By Jesse Mudaliyar
Introduction
Fintech innovation, powered by advancements in technology such as blockchain, artificial intelligence, and mobile applications, have transcended traditional borders, enabling seamless transactions across jurisdictions. While this global outlook presents immense opportunities for innovation and financial inclusion, it also introduces a myriad of legal complexities that must be navigated to mitigate risk and ensure continued compliance.
Despite these challenges, navigating the legal complexities of cross-border fintech transactions is essential to unlock the full potential of global fintech innovation. This will require collaboration among fintech companies, regulators, legal experts, payment providers and financial institutions. By proactively addressing regulatory harmonization, currency exchange regulations, and jurisdictional challenges, these stakeholders can foster a progressive environment where cross-border fintech innovation can thrive while ensuring compliance with applicable laws and regulations.
Cross-Border Fintech Transactions
Fintech is defined as a technologically enabled financial innovation that could result in new business models, applications, processes, or products with an associated material effect on financial markets and institutions and the provision of financial services.[1]
Cross-border transaction is a trade, business or financial activity that occurs between entities in two different countries, such as buying goods from a foreign supplier or transferring money internationally.[2]
Cross-border fintech transactions therefore means the exchange of financial services or products across international borders with the aid of technology. These transactions leverage digital platforms, such as mobile applications, blockchain, and online marketplaces, to enable seamless financial interactions between individuals, businesses, government institutions and financial institutions across different countries. Cross-border fintech transactions encompass a wide range of activities, including international money transfers, currency exchange, digital payments, peer-to-peer lending, crowdfunding, and digital asset trading.
Regulatory Divergence and Harmonization Efforts
Regulatory harmonization refers to the process of aligning various regulatory frameworks across jurisdictions to ease cross-border fintech activities. Achieving regulatory consistency is not an easy task, given the diverse legal systems, cultural variations, and political and economic priorities of each country. Harmonization efforts are further complicated by the rapid pace of technological innovation, which often outpaces regulatory adaptation. The World Economic Forum (WEF) indicated that the rise of cross-border payments due to increasing international trade and technology advances has outpaced the development of regulatory frameworks suitable for global trade. It further noted that such discrepancy(ies) results in inefficiencies and barriers that hinder seamless and cost-effective transactions on a global scale.[3]
Industry stakeholders have identified this ‘pacing problem’[4] and have made several efforts across both national and international levels to address regulatory divergence and promote a more harmonized regulatory environment for cross-border fintech transactions:
- International Coordination and Cooperation: International organizations, such as the Financial Stability Board (FSB)[5], the International Organization of Securities Commissions (IOSCO)[6], and the Basel Committee on Banking Supervision (BCBS)[7], facilitate coordination and cooperation among regulators from different countries. Through forums like the G20[8], regulators engage in dialogue to identify common challenges, share best practices, and promote regulatory convergence in the fintech sector.
- Standard-Setting and Guidance: Standard-setting bodies, such as the International Organization for Standardization (ISO), develop guidelines and standards to promote consistency and interoperability in fintech regulations. Regulatory bodies may issue guidance documents, principles, or recommendations to provide clarity on regulatory expectations and promote uniformity in regulatory approaches across jurisdictions.
- Regulatory Sandboxes and Innovation Hubs: Many countries have established regulatory sandboxes[9] or innovation hubs to facilitate experimentation and innovation in the fintech sector while ensuring regulatory compliance. These initiatives provide fintech companies with a controlled environment to test new products, services, and business models, enabling regulators to gain insights into emerging risks and regulatory challenges.
- Bilateral and Multilateral Agreements: Bilateral and multilateral agreements between countries may include provisions for cooperation on fintech regulation, mutual recognition of regulatory frameworks, and information sharing to enhance regulatory harmonization.
- Regulatory Reform and Modernization: Regulatory reform efforts aimed at modernizing outdated regulations and adapting regulatory frameworks to accommodate fintech innovation can contribute to greater regulatory consistency and harmonization.
