Last year—2015—marked a peak in the amount of venture capital and other investments that were made in the financial technology (fintech) sector. This rapid growth has attracted the attention of a growing number of legislators, which has in turn led to rising concern from many fintech CEOs.  

Haskell Garfinkel, a fintech co-lead with PwC, which released data saying that more than 85% of fintech CEOs are now worried about increased regulations, told CNBC back in May of 2016 that "the twin pillars of financial services regulation in the U.S. are safety and soundness and consumer protection. Regulators are trying to balance these mandates with the flood of innovation occurring on the periphery of the regulated industry."

More recently, the Securities and Exchange Commission (SEC) held a fintech forum to explore the impact these startups can have on investing, financial advice and other financial services. Long-standing industry players and fintech innovators alike have all been keen to make their voices heard with the SEC, and also to learn just how regulators might approach fintech companies in the future. As policies in Washington shift over the next year, it is possible that new regulations could make life easier for fintech firms in some ways, but some analysts see risks ahead.

Here's why some fintech leaders may be worried, and what steps they're taking to prepare for regulatory scrutiny. (For related reading, see: 2016's FinTech Disruptors: How Can You Benefit)

A Growing Movement

Many innovative products and services offered by fintech companies have fallen outside the regulations that apply to more traditional financial institutions. Regulatory agencies have therefore scrambled to catch up to these new business models, and they have now started to take a few concrete steps towards increasing regulation of firms offering them. The Treasury department issued research and recommendations pertaining to marketplace lending back in May 2016, and the Consumer Financial Protection Bureau has made formal inquiries with fintech firms about their business practices and origination fees. The Federal Trade Commission also hosted a forum in June with both consumer advocates and regulators to evaluate the impact of fintech on the consumer business model.

The increase in regulatory scrutiny is coming at the same time that investment capital is drying up. The PwC report noted that investments into fintech were down more than 40% during the first quarter of 2016 compared to the previous year. Some fintech companies are dealing with the increased regulatory scrutiny by putting ex-regulators in key positions in the company. For example, student lender and refinancer SoFi recently brought on ex-SEC chairman Arthur Levitt as an adviser. Peer-to-peer lender Avant hired ex-FDIC chairman Sheila Bair onto its board of directors.

Other companies such as the startup Circle that deals in payments have made similar hires. SoFi general counsel Rob Lavet told CNBC that these moves are designed to help fintech companies bolster their profiles with regulators and show that they are committed to doing what’s right for customers. "Regulatory agencies want to ensure that consumers receive all required disclosures and that the product will not harm consumers,” he said. (For related reading, see: Here's Why Fintech Will Continue to See Rapid Growth.)

One avenue that many fintech firms are seeking to establish with regulators is one that allows them to try out new products and services with clients without having to go through the rigorous, formal process of obtaining regulatory approval. This can enable them to test out various offerings to see whether they are viable options before undergoing the full compliance process. Regulators seem to be receptive to this idea: Representative Patrick McHenry (R-NC) has introduced a bill to do just that. He told The Wall Street Journal that “we have this wide variety of prudential regulators, and their responsibility traditionally is to kill it before it grows. We want to have a mind-set shift in how regulators function, and we want them to be responsive in order to enable financial innovation … and to drive it forward.”

The Bottom Line

Greater regulation will most likely be applied to the fintech industry sooner or later, regardless of its form. Financial experts caution that this is one area where the regulators need to get the correct set of rules in place that can foster growth and still protect the consumer as fintech represents the future of the financial marketplace. Time will tell how well future rules will accomplish this goal. (For related reading, see: What Does Trump Mean for the Fintech Market?

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