECB Regulation (EU) No 673/2014, or the member appointed by the participating member state whose competent authority has joined an existing request for mediation under Article 8(2) thereof (ECB Regulation 673/2014, Article 9(3)). (c) Within fifteen working days from receipt by the mediation panel of the notice requesting mediation, the case committee must submit to the chair of the mediation panel a draft opinion, which will contain an analysis of whether the request for mediation is admissible and legally founded (ECB Regulation 673/2014, Article 9(4)).17 The chair must immediately submit

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this draft opinion to the mediation panel and call a meeting (ECB Regulation 673/2014, Article 9(5)). 3.2.2.3 Decision-making process After considering the draft opinion of the case committee, the mediation panel must submit its own opinion to the supervisory board and the governing council, in principle within twenty working days from receipt of the notice requesting mediation. This opinion, which must be in writing and be reasoned, is not binding either on the supervisory board or on the governing council (ECB Regulation 673/2014, Article 10).18 Upon submission of the mediation panel’s opinion, it is at the discretion of the supervisory board to submit a new draft decision to the governing council, in principle within ten working days from the submission (in urgent cases, the chair of the supervisory board may decide to shorten this period). A request for mediation concerning an objection by the governing council to a new draft decision is not admissible (ECB Regulation 673/2014, Article 11). 3.2.3 Confidentiality and professional secrecy Even though the mediation panels proceedings are confidential, the governing council may authorise the ECB President to make their outcome public. Documents drawn up or held by the mediation panel are ECB documents and must be classified and handled in accordance with Article 23.3 of the ECB Rules of Procedure, i.e. in accordance with the organisational rules regarding professional secrecy, as well as management and confidentiality of information (ECB Regulation 673/2014, Article 12).

Concluding remarks (a) Conferring supervisory competences over financial system participants to a monetary authority generally raises concerns of conflicts of interests. In the ECB case, it is calling into question its ability, as a monetary authority, to consistently pursue its primary objective of maintaining price stability. The provisions on the separation of monetary policy and banking supervision functions, as laid down in Article 25 SSMR and further specified in the ECB Decision 2014/723/EU and in the ECB Regulation (EU) No 673/2014, is a safeguard embedded into the new framework in order to avoid such conflicts and any ensuing potential reputational risk

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for the ECB. It remains, nevertheless, to be seen how well this separation will operate in practice.19 (b) One cannot preclude the (undesirable) eventuality of one or more significant credit institutions under the direct ECB supervision becoming insolvent in the first few years of the ECB’s term of office as supervisory authority, which might also be attributed to a deficient performance of its duties. In such a case, the ECB’s reliability as an efficient monetary authority would be strongly called into question (not only in terms of substance, but mainly from a political point of view), with all the negative consequences that this would entail for the sustainability of the euro area. This aspect of reputational risk is, of course, a visible risk for all central banks with statutory competence on micro-prudential supervision over credit institutions, and it is one of the main concerns with regard to the assignment of such competences to the latter. Ultimately, the onus of the efficient performance of the extensive range of tasks that have been conferred on the ECB will be on the ECB itself.

References Central Bank Governance Group 2011. Central Bank Governance and Financial Stability. Report, Bank for International Settlements, May Code of Conduct for the members of the supervisory board on separation from the monetary policy function, OJ C 93, Brussels 20.3.2015. Commission Implementing Regulation (EU) No 680/2014 of 16 April 2014 laying down implementing technical standards with regard to supervisory reporting of institutions according to Regulation (EU) No 575/2013 of the European Parliament and of the Council, OJ L 191/1, Brussels 28.6.2014. Council Regulation (EC) No 2533/98 of 23 November 1998 concerning the collection of statistical information by the European Central Bank, OJ L 318/8, Brussels 27.11.1998. —. No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions, OJ L 287/63, Brussels 29.10.2013. —. No 1096/2010 of 17 November 2010 conferring specific tasks upon the European Central bank concerning the functioning of the European Systemic Risk Board, OJ L 331/162, Brussels 15.12.2010 Davies, H. and D. Green 2010. Global Financial Regulation. The Essential Guide. Cambridge, UK - Malden, USA: Polity Press.

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Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 “on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, OJ L 176/338, Brussels 27.6.2013. ECB Decision 2014/257/EC (ECB Rules of Procedure) of 19 February 2004 adopting the Rules of Procedure of the European Central Bank (ECB/2004/2), OJ L 80/33, Brussels 18.3.2004. —. 2014/723/EU of 17 September 2014 on the implementation of separation between the monetary and supervision functions of the European Central Bank (ECB/2014/39), OJ L 300/57, Brussels 18.10.2014. ECB Regulation (EU) No 673/2014 of 2 June 2014 concerning the establishment of a mediation panel and its Rules of Procedure (ECB/2014/26), OJ L 179/72, Brussels 19.06.2014. European Central Bank 2011. The Monetary Policy of the ECB, European Central Bank, third edition, May. Gortsos, Ch.V. 2011. The European Banking Authority within the European System of Financial Supervision, ECEFIL Working Paper Series, No. 1, August, available at: http://www.ecefil.eu//UplFiles/wps/wps2011-1.pdf. —. 2015a. The Single Supervisory Mechanism (SSM): Legal aspects of the first pillar of the European Banking Union. Athens: Nomiki Bibliothiki - European Public Law Organisation (EPLO). —. 2015b. Last-resort lending to solvent credit institutionsin in the euro area: a detailed presentation of the Emergency Liquidity Assistance (ELA) mechanism, available at: http://ssrn.com/abstract=2688953. Herring, R.J. and J. Carmassi 2008. The Structure of Cross-Sector Financial Supervision. Financial Markets, Institutions & Instruments. Vol. 17, No. 1, February. Lastra, R.M. 2013. Banking Union and Single Market: Conflict or Companionship?. Fordham International Law Journal, Volume 36, pp. 1189-1223. Lastra, R.M. and J.V. Louis 2013. European Economic and Monetary Union: History, Trends, and Prospects. Yearbook of Economic Law, pp. 1-150. Louis, J.-V. 2009. L’Union européenne et sa monnaie, in Commentaire J. Megret, 3e édition, Institut d’ Etudes Européennes. Bruxelles: Editions de l’ Université de Bruxelles. Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European

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Deposit Insurance Scheme COM (2015) 586 final, Strasbourg, 24.11.2015. Regulation (EU) No 1092/2010 of the European Parliament and of the Council of 24 November 2010 on European Union macro-prudential oversight of the financial system and establishing a European Systemic Risk Board, OJ L 331/1, Brussels 15.12.2010, —. No 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010, OJ L 225/1, Brussels 30.7.2014. Schinasi, G. 2006. Safeguarding Financial Stability - Theory and Practice. Washington D.C.: International Monetary Fund. Smits, R. 1997. The European Central Bank - Institutional Aspects. The Hague: Kluwer Law International. Statute of the European System of Central Banks and of the ECB, Protocol (No 4) attached to the EU Treaties, OJ C 326, Brussels 26.10.2012, pp. 230-250. Thiele, A. 2014. Finanzaufsicht. Jus Publicum 229, Tübingen: Mohr Siebeck. Treaty on the Functioning of the European Union, OJ C 326, Brussels 26.10.2012, pp. 47-200. Tridimas, T. 2011. EU Financial Regulation: Federalization, Crisis Management, and Law Reform, in Craig, P. and G. de Búrca 2011, editors): The Evolution of EU Law. 2nd edition. Oxford - New York: Oxford University Press, pp. 783-804.

Further References Bank of England 2014. Financial Stability Report, June, available at: http://www.bankofengland.co.uk/publications/Pages/fsr/2014/fsr35.aspx. Bean, Ch., Broda, Ch., Ito, T. and R. Kroszner 2015. Low for Long? Causes and Consequences of Persistently Low Interest Rates. Geneva Reports on the World Economy, no. 17, International Center for Monetary and Banking Studies (ICMB). Beck, Th. and D. Gros 2013. Monetary Policy and Banking Supervision: Coordination Instead of Separation. CEPS Policy Brief No. 286, available at: http://ssrn.com/abstract=2189364. Binder, J.-H. and Ch. V. Gortsos 2015. Banking Union - Introduction and Materials. C.H. Beck - Hart - Nomos (forthcoming).

