Luc Frieden, ex-finance minister of Luxembourg, heading VNX licensing process, speaking at the Moscow Stock Exchange

Luc Frieden spent 16 years working in the government of Luxembourg. Notably, he was the Minister of Finance in the post-crisis years, which were challenging for the Eurozone. Now, however, he speaks about the country’s successes in regulating new financial technologies with greater enthusiasm than about overcoming the 2008 crisis. During Frieden’s term of office, Luxembourg attracted companies like PayPal and Amazon (which opened their European headquarters there) and later, owing to the regulatory foundation laid in the country, it even managed to attract cryptocurrency exchanges. Bitstamp, one of the oldest crypto exchanges in the world, was registered in Luxembourg in 2016, becoming the first crypto exchange to be licensed in Europe. The Japanese exchange bitFlyer now operates in the Great Duchy too.

Meanwhile, Russian authorities are still trying to find the right approach to regulating digital financial assets (DFA). They seem to be intimidated by the new technologies: while the first draft bill contained an attempt to define the notions of crypto currency, mining, and token, the draft prepared for the second reading in the State Duma doesn’t mention these notions at all.

Frieden believes that the secret for integrating cutting-edge technologies into the legal framework is very simple: by establishing dialogue with businesses, the Luxembourgish government finds a way to harmonise their operations with the existing legislation. Frieden considers this approach the key to success: the market must have a level playing field for both traditional and innovative participants.

Not so long ago in Moscow, Frieden took part in a round table on regulating DFA and related financial instruments, and on creating digital investment products. Various issues related to creating a framework for digitizing assets were discussed with representatives of bitFlyer, Litecoin, and NEM issuers (the seventh and the 17th crypto currencies by current capitalisation, according to CoinMarketCap), VNX Exchange (a Luxembourgish exchange for tokenised financial instruments), and others. Frieden, who not only assessed new financial technologies as Minister of Finance but also knows the financial market from within, being currently a member of the Board of Directors of the Luxembourg Stock Exchange, believes that DFA are attractive for investors from the point of view of diversification, but only institutional investors should be allowed to work with them at first.

– Digital assets are developing very rapidly today, and countries are trying to figure out how to regulate them. So what should come first – technologies or legislation?

– Law should always follow technologies, because they progress faster, and we must always see: first, just what exactly a new technology carries; second, whether the existing legislative norms are sufficient to regulate the technology; third, whether we should prepare a new law – better a European or an international one in this case because this is a cross-border activity.

– What objectives should legislators and regulators set for themselves when they see how crypto assets and technologies are developing?

– The same objectives as when preparing general legislation on financial services. First, to ensure financial stability; second, to prevent money laundering and funding criminal activities; and third, to protect investors and consumers – especially retail investors.

– Do you think these assets are intended for retail investors?

– As they carry serious risks, they shouldn’t be used by retail investors at first. They are more suitable for institutional investors.

– Do you see any considerable demand for them? From rich private investors, maybe? Besides institutional investors.

– Yes, there is an interest from institutional investors in the context of diversification and the opportunities these assets provide, and this is quite justified. These assets provide new sources of funding – in the fintech area, first of all. A number of investment funds registered in Luxembourg and oriented at institutional investors now have an option of investing in tokens and blockchain-related projects.

Frieden’s method

– You say that legislation should always follow technologies. Please tell us, based on your experience as Minister for Finance: when a cutting-edge technology emerges – how do you see that an increasing number of people are getting interested in it and what steps do you take so as not to stop the development while at the same time protecting investors and consumers?

– The method I used to prepare legislation in the area of financial services has proved highly successful. I created a committee to have regular meetings with leading lawyers, auditors, bank officials, and investment fund managers – with all the interested parties. At the meetings I always heard them out when they spoke about the needs of the financial sector and the legal community. And when they said to me: here’s a new opportunity – then we started to discuss what legislation was necessary to support regulatory and economic development of these services. They used to assist with preparing draft legislation, and after that, of course, it was time for state agencies to start working on the bill to introduce it into the parliament. I think that such constant dialogue between financial professionals and lawyers on one side and the government on the other side is what has made Luxembourg open to business, a place where new financial services are actively developed and offered. A prerequisite for this, of course, is an unbiased attitude to cutting-edge technologies, and so Luxembourg’s successive governments have been taking the approach when new ideas are welcomed instead of being dismissed out of hand. And this is why we are a leading fintech centre in Europe now.

– When was this committee created?

