Financial Technology: Information on Subsectors and Regulatory Oversight
Published: 2017-04-19T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Advances in technology and the widespread use of the Internet and mobile communication devices have helped fuel the growth in fintech products and services, such as small business financing, student loan refinancing, mobile wallets, virtual currencies, and platforms to connect investors and start-ups. Some fintech products and services offer the potential to expand access to financial services to individuals previously underserved by traditional financial institutions.
GAO was asked to review a number of issues related to the fintech industry, including how fintech products and services are regulated. This report, the first in a series of planned reports on fintech, describes four commonly referenced subsectors of fintech and their regulatory oversight. GAO conducted background research and a literature search of publications from agencies and other knowledgeable parties. GAO also reviewed guidance, final rulemakings, initiatives, and enforcement actions from agencies. GAO interviewed representatives of federal agencies, including the federal prudential regulators, state supervision agencies, trade associations, and other knowledgeable parties.
GAO is making no recommendations in this report.
section_title: What GAO Found
paragraphs: The financial technology (fintech) industry is generally described in terms of subsectors that have or are likely to have the greatest impact on financial services, such as credit and payments. Commonly referenced subsectors associated with fintech include marketplace lending, mobile payments, digital wealth management, and distributed ledger technology.
Marketplace lenders connect consumers and small businesses seeking online and timelier access to credit with individuals and institutions seeking profitable lending opportunities. Marketplace lenders use traditional and may use less traditional data and credit algorithms to underwrite consumer loans, small business loans, lines of credit, and other loan products.
Mobile payments allow consumers to use their smartphones or other mobile devices to make purchases and transfer money instead of relying on the physical use of cash, checks, or credit and debit cards. There are different ways to make mobile payments, including the use of a mobile wallet.
use algorithms based on consumers' data and risk preferences to provide digital services, including investment and financial advice, directly to consumers. Digital wealth management platforms provide services including portfolio selection, asset allocation, account aggregation, and online risk assessments.
Distributed ledger technology was introduced to facilitate the recording and transferring of virtual currencies, specifically using a type of distributed ledger technology, known as blockchain. Distributed ledger technology has the potential to be a secure way of conducting transfers of digital assets in a near real-time basis potentially without the need for an intermediary.
Regulation of these subsectors depends on the extent to which the firms provide a regulated service and the format in which the services are provided. For example, a marketplace lender may be subject to:
federal regulation and examination by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency in connection with certain services provided to depository institutions by the lender;
state licensing and regulation in the states in which the lender conducts business;
securities offering registration requirements administered by the Securities and Exchange Commission if the lender publicly offers securities; and/or
enforcement actions by the Bureau of Consumer Financial Protection and the Federal Trade Commission for violations of certain consumer protection laws.
To learn about the fintech industry, some agencies hosted forums, formed working groups, and published whitepapers and regulatory guidance.

section_title: Letter
paragraphs: Advances in technology and the widespread use of the Internet and  mobile communication devices have helped fuel the growth in financial  technology (fintech) products and services. Consumer access to these  new technologies has resulted in changes in their preferences and  expectations regarding how they conduct financial transactions, such as  using their smartphones to make payments or purchases. Fintech  products and services include small business financing, education  refinancing, mobile wallets, virtual currencies, and platforms to connect  investors and start-ups.
There is no universal definition of fintech. It is also difficult to quantify the  size of the industry because data are not separately reported from  existing financial services or products’ data, and because the industry is  constantly evolving. Traditional financial service firms also provide fintech  products or services (e.g., existing financial services firms introducing  fintech products and services). The fintech industry is generally described  in terms of subsectors that have or are likely to have the greatest impact  on traditional financial services, such as credit and payments.
You asked us to provide information on the fintech industry, including the  marketplace lending subsector, such as its structure and development  over the last several years, as well as how federal regulators supervise  fintech firms. This report, the first in a series of planned reports on fintech,  describes four commonly referenced subsectors of fintech: marketplace  lending; mobile payments; digital wealth management; and distributed  ledger technology and their regulatory oversight. For each subsector, this  report provides information including what it is and how it works; potential  benefits and risks; industry trends; and regulation and oversight.
To identify and describe fintech industry subsectors, we conducted  background research and a literature search of publications from  agencies, including regulators (agencies), industry groups, and other  knowledgeable parties. We also reviewed prior GAO reports on person- to-person lending and virtual currencies. Once we identified commonly  referenced subsectors, we conducted interviews with agencies, industry  groups, and other knowledgeable parties to identify information for each  subsector on what it is and how it works, including potential benefits and  risks and industry trends for each subsector. We also attended and  summarized fintech-related forums held by federal agencies and others.
To identify the regulation and oversight of the four commonly referenced  subsectors, we reviewed publications from federal and state agencies  and other knowledgeable parties. We also reviewed prior GAO work on  financial regulation. We reviewed examples of federal laws and  regulations related to fintech subsectors. We also reviewed guidance,  final rulemakings, initiatives, and enforcement actions from agencies. We  interviewed staff from agencies and other knowledgeable officials to  obtain information on fintech oversight and regulation at the federal and  state levels. To obtain a federal regulatory perspective, we interviewed  staff from the federal prudential regulators: the Board of Governors of the  Federal Reserve System (Federal Reserve), the Federal Deposit  Insurance Corporation (FDIC), the National Credit Union Administration  (NCUA), and the Office of the Comptroller of the Currency (OCC), as well  as staff from the Commodity Futures Trading Commission (CFTC),  Bureau of Consumer Financial Protection, known as the Consumer  Financial Protection Bureau (CFPB), Department of the Treasury  (Treasury), Federal Trade Commission (FTC), Financial Industry  Regulatory Authority (FINRA), Securities and Exchange Commission  (SEC), and Small Business Administration (SBA). To obtain a state-level  perspective we interviewed representatives of the Conference of State  Bank Supervisors (CSBS) and the National Association of State Credit  Union Supervisors. We also interviewed knowledgeable officials and  representatives of trade associations including representatives of the  American Bankers Association, Barefoot Innovation Group, Center for  Financial Services Innovation, Chamber of Digital Commerce, Electronic  Funds Transfer Association, Electronic Transactions Association,  Financial Innovation Now, Innovative Lending Platform Association,  Marketplace Lending Association, Milken Institute Center for Financial  Markets, and Money Transmitter Regulators Association.