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Di Noia, C. and G. Di Giorgio 1999. Should Banking Supervision and Monetary Policy Tasks be Given to Different Agencies?. Universitat Pompeu Fabra, Economic Working Paper No. 411, available at: http://ssrn.com/abstract=193730. Eijffinger, S. and R. Nijskens 2012. Monetary Policy and Banking Supervision. European Parliament, Directorate General for Internal Policies, IP/A/ECON/NT/2012-06, available at: http://www.europarl.europa.eu/studies. Filipova, T. 2007. The Concept of Integrated Financial Supervision and Regulation of Financial Conglomerates in Germany and the United Kingdom. Nomos Verlag/ C.H.Beck. Gianviti, F. 2010. The Objectives of Central Banks, in Giovanoli, M. and D. Devos (2010, editors): International Monetary and Financial Law: The Global Crisis. Oxford - New York: Oxford University Press, Chapter 22, pp. 449-483 Goodhart, C.A.E. 2000. The Organizational Structure of Banking Supervision. Financial Stability Institute, Occasional Paper No 1, October, available at: www.bis.org/fsi/fsipapers.htm. Goodhart, C.A.E. and D. Schoenmaker 1993. Institutional Separation between Supervisory and Monetary Agencies, in Goodhart, C.A.E. (1993, editor): The Central Bank and the Financial System. London: Macmillan Press. Group of Thirty 2008. ȉhe Structure of Financial Supervision – Approaches and Challenges in a Global Marketplace. Washington, D.C.: Group of Thirty. Hadjiemmanuil, Ch. 2004. Institutional Structure of Financial Regulation, A Trend towards “Megaregulators”?, in: Yearbook of International Financial and Economic Law, p. 127-190. Haubrich, J. 1996. Combining Bank Supervision and Monetary Policy. Economic Commentary, no. 11. Seelig, S. and Al. Novoa 2009. Governance Practices at Financial Regulatory and Supervisory Agencies. IMF Working Paper WP/09/135, available at: http://www.imf. org/external/pubs/ft/wp/2009/wp09135.pdf. Wymeersch, Ed. 2006. The Structure of Financial Supervision in Europe. About Single, Twin Peaks and Multiple Financial Supervisors. Working Paper, available at: http://ssrn.com/abstract=946695.

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Notes 1

On the legal aspects on the EBU and the SSM see Gortsos (2015a), with extensive further references. All legal acts pertaining to the SSM (including those reference to which is made in this article), as well as to the Single Resolution Mechanism (SRM), which is the second main pillar of the EBU and is based on Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 “establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010”, are contained in Binder and Gortsos (2015). It is worth just mentioning that the progress in establishing the third EBU main pillar, a Single Deposit Insurance Scheme, has been very slow. It is only very recently, on 24 November 2015, that the Commission submitted a proposal for a Regulation of the European Parliament and of the Council “amending Regulation EU No 806/2014 in order to establish a European Deposit Insurance Scheme”. This scheme (the EDIS) is planned to be introduced gradually, in three stages, with the steady state envisaged for 2024. 2 For a detailed analysis of this Article, see Smits (1997), pp. 355-360, Louis (2009), pp. 166-168, and Lastra and Louis (2013), pp. 82-94. On the criticism for having used this TFEU provision as the legal basis for the SSMR has not escaped criticism see Lastra (2013), p. 1197. 3 The term ‘stability of the financial system’ is not defined either in the SSMR or in any other legal act constituting a source of EU banking (and in general financial) law. The author adopts hence, among the different definitions used, the one provided by Schinasi (2006), p. 82, according to which: Financial stability is a situation in which the financial system in capable of satisfactorily performing its three functions simultaneously [intermediation, direct financing through markets, and operation of financial infrastructures]. First, the financial system is efficiently and smoothly facilitating the intertemporal allocation of resources from savers to investors and the allocation of resources generally. Second forwardlooking financial risks are being assessed and priced reasonably accurately and are being relatively well managed. Third the financial system is in such condition that it can comfortably if not smoothly absorb financial and real economic surprises and shocks. 4 It is worth mentioning that reference to this primary objective is also made in Articles 119(2)-(3), 219(1)-(2), and 282(2) TFEU. 5 Article 127(2), first indent TFEU refers to the ‘monetary policy of the Union’. Since, however, the provisions of this paragraph apply only to the member states whose currency is the euro (ibid., Article 139(2), point (c)), the use of the term ‘monetary policy of the euro area’ would obviously be more accurate. 6 On the trend towards integrating sectoral financial supervisory authorities (for banking, capital markets and insurance/reinsurance) into a single body, see

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Hadjiemmanuil (2004), Wymeersch (2006) (specifically in Europe), Filipova (2007), Group of Thirty (2008), and Seelig and Novoa (2009). 7 For an overview of the debate on whether it is appropriate for a central bank, as a monetary authority, to also perform micro-prudential banking supervision tasks (‘separation of monetary and supervisory tasks of central banks’), see the seminal paper by Goodhart and Schoenmaker (1993), as well as Haubrich (1996), Di Noia and Di Giorgio (1999), Goodhart (2000), Gianviti (2010), pp. 480-482, Eijffinger and Nijskens (2012) and Beck and Gros (2013). 8 Under the UK Financial Services Act 2012, the Prudential Regulation Authority (PRA) was established as a subsidiary of the Bank of England, responsible for the micro-prudential supervision of banks, building societies and credit unions, insurers and major investment firms. In addition, the above Act established the Financial Conduct Authority as a conduct of business regulator. Finally, an independent Financial Policy Committee (FPC) was also established, entrusted with the objective of financial stability and macro-prudential financial oversight. On the most recent work of the PRA, see Bank of England (2014). Its publications are available at: http://www.bankofengland.co.uk/pra/Pages/publications/default. aspx. 9 The other sentences of this Article as well as Article 1(3) repeat almost verbatim the above-mentioned provisions of Article 25 SSMR. 10 The term “ECB Confidentiality Regime” is defined in Article 2, point (4) (ECB Decision 2014/723/EU) as meaning the ECB regime which defines how to classify, handle and protect confidential ECB information. 11 The term “raw data” is defined in Article 2, point (3) of ECB Decision 2014/723/EU as meaning data transmitted by reporting agents, after statistical processing and validation, or data generated by the ECB through the execution of its functions. 12 The term “need to know” is defined in Article 2, point (2) of ECB Decision 2014/723/EU as meaning the need to have access to confidential information necessary for the fulfilment of a statutory function or task of the ECB, which in case of information labelled as ECB-CONFIDENTIAL must be broad enough to enable staff both to access information relevant to their tasks and take over tasks from colleagues with minimal delays. 13 The term “confidential information” is defined in Article 2, point (1) of ECB Decision 2014/723/EU to mean: x information classified as “ECB-CONFIDENTIAL” or “ECB-SECRET” under the ECB’s Confidentiality Regime, x other confidential information, including information covered by data protection rules or by the obligation of professional secrecy, created within the ECB or forwarded to it by other bodies or individuals x any confidential information falling under the professional secrecy rules of the CRD IV, and

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confidential statistical information in accordance with Council Regulation (EC) No 2533/98 of 23 November 1998 “concerning the collection of statistical information by the European Central Bank” (OJ L 318, 27.11.1998, pp. 8–19). 14 See on this Commission Implementing Regulation (EU) No 680/2014 of 16 April 2014 “laying down implementing technical standards with regard to supervisory reporting of institutions according to Regulation (EU) No 575/2013 of the European Parliament and of the Council” (OJ L 191, 28.6.2014, pp. 1-1861). 15 Article 114(1) CRD IV classifies a situation as an emergency, if it has the potential to jeopardise market liquidity and the stability of the financial system in any of the member states where entities of a group have been authorised or significant branches are established. 16 The second sentence of Article 1 of ECB Regulation 673/2014 provides that the terms used in the Regulation have the same meaning as the terms defined in the ECB Rules of Procedure. 17 In urgent cases, the Case Committee must deliver the draft opinion within a shorter period to be set by the Chair ((ECB Regulation 673/2014, Article 9(4), in finem). 18 In urgent cases, the mediation panel must deliver its opinion within a shorter period to be set by the Chair. 19 In our days, after a prolonged period of low interest rates (which is expected to last further), a major policy challenge is to limit the financial excesses resulting from accommodative monetary policies, by managing the resulting negative financial impact, in order to avoid repeating one of the main causes of the recent (2007-2009) international financial crisis. On the causes and consequences of persistently low interest rates, see Bean, Broda, Ito and Kroszner (2015), with extensive further references.

