Earlier this month, we discussed the key results and considerations from IOSCO's updates survey on the use of automated investment advice. IOSCO noted that technology tools will affect all elements of the advice value chain and that this would raise a number of questions for global regulators.
In the New Zealand context, the Financial Markets Authority’s (FMA) Strategic Risk Outlook 2017 identifies regulating for rapid technological innovation as a developing theme on its risk radar. FinTech companies, and those who are actively innovating in financial services, are encouraged to talk to FMA about their plans at an early stage. FMA expressly notes that balancing the reduction of risk with innovation and improved efficiency in the financial services sector is the challenge that it and other international regulators currently face. The Reserve Bank of New Zealand has also noted, in a Bulletin issued in the middle of 2016, that there may be positive and negative impacts of digital disruption in banking services and that the situation would be monitored closely.
In a further pointer towards a greater level of regulation and oversight of FinTech, Mark Carney (acting as Chair of the Financial Stability Board (FSB)) gave a speech at the end of last month with the title 'The Promise of FinTech - Something New Under the Sun?'. The FSB's role is to promote global financial stability, and it brings together senior policy makers from the G20 countries plus Hong Kong, Singapore, Spain and Switzerland. It operates by moral persuasion and peer pressure, to set internationally agreed policies and minimum standards that its members commit to implement at national level.
The speech noted the huge potential of FinTech to make the financial system more inclusive, efficient, effective and resilient. It also considered the regulatory challenge to ensure that FinTech develops in a way that maximises these opportunities and minimises risks to society.
The key points were:
- The true potential of FinTech is unbundling banking into the core functions of: (i) settling; (ii) performing maturity transformation (ie where banks borrow money on shorter timeframes than they lend money out); (iii) sharing risk; and (iv) allocating capital.
- Inevitably the increase in FinTech will result in the evolution of systemic risks – changes to customer loyalties might influence the stability of bank funding; underwriting models could affect credit quality and even macro-economic dynamics; new applications and infrastructure could reduce costs and improve efficiency but at the same time create new critical economic functions.
- The application of FinTech permeates throughout the financial services value chain, from payment processing to customer offerings/customer relationship, retail and commercial banking though the use of peer-to¬-peer lending, and platforms using AI and robotics, to wholesale banking and markets and the rise of non-intermediated trading. Much of these sit outside the "traditional" conventional banking market, which is heavily regulated.
- The basic premise should be that just because something is new, doesn't necessarily mean it should be treated differently. But also just because something is outside the regulatory perimeter, doesn't mean it needs to be brought inside.
- The diagram below (taken from Mark Carney's speech) sets out the potential issues with FinTech affecting the financial services value chain.
The key risks identified were:
- New payment systems become systemically important.
- The opening up of the customer interface and payment services could signal the end of universal banking, and this could result in more arm's-length customer relationships leading to greater volatility of deposits and liquidity; profitability of the banks might be affected.
- The increase in peer-to-peer lending might signal access to, and reliance on, funding that would not be available from banks. The sectors' underwriting measures and ability to withstand losses has not been tested yet.
- Robo-advice and risk management algorithms might lead to excess volatility, if the underlying algorithms are overly sensitive or highly correlated.
- Innovations such as distributed ledger will need to meet the highest standards of resilience, reliability, privacy and scalability.
- The advent of FinTech materially changes operational and cyber risks – regulators will need to look at single points of failure risks, the protection of data and the integrity of the systems.
It will be interesting to see how the regulatory balance plays out – innovation and inclusion are important but so is a level regulatory playing field. As Mark Carney notes in his speech, just because something is new, doesn't necessarily mean it should be regulated differently.