Fintech – A Boon or Bane?
Fintech, in its literal meaning, is a fusion of the terms “financial” and “technology”. Fintech is an industry whereby disruptive technological innovation is utilised in the provision of financial services.
In this early part of 21st century, retail financial services are being enhanced and digi¬talized via mobile wallets, electronic payment applications, robo-advisors for wealth & retirement planning, equity crowdfunding and peer-to-peer lending platforms. Fintech has been under the spotlight in recent years and is viewed as a competitor or rather, a potential replacement of the conventional banking services. On the outset, fintech can be divided into two broad categories, namely institutional and consumer-facing.
In Malaysia, fintech, especially in the area of electronic payment applications and mobile wallets, is slowly gaining traction in recent years. That being said, fintech is already widely used in some countries. Examples of the application of disruptive technology to the financial services industry around the world includes M-Pesa which is a system established in Kenya by Vodafone’s Kenyan associate, Safaricom, in 2007 as a simple method of texting small payments between users.1 Over the last decade, M-Pesa has since played the role of the banks by assisting and allowing people to borrow, spend and pay for products and services using mobile application, effectively bypassing the banks altogether. M-Pesa has expanded its services to Tanzania, India, Afghanistan, India and some countries in Middle East and Eastern Europe.2
In China, Alipay first appeared in 2004 as an escrow system on Taobao and slowly evolved as a seller-accreditation and partnered with all major Chinese banking insti¬tutions offering online payment services.3 With more users and cash sitting in Ali¬pay’s deposit pool, Alipay has released a virtual wallet, Yu’EBao service, which is a money market fund for users’ deposits in their Alipay’s accounts.4 To ensure that a secured platform and sufficient protection are provided to the institution and con¬sumers, certain rules and regulations were subsequently issued by the China’s Cen¬tral Bank and the Chinese Securities Regulatory Commission.5
However, fintech does not merely cover electronic payment applications, and banking and financial services; it is poised to disrupt more than just the banking & financial industry. Fintech extends to the area of e-KYC (Know-Your-Customer), regtech, insurtech, artificial intelligence, blockchain technology, cryptocurrency, robo-advisors, e-currency exchanges and etc.6
While the presence of fintech in Malay¬sia is still nascent, examples from other countries such as China and the United States proved that the fintech industry has the potential to grow rapidly and consequently, draw nervous reactions from major players, financial institutions and regulators.
A Leash on Industry
The financial services system in Malaysia is highly regulated and is governed by several legislations as listed below:
- Capital Markets and Services Act 2007;
- Financial Services Act 2013 (“FSA 2013”);
- Islamic Financial Services Act 2013 (“IFSA 2013”);
- Money Services Business Act 2011 (“MSBA 2011”);
- Personal Data Protection Act 2010;
- Communication and Multimedia Act 1998;
- Anti-Money Laundering, Anti-ter¬rorism Financing and Proceeds of Unlawful Activities Act 2001; and
- Computer Crimes Act 1997.
[Note: This list is not exhaustive]
To stimulate the growth of the fintech industry, our monetary regulator, the Central Bank of Malaysia (“BNM”), in¬troduced the Financial Technology Reg¬ulatory Sandbox Framework (“Frame¬work”) on 18 October 2016.
Sandbox - A Playground for the Fintech Innovation
A regulatory sandbox is a framework set up by BNM to allow live testing of fintech innovations in a controlled environment under the BNM’s supervision, whilst be¬ing accompanied by the appropriate and adequate safeguards for a prescribed pe¬riod.
In Malaysia, the regulatory sandbox, which is introduced by BNM, enables fintech innovation to be deployed and tested in a live environment (“Sandbox”), within specified parameters and time¬frames. In the Sandbox, participants may test their product, service or solution (“Fintech Product”) under the control of a single entity, BNM, which ensures that all participants are aware of the details of the framework and that no legislations are being overlooked.
The Sandbox is not tool to circumvent existing laws, rules and regulations. Products or services that are regulated under the prevailing laws and regula¬tions in Malaysia are not suitable to be tested under the Sandbox. In considering the applications made by the applicants to participate in the Sandbox, BNM has indicated that it will adopt an “informal steer” approach by providing guidance and advice on the modifications that can be applied to the proposed Fintech Prod¬uct to comply with the prevailing laws and regulations.
