By Maria Earley and Ashley Shively
Maria Earley is a partner in Reed Smith’s Financial Industry Group in Washington, D.C. She advises and represents financial services companies in enforcement, examination, litigation, transactional and counseling matters. She is a former Consumer Financial Protection Bureau (CFPB) enforcement attorney with wide-ranging knowledge of federal and state consumer financial laws.
Ashley Shively is a partner in Reed Smith’s Financial Industry Group in San Francisco. She represents financial institutions and businesses in consumer class and individual actions, including fair lending, privacy, credit reporting, debt collection, false advertising, and unfair business practices. Ashley also counsels fintech and other clients on compliance matters related to privacy issues and consumer protection.
Consumers have come to expect on-demand access to information, services, and goods. Whether watching a movie, ordering takeout, or buying a new television, innovation in the digital age provides push-button delivery of nearly anything the customer desires. Industries such as retail and telecom have traditionally been at the forefront of digital innovation. However, the increased trust in and engagement with digital technologies has given rise to numerous financial technology (fintech) companies seeking to bring efficiency and expediency to activities commonly associated with traditional financial services institutions, from loan generation and servicing to immediate transaction settlement via blockchain.
Fintech organizations serve as both a threat—in that they provide competitive products, without the burden of the brick and mortar, paper-based processes of the past—and an enabler to large incumbent financial institutions. Seeing an opportunity to rethink how they deliver service and leverage their existing customer relationships, large financial institutions have sought to emulate and embrace the wave of fintech innovation by partnering with and acquiring these upstarts.
While fintechs offer streamlined services and technologies, barriers to entry can hinder their ability to penetrate the market. Understanding how their products interplay with the patchwork quilt of federal and state laws, navigating the cumbersome and time-consuming process of obtaining appropriate state licenses, and building brand recognition are just some of the hurdles fintechs face. Mainstream players, on the other hand, have largely worked through those issues.
As the delivery of financial services continues to evolve, fintechs and traditional financial institutions are finally starting to work together and determine the best way to leverage each other’s strengths. Both sides remain distinct—one viewed as mature and well-known, the other as fresh and innovative. Nonetheless, their partnerships are evolving, providing financial and reputational benefits as they collaborate to satisfy growing customer demand.
Consumer demand for better options, less hassle and faster service extends to consumers’ expectations about their finances. As a result, there have been a number of new entrants in the marketplace that utilize technology as the core method for delivery. For the vast majority of these companies, a cultural shift towards expediency as a replacement to bureaucracy is integrally linked with their mission: to provide financial services to consumers in an efficient, streamlined and easy-to-use manner. Many of these companies were created by, and are currently staffed with, individuals who experienced firsthand the impacts of the Great Recession. They were witnesses to the loss of trust among consumers when “too big to fail” institutions received government funds to weather the storm. The endless drumbeat of lawsuits, government investigations and data breaches, which continue even today, has led these entrepreneurs to seek a better and different way to meet consumers’ financial needs.
In many aspects, fintechs are positioned to do better and take market share from their traditional counterparts. Marketplace innovators are, by definition, not bound by the existing orthodoxy. There is no culture shift that needs to occur, no reorganization or leadership shuffle necessary to provide new products and services, and entrenched assumptions are immediately questioned and tested. Fintechs are learning as they go, shaping their strategy around the product and consumer experience, rather than expecting the consumer to adjust to them. They actively seek out inefficiencies in the marketplace, nimbly create technology-based solutions to fill those gaps, and bring them to market as quickly as possible. As a result, successful fintech organizations have permeated our everyday lives.
Given this ability to move swiftly and the sheer volume of new entrants into the market, state and federal regulators in the United States are still formulating their approach to fintech. The approach to date has been generally favorable to fintechs, much to the chagrin of traditional financial institutions. Perhaps the best example is the Office of the Comptroller of the Currency (OCC) release of a proposed framework for a special purpose charter that would make it easier for fintech companies to enter the market. A review of public activity by other federal regulators, such as the Consumer Finance Protection Bureau (CFPB) and Federal Trade Commission (FTC), reveals only a smattering of actions against fintech companies.
Despite the explosive growth of fintech, traditional financial institutions continue to play a significant role in most consumers’ financial lives – and likely will continue to do so in the foreseeable future. In many ways these companies are the bedrock of America’s financial DNA. Even in this climate defined by rapid change, their footprint and familiarity represent what is safe, tried, true, and reliable. Their CEOs and senior leaders are household names who routinely head to Washington to debate and create economic policy. Consumers can feel confident that at least one regulator and many (many) lawyers and business people have vetted the products or services offered by mainstream institutions.
All this being said, the machinery that delivers the reliability of mainstream institutions also hinders their ability to innovate. The sheer size and complexities of these organizations is one major hurdle. Rather than one entrepreneurial team in a California co-working space, it takes entire departments, and several supervisory layers, to vet and approve new product offerings. Indeed, it took major banks more than six years to finally roll out an integrated digital payment solution to compete with Venmo and Square Cash.