CHAPTER TEN THE CHANGING NATURE OF THE CRISIS AND THE REVIVAL OF THE LENDER OF LAST RESORT IN EUROPE LUIGI SCIPIONE1

The decisions taken during the crisis (and the circumstances that caused them) have reopened the debate on the role of central banks, their objectives, and the adequacy of monetary policy strategies. As is well known, the ECB has been granted exclusive jurisdiction to conduct the monetary policy of the euro area. However, rather than the view of the ECB as being tortured by its own statutes, the European Central Bank has exercised its crucial role as a lender of last resort to support the banking and public sectors, with the ultimate goal of safeguarding the stability of the euro area. In reviewing these issues in the light of the major changes, which have affected the economic and financial environment, we shall attempt a thorough analysis of the principles guiding European monetary authorities in their response to the financial emergency. The aim of this chapter is to prove that a similar evolution, not exclusive to national “central banking”, represents the natural outcome of the instrumental framework with which the ECB has been endowed, in order to carry out its tasks effectively. Key words: lender of last resort, monetary policy, central banking, debt crisis, bail out 1

Research Fellow in Economic Law, Law Department, Federico II University of Naples. Contact: [email protected]

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1. Introductory notes Since its conception, a characteristic of the Eurozone has been the anomaly of the co-existence of many countries and a single monetary policy. In addition, monetarist orthodoxy, constantly reaffirmed in European treaties, has reinforced the neoliberal postulate “currency without a State and States without a currency” (Padoa Schioppa, 2004, p. 5). The euro suffers from “lame” monetary sovereignty because of the lack of national and European “political” counterweights, and its premises sanction it as a failure in the diachronic sense. At the summit of the incomplete institutional framework of the European “fractal” stands a centralized monetary policy that is committed to an institution, the European Central Bank (ECB), which is independent of political decisionmakers and has its sole guiding star in the control of inflation.2 Creating a “currency without a state”, however, soon proved to be a utopian operation, and giving birth to a currency without an integrated banking system has not proved a wise choice either (Oddenino, 2015, p. 10). For all the institutions belonging to the European System of Central Banks (ESCB), this structure has also separated currency management from any constraint related to national policies on public debt (Della Cananea, 2011; Merusi, 2014, p. 2 f.) 3. The reflections presented here are based on the claim that the structural malfunctioning of the “single currency” is a factor of imbalance (or rebalance, where possible) in relations within the market of the economic and monetary union. The specification of the functions and role assigned to the ECB in the treaties forms the content of this analysis, which, therefore, involves various issues, and tries to provide an appropriate line of argument focusing on the role of the “Lender of Last Resort” (LoLR). Besides the study of the classical notion of the lender of last resort, this line of study also concerns an examination of the extraordinary macroeconomic credit granted by the ECB in relation to, first of all, the liquidity crisis that has strangled the banking system, and, in rapid sequence, to the sovereign debt crisis in some member states. The virulence of the events in question did in effect require, as shown, the use of an instrument outside the contexts within which it was traditionally conceived and applied.

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Here, we fear, there is an insufficiently explored link, which is combined with the need to focus research on the examination of a possible change in the institutional role of the ECB. Indeed, the central bank may be asked in the future to perform a far more extensive and important function than that hitherto covered, thus clearly affecting its own subjective organisation.

2. The link (conflict?) between lex monetae and fiscal discipline in the light of the treaties Governing by rules finds its best embodiment in the “economic constitution”, namely monetary policy and fiscal policy, and specifically their mutual relationship. The initial weakness in European institutional design raised fears about the integrity of the monetary union, particularly with regard to the choice of separating monetary and economic policies while establishing a single currency. Government of monetary policy was assigned exclusively to the Union, pursuant to art. 3, (1), (C) TFEU; the government of economic policy was mainly attributed to the member states, with rather minimal EU (art. 5 TFEU) competence, which plays only a facilitating role in the coordination of the various national choices (Triulzi 2015, p. 7 ff.; Bucci, 2012; Mostacci, 2013, p. 492 ff.). The aforementioned separation contributes to uncertainty concerning the real effectiveness of economic policy coordination, which is impaired by the weakness of procedures of multilateral surveillance (art. 121 TFEU) on the one hand, and excessive deficit detection (art. 126 TFEU) on the other, and most of all by the penalties provided in the event of default (Peroni, 2011, p. 977; Fabbrini, 2013, p. 102 f.; Cafaro, 2001, p. 29 ff.)4. The reason for this distinction stems from the idea that monetary policy, aiming to ensure price stability, should be entrusted to a technical body acting in a position of absolute independence from the political influence of the representative bodies (Predieri, 1996; Morosini, 2014, p. 29 ff.). However, because of their redistributive effects, economic and budget policy choices necessarily require a solid foundation in democratic legitimacy that only national political processes can provide. In the absence of a political union, the economic governance of the euro area was founded on fiscal rules and the “no-bailout clause” among member countries. This constitutes a fragile combination of market forces and rules of conduct, in the mistaken belief that, thanks to “governing by rules” Europe might live forever in a postmodern paradise; an era with no war, the “age of Venus”. Market forces drove economic convergence

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among member countries, moving towards the definition and implementation of the necessary structural reforms at national level. The rules of conduct were used to ensure prudent fiscal policies. As pointed out in 1989 by the Delors Report on Economic and Monetary Union, the financial markets were considered unable to provide the right incentives to conduct prudent fiscal policies by themselves5. The decision not to have a “sovereign called upon to decide on the exception” did not however disarm the state of exception, and thus did not deprive public power of its necessary weapons. First and foremost, this is because the exchange rate and interest rate on public debt, which normally react to unsustainable fiscal policies, cannot exercise their moderating action in a monetary union, thus potentially causing a member state’s policy makers to achieve a budget deficit higher than what is financially tolerable for that country (Winkler, 2014, p. 3 f.). In a currency area such as the Eurozone, there is a high risk of moral hazard also on the part of national governments. Basically, it is widely held that market discipline is unable to induce responsible behaviours, despite the no-bailout clause and the prohibition of deficit monetization (arts. 125 and 123 TFEU respectively) enshrined in the treaties. Moreover, unsustainable fiscal policy in a country can produce spillover effects on other partners.

