Regulating Financial Innovation: Fintech and the Information Deficit (EBI Studies in Banking and Capital Markets Law)

This book explores the impact of 'Fintech' on the information asymmetry between the financial regulator and the markets. It details the growing regulatory mismatch and how Fintech exacerbates the “pacing problem”, where the regulator struggles to keep up with innovation. With information as a point of reference, the book adds a new perspective on the latest phenomenon in financial innovation and presents a novel framework for navigating structural changes in the financial sector. Based on this analysis, a number of proposals to reduce the information gap and avoid regulatory mismatch are discussed. Thereby, new and promising regulatory concepts, such as regulatory sandboxes and SupTech applications are also covered. This book provides a practical framework for regulatory responses to financial innovation. It will be relevant to researchers and practitioners interested in financial technology and regulation. Preface Contents List of Figures List of Tables 1 Introduction 1 The Aim and Contribution of This Book 2 Limitations 3 Course of the Study 2 Foundations of Financial Regulation 1 Financial Markets and Financial Intermediaries 1.1 Direct Finance 1.2 Indirect Finance 2 Regulation of Financial Markets 2.1 The Concept of Regulation 2.1.1 What Is Regulation? 2.1.2 Information in Regulation 2.2 Regulation in the Financial Sector 2.2.1 Reasons for Regulation of the Financial Sector 2.2.2 Goals and Objectives of Financial Regulation 2.2.3 Architecture of Financial Regulation 2.2.4 Styles/Modes of Financial Regulation 3 The Information Problem and Regulatory Failure 1 The Information Challenge in Financial Regulation 1.1 The Information Deficit 1.1.1 The Information Gap 1.1.2 Unknown Information 1.1.3 Knightian Uncertainty 1.2 The Role of Complexity 1.3 Addressing the Information Deficit 2 Regulatory Failure 2.1 Regulatory Capture 2.2 Crises-driven Regulation 2.3 Regulatory Forbearance 3 Result: Regulation—A Losing Game? 4 An Introduction to Financial Innovation 1 The Role and Meaning of Innovation 2 Innovation and Regulatory Dialectic 2.1 The Industry Side of the Game 2.2 The Regulator’s Side of the Game 2.3 The ‘Pacing Problem’ 3 A Primer to Financial Innovation 3.1 Financial Innovation: A Chequered History 3.2 Defining and Classifying Financial Innovation 3.2.1 ‘Good’ and ‘Bad’ Innovation 3.2.2 ‘Incremental’ and ‘Radical’ Innovation 3.2.3 ‘Product’ and ‘Process’ Innovation 3.2.4 Three Key Considerations When Assessing Financial Innovation 3.3 The Distinct Nature of Financial Innovation 3.4 Drivers of Financial Innovation 3.4.1 Demand-Driven Innovation 3.4.2 Supply-Driven Innovation 3.4.3 Regulation as a Driver for Financial Innovation 3.5 Assessing Financial Innovation: Implications so Far 3.5.1 Innovation and the Information Deficit 3.5.2 Regulating in the Face of Financial Innovation 3.5.3 Implications for Regulatory Objectives 5 Fintech—What’s New About It (and What Isn’t)? 1 The Term Fintech and What Is Captured by It 2 Fintech Drivers 2.1 Supply-Side Drivers of Fintech 2.2 Demand-Side Drivers of Fintech 2.3 Regulation as a Driver of Fintech 2.4 Contextualization of Fintech Drivers 3 New Fintech Business Models 3.1 Payment, Clearing, and Settlement 3.2 Deposit, Lending, and Capital Raising 3.3 Asset Management and Financial Advice 3.4 Market Support Services 3.4.1 Banking-as-a-Platform 3.4.2 Regtech 4 Same Same, but Different: Distinctive Features of Fintech 4.1 New Field of Actors 4.1.1 The (Standalone) Consumer-Faced Fintech Firm 4.1.2 Techfin and Bigtech 4.1.3 Technology Provider/TPPs 4.1.4 Neo-Banks 4.1.5 Incumbent Financial Institutions 4.2 New Pace of Innovation 6 Digital Disruption: Structural Shifts Under Fintech 1 Introduction