Minding the regulatory gap in the Fintech space

The speed at which technology is changing the financial services landscape is imposing unprecedented pressure on regulators.

Digital technologies are reshaping payments, lending, insurance and wealth management – a process that the COVID-19 pandemic has accelerated.

As policymakers attempt to set the stage for its inevitable closer integration with traditional finance, they have a fine balance to tread between:

• Not stifling but fostering innovation
• Meeting their core regulatory objectives of financial stability, financial integrity, fair competition, and consumer protection (including data privacy).
• Staying a step ahead of the potential unintended consequences of disruption

Multiple technologies are enabling innovation in the financial sector. Be it APIs, AI and ML, biometrics, cloud computing or DLT, they all come with their own regulatory challenges.

These emerging technologies ­– in the guise of digital banking, crowdfunding, bordlerless payments, roboadvice or cryptoassets etc – are all scaling fast.

And they are creating new models of consumer behaviour – bypassing traditional intermediaries and eroding old boundaries — and disrupting traditional business models.

It all means the regulatory gap is a challenge: for innovators and regulators alike. The idea that regulations can be drafted slowly and remain unchanged, for long periods of time, has been turned upside down. But with most existing regulation not having been crafted with digital channels in mind, innovation and regulation is often at odds.

With the rapid emergence of new Fintech services, government agencies are being challenged to draft or modify regulations at a previously undreamed-of pace.

Regulatory agencies are having to weigh up the benefits and risks, while developing technology-specific policies, guidance, and/or regulations to protect consumers, and safeguard the financial system.

But the good news is that many governments are acting fast. The global success of the ‘regulatory sandbox’ approach is evidence of this.

In the UK, following the Kalifa Review of UK FinTech, the UK has now permanently opened the regulatory sandbox it began trialling in 2015.

What is it? It is a service that provides access to regulatory expertise to ease pre-launch testing for firms looking to deliver innovation in the UK financial services market.

And it is being emulated worldwide – in around 50+ countries, making sandboxes now synonymous with Fintech innovation.

This test-and-learn approach is proving a win-win for regulators and FinTech firms alike:

• Sandboxes offer Fintechs a safe environment in which they can test their products under close regulatory supervision
• Firms receive advice to help them navigate the complexities of regulations and to ease the route to authorisation
• Meanwhile, regulators get an evidence base for their regulations and awareness of what needs to change.
• Plus they gain the advantage of familiarity with new financial technologies and trends, and the opportunity to identify risks.

Technological developments may have not yet led to major changes in the structure of financial regulation. Its prudential safeguards, consumer protection and market integrity remain broadly unaffected.

But if the future of Fintech is to be driven by technology, regulatory and supervisory intervention will inevitably catch up as regulators gauge the innovation and efficiency brought by new entrants against the potential challenges for oversight, enforcement and consumer protection.

The key to success will be balance. For regulators, that means keeping pace with innovation. For the Fintech arena, it means responsible creation.