A Legal Perspective On Digital Money In Europe

The purpose of this article is to look at some legal perspectives on digital money in Europe but, before doing so, analyses the legal framework for digital money.

Many of the new electronic payment systems incorporate in their name the word "cash" or "money". It is important to understand what these terms mean, in reality, and what the relevance of this is, in terms of the issue of electronic cash or money.

There is some UK case law on the definition of money. Moss v Hancock [1899] 2 QB 111 contains a definition of money which could encompass certain digital payment methods. Money is described as "that which passes freely from hand to hand throughout the community in final discharge of debts and full payment for commodities, being accepted equally without reference to the character or credit of the person who offers it and without the intention of the person who receives it to consume it or to apply it to any other person other than in turn to tender it to others in discharge of debts or payment for commodities".

The word "money" is used in many different contexts. For example, a contract of sale of goods is one where the goods are agreed to be transferred "to the buyer for a money consideration, called the "price" . In the definition of a "bill of exchange", a bill of exchange is an instrument that requires the drawee to pay a sum certain "in money" and an instrument requiring payment of something other than "money" will not be a negotiable instrument .

"Money" appears in some contexts to mean money in its physical form and in others the abstract concept of money. A bank account, for example, is a debt, but bank accounts are not money. Without the consent of the creditor, a debt cannot be discharged otherwise than by the payment of what the law considers as money, namely legal tender.

Legal tender is such money as a legislator in a particular jurisdiction has defined in its statutes as such and governs that country's monetary system. It is not necessarily the case that everything which is "money" is "legal tender" or, indeed, that all legal tender is money. There was a time, in English history, when bank notes were not legal tender and could not be regarded as money for all purposes. The present law in England is that, under the Currency and Bank Notes Act 1954, all Bank of England notes are recognised legal tender. The legal tender quality of coins in the United Kingdom is defined by Section 2 of the Coinage Act 1971 (as amended by Section 1 of the Currency Act 1983).

It is not clear whether "money" is limited to legal tender which, certainly in England, would not include digital cash. If one uses legal tender to pay for goods or services the discharge of the debt using legal tender is an absolute form of payment.

The effect of bank notes and coins being legal tender is that a creditor to whom the appropriate amount is offered in legal tender and who refuses to accept it can have certain adverse consequences for he who refuses to accept .

Legal tender does not depend on any third party performing any obligation. This is different to a cheque, for example, which is a conditional form of payment, dependent upon the cheque being honoured by the bank upon which it is drawn.

With credit cards, the payment position, as to whether it is conditional or unconditional, is as set out in the case of Re Chargecard Services Limited. [1986] 3 ALL ER 289.

In that case, a company operated a chargecard scheme under which it issued chargecards to cardholders. The chargecard could be used to buy petrol and other products from various garages. The company entered into an agreement with C Ltd whereby all present and future debts owed by card holders to the company were assigned to C Ltd. The company became insolvent. At the time of liquidation, a large sum of receivables were due from card holders. One of the main issues which arose was whether the debts due from the account holders (when the company ceased to trade) in respect of petrol and other products were debts due to the garages or debts due to C Ltd.

It was submitted by the garages that payment by card, like payment by cheque, operates as a conditional payment and, on default of payment, the cardholder is liable to pay the garage. It was submitted that there is a general principle of law that, whenever a method of payment is adopted which involves a risk of a non payment, there is a presumption that this method of payment is conditional.

The court stated that payment was effective from the point at which the card holder signs the voucher at the point of sale and that no such general principle of law existed and that payment by credit and chargecards were not conditional forms of payment. This is because of the features that exist when using a chargecard, such as:

(i) The garage had no means of tracing the customer and therefore must have intended that payment was effective from the point of signing the voucher;

(ii) The payment mechanics did not require disclosure of customers' addresses to the supplier; and

(iii) Availability of a chargecard as a payment method was advantageous to both parties.

