Expected benefits and challenges of Blockchain technology
Potential savings and efficiencies were widespread and easily identifiable particularly for Blockchain and Distributed Ledger Technology (DLT) applications and in the securities post-trading area. Financial technology could lead to new business models and contribute to a significant growth of the industry via lower transaction costs, shorter delays, greater convenience, thus facilitating access to capital markets. Potentially billions could be saved. Polls had shown that the expected benefits of Blockchain included transparency and easier tracking, reduced reconciliations and increased capital mobility. Blockchain was however not a silver bullet and its actual impacts were still unclear, several speakers considered.
These evolutions had to be viewed in the wider context of digitalisation, which was nothing new in the financial sector. Dematerialisation and developments related to the internet for example had been expanding for many years. DLT was a further step of this development. Moreover DLT did not have a monopoly on distributed databases, which were already used but their development was expected to increase with DLT applications. The benefits of data distribution were not disputed, but there were constraints that needed to be addressed, such as issues of maintenance and access. DLT was therefore not the solution to all problems and it would have to be adapted depending on the strategy pursued.
The development of Blockchain would probably not be a big bang evolution
The complete overhaul of capital markets would not be seen for 15 20 years and applications to core clearing and settlement processes for blue chip stocks were still a remote objective, several speakers considered. Blockchain technology would probably first apply to small and discrete processes that surround the main settlement and clearing engines and provide incremental benefits.
It was still difficult to determine at present whether Blockchain would lead to disruption or incremental evolution, some speakers believed, because the securities industry was not known for radical shifts. Building integration with existing infrastructures in capital markets was an issue of importance and genuine infrastructural change would take many years. There were limited incentives to move away from the current functioning of the market, due to the huge investments needed and legal issues. There were also governance issues to be addressed regarding: the technology, who could participate in the network, the roles and responsibilities in the network and possible sanctions for misbehaviour. Moreover benefits may not be individual but shared with the entire network of players interacting in the capital markets.
An outside-in movement triggered by third parties was possible but would require the whole industry to move which seemed unlikely in the short term without significant intervention from central authorities, a panellist suggested. Moreover changes in securities laws that may be required were a complex issue. The internet had previously brought many changes but the main market players had largely remained unchanged. First-movers are expected to propose new solutions but they will probably be peripheral to the core clearing and settlement processes. A panellist suggested that many firms had already decided to provide technology and know-how to incumbent companies, rather than entering in direct competition with them due to high compliance costs in particular. Such collaborations could be a more efficient way of providing these technologies for society.
Significant transformation could however be expected over time. It was agreed that smart contracts would be a fast moving catalyst for change. There was no question that contracts could be reduced to an algorithm, and that algorithms would become a very powerful asset used in conjunction with other technologies, for both firms and regulators.
A significant amount has been invested in order to cover all relevant aspects of the evolution of financial technology. The approach was to identify opportunities, build solutions and learn from them. Learnings were both technical and non-technical, including issues related to the governance of the network. The main technical challenge of DLT was to build applications which could leverage the properties of the underlying ledgers.
However it was clear that electronification would not rule out risk in capital markets. Digital finance methods were still subject to possible manipulations and errors; and alongside the possibility for error would come a necessity for responsibility and a call for supervision in order to ensure sufficient trust. Finally technology could disturb the present capital markets ecosystem which was highly tuned with different levels of intermediation, thus potentially creating new risks.
Policy development and oversight strategies
Working out a strategy for policy development and supervision was a pressing issue given the uncertainty regarding the precise impact that technology might have on the financial services sector and related policy fields. Trade-offs between supporting innovation and prudence should be avoided, a regulator believed. At the same time, regulators should endeavour not to stifle innovation and treat it in a flexible manner. Moreover striving for artificial separations between traditional banking and digital finance was warned against, even if legal issues had to be adapted to digital contexts. Technology should be treated neutrally on a “same business, same risk, same rules” basis and a specific entity needed to be responsible for operational risk. They needed a level playing field with modernised rules that could ensure the efficiency and effectiveness of best market forces in the long term.
