It is a pleasure to be with you in Malta at the World Federation of Exchanges (WFE) 61st General Assembly & Annual Meeting. That it is your 61st Annual Meeting is a testament to the work done by WFE over the past decades in looking to enable and develop fair, orderly and transparent markets, and reduce systemic risk.
Not surprisingly, these objectives align with IOSCO’s objectives of investor protection, fair efficient and transparent markets and the reduction of systemic risk.
As the global standard setter for securities markets regulation, IOSCO’s focus is on the risks to these objectives of securities regulation and how to achieve the desired regulatory outcomes.
I am going to update you on the work that IOSCO has been doing in the area of FinTech, especially crypto assets. While recent technological advancements carry the promise for significant efficiency gains – across trading, clearing and settlement activities – we are focused on ensuring that equivalent levels of investor protection and market integrity are maintained with respect to risks arising from economically equivalent activities. In essence, we are using the approach of “same risks, same regulatory outcomes.”
The present context
Since the emergence of Bitcoin in 2008 and Ethereum in 2015, the crypto-asset sector has expanded well beyond providing alternatives to digital payments. It has branched out into a wide array of asset classes and use cases – that often are functionally economic substitutes to traditional financial market products. These markets are also global in their reach, operating on a cross-border basis and transcending traditional jurisdictional boundaries.
The industry has experimented with new innovations, combining the use of distributed ledger technology with smart contracts to expand the variety of use cases beyond cryptocurrency. This has allowed the development of decentralised finance, or DeFi, which has itself been another key catalyst for the recent market boom. I will talk a little bit later about our DeFi work, but most of the activities in DeFi seek to replicate or clone traditional financial services.
Global crypto-asset market capitalisation has increased exponentially; it hit a peak of just over $3 trillion in November, although this has receded very significantly to about $1 trillion in recent weeks. In 2021, total value locked in DeFi transactions across blockchains grew to a peak of more than $250 billion from $19 billion just a year before, though it has come down from that level.
This illustrates a couple of important points:
Firstly, that the crypto-asset market is no longer in its infancy and cannot be ignored by either investors or regulators.
Secondly, there can be much volatility and opaqueness in crypto-asset markets, which calls for regulatory guardrails to be developed to ensure fairness and resilience.
Fintech Task Force
Many of you may be aware that in March this year, we set up a board-level Fintech Task Force. The FTF is chaired by the Monetary Authority of Singapore (MAS). It has 28 members from IOSCO Board member jurisdictions. This should give you a sense of the importance that we are attaching to this area.
In its first 12 to 24 months of operation, the FTF will focus its immediate attention on delivering policy-focused work on crypto-asset markets and activities primarily relating to investor protection and market integrity.
In July, we published our Crypto-Asset Roadmap for 2022-2023, which plots out our ambitions over the coming months into next year.
Before I go on to the work we will be doing under the IOSCO Crypto Asset Roadmap, let me mention the work we have done together with the CPMI on stablecoins. This is because stablecoins are a crucial part of the connection between the fiat currency and crypto-asset worlds, providing the on- and off-ramps.
The rise of stablecoins has also fuelled the explosive growth of DeFi. Stablecoin market capitalisation grew from next-to-nothing in early-2020 to over $150 billion by January 2022. Apart from their use in the area of payments, stablecoins are typically used as the “cash of crypto,” which includes the purportedly stable leg in a variety of DeFi transactions. They sit at the heart of DeFi market plumbing, playing the role that fiat currencies play in traditional financial markets for settlement purposes. This way, they provide a significant share of liquidity for the major DeFi protocols and allow asset holders to trade without moving any value ‘off-chain’. Stablecoins are also used by crypto-asset investors as collateral to fund positions or to generate yield in the DeFi ecosystem through different lending arrangements across blockchain networks.
The recent disruption faced by Tether and the Terra/ Luna episode showed how quickly confidence can be eroded and how volatile stablecoins, and crypto assets more generally, could be.
With that in mind, we looked at the application of the PFMI to globally systemic stablecoin arrangements, and we published our final report in July this year, saying that the PFMI apply to globally systemic stablecoin arrangements. I will highlight two key requirements:
First, stablecoin arrangements will need to guarantee timely convertibility into other forms of money that we accept in our economies. This in turn will determine the nature of reserve assets backing a stablecoin and the legal, technical and operational arrangements for paying out stablecoin holders.
Second, stablecoin arrangements should have clear and direct lines of responsibility and accountability by making clear what the responsible legal entity is and who the people responsible for operating that entity are. In addition, human intervention to oversee the workings of the stablecoin should always be possible.
The Crypto and Digital Assets and DeFI Workstreams
The FTF work is now progressing through two core workstreams, namely the Crypto and Digital Assets (CDA) and the Decentralised Finance (DeFi) workstreams, under the stewardship of the UK FCA and the US SEC, respectively.