3. The lender of last resort in the banking and sovereign debt crisis At least until the nineties, the role of lender of last resort was usually understood to fall to the national central banks as the last bulwark against the collapse of the domestic banking system. But in recent years, and specifically after the Mexican crisis, the idea has increasingly taken hold that an LoLR can be a good solution even when extended to bailing out states, especially when applied to an economic and financial area that has proved to be more fragile than expected, such as the economic and monetary union. Therefore, it is not surprising that this role has expanded to the states, because, as Bagehot argues, it is necessary to lend freely to anyone at risk of a liquidity crisis. Sovereign states are not at all different from other debtors when they lack immediate liquidity to face their debts. Moreover,

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their possible liquidity crisis is even more dangerous because, given their size, it will inevitably turn into a systemic crisis that then puts the survival of the monetary union at risk. For some years, it was expected that national banking systems would harmoniously follow the path laid out by the single currency, breaking that centuries-old bond that united them to the nation states. The crisis has obviously broken the spell, showing first of all how risky it is to create a central bank without providing it with the powers typical of the lender of last resort, secondly, how ephemeral and reversible the integration process is and, finally, how close relations between states and banks are (De Grauwe, 2013, p. 520 ff.; Butther, Rahbari, 2012; Wilsher, 2014, p. 255 f.). The term “lender of last resort” implies a degree of specificity that goes beyond what the function can legitimately define. In the confused political-institutional framework of the euro, central banks tried to face the crisis promptly and incisively, using a wide range of measures (Russo, 2010, p. 492 ff.; ECB, 2010). The financial emergency required a review of the range of interventions designed to further neutralise the degenerative dynamics of the imbalances that had occurred in the economic systems6. As empirical evidence has shown, meeting the sudden increase in demand for liquidity prevented a descent into the messy process of deleveraging, and averted the collapse of illiquid, but solvent, banks and, more generally, strengthened confidence in the economy7. The spread of the risk of contagion through the banking system and member states in difficulty explains why, from summer 2007 to summer 2008, containing the crisis was largely entrusted to the monetary policy authorities in the major currency areas (Federal Reserve; European Central Bank, Bank of England) and the supervisory authorities of the national banking systems. The first guaranteed the broad refinancing of distressed banks through loans of last resort (discount windows) and open market operations; the second, in agreement with national governments, proceeded at their discretion to bail out banks on the brink of bankruptcy, with the stated purpose of avoiding systemic crises (Solow, 1982). More generally speaking, the EU response developed along three lines of action: i) providing financial assistance to countries in crisis (Greece, Ireland, Portugal); ii) strengthening controls on the fiscal policies of member states (Spain and Italy); iii) stabilising the conditions of money and capital markets.

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The first two lines of action mainly involved the European Commission and national governments at ECOFIN (Council of Finance Ministers) and the European Council; the third line called into question the powers of the European Central Bank (Tufano, 2012, p. 139). In such a situation, the demand for the implementation of extraordinary measures rose, in addition to the call for the adoption by monetary authorities of “quasi-fiscal” interventions suited to the objective of achieving cohesive order within highly pluralistic contexts. In particular, to prevent tensions in sovereign bond markets likely to jeopardize the smooth transmission of monetary policy because of their impact on the money market and bank lending, the ECB, while continuing to make use of fixed rate full allotment tenders for the refinancing of banks, also launched a programme of government bond purchasing (Securities Market Programme, “SMP”). Finally, the European Central Bank had to accept and play the role of lender of last resort, at first only de facto (through 3-year long-term refinancing operations), and then unofficially (with the announcement of the Outright Monetary Transactions plan). The outcome was a somewhat macroscopic expansion of its role that, going beyond the actions related to price stability, extends to the preservation of the European currency itself (Allemand, Martucci, 2012, p. 21).

4. The “floating” nature of the LoLR in relation to the concrete objectives of the treaty The novelty consisting in the replacement of national currencies by a single one is incorporated in the constitution of the European Central Bank, implying “first the uniqueness of the function of currency issue and management, and thus the transfer of a national sovereign function to the Federation” (Merusi, 1997, p. 7). Hence the key role granted to this institution within the Euro-system, as the latter carries out its functions primarily through the organs of the ECB (Papadia, Santini, 1998, p. 28; Santini, 2001, p. 12 ff.; Pellegrini, 2003, p. 214). The central bank bases its legitimacy on a carefully defined mandate that is integrated into a democratically established constitutional order by virtue of treaty provisions stating the independence of the issuing institution (Art. 130 TFEU), and that of the rules that identify the

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"residual" target of the monetary policy. This attribute proved to be a point of undoubted strength for the overall “system” of crisis management. Indeed, support for the general policies of the Union is to be pursued only when the goal of price stability is “safeguarded” (Art. 127 TFEU)8, which is to be considered the true "mantra" of EU monetary policy 9. Monetary stability stands out as “an essential figure and a definite limit with respect to the ability of the ECB to profile or independently determine its goals. On the other hand, the primary right is always to set this objective within the overall objectives of the EU” (Oddenino 2015, p. 7)10. Therefore, entrusting the ECB with methods of implementing price stability would represent the way to combine the priority goal with the overall framework of its action. Indeed, it is not to be excluded a priori that, in order to act upon “an open market economy with free competition”, as stated in the final part of the previously mentioned para. 1 of art. 127, the drafters of the treaty – based on a criterion that ascribes primary emphasis to “cooperation” among member states – might have meant to confer upon the ECB broad and diverse competencies, which may certainly extend well beyond the mere coordination of monetary policies. This broader interpretation of article 127 would allow for a reduction of the importance of the primary objective of price stability to the benefit of supporting broader economic policies, and thus the legitimacy of further interventions that can be achieved in various ways and expanded in different directions11. Moreover, the disputed initiatives put in place by the ECB - while configuring prima facie a further exercise of its power of intervention recognised by the “Treaty on European Union” and the “Statute of the ESCB and of the Central Bank” – weigh on the sphere of competence originally assigned to the authority12. As stated, these are unconventional operations, all geared to controlling price stability, which materialised in the refinancing of the banking system and the purchase of debt securities of member states. As is well known, the transmission mechanism of monetary policy is the process by which the European Central Bank aims to influence prices in the Eurozone, i.e. by acting on interest rates of reference. The ECB may intervene if the mechanism is hindered by disruptions in some market

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segments, and the signal inherent in the ECB rate is not transmitted evenly across the whole Eurozone. In times of extraordinary financial market stress, the ESCB may resort to any means compatible with the treaty that are vital to achieving the objectives set. Therefore, it may decide to counter these tensions by using non-standard measures, which are part of the instruments for the implementation of monetary policy at its disposal, but which are, by definition, extraordinary and temporary tools.

5. “States of exception” and interventions by the monetary authority as LoLR So, the role of the ECB in managing the crisis required many interventions, which can be considered as those of a lender of last resort coming into play in order to avoid bankruptcy; in the first place that of banks, and secondly that of states when faced with the risk of a fraying union (De Grauwe, 2011; Scipione, 2012, p. 67)13. From this perspective, the ECB’s addresses, documents, and procedures were gradually adapted to the growing emergency, with a transition from the range of the traditional instruments of monetary policy to the unprecedented use of non-standard operations impacting on financial markets. Monetary stability is indeed a primary interest, but it should be balanced against the equally important need not to exonerate those member states that do not respect budgetary discipline from their responsibility. However, it is observed that in the history of central banking this goal has coexisted with others. It coexists with others in the Treaty on European Union as well, so it is not unreasonable for the ECB to purchase debt securities issued by a sovereign state. Among the reasons for this choice is certainly the explicit will to prevent alterations deemed dangerous to the market economy, such as systemic crises. Therefore, if through a gradual, although not necessarily linear process, the European Central Bank has come to believe that it has a duty to intervene in support of this or that sovereign debt, such a choice should not be labelled as extra legem or even contra legem14 (Nielsen, 2012; Merler, Pisani-Ferry, 2012; Krauskopf, Steven, 2009, p. 1144 ff.; Perassi, 2011; Malatesta, 2003; Zilioli, Selmayr, 2007). In fact – as described in economics literature – purchase interventions on the secondary market can affect the financing conditions of public

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budgets, with a risk of interfering in fiscal policy. On the other hand, it is interesting to note that other measures that have directly affected the financing of the banking system have not provoked similar debate, although they have also led to a risk of interference, specifically with the prudential supervision authorities. Whenever the central bank injects liquidity through a transaction by which it purchases a banking or a public title for a specified time, it risks creating distortions in the prices of such assets; hence the need for procedures and safeguards. In the case of a loan to the banking system, it is necessary for the banks involved to be deemed healthy, and for the operations carried out to have adequate collateral. Likewise, in the specific case of both public or private securities purchases, it is crucial to consider the underlying status of the issuer healthy and the debt sustainable. The core of the reflections so far presented should therefore be addressed to the interpretation of the European Central Bank’s role in the context of European governance. Its reform resulted in albeit limited waivers of sovereignty by all member states, both in the field of the public budget and in the definition of structural policies.