The “First Do No Harm” regulatory approach used during the mid 1990s for the internet could be used as a source of inspiration, an official suggested. Evolutions such as Blockchain could not be decided by regulators, could not be held off and were going to happen. Moreover diverse and contradictory regulations should be avoided, as well as laborious ones which might kill off innovative business models. Rules will need to be adapted to quickly evolving technology and the related data completed.
From a central bank perspective, there were three angles to consider: the impact of technology on regulatory and oversight capacities; the catalyst function to be played by the ECB in the further integration of financial markets: i.e. issues related to access to data and to its circulation, as well as standardising practices; and finally the perspective of an infrastructure operator such as TARGET2Securities (T2S) regarding the capacity for technology to increase efficiency safely. Cyber-resilience was also an issue and developing an appropriate IT stress testing framework was essential to ensure that technology was resilient.
Mechanisms such as regulatory sandboxes were useful for testing innovative products, services and business models but technology was quickly evolving and may have systemic relevance.
Regulators needed to anticipate changes and modernise their approach. The current ruleset needed to be rethought for the digital world, because it partly ignored digital realities and the fact that decisions would increasingly be made by artificial intelligence and algorithms rather than human interaction; legal issues had to be adapted to these changes. They also needed to ensure that digital technology developed in a way which allowed it the greatest utilisation by both industry and regulators.
It was further advised that a supervisor ultimately had to act on a clear legal basis, which was why it was essential to ensure sufficient legal certainty. The availability of appropriate trading data at the global level was also an essential issue.
A culture clash was expected with the increasing development of Fintechs. It was suggested that firms in the post crisis era had become accustomed to seeking permission before acting, which differed from the culture of Fintech firms that never sought permission. There was however confidence that the world would unite and that a common development could be achieved although it may not happen in a straight line.
The importance of standards
The importance of standards for the development of technology in capital markets was emphasized. It had been the key issue for the T2S project. Standards would also be essential for moving things forward with regard to Fintech applications. However, it was emphasised that much time would pass before Blockchain would be ready. Many technologies rendered the same service, and it was as yet unclear which of those would be dominant, if any. A layer of standards was required to allow each service to do their job whilst offering consumers a space to build applications in confidence. Moreover a sandbox where practitioners, innovators and regulators could collaborate would be useful.
It was suggested that standardisation had five key areas that needed to be looked at: governance of access; the status of legal entities used for supervisory and reporting purposes; consistent data semantics; algorithms and their maintenance; and integration strategies between legacy systems and DLT.
1. The expected impacts of growing electronification in the capital markets
1.1. Major impacts are expected from technology in the capital markets but some issues need to be addressed
The ongoing IT revolution continued to have implications for the financial sector, a public representative emphasized. With Blockchain in particular, large efficiency gains were possible. New developments had become possible because of the IT revolution. Billions of euros were being invested in IT and there was rapid growth potential; which would also pose new challenges and risk. The question for regulators was how to deal with that; and for businesses was how to position themselves to cope. Regulators could not afford to stifle innovation, but had to deal with it in a sound and flexible manner.
A regulator outlined that when talking about electronification of the capital markets, three different subjects were being addressed. The first was market infrastructures, which were challenged by Blockchain applications; the question was whether they could render contracting and settlements cheaper and faster. The second was regarding crowdfunding platforms and what that would mean for the intermediation between capital demand and supply. Third was regarding Fintechs and whether they would work to provide cheaper, quicker and more convenient services anywhere in the financial industry.
An industry representative had recently attended a business forum in London wherein they had polled participants on why CEOs, COOs, CTOs, etc., were currently looking into technology. They had asked a few questions in a poll of 150 people. The first promise of Distributed Ledger Technology (DLT) had been on transparency, and track and trace, which had been noted by 31% of respondents. The second had been on reduction of reconciliations, which had been 23%. The third had been the increase of capital mobility by 15%.
