Fintech’s regulatory challenges and dimensional construction

Regulatory Challenges: The Variation and Impact of Fintech

Fintech has rapidly formed a new financial ecology outside the traditional financial system, just as a new city is formed outside the old city. The financial reengineering project bypass many traditional financial supervision and laws. These changes urgently need to restructure financial supervision to cope with the technology-driven financial industry that is constantly accelerating iterative innovation.

Technological innovation brings quantitative and even qualitative changes in financial risks. Finance is closely integrated with technology in the process of development, and technological changes are rewriting the trading rules of the financial service industry, and at the same time risks arise. Fintech has greatly reduced the cost of connection between the providers of funds and the demanders, achieving high efficiency and low cost. At the same time, the characteristics of concealment, suddenness, contagion, and negative externalities of financial risks still exist. At the same time, financial, technological, and network risks are more likely to produce superimposition and aggregation effects, so that risks can be transmitted faster and spread more widely. Under certain circumstances, the technical and operational risks of financial technology will rapidly escalate from quantitative changes to qualitative changes, triggering financial systemic risks.

Traditional financial supervision is weak. In the face of technology-driven financial innovation, traditional financial supervision and legislation are becoming more and more backward. Technological innovation often drifts outside the regulatory system, or evades supervision in a disguised form, realizing regulatory arbitrage or triggering regulatory gaps. Supervision is subject to information asymmetry, lack of supervisory technical means, and lagging financial supervision laws, especially the obsolescence or failure of financial supervision concepts and theories. The above-mentioned problems make financial supervisors weak in dealing with financial technology risks. Therefore, seeking a new and effective regulatory dimension system has become an inevitable choice for financial regulation in the new era. The new regulatory dimension system is not only a repair and patching of the traditional supervision model, but also requires new thinking, new dimensions, and new theories, carefully analyze the factors that restrict the functioning of traditional financial supervision. The shortcomings are either due to the limitation of supervision by technology itself, or the shortcomings can be effectively alleviated by using scientific and technological means. Therefore, the information asymmetry between regulators and regulated parties brought about by the development of financial technology is largely due to the lack of regulatory technology means.

Dimensional construction: the two-dimensional logic of Fintech supervision

Supervision principles and supervision methods are driving the development of financial supervision. The previous supervisory principle is the optimal supervisory principle based on the relatively fixed basis of supervisory technology. It is necessary for us to form a two-dimensional regulatory system in addition to the traditional financial supervision dimension and the technological dimension, to respond to the challenges of financial supervision caused by the development of new technologies with a technology-driven regulatory approach, and to adopt a technology-driven type that matches the development of financial technology. The regulatory model responds to the peculiarities of financial technology supervision and conforms to the technical nature of financial technology innovation.

Regtech and technology-driven supervision solve systemic risks such as information asymmetry. Regtech 2.0 refers to the post-2008 financial crisis paradigm, which is mainly driven by strict regulatory requirements and high compliance costs in the financial services industry. In the Regtech 2.0 stage, all parties are driven by technology to improve regulatory compliance and regulatory efficiency, which can reduce the cost and increase the marginal efficiency of large banks and companies challenged by financial technology companies. At the same time, it will benefit entities outside the financial services sector, such as that it is convenient for companies to carry out quick identity authentication. Technology-driven supervision points to the Regtech 2.0 stage, focusing on regulators relying on scientific and technological means to obtain information and conduct real-time and dynamic supervision, so as to solve the asymmetry of supervision information and alleviate the legal lag. It is supervised by the information-sharing mechanism with the participation of all parties, so as to reduce the supervision cost and data effectiveness, and truly realize a real-time, predictive, top-down, as well as transparent supervision system with technical support as the core.

