Featured Product

    BIS Paper on Embedded Supervision of Blockchain-Based Financial Market

    September 16, 2019

    BIS published a working paper that investigates ways to regulate and supervise blockchain-based financial markets. The paper argues that asset tokenization and underlying distributed ledger technology (DLT) open up new ways of supervising financial risks. It makes the case for "embedded supervision"—that is, a framework that allows compliance with regulatory goals to be automatically monitored by reading the ledger of a market, thus reducing the need for firms to actively collect, verify, and deliver data. The paper concludes with a discussion of the legislative and operational requirements that would promote low-cost supervision and a level playing field for small and large firms.

    Embedded supervision is distinct from other forms of suptech or regtech, which aim to use machine learning or artificial intelligence to more efficiently monitor the financial industry. The key principle of embedded supervision is to rely on the trust-creating mechanism of decentralized markets for regulatory purposes too. If DLT-based markets were to develop, this would change the way assets are traded and how they are packaged into complex financial products. In DLT-based markets, data credibility is assured by economic incentives. This paper discusses the following four principles for deployment of embedded supervision:

    • Embedded supervision can only function as part of an overall regulatory framework that is backed up by an effective legal system and supporting institutions.
    • Embedded supervision can be applied to decentralized markets that achieve economic finality.
    • Embedded supervision needs to be designed in the context of economic market consensus, taking into account how the market will react to being automatically supervised.
    • Embedded supervision should promote low-cost compliance and a level playing field for small and large firms.

    In most jurisdictions, the legal setup is such that a single and regulated clearing and settlement provider is required to verify that an irreversible transfer of ownership has occurred. DLT, however, achieves such a transfer via the economic incentives of verifiers rather than by the authority of a central institution. Only if the principles of finality underlying the regulation and supervision of financial markets infrastructures are modified to recognize decentralized exchange could DLT ever gain traction in regulated finance. Along with this, regulators and supervisors would also have to design rules regarding the assignment of responsibility in decentralized markets in the case of illegal activity.

    To implement embedded supervision, regulators would also be required to acquire substantial technological know-how and the willingness to adjust their operational approach to the technology that is being developed by the financial sector. Many supervisors worldwide are open to this possibility and some are already developing the requisite sandboxes. One example is “LBchain,” a blockchain-based sandbox of the Bank of Lithuania, which seeks to embed regulatory infrastructure in a DLT-based market. The benefits might include lower costs for market participants and supervisors, real-time monitoring, deeper insights into the use of internal models, and improved detection of potential window-dressing and other abuses. 

     

    Related Link: Working Paper

     

    Keywords: International, Banking, Securities, Blockchain, Embedded Supervision, Regtech, Suptech, Research, Distributed Ledger Technology, Regulatory Sandbox, BIS

    Related Articles
    News

    EBA Updates List of Validation Rules for Reporting by Banks

    EBA issued a revised list of validation rules with respect to the implementing technical standards on supervisory reporting.

    September 10, 2020 WebPage Regulatory News
    News

    EBA Responds to EC Call for Advice to Strengthen AML/CFT Framework

    EBA published its response to the call for advice of EC on ways to strengthen the EU legal framework on anti-money laundering and countering the financing of terrorism (AML/CFT).

    September 10, 2020 WebPage Regulatory News
    News

    NGFS Advocates Environmental Risk Analysis for Financial Sector

    NGFS published a paper on the overview of environmental risk analysis by financial institutions and an occasional paper on the case studies on environmental risk analysis methodologies.

    September 10, 2020 WebPage Regulatory News
    News

    MAS Issues Guidelines to Promote Senior Management Accountability

    MAS published the guidelines on individual accountability and conduct at financial institutions.

    September 10, 2020 WebPage Regulatory News
    News

    APRA Formalizes Capital Treatment and Reporting of COVID-19 Loans

    APRA published final versions of the prudential standard APS 220 on credit quality and the reporting standard ARS 923.2 on repayment deferrals.

    September 09, 2020 WebPage Regulatory News
    News

    SRB Chair Discusses Path to Harmonized Liquidation Regime for Banks

    SRB published two articles, with one article discussing the framework in place to safeguard financial stability amid crisis and the other article outlining the path to a harmonized and predictable liquidation regime.

    September 09, 2020 WebPage Regulatory News
    News

    FSB Workshop Discusses Preliminary Findings of Too-Big-To-Fail Reforms

    FSB hosted a virtual workshop as part of the consultation process for its evaluation of the too-big-to-fail reforms.

    September 09, 2020 WebPage Regulatory News
    News

    ECB Updates List of Supervised Entities in EU in September 2020

    ECB updated the list of supervised entities in EU, with the number of significant supervised entities being 115.

    September 08, 2020 WebPage Regulatory News
    News

    OSFI Identifies Focus Areas to Strengthen Third-Party Risk Management

    OSFI published the key findings of a study on third-party risk management.

    September 08, 2020 WebPage Regulatory News
    News

    FSB Extends Implementation Timeline for Framework on SFTs

    FSB is extending the implementation timeline, by one year, for the minimum haircut standards for non-centrally cleared securities financing transactions or SFTs.

    September 07, 2020 WebPage Regulatory News
    RESULTS 1 - 10 OF 5796