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How Regulators Nearly Killed Off Libra—and Why They Might Yet Have Second Thoughts About the Digital Currency

October 21, 2019, 10:44 AM UTC

Facebook’s Libra project is fighting for its life after taking a mauling from regulators and politicians who, while they may like the idea of a global digital currency, don’t trust the social media company an inch to operate it.

CEO Mark Zuckerberg, who’s due in Washington this week to defend his latest brainchild in front of the House Financial Services Committee, wants to build a payments infrastructure that would open the door to executing all manner of transactions on Facebook’s social networks or its messaging platforms. By doing so, he would diversify the group’s revenue away from ads, while simultaneously making the ad business more valuable by adding a new dimension to the sites that host them.

But pressure from Capitol Hill and, to a lesser extent, from Frankfurt, Paris and London, have deprived him of fully one quarter of the companies who he hoped would help him build Libra. Analysts say he might yet succeed, but the chances are that the project will launch later and with less reach—if at all.

The reaction from politicians has been mostly hostile: Visa, Mastercard and Stripe bowed out earlier this month after being warned off it in strikingly aggressive terms by Democratic Senators Sherrod Brown and Brian Schatz.

“Facebook appears to want the benefits of engaging in financial activities without the responsibility of being regulated as a financial services company,” the senators warned. “If you take this on, you can expect a high level of scrutiny from regulators not only on Libra-related activities, but on all payment activities.”

Rep. Maxine Waters has gone even further, circulating draft legislation explicitly aimed at blocking Libra, called the “Keep Big Tech out of Finance Bill.”

“A very serious blow”

It’s not just a Democrat position. Treasury Secretary Steven Mnuchin also took responsibility for scaring them off in an interview with CNBC earlier this week. Mnuchin said he met with Libra representatives many times and had been “very clear” they would face the wrath of the Financial Crimes Enforcement Network if Libra didn’t come up to snuff on anti-money-laundering standards.

“I think they realized that they’re not ready, they’re not up to par,” Mnuchin said. “And I assume some of the partners got concerned and dropped out until they meet those standards.” With PayPal, eBay and Booking.com also jumping ship, the project has lost a lot of its payments-related expertise (and, one assumes, a good deal of its lobbying power).

“It’s a very serious blow,” said Lu Zurawski, head of consumer payments at Nasdaq-listed ACI Worldwide. “Payment companies with intimate experience of regulatory matters pulling out raises questions about Libra’s trajectory towards political approval. The fact that e-commerce companies are also turning their back on the project poses further problems, because of the loss of network effect.”

In Europe too, Facebook’s project immediately ran into formidable problems of trust, due to its repeated controversies with the handling of its user data. In a withering attack in September, European Central Bank board member Yves Mersch’s initial criticism of Libra was that it was headed “by the very same people who had to explain themselves in front of legislators in the United States and the European Union on the threats to our democracies from their handling of personal data on their social media platform.”

But Mersch also landed some telling punches as regards Libra’s shortcomings as an actual currency: it lacks a lender of last resort, and any form of deposit guarantee system. Moreover, he argued, it’s set up to dodge responsibility if it goes wrong—a familiar criticism of Big Tech’s scale-fast-fix-later business model. (Uber, no stranger to similar accusations, is one of the biggest names left in the circle of Libra backers).

“Who would stand behind it in a liquidity crisis situation?” Mersch asked. “The limited liability of the Libra Association members raises serious questions about their resolve to satisfy the claims of Libra holders with their full faith and credit, as central banks do with public money.”

Part of the trouble, of course, is that even without some of its partners, a currency with 2.4 billion potential users is a potential threat to the global financial system from day one. Not for nothing did Bank of England Governor Mark Carney tell the U.K. parliament this week that: “This will not be a case where something gets up and starts running and the system tries to work out after the fact how it’s regulated. It’s either going to be regulated properly, overseen properly, or it’s not going to happen.”

The ferocity of the backlash has left David Marcus, hired from PayPal by Facebook to lead the Libra initiative, playing defence. “For the record, this is not tough, it’s right,” he said of Carney’s comments. “And we all agree.”

Marcus insisted to Bloomberg TV on Thursday that “we are going to move forward. We are going to add more members.”

