The Fintech guide provides expert legal commentary on key issues for businesses. The guide covers the important developments in the most significant jurisdictions.
Last Updated October 17, 2018
In recent years, both interest and activity in the Fintech sector have increased significantly, fuelled by, among other things, the rapid development of innovative technology that can be applied to the provision of financial services and a wide range of motivations. “Fintech” has become nothing less than a phenomenon, and presents myriad opportunities and challenges for the legal community, governments and regulators, recipients of financial services and other market participants worldwide.
Financial commitment to the Fintech sector has exploded in recent years. Although precise data is difficult to come by, a frequently cited report by KPMG estimates that nearly USD50 billion was invested globally in the Fintech sector in 2015, about USD25 billion was invested in 2016, and about USD8.4 billion was invested through the second quarter of 2017. Although these amounts are small compared to the overall size of the global financial services sector, they reflect a substantial commitment to the Fintech sector.
Fintech is an extremely broad term, with numerous and varying definitions provided by market participants, market observers, regulatory agencies and others. Virtually all these definitions make clear that the term encompasses a broad range of technologies, products and services, business models, business structures, target customers, distribution channels and regulatory regimes. As an example, the Financial Stability Board (FSB) has defined Fintech as “technology-enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on the provision of financial services.”
Of course, innovation in the financial services sector is not new. For example, the banking industry has experienced waves of innovation in the past, and is continuously innovating and finding new ways to deliver products and services. However, as the Basel Committee on Banking Supervision (BCBS) recently noted in a report on the Fintech sector, “the rapid adoption of new technologies along with their effect in lowering barriers to entry in the financial services market has fostered the emergence of new business models and many new fintech entrants. These factors may prove to be more disruptive than previous changes in the banking industry . . . .” The factors noted by the BCBS also reflect changes in social and demographic trends (including a growing degree of comfort with technology by the general populace and disruptions in financial relationships resulting from the 2008-2009 global financial crisis), the advent of new markets for financial services, and increased collaboration among market participants, all of which may differentiate the current Fintech phenomenon from prior waves of innovation in the financial services sector. More burdensome regulation for traditional financial institutions may also have led those institutions to scale back products and services, thereby allowing non-traditional providers opportunities to fill any market gaps. This has been particularly evident in the consumer lending area.
The products and services encompassed by the Fintech sector include offerings in the payments, clearing and settlement areas (such as mobile wallets, digital currencies, digital exchange platforms, and peer-to-peer transfers), the credit, deposit and capital raising areas (such as lending marketplaces, mobile banking, and crowd-funding), and the investment management area (such as robo-advising and high-frequency trading). There are also a number of other technology-based products, services and methodologies – the so-called “market support” area – that facilitate the provision of financial services and are typically viewed as part of the Fintech landscape (although not exclusively so), including data aggregators, distributed ledger technology, customer identification and authentication, mobile technology and artificial intelligence. Fintech innovations are also being applied to traditional financial services and structures, including new methods for effecting secure payments and deliveries between financial institutions, new systems for recording ownership and transfers of financial assets, and new approaches to structuring financial exchanges and trading systems. The Fintech sector impacts virtually every area of the financial services universe.
In earlier phases of innovation, the key actors in financial innovation were banking institutions (in particular large banks) and “traditional” technology service-providers (such as companies that provide operating platforms and other technologies to financial institutions). In the current Fintech boom, the key actors continue to include these types of entities, but also include a growing number of other participants. Many of these other participants are early- and mid-stage companies that do not have the financial, managerial and other resources of the traditional players, and many of them are not currently subject to the same kind of regulatory oversight as the traditional players. A number of traditional financial institutions have partnered with independent Fintech providers to co-develop technology and Fintech products and services, linking the innovation and creativity of the newer entrants with the scale, experience and resources of the traditional institutions. Large financial institutions have often developed these relationships to leverage their own internal innovation labs, often focused on the same subsectors within Fintech.
