“Banking is not rocket science. It’s actually much more complicated.” Morgan Stanley told me this at new hire orientation ~15 years ago. A lawyer explained that banking involves thousands more regulations than launching rockets.
All these regs also apply to Fintech startups. So do regulations around cryptography, telecom, cross-border technology transfers, data privacy, and more. It’s daunting.
Incumbent banks have a huge advantage. Their compliance departments grew in lockstep with the cumulative workload. When regulators issued a new mandate, regulatees just bolted on another procedure. (FYI – My first job at Morgan Stanley was smoothing out the high-cost, high-effort solution bolted on to meet the new Sarbanes Oxley rules.) Banks and regulators grew symbiotically for decades.
Fintechs can take a few approaches:
- Imitation: Copy the banks’ approach to all-encompassing compliance. Massively expensive and time-consuming… But the regulators will be satisfied.
- Incubation: Avoid regulated activity. Let banks keep the compliance burden. Banks are your client. You’re just a vendor or project team. Low compliance risk.
- Specialization: Focus on a narrow regulated niche. Specialize in a single product, activity and/or market. Minimize regulatory footprint and stay compliant.
- Revolution: Change the tires while driving. Really, really fast.
Strategy #4 built quite a few unicorns outside the finance industry. Look at Uber, AirBnB & Lyft. Their compliance strategy can be summed up.
- Push boundaries of licensing & compliance. Break some rules outright.
- Along the way, pay some fines and lobby to change the regs.
- Pull back in markets where reg enforcement will break your model.
- Stay in markets where cost/benefit makes sense, even if the “cost” includes legal fines & penalties.
- Relentlessly work on ways to better comply with, circumvent, or keep breaking rules as appropriate.
Inside the banking and securities industry, regulations work a little differently. Finance industry compliance is more like changing the tires while driving as the police watch. They expected you to pull over, stay in your car until it’s safe, then set up traffic cones, and read the manual before reaching the jack and the spare…
Finance activities generally require licenses. If you break the rules, enforcement agencies can revoke your licenses and levy massive fines. The penalties get worse for doing business without a license or committing repeat offenses. Even first offenders can face jail time. The penalties can be personal. You’re not safe just because you work for a “limited liability corporation”.
Regulations are holding back progress. The technology is ready (and rapidly improving).
- Massively automated on-boarding processes
- Identity validation via biometrics
- “Tokenized” securities that allow real-time cap table ownership verification and complete chain-of-custody audit trail since inception for each product from the moment of original issuance.
- Self-custody via blockchain token “wallets”.
- Disintermediated trading via “DEX” (decentralized exchanges).
Note: Regulations are SUPPOSED to hold back progress. At least they are supposed to prevent shortsighted changes that impose massive disruptions and negative cost-benefit. Changing tires while driving is a perfect example. The day may come when Elon Musk creates “while you drive” self-changing tires with a 0.00000001% error rate… In the meantime, the cops will come after you for reckless endangerment for trying it.
Moral of the Story
Draw you own conclusions. Seriously. Fintech is already making a big difference to the global financial system, with massive positive disruption in some markets (eg payments revolution in China), and a more gradual impact in places that still use ATM’s, credit cards, and traditional bank loans as we all did 15 years ago.
The future will be regulated. Banking & securities rules will evolve, but they will not disappear. There will be laws, rules, guidance documents and court precedents covering licensing, KYC/suitability, AML, CFT, FATCA/CRS, public offering, investor qualifications, capital adequacy, liquidity, etc etc etc.
There will also be tech innovation, much of it led by today’s Fintech startups.
They just need to have all four wheels on the ground when the vehicle is in motion and the authorities are watching.