We all rely on the world that regulation creates – yet we groan at the mere mention of the dreaded ‘red tape’.  

With each new evolution in payments regulations, like the introduction of PSD2, we see a slew of doom-mongering articles on how it will negatively impact the industry, its stakeholders, potentially cause friction in the payments process, for example. Similarly, in the crypto industry, founded on fringe libertarian ideals of stateless personal sovereignty, the introduction of regulation that treats crypto like any other financial instrument has been met with howls of dismay.

However, what we have seen over the last 20 years is that regulations have, on the whole, been positive for the FinTech industry, and has even laid the foundations for new forms of businesses, such as RegTech.

Regulations are never perfect, as the fact that PSD has become PSD2 and will soon be replaced by PSD3 attests, but they have helped keep us all on the straight and narrow, and while regulation does of course increase complexity when compared to an impossible laisse faire system, it does so on an even playing field – everyone has the same level of complexity.

Fintech regulations, then and now

While regulation is rarely popular and financial companies too often try to circumvent them, we have an example from living memory of what happens when the sector is unregulated; the 2008 financial crash happened, in large part, because of a lack of effective regulation. At the time, money could be lent to lenders who had no ability to pay it back (so called ‘sub-prime’ mortgages) and banks could buy their debt for pennies on the dollar to effectively gamble on. When their bets failed, major institutions collapsed and others had to be bailed out for trillions of dollars.

The US responded with the Dodd-Frank act, with similar regulations elsewhere, which led to the second-longest bull-run in US history: 132 months, with an S&P return of 400.5%. If the recent pandemic had never took hold, there’s a good chance that we might still be in that bull run. Did Dodd-Frank impede innovation? Of course not: the entire FinTech industry as we know it was developed in a post-Dodds environment.

For all the talk about cutting red tape, few, if any, would argue that the financial world should be completely unregulated. It is more the case that people want fewer regulations, but those regulations that do exist need to be perfect. Clearly a near-impossible task, particularly when digital transformation has made finance exponentially more complex. Instead, effective regulation should facilitate innovation for the betterment of the sector, and we should put paid it the notion that regulation stifles innovation – that is only true to poor regulation.

An eagerness to let go of the reins by one government also doesn’t make much difference for companies working across national borders. PSD2 might be transnational, but now that the UK is out of the EU our companies will have to deal with different rules on both sides of the channel, and further afield these regulations multiply.

I would hope that there are no economy-destroying scams on the scale of 2008 happening, and the zero-interest rate policies that were a key feature of that era’s recovery are beginning to wind down before they distort the economy too badly. As a result, we should have learned that regulations benefit everyone, and yet as the introduction of crypto regulations showed, there are still those who don’t want to play by the rules, or any rules.

Regulations to reduce complexity

The argument against regulations is that they create complexity, thereby creating additional barriers of entry, greater operational costs, and stifling innovation, but this is a superficial argument that ignores the opportunities it can create and discounts both the importance and advantages of protecting the consumer. When every company in a given area is working from the same standards creates a fair and even playing field and drives demand for services that address any complexity created by regulation. Having strong, but well-targeted regulations pave the way for RegTech that can not only complexity directly for both the business and the consumer. Everybody wins.

For example, Anti-Money Laundering (AML) and Know Your Customer (KYC) regulation could increase complexity, but they also crate the opportunity for greater automation. Open Banking, introduced via PSD2, is another example of where regulatory changes created an entire new section of the industry.

3DSecure is perhaps the most widely used example of this: instead of putting the onus on each payments company and merchant to carry out SCA Authentication on card payments for themselves with their own systems, 3DSecure gives them a solution that can easily be plugged in – many smaller merchants won’t even need to think about PSD2 compliance because of how easy it’s become. But it’s not just reducing complexity – it helps manage fraud and reduces the likelihood of chargebacks, thereby protecting the customer and creating a more dependable revenue streams for the business.

The possibilities don’t stop there. Regulations, done well, provide the basis for automation, which increases productivity. Individual regulations can be debated on their own merits, but the idea of regulation itself has been proven time and time again to be a benefit to the finance space and the world at large.