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The future of regulation

Jerry Brito, Coin Center

J. Christopher Giancarlo, CFTC

Benjamin Lawsky, Lawsky Group

Mark Wetjen, DTCC

JB: I want to start with Giancarlo. Your approach has been "first do no harm". What opportunity is this?

Giancarlo: There are a number of elements to my interest. I want to go back to a moment of time where it became clear tome that something like this, although I don't know if it would be this, was tremendously necessary. In September 2008, days before Lehman Brothers ecollapsed, I was a senior executive for the world's argest trading repository for credit default swaps. In days before, in the imddle of that crisis, before Lehman Brothers fell, we were launching credit spreads on Lehman Brothers, gapping out hundreds of basis points, indicating real stress in their viability. We were in conversations then with bank regulators and the fed and others asking us questions as to what we were seeing in the marketplace. Where were the credit spreads? How much stress the counterparties were on? Were the counterparties trading with each other? What market signals were they seeing that the regulators didn't see? It became clear to me that the core of the financial crisis was the lack of visibilit by regulators into the counterparty credit exposures of the world's largest trading banks between each other. The regulatory solution for that in Dodd-Frank was to create swap data repositories where information could be gathered and then re-assembled to somehow look ike the actual trading ledgers of the different financial institutions. 8 years after the crisis, we're trying to gather that information, clean that data and reassemble ledgers. We are going to be doing that for a ong time to come. Because of the way of regulatory regimes. At the CFTC, we have responsibilities for credit swap indices while the SEC has responsibility for credit default swaps, two products that trade in the real world in tandem but separated in the regulation world. We will be trying to reassemble ledgers forever, without being able to see what blockchain database technology could potentially provide us. I think there are many reasons to continue to develop blockchain database technology. This will provide regulators something they didn't have during the financial crisis. I don't think it will prevent the crises, I don't think this is risk avoidance, but it's certainly a risk response methodology.

JB: Your message has been "first do no harm". What potential regulatory harm could ther ebe? What rules need to change?

Giancarlo: The harm is death by a thousand cuts. The financial sector is overseen by many state regulators and multiple federa regulators before you even get beyond our borders. And yet banking is a global business. Banks need to operate across jurisdictions and across regulatory authority. The development of blockchain database technology will be hindered by disparate regulation and regulators looking at it from different perspectives.

JB: How?

Giancarlo: My approach is "first do no harm". I believe "first do no harm" is not ony for the CFTC. I believe it's hte basis for global consensus. It draws on the very sensible way that the United States went about regulatory response to the internet. Back in 1996, the congress passed television communications act, then Clinton the next year put forward principles for commercial commerce on the internet. Regulators should first do no harm. The private sector, through private contractual arrangements, through industry standard setting, should be the basis of the development of the internet. While I am not saying blockchain database technology is the same technological evolution as the internet, I do believe that the regulatory response to this technology should borrow from the light weight that the United States government went to regulating the internet. Thos eprinciples that were laid out by Congress and the Clinton administration became the world-wide standard certainly for the G20 nations that adopted that. So when I say "first do no harm", I am recognizing all the sandboxes that the U.K. and so on are setting up. I think that's smart, but we can't have individual sandboxes. All of the regulators need to adopt the "First do no harm" approach if ony for the selfish reason because this tech can provide regulators more insight into market activities that they didn't have back in 2008.

JB: Ben, you made history for making the first license specifically aimed at digital currency. What was the goal of bitlicense?

BL: Thank you for having me here. I agree with Giancarlo. I think those comments go back to the goals we had. We knew that as a banking regulator, at DFS, we had several duties. I think I agree with a lot of what was said about internet regulation and its transferability here. And I think the difference here, espe-- it's really true for use cases for blockchain database technology which are non-financial... but earlier, if you had banking regulation sure, but not internet regulation. When we were at DFS, to the extent that blockchain database technology and bitcoin technology were being used to essentially manage the money or move the money or others, there are some regulators that have responsibilities because one of your number one priorities is to make sure your money doesn't disappear, like as happened at MtGox. We approached that problem, we had existing regulations that were written around the time of the Civil War. So they were not particularly weill suited for bitcoin and other digital currency. So we set about to find out if we could create regulations that satisfy some of the same goals we had as a banking regulator, to protect consumers, adequate capital standards, making sure the money doesn't disappear, and could you do that in a way that would first be better suited for new technoogies and coud we do it in a way that wouldn't crush these nascent companies in the development of this important and interesting technology that continues to change hte way the financial system works? That was the goal. That was hwy it took 2 years going back over thousands and htousands of comments. I think the regulation exists. How it's turned out, the jury is out on that. I am obviously biased. I think we'll learn more over time. The goal was to put the right controls in place to protect the system and protect consumers but not squels htthis new technology. It's tricky though.

JB: States like Caifornia considered approaches like not .... non-custodian uses of bitcoin. In bitlicense, you mentioned an exemption for that for non-financial? Does that mean non-custodian?

