Adapting Regulatory Responsibilities to Innovatory Influences – The ASIC Example

The Task of Regulation is Evolving

In decades past, the core roles of corporate and industry regulators were typically focused almost entirely on the twin responsibilities of compliance and enforcement. Market and regulatory failures that have occurred at various times have often been followed by further rounds of regulatory reform with the aim of seeking to prevent and deter the possibilities of similar failures recurring. Typically, this has meant an increase in the amount and range of regulation over time and has often been accompanied by, or followed soon after by, the introduction of new rounds of compliance and/or enforcement measures. Yet, as the needs for the protection of consumer, employee, and investor interests have progressed, so too have the roles of corporate and industry regulation evolved.

In earlier eras, the frequent trend towards more regulatory rules accompanied by relatively rigid application of compliance and enforcement measures may have significantly met the developing needs of consumer, employee, and investor protection in various jurisdictions. However, in the current era of increasing globalisation and new levels of complexity at play, where changes in markets, products, and services are increasingly triggered not necessarily just by a single innovation but a wave of innovations, many of them based on very significant technological breakthroughs, there are additional forces at work. While these forces don’t in any way make redundant the need for the protection of potentially vulnerable parties, they do add additional layers of complexity to the regulatory task. And the regulator ideally needs to adapt.

These forces may call for additional flexibility in how regulations are applied and under which circumstances. If the particular domain of a specific set of regulations (be it a specific industry or some particular national or other jurisdiction) is experiencing considerable change through innovation, maintaining the strictest of compliance approaches under all circumstances might happen to curtail the rate of development and adoption of innovation throughout that domain. Such restrictions can place a sector, an industry, and even a specific country at a very significant competitive or operational disadvantage over time as other innovation-driven domains capitalise upon the vast benefits that innovation can precipitate. Strategic flexibility in regulatory application may be warranted to minimise the occurrence of such disadvantages.

Yet there are dangers involved, so any such revised approach needs to be implemented with care.

The corporate regulatory task is evolving. Effective regulation nowadays calls for new perspectives and additional strategies, and higher levels of awareness and responsiveness to the market and to the activities of market participants. Innovation has come knocking on the corporate and industry regulator’s door. And the increasing speed of change that innovation precipitates, in frequent concert with the effects of globalisation, means that entities tasked with regulation cannot afford to keep the regulatory door closed, so to speak. The guest has arrived, invited or not, and the better approach for the corporate or industry regulator is to invite innovation in and accommodate her.  Sure, there are additional risks at play. Yet there is power in being strategically flexible and the primary end game is still the protection of potentially vulnerable parties. It’s just that the desired outcome now requires the application of a higher level of strategy accompanied by the deployment of a wider range of management awareness and skill.

Australia’s ASIC – Recognition of the Challenges

In Australia, the Australian Securities and Investments Commission (ASIC) is an independent statutory body set up under the Australian Securities and Investments Commission Act (2001). ASIC has been allotted the responsibilities within the country for regulation of Australian companies, financial markets, as well as financial services organisations and individuals who deal and advise in investments, superannuation, insurance, deposit taking, and credit.

Within the domain of ASIC’s responsibilities, therefore, is the oversight of financial markets and of financial services providers. And it’s within financial markets not just within Australia but worldwide that some of the most dynamic technological advancements of any industry are occurring. Technologies that can be applied to financial markets and financial services delivery have reached a stage at which they very substantially challenge in many different ways existing services and mechanisms of service delivery. Fintech has now become a high-growth and fast-growth industry in itself, albeit it is part of the broader finance and banking industry. And as Australian businesses seek increasingly to play a significant role in developing and implementing fintech innovations, ASIC plays an increasingly and significant pivotal role in the ability of both existing financial services businesses and new financial services entrants in Australia to establish  their part in the massive value-adding within financial markets that evolving financial technologies make possible. The additional benefits that fintech businesses can potentially deliver to customers, as well as to investors, through innovative products, services, service-delivery platforms, and processes produce considerable pressures for change upon the financial services industry.

