Can Regulators and Fintech Find the Right Formula for Innovation?

A pair of sessions held during the LendIt Fintech USA conference in New York raised some prospects for finding ways for regulators and fintech advocates to coexist and clear the way for innovation.

The attention fintech, from decentralized finance to cryptocurrency, gets from the public these days might only be matched by the scrutiny of regulators who see a need to establish policy for this new frontier. Whether it is with startups or incumbent financial institutions adopting new approaches to handling and investing money, new layers of regulation are likely inevitable.

A fireside chat with the New York Department of Financial Services and a separate panel with stakeholders on reimagining regulations in fintech gave glimpses of discussions underway with regulators. It is not just that there are new forms of currency -- there are different dynamics at play in transactions, ownership, chain of custody, accountability, and how digital assets are valued.

For example, a murky tug-of-war is underway over Bored Ape NFTs stolen from comedian and actor Seth Green -- NFTs he had planned to feature in a new TV show he created. Green has been looking for legal recourse to reclaim control of the NFTs, apparently taken by phishing scammers and then sold to a third party. The trouble for Green is there seems to be no clear legal precedence to seek immediate remedy. That is just one type of emerging issue financial regulators may have to weigh in the digital space.

Michele Alt, partner and co-founder of Klaros Group, moderated a panel that gathered Custodia Bank, the American Fintech Council, and Figure Technologies to discuss “Reimagining Fintech Regulation to Foster Innovation.” Alt said regulation and innovation often seem mutually exclusive especially after the recent crash of cryptocurrency drew calls for regulation, but there may be ways to navigate the needs of each side.

Yana Miles, general counsel and senior vice president, head of regulatory affairs with the American Fintech Council, said her organization is onboard with regulation that does not eliminate positive aspects of this growing sector. “We want regulations to be reasonable,” she said. “We believe in following the law.” Miles acknowledged the challenges regulators face catching predatory actors who seek to exploit public interest in fintech. She also saw a need for patience given the pressure regulators received after not catching the past subprime crisis before it went national.

Miles said innovative lending in fintech offers a variety of benefits to the public, such as playing a role in sustainable access to credit that can be significant in addressing the wealth gap and underserved communities -- which often do not have access to brick-and-mortar banking systems. Finding ways to work with regulators, she said, can lead to adjusted policies that work with existing business models. “We’re not saying, ‘Don’t have regs,’” Miles said. “We want regs. We want the bad actors out. We want the illegal conduct out but let’s do this in a way that we’re not inadvertently cutting out people.”

“It’s a really choppy time from a regulatory perspective,” said Ashley Harris, general counsel with Figure Technologies. “The collapse of Terra and now the crypto market falling highlights that.” She said regulators are trying to catch up while banks are trying to lean into this space. The USDF Consortium, which Ashley Harris is involved with, is looking for a measured way for banks to be involved in the crypto ecosystem and create an alternative to stablecoin that is bank-minted and represents deposits, she said. “In our view, it’s the safest, most stable way for someone to transact on blockchain.”

The mercurial shifts in the crypto ecosystem have introduced challenges from a regulatory perspective, Ashley Harris said, because regulators are in learning mode. “Every time something happens with crypto, there’s a pause and there’s sort of a reset,” she said. The fall of crypto markets became a prompt for Acting Comptroller of the Currency Michael Hsu to signal caution, Ashley Harris said.

“Then at the same time we have things like the Biden executive order saying it’s really important for the US to have a strong, highly regulated crypto market because it’s important for national security and competitiveness,” she said, further describing the competing tensions that fintech stakeholders must navigate. Ashley Harris also described it as an opportunity to educate regulators and bridge the knowledge gap.

There are differences between federal and state regulators, said Caitlin Long, CEO and founder of Custodia Bank, in terms of action and objectives. While state regulators tend to have economic development in their respective mission statements the same might not hold true at the national level, she said. “Federal regulators have every incentive to halt everything, and the state regulators actually have an incentive to work on new things.”

Adrienne Harris, superintendent, New York State Department of Financial Services Credit: Joao-Pierre S. Ruth

Offering her vision of the role that the New York State Department of Financial Services might play in fintech innovation, Superintendent Adrienne Harris spoke in a fireside chat with Garry Reeder, CEO of the American Fintech Council.

“Given the changes that we’ve seen in the industry, given the changes that we’re seeing post-pandemic in a macroeconomic context, it’s given me a broad perspective to think about,” Adrienne Harris said. “How do you build a transparent, resilient, equitable financial system through the lens of a future-looking, data driven model?”

Reeder asked for some perspective on New York’s history as a regulator in virtual currency in light of the volatility seen in the last month in this space. Adrienne Harris said DFS established a rigorous framework with similar anti-money laundering and cybersecurity standards as banks. For example, DFS requires each stablecoin to include cash equivalents on reserve, third-party attestations of the reserves, and other measures. “The standards are incredibly high,” Adrienne Harris said.

Historically speaking, she said it has taken a very long time for some new fintech players to get cleared through New York’s approval processed. “We’ve done a lot of work to increase the efficiency of the licensing process without sacrificing regulatory rigor that the state demands,” she said.

Adrienne Harris said her department is also working closely with and lending their experience to federal and international regulators who now are starting to look at these spaces.

Reeder asked what role fintech might play in climate change risk mitigation as it intersects with financial services. Adrienne Harris said DFS had already established climate guidance for insurers and is in the process of doing the same for banks and mortgage lenders. “We’re really focused on risk communication and governance,” she said. “This is really about the data, safety and soundness, consumer protection.”

The role banks can play in climate change may affect certain demographics that can face the brunt of ecological issues. “We know that low- and moderate-income communities and communities of color are disproportionally impacted by climate change,” Adrienne Harris said. This may be on top of being underserved by financial institutions. “We’ve really gone to great lengths to say as part of this guidance, you cannot abdicate your responsibility around fair lending, and equal access to credit, and an equitable financial system in service of your climate goals.”

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