The Definitive Guide: Mexican FinTech Law, a look 3 years after its publication
Author: Carlos Valderrama (more information here)
Nowadays there are multiple fintech regulation and based on that fintech start ups have obtained approval to operate as a financial technology institution, that have had an exponential growth and have generated a greater financial inclusion, but Do you know how it all started?, What is a financial technology institution, a crowdfunding institution or an electronic payment fund? What was the influence of the Mexican Banking Association (ABM) or our central bank in the process?, Which financial entity has been authorized and what do they think about the process?, What happens if you carry out activities regulated by the so called FinTech Law in the FinTech industry? What is the status of the collaborations between a FinTech company or FinTech firms and a financial entity or traditional banks or a financial institution or Mexican Banks?, What kind of technology can be applied in a FinTech institution through an innovative model? Find out the answer to these and other questions in connection with the Mexico's FinTech law in company of Legal Paradox®.
Was a FinTech Law necessary?
Although the FinTech Law was published on March 9, 2018 (more information here), its drafting started back in 2016. Even if we go further, the related work actually started since 2014 with an intense collaboration between the FinTech ecosystem and the financial regulator.
It all started once upon a time when players such as Prestadero (disclaimer, Prestadero is a client of Legal Paradox®), Bitso, the Mexican Crowdfunding Association (AFICO also a client of Legal Paradox®), among others, recognized that the activity they were performing could be found in a gray a rea since it was possible to argue that it was actually a regulated financial activity reserved to authorized financial entities.
The implication of the above could be brutal and the consequences fulminant for a FinTech sector that was just starting and that in 2016 had only 158 participants in its ecosystem according with the FinTech radar of Finnovista, but that was already positioned as the largest FinTech market in Latin America (more information here). The above, since the consequences could result in million dollar fines and even the real possibility of up to 15 years in prison which, for Startups led by entrepreneurs recognized in other countries as great innovators, implied a real risk since they were being investigated for possible illegal money raising.
Indeed, during 2017, around 35% of Mexican FinTech were being investigated for the possible performance of regulated transactions or financial activities that were reserved to authorized financial entities. Given the situation, there was an obvious need for self-regulation, which is why AFICO, together with Legal Paradox®, built regulatory criteria from the sector for the sector itself in order to generate a system based on international best practices. Moreover, we were convinced that it was of vital importance to have legal certainty and to know what could be done and what could not be done. Therefore, as a guild, we approached the financial regulator and asked, almost begged, to be regulated.
Fortunately, we had a responsive financial regulator who patiently took more than 270 meetings with us as a ecosystem to explain what we were doing, what were the risks, how they were mitigated and why our activity represented something different within the financial regulatory world, financial intermediaries and more importantly, why it was desirable and even necessary to allow these activities to generate greater financial inclusion, competition, as well as greater penetration of financial products and services in Mexico.
At the end of the day, our aim was to establish how to leave the gray line and move into the major leagues, as well as to what extent regulation was going to help us and not to kill us in the process.
In that context, we should remember that in 2018 we were starting from a reality in which Mexico displayed a highly concentrated financial services market where the supply of products and services was largely dominated by the traditional financial sector, in particular by BBVA. Because of this, evidently the influence of the banks, and in particular the Mexican Banking Association and our Central Bank, was tremendous as they were concerned that regulatory arbitrage would be generated, i.e. the possibility of FinTech competing with them with lower rules and barriers of entry.
On the other hand, and like the rest of the international financial sector, Mexico has a strong financial regulation that in many cases inhibits the generation of disruptive innovation in the sector, imposing a strong barrier of entry and inefficiencies in the system that are reflected in a lack of competition and high cost for the user of financial products and services.
It was under such environment that the Law to Regulate Financial Technology Institutions (called the FinTech Law) was interestingly signed in the framework of the inaugural session of the 81st Banking Convention and published on March 9, 2018. The Mexican FinTech Law was one of the first regulatory bodies created specifically to promote innovation, the transformation of traditional banking and credit financial services that would even allow the possibility of incorporating exponential technology such as Artificial Intelligence, Blockchain, collaborative economies and peer-to-peer financial services in secure regulatory spaces.
