Disrupting the disrupted: the dawn of fintech regulation in the Twin Peaks new world order
In the fintech and crypto-currency industry, rapid innovation punishes those who wait, says Seshree Govender, associate at Webber Wentzel.
The South African Revenue Service (SARS) has effectively broken the regulator blood oath taken in 2014 that had frozen the South African crypto-currency market in the realm of regulatory neutrality for the past three years, says Seshree Govender, Associate at Webber Wentzel.
In accordance with the user alert published in 2014 by the South African Reserve Bank (SARB), the Financial Services Board (FSB), SARS and the Financial Intelligence Centre, the regulators adopted the "users beware" stance in respect of crypto-currencies, stating: "There are no specific laws or regulations that address the use of crypto-currency."i
On 6 April 2018, SARS confirmed its stance on the tax treatment of crypto-currencies, as intangible assets subject to the consequences of the Income Tax Act.ii
However, SARS is not the only regulator in our purview. On 13 February 2018, the SARB announced the establishment of the Fintech Programme designed to assess the emergence and regulatory implications of fintech iii - and in March 2018, we have seen the publications, presentations and media releases from the FSB around fintech regulation.iv As we move towards the end of the regulatory neutrality era, we are able to catch a glimpse into our fintech regulatory future.
Seeing Twin Peaks amid the grey area
The tale South Africa will tell about the emergence of any fintech regulatory regime will differ from tales told by other countries that are developing regulation in this space. Unlike most other jurisdictions that have begun formulating policy around fintech and crypto-currency, South Africa's move towards fintech regulatory development comes on the cusp of the most extensive regulatory reform the financial services sector has seen in the last quarter century.
The development of fintech policy and regulations within the changing South African financial sector will essentially bring about the disruption of a sector already in the midst of being disrupted.
The Financial Sector Regulation Act (FSR Act), signed into law in 2017, is the overarching legislation in terms of which the Twin Peaks (dual regulators) of financial sector regulation will be created with effect from 1 April 2018, namely:
* The Prudential Authority (housed within the South African Reserve Bank): the objective of the Prudential Authority focuses predominantly on ensuring a safe and financially sound financial sector by supervising financial institutions, monitoring financial stability of such institutions, but more particularly, the risk such institutions introduce to the overall stability of the financial sector and taking measures to mitigate such risk.
* The Financial Sector Conduct Authority: as the Financial Services Board in a previous life (pre-April 2018), the objective of the Financial Sector Conduct Authority is essentially the protection of financial customers and the providing of education to enable customers to make sound decisions when engaging in the financial sector.
The delineation between the regulatory mandates of the Prudential Authority as compared to that of the Financial Sector Authority is echoed in the differing focus and policy objectives prevalent in the fintech regulatory proposals and initiatives of both regulators, respectively.
The objectives of the SARB's Fintech Programme are geared towards determining the manner in which fintech will impact the stability of current financial systems and the overall financial sector v - while the FSB's recent updates on the implementation of the FSR Act has particular a focus on consumer protection and the aspects of fintech that impact the services being offered to customers, the distribution channels, the entities providing the services and post-sale barriers.vi
The respective positions of the regulators have aided us in identifying the Twin Peaks in the maze of the fintech regulation discussion. In doing so, the regulators have provided the industry with a much welcomed sense of direction in a regulatory environment that is gradually moving away from regulatory neutrality. In particular, the fintech industry can now begin interrogating the manner in which advents in fintech and crypto-currencies may interplay with the objectives and provisions of the FSR Act that empowers the policy mandates of both regulators.
Additionally, by delineating the dual regulatory mandates, we can demystify the broad and all-encompassing concept of financial sector disruption and disruptive technologies by identifying disruption within the context of either regulator mandate:
* Disruption within the Prudential Authority Regulatory Mandate, where disruptive technologies have the ability to pose potential risks to financial stability. Case in point: blockchain, which has the ability to disrupt a payment, clearing and settlement regulatory system that has entrenched the position of banking institutions as a primary mechanism for ensuring financial stability.
