On 16 September 2015, in a speech by Greg Medcraft, Chairman of the Australian Securities and Investments Commission (“ASIC”) and Chairman of the International Organization of Securities Commissions (“IOSCO”), the key topic of discussion was the future of the financial markets and the impact that technological innovation has had and will have on them. In his speech Mr Medcraft addressed a number of opportunities and challenges to consumers and regulators and emphasised the scale and importance of the changing environment. There were three main topics covered in the speech:
- the changes which digital disruption is bringing to existing business models;
- the potential of such developments for the capital markets, with particular reference to the emergence of blockchain technology; and
- the potential responses by regulators to such changes.
Digital innovation in the financial services industry:
- The continuous growth of digital disruption has enormous potential to reconfigure and radically improve the efficiency of global capital markets. Digital disruption will give investors, and businesses looking for capital, more direct, more immediate and cheaper access to each other thereby accounting for a more fluid and dynamic industry altogether. However, what this means for regulators, is reconfiguring their toolkit around the end users of the markets’ businesses and investors – and how they behave. Hence, some of the key challenges faced by regulators involve striking a balance between a free-market based system and investor protection, as Mr Medcraft pointed out – cyber resilience is critical in a growing digital economy due to the opportunities and challenges posed by the structural change and digital disruption coming about as a result of the continuously developing technologies which impact the markets.
However, Mr Medcraft stated that it is his belief that the great drawcard of digital disruption is the opportunity it brings, therefore signaling his and the organisations he represents, open-arm approach to change and innovation. Some of the key technological developments in the financial services industry discussed in the speech include:
- peer-to-peer lending and market-place lending;
- robo-financial or digital advice;
- crowdfunding; and
- payments infrastructures (e.g. digital currencies, Apple Pay).
All these innovations have the potential to change the way that investors and financial consumers interact with financial products and payments. But many of these activities may not fit neatly within existing regulatory frameworks or policy. However, one particular element of innovation which Mr Medcraft focused on in his speech was blockchain and its impacts. Blockchain is the algorithm behind bitcoin that allows it to be traded without a centralised ledger. In basic terms, it is an electronic ledger of digital events – one that’s ‘distributed’ or shared between many different parties. And it maintains a continuously growing list of data records.
- The three key features of blockchain are that: (i) it is a vehicle for transferring value and holding records – each transaction or record is evidenced by a unique data set or ‘block’ that attaches to the continuously growing blockchain; (ii) it does not involve a central authority or third-party intermediary overseeing it or deciding what goes into it. The computers that store the blockchain are decentralised and are not controlled or owned by any single entity; and (iii) every block in the ledger is connected to the prior one in a digital chain algorithm. So the record of every transaction lives on the computers of anyone who has interacted with it, and is updated with each entry. The continual replication and decentralised nature makes it secure. Thanks to these features, blockchain can transform the capital markets by increasing efficiency and speed, disintermediation, reducing transaction costs and improving overall market access. For this reason the usage of blockchain in practice has been consistently growing, some examples of such use include:
- a series of start-ups are looking to use blockchain to execute and settle securities and derivative trades;
- the US stock exchange, NASDAQ, is experimenting with using blockchain technology as a way of recording private equity transactions. In doing so, it hopes to provide ‘extensive integrity, audit ability, governance and transfer of ownership capabilities’;
- a US firm is developing a way to use blockchain to record and settle short-term government bond trades on a distributed ledger; and
- in Mexico City a firm has developed an app that lets migrants send money via the blockchain to Mexico and withdraw cash from ATMs.
Response from regulators:
- It is important for regulators to ensure that their response to the continuously evolving technological advancements in the financial services industry is sufficiently harnessing the opportunities and the broader economic benefits – not standing in the way of innovation and development. At the same time, regulators also need to address the risks associated with these advancements and to mitigate them as much as possible, something which has proven to be a challenging task. In particular, the AISC and IOSCO have addressed these issues in the following manner:
- supporting investors and financial consumers in understanding the opportunities and the risks of participating in the digital economy and providing industry guidance in the relevant areas. For example, AISC’s MoneySmart website, which last year received over 5 million visits;
- monitoring the market to develop an understanding of how investors use technology and financial products and the risks that arise;
- enforcement where misconduct has been detected, a particular challenge in this area will be to understand how regulatory action can be taken where a transaction entered into is recorded in the blockchain; and
- proving policy advice in order to ensure the right regulation is in place to protect investors and keep them confident and informed, while also not interfering with innovation.
- identifying and understanding the risks flowing from digital disruption to business models (the IOSCO Board will be holding a roundtable in October in Toronto to discuss financial technology developments and regulatory responses);
- designing regulatory toolkits and responses that are flexible, creative, and provide incentives for financial technology innovation that drive growth without undermining investor and financial consumer trust and confidence in our markets (such as work currently being considered in the crowdfunding space);
- developing cyber resilience by working with the Committee for Payments and Market Infrastructures to develop guidance that will help strengthen the cyber resilience of financial market intermediaries (expected to be finalised in 2016); and
- enhancing IOSCO’s Multilateral Memorandum of Understanding – or MMOU – to deal with the new technological environment which the financial services industry is entering.
Despite the amount of attention drawn towards the technological innovations in the financial services industry, there is still little certainty on a general level in regards to the approach to be taken by regulators due to the flexible and fluid nature of innovation. Financial services firms which are involved in or are utilising new technologies should seek assistance from regulators in their respective jurisdictions in regards to innovative financial products and systems. For example, in UK, the FCA have sought to assist such firms through their Project Innovate and by creating innovation hubs where firms can receive feedback from the regulator and can consult on matters where there is little clarity.
To view the full keynote speech by Greg Medcraft please follow this link.
Should you require any further advice or information on the above, Cleveland & Co, your external in-house counsel, are here to help.