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Regulation

As financial technology advances, push for updating regulations grows

A number of new reports and proposals are calling for an update to regulations surrounding fast-changing financial technology, a move that institutional investors said would bring certainty to the market and increase efficiencies.

Earlier this month, the Bureau of Consumer Financial Protection said it was working with 11 financial regulators around the globe on an initiative to create the Global Financial Innovation Network, which would allow firms to test new financial services and products, such as artificial intelligence, in different financial markets under a single regulatory umbrella. In late July, the Financial Industry Regulatory Authority said it was seeking public comment on how it can best support fintech innovation, while the Treasury Department put out a 222-page report on fintech regulations the same week with more than 80 recommendations for lawmakers and regulators that it said enables "responsible experimentation in the financial sector, improves regulatory agility and advances American interests abroad."

Institutional investors who are members of the Committee on Investment of Employee Benefit Assets often have to simultaneously navigate myriad regulatory agencies, like a combination of the Securities and Exchange Commission, Department of Labor, IRS and Treasury Department, said Dennis Simmons, CIEBA's executive director in Washington.

"It's much more inefficient when some of the subtleties in regulations are slightly different," Mr. Simmons added. "It's just more costly for plans to maintain additional staff and to have dot the 'i's' and cross the 't's' on slightly disparate rules.

"Anything that allows for more innovation in the investment space, we really do think is a positive for prudent long-term investors like ourselves," Mr. Simmons said.

A report from The Pew Charitable Trusts earlier this month described the current state of the U.S. financial services regulations as "a patchwork of state and federal initiatives that lack a common organizing strategy," which cause regulatory uncertainty for businesses and investors.

"For institutional investors, it's all about regulatory efficiency," Mr. Simmons said. "The advantages are numerous when you're really dealing with one set of guidelines from regulators rather than multiple guidelines."

That's why the regulatory landscape in this arena must be reformed, said Scott Talbott, senior vice president of government affairs for the Electronic Transactions Association in Washington.

"Technology here has definitely outpaced the regulatory environment," he said.

The Treasury report is the agency's fourth stemming from an executive order President Donald Trump signed soon after entering the White House that called on the department to find laws and regulations that are inconsistent with Treasury's regulatory aim.

The report called for removing "regulatory barriers to foundational technologies" that would enable the use of scalable, competitive technologies, adding, "similarly, facilitating the further development and incorporation of cloud technologies, machine learning, and artificial intelligence into financial services is important to realizing the potential these technologies can provide for financial services and the broader economy."

With respect to financial planning, Treasury stated in the report that it "has concerns that the current regulatory structure discourages the provision of integrated investment advice for assets held in retirement and non-retirement accounts."

Currently, financial planners selling insurance products are regulated by state insurance regulators while financial planners providing advice to plan participants in corporate 401(k) plans must comply with ERISA. Treasury recommended that an existing regulator be tasked as the primary regulator. If the financial planner is providing investment advice, the relevant regulator will likely be the SEC or a state securities regulator, the report said.

The SEC concluded the comment period earlier this month on its proposed Regulation Best Interest, which requires that broker-dealers and those employed by them place the interests of the clients above those of the broker-dealers, and applies to retail customers. But uncertainty remains as to when individuals withdrawing assets from employers' retirement plans become retail customers.

"We were pleased that Treasury is looking at improving the ability for (retirement plan advisers to offer) insurance and other products in the retirement plans," Mr. Simmons said. "Particularly it's an issue for our members when employees get to the distribution phase and having more flexibility within a plan to offer, say, annuity distributions or other lifetime income products" makes sense.

Treasury also said that it will work with federal and state financial regulators to establish a regulatory sandbox, which would unify the various regulatory stakeholders and make it easier for companies to bring a product or service to market.

"Frequently, firms find that it is not even clear which agencies — or which units within those agencies — need to be engaged. The result is that innovators, particularly smaller firms, face significant and unnecessary burdens in terms of time, money, and opportunity costs," the Treasury report stated.

Harvey Hudes, director of the FinTech Professional Association and CEO of Caliber Corporate Advisers LLC in New York, said the creation of a sandbox would be an important step toward connecting the dots between financial innovation and consumer protection.

"One of the concerns we hear most from new fintech entrants is around the challenge of finding a single source of truth when it comes to regulatory guidance on launching a new product or service," he said.

Hal Crawford, a managing director in Alvarez & Marsal's financial industry advisory services group, said the timing of efforts to modernize the nation's financial regulations makes sense.

"I think a lot of the regulatory agencies and authorities were not up to pace and as (the bitcoin ) market skyrocketed and then subsequently fell, even in the U.S. it forced the regulators in March, April, May to say 'should we have been more out in front of this subject? What did we miss?'"

No matter the timing, a regulatory update is needed, said Aaron Klein, a fellow in economic studies at Brookings Institution in Washington. "As finance is one of the most highly regulated sectors of our economy, outdated regulation that is not modernized and expanded will slow down adoption, thus reducing growth and the benefits that can be done from technology," he said.

The recommendations outlined by Treasury won't be implemented overnight, but industry stakeholders said having a blueprint makes things easier for everyone.

"While Treasury is not a regulator, and you won't see any immediate changes, what you can see is a shift to recognize the modern marketplace and ask the regulatory framework to update itself … which overall is a positive," Mr. Talbott said. "What investors like is certainty and predictability and this report helps achieve that by letting everyone know what the new rules of the road are."