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CHAPTER V - What Role for Government?

What Role for Government?

In the end, solving many of the problems cited in the conference and developing effective solutions requires government in one role or another. Most conference participants agreed that this is a significant problem unto itself. Society needs to re-think the proper role of government so that larger collective concerns can be addressed—privacy, consumer protection, social inclusion, competition—without stifling valuable innovation that addresses needs more cheaply, effectively and efficiently.

The complaints against government are familiar. Perhaps the biggest issues are the time, complexity and inconsistency of regulation, resulting in systems that are static, incumbent-oriented and hostile to innovation. A number of conference participants noted that government agencies overseeing financial services in the U.S. tend to use highly specific and prescriptive mandates (“input-based”) rather than general performance metrics that allow regulated enterprise to choose how best to meet specified goals (“output-based”). “U.S. regulators have radically strayed into the ‘how it should be done’ space,” said Michael Barrett of the FIDO Alliance.

Because of the rapid pace of technological change, it is common for government regulation to be based on the assumptions of old technological or business paradigms, said Jack Stephenson of JPMorgan Chase. “With the exception of PayPal, I would say that a lot of the problems with the current payment systems are based on forms of commerce that used to exist. We’ve kind of tried to adapt them to this new world.” But successful adaptations are often very difficult because there are multiple layers of government—state, federal and international—and legitimate challenges in interpreting regulations and complying in conscientious ways.

Stephenson told the story of the difficulties of obtaining a “money transmittal license” (MTL) when the bank acquired a stake in a payment company, GoPago. (An MTL is needed to transmit money across state lines in the U.S.) “The regulators wanted an MTL for five states, and I had to fill out something like seventy pages of forms, and every state had a different form. And I had to get physically fingerprinted five different times. And this was for only five states!” The process aimed to address legitimate goals—protecting consumers from fraud and the bankruptcy of companies—but the process is not friendly to startups or innovators. Moreover, said Eric Dunn of Intuit Corporation, “there is mission-creep in MTLs” that adds unwarranted layers of process and regulation.

Crudely put, the new realities of e-commerce are causing serious tensions with old regulatory schemes. In some countries, mobile telephone regulators are expanding into regulating mobile currencies, arguably an issue that bank regulators should be dealing with. If regulators are not “competing” with each other, sometimes they are zealously focused on patrolling specific geographic boundaries or payment systems even though such categories may make less sense and actively impede commerce and innovation.

This led many participants to agree that governments themselves need to rethink how they regulate. “The business of governments is governance,” said John Clippinger of ID3, “and the way that governments do governance is totally antiquated. We really need fundamental innovations in governance.” Besides dealing with some of the complaints mentioned above, governance needs to allow greater international harmonization; prevent the capture of policy by incumbent players; and foster innovation and competition, he said. Right now, companies tend to engage in “governance arbitrage” among different jurisdictions, which often results in a “race to the bottom” in terms of social and ethical performance.

Instead of framing regulatory schemes by sectoral interests that may have existed in the nineteenth or twentieth centuries, said Clippinger, we need new sorts of regulatory structures that appreciate the value of innovation in digital sectors today. Clippinger suggested that governments develop a new regime of regulation based on “open APIs,” which could allow them to specify performance goals and collect real-time performance data from companies while allowing companies to use innovative, data-verified ways to meet goals.

Another idea that has great promise, he said, is the “safe harbor provisions” in federal law that allow companies to engage in innovative experimentation within certain performance parameters. “This is a higher-level notion of how government can regulate,” said Clippinger. “The idea is to use ‘meta-rules’ and ‘safety nets’ to oversee the behavior of companies instead of getting into the micro-decisions. This also allows you to start running experiments to see where the failure points are, to build real innovations on top of those findings.” Clippinger added that regulators might also begin to experiment with “zero-knowledge proofs,” which are mathematical systems to “prove something without having the other party reveal it. So a regulator could make a query and get an answer without having to get access to the underlying (confidential or private) data.”

Regulators in the United Kingdom are attempting to develop regulatory frameworks that allow the evolution of better technological models, said Michael Barrett of the FIDO Alliance. “The UK government has set up experiments that see how a new approach can actually work in practice. This seems to be a much more fruitful approach—to iterate into what the best solution looks like.” The virtue of such approaches is that they would begin to take seriously the idea of commerce as a dynamic social ecosystem, one that needs to be seen holistically and regulated with an awareness of networked relationships.

Despite the criticism of conventional regulation, participants agreed that government has many important roles to play. These include government as:

· convenor of interested parties to forge new policies;

· direct provider or operator of services;

· regulator to ensure basic safety and soundness of market activity;

· referee or overseer of market behavior;

· customer or “anchor tenant” to stimulate demand for innovative technologies or services;

· standard-setter for minimal social or technical performance;

· guarantor and trust-builder in the marketplace; and

· authenticator of identity.

While some industry players recoil at government interventions that they consider unnecessary or intrusive, others pointed out that government has a leadership role to play, especially in spurring innovation. “There has been a complete stagnation in innovation within core finance services infrastructure,” said Michael Barrett. While other countries have managed to develop instantaneous or one-day settlement times for ACH transfers, the U.S. remains stuck in a two-day settlement system.

Just as the Federal Reserve in decades past helped American banks move to a system of check-clearing and ACH transfers, so it could serve a useful leadership role today in improving the payment system. Other countries like the UK and Nordic countries have innovated around payment systems, including person-to-person transfers. Why not the U.S.?

Eric Dunn of Intuit Corporation believes it should be a priority for the Fed to “rethink the public/private partnership that is the ACH so that it could include an explicit public policy goal of improving our payment system.” Organizations such as the National Association of Clearinghouses, now NACHA, which dominates a lot of the governance and rulemaking over such things, should be prodded to embrace a larger public policy agenda. Jack Stephenson of JPMorgan Chase identified several other important goals that ought to be encouraged: easy cross-border payments; a peer-to-peer architecture with open APIs [application protocol interfaces] to allow innovation to evolve on top of the system in customized ways; and a set of intermediaries to assure that the whole system is “safe, sound and protected.”

Vijay Sondhi of Visa replied, “The system you described for consumer payments already exists. It’s Visa. It’s MasterCard. It’s real-time settlement.” Sondhi stressed that we need to distinguish between different payment markets because consumer, business and government payments are very different markets with different transactional needs and different technical requirements.

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