FinTech Regulation & Ecosystem

FinTech – a combination of the words ‘finance’ and ‘technology’, refers to the integration of technology into financial services or vice versa. It rose to prominence after the 2008 economic crisis, helped by technological advancements in smartphone usage and blockchain. There were also US FinTech regulation changes to promote smaller players to enter the financial services with its adjustments giving birth to a new US FinTech ecosystem. The US government is moving much slower than the UK although it has passed several resolutions, whereas its regulatory system stays one of the most complex in the world because it is historically regulated both on the federal and state level.

The United States has two types of financial socio-geo-political regulators: federal and non-federal.

From a federal perspective we observe five types of regulators based on their jurisdiction:

Depository Institution Regulators oversee three types of financial entities: commercial banks, thrifts (i.e. savings/loans) and credit unions. The US has a dual banking system where each depository institution is regulated by its chartering authority: at state and federal level (Congressional Research Service, 2017).

National banks and thrifts are federally regulated from a safety perspective by the Office of the Comptroller of the Currency (OCC). State-chartered banks are members of the Federal Reserve System (FRS) and regulated by the Federal Reserve. Non-members of the FRS are overseen by the Federal Deposit Insurance Corporation (FDIC). Federally chartered or insured credit unions are regulated by the National Credit Union Administration (NCUA), which administers a deposit insurance fund separate from the FDIC’s. Foreign banks’ primary regulators are the Federal Reserve and the OCC (Congressional Research Service, 2017).

The Consumer Financial Protection Bureau (CFPB) is a federal institution, housed within – but independent from – the Federal Reserve. It administers the set of rules that protects customers: disclosure and suitability standards and banning abusive practices (Congressional Research Service, 2017).

Securities Regulation happen mainly on a federal level and it is primarily assured by the Securities and Exchange Commission (SEC), except for certain types of derivatives (futures, swaps, and a few types options) (ZUCCHI, 2018) which are regulated by the Commodity Futures Trading Commission (CFTC) (Congressional Research Service, 2017).

The Congress created Government-Sponsored Enterprises (GSEs) as privately- owned institutions with limited missions and charters to support the mortgage and agricultural credit markets. The two regulators that exclusively oversee the GSEs are the Federal Housing Finance Agency (FHFA) and the Farm Credit Administration (FCA) (Congressional Research Service, 2017).

Regulatory Umbrella Groups coordinate between regulators. Although different task forces have been set up, the only three permanent interagency organizations are the Financial Stability Oversight Council (FSOC), the Federal Financial Institution Examination Council (FFIEC), and the President’s Working Group on Financial Markets (Congressional Research Service, 2017).

From a non-federal perspective we observe 3 types of financial socio-geo-political regulators: Insurance, State Regulation, International.

There are no federal regulators for Insurance, the companies are chartered and regulated solely by the states. Other than insurance, there are State Regulators for banking, securities markets and nonbank consumer financial protection (Congressional Research Service, 2017). This makes an extensive list of state-level institutions. (see Appendix 1). There are multiple International standard setting bodies: the Basel Committee on Banking Supervision for banking regulation, the International Organization of Securities Commissions (IOSCO) for securities and derivatives regulation, and the International Association of Insurance Supervisors (IAIS) for insurance regulation (Congressional Research Service, 2017).

The below figure represents a simplified overview of the complex US financial regulatory system

(Congressional Research Service, 2017)

This heavily regulated environment makes it harder for emerging FinTechs to join the regional ecosystem. For example, WorldRemit took 3 years to obtain its banking license from all the US states. However, the region has a big and growing market.

(US FINTECH MARKET – GROWTH, TRENDS, AND FORECAST (2020 – 2025), 2020)

We can identify the five major FinTech trends in the US at the moment based on the highest valuations of FinTech companies; this includes Payments processing, Cryptocurrencies, Securities, Lending, and HR management (Appendix 2). These 5 verticals have seen tremendous continuous growth in the past 5 years, as more companies obtain a billion dollar valuations.

Regionally, we can observe growth in FinTech startup numbers in the central part of the US. Although the majority of VC backed companies with investments totaling $1000+ M/state since 2014 are based on the East and West Coasts, states such as Texas, Utah, Kansas, Missouri, Minnesota, Tennessee have shown a rapid growth in VC funding and accelerators presence.

(The United States Of Fintech Startups, 2019)

Interestingly, another segment that has seen high growth is student lending (as can be seen in the below figure). This is a market segment previously underserved from a FinTech perspective. Personal lending and SME-focused landing have also seen increases since 2014.

(Darden, Dixit, & Mason, 2018)

For the scope of this paper we have selected Blockchain and Open Banking Application Programming Interfaces (API) as we think these are the most exciting and current FinTech advances in the market. Fintech as well as the Fintech regulation will alway play are part in the implemtation and its complexity.

