South African Reserve Bank
Keynote address by Francois Groepe,
Deputy Governor of the South African Reserve Bank,
at the Strate GIBS FinTech Innovation Conference 2017
Gordon Institute of Business Science, Johannesburg
22 August 2017
Regulatory responses to FinTech developments
Introduction
Programme Director, distinguished guests, ladies and gentlemen.
I would like to start by thanking the organisers for the invitation to address you at
this year's Strate GIBS
FinTech Innovation Conference. The conference is timely
as we potentially face one of the most severe innovation- and technology-driven
disruptions to products and services, particularly in the financial sector space.
"We
Arvind Sankaran, an advisor on FinTech, argues: are witnessing the creative
destruction of financial services, rearranging itself around the consumer. Who
wins!"
does this in the most relevant, exciting way, using data and digital, To
paraphrase the famous Austrian-born economist Joseph Schumpter: it is the
process of industrial mutation that revolutionises the economic structure within,
incessantly destroying the old one, incessantly creating a new one, a prominent
- which he further describes as the 'perennial gale
feature of capitalism of creative
destruction'.
My address today will focus on regulatory responses to FinTech developments.
FinTech developments viewed from a regulatory perspective
Over the last decade or so, FinTech has attracted attention from many quarters;
publicity around FinTech developments continues to increase.
Interestingly, some parties suggest that FinTech may offer revolutionary changes,
such as completely new ways of banking where peer-to-peer lending
arrangements, for example, may displace more traditional intermediaries. By
contrast, others suggest that this type of innovation is not different to that
experienced in the past. Moreover, like the Internet, these innovations are likely to
integrate existing value chains and business processes that will give expression to
a symbiosis between new FinTech firms and incumbents. Along these lines, others
still argue that developments in the FinTech space are merely part of an
-
evolutionary process driven by innovation that this is therefore nothing new and
that regulatory regimes are adequate to deal with these developments.
Given these varying perspectives, regulators continue to reflect on how to respond
to developments in the FinTech space. I believe that the following three proposals
could serve to strengthen regulatory approaches to FinTech developments. These
are:
i. focusing analysis on activities involving financial services rather than on firms
or technologies;
ii. continuing collaboration between local and global regulatory authorities; and
iii. investigating and deciding on the most appropriate structures, such as
sandboxes, to keep abreast of FinTech developments and to allow for
demonstration of the technology and experimentation with user cases.
These three approaches are not mutually exclusive and are of importance in
developing sound policy stances for FinTech. I will address each of these in turn.
Focusing analysis on financial services activities
FinTech is developing rapidly. It has a vast scope that touches, among other
things, on chatbots, artificial intelligence, block chains, cloud computing, and smart
contracts. Given the pace of change, regulators, like most mortals, may find it hard
to remain up to date with these developments; we are faced with the daunting
prospect of having to reflect on the most appropriate regulatory responses to
technologies that we may not fully comprehend yet.
I favour a 'back to basics' approach.
In this regard, Regulators should focus on
regulatory principles that are risk-based rather than creating excessive
rules-based regulations aimed at these technologies or products. For example,
financial regulators do not regulate the Internet, biometric technology, or mobile
devices. Regulatory intervention should be appropriate and applied to the
underlying economic function. In the case of most central banks, the regulated
activities should fall within the ambit of their regulatory mandate and would
typically include deposit taking, payments, lending, insurance, and investments.
The Financial Stability Board describes FinTech as 'technology-enabled innovation
in financial services that could result in new business models, applications,
processes or products with an associated material effect on the provision of
financial services'1
by focusing on the identified activities. In this regard, the focus
centres on business process innovations and de-emphasises both the entities and
the emerging technologies.
Through this lens, we identify four areas of economic activities and potential areas
of financial services provision.
New forms of money or value storage
The concept of virtual currencies is increasingly recognised. As people become
more familiar with the concept, it has the potential to become more widely
money', has the advantage that its issuer is a trusted third party. However, it is
conceivable that other trusted third parties may emerge issuing virtual currency in
the future.
Virtual currencies that utilise advanced cryptography have enabled the issuance of
private crypto-currency. In particular, Bitcoin and its underlying enabling
technology, the blockchain protocol, has created the capability to exchange value
on a peer-to-peer basis.
In the words of Thomas Carper, a US Senator, 'virtual currencies, perhaps most
notably Bitcoin, have captured the imagination of some, struck fear among others,
and confused the heck out of the rest of us'.
According to the website coinmarketcap.com2, the total market capitalisation of
more than 800 different virtual currencies is about US$146 billion, of which Bitcoin
makes up approximately 47%, followed by Etherium, Ripple, and Litecoin3. This is
still significantly lower than the current value of all money (approximately
US$84 trillion) or physical money (approximately US$31 trillion).
Although much lower in value, virtual currencies are emerging as a new form of
money and/or a new 'store of value' that is 'held' within a network of computers.
The underlying technology, such as the distributed ledger technology (DLT),
although immature and still needing to be fully proven, could serve as a means to
possibly reshaping financial services. Potential applications include general
banking activities, trade finance, insurance, and payments.
However, virtual currency is not without controversy. According to a paper issued
by the Financial Action Task Force on Money Laundering (FATF) in 20144, one of
the challenges facing regulators, the private sector, government as well as law
enforcement agencies is the lack of a common understanding of virtual currencies,
including how virtual currencies operate, the potential risks associated with them,
Payments
The second set of innovations that affects financial services is the transfer of value
undertaken through the effecting of payments. Due to its nature, the payment
environment lends itself to being a 'natural testing environment' to allow for
developmental innovations such as FinTech. Attention has been drawn to
innovations such as SamsungPay or ApplePay, which have created the ability of
paying with your mobile device, using your smartphone as a point-of-sale device5.
A preliminary analysis conducted by the South African Reserve Bank (SARB)
reveals that these innovations leverage existing payments infrastructure and that
these new firms integrate themselves into existing value chains. Whether these
innovations will fundamentally reshape or disintermediate existing business
models remains an open question.
In addition, new payment business models are emerging where current DLT
solutions are applied to extended value chains. An example includes cross-border
remittances where FinTech firms use DLT solutions to streamline the remittance
value chain. The new business processes remove intermediaries, thus lowering
costs and reducing the time taken to effect these payments and remittances.
Against this backdrop, the SARB continues to monitor payment use cases
involving DLT closely. Other activities include the use of social media and other
emerging platforms such as WeChat and AliPay. Innovations that remove friction
in the system, but also reduce transaction costs and information asymmetries are
encouraging but, as regulators, we should be mindful of the risks and social costs.
A FATF report6 highlights some of the risks when virtual currency is exchanged for
real currency. These include money-laundering and terrorism financing. As virtual
currencies permit anonymity, they are ideally placed to be traded on the Internet
then becomes the
(which 'darknet') and allow for anonymous funding activity. The
traditional 'know your customer' philosophy and the tracing of funds become
nearly impossible. An unintended consequence of these developments may be
increased regulatory costs.
Lending
The third major domain of financial services that may potentially be impacted by
FinTech developments is the provision of credit. Online peer-to-peer and equity
crowd-based funding platforms have provided alternative financial services
options. These platforms connect investors to borrowers and disintermediate the
traditional lending by banks and other service providers. Some of these platforms
have grown rapidly, providing consumers and small businesses with opportunities
to access credit. Regulatory authorities, however, have to balance this with
concerns regarding issues such as the protection of consumers, investors and
lenders alike, liquidity, procyclicality, general business risk7 as well as the
unintended consequences that these activities may potentially have for the
traditional banking models.
Investments
The so-called 'robo-advice' and high-frequency trading (HFT) are FinTech
innovations in the investment domain. 'Robo-advisors' are a class of financial
advisors that provides financial advice and portfolio management services online,
with minimal human intervention. The software that is used for these services
utilises its algorithms to automatically allocate, manage, and optimise clients'
assets.
Similarly to 'robo-advisors', HFT firms have established themselves as notable
participants in the financial markets. The Financial Stability Review published by
the Banque de France in 20168 highlights that HFT firms have two characteristics
which enable them to carry out very large numbers of small trades with short-term
investment horizons (often intraday), namely:
- -
i. ultra-fast access just a few milliseconds to trading platforms and market
information; and
ii. trading algorithms that operate autonomously without human involvement
when markets are open.
The rapid development of HFT firms takes advantage of low entry barriers. These
financial services providers tend to be non-banks with small or even negligible
amounts of capital compared with the traditional market makers, i.e. the banks,
whose regulatory capital requirements for trading books have increased.
The rapid growth of these activities has attracted the attention of regulators due to
the impact and potential systemic risks that HFT companies may unleash on
financial markets and market stability. An example of this is short-lived but severe
market crashes, such as the 'Flash Crash' in the US markets
in May 20109.
In summary, FinTech innovation can be observed across multiple financial
services, including deposit taking, payments, lending, and investments. An
in-depth analysis of the activities rather than of the technologies and/or firms
providing these services helps one to understand these developments. New
technologies will continue to present opportunities to reshape financial services. I
would like to suggest that policymakers should focus unrelentingly on financial
services and their underlying activities, as opposed to the ever-evolving
per
technologies se. Such a focus will most likely ensure appropriate regulatory
treatment of similar activities, irrespective of the entity providing such activities,
and will thus aim to better achieve level playing fields.
Continuing collaboration between local and global authorities
I would now like to turn to the importance of continued collaboration by regulatory
authorities. Given the fast pace of change and the global nature of these
innovations, collaboration between regulators is important.