He however remarked that it was important to appreciate that the technology was not simple. The technology had many components and although DLT was a great technology, it was not a silver bullet. The second question had been on what the key industry requirements were. They had asked what needed to be done at the industry level to make it work and whether there was a usecase. Compliance with regulations including KYC and sanctions had come first, with 25%. At 21% had been an identity framework to know who was what on Blockchain and any other system. Standardisation, security and cyber defence had each been at 14%.
1.2. Expected benefits and challenges of Blockchain Technology
Potential Future Savings and Efficiencies
One industry representative stated that savings and efficiencies were large, particularly in the clearing and settlement area, and easy to identify. The exciting thing was that it would enable business models that they could not currently contemplate. Changes could be fundamental.
Another industry representative suggested that technology would contribute to the growth of the financial sector through lower transaction costs, shorter delays, and greater convenience.
One industry representative suggested that Blockchain and Fintech could be two separate things, and that they should focus on Blockchain first. He felt that the promise of Blockchain was enormous, and that the industry aligned on those views because they shared so many common forums that spoke about Blockchain.
One industry speaker thought that Blockchain was the disruptive technology that the posttrade world had been looking for. It had great significance in terms of cost saving and opportunities. He stated that the potential cost saving was billions. The potential in terms of creating access to capital markets for companies further down the value chain was also significant.
Fintech and blockchain are part of a broader digital evolution
A regulator stressed that these evolutions had to be viewed in the wider context of Fintech. He stated that Fintech was nothing new and the financial service sector had been the largest consumer of telecommunications technology over the last twenty years.
He outlined that we were living in the second development phase of the internet, where the digitisation of our entire modern lives was taking place; financial services being no exception. He concluded that digitisation was taking place in everything, and financial services was no exception. The question was not of whether Fintech was good, or would realise its promise. The fact was that it just was; and that the financial services industry was not immune from the digitisation of everything.
An official agreed that digitalisation was nothing new. They had dematerialized securities, and most payments were currently done through systems. The ECB’s TARGET2Securities (T2S) system which is being implemented puts all securities transactions in Europe on the same platform in an electronic format and digital way.
Digitalisation was a process, and the internet was one step into it. Distributed ledger technology may be a step towards new technologies that could be used by financial market infrastructures (FMI) in the future, following previous evolutions from mainframe to distributed technology and the use of alternative networks to establish connections in the market.
Timescale and pace of change
An industry representative noted that when observers attempted to design the model of how the postBlockchain world would look, many started with a blank sheet of paper, without considering existing infrastructures and systems. However, the reality was that it would not go like that. The promise of Blockchain was good, but they would not get there by a big bang.
His company was looking at how Blockchain technology could offer benefits in small and discrete processes that sat around the core of the settlement and clearing engines. Those were areas where Blockchain could perhaps make a first inroad.
He noted however that solving the issues related to the settlement of a Blockchain of EURO STOXX 50 equities with all market participants involved was far away. The T2S had been a 10 year project. In his view, the main issue had not been around the technology, but around agreeing standardisation. They currently had that, but the implementation was ongoing, and some things had to be rolled out.
The industry representative summarised that his company was looking at incremental innovation excellence that was currently happening and would do over the next two to five years. He suggested that in five years they could have some processes on a technology like Blockchain; but noted that the complete overhaul of capital markets and the white sheet of paper would not be seen for 1520 years.
He felt that it was difficult to determine at present whether Blockchain would lead to, whether it would be disruption versus incremental evolution in the context of public and private Blockchain because their industry was not known for radical shift movements. He thought that the incentive for a firstmover to move away from the way it happened currently was low for many of the incumbents currently in the capital markets. The investments to do so would be huge, and the benefits would not be individual, but shared with the entire network of players interacting in the capital markets.
