What is technological neutrality? Why is FINMA, the Swiss federal financial regulator, proposing to waive it for financial IT start-ups? The answers are here.

The regulation of financial technology is being developed worldwide. As traditional regulatory models are not suitable for 'fintech,' regulators ought to revise the current regulations to suit the new business models. In Switzerland, FINMA (the main regulator) and the Swiss Federal Council (the country's seven-man head of state) have realised this and have embarked on several reform initiatives in the past few months.

FINMA ready for fintech!

FINMA taken some initial steps towards reform, such as creating an informative online presence (the 'Fintech Desk'), dealing with questions relating to financial technology, and serving as a point of contact for fintech firms.

FINMA pursues an innovation-friendly and technology-neutral policy with regard to fintech. In line with that approach, it has issued a new circular (number 2016/7) on video and online identification. The circular, in force since 18 March, allows financial intermediaries to 'onboard' clients by means of audiovisual communications in real time under certain conditions. When a firm wants to identify a contracting party, this video identification process is as valid as face-to-face identification. FINMA has also made the process of 'onboarding' clients on the Internet easier by permitting various forms of online identification such as qualified electronic signatures. It has, furthermore, adapted its circular (number 2009/1, entitled "Guidelines for asset management") to align it with its technology-neutral concept. As of 1 August, asset management agreements no longer have to be concluded in writing. The revised circular now allows for their digital conclusion. With this step, FINMA finished turning its regulations into technology-neutral ones.

What is technological neutrality?

The phrase 'technology-neutral' or 'technologial neutrality' is, according to the academics Ulrich Kamechk and Torsten Korber, a widely accepted but little discussed regulatory principle in the European Union. In a paper from 2008 they note: "Given how little systematic attention has been devoted to the principle’s interpretation, there is reason to suspect that technological neutrality is in danger of degenerating into an empty formula evoked to support inconsistent political statements. This suspicion is supported by contradictory conclusions recently derived from the principle."

The European Union defines 'technological neutrality' in recital 18 of its Framework Directive (no 2002/212) as follows: "The requirement for member states to ensure that national regulatory authorities take the utmost account of the desirability of making regulation technologically neutral, that is to say that it neither imposes nor discriminates in favour of the use of a particular type of technology, does not preclude the taking of proportionate steps to promote certain specific services where this is justified, for example digital television as a means for increasing spectrum efficiency."

More succinctly, IT Law Wiki describes technological neutrality as “different technologies offering essentially similar services being regulated in similar manners."

FINMA goes against this principle, which it applies everywhere else, by taking the view that a legitimate need exists for it to create a less onerous licensing process for start-ups in the financial IT industry. It believes that the stringent requirements for granting licences that are set out in the Swiss Banking Act are not suitable for fintech firms that perform only certain elements of banking business. It believes that these requirements present a significant barrier to market entry. Consequently, FINMA wants to create a new type of licence for fintech firms.

Enter the Federal Council

In April the Swiss Federal Council picked up FINMA’s proposal and instructed the Federal Department of Finance (FDF) to examine the "need for regulatory action" regarding fintech and to submit proposals for improvements by the autumn of 2016.

On 2 November, the Federal Council published a policy statement in which it outlined a "three-step plan" to adjust regulation in Switzerland to suit the new fintech industry.

Three pillars of wisdom

The regulatory amendments that the Federal Council is proposing will, if all goes according to plan, be based on three complementary pillars. Anti-money laundering regulations will continue to apply to fintech firms if they act as financial intermediaries.

First pillar: the extension of the holding period for crowdfunding platforms and other ventures. According to Art 5 para 3 lit c Swiss Banking Ordinance, the accounts of securities dealers, precious metal traders, asset managers or similar firms do not qualify as deposits from the public if they are interest-free and used exclusively for the settlement of client transactions. Nonetheless, according to FINMA practice, such funds can only be held for a period of up to seven days. This time-frame has turned out to be too short, especially in the crowdfunding sector.

Therefore, in its policy statement, the Federal Council has proposed to prolong the holding period in settlement accounts to 60 days. This change will enable crowdfunding firms (as well as other firms with settlement accounts) to collect funds and to hold such funds for a period of up to 60 days without the need to apply for a banking licence.

Second Pillar: an innovation area or 'sandbox.' The current regulation dictates that funds taken from more than 20 depositors qualify as deposits and are subject to a banking licence unless an exemption applies (Arts 5 and 6 Banking Ordinance).

Because the taking-in of deposits is part of the financial activity of fintech firms, this restriction limits their potential for development. In response thereto, the proposal is to allow for the performance of authorisation-exempt bank-like activities in an innovation area called a 'sandbox.'

Accordingly, the Federal Council is proposing to allow a firm that operates in this exempted innovation area to accept deposits without restriction up to a total value of SFr1 million (€922,700).

Third Pillar: a 'fintech licence.' Having identified a need to create a less onerous licence for fintech firms, the Federal Council is proposing to create a new licence category for institutions outside the lending business.

It wants a so-called "fintech licence" to impose fewer regulatory requirements on the holder than a regular banking licence does. It wants this licence to entitle fintech firms to accept public funds up to the value of SFr 100 million, even if such funds are qualified as deposits in the style of the Banking Ordinance. Further exceptions for a higher threshold than SFr100 million are foreseen if special requirements can guarantee protection to the individual high-net-worth client.

If the reforms go ahead, firms that hold fintech licences will be asked to hold a minimum capital of 5% of the accepted funds but not less than SFr300,000. The licence, if it appears in its proposed form, will have no equal in the world.

What next?

The Federal Council has instructed the FDF to prepare a consultative draft to implement the proposed legislative amendments. This draft will be available by the beginning of 2017. Interested parties ought to tell the ministry whether they think it should make even more regulatory reforms to remove further barriers to fintech firms’ entry into the financial markets.