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What is the general approach of the financial market regulator or regulators in relation to Fintech?

June 2019 - Banking and Finance. Legal Developments by IR Global.

More articles by this firm.

The following article discusses session three in the IR Global Virtual Series on 'A Fintech Paradigm - The Changing Face of Financial Services'

Luxembourg – MTA The general approach to Fintech regulation of the Commission de Surveillance du Secteur Financier, the Luxembourg financial market authority (the ‘CSSF’), is predominantly reactive.

For example, the CSSF issued warnings on 14 March 2018, on initial coin offerings (ICOs) and virtual currencies, following statements from ESMA, IOSCO and other organisations. At present, the CSSF has not taken a formal stance on the regulatory treatment of ICOs or issued any specific guidance to aid the self-assessment by companies contemplating an ICO.

In some matters, the CSSF has taken a proactive stance. For example, the regulator issued a Frequently Asked Questions (FAQ) in respect of AMLF/CFT and IT requirements for specific customer on-boarding/KYC methods, which provide guidance on customer identification through video chat. It has also granted payment service provider licenses to two virtual currencies exchanges (BitFlyer and Bitstamp).

To our knowledge, the CSSF does not use innovation spaces or sandboxes. At the same time, the CSSF engages in a dialogue with the industry through speeches and conferences in which it positions itself as a flexible and business-minded regulator.

We see a need for more regulatory action to enable the Fintech ecosystem. Such action does not necessarily imply more rules. Financial services regulation is fairly comprehensive and Fintech products and services are already subject to the existing rules. We would welcome regulatory guidance as to the application of the existing regulatory regimes. Such guidance should also consider the use of artificial intelligence, of large-scale data collection and monetisation, and of automation by Fintech firms. Similarly, we do not see the need to introduce a general Fintech license, since it would introduce regulatory complexity and prevent a level playing field for all actors. Alternatively, to stimulate start-up and SME activity in the Fintech space, evidence-based exemptions to existing rules could be introduced.

Switzerland – HK The Swiss Financial Market Supervisory Authority (FINMA) tries to take a positive stance in relation to Fintechs and their potential, responding to considerable pressure from the political system. It has a Fintech desk and has issued guidance and various recommendations in order to clarify if and how regulations apply. It is also possible to submit a project to FINMA in order to obtain a no-action letter.

There is a broad consensus that regulation of financial services is needed, and that further clarification is necessary. It is becoming increasingly clear, however, that it will be difficult to accommodate all the risks presented by Fintech startups within the confines of the traditional regulatory system. A more flexible, case by case approach from FINMA, would be warranted. Moreover, the recent ICO boom has resulted in a heavy workload for the Fintech desk and delays in answering requests from start-ups.

Malta – GM The very reason Fintech organisations have been successful is the fact that they are primarily agile tech operations, steering away from or cutting through the regulatory implications. So, pushing for regulation over Fintech may also imply a slowdown to the delivery capabilities of Fintech organisations. This is something that is yet to be seen, possibly leading to a new breed of Fintech organisations evolving from the current ecosystem.

The regulatory landscape is evolving in Malta and at a very quick pace. So far various regulatory bodies have been involved in the Fintech and blockchain industry, including the Maltese financial services and remote gaming authorities, via consultation and position papers. Earlier in 2018, the Government of Malta announced plans to set up a new authority focusing primarily on the regulatory aspects of innovations delivered through blockchain, but also embracing Fintech organisations.

Three bills have been presented in parliament promising to make Malta the first jurisdiction to regulate the current vacuum in which distributed ledger technology (DLT) companies operate. Malta holds an ambition to be the blockchain island, and the three bills refer to the establishment of the Malta Digital Innovation Authority (MDIA), the authority itself to regulate the digital innovation, setting out a regime for the registration of technology service providers and a third bill to set up a framework for cryptocurrencies.

The cryptocurrency framework also includes a regime, developed by the Malta Financial Services Authority (MFSA), for the approval of ICOs and the regulation of certain service providers dealing in Virtual Currencies (VCs) including brokers, exchanges, wallet providers, asset managers, investment advisors and market makers.

