Digitalization Of Payments And Currency - Financial Services

Key Takeaways from a Third Virtual Workshop with Canadian and International Experts on the Digitalization of Money

Introduction

On March 7, 2023, the Centre for International Governance Innovation (CIGI) and Bennett Jones LLP hosted a virtual workshop with international and Canadian experts, from the public and private sectors as well as from academia, on international developments and the work required for Canada to keep pace with developments in the digitalization of payments and currency.

The discussion built on CIGI and Bennett Jones's previous work (Fay et al. 2021; 2022) convening experts to discuss the potential benefits and drawbacks of emerging central bank digital currencies (CBDCs) and the steps Canada would need to take if it chose to introduce such a payment instrument. Broadening the conversation beyond CBDCs, the workshop was organized around four topics at the centre of payments digitalization: payments system modernization, open banking, stablecoins and CBDCs. Using the experience of leading international peers as a springboard, discussion focused on the opportunities and barriers facing Canada as we look toward the future of the economic, technical and regulatory systems that underpin the foundation of the Canadian economy.

This conference report shares key takeaways from the workshop, which was held under the CIGI Rule.¹ It does not purport to represent a consensus among the participants, nor to convey the views of any individual or organization. Its goal is to communicate the lessons that Canada can take away from international partners on aspects of the digitalization of our economy's payments and monetary policy frameworks, and to demonstrate how those lessons might apply in our domestic context.

Box 1 summarizes key messages emerging from the discussion across each of these important topics.

Balancing Opportunity Creation and Risk Prevention in Canada's Payments System

A core message leading the discussion was that the payments system (that is, how Canadians buy the necessities for daily life, operate their own businesses and send money to loved ones) is the foundation not only of our economy but also of our society and democracy. Trust in that system (that money will reach its destination quickly and securely, that Canadians can dependably access and put to work their hard-earned savings, that their data is shared in a trusted way) is the bedrock on which all other economic activity takes place, allowing Canadians to move seamlessly through their days.

That trust is earned not just by the reliability and stability of the payments system but by the common understanding and acceptance that Canadians deserve a modern and efficient payments system, enjoying the benefits that competition and innovation offer. This is increasingly clear as the economy around us continues to progress into the digital age and future economic shifts begin to materialize.

Too often in Canada, the approach to the evolution of our payments system has been one that focuses on risk prevention to the detriment of the creation of new economic opportunities and has been hampered by the use of siloed efforts across policy frameworks and institutions rather than a holistic approach. Instead of viewing the system as a platform for success, Canada's payments system has more often presented a slow, inflexible barrier to opportunity for new entrants, and a gate to be kept in the interest of incumbents rather than innovators. Canada's banks are world leaders in some respects, but they are not sources of technological innovation, and are constrained both by their incentives to preserve profits and by the legacy information systems that have supported their operation for decades. To realize the benefits of an innovative and efficient payments system, Canada must allow a broader set of actors to participate, not just those with the blessing of entrenched incumbents.

Box 1: Key Messages Emerging from the Workshop

Canada has before it a tremendous opportunity to build a modern payments system that addresses the challenges we see in our existing system, delivers security and value to Canadians for years to come, and has the adaptability to weather future economic shifts. Seizing that opportunity, however, will require an approach that cuts across regulatory silos and incumbent interests entrenched in our evolving economy and takes a longer-term vision.

Canada lacks a comprehensive policy vision for the future of its payments system, despite a thorough federal study of the potential future of Canada's payments system released more than a decade ago. Although Budget 2022 announced consultations on the digitalization of money over a five-year window, there is little sense that this is a priority for the federal government. Yet Canada's apparent complacency in bringing key elements of its financial system into the digital age relative to global peers benefits incumbent interests and represents a hidden and substantial cost to its economy.
Although financial stability must remain a paramount concern for payments and the broader financial system, governments, central banks and regulators need to create a system that strongly supports opportunity creation in the public interest. In charting a new course for its payments system, however, Canada must contend with the interests of the incumbents that dominate the current state and have an interest in delaying and shaping the future to their advantage.
At the same time, there is a need for a governance framework that can adapt to the ongoing technical evolution in the space rather than a one-shot approach that aims no further than to address the challenges seen today. Concerns were raised about the lack of an appropriate governing body in Canada equipped to implement such a framework, and jurisdictions leading the pack were identified as those who not only had tasked bodies with moving their open finance agendas forward, but also had incentivized stakeholders outside government to contribute to that agenda.
Public and private sector innovation in jurisdictions such as Brazil and Europe have brought down the cost of digital payments for businesses by an order of magnitude, but in Canada the scope of benefits of a modern payments system has not been made apparent to consumers and businesses.
Thinking beyond the financial sector, allowing consumers to realize the potential value of their own data requires a suitable policy infrastructure that includes digital identifiers and consumer data rights, as well as investments in cybersecurity and network resilience.

