After news that the Financial Conduct Authority is launching a regulatory sandbox, it poses the question of whether or not financial technology should be regulated and in turn, increases concerns about whether money management systems should be considered financial products or technology.
A safe place for UK fintech
Last month, as a part of the Project Innovate initiative, the FCA opened its regulatory sandbox to applications from companies in order to provide a “safe place” in which they can test services and business models before being offered to the consumer. The underlying reason for this flexibility in regulation is to support young companies with a tailored authorisation process and Tracey McDermott, Acting Chief Executive at the FCA, highlighted that this is vital. “Our aspiration is that the sandbox not only enables innovative ideas to be tested and brought to market, but also helps to reduce the time and the cost of getting them there.”
At the Innovate Finance Global Summit, FCA Director of Strategy and Competition, Christopher Woolard, explored how although this is a crucial project to undertake, it could prove to be difficult and even dangerous. One of the challenges that the regulator faced was implementing a sandbox where the activities of the company remained in line with current regulations, but lowers barriers to testing as well. With the tailored authorisation process, this is possible, and if the company would like to launch, it can do so under the threshold conditions. “We think this strikes the right balance – regulation that starts in proportion to the scale of the concept being tested and can grow with the ambition of the full business model,” Woolard said.
Woolard continued to explain that firms working in an unregulated environment would not be feasible, or legal for that matter, and the tailored approach would help the company prepare for the future, as well as encourage consumers to trust the new products. “Finance is an established industry with many rules that pre-date smartphones, let alone blockchain or biometrics identifiers. We recognise that there may be regulatory uncertainty if something is not established market practice,” Woolard detailed. Risk to consumers is another challenge that the FCA had to deal with and have instilled a three-step consumer protection model that ensures that there is no transfer of risk.
“We are the first regulator to launch a programme like the sandbox anywhere in the world. It would underline our deep commitment to innovation. We see this as an essential part of promoting competition. It is an experiment for all involved and will need to learn as much as the firms engaged in it. And it will not work if consumers are not given proportionate protection. But the prize is there. If between us we can get this right, the sandbox can play a hugely important part in helping firms get new and exciting ideas to market more quickly,” Woolard concluded.
Saying yes to regulation
Chief Marketing Officer of Currency Cloud, Todd Latham, commended the UK regulatory system and hoped that the FCA’s new venture works. “Treading the line between keeping customers safe and encouraging financial innovation is a constant battle for regulators and we may find the sandbox goes through a number of iterations before reaching a model that produces real benefits to the industry. In the UK, we have one of the most dynamic financial regulatory systems in the world; given the right support, this scheme could become a flagship model that guides regulation on a global scale”. Latham also said that the fact that regulators are relaxing laws shows how much of an impact the fintech industry is making. Government bodies and corporate giants have been forced to sit up and pay attention.
In a recent Ernst and Young report, Philip Treleaven, Professor of Computing and Director of the Financial Computing Centre at University College London, states that financial regulation is crucial to the innovation and future success of the fintech ecosystem. With the Libor scandal and PPI still an issue, complying with old and new EU centric regulations while producing vast amounts of data on risk, those in finance could feel as if they also deserve the flexible regulations that new alternative finance entrant could get. “This situation is both a challenge and an opportunity. A challenge to make financial regulation and reporting transparent, efficient and effective; but an opportunity to apply the innovative fintech paradigms and big data analytics to regulation and compliance,” Treleaven said.
With the emergence of regtech, regulators are starting relationships with fintech startups and others in finance in order to push the correct method of compliance. A new decision-making model, SMART Governance, which is advocated by PayPal aims to regulate payments in a way that benefits the government, the consumers and the industry as a whole. “Performance standards have failed to become the dominant regulatory paradigm in part because industry found them overly static and carrying too much regulatory risk in exchange for too little real-world flexibility,” the EY report read. On the topic of payment, the FCA are also working with the new UK payment systems regulator (PSR) whose objective is to promote innovation and is setting up a payments strategy forum.
To summarise, while traditional players and regulators have worked hard to form solid reputations, as David Rush, Director at Alderbrooke, explains banker bashing is still happening. “To address this, banks and institutions need to go a step beyond fulfilling their sector’s basic requirements and must proactively embrace culture diagnostics and assessment themselves. This would be a bold first step for an industry that must stop waiting to be called trustworthy, and which should instead take active steps to be worthy of the public’s trust,” Rush said.
Regulators in other countries are also looking into launching sandboxes. This week, the Monetary Authority of Singapore (MAS) released a consultation paper asking the public to provide feedback on guidelines for fintech innovations. The MAS deputy managing director Jacqueline Loh said that “this will give innovations a better chance to take root” in a world where fintechs are becoming more and more sophisticated. “The sandbox cannot remove all risks, as failure is an inherent characteristic of innovation. In this regard, the sandbox aims to provide an environment where if an experiment fails, its impact on consumers and on financial stability will be limited,” the paper read.
As Singapore aims to develop as a global financial centre, excelling in fintech is a must and last year the MAS committed S$225 to help the fintech industry grow. MAS’s Managing Director Ravi Menon explained how Singapore has embraced fintech. “First, payments at stores and restaurants. This is almost a Uniquely Singapore phenomenon: many of our stores and restaurants have multiple Points-of-Sale (‘POS’) at their payment counters,” Menon said. Ian Wood, partner at international law firm Simmons & Simmons, believes that Hong Kong should follow in the UK’s and Singapore’s footstep and start thinking about creating a regulatory sandbox, according to Computerworld Hong Kong.
“It is all about proportionate regulations or risk-based regulations for fintech businesses. Fintech businesses are in a startup mode. They are experimental and they are coming out with innovative products and services. And they are allowed to operate without having the full force – if you like – of the financial regulatory regime. That is a very great idea,” Wood said. He went on to highlight that although Hong Kong is a little behind Singapore, it is moving forward in the B2B sector of fintech. “They seem less keen in developing a consumer-focused fintech such as P2P lending and crowdfunding, which are a bit of a challenge in Hong Kong where regulations do not really allow you to set up lending platforms very easily.”
Although some are predicting other regulators to roll out sandboxes, it must be pointed out that this is still relatively new and results will take some time to be seen. Sean Park from Anthemis Group advocates this one size fits all approach, but states that regulators should always keep in mind that existing frameworks may not be well-suited to the information age. “We are at the early stages of what is a multi-decade transformation of financial services and the financial services industry,” Park said.
Regulating the next generation
Park also said that the UK is in an advantageous position as the government is supportive of fintech innovation, but again “certain regulations must be adapted to enable the application of their core principles to algorithms and AI as opposed to only “traditional” human intervention.” Senior Vice President of VirtusaPolaris, Madhukar Sharma had the same attitude and said that the impact of technology on finance cannot be overstated. “Going forward the line between the two is set to blur further still, with a growing number of financial products shaped by technological advancements. So it’s no surprise that the FCA has announced its regulatory sandbox environment; it’s critical for regulators to adapt to changes and provide a framework which addresses the changing financial landscape.”