Hester Peirce on Innovation: A Vision for 'Open' Regulation

Interviewed on a recent Intercontinental Exchange podcast, Hester Peirce of the U.S. Securities and Exchange Commission said that contrary to what people in the cryptocurrency community may believe, she does not spend most of her time working on or thinking about technologies and products that are important to them.

Yet Peirce's receptivity to those developments has set her apart from the regulatory crowd. It earned her the nickname “Crypto Mom” and such popularity that, she says, most of her Twitter followers “are from the crypto space.”

As she was intimating in that interview, there is much more than those potentially disruptive digital currencies on the SEC's agenda. And there is much more to Peirce's view of her job and of the financial world than her point of view on crypto. But from her body of work, particularly statements and speeches since she became an SEC commissioner in January 2018, has emerged a coherent vision of regulation and how it relates to innovation.

To an ongoing fintech conversation among authorities around the world, Peirce brings a grounding in free-market principles. Not all of her international counterparts may be in tune with Trump administration deregulatory attitudes, but in the active encouragement of technological experimentation, they could find common ground with Peirce.

Before taking her seat as a Republican commissioner, the Yale Law School graduate was senior research fellow and director of the Financial Markets Working Group (now Program on Financial Regulation) at the Mercatus Center at George Mason University, where “research focuses on how markets solve problems.” A critic of the legislative response to the 2008 crisis, Peirce wrote in a February 2017 paper, Revisiting Dodd-Frank, that the rationale for financial regulation was misguided, and repealing flawed aspects of the 2010 law would be important but “not enough.”

“A Perspective Shift”

“To be effective, financial regulation also needs a perspective shift - a shift away from the current regulator-centric approach to a regulatory system that is grounded in the superior ability and incentives of market participants to collect, process, and act on information,” the paper said. “An effective regulatory system punishes fraud, holds the institutions and people who take risks responsible for any resulting losses, avoids nonregulatory social objectives, forecloses bailout opportunities, embraces creative destruction, presumptively fosters innovation, and removes roadblocks to competition in the financial system.”

Peirce, who pre-Mercatus was a staff member of the SEC and of the Senate Banking Committee, continues to stress market solutions. As she stated in an August 7 speech in Tokyo: “Government's role, as I see it, is not deciding where or how innovation takes place, but rather laying the groundwork within which healthy capital formation happens spontaneously as people think, produce, and interact with one another. That groundwork consists of a predictable, efficient, evenly applied set of rules within which individuals and the companies they form can enter into the mutually beneficial arrangements that allow capital to be put to productive use.

“Government does not need to be the innovator or guide the hands of the people who have the ideas or the money that generate innovation. In setting and enforcing consistent, clear, and considered rules, the government plays the only role it needs to.”

Cross-Border Challenges

Eight days earlier, visiting the fintech hotbed of Singapore, Peirce spoke at length on the challenges of cross-border regulation and international regulatory cooperation, and how they are playing out with digital assets.

She listed familiar “standard concerns,” such as the need to examine foreign entities operating in a given market, the ability to enforce domestic rules on entities operating abroad, and ensuring investor protections when an institution fails.

The concerns are magnified when it comes to crypto: “First, countries all over the world are still in the early stages of determining how and whether to regulate crypto,” Peirce explained. “Uncertainty about what the rules in any particular country are makes a determination of which country's rules apply even more difficult.

“Second, much of the allure of cryptocurrency is the ability to join people from all across the world in common enterprises, which makes pinning down a domicile for these enterprises difficult.

“Third, the precise nature - currency, commodity, security, derivative - of many of the assets at issue is difficult to determine. Accordingly, academics and regulators are thinking through cross-border questions in the digital asset context.”

Regulatory Patchworks

Here the commissioner was wading into the realities and complexities of what has been called the regulatory patchwork.

The financial supervisory architecture within the U.S. - multiple regulators at the federal level, and many more with a variety of structures and approaches at the state level - was recently criticized in congressional testimony by Jeremy Allaire, CEO of cryptocurrency exchange and blockchain payments company Circle Internet Financial. He pointed to Bermuda as a more hospitable domicile for a digital asset venture. (See New York's DFS: A State Regulator on the World - and Crypto - Stage)

As Allaire implied, numerous non-U.S. jurisdictions are competing to attract financial innovators, often with well-tailored legal frameworks that do not confuse “the precise nature - currency, commodity, security, derivative - of many of the assets,” as Peirce put it. She noted in her Singapore speech that there are forums for education, exchanges of views and, where appropriate, coordination, such as the International Organization of Securities Commissions (IOSCO) for the SEC and its peers, and the Financial Stability Board.

