Fintech Regulation: Achieving the right balance to foster innovation

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Financial Post | Special 'Op Ed' Post, Dinaro Ly | June 4, 2017

For nine months last year, executives of Lending Loop, which describes itself as Canada’s first peer-to-peer lending market, voluntarily put the company’s ambitious growth plan on pause to spend some quality time with securities regulators. As CEO Cato Pastoll recounts, the unusual interregnum was all about figuring out how the firm could operate within a regulatory system that doesn’t really know what to do with fintech firms like his.

“The Canadian regulator’s approach is to say, `Let’s stop anything from happening until we’re 100% okay [with the business offering].’” While Lending Loop emerged from the process and is now operating, Pastoll’s frustration is evident. “You can limit everything by being super prescriptive, but if you’re not innovative, everyone’s going to fly by you.”

Lending Loop is hardly alone. Canadian banking and securities regulators, as well as innovation and competition policy-makers, have been cautiously moving ahead with the task of developing new rules for a group of startups that have little in common with the giant banking and investment entities regulated by provincial securities commissions, federal banking regulators and other agencies.

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Some agencies, such as the Ontario Securities Commission’s LaunchPad program, have sought to test more flexible approaches to rules, such as intensive financial reporting requirements that currently apply to relatively modest fundraising programs. “The regulator has to have the capacity to be able to help,” says Adam Spence, Associate Director, Venture & Capital Programs at the MaRS Centre for Impact Investing. “What LaunchPad is doing with intermediaries looking to expand into these new regulatory environments is key.”

In Canada, most current rules reflect more traditional ways of lending, borrowing, underwriting and selling, as well as the overlay of more recent banking regulations designed to short-circuit financial fraud. As Pastoll says, existing anti-money-laundering and know-your-customer (KYC) rules were built for an era of face-to-face contact with customers, which is not applicable with fintech offerings.

A May 2017 report on fintech regulation by the federal Competition Bureau echoes this sentiment, pointing to a “disconnect” between the expressions of enthusiasm for new fintech solutions by regulatory bodies and the rigidity of their staff tasked with the day-to-day enforcement of the rules.

“Regulation should be done in a way that encourages and enables innovative startups to offer better solutions in the marketplace,” says Dave Feller, CEO of fintech Mogo, adding that the high cost of regulation for new entrants effectively serves to protect incumbents and prevent consumers from accessing cheaper and more flexible financial services.

A case in point: when the U.K. banned embedded commissions for wealth advisors three years ago, about a quarter of the established players pulled out, leaving an opportunity for upstart “robo-advisor” firms that offer discount services at a fraction of the fee. (The Canadian Securities Administrators have taken note, and recently released a discussion paper on discontinuing embedded commissions.)

A key source of friction about the evolution of regulation has to do with the legacy of the 2008 financial crisis. Unlike many western countries, Canada didn’t experience bank collapses and its financial services regulation and oversight system was widely praised internationally. As Pastoll says, that success “has been an excuse for the last nine years as to why things are the way they are.”

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

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