Blockchain Roundtable: practical implications of a revolutionary technology for financial markets and beyond
I would like to thank Commissioner Chilton for inviting me to speak today – particularly on such an interesting topic as blockchain.
Normally, you are all used to hearing me talk about the next dull and complex piece of EU regulation coming down the pipeline. Or more recently extolling the benefits of UK membership within the EU.
Talking about the benefits of the single market, and how access to the EU’s 520 million consumers, investors and pensioners.
So it really is a pleasure today to speak on a much more interesting topic today on the future role of block chain in financial markets.
The EU stage is now set for a constructive debate on this topic.
Now that Jean Claude Juncker and Jonathan Hill have set a much more reasonable financial services agenda, by looking at how we can improve existing legislation, and examining the evidence on overlaps, in order to make changes to improve the current regulatory framework.
It is now time to use the EU regulatory process to accommodate new innovations and technologies.
Instead of fighting back the Tsunami of regulation, we all have time to get excited about new innovations and new opportunities for financial services – including exploring the potential of technologies like blockchain.
Like many in this room, my first interaction with blockchain was via Bitcoin – perceived by many as this dark ominous cryptocurrency, established by shadowy and up until recently anonymous figures from the cyberpunk movement.
With a reputation for Being used by drug dealers on the dark net via Silk Road, money launderers and even paid assassins - if you believe some of the hyped up claims that are out there on current uses for Bitcoin.
Yet the transformation over the past few years from that shadowy world into respectability and mainstream uses has been nothing short of meteoric.
We are now entering into discussions over whether blockchain is the new internet, whether blockchain can solve all of the developing world’s problems via revolutionising remittances, whether it can create a more engaged electorate via e-democracy.
Maybe some of these are again just hype – but its potential in the financial services sector could undoubtedly be huge.
The list of services in the financial sector that could be replaced or made more efficient by blockchain – or to be more formal using distributed ledger technology, is constantly growing.
Clearing, securities settlement, collateral management, custodian services not to mention reporting, reconciliation and corporate actions.
Apparently distributed ledger technology could even replace the need for Central Banks according to some of the marketing material I’ve seen – although perhaps now isn’t the time to tell Mark Carney and Mario Draghi they may be out of a job soon as they and their institutions have been supportive of the development of distributed ledger technology thus far.
Needless to say – there is a lot of hype.
And with new technologies – or n this case more accurately as with new uses for existing technology – as DLT has been around for decades – it is hard to separate out the hype from genuine use in future processes.
It’s also hard from a regulatory perspective to know when to treat new innovation with suspicion and when to welcome the new efficiencies they may bring. Oliver Wyman and Morgan Stanley have estimated that costs in global post trade processing range from 17 billion US dollars to 24 billion US Dollars, as well as an annual cost of 12 billion US dollars in compliance costs related to Anti Money Laundering and Know Your Customer compliance costs.
They claim that 50% of the costs associated with capital market transactions could be removed if DLT was utilised efficiently.
It’s easy to see why there is so much hype if savings of that size can be realised.
Yet a lot of the costly inefficiencies in post trade in Europe have nothing to do with limitations in the current technology.
They are actually there because someone is making money out of the inefficiency and is in a position to prevent other solutions from coming to the fore.
While those huge headline savings are providing an incentive for people to invest in DLT solutions, they are also revenue and profits that will have to cannibalise someone else’s core business.
As Peter Norman, the great post trade writer says – “Qui bono?” – “Who benefits?” – is always the key question to ask when looking at seemingly illogical inconsistencies in the post trade space.
From a public policy perspective that means I am looking critically at some of the seemingly insurmountable problems incumbent market participants are bringing to my attention to see whether they really are so insurmountable.
I have already heard tales that the Distributed Ledger Technology is really a way of getting around EU rules on Anti Money Laundering and could allow certain entities to side step MiFID and CSDR.
This is why I am fully supportive of the approach being taken by the FCA here in London to Fintech firms more widely.
Looking at how the regulation can be applied to these firms, without stifling them.
Trying to understand the new technology instead of banning it.
Under previous EU approaches, I would have been concerned that the EU regulatory process might not be flexible enough to accommodate this way of looking at the world.
But that’s not a big concern for me anymore.
The EU’s digital Agenda is much wider than just digitalisation and has already played a part in Jonathan Hill’s Capital Markets Union Action plan.
The Commission has also just set up a new Post Trade Forum to look at innovations in the post trade space.
Interestingly, at their very first meeting, instead of a depressing recap of how little progress has been made on breaking down the Giovannini barriers identified in 2001, they had an in-depth presentation on blockchain by SWIFT.
Europe is uniquely placed to adopt DLT on a broad basis in the financial markets, long before the US because of a few simple factors.
Firstly, we have a pan EU approach to regulation that has already meant market players have looked for legal solutions to overcome differences in local laws.
