As federal fintech regulatory plans founder, a push for alternatives
WASHINGTON — As federal regulatory options for fintech firms remain elusive, many in the space are pushing for the creation of an alternative "flexible" supervisory regime that relies on existing authorities and a more collaborative approach from state agencies.
The Office of the Comptroller of the Currency has so far been stymied in its attempts to create a national fintech charter, with it planning to appeal a court decision last month that threw out its proposal of the idea. The Federal Deposit Insurance Corp., meanwhile, appears to still be debating whether to grant industrial loan company charters to fintech applicants.
That has left the industry, which is currently overseen by dozens of state regulators, seeking other options. The Information Technology & Innovation Foundation, a Washington think tank with a history of tech-friendly policy stances, issued a report this week that included a range of suggestions, including more multistate compacts and reciprocity agreements among state agencies and the expanded use of no-action letters and regulatory sandboxes.
But the recommendations face headwinds in the current political environment, with lawmakers skeptical of technology firms' attempts to break into banking.
“There’s a genuine desire among regulators to open the door to allowing more innovation within the system,” said Cliff Stanford, a partner at Alston & Bird. “But there are elements of our legal structure that would constrain those efforts without some real change.”
Pointing at the myriad of regulators on both the state and federal level that fintech companies have to contend with in order to get to market, the ITIF argues that when states move together on supervision, innovators with national ambitions can focus on innovating, rather than complying with 50 different state regimes. The report points to Vision 2020, a project launched by the Conference of State Bank Supervisors last year to streamline the licensing process for fintechs operating across state lines, as one example.
“Without a single, comprehensive strategy for financial regulation, regulators will continue to be at odds, and states will continue to pass mismatched rules that raise costs and reduce consumer welfare,” the report said.
To date, that approach has seen some success in the U.S. — namely with reaching multistate agreements on the use of certain technologies and money transmitter licensing — especially when paired with a backstop at the federal level, where a national framework will takeover if a state can’t agree on a certain set of rules.
“Frankly, fintech companies would like to see the efforts on passporting and in the money transmitter space expanded to other product lines,” said John Kromer, a partner at Buckley LLP. “That kind of approach on some of these issues can be very beneficial in promoting greater uniformity but also maintaining federalism."
The appeal of state-level agreements has also grown as the OCC's fintech charter proposal has foundered.
“The reality at this point is that national efforts [at fintech regulation] are going to run into difficult challenges in court, but there are some genuine efforts happening among a plurality of states,” Stanford said.
But it hardly seems to be a silver bullet. Others argue that the more state patchworks that appear for fintechs to keep track of, “the greater their compliance costs,” said Roy Kim, director of banking asset management at ACA Compliance. “States and even countries are coming out with their own versions” of fintech regulation," he said, “which increases the complexity and cost for any firm to effectively comply.”
The ITIF’s report also encouraged broader use of two regulator tools to give fintech firms room to experiment with their products: regulatory sandboxes and no-action letters.
Regulatory sandboxes are more formal regulatory arrangements that allow multiple firms to interact with a limited but real pool of consumers in a new kind of financial service market or business model. Sandboxes, the ITIF report argues, allow regulators to closely study the potential effects a new kind of product without squashing it outright.
Although sandboxes aren’t as widely used in the U.S. as they are in Europe and Asia, “we have a very business-friendly leadership among the federal banking regulators,” Kim said. “As such, it’s a good time to try.”
Similarly, no-action letters, used by the Consumer Finance Protection Bureau and Securities and Exchange Commission, basically function as individual applications for certain firms and products. While the letters are typically granted on a case-by-case basis and built around the facts of a given application, the ITIF argued in its report that they “allow regulators to send a signal to the market about what behaviors are permissible, thereby setting a precedent and allowing financial services to innovate around those signals.”
Some experts agree no-action letters have a real potential to foster innovation if used on a broader scale. “They absolutely could have the broadest impact, especially when it comes to the CFPB,” Kromer said. “It’s a vehicle that’s approachable and can produce reliable guidance and some real certainty.”
But others have pushed back on the efficiency of such letters. The CFPB, in particular, has said that no-action letters are potentially subject to judicial review, which could make a fintech firm vulnerable to years of litigation.
“That clouds the horizon for any fintech company that wants to pursue that kind of approval,” said Stanford. But even with that risk, many fintech companies see a social value in no-action letter approval. “It’s like street cred: It shows a fintech company can engage with regulators and market itself on that basis.”
The ITIF’s report also raised the specter of a more controversial idea — self-regulation.
“Self-regulation allows industries, especially those with no specific guiding laws, to set rules and enforce them under the supervision of traditional regulators,” the report argues, pointing to the examples of the Financial Industry Regulatory Authority for securities brokers or the National Automated Clearing House Association for payment processors.
But several analysts said that the idea of self regulation for fintech firms specifically is hard to imagine given the sheer range of focus and services to which that the “fintech” label can be applied.
"Self-regulation could makes sense in particular industries, but ‘fintech’ as a term is so overbroad as to be almost meaningless at this point,” Kromer said. “At the same time, there is a role for segments of the industry to proactively make recommendations and come to the table with ideas for regulation.”
Others argued financial services simply have too many regulations to contend with to ever expect self-regulation to be a realistic possibility. “Given how technology is integrated in every part of a bank and the very high expectations by federal banking regulators from a risk and control perspective, I do not see self-regulation of the tech industry any time soon,” Kim said.
Then there’s the risk to consumers that’s inherent to industry-friendly regulation. “You really can’t self-regulate in the consumer protection space,” Stanford said. “The rubber hits the road when it comes to consumers.”