Financial Institutions Risk To Cut Themselves Off From Innovations
This is a speech by Hester M. Peirce, pro-crypto commissionaire at the US Securities and Exchange Commission (SEC), given at the FinTech Panel at the Institute of International Bankers 2021 Annual Washington Conference this week.
Thank you, Briget [Polichene]. Good afternoon and thank you to the Institute of International Bankers for inviting me to speak at your conference. It is a pleasure to be with you virtually today. I must note at the outset that the views I express are my own and do not necessarily represent those of the Securities and Exchange Commission or my fellow Commissioners.
As vaccinations ramp up and the pandemic consequently winds down (we hope), I am beginning to regret not having gotten a pandemic puppy. (Technically, my condo building does not allow them, but the German shepherd sometimes seen roaming the halls leads me to believe there are exceptions.) Pandemic puppies do not always work out, of course. One friend already rehomed hers, and another friend is about to rehome her husband and sons for failing to live up to the agreement they had about who would take care of the new puppy. The pets I did acquire during the pandemic are a bit more manageable—three tiny shrimp that live in a perfectly self-sustaining sealed globe environment. The shrimp swim around and do not seem to know how much they are missing on the outside.
Much like my adorable shrimp, the legacy financial system runs the risk of being sealed in a world of its own, untouched by technological innovation and new approaches to serving clients. The stakes are higher, of course, than they are for the shrimp, who candidly look quite content in their tiny globe.
The risk that financial institutions will cut themselves off from the most innovative parts of the economy arises for a number of reasons that I will touch on briefly today. There is still time, however, to change course and build a financial system that is open to new ideas, new entrants, and new technologies.
First, much of the legacy financial system is treating FinTech as a threat rather than an opportunity.
A few weeks ago, I read a Financial Times article discussing how certain bank lobbyists and executives are pushing for tougher regulation under the new administration to neutralize FinTech startups and to provide the more established financial institutions an edge over competitors – both big and small – from the tech industry. This story is a familiar one. Legacy players in an industry often attempt to use regulation to keep out the competition. We regulators, with our own skepticism of new ways of doing things, are frequent facilitators of these efforts. Our reluctance to accommodate innovators comes from an understandable fear of bad consequences that are difficult to foresee and prevent, legal complexities around fitting new technology into existing regulatory frameworks, and the comfort we have in our repeat dealings with an unchanging set of regulated incumbents. New entrants should not get a free pass on regulation, but regulation should not be used as a way to prevent them from competing.
A second potential threat to the dynamism of the legacy financial industry and its ability to interact with the most innovative parts of the economy is the government’s use of the financial industry to achieve policy ends.
Those policy objectives may change over time. Government may call on financial institutions to fund certain activity or avoid funding other activity. Today, for example, many observers are advocating government policies to require financial institutions to steer capital to projects deemed “green” by the government to help achieve national and international climate commitments. In another example, some governments expressly direct or implicitly nudge financial institutions to avoid facilitating the crypto industry. These centrally made capital allocation decisions override the much more nuanced lending and investing decisions that financial institutions otherwise could make after a full assessment of the circumstances. As a consequence, financial institutions may be prohibited, either implicitly or explicitly, from partnering with the sectors of the economy where they anticipate dynamic growth will happen and from providing capital to companies developing solutions to society’s problems.
A third and related concern is that when the link between government and regulated financial institutions becomes too close, people will avoid dealing with regulated financial institutions.
A recent FinCEN rule proposal related to virtual currencies, for example, highlighted the potential consequences of increasing those Bank Secrecy Act obligations on financial institutions. FinCEN’s digital assets proposal would have required banks to gather information not only about their customers, but about their customers’ counterparties; banks effectively would be monitoring customers’ interactions with third parties with whom they had no relationship and submitting that information to the federal government. Many commenters raised concerns about undue burdens on financial institutions and unwarranted intrusion on customers’ privacy. The proposal’s effect could be to force activity further away from regulated financial institutions. If this were to happen, financial institutions could be cut off from a lot of important economic activity.
A fourth issue that may be driving a wedge between legacy financial institutions and innovation is the lack of regulatory clarity around FinTech.
While regulatory uncertainty matters for everyone, a startup can pick up and move to another jurisdiction with a clear ruleset. The global nature of these markets can complicate efforts to escape any particular jurisdiction’s regulation, but it may be feasible for a small start-up to do so. A legacy financial institution with a large US footprint is less able to avoid US regulators and more cognizant of the high stakes of failing to abide by the rules. So regulatory clarity is of particular importance to financial institutions seeking to participate in FinTech.
As one example, consider the lack of clarity around crypto, which is becoming a larger problem as legacy financial institutions seek to interact with, and give their clients onramps to, this sector.