According to the Financial Technology Enabler Group (“FTEG”), the Sandbox is accessible to all fintech companies and institutions (“Fintech Innovators”), in¬cluding those without a presence in Ma¬laysia. The Fintech Innovators with the potential to contribute to the creation of high value-added jobs in Malaysia will be assessed more favourably by BNM. In a gist, the following bodies may apply to enter the Sandbox:
- a financial institution;
- a fintech company (i.e. company that utilises or plans to utilise fin¬tech but excluding a financial insti¬tution) which collaborates with a financial institution;
- a fintech company intending to car¬ry on:
- an authorised or registered business as defined in the FSA 2013;
- an authorised business as de¬fined in the IFSA 2013;
- a money services business as defined in the MSBA 2011.
BNM has also set up certain eligibility criteria for entry into the Sandbox. The following is a brief summary of the require¬ments for entry as a participant in the Sandbox:
- the Fintech Product is genuinely innovative with the po¬tential to render good quality in the provision of financial services and improve the Malaysian economy;
- appropriate and adequate assessment has been conducted by the applicant to demonstrate the usefulness and func¬tionality of the Fintech Product and identified associated risks;
- the applicant has necessary resources to support testing by controlling and mitigating potential risk and losses;
- a realistic business plan is in place to deploy the Fintech Product on a commercial scale in Malaysia after its suc¬cessful testing in the Sandbox; and
- the applicant or the Fintech Product is led and managed by persons with credibility and integrity.
In addition to that, an applicant is expected to identify the po¬tential risks to financial consumers and financial institutions that are likely to arise from the testing of the Fintech Product. The applicant must also propose appropriate safeguards to ad¬dress the identified risks.
According to the Framework, BNM is committed to inform¬ing an applicant of its eligibility to participate in the Sandbox within fifteen (15) working days of receiving a complete appli-cation. Upon confirmation and acceptance of the application to participate in the Sandbox, and prior to the formal testing of the Fintech Product in the Sandbox, preparatory engagements will be held between BNM and the applicant whereby the fol¬lowings are discussed and determined:
- details of the testing parameters;
- specific measures to determine the success or failure of the test;
- an exit strategy; and
- a transition plan for the deployment of the Fintech Product on a commercial scale upon successful testing and “gradu¬ation” from the Sandbox.
Upon obtaining its approval from BNM, the participant may proceed with the live-testing of its Fintech Product in the Sand¬box. During the testing period, the participant must ensure the proper maintenance of records to support reviews of the test by BNM. The participant must also submit interim reports and a final report to BNM in accordance with the agreed timeline.
It is also expected that BNM is willing to “relax” certain rules and regulations to enable testing in a way that the risks can be appropriately contained in a strong value-added proposition Fintech Product as this is the ultimate purpose of the Frame¬work.
In normal circumstances, the initial testing period would not exceed 12 months from the start date of the testing period. Upon expiry of the testing period, the regulatory flexibility ac¬corded to the participants will be deemed to expire automati¬cally, unless the participant successfully obtains an approval from BNM. An example is the e-KYC service which is devel¬oped by CIMB Bank Berhad in collaboration with Paycasso Verify Ltd, whereby an extension of time is given until 30 April 2019 from its initial expiry date of 19 October 2018.
Graduation from the Sandbox
Upon the completion of the testing period, BNM will then de¬cide whether to allow the participant’s Fintech Product to be in¬troduced to the market on a wider scale. When this is allowed, the Fintech Product is deemed to have “graduated” from the Sandbox and will thereafter be assessed based on the applicable approval, licensing and registration criteria under the prevail¬ing laws and regulations, as the case may be.
Framework as the Catalyst for the Growth of Fintech in Malaysia?
The benefits of the introduction of the Framework could be demonstrated in various perspectives. One of the primary pur¬pose of the Sandbox is to ensure that the compliance and regu¬lations are aligned with the rapid growth of Fintech Innovators without drowning the Fintech Innovators in prevailing laws and regulations, but at the same time, without compromising on security of consumers.
With the introduction of the Framework, BNM, as a regulator, adopts a fine line between safeguarding financial stability and promoting innovation and growth. The Sandbox enables a two-way learning whereby Fintech Innovators, become familiar with the laws and regulations that they should be adhering to, while BNM can have the opportunity to learn from Fintech Innovators about these emerging technologies. Greater visibility is created in the sense that BNM could observe and work with the Fintech Innovators in a safe, controlled, and live-testing environment.
