Digitized securities are innovating FinTech by addressing regulatory compliance

This article was originally published on Forbes China and got translated for our English blog audience.

FinTech is set to make a big impact on the way businesses manage capital and investments. From 2010 to 2019, there have been a total of US$53.3 billion in venture capital investments toward FinTech startups and projects. Two-thirds of bankers around the world believe that FinTech will greatly change consumer behavior with respect to mobile payments and digital assets. 

Digital payments will be the biggest driver of growth, with an estimated 3.96 billion users in 2020 growing to 4.48 billion by 2023, with a transaction value growing from US$4.77 trillion to US$6.70 trillion during this period. 

This underscores the growing role of technology in both consumer and business finance. However, given the global impact of FinTech, one particular challenge faced by investors and service providers is regulatory fragmentation. 

Regulations need to be conducive to innovation 

As early as 2016, the World Economic Forum already took note of these challenges in a whitepaper on FinTech and regulations. It cites the need for policymakers to develop frameworks conducive to growth and innovation while balancing the need to address the potential risks to ensure safeguards for consumers. It stressed that the regulations need to be clear and transparent and that regulatory architectures need to be dynamic enough to handle the fast pace of innovation. 

While the need to redefine policy falls upon the regulators’ purview, FinTech providers and technology companies are already making headway into innovating their products in order to achieve better compliance with these regulatory requirements. 

For one, digitized securities are introducing compliance and regulatory frameworks to the digital asset ecosystem, thus establishing confidence among both investors and consumers with better transparency and standards. As these are backed with real assets such as equity, loans, or investment funds, these are required to follow the same regulatory compliance as traditional securities. 

“The issued securities grant investors the same rights as traditional financial market instruments and must fulfill the regulatory requirements of the respective jurisdiction,” says Stefan Schuetze, Member of the Management Board at FinLab AG, an incubator for FinTech startups. 

“Since it combines the advantages of a digital asset economy with compliance through financial regulation, digitized securities enable a much more flexible and cost-efficient investment method than most of the traditional financial instruments,” he adds. 

Toward a standard for regulations across different jurisdictions 

One big challenge in decentralized finance (DeFi) is compliance across different jurisdictions. Schuetze says that “the biggest challenge that comes with digitized securities is that issuers do not only have to fulfill the regulations of their own jurisdiction, they must also ensure compliance with the requirements of the investors’ regulatory bodies.” 

With traditional securities, each market has its own regulatory body, which oversees compliance, such as the US’ Securities and Exchange Commission, for example, or the European Union’s Securities and Markets Authority. 

However, digitized securities also go beyond the primary capital markets. FinTech enables trading on a global scale, and it is also possible to trade securities on the secondary market without any intermediary. This means that trading platforms need solutions that ensure globally compliant Know-Your-Customer (KYC) and Anti-Money Laundering (AML) standards. 

In lieu of a unified regulatory framework on a global basis, compliance companies will need to utilize existing laws in the best possible way by providing their own compliance layers. This enables compliance among issuers and traders in their respective jurisdictions, which is integral to achieving mass adoption in the industry. 

“For issuers these hurdles largely, but not exclusively, come with regulatory compliance: In order to act in accordance with AML and terrorism financing regulations, issuers of digital securities have to apply to the national legal requirements,” says Phong Dao, Co-Founder and Chief Executive Officer at Agora Labs, a company that digitizes and improves traditional funding methods through distributed ledger technology. 

He adds that there are certain requirements that both investors and issuers face when it comes to the digitization of assets. “For investors these hurdles include going through the KYC process, creating and owning a digital asset wallet, and a general understanding of blockchain technology.” 

Transparency enhances trust 

In order to establish widespread use and acceptance of platforms for digital securities, transparency and trust will be essential for mass adoption. Agora Labs’ Dao highlights the role of automation in making it easier for businesses to achieve compliance. “Automating processes and programmable compliance necessary for regulation is the biggest step towards simplifying digital securities,” he says. 

Processes like regular reporting, globally-compliant KYC procedures, immutable transaction logging, and smart trigger-driven transaction alerts, will ensure an unprecedented level of transparency, which digitized securities can provide. 

“Immediate ownership transfer, easy access, real-time settlement – these are just some of the major advantages of digitizing traditional securities and assets. But these same digitized securities and assets and the transactions related to them require monitoring, audit and if necessary, timely reaction to ensure the maintenance of compliance, security and business integrity of these processes,” says Hendrik Henrikson, Chief Business Development Officer at PARSIQ, a compliance tool that enables businesses to automate their blockchain workflows. 

Henrikson adds that trust is the biggest benefit of regulation and compliance, and this requires transparency. “When talking about DeFi I believe that ‘regulation and compliance’ transforms to ‘transparency and trust’. The more we can observe how these products work and how they are managed internally, the better.” 

The digital securities market has greatly evolved, and investors can look forward to more innovations that will make investing in digital securities more accessible and more transparent, thus providing more potential for growth. 

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