Recent developments of signifi cance to FinTech are increasingly of an international fl avour, with much debate over the impact that political events such as Brexit and the Trump election will have on the FinTech sector. The future US President has said he wants to dismantle and replace the Dodd-Frank Wall Street Reform and Consumer Protection Act, a massive piece of fi nancial reform legislation passed in 2010 as a response to the fi nancial crisis of 2008, and roll back regulation generally. However, without knowing what will be put in place instead it is too soon to say what the Trump election will mean in practice for the FinTech sector.
In recent months there has also been a defi nite ramping up in the number of speeches, papers and initiatives relating to FinTech from worldwide regulators, governments and international organisations.
EU FinTech activity
EU organisations have been relatively active on FinTech recently, with the European Parliament's November 2016 hearing on FinTech suggesting that a policy paper on a possible EU regulatory regime for FinTech will be produced in early 2017. Shortly before that, the European Commission had announced that it is launching an internal task force on fi nancial technology (TFFT) as part of its FinTech work to accelerate capital markets union reforms. The aim of the TFFT is to assess and make the most of FinTech innovation while also developing strategies to address potential challenges, with policy suggestions and recommendations due to be delivered in the fi rst half of 2017. Shortly before launching the TFFT, the Commission's call for tenders to conduct a study to provide an overview of the FinTech sector closed. The stated aim of the study is to better understand FinTech and develop possible scenarios for EU policymaking and regulation. The study and related tasks must be completed within 16 months and a budget of €300,000.
It is not clear how the Commission's study and the TFFT will be joined up and it will be interesting to compare the products of the Commission's work strands with that of the Parliament. Generally speaking, the more effort policymakers put into understanding and consulting with a particular sector, the better and more workable any resulting regulation is likely to be. The FinTech industry and the EU could stand to benefi t greatly if EU policymakers use this valuable opportunity to put a workable harmonised regime in place. It is vital that policymakers consult with, and listen to, the FinTech sector and regulators such as the FCA before committing themselves to policy. Harmonised regulations are just as feasible for FinTech businesses as for more traditional fi nancial services, so long as the regulations are well thought out. However, EU regulators should avoid a "one size fi ts all" approach with a single legislative measure attempting cover all FinTech businesses, given their range and size and also the blurring of lines with more traditional fi nancial sector businesses (see below).
Financial stability concerns
Also in November 2016, the Secretary General of the Financial Stability Board (FSB), Svein Andresen, provided some details about the FSB's work on FinTech. As one would expect, given the FSB's remit, this focuses on areas potentially having implications for fi nancial stability (which the FSB has identifi ed as being distributed ledger technology and peer-to-peer lending) rather than the upsides of FinTech. Greater access to and convenience of fi nancial services, greater effi ciency of fi nancial services, and a push toward a more decentralised fi nancial system are normally perceived as positive, but the FSB has warned they all have fi nancial stability implications. Mr Andresen recommends that authorities should, therefore, be vigilant and actively monitor the effects that FinTech innovations have on specifi c products and services, as well as on incumbent fi nancial institutions, markets, and the broader economy.
Continuing UK focus
In the UK, the Chancellor of the Exchequer delivered the 2016 Autumn Statement, which includes a number of announcements that can be welcomed by the UK FinTech sector. Of particular use, in practice, is the agreement of the Joint Money Laundering Steering Group (JMLSG) to modernise its guidance on electronic ID verification to support the use of technology to access fi nancial services. Although perhaps not a headline grabber, this initiative will not only make life more straightforward for FinTech fi rms that operate online only, but will also potentially open another avenue for FinTech fi rms to provide electronic ID verifi cation solutions to incumbent financial businesses.
It is rare to fi nd a regulator or international organisation comment on FinTech that doesn't use talk about welcoming the "benefi ts and opportunities" of FinTech while needing to deal with associated "risks, threats or challenges". The current crop discussed here are no exception, with the FCA stating in its October 2016 Mission document that technology is "creating both huge opportunities and new risks." The Mission document contains positive messages for FinTech. Notably, it is explicitly accepted that regulatory requirements impose costs on fi rms that are ultimately passed to consumers; a message that many in the fi nancial sector have been trying to get across for years. The FCA has already begun, and commits to continue, to identify specific areas where its regulations are inhibiting competition. It will take action, including a review of its Handbook, to reduce the restrictions its regulations cause. This is good news and FinTech businesses should take the opportunity to let the FCA know their views. From experience, the more specifi c, evidence-based and constructive such feedback is, the more likely it is to take root.
Turning to RegTech matters, the FCA's Mission document also rightly recognises the benefi ts that RegTech offers to regulators. In particular, it fl ags machine learning or artifi cial intelligence as allowing the FCA to extract useful information from increasingly large, complex and varied datasets to identify fi rms with a greater risk of regulatory breach. The FCA can then monitor fi rms on a more targeted basis. It would be really good to see RegTech solutions used not only by the FCA internally but also in collaboration with regulated fi rms to reduce duplication and facilitate compliance. RegTech businesses should take note that the FCA's next focus will be on using technology to detect insider trading, market manipulation and anti-money laundering, although it will explore other applications for technology over time.
