Douglas Arner et al on Decentralized Finance (Journal of Financial Regulation)

"Decentralized Finance"
Dirk A Zetzsche, Douglas W Arner, Ross P Buckley
Journal of Financial Regulation, Volume 6, Issue 2, pp.  172–203
Published in September 2020

Abstract: DeFi (‘decentralized finance’) has joined FinTech (‘financial technology’), RegTech (‘regulatory technology’), cryptocurrencies, and digital assets as one of the most discussed emerging technological evolutions in global finance. Yet little is really understood about its meaning, legal implications, and policy consequences. In this article we introduce DeFi, put DeFi in the context of the traditional financial economy, connect DeFi to open banking, and end with some policy considerations. We suggest that decentralization has the potential to undermine traditional forms of accountability and erode the effectiveness of traditional financial regulation and enforcement. At the same time, we find that where parts of the financial services value chain are decentralized, there will be a reconcentration in a different (but possibly less regulated, less visible, and less transparent) part of the value chain. DeFi regulation could, and should, focus on this reconcentrated portion of the value chain to ensure effective oversight and risk control. Rather than eliminating the need for regulation, in fact DeFi requires regulation in order to achieve its core objective of decentralization. Furthermore, DeFi potentially offers an opportunity for the development of an entirely new way to design regulation: the idea of ‘embedded regulation’. Regulatory approaches could be built into the design of DeFi, thus potentially decentralizing both finance and its regulation, in the ultimate expression of RegTech.

Douglas Arner et al on Decentralized Finance (Journal of Financial Regulation)

"Decentralized Finance"
Dirk A Zetzsche, Douglas W Arner, Ross P Buckley

Journal of Financial Regulation

Published in September 2020

Abstract: DeFi (‘decentralized finance’) has joined FinTech (‘financial technology’), RegTech (‘regulatory technology’), cryptocurrencies, and digital assets as one of the most discussed emerging technological evolutions in global finance. Yet little is really understood about its meaning, legal implications, and policy consequences. In this article we introduce DeFi, put DeFi in the context of the traditional financial economy, connect DeFi to open banking, and end with some policy considerations. We suggest that decentralization has the potential to undermine traditional forms of accountability and erode the effectiveness of traditional financial regulation and enforcement. At the same time, we find that where parts of the financial services value chain are decentralized, there will be a reconcentration in a different (but possibly less regulated, less visible, and less transparent) part of the value chain. DeFi regulation could, and should, focus on this reconcentrated portion of the value chain to ensure effective oversight and risk control. Rather than eliminating the need for regulation, in fact DeFi requires regulation in order to achieve its core objective of decentralization. Furthermore, DeFi potentially offers an opportunity for the development of an entirely new way to design regulation: the idea of ‘embedded regulation’. Regulatory approaches could be built into the design of DeFi, thus potentially decentralizing both finance and its regulation, in the ultimate expression of RegTech.

HKU FinTech Day 2018 (Programme)