– Even before blockchain emerged. It was when I was appointed minister of finance, and I held this post for five years. I believe that it’s wrong to prepare laws based on theory only – devise them in an ivory tower. Laws are intended to be used, they are written for people. So you have to speak with industry participants and then decide whether you have reached the objectives I mentioned before. You don’t have to agree with industry participants, but you must hear them out because otherwise the decisions you make are theoretical and there’s nothing good about it for the economy.

I faced a similar problem when I was Minister of the Treasury (responsible for budget and financial services – Vedomosti). [The payment system] PayPal was trying to obtain a banking license for operating in Luxembourg. A regulator said to me: we don’t quite see what we are going to do with this new technology. The technology wasn’t taken seriously. Later we analysed our current legislation and said to ourselves that it was really a kind of bank, though not in the classical sense. As a result, they received a full banking license of Luxembourg [it came into effect on July 2, 2007; the European representative office of PayPal subsequently moved from Great Britain to Luxembourg – Vedomosti].

– How much time does it usually take in Luxembourg for such a dialogue to produce a tangible result?

– This can be done very quickly. If there is a consensus, it can take as little as half a year. I’ll give you an example. Luxembourg today is a leading European centre for investment funds. Our legislation is based on European law but we were the first to translate it into national legislation. Luxembourg has not only made it possible for investment funds to arrive, but it has also created an ecosystem due to an inflow of lawyers, auditors, and professionals from other finance-related fields. This is why we have to act fast to create a complete system where all the participants – the government, regulators, and the financial sector – work together within an appropriate legal framework. Without a system based on supremacy of law, an economy is unable to grow.

How to regulate unsafe technologies

– While we are speaking about developing cutting-edge technologies, it looks like in other countries the governments are ready to make their regulation more stringent for such tech giants as Google, Twitter, or Facebook (in the USA, for instance, the Congress put pressure on Facebook because the company had transferred consumer data to third parties). In the EU and in China we can also observe similar processes. Perhaps, these companies have grown too large, like Standard Oil over a 100 years ago?

– This isn’t my approach. You must welcome what companies do in technological and financial areas. You must ensure adherence to the law, effective collaboration, and operational transparency. I never use words like “pressure”. Big international companies are beneficial for mankind, they do much good for its future, they contribute to the progress of the society. The only thing is that you must make sure that the rules are the same for everybody, and that neither the Internet, nor blockchain, nor other technologies, nor financial transactions (which are today, to a great extent, related to technologies too) can be used to violate the law. Supremacy of law is vital.

– But it seems there is a fundamental contradiction between the decentralised nature of blockchain and the nature of legislation and supervision which is, by definition, centralised. How can they coexist?

– I don’t see any contradiction here because cross-border activities are a widespread phenomenon. This is why I believe that in the end legislation must be made European or, better still, international, and we need mechanisms to enable regulators to collaborate so that they employ regulatory measures in a similar way. In the sector of traditional finance the situation is, in fact, the same. This is why, for example, we have created the European banking union where the ECB supervises major banks, and I don’t think that the situation with blockchain is very much different from this one. We are at the beginning of a new process, and before we work out the required standards we must see first how the technology progresses.

– If we speak about cryptocurrency as a payment method – why should monetary authorities permit using an instrument which they can’t control?

– You must remember that crypto currencies aren’t guaranteed by the State; as a means of payment they resemble the barter system of a long time ago. This is why they can’t ensure the security provided by official money.

– But cryptocurrencies and digital assets can be used to avoid state control – this is just what the problem is. For example, Chinese dealers have been known to sell smuggled goods on Russian markets, then buy bitcoins for the earned rubles and then cash the bitcoins in Hong Kong. The state is excluded from this scheme. So governments hesitate to permit using cryptocurrencies because they are afraid they might lose control over money circulation. What do you think about this?

– It’s extremely important to fight against money laundering and funding terrorist and criminal activities. This struggle must remain one of the priorities of any civilised state. It must be ensured that financial instruments, both traditional and new, aren’t used for these purposes. I think it’s possible with an effective regulatory framework for exchanges and new technologies. With blockchain, you can track any step of the transaction for all its participants, this is why supervision in this area can be even more effective than in traditional finance. Some cryptocurrency payment systems – in Japan and in Luxembourg – are already regulated; they are intended to prove to regulators that they have the same mechanisms of control as in traditional banks. Yes, there are certain concerns, like in any sector of the financial industry, and legislators and regulators must find technical and legal responses to these issues.