Thirty-eight agencies, including the U.K. Financial Conduct Authority, Monetary Authority of Singapore and U.S. Consumer Financial Protection Bureau, are members of the Global Financial Innovation Network (GFIN) which “seeks to provide a more efficient way for innovative firms to interact with regulators” and “aims to create a new framework for cooperation between financial services regulators on innovation-related topics, sharing different experiences and approaches.”

Friction and Competition

Said Peirce, “Although the existence of many jurisdictions can create regulatory friction, it also can create regulatory competition, which is healthy because it enables us to learn from one another.”

She said that “just as states take different approaches and learn from one another in the U.S., crypto regulation affords international regulators the opportunity to learn from one another,” and added, “The U.S. SEC can look to our counterparts overseas for ideas in untangling some of our most difficult legal and policy questions in this area. Other countries, the citizens of which are already actively trading and using cryptocurrencies, are confronting the same questions we are as they create their own regulatory regimes.

“The resulting regulatory competition will allow us to see what works well and what does not work at all. My fondness for competitive markets extends to regulatory markets.”

ETP Dissent

While Peirce expresses overall support for the SEC's direction under chairman Jay Clayton, she is not entirely pleased with how its innovation program, and specifically with regard to cryptocurrency, has unfolded.

The five-member commission has turned away applications to offer cryptocurrency exchange-traded products (ETPs). In July 2018, Peirce dissented from the majority's rejection of Winklevoss Bitcoin Trust, saying that it set back the cause of institutionalization of crypto markets and reflected “a skeptical view of innovation.”

“If we were to approve the ETP at issue here, investors could choose whether to buy it or avoid it,” Peirce concluded. “The commission's action today deprives investors of this choice. I reject the role of gatekeeper of innovation - a role very different from (and, indeed, inconsistent with) our mission of protecting investors, fostering capital formation, and facilitating fair, orderly, and efficient markets.”

She said in the recent Singapore speech that “I would like to see more focused momentum at the U.S. SEC toward finalizing our regulatory regime for digital assets.” And in the Intercontinental Exchange interview she acknowledged that “the agency is not great with innovation,” owing to a regulatory body's natural risk-aversity.

“I wanted to see a much more open attitude toward innovation, paired with a very clear message to investors that just because we let something trade in our markets doesn't mean we're telling anyone it's a good idea . . . Let's let innovation happen, let's let the market test new products. If the market likes them, they'll succeed. If it doesn't, they won't.”

An Innovation Hub

Unlike some of the trailblazing GFIN members as well as U.S. and state agencies, the SEC does not have a formal office of innovation. In that sense, it has not moved as quickly as its futures market counterpart, the Commodity Futures Trading Commission, with its two-year-old LabCFTC. But the SEC does have the Strategic Hub for Innovation and Financial Technology, or FinHub, launched last October, “which coordinates our approach to digital assets,” Peirce pointed out.

“FinHub staff have met with hundreds of market participants to hear what they are working on and where they need regulatory clarity,” she said. “At the end of May, FinHub held a one-day FinTech Forum to consider issues arising in several key areas of securities law: capital formation, secondary trading and markets, and investment management. The participants explored and provided us with market insight into how initial coin offerings (ICOs) proceed, what issues auditors face in auditing digital assets, how brokers can think about custody, and what investors might consider in deciding to buy digital assets.”

In an example of what she called “co-learning” with international “laboratories of innovation,” Peirce said she was looking to learn “more about Bermuda's custody framework to see if we can draw from it as we think about how our custody rules apply in the crypto context.”

In addition, “motivated in part by the approach taken by Singapore, which does not treat every token offering as a securities offering, I would support the creation of a non-exclusive safe harbor for the offer and sale of certain tokens . . . A non-exclusive safe harbor would permit issuers to offer tokens under an alternative regime with robust requirements. The relief could be time-limited to guard against reliance on the safe harbor by projects without a workable plan to build operational networks. The requirements would be tailored to the needs of purchasers of digital assets in a way that our current regulations are not.”

Peirce said that as crypto market regulation evolves, “continued communication among the world's financial regulators will be important. While I believe a single global regulatory framework would be unwise, regulators can create a healthy environment for this new market to grow by sharing information that will smooth cross-border transactions while stamping out fraud and other harmful activity. We also can continue to learn from one another to fill the gaps in our own regulation and borrow, when appropriate, from frameworks developed and tested in other places.”