The future of FMI regulation in the fintech era

As we navigate through the exciting digital landscape of fintech, we stand on the brink of a new era. We have been witnessing the increasing advancement and adoption of innovative technologies, including cloud computing, artificial intelligence and Web 3.0.

With the emergence of digital asset classes like cryptocurrencies, the landscape of financial market infrastructures (FMIs) is evolving rapidly. While this development brings immense potential for financial inclusivity and efficiency, it also introduces new challenges for regulators, institutions, and customers alike. This piece will delve into the current state of FMI regulation, explore the issues raised by emerging fintech innovations, and consider possible solutions as we contemplate the future of this dynamic sector.

The evolving landscape of FMIs

A review of our traditional FMIs reminds us of the profound transformation that the industry has undergone in the years following the 2007-09 financial crisis. The increasing presence of cryptocurrencies and decentralised finance (DeFi) applications, for instance, has challenged the foundations of established FMIs. This emergence demands a fresh regulatory perspective to safeguard market integrity and consumer protection without stifling innovation.

Take, for instance, the recent developments at the Commodity Futures Trading Commission (CFTC), whose oversight has expanded to accommodate a new wave of digital assets and derivative contracts. Consider the case of LedgerX, a derivatives clearing organisation (DCO) acquired by FTX in 2021. Leveraging LedgerX’s registration with the CFTC, FTX created a structure to enable direct retail access to fully collateralized contracts – a departure from the traditional structure of Central Counterparties (CCPs). The evolution of such an entity and its associated implications offer valuable insights into the necessary recalibration of regulatory oversight.

The challenges and opportunities of governance and risk management

The fintech era has exposed a significant shortcoming in governance and risk management, which, if not addressed, could erode market trust and engagement. To highlight this, let's refer to FTX and BlockFi among the laundry list of entities that have petitioned for bankruptcy protection due to failures in governance and risk management. The solution lies in creating a culture of compliance and integrating reforms in corporate governance and risk management.

Implementing internal infrastructures responsive to the changing market dynamics, establishing robust board committees, integrating internal audits, and ensuring the correct protection of customer assets are all necessary steps in creating this culture of compliance. This could potentially transform firms into the first line of defence, protecting customers and ensuring market integrity.

The need for an international regulatory dialogue

An international dialogue among regulators is essential to establish a threshold of a regulatory framework that ensures customer protection and market integrity. Recognizing the potential of this dialogue, international standard setters like the Financial Stability Board (FSB), the Basel Committee on Banking Supervision, and the IOSCO’s fintech task force have already started consultations on crypto regulation.

For example, there is a growing collaboration between the Financial Conduct Authority (FCA) and the treasury in the UK to establish a safety net for investors. At the same time, the progression of the Markets in Cryptoassets (MiCA) regulation in Europe is under close observation, indicating an increasing international focus on the regulation of crypto assets.

Cybersecurity: an underestimated concern

The focus on the future of FMI regulation would be incomplete without addressing cybersecurity, a topic that has been underestimated and under-emphasised in regulatory discussions. The threat of cybersecurity breaches is real and significant, as shown by the ransomware attack against ION, a third-party service provider for global derivatives markets transactions. In light of such threats, the CFTC and other regulators are contemplating a number of cybersecurity policies that can ensure the protection of both individual and sophisticated customers, as well as market integrity.

Embracing the future of FMI regulation in the fintech era

The rapid evolution of fintech and the emergence of new asset classes demand an equally agile and adaptable approach to regulation. By cultivating a compliance culture, engaging in global regulatory dialogues, and prioritising cybersecurity, FMIs can establish a balance between innovation and resilience.

The goal is to ensure that the FMIs of the future reflect the protection and resilience historically associated with traditional markets. This necessitates proactive engagement from regulators, FMIs, market participants, and technology providers to ensure that these new digital landscapes remain safe, fair, and transparent for all parties involved. It is through this collective effort that we can optimistically envision the future of FMI regulation in the fintech era.

Get in touch to find out more about Cumulus9.