Fintech Startups and Incumbent Players Series - Why Regulating Fintech Requires a Fundamental Shift in How We Regulate Finance

The rise of fintech in the last decade is often described as a ‘revolution’ in finance. It is not hard to see why that is. New digital technologies and advances in data analytics are transforming the way we conduct financial transactions and interact with one another in virtual financial markets. And, as transacting becomes faster, cheaper, and more convenient, it potentially enables much wider swaths of the world’s population to enter the world of digital finance. In this sense, fintech is often seen not only as a financial-market disruption but also as a force of greater financial inclusion and broader social progress. 

With all this excitement, however, it is all too easy to forget a simple fact that that technology—even the most powerful one—is ultimately just a tool. How to use that tool, for what purposes and to what effects, is a choice. So, what exactly does this choice involve in the context of fintech? And how can it be translated into a coherent strategy of fintech regulation?  

In a new article, ‘Technology v. Technocracy: Fintech as a Regulatory Challenge’, I address these ‘big-picture’ questions. The article takes a deliberately broad view of fintech as a systemic force disrupting the very enterprise of financial regulation, as opposed to any particular regulatory scheme (such as securities or bank regulation, consumer protection regimes, anti-money-laundering rules, and so on). From this macro-level perspective, fintech’s principal impact appears not merely as a mechanical sum of various regulatory ‘gaps’ but as a fundamental structural challenge to the very paradigm of modern financial regulation. 
To build this argument, the article starts by showing that most jurisdictions currently follow a fundamentally technocratic paradigm of financial regulation. This dominant regulatory model operates primarily through the mechanisms of structural compartmentalization, bureaucratic specialization, and narrow targeting of specifically cognizable ‘market failures’ within the relevant agencies’ jurisdiction. One of the core premises of the technocratic paradigm is the possibility of identifying and isolating well-controlled micro-level phenomena and decision points, so that the desired macro-level outcomes are simply accretive. 

Fintech, however, is transforming financial markets in ways that undermine basic assumptions built into, and shaping the operation of, this technocratic regulatory paradigm. Exploring these dynamics, the article develops a five-part taxonomy of the key tech-driven changes in the structure and operation of the financial system, and the corresponding challenges these systemic shifts pose to the continuing efficacy of the regulatory enterprise. Specifically, it shows how new technologies dramatically increase the scale and scope of the financial system, make it move at an unprecedented speed, shift financial markets’ decisional center of gravity from humans to algorithms, render finance less transparent and more complex, and blur traditional jurisdictional boundaries. In this tech-driven financial universe, it is increasingly difficult to isolate and target in a controlled manner specific points of ‘market failure’ and assume that a salutary system-wide outcome will follow.
This high-level taxonomic exercise reveals the fundamental tension at the core of the fintech problem. On the one hand, new technology is causing significant structural shifts in the financial system. On the other hand, the emerging regulatory responses to these macro-level changes continue to operate primarily on the micro-level. Using the US experience as its principal example, the article surveys current efforts to regulate fintech (including regulatory sandboxes, special fintech charters, and so-called ‘RegTech’ initiatives) and shows the limiting effects of the technocratic bias built into their design. 

The article concludes by outlining several alternative regulatory options that would explicitly target the core macro-structural, as opposed to micro-transactional, aspects of the fintech challenge in a more comprehensive and normatively unified manner. Three key features characterize this type of a qualitatively new regulatory strategy. First, a comprehensive and normatively unified fintech strategy implies a fundamentally proactive, rather than reactive, regulatory stance with respect to technology. Second, it elevates the role and significance of deliberately structural, rather than transactional, regulatory measures. Finally, an effective fintech strategy incorporates specific tools of direct public participation in financial markets, in addition to traditional forms of regulation and supervision. Without claiming to offer fully developed reform blueprints, the article discusses an array of regulatory tools for pursuing this new regulatory philosophy. 

Saule T. Omarova is Beth and Marc Goldberg Professor of Law at Cornell University.