The FCA's regulatory sandbox is one of its rightly applauded initiatives to support FinTech. In a November 2016 press release, the FCA identifi ed those fi rms that have succeeded in their applications to begin testing in the fi rst cohort of its regulatory sandbox. Less widely publicised than the FCA's measures, but of signifi cance as a model for regulators worldwide, is the Bank of England's (BoE) own FinTech Accelerator, fi rst announced in June 2016. This could perhaps better be referred to as a RegTech accelerator, as it is a partnership between the BoE and FinTech fi rms the aim of which is to develop new approaches to the delivery of the BoE's own mission and operations. Firms selected by the BoE can test their products in a live environment, working closely with the BoE, allowing the BoE to assess the outcomes against the initial criteria. The BoE then writes up a case study and, in certain cases, proceeds to an open procurement.
Charlotte Hogg, BoE Chief Operating Offi cer, summarised, in a recent speech, the key elements of the proof of concepts (PoC) projects that have been completed or that are currently in progress, drawing particular attention to current work on data analytics and technologies relating to cyber-security intelligence data. These two areas are likely to have a signifi cant impact on all our lives in the immediate future and, again, offer great opportunities for RegTech businesses. The BoE has already opened its next call for applications, which closes on 9 December 2016.
The BoE's initiative is notable as a model for how regulators worldwide should partner with fi rms to improve regulatory compliance processes, which are currently costly and time-consuming. All types of regulated fi rms are required to gather and report massive amounts of information and to constantly monitor regulatory developments and identify and implement new regulation, which is often inconsistent across multiple jurisdictions. The regulatory compliance burden limits expansion in terms of services, products and geographies and so presents a very real risk to economic growth. RegTech has the potential to revolutionise regulatory compliance to benefi t regulators, regulated fi rms and underlying customers who tend to bear the costs of regulatory compliance alike. The FCA is leading the way on this, having back in July published a feedback statement on supporting the development and adopters of RegTech (FS16/4), through which the FCA is exploring its role as facilitator in the development of the RegTech sector.
Another good RegTech approach is that of the Jersey government, which in conjunction with the Jersey Financial Services Commission issued in November 2016 a Strategic Engagement document to consider the adoption of electronic verifi ed identifi cation for use across the Jersey fi nancial and professional services industry. This is a good example of how RegTech can be used to make it easier to do business.
CROSS-BORDER ISSUES: DIVERGENCE OF REGULATORY APPROACH
In its 2017 work programme, the Joint Committee of the European Supervisory Authorities (ESAs) explain that the ESA's will focus in 2017 on assessing both cross-sectoral opportunities and threats posed by the increasing digitalisation of fi nance and fi nancial technology. The ESAs will continue co-operating to ensure cross-sectoral consistency, as well as supervisory convergence. Cross-sectoral consistency in the regulation of FinTech is sadly lacking at present, so this initiative is positive in principle. Currently, there are wide divergences in national regulators' approaches to FinTech. National authorisation requirements for FinTech fi rms range from licensing requirements under bespoke regimes to general lack of recognition. For example, in the EU peer-to-peer lending is not among the activities enjoying EU passporting rights, so platforms need to obtain authorisation from regulators on a state-by-state basis. Those investment-based crowdfunding platforms authorised under MiFID should benefi t, in principle, from a passport to carry out regulated services throughout the EU. However, some EU member states consider that platforms must be authorised under their domestic bespoke regimes to operate as crowdfunding platforms outside the MiFID framework.
Moreover, there is still no satisfactory regulatory co-ordination, even within the EU, on the extent to which an offer of products or services through an online platform located in one state can be considered a domestic offer. Individual countries impose their own restrictions and requirements on sales and marketing of fi nancial products and services, which means that what is permitted in one country may be unlawful in others. This issue is particularly signifi cant for FinTech businesses, which primarily rely on digital and mobile-based technology that does not recognise national boundaries. Although this is also challenging for more traditional issuers, lenders and investment funds, those businesses are generally far less digital or mobile-based as compared to FinTechs.
Although a key Brexit concern for FinTech fi rms in the UK is EU cross-border passporting, in practice, passporting will only be a direct consideration for those FinTech fi rms that are not only regulated themselves, but also within scope of a single market directive that provides passporting rights, such as MiFID. There are many unregulated FinTech fi rms (for example, providing back offi ce processing solutions) and regulated yet unable to passport FinTech fi rms (for example, peer-to peer lenders) which will not be directly impacted. However, another key Brexit concern - the need to continue to attract global talent - is vital to the UK's FinTech sector.
