Light Touch and Sandbox Insights on Regulating FinTech Presented by - PowerPoint PPT Presentation

Light Touch and Sandbox Insights on Regulating FinTech Presented by Rafael Padilla Next Money MNL First Meetup. 22 September 2016

AGENDA 1. FinTech as subject of regulation 2. Heavy handed regulation 3. The light touch approach 4. Regulatory sandbox as emerging trend 5. Focus on specific legal risks a. consumer protection b. AML, CFT and sanctions enforcement 6. Observations on selected FinTech regimes in Asia-Pacific a. Singapore b. Hong Kong c. China d. Japan e. Australia f. UAE g. Philippines

1 | | FINTECH AS SUBJECT OF REGULATION • Financial services are traditionally subject to heavy regulation. • But regulators don’t want another Red-Flag Law. • Regulating FinTech entails balancing of interest between public safety and innovation . • “ Regulations should control that which is bad and support that which is good. ” (Ditchley Conference on the Regulation of Cyberspace, 2000)

1 | | FINTECH AS SUBJECT OF REGULATION (continued) • Nascent FinTech space already witnessed a number of high-profile scandals and compliance issues. ( e.g., E-gold, Liberty Reserve, Mt. Gox, Ripple Labs and Dwolla) • Regulation will help: 1. legitimise disruptive technologies; 2. clarify misconceptions and settle controversies; 3. discourage bad actors; 4. (and consequently) increase consumer and institutional adoption.

1 | | FINTECH AS OBJECT OF REGULATION (continued) Concerns on regulating FinTech • Regulation lags behind new business/delivery models. • Uncertainty on regulatory treatment /characterisation when traditional financial systems partner with FinTech firms. • Absence of regulation creates a compliance loophole ( e.g. AML). • Fintech firms are not used to dealing with the compliance and regulation unlike traditional financial institutions. • Regulatory / compliance costs are expensive for start-ups. • How do you regulate decentralised / distributed applications?

2 | | HEAVY HANDED REGULATION U.S.A. (federal and state level) • 2013 - FINCEN issued guidance advising that Bitcoin exchanges and related enterprises are money transmitters under the Bank Secrecy Act. FINCEN required these businesses to register as MSB and to comply with AML regulations. • 2015 – New York DFS issued the first ever Virtual Currencies (VC) Regulation. New York DFS was praised for being a pioneer, but also criticised for establishing onerous requirements and conditions to qualify for “ BitLicense ” . Many FinTechs operating in New York migrated their business elsewhere ( e.g . UK, Isle of Man) to escape the compliance-ridden New York rules.

2 | | HEAVY HANDED REGULATION (continued) China • The 2008 Financial Crisis slowed down the appetite of regulators for large- scale reform. On the contrary, regulatory environment is tightening in China. • PBOC intends to maintain great vigilance on shadow banking activities and capital flight. • In 2014, Ant Financial Group (Alipay) was spun off from Alibaba before its IPO listing in NYSE partly due to concerns over regulatory compliance in China for digital financial services. • P2P marketplace lending in China has led to widespread fraud ( e.g. Ezubo). PBOC is expected to issue regulations to target these types of fraud. • PBOC has barred financial institutions from dealing or transacting with bitcoin and other digital currencies.

3 | THE LIGHT TOUCH APPROACH • Pioneered by UK regulator FCA . • The approach is intended to lower barriers to entry faced by fintech start-ups by reducing compliance costs and promoting financial innovation while maintaining the fundamental principles of the regulatory and licensing framework governing financial services. • In the U.S., one state – the State of Texas – has been reported to be considering a light touch regulation on virtual currencies. • But from the subject’s perspective, what is light touch is relative.

4 | | REGULATORY SANDBOX AS EMERGING TREND • Under the regulatory sandbox, the UK regulator offers bespoke guidance to FinTechs on whether their product/service comply with the relevant regulations. • Within the sandbox, FinTechs could test their products without immediately triggering regulatory consequences. • FCA may further waive or modifying applicable administrative regulations if they prove to be too onerous for FinTechs. - But UK laws and EU directives cannot be waived or modified by FCA. • By following FCA’s guidance, the FinTechs will be considered to have complied with the relevant rules for the purposes of the sandbox.

