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By Richard Hill
The CFTC’s acting chairman is signaling he may be more open to helping incubate financial technology than other federal regulators.
J. Christopher Giancarlo has indicated he is more willing to create safe spaces dubbed “regulatory sandboxes” in which fintech companies can experiment with new ideas without fear of being tapped on the shoulder by authorities. The result could radically change the derivative industry’s settlements and recordkeeping processes, industry observers told Bloomberg BNA.
Foreign regulators from Singapore to the U.K. have also embraced the idea of regulatory sandboxes, but Comptroller of the Currency Thomas Curry and Federal Reserve Governor Lael Brainard have both been skeptical in public remarks.
“Of the U.S. regulators, it seems Giancarlo has been the most vocal about working with fintech firms and allowing them room to innovate,” Nikiforos Mathews, a partner at Orrick, Herrington & Sutcliffe LLP, told Bloomberg BNA. “The approach he’s taking is, listen and learn. Have [fintech innovators] come up with their models and products and keep a close eye on them, but you don’t have to put up obstacles left and right.”
Giancarlo became acting Commodity Futures Trading Commission chairman in January and is a leading contender for the position permanently.
Giancarlo has spoken frequently since becoming a commissioner in 2014 about the virtues of fintech for both market participants and regulators. In one of his first moves as acting chairman, Giancarlo appointed a special adviser for fintech matters and told staff that fintech “will become an increased focus of our work.”
His approach already sets him apart from the CFTC’s last chairman, Timothy Massad, who generally didn’t publicly address fintech issues.
Giancarlo has singled out the potential promise of “distributed ledger technology” (DLT)—a shared, decentralized, cryptographically secure ledger of transactions—of which blockchain is probably the best known.
Blockchain was originally created to track virtual currency transactions. If adapted to derivatives markets, it could prove equally useful to both regulators and market participants. Blockchain could help modernize trade settlement and recordkeeping, turning processes that used to take days into minutes and providing regulators a near real-time window into derivatives data.
“Blockchain can help regulators put in place real time compliance processes,” Paolo Tasca, director of University College London’s Centre for Blockchain Technologies, told Bloomberg BNA. Regulators potentially can “better extract and analyze firm and market information in order to enhance their” capabilities, he said.
Major financial institutions are already working on using blockchain. Last month, Depository Trust & Clearing Corp., a leading financial settlement firm, announced plans to partner with IBM and others. Overall, approximately $450 million was invested in 2016 in companies that are creating distributed ledger technology, according to PricewaterhouseCoopers.
Giancarlo has said his plan for fintech is to first “do no harm” to the fledgling technology. CFTC regulators, working with their peers at the Securities and Exchange Commission and the banking authorities, should “participate directly” with fintech innovators in order to “advance regulatory understanding of technological innovation,” he said in a December speech.
“I see a focus on trying to understand the technology and its potential benefits and fostering the advancement of the fintech sector in a way that it’s under the watchful eye of the regulators,” Mathews, global co-head of Orrick’s Derivatives Group, said of the agency’s approach to fintech.
Mathews said Giancarlo may designate tech-savvy people at the CFTC to work closely with fintech innovators, and give the fledgling industry “breathing room” so it can experiment without worrying about heavy-handed oversight.
Such a light touch would allow for innovation and competition, but also keep the CFTC involved as the technology matures—both in terms of learning about the innovations and the various ways it can be applied, and making sure its development stays within certain parameters.
“If you’re knowledgeable about their innovations, then you’ll be in a better position to raise any red flags,” Mathews said.
Regulators in the UK, Australia, Singapore, Hong Kong and Japan have adopted a similar model. Such “sandbox” programs “open up a dialogue between market participants interested in using fintech and regulators,” Bo Harvey, an attorney at McGuireWoods LLP, New York who co-authors a blog on the intersection of fintech and legal issues, said in an interview.
“Based on his speeches, [Giancarlo] supports a regulatory sandbox,” Harvey said.
U.S. banking regulators have been more skeptical of giving fintech too much regulatory freedom, however. Federal Reserve Governor Brainard said in October that it would be “premature” for the Fed to consider a DLT sandbox because the technology still is too immature while Comptroller of the Currency Curry was equally skeptical a month later.
Giancarlo is presenting himself as the most ambitious U.S. regulator in incubating and leveraging DLT, observers said. “I think he’s a little bit ahead because he’s thought more deeply about it and the effects of redundant technology,” McGuireWoods partner John Servidio said in an interview.
The CFTC has historically been the regulator most open to innovating and bringing along new technology such as shifting from floor to electronic trading, Paul Architzel, co-head of the futures and derivatives group at Wilmer Cutler Pickering Hale and Dorr LLP, Washington, said in an interview.
“I think the idea behind what he is doing is to recapture that spirit,” Architzel said.
Not everyone agrees that a stand-back approach is the way to go. “I think there’s a lot of drawback with a hands-off, let-the-industry-take-the-lead approach,” said Tyson Slocum, a policy analyst at consumer-oriented Public Citizen. For one thing, the interests of exchanges and major market participants, such as banks, which are taking the lead in developing fintech tools, don’t necessarily align with the public interest, he said.
“An infrastructure that’s going to effectively serve the needs of a JPMorgan or CME Group is not necessarily the same thing that is going to serve the needs of consumers that are impacted by these markets,” Slocum said. “You can’t just let industry pursue a technology path that is going to prioritize their interests without also ensuring it’s not going to compromise other interests.”
Nor do the institutions most likely to benefit from a pro-innovation model have the best records for being transparent about their vulnerabilities and failures, Slocum said. “As part of any transition [to using DLT], the industry has to do a far better job of reporting and sharing [technological] vulnerabilities,” Slocum said. “I don’t think it’s an appropriate role for regulators to say, we’re going to trust industry and some of the for-profit exchanges to do the right thing. I don’t they’ve earned the public’s trust.”
While Giancarlo seems leery of regulating DLT and other fintech applications too soon, regulators will eventually have to modify existing rules or adopt new ones, Architzel and others said.
“The current rules were developed in the context of the current technological framework,” Architzel said. “In order to apply [the rules] to new frameworks or contexts, they need to be examined to see whether they can apply as currently drafted, or if they need to be amended or tweaked.”
Architzel likened fintech innovations to the advent of high-speed, computerized trading and that industry’s need for more contemporary rules. “Saying that an algorithmic trader has to abide by rules that existed 20 years ago doesn’t really make sense,” he said.
“At the end of the day, with early regulatory involvement, regulators are going to understand the market better [and eventually] put out smarter rules,” Mathews said.
To contact the reporter on this story: Richard Hill in Washington at firstname.lastname@example.org
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
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