Future of capital market regulation

Disruptions in technology offers new ways to rethink finance and the systems that underpin capital markets. Hence, forward-thinking reforms will have to

1. Ensure regulatory clarity within the burgeoning crypto/ decentralized- finance space.

Although comparatively speaking the cryptocurrency market is a fraction of the US capital market ($2 trillion compared to $49 trillion in Q1 2021), this is still a segment of the capital market that is rapidly growing, hence more regulatory attention needs to be provided.

Despite the ideal of decentralization, the current de-fi/ crypto ecosystem still operate through centralized intermediaries. Crypto custodial exchanges like Coinbase, Binance and the de-fi equivalent (which relies on automated market maker for users to trade digital assets without using an order book) of Uniwrap, Bancor have similar roles of being central actors within capital markets. We need regulations to keep these new players — who often have a custodial responsibility — accountable, to ensure that customer assets are protected against fraud.

Currently, the SEC, and CFTC do not have the sufficient judiristion to regulate. Grey areas include — bitcoin and other digital currencies being technically not securities hence are out of the limits of SEC jurisdiction, and while CFTC has jurisdiction over derivatives using cryptocurrencies, the CFTC does not have jurisdiction over regulating crypto-exchanges.

Progress has been made with the passing of a bipartisan legislation known as the Eliminate Barriers to Innovation Act of 2021, which seeks to set up a digital asset working group with joint representation from both SEC and CFTC. This is the kind of regulatory involvement needed to ensure that that grey areas, boundary conditions and corner cases are properly accounted for and that existing regulatory agencies can have sufficient power to provide clarity within emerging spaces in finance.

2. Incorporate technology and digitization into financial regulation

One of the pressing areas of concerns for financial regulators is the lack of transparency within the financial ecosystem. Monitoring is needed to collate better data across banks and non-bank financial participants. Financial markets are increasingly complicated with the rise of various market participants and the exponential growth in volume of data and capital flows. The liquidity movements among non-bank financial intermediaries in response to the pandemic amplified market stresses and instability in March 2020. This further demonstrated the importance of market monitoring efforts.

Technological advances offer new ways to rethink risk monitoring. The growing adoption of supervisory technology (SupTech) by regulators enable streamline data (both structured and unstructured) ingestion, analysis and automated reporting of financial trends. The SEC is already making headway by using cloud computing to process large data volumes to handle real-time monitoring of primary and secondary capital markets. Analytics can then be applied to the data around use cases such as market surveillance to identify suspicious trading activities, macroprudential supervision to detect liquidity risks or signals of emerging bank runs.

The use of suptech can help create ways to strengthen financial supervision, however this needs to be developed in tandem with the appropriate governance, processes, and institutional reforms.

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Dora Heng

Recovering economist passionate about global development and being human in an age of technological disruption