Introduction

Over the past few years, FinTech has gone through rapid development, and regulation of FinTech also becomes a big challenge to financial regulators. On 8th July, Shanghai Finance Institute (SFI) released its annual report “International Experiences with FinTech Development and China’s Policy Direction” which presents a comprehensive analysis of FinTech development in China and other countries.

The authors believe that FinTech will be placed under greater prudential supervision, behavioral regulation, and macro prudential regulation. To further promote the development of FinTech, coordination of financial regulations should be strengthened focusing on functional supervision, regulatory mechanisms such as sandboxes should be more actively experimented and promoted, and the interaction between the regulators and the market should be enhanced.

The new risks brought by FinTech have put forward new requirements for financial regulation. First, the inclusiveness of FinTech reinforces the externality of financial services. Secondly, the innovativeness of FinTech highlights the risk of information technology. As a whole, the inherent financial risks of FinTech are more complex and hidden, while the information technology risks and financial externalities are more prominent, so the potential systemic and cyclical risks are more complex.

Underlying FinTech regulation is the classic relationship between humans and technology. The more artificial intelligence and technology we rely on, the more governance and supporting mechanisms we need to ensure combining the neutral “technology” and “internet” with “finance” which has strong negative externality to generate the positive externalities that will help to improve the efficiency of financial services. In other words, it is a major issue that every country needs to solve to strike a balance between the development and regulation of FinTech. We should not only promote FinTech’s development and ensure its innovative vitality, but also introduce appropriate and effective regulatory rules for the healthy development of FinTech.

FinTech regulation at the national level

At the national level, countries all over the world have taken measures to provide a good development environment for FinTech innovation. The measures mostly fall into three categories:

First, establishing a framework for FinTech. In January 2017, the National Economic Council of the United States published a whitepaper report titled “A Framework for FinTech”, elaborating six policy objectives for FinTech including: 1. to foster positive financial services innovation and entrepreneurship; 2. to promote safe, affordable, and fair access to capital; 3. to strengthen financial inclusion and health; 4. to address financial stability risks; 5. to further a 21st Century financial regulatory framework; 6. to maintain national competitiveness.

Second, introduction of FinTech regulatory arrangements such as regulatory sandboxes, innovation centers and accelerators to encourage innovation. The innovation center aims to support and instruct financial institutions in understanding the financial regulatory framework and identifying regulatory, policy and legal issues of innovation. This model has been implemented in the UK, Singapore, Australia, Japan and Hong Kong China. Regulatory sandboxes allow for real or virtual testing of new FinTech products or services in a controllable testing environment. This model can simplify the standards and procedures of market access, exempt the firms from some of the laws and regulations, bring new businesses to market more quickly under the precondition of ensuring the rights and interests of consumers, and promote the new businesses based on the results of sandbox tests. UK and Singapore are leading in the application of sandboxes. Innovation accelerators help regulators or governments and the financial sectors establish cooperation mechanisms to accelerate the development and application of FinTech with financial or policy support.

Third, more emphasis on financial consumer protection. ⅰ) information disclosure is strengthened and Fintech firms are required to fully meet the obligation of informing customers of risks. For example, the British Financial Conduct Authority (FCA) requires that the P2P platforms accurately disclose information of investment products (such as returns and risks) to investors using plain language. ⅱ) The handling mechanism for FinTech-related consumer complaints is improved. For example, in the United States, the Securities and Exchange Commission (SEC) is responsible for the regulation of P2P platforms, Consumer Financial Protection Bureau (CFPB) collects data on complaints from P2P consumers, and the Federal Trade Commission (FTC) is in charge of supervising and deterring unfair or fraudulent behavior of P2P platforms. ⅲ) Protection of consumer information is enhanced with punitive measures enacted. The regulatory authorities in the United States and UK both require FinTech companies to publish measures to protect consumer privacy and develop corresponding punitive measures against misconduct.

The future trend of FinTech regulation

From a global perspective, effective regulation has boosted the development of FinTech development. In the countries with good supervision mechanisms and rule of law, FinTech has enjoyed stable development, while in some other countries that did not have appropriate regulation in place from an early stage and where rule of law is lacking, problems such as terrorism financing, money laundering, and infringement of consumer rights have occurred.

