How should fintech be regulated?

Congress should consider allowing state and federal regulators to set up “regulatory sandboxes” to allow limited trials of innovative products, law professors and academics said Tuesday.

In testimony before the House Financial Services Subcommittee on Financial Institutions and Consumer Credit during a hearing to examine opportunities and challenges in the fintech marketplace, Brian Knight, director of the Program on Financial Regulation at the Mercatus Center at George Mason University, opined that lawmakers could allow firms that participate in a regulatory sandbox program and comply with its requirements to avoid liability as long as the firm makes “customers whole if the firm causes harm owing to a violation of the law.”

The United Kingdom Financial Conduct Authority, Knight said, is credited with launching the first regulatory sandbox for fintech in 2015.

Adam J. Levitin, professor of law at Georgetown University Law Center, agreed that such a sandbox could allow companies to “try new things out with the understanding that customers must be protected.”

Having said that, however, the “fragmentation of the regulatory system [around fintech] makes it hard for experimentation,” Levitin added.

“We need to regulate to the risk,” Levitin continued, noting the risks in initial coin offerings.

Mercatus’ Knight stated that while ICOs “may enable firms to access capital more effectively than traditional methods, there are significant concerns that they are being used by both outright frauds and well-meaning but ignorant firms to obtain capital in contravention of existing laws governing the sales of securities, commodities futures contracts, and products and services.”

The “considerable increase in value for numerous virtual currencies in the past year has given rise to fears that the prices reflect an asset bubble rather than the assets’ true value and that the eye-popping prices attract scammers preying on the vulnerable,” Knight continued.

“Virtual currencies may also potentially present risks to both law enforcement and national security by allowing bad actors to move money illegally or avoid sanctions.”

Levitin argued that “no acute crisis” exists with the current fintech regulatory framework.

“It might be less than ideal, but so too is the general structure of U.S. financial regulation,” he added. “Fintechs have been able to blossom and prosper under the current regulatory regime. What this means is that Congress should proceed deliberately and carefully in making changes to the fintech regulatory framework, with the first principle being ‘do no harm.’”

However, the current fintech regulatory framework is not without issues, he said, adding that “the issues posed by the existing regulatory framework vary depending on what a fintech does.”

— Check out Ladenburg Makes New Fintech Push on ThinkAdvisor.