The FinTech Law was based on the following principles:
1. Financial Inclusion, which seeks to bring financial services closer to people and sectors that have not traditionally been part of the financial system.
2. Principle of innovation, to provide tools to increase the use of financial services.
3. Principle of consumer protection, in order to take care of the client by establishing defense mechanisms and verification of minimum standards.
4. Principle of preservation of financial stability, which seeks to provide a general framework for authorization and supervised operation, prudential rules for financial, operation, market, technological, corporate governance and accounting risks.
5. Healthy competition, which promotes greater diversity and new distribution channels for financial services, cost reduction and improvement in the provision of services.
6. Prevention of money laundering and terrorist financing.
7. Technologically neutral, which implies that the technology is indifferent to the services provided.
It is important to highlight that the Mexican FinTech Law is internationally recognized as an example of how to achieve a regulatory framework that promotes innovation while guaranteeing adequate control for the risks that could be generated.
What is a Financial Technology Institution?
The regulatory framework created the possibility of having two new financial entities or Financial Technology Institutions, the Collective Financing Institutions known as IFC or Crowdfunding and the Electronic Payment Fund Institutions known as IFPEs or Wallets.
With the implementation of these entities, their purpose was expressly reserved for authorized entities. Therefore, if you are a FinTech created after the issuance of the FinTech Law, you will not be able to operate until you have the corresponding authorization under penalty of incurring in administrative sanctions of millions and even imprisonment of up to 15 years.
In addition to the creation of the two new financial entities, and for the rest of the FinTech world it became possible the implementation of new models or the regulatory sandbox, the use of virtual assets and APIs that will generate what is known as Open Finance, Open Data or Open Banking Initiative.
1. Crowdfunding or IFC
These institutions have the possibility of carrying out activities that are created for connecting people from the general public, with the purpose of granting each other financing through debt, equity (capital stock) and co-ownership operations or royalties (more information here).
2. Wallets or IFPEs
These entities are created for the regular and professional issuance, administration, redemption and transmission of electronic payment funds that can even use foreign currency, like a bank account without having all the functionality of a bank (more information here).
3. Innovative model or regulatory sandboxes
Although in FinTech there is still a lot to do, we can conclude that: (i) technology always comes before regulation; and (ii) it is always good to have a minimum viable product to go out and test your solutions in the market before investing millions of dollars in launching financial products or services to the general public.
Based on these premises, what is known as innovative model or Regulatory Sandbox is created, which in a basic way is the launch of financial products or services for which authorization, registration or concession is required by the financial regulator (more information here), which may operate under a determined period of time and in a controlled environment, being possible to request certain exclusions to the regulatory framework.
4. Virtual assets
Our regulation defined as a virtual asset the representation of value registered electronically and used among the public as a means of payment for all types of legal acts and whose transfer can only be carried our through electronic means, thus detonating a world of possibilities and new regulation applicable to FinTech projects or traditional financial entities using Blockchain (more information here, including the legal framework for cryptocurrency exchange and other use cases of virtual assets).
5. APIs or Open Banking / Finance
The regulation contemplates the obligation for financial institutions to generate programming interfaces for applications developed or managed to share data and thus enable what is know as Open Finance or Open Banking (more information here).
Are there incentives to encourage investment in FinTech?
While it is true that, together with AFICO, we have approached the tax regulator in order to find incentives to encourage investment in the creation of FinTech and in the massive use of their products and services, it is also true that to date there has been no response as they consider that there are other more pressing issues.
Notwithstanding the above, a strong incentive is the level of investment that angel investors, venture capital firms and other relevant actors are detonating in Mexico. Such has been the level of investment that a few months after having the first Mexican unicorn with a valuation of more than one billion dollars (more information here), exactly 7 months later, Kavak quadrupled its valuation reaching 4 Billion Dollars (more information here) sending a powerful message to the world.
