CSFME Outreach Programs

Outreach Events

Outreach Blog

Tuesday, January 25, 2022

The Fed Weighs in on a 'Digital Dollar'

Vast Cross-border Implications for Central Bank Digital Currencies


Author: David Schwartz J.D. CPA

 

 

A discussion paper published on January 20th invites the public to explore with the U.S. Federal Reserve Board the creation of a digital version of the U.S. dollar. A Central Bank Digital Currency (CBDC) backed by the Federal Reserve would be designed, according to the Fed’s paper, to compete with cryptocurrencies like Bitcoin and Ethereum. Comments are due by May 20, 2022.

 

Official issuance of a U.S. Federal Reserve sponsored CBDC could change the global payment system as much as the 1971 U.S. decision to float the dollar and exit the gold standard. Setting aside monetary, legal, and legislative policy issues, a U.S. CBDC could force reengineering of the existing cross-border payment systems of companies and financial firms. For example, settling securities financing transactions through global custodian banks might no longer be the only option for cross-border traders using fintechs with a digital dollar account at the Federal Reserve.  

 

Other nations’ central banks have also explored digital versions of their own fiat currencies. Nine relatively small, mainly offshore nations have already launched central bank digital currencies. [1] While stressing that no final decisions about a digital currency have yet been reached, the Fed's paper said it would likely follow an "intermediated model" under which banks or payment firms would create accounts or digital wallets. [2]

 

CBDC’s are Not Cryptocurrencies

 

Cryptocurrencies lack sovereign backing or official convertibility and store value for their holders in tokens encrypted on a blockchain. By contrast, CBDC’s represent fiat currency, e.g., notes and coins, held in a digital wallet for conversion into physical cash at an ATM or bank.[3] The Bank for International Settlements defines state-backed CBDCs as either the retail equivalents of cash or as wholesale claims used for interbank payments.

 

The Fed’s paper distinguishes CBDCs from what it calls “commercial bank money” and “non-bank money,” which currently allow businesses and consumers to conduct digital commerce and transfer funds electronically.[4] A U.S. CBDC dollar, according to the Fed, would be a liability of the central bank, not a liability on the books of private banks or other financial institutions.[5]

 

Both cryptocurrencies and CBDCs are dependent on networked computer resources to create, track and validate transactions. In the case of most cryptocurrencies, those resources are anonymous and distributed through decentralized ledgers. For CBDC’s, a central bank ultimately controls issuance by providing every "e-dollar" with a unique identifying serial number, like a physical dollar. Because CBDCs are electronic analogs of a nation’s hard currency, central banks would be expected to peg the value of their digital currency to their existing fiat currency.[6]

 

Cryptocurrencies, according to a 2021 study by the Bank for International Settlements, have not yet made any real inroads into commercial cross-border transaction settlements. Their novelty, volatility, and general lack of centralized monetary controls have so far made them unsuitable to use as a medium of exchange for most businesses and financial firms.

 

 U.S. Dollar Hegemony is at Risk from Competing Digital Currencies

 

The Fed’s report acknowledges that without a dollar-denominated CBDC, the U.S. Dollar runs the risk of being eclipsed by competing countries’ CBDCs. 

 

“Today, the dollar is widely used across the globe because of the depth and liquidity of U.S. financial markets, the size and openness of the U.S. economy, and international trust in U.S. institutions and rule of law. It is important, however, to consider the implications of a potential future state in which many foreign countries and currency unions may have introduced CBDCs. Some have suggested that, if these new CBDCs were more attractive than existing forms of the U.S. dollar, global use of the dollar could decrease—and a U.S. CBDC might help preserve the international role of the dollar.”[7]

 

A digital dollar would compete with other nations’ CBDCs for cross-border transactions. For example, China’s digital currency, the renminbi (or e-CNY), could allow Chinese firms and their trading partners to reduce the usage of the U.S. dollar for cross-border transactions and perhaps circumvent channels that may be vulnerable to U.S. sanctions or jurisdictional control. To compete, the Fed must address the pain points in the cross-border payment markets.

