Putting the Fintech House in Order

It seems that the years when fintech was just a developing sector where everyone was competing for a piece of the lucrative pie have long gone. The time has come for this millennial-driven industry to regulate itself and take its place as one more wheel of the financial industry’s vehicle.

At the end of February this year, the International Organization of Securities Commissions (Iosco) will hold a closed-door conference at its headquarters in Madrid to discuss how regulators across the world should deal with technological advancements that attempt to disrupt the traditional structures within the capital markets. An Iosco spokesperson tells Waters that the Committees will try to agree on a number of fundamental principles that will help global markets take full advantage of emerging technologies. 

Determining best practices around how to implement and operate new technologies such as blockchain and artificial intelligence (AI) has been a point of interest for many regional regulators lately. They understand that fintech, with its explosive and seemingly unlimited growth potential, has to be brought under the control of the industry that it is supposed to be serving.  

In December last year, the World Federation of Exchanges (WFE), the industry’s largest association of exchanges and clearinghouses with over 63 members from all over the world, published a paper, Fintech in the Market Infrastructure, calling on market participants and regulators to coordinate their efforts to produce a set of standards for technology solutions specifically for the capital markets. The paper suggested that emerging technologies and software coming from either fintech firms or large technology corporations should not remain unregulated and that the existing legal framework from regions including the EU and the US should be sufficient in determining best practices with respect to how these technologies should be handled. 

Battling Risk

The concept of adopting global standards for fintech boils down to preventing the amount of risk that the new technologies introduce. Mike Leibrock, chief risk officer at the Depository Trust and Clearing Corp. (DTCC), says that while fintech can increase competition, improve efficiencies and lower costs, it also brings a certain level of operational risk. “Fintech has the potential to fragment the creation and delivery of financial services, which could result in increasing cyber risk, operational issues and divergent data standards that hamper interoperability, leading to a less efficient financial system overall,” he says. 

Spencer Mindlin, capital markets analyst at Aite Group, adds that when there is a dearth of global standards, the industry faces complexities, inconsistencies and possibly additional risks and costs. “You have investors in companies meeting in a global marketplace, accessing extended capital and they have to deal with inconsistent rules and policies from national regulators,” he says.  “The lack of global standards adds friction, risk, and complexity to the system.”

Mindlin says standards that can be audited are able to provide the confidence clients and investors seek. “Clients should be able to trust that you’re holding your technology to a certain level and they can have confidence in it,” Mindlin says. “The only real way to know whether or not you can rely on the technology you’re outsourcing from fintech firms is by having standards.”

Fintech Reaction

The WFE’s paper was met with equal measures of enthusiasm and skepticism. Jean-Marc Guiteau, head of regtech, digital transformation at BNP Paribas Securities Services, explains that the report was proposed by those who represent market participants’ interests. “Depending on which side you’re on, you could either consider these principles to be fair or that they’re going a bit too far and limit innovation,” he says. He adds that from a fintech perspective, it would be understandable to dismiss any effort to impose standards on them. However, the industry has come to a point where standards are much needed. “Fintech firms offer their products with minimal impact on regulation, and that’s a good way for them to stay agile,” Guiteau says. “That’s the starting point of the discussion, and that’s the main driver of the WFE report, which seeks to ensure some kind of level playing field for all participants.”

Veronica Augustsson, founder and CEO of Cinnober, a Stockholm-based technology provider for exchanges and clearinghouses, says she opposes any external interference because it would be a mistake from both regulators and capital markets participants to apply the existing legal framework to technology companies. “Technology should not be regulated,” she says. “If we’re talking about a standard on how to technically communicate and solve a problem, I think the industry is better off working together on what protocol or that standard should be.”

Markets vs. Regulators 

Standardizing the fintech market has evolved to be not only a heated debate between fintech firms and financial institutions, but also a competitive field between regulators and the capital markets they oversee. Both claim the role of the standards setter, creating a bipolar view of the future of financial technology. For most participants and technology companies, markets should be able to self-regulate when it comes to establishing and adopting fintech standards. “A standard does not become a standard just because someone had a great idea—it is important to have a community that can agree that something is working well and is, therefore, worth implementing. That’s the easiest way to create a new standard,” Augustsson argues. “Standards that are regulatory-driven or mandated tend to be more complicated and may create a risk that is not aligned with market expectations and capabilities.”

Christopher Truce, head of fintech at Saxo Bank, says the Danish broker is the perfect example of how the industry can set its own best practices when implementing new products. “As a fintech provider, we work with hundreds of different institutions that are already using our infrastructures to provide services to their own clients,” he says. “As such, one can see how standards can be developed, because of the multiple integrations that exist between institutions.”

Truce says regulators are well aware that too much regulation around fintech stifles innovation and that, at least in Europe, the authorities have promoted a more lenient approach, allowing fintech firms to flourish. “Currently in Europe, a number of regulators offer sandboxes for startups to operate in, enabling them to experiment with emerging technology in a controlled environment,” he says. 

