In 2016, few people had ever heard of Bitcoin or blockchain, initial coin offerings were non-existent, and US financial regulatory agencies had yet to react to the emergence of non-bank financial services providers. The FinTech industry has changed dramatically since then: Bitcoin has captured the public imagination and spawned new derivatives products, you can apply for a mortgage on your smartphone, initial coin offerings are now a viable alternative to venture capital funding, and the Office of the Comptroller of the Currency has proposed a new kind of bank charter specifically for FinTech firms.
While many have focused on the technologies underpinning the FinTech revolution, less attention has been placed on how these technologies fit within the current financial regulatory framework. Understanding this framework is critical to the long-term success of any FinTech startup. While technology startups in other sectors may predicate their business on breaking rules and ignoring regulations, such a strategy is sure to fail if deployed by a FinTech firm. This is because the financial industry is heavily regulated by multiple state and federal agencies that often have overlapping authority. Being a successful FinTech firm requires more than just great technology; it also requires an understanding of the laws and regulations applicable to your business.
Therefore, I am excited to announce the launch of a new online course that will provide you with that understanding. “FinTech Law and Policy” will teach you about the critical legal, regulatory, and policy issues associated with cryptocurrencies, initial coin offerings, online lending, new payments and wealth management technologies, and financial account aggregators. In addition, you will learn how regulatory agencies in the US are continually adjusting to the emergence of new financial technologies and how the Office of the Comptroller of the Currency has proposed a path for FinTech firms to become regulated banks. You will also learn the basics of how banks are regulated in the US.
While there are existing online courses that focus on the technologies underpinning the FinTech revolution, this is the first open online course focused on how these technologies fit within the current financial regulatory framework. The US financial regulatory structure is complex, and it can challenge even the most sophisticated FinTech firm’s ability to identify the regulations with which they must comply. The core issue is regulatory oversight in the United States is fragmented across multiple regulators at the federal level and many FinTechs will also have to deal with regulatory bodies in the states they wish to do business in. Adding to the confusion, many of the regulations implemented and overseen by all these federal and state agencies were developed long before the type of product or service FinTech firms are now offering existed.
As you might imagine, navigating this complex web of regulation takes time and is costly. The cost of researching applicable laws and regulations can be particularly significant for FinTech firms that begin as technology startups with small staffs and limited venture capital funding. One of the biggest costs for FinTech firms seeking to operate nationwide is the cost to obtain state licenses. FinTech payments and lending firms that are not subject to routine federal oversight must typically obtain state licenses. The Government Accountability Office estimates that obtaining all state licenses generally costs FinTech payments firms and lenders $1 million to $30 million, which includes legal fees, state bonds, and direct regulatory costs.[i]
There are also costs associated with being examined. Because most FinTech firms operate in multiple states, it is possible for a single FinTech firm to be examined multiple times a year by various state regulatory agencies. Examinations impose costs on FinTech firms by way of time and resources that otherwise could have been spent on growing the business.
These challenges are not unique to FinTech firms. But what does make FinTech firms different is that they typically seek to operate in multiple states, or nationwide, at their inception. Historically, money transmitters or nonbank lenders got their start in a limited geographic area and therefore, only had to obtain a license in one state. As their business grew, they may have expanded into additional states and obtained licenses in those states, but they were able to spread the cost of getting these licenses over time. For a FinTech firm, obtaining a license in multiple states at inception can eat into limited venture capital funding and divert critical resources away from the task of building the business.
FinTech firms also face uncertainty when it comes to how their product is regulated and how regulation may change. FinTech lenders for instance, must contend with multiple agencies who have authorities related to consumer protection and fair lending. The Federal Trade Commission and Consumer Financial Protection Bureau can take enforcement actions against nonbank FinTech firms for violations of any federal consumer protection laws they enforce, and they may have different interpretations of what conduct might merit consumer protection enforcement actions. One specific area where this creates uncertainty is in the use of nontraditional data by FinTech lenders to assess borrower creditworthiness. Many FinTech lenders are concerned that the use of this data may produce outcomes that violate fair lending laws and regulations.
Companies that aggregate information pertaining to a consumer’s financial accounts, like Mint, face uncertainty as to which party will bear responsibility for unauthorized transactions. Will it be the aggregator, or will it be the bank or other financial institution where the customer holds their account?
There is also significant uncertainty as to whether or not it’s possible to structure an initial coin offering (ICO) to avoid it being classified as a security subject to SEC registration. The SEC has yet to offer definitive guidance on the status of ICOs, choosing instead to take enforcement actions where clear violations of securities laws have occurred.
The costs and uncertainty imposed by the US’ fragmented regulatory structure has led many FinTech firms to reassess their business strategy. The idealism present in the early days of the modern FinTech moment, circa 2008, has given way to a more pragmatic approach, whereby the goal of many FinTech firms now is to partner with, or be acquired by, a traditional financial institution. This goal is more easily accomplished when the FinTech firm has a strong record of regulatory compliance.
Conclusion
Over the next couple of days, I will publish a series of posts that pertain to various lectures in the online course. These posts will introduce you to the concept of FinTech, examine the FinTech industry’s recent evolution, and highlight the efforts by regulatory agencies around the world to address the emergence of new financial technologies. If you are interested in learning more about a specific FinTech sector, such as online lending or cryptocurrency, I encourage you to check out the course (you can audit the course for free.) Each course module is designed to be a standalone lesson, meaning you don’t need to watch the previous modules in order to follow along. So, if all you’re interested in learning about is FinTech payments, by all means jump straight to week 5. And if you are unfamiliar with how these new financial technologies work, fear not. Each module begins with a high-level overview of the underlying technology.
I hope you enjoy the course and I encourage you to provide feedback at reiners@law.duke.edu
[i] https://www.gao.gov/assets/700/690803.pdf
