GLOBAL FINTECH POLICY OUTLOOK

Transcription

1 GLOBAL FINTECH POLICY OUTLOOK

2 IIn 1995, the United States House of Representatives Financial Services Committee held a hearing titled The Future of Money. Congressman Mike Castle (R-DE) remarked at the time: The future of money contains the potential both for great commercial promise and for enormous risk of undermining the system of exchange and the administration of justice. This is true whether the media of exchange enter electronic commerce using computers linked into networks or via computer chips embedded in cards or other devices. You could easily imagine hearing those same words today. More than 20 years ago, the future of money was early electronic payment cards. Today we talk about cryptocurrencies, big data, artificial intelligence, or machine learning. In 1995, one could barely imagine the overwhelming role that the internet would play in our lives today, especially as it relates to financial services. And technology is continuing to reshape how financial products and services are being developed and delivered to consumers. Enabled by the internet and empowered by mobile computing, technology platforms and protocols are rewiring traditional financial relationships on a global scale. This technological shift presents enormous commercial promise - but also new challenges - for policymakers the world over. Red Flag has been closely monitoring global developments in the financial technology (FinTech) space for clients and believes we are on the cusp of a unique tipping point that will see increased regulatory and media scrutiny over the coming 12 months. The Summary The coming year is set to be critical for the FinTech space. In the United States, a battle is ongoing between federal and state regulators, with both believing the regulation of financial technology resides with them. With political intransigence continuing on the federal level, states are beginning to step in with FinTech innovation agendas, including active proposals to establish state level regulatory sandboxes. In Europe, all levels of the EU political infrastructure are voicing their opinions and collecting information from the sector. We can expect a number of financial technology policy proposals coming from the EU before end of the year, across various business verticals. Blockchain and distributed ledger technology applications are continuing to be developed and tested. Regulators are continuing to take a wait-and-see approach with a welcoming eye for the promised efficiencies the technology may bring. The increased price of digital currencies like bitcoin, accompanied by the rise of so-called Initial Coin Offerings (ICOs), has put the digital currency industry under greater scrutiny and attention from both the media and regulators. 3

3 The future is now, but it s not new United States In the United States, the FinTech policy landscape has been dominated by the OCC s proposal to grant special national purpose bank charters to FinTechs. The OCC, in the past, has granted such charters to financial services companies covering very specific lines of business, such as credit cards. In a July 19 speech, Comptroller of the Currency, Keith Noreika said offering such limited, special charters would help ensure the federal banking system can evolve to meet the changing needs of the marketplace and its customers. However, in September, Noreika announced that the agency is not yet ready to begin accepting applications for FinTech charters. He said the agency was still in the exploratory phase of creating the charter. Many states have balked at the proposition of special purpose charters for FinTechs, believing the OCC is overstepping its remit. The Conference of State Bank Supervisors (CSBS) and the State of New York have both led individual lawsuits against the OCC in an attempt to stop them from moving forward. Domestic politics and a difficult beginning for the Trump Administration have slowed the rollout of an overarching FinTech agenda. That said, Counselor to U.S. Treasury Secretary Mnuchin, Craig Phillips, recently promised that the Department would deliver a report on FinTech by the end of In this vacuum, various financial regulatory agencies are competing for first mover advantage, including the SEC, CFTC, CFPB, and others. The CFTC recently stood up Lab- CFTC to promote FinTech innovation and improve engagement between the regulators and FinTech companies, with a particular focus on the regulatory technology (RegTech) space. 5

4 European Union In the European Union, FinTech activity is beginning to heat up. September saw regulators and legislators map out their views on FinTech. New regulations will be introduced in no time. Council of the EU: European Union finance ministers met informally in mid-september where they were presented with a paper on FinTech by leading economic think tank Bruegel. The paper said that FinTech has the potential to become very important to cross-border financial integration if big players enter the market. It highlighted four issues for EU policymakers to consider: ➊ Should FinTech markets be European or national? ➋ What regulatory approach to take? ➌ Does the EU need an institution to oversee FinTech? ➍ Should there be a new process for FinTech regulation at high level? European Parliament: The European Parliament released its own report on the FinTech sector in April, having previously reported on virtual currencies in While they do not have a direct legislative and regulatory impact, it does indicate the prospective position of European legislators in advance of the introduction of new regulations. The Parliament has taken the approach of being open to FinTech and recognizing the need not to stifle innovation. European Central Bank (ECB): The European Central Bank (ECB is perhaps the most cautious of institutions when it comes to FinTech. After all, something like digital currencies undermines the very essence of its being. Already senior officials have dismissed elements of FinTech in public (ECB Vice President Vitor Constancio recently compared bitcoin to tulip-mania ). However, the ECB has just launched a consultation on how FinTech firms might obtain a banking license. European Commission: The European Commission is expected to publish a new regulatory framework by the end of this year. A task force on FinTech was set up in November 2016 to develop strategies to address the potential challenges and opportunities fintech poses to Europe. The task force began its work with five clear objectives: ➊ Ensure all European policy work is informed by, and takes into account, technological innovation; ➋ Assess whether existing rules and policies are fit for purpose in the digital age; ➌ Identify actions and proposals that could harness the potential opportunities FinTech offers, while also addressing the possible risks; ➍ Devise a strategy to combine the need for a level playing field with the need to foster technological innovation in Europe; ➎ Safeguard innovation from legislation and regulation. In addition, the European Commision has proposed to reform the financial authorities in Europe and has specifically referenced FinTech as an area of focus. The Commission calls for authorities, namely the European Banking Authority (EBA) and European Securities and Markets Authority (ESMA), to foster its development and to make sure that sustainability considerations are taken into account. European Supervisory Authorities: These agencies have all presented differing messages. In early August the European Banking Authority (EBA) launched its own consultation on a discussion paper laying out its approach to financial technology. In the Commission s proposal to reform financial authorities, EBA and ESMA will be required to prioritize FinTech, and will coordinate national initiatives which promote innovation and strengthen cybersecurity. Both have been asked to take into consideration technological innovation in all the tasks they perform. However, in their Autumn report on risks to the financial system, the rapid development of FinTech was cited. The authorities have identified data privacy issues, potential client discrimination, vulnerability to cyber-crime and associated legal issues among key risks to consumers and financial institutions. ENISA (European Cybersecurity Agency): ENISA relased a report on cryptocurrencies in September. It takes a cautious approach and recommends a proportionate regulatory approach in order to avoid imposing an excessive burden that would undermine the advantages and flexibility that cryptocurrencies currently have. 7

