Fintech Regulations to Expect in 2021

Currently operating with very little capital, fintech companies are open to severe regulatory risks that can knock them down. Hence, estimation of the operational ‘fintech regulatory environment’ will play a pivotal role in the fintech industry in 2021. This article throws light on fintech regulations to expect this year.

The fintech industry is growing at an extraordinary pace, making it difficult for financial regulators to understand how newer technologies fit into the existing regulatory framework. As they don’t want financial frauds to increase with the growth of fintech, regulators take several measures to make it one of the most heavily regulated sectors in the world.

Fintech regulations will play a key role in shaping the industry over the next 12 months, right from open banking to payments, sustainability, finance-as-a-Service, and more. Fintechs will have to comply with specific regulations depending on the activities they pursue. However, there are some particularly common regulations that every fintech operational in the U.S. should comply with. Let’s understand what they are. 

1. Open Banking Regulations

Open banking is set to be a top priority for 2021, with industry leaders indicating that the data-sharing framework will be important for the countries that introduce it. Open banking has already established itself in Europe and is making significant progress across countries like Australia and Canada. The U.S., however, has been slower to enact regulations.

The Consumer Financial Protection Bureau (CFPB) issued an advanced notice of proposed rulemaking (ANPR) that requests information from the public on how the access of consumers to their financial records should be regulated. Essentially, the ANPR serves as a first step in creating formal regulation in the U.S. around open banking. 

In MexicoOpens a new window , the publication of secondary open banking laws regarding transactional APIs, which is expected in the first quarter, will have important repercussions for users and entities that request their clients’ authorization to access balance and movement details at other banks and vice versa. Countries such as Chile are preparingOpens a new window new regulations to regulate the fintech sector and open banking. Legal sources predict that these regulations could be published in a couple of years.

Looking at this progression, governments and regulators will continue to pass laws and frameworks for open banking in their jurisdictions. In turn, banking data will continue to fall into the hands of financial innovators around the world.

Also Read: Major U.S. Banks on the Brink of Bitcoin Adoption

2. Online Payments and SCA Regulations

Online payments will undoubtedly be the biggest fintech eye-catcher in 2021. From January 1, 2021, online card payments within the EU must now go through the second Payment Services Directive’s (PSD2) secure customer authentication (SCA) protocol. While this security feature is good news for consumers, merchants will likely struggle as SCA can increase shopping cart abandonment. As a result, merchants and other online retailers will look to alternative payment methods to securely process transactions without detracting from the user experienceOpens a new window .

Importantly, for U.S.-based ecommerce merchants, ‘one leg out’ transactions (where only one party is based in the European Union) are not subject to SCA. Therefore, U.S.-based merchants selling to EU customers are exempt as of now.

However, this may change. For one, the European Union’s efforts have already spread to other countries like Australia, Turkey, and Mexico — these countries seem to have already adopted or are actively considering SCA regimes. And should a country subject one leg out transactions to SCA standards, it could capture U.S. merchants too.

Secondly, even in the U.S., voluntary compliance by the card brands is already underway. Consider the adoption of EMVCo’s SCA-compliant 3-D Secure 2.0 standard (‘3DS2’) for mobile app-based ecommerce. The incoming administration’s Consumer Financial Protection Bureau might well take on SCA as part of a broader consumer protection regulatory focus. And change need not come from the federal government. 

3. Regulations Under Finance-as-a-Service

As the catalog of APIs continues to grow, with new regulations popping up with every fintech advancement, the finance-as-a-service movement will see immense growth in 2021. Like other X-aaS products, finance-as-a-service allows non-regulated entities to offer regulated financial products.

Three key verticals under finance-as-a-service that are expected to grow in 2021 include:

1. Banking-as-a-Service (BaaS): BaaS allows industries such as ecommerce, travel, and the gig economy to offer financial services such as loans and e-wallets.
2. Regulation-as-a-Service (RaaS): Like BaaS, RaaS lets non-financial companies access certain regulated financial products through a third-party’s banking license. RaaS enables entrepreneurs to build new fintech products without regulatory authorization quickly.
3. Brokerage-as-a-Service (BraaS): Traditional banking involves managing wealth. BraaS enables innovators to build investment management products on top of a licensed brokerage’s APIs.

