The growth of financial and regulatory technologies is redefining the relationship between central banks, regulatory bodies and financial services firms. In 2016, venture capital investments in fintech reached USD 17.4 billion globally,1 but the enormous opportunity presented by its growth may be countered by uncertainty over a potential impact on systemic risk.
Key Insights
- Global supervisory authorities are likely to pursue a more intense focus on the regulatory perimeters of fintech in order to protect investors and mitigate systemic risk, and it is important that financial institutions play a role in supporting this process
For asset managers, the scope of fintech disruption is still being defined. The extent to which new technologies will enhance existing investment strategies or further automate processes will partly depend on the evolution of the regulatory environment. As supervisory authorities align compliance obligations with the rate of innovation, industries and markets will continue to feel the effects of digital transformation. Alongside this, the internal development and use of blockchain and Robotic Process Automation by financial services providers may lead to further co-operation with regulators to ensure robust governance.
Cautious Experimentation
Regulators around the globe are closely following developments in the burgeoning fintech sector. In the UK, for example, the Financial Conduct Authority (FCA) has worked with the Bank of England to launch a 'regulatory sandbox'. This innovation hub is being used to trial new financial and regulatory technologies within a closely supervised environment. In return, financial firms operating within the sandbox are afforded waivers or exemptions from some of the regulatory requirements.
Regulators around the globe are closely following developments in the burgeoning fintech sector
Such testing environments are gaining broader attention. Hong Kong, Singapore, Abu Dhabi, Sydney, and most recently, Toronto, have followed the UK in establishing their own regulatory sandboxes. The Reserve Bank of India, however, is still considering this approach amid concern around unfettered experimentation. The testing of new products, services, business models, and delivery mechanisms in live environments enables regulatory bodies to remain agile in their drafting and understanding of compliance obligations, as well as gauging the potential market impact and underlying systemic risks.
Speaking at the Deutsche Bundesbank G20 conference in January 2017, Financial Stability Board Chairman Mark Carney spoke broadly about the evolving systemic risks associated with new financial technologies.
“Some innovations could generate systemic risks through increased interconnectedness and complexity, greater herding and liquidity risks, more intense operational risk and opportunities for regulatory arbitrage," he warned.2
Financial firms should expect to see more dynamic settings of prudential requirements and a broader commitment to resolution regimes
Carney went on to stress that authorities must perform thorough business model analysis and market impact assessments to arrive at sensible and proportionate regulatory requirements. As regulatory bodies seek to understand these emerging risks, investors and financial firms should expect to see more dynamic settings of prudential requirements and a broader commitment to resolution regimes.
Despite the importance of mitigating systemic risks, bolstering compliance obligations is rarely straightforward. As such, the Financial Stability Board and other global supervisory authorities may pursue a more intensive focus on the regulatory perimeters that should apply around the fintech sector. In order for these frameworks to be effective and enforceable, it is important that current financial institutions co-operate this process.
For investment and financial firms, as well as industry bodies, regulatory sandboxes present a unique opportunity to experiment with these technologies in a less regulated environment which allows new products, services, or business models to be pursued.
Working with Regulators
To leverage the opportunities supervisory experimentation represents, firms must collaborate with regulatory bodies and offer guidance to central banks on how best to shape future compliance obligations. For example, following a 10-hour outage of the UK's real time gross settlements system in 2014, Deloitte conducted an independent review on behalf of the Bank of England (BoE). As a result of the report's key recommendations, the BoE delayed the joining of two banks to the Clearing House Automated Payments System and facilitated faster access for "challenger banks" to the Bankers Automated Clearing Service (BACS) and Faster Payments schemes.3
For financial services providers, being part of the conversation about how emerging fintech innovations are policed may ultimately provide a competitive advantage
When it comes to managing risk, regulators and central banks are eager to take on board the expertise of private firms. For financial services providers, being part of the conversation about how emerging fintech innovations are policed may ultimately provide a competitive advantage over players that exclude themselves from this process.
As fintech becomes more vital for global trading and investment, bringing together industry knowledge with regulatory experience looks to be a promising way to further grow markets. The chance to play a role in shaping future frameworks should be seen as an irresistible opportunity for innovative financial firms to shape their competitive advantage. If they are not contributing to the discussion about how these technologies are regulated, the firms risk not preparing for the future.
Sources
- Innovate Finance (February 7, 2017) - Innovate Finance Releases 2016 Global FinTech VC Investment Landscape
- Deutsche Bundesbank G20 conference on, “Digitising finance, financial inclusion and financial literacy, " (January 25, 2017) - The Promise of FinTech – Something New Under the Sun?
- Deloitte (March 23, 2015) - Independent Review of RTGS Outage on 20 October 2014