Regulators Show Interest in Blockchain to Monitor Systemic Risk

All Banking Law, All in One Place. Bloomberg Law: Banking is the comprehensive research solution that powers your practice with access to integrated banking-related legal news, analysis,...

By Stephen Joyce

Dec. 2 — Regulators are looking at whether blockchain technology that uses encrypted databases or ledgers to record and authenticate transactions can help monitor global financial systems for systemic risk.

R3 CEV, a financial services technology company backed by JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and other large banks, has discussed with regulators the possibility of using blockchain technologies, said Charley Cooper, the firm's managing director. Cooper told Bloomberg BNA that regulators in jurisdictions around the world have raised the issue at meetings scheduled for other purposes.

“We realized there was an appetite for, and I would suggest a significant appetite for, some sort of ledger structure that would allow regulators to have a view into the world of finance,” Cooper, a former chief operating officer at the Commodity Futures Trading Commission, told Bloomberg BNA. “It's still early days. We haven't designed exactly what that might look like, but it's definitely something that's factored into our thinking and it's something that is driving a number of different regulatory conversations we've been having globally,” Cooper said.

Marco Santori, an attorney who leads the digital currency and blockchain technology team at Pillsbury Winthrop Shaw Pittman LLP, told Bloomberg BNA that he has talked with regulators about the potential use of blockchain technology to monitor financial systems. “They're absolutely interested in it,” he said.

Spokesmen for the Treasury Department, Federal Reserve System and the Financial Stability Board declined to comment on the matter. JPMorgan Chase, Wells Fargo, Bank of America and other banks involved in the R3 consortium also declined to comment.

Monitoring Tool

It's possible to construct private blockchains—distributed databases or ledgers shared by self-selected organizations—in which invited counterparties could report trading activity while keeping individual trading positions confidential, Cooper said.

Regulators accessing such a database could be given access to all of the positions entered on the database, enabling them to monitor entire markets almost instantaneously, he said. Regulators ultimately would determine what to do with the information.

Montreal-based Blocksteam is developing open-source software allowing counterparties to keep confidential information about limited types of transactions while electing to share transaction data with a third party, such as a compliance officer, legal team or a regulator, Austin Hill, the firm's chief executive officer, told Bloomberg BNA. The software, which could likely be expanded to monitor debt and equities markets, might even be designed to prevent certain transactions from occurring such as transactions deemed too risky, he said.

Hill and others said that while the technology is promising, its use by financial regulators is not imminent. “I think we are a little bit away from that being in full production with full systemic risk analysis. But when it gets there, you're talking about real-time systemic views of everything that's happening,” TradeBlock partner Greg Schvey told Bloomberg BNA.

But some agencies have certainly taken notice. “While I am not advocating for the adoption or effectiveness of blockchain technology, it appears to offer potential. One can imagine a world in which securities lending, repo, and margin financing are all traceable through blockchain's transparent and open approach to tracking transactions,” Securities and Exchange Commissioner Kara Stein said in prepared remarks Nov. 9 at Harvard Law School. “That could revolutionize regulators’ approach to monitoring systemic risk in these areas, including the oversight of collateral reuse, to name just one potential use,” she said.

Integration Concerns

Concerns about trustworthiness and security issues, as well as the amount of work needed to change their existing infrastructure, have made some banks reluctant to embrace the technology. Cooper and others said it may be possible for banks to continue using their legacy trading systems and integrate a separate system solely used to monitor systemic risk.

At this stage, many banks are focusing on emerging technologies, including blockchain technologies, as a way to reduce costs and settlement times, which in itself reduces risk, Reuben Grinberg, Davis Polk & Wardwell LLP associate and former trading software programmer, told Bloomberg BNA.

The promise of the technology is evident, however, to several specialists. If the technology develops as envisioned, “it would actually be extremely easy to have full audit trails, automatic reporting and automation of other regulatory functions and analysis,” said TradeBlock's Schvey, whose company provides execution and analytical tools to institutions utilizing blockchain technology.

R3 CEV is a financial innovation firm that has partnered with 30 of the world's largest banks to design and deliver advanced distributed ledger technologies to the financial markets. Financial institutions associated with the project include Goldman Sachs & Co., Morgan Stanley and Citigroup Inc. as well as non-U.S. banking institutions such as Deutsche Bank, ING Bank, National Australia Bank and Nordea Bank.

To contact the reporter on this story: Stephen Joyce in New York at sjoyce@bna.com

To contact the editor responsible for this story: Mike Ferullo in Washington at mferullo@bna.com