As we discussed in our last blog, technology continues to transform the financial services industry, particularly in regulatory technology or RegTech.  Venture capital firms have continued to invest heavily in RegTech, while financial services firms are embracing RegTech on a significant basis, exploring different ways to overcome barriers to progress, including a lack of budget and an uncertain regulatory landscape.  Joint activities (including R&D and product placement), investment, acquisition and in-house RegTech development have been four viable partnership and collaboration strategies employed by financial service firms looking to adopt RegTech.

Unfortunately, we have not seen a great deal more clarity in terms of the US regulatory landscape throughout 2018.  It is true that US regulatory bodies – including Financial Industry Regulatory Authority (FINRA) and the US Department of the Treasury – have been highly supportive of Fintech and RegTech.  As Treasury Secretary Steven Mnuchin said in a recent report, “We must keep pace with industry changes and encourage financial ingenuity to foster the nation’s vibrant financial services and technology sectors.” Treasury, for its part, has voiced support for a national charter for Fintech firms.

Both FINRA and Treasury have commissioned studies on the potential benefits of technology adoption and have encouraged the launch of sandboxes in the US.  The Consumer Finance Protection Bureau (CFPB) has taken this a step further in creating and staffing an “office of innovation” to help the Bureau fulfill its statutory mandate “… to promote competition, innovation and consumer access within financial services.” Beyond this type of sentiment, which is notable given regulators’ historic reluctance to comment (perhaps out of a desire to remain agnostic), neither of the regulators’ papers did much to advance the conversation beyond thoughts and ideas that have already been discussed.

However, US regulators at the Federal level have, for the most part, held back from direct involvement in such sandboxes, letting state regulators, industry groups and others take the lead.  Thus far, this approach has yielded limited results.

In our view, the US financial services industry (along with financial services customers and other stakeholders) would benefit from more direct involvement by regulators in the creation and promotion of regulatory sandboxes.  Importantly, this means implementing practical funding models, possibly an industry utility that imposes dues, fees and even fines to support sandboxes and other accelerators, as funding any such initiative remains a key issue.

Without direct participation, the US runs the risk of falling further behind non-US competitors with respect to Fintech and RegTech innovation and advancement.   For example, non-US regulators – including the Financial Conduct Authority (FCA) in the UK and the Singapore Monetary Authority – were among the first to jump in and have not only encouraged but have actively participated in the creation and use of sandboxes to accelerate RegTech development.  Such sandboxes prompt dialogue between companies and regulatory authorities, letting regulators have a preview of innovations without the potentially severe consequences of regulatory intervention.  More importantly, perhaps, they put themselves and their countries on the map as “RegTech friendly” and created some of the earliest discussion and “buzz” around the value of sandboxes that are supported by regulators.  The FCA program, in particular, has become a successful model for other countries and organizations to follow.

Sandboxes spur RegTech innovation, which provide three key benefits to the financial services industry:

  1. RegTech innovation help financial services firms.  By making it easier to comply with regulations – and to produce mandated reports and data at the pace and level of detail sought by regulators – good sandbox programs can lead to stronger compliance programs and, in the long run, to safer markets.
  2. RegTech innovation help regulators.  Regulators’ ultimate objective is to lower the risks of financial crime and of enterprise- or system-wide failures.  Application of technologies ranging from big data and analytics to machine learning and artificial intelligence help regulators by helping firms spot anomalies and suspicious trading patterns, identify problematic transactions, conduct modeling and stress tests and perform a host of other activities related to risk mitigation.
  3. RegTech innovation help customers.  Financial services firms often need to clear significant regulatory hurdles before they can launch new products, even if such products offer large potential benefits to consumers.   Sandbox programs can accelerate innovation and help get new products to market more quickly.  

There is also a macroeconomic reason for US regulators to take a more participatory approach to RegTech sandboxes:  Fintech and RegTech are fast-growing, highly creative fields attracting top talent in fields from data science to cybersecurity to software development.  Fintech and RegTech are closely related and advances in one sector often find immediate application in the other.

The FCA has taken the lead in the development of a robust and structured framework for the efficient testing of innovative financial services.  Since the sandbox launch in 2016, the FCA has won accolades from banking officials worldwide for providing a safe space for Fintech and RegTech firms to test out products without the threat of punishment if those products break any rules.

Right now, the US still holds a tenuous leadership position in fintech. But, in Fintech generally, and in RegTech in particular, a receptive regulatory environment is an essential condition for continued innovation and growth.  It is good that US regulators support and encourage innovation in the financial services sector, but it would be even better if they backed their words with some specific steps, such as working with the financial services industry to create and fund an innovation sandbox at the national level.  Without such direct involvement, we run the risk of falling behind in this key sector.

Please contact me if you have any questions.

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