Main Image Credit The City of London seen from the south bank of the River Thames in London. Courtesy of 0x010C/Wikimedia.
Technology is transforming the financial services industry. So how should national regulators and intergovernmental organisations keep pace, set robust standards and provide relevant guidance?
The financial services landscape has been fundamentally redrawn in recent years due to both technological innovation and increased global regulation, with the latter coming largely in response to banking crises and compliance failures.
Such events coincided with a digital revolution – and the rise of financial technology (or FinTech, as it is better known), which places customer experience and efficiency at the heart of its business model.
There has been an explosion of companies offering pioneering ways to advance financial behaviour and experience: mobile payments; peer-to-peer lending; money transfer services; crowdfunding; wealth management; virtual currencies; and e-wallets to name but a few.
The portmanteaux do not end here. From ‘RegTech’ (technology using automated processes to facilitate compliance with regulations) to ‘InsurTech’ (the application of technology to the insurance industry) the often lucrative model of technology-enabled disruption to traditional financial services is here to stay.
While this new breed of financial jargon can be off-putting, its transformative effect should not be underestimated.
Nor should the speed of change. For incumbent service providers, increasingly perceived as employing processes that are cumbersome, out-of-date and which ultimately do not place the consumer first, are moving rapidly to adopt new technologies themselves, partnering with start-ups in order not to fall behind.
In the UK, this innovation has been embraced. London is recognised as a global hub, ranking first in the world for having the strongest FinTech ecosystem, according to a 2016 HM Treasury report conducted by global consultancy EY.
And in 2015, the City watchdog, the Financial Conduct Authority, introduced Project Innovate, which includes a regulatory sandbox mechanism allowing selected businesses to test their products in a live, unencumbered environment.
These developments are clearly positive, but still beg the question: how should national governments and intergovernmental organisations such as the EU and the Financial Action Task Force (or FATF – the global standard setter for anti-money laundering and counter-terrorist finance) create financial crime-related regulations and guidance that are relevant for this new, developing financial world?
Given the widely held perception that organised criminals and terrorists will seek to utilise new technologies to aid their activities, ensuring industry standards are high and that appropriate financial crime controls are in place is essential as the FinTech sector grows.
There are indeed risks that are more specific to FinTechs than traditional financial institutions. As noted in a recent RUSI Occasional Paper, virtual currencies offer degrees of pseudonymity and anonymity and an ability to facilitate rapid international transfers that offer clear benefits to organised criminals.
While evidence of money laundering and terrorist financing is limited, it seems inevitable that as the sector grows, it will be exploited for criminal purposes. Other risk areas that FinTech companies should be considering are fraud, onboarding or sending money to sanctioned entities, facilitating bribery and corruption and even tax evasion.
Anticipating these risks via appropriate regulation is key.
The nature of these businesses (and the inherent agility and opportunity to innovate that comes with being small-scale) means that FinTechs are often better placed to build financial crime controls from the ground up – without the inefficiencies and systemic weaknesses that have challenged traditional financial institutions in the past.
For example, Monzo, a challenger bank built for smartphones that uses machine learning to monitor its customers’ account behaviour, identify illicit activity, and adapt to new financial crime typologies.
In RegTech, there has been an a year-on-year rise in investment by venture capitalists since 2012, with 2016 marking a record high, an indication of the competitive advantage that automation of regulatory compliance can give to financial services providers.
So, where does this leave those tasked with providing regulations and guidance?
At the EU level, thinking is progressing, with the creation of its Internal Task Force on FinTech. In January 2017, the European Parliament’s Economic and Monetary Affairs Committee presented its draft report on FinTech, and last month Parliament’s Research Service published a briefing summarising the prospects and challenges that FinTech presents.
Under the German presidency, FinTech has also been prioritised by the G20. The G20 has emphasised not only the convenience it provides to wealthy countries, but also the positive impact on the approximately 2 billion people worldwide that remain financially excluded.
For their part, FinTech firms are closely following EU regulatory developments including the Fourth Anti-Money Laundering Directive, which must be implemented by 26 June, and the Payment Services Directive 2 which must be transposed into national law by 13 January 2018. Both these will present challenges and opportunities for the sector.
Last June, FATF president Juan Manuel Vega-Serrano placed partnership with the FinTech and RegTech sector at the top of his year-long agenda. This dialogue appears to be taking shape, with the inclusion of a FinTech session at FATF’s Private Sector Consultative Forum in March.
While FATF is still in the early stages of evidence gathering, its focus on the topic is promising with a further session on FinTech and RegTech to be held in Silicon Valley next month.
The critical challenge for FATF as it moves forward is to assess whether or not its current standards are relevant for the financial services landscape of both today and tomorrow. What is certain is that technological innovation is unlikely to slow down any time soon and thus FATF needs to ensure that its standards and guidance are not left behind.
To remain relevant, FATF must make a fundamental assessment of the different services on offer, recognising that the FinTech community is by no means homogenous. FATF must provide definitional clarity, demonstrate clear understanding and assess its standards as they relate to the risks and opportunities presented by FinTech.
Collaboration between public and private sectors has been a growing theme in recent years among those seeking to maintain and strengthen the integrity of the financial system. Such an approach is critical if standard setters and regulators are to avoid stifling innovation and keep pace with FinTech where the status quo is challenged every day.
FATF needs to establish lasting mechanisms and guidance that encourage new technology firms, law enforcement and regulators to work together in order to develop an approach to financial crime that not only maintains standards, but, critically, also reflects and exploits the anti-financial crime opportunities offered by FinTech.