5 31% 19 of 24* countries * of FinTech companies are not regulated under EU or national law reported that FinTech firms are not part of a deposit guarantee scheme 18% * of regulated FinTech firms in Europe fall under the Payment Services Directive (PSD2) *EBA survey Influencing Nexus PSD2 The new Payment Services Directive (PSD2) will come into force across the EU on 13 January This will be the start of 18 to 24 months of radical changes in financial services infrastructure. The new rules will innovate the way financial institutions treat data, it will open the door to start-ups and companies to create new ways to process payments.this drive towards innovation and digitisation will drive consumers, companies and wider society, ultimately, to a cashless society. GDPR The General Data Protection Regulation (GDPR) will enter into force in May This regulation was not only one of the most momentous pieces of legislation to come out of Brussels but its rules will have a global impact - any company that works with the data of European citizens will be affected. This regulation is designed to not only improve the security and privacy of personal data in the EU, but to return the control of personal data to the individual. There is talk of using blockchain technology to move the ultimate control for personal data away from third party controllers and processors to the individual themselves. However, this has not yet gained enough traction in Europe. 9

6 State of the Digital Currency Industry and Open Blockchain Networks Existing natively on the internet, one could say that digital currencies and the open blockchain networks that enable them are arguably the purest form of financial technology. Over the past several months there has been a marked increase in attention given to the digital currency and open blockchain space from both the media and regulators. This attention has been driven largely by increasing prices of digital currencies on major exchanges across the world. Since January, the prices of Bitcoin and Ethereum - the world s largest cryptocurrencies by market capitalization - have risen steadily. The exact reasoning for this increase is unclear but is likely driven by a number of factors including the increased number of token sales and Initial Coin Offerings (ICOs) and increased attention from institutional investors. Token Sales/ ICOs Token sales, for the most part, have been synonymous with ICOs. Tokens are run on top of the Ethereum blockchain, which - in addition to being a ledger of transactions such as the bitcoin blockchain - also functions as a sort of large, global, decentralized computer. While some ventures appear to use the tokens as a critical part of their application (i.e., in order to use the application when it is launched an individual will need to use the token, similar to an arcade game), others appear to just be using the tokens as a sort of decentralized, crowd funded venture capital effort. It is the latter case that has raised the ire of regulators globally. On July 25, 2017, the U.S. Securities and Exchange Commission (SEC) issued a Report of Investigation detailing its findings around the Digital Autonomous Organization (DAO) blockchain token sale. The DAO was the first widely publicized token sale, representing the largest crowdfund in history at the time. The SEC found the tokens sold by the DAO are considered securities under U.S. law. It is unclear how many other tokens currently being launched by companies and then traded on exchanges might be considered securities. However, the SEC did make clear that each one token will be judged by the facts and circumstance around their issuance. Further, on September 26, 2017, the SEC announced the creation of a new Cyber Unit which, among other priorities, will focus on violations involving distributed ledger technology and initial coin offerings. Since the SEC s initial announcement a number of other nations have followed suit, including Canada, Singapore and the UK. China issued warnings around token sales and then went so far as to call for a halt of all cryptocurrency trading in the country. With that in mind it is likely that some tokens currently available for sale on exchanges across the world, will be considered a security by regulators. This has implications for the companies that launch tokens, as well as the exchanges and users who trade those tokens. Though most countries, including the United States, did not take any punitive action along with their announcements, they clearly make the case that they have the power and jurisdiction to do so. It isn t unreasonable, then, to assume that future action may be taken at some point and that other authorities may also take notice. 11

