Financial Conduct Authority (UK) releases discussion paper on distributed ledger technology
The Financial Conduct Authority (FCA) has released DP17/3, seeking views on potential use cases for distributed ledger technology (DLT) in the financial sector. The discussion paper put forward 17 questions seeking views on the risks and opportunities for the financial sector associated with DLT, and whether implementation of a DLT solution was compatible with existing regulation.
The FCA strives for technology neutrality, however four areas were identified where existing regulation may not be sufficient to facilitate implementation of DLT solutions. These areas were:
- Allocation of responsibility on the DLT solution: the absence of a single controlling entity means that compliance responsibilities are not always clearly identified and this can lead to governance issues. For instance, on a distributed ledger, who operates under the regulator’s remit and who carries out the regulated activity?
- Digital asset trading: the FCA is seeking to understand the scope of DLT application in securities issuance and trading by identifying potential use cases. It is also concerned with the parallels between initial coin offerings and other methods of raising capital, such as initial public offerings, private placements and crowd sales. The FCA considers these initial coin offerings may fall within its current regulatory ambit.
- Collateral management: smart contracts may be used to reduce certain prudential requirements by automating and expediting the calculation and exchange of collateral. The example of possible DLT application given by the FCA was in relation to the “margin period of risk” (time between the most recent exchange of collateral for transactions with a defaulting counterparty and when those transactions can be closed out) for non-centrally cleared OTC derivative contracts. Currently, a legislated ten day time period applies but that could be reduced.
- Data protection: the UK has legislated a right to erasure (or a “right to be forgotten”) under its data protection regime. Where a DLT solution creates immutable records which cannot be removed, it may impede enforcement of this right. The FCA did not invite comments on this topic but advised firms to consider this issue when developing a DLT solution.
The generally cautious tone of the discussion paper towards DLT responsive regulatory change is notable. The FCA noted that it had “not yet discovered a need for fundamental change to our regulatory framework” based on engagement with industry and that there were other existing technologies that could facilitate much of same functionality that DLT offers. The FCA did concede that DLT may represent an overall improvement on other currently available technology.