This summer, the U.S. Department of the Treasury issued a report to President Trump entitled “A Financial System That Creates Economic Opportunities; Nonbank Financials, Fintech and Innovation” (the “Treasury Report”). The Treasury Report was issued in response to an executive order dated February 3, 2017 which has resulted in a series of such reports. The executive order identified Core Principles and requested the Treasury Department to identify laws, treaties, regulations, guidance, reporting and record-keeping requirements, and other government policies that promote or inhibit federal regulation of the U.S. financial system in a manner consistent with the Core Principles. In response to its directive, the Treasury Department is issuing four reports. For a summary of the Treasury Department Report on Capital Markets, see HERE.
The Core Principles identified in the executive order are:
- Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
- Prevent taxpayer-funded bailouts;
- Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;
- Enable American companies to be competitive with foreign firms in domestic and foreign markets;
- Advance American interests in international financial regulatory negotiations and meetings;
- Make regulation efficient, effective, and appropriately tailored; and
- Restore public accountability within federal financial regulatory agencies and rationalize the federal financial regulatory framework.
This blog will summarize key portions of the 222-page report; however, for those interested, the entire Report, and especially the beginning Executive Summary, is well written and thought-provoking. Exhibit B to the Report contains a succinct table of all recommendations broken down by category.
Interestingly, the Treasury Report opts not to provide any detailed coverage on blockchain, distributed ledger technologies or digital assets, instead finding that topic to be significant enough to warrant stand-alone treatment. The Treasury Department is party of an interagency working group of the Financial Stability Oversight Council focused on this new area of technology and capital resources.
Non-bank Financials, Fintech, and Innovation
A non-bank financial firm provides financial services, including extending credit; providing investment advice; executive retail investment transactions; processing payments; facilitating back-end check processing; enabling card issuance, processing, and network activities; and providing customer-facing digital payments software. As such, non-bank financial firms play an important role in the U.S. economy.
During the financial crisis, the government wrote far-reaching laws that mandated the adoption of hundreds of new regulations, many of which either limited certain services by banks or made them unprofitable. As a result, the financial service sector grew rapidly. Importantly, capital is available for companies in the financial services and fintech sectors. The financing of financial services firms has reached in excess of $22 billion globally, and such firms now make up more than 36% of all U.S. personal loans, up from less than 1% in 2010.
In addition, at the same time, the rapid development of financial technology enabled financial services firms to improve operational efficiencies and lower regulatory compliance costs. The Treasury Report succinctly notes, “[S]ince the financial crisis, there has been a proliferation in technological capabilities and processes at increasing levels of cost effectiveness and speed. The use of data, the speed of communication, the proliferation of mobile devices and applications, and the expansion of information flow all have broken down barriers to entry for a wide range of startups and other technology-based firms that are now competing or partnering with traditional providers in nearly every aspect of the financial services industry.”
There are abundant examples of significant changes in the world economy. Digital advice platforms make financial planning and wealth management tools available to all households regardless of income level. Technology provides options for the unbanked and underbanked population through mobile-based applications. Consumer and mortgage lending are all available online in a shorter process than ever before. Payment processors allow for quick and easy transactions between businesses and consumers and person-to-person among friends sharing a bill. Cloud computing, machine learning, artificial intelligence, blockchain and distributed ledger technologies are likewise revolutionizing the financial service sectors.
Issues and Recommendations
The Treasury Report groups its recommendations into four categories: (i) adapting regulatory approaches to changes in the aggregation, sharing and use of consumer financial data and support competitive technologies; (ii) aligning the regulatory framework to eliminate regulatory fragmentation and support new business models; (iii) updating activity-specific regulations, especially those that are outdated by technological advances; and (iv) advocating an approach that supports responsible experimentation in the financial sector and helps America be competitive internationally.
Specific recommendations include:
Consumer Financial Data
The Treasury Report recommendations focus on improving consumers’ access to data and its use by third parties to support better delivery of services. In particular, there are numerous regulations and regulatory uncertainties that act as impediments for financial service companies and data aggregators desiring to establish data sharing agreements. The Treasury Report also recommends that Congress enact a federal data security and breach notification law to protect consumer financial data and ensures that consumers are notified of breaches in a timely manner.
