What is the Future of the Fin-Tech/Regulator Partnership?

In the last decade, the CFPB has tried to tackle the question of innovation through partnerships and No-Action Letters. First, there was Project Catalyst which resulted in very few collaborations and a small amount of No-Action Letters. Then there was the Office of Innovation which stood up the Compliance Assistance Sandbox which approved only 3 applications. Now the newly re-tooled Office of Competition and Innovation looks to continue these innovation partnerships but will it succeed? Nat Hoopes, VP and Head of Public Policy and Regulatory Affairs at Upstart stops by #creditecotogo to talk about the challenges of a regulatory partnership. While a No-Action Letter can offer a fintech or financial services entity an opportunity to “innovate in plain sight”, the time and available resources may not be attractive to many companies. For Upstart, the experience and collaboration with the CFPB was very positive but others may see that the juice is not worth the squeeze. 

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DISCLAIMER – No information contained in this Podcast or on this Website shall constitute financial, investment, legal and/or other professional advice and that no professional relationship of any kind is created between you and podcast host, the guests or Clark Hill PLC. You are urged to speak with your financial, investment, or legal advisors before making any investment or legal decisions.

Transcript

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Hello and welcome to another episode of Clark Hill's Credit Eco2Go, curbside thought leadership for financial services. My name is Joanne Needleman and I am a partner at Clark Hill as well as a member of the firm's banking and financial services practice group. The partnership of fintechs and regulators has been a daunting courtship. On paper it makes sense, uh, but sometimes... So we have to see whether the marriage is really going to work. Um, my guest today is Nat Hoops, VP and Head of Public Policy and Regulatory Affairs at Upstart. Prior to Upstart, Nat was the Executive Director of the American FinTech Council. Formerly known as the Marketplace Lending Association. And prior to that, Nat was the Executive Director of the Financial Services Forum, whose members are the CEOs of the largest financial institutions headquartered in the United States. Um, Nat, good morning and thanks for coming on to Credite Go2Go. Thanks, Joanne. You're happy to be here. We're thrilled to have you here. So, you know, upstart was the first company to receive a no action letter from the CCFs p v back in, uh, 2017. So I'd love you to talk a little bit about the brief history of your participation with the C Fs p V and the no Action Letter program. Sure. Yeah, well, it predates my time at upstart, but I was leading Marketplace Lending Association, which represented upstart in D. C. And, you know, really, um, I think it was an attempt to ensure that regulators can, uh, come along with some of the innovation that's happening out there in A. I. As it as it relates to consumer credit and, um, The use of alternative data to expand access, uh, to consumers who previously been shut out. And so, you know, when you're on the side of innovation, there's only, you know, so many ways that you can ensure that, um, the people that you know, uh, are going to be across the table from you in government are knowledgeable about what you do. And, uh, the no action letter was certainly an attempt, um, under, uh, you started under director Richard Cordray administration. To give that opportunity for companies to come and work directly alongside regulators as they work to sort of conform new technologies to old laws. Right. And, but Dodd Frank mandated the no action letter program. Correct. Yep. Yeah. It was, it was set up, you know, it was then under Project Cat, known as Project Catalyst. Yep. And yeah, it was, it was established again as a way to encourage people rather than. Kind of go innovate in the shadows and then wait until you get whacked, uh, by a regulator. But instead it was sort of, you know, innovate in plain sight, uh, right along with the regulator where people can start to understand the way, um, that government expects innovators to try to comply with old laws. And then similarly, um, you know, innovators can show government the potential value of some of these new technologies. Right. So talk a little bit about your partnership because, I mean, look, the Bureau was stood up in 20, uh, 2012, um, and, but it took a while, uh, for them to get Project Catalyst off the ground. Now, clearly there were other more significant priorities like mortgage crisis that they had and we all get that. But, you know, they did get Project Catalyst off the ground. But it really took them till 2017, you know, to, to issue their first no action letter to, to upstart. And I know it predates you, but if you can talk a little bit about what that partnership and collaboration looks like. Yeah. So, uh, you know, I think it was really to bring, um, a lot of the advanced testing tools under the equal credit opportunity act, uh, that you saying, Hey, we're going to be using a lot more data and, uh, New math and A. I. To evaluate consumer credit. And by doing so, we can unlock credit for a lot of people who fall below the sort of traditional definition of prime at but at prime rates. So rather than having to charge people who have, you know, 6 20 credit scores, an arm and a leg for credit, you could charge them. If they really don't present more risk than somebody with 710. It's just simply