Series 5 Episode 7: Digital assets - the global march of regulation

Transcript

Andrew Strange: Hi everyone, and welcome to the latest episode of Risk & Regulation Rundown, a podcast where we share our views and insights on hot topics in financial services risk and regulation. I'm Andrew Strange. I'm your stand-in host for the third and I'm hoping, final month running, but actually this episode is going to be really exciting. We're delving into the world of digital assets. I'm really pleased to welcome two expert guests. Firstly, virtually from Washington, we have Amanda Wick, founder and CEO of the Association for Women in Cryptocurrency, a professional association for women and male allies that seeks to build a global network advocating for equal inclusion of women in the future of digital finance. Because it's virtual, if there's any glitches to the sound, we apologise in advance. Secondly, and in the room, I have Laura Talvitie, a senior manager from my Financial Services Regulatory Insights team here in London, who leads on all things digital assets and technology regulation, and a whole range of other stuff but she doesn't like to admit it, but welcome both to the podcast.

Laura Talvitie: Thanks, Andrew.

Amanda Wick: Thank you for having us.

Andrew: You're most welcome. So, Laura, let's start with you. There's been lots of activity from UK policy-makers and regulators recently, with a number of policy papers published covering digital assets. Do you want to just take us through some of the highlights, and what are the key takeaways?

Laura: Yes, definitely, Andrew. You're right. This is very exciting. We got over 300 pages of statements and discussion papers from the UK authorities towards the end of 2023, so this will be a very short summary of those. Overall, everyone remains committed to making the UK a good place for crypto assets, fiat backed stablecoins and the related innovation, and that will be supported by a clear regulatory framework, i.e. the expectations will be lifted to the same level as in place for traditional FS firms, and that's what we need. There will be a new authorisation regime replacing the current registration requirements. By and large, the existing FS conduct, organisational and reporting rules will apply to digital asset firms as well. There will be a new crypto prudential regime. There will be strict rules on what stablecoin-backing assets need to be and potentially a new gateway for overseas stablecoins to access the UK payment chain. The Bank of England will supervise systemic sterling-backed firms. All positive, as regulatory clarity gives firms both crypto-native and traditional finance the opportunity to participate and expand in this space.

Andrew: And that's mainly the UK perspective we're talking about there?

Laura: Yes, indeed.

Andrew: Well, in that case, let's broaden it out and let's talk about the world, so, Amanda, with your wealth of experience in working in the US, not least in your roles at the Financial Crime Enforcement Network, the US Justice Department, and senior investigative counsel for the House of Representatives Select Committee, what are your perspectives on how the question of regulation of digital assets has progressed in that wider environment, and what are some of the challenges facing policy-makers, and are there significant differences in how authorities have been approaching, enabling, or regulating the sector?

Amanda: Yes, there are so many good questions in that question so let me try to take them piece by piece. So I think there's a lot going on right now globally. There are tons of policy experts who put out really good blogs and LinkedIn posts about it so I definitely recommend following those folks because there's a lot of exciting stuff happening. I think mostly the jurisdictions that people are watching are United Arab Emirates, Singapore, UK, EU, even Australia recently put out a proposal for calls for papers for a proposed framework for digital assets, and I think all of that is really promising in the sense that there are some jurisdictions that are trying to do what we've called fit-for-purpose regulation, and the idea there is, they don't necessarily expect to get it perfect. They're just trying to get something because this is usually financial services in some sense, and you do need some guardrails, so you see some regulators that are a bit more nimble than others who are able to put up some guardrails and say, 'Well, let's try this and see how it goes,' and those jurisdictions have had really great, productive working relationships with industry where it's tended to be a pretty good public/private partnership in terms of what those guardrails should look like. Let's see how it goes. Maybe they have regulatory sandboxes. There's all kinds of different programmes that they might have but the gist of it being, 'We need to get something on the books for regulatory clarity and we can always fix it later if we need to,' and I think that's what you're seeing in the jurisdictions that are moving ahead, like the UK, Europe, UAE, and Singapore.

Andrew: Thank you, and how do you think the industry is responding to the prospect of that regulation? I mean, if we reflect on where the industry has come from, has it learned from some of its high profile failures?

Amanda: I'd like to think so, for sure. I mean, you know, when I was a federal prosecutor at the Department of Justice, this was back, I guess, about ten years ago, it was a little frustrating because back then the industry's attitude was, 'Don't regulate us at all,' and I think many of us, especially on the American side, were a little frustrated at how long that narrative lasted, but I think now you see really productive conversations, really helpful responses, comments, papers being submitted. I mean, some of the most brilliant minds in the industry are submitting proposals, which I think is really helpful for the industry for two reasons.

