Regulating FinTech

Senior Advisor to the Dean and Adjunct Professor of Finance, HKUST Business School

Former Secretary for Financial Services and the Treasury, the Government of HKSAR (2007-2017)

Rigorous application of regulatory principles without stifling true innovations should form the solid bedrock of a sound FinTech policy.

Regulation is often seen to play a critical role in the development of FinTech. The early days of FinTech development saw many technology companies trying to offer new ways of delivering financial services. Like money transfers, or peer-to-peer (p2p) lending, they are usually regulated activities, but the existing regulations are set for traditional, large and comprehensive financial institutions. The FinTech community often argues that the regulation for them should be tailored to the specific services they provide.

Some FinTech activities can be regulated by extending current regulations, for example, extending the remittance regulation to the money transfer business. For most other FinTech business models, new tailor-made regulations would be required. However, coming up with new tailor-made regulations for a new business FinTech model may not be practical, and whether that should be done depends on the perceived novelty or economic benefits of that FinTech activity. In some cases, regulators may make use of the exemption provisions in the existing regulation, such as the exemptions for accredited and professional investors.

Most regulators also adopt the principle of technological neutrality. That is, regulators will apply the same set of principles in regulating financial activities, regardless of whether they are delivered by traditional institutions or by FinTech firms. For example, a transfer of money using blockchain technology must still comply with the anti-money laundering regulations. But this approach is not without problems. In the case of p2p lending, if money is taken from individual investors, securities regulation on fund raising should apply. However, existing securities regulations that deal with investment products like stocks and bonds might be too onerous for smaller investments on the p2p platform. As a result regulators might choose to adopt a lighter approach but restricting its scope of application by putting a cap on the size of such loans.

Regulations need not stifle development

The upshot of this is that regulators have tried different ways to regulate FinTech without stifling its development. For example, in p2p lending, regulators in different countries have adopted very different approaches based on how much they want to promote this new business model versus the costs of setting up a new regulatory regime.

We often hear of complaints about regulators being too conservative in dealing with FinTech. Admittedly I am not an uninterested observer given my past role in the Government, but I would say that regulators generally recognize the benefits of FinTech and accept their roles in promoting FinTech. Because many FinTech business models are in their infancy, often it is not quite easy to know how they intersect with existing regulations. That explains the popularity of the “regulatory sandbox” schemes. They allow existing financial institutions and FinTech companies to try out a new technology or a new business model in a confined environment, so that both regulators and the companies involved can learn what problems may arise. The latest example of this approach is the Hong Kong Securities and Futures Commission (SFC) invitation to cryptocurrency trading platforms to join a regulatory sandbox if they want to be regulated.

If there is a lesson to draw from the experience with FinTech thus far, it is that sound regulations are needed for FinTech development. The collapse of many p2p lending platforms on the Mainland, and the many frauds and failures that plague Initial Coin Offerings, illustrate this point. While some business models are new, finance is still finance, and investor protection is needed to accompany new ways of doing finance.

Many regulators, often with political support from governments, have also introduced measures to promote FinTech. In my view, regulators in Asia are quite proactive, because of the generally high public acceptance of the new technology. In Hong Kong, FinTech awareness is also high, partly due to the perception that Hong Kong lags behind the Mainland in digital payments. The Government also makes FinTech development its policy goal. As a result, Hong Kong regulators have taken an active approach to create the environment for FinTech growth.

In the area of distributed ledger technology, the Hong Kong Monetary Authority (HKMA) has taken the lead to encourage the application of blockchain to trade finance. In banking, the HKMA announced seven measures to promote FinTech in September 2017. Several of these are especially noteworthy. The Faster Payment System, which began operations in October 2018, is a new payment infrastructure built by the HKMA to promote full connectivity in digital payments, person to person or person to merchants. The virtual banks initiative introduces digital banks without physical branches. The Banking Made Easy initiative streamlines existing regulations to remove obstacles to adopting technology to provide banking services.

Existing regulations remain strong

None of the measures introduced by the HKMA weaken or relax existing regulations. The Banking Made Easy initiative, for example, aims to make changes to existing regulations and procedures so banks and their customers can rely on the new technology rather than face-to-face meetings. So a review of some older procedures is necessary. As for the licensing of virtual banks, the HKMA makes it clear that they will regulate virtual banks in the same way they regulate conventional banks. Even if their business focus and methods of delivery may be different from conventional banks, they have similar capital and liquidity requirements, and must observe the same set of anti-money laundering rules.

The HKMA also takes up the role of a competition facilitator and digitization enabler. The virtual banking initiative could bring new players to the banking industry. The Faster Payment System is a public infrastructure that the private sector players have little incentives to build. Another initiative, the Open API, will allow third-party application providers to connect to the IT systems of the banks, which will offer more value-added financial products to customers. Together they foster competition in the banking industry.

Regulators in many countries, notably the UK and Singapore, are also adopting similar approaches to facilitate FinTech development. Sound and robust regulation is the key to public trust in the financial system. In a way, new business models made possible by FinTech need even stronger public trust, and therefore good regulations. The regulatory approach so far has resulted in the healthy development of the FinTech industry. But there is no room for complacency, as the continuing development of financial technology will challenge existing regulations. Rigorous application of regulatory principles without stifling true innovations should remain the bedrock of a sound FinTech policy.




Adjunct Professor of Finance