Cracks are emerging in the post-crisis drive to harmonise global financial regulation, with policy-makers diverging in everything from payments to data residency. The effects could be profound, as Danielle Myles discovers. 

Charting their own course

In the deep South Pacific, an island nation of 4.5 million people is quietly undergoing a crowdfunding revolution. In the 12 months to June, New Zealand saw the equivalent of $51m raised through crowdfunding campaigns, per capita nearly three times more than the UK, which is considered the world’s most advanced crowdfunding market.

A vital ingredient in New Zealand’s unlikely leadership in this field is its regulatory framework. Not only was it one of the world’s first to fully embrace crowdfunding, it is also comparatively liberal, opening the market to issuers of all sizes and placing no caps on investor contributions. It has supported a flourishing microbrewery industry, returned a private beach to public hands, and laid the groundwork for a thriving national start-up culture.

Regulatory reawakenings

New Zealand’s crowdfunding experience is emblematic of a shift that is happening on a global scale. The global financial crisis sparked an unprecedented drive to standardise financial rule-making – governments diligently implemented the G20’s derivatives recommendations and Basel III was more widely adopted than Basel II – but countries are now showing an increased appetite to take back control.

“When there was more fear among the regulators and policy-makers, there was a harmonised reaction. But as countries have recovered at different paces and in different circumstances, there has been more willingness to tailor regulation to the national situation,” says Santiago Fernández de Lis, BBVA Research’s head of regulation.

This new mindset is apparent in the European Commission’s call for evidence on financial regulation’s impact, the US Treasury’s recommended lightening of banking rules, and the likes of Hong Kong and Australia postponing implementation of the Fundamental Review of the Trading Book long before the Basel Committee agreed to a two-year delay.

“A lot of [post-crisis rules] were implemented by Asian jurisdictions without a lot of thought, as they were just following the reforms coming out of the G20, or Basel or Financial Stability Board. We are now starting to see some Asian regulators assert more of their sovereignty, having realised that their markets are at a very different stage of development to those in the West,” says Mark Austen, CEO of the Asia Securities Industry and Financial Markets Association.

The trend is not uniform. Instead, cracks are appearing in pockets of regulation, predominantly those related to technology. These have the potential to re-map the financial services environment by creating new innovation leaders and putting some regions on a faster path to financial inclusion. Unfortunately, this fragmentation could also jeopardise a coordinated response to the next crisis.

The platform effect

Perhaps the best example is ownership of customer data. Policy-makers in China, Europe and the US are taking different approaches to the ‘open banking’ phenomenon whereby firms are connecting their payments infrastructure and sharing information with other players by opening their application programming interfaces (APIs).

Chinese authorities have taken a permissive approach, the EU’s Payment Services Directive 2 (PSD2) requires banks to share data with third parties at the customer’s request, while in the US no such mandate is expected soonAs a result, each region will develop its own distinct consumer finance operating model.

China’s is the most advanced. Ant Financial (an affiliate of Alibaba) and internet conglomerate Tencent have leveraged their group’s links with banks, and the piles of financial information they hold on users, to become dominant players in retail finance. Their first foray into finance was an escrow service between online buyers and sellers, eventually growing into e-payment giants that processed most of the $5500bn in payments that Chinese consumers made via their mobiles in 2016 (cash and cards are now a rarity in the country).

An accommodative regulatory stance on data privacy, combined with local lenders’ lack of digital offerings, created space for these tech firms to morph into platforms that do everything from originate products to provide the customer interface. “In China, we’ve seen banking ‘stacks’ built entirely by technology firms that manufacture and distribute these financial products in a way that’s tightly integrated into their social offerings,” says R Jesse McWaters, the World Economic Forum’s project lead on disruptive innovation in financial services.

These tech companies’ range of services is so large they have become known as ecosystems. For instance, Ant customers can not only shop using the Alipay app, but can also book plane tickets, obtain a loan via its affiliate Mybank, invest in its money market fund Yu'E Bao (the world’s biggest), use its credit-scoring service and, depending on their payment history, check into a hotel without a deposit. “The user experience is so seamless that Chinese consumers are at the point where they expect to be able to do all this within a single app,” says Joseph Ngai, managing partner at McKinsey’s Greater China office.

