last decade It has experienced extraordinary growth in technological innovation. In terms of financial services, innovation has been driven by financial technology or financial technology and has been particularly stimulated by blockchain technology and distributed ledger technology more broadly. Innovations include: new ways to raise funding, such as initial coin offerings; New means of exchange for payment purposes, such as cryptocurrencies; New asset classes, such as crypto assets (which include cryptocurrencies and tokens more broadly); and new forms of business, such as decentralized autonomous organizations.
Technological innovation has presented challenges for both regulators and regulatory design, with this column previously discussing technological innovation and regulatory challenges (see Chinese Business Law JournalVolume 7, Issue 8: FinTech and Smart Contracts; Chinese Business Law JournalVolume 8, Issue 9: Cryptocurrencies; Chinese Business Law JournalVolume 12, Issue 9: Decentralized Autonomous Organizations; Chinese Business Law JournalVolume 13, Issue 4: Regulation of Cryptoassets).
This column first discusses the principle of technology neutrality. For many years, this has been the guiding principle of regulation, especially in the financial services sector. The column then identifies how regulation responds to technological innovation. Finally, the column discusses whether the principle of technology neutrality should apply.
What is technology neutrality?
According to the principle of technology neutrality, laws and regulations should not favor or discriminate against any technology. Three main reasons have been presented to justify the adoption of this principle.
First, it is important to make regulation future-proof so that it does not become outdated and unable to respond to technological innovation. Second, regulation should be impartial and should not discriminate against companies on the basis of the technology they choose to use. Third, regardless of the technology used, companies involving the same activities and risks should be subject to the same rules. This is often referred to as “functional equivalence”; That is, an activity should be organized by reference to its function rather than by reference to the way the activity is carried out or the label given to the activity.
A few years ago, the Chief Executive of the Hong Kong Monetary Authority (HKMA) referred to technology neutrality and risk-based regulation as follows:
The Hong Kong Monetary Authority takes a risk-based and technology-neutral approach to its supervision. This means that when developing and implementing the regulatory framework and requirements, we will rely (supervise) only on the essential characteristics of financial activities or transactions and the risks arising from them. We will not provide unnecessary exemptions or requirements simply for the use of some new technological application. This would help ensure an environment conducive to innovation and fair competition for market participants, while end users would not have to bear unnecessary or unwarranted risks.
A logical corollary of this principle is that law and regulation should not be technology-specific, except when necessary. In 2014, the Murray Inquiry, which examined Australia’s financial system, defined the concept of technology neutrality as follows:
In general, regulation should be principles-based and practical in design, focusing on outcomes rather than describing the way in which they should be achieved. However,… technology-specific regulation may still be needed and is useful in cases where the adoption of a common technology standard improves overall system efficiency. In these cases, forward-looking review mechanisms should be established to ensure that technology-specific regulation does not hinder innovation.
Focusing on outcomes rather than on process has at least two benefits. First, companies have more flexibility. As long as they achieve the right results, they can determine the most effective way to comply with regulation. Second, companies can take an innovative approach in determining how to comply with regulations and, ultimately, reduce the cost to consumers.
Importantly, the Murray Inquiry recognized that technology-specific regulation may be appropriate in certain circumstances, but care must be taken to ensure that such regulation does not hinder innovation.
How should regulation respond to technological innovation?
There are three options for organization. The first option is to adapt existing regulations, which often involves expanding legislation to accommodate technological innovation. Examples include amendments to legislation governing companies to enable them to communicate with shareholders electronically in addition to or instead of paper communications.
Another example arises in the context of payment systems, where the definition of “payment system” has been expanded to include various forms of payment, including cryptocurrencies, and not just money (or fiat currency). In Australia, for example, the term “payment system” is currently defined in relevant legislation as “a money transfer system that facilitates the circulation of money, and includes any tools and procedures related to the system.” The government proposes to amend the definition so that it refers to “enabling or facilitating payment or transfer of value” and is not limited to the circulation of money. In explaining the proposal, the government explained that the approach is:
It is technology-neutral and does not explicitly identify which operators and service providers are caught, to increase the likelihood that future innovations will be covered by the law, including if new services emerge that have a role in the payments chain, or future issues with entities that are outside the scope of regulation. Domain. It also mitigates the risk of regulatory arbitrage.
Similar amendments have already been made to legislation governing payment systems in other jurisdictions, including the UK, Canada and Singapore.
The second option for regulation is to define the technology and, where appropriate, create technology-specific regulation for innovation areas (such as crypto assets and crypto asset-related services).
This choice has appeared in anti-money laundering legislation. In Australia, for example, a definition of digital currency appears in legislation. In other jurisdictions, technology-specific definitions have been adopted for licensing purposes. In June 2023, for example, Hong Kong enacted legislation requiring virtual asset trading platforms to be licensed and regulated by the Securities and Futures Commission. The legislation defines “virtual assets” as “a cryptographically secured digital representation of value.” Another example is New York State, where a BitLicense is required for “virtual currency business activities,” as defined.
The third option for regulation is to allow technology to regulate itself, taking into account general laws such as those governing consumer protection. This choice is consistent with the argument that “the law is the law” and that it should therefore replace the law in regulating technology and technology-based products and services. To date, this has been the approach taken in many jurisdictions in the field of decentralized autonomous organizations (DAOs), where DAOs have not been specifically regulated.
Should the principle of technology neutrality be applied?
Although there is nothing new in technological innovation, there is no doubt that we are witnessing today a technological innovation that is qualitatively different from previous technological innovation. Twenty years ago, there was a similar debate about how to regulate the Internet and e-commerce, as technology began to be used as a means of facilitating transactions. However, the focus at that time was on traditional transactions and traditional services. E-commerce has traditionally been about using digital technologies to transact with traditional goods and services, in the same way that electronic money has traditionally served as a digital representation of fiat currency (in other words, traditional sovereign currency).
Today, by comparison, the function of technology as it is used in cryptoassets is not to facilitate transactions in traditional assets or services, but rather to create digital or virtual assets and services. In other words, the function of technology is not inherently facilitative but inherently constitutive – technology is integral to the creation of virtual assets and services; It is the technology that brought these virtual assets and services into existence. Perhaps the most common example is digital currencies or cryptocurrencies. As technology becomes an essential component of financial products and services, the logic of maintaining technology neutrality is increasingly being tested.
Some people argue that the principle of technology neutrality has hampered the development of regulation because it has made legislators and regulators reluctant to define technology for regulatory purposes and create technology-specific regulation. This, in turn, has undermined consumer and investor protections and given courts too much discretion to determine the scope of regulated activity. In addition, the preference to adapt the existing regulatory framework stifled innovation and de facto favored existing technologies – the opposite result of what technology neutrality aims to achieve.
The solution, as in other contexts, is likely to lie in achieving an appropriate balance between technology-neutral and technology-specific regulation.
Andrew Goodwin is currently a member of the World Bank team advising a central bank in Asia on potential reforms to its mandate. He previously practiced foreign law in Shanghai (1996-2006) before returning to his alma mater, Melbourne Law School in Australia, to teach and research law (2006-2021). Andrew is currently a Senior Fellow (Honorary) at the Asian Law Centre, Melbourne Law School, and an advisor to several organisations, including Linklaters, the Australian Law Reform Commission and the World Bank.