The rise of the digital economy and remote working has led to a corresponding demand for financial technology that can meet the new needs of consumers and businesses alike. Canada’s FinTech sector stands at a cross-roads, with challenges aplenty but with numerous exciting opportunities for growth and innovation if these can be overcome. We asked three lawyers from Dentons to explain the current state of the financial technology space, what hurdles must be overcome, and why the future of Canadian FinTech is a bright one.
Considering the consolidated nature of the Canadian banking, how difficult is it for new FinTech firms to enter that market? What legal and regulatory challenges do startups and foreign operations have setting up operations in Canada?
It is currently quite difficult for new FinTech firms to enter the market. While consolidation might be one factor, the lack of regulatory certainty and standards for new market participants contribute significantly to that difficulty, particularly for entities that are coming from a more open, but highly regulated jurisdiction. However, 1) the regulatory landscape is changing and new opportunities for FinTech participation are beginning to take shape; 2) once FinTechs overcome regulatory hurdles they may have an advantage because the market remains difficult to enter and traditional financial services companies are also regulated making it harder for them to nimbly react to competition; and 3) barriers to entry and increasing predictability have allowed strategic capital deployed by financial institutions to augment venture capital in supporting Canadian FinTech companies.
More information regarding the legal and regulatory challenges is discussed below:
- Accessing Core Technological Infrastructure
The current regulatory framework prevents PayTechs (which form a substantial portion of FinTech companies operating in Canada) from directly accessing the core Canadian retail payments system (the Automated Clearing Settlement System (ACSS)). Access is limited to members of Payments Canada and is governed by the Canadian Payments Act. While Payments Canada membership has broadened over time, it is limited to “traditional” financial institutions like banks and trust and loan companies. While the federal government has signalled an openness to expanding membership to non-traditional financial services providers, those changes have yet to be proposed.
- Regulatory Uncertainty
It can be difficult for FinTechs to participate in the Canadian market because the current regulatory framework was not designed with modern FinTech functionality in mind. As a result assessing the applicability (or non-applicability) of particular legislation can be difficult. However, legislative proposals were recently introduced to that hint at long-awaited regulatory clarity. Perhaps most relevant to FinTechs is the prospective data mobility framework under the Consumer Privacy Protection Act, and operational risk management and incident response framework under the proposed Retail Payment Activities Act. Prescribed regulation outlining the rules of each framework have not yet been released, but both pieces of legislation would be important steps in formalizing FinTechs’ role in Canadian financial services.
How can FinTech clients prepare themselves for the launch of Real-Time Rail? What are the implications of the introduction of real-time payments for the FinTech industry?
While we await the development of prescribed regulations for data mobility and payment operations, FinTechs can prepare themselves for the launch of Real-Time Rail (“RTR”) by getting involved in the regulatory development process – participating in consultations and industry associations whenever possible. Working to raise consumer aware about innovative payment methods. Additionally, FinTechs can start preparing now for the technical and regulatory requirements they will need to meet to participate more actively in the retail payments system.
From a technical perspective, Canadian payments systems will leverage the ISO 20022 data standard. FinTechs should therefore consider the compatibility of their technical infrastructure with that standard.
From a regulatory perspective, access to RTR and the performance of retail payment activities will be governed by the newly proposed Retail Payment Activities Act (“RPAA”) overseen by the Bank of Canada. While the RPAA is not yet in effect, the legislation offers valuable insight into the coming regulatory landscape. To prepare, FinTechs should develop policies and procedures that will likely be required to register as a payment service provider and participate more fully in the retail payments system – this is an increasingly active area for Canadian payments lawyers. While regulatory uncertainty remains, the relatively mature regulatory frameworks in Europe and the United Kingdom can serve as valuable case studies for the development of such policies and procedures as well, as they will likely inform the development of comparable standards in Canada.
Real time payments functionality will allow consumers and businesses to deliver funds in a matter of seconds. For businesses, this could improve cash flow and enable them to make payments immediately. For consumers, this means they will have faster, simpler, and more convenient payment options at their disposal. FinTechs will serve as the platforms facilitating this innovation by creating more opportunities to deliver value to consumers and businesses alike.
What can FinTech firms do to make themselves more attractive to investment? What trends have you seen in the FinTech investment space recently, and how do you see this continuing in the short- and long-terms?
Despite the emergence of several funds focused on early-stage FinTech in recent years, Canadian VC investment reveals that newer companies will increasingly need to demonstrate a high degree of differentiation to generate interest. Investors are more demanding than ever in terms of wanting to see a clear path to revenues and market share. While 2020 had ups and downs, especially for foreign investment in Canadian FinTech, 2021 has been very active. While demonstrating a strong and clear approach to regulatory compliance can only increase a FinTech’s attractiveness to investment, factors like the strength of a FinTech’s leadership, technical talent and intellectual property will likely be key drivers of success provided the team has demonstrated an ability to execute on its corporate goals.
Fortunately, for both consumer FinTech and business-to-business FinTech innovation, retail consumers, financial institutions and other corporate channel partners have become more comfortable with FinTech entrants. We have noticed trends in investment towards FinTechs offering payment services, services related to data ownership, privacy and digital identity, and open-banking/consumer-directed finance.
