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When Regulation and Innovation Collide: Lessons for Financial Services

Posted by Jim Eckenrode, executive director, Deloitte Center for Financial Services, Deloitte Services LP, on August 20, 2014

Financial institutions have been increasingly concerned about the threat of a disruptive new entrant into the business, principally arising from some new technology innovator that changes the status quo, whether by changing the nature of customer interaction or perhaps the way that transactions are processed.

But these threats may take longer than imagined to manifest themselves as meaningful change.

A little more than a year ago, I wrote a post on the notion that technology advancement, an "irresistible force," could be entering an era of challenge from regulation, which some view as an "immovable object." With greater frequency this is coming to pass, both within and outside of the financial services industry. What do these developments mean for disruptive innovators? And perhaps more importantly, what can FSI executives learn from these examples?

Several interesting cases of technology-driven innovation come from the world of "collaborative commerce," where individuals create an opportunity to derive revenue from valuable assets on which they have a legal claim. One such example is apartment-sharing applications that allow real estate owners or renters to grant a short-term (as little as one day) rental or sublease to a traveler. However, these initiatives have recently run afoul of housing and hotel regulations in various cities, as regulators and attorneys general are concerned about ensuring that the same standards imposed on hotels for safety and cleanliness are adhered to by these new offerings. Ride share services that compete with established taxi and limousine services create some of the same concerns, with the additional point that pricing tends to also be regulated — at least for taxis — but not yet for these ride share services.

Of course, there are also squeals emerging from the existing stakeholders about impacts on their revenue streams, whether it relates to lost tax revenue, reductions in taxi medallion prices, or other complaints. That's par for the disruptive innovation course.

Then there are other technology-based innovators that leverage either existing mobile apps, or sensor technologies like GPS, to create a marketplace for goods and services that, technically, the seller does not own. Two such examples are the selling of parking spaces and restaurant reservations. These examples suggest that innovations can be somewhat akin to "scalping," but can also run afoul of city regulations related to the selling of access to a public resource (a parking space), or to the potentially uninvited assumption of a wholesaler-type role within an established process (for example, booking and then selling restaurant reservations).

Finally, an interesting example that comes more directly from within the financial services world is the emergence of crypto-currencies. We recently wrote a research report on this topic, and while the full story of crypto-currencies is still developing, regulators have begun to take positions regarding oversight and licensure of issuers and processors of transactions using these alternative currencies. And according to our research, financial institutions over time may be more interested in the payment authentication, clearing, and settlement mechanisms that are a part of these currency innovations than in the currencies themselves.

So what do these developments mean for the financial services industry?

First, in the long run and perhaps most important, is that technology is yet another way for consumers to not only take control of their relationship with their financial institution, but also to leverage that technology to invent credible alternatives to those offered by incumbents in the marketplace. And revenue impacts may be likely to follow.

The next concept has to do with the potential for individuals (or startups, or even incumbents) to use technology to monetize parts of a value chain that were not formerly "products" in and of themselves, and in so doing, create a new market.

Finally, these examples show how regulators are, in many respects, being forced to play catch-up with these innovations, either to enforce existing standards upon new types of competitors, or to uphold ownership or "public resource" rights in areas that formerly were not of potential concern — that is, until some creative developer found a way to make that so.

What do you think? Are disruptive competitors extending beyond what is reasonable or allowable — at least, as it may be conceived today? Can regulators and legislative bodies keep up with these changes? And will "collaborative commerce" become a meaningful disruptive force in financial services?

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