One of the US’ current innovations are the development of open banking APIs, whose main driver behind it is “Afinis – a unit of the National Automated Clearing House Association (NACHA), the financial industry association that administers and facilitates private-sector operating rules for ACH payments”. (Azzara, 2020) (appendix 3) Currently, Afinis are building the following 3 APIs:

1. Get Transaction Status, which allows a transaction participant to verify the status of the deposited funds;
2. Business to Business (B2B) Payments Interoperability
3. Originate ACH Payment, which “enables businesses to submit ACH paymentinstructions without needing to access multiple systems and track scheduling

(Azzara, 2020)

Blockchain technology has become increasingly used in the USA in recent years. For example, the U.S. Securities Exchange Commission (SEC) has been actively exploring applications of blockchains for transactions in the public securities market. Furthermore, the SEC are convinced that cryptocurrencies are under their jurisdiction and have adopted blockchain as it relates to securities using its t0.com (https://www.tzero.com/) blockchain platform. (https://tzeroats.com/) (Blockchain Regulation and Landscape In USA, 2018)

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We anticipate that the US will see an increased adoption of technology usage at a regulatory level in the next couple of years. On the other hand, the presence of such a vast amount of regulatory state-level bodies, will continue. Initiatives such as the Conference of State Bank Supervisors (CSBS, 2018) will also be more common as they strive for a democratized regulatory system for cross-state level finance regulators.

The current UK regulatory framework, who serve the treasury, is set out as the Bank of England (BoE), Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) (Understanding the new ‘Twin Peaks’ Regulatory Environment, 2013) (Appendix 4). Whilst there is no specific regulatory framework for FinTech, the FCA have created a global regulatory sandbox – Global Financial Innovation Network (GFIN) – which allows regulators to ensure that new market entrants are compliant.

In 2018, a ‘task force’ was commissioned by the UK chancellor of the exchequer to police cryptocurrencies as it was becoming a growing regulatory concern (i.e. decentralised) (appendix 5).

UK FinTech Ecosystem

(Nonninger & Tesfaye, 2018)

RegTech is being increasingly adopted by the FCA for activities like Know Your Customer

(KYC), Anti money laundering (AML), Customer Due Diligence (CDD). This has also

disrupted internal compliance teams for banks.

Europe FinTech

The UK could export its RegsTech & GFIN vertical/frameworks to support FinTech regulation innovation from the UK to cross board. This is a reference to the global and domestic market post Brexit.

The EU was highly influential in laws in the UK for financial services which came in the forms of regulations and directives, where it was the role of the BoE & PRA to decipher the laws and legislation from the EU and assess how they can be implemented under the current legal system and then for the FCA to police this once implemented.

GFIN

GFIN was founded by the FCA in April 2018 and formally launched in January 2019 as a cross border to allow innovation in the FinTech market on the global stage in the interests of consumers, where it currently has 50 organisations committed.

(GFIN, 2020)

Comparison between UK & US FinTech

The UK has only 3 main regulators compared to the US, who has federal and state level regulators with overlapping authorities, making it very hard for FinTech companies to become compliant across US states. Further, from an innovation point of view, whereas the EU and UK have open banking initiatives like PSD2, the US “currently has no legal requirement stipulating a financial institution must make a consumer’s financial data available to a third party in the event that a consumer provides affirmative consent” (Boms, 2018). In this regard, “the US has a lot of catching up to do” (Boms, 2018).

After Brexit, more UK FinTech startups will look to the US as the UK strengthens trade deals with the US, alongside negotiating their exit from the EU. This can be thought of as a hotspot for FinTech, seeing as both populations speak english (i.e low cultural barriers). This can be evidenced by several of the leading UK FinTechs (e.g. Monzo, Revolut, Oaknorth) announcing their US expansion plans in 2019.

Appendices
Appendix 1: List of State and Territories Level US Financial Regulators

1. AlabamaStateBankingDepartment
2. AlaskaDivisionofBankingandSecurities
3. American Samoa Government Office of Financial Institutions
4. Arizona Department of Financial Institutions
5. ArkansasStateBankDepartment
6. California Department of Business Oversight
7. ColoradoDivisionofBanking
8. ConnecticutDepartmentofBanking
9. Delaware Office of the State Bank Commissioner

