Senate financial reform lacks a vision for digital age

Chairman Mike Crapo (R-Idaho) and Sen. Bob Corker (R-Tenn.) of the Senate Banking Committee announced a bipartisan agreement on a legislative proposal to improve our nation’s financial regulatory framework and promote economic growth.

While little detail was released, the four-page summary, TITLE I-IV, addressed regulatory protections and mortgage and credit relief for consumers, veterans, homeowners and tenants. It also targeted modifying regulations for certain banks, custodians and municipal investments.

While detail is yet to be provided, it is safe to say the proposal amounts to slightly more than making modifications at the rough edges of existing regulations.

Those regulations, proposed after the 2007-2008 financial crisis, were hastily drafted and quickly passed by a political class that needed feel-good remedies to appease its irate constituents. Now, nearly a decade later, the financial system we once knew has been dramatically transformed.

Yet, the proposal looks only to add incremental change on this older regulatory order, save for its final section, which requests the Treasury Depatrment to report on cyber threats and the SEC to report on algorithmic trading.

Both are critical to understand the technological implications of the digital age of finance on our financial institutions and our markets. However, it is far short of other studies that are needed to position its financial institutions to aid the U.S. economy on a global growth trajectory.

Cybersecurity and algorithmic trading vulnerabilities are present dangers but must be addressed in the context of a radically changed financial system, one now driven by advanced technologies. To focus on just these two vulnerabilities misses the point of the transformative events now present in finance.

Cloud computing accommodating more of our financial data introduces technology companies into the financial system in ways never contemplated, even a decade ago. Artificial intelligence in investment decision-making promises to replace individual human judgement through collecting huge amounts of data in the cloud and optimizing on the collective judgement of the crowd.

Blockchain and distributed ledger technology (DLT), only a decade old, has begun a similar transformation of finance as did the internet, itself only two decades old. FinTech (financial technology) startups are using the newer technologies to compete against traditional financial institutions

Title V is a good start but needs to be expanded to study the realities of an already obsolete regulatory framework not fit for the digital future already here today. Many government entities are engaged in pilots to encourage technological innovation.

The Office of the Comptroller of the Currency (OCC) is preparing to offer special purpose bank charters for FinTech startups for retail payment, lending and deposit taking. The Federal Reserve has offered up its own research on FinTech, exploring uses in payments, securities clearance and settlement.

The CFTC has initiated its own research into how DLT can help in alleviating the data issues that have prevented them from reporting and aggregating trades and pre- and post- trade data for risk analysis.

The International Swaps and Derivatives Association (ISDA), has initiated a modelling exercise to demonstrate the way derivatives contracts can leverage DLT. It has also explored the creation of a “smart contract” (a combination of automated process and data for automatically effecting a financial transaction between parties) for communication and storage using DLT.

The EU, U.K., Singapore and Hong Kong, already global financial centers, are experimenting with these digital technologies and techniques, allowing entrepreneurs to enter into “light” regulatory regimes in order to foster innovation and competition.

Regulators across the globe are imposing global data standards for identifying financial market participants and the contracts and financial instruments they trade in, and standardizing the data components of the transactions they transmit to regulators.

A concept of RegTech (regulatory technology) is being promoted to improve regulatory reporting and allow for better surveillance and oversight.

It is in the above context that Title V falls short in just studying cyber risk and algorithmic trading. Title V needs to be expanded to study all of the transformational issues facing our financial system’s digital future, lest we fall behind others who started later and did not have as much an investment in legacy systems and legacy regulations.

Allan Grody is the president of Financial InterGroup Advisors — strategists, consultants and researchers in financial services with particular focus on bank regulation. Grody is also an editorial board member of the Journal of Risk Management in Financial Institutions.