Heath Tarbert, Chairman of the Commodities Futures Trading Commission (CFTC) believes principles-based regulation should be applied to the fintech, blockchain and digital asset sectors. Writing in the Harvard Business Law Review (HBLR), he compared principles-based regulation to more prescriptive rule-based regulation, weighing the pros, cons and contexts.
Talking to CNBC last November, Tarbert spoke about digital assets: “I want the United States to lead, particularly in the blockchain technology that underlies digital assets.” However, he noted that when it came to Facebook’s Libra, the U.S. was neither the first nor second choice for its domicile.
He continued: “I think whoever ends up leading in this technology will end up writing the rules of the road for the rest of the world. My emphasis is on making sure that the United States is a leader.”
In the Harvard paper, Tarbert argued for a principles-based regulatory approach to digital assets to allow for a period of development and observation. However, he has his eyes wide open, highlighting the risks as retail participation increases.
“Detailed sales practice and disclosure obligation rules may be appropriate for these markets, as well as rules regarding the custodying of customer assets,” the paper states.
To date, many digital assets have been pretty weak on disclosure. Foundations are happy to issue press releases about deals but less open with financial disclosure. Our observation at Ledger Insights is that there’s a risk that some may incentivize executives at large organizations with tokens. Or owning certain digital assets might sway decision making about which technology to use. Skin in the game can cause conflicts where individuals own the assets.
Principles v Rule-based regulation
Much of the paper explores the different approaches to regulation and observes that most frameworks are a hybrid of principles versus rules.
Giving the example of speed limits, Tarbert states: “A rule might say, ‘Do not drive faster than 55 mph.’ A principle might say, ‘Drive carefully under the circumstances’ or ‘Drive prudently.'”
Tarbert noted that in the 2000s a principles approach became synonymous with light-touch regulation. “In my view, so-called light-touch regulation is not really regulation at all; rather, it serves more of a monitoring function,” he said.
Looking at the advantages of each approach, principles encourage simplicity and reduce the need for volumes of regulation. Complexity can impede compliance and favors large firms that can afford a compliance team. Hence a principles-based approach encourages innovation.
Principes enable greater flexibility, whereas specific rules can become ossified. With rules, it’s also tough to get it right. It’s easy to ban conduct unintentionally and permit behavior that should be outlawed. It encourages some to look for loopholes and a checklist approach.
A principles approach can also result in the involvement of more senior personnel in decisions, as opposed to compliance departments. Additionally, regulators tend to have more dialogue with firms and it facilitates international cooperation.
On the flipside, rules provide greater clarity, which can be good for less sophisticated market participants, and reduces the risk of regulatory decisions being made retrospectively. Rules provide a safe harbor against private litigation and help to blur the distinction between minimum standards and best practice.
Right now companies in both the cryptocurrency and enterprise blockchain sectors rank regulatory compliance as the number one hurdle. Whether its Santander issuing a bond on a public blockchain or HQLAX and its digital collateral registry, both spent more time with lawyers saying the technical implementation as the easy part.