He continued that it would be hard to get a big bangtype disruption from the insideout. From the outsidein perhaps a third party would enter to build a new system for swaps on a private Blockchain. That was a reality that could happen, but getting the whole market to buy into that would require the whole industry to move, including lawyers and regulators; that would be tough to achieve, and there was scepticism that a big bang movement like that could happen. He outlined that the only way to get that kind of movement was when you had central authorities that took the initiative to make the change happen.
Another industry speaker noted that there was some danger in trying to predict a possible timescale of implementation. He stated that real change would take 10 or more years, but they needed to be conscious that that change would not be in a straight line and that they would end up with a different dynamic from what was initially imagined.
He noted that there were difficult fundamental issues to address, like whether they needed to change securities law. Those issues needed to be resolved, which took time and so it was difficult to define ex ante the time it would take. He felt that frankly there was a lot of boring, hard, legal work to be done, but things could take off exponentially.
He believed that the regulatory stakeholder would be key. Regulation encompassed all the institutional framework around it, and it would be hard to get going. He felt however that once that was done, the demand would be unstoppable. That would be the time to look back and see the amount of progress that had been made. He added that the hard yards were at the beginning, but once those were done, growth would be substantial.
Catalysts and first-movers
One industry representative outlined that digitalisation was continual, and they were at the latest version. There had been the same evolutions with the internet. It was going to change banking, bring in many new players and change the world entirely many observers argued. The internet had done many things for both the industry and economic growth, but those that were the main players to begin with had largely remained so with the changes brought by the internet.
He understood why the concept of Blockchain was positive, but said that the real world had many practicalities, and that some of the most significant stakeholders in terms of the balance between innovation and risk control were the regulators. He felt that what had been achieved with the internet in the past was to some extent a good balance.
Within a couple of years some of the firstmovers would come up with some solutions but they will probably be small, remote and peripheral to the core clearing and settlement processes. He noted that he had been asked why his company was not leading Blockchain with its 28 trillion in European assets, to which he had usually responded that he wanted to start with applying the technology to processes less globally systemic and with more limited financial stakes.
He believed that there would be strong collaborative efforts that would create a lot of efficiencies, and that they would take time because there would be interference. The financial industry had historically proven reluctant to change until they had no other choice. The industry was still at a stage where a lot of people were thinking that Blockchain would take a few more years, and they hopefully would have retired by then. He felt that realistically they could either sit back and complain, or embrace the technology and accept that it could be an interesting way forward; and the latter was the only real way to go.
He summarised that they looked at Blockchain in the sense of how it could be used in the core of what they did; the answer was that it could not be used as much as it would be in the future. He continued that the thought that there would be an overnight shift was misplaced, as was the idea that it could be put to one side until it became core in the future. It would have a lot of significant impacts, but was still a few years away.
An official noted that he had been reminded of a comment by Bill Gates saying that if one looked forward two years, what got done was disappointing; but looking back 10 years, the amount of transformation was amazing. He felt that there could be a similar dynamic in the current regard.
His view was that smart contracts would be one of the big catalysts, and would move fast. Other speakers agreed. He felt that if they could reduce the entire world’s music library to one mp3 player, then there was no question that contracts could be reduced to an algorithm. Once they were reduced to algorithms, they would be stored in electronic file formats, and once those electronic file formats began to exist in the ledgers of different commercial firms, it would be only a matter of time before they were linked to other technologies. He believed that those would provide enormous benefits to firms, as well as regulators; and that the transformation would take place quicker than anticipated.
Integration with existing infrastructure
An industry representative said that integration with existing infrastructures for capital markets was also a big thing. They were not starting from a blank sheet of paper, but an existing world; and they needed to adapt to that.
An infrastructure operator noted however that they saw genuine infrastructural change taking several years because there were genuine issues. He recalled a recent conversation with a startup where they had told him that they were going to steal all of his business. He had remained calm because they had warned him that in order to do so they needed only to change the securities law in every country, which gave him some time to breathe.
