Point of View: Regulating The Fintech Revolution

What was previously a relatively innocuous industry sector, the financial technology (or “Fintech”) industry has exploded over the past few years.

With the litany of new Fintech startups and existing Fintech businesses, and even Fintech specific incubators and accelerators popping up, the Fintech revolution is clearly in full effect.

As with any fast growing industry however, the current laws are often ill-suited to cover the substantive issues and it takes time for regulatory bodies to catch up. This could not be truer for the Fintech industry which is currently experiencing significant regulatory growing pains.

What Is Fintech Exactly?

Fintech is a portmanteau (that’s your word of the day) for the term financial technology. Originally the Fintech title referred primarily to technology fostered by established financial institutions and trading organizations (e.g. ATMs, e-trade, etc.). Today however, depending on whom you talk to, the ever expanding Fintech term can be used to describe any technological innovation in, or related to, money or investment. The most commonly referenced subsectors of the Fintech industry today include:

  • Marketplace/Peer-To-Peer (P2P) Online Lending Tech & Crowdfunding – Technology focused on connecting individuals and small businesses seeking funding (often those who cannot find funding under traditional options) with access to available funds.
  • Mobile Payment Tech – Technology (particularly smartphone related) focused on creating new ways to allow consumers to use their money (e.g. make purchases, transfer money, etc.) without relying on cash, checks, or cards.
  • Wealth Management Tech – Technology focused on creating new ways to allow consumers to invest their money and manage their investments; including investment selection, asset allocation, account aggregation, risk assessment and even automated investments based on the individual’s data and risk preference.
  • Blockchain Tech (also referred to as “Distributed Ledger Tech” or “DLT”) – Technology focused on providing a secure method of conducting near real-time transfers of digital assets (potentially without the need for an intermediary) and/or evidencing the authenticity and chain of title of digital assets.

Participants in the new market sectors above have experienced astronomical growth over the last few years. As highlighted in a recent Forbes article, VBProfiles (San Francisco-based market intelligence platform, that tracks the Fintech sector) estimates that there are currently over 1,000 Fintech companies (startups and established companies) operating across the U.S., Europe, and the Asia-Pacific region which, together, represent over $105 billion in total funding and nearly $870 billion in estimated current value.

As if that wasn’t enough, we need to remember that this industry is literally still in its infancy and this is only the beginning.

According to VBProfiles, the main global hubs for Fintech revolution are the US, the UK and France. Domestically, California, New York and Illinois stand-out as the primary Fintech innovation hubs.

Increasing Regulatory Issues

The growing Fintech sector is presenting unique and significant legal, compliance, and practical challenges for both Fintech companies and traditional financial institutions, particularly here in the US.

Other global hubs like the UK and France have significantly modified, and in some instances thrown out and completely re-written, existing laws to better suit the needs and concerns of the growing Fintech industry.

In the US however, we are not as lucky. Fintech companies often face a complex matrix of federal and state regulation with little to no guidance as to exactly which laws are applicable. To make matters worse, the majority of these laws are antiquated and do not translate well, if at all, into today’s internet and mobile based society leaving their application open to significant interpretation.

In fact, while there has been some recent state and federal initiatives to craft Fintech specific regulations, much of the current regulation concerning the Fintech industry is driven primarily by the interpretations of courts and financial regulators as to how preexisting, age-old, laws and regulations apply to today’s Fintech companies.

While not Fintech specific, there is currently a ton of federal and state regulation concerning financial institutions and intermediaries; including banks, investment vehicles and investment advisors.

In fact a good rule of thumb, which many Fintech entrepreneurs fail to realize, is that if a company’s business relates to the movement of money in one way or another there is almost certainly some federal and/or state regulation in effect which the company should be complying with.

One of the biggest issues for Fintech entrepreneurs and companies today is determining which of the cavalcade of existing state and federal rules and regulations they should be complying with. The process becomes even more convoluted when, as often happens, the Fintech company doesn’t fit squarely into a particular financial sector (e.g. a company is lending funds vs. selling debt securities). Without going into detail, as we will be here all day, let’s take a quick look at the issues a US Fintech company might deal with in navigating the current financial regulatory schemes.

To determine which laws a company would be subject, the company would first need to narrowly define what financial services and products it actually provides, or intends to provide, and where it intends to operate. This exercise is easier said than done and is often taken too lightly by companies. All to often the difference between falling under one regulatory scheme and a completely different one will hinge on a single product or service differentiation (e.g. a company is lending funds vs. selling debt securities). Let’s assume for the sake of example that our subject company is an Illinois company engaged in a business similar to SoFi (a Fintech company that helps users refinance existing student and other loans).   

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