Regulating the technological revolution in finance
Thank you for inviting me to address AmCham once again.
Following two years of pandemic-related disruption that has dominated our lives, the world is now consumed with responding to Russia’s invasion of Ukraine. Both of these events – the pandemic and the invasion – have been sudden and unexpected, have come with a terrible human toll, and have long-lasting implications for all aspects of society. Although neither was a financial event, the financial impacts have been significant, and the work of the financial sector, and its regulators, has been intensive and extensive.
I doubt many of us needed further reminders that economic shocks can emerge at short notice and from unexpected quarters. We need to be prepared for them. But we can’t afford to lose sight of the somewhat slower, but in many ways more important, longer-term shifts in the environment that are underway. As I have noted elsewhere,1 while crises have demanded our time and attention, they haven’t disrupted other changes sweeping through the financial system. Technological change, digitisation and new forms of finance have continued apace while we are all busy looking after the here and now. Indeed, in some ways, the crises have sped up these shifts.
Regulation of the financial system exists because history has taught us that, left to its own devices, the system is prone to bouts of instability and considerable harm to society. But equally we know a dynamic and innovative financial system – with participants able to take risk and innovate to deliver better products, services, and ways of doing business – generates important and long-lasting economic benefits for society. Finding that Goldilocks point for regulation – not too much, not too little – so as to allow the digitisation of finance to generate maximum economic benefit, but doing so within society’s risk tolerance, is what we strive for.
That, of course, is much easier said than done.
The perils of prediction
A few years ago, I gave a speech titled Peering into a cloudy future. The premise of the speech was that there were many plausible scenarios for how the financial system might evolve in response to digital innovation. But which scenario(s) might come about was highly uncertain.
Three and a half years later, have the clouds lifted in any way? In short: yes, but it’s still quite foggy.
On the surface, some of the questions we had in 2018 appear to have been answered. The digitisation of the Australian and global economies has continued, as consumers and businesses have chosen to rely evermore on mobile phones, digital wallets and online transfers to pay for everyday goods and services. Noone seriously expects this trend will be reversed. The New Payments Platform arrived to make many electronic financial transfers virtually instantaneous. Banks have been forced to respond to innovation occurring around them: for example, offering buy-now-pay-later (BNPL) products in response to the emergence of strong new competitors in the consumer credit space; offering banking-as-a-service to non-banks who are encroaching on their traditional turf as technology lowers barriers to entry in many markets; and most recently, experimenting with issuing their own stablecoins in the face of crypto-assets moving from the fringes of the internet towards the global mainstream.2
Even central banks are conducting pilot exercises to test the use case for central bank digital currencies (CBDCs). Some countries – ranging from the Bahamas to China to Nigeria – have moved beyond pilots to general use.
These latter developments are probably the most fundamental. At the heart of the financial system is money – after all, the system exists to store, borrow, invest and transfer money. Evolution in the nature of money – from shells, to beads, to gold coins, to privately-issued bank notes, to central bank-issued bank notes, to the electronic bank deposits most of us use today – has in turn shaped how the entire financial system has evolved.
As possible new forms of money, CBDCs, digital currencies/stablecoins and crypto-assets have the potential to significantly reshape the financial system. However, there remains significant uncertainty over what a more digital and decentralised financial system will ultimately look like, which new types of money will gain prominence, which products and services will take off, and which will fade away as newer, better alternatives emerge. Those of us with long memories will recall that Google and Facebook are not dominant today because they were first to market: Yahoo! and MySpace were arguably the first to gain widespread prominence as leaders in search and social media.
In all likelihood, this will come down to what Agustin Carstens, the General Manager of the Bank of International Settlements, described as the “soul of money” – that is, public trust. “People accept money today with the expectation that everyone else will accept it tomorrow.”3
How money will change – and how the financial system will change with it – is fundamentally about where the users of money decide to place their trust. At one end of the spectrum, the case for digital forms of money such as CBDCs and stablecoins is harnessing the benefits of new technology by using trusted systems, with known issuers, permissioned technology and established convertibility. At the other end, the case for many other types of crypto-assets is often based on a distrust of these same systems, and a preference to place trust in decentralised, permission-less systems, without ties to current institutions or conventional currencies.
Governments can, through regulation, have a significant influence on the outcome. But even then, there are limits. The emergence of ride-share companies provides a case in point – despite the laws that existed at the time, surging public trust in the new transport apps forced governments to completely overhaul the regulatory framework so as to accommodate the community’s choice.
Preparing for tomorrow
So, how do regulators respond to a world of rapid shifts, great opportunity, but also material risks?
First, by not charging ahead pretending we have the answers.
My predecessor as APRA’s Chair, John Laker, liked to use a horse racing analogy when describing where regulators ought to position themselves. He said regulators should try to be “one out and one back”. In other words, we should be sufficiently up with the pace so we can keep an eye on the tactics of the frontrunners, and not be left behind. But equally we should not be out in front dictating how the race must be run.
Second, by ensuring that the regulatory agenda is focused on consumer benefits as much as it is on harm prevention.
Talk of regulation is often framed in the negative; in terms of restrictions and red tape. But it can provide a stamp of approval that reassures customers a company or product can be trusted, allowing new markets and services to flourish in the face of information asymmetry. It can also be the foundation for innovation: the establishment of the consumer data right and open banking in Australia is an obvious example. We must not allow an aversion to regulation to cause us to miss these benefits.