We conducted this performance audit from July 2016 to April 2017 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Marketplace Lending
paragraphs: Marketplace lending connects consumers and small businesses seeking  online and timelier access to credit with individuals and institutions  seeking investment opportunities. Marketplace lenders use traditional and  may use less traditional types of data and credit algorithms to assess  creditworthiness and underwrite consumer loans, small business loans,  lines of credit, and other loan products.
subsections: section_title: What It Is and How It Works
paragraphs: The marketplace lending subsector originated as person-to-person  lending where individual investors financed loans to consumers. The  investor base for online marketplace lenders has expanded to include  institutional investors such as hedge funds and financial institutions.  Additionally, there has been the emergence of a market for securitizations  of marketplace lending loans—both consumer and small business loan- backed offerings. Marketplace lending firms have evolved to offer a wide  variety of loan products and services to consumers and small businesses  and have recently begun to offer mortgages, life insurance, and auto  loans. Although a number of marketplace lending models exist, publications we reviewed highlighted two common models: direct lenders  and platform lenders. Direct lenders, also known as balance sheet  lenders, use capital obtained from outside sources to fund loans and  often hold loans on their balance sheet. Examples of direct lenders  include CAN Capital, Kabbage, and SoFi. Platform lenders partner with  depository institutions to originate loans that are then purchased by the  lender or by an investor through the platform. Examples of platform  lenders include LendingClub Corporation, Prosper, and Upstart. However,  there are various permutations based on these two common models. For  example, direct lenders like OnDeck have developed hybrid models,  selling some whole loans to institutional investors while retaining servicing  responsibilities.
The marketplace lending process for the two models typically begins with  a prospective borrower filling out an online application on the marketplace  lending platform’s website. Marketplace lenders use traditional and may  use less traditional types of data and credit algorithms to assess  creditworthiness and underwrite loans. Marketplace lenders use  traditional credit data (e.g., credit scores, income, and debt repayment  history) but, according to publications we reviewed, may also use less  traditional data such as monthly cash flow and expenses, educational  history, payment and sales history, and online customer reviews.
After assessing the creditworthiness and needs of the applicant, the  marketplace lender will approve or deny the borrower’s loan request.  Generally, the loan will include a principal amount, an interest amount,  and the marketplace lender may charge a servicing fee for collecting and  transmitting payments and handling collections in case of a default.
Funding a borrower’s request depends on the business model of the  marketplace lender. Direct lenders typically originate the loan, hold most  or all of the loans on their own balance sheets, earn interest on the loans,  and carry credit risk for the entire loan (the risk is that the borrower does  not repay), see figure 1. These lenders can raise funds to make loans by  issuing equity to institutional investors (in addition to other means).  Platform lenders match investors (institutional or individual) to loans that a  depository institution, such as a bank, originates (see fig. 2). If the loan is  made and transferred to investors, the platform lender services the  account. Investors have the option of either partially or fully funding a  loan.
section_title: Who Uses It
paragraphs: Consumers: can use term loans from marketplace lenders to cover  personal expenses (such as home or medical expenses); consolidate  debt; or refinance student loans, among other reasons. According to  Treasury, three marketplace lenders offer consumer loans ranging from  $1,000 to $40,000. Treasury also indicated that marketplace lending  firms generally provide consumer loans to prime and near-prime  borrowers although some marketplace lending firms target subprime  borrowers or applicants without credit scores or with a limited credit  history.
Small Businesses: can use short and fixed-term loans, lines of credit, and  merchant cash advances from marketplace lenders, among other  products and services, to finance business expenses and expansions,  among other reasons. According to a Federal Reserve Bank of Cleveland  publication, limited data are available about the types of small businesses  that use online lenders, why they have chosen to apply, how successful  they are in obtaining funds, and how satisfied they are with their  experiences as borrowers.
section_title: Potential Benefits
paragraphs: Lower costs: Marketplace lenders’ online structure may reduce overhead  costs because not all firms have brick-and-mortar locations. In addition,  the algorithms used by marketplace lenders to underwrite credit decisions  may result in lower underwriting costs when compared to banks’  underwriting costs.
Expanded access to credit: Marketplace lending may expand credit  access to underserved populations that may not meet traditional lending  requirements or that seek smaller loans than those that banks traditionally  offer.
Faster service: According to Treasury, marketplace lenders can provide  funding decisions within 48 to 72 hours from when applications are  submitted. According to an SBA Office of Advocacy publication,  LendingClub Corporation advertises that potential applicants can receive  a quote within minutes and that its approval and funding process typically  takes 7 days, Kabbage Inc. can provide same-day approval for small  business loans, and OnDeck can provide funding within 24 hours.  According to representatives from one industry organization we spoke  with, faster service is beneficial to small businesses that may need quick  access to credit in an emergency, such as a restaurant that needs its  oven or refrigerator repaired to continue operations.
section_title: Potential Risks
paragraphs: Payment term transparency: Marketplace lending firms offer various loan  types and terms, particularly for small business loans. It can be difficult for  small businesses to understand and compare loan terms such as the total  cost of capital or the annual percentage rate. According to a Federal  Reserve 2015 survey, one reason for small business lenders’  dissatisfaction with online lenders was a lack of transparency.
Small business borrower protections: Current federal laws and  regulations applicable to marketplace lending generally apply to  consumer loans and not small business loans or other commercial  loans. For example, the Truth in Lending Act, which among other things,  requires the lender to show the cost and terms to the borrower, applies to  consumer loans but generally not small business loans. According to  Treasury, small business loans under $100,000 share common  characteristics with consumer loans, yet do not receive the same  protections. However, the report also notes that small business loans may  receive protection under the enforcement of fair lending laws under the  Equal Credit Opportunity Act.