Globally, there are two major problems with FinTech regulation.

First, countries have different regulatory measures, and there are no uniform global standards. Until now, countries around the world mainly focus on the regulation of internet financing and electronic currency. In other FinTech areas, the regulatory rules for payments are relatively mature, while the understanding of the blockchain technology and its impact are still at a primitive stage. Overall, there is a big difference between the regulatory standards for specific FinTech areas among countries. Uniform standards are lacking and regulation is fragmented on a global scale.

Second, international regulatory cooperation has fallen behind the development of FinTech which has a strong cross-border feature. At present,the traditional financial industry has been greatly affected by border-free FinTech. However, international regulatory cooperation is far behind the pace FinTech development across borders. There is no cooperation mechanism among countries for regulation or consumer protection.

In the future, FinTech will certainly be included the framework of prudential supervision, behavioral regulation and macro prudential regulation. At the national level, the governments should clarify the regulatory responsibilities, and place FinTech under the existing regulatory framework. At the international level, international governance is accelerated and bilateral cooperation has started. After the Financial Stability Board (FSB) formally included FinTech in its agenda in March 2016, the sub-committees on banking, securities and insurance started to accelerate their work in this field. The regulatory framework has begun to take shape, and more detailed regulatory standards are being worked out at the work group level.

Financial regulation must set regulatory boundary according to the social impact and risk contagion level of financial businesses. It is the international practice to arrange a “regulatory ladder” from weak to strong. For example, the credit intermediaries are mainly regulated by prudential supervision focusing on loss absorption; the direct financing is mainly regulated by behavioral regulation centering around information disclosure. After the global financial crisis, all the countries have laid more emphasis on the protection of financial consumers and investors. These traditional regulations have extended to the field of FinTech regulation.

Proposals on how to standardize and promote the development of FinTech in China

The regulatory stance.

ⅰ) We must assess China’s FinTech development in an objective and sensible matter, and continue to encourage the development of the industry through improved market conditions and technological progress. According to some data and indicators, China is indeed slightly ahead in some areas of FinTech, especially in terms of payment and Internet financing. China mainly has an advantage in the size of transactions, which is supported by China’s huge population and market size. In terms of the market conditions and technical levels, we have no competitive advantage, and China’s ranking in the world is still relatively low.

ⅱ) The rules must be made at an early stage so that the market will have clear expectations. Although the regulation of innovations cannot be possibly perfect in the early days, however, the restricted area and the bottom line must be made clear in the beginning, and the rules should be operational and easily implementable. Only in this way can the market players clearly predict the future development of the industry and the market.

ⅲ) It is necessary to encourage the traditional financial institutions to better understand the significance of FinTech and participate more actively and effectively in FinTech. FinTech companies and traditional financial institutions are not rivals in a zero-sum game. On the contrary, there is considerable room for win-win cooperation. China’s traditional financial institutions have achieved short-term goals of increasing customers and boosting incomes through cooperation with the FinTech industry, and the potential for future cooperation is enormous. The development of FinTech is not the process of subverting the traditional finance, but the process of merging, absorbing and advancing FinTech innovation by the traditional institutions. The development of FinTech depends on two driving forces, i.e. finance and technology, so the traditional financial institutions should pay more attention and invest more resources in FinTech.

The regulatory principles.

ⅰ) Consistency. FinTech does not change the essence of finance, so it certainly will face potential risks similar to those associated with traditional finance. Therefore, the same regulatory principles should be applied to FinTech as those for traditional finance, and regulation should be based on the nature of market behavior rather than the type of institutions. The same principles and standards should be used for the same type of financial businesses online and offline, as well as for both licensed and non-licensed institutions.

ⅱ) Reliability. Unlike traditional financial institutions, FinTech involves non-face-to-face electronic transactions with no physical outlets, it therefore relies more on mutual trust among the parties to the transactions. FinTech depends on the use of new technologies, so it is necessary to ensure the security and reliability and relevant verification and authentication is needed. In addition, including the FinTech activities in the scope of regulation can help the firms improve their ability for risk management and enhance the reliability of their operations.

