Fintech and Regulation

For all the rhetoric, Trump’s regulatory agenda remains vague.  In the financial realm, he has talked about disassembling Dodd-Frank, but has given few details on how, in which ways, or when.  He has delayed the Labor Department’s disruptive fiduciary rule for brokers and fund managers, but given no indication of what, if anything will replace it.  Despite such huge uncertainties, however, some regulatory questions yield to a measure of clarity, particularly where financial technology is concerned or, as it is increasingly called, fintech.  Its rapidly expanding reach has all but ensured increased regulatory attention.  But more, fintech also seems poised assume a larger role in how regulation is administered and how firms of all sorts comply.

Fintech surely has made impressive strides.  In 2015 alone, according to a study by Business Insider Intelligence, venture-capital investment in the area increased 106 percent to almost $15 billion globally.  There is only incomplete data as yet for 2016.  During the last few years, fintech inroads into legacy financial activities have occurred so fast that, according to Goldman Sachs, startups are poised to siphon $4.7 trillion in annual revenue from legacy banks.  That same research estimates that traditional financial services firms will ultimately lose 20 percent of their business to fintech, and that job losses in these firms will approach 30 percent.  Meanwhile, traditional wealth mangers have already lost significant business to internet-based investment advice software, what the industry calls robo-advisors.  These increasingly threaten to become a dominant intermediary between many financial firms and their customers.  Yet, even as fintech has taken from traditional players, it has brought welcome financial services to thousands that previously had no access.

This growth, not unreasonably, has spurred regulatory action the world over.  In the United Kingdom, the Financial Conduct Authority (FCA) has recently brought what it describes a special range of considerations for fintech and linked the effort to its counterpart in Australia.  At recent meetings of the world’s leading economies, the so-called Group of 20 or G-20, the host nation, Germany, argued that global financial stability hinges in no small part on fintech regulation.  Though G-20 participants also noted approvingly how fintech has the potential to bring financial services to the billions around the world presently without access, including some 40 percent of small- and medium-sized businesses, they nonetheless also agreed on the need for more regulation.  Accordingly, the G-20’s Financial Stability Board (FSB), presently headed by Mark Carney, has begun the process of devising rules that can at once encourage innovation while guarding against abuse, inequity, and risky behavior.

If the efforts of the G-20 and the FSB aim at a global framework for fintech regulation, each national regulatory body, like the UK’s FCA, is grappling with its own efforts.  All aim to strike a balance between encouraging welcome innovation on the one hand and protecting consumers and the financial system on the other.  The United States seems to face  especially difficult problems, enough for fintech managers to identify frustration as their primary response to regulatory contact, at least according to a recent survey conducted by Silicon Valley Bank.

A big part of this frustration stems from the number of agencies this country uses in financial regulation.  In addition to the Federal Reserve, there is the Consumer Financial Protection Bureau (CFPB), the Financial Industry Regulatory Authority (FINRA), the Securities and Exchange Commission (SEC), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corp (FDIC), the Federal Crimes Enforcement Network, and this is only a partial list.  It confuses still more that these agencies themselves cannot agree which is responsible for the oversight of which sort of fintech firms or arrangements.  And, of course, each of the 50 states has one or more regulatory agencies.  Further difficulties emerge because many of the regulations were written before there was an internet or e-commerce, and regulators remain reluctant to interpret rules for new business models.

Against this background, many will no doubt welcome recent steps by the OCC.  With an eye to cutting through the regulatory confusion, the agency has invited a dialog among financial firms of all stripes and regulators from all agencies to suggest ways to foster “responsible innovation” among fintech providers in a culture of compliance, an awareness of risk, and the fair treatment of consumers.  The goal is a “national charter” for fintech, much as regulators did with credit card companies years ago when their activities disrupted older, established patterns.

These efforts will need to jump many hurdles to reach their goal.  State regulators may present the biggest challenge.  They have expressed concerns that a national charter will create what they call a “weak baseline” that encourages a competition among states to use regulatory ease in order to attract fintech clusters.  Still, it is encouraging that in addition to the OCC effort the CFPB has also taken steps to make regulatory applications more predictable, in this case by offering what it calls “No-Action Letters” that would allow innovative firms to try out products without fear of regulatory reprisals.  While there is room in these early efforts for skepticism, even cynicism, it is nonetheless encouraging that a clarification and simplification process has at least begun.

Foreign competition should secure and accelerate these efforts.  It is certainly clear that other nations are using regulatory gestures to lure fintech.  The UK certainly has positioned itself as an imposing competitor.  Britain’s FCA has begun an effort to promote London as a fintech center through what it calls “Project Innovate.”  Though it has insisted, as its charter demands, on risk control, compliance, and concern for consumers, the FCA has taken a step beyond anything discussed in the United States. It aims to develop cooperative procedures to road test new ideas in something of a controlled environment, what it refers to as a “regulatory sandbox.”  This novel arrangement surely could enhance London’s already dominant fintech position and threaten to draw business from the United States.  Since at the same time, Hong Kong has initiated similar efforts, as has Singapore, under its “Smart Nation” program, and Australia’s Securities and Investments Commission (ASIC) under its “Innovation Hub” program, the U.S. authorities must feel an intense need to secure the industry by relieving its frustrations with present regulatory ambiguities.

Fintech has potentials that can at once complicate and ease this regulatory conundrum.  Not only has its success invited regulation, but its remarkable flexibility has allowed it to provide answers for compliance problems throughout the financial industry.  It seems a natural outgrowth of its ability to gather, sort, manipulate, and present data in myriad of forms.  This part of the business has met with so much success that Kirk Wylie, founder of early fintech startups, has asserted that “[t]he easiest way to start a [fintech] business  […] is to look for regulation that is coming down the pipe and develop a solution for that thing.”  Other fintech efforts have offered ways for legacy financial firms to streamline the multiple overlapping and labor intensive solutions they have long used for compliance.  At the same time as this so-called reg-tech is gaining traction, regulators have begun to realize that fintech solutions may well also streamline their practices and procedures.  The UK’s FCA in particular has started experimenting along these lines.

Though fintech seems well positioned to work all sides of these questions, the one thing it cannot do is tell where this revolution is going.  Even if Donald Trump were not promising to upend the American regulatory climate, which he is, that would be impossible.  But if specific directions remain obsure, it is nonetheless clear that fintech will at once need to deal with greater regulatory scrutiny than in the past but will also have increasing opportunities to shape the nature of its own and others’ relationships with regulators.

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