Use of less traditional data in credit decisions: Unlike traditional lending  companies that look at a person’s credit reports (which include reported  installment credit and revolving credit), publications we reviewed indicate  that some marketplace lenders also take into account or have considered  using less traditional data (e.g., utilities, rent, telephone bills, educational history) during the underwriting process. However, according to  Treasury, data-driven algorithms used by marketplace lenders carry the  risk for potential fair lending violations. According to staff from FTC,  marketplace lenders must ensure that their practices meet fair lending  and credit reporting laws. The use of less traditional data also  introduces the risk that the data used are inaccurate and concerns that  consumers may not have sufficient recourse if the information being used  is incorrect.
Uncertainty about performance in full credit cycle: According to  publications we reviewed, the marketplace lending subsector experienced  considerable growth following the 2007-2009 economic downturn in an  environment with tightened lending standards and low interest rates. In  addition, little is known about how the industry will perform in other  economic conditions such as a recession, which could lead to  delinquency and defaults of marketplace loans. According to the  Congressional Research Service (CRS), it is also possible that loan  servicing could be disrupted in the event the marketplace lender goes out  of business.
section_title: Industry Trends
paragraphs: Partnerships: According to Treasury, some marketplace lenders have  sought partnerships with traditional banks and community development  financial institutions (CDFI) in various models. According to a CRS  report, in a white label partnership, a traditional bank sets underwriting  standards, originates the loan, and holds the loan once issued. The  bank can integrate a marketplace lending firm’s technology services to  originate the loan. For example, JPMorgan Chase & Co. partnered with  OnDeck to offer small business loans to JPMorgan Chase & Co.  customers. In referral partnerships, banks refer customers who do not  meet a bank’s underwriting standards, or who are seeking products the  bank does not offer, to a marketplace lender. In turn, the bank may collect  a fee from the marketplace lender. Referrals may also allow CDFIs to  reach customers that may otherwise not be served. For example, in 2015,  Regions Bank, Fundation Group LLC (an online small business  marketplace lender), and TruFund (a CDFI) partnered to provide small  loans to underserved small businesses.
Self-regulatory efforts: A number of self-regulatory marketplace lending  efforts were established with the intent of developing responsible  innovation and mitigating and reporting risks to potential borrowers  seeking marketplace lending products. However, limited information is  available on the impact of these efforts. Four examples are discussed  below.
The Marketplace Lending Association (MLA) was established in April  2016 to represent the marketplace lending industry. MLA states that one  of its goals is to support responsible growth in the marketplace lending  sector.
The Online Lenders Alliance represents firms offering loans online. The  Alliance provides resources including a consumer hotline, a portal to  report fraud, and consumer tips.
In 2016, three small business lending platforms formed the Innovative  Lending Platform Association. The Association developed the  Straightforward Metrics Around Rate and Total cost (SMART) Box tool to  help small businesses understand and assess the cost of their small  business finance options. For example, some metrics described in the  SMART Box tool include total cost of capital, annual percentage rate  calculations, and average monthly payment amounts. Its goal is to  include clear and consistent pricing metrics, metric calculations, and  metric explanations to help small businesses understand and assess the  costs of their small business finance options.
In 2015, the Responsible Business Lending Coalition launched the Small  Business Borrowers Bill of Rights to foster greater transparency and  accountability across the small business lending sector.
section_title: Regulation and Oversight
paragraphs: The regulation of marketplace lenders is largely determined by the  lenders’ business model and the borrower or loan type. For example,  marketplace lenders that provide services through an arrangement with a  federally regulated depository institution may be subject to examination  as a third-party service provider by the federal prudential regulator. The  federal prudential regulators have provided third-party guidance or vendor  risk management guidance to depository institutions that describes the  risk assessment, due diligence and risk monitoring, and oversight that  depository institutions should engage in when they deal with third parties,  including marketplace lenders.
Depending on the facts and circumstances, including the type of activities  being performed, marketplace lenders may be subject to federal  consumer protection laws enforced by CFPB and FTC. Also, CFPB and  FTC maintain databases of consumer complaints. In March 2016, CFPB  announced it would begin accepting consumer complaints about  marketplace lenders. However, according to CFPB staff, CFPB’s  complaint system does not specifically categorize complaints for  marketplace lending because consumers may not know whether to  categorize those services as such. FTC encourages consumers to file a  complaint if they believe they have been the victim of fraud, identity theft,  or other unfair or deceptive business practices. According to FTC staff,  fintech is not a category within FTC’s consumer complaint database and  marketplace lending complaints are generally categorized as consumer  loan complaints.
As previously discussed, certain regulations generally apply to consumer  loans but may not apply to small business loans or other commercial  loans. However, FTC has authority under Section 5 of the Federal Trade  Commission Act to protect, among others, small businesses that are  consumers of marketplace lending products or services from unfair or  deceptive business acts or practices.
At the federal level, we previously noted that SEC regulates the offer and  sale of securities to investors through disclosure requirements and  antifraud provisions that can be used to hold companies liable for  providing false or misleading information to investors. The Securities Act  of 1933 generally requires issuers that make a public offering of securities  to register the offer and sale of their securities with SEC and provide  investors with disclosures that include information about the company  issuing securities such as risk factors and financial  information.According to staff from SEC, certain transactions by  marketplace lenders may be exempt from the registration requirements of  the Securities Act of 1933 depending on the particular facts of their  securities offerings. At the state level, state securities regulators are  generally responsible for registering certain securities products and, along  with SEC, investigating securities fraud. Table 1 provides examples of  federal laws and regulations relevant to marketplace lending.
Marketplace lenders are subject to state-level laws in each state in which  they are licensed to conduct business. Specifically, some marketplace  lenders that originate loans directly to consumers or businesses (e.g., a  direct marketplace lender) are generally required to obtain licenses and  register in each state in which they provide lending services. According  to officials from CSBS, state regulators then have the ability to  supervise these lenders, ensuring that the lender is complying with  state and federal lending laws. CSBS officials noted that the states  leverage the Nationwide Multistate Licensing System (NMLS) to facilitate  compliance with state-by-state licensing mechanisms. NMLS is intended  to enable firms to complete one record to apply for state licensing that  fulfills the requirements of each state, for states that participate in the  system.