Why is Mexico a fertile ground for FinTech?
As if the millions of dollars in investment were not enough, Mexico is a country with a population of more than 126 million people that includes a demographic bonus led by generation Z and Millennials full of people of productive age, of which 56% have a financial product, 52% a payroll account and 36% a savings account, which represents low levels of financial inclusion, as well as multiple segments of the population whose financial needs are not met by traditional banking.
In addition, Mexico has one of the highest bank asset concentration indexes in Latin America, where only 5 institutions control the financial destiny of millions. In the words of our economic competition regulator, COFECE, this concentration is the result of market failures and restrictions to competition generated by the overregulation of the financial sector, which brought about a disincentive in financial inclusion, creating barriers that seemed to be insurmountable... (more information here).
Given the above scenario, Mexico presents the ideal conditions to generate the perfect FinTech breeding ground since 80% of its population has smartphones and 95% of these have internet access (more information here).
From our perspective, the future of FinTech entrepreneurship is definitely being written in Mexico.
What progress has been made and what's next?
We must accept it, the FinTech Law is not perfect, but from our perspective it does allow us to generate innovation in the Mexican financial system, while controlling the possible risks that could arise.
While it is true that, to date, some FinTech have decided to withdraw from the process and others have been rejected by the financial regulator, it is also true that there are already dozens of authorized FinTech (more information here) that are growing and doing very well. Some of our clients have already submitted authorization processes to have what could be the first financial institutions in Mexico to work with stablecoins (more information here) and bitcoin, something that seemed completely impossible and that is beginning to arouse the interest of the traditional sector. So, we will watch with expectation what continues to happen.
We will definitely have to make an evaluation for the effects of the FinTech Law on the industry and whether the principles and ideals to which the explanatory memorandum of the law aspired have been achieved, and only time will tell.
Notwithstanding the above, the numbers are clear as FinTech are growing in Mexico 50% compared to 20% worldwide (more information here), from 2017 to 2019 FinTech app downloads grew by 145% and even beat any app in the traditional financial sector (more information here), also since the publication of the FinTech Law the sector has had a growth of more than 90% (more information here).
What have been the impacts of Covid-19 on FinTech in Mexico?
As we well know, the harsh and crushing "new reality" imposed by Covid-19 changed everyone's plans, including those that the financial regulator had for the attention of the process of various applications that startups from the Mexican FinTech ecosystem submitted. The processes that in theory should have lasted around 6 months ended up extending up to two years.
Nevertheless, from our perspective, the balance has been good because it has allowed the financial regulator to go deeper into the analysis of the different files and the startups to go through an intensive process of professionalization in order to be ready for the challenges of playing in the big leagues.
In addition, we have witnessed the unprecedented growth that "healthy distance" has triggered in the use of FinTech. It is noteworthy that some of our clients have grown during the pandemic what they had projected in up to 5 years.
Does Mexico have cybersecurity and personal data protection regulations applicable to FinTech?
Yes, México has strong regulation for cybersecurity issues (more information here) and even for personal data protection where fines for non-compliance are the highest in the Mexican regulatory system after economic competition.
What is the status of collaboration between the FinTech ecosystem and traditional financial institutions?
At Legal Paradox® we have observed that traditional financial institutions, or incumbents, have gone from observing FinTech to actively entering into strategic alliances, but who better that the protagonist of the story to tell you their perspective.
Angélica Arana, Director of Architecture Governance at Grupo Financiero Banorte:
“In my opinion, FinTech have undoubtedly disrupted the financial sector, challenging the status quo of traditional financial institutions. FinTech companies have come together to cover needs that had been neglected for a long time, both for the population that had never had a financial product, as well as for those that did have one, but had to adapt to the offer of existing financial services and products, even if they were not entirely suitable for them.