Another barrier to innovation that cannot be understated is the burden and cost of regulation on traditional financial institutions. The alphabet soup of regulators—the OCC, CFPB, FTC, and Securities and Exchange Commission (SEC)—are just some of the entities that exercise direct regulatory authority over mainstream institutions. A large financial institution with widespread brand recognition is at much greater risk of regulatory review if it becomes the next headline. For traditional companies under constant scrutiny, that risk is very real and the result is a more cautious approach to innovation.
Against that backdrop, today’s financial services landscape features two vastly different sets of players with distinct cultures and pressure points, but whose products and target consumer base overlap. As outside counsel, these differences pose unique challenges. Fintech clients’ expectations of their lawyers mirror what consumers expect from them: fast, reliable, top-quality service that is accessible and easy to understand. Advice must be succinct and pragmatic. What’s more, fintechs are willing to take calculated risk. They will more readily adopt the ‘ask-for-forgiveness-not-permission’ approach than their well-established counterparts. As outside counsel, we must understand the client’s risk tolerance if we are to effectively present a range of appropriate solutions.
For mainstream financial institutions, the opposite is often true. While they also appreciate targeted advice, it is equally important to demonstrate adequate processes to the regulators. Detailed legal analysis and layers of review are often required to show appropriate treatment of consumer protection issues. As a result, overall risk tolerance remains low, particularly when intense regulatory scrutiny remains an over-arching concern. And regulators are not the only concern. Major financial institutions are also responsible to public investors in ways that simply do not hamper most fintechs.
Although these differences have been a barrier to collaboration between fintechs and mainstream companies, there recently appears to be recognition on both sides that collaboration may have advantages. This shift is being driven, in part, out of necessity. Many fintechs rely on access to vast amounts of data created and maintained by mainstream financial institutions. On the other hand, mainstream players seeking to make inroads with millennial (and younger) consumers are trying to create the products and services steeped in innovation that this population demands. Lastly, many fintechs have proven a maturity level that allays the concerns of many mainstream institutions and allows for co-innovation. In these cases, both sides benefit from adopting key aspects of each other’s respective cultures. Mainstream players must learn to balance adversity to risk with the need to be nimble. Fintechs can apply the experiences of their traditional counterparts. As fintechs grow their customer base beyond visionary early adopters (who generally have high risk tolerances) to more mainstream consumers (who tend to be far more risk adverse), companies’ controls and appetite for risk must adapt with that of their customers.
For these reasons, and a host of others, fintechs and traditional financial institutions are working through their differences and forming a variety of partnerships. Some are being acquired by mainstream players, some are forming direct partnerships governed through agreements, and some institutions are making strategic investments in fintechs. The trend is clear—a mutual understanding and co-existence is developing between the two.
In the end, both fintechs and mainstream financial institutions serve the same master—consumers. Consumers are driving this trend through a desire for innovative services that make their lives easier. Consumers like being able to pay a friend using a cell phone app. If the most efficient way to accomplish that is for fintechs and mainstream players to work together, the rationale behind forging these strategic relationships becomes evident.
Regulators appear to recognize this dynamic. The CFPB’s efforts to develop a set of guardrails that govern consumer-authorized data sharing between mainstream companies and fintechs is a prime example. The CFPB also released its first and only “No Action Letter” to a fintech company seeking to use alternative data to offer credit solutions. Although the CFPB has stated that it will only issue No Action letters in circumstances where a company has allowed the CFPB to fully vet a potential new product or service, No Action letters ensure that the CFPB will not take an adverse action against the company to which the letter was issued except in certain circumstances. In addition, senior leadership at the Federal Reserve, CFPB and OCC noted at a recent banking conference their efforts to better understand the developing partnerships between fintech companies and their more traditional counterparts.
The trend towards partnerships will likely continue. With the current administration’s hands-off approach to consumer protection, and the CFPB openly stating it will sit on the sidelines for the foreseeable future, innovation will continue to plow forward. Even some mainstream banks appear ready to experiment in ways that were unheard of just a few years ago. Wells Fargo, for instance, has its own Startup Accelerator and recently joined with fintech SigFig to launch an automated investment solution for Wells’ self-directed investment customers. JPMorgan Chase partnered with California-based InvestCloud to improve the bank’s digital capabilities for its individual investor customers. To cement the alliance, the bank also made an equity investment in its new partner.
In the end, however, the regulatory environment may not be the leading factor motivating these budding partnerships. Instead, it appears to be driven by consumers and the desire for cutting-edge financial services. While financial services is currently experiencing a transformative moment, one thing remains certain: fintechs and mainstream players will find ways to deliver the services we demand. The question is, will they do so as collaborators or competitors.
Copyright © 2018 The Bureau of National Affairs, Inc. All Rights Reserved.
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