Slide 3 of 9
The current basis of most financial regulation is that an organisation becomes subject to the regulation if it engages in specified activities, such as deposit taking or the giving of investment advice. Organisations which do not engage in these activities are not regulated. This opens up real opportunities for new types of financial organisation, operating solely in those areas where regulation is absent. One prime example is the issuance of and dealing in electronic money, which in most jurisdictions falls outside the scope of financial regulation (see below).
Once a financial institution is regulated, however, its unregulated activities are likely to come within the scope of regulatory supervision. This is because they have the potential to affect the financial stability of the institution. Thus a bank which issues electronic money runs the risk that the encryption technology on which that electronic money relies becomes insecure, in which case its potential liability to holders of that money becomes unquantifiable. A consequence of such an event would be that the bank’s solvency and liquidity ratios are effected, a matter which is normally directly regulated and supervised.
One way in which regulated institutions can avoid the supervisory burden is to undertake unregulated activities through separate legal entities, working seamlessly together via the Internet technologies. This has the further advantage that the potential liability risks presented by new types of activity can be ring-fenced, thus safeguarding existing assets.