Last week, Commodity Futures Trading Commission (CFTC) Chairman Christopher Giancarlo and CFTC Chief Economist Bruce Tuckman published a white paper analyzing the state of post-Dodd-Frank swaps regulation, making a number of recommendations for “Swaps Regulation 2.0.” Giancarlo announced the publication in a fireside chat at the International Swaps and Derivatives Association (ISDA) annual conference in Miami, and shared his candid thoughts with those of us in the audience on how the Obama-era CFTC performed in implementing regulatory reform, and what the agency could have done better.
What does this have to do with blockchain? I’m glad you asked. If you flip through the 114 pages of the white paper, skipping past the rather dry sections on central counterparties, swap execution and swap dealer capital (well, it’s not dry to us derivatives lawyers), you will reach a section titled “The Future.” And this is where Giancarlo and Tuckman discuss a rather novel and groundbreaking use of distributed ledger technology (DLT): the “regulator node.”
If you’ve been following blockchain technology, you’ve probably heard of its myriad potential uses and efficiencies, well beyond bitcoin: blockchain may improve supply chain management, put title insurance companies out of business, prevent foodborne illnesses from spreading, speed up financial transactions, and accurately determine the provenance of a piece of art. But, have you heard of a regulator node, also referred to as a “supervisory observer node?” Perhaps not.
A regulator node is exactly what it sounds like: a regulator such as the CFTC would be one of the “nodes” in a given distributed ledger platform, from which it would be able to monitor the transactions taking place within the platform. In the heavily-regulated world of swaps, a regulator node could be a boon to both regulators and regulated entities. By relying on a distributed ledger, market participants could instantly comply with their reporting and recordkeeping requirements. Regulators could efficiently access the data they need to properly understand and regulate the market without any intermediaries, and potentially for a lower cost.
At present, swap market participants must report swap data in real-time and throughout the course of a swap transaction to the CFTC. They do so in a multi-step and costly process by which one of the swap counterparties sends data to a swap repository, which then sends data to the CFTC. This four-part, two-week onboarding process for one of the largest swap data repositories demonstrates just some of the inefficiencies that exist in the current practice of swap reporting. By relying on a blockchain-based reporting and recordkeeping system, swap market participants could potentially eliminate the middleman (swap data repositories) entirely.
Let’s back up for one minute though – is anyone else getting anxious about a federal regulator “sitting in” on its financial transactions and seeing all of the related data? This is a valid concern, and one that is being addressed by the tech world as we speak. Corda, the distributed ledger created by the blockchain consortium R3, is probably the first platform to include supervisory observer nodes. Unlike bitcoin, which is a public, permission-less blockchain (in which all transactions are distributed amongst all nodes), Corda relies on a type of distributed ledger – technically not a blockchain – that only decentralizes data when the members deem that it is necessary. In other words, if the CFTC had a supervisory observer node in a Corda-based platform, its access could be limited to only the data that is required by the CFTC’s reporting and recordkeeping regulations. These access “rules” would be written into the code that dictates how the DLT platform operates.
Here’s what Giancarlo and Tuckman have to say about this:
“The evolution of distributed ledger technology (DLT) could allow the CFTC… to access swaps data automatically and seamlessly… without human intervention or the use of other intermediaries. This functionality could increase the speed with which regulators could access data and increase the reliability of the data, while reducing the costs of making the data available to regulators. …In this way, the Commission would be updated on new or amended swap transactions as they happen, allowing for near-real-time oversight of the swaps markets, including the Commission’s surveillance and risk monitoring responsibilities.”
It’s no accident that Giancarlo has gained the nickname “Cryptodad” by his twitter follows – he is supportive of the technology and ready to put it to use in the regulatory environment. I am eager to see how supervisory observer nodes are adopted in financial markets and what efficiencies may come of it – keep your eye on this!