Fintech Sandbox? States, OCC Mull Regulatory Options

It’s called the “New England Regulatory FinTech Sandbox.”

Cynthia Stuart – Deputy Commissioner of Banking, Vermont

State banking regulators across the six New England states are exploring the creation of a regional compact that would allow financial technology companies to experiment with new and expanded products in “a safe, collaborative environment,” says Cynthia Stuart, deputy commissioner of the banking division at the Vermont Department of Financial Regulation.

Stuart asserts that she and her New England cohorts are adroitly positioned and uniquely qualified to oversee laboratories of finance. In Vermont, for example, she heads an agency that oversees regulation and examination of banks, trust companies, and credit unions as well as such nonbank financial providers as mortgage brokers, money transmitters, payday lenders and debt adjusters.

Financial watchdogs at the state level, Stuart observes, “are already witnesses to a wide breadth of financial services offerings and understand how they impact communities and consumers. As technology intersects with financial regulation,” she adds, “state regulators also appreciate the need to be open to technological innovation while balancing risk and return.”

The regional fintech sandbox is the brainchild of David Cotney, the former Massachusetts Commissioner of Banks, and Cornelius Hurley, director of Boston University’s Center for Finance, Law and Policy. The sandbox stitches together elements of Project Innovate, a development program for fintechs inaugurated by the U.K.’s banking regulator, and the European Union’s “passport” model for cross-border banking operations.

In the U.K., the Financial Conduct Authority is supporting both small and large businesses “that are developing products and services that could genuinely improve consumers’ experience and outcomes,” according to a 2015 report by the London agency. In harmonizing the regulatory regime for the sandbox across state lines of Maine, New Hampshire, Vermont, Massachusetts, Rhode Island and Connecticut, the program emulates the EU’s “passport.” Since 1989, a bank licensed in one EU country has been able to set up shop there while – thanks to the “passport” –operating seamlessly throughout the 28 states of the EU (soon to be 27 after “Brexit”).

David J. Cotney

“It’s still preliminary,” Cotney says of the proposed New England sandbox-cum-passport, “but we’ve talked to the financial regulators in all six states and there’s universal openness. Nobody want to be seen as being a barrier to innovation.”

(Barred by law from lobbying in Massachusetts, Cotney hands off the Bay State duties to Hurley while he meets with regulators and other officials in the five remaining New England states. In March, Cotney was named a director at Cross River Bank, a Fort Lee, N.J.-based, $600 million-asset community bank known for its partnerships with peer-to-peer lenders including Lending Club, Rocket Loans and Loan Depot.)

This nascent effort of financial Transcendentalism in New England is, meanwhile, taking place against the backdrop of an increasingly acrimonious battle between the Office of the Comptroller of the Currency and state banking authorities over the licensing and regulation of fintech companies. At issue is the OCC’s plan announced in a December, 2016 “whitepaper” to issue a “special purpose national bank” charter to nonbank fintechs.

Siding with the OCC are the fintechs themselves, including Lending Club, Kabbage, Funding Circle, ParityPay, WingCash. “A special purpose national bank charter for fintechs creates an opportunity for greater access to banking products, empowers a diverse and often underserved customer base, promotes efficiency in financial services, and encourages industry competition,” Kabbage wrote to the OCC in a sample industry comment to its whitepaper (which is on the agency’s website).

Also on board for the OCC’s fintech charter are powerful Washington trade associations such as Financial Innovation Now, the membership of which comprises Amazon, Apple, Google, Intuit and PayPal, and industry research organizations like the Center for Financial Services Innovation. The U.S. banking establishment also appears largely supportive of the OCC. While qualifying its imprimatur somewhat, the American Bankers Association declared that it “views the OCC’s intent to issue charters as an opportunity to further bring financial technology into the banking system…”

But an irate army of detractors is condemning the fintech charter outright. Consumer groups, small-business organizations, community banks, and state attorneys general number among the furious opposition. No cohort, however, has been more hostile to the OCC’s fintech charter than state banking regulators.

Maria T. Vullo, Superintendent of the Department of Financial Services, New York

Maria T. Vullo, superintendent of New York State’s Department of Financial Services, has emerged as a firebrand. “The imposition of an entirely new federal regulatory scheme on an already fully functional and deeply rooted state regulatory landscape,” she wrote to the OCC earlier this year, “will invite serious risk of regulatory confusion and uncertainty, stifle small business innovation, create institutions that are too big to fail, imperil crucially important state-based consumer protection laws, and increase the risks presented by nonbank entities.”