The ongoing modernization of Canada's payments infrastructure provides an opportunity to broaden the range of actors innovating in the financial space, and Canada has much to learn from peers on how to maximize this potential.

Regulators must keep in mind the different roles that financial and technology firms play in driving innovation in the payments space, with the latter generating many of the innovative offerings adopted by financial institutions.
International examples such as the Central Bank of Brazil's (Banco Central do Brasil's [BCB's]) Pix system demonstrate that with the proper legal framework, central banks can fulfill the role of designer and regulator while introducing competition and innovation into the payments system upon which the private sector can innovate.
As Canada continues its work to implement the delayed Real-Time Rail payments system, it must also look 10 years down the road to what the future of the payments system should look like, not just focus on what is viewed as the current finish line.

As Canada progresses toward implementing its own open banking regime, lessons from other jurisdictions show the value of a broader vision for Canadians' control of their data.

By taking a view of consumer data rights that looks beyond banking and the financial sector and keeps the potential for improving competition at the fore, international players such as Australia have been able to unlock value and innovation for consumers in a range of sectors as well as encourage the private sector to participate.
Although international examples are useful to inform Canada's approach to open banking, the design of open banking should be at least equally informed by the potential value proposition to the Canadian economy.
A customer focus is essential in order to have broad uptake of open banking, but government must also address the question of governance, particularly when considering the institution or institutions that will ultimately determine the scope and content of the open banking regime.

After a whirlwind year in the stablecoin space, important questions remain about whether regulation can unlock underlying value for the financial system.

Use cases for stablecoins outside the crypto space are far from proven, and initial activity on the part of international regulators has cooled in light of the ongoing investigations and litigation against major private sector players.
Multiple paths forward for regulation of stablecoins exist, but absent leadership from national players, subnational regulators are moving to create a patchwork of responses, raising the potential for regulatory arbitrage.
A promising potential path in Canada to address prudential risks associated with stablecoins could be an instrument-neutral "same risk, same activity, same regulation" framework that builds off Canada's strong existing regulation of deposit-taking institutions to address prudential risks associated with stablecoins.
Although whether stablecoins should be considered securities or payment instruments remains contested, the definition adopted by regulators could open or foreclose opportunities to shape the space toward more socially beneficial outcomes.

The Bank of Canada (BoC) has progressed its work on CBDCs, with resources moving beyond research and toward development:

Peer jurisdictions continue to progress in the research, development and testing of CBDCs, with smaller jurisdictions leading the way and larger jurisdictions increasingly moving into pilot phases.
Although no decision has been made toward implementing a CBDC, the BoC appears to be shifting resources from more theoretical research of potential CBDC futures toward the development that would be required to make that a reality.
Core to the successful implementation of a CBDC must be the everyday use of the digital currency by Canadians - something that will require leadership rather than consensus to define and realize.

Change in Canada's financial system will require leadership to implement a vision that serves Canadians more than incumbents.

Bringing together the topics of discussion, despite setbacks to date, Canada has a real opportunity to forge its own path toward the goal of a secure, fast and efficient financial system through various policy levers.
In order to anticipate the potential responses of incumbents to policy action, regulators must have a deep understanding of the business models that support these incumbents and their consequences for Canadians.
Echoing the findings of previous studies and reports, governance and leadership are necessary components of successful reform and transformation of the financial system and to move Canada from its current lagging status.

Relative to international peers, Canada's approach has been one of complacency, allowing others to move forward years before we even consider changes to our own system. Although the costs of this complacent approach may be individually minute, the volume of activity flowing through Canada's payments system means the sum of those costs can be staggering, with basis points becoming billions annually. Just one example of the cost of Canada's risk-averse approach to payments is the sixfold difference in interchange fees (charged by financial institutions to consumers and businesses to process transactions) between Canada and the European Union.

As raised by workshop participants, shaking off that complacency and embracing digitalization across the financial system begins with policy makers setting out a vision of what they wish to achieve, and ambitious but frank consideration of what is possible. A key element of that vision must be the trade-offs inherent between opening access to the financial system, rewarding investment and maintaining the paramount policy goal of stability. Because it is understood that policy makers cannot forecast the forms innovation will take, the vision should maintain technological neutrality in making these trade-offs to avoid foreclosing potentially valuable paths of development. Once the vision is articulated, policy makers should understand the different capabilities the public and private sectors can bring to bear and capitalize on them as they work to realize that vision.

Today, Canada still lacks a policy vision for the future of its payments system articulated by the most senior officials tasked with the stewardship of our financial sector. This remains the case despite a thorough federal study of the potential future of Canada's payments system released over a decade ago. Although Budget 2022 announced consultations on the digitalization of money over a five-year window, there is little sense that this is a priority for the federal government.

It is this context in which the workshop discussion took place, one where Canada continues to lag behind global peers in evolution and reform of its payments system in an increasingly digital economy. Canvassing major developments in the payments space, payments system modernization, open banking, stablecoins and CBDCs, workshop participants offered a view into not only how other countries have approached these developments in their own economies, but also how Canada might overcome the barriers to creating a modern payments infrastructure and realize those benefits achieved by our international peers.

