Fintech
Finance is one of the most uneven playing fields in the Pacific region. The profit-driven model of traditional commercial banks targets high value, low volume business when the overwhelming need of Pacific peoples and businesses is for accessible services that enable small value, high volume transactions at low cost. This mismatch has left many people and small businesses in urban and remote areas, as well as offshore remittance workers, exploited and/or unbanked.
This lack of commitment from foreign commercial banks makes the disruptive potential of fintech services very attractive. Yet there are systemic barriers to the uptake of e-finance in Pacific Island Countries. The Pacific E-commerce Strategy identifies regulatory gaps, low financial and technological literacy among lawmakers and policymakers, and limited digital infrastructure. From the users’ side, there are issues of cost and trust. There are also supply problems in attracting providers to develop appropriate regional solutions for domestic and cross-border transactions.
The Pacific E-commerce Strategy proposes a range of fintech services and payment options for the region. Unfortunately, Pacific Islands governments have limited capacity to regulate even the existing financial services sector. Fintech is both higher risk and less well understood.
As with digital development generally, fintech requires a balanced public policy and regulatory regime. The IMF’s 2019 Strategy for fintech in Pacific Island Countries is more nuanced than the Pacific E-commerce Strategy, advising that innovative technologies can help address the challenges facing the Pacific, if managed well and bearing in mind the risks.
As with the digital domain generally, trade in services agreements constrain how governments can regulate the finance sector. The standard definition of financial services in the WTO and FTAs, including PACER Plus and the MSGFTA3, covers every conceivable financial service and product, automatically applying to those not yet conceived of, because the definition is not exhaustive. The rules aim to limit the regulation of those financial services.
These agreements pose significant legal and practical challenges for financial regulators. As a brief explanation, the core rules involve promises not to treat firms of the other party and their financial services or products less well than local counterparts or to restrict their access to the market.
As a hypothetical example, an ANZ bank branch that was legally established in Samoa, or a local Samoan mobile money operator, that supply their financial services into Tonga via the Internet could not be required to have a local presence in Tonga that would bring it under Tongan jurisdiction or to retain data sourced from Tonga within the country.
UNCTAD’s 2018 regional digital integration strategy stresses the need for a strong supervisory framework, rules on data protection and competition, and payment and clearing sytems. It urges extreme caution against governments restricting their policy space to regulate digital payment platforms – a subsector on which all Pacific Islands Countries made commitments to the benefit of Australian and New Zealand financial service providers in PACER-Plus for a commercial presence (foreign investor), and the Cook Islands, Niue, Solomon Islands, Tonga, Tuvalu and Vanuatu made for cross-border supply of the service.
Previously, governments might have looked to options like universal service obligations to ensure access to financial services or required joint ventures between foreign and local or state-owned banks. These measures potentially conflict with trade in financial services commitments under PACER Plus (and MSGFTA3) relating to commercial establishment of foreign financial service providers.
Regulatory foundations for fintech
Regulating Financial Data
Regulating financial data raises particularly difficult challenges. Data is the driver for fintech, as for the wider digital domain. Who controls financial data controls fintech, builds its algorithms and constructs blockchains to enable digital currencies.
It has been hard enough to establish regulatory frameworks for financial data that protect individuals’ privacy and rights before this sophisticated technology and digital financial services emerged. Today’s challenges are far greater. Data may be held by foreign firms outside the country or the region. The fintech providers may have no local presence or might take a legal form, such as a branch or representative office, that does not make them subject to national regulation. Protecting these firms’ right to do so is a major objective of contemporary digital trade rules.
Likewise, the rules can prevent regulators from requiring access to source codes and algorithms to assess their integrity or cultural or gender bias. Conducting this kind of scrutiny on a national level is likely to be beyond individual Pacific countries’ regulatory capacity. As similar issues are likely to arise across the region, working towards a shared regulatory framework that enhances digital sovereignty is crucial.
Financial regulators need ready and reliable access to information about and from financial service suppliers so they can assess financial stability and risk, and prevent or respond to failures.
Trade rules on financial services, including the storage and processing of financial data, affect what a Pacific government or regional authority can do. Almost all parties to PACER-plus have made full commitments not to discriminate or limit the market for cross-border “provision and transfer of financial information and financial data processing and related software by suppliers of other financial services”.
Successive financial crises have increased awareness in both developed and developing countries that new types of financial products, services and technologies may bring unforeseen and often unforeseeable risks. The Pacific E-commerce Strategy observes that central banks take a relatively conservative approach to regulation out of concern about the disruptive power and destabilising impacts on financial services if they are not properly regulated.
As a response, the Strategy endorses both a Regional Regulatory Sandbox, the guidelines for which took effect in March 2020, and the establishment of innovation offices to support fintech enter the market. The following comments focus only on the sandbox (a controlled environment for a new financial services and products to be trailed before being applied more widely).
Neither the Pacific E-commerce Strategy nor the Guidelines addresses several significant concerns. One concern emerges from the IMF report on fintech options for the Pacific Island Countries. While the regulatory sandbox allows financial service providers to simulate and test their innovative financial products, services, and business models in a controlled environment, the IMF warns this is resource intensive and can be complex and costly, with the costs outweighing the benefits. It also suggests that most regulatory questions do not need a live testing environment. The IMF advised Pacific Island Countries to undertake a feasibility assessment before deciding whether to proceed.