How do you see financial data protection and privacy regulations affecting this sector in the future? Do transnational companies face greater challenges in this area than firms with Canada-only operations?
Financial data protection and privacy regulation will have a major impact on the development of this sector in Canada. Perhaps most relevant to the development of the sector is the introduction of a data mobility right, which would theoretically allow individual consumers to transfer their data to an eligible FinTech. Such a right would allow these FinTechs to more effectively compete with incumbent banks by granting them access to valuable consumer data they could use to tailor their services in a more accurate and helpful way.
Canadian data protection and privacy regulations require companies to provide the same level of protection, regardless of whether the company carries out operations internationally or solely in Canada. However, entities with transnational operations may face challenges relating to compliance with different data protection and privacy regulations, and the cross-border transfer of personal information. Moreover, as retail payments in Canada become more data-rich, additional obligations around the treatment of that payment information may be introduced.
How has the rise of cryptocurrency affected the FinTech space? What specific challenges and opportunity does this subsector offer to Canadian firms?
A resurgence in crypto activity has resulted in the adoption of new digital currency verticals by Canadian FinTechs, including digital currency lending activities, crypto trading, and digital identity models. FinTechs seeking to conduct cryptocurrency related activities will likely face challenges related to regulatory compliance; specifically, ensuring compliance with securities and anti-money laundering / know-your-client regulations that likely apply to FinTechs’ different facilitating activities.
However, the rise of this subsector and associated crypto applications also creates many unique opportunities for Canadian firms. Emerging financing applications include token securitization and non-fungible tokens (NFTs), both of which could facilitate unique mechanisms for financing through fragmented ownership in both public and private market transactions. More general crypto applications that excite us are those that rely on decentralized ledgers to secure and distribute information amongst network participants. User control of digital identity (IB: identity?), supply chain logistics, and the development of shared resource networks are a few examples of such crypto-related business models.
What is the future for delivery and implementation of consumer-directed finance in Canada? What are the risks and merits of its introduction for FinTech firms?
The Canadian government has made a strong commitment to fostering the growth of consumer-directed finance, which makes its future brighter. The hope is that the development of risk-based regulation and standards, established in collaboration with the public and private sector will foster innovation and deliver benefits to consumers, while mitigating risks involved in increased data sharing.
Some of the advantages of consumer-directed finance are that it puts more power into the hands of Canadian consumers to choose financial products best suited for them and that it fosters innovation and competition by introducing new players into what has long been a closed network of providers.
However, this movement is not without some risk. The consumer-directed finance market also requires robust financial education and increased financial literacy to arm consumers with the tools they need to direct their financial choices effectively. Consumer protection will continue to be of paramount importance. With an increased number of players in the consumer finance space, monitoring disclosures, consumer recourse provisions and other protective mechanisms may become more challenging for regulators, particularly as FinTechs adapt to working in a more highly regulated space. Additionally, as consumer data is increasingly shared, additional data security risks may be introduced.
Do you have any other insights on helping FinTech clients navigate the legal landscape post/during COVID?
Reports indicate that 37% of Canadians do not expect to return to using cash payments to the same extent that they did pre-COVID-19, and 42% reported that the pandemic has changed their payment preferences to digital and contactless payments for the long-term. Assuming this pattern of consumer behaviour continues during the post-COVID-19 era, such a transition towards digitization may suggest increased opportunities for FinTechs. However, alongside that growth in digital payments is a similar increase in fraud associated with those payment methods. Post-COVID, we anticipate regulators focusing increasingly on fraud mitigation measures, the prevention of money laundering and continued progress on the regulation of cryptocurrency and other crypto-assets.
We would like to emphasize the importance of remaining up to date on developments in regulation and maintaining open channels of communication with key stakeholders like Payments Canada, the Department of Finance, the Bank of Canada so FinTechs can establish they necessary foundation to participate in the Canadian FinTech ecosystem and capitalize on these trends.
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Mike Hollinger leads Dentons’ Toronto venture technology practice and focuses on venture capital financings, M&A and capital markets transactions. Mike has deep experience advising FinTech entrepreneurs, emerging growth companies, and venture capital and corporate venture capital investors, including many collaborations on FinTech innovation projects between start-ups and some of the world’s largest financial institutions.
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Tracy Molino is counsel in Dentons Banking and Finance group. She has extensive experience payments law and technology, bank regulatory and policy matters, and consumer protection issues. She has particular interest in FinTech, PayTech and other innovative technologies, including blockchain. Tracy has a unique combination of private sector and regulatory experience. Prior to joining Dentons, Tracy worked as a director at Payments Canada, where she supported ongoing efforts to modernize Canada’s national payments systems, as well as legal and policy framework development. She has also worked as Senior Counsel at the Bank of Montreal.
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Noah Walters is returning to Dentons as an associate in the fall having completed his articles and graduating from the JD/MBA program at the University of Ottawa. Prior to law school, Noah co-founded Feedback, a social enterprise that reduces food waste by helping restaurants sell food at off-peak hours. While at law school, Noah built the Blockchain Law Society, which he grew into a consultancy that connected entrepreneurs with lawyers and venture capital groups in six countries. During his articles, Noah’s worked as a Director of Covid Care Collective, a non-profit that helps at risk individuals obtain food, medication, preventative gear, and other essential items.