He clarified that there were good and strong things associated with Blockchain, but there were also a lot of real world legal issues. The idea of ending up with a single shared truth with more data and detail contained and open to all was very strong, and getting there would take some time.
1.3. Risks associated with Capital Market Electronification
A regulator felt that the future was unclear. Blockchain technology was likely to take some years before it became a disruptive impact, and so it was uncertain which financial services sector would be affected.
He asked if there was reason to think that electronification would rule out risks for capital markets. He argued that digital applications exhibited promising attributes, but that it would have been wrong to assume that digital finance had no errors. He had three such examples. First was that collective intelligence attributed to crowdfunding platforms did not rule out herding or panic of market participants. Second was that algorithms were potentially transparent, reliable and intelligent, but manipulations could still easily occur in complex applications. A Central Bank colleague of his had noted recently that a selfdriving car could still knock down humans, and so errors and manipulations were not something that could be excluded. Third was that selfregulation of Blockchain would not be a solution. Legal issues had already arisen and so somebody had to be responsible for errors; the applications required some supervision.
One speaker flagged the trust that was required when talking about financial transfers. WhatsApp for example had had a very serious security flaw exposed in its software. That may not have been such a problem with text messages, but could be considerably more damaging in the context of a payment system.
An industry representative outlined that the potential benefits were both in the savings and changing the way capital markets fitted together; which was both the most exciting and scary part because capital markets were a very highly tuned ecosystem with different layers of intermediation. He highlighted that the risk was that that ecosystem could be disturbed and that processing could be transferred without necessarily transferring, monitoring or controlling the risks that were there.
1.4. Impacts of Blockchain on the Centralised Database Structure
One speaker noted that Blockchain offered the potential to decentralise the currently centralised database approach to transaction processing. He wondered how disruptive it would be to take on the new distributed architecture and what impact this may have on resilience and the competitive landscape.
An industry representative responded that DLT did not have a monopoly on distributing databases. Distributed databases were already built upon requirement in some cases. Therefore if there was a system where the requirement was to have a distributed database and no central database, they would build that. The current design did not necessarily include distributed ledger technologies. He emphasised the silver bullet point, and that DLT was not an answer to all questions.
The distribution of data itself could have been useful for some usecases, but it created another set of requirements to maintain all of the data together and who could access it. From a data location standpoint, he wondered whether, if the same data was distributed in various jurisdictions across 1520 different countries, the regulatory regime would be the same for all countries for the same data.
He did not dispute the benefits of data distribution, but noted that there were constraints which needed to be balanced depending on the strategy that firms wanted to pursue.
1.5. Investment in Technology
One speaker noted that new technologies could change the way they thought about and did transactions, clearing and settlements. He wondered how much was currently invested in these technologies.
One industry representative responded that their R&D budget was around 12% of their revenue. He said that although they sometimes operated in their own name when running their exchanges and ECP depositories, the bulk of what they did was providing solutions to other exchanges, ECP depositories, and market surveillance organisations; and that it was really about financial technology.
He said that they tried to cover everything relevant in the evolution of financial technology, not only Blockchain, but also cryptographic solutions, big data, cloud computing etc…, and so they invested a significant amount. Their approach was to start with identifying an opportunity where they could build solutions and put them out for client consumption to satisfy a specific need, and then learn from them.
He continued that they would then find issues that were often nontechnical. Their most recent implementation was the Blockchainbased solution they had built in the U.S. where private companies could issue shares that could be transfered between investors in a secondary market without the need for a depository or CCP.
They would then find that the technology needed work, but everything seemed to point in the right direction. They would solve technical issues, but governance was still needed. Governance was required around the technology: who could participate; what they were supposed to do as part of the network; and what sanctions there were for misbehaviour.