BL: I am here in my personal capacity. I am not the interpreter of Bitlicense anymore. I think at the time we certainly did not set out to regulate software or coding. We wanted to regulate financial intermedaries only. We made it pretty clear in multiple iterations that we were only regulating financial intermedaries. If you are not a financial intermediary, then you should not be covered by regulation.

JB: Mark, you put bitcoin on the agenda at the CFTC. What did you expect and how did it turn out?

MW: Well you were at it.

JB: I know.

MW: Well, just some history at the itme. This was around fall 2014. In the spring, the agency had received a request by one of the exchanges, in this case a swap execution facility to list a derivative product denominated in bitcoin. We had a responsibility to respond to that request. We had to make sure we understood the technology and how the rules applied to a SEF. In some ways, it was almost out of necessity by that I mean to say, I think as an agency, the CFTC had a duty to evaluate this and look at this novel set of issues. There was also an effort to convey to the public that the agency took its responsibility seriously. There was also a sense of openness not only to educating the agency and openness to the technology itself and try to figure out how it coud be responsible.

JB: What did you learn? What happened?

MW: One of the things we were really surprised by at hte time was the amount of interest in the medium itself. As someone else put it, it wasn't ike stuffing the internet with cat videos. By the standards of meetings hosted by the federal government, it was ... in the history of the federal government. The thing that was interesting about it is that it was the largest concentration of viewers were outside of the United States. We were surprised by that. The other thing I want to add is that even back then, comparing how it felt and how things seemed in 2014 to now comparing that to day in May 2016, now we're standing in clear extraordinary interest. I am not sure that I would have predicted this high level of interest. It says a lot about the opportunities participated.

JB: So you are now at DTCC which has been forward about distributed ledger technology, and you have conducted several tests? What is DTCC's interest.

MW: As far as DTCC's vision, what it sees as the biggest opportunities are one, this could be a chance to really try and come up with post-trade infrastructure that doesn't have the same amount of fragmentation and silo systems that we have today. The problem with that type of system and silos is that, just imagine, it creates inefficiencies and costs. DTCC is a company that is really in service to the marketplace. That's probably really the main opportunity the company sees, to leverage technology and do away with silo entities throughout the financia service industries. Instead, have something much more integrated and communicates much more efficiently. The second thing I woud say is the gains we can have by transparency and accessibility with data.

JB: What about the tests you ran?

MW: Yeah so the actual use cases being explored right now are related to repo trades, that's use case number one. The second use case relates to credit events, post trade, signal events, CVS... the actual experimentation is further along, there's a CVS use case in matter of weeks we will see some actual testing in the repo space. I think it's important to say there are resources that we have devoted to.. real experimentation, real analysis as it... the technology.

JB: I am going to direct this question to Giancarlo. You guys mentioned that one of the benefits of this is access to regulators for the data. Can you be more specific about what that would be? What would you like to see? How would you use it?

Giancarlo: Well let's talk about what we have now. What we have now is ex post facto data. We have data after the events. We have data sets that have varying degrees of completeness to them. We have good data of cleared swaps, we have lacking data for uncleared swaps. Sometimes a trading book we see may look terribly unbalanced, maybe it shows the cleared swaps but not the uncelared swaps. Maybe it would look more balanced as a portfolio with more data? We are trying to reassemble ledgers between trading partners. With the potential of blockchain database technology, we could see real ledgers in real time across markets and across asset classes. That would be a tremendous step forward. That would be information that we didn't have before. In the event of a future crisis, regulators would be able to be more precise and more calibrated in their response to crisis conditions. This doesn't necessarily avoid failure, the tech is not going to avoid failures, because failures come down to how humans handle it. I was misquoted saying "blockchain database technology would have prevented Lehman Brothers from failing". No, it would not have been prevented by tech, but it would have been prevented by reguator response. Regulators would have had more insight into figuring out how to prevent Lehman from failing. The promise for blockchain database technology to regulators is to provide counterparty exposure and transparency that was lacking. This is only one part of the process. In the wake of the financial crisis, the G20 nations have posted a lot of new capital requirements and new mandates on financial institutions, creating an enormous amount of operational complexity and capital complexity. I think blockchain database technology offers promise there too, of being able to transcend some of that regulatory and operational complexity. I think regulators have their own reasons, reasons that help them fulfill their mission to taxpayers, but also have reason to see this technology thrive to allow regulated entities to meet their obligations under regulatory....

JB: I imagine regulators are interested in solvency, to get views into companies and setup risk profiles.

Lawsky: Yeah potentially, plus to help with anti-money laundering. I think the kind of transparency that the commissioner Giancarlo is talking about is extremely interesting. I think it's going to take time. Over the next few years, regulators who aren't as wel versed as this commissioner talking today, trying to catch up. They have tons of other responsibiities. The more they focus on this, the more they will realize....

