Bright young companies who are subjected to decade-old rules may feel regulations are contrary to their stated aim: innovation and betterment of the markets. However, could there be an upside to fintech regulation?
Safety in regulation
Imagine a world without regulation. What would it look like, if we weren’t subjected to the principles, rules and frameworks to which we must adhere? Some industries would reduce our civilisation to a ruin of collapsing buildings from which men and women would flee, exhibiting symptoms of sudden hair loss and bouts of uncontrollable itching. Construction and pharma come to mind, but food manufacturing and energy aren’t far behind. Regulation is imposed to provide a minimum level of security to everyone who uses the services within its remit.
Financial services often consider themselves special, distinct from other sectors due to its cryptic acronyms and complex product range. But consider how fundamental it is to our everyday lives: retail payments are easier with cards (some pubs are simply refusing cash!1) and getting things like car insurance is starting to be a doddle. Even rarer financial events, like purchasing a home, are enabled by the structures of credit. In the absence of a minimum standard for banks and insurers to adhere to, might the high street turn into a wild west?
Fintech surge – white knight or dark horse?
It isn’t in the best interest of the financial services industry to amass any more notoriety. Trust in established players has already ebbed to unacceptable levels. I’ve written recently about the importance of self-regulation and how many firms are expanding real effort into increasing transparency and bolstering the integrity of markets. But new market entrants have been looked at with suspicion: they don’t have the same skin in the game. A disruptive technology disintermediating insurance brokers might be viewed as a dark horse – someone in it for the quick buck. What interest do such newcomers have to keep the conduct game clean? It turns out, all the interest in the world.
The more I speak to fintechs, the more I realise for many their ambition is couched beyond swift profit. It’s about making and doing things better. Better than they were before the technological disruption allowed the end users closer to the means of production and capital. Better from the perspective of both the individual and wider society. In addition to making life easier in the developed world, many fintechs are geared towards greater financial inclusion, making buying and selling of basic goods and services more reliable and physically safer in the developing world2. And though most of them are also concerned about making a profit, this sometimes feels like an additional puzzle to solve. After you’ve cracked the code on how to make a payments system faster and more reliable, imposing a transaction fee which will make the business a going concern but still make it more efficient and cheaper than the status quo, is almost a cherry on top. Almost. These tech-savvy firms also know the value of a disruptive idea.
World leading tools to support fintech innovation
The existing market practice has grown out of comparatively steady development. Regulation, almost by necessity, lags behind progress. How does the marketplace incorporate fintechs and their (re)thinking, when they can come across as disruptors and innovative in the extreme?
The threat posed to the existing players is not insignificant. The brokerage model is undermined if technology can do the job faster and cheaper, without tripping over itself when offering a service that clients want.
”The threat posed to the existing players is not insignificant. The brokerage model is undermined if technology can do the job faster and cheaper, without tripping over itself when offering a service that clients want.
The regulators themselves are new to this game. Despite the FCA’s Innovate team and its market-leading regulatory sandbox3, both geared towards supporting fintechs, many tech start-ups are left thinking whether financial services is the right industry to enter. The sector’s regulation is perceived as rigorous, the business models complex and barriers to entry remain high. Might it not be easier to work on machine learning in aspects of engineering, or deploy artificial intelligence strategies to solve optimisation problems in fast moving consumer goods?
What can fintechs do?
1. Get your head around the regulatory perimeter
The first step for a tech start-up is to learn about the regulatory landscape. After some initial research, it may well be worth speaking to a regulatory expert about how to set up a company to avoid bringing you under regulatory scrutiny.
In the UK, the Financial Conduct Authority (FCA) regulates firms in a ‘technology neutral’ manner. Meaning that: “the use of new technology alone does not alter how we consider it fits within the regulatory perimeter. However, while [the FCA’s] tech-neutrality means we’re agnostic about the type of technology used, the choice of technology may influence the way in which regulation applies. While the use of a certain technology won’t usually have an impact on the permissions the firm requires, it might have an impact on the unique risks associated with the carrying on of certain regulated activity”5.
In practice, this means that if a firm is engaging in activity defined as ‘within’ the regulatory perimeter, no matter the technology deployed, relevant permissions and authorisations must be sought. In a recent paper, the FCA set out this simple diagram below to represent the high-level activities falling within its regulatory perimeter for wholesale markets (and therefore requiring permissions/authorisations)6.
A brilliant idea executed without a sense of the regulatory perimeter could be the difference between a thriving solution to a market issue or a failed attempt to get a functioning MVP off the ground.
2. Don’t forget peer engagement
Every fintech should learn from wider market practice and interact with peers in a constructive manner. This can mean both their fintech peers – seeking counsel from those who have been there before. I would also challenge slightly more mature fintechs to engage with the with the broader industry.
ClauseMatch’s entry into the Investment Association7 is a case in point of how technology firms are having stronger links with other FS companies, beyond just their actual or potential clients. The regtech aiming at automating the entire regulatory lifecycle has been welcomed into the fold by peers and the trade body alike. ClauseMatch Sales VP, Carl-Henrik Thorsen, says that though some may resist the change, the industry is ripe for innovative platforms enabling firms to focus on their core activities. Fintechs more generally are moving from the role of the dark horse to that of the white knight, helping the industry renew itself.
3. Stick with it!
Finally, my advice would be to not give up at the first hurdle. Even if your new business idea does look like it might need to be authorised, the FCA’s regulatory sandbox is a great place to test your idea. Think deeply about the way your solution engages with the current infrastructure and the end users. Surround yourself with peers and advisors who can truly support you in the effort to inject a bit of constructive revolution into financial services.