The last 10 years has witnessed a huge boom in alternative finance (“altfi”). As many commentators have observed, this was in part kick-started by the global financial crisis – with consumers becoming disillusioned by traditional financial service providers, assets classes and practices. Prior to 2008, attitudes to finance were often characterised by apathy, acceptance of “the way things were done”, and perhaps even a blind trust that regulators and banks would keep the economy (and people’s savings) safe. Then it all hit the fan in the wake of the Lehman collapse, and much trust in traditional institutions was lost. Since then we’ve seen individuals demanding more transparency and control over their finances, lower transaction and service costs, and better conduct – which has provided opportunities for a new wave of customer-focussed altfi providers to satisfy that demand.
But even more than changing attitudes, it is technology that has been the bedrock of altfi’s success. New financial products, such as crowdfunding and peer-to-peer lending, simply wouldn’t be possible without the use of sophisticated technology platforms, which enable those services to be provided in a low-cost, time efficient manner. The use of technology engenders not only transparency and accountability (it is difficult to escape customer censure when it forever becomes a part of Google’s online memory), but also financial inclusion. Venture capital, for example, used to be an investment activity reserved for those that had vast quantities of both money and time on their hands – but since the dawn of equity crowdfunding, any person can invest businesses they believe in at the click of a button, from as little of £10.
Financial technology (“fintech”) has had far-reaching benefits across the financial services sector: at the retail end, we’ve seen challenger banks such as Revolut, which provides low cost FX to travellers through an app, and Plum, a savings tool that works through online messenger; to the institutional end, where blockchain technology is reducing the opportunity for transaction fraud using smart contracts, and even the traditional bond market is being made more efficient by online platforms such as Origin, which optimise connections between issuers and dealers.
The regulation of fintech, however, is proving a challenge. We see regulators across the globe struggling to keep up with the pace of change – both in terms of facilitation and intervention. There is a tendency for a regulator to consciously delay addressing a sector, because it is not yet sufficiently developed or isn’t deemed to have “systemic importance”, but this can have the following negative implications:
First, lack of regulatory involvement or interest can result in a sector being seen by consumers as illegitimate, which can slow or even hamper its development. See, for example, the peer-to-peer lending space, which had to lobby for years to come under the regulator’s jurisdiction.
Second, it can mean that bad actors have the licence to operate around the edges of existing regulation. Whilst the impact of any fallout from this may not be “systemic”, if it is a retail product, it can very well affect the most vulnerable in society.
Third, even when existing regulation does apply, it is often not fit for purpose. Much of the regulator’s rulebook is based on the idea of paper records and manual systems, rather than today’s digital reality – and compliance with such rules not only increases costs for the provider, but can be frustrating for the consumer. In the realm of identity checks, for example, the idea of an online platform asking customers to come into the office with a passport is wholly incongruous with an online experience.
Fourth, just because one regulator chooses not to act, doesn’t mean others will take the same view. In Europe, for example, we have seen many jurisdictions building bespoke, unconnected regulatory regimes that make operating cross-border very challenging.
And finally, fifth, too many times shortly after regulators have publicly stated they will not intervene, they change their minds within a matter of months. This change of tack can result in panic in the industry, and risks new regulation being incomplete and/or out of date as soon as it is published.
In the United Kingdom, we are lucky enough to have a pro-active, forward-thinking regulator, the Financial Conduct Authority (“FCA”). In 2014, it launched a new initiative,” The Innovation Hub” with the dual objectives of helping new altfi firms navigate the existing regulatory landscape, and educating itself about changes in fintech. Accompanying the Innovation Hub, is the FCA’s “Regulatory Sandbox”, launched in mid 2016, which provides an opportunity for altfis to test their proposals in a confined regulatory testing environment – and over the last two years, it has invited the trials of businesses from a variety of sectors, from insurance to pensions, retail to wholesale. The FCA has also signed a number of collaboration agreements with overseas regulators on the development of fintech, in a bid to share ideas and understanding and, recently, it sought feedback on whether it should expand its sandbox to global testing – an initiative that will no doubt be popular, given that, by its very nature, the digital provision of finance knows no geographical bounds.
The benefits of technological engagement, such as we are seeing from the FCA, cannot be underestimated. But engagement needs to be accompanied by the right sort of resources to support regulatory change. Perhaps unsurprisingly, the top computer scientists and mathematicians aren’t typically attracted to life as a regulator, and as such it can be difficult for even forward-thinking regulators to put their learning into practice. Which is why I think regulatory compliance in the era of fintech need to be re-focussed. No longer should it simply be about checking boxes to satisfy rules designed for earlier models of finance, or regulatory reporting through systems that don’t run on modern web browsers. It should be about problem solving: seeing technology as a way to not only provide financial services but regulate them too – using such techniques as behavioural algorithms and big data analysis to identify and react to risks. In doing so, regulators will attract the type of technology talent that it needs to effectively supervise today’s financial services firms.