In terms of definitional usefulness, like explaining how the technology works, I think that's where industry can be really beneficial, but also some of these regimes, and I'll just use the United States as an example, our Bank Secrecy Act was passed in 1970 for cash, right? So it's not necessarily the best framework for digital assets, and I think, you're seeing a little bit more of the industry being more proactive in saying, 'Here's a good way to regulate us,' or, 'Here's what you're trying to do and here's how we can help you do it, possibly in a different technological way, that makes sense for digital assets that might look slightly different than what you envision for cash.' I think those conversations are really more recent but I think the industry is coming around and is being a lot more productive, and I think that's because a lot of folks came to the realisation that if you don't start helping regulators get it right, you're going to get what you get and it might be really, really wrong, so I think only in the last few years have we seen that shift and it's just been a more productive conversation coming from industry to the regulators.

Andrew: Yes, and I suppose that regulatory clarity that you talked about, Laura, as well, is really important for firms and for the good actors. So if we move onto, looking ahead to a world where there is some regulation, or there's more regulation, or there's existing regulation that does apply to firms, what Laura, do you think the future of digital assets looks like as an industry?

Laura: I'd start by saying that too often the word 'crypto' is understood as unpacked cryptocurrencies only, but the biggest opportunities for the tech are in payments and organisation, so payments in terms of stablecoins operating on blockchain technology with programmable capabilities, enabling more inclusive payment and financial systems, faster, cheaper payments and less barriers, especially for cross-border payments, and this applies to retail, wholesale, and inter-company stablecoins. Stablecoins will transfer online services, support Web3 innovations, and will also play a big role in digitising traditional securities in tokenised financial markets. So tokenisation itself will revolutionise the FS industry as a whole and, in the short term, asset management in particular. Think of fewer intermediaries and more direct access for customers, especially on real life assets, and you'll also get lower costs and quicker settlements, and despite DLT being decentralised as a technology, it has the potential to consolidate risk within a single tech platform. For instance, using a single DLT infrastructure for payments, so I reckon those two are probably some of the biggest opportunities in the market at the moment.

Andrew: It's interesting. I'm going to get all the names wrong, but there was a recent paper around the regulatory framework for tokenisation that came out of the Asset Management Taskforce group led by Treasury, wasn't there? And actually, I think the conclusions were actually there weren't necessarily current barriers to firms taking first steps in this place, which will be really interesting.

Laura: It will be, yes.

Andrew: Obviously, it's all full of opportunity but there must be some challenges for industry as well. What are the challenges?

Laura: Well, in terms of regulation in my opinion, the lack of jurisdictional equivalence, which Amanda touched on. So where the regulatory standards in one location would be comparable to the standards of another, that's lacking, and navigating through often contradictory obligations can be really challenging for firms. So in this space, as you can imagine, very much global, firms really have to think about their long-term global strategy early, even when they are still at startup stage, and not just the regulatory immaturity of countries, or a country, but also what impact that will have on their cost of operations, available talent pool, and the country's global reputation.

Andrew: That's very true, and I know, certainly, in one of our prep calls, we had some interesting debates about the movement of talent around the world, because you're right, it is very much a global issue when it comes down to it, so fascinating. So Amanda, we've talked a little bit about how policy-makers and regulators might approach this from a regulatory perspective but if I think about supervision or enforcement of the industry, how do you think that's going to progress and develop?

Amanda: Well, I think we've had some major enforcement actions recently in the United States, both with two major exchanges involving the Department of Justice, FinCEN, the CFTC, the SEC. There was a full alphabet soup, I think, on the last big one. And I think that was a really important piece in the sense that I really do think that enforcement of exchanges, you're probably going to see that pick up because to Laura's point earlier, you can't have jurisdictional arbitrage, which means that even if jurisdictions have similar rules, they have to have enforcement, right? So if companies register and are doing business in a jurisdiction, they need to be examined, they need to be supervised, and there has to be enforcement for it to matter, so I think, so far, many of the major enforcement actions have come from the jurisdiction that actually has the least regulatory clarity, although I will say, in the AML sphere, it's been clear since 2013. That's the one thing that we did do, was AML, but I think, the general hope is that enforcement actions unfortunately are necessary to get folks to do the right thing. If you were in the TradFi industry, you saw this. You know, if you worked in an AML department in a financial institution, pretty much anywhere that was properly regulated, there's a constant tension between the business side of a company and the regulated side of a company, so unfortunately you need enforcement to get companies to do the right thing, and that's probably my background as an enforcer that tends to think that, but I think the general hope is that, I don't want to say a slow and steady stream of enforcement actions, but where there need to be enforcement actions. I think you're going to see some on exchanges. I think you're going to see more on mixers. We're constantly seeing designations of mixers, so I think you'll probably see more enforcement actions there.

