The FCA on Distributed Ledger Technologies

The specific wording “Historically, the FCA’s philosophy has been one of ‘technology neutrality’ i.e. not to regulate specific technology types” was echoed during presentations, with the best summary coming from David Geale, Director of Policy at the FCA who explained that the FCA does not currently regulate the specific databases or technologies that firms use so long as the outcome meets the FCA obligations. It was clear that this is still the intention going forward, allowing firms to choose the most appropriate technologies to meet their goals.

This makes perfect sense and pushes responsibility (And liability) to firms who often understand the technologies better than the regulator. At the same time, the FCA acknowledges that in some places Distributed Ledgers are incompatible with its current handbook and that changes may be needed to ensure that they do not stifle a new technology but as a general rule they will not be seeking to rule out its used entirely.

But wait Mike, I thought 5MLD was aiming to amend the regulations to include crypto currencies? Surely this means they are trying to be forced to regulate the technology?

What was made very clear by the FCA was that they recognise that Distributed Ledger Technology (DLT) is  entirely separate from Bitcoin, which is a very important distinction to make. Whilst Bitcoin operates on DLT, the underlying technology is separate and can be used for a wide range of applications which are not Bitcoin related.  

Other forms of transactional based databases could move to a DLT to share and create data, bringing the benefits of decentralisation (which helps with business continuity) as well as potential reductions in costs as the firm does not need to host a costly central database somewhere.

But at the same time, the FCA and multiple speakers at the event were keen to point out that DLT’s were not the all singing panacea of the financial services world. A number of new risks exist with DLT’s and as the Bank of International Settlements stated in their February report “In most instances, the risks associated with payment, clearing and settlement activities are the same irrespective of whether the activity occurs on a single central ledger or a synchronised distributed ledger”

Another issue noted by Simon Taylor of 11:FS was that we do not have a green field in the technological world. A new Distributed Ledger cannot just take over from our existing processes. Historical data will still need to be migrated into the systems, taking into account the lack of compatibility and inability to reconcile that data. Moving to a distributed ledger will not fix this immediately and so poor data hygiene will still be an issue.

Distributed Ledgers will also not be able to create data from thin air. Whilst the UN has stated that it aims to give everyone an Identity by 2030 (Which some people have claimed could use a Distributed Ledger) the reality is that if people’s birth were never registered, or they have never been known to any government databases,  DLT technologies will not magically be able to find them.   

So, whilst Distributed Ledgers represent a great new way of sharing data, they do not fix all of the problems that we have with current database technologies.  This was highlighted during the panel discussion at yesterdays event, which can be summarised as “The right tool for the right job”.

Firms should not be rushing to cram DLT into every new tool they build just because it is the new kid on the block and should be cautious of solutions using DLT unless they actually understand the benefits and pitfalls of it. As with any system, it is up to the firm to make sure they understand it and that it meets their regulatory obligations, as well as understanding any of the gaps or issues which are created by changing to a new system.

At the same time even where firms have historical and embedded systems, they should be considering the benefits and pitfalls of those existing systems, as an outdated system will come with its own flaws.

Conclusion

In short, DLT is very very cool, but its not magic. Approach it with caution, and don’t let anyone sell you a DLT based system or a process solely on the basis that it has this magical new component. The regulator will expect you to be able to explain it and to prove that you assessed it fully, so take the time to ask the vendor for all of the details and to explain it. Preferably in a language you understand and can repeat confidently.