Some agencies have taken a number of steps to understand and monitor  the fintech industry, including the marketplace lending subsector. For  example, in May 2016, Treasury issued a whitepaper on marketplace  lending. In November 2016, SEC hosted a fintech forum where industry  representatives and regulators discussed capital formation (including  marketplace lending and crowdfunding) and related investor protections.  On December 2, 2016, the Comptroller of the Currency announced intent  to make special-purpose national bank charters available to fintech  companies, such as marketplace lenders. OCC published a paper  discussing issues related to chartering special-purpose national banks  and solicited public comment to help inform its path moving forward.  OCC plans to evaluate prospective applicants’ reasonable chance of  success, appropriate risk management, effective consumer protection,  fair treatment and access, and capital and liquidity position.
section_title: Mobile Payments
paragraphs: Mobile payments allow consumers to use their smartphones or other  mobile devices to make purchases and transfer money. Consumers and  businesses use these devices to make and receive payments instead of  relying on the physical use of cash, checks, or credit and debit cards.
subsections: section_title: What It Is and How It Works
paragraphs: According to publications we reviewed, there are different ways to make  mobile payments, including the use of a mobile wallet. Mobile wallets are  electronic versions of consumers’ wallets that offer consumers the  convenience of faster transactions without having to enter credit or debit  card information for each transaction. Using a mobile wallet, consumers  can store payment card information and other information on their mobile  devices that is often needed to complete a payment for later use.  Generally, mobile wallets replace sensitive information with randomly- generated numbers—a process called tokenization—that provides greater  security when making a payment, and then transmit this information using  existing credit and debit card networks. A variety of companies provide  mobile wallets, including Apple, Google, and Samsung; merchants such  as Starbucks, Walmart, and CVS; and financial institutions such as  JPMorgan Chase & Co. and Citibank. Consumers may use mobile wallets  to make payments to other consumers, referred to as person-to-person  (P2P) payments, or to businesses, referred to as person-to-business  (P2B) payments, either in mobile applications, through mobile browsers,  or in person at a store’s point-of-sale terminal. In addition, other providers, such as Paypal or Venmo, allow individuals to create accounts  to receive and make payments.
P2P payments: Consumers can transfer value from a bank account  (checking or savings), stored funds in a mobile wallet, credit/debit card, or  prepaid card to another consumer’s account. P2P methods use the  Internet, mobile applications, or text messages and generally move funds  through the automated clearing house (ACH) network or debit and credit  card networks. A variety of fintech firms provide P2P services. For  example, current P2P providers include PayPal, Venmo, and Google;  social networks such as Facebook and Snapchat; and financial  institutions such as Bank of America Corporation and JPMorgan Chase &  Co.
P2B payments: Consumers can also use their mobile devices to make  payments to businesses in stores or on their mobile device. In stores,  consumers can use mobile wallets to pay a business for goods or  services at compatible point-of-sale terminals. These transactions rely on  various technologies to transfer payment data between the consumer’s  mobile device and the business, including quick response (QR) codes  and wireless communication technologies that enable the payment  information to be transferred by allowing compatible devices to exchange  data when placed in very close proximity to each other (see fig. 3).
section_title: Who Uses It
paragraphs: The Federal Reserve’s 2016 report on Consumers and Mobile Financial  Services found that of those with a mobile phone in 2015, 30 percent of  individuals ages 18 to 29 and 32 percent of individuals ages 30 to 44  made mobile payments. By comparison, 13 percent of those ages 60 or  over made a mobile payment (see fig. 4). From 2011 to 2014, the same  general trend was true: younger adults were more likely to make a mobile  payment than older age groups. However, the survey results are not  comparable because the definition of mobile payments was revised for  the 2015 survey.
According to a survey by the Pew Charitable Trusts of over 2,000  consumers, 46 percent of the U.S. population reported having made a  mobile payment. Specifically, 39 percent of mobile payments users  were millennials and 33 percent were between the ages of 35 and 50  compared to 29 percent of users over the age of 50.
Underbanked: FDIC and the Federal Reserve have found that  underbanked consumers use mobile financial services. According to a  2015 survey by FDIC, 20 percent of households in the United States were  underbanked, meaning that the household had an account at an insured  institution but also obtained financial services and products outside of the  banking system. According to qualitative research conducted by FDIC in  2016, underbanked consumers stated that they used P2P payments and  a variety of financial products to manage their day-to-day finances. The  Federal Reserve’s 2015 survey indicated that a higher percentage of  underbanked consumers used mobile payments than fully banked  respondents (34 percent versus 20 percent).
section_title: Potential Benefits
paragraphs: Convenience and efficiency: According to publications we reviewed,  mobile wallets offer consumers the convenience of instant transactions  without having to enter credit card information, PIN numbers, and  shipping addresses each time they make a purchase. Mobile wallets can also streamline the checkout time. For example, consumers can  wave their smartphone in front of an in-store terminal to make a  purchase, which can be faster than swiping a credit or debit card.
Data security: Mobile payments can be protected by various security  mechanisms, such as codes that must be entered to access a mobile  device. According to publications we reviewed, mobile wallets may also  improve data security by replacing a consumer’s payment card  information with a randomly generated number, or token. Mobile  payments can use this token to transact with a merchant, which better  protects consumer account credentials.
section_title: Potential Risks
paragraphs: Many of the potential risks associated with mobile payments are the same  as those that exist with traditional payment products. Some examples of  those risks are discussed below.
Data security: Data security risks include the possibility of payment and  personal data being lost or vulnerable to theft because of consumers’  reliance on the use of smartphones or other mobile communication  devices. According to the Federal Reserve’s 2015 survey, respondents  identified concerns about the security of the technology as one of the  main reasons they do not use mobile payments. Security concerns  include the event of a smartphone being hacked, the loss or theft of a  smartphone, or if a company does not sufficiently protect mobile  transactions, among other concerns.
Human error and confusion: According to publications we reviewed,  mobile payment methods can create operational risk for human error.  For example, consumers can deposit or send money to the wrong person  when using P2P payments (e.g., if they type in the wrong phone number).  Mobile payment methods can also increase consumer confusion  regarding protections based on the underlying funding source. According  to FDIC, consumers may not understand which regulators supervise the  parties providing mobile payments and may be unsure which consumer  protections apply.
section_title: Industry Trends
paragraphs: Mobile Payment Activities: According to the Federal Reserve’s 2015  survey, the three most common mobile payment activities among mobile  payments users with smartphones were paying bills through a mobile  phone web browser or app (65 percent), purchasing a physical item or  digital content remotely using a mobile phone (42 percent), and paying for  something in-store using a mobile phone (33 percent).
