Thought Leaders are articles that are contributed by respected members of the fintech & digital assets community. They may or may not necessarily reflect the views held by the Securities.io team.
Back and middle-office processes often play second fiddle to the front-office. After all, firms tend to prioritize front end enhancements over and above behind-the-scenes operations.
This has rarely been more apparent than over the last few months. In November, the financial sector watched as FTX, the world’s third-largest cryptocurrency exchange, collapsed into bankruptcy, whilst in March a run on SVB, the bank for innovative and promising technology firms, left the public questioning how such a seemingly stable organization could be undone almost overnight.
Repercussions of poor financial controls
The answer to both failures – and others likes them – comes down to poor financial controls, and the demise of both institutions serves as a stark reminder of the real-world repercussions, beyond reputational difficulties, of a lax approach.
Following the 2008 financial crash, the Dodd-Frank Wall Street reforms imposed tighter financial controls on banks to insure against a domino-style contagion effect afflicting the financial sector in the future. But a roll-back of this legislation in 2018, in a period of deregulation, undermined these safeguards for smaller banks – and ultimately this is what allowed SVB to slip through the net this Spring.
According to the Fed’s report on the collapse, had SVB been subject to the tighter liquidity requirements that existed before, it “may have more proactively managed its capital positions or maintained a different balance sheet composition.” A stark assessment of what could have been.
But in both cases, and across the board, insufficient financial controls had a detrimental impact on business. In the best-case scenario, they act as a distraction to everyday activity – but in the worst cases these examples epitomize the fact that insolvency is a very real risk. And whilst human error is often regarded as an accepted fact of business, in a world in which automation is now widely available, consistent mistakes will be looked on with much less sympathy by regulators in the future.
The regulator’s reaction
In February of this year the UK government released a comprehensive plan for future crypto regulations. However, the “ambitious plans to protect consumers and grow the economy” have yet to be outlined in detail, raising the question as to when this will happen.
In the EU, the new Markets in Crypto-Assets (MiCA) regulation, approved in October 2022, is expected to start coming into force in mid-2024 or early 2025 – but will that be soon enough? In the wake of FTX’s collapse, European Commissioner for Financial Services, Mairead McGuinness, is pushing for global uptake of the new rules as soon as possible.
The outgoing secretary-general of the Financial Stability Board (FSB) told the Financial Times it was formulating plans to introduce global crypto regulation as part of an attempt to stop firms ‘straddling’ borders to avoid oversight.
Financial services firms will need to prepare for the upcoming MiCA regulation which, a European Commission spokesperson said, will “protect consumers, market integrity and financial stability. It will bring crypto-asset exchanges, wallet providers or issuers of crypto-assets under EU supervision.”
In the UK, the Treasury is preparing to introduce a raft of new regulations that aim to regulate the “wild west” of the crypto industry, and whilst these plans were already being hatched in April of 2022, the collapse of FTX has only acted as an accelerator and a prime example of the importance of the need for closer regulatory supervision.
As part of the Financial Services and Markets Bill, the new powers will “enable the FCA to oversee crypto more broadly, including monitoring how companies operate and advertise their products”, the FT explains. “There would be restrictions on selling into the UK market from overseas and…the proposals would set out how crypto companies could be wound down.”
Whilst it’s unlikely that firms will be surprised by new regulations, our recent global payments survey found that 63% of payments executives expect their firm’s regulatory burden to increase over the next two years, there is no doubt that firms will need to ensure they are prepared for this shift.
The lessons learnt
In both the case of SVB and FTX, the laxity illustrated by the respective leadership teams was significant. In FTX’s bankruptcy court filing, the current CEO stated that “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”
The failures act as a cautionary tale for firms that fail to protect customer funds and neglect to segregate them from their own. With regulators now tightening their grip on the crypto industry, it’s crucial that firms take the necessary steps to bolster their process governance and overall operational effectiveness.
The FCA has been focusing heavily on safeguarding rules for payments and e-money firms in recent years, requiring them to segregate and protect customer funds in the event of insolvency. We can likely expect new regulation to bring the crypto industry under the same sort of guidelines to protect customers’ funds as digital currencies become commonplace.
Should similar regulations be applied to the crypto industry, firms will need to build robust financial controls, ensure appropriate process governance, and enhance reporting capabilities to comply.