Financial services is perhaps the most regulated industry in the world, and the intersection between financial services, technology and law remains a complex and evolving space. A team of lawyers from Morgan Lewis recently attended the Money 20/20 2023 conference and previewed some major themes and trends the industry can expect in 2024.
Regulators are in full force
With current and former politicians, government officials and regulators serving as panelists and in attendance at this year’s conference, Washington’s attention to the fintech industry is undeniable.
From “Eyes Wide Open: Adapting and Surviving as Regulatory Oversight Evolves” to “The Next Wave of FinTech Regulation” to “Sausage Making: Politics in Financial Regulation,” the topics of the panel covered a host of issues involving legislation and regulatory prospects in fintech, including how to manage the growth of artificial intelligence (AI), lessons learned from this year’s bank failures, and how to prevent future crises, as well as creating a fair and inclusive financial environment.
Instead of comprehensive federal legislation, a patchwork of U.S. state and federal agencies oversees crypto market participants in the United States, with most, if not all, legislative initiatives having consumer protection goals at the forefront. plan. Over the past 12 months, we have seen the Consumer Financial Protection Bureau (CFPB) Open banking rule giving consumers control of their financial data; the joint efforts of the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency to issue a final rule to strengthen and modernize the regulations implementing the Community Reinvestment Act; and the final publication by the CFPB of its Small Business Lending Rule.
In the area of digital assets, the Federal Reserve Announced Surveillance Developments for dollar tokens and “novel activities,” while individual U.S. state agencies join the conversation, with California And new York opening the way.
California has passed its own digital asset laws, one targeting crypto kiosks and another requiring that individuals engaged in “commercial activities relating to digital financial assets” (e.g., exchanges, wallet providers , administrators) obtain a license from the state Department of Financial Protection. and Innovation, joining New York’s efforts to license those who engage in certain activities involving digital assets.
Examples of regulation by enforcement appear with the United States Commodity Futures Trading Commission (CFTC). recent settlement actions, apparently as part of a strengthened push for decentralized finance, or DeFi. Despite the various meetings and listening sessions, the Biden administration has moved forward with the regulations. The $64,000 question remains whether regulators are adequately engaging with industry stakeholders.
Access to Personal Financial Data and Use by Third Parties
Fresh off the CFPB’s publication of its much-anticipated Open banking ruleIndustry players have begun to prepare for the new world envisioned by the Bureau, in which customers of financial institutions can seamlessly transfer their data to third-party institutions, and fintech companies will face constraints on the extent to which they may sell, transfer or otherwise use data.
A cascade of new product offerings is expected even if regulations remain static
In 2023, many know-your-customer and anti-money laundering offerings have hit the market, reflecting the focus on traditional regulation even for new products. Innovators should expect most traditional regulatory frameworks to remain in place, and new products requiring regulatory change will likely continue to face significant challenges.
Innovating in the Face of Conflicting Federal and State Guarantees
According to some in the industry, there appears to be a disconnect between state and federal regulators when it comes to encouraging innovation within the fintech industry with some of the recent rules and guidelines that have been released. Retail investors remain an underlying problem, as regulators appear to struggle with the level at which a person is considered sophisticated enough to invest in complex products, and regulators have put in place guardrails – which some consider too restrictive – on what individuals can do with their investments. money.
Despite this, the United States remains the “promised land” for international startups seeking seed capital and launching their products.
Empowerment through education
There appears to be industry-wide acceptance and willingness to use TikTok and other popular social media platforms to educate Gen Z about financial products and the social nature of investing. Traditional financial models are not suitable for the next generation, especially when it comes to building trust in financial management.
For Gen Z, this trust comes from well-known influencers and, as such, the industry relies on these influencers to educate and empower them. Therefore, regulators are increasingly focusing on these marketing techniques.
Authentication, validation and trust
The market is flooded with technologies related to identity verification, one-click logins and two-step authentication to protect assets and improve trust among banks and financial institutions. Some of the newer technologies aim to create a trustworthy transaction, even when parties may enter a trustless network situation.
Another topic that concerns us is leveraging technology to detect and prevent financial fraud. According to LexisNexis, the annual impact of global fraud exceeds 1 trillion dollarswith every dollar lost to fraud costing $4.23 for U.S. financial services companies, an increase of 16.2% from 2020. In a complex industry due to many business models operating with little or no standardization or regulation, fintechs are under pressure to prevent fraud and mitigate risks in the face of increasing global risks. digitization.
Fintechs are leveraging new technologies, including AI (as discussed below), to help achieve compliance goals while helping to detect and prevent financial fraud.
Action on the sidelines
Deal-making activity and the startup scene were there, with a strong international presence. A persistent challenge most fintech startups face is their unfamiliarity with regulations, and they are often surprised to learn that registration is required at the state or federal level (or both). Overall, despite market turmoil and continued high interest rates, the fintech sector remains a popular area for investment.
For industry players engaging in M&A transactions, unfamiliarity with different global regulatory frameworks can potentially create unexpected pitfalls and obstacles. When working on a transaction, parties must consider not only the transfer of value, but also the transfer of regulatory and enforcement risks. It is more important than ever that due diligence is thorough and complete.
Cautious optimism about generative AI
From using generative AI technology to democratize lending to fraud prevention and financial education, the usefulness – and potential benefits – of generative AI are numerous. However, facing the potential threat of misinformation and manipulation of digital media as well as copyright and ownership issues, the industry is treading lightly in its adoption and integration of technology.
In a first step toward a federal regulatory framework, US President Joseph Biden recently issued a decree designed to protect against AI risks while encouraging the global growth and expansion of AI development and use.
What happens next
Looking ahead to 2024, the fintech industry is in a unique position, shaped by the confluence of increasing regulatory oversight, technological innovation and market dynamics. Interest from federal and state agencies sets the stage for a year marked by evolving legislative frameworks.
The delicate balance between federal and state safeguards and the pursuit of innovation remains a priority, with the United States remaining an attractive hub even for international startups. As demonstrated by the CFPB’s proposed Open Banking Rule and certain authentication technologies and fraud prevention measures, consumer protection remains a high priority and will be a major priority for regulators and industry stakeholders over the course of the year to come.