In this sense, competition is healthy in any sector and the financial sector is no exception as it challenges financial institutions that have existed for many years to improve the experience and meet the needs of their customers. In this maelstrom, they have realized that they will never have the agility of a FinTech but they have experience and strength. And therefore, it makes sense to collaborate with this new boiling ecosystem that FinTech represent, which is why very interesting synergies have been made between FinTech and banks, insurance companies, etc., and with very good results. We will continue to see alliances and collaborations of great value not only for the entities involved but also for us as users of financial services with more variety and better products, and we will also be able to have a greater reach in the financial inclusion of the population.
I am optimistic about this pairing between FinTech and incumbent financial institutions, I consider it healthy for the financial sector and I am sure we will see a very interesting reconfiguration of the sector due to this disruption brought about by the collaboration.”
Martin Mexia Ponce, Head of Rappipay Mexico: “I think the relationship between FinTech and incumbents can be divided into 4 different sectors depending on the incumbent and its strategy:
1) There are several incumbents that believe that there is no need for FinTech and that everything a FinTech does they can do better. They may have some investment or acquisition strategy around FinTech, but in the end their goal is to create everything themselves.
2) The second type of incumbents are those who truly believe in the disruptive power that FinTech possess and are always thinking about how to use the knowledge and technology that FinTech have to gain an advantage over the competition.
3) There are also the incumbents who see themselves as enablers of the ecosystem, in this sector you can find those who collaborate very closely with FinTech (because the business model allows it, revenue sharing as an example) and those who see FinTech as just another corporate customer.
4) And of course there are the incumbents who are still far behind and have no idea how to react to this new wave of competition.
In Mexico I do believe that we have these 4 types of incumbents and fortunately more and more are fluctuating towards number 2 and 3. Understanding that FinTech is a force to be reckoned with and that working together is the best strategy. I do believe that the FinTech Law forded us to this "collaboration" since in some cases to be able to work we must have an incumbent behind us, which allows in one way or another to create a business case around FinTech.”
Felipe Vallejo Dabdoub, Head of Risk and Corporate Affairs at Bitso: “Although the perspective and operating environment of both entities is different, the collaboration between the traditional financial sector and the FinTech sector has great potential. Both are entities that face, for the most part, the same type of challenges and are trying to solve the same problems. Being regulated participants, private sector coordination must be uniform in order to make collaboration more efficient in different aspects, especially when it comes to the regulatory changes and legal frameworks of the financial system that we will have to adapt to the use of new technologies. A level playing filed could mean a modern regulatory floor for different parts of the financial sector in Mexico in favor of users”
Amanda Jacobson, Chief of Staff at Oyster Financial: “Many FinTech don't hate banks. At Oyster, we believe that collaboration and free competition between banks and FinTech is key to ensuring that Mexicans receive the best possible products. It is easy for a FinTech to say that banks are the bad guys and that the only option is to switch to a new solution. However, the reality is that we all have to complement each other and push each other to provide the best possible service to make real and lasting progress.”
Cristina Cacho Caamaño, Chief Revenue Officer at Kueski: "Traditional banking is increasingly understanding the purpose of FinTech, and in that sense we will be seeing much more alliances that allow us to continue looking for strategies at both government and private levels to discourage the use of cash and propose much more secure and effective solutions, mainly in tax issues.
Both industries are improving our authentication and identity validation methods to guarantee much more secure and user-friendly processes. Undoubtedly, banking and FinTech are allies who are looking for ways to increase the level of bankarization of Mexicans that the country currently has."
What are the consequences of the FinTech Law for traditional financial institutions?
In addition to a healthy and desirable competition that will eventually lead to cheaper financial products and services, with the corresponding decrease in their profits, the more than 5,000 financial entities in Mexico will be obliged to open their data to generate the so-called Open Finance (more information here).
What is the financial regulator doing to boost innovation in the sector?
