TORONTO (Thomson Reuters Regulatory Intelligence) - Financial regulators in Canada are rolling out the welcome mat for financial technology firms, or “fintechs.” Recognizing the need to shift its regulatory focus to accommodate the use of advanced technology in the delivery of financial services, the Ontario Securities Commission (OSC) has launched initiatives aimed at providing compliance advice and flexible regulatory requirements for fintechs.
The OSC’s action coincide with wider interest globally in exploring how fintech intersects with securities market regulation, particularly in the areas of automated advice and peer-to-peer lending. Other fintech applications with regulatory implications include the use of distribution ledger technologies such as blockchain in payment transactions. Fintech has a wide range of applications in the financial services sector, spanning from clearing and settlement to algorithmic asset management.
In October 2016, the OSC started OSC LaunchPad to provide compliance advice and other support to fintech startups. The LaunchPad is staffed with representatives of regulator’s branches, including Compliance & Registrant Regulation, Corporate Finance, Derivatives, Investment Funds & Structured Products, Market Regulation and Strategy & Operations.
The OSC Launchpad initiative provides some flexibility in regulatory compliance for fintechs with the aim of making it easier for startups to innovate. The types of relief or support available through the OSC LaunchPad include informal guidance on regulatory compliance matters from OSC staff and, on a case-by-case basis, eligibility for time-limited registration or exemptive relief. At the same time the OSC has stated (here) that it will continue to scrutinize fintechs for potential investor protection risks.
In January 2017, the OSC announced the formation of the Fintech Advisory Committee, which will advise the regulator on fintech-related developments as well as regulatory challenges faced by businesses in this sector. Input from the committee will be used by OSC to guide future regulatory reform.
While the OSC is the first provincial securities regulator to undertake formal fintech initiatives, other provinces and territories have begun to recognize a need for more flexibility in overseeing fintechs. When Lending Loop, a peer-to-peer lending platform, began in Canada in 2015, it had to obtain approval from provincial securities regulators for a prospectus and comply with other securities-related regulatory requirements. The Toronto-based company subsequently paused its operations and re-launched in late 2016 under an exempt market dealer license (here) that was granted by the OSC. Recognized by other provincial regulators, the license allows Lending Loop to connect small businesses with individual lenders across Canada, except in the province of Québec.
Recognizing a need to be competitive with fintech startups, many of Canada’s traditional financial institutions have looked to develop their own financial technology in-house, through organic growth as well as direct acquisitions.
In recent years, major Canadian banks such as the Royal Bank of Canada (RBC), Toronto-Dominion Bank (TD Bank), Canadian Imperial Commerce Bank (CIBC) and the Bank of Nova Scotia have all launched a variety of fintech research and development projects. Blockchain technology, big data, automated advice and payments services are some of the areas where banks have invested resources.
The rising popularity of robo-advisers that provide investors with automated financial advice in jurisdictions such as the United States has also been noticed in Canada, particularly by wealth managers and integrated firms. However, current regulations require financial advisers, as individuals and firms, to register with securities regulators and self-regulatory organizations in order to provide financial advice to investors. As a result, robo-advisors operating in Canada have had to develop a hybrid of automated advice and the input of licensed financial advisers.
Last year, the Bank of Montreal (BMO) launched SmartFolio, a robo-advisory that provides portfolio management services. The portfolio is managed by a small team of BMO investment managers, with the assistance of fintech.
Beyond Canada, financial regulators in other jurisdictions are also considering more customized regulatory options for fintechs. In the United Kingdom, the UK Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) have moved towards streamlining requirements and lowering initial minimum capital and liquidity requirements for banking licenses in recent years. The policy changes, which are not limited to fintech applicants, have nonetheless encouraged a number of digital banks, peer-to-peer lenders and other fintechs to apply for banking licenses to serve the UK market.
In the United States, the Office of the Comptroller of the Currency (OCC), which grants national banking charters, announced in December 2016 that it would consider fintech charter applications under special purpose banking licenses.
FINANCIAL REGULATORS KEEP SYSTEMIC RISK, INVESTOR PROTECTION IN MIND
Financial regulators around the world are paying close attention to the growing popularity of fintech startups with investors and retail banking customers. At the same time, traditional financial institutions have also moved to incorporate financial technology into their business lines to create efficiency and new products.
While regulators recognize the need to offer flexibility and in some cases, reduced compliance burdens for fintechs, concern over systemic risk and investor protection are important considerations in many jurisdictions.
Bank of England Governor Mark Carney recently noted that the growing participation of fintechs in payment services and retail banking could pose stability and liquidity risks to the financial system if left unchecked by regulators. Carney recommended that regulators keep in mind that fintechs can pose systemic risks, and that appropriate regulatory safeguards aimed at managing that risk should apply to startups and established institutions alike.
Aside from systemic risk, investor protection concerns weigh heavily on the regulatory consideration of fintech, particularly the growing popularity of automated advice. The International Organization of Securities Commissions (IOSCO) recently updated a report (PDF) on the use of automated advice tools by financial institutions and retail investors, based on results of a survey that was conducted in 2016.
The survey revealed that the demand and regulatory response for automated advice is growing at a rapid pace around the world. Some of the regulatory concerns identified by IOSCO included whether firms have the ability to track whether automated advice given to clients is general in nature or involves a specific recommendation. The latter, in many jurisdictions, requires firms to demonstrate compliance with Know-Your-Customer, suitability and other regulatory requirements. IOSCO also expressed concern over whether advice tools that provide holistic financial planning meet the relevant fiduciary and other regulatory requirements in the jurisdictions in which they operate.
Fintechs are slowly being welcomed into Canada, amid growing popularity in other jurisdictions. However, startups should bear in mind that they will still be subject to regulatory compliance obligations, depending on the type of financial services they are offering. In Canada, fintechs may also be subject to differential regulation and licensing requirements, depending on which province they operate in.
As a result, fintechs in Canada must evaluate regulatory compliance obligations as an integral part of their business plans. Financial institutions that are considering investments in fintech or acquisitions of startups should ensure that compliance functions have the adequate skills to evaluate regulatory risks of potential targets.
Companies should take advantage of regulatory outreach initiatives such as the OSC Launchpad to ensure that they have the adequate internal controls and processes in place, in addition to any registration or licenses required before beginning operations. The informal guidance offered by programs such as the OSC LaunchPad can further serve as an opportunity for fintechs to obtain customized compliance advice for prototype technologies and test runs for new products.
OSC Fintech Advisory Committee announcement:here
OCC announces fintech charter applications:here
Mark Carney speech (Fintech):here
IOSCO fintech research report:here
(Helen Chan is a regulatory intelligence and e-learning expert in the Enterprise Risk Management division of Thomson Reuters Regulatory Intelligence. Email Helen at firstname.lastname@example.org)
This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Feb. 21. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters