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As we begin 2023, regulation is top of mind for many fintech investors, especially in the more niche areas of the market, like crypto. Critically, fintech regulatory environments vary significantly by country and may either create substantial investment risks or potentially significant opportunities for growth.
In this piece, we outline how fintech’s growing role as a national strategic imperative impacts regulations, the effect of ESG on regulation, and the specific need for regulation in crypto markets.
Governments around the globe have started to consider the fintech sector a national strategic imperative over the course of the last five to 10 years. The impact of the war in Ukraine is one example of this shift in action. Major credit card networks exited Russia relatively quickly when the war began, but because Russia built a state-owned domestic debit network after the 2014 annexation of Crimea, the country’s payment systems were able to continue to function. This was despite significant fintech mindshare and intellectual property leaving the country.
Countries across the emerging and developed world are increasingly proposing or adopting fintech-focused regulatory changes with the goal of growing, stabilizing, and/or securing their domestic financial services industries.
Emerging market fintech regulation
Key fintech markets like Brazil, India, Indonesia, and China possess a unique recipe for innovation to drive growth. All four markets have significant monopolistic behavior, state-owned enterprises, banking and payments systems that have taken advantage of that structure, and low-quality existing financial products with high margins. This combination can create a great environment for innovators to challenge sleepy incumbents and capture margins by solving problems and disrupting products. However, a growing fintech industry also needs a regulatory environment that supports innovation. Contrasting Brazil, India, and Indonesia with China shows the range of potential regulatory stances.
In Brazil, we’ve seen the government deregulate industries like payments, opening up merchant acquiring and payment processing services for local competition. This intervention in favor of disruptors has significantly reduced pricing, improved customer service, and increased the cadence of product innovation. In India, the government increased foreign direct investment in industries like insurance from 25% to 75%, allowing for an increase in global capital to flow into the industry and spur innovation. In Indonesia, the government appears to be favoring accommodative policy but is earlier in the process. Indonesia’s Financial Services Authority (known as OJK) has put together a Digital Finance Innovation Roadmap to help balance innovation and consumer protection.
China, on the other hand, has been less supportive of fintech disruption because the government views the sector as very important for currency control, for banking system soundness and stability, and, therefore, for its ability to manage the economy. The Chinese government has effectively locked out Western payments companies, such as the leading global card networks, in favor of national champions and local competition. Critically, fintechs in China got so large that they became systemically important, which caused a more restrictive policy response. For example, two companies controlled more than 50% of payment volumes and consumer lending volumes at one point. We believe that China’s regulations to bolster domestic fintech, to support competition, and to limit companies from growing too large are trends that will continue and challenges that companies will have to navigate. This was evidenced by headline-making postponement of the IPO of the leading e-commerce provider’s fintech arm in late 2020.
Though Brazil, India, and Indonesia have thus far favored accommodative policy, it is possible that China’s restrictive regulatory trends could be replicated in other countries if their respective domestic fintech ecosystems see players become too systemically important.
US fintech regulation
Notably, there are very few, if any, systemically important fintech companies in the US. Countless US fintechs are trying to take market share from many much larger traditional banks and insurance companies. This diverse ecosystem has likely led to less regulatory urgency.
Moreover, US regulation of broader financial services has often led to innovation from fintechs. For example, the Dodd-Frank bill that was passed after the global financial crisis included the Durbin Amendment, which regulated debit interchange (the fee a card issuer receives to help manage the system and protect against fraud) down to a low level for banks with over US$10 billion of assets. This created an opportunity for banks under that threshold (including new fintechs) to continue to earn attractive debit interchange. This helped fuel the US fintech sector’s evolution as it generated high revenue, enabling fintechs to raise large venture capital rounds to then invest in other growth areas.
In our view, US regulators do not feel fintechs pose a systemic risk, and potential financial services regulations are likely to continue to create opportunities in most subsectors. This could be in part because the market’s strong support for greater financial inclusion has also made regulators hesitant to overregulate the fintech industry. Many new fintech players are providing financial services to customers that have long been underserved. Though regulation is important to a well-functioning financial services ecosystem, it’s possible, and perhaps likely, that the positive impacts of greater access to financial services make US regulators less likely to enact restrictive regulations on the sector. This may also be true in other non-US markets where fintechs are driving financial inclusion and do not present a systemic threat.
The crypto industry, on the other hand, saw increased calls for regulation after the collapse of a multi-billion-dollar stablecoin, several crypto lenders, and a prominent exchange. While some see the bear market in crypto as a setback to innovation, we see it as an accelerant that can help to weed out unsustainable business models, speed up progress toward greater regulatory clarity, and improve methods of addressing bad actors.
We expect progress across several dimensions of regulation. One area is tokens, where clearer rules on a potential security definition may cause a challenging adjustment process but could also enable regulated tokens to be incorporated into more business models. Other potential areas of regulatory focus include stablecoins, custody, and intellectual property.
We also see greater attention to the privacy considerations in crypto. Though blockchain data is linked to anonymous account numbers, it is becoming increasingly easy to link one’s transaction record to one’s real-world identity. Striking the right balance between privacy and regulatory oversight is of paramount importance, particularly for users under oppressive political regimes.
Importantly, the shifting geopolitical landscape will have an impact on crypto adoption and regulation. Citizens in many countries do not have access to well-functioning financial markets, and for them, decentralized crypto protocols could present significant upgrades to their current systems. There is also a growing possibility that crypto becomes a foundation for a move away from a Western-centric financial system by some countries in an increasingly multipolar world.
Amid crypto’s recent volatility and negative headlines, it has been easy to lose sight of how some decentralized finance mechanisms fared quite well and demonstrated how the use of transparent blockchains in finance can improve the resiliency of a system. We see many potential ways in which crypto innovation can be a solution to regulatory challenges. Critically, there is a wide range of outcomes for crypto regulation and adoption around the world, and we believe it is important to explore a breadth of scenarios to better prepare for inevitable surprises along the way.
Each country’s fintech regulatory landscape may evolve as the sector becomes an increasingly crucial part of its economy and national security. To navigate long-term fintech opportunities and risks in 2023 and beyond, we believe industry experience and deep domain expertise are essential to understanding the impact of today’s shifting geopolitics, ESG landscapes, and country-specific regulatory environments.
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