The International Organization of Securities Commissions (IOSCO) is a highly influential consortium of global regulators whose members cover 95% of the world’s securities and futures markets across 115 jurisdictions. Given IOSCO’s expansive reach, many consider the association as the global standard setter for rules relating to industry regulatory reform. Recently, IOSCO published their list of 2019 priorities. And while the association cannot create any binding law or regulation, their opinion carries significant weight, and may serve as a guide to how regulation is framed across the globe. In short: When IOSCO talks, the industry listens.
Below we explore IOSCO’s five 2019 priorities as a road map for global regulatory standards:
- Crypto assets
- Artificial intelligence and machine learning
- Passive investing and index providers
- Retail distribution and digitalization
- Market fragmentation
IOSCO acknowledged concerns throughout the industry about the trading, custody and settlement, accounting, valuation, intermediation, and investment fund exposure relating to crypto assets. They want to look at whether the platforms and exchanges where crypto assets trade are properly regulated and how they should be regulated. Another question is whether or not investment funds should be allowed gain exposure to crypto assets and other digital or tokenized assets.
Another area of focus will be distributed ledger technology (DLT). As we’ve discussed before, sometimes new technology can be solutions looking for problems to solve and not the other way around. IOSCO plans to explore use cases and realistic applications for DLT in securities markets.
Without a solid foundation of law and regulation, there is unlikely to be a mass adoption of crypto assets. To help address these questions and remain up to date and globally in sync, IOSCO will set up a portal where members can share information on the topic.
We expect that between the portal, the planned IOSCO consultation paper on crypto asset platforms, and ongoing work at the national regulator level, by the time IOSCO publishes their final report, we may have a clearer view of the global standards applying to this asset class. We also expect that will, in turn, drive its growth with increased institutional allocations to digital and tokenized assets.
Artificial Intelligence and Machine Learning
Artificial intelligence and machine learning, which IOSCO refers to as AIML, are increasingly used across the global asset management industry in front, middle, and back office functions. Regulators themselves are also looking to use these technologies to assist with their own supervision of data and reporting, and the pros and cons of machine-readable rule books. This year, IOSCO plans to review supervision of market intermediaries including asset managers.
Perhaps surprisingly, IOSCO specifically calls out the ethical challenges of AIML as one of the areas they would most like to review. Because AIML programs are only as smart as the people that program them, there is a concern that even machines can learn to be biased. Earlier this year, Luxembourg’s financial regulator outlined its views on AI and now IOSCO is looking to bring together a global view.
Passive Investing and Index Providers
As of 2017, passively invested assets were estimated to represent USD $8 trillion globally – about 20% of all assets under management. However, IOSCO notes many regulators have questions around how passive investing impacts price discovery, allocation of capital, and corporate governance and therefore it’s another area they would like to review. Many asset managers believe these concerns are misguided and look forward to engaging in a debate on this topic.
IOSCO also wants to focus specifically on the role of index providers in asset management. They’ve created a workstream, co-led by the Central Bank of Ireland (CBI) and the US Securities and Exchange Commission (SEC), to look at their specific market structures – of course, Ireland is the home of many index, passive, and exchange traded funds (ETF) in Europe and the US has the biggest market for ETFs and passive funds globally.
And regulators aren’t working in a vacuum. IOSCO and the Financial Stability Board (FSB) are also hosting a joint workshop for industry participants in Washington DC on June 10 on ETFs. They’ve asked the industry to submit academic papers on the topics ahead of the workshop.
Retail Distribution and Digitalization
The use of social media and its place in financial services is in a state of discovery. IOSCO addresses that regulators need to look at how social media is used to promote financial products including investment funds. They plan to address product distribution through new types of financial intermediaries such as robo-advisory services or applications that use artificial intelligence to make customer investment decisions.
This debate is another clear indicator of the global regulatory focus on technology adoption. Some regulators are setting up innovation hubs or “sandboxes” to explore these technologies in a controlled environment. Regulators have their work cut out for them in trying to keep pace with the rapid advancement in innovation happening in the markets.
Since the 2008 financial crisis, market fragmentation remains a cross-border regulation sore spot. While regulators across the world sought the same themes and outcomes, each implemented in a slightly different fashion. These disconnects became more pronounced following mega-regulations in the EU such as MiFID II, EMIR, and AIFMD, which have extra territorial impacts in the US and Asia. IOSCO plans to further assess the implications of these types of regulation and ultimately drive more harmonization of global standards.
IOSCO plans to produce several reports and host events over the coming months which include:
- Consultation report on crypto-asset trading platforms
- Reports to the G-20 on crypto-asset trading platforms and market fragmentation
- Consultation report on systems and controls surrounding the general use of AIML by market intermediaries, including asset managers
- Conference on technology applied to securities market enforcement
- Final Report on consistent measures of leverage in investment funds
- Joint IOSCO/FSB workshop on ETFs
- Roundtable on ethics in AIML
- Report on outsourcing and third-party providers
- Industry roundtable on efficient resiliency
- Sustainable finance report
- Report on the review of IOSCO principles on secondary and other alternative trading venues in the context of market fragmentation
- Report on Suitability requirements for complex financial products
- Consultation paper on recommendations to reform audit-related standards
- Report on the use of behavioral insights in retail investor protection
IOSCO have laid out the map and we
expect the US Securities and Exchange Commission, the European Securities and
Markets Authority, Japan’s Financial Services Agency, among others, to take
steps toward drafting specific regulation. Regardless of the geographic area in
which managers do business, they should focus on these five priority areas as
they are likely coming to a rules and regulation handbook near you!