The SEC has been slow to provide regulatory certainty on a host of crypto-related issues, including when a sale of digital assets will be treated as a securities offering and when digital assets sold in a securities offering can trade without being subject to the securities laws. Both for digital asset securities and for digital assets that are not securities, we need to provide clarity for our registered entities about how they can interact with these assets. We took an important, but limited, step in the right direction last December when the Commission issued temporary relief and request for comment regarding the custody of digital asset securities by broker-dealers. Another area where we can provide an entry point for institutions looking to engage with crypto on their own behalf or that of their clients is through the approval of a bitcoin exchange-traded product (“ETP”), a step that Canada took last month.
The SEC needs a clearer approach to considering applications for crypto ETPs that is more consistent with precedent. On these and other issues, SEC Chairman nominee Gary Gensler will bring deep appreciation for the growth and ingenuity in the digital assets space and the need for regulatory clarity for financial institutions looking to engage with that activity to the job.
The legacy financial industry can join with industry newcomers in identifying areas where regulatory clarity is needed.
A fifth challenge that makes it hard for legacy financial institutions to engage with the innovative outside world is the difficulty of thinking outside of the box.
An industry that is so defined by regulation, as the legacy financial industry is, can be a hostile place for creative thinkers. As institutions, you can make a conscious choice to foster that kind of thinking. As regulators, we can encourage you to do so and not dismiss you out of hand when you come to talk to us about a new way of doing things. That will require a more open attitude on both of our parts. The new way of approaching a problem is not always the best; as with anything else, the benefit-cost balance matters. Let us all, however, keep open minds, even as we ask the tough questions of the out-of-the-box thinkers.
Having highlighted some of the things that could keep traditional financial institutions walled off from the wider world, I will close on a more optimistic note. Legacy firms and regulators should look at new technology and ideas brought forth by FinTech entrants as opportunities to expand the reach and efficiency of the financial industry and effectiveness of its regulators. This more welcoming approach would keep the financial industry-relevant, dynamic, and healthy. For example, as I expect you will hear about in the upcoming panel, the Office of the Comptroller of the Currency, in the past two administrations has looked at ways to integrate innovative tools into the banking system. In October 2016, under the leadership of Thomas Curry, the OCC issued a responsible innovation framework and started the Office of Innovation with Beth Knickerbocker, who is on today’s panel, at its helm.
In January of this year, under the leadership of Brian Brooks, the OCC opened the door for federally chartered banks and thrifts to “participate in independent node verification networks and use stablecoins for payment activities.” An approach that seeks to provide clear paths to compliance with the law through guidance, interpretive, exemptive or no-action relief, and, where necessary, rule modifications is the way to keep the financial industry sphere open.
Regulators can take concrete steps to signal an openness to innovation at their own agencies and at the entities they regulate.
Recent Chairmen of the Commodity Futures Trading Commission—Chris Giancarlo and Heath Tarbert—made a concerted effort to welcome and encourage innovation in their space, including by founding LabCFTC of which another one of today’s panelists—Melissa Netram, is the head. Although the SEC has had an uneven response to FinTech innovation, a recent positive step was the elevation of the FinHub – our office dedicated to FinTech issues – to a stand-alone office in the SEC, with an expanding staff and Val Szczepanik remaining its leader and reporting directly to the Chairman.
Those of you who belong to the legacy financial system likewise can embrace innovation and find ways to bring new voices and new visions into your institutions.
By building pathways to the new world of technology, rather than shutting it off, you will make your institutions’ futures brighter and your client relationships stronger.
Thank you for listening, and I look forward to what promises to be an engaging discussion on the FinTech panel. Enjoy the rest of the conference. Now I’ll hand it over to you, Donna [Daniels].
 Robert Armstrong, Laura Noonan, & Mark Vandevelde, Wall Street Wants Biden to Crimp Tech Rivals, Financial Times (Feb. 10, 2021).
 FinCEN, Requirements for Certain Transactions Involving Convertible Virtual Currency or Digital Assets, 85 FR 83840 (Dec. 23, 2020).
 Comments can be viewed here.
 Custody of Digital Asset Securities by Special Purpose Broker-Dealers, U.S. Sec. & Exch. Comm’n Release No. 34-90788; File No. S7-25-20 (Dec. 23, 2020), 86 Fed. Reg. 11627 (Feb. 26, 2021).
 See Zack Guzman, World’s First Bitcoin ETF Soars Past $500 Million in Assets Under Management, Yahoo Finance (Feb. 25, 2021).
 Press Release, OCC, OCC Issues Responsible Innovation Framework (Oct. 26, 2016).
 Press Release, OCC, Federally Chartered Banks and Thrifts May Participate in Independent Node Verification Networks and Use Stablecoins for Payment Activities (Jan. 4, 2021); see also Press Release, OCC, Federally Chartered Banks and Thrifts May Provide Custody Services For Crypto Assets (July 22, 2020); Press Release, OCC, Federally Chartered Banks and Thrifts May Engage in Certain Stablecoin Activities (Sept. 21, 2020).
 To learn more about LabCFTC, see LabCFTC, US Commodity Futures Trading Comm’n, (last visited Mar. 1, 2021).
 To learn more and engage with FinHub, see FinHub, U.S. Sec. & Exch. Comm’n, (last visited Mar. 1, 2021).