Partnerships: Some industry stakeholders we spoke with said that the  relationship between banks and mobile payment firms has changed to  more partnerships because banks and mobile payment firms recognize  mutual benefits. For example, mobile payment firms can benefit from  banks’ experience with regulatory compliance and banks can remain  competitive by meeting the needs of their customers.
section_title: Regulation and Oversight
paragraphs: The regulatory and oversight framework for mobile payments consists of  a variety of federal and state regulation and oversight. Determining which  laws apply to mobile payments depends on several factors, including  agency jurisdiction, mobile payment providers’ relationship to depository  institutions, and the type of account used by a consumer to make a  mobile payment.
Three of the federal prudential regulators—Federal Reserve, FDIC, and  OCC—are authorized to examine and regulate the provision of certain  services provided by mobile payment providers for federally insured  banks and thrifts. For example, these regulators can examine mobile  payment providers that are considered third-party service providers of a  regulated depository institution if the payment provider offers services to  customers on behalf of a depository institution. The federal prudential  regulators can also take enforcement actions against mobile payment  providers if the provider is an institution-affiliated party of the bank.
CFPB has consumer protection authority over certain nonbank institutions  and enforcement jurisdiction over entities that offer or provide consumer  financial products or services. In October 2016, CFPB issued a final rule  to add prepaid cards and some of the payment services that fintech  providers are offering, such as PayPal, to the definition of accounts  covered under regulations applicable to electronic fund transfer systems  such as automated teller machine transfers, telephone bill-payment  services, point-of-sale terminal transfers in stores, and preauthorized  transfers from or to a consumer’s account (such as direct deposit and  Social Security payments). According to CFPB staff, the rule is aimed at  providing wide-ranging protections to consumers holding prepaid  accounts. Although this rule largely focuses on prepaid cards, the  protections also extend to P2P payments and certain mobile wallets that  can store funds.
Nonbank providers of financial products and services, including mobile  payment providers and prepaid card providers, may be subject to FTC  consumer protection enforcement actions. According to FTC staff, FTC  has brought and settled enforcement actions alleging unfair or deceptive  conduct by wireless providers providing mobile payment services.
Finally, at the federal level, the Federal Communications Commission  (FCC) has jurisdiction over wireless providers, which provide the devices  used for mobile payments or sometimes collect such payments through  their customers’ billing statements.
According to FDIC, to date, no federal laws and regulations specifically  govern mobile payments. However, to the extent a mobile payment uses  an existing payment method, the laws and regulations that apply to that  method also apply to the mobile payment. Table 2 provides examples of  federal laws and regulations relevant to mobile payment transactions.
State regulators also have authority to regulate mobile payment  providers. For example, most states have licensing and regulatory  authority over money service businesses that provide money transfer  services or payment instruments, which can include mobile payment  providers. For example, fintech firms such as PayPal and Google Wallet  are subject to state money transmitter laws. State regulators have made  efforts to make the state licensing process less burdensome by  conducting multistate exams and using NMLS to facilitate these  processes.
According to interviews with some agencies, they formed working groups  to monitor and understand mobile payments. These examples are listed  below.
In January 2010, the Federal Reserve started the Mobile Payments  Industry Working Group to facilitate discussions as to how a successful  mobile payments (as opposed to mobile banking) system could evolve in  the United States. The working group meets several times annually to  share information and ideas. In addition, the Federal Reserve established  a multidisciplinary working group focused on analyzing potential  innovation in fintech including payments.
FDIC established a formal FinTech Steering Committee and two working  groups, one focus of one of the working groups includes mobile  payments.
CFPB met with payment innovators through its Project Catalyst.
CSBS formed an Emerging Payments and Innovation Task Force in 2013  to study changes in payment systems to determine the potential impact  on consumer protection, state law, and banks and nonbank entities  chartered or licensed by the states.
section_title: Digital Wealth Management
paragraphs: Digital wealth management platforms, including robo-advisors, use  algorithms based on consumers’ data and risk preferences to provide  digital services, including investment and financial advice, directly to  consumers. Digital wealth management platforms provide services  including portfolio selection, asset allocation, banking and account  aggregation, and online risk assessments.
subsections: section_title: What It Is and How It Works
paragraphs: According to data from SEC, there were over 12,000 SEC-registered  investment advisers in 2016. However, according to staff from SEC,  because digital wealth management firms register as investment advisers  and are not all separately counted or categorized, the total number of  these entities is not known. Digital wealth management firms incorporate  technologies into their portfolio management platforms primarily through  the use of algorithms designed to optimize wealth management services.  Fully automated platforms have features that let investors manage their  portfolios without direct human interaction. Examples of current digital  wealth management firms include Betterment, Wealthfront, Personal  Capital, BlackRock’s Future Advisor, and Acorns.
Publications we reviewed indicate that digital wealth management  platforms typically collect information on customers and their financial  history using online questionnaires. These questionnaires may cover  topics such as the customer’s age, income, investment horizon, risk  tolerance, and expected returns, among other information. Digital wealth  management platforms allow customers with a need to connect multiple  accounts—often across multiple providers—to create a holistic picture of  their wealth and more easily manage their finances across multiple asset  classes and firms. Digital wealth management platforms use the  information inputted by the customer to help the customer select a risk  profile. The firms then use algorithms to generate a suggested investment  strategy to the customer based on that risk profile. Platforms can  automatically rebalance customers’ portfolios in response to the  performance of the underlying investments, and the customers’ goals  (see fig. 5).