Technology governance is the theoretical basis of technology-driven supervision, and a regulatory system guided by technology governance is an inevitable trend for realizing the regulation of new financial formats. New technology promotes changes in business and society, making traditional financial regulations and laws unable to cope with industry changes brought about by the rapid development of Fintech. The birth of Fintech will inevitably bring about the restructuring of financial supervision. On the one hand, the evolution of technology can effectively deal with the risks brought by new financial formats, and it is logical to adopt technology governance. On the other hand, the financial model guided by the traditional financial supervision theory is aimed at the traditional financial format and cannot effectively respond to the regulatory needs of the new technology-driven financial format. Therefore, it is necessary to construct a technological dimension outside the traditional financial supervision model to realize technology governance. There are two logical evolutions of technology governance, which are the evolution from rule governance—principle governance—technology governance, and prudential supervision—behavior supervision—technology governance. It should be noted that technology governance is not a substitute for the previous financial regulatory governance principles or regulatory concepts, but focuses on the use of scientific and technological means to carry out real-time, dynamic, and transparent intelligent supervision, thereby improving the efficiency of financial supervision and making up for the limitations of traditional financial supervision in dealing with Fintech supervision.

Rule Governance—Principle Governance—Technology Governance

Throughout the history of the evolution of financial supervision laws, at first, detailed supervision rules were formulated for financial supervision. However, rule governance cannot effectively deal with new financial innovations that have not been included in the original supervision category. Therefore, financial supervision and laws need to design the principles of abstraction, generalization, and flexibility to govern. Technology governance can avoid the deficiencies of rule-based supervision and principled supervision. In the context of the rapid development of technology-driven financial innovation, if regulators still ignore the application of technology, they will not be able to effectively deal with the accumulated financial risks. Therefore, increasing the technological dimension of financial supervision is an inevitable trend of supervision. The application of technology has profoundly affected the law and governance. Adhering to the combination of technology governance and legal governance is an effective way to reshape financial supervision.

Prudential Supervision—Behavior Supervision—Technology Governance

New technologies have impacted the traditional financial market and caused major changes in the financial service industry. Traditional financial regulatory theories such as the Double Peak Theory have been unable to effectively respond to the changed financial market environment, triggering regulatory escaping and even bringing regulatory gaps. At the level of financial institution supervision, the traditional financial supervision model based on physical financial institutions has no time to deal with the new financial formats driven by technology. It must rely on scientific and technological means to achieve effective supervision. With the support of technologies such as artificial intelligence, big data, cloud computing, and blockchain, regulators can maximize the identification of funds and investors, diversify investment and other risk management, realize simultaneous innovation, and control of funds and assets. At the level of financial consumer protection, pre-regulatory measures such as high entry barriers are costly and inefficient. The emergence of new Fintech in this era is a fundamental measure to solve the opacity of regulatory information and will strongly improve the quality and efficiency of financial supervision.

Measures to achieve technology-driven supervision

The bimodal theory deals with the problems of the traditional financial market. Its essence is the extension of prudential supervision. It extends the thinking of protecting financial institutions to financial consumers and proposes two goals for financial supervision. The two-dimensional supervision system is not only for this. The two goals provide a better path to achieve, and can overcome the shortcomings and shortcomings of traditional financial supervision such as prudential supervision. Technology-driven supervision will bring about a fundamental change in the financial supervision model, which includes not only real-time access to dynamic data, but also real-time feedback information and timely instructions, the use of scientific and technological means to achieve real-time supervision, as well as a kind of anticipation and early supervision of the future.

Data-driven financial supervision at the core, technology-driven supervision mainly revolves around data aggregation, big data processing and interpretation, modeling analysis and prediction, but it needs to rely on high-quality data and powerful computing power.

The key to financial supervision is to take data as the foundation, enrich the diversified methods of data supervision, and propose scientific and technological governance plans, from rule and principle governance to scientific and technological governance. The core concept is transparency, equality, and intelligence, so as to build a real-time and dynamic supervision system. Specifically, the use of data in a technology-driven regulatory model includes the following four progressive processes:

First, data collection and data access, that is, the acquisition of data and the identification of the authenticity of the data.

Second, data sharing. That is to say, the sharing of data between or within the supervisory level, industry associations, and consumers. Data sharing is the basis of integrated financial supervision.

Third, data analysis and decision-making. The development of the financial market increasingly relies on data. Data analysis is becoming more and more important for financial services and financial institutions. With the help of complete data sets and effective data analysis, Fintech companies can better make credit ratings for actual risks and provide "personalized" financial services at a low cost per customer.

