Over the last few years, the media has been full of daily references to industries being disrupted. The poster child for disruption is Uber, which disrupted municipal taxi markets with an “enter first and ask for permission later” philosophy. Airbnb similarly disrupted hotel markets by upending local zoning bylaws and regulations. In both cases, regulators were caught looking like Wile E. Coyote chasing the Road Runner unsuccessfully in the old Looney Tunes cartoons.
The latest industry to face the threat of disruption is the financial services industry and the source of the disruption is coming from information technology innovations. These disparate innovations are lumped together under the rubric of “fintech.” Fintech is often used to describe technology-enabled finance, e.g., lending, raising capital and investment management, foreign exchange and money transfer, robot advisers and the application of digital technology to insurance and regulatory compliance.
In Canada, fintech can fall under the purview of one or many regulatory bodies such as the federal Department of Finance, the Office of the Superintendent of Financial Institutions, the Ontario Securities Commission, the Financial Consumer Agency of Canada, the Financial Transactions and Reports Analysis Centre of Canada and Payments Canada. The regulators in the financial services industry seem determined not to play the role of Wile E. Coyote to the fintech Road Runner.
In Canada in 2016, the OSC unveiled its LaunchPad project, a fintech hub aimed at supporting new and early-stage fintech businesses. More recently, the OSC signed a deal with its U.K. counterpart to provide support to emerging fintech startups in both markets looking to expand across the pond. For its part, the Bank of Canada is currently working on a blockchain experiment launched in 2016 as a joint initiative between the central bank, Payments Canada and R3, a consortium of the world's largest financial institutions, including Canada's biggest banks.
In 2016, the Competition Bureau launched a fintech market study to examine Canada’s competitive landscape for new technology-led innovation and emerging services in the Canadian financial services sector. The study is exploring the competitive impact of fintech, barriers to entry or innovation and potential regulatory reform.
The study focuses on fintech that affects the financial products and services that Canadian consumers and small and medium-size businesses commonly seek out and use. These include: peer to peer and small/medium-size business lending, including crowdfunding; the use of technology to pay for goods and services; the systems that enable clearing and settling payments between institutions; and online-based financial advisory services. Notably, the Bureau is not studying: insurance; currencies and crypto currencies (e.g., Bitcoin); payday loans; loyalty programs; deposit-taking; accounting, auditing and tax preparation and services; large corporate, commercial or institutional investing and banking; and business-to-business financial services (e.g., cash handling).
This month, the Bureau hosted a workshop to examine the intersection of competition, innovation and regulation in Canada’s financial services sector focused on the competitive forces at play and possible impediments to the growth of fintech in Canada. This was a useful forum to discuss how best to balance the fintech competitive benefits with necessary consumer protections.
Another question that policy-makers and regulators are grappling with is whether fintech is a disruptor or enabler for Canada’s big banks. When asked by the think tank Canada 2020 in a February 2017 report “What is the biggest barrier to innovation in Canada’s financial sector?” a common answer was the oligopolistic structure of Canada’s financial sector dominated by six big banks. In the view of some startups, this creates an incentive for the banks to fight disruptive innovations.
By contrast, the incumbent banks argue that they have an incentive to actively engage in fintech rather than wait to face challenges from outside. They argue that the threat is not likely to come from startups but rather from social media companies, cable and telephone providers and foreign banks.
The risk for established financial institutions is that they may lose their most profitable lines of business to new fintech competitors while these new fintech firms become the trusted intermediaries between the financial institutions and their customers. A 2015 report from the Innovation Policy Lab At the Munk School of Global Affairs concluded that Canadian banks may be more vulnerable to this unbundling and disintermediation despite the perception that Canada’s current regulatory environment provides an effective “moat” around the activities of its leading financial institutions.
Innovation is identified as playing a major role in the 2008 global financial crisis, and the highly consolidated and regulated nature of the Canadian banking industry is often cited as having protected Canada from the worst effects of that crisis. At present, the bulk of industry regulation applies equally to big banks and financial startups; however, some question whether this is always appropriate, given that the failure of small players does not create the systemic risk that the failure of a big bank would.
In its response to the Bureau’s market study, the Canadian Bankers Association noted that the industry is supportive of a regulatory framework that continues to promote competition and innovation with appropriate regulatory oversight. However, it cautioned that a regulatory framework that provides oversight for all providers will help to maintain public confidence in the financial system and that such a framework must mitigate market conduct, as well as financial and operational risks that come with any new and emerging players and business models.
Globally, a number of authorities, including in the U.K.’s Financial Conduct Authority and Singapore, are moving toward a regulatory approach that allows fintech firms to enter the market in a limited way for the purpose of testing their products and services. Additionally, this “sandbox” approach provides the regulator with an opportunity to understand the fintech business model and adapt regulations or provide a waiver, as appropriate.
From a competition law perspective, depending on the market shares of the incumbents, their reactions to fintech market disruption could involve conduct that might otherwise be viewed as having valid business justifications and serving pro-competitive objectives. Another key competition law risk may arise from information sharing whether as a function of the new technology itself or in order to facilitate fintech development. Where any data is shared among competitors, it is crucial to ensure that this does not include the exchange of competitively sensitive information. Additionally, interoperability between the systems and fintech products used by different banks could give rise to competition law risks if such standards deny competitors access to essential technical specifications required to develop interoperable products.
The true extent of competition law issues will only become apparent as more fintech products and services enter the market. It is clear, however, that competition enforcers in Canada and around the world are keen to not be “Ubered” in the process. Given the particular history and structure of the banking industry in Canada, a key question will be whether adoption of fintech will be “top down” from incumbent banks and “captured” existing regulators, “bottom up” from startups or sideways from global competitors. In other words, will the disruptors be disrupted before they have even really hit the ground?