Fog descends on a busy highway and catastrophe often ensues. It is hard to navigate when you can’t see the road ahead. Yet that is just what many of us in the alternative finance industry have been trying to do for the last decade. We’ve avoided collisions so far, but if alternative finance is going to grow to serve the 28 million (and counting) small businesses in America, it is going to need some direction, and regulation can help provide that.
The question is: how can we make that happen without unnecessary roadblocks or delays?
Regulation is inevitable. Every industry, in every economy, faces some degree of regulation, and alternative finance will be no exception. But there is good regulation and there is burdensome regulation -- strictures that are burdensome for businesses and burdensome for those that they are trying to serve. And as Wall Street hopefully learned from the backlash to the 2008 crash and global economic meltdown that followed, it is easier to craft appropriate regulation when no one is calling for your head on a stake.
It is also better, at least for the financial services industry, if the central government is the one to craft the regulation instead of getting one rule from each of the 50 state governments. That however, is what seems to be happening now in alternative finance, particularly equity crowdfunding.
In early 2012, the Securities and Exchange Commission was given oversight over equity crowdfunding as part of the Jumpstart Our Business Start-ups (JOBS) Act. The SEC was given until the end of that year to draft rules on who could be an investor, but didn’t get the job done. So while the SEC has been overwhelmed with supervising Wall Street, more than a dozen states jumped in with their own regulation. The SEC finally took action on Title IV in late March. Now companies must wait again as states reconcile their rules with those of the SEC.
Regulation at the federal level can also shield the industry from local and state laws that may have been crafted for reasons other than the facilitation of small business finance. Colorado Governor John Hickenlooper is to be commended for vetoing legislation that his state lawmakers passed in May that would have raised the rates on small loans to people with bad credit to 21% from 15%. The small business community in Chicago might be better served by an expansion of the city’s commendable microloan and business education programs than by Mayor Rahm Emanuel’s declaration of war on lenders that he has branded as “predatory”.
The call for regulation is often spurred by business decisions that could most charitably be described as unwise. Payday lenders should have, by themselves, decided that it was unwise to lend to people who had little chance of paying them back without taking out additional loans. They didn’t, so the Consumer Finance Protection Bureau (CFPB) stepped in to propose a bit of common sense. Payday and auto title lenders should have, by themselves, decided that it was at best inappropriate to target America’s servicemen and women with high interest loans. But they didn’t, so regulators will be stepping in.
Some people believe that Washington’s new tone on regulation -- Dodd-Frank and the CFPB -- will blow over when the U.S. economy is sufficiently stabilized (or Republicans are back in office). I’m not among them. I agree with Deloitte’s assessment of the regulatory outlook. The report was issued last year and focused mostly on banks; but some of the driving factors it highlighted are applicable to alternative finance as well. All of us must manage risk, and we must have the appropriate technology and employee standards to do so. We must handle the sensitive data we collect with care, and we must make sure that any company we partner with does the same. We need to be clear about the terms of our interactions with customers and our responsibilities for the financial transactions we enter into. If we fail to do any of these tasks, we are issuing an open invitation to have regulators make us do so.
Regulation will drive some companies out of the alternative finance industry. But it won’t kill it. When New York issued the final version of its BitLicense rules on virtual currency transactions in June, there were stories in the press of virtual currency businesses saying they would move their operations from New York as a result. But other bitcoin businesses will stay, and more will likely come, now that the rules of engagement in New York are clear. With the Internet erasing state and national borders, all, however, are probably wishing that regulation could have been handled at some level higher than Albany.
What higher level might that be? There’s no shortage of candidates in the United States, from the Federal Reserve and the Federal Deposit Insurance Corporation, to the Office of the Comptroller of the Currency, the Financial Industry Regulatory Authority, the National Credit Union Administration, the Commodity Futures Trading Commission, the Securities & Exchange Commission and the CFPB.
I think the CFPB is the agency most likely to be tasked with regulating alternative finance. The Dodd–Frank Wall Street Reform and Consumer Protection Act put it in charge of looking out for consumers’ interests in their interactions with a wide variety of financial services businesses, from banks and credit unions to payday lenders and debt collectors. The CFPB also has responsibility for collecting data on small business loans. Not all alternative finance products are loans: The industry includes merchant cash advance companies, accounts receivable firms, equipment finance specialists and crowdfunding. But in each, there are enough consumer touchpoints that make it more likely than not that alternative finance should expect to receive correspondence from the CFPB’s lower Manhattan headquarters.
Alternative finance isn’t the only corner of the financial services industry that must cope with regulation, of course. Banks have dealt with it for decades. But alternative finance has been growing and evolving at a much faster pace than regulators typically move. And we could all move better if we didn’t have to move through a fog.