Compliance officers should leapfrog regulators in providing crypto trading guidance to employees

Digital assets and cryptocurrencies have further exposed the diametrically opposed relationship between technological innovation and regulatory rulemaking. While crypto innovation has moved at lightning speed, presenting significant growth and wealth creation opportunities, rulemaking by regulators for the broader industry and within specific wirehouses, broker-deals and RIAs has moved at a slower, more deliberative pace.

This means employees who own and trade these currencies are left without the knowledge required to comply with the professional conduct rules of their firms. At the same time, compliance officers are steering away from developing complex protocols which may not align with future regulations — ones certain to be instituted as the crypto market remains extremely volatile.

Today, there are no direct cryptocurrency market regulations. But several oversight agencies may issue rules that impact the development of the digital asset ecosystem as they continue to gain popularity with financial services industry employees, even as these assets experience a significant downgrade in valuation. 

The SEC may lead much of this process, with recent announcements from Chair Gary Gensler outlining consumer and investor protections from cryptocurrency scams. But it’s also possible the Commodity Futures Trading Commission, the Financial Industry Regulatory Authority and the Financial Stability Oversight Council will have meaningful roles. Factor in that the blind nature of transferring crypto assets may bring law enforcement and tax agencies into the equation.

Until regulators do act, financial services companies that monitor traditional employee trading activities should develop specific cryptocurrency-related protocols. Compliance officers agree: In November 2021, 83% of compliance professionals surveyed by ComplySci said monitoring the use of cryptocurrency should be a priority. It’s striking to note that only 53% of the same survey pool held that opinion in August.

Add that to the fact that in January 2022, only 30% of firms surveyed were requiring employees to certify cryptocurrency accounts and wallets, and only 21% were requiring employees to preclear any cryptocurrency trading. 

Crypto by any other name
With thousands of recognized cryptocurrency coins in circulation worldwide, it’s likely U.S. regulators will create frameworks that will treat these assets by their overarching, rather than their individual, characteristics. Therefore, a sound interim compliance program should start by recognizing two major classes of digital assets: established and emerging coins.

Bitcoin and ethereum are examples of well-established cryptocurrency coins with market-driven valuations. As such, they bear similarities to commodities and may be regulated as such. Smaller, emerging coins, which include “meme coins,” are cryptocurrency minted by companies or individuals to generate income or, in some cases, serve as entertainment. These digital assets are tied to a company or organization and function similarly to securities. By categorizing cryptocurrency within one of these two classes, firms can leverage existing compliance policies to encompass any use of these digital coins within an employee’s portfolio (though it can be challenging to monitor employee trading activity if that technology is not integrated into existing reporting programs). 

Using this general construct allows firms to leverage current compliance policies for cryptocurrencies and lay the groundwork to cope with future regulation. Even if this isn’t how regulators end up designing digital asset regulations, taking these actions now will foster a compliance culture in a volatile financial services space.

Preparation for the unknown
While cryptocurrencies remain dynamic, and debates will continue about their value and impact on the financial industry, they are here to stay. 

Regulators have already started internal processes and have included digital asset and cryptocurrency matters within 2022 exam requirements, so forward-thinking financial services institutions should develop actionable compliance protocols to address oversight of these evolving assets.

Applying today’s regulatory infrastructure to these assets not only positions firms for success moving forward but also demonstrates preparedness and readiness to comply with future regulatory requirements.