Skip to main content

Balancing Risk and Innovation A Regulators Perspective

By Joseph King | April 10, 2018

Balancing Risk and Innovation – A Regulator’s Perspective

As financial services firms seek to keep pace with the rapidly evolving fintech landscape, global regulators are working on a variety of initiatives to better understand and manage the risks associated with fintech, while preserving its promise to fundamentally enhance the provision of financial services.

Mark Wetjen, DTCC Managing Director, Head of Global Public Policy, and Brett Redfearn, Director of the Division of Trading and Markets, U.S. Securities and Exchange Commission, discussed the regulatory approach to transformative innovations at the DTCC Fintech Symposium 2018, DTCC’s annual forum dedicated to issues at the intersection of technology and financial services.

READ DTCC’S WHITE PAPER: Fintech and Financial Stability

Proceed with Caution

To help the agency stay on top on fintech trends and risks, the SEC formed a Fintech Working Group in 2016. “The commission embraces technology and is very much trying to strike the right balance between making sure we’re protecting investors and meeting the mission of the Securities and Exchange Commission, while at the same time not stifling innovation in that process,” Redfearn said.

He cited his agency’s work with crypto assets and initial coin offerings (ICOs) as an example of that balancing act.

“This is an area where we have seen a lot of activity,” he said. “We’ve seen exchanges come in and people who are issuing products that look an awful lot like securities or that might be securities. In that space, we have a number of concerns and there’s a number of risks there that we have to watch out for very closely.”

Those risks include fraud, manipulation, theft, cyber security and, perhaps most importantly, the potential for terrorist financing and money laundering.

Redfearn said there is a rush of money going into some of these assets leading to a significant risk of fraud. Spoofing, front running, wash trading, pump and dump, insider trading represent forms of market manipulation that the SEC is monitoring.

Redfearn noted that there’s been discussions around the security of blockchain, adding that the roughly 10% of funds raised through ICOs are either lost or stolen via hacks, translating into about $400 million worth of funds. Cyber security (read DTCC Risk Barometer) is always a concern, according to Redfearn. “You have a world where if bad actors can get in and take crypto assets, they will find ways of doing so, and we have seen that cyber security protocols are not always as tight as we would like them to be.”

Perhaps most importantly, Redfearn explained how cryptocurrency can be used for illicit purposes. “The potential for terrorist financing and money laundering is there because monies are moving undetected and anonymously,” he said. Monitoring cryptocurrency and ICOs is keeping the SEC enforcement division busy, according to Redfearn. “This is an area where you hear the term Wild West often,” he said. “When you have this kind of environment with unstructured activity it requires careful and diligent oversight.”

Artificial Intelligence

On the topic of artificial intelligence, or AI, Wejten asked Redfearn for the SEC Trading Markets’ perspective in terms of the risk that this technology might present as firms begin to use AI more frequently.

Redfearn noted that that while AI holds a great deal of promise, it also presents some challenges, including its use in proprietary trading. Redfearn explained that if you have a proprietary trading system using AI and the general objective is to make money, how long is it going to take that system to say, “hey, if I spoof, I can make more money?”

“How do we know that as it’s learning, it has the rules baked into the thinking so that it stays within the scope of the rules?” Redfearn said. “So, there are concerns about AI and trading systems learning to do things that make money that aren’t necessarily compliant with all of our rules.

“But we are very excited to see how AI can be applied to help us learn more about market activity and do a better job surveilling the markets so that we can continue on our mission to protect investors.”