Published online by Cambridge University Press: 03 October 2017
Modern financial regulation has predominantly been economically-driven,1 progressing from addressing market failures to making markets more competitive and work better.2 The UK Financial Conduct Authority is expressly mandated to pursue regulatory objectives that maintain market integrity and protect consumers (addressing market failures) and to promote competition (making markets work better).3 Both the FCA and its sister regulator, the Prudential Regulation Authority (for banks), have recently adopted innovative regulatory initiatives to promote technologically-driven innovation, aimed at making markets work better. These initiatives are also a response to the recent explosion of technologically-led financial innovation outside of the regulatory perimeter.
In promoting financial innovation, we argue that the regulators have insufficiently focused on the need to govern financial innovation more generally. Although this concern may seem premature, the regulatory innovations are increasingly extending the perimeter for regulatory oversight of financial innovations. As the regulatory innovations have the potential to develop into more mature regulatory frameworks for governing financial innovation, we argue that regulators should manage the risks of their current approach and develop a regulatory strategy framework for balancing regulatory objectives and developing regulatory policy. We propose a framework anchored in rationality, consistency and accountability in governing financial innovation.
Professor of Corporate Law and Financial Regulation, University College London. I thank Professors Florian Moslein and Maria Lee for comments on an earlier draft. I also thank an anonymous reviewer for helpful suggestions towards finalising this version. All errors and omissions are mine.
Summed up in
Financial Services and Markets Act 2000, ss 1B–1E, amended by the Financial Services Act 2012.
4 This point is discussed in greater detail in Section II. For example see Giuseppe Nicoletti and Stefano Scarpetta, “Regulation, Productivity and Growth: OECD Evidence” (World Bank Research Paper, 2003); Alain de Serres et al, “Regulation of Financial Systems and Economic Growth” (OECD Working Paper, 2006), available at <http://ssrn.com/abstract=965693>.
6 Price Waterhouse Coopers, Blurred Lines: How Fintech is Shaping the Financial Services Industry (March 2016); Douglas Arner, Jànos Barberi and Ross P Buckley, “The Evolution of Fintech: A New Post-Crisis Paradigm?” (2015), available at <http://ssrn.com/abstract=2676553>.
7 Dirk Zetzsche, Douglas Arner, Ross P Buckley and Janos N Barberis, “From Fintech to Techfin: The Regulatory Challenges of Data-Driven Finance” (2017), available at <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2959925>.
8 Douglas Arner, Jànos Barberis and Ross P Buckley, “FinTech, RegTech and the Reconceptualisation of Financial Regulation” (2017) Northwestern Journal of International Law and Business (forthcoming), available at <http://ssrn.com/abstract=2847806>; FCA, Call for Input: Supporting the Development and Adoption of RegTech (November 2015) and Feedback Statement: Call for Input: Supporting the Development and Adoption of RegTech (July 2016).
9 See an overview in Chiu, Iris H-Y, “Fintech and Disruptive Business Models in Financial Products, Intermediation and Markets – Policy Implications for Financial Regulators” (2016) 21 Journal of Technology Law and Policy 168 Google Scholar.
10 Yeung provides an overview of regulatory response in the face of disruption that threatens to make regulatory policy obsolete or inappropriate – regulators could resist and enforce, or become overwhelmed or indeed choose to grapple with industry changes and adapt intelligently, see Karen Yeung, “Governance by Blockchain: The Coming Battle for Supremacy Between the Code of Law Vs Code as Law?”, speech at the Symposium on Blockchain and the New Financial Order, University College London, 19 June 2017.
11 FCA, Regulatory Sandbox (November 2015).
12 In light of the established market gaps for consumer investment advice, the FCA would look specifically into how financial technology innovation can fill the gap. See FCA, Financial Advice Markets Review (April 2017).
14 Section 19 and Sch 2, see also case law that has taken an approach of interpreting the scope of the regulatory perimeter as capturing all functionally equivalent activities as those prescribed in Sch 2, for eg FSA v Anderson  EWHC 599 (Ch)). Further, see the hugely contested characterisation of land-banking schemes as illegal collective investments which was finally settled in the regulator’s favour after several years of litigation, see Asset Land Investment Plc v The Financial Conduct Authority  UKSC 17.
15 Highlighted by the Financial Stability Board, see FSB, Financial Stability Implications from Fintech (27 June 2016), available at <www.fsb.org/2017/06/financial-stability-implications-from-fintech/>.
16 It has been adopted in Hong Kong, Singapore, Australia, Canada and Japan.
17 See interview with Martin Wheatley (CEO of FCA 2013–2015), available at <http://play.buto.tv/DWCTY>.
19 FCA, Financial Advice Markets Review (April 2017).
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22 Described as a “performative turn” in regulation, Ioannis Lianos, “Law, Fintech, and the Performative Turn in Regulation”, paper delivered at the Blockchain Technology and a New Financial Order Conference, Centre for Law, Economy and Society, 19 June 2017, arguing that the regulator now makes regulatory policy and decisions within a new “society” of innovators, the financial industry, socially embedding such policies and decisions, perhaps distinguishing from merely being economically driven.
