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PUBLICATION 16.3CM | Document subtitle FSI Briefs No 12 Big techs in finance: regulatory approaches and policy options Juan Carlos Crisanto, Johannes Ehrentraud and Marcos Fabian March 2021FSI Briefs are written by staff members of the Financial Stability Institute (FSI) of the Bank for International Settlements (BIS), sometimes in cooperation with other experts. They are short notes on regulatory and supervisory subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS or the Basel-based standard setting bodies. Authorised by the Chairman of the FSI, Fernando Restoy. This publication is available on the BIS website (bis). To contact the BIS Media and Public Relations team, please email pressbis. You can sign up for email alerts at bis/emailalerts.htm. Bank for International Settlements 2021. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISSN 2708-1117 (online) ISBN 978-92-9259-458-9 (online)Big techs in finance: regulatory approaches and policy options 1 Big techs in finance: regulatory approaches and policy options 1 Highlights At present, financial services represent a relatively small part of big techs overall activities, though this can change rapidly due to the unique features of their business models and they could quickly become systemically important or “too big to fail”. Big techs financial operations are subject to the same requirements as those of other market participants. As such, big techs need to hold appropriate licences to perform regulated financial activities or provide their services in partnership with financial institutions that meet the regulatory requirements. Risks connected with big tech activities in finance may not be fully captured by the regulatory approach up to now, which is geared towards individual entities or specific activities and not the risks that are created by substantive interlinkages within big tech groups and their role as critical service providers for financial institutions. An effective oversight of big tech activities in finance calls for going beyond a piecemeal policy framework and considering recalibrating the mix of entity-based and activity-based rules, in favour of the former in certain policy areas. A step further would be to assess the possibility of introducing a bespoke approach for big techs encompassing a comprehensive public policy framework. In any case, there is a need for enhancing cross-sectoral and cross-border cooperative arrangements. 1. Introduction Large technology companies big techs are increasingly attracting the attention of policymakers. More recently, there has been growing political momentum to adopt new legislation, particularly in the area of competition and antitrust. Examples signalling this approach include the US congressional report on the biggest American technology companies; the EU Digital Markets Act and Digital Services Act; or the recent antitrust actions by Chinas banking and market regulators. 2 These regulatory efforts are particularly relevant as big techs continue to expand their financial offerings. Yet questions are growing louder as to whether the regulatory framework is commensurate to the risks they bring to the financial sector. This paper provides an overview of the current regulatory landscape for big techs operating in finance and discusses avenues for improvement. Section 2 describes why big techs are unlike other entities and deserve regulatory attention. Section 3 outlines their regulatory treatment and the financial licences 1 2 Juan Carlos Crisanto (Juan-Carlos.Crisantobis) and Johannes Ehrentraud (Johannes.Ehrentraudbis), Bank for International Settlements, and Marcos Fabian (fabianasbasupervision), Association of Supervisors of Banks of the Americas (ASBA). We are grateful to Stijn Claessens, Jon Frost, Leonardo Gambacorta, Denise Garcia Ocampo, Joseph Noss and Jermy Prenio for helpful comments and to Esther Knzi for administrative support. For the United States, see the Investigation of competition in digital markets published in October 2020 at judiciary.house.gov/uploadedfiles/competition_in_digital_markets.pdf?utm_campaign=4493-519; for the European Union, see proposals for the Digital Markets Act and Digital Services Act published in December 2020 at eur- lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52020PC0842 and eur-lex.europa.eu/legal-content/EN/TXT/ PDF/?uri=CELEX:52020PC0825; and for China, see Box 3 in Restoy (2021).2 Big techs in finance: regulatory approaches and policy options they have obtained in a number of jurisdictions. Section 4 offers some considerations for policymakers and Section 5 concludes. 2. Big techs in finance: why they deserve attention Big techs business model is geared towards operating digital ecosystems of interconnected products and services. At the moment, big tech platforms mainly operate outside finance in areas such as e-commerce, internet search or social media. Leveraging their strong technology capabilities, some big techs are also important providers of IT services and infrastructure such as cloud computing and data analytics. 