Adviser-assisted digital wealth management platforms combine a digital  client portal and investment automation with a virtual financial adviser  typically conducting simple financial planning and periodic reviews over  the phone. Examples of current platforms in this category include  Personal Capital, Future Advisor, and LearnVest. To further differentiate  themselves, they may offer value-added services like asset aggregation  capabilities that enable the provision of more holistic advice than fully  automated digital wealth managers, based on a comprehensive view of  client assets and liabilities, as well as expense-tracking and advice on  budgeting and financial-goal planning.
section_title: Potential Benefits
paragraphs: Increased access to wealth management services: Publications we  reviewed indicated that digital wealth management platforms may expand  access to underserved segments such as customers with smaller asset  amounts than those of traditional consumers of wealth management  services. For example, some platforms may not require customers to  maintain minimum balance amounts. Traditional firms may require  minimum investment amounts of $250,000, whereas some digital  platforms require a minimum of approximately $500 or no minimum at  all.
Convenience: Regardless of location or the time of day, investors with a  smart phone, tablet, or computer can make changes to their data and  preference inputs, send instructions, access their portfolios, and receive  updated digital advice.
Lower fees: According to publications we reviewed, digital wealth  management platforms may charge lower fees for services such as  investment trade fees than traditional wealth management firms.
section_title: Potential Risks
paragraphs: Some of the potential risks associated with digital wealth management  platforms may be similar to those that exist with traditional wealth  management services. Examples of those risks are discussed below.
Insufficient or incomplete information from customers: According to  publications we reviewed, some digital wealth management platforms  generate investment outputs based on information provided by the client  from questionnaire responses. A traditional wealth manager is able to  ask and clarify questions and request follow-up information to capture a  customer’s full finances and goals. However, automated responses may  not allow the platform to capture a full picture of the customer’s  circumstances or short-term goals, for example, whether the customer  may need investment money to buy a new home. If the customer does  not understand a question, or does not answer it completely, the platform  may not assess customers’ full financial circumstances; for example, if a  customer provides conflicting information on his or her finances, the  digital wealth management platform may not have a full picture of the  client’s financial condition or a customer may end up with an undesired  portfolio.
Inaccurate or inappropriate assumptions: Staff of SEC’s Office of Investor  Education and Advocacy (OIEA) and FINRA issued an investor alert on  May 8, 2015, which cautioned that assumptions that underlie the  algorithms used by digital wealth management firms could be incorrect.  For example, the alert states that the platform may be programmed to use  economic assumptions that will not react to shifts in the market.  Specifically, if the platform assumes that interest rates will remain low but  interest rates rise instead, the platform’s output will be flawed, which  could adversely affect investors.
Consumer Data Protection: To use digital wealth management platforms  customers must enter personal information. According to an investor alert  issued by SEC and FINRA staff, digital wealth management platforms  may be collecting and sharing personal information for purposes  unrelated to the platform. The alert cautions customers to safeguard  personal information.
section_title: Industry Trends
paragraphs: According to publications we reviewed, fintech firms, including at least  one digital wealth management platform, are using or have considered  using innovative technologies such as machine learning and artificial  intelligence. For example, one platform is intended to track consumers’  financial account activity and apply user behavior to the advice it delivers.
Hybrid services have evolved that combine traditional wealth  management and digital wealth management. For example, in 2015  Vanguard implemented a service that offers investors an option of  consulting with a human advisory representative in addition to its  automated investment platform. Traditional wealth management firms  also offer digital wealth management services. For example, in 2015,  Charles Schwab developed Intelligent Portfolios, available to customers  with $5,000 in savings, and Deutsche Bank launched a robo-advisor  within its online investment platform.
section_title: Regulation and Oversight
paragraphs: SEC regulates investment advisers, which generally includes firms that  provide digital wealth management platforms. Other federal and state  agencies have a role with respect to oversight of digital wealth  management firms, depending upon the services a digital wealth  management platform provides.
SEC and state securities regulators share responsibility for the oversight  of investment advisers in accordance with the Investment Advisers Act of  1940 (Advisers Act). SEC subjects digital wealth management firms to  the same regulations as traditional investment advisers and requires  digital wealth management firms that manage over $110 million in assets  to register as investment advisers. The Advisers Act generally requires  anyone in the business of receiving compensation for providing  investment advice to others regarding securities to register with SEC or  one or more states. SEC’s supervision of investment advisers includes  evaluating their compliance with federal securities laws by conducting  examinations, including reviewing disclosures made to customers. It also  investigates and imposes sanctions for violations of securities laws. SEC  held a forum in November 2016 that discussed fintech innovation in the  financial services industry, including the impact of recent innovation in  investment advisory services, which includes digital wealth management.  In January 2017, SEC’s Office of Compliance Inspections and  Examinations announced that electronic investment advice is a 2017  examination priority. In February 2017, SEC’s Division of Investment  Management issued guidance for robo-advisers that provide services  directly to clients over the Internet. SEC’s Office of Investor Education  and Advocacy issued an Investor Bulletin that provided information to  help investors using robo-advisers to make informed decisions in meeting  their investment goals.
State securities regulators generally have registration and oversight  responsibilities for investment adviser firms that manage less than $100  million in client assets, if they are not registered with SEC. According to  staff from SEC, state securities regulators can bring enforcement actions  against firms with assets of any amount for violations of state fraud laws.  For example, the state of Massachusetts’ Securities Division issued a  policy in April 2016 stating that fully automated robo-advisers may be  inherently unable to carry out the fiduciary obligations of a Massachusetts  state-registered investment adviser. The policy states that until  regulators have determined the proper regulatory framework for  automated investment advice, robo-advisers seeking state registration will  be evaluated on a case-by-case basis.
FINRA, a self-regulatory organization, is also responsible for regulating  broker-dealers doing business with the public in the United States.
Broker-dealers can use digital investment advice tools to provide  investment services to clients. According to FINRA staff, FINRA may  test the use of digital wealth management technologies by broker-dealers  as part of its examinations. According to FINRA staff, FINRA has taken  one enforcement action against a broker-dealer offering clients robo- adviser-like functionality. In March 2016, FINRA issued a report to  share effective practices related to digital investment advice tools and  remind FINRA-registered broker-dealers of their obligations under FINRA  rules, including that broker-dealers are required to supervise the types of  businesses in which they engage.
CFTC has oversight authority with respect to commodity trading advisers  under the Commodity Exchange Act. According to CFTC officials,  digital wealth management firms that meet the statutory definition of a  commodity trading adviser would be subject to the same oversight and  compliance obligations as other traditional commodity trading advisers.  The act generally requires that commodity trading advisers register with  CFTC.