Currency Exchange Regulations and Compliance
Currency exchange regulations pose another significant challenge for cross-border fintech transactions. Fluctuating exchange rates, regulatory restrictions on currency conversion, and compliance requirements also add to the complexity of international transactions.
At the heart of currency exchange regulations are measures designed to manage foreign exchange (forex) markets, mitigate currency risks, and prevent illicit financial activities such as money laundering and terrorist financing. Regulatory requirements may include obtaining licenses or permits from relevant authorities, adhering to transaction reporting and record-keeping obligations, and implementing robust anti-money laundering (AML) and know your customer (KYC) procedures. In KYC procedures, data plays an important role, as it involves the collection and verification of personal information. Analyzing this data helps to assess risk profiles, continuously monitor transactions for suspicious activities, and ensure secure storage and reporting. Efficient data management is essential for accuracy, regulatory compliance, and the effective prevention of financial crimes.
Fintech companies engaged in cross-border currency exchange must navigate a complex regulatory landscape characterized by varying regulatory frameworks, exchange controls, and compliance standards across different countries. For example, some jurisdictions may impose restrictions on the conversion of local currency into foreign currency or require approval from central banks for certain types of transactions. Additionally, there may be limitations on transaction amounts and types, such as caps on the maximum amount that can be exchanged or restrictions on specific types of transactions like remittances or speculative trading. Compliance with these diverse regulations is essential for fintech companies to operate legally and mitigate regulatory risks associated with cross-border transactions. Some of the practical strategies that may help fintech companies in this regard are:
- Conducting thorough due diligence on regulatory requirements in each jurisdiction where they operate or facilitate transactions.
- Implementing robust AML and KYC procedures to verify the identities of customers and detect and prevent financial crime.
- Utilizing technology solutions such as blockchain and artificial intelligence to automate compliance processes and enhance transaction monitoring.
- Establishing strategic partnerships with licensed financial institutions or money services businesses to facilitate currency exchange transactions and leverage their expertise in regulatory compliance.
- Engaging with regulatory authorities and industry associations to stay updated on regulatory developments, seek guidance on compliance matters, share ideas and challenges as a key player in the ecosystem and participate in industry-wide initiatives to promote regulatory harmonization and innovation.
Jurisdictional analysis and legal frameworks
In cross-border fintech transactions, determining the appropriate jurisdiction is important, as it dictates the regulatory framework within which transactions must comply. Jurisdictions may differ in terms of their regulatory approach, legal standards, and enforcement mechanisms, posing challenges for fintech companies seeking to operate internationally.
Legal frameworks in each jurisdiction encompass a wide range of laws, regulations, and regulatory agencies governing various aspects of fintech activities, such as licensing and registration requirements, consumer protection, data privacy, cybersecurity, and dispute resolution. For example, some jurisdictions may have specific regulations tailored to fintech activities, while others may apply traditional financial regulations to fintech firms. Navigating jurisdictional challenges require careful consideration of several factors, including:
- Understanding the regulatory requirements imposed by each jurisdiction, including licensing obligations, compliance standards, and reporting obligations.
- Identifying potential legal risks associated with cross-border transactions, such as regulatory enforcement actions, contractual disputes, and jurisdictional conflicts.
- Developing compliance strategies tailored to the regulatory requirements of each jurisdiction, including implementing robust compliance programs, conducting due diligence on counterparties, and obtaining necessary licenses or permits.
- Drafting clear and enforceable contractual agreements that specify the applicable laws, choice of jurisdiction, and dispute resolution mechanisms to mitigate legal uncertainties and minimize the risk of disputes.
- Engaging with regulatory authorities and legal experts in each jurisdiction to seek guidance on regulatory matters, obtain necessary approvals, and stay informed about regulatory developments.
Cross-Border Collaboration and Stakeholder Engagement
In cross-border fintech transactions, collaboration among stakeholders is an important step towards overcoming regulatory barriers, promoting interoperability, and enhancing market access across different jurisdictions. This collaboration involves:
Industry Partnerships: Partnerships and alliances among fintech companies, financial institutions, technology providers, and other industry stakeholders provides platform to leverage complementary strengths, share resources, and co-create innovative solutions for cross-border transactions. The collaboration may be in the form of, joint ventures, strategic alliances, and consortia focused on developing interoperable platforms, standards, and infrastructure for cross-border fintech services.
