HKEX Report丨Fintech Applications & Related Regulatory Framework

Editor's Note

In the new era of Fintech, stock exchanges around the globe are actively exploring ways to perform system upgrades and service enhancements with Fintech. This report focuses on blockchain and AI applications in the securities industry and explores how these new technologies could be integrated in the areas of investment, trading, clearing and settlement, as well as regulation, with a view to find specific feasible applications of Fintech in the capital market.

Author: Chief China Economist's Office and Innovation Lab, Hong Kong Exchanges and Clearing Limited

REPORT SUMMARY

Financial technology, or Fintech, refers to financial innovations driven by technological advancement in the forms of new business models, new financial services, and new software and applications that have a great impact on the provision of financial services and the development of the financial industry. In the new era of Fintech, stock exchanges around the globe are actively exploring ways to perform system upgrades and service enhancements with Fintech. However, most of the existing Fintech applications are deployed in the industries of banking, Internet finance and digital currencies rather than the securities industry, in which only very few could come up with feasible plans based on specific securities business models. It is generally believed that blockchain and Artificial Intelligence (AI) technologies such as intelligent investment advisor (robo-advisor) would be the most applicable in the exchange market.

This report focuses on blockchain and AI applications in the securities industry and explores how these new technologies could be integrated in the areas of investment, trading, clearing and settlement, as well as regulation, with a view to find specific feasible applications of Fintech in the capital market. Practical examples are presented to illustrate the impacts and significance of Fintech in the capital market and securities trading. This report introduces examples of blockchain technology deployed in trading and clearing and settlement businesses, asset rehypothecation business and private equity market as well as the use of AI technology in intelligent/roboinvestment research and advisory services. Each example compares the pros and cons of the new technology and the traditional business model, and the difficulties and challenges arising from the use of blockchain and AI technologies. Noteworthily, AI technologies in intelligent investment advisor and investment research are currently a key testing item in the “supervisory sandbox”, and securities regulators in certain countries (e.g. Korea) have already established a dedicated testing environment. These international experience could be made reference to for considering the next step in the Hong Kong market.

This report also discusses the principles and tools in the establishment of the regulatory framework  for the development of Fintech. As an emerging industry, Fintech-based business models have been evolving and becoming increasingly complicated. To a certain extent, the use of Fintech may not help reduce the inherent risks in the financial system but rather, may magnify or expose new forms of financial risk. Therefore, regulators should consider how to enable the application of Fintech innovations in the securities industry under an appropriate regulatory framework.

“Supervisory sandbox” is an effective tool for testing new financial technologies. A number of countries have been conducting “sandbox” testing on Fintech elements to different degrees. To minimize, in a controllable way, the potential negative impacts of new technology applications under uncertain regulations regulators could provide a regulatory sandbox testing environment with relatively loose regulations for pilot trials of Fintech applications. Once the risks and issues encountered in the trial have been eliminated or resolved, and that the protection of customers’ interests and the smooth operation of the financial system are ensured, the Fintech could then be extended to a larger scope.

This report also discusses the consistency principle in financial regulation. The consistency principle means that financial businesses of the same nature should be subject to the same regulation. Financial services, be they offered in a virtual or real environment, should be governed by the same legal framework. This will ensure fair competition and prevent regulatory arbitrage. At the same time, the regulatory framework should also be continuously upgraded to keep in pace with Fintech developments, to avoid any possible regulatory loopholes.

Lastly, the report discusses the feasibility of using big data, deep learning and knowledge-graph to establish effective regulatory technology systems. It is essential for regulators to build an effective regulatory technology (Regtech) system, using big data and AI analysis to strengthen their ability to do macro-analysis of financial institutions and track systematic risks, in order to better monitor and prevent systemic financial risks.

FULL REPORT

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Source: HKEX official website, October 2018（Opinions in this report stand for author's personal research view only, not for opinions of any institution）

Editor：JU Chenchen