EU regulatory framework on the establishment of the digital euro: from investigation to realisation

With the approaching end of the investigation phase of the ECB’s digital euro project in October 2023, and the expectance of a decision on starting a realisation phase by the end of this year, the pros and cons of a potential digital euro have been widely discussed in the past months. The topic became even more prevalent after the European Parliament put forward a proposal on the establishment of a digital euro on 28 June 2023. Moreover, during the summer the ECB published two additional progress reports (third report and fourth report), on the ongoing investigation phase of their work.

European Parliament published a proposal for a regulation on the establishment of the digital euro

While EU regulatory institutions and many industry organisations have welcomed the proposal and the discussed technical features, questions are still unanswered and concerns continue to exist. The regulatory text defines the legal tender status, issuance, distribution, use, and technical features of the digital euro.

The digital euro is defined as “the digital form of the single currency” in the Eurozone, hence an extension to the existing fiat currency. It shall be available along already present national and international private means of payment – e.g. cards and electronic banking applications, to the residents of the Eurozone. Payments will be available both online and offline through a digital wallet.

The issuance will be authorized by the European Central Bank (ECB), and executed by the ECB and/or the national central banks. Either way, a digital euro will be a liability of the Eurosystem towards digital euro users. As a legal tender, the digital euro shall entail mandatory acceptance at a full face value.

The regulatory proposal clearly states that the use of the digital euro as a store of value may be subject to limits developed by the European Central Bank. Those include holding limits per account holder which shall apply to the total amount held by a person both online and offline. How is the ECB going to enforce this without accessing real-time user data from the offline accounts is not clear yet. In addition, careful considerations should be applied by the ECB, as the holding limit must strike a proper balance between curbing sudden outflows form bank deposits on one hand and user needs on the other. An initially discussed threshold of 3,000 to 4,000 digital euros per holder leads to a scenario, where most digital euro users are forced to maintain commercial bank accounts and take advantage of the so-called waterfall functionality (users may receive and make payments in excess of the holding limit through a linked commercial bank account, where funds will be automatically routed or pulled from).

The proposed framework calls for the digital euro to bear no interest within the scope of the regulation. While the intended characteristic brings the digital euro closer to cash, there is still room for legislation outside the scope of the proposal. And if at a certain (later) point the ECB decides to use remuneration tools with the digital euro, the distinction between public money and monetary policy instruments will get diluted.

The distribution of the digital euro will be delegated to “supervised intermediaries”, which are payment service providers (PSP) according to Payment Service Directive (PSD2) regulations. Users will have the option to open multiple digital payment accounts with the same and/or different PSPs, and the total amount held across all digital euro accounts should not exceed the set individual holding limit. This brings many technical complications and concerns regarding data sharing and privacy. How would registration with various PSPs be synchronized? Will PSPs be allowed to use personal and transaction data for business purposes? Will PSPs have access to a holder’s different balances only at registration, or at all times?

The success of a digital euro might also be constrained by the proposed regulatory restrictions on commercial incentives for intermediaries. There will be limits on “the level of charges or fees to be paid by natural persons or merchants” to PSPs, as well as limits on the inter-PSP charges. The regulatory text proposes a defined compensation scheme for the PSPs complemented by ongoing monitoring from the ECB and the EBA. Such requirements decrease the opportunities for fair and market-oriented pricing for the service provision. Whereas a digital euro is important for keeping and strengthening the European sovereignty, so is the competitiveness of a European payment system.

A digital euro infrastructure, which is interoperable with the ECB’s core infrastructure and compliant with all rules and regulations, should be built and maintained by the PSPs, thus creating operational risks and up-front costs. In addition, intermediaries will compete to offer their own private-money payments. It remains to be seen how the PSPs will offset such costs and what opportunities will arise for them afterwards.

ECB released progress reports 3 and 4 on the investigation phase of a digital euro project

The Eurosystem’s proposal for a digital euro aims to provide initial access to euro area residents, merchants, and governments. Non-resident euro area citizens could access it if they maintain an account relationship with a euro area Payment Service Provider (PSP). Consumers across the European Economic Area (EEA) and select third countries may gain access in subsequent releases. Uniform holding limits for individuals will facilitate daily transactions, while merchants and governments will have a zero-holding limit. Users can access the digital euro via existing banking/payment apps or a Eurosystem-provided app. PSPs will offer core services with the potential for additional optional and value-added services. The provision of core services (e.g. opening/closing of an account, onboarding and funding/defunding), both online and offline, will be mandatory for PSPs. Optional and value-added services like recurring payments and splitting payments among multiple payers, shall be offered voluntarily. The Eurosystem is also considering interoperability with other central bank digital currencies for cross-currency transactions.

The fourth progress report outlines proposed principles for a compensation model for a digital euro, emphasizing its nature as a public good. It suggests offering basic services free of charge to citizens in line with users’ experience with cash. Furthermore, intermediaries should be compensated for their services, similar to their compensation when offering electronic payments. Charges to merchants are to be controlled by the regulator. Currently, the Eurosystem is consolidating endorsed design options for the digital euro and is conducting detailed analyses on various services and fraud prevention. Prototyping and market research results indicate that a digital euro could seamlessly integrate with the European payments landscape and that many European providers are ready to develop solutions. The Rulebook Development Group (RDG) is drafting rules for the digital euro scheme, focusing on use cases, user journeys, and infrastructure requirements.

All of the requirements towards PSPs, combined with compensation limitations, further confirm the above-discussed pain points for the existing payments industry participants which might need to be further discussed and resolved. The obvious challenges around data privacy, cybersecurity and regulatory complexity are still there as well. Nevertheless, the interrelation between the public and the private sector, which would facilitate the distribution and adaptation of a digital euro needs further consideration and evaluation from all sides. Otherwise, successful execution might not prevail.  

What’s next

Looking ahead, the Investigation phase will be completed in October 2023. By the end of the year, a decision must be reached on whether the ECB shall enter into a three-year Realization phase at the beginning of 2024. In the meantime, the EU Parliament, the Council, and the European Commission will have to enter into a “trilogue” discussion on the adoption of the proposed digital euro regulation. Only time will show how all regulatory discussions and suggestions develop.

Meglena Grueva

Head of Digital Assets Solutions, Mazars in Germany - Frankfurt