The U.S. Treasury Department ("Treasury") recently released a report on the regulation of fintech firms and data aggregators. The report, A Financial System That Creates Economic Opportunities: Nonbank Financials, Fintech, and Innovation ("report"), includes 80 recommendations to Congress and regulators for promoting innovation in financial services. The report was written in response to President Trump's February 3, 2017, Executive Order 13722, Core Principles for Regulating the United States Financial System.
For fintechs, banks, and other stakeholders, the report builds on prior Treasury reports and provides insight into the federal government's plans for shaping the future of the non-bank financial services industry. Notably, however, the report avoids blockchain technologies and digital assets, which will be addressed separately through an interagency effort led by the Financial Stability Oversight Council.
We provide key takeaways and highlights from the report below, including an overview of emerging trends in the financial industry and a summary of the Treasury's recommendations.
Emerging Trends
The financial services industry, according to the Treasury, has changed significantly. In fact, the Treasury states that from 2010 to 2017, more than 3,330 new "technology-based firms serving the financial services industry have been founded," and "consumer data aggregators can serve more than 21 million customers." The change is attributed to several important trends, including (1) rapid technological advances; (2) increased efficiency resulting from the digitization of the economy; and (3) more available capital to facilitate innovation.
(1) Rapid Technological Advances: The report addresses the rapid technological advances occurring in the financial industry. For example:
- The development of new digital lending platforms has enabled greater access to credit and financial services, specifically to households with a lower net worth;
- The improvement in speed, convenience, and security, as well as the proliferation of mobile and person-to-person payment platforms, has increased the digitization of financial services; and
- The ability of financial providers, through technology, to charge less and reach a larger number of investors.
(2) Increased Efficiency from the Digitization of the Economy: The report discusses an increase in efficiency due to the digitization of the economy. For example:
- Advances in core computing and data storage capacity provide a new generation of design, marketing, and delivery of financial services to consumers; and
- Advances in data analytics and machine learning enable firms to analyze and utilize data more efficiently.
(3) More Available Capital to Facilitate Innovation: The report suggests that an increase in available capital has facilitated innovation, particularly in the United States. Worldwide, between 2010 and 2017, there was $117 billion in fintech investment, of which nearly half came from U.S. firms.
Recommendations
The report includes 80 recommendations, which are organized into several groups: (1) Embracing Digitization, Data, and Technology; (2) Aligning the Regulatory Framework to Promote Innovation; (3) Updating Activity-Specific Regulations; and (4) Enabling the Policy Environment.
(1) Embracing Digitization, Data, and Technology: The report proposes that regulators adopt an approach that embraces the aggregation, sharing, and use of consumer financial data, while also being mindful of data security and privacy concerns. These recommendations cover both general principles and industry-specific areas. For example, Treasury recommends:
- Congress enact a federal data security and breach notification law to protect consumers' financial data and notify consumers of a breach.
- The Consumer Financial Protection Bureau promulgate recommendations under the Fair Debt Collection Protections Act to codify that "reasonable digital communications" are suitable for debt collection; and
- Consumers have the ability to revoke their prior authorization, permitting data aggregators and fintech applications to access consumers' financial account and transaction data.
(2) Aligning the Regulatory Framework to Promote Innovation: The report recommends that the regulatory framework promote innovation and avoid unnecessary fragmentation. For example, Treasury recommends:
- Congress encourage greater uniformity among the states in lending and money transmission rules if, within three years, states are unable to achieve "meaningful harmonization" throughout their licensing and supervisory regimes. To date, the Conference of State Bank Supervisors has promoted a number of efforts in this area, including a revamp of the Nationwide Mortgage Licensing System as part of its Vision 2020 effort and limited money transmission licensing reciprocity efforts among some states. However, full harmonization of licensing and examination standards among states is still a long way off; and
- Federal banking regulators review and harmonize their third-party service provider guidance through a notice and comment process, with particular emphasis on (1) refining the current tailoring and scope of their guidance and (2) facilitating safe and prudent innovation. The federal banking regulators have published differing guidance on relationships between depository institutions, technology vendors, and other service providers, increasing friction for technology vendors that serve banks with different regulators.
(3) Updating Activity-Specific Regulations: The report encourages regulators to update activity-specific regulations relevant to the services and products offered by nonbank financial institutions to account for outdated technological advances. For example, Treasury recommends:
- Congress codify the "valid when made" doctrine and clarify that a service or economic relationship between a bank and a third party, such as a fintech company, does not affect the bank's role as the true lender of the bank's loan. These recommendations are designed to address issues related to the Second Circuit's decision in Madden v. Midland and the legitimacy of bank-partner origination models; and
- Federal and state financial regulators enable sustainable and responsible, short-term, small-dollar lending installments.
(4) Enabling the Policy Environment: The report suggests that regulations enable experimentation, improve efficiency, and promote America's interests abroad. For example, Treasury recommends:
- Federal and state financial regulators create a unified solution, called a "regulatory sandbox," to permit the meaningful experimentation of innovative products, services, and processes. This is a process that has already begun in some states, such as Arizona, which has set up a dedicated sandbox program for fintech firms; and
- Financial regulators periodically review, in a cost-effective manner, current regulations as new, innovative technology emerges, to determine whether such regulations achieve their original purpose.
Conclusions
The Treasury report underscores what the fintech industry has said for years – the regulatory landscape is fragmented and presents significant challenges for startups and other innovative companies. These challenges come in various forms, whether differences in federal and state regulatory requirements, the unique requirements of bank partnerships, or the introduction of new products and services that do not fit squarely within existing regulator frameworks. The Treasury report, however, demonstrates that policymakers understand these issues, and suggests that changes may be on the horizon.
If you have any questions or concerns regarding fintech regulations or consumer financial services generally, please contact the Venable team.