 

“Accordingly, efforts aimed at reducing the costs of existing payments channels for large-value cross-border transactions denominated in U.S. dollars should be accelerated, and Washington should support public- and private-sector efforts aimed at leveraging new technologies to improve the efficiency of large-value cross-border payments [or else] the United States risks losing its leading influence over global payments infrastructure."[8]

 

CBDCs can Improve Efficiency of Cross-border Trading

 

Inefficiencies and high costs associated with the current cross-border payment systems have been a focus of global policymakers for years. The G20 countries agreed in 2020 to a multiyear roadmap to identify and deploy improvements to cross-border payments, including exploring the potential benefits of CBDCs to help address these frictions.[9]

 

“Cross-border payments currently face a number of challenges, including slow settlement, high fees, and limited accessibility. The sources of these frictions include the mechanics of currency exchange, variations in different countries’ legal regimes and technological infrastructure, timezone complications, and coordination problems among intermediaries, including correspondent banks and nonbank financial service providers. Regulatory requirements related to money laundering and other illicit activities introduce further complications."[10]

 

Champions of a digital dollar estimate that the streamlining cross-border exchanges made possible by CBDCs could dramatically reduce transaction costs, freeing up capital that could be more productively employed.

 

“Global corporates move nearly $23.5 trillion across countries annually, equivalent to about 25% of global GDP. To do this, they have to rely on wholesale cross-border payment processes which remain sub-optimal from a cost, speed, and transparency standpoint. As well as resulting in significant transaction costs of $120 billion per annum, these processes also result in additional costs from FX conversion, trapped liquidity and delayed settlements."[11]

 

In a trial conducted by the Bank for International Settlements (BIS), cross-border transactions employing CBDCs could be made in a few seconds, instead of the three to five days necessary using payments passed through a network of banks.[12]

 

[1] Nine countries have launched CBDCs: Antiqua and Barbuda, Dominica, Grenada, Montserrat, Nigeria, Saint Vincent and the Grenadines, Saint Lucia, Saint Kitts and Nevis, and The Bahamas. Fourteen nations, including China and Saudi Arabia, have CBDC pilots. Sixteen countries have CBDCs under development, including Canada, Brazil, Russia, and Australia. https://www.atlanticcouncil.org/cbdctracker/ 

[2] The Fed is also exploring an alternative system that permits the issuance of digital dollars directly to consumers. But as the paper notes, “the Federal Reserve Act does not authorize direct Federal Reserve accounts for individuals, and such accounts would represent a significant expansion of the Federal Reserve’s role in the financial system and the economy.” 

Federal Reserve Board, “Money and Payments: The U.S. Dollar in the Age of Digital Transformation,” Jan. 2022, p. 13. (“Fed CBDC Report”).

[3] Chadha, Sunainaa, "Digital Currency vs Cryptocurrency: What the Row is all About," Times of India, Nov. 25, 2021. 

[4] According to the Fed:

  • Commercial bank money is the digital form of money that is most commonly used by the public. Commercial bank money is held in accounts at commercial banks. 
  • Nonbank money is digital money held as balances at nonbank financial service providers. These firms typically conduct balance transfers on their own books using a range of technologies,  including mobile apps.  Fed CBDC Report, p. 15.

[5]  Fed CBDC Report, pp.13-14.

[6] CBDCs are alternatively called “digital fiat currencies.”

[7] Fed CBDC Report, p. 15.

[8] Greene, Robert, "Beijing’s Global Ambitions for Central Bank Digital Currencies Are Growing Clearer," Carnegie Endowment for International Peace, Oct. 6, 2021 

[9] See “Financial Stability Board, “Enhancing Cross-border Payments: Stage 3 Roadmap”, Oct. 2020 

[10] Fed CBDC Report, p. 9.

[11] JP Morgan & Oliver Wyman, “Unlocking $120 billion in Cross-Border Payments: How Banks can Leverage Digital Currencies for Corporates,” 2021. 

[12] Bank for International Settlements, “Project Helvetia Phase II: Settling tokenised assets in wholesale CBDC,” Jan. 13, 2022

 

 

Print

The CSFME’s Regulatory Outreach Programs

Regulatory reform has become a collaborative process. Where once market supervisors promulgated rules without regard for input from practitioners, today’s reform process has evolved into a dialogue of mutual respect for the opinions of all stakeholders in the capital markets. The process of regulatory outreach has become embodied in virtually every developed markets in the world.

The CSFME has adopted a role of facilitating this collaborative dialogue at all stages of the professional contribution process. Starting with students’ contributions to published commentary letters, through panel presentation and webinars, right up to trade association initiatives, the CSFME provides assistance through education, data compilation, analysis and commentary for some of the most pressing issues in contemporary markets.

DLT and Preferred Securities Financing

We believe the widespread use of encrypted third-party ledgers, blockchains, and smart contracts (i.e., DLT) is inevitable in securities finance, and that those technologies will permit lending agents to offer new revenue opportunities to their clients. Among these, we believe that certain agents will use DLT to help their lenders expand their loan books by opening their lendable portfolios on a preferential basis to the hedge funds in which they've already invested, as well as to other trusted counterparties, a concept we have dubbed, “Preferred Securities Financing.”  

CSFME is openly soliciting participation in a research initiative to assess the potential benefits to securities lenders from the use of DLT and data sourced from new regulatory disclosures. Specifically, our research will focus on how DLT, blockchain, and smart contracts can facilitate Preferred Securities Financing.  Learn More about our DLT Securities Finance Initiative. 

Research and Analysis of the Effects of Financial Regulatory Reforms

Given the sweeping changes in financial market regulation following the financial crisis, CSFME has turned its focus to questions relating to to how these changes are affecting the risks and economics of bank activities. The purpose of the Center’s research in this area is to foster sound policymaking and effective regulation with minimal adverse and unintended consequences. CSFME studies supervision and regulation of global financial institutions, the effects of reregulation on the global financial industry, optimal roles and methods of regulation in securities markets, corporate governance at financial institutions, and the most effective metrics and methods of data collection for understanding and measuring the effects of regulations on the global financial landscape. 

Lately, in response to a call from the FDIC for research on financial sector policy and regulation, the Center submitted a paper modeling the indirect costs to markets of bank regulatory reform.  The paper critiques regulators’ models for assessing these costs, and provides empirically-based suggestions for a more complete dynamic model of the long-term effect of bank capital reform.  Mindful of the Basel Committee's ongoing reviews of modeling tools, i.e., May 2012 and March 2016, the Center's critique is intended as a constructive addition to the holistic conceptual base of the regulatory reforms.

The Center also continues to provide input on regulatory proposals.

In March of 2016, CSFME submitted a comment letter to the Bank for International Settlement's (BIS) December 2015 consultative document regarding step in risk.  While supporting generally the goals of the Basel Committee to minimize the potential systemic implications resulting from situations where banks may choose to provide financial support during periods of financial stress to entities beyond or in the absence of any contractual obligations, the Center expressed some concerns and offered some suggestions regarding the approach taken by the Consultation. Drawing on practical experience, the Center offered an example from the trade finance sector supporting its belief that the nature of step-in risk may be one example of an acceptable, non-diversifiable exposure, given the potential positives for the economy at large.

In February 2015, CSFME submitted a comment letter in response to the Financial Stability Board’s November 2014 consultative document, Standards and Processes for Global Securities Financing Data Collection and Aggregation. In its letter, the Center identified additional metrics that may be necessary to assess properly the risk of collateral fire sales associated with securities lending transactions.  In particular, CSFME asserted that FSB and sovereign regulators must expand the data initiative beyond position aggregates, to include risk mitigation resources as well as termination activity.

Students Learn to Evaluate and Contribute to the Reform Process

As the level of intensity surrounding the reform process continued to build in 2013, the CSFME began to bring a fresh perspective to the reform process. By working with finance students and the US regulatory agencies, CSFME hoped to challenge the settled views of stakeholder by introducing the views of those whose careers would be shaped by the outcome of the reforms.

In the spring of 2013, a select group of Fordham University economics students met in Washington with officials at the U.S. Treasury, Office of Management and Budget, Federal Reserve Board, and the Securities and Exchange Commission. The CSFME helped arrange the meetings and funded the logistics. By all accounts, the experience was very positive for students and regulators alike.

Buidling upon the success of the 2013 pilot program, in 2014, both Fordham and the CSFME decided to expand the outreach program and formalized the Regulatory Outreach for Student Education program as the ROSE program. Honor students in finance and economics were selected by the deans of four schools within the university: the Graduate School of Business Administration, Fordham College at Lincoln Center, the Gabelli School of Business, and Fordham College at Rose Hill. The students were organized into four teams representing their schools. The CSFME selected a contemporary issue of career significance, the Financial Stability Board’s Consultative Document on G-SIFI designation of non-bank, non-insurer financial institutions. Each team was charged with studying the issues in debate, then presenting their opinions in the manner of a formal comment letter to the FSB. Over four months, the students reviewed earlier opinion pieces, met with practitioners and regulators, and then submitted their opinions. Without influencing their opinions, the CSFME arranged access to research materials and opinion leaders, then reviewed their letters and, as appropriate, recommended submission on university letterhead. In April, 2014, the four teams’ letters were published by the FSB on its website. In recent memory, no university had ever had one letter, much less four, published on a regulatory website. To finalize the 2014 ROSE program, the CSFME arranged for all four teams to present their opinions to the key regulators at the Federal Reserve Board and the SEC in Washington, D.C. The day of meetings ended with regulators’ praise at the degree to which the students had understood the issues and presented their opinions clearly.

