Keynote Remarks of Commissioner Brian Quintenz before the Symphony Innovate 2017 Conference
October 4, 2017
Thank you Diane for that very kind introduction and thank you for your generous welcome. A big thank you to Symphony for hosting such an amazing conference. This is only your second conference, yet, in terms of your experience hosting conferences versus mine of giving speeches, you have me beat, so hopefully this isn’t the point where everything goes off the rails. But I appreciate the opportunity to speak with you today about the ways in which the government can advance and promote innovation in financial marketplaces. Before I begin, let me quickly say that the views contained in this speech are my own and do not represent the views of the Commission. Somewhere an ethics attorney is smiling.
We as a people assimilate to technological innovation at a remarkable pace. It wasn’t that long ago that we survived without posting, FaceTiming, or swiping. Technological innovation has the power to give us more choices, more information, more speed, or more time—often simultaneously. Some important technological change occurs gradually. At other times, technology drives significant spikes in productivity…dramatically altering how we transact and engage in economic activity. Financial markets and services may now be experiencing such a shift, finally benefitting from advancements made possible by the Internet and the exponential growth of computing power.
New types of companies are now expanding into financial services, motivated by confidence in proprietary technological advancements. For instance, Tesla’s confidence in its cars’ self-driving and safety features has propelled them to offer lifetime auto insurance to their car buyers in Asia, the cost of which is included in the purchase price of the vehicle.1
Amazon is leveraging its visibility into micro-sales growth rates to strategically extend credit to fast growing small businesses.2 Imagine if Amazon had access to low cost deposits via a bank charter and put branch infrastructure in its brick and mortar Whole Foods stores. By combining low cost deposits with its real time sales and customer satisfaction visibility to make credit quality decisions, Amazon might become THE dominant retailing-merchant lender overnight.
A recent World Economic Forum report noted that at least one systemically important bank has turned to an artificial intelligence firm to assist its stress testing, streamlining the task from nine months to three and from requiring hundreds of employees to using less than 100 specialists.3
Whether looking at the power of data analytics and machine learning, algorithmic trading, movement of data to the cloud, or DLT, we see a world that moves faster, at lower cost, more transparently, and with greater efficiency. These dynamics can provide tremendous benefit to our society, foster broader and deeper markets, and permit improved risk-sharing that drives increased real-world economic activity.
New technologies and innovations can also be accompanied by new risks. While speed in trading can have significant benefits, it can also trigger events that undermine market stability. The increased movement and importance of data demands heightened and careful attention to data integrity and cyber-security.
Emerging technologies drive the need for new perspectives on how to foster the good, deter and prevent the bad, and ensure a level playing field for all market participants.
So how do we best accomplish this critical mission? I would suggest there are two key elements: having regulatory leadership which prioritizes a consistent and engaging dialogue with the fintech community, and secondly, fully utilizing existing avenues and creating new structures to empower those conversations.
On the first element, leadership, CFTC Chairman Chris Giancarlo has consistently advocated for modernizing our agency’s approach to technology by creating a 21st Century regulator and for presenting a coherent message to the fintech community that beneficial innovation will be encouraged and is viewed as vital to the health and vibrancy of our markets.
To the second element, Chairman Giancarlo has created a new initiative called LabCFTC as a pathway through which we can develop and foster that dialogue. LabCFTC serves as the Commission's outreach effort to understand and facilitate market-enhancing fintech innovation while also promoting forward-looking policy for the benefit of our markets and the American public.
LabCFTC was launched in May of this year, and is led by Daniel Gorfine, our Chief Innovation Officer. LabCFTC is designed to make the CFTC more accessible to fintech innovators, and serves as a platform to inform the Commission's understanding of emerging technologies and how they square with current rules. Additionally, LabCFTC is an information source for the Commission and the CFTC staff on market-enhancing innovation that may influence policy development. LabCFTC will enable the CFTC to be proactive as fintech applications continue to develop, and to help identify related regulatory opportunities, challenges, and risks.
The LabCFTC initiative will accomplish its mission through three primary work streams: (1) thoughtful engagement with innovators; (2) understanding and considering how new technologies can help make the Commission more effective and efficient; and (3) the development of LabCFTC as a vehicle for collaboration with external organizations, including domestic and international regulators.
