Creating a level playing field for regulating FinTech

The Bank of International Settlements (BIS) just released a paper on how governments and central banks should deal with FinTech upstarts. Here are the conclusions:

Helping to achieve a level playing field in the provision of financial services is a desired outcome of the regulatory framework. This entails facilitating an orderly entry of new participants – such as fintechs and big techs – that could expand consumers’ opportunity set, promote innovation and foster competition.

However, it also requires unwarranted discrepancies in regulatory obligations to be avoided that might jeopardise the competitive position of incumbents (such as banks) vis-à-vis that of new entrants. Yet fostering a level playing field is not the primary objective of financial regulation. Public policy goals such as financial stability, market integrity and consumer protection rank first in the order of priorities. Moreover, equating the conditions to be satisfied by different types of player in particular market segments would not always promote more competitive markets. Therefore, achieving a level playing field would only be desirable if higher-priority policy objectives are ensured.

In some policy domains, such as consumer protection or AML/CFT, an activity-based approach may well be adequate enough to achieve primary objectives. Yet in others, such as financial stability, an entity-based approach is indispensable. In a third group of policies, such as those on operational resilience and competition, regulations require a combination of activity- and entity-based rules, addressing the specific risks that different types of players can generate to meet those policy objectives.

Therefore, regulation may create unwarranted competitive distortions in two ways: first, by introducing specific entity-based obligations for a specific set of competitors on policy areas in which an activity-based approach could deliver the desired objectives; and second, by imposing specific obligations on some but not all types of players for which entity-based rules would be warranted on higher-priority policy grounds.

The existing regulatory framework in major jurisdictions does tend to impose comparable rules for consumer protections and AML/CFT on all relevant providers of financial services. Yet supervision and enforcement of these rules may be different across different types of entities that provide the same services. A functional – as opposed to a sectoral – organisation of financial supervision may help eliminate those unwarranted discrepancies and contribute to a more level playing field. In the area of AML/CFT, heightened vigilance of new, non-bank players’ activity seems essential in order to address current challenges in ensuring market integrity, as well as to mitigate distortions created by differences in the effective regulatory burden experienced by different types of entity.

The situation is different in policy areas for which entity-based rules may be appropriate. Despite recent progress, rules aimed at ensuring the adequate operational resilience of traditional financial institutions – such as banks and insurance companies – are generally more stringent than those for other entities. As things move forward, and some big techs continue to increase their presence in the financial services market, their operations may acquire systemic importance. This should be acknowledged by the regulatory framework. A complication is that they operate across a range of financial and non-financial business lines, thus requiring cooperation across different authorities.

Finally, with regard to competition, the potential of big techs to achieve a dominant position and to use that position to adopt anti-competitive practices may deserve specific action. An entity-based regulation targeting those risks, including rules that facilitate comprehensive and efficient data-sharing, seems a promising strategy.

In summary, there is currently only limited scope for further harmonising the formal requirements to be satisfied by different players in specific market segments without jeopardising higher-priority policy goals. In fact, contrary to what industry and other observers often claim, there seems to be a strong case for relying more, and not less, on entity-based rules. The current framework could be complemented with specific requirements for big techs that would address risks stemming from the different activities they perform. That strategy would not only improve the ability of financial regulation to achieve primary objectives, but would also help promote a level playing field. The concrete definition and the enforcement of those new rules would entail close cooperation across financial, competition and data protection authorities worldwide.