The FCA has rightly attracted plaudits for its groundbreaking approach to supporting FinTech and now RegTech, but other countries are competing for the sector. It is now commonly recognised that FinTech has great potential to bring benefi ts to national economies in terms of jobs and growth and, by providing an online marketplace, bringing more competition into retail and wholesale markets. Political appetite for the benefi ts means that many jurisdictions are now keen to encourage FinTech. The fact is that FinTech businesses compare regulatory regimes, just as they do other factors, when deciding where to set up. Regulators may therefore be under pressure to compete to provide attractive regimes. However, in practice this means appropriate, rather than minimal, regulation. For example, many overseas peer-to-peer lending platform operators have sought to set up in the UK because, not despite, of the new bespoke regime in 2014, which was campaigned for the industry.
While countries compete to host the FinTech sector, FinTech businesses themselves are generally not wedded to staying within one geographical area. Internationalisation within the FinTech sector itself is an emerging trend, driven by the need to increase economies of scale and expand both investor base and client base. The fact that Hong Kong, the Channel Islands or Singapore, for example, are welcoming FinTech businesses will help, rather than hinder, the sector as a whole. It is also likely that a maturing FinTech sector will look to international fi nancial centres in structuring, in the same way as some more traditional investment businesses already do.
The FCA is demonstrably prepared to leapfrog the EU and build direct regulatory bridges with like-minded regulators in other parts of the world, with co-operation agreements intended to assist innovative businesses (which should include crowdfunding) to enter each other's markets. Agreements entered into by the FCA in 2016 include ones with the Hong Kong Monetary Authority, Australian Securities & Investments Commission, the Monetary Authority of Singapore, the Korean Financial Services Commission and the People's Bank of China. It is important that such regulatory collaboration becomes more widespread.
BLURRED LINES AND INSTITUTIONALISATION
The FCA's Mission document recognises that, in practice, the lines between regulated and unregulated activities have become blurred in recent years. A separate but related concern raised by regulators (including the FCA in its July 2016 call for input to its crowdfunding post-implementation review and ESMA in its opinion on crowdfunding (ESMA/2014/1378)) relates to the increasingly blurred lines between FinTech fi rms and other more traditional business models, such as banking or asset management. It is good to see that the 24 chosen applicants for the FCA's regulatory sandbox include traditional fi nance household names (including HSBC Holdings plc and Lloyds Banking Group plc) forming part of the cohort, as well as start-ups. This is a reminder that FinTech is also becoming increasingly institutionalised and helps prevent it being regarded as only about one-product start-ups.
The blurring of lines is seen by regulators, such as the FCA and ESMA, as creating a risk that crowdfunding or peer-to peer lending fi rms, for example, may conduct business that looks similar to asset management or banking, as the case may be, but under a regulatory regime that was not designed for asset management or banking business models. FinTech fi rms would argue that they are very different from asset managers or banks and to treat them the same would be inappropriate and potentially put some out of business. Meanwhile, those in more traditional areas of the fi nancial services sector question why FinTech fi rms should be subject to any less onerous requirements.
ESMA considered that the Alternative Investment Fund Managers Directive (2011/61/EU) (AIFMD) could apply to a crowdfunding platform if it manages a collective investment undertaking that raises capital from a number of investors with a view to investing it in accordance with a defi ned investment policy. This was notwithstanding ESMA's recognition that the crowdfunding operating model is typically that the decision to invest is taken by investors, with the investment vehicle's discretion limited to any decision to sell the investment and potentially how to exercise voting rights. In examining whether the vehicle's lack of discretion prevented it from having a defi ned investment policy, ESMA believed that a possible interpretation would be that the vehicle simply had a very restrictive defi ned investment policy. Consistent with ESMA's opinion, some investment-based crowdfunding businesses are, in fact, authorised as asset managers. These fi rms hold permissions to manage alternative
investment funds under the AIFMD and are, accordingly, subject to the regulatory regime for investment fund managers rather than for crowdfunders.
ESMA also examined whether crowdfunding platforms are operating multilateral trading facilities (MTFs), noting that while in general they are not, there is increasing interest for platforms in developing secondary markets. If a platform brings together multiple buying and selling interests in a system with non-discretionary rules (that is, rules where the operator has no discretion as to how interests may interact) in a way that results in a contract, it would in ESMA's opinion amount to operating an MTF.
The FCA, meanwhile, said it is increasingly seeing maturity mismatch products on loan-based crowdfunding platforms. This has led to the FCA comparing such platforms with banks. It considers that while these products are similar to banks' 30-day notice savings accounts, banks are subject to far higher prudential standards and must meet minimum liquidity reserves to mitigate the maturity mismatch risk. It believes loan-based crowdfunding platforms cannot guarantee access after 30 days, as they can only repay investors if they have their own money available or other investors are willing to buy the loan on a secondary market. This makes valuing investors' claims more diffi cult and might also transfer risk from investors who leave platforms to those that stay on.
These blurred lines therefore set a challenge for regulators, requiring them to understand many different types of business model and keep abreast of innovations in both FinTech as well as more traditional fi nancial sector businesses.
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