US regulatory environment threatens the rise of fintech

The growth of fintech is challenging governments to devise new regulations to meet the demands of the burgeoning industry. The U.S. currently draws the largest amount of fintech investment and is home to many early success stories.

Therefore, it may come as a surprise that the regulatory environment in America is hindering the growth of fintech and impeding its impact on the broader economy.

Fintech companies earned approximately ₤6.6 ($8.15) billion in revenue globally in 2015, according to a report commissioned by the Treasury of the U.K. government. Recent data on the sector from KPMG shows that while North America has fallen behind Asia in terms of regional investments in fintech, companies in North America still received $900 million of $2.4 billion, or more than 37.5 percent of funds, in the third quarter of 2016. KPMG notes that both the number of deals and total amount invested in American fintech companies has dropped significantly, while Asia continues to see growth in fintech investments. 

North America, Europe and Asia all had the lowest number of venture capital financing deals for fintech companies in five quarters. The five largest investments, however, were all in Asia, including massive financing deals for China’s Qufenqi ($449 million) and U51 ($310 million), which amounted to more than 80 percent of the total received by the 96 North American companies in the quarter. U51 has also since revealed a further $84 million — more than any U.S. company attracted in the quarter — as part of the same funding round.

The U.S. is producing many fintech startups attractive to investors — just not as attractive as the less numerous Asian startups. The third quarter of 2016 was the second of the year in which Asian fintech companies attracted more venture capital funding than North America, and pending fourth quarter results, total investment for the year by venture capital in Asian fintech outstrips that in North American fintech $4.7 billion to $4.5 billion. America remains a fintech leader, but its position is being challenged.

Uncertainty about the future direction of fintech regulation would be more understandable, and perhaps less daunting to investors and entrepreneurs, if the current regime were less confusing.

One reason for the regional shift can be found in the Treasury report, which ranks New York, California and six top countries for fintech, according to several criteria. The American fintech hubs ranked last and second-to-last in terms of “policy,” including regulatory regimes, government programs and taxation. 

Not just which rules, but whose?

One reason the report notes for the low ranking is that the U.S. fintech hubs on either coast are subject to regulation at the state level, by the Department of Financial Oversight in California and the Department of Financial Services in New York, respectively. Another is the lack of government support and collaboration with businesses in innovative fields.

The two American regions dominated the U.K. government’s rankings, aside from their regulation-related woes. Correspondingly, while some of the world’s biggest fintech firms are American, the distribution of unicorns and other fast-growing startups is tilting toward a more even global balance.

Not just the Treasury report, but investors themselves, as well as founders, have identified regulation as a main concern, and European regulators have responded by overhauling EU laws related to payment services to benefit fintech startups. In Asia, numerous countries have already adjusted regulations to promote fintech growth, including the largest consumer markets, China and India.

The problem with fintech regulation in the U.S. is not just what those regulations are, but persistent confusion about what those regulations are, and deep uncertainty about how they are evolving. The Government Accountability Office has recognized the problem, but federal lawmakers have yet to act, and federal agencies have done little. In December, the Office of the Comptroller of the Currency announced plans to introduce a special charter for fintech companies to be subject to federal banking rules, but those plans have faced criticism from such organizations as the Center for Responsible Lending and New York’s Department of Financial Services.

Federal weight, or federal wait?

One major step undertaken by the U.S. government to deal with the problem is the attempted creation of a “sandbox” on the model of the successful U.K. one, with the Financial Services Innovation Act of 2016. The Act currently sits with two committees, having been referred by the House Agriculture Committee to a subcommittee in mid-October. 

The traditional banking industry is famously — or even infamously — influential in Washington, its reach sparking complaints about the undue power of “Government Sachs” and other Wall Street institutions. That influence has not benefited fintech, as big banks are hardly fast to adapt, let alone eager to share revenues. PwC warned of tightening regulations in the U.S. in a 2016 report, in which it found 86 percent of fintech CEOs are worried about what that might mean.

Speculation will continue to surround the industry until concrete policy or legislation is announced.

Uncertainty about the future direction of fintech regulation would be more understandable, and perhaps less daunting to investors and entrepreneurs, if the current regime were less confusing. Part of that uncertainty is inherent to fintech at this point in time — should they be regulated as financial companies or IT service providers? Lending platforms and e-commerce payments providers have overlapping, but significantly different concerns and responsibilities.

On crucial points, the regulations on the books could be tested in the courts, a risk that chokes off potentially lucrative innovation.

Is major change coming?

This is all to say nothing of the incoming government. Legislative and executive branches united by the same party should help clarify things, but the topic has not been specifically addressed.

Uncertainty about international trade agreements are as worrying for some fintech companies as the prospect of an easy regulatory load is uplifting for others.

While as PayPal co-founder, one of President Trump’s top advisers, Peter Thiel, gained his wealth and reputation from fintech, there has been scant indication of the direction of fintech regulation change over the next four years. Thiel has recently invested in several fintech companies — in Europe.

An early attempt to predict the Trump administration’s impact on fintech by BI Intelligence says new regulation specific to fintech may not be coming at all, and the lack of clarity about the administration’s economic plans will likely slow investment in the sector. The uncertainty, and its damaging effects on American fintech growth, are likely to continue until specific steps are outlined to ease and clarify the regulatory burden facing U.S. companies.

The uncertainty about direction even extends to the very real possibility that nothing will happen at all. There have been indications that cutting red tape and reducing regulation is a priority for the new U.S. government, and with the Republican Party capturing the House, Senate and White House, deregulation could be relatively swift. 

Speculation will continue to surround the industry until concrete policy or legislation is announced. There are other ways the U.S. government could help or hinder its domestic fintech industry, as well. Not just access to foreign markets, but access to skilled labor, research and development funding, and other conditions, will also impact the role U.S. fintech companies have in the global industry.