Peter Guy, Regulation Asia, September 14, 2015

The socialisation and democratisation of financial and consumer financial services pose a challenge to traditional institutions.

Disruptive technologies and businesses are assailing the world’s financial industries - one regulatory jurisdiction at a time. Whether it’s taxis or financial services, participants marvel at how quickly products that were one part of everyday life become relics. Data, technology and automation are driving innovation, improved access and significant cost savings. They are moving faster than the ability of regulators to understand and keep up with and creating fragmented international regulations. How each regulator and country copes with their own demographics will also determine who dominates the new financial sectors.

Regulations drive and are being driven to change by every incremental or revolutionary innovation. From the changing regulatory environment after the financial crisis to the US JOBS Act in 2012, which encouraged financial tech startups, the evolving landscape of regulation and the unmet consumer demand from the existing banking system have created significant opportunities for the social finance platforms to emerge and gain traction. New and traditional sectors are affected: peer-to-peer lending, wealth management, crowdfunding and socialised payments.

Regulatory advantages and differences emerged as a secular reaction to the financial crisis. Financial institutions that existed to do these activities in 2008 either failed or were forced into much more restrictive and expensive banking holding company regulatory frameworks. This allowed new, mostly American startups to take advantage of greenfield opportunities to serve those markets while remaining outside the more restrictive legacy regulatory frameworks.

Fragmentation is the first effect of these regulations because regulators in other countries have been slow or reluctant to follow them. For example, in Hong Kong the Securities and Futures Commission still restricts how asset managers and their marketing channels communicate to investors. Asset managers are forced to waste marketing budgets advertising their funds (complete with legal boilerplate) on buses and trams. Meanwhile, one of the biggest changes in consumer finance is the unregulated ecosystem and network that socialised finance has cultivated. The JOBS Act also lowered the requirement of what constitutes an offer or solicitation for greenfield startups, which other regulators must respond to in kind.

Senior bankers or asset managers at large traditional financial institutions are experiencing organisational difficulties or resistance to confronting the competitive threat. Or they don’t believe that these new disintermediators pose a substantial threat. Internal resistance and the sheer size of some banks requires months just to change the homepage of a website. Unlike the startups, bank services and products are more heavily regulated and new financial technologies are more nimble with product offerings.

However, the perception of large financial institutions on new financial tech companies that are trying to disrupt lending, payment transaction and asset management displays curiosity and detachment. All of them understand and appreciate the power of disintermediation and that the socialisation of finance is a very real trend. But regulations designate them as systemically important financial institutions preventing them from starting new platforms.

New platforms aren’t burdened by legacy infrastructure and with new systems they can be compliant from the start. Adapting to new compliance rules is also easier. But as one senior banker warned me, once they become larger they either become regulated or have to deal with regulated institutions - banks, to execute transactions or working capital. Risk still has to be managed.

While they are effective front end aggregators for clients that large banks cannot economically attract and serve, they do not possess an infrastructure for handling risk. After all, managing risk in today’s highly regulated environment is the basic function of banks. Asset managers understand the competitive advantage of a new kind of marketing and distribution system, but they admit there is little they can do other than watch the aggressive and curious developments from their entrenched positions.

As a result of the increasing socialisation and democratisation of financial services, consumer financial services are improving in terms of transaction speeds, ease of use, affordability and availability. Regulators need to stay ahead of developments such as crowdfunding, wealth management, lending, and payments – where the socialisation of finance has reached various stages of development and new models are discovering advantages over traditional financial systems.

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