HKU FinTech Day

as part of the 2018 FinTech Education Series @ Hong Kong FinTech Week 

www.hkufintech.com 

29 October 2018 (Monday), 12:30pm – 5:30pm Large Moot Court, 2/F Cheng Yu Tung Tower The University of Hong Kong 

       Programme

12:30 – 13:00	Registration
13:00 – 13:10	Welcome Remarks Professor Christopher Chao, Dean, HKU Faculty of Engineering
13:10 – 14:00	Panel Discussion: The Future is Now: Understanding and Preparing for the Implications of Artificial Intelligence Gary Meggitt, Director, Asian Institute of International Financial Law, HKU Soujit Ghosh, Co-Founder, Squared-S Artificial Intelligence Kevin Pereira, Managing Director, blu Artificial Intelligence Kane Wu, Co-Founder of ThinkCol and Chairman of Hong Kong Data Science Society David S. Lee, Senior Lecturer, HKU Faculty of Business & Economics
14:00 – 14:15	Special Announcement: Introducing the New FinTech MOOCs Professor Douglas Arner, HKU Faculty of Law Professor David Bishop, HKU Faculty of Business & Economics Professor S.M. Yiu, HKU Department of Computer Science HKU TELI (Technology Enriched Learning Initiative) Jen Lee, HKU Faculty of Law Jon Pederson, HKU Faculty of Business & Economics
14:15 – 14:25 14:25 – 14:30	Special Announcement: Introducing BASc in FinTech Professor S.M. Yiu, HKU Department of Computer Science Dr Alan Kwan, HKU Faculty of Business & Economics Special Announcement: Introducing LITE Professor Michael Hor, Dean, HKU Faculty of Law Brian Tang, Founding Executive Director of Law, Innovation, Technology and Entrepreneurship (LITE) Programme, HKU Faculty of Law
14:30 – 15:00	Be Future Ready in the new Era of ABC: AI, Big Data and Cloud Maria Hui, HR Director, Microsoft Bess Chung, Product Marketing Manager, Microsoft
15:00 – 15:10 15:10 – 15:40 15:40 – 16:20	Education for Emerging Cohort of Fintech Entrepreneurs Maria Pennanen, CEO, Santiment Deutschland Panel Discussion: Blockchain Fever: How to Cure This Mystery Affliction Bowie Lau, Founder, MaGESpire Professor Pedro Eloy, Head of BusinessLab, HKU MBA, Faculty of Business & Economics, CEO of Pelham Grey Avril Parkin, Co-Chair for the Big Data Committee, FinTech Association of Hong Kong Maria Pennanen, CEO, Santiment Deutschland Anil Kudalkar, Co-Founder, MaGESpire Partners Fintech Startup Fireside Pitches: Planto and MediConCen Laurence Tang, iDendron Judging panel of industry experts
16:20 – 17:20	Panel Discussion: Global Leadership in Digital Banking – RegTech as a Secret Sauce Huiya Yao, Head of FinTech Innovation, WeBank Max Yevdokimov, Chief Digital CX Officer, Tinkoff Bank Alex Kong, Founder and CEO, TNG Brian Tang, Founding Executive Director of LITE Programme, HKU Faculty of Law and Founder of ACMI
17:20 – 17:30	Closing Remarks Syed Musheer Ahmed, General Manager, FinTech Association of Hong Kong
17:30 – 18:30	Networking in the 1/F foyer of Cheng Yu Tung Tower

HKU FinTech Research and Teaching Showcase will be held in the 1/F foyer

Reserve your seat here 

Enquiries: Flora Leung at fkleung@hku.hk

Douglas Arner Interviewed on How Central Banks Can Capitalise on Regtech (Central Banking)

"Capitalising on regtech"
Joel Clark
Central Banking
30 July 2018

If one were to imagine the ideal financial supervision system of the future, it would probably look very different from what we have today. Financial institutions would report details of transactions to a central utility, from which regulators would be able to extract information in real time. They might monitor markets through multiple screens in futuristic control rooms, picking up systemic risks with the help of flashing lights and heat maps.

     Data reporting requirements have increased dramatically since the 2007–2008 financial crisis, but central banks and regulators admit they cannot yet use this data to build an accurate picture of risk in the financial system. The evolution of regulatory technology, or regtech, might help deal with this problem – and some central banks are actively exploring opportunities – but there is a long way to go.

...

   “New regulations over the past decade have created a massive new pool of data that didn’t previously exist, so there is a major opportunity for central banks to use this data to obtain better insights and achieve better regulatory outcomes,” says Douglas Arner, professor of law at the University of Hong Kong.

     Enthusiasm for exploring regtech varies across the central bank community, with some institutions already surveying and testing new approaches while others wait to see how the technology evolves. But the data challenge shows little sign of diminishing, with the likelihood of further reporting requirements being layered on top of existing ones... Click here to read the full article.

