Risk-based and technology-neutral – the HKMA’s supervisory approach to financial technology (Fintech)
I have very limited knowledge of the popular board game “Go”. However, like many others, I was engrossed in the news reports about the recent matches between South Korea’s “Go” grandmaster, Lee Sedol, and the artificial intelligence programme AlphaGo. In the end, Lee suffered a crushing defeat to AlphaGo in the five-game “Go” tournament with a final score of 1 to 4. The result has generated widespread debate on whether, or even when, machines will fully replace humans in their jobs.
I wish I had the answer. Artificial intelligence is not something new and is already widely used in the financial sector. The plan to introduce “robo-advisers” to deliver investment advice to customers by some banks in Europe and the US is one of the many examples of applying artificial intelligence in the area of Fintech.
Major advancements in Fintech in recent years have attracted the attention of financial regulators around the world, including the HKMA. Indeed, some say Fintech’s development in Hong Kong is lagging behind other places and they blame the Government for not being proactive enough or even for stifling its development. In this article, I will discuss the views of the HKMA, as a banking regulator, towards Fintech and talk about the work priorities of our newly established Fintech Facilitation Office.
Some commentators believe Fintech can bring about great change, or even revolutionise the traditional role of the banking industry. For example, the peer-to-peer (P2P) lending platform, which has garnered much attention, may replace the intermediation role of banks by matching the supply of, and demand for, funds.
One of the advantages of the P2P business model is that it substantially lowers the threshold for loans. Through the P2P platform, individuals might find lenders for microcredit and unsecured loans that banks in general would not be interested in. For lenders, rather than depositing money into a bank for modest interest income and letting the bank lend out the money, the P2P provides an alternative investment to lenders, allowing them to lend out the money directly and profit from the interest rate spread.
Crowdfunding is another recent and growing example of Fintech solutions. In order to get funding for their projects or businesses, fund-raisers will usually propose their ideas through the Internet with promises to offer investors shares in, or profit generated from, the projects or businesses in return. Take Kickstarter, the most “successful” crowdfunding platform, as an example. One of its projects, the Zano mini-drone, attracted over 10,000 investors and raised more than US$3.5 million.
The wide range of financial products and services in the market is simply overwhelming, and the players come from different professions including finance, technology, legal and even psychology. The great challenge for the HKMA is to provide adequate protection for Fintech consumers, while retaining appropriate flexibility so as not to hinder the development of Fintech. Whether we can achieve this goal hinges on three key factors:
I. Our willingness to learn and understand Fintech
As a regulator, we should fully understand the characteristics, potential and risks of Fintech. Take Blockchain as an example: we must thoroughly consider the benefits and risks to the financial system should this be widely used at the retail or corporate customer level.
II. Our ability to maintain close contact with the industry and other stakeholders
As to how the Government should regulate Fintech, so far there has been no internationally accepted yardstick. Nevertheless, the HKMA will study and make reference to actual cases and experiences gained in Mainland China and overseas. We have also heard that some Fintech operators are worried about inadvertently infringing the law because of some grey areas in existing legislation. This will no doubt hinder the development of Fintech in Hong Kong. In fact, the enactment of new legislation last November aimed at licensing and regulating stored value facilities is a good example of how we respond to the latest developments after exchanging views and communicating with the industry.
III. Our ability to achieve a good balance between market development and user protection
Despite issues which may emerge with the arrival of novel technological applications, the premature and indiscriminate introduction of exhaustive regulations, based on a “zero-risk tolerance” and “no-gaps-allowed” mind-set, may hinder the development of Fintech.
However, to adopt a completely free rein is another extreme and equally undesirable approach. In recent times, and in different parts of the world, there have been many cases of companies, acting under the cover of Fintech, going under and failing to meet their obligations. For example, the crowdfunding Zano project I mentioned earlier, had to seek voluntary liquidation, leaving its investors stranded. In another example, Ascenergy, purporting to be an oil and gas company which raised US$5 million from crowdfunding, was found to have misappropriated most of the funds to non-energy uses. The US Securities and Exchange Commission has since filed charges against Ascenergy.
Also in Mainland China, an online finance company, Ezubao, was seized by the authorities after it was found that 95% of the projects financed through the company were scams. Over 900,000 investors appear to have lost some RMB50 billion raised by Ezubao in the scam.
Listing the examples above is not to throw a wet blanket over the development of Fintech; but the HKMA, as a regulatory authority, must be “concerned about these issues before others” and prepare for the possible worst case scenario. This is our responsibility.
To assist the industry in understanding the local regulatory landscape and to facilitate a healthy development of Fintech in Hong Kong, the HKMA has recently established the Fintech Facilitation Office. A dedicated email account (firstname.lastname@example.org) for contact purposes has been set up after the announcement of the Budget.
The Office has three main functions – working with the industry to promote research in Fintech solutions; providing a platform for industry communication and outreach activities; and acting as an interface and major point of contact between Fintech market participants and regulators.
The HKMA adopts a risk-based and technology-neutral approach in its supervision. This means that when developing and implementing regulatory framework and requirements, we will only base on the intrinsic characteristics of the financial activities or transactions, and the risks arising from them. We will not introduce undue exemptions or requirements simply because some novel technological applications have been used. This will help ensure the creation of an environment that is conducive to innovation and fair competition for market participants, while end users will not have to bear unnecessary or undue risk.
We welcome different stakeholders to contact the HKMA to exchange views on Fintech innovation. We will provide further details about the work progress of the Fintech Facilitation Office at the Cyber Security Framework Symposium in Hong Kong in mid-May.
Hong Kong Monetary Authority
21 March 2016
Note: This article is an excerpt from Mr Norman Chan’s speech titled “Fintech Supervision and Innovation” delivered at the Ming Pao Summit on “New Opportunities for Hong Kong: the 13th Five-year Plan”.