June 12, 2020
The financial technology (Fintech) industry uses technology to support and enhance financial and banking services. Fintech businesses largely bypass the face-to-face interaction of traditional lenders through the use of technology – something that consumers will demand in increasing numbers in current and post-COVID-19 environment.
Although the Fintech market is rapidly growing in Canada, the industry is still relatively new. As such, the regulatory environment for Fintech businesses is fragmented and complex. There is no one single regulator or statute that governs Fintech companies, either federally or provincially. Navigating this regulatory environment can be challenging for new businesses and requires careful consideration.
Here are the top five legal considerations for tech startups thinking about entering Canada’s financial services industry.
1. Structure and Regulations
Before entering a new industry, a key consideration to take into account is how to structure your business and whether to incorporate it. If you choose to incorporate, one major factor to consider is whether to incorporate federally or provincially. Although there are benefits to choosing either jurisdiction, Fintech businesses will also have to consider whether their business operations require them to incorporate under specific statutes.
No matter where you incorporate, there is broad consumer protection legislation that may be applicable both provincially and federally. These statutes outline requirements that apply to certain consumer agreements and prohibit practices deemed “unfair” to consumers. In addition to the general consumer protection requirements, each province regulates or licenses certain businesses and industries that interact with consumers. Although these requirements differ slightly between provinces, most require businesses to be licensed if they deal with consumer credit and debt or act as lenders (without taking deposits). Many provinces, with some exceptions, also regulate payday lenders and require them to obtain payday lender licenses.
Foreign Fintech companies looking to enter the Canadian market should also consider the fact that federal incorporation and many provinces and territories require that at least some directors be Canadian.
2. Deposit-taking Entities
Financial institutions, including banks, trust, loan companies, and insurance companies tend to be federally-regulated. While Fintech businesses can often bypass the regulations imposed on traditional lenders, providing certain services will bring a Fintech business within this regulatory environment.
Fintech companies that carry on business as deposit-takers will be subjected to stricter regulations under the federal or provincial Loan and Trust Companies Acts, and possibly the Bank Act. Loan companies are deposit-taking corporations which receive deposits from the public and lend or invest those deposits; however, they are not legally considered banks. If you want to officially be considered a bank and offer banking services, you must be incorporated under the Bank Act. Once a Fintech business begins offering deposit-taking services they will need to become a federally regulated financial institution and apply to incorporate under either the Loan and Trust Companies Act or the Bank Act. The Office of the Superintendent of Financial Institutions (OSFI) regulates federally regulated financial institutions.
One major advantage of incorporating as a federally regulated financial institution is that your company is able to provide services that are prohibited from others, such as deposit-taking. In Canada, banks are considered highly trustworthy, in part because of the strict regulations that protect consumers. Thus, being able to refer to your business as a bank can be advantageous when marketing your services. Because many Canadians consider their banks stable, secure, and trustworthy, Fintech companies have been partnering with banks to provide innovative banking services to consumers.
There are also safeguards in place to help companies that choose to incorporate under these stricter regulations. OFSI assists banks with disaster recovery plans in conjunction with the Canada Deposit and Insurance Corporation (CDIC), the Bank of Canada, and the Canadian Department of Finance. The purpose of this intervention is to enable OFSI and, at times CDIC, to help identify issues earlier and work collaboratively with the bank to create a process that will allow the bank to be brought back into full compliance with the regulatory requirements. Another goal, where relevant, is to help strengthen the bank’s overall financial position.
The process to start a bank or loan company in Canada is much longer than regular incorporation. There are numerous regulatory requirements you must meet before opening a loan company or a bank in Canada. OSFI is responsible for the regulation of deposit-taking entities, including loan companies and banks. OFSI assesses applications for incorporation and makes recommendations to the Minister of Finance, who ultimately approves or denies the incorporation of a federally regulated financial institution. Fintech companies that wish to operate as federally regulated financial institutions will be required to meet specific criteria in order to be approved for incorporation under the applicable statute.
Once incorporated, there may be other restrictions on their activities. For example, a bank cannot carry on any business other than the business of banking and activities generally relating to banking. Banks have a limited capacity to deal in securities or to distribute insurance products. They are not permitted to act as trustees or engage in certain personal property leasing activities. The regulations include onerous reporting requirements as well. OFSI requires banks to submit a series of monthly, quarterly, and annual reports on a variety of matters to ensure compliance with the regulations.
If a Fintech company offers deposit-taking services, the company will be subjected to the same strict regulations as loan companies under the federal or provincial Loan and Trust Companies Acts. These detailed, strict regulations are set up to protect depositors and borrowers. Federally regulated financial institutions such as loan companies are required to maintain minimum levels of regulatory capital. These constraints can be more difficult to manage as a Fintech startup.
Finally, all federally regulated financial institutions that will be taking deposits are required to become members of CDIC. Loan companies cannot opt-out of CDIC. Companies may also be required to join the Canadian Payment Association (CPA). This membership is not optional for banks.
3. Securities Regulations
A Fintech business may need to comply with Canadian securities law requirements if:
Although these types of businesses may be subject to securities regulations, there are exemptions that may apply in certain situations and companies should engage with experienced legal counsel to familiarize themselves with the applicable exemptions and regulations.
4. Sandbox Programs
Sandbox programs, which allow Fintech companies to apply for exemptive relief from stricter regulations imposed on traditional financial businesses, have been implemented in many countries. In Canada, the Canadian Securities Administrators (CSA) has created the CSA Regulatory Sandbox initiative to support Fintech businesses looking to offer innovative products, services, and applications. Fintech businesses can apply to register and/or obtain exemptive relief from securities laws requirements through the Sandbox. The process through the Sandbox is faster and easier than the standard application. The focus is to encourage innovation in the Canadian Fintech market. Eligible applicants range from startups to well-established companies, as long as the business model is innovative from a Canadian market perspective.
5. Privacy Laws
Fintech businesses that are collecting, storing, or processing personal information must be mindful of Canada’s federal privacy laws, such as the Personal Information Protection and Electronic Documents Act (PIPEDA). PIPEDA sets out requirements for how businesses must handle the personal information they collect and process. PIPEDA applies to any private-sector organization that collects, uses, or discloses personal information in the course of commercial activity. It also applies to any business that operates in Canada and handles personal information that crosses provincial or national borders. Because of their online platforms, Fintech companies will need to pay special attention to whether they have obtained meaningful consent from their users to collect and process their personal information.
Every Fintech company subject to PIPEDA must also comply with the Digital Privacy Act (DPA). The DPA is a federal law that amends PIPEDA, mandating responses to data breaches. It includes requirements of reporting, notification, and record-keeping. These obligations are strict and onerous. In order to comply with these obligations, Fintech companies should create a compliance plan in advance to reduce potential liability and risks if a data breach occurs. Fintech businesses that deal with the collection, storing, and processing of personal information in the course of commercial activity should familiarize themselves with Canadian privacy laws in order to ensure compliance.
Please contact your McInnes Cooper lawyer or any member of our Startups & High Growth Companies Law Team @ McInnes Cooper to discuss this topic or any other legal issue.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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