Regulators should be flexible in dealing with fintechs

By James Langton | March 2017

Regulators are accustomed to being criticized for hampering business needlessly and increasing the already hefty compliance burden on financial firms. However, regulators are trying to recast themselves as champions of innovation in the financial technology (fintech)space.

For the past couple of years, the hype surrounding fintechs has grown steadily louder. The retail investment business is ever more crowded with robo-advisors. There's seemingly a new blockchain initiative every week. And proponents of artificial intelligence (AI) and machine learning claim that the technology will revolutionize the financial services sector.

Policy-makers are beginning to devote more attention to the emerging fintech industry, too. Canada's Competition Bureau is in the midst of a market study examining the competitive landscape for fintechs. The bureau is expected to produce a draft report this spring, with a view to publishing a final report by the end of the year.

As part of that project, the bureau held a workshop in Ottawa last month to examine some of the themes that have emerged from the agency's initial consultations with the financial services sector, policy-makers and others.

One of the fundamental issues that policy-makers are grappling with revolves around regulation and its potential impact on competition. For fintech startups, the voluminous, complex body of regulation in the financial services sector represents a potential barrier to entry.

Conversely, innovations that don't slot easily into the existing regulatory framework may have a distinct competitive advantage if they can avoid the extensive regulation that governs traditional firms. (Consider the long-running battle between Uber Technologies Inc. and the traditional taxi industry for reference.)

Financial services regulators shouldn't be aiming for identical regulation for both startups and traditional firms, says Robert Atkinson, president of Information Technology and Innovation Foundation, a Washington, D.C.-based think-tank. Instead, the goal should be ensuring equivalent protection, he says, but with the flexibility to allow for different ways of meeting those standards.

In other words, policy-makers should be contemplating more principles-based regulation that provides latitude for firms to comply with regulators' objectives, but doesn't set out detailed, prescriptive rules to tell firms exactly how to get there.

This flexible approach to fintechs is catching on with the regulators. Late last month, the Canadian Securities Administrators (CSA) announced that it would be opening a "regulatory sandbox" across the country, which will allow both fintechs and traditional financial services firms to test innovative products and services without first fully meeting the existing regulatory requirements.

For example, regulators may grant a time-limited exemption to allow a firm to experiment with an innovative business model or could permit the use of an original product or service by a limited audience.

The goal is to allow firms to test an innovative idea that may not fit neatly into the existing regulatory framework, while also ensuring that consumers aren't exposed excessively to harm from an unproven scheme.

The concept of the regulatory sandbox is innovative in itself, although the CSA is not the first to embrace the concept. The Ontario Securities Commission (OSC) was the first regulator in Canada to adopt the concept, through the OSC LaunchPad initiative last autumn. Before the OSC founded its dedicated fintech team, regulators in the U.K., Australia and Singapore, among others, were utilizing the sandbox model, too.

In Ontario, regulators report that they have worked with firms seeking to bring novel business models to market. Some of these firms are being allowed the opportunity to experiment.

For example, the OSC has granted a two-year exemption from certain registration and prospectus requirements to an online platform that aims to match experienced venture-capital and angel investors with tech startups that are seeking support, ranging from advice and mentorship to capital.

The exemption for this online angel network is an opportunity to explore whether the concept will work in Canada, subject to various conditions designed to ensure investor protection (by limiting both the types of investors and companies that can participate in the network).

Although these efforts to nurture and support fintechs surely are welcome, this approach is likely take time to filter down into the traditional, rules-focused regulatory culture.

Michael Katchen, founder and CEO of Toronto-based Wealthsimple Inc., which operates on an online model, says that although the leadership at the regulators certainly are taking a very constructive, progressive approach to working with fintechs, the day-to-day business of complying with the existing rules that were written for another era remains more of a challenge.

Indeed, the regulatory culture is not going to change overnight. However, Pat Chaukos, chief of the OSC LaunchPad team, maintains that the OSC is working to "keep regulation in step with digital innovation."

In addition to the creation of OSC LaunchPad, she notes, the OSC also hosted its first "hackathon" last autumn, which was attended by 40 staffers from the commission.

It also recently created a Fintech Advisory Committee to provide the OSC with more insight into the emerging fintech space and the challenges fintechs face. The OSC also is connecting with other regulators that are making concerted efforts to facilitate fintech innovation.

Late last month, the OSC signed an agreement with the U.K.'s Financial Conduct Authority that will see the regulators facilitate the entry of fintechs into one another's markets. (The OSC also signed a similar arrangement with the Australian Securities and Investments Commission [ASIC}last year.)

"While [we're] still in early days, OSC LaunchPad staff have had many productive discussions with ASIC about emerging trends, regulatory issues and outreach to the fintech community," Chaukos says.

"We are learning from one another's experiences,"Chaukos says, "and hope to use this knowledge to enhance the regulatory experience for innovative businesses seeking to enter our markets."

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