July 2023 

The European Commission has now published draft legislation for the legal framework of a potential digital euro. Despite setting out baseline requirements, the final issuance decision sits with the ECB. In an attempt to quell concerns of any associated 'phase out' of cash, the proposal was accompanied by another draft bill clarifying the legal tender status of cash and committing to improving its acceptance and accessibility across the bloc. Together, these proposals make up what is being dubbed the 'single currency package'.

Digital euro bill

The flagship element of the package is the much-anticipated legal framework for a possible retail digital euro. This will now be debated, and likely amended, by both the European Parliament and Council before becoming final. Following this, any decision on whether or not to actually issue a digital euro would ultimately rest with the ECB. 

In order to ensure that — should issuance proceed — the relevant legislation is in place, the Commission launched this proposal alongside the ECB's 24 month investigation phase (which is set to conclude in October 2023, with the development of a prototype).

The proposal also follows a statement from European finance ministers, highlighting certain key elements that they wanted to see prioritised. These elements included privacy protection, convertibility, interoperability, avoidance of programmability and holding limits — all of which have been accounted for.

The main features of the proposal include the following: 

  • The digital euro would be treated as legal tender within the euro area — with relevant Member states designating competent authorities to monitor and enforce these obligations
  • The digital euro would act as a complement to banknotes and cash — being an 'additional choice' on top of current private options
  • The digital euro would not be remunerated or interest-bearing
  • The digital euro would not be programmable. While authorities would be prohibited from setting any restrictions on use, users themselves could enact functions like recurrent or conditional payments 
  • To the extent possible, the ECB should ensure that the digital euro is compatible with private digital payment solutions
  • The digital euro could be used offline — i.e., peer-to-peer validated payments could be made from device to device without an internet connection, if in close physical proximity 
  • The ECB should develop instruments to limit the use of the digital euro as a store of value, which may include setting holding limits (accounting to both online and offline holdings)
    • However, users would be able to use the digital euro for payments of any amount. In instances where the payment value was above the specified holding limit, additional funds would be transferred automatically to (or from) a linked commercial bank account via a 'waterfall' (or 'reverse waterfall') mechanism
    • Offline holding limits would be lower and would be provided for in an adjusted AML / CFT framework
    • Users may have one or several digital euro accounts — however, the individual holding limit would apply across the board
    • Although the value of the holding limit is yet to be specified by the ECB, reporting from the Joint Research Centre notes that a digital euro take-up of less than €3,000 per household “would not pose any significant risks to financial stability”
  • All credit institutions providing payment services will be required to offer basic digital euro payment services, upon request and free of charge. Distribution would also be allowed by authorised payment service providers (under PSD II)
    • Basic services include opening / closing an account, consulting balances, funding / defunding an account (including managing waterfall or reverse waterfall flows) and making payments or purchases
    • Credit institutions could only charge customers for any commercial bank accounts to which the digital euro may be linked or for voluntary, non-basic services (e.g., conditional payments). In general, all distributors would be allowed to further innovate solutions for clients, for which they could charge a fee
    • Some public entities (e.g., post offices) would also support basic distribution — to accommodate individuals without a commercial bank account
    • Distributors would need to provide digital inclusion support to assist with onboarding and use of digital euro services
    • An ancillary proposal is included in the EC's package, which regulates distribution for providers in non-euro denominated Member states
  • The digital euro would offer a high level of privacy that would be ensured by the European Data Protection Supervisor
    • Online transactions would offer the same level of data privacy as existing digital means of payment, while offline transactions would offer the same level of privacy as 'taking cash from an ATM'
    • The ECB would only have access to encrypted data — and only to the extent that is necessary to settle transactions and support providers
  • As legal tender, merchants would be required to accept the digital euro as payment (unless they have expressly made an alternative agreement with their customers)
    • There would be an exception for very small merchants (i.e. those who do not have the infrastructure to accept other forms of digital payment)
  • Merchants would be required to pay providers a 'capped' fee to process digital euro payments 
    • These fees should not exceed the lower of (i) the relevant costs incurred by providers and (ii) fees requested for comparable means of payment (e.g., debit cards)
  • Access would be available to:
    • Those residing in Member states whose currency is the euro
    • Those who opened a digital euro account at a time they resided in Member states whose currency is the euro — however, this may only be granted temporarily
    • Visitors — however, this may only be granted temporarily
    • Those residing in Member states whose currency is not the euro — subject to conditions agreed between the relevant national authorities
    • Those residing in third countries  subject to conditions agreed between the relevant national authorities