Fourth, supervise the implementation. Technological supervision is not only to obtain and analyze data, but also to use technological means to allow the supervisor to accept the supervision of the supervisor in real-time, and even withdraw from the market and be punished when necessary.

In summary, in the era of Fintech, data and information are the core of supervision. Financial supervision is increasingly driven by data, and regulatory agencies require data to be more granular and more frequent. The importance of data determines that legal and effective methods must be used to realize data collection and in-depth mining to promote effective supervision.

From the overall perspective of financial regulatory reform, scientific and technological governance plays a fundamental role in the implementation of regulatory regulations and compliance, and plays a positive role in improving the regulatory and compliance level of financial institutions and preventing risks. The fast-developing Fintech urgently needs simultaneous changes in regulatory technology.

First, establish a comprehensive and complete data collection system. Technology-driven supervision requires regulators to focus on the continuous operation capabilities and risk control capabilities of financial institutions, and use artificial intelligence, big data, cloud computing, and other technologies to achieve an accurate assessment of risks and financial institutions’ operational capabilities.

Second, build a big data analysis and risk early warning mechanism. Relying on technologies such as big data, artificial intelligence, cloud computing, and blockchain can help detect and prevent the occurrence of financial risks in advance, and can also achieve simultaneous supervision and tracking, providing a strong evidence basis for supervision during and after the event.

Third, improve supporting safeguard measures. Supervisory agencies should focus on the supervision of the technical infrastructure of financial institutions, grading and filing and testing the basic and critical information systems of financial institutions, and improving technical supervision.

The three paths of technology-driven supervision are as follows:

First, a distributed and equal supervision mechanism. Under the technology-driven regulatory model based on the concept of technology governance, regulators can use technology to obtain data in a timely and effective manner. The regulation changes from passive to active. An equal information sharing mechanism forms an organic interactive system through data sharing. To build a new type of relationship under the scientific and technological governance model, regulators, financial intermediaries, and financial consumers are equal participants, so that open conversations can be conducted to understand the goals of supervision from the perspective of the regulator and observe the regulatory requirements from the perspective of the company.

Second, an intelligent dynamic supervision mechanism. The artificial intelligence-based supervision system can immediately and automatically supervise the supervised persons according to the supervision rules, avoiding the situation of insufficient supervision caused by insufficient incentives. Technological innovation has made supervision more transparent and automated, thereby making compliance procedures more complete; the automated reporting procedures established by Regtech have reduced the compliance workload of financial institutions, and the automated supervision process will facilitate more effective risk identification and regulatory compliance. In addition, the realization of intelligent dynamic supervision relies on the coding of financial supervision rules or making machines identifiable, that is, Regulate-Through-Code.

Third, the pilot supervision sandbox mechanism. Regulators cannot rely solely on the private sector to set rules or comply with regulations. The approach to regulatory testing is necessary for areas that are constantly changing, such as financial market infrastructure. The "Supervisory Sandbox" system that the British Financial Conduct Authority (FCA) creatively developed to effectively test financial innovative products and services provides an opportunity to support the future development of technology-driven supervision (Regtech). Financial regulatory institutions can implement sandbox experiments for regulatory technology, gradually formulate relevant technical infrastructure standard guidelines, risk early warning, risk assessment, and risk regulation measures, formulate plans for data collection, data use and data assessment, formulate contingency plans and measures in case of emergency, and improve relevant supervision on the basis of gradually piloting and verifying the reliability of science and technology.

It should be noted that, at least compared with traditional management processes, innovation, experimentation, and testing may greatly increase the cost of supervision. Then, resources must be put into use, not only to propose legislation and comments, but also to create conditions for experiments, formulate appropriate safeguards, and review the expected results of formulating and improving preliminary policies. Moreover, even after a thoughtful policy approach has been formulated, it is necessary to regularly update and improve the policy to make changes in market practices or infrastructure. In addition, when different efforts to develop and promote regulatory technology produce positive results, cooperation and coordinated efforts are essential.