Fintech Compliance Regulations: Tips For Effective Risk Management
The fusion of financial services with digital technologies has led to the emergence of numerous innovative products and services on the market, as well as the introduction of multiple regulations in the area of fintech compliance. While banks and credit unions have a long history of working with regulatory bodies, fast-growing companies are just learning how to operate in a highly regulated space. This is especially difficult for small fintech startups that prioritize their product and intensely compete for clients with rivaling startups. They often lack the resources and knowledge to manage risks and follow multiple compliance requirements to avoid penalties from various regulators.
Fintech companies are increasingly acting like banks, and as a result, they are subject to the same regulations. However, there are three additional challenges:
- Broad access. The core advantages of fintech — easy access to financial services and quick integration of new technologies into financial products — also increase the risk of failure. Attracting a larger pool of customers makes it challenging to keep an eye out and remain compliant with numerous regulations.
- Increased scrutiny. As many associate the future of finance with the further growth of the number of bank-fintech partnerships and deep integrations of digital technologies into traditional banking services, new players attract more attention from authorities and malicious third parties. Fintech companies must adopt a strong compliance culture quickly.
- Complex regulatory landscape. In the US, there is no specific set of laws for fintech. Businesses must register and comply with the obligations set out by one or more regulatory bodies. Organizations are subject to regulations at both federal and state levels.
Compliance should be a top-level priority for any financial business. However, it is important to remember that every business will be subject to specific regulatory requirements, that’s why many fintech players start to build their own compliance programs or apply to well-established regtech (regulation technology) companies.
In this article, we’ll shed light on core components and considerations regarding fintech compliance and best practices on how to successfully operate in the financial services industry. All of this is mostly based on our personal expertise, as the Surf team has extensive experience working with fintech companies that daily face the need to strictly monitor compliance with regulations in the industry of financial services.
Areas of risks in financial services
The compliance procedures required by fintech regulations cover several areas of risk that have direct implications on companies.
Reputational risks
Such risks exist in every new product launched by any financial institution or a fintech firm. Both types of firms invest significant time and resources into building client relationships. Even a tiny mistake can shatter users’ trust and loyalty. Moreover, reputational issues could affect the revenue from other products and the company’s viability in the market.
Regulatory risks
New technologies and innovations are disrupting the financial services market and developing at quite a fast pace so regulatory bodies often don’t manage to provide new regulations in time. It often takes years to review, finalize, and approve new fintech standards or proposals to adjust existing rules. At the same time, fintech startups that partner with banks are being monitored closely for compliance with regulations through the partnership. For financial institutions in these relationships, communicating and fostering a clear foundation of compliance is paramount in risk management.
Financial risks
Non-compliance or violations of governmental regulations can directly affect the revenue of the organization, the share price, potential future profit, and the ability to attract additional rounds of capital and lead to a loss of investor and consumer confidence.
Business risks
There’s always the risk of the unknown when introducing something new. Fintech companies create business models that are primarily aimed at driving innovation, while traditional banks and credit unions are accustomed to working in narrow regulatory environments with many compliance procedures. These opposing forces could overlap and contribute to significant «blind spots» in risk management. Moreover, unexpected economic, political, and social events can also trigger changes in laws and regulations.
Key US regulations affecting fintech
A few key compliance regulations affecting fintech companies are:
US anti-money laundering (AML) regulations. Fintech AML risks should always be properly managed. There are currently two AML documents in force in the US: the Bank Secrecy Act (BSA) and the US Patriot Act.
- BSA requires financial institutions to help the country’s authorities in detecting and preventing money laundering. In compliance with the regulation, companies should monitor and report cash purchases of negotiable instruments (for example, money orders and cashier’s checks) with a monetary instrument report (MIS), or currency transaction report (CTR) if the transactions exceed $10,000. They must also report any potential suspicious activity that could lead to money laundering or terrorist financing.
- The US Patriot Act is another law that affects fintech standards and requires financial institutions to introduce customer identification programs and maintain related customer due diligence standards, referred to as «know your customer» (KYC). The act requires companies to establish anti-money-laundering programs through internal policies, procedures, and controls, assign compliance officers who provide continuous employee training, and test their programs through independent audits.
Gramm-Leach Bliley Act (GLBA) or the Financial Modernization Act. This compliance regulation stipulates that all financial institutions should explain to their customers how their information is being shared, and take measures to protect their sensitive data.
2012 Jumpstart Our Business Startups Act (JOBS Act). The act requires crowdfunding platforms to register with the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) to make their functioning more secure. The JOBS Act also introduces maximum fundraising amounts and disclosure requirements. As for P2P (peer-to-peer) lending, a crowdfunding platform is considered a third party if it partners with a bank, and the latter is responsible for adhering to fintech compliance regulations.
