New Report Calls for Regulators & Lawmakers to Improve Frameworks for Blockchain

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The need to get regulators and lawmakers to be more actively involved in improving current frameworks and shape the future architecture of blockchain – or Distributed Ledger Technology – is the underlying message of a new report by Innovate Finance, EY & Hogan Lovells on Blockchain adoption and current regulatory environment in the UK.

The report, titled Blockchain, DLT and the Capital Markets Journey: Navigating the Legal and Regulatory Landscape identified the key issues that DLT capital market products must navigate in the UK’s legal and regulatory landscape – where applicable, by reference to EU law.

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Structured in a Q&A format that covers 10 different legal and regulatory questions, the report aims to create an understanding of analysis that would be applicable in other markets with similar issues and concepts it identifies. The report also helps progress the thinking on the regulatory and legal issues to be navigated in other jurisdictions since there is a need for international co-operation in responding to a global technology.

The report notes that despite what unfolds with Brexit, a UK capital markets DLT system that is introduced without significant foreign interest or intervention appears unlikely. It also envisages that the administration of a DLT system and certain governance tasks undertaken by entities within the system will likely become regulated.

Global FinTech Leader at EY, Imran Gulamhuseinwala said: “We do not have all the answers yet, but it is clear that the full benefits of blockchain will require substantial changes to the regulatory and legal frameworks governing capital markets. It is only by addressing major regulatory and legal axioms (such as legal title, contract enforceability and the role of market infrastructure intermediaries) that blockchain technology can deliver on the promise of risk mitigation and capital efficiency – and the operational benefits associated with eliminating reconciliations.”

Some of the key issues identified include the possibility of using a distributed ledger to record transactions in securities through smart contracts, the possibility of securities traded on DLT systems being used to effectively collateralize other obligations, whether the current financial services regulatory environment make specific provision for smart contracts and how the DLT solution that fails either wholly or in part would be managed.

Another key issue is about the roles national and supra-national regulators would play among market participants particularly as they will be unable to reach a unilateral decision that a DLT system should be adopted for the purpose of reducing or enabling better management of post-trade risk. The market will need regulatory agreement to proceed – likely at EU level or with the G20 and Financial Stability Board.

“We believe that government-led advocacy will be crucial to attracting the levels of commitment needed to launch a comprehensive DLT initiative,” the report says.

“Without strong government or regulator support, thinly capitalised start-ups may struggle to secure the funding they need if there is a view that regulatory risk is too great to make a significant investment. Typically, regulators wait for fully developed business propositions before they issue or refuse a licence. This approach will not be sufficient. A collaborative approach with regulators would help generate the confidence needed by many to invest capital in a DLT project. It may be that the development of robust regulatory criteria which a system must meet to be able to obtain a licence could satisfy both sides.”

Recommendations proffered seek to enable the level of collaboration between industry and regulators required to ensure that authorities formulate a right-touch approach to DLT regulation and DLT solutions are developed with an adequate risk framework in mind.

Innovate Finance is an independent not-for-profit membership association representing the UK’s global FinTech community.

Images from Shutterstock.

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