The Regulatory Contemporary & Bilding Compliant Blockchain Solutions

Jun 06, 2017 at 15:14 // IMO as an Expert
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After nearly 10 years of exploration of blockchain technology, we are at the pinnacle of innovation, with a range of major corporations to small businesses exploring blockchain opportunities and use-cases to cut costs and add value throughout the business process. However, these recent developments have equally attracted interest from regulators across continents; prominent amongst them being Europe.

This article intends to provide a broader five-fold regulatory perspective in order to cultivate a preliminary understanding and build rapport between the reader (presumably decision makers in the Blockchain ecosystem) and the regulatory ecosystem. 

Point of Convergence:

For the past several years, many startups and emerging technology groups from various banks and other commercial entities have come up with intuitive designs for blockchain. But the current EU consumer and investor protection framework for financial services does not address all such innovations adequately. 

Recently the European Parliament passed a major “Pro-FinTech” resolution and mentions - 

“The European Supervisory Authorities (ESAs) have started identifying the potential risks and benefits of innovative financial technologies, and, 
The FinTech Task Force is welcomed by the European Parliament & Commission for coordination between member states at national level to revise regulations in order to welcome relevant FinTech innovation. ”

We are now entering the unprecedented time of valid concerns, criticisms and value discovery of the Blockchain and other affiliated technologies. The further of the article is based on the core ideology - “Blockchain is the converging point for all FinTech, RegTech and other affiliated innovations”. 

Regulatory Priorities:

Analyzing a pile of reports and whitepapers from various entities and regulatory agencies, we have shortlisted some of the common-yet-major concerns in the regulatory landscape common to all countries:

Distributed Geography & Cross-Border Information Computation

Several regulatory bodies and special committees have spent hundreds of man hours in designing and concluding at a strategic legal framework suitable for current infrastructure. How this changes is completely dependent upon the priorities each incumbent exhibits in the pool for information transparency and long-term risks.

Criminal penalty

Reforming existing regulation without adding risk

Facing more than 15 standards bodies and frameworks that are associated with cross-border compliance (GDPR, MiFID, ESMA, EMIR, FIS, FinCEN, SEC etc., to name a few), the technology and operations ecosystem must ensure no/minimal  addition of risk during the infusion/integration of blockchain to the existing infrastructure. The last thing we need is a “Black”chain (pun intended). 

Measuring risk in the market (production-level)

Operational risks are evident in all forms of financial instrument carrying infrastructures ranging from payment gateways to HFT. Ensuring strict risk-management practices is just the beginning; we may observe the invasion of ML & AI in preventing the exposure of the underlying infrastructure to strategic and systemic risks. 

Smart Contracts - Dispute resolution in agreements

Smart contracts introduce a whole new level of abstraction that simplifies most of the asset management tasks, carried out by floor-level employees. However, the underlying engineering mechanisms of several smart contract platforms are under scrutiny from major banks and corporations, with a key focus on preserving the current nature of the transaction lifecycle. Ensuring enhanced performance, reliability and compatibility, in the long run, is the key to acceptance. 

Framework for assessment and execution control

The distributed nature of blockchain technology doesn’t shun the control aspects, but surprisingly creates new avenues to welcome stakeholdership in controlling the entire ecosystem, thereby making every entity responsible in many ways. A transparent and unbiased framework is the need of the hour, to meet the expectations and ensure the blockchain technology is adopted for a common betterment, not personal gains. 

Overcoming the waves of uncertainty:

Although the above-mentioned priorities are being looked at, a voluntary approach towards compliance from blockchain stakeholders (developers, infrastructure providers alike) could untie the ecosystem from criticism. Mentioned below are the top measures: 

Beyond the “Prima Facie” benefits of Blockchain / DLT

Multiple research agencies and special committees have formed to study the effects of blockchain technology on our everyday life. However, the surface of the blockchain and affiliated technologies are barely touched. We need to re-instigate the research, wherever failing, with extended methodologies to ensure a thorough technical understanding of consequences and its limitations acknowledged for reliable results. 

Lookup arrangements for title of asset ownership in the jurisdiction

The legal form of asset ownership differs from one jurisdiction to another. Reference to such wide range of asset classes beyond borders might be one of the most opportunistic initiatives regulatory agencies can encourage, that has the immense potential to bring the blockchain era closer. Looking up for acceptable forms of entitlements in a multi-judiciary landscape that can represent a full/beneficial title of ownership to underlying assets, including collateralization (FCD-2002/47/EC, the Financial Collateral Directive), may have the potential to welcome beneficial legislation intervention. 

