Fintech regulation
Achieving the right balance to foster innovation
For nine months last year, executives of Lending Loop, which describes itself as Canada’s first peer-to-peer lending market, voluntarily put the company’s ambitious growth plan on pause to spend some quality time with securities regulators. As CEO Cato Pastoll recounts, the unusual interregnum was all about figuring out how the firm could operate within a regulatory system that doesn’t really know what to do with fintech firms like his.
“The Canadian regulator’s approach is to say, ‘Let’s stop anything from happening until we’re 100 per cent OK [with the business offering].’ ” While Lending Loop emerged from the process and is now operating, Pastoll’s frustration is evident. “You can limit everything by being super prescriptive but if you’re not innovative, everyone’s going to fly by you.”
Lending Loop is hardly alone. Canadian banking and securities regulators, as well as innovation and competition policy-makers, have been cautiously moving ahead with the task of developing new rules for a group of startups that have little in common with the giant banking and investment entities regulated by provincial securities commissions, federal banking regulators and other agencies.
Some agencies, such as the Ontario Securities Commission’s LaunchPad program, have sought to test more flexible approaches to rules, such as intensive financial reporting requirements that currently apply to relatively modest fundraising programs. “The regulator has to have the capacity to be able to help,” says Adam Spence, associate director, venture and capital programs, at the MaRS Centre for Impact Investing. “What LaunchPad is doing with intermediaries looking to expand into these new regulatory environments is key.”
In Canada, most current rules reflect more traditional ways of lending, borrowing, underwriting and selling, as well as the overlay of more recent banking regulations designed to short-circuit financial fraud. As Pastoll says, existing anti-money-laundering and know-your-customer (KYC) rules were built for an era of face-to-face contact with customers, which is not applicable with fintech offerings.
A May 2017 report on fintech regulation by the federal Competition Bureau echoes this sentiment, pointing to a “disconnect” between the expressions of enthusiasm for new fintech solutions by regulatory bodies and the rigidity of their staff tasked with the day-to-day enforcement of the rules.
“Regulation should be done in a way that encourages and enables innovative startups to offer better solutions in the marketplace,” says Dave Feller, CEO of fintech Mogo, adding that the high cost of regulation for new entrants effectively serves to protect incumbents and prevent consumers from accessing cheaper and more flexible financial services.
A case in point: when the U.K. banned embedded commissions for wealth advisers three years ago, about a quarter of the established players pulled out, leaving an opportunity for upstart “robo-adviser” firms that offer discount services at a fraction of the fee. (The Canadian Securities Administrators have taken note, and recently released a discussion paper on discontinuing embedded commissions.)
A key source of friction about the evolution of regulation has to do with the legacy of the 2008 financial crisis. Unlike many Western countries, Canada didn’t experience bank collapses and its financial services regulation and oversight system was widely praised internationally. As Pastoll says, that success “has been an excuse for the last nine years as to why things are the way they are.”
But Zac Cohen, general manager of Trulioo Information Services, a Vancouverbased identity verification service, says that regulators are starting to respond to the particular requirements of new digital technologies, pointing to new rules from the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) that lay out the sorts of data sources that can be treated as reliable for customer verification processes.
“We rely heavily on credit bureaus to do KYC,” he says, adding that the new FINTRAC regulations now allow Trulioo and other data firms to use driver’s licences, customer phone bills and social insurance numbers to do these checks.
Australia, by comparison, takes an even less prescriptive approach. Its document verification service providers can confirm customer identification by drawing on a wider array of data sets, including passports and medical databases.
He also points to cuttingedge European Union customer information protection regulations that are seen as further ahead than most other parts of the world. These rules, Cohen says, ensure the protection of customer data by guaranteeing customers the absolute right to determine what is done with their information, including the right to be forgotten. “If it does have a positive impact, all regulatory jurisdictions should look at this [system].”
Both Pastoll and Feller point out that they’re not looking for a laissez-faire system, but rather a more flexible regulatory environment that balances the importance of consumer and investor protection against the importance of allowing new entrants to develop products and services that reduce the cost and complexity of financial services.
With jurisdictions like the U.K. far ahead, Pastoll warns that Canadian regulators, through excessive caution, run the risk of undermining a sector that will attract entrepreneurs, investment and jobs, and provide more efficient services for consumers. “Canada has a massive opportunity when it comes to fintech,” he says.
To seize this opportunity, Canada needs to be more proactive in two key areas: we need leadership from the federal government to mandate new regulatory frameworks such as the EU’s PSD2 (revised payment service directive), and we need to increase the pace of regulatory change to keep up with — and foster — fintech innovation in Canada.