Until recently, federal regulators appeared to be waiting for someone else to make the first move in fintech.
But in March, the Office of the Comptroller of the Currency released a white paper calling for a new dialogue on "responsible innovation." Soon enough, representatives from across the financial industry — big banks, online lenders and virtual currency companies — proposed a range of solutions to the challenge of regulating fintech.
While the proposals varied, they seemed to agree on one thing: Today's complex regulatory landscape could stifle innovation in the U.S.
There are moving parts on both sides of the debate. Old-guard financial institutions are increasingly partnering with fintech companies. Still, other parts of fintech are attempting to distance themselves from the banking sector entirely. Meanwhile, regulators are struggling to unite in creating consistent rules of the road for these modern businesses.
"We have so much regulation in finance that it's very hard to change one piece of the regulatory ecosystem without impacting others unintentionally," said Jo Ann Barefoot, a consultant who has advised both regulators and fintech companies. "Nobody would have designed the regulatory structure we have now, today."
This is not purely politicking and policymaking, however. The complexities of the current system and uncertainty of the future threaten to leave fintech in the U.S. lagging behind the rest of the world, observers said.
Why an OCC Charter?
Fintechs have a beef with state-by-state licensing. It's burdensome.
Virtual currency firms, for example, typically have to register as money transmitters in each jurisdiction they want to operate in and then comply with varying standards for things like net worth, bonding and investor due diligence.
"It's completely fractured," said Jerry Brito, the executive director of Coin Center, a virtual currency advocacy group. "What companies are looking for is to have one clear set of rules, and ideally [one] regulator that they can deal with."
That's why many fintech companies were excited to hear the OCC is looking into the possibility of a national fintech charter — which would likely be similar in scope to the limited-purpose charters created for credit card companies and Internet banks.
The OCC is still working on it. The agency is set to issue a framework this fall that will highlight some of the policy issues with which it is grappling.
"We are going through a very deliberate and thoughtful process," OCC General Counsel Amy Friend said in a statement, "in order to identify all the issues that may be raised by a special purpose charter and to consider recommendations for how to deal with these issues."
Banks are largely on board with the charter, because it would address what they feel is an unfair competitive advantage for fintech.
Institutions worry that fintech companies face less stringent exam schedules and avoid certain rules, such as community reinvestment requirements. Fintechs do have to comply with other measures though, including consumer protection and anti-money-laundering laws.
Still, the lack of federal oversight can create an incentive for firms — especially young, growth-oriented companies — to ignore the rules.
"Everybody on the road is speeding, but the question is who's going to get pulled over and be given a ticket," said Carol Van Cleef, a partner at Manatt, Phelps & Phillips. "We really need to rethink whether we should have those laws in place if we're not going to enforce them."
Instead of jumping through the hoops, certain fintech companies have gotten creative with their regulatory strategy.
For instance, the bitcoin exchange itBit applied for an arcane permit called the limited-purpose trust charter instead of applying for New York's BitLicense, a process that has been called too onerous by virtual currency advocates.
Also, itBit believed the trust charter would allow it to operate in other states, unlike the BitLicense. It hasn't been that easy; states are still debating how to address itBit's unique status.
More commonly, many of the online lenders have used a "rent-a-charter" model. They've relied on bank partners for access to compliance know-how and pools of capital.
"If you want to be a fintech startup and your goal is to move money, that's a heavily regulated industry to be in," said Jason Oxman, chief executive of the Electronic Transactions Association, an industry group that represents some of the largest banks, in addition to fintech heavyweights such as PayPal. "One of the ways that fintech startups deal with that issue is to partner with banks."
But regulators have warned banks that they are on the hook for their fintech partners' compliance mishaps. Over the last few years, the OCC and the Federal Deposit Insurance Corp. have published guidance on risk-management of third-party affiliates, including online lenders.
That regulators are worried about banks' exposure to outsiders is not necessarily a new phenomenon, however.
"This impulse on the part of regulators is one that has been with us for many, many, many years," said John Beaty, a partner at Venable and a former assistant general counsel at the FDIC. "They have always been concerned about banks' adequately reviewing loans that they're getting from nonbanks or other entities."
Obstacles for Regulators
Federal regulators will have to overcome some obstacles too if they want to bring fintech companies into their purview.
For one, despite the OCC's apparent desire to lead the charge on regulating fintech, the agency is still feeling the effects of the 2008 financial crisis. The embarrassment over how many de novo banks failed during the crisis is still fresh. (To be fair, the number of de novos with national charters that failed was much smaller than the number with state charters.)
"The sanctity of the charter was something that in large-bank supervision we needed to reflect on after the financial crisis," Maryann Kennedy, the OCC's deputy comptroller for large-bank supervision, said in June.
The OCC would also need to get its fellow federal regulators on board with a new charter.
In September, the agency released a proposal detailing its receivership powers over nationally chartered financial institutions that are not insured by the FDIC.
This could lay the groundwork for a fintech charter that could be issued single-handedly by the OCC. Most banks need the FDIC's approval as mandatory insurer, because they hold customer deposits.
