FinTech and Blockchain Law Watch – Page 55 – At the Crossroads of Law, Innovation and Commerce

DLT for the OTC

Jul 07 2016

On June 21, 2016, some of Europe’s largest financial institutions announced they had entered into a memorandum of understanding (“MOU”) under which they would work together to develop a blockchain-based settlement procedure for over the counter (“OTC”) transactions. According to the MOU, several European legislators are concerned that small and medium-sized enterprises (“SMEs”) do not have adequate access to capital. The MOU seeks to solve such concerns by bringing together European exchanges and investment banks under a common mandate to reduce the cost for SMEs raising capital in the OTC market. Blockchain may be the solution they are looking for.

Generally, blockchain is a decentralized digital ledger, and its creation established a new class of digital ledgers called, distributed ledger technology (“DLT”). Unlike current financial settlement systems, DLTs are more efficient because all transactions are mathematically provable and do not require a multi-day verification process. DLT protocols use encryption combined with distributed copies of the ledger to replace the need for a third-party to serve as the ledger’s custodian. In short, DLTs create an immutable record of the truth arrived at through distributed consensus.

Regulators notice small business loans are big business

Jul 07 2016

By Jim Bulling and Michelle Chasser

The focus in marketplace lending appears to be shifting to small business loans recently and it is clear that small business loans are big business. The European Investment Bank has agreed to make a £100 million investment in small business loans originated through Funding Circle in the UK as part of its priority to improve access to finance for small and medium businesses. In the US marketplace lenders originated around US$1.9B in 2015 up nearly 60% from 2014.

The increased volume of small business loans has not escaped the notice of US federal regulators. There are concerns that sometimes small businesses are essentially individual entrepreneurs and may not have any more tools than consumers to assess the terms of loans offered to them. The US Treasury’s recent white paper, Opportunities and Challenges in Online Marketplace Lending, made a number of recommendations including that more robust small business borrower protections and effective oversight be introduced for online marketplace lenders. A number of regulators including the Consumer Financial Protection Bureau, the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York and the Securities and Exchange Commission were contributors to that paper.

Increasing investment in blockchain initiatives

Jul 07 2016

By Jim Bulling

Over US$1B is likely to be collectively spent on bringing blockchain technology to capital markets in 2016, according to a recent survey of 134 global market participants. Of the businesses with bitcoin projects, 32% have an annual budget in excess of US$5 million, and 47% top US$2 million. This significant level of investment has been motivated by the various advantages presented by bitcoin technology and its potential to revolutionise global capital markets. Indeed, a majority of businesses surveyed predicted blockchain would create ‘meaningful change’ in capital markets within five years. Furthermore, the survey participants were mostly unconvinced that legal regulation would significantly impede blockchain adoption. As such, the nascent interest in blockchain use in capital markets seems likely to continue.

Public financial institutions are also getting involved. At a recent international summit of international bankers, the US Chairperson encouraged attendees to educate themselves on blockchain. In Canada, the central bank is working alongside private banks and R3 (a blockchain company). They are trialling a digital currency (Cad-Coin) and allowing limited participants to engage in interbank payments with blockchain technology. The Bank of England is also looking into possible applications of the technology, with the deputy governor raising the possible consequences of a digital pound in a recent speech.

Blockchain… A Threat to Safety, Soundness & Resiliency?

Jul 04 2016

By Tyler Kirk

On June 21, 2016, the U.S. Financial Stability Oversight counsel (“FSOC”) released its 2016 annual report. The purpose of the annual report is to summarize the FSOC’s current views on the U.S. financial system according to its mission to: (1) identify risks; (2) promote market discipline; and (3) respond to emerging threats. Notably, the 2016 report identified the use of blockchain as an emerging business practice requiring vigilant monitoring by financial regulators.

Since its establishment in 2010, the FSOC has issued six annual reports. This is the first time FinTech issues such as the blockchain have been identified as a potential risk to U.S. financial market stability. The FSOC noted that the use of blockchain protocols by financial institutions could positively impact the U.S. financial system by introducing efficiencies and reducing costs. However, according to the FSOC, “Market participants have limited experience working with distributed ledger systems, and it is possible that operational vulnerabilities associated with such systems may not become apparent until they are deployed at scale.”

Further, the FSOC cautioned that a “considerable degree of coordination among regulators” may be required given the distributed nature of blockchain networks. Noting that the U.S. financial system is constantly evolving, Treasury Secretary Jacob Lew advocated for regulators to remain vigilant in order to maintain the safety, soundness and resiliency of the U.S. financial system. Yet, beyond vigilance, the FSOC did not recommend any specific action on blockchain by regulators, preserving the current hands-off approach.

The FSOC 2016 report can be found here.

Project Bletchley

Jul 04 2016

By Tyler Kirk

On June 15, 2016, Microsoft released a white paper introducing Project Bletchley, Microsoft’s next iteration on its blockchain as a service (“BaaS”) product. In late 2015, Microsoft announced that it would be leveraging its cloud platform, Azure, to provide a low-risk sandbox for customers to gain experience with how blockchain may be applied in various business scenarios, such as supply chain management. Bletchley is positioned as incorporating the latest innovations on the blockchain protocol in the Azure cloud service.

