It’s been a year since officials said strict procurement rules could block regulators from working closely with financial technology firms, but no legislative solution is teed up to correct what many see as a problem.
Two bills in the House would ensure that the Securities and Exchange Commission and the Commodity Futures Trading Commission could avoid transgressing those rules and still obtain access to industry-created technologies. Both measures have bipartisan support, but with attention on the country’s coronavirus response, neither is on a fast track.
Close fintech watchers are rooting for these bills and other policies to better align regulators’ technological capabilities with an industry that’s eager to progress.
Federal law prohibits agencies from accepting gratuitous goods or services like technology that could help them better regulate the market. Such access is deemed a way for the agency to increase its appropriation. This has led a handful of lawmakers to sponsor bills that would free up regulatory agencies to access platforms such as those used in fintech.
The proposals are mainly about “getting regulators up to speed with the latest technology in play,” said Jackson Mueller of the Milken Institute. The organization is a nonprofit think tank, and Mueller serves as associate director of its Center for Financial Markets, where he tracks fintech developments.
“These rules effectively prevent the CFTC and other federal regulators from being able to gain a closer look at and gain a greater understanding of the latest technology and trends as they develop,” Mueller said.
A bill by Rep. Austin Scott, R-Ga., and a CFTC reauthorization measure by Rep. Collin C. Peterson, D-Minn., would carve out gift rule exceptions to authorize regulators to access research, data and blockchain or other digital infrastructure designed by private innovators as long as selection is determined by a competitive process. They are among 124 bills that relate directly to fintech that the Milken Institute is tracking.
A third proposal — the Financial Technology Protection Act, by Rep. Ted Budd, R-N.C. — would establish a fintech grant program funded through fines from terrorism financiers working in digital currency. It passed the House by voice vote in 2019 but remains stalled in the Senate Banking Committee.
Similar proposals made it out of committee in the past, indicating that the issue has received at least some lawmakers’ attention.
While Congress wrangles over how to modernize procurement rules, the industry’s major players are already investing in distributed-ledger solutions.
Options Clearing Corp., a financial utility owned by securities exchanges that makes trading less risky, unveiled a plan this month to partner with technology firm Axoni to design a distributed-ledger settlement platform that will eventually replace its securities lending infrastructure, it said.
Some transactions are too cumbersome to manage with old technology, according to Axoni. If discrepancies arise, analysts have to manually sort through the data from multiple trades. A distributed ledger allows both sides of the deal to see real-time activity, rendering any manual reconciliation unnecessary, it said.
“Our work with Axoni seeks to address industry challenges and reduce costs stemming from manual processes, lack of automation and disparate systems,” said Matt Wolfe, vice president of securities finance at Options Clearing. “The new platform lays the foundation for a future-fit CCP [central counterparty clearing] securities lending model.”
Similarly, BOX Exchange LLC, based in Boston, asked the SEC to approve its plan to require all trades to be recorded on the blockchain known as Ethereum, in addition to keeping traditional records. The SEC set June 14 for its decision on the request.
Axoni is a New York-based technology company working in capital markets. It plans to create a cloud-based distributed ledger that relies on its existing blockchain protocol known as Axcore, the company said.
Development will begin this quarter, and the finished product will be rolled out in multiple phases, according to a May 5 statement from Ishan Singh, Axoni’s vice president of solutions.
“Deploying distributed-ledger technology in production at this scale will be a significant moment for the securities lending industry,” Singh said. “The combination of technology and business expertise being applied to this project will generate a variety of benefits for industry stakeholders.”
Ultimately, all transactions for Options Clearing Corp. will process through the distributed-ledger network designed by Axoni.
A common distributed ledger is blockchain, the technology underpinning bitcoin. These networks generally protect the integrity of record keeping through decentralization. Every transaction is recorded on the network for all to see.
“An essence of using blockchain is that the participants don’t trust each other,” Maurice Herlihy, professor of computer science at Brown University, said in a call with CQ Roll Call. Distributed-ledger technology being both “highly available and tamper-proof” makes it a good solution to ensure integrity, Herlihy said.
Beyond the realm of finance, public health experts battling the COVID-19 pandemic have also looked to blockchain to devise a system of encrypted contact tracing to help track the spread of the disease while sidestepping many associated privacy concerns, according to recent reports.
Options Clearing called its blockchain rollout for securities lending a part of the company’s broader, five-year “renaissance initiative,” which, according to its website, includes a focus on bringing the latest technologies to the nearly 50-year-old CCP, which clears more than 5 billion derivatives contracts in a year.
“Our systems have proven to be resilient, and we have cleared the markets every day, even in times of record volumes, serving our vital role,” the company said. “Our ongoing transformation will allow us to continue doing so with enhanced technology, security and compliance focus.”
These types of advances could leave regulators in the dust. Groups like the Milken Institute continue to press them to catch up to the speed of innovation, but first Congress must change the law surrounding procurement, they say.
“In the absence of legislative activity, the Milken Institute recommends the Task Force on Financial Technology, the Task Force on Artificial Intelligence and the House Committee on Agriculture hold a joint public hearing covering the challenges and opportunities regulators face in procuring innovative technologies to enhance their oversight functions, including a discussion on legislative actions to address such challenges,” Mueller said. The two task forces are part of the House Financial Services Committee.
Former CFTC Chairman Christopher Giancarlo testified about the procurement problem before a House Agriculture subcommittee last year.
“We have been offered the opportunity by many innovators to actually participate in blockchain experiments, but I have been advised by our general counsel’s office that if we were to participate, it would be considered a gift, which we couldn’t accept,” Giancarlo told the lawmakers in his May 2019 testimony. “We should be a part of these innovations.”