ⅲ) Interaction between regulators and the industry. Regulators should actively participate in the entire process of financial innovation, improve the rules through the interaction with market players, and jointly promote responsible market innovation. FinTech regulations in developed countries such as Europe and the United States all went through a process from observation to action. Before the innovation reaches a certain scale, its risk is limited and controllable, so there is no rush to make or change regulatory rules. Regulatory authorities need to implement supervision only when the risk of innovation reaches a certain level. Regulators should strengthen the monitoring of market development and risk trends, enhance the interaction with the market, and determine the degree of the regulation on the basis of potential risks of the businesses.

ⅳ) Inclusiveness. We should ensure that FinTech closely serves the real economy, macroeconomic adjustment as well as economic and financial stability. We should encourage institutions to fully employ the advantages of FinTech in innovating service models, improving efficiency and reducing operation costs, and focus particularly on small and micro enterprises whose businesses are in line with national industrial policy. Financial regulators also need to recognize the new challenges of technological innovation on financial consumer protection, and impose requirements on the qualification and quota of financing institutions, tighten the requirements for information disclosure and the annual investment quota.

ⅴ) Self-discipline. It is impossible to rely solely on the regulators to supervise and prevent the risks of the financial industry. Especially in new fields such as FinTech, more attention should be paid to the important role of self-regulatory organizations when relevant rules have not yet formed. At present, it is urgent to draw support from intermediaries such as audit and law firms and rating agencies to supervise market players. In addition, industry associations should be established to make self-regulation rules and promote the orderly development of FinTech.

Regulatory approaches.

ⅰ) We should strengthen regulatory coordination focusing on functional supervision. Risk-based penetrating regulation is not only the core of traditional financial supervision, but also the key to FinTech regulation. The rapid cross-market development of FinTech indicates that the businesses overlapping across markets will greatly increase, and the correlation and contagion of risks will also be enhanced. Accordingly, there should be some innovations in the regulatory models. Functional and behavioral regulation based on businesses and risks should be employed more in addition to the institutional regulation based on the types of financial institutions.

ⅱ) Regulatory mechanisms such as sandboxes should be more actively experimented and promoted. Regulatory sandboxes have strong value because of their timely response to market innovation and regulatory flexibility.

ⅲ) Interaction between the regulators and the market should be strengthened. Full and frank communication is one of the prerequisites for ensuring the effective implementation of regulatory purposes. As suggested by G20 in “High-level Principles for Digital Financial Inclusion -- Specific Actions”, we should “work with industry and risk-management experts to research, identify, and assess the risks arising from the use of new digital technologies, and ensure they are effectively monitored and managed. Establish regular knowledge-sharing mechanisms between regulators and service providers along with clear communications channels.” Therefore, in addition to regulators and practitioners, experts and investors are also needed in FinTech regulation. Through active communication, all the parties involved can resolve issues between regulation and innovation, clear up misunderstanding, reach consensuses, and provide useful advice on regulatory rule-making, improvement of Fintech innovations, as well as investor protection and education.

Regulatory capability.

According to the Institute of International Finance (IIF), regulatory technology (RegTech) is the use of new technologies to solve regulatory and compliance requirements more effectively and efficiently. Specifically, it includes two dimensions: on the one hand, financial institutions use new technologies to solve regulatory compliance problems more effectively; on the other hand, regulators also take advantage of new technologies to obtain regulatory information in a timely manner so as to solve the problem of information asymmetry, and then capture various risks of financial institutions in advance.

Regulators should promote the development of RegTech from the following aspects:

ⅰ) Data sharing. Regulators should constantly assess the impact of technological progress on data security and privacy in order to ensure that regulation can strike a balance between the effective use of data and the security and privacy of data. Data sharing and utilization for the regulatory purpose is the key point.

ⅱ) Standardization of data. Data standards and definitions should be coordinated among countries and within one country.

ⅲ) Modernization of KYC (i.e., know your customer) process. Regulators should assess the current laws and regulations for anti-money laundering and anti--terrorism financing, remove the mandatory requirement of “face-to-face signing” in the KYC process to adapt to the development of technology in the digital age, and allow the use of online identification measures (such as biometric identification, video conference, third party verification etc.).

ⅳ) Technological upgrade of regulators. Regulators should consider exploring the codification of regulatory legislation, thereby creating conditions for financial institutions to achieve the automated compliance control.