In its Corporate Plan 2016-2017 to 2019-2020, ASIC explicitly declares that it recognises the challenges of “digital disruption and cyber resilience in … financial services and markets”, the “complexity in financial markets and products, driven by innovation”, as well as “globalisation of financial markets, products, and services”. ASIC also acknowledges the rapid rate of technological innovations occurring and affecting digital platforms and service creation in areas including payments systems, crowd-sourced equity funding, distributed ledger technologies, market place lending, and digital advice, among others.

Cognisant of its investor and consumer protection role, this Australian regulator very consciously seeks to maintain a balance between the benefits of innovation and the risks of innovation, seeking to ensure that innovations in marketing and delivery of financial services enhance rather than undermine investor and consumer knowledge, decisions and outcomes.

ASIC’s ‘Innovation Hub’

ASIC acknowledges that various emerging financial technologies (such as in the areas of marketplace lending, crowd-sourced funding, robo advice, payments and blockchain technology) are very often initiated by small and startup businesses and, by their nature in bringing about breakthroughs in both processes and service delivery mechanisms, they are likely to give rise to entirely new business models. And it’s therefore considerably likely that some of these business models might not easily fit with ASIC’s existing regulatory framework. At the same time, many such startup businesses have limited access to certain key resources, such as monetary, time and professional advice resources. Recognising these factors, and taking also into account the considerable potential value that these fintech innovators can deliver, ASIC has embarked upon a very deliberate strategy of introducing a variety of flexibilities and additional services to encourage fintech businesses in Australia, with a special emphasis on encouraging startup fintech businesses.

ASIC has established what it calls an ‘Innovation Hub’, centred around a dedicated Innovation Hub website through which the regulator offers additional assistance to fintech businesses to, amongst other things, ease the licensing processes involved and provide a central source for relevant information and services. Through the Innovation Hub, ASIC has chosen to also provide “informal guidance” to qualified businesses, with a contact person within ASIC allocated to assist each business with the relevant licencing requirements, as well as to help business managers understand what waivers to compliance requirements ASIC may be willing to provide, and under which specific circumstances. And by holding and attending frequent events across different cities to communicate ASIC’s approach to regulatory requirements and changes it is making, ASIC is able to further engage with the fintech community. The additional opportunities for two-way communication between fintech businesses and ASIC provides ASIC with additional feedback as to where regulations might become obsolete or inappropriate as technologies develop further and as service provision in the sector evolves and transforms. In an industry where the rate of technological change foretells of very swift changes in financial services and service-delivery platforms available, there are benefits to the regulator to be ever aware of impending needs for change regarding the applicability of specific regulations. The combination of speed and diversity of technological change acts as an encouragement to the regulator to resist any possible tendency towards complacency.

ASIC’s ‘Regulatory Sandbox’ Framework

In order to provide fintech innovators in Australia with the potential to test certain types of products or services, ASIC launched in December 2016 its ‘Regulatory Sandbox’ consisting of several alternative options.

Firstly, fintech businesses in Australia might choose to take advantage of some of the flexibilities that already exist within the regulations. For example, businesses that operate as a representative of a business which is already licensed to provide financial services or credit services are themselves exempt from the need to obtain a similar licence.

Secondly, ASIC has the capacity to apply its own discretion in individual business cases to consider partial waivers of regulation under various circumstances, taking into account an evaluation of a particular business’ organisational competence. This can result in an organisation being granted a limited licence where there are restrictions on what business activities the particular business entity can engage in.

