As Asia-Pacific (APAC) embraces FinTech, new challenges are emerging for its traditional financial services institutions.
Not least the question of how to innovate while maintaining compliance with the types of regulations that different governments will set across the region. APAC's respective governments know that FinTech has the potential to deliver economic benefits by lowering the cost of operations and enhancing competition. They also appreciate the potential societal benefits FinTech can bring by boosting financial inclusion and delivering more convenient financial services.
To accommodate the unprecedented pace of digital change in the region, financial regulators are considering paths to "optimal regulation" - i.e. creating an environment that encourages FinTech providers to harness emerging technologies without weakening the financial system or eroding consumer protections.
This is where regulatory sandboxes come in, because they can encourage innovation while ensuring security and stability for organizations, customers and governments.
The challenges FinTech poses for regulators
The FinTech revolution is still in its first decade, but it has already influenced financial services on a global scale. According to the most recent EY FinTech Adoption Index, an average of 33% of digitally active consumers make use of FinTech products and services. Of the 20 countries surveyed, China and India are leading, with 69% and 52% FinTech adoption respectively.
FinTech's rise poses serious new regulatory dilemmas around a range of technologies. Crowd-funding is a useful example of this: if a private company wishes to raise money from the general public via crowd-funding, what level of disclosure should it follow?
On the one hand, if a high level of disclosure is required, the cost of independent assessment may mean that crowd-funding no longer offers an attractive means of raising capital. On the other hand, if the disclosure requirement is low, how will regulations protect investors who may not be able to fully assess the risks of these early-stage companies?
A second example of FinTech's complex regulatory implications can be found in robo-advisory services. Unlike conventional financial advice, robo-advisory services rely on algorithms and portfolio management to analyze investor data and automatically recommend investment portfolios. With this high level of automation that is detached from human oversight, how can regulators be sure that the computer-generated asset allocation models are accurate, and can handle extreme "black swan" events? Furthermore, will the information that clients provide on their risk tolerance and level of income be sufficiently precise to generate suitable advice?
Thirdly, there is concern that regulation can hamper FinTech's potential. For example, banks can give third-party financial service providers access to their customers' accounts - with the clients' permission - through application programing interfaces (APIs) or data sharing. The richer the data that banks provide to these third parties, the more helpful the solutions they can offer. Third-party service providers can then tailor their recommendations based on users' saving patterns and offer attractive interest rates based on historical transaction history. However, this may contradict or contravene existing regulation in regard to data privacy and sharing.
Despite the wide range of economic development and regulatory regimes across APAC, all jurisdictions are striving to strike the right balance between innovation and regulation. Regulatory sandboxes are emerging as a solution to this common problem.
A safe space for innovation
Regulatory sandboxes provide an environment of reduced regulatory constraints on innovative financial products and services. They enable financial services innovators - both incumbents and startups - to test new products and services in a "safe area", providing greater flexibility or even exemptions from existing regulation.
Sandboxes can be highly valuable to financial services institutions in three important ways:
- They reduce the time and cost of getting innovation to market.
- They provide innovators with greater access to finance by reducing risks of client adoption and increasing returns on capital investment.
- They enable innovators to work with regulators to ensure new development of technologies and business models aligns with regulations.
Regulatory Sandboxes typically function in four phases - Application, Preparation, Experimentation and Validation. These are illustrated in figure 1.