Friday, September 03, 2021

SEC Chair Gensler addresses EU on cryptocurrency and ESG disclosure

By Jay Fishman. J.D.

SEC Chair Gary Gensler, on September 1, 2021, addressed the European Parliament Committee on Economic and Monetary Affairs about predictive data analytics, digital engagement practices, financial stability, crypto assets, and issuer environment, social, and governance (ESG) disclosures. Gensler’s last time appearing before this Committee was in 2012 when he was Commodity Futures Trading Commission chair. Gensler opened his remarks by stressing the need, now more than ever, for cooperation between U.S. and European economic and financial regulatory organizations because: (1) our global markets are inextricably linked, with money flowing between them in microseconds; and (2) new financial technologies continue to change the face of finance for investors and businesses.

One of the European Parliament committee members, Sven Giegold, asked Gensler to offer three recommendations to Europe on how to create more efficient markets. Gensler responded: (1) move toward allowing more competition and transparency in the markets; (2) address conflicts of interest; and (3) level the field among the online trading platforms to facilitate fair competition between all the market makers.

Predictive data analytics, digital engagement practices, and financial stability. Gensler spoke about how predictive data analytics resides behind technologies such as apps we use every day to, for example, buy a product online or watch a television program. Similarly, data analytics, also known as digital engagement practices (DEPs), is behind online trading platforms that collect data on customers to predict their investment habits and encourage them to easily buy certain products that may be too risky for them. This practice then begs the question whether there are potential conflicts of interest between those investors and the platform, and whether the platform is simply making recommendations or illegally providing investment advice in violation of U.S. securities laws.

In light of the escalation of DEPs and online trading platforms, Gensler has asked the Commission to publish a request for public comments on financial industry firms’ use of new and emerging technologies. But he emphasized that monitoring new financial technologies is key to protecting financial stability and resiliency to ensure investor protection. One of the committee members, Billy Kelleher, asked Gensler whether there were any technologies available now that could be put on platforms to oversee online trading to protect investors. Gensler responded that yes, there were technologies available to help monitor money laundering activities, for example. But he pointed out that what’s crucial is having the right software to detect these activities and creating laws and regulations that write provisions permitting the use of the software for regulatory purposes.

Pertaining to financial stability, Markus Ferber, a vice chair on the committee, asked Gensler to comment on a U.S. order flow market ban and sustainable finance. Gensler proclaimed that the order flow issue stems from a few wholesalers buying most of the orders on the dark web rather than going through a legitimate exchange. For instance, the Frankfurt Stock Exchange, which creates a conflict of interest by concentrating this activity among a few market makers, hinders necessary competition.

As for sustainable finance, Gensler stressed the need for more disclosures, specifically requesting issuers who say their funds are "green" to provide qualitative and quantitative underlying disclosures proving those claims. Here, Gensler has directed SEC staff to review current practices and consider recommendations about whether fund managers should disclose the above-mentioned criteria and underlying data they use to market themselves as green.

Issuer disclosures. Committee member Paul Tang asked Gensler to discuss his view on sustainability not just with respect to financials but also about sustaining people and the planet. Gensler responded that the Commission is moving toward mandating issuers to disclose the negative impact of poor sustainability and what issuers are doing to mitigate that impact, which is born from investors calling for this information from the companies they invest in. Gensler stressed that the Commission will increasingly request companies to disclose the information their investors want to know. These disclosures would then become the relevant disclosures in the future.

Gensler remarked that today’s investors increasingly want to understand the climate risks, hired workforces, and cybersecurity risks of the companies whose stock they own or might buy. Regarding climate risk, Gensler asked SEC staff to develop a proposal for climate risk disclosure requirements.

Gensler additionally stated that for issuers committed to improving their financial, social, and environmental sustainability, a chief question for them, and for the Commission’s monitoring, is "how well is the company managing the risk it is taking to improve its sustainability?" Gensler, responding to Billy Kelleher’s question on how we get companies on both sides of the Atlantic to move toward green finance or green bonds and become more carbon neutral, said he is asking the SEC staff to address this issue with recommendations for fund managers in the U.S. and Europe.

Crypto assets. Gensler voiced his concern that the current $2.1 trillion crypto asset class trades on crypto platforms that are either centralized or decentralized (DeFi) and provide direct access to millions of investors—without a financial intermediary or broker to ensure the investment is suitable and fair to them. Therefore, absent clear investor protection obligations on these platforms, the investing public is left vulnerable and increasingly subject to fraudulent scams. Gensler separately mentioned cryptocurrencies such as bitcoin, stablecoins, and Facebook’s Diem that are traded in a market worth $116 billion, and comprise tokens embedded in crypto trading and lending platforms.

Committee member Danuta Hubner asked Gensler what he thought were the crypto issues. Committee member Aurore Lalucu went further to point out how derivatives are regulated as securities, but crypto assets are not. Addressing both of their concerns, Gensler acknowledged that there are regulatory gaps that currently leave crypto assets out of the securities frame (though they are in the purview of the Commodity Futures Trading Commission). He understands the need to regulate this growing cryptocurrency market in the same way derivatives are regulated. But he stressed that closing the gap will require help from the U.S. Congress to promulgate laws mandating SEC regulation over crypto assets. To Laluco’s point, though, Gensler lamented the current lack of protection for this $2.1 trillion asset class and that these highly specialized tokens must be brought within the investor protection regulatory frame, otherwise the public will increasingly be hurt.

Lastly, committee member Eero Heinaluoma asked Gensler about how to solve bitcoin’s large carbon footprint. Gensler remarked that bitcoin does use much electricity when it is mined and, therefore, has a greater carbon footprint. But, how to solve this problem environmentally is outside his scope as SEC chair. However, as SEC chair, he said he could attack the problem indirectly by requiring issuer ESG disclosures. He noted that currently China and Hong Kong are two places that refuse to comply with Sarbanes-Oxley auditing and accounting rules. If they continue not to comply in the next three years, they will be banned from effecting stock transactions in the United States.