Zetzsche, Buckley, Barberis & Arner on Regulating a Revolution: from Regulatory Sandboxes to Smart Regulation (Fordham J of Corp & Fin L)

"Regulating a Revolution: from Regulatory Sandboxes to Smart Regulation"

Dirk A Zetzsche, Ross P Buckley, Janos N Barberis and Douglas W Arner
Fordham Journal of Corporate & Financial Law  
2017, Vol. 23, Issue. 1, pp. 31-103

Abstract: Prior to the global financial crisis, financial innovation was viewed very positively, resulting in a laissez-faire, deregulatory approach to financial regulation. Since the crisis the regulatory pendulum has swung to the other extreme. Post-crisis regulation, plus rapid technological change, have spurred the development of financial technology (FinTech). FinTech firms and data-driven financial service providers profoundly challenge the current regulatory paradigm. Financial regulators increasingly seek to balance the traditional regulatory objectives of financial stability and consumer protection with promoting growth and innovation. The resulting regulatory innovations include RegTech, regulatory sandboxes, and special charters. This Article analyzes possible new regulatory approaches, ranging from doing nothing (which spans being permissive to highly restrictive, depending on context), cautious permissiveness (on a case-by-case basis, or through special charters), structured experimentalism (such as sandboxes or piloting), and development of specific new regulatory frameworks. Building on this framework, we argue for a new regulatory approach, which incorporates these rebalanced objectives, and which we term 'smart regulation.' Our new automated and proportionate regime builds on shared principles from a range of jurisdictions and supports innovation in financial markets. The fragmentation of market participants and the increased use of technology requires regulators to adopt a sequential reform process, starting with digitization, before building digitally-smart regulation. This Article provides a roadmap for this process. Click here to download the full article.

Syren Johnstone on ICO Utility Tokens and the Relevance of Securities Law (HK Lawyer)

"ICO Utility Tokens and the Relevance of Securities Law"
Syren Johnstone
Hong Kong Lawyer

March 2018, pp. 30-33

     Abraham Lincoln famously posited that if one calls a tail a leg it doesn't mean that a dog has five legs. Similarly, a blockchain-based token offered in an initial coin offering ('ICO') may, irrespective of how it is called, be a security subject to securities laws applicable to the primary market as well as secondary market activities. ICOs are an example of how new technology is changing the way the public capital market is accessed by business, typically start-ups, in need of capital.

    The legal treatment of tokens remains unclear in my jurisdictions, which is increasingly problematic as ICO activity has ballooned from around US$300 million during 2013 to 2016 to well in excess of US$5 billion in 2017. As Hong Kong is now considering its potential status as an ICO hub, it is essential that regulatory agencies and market professionals come to grips with a better understanding of how tokens are, or may be, regulated.
     A focus of this article is "utility tokens"...The nature of a utility token is to permit the holder to access a service provided by the user's platform. This is typically a pre-sale made by a start-up seeking capital to develop the promised service. ...
    The law applying to the offering of securities and their marketing in Hong Kong, as set out in the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) and the Securities and Future Ordinance ('SFO') (Cap. 571), is in general consistent with best international practices that prohibit accessing public capital unless registration or authorisation requirements are complied with it a relevant exemption applies. Tokens that are securities may also be subject to laws concerning regulated activities and the operation of exchanges and automated trading services. However, whether a specific token is a security will require careful consideration. ...
     First, because Howey has been applied to tokens by the U.S. SEC...
     Second, because of potential similarities to elements in the definition of CIS that align with, though are not identical to, the concept in Howey of a common enterprise in which the efforts of another are key.
    However, applying existing law to tokens is inherently problematic because blockchain has enabled fundamental changes in the ease and manner of accessing public capital, the cost and time of doing so, the willingness of the public to purchase tokens and the ease of trading them.
     Hong Kong practitioners will therefore need to exercise some caution when advising on the nature of a proposed token issuance and how it is undertaken.
     The increasing awareness that tokens can be subject to securities laws that possess uncertainties in their potential scope of application has had an impact on practices in the industry. ...
     While best practices have been developed to promote self-regulation of the industry, they have not always been observed in practice...