3 Amazon Web Services (AWS), for example, is one of the dominant players in cloud computing for financial institutions in areas such as risk management, core banking systems and data analytics (IBFED and Oliver Wyman (2020). Big techs are increasingly making inroads into finance. While big tech firms do not operate primarily in financial services, they offer them as part of a much wider set of activities. Big tech firms involvement in finance started with payments, where they have reached a substantial market share in some jurisdictions. 4 They soon expanded into other sectors and are now also involved in the provision of credit (particularly consumer financing and microloans with shorter maturities), banking, crowdfunding, asset management and insurance (Table 1). Geographically, big techs expansion into financial services has been more pronounced in emerging and developing economies, particularly China, than in advanced economies (FSB (2020a). 5 By augmenting their business lines with financial services, big techs diversify their revenue streams, access new sources of data and reduce frictions in their core non-financial offerings, thereby making their overall ecosystem more attractive to users (FSB (2019b). 3 See, for example, BIS (2019), FSB (2017), Frost (2020) and Croxson et al (forthcoming). 4 In China, for example, big tech firms processed payments equivalent to 38% of GDP in 2018 (FSB (2020a). 5 At global level, big tech credit was estimated to reach USD 572 billion in 2019 (Cornelli et al (2020).Big techs in finance: regulatory approaches and policy options 3 Big techs provide their financial services either in competition with traditional financial institutions or in partnership as overlays on top of their products and infrastructure, with big techs only providing the customer-facing layer in some cases. 6 Apart from providing financial services themselves, big techs are also investing in financial institutions outside their groups. 7 While financial services currently do not contribute a substantial amount to big techs overall revenues 8 and mostly play a subordinated role in their business model, this has the potential to change rapidly due to their unique features and they could quickly become systemically important or “too big to fail” (Carstens (2021). Four features stand out. First, big techs are exploiting activities with strong network effects. As such, they benefit from competitive advantages stemming from the so-called data analytics, network externalities and interwoven activities (DNA) loop. Once a big tech has attracted a sufficient mass of users on both sides of its platform, network effects kick in, accelerating its growth and increasing returns to scale. Every additional user creates value for all others more buyers attract more sellers and vice versa. The more users a platform has, the more data it generates. More data, in turn, provide a better basis for data analytics, which enhances existing services and thereby attracts more users (BIS (2019). 6 Existing partnership arrangements include, for illustration, Apple/Goldman Sachs and Amazon/JPMorgan Chase (to offer credit cards); Google/Citigroup (to offer checking accounts through the Google Pay app); and Amazon/Bank of America (as funding partners for Amazon lending). Big techs may also act as intermediaries. Amazon India, for example, operates an API-based Seller Lending Network (SLN), which allows sellers on its platform to seek loans from third-party lenders. 7 For example, Tencent is a minority shareholder in Brazils Nubank. 8 In 2018, big techs core businesses accounted for around 46% of their revenues; financial services for about 11% (BIS (2019). Financial service offerings by big tech companies Table 1 Big tech Main business Banking % Credit provision Payments Crowd- funding Asset management Insurance Google Internet search/advertising * Apple Tech/producing hardware Facebook Social media/advertising Amazon E-commerce/online retail Alibaba (Ant Group) E-commerce/online retail Baidu (Du Xiaoman) Internet search/advertising JD (JD Digits) E-commerce/online retail Tencent Tech/gaming and messaging NTT Docomo Mobile communications Rakuten E-commerce/online retail Mercado Libre E-commerce/online retail Provision of financial service through big tech entity and/or in partnership with financial institutions outside big tech group in at least one jurisdiction. * Launch expected in 2021. % The core activity of an entity engaged in banking is taking deposits, though regulations vary across countries. Sources: BIS (2019); Citi GPS (2018); FSB (2019b); IBFED and Oliver Wyman (2020); van der Spek and Phijffer (2020); public sources; FSI.4 Big techs in finance: regulatory approaches and policy options Second, significant network effects may enable big techs to become gatekeepers, allowing them to leverage their dominant position in a given market to exert influence over its functioning. This may include control over who can enter the market, who receives what kind of data and how the market operates. Their sphere of influence in one market often extends to other markets connected to it. Third, big techs have a large and captive user base at their disposal. 