Can the regulator learn and adapt? What resources are in place to do that?
In the Welfare State era of top-down, detail-oriented, prescriptive regulatory regimes, drafting legislation and its associated regulations tended to be the most difficult part. Once drafted, compliance and enforcement personnel had clear marching orders, and the task was far simpler.
This is no longer the case. The speed and complexity that characterise financial markets, and changes in the financial sector, cannot be responded to in such a static manner. International competition for global financial business also provides a clear incentive for regulators to develop flexible, context-sensitive, ‘optimised’ regulatory structures that impose the least possible regulatory burden on financial industry actors. In this environment, drafting general principles-based legislation and delegating decision-making authority (including to private actors) is actually the easier part. The far harder part is ensuring that such a flexible regime is nevertheless robust and meaningful; that is, that there is the back-end capacity needed to gather and digest information, to track and evaluate changes, and to learn from experience. This work can be tedious and it is never-ending, but it is indispensable. It requires tenacity, commitment and resources. In case after case in financial regulation, it is at this implementation stage that efforts fall short.
Implementing innovation-ready regulation in a meaningful way can be difficult for a few different reasons. We can underestimate the resources required, or provide the wrong kind of resources, or resourcing can dry up over time - something that is especially possible during times when things seem to be going well. We can become complacent as markets
A regulatory roadmap for financial innovation 75 rise, or as fintech innovations seem to deliver benefits. Regulatory judgment can be swayed by self-interested industry framing of issues, or even simply by the social and emotional appeal of being pro-innovation, forward-looking, plugged-in. We can fall back on heuristics, assumptions and default rules, for the sake of clarity and comfort, and those shortcuts can lead us astray.
With respect to fintech and other fast-moving environments, humans’ cognitive limitations also play a role. As a species, along with the other pitfalls above, it turns out that we do not like uncertainty that much, and we are liable to underplay it. We are also not terribly good at registering or responding to change. This includes human-generated change. We are especially poor at registering incremental change, which by its nature never trips an alarm. Fintechs’ incursion into the traditional business of banking may be an innovation of this variety. On the other hand, after a high salience disaster has occurred, we suffer from hindsight bias and tend to overreact, over-blame and behave reductively. One can imagine such a reaction in the event that a popular fintech product were to collapse and harm members of the public. We can also be heavily influenced by the hierarchy and strategic priorities of the organisations in which we operate. When it comes to fintech in particular, regulators should also recognise the interjurisdictional competitiveness that may be pushing them towards overeager acceptance of, and perhaps inadequate scepticism about new products. Pretending that these factors are not operating is not helpful. What is helpful is to develop mechanisms, including analytical roadmaps and better data, to compensate for the cognitive limitations and institutional pressures that are operating.
The question of how regulation should engage with fintech is not one that can be answered at one point in time, and so resolved. Regulators must continually gather data and roll it back into their own learning and analysis. Relevant data would include not only information gathered from within a government-sponsored fintech sandbox, if one is in place in the jurisdiction, but also from the broader environment. Regulators must ask themselves, continually, whether they still know who the main fintech actors in their space are, whether their assumptions still hold true, what might be happening beyond the borders of their vision and so on. This requires a substantially different frame of mind, and different training, than that which most financial regulators held across most of the last century. It also requires courage, independence and the ability to try to imagine how to apply regulation’s underlying normative commitments and its goals to continually new contexts.