The potential of financial technology for innovation and growth is well-established by now. Yet startups often face many regulatory challenges in the early years, obstructing market access. Technology firms and incumbent financial institutions are experimenting with new solutions to this problem, often establishing co-operative linkages between them. At the same time, governments and regulators have introduced special frameworks that may facilitate the newcomers’ market entry. Among these are regulatory 'sandboxes', which provide for a safe experimentation space allowing new market participants to test their services in the real market with a reduced regulatory burden, but under close scrutiny of the supervisor. Governments are continuing to experiment with other formats to help new market entrants with the regulatory complexity, including through incubators and mentorship programmes.
The 4th Annual Oxford Business Law Blog Conference, co-organized by the University of Oxford, the University of Hamburg and the European Banking Institute, put together high-level academics, regulators and practitioners involved with these issues, with the objective of evaluating these different initiatives. The conference programme can be downloaded here.
The conference, generously sponsored by Intesa Sanpaolo, was held online on Friday 27 March 2020. A recording of the conference is available here.
A brief summary of all sessions and the practitioners’ panel discussion is provided below. Please note that the views expressed by paper presenters, discussants and practitioners are personal and do not represent the views of any organisation.
Session 1: Interaction of banks and fintechs
- How successfully do banks interact with fintechs?
Lars Hornuf (University of Bremen) presented an empirical study that examines how banks interact with fintech firms—how prevalent are alliances between banks and fintechs, and what form do they take? What are the motivations for these alliances, and what is their impact on bank value? The study examines these questions by collecting and analysing data from the hundred largest banks in each of Canada, France, Germany and the UK in the ten years between 2007 and 2017, and through an event study of changes in listed bank value in response to alliance announcements. His key findings are that:
- banks are more likely to ally with fintechs if banks have a digitalization strategy or a Chief Digital Officer;
- the most likely alliances take the form of minority stake investments by large listed banks in small fintechs;
- surprisingly, an announcement of an alliance has a slightly negative effect on bank value in the short term, except where the bank is a digital bank, where there is slightly positive effect.
The discussant, Kristin van Zwieten (University of Oxford),brought attention to whether there is any causal relationship between banks’ digitalisation strategy or appointment of a Chief Digital Officer and their entry into fintech alliances—is it possible that alliances pursued through an informal commercial strategy prompt banks to adopt a more formal and publicised strategy? She also noted the paper’s conclusion as to the typical form of alliances appears to be driven primarily by larger fintechs, and if this variable is controlled for, then the typical form of alliance is less clear. She suggested that there may perhaps be other factors impacting more on fintechs’ (rather than banks’) choices, that could be explored in subsequent (perhaps more qualitative) research. The counterintuitive result regarding bank value seems to point toward some other factor explaining negative market reactions.
- The case for a fintech mentorship regime
Georg Ringe (University of Hamburg) presented a paper co-authored with Luca Enriques (University of Oxford) that makes the case for a ‘mentorship regime’ as a regulatory framework to address issues of regulatory responsibility, supervision, and enforcement that arise from increasingly closer collaboration between banks and fintechs in the provision of banking services. While there are numerous advantages (especially to fintechs) from this form of collaboration, including access to data and knowledge, economies of scale, marketing and reputational spill over effects, and development of a compliance culture, the outsourcing of bank functions to fintech firms can also create risks by taking banking activities outside of the regulatory perimeter. A complementary (and optional) mentorship regime would address some of these risks by allowing banks to extend their regulatory licence to fintechs. In doing so, a bank would also take legal responsibility for a fintech firm’s conduct, thereby subjecting the fintech firm to the bank’s own compliance and internal control functions. This would place banks in more of a ‘gatekeeper’ role and should improve the regulation of banking services that are outsourced to fintech firms.
The discussant, Edmund Schuster (London School of Economics), supported the paper’s argument that the current framework likely enables regulatory arbitrage and poses the risk of inadequate supervision of fintech firms. Noting the ongoing Covid-19 pandemic, he pointed to questions of how the current crisis will impact the fintech landscape, particularly its potential effect on fintechs with stretched valuations and high rates of ‘cash burn’. Turning to the authors’ proposed mentorship regime, he queried whether fintechs may be reluctant to enter into the kind of highly integrated relationship that banks may require if they have regulatory responsibility for the fintech firm that they partner with. He opined that, if adopted widely, the proposal would clearly improve the status quo from a regulatory perspective, but also noted the importance of encouraging uptake of mentorship by regulated parties, either by introducing incentives to take up mentorship or a mandatory element to the regime.