Tencent and Ant’s expansion throughout southeast Asia means other countries may leapfrog the widespread adoption of branch banking and go straight to mobile banking and digital payments, as is occurring in parts of Africa. “It’s not unreasonable to think that systems similar to those seen today in China will evolve in other markets,” says Mr McWaters. India has also seen a surge in digital payments – but thanks to a different regulatory driver: the demonetisation of Rs500 and Rs1000 notes in 2016 led the annual e-wallet adoption to grow some 160% on the previous year.

Meanwhile, in the West...

China’s end-to-end platforms would struggle to reach the same scale in Europe due to the region’s strict data privacy rules. But under PSD2, Europe could soon see its own customer-centric financial model. Requiring banks to move customer data to third parties disrupts their vertically integrated system. It creates opportunities for non-banks to collect data on behalf of customers and create a dashboard of their various financial accounts – whether savings, credit, stocks or a fund – all of which may be provided by different institutions.

“It isn’t too hard to imagine a type of Amazon for financial services, which aggregates customer data from many different financial products, and makes recommendations on what new products are the best fit for that customer,” says Mr McWaters.

The US, however, is not likely to see these types of platforms simply because its banks can choose to whom they open their APIs. “In Europe there’s the potential for the separation of distribution and manufacturing. But in the US, where there are no signs of impending open data regulations, it’s more likely that large financial institutions will curate relationships with select fintechs, and for the large part retain customer data internally,” says Mr McWaters. Until regulators require them to pass on data at a customer’s request, they look set to retain their traditional value chains.

Fintech philosophies

These different approaches to open banking reveal some distinct regulatory philosophies regarding fintech and innovation. “China’s rather unique approach has been to open up key parts of the market, allow these companies to innovate, and then regulate and clamp down on them once they reach a size that they create systemic risk,” says Mr Austen.

The best example is peer-to-peer lending, which became a $130bn industry that experienced many high-profile collapses before regulations were tightened 18 months ago. “There was confusion as to whether you needed a licence, who regulated you and if there were lending standards, but there has now been a big crackdown on firms operating illegally and detailed guidelines have been released,” says Mr Ngai.

The rest of Asia has not replicated China’s approach. The Monetary Authority of Singapore (MAS), the central bank of what is arguably the region’s fintech leader, and the government are proactively supporting innovation. MAS has a sandbox that allows firms to experiment with financial products before becoming fully regulated. It launched PayNow, which is perhaps the world’s fastest fund transfer system, and set up a personal data-sharing platform that allows banks to sign up customers digitally. It has fostered more than 400 financial start-ups that are not concentrated in payments – fintechs’ speciality.

Singapore’s regulatory philosophy is epitomised by its approach to open banking. Over the past two-and-a-half years MAS has encouraged – not required – banks to open their infrastructure so they can integrate with fintechs. “As a policy-maker, our view on APIs is that ‘open banking’ doesn’t mean open mandate, but rather open collaboration,” says MAS’s chief fintech officer, Sopnendu Mohanty. It appears to be working, given local lender DBS now has the world’s biggest banking API developer platform.

Other regional leaders in Asia-Pacific are Australia, which has a regulatory sandbox, and the Reserve Bank of India, whose biometric ID scheme called Aadhaar covers more than 90% of the country’s far-flung population, making it widespread enough to support mobile-only lenders such as Digibank. Neal Cross, DBS’s chief innovation officer, says other authorities in the region are trying to be more innovative, and many are looking at what Singapore has done so well.

European precision

In contrast to MAS’s collaborative role, the EU has taken a characteristically prescriptive approach to regulation. While Singaporean banks have voluntarily opened APIs without losing business, some EU banks view PSD2 as a way for fintechs to displace them. “In Europe there’s been concern among banks that this is a bad thing that they are being forced into, while for us it’s been about exploring ways to improve our services,” says Mr Cross. “The end point will be similar, but one approach is causing fear and the other is instilling innovation in banks.”