     Legal practitioners will be well aware that avoidance and evasion are quite different matters...

    While that distinction may be clear-cut in principle, the characteristics of a utility token that might cause it to be regarded as a security are less clear...
     The overarching purpose of securities laws is to regulate investments, irrespective of the form or name they assume ...
     One might point to the development of structured product regulation as a lesson in the failure of looking at how a product fits into a pre-existing set of categories, rather than considering its function in the market...
    New challenges may require regulatory agencies to interpret the law with one eye firmly fixed on regulatory intent...
   Care needs to be taken that purposive flexibility is not applied by regulators in a way that creates uncertainty...
     Returning to Abraham Lincoln, he was wrong semantically. If a tail is called a leg then it can be said that a dog has five legs. And if utility token issuances put public capital at risk, expose consumers to fraud, and behave similarly to an investment in established classes of securities, then perhaps that is enough to render it a security within the original intent of the legislature. Practitioners call it "the smell test". Indeed, the SFO provides that "interests, rights or property...commonly known as securities" are to be regarded as securities. On the other hand, calling a security a utility token does not change its nature. Click here to read the full text.

Douglas Arner Comments on Anti-money-laundering Regulations (Investor Daily)

"Anti-money-laundering Regulators 'Useless'"
Jessica Yun
Investor Daily
7 Feb 2018

Speaking at the University of New South Wales on Monday, University of Hong Kong law professor Douglas Arner called into question the aims and the efficacy of anti-money laundering and counter-terrorism financing regulatory bodies.

    “Is the point of [anti-money laundering agencies] about producing suspicious transaction reports? Not really,” he said. “It's about reducing the criminal and terrorist use of the financial system.” He said that producing reports was only an attempt that had “developed over time” to reduce criminal and terrorist activity, but that it “doesn’t really work very well”.

     “But it ends up, for a number of jurisdictions, with warehousefuls of suspicious transaction reports which regulators will typically only look at after something happens,” he said.

“They are completely useless from the standpoint of prevention. They are only useful from the standpoint of ex post facto (with retrospective action or force) pursuit.”... Click here to read the full article.

Arner, Barberis, Buckley on The Emergence of Regtech 2.0 (J Financial Transformation)

"The Emergence of Regtech 2.0: From Know Your Customer to Know Your Data"

Douglas Arner, Janos Barberis (PhD Candidate), Ross Buckley

Journal of Financial Transformation
Nov 2016, Vol 44, pp 79-86
Oct 2017, posted online

Abstract: The regulatory changes and technological developments following the 2008 Global Financial Crisis are fundamentally changing the nature of financial markets, services and institutions. At the juncture of these two phenomena lies regulatory technology or ‘RegTech’ – the use of technology, particularly information technology, in the context of regulatory monitoring, reporting and compliance.
     RegTech to date has focused on the digitization of manual reporting and compliance processes, for example in the context of know-your-customer requirements. This offers tremendous cost savings to the financial services industry and regulators. However, the potential of RegTech is far greater – it could enable a close to real-time and proportionate regulatory regime that identifies and addresses risk while also facilitating more efficient regulatory compliance.
     We argue that the transformative nature of technology will only be captured by a new approach that sits at the nexus between data, digital identity and regulation. The development of financial technology (‘FinTech’), rapid developments in emerging markets, and recent pro-active stance of regulators in developing regulatory sandboxes, represent a unique combination of events, which could facilitate the transition from one regulatory model to another.

HKU Partners in Three Continent FinTech/RegTech Research Collaboration

International collaboration of law experts from three continents towards global FinTech and RegTech research

To support Hong Kong's aspirations of becoming a financial technology (FinTech) hub, Professor Douglas Arner from the Faculty of Law at the University of Hong Kong (HKU) has joined forces with law professors from Europe and Australia to cooperate in researching the law and regulation of FinTech.

