OCC advocates for proactively modernising the regulatory perimeter for crypto

The US Office of the Comptroller of the Currency’s (OCC) Michael J. Hsu has highlighted the importance of proactive regulation in a recent speech on modernizing the financial regulatory perimeter.

In remarks to the Fifth Annual Fintech Conference in Philadelphia, the Acting Comptroller set out a compelling case that “given the pace and breadth of innovation”, especially in areas such as cryptocurrency and fintech, regulators “cannot wait” to address and adapt emerging areas of innovation.

Moving the regulatory perimeter for fintechs and crypto

Hsu points out that in the last five years, the market cap of crypto and fintech firms has risen from $100 billion to $3 trillion, with some of the largest fintechs now rivalling the largest banks. Many of these emerging entities operate in a similar way to banks and can provide broadly the same suite of banking and investment services – only they have the addition of including cryptocurrency into their offering, and have the undeniable “convenience of tech”.

Why is it then, if fintech and crypto firms are beginning to function like banks and on a similar scale, that a robust regulatory framework does not yet exist? Hsu asks whether bringing such firms within the current bank regulatory perimeter would be “the right solution”. Or, instead, is it time that the regulatory goalposts were moved, and regulators started to adapt.

Hsu points out that, broadly speaking, banks need a regulatory system and “to be safe and sound” because a “loss of trust and unexpected failure can infect healthy peers and impact the broader economy”. At what point, then, can the same be said for fintechs and crypto. If financial services are reaching a point where the same is true for these tech-savvy entities, regulators should be acting now to adapt and implement a robust structure, rather than waiting for any unexpected failure to ensue.

Proactive rather than reactive

It is a common theme within financial services that regulation and compliance are often reactive rather than proactive. As Hsu points out, “typically, changes to the reg perimeter are driven by responses to crises and failures.” As has been noted many times, the breadth and breadth of financial regulation that we see today did not exist before the 2008 financial crises. Indeed, it was this crisis – one that ruined economies and diminished trust – that spurred on the vast regulatory system that we see today.

If we were to follow this precedent, Hsu points out that “we would wait for a large crypto firm to take excessive risk and implode or grow to such a size as to be systemically important, before subjecting it to consolidated supervision”. As an alternative, Hsu suggests regulators consider how supervision can be best achieved now, rather than later.

One of the problems we see of crypto and fintechs is that their activities can be broad in scope, or don’t fit the traditional mould of financial services and good practice. Because of this, it’s hard to define what ‘good’ looks like. In a brief philosophical moment, Hsu quotes from “A Brief History of the US Regulatory Perimeter” to note that while financial regulation and expectation has evolved, the “overarching framework has been relatively stable”. He quotes:

“For the last 150 years, federal financial laws have followed the same rough and ready rule: Because you do, you are; and because you are, you do.”

In order to proactively regulate for crypto, and in order to adapt the regulatory perimeters to meet it, Hsu suggests we need to act now to define what constitutes the “doing” for such businesses – and also what is acceptable in terms of a “bank-fintech” relationship.

If regulators can clarify this sooner rather than later, they remove the potential for “gaps in supervision” and can hopefully avoid having to retrospectively define “doing” in the shadow of crisis or failure, which Hsu notes is what has historically driven the evolution of the regulatory perimeter.

Less regulatory competition, more cooperation

Under currently regulatory frameworks, no crypto firm is subject to consolidated supervision. Hsu points out that this means there are “gaps in supervision, and risks can build out of the sight and reach of regulators.”

The difficulty with regulating crypto and, to some extent, fintechs however is that these are not small entities operating in a single jurisdiction on a standard basis of activities. These companies are multi-faceted and diverse, often growing at pace and expanding across jurisdictions.

With that in mind, Hsu suggests that regulatory agencies – including state regulators – need to interact differently in order to be effective in their supervision goals. In short, “there needs to be less regulatory competition and more cooperation […] less go-it-alone independence and more interdependence”. If regulators can cooperate and collaborate to define the crypto ecosystem, they may stand a chance of developing a supervisory framework that proactively regulates, thereby breaking the pattern of a lifetime.

CUBE comment

Hsu’s remarks before the Federal Reserve Bank of Philadelphia hit on three key principles that we frequently highlight at CUBE:

• Regulation is evolving, and will need to evolve further
• Financial services should be proactive rather than reactive – whether that happens in compliance or regulation or innovation
• Regulations lack regulatory standards and industries must collaborate to rectify this (and close gaps)

After years of patching the gaps of the past, it is refreshing – almost exciting – to see a regulator talking so clearly about proactively adjusting the regulatory perimeter. It is often the case, especially with technological innovation, that financial services have buried their heads in the sand to avoid looming change. This is especially true of compliance – where compliance officers cry out for investment and tech, those at the top bury their heads. If recent headlines are anything to go by, some executives have even lost their jobs where compliance concerns have been raised.

Acting Comptroller Hsu commented that “proactive prevention may be a better path”. This is a statement that rings true across financial services. The pattern of innovating, investing, or regulating for compliance only in the face of crises, or where something goes wrong, is counterintuitive and costly. Here’s hoping Hsu’s message resonates and is echoed across other global financial regulators. Who knows, proactive compliance and collaborative regulation might not be a pipe dream after all.

CUBE can help you keep abreast of every regulatory change and make sense of it for your business, from the OCC to the SEC.