6. The ECB’s unconventional monetary policy and support to general economic policies In the wake of the peculiar contingency mentioned above, the public debt crisis in Greece, Ireland, Portugal, Spain, and Italy coincides with a profound change in the institutional design of the Eurozone, and goes far beyond the scope of monetary policy alone, where it originated. Thus, a power structure has begun to be established, able to redefine the spheres of influence of monetary authority and national governments in Europe. In this sense, we can say that the Greek case has clearly shown the disciplinary nature of monetary policy on public debt in the crisis context. This manifestation of the phenomenon quickly leaves room for a comprehensive institutional architecture improving and systematically repeating the set of operational practices put in place by the monetary authority. The new European institutional framework, based on the instruments of the European Stability Mechanism (ESM) and Outright Monetary Transactions (OMT), is the most refined form of the disciplining device through which the ECB and the European Commission can exert their influence on national economic policies in Europe (Winkler, 2014, p. 6 f.).

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Like ESM, the OMT is nothing but a refinement of the tools necessary to manage financial instabilities with increasing precision, so as to precisely calibrate the degree of pressure exerted on national economic policy makers, and systematically transfer instability within the disciplinary device of the conditional support provided by the lender of last resort. Indeed, the OMT instrument is bound, according to the principle of conditionality, to the larger design of monetary policy on public debt (Draghi, 2013a). For the reasons mentioned earlier, it is indisputable that the OMT programme blurs the separation between monetary policy and fiscal policy within the Eurozone: monetary policy is able to ensure stability only if the economic fundamentals and the institutional architecture are consistent with it15. Fears about the reversibility of the euro are related primarily to those on the sustainability of public debt and the competitiveness of member countries. Therefore, the activation of OMT by the European Central Bank and their continuation depends on precise commitments in terms of public finance and structural reforms within the framework of assistance programmes. Financing programmes using the common resources of the ESM is an incentive to continue to strengthen union governance, which is essential to permanently reduce the “European” component of spreads. From this perspective, the OMT are perfecting the ECB’s activity in the financial markets between 2010 and 2011 through SMP: the ESCB is committed to ensuring stability in the quotes of government bonds only if the country “hit” by financial instability accepts the lines of economic policy set out by the European authorities. Let it be clear that the strongest reasons in support of the ECB intervention can be found in its consistency with respect to other and further objectives than the ones of strict monetary policy; i.e., the underlying objectives of the union – economic, social, and territorial cohesion, and solidarity among member states (art. 3 TEU) – as reflected in the provision of support measures in case of crisis (arts 122 and 143 TFEU). Within the described framework of action, the relationship between economic policy and monetary policy is heavily tilted in favour of the latter, as the subject of the first involves a constant adjustment according to changes in the economic situation. This is not so much due to a formal aspect, considering that the instances for economic growth are also present in the treaties (as seen in relation to art. 127 TFEU), but more to a

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substantial and identitarian one. Indeed, the ECB has come to identify itself with a very specific model, and based on this model it has exercised its discretion in identifying the graduation of the objectives it is committed to, considering at length its first and main objective, price stability, as potentially fully encompassing all others (Barbier, 2012, p. 212). These are the aspects that, more than others, provide useful tools to explain the role played by the ECB in respect of the disruption of basic paradigms that international financial markets nowadays hetero-impose on the different spheres of monetary sovereignty. Given that the monetary policy mandate by state sovereignties fades and eventually disappears, it is clear how this causes a tendency to absolutise the monetary imperatives, until the conclusion that the ground for discussion of monetary policies should always be the market, characterised by established, more than proven, self-regulatory virtues (Oddenino, 2015, p. 11). Are these considerations enough to ensure that the actions of the ECB are located in the flow of community legitimacy? At least from the point of view of institutional balance, there is no denying that there was a de facto change or evolution. The ECB has undeniably qualified as an (on-demand) political decision-maker and not merely a technocratic body, as the treaty describes it (Papadia, 2014, pp. 93 ff.; Tucker, 2014, p. 10).

7. Operational discretion by the ECB and profiles of central banking In the crisis scenario, some operational forms of the ECB mark the requirement for acknowledging a role that is fully responsive to its nomen iuris. From the point of view of theoretical argumentation, it is not of secondary importance to stress how the measures taken by the ECB offer the example of an agent who – being forced by external shocks – engages in a redefinition of its mandate, which leads to deepening the integration process and, consequently, clashes with the attempts by some devices to restrain such an evolution. It is obvious that the role of the LoLR is definitely more effective when assigned to a supranational body (a characteristic that the FED does not possess), and as such the ECB plays a key role in this field, provided, however, reforms are made to both the structure of the monetary union (with important waivers of sovereignty by states) and the powers conferred upon the issuing central institute.

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The internationalisation of financial transactions has blurred the lines of responsibility for a national LoLR. Even more important is the fact that today the actions of a central bank produce effects on foreign financial markets, in addition to potential effects on exchange rates. In situations of distress, such as those imposed by the financial crisis, these actions may result in the further destabilisation of markets. Therefore, LoLRs that are nowadays capable of providing liquidity at the global level are more necessary than ever. There are four potential roles that a supranational level LoLR may play in a context of illiquidity: (i) to prevent panic, simply by virtue of its existence; (ii) if panic is already present, to lend what is needed to avoid worsening the situation; (iii) to grant loans during a debt crisis, also defining reimbursement priorities, as happens in cases of bankruptcy on a national level; (iv) to grant loans during the collapse of a state’s public sector, to support it in the strengthening or regaining of its sovereignty - an unlikely mission for private markets (Sachs, 1999, p. 382). These components make it increasingly urgent to rethink the international, not only European, financial architecture. A possible solution could be found, as has happened with the national central banks since the end of the nineteenth century, in providing the ECB with the full functions of lender of last resort. Therefore, there is broad consensus on an interpretation of this role that entrusts the European Central Bank with two specific functions: (A) “Crisis lender”, which the ECB would be able to play because of its power to mobilise still very large resources (B) “Crisis manager”, that is to say a coordinator of relations between creditors and debtors, which does not necessarily require financial resources, but above all the ability to impose concrete commitments on both parties, and to verify compliance. To date, the use of the instrument seems to meet the expectations. The ECB seems to be the most suitable institution to carry out an analysis of the nature of crises in the Eurozone, which, in the national context, corresponds to the liquidity risk assessment of a bank16. In all honesty, this argument has not always been presented as thoroughgoing. In the face of a widespread financial crisis, it is not easy to conceive an automatic market mechanism that would make a lender of last

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resort unnecessary. The first required procedure is to try and prevent contagion upstream, by supporting states where outbreaks of illiquidity are kindled. Then, such intervention as is aimed at those states cannot shrink to open market operations; it must be allowed to extend to forms of direct refinancing. This is all the more so as the money market moves away from an abstract, never reached, and unattainable perfection. One thing is certain: the transformation of the ECB into a lender of last resort for the European Monetary Union, in the full sense that the experience of Western countries and the literature on central banking have credited to it, will require a transformation of the international legal system: from a set of sovereign states governed by the principle of pacta sunt servanda, but basically devoid of any legal sanction, into a supranational system governed by rules whose breach entails specific consequences provided by law (Giannini, 2004; Howarth, Loedel, 2003; Haan, 2005; Harold, 2012). Moreover, the lender of last resort is a borderline instrument, between monetary policy and surveillance; in other words, it is addressed to the system as a whole and granted to the individual units that are part of it. The stability of the banking and financial industry is the original and permanent, though no longer the only, raison d’être of central banking.

8. Conclusions Reporting several points of weakness in the legal framework of the European Monetary Union brings a further implication, this time regarding the opportunities that the financial and economic crisis unfolds (Darvas, Merler, 2013, p. 8). The course of action taken by the European Central Bank – although addressed to the restoration of monetary policy and, therefore, to market stabilisation for sovereign debt – cannot be considered in lieu of a real policy of public budget consolidation. For non-standard measures to yield expected results, the action of the ECB must be an integral part in a framework of broader reforms at European Community level17. But then, the strong “interventionism” that has characterised the activities of the ECB since the beginning of the crisis is a mere consequence of the political vacuum in the European Union and the Eurozone’s institutional and political failures18.