Eliminating Regulatory Fragmentation and Supporting New Business Models
Treasury makes numerous recommendations for removing regulatory burdens and fragmentation and for new regulations that will support cloud technologies, machine learning, and artificial intelligence into financial services. Treasury also recommends a more unified state law system, including the drafting of model laws and unifying licensing processes across states. Treasury supports Vision 2020, an effort by the Conference of State Bank Supervisors that includes establishing a Fintech Industry Advisory Panel to help improve state regulation, harmonizing multi-state supervisory processes, and redesigning the Nationwide Multistate Licensing System.
Further at the federal level, Treasury encourages the development of a special-purpose national bank charter for non-bank financial service providers. Interestingly, on the same day as the release of the Treasury Report, the Office of the Comptroller of the Currency announced that it would begin accepting applications for special-purpose national bank charters from financial technology companies that don’t take deposits. As of the date of this blog, no such charters have yet been issued. Moreover, the Conference of State Bank Supervisors (CSBS) has filed a federal lawsuit claiming the program is illegal.
The Treasury Report also encourages banking regulators to clarify guidance regarding bank partnerships with non-bank financial firms, encouraging such partnerships, especially those that promote innovation. Furthermore, Treasury makes recommendations regarding changes to permissible activities, including bank activities related to acquiring or investing in non-bank platforms.
Updating Activity-specific Regulations
Specific areas with recommendations for regulatory reform include:
- Marketplace lending – The Treasury Report recommends eliminating constraints on relationships between non-bank and bank lenders, codifying the “valid when made” doctrine and the role of the bank as the “true lender” of loans it makes.
- Mortgage Lending and Servicing – Non-bank financial firms now originate approximately half of all new mortgages. Regulatory changes should encourage broad primary market participation and the adoption of technological developments, shorten origination timelines, facilitate efficient loss mitigation and generally help deliver a more reliable, lower-cost mortgage product.
- Student Lending and Servicing – The federal student loan program represents more than 90% of outstanding student loans and is managed by a network of non-banks for servicing and collection. The Treasury Report recommends that the U.S. Department of Education establish minimum effective servicing standards and the increased use of technology for communication with borrowers, monitoring and management.
- Short-Term, Small Dollar Lending – Treasury recommends that the Bureau of Consumer Financial Protection rescind its Payday Rule as state regulations are adequate. The goal is to encourage access to short-term, small-dollar installment lending by both non-bank and bank financial institutions.
- Debt Collection – Treasury recommends that the Bureau establish minimum effective federal standards for third-party debt collectors, including standards for the information that must be transferred with the debt for purposes of third-party collection or sale.
- New Credit Models and Data – Regulators should provide regulatory clarity for the use of new data and modeling approaches that are generally recognized as providing predictive value.
- Credit Bureaus – Credit bureaus are not routinely monitored for the privacy provisions and data security requirements under the federal Gramm-Leach-Bliley Act and as such, the Treasury Report recommends that processes be put into place for such monitoring. Treasury also recommends that Congress amend the Credit Repair Organizations Act to exclude national credit bureaus and national credit scorers in order to allow these entities to provide credit education and counseling services to consumers to prospectively improve their credit scores.
- IRS Income Verification – The Internal Revenue Service (IRS) system that lenders and vendors use to obtain borrower tax transcripts is outdated and should be modernized in order to minimize delays in accessing tax information, which would facilitate the consumer and small business credit origination process.
- Payments – Treasury recommends that the states work to harmonize money transmitter requirements for licensing and supervisory examinations, and urges the Bureau to provide more flexibility regarding the issuance of remittance disclosures. Treasury encourages the Federal Reserve to move quickly in facilitating a faster retail payments system, such as through the development of a real-time settlement service that would allow for more efficient and widespread access to innovative payment capabilities.
- Wealth Management and Digital Financial Planning – Under the current regulatory structure, financial planners may be regulated at both the federal and state levels. Although many financial planners are regulated by the SEC or state securities regulators, they may also be subject to regulation by the Department of Labor, the Bureau, federal or state banking regulators, state insurance commissioners, state boards of accountancy, and state bars. This patchwork of regulatory authority increases costs and potentially presents unnecessary barriers to the development of digital financial planning services. Treasury recommends that an appropriate existing regulator of a financial planner be tasked with primary oversight of that financial planner and other regulators defer to that regulator.
Supporting Experimentation in the Financial Sector
The theme of the Treasury Report is to support innovation and permit experimentation and changes in the financial services industry. Many other countries have created innovation facilitators and other groups to test new technologies in the financial sector. Unfortunately the fragmentation of the U.S. regulatory system makes it more difficult for the U.S. to maintain global competitiveness. The Treasury Report recommendations focus on defragmenting the regulatory system and supporting innovative changes.