Digital wealth management firms are subject to consumer protection laws  that are enforced by FTC. FTC is charged with protecting consumers  against unfair or deceptive acts or practices in commerce. According to  FTC staff, FTC enforces applicable consumer protection laws in regard to  fintech services, such as digital wealth management, just as it applies  those laws to other products and services. According to staff from CFPB,  certain aspects of digital wealth management such as data aggregation,  credit, or linked deposit accounts may also be subject to consumer  oversight authority by CFPB.
In April 2016, the Department of Labor (DOL) adopted a regulation that  would expand the circumstances in which those who provide retirement  investment advice, including digital wealth management firms, would  have to abide by a “fiduciary” standard, acting prudently and in the best  interest of their clients. The rule was scheduled to be applicable in April  2017. However, the President issued a memorandum on February 3,  2017, that directed the Secretary of DOL to examine the fiduciary duty  rule to determine whether it may adversely affect the ability of Americans  to gain access to retirement information and financial advice. In April  2017, DOL extended the applicability date for an extra 60 days.
section_title: Distributed Ledger Technology
paragraphs: Distributed ledger technology (DLT) was introduced in 2009 as a  technology intended to facilitate the recording and transferring of bitcoin,  a virtual currency, specifically using blockchain. DLT has the potential  to be a secured way of conducting transfers of digital assets in a near  real-time basis potentially without the need for an intermediary.
subsections: section_title: What It Is and How It Works
paragraphs: DLT is a generic technology for a distributed database, while blockchain  is one type of DLT. According to one study we reviewed, DLT involves  a distributed database maintained over a network of computers  connected on a peer-to-peer basis, such that network participants can  share and retain identical, cryptographically secured records in a  decentralized manner. A network can consist of individuals,  businesses, or financial entities.
One type of DLT is blockchain, which is a shared ledger that records  transactions in a peer-to-peer network. Blockchain is a series of digital  blocks of information (transactions) that are chained together. The party  initiating a transaction sends a message represented as a block to a  network of participants that can include financial institutions, financial  market participants, and regulators. For a transaction to be included,  network participants must validate the transaction. Once a transaction  has been confirmed, details of the transaction are recorded on the  blockchain that can be visible to network participants (see fig. 6).
DLT solutions can have different types of access control. For example,  there may be “permissionless” (public) ledgers that are open to everyone  to contribute data to the ledger and cannot be owned; or “permissioned”  (private) ledgers that may have one or many owners and only they can  add records and verify the contents of the ledger. According to one study,  permissioned DLT is not fully decentralized.
According to publications we reviewed, an important feature of blockchain  is that transactions added to a ledger are validated by network  participants. This validation process is referred to as a consensus  mechanism. Consensus mechanisms can help prevent the problem of  double spending. Publications we reviewed indicate there are different  kinds of consensus mechanisms that include proof-of-work and proof-of- stake. Proof-of-work may be used in permissionless DLT and proof-of- stake may be used in permissioned DLT. Consensus mechanisms also  incorporate security aspects such as cryptography and digital signatures  that are listed below:
Cryptography is used to encrypt data to ensure transactions are valid and  provide identity verification. For example, during asset transfers, a form  of cryptography known as public key cryptography usually forms the  foundation of the transaction validation process.
Digital signatures are based on cryptography and are used in DLT to  certify the authenticity of transactions (i.e., to show that a person is the  true owner of an indicated digital identity). When a person creates and  sends a DLT transaction, the transaction must also bear that person’s  digital signature.
section_title: Who Uses It
paragraphs: According to publications we reviewed, agencies, financial institutions,  and industry stakeholders have identified potential uses for DLT in the  financial service industry through the clearing and settlement of financial  transactions. Examples of these transactions include: private trades in the equity market; and  insurance claims processing and management.
DLT can also incorporate smart contracts. Smart contracts can automate  different kinds of processes and operations. For example, smart contracts  can facilitate the automation of complex, multiparty transactions, such as  the payment of bonds and insurance coupons. According to one study,  there are several versions of smart contracts composed using computer  code.
section_title: Potential Benefits
paragraphs: Transparency: According to publications we reviewed, DLT has the  potential to facilitate transparency between financial institutions,  regulators, and other financial market participants. DLT can increase  transparency between participants by creating a shared record of activity  where participants have access in real time. Changes by any participant  with the necessary permission to modify the ledger are immediately  reflected in all copies of the ledger. Because distributed ledgers can be  designed to be broadly accessible and verifiable, the technology could  enhance financial market transparency.
Efficiencies: According to publications we reviewed, DLT can enhance  efficiencies in securities and payment clearing and settlement times.  Specifically, DLT has the potential to reduce settlement times for  securities transactions by facilitating the exchange of digital assets during  the same period of time as the execution of a trade. According to staff  from SEC, while the financial services industry is moving toward  shortening settlement cycles, DLT may offer efficiencies should it be  deployed in securities clearance and settlement functions. In 2015, SEC  requested comments on how blockchain technology could facilitate the  role of a transfer agent and separately, in 2016, requested comments on  the utility of DLT in shortening the settlement cycle for most broker-dealer  securities transactions. In addition, conducting international money  transfers through DLT can provide real-time settlement.
section_title: Potential Risks
paragraphs: Like most new technologies, DLT can pose certain risks and  uncertainties, which market participants and financial regulators and  agencies will need to monitor.
Operational risk including security risk: According to a publication by the  Board of Governors of the Federal Reserve System, operational failures  include errors or delays in processing, system outages, insufficient  capacity, fraud, and data loss and leakage. According to a FINRA  report, given that DLT involves sharing of information over a network it  poses security-related risks. The Financial Stability Oversight Council  noted that market participants have limited experience working with  distributed ledger systems, and it is possible that operational  vulnerabilities associated with such systems may not become apparent  until they are deployed at scale. According to officials from CSBS,  permissionless DLT presents security risks (e.g., anti-money-laundering  and Bank Secrecy Act) that can be mitigated.
section_title: Industry Trends
paragraphs: Publications we reviewed suggest some financial institutions have taken  several approaches to adopt DLT. For example, some financial  institutions have initiated blockchain projects, joined a multiparty  consortium, or announced partnerships to examine DLT’s potential. In  addition, the largest securities depository and a large stock exchange  have used DLT.