And third, by trying to work with some key principles for good regulatory design:
By making sure regulation is technology-neutral – that is, making sure we look through the form in which an activity is undertaken, and focus on the underlying benefits and risks for members of society.
By utilising principles-based regulation wherever possible – seeking to avoid the prescription that can otherwise limit innovation or new ways of doing things simply because they hadn’t been envisaged at the time regulation was written.
By working with a whole-of-system perspective – recognising that many of the difficult regulatory challenges of the future will come precisely because they do not fit neatly within existing regulatory structures and boundaries, and only with a whole-of-system approach can they be effectively be tackled. (The Executive Order signed a month ago by President Biden is such an example: the Order seeks to establish a whole-of-government approach to addressing the risks and harnessing the potential benefits of digital assets and their underlying technology. The UK Government this week set out coordinated plan to make UK a global crypto-asset technology hub).
Putting it into practice
How is my organisation, APRA, approaching this – what do we see as our role?
There are essentially two parts to our response.
The first part is our contribution to the whole-of-Government agenda.
Last year saw a number of important reviews take place, notably the Farrell Review of the Australian Payments System, the Senate Select Committee report on Australia as a Technology and Financial Centre, and the Parliament Joint Committee report on Mobile Payment and Digital Wallet Financial Services. Together, these reports provide an important roadmap for the setting up the Australian regulatory framework for the future.
The Federal Government is, appropriately, overseeing the overall response, and has already announced a number of important measures to ensure Australia is well-equipped for the digital revolution (such as proposed new crypto asset licensing and custody requirements). At an agency level, the Council of Financial Regulators – comprising APRA, Treasury, the Reserve Bank and the Australian Securities and Investments Commission (ASIC) – has been collaborating actively on the design and implementation of new regulatory measures. Of particular relevance to APRA is the work to develop a new Australian regulatory framework for stored-value facilities, including certain types of digital wallets and stablecoins, which we see as a high priority issue. These products can have many of the same features of traditional bank deposits, but without (at the moment) the same consumer protections. Given it is difficult for consumers to understand and compare the respective risks, the playing field is not level. We are keen to work with the Government and our peer agencies to make sure we have a fit-for-purpose framework for the future.
The second part of our contribution is ensuring our own house is in order.
In the immediate term, we would like to give regulated institutions more clarity on regulatory expectations. Following a similar path to our UK equivalent, we are in the process of finalising a letter to regulated firms on how we expect them to manage their dealings with digital assets, including stablecoins and crypto-assets. The letter will not introduce new regulatory requirements. Much like our approach to climate risk, its underlying message is primarily one of: “by all means innovate, but proceed with care and in full knowledge of the risks”.
With a longer-term perspective, our 2021-2025 Corporate Plan released last year included a major initiative that we called ‘Modernising the Prudential Architecture’. There are two main drivers for this work:
the first is that in response to a range of developments ranging from the GFC, to the Financial System Inquiry, to the Hayne Royal Commission, our prudential rulebook has grown considerably in size and complexity. It is increasingly difficult to maintain, navigate and – most importantly – comply with.
the second driver is the recognition that the prudential framework may suit the financial institutions of today, but not necessarily those of tomorrow. New technologies, new business models, and new ecosystems will mean regulation needs to be framed and applied differently in the future.
We have set ourselves three goals for this initiative:
to devise better regulation – a set of prudential requirements that are easy to find, navigate and understand.
to adopt a digital first approach – building a foundation that enables suptech, regtech, and AI solutions, enabling better compliance at lower cost.
to ensure the framework is responsive to innovation – capable of dealing with the digital economy, and not trying to force-fit the new into the old.
To repeat my comment earlier, it will be easier said than done. And it will take time. But if we want to stay not too far off the pace of industry innovation and development, we best get on with it.
Before I conclude, I would like to make one important point about something that we don’t see as our role.
We are first and foremost a safety regulator, with a mandate from the Australian Parliament to promote stability. That does not, however, translate to limiting change with a view to preserving the status quo. Nor does it mean protecting incumbent financial institutions, when better, safer and more efficient ways of doing business emerge.
If technology can deliver a financial system that is indeed better, safer and more efficient, our task is to embrace the changes for the benefit of the Australian community.
The task ahead
Getting the regulatory framework just right – now and into the future – for a financial system that is rapidly evolving is a challenging task. That well-worn phrase that “predictions are hard, especially about the future”, applies to all I have talked about today.
What we know is that the digitisation of finance is reshaping the financial system, at speed. The move towards a more digital, decentralised financial system has the potential to deliver major benefits: faster, more efficient payments, lower costs to businesses, job creation and economic growth. It also poses risks, given the financial system’s propensity to instability and community harm if not carefully managed.
Getting the regulatory balance right requires a clear plan, a flexible approach, and a coordinated response. In Australia, we are well on the path to having those important foundations in place.
1 Remarks to the AMF-BCBS-FSI High-level meeting on the post COVID-19 banking system, 10 December 2021. 2 The share of the Australian population that holds some form of crypto-asset is unclear: a quick Google search will produce surveys from 2021 that tell you it is somewhere between 3 per cent and almost 30 per cent, but even if towards the lower end of that range it is still a meaningful number of people. 3 Digital currencies and the soul of money, Speech to the Goethe University’s Institute of Law and Finance conference, 18 January 2022.
The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the financial services industry. It oversees banks, mutuals, general insurance and reinsurance companies, life insurance, private health insurers, friendly societies, and most members of the superannuation industry. APRA currently supervises institutions holding around $9 trillion in assets for Australian depositors, policyholders and superannuation fund members.
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