Afterpay takeover highlights the need to rethink financial regulation

August 4, 2021 â€" 12.26pm

It’s a neat coincidence that as US payments heavyweight Square was announcing its $39 billion bid for Afterpay on Monday, the Bank for International Settlements issued a paper on the regulation of “big techs” in finance.

The staff paper is timely because Square’s acquisition of Afterpay illustrates how rapidly the fintech sector is growing and evolving, bringing together Afterpay’s buy-now-pay-later business into a mini financial conglomerate that offers everything from payments hardware to retail information management, marketing support and basic banking services.

Fintechs, even the big ones, aren’t banks and aren’t regulated like banks. But they are increasingly offering a range of services and products that look like, and compete with, banking services and products.

The $39 billion takeover of Afterpay announced this week highlights the urgent need for more regulation of the growing fintech sector.Credit:Renee Nowytarger

Regulators around the world have generally encouraged the emergence of fintechs to generate competition to traditional lenders and drive consumer-friendly innovation even as they have loaded ever more and ever more costly prudential regulation and obligations on the banks, such as stringent anti-money-laundering laws.

The increasing interest and presence of mega techs Apple, Facebook, Amazon and Google in financial services creates challenges for regulators that, with one glaring exception, they’ve struggled to respond to.

The exception is China where, for a variety of reasons â€" and financial stability, competition and consumer protections are only part of them â€" there has been a massive crackdown on big tech companies, and fintechs in particular.

With Alibaba and Tencent accounting, according to the BIS, for 94 per cent of the mobile payments market in China it perhaps isn’t surprising that the authorities have acted to curb their dominance, curtail some of their anti-competitive behaviour and regulate them more like banks.

BIS says central banks and financial regulators should “invest with urgency” in monitoring and understanding the multi-faceted public policy challenges posed by the entry of the big tech companies into their payments systems.

Other jurisdictions are still trying to come to grips with the trade-offs between promoting more competition and innovation and the implications of these new, powerful and different participants in corners of their financial systems.

The BIS paper notes that the big tech firms entering financial services have the capacity to scale up very rapidly because of their existing hoards of customer data from their non-financial e-commerce or social media activities and by harnessing their inherent network effects in digital services.

In addition to traditional regulators’ concerns â€" financial risks, consumer protection and operational resilience â€" the entry of big techs into financial services created new challenges around the concentration of market power and data governance, the paper warned.

The big techs have provoked intense debate and looming regulation on competition and data privacy issues around the world â€" in the US they even face the threat of break-ups -- but financial regulators are still trying to get their minds around the balance between the pro-competitive force they represent against banks and other traditional institutions and the risks they might pose to system stability, fair competition and the long-term interests of consumers.

There’s little doubt that fintechs are going to play an increasing role in the financial system.Credit:Fairfax Media

The virtuous circle that powers big tech -- the network effects generated by the fact that the more users they have, the more users are attracted to the network and the more data they gain access to â€" could lead to big tech companies emerging as major financial sector players quite rapidly, creating concerns about concentration of market power and systemic importance.

The BIS says that presents various policy challenges, some variations on themes familiar to central banks and financial regulators such as the mitigation of financial risks, the oversight of operational resilience and consumer protection. But also some new challenges outside of the scope of central banks’ remits that stem from the potential for excessive concentration of market power and the issue of data governance.

One of the core issues banking and competition regulators confront in trying to determine how to respond to the rise of the fintechs is the asymmetry of regulation, particularly as it relates to data.

Australian banks, and banks in some other jurisdictions, now operate in “open banking” regimes where they are required to provide access to their customer data and customers can more easily move their accounts. But tech companies, a number of who are larger than any bank, don’t have to provide access to their data and their customers are effectively locked into their networks.

Most non-banks, regardless of size, generally face activities-based regulation, where they might be required to hold a licence for highly specific business lines, if indeed any licence is required.

Banks and other big regulated institutions faced both activities-based regulation and entity-based, or whole-of-company, regulation to try to ensure that the aggregation of their activities doesn’t pose risks to financial stability, competition, consumer protection, money-laundering and other public policy objectives.

The BIS says a common thread in international legislative initiatives have been provisions aimed at preventing data concentration and anti-competitive practices by the big tech companies. For central banks a “natural follow-up” would be to study their potential systemic relevance and the need to introduce specific safeguards to guarantee operational resilience, it said.

That might be particularly relevant for those big techs that offer systemically important payment services to a significant proportion of the population â€" as Apple, for instance, does here.

BIS says central banks and financial regulators should “invest with urgency” in monitoring and understanding the multi-faceted public policy challenges posed by the entry of the big tech companies into their payments systems.

There’s little doubt that big tech, and smaller fintechs, are going to play an increasing role in the financial system and that some, left largely unregulated, will be able to leverage their vast stores of data into positions of systemic â€" possibly globally systemic â€" significance.

The nature of the companies means they don’t fit neatly into existing regulatory silos. They will have to be responded to by a blend of financial, competition and data privacy regulators and legislation and those regulators have different, sometimes conflicting, objectives.

The foray of companies like Apple and Square into payment systems and the blend of consumer credit, other financial services and non-financial activities that the combination of Square and Afterpay, or companies such as Apple, Facebook, Google and Amazon (or Alibaba and Tencent) present dictates a more coherent and co-ordinated response from a range of regulators and legislators.

The rate at which the landscape is changing, the uneveness of the playing fields and the potential for mega-mergers (the Square and Afterpay combination will create a near $200 billion company) to reshape that landscape almost overnight adds some urgency to that task.

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Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.

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