The growth of fintech from being a niche handful of solutions around mobile payments to a global phenomenon has continued despite – and in some areas arguably because of – a simultaneous rise in economic and political uncertainty. Fintech is at its heart the use of technology, often in innovative ways, to provide financial services that are in some way “better.” These improvements can manifest themselves in greater speed or coverage of something that was already being done; or in providing financial services to customers who were previously unserved by the incumbent infrastructure; or, perhaps most interestingly, in providing financial services that were previously not carried out at all. The market for all these forms of “better” has continued, and we predict will continue, to expand globally; and the UK will continue to lead that expansion, despite some obvious risks. We set out below the factors that will help the UK to retain that leading position; the risks that threaten it; and other general trends that are likely to prevail in 2019.
Continued leadership and the reasons behind it
The UK is likely to retain its leading position as a fintech centre for a number of reasons. The UK has always been unusually well placed to act as a focal point for this type of innovation: it has large talent pools and embedded experience in both financial services and technology (both the “fin” and the “tech” sides of the equation); it has tax breaks for innovators and investors that encourage entrepreneurs to put their ideas into action; it has high penetration of internet and smartphone access; and an established and well-resourced incumbent financial sector that in many areas was due for a dramatic tech upgrade. These are just some of the reasons why the UK has managed to establish itself as one of the world’s leading hubs for fintech innovation and investment. Uncertainty over Brexit has led some to wonder whether it can retain that leading position, with issues such as passporting and immigration often being quoted as key factors. Despite these threats, fintech is likely to continue to grow in the UK, for the following reasons.
The first is the significant political will to maintain the UK’s position. This has manifested itself in a number of high profile initiatives that have been extremely effective in encouraging development and innovation. One such initiative is the significant work done by the Open Banking Implementation Entity, a body formed as a result of a market investigation carried out by the Competition and Markets Authority. It is governed by the CMA, includes and is funded by nine of the major retail banks, and has the mandate to create API standards and procure the building of working APIs to enable authorised fintechs to plug into the data stores and payment services of the banks. Whilst this provision of access is a requirement that falls on financial institutions in all EU Member States under the auspices of the Second Payment Services Directive, the UK now sits a long way ahead of other Member States in terms of making that access a practical reality: the creation and deployment of working APIs and standards, which has been achieved at considerable cost and effort by the banks, has not been matched in any other jurisdiction. This in turn means that fintechs operating in the open banking space are likely to continue to see the UK as a key destination to operate in, as the experience, structures and market penetration around it grow ahead of those in neighbouring countries.
Large incumbent financial institutions to engage with fintechs. The mindset of the major UK financial institutions has largely moved from seeing fintechs as disruptive threats, to seeing them as either helpful suppliers or revenue-generating partnership opportunities. This shift was neatly captured by the release of a set of guidelines (available here), published by the British Standards Institute in collaboration with five of the UK’s biggest banks and a number of leading start-ups, on the best ways for a fintech to engage with a financial institution. It reads like a survival handbook on how to navigate through the vagaries of a bank’s procurement processes and is to our knowledge the first initiative of its kind in the world. This was again the result of an essentially politically-facilitated effort by the Fintech Delivery Panel (which is itself run by the government’s Tech Nation programme) but would not have been possible were it not for the willingness of the banks to participate, and the body of knowledge and lessons they had already gathered over the past few years of burgeoning partnerships.
The third is the regulatory environment. The UK government is pursuing a Fintech Sector Strategy, which aims at removing barriers to market entry and growth for innovative firms by increasing competition in financial services. It hopes that in doing so it will be able to harness the benefits of fintech for ordinary people and for the many small businesses that form the backbone of the UK economy. At the central bank level, the Bank of England has established the Fintech Hub, which is tasked with exploring the policy implications of fintech, including how new technologies are being adopted and why. Most prominently, however, the Financial Conduct Authority has gone out of its way to engