How Can Regulations Boost Technology Development in Financing?Mon, 04/01/2019 - 09:53
Although Mexican banks have long portrayed themselves as innovators, fintech companies spurred a race in the digital innovation arena and opened the door to new financial regulation aimed at leveling the playing field between traditional financial institutions and digitally-native players. However, new regulations can pose a problem for innovators and entrepreneurs by setting a too-rigid framework that may halt innovation by constraining new activities or setting up sky-high costs for new business ventures. The challenge that authorities and the financial ecosystem face is finding an adequate balance that protects consumers and encourages innovation.
Fintech can become a provider of technology to the sector, including to stock exchanges. The important thing is to first have a strong primary legislation, which was already published. I think this will allow fintech companies to grow in an orderly and uniform way, so no incident happens that may smear the name of the rest of the industry. The aim of the fintech regulation is to add value. Fintech sounds very nice but obtaining the financing for it is not so simple, so we have been talking with those companies that want to obtain funding to grow through the BMV. We are having the same conversation with various sectors which do not have access to financing or that find it difficult to find it. One such sector is Sofomes in Mexico. We have an agreement with ASOFOM and we have been able to help many Sofomes, small and large alike, to access funding through the BMV in the capital and debt markets.
All regulations and laws impose restrictions and limits, but these should exist for the right reason. For the Fintech Act, regulators scrutinized laws from around the world and tried to incorporate the best regulations and practices they saw in other countries. The authorities also created the idea of a sandbox that allows fintech companies that are not covered by the main regulation to operate in a controlled environment with a limited number of users. This provides the space for new ideas to be explored and to be evaluated by the regulator. Regulators are leaving open this sandbox environment so innovation can continue. I do not think the innovation experienced by the sector, nor its speed, will be limited. Moreover, the authority will provide the space for innovation. Companies will have somewhere to reach customers and improve accessibility to services and products.
The Fintech Act is positive because it promotes four fundamental pillars: consumer protection, minimum operation standards, certainty for companies and investors and financial inclusion. It is a very general law that promotes flexibility, which means that changing industry conditions will only imply changes in secondary regulation thus avoiding a legislative process. However, I believe there is a risk that the law will not be as permissive as it should be with smaller players, which could halt innovation in the country. Part of our proposal is that regulation should be proportional to the operational level of every company. When it comes to regulation, you have a clear trade off: the level of innovation you want to foster versus the level of risk you want these companies to take on.
When it comes to fintech, the ecosystem is diverse. To define secondary regulations, authorities have sat with different players and associations, which has been fairly positive. We would like to see an environment that fosters the creation of more fintech companies and that allows existing companies to do what they are already doing. Players should continue growing and filling the market niches that had been neglected by traditional financial institutions. The road toward regulation has been collaborative and we want it to generate growth in the sector and at the same time foster financial inclusion.
It is a good thing that we are being regulated. You have to do things right and you cannot have that many companies in limbo. However, it worries us that the law has several requirements that for entrepreneurs are hard to comply with. We expect the CNBV to fix this through the secondary legislation. It would be ideal to have a regulatory sandbox with very basic regulations for startups and once they have grown enough, to subject them to more regulation. This would be particularly beneficial for companies that have a strong risk component, such as crowdfunding or loans.
It is very important to pay attention to detail. One of the things that needs to be carefully considered is the amount of money that regulators will ask fintech companies to withhold in their financial statements. That amount will be determined by the CNBV and will depend on the size of the fintech company, its number of clients and operations. The risk involved here is that probably the minimum threshold required by regulators may be too high for startups. However, the Fintech Act has some good points. For instance, it will force fintech companies to strengthen their KYC processes and have all their clients’ funds divided, meaning the money belonging to each client must be clearly separated from the funds of other clients, identified and made susceptible to audit by a third party.
CNBV, Banxico, CONDUSEF and the Ministry of Finance and Public Credit are in charge of the secondary rules. With these rules, there are two important things to consider. Some must be applied regardless of whether we are banks, SOFIPOS or fintech companies, such as those related to the prevention of money laundering or rights of clients and users. However, the regulation also states that the complexity of the activity and the size of companies will determine the required regulation. It all depends on how the law is applied. If a company is very small, then it should not be asked to make regulatory reports as if it were a big company because the systemic risk is lower. This generates fewer operational costs.
Having an ideal law is very hard. However, what the Fintech Act should definitely have is absolute clarity, regardless if the sector is heavily regulated or not. One of the things that has impacted financial institutions the most is that there is a lot of room for interpretation. Compliance officers have different perspectives, there are different rules within banks and it depends greatly on who interprets the regulation. In the US, law interpretation also varies widely, which complicates relationships with financial entities outside Mexico. An ideal law would find a middle ground between being too strict and too permissive and would be absolutely clear with no room for interpretation.