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It is now quite clear that the euro crisis is not due solely to the lack of coordination of economic policies in member states, but is mainly the result of the absence of a decision-making centre where a European unitary fiscal policy can be defined and then applied uniformly in each member state. To allow the ECB to conduct an independent and effective monetary policy in a timely manner, it is necessary to achieve a euro architecture in which all players know their own part: governments, the central bank, and the European institutions. It goes without saying that greater and clearer assignment of responsibilities to the ECB should match a context of strengthened democratic legitimacy. Euro economic governance is nowadays characterised, on the one hand, by an excessive focus on balanced budgets, as imposed by “fiscal compact”, and on the other, by the search for an adequate conditionality, which, with varying degrees of intensity, accompanies the financial assistance provided by the Financial Stability Mechanism and the ECB itself. Shaping a new formula for the government of economy and currency at the European level is the factual premise for developing answers to be consistent with EU policy and interventions in support of the purposes mentioned above - namely, facing speculative turbulence on sovereign debt while pursuing, at the same time, strict fiscal policies. If any form of monetary union is to exist, it is essential, first and foremost, for it to evolve through a gradual transition into a real political union, and secondly, that there be a central bank capable of intervening during financial crises, either by means of an unlimited liquidity offering to calm down the markets or through the so-called liquidity preference (assuming a debt crisis cannot be resolved with the issuance of more debt). The structural limit of the institutional design of the Eurozone can be overcome by combining two types of interventions: (i) a centralised fiscal policy19, so as to re-tally the geographical boundaries of the fiscal and monetary authorities, and (ii) an implicit guarantee of government debt by the ECB, through the activity of a buyer of last resort of government debt securities, with no limitations (Panico, Purificato, 2012, p. 17). Only the transfer of fiscal policy from individual states to the European Union will probably solve the euro crisis. The prevailing argument is that the action of the ECB in the financial markets, through its large arsenal of monetary instruments, can only limit the negative effects of the crisis. On

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the other hand, in the absence of an adequate political response on the future of the euro, it will never be able to permanently solve such a dramatic phenomenon20.

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Notes 2

So, the link between state and currency, and likewise between fiscal and monetary policy (which is raised with extreme relevance) has deep roots that refer to the origins of the currency. Scholars had already pointed out the anomaly of the Eurosystem in the weak link between currency and State, to a degree never seen before (Goodhart, 1998, p. 407 ff.). A divorce between monetary and fiscal policy that could have absolutely unexpected implications, he wrote. Normally a currency is associated to a State. Rarely is a single currency associated with many States of significant size and with different fiscal policies, such as in the euro area. 3 Della Cananea, 2011. The States’ legal systems were based on an assumption generally taken for granted in legal treatises: for all States, financial sovereignty equals monetary sovereignty. In a united Europe, both postulates have failed, although to varying degrees. As regards currency, what Hayek considered to be the main route, the establishment and control of competition between national currencies, was not followed. It was decided that public authorities would have exclusive competence, but transferring it up to Union level. The adoption of a single lex monetae in Europe set aside the differences between countries. 4 Notwithstanding these limitations, even before 2008 the Eurozone had gradually qualified as a legally distinct area within the Union, an incubator for those innovations that then became necessary to react to the crisis. (See: Dickmann, 2012; Overbeek, 2012, pp. 30 ff., p 38 ff.; Ruffert, 2011, p. 1777 ff.; Chiti, 2012, p. 783 ff.; Chaltiel, 2012, p. 293 f.; Athanassiou, 2011, p. 558 ff.) 5 Indeed, it was considered in the 1989 Delors Report that regarding public finance, “the constraints imposed by market forces might either be too slow and

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weak or too sudden and disruptive”. As highlighted in the report, what is lacking in EU economic policy, unlike monetary policy, is the 'institutional solution': its eminently regulatory character, although involving European institutions in the mechanisms of control and correction, entrusts them with very few powers of government. To paraphrase a renowned scholar (Carreau, 1971, p. 592) it can be assumed that once again the EC Treaty seems to be written for a “happy future”, “because the lack of elasticity of such a system that would be necessary to adapt to changed circumstances is clear.” (Cafaro, 2001, p. 343). 6 As explained by De Grauwe, 2012: [...] if financial stability is to be maintained, because the sovereign and the banks hold each other in a deadly embrace. When the banking system collapses, this threatens the solvency of the sovereign. When the sovereign defaults on its debt, it pulls the banks into default. This means that the banking sector cannot be stabilized if the sovereign is unstable. A central bank that wishes to stabilize the banking sector is condemned to also stabilize the government bond market. Failure to do so leads to a banking crisis, forcing the central bank to provide huge amounts of liquidity to banks that it refuses to provide to the sovereign. 7

To safeguard the stability of the system, there are proposals to replace the traditional Lender of Last Resort with a Liquidity Provider of Last Resort; a sort of “government” lender that would be ready to purchase Securities in the markets when the panic materialises rather than inject liquidity into the banks. 8 Consistently with the aim of maintaining price stability and controlling inflation (implemented through monitoring of the monetary base and/or setting short-term interest rates), the European Central Bank, pursuant to art. 127, para. 1 of the TFEU, is competent “to support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union”. Namely the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and favoring an efficient allocation of resources and respecting the principles of art. 119, (3), TFEU: “stable prices, sound public finances and monetary conditions and a sustainable balance of payments”. 9 It should be borne in mind that Art. 2 of the ECB Statute allows the Central Bank to act in support of the EU general economic policies, only subject to the maintenance of price stability. 10 Although a basic precondition for meeting the general objectives of the Union, the achievement of monetary stability is a device “not unique in its strategic components, and whose definition is left to the responsibility of the organ deputed to its pursuit, and to this end, independent” (Oddenino 2015, p. 7). With reference to these profiles, see Bini Smaghi, Gross, 2000; Eijffinger, De Haan, 2000; De Grauwe, 2013a, p. 196.

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11 In favour of a more flexible interpretation of the same principle of monetary stability see (De Grauwe, 2006, p. 158 ff.; and Domingo Solans, 1999). 12 See, among others, Capriglione, 1999, p. 761 ff., who, with regard to the "supervisory policy" (p. 764), stresses that the original Community legislation limited ECB intervention to an advisory capacity, while specifying that such activity might “affect the exercise of supervision in the Member States”. 13 In this sense, see De Grauwe, 2011a, p. 2, who believes that “[t]he only institution in the Eurozone that can perform this role is the European Central Bank. Up until recently, the ECB has performed this role either directly by buying government bonds, or indirectly by accepting government bonds as collateral in its liquidity provision to the banking system”. 14 Pinelli, 2012, 3: The ECB is in fact an even unitary institution when considering the control of monetary policy, and is structurally supranational, in whose regard the inter-state coordination cannot serve as a political counterweight. By contrast, the Treaty of Lisbon institutionalised the European Council to the point that it became something more than a simple counterweight to the strengthened network between supranational institutions (Parliament and Commission). 15

According to the European judges (Court of Justice, Case C-62/14), the line between measures of monetary policy and economic policy cannot be traced clearly, as certainly the former have an impact on economic policy and are part of it. Although elusive, the distinction between the two is of considerable importance as it is relevant to the division of responsibilities (both horizontal between institutions and vertically between States and the European Union) as provided for by the Treaties (para 129). On this, the Court of Justice had already ruled in the Pringle case (Court of Justice, case C-370/12). On that occasion it had stated that “an economic policy measure cannot be treated as equivalent to a monetary policy measure for the sole reason that it may have a direct effect on the stability of the euro” (para 56) and that “the grant of financial assistance to a Member State however clearly does not fall within monetary policy.” (para 57). 16 Cf. Praet, 2012, who argues that the ECB has been acting as lender of last resort for the sovereigns of the euro system since it started its outright purchases of euro area periphery sovereign debt under the securities market program (SMP) in May 2010. The scale of its interventions as LoLR for sovereigns has grown steadily since then and its range of instruments has expanded. We interpret the longer term refinancing operations (LTROs) of December 2011 and February 2012 as being as much about acting, indirectly, as LoLR for the Spanish and Italian