23 “Responsiveness” in regulation first developed in relation to enforcement and securing proportionate enforcement that reinforces meaningful compliance, see Ayres, Ian and Braithwaite, John, Responsive Regulation (Oxford, Oxford University Press, 1992)Google Scholar. This was subsequently developed into responsiveness in the supervisory process, see Baldwin, Robert and Black, Julia, “Really Responsive Regulation” (2008) 71 Modern Law Review 59 CrossRefGoogle Scholar.
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27 FCA, Regulatory Sandbox (November 2015).
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32 FCA, Project Innovate: Call for input Feedback Statement (October 2014), available at <www.fca.org.uk/publication/feedback/fs-14-2.pdf>.
33 Francesco Daveri, Rémy Lecat and Maria Laura Parisi, “Service Deregulation, Competition and the Performance of French and Italian Firms” (2011), available at <http://ssrn.com/abstract=1950551>.
34 Eg Arie Melnik and Oz Shy, “Exclusion, Competition, and Regulation in the Retail Loan Market” (2014), available at <http://ssrn.com/abstract=2374975> on how competitive financial markets promote financial inclusion.
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37 Deakin, Simon, “The Rise of Finance: What Is It, What Is Driving It, What Might Stop It?” (2008) 30 Comparative Labour Law and Policy Journal 67 Google Scholar; on the US, see David G Tarr, “The Political, Regulatory and Market Failures That Caused the US Financial Crisis” (World Bank Research Paper, 2016) however qualifying that it was not de-regulation in terms of the lack of regulation, but rather loosening standards through “perverse” regulation (a term used in the article) as a form of “de-governance” that supported financial markets liberalisation.
38 Andenas and Chiu, supra, note 1, at chs 2 and 3.
39 For example the Investment Services Directive 1992 emphasised the EU passport for investment firms and only provided a skeletal set of principles for protecting investors. This relative imbalance was only slowly addressed. We can compare the first Markets in Financial Instruments Directive 2004 that replaced the 1992 Directive with the intense suite of investor-protection reforms in the 2014 Directive that replaced the 2004 one.
40 FSA, “The Turner Review: A Regulatory Response to the Global Banking Crisis” (March 2009), available at <www.fsa.gov.uk/pubs/other/turner_review.pdf>.
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43 See eg discussion in Michel Klein and Colin Mayer, “Mobile Banking and Financial Inclusion: The Regulatory Lessons” (2011), available at <http://ssrn.com/abstract=1846305>.
44 Where “good” firms are driven from the market and only “bad” firms remain, as consumers are unable to differentiate between the two, therefore disincentivising “good” behaviour.
45 De Serres et al, supra, note 4.
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48 C Joerges, “The Law in the Process of Constitutionalising Europe” EUI Working Paper 2002/4 (Florence, European University Institute, 2002).
49 Bank of England, The Financial Policy Committee’s powers over Housing Tools: A Policy Statement (July 2015), available at <www.bankofengland.co.uk/financialstability/Documents/fpc/policystatement010715.pdf>.
50 FSB, Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities (January 2017), available at <www.fsb.org/2017/01/policy-recommendations-to-address-structural-vulnerabilities-from-asset-management-activities/>.
51 Christos Staikouras and Geoffrey Wood, “Competition and Banking Stability in the Euro Area: The Cases for Greece and Spain” (2000), available at <http://papers.ssrn.com/paper.taf?abstract_id=233911>.
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57 Lars Norden, Consuelo Silva Buston and Wolf Wagner, “Financial Innovation and Bank Behavior: Evidence from Credit Markets” (2011), available at <http://ssrn.com/abstract=1800162>.
58 Thorsten Beck et al, “Financial Innovation: The Bright and the Dark Sides” (2014), available at <http://ssrn.com/abstract=1991216>. However, there is also contrary research that shows such benefits to be limited for countries that already have stringent and developed bank regulations in place, such as capital adequacy.
59 Saumitra Jha, “Sharing the Future: Financial Innovation and Innovators in Solving the Political Economy Challenges of Development” (2012), available at <http://ssrn.com/abstract=2001039>, on how financial innovation penetrates the political economy and brings about stability for economic development.
61 Giuseppe Nicoletti and Stefano Scarpetta, “Regulation, Productivity and Growth: OECD Evidence” (World Bank Research Paper, 2003).
62 Such as the “suitability” standard in the FCA Handbook COBS 9; the EU Markets in Financial Instruments Directive 2014, Art 25(2). It is arguable that the fiduciary standard applicable in the US is also premised upon human judgment, see Melanie Fein, “FINRA’s Report on Robo-Advisors: Fiduciary Implications” (2016), available at <http://ssrn.com/abstract=2768295>.
63 Carla Reyes, Nizan Packin and Benjamin P Edwards, “Distributed Governance” (2016), available at <https://ssrn.com/abstract=2884978>.
64 Tedesco, Darren, “I, Robo-Adviser? Creating the Blended Adviser Experience” (2015) Journal of Financial Planning 17 Google Scholar.
65 Eric Biber et al, “Regulating Business Innovation as Policy Disruption: From the Model T to Airbnb” (2017) Vanderbilt Law Review (forthcoming), available at <http://ssrn.com/abstract_id=2951919>.
66 Missing out on the social benefits of innovation was pointed out in Slating, Timothy A and Kesan, Jay P, “Making Regulatory Innovation Keep Pace with Technological Innovation” (2011) Wisconsin Law Review 1009 Google Scholar.
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73 FSB, “FinTech Credit: Market Structure, Business Models and Financial Stability Implications” (May 2017), available at <www.fsb.org/wp-content/uploads/CGFS-FSB-Report-on-FinTech-Credit.pdf>.
76 John Kay, “Bonds designed to leave savers bemused”, Financial Times (16 November 2010), available at <www.ft.com/content/1912d062-f1ba-11df-bb5a-00144feab49a>.
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79 Nicola Gennaioli, Andrei Schleifer and Robert Vishny, “Financial Innovation and Financial Fragility” (2010), available at <ssrn.com/abstract=1688940>.
80 Blair, supra, note 72; Wenxi Jiang and Hongjun Yan, “Financial Innovation, Investor Behavior, and Arbitrage: Evidence from the ETF Market” (2016), available at <ssrn.com/abstract=2023142>.
81 Awrey (2012), supra, note 74.
82 Cortez, supra, note 21.
83 Slating and Kesan, supra, note 66.
84 Erik Vermeulen, Mark Fenwick and Wulf A Kaal, “Regulation Tomorrow: What Happens when Technology is Faster than the Law?” (2016), available at <http://ssrn.com/abstract=2834531>.
85 State policy for innovation is usually characterised by being facilitative, supportive and even pro-active in terms of energising and funding activity, see Caarlson, Bo, “Entrepreneurship and Public Policy in Merging Clusters” in Annika Rickne et al (eds), Innovation Governance in an Open Economy (Oxford, Routledge, 2012) at 251 Google Scholar, but regulators have mandates to govern and control behaviour and activity within the scope of their jurisdiction and should arguably not pursue a single-minded promotion approach.
86 Iain MacNeil, “Innovation, Law and Regulation” (2017, on file with author).
87 Competition Act 1998 and subsequent amendments form the basis of the UK’s competition law. This area of policy is, however, largely shaped by EU legislation transposed in the UK. For an overview of powers and enforcement against anti-competitive practices such as price fixing, cartels, abuse of dominant positions, see Whish, Richard and Bailey, David, Competition Law (Oxford, Oxford University Press, 2012)Google Scholar.
88 FCA, Investment and Corporate Banking Market Study (October 2016), available at <www.fca.org.uk/publication/market-studies/ms15-1-3-final-report.pdf>; and the FCA’s proposed reforms to remove anti-competitive practices such as contractual restrictions in FCA, Reforming the Availability of Information in the UK Equity IPO Process (March 2017), available at <www.fca.org.uk/publications/consultation-papers/reforming-availability-information-uk-equity-ipo-process>.
89 FCA, Asset Management Market Study (Interim Report November 2016); Final Report (2017), available at <www.fca.org.uk/publication/market-studies/ms15-2-3.pdf>.
90 As part of the “Responsible Lending Review”, the competitiveness of the residential mortgage sector will be reviewed in this ongoing endeavour: FCA, Feedback Statement: Call for Inputs on Competition in the Mortgage Sector (May 2016), available at <www.fca.org.uk/publication/feedback/fs16-03.pdf>, which indicates that the FCA will undertake a market study in this area to determine next steps.
91 E Wymeersch, “The Structure of Financial Supervision in Europe: About Single, Twin Peaks and Multiple Financial Supervisors”, available at <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=946695>.
93 FCA, Economics for Effective Regulation, supra, note 53.
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101 Sunstein (2014), supra, note 95.
102 FCA, Call for Input: Supporting the Development and Adoption of RegTech (November 2015) and Feedback Statement: Call for Input: Supporting the Development and Adoption of RegTech (July 2016).
103 FCA, Economics for Effective Regulation, supra, note 53.
104 Daniel C Hardy, “Regulatory Capture in Banking” (IMF Working Paper, 2006), available at <http://ssrn.com/abstract=892925>.
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108 Christian Voegtlin and Andreas Georg Scherer, “Responsible Innovation and the Innovation of Responsibility: Governing Sustainable Development in a Globalized World” (2015), available at <http://ssrn.com/abstract=2716152>, on the necessity of governing innovation in order to ensure that social responsibility objectives are also met alongside the private interests of exploiting and profiting from innovation.
109 Wiener, supra, note 99; Harrison, supra, note 97.
110 Supra, note 95.