The financial services industry is growing and evolving, thanks to the increase in Financial Technology (FinTech) companies in recent years. FinTech companies utilize new technological developments to provide accessibility and connectivity to customers and institutional users. Open source software and cloud technology have opened the door for new players and allowed small independent companies to compete with mainstream banks.
FinTech companies, despite delivering exciting new services and market innovation, must comply with the regulations that cover all financial services organizations. However, will the new levels of regulation that have been imposed on the financial services industry since the financial crisis limit FinTech innovation?
Global investment in the FinTech sector is expected to more than double by 2018, reaching between $6 billion and $8 billion.[i] Growth in the FinTech industry has been driven by technological developments that lead to the disruption of traditional approaches to transactions, lower cost alternatives, and faster processing. Moreover, traditional bank services such as lending have decreased, and FinTech companies have filled the gap by providing small businesses and individuals with alternative borrowing options. Rapidly growing subsectors of the FinTech market include peer-to-peer lending, social payments, crowd funding, and location-based commerce.
According to a recent report produced by Accenture on the rise of FinTech in Silicon Alley, despite traditional banks’ lack of activity within FinTech in the past, banks are now seeing the digital revolution as both a threat and an opportunity. With the risk of market share moving to the FinTech companies banks are now looking to partner with innovators, and making speculative investments in technology businesses, through bank sponsored venture capital funds with a core focus on FinTech.[ii]
However, with the new levels of regulation imposed on the financial services industry it can be difficult for small FinTech companies to understand, interpret and incorporate these into their compliance policies. In addition, regulation and compliance vary country to country, and small firms that do business internationally might find it difficult to navigate the competing guidelines. Currently, a company doing business in the United States must comply with KYC, FATCA, Consumer Protection, Data Privacy, and Dodd Frank, which is enough to scare off any technology entrepreneur. Equally can regulation keep pace with new innovation, for example crypto currencies such as Bitcoin?
Several scholars have explored the impact of FinTech companies and how the regulatory landscape will adapt to new developments in the industry. Professor Douglas Arner and Janos Barberis of FinTech Hong Kong led a seminar discussing this topic, during which they introduced the idea of “too small to care,” which refers to how regulators view small FinTech companies. However, there are several forward-looking, pro-active regulations which have been created:
- Jump-Start Our Business Start-Up Act 2012 (JOBS Act) in the US covers alternative financing.
- The Small Business, Enterprise, and Employment Bill in the UK covers loan referrals for peer-to-peer lending.
During their seminar, Arner and Janos discussed the variety of risks associated with the new business models of FinTech companies, including consumer risk and risk associated with scalability and risk management. Data transparency is a major benefit of the use of technology, as it enables regulators to obtain direct insight into the activity of not only financial institutions and large banks, but also FinTech companies.[iii]
While guidelines are certainly necessary to regulate the industry, regulators are faced with a complex balancing act between having too many and too few regulatory obligations surrounding FinTech. Regulation that is too heavy will prohibit innovation and the use of creative solutions; whereas regulation that is too light will leave customers and consumers unprotected or with the ability to take advantage of unmonitored transactions. The direction that regulation will take is still left to be determined.
Barberis and Arner pose a few key questions that remain:
- Can regulators create a framework that enables FinTech companies to manage the costs of compliance despite their low-cost business models?
- Can financial regulation cover the new business models but also allow room for the speed of innovation seen in this space?
As companies mature, the market expands and investment increases, the need for FinTech-specific rules and guidelines will increase. In the meantime, entrepreneurs will strive to remain innovative and nimble while coping with rising compliance costs despite their lean business models.
[i] 2015 Financial Services M&A Selected Opportunities New rules, new players – new game?, see also – http://www2.deloitte.com/content/dam/Deloitte/global/Documents/Financial-Services/gx-fsi-2015-fs-ma-predictions.pdf , Deloitte 2014.
[ii] The Rise of FinTech New York’s Opportunity for Tech Leadership, see also – http://www.accenture.com/SiteCollectionDocuments/PDF/Accenture-Rise-of-Fintech-New-York.pdf, Accenture 26 June 2014.
[iii] FinTech and Regulation Recent Developments and Outlook, see also – http://www.slideshare.net/FinTechHk/fintech-regulation-by, FinTech HK 26 March 2015.