On October 20, 2017, the United Kingdom’s Financial Conduct Authority (FCA) published a report to summarize lessons learned from its regulatory sandbox. In a section titled “Access to banking services,” the FCA found that “some banks have been withdrawing or failing to offer banking services to some types of customers.” More specifically, it appears that banks have discriminated against firms developing distributed ledger technology (DLT) products.
“We have witnessed the denial of banking services first-hand across a number of firms in the first two cohorts of the sandbox,” wrote the FCA. “Difficulties have been particularly pronounced for firms wishing to leverage DLT, become payment institutions, or become electronic money institutions.”
Traditional financial institutions could be hesitant to support DLT firms for a number of reasons. Potential money laundering and terrorist financing risks may open banks up to legal liabilities. Banks could also worry about the profitability and credit risk of certain firms. But, perhaps, these age-old financial institutions fear the disruptive nature of DLT firms. Providing financial services to their challengers presents banks with an ethical dilemma and the FCA seems to think that something is awry.
“We are concerned by what appear to be blanket refusals for certain kinds of applicant firms,” wrote the FCA. “There are also apparent inconsistencies within individual banks regarding how they apply their assessment criteria in approving access to banking services.”
Through its regulatory sandbox, the FCA provides firms with government compliance expertise and tools to facilitate testing. The sandbox is broken into six-month periods called cohorts – two cohorts in each year. In the first two cohorts, the FCA received 146 applications and accepted 50 firms for participation. Among those firms, 17 utilized DLT in some way, making it the most popular technology among participants.
The FCA wrote, “The majority of sandbox firms using DLT across the first two cohorts are electronic money or payments institutions.” Multiple firms experimented with DLT for cross-border payments, a use case that could reduce transaction times and offer better exchange rates. Other firms examined DLT-based share management and corporate governance, as well as debt instrument issuance.
While many DLT firms showed promise, the FCA wrote, “Through the sandbox we have observed that execution time uncertainty, volatility in the value of digital currencies, liquidity requirements, transaction fees and the availability of exchanges have all proved to be limiting factors to the success of tests in this area. Firms will need to carefully manage these risks and others if these services are offered on a wider scale.”