Fintech – a regulator’s perspective
Bénédicte Nolens, Senior Director, Head of Risk & Strategy and Head of the Fintech Contact Point, Securities and Futures Commission (SFC), gives a regulator’s perspective on how technology is transforming the financial sector.
In a recent article, Klaus Schwab, Founder and Executive Chairman of the World Economic Forum (WEF), suggested that technological advances have meant we are living through the fourth industrial revolution. How radically do you think new technologies are going to transform the financial sector in Hong Kong?
‘I share the WEF view that significant change is underway. For financial services, new technologies are evolutionary when viewed in the short term, and transformative when viewed in the long term. In the short term, while increasingly automated, the financial products and services offered are still similar. In the long term, the combined outcome of the changes already underway will be transformative.
As financial services (banking, brokerage and investment) become increasingly automated, online and mobile-enabled, they can be delivered in different ways and by different players. There are abundant examples of this evolution already being underway in each of the core business lines of financial services. In the “Synopsis of the SFC Fintech and Regtech Contact Day” we included a picture that visualises this evolution: e-payments, robo-advice, crowdfunding, marketplace (also referred to as peer-to-peer) lending, big data analytics, machine learning, natural language processing and artificial intelligence, as applied to securities investment and trading, are examples of fintech that have already taken hold. Distributed ledger technology or blockchain, once it takes hold, can further catalyse this transformation.’
Will the traditional financial institutions survive in their current form? Will they absorb new players and offer the same services?
‘It is hard to predict how this evolution will play out, but one thing is clear – it will only go in one direction and that is towards further automation. Unless traditional financial institutions act fast and make the customer experience, design and automation core to their mission, they are giving new technology-driven players the opportunity to seize market share.
Technology companies have a history of scaling fast. Ambitious fintech players want to be the front end – the user interface – with the financial institutions remaining the back end, processing the transactions and acting as custodian. But the back end is not where money is made. Money is made in payments, investment advice, trading, broking, capital raising and lending – areas in which fintech firms are already taking hold. Also, Mainland China is seeing the emergence of technology-driven integrated financial institutions that service each of these core business lines under one corporate umbrella in a highly automated fashion, heralding what the future may hold.’
There has been a lot of interest in the implications of DLT – distributed ledger technology – for the financial sector. Could we talk in more detail about this new area?
‘Experimentation with DLT is happening in many different fields of finance, including securities placement, trading, clearing, settlement, corporate actions etc. In addition, DLT is being tested in the context of ‘know-your-customer’ [KYC] and digital identity.
The current on-boarding model consists of each financial institution individually collecting, record keeping and updating KYC documents. This means that if you want to open an account with different financial institutions, you have to provide the same KYC information to each of those different institutions individually. Conceptually, this on-boarding approach can be replaced by an “industry utility” approach, or by a DLT approach.
Regtech firms are experimenting with different approaches – some are creating central databases which financial services firms can subscribe to and on which KYC documents are stored. Other fintech firms or industry consortia are exploring the creation of “permission-based distributed or shared ledgers” between groups of participating financial institutions. Still others are experimenting with “self-sovereign digital ID” run on DLT. In this last model, individuals control their own digital identity, as well as which parties to share it with.’
Is that last model already a reality?
‘Yes. There are several startups that are pioneering this model. It is a bit like having a LinkedIn account – you control your own identity. Except it goes further — your profile is kept confidential and different parties in the DLT network are enabled to confirm the accuracy of your identity details. For example, conceptually, participating banks in the DLT network can confirm that you have an account with them, utilities can confirm your proof of address, government databases can confirm residency, etc. Biometric data can also be stored and verified.
In such a model, your digital identity becomes a combination of traditional identification methods such as copies of your passport, and of novel methods such as your biometric data and verification of identity details by parties participating in the DLT network. Given the confidential nature, data privacy and security is of the essence for the model to take root.’
Wouldn’t that be more efficient than the current model, particularly for AML? We have heard a lot recently in Hong Kong about how hard it is for SMEs to open a bank account partly because banks are under pressure to ensure compliance with AML requirements.
‘I think the current on-boarding model is inefficient. For the financial institutions, it has led to massive operational risk, cost and fines; and for the consumer it has meant that, when you want to open a new account, you have to provide the same documents multiple times, and wait many weeks for the financial institution to complete the verification and to revert to you whether the account will be opened or not. Streamlined and shared processes can improve the current sub-optimal outcome.’
Which do you think will become the standard model in the future?
‘I think these different models will gain traction in parallel. They may end up catering for different customer segments and markets. To cite a few examples – institutional clients are already placing their corporate documents in KYC utilities in order to reduce the burden of providing the same information multiple times to each financial institution that they have an account with. DLT is being tested in the context of automated credit passports for individuals in Mainland China, and self-sovereign digital ID is being experimented with by different start-ups in different markets.’
