Regulation Innovation

The differences in approach to FinTech regulation in the United States, the United Kingdom, and the European Union

The tension between innovation and regulation and the need for clear guidelines tightened last week in the United States. Two officials from agencies that regulate U.S. financial institutions moved their financial-technology regulatory agendas forward in an attempt to promote innovation while protecting consumers.

The Office of the Comptroller of the Currency (OCC) is willing to issue special national bank charters to FinTech firms as a way to advance financial innovations in the public interest, including financial inclusion. “Providing a national charter to those responsible innovators who seek one and meet our high standards can help promote economic growth across the country and recognizes that technology-based products and services are the future of banking and the economy,” said Thomas J. Curry in a Dec. 2 speech.

Responsible innovation

Responsible innovation” is the OCC’s tag phrase for the initiative, put forth in a paper released in March 2016 and extended in October. “Individuals and businesses should have access to useful and affordable financial products and services that meet their needs, and that are provided in a fair and responsible manner, no matter the source of those products and services,” Curry said. Reaction is predictably mixed.

The Federal Reserve Board of Governors also weighed in on Dec. 2 speech by Governor Lael Brainard at the Conference on Financial Innovation Dec. 2. Picking up on the “responsible innovation” phrase, governor Brainard stated, “The challenge will be to foster socially beneficial innovation that responsibly expands access to credit for underserved consumers and small businesses, and those who otherwise would qualify only for high-cost alternatives.”

For its part, the Consumer Protection Finance Bureau (CFPB) recently issued a request for information on consumer access to financial records. The RFI is part of the bureau’s charge to “develop practices and procedures that enable consumers to realize the benefits associated with safe access to their financial records, assess necessary consumer protections and safeguards, and spur innovation.”

Meanwhile, regulations in the United Kingdom and Europe are moving apace, with support for competition in the U.K. and for consumer choice in the Eurozone. These and a number of other initiatives fall under the my tagline “The Empire Strikes,” one of my FinTech trends to watch in 2016. Given the recent activity as 2016 draws to a close, the development of FinTech regulatory regimes will be the most critical trend in 2017.


Regulatory approaches to innovation

Regulators rightly walk a fine line between supporting innovation and protecting consumers. Several sessions at the Money20/20 FinTech conference held Oct. 23 – 26  highlighted the different approaches regulators can take to keeping a regulatory balance.

“The regulators have the hardest job, to help innovation happen and block harm,” said Jo Ann Barefoot, a former regulator who heads the Barefoot Innovation Group. She held a fireside chat with CFPB director Richard Cordray at Money20/20.

Money20/20 speakers highlighted three different approaches to regulation:
1. A paternalistic approach to consumer protection first and foremost exemplified by the U.S. CFPB and OCC.
2. An entrepreneurial approach to increasing competition in financial services taken by the United Kingdom’s Financial Conduct Authority (FCA).
3. A public-interest approach concerned about making financial institutions into utilities characteristic of some regulation from the European Union.

The “responsible innovation” tag used by the OCC and Federal Reserve and, in effect if not in name, the CFPB puts innovation and consumer protection as dual goals. The balance can go either way, and likely will vary by U.S. regulatory authority.

Given Fed governor Brainard’s warning, however, FinTech firms operating in the United States should not expect a regulatory break even with a special charter from the OCC. “New entrants need to understand that the financial arena is a carefully regulated space with a compelling rationale underlying the various rules at play, even if these are likely to evolve over time.”

The U.K.’s Financial Conduct Authority (FCA) started Project Innovate to make the regulatory system more innovation friendly. The FCA provides unofficial advice to FinTech startups and runs Project Innovate to provide a “regulatory sandbox” in which FinTech firms can test their products within a regulatory framework. Interest was so high in the initial FCA class that it had to expand the number of companies supported and accepted 24 in its first class.

“The bottom line here is not innovation,” said Bob Ferguson, who heads Project Innovate for the FCA, speaking at Money20/20. “The bottom line here is competition with innovation as a means to that end.” The approach appears to work, given that London remains the world center of FinTech innovation, even with some slowdown in the wake of the Brexit vote.

In contrast, the CFBP and other U.S. agencies clearly put priority on innovations that expand financial inclusion, whether that means providing services to people without bank accounts, expanding their access to reasonably priced credit, or reducing the costs of financial services to consumers. “It is clear that FinTtech companies hold great potential to expand financial inclusion, empower consumers, and help families and businesses take more control of their financial matters,” the OCC’s Curry said.

The CFBP runs Project Catalyst to encourage innovations that are “safe and beneficial for consumers.” Cordray provided some guidance on that by asking entrepreneurs at Money20/20 to consider such questions as:

  • Does your project expand access to financial services?
  • Does it serve not only people at the bank but also the unbanked?
  • Does it increase access to credit without exorbitant interest rates?

Open data

In the European Union, the move for banks to connect using APIs in order to give consumers the ability to grant other parties to access their accounts is causing a great deal of anxiety, noted Rene Pelegero, President and Managing Director, Retail Payments Global. Speaking at the Federal Reserve Bank of Chicago Payments Symposium on Oct. 12, he described how merchants and other third parties will be able to obtain permission from consumers to access funds in their bank accounts.

“Then there is fundamentally a realtime transaction, where the consumer account is debited and the merchant account is credited,” he explained. This effectively eliminates banks as intermediaries and turns them into public utilities, complete with regulated fees.

But PSD2 goes beyond payments to bring  dramatic changes to banking. The underlying premise endorsed in the U.K. and under study by the CFPB is that the account data do not belong to the bank; they belong to the consumer.

Cordray sparked a bit of ire among bankers when he endorsed the principle of consumer control over account information in his prepared remarks at Money20/20. “Let me state the matter as clearly as I can here: We believe consumers should be able to access this information and give their permission for third-party companies to access this information as well,” he said.

Technically this translates in the U.K. into a proposal to require banks to adopt an “open API” technology stance. Whether that encourages or stifles innovation remains to be seen and depends on your point of view. The products of many FinTech firms either rely on or would benefit from bank account and data access.

APIs or application programming interfaces are software connection for passing data from one program or service to another and are critical to the future of FinTech and financial services, and investors are taking note. Payments technology firm Stripe, which provides APIs and other technologies that make it easy for ecommerce systems to connect to payments infrastructure, on Nov. 25 raised another $150 million. The importance back-end connectivity technologies nearly doubled its valuation for the round to $9.2 billion.

Regardless, regulators working with FinTechs is a good move. The technologists need the regulators looking over their shoulders, as they tend to equate technology with innovation. As the financial crisis so vividly illustrated, however, existing financial institutions do not necessarily put their primary focus on consumers and their interests.

Innovative applications of technology and regulation together can empower individuals and enable smaller businesses and financial institutions to compete. If it makes the larger financial institutions and networks scramble a bit, so be it, but let’s do it in a way that rewards everyone for their efforts.

As Barefoot put it, “We have entered a time when technology potentially makes it possible to accomplish things we have been wanting to accomplish with regulation for decades on both protection and inclusions, if regulators get it right.”