Navigating regulations to achieve innovation
There are numerous known challenges to starting a fintech business, ranging from finding funding to protecting valuable data from cyber attacks. However, the biggest obstacle facing many fintech entrepreneurs is how to navigate the still-muddy waters of South African fintech regulation.
“There is no regulation specific to fintech per se; regulation tends to govern the financial product itself”, says Angus Brown, co-founder of Bitcoin-based payments business Centbee.
Existing regulation can provide a guide
This is fine if your product or service is similar enough to other offerings in the market such that existing regulations apply without much ambiguity, which is important to both investors and customers.
“In most cases, fintech companies are building financial products and services using traditional money [as opposed to cryptocurrency] and infrastructure, which means they can apply existing regulation that is of relevance to similar institutions”, says Marius Reitz, General Manager for Africa at global cryptocurrency firm Luno. “One of the advantages of this is that these companies have regulatory certainty from the start and this immediately helps build trust for businesses and consumers because they know the product or service is being held to defined regulatory standard”, he says.
Square peg in a round hole
But if your fintech doesn’t obviously fit into the prevailing legal structure, it can make things difficult or even impossible, thereby stifling innovation and growth in the industry as a whole. Nerushka Bowan is an emerging law specialist and legal tech innovator. She explains that regulation is often retrospective which can present complications to new entrants. “Regulation is often drafted in a reactive manner in response to identified risks and built around incumbents”, says Bowan. “When you create a new way of doing something that does not fit the existing mould, especially in a highly regulated area like financial services, it can be a daunting task to determine where your regulatory requirements lie”, she says.
This is one of the challenges that global cryptocurrency firm Luno has faced in South Africa because crypto is a completely different kettle of fish compared to traditional money.“Cryptocurrency companies like Luno are building financial products and services on entirely new infrastructure, which makes it tricky for consumers and regulators: should cryptocurrency be treated as an asset, as a currency, as a payment mechanism or as an open, global technology?”, says Reitz.
Brown has a similar take, believing that the absence of comprehensive regulatory guidance on the use of cryptocurrency is a disadvantage to both service providers and customers. “The lack of a clear regulatory framework for cryptocurrency provides an excuse to conservative merchants and financial services firms to shy away from Bitcoin”, says Brown. “They conflate “not regulated” with “illegal” and hence may miss out on the opportunity to provide valuable services to customers”, he says.
He cites the ability to digitally identify a customer as an example of an innovation being stifled by unclear regulations. “In my opinion, the ability to perform a digital “Know Your Customer” identification using data embedded in a mobile phone, along with simple customer interaction, is a critical enabler of financial services,” he says. “The technology is mature and reliable, but the regulations across financial services are inconsistent and hearken back to branch-based interaction”.
Thomas Reisenberger, Compliance Legal Adviser at Legalese, a creative legal agency for start-ups, technology and creative firms, believes the difficulties fintech entrepreneurs encounter in obtaining timely regulatory advice from relevant authorities is one of the key issues facing South Africa’s fintech industry.
“The biggest hurdle I am experiencing on behalf of my clients is their inability, as grass-roots developers and entrepreneurs in the fintech sector with no legal training or network connections, to obtain authoritative, reliable and consistent legal advice from the respective authorities”, says Reisenberger. “A lot of these entrepreneurs need to move quickly and with certainty (e.g. to get to market first, or to attract good foreign investment). Not being able to get correct, quick legal guidance from the authorities is disastrous, usually killing these excellent novel entities before they even begin”, he says.
Brown agrees that the lack of regulatory clarity can be detrimental to a fintech’s ambitions.“Fintech providers can either offer their services direct to the customer (B2C) for which they need to obtain financial services licenses, or provide software solutions to existing providers (a B2B model)”, Brown explains. “Fintech start-ups are small, cash-poor and often have difficulty getting hold of licenses. As a result, I see many pivot from innovative B2C offerings, to providing white-label solutions on a B2B model to incumbents”, he says.
A fine line
Regulating the industry is a balancing act though. Do too little and investors and you leave clients and investors vulnerable; do too much and you risk regulation that is so onerous as to inhibit innovation altogether. There needs to be a middle ground that benefits both parties. “There is the danger that regulators try and front-run innovation with restrictive and highly burdensome regulations, slowing down the speed of growth and innovation in the fintech industry”, says Reitz. “For fintechs with small teams and limited resources, having to comply with certain regulatory requirements from the start can be extremely burdensome and costly which could ultimately lead to the stifling of innovation”, he says.
SA on the right track
However, South Africa does seem to be moving in the right direction. The Intergovernmental Fintech Working Group (IFWG) was set up at the end of 2016 with the express objective of developing a co-ordinated approach to fintech regulation that would both encourage innovation while at the same time ensure continued financial stability, including the protection of customers and investors. The IFWG consists of members of the National Treasury, the South African Reserve Bank (SARB), the Financial Services Board (FSB) and the Financial Intelligence Centre (FIC). The group is expected to publish an updated regulatory framework for the fintech industry in the coming months.