the, the way the credit score algorithm math works. And we sort of felt like that technology was old. Um, but when you're going to use new data and new tools, a lot of people are going to kind of raise eyebrows and say, well, how do you make sure that you're going to be compliant? And so, all right, I think the idea at Upstart was we'll go directly and work with the CFPB, do the fair lending testing with them, run the diagnostics that they want to see run. And try to kind of show the value add and then also show, you know, what is compliance look like for these new, you know, data sources and technology when it comes to that one law equal credit opportunity act. And so we work directly with the office of innovation. The office of fair lending was obviously, um. You know, also involved, and, um, they, uh, you know, after a couple of years published results in 2019 on how is this going, uh, in terms of consumer access. Now, those results were upstarts tests. So one of the, I would say, you know, challenges of the whole process is the ability. Of the Bureau to kind of or any government agency to kind of validate to, you know, themselves to independently validate or a test to the technology or, or the, you know, the proof points. Um, and so that, I think. Ultimately became just 1 of the things that was tricky for the Bureau over time was making sure that operating in this program didn't mean that. That upstart or any other no action there ended up being six or seven no action letter participants were sort of endorsed by the Bureau or validated or right left, right last. And so, you know, it was very, it was a, it was a really careful, you know, we always try to speak about it very carefully. The Bureau was always very careful to say, you know, this isn't endorsed or validated by us. Right. But, um, at the same time, I think. For our company's development, I do think that it was significant in that it showed a willingness to be transparent with the government that we felt confident in our own fair lending, testing and financial inclusion numbers enough to go share them directly with the CFPB and to work directly. So I think it was that sort of that it was more that in talking to partners that made them feel confident bank partners, credit union partners say, okay, you know, this is great that you, um. You know, are you sort of stand behind your numbers enough that you're willing to go share with the CFPB. So, right, right. You know, you saw a couple weeks ago. I was actually like the beginning of May. Uh, the Bureau issued, um, you know, they're issuing a lot of guidance. They're making a lot of statements and it was about trying to, they called it, you know, defending the algorithms in the black box. Um, do you think that any of that came from the research and the partnership that That they had with upstart and I'm not trying to say that it's targeting upstart, but you know this whole idea of A fair lending around algorithms has been a real issue for the bureau for a long time I will tell you when I sat on the advisory board that was a big topic and that was going back 20 almost 2017 20 2016 2017 Yeah, I would say that it's been a focus, um, in part because, uh, FICO is an algorithm, right? And they, you know, now vantage score has come up, which is an effort by the three bureaus to have their own score. But the bottom line is that, um, there's an enormous amount of inequality. In credit scoring, obviously there's underlying inequality and wealth and stemming from, you know, the history of, uh, you know, our country's unfortunate, you know, racial prejudice and, and, you know, going all the way back, uh, based on structural racism. But the reality is that, um, you know, credit scoring, uh. Again, is an older technology. And so I think the Bureau has used the work with upstart to kind of inform itself about. Okay. We kind of know a lot about the problems underlying. Um, the existing algorithms and FICO and the problems there with, you know, financial institutions, not really, really doing a lot of diligence on how the FICO score is created, right? That's not a government. That's not a government score. It's not a government blessed score. It is. You know, sort of embedded within the GSEs in the mortgage space, um, but it isn't sort of given any kind of safe harbors. We kind of know that, you know, we had kind of understand that set of problems and and now the work with upstart can kind of help us understand a little bit more about where. If, you know, if it were to go off the rails or not be done carefully and tested carefully, here's where you could see problems with AI and so forth. So I would say that it has been, it was sort of mutually informative. Um, it certainly helped us develop what we think is a best in class. Um, You know, compliance program. Um, a best in class, you know, uh, work around fair lending. Um, you know, we just do more testing. We test every loan. Um, we really, you know, kind of harness technology itself to improve. Um, and make testing more fair lending, testing more rigorous and more comprehensive than I think traditionally has been done in, in, in financial services and in lending. So, um, I think it was mutually beneficial, but again, I think 1 of the challenges that that always permeated it was to make it clear that that there is no endorsed operating under no action letter is all about willingness to share and transparency back and forth. But it isn't some, some sort of a. So it's a good segue to what, you know, I think my next question is, is that, you know, the Bureau has been stood up for a decade. Um, there's only been six or seven no action