     Professor Arner will partner with Professor Dirk Zetzsche (ADA Chair in Financial Law/Inclusive Finance) at the University of Luxembourg and Professor Ross Buckley at the University of New South Wales (UNSW) in Sydney, Australia to form an international law team based in three continents and three major global financial centres.

     The team, alongside other renowned researchers and FinTech regulators, will present their latest work at the third annual FinTech Conference organised by the University of Luxembourg's Research Unit in Law on 9 October 2017.

     Since embarking on their collaboration early this year, the three FinTech and regulatory technology (RegTech) experts, in cooperation with HKU PhD candidate Janos Barberis, founder of the SuperCharger FinTech Accelerator headquartered in Hong Kong, have produced four draft papers on the impact of big data on the financial system¹, the challenges of regulating FinTech², a theory of smart regulation that considers different regulatory tools and their role in enabling or restricting innovation³ as well as an analysis of liability risk and its impact on the use and set-up of blockchain⁴. Together, their works have been downloaded more than 27,000 times on the Social Science Research Network (SSRN) and they have published over 30 scholarly articles and book chapters in the past year.

     The financial centres of Luxembourg, Sydney and Hong Kong have been responding to rapid technological innovation and disruption recently. In Hong Kong, for example, the 2017 government's Policy Address pledged to establish the city as a hub for FinTech application and setting of standards for cutting-edge FinTech. Commenting on the cooperation, Professor Zetzsche (currently in the top 10% of the SSRN's top 3,000 law authors globally) said: "Smartly regulating financial innovation requires all stakeholders - the financial sector, start-ups, regulators and academics - to understand technology and law. Only global research is able to grasp the true speed and depth of these developments." He was supported in his assessment by Professor Arner (currently 7th of the SSRN's top 3,000 law authors globally): "Financial technology, through big data, artificial intelligence, regulatory technology, crowdfunding, smart contracts, etc. changes the fundamentals of our regulatory system. Only financial centres that adjust their regulatory environment will be able to maintain and develop further their relevance." The potential for FinTech is substantial, added Professor Buckley (9th of the SSRN's top 3,000 law authors globally): "FinTech can tackle issues of transaction, compliance and risk management costs. But these benefits can come at a price - exchanging human errors for risks stemming from information technology. A smart, analytical approach is needed and this is where academic research can make a fundamental difference."

     The team's global FinTech and RegTech research cooperation is supported by three funding bodies: Luxembourg's National Research Fund contributed to an Intermobility Programme "Smart Regulation - Towards a New Law for FinTech", the Australian Research Council funding of the project "Regulating a Revolution: A New Regulatory Model for Digital Finance" and the Hong Kong Research Grants Council Theme-based Research Scheme providing financial support for "Enhancing Hong Kong's Future as a Leading International Financial Centre". The FNR's Intermobility Programme allowed Professor Zetzsche to spend three months at UNSW Sydney, where the cooperation was formalised.

Notes

¹ See Zetzsche, Buckley, Arner, Barberis, "From FinTech to TechFin: The Regulatory Challenges of Data-Driven Finance," available online https://ssrn.com/abstract=2959925, forthcoming New York University Journal of Law & Business (2018).

² Arner, Zetzsche, Buckley, Barberis, "FinTech and RegTech: Enabling Innovation while Preserving Financial Stability", forthcoming Georgetown Journal of International Affairs (2018).

³ Zetzsche, Buckley, Arner, Barberis, "Regulating a Revolution: From Regulatory Sandboxes to Smart Regulation", available online https://ssrn.com/abstract=3018534.

⁴ Zetzsche, Buckley, Arner, "The Distributed liability of Distributed Ledgers: Legal Risks of Blockchain", available online https://ssrn.com/abstract=3018214.

