Why we need a federal fintech charter

Yesterday we filed a comment letter responding to the Office of the Comptroller of the Currency’s request for comment on its recent white paper on innovation. In it, we praise the OCC for their forthright observation that they may have a “low risk tolerance for innovative products and services” which can result in “a deliberate and extended vetting process that can discourage innovation inadvertently.” And then we ask for action: a federal fintech charter.

America’s Regulatory Minefield

As we explain, the regulatory problems facing American fintech firms originate outside of the OCC and they come from structural rather than attitudinal realities. Structurally, we have too much overlapping and incongruous regulation thanks to our state-by-state approach to money transmission licensing. And those regulations often take a rules-based rather than principles-based approach. The result is a minefield of prescriptive and inflexible compliance obligations that differ state by state.

This all stands in sharp contrast to the approach recently pioneered in the UK. For one thing, there’s really only one regulator to worry about in the UK: Her Majesty’s Treasury. That’s a lot easier than some 53 states and territories along with a handful of federal agencies. Second, the UK approach is principles-based; it forgoes rigid, often obsolete, and check-the-box requirements in favor of a cooperative dialog between innovators and regulators. That dialog is aimed at achieving a set of principles—adequate protection of consumer funds, prevention of systemic risks to the economy, and effective transparency for law enforcement—in light of the fresh opportunities and limitations of some new technology or business model.

Responsible Innovation is Open

The OCC’s white paper talks about “responsible” innovation specifically. In our comment we make the case that, in the 21st century, responsible financial innovation means open innovation, both open source and open network.

In the 21st century, responsible financial innovation is open innovation, both open source and open network.

We describe how open source software and open network architectures can provide more robust security and enhanced interoperability than existing systems. However, because of the nature of these technologies, open network firms will also be virtual currency firms, and that means they’ll often be treated as money transmitters under state and federal laws. The result is that open technologies face tougher regulatory scrutiny than closed systems despite offering real consumer benefits over those proprietary architectures. That regulatory calculus doesn’t add up.

The OCC Can Fix This

The OCC is in a prime position to change the balance; it can remove the barriers to American competitiveness far more rapidly than any other regulatory or political means.

In its White Paper, the OCC asks “How can [we] facilitate responsible innovation by institutions of all sizes?” The simplest and most promising answer is to create a lightweight, limited-purpose federal charter for fintech firms that mirrors the regulatory environment of the UK: principles-based regulation with passporting across the several states.

Innovative firms have, principally, two needs that such a federal charter could satisfy. (1) A federal charter could be made to preempt state money transmission regulation and grant the firm a passport enabling them to operate in any and all of the several states. (2) A federal charter could facilitate access to the payment system so that the fintech firm need not struggle to obtain banking services from existing financial institutions who may be risk averse (see our Banking Paper that describes how hard it is for virtual currency firms to get banked).

The OCC, by virtue of being a federal agency with preemptive power over state law, is ideally positioned to address the first concern. The OCC need not fully preempt state authority in this space, but can—instead—craft a new federal alternative to state money transmission regulation for fintech firms who choose to seek a limited charter. Similarly, the OCC is the ideal choice for crafting and enforcing flexible, principles-based rather than rules-based regulations because of its history of working closely and flexibly with other federally chartered institutions.

The OCC could also effectively limit its own risk by establishing a limited federal fintech charter. Primarily, the OCC would be taking real steps to ensure that American institutions remain relevant in the development of the future global financial system. Migration of innovative firms to other nations would narrow the window that US regulators have into financial networks and hamstring the US’s global policy objectives. Second, the OCC could craft a risk-mitigating charter that only enables fintech firms to engage in some of the core activities of banks. Given the risks associated with deposit-taking and lending, fintech firms could be limited in their charters to performing the check payment function. Effectively, the firm only gains access to ACH or Fedwire in order to facilitate exchange or interoperability between virtual currencies and the dollar. In this potential model of a limited charter, the fintech firm would have the key benefits of federal regulation, preemption of state law, and access to the payments system, but would not engage in risk-generating activities like deposit taking or credit extension.

What it boils down to

Governments like the UK’s are already taking substantial steps to encourage fintech innovation, especially in the realm of virtual currencies. Substantial structural impediments to innovation exist within the US regulatory landscape: federalism and a rules-based approach. Responsible innovation is open innovation, which will often involve the use of virtual currencies, money transmission, and—by inevitable extension—even greater regulatory confusion. The OCC has a precious opportunity to remove these impediments and ensure continued American competitiveness in the coming global financial technology revolution.