july 2017 u.s. regulators enter the fintech sandboxregulatory enforcement actions that often result...
TRANSCRIPT
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polsinelli.com
July 2017
A t t o r n e y ###.###.####[email protected]
By Richard B. Levin, Jason A. Nagi and Robert W. Wenner
After trailing their foreign counterparts, U.S. regulators are focusing on how to regulate financial technology (“FinTech”) in a manner that will not stifle innovation. On May 17, the U.S. Commodity Futures Trading Commission (the “CFTC”) announced the creation of
LabCFTC, an initiative designed to enhance the agency’s engagement with the FinTech industry. This announcement follows the announcement by the Office of the Comptroller of Currency’s (the “OCC”) earlier this year of a draft licensing manual for FinTech companies seeking to conduct banking activities.
Regulatory sandboxes should help the U.S. FinTech industry grow in a healthy way. They help FinTech companies by giving them a framework that should spare companies from regulatory enforcement actions that often result in financial penalties and legal costs. Sandboxes are good for individual investors by promoting an appropriate level of regulation of innovative financial products and services. Sandboxes are good for the U.S. economy because they allow new companies to grow, creating jobs and a thriving employment sector. Finally, sandboxes are good for regulators, as they help regulators understand new technologies, where any regulatory dangers may lie, and alternatively, where there are none, allowing for efficient, rather than cumbersome guidance.
What is a Regulatory Sandbox
Regulatory sandboxes are a free-market approach to regulation created to support innovation. They allow companies to develop within predetermined regulatory bounds without being subject to the usual, often costly, and time-consuming, registration and supervisory requirements. Such requirements can be burdensome to early-stage companies, which have been the drivers of innovation in FinTech. Regulatory sandboxes do not entirely free companies from regulation. As part of the established bounds of the sandboxes, participants agree to limit their product and service offerings to certain established parameters, as well as to work with regulators on the development of regulation that are well-suited to the industry.
Regulatory sandboxes also offer benefits to regulators who are able to gain valuable industry insight through a constructive dialogue with the FinTech industry. This allows regulators to monitor the growth of the industry and tailor regulations to specific needs. In an industry like FinTech, this is critical, as many agencies have no specific guidance, leaving industry actors to do their best to fit within oftentimes ill-suited frameworks. The bounds of the sandbox are set in place by the regulator and can include limitations such as the restrictions on the size of
July 2017
In this Issue: What is a Regulatory Sandbox ........... 1
LabCFTC ............................................. 2
The FinTech Charter ........................... 2
International Sandboxes ................... 2
Conclusion .......................................... 3
Authors ............................................... 3
For More Information ......................... 4
Financial Technology (FinTech) and Regulation
U.S. Regulators Enter the FinTech Sandbox
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would preferably be used for building the disruptive technologies that are the hallmark of FinTech. The development of LabCFTC shows the CFTC has recognized that developing effective regulation for FinTech likely requires engaging with firms to learn about their specific needs in order to develop a regulatory framework that can foster innovation.
The FinTech Charter
Like the CFTC, the OCC has proposed a regulatory framework that is designed to promote innovation while protecting the public. In March, the OCC introduced a draft supplement FinTech licensing manual, for companies seeking to conduct banking activities that meet bank charter standards. Recognizing that FinTech companies are providing important financial services to millions of Americans, the OCC is seeking to provide a structure to allow for these companies to continue to provide those services with oversight to protect consumers, businesses and other participants.
Recognizing the agency was moving into new territory, the OCC was careful to provide policy considerations that support its expansion of banking regulation to FinTech. For example, the OCC stated that “providing a path for FinTech companies to become national banks can make the financial system stronger by promoting growth, modernization and competition.” The OCC believes expanding the scope of banking regulation to FinTech provides an “enhanced ‘window’ into developing technologies and financial innovations [which] positions the OCC to better evaluate and respond to the risks that accompany the delivery of those technologies.” The policy considerations reflect what some critics might call mission creep, and others might call a recognition of reality – the OCC is already supervising “technology service providers” with respect to “emerging technologies for banking services.”
International Sandboxes
While the CFTC and OCC are making advances in the regulation of FinTech, regulators in Singapore, the United Kingdom, Hong Kong, and the United Arab Emirates have announced and are developing regulatory sandboxes for FinTech. Unlike the regulatory approach of the United States, these countries are well-positioned to develop an effective regulatory model for FinTech. The Monetary Authority of Singapore (the “MAS”) is currently developing a system of sandboxes with rules tailored to the specific technologies in use. This will allow the regulator to develop rules that are tailored to the variety of FinTech products and services. The MAS intends to allow FinTech companies to grow within its proposed structure until they have reached a size where they would pose risks to
businesses permitted to participate, time limitations, pre-defined exemptions and specifications related to the degrees of risk exposure permitted.
A key aspect of all regulatory sandboxes is their collaborative nature, facilitating communication between the regulator and the industry to develop effective supervisory frameworks. Such communication and cooperation benefits all parties involved. The regulator is able to develop regulations that are tailored to the industry, that promote innovation, and that are designed to protect the public.