Session 2: Competition & fintech
- Data, innovation and competition in finance: the case of the access to account Rule
Oscar Borgogno (University of Turin), who presented a paper co-authored with Giuseppe Colangelo (University of Basilicata) started out with an analysis of consumer inertia in financial market. He briefly discussed the research by the UK Competition Markets Authority (CMA) on how consumers do not switch bank accounts and how big banks have exercised market power by increasing the bank charges, in the highly concentrated UK retail banking market. He underscored the importance of consumer data as fintech firms are increasingly providing data-enabled services, particularly in the payment service industry. Banks who largely control customer data did not have enough incentives to provide access to the data to fintech firms thereby leading to the ‘data bottleneck problem’.
To mitigate the ‘data bottleneck problem’, the EU Revised Payment Directive (PSD2) granted access to consumer data on real-time basis to fintechs (subject to consumer consent). This is also known as the ‘access to account rule’. His paper noted that the technical specifications such as standardised Application Programming Interfaces (APIs) are crucial for smooth functioning otherwise the PSD2 would remain a dead letter. The CMA had issued a Market Order requiring nine large banks to develop a common set of APIs to access the consumer data also known as the Open Banking initiative. By such demand side regulatory intervention, fintech has served as a new frontier of antitrust enforcement. Australia, Singapore, Canada, Japan and other EU member states have also embraced this approach.
However, these interventions may have unintended consequences if bigtech firms, who have huge resources, could use the consumer data to gain unfair advantage in the retail banking market. Additionally, the paper proposed that banks would have to carry out a regulatory role for their own services to mitigate the unintended consequences of the access to account rule.
The discussant, Katja Langenbucher (Goethe University Frankfurt), raised concerns regarding how banks and bigtech could misuse data. She highlighted the lack of regulatory capacity to monitor concerns that stem from the access to account rule. Further, she noted that whether this rule would benefit consumers and/ or change their behaviour remains an open question.
- ‘Platformification’ of banking: strategy and challenges of challenger versus incumbent banks in response to regulatory change in the UK
From booking a cab or a vacation home to purchasing financial services, platforms have today occupied a central role in the day to day lives of many. Pinar Ozcan (Said Business School), Markos Zachariadis (Warwick Business School) and Dize Dinckol (Warwick Business School) are the co-authors of a paper on ‘platformification’ in the banking industry. Ozcan explained the rationale behind the success of platforms, ie that they reduce transaction costs. Another important feature of platforms is the network effects or externalities that are associated with them.
She discussed whether new players and incumbents are similarly placed in terms of developing a platform and attracting innovators that sell products and services through it. The two key research issues that this study focuses on are: (a) the challenges and opportunities that new platform players and incumbents face in platform formation; and (b) their influence on strategic decisions pertaining to platform ownership and openness. She and her co-authors had collected data from September 2016 to January 2018 and conducted interviews with 100 key stakeholders (regulators and industry participants) in the UK and EU.
She distinguished between two major kinds of platforms—incumbent-based platforms (self-built or outsourced) and new entrant platforms (self-built). Apart from organisational and cultural issues, established banks face a decision as to which parties to be allowed on their platform given that they also have their products and services to sell. On the other hand, new entrants would build their own platforms but are faced with a growth issue, mostly due to regulation and the problem of consumer inertia.
Joe McCahery (Tilburg University) highlighted that the paper’s key contribution lies in the impact analysis of the trade-offs that incumbent firms and new entrants face while transitioning/ entering into the platform business. Further, he noticed how cyber security threats and attached liabilities (reputational risk) may create a defence mentality with respect to incumbent banks. Fintechs may have the technological expertise for ensuring cyber security. However, they may not have sufficient reputational concerns.
Session 3: Technological aspects of fintech regulation
- Technology v technocracy: fintech as a regulatory challenge
In the third session of the conference, insight was offered into the regulatory opportunities and challenges presented by the emergence of fintech start-ups in the financial system.
In her conference contribution, Saule Omarova (Cornell Law School) claimed that the emergence of fintech disrupts the underlying ‘technocratic paradigm’ of financial regulation. Using the USA as a case study, her paper analysed the key fintech-driven changes to the financial system as well as the corresponding challenges presented to regulators. Omarova identified as the ‘core of the fintech problem’ that technocratically-minded financial regulation still acts primarily at the ‘micro-level’; this means that it operates mainly along ‘product/entity’ lines and targets isolated transactional phenomena, which encourages bureaucratic specialisation and deep but narrow technological expertise. ‘Regulatory sandboxes’, special fintech charters, and ‘regtech’ exemplify these tendencies. Omarova argued that the fast growth of the financial system in size and complexity, driven by fintech, cannot be handled by this traditional way of regulation, shifting the control over technology to private actors and leaving financial regulators in a ‘catching-up role’. She suggested alternative forms of regulation that target the ‘macro-structural’ aspects of the financial system. This approach is based on three main pillars: a proactive rather than a reactive role of regulators, a focus on structural rather than transactional regulation, and the incorporation of direct public participation in financial markets. Examples for this could be the licensing of new financial products or the issuance of a digital currency by central banks.
