Can regulators and Fintech find the right formula for innovation?

by James · July 29, 2022

A pair of sessions held during the LendIt Fintech USA conference in New York offered some prospects for finding ways for regulators and fintech advocates to co-exist and clear the way for innovation.

The attention fintech, from decentralized finance to cryptocurrency, is getting from the public these days can only be matched by the scrutiny of regulators who see a need to establish policies for this new frontier. Whether it’s with startups or established financial institutions adopting new approaches to handling and investing money, new layers of regulation are likely inevitable.

A fireside chat with the New York Department of Financial Services and a separate panel of stakeholders on reimagining fintech regulations provided glimpses of ongoing discussions with regulators. It’s not just that there are new forms of currency – there are different dynamics at play in transactions, ownership, chain of custody, accountability and how digital assets are valued.

For example, a murky tug-of-war is underway over Bored Ape NFTs stolen from comedian and actor Seth Green – NFTs he had planned to feature in a new TV show he was creating. Green has been looking for legal means to regain control of the NFTs, apparently taken by phishing scammers and then sold to a third party. The problem for Green is that there appears to be no clear legal precedence for seeking immediate redress. That’s just one type of new problem that financial regulators may have to weigh in the digital space.

Michele Alt, partner and co-founder of Klaros Group, moderated a panel that brought together Custodia Bank, the American Fintech Council and Figure Technologies to discuss “Reimagining Fintech Regulation to Foster Innovation.” That said, regulation and innovation often seem mutually exclusive, especially after the recent cryptocurrency crash drew calls for regulation, but there may be ways to navigate the needs of each side.

Yana Miles, general counsel and senior vice president, head of regulatory affairs at the American Fintech Council, said her organization supports regulations that do not eliminate positive aspects of this growing sector. “We want the regulations to be reasonable,” she said. “We believe in following the law.” Miles acknowledged the challenges regulators face in catching predatory actors seeking to exploit public interest in fintech. She also saw a need for patience given the pressure regulators received for not catching the latest subprime crisis before it went national.

Miles said innovative lending in fintech offers a number of benefits to the public, such as playing a role in sustainable access to credit that can be important in addressing the wealth gap and underserved communities – which often do not have access to brick and mortar banking systems. Finding ways to work with regulators, she said, could lead to adjusted policies that work with existing business models. “We don’t say, ‘Don’t have regs,'” Miles said. “We want bills. We want the bad actors out. We want the illegal behavior out, but let’s do this in a way that doesn’t inadvertently cut people out.”

“It’s a very choppy time from a regulatory perspective,” said Ashley Harris, general counsel at Figure Technologies. “The collapse of Terra and now falling crypto market highlights that.” She said regulators are trying to catch up as banks try to lean into this space. The USDF Consortium, which Ashley Harris is involved with, is looking for a measured way for banks to get involved in the crypto ecosystem and create an alternative to stablecoins that are bank-branded and represent deposits, she said. “In our view, it’s the safest and most stable way for anyone to trade on the blockchain.”

The mercurial changes in the crypto ecosystem have introduced challenges from a regulatory perspective, Ashley Harris said, because regulators are in learning mode. “Every time something happens with crypto, there’s a pause and there’s kind of a reset,” she said. The fall of crypto markets prompted Acting Comptroller of the Currency Michael Hsu to signal caution, Ashley Harris said.

“Then at the same time we have things like the Biden order that says it’s very important for the United States to have a strong, highly regulated crypto market because it’s important to national security and competitiveness,” she said, further describing the competitive tensions that fintech has . stakeholders must navigate. Ashley Harris also described it as an opportunity to educate regulators and bridge the knowledge gap.

There are differences between federal and state regulators, said Caitlin Long, CEO and founder of Custodia Bank, in terms of action and goals. While state regulators tend to have economic development in their respective mission statements, that may not be true at the national level, she said. “Federal regulators all have an incentive to stop everything, and state regulators actually have an incentive to work on new things.”

Adrienne Harris, Superintendent, New York State Department of Financial Services

Credit: Joao-Pierre S. Ruth

Superintendent Adrienne Harris offered her vision for the role the New York State Department of Financial Services can play in fintech innovation, speaking in a fireside chat with Garry Reeder, executive director of the American Fintech Council.

“Given the changes we’ve seen in the industry, given the changes we’re seeing post-pandemic in a macroeconomic context, it’s given me a broad perspective to think about,” Adrienne Harris said. “How do you build a transparent, robust, fair financial system through the lens of a forward-looking, data-driven model?”

Reeder asked for perspective on New York’s history as a virtual currency regulator in light of the volatility seen in the past month in this space. Adrienne Harris said DFS established a strict framework with similar anti-money laundering and cyber security standards as banks. For example, DFS requires each stablecoin to include cash equivalents on the reserve, third-party attestation of the reserves, and other measures. “The standards are incredibly high,” Adrienne Harris said.

Historically, she said, it has taken a very long time for some new fintech players to be cleared through New York’s approval process. “We’ve done a lot of work to increase efficiency in the licensing process without sacrificing regulatory rigor that the state requires,” she said.

Adrienne Harris said her department is also working closely with and lending its experience to federal and international regulators who are now beginning to look at these areas.

Reeder asked what role fintech can play in mitigating climate change risk as it intersects with financial services. Adrienne Harris said DFS has already established climate guidance for insurance companies and is in the process of doing the same for banks and mortgages. “We’re really focused on risk communication and governance,” she said. “This is really about data, safety and soundness, consumer protection.”

The role banks can play in climate change can affect certain demographics that can face the brunt of ecological problems. “We know that low- and moderate-income communities and communities of color are disproportionately affected by climate change,” said Adrienne Harris. This may be in addition to the fact that the financial institutions do not have it. “We’ve really gone to great lengths to say that as part of this guidance, you can’t abdicate your responsibility for fair lending and equal access to credit and a fair financial system in service of your climate goals.”