Practical insights for compliance and ethics professionals and commentary on the intersection of compliance and culture.

Business compliance wish list for cryptocurrencies

One of the hottest topics of 2017 was cryptocurrencies.  The blockchain-derived digital currencies such as Bitcoin, Ethereum, and Ripple were the subject of seemingly endless interest and speculation, in both the media and the markets.  In an excitement reminiscent to many of the dot-com boom, cryptocurrency companies rushed to become issuers via initial coin offerings (ICOs).  Companies that were previously unrelated to blockchain or any product of the technology changed their names or indeed their entire operational purposes to attract market interest.  Investors searched for information and guidance, experimented with the digital currency as both a payment service and a securities holding, and filled social media and dinner table conversation with curiosity and enthusiasm for the disruptive potential cryptocurrencies hold for banking, technology, and the markets.


Round-up on CFTC compliance

This is the first in a series of seven posts about regulatory compliance priorities and enforcement trends.  Today’s post will be about the Commodity Futures Trading Commission (CFTC).  On Thursday December 28, the post will be about the Federal Trade Commission (FTC).  On Thursday January 4, the post will be about the Securities & Exchange Commission (SEC).  On Thursday January 11, the post will be about the Food & Drug Administration (FDA).  On Thursday January 18, the post will be about the U.S. Department of Agriculture (USDA).  On Thursday January 25, the post will be about the Environmental Protection Agency (EPA).  Finally, on Thursday February 1, the post will be about the Federal Communications Commission (FCC).

The Commodity Futures Trading Commission (CFTC) is the US regulator charged with supervisory authority over the futures and option markets. Created in 1974 by the Commodities Futures Trading Act, the CFTC is an independent regulatory agency with the purpose to monitor and protect the markets by prohibiting fraudulent activity or other misconduct and to control against risk from these. In the aftermath of the 2008 global financial crisis and the markets reforms which were implemented during the economic recovery, the CFTC has played a more prominent role in the largely unregulated general derivatives (contracts that derive their value from the performance of an underlying entity, such as an asset, index, or interest rate) and specifically, swaps (derivative contracts where two counterparties exchange cash flows of each other’s financial instruments) markets, to encourage transparency and gradually move toward a more stringent supervisory framework.

The CFTC’s principal mission is to ensure the successful and efficient operations of the futures markets, by keeping competition fair and preventing market abuse or other threats to financial integrity and efficacy. As the futures markets and particularly the derivatives and swaps markets are very international, the CFTC collaborates heavily with international partners and oversees a huge variety of diverse financial institutions and service providers, including exchanges, clearing houses, dealers, and commodity pool operators.

The CFTC has often been seen as the smaller, less powerful or prominent cousin agency to the Securities and Exchange Commission (SEC). However, as the CFTC refines its position within the financial regulatory landscape of the global markets and within the US economy, certain issues and emphases have emerged which distinguish the CFTC.