The proposal also outlines expectations for the ECB to report regularly to the Council, Parliament and Commission. In particular, the ECB must report on instruments to limit the digital euro's use as a store of value no later than 6-months before any planned issuance (and at regular intervals afterwards). 

While previous ECB timelines indicated that a digital euro could be launched by 2026, the Q&A sheet that accompanies this proposal now notes that this would not be possible before 2028.

Despite the initial narrative around CBDCs being closely linked to blockchain, Fabio Panetta (who leads the ECB's CBDC work) has recently flagged that blockchain technology is unlikely to have the processing power to support a digital euro aimed at catering to ~350 million Europeans. Instead, the digital euro may need to be designed on a centralised ledger — albeit one that is compatible with decentralised blockchains.

Legal tender of euro cash bill

As mentioned, the digital euro proposal was accompanied by an associated proposal on the legal tender of euro cash. This proposal predominantly aims to deter criticism of the digital euro initiative as being a covert way to phase out cash, by codifying and clarifying cash's legal tender status and setting out mandatory rules for its acceptance and accessibility (i.e. 'access to cash').

Following a judgement by the European Court of Justice in 2021, this is the first time that a definition of legal tender will be set out in secondary legislation. In view of the potential issuance of a digital euro with legal tender status, it's important to regulate this definition to ensure consistency among the two forms of public money. This will ensure that, taken together, they will operate interchangeably as a 'single currency'. 

The proposal delegates enforcement obligations to the European capitals, who would be required to monitor cash acceptance and access levels and provide annual updates to the EC and ECB (also evidencing measures they are taking to address any problems identified).

Further afield

In the UK, the Bank of England (BoE) and HM Treasury consultation for a digital pound closed on 7 June 2023, with the BoE now moving onto the 'design' phase of the project. Read more in our recent article here.

According to a recent BIS report, 93% of surveyed central banks are considering issuing a CBDC. Specifically, the survey suggests that there could be 15 retail and 9 wholesale CBDCs publicly circulating before the end of the decade. However, what’s interesting to note is that, of the first-mover jurisdictions who have already minted their own CBDCs, uptake has been low. Research from think tank Bruegel indicates that, for the most part, these CBDCs constitute less than 1% of currency in circulation. This seems to be the result of a slew of possible factors including citizens mistaking CBDC for privately issued cryptocurrency, lack of merchant acceptance and distrust in the underlying fiat itself.”

What does this mean for financial services firms?

In October, the Governing Council of the ECB is set to decide on whether to proceed with the next phase — the “develop and test” phase — of the digital euro, bringing them closer towards a final decision on issuance. 

In the interim, this proposal set forth by the EC, clarifies a base-line framework that financial institutions could expect in an eventual ‘yes’ scenario. And it is one that would have significant impacts on the business models of banks and other payment service providers. 

Although plenty of debate is still expected — particularly when the proposal reaches MEPs — the direction of travel seems to indicate that this is no longer a question of ‘if’ but 'when' and 'in what form' a digital euro will come, and how institutions should respond. 

Alongside this, firms are also concurrently operating within a wider payment ecosystem that continues to evolve and develop. MiCA’s regulatory framework for stablecoins is being implemented, while other initiatives (like the proposed instant payments regulation) are progressing to improve the efficiency of payments infrastructure.

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