It is a good example of EU policy-makers using regulations to dictate how they believe the industry should function, an approach that tends to have unintended consequences. Another is the proposed ePrivacy Regulation, which currently lacks a bank carve-out. This means individuals’ privacy rights would take priority over firms’ ability to check employee and client e-mails to ensure the bank is not engaging in prohibited activities. “Banks try to monitor everything and if this regulation goes ahead that would make that very difficult,” says Alan Houmann, Citi’s Europe, Middle East and Africa head of government affairs.

The UK’s Financial Conduct Authority (FCA) is a regional exception, having launched the world’s first regulatory sandbox and established itself as Europe’s fintech policy leader. “On the continent, the role of the regulator is to enforce a code, not help the market be more efficient,” says PJ Di Giammarino, CEO of think-tank JWG. “Some have moaned that they don’t have sandboxes, they currently don’t have ways to do things with the industry – but that could change soon.” Indeed, the European Commission’s recently convened FinTech Task Force has sought feedback on an EU-wide sandbox.  

The US spirit of ingenuity

The US lags other major markets in encouraging financial innovation. It has no national fintech policy, financial regulators are not required to improve competition (unlike the FCA), and fintechs must be authorised by each state in which they operate. However, lenient privacy rules mean that data – the lifeblood of fintechs – is easily accessible. “The US has very low standards when it comes to data protection and restrictions on data sharing. Banks can sell client data in a way that’s unthinkable in the EU,” says Norbert Gittfried, associate director at Boston Consulting Group.

Being home to the world’s leading technology centre, Silicon Valley, plus its large pool of institutional investors and 6000-odd banks, has also helped the US fintech industry become one of the world’s biggest. Its entrepreneurial culture has seen some US banks open their APIs (when they stand to benefit) and others commit to setting up a fast payment infrastructure before the Federal Reserve convened a task force to discuss a national system – 10 years after the UK launched its Faster Payments system. 

While commercial incentives have prodded financial firms into action, this has its limits. “The US government seems to be relying on the American spirit of ingenuity and free market competition, but I’m not sure if that’s going to be enough in the long run,” says Samantha Pelosi, head of payments and innovation at the Bankers Association for Finance and Trade.

One area where the US private sector cannot pick up regulators’ slack is regtech. UK authorities embraced it more than four years ago, while Hong Kong’s securities watchdog and Singapore’s MAS have incorporated emerging technology into their monitoring processes and encouraged local firms to follow suit. US authorities, on the other hand, are just now starting to investigate it.

“As a major technology centre, the US financial services policy agenda is far behind when it comes to overcoming historical market failures to improve regulatory compliance capabilities,” says Mr Di Giammarino. As it helps business to combat crime while reducing compliance costs, Ms Pelosi describes regtech as a win for both regulators and banks. By forgoing these benefits, the US is missing an opportunity to reduce the enormous fines being imposed on the industry.

Up in the clouds

Countries have taken very different approaches to data residency, rules that often dictate a firm’s ability to use cloud computing. For example, regulators in China, Turkey, Russia, Brazil and many African states are among the growing number to favour data localisation – a policy that requires information to be stored locally, creating a barrier to cloud adoption.

At the other end of the spectrum are the likes of Australia, the Netherlands and Singapore, which in 2016 introduced guidelines that do not restrict where data is located, as long as an exhaustive list of controls are abided by. Firms in these cloud-friendly jurisdictions can take advantage of its many benefits, including reduced IT costs, greater cross-border efficiencies, and the chance to scale innovations. “Fintech players do not write software hoping they will run it at a data centre. They write software to run it in the cloud,” says MAS’s Mr Mohanty.

As new technology is increasingly locationless, residency policies can stymie the uptake of new tools such as data science and make multi-nationals’ disbursed operations more expensive. “When you are in an emerging market, adding $100m to the running costs can make some firm’s presence look uneconomic. So it can be self-defeating,” says Citi’s Mr Houmann.

Re-mapping economies

Studies by US think-tank the Information Technology and Innovation Foundation have found that data localisation and other barriers to cross-border data flow reduce gross domestic product in Brazil, the EU, and several Asian jurisdictions by 0.7% to 1.7%. It is just one example of how regulatory discrepancies have the potential to change the course of finance, and economies, within different regions.