The discussant, Luca Enriques (University of Oxford), qualified Omarova’s suggested approach to fintech (and financial regulation more generally) as a ‘testing and tracing’ model and noticed how in fact elements of this approach may already be present in the current financial regulation framework. An example of that is regulators’ pro-active stance vis-à-vis Facebook’s Libra project.
- Technologising the bank charter
David Zaring (Wharton Business School) investigated into the merits of the US Office of the Comptroller of the Currency’s (OCC) special purpose (federal) charter for fintech start-ups. This proposal has raised concern and even legal dispute, which Zaring held to be misplaced. One of the crucial aspects of OCC’s new path is the chartering of businesses that are clearly not banks—as opposed to the already-in-place procedure of allowing banks to offer non-banking services. OCC’s authority to do so is primarily dependent on whether non-bank fintechs can be regarded as being engaged in the ‘business of banking’ in the sense of the National Banking Act. In his paper, Zaring argues that OCC should win this dispute on the grounds:(1) the ‘Chevron deference’ rule; (2)the policy rationale of improving access to financial services and rationalising the regulation of internet-only businesses; (3) the agency’s cautious approach. A second question he touched upon was whether the fintech special charter should be extended to bigtech-businesses such as Amazon or Google. Zaring made the point that this would essentially mean the end of the traditional separation of banking and commerce—a question whose answer should be left to Congress, rather than to an agency.
The discussant of this contribution, David Ramos Muñoz (Carlos III University, Madrid), welcomed the rare combination of regulatory, industry, and constitutional issues in the paper. He underlined how the desirability of a special purpose charter for fintechs is the crucial analytical point. Central issues in this respect are, for example, the balance of regulatory competition v regulatory harmonisation or the diversity in banking vis-a-vis financial stability. Also important is the legality of the measure, ie whether OCC can take up regulatory competences previously exercised by the states. This depends on whether the agency is granted deference by the courts, which in turn depends on two things. First: whether the agency power is based on open-textured concepts, subject to interpretation, which is the case with the ‘business of banking’. Second: whether the issue on which the competence is exercised is ‘interstitial’ (in which case deference is granted) or ‘fundamental’ (in which case the court will be more circumspect). Thus, the key question: is the fintech charter an ‘interstitial’ matter (a new regime at the margins of the system) or a ‘fundamental’ matter with the potential to reshape the face of the market? Here the issue of ‘desirability’ converges with the issue of the ‘legality’ of the regime.
Session 4: Regulating financial innovation
- How to best regulate financial innovation?
Dirk Zetzsche, Roberta Consiglio and Robin Veidt (University of Luxembourg) offered a quantitative approach to assess the impact of regulation on financial innovation and answer questions on the fintech-specific tools and resources employed by regulators. Their database stems from the preliminary results of their survey of Financial Supervisory Authorities (FSA) across the globe and public disclosures made by these FSAs. The data and the questions posed in the survey focus primarily on the cooperation of general supervisory approaches as well as the cooperation between banks and fintechs.
Acknowledging the importance of regulatory sandboxes, the authors shed light on the relation between the various regulatory tools and their impact on financial innovation. Beyond the use of different regulatory tools, the survey aims to fill a gap in the existing literature by identifying country-specific challenges and features of the financial ecosystem that might influence the choice or the success of one regulatory approach over another. The research questions also revolve around the fintech ecosystem in general, with emphasis on the fintech-regulator communication and the cooperation between the regulated entities and fintech enterprises.
Some of the preliminary results of this survey, such as the lack of clarity characterising the entry and reporting requirements applicable to fintechs, were further analysed. The survey results also brought useful conclusions on the importance of a clear national fintech strategy or the relationship between the number of employees in fintech departments and regulators’ commitment to promote fintech. On the bank-fintech cooperation level the survey seems to suggest that more needs to be done (even if regulators already recognise its value for all stakeholders).
A core takeaway is the lack of clarity with regards to regulatory and licensing requirements, this being a considerable impediment and potentially an entry barrier for innovative fintechs.