Also Read: Open Banking Leads the Next Generation of Financial Services

4. Regulations for Neobanks

Building on its past year, the neo banking movement will iterate into deeper verticals and niches. Branchless, online-only neobanks (also known as challenger banks or digital-only banks) are prevalent across Europe, Latin America, and Asia and are quickly gaining traction in the U.S. Various regulations concerning neobanks are expected to rise, such as the ones mentioned below:

1) Know your customer (KYC) regulations for opening remote accounts

All banks must onboard customers in compliance with relevant KYC regulations. These regulations stipulate that banks must verify the identity of the person who is opening a new account, even if that user is remote and not physically present in a branch. As neobanks rely on mobile and online account opening, it is especially important to make sure that they conform to regulations covering digital identity verification.

2) Online security and risk-based authentication regulations

Like traditional banks, neobanks must integrate and maintain robust online anti-fraud and digital security systems. These include back-end security, the securing of front-end systems, as well as compliance and reporting. 

Aside from the regulatory requirements, neobanks have another strong driver for securing their customers’ accounts, including reputation management and consumer perception. While 90% of neobank customers in the U.S. and 88% in the U.KOpens a new window . say they are satisfied with their neobank experience, 61% of consumers say that they trust a traditional bank more with their money than a neobank, and 82% say that ensuring the security of transactions is a critical concern when choosing a bank.

3) Data protection and privacy

Given the well-publicized breaches over the past few years and the unauthorized selling and sharing of consumer data by data aggregators, neobanks must protect their customers’ data from breaches and attacks. Beyond fines, data breaches and attacks can significantly damage consumer confidence in non-traditional banks. Privacy and data protection concerns can also stop consumers from switching to neobanks.

4) Mobile channel protection

All banks, especially branchless neobanks, must implement robust security for the mobile channel, especially the mobile app itself. This is critical in the wake of the global pandemic, which has seenOpens a new window  mobile threats surge for traditional banks, challenger banks, and fintech. The FBI recently warnedOpens a new window consumers that an increase in mobile app-based banking Trojan activity was expected due to the pandemic-driven rise in mobile banking activity.

Also Read: Robinhood Eases Curbs on the Purchase of GameStop Shares

5. Green Finance Regulations

Over the past few years, sustainability, social responsibility, and good governance were among the hottest global investment trends. With an increasingly volatile climate, ‘green’ financial products will move beyond investments and to all reaches of the industry in 2021.

The U.S. does not have a federal framework for consideration of sustainability in disclosure, risk analysis, or remuneration. While the legal authority to regulate financial advisors and financial products exists through several government departments and agencies, there has not yet been a coordinated consideration of a financial regulatory initiative related to sustainable finance. 

A September 2020 reportOpens a new window by the Commodity Futures Trading Commission on managing climate risk in the U.S. financial system outlined the existing authority. It made recommendations to financial regulators, which may be considered in the future. Furthermore, in October 2020, the New York Department of Financial Services issuedOpens a new window guidance to banking and insurance institutions under its jurisdiction. It shared detailed information about climate risks and outlined expectations for all regulated banking organizations.

The incoming Biden administration is expected to focus on sustainability, but it is unclear what regulatory or legislative initiatives may follow. 

6. Regulatory Sandboxes

Many countries have established ‘regulatory sandboxes’, i.e., test environments in which fintech companies can carry out experiments under regulatory supervision. Regulators in some countries (notably the FCA in the UK) allow fintechs to conduct those experiments with real customers.

No such framework currently exists at the federal level in the U.S., but there have been attempts to establish one. Notably, in 2018, the CFPB and Treasury both published reports, including proposals for establishing sandboxes. These tools do exist in some states: Arizona passedOpens a new window a sandbox law in 2018 and Wyoming followedOpens a new window in 2019; meanwhile, Washington DC is actively considering such a law.

In 2019, four U.S. regulators joinedOpens a new window the Global Financial Innovation Network (GFIN), an international alliance of government regulators led by the UK’s Financial Conduct Authority seeking to bolster the future of fintech. Their participation in the networkOpens a new window brings federal regulators into GFIN’s mission of developing a ‘global sandbox’ for financial innovations.

In conclusion

The regulatory landscape evolves as regulators cooperate and contribute with a common goal. As the regulatory landscape matures, lawmakers are trying to assimilate the true nature of the fintech sector. They are attempting to simplify the legal framework to encourage fintech growth. That being said, it remains to be seen which fintech regulations dominate 2021 and drive the global economy.

Do you think the fintech advancement will promote the change in its regulatory landscape in 2021? Comment below or let us know on LinkedInOpens a new window , TwitterOpens a new window , or FacebookOpens a new window . We’d love to hear from you!