Stability’s important, but Canada needs to take more chances with fintech
According to Ernst & Young’s 2019 Global Fintech Adoption Index, Canada is 14 points, and the U.S. 18 points, behind the global average of 64 per cent consumer fintech adoption, and we trail world leaders like China, India and Russia by even more. The two countries’ approaches to regulating fintech, which in many ways reflect enduring national stereotypes, almost certainly have contributed to our continent’s fintech lag.
Canada tends to favour large but stable financial institutions and Canadian regulation has generally helped preserve this status quo. At the same time, there is undeniable interest in fostering fintech, and helpful steps have been taken, the Canadian Securities Administrators’ (CSA) fintech “regulatory sandbox” being a notable example.
But our lawmakers are cautious, slow to adapt, and reluctant to experiment, and we don’t have the vibrant startup funding ecosystem the U.S. does. On the other hand, what the U.S. gains in fintech competition, regulatory experimentation, and more venture capital, it tends to lose from the costs of regulatory fragmentation and complexity.
Even so, and despite scoring lower on the EY scale, the U.S. has at least a slight edge in competition, which may pay off over time, given that country’s historically more aggressive approach to legislative change —even if, in the current U.S. political climate, legislation on anything seems unlikely.
The need for fintech regulation is evident. Crypto-asset trading platforms are a recurring haven for hacks. The QuadrigaCX scandal, in which over $200 million of cryptocurrency and cash went missing when founder Gerald Cotten died with sole access to the platform’s cryptocurrency wallets and private keys, highlights the dangers of lax oversight.
Fintech can expose customer data, increase systemic risk, create moral hazard in peer-to-peer lending, and drive investor herds with robo-advisers. Money laundering is also a higher risk in virtual currency. FinCEN (a bureau of the U.S. Treasury) and FINTRAC (Canada’s money-laundering overseer) have both issued detailed guidance, with new FINTRAC regulations coming into force next year. Looming ominously is Facebook’s Libra, which if embraced on a global scale could upend sovereign control of monetary policy.
But while fintech regulation is clearly needed, too much of it may restrict consumer-friendly innovation. The U.S. has a long history of fostering competition in banking. Its “dual” state and federal banking systems drive competition, and now technology firms can also become banks. Last summer the Office of the Comptroller of the Currency (OCC) launched a “special purpose” fintech national banking charter, endorsed by Treasury.
The charter has been criticized (and litigated) by state regulators as exceeding the OCC’s legal authority, and some tech firms may ultimately decide that the costs of enhanced supervision exceed the charter’s benefits. But it represents a strong policy signal that the U.S. is open for business and willing to experiment with non-traditional banking to increase innovation and benefit consumers. Arizona and Wyoming have passed accommodating fintech legislation while the federal government’s Commodity Futures Trading Commission and the Consumer Financial Protection Bureau have both created innovation initiatives. Changes are now being sought in Congress to provide clarity in regulating digital tokens.
Canada lacks a special purpose vehicle like the OCC’s. Despite numerous government consultations, fintech-related legislative changes have been rare and slow-moving, and some proposed rules — like the CSA / IIROC framework for crypto-asset trading platforms — may increase regulatory costs rather than reduce entry barriers.
Banks in Canada integrate fintech internally in competition with other major banks. The Competition Bureau has noted progress in adjusting regulations limiting “access to core infrastructure and services” and governing “de-risking” of major banks as entry barriers for new fintech firms, but more can be done. Competition could increase if the Department of Finance were to accelerate its recent review of “open banking” — a concept already adopted in Europe that gives customers greater control over and portability of their banking data, in particular for disclosure to fintechs.
Despite its pro-competitive bias, U.S. fintech adoption is hampered by a highly fragmented and complex web of federal and state agency supervision. Navigating this maze is very costly for new firms. This is less of a problem in Canada since most financial transactions happen at federally regulated banks under integrated OSFI oversight.
Our lawmakers are cautious, slow to adapt, and reluctant to experiment, and we don’t have the vibrant startup funding ecosystem the U.S. does
A harmonizing bright spot is the CSA fintech “sandbox,” which created a national “testing space” for firms to operate with regulatory relief under bespoke supervision. The CSA sandbox has helped launch, among other initiatives, ZED Network’s blockchain-based “foreign exchange remittance network system,” and Token Funder’s platform for issuing “tokenized” securities. A national sandbox doesn’t yet exist in the U.S. SEC Commissioner Hester Peirce has said she doesn’t want regulators “sitting” next to entrepreneurs as they “grab hold of the shovels and buckets.” So far in Canada, regulatory meddling in entrepreneurial decisions seems not to have been a problem, although it would be nice to have more sandbox participants.
Canada’s financial strength — stability — is also its weakness as a launching pad for disruptive tech. Maintaining financial system stability is important, but unless Canada can increase competition in its financial services sector it runs a real risk of falling further behind in the fintech world. Keeping up will require more experimentation in regulation.
Ryan Clements is an assistant professor at the University of Calgary Faculty of Law and consultant to the Alberta Securities Commission (ASC). The opinions expressed here are his alone.