Fintech – The Israeli experience.
Zvi Gabbay, Dotan Baruch, David Gilinsky
Outside the USA, Israel is probably one of the leading, if not the leading jurisdiction globally for fintech startup companies that successfully raise funds and develop viable products that change the way financial services are delivered and managed.
Some numbers on Israeli Fintech
Global financial services companies are taking an increasing interest in Israel’s fintech sector – during 2018 to date, according to Start-Up Nation Central, a body that monitors the development of the Israeli startup sector, foreign investors have participated in 73% of all fund-raisings for fintech businesses, an increase from 66% in 2017.
As of the end of 2017, there were 475 active fintech startups in Israel, compared to 159 in 2012.
In the first half of 2018, 45 deals raised over $400 million - a sum more than a third higher than the amount raised last year. The median deal size has tripled over the last few years, such that it is now at US$30 million for late stage fund-raises.
Reasons for Israeli strength
Leading figures in the Israeli fintech and VC industry have noted a number of reasons why Israel has become so strong in this area.
Employees in Israel as a group have, on a relative basis when compared to their global peer group, a very high level of fundamental experience and knowledge in areas such as real time analytics, algorithmics, big data, risk management, anti-fraud and security. The country also has one of the highest usage of mobile electronic devices globally, and Israeli entrepreneurs have amassed significant experience in recent decades in online marketing knowledge and are now able to apply this experience to the fintech marketplace.
The fintech industry in general is still in relative infancy, and as such is still very much open to new initiatives and ground-breaking ventures, as the regulatory landscape is itself still open to discussion and has yet to be incorporated into a set of lengthy laws and regulations. If one combines this with the fact that the conventional financial services industry is ripe for disruptive efforts, you find that this industry is right up the alley of the Israeli entrepreneurs, as it allows them – and almost beckons them – to use their out of the box mode of thought in order to take this industry forward.
Indeed, the blockchain and cryptocurrency sector (including initial coin offerings) proves this exact point – a new and innovative technology that is used in order to attempt to provide a new manner of doing business. This has attracted a large number of Israelis seeking to use and exploit this technology in order to create and disseminate various ventures, products and services.
There is a legacy of successful companies in the field that has created a pool of experienced employees and entrepreneurs, a number of whom are now on their second or third startup in this field. However, the sector is so successful that it is now suffering from a lack of suitably qualified and experienced personnel. The sector is trying to address this challenge by encouraging more Arab and ultra-orthodox Israelis to enter the workforce in the sector, and by providing training, with the support of government, in suitable skills. Some parts of the sector are also seeking to obtain work permits for foreign workers to enter Israel in order to take up positions, and other companies have consciously targeted, and perhaps even been a catalyst for encouraging new immigrants from western and English speaking countries.
There are also many Israelis working abroad inside financial institutions or fintech businesses; some return to Israel and bring their insight and experience to bear on the local market, and the strength of the sector may be encouraging this phenomenon.
Israeli banks and insurers are involved in the sector, and over the years have supported the development of fintech businesses through investments, joint ventures, or by running accelerators and funds.
One of the key issues that any fintech venture needs to face is regulation. As many fintech ventures are disruptive and seek to turn the existing financial industries upside-down, they often face regulatory uncertainties or – in quite a few instances – legislation or regulators that do not contemplate or understand their business, or which prohibit their activities.
One of the key regulators in the Israeli market, inasmuch as it has to do with the fintech industry, is the Bank of Israel (the central bank) with its bank supervision unit. One of the goals of this unit is to preserve the stability of the Israeli banks. This, in turn, has caused the Bank of Israel to oppose some developments that sought to disrupt the current Israeli bank scene, including, by way of example, by refusing to substantially ease the capital requirements that are required in order to establish a bank, where it was sought to establish a cooperative bank and a digital bank. While the Bank of Israel allowed for a reduced initial capital levels in certain instances, the relaxation of the various regulatory requirements is still insufficient as it fails to take into account the technological developments and the need for banks that do not follow the regular and conservative way of doing business.Other regulators are more open to developments and new concepts, however. For instance, the Israeli Securities Authority championed a legislative process that regulated and licensed online financial trading conducted via an own account trading ring. While such legislation and regulations introduce rather lengthy and burdensome regulatory requirements, it has allowed for several entities to obtain licences and offer their products and services in the Israeli market.
Another example of the Israeli Securities Authority's willingness to embrace the fintech industry relates to formal guidance it published for licensed investment advisors and portfolio managers seeking to provide services via technological platforms. The Authority also promoted legislation that regulates crowdfunding – where the Authority sought to allow startups to be able to receive funding without running afoul of the securities legislation.
Another regulator that is considered pro fintech is the Capital, Insurance and Savings Authority, which a few months ago issued a clarification according to which carpooling does not require the issuing of an extension of the regular car insurance policy or the issuing of a new policy. While this does not relate directly to the fintech industry, it does show that this regulator is very much looking to have fintech ventures introduce digital developments; indeed, towards the end of 2017, this Authority held a hackathon in the spheres of insurance and pensions.
The Capital, Insurance and Savings Authority was also granted the responsibility for the oversight of p2p lending, as part of new legislation enacted – once again in order to respond to the needs of the society and in order to provide regulatory routes for such platforms and companies.
It is unclear whether this Authority will continue to act in this manner, given that the head of this Authority, who has been very active, left her role towards the end of 2018, and the stance of the new person at the helm is not yet clear.
Virtual currencies are regulated via the Financial Services Supervision Act, which, albeit very briefly, notes that virtual currencies are to be treated, for the purposes of that act, as a financial asset; this, in turn, may require a person that trades or holds virtual currencies to obtain a regulatory licence.
Naturally, the fintech industry faces "regular" regulatory issues that are faced by other industries as well. One of them relates to the issue of privacy and data protection, which is becoming an increasingly hot topic with regulators in recent years. In Europe, we have seen the implementation of GDPR, an EU wide law that imposes strict rules on how to handle personal data; this has an impact of Israeli startups as well, where the GDPR applies to them. In Israel also, the laws on Data Privacy have to be adhered to, with a recent new addition in May 2018 that sets the regulatory structure in connection with the protection of databases and the handling of breach events. For a small startup business it can be a challenge to keep up with these detailed laws and to implement them properly.
All of the above causes some Israeli fintech ventures to avoid offering their products and services in Israel, and to offer them in other jurisdictions instead. Thus, the modus operandi of quite a few of the fintech ventures in Israel is that while the entrepreneurs are located in Israel and the development of the products and services is done (at least partially) from Israel, the ventures aim for the world (and not the Israeli) markets. Israel could be a hotbed for their experiments, but it is the world that they wish to conquer. With the proper funding and regulatory acceptance, there is no doubt that this aim will be achieved.