One regulator asked whether the R&D spend on Blockchain was a core or an R&D aspect. An industry representative responded that they did not develop Blockchain’s underlying ledger technology, but built applications which leveraged the inherent properties of the underlying ledgers. It did not matter for applications whether it was a Blockchain or central database solution. He added that the ledger itself was nothing special, just a ledger. To do something valuable with it, they needed lots of applications on top of it.
2. Evolutions needed in financial regulation and supervision
2.1. Strategy for Policy Development regarding technology
One regulator argued that given the uncertainty regarding the impact Blockchain may have on the financial services sector and related policy fields, the most pressing issue should be to work out a strategy for policy development. The ultimate goal was a prospering, reliable and resilient capital market. Those principles had also guided the European Capital Markets Union.
However he felt that they should avoid entering into vague tradeoffs between supporting innovation or prudence. They needed a level playing field with uptodate rules that ensured efficiency and effectiveness of market forces in the long run. He concluded that they should strive to remove hurdles rather than bolster innovation.
He felt that regulation partly ignored digital realities and so the interaction of participants was different from the analogue world, which meant that legal issues had to be adapted to digital contexts. He believed that a consistent longterm regulatory framework synchronised on a European scale was the best service that they could currently offer to financial innovation.
He continued that they should not strive for artificial separation between traditional banks and digital finance. He argued that technology should be treated neutrally. The guiding principles for supervisors stayed the same. The “same business, same risk, same rules” principle used in Banking supervision had so far proven to be a good standard for innovations. He advised that whatever direction financial innovations were headed, they needed to be certain that supervisors could assume that a concrete entity was responsible for operational risk; technology cannot be expected to regulate itself, but somebody had to regulate technology.
A speaker commented that that had been a very clear call for functional regulation that was technologically neutral, whilst at the same time being a call for regulation that was technologically aware, as there were specific dangers and stress tests that needed to be addressed and engaged with.
An official referred back to the 1990s, where the internet’s commercial development had been at its first critical juncture. He outlined that in 1996 the U.S. Congress had passed the Telecommunications Act and the Clinton Administration had come up with a set of principles saying first that the internet should develop through the private economy, and second that regulators should take a careful “First Do No Harm” approach to the internet. That regulatory approach had helped the development of the internet as well as many new innovations. He believed that they should take a similar approach towards technological innovation in the financial sector.
He noted that he made that comment in the context of a U.S. environment with 50 potential State regulators and a multiplicity of federal regulators. He was therefore very concerned about different regulators jumping in with diverse and contradictory regulations. He hoped that there would be a general consensus around an approach that said that this was not technology that they could hold off. It would happen and the question was around how they would respond. He warned that it would backfire if they tried to stifle it and they would be better off taking a “First Do No Harm” approach. They needed to watch carefully and see how it evolved. He saw it providing as many benefits to the regulators as it would to the financial services industry. Blockchain was not something that they could decide whether or not to like; they just had to accept that it was going to happen.
An industry representative agreed and suggested that what was needed was an approach to regulation and legislation which aimed to not kill innovative business models with laborious regulation. He felt however that more was needed to help technology along. Legal uncertainties were being created by current legislation and regulation not anticipating the new ways of satisfying needs; for example, it was unclear whether the present law would recognise the issuing of shares in Blockchain format.
One public representative outlined that the current internet governance had worked for consumers, but in hindsight was not the way that they would have set it up. He noted that they were having trouble to repair some of the mistakes made when setting it up.
One of the public authorities felt that it was interesting to reflect on what had been done in market infrastructures in the past three decades. He outlined that the ECB and the eurosystem were looking at technological evolutions from three different angles.
First was as a regulator and overseer, to see whether it changed the part in which they developed their oversight capacities. Regulation was currently looking to entities; if those entities used new technologies then regulators had to ensure that their capacity to oversee Financial Market Infrastructures (FMIs) was not affected, and that they could still guarantee safety and efficiency of the system.