The above is planned to be implemented in the context of jurisdiction with vibrant financial services and online gaming ecosystems that already embrace e-money institutions, payment service providers, and various other regulations including MIFID II and GDPR.

Organisations such as Binance have recently moved their headquarters to Malta in anticipation of the regulatory setup in a jurisdiction that is set to fill the regulatory vacuum. The key objective for such a move is to operate in a regulated context, something that so far is a key challenge for many operators in the Fintech and blockchain space, including crypto exchanges.

Brazil – AC The Brazilian Central Bank sees the new business models as challenging and is studying them in order to decide on a case by case basis whether to regulate or not.

Since 2013, the Bank has been regulating payment providers, however, only the payment institutions that have a certain minimum volume of payments are subject to more restrictive requirements and obligations.

The Central Bank has also been working on regulations for online credit solutions. After submitting a draft regulation to the public in August 2017, the Central Bank issued in April 2018 Resolution 4,656, which regulates the organisation and operation of two types of Fintechs in Brazil:

i.                    Direct credit companies (Sociedade de Crédito Direto - SCD) are financial institutions which provide loans and financing exclusively through an online platform with their own capital,

ii.                  Peer-to-peer lending companies (Sociedade de Empréstimo entre Pessoas - SEP) are financial institutions that enable loans and financing among people exclusively through an electronic platform.

Such online credit Fintechs can only operate after they obtain an authorization from the Central Bank and they are subject to other regulations applicable to financial institutions.

One example is Resolution 4,658, also issued in April 2018, which establishes cybersecurity requirements for all institutions subject to Central Bank’s authorisation. The resolution and other Central Bank regulations could represent a major cost increase for this type of Fintechs in Brazil.

The authorities have not expressly regulated or prohibited ICOs or cryptocurrencies, but are following the developments in these markets closely.

On a couple of opportunities, the Central Bank stated that there is no assurance that ‘virtual coins’ can be convertible into legal currency, clarified that ‘virtual currencies’ are not to be mistaken for ‘electronic currencies’ (which result from conversion of currency in the context of payment arrangements subject to specific regulations), and clarified that entities that issue, trade and store virtual currencies are not regulated, authorised or supervised by the Central Bank. The Central Bank also alerted that any transactions with virtual currencies involving international transfers based on foreign currencies are subject to the Brazilian currency exchange regulations and controls.

In October 2017, the Brazilian Securities Exchange Commission (CVM) clarified that securities offered through Initial Coin Offerings (ICO) cannot be legally traded in specific trading venues for virtual currencies, as these are not authorised by the CVM to make available securities trading environments in Brazilian territory.

In January 2018, CVM issued a note stating that investment funds cannot invest in cryptocurrencies as these are not deemed as financial assets for regulatory purposes. It is unclear if and how the Congress will try to regulate cryptocurrencies.

Capturing investment via crowdfunding emerged as an alternative to the financing of start-ups and was not properly regulated in Brazil until mid2017. Following a public hearing, the Securities and Exchange Commission (CVM) published on July 14, 2017, CVM Instruction 588, regulating this type of operation.

Hong Kong – CM An example of the Hong Kong regulators’ positive approach to Fintech is the establishment of regulatory sandboxes as discussed above, in particular, the further initiatives announced by the HKMA in September 2017 designed to facilitate Hong Kong entering a new era of smart banking. Previously, there had been criticism that the HKMA FSS only allowed large existing financial institutions to innovate, while technology companies were excluded by regulations. The new initiatives opened the FSS to technology firms and created a new policy relating to the opening up of banks’ application programmes to technology companies.

With respect to ICOs, given the different types of ICO tokens, and the fact that some may be hybrid forms of different types, there is considerable uncertainty in many cases as to whether an ICO involves a securities offering. ICOs which do not involve securities offers are currently not regulated in Hong Kong.