South-South or triangular cooperation can provide short-cuts to understand emerging financial innovations so that regulators can identify their potential benefits and means to regulate them, while warning governments and users against more toxic financial products and services.
A regional regulatory sandbox
Inter-operability
Most Pacific Island Countries have high dependency on tourism and remittances that often involve frequent small value cross-border transactions. The non-Compact states rely heavily on Australian and New Zealand banks to facilitate domestic and cross-border payments and currency exchange, including through correspondent banking services between one bank and another.
In 2021, the RBNZ rang warning bells about the decline of correspondent banking in the Pacific region. Withdrawal of those services impacts on small Pacific Island Countries disproportionately. The Reserve Bank cautioned that “contraction in the network has reached a critical level where some domestic Pacific banks may find themselves cut off from safe, reliable, affordable access to the global financial system”. The National Bank of Tuvalu, according to the IMF in 2021, risked losing its only corresponding banking relationship with an Australian bank.
This situation poses serious problems of availability, access and affordability for Pacific communities, Pacific businesses, local Pacific banks, and Pacific workers offshore. The Pacific E-commerce Strategy hopes that greater availability and use of mobile network options can stem or reverse the declining commitment of traditional commercial banks to the region.
That seems unduly optimistic given the reasons the RBNZ identifies for the major banks’ retreat from these relationships. These reasons include:
high compliance costs to meet international rules on anti-money laundering and terrorism financing;
unattractive commercial conditions and low profitability in small, low income markets with large volumes of low value payments; and
under-development of regulatory compliance capabilities among Pacific banks and other financial institutions and or per-requisites such as ID among users.
These commercial banks are unlikely to change their profit-centred business model without very significant financial incentives.
Transforming this traditional financial services landscape would require a major disruption to the status quo that is supported by secure, stable and ethical alternatives and robust regulatory frameworks. This regulatory framework is lacking in many Pacific Island Countries. Building it up at a national level will require more time than is realistically available.
The RBNZ was concerned that a near-complete loss of correspondent banking relationships could force payment flows into riskier networks with people resorting to unregulated payment options outside the formal banking sector that have weak regulatory compliance capabilities.
Mobile money
The Pacific E-commerce Strategy promotes mobile money, digital currencies and digital wallets, in cooperation with traditional banks or as stand-alone providers. These more disruptive forms of fintech rely on technologies, providers and services that do not conform to traditional business models or to regulatory structures that assume a local presence and a specific legal form.
Tonga’s ‘Ave Pa’anga Pau, launched in 2017 and operated through government-owned Tonga Development Bank (TDB), is a positive example of a cheap, convenient and trustworthy remittance pathway. They currently charge a commission of 4.5%, which compares to 9% from Western Union and 16% from banks.
Other fintech providers are delivering money transfer services for their customers through smartphones and electronic wallets. Digicel and Vodafone support several forms of electronic wallet, including KlickEx, which offers “lower fees and great exchange rates” to the telcos’ customers.
However, the rapid growth of private mobile money has not been accompanied by effective regulatory frameworks and consumer protections. Their business models and delivery methods allow them to bypass regulatory frameworks that are designed for the traditional banking system.
Indonesia’s experience with ‘pay later’ services shows how mobile phone financers that use slick marketing, and lack effective regulation, create deep debt traps for those they target, especially the poor and those with limited financial literacy. [hyperlink]
Digital currencies
The stakes increase further with digital currencies like Bitcoin that operate through blockchain. Many digital currencies known as cryptocurrencies lack the security of redemption against fiat currencies or backing of real assets, with no transparent treasury or clearing house that can be held accountable.
Governments generally have not been able to regulate cryptocurrencies effectively. Some countries’ central banks have decided to issue their own digital currencies, Although investing money with a bank is not risk-free, the volatility and lack of regulation of most digital currencies make them much higher risk for users, especially where there is low financial literacy.
Although the rules on trade in financial services were never developed with these instruments in mind, trading in them could fall within the definition of financial services. They would also then potentially qualify as “new financial services” or products under the rule in the MSGFTA3 that would restrict their regulation, should that agreement ever enter into force.
Digital Wallets
Contactless payments avoid the need to hold and have access to cash or use consumer banking, provided that users have access to smart devices and connectivity. They are secure and operate through sophisticated algorithms. But again there are downsides to relying on partnerships with the major payment platforms that the Pacific E-commerce Strategy does not address.
Providers like Apple Pay or AliPay are integrated into the digital ecosystem of search engines, advertising, ordering, shipping and payments that allows them to set the terms of participation and effectively exclude competitors. As with their digital platforms and marketplaces, their anti-competitive practices have been found to block actual and potential competition, including from local providers.
Pacific Islands governments need to exercise extreme caution about promoting partnerships with entities that operate digital currencies, unless they have implemented robust regulatory regimes – something even central banks, financial regulators and competition authorities in the EU and US are struggling to establish.
The overall message on fintech is the need for Pacific governments, financial regulators and central banks to exercise utmost caution when looking to unregulated digital providers and instruments to fill the current financial services deficit. That caution should be accompanied by the best possible available advice from regulators and advisers who do not have a conflict of interest, drawing on experiences of other developing countries.
Mobile money, digital currencies and digital wallets