Enhanced consumer protection & privacy

With each country having its own consumer protection agency, we must ensure that Blockchain solutions fulfil some of the basic general criteria that represent a responsible form of innovation. Governance of these criteria is as simple as managing existing guidelines for the trading scenarios. The underlying mechanism of blockchain create a shift in consumer’s priorities on what data to be shared and revealed to the ecosystem; hence privacy aspects must be addressed with special attention. Keeping the nature of blockchain in hand, we can leverage Secret Sharing and Encryption techniques at the primary level. More sketches can be borrowed from the EU-US and Swiss-US Privacy Shield Frameworks, DPD and the GDPR. Regardless, there are concerns by many regulatory authorities on how this affects their ability in tracing illicit transactions. 

Self-evident Smart contract environment

Smart contracts are the hot cakes the blockchain has been baking for a long time. A great many number of use cases in all verticals are designed with smart contracts as the logic-centric element. Self-evident and human-readable contracts must be designed & developed to interpret terms and explain in the case of judicial intervention if a party defaults or declares erroneous trade. In the year 2014, the Basel Committee’s SA-CCR provided an extended outlook on determining and managing counterparty risk to address exposure at default and potential future exposure. 

Practical contingency plans

As any other technology poses risk, Blockchain technology also poses a few risks. The ripple effects due to the faults and failures may be devastating at the operational level but systemic at the strategic long-term level. These risks may appear in the case of integration crisis, cyber security disasters and Byzantine circumstances. Contingency plans must be designed with a partisan approach and must welcome technology experts for an updated design reviews. As strange as it sounds, Blockchain is as unpredictable as current systems due to the distributed control nature.

Blockchain

Questions worth asking:

This is just the beginning. A vast amount of insights must be collected from a broad range of verticals. This is also the right time to ask the right questions: 

Who are the principals behind the regulatory guidance?

The majority of appointed agencies, special committees and delegated frameworks constituting the regulatory landscape are all part of spearheading this new ecosystem and are responsible for answering to related inquiries. Please observe the notice boards of respective directives for new resolutions frequently. Get help if you need one for interpreting the guidelines in the implementation. 

How can I work towards compliant DLT products?

The Current maturity level of several Blockchain platforms is being tested by the individual FIs as well as present incumbents overlooking compliance processes in the ecosystem. We need to explore, more broadly and deeper, on finding an appropriate balance between privacy/transparency and data/execution control. Either Retention or Disintermediation should not be the key goals of our efforts. Finding a way to comply without additional legal risks is always a win-win situation for everyone. Specific instructions depend upon the requirements and the industry vertical, however, keep in mind a few favoring attributes such as compliance with ISO 20022, SWIFT Message Types, X.509, FIPS, PCI-DSS,  etc., are highly valued in the ecosystem. 

What if my local regulatory environment doesn’t promote DLT?

First, lookup for an update from respective directives/commissions. Speak up to your national commissions responsible for overlooking financial infrastructure and instrument engagements. If you know enough of blockchain already, accompany a Blockchain consultant along and evangelise the technology. There’s always no harm but always a common good if we, the industry, show spontaneous response and display unity in welcoming new technologies proven to be beneficial offshore. The regulatory bodies can then finally resolve in determining what’s important and relevant to the economy. 

How to mitigate legal & regulatory uncertainty in our markets?

Several verticals ranging from Supply Chain & Financial Services to Media & Politics are interested in what the underlying mechanism of the blockchain technology offers: “ the sense of trust ”. I request to ensure a stable validation model before confirming POCs. Some of these use-case applications designed are just a victim of overhype and compliance strikes hard in no time when such solutions are used in production without consent/acknowledgement from local regulators. Talk to your compliance consultants on whether your actions are viable before allocating a copious amount of resources and hard work at harm’s way. Time shall prevail. 

What would be the wider cross-border regulation agenda?

We are at an early stage of regulatory uncertainty concerning Blockchain and affiliated applications in regulated markets. Every country has been busy working on their own internal problems or responding to some external issues. Bitcoin, altcoins, ethereum and other affiliated cryptocoins have been attracting legislative and regulatory interest due to recent ill developments and circumstances abusing them. Unfortunately, Blockchain logically inherits a few of these criticisms which can’t be ignored without a proof and contingency measure.

About the Author:

Ganesh Prasad Kumble.jpg

Ganesh Prasad Kumble leads a small team of R&D Computer Scientists, Market Specialists and Regulatory experts at Sterne Fintech. With around 5+ years of entrepreneurial voyaging in FinTech and RegTech, he aims to build and deliver robust blockchain systems for regulated sectors such as Healthcare, Financial Services & Enterprise. He spends his leisure in exploring blockchain use-cases in new whitespaces and offers consultancy to startups, enterprises and regulatory agencies.