letters. Uh, Kathy Kraninger started, uh, with the office of innovation to have someone of a What they call Compliance Assistance Sandbox, but I don't think that there's been many people accepted into that program. There may have been one regarding some housing counseling with Bank of America. What do you see as the challenges? I know you talked about. Um, you know, this whole issue of endorsement, but it doesn't seem that even with that, people are embracing the opportunity of doing these kind of innovation labs, tech sprints or, or anything like that. What has been the challenge, especially with the CFPB in getting people to come in and partner with them on these types of projects? Yeah, I, I don't know, you know, it's hard because I don't know that we really have a baseline of how much we should expect. Right people to participate in some ways, you know, like I know that the F D I C tech sprints have gotten participation. The ccf p b did get six or seven no action letters. So I don't know that they ever envisioned, you know, issuing a hundred right. Of these things. Right. So I, so in some ways I think it's kind of hard to know where the measuring stick is for, you know, this is success or this isn't. That said, I think one of the things in the US that's been hard is the, um, Fragmented regulatory system, and it was something that that, you know, when I was on Capitol Hill, we did try to address in Dodd Frank, but it didn't end up, you know, sort of as much as much headway as I think we would have liked. But the bottom line is, you know, if you're, if you're working with. You know, 1 agency, you still have. So, if you like, say, you're working with the CFPB, you still have the prudential regulators. Um, you know, whoever is the primary prudential regulator for, for the regulated entity, then you, on top of it, you might have the FTC and then you have the states. And so, you know, you don't, I think that it can become. An awful lot of noise, and it's a resource issue. So how many of these different things can you participate in? And and given that it's so fragmented, where are you going to get the bang for the buck? Right? So, so I think overall, all of the innovation. Efforts. I mean, I think that Beth Knickerbocker at the O. C. C. has done terrific work with the O. C. C. and they've done, you know, I think that the office of innovation at the C. F. P. B. has done fantastic work. So there has been great work done. I think as a large scale mechanism for kind of a new form of compliance for innovation. I don't think that no action letters or sort of related sandboxes have kind of Yeah, Become a scalable way of doing that, where, where everybody who operates in a certain market chooses to kind of operate in some sort of a sharing transparent sharing arrangement where everybody knows exactly how their numbers are, and, you know, there's some sort of a cutoff line where if you, you know, you remain in compliance like that would take new rule writing and so forth. So, um, yeah, I think that that's That's the truth of the matter. But overall, um, it's a tough, it's not an easy, it's not an easy, uh, challenge to solve of, of how do you, how do you make innovators feel like they are in touch enough with government to know that they can remain on the right side of the expectations, but at the same time provide them the incentive to do a lot more work than their peers. Right. And, and we certainly saw that, that it was a significant resource. Intensive effort for us, for, for us at upstart, the, all the work with the C F P B. Right? Right. And it's, it's hard to see what comes out on the other side putting in all that time. What, what's your r o i with all of this? Right? It, it's and I don't mean that in dollars and cents, but it's gotta mean something to the, to the entity. I think it can be helpful. I do think it can be helpful in the development of a new market or a new industry to show that this is not, That this is not a black box or a sort of innovation in the shadows that this isn't something that we kind of have to whisper about that that we're doing this. This is something that, um, you know, really, I think the numbers are pretty compelling. We can approve 30 to 40 percent more minority borrowers, um, at 15 to 20 percent lower APRs. And so the banks that are using our technology are not just making incremental gains, like, Oh, you know, we, we managed around the margins to approve a few more minorities than we used to, like, you can, you can kind of potentially throw out the old FICO dominated models and use admittedly a more complex AI model, but you get massive gains when it comes to the ability to be inclusive. Um, and so that's the kind of the thing that if, if the CFPB had never been inside of. Seeing that work. I don't know that that, you know, we would have made as much progress as we've made with now we have, you know, 60 plus lending partners using the, um, the technology and so forth. Well, that's great. That's great. So, you know, to kind of round out this conversation, uh, About a couple of weeks ago, it's been on its hair with a lot of announcements, by the way. Um, so the Office of Innovation is now called the Office of Competition and Innovation. And, um, in the press release or in the materials that they have put out, you know, Director Chopra said he wants to, uh, he said that He felt that the no action letters and what has already been stood up was ineffective. That's quoting him. Um, and he wants to focus more on competition. Now that doesn't surprise me because he's coming from the FTC, which has always been focused on fairness and antitrust