A Tighter Leash on Regulation

Donald Trump rode to the White House thanks, in part, to his statements proclaiming that he would usher in an era of deregulation. So far, none of the nominees for cabinet positions and chairs of the major regulatory offices have indicated whether any specific rules will be repealed or watered down, although there are a couple ripe for picking. 

Regulation Systems Compliance and Integrity—better known as Reg SCI—could be one of those casualties, though many believe it’s not a large and prominent enough rule that the new US Securities and Exchange Commission (SEC) would scramble to put it out to pasture in the first 100 days under Trump. However, Reg SCI could be one of the best candidates for potential repeal or refinement because it’s already common sense for exchanges and other SCI entities to maintain their systems (see page 16).

Reg SCI is a burden for exchanges, but regulators need assurances that the markets will remain strong as they become more electronic and outages increasingly prevalent. Yes, it is in the best interests of exchanges and other SCI entities—of which there are more than 40—to maintain the integrity of their systems. But the SEC requires more than that, given that it is accountable to the public and has to demonstrate that it is doing everything in its power to protect the US capital markets.

Right now, Reg SCI really only affects a small number of firms and groups so it’s not something to panic about if it is repealed. It is, after all, not quite as sweeping as, say, Regulation Automated Trading (Reg AT), which is also under threat of repeal. Reg SCI may prove to be an additional headache, but I see it as another way of discouraging complacency by maintaining the technological backbone of the markets.

Spencer Mindlin, an analyst at Aite Group, points out that Reg SCI should at least encourage dialogue on system fragility. “Some people believe Reg SCI creates a contentious environment where the SEC is just waiting to fine those that experience a disruption or don’t fully comply,” Mindlin says. “But I think it can be a way to encourage dialogue between firms on system fragility because it’s not just a function of individual firms’ poor practice, but the whole market keeping vigilance.”

While Reg SCI—and AT—might be on the chopping block, there are certainly other regulations that may still be passed.

Regulatory Sandboxes

While Reg SCI—and AT—might be on the chopping block, there are certainly other regulations that may still be passed, even with a government wary of adding more rules for businesses to follow. Late last year, the Office of the Comptroller of the Currency (OCC) announced that it was investigating the possibility of granting special charters to financial technology firms to act as banks, essentially regulating their business practices. This regulation could mostly affect the retail side of the industry, but if one area of fintech can be regulated, might it be possible that fintech startups in the capital markets could come under government supervision, too?

I spoke to a number of sources about this possibility and whether regulatory sandboxes might be a good idea. Nikhil Lele, partner and principal strategy leader of financial services for consultancy EY, says regulators have a fine line to tread when it comes to innovation.

“Regulators do not want to stifle innovation, but they also have to protect consumers,” Lele says. “In Europe, they’re gaining traction with regulatory sandboxes, but there needs to be a framework surrounding that.”

Lele points out, though, that there might not be that many fintech firms interested in becoming chartered by the OCC. “We don’t know if a large volume of fintech firms will be interested, so maybe if they face capital constrains and want access to liquidity there might be more,” Lele says.

On the capital markets side, many fintech companies are partnering with banks or are joining incubators and accelerators. The possibility of needing special charters might not be something they are especially interested in, even though the largest vendors in the space and the smallest startups are evaluating this new environment and contemplating what exactly it might mean for them.