The Transatlantic Policy Working Group (“TPWG”), an organization set up by Innovate Finance and some of its partners and which is dedicated to Fintech policy discussion between the United States and United Kingdom, recently published a report entitled The Future of RegTech for Regulators (the “TPWG Report”). RegTech refers to the use of technology to facilitate compliance with regulatory requirements via improved data analytics, reporting, and information governance (please see our previous blog posts on RegTech here and here). These technologies have the potential to help business increase accuracy of their reporting and compliance programs while concurrently reducing costs.
The TPWG Report highlights possible ways in which regulators may approach Fintech solutions for regulatory compliance in the future. Understanding the models behind the approaches adopted by regulators will be key to ensuring that Fintech entities understand the letter and spirit of future regulations.
The key conclusion of the TPWG Report is that regulators should keep an open mind to the different approaches being taken by their counterparts in other countries. There are different models which regulators can follow, which include the “Ecosystem Approach”, the “Digital Financial Infrastructure Approach” and the “Rule and Process Change Approach”. Critical consideration of these underlying models can be important in ensuring that regulation is consistent and strikes the appropriate balance between encouraging innovation and protecting the financial system from risk.
In an Ecosystem approach to Fintech regulation, regulators seek to create a comprehensive environment of cooperation between industry and policymakers. This can be done by building relationships with Fintech startups, academics, and incumbent players in the space and providing them with forums for communicating their ideas and concerns. The end goal is to facilitate a constructive dialogue between market players and regulators which drives innovation.
Several countries have adopted the Ecosystem approach to Fintech regulation. For example, the Monetary Authority of Singapore has created a Fintech & Innovation Group which seeks to work with industry in the areas of payments, technology infrastructure, and testing of next solutions. Likewise the United Kingdom’s Bank of England has established a Fintech Accelerator to encourage proofs of concept in priority areas like fraud prevention, enforcement action transparency, and trading exchange analytics. In Canada, both the Ontario Securities Commission and the Autorité des marchés financiers have established fintech advisory committees composed of industry experts.
Digital Financial Infrastructure Approach
The Digital Financial Infrastructure approach focuses on modernization of regulatory infrastructure and processes in the medium term. This model recognizes that highly complex reporting obligations inherently favour large incumbents with significant compliance teams. By streamlining and harmonizing processes across regulatory agencies, governments can spur innovation while enhancing data driven compliance.
The Digital Financial Infrastructure approach has been enthusiastically adopted by the Government of Austria. The Austrian Central Bank has collaborated with the country’s commercial banks to create a common platform for reporting. The idea behind this new platform is regulators should be proactive rather than reactive in their monitoring of financial markets. The Austrian model is different from template based reporting which requires institutions to aggregate their information and fill out forms after the fact. Instead, the new platform encourages institutions to share data such as loans, contracts, or deposits in real time. Analytics can then aggregate and enrich this data to assess how the position of the Austrian financial sector is changing on a daily basis.
Applying the Digital Financial Infrastructure approach has significant potential in countries which have a myriad of regulators interested in the financial sector. For example, the United States financial system is overseen in part by the Office of the Comptroller of the Currency, Federal Reserve, Federal Deposit Insurance Corporation, National Credit Union Administration, Consumer Financial Protection Bureau, Securities and Exchange Commission, Commodity Futures Trading Commission, Financial Industry Regulatory Authority, Federal Trade Commission and various additional state regulators. Similarly in Canada, the financial system is overseen by a multitude of federal and provincial regulators, including the Office of the Superintendent of Financial Institutions (OSFI), the Bank of Canada, the Financial Transactions and Reports Analysis Centre (FINTRAC), the Financial Consumer Agency of Canada (FCAC), provincial securities commissions and provincial financial services regulators, and various industry regulatory bodies. Simply updating existing platforms to have common nomenclatures for reporting could significantly enhance market efficiency and result in fewer resources being needed for corporate compliance.
Rule and Process Change Approach
In the longer term, regulators may want to change their rules and processes to implement policies for an increasingly digitized financial sector. Important areas which may require regulatory change include open application programming interfaces (“APIs”), digital identity, data protection, and machine learning. The Rule and Process Change Approach is a way of systematically adjusting regulations to accommodate emerging technology which maintaining regulatory consistency.
Updating rules and requirements to address the Fintech revolution is most effective if regulators collaborate with industry and adopt a principles based approach. The end goal of a principles-based approach is to avoid creating rules which become obsolete because they are not flexible enough to adjust to technological progress. For example, by publishing consultation papers on potential rules changes, regulators can get a sense of industry concerns before creating permanent requirements. The Canadian approach is consistent with this approach. Canadian financial services regulators have long favoured principles-based regulation and legislators and regulators issue consultation papers to obtain industry feedback. For example, the federal government has recently released consultation papers regarding Canada’s payments framework and the federal financial framework.
Regulatory and Industry Sandboxes
Sandboxes are a method of integrating the Ecosystem, Digital Financial Infrastructure and Rules Changes approaches. Regulatory sandboxes are groups within financial regulators which help Fintech entities “conduct controlled market tests under less stringent regulatory requirements”. The idea is that this will let innovators quickly create proofs of concept which can guide regulators in adjusting the financial sector infrastructure and rules as required. Regulatory sandboxes have been launched in the UK, Singapore, Australia, and Canadian securities commissions, among others.
The concept of regulatory sandboxes can be expanded to the broader financial sector. In an industry sandbox, different industry players come together to test solutions and “fail fast” in order to assess their proofs of concept. Industry Sandboxes are a key element of the Ecosystem approach to Fintech regulation. In Ontario, the Ontario Centres of Excellence recently announced a partnership with Boston-based FinTech Sandbox to help create such an industry sandbox in Canada, starting with Ontario, in order to further develop Ontario as a global start-up hub. Tracking developments in industry and regulatory sandboxes can assist regulators seeking to stay ahead of the curve in financial sector regulation.
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