The discussant, Hilary Allen (American University Washington College of Law), acknowledged the importance of the survey in light of the lack of empirical data in this area and its timeliness given regulators’ eagerness to revise their initial approach to fintech regulation. She highlighted that the survey questions seem to revolve around the issue of how regulators can further financial innovation in the private sector, overlooking the importance of other FSA’s mandates such as consumer protection. In fact, she argued that the core questions should be why we need to regulate fintech in the first place, whether fintech innovation furthers certain regulatory goals and, in turn, how such considerations should influence policies to promote fintech innovation in the regulatory system. She also suggested an additional set of questions pertaining to information sharing, the allocation of resources or the educational aspects of sandboxes.
Practitioners’ panel: a roundtable discussion
The final round table was chaired by Thomas Hellmann (Said Business School) and included practitioners working with or at fintech firms. The panel offered insights into the various themes covered throughout the day.
Huy Nguyen Triêu (The Disruptive Group) presented an operating model for the collaboration between new entrants and banks. He emphasised that large and small organisations differ not only in the profiles, mindsets and objectives of the people working within them but also in technology and processes. To underline the importance of people, processes and technology, he presented three case studies of successful collaborations between incumbents and fintechs where challenges in relation to were dealt with successfully.
According to Jeff Lynn (Seedrs) there are fintechs that build technology meant to work with incumbents and these that act as disruptors and may not so easily fit with large organisations. Describing his own experience, Jeff Lynn focused on this second category and explained the hurdles his company faced in the collaboration with incumbents. The problems were mainly attributed to the different risk aptitude and risk profiles: fintechs would like to collaborate with incumbents on activities that would usually create more risk for the incumbent than value. Incumbents’ business on the other hand is based on the integrity of their regulatory licence and the risk to jeopardising their existing structure and integrity by incorporating a new fintech model would rarely make sense.
Silvio Fraternali (Banca 5, Intesa Sanpaolo Group) offered his view on the collaboration between new entrants and banks from the side of the incumbent. Drawing on his insight into the industrial collaboration between his bank and a fintech, a partnership based on commercial synergies which resulted in the combination of two business models instead of a mere investment in the fintech, he noted that this process required the transformation of the group’s proposition in a way that would allow growth and benefit for both sides and described the tedious process and the challenges they faced to achieve this. In addition to the explanations and clearance requested by the regulator, substantial work was required by the group’s own business units and control functions. In general, the preparation needed for such collaboration to work was a rather lengthy process, even if each single step examined in isolation may ex-post seem reasonable and necessary.
Silvio Fraternali identified this long timeline as a core problem. The differing EU-national regulatory frameworks and the inconsistency of the rules and methodologies adopted by the different regulators were definitely another delaying factor. In his view, shortening this timeline would thus be necessary to facilitate the fintech-incumbent collaboration, also considering fintechs’ dynamic nature.
Ben Davey (Barclays Ventures) acknowledged the regulatory and other operational hurdles faced by fintechs in the current landscape. Coming from an incumbent’s perspective, he suggested that a collaborative model between the new entrants and the incumbents is the best way forward, particularly in these troubled times. He recommended that the eligibility conditions for incumbents to access the sandbox be further relaxed.
Zlil Salomon-Levin (Israel Discount Bank) contributed a regulatory perspective based on her previous position at the Israeli Ministry of Justice. She discussed the unique approach suggested by the Israeli Government, namely creating a joint regulatory panel consisting of all financial sector regulators in Israel to regulate the sandbox programme. This approach ensured that fintech products under the purview of multiple regulators do not fall through the cracks and a more nuanced perspective is ensured in dealing with them. It was also suggested that Israeli regulators put in place a mentorship scheme for incumbents, providing guidance regarding future fintech products. This scheme is also helpful as regulators get to learn about new fintech products and their regulatory implications beforehand.
To conclude, broad consensus on the need to promote innovation and competition between incumbents and fintech firms emerged from the practitioners’ panel, together with the caveat that regulators need to be wary of the unintended consequences of any policy responses on this front. Regulators may also need to ‘innovate’ in terms of policy action to be up to speed in this sector. Finally, the development of new forms of regulatory cooperation across jurisdictional borders for the spread of fintech-based innovation is the need of the hour.
Over the course of the coming weeks, the Oxford Business Law Blog will be featuring the ‘Fintech Startups and Incumbent Players Series'. This series will consist of posts summarizing papers presented and presentations made at the 4th Annual Oxford Business Law Blog Conference.
Eftim Ancev, Carlo Brunold, Param Pandya and Georgios Pantelias are Associate Editors of the Oxford Business Law Blog.