Generally, blockchain is a decentralized digital ledger. Blockchain differs from traditional centralized ledgers because the blockchain protocol uses encryption combined with distributed copies of the ledger to replace the need for a third-party to serve as the ledger’s trusted guardian. Further, blockchain is more efficient because all transactions are mathematically provable and do not require a multi-day verification process. The protocol is append only, and distributed, thus every participant receives an update to their copy of the ledger with the latest transactions. Yet, this revolutionary framework, blockchain 1.0, was just the beginning.

FCA research into the issue of de-risking

Jun 30 2016

By Jacob Ghanty

In July 2015, the FCA commissioned research into the banking phenomenon known as “de-risking”. De-risking refers to banks removing bank accounts and services from customers or other relationships that they perceive as having higher money laundering (ML) risk. There has been a perception that this process is driven by banks’ concerns about ML and terrorist financing (TF) risks posed by certain types of customer, which have been heightened by large regulatory fines imposed on banks, notably in the United States, for failings in anti-money laundering (AML) processes and breaches of sanctions. The FCA recently published the consultants’ report.

There has been much publicity of the effects of de-risking in the money services business (MSB) and money remittance sector. However, the report shows that the issue affects other businesses as well, including pawnbrokers, fintech companies and charities operating in geographical areas where the perceived ML and TF risk is greater. The report concludes that banks take the issue of de-risking seriously and are mindful of their obligations to treat customers fairly and of the financial inclusion agenda. The banks believe that they are attempting to apply the risk-based approach to financial crime in an even-handed and objective way, given inherent uncertainties about how customers will behave and how regulators and courts will view their own position in relation to misconduct in accounts that they hold. Regardless of the drivers of de-risking, the report confirms that there is no “silver bullet” for the issue. It suggests potential solutions may lie in balancing of costs and risks between banks and high risk sectors and a better developed understanding of how to measure ML and TF risk on a case-by-case basis.

The FCA’s response to the report is to admit that de-risking is a complex issue. It warns that banks should not use AML as an excuse for closing accounts when they are closing them for other reasons. The FCA also warns banks of their obligations under competition law when deciding whether to terminate existing relationships or decline new relationships.

Looking to the future, certain legislation may help some sectors affected by de-risking. From 18 September 2016, the Payment Accounts Regulations (SI 2015/2038) (PARs) will require some banks to offer a payment account with basic features to consumers legally resident in the EU. Also, PSD2 needs to be implemented by 12 January 2018, requiring payment institutions to have access to credit institutions’ payment account services on an objective, non-discriminatory and proportionate basis.

Monetary Authority of Singapore – Consultation on regulatory sandbox for FinTech solutions

Jun 23 2016

By Nicholas Hanna and Penelope Davey

In a move that is targeted at promoting Singapore as a leading FinTech hub in Asia-Pacific, the Monetary Authority of Singapore (MAS), the regulatory authority overseeing financial matters in Singapore, issued a consultation paper on 6 June 2016 which outlined a proposal for a “regulatory sandbox” for FinTech solutions.

The proposal will permit financial institutions and other entities to experiment with new FinTech solutions in an environment of relaxed regulation whilst maintaining appropriate safeguards. It is hoped that this proposed relaxed regulatory environment will allow such solutions to take root without being impeded by regulatory compliance costs and will improve the viability of innovations in the FinTech sector.

Blockchain catches a righteous break and avoids becoming unchained

Jun 15 2016

By Tyler Kirk (ed. Cameron Abbott and Giles Whittaker)

Blockchain is alive and well – one of the greatest threats to blockchain’s success appears to have been seen off with the end of efforts to legislate “exceptional access” to all encryption in the United States. Tyler Kirk explains this in more detail in his article, “Blockchain Catches a Righteous Break and Avoids Becoming Unchained.”

You can read his full article on K&L Gates Hub here.

Regulatory sandbox and innovative regulation

Jun 09 2016

By Daniel Knight

Australian FinTechs are closer to getting a regulatory “sandbox” after the Australian Securities and Investments Commission (ASIC) released its detailed consultation paper this week. The paper details proposals for a testing ground for innovative robo-advice providers and other similar services. It also highlights ASIC’s views about some regulatory options already open to FinTechs under the current law, as we discussed in a previous post.

In a sign of ASIC’s engagement with this nascent sector, ASIC launched its proposals at a fintech startup founders event in Melbourne. ASIC emphasised it is seeking industry feedback and is open to making changes.

EU movement on virtual currencies and distributed ledger technologies

Jun 07 2016

By Jim Bulling and Michelle Chasser

The EU Parliament has called for the creation of a task force to be led by the EU Commission to monitor distributed ledger technologies (DLT) and virtual currencies (VC). The EU Parliament proposed that the task force consist of technical and regulatory experts who will:

provide the necessary expertise to support EU member states’ efforts to monitor DLT;
bring together stakeholders;
foster awareness and analyse the benefits and risks of DLT;
identify best practice standards;
assess existing EU regulation with a view to updating it in response to increased DLT use; and
develop stress tests for widely used VCs and DLT schemes.

The EU Parliament also recommended that the EU Commission revise EU legislation on payments in light of new technological developments with a view to furthering competition and lowering transaction costs possibly by means of promoting a universal and non-proprietary electronic wallet. The EU Commission is currently considering proposals to include VC exchange platforms in the EU Anti-Money Laundering Directive to end the anonymity that has been traditionally associated with such platforms.

This recent regulatory activity in the EU reflects the increased attention that VCs and DLT have been receiving from governments around the world. Australia has recently focused on anti-money laundering and tax implications for VCs and Japan introduced regulations on VC exchanges in March.