Fair Credit Reporting Act (FCRA). The FCRA sets up ways to protect information collected by consumer reporting agencies such as credit bureaus, medical information companies, and tenant screening services. Only those with a purpose specified in the FCRA compliance documentation can access consumer reports.
Truth in Lending Act (TILA). This act can be regarded as not only financial compliance regulation but a fintech standard as well. It contains consumer protection requirements for credit card holders that are designed to improve credit card disclosures, rate increases, payment allocations (above minimum payment), and a reasonable amount of time to make payments.
Security Act and Exchange Act. Initial Coin Offerings (ICOs) are popular among fintech firms, but no specific compliance regulations have been developed for them. The precedent has now been set with what is known as the Howey Test, determining the legal status of the ICO. If the ICO meets the threshold requirements, it will be subject to the Securities Act and Exchange Act.
Required fintech licenses explained
Whether you are about to launch a fintech app or just research the market to start working on a separate product, you need to be certain about compliance regulations to follow and licenses to obtain. Taking into account the complexity of the US regulatory environment in this sphere, even a small nuance could be critical in determining whether a fintech project should obtain one or another paper. The main documents and registrations that could be required from fintech firms are:
- Money Service Business (MSB) registration is required from all firms that are prone to fintech AML risks and subject to BSA’s reporting and compliance rules: digital wallets, mobile payment systems, and peer-to-peer transfer systems.
- Money Transmitter License (MTL) should be obtained by any business performing money transmissions. In the United States, activities falling under this category vary state-by-state, and the process for obtaining compliance in each state is lengthy and costly, with certain states being less restrictive than others.
- Offerings through Reg A. Reg A is an exemption from the registration requirements, allowing companies to offer and sell their securities, which are capped at $50 million for one year, without having to register the offering with the SEC. At the same time, state and federal jurisdictions still fall under the SEC. There are similar frameworks for private placements and smaller companies (Reg D). Therefore, fintech companies with new security offerings must ensure proper registration and be fully compliant with these regulations before launch.
- BitLicense compliance is required for firms that deal with cryptocurrency activities. The document is issued by the New York State Department of Financial Services (NYSDFS).
Four best fintech compliance and regulatory practices
Here are four best practices to ensure your company not only meets but exceeds regulatory expectations.
AML scrutiny. In 2015, the Financial Crimes Enforcement Network (FinCEN) levied a $700.000 penalty against a digital currency operator for breaking fintech regulations by not enforcing an adequate AML program. As your company offers financial services, you must have a scalable and solid AML program from day one.
Keeping consumers in mind. It is crucial to maintain vigilance in this area, as numerous regulatory bodies are intensifying their scrutiny of compliance with consumer rights. The Consumer Financial Protection Bureau (CFPB) is the regulator investigating financial institutions that have allegedly violated consumer rights. This has extended not only to established financial institutions but also to fintech companies.
Know your customer. Operating in compliance with the KYC concept should be a top priority for fintech firms. Banks are investing heavily in anti-fraud and anti-terrorist financing measures, and these companies should do the same.
Plan ahead and be ready to scale up your compliance program. Fintech regulation is still being drafted and is constantly evolving in multiple directions as an addition to guidelines for banks. Like banks, fintech companies must interact with regulators and stay updated on the latest developments to ensure consumers have access to the most innovative digital financial services and products.
Bottom line
Let’s summarize:
- Operating in the financial services industry generates multiple compliance concerns companies should be aware of, including reputational, regulatory, financial, and business risks.
- The US regulatory environment is complex: there are multiple documents that regulate the activities of organizations that perform banking functions, while formalized compliance guidelines exclusively for the fintech market have not been developed yet. Moreover, existing laws are in force on different levels (state and federal).
- The type of activity of a fintech firm determines the exact compliance rules to follow and licenses to obtain to continue operation (for example, regulations for an electronic wallet and banking app will be different at some point).
- Put special attention to your company’s AML program, ensure that it’s scalable and comprehensive.
- Respect for consumer rights should be at the center of your product development. There are also specialized bodies that monitor compliance on this aspect.
- The KYC concept should be a top priority for any fintech firm to eliminate fraud.
- Planning ahead your compliance strategy is the key to success. You should also be ready to scale up your compliance program, as the pool of regulations in this sector is constantly evolving and changing.
Surf team closely works with fintech projects, delivering industry expertise and best fintech app development practices to our clients. We are also ready to advise you on how to build a proper compliance program for a fintech project and integrate necessary tools in your app — look at how we integrated a mobile app for one of the top-15 European banks with the State Information System on State and Municipal Payments (GIS GMP) and KYC to make sure that compliance regulation requirements are fulfilled. Fill in the form and we will return shortly with the feedback regarding your project.
