Regulating Financial Services in an Era of Technological Disruption

Nicholas Morris – La Trobe LawTech, La Trobe Law School, Australia;

Sue Jaffer - La Trobe LawTech, La Trobe Law School, Australia;

Louis de Koker - La Trobe LawTech, La Trobe Law School, Australia

-- One of the greatest challenges faced by financial regulators in the 21st Century is the rate of change of technology. All regulated markets now face a bewildering array of technological “disruptors” – new ways of doing business which pose significant challenges for those who seek to regulate complex industries. In the financial industry, particular challenges include cryptocurrencies, high-frequency trading, and the provision of digital services, The danger is that those with superior knowledge, technology or market power, unchecked, will take advantage of the most vulnerable in society, gain a market stranglehold that undermines competition or destabilise financial markets.

Not only are regulators expected to prevent the criminal and unethical behaviour which may be facilitated by the new technologies, they also face a bewildering array of tools which are supposed to make their job easier. Often they do not have the budgets required to employ the necessary expertise, current rules are not necessarily sufficient or effective, and the political process of defining what actions they are permitted to take in the light of each new challenge can be painfully slow. Regulators that fail to respond in a timely manner may drive innovation offshore and deprive their markets and consumers of appropriate, new services.

Our recent article, "Regulating Financial Services in an Era of Technological Disruption," explores the way in which regulators have responded to this challenge worldwide, drawing on case studies of regulatory response to automated vehicles, emissions trading in China, and Uber and its clones. It notes that in many jurisdictions regulators have been establishing tools such as innovation hubs and regulatory sandboxes. Innovation hubs enable regulators to engage innovators more effectively. Sandboxes allow the products to be tested in a controlled environment and enable regulators to consider whether existing laws are appropriate to regulate such products and, if not, what further measures may be required. The provision of software and systems to support FinTech, RegTech and SupTech has become a major growth industry.

Sandboxing is an example of a ‘test-and-learn’ approach by regulators. This approach predates sandboxing in relation innovative financial services, as illustrated by the regulatory approach to mobile money services in Kenya in 2007. The Chinese approach to the introduction of emissions trading provides a good non-financial ‘test and learn’ example. The early involvement of regulators in these cases provided two-way benefits: regulators learnt from technical experts, but were also able to encourage innovation. The UK FCA’s innovation hubs are also generally regarded as having had beneficial effects. Other ‘sandbox like’ approaches have been found to be helpful, for example in Transport for London’s negotiations with Uber.

A challenge facing regulators is the rather sophisticated version of regulatory capture which hubs and sandboxes can facilitate. Under the guise of assisting regulators to acquire skills, unprincipled actors with greater knowledge and resources can potentially drive and capture the regulatory agenda.

Technological disruptors are a fact of life, and are emerging at a bewildering rate. Governments, legislators and regulators have to recognize both the benefits and the dangers of this trend and to create effective responses. This means that regulators need to be fully supported as they seek to understand each new technology, but they must do so with open eyes, recognizing that self-interest may well lead the commercial actors to be less than open when offering technical information.

Hub and sandbox design needs to take these dangers seriously, and ensure that there are sufficient checks and balances to the privilege afforded to industry participants.

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