Payments System Modernization

In the last 20 years, countries around the world have conducted sweeping modernizations of the technical and regulatory infrastructure underpinning their payments systems. Rushing to take advantage of the potential benefits brought by increasing digitalization, countries of all stripes have invested in creating secure, fast and efficient payments systems commensurate with the digital age our economies have been pulled into. Setting the stage for a discussion of the work of payments modernization, participants highlighted that the process of modernization of the payments system is fundamentally a question of how we choose to govern ongoing technological change - no small task for governments and their citizens.

Although the steps to modernization will differ from country to country, participants presented common blueprint elements that could support jurisdictions in the move toward a modern payments infrastructure. Not limited to policy goals in the payments space, elements such as digital identifiers, consumer data rights, and cybersecurity and network resilience were listed as core complements to an economy suited for the digital era. Narrowing the focus to the payments space, enablers of successful modernization included consideration of prudential regulation, what entities have access to the payments system and the role of open finance. While the plans and needs of jurisdictions will differ, participants stressed the need for a plan and governance bodies able to execute that plan. On the topic of prudential regulation, participants spoke to the exogenous nature of technology change in the payments space, with change emerging from technology providers rather than banks, and recommended a separation of finance and payments technology for the purposes of prudential regulation. This was particularly the case for corporate bankruptcy frameworks, core to the broader economy but antithetical to the banking system. This separation raises the question of the handling of non-bank payment providers, and how the government might handle their resolution in times of stress.

Although Canada has made progress with regard to the prudential regulation of payments providers with the Retail Payment Activities Act and draft regulations, there continues to be a lack of legal clarity around access to the payments system, and how monetary policy might change as non-bank payment providers are allowed to enter the payments system. With regard to open finance, Canada was considered to be in the middle of the pack, lagging behind jurisdictions such as Australia, the European Union, Singapore and the United Kingdom but ahead of other peers including the United States. Participants observed that an approach to open finance would require an ongoing governance framework able to adapt to the ongoing technical evolutions in the space rather than a one-shot approach that aims to address the challenges seen today. Concerns were raised about the lack of an appropriate governing body in Canada equipped to implement such a framework, and jurisdictions leading the pack were identified as those who not only had their own bodies tasked with moving the open finance agendas forward but also incentivized stakeholders outside of the government to contribute to that agenda.

As a case study for discussion, participants were provided with an overview of the case of Brazil, a country that began its payments modernization journey over 20 years ago, culminating with the launch of the Pix real-time retail payments system a decade later. Beginning as an investigation into the state of competition in credit card markets and initially focused on real-time wholesale payments between financial institutions, Brazil's work has culminated in a new payments institution operated by the BCB that is now a major fixture of the Brazilian payments space. As the payments system handling the highest transaction value in Brazil, participants pointed to several features that contributed to the successful deployment and operation of Pix by the BCB, including mandatory participation by major financial institutions, access beyond traditional financial institutions, and low-cost or free transactions. Core to the access beyond traditional financial institutions was the 2013 extension of the remit of the BCB to include regulation and supervision of non-bank payments providers. The success of Pix was also attributed to the BCB's mandate, broader than peer central banks with its goals of not just monetary and financial stability but also the promotion of competition, financial inclusion and efficiency in the payments sector. By creating a public offering on top of which private sector actors can innovate and create their own offerings, Pix is able to introduce competition into the Brazilian payments ecosystem while preserving incentives for a broader range of actors to create innovative alternatives.

Participants contrasted Brazil's successful introduction of Pix with the delayed ongoing payments system modernization in Canada. Throughout 2010 and 2011, the Task Force for the Payments System Review studied the possibilities for modernizing Canada's payments architecture, including an assessment of Brazil's experience, noting that even at that time, Canada was already well behind 27 peer jurisdictions. Although there has been some progress, key elements proposed over a decade ago remain to be realized, and design choices taken to date raise concerns about the influence of incumbents on the future direction of Canada's payments system. The same task force report pointed to this influence in no uncertain terms, noting that the major banks' interests "are best served by keeping at bay new entrants to the system" (Department of Finance Canada 2011, 5). Participants drew attention to the decision to build Canada's Real-Time Rail system on top of the existing Interac messaging system and questioned whether a three-decades-old system ought to form the basis of a modern payments infrastructure. Core to concerns of reliance on the existing Interac system is its joint ownership by Canada's major financial institutions, its conversion from a non-profit to for-profit entity, and its history of interactions with the Competition Bureau, Canada's competition law authority. Again, comparing the case of Brazil with Canada, to disrupt the power of incumbents and encourage them to be more welcoming to competition, participants suggested that a path forward could be the introduction of a public alternative to spur the kind of innovation available in countries that have more fully embraced the digital economy.

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Footnote

1. See www.cigionline.org/about/cigi-rule/.

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