  • Bitcoin: The CFTC made headlines in November 2017 in paving the way for CME Group and Cboe Global Markets Inc to trade bitcoin futures contracts. Investors and markets professionals all over the world have been waiting for the first regulatory verdicts in the US on how cryptocurrencies markets may be handled. The CFTC has answered this boldly, indicating a permissive attitude toward the trading practices coupled with a strict expectation for robust monitoring and reporting to enable oversight of the famously volatile and active bitcoin trading markets. The CFTC had already declared in 2015 that it would treat bitcoin as a commodity, and the ensuing years have shown US financial regulators struggling to agree on what the cryptocurrency is in terms of financial markets and what risks and protections might be applicable for those wishing to invest or speculate in it. The CFTC has chosen to give the futures trading a yellow light, allowing it to go ahead with a cautious eye toward the intense enforcement and investor protection needs that could arise and obtaining assurances from the exchanges that they will proactively cooperate and share the necessary data with the CFTC: Bitcoin Futures Are Coming and Regulators Are Racing to Catch Up
  • Whistleblowers: While far outpaced by the SEC’s much more well-known and publicized whistleblower program, the CFTC’s program was created at the same time as the SEC’s, by the post-financial crisis Dodd-Frank Act in 2010. In 2017, while still modest in comparison to the SEC, the CFTC is having a banner year for payments of whistleblower rewards. These rewards come from sanctions imposed by the CFTC due to validated whistleblower claims against CFTC-covered organizations. This represents a reporting increase by whistleblowers to the CFTC of 70 percent over 2016, indicating that whistleblowers are recognizing the value of the CFTC as an enforcement body. Therefore this uptrend in handling of whistleblower claims could likely continue: Why Wall Street Should Worry About the CFTC Whistleblower Program
  • Deregulation: The overall trend in the US is toward a preference for fewer or more efficient and targeted regulations. This is a clear reversal especially in the financial markets, where in the years after the global financial crisis the momentum was toward more complex and far-reaching regulatory and supervisory oversight on the economy and market participants. This was a reasonable and necessary response to not only the recession but the numerous and varied financial scandals and frauds that were uncovered and damaged the markets and society’s trust in the financial systems. These risks and root causes of misconduct and abuse are still present, so balancing a regulatory posture which prefers a lighter touch against the need for investor protector and facilitation of transparent and equitable markets is a challenge for all regulatory agencies, including the CFTC: CFTC Enforcement Actions Drop Sharply in 2017
  • MiFID II: The revised Markets in Financial Instruments Directive, or MiFID II, is a wide-sweeping set of EU financial regulatory rules coming into effect in January 2018. These new regulations will have huge impact on the way banks and other financial institutions interact with and make money from the markets. While these are European laws, the globality of the markets means that regulators and market participants all over the world are contending with how to handle these new supervisory guidelines. The Futures Industry Association (FIA) has been actively lobbying the CFTC on behalf of its members, including large banks such as Goldman Sachs and Morgan Stanley, to confirm that the new European requirements will not bring expensive new limitations in the US as well: Wall Street Has New MiFID Migraine, Now in Futures Market
    In continuation of this, one important area in which the CFTC has already been deal-making with the EU in anticipation of the approaching MiFID II application is with derivatives trading venues. The European Commission and the CFTC have agreed upon mutual recognition of trading venues so that those in the United States can benefit from an equivalence decision recognizing them as eligible for compliance with MiFID II requirements by virtue of their satisfaction of CFTC requirements: EU and CFTC Implement Mutual Recognition of Derivatives Trading Venues
  • Blockchain: Apart from regulating bitcoin as a commodity, the CFTC hopes to benefit from the technology that underlies cryptocurrencies, blockchain. The CFTC has voluminous amounts of data from the diverse market platofrms and service providers that it supervises and has historically struggled to parse and study these huge troves of data efficiently and meaningfully. The CFTC hopes that the reporting reliability, transparency, and information security offered by the ledger technology blockchain can enable better review and analysis of this data. Traditional procurement requirements have often dogged attempts to implement more advanced or emerging technologies, but one of the priorities of the CFTC and other US government agencies currently is to leverage innovation such as from financial technology (fintech), regulatory technology (regtech), and supervisory technology (suptech): CFTC Looks to Blockchain to Transform How It Monitors Markets

Be sure to check back next week for a round-up on FTC regulatory compliance.


Round-up on compliance issues with blockchain technology

One of the hottest topics of 2017 is blockchain. This advancing technology is seemingly the possible solution to every business problem conceivable. Companies across all industries – as diverse as banking to food production and seemingly everywhere in between – are experimenting with how they might be able to use blockchain to make their reporting and related processes more reliable or efficient. Many are even contemplating how they may take advantage of blockchain to market software applications to other companies, hoping to enter the profitable fintech (financial technology), regtech (regulatory technology), or suptech (supervisory technology) markets.

But what is blockchain? Most famously, it is the core technological component of the well-known cryptocurrencies, such as Bitcoin or Ethereum. Simply put, blockchain is an open list of records (which comprise the “blocks”) which are securely linked together with cryptography. As the blocks are all linked together and independently identified with references to their linked blocks, the data contained therein is extra safe from individual manipulation or alteration. This is a decentralized computing system which is incredibly useful for recordkeeping and records management activities, especially those where security is especially important such as identity management and medical records.

Due to the broad desirability of a secure and adaptable record maintenance technology, blockchain, which was initially developed only less than a decade ago, has been a disruptive influence in many industries already. Across all business areas, companies are looking to blockchain for possible benefits, all relevant to compliance, to their reporting processes.

