International FinTech Regulation -- Part II
A version of this blogpost originally appeared on The FinReg Blog hosted by the Global Financial Markets Center at Duke Law School.
February 2019 could rightly have been called “FinTech Month” in Basel, Switzerland, given the number of documents published by the Financial Stability Board (FSB) that point to a shift in priorities for the international standard setting body. While little noticed by the financial press, this post analyzes the FSB developments and forecast the next set of pressure points as policymakers struggle to keep pace with a rapidly evolving market that is fueled by new technology in the banking, securities, payments, currency and insurance sectors.
Speech by Federal Reserve Vice Chairman for Supervision and Chair of the Financial Stability Board, Randal K. Quarles (Feb. 10):
The new FSB Chairman delivers a speech to central bank governors in Hong Kong proposing a post-crisis policy pivot for the FSB towards (i) increased public engagement, (ii) proactive issue identification, and (iii) assessing the impact of regulation rather than just articulating standards and assessing compliance with those standards.
2019 FSB Work Programme (Feb. 12): A cursory look at the programme reveals no significant shifts, as familiar issues feature prominently in the headings (financial stability, post-crisis reform implementation, etc.). But buried within the programme is clear language indicating the FSB intends to expand its role regarding cross-border FinTech regulation: “The FSB will also continue to assess the impact of evolving market structures and or technological innovation on global financial stability.”
FSB FinTech Report (Feb 14): The FSB issues a 33-page report: FinTech and market structure in financial services: market developments and potential financial stability implications. The report adds to the FinTech lexicon by referring to “Big Tech” firms (large, established technology firms). The FSB recognizes that BigTech could fundamentally disrupt the finance industry should these firms chose to provide financial services (some already are) and potentially threaten financial stability, thereby opening the door for future regulation. The report significantly expands upon the FSBs thinking from their 2017 report (analyzed here) regarding financial stability risks arising from FinTech credit.
Why It Matters
These three releases signal a shift in the focus and function of the cross-border policy process for financial regulation, with FinTech policy firmly in the crosshairs.
Since its elevation from a “forum” to a “board” during the Global Financial Crisis, the FSB has largely identified policy priorities in a reactive manner. The FSB simply responded to G20 directives and issued progress reports along the way. There was little by way of public consultation.
Releasing a work programme separate from a G20 ministerial meeting indicates that mean reversion is underway. Those of us who remember the Financial Stability Forum will remember as well that regulatory policymakers routinely operated independently of what was then only a ministerial-level Group of Twenty (G20). In that sense, the FSB is returning to its roots – even as it grows – as the new FSB Chairman noted in his speech. Significant policy expansions should be expected, as Quarles’ speech indicates, the FSB will be increasing outreach and dialogue from entities beyond the official sector and beyond the FSB’s membership. Consider:
"While we are directly accountable to the G20, we are, through the G20, accountable to all of the people affected by our actions. In my view, that means we must engage in genuine, substantial dialogue with all of these stakeholders, to a greater and more effective degree than we have in the past…The FSB must maintain its legitimacy in order to be effective, and to do that we have to work hard to hear from all relevant parties when deliberating. What’s more, we have to do so publicly and methodically. Everyone around the world should understand that we only make recommendations once we have gathered and considered all points of view."
The FSB is now doing what the Basel Committee did in the 1990s: opening the door for real dialogue with what Europeans call “civil society.” In so doing, they are creating a direct link between the legitimacy of their actions and the acceptability of those actions by “all of the people affected.”
A commitment to traditional transparency, and outreach to the broader public, are not the only signs of a policy shift at the FSB. As indicated, the FSB may be considering extending the traditional financial system regulatory perimeter to include large technology companies that offer financial services. Thus far, these firms have been successful in avoiding direct supervision but their entrée into financial services may quickly change that.
To be sure, the FSB and other international groups have periodically assessed financial stability risks arising from “non-bank intermediation” during and after the Global Financial Crisis. Those assessments mostly sought to identify links between existing capital markets entities (hedge funds, private equity funds, and sovereign wealth funds) and financial stability risks. The current initiative is broader.
