Regulators Under Pressure From Banking To Crypto – Who Is Leading The Strategic Digital Innovation Agenda For Financial Services?
The failure of SVB and Signature bank has put pressure on U.S. banking regulators as concerns mount about short positions and further failures with mid-tier banks. Jamie Dimon, who’s own JP Morgan, is engaged in advising and funding struggling First Republic, has been critical of banking regulators in his annual shareholder letter predicting it is “not over yet” and will be felt for years.
The failure of SVB, the flag bearer for America’s “West Coast” tech sector, is like a Greek tragedy – heroes funding Americas tech venture sector, the crown jewel in the new global digital space race, brought down by a combination of fate and fiduciary mismanagement.
As the finger pointing heightens, the crypto industry is caught in the crossfire, concerned there is mounting evidence of systematic anti-crypto agenda with Signature bank. The crypto industry was prepared, to some extent, for regulation by enforcement in 2023, following the collapse of FTX, but evidence of Operation Chokepoint 2.0 has sent a chill down the spines of crypto CxOs and financiers.
Chris Brummer at Georgetown University, et al, have published a paper for the forthcoming University of Southern California Law Review on “Regulation by Enforcement” outlining the pro and cons, and a framework for agency guidance. Whichever way policymakers land on this issue, the pursuit of regulation by enforcement on nascent digital industries setting out to transform economies and improve the relationship citizens have with money makes for bad optics.
Often, the velocity of digital innovation fueled by vast amounts of capital investment, challenges regulators who do not have the digital knowledge and only a blunt set of tools in their mandates to deploy, including enforcement. For capitalists, regulation by enforcement reeks of deep state and questions whether agency motives are really in the public interest.
Empirically, most citizens in (democratic) societies expect fair and competitive markets, this is the regulator’s primacy.
The Policymakers Digital Innovation Czar?
The U.K.’s Financial Services and Markets Bill is the largest draft of new legislation for the financial services sector in 30 years and is set to make wide-ranging changes. The Bill is currently winding its way through the House of Lords, the Upper House, and is expected to be enacted in late spring 2023.
The Bill includes implementing the outcomes of a Future Regulatory Framework review and establishing a regime to regulate stablecoins and cryptoassets, and protect access to cash.
It also includes proposals to grant HM Treasury the power to create financial market infrastructure sandboxes which would allow the testing and adoption of new digital technologies by temporarily disapplying, modifying or even applying certain legislation for specific purposes – creating a “safe harbour”, a page out of SEC Commissioner Peirce’s proposed playbook.
As importantly, the Bill proposes to extend the regulator’s competition mandate to include “international competition” and “growth”. The jaw-dropping innovative nature of this mandate for a conduct regulator is matched by policymakers’ unease of granting such great powers to a regulator without an accountability check and balance to policymakers in Parliament.
Lord Holmes of Richmond is championing an amendment to the bill proposing creating an office for financial regulatory accountability, an expert, independent, statutory advisory body, which would work to a remit set by the Government and laid before Parliament.
Says Holmes, “The Bill, as currently drafted, confers huge new powers on the regulators, repatriated from the EU, without making any meaningful suggestions to make them more accountable when they exercise those powers.
“We have seen the positive impact of regulatory sandboxes can have, perhaps the best measure of success was the original FCA regulatory sandbox which was replicated in well over 50 jurisdictions around the world. It now makes complete sense to sandbox digital assets, DAOs, AI, digital ID, cyber, and more.
“It is vital that we improve the reporting by the regulators and improve parliamentary scrutiny to help steward through this new era of digital innovation.”
The Electronic Trade Documents Bill, also winding its way through the House of Lords will ensure digital documents have the “same legal treatment, effects and functionality” as paper documents as long as they satisfy various criteria. The Bill offers a clear and effective approach to legislating and regulating that takes account of the speed, power, and potential of new digital technologies.
These Bills, combined with the Law Commission of England and Wales’ consultation paper recognizing digital assets as a distinct “data object” class of property, go a long way to recognizing the importance to society of the digital innovations emerging in financial services.
U.K. Prime Minister Rishi Sunak, a Stanford techbro, is leading this digital innovation charge with the free marketer Andrew Griffith, the Economic Secretary to the Treasury and City Minister, who’s open and collaborate approach to industry has not been seen since before Brexit. The U.K. has a blueprint for digital innovation, digital regulation, and digital legal rights, to help transform its economy for the next millennia.
Impossible N’est Pas
Blockchain Week in Paris last month was the hottest ticket on the planet, signaling the “arrival” of France as a digital innovation tour de force hub in Europe. Circle, Binance, and Crypto.com have all chosen Paris for their European headquarters. France has also been a post-Brexit European winner for banking with Goldman Sachs, Bank of America, Deutsche Bank and Citigroup, expanding their presence in Paris and energizing the European banking landscape.
With global banks and asset managers forecasting for the tokenization of real assets, such as securities, in the trillions of dollars, France’s fully dematerialized bond market, requiring no paper and wet ink, will drive greater issuances of digital bonds in the short term. The European Investment Bank leads the way in digital bond issuance, with a number of innovative French banks at the heart of these projects including BNP Paribas and Societe General.
France’s innovation charge is very much industry led in collaboration with policymakers from Prime Minister Emanuel Macron to Digital Minister Jean-Noel Barrot, who along with the Banque de France’s regulators, the AMF (conduct) and ACPR (prudential) and are taking a very proactive role in shaping policy and regulation through significant industry engagement.