Second was the catalyst function that they had to play to integrate financial markets, in Europe. He felt that the problem of integration would soon appear at the global level, related to the capacity and speed of access to data which was very relevant in this case. He felt that they should not underestimate the fact that technology was one element, and probably the least complex, of getting there because they first had to harmonise standardised practices. Standardisation was a key factor, and the implementation of harmonised processes was key to using the data currently digitally circulating.
The final role was of an operator, since the ECB operates TARGET2Securities (T2S). He was looking into technological developments to see whether they could bring cost efficiencies whilst preserving safety, which emphasised the importance of the point made on safety.
He added that the ECB did a lot of work with other central banks on cyber resilience, because the users of the system needed reassurance that the system through which their financial services were executed was safe. The ECB did a lot of nonfunctional tests for IT infrastructure. They were stretching their computer capacities for T2S to ensure that they could cope with peak activity or cyber threats. He however felt that they did not yet have the right framework for IT stress testing and needed to continue its development. As the technology developed, they had to develop to ensure that the technology was resilient. They were therefore in a continuous process, which was why there was an element of groupthink on market infrastructures and payments, looking at cyber resilience and defining principles that were being relayed to the central banks to see how they could develop extra security levels.
The ECB, as an issuer of a currency, was also looking at cryptocurrency issues and whether this would help to be more efficient e.g. replacing bank notes or making payment more instant.
What was clear to him was that there was no time to sit and wait. The ECB were currently active and thinking of the future. He highlighted that they had already announced their vision on how market infrastructure (i.e. payment system, securities settlement system and collateral processor) should look like in the medium term (Vision 2020), and would come up with new projects for that.
An industry representative explained that at Sibos in Singapore they had had a discussion where people had been asked whether Blockchain or cyber would kill their business. 90% of people had responded that it would be Blockchain. They felt that cyber would not kill them, and that that came back to the stresstesting of IT. Blockchain may have helped a lot on cyber, but the world was slightly more parallel than serial on those things.
2.2. Rules will need to be adapted and data completed
A public representative noted that a previous panel of the Eurofi seminar had observed that regulatory sandboxes were very good for trying out new technologies, but had warned that they should not attempt to “build skyscrapers in sandboxes”. Moreover the adolescence of Fintechs might be a difficult period, for regulators, when they no longer played in the sandbox, but were not quite grown up.
He stated that technology was quickly evolving, and people needed space to experiment, but in the end they were potentially talking about highly systemic new technologies. He wondered how those challenges were met on a daytoday basis as a regulator.
A regulator highlighted that there was a question for all regulators about how to anticipate changes and modernise themselves. Their rules had been written for a 20th century world where transactions had taken place through human actions, but they were moving towards a world where decisions would be made by artificial intelligence. He emphasised that their ruleset had been designed to catch bad people, but would have to be redesigned to catch bad algorithms. They would have to rethink their regulatory ruleset for the digital world to come.
His view was that they needed to make sure that digital technology developed in a way that allowed it the potential to reach its greatest utilisation for both the industry and regulators.
The availability of data was however still an issue. In 2008 regulators had no ability to see the trading books of the world’s largest CDS traders; one of whom had failed a few days later. He noted that eight years on they were still trying to piece together trading data of some of the largest banks.
He summarised that Blockchain had potential. He did not know whether it was a silver bullet, but knew that they were still currently struggling to assemble trading books to monitor trading activity. If Blockchain reached its potential then regulators would have a much greater tool to see what was happening in banking and other financial sector markets.
Another speaker confirmed that an important point had been made: they needed to look at the issue as regulators and legislators, as well as users of the technology. He agreed that Blockchain had potential in that respect.
An industry representative added that, in the end, a supervisor had to act on a clear legal basis. That was why it was important to get sufficient legal certainty.
2.3. An expected culture clash between fintechs and traditional financial players
One speaker wondered who would decide that issues have become relevant from a supervisory perspective in regard to technology and how they would monitor developments sufficiently closely so that, in an environment where exponential growth was possible, they would be there just in time.