Trying to transpose the facts of Chargecard to the Internet, for example, the important act in the Chargecard case was the signing of a sales voucher. Clearly, by signing the voucher, the customer is irrevocably agreeing to the transaction. Presumably, the courts would look at the overall facts of an Internet transaction and conclude what act constitutes the equivalent of irrevocable agreement.

Legal tender or cash has several attractive features for the person in possession:

(1) Acceptability: cash is widely acceptable as a form of payment, regardless of the transaction amount;

(2) Guaranteed payment: legal tender, as has been seen above, means that the physical handing over of appropriate coins and notes completes the transaction with no possible risk of dishonour of the payment thereafter;

(3) Transaction charges: cash, being physically delivered from person to person, carries no transaction charges. No authorisations will ever be required (cf. a credit card) and therefore there are no communications charges;

(4) Anonymity: cash is anonymous. Many other forms of payment involve the creation of a paper trail or a "digital trail". This could prevent either or both of the parties to a transaction concealing that party's important information. Anonymity is not solely attractive to fraudsters and money launderers, but also to the man on the street who does not like big brother knowing too much about his affairs, however legitimate they may be.

Systems involving "digital" or "electronic" cash come in a variety of guises. The fundamental difference between them and traditional cash is that streams of digital bits represent payment amounts and there is never physical delivery of those payments.

Perhaps the most important legal characteristic of electronic cash, as it is not legal tender, is that it is not an absolute payment for the discharge of an obligation and the person to whom the debt is owed cannot be obliged to accept a value represented digitally as payment. Hence why agreements between the payer and the payee must provide for the parties to do this and accept a digital payment as payment. Use by a retailer of a particular logo of a provider of a particular type of electronic cash would mean that that merchant is holding itself out as agreeing to accept such digital payments as discharging any debt incurred with it.

Attempts to create an electronic cash payment method have tried to create the cash-like attributes described in the previous section such as anonymity. These systems cannot replicate all the attributes of legal tender - including universal recognition and acceptability.

Banks in the UK provide a number of services which include the lending of money; a vast range of payment services and cash management services; and account holding.

Of these three activities, only account holding (deposit taking) requires the financial institution to be authorised under the Banking Act 1987 (the "Act").

That is not to say that other regulations do not apply to those lending money, for example. Those who lend to consumers may require a Consumer Credit Licence under the Consumer Credit Act 1974. Hence why, subject to consumer credit considerations, stores can issue their own brand credit-based payment cards without requiring a banking licence.

A debit card is different. This is because the debit card structure works because the card holder will have an account with the provider of the debit card to which payments are debited (e.g. Barclays Connect card).

A company that opens accounts for a customer is, in so doing, accepting a deposit from the customer.

If I open an account with my bank, what am I actually doing? For the sake of argument, let us take the example of opening a bank account and paying in £1,000 in bank notes (legal tender). I deposit that money with my bank which is then entitled to use that money as part of its business of banking. By contract, it agrees to give me a rate of interest on that money. The relationship between the bank and me is then one of debtor-creditor, ie that, having given £1,000 to my bank to use, it now owes me a debt of £1,000 -see Foley v Hill [(1848) 2 HL Cas 28]. The important point is that the bank does not simply open an account like opening a safety deposit box and deposit my 1,000 identified pounds in that box. It takes that £1,000 and promises to repay me the sum of £1,000 (but not the same £1,000) should I request it. The obvious danger here is if the bank becomes insolvent. If the bank does become insolvent, it may not be able to repay the debt it owes me. That is why many banking regulatory regimes provide some sort of deposit protection scheme and why banking regulation is primarily aimed at the taking of deposits.

It is an offence under the Act for any institution to carry on a "deposit taking business" without being authorised to do so by the Bank of England. The definition of a "deposit" is, broadly speaking, a sum of money, in any currency, which is paid on terms that it will be repaid, whether with or without interest or any premium, on demand or at some other agreed time (see s 8 of the Act). It can be seen from the above explanation that a deposit is effectively an undertaking by the financial institution to redeem.