Regulators in the dark

With some of its biggest backers pulling out, new members may well want more assurances of clarity before they put money into the project. For now, FINMA, the financial regulator in Switzerland where the Libra Association has set up shop, can’t say how it intends to regulate Libra because Libra hasn’t formally asked for a specific license yet.

Generally, financial firms are supervised with differing degrees of intensity according to their activities and their size. A small firm that only wanted to facilitate payments would normally be checked for anti-money-laundering procedures and the safety of client funds, but little else. But Switzerland, like most everywhere else, sets the bar higher if you want to engage in taking deposits or making loans, and a lot higher if you are so big that you would bring the financial system down with you if you crashed, like Lehman Brothers in 2008.

By signalling its intention to issue tokens, Libra has made clear that it wants to be more than just a payments system, FINMA said. But it’s not clear from the information Libra has published what other activities will need to be supervised, or by whom. One thing that is clear, FINMA said, is that Libra’s global ambition will require regulators to coordinate their policies.

After making no attempt to hide its ambition to shake up the global financial system, Facebook managed to rally the whole of the G7 against it by the time the countries’ finance ministers met in July. The G7’s report, published on Friday, recommended that no global stablecoin should be issued until all the relevant regulatory concerns had been addressed. (A stablecoin is a means of payment that aims to offer the benefits of speed, cost and security of digital transactions, while minimizing the risk of wild swings in its value by tying it to a reserve of traditional currencies.)

Libra tweeted last week that it wouldn’t ever have dreamed of doing otherwise (the company that lives by “Move Fast and Break Things” is just one of 21 equal partners in the project, you understand). But given that the G7’s to-resolve list for Libra included antitrust and data privacy issues as well as those related to the financial system, the intended 2020 launch date looks as if it may be optimistic.

“One of the lessons for other potential new entrants into the cryptoassets world is that it’s best to develop out of the public eye, until you are ready to deliver your project,” Dan Wolfe, managing director of Simoleon Long-Term Value, said in an email exchange. “There seems little advantage to making loud announcements long in advance of project launch.”

Even since the scale of backlash became clear, says Martha Bennett, an analyst with research group Forrester, Libra’s statements have been “thin on detail” and downright unhelpful in their evasive tone.

“There’s not much point in reiterating that Libra won’t pose systemic risk—if regulators and governments have concluded that it does, a more comprehensive and in-depth response is called for,” Bennett said. “If they want to continue with this, it needs a complete reset.”

The China question

And yet it’s not that the project doesn’t have friends. Even the central bankers whose own payment systems and monetary policies are threatened by it acknowledge the benefits of making payments faster, cheaper and easier. The Federal Reserve wants to launch a new system, called “FedNow”, to do just that. But its launch date is years away. The ECB’s deepest thinker, Benoit Coeure, wishes central banks’ systems worked so well that people didn’t need to resort to crypto assets. According to Carney, the U.K.’s system is too slow, too expensive and just “not good enough in this day and age.”

All are haunted, to greater or lesser degrees, by the fear that squashing innovation in digital assets will one day hand control of the global financial system to China, where closer cooperation between the private and public sectors has allowed faster progress to be made.

Indeed, Carney admitted to a forum hosted by the International Monetary Fund on Thursday that Libra, which is supposed to be backed 1:1 by a reserve of fiat currencies from around the world, looks more than a little like the future of the global financial system he was calling for at this year’s Fed symposium at Jackson Hole. In his speech there, Carney spelled out how the dollar’s dominance made the global economy and financial system more fragile and vulnerable to shocks.

“There is an upside from (Libra) having a basket currency,” Carney said on Wednesday. “If it is adopted in that way, it would be part of rebalancing the system away from the hegemon right now, which is the U.S. dollar, to something more balanced.”

Others, such as Robert Courtneidge, CEO of London law firm Moorwand, say it’s more likely that the U.S. will try to co-opt Libra into being a digital version of the dollar, aiming to defend the greenback’s primacy in world markets. At that point, Zuckerberg and Marcus could surely declare Mission Accomplished, irrespective of their stated aims of giving the world’s unbanked access to finance.

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