While this is welcome to the extent that it has allowed ICOs to be issued and offered in Hong Kong, there have been calls for more guidance as to the characteristics which would render an ICO a securities offering. It is also considered that some form of light-touch, caveat emptor regulation of ICOs would have the advantage of providing legitimacy and discouraging bad actors from entering the market. Another possible area in which regulation might be welcome would be with regard to cryptocurrency trading exchanges which are not currently regulated.

Although many existing crypto exchanges self-regulate, there have been calls for introducing licensing requirements for these exchanges and imposing obligations on them to conduct anti-money laundering and counter-terrorist financing checks on counterparties.

Another area in which regulation would be welcome is crowdfunding, particularly equity crowdfunding and peer-topeer lending, which are not currently permitted under Hong Kong’s regulatory framework. Hong Kong’s Financial Services Development Council published a paper calling for the establishment of an equity crowdfunding regime in Hong Kong. A crowdfunding regime would be particularly welcome in Hong Kong given that the Hong Kong Stock Exchange’s proposal for a new third board for the listing of start-up and early-stage technology and other innovative companies is not to be adopted.

Belgium – KB The supervision authority (FSMA) is quite reactive on the matter. Since 1st February 2017, new rules have come into effect for crowdfunding platforms. These platforms must be approved by the FSMA and comply with certain rules of conduct.

The FSMA issued a warning on ICOs on November 13, 2017, aimed at ICO issuers and consumers. After the 2008 financial crisis, supervisors became quite conservative. There was also little political support for deregulation and therefore, the FSMA now has a proactive but prudent approach.

Fintech companies are supposed to have basic knowledge of financial regulations and must make sure their projects have reached a certain level of maturity. There is no formal ‘sandbox’, but rather a ‘soundbox’ approach, referring to sound rules giving access to European passports, which gives them a firm footing from which to innovate and oversight that is proportional to their activities. A personalised contact with the supervisory authority is always available through the contact point and much appreciated by Fintech companies.

UK – CB The regulatory body for the Fintech sector in the UK is the Financial Conduct Authority (‘FCA’). The FCA is actively encouraging Fintech businesses to engage with it and has consciously taken that message to the market. The FCA has actively pushed their engagement across the UK, outside of its London base – and the centre of Fintech activity in the UK. The message from the FCA is one of ‘we are here to help’, further reinforcing the ecosystem culture in the UK.

The FCA Regulatory Sandbox allows companies to test their innovative products out on consumers in a controlled environment. This initiative provides participants with a supported route to market, lowering their cost to entry and providing improved access to finance. Big players such as Barclays, HSBC and Lloyds Bank have participated but the mainstay ‘cohorts’ are private sector Fintech disruptors.

The Bank of England has got in on the act too with its Fintech Accelerator project which supports exploring proof-of-concept where the technology supports the Bank’s mission of clearer understanding of the Fintech industry.

Cryptocurrency does not enjoy the same regulatory understanding though. Regulators have failed to keep pace with a market that they seem unwilling to commit on. Continual monitoring and review are not serving to clear the confusion that reigns over the sector. Perhaps this is due to the uncertainty of markets and currencies, or perhaps because of the potential nightmare of policing either.

The widespread belief is that the lack of regulation is restricting the growth of the cryptocurrency sector across the UK and potentially globally. UK startups are actually chasing the regulators to ask ‘How will regulation work?’ This could be a major issue for the UK if it doesn’t get its act together on regulating cryptocurrency as the global interest shows no sign of slowing down despite market crashes and devaluation.

Cyprus – SF It is crucial that, while certain regulations are favourable to Fintech start-ups, as soon as risks increase, the need for regulatory action will also rise. More regulatory measures will need to be taken in Cyprus, especially with regard to the amendment of existing legislation, the implementation of European regulations and directives and addressing some specific Fintech innovations.

To begin with, the Law on Electronic Money 81(I)/2012, has been enacted in Cyprus to regulate the issuance of electronic money in the Republic of Cyprus. It covers issuance in other EU/ EEA Member States or third countries by a natural person residing in Cyprus or a legal person incorporated in the Republic of Cyprus. It also covers the authorisation and prudential supervision of electronic money institutions.