The first prong of our effort is called ‘GuidePoint,’ and it serves as the point of contact for fintech innovators to engage with the CFTC, learn about the CFTC’s regulatory framework, and obtain feedback and information on the implementation of fintech innovations. The LabCFTC team hosts pre-announced ‘office hours’ with innovators in the CFTC’s Manhattan offices at 140 Broadway, the most recent of which occurred two weeks ago, with additional office hours announced just yesterday for Chicago on Friday October 20th. Over the next few months, we will host office hours in Silicon Valley and in other U.S. tech centers.
We are encouraging ALL innovators to engage with us, whether they be a garage-based startup, a regulated financial institution, or a technology company. Engagement is not intended to establish a model of pre-approval for new ideas, but rather to permit two-way dialogue around how certain innovations can improve our markets, help allocate capital more efficiently, or provide other benefits to the American public.
You know, in a recent survey of market participants, the Quote Unquote “Market Support Services” category of fintech solutions was the second largest category by number of firms, behind only the Payments, Clearing, and Settlement Services category.4 This brings up an opportunity for those of us interested in furthering a Fintech-Regulator dialogue. While many other regulatory jurisdictions are promoting their fintech sandboxes, most are engaging only the firms that are on a path toward eventual registration. Sure, providing less-burdensome regulatory on-ramps is important, and it is one aspect of LabCFTC’s mission. However, engaging with the third party service providers who might always exist outside of our regulatory framework may give these innovators ideas as to how to better shape or transform their products to meet their clients’ needs and satisfy their clients’ regulatory burdens. It also allows us, the regulator, an opportunity to better understand where our markets are heading and explore how we can begin to craft forward-looking policy frameworks that account for market-enhancing change.
If you are interested in keeping up to date with these office hour announcements or want to schedule a meeting with us during the announced times, please email [email protected].
The second prong of the LabCFTC effort, called ‘CFTC 2.0,’ is an extension of GuidePoint focused on the understanding, testing, and adoption of new technologies that can make the CFTC a more effective and efficient regulator. The goal here is to fully wrap our heads around new technologies, test them, and fully appreciate their potential.
Interestingly, a legal barrier has actually prevented us as a federal agency from effectively “demo-ing” technology and having the same authorities and flexibilities as some of our foreign counterparts to work on ‘proof of concept’ projects with innovators. Ethics rules preclude the agency from accepting “anything of value” without providing fair compensation. However, providing compensation would trigger an arduous and tightly framed procurement process, making sandbox demos enormously burdensome and time consuming.5 Fortunately, Congressman Patrick McHenry (R-NC), the Chairman of the House Innovation Caucus, is providing leadership on the issue of federal government interaction with fintech innovation.6 I look forward to working with him and his staff to help correct this specific issue as he looks to introduce legislation. Until a legislative fix occurs, we remain committed to using the tools that we do have at our disposal, including prize competitions or “hackathons,” to foster and incorporate technologies that can help us keep pace with digital markets.
Finally, the third prong of LabCFTC is to act as a coordination hub with other U.S. and international regulatory authorities. At the international level, we believe there is an opportunity to formalize our collaboration through agreements that facilitate high-level information-sharing, especially on emerging RegTech trends. While international jurisdictions have an incentive to compete for fintech innovators, we should also have an incentive to collaborate on various RegTech ideas and solutions. Global financial stability is enhanced when regulators are equipped with leading-edge technology, and we can all benefit by sharing insights and best practices.
TECHNOLOGY ADVISORY COMMITTEE
In addition to the new avenue of LabCFTC, the Commission can further engage with the fintech community and enhance our innovator-focused dialogue through an existing avenue - the Commission’s Technology Advisory Committee, or the TAC. I am very pleased to have been named the sponsor of this Committee, which is composed of outside professionals and structured to provide the CFTC with formal guidance on existing or emerging technological advances and associated potential regulatory issues.
