Governance and Regulation

Globally, regulators are approaching the industry’s digital evolution with similar intentions but potentially different methodologies, which could result in ‘regulatory arbitrage’. This emphasises the need for a shared taxonomy in how emerging technologies are regulated but also the requirement for a flexible and adaptive approach underpinned by a continuing commitment to investor protection.

Asset servicers will also need to address the multiple drivers which are transforming the industry, the first of which is regulation. The need for an efficient, regulated marketplace is essential in an industry juggling multiple ecosystems and stakeholders. It is also essential to maintain investor protections.

The advent of the digital age brings with it concerns about ‘regulatory arbitrage’. In the aftermath of the global financial crisis, new regulations were introduced, some of which were related to digital assets.

Moreover, if emerging digital assets are treated differently to other assets, then there is a risk that regulation could be mismatched, particularly if, globally, one jurisdiction is seen as more ‘light touch’ than another.

It is why the Association for Financial Markets in Europe (AFME) responded to the European Commission’s public consultation on the EU’s Framework for Markets and Crypto-Assets in 2020 by recommending that the Commission applies the principle of ‘same activity, same risk, same regulation’ to foster a level playing field.^xx

This response, as well as others from the industry,^xxi also emphasises the need to establish a taxonomy for digital assets, differentiating between different types of assets, and their functionality, when making recommendations for their regulation and oversight.

Taxonomy
Taxonomy is important because, as new markets develop, and operational functions become self-learning and self-functioning, and with the integration of data becoming far easier, the issue of standardisation will be paramount.

It is why Northern Trust is working with regulators, governments, industry peers and market associations to build a set of standardised and globally understood taxonomies.

The role of the asset servicer is to provide access points to new and existing marketplaces. With emerging digital assets and connectivity models that are starting to move into the digital world, there will be a multiplicity of different connection channels on offer.

Asset servicing companies will need to align these multiple channels, and will need to ensure that a proliferation of differing standards does not occur, but that new technologies are as cohesive as possible.

GOVERNANCE AND REGULATION

Ultimately, regulators are concerned about standardisation of the operational market as well. They want to mitigate any financial, cyber, and compliance risk. Regulators are looking at existing frameworks and considering whether they are fit for purpose, or whether they need to evolve.

We believe that by 2030, regulators themselves will be integrated into the new digital ecosystem as part of their own digital journey. They will be running their own AI algorithms to supervise market movements, while market participants will be self-reporting through their technologies.

Today, asset servicers report transactions to the regulator. By 2030, with the use of smart technology, transactions will report themselves.^xxii

We also think that by 2030, asset servicers will have strengthened their real-time auditing via blockchain technology as well, which will make that process more efficient.

Case Study
Northern Trust did this for its private equity life cycle in 2018, when it began working with PWC and other audit firms in Guernsey, and proved that auditors can now access fund data held on the private equity blockchain directly, in order to audit specific events.^xxiii

This live audit capability – which flags up any breaches to parameters in real time, makes a retrospective audit process, which can take place many months later, look archaic. In the future, we believe that industry participants and regulators themselves will begin to adopt live auditing.

We also think the markets will regulate themselves, based on algorithmic updates. Robo-auditors will also be used, which will make the markets more efficient, even for complex assets.^xxiv

Recent regulations with a focus on accountability and governance have already encouraged the creation of new technologies for dramatically enhancing transparency, and by 2030, questions of tax rates and repetition of associated data may well be eliminated through the intermediary chain.

Similarly, in corporate actions, regulations will have significantly reduced competitive differentiation from corporate event announcements and disclosures – the bar will be significantly higher and custodians will have to differentiate themselves based on their service.^xxv

We would argue that for regulation to be effective in a fast moving technological world, it must be flexible and adaptive.