LabCFTC
The CFTC has created LabCFTC with two primary objectives:
� To promote FinTech innovation in order to improve market functionality; and
� To “accelerate CFTC engagement with FinTech and RegTech solutions that may enable the CFTC to carry out its mission responsibilities more effectively and efficiently.”
To help achieve these goals, the CFTC will create two primary components, GuidePoint and CFTC 2.0. GuidePoint will serve as a point of for communication between FinTech innovators and the CFTC, allowing industry actors to obtain feedback and information directly from the regulators related relevant issues, such as where current regulation may be lacking. CFTC 2.0 will serve as the heart of the CFTC’s regulatory sandbox, though the exact details are still being developed based upon industry feedback. The CFTC sees CFTC 2.0 as an opportunity to engage innovators to help inform the CFTC’s understanding of FinTech and the effect the industry may have on the agency’s operating and policy goals. As part of CFTC 2.0, the agency plans to develop a “secure testing environment” that will consist of a “secure, walled-off workspace to conduct experiments” with the goal of exposing the CFTC to new and disruptive technologies. The agency acknowledges CFTC 2.0 is in its early stages of development and sees it developing as the agency explores new modes of interaction and ways to promote responsible innovation.
Though CFTC’s program for engaging with FinTech firms is in its infancy, this is a critical development in the regulation of FinTech. The agency has acknowledged the importance of FinTech and has sought to engage innovators in a way that is not overly burdensome. Much of the innovation in FinTech has been driven by early to mid-stage companies developing new technologies. Regulation can have a disproportionate effect on such companies, creating a burden that can place demands on limited funds that
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Conclusion
Are the efforts of the OCC and the CFTC the beginning of a new U.S. approach to regulation of FinTech? No matter the classification, this is likely a step in the right direction. Innovation is a key economic driver, and FinTech companies are an important and growing source of financial freedom, democratization of money, revenue and job growth. The CFTC and the OCC will not only benefit as regulators, they will also benefit as innovators. Just as LabCFTC allows for a conduit of communication between the regulator and the regulated, the OCC should create a program that allows the parties involved to interact and learn how best to meet the goals of regulation. It remains to be seen exactly what will come from the OCC’s recent developments, but the agency and others in the U.S. can likely learn from their counterparts abroad.
The CFTC and the OCC have taken an important step-forward in the regulation of FinTech. Innovators need clear regulatory guidance for there to be sustainable growth in the industry. Regulatory sandboxes are a promising approach for both regulators and the FinTech industry. By allowing FinTech companies to develop without unduly burdensome regulation, the limited funds they have can be directed to developing new technologies rather than complying with unnecessarily complex regulations. In exchange for regulations that strike a reasonable balance between protecting the public and promoting market integrity, the regulators have the opportunity to learn from the industry where guidance is needed and to develop supervisory frameworks that are truly effective. We believe regulatory sandboxes hold a wealth of potential for FinTech, and look forward to other U.S. regulators following the lead of the CFTC and OCC.
consumers and the wider financial system if they were to carry on without more comprehensive regulation.
Similarly, the United Kingdom’s Financial Conduct Authority (the “FCA”) has recognized that the growth of FinTech has been the result of innovators and has sought to limit regulatory barriers to entry. To do this, the FCA intends to develop a regulatory sandbox to allow industry actors to refine their business models without full-fledged regulation while learning more about the industry’s needs.
Finally, the United Arab Emirates has identified FinTech as a driver of innovation. Though the UAE’s international FinTech presence is limited, it has sought to identify it as a hub for start-ups and economic growth by developing a regulatory sandbox. Similar to the regulatory sandboxes in the UK and Singapore, in November 2016 the UAE launched the FinTech Regulatory Laboratory, which will allow FinTech start-ups to operate under a reduced regulatory framework. Current regulations in the UAE pose unique obstacles to FinTech innovation, including that know-your-customer laws require face-to-face meetings with customers and there is a relative lack of credit scoring country-wide. The FinTech Regulatory Laboratory is designed to help FinTech companies navigate such regulations and ensure they are able to grow in a sustainable manner.
From an innovation standpoint, the United States risks hampering growth in FinTech due to the existing piecemeal and burdensome regulation at an inflection point for the industry. It is critical that financial services regulators in the United States develop a regulatory model that is designed to protect the public and promote market integrity, while promoting innovation.
Authors:
Richard B. Levin Practice Group Chair 303.583.8261 [email protected]
Jason A. Nagi Shareholder 212.644.2092 [email protected]
Robert W. Wenner Associate 303.583.8262 [email protected]
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For More Information
For questions regarding this alert or to learn more about how it may impact your business, please contact one of the authors, a member of our Financial Technology (FinTech) and Regulation practice, or your Polsinelli attorney.
To learn more about our Financial Technology (FinTech) and Regulation practice, or to contact a member of our team, visit our website at www.polsinelli.com/industries/financial-technology-fintech
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