Autonomous, Algorithmic Trading
One such issue is the modern trading environment. Think about regulating an autonomous, algorithmic market from an enforcement perspective for a moment. The idea of “Intent,” or mens rea in Latin legal terminology, is a key component of an investment fraud or market manipulation charge. But intent is an especially challenging concept when dealing with automatic, algorithmic trading. How do we think about intent when looking at computer code? As market participants further progress into Artificial Intelligence and machine learning, does the legal concept of intent have to change? What about the compliance issue of Supervision? How does a firm prove a “diligent review” over AI trading strategies? These are questions the agency has already been tasked with answering, about which we should continue to think, and on which we hope to engage you.
The discussion of algorithmic trading leads me to address what is, in my opinion, one of the most serious missed opportunities of the agency’s prior pending rulemakings—Regulation Automated Trading, or “Reg AT.” The agency’s process on this rule development was so confused, the regulation is titled Regulation Automated Trading but the entities it would require to register were classified as Algorithmic Trading Persons. Those are not interchangeable terms. Not all algorithmic trading strategies have completely automated functionality. This is more than semantics—it demonstrates a top-level disregard for the enormity of the trading method spectrum and, therefore, a disregard for the proper assessment of market risk posed throughout that broad spectrum. Evidence of that disregard permeates the original proposal.
In its originally-conceived form, an Algorithmic Trading Person, or an AT person, was defined so broadly that anyone using something as simple as a trailing stop — or anything with a similar, limited amount of automated functionality7 — would have been captured, forced to register with the Commission, and subject to the same rules and requirements as the most sophisticated High Frequency Trading firms. That is poorly-crafted and flawed public policy.
While the agency’s lame-duck re-proposal of Reg AT in December of last year attempted to address the breadth of the AT person definition by including a trading frequency threshold, it was still a registration scheme. I don’t believe the right answer is to regulate and dictate all algorithmic trading activity. The right answer is to understand and address automated trading risk. The agency needs to reset its posture on this issue, and we need to have a serious discussion about the finite circumstances under which automated, algorithmic activity can create large-scale market disruptions. Only then should we examine what, if any, additional regulatory solutions are necessary to address those concrete and specific instances. I look forward to exploring this issue within the TAC.
Lastly, let me use this opportunity to say that the prior administration’s massively over-reaching and highly concerning “source code repository” proposal is D-E-A-D.
Bitcoin and Digital Ledger Technology
A second topic for the TAC, and one that probably none of you have heard of, is called Bitcoin and the Distributed Ledger Technology closely associated with it.
Before I address the primary regulatory issues, I’d like to provide some of my personal thoughts on the recent press around Bitcoin, which I think is terribly misguided. Certainly, we can all debate the value of Bitcoin - whether it is overvalued, undervalued, or a “fraud,” but that price-based conversation misses Bitcoin’s broader technological and innovation achievements entirely. One of the most fascinating aspects of Bitcoin is not that it’s a virtual currency. It’s that it’s an ecosystem. It’s an ecosystem where all the discrepant parts interact and are necessary to nurture and support a created, digitized, and sovereign-less currency. The encrypted ledger, the distributed nature of the verification process, and the incentive of mining to conduct that verification all work in harmony to provide a record of ownership and transfer for something that exists only in ether. Which leads me to note that if one removes DLT from that ecosystem, permissions it, and takes away the verification incentives, what’s left really isn’t DLT, and it’s not as revolutionary. That is not to say that thinking about ledgers in a more distributed, if permissioned, way isn’t innovative. But it is important for us as regulators to be aware of the diversity of these potential ledger ecosystems, from the narrow and mostly private to the very broad and incentivized, so we can appropriately estimate risk and regulation.
Speaking of regulation and bitcoin, the CFTC, through successive enforcement cases8 before I arrived, determined that Bitcoin is a commodity and that trading in Bitcoin represents trading in a commodity interest. As a result, if a platform sells bitcoins to retail persons and finances those transactions, it would be required to register with the CFTC as a Futures Commission Merchant.9 However, an important exception to that registration requirement is if “actual delivery” has occurred, and, to be specific, if it has occurred within 28days.10 Let me say that again: if a platform offers a transaction in Bitcoins which is margined, leveraged, or financed, it needs to Quote Unquote “deliver” that Bitcoin to the buyer within 28 days or it must register as an FCM.
