Is Fintech Regulation The New Square Peg?

By Mike Baliman on Wednesday 26 August 2015

There is a vitally important debate to be had about about regulation and innovation.

One which so far has been over-looked.

The conventional narrative is that regulation is helpful to Fintech. 

And, up to a point, it has been. After all, real Alternative Finance is in the business of FS, and FS is about trust and FS can lose folks money via incompetence or fraud. 

So some regulation is a good thing.

But are we reaching a tipping point?

Is regulation actually light touch?

Is it getting heavier touch? Will it get “ever-heavier touch”? If not what will stop it?

Is Fintech regulation fostering or inhibiting regulation?

Regulation, Law and Fintech

In the latest London Fintech Podcast I discuss the new legal challenges posed by Fintech and Alternative Finance with Jon Segal, lead Fintech lawyer at Fox Williams.

The challenges fall into three main categories:

  1. rapidly scaling firms“legal debt”  (cf “tech debt”) – fast-growing firms are always in catch-up mode (by definition);
  2. innovative structures – it is generally overlooked that legal agreements are just words on a page … you might say they are like computer code which one day might be run on a CPU (“a court”) – at which point you find out how many bugs your code had. Until then it’s literally un-tested, and un-precedented (sic)
  3. regulation – under the guise of “consumer protection” - no caveat emptor these days - you can’t treat the populus as grown-ups. 

Is Regulation Actually Light Touch?

The “to the cameras” narrative is all about “light touch regulation” [well you wouldn’t say the opposite would you if you are (as most are right now) in the process of wanting to get that regulatory tick].

Off-stage conversations with many key players in the Alternative Finance space are that it is not light touch.

It’s somewhat burdensome, arguably disproportionate, and definitely time (and resource) consuming.

Now if this was a one-off it might just be one of life’s grumbles. Kind of hassle in the cloakroom before you are free to play the game.

But it’s more than this. There are three areas of concern:

  1. what forces encourage and what forces inhibit the regulatory burden’s weight increasing?
  2. what is the impact of this regulatory burden on innovation?
  3. what impact does the structure of regulation have on innovation?

Who Controls The Weight of the Regulatory Burden?

For avoidance of doubt I am not blaming regulators as people at all – they have a one-way risk – things go right and the firms get the credit, things go wrong and the regulator gets the blame … so who wouldn’t over-control in those circs? 

Rather it’s the global regulatory game they are in that has gone badly Pete Tong.

As I wrote in “4 Vital Lessons For Alternative Finance From What Went Wrong With FS Risk” “FS Regulation – Adam Smith to Joseph Stalin” the regulation game has shifted over the past 30 years from regulation of structure [pre-Big Bang] through regulation of competition [Basle I] to regulation of minutiae [post ’08].

It’s this third type of regulation which is so pernicious – you can’t really over-regulate too much in the first two cases.

In the third though you can regulate without limit and it’s a never ending ratchet (ask any bank).

Unlike in aircraft regulation where the “weight” (sic lol) of regulation is constrained by the need for the plane to actually get off the ground there is no such restriction on FS regulation.

As economic historian Niall Ferguson has said (about FS regulation) excessively complex regulation is the disease of which it purports to be the cure.

What Impact Does The Regulatory Burden Have On Innovation?

Let’s say you have a great new idea. Something that will topple the new incumbents.

Well you really need to have some dough dude. It will cost you more than a pretty penny  to tick all those boxes and get state approval to play in the game.

Ironically the former young turk innovators are now incumbents in the FS space and are protected by barriers to entry. 

And so the same cycle that has led banking to be so protected (and ultimately so poor) starts again. 

Fine if you are in the game. Not fine if you are not (or if you are a consumer (and who isn’t?)).

What Impact Does the Structure Of Regulation Have On Innovation?

A vital point that Jon discusses on the podcast is how regulation becomes in essence “the new Square Peg”.

If you are really innovative you are not going to be a “me-too”. You are not going to be copying the current incumbents.

So, metaphorically speaking, you come up with a triangular peg – your great innovation.

But then you face the challenge that, say, regulation only permits square pegs and round pegs.

You ain’t gonna’ fit in those holes.

But – Catch-22 – you need regulatory approval.

So either you get some new regulation for yourself …

Ha! Good Luck! (and you better start raising some real money and have plenty of time if you need to change the system).

…or … you knock the corners off your triangle and become more square-like or more circle-like. 

At which point you aren’t very innovative after all.

Regulation is always like a sieve and a sieve always lets some things through and rejects others. It always has a certain mesh shape and size.

Regulatory Wrap

Alternative Finance regulation in the UK is not actually light-touch.  Furthermore we can expect it to get “heavier-touch” (wait until there is a blow-up…). I cannot think of any precedent for regulation (or the law as a whole) getting lighter over time.  And in FS quite the opposite precedent is clear.

The cost of regulatory approval is a barrier to entry for new players which serves to protect incumbents.

The structure of regulation has already become a new square peg which discourages innovation.

All of the above have applied for a couple of decades in #oldFS and now apply in #newFS.

Plus ça change, plus c'est la même chose?

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