At the domestic level, the SARB's involvement in monitoring
FinTech innovation
started in 2013 when it joined an informal intergovernmental working group (IWG)
in our jurisdiction. This work group was established to better understand virtual
currencies such as Bitcoin and their regulatory implications. The IWG consisted of
National Treasury, the Financial Intelligence Centre, the South African Revenue
Services, and the SARB. In 2014, the working group issued a user alert on virtual
currencies through National Treasury. The SARB in turn, through its National
Payment System Department, furthermore issued a position paper on virtual
currencies later that same year.
In 2016, the SARB established an internal Virtual Currencies and DLT Working
Group. In recognising the growing evolution of cryptocurrencies, the SARB tasked
this cross-disciplinary working group to research and analyse the evolution of user
cases of emerging technologies, including blockchain and DLT. The main
objective was to gain a better understanding of underlying DLT and smart
contracts that leverage these emerging technologies.
Further, by focusing on financial services activities, the SARB has accepted that
FinTech extends beyond virtual currencies and DLT. For this reason, the SARB
has recently decided to establish a broader FinTech programme, with three
dedicated full-time staff members that report directly to me. Although it is at an
early stage, this programme will be required to strategically review the emergence
of FinTech and assess the related user cases. The primary responsibilities are
expected to include the facilitation of the development of refreshed policy stances
for the SARB across the FinTech domain. This will be done by robustly analysing
both the pros and the cons of emerging FinTech innovations as well as the
appropriate regulatory responses to these developments.
A critical success factor of the programme will be the ongoing collaboration with
our fellow regulators. We thus continue to work closely with National Treasury, the
Financial Services Board, and the Financial Intelligence Centre in an
intergovernmental FinTech working group. We will collectively determine the
appropriateness of applicable regulatory frameworks and further review how our
frameworks can strengthen policy goals such as financial inclusion and the
deepening of competition.
Besides collaborating locally, the SARB actively participates in international
regulatory and standard-setting bodies. Work undertaken by the various working
groups at the Financial Stability Board and the Bank for International Settlements
has been proactive in trying to understand the FinTech phenomenon and robustly
explore its benefits, risks and appropriate regulatory frameworks. The SARB has
contributed a paper recently published on assessing DLT and its impact on
payments and securities markets. Additional work has also been published on the
impact of FinTech on financial stability. In addition, work continues on matters
such as machine learning, artificial intelligence, and digital currencies issued by
central banks. The ongoing global collaboration is vital in order to keep pace with
these developments. The SARB is committed to staying abreast of and
contributing to global thought leadership on FinTech.
Deciding on the appropriateness of structures, such as innovation hubs and
sandboxes to keep abreast of FinTech developments
Lastly, I would like to turn to innovation hubs and sandboxes. The SARB has been
following the approaches, adopted by other jurisdictions, to assist policymakers
and regulators in staying abreast of FinTech developments given how some
lending and payment platforms have grown to become systemically important
systems within a short space of time.
For this reason, jurisdictions such as Australia, Hong Kong, Singapore and the
United Kingdom have implemented innovation hubs and regulatory sandboxes.
Innovation hubs provide support, advice and guidance to firms in navigating the
regulatory framework and/or identifying supervisory, policy or legal issues and
concerns. Regulatory sandboxes provide the platform for live or virtual testing of
new products or services, in a controlled environment, with or without any
'regulatory relief'.
With added attention to FinTech, through the newly established
FinTech programme within the SARB, we will urgently review the need for and
appropriateness of innovation hubs and regulatory sandboxes and how to be in a
potion to take a firm decision within the coming year in this regard.
Conclusion
In conclusion, I would like to note that we live in an era of ongoing and rapid
change which may hold significant implications for the regulation of financial
services in response to these changes.
I have suggested approaches that could aid the development of new regulatory
frameworks in response to FinTech developments. The first fundamental principle
is to focus sharply on regulating financial services provision or related activities.
-
Regulation must, however, be appropriate, purposeful and smart and it must aim
to ensure a level playing field. Regulations should not be an impediment to
progress, competition, or efficiency.
The second fundamental principle that needs to be adopted relates to continued
collaborating at both local and international levels. In the current age of universal
provision of financial services, ensuring harmonised frameworks that limit
regulatory arbitrage is crucial.
Lastly, structures such as innovation hubs and sandboxes need to be considered
carefully. The success of these structures is dependent on a clear regulatory
purpose, open and transparent participation criteria, and measurable success
criteria.
"It is not the strongest of the species that survive,
Charles Darwin famously said:
most responsive to change."
nor the most intelligent, but the ones Significant
incumbent financial sector firms and other service providers would need to learn to
appreciate that the biggest threat to the sustainability of their business is not
necessarily their traditional competitors. It may very well be firms still to be
established, that utilise technology still to be developed, and that leverage
innovations still to be incubated.
I wish you well in your deliberations and hope that these thoughts have created
insights on how we as regulators may respond to developments in the FinTech
space.
Thank you.