Both workstreams will primarily focus on investor protection and market integrity concerns within each segment of the broader market. They are developing an outcomes-focused, principles-based approach, to map our key principles and standards to relevant elements of the crypto area.
The CDA workstream has two phases: First, it will look at issues on fair and orderly trading, transparent markets, suitability, and market manipulation. It will then investigate matters relating to safekeeping, custody and financial soundness in phase two.
The DeFi workstream will continue to explore and highlight the links between DeFi, stablecoins, and crypto-asset trading, lending and borrowing platforms, as well as the interactions of DeFi with broader financial markets.
You might be aware that IOSCO published a report on Decentralised Finance (DeFi) in March of this year which:
offers a comprehensive review of the fast-evolving DeFi market, its products, services and principal participants; and
identifies the main risks and challenges associated with DeFi activity as well as the implications for regulatory frameworks.
I would commend the March DeFi report not only for its comprehensiveness, but because it goes to the point generally of the decentralised characteristics of these markets which hamper regulators’ ability to monitor and oversee them. This is because our frameworks typically impose requirements on intermediaries that are centrally governed legal entities.
Yet despite claims of decentralisation, our DeFi report puts a serious question mark over the true level of decentralisation occurring within this sector. The report concludes that central actors often retain control – for example, through the distribution of “governance tokens” that do not necessarily distribute control of the enterprise – and through the important role played by centralised platforms as the ‘on-ramp’ to participation.
The DeFi WG is now digging even deeper analysing this space.
Traditional Markets and Crypto Asset Trading Platforms
Let me turn my focus to discuss matters related to secondary markets and the role of trading venues in the crypto asset market.
Ironically, with all the promise of decentralisation and disintermediation, we have ended-up with a relatively centralised market infrastructure where a selection of crypto asset trading platforms or service providers hold a significant percentage of market share and volume.
This concentration in turn amplifies risks via high levels of interconnectedness. Moreover, we are also witnessing significant levels of vertical integration where multiple services and activities are carried out by a single entity. This includes asset listings, trading, clearing and settlement but also unsecured lending and custody services and wallet provision.
The range of services cutting across intermediaries, both exchange-like and credit intermediation activity, goes well beyond what we are accustomed to see in traditional financial markets. And all of this is happening when much of the activities are either not subject to regulatory oversight or are taking place in non-compliance with existing standards. Add to this the fact that these activities are taking place in a borderless scheme, and you have quite a potent mix!
IOSCO work on Crypto Asset Trading Platforms
As you may be aware, we published in early 2020 our report on Issues, Risks and Regulatory Considerations relating to Crypto Asset Trading Platforms.
None of the considerations in that report will be surprising to you, since they sum up what regulated exchanges already have a strong tradition of addressing. These are equally—if not more—relevant to crypto platforms, like:
Access to and on-boarding of investors;
The ability to safeguard the assets of clients, including custody arrangements;
The identification, monitoring and management of conflict of interest risks;
Transparency of their operations;
Market monitoring – the ability to identify suspicious transactions and market abuse;
Effective price discovery mechanisms;
Clearing and settlement; and
Fundamentally, the technology, operational resilience and cyber security of the trading platform.
We did not get into the issue of whether a crypto asset or platform falls within the remit of securities regulators, because that is jurisdiction specific. Rather, we focused on the trading of crypto assets on CATPs when it was determined that the regulatory authority had jurisdiction.
Through our two FTF workstreams we are looking closely at the role of crypto asset trading platforms and service providers with the aim of improving investor protection and market integrity outcomes.
To conclude, we want to be laser focused on our three objectives of investor protection, market integrity and systemic risk.
Given how difficult and lengthy it is for jurisdictions to develop and implement legislation, and how fast moving and cross-border but also shape-shifting this area is, we are consciously adopting a principles-based approach to ensure that our output is reliable and useful in the long term.
The proud tradition that regulated exchanges have had of having frameworks for mitigating conflicts of interest, governance and transparency and market monitoring- among others- are good examples of bringing about outcomes that instil trust in the investors and in the system. Many actors in the crypto space now recognise the value of well-regulated markets and not surprisingly we are looking at these very same considerations for them.
We will seek to deliver on the Crypto roadmap of our FTF in 2023 and there will be ample opportunity for input from all stakeholders throughout this process, so I encourage you to feed in your expertise and insights to inform our policy formation.
The keynote speech was delivered at the WFE’s Annual Meeting in Malta, Sept 27-29.
The views, thoughts and opinions contained in this Focus article belong solely to the author and do not necessarily reflect the WFE’s policy position on the issue, or the WFE’s views or opinions.