Excerpts from remarks of CFTC chair Christopher Giancarlo at Commissione Nazionale per le Societa e la Borsa (CONSOB), Rome, Italy, June 3, 2019, “The New Futurism: 21st Century Financial Markets, Technology and Regulation”
Imagine what a difference it would have made a decade ago on the eve of the financial crisis if regulators had access to the real-time trading ledgers of large Wall Street banks, rather than trying to assemble piecemeal data to recreate complex, individual trading portfolios. Imagine if, instead of having to call around to brokerage firms searching for market information, prudential regulators had access then to a “golden record” of the real-time ledgers of all regulated trading participants.
And imagine if in 2008 regulators could have viewed a real-time distributed ledger, and, perhaps, been able to utilize modern cognitive computing capabilities to recognize anomalies in market-wide trade activity and diverging counterparty exposures indicating heightened risk of bank failure. And imagine if, that insight would have shown that the $400 billion notional of outstanding credit default swaps written on Lehman Brothers represented under $8 billion in net market exposure to failure of the firm.
In short, what a difference it would have made a decade ago if blockchain technology on a private distributed ledger accessible to regulators had been the informational foundation of Wall Street’s derivatives exposures. At a minimum, it would certainly have allowed for far faster, better-informed, and more calibrated regulatory intervention instead of the disorganized response that unfortunately ensued.
Now, let’s fast forward to today. Bitcoin has refocused attention on topics of back-office infrastructure, interoperable databases, and shared ledgers – and this is a good thing. It means that efforts to upgrade data infrastructure with blockchain and Distributed Ledger Technology (DLT)-inspired systems is getting the attention required to drive broader adoption. And these systems could enhance efficiencies and transparency not just in our financial markets, but also across the real-economy.
With respect to financial markets, DLT and its inspired systems is likely to have a broad and lasting impact in payments, banking, securities settlement, title recording, cybersecurity and trade reporting and analysis.
Additionally, as our recent LabCFTC primer on smart contracts makes clear, DLT will likely develop hand-in-hand with smart contracts that can value themselves in real-time, report themselves to data repositories, automatically calculate and perform margin payments and even terminate themselves in the event of counterparty default.
DLT may further enable financial market participants to manage the significant operational, transactional and capital complexities brought about by the many mandates, regulations and capital requirements promulgated by regulators here and abroad in the wake of the financial crisis.
In fact, one study estimates that DLT could eventually allow financial institutions to save as much as $20 billion by 2022 in infrastructure and operational costs each year. Another study reportedly estimates that the technology could cut trading settlement costs by a third, or $16 billion a year, and cut capital requirements by $120 billion. Moving from systems-of-record at the level of a firm to an authoritative system-of-record at the level of a market is an enormous opportunity to improve existing market infrastructure.
Outside of the financial services industry, many use cases for DLT are being posited from international trade to charitable endeavors and social services. International agricultural commodities merchant, Louis Dreyfus, and a group of financing banks last year completed the first agricultural deal using DLT for the sale of 60,000 tons of U.S. soybeans to China.[12] Other potential DLT use cases include: legal records management, inventory control and logistics, charitable donation tracking and confirmation, voting security, and human refugee identification and relocation.
Clearly, DLT development and adoption will not be easy, and challenges remain around scalability, governance, security, and value. Indeed, as I have observed over the past few years, some advances will seem slow, until they hit a tipping point.
Yet it is undeniable that DLT and interoperable database systems hold enormous commercial promise. It may provide critical assistance to financial market regulators in meeting their mission to oversee healthy markets and mitigate financial risk. And, that is just one of the reasons why I am excited about the promise and prospects of DLT.
Regulatory response to exponential technologies: the CFTC approach
The sheer speed of innovation has increased exponentially, both in terms of production of new models and products and their subsequent public adoption. The former dynamic is driven by increases in the power of computing coupled with decreases in computing costs, and the latter is a function of how the internet and mobile allow for rapid public adoption and scalability. These dynamics put pressure on regulators to keep pace with rapidly changing markets, especially given the potential for new technologies to impact markets in short order.
The second characteristic is the disintermediation of traditional actors or business models, which can challenge regulators and existing regulatory frameworks. Consider, for example, how the digitization of everything, including music, travel, trading, and even farming have furthered the decentralization of traditional intermediaries. Such decentralization of key economic actors is an enormous challenge to most regulatory approaches and frameworks, which tend to focus on key intermediaries through registration of major market participants and designation of self-regulatory organizations comprised of such participants.
Consider cryptocurrencies, for example, which seek to offer alternative means and rails to execute payment transactions, power self-executing software, or drive capital raising activity. In many instances crypto-related activity may occur outside of traditional intermediaries – indeed frequently by intentional design in order to offer an alternative model – and include new economic actors not covered by existing regulatory frameworks or covering them in an ill-fitted manner.
The third characteristic is that the pace and nature of technology-driven innovation requires heightened technological literacy across leaders in business and government. How many today truly understand the technologies that power underlying business models? And from a government perspective, how can regulators be expected to mitigate risks and formulate sound policies that foster market-enhancing innovation without requisite technology literacy?
Given these characteristics, how is a regulator to respond and keep pace with rapidly changing markets? During my tenure as chairman of the CFTC we have taken affirmative steps to evolve into a 21st century regulator and craft a modern regulatory approach. Our formula for this evolution is quite straightforward and is predicated on four key elements:
- adopting an exponential growth mindset
- creating an internal fintech stakeholder
- becoming a quantitative regulator
- embracing market-based solutions