10.District of Columbia Department of Insurance, Securities and Banking 11.Florida Office of Financial Regulation
12.Georgia Department of Banking and Finance
13.Guam Department of Revenue and Taxation
14.Guam Public Utilities Commission
15.Hawaii Department of Commerce and Consumer Affairs
16.Idaho Department of Finance
17.Illinois Department of Financial and Professional Regulation
18.Indiana Department of Financial Institutions
19.Iowa Division of Banking
20.Kansas Office of the State Bank Commissioner
21.Kentucky Department of Financial Institutions
22.Louisiana Office of Financial Institutions
23.Maine Bureau of Financial Institutions
24.Maryland Office of the Commissioner of Financial Regulation 25.Massachusetts Office of Consumer Affairs and Business Regulation 26.Michigan Department of Insurance and Financial Services
27.Minnesota Department of Commerce
28.Mississippi Department of Banking and Consumer Finance
29.Missouri Division of Finance
30.Montana Division of Banking and Financial Institutions
31.Nebraska Department of Banking and Finance
32.Nevada Department of Business & Industry Financial Institutions Division 33.New Hampshire State Banking Department
34.New Jersey Department of Banking and Insurance
35.New Mexico Regulation and Licensing Department

36.New York State Department of Financial Services

37.North Carolina Commissioner of Banks
38.North Dakota Department of Financial Institutions
39.Commonwealth of the Northern Mariana Islands Department of Commerce 40.Ohio Department of Commerce

41.Oklahoma State Banking Department
42.Oregon Division of Financial Regulation
43.Pennsylvania Department of Banking and Securities
44.Commissioner of Financial Institutions of Puerto Rico
45.Rhode Island Department of Business Regulation
46.South Carolina Office of the Commissioner of Banking
47.South Dakota Department of Labor and Regulation
48.Tennessee Department of Financial Institutions
49.Texas Department of Banking
50.Utah Department of Financial Institutions
51.Vermont Department of Financial Regulation
52.Virgin Islands Division of Banking, Insurance, and Financial Regulation 53.Virginia State Corporation Commission
54.Washington State Department of Financial Institutions
55.West Virginia Division of Financial Institutions
56.State of Wisconsin Department of Financial Institutions
57.Wyoming Division of Banking

(Ontario Securities Commission, 2020)

Appendix 2

(Kauflin, 2019)

Appendix 3

Automated Clearing House (ACH) payments are electronic transfers from one bank account to another (Prichard, 2020).

Appendix 4:

Appendix 5

(Understanding the new ‘Twin Peaks’ Regulatory Environment, 2013)

Elaboration on commissioned ‘task force’ for cryptocurrencies:

Big risks are for AML and loss of collecting taxes. There is no way of creating more money in the system with quantitative easing but only to use taxes in some form to increase / decrease its value.

References

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Azzara, T. (2020, 02 05). Open Banking APIs Gather Momentum in the U.S. From American Express: https://www.americanexpress.com/us/foreign- exchange/articles/open-banking-api-gain-momentum-in-us/

Blockchain Regulation and Landscape In USA. (2018, 08 08). Retrieved 02 05, 2020 from Asia Blockchain Review: https://www.asiablockchainreview.com/blockchain- regulation-and-landscape-in-usa/

Boms, S. (2018, 09 21). U.S. way behind the curve on open banking. Retrieved 02 05, 2020 from American Banker.

CSBS. (2018, 03 01). Retrieved 05 02, 2020 from Cooperative Agreements: https://www.csbs.org/cooperative-agreements

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GFIN. (2020, 02 05). From Our Members: https://www.thegfin.com/members Kauflin, J. (2019, 02 04). The 11 Biggest Fintech Companies In America 2019.

Retrieved 02 05, 2020 from Forbes: https://www.forbes.com/sites/jeffkauflin/2019/02/04/the-10-biggest-fintech- companies-in-america-2019/

Nonninger , L., & Tesfaye, M. (2018, 12 21). Overview of the fintech industry in 2020: Latest trends, market research and analysis from our ecosystem report. Retrieved 02 05, 2020 from Business Insider: https://www.businessinsider.com/fintech-ecosystem-report?r=US&IR=T

Ontario Securities Commission. (2020, 02 05). From The U.S. Financial Regulatory System: https://research.osc.gov.on.ca/globalreg/usreg

Prichard, J. (2020, 02 03). Learn How ACH Payments Work. Retrieved 02 05, 2020 from The balance: https://www.thebalance.com/how-ach-payments-work-315441

The United States Of Fintech Startups. (2019, 11 06). Retrieved 02 05, 2020 from CB Insights: https://www.cbinsights.com/research/fintech-startups-us-map/

Understanding the new ‘Twin Peaks’ Regulatory Environment. (2013, 03 15). Retrieved 02 05, 2020 from Stratex Systems: https://stratexsystemsadmin.squarespace.com/blog/2013/3/15/understanding- the-new-twin-peaks-regulatory-environment

US FINTECH MARKET – GROWTH, TRENDS, AND FORECAST (2020 – 2025). (2020, 02 05). From Mordor Intelligence: https://www.mordorintelligence.com/industry- reports/us-fintech-market

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