And thirdly, initiating its own innovation in the field of regulation, ASIC has also introduced what it describes as a “world-first class exemption” to licensing. Given that there are a range of barriers to innovation for businesses in the fintech field, ASIC’s regulatory sandbox framework permits particular types of fintech services to be tested in the Australian market under strict, specified conditions without the fintech business concerned first obtaining a licence. This licensing exemption is currently available to fintech businesses for a 12-month duration and permits participating businesses to acquire up to 100 retail clients during the licensing exemption period with no similar limit on wholesale clients. Fintech businesses choosing to take up the exemption do not need to apply for the exemption: there is indeed no application process involved to be granted the exemption. Rather, participating businesses must notify ASIC before they commence their relevant business activities that they wish to take up the one-year exemption, and throughout that period there are particular consumer protection provisions with which they must comply. There are substantial limits also to the range of products and services involved: the exemption is specifically available for businesses providing advice or dealing in or distributing products but not for businesses issuing their own product, not for businesses lending money to consumers, nor for businesses operating their own management investment scheme. In addition, the waiver on licensing through ASIC does not extend to other regulations that may still apply to particular business activities beyond ASIC’s scope of regulatory jurisdiction and through other regulatory bodies.

The overall aim of ASIC’s licensing exemption within the regulatory sandbox is to facilitate innovation by allowing businesses to test their financial and credit product and service offerings for a limited period without needing to apply for, and comply with all the requirements for, a relevant licence. The limited exemption period of ASIC’s licencing exemption provides fintech businesses who take advantage of it a period during which those businesses can validate the concepts and viability of their innovatory services within a reduced regulatory environment, potentially facilitating their ability to determine the commercial viability of their service offerings and to gain better understandings of what changes to their offerings may be required to improve that commercial viability, while simultaneously lowering their compliance costs during their product / service testing phase. Participating entities, should they decide ultimately to continue providing their services once the testing period is terminated, can use the period of regulatory relaxation to become more familiar with the regulatory obligations that they do need to comply with at the conclusion of the testing phase.

ASIC’s regulatory sandbox, therefore, adds to the regulatory flexibilities that already existed by widening the options available to fintech businesses in particular with the provision of a testing period so that such businesses can ease towards full regulatory compliance. The flexibilities, however, maintain relevant consumer protections, the range of services that fall within the exemptions are limited, and the regulatory exemption period is limited, too, all to minimise the potential for loss. Through the regulatory sandbox framework, the regulator is conveying to potential fintech startups that if you are developing an innovative product, service or service-delivery platform for which you need to market-test to verify that there is indeed a viable market in or from Australia for your fintech offering, then ASIC is potentially willing to provide you, under certain circumstances, a level of cautious flexibility in the application of regulations, though strict conditions will still be attached.

Albeit under limits in the range of fintech products and services, the process in Australia of testing innovative fintech products and services has just become more flexible. With that flexibility, the regulatory environment in Australia has taken a further step in becoming more accommodating to the fintech innovator. Fintech businesses which can avail themselves of the opportunities provided by the regulatory sandbox to their advantage may well be able to bring new products, services and service delivery mechanisms to the Australian market with a greater chance of ultimate market success and potentially at lower initial cost.

Encouragement and Support for RegTech

ASIC is venturing out with some degree of caution to accommodate developments and the provision of products and services in the “regtech”, or regulatory technology, arena. Regtech is a relatively new and rapidly developing area of business which holds enormous potential for advancements around such areas, from ASIC’s perception, as automation of processes, real time collection of standardised compliance data, analysis of large data sets for compliance risk and monitoring, and automatic report generation, identity verification, fraud prevention through transaction analysis, trade tracking and analysis, anti-money laundering, know-your-customer (KYC) compliance, and monitoring culture through people analytics. ASIC is encouraging businesses in the regtech space to engage in dialogue with the regulator, which is aimed as much at this stage for the regulator to gain a better understanding of the possibilities within regtech and where the technologies might lead as to be able to provide areas of guidance to regtech businesses to allow them to meet regulatory requirements more effectively and efficiently.

The regulator has identified three particular areas of product and service development or delivery for business eligibility for assistance, specifically:

1. Innovations that promote a better outcome for consumers and investors
2. Innovations that have the potential to raise standards of compliance or risk management
3. Innovations that have the potential to promote information sharing with ASIC as the regulatory body.

