As the UK Parliament’s Treasury Committee launched an investigation in March 2018 into the benefits and risks of cryptocurrencies and the potential impact of Distributed Ledger Technology (“DLT“), and the European Commission launched an EU Blockchain Observatory and Forum in February 2018 (to highlight key developments of blockchain technology and reinforce engagement with multiple stakeholders involved in blockchain activities), regulators have also been taking a closer look at the implications of DLT, including the Financial Conduct Authority in the UK.On 15 December 2017, the FCA published the Feedback Statement to its April 2017 Discussion Paper DP17/03 on the regulatory implications of current and potential developments of DLT in financial services. The Discussion Paper also explored the potential risks and benefits of DLT applications in financial services and whether DLT could promote the FCA’s statutory objectives of promoting effective competition, financial market integrity and financial consumer protection. A distributed ledger is a system for recording transactions via a peer-to-peer network, rather than a central database. DLT was the technology first used for the digital currency Bitcoin. Market participants are now exploring the benefits and risks of other use cases in financial services, most of which involve sharing data amongst multiple network participants, and do not need to involve digital currencies.
The introduction to the Feedback Statement, the FCA articulates its position on DLT as follows: “Our aim is to be alive to current and potential developments involving DLT, to keep pace with them, and to strike a proportionate regulatory balance between the risks and opportunities they present. We see regulation as an enabler of positive innovation based on new technologies as well as a means of containing undue risk. Our regulatory philosophy (subject to any risks to our objectives) is to be ‘technology-neutral’.”
The Feedback Statement covers observations highlighted by respondents in the following key areas: (i) operational risk, including outsourcing and network security; (ii) digital currency, including derivatives and Initial Coin Offerings; (iii) digital asset trading and smart contracts; (iv) regulatory reporting; (v) financial crime; and (vi) the EU General Data Protection Regulation.
The FCA received 47 responses to the Discussion Paper, ranging from regulated firms, trade associations, technology providers, law firms and consultancies. The regulator commented that the Discussion Paper was positively received, with particular support expressed for the FCA’s ‘technology-neutral’ approach to regulation as well as its open and proactive approach to new technology (including its “Sandbox” and “Regtech” initiatives).
The feedback received to the Discussion Paper also supported the view that the FCA’s current rules are sufficiently flexible to accommodate various technologies, including the use of DLT by regulated firms. Current FCA rules were said to present “no substantial barriers” to adopting DLT and no changes to specific rules were proposed. However, some respondents doubted the compatibility of permission-less networks with the regulatory regime. In addition, whilst respondents suggested that there are many benefits and risks in using permissionless and permissioned DLT networks in financial services, it was acknowledged that those risks depend heavily on the specific application of DLT.
On the interplay of DLT with the GDPR, at this stage the FCA did not identify any substantial incompatibilities between the FCA rules (including the management of CDD data or effective access to data obligations) and the GDPR requirements – as per the joint statement issued by the FCA and the ICO referred to above. As such, the regulator did not envisage further FCA guidance on this particular issue. The FCA also acknowledged that the combination of the GDPR requirements and the use of DLT have the potential to improve the way in which firms collect, store and process personal data, resulting in significantly improved outcomes for consumers.
The FCA will now continue to monitor DLT-related market developments to determine whether there is a need for regulatory action and will engage with both industry stakeholders and regulatory bodies at the national and international level to help shape the regulatory response to this new emerging technology.