The Quest for FinTech Regulation in the United States
FinTech growth has been sky-rocketing in the past years. As of Q4 2016 more than 1,000 FinTech companies are operating globally and over $105 billion in total funding has been raised for a total worth of nearly $870 billion.
As the following table shows, the FinTech landscape has been expanding with a wide variety of actors developing a large array of sectors ranging from RegTech to InsurTech, to Currencies and Blockchain.
After operating quite freely without the most stringent regulatory constraints applying to them, FinTech companies have caught regulators’ eyes by the OCC’s latest initiatives.
Moreover, as they are working increasingly in competition against or with regular Financial Institutions through partnerships, accelerators, incubators and acquisitions, it is highly probable that FinTech companies will be subject to some of the same regulations as the businesses they are currently disrupting.
A complex existing landscape along with increasing regulatory issues
With its biggest footprint on the U.S market, the growing and diverse FinTech ecosystem presents unique and significant legal, compliance, and practical challenges for both the regulators and traditional financial institutions.
On the opposite side of the Atlantic, other global hubs, like the UK and France, are taking into account the concerns and expectations of FinTech companies and have begun significantly modifying and even completely overhauling existing regulations in order to better suit the needs of this developing industry.
In the U.S., Federal and State laws represent a complex picture for FinTech companies with little to no guidance as to which laws apply. In addition, most of these laws were not designed for today’s internet and mobile based society or for the disruptive business models of FinTech companies that do not fit squarely into a particular financial sector. All of these elements contribute to the addition of several layers of complexity when interpreting these legacy regulations.
Certain initiatives, however, have been created in order to overcome the entanglement of regulatory barriers with which FinTech companies must wrestle.
The table below provides an overview of some of the most important federal regulations that may directly impact FinTech companies or that are crafted specifically for theses startups.
Initiatives to unravel the regulatory mystery
Considering the web of existing regulations, the Office of the Comptroller of the Currency (OCC) has decided to take the first step towards creating a uniform, national set of standards for Fintech companies. What started as a request for comments on regulatory standards by the OCC last March 2016 has since transformed into a formal proposal impacting the entire FinTech industry.
This OCC proposal aims to establish a new program that allows Fintech companies to apply for charters as “special purpose national banks” in order to foster “responsible innovation”.
The OCC intends to apply existing national bank licensing standards and requirements to Fintech companies seeking registration under the new program. In particular, registered Fintech companies would be subject to, among other things:
- Bank-like regulation and oversight (including compliance and risk management controls and ratings
- Varying supervisory standards depending on the size and complexity of the Fintech company
- Identical minimum capital requirements as traditional banks, although the OCC will have the power to establish special minimum capital requirements, on a case-by-case basis
The most significant advantage of subscribing to this optional program would be for FinTech companies to participate in building this initiative that benefits federal preemption of state laws. Such participation would limit the oversight and authority of state agencies over these chartered companies.
On the downside, registered Fintech companies would be subject to the same extensive federal regulation (including regulatory agency supervision as well as reporting and examination requirements) as national banks.
As one of the key drivers of change in the Financial Industry the FinTech sector needs guidelines and a clearer regulatory path to meet consumer protection requirements.
This proposal is currently facing challenge from state regulatory authorities such as the New York Department of Financial Services (NYDFS).
A second initiative, the Financial Services Innovation Act of 2016, created a regulatory "sandbox" approach for FinTech firms in September 2016 by Representative Patrick McHenry. This framework allows companies to work hand-in-hand with a regulator when testing a FinTech product or service. This bill would provide FinTech firms with the ability to test new products or services with a limited launch without going through a full regulatory process. This bill requires the 12 financial federal regulators to develop an internal "Financial Services Innovation Office", as part of this approach, where companies can seek help in testing a product or service.
In addition, two US regulators recently launched initiatives that encourage cooperation between the securities industry and its regulators. The US Commodity Futures Trading Commission (CFTC) launched LabCFTC in May 2017, and the Financial Industry Regulatory Authority (FINRA) announced its Innovation Outreach Initiative this past June.
The main goal of the LabCFTC initiative is to promote responsible FinTech innovation in the markets subject to CFTC regulation, thanks to two main components:
- GuidePoint is a point of contact specifically dedicated to help FinTech innovators engage with the CFTC, learn about the CFTC’s regulatory framework, and obtain feedback and information on FinTech market innovations. This platform aims to better innovators’ understanding of the CFTC’s regulatory framework and its application to their FinTech technology.
- CFTC 2.0 is an initiative that fosters the adoption of new technologies by the CFTC into its activities through collaboration with the FinTech industry.
FINRA President and CEO Robert Cook defined the mission of FINRA’s Innovation Outreach Initiative as “support[ing] innovation in the industry while maintaining investor protection and market integrity.” This initiative will create a “Fintech Industry Committee” to facilitate discussion on FinTech developments and how FINRA’s rules and programs will apply to such developments.
In Sia Partner’s opinion, federal regulators will keep designing sets of rules allowing FinTech companies to be submitted to the same regulations applying to traditional Financial Institutions. This would help protecting consumers interacting with FinTech companies as well as allowing FinTech firms and Financial Institutions to interact in a more frictionless manner. These rules could also progressively overcome state-level regulations in order to help FinTech navigate more easily the complex regulatory landscape and to federate healthy innovation.
The regulatory landscape surrounding Fintech products and services will continue to change significantly, as existing laws are interpreted in new ways, and more importantly new laws are enacted, to deal with the unique challenges presented by the Fintech industry. Regulators also struggle to navigate this maze too, for there is always the risk of imposing too many regulations and costs on growing Fintech companies, consequently undermining innovation.
Several Regulators are launching initiatives to clarify the landscape of regulations applicable to FinTech companies. The OCC, the CFTC and FINRA acknowledge the need for continuing coordination among regulators in the FinTech industry. These plans are a first step in catching up with similar approaches launched by regulators in other countries such as the adaptations of laws that countries like the UK or France have been implementing.