Financial services is perhaps the most regulated industry in the world, and the intersection between financial services, technology, and law remains a complicated and evolving space. A team of Morgan Lewis lawyers recently attended the 2023 Money 20/20 conference and previewed some major themes and trends that the industry can expect in 2024.
Regulators Are Out 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: Adapt and Survive as Regulatory Scrutiny Evolves” to “The Next Wave of Fintech Regulation” to “The Sausage Making: Politics in Financial Regulation,” panel topics spanned a multitude of issues involving legislation and the outlook for regulation 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, and creating an equitable and inclusive financial environment.
In place of comprehensive federal legislation, a patchwork of state and US federal agencies have oversight of crypto market participants in the United States, with most, if not all, legislative initiatives having consumer protection goals front and center. Within the last 12 months we have seen the Consumer Financial Protection Bureau’s (CFPB’s) Open Banking Rule giving consumers control over their financial data; the joint efforts of the Federal Reserve, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency in issuing a final rule to strengthen and modernize regulations implementing the Community Reinvestment Act; and the CFPB’s final issuance of its Small Business Lending Rule.
In the digital assets space, the Federal Reserve announced supervisory developments for dollar tokens and “novel activities,” while individual US state agencies are joining the conversation, with California and New York paving the way.
California has adopted its own digital asset laws, with one aimed at crypto kiosks and one that requires persons engaged in “digital financial asset business activity” (e.g., exchanges, wallet providers, administrators) to obtain a license from the state’s Department of Financial Protection and Innovation, joining New York’s efforts to license those engaged in certain activities involving digital assets.
Examples of regulation by enforcement are emerging with the US Commodity Futures Trading Commission’s (CFTC’s) recent settlement actions, apparently part of an enhanced enforcement push into decentralized finance, or DeFi. Despite the various meetings and listening sessions, the Biden administration has pushed forward with regulation. The $64,000 question remains to be whether regulators are adequately collaborating with industry stakeholders.
Access to Personal Financial Data and Third-Party Use
Fresh off the CFPB’s issuance of its long-awaited Open Banking Rule, industry participants have begun preparing for the new world envisioned by the Bureau, where customers of financial institutions can seamlessly port their data to third-party institutions, and fintech companies will face constraints about the degree to which they can sell, transfer, or otherwise use data.
Cascade of Novel Product Offerings Expected Even as Regulation Remains Static
2023 has seen numerous know your customer/anti-money laundering offerings come onto the market, reflecting a focus on traditional regulation even for novel products. Innovators should expect traditional regulatory frameworks for the most part to remain in place, and novel products requiring regulatory change will likely continue to face strong headwinds.
Innovation in the Face of Conflicting Federal and State Safeguards
According to some industry stakeholders, there appears to be a disconnect between state and federal regulators when encouraging innovation within the fintech industry with some of the recent rules and guidance that have been issued. Retail investors remain an underlying issue as regulators seem to grapple with the level at which someone is considered sophisticated enough to make investments into complex products, and regulators have put into place safeguards—which some argue are too restrictive—on what individuals can do with their money.
Despite this, the United States remains the “promised land” for international startups looking for seed money and to launch their products.
Empowerment Through Education
There appears to be an industrywide acceptance and push to use TikTok and other popular social media platforms to educate Gen Z on financial products and the social nature of investing. The traditional financial models do not speak to the next generation, particularly with respect to establishing trust in money management.
For Gen Z, that trust comes from well-known influencers, and as such the industry is embracing those influencers to educate and empower. Consequently, regulators are focusing more and more on these marketing techniques.
Authentication, Validation, and Trust
Flooding the market is technology related to identity verification, one-click sign-ins, and two-step authentication to protect assets and improve banking and financial institution trust. Some of the newer technologies focus on creating a reliable transaction even where the parties may be entering into a trustless networking situation.
Another topic that is top of mind is harnessing technology to detect and prevent financial fraud. According to LexisNexis, the annual impact of global fraud exceeds $1 trillion, with every dollar lost to fraud costing $4.23 for US financial services firms, a 16.2% increase from 2020. In a sector that is complex due to the numerous business models operating under little to none standardization or regulation, fintechs are under pressure to prevent fraud and mitigate risk in the face of increasing global digitalization.
Fintechs are harnessing new technologies, including AI (as discussed below), to help meet compliance objectives while aiding in the detection and prevention of financial fraud.
Action on the Sidelines
Deal-making activity and the startup scene were out in full force, with a strong international presence. One persistent challenge facing most fintech startups is their unfamiliarity with regulation, and they are often surprised to learn that registration is needed at the state or federal level (or both). As a whole, despite market turmoil and continued high interest rates, the fintech industry remains a hot investment area.
For industry participants engaging in M&A deals, unfamiliarity with the varying global regulatory framework can potentially produce pitfalls and unexpected obstacles. When working on a transaction, parties should consider not only the transfer of value, but also the transfer of regulatory and enforcement risk. It is more important than ever for due diligence to be thorough and complete.
Cautious Optimism About Generative AI
From using generative AI technology to democratize lending to fraud prevention and financial education, the utility—and potential benefits—of generative AI are copious. However, with the potential threat of misinformation and digital media manipulation as well as copyright and ownership concerns, the industry is treading lightly in its embrace and integration of the technology.
In a first step toward a federal regulatory framework, US President Joseph Biden recently issued an executive order designed to protect against the risks of AI while encouraging the global growth and expansion of AI development and use.
What Comes Next
Heading into 2024, the fintech industry sits at a unique position, shaped by a confluence of increasing regulatory scrutiny, technological innovation, and market dynamics. Interest from federal and state-level agencies is setting the stage for a year marked by evolving legislative frameworks.
The delicate balance between federal and state safeguards and the pursuit of innovation continues to be a focal point, with the United States remaining an attractive hub, even for international startups. As demonstrated by the CFPB’s Open Banking Rule proposal and some of the authentication technologies and fraud prevention measures, consumer protection remains a high priority and will be a huge focus for both regulators and industry stakeholders in the coming year.