  • Transparency for pension fund reporting is one major potential use of blockchain. Following the Madoff scandal and other highly-publicized frauds in the investment management industry, there has been more pressure than ever in expectations for investor protection and reporting disclosures. Many pension funds have balked at public and supervisory demands for increased transparency due to the cost concerns for implementing additional reporting mechanisms in balance with very low profit margins. This reaction does not help to enhance trust between investor clients and this fraud-vulnerable industry. Therefore the decentralized, secure nature of blockchain offers appealing opportunities for filling this confidence vacuum. Blockchain-based platforms can get investors access to their own pension information without fears of data manipulation or increased cost burden on firms: How Blockchain is revolutionizing fraud prone industries
  • On a related note, banks and other financial institutions have borne much of the competitive pressure blockchain has created with the advent of cryptocurrencies – but they also stand to benefit from this, if they can make the best of it. Cryptocurrencies such as Bitcoin are a compelling alternative to the centralized, traditional banking system for customers who desire extra security or anonymity. While cryptocurrencies have been traditionally depicted as a safe haven for illegitimate or even illegal payment activities, the mainstream attention on them has created a broader appeal and audience for them. As a response to the interest their customers have shown in cryptocurrencies, banks have started to delve into the potential for the blockchain technology. Some has invested in tech start-up companies concentrating on various blockchain applications while others have delved more deeply into relationships with fintech partners. At this point banks’ proprietary efforts have mostly been restricted to in-house research on potential use of blockchain, but inevitably competitive momentum will start to drive larger institutions toward developing their own projects in this space. These developments are likely to encourage efficiency, inspire leaner and more innovative business models, and serve the regtech and suptech goals of increasing cooperation with regulatory authorities. Ultimately this could help to modernize and improve the persistently staid and legacy-driven banking industry into a bolder and more transparent business model:  How banks and financial institutions are implementing blockchain technology
  • The advertising industry is newly subject to regulatory scrutiny with the upcoming EU privacy directive, the General Data Protection Regulation (GDPR). This law will apply to any organization doing business in, using technology in, or targeting the citizens of, any EU country, so it has a broad global reach. The GDPR will impose new requirements for handling and controlling private data, including protective and disclosure obligations. Therefore blockchain-based solutions, which can be both secure against manipulation or leakage, and distributed with open access so that users making disclosure requests can see the information directly for themselves. This will help to reduce the burden of this reporting as well as improve cost margins rather than coming up with expensive and vulnerable in-house solutions or outsourcing the reporting to third-parties with their own attendant risks: How Blockchains Can Help the Ad Industry Comply With the GDPR
  • Commercial aviation is another industry looking to blockchain systems to help with its risks – this time in cybersecurity management. Airlines and support companies rely a lot on IT systems to do everything from fly and direct aircraft to book and manage passenger travel. These systems are highly imperfect, as system outages and computer crashes that lead to flight cancellations and stranded passengers show in the news each year. They are also vulnerable to cybersecurity risks where intruders could breach personal data, disrupt airline operations, or corrupt and steal client and aircraft information. Storing and protecting this data within vulnerable or old/legacy systems poses many cybersecurity challenges. The concept of tamper-proof blockchain technology is therefore compelling to the aviation industry for these obvious reasons. Blockchain could help to keep operational data safe and protect companies from cyberattacks. More importantly, pressure to adopt it could drive aviation companies to make the difficult yet very important technological updates and improvements to their systems which will serve safety and regulatory concerns alike: How Blockchain, Cloud Can Reinforce Cybersecurity in Commercial Aviation
  • The pharmaceutical industry has long been vexed by inaccurate and unreliable supply chain tracking. It is especially vulnerable to stolen and counterfeit medication entering the supply chain untracked and finding its way to patients, putting their safety at risk. Tracking medicine with blockchain could change all this. A consortium of pharmaceutical companies, including major firms Genentech and Pfizer, are already collaborating together on a tool called the MediLedger Project, which seeks to manage the pharmaceutical supply chain and track medicines within it to ensure that drug deliveries are recorded accurately and transparently. This would take the current complicated and inefficient network of software management in the supply chain to the next level, securing the supply chain with an integrated and decentralized blockchain system. It could also enable sharing of essential information from companies to partners and customers without exposing sensitive business information, a challenge in the industry so far: Big Pharma Turns to Blockchain to Track Meds

There are many potential advantages from a compliance perspective to blockchain, which has the potential to enhance transparency, protect privacy, address various process-driven risks, and strengthen cybersecurity controls, among other benefits. As the technology advances time will tell how broad the applications of blockchain may be across these diverse industries with similar needs for compliance risk management.


Round-up on compliance issues in food technology

Food technology, concerning the production processes that manufacture, transport, and distribute foods, continues to expand as disruptive technologies in general advance. As any practice that impacts food has obvious heavy impact on consumer safety, food technology practices are coming under increased scrutiny. While public attention was once mostly limited to risk-benefit analysis of various foods and the resulting consumer preferences and perceptions, innovative technologies are driving further questions and desires for customer protections and process disclosures.

