Supervisory challenges of Fintech

Finanssivalvonta | Finansinspektionen | Financial Supervisory Authority ■ ■
Supervisory challenges of Fintech
Arcada, Fintech I: Fintech in the past, present and future
19.11.2016 0Markku Koponen

About the speaker
■ MSc, Computer Science, CISA
– Financial Supervision, 25+ years,
various positions
– Helsinki University, lecturer
– Nokia, Software Engineer
■ Bank of Finland workgroup and
report ”Digitalisation in Financial
Sector”, member
■ Launching the work for Innovation
HelpDesk in FSA-Finland
19.11.2016
Markku Koponen
Head of Division Operational Risks
Financial Supervisory Authority
markku.koponen(at)finanssivalvonta.fi
1Markku Koponen

Agenda
■ History of Fintech (”short version”)
■ Fintech – growing business – statistics
■ Introduction – regulation vs. innovation; digital lipstick?
■ Digitalisation – consequences in financial sector
■ Driving factors for innovations
■ Fintech – opportunities and risks
■ Scenarios for banking
■ Challenges for industry and supervisors
■ Supervisory response
■ FIN-FSA response
■ Supervisory response – other supervisors

History of Fintech
■ Google: Fintech 33 600 6000 hits, ”history of Fintech” 20 400 hits
■ ”Fintech is a relatively new term”
■ ”Fintech is a very broad sector with a long history”
■ ”Last 65 years paint a picture of continued innovation and evolution”
– (the telegraph is introduced in 1838)
– 1950s credit cards
– 1960s ATM´s
– 1970s electronic stock trading
– 1980 bank mainframes (1958 ENSI in Postisäästöpankki!)
– 1990s Internet, web banking, e-commerce, PayPal
■ 2010s
– mobile wallets, payment apps
– robo-advisors
– crowdfunding, online lending platforms
– etc.
■ http://www.forbes.com/sites/falgunidesai/2015/12/13/the-evolution-of-fintech/2/#5f5a17aa61e3
■ http://www.nytimes.com/2016/04/07/business/dealbook/the-evolution-of-fintech.html?_r=0

Fintech – growing business

Introduction I: Financial Conduct Authority, UK
Christopher Woolard, FCA Director of Strategy and Competition
■ “How can regulation foster innovation in financial services? And as
part of that how can we ensure that we have a regulatory environment
fit for future innovation?”
■ “…why does the FCA care about innovation? Primarily because of our
duty to promote competition in the interests of consumers. One of
the best ways we can promote competition is to foster disruptive
innovation.”
■ “The key challenge for government, industry and regulators is to
continue to ensure the regulatory environment fosters the best of
financial innovation. Our ultimate goal is that the benefits of
competition can be realised in the interest of UK consumers”

Introduction II: Digital lipstick?
■ "Banks are trying to be cool and hip and build super cool digital front
ends... But it’s like putting lipstick on a pig - ultimately it’s still a pig and
the new front end is still running into an awful digital back end."
– Mark Mullen, Chief Executive Atom, Durham, UK

Digitalisation, consequences in financial sector I
■ Internal processes in banks and customer experience in
services have changed strongly
■ Structural changes in financial sector due to digitalisation
pretty low so far
– same products offered via digital channels
– new entrants (innovators) pretty small
■ Structural changes expected to grow
– new entrants, global markets, regulation
■ No major changes in payment infrastructures so far
■ Banks recruiting new knowhow: chief digital officers
■ Banks setting up start up acceletors, partnering with Fintechs
■ Potential of new technologies, e.g. blockchain, recognized in
financial sector

Digitalisation, consequences in financial sector II
■ Big european players in banking industry invest in
digitalisation: e.g. BBvA, BNP Baribas
■ Small agile Fintechs: payment innovations, mobile
payments, crowdfunding, peer-to-peer lending, Roboadvisors
etc.
■ Innovations in insurance sector, e.g. intelligent insurances,
usage based insurances (UBI)
■ Mobile services and apps: still growing popularity

Four factors drive the application of technological
innovations in the financial sector
19.11.2016
Source: Technological innovation and the Dutch financial sector. DeNederlandcheBank.
9Markku Koponen

Fintech – opportunities and risks
19.11.2016
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Dilemma: regulation and supervision vs. innovations
■ Supervisors ensure that
– requirements for authorisation are fullfilled
– supervised entities obey legislation, regulations and guidelines
– supervised entities are professionally managed and they have adequate risk
management systems in place
■ Supervisors also
– promote compliance with good practice in financial markets
– require capital adequacy and liquidity buffers to adequately cover material
risks
– etc.
■ On the other hand supervisors are expected
– to foster innovations and competition (at least by innovators)
– support and help innovators applying authorisation
■ Preconditions
– financial sector is heavily regulated
– possibilities for interpretations of EU-legislation are limited

Scenarios for banking
19.11.2016
■ In the first, established financial institutions embrace and successfully
exploit innovation, thereby changing the structure of the financial
sector relatively little.
■ In the second, the market becomes fragmented as new, specialist
players compete effectively with established financial institutions.
■ In the third, large technology companies such as Google and Apple
displace established institutions by exploiting their scale and
innovative capacity.
12Markku Koponen

