The Urgent Need for Responsible Innovation and Regulatory Reform in Fintech

Innovation is undeniably valuable, but responsible innovation has even greater impact. In various ways, fintech has filled gaps that traditional finance cannot. However, the rapid pace of fintech innovation far outstrips regulatory framework development in some countries. This discrepancy drives fintech firms to seek out regions with minimal regulatory obstacles, with the United States being a prime example. Unfortunately, the U.S. currently leads in fintech startups not necessarily due to favorable innovation but due to loose regulatory structures. Notably, the lack of stringent regulations has made it easy to exploit these gaps in oversight—no need for “professional money launderers” to navigate the lax environment, especially in the U.S.

Critics frequently raise two counterpoints in response to these concerns.

1) Aren’t fintechs regulated under MSB (money services businesses) laws in the U.S.?

2) Don’t partner banks enforce their AML programs onto their fintech collaborators?

Let’s start with the MSB question. In short, the answer is no. Only a minimal number of fintech companies fall under MSB regulations, and within that subset, even fewer transactions are covered by MSB laws.

The second objection generally addresses highly regulated financial institutions (FIs) that partner with fintech companies. My simplest response to this is to ask: “Have you been following the U.S. news?” Each week seems to bring a new headline about partner banks facing consent orders for failing to implement effective AML programs. Adding fintech oversight responsibilities to their AML compliance burdens is simply too much for some banks. Expecting banks to act as de facto regulators of fintechs where the government should impose its own regulatory oversight is both unsustainable and unfair.

Even if banks could serve as effective “regulators” for fintechs, they remain distanced from the downstream customers and transactions. Given the still-developing regulatory framework in the U.S., it wouldn’t take a mastermind to launder significant sums through P2P platforms without meeting CIP-level ID requirements. This problem stems, in part, from outdated MSB laws.

There’s an aspect of fintech innovation exploiting legal exemptions under federal law that isn’t adequately addressed. While fintech innovation typically refers to their products, we neglect to innovate our regulatory approach. The need is for responsible innovation on both sides. Today’s fintech innovation largely involves utilizing regulatory exemptions that have been on the books for 21 years, especially those relevant to payment processors.

These platforms are not transferring funds domestically; they operate behind the scenes using fintech payout rails like ACH (Automatic Clearing House) or wire transfers. While these payment rails are innovative, they rely on existing regulatory exemptions. Consider a hypothetical case: a Russian oligarch with a vacation home held under an anonymous trust, rented out at $10,000 a night. By directing those who owe him money to make payments using his property ID, he skirts regulatory oversight. Inbound payments may only partially fall under AML oversight in the U.S., and more critically, outbound payments evade AML scrutiny entirely through the payment rail exemptions.

Interestingly, if the same payment structure were used outside the U.S., it would be regulated in countries such as Australia and Canada.

There’s a further issue not receiving the attention it warrants—data. Alongside regulatory gaps, these loopholes allow vast numbers of transactions to proceed without accurate information. This deficiency directly affects the quality of data that travels (or doesn’t travel) with a payment. Data is essential for investigations, and when cross-border inquiries end in the U.S., our system’s limitations are exposed.

We need well-defined regulations that clearly classify fintech activities within a flexible framework similar to Australia’s model. Such a framework should delineate that “if your firm does X, then your customer is Y, and you must do Z.” Achieving this requires engaging not only lawyers but also operational experts in shaping fintech regulations. One core issue is that our global regulatory bodies aren’t sure where to focus their efforts. Involving operational experts would go a long way in bridging this regulatory knowledge gap.