The pervasiveness of Ant Financial and Tencent’s platforms makes it crucial for Chinese businesses to be connected to one of them. “In other markets there are many verticals but in China you can do almost everything within one of these ecosystems, which creates the question of why [customers] would go elsewhere,” says Mr Ngai. “If you are a service provider, it makes it very important to become aligned with one of these big players as that is how you will get customer traffic.”

Compared with the US – where there is no credible threat to bank’s traditional value chains – in markets where regulators support payment innovation, finance will become more integrated into people’s lives. “Fintech payment providers will also assist the unbanked and underbanked populations of these countries,” says Ms Pelosi. Indeed, a 2016 study by the Bank for International Settlements and the World Bank found that payments is the gateway to financial inclusion. While fees, lack of trust or not qualifying for an account can stop individuals from obtaining a bank account, these barriers are smaller for non-bank payment providers. They also act as a good introduction to the formal financial network, motivating users to consider other financial products.

Beyond payments, MAS has spearheaded the Association of South-east Asian Nations’ Financial Innovation Network, which provides a marketplace for fintechs from 10 Asian countries that help banks digitise to improve financial inclusion; a primary concern in Asia. “Finding a way for fintechs to connect with small banks in small towns across different countries could transform these far-flung financial institutions’ ability to better connect and serve their local communities,” says Mr Mohanty.

Networks such as this help disruptive technologies achieve their potential, and show why regulators cannot view them as local businesses. Mr Mohanty notes that fintechs can “do OK” in large domestic markets, but most tend to be small and need to operate in multiple geographies. “Scaling beyond national borders is not an area in which fintechs have seen great success to date, and it's only possible with common policy-making across multiple markets,” he adds.

An even bigger imperative to cross-border coordination is ensuring a joined-up response to the next global crisis. Mr Houmann says cybercrime, which knows no borders, is probably today’s biggest danger for every firm. While countries are creating their own policies to combat cyber-threats, no single country can tackle this alone, making global standards essential.

The different retail finance models emerging around the world could also complicate the regulatory response in times of stress. Besides requiring region-specific macroprudential policies, Mr McWaters says their divergence could make it harder for authorities to understand one another and the systems they manage. “There are some concerns about whether regulatory coordination will be more difficult in an environment where financial operating models diverge significantly across regions,” he says. Each region may be forging its own path, but the undeniably global nature of modern finance means regulators must be familiar with the direction their peers are taking.

Regulatory red herrings

Other regulatory discrepancies have hit the headlines for creating an unlevel playing field – particularly between the EU and the US – but unlike rules governing data and fintech, they will not fundamentally change the direction of finance.

The EU's and US’s implementation of global derivatives reforms, for instance, jarred for many years, but today transatlantic dialogue and coordination have never been stronger. Their regulators now recognise each other’s derivatives rules as equivalent and in December EU firms were cleared to use US platforms to comply with the EU’s new trading regime, an announcement that Enrico Bruni, Tradeweb’s head of Europe and Asia business, describes as “the final confirmation of a genuine willingness from regulators on both sides of the Atlantic to work together to achieve a good outcome for markets”.

US president Donald Trump’s deregulation rhetoric has fizzled into some middle-of-the-road proposals contained in the US Treasury’s report on the banking sector. “There was concern there would be an 'America First' approach at the expense of foreign banks, but we were encouraged by its acknowledgment of the role they play and that they provide more credit to the US than the community banks combined,” says the Securities Industry and Financial Markets Association CEO Kenneth Bentsen.

The exception to this coordination is host regulators’ desire to control foreign branches and subsidiaries. The US requirement for sizeable foreign banks to have a fully capitalised intermediate holding company, and the EU’s proposal for a similar framework, are prime examples.

“More countries and their regulators are wanting their own pots of capital and liquidity, which to some extent is down to a lack of trust due to the experience of the financial crisis,” says Michael Lever, head of prudential regulation at the Association for Financial Markets in Europe. “The paradox is that as banks have got stronger, the trust has become weaker.”

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