Bahrain’s Future-Ready Regulatory Landscape

As AI and Fintech revolutionise global banking, Bahrain’s regulatory frameworks evolve to balance innovation and consumer protection. Gaby Samir El Hakim and Maha Alkhabbaz of NBB and Sayed Mahmood Al Alawi of Qarooni Partners examine the intersection of these technologies with legal developments, highlighting the opportunities and challenges ahead.

The rapid evolution of artificial intelligence (“AI”) and financial technology (“Fintech”) has transformed the banking landscape worldwide, creating opportunities and challenges for institutions across the globe. As leading lawyers in the banking and finance industry in Bahrain, we have witnessed firsthand how regulatory frameworks are developing to keep pace with technological advancements.

Fintech encompasses a broad range of services, from mobile payments and peer-to-peer lending to blockchain and robotic advisors. The proliferation of these technologies has democratised access to financial services, particularly for underserved populations. However, with this growth comes unique risks and challenges, as regulatory landscapes are pushed to keep pace with changing trends and address key legal concerns. This article aims to explore the intersection of fintech and AI with regulatory developments, emphasising the need for a balanced approach that fosters innovation while safeguarding consumer interests.

LEGAL LIABILITY: ARTIFICIAL INTELLIGENCE

With innovation comes an undeniable challenge of balancing innovation with core legal principles, such as the grant of a separate agency or a separate legal personality to an AI program. This triggers a range of queries, such as whether an AI program can own assets, hold intellectual property rights, and be liable for any loss or damages that occur.

The legal framework governing such innovation currently in place in the Kingdom of Bahrain is the Electronic Transactions Law No. 54 of 2018 (as amended from time to time), which can be argued to recognise the legality of AI programs/devices and to grant them the power and authority to engage in legal transactions with binding effect, acting as an agent.

This is evidenced by the concept of an ‘Electronic Agent’ under Article 1, defined as “A computer program or any other electronic means used to perform an action or to respond to electronic records or acts – in whole or in part – without review or intervention by any natural person at the time of performing the act or responding to it.” This is further supported by Article 14, which states that a contract entered into by an electronic agent and a natural person, or between two electronic agents, is valid and enforceable.

However, as an AI program does not have the ability to distinguish right from wrong, therefore they lack legal capacity and cannot be granted a separate legal personality under the law. Under the laws of Bahrain, AI programs/devices are given the legal capacity of an agent, thus the responsibility resulting from their action rests with the principle who is their guardian. Legal precedent in Bahrain dictates that any act performed by an agent within the scope of their agency shall be attributed to the principal as if the principal had performed it personally. Consequently, the principal shall be responsible for its execution and has the standing to participate in any dispute arising from it.

REGULATORY LANDSCAPE IN THE KINGDOM OF BAHRAIN

1. Crypto-Assets

As of now, regulatory bodies around the world are assessing the implications of Fintech. It is key for the regulator in the Kingdom of Bahrain, being the Central Bank of Bahrain (“CBB”) to strike a balance between innovation and regulation.

This is evidenced by the Regulatory Sandbox Framework developed by the CBB in 2017, which enables Fintech entities to experiment and further enhance their technology-based solutions and ideas within a controlled and innovative environment, without being burdened by regulatory and financial requirements that would otherwise apply.

Moreover, the CBB has issued comprehensive regulations on licensing requirements, capital requirements, its supervision, and its governing of the use of regulated crypto assets, as set out in Volume 6 – Capital Markets of the CBB Rulebook. The regulations aim to minimise the unlawful use of crypto-assets and financial crime incurred as a result, where crypto-assets are defined under such regulation as any ‘virtual or digital assets as tokens, operating on a blockchain platform’. Such regulated services include the reception and execution of orders on behalf of clients, portfolio management, investment advice, and crypto asset exchange services. The license which may be granted by the CBB is set out in four license categories, subject to which of the regulated crypto-asset services will be undertaken. Capital requirements range from a minimum amount of BHD25,000 to a maximum of BHD300,000, subject to which of the four license categories is applicable.

It is highlighted that in March 2022, the CBB has granted a license to Binance to operate as a cryptocurrency exchange platform, being the first of its kind in the GCC.

The CBB regulation has a significant impact on the digital asset industry, as it ensures that such is a well-regulated industry that protects all key stakeholders (such as the investor) and it assists in attracting foreign investors to be involved in cryptocurrency exchange.

2. Stablecoin

The CBB has further issued an open consultation paper on October 20, 2024 regarding a proposed regulatory framework to issue and offer stablecoins, with the aim of further developing the financial sector. A stablecoin is a type of cryptocurrency designed to maintain a stable value by pegging its price to a reserve asset, such as a currency (e.g. the Bahraini Dinar) which is known as “Fiat-Collateralized Stablecoins” or a commodity (e.g. gold) which is known as “Commodity-Backed Stablecoins”. The proposed regulatory framework has only allowed for Fiat-Collateralized Stablecoins. According to SIO 1.2.1 stablecoins can be backed by Bahraini Dinar, US Dollar or any other fiat currency acceptable to the CBB. Furthermore, SIO-6.1.7 provides that reserve asset can be held in 4 secure forms: (a) Cash and deposits held with banks rated at a minimum AA- or equivalent (b) Debt securities with residual maturity of 90 days or less issued by the central bank of the reference currency (c) Backed repurchase agreements with a maturity of 7 days or less (d) Short term government money market funds.

Stablecoins contrast with traditional cryptocurrencies like Bitcoin, which are decentralised, have a finite supply, and are intended as an alternative to traditional currency. As such is backed by a tangible currency or commodity as reserve, it holds lower risk than a standard cryptocurrency.

Such proposed regulation governs the issuance, total supply of, minting and burning of stablecoin, being a form of crypto asset with a stabilisation mechanism that maintains a stable value against a specific asset.

The impact such proposed regulation may have on financial institutions falls under the role of a ‘stablecoin custodian’, where reserve assets for stablecoins must be held by a third party, such as a bank, investment firm, or independent custodian (subject to a rigorous selection process). According to SIO-6.4.7, a custodian must “have the necessary expertise and market reputation to safeguard the reserve assets, considering the accounting practices, safekeeping procedures, and internal control mechanisms of those entities.” Additionally, financial institutions may be an issuer of stablecoin, which will trigger additional IT security, audit, internal control and governance requirements. By way of example, a financial institution may issue one stablecoin to a customer in exchange for a deposit of one dollar. At any time, that customer may redeem the stablecoin for the value of a dollar, where greater protection is provided as a result of the stablecoin being pegged to a currency.

CONCLUSION

The Fintech revolution presents both opportunities and challenges for the banking sector. As we navigate this evolving landscape, it is imperative that regulators, fintech companies, and traditional banks work together to create a regulatory framework that encourages innovation while protecting consumers.

Text by:

GABY SAMIR EL HAKIM, group chief legal officer & corporate secretary,
National Bank of Bahrain B.S.C.

MAHA ALKHABBAZ, legal counsel, National Bank of Bahrain B.S.C.

SAYED MAHMOOD AL ALAWI, partner, Qarooni & Partners