Financial regulators will face new challenges arising from the "digitalization" of finance and may need to extend their oversight powers to include certain services provided by technology companies, according to Felix Hufeld, the president of Germany's Federal Financial Supervisory Authority, known as BaFin.
Speaking on Oct. 4 at a fintech conference in Washington, D.C. organized by the Commodity Futures Trading Commission, Hufeld cautioned that traditional models for supervision and regulation need to be adjusted to address the impact of technology on financial services. Hufeld spoke primarily about the implications of big data and artificial intelligence, although he also pointed to distributed ledger technology as having the potential to transform the financial services sector.
BaFin President Felix Hufeld stands with CFTC Chairman Chris Giancarlo at the October fintech event.
Hufeld, who has been the head of BaFin since March 2015, commented that "more is better" in the new world of big data and artificial intelligence. Companies that can feed more data into their artificial intelligence systems will gain "huge advantages" over their competitors when developing new products and services, he explained. For example, companies will be able to calculate risks more precisely and adjust pricing accordingly. While Hufeld agreed that both consumers and financial services providers will benefit from increased efficiencies and more tailored products, he encouraged the regulatory community to consider how these technologies will change market structure by introducing new business models.
He put a particular emphasis on what he called the "platform providers" for these new technologies. As these companies enter the marketplace for financial services, regulators will be confronted with "fundamentally new challenges," he predicted. He cited Amazon and Google as examples of platform providers, and noted that they are in position to amass large amounts of data on consumer financial behavior.
BaFin, the German agency that oversees banking, securities and insurance, has been studying this issue for some time and is seeking to promote a dialogue with other regulators as well as financial institutions and other market participants. In July the agency published a nearly 200-page analysis of big data and artificial intelligence. That study highlighted the emergence of "new business models" that are outside the current regulatory framework for financial services, and asked for comment on how financial regulators should respond.
Hufeld, who spent many years in the private sector before joining BaFin, explained in his CFTC speech that BaFin is not opposed to this type of innovation. In fact the agency itself is beginning to deploy these technologies in areas such as the detection of money laundering. However, regulators need to think about the kinds of tools they will need to address the emerging risks of "digitalization," he said.
Attempting to regulate technology companies is not an option, Hufeld emphasized. Like other financial regulators, BaFin does not have that kind of authority. Instead the focus should be on taking a "horizontal view" of the services provided by these companies and understanding the role played certain "components" of these companies.
A key criteria should be their "systemic importance," he said. This can come about in two ways: first, directly through their impact on customer behavior and market structure; and second, indirectly by selling information to financial institutions or by providing them with infrastructure to run big data and artificial intelligence systems. In the latter case, a large number of financial companies could find themselves dependent on a single provider or a chain of providers.
The challenge for regulators such as BaFin is that the risks of these platform providers are not within the organizational structure of supervised firms, he warned. "It is therefore necessary to examine whether the definition of systemic importance in the supervisory sense ... should be revised in order to take into account new business models and market structures," he said.
So what is the solution? During a question and answer session after the speech at the CFTC fintech event, Hufeld commented that regulators already have several tools that could serve as models for the future. He cited conduct regulations designed to protect market integrity, which are applied not only to financial market participants but also industrial companies. When these companies are involved in activities that policymakers have deemed important for market integrity, market regulators take a horizontal approach and "zoom in" to ensure that specific conduct requirements are met.
"We are a financial regulator. We of course don't supervise Google or Amazon or any of such companies," Hufeld said. "However I think there is a basic tool available which particularly securities supervisors or market infrastructure supervisors are quite accustomed to, which I think could be utilized in such a space as well. What I am talking about is types of conduct regulation where market integrity as such needs to be supervised."
This approach could be applied to the technology companies that are becoming more important in the financial services sector, he suggested, and specifically the "components" that are systemically important.
"That logical tool, that structural tool, to establish certain conduct requirements can very well be utilized in other spaces like IT-related services," Hufeld said. "Of course there is no point in people like us or the CFTC in supervising Amazon as such, ... but there could be specific things which we all together, the regulatory community and the legislators, deem to be key to preserving market integrity or financial stability."