7 Increased Attention on Exchanges In addition to the SEC report issued in July, a number of actions were recently taken against a major global digital currency exchange, BTC-E. Firstly, the Justice Department of the United States indicted the company and its founder for money laundering, implicating it in connection with the MT GOX hacking that occurred in Secondly, the U.S. Treasury s Financial Crimes Enforcement Network ( FinCEN ) fined the company and its founder over $120M for various violations of licensing and anti-money laundering laws. This represents the first punitive action from FinCEN against any foreign money service business ( MSB ), and the second such action against a digital currency business. We can expect increased attention on exchanges in the coming year as regulators scrutinize market fairness and transparency, and the efficacy of implemented AML/KYC regimes. AMLD4 The latest anti-money laundering directive (AMLD4) came into effect on 26 June 2017, strengthening the rules around transparency, obligations of financial institutions and cooperation among authorities and non-european countries. Additional measures are currently being negotiated (so called, AMLD5) that have further implications on the FinTech industry - with virtual currencies and wallets coming under scrutiny. Regulatory outlook for Blockchain /Distributed Ledger Technology Companies and banks continue to develop proprietary, closed, or permissioned ledgers for enterprises. Though some products utilize elements of open blockchain protocols, many are blockchain inspired software designs that allow institutions to collaborate and share records and transactions in more seamless and efficient way. While the models differ, these companies are working with large institutions (mostly in the financial and insurance sectors) to implement develop, test, and implement these technologies, often referred to as distributed ledger technology ( DLT ). While the global conversation around innovation, both generally and specifically regarding financial technology, has generally been to take a hands off approach, the European conversation around DLT could be the exception to the no regulation consensus. The European Commission s recent FinTech consultation suggests there may need to be regulation in the near future. Specifically, some legal recognition might be needed to prove the use of DLT is true and accurate, and has legal value. While somewhat positive, it s clear that European regulators fear what they don t know regarding potential uses of blockchain and DLT, especially as it relates to financial institutions. Concerns regarding industry cartelization have been voiced, signaling a need for better education and advocacy. In the United States, the federal regulatory environment around DLT has been overall positive, albeit quieter. Regulators and policymakers appear to be willing to sit on the sidelines as industry and financial institutions develop tangible products and use cases for the technology. The State of Delaware recently enacted changes to their existing corporate governance laws to better allow the development and use of blockchain technology for certain corporate recordkeeping and shares issuance. 13

8 Regulatory Sandboxes Another major development we ve observed is the rise of regulatory sandboxes or labs ( RegLabs ) for financial technology companies across a number of national jurisdictions. RegLabs function as regulatory safe zones that allow companies, working hand in hand with regulators, to develop applications and test them in live, small-scale environments with customers. In Silicon Valley the default mode for development is to move fast and break things, which is not how traditional financial services has evolved to work. The value of a sandbox or RegLab comes from allowing new products to be tested and developed in real-time, while also ensuring the right safety, soundness, and consumer protection attributes we have come to expect from the financial system. The United Kingdom, Australia, Singapore, and others are running such programs. However, because of political gridlock and the financial regulatory structure of the United States, it s been difficult to replicate there. There are active discussions around individual states launching their own regulatory sandboxes. A group of six New England states have already begun conversations around what a shared, multi-state agreement might look like and Arizona s Attorney General recently called for the state to launch a sandbox. A recent Aspen Institute report said that for U.S-based sandboxes: the most promising near-term opportunities may lie with the States. However, the report notes that cooperation with and between other state and federal regulators would be needed to maximize the potential. The European Commission has raised the idea of a Europe-wide sandbox in their recent FinTech consultation, citing the launch of similar efforts in competing jurisdictions. Industry groups, such as the European Banking Federation, have in the past been supportive of such efforts. The Commission is expected to issue a final report following from the consultation by the end of the year. 15

9 Staff authors John Collins, Head of Red Flag USA John heads up Red Flag s newly-established Red Flag Washington DC office, and leads the firm s FinTech practice. Previously he served at the American Bankers Association s international subsidiary, BAFT, where he was vice-president for international policy, responsible for files including blockchain and payments technology at global and regional level. John previously served as head of policy for Coinbase, the world s largest digital currency company, and as a senior staffer in the United States Senate. He is affiliated with the Berkman Klein Center at Harvard University where he focuses on emerging public policy issues surrounding financial technology. john.collins@thisisredflag.com Emma Brown, Account Manager Emma manages media, political and regulatory engagement for Red Flag clients in Europe and the US. She works with the media in Brussels and across Europe, Africa and the US. She has experience leading major pan-european campaigns in the fields of environment, chemical, consumer, agriculture, healthcare, digital and financial services. Emma previously provided strategic advice to a non-profit organisation, worked for a policy unit in the European Commission, and for a trade association representing the toy industry. emma.brown@thisisredflag.com Kevin Hiney, Regulatory Futures Manager Kevin leads Red Flag s regulatory futures division, managing major research projects, political and media monitoring as well as regulatory engagement and horizon-scanning on behalf of clients. Kevin joined Red Flag from Airbus Group where he worked as a policy analyst in Brussels, and previously worked in the Irish Department of Foreign Affairs. kevin.hiney@thisisredflag.com 17

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