What are the human resources implications of these new technologies – will increasing automation lead to massive job losses in the financial sector?
‘That’s not so certain. The opening of more savings, brokerage and investment accounts through fintech can increase financial market size and activity. In India, since the government introduced the Aadhaar digital identity system, 400 million bank accounts have been linked to Aadhaar IDs. In Mainland China, the four largest technology players have extended their reach into financial services, thereby significantly increasing financial inclusion – cashless payments are made instantaneously, loans are extended in a matter of minutes through automated credit passports, and small amounts of excess cash are invested at higher returns than in savings accounts. There are many more examples in Africa and in Latin America, where fintech is able to leapfrog current technology and bring about greater financial inclusion.
In markets with high financial inclusion, such as Hong Kong, fintech can be used to streamline old processes and facilitate new services, such as e-payments, robo-advice, trading supported by machine learning, big data analytics to support risk management and compliance, etc. How this plays out for different markets and financial institutions depends on how much they embrace technological evolution – or, in the words of the WEF, the fourth industrial revolution.’
What is the SFC’s view of the new technologies impacting the financial sector?
‘In a recent speech I noted that the SFC welcomes fintech and regtech innovation. Robo-advisers can apply for an SFC licence; equity crowdfunding and peer-to-peer lending platforms can do the same, though for the latter – due to current limitations in the Securities and Futures Ordinance (SFO) – the service would need to be limited to professional investors. In addition, the SFC recently issued a circular in which it stated that it is open to the greater use of technology in the context of multi-factor authentication, cybersecurity, data protection and fraud control. We also set up the SFC Fintech Contact Point, which I lead.’
Securities regulators pursue investor protection – how does an investor protection model really work in a global, online context?
‘This is a very good question. Investor protection rules are national in nature. Fintech, however, does not limit itself to national borders. The challenge is that, even if we don’t allow a certain type of fintech in our market, investors can probably access it online in another market.
As with any investment, investors should understand the risks. For example, statistics show that 50%-90% of crowdfunding start-ups fail, which means that, in the case of an early stage equity investment, the value of the investment drops to zero in 50%-90% of the cases. Marketplace lending has lower non-performing loan rates. Also, whereas equity crowdfunding has a multi-year investment horizon before returns materialise, peer-to-peer loans pay monthly interest. As such, the risk profile of these two business models is different. Numbers published by the Cambridge Centre for Alternative Finance show that, seen on global levels, marketplace lending is much larger than equity crowdfunding.’
Could we finish with some personal background about yourself?
‘Certainly. I was born in a village in Belgium with less than 6,000 inhabitants. I completed my first law degree at the University of Leuven, and then moved on to the University of Chicago to complete a second masters degree in law. I was hired by White and Case in New York, where I started as a lawyer. In 1997, I was invited to “come visit China”, and during that visit was offered a job by Goldman Sachs.’
As a lawyer?
‘In compliance, all be it by coincidence. My hiring manager said that “in many ways compliance is more interesting than the law, and will grow fast”. She was right – compliance grew very fast. Also, risk-based thinking is what I like, and compliance offered me exactly that. I stayed with Goldman Sachs for 10 years. Then, in 2007, Credit Suisse approached me to become their regional head of compliance. I worked with them for five years until 2012 when I was approached by the SFC to set up a new function – Risk and Strategy. Having taken note of the very full post-crisis regulatory agenda, I felt it was the right time to move to the other side of the fence!
That, in a nutshell, is my background. You can glean from this that I have a long-term behavioural tendency of some sort to leave my comfort zone and think outside the box. I left my village for Chicago and New York; I moved to Hong Kong five months after the handover in 1997, right at the onset of the Asian financial crisis; I also lived through the dot.com burst and the global financial crisis. And now, I am enjoying the regulatory perspective – having performed various field studies and issued several practical research reports, including the latest IOSCO report on fintech.’
Bénédicte Nolens was interviewed by Kieran Colvert, Editor, CSj.
SIDEBAR: Online Resources
The online materials referred to in this article can be accessed at the websites listed below.
The World Economic Forum website (see the article by Klaus Schwab, Founder and Executive Chairman of the World Economic Forum, ‘The Fourth Industrial Revolution: what it means, how to respond’):
The Cambridge Centre for Alternative Finance (see the statistics on marketplace lending and equity crowdfunding): www.jbs.cam.ac.uk.
The Fintech Contact Point and related publications can be accessed from: www.sfc.hk/web/EN/sfc-fintech-contact-point/.
The latest IOSCO report on fintech (see the IOSCO Research Report on Financial Technology at ‘publications/public reports’): www.iosco.org.