Obviously, “actual delivery” in this context becomes an enormously important term. Would someone here like to tell me how to define the “actual delivery” of a virtual commodity? The CFTC is working very hard to provide a suitable response to that question. Once a proposal comes forward, I expect to request the TAC’s input and feedback as we work to provide regulatory consistency with other commodities….as well as regulatory certainty within which a more constructive trading environment may develop.
A final topic for this morning, but certainly not the last in terms of what I hope will be the many focuses of TAC, is cybersecurity. Cyberspace is the 21st century battlefield for those wanting to harm our country and threaten our way of life. As recent public and private sector attacks make clear, no private sector company or government entity should feel immune from this threat.
While prevention is of the highest importance, these recent breaches have shown we also need to focus on mitigation and recovery. We owe it to our registrants, who send us highly sensitive and proprietary information, to make a realistic assessment of our vulnerabilities and ensure that all data submitted is rationalized and completely necessary. At the end of the life cycle, what are the proper standards for data disposal and are we using them? I hope the TAC can help answer these questions or validate our existing practices.
From the mandatory and thorough cybersecurity training I’ve completed since joining the agency, it is clear that one of our primary defenses against attack isn’t technology, it is our people. But, people themselves can also be one of our greatest vulnerabilities. While it is tempting to fight a technological threat with technology, we cannot lose sight of the fact that sometimes cyber threats are a people problem as much as a technology problem. While I believe our agency’s employee cyber-training is robust, I would like to work with the private sector through the TAC to ensure we are training our people according to the highest standards, on most recent threats, and at the appropriate intervals.
From a fintech perspective, many start-ups lack physical infrastructure and are cloud-dependent. We should allow and encourage this while also exploring how the physical location density of back-up facilities and the concentration of cloud-based data providers raise or alleviate questions or around cloud resiliency.11
Innovation won’t wait for us. The world is changing, and we as regulators must now change. A 21st century economy demands 21st century regulation. As my remarks today hopefully underscore, we believe we have the vision, mindset, and plan to keep pace and ensure the continued leadership of American capital markets.
1 “Tesla is so sure its cars are safe that it now offers insurance for life”. Mashable, February 23, 2017, http://mashable.com/2017/02/23/elon-musk-tesla-lifetime-insurance/#MQjXljSkpkqQ
2 “Amazon has lent over $3 billion to merchants since 2011”. TechSpot https://www.techspot.com/news/69665-amazon-has-lent-over-3-billion-merchants-since.html
3 World Economic Forum, “Beyond Fintech: A Pragmatic Assessment of Disruptive Potential in Financial Services,” August 22, 2017; http://www3.weforum.org/docs/Beyond_Fintech_-_A_Pragmatic_Assessment_of_Disruptive_Potential_in_Financial_Services.pdf
5 Rubin, Gabriel, “CFTC Looks to Blockchain to Transform How it Monitors Markets,” September 25, 2017, at: https://www.wsj.com/articles/cftc-looks-to-blockchain-to-transform-how-it-monitors-markets-1506304800?mg=prod/accounts-wsj
6 “McHenry Introduces Financial Services Innovation Act of 2016,” September 22, 2016, at: https://mchenry.house.gov/news/documentsingle.aspx?DocumentID=398355
7 See comment letter from Todd Kemp, National Grain and Feed Association, regarding Proposed Reg AT, March 16, 2016, describing commonly used algorithmic hedging tools in the agricultural sector.
8 See In re Coinflip, Inc., CTFC No. 15-29, 2015 WL 5535736, (Sept. 17, 2015).; In re TeraExchange LLC, CFTC No. 15-33, 2015 WL 5658082 (Sept. 24, 2015); In re BFXNA Inc., CFTC No. 16-19, 2016 WL 3137612,(June 2, 2016).
9 See 7 U.S.C. § 6d.
10 See Retail Commodity Transactions Under Commodity Exchange Act, 78 Fed. Reg. 52,426-27 (Aug. 23,
11 “The Leading Could Providers Continue to Run Away with the Market,” Synergy Research Group report, July 27, 2017, at: https://www.srgresearch.com/articles/leading-cloud-providers-continue-run-away-market
Last Updated: October 5, 2017