The last time the financial industry swooned so much for a new technology, it was the early 1990s. The Berlin Wall had just fallen, the Latin American financial crisis was almost over, and everyone everywhere (it seemed) was talking about....derivatives. Today's marketplace feels very similar to those frothy days.
But a crucial difference exists. In the early 1990s, no ambiguity existed about what might (or might not be) a financial derivative. In addition to the age-old futures and options (which were mostly exchange-traded), the hot new thing on the market were swaps and over-the-counter (OTC) futures and options.
It is not so easy to identify what kinds of firms fall under the heading "FinTech" and which don't. Ambiguity is fueled by start-up marketing since savvy start-ups know that the fastest way to find funding right now is to market yourself as a FinTech.
The question has been on my mind lately. When I introduce the company and the FinTech RegTrends Report to people, half the time someone says to me: "Oh! You are a FinTech company." The conversation proceeds and the person thinks they understand the niche in which we operate. But are we really a FinTech company?
Do all FinTech companies want to grow up to be regulated financial institutions? Can established incumbents become FinTechs just by creating innovation centers and buying a ping-pong table? What about RegTech companies and data providers?
These and other burning questions are the subject of this post.
No single definition has yet emerged regarding this sector. In an attempt to shed some light on the issue, we consulted Wikipedia, Investopedia and Forbes:
Citing a 2015 Wake Forest Law Review article, Wikipedia indicates that FinTech "is an industry composed of companies that use new technology and innovation with available resources in order to compete in the marketplace of traditional financial institutions and intermediaries in the delivery of financial services."
Investopedia disagrees, seeing the industry as being much broader: "Since the end of the first decade of the 21st century, the term has expanded to include any technological innovation in the financial sector, including innovations in financial literacy and education, retail banking, investment, and even crypto-currencies like bitcoin."
Forbes offered another perspective in February of this year: FinTech refers to "technologies used and applied in the financial sector, chiefly used by financial institutions themselves on the back end of their businesses...(and increasingly) technologies that are disrupting traditional financial services, including mobile payments, money transfers, loans, fundraising, and asset management."
Regulatory status does not figure in to the sector's definition. Nor does age.
All three of the definitions above apply equally both to start-ups and to established incumbents that implement innovative technologies in innovative ways as today's Citi/NASDAQ deal illustrates.
The crucial question is whether a FinTech company must engage in intermediation (lending, deposit-taking, advising on financial transactions, executing financial transactions, operating a payment system, issuing currency) in order to be considered a "FinTech" company. Investopedia and Forbes suggest instead that non-intermediation activities could qualify as well.
Why It Matters
At the moment, the question of "what counts" as a FinTech seems like it would matter only (if at all) to marketers. Investors want to be part of the hip, happening, highly innovative technology scene that seems likely to generate the magical appearance of unicorns. Companies (ourselves included!) want to spread the excitement about the magic that their algorithms and new data sets can provide to help people make smarter decisions faster.
But the sector's growth does not occur in a vacuum. Rapid growth attracts regulatory attention.
Policymakers, like technology evangelists, understand that we are only at the front end of a profound data revolution that will transform how people think, how decisions are made, and how business is conducted.
The FinTech sector, operating in one of the most regulated industries on the planet (financial services), is on the forefront of this revolution. So are its regulators.
Industry promoters and true believers seek to magnify the momentum, often endorsing the broadest perspective of "what counts" as falling within the scope of this new industry segment. One consequence is that financial regulation could extend to a much broader segment of the commercial marketplace than at present.
If indeed "FinTech" includes "technology used and applied in the financial sector" then policymakers could believe themselves to be justified extending financial regulation to database vendors, cloud providers, blockchain companies, neural net computation/architecture companies, natural language processing companies, search engines...the list goes on.
At present, certain regulators "export" compliance to third party vendors used by financial institutions. They rely on banks in particular to incorporate into business contracts obligations for the third party to meet the bank's legal and regulatory compliance obligations as those apply to the function being outsourced to the third-party vendor.
FinTechs servicing commercial banks subject to these rules therefore already bear much of the compliance burden associated with banking regulation, even if they are not in the intermediation business. This explains why some FinTech firms seek access to sandboxes and/or special purpose banking licenses. Since they already bear the cost of compliance, they might as well receive the benefits in the retail marketplace associated with having a regulatory license. This also explains why some financial institutions view the sandbox/special purpose banking license with such concern.
But what if the outside vendor is not close to the intermediation or compliance functions? What if the outside vendor merely provides new data for use within a financial institution's risk management or pricing functions? What if the outside vendor NEVER seeks to:
accept a deposit,
intermediate the purchase and sale of a security,
offer investment advice or
operate a payment system?
Here are the most important questions of all: If the outside vendor does not approach the intermediation function, is it still a FinTech? What if the new data sets and innovative information processing systems change our understanding about what a financial institution does and how it should be regulated?
Governments regulate intermediation in large part to provide confidence to the public that they can trust third parties (banks, insurance companies, securities firms) to handle their money.
If new technologies like blockchain provide an alternative mechanism to engender trust in the intermediation process, what roles remain for financial regulation...and which types of firms may become subject to their rules?
Noone can know the answer to these questions yet. But we need to start thinking about it now because the trajectory for financial institutions places them squarely on a collision path with some foundational components of the regulatory system.
Why It Matters To Us
We have more than a passing interest in these questions at BCM International Regulatory Analytics LLC. We are creating a new data set regarding policy risk using our patented, proprietary process. This data forms the foundation for patented functions useful for anticipating policy outcomes. Subscribers to the FinTech RegTrends Report have a sense of what some of the outputs will look like when the toolkit has been built.
Financial institutions can use this patented toolkit to price policy risk more effectively. They will also use the tools to manage their exposure to policy risk in a more dynamic and effective manner. But financial institutions will not be the only users, even if they are early adopters. Corporations and advocates will also be active users.
So if the exact same data sets and algorithms are provided to a broad range of customers beyond financial services, are we still a FinTech? If we build in to our business plan from the beginning a commitment to meet financial institution compliance requirements, will this make us a more competitive firm than those that participate in regulatory sandboxes (where they exist)? If some customers use the toolkit for advocacy but not pricing or risk management, are we still a FinTech or have we morphed into a....RegTech company even if we have nothing to do with the compliance function?
Stay tuned. We are all about to find out.