In a discussion paper released in March, ACPR signaled that DeFi might be regulated in Europe under a future iteration of MiCA. DeFi is not included in the groundbreaking MiCA framework but is one of the first areas to be considered following its imminent adoption by lawmakers this month.
The paper suggests that certain (native stablecoin) DeFi protocols incorporating in the EU would be considered intermediaries under MiCA as (electronic money token) issuers, while proposing a certification system for smart contracts on decentralized protocols (using non-native tokens), which would apply to the product itself, without the need to define a person that would be directly responsible for compliance with this obligation.
In addition to MiCA, the DLT Pilot Regime is the second leg of the two main legislative initiatives in Europe to regulate digital assets with a pilot regime for market infrastructures based on distributed ledger technology which opened in March.
The (safe harbour) Pilot Regime enables participating entities to conditionally obtain an EU-wide temporary authorization to offer DLT-based trading facilities and settlement systems to both professional and retail clients in secondary markets.
With an impending vote in the European Parliament on MiCA this month, followed by Council approval in May, the regulation will become in-force in June, with an 18-month transitional period to implementation in 2024. The legislative process is endeavoring to keep pace with industry developments.
MiCA is nothing short of a comprehensive legal framework for crypto and digital assets that, from conception to inception, took three years and is harmonized across 27 countries – it is an impressive use case for policymakers.
Don’t Throw The Baby Out With The Bathwater
January 2023 marked the 14th anniversary of bitcoin and the blockchain. It is the decentralized native cryptocurrency protocol that launched a thousand crypto, digital asset, and infrastructure projects across industry, central banks, and government agencies, and set the world on its journey to the next era of revolutionary digital innovation in finance.
Thank you, Satoshi, you should be nominated for a Nobel prize, whoever you are.
The 2023 Economic Report Of The President published in March is relatively disparaging of cryptoassets and DLTs. The report posits that “there have been limited economic benefits from DLT technology.” This would have been like saying, “there have been limited economic benefits from the internal combustion engine,” in 1860.
The statement has the whiff of Neo-Luddism about it, and misses the point by discounting both the substantial capital investment in DLT in the past 14 years by industry, central banks, and governments, and the projected future value of the economic benefits from the social and commercial transformation the technology delivers.
In 1798 John Stevens built the first American internal combustion engine during the Industrial Revolution with the first commercially successful engines coming onto the market in Europe from the 1860’s onwards. The internal combustion engine is arguably the most important invention in history due to its (efficient) impact on the transformation of society, even in consideration of its negative environmental effects, which have greatly improved over time.
With an estimated 100 central bank digital currency (CBDC) projects underway, 11 CBDCs launched, 18 in pilot – including the Central Bank of China, and projects being developed the Bank of England, the European Central Bank, and the U.S. Fed, these agencies, mainly independent of, but important to government, appear seriously committed to the future of DLT.
The evidence of progressive policy and regulation in crypto digital assets, and DLT from governments and agencies around the world is abundant: the Falcon economies of Dubai, Abu Dhabi, and the U.A.E; Singapore, Hong Kong, Seoul, Japan, Australia, Brazil, Nigeria, and this list is getting bigger – this is decentralized digital innovation in action, at a national to regional level.
The Report also posits that most cryptoassets have no fundamental value, just as bitcoin finds its support at $30,000, again. The market is the best arbiter of value and there is a lot of “smart money” in BTC – it has become the de facto “hedge against uncertainty”.
The Bitcoin network may have the energy consumption profile of small country – comparisons are often made to Denmark or New Zealand – but it has a marketcap of twice the GDP of small countries. In addition, 90 percent of bitcoins are already mined and once the remaining 10 percent is mined, reaching the cap of 21 million bitcoins, miners will move to transaction fees, a positive impact on network energy consumption.
New bitcoin rallies are not without perennial attacks on the blockchain’s energy consumption with arguments from across the divide. Most agree there is room for improvement, and this is an area clean green policy leadership would better support blockchain miners. The future energy consumption of DLTs is bright, Ethereum’s mainnet has moved to a consensus method called Proof of Staking (PoS) which claims a 99.9 percent reduction in energy usage of the infrastructure.
The Report also contains some very positive data. The U.S created a record 12 million jobs, the strongest two years of job gains on record. Unemployment is at a more than 50-year low, with near-record lows for Black and Latino workers, and manufacturing jobs have recovered faster than in any business cycle since 1953. Following a global pandemic, and with persistent inflation in the West, this should be applauded.
That there appears very little support in the Report for the future economic and strategic benefits of crypto, digital assets, and DLT appears “tone deaf” for a nation of capitalists that believe the U.S. leads the digital space race and leads the global financial services markets.
This is especially the case while U.S. mid-tier banks and regulators are struggling, and there is even greater uncertainty in the crypto, digital assets and DLT regulation space, due to a raft of bankruptcies and continued regulation by enforcement.
It should be noted that the SEC has just released a statement that it is considering whether to issue a supplemental release to its January 2022 proposal requiring significant trading platforms to come under important rules for the markets under existing securities laws (Regulation ATS) – and to include communication protocols in the crypto markets.
We may wish to pay a bit more attention to our cousins across the pond. They excel at building market infrastructure through industry collaboration not litigation, and these practices extend far beyond the U.K and Europe to the Middle East, Africa, APAC, and Latin America.