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sovereigns by facilitating the purchase of their debt by domestic banks in the primary issue market as about dealing with a liquidity crunch for Euro area banks. Accordingly, see also the arguments put forward by Buiter, Rahbari, 2012, p. 1 ff.; Trichet, 2010. 17 The incompleteness of European integration has effectively prevented the transmission of monetary policy among the member States, thus endangering the functional independence of the ECB. From this perspective, the European sovereign debt crisis has shown that there is no alternative to the harmonisation of European fiscal policies and the reform of EU policies. On the destabilising capacity due to the absence of a common fiscal policy in a common currency area, see Fatás, Mihov, 2010, p. 287 ff. See also the remarks of Gualandri, 2008, p. 3 ff.; Hellwig, 2011, n. 11, June; as well as the intervention of Draghi, 2008. In economics scholarship it is widely accepted that the fiscal crisis and the banking crisis are closely linked: coordination and rules on budgetary discipline must be added with convincing political support for the European supervision and regulation of banks. 18 This is quite a substantial difference compared with the American system, where the FED faces the Congress and, if necessary, the Treasury Department as its political counterparts, both of which are able to work at federal level, and are highly expansive when necessary. 19 For an overall appraisal of the new instruments of European economic governance, see Rossolillo, 2014, p. 325 ff.; S. Rossi, 2014, p. 11 f.; European Council, 2012; Boitani, 2012, p. 99 ff.; Bordignon, 2012, p. 139 ff.; Marzinotto, Sapir, Wolff, 2011; Manasse, 2007. 20 According to Draghi, 2012, although a full federation between European States is not indispensable, in the long term it will be necessary to proceed gradually and achieve four pillars: financial union, fiscal union, economic union, and political union.

CONCLUSIONS VITTORIO SANTORO1

As a jurist, it is difficult to draw conclusions concerning contributions so varied, not only in terms of subject but also range of expertise of the authors, namely jurists, economists, and sociologists. There is no doubt, however, that the focal point of all these studies is the concept of money, and that, at the same time, the reason for so much interest in the subject in Europe is that there is an ongoing process, which seems to me as yet incomplete, whereby monetary sovereignty is being transferred from the individual nations to the EU bodies. Firstly, Scipione warns that the euro is a currency without a state, addressing how the financial crisis has clearly shown that the ECB needs the means to intervene to counter the crisis. This concern may be shared at a time in history when the uniqueness of the relationship between monetary sovereignty and the state as such no longer holds for the states of the European Union, where, generally speaking, the concept of sovereignty and, in particular, that of monetary sovereignty, are no longer related to the state as such, but to the legal order, the so called “ordinamento giuridico”. In fact, under the Maastricht Treaty, the individual states are called upon to contribute to the stability of the European monetary system, while it is the specific task of the European System of Central Banks, among other things, to "promote the smooth functioning of the payment system" (art. 127, para. 2, clause 4). Secondly, from the economic standpoint, Mertzanis reminds us that: "The Maastricht Treaty has separated the supervision of financial stability from monetary policy." I think, therefore, that it is permissible to draw some observations from here, noting first of all that it is a well-known fact that the priority mission with which the ECB and, consequently, the national 1

Full Professor of Business and Company Law, Department of Law, University of Siena. Contact: [email protected]

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central banks, are vested consists in the pursuance of price stability. Thus, according to the modus operandi of the ESCB, the general objectives of economic policy (regional policies; full employment and so forth) rank second to the maintenance of price stability: the interest deserving tutelage is the purchasing power of currency. It should be recalled that the aforesaid principle can be traced back to the constitutions (both formal and substantial) of many EU member states, and that it has been further strengthened above all as a result of the turbulence caused by sovereign debt (such as Greece, Italy, Spain, etc.). Once this priority has been institutionalised, the system is required to support the general economic policy of the Union. As a matter of fact, by considering price-stability as the exclusive objective of the system, a pre-eminent role is attributed to this goal under arts. 126-127 of TFUE. To sum up, the economy takes precedence over public policy in the construction of Europe. Expressed in these terms, loss of sovereignty seems to be less painful, even if it concerns aspects that are an indispensable element in the very essence of each state, namely, the right to “mint coins”. But, just how painful and fraught, with devastating social consequences, has this choice been in some Eurozone countries. In any case, an organisation grounded in a federal basis requires first of all that great importance be attributed to the will of the state (of equal value), despite that of the people (a democratic one), so that the new rules are fully rooted within the objectivity of the economic policies rather than responding to the expectations and social needs democratically expressed by the people. Thirdly, from the sociological perspective, Celia de Anca offers us a more optimistic view, wondering how, and hoping that, money can contribute to creating a sense of community and a European identity; to build this identity she appeals, among other things, to “community finance”, which she claims includes ethical banking, credit unions, micro finance, mutual organisations, Islamic finance (more thoroughly addressed by Cattelan), and other financial traditions. This bottom-up conclusion can even lead to tolerating, if not authorising, the so-called alternative or private currencies, including the bitcoin. It goes without saying that money has undergone a process of dematerialisation, so it is clear that there is no res (bank notes, government tickets, coins etc.) to which the monetary function can be attributed. Money, both in the economic sense (Keynes) and in the legal sense

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(Olivecrona, Fogen, Mann), is to be considered as a measure of value, an abstract parameter on the basis of which to indicate the value of all other goods. Therefore, in legal terms, the interest of the creditor in the availability of money becomes objectified as a legal good in the monetary obligation. And that good is represented by money as a form of measure, and the legal availability of the amount due is the good that the creditor (more generally the beneficiary) has an interest and right to obtain (Savatier). The phenomenon, long taken into consideration by more astute scholars, is now clear to everyone, given the spread not only of bank money, but also of other forms where technological development has removed the residual material semblance from money (Nussbaum), also allowing payment transactions through digital and computerised means. This is emphasised by Borroni and Seghesio in Chapter 6, while in Chapter 7 Bozina Beros remarks that what counts most is preserving public confidence in currency and guaranteeing the stability of the financial markets. Accordingly, money has always been considered a sui generis asset, regarding which the interest of the subject does not lie in its material possession, nor in a particular legal relationship (ownership). What is important, however, is that it may be used in various ways (namely as credit), and also through other entities (banks or other payment intermediary), provided that these record the transferral of funds. The problem is not, therefore, to exclude from the list of means of satisfaction those not identified with legal tender, but rather to ensure that other means of payment (credit transfer, debit transfer, credit and debit cards, phone messages etc.) give the beneficiary the legal right to use the sums of money which are the true object of monetary obligations, and this question has been addressed, in various terms, by Janczuk-Gorywoda, Gimigliano, and Vardi. Concluding, it is important to make a further observation on the interesting debate on the governance of money and payment systems within the European Union framework, regarding a topic that deserves more attention. According to Art. 49, § 1, of Directive 2007/64/EC: "Payments shall be made in the currency agreed by the parties." In its apparent simplicity, this provision is fraught with serious consequences for the national legal systems of EU countries. In this respect it is important to start from the premise that the European legislator, while purporting to wish to stop short of the threshold of the lex obligationis, leaving this to national legislators, has however also appropriated to itself the power to

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regulate a good chunk of the provisions on monetary obligations and, ultimately, has implicitly suggested to the national legislators that they should abandon some of the cornerstones of monetary law, starting from the age-old principle that currency una in alia solvi potest (Nussbaum, 1950; Ascarelli, 1971; Proctor, 2005; Atamer, 2009). Indeed, it had already been underlined how the European harmonisation process in the field of lex monetae would have led to consequences also in terms of the law of obligations (Vardi, 2007). The rule, in consideration of the European single market, aims to make all the currencies in this geographical area substantially the same, on the basis of their total transferability and mutual convertibility (Dalhuisen, 2010), which is in any case required by the principle of the free movement of capital. Nevertheless, cash payments are excluded from the scope of the provision, so that in this respect the only regulation comes from domestic law. The exception is serious and risks posing some systemic problems concerning the law of monetary obligations, depending on whether they are accomplished in cash or through intermediaries in the payment system. The question does not only concern Italy, as most EU countries have regulations, such as our art. 1278 of the Italian Civil Code. In this regard it may be useful to consider that art. 1278 of the Civil Code, granting the debtor the right to pay in euros even when the debt is in another currency, is more favourable to the debtor than the norm in art. 49, § 1, Directive 2007/64/EC. Therefore, there is a risk that if the debtor is the stronger party, he or she may impose a clause stipulating cash-only payment in order to have the freedom to choose the currency he or she deems most favourable at the time of repayment. In any case, I do not think that this result is consistent with the wish of the European legislator, as it would conflict with the aim of building up a single European market. On this question, the direction in which the European legislator is moving is well-documented in the specific point in the principles, definition and model rules of European private law, where we read that: "Payment of money due may be made by any method used in the ordinary course of business" (art. 2: 108 of Book II). Any doubt regarding interpretations that might undermine the principle of the possible equivalence of other means of payment compared with cash must be set aside, or at least those of fairness and goodwill in carrying out economic and social activities.