  • In response to perennial consumer demand for more flavorful and interesting plant-based products to present vegetarian and vegan friendly burgers, Impossible Foods created their Impossible Burger, with soy leghemoglobin giving it an uncanny resemblance to meat and a regulatory problem with the U.S. Food & Drug Administration; can high-profile investors and customer interest overcome food safety concerns and the burdens of government supervisory challenges:  Impossible Burger’s ‘Secret Sauce’ Highlights Challenges of Food Tech
  • Walmart and a consortium of major food companies including Unilever and Kroger are experimenting with blockchain technology to simplify and automate their supply chains, in hopes of making a very complex set of production processes much more agile and enabling quicker investigations into outbreaks of food-borne illnesses, with improved documentation:  Walmart and 9 Food Giants Team Up on IBM Blockchain Plans
  • Another fascinating, developing use of blockchain in order to make the supply chain safer by combating food counterfeiting and tampering, illegal shipping, and industry malpractice by tracking products through the process and requiring non-anonymous, reliable documentation, all informed by industry “spying” that has uncovered the causes of abuses across food business sectors and country cultures:  Inside the Secret World of Global Food Spies
  • Personalized nutrition plans combine the trend for home genetic testing with consumer desires for at-home meal delivery or menu selection services, but how does freedom of choice and a culture of individual preference with emphasis on customization fit in with the goals of libertarian paternalism that can be espoused by suggesting biometrically-determined food choices:  I sent in my DNA to get a personalized diet plan. What I discovered disturbs me. 
  • Amazon continues to search for growth opportunities in the food business after announcing plans to acquire Whole Foods earlier this summer, this time turning to U.S. military technology to aim to deliver meals that do not need to be refrigerated, but will consumers be enthusiastic or will this solution only create new potential problems in trademarking of kits and safe fulfillment of orders:  Amazon looks to new food technology for home delivery

Blockchain will likely continue to pose the most challenging and exciting advances in the food technology industry. Making the supply chain for food more transparent and accountable, and also simpler to navigate, is a lofty goal which would serve the public interest. Integrity and consumer choice in the food business, with or without the impact of regulatory supervision, should drive innovation going forward.


Round-up on compliance issues in cryptocurrencies

Cryptocurrencies are secure, usually anonymous digital forms of money. Cryptocurrencies use blockchain, a decentralized technology linked to a public record of all transactions in the currency, to make payments and store money without attaching their identities to the cryptocurrency or needing to use a bank. The first and perhaps best known of these is Bitcoin, created almost ten years ago, but there are now as many as 1,000 cryptocurrencies available and more being added every day.

A payment method that was created to be secretive and operate outside of the banking system, and therefore outside of all its regulatory and legal controls as well, carries obvious associations of being used in facilitating illegal activities. Furthermore, as trading of cryptocurrencies evolves as an investment practice, heightened volatility and uncertainty in the still-emerging markets bring greater risks.

  • As speculation of a possible boom in the cryptocurrencies market grows, it is important to take cryptocurrencies seriously as businesses, and take from lessons that established technology companies have demonstrated – consider fundamental controls for the entities involved in cryptocurrencies, as paradoxical as that may seem for forms of money that are designed to exist outside of structured systems, but will certainly be vulnerable to the same organizational and individual abuses and vulnerabilities as those systems:  Cryptocurrency skeptics warn of another dot-com bubble, but remember: That’s where Amazon and Google started
  • The influence of artificial intelligence trading and trading/chat bots in traditional markets has already been disruptive and complicated. Now they’re appearing in cryptocurrency markets as well. These applications offer additional tools and advantages, but bring the possibility of eroding market expertise and increasing risks of errors and anomalies:  The Role of Trading Bots in the Cryptocurrency Market
  • What is the difference between a user, an owner, and a customer? All of these somewhat philosophical questions have very concrete foundations in regulation and law that may apply depending on the role of an individual in a transaction. As the cryptocurrency community continues to develop and inevitably professionalize, legal challenges that move these companies closer to the traditional banking organizations they aimed to make obsolete are certain to materialize:  Bitcoin Cash Soars to $700, Coinbase Customers Threaten to Sue
  • As cryptocurrency companies continue to grow in complexity and reach, competency and credibility will become very important, perhaps even competitive advantage for the prepared and professional cryptocurrency over the uncertain and ad hoc one. With “forks” on trading platforms affecting bitcoin holdings like splits would stocks, traders need consistent policy to set precedent and guidelines. Cryptocurrencies want to be free of negative controls that traditional banking systems impose, but fairness and transparency should not be the baby thrown out with the bathwater. Perhaps bitcoin exchanges, faced with conflicts of judgment among themselves, will be desperately seeking a self-regulatory organization before long:  Bitcoin Exchange Had Too Many Bitcoins
  • Cryptocurrencies may have an identity crisis ahead, as attempts to normalize mainstream uses and pave the way for this digital money to be seen as ordinary money are complicated by its continued connection to illicit activity. This time, it’s invoking the spectre of terrorist financing:  Controversial US Sanctions Bill Calls for Cryptocurrency Research

People will certainly continue to turn to cryptocurrencies both as payment methods and as investment opportunities. As this increases, risks for the organizations providing the technology and access in order to transfer, store, and trade cryptocurrencies will also grow. At the same time, users of cryptocurrencies can be seen as consumers deserving of protections, as well as possibly proxies for clients in the decentralised system, subject to some due diligence and markets governance.

Compliance in the cryptocurrencies markets can be a positive influence to ensure the fairness of markets and protect consumers. How to take an uncontrolled market and regulate it smartly, and appropriately for its spirit, without straying into bad or unnecessary regulation which will be the prevailing argument against the proposition for a culture of compliance, is the challenge ahead.