Challenges for supervisors
19.11.2016
■ Ability to analyse
– how do technological innovations impact the financial sector?
– to which structural changes in the financial sector does technological
innovation lead?
■ Ability to recognise opportunities and potential risks for new business
models and Fintech
– potential risks: data security and privacy issues (e.g. information leaks),
cyber risks, misselling, misconduct in markets, etc.
■ Which actions should supervisors take in order to mitigate potential
risks?
 Develop supervisory framework
 International supervisory coordination needed
The ESAs could play a central role in coordinating policy
cooperation in the EU context
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Challenges for supervisors II
19.11.2016
■ Cultural differences: start-ups vs. supervisors
– start-ups agile, innovative, high risk appetite
– supervisors emphasise risk management, consumer protection
■ Overlapping regulation for
– payment services
– banking
– securities markets
– consumer credits
■ Lacking regulation, e.g.
– crowdfunding
– virtual currencies
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Some challenges - Finnish innovators
■ Heavy regulation, authorisation process
■ Demand of strong authentication in
payments
– no common model or services for strong
authentication in EU
■ Agility typical for startups – challenging in
financial sector
– possibility to pilot services before launching
suggested
■ According to innovators ”There is a certain
threshold to approach authorities”
– web pages could be more user friendly
– help desk for innovators suggested
■ On the other hand
– EU regulation helps to access markets within
EU: same regulation in EU area and EU
passport

Risk mitigation actions for supervisors
19.11.2016
16Markku Koponen

Supervisory response I
19.11.2016
■ Resources: supervisors need new expertise to understand
– technological innovations and new business models
– risks characteristic for innovators: e.g. cyber risks, data privacy risks,
business model risks
■ Setting up innovation hubs to support Fintechs
– Regulatory Sandbox – possibility for innovators to pilot services (“test in
live environment”)?
■ Networking with industry and other supervisors: co-operation needed
to understand new technological innovations and risks
17Markku Koponen

Supervisory response II
19.11.2016
■ No compromising in AML and CFT regulation
■ Further work is needed on:
– do we need Regulatory Sandbox – possibility for innovators to pilot
services (“test in live environment”)
– operational risk regulation (outsourcing, IT) needs further development:
should we directly supervise critical service providers?
– tailored regulation (FinTech licence): principle based regulation seems
better suited to fast-changing environment
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Supervisory response – some FIN-FSA actions I
■ FIN-FSA seminar 4.10.2016: Digitalisation in financial
sector: threats and possibilities
– questionnaire about digitalisation to supervised entities
– http://www.finanssivalvonta.fi/en/Publications/Blogs/Pag
es/digitalisation.aspx
■ Networking with Fintechs
– attending Fintech Finland Community, HUB13 and
Slush meetups, giving presentations
– Slush side event 30.11 Bank of Finland Museum: PSD2,
regulation, panel https://www.lyyti.in/FinTech_301116
■ Dialogue with innovators
– discussions with a few innovators related to setting up
FIN-FSA Innovation HelpDesk
– ongoing discussions with innovators about the need for
authorisation

Supervisory response – some FIN-FSA actions II
■ Setting up Innovation HelpDesk
– launched 4.10.2016
– http://www.finanssivalvonta.fi/fi/Toimiluvat/Innovaatio/Pa
ges/Default.aspx
■ Recruiting Senior Advisor in digitalisation (closing date
for applications 27.11)

FIN-FSA Innovation HelpDesk I
Press release 4 October 2016 – 16/2016
The Financial Supervisory Authority opens an Innovation HelpDesk
The FIN-FSA today opens a new Innovation HelpDesk for FinTech entities and other
innovators in the sector – both old and new.
Objectives
■ to increase dialogue between the FIN-FSA and FinTech entities
■ to create a positive atmosphere that supports the development of the sector
■ to make the supervisory authority more easily approachable
■ to increase entities' awareness of financial sector regulation and related interpretations
■ to enhance the development of innovations and facilitate the subsequent authorisation or
registration application processes
Preconditions: the HelpDesk
■ does not replace the work of innovators themselves – you must still do your homework
■ is not a replacement for consultants (e.g. lawyers)
■ is not a promise of positive supervisory decisions in the future

FIN-FSA Innovation HelpDesk II
■ ‘The purpose of the HelpDesk is to provide general guidance on the
regulation related to innovation, as well as on supervisory issues, and
to advise entities to provide necessary additional information, eg prior
to a possible official authorisation or registration application process,’
says Jarmo Parkkonen, Head of Department.
■ The Innovation HelpDesk provides guidance in the form of replies to
e-mail enquiries, advisory calls with an expert (max. 30 mins) and
advisory meetings with several experts (max. 1 hr). The first advisory
meetings will be held in connection with the Slush event on 1
December 2016.

FIN-FSA Innovation HelpDesk III

Results of the FIN-FSA questionnaire I

Results of the FIN-FSA questionnaire II

Results of the FIN-FSA questionnaire III

Results of the FIN-FSA questionnaire IV

Supervisory response, other supervisors
■ De Nederlandche Bank (DNB) and supervisor (AFM): innovation hub
■ FCA UK
– Project innovative, Innovative Hub, Sandbox: “We assist innovative
firms to work with us...We are here to help both types of queries as long
as propositions meet our criteria that they are innovative and we can see
benefits to consumers.”
– “The Innovation Hub team also offers guidance pre-authorisation ...
Firms that have received initial support from the Hub will have their
applications handled by a specialised Project Innovate authorisation
process. After authorisation we will provide dedicated supervisory
support, normally for one year.”
– https://innovate.fca.org.uk/
■ FSA Japan, Fintech Support Desk 2015

Supervisory challenges of Fintech

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