Media enquiry

Ms Rhea Leung, Communications and Public Affairs Office, The University of Hong Kong (Tel: +852 2857 8555; Email: rhea.leung@hku.hk; Website: www.hku.hk )

Ms Laura Bianchi, Communications Department, University of Luxembourg (Tel +352 46 66 44 9551;

M +352 621 547 950; Email: laura.bianchi@uni.lu; Website: www.uni.lu )

Ms Clare Morgan, Media Office, UNSW SYDNEY (Tel +61 (2) 9385 8920; Email: clare.morgan@unsw.edu.au; Website: law.unsw.edu.au )

For the online press release, click here.

Emily Lee on Financial Inclusion, FinTech, RegTech & AML (J Business Law)

"Financial Inclusion: a Challenge to the New Paradigm of Financial Technology, Regulatory Technology and Anti-Money Laundering Law"

Emily Lee

Journal of Business Law

2017, Issue 6, published, pp 473-498

Abstract: This article evaluates the claim that FinTech—a portmanteau of finance and technology, including blockchain and automated suspicious transaction monitoring technology systems—has the ability to revolutionise financial inclusion, and examines whether regulatory technology (RegTech) can be used by regulators for tracking and monitoring AML/CFT compliance activities.

     Introduction: Financial inclusion denotes banks’ provision of basic financial services at affordable costs to those that need and qualify for them. Financial inclusion has strong social and economic implications. Access to basic financial services has been recognised as a basic civil right by the European Accessibility Act. The opposite is financial exclusion, which is when banks deny financial services to customers that they consider as posing high risks for money laundering and terrorist financing, giving rise to the term “de-risking”. 

     A litany of financial exclusion reports impelled the Hong Kong Money Authority (HKMA), the territory’s banking regulator, on 8 September 2016, to issue a circular to banks warning against the practice of de-risking, excluding customers from the financial system as the territory’s banks attempt to meet the anti-money laundering/countering the financing of terrorism (AML/CFT) requirements. Financial exclusion is driven by increasingly stringent documentary requirements and/or banks’ fear of regulatory reprisals if customers cannot prove the legality of their income or source of funds to their banks’ satisfaction. In over-compensating, banks have refused to approve account opening applications from some customer groups, with small and medium-sized enterprises (SMEs) and start-up companies (start-ups) being most affected... 

     This article addresses the following key issues: (1) the importance of financial inclusion since it has strong social and economic implications; (2) the claim that FinTech enables financial inclusion; (3) the problem of financial exclusion, which is linked to AML/CFT requirements; and consequently considers (4) whether the AML/CFT requirements are suitable to be put into a regulatory sandbox, a new regulatory approach whereby innovative FinTech products or services will be provided with regulatory flexibility for them to be introduced and tested in the market, and, if not, whether there is an alternative approach to grant regulatory flexibility so as to make financial services more accessible—the essence of financial inclusion...  Download the full paper here. 

FinTech and RegTech in a Nutshell, and the Future in a Sandbox (CFA Institute)

"FinTech and RegTech in a Nutshell, and the Future in a Sandbox"

Douglas W. Arner, Jànos Barberis, and Ross P. Buckley

Research Foundation Briefs, CFA Institute

July 2017, Volume 3, Issue 4, pp 1-20

Abstract: The 2008 global financial crisis represented a pivotal moment that separated prior phases of the development of financial technology (FinTech) and regulatory technology (RegTech) from the current paradigm. Today, FinTech has entered a phase of rapid development marked by the proliferation of startups and other new entrants, such as IT and ecommerce firms that have fragmented the financial services market. This new era presents fresh challenges for regulators and highlights why the evolution of FinTech necessitates a parallel development of RegTech. In particular, regulators must develop a robust new framework that promotes innovation and market confidence, aided by the use of regulatory "sandboxes." Certain RegTech developments today are highlighting the path toward another paradigm shift, which will be marked by a reconceptualization of the nature of financial regulation.  Click here for the full text.