Furthermore, the Cyprus Securities and Exchange Commission, as the supervisory authority for Cyprus Investment Firms, market operators and data reporting service providers, undertakes to authorise such firms and ensure they comply with the Law 87(I)/2017, enacted in January 2018 to implement MIFID II.

Regarding the regulation of e-commerce in Cyprus, the Law on Certain Legal Aspects of Information Society Services in Particular Electronic Commerce and Associated Matters156(I)/2004, implementing Directive 200/31/EC, aims at ensuring the free movement of information society services between the Republic of Cyprus and the EU/EEA Member States and additionally regulates online information services, online advertising and marketing, online selling of products and services and online entertainment services.

It should also be mentioned that a bill has been drafted to replace the Law 138(I)/2001 on personal data, which will implement the General Data Protection Regulation Reg(EE)2016/679. This is a response to the Fintech evolution as the need to avoid risks and protect personal data becomes higher.

USA – DS There is a risk of over-regulation in areas such as cryptocurrency and tokenisation, because of the problems with scammers and fraud right now.

We are seeing the US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) lining up with the individual US States on the issues of the blockchain, smart contracts and cryptocurrency. This is a very hot button topic at present with several issues that need to be resolved, including the proper regulation of ICOs and the recognition of tokens and currencies as tangible real-world assets subject to wider use and tax.

Curaçao – LS The local central banks of both Curaçao and Aruba are actively reviewing the current payments landscape and outlining the requirements for a future state payment system. In Aruba, for example, the ambition is to start with the implementation of a new payment infrastructure halfway through 2018, should show tangible progress next year, with the ambition to have a fully modernised payment infrastructure in place by 2020.

Other innovative approaches involving InfoCapital include working with partner companies like Earlybird Funding (EBF) who act as brokers on the Dutch Caribbean Securities Exchange (DCSX) platform.

EBF provides the tools necessary to empower its community of investors to manage their investments in Fintech companies effectively. EBF, together with the DCSX, provides access to a regulated and transparent marketplace through its unique platform and model that enables funding and investment in Fintech start-up companies in exchange for shares.

The Curaçao Ministry of Economic Development has a number of initiatives to increase attention to new Fintech opportunities, including annual conferences and its innovation incubator CITI.

Crypto and blockchain enterprises and projects in Curaçao have made compliance their foundation and as such have met existing regulations well. We consider this a differentiator for the jurisdiction, as it means no new regulation and special sandbox is needed.

Foreign exchange bank account requirements need adjustment to allow for compliant crypto and blockchain business. This is not a standalone of course, as the correspondent bank issue remains a major challenge.

Contributors

Luis Santine (LS) InfoCapital – Curaçao www.irglobal.com/advisor/luis-santine-jr

Adriano Chaves (AC) CGM Advogados – Brazil www.irglobal.com/advisor/adriano-raposo-do-amaral-pinto-chaves

David Sorin (DS) McCarter & English LLP – USA www.mccarter.com/David-J-Sorin/   

Craig Blackmore (CB) Verde Corporate Finance – UK www.irglobal.com/advisor/craig-blackmore

Soteris Flourentzos (SF) Soteris Flourentzos & Associates LLC – Cyprus www.irglobal.com/advisor/soteris-flourentzos

Clinton Morrow (CM) Charltons Law – Hong Kong www.irglobal.com/advisor/clinton-morrow

Hans Kuhn (HK) Zulauf Partner – Switzerland www.irglobal.com/advisor/dr-hans-kuhn

Evelyn Maher Bonn Steichen & Partners – Luxembourg www.irglobal.com/advisor/evelyn-maher

Melvin Tjon Akon (MTA) Bonn Steichen & Partners – Luxembourg www.bsp.lu/professionals/associate/melvin-tjon-akon

Gordon Micallef (GM) RSM Malta – Malta www.rsm.global/malta/people/gordon-micallef

Kevin Bertouille (KB) Everest Law – Belgium www.everest-law.eu/nl/advocaten/kevin-bertouille