One public authority speaker responded that regulated firms in the postcrisis era had become accustomed to seeking permission before acting; it was in their culture. He anticipated an interesting culture clash over the coming years as regulators began working with Fintech firms who never sought permission.
Another issue was that regulators currently operated under a premise that was not adapted to the on-going innovation. They were engaged in outlawing the behaviour which caused the last crisis and did not sufficiently look forward at what the next innovation would be.
He stated that they all worked within their regulatory cultural mindset. Fortunately, the law was a constantly evolving and always adapting to new technology. There would be regulatory action that felt its way to the future and the CFTC was moving forward with regulation in the area of algorithmic and automated trading.
He was confident that the world would come together. He agreed that it would not be in a straight line, but more of a crooked and dynamic one; but all of the cultures would come together. He continued that the technology would move forward unabated, and they would all deal with it. He concluded that they had a fascinating few years ahead, and he looked forward to them.
One industry representative confirmed that he had already seen the culture clash happening in the Blockchain space. Over the last two years people had suggested that roughly $1 billion had gone into Bitcoin and Blockchain forums; a lot of which had been in the Blockchain disrupt Wall Street usecase on a grand scale. He suggested that a lot of firms had pivoted upon the realisation that the first thing that they had to do to compete with Wall Street or the City was to employ 200 compliance officers, which was not an attractive move for them. He said that they had therefore turned in to be technology and knowhow providers to companies already operating in the markets. He concluded that that did not mean that society would be deprived of those new technologies that could enable more efficiency, but meant that it would mainly be incumbent on existing players to implement these solutions.
One speaker expressed his confidence that the culture clash would be inspiring, rather than disruptive.
3. Standards are essential to making progress with technological applications
One industry representative stated that standards were key to moving things forward. The Hyper Ledger and other things were helping, but it was clear that a lot of people had slightly different views of the same standards. He said that different continents had different geopolitical perspectives, and that within the same groups there was scope for different interpretations. It would be a rocky path, but the benefits in efficiencies and opening up of capital markets were such that they would get through.
He emphasised that they did not need to do everything by the next week; they had time.
One industry representative stated that they first needed to walk the talk. There were still lots of technologies that rendered the same service, and they did not know which of them would win, if any. What was needed was a layer of standards to let them do their job and make sure that the consumer of that technology could build applications in confidence. His proposal was that they needed a sandbox where practitioners, innovators and regulators did things together.
He stated that there were five elements of standardisation that needed to be looked at. The first was governance of who had access to what; of which the permissionbased ledger was potentially the best way to go.
The second was that legal entities remained the basis of supervision and reporting. The identity framework on the distributed ledger was not legal entitybased and the two would coexist. He therefore asked how one could create a framework whereby whichever ledger was used the unicity of legal entities could be maintained. Those were things that could also go into the sandbox.
The third was on data semantics. Whether or not it was on a distributed ledger, the record date was the record date; it needed to mean the same thing. If it was agreed that the endtoend business process would go from the distributed ledger to the legacy system, they needed to ensure that they preserved the semantics of the data, and that new and existing standards were consistent with each other.
The fourth was on algorithms. Business processes could be automated in view of the distributed ledger. He noted however the (Know Your Algorithm) KYA was important because they needed to know who was in charge of making sure that the code in an automation was maintained, enforceable or valid. He added that those rules could have been organised in the sandbox.
The final element was that they would need to work on interface and integration strategies to ensure that legacy and DLT worked together if it was agreed that there would be backwards compatibility issues between them.
- The example of tractors driven by GPS satellites and not farmers was given. The tractor relays soil content information to the GPS satellite, and so tractor companies with their own satellites were becoming data companies.
- The regulatory sandbox defined by the UK FCA aims to create a ‘safe space’ in which businesses can test innovative products, services, business models and delivery mechanisms in a live environment without immediately incurring all the normal regulatory consequences of engaging in the activity in question.