Fintech developments have attracted the attention of governments and regulatory agencies around the world. There have been significant efforts by governments, as well as international standard-setting organisations like the FSB and BCBS, to understand the implications of Fintech. Regulators issued new regulations and guidance for Fintech providers, both to address the impact of these industries on consumers and existing financial structures and, in some jurisdictions, to make their jurisdiction more attractive to Fintech providers. These developments raise both new opportunities and new challenges for lawyers practising in this sector.
The practice of law in the Fintech sector requires expertise spanning financial regulatory and compliance law, intellectual property law, privacy law and cybersecurity law, as well as an understanding of the commercial law underpinning the relationships among the participants. As a result of globalisation and the ease with which technology can cross borders, practitioners in the Fintech sector must work closely with legal advisers in other jurisdictions to ensure that clients can thread the needle on differing legal regimes to achieve their objectives. This Chambers Global Fintech Practice Guide is designed to help and encourage a cross-border dialogue about these issues with an eye towards professional co-operation and exceeding client expectations.
There are a number of issues and trends in the Fintech sector that are of relevance to legal practitioners in this area, and among the most important are those presented by financial regulatory regimes and their implications for Fintech providers. A few key areas of focus for regulators and Fintech providers are discussed below.
Application of existing regulatory regimes
The regulatory regime to which a Fintech provider is or may be subject is one of the most significant factors determining the scope of activities in which it may engage. In most cases, Fintech providers must fit within regulatory structures that were developed well before the Fintech boom began. As a result, whether and how Fintech providers are regulated will generally depend upon factors such as the nature of the products and services provided and how the provider is legally organised (for example, bank versus non-bank). Fundamentally, Fintech providers fall broadly (but not exclusively, and with some overlap) into four broad categories based on the level of regulation applicable to them, scaling from the most regulated to the least:
Some of these entities do not fit neatly (or at all) into existing frameworks of financial services regulation. This lack of “fit” has led to a substantial amount of uncertainty in some jurisdictions as to whether and how some Fintech providers that are not traditional financial institutions should be regulated, and whether the regulatory regimes for traditional financial institutions are sufficient – or excessively constraining – for some types of Fintech activity. Fundamentally, the policy objectives that underlie financial regulation may not be achieved by existing regulatory frameworks, or may be achieved at the cost of innovation due to regulation that is overly burdensome and not fit for purpose when it comes to Fintech. There may also be policy issues and risks presented by Fintech that are not addressed by existing frameworks. Financial regulation has struggled to keep up with the pace of Fintech innovation.
Financial regulation potentially applicable to Fintech covers many different areas. Regulatory priorities for Fintech include cybersecurity and privacy, anti-money laundering and sanctions -- topics that are discussed in the jurisdictional summaries in this Guide. Unsurprisingly, the focus on these priorities reflects current events. For example, incidents of data breaches by cyber attackers are on the rise, and even established and experienced handlers of consumer financial data are susceptible to attack – as was recently evidenced by a major breach at Equifax, a US-based credit reporting agency, in which the financial data of up to 143 million people were compromised. These events put even more pressure on all participants in the Fintech sector, but start-up companies in particular, as less mature companies are often viewed, rightly or wrongly, as more vulnerable to cyberattack.
The potential impact of the Fintech phenomenon has not gone unnoticed by governments and regulators around the world. They have begun to examine Fintech, including how it affects traditional financial institutions, consumers of financial services and financial systems in their jurisdictions. As part of this examination, regulators are considering new regulations and guidance for Fintech providers.
Importantly, regulatory trends resulting from the global financial crisis of 2008-2009 are a critical backdrop to the study of Fintech by governments and regulators, and affect how these bodies view Fintech. For example, many jurisdictions significantly increased the scope and depth of financial regulation following the financial crisis. In addition, regulatory scrutiny of traditional financial institutions intensified following the financial crisis, and resulted in significant enforcement actions against large financial institutions in various jurisdictions, particularly in the US. These enforcement actions encompassed a broad range of compliance areas, including anti-money-laundering and sanctions’ compliance, consumer protection and reduction in systemic risk. The resulting regulatory environment has been very challenging for financial institutions of all stripes. It is against this backdrop that regulators are considering the implications of Fintech.