Still, if a fintech company obtains a national OCC charter, the questions arise as to whether its parent company would also have to be supervised by the Federal Reserve as a bank holding company.
Regardless, the OCC will likely have to get both fellow regulators on board.
"Federal bank regulators generally try to cooperate as much as possible," Beaty said. "They don't try to create situations that could trigger the concerns of other regulators."
While regulators work these wrinkles out, advocates worry the U.S. fintech industry is losing precious time to grow and compete within a global market.
"The regulatory system is designed … to be slow and deliberative," Barefoot said. "By the time you get the regulation out the thing you are regulating will have already changed."
State Regulators, Virtual Currencies and the Future
State regulators are cornered between the impatience of fintech firms seeking clarity and federal regulators' desires to establish baseline requirements that could override local restrictions.
Ray Grace, the North Carolina Commissioner of Banks, said he and his counterparts tend to be viewed as "gimlet-eyed, stodgy old regulators, because we're in the way."
But that's how they can protect consumers, Grace said. "We have to figure out what the potential pitfalls are."
Many state regulators fear that a federal regulation of fintech could create weak baseline standards for these new companies and override state usury and other consumer protection laws. Supporters of an OCC-issued charter said that the federal regulators are better resourced to address the new wave of fintech businesses.
Grace argues the state system creates more competition for firms to determine which regulatory framework is best — at least for them.
"They're going to go where they see the most friendly regulatory environment," he said. "Sooner or later, if it's a really compelling product or service it will find its way to any market — just not as quickly as some in the fintech industry would like."
This could ultimately lead to the creation of fintech clusters in states that offer more industry-amenable regulation, in the vein of Silicon Valley.
"In my experience, markets get what markets want, ultimately," Grace said.
The potential of harnessing state competition to create a more workable regulatory landscape is not lost on the industry.
For Brito, in a near-perfect world, all states would have their own virtual currency license, but a federal law would require them to be reciprocal. If each state's license could be used to reach customers in all the other states, the level of competition could be through the roof. An industry-favorable policy in Montana would as potent as one in California, because no matter where businesses establish themselves, they would still have access to all U.S. customers.
Of course, getting such reciprocity mandated by federal law would be no small feat.
"It would require an act of Congress signed by the president," Brito said. "Those types of things are very difficult to come by these days."
Instead, virtual currency advocates are hoping that the OCC will create a provision for them should it create a national fintech charter. Because many are not seeking the right to take in deposits, or even to transfer funds, virtual currency firms believe they could skate by with a fairly simple charter.
"The ask that digital currency firms are making with the OCC is very small," Brito said. "All we want is a charter that gives us access to [payment transfer systems,] ACH and Fedwire."
But regulators at all levels first need to better understand what they are dealing with. Virtual currency advocates argue, for instance, that it makes no sense to regulate any of the underlying technology behind bitcoin, which is open-source, and not in and of itself connected to the financial system. Generally, companies that are not involved in the storage of funds should be left out, they argue.
"Regulate with a scalpel, not a chainsaw," said Perianne Boring, the president of the Chamber of Digital Commerce.
That's perhaps why states are taking a slowly-but-surely approach to working out how to address virtual currencies.
In California, a virtual currency bill that was once considered more palatable to the industry than New York's BitLicense was shelved in August after a rewrite that drew backlash from groups like Coin Center. Similarly, an effort by the Chicago-based nonprofit Uniform Law Commission to draft a model state law for virtual currency is being intently surveilled by industry advocates, who want to ensure it uses the right definitions.
There might be an upside to the debate, at least for those working with distributed-ledger technology. Waiting for blockchain technology to infiltrate the financial sector before setting up new rules could be a wise move.
"Right now, the world of financial services is still pretty Balkanized," said Alex Tapscott, CEO and founder of the blockchain industry advisory firm Northwest Passage Ventures, and author of the book "Blockchain Revolution."
But eventually, in his view, "everything from vanilla public equities to over-the-counter securities will inhabit blockchain."
That would mean that transactions could be more easily monitored, according to Tapscott. "If a regulator could see in real time what banks are doing ... then you could argue that they actually could use a lighter touch."
In the meantime, though, the fragmented regulatory landscape could create risks for consumers.
When it comes to virtual currency, for instance, tough state laws could push U.S. bitcoin holders away from national exchanges, to the detriment of market safety.
"There might be some states were they don't have any options," Boring said. "So they have to go … overseas and they're putting their money in exchanges like Mt. Gox."
Ultimately, whatever form the OCC's foray into "responsible innovation" takes, it could have a trickle-down effect on the regulatory landscape faced by fintech.
"If the OCC permits these charters, it will start to foster models that everyone can see are being viewed as sound by the OCC and the regulators," Barefoot said. "People will begin to learn about what it takes to get a charter — and that will help more companies gravitate toward models that have fewer regulatory headwinds."
Already, fintech startups are getting better at talking to regulators.
"We see more maturity in the way fintech organizations are coming forward with their products and approaching the regulatory environment," Grace said.