With some of the new payment systems being developed with the Internet in mind, the regulatory structure will be dependent upon whether value represented electronically and held by the consumer or a supplier represents a deposit, because it can be redeemed for legal tender or by being credited to some form of account held with the institution redeeming the electronic value.

It is important for issuers to appreciate this since, if it constitutes deposit taking business, this means that it would fall under the full regulation of the Bank of England, including, for example, the liquidity rules under which banks must have a minimum percentage of their assets available in liquid form to enable them to meet all normal foreseeable calls upon deposits. Liquidity usually means such assets bear a lower rate of return for the bank on the assets in question so these issues are important. The Act also imposes on banks certain obligations to run their business in a prudent manner and, in particular, to have regard to how they use technology (see, for example, the Bank of England's "Guidance Note on Accounting and Other Records and Internal Control Systems" .

In July 1998, the European Commission announced proposals for a clearer regulatory framework for electronic money within the EU. The proposals were announced by Mario Monti, the EU Financial Services Commissioner. The intention was to harmonise minimum rules for ensuring that institutions issuing electronic money are stable and sound.

The proposals are intended to increase confidence in the use of electronic money by creating "legal certainty" for electronic money and to assist the growth of electronic commerce in the EU. The Commission recognised the benefits to consumers of using electronic money enabling them to make small payments in euros in other Member States without having to convert national currencies, and this would be particularly true in the period before euro notes and coins are introduced. Mr Monti said that the development of electronic money was "particularly positive" in the light of European economic and monetary union, because of the fact there would be a "gap" between the launch of the euro single currency in 1999 and its physical introduction in 2002, Monti said. "During this transition period ... non-cash instruments will be the only means of making payments in euro." This view was reiterated in May this year by the European Central Bank's Chief Economist Otmar Issing who said that the three-year absence of the euro in the form of banknotes and coins may stimulate the development of electronic money. He said "The only means of access to the euro for households, and possibly for many small firms, (in its first three years) may therefore be via electronic media. The non-availability of the euro in the form of notes and coins could therefore impart an extra stimulus to the growth of e-money and electronic access products".

The other main express intention of the proposal is to create a level playing field between banks and others issuing electronic money and to allow electronic money institutions to offer their services throughout the EU, provided that they have appropriate supervisory authority in their home state. It would lift obstacles to the issuance of cards that exist today in some countries, such as Germany and Italy.

The proposals define electronic money as "monetary value stored on a chip card (prepaid card or "electronic purse") or on a computer memory (network or software money) and which is accepted as a means of payment by undertakings other than the issuer".

The proposal is for two directives, one which would amend the definition of "credit institution" for the purposes of the First Banking Coordination Directive, so as to bring electronic money institutions within the general regulatory regime of the First and Second Banking Directives. This would enable companies wishing to issue electronic money (but not wishing to provide the full range of banking services) to enjoy the benefit of being able to operate throughout the Single Market, based on a home state authorisation. This would put them on an equal footing with credit institutions.

When introducing the measures, Mr Monti recognised that the Commission needed to "safeguard the needs of the monetary policy" within the EU. He said "we feel as legislators we have to make it easy for the European Central Bank, if it wishes, to subject non-bank issuers of electronic money to the minimum reserve requirement that it wants to establish. "

One effect of this proposal might be that all issuers of electronic money could be subject to "reserve" requirements imposed by the European Central Bank as part of its monetary policy measures. Such requirements would mean that non credit institutions would need to satisfy the requirement that a percentage of its assets are available to cover its liabilities in respect of its liabilities incurred by virtue of issuing electronic money. Issuers of electronic money which do not provide a full banking service would be exempt from various of the supervision rules established under the First and Second Banking Directives but would be subject to rules established for issuers of electronic money.

In addition to the above, a Second Directive is proposed which would define the types of business activities that could be carried out by electronic money institutions and it would also seek to define electronic money in a "technology neutral" manner ie. not defining it by reference to any of the various different types of electronic money currently being used or developed.

To meet concerns raised by the European Central Bank and some supervisors, the Commission said that companies wishing to issue electronic money would have to set up "credit institution" subsidiaries, authorised by banking regulators.