and competition. But, you know, I think that his statement about ineffective, you know, listening to you, It doesn't sound like your relationship was ineffective, um, you know, where do you think, what do you think this new office and under this new policy, what they ultimately want to achieve? I, let me just add, I was surprised to also see saying a statement where he said, well, you know, we, we want to innovate, but really. We, you know, we want you to file petition for rulemaking that that we think will be the best way Uh to spawn innovation and competition and I don't necessarily know if I agree with that. I'm interested in your thoughts Yeah, I I do think that the uh, focus on competition could be really good for innovation, right? Right Uh, there are large, um, you know, oligopolies, monopolies across financial services. Um, you know, we already discussed FICO, one of them. Um, so anything where the CFPB is really kind of digging into the underlying market dynamics and saying, well, what, why is it that That the sort of the whole credit ecosystem is beholden to this one three digit number, whether, whether the size of the loan is a 5, 000 personal loan, a 50, 000 auto loan, or a 500, 000 mortgage. It's like one number. It seems like I can imagine millions of people repay the first loan, but you would, you would not be 500, 000 mortgage, right? Like, so that, that, um, it seems as though, uh, it's an area ripe for. The CFPB to kind of look at like, well, what are the forces that are that are driving that kind of uniformity? Um, in in terms of the lines and and there's been recent progress, um, from the competition and credit scoring act, for instance, now, the are looking at alternative scores like vantage score. So it's starting to kind of happen. I do think that, um, so a focus on competition could be really healthy and helpful to innovation. Um, I think that the, uh, the, the CFPB is also, um, trying to kind of like crack down hard on what they're calling repeat offenders. So people who are kind of seen as so ubiquitous in the market that getting hammered with a really bad enforcement action or, you know, a situation where they've broken the law. Doesn't seem to hurt them. So, you know, there's there's sort of an emphasis, I think, on that of like, you can't be so big that that you're essentially your business isn't even damaged when when you operate outside of the bounds of law. So I think that can be helpful to the new entrants who kind of coming up haven't. Haven't don't have those kind of black marks on their record because they can kind of see like, look, we're, you know, give us a shot right to the consumer. They can say, give us a shot. We're not the one kind of on the right of the government. So, um, there can be the benefit. I think the petition for rulemaking is a little tricky because the CFPB has a really full agenda and a lot of these laws. You know, they're, they're not necessarily set up well, where, you know, oh, they're just going to provide you some kind of a clarity or bright line test of, you know, oh, if you just do X, Y, or Z, then you're, then you're, you know, compliant. And if you're not, that's, that's just not really the way that they were written. And it's not the way that, um, that, that CFPB would go, even though that's what industry would obviously like. Right. So, so that's, you know, and so I think instead, you know, what you're going to see. I do think the other thing you've seen with Chopra recently is the sort of focus on simplification, this idea that, okay, that the implementing regulations can combine with the interpretations are leading to these kind of weird, perverse consequences where people are not kind of taking what the spirit of the law was. And so I think that he definitely seems like there's an in addition to focus on competition. He seems like he's taking a fresh look at everything under the lens of like, well, what was the plain reading of this law? Like, what was it clearly intended to do? Right? And so, you know, that that could be another. Opportunity for for a reset. It probably can be, you know, a little scary for for a lot of the industry. If you've been sort of operating under one kind of framework for a long time of interpretation, and then you kind of say, well, wait a second, they're taking a fresh look at this law that was written in the 1960s or 70s or something. Well, I mean, but that's always been the problem. And I saw this recently with with regulation F. I mean, if you're trying to write regulations for statutes that are. 40 years old. And that's, that's an oil and water situation. I mean, it's just things that have happened 40 years ago are just not the way business is done now. If you can't go outside the parameters of the statute, I mean, you could, but ultimately you'll end up in a lot of litigation. Well, the other thing in the U S is it's really, it's even more important in some ways, because if you have a single regulator, Like in the UK, then you're kind of going to the same body for the implementation or the enforcement of it that you go to, you know, to petition for the writing of it, right? But in the case of the US, you know, you're going to see a law or regulation kind of potentially redrafted if you petition and then it's going to be interpreted by a G's and a whole host of other other actors. Right? So, you know, it's a little bit of a Um, I think people are probably going to feel that that idea of petitioning for whole new rulemaking, um, unless it's, you know, some area where technology has advanced, uh, where there's really clear, like, you know, opportunity. Um, but I