According to the World Economic Forum, 80 percent of banks are  expected to initiate blockchain projects by 2017.
The R3 industry consortium made up of over 50 financial institutions  designed a DLT platform for recording and managing financial  agreements named Corda.
The Depository Trust and Clearing Corporation proposed to build a  derivatives distributed ledger solution for post-trade processing.  Through this initiative, the Depository Trust and Clearing Corporation  seeks to reduce costs and increase efficiencies in the post-trade process.
In December 2015, the stock exchange Nasdaq enabled its first trade on  a blockchain using its Linq ledger through a private blockchain  developer. Nasdaq Linq is a digital ledger technology that leverages a  blockchain to issue and record transfers of shares of privately-held  companies.
section_title: Regulation and Oversight
paragraphs: Continued development of DLT is needed to understand how DLT and its  components will be regulated by the existing legal and regulatory  system. Additionally, it is unclear whether new regulation will need to  be created because DLT can present new and unique challenges.  According to the Financial Stability Oversight Council, financial regulators  should monitor how a DLT network can affect regulated entities and their  operations. Representatives of financial regulators have noted the  importance of implementing DLT in a manner that is transparent and  satisfies regulatory requirements.
With respect to virtual currencies, federal and state regulators have taken  varied approaches to regulation and oversight. For example, in 2015,  CFTC stated it considers bitcoin and other virtual currencies to be  included in the definition of “commodity” under the Commodity Exchange  Act. SEC’s Office of Investor Education and Advocacy has stated that  the rise of bitcoin and other virtual and digital currencies creates new  concerns for investors. Two bureaus within the Department of the  Treasury treat bitcoin in different ways, including the Department of the  Treasury Financial Crimes and Enforcement Network (FinCEN), which  determined that certain virtual currency businesses would be money  transmitters under the Bank Secrecy Act, subject to regulation as money  services businesses, and the Internal Revenue Service, which treats  bitcoin as property for U.S. federal tax purposes. FTC can apply the  Federal Trade Commission Act to combat unfair or deceptive acts or  practices in or affecting commerce, which includes virtual currencies. In  addition, approximately 44 states have issued licenses to companies that  use virtual currency in their business model. The existing regulatory complexity for virtual currencies indicates that regulatory approaches for  future applications for DLT will also be complex.
According to interviews we conducted, some agencies and one industry  association formed working groups to monitor and understand DLT and  virtual currencies. These examples are listed below.
In 2015, CFTC formed a working group on blockchain, distributed ledger  technology, and virtual currencies to study their application to the  derivatives market and promote understanding and communication  across the agency. In 2017, the group broadened its focus to cover other  aspects of fintech and changed its name to the FinTech Working Group.
In 2016, the Federal Reserve established a working group that is looking  at financial innovation across a broad range of responsibilities, including  in payments and market infrastructures, supervision, and financial  stability.
In November 2013, SEC formed an internal Digital Currency Working  Group to build expertise; identify emerging risk areas for potential  regulatory, examination, and enforcement action; and coordinate efforts  within SEC in the digital and virtual currency space. In November 2016,  the group changed its name to reflect that its efforts had expanded  beyond digital and virtual currencies into related distributed ledger  technologies and their applications. According to SEC staff, the  Distributed Ledger Technology Working Group plans to evaluate when  and how distributed ledger technology will be used within the securities  market.
In 2016, FDIC established the FinTech wholesale working group of intra- agency experts to monitor work in the areas of DLT, blockchain, and  smart contracts.
In 2015, the Chamber of Digital Commerce formed an alliance to provide  technical assistance and periodic informational sessions on Bitcoin, other  digital currencies, and broader uses of blockchain.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report for review and comment to CFPB,  CFTC, CSBS, FDIC, the Federal Reserve, FINRA, FTC, NCUA, OCC,  SBA, SEC, and Treasury. We incorporated technical comments we  received from these agencies, as appropriate. In addition, we received  written comments from NCUA and CSBS, which are summarized below  and reprinted in appendixes II and III.
In its written comments, NCUA acknowledged that regulators face  challenges understanding the risk of the rapidly evolving financial  technology industry and the challenge of balancing regulations and  guidance to address those risks against stifling innovation. NCUA noted  that it continues to evaluate risks and monitor the evolving market impact  driven by fintech companies and to indirectly supervise activities through  credit unions to the extent possible.
In its written comments, CSBS noted that it had formed a task force to  study fintech developments and determine the potential impact on  consumer protection, state law, and banks and nonbank entities  chartered or licensed by the states. CSBS also provided additional  information about the state regulatory system for marketplace lending,  mobile payments, and distributed ledger consumer products while noting  that the states actively license and supervise companies engaged in  these services. CSBS also noted that the states have work under way to  improve the Nationwide Multistate Licensing System with a technological  overhaul to improve compliance with state licensing requirements.
We are sending copies of this report to the congressional requesters,  agencies, and other interested parties. In addition, this report will be  available at no charge on our website at http://www.gao.gov.
If you or your staff members have any questions about this report, please  contact me at (202) 512-8678 or evansl@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix IV.
section_title: Appendix I: Agencies with Oversight Responsibilities Related to Financial Technology Firms
paragraphs: Regulation of financial technology (fintech) firms depends on the extent to  which the firms provide a regulated service and the format in which the  services are provided. Table 3 explains the basic functions of federal and  state regulators and agencies with oversight responsibilities related to the  following subsectors: marketplace lending, mobile payments, digital  wealth management, and distributed ledger technology.
section_title: Appendix II: Comments from the National Credit Union Administration
section_title: Appendix III: Comments from the Conference of State Bank Supervisors
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: GAO staff who made major contributions to this report include Harry  Medina (Assistant Director), Lauren Comeau (Analyst in Charge), Namita  Bhatia-Sabharwal, Chloe Brown, Pamela Davidson, Janet Eackloff, Cody  Goebel, Davis Judson, Silvia Porres, Tovah Rom, Jessica Sandler, and  Jena Sinkfield.
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