Giancarlo?: Someone mentioned earlier it is important for market participants to articulate the benefits. I think there's one way to understand this directly.... we have long had access by law and by rule, to market participants.... When blockchain database technology is a way of digitizing those ledgers. Digitizing those edgers and transmitting that information in real time. From a regulator's point of view, it's the next technological .... it's the next step in regulated and regulated entity and regulator, it's the digitization of that relationship.

JB: YTou mentioend this taking some time. The UK government might be moving faster. The chancellor in the UK said, getting fintech embraced and they intend to win. Those regulators are bending overbackwards to attract backwards. When you are icensed in the UK, you are licensed in every state in the EU. You have incubators that track companies, AML rules recently announced-- that they will not apply AML to software wallets, only to exchanges. To the whole panel, how is the U.S. fairing as far as international competence?

Lawsky: Setting apart the wallet question.... I love what the UK is doing. I think competition between states and the federal government, to try to innovate regulation and to drive more companies to promote innovation and to promote companies, I think that's great. What you want to avoid is a regulatory competition that is really just a race to the bottom which is who can have the lightest touch regulation. I think we saw that in the years leading up to the financial crisis. The results were not good. I think it's good to have competition where we have smart thoughtful regulation but also thinking about promoting innovation and the regulatory sandbox. We see the CFTC, sorry the (???) .... promoting innovation while still wisely regulating... when it comes to wallets, I think you have to be careful there. Just say you're not going to look at AML for wallets. I assume the assumption there is that everything in the walet has gone through an AML check at an exchange. But does everything in a wallet end up going through an AML check? Are you never going to look at wallets? Well they are holding the funds of others. I think we have to be careful there. When it comes to AML, you don't want to make a mistake. Been through the crisis and a lot of other work around terrorist financing, I think you want to be really careful about your responsibilities as a regulator.

Giancarlo: I am going to disagree slightly. I don't believe there's a regulatory race to the bottom in sophisticated marketplaces. Market participants don't want to go to the least regulated jurisdiction. If they did, perhaps Zimbabwe would be the financial capita of the world. Market participants go to where there is the best balance of regulation and the best regulation. There is a reason why the United States is the best. We're competing against Hong Kong and London every day because we're seen as having the best balance of regulation. Nobody would say this is an easy jurisdiction. The disclosure obligations of the SEC are definitely onerous. Delaware is seen as having the best investor protections as well as corporate board protections. I believe we are in competition amongst jurisdictions like New York, London, Hong Kong, but we must have the best balance of regulation. Not a big disagreemnet with you, but I don't think the risk is that we go so light that we will flow here, but I think that business flows to where the regulation is the best. I think in the United States we need to take London seriously and develop our own sandboxes and our own approaches to this. We got it right in the Internet. There's no reason we shoudn't expect to get it right this time around if we take appropriate steps. ((applause)

JB: So, Mark, DTCC chief architect said open-source is required to reach full potential to avoid silos. How important is interoperability and standardization? How to accomplish this?

MW: It's critical. For Rob, to make a point, he's our chief technologist architect, he's also the.... we should be looking at this technology and so on. I think what Rob means, and it reates to the question just asked about comeptition and some sense of that between regulators. As I said before, the opportunity that DTCC sees is moving away from silos of data in order to better ensure there's some sort of way to easier way to rationalize information between financial entities. The same is true of regulators. We talk about swap data repositories. We need a particular set of standards. In the UK, data getting to the regulator, has to abide by a set of standards, and in a different country, it has a different standard. We are in the same spot we are for SDRs.... that's not to say there aren't legitimate reasons for the ways things are today, because each country has its own public that have representatives and regulators are accountable to.... there are also differences here. This technology itself is not necessariy a utopia, it provides this opportunity to harmonize data standards in a way that is powerfu but it coud be undone if we have a patchwork of different regulation or standards.

JB: So in a recent speech, Giancarlo said that this allows regulator to transcend fragmented data silos to get a single record of financial record. A single verified record? How important is standardization?

Giancarlo: Well that's somewhat aspirational. The goal is to get to a composite ledger that would provide visibility to trade authorities about meeting regulatory needs.

JB: Putting technical reasons aside, are there any policy reasons that would prevent bitcoin from filling this role?

Giancarlo: As a reuglator, and by the way my comments reflect my own views and not the views of...

JB: It's a litte late to say that, isn't it?

Giancarlo: But I got in. It's important in my role to not be seen as putting my finger on this. There are promises for both sides of that debate. I think there's utilization for both elements of that. I would like to see both permissionless and permissioned. I think they will fall into their rightful niches as this technology develops.

JB: Is there any regulatory role why that might not happen?

Giancarlo: I am sure there would be a lot of thought going into that from regulators and market participants. That's going to be interesting.

JB: And that's why regulation matters today?

Giancarlo: That's right.

JB: Thank you very much.