However, the question remains, how easy is it for market participants to set their own standards in fintech without the regulators’ intervention? The doubts as to whether participants are able to set best practices for fintech are fairly legitimate. Recent history has proved that capital markets often don’t excel in policing themselves. Regulators have had to step in and impose policies, not for the sake of imposing them, but for the sake of ensuring that markets are safe and are operating as intended. 

Aite’s Mindlin says the landscape since the financial crisis of 2008 has indeed changed, but there are still a number of hurdles to overcome when it comes to coordination among market participants. “If you look at the trend, it leans toward better collaboration and coordination among players,” he says. “But you’re dealing with a competitive environment and the problem with that is the extent to which they can cooperate.”

Mindlin says the problem also lies in the fact that there are differences in the various communities inside the markets. “There is definitely a lot more coordination among the equity markets than other asset classes because they are already more regulated and have to have a coordinated response to the regulators,” he says. “The way the equities markets cooperate versus the foreign-exchange (FX) markets, for example, is apples and oranges because FX is less regulated and there’s little to no collaboration.”

Challenges 

With this lack of collaboration in the markets, the rationale for Iosco stepping in and proposing global guidelines around fintech doesn’t seem too misplaced. There are, nevertheless, a significant number of challenges that need to be addressed. For example, as Mindlin says, there are different priorities, agendas, political regimes and approaches from all involved parties. “These priorities change over time, and not all markets are at the same point of their growth,” he says. “What may be best practice for one market might be much more advanced for another that’s trying to kick-start its capital markets environment.”

John Salmon, technology partner at the UK law firm Hogan Lovells, says the issue is complex. He adds that regulators need to decide how to issue international guidelines in order to create a level playing field between fintech firms and incumbent financial institutions, as well as space for technology companies that are not defined as fintech entities but can offer various ancillary services to the industry. “The starting point is that you always have to apply the existing laws and regulations to the new products and services the fintechs are creating,” he says. “The challenge with that is that it can be quite difficult to apply existing laws designed for an analog world to a digital environment, particularly one that involves a big shift in how things are done.”

The next big challenge is that while regulators seek to enact the same principles on fintech firms, different jurisdictions have different ways of imposing rules depending on their legal tradition. For example, as Salmon explains, US legislation tends to be more prescriptive than the principles-based regulations of the EU. “One of the challenges of that is how you balance certainty versus adopting a technology-neutral approach,” Salmon says. “EU legislation is written in a technology-neutral way to remain relevant as technology changes while in the US, the law is written in a more prescriptive way.” 

Utopia or Reality

How feasible it is for Iosco to write global guidelines for fintech and market participants is an issue that crops up every time the involved parties have this conversation. According to BNP Paribas’ Guiteau, before anything else the involved parties need to realize their role in the system and the significance of evolving into a flexible trading ecosystem. He explains that while regulators have to ensure that there is a consistently regulated ecosystem and a consistent operating market, market participants’ roles are to facilitate and provide market access and bring value by ensuring that investment transactions are performed efficiently in terms of price and liquidity. “In between, there are fintechs that come and help with things that are not working well, whenever there are inconsistencies between regulators and participants,” he says. 

Guiteau explains that if everyone stays in their positions, everybody loses. “We have to define how to interact and to articulate the interactions between these different stakeholders,” he adds.

After this interaction is achieved, the capital markets industry can start creating global standards despite the challenges, according to Hogan Lovells’ Salmon. 

“I don’t think it’s impossible to set global standards—it would be difficult to accomplish, but it would be a fantastic achievement,” he says. “Even a simple move to common standards or principles would be welcomed.” 

Salmon says if regulators want to set the standards on a global scale, they need a higher level of agreement between them and the markets in terms of how they will regulate in a broad, principles-based way.  After all, it will be even harder for markets to do it themselves, adds Aite’s Mindlin. “There’s nobody out there to do it,” he says. “Companies would have to go to third parties to confirm that they’re meeting the standards. It might create a whole different business of providing affirmation that the standards have been met.”

Globalization

There is one variable left outside of this interconnection between markets, regulators and fintech firms that could foster the establishment of global standards: globalization. We talk about global markets, global regulators and a global industry, but do any of these really exist? According to BNP Paribas’ Guiteau, in theory, yes they do, but in practice they do not. “We are a sum of people who have knowledge of the local market, the local practices and standards,” he says. “Regulators have a national perspective in their laws, while the central counterparties (CCPs) and marketplaces have access to every asset in the world, yet they serve mainly local investors. And finally, fintechs address mostly local or regional issues.” 

So far, he says, he has not seen any fintech or regtech firm offering a truly global service that covers all markets and all regulations. “The world is complex and I am not even sure we need such global intervention,” he adds.