Although big-state regulators from New York, California and Illinois have been in the vanguard of opposition, their unhappiness with the OCC is widely shared. Vermont regulator Stuart, who emphasizes the need for regulators “to embrace change,” nonetheless disparages the OCC’s endeavor.

“Of particular concern is the creation of an un-level playing field for traditional, full-service Vermont institutions to the advantage of the proposed nonbank charter,” she told AltFinanceDaily. “The special purpose national nonbank charter would not be subject to most federal banking laws and would be regulated with a confidential OCC agreement. The disparity in regulatory approaches is concerning.”

What had been confined to a war of words – rounds of angry denunciations packed into letters and press releases directed at the OCC — reached fever-pitch last week when, on April 26, the Conference of State Banking Supervisors filed suit against the OCC in federal court. The lawsuit seeks to prevent the agency “from moving forward with an unlawful attempt to create a national nonbank charter that will harm markets, innovation and consumers,” according to a CSBS statement.

Among other things, the conference’s complaint charges that by creating a national bank charter for nonbank companies, the OCC has “gone far beyond the limited authority granted to it by Congress under the National Bank Act and other federal banking laws. Those laws,” the conference’s statement continues, “authorize the OCC to only charter institutions that engage in the ‘business of banking.’”

Under the National Bank Act, the conference’s complaint asserts, a financial institution must “at a minimum” accept deposits to qualify as a bank. By “attempting to create a new special purpose charter for nonbank companies that do not take deposits,” the complaint adds, the OCC is acting outside its legal authority.

Christopher Cole, senior regulatory counsel at the Independent Community Bankers Association – a Washington, D.C. trade association of Main Street bankers known for punching above its weight — asserts that the state banking regulators are on solid ground. “The whole question comes down to what should a bank be for purposes of a national bank charter,” he says in a telephone interview. “The Bank Holding Company Act (of 1956), federal bankruptcy laws, and tax laws – all three – define banks as insured depository institutions. It’s right there in the statutes. So our recommendation,” he says, “is for the OCC to go back to Congress” and ask for the explicit authority to create a fintech charter.

Because the OCC has “short-circuited rule-making” protocol required by another law – known as the Administrative Procedures Act — “the process hasn’t been kosher,” Cole adds.

Many members of Congress are also expressing outrage at the OCC. Not only have Democratic Senators Sherrod Brown of Ohio and Jeff Merkley of Oregon strenuously objected to the OCC’s fintech charter, but on March 10, 2017, Jeb Hensarling, the chairman of the House Financial Services Committee, fired off a “hold-your-horses” letter to Comptroller Thomas J. Curry. Signed by 34 House Republicans, the March 10 letter reminded Curry that his term of office would officially be up at the end of April, 2017, and urged him not to “rush this decision” regarding the fintech charters.

“If the OCC proceeds in haste to create a new policy for fintech charters without providing the details for additional comment, or rushing to finalize the charter prior to the confirmation of a new Comptroller,” the letter from Hensarling et alia declares, “please be aware that we will work with our colleagues to ensure that Congress will examine the OCC’s actions and, if appropriate, will overturn them.”

Never mind the stern letter from Chairman Hensarling, or the fact that an impressive array of Congressmembers on both sides of the aisle are bipartisanly unhappy, or that state banking regulators’ have filed suit, or that Curry’s replacement as Comptroller is overdue: the OCC is pushing ahead. The agency will play host to a bevy of financial technology companies and other financial institutions on May 16 for two days of get-acquainted sessions in its San Francisco office.

Billed as “office hours,” the West Coast meetings will consist of one-on-one, hour-long informational meetings “to discuss the OCC’s perspective on responsible innovation,” Beth Knickerbocker, the OCC’s acting chief innovation officer, says in a press release.

The office hours, Knickerbocker adds, “are an opportunity to have candid discussions with OCC staff regarding financial technology, new products or services, partnering with a bank or fintech company, or other matters related to financial innovation.”

Back in New England, Hurley, the Boston University law professor advocating the regional sandbox, says: “No one knows where fintech is going. But one place it’s not going is away.”