think that you're going to probably see companies are going to be a little cautious about petitioning. At least the private sector is going to be cautious about petitioning for new rules. Yeah, I think so too. I mean, it just takes an awfully long time. It really, really does. And then there's challenges and it's just, you know, we like rules. We like, sometimes we'd like break lines, but we don't have the patience to get there, unfortunately. But, uh, Matt, well, this was a great conversation. It's so important. It's one that's certainly not going to go away. So I appreciate you taking a few moments of, I know you're very busy schedule to come on to the podcast. I certainly appreciate it. Let me, um, before you go. There's two questions I always ask my guests with every podcast, so hopefully you'll play along. Um, so when I first started the podcast, it'll be two years ago next week. Um, we were all sheltering in place, and it was a good way to connect with, uh, with folks, and find out what they were doing while they were sitting at home. Um, but now that we're, we're somewhat back to normal, which is good, um, I always ask, uh, my guests now, um, what are you doing? In the, what are you doing now that you would have done, but for COVID? Yeah, I, I thought about this question and I think the answer has got to be that, that we play. So I have three boys, nine, six, and four, and we play an awful lot of five card draw. And, and, and so like we play a lot of poker and I was never a big poker player and I like not a gambler, but I'll tell you like. It is a great way to occupy kids to play cards. So we like, especially in the winter months, we fire, we get the fire going and we sit around and play a lot of poker. So do we let mom come in? Mom comes in. Mom comes in. Yeah. Yeah. We have a new baby right now. So, so mom is kind of otherwise occupied at the current moment. But, uh, yeah, when mom comes in and plays the five card girl, my dad got, you got a whole big. Poker chip thing, like, you know, World Series, a poker case. So we have the chips gone and the whole thing. So that, that would not, that would not have, that would not be happening in the hoops house, absent the change in habits around COVID. Oh, that's great. I love that story. That is wonderful. Um, so the other thing we always do on the podcast in consideration of your time coming on to credit, decode to go, um, Initially when I started the podcast, it has a sort of a to go theme and this whole curbside because we're all ordering out and not being able to go to restaurants. But the other thing I also saw on the news, as I'm sure you did, was car lines for food. Like, when did that happen? In this country to have people lined up because there was no food was really something that it really resonated with me. And we started to, uh, Ask our guests to identify food banks or something that would help people help people with, you know, during the COVID crisis, um, to the extent that, you know, there was food shortages. And so we really supported a lot of food banks all over the country, you know, now with the. Thankfully, getting back to normal. I asked my guest to identify any organization helping anybody in your community that you have a affinity with. So I'm hoping you can identify one for us and let us know what they do. Yeah, sure. So, uh, I am a big golfer. So I, uh, I love the game and I think the first T of greater Washington does amazing work in the community. It's called the first T and it, and it really helps kids get started in golf. Um, food related, but it also helps them with life skills and education and there's tutoring involved. And so it's a wonderful way of kind of. Um, you know, bringing bringing communities together and giving kids an early start in a game that ends up being so important in the business world, the professional world. If you can play, it's a great kind of equalizer in the in the world. So, I, I do, I do love the first T of greater Washington. They do great work down here in D. C. And so anything you want to do for them will be great. Oh, that's wonderful. Great choice. We've had a couple similar type organizations. One was the Equestrian Center of Ivyville, which is outside of Philadelphia, which helps kids, uh, learn how to horseback ride. So, you know, anything that is You know, taking their mind off of, of, of all the other difficulties in the world, we, we fully appreciate. So, thank you for identifying them and, uh, we will absolutely make a donation on your behalf. Um, so, thank you again for coming onto the podcast and many thanks to our loyal Credit Eco2Go listeners for tuning in and logging on. All episodes of Credit Eco2Go can be found on Buzzsprout and Spotify. Information on our podcast can be found on my carkill. com bio page as well as on my LinkedIn page. If you'd like to be a guest on the show or have ideas for future show topics, please email us at creditecotogo at carkill. com. Thank you, be well, and stay safe. Thanks, Matt. Thanks, Brad. This podcast is intended for general education and informational purposes only and should not be regarded as either legal advice. or a legal opinion. You should not act upon or use this publication or any of its contents for any specific situation. Recipients are cautioned to obtain legal advice from their legal counsel with respect to any decision or course of action contemplated in a specific situation. Clark Hill PLC and its attorneys provide legal advice only after establishing an attorney client relationship through a written attorney client engagement agreement. 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