Good news, everyone! The World Economic Forum in Davos has come up with a new buzzword: ‘polycrisis’, which describes all “the bad stuff out there that we’re all having to negotiate”. Those were the words of urbane CNBC anchor Steve Sedgewick, whose career hit something of a ‘kerching!’ plateau this week, hosting several WEF panels. The first was on financial innovation.
But we all know of what Sedgewick spoke. War, pandemic, FTX fraud, the crypto winter, stagflation, the energy crisis, recession, climate change, shadow banking, systemic challenges: you name it, the world’s got it in 2023. Plus (insert Sad Face here) problems in the bond market. Boo!
Fortunately, the “global elite” – “I have to justify the vast amount of money you spend coming here”, he told delegates – can exploit the “amazing opportunities” of financial innovation. Then Sedgewick added, “But also the world as well”. (Thanks, Steve!) But the “elephant in the room is that financial innovation is not always for the greater good,” he noted (Sad Face again).
On the “massive panel” of five titans wearing their best Davos faces (slow-mo serious, projecting concern about the poor, while clearly picturing themselves on a throne) were Ronald P O’Hanley, Chairman and CEO of State Street Corporation (“Lovely to see you, sir!”), Dan Schulman, President and CEO of PayPal USA (“Rocking the cowboy boots there, Dan!”), Mark Suzman, CEO of the Bill and Melinda Gates Foundation (tumbleweed), Lynn Martin, President of the New York Stock Exchange (“Nice to see you as well…”), and Mohammed Al-Jadaan, Minister of Finance for Saudi Arabia, who Sedgewick practically bowed in front of – something of a risk in that country if you’re a journalist.
His laser focus on power (“I want to start with His Excellency – if I may, sir?”) made Sedgewick turn to Al-Jadaan first. How would his government sum up the world of financial innovation during the, ahem, polycrisis – not mentioning the price of oil, obviously?
(There is) obviously a legitimate concern and legitimate need, both at the private side – innovators, conventional financial institutions – but also disruptors. And there is also a genuine concern at the regulators’ side. Both have legitimate concerns, and both need to be understood and to work together.
I think the society, businesses, are calling for modernization. There are a lot of benefits from innovation. We have seen tremendous benefits to societies – to inclusiveness, to dealing with the issues, dealing with risks that innovation helps with. But at the same time, regulators need to be cautious. They need to make sure that financial stability is not impacted, that risks are mitigated to the extent possible.
A risk not yet seen
An interesting rundown of priorities as recessionary forces gather, inflation soars, and, in many societies, people are being forced to choose between ‘heat or eat’.
So, if “everyone is in a happy world, in their regulated world”, asked people’s champion Sedgewick, how does that “push into” the unregulated one? (Wait, has something happened in the world of crypto and digital finance?). Al-Jadaan said:
We have seen people losing a lot of money when you are not too careful with the regulatory framework.
Indeed. State Street’s O’Hanley said:
It's not that the regulators have ignored it, but they've more or less said, ‘If it's not going to create systemic risks, then I'm not going to really focus on it at this point.’ And it’s true, it's not creating systemic risks.
I mean, FTX happened and somewhere between two and three trillion dollars of value were destroyed. And yet we're all here, right? We didn't cancel because of FTX. But that doesn't mean that people weren't harmed. The last number I heard, there's a million investors, many core participants that were harmed.
So, part of this is there needs to be a change in the regulatory mindset. Systemic risk and avoiding it is very important, but there's other things out there. Such as how are we going to keep up with this technology?
At this point, Sedgewick seemed to remember that he is a journalist, and part of that role is speaking truth to power. He said:
Everything that I’ve heard worries me intensely. We’ve got Ronald saying, ‘Oh, yeah, we lost two to three trillion, conservatively, on the crypto winter, but we kind of got away of it. We're all here…’
No, it’s trillion. Trillion.
…trillion. But we all kind of got away with it. It’s worrying that so much money can be lost. And yet we're all here because that's okay, it wasn't regulated. We're not so worried about it. But that was a near miss as far as I'm concerned.
[O’Hanley whispering to Schulman]:
Then Al-Jadaan seized his moment too and said:
They are the experts, so these are very, very interesting insights. But I really believe that we still haven't seen the real risk of these innovations. If we are talking about one incident and the loss of a number with twelve zeros, then that’s one incident that shows how risky it is. And it will trigger a lot of thinking among regulators about what needs to be done.
Thankfully, in this incident, the risk was quite widely distributed [among investors globally]. But it is also selfish from the central banks’ point of view, and the traditional institutions’ point of view, to say it's not them who lost the money, it's just the public. It’s the wider public who have not been really protected enough.
At least to me, I think the risk is even wider. […] We need to think about basic things. How are we going to deal with anti-money-laundering, how are we going to deal with terrorism financing illicit activities that use these technologies to circumvent the regulatory framework?
An excellent question there from the Saudi government. The NYSE’s Martin said:
The key there is to have guardrails. I think fair, transparent markets have been the reason why you haven't seen more systemic issues in the current market.
Take 2008, for example, when we had a variety of challenges, systemic issues in financial markets. The advent of central clearing, the credit default swap market. […] Why you don't have those issues today is because, when you talk about the crypto markets, those haven't been adopted by institutions.
Why haven't they been adopted by institutions? Because there aren’t the guardrails that have been telegraphed for other financial instruments: requirements to go on exchange, to be centrally cleared.
Those models have been battle-tested through multiple financial crises – seller meets buyer, there's a central counterparty that guarantees settlement. And if you look at the issues over the last few months, in particular with the FTX bankruptcy – or whatever the case may be [Just say fraud!] – there isn't a central counterparty that's ensuring someone is the buyer to every seller, and the seller to every buyer to guarantee settlement.
So, I think the more traditional financial models – the financial structures, such as the exchanges, the clearing houses – have shown to be, again, beacons of transparency in a challenging, volatile market.
I’ll leave it to readers to look up their favourite examples of money laundering, market rigging, misselling, insider dealing, fraud, and other traditional banking scandals. (Libor and Forex, anyone?) But in fairness to Martin, she was making a technical point.
Then O’Hanley observed:
If you think about the last 15 years since the financial crisis, the overriding theme of regulators has been to reduce, if not eliminate, systemic risk. They'll never say it that way, but that’s really what it's about.
If you think about 2008, there was a vast concentration of risk. And all of the regulations since then have been about how do we distribute that risk? Some of it has been around stress-testing and raising capital requirements. A lot of it is around sets of activities – and innovators that came when it became too expensive for banks, because of capital requirements.
Consider credit in the United States. Back at around the time of the financial crisis, 80% of all mortgages were originated by a bank. Today it's just 20%. Last year and the year before, over half of all credit initiated, originated, in the United States was done through some kind of private credit. So, it's a distribution of risk.
Inclusion or state paternalism?
So, what are the core benefits of those separate, though in some ways linked, innovations such as cryptocurrencies, stablecoins, central bank digital currencies (CBDCs), and their underlying systems, such as blockchain and distributed ledger technology (DLT)?
PayPal’s Schulman had thoughts on at least one of these areas.
It’s important not to conflate cryptocurrencies, CBDCs, stablecoins, and DLT. But I think things like CBDCs and interoperability, these things are linked.
When the West weaponized Swift and sanctions against Russia, I think large parts of the world – whether it be China, India, the Middle East, South America – saw that capability and said to themselves, ‘Do I want to be subjected, possibly, to that happening?’
And so, this interoperability, we need to think that through CBDCs, and stablecoins, it might be an answer. It’s an interesting topic as these neutral, third-party money transmitters became weaponized. I think you're seeing state actors begin to look at CBDCs and begin to think, maybe that is a way of lessening the primacy of the US Dollar as the global currency reserve.
So, I think there's a lot to be thought about from a geopolitical perspective, a technology perspective, and an inclusivity perspective as we talk about these.
And from a PayPal perspective too, surely.
When we talk about CBDCs and similar, even government-sponsored currencies, I think one also needs to think about privacy. You cannot have your cake and eat it. The minute you go with a CBDC, the minute you go with government-sponsored currencies, you need to realize that part of the compromise is on privacy, because it will provide a lot of data to whoever is holding the data registry.
And you could go even more extreme and think about what can be done with a CBDC. For me, I think CBDCs, at least for developing nations, will be a fantastic tool to provide, for example, a social safety net.
So, if I wanted to provide my citizens with certain support, I would actually flag that CBDC to say you can only [use it to] buy milk, rice, oil, but you cannot go and buy a new iPhone.
Wow. So, what does the Gates Foundation make of all this, as a non-profit fighting for a fairer and more equitable distribution of wealth and opportunity? CEO Suzman said:
Attributed digital currencies, which may be central bank issued or other tools, we believe can be an incredibly powerful lubricant for the economy, one that actually brings in inclusion for the poor.
It both potentially significantly reduces corruption, because you can actually track one of the largest sets of payments, government payments, that go to support poor people. Whether it might be direct grant payments – the kinds of things we saw during COVID for support. Or whether it might be subsidized forms of public private credit that are there to try and generate entrepreneur systems.
But isn’t this just a form of technology-enabled paternalism or surveillance, in effect? A restatement of Al-Jadaan’s ‘you can buy milk, rice, and oil, but not an iPhone’?
Remember, the poor pay a much higher margin than the rich do for any financial product they access, whether it's a remittance, whether it's a loan, whether it's a basic transaction, and that's just a fundamental injustice.
And with digital currency tools, you can create the framework of that interoperability that you do want. In this case, it's the best of the intermingling of the technology firms, including some of the mobile phone services providers, with the banking infrastructure.
I think there is a very positive framework that can be adequately regulated. Because these people need that security more. That potential is very real. It's the biggest platform we have that can actually help re-energize the kind of big global growth and poverty reduction we need.
Meanwhile, Martin talked up the need to separate core technology from some of the more damaging innovations it supports:
The underlying technology that underpins the crypto market is good. If you look at DLT, if you look at the way you can employ some of the technology to make things like settlement, equity settlement, equity issuance more efficient, it's a great thing. It's absolutely something we should leverage as an institution. But for whatever reason, the blockchains get a little bit of a bad name.
A fascinating, in places jaw-dropping discussion. But one that sidestepped a critical point. For all its failings – and there have been many, from dangerous currency speculation to technology-enabled Ponzi schemes and fraud – at the core of digital finance is marginalized people’s desire to help themselves, not to be told what they can and cannot do or buy by remote bankers and innovators. Some of whom have become staggeringly wealthy while millions can’t afford to eat.