9 Extensive customer networks, coupled with low online acquisition costs, bring with them the ability to scale up quickly in market segments that are outside their core business. For example, it took Ant Financials Sesame Credit 11 months to reach 100 million users; its money market fund Yue Bao took 20 months (Citi GPS (2018). Fourth, with big data as their lifeblood, it is not surprising that big techs devote significant resources to developing or acquiring state-of-the-art technologies. 10 After all, access to large troves of data generates value only if it is matched by technological capabilities to analyse it. Big techs use the insights derived from data analytics as a basis for developing novel services, including for hard-to-reach market segments, or enhancing the user experience and speed of existing ones. 11 With big techs ante portas, financial authorities are seeking to find a balance that supports the benefits of big tech while minimising potential risks to the financial system. While the jury is still out on the overall impact of big techs entry into financial services, big tech is said to potentially make the financial sector more efficient, lead to improved customer outcomes and aid financial inclusion. However, it may create or increase risks for financial stability and consumer protection, and comes with challenges for competition, data privacy and cyber security. 12 9 For example, Facebook has around 2.3 billion monthly active users; Tencents WeChat around 1 billion (IBFED and Oliver Wyman (2020). 10 Google, Amazon, Apple and Microsoft now account for four of the global top 10 companies by research and development spend; on mergers and acquisitions, they have spent over USD 10 billion on 100 deals since 2012 (IBFED and Oliver Wyman (2020). 11 On a market level, Gambacorta et al (2020) find that the use of big data to assess firms creditworthiness may reduce the need for collateral in credit markets. On a product level, MYbanks “310” loans, for example, require three minutes to apply, one second to approve and zero human interaction (Lu (2018). 12 These benefits and risks may differ for emerging and developed markets. For a discussion on risks and benefits see, for example, BIS (2019), Carstens (2018), Croxson et al (forthcoming) and FSB (2019b, 2020a).Big techs in finance: regulatory approaches and policy options 5 3. Regulatory landscape for big techs There is no specific regulatory treatment of big techs operating in finance. Rather, it depends on their specific business model, in particular the type of financial activities they are engaged in. This means big techs are subject to a combination of: (i) regulations specific to the financial industry and therefore applying to the types of services provided, such as banking, extending credit or transmitting payments; and (ii) general laws and regulations that apply to financial and non-financial activities (Graph 1). These two types of regulations have been referred to as finance-specific regulations and cross-industry (or cross- sector/horizontal) regulations, respectively (IBFED and Oliver Wyman (2020). Regulatory environment for big tech groups Graph 1 Source: FSI. In terms of finance-specific regulations, when providing financial services, big techs are generally subject to the same requirements as other market participants. Like them, big techs, or more accurately individual entities within a big tech group, need to hold appropriate licences to perform specific regulated activities. 13 Yet differences in the regulatory treatment of banks and non-bank financial institutions (NBFIs) 14 may have an implication for what type of financial services big techs choose to provide and how to provide them. Banks and certain NBFIs are subject to microprudential requirements based on internationally agreed standards. 15 These make them subject to minimum capital obligations calculated on the basis of their consolidated balance sheets, and supervisors must review the main activities of the 13 Holders of the same type of licence, however, may face different requirements. This is due to the embedded proportionality of financial regulation (based inter alia on entities size), which tends to alleviate the obligations of certain entities due to the smaller scale and nature of their businesses. 14 Entities allowed to provide financial services other than those reserved for banks, such as deposit taking. NBFIs include, for example, payment service pro
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