By Tory Barringer
Whatever your thoughts are about the current regulatory environment, there’s one point on which we can all agree: Today’s regulators are not equipped to keep up with the pace at which financial technology—FinTech, in future-speak—is progressing. That’s not so surprising; a department or agency must first grasp not only what a new technology is intended to do, but also how it is actually being applied in the field (and make no mistake, intention and application are by no means always the same thing) before taking steps to create reasonable guidelines or restrictions.
Another major issue—and one that certainly isn’t foreign to professionals in the mortgage industry—is the problem that there are so many regulatory agencies both at the state and federal levels, each of which has its own proposed method for classifying and monitoring FinTech firms.
“In the United States, we have state and federal regulators, and we don’t have a unified regulatory body, so just like any other financial services product, FinTech is now faced with the challenge of finding out which regulator has authority. [And] it could be more than one,” explained Richard Levin, chair of Polsinelli PC’s FinTech and Regulation practice.
The industry is struggling with this even as some regulators demand increased investment in technology. In a supervisory report released last summer, the Consumer Financial Protection Bureau (CFPB) chided some mortgage servicers for using “failed technology” that resulted in compliance violations. In a release accompanying the report, CFPB director Richard Cordray insisted that bad systems or outdated technology “are [not] excuses for not following federal rules,” adding, “Mortgage servicers and their service providers must step up and make the investments necessary to do their jobs properly and legally.”
A New Framework (and the Square Peg Problem)
It’s clear at this point that financially-focused technology does need a solid regulatory foundation, and participants in that space certainly need to know where they stand. Regulators are aware of this, which is why they’ve taken steps in the past year to carve out a place for these firms. The Office of the Comptroller of the Currency (OCC) made what is probably the biggest leap forward by publishing in October 2016 a proposal laying out a framework to establish an “Office of Innovation” that will act as a focal point for future regulation the financial services technology arena. It also proposes to treat approved FinTech businesses as “specialty purpose national banks,” granting them a classification that may make them easier to regulate.
While the proposal marks a step in the right direction—or at least in some direction—it may not ease the fears of FinTech firms and industry observers who are concerned about who are concerned about overregulation and its chilling effect on innovation. Indeed, in a white paper released by Polsinelli, Levin and co-author Bobby Wenner note that “the regulatory and supervisory burdens of the special purpose national bank charter may outweigh the benefits,” adding that a more tailored approach may be necessary.
Levin expounded on that point in an interview: “Many regulators around the world would admit that we’re dealing with a square peg in a round hole problem, which is that the regulations are the round hole and FinTech companies are the square peg. They’re trying to fit them into existing regulation as best they can.”
A Regulatory Sandbox
One interesting note in the OCC’s innovation proposal is the potential development of an optional program for agency participation in bank-run pilots, which could effectively result in “safe spaces” for banks to test out new services and products for a limited period without being subject to the full brunt of regulatory requirements (but still making allowances for consumer protections). Notably, the CFPB also unveiled its own innovation proposal early last year, allowing companies to apply for “no-action” letters from the bureau that would make limited allowances for product testing.
While both policies are promising, they fall short of creating the full “sandbox” framework that many commenters have called for and which already exists in countries such as Singapore and the United Kingdom. Under such a framework, regulatory authorities would allow up and coming FinTech firms a little more leeway to test products and services without being constrained by every rule that would normally be applied to them. Once the company grows, it graduates out of the program. This approach would accomplish two purposes, advocates say: One, it prevents regulatory burden and uncertainty from stifling growth; and two, regulators may track the progress of their sandbox participants and use the information to fine-tune their own guidelines.
There’s a reason both the OCC and CFPB stopped just short of the sandbox idea: Without legislation allowing for the creation of such an environment, their hands are tied. Instead, the best they can do is dip a toe into the water with and pilot programs and policies such as those already proposed. With a Republican in the White House and the GOP controlling both houses of Congress, there is a possibility that the regulatory space might open up a bit, but not without heavy opposition from the other side of the aisle.
In the meantime, FinTech firms and companies that depend on their services will have to proceed as they have been in the last half-decade—with caution.
“The regulators have already taken action against a number of firms,” Levin warned. “Some firms just don’t know they’ve stepped foot in a regulated zone, and in the future they try to fix it and be compliant.
“But some members of the community, in effect ‘regulatory Luddites,’ are putting their heads in the sand and saying, ‘We don’t want to be regulated, we don’t think we should be regulated, we don’t think the law has anything to do with FinTech.’ Those firms are in for a very rude awakening.”
Tory Barringer is an experienced mortgage journalist and managing editor of Mortgage Compliance Magazine. He can be reached at TBarringer@MortgageComplianceMagazine.com.