Much has been written about how artificial intelligence, process automation, alternative data, machine learning and blockchain are redefining capital, credit, and insurance markets; payment systems; and currency issuance. The FSB report defines the metric by which it will evaluate financial technology: financial stability.
Insurance regulators and securities regulators are bound to cringe. During the Global Financial Crisis, these sector regulators complained bitterly about the expansion of central bank financial stability priorities into their domains. The FSB report suggests that the FinTech sector may be next. The challenge here is that many providers of currency, payment, and intermediation services – not to mention blockchain innovators – have never been subject to supervision by a central bank or other financial regulatory agency.
What Comes Next – Missing Pieces in the FinTech Policy Universe
Regular readers of this blog know that policymakers have been actively engaged in gently extending their jurisdiction into non-traditional areas through FinTech sandboxes, ICO regulation, MOUs, and other initiatives. The bigger question is: what happened to the proposed Global Financial Innovation Network (GFIN)?
In August 2018, thirteen policymakers proposed to unite under a GFIN banner to accelerate FinTech standard-setting and regulatory cooperation. A consultative paper was issued and the proposal was analyzed in this FinReg Blog piece. But no announcement was made, save for a little-noticed podcast which was analyzed here. In 2017, the Basel Committee on Banking Supervision proposed cross-border FinTech regulatory standards that would extend the perimeter of banking regulation to cover FinTech. Their final standards were issued one year ago but the FSB did not mention these standards or the GFIN in their recent releases.
This is not merely a petty bureaucratic turf battle among overlapping groups. It is a drama regarding the right prism through which FinTech firms should be regulated. And the drama is just beginning.
The FSB is dominated by central banks and finance ministries, with supporting roles for selected sectoral regulators. The GFIN structure, as proposed, was potentially quite radical by providing roles for one World Bank-affiliated NGO and a few consumer protection regulators with securities regulators in the driver’s seat.
The composition of the groups matters. A focus on financial stability by entities responsible for spending official sector funds to safeguard financial stability (with mandatory restrictions on risk taking) is significantly different from a policy focus designed to foster industry development driven predominantly by securities market and consumer protection standards (with disclosure/buyer-beware standards at its core).
FSB policymakers, at present, seek to balance safeguarding financial stability and encouraging innovation. It is a good place to start. But the trajectory and velocity of market developments will soon place pressure on these good intentions. Pressure points include:
E-Currencies: Widespread use of cryptocurrencies will place pressure on central banks and other regulators to identify whether or not these currencies may be used within mainstream intermediation and payment systems as an alternative to central bank monies. If they achieve scale, they can also create challenges for monetary policy execution.
Data Privacy/AI: Expanded use of alternative data to make lending and insurance (health) policy decisions creates real pressure on the boundary between public information and private information, and how private information should be protected. Legitimate questions exist about whether and to what extent credit decisions made using alternative data and/or artificial intelligence incorporate (deliberately or accidentally) impermissible biases.
Regulatory Perimeter – The Uber/Airbnb and SWIFT Problems: Should central banks, finance ministries, and/or sectoral regulators require licensing and exercise oversight regarding financial system operations of technology companies? When is a platform a securities exchange and when is it just a technical communication mechanism? Even if it is just a communication mechanism, official sector jurisdiction can be justified on law enforcement/public safety grounds separate from sectoral financial regulation as the SWIFT example illustrates.
The FSB thus has a looming jurisdictional problem.
Neither the FSB nor the proposed GFIN provides a cross-border platform for engagement with policymakers that currently loom largest in the FinTech universe: data protection regulators, consumer protection regulators, competition regulators, trade regulators, and law enforcement officials.
With the exception of trade policy (WTO) and law enforcement (FATF), national policymakers in other disciplines do not have a tradition of working together to set common standards. These three policy areas (data protection, consumer protection, competition) have traditionally been seen as the province of national regulators. Many, if not most, of the national entities may have limited or nonexistent authority to engage with counterparts internationally.
The FSB initiative to focus on the systemic impact of rapidly accelerating financial technology is understandable. Its efforts to become more transparent and engaged in dialogue beyond its members should be welcome. But the pace of market developments will soon press the FSB into new territory.