Yesterday at R3’s Corda Con, Chris Woolard a board member of the Financial Conduct Authority (FCA) gave an engaging speech for a regulator. The overall message was that the FCA is open and flexible when it comes to many technologies. They’re upbeat about the potential for distributed ledger technology (DLT), but not at a hype level of enthusiasm. The emphasis is on balancing the risks and the need for senior executives to be accountable and hence understand what they’re managing.
The ultimate goal for the FCA is to protect consumers. To that end, the FCA regulates financial activities as opposed to individual technologies. Hence they are technology neutral. The motivation is simply that technology moves faster than regulation. But as technology evolves they need to ensure their rules remain relevant.
Woolard commented: “We’re ten years on from the financial crisis where overly complex financial engineering played a significant role in making the impact so severe. We have to be alert to the risks that complexity can bring.”
The regulator highlighted some of the complexities of DLT: the need to understand cryptography, game theory, technology concepts, and economic concepts.
He continued: “If organizations are going to deploy these kinds of technologies, then we have a simple expectation which is if you are in senior leadership of those organizations, you know what you’re doing, you have the expertise around you or even the expertise yourself. Actually, we have to ask ourselves the question: Is that common in many boardrooms today?”
Additionally, if a process is automatically executed on a DLT network, the lines of accountability could be obscured. The regulator said the black box defense would not work: “I put it in the black box, I didn’t know what it did. It had that outcome; you can’t blame me.”
A related issue involves outsourcing. When an organization outsources a function in a regulated space, they have to inform the FCA. That allows the FCA to monitor for concentration or systemic risks. For example, there are only a handful of widely used cloud providers, and the FCA is establishing whether this is a material risk. So the question is whether using DLT amounts to outsourcing or could lead to these sorts of risks.
The FCA’s regulatory sandbox has been running for four years, and a third of the 89 firms use DLT. Based on these examples the FCA identified three DLT benefits. Firstly, it can improve operational resilience by removing critical points of failure. Secondly, it helps to improve transparency. And thirdly the automation reduces costs as a result of less administration and fewer intermediaries.
The regulator compared DLT with the economic impact of the sharing economy. “We used to say not that long ago: ‘Don’t meet people you’ve met online, don’t stay in their houses and certainly don’t get in their car’. Smartphones and the internet have created a whole range of services that have broken many of those assumptions.”
But Woolard went on to say that it’s not yet clear whether DLT can create quite such a disruptive change. However, he is confident that DLT can improve the delivery of financial services. He commented: “Whilst it’s early on, an awful lot of what we’ve seen around the use of DLT has been impressive but only when the accompanying risks have been thought about and mitigated.”
The regulator fleetingly discussed interoperability with their own systems. Specifically, the systems they use for reporting, oversight, and controls have been developed over many years, so they can’t replace or remove them quickly. He stated this was not an insurmountable issue. But perhaps it could be an issue that causes delays?
Woolard concluded by saying they want to continue to engage and their door is always open.