Fintech — Building Trust Through Regulation

IMF News, April 9, 2018

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Remarks by Tobias Adrian, IMF Financial Counsellor and Director of the Monetary and Capital Markets Department, delivered at the IMF Fintech Roundtable on April 9, 2018.
Purpose: discuss pivotal issues for policymakers and regulators about new financial technologies, including crypto-assets, and how to build confidence and public trust while enabling innovation.

Emerging technologies can:
- support the introduction of new services;
- drive efficiency gains in the financial sector;
- foster financial inclusion and financial deepening;
- deliver widespread economic and social benefits.
Policy tools to support exploration:
- enhance “fintech” awareness at official institutions;
- create controlled environments where new technologies can be tested (innovation hubs and regulatory sandboxes);
- promote financial education.

Market capitalization of crypto-assets reached more than $900 billion early this year.
There are about 1,600 types of crypto-assets being traded worldwide.
In 2017:
- there were 880 Initial Coin Offerings, which raised about $6 billion.
Previous year:
- there were only 43 ICOs, which raised just $95 million.
About half of last year’s ICOs have already failed.
Coincheck breach: cyber losses (about $500 million) were higher than its total registered capital.

Financial stability risks:
- disruptions to existing service providers, business models, and market structure;
- migration of activities to unregulated sectors;
- potential for contagion via indirect exposures (investments in related technologies, lending to crypto-investors, offering futures trading to clients).
Investor and consumer risks:
- extreme volatility and rapid retail growth have intensified concerns;
- many small-scale investors have suffered dramatic losses, undermining confidence.
Market integrity risks:
- manipulation and insider trading threaten market integrity and warrant enforcement action.
Operational, cyber, and liquidity risks at crypto-exchanges:
- market risks in exchanges’ inventories due to higher volatility;
- material counterparty default risk from margin lending when price moves exceed margin models;
- liquidity risk if investor cash is not segregated and is used for other purposes;
- some exchanges do not accept any fiat currencies, complicating liquidity management;
- intrinsic operational and cyber risks illustrated by the Coincheck breach (about $500 million).
Legal, data, and ethical concerns:
- erosion of legal certainty;
- balance between transparency and privacy;
- ethical use, accountability, and ownership of customers’ personal data.
Supervisory capacity gaps:
- “Fintech awareness gap” where many supervisors lack understanding of exposures to crypto-assets and are not prepared given legal mandates and limited resources.

Crypto-assets were created outside traditional regulatory boundaries; many do not meet definitions of financial instruments, while some function similarly to them.
Examples of existing regulatory reach:
- many ICOs qualify as “public offerings of securities” and are covered by public-offering regulations and private-placement exceptions;
- jurisdictions use enforcement powers to prosecute fraud and issue public warnings;
- some regulators license exchanges or treat them as money transmitters;
- many crypto-exchanges and intermediaries are subject to anti-money-laundering regulations.
Regulatory approaches are varied and jurisdiction-specific, enabling businesses to move locations to optimize and arbitrage regulatory treatments.
Uncoordinated regulations risk fragmentation and a “race to the bottom.”

Strike a sensible balance between supporting innovation and maintaining a robust regulatory framework.
Provide clear guidelines to reduce regulatory uncertainty and avoid the risk of a major clampdown that could destabilize the sector.
Apply existing international principles where relevant, including governance, auditing, client asset segregation, minimum capital, outsourcing, cyber-security, and disclosure, to publicly offered crypto-assets and exchanges.
Treat ICOs offered to the general public, tradable, and invested with an expectation of financial return as assets subject to regulation similar to other asset types.
Subject ETFs, investment funds and derivatives of crypto-assets to appropriate regulation.
Actively supervise crypto-exchanges with intrusive supervision given inherent risks.
Strengthen investor and consumer protection measures and consider targeted investor-education programs.
Address data gaps and enhance monitoring of direct and indirect exposures to crypto-assets.
Encourage firms to limit exposures and apply prudential treatment for material exposures.
Build international consensus and coordination to prevent regulatory gaps and to strengthen public confidence.

Prioritize enhanced monitoring and closing the “Fintech awareness gap.”
Develop deep, multidisciplinary expertise combining technology, finance, law enforcement, prudential regulation, and public policy.
Foster cooperation and coordination across jurisdictions and institutions to manage cross-sector and cross-border risks.
Use the IMF’s role to facilitate global dialogue and help members strengthen regulatory frameworks and build trust.

Regulation is necessary where distortions, excessive arbitrage, market abuse, and contagion risk consumer, investor, and systemic safety.
Financial innovation is occurring amid low public trust and movement toward less-regulated sectors; this calls for a far-reaching regulatory response.
Building trust in new technologies requires frameworks that encourage creativity while safeguarding consumers and systemic stability.

Remarks by Tobias Adrian, IMF Fintech Roundtable, April 9, 2018 — Fintech — Building Trust Through Regulation