Financial technology (‘FinTech’) is transforming finance and challenging its regulation at an unprecedented rate. Two major trends stand out in the current period of FinTech development.
The first is the speed of change driven by the commoditization of technology, Big Data analytics, machine learning and artificial intelligence. The second is the increasing number and variety of new entrants into the financial sector, including pre-existing technology, e-commerce and telecommunications companies.
In a new research paper, From Fintech to TechFin: The Regulatory Challenges of Data-Driven Finance, we consider the impact of these new entrants with their typically large pre-existing non-financial services customer bases on financial law and regulation. These firms (loosely termed ‘TechFins’) may be characterized by their capacity to leverage the data gathered in their primary business into financial services.
China has been at the forefront of this change, with Alibaba raising the profile of its entry in the financial services sector with the creation of Ant Financial in 2016 and with its founder, Jack Ma, often said to have coined the term ‘TechFin’. But also firms like Amazon (US), Apple (US), Facebook (US), Google (US), Microsoft (US), Samsung (Korea), Baidu and Tencent (China), Vodafone (UK, India and Africa), and Uber (US) all offer various forms of payment, lending and/or other financial services. The entry of these firms signals a shift from financial intermediary (FinTech) to data intermediary (TechFin). As established tech firms enter the world of finance, important questions arise: how do these firms fit within the framework of financial regulation? To what extent do their activities signal arbitrage opportunities and deficiencies of the current regulatory system?
We argue in our paper that there are five reasons why the rise of TechFin may be the single most important development in financial services going forward.
First, TechFins are not simply a progression of FinTechs but instead represent a brand new type of market participant. They have their origin in Tech or e-commerce environments which are typically connected to a multitude of clients (both consumers and/or small businesses) and a very deep well of data. As TechFins reach a significant size, they often do so having established an international network, and having gathered a very meaningful dataset. These data give them a real advantage in the provision of financial services. TechFins may first enter the world of finance by providing their data, either raw or processed, to established financial services firms and/or FinTech startups, but over time the likelihood is that many will start providing financial services directly to their customers.
Second, TechFins may be able to provide far more efficient financial services for society. In particular, they may reduce transaction costs and improve decision-making by using/providing a more comprehensive dataset than that to which established financial intermediaries have access. TechFin could result in an increased level of financial inclusion for SMEs, consumers and the underprivileged in developing and developed parts of the world.
Third, established thresholds such as size of balance sheet and asset under management as well as established tests for the imposition of financial regulation, such as the solicitation of customers, deposit-taking, pooling of assets, or discretion over client assets, may often fail to subject TechFins to regulation. In turn, regulators will be unable to enforce customer protection measures and monitor and mitigate systemic risk. Moreover, protected factors in society (such as gender, race and religious neutrality) may often be put at risk, at times unwittingly, by TechFins.
Fourth, if financial regulation matters in furthering market efficiency and customer protection, TechFins should be subjected to it when offering financial services. Moreover, TechFins will provide uneven competition to established licensed intermediaries if they are unrestricted by risk and compliance considerations in the build-up phase of their business model and do not bear the minimum costs of a regulated entity in terms of compliance and capital costs.
Fifth, in the world of TechFin, most customers give their data away for free, looking for some side service, so ‘following the money’ (as traditional financial law does) is likely to fail. ‘Following the data’ may provide an alternative, however. This alternative is not a mere policy choice, it is a necessity in a world where the value of data exceeds the value of traditional production if measured by market valuation. In a world where data is the new currency and where special legislation regulates intermediaries managing financial assets owed to and owned by others (as banks and asset managers do), it is a pressing need to adequately regulate ‘data intermediaries’ in addition to financial intermediaries given that both pose similar risk to individuals and society.
We conclude that regulators should consider defining financial data gathering and analytics as a regulated activity, if the activity exceeds certain size thresholds. A threshold set as coverage of a percentage of the overall population in the reference market may reflect the segregating line between ‘too small to care’ and ‘too large to ignore’. Above this threshold, TechFin regulation should focus on information gathering and ensuring regulatory access to data-based business models in order to ensure sound analytical methods and adherence to protected factors relevant to that reference market. If the risk analysis arising from the regulatory inquiry reveals systemic risk – for instance, because TechFin data is essential for one significant financial institution, or the TechFin provides the main client access for several financial institutions which together are of systemic relevance – systemic risk prevention measures should apply.
Dirk A. Zetzsche is the ADA Chair in Financial Law (Inclusive Finance) at the University of Luxembourg.
Ross P. Buckley is a Scientia Professor and the King & Wood Mallesons Chair of International Financial Law at UNSW Australia.
Douglas W. Arner is the Kerry Holdings Professor in Law at the University of Hong Kong.
Janos Nathan Barberis is a Senior Research Fellow and a PhD Candidate at the University of Hong Kong.