Fintech and the Regulatory Evolution

Fintech and the Regulatory Evolution

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Hong Kong FinTech Week – an annual event drawing thousands of visitors from across the world – attracts big-name players such as Tencent and Alibaba, as well as niche operators offering apps for making small loans, perhaps for a wedding. A highlight at this year’s event, held November 4-8, was an address by Ashley Alder, chief executive officer of Hong Kong’s Securities and Futures Commission, one of the financial regulators in Hong Kong.

On November 6, Mr Alder announced a new regulatory framework for virtual asset trading platforms that “draws heavily on the standards which we expect of conventional securities brokers and automated trading systems”, but with additional requirements to address specific risks associated with trading of virtual assets. “Our new regulatory framework covers major investor protection concerns, including the safe custody of assets, know-your-client (KYC) requirements, anti-money laundering and market manipulation,” he said.

As new technology rapidly disrupts the financial services sector, regulation must try to keep pace. Hong Kong has become a case study, taking a global lead in creating a regulatory environment that is conducive to fintech development and in regulatory technology (regtech), which manages regulatory processes such as monitoring, reporting and compliance within the financial services sector through technology.

“Hong Kong’s unique environment – a leading financial hub with growing momentum in regulatory technology adoption – provides a strong foundation for its regtech startups,” said Felix Cheung, chairman of the RegTech Association of Hong Kong and chief executive officer of Cyberport’s incubatee, Riskflo Asia Limited. “Regtech solutions are in great demand to help different companies and industries to better adhere to the best global practices and standards.”

“Regtech solutions are in great demand to help different companies and industries to better adhere to the best global practices and standards.”

Felix Cheung, chairman of the RegTech Association of Hong Kong

Hong Kong’s deployment of regtech to enhance regulatory compliance and risk management in a rapidly changing financial-services landscape has been welcomed by the industry. “Hong Kong is among the more forward-thinking regulators in the world right now,” said Lizzie Chapman, chief executive officer of ZestMoney, a consumer lending platform based in Bangalore, India, who cited the recent issuance of banking licences to virtual banks as an example of Hong Kong’s proactive stance.

Regtech is one of the “hottest trends” in financial services, according to a report by WHub, a Hong Kong-based startup community, adding that worldwide regtech investment more than tripled from US$1.2 billion in 2017 to US$3.7 billion in 2018. The market is expected to be worth US$6.4 billion in 2020. “It represents an opportunity to reinvent the compliance function,” WHub’s recent FinTech White Paper noted.

The FinTech Supervisory Sandbox launched by the Hong Kong Monetary Authority (HKMA) in 2016 facilitates pilot trials of fintech initiatives without the need to achieve full compliance with the HKMA’s supervisory requirements. The financial sector has welcomed the initiative. “Innovative technology solutions with non-traditional processes can be explored safely in a sandbox framework,” said Mary Huen, chief executive officer of Standard Chartered Bank (Hong Kong). “This is increasing the chance of building more sophisticated solutions to tackle any new risks emerging from the increasing use of technology, including cyber and data security.”

Several regtech initiatives are in a trial phase, such as Earth Channel, a startup which provides solutions to address inefficiencies in the KYC and anti-money-laundering (AML) processes and graduated from the Cyberport Incubation Programme in September.

“We are turning regulatory problems into business opportunities.”

Wong Wai-kong, chief executive and chief technology officer, Earth Channel

“Our product is a platform for financial institutions targeting small and medium-sized enterprises to collaborate in shared KYC and AML services,” said Wong Wai-kong, Earth Channel’s chief executive and chief technology officer. “We help them in transforming traditional KYC processes from a cost-centre to a value-added function. We are turning regulatory problems into business opportunities.”

Fintech analysts praise the HKMA for taking a regional and global approach to regulation. “For example, at Hong Kong FinTech Week, HKMA was sitting together with the People’s Bank of China and Bank of Thailand and talking about Libra,” said Karen Man, a Hong Kong financial services partner at law firm Baker McKenzie. “Global financial regulation can be a grey area and creates a lot of potential concern. It’s good to hear what other regulators are saying.”

For HKMA, one of the major areas of work is the introduction of “virtual banks” that have energised the fintech sector globally. “What’s different between many new fintechs and historical fintechs that provided technology services to banks is that the former are establishing direct relationships with customers,” said Kathryn Petralia, co-founder and president of Kabbage, an Atlanta-based business loan provider. Ms Petralia, a Hong Kong FinTech Week attendee, said virtual banks provide specialised products and services to their customers. “They generally focus on delivering a small number of solutions and doing it incredibly well.”

“I was quite surprised to see so many of the global banks having a strong presence here and doing pretty innovative stuff.”

Lizzie Chapman, chief executive officer, ZestMoney

While the rise of fintech is a challenge to incumbent brick-and-mortar banks, Hong Kong is likely to create a legal environment that enables traditional incumbents and disrupters to co-exist and work together. “I was quite surprised to see so many of the global banks having a strong presence here and doing pretty innovative stuff,” said Ms Chapman.

Ms Huen at Standard Chartered agreed. “With the HKMA actively promoting the use of regtech, innovative technology solutions can be explored, increasing the chance of building more sophisticated solutions to tackle any new risks,” she said. “We look forward to closely working with the HKMA and the fintech industry to make the best use of innovation opportunities in this area.”

Fintech is likely to encourage existing banks to consider how to further upgrade their services and make better use of tech, HKMA chief executive Eddie Yue said at the Hong Kong FinTech Week. “The result, I hope, will be a more innovative and globally competitive banking sector in Hong Kong, offering customers more diversified and efficient services.”

Ultimately, fintech should be designed to help as many people as possible. At a grassroots level, the Financial Services and the Treasury Bureau of the Government of the Hong Kong Special Administrative Region announced that in order to bring greater convenience to the public, the government accepts payments of taxes, rates and Government rent, as well as water charges through the Faster Payment System (FPS) starting from November 1, 2019.

“We have seen strong growth in the number of FPS registrations,” Mr Yue said in his speech. “Right now, there are over 3.6 million registrations out of a population of just over 7 million, so the penetration rate of our FPS is likely among the highest in the world.” Mr Yue added that new products and services will continue to improve and evolve, and tech adoption by financial institutions is likely to bring another wave of regulatory changes. “For us at the HKMA,” he said, “this raises important questions about balancing risks and rewards.”

In pioneering Hong Kong, regtech development is being driven by regulators who strive to set high standards of compliance, regtech providers who desire scalability of their products, and customers who demand transparency and user-friendliness. Facilitating regtech under a global benchmarking system could help set best practices and promote strengthened compliance, and reduce the cost of financial services for consumers.