to the Analysis 2 Decentralization 2.1 Decentralization of the Playing Field 2.2 Decentralization of Activity 2.3 Decentralized Technology 3 Automation 3.1 Automation of Front-Office Activity 3.2 Automation in the Back Office 3.3 Shifting Gravity: From Human-Driven to Algorithmic Finance 4 Datafication 4.1 The Three Vs 4.1.1 Volume 4.1.2 Variety 4.1.3 Velocity 4.2 The Data-Induced Shift of the Sector 5 Conclusion 7 The Information Problem Under Fintech 1 The Fintech Complexity 1.1 New Opaque Market Structures 1.2 Technological Sophistication and Specialization 1.3 Speed and Size-Induced Complexity 2 Information Deficit Under Fintech 2.1 Fintech and the Widening Information Gap 2.1.1 Inherent and Artificial Information Advantages Under Fintech 2.1.2 Information Processing Capacity in the Era of Fintech 2.2 Fintech and Unknown Information 3 Summary of Findings and Some Real-World Indicators 4 Regulatory Implications 4.1 Fintech Challenging Traditional Style and Architecture of Financial Regulation 4.2 Fintech and Regulatory Failure 8 Conceptualizing a Regulatory Response to Fintech 1 The Point of Departure 2 A New Regulatory Approach: Rethinking the Public–private Divide 2.1 Three Guiding Principles Underwriting a New Structure: Experimentation, Participation, and Decentralization 2.1.1 The First Theoretical Foundation: Experimentation 2.1.2 The Second Principle: Participation 2.1.3 Decentralization 2.1.4 Summing up a New Collaborative Approach 2.2 Flexibility 2.2.1 The Rigidness of the Status Quo 2.2.2 The Case for More Principles 2.2.3 Downsides of Principles 2.2.4 A More Nuanced View 2.2.5 Principles in Practice 2.3 Harness Technology 2.3.1 The Necessity of Technologization 2.3.2 Human vs Machine Regulator 2.3.3 Machine Regulatory Failure 2.4 Risks and Challenges of the New Approach 2.4.1 The Risk of Regulator Failure in a PPP Approach 2.4.2 Aligning Incentives in a PPP Model 2.4.3 Addressing (Regulatory) Uncertainty 2.5 The New Approach in Light of the Regulatory Objectives 9 Analysing the Current Menu of Fintech Regulation 1 Context and Goal of the Analysis 2 Innovation Hubs/Facilitators 2.1 Concept 2.2 Case Study: The EU Innovation Hub Landscape 2.3 Assessment 3 Fintech Sandboxes 3.1 The Regulatory Sandbox 3.1.1 Concept 3.1.2 Case Study: The FCA Regulatory Sandbox and Beyond 3.1.3 Assessment 3.2 Umbrella Sandbox 4 Supervisory Technology (Suptech) 4.1 Infrastructure Suptech 4.1.1 API Architecture and Real-Time Monitoring 4.1.2 Data-Pull Approach 4.2 Suptech Tools: Machine-Readable and Executable Regulation 4.2.1 MRER Pilots 4.2.2 Risks and Limitations of MRER 10 A Reg- and Suptech Platform for Fintech (Policy Proposal) 1 Recapturing the Findings so Far 2 Overhauling the Architecture of Financial Regulation 3 Optimizing and Expanding the Regulatory Toolkit 3.1 Optimizing the Regulatory Sandbox 3.2 Adding Specialized and Thematic Experimentation Spaces to the regulator’s Toolkit 3.2.1 Specialized Sandboxes 3.2.2 Thematic Sandboxes 3.2.3 Industry Sandboxes and Regulatory Labs 3.3 Summary—Spoilt for Choice 3.4 Implications for the Information Gap and Regulator’s Mandate 4 Necessary Structural Changes to the Regulator 4.1 More Discretion for the Regulator 4.2 Resource Requirements for the New Approach 4.3 A Cultural Change Inside the Regulator 5 Remaining Risks and Limitations 11 Summary and Conclusion 1 Financial Regulation and Its Inherent Information Problem 2 Financial Innovation and Its Contribution to the Problem 3 Fintech as the Current Manifestation of Financial Innovation 4 Digital Disruption: Structural Shifts by Fintech 5 Informational Implications of the Structural Shifts 6 Three Guiding Principles – the Intellectual Foundation of a New Approach 7 Two Necessary Conditions 8 Current Regulatory Approaches to Fintech 9 The Proposal Bibliography Index