4 | | REGULATORY SANDBOX AS EMERGING TREND (continued) • UK’s Innovation Hub is intended to give FinTech firms some insight on how the regulatory system is going to play relative to the concepts and products they wish to bring to the market. • Because regulators have limited resources FinTechs that could “play” in the sandbox will actually be very limited. • In UK, some 500 firms applied to the Innovation Hub scheme; 270 have been accepted; only 18 have been authorised. (as of June 2016) • The sandbox testing will be only for a limited period (6 months in UK, SG and AU; 2 years proposed in UAE)

5| FOCUS ON SPECIFIC LEGAL RISKS: a| Consumer Protection • In the U.S., a consumer-focused regulator – the CFTB (Consumer Financial Protection Bureau) was formed in the wake of the 2008 financial crash by the Dodd-Frank Wall Street Reform and Consumer Protection Act. • Remittance: money transmission laws, in particular the licensing regime, are enacted mainly to protect consumers. • In regulatory sandbox environment - regulators want to be sure that as part of the authorisation process, the FinTech applicant has put in place the necessary safeguards, risk management and control systems to address the risks of the FinTech proposal. • New York DFS proposed last week a pioneering regulation requiring banks and other FI’s to carry out due diligence security checks on third-party service providers (Vendor Due Diligence) to enhance cybersecurity.

5| FOCUS ON SPECIFIC LEGAL RISKS: b| AML, CFT and sanctions enforcement • Most of the jurisdictions advocating for light touch regulation stresses that AML /CFT rules cannot be compromised. • FATF Recommendation 15 (New Technologies) “Countries and financial institutions should identify and assess the money laundering or terrorist financing risks that may arise in relation to (a) the development of new products and new business practices, including new delivery mechanisms, and (b) the use of new or developing technologies for both new and pre-existing products. ” • In 2014 and 2015, FATF issued a specific Guidance Note on Virtual Currencies to complement the 2013 Guidance Note on Prepaid Cards, Mobile Payments and Online Payments. • Just this month, the FATF announced that it needs to adjust its recommendations to take into account emerging business models.

6| SELECTED FINTECH REGIMES IN ASIA PACIFIC : a| SINGAPORE • MAS is currently consulting on proposed guidelines on regulatory "sandbox" for FinTech experiments, activity-based payments framework and creation of National Payments Council. • For the duration of the regulatory sandbox, MAS will relax specific regulatory requirements which an applicant would otherwise be subject to. (“materiality and proportionality test”) • Singapore declared that AML rules and consumer protection – in particular confidentiality and data protection - will not be bargained away by the light touch regulation. • FinTechs are encouraged to approach MAS to discuss how innovative solutions can be launched in regulatory sandbox, even at this moment that the proposed guidelines are being finalised.

6| SELECTED FINTECH REGIMES IN ASIA PACIFIC : a| SINGAPORE (continued )

6| SELECTED FINTECH REGIMES IN ASIA PACIFIC : b| HONG KONG • HKMA recently established the Fintech Facilitation Office (FFO) to facilitate the healthy development of the fintech ecosystem in Hong Kong and to promote Hong Kong as a fintech hub in Asia. • HKMA and ASTRI introduced also introduced the FinTech Innovation Hub for authorized institutions to conduct research, and developed a Sandbox for banks to test fintech services. • HKMA will require bankers operating in HK to be trained and certified to deal with cyber security and money laundering, to beef up its regulations as it competes to become the Asian hub for FinTech.

6| SELECTED FINTECH REGIMES IN ASIA PACIFIC : c| CHINA • 2015 (July) - PBOC, CBRC, CIRC, CSRC and MIIT jointly released the Guiding Opinions on Promotion of Healthy Development of Internet Finance . It was the first comprehensive regulation issued by China in the FinTech space - setting compliance rules on internet payment, internet insurance, online lending, crowd funding and online sales of funds. • 2015 (Dec) - PBOC published a regulation on non-banking online payment service providers . Online payment service providers must obtain payment operating permit from PBOC to operate and must establish sound KYC policy. They cannot engage in the business of securities, insurance, financing, trust, wealth management, FX or withdrawal services. • 2016 (July) - the NPC Standing Committee debated the proposal to introduce the Network Security Law to increase the safety of the users themselves, as well as to improve the quality of services within the fintech industry.