By engaging with the regtech community through events and meetups, and by direct engagement with individual eligible businesses, ASIC is laying some of the communication groundwork that may broaden the potential for new products, services, and service platforms that provide efficiencies in the ways that businesses meet regulatory responsibilities, whether with ASIC itself or with other regulatory bodies in Australia.  By encouraging regtech innovations ASIC might prudently be opening doorways that ultimately result in the facilitation of the performance of the functions that the regulator itself is tasked to perform. The regulator does, however, emphasise that it does not endorse any regtech business that engages with it, whether through its Innovation Hub or otherwise.

Communication and Engagement

Especially important for a regulatory entity within an environment characterised by rapid innovation is ensuring effective two-way communication flows between the regulatory body and interested or affected parties. Fluidity in communication allows a regulator the opportunity to gain deeper insights into a range of factors that can ultimately influence its strategy and how it chooses to respond to, and prepare for, changes triggered by the effects of innovation. It permits the application of regulatory flexibility, too, at a more granular level, potentially better meeting specific needs for specific businesses with innovative products and services.

ASIC has established an on-going programme of active engagement with fintech- and regtech-interested parties by holding frequent open forums in various locations around Australia on specific topics concerning regulation and changes that are either being implemented, are forthcoming, or are being considered. This gives senior ASIC representatives the opportunity to convey to interested forum attendees the steps that ASIC is taking or intending to take. It provides attendees a level of greater awareness of options and services available to them as well as the opportunity to commence dialogue with the regulator that could, on the one hand, facilitate their business endeavours, and on another front, allow them to give feedback to the regulator of their perspectives of the market, of how technology is opening the way for them to create more diverse product and service offerings, and even to convey their thoughts on the relevance (or otherwise) and their perceptions of the benefits (or unreasonable constraints) of the regulator’s offerings of flexibility to the market.

As fintech and regtech innovations are rapidly developing, even fundamentally influencing how business is conducted around the world while, indeed, facilitating the capacities of businesses and transactions to traverse national borders, regulatory bodies in diverse countries have perceived an increased need for ongoing communication between each other in relation to fintech and regtech developments. ASIC is no exception and has recently reached unilateral agreements with a range of the reciprocal bodies in other jurisdictions. Consequently, we have seen recent agreements reached on fintech cooperation between ASIC (on Australia’s behalf) and each of the relevant regulatory bodies in Kenya, Indonesia, Hong Kong, Japan, Malaysia, and Abu Dhabi, among others. These agreements are aimed at providing greater ability for the respective regulatory bodies to share between them information about the changing nature of business brought about by fintech and regtech innovations, to discuss different approaches available to the changing regulatory landscape, and to also provide support for each other in the process. As fintech and regtech innovations proceed to reach almost inevitably into the vast majority of business and commercial transactions entered into world-wide, effective communication and cooperation between regulatory bodies in their respective jurisdictions will be key to ensuring that regulatory frameworks evolve to continue, as much as possible, to adequately protect investor and consumer interests.

Proactive Regulation Strategy Engenders Value Creation

The example of ASIC provides one strong presentation of how fast-occurring innovation in industry can influence an industry regulator. But it equally provides a display of how a corporate or industry regulator can choose not to sit on any potential standard of complacent behaviour by being mostly reactive, but rather to take a determinedly proactive stance to allow as much of the benefits of innovation as possible to flow without compromising, if at all possible, the core (implicit and explicit) consumer and investor protection task of the regulatory body.

In seeking some form of balance, ASIC is showing that the regulatory task has modified, and is modifying. Influenced externally by increasing amounts and rates of innovation, the enforcers of regulation are themselves setting about to create, encourage and adopt both process innovation and service innovation.

The changing nature of the ‘business’ of regulation shows that when you begin to carefully and selectively loosen core constraints in a strategic manner, you can allow innovation to feed innovation. And additional benefits and value flow, circulate, and build. Even when your ‘business’ is that of regulation.

The industry of regulation is a ‘watch-this-space’ space.