The impact of this backdrop affects both traditional and emerging Fintech providers, albeit potentially in different ways. Traditional or established financial institutions may have trouble bringing new products and services to market in a challenging regulatory environment, particularly where it is not clear whether or how existing regulations apply. For start-ups and other Fintech providers that have not operated under a regulatory framework (or perhaps a less robust one), it may be financially and operationally difficult, or impossible, to build a compliance function that is sufficient to meet the requirements of a regulatory regime developed to apply to much larger institutions until a product or service has been developed and tested and is shown to be workable. Without workable products and services it is difficult to attract capital for compliance functions.
Regulators in some jurisdictions have focused their proposals for regulation of and guidance for Fintech on encouraging so-called “responsible innovation”. For example, the US Office of the Comptroller of the Currency, one of the principal banking regulators in the US, defines “responsible innovation” as “the use of new or improved financial products, services and processes to meet the evolving needs of consumers, businesses, and communities in a manner that is consistent with sound risk-management and is aligned with an institution’s overall business strategy.” Responsible innovation proposals seek to foster Fintech innovation while maintaining the safety and soundness of financial systems and consumer protections. This combination of objectives is challenging, and reflects the struggle that regulators face between encouraging innovation and preserving regulatory priorities. In an environment of limited tolerance for compliance failures by regulators, these objectives may seem incompatible.
Some jurisdictions have proposed a solution to these compliance burdens in the form of a regulatory “sandbox” for Fintech companies. A regulatory sandbox is meant to provide proponents of Fintech innovations with flexibility in meeting regulatory requirements and a safe harbour for inadvertent regulatory violations. Regulators in the UK, Australia, Abu Dhabi, Singapore, Malaysia, Hong Kong, Indonesia and Thailand currently offer Fintech sandboxes. They do so in recognition that Fintech products and services, even consumer-facing ones, may require beta-testing before being rolled out to the marketplace – and therefore before the companies offering the services have reached the scale that would permit them to implement full compliance functions. In addition to fostering innovation, these regulators hope to use sandboxes to improve their understanding and regulatory expertise by engaging closely with the innovative products and services in the Fintech pipeline. Some jurisdictions, such as the UK and Singapore, are also considering bilateral agreements with other countries that adopt a “substituted compliance” approach to permit a Fintech provider to operate in a participating regulator’s own jurisdiction while complying with the regulations of another jurisdiction. Other potential solutions include “innovation hubs”, in which Fintech providers exchange information with regulators on particular proposals to obtain formal or informal feedback or guidance. This feedback or guidance can take the form of guidance on applications, or no-action-type letters from regulators.
Another factor that regulators must face is the conflict between traditional financial institutions and the new entrants driving many Fintech innovations. The ability of Fintech providers in some jurisdictions to operate outside of traditional financial institutions, sometimes in a more lightly regulated fashion, have caused regulators and traditional financial institutions in some jurisdictions to express concerns about fairness and competitive disadvantages by operating through a model with a heavier regulatory burden. Regulators in some jurisdictions are seeking to ensure that comparable financial products and services are regulated similarly, regardless of the nature of the provider of those products and services, to minimise the opportunity for regulatory arbitrage.
Efforts to streamline cross-border compliance difficulties for Fintech providers will ultimately require multinational regulatory co-ordination. To that end, organisations such as central banks, international trade organisations, cross-border financial infrastructure associations and humanitarian organisations working towards global financial inclusion have expanded their outreach programmes to understand the costs and benefits of Fintech regulation. For example, the FSB recently issued a report covering, among other things, priority areas for international co-operation on Fintech issues. These efforts will likely increase as attention to Fintech by regulators and market participants increases.