Weekly Fintech Focus

• The House Financial Services Committee takes on AI bias issues.
• The Fed prioritizes interoperability for its FedNow payments service.
• Colorado releases a roadmap for banks and others that provide financial services to cannabis-related businesses.
• Mastercard gets preliminary approval to operate in China.
• NY Court Finds Fantasy Sports Betting Illegal.
• Fed Reserve Governor Discusses Digitalization of Payments and Currency.

House Financial Services Committee Hearing on AI Bias in Financial Services

On February 12, 2020, the House Committee on Financial Services held a hearing to examine ways to reduce AI bias in financial services. There was no bill being debated at the hearing, but the Committee did provide a short memorandum discussing the ethical and other concerns tied to AI technologies in financial services, including risks of bias serving as the basis for algorithms used by financial services or bias resulting from the use of algorithms. The memorandum noted that bias and discrimination in financial services are addressed by the Equal Credit Opportunity Act, the Fair Housing Act, and the Fair Credit Reporting Act, but that AI was not contemplated by the drafters of these laws. In particular, the memorandum addressed the risks posed by a lack of explainability in AI models used in financial services.

The Committee mentioned recent updates to regulatory requirements and examples of AI technologies and algorithmic decision-making, including regulatory sandboxes, the Consumer Financial Protection Bureau’s No-Action Letter Policy and Upstart, a recipient of a No Action Letter (discussed by us, here and here), and the recent proposed changes to the Fair Housing Act (discussed by us, here).

Fed’s Powell Says FedNow Interoperability is High Priority

This week, Chairman Jerome Powell appeared before the Senate Banking Committee and discussed the upcoming FedNow payment system. His responses to questions about the FedNow system emphasized that the Federal Reserve is working to build the system to be fully interoperable with the Clearing House’s RTP network. While such interoperability will be a challenge to accomplish, it is a focus at the design stage. It is unclear at this time the level of priority of interoperability as the Federal Reserve had previously considered it to be an issue to address later in the development process, and the Clearing House considers such interoperability to be incredibly challenging to accomplish.

Colorado Releases Cannabis Banking and Financial Services Roadmap

Colorado Governor Jared Polis and the Colorado Department of Regulatory Agencies (DORA) recently released a document called the “Roadmap to Cannabis Banking & Financial Services” (the “Roadmap”) to provide guidance to state-chartered financial services companies that serve cannabis-related businesses. The Roadmap states that Colorado’s goal is to implement a plan to increase the number of financial services providers who serve cannabis-related businesses by 20% by June 30, 2020. To accomplish this goal, Colorado plans to create a regulatory landscape amenable to the development of more financial services for cannabis-related businesses, explore emerging technologies and business models in the financial services industry, and identify opportunities for state legislative and regulatory clarity for state-chartered and -licensed businesses to provide services to cannabis-related businesses.

The Roadmap lists seven strategies that the state will use to accomplish its goal:

1. Establish a working group consisting of senior leadership at DORA to meet monthly to discuss developing a more favorable regulatory structure.
2. Increase transparency of information about cannabis-related businesses, including improved interagency coordination.
3. Engage banking and credit union trade associations to identify areas of opportunity.
4. Encourage innovative technologies to enter the Colorado market, including obtaining legal guidance from the Attorney General regarding providing services under the Money Transmission Act and the Trust Companies Act.
5. Provide guidance for state-chartered banks and credit unions that provide services to cannabis-related businesses.
6. Reduce barriers to entry while maintain consumer protection through evaluating current chartering and licensing requirements.
7. Demonstrate support for a federal solution by submitting letters in partnership with other state bank regulators.

Mastercard to Expand to China

After a years-long process, and nearly a year after Mastercard’s latest application, Mastercard announced that it had received “in-principal approval from the People’s Bank of China (PBOC) to begin formal preparations to set up a domestic bankcard clearing institution in China.” Mastercard’s operations in China would be conducted through a joint venture with NetsUnion Clearing Corporation. Within a year, the joint venture will be able to apply to the PBOC for formal approval to begin domestic bankcard clearing activity. Upon final approval, Mastercard will join American Express, who won approval in 2018, as the only U.S. bankcard clearing institutions operating in China. Visa has a similar application pending but has not yet been approved.