– In Russia, we haven’t even approached the question of regulating crypto exchanges, we are still at the stage of discussing definitions of cryptocurrencies and blockchain. Meanwhile in Luxembourg there is Bitstamp, a registered crypto exchange created by Slovenian entrepreneurs and one of the oldest crypto exchanges. What were the regulatory requirements for it to receive a license?

– As I said before, we didn’t have any special legislation – neither for crypto assets, nor for blockchain-related activities. We just checked whether our existing norms were sufficient. The Ministry of Finance and the regulator concluded that the law on payment services provided an appropriate legal basis to issue a license for Bitstamp and bitFlyer [the Japanese crypto exchange] as payment service providers. As a result of a discussion with Luxembourg regulators, these exchanges came to a conclusion that they could match the criteria for conventional providers of such services and so they brought their activities in accordance with these criteria. Among other things they introduced the “know your client” (KYC) requirement as an anti-money laundering (AML) measure. Otherwise they wouldn’t have received the license. The law was adopted as early as in 2009 – I introduced it into the parliament; there wasn’t such thing as blockchain then. Such an approach makes it possible to ensure that everyone – traditional market participants and new ones – plays by the same rules. I think it’s important.

It must be said that regulation in Luxembourg is rather strict – you can’t do what you want there. This is a question of the state’s reputation. Our regulators are serious but they are open to new ideas and technologies.

– Still, Luxembourg isn’t used for ICOs (mostly often, initial coin offerings for cryptocurrencies are done in the British Virgin Islands – BVI). Why so?

– I don’t think you can compare Luxembourg with the BVI – these are two different worlds. In the fintech sector we are ready to cooperate on blockchain and even on ICO with those who are serious about working in a regulated international financial centre. And we see a tendency for organisations – for example, in the sector of investment funds – to migrate from poorly regulated financial centres outside Europe to European ones. The ICO sector is still at an early stage of its development, but Luxembourg can still play its part here if the issuer wants to be a serious financial market player in Europe. Even today, you can already perform ICO in Luxembourg under the supervision of regulators, although if you want to do it in the Wild West – you are welcome to go elsewhere. As Luxembourg is part of the EU, you receive a pan-European placement after an ICO there, though the process is more complicated because you have to comply with the regulatory norms. If, however, you issue tokens through the BVI and then try to sell them to citizens of EU countries, such a placement is against the laws of the EU and you can end up in jail. There is one other option: if tokens are intended for trading outside the EU, in a country without a regulatory framework – for example, in Africa – then ICO can be done by an organisation registered in Luxembourg (we have already had several placements of this kind). In this case, Luxembourg law is applied to the company, but the laws that protect the rights of European investors aren’t applicable because the ICO isn’t intended for these investors and you can’t sell the tokens, say, in Germany.

– Last year was the year of bitcoin and other cryptocurrencies – their rates first soared and then dropped. I’ve heard an opinion that bitcoin can be compared to Netscape Navigator [one of the first Internet browsers which was leading in mid-90s but eventually lost the competition – Vedomosti]: it’s just the first iteration in the long process of introducing blockchain and crypto-related innovations. Do you think this comparison is justified and what can the next iterations be like?

– Even if cryptocurrencies once were part of a bubble, they will continue to exist. To say it again, they will never replace money issued by the Central Bank and guaranteed by the state, but they are a method of payment, a tool which can be used by some people. This must be taken as a given. There will be further rises and falls, crypto currencies carry risks, and we must reach a common view of what all this means. But I think they have come to stay. And this doesn’t match your example. As for blockchain, I’m not a technical specialist to assess its prospects and potential uses. But you can’t ignore it either, because it’s already here. It opens up new opportunities – and you should always grasp them. This is actually the case with all the technologies that emerged in the last decades – the Internet, self-driving cars, etc: they all carry risks and have some negative side effects but they help us progress in communications, science, medicine. This is why you should never stop technological progress; this would be very bad for humanity.

– In which countries, do you think, the regulatory system in this area is well designed, and in which it is not?

– I never comment on other countries’ laws. I can only say once more that first, legislation should follow technology. And second, there is a need for an exchange of opinions at the international level on how to regulate this in the most efficient way. I have been active in calling the European Union for creating a European legal base for this phenomenon. However, as the digital world isn’t confined to European borders, this matter must be discussed at the international level with the participation of big players such as the USA, Russia, China, and others.

Lessons learnt from the crisis and new risks

– Not so long ago, it was ten years since the global financial crisis. As a Minister of Finance, you had to deal with its consequences. How did the crisis change the mindsets of regulators in the financial sector and in economics?

