Though it may be winter, U.S. financial technology regulation is heating up. Just this month, the Office of the Comptroller of the Currency (OCC) announced that it will consider financial technology applications to become special purpose national banks, while the Federal Reserve Board released its long-anticipated paper on regulation for distributed ledger technology.
The U.S. government has finally started to signal clearer guidance on what regulators view as the greatest risks and rewards of new financial technologies, and what requirements banking and nonbank players will be held to. In the face of these developments, the big question for many is, “Will regulation increase competition or provide a competitive advantage?”
What we’ve seen so far with policy
Aside from virtual currency, U.S. regulators have maintained a hands-off approach to proposing financial technology regulation up until now. But it is not accurate to say that U.S. financial technology businesses are unregulated. State-level regulation is in place, as well as other national rules and requirements for third party-vendors. This has created a baseline of consumer protection and safety mechanisms for the financial technology ecosystem. Recent developments show that U.S. regulators are starting to better clarify and coordinate their thinking.
Though the U.S. has yet to implement a regulatory “sandbox,” or a supervised environment where financial technology firms can test their products and services without immediately incurring all the normal regulatory consequences of engaging in such activity, like in other countries around the world, the Financial Services Innovation Act introduced by Rep. Patrick McHenry (R-N.C.) this fall could change that.
The bill would create a regulatory sandbox in the U.S. by requiring 12 different government agencies, including the OCC, Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC), to identify three or more areas of existing regulation that an agency would consider modifying or waiving if the agency were to receive a petition under the bill. Each agency would be required to create a Financial Services Innovation Office (FSIO) to support the development of financial innovations, coordinate with FSIOs at other agencies to share information and data, establish procedures to reduce the time and cost of offering a financial innovation to the public and enable greater access to financial innovations.
Coupled with an OCC report issued in October stating the agency’s recommendations and decisions to implement a responsible innovation framework, we can see an acceleration of U.S. financial technology regulatory formulation.
What the recent developments tell us
The OCC and Fed developments this month indicate that they intend to move forward with formal guidance for financial technology companies and the institutions that intend to partner with these newer firms. The Fed makes clear that innovation to payments, clearing and settlement in the wholesale and retail financial markets are seen as the greatest opportunities for distributed ledger technology, while risks such as fraud, money laundering or collusion are top concerns.
The Fed acknowledges that further research and analysis is necessary to formulate sound policy decisions. Given the increasing competition on the horizon and the Fed’s consultation of financial technology startups, it is also clear that regulators are trying to balance both sides of the equation, creating opportunity for innovation while also fairly managing risk in keeping with the historical requirements set for the banking industry.
It’s too early to make a call on whether new regulations will increase competition for financial institutions or create a competitive advantage for financial institutions that use innovation to better compete. But if we interpret the statements and papers to date as evidence of a desire by regulators to provide more certainty to financial institutions and newer financial technology companies, then it is clear that the primary questions and concerns of market players will include appropriate risk management, capital, liquidity and consumer protections.
What we should expect with regulation
In order to facilitate new effective regulation, agencies are requiring financial institutions to capture and manipulate more and more data. In the past, this has led to many financial institutions implementing one-off solutions to comply with a specific new law or regulation. But thanks to a new technological trend, financial institutions will be able to arm themselves with the ability to have these large, unpliable numbers transformed into useable information, thus whittling down the traditionally high cost of compliance.
There are regulatory technology opportunities that are apparent in the U.S. and some opportunities that are more imprecise. As part of the CFPB’s updates to the regulatory requirements for the Home Mortgage Disclosure Act (HMDA), for example, financial institutions required to file HMDA data will have to use the CFPB’s in-development HMDA platform starting next year. Financial institutions will likely use new regulatory technology reporting software that is compatible with the new HMDA Platform.
In other areas where new technologies may be useful, the development of regulatory technology may need to be more flexible. In October, American Banker reported that small banks within a 60-mile radius in Kansas are considering sharing a compliance officer. This would allow banks that generally could not afford a compliance officer with more than 20 years’ experience to hire an expert to run their compliance programs. While there are obvious red flags, the OCC outlined a way for community banks to collaborate in specific areas, including “data processing, records management and data storage, surveys, training and education.” It also mentioned regulatory compliance in the areas of the Bank Secrecy Act, anti-money laundering and mortgage rules.
Whichever direction the Fed, OCC and other federal financial regulators ultimately take, we can be sure that technology will be ready to help financial institutions and financial technology companies meet these new demands. Financial institutions that embrace innovation and strategically align technology into their business planning will not be concerned with increased competition. Rather, they will be well positioned to compete in the 21st century and find the competitive advantages they are looking for.
Peter Dugas is the managing director of government affairs at the Center of Regulatory Intelligence for FIS, a global financial technology solutions firm. He served as a deputy assistant secretary at the U.S. Department of Treasury under President George W. Bush.
The views of Contributors are their own and are not the views of The Hill.