Overcoming Challenges to International Regulatory Cooperation on Fintech
Yesha Yadav - Vanderbilt Law School
-- The international tussle over the fate of TikTok – the popular video-sharing app – underscores the regulatory stakes involved in the cross-border consumption of sensitive consumer data and the powerful algorithms that mine it for insights. Owned by the Chinese-company Bytedance, TikTok’s algorithm has attracted the ire of U.S. authorities that have sought to ban its use in the U.S. Short of a ban, the U.S. has pushed to have TikTok’s U.S. operations (and algorithm) come to rest in the hands of American companies, citing national security concerns. The TikTok ban appears to be an opening salvo in a global tug-of-war over the regulation of popular super-apps that combine social media, e-commerce and consumer financial services (e.g. payments). Looking forward, as Facebook looks to launch its worldwide payments network, capable of tapping into the data of billions, uncoordinated, tit-for-tat wrangling by domestic regulators risks bringing a chaotic approach to the oversight of cross-border digital technologies for social media and the fintech that commonly accompanies it.
As Chris Brummer and I have written in, Fintech and the Innovation Trilemma, policymakers face a trilemma when seeking to balance the objectives of preserving market integrity, promoting financial innovation and doing so using clear rulemaking. In trying to achieve these three goals, we argue that regulators can achieve only two of them. For example, when protecting market integrity using clearly drafted rules (e.g. simple bans of financial activities), regulators will struggle to promote innovation. Alternatively, by encouraging innovation through simple rules (e.g. broad permissions), regulators can imperil market integrity. Finally, trying to achieve both market integrity alongside financial innovation will likely require a complex set of rules, undermining clarity in crafting regulation.
Fintech poses special difficulties for the trilemma. Sophisticated algorithms that undergird the new financial technologies – often boasting cutting-edge, “black box” artificial intelligence – pose informational challenges for regulators. Ironically, the enormous volumes of digital data that fintech algorithms need and produce, can fail to fill these information gaps. New kinds of data commonly harnessed in fintech products (e.g. online lending) – like insights gleaned from a consumer’s social media use, geolocation, contacts or online shopping habits – are new and lack a proven track record of forecasting risks (e.g. will the borrower default on their debt?). Finally, while regulators have confronted new risks and complex types of data in the past, fintech brings a diverse mix of firms to markets. In addition to banks and investment firms, the fintech ecosystem is populated by non-traditional groupings of tech specialists, social media firms, start-ups or e-commerce companies. This complicates the decision of how to regulate firms that can lack regulatory compliance experience and possess fewer resources than financial firms.
As argued in my recent paper, Fintech and International Financial Regulation, the task of applying the trilemma to cross-border fintech is even thornier. At first glance, this state of affairs should look more optimistic. Post-2008, international financial regulation (IFR) has flourished through a system of oversight comprising standard-setting bodies like the Basel Committee on Banking Regulation as well as surveillance thought the International Monetary Fund and the World Bank.
But the cross-border regulation of fintech poses new challenges. First, rulemaking must overcome the difficulty of being compatible with a range of national domestic legal environments and administrative processes. The need for international standards to be drafted in a way allows them to be absorbed into local legal systems makes achieving rules clarity more elusive. It also increases negotiation costs between domestic regulators.
Secondly, fintech has risen to meet real economic needs within markets that have not been historically well-served by traditional financial firms. In China, for example, WeChat Pay and AliPay have grown to offer a range of digital payments and financial services. The Ant Group’s AliPay, boasting over a billion active users, provided digital payments in 2019 equal to around $16 trillion, 25 times more than PayPal. In addition, the Ant Group is a provider of credit to consumers and businesses, claiming to use around 3000 variables in its three-minute automated decisions of whether to extend a loan. With this foothold within the Chinese economy, fintech has responded to consumer need for financial services and products. By contrast, in countries with historically more developed banking systems, consumers might already be well-served by conventional financial firms, slowing their switch to fintech. These differences mean that countries face varying economic (and political costs) for imposing compliance burdens on fintech firms. Where fintech services meet local economic needs, regulators may be wary of imposing regulatory burdens on their operation. In short, countries with the deepest entanglement with fintech may be the most reluctant to engage in international standard-setting and surveillance.
Thirdly, standard-setting by global regulators must account for structural differences in the make-up of domestic financial markets, which may be in various stages of disentangling from traditional financial intermediaries. Where fintech firms are displacing banks and investment banks, regulators have to consider the impact of rulemaking on a large spectrum of non-traditional firms, including smaller start-ups, tech specialists or social media firms. This adds complexity to the task of rulemaking and may discourage domestic regulators of less banking-oriented systems from engaging in international rulemaking that places a higher relative cost on non-traditional firms over more conventional financial ones.
In concluding, the Article outlines pathways to foster international regulatory cooperation for fintech. With fintech growing in prominence and becoming a more fundamental part of domestic and cross-border financial systems, the ability of international policymakers to respond constitutes a decisive existential challenge for the post-2008 financial regulatory order.