"Fin-RegTech: Regulatory challenges with emphasis on Europe"
Keynote speech
by
Professor John (Iannis) Mourmouras
Senior Deputy Governor
Bank of Greece
Former Deputy Finance Minister
Former Chief Economic Advisor to the Prime Minister
New York, Cornell University, 28 February 2019
Introduction
It is a great pleasure for me to be in New York upon the invitation of Citigroup to speak at Cornell University's
"Tech Day", at such a ground-breaking seminar, entitled "Big Data and FinTech Innovation". As you know, the
University which hosts us today was founded 150 years ago by Ezra Cornell, the inventor of the electric
telegraph and founder of Western Union. His motto - which became the University's founding principle, "an
institution where anyone can find instruction in any study" - has formed the basis for Cornell University's
countless contributions across all fields of knowledge, prioritising public engagement to help improve quality of
life worldwide. At this University, founded by such a revolutionary spirit, I have the opportunity to share my
thoughts and exchange views with you on what economists have called a major catalyst in the "fourth industrial
revolution", the FinTech industry, due to its significant transformative impact on financial services. And let me
draw your attention to another parallel: the term FinTech first appeared in the public domain, introduced in the
early 1990s by Citigroup, the main organiser of today's event!
My speech today will be structured as follows: After offering some introductory remarks to clarify technical
jargon and some remarks on FinTech's current landscape, I will then move on to an overview of FinTech's
current state-of-play in the European Union (EU), focusing on its potential impact on the established financial
sector, as well as the risks and challenges ahead. Finally, I will take a look into the regulation gap as far as
FinTech activities are concerned and possible ways to fill this gap.
2. The FinTech landscape today
2.1 What is Fintech?
Despite its widespread usage, FinTech does not have a broadly and formally accepted definition. In general terms,
FinTech stands for Financial Technology and describes technologically enabled financial innovations that could
result in new business models, applications, processes or products with an associated material effect on financial
markets and institutions and the provision of financial services.
A term associated with FinTech is RegTech, a commonly recognised term for technologies that can be used by
market participants, to follow regulatory and compliance requirements more effectively and efficiently, and by
competent authorities, for supervisory purposes. RegTech is not entirely new, but is rapidly developing (in line
with other technological applications), fuelled by growing computing power, emerging technology's diminishing
cost and the data explosion. In 2018, RegTech investment reached the amount of US $2 billion and is forecasted
to exceed $ 76 billion by 2022. RegTech provides senior executives with an opportunity to introduce new
capabilities that are designed to leverage existing systems and data to produce regulatory data and reporting in a
cost-effective, flexible and timely manner without taking the risk of replacing / updating legacy systems. Having
said this, my intention today is to focus on the regulatory challenges surrounding FinTech and how to close the
regulatory gap I mentioned earlier.
2.2 FinTech landscape
The global FinTech landscape can be mapped across eight distinct categories: payments, insurance, financial
planning, lending and crowdfunding, blockchain, trading and investment, data and analytics, and cybersecurity
(see Chart 1).
Chart 1 FinTech landscape used by IOSCO (International Organization of Securities Commissions)
In more detail, blockchain, also known as distributed ledger technology or DLT, became widely known as the
technology that underlies Bitcoin, which holds 60% of the cryptocurrency market. Of course, numerous potential
applications of DLT to financial services other than digital currencies are lately becoming apparent such as
roboadvice and peer-to-peer insurance.
Another category in the FinTech landscape is data & analytics. As you know, advances in digital technology
such as Artificial Intelligence (AI) and Big Data have greatly increased the usability of advanced analytics in the
financial services sector. This development can lead to better suited products and services, but it also poses the
question whether a limit should be put on the profiling of individuals. In this respect, the expanded availability
and broader use of consumer data raises issues relating to data ownership and data usage and their implications
for consumer privacy. A small digression on AI may be in order here. It is said that the world's most valuable
resource is no longer oil, but data and AI has the capability to unlock and leverage data, transforming our lives. I
don't have to mention the list of world "firsts" AI has already achieved. AI ferryboats, AI hearing aids, aI
toothbrush, AI ski instructor, financial reports, video games, etc. and in the near future autonomous driving
which e.g. could reshape the trucking industry, resulting in fewer accidents, smart cities with less pollution and
energy usage, smart farms with better quality products and so on.
A final category in the FinTech landscape is cybersecurity. While increased reliance on digital technology may
heighten the risk of cybersecurity being compromised, digital technology also presents numerous opportunities to
improve security of digital financial services. Data encryption to protect digitally stored data is improving with
technological advances. Data analytics can be used to detect irregular patterns and fraud. DLT could increase the
transparency of transactions, making them easier to track and control, improving Anti-Money Laundering (AML)
regulations.
3. A look into the rise of FinTech in the EU
Over the last couple of years, global FinTech investment activity has been recording robust growth. While in
2012 total investment in this sector was less than US $12 billion, in 2018 global investment in FinTech
companies reached approximately US $112 billion (with 2,200 deals), more than double its 2017 level of around
US $51 billion (as you can see in Chart 2). Moreover, 2018 was a year in which Fintech investment, including
Venture Capitals (VC), Mergers and Acquisitions (M&A) and Private Equities (PE), recorded a series of peaks.
Emerging Fintech subsectors have seen the number of new startups rise rapidly, while highly mature sectors such
as payments experienced a certain degree of consolidation.
Chart 2 Global investment and banks' activity in FinTech
The US and Silicon Valley remain the world's biggest hubs for FinTech companies and have the lion's share in
terms of financing. In 2018, US FinTech investment reached US $55 billion across 1,245 deals. Europe's
FinTech sector has been catching up with US FinTech investment growth, with investment following an upward
path since 2008, having reached US $34 billion with 536 deals in 2018, driven by big mergers and acquisitions
(M&As) (see Chart 3). Venture Capital investment remains high in Europe and in 2018, it attracted the second
largest amount ever of VC investment in FinTech.
Chart 3 Total investment activity (VC, PE and M&A) in FinTech in Europe (2013-2018)
Despite concerns about Brexit, the UK remained a leader in FinTech in 2018 (see Chart 4 for the number of
companies established in individual EU countries). The UK accounts for half of the region's top VC deals, with
last year's total investment activity amounting to US $21 billion. Throughout 2018, the UK government
continued to build FinTech bridges with other jurisdictions, so as to reduce regulatory barriers and support
growth in a post-Brexit world. Ireland saw increasing interest from global FinTech companies and financial
institutions, spurred by Brexit-related concerns. More precisely, 55 FinTech or financial services companies
opted for establishment in Ireland last year, and their move is expected to bring more than 4,500 new jobs to the
country (IDA, Ireland). Around 50 applications for authorization were submitted to the Central Bank of Ireland
by year-end covering almost the entire spectrum of financial services including banking, insurance, asset
management and payments. Multinational companies seem to be concerned about a no-deal Brexit and these
moves in 2018 suggest their efforts to mitigate its impact.
Chart 4 Fintech sector development across European Union
Sources: Ernst and Young, Crunchbase, Digital Agenda Scoreboard, and European Central Bank.
This year, we are expecting more FinTech consolidation driven both by FinTech companies looking to buy in
order to achieve greater scale and by conventional banks looking to buy FinTech in order to drive their own
strategic objectives. Over the next few quarters, Fintech activity is expected to rise in terms of open banking,
RegTech, the acquisition of FinTech by banks, insurance tech, and the creation of start-ups, given that Europe
offers a start-up friendly regulatory environment that encourages young entrepreneurs to experiment with
innovative FinTech services.
4. FinTech's impact upon and interaction with the conventional financial system and monetary policy
transmission mechanism
But what is FinTech's estimated impact of and interaction with the conventional financial system? All the above
developments of the financial technology infrastructure have non-negligible implications. Therefore, it is
interesting to briefly discuss the main effects of FinTech revolutions on customers, competition among market
players and, overall, the financial industry's operation and structure.
Currently, five main drivers appear to be shaping and are expected to bring changes to the established financial
sector:
The first driver is reduction of information asymmetry. The ability of new technology to capture and process a
high amount of data in real time is improving the price discovery mechanism in several areas of the financial
system such as the credit gap between borrowers and lenders, to the extent that clients' information history
becomes more transparent, improving borrower's behaviour through competition and resilience.
The second driver is improvement of Communication Efficacy and the third is supporting lending for small- and
medium-sized enterprises (SMEs). The fourth is supporting a sharing Fintech facilitates sharing
economy:
economy through digital platforms that enable the matching of buyers and sellers. Finally, the fifth driver is
increasing financial inclusion. In other words, the sustainable provision of affordable financial services (mainly
bank accounts) to more vulnerable people with limited economic means, as well as population groups living in
underdeveloped areas and countries.
Last but not least, in terms of the transmission mechanism of monetary policy (this is the transmission of
monetary policy to the real economy), FinTech has the potential to alter some of the transmission channels, thus
affecting economic variables and inflation, mainly through two channels, firstly, the credit channel and secondly,
the bank lending channel. On the one hand, an expansion of FinTech firms in the credit market could alter the
functioning of the credit channel, mainly through softening information asymmetries in the credit market, when
pricing borrower's risk. On the other hand, FinTech companies have the potential to affect the pass-through of
monetary policy to bank lending rates. In 2018, in the US the overall loans originated via alternative lending
platforms reached about 5% of the value of newly issued consumer credit. Worldwide, the total value of
transactions through alternative lending platforms climbed to an amount of US $196 billion, expected to grow by
an annual rate of 10.7% in the period between 2019-2023, resulting in a total amount of $363 billion (Statista,
2018). China, and, to a minor extent, the US and Europe, fuelled the expansion of alternative lending, accounting
for around 93% of the total value of transactions in 2018. The increasing importance of FinTech firms could
threaten the informational content of money aggregates and credit supply, lessening potentially the ability of
central banks to gather reliable information for conducting monetary policy and also affecting the interest rate
pass-through.
5. Regulating FinTech
5.1 Risks from a regulatory point of view
Regulators and supervisors need to follow market developments to understand how the emergence of new
players, infrastructures, products and distribution channels is going to transform the financial system. In this
regard, a significant proportion of EU FinTech companies is not subject to any regulatory regime (31%) or is
only subject to a national authorisation or registration regime (14%). From a prudential and regulatory point of
view, I will try to briefly summarise the associated risks by order of importance:
First, risks arise when automating customer and investment services as competition becomes stronger with the
entrance of new firms into the financial sector. The challenge for regulation is to keep a level-playing field
between existing and new companies which promotes innovation and fosters competition, and, at the same time,
preserves financial stability. In this context, since January 2018, the application of PSD21 and the related set of
guidelines and technical standards for the security of payment and investment services in the EU facilitate
innovation, and efficiency preventing regulatory arbitrage and promoting equal competition. Furthermore, while
a number of new propositions on automated investment recommendations have been launched in the recent years
using extensively algorithms not many have been identified as offering automated investment advice in the
context of MiFID/MiFID II.
Second, FinTech growth increases the financial system's susceptibility operational and cyber risks. Higher
reliance on third-party provision of services - such as communications and cloud storing - could entail higher
operational risks. As far as cyber risks are concerned, as the technological systems of financial institutions are
more interconnected, there are more possible entry points for potential attacks with more significant
consequences. Finally, information use and storage by FinTechs raises important data privacy and security issues.
the issue of risk misallocation arises here, because micro-transactions provide a layer of diversification,
Third,
credit risk from the borrower to the creditor still passes through under-regulated and under-controlled channels
compared to conventional financial services. The first principle of risk management applies to all banks, but also
to high-flying FinTech companies: "if you owe 1 dollar to your lender, it's your debt, if you owe 1 million, then
it's the lender's problem"! For example, Ye'e Bao (translated as 'hidden treasure'), associated with the biggest
Chinese online retailer, is in practice the largest money market fund in the world, whose assets under
management are worth close to US $265 billion, but the regulations affecting dedicated money market funds are
not entirely binding Ye'e Bao, as it is not owned by, and does not legally constitute, a financial institution.
Fourth, another major issue in the debate regarding FinTech revolves around the risks it entails in terms of
increasing financial discrimination through the extensive use of algorithms based on consumers' demographic
and personal information available online (collected by big tech companies) and, as a result, having the potential
to give rise to greater income inequality. With the expansion of FinTech, it may become even harder for
population groups of lower income, ethnic minority background, younger age, women or people with disabilities,
etc. may be discriminated against in terms of consumer finance, so that only those financially better off, i.e. the
richer ones, are chosen to have access to loans, investment products, etc.
Unlike regulated banks, FinTech companies are not subject to strict rules on consumer protection, e.g. to
compensate consumers, offer deposit insurance and meet standards in order to prevent misleading vulnerable
consumers into buying unsuitable or harmful financial products. We, therefore, need to pay particular attention to
the risk that those who trust FinTech products lacking such a safety net are currently running, by relying on big
FinTech providers to regulate themselves.
5.2 Existing regulatory framework in the US and the EU
Taking stock of the existing US and EU regulatory framework, it should be pointed out that there is no singular
regulatory framework for FinTech companies. In the US, Fintech companies are generally regulated at the state
level. For example, many states have enacted legislation governing the extension of credit and money
transmission in their jurisdictions, combined with licensing requirements for such activities. Similarly, in the EU,
Fintech companies operate under passportable licenses. In the EU, certain services provided by FinTech
companies, such as retail banking, payment services and financial market services, are subject to the
panEuropean 'passporting' regime: a company licensed in one EU Member State (home state) may provide such
services in another EU Member State (host state), e.g. via a local branch, using its home-state license as a sort of
"European passport". Moreover, in both the United States and the EU, cybersecurity-related regulations and
Anti-Money Laundering and Counter-Terrorist Financing (AML/CFT) regulations apply to FinTech companies.