Encouragingly for Reitz, part of the IFWG’s remit is to gauge the need for regulatory sandboxes. The use of regulatory sandboxes is becoming increasingly popular with global regulators; most sandboxes have been set up in Asian and European countries so far but Canada launched one in February 2019 and there are hopes that South Africa will soon follow suit.“A regulatory sandbox is a framework set up by a regulator that allows fintech start-ups and innovators to conduct live experiments in a controlled environment under a regulator's supervision”, he says. “This provides start-ups with regulatory relief and support to help them navigate the regulatory framework.”
Not only is a sandbox beneficial for fintechs to experiment with innovation, but also for regulators who can test the waters with greater visibility as to the most appropriate regulations to implement. “A regulatory sandbox provides tight constraints (such as value or customer volumes) so that firms can test out new business models and technologies. Regulators can then be guided by hard data and direct customer experiences into the most suitable regulations to promulgate”, he says.
Tips from the top
1) Watch out for sandboxes
More and more regulators are looking to set sandboxes up in order to meet evolving customer demands, according to Reitz. He advises new fintech entrants keep an eye out for the introduction of these regulatory sandboxes in South Africa. “These might be good platforms for you to engage with the regulators directly in a less restrictive environment”, he says.
2) Build relationships with regulators
He believes building and maintaining a good working relationship with the relevant regulatory bodies is critical to success. “Engage with them, ensure your business model is clear to them, and offer assistance in drafting or advising on policy considerations”, he says.
3) Seek guidance sooner rather than later
Bowan’s advice is to do this early on in the process, during your design phase. “If you know what potential hurdles you may face, you can build or design with them in mind. If you build your product and only obtain regulatory advice just before you go to market, if may feel like you’re trying to unscramble an egg”, she says.
4) Ask for help from peers
But it’s not just about being in conversation with regulators. There is a wide network of fintech entrepreneurs who have had to, or are still having to, contend with murky regulations on whose experience you can draw.
Brown advocates asking for help from those in a similar position to you. “Reach out to the community for advice. South Africa’s entrepreneurial community is more collaborative than competitive and those with experience are generally happy to share advice”, he says.
5) Do your (legal) research
Importantly, the regulatory environment may not be 100% clear-cut but claiming a lack of knowledge or certainty is not an option. Reisenberger says: “You have to understand the exact laws to which your product or service is subject. Feigning ignorance of the law is not an excuse to avoid liability or risk; authorities, investors and customers all know this”.
Although Brown concedes that it may be difficult to get to grips with the appropriate legal regime, there is no alternative. “Take the time to read the Acts and relevant regulations. They may be dense and in “legalese” but you have to study them”, he says.
Reitz is a firm believer in using self-regulation to address the challenge of regulatory ambiguity. “Don’t let regulatory uncertainty stop you from innovating and taking your product to market”, he says. “Start your business and follow a self-regulatory approach according to existing regulation that is of relevance to similar institutions in the financial industry. For example, when we first launched we started by applying the highest levels of Know Your Customer and Anti-Money Laundering requirements and taking guidance from other existing financial regulations”.
He adds: “The process to figure out whether your business should operate within existing frameworks or within a new framework can take years. More often than not, existing laws and regulation covers aspects like consumer protection and money laundering which will be applicable to you.”
What does the future look like?
For Bowan, regulators need to ensure they introduce regulations that are not too severe or restrictive. “Regulation needs to move away from strict tick-box exercises, towards a risk-based and practical approach”, she says. “Rather than rigid regulation that gets quickly outdated, there should be frameworks, guidelines and the establishment of self-regulatory bodies that set up industry best practices with a focus on consumer protection. This is the future of regulation”.
Brown sees the regulatory environment becoming less constrained by geographic limits. “Regulators are increasingly coordinating amongst each other across national borders”, he says. “Global think-tanks such as the Bank of International Settlements and the Financial Action Task Force will play a bigger role in drawing up global policy and guidelines. These recommendations will guide independent national regulators to harmonise local regulations”.
A more collaborative approach between global authorities will undoubtedly help speed up the implementation of what is clearly very necessary regulation in South Africa. Encouragingly, Reitz believes our regulators to be ahead of the curve. “Broadly speaking, South African regulators tend to move faster than some of their international counterparts, using existing legislation to cover new technologies, instead of drafting entirely new regulation which tends to be slow and expensive”, he says.
Although legislation governing the industry is still somewhat opaque, many South African fintechs are successfully navigating the muddy waters. Early-stage businesses and new entrants should therefore not be put off by the lack of explicit and clear-cut regulations. Rather, they should take heart from how forward-thinking and proactive our regulators are; they are clearly on board with facilitating an environment that is both conducive to financial innovation and protective of investors and customers. This can only bode well for an industry that has the potential to meaningfully contribute to an economy that is sorely in need of revival.