From our perspective, the financial regulator has done its best to achieve disruptive innovation in the financial sector. While it is true, they are always concerned about how to control related risks, they have also conveyed to us a propositional vision for the FinTech world.
On the other hand, the financial regulator itself promoted the first innovation contest in the financial sector, the SandBox Challenge, of which Legal Paradox® was proud sponsor (more information here).
Are there imminent risks for the growth of the FinTech sector in Mexico?
Who better to comment on this point than some of the most relevant players in the sector:
Vicente Fenoll, founder of Kubo Financiero: “I believe that there are risks and also great opportunities: on the risk side, there are still many FinTech to be authorized, and the value offer between them is not very differentiated. On the other hand, the opportunities are seen in segments of companies that can be very specialized in payment problems and information management in a very particular way to market segments such as SMEs and new entrepreneurs”.
Gerardo Obregón, founder of Prestadero: “A potential risk could be the lack of flexibility in regulation, so that authorized FinTech companies can innovate new products, new sources of income, or new processes within the current regulatory framework”.
Felipe Vallejo Dabdoub, Head of Risk and Corporate Affairs at Bitso: “One of the main risks facing the FinTech sector is the lack of certainty. The speed with which consumers are adopting and using new technologies is unprecedent. However, it must be considered that legal and regulatory changes for these entities, which are mostly small and medium-sized companies, can mean life or death. The ability to adapt to regulatory changes diminishes the agility of FinTech, limits the range of services they can offer in their business plans and could mean the loss of viability of many operating schemes. It is extremely important that companies find and environment that protects consumers and users of the financial system, but also encourages innovation and allows entrepreneurs to explore new products and services.
Applying traditional financial rules to innovative schemes generates all kinds of problems, which is why it is important to take advantage of the FinTech juncture to modernize rules and supervisions schemes.”
Adalberto Flores Ochoa, CEO at Kueski: "Although the FinTech landscape in Mexico is very encouraging, it is the management of each of them that will determine their success. The companies that manage to better meet the needs of users and with good execution are the ones that will have a major impact on the industry.
Just because some FinTech do not succeed does not mean that they will have a limited impact on the ecosystem. Rather, a limited number of FinTech will have a major impact on the financial ecosystem"
Is it possible to apply exponential technologies such as Blockchain and Artificial Intelligence to FinTech in Mexico?
Let´s remember that the FinTech Law is built under a principle of technological neutrality so of course the use of exponential technologies such as Blockchain and Artificial Intelligence is possible.
On the other hand, the very definition of an innovative model, or regulatory sandbox, contemplates that this occurs when the provision of financial services uses technological tools or means with modalities different from those existing in the market at the time the authorization was granted, in that sense any new technology that implies a change in the modality of the provision of the financial service may be applicable.
For all the above, it seems to us that the collaborative attitude between the public sector and FinTech must continue as we will definitely continue to see results and lessons learned on how to recalibrate the secondary regulation.
Accept it, FinTech is here to stay and little by little we will be permeating every corner of the Mexican financial system, are you ready? I hope you are, because we are going for all.
Finally, we appreciate the valuable time of all the people who gave us their opinion during the preparation of this guide.
Legal Paradox® is a 100% Mexican law firm focused on the FinTech & Blockchain sector.
Our challenge is to empower the sector. When we started, FinTech & Blockchain were not concepts of reference in the country; therefore, day by day we have pursued this mission and thus we have generated a change in the Mexican financial world. Since the creation of this firm in June 2017, we have worked hand in hand with more than 200 companies in the sector, that is, more than 30% of those existing in the country.
In less than 2 years we were recognized by Chambers & Partners as part of the legal FinTech elite in Mexico. These results are due to the fact that we base our operation on technology, even working on our own developments such as the FinTech Tour map and Parabot, an artificial intelligence-based assistant that aims to help a person or company find FinTech solutions.
Our deep understanding of technology has led us to find out how it is possible to achieve innovative disruption in the financial sector, which is why our clients recommend us mainly for understanding their business and even empowering it.
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