The Framework reflects BNM’s long standing policy in strik¬ing an optimal balance between promoting fintech innovations whilst preserving financial stability and protecting consumers’ interest. With the Sandbox and the Framework, BNM is able to learn from Fintech Innovators and adapt to new and emerging risks emanating from the offering of new Fintech Products.
It is also worth mentioning that the Fintech Innovators which collaborate with financial institutions can directly gain advan¬tages from the support and guidance provided by the financial institutions in complying with the relevant and related regula¬tory requirements and effectively handle risk mitigations.
Another primary aim of the Framework is to encourage invest¬ments from different players in the industry in the hopes of securing investment. Regulatory uncertainty would, directly or indirectly, discourage potential investors to invest in a Fintech Product that remains in an unregulated landscape as authori¬ties and regulatory bodies may swoop in unexpectedly, decide that the operation of the Fintech Product is improper or even illegal and thereafter force the Fintech Innovator to either change its business model drastically or remove the Fintech Product from the market.
Similarly, the investors would not intend to invest their mon¬ies in an overregulated market either, as overregulation has the potential of hindering innovation and adversely affect the growth rate of the Fintech Product and its ability to achieve a worthwhile return of their investments.
As a result, BNM intends for the Framework to boost investors’ confidence wherein every penny that they have invested in the Fintech products are secured and regulated under a supervised yet liberal environment.
Kate Lauer, who is an expert in global financial regulation, once said that “Crafting regulation and ensuring that the regulator understands the consumer protection risk is something that’s really critical ... to the healthy future of fintech…”. The truth is that not everyone knows what is fintech. Fintech is not a top¬ic which a person on the Clapham omnibus will speak about in his or her daily conversation. Many customers of financial systems are not familiar to what they are using and do simply agree to the terms and conditions without understanding them. The Framework intends to put a stop to that problem. With the Framework, users are protected as the Fintech Product is tested properly before the Fintech Product is marketed to the general public. This in turn creates a safe environment for the average user, i.e. a person on the Clapham omnibus.
An Analysis on the Framework
Malaysia is not the only country which has embarked on this in¬itiative. Countries around the world have introduced their own sandbox regulatory framework, each catered for catalysing the growth of fintech in the respective countries. One of the key dif¬ferences which separates Malaysia’s Sandbox regime from the regulatory sandbox regimes of UK and Australia is the length of its testing stage. Whilst the participants of Malaysia’s Sandbox have at least 12 months to test their products in the sandbox, participants in UK and Australia get between 3 to 6 months. In my view, a longer testing period benefits the regime as a whole as it allows the Fintech Product to undergo a more substantial phase of product development and commercialisation. Any is¬sues with the Fintech Product which were not identified and resolved during the initial stages can be remedied before the actual launch of the Fintech Product.
Since participants are exempted from specific regulations for the duration of the Sandbox, this allows the participants who face challenges in meeting all regulatory requirements to test or roll out their products under a more relaxed regulatory frame¬work, albeit within a controlled environment. Other than that, constant engagement between BNM and the participants of the Sandbox may pave the way to a more practical regulatory framework in the future. As it now stands and as highlighted above, there is no single legislation which regulates the fintech industry in Malaysia. It remains to be seen whether the Malaysian government, under the leadership of Tun Dr. Mahathir bin Mohamad, has plans to in¬troduce a regulatory framework for the fintech in¬dustry in the near future.
The Sandbox is not perfect. One of the weaknesses of the Sandbox is participants will have to make huge investments to make sure that their systems are fully developed and ready to be tested. This will not be an issue for the bigger market players who have secured funding in the earlier stages. Howev¬er, this flaw could impact the smaller players.
The Way Forward for Our Future
Be that as it may, the introduction of the Sandbox will benefit Malaysia’s fintech landscape. Our neigh¬bouring countries such as Singapore, Hong Kong and Thailand have introduced their own fintech regula¬tory sandbox framework. It is anyone’s guess as to which country will be the leader of South East Asia’s fintech industry. Perhaps it can be our own nation, Malaysia.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position taken by the relevant governmental agencies.