By: Joe Schifano, Global Head of Regulatory Affairs at Eventus Systems
Originally published on TabbFORUM
History is littered with examples of “post-crisis” regulation. The Securities Act of 1933, the Securities and Exchange of 1934, and the Dodd-Frank Wall Street Reform and Consumer Protection Act are well-known examples. Even the Securities Act Amendments of 1975 were in large part reactive to the industry being overwhelmed by increased trading volume of the late 1960s and early 1970s. History has proven time and again that regulation evolves slower than products and technology in the markets, and regulation does not “awaken” until a crisis.
The digital asset industry is bucking that trend. Follow traditional financial news, and you rarely hear about digital assets other than the occasional story about a digital venue being hacked, or efforts by well-known technology firms to enter the fray. But, immerse yourself in increasingly popular digital asset publications, and you find a burgeoning industry that regulators and big technology firms are taking quite seriously. This time, regulators have studied their history and are trying to be ahead of the curve. Look no further than the DOJ report published this month, “The Report of the Attorney General’s Cyber Digital Task Force.” In this report, the DOJ ponders,
“Technological innovation and human flourishing are complementary concepts, but the former does not guarantee the latter. Good public policy—and the fair and equitable enforcement of such policy—can help bring the two into alignment. And even as too much regulation undoubtedly stifles innovation (and human flourishing, too), the absence of law’s protections can endanger progress across both dimensions.”
This awakening is happening in the U.S. In September, Congressman Michael Conaway introduced The Digital Commodity Exchange Act (DCEA) bill which endeavors to “regulate the trading venues which list emerging digital commodities, such as Bitcoin, Ether, their forks, and other similar digital assets, for trading.” The DCEA offers a national registration under the jurisdiction of the CFTC as an alternative to the current state-by-state, money transmitter-centric approach. The CFTC itself has been active in the past few years offering interpretive guidance and a series of customer advisories and primers. In July, the CFTC issued its strategic plan for 2020-2024, which includes a holistic framework to promote responsible innovation of digital assets. A key element of its strategic objectives in digital assets is to “address the risks and opportunities arising from 21st century commodities,” which clearly acknowledges the more proactive stance regulators are taking with digital assets. And just recently, 25 U.S.-based virtual asset providers (VASPs) came together to publish a white paper on an industry-wide solution to comply with the Financial Action Task Force (FATF) travel rule.
This awakening is happening around the globe. Earlier this year, the European Union’s 28-member nation-states adopted the Fifth Anti-Money Laundering Directive or AMLD5. These new rules require crypto exchanges and custodial service providers to register with their local regulator and demonstrate compliance with know-your-customer (KYC) and anti-money laundering (AML) procedures. Further, the directive gives greater power and reach to financial intelligence units and law enforcement. In the Asia-Pacific region, the regulatory awakening is uneven, with Singapore leading the way. In January, the Monetary Authority of Singapore enacted the Payment Services Act, regulating the circulation of cryptocurrencies and the activities of related companies, which must comply with Anti-Money Laundering and Combating the Financing of Terrorism rules.
Digital asset venues are building out state-of-the-art compliance and surveillance tools to keep ahead of this regulatory awakening. Venues are particularly focused on ensuring their markets are safe for public participation and institutional investment. They are doing this by being transparent with regulators and legislators, forming a number of working groups and associations to create an appropriate regulatory regime for this growing market, and of course, building out traditional compliance functions and policies and procedures normally seen in more established asset classes. The adoption of an appropriate regulatory scheme and key compliance processes is well underway and critical in order to ensure the continued growth and adoption of this exciting new asset class.
Working groups and industry associations are forming to dissect and shape regulatory activity and interpretive guidance. The Association of Digital Asset Management has spearheaded a Code of Conduct for digital market participants. The Chamber of Digital Commerce is focused on policy and education. There are multiple efforts underway to create a self-regulatory organization for digital venues including the Virtual Commodity Association and the Global Digital Asset & Cryptocurrency Association.
While regulatory schemes evolve, many venues looking to compete are proactively building their compliance programs and surveillance tools. Critical elements required for a robust surveillance program in the digital asset space include:
- KYC protocols and risk-based procedures for ongoing Customer Due Diligence (CDD)
- Internal risk assessments and controls to monitor account activity
- Surveillance for market manipulation
- Designation of senior compliance staff responsible for day-to-day compliance
What is the risk to venues that are not proactive? Among them:
- Regulatory – may include fines and trading bans
- Business – may include lack of client interest or withdrawals
- Headline – may include existential threat to business if headlines are inflammatory
- Financial – may include lack of investment or low trading volumes due to lack of confidence
Around the globe, the regulatory awakening will continue unabated. At a minimum, regulators demand that digital asset venues are thoughtful about transparency and their compliance programs. So, it would be prudent for digital asset venues to be proactive and transparent when building out your compliance infrastructure. Regulators are far more understanding when they see best efforts versus avoidance and opacity.
 For example, venues registered in New York look to NYDFS Part 504, §504.3 for guidance on building out their transaction monitoring and filtering programs.
Eventus Systems is a leading global provider of multi-asset class trade surveillance and market risk solutions. Its powerful, award-winning Validus platform is easy to deploy, customize and operate across equities, options, futures, foreign exchange (FX), fixed income and digital asset markets. Validus is proven in the most complex, high-volume and real-time environments of tier-1 banks, broker-dealers, futures commission merchants (FCMs), proprietary trading groups, market centers, buy-side institutions, energy and commodity trading firms, and regulators. The company’s rapidly growing client base of more than 60 firms relies on Validus and Eventus’ responsive support and product development teams to overcome its most pressing regulatory challenges. For more, visit www.eventus.com.