The approval for Mastercard comes just weeks after the US and China released the text of the Phase 1 trade agreement between the two countries, which takes effect on February 14, 2020. As part of the agreement (Article 4.4), China has agreed to “accept any applications from a U.S. electronic payment services supplier . . . to begin preparatory work to become a bank card clearing institution within five working days of submission.” Within a month of completion of the preparatory work, China also agrees to make a determination with respect to the application and to provide an explanation of any adverse determination. The US in turn has committed to giving non-discriminatory treatment to Chinese electronic payment service suppliers, including UnionPay.

NY Court Rules Fantasy Sports Betting is Illegal

The New York Appellate Division struck down a 2016 law that seemingly enabled fantasy sports betting as an unconstitutional expansion of the New York penal code because fantasy sports betting contained a material element of chance, and therefore constituted gambling. The court noted that a constitutional amendment would be required to change this law and that the legislature could not unilaterally expand it.

Specifically, the New York court found that although “participants in [internet fantasy sports] contests may use their skill in selecting teams, they cannot control how the athletes on their [internet fantasy sports] teams will perform in the real-world sporting events.” Thus, fantasy sports betting is not a game of skill and represents a material element of chance.

Additionally, the court relied on the New York Constitution’s language that stated “no … book-making, or any other kind of gambling … shall hereafter be authorized or allowed” when making its determination.

In response, DraftKings stated that they “believe the [2016 law] authorizing fantasy sports in New York was constitutional and in the best interests of taxpayers and fantasy sports fans.” Moreover, FanDuel stated that they “expect that there will be an appeal.” DraftKings and FanDuel are two major offerors of fantasy sports activity in the United States.

Fed Reserve Governor Discusses the Digitalization of Payments and Currency

At the Symposium on the Future of Payments, Federal Reserve Governor, Lael Brainard, discussed the benefits and risks associated with the digitalization of payments and currency. Ms. Brainard highlighted how digitalization enables consumers and businesses to transfer value instantaneously, resulting in greater convenience at a lower cost. However, Ms. Brainard cautioned that there are new participants that fall outside of the financial system’s regulatory guardrails that pose unique challenges with regard to illicit finance, privacy, stability, and money policy generally.

She noted that the public sector must determine whether the traditional regulatory perimeters need to be redrawn or new approaches are needed in these developing areas – particularly with regard to consumer data, identity authentication, and the role of central bank digital currencies. Moreover, Ms. Brainard noted the importance of sovereign currencies staying at the center of each nation’s financial system and specifically noted that central bank money represents “a safe settlement asset, allowing users to exchange central bank liabilities with confidence.”

Ms. Brainard noted how technology has enabled payments to transition from trusted intermediaries like banks to new platforms with massive networks like Alipay and WeChat Pay in China. While there are benefits of convenience, accessibility, and low transaction costs, she indicated that many of these new solutions do not offer consumers the same protections or recourse as traditional products. Ms. Brainard also hypothesized that a review of the United States’ oversight framework for retail payment systems might be helpful to identify important gaps as payments technology continues to expand.

She proceeded to discuss the benefits of a real-time infrastructure including the speed of refunds and the access to funds generally, while noting the Clearing House’s RTP and FedNow’s developments. However, Ms. Brainard also noted that the digitalization of payments, and the development of new mediums of exchange, have created new potential challenges relating to illicit activity and consumer risk. As an example, Ms. Brainard discussed Bitcoin and other cryptocurrencies. In that regard, Ms. Brainard noted that Bitcoin has not achieved widespread acceptance as a means of payment or unit of account due to its extreme volatility, limited throughput capacity, unpredictable transaction costs, limited governance and limited transparency. Thereafter, she noted that the design of stablecoins came about to specifically overcome the volatility of first-generation cryptocurrencies by tying the digital currency to an asset or basket of asset.

Lastly, Ms. Brainard discussed the prospect of a rapid adoption of a global stablecoin payment system. She cited a Bank for International Settlements survey that found more than 80% of central banks were engaged in some type of central bank digital currency work and that the motivations for this development ranged from payments safety to robustness to efficiency. Ms. Brainard concluded by noting the dollar’s important role in the world and the criticality of remaining on the frontier of research and policy.

The full text of Ms. Brainard’s speech can be found here.