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Ultimately, the rationale underlying the European regulation forms part of the framework of the smooth functioning of the single European market and, more broadly, of its expansion in the European Economic Area. In fact, the rationale considers all the currency in the area to be substantially equivalent, which is why it is not applied to transactions in currencies extraneous to the European Economic Area, such as, for example, the US dollar or the Yen, even when such transactions occur between residents. It can be said that, in terms of legislative policy, the European regulator has gambled that all the countries concerned will set up uniform economic policies so that the market will not experience significant fluctuations in exchange rates. This economic given, if corroborated by facts, should encourage the growth of intra-European exchange, and ultimately create a single large money market. This provision in question shifts the centre of gravity from national currency to the currency selected in the contract. However, the fact remains that, if - by virtue of the rules of private international law - the forum for the contract is Italian legal order (if I may), the provisions of this order will apply to the foreign currency and, to mention the more significant ones, the nominal value principle (art. 1277 Italian Civil Code), and then the rules on interest (art. 1282 Italian Civil Code and those on the legal revaluation in the event of debtor default (art. 1224 Italian Civil Code). The parties are free to choose the reference "European" currency in the contract (and so far there is nothing new) with the result (and this is the novelty) that the currency must also be the one in which the payment is due. In other words, in contracts concluded in a "European" currency, an "effective" payment clause is naturally adopted (Ascarelli, 1971), so, in order to restore to the debtor the right to discharge the debt in euros, an explicit clause to that effect would be required. The provision does not limit the choice of the currency as long as it belongs to one of the states of the European Economic Area. Although at this time the hypothesis does not exist, I think it could even be a question of money that, in another system, might only be scriptural. The euro, before physically entering circulation, was, for a time, only scriptural money. This could happen again if a country that is about to switch from the national currency to the euro decides (supposedly to ease transition) to maintain the old national currency only as scriptural money for a further period.

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References Ascarelli, T. 1971. Obbligazioni pecuniarie. In: Comm. Scialoja-Branca. Bologna-Roma. Atamer, T. Art. 6.1.9. 2009. In: Vogenauer, S., Kleinheisterkamp, J. (eds). Commentary on the Principles of International Commercial Contracts (PICC). Oxford University Press. Dalhuisen, J. 2010. Dalhuisen on Transnational Comparative Commercial Financial and Trade Law. vol. 3. 4th ed. Oxford: Hart Publishing. Keynes, J.M. 1930. A Treatise on Money. London: Macmillan Publisher. Mann, F.A. The Legal Aspects of Money. New York: Oxford University Press Nussbaum, A. 1950. Money in the Law National and International. Brooklyn: The Foundation Press Incorporation. Olicrona, K. 1957. The problem of monetary unit. Stockholm: Almqvist & Wiksell Study Group on a European Civil Code. 2008. Principles, Definitions and Model Rules of European Private Law. Munich. Proctor, 2005. Mann on the Legal Aspect of the Money. 6a ed., Oxford: Oxford University Press. Vardi, N. 2007. Reflections on Trends and Evolutions in the Law Monetary Obligations in European Private Law. European Business Law Review. pp. 443 – 475.

ABOUT THE AUTHORS

Editor Gabriella Gimigliano is a Law Graduate cum laude at Federico II Univesity of Naples and holds a Ph.D. in Banking Law and Law of Financial Market at University of Siena. She has been working as post-doc fellow in Business Law and Economic Law and She is currently Lecturer in Business Law and Academic Coordinator of Jean Monnet Module “The Building up of a Payment System for the European Union” (2013-2016) at the University of Siena.

Contributors Agnieszka Janczuk-Gorywoda is Assistant Professor at Tilburg Law School and Research Coordinator of Tilburg Law and Economics Center (TILEC). She holds MA in Economics from the Warsaw School of Economics, JD from the Warsaw University, LLM in International Competition Law and Policy from University of East Anglia and PhD in Law from European University Institute. She was also a a post-doctoral research scholar at Columbia Law School. Gabriella Gimigliano (see above) Noah Vardi is Associate Professor of Private Comparative Law at the Law School of the University of Roma Tre, Rome Italy. She is the author of a monograph on “The Integration of European Financial Markets: The regulation of monetary obligations” (Routledge, 2010). Dr. Celia de Anca is currently the Director of the Center for Diversity in Global Management at IE Business School. She is the Author of Beyond Tribalism (McMillan 2012) and co-author of Managing Diversity in the Global Organization. (McMillan 2007). She has received the award of the women executive of the year 2008 by ASEME and is listed at the 2013 top50 thinkers ranking of global management thinkers. Prof. Celia de Anca is fluent in Spanish, English, French and Arabic.

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Valentino Cattelan holds a Ph.D. in Law & Economics (2009, University of Siena) and is specialized in Islamic law, economics and finance. He was the Academic Coordinator of the European Module Integrating Islamic Finance in the EU Market (University of Rome Tor Vergata, 2010-2013) and Visiting Fellow at the Oxford Centre for Islamic Studies (University of Oxford, 2013-2014); currently he teaches at the University of Florence. Dr. Cattelan is the editor of the volume Islamic Finance in Europe: Towards a Plural Financial System (Edward Elgar Publishing, 2013). Andrea Borroni is a tenured researcher in Private Comparative Law and adjunct professor at the Second University of Naples, Jean Monnet Department of Political Sciences. He was awarded a PhD by the University of Trento and an LLM with honors by the Louisiana State University (LSU) in 2006. Marco Seghesio is currently serving as contract professor within the Erasmus+ project Legal Information Technology Community – LITC, coordinated by the Danubius University of Galati, Romania. He holds a doctorate degree in Comparative Law and Processes of Integration from the Second University of Naples, and a master’s degree, summa cum laude, in Law from the University of Pavia. Marta Bozina Beros is Assistant Professor at the Faculty of Economics and Tourism (UNIPU) where she teaches courses on regulatory policies and governance of the EU financial system and leader of two Jean Monnet Modules. She holds a LL.B. cum laude from the Faculty of Law University of Zagreb and a MSc from the Faculty of Economics University of Zagreb. She obtained her PhD from the University of Ljubljana. Charilaos Mertzanis is currently Associate Professor of Finance at the American University in Cairo and Abraaj Group Chair of Private Equity. Previously, he served as the Director of Research and Market Regulation in the Hellenic Capital Market Commission for over fifteen years. He was educated at the Aristotle University of Thessaloniki and the New School for Social Research, where he received a Ph.D in economics and finance. Christos Gortsos is Professor of Public Economic Law, Law School, National and Kapodistrian University of Athens. He is also Visiting Professor and has teaching assignments at Europa Institut of the Zurich University, the Europa Institut of the Saarland University and the Law Faculty of the Izmir University of Economics.

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Luigi Scipione is Post-Doc Fellow at the Department of Law, Federico II University of Naples. He has been awarded with a Ph.D. in Banking Law and Law of Financial Market from the University of Siena. Vittorio Santoro is Professor of Business and Company Law and Director of Ph.D. School in Legal Studies at the University of Siena. He is currently the academic coordinator of a National Research Project (PRIN) on “The Governance of Markets within the European Union”.