EU regulation has been the perfect tool in the case of MiFID to foster the creation of pan EU platforms instead of protecting national incumbents – who would now be more reticent to adapt to new technologies.
The Central Securities Depositories Regulation is yet to be fully implemented, but it is already looking to a future where the legal obstacles to cross border settlement and issuances are removed – that is not so many steps away from being able to facilitate a DLT approach to securities settlement.
But the biggest EU advantage that really increases the likelihood of DLT taking off on a broad basis in securities settlement – is Target2Securities
A central infrastructure with a diffused governance structure, no profit making incentive, could be the perfect vehicle for new solutions to be developed. Maybe or maybe not?
In any event, wherever DLT is developed for use in the securities trading or post-trade space, we should look at lessons from the past and try to avoid previous mistakes, Open Industry Standards and common protocols need to be developed.
Closed systems for Know Your Customer and Anti Money Laundering compliance within banks could solve the KYC issues but they will only actually be useful in reducing costs if they can be used between banks and interface in a seamless manner.
Hybrid or Consortium systems, set up between financial market participants, where a pre-selected group of organisations controls the validation consensus mechanism of who can make changes to the distributed ledger will have to be careful not to act as a cartel.
The principles of MiFID around open access should be taken as a template.
No discrimination against those wishing to participate, even if that those participants have to meet a strict set of criteria to join.
EU regulation already mandates ISOs like ISO 20 022 in Target2Securities, CSDR and MiFID2, as well as the use of identifiers such as the LEI, but in each case industry has had to work together first, before the regulation mandated one system.
I think if a large enough and broad enough group of industry is able to come together to agree the building blocks of the protocols required to facilitate a DLT solution, then regulators globally – or at least in the EU – will be keen to interact and endorse it.
Commissioner Giancarlo of the CFTC recently gave a speech on blockchain calling for such an approach, however he compared the stance he thought policy makers should take to that of the Clinton administration to the internet.
Where in the 1990s a “Do no harm” principle was taken by supervisors in order to allow the internet to flourish for a multitude of purposes.
I’m not sure if this approach can be applied to the use of DLT in the financial services world.
Financial Services is already a heavily regulated industry, and many new innovations will be treated as regulatory arbitrage or malicious avoidance.
The onus is therefore upon you, the industry, if you really think that the efficiencies of this technology are worth the investment, cost and change, to bring regulators and policy makers with you.
To Show how KYC can be improved by a permissioned system.
To Show how resilience to cyber threats can be improved through a system that stores data in multiple locations
And Most importantly show how investors will not lose rights or protections under new more elaborate protocols.
We have already seen examples of regulators with the best of intentions getting it wrong on new technology.
Under EMIR and Dodd-Frank trade repositories have had to set up multiple entities to try to obey privacy laws in different jurisdictions.
ESMA admits in its review of EMIR that it can only interrogate data from 4 of the 6 trade repositories in Europe.
Reporting fields don’t match up across different regulations meaning firms have to pay for duplicative technology systems to fulfil slightly different requirements.
The New York attempt to get out ahead on Bitcoin regulation by bringing in a licensing regime that was not fit for purpose has resulted in only 1 license being granted since its inception.
Still – better than Bangladesh that banned all virtual currencies – I have no idea how they are enforcing that one!
Having painted a pan EU picture of what could happen in the future, in all likelihood, Distributed Ledger Technology is going to have to start small and prove its value case by case in financial markets.
This will probably initially involve assisting in the settlement of those assets currently outside of a CSD – for example syndicated loans, or securities lending or possibly even insurance contracts.
These are proof of principle experiments worth involving regulators and supervisors in assessing risks and benefits to all stakeholders.
The only way that DLT will be accepted in the public equity markets where retail investors place their retirement savings, is if it is proved suitable for professional participants first.
Personally, I don’t think that Blockchain will sound the death knoll for all traditional market infrastructure.
I'm not even sure there will be an “Uber” moment for disruptive technologies in the financial markets.
I think financial institutions came together to create trusted third parties to stand between them, not just to manage credit, counterparty or settlement risk, but because they were trusted entities that performed a service.
These entities are going to have to innovate to survive and clearly show their value in the new high tech world – but I am confident that many intermediaries will rise to the challenge.
And no one will mourn the loss of those intermediaries that turn out to be solely cost centres that when eliminated from the system yield a much needed round of efficiency saving that will benefit investors.
Most blockchain executed functions in financial markets are likely to be fully regulated by similar legislation that exists in traditional markets today, however, the policymakers and enforcers need to ensure that they are not applied too early and that regulation is not used as the ultimate barrier to entry and the block to more efficient capital markets in the EU.
I hope this gives a framework for this morning's panel of experts and I look forward to hearing the industry's take on how this new technology may assist in future market efficiencies.