Andrew: I would agree, and I think different regulators have different degrees of intrusiveness. We're seeing quite an intrusive regulator in the UK at the moment, but going back to the original point, actually good firms will want that. You know, we don't want bad actors in the industry, therefore firms that want to embrace this are going to be keen to see poor practice driven out, so very interesting.

Amanda: I know a lot of us are hoping that one of the industry shifts is, in the past the industry has tended not to call out its own bad actors and that's a little problematic. There are some trade associations that are calling for full self-regulatory organisations, or SROs we would call them in the United States, but before you get there, there's acknowledging the difference in bad actors, right? A company can have a regulatory issue but that's different than money laundering and other crimes, so I think it's really important that the industry acknowledge and recognise the ones that are doing it right, or are trying to do it right, but then also call a spade a spade when there are ones that are really doing it wrong. I think that's part of the maturation process that has to happen with this industry, is the good ones not standing by the bad ones and letting the bad ones drag their reputation down, so we'll see what happens with the last couple of exchange enforcement actions and how the industry responds, but I think folks are hoping that there's a maturation there to say, 'This is a good maturation process for the industry.' I have found those responses quite promising.

Andrew: Yes, I'd agree, and certainly from a UK perspective, we had SROs maybe ten, twenty years ago in bits of financial services. If I think about, for example, my sector, in the asset and wealth management space, we've got a regulator now that's trying to almost reverse engineer some of the compensation scheme to encourage a better polluter-pays environment rather than just offering protection full stop, to consumers. I think therefore, good firms have struggled because there hasn't been that clarity of dialogue or necessarily the approach that they would have wanted to see.

Amanda: I think that's a tension that you're also seeing in the US. Like, we have this conversation all the time. The difference between consumer protection but then also financial inclusion, right? So in the United States, we have something called the accredited investor rule, and there are certain products that are very limited in terms of who can participate in it, and some people are excluded from entire asset classes, and there's a very real debate that crypto brings up, in terms of its potential to democratise finance and give people the opportunity to get involved in assets that are, frankly, at a risk level that they might not otherwise be able to do but also come with the potential for massive amounts of wealth gain, right? And there's this discussion going on in the United States. Historically, we've dealt with that with disclosures. We've disclosed the risk and then people are able to make an informed decision, and I think, right now, that's something still missing in some jurisdictions, and Laura, I'd be curious your opinion on it, but I think in the US right now, there's a real concern that the balance between consumer protection and financial inclusion hasn't really been struck because the awareness of scams, the awareness of volatility, the awareness of the security issues, doesn't really seem to be commensurate with what's necessary from an education perspective, and certainly not from a disclosure perspective. I think some other jurisdictions are doing that better, where you see mandatory disclosures on nearly everything related to crypto, and some jurisdictions are a little bit behind.

Andrew: Yes. I would agree. It's interesting. I was just looking up a quote from our new City Minister in the UK from the end of November where he described, when challenging regulators, that he didn't want watchdogs to end up overseeing the safest graveyard, but I think there's a really interesting debate, probably far broader than this podcast, around the interaction between innovation and risk and competitiveness, between protection and vulnerabilities and so on, because these things are all inherently linked and it's a difficult balance to seek.

Laura: Yes, 100%. Well, you know, like, Amanda, you were saying about some people being excluded from asset classes completely, and then, on the other end of the spectrum, fraud is currently in the UK, the biggest form of crime, so it's really tricky to balance that out.

Amanda: Yes. I think that's something that all jurisdictions are facing. I just got back from the Crypto Assembly conference in Australia, and in Australia right now the discussion is just consumed with scams, right? Like, it's very difficult to get past that, which is slightly ironic. I will say, as a federal prosecutor who specialised in money laundering, my background was illicit finance so for years, we prosecuted money laundering. Nobody really cared. We had terrorist financing. Nobody really paid attention to it. I mean, it's a very strange thing that now that those things are going through crypto, everybody's paying attention and banks that I couldn't get to care about romance scams and elderly scams. All of a sudden now they can't talk about scams enough because it's going through crypto, and that, I think, I find a little bit frustrating, is the disingenuousness. Crypto is in some ways, a victim of its own success because the visibility in crypto allows you to see it and point to it and say, 'See right there? There's crypto involved in this illicit finance.' It was happening in TradFi. It just was a lot harder to find in siloed banks and banks that didn't have as good of an ability to trace back to illicit finance, so it's a very strange thing. Yes, like, we're focused on the fraud but the fraud was there before. To be clear, it just flowed like water from TradFi to crypto, which is a weird thing sometimes to talk to people about.