We may argue that the EU has expanded the scope of its rules to include services that EU FinTech companies
offer to consumers. Moreover, the European Banking Authority (EBA) recognises the benefit in protecting
consumers when they use financial services offered by firms outside the conventional financial services sector. It
recommends defining consumers' rights in the FinTech space, creating effective procedures for processing
consumer complaints, improving the quality of disclosures to consumers in a digital environment, and increasing
consumer financial literacy. In light of the potentially inconsistent regulatory regimes to which EU FinTech
companies are subject, the European Commission published last year an action plan for the implementation of an
EU-wide framework dedicated to FinTech companies aimed at "a more competitive and innovative European
financial sector". The Commission's Action Plan proposes 23 steps to enable innovative business models to scale
up and support the uptake of new technologies, and to enhance cybersecurity and the integrity of the financial
system, including an EU Fintech Laboratory where European and national authorities will engage with
technology providers and an EU Blockchain Observatory and Forum, which will report on the challenges and
opportunities of crypto-assets.
5.3 Filling in the regulatory gap
From the aforementioned regulatory frameworks, we all agree that risks related to regulation and compliance
arise from FinTech's rapid growth and it is reasonable to expect that new or evolving risks will emerge for the
system and for individual institutions.
It appears that the main challenge is to implement legislation governing FinTech companies in order to protect
users and markets, while offering an environment favourable to growth. In the context of financial regulation, it
is of utmost importance to strike a balance between the following three fundamental elements:
1. Manage the trade-off between efficiency gains associated with technological innovation and the
protection of stakeholders in the financial industry. On the one hand, regulation must not be too
stringent to the point it preempts the creation and development of new technologies that generate
efficiency and savings in transaction costs; on the other hand, regulation must not be too lax, so as to
make sure that investors and users of financial services are adequately protected and that regulatory
frameworks are continuously adapting to technological advances, rather than falling behind the curve.
2. Ensure an adequate regulatory level playing field for banks and FinTechs, fundamental to achieve
appropriate competition. First, activities involving the same risks in terms of financial stability,
consumer protection and the integrity of the financial system should receive the same regulatory
treatment (this is the number one principle or regulation). Therefore, any difference in regulation and
supervision should be based on the risks posed by different products and services. Second, there
should not be unnecessary barriers to competition in the market beyond those justified by risk
considerations. In relation to this, authorities should further assess the implications of prudential
regulation, which often leaves banks in a situation of competitive disadvantage vis-a-vis other players,
and work towards eliminating existing loopholes in regulatory frameworks.
3. Given the global dimension of most technological innovations and the increased interconnectedness
of the financial system, regulatory frameworks need to be internationally co-ordinated and upgraded.
The work of the Financial Stability Board (FSB) and other international standard-setting bodies (SSBs)
will be crucial in this endeavour. However, as pointed out by the FSB, regulatory and supervisory
approaches to FinTech are becoming increasingly fragmented, undermining the effectiveness of
financial institutions' efforts to address the ensuing risks. We, first of all, need to determine the
legitimate uses and purposes of FinTech innovations and then define guiding principles at global level
that serve to avoid fragmentation across countries' regulatory approaches. In other words, we do not
want to overregulate. We must first see whether there is a fundamental economic case for regulating
specific products/functions (which, in some cases, might ultimately be proven useless) and then
regulate in a coordinated manner.
Epilogue
In closing, we are at the beginning of the "fourth industrial revolution", which is transforming the way we live,
work and interact. As the FinTech sector grows, it is important that all parties involved not only pay close
attention to technical, regulatory, policy, and legal considerations, but also monitor its growth and better
understand its impact.
Regulatory trends become increasingly complex and regulators demand ever larger amounts of granular data
from firms, as a result, there is substantial scope for big data analytics and machine learning to help both market
participants follow regulatory and compliance requirements and supervisory authorities assess compliance and
measure risk. One thing is for sure: no matter what, human intervention to provide a final arbitration will always
be required!
One final comment, with my professorial hat: More generally and in more philosophical terms, as new
technologies evolve and become more accessible, naturally more ethical issues will arise, but I believe the
foundation on which everything must be built is quite simple: putting humans and their needs first. Plato the
famous ancient Greek philosopher who lived in Athens 2,500 years ago said: the purpose of humanity is to obtain
knowledge. In today's world this could be translated as follows: knowledge for innovation to improve the human
condition. The symbiotic relationship between human creativity and computational creativity is still in its infancy.
Ultimately, the question is not about what new technologies can create, but rather what humans can create with
new technologies to empower the future of humanity.
Thank you for your attention!