Tokenized finance is forcing governments to coordinate rules for markets that are still being built

Guest:	John Kearney
Title:	Director of product management at MyComplianceOffice
Summary:	Technology doesn't stop at national borders, and increasingly neither can regulation. A new U.S.-U.K. effort to coordinate oversight of tokenized finance highlights the challenge of creating rules for markets that are still taking shape.

The Federal Drive with Terry Gerton provides expert insights on current events in the federal community. Read more interviews to keep up with daily news and analysis that affect the federal workforce. Reach out to Terry and the Federal Drive producers with feedback and story ideas at FederalDrive@federalnewsnetwork.com.

Interview transcript

Terry Gerton Recently, the U.S. And the United Kingdom unveiled what they’re calling a joint roadmap to coordinate digital asset oversight. Before we jump into the whys and wherefores of that, can I ask you for a very quick primer on those digital financial assets and what people are calling tokenization?

John Kearney Yeah, so tokenization, it’s a whole new frontier. It’s, you know, I’ll give you an example. We’re all very familiar with stocks, say Tesla stock for instance, and you can currently buy that at any brokerage in the U.S. Or in the U.K. for instance. But there’s been a change in that where we’re now taking those stocks, where firms are custodying that one, security that you’re talking about, and then they’re issuing a token for that. And the big benefit of that, of course, is that you can then trade at 24 by 7, right? So it’s a tokenized security and it has a whole load of new capabilities because of that. So that’s really, you know, the premises of tokenization. You can take one asset and you can tokenize it and can then trade it 24 by 7 or internationally.

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Terry Gerton That movement of the financial markets to a 24/7 global, continuous market is really a change. And in this case, why is it so important, or what’s significant about the United States and the U.K. deciding to coordinate their approach to tokenized finance?

John Kearney Well, I mean, what’s really significant about it is that, you know, typically when any new regulations come out, they’re typically in one jurisdiction, right? This is two jurisdictions, probably the two biggest jurisdictions, when it comes to, I would say, the securities markets are coming together and coordinating what they’re going to do before they really put their frameworks in place around how they’re gonna deal with tokenized assets. So that’s alignment that allows them to have standardization across both regimes instead of trying to come together after the fact, which typically is hard to do and typically ends up with a lot more costs coming into play if you’re trying to retrofit something after you’ve put regulation in place and two different jurisdictions.

Terry Gerton Right. Very much going back to that 24/7, anywhere, anytime open market. If the U.S. And the U.K. didn’t coordinate, if they took different approaches to regulating this kind of financial asset, what would be the consequences? Would firms sort of gravitate to whichever market had the most favorable regulations?

John Kearney That’s a very good question. Mostly no, I would say the large firms are already like dually regulated. They can’t really pick one. What you would probably see on the fringes is certain firms going to the less regulated one, but in general, what the end result would probably be that firms would end up having to have two approaches to how to handle regulation and compliance. And there’d be extra costs that would come with that. So for instance, in the industry we’re in, where we’re managing employee conflicts of interest, it would result in firms either trying to manage how they monitor digital assets in the U.K. in one way and doing it slightly differently in the U.S. or what some firms do is they tend to implement the most stringent restrictions and the end result of that of course is that individuals who are innocently then getting hit with that harder restriction just because they happen to be in the jurisdiction that has the less stringent controls in place.

Terry Gerton John Kearney is director of product management at MyComplianceOffice. John, one of the questions that comes to my mind here, especially a challenge for regulators, is that this arena is really evolving and it’s evolving quickly. As you’re trying to set regulation, is there enough certainty for markets at this point or do you risk over-regulating at a time when you’re not quite sure which direction it’s going?