One student team even offered suggestions that regulators had not previously considered and praised for their creativity. “We always know what the trade groups will say, but you brought a fresh perspective.” That team, Fordham College at Lincoln Center, was awarded the 2014 ROSE Award for Analytic Excellence. In retrospect. each student completed the program with a credit that will not only endure on their resumes but also contribute to the evolution of the financial markets through the Twenty First Century.

In 2015 and 2016, Fordham formalized the ROSE Program as a for-credit course in their curriculum. The focus of the 2016 ROSE Program was the Bank for International Settlement's December 2015 consultative document proposing a preliminary framework for identifying, assessing and addressing step-in risk potentially embedded in banks' relationships with shadow banking entities.  Five teams of graduate and undergraduate students in economics, finance, accounting, management, and law researched and drafted comment letters on the consultation and submitted their letters to a panel of distinguished industry judges.  After reviewing each excellent submission, the judges then one winning letter to be presented at a visit to the Federal Reserve Bank on April 27, 2016. The winning team's letter was submitted in full to the BIS, along with a summary of the key ideas from the letters from each of the other four teams, and the submission was published on the organization's website with those of the consultation's other commenters.   All five teams of Fordham Scholars visited Washington, DC on April 27, 2016 and met with officials at the Fed, Treasury Department, and FINRA.  

Institutional Securities Lenders respond to Academic Criticisms

In 2006 the Center was created, initially for the purpose of testing academic criticisms of the securities lending markets. With funding and data support from the Risk Management Association, CSFME found “no strong evidence to conclude that securities lending programs have been used to any great extent to manipulate proxy votes or exercise undue influence on Corporate Governance issues.” Our study also found that “broker borrowbacks” had contributed to spikes in lending activity around record date – the same phenomenon that the academics had misinterpreted as evidence of hedge fund manipulation – due to the efforts of brokers to meet recall notices from securities lenders. In effect, the brokers were scrambling to acquire votes for their customers, not building positions to swing corporate elections. The academics had fatally misinterpreted their findings!

Ed Blount of CSFME testified at the SEC’s Roundtable on the results of the research in September, 2009. Then, the CSFME white paper, published in 2010, was submitted to the SEC as an attachment in response to a consultative document on the “Proxy Plumbing” process. As a result of the Center’s contribution to the collaborative process, the misguided call for reform of securities lending began to subside. Once again, securities borrowers were fairly recognized to be honest brokers in the corporate governance arena.

Securities Lenders consider new means to retain their Voting Rights

In a follow-up to the Empty Voting project (“Borrowed Proxy Abuse” as it came to be known), the CSFME responded in 2011 to requests by the participating securities lenders, by turning its attention to ways in which those lenders might be able to retain their corporate governance rights, while still benefiting from the income attributable to their securities loans. After all, as many studies have found, securities lending contributes significantly to the efficiency of market operations. Why should lenders be forced to choose between their loan fees and fiduciary duties to vote their shares, especially if they are contributing to market efficiency?? With independent funding, the CSFME retained attorneys from two prestigious Washington D.C. law firms, Stradley Ronon and Sidley Austin, to investigate the legal underpinnings to market practices which force pensions, mutual funds, insurers and other institutional securities lenders to give up their voting rights when they lend portfolio securities. In practice, margin customers of brokers also lend their securities, yet they usually retain voting rights -- and most of them aren’t even long-term beneficial owners. Both groups of beneficial owners retain dividend rights, so why, institutional investors asked, shouldn’t institutions also keep their voting rights? With the benefit of exhaustive legal research, CSFME filed a petition with the Securities & Exchange Commission to initiate a pilot program to test new market procedures by which recently-introduced efficiencies in market operations might permit lender to retain votes.  Learn more about Paradoxical Erosion of Corporate Governance

In 2013, the SEC approved that pilot program, largely in response to the encouraging recommendations of the International Corporate Governance Association, as well as the California State Teachers Retirement System and the Florida State Board of Administration.

That pilot was initiated in 2014. Simultaneously, the CSFME began to apply the results to new initiatives in Canada and Switzerland, where the pressure to meet fiduciary voting obligations was intensifying.  More about Full Entitlement Voting



Home