Laura: 100%, and fraud in cash still ongoing and the biggest of them all, I'm sure.

Andrew: Yes, I think we actually picked this up a couple of months ago in our podcast with Ben Luddington from PwC, where we were talking about some of these issues as well, and I don't want to go over old ground again but, Amanda, since we've got you here, our podcast last month was around diversity and inclusion, which obviously is something your organisation is heavily involved in and very passionate about. The UK recently actually published a number of consultation papers aimed at boosting diversity and inclusion in financial services more broadly, but given your role, what do you see as some of the challenges related to D&I that digital assets, or digital asset industry faces, and how can these be overcome?

Amanda: Obviously, it's something I'm super passionate about. I founded the Association for Women in Cryptocurrency a little over a year ago because, when I left the US government where tons of folks in crypto, in fact most of us in crypto, the agents, the prosecutors, the analysts, OFAC, FinCEN, DOJ, everywhere you looked, it was actually all women. It was amazing. And then I left the US government, went to Chainalysis, and looked around the private sector, and you would have thought there were no women in the industry. There actually are. There's thousands. There's something very weird where, at crypto conferences, blockchain conferences, there's just not the same inclusion of women, the same profiling. Even when articles or media go for people to quote, it tends to be men, and so the perception is-, in fact, it drives me crazy when people are, like, 'Well, we need more women in this industry,' and I'm like, 'Don't get me wrong, we need more women in parts of the industry,' and we can talk about how there's a pipeline problem for things like engineering and product, etc., but there are thousands of women who are actually in this industry, in some levels, at the highest levels of the industry, who don't get profiled the same way. And I tell people, 'It's not really that surprising,' because when you think about the fact that financial services and the tech industry had a baby and made Fintech, those parents were not doing inclusion very well before, so it's not really surprising that our industry inherited the worst practices.

I think the thing that's really encouraging, and the reason why I find hope every day with the Association, is one of the amazing things about this community, if you get into crypto, blockchain, and Web3, is that it tends to be a lot of people who, now, especially, left government, left TradFi, left places because they saw that the system was broken and could be made better, and when you're building better with that mindset, building inclusion in from the foundational level is a lot easier than what we've had to do with TradFi and tech, which is bolted on later on as, like, an after-market idea, and that does not go so well. I think jurisdictions like the UK that are basically baking it in, I think are really ahead, and studies show that companies that have diverse leaders profit more, so I think the jurisdictions that are really taking inclusion seriously, like the UK-, I was surprised when I went to the UAE and was at a conference where their Minister of Economics spoke, and they were incredibly pro-woman, and I think 50% of their government online is women, and he was so happy for the question, which really took me by surprise, but I think if you look at jurisdictions that are recognising the importance of inclusion, you're just seeing a better future-proofing for the industry, and I hope that more people follow what the UK and Europe is doing.

Andrew: Yes, I agree, and I think the 'youth', in inverted commas, of both the industry and some of the people in it, I hope encourages that continued, kind of, development of diverse viewpoints and diverse people. You're quite right. I think it's very important indeed. Okay, Amanda, thank you. That was really fascinating and a very interesting discussion overall, and also thank you too, as well, to Laura, to you too. PwC's obviously got a number of reports on this area. We recently published a CBDC Index and stablecoin overview and I understand that we have, in early next year, a regulatory outlook and a tax report around the crypto agenda coming too.

Laura: Yes, we do, and all these reports are global, not just for the UK audience.

Andrew: Absolutely, and, yes, thank you to our audience for listening to this as well, whether you're domestic or global. I hope you've enjoyed our conversation and thank you for listening for this podcast and, actually, over the course of this year too. Please do subscribe to future episodes, and rate and review the series, as it helps other listeners to find us. If you'd like to hear more on the subject of risk and regulation then please do check out our notes after the show, which will have links through to our website where you'll be able to see our other publications, and we'll be back next month, although possible Tessa will be back in the hosting chair next month, with our next episode. Thank you.