John Kearney Yeah, I mean, I suppose my take on this is, like the answer is yes, no, I guess, right? But my approach to this is really, for regulators to really put in principles rather than putting strong rules in place early on and then potentially add in those rules as more certainty comes into what’s happening. Also, you know, like focusing in on regulating the function or behavior and not really focusing in on the technology ends up with less risks that you’ll have problems later. So in the business we’re in, right, conflicts of interest, you know, a conflict of interest exists whether it’s tokenized security or whether it is a traditional financial asset. You know, the fact that somebody could have insider information and trade on it, you know, that’s still going to exist with tokenized securities as it did with traditional assets. And, you know the approach should be to focus in on the conflict of interest and not what way it was if it happened.

Terry Gerton Are there certain principles or assumptions that you’re seeing made right now in this joint policy statement that might be at risk because of the rate of change of the technology and the products here?

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John Kearney So on this, look, I think the way they’re focusing on this approach here is that they’re very much focusing on, I would say, items that are not that controversial. They’re focused in on what I would say is the boring areas of finance, which are things like settlement. So I think there’s probably not a huge amount of risk that they are going to end up putting something in place that they going to have a problem with, I think, what they’re doing is fairly smart. It’s an area where I think they’ll all potentially be able to agree because it’s something that is kind of the basis of how the financial markets work. So I’m not concerned that we’re going to have a problem.

Terry Gerton We’re talking a little bit about the complexity of international agreements on this sort of framework and rules for financial markets. What is the role of the private sector here? How are the banks and the financial industry coming in and providing input? Are they, into this conversation?

John Kearney Yeah, well, I think in the U.S., you know, we’re seeing a strong debate around the Clarity Act. And, you now, we’ve got lots of different voices coming into play. And I think that’s healthy, to be honest. I know it’s been quite fractious, in some cases, and a lot of people have strong opinions. But I think healthy and. That’s something that has to happen, that people hear their voices. And that is happening in the U.S. with the private sector. And I think what really works there is if you have transparency, you bring in as wide an audience as you possibly can. You bring in the technology providers, the large players, the small, the medium players, you get their input and you make it public so that there’s that transparency in place and everybody can see what inputs are put into the debate and where it ends up.

Terry Gerton Certainly here in the U.S., there’s a lot of tension always between the regulators and the market players themselves and we think that that’s a good thing, but there’s always room for going back and forth. I’m not nearly as familiar with the U.K. markets, but I will assume that that a Characteristic of those markets as well. How, if you’re a regulator, do you stay close enough to industry developments to write these kinds of workable rules without really allowing the industry to effectively write the rules itself?

John Kearney Yeah, so look, I think a lot of it is taking, you know, the regulators taking an approach as to what their objective is out of it, you know from the side of it that I’m coming from, it’s conflicts of interest, it’s the regulator’s role and my opinion is to make sure that there’s transparency and fairness in the market. So their objective should be to make sure that that’s what happens. You know, how it works in practice is what you’re going to get from players so we should be looking to them to actually provide the information on that and then the regulators provide what the objective is and you know going back to what I was saying keeping transparency there, regarding what everybody said what their inputs were and you know keeping everybody honest through that transparency I think is a key to the whole approach.

Terry Gerton This seems like a very foundational document in agreement. If it plays out, what do you expect to see in this tokenization space a couple of years from now? Will we have built on this foundation? Will we changed it completely? What’s going to happen to the market?

John Kearney I think it provides the opportunity for cross border tokenized securities to work right without needing a legal opinion on what happens in the U.K., what happens in the U.S. and just transparency on that and also consistency on that so that people know how it’s going to work. I think that it will be good for the industry from that point of view. And it’ll also provide clarity to the market around things like, you know, what is a security, what’s not a security. You know, that’s been pretty vague for the last few years, not just in the U.S., but also worldwide. And you know for, from the industry that we’re in and the customers that we have. Provides the opportunity to just have one control framework, not two in place to be able to standardize the controls you have in place around conflicts of interest and not have multiple controls which are costly to keep. And I suppose look, the reality is if in five years time when we come back and look at this, if a compliance team is able to just have one control, or remove one control from what they had to have in the past because these two jurisdictions come together, that would be a good thing.

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