Regulatory Engagement: Engaging in constructive dialogue with regulatory authorities and policymakers to advocate for supportive regulatory frameworks, address regulatory uncertainties, and promote regulatory convergence and harmonization across borders. This may involve participating in regulatory consultations, industry forums, and working groups focused on fintech policy and regulation, as well as engaging in bilateral and multilateral discussions to facilitate cross-border cooperation and information sharing among regulators.
Cross-Border Initiatives: Supporting and participating in cross-border initiatives and programs aimed at promoting collaboration, innovation, and market integration in the global fintech landscape. Examples include cross-border innovation hubs, regulatory sandboxes, and fintech accelerators that facilitate cross-border experimentation, market entry, and regulatory compliance for fintech startups and scale-ups operating internationally.
Public-Private Partnerships: Collaborating with governments, international organizations, and development agencies to address common challenges, such as financial inclusion, cybersecurity, and digital infrastructure, through public-private partnerships. These partnerships can leverage public sector resources, expertise, and networks to support fintech innovation and enhance access to financial services for underserved populations in cross-border markets.
Industry Advocacy: Advocating for the interests of the fintech industry through industry associations, advocacy groups, and trade bodies to shape regulatory policies, influence legislative agendas, and raise awareness of key issues impacting cross-border fintech transactions. By collectively advocating for regulatory clarity, proportionate regulation, and a level playing field, stakeholders can create an enabling environment for fintech innovation and market growth.
Conclusion
In conclusion, navigating the legal complexities of cross-border fintech transactions requires a multifaceted approach that will incorporate regulatory compliance, risk management, and collaborative stakeholder engagement. Efforts at promoting regulatory harmonization, standard-setting, and international cooperation are essential for creating a progressive environment for cross-border fintech transactions. By advocating for supportive regulatory frameworks, engaging in dialogue with regulators, and participating in cross-border initiatives, stakeholders can address regulatory barriers, foster innovation, and enhance global market access.
Jesse is Vice President, Senior Managing Counsel, EASTERN EUROPE MIDDLE EAST AFRICA at Mastercard
[1] Page 7 FSB Financial Stability Implications from FinTech Supervisory and Regulatory Issues that Merit Authorities’ Attention
[2] Cross-Border Transactions: Types, Benefits & Challenges Briefed – https://www.vance.tech/
[3] Unlocking Interoperability: Overcoming Regulatory Frictions in Cross-Border Payments- WES White Paper 2023 https://www3.weforum.org/docs/WEF_Unlocking_Interoperability_2023.pdf
[4] Adam Thiere coined the phrase the pacing problem in reference to the situation when technological innovation outpaces the ability of laws and regulations to keep up; The Pacing Problem and the Future of Technology Regulation
Why Policymakers Must Adapt to a World That’s Constantly Innovating
[5] Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system. https://www.fsb.org/about/ One of FSB’s mandate is to promote member jurisdictions’ implementation of agreed commitments, standards and policy recommendations, through monitoring of implementation, peer review and disclosure.
[6] IOSCO develops, implements and promotes adherence to internationally recognized standards for securities regulation. It works intensively with the G20 and the Financial Stability Board (FSB) on the global regulatory reform agenda.
[7] The Basel Committee on Banking Supervision (BCBS) is the primary global standard setter for the prudential regulation of banks and provides a forum for regular cooperation on banking supervisory matters. Its 45 members comprise central banks and bank supervisors from 28 jurisdictions.
[8] https://www.fsb.org/wp-content/uploads/P091023-2.pdf
[9] A Regulatory Sandbox is a formal process for firms to conduct live tests of new, innovative products & services, delivery channels, or business models in a controlled environment, with regulatory oversight, subject to appropriate conditions and safeguards.
