These are exciting times for financial technology (fintech). As ComputerworldUK recently reported, there are currently more than 3,000 fintech start-ups, commanding $3 billion worth of investment.
These new firms naturally present new challenges to long-established financial services providers but it also provides new opportunities. First, these startups will force traditional financial companies to up their game and quicken the pace of their own digital transformations; secondly, they provide tempting targets for mergers and acquisition (M&A).
One problem facing both startups and acquiring companies is the perennial bugbear of the fintech industry: compliance. In all the excitement of building a new service or technology platform – which might not initially be considered as financial services-focused – dealing with financial services regulation is unlikely to be top of most people's to-do lists. In recent years, though, the UK has seen a rapid evolution in fintech, attracting the attention of the Financial Conduct Authority (FCA) and bringing an extra range of considerations for fintech businesses.
Although a technology startup may not see financial regulations as being particularly applicable to their business, they suddenly become extremely relevant if addressing questions at fundraising or buy-out time. That is why it is so important that, right from the early startup days and throughout the lifecycle of the business, technology entrepreneurs should be aiming to build a sustainable business model that complies with financial services regulation.
It is also crucial to understand how your target clients fit within regulations; the success of your business could depend on whether a product or service is compatible with your clients' regulatory obligations and provide efficiencies or enhancements.
What rules apply?
Determining if, and how, regulation applies to your fintech business is key. Checking the UK FCA's authorisation requirements at the outset allows you to adopt a framework that is effective today and flexible enough for the future. The UK regulates certain activities carried on in relation to a range of payment, investment, insurance and lending propositions which means, as a general rule, a fintech business needs to consider at an early stage whether it requires regulatory approval to conduct business in the UK. A surprising range of business models need regulatory approval to operate in the UK – even when they are not based in the UK.
The FCA's application process, if managed well, need not be overly complicated or intrusive. The typical authorisation timeframe with appropriate resources in place can comprise a six-week pre-submission preparation period, followed by a statutory post-submission period (of up to six months) for the FCA to consider the application.
Compliance needn’t hinder innovation
Authorisation brings firms within a range of rules and requirements about how their business is run. These issues are not unique to fintech businesses – the UK regulators generally intend their rules to be business model neutral.
The FCA, with its consumer protection objective, is particularly keen that firms can demonstrate they have a compliance culture at their core. Firms may feel the regulatory regime is uncertain with rules that are often perceived to be vague (and, therefore, difficult to comply with). But the outcomes-based theme to most UK regulation can actually benefit the fintech sector, as it leaves the door open for creativity and a new, proportionate approach to compliance.
What does compliance look like for fintech businesses?
The basic starting point has to be an intention to put consumer protection at the heart of your firm's approach and following the FCA's mantra of "doing the right thing". From this point the FCA expects the firms it regulates, even if small and entrepreneurial, to implement effective compliance policies and procedures.
In small entrepreneurial businesses, this might include:
- Ensuring the management team has the intention to comply with regulation, supported by appropriate training and systems and controls.
- Understanding how your services may cause unfair outcomes for consumers even if you do not have direct consumer interaction
- Designing an approach to sales and marketing activities which includes processes to review client communications for compliance with financial promotions requirements and to minimise mis-selling risks.
- Ensuring terms and conditions are fair and can be easily understood.
- Ensuring your complaints process meets FCA requirements.
- Setting a reward and incentives structure that does not encourage excessive risk.
- Regularly reviewing your systems and controls processes (e.g. to address risks from bribery and money laundering).
Responsibility and risks
Controlling legal and regulatory risk is the senior management's responsibility even in a small business. This means establishing the right environment and attitude to ensure the strategic aims of the business provide fair and sustainable outcomes for consumers.
While it is easy to baulk at the idea of compliance, the costs and drain on time of getting it wrong can be drastic for both businesses and individuals, which are likely to face a high degree of regulatory scrutiny; legal and regulatory sanctions, including personal prohibitions, criminal penalties, fines, restrictions on activities and business closure; adverse publicity and reputational damage; difficulty obtaining investment; and, potentially, failed M&A.
Influence the future
A really significant way to ensure that regulation develops in a proportionate way is to help set the regulatory agenda. Firms will want to consider influencing the UK's national policy and strategy towards fintech. In this vein, the FCA's Project Innovate is designed to encourage firms to bring innovation to the financial services market. This initiative captures the concept of sharing expertise and nurturing learning on a two-way basis.
In August 2014 George Osborne launched a new industry trade body, Innovate Finance, established to promote the interests of the UK's fintech sector. At the launch, the UK government announced initiatives to help fintech businesses prosper, with the intention of placing London and the UK at the forefront of a significant transformation in the provision of financial services.
As an example of continued development on this front, on 3 November 2014 HM Treasury released a call for action to help it assess the risks and benefits offered by digital currencies and the technology that underpins them. Feedback can be given by 3 December 2014.
The door is open for fintech
We believe there is an abundance of opportunity in this sector for innovative businesses. The way consumers interact with financial services products will change beyond all recognition in the years to come. Regulatory compliance has the potential to absorb management time and can be seen as a diversion from the core objectives of the business, but getting the culture right from the outset will pay dividends in the future.
Posted by Jonathan Rogers, partner in the Financial Services Regulatory group at Taylor Wessing LLP