– As with any crisis, we have learnt a number of lessons. To ensure stability for banks, we established new requirements for capital, restricted high-risk transactions, and made the supervision over cross-border financial activities more coordinated. These are the three main conclusions drawn from the 2008 crisis.

– But have these three lessons been learnt well enough? In the USA, the banking sector is the most likely to withstand possible shocks while the European one remains fairly weak, even after the debt crisis in the Eurozone. Why so?

– I don’t agree that the European banking sector is weak. It is much stronger than it was before the crisis, and the supervision is quite good.

– Why do you think so? There are examples to the contrary. For instance, Deutsche Bank is, to a certain extent, still suffering a reputational and business crisis; many other banks have bonds of weak economies, such as Greece or Italy, on their balance sheets. Also, it is said that if the ECB cuts down its monetary incentives it may hit European banks hard.

– I don’t share this view. As I have said, the finance industry has grown much stronger, and all its participants have proved since 2008 that they can collaborate and that people can trust the industry. It is strong enough to withstand a possible external shock.

– What are the primary risks for the global economy and the financial system that you see today?

– The greatest risk is probably the geopolitical one. Also, the EU and the Eurozone must ensure a stronger coordination in their budgetary and economic policy so that problems in one country wouldn’t bring grave consequences to other countries.

– The USA and the EU have introduced a number of sanctions against Russia. It has also been said that Russian banks will probably be disconnected from the SWIFT system. Is it hard to do?

– The sanctions are a consequence of a number of geopolitical events. This is why it isn’t advisable to concentrate on what might or might not happen. A constant dialogue is needed to find a solution to the problems which gave rise to the sanctions. Everything else is speculation.

– It looks like only the EU stands for the dialogue; neither Russia, nor Great Britain, nor the USA are interested in starting a dialogue. It’s not only the question of Ukraine now – it’s about the Skripal case, for instance, or the interference with American elections.

– For a dialogue, two sides are needed. Some elements of a dialogue can be seen: for example, the summer meeting of the Chancellor of Germany and the President of Russia, and other events – these are positive steps in this direction. The issues to be discussed are complicated, there’s no easy solution. However, Europe needs Russia just as Russia needs Europe because we live on the same continent.

– The USA is considering increased pressure as a solution to the problem. In particular, this can include a prohibition on buying Russia’s national debt. Does the EU consider such a possibility?

– I don’t speculate on possible potential measures. I think we must focus (and European leaders are already doing it) on searching for a solution to the original problems which caused the sanctions. This is more profitable than speculating about what can possibly happen in future. Besides, there is a great number of other matters, apart from geopolitical issues, that must be solved together – the much discussed digital assets, for one. This can serve as a means to keep us from building new walls in place of the ones we demolished 30 years ago.

– Can cryptocurrencies be used to circumvent sanctions?

– No, this isn’t a thing to do, surely! (Laughs.)

Luc Frieden

former Minister of Finance of Luxembourg, Chairman of the Board of Directors of BIL (Banque Internationale à Luxembourg)

Born in 1963 in Esch-sur-Alzette (Luxembourg). Graduated in business law from Université Paris 1 Panthéon-Sorbonne. Obtained a Master’s Degree in comparative law from the University of Cambridge (UK) and a Master of Laws Degree from Harvard Law School.

1994: Member of Parliament of Luxembourg

1998: Minister of Justice, Minister of the Treasury and Budget

2009: Minister of Finance

2014: Vice Chairman at Deutsche Bank Group in London

2016: Chairman of the Board of Directors of BIL (Banque Internationale à Luxembourg), Partner of Elvinger Hoss (Luxembourgish law firm)

The Grand Duchy of Luxembourg

a state in Western Europe

Area: 2,586 sqkm

Population (asofJanuary 1, 2018): 602,005

GDP (as of 2017, expressed in current prices): 55.3 billion euro

Inflation rate (as of October, 2018, on an annual basis): 2.01%

Unemployment (as of September, 2018): 5.4%

Foreign trade turnover (as of 2017):

Exports: 123.36 billion euro

Imports: 104.95 billion euro

National debt (as of late 2017): 23% of GDP

Luxembourg was established in 963 as a county, becoming a duchy in 1354. At different times of its history it was controlled by German, French, Austrian, Dutch, and Spanish rulers. In 1867, Luxembourg’s independence and neutrality were affirmed by the Treaty of London (in 1948 the article on neutrality was removed from the state’s constitution). Luxembourg is a constitutional monarchy; since 1890 the ruling dynasty is the House of Nassau.

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