The second proposed Directive would establish rules for:

(a) an initial capital requirement for such company (minimum ECU 500,000 or 2% of their liabilities, rather than the 8% laid down for commercial banks) and ongoing funds requirements, including a requirement that investments are limited to highly liquid, low risk assets;

(b) minimum standards and fit and proper management;

(c) ongoing supervision;

(d) prior authorisation by competent national authorities;

(e) requirements for such companies to satisfy their regulators of their sound and prudent operations; and

(f) the application of various directives such as the Money Laundering Directive.

These draft Directives, if adopted, will represent the fulfilment of a commitment by the Commission in a Communication of April 1997, entitled "A European Initiative in Electronic Commerce" to provide a supervisory framework for electronic money.

The UK broadly opposed the position when the proposal was published, concerned that such "bank-style" regulation could in fact stifle this emerging market, rather than encouraging it. Britain, Denmark and Finland are currently among the few countries where there are no rules as to who can issue electronic money unless, of course, the structure of the particular product is such that it involves the issuer of the cash in deposit taking, in which event the Act would apply.

One point that has been made by a European Commission official is that there may well be permitted exceptions from the regulation for "small" electronic money schemes - perhaps within universities or other closed groups where the total amount in circulation is small.

Both proposals for directives were submitted to the EU's Council of Ministers and the European Parliament for adoption under the "co-decision procedure."

The co-decision procedure means that the proposal needs to be approved by the Council of the European Parliament and also by the European Parliament. The proposal had its first reading under the co-decision procedure in April, when a simple majority of the European Parliament was required for amendments to be adopted. On Thursday 15th April, MEPs approved the two proposals, together with a number of amendments.

Astrid Thors, a Finnish Liberal MEP produced to the European Parliament a report of the European Parliament's Legal Affairs Committee which was adopted, slightly amended. The Report recommended some 30 amendments to the original proposal. The Report acknowledged the needs for solvency requirements, illustrated by the recent bankruptcy of the non-bank electronic money issuer, "DigiCash". The Committee in particular called on the Commission to take measures to promote the inter operability of electronic money systems so that payment can be used in other countries and on other systems.

Whilst approving the provisions proposed by the European Commission to set up a regulatory framework providing for guarantees of solvency to prevent bankruptcies, the Parliament also wants to step up consumer protection and encourage the use of electronic money.

It also called for electronic payments to be exempt from any additional charges. Consumers would have the right to obtain, without cost, a refund in coins and notes of the balance of their electronic payment card.

The European Parliament endorses the Committee's call for measures to be taken to secure the inter operability of the different systems.

Since 1st January 1999, the fixing of rates between the eleven euro zone currencies means that national bank bills and coins are merely local expressions of Europe's single currency. However, banks continue to charge for exchanging euro-zone currencies and for cross border transfers. Their argument is that exchange fluctuation risks represented no more than 15% of their charges and that they still need to cover staffing, transport and security costs. European Parliament deputies fear a summer backlash when holiday-makers discover that nothing has changed, despite the high-profile launch of the euro.

Astrid Thors, the author of the report, was of view that the three year window before euro notes and coins are issued in 2002 offers "an opportunity to be seized" by the various organisations currently issuing electronic money. These include Mondex in the UK; Geldkarte in Germany and Proton in Belgium.

During the course of their discussions, the European Parliament particularly welcomed the fact that, at least in its current form, the draft would allow "non-banks" to issue electronic money.

In the middle of May, the European Commission announced a series of policy measures intended to improve the Single Market for financial services over the next five years. The plan includes indicative priorities and timescales for measures, both legislative and otherwise, to obtain three objectives: (a) ensuring a Single Market for wholesale financial services; (b) open and secure retail markets; and (c) state of the art prudential rules and supervision.

As part of this plan the European Commission has pushed strongly for the electronic money proposals to be adopted by the end of 1999.

The text of the May communication is available on the Europa website: http://europa.eu.int/comm/dg15