* Disruption within the Financial Sector Conduct Authority, where disruption takes the form of alternative wealth generating products and services, and/or disrupting the overall customer engagement process through new distribution models and disintermediation.
Dear regulators of Twin Peaks new world order
In anticipation of further developments following the conclusion of reviews and assessments in the second half of 2018, as well as the transitional implementation of the FSR Act, it is important to remember that while the formal regulatory position may have been frozen in neutrality since 2014, South Africa's fintech market has most certainly not. Therefore, while the decision to move away from the regulatory neutral position is welcomed for number of reasons, the regulator's role in fintech policy development can no longer continue as merely an observer during this interim period and regulator under a future regime.
While wide-scale regulatory developments in this sector are admittedly a difficult, risky and time-consuming process, interim regulatory developments are required to prevent stagnation in a rapidly growing market, while at the same time entrenching a culture of consumer protection. Such interim developments are not particular to the technological advents and innovations in the fintech industry, but rather focus on the current and future commercial and legal position of the market, and thus, may potentially include:
* Providing a risk-based, or outcomes-based, framework to entrench a culture of consumer protection and education.
* Entering into memorandums of understanding with fintech regulators in other jurisdictions that seek to promote the development of fintech so as to bridge the South African fintech market with other global markets. Such arrangements are essential to enable South African fintechs to participate and compete in the global fintech market and to protect South African consumers participating in the global market.
* Providing clarity as to the position of fintech companies in the post-fintech regulation era. In particular, the manner in which a sector, effectively operating in an unregulated environment, will transition into a regulated environment. The way in which services that may be regarded as potentially non-compliant will be treated, the way in entities requiring licensing will be administered and the possibility of industry exemptions - all while bearing in mind the FSR Act objective of financial inclusion.
To wait or not to wait? That is the question
With the knowledge of an impending regulatory regime, the fintech industry is now left in regulatory purgatory. Akin to the split-second decision made on a traffic light turning from green to amber, the industry now needs to decide whether it should speed ahead in further expanding the industry in the hopes that it will amass a consumer base and, following that, justify its continued operation in a post-regulatory world - or whether its needs to slow down in fear of impending regulations requiring an overhaul of its operations.
While there are risks inherent in either decision, a palatable middle ground may lie in the way in which the structure, products, services and operations of fintech participants may begin aligning with risk mitagators apparent in the regulatory mandates of the respective regulators. At this stage such alignments would primary entail (i) putting in place consumer protection, consumer education and financial crime prevention mechanisms; (ii) determining whether an envisaged product, service or system is a prudential/financial stability disruptor or a market conduct disruptor; and (iii) creating new, and utilising existing, avenues to engage and share information with the regulators.
Essentially, while charging on ahead may invoke regulatory risks that are becoming ever more apparent, yet still shrouded in uncertainty, such risks can be mitigated. However, while the hesitation in charging ahead may negate the regulatory risks, a harsh lesson learned in the fintech market is the merciless way in which rapid innovation punishes those who wait.
i User Alert: Monitoring Virtual Currencies (2014)
ii SARS Media Release "SARS's Stance On The Tax Treatment Of Cryptocurrencies" http://www.sars.gov.za/Media/MediaReleases/Pages/6-April-2018---SARS-stance-on-the-tax-treatment-of-cryptocurrencies-.aspx>
iii SARB Media Statement (13 February 2018) https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/8259/SARB%20FinTech%20release%2013%20February.pdf>
iv FSB Twin Peaks Newsletter (Issue 3) https://www.fsb.co.za/TPNL/3/fsb3/fast.html>; FAIS Conference March 2018 Presentation "Digital Innovation & Financial Technology: Global and Local perspectives" presenter: F. Badat
v SARB Media Statement (13 February 2018) https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/8259/SARB%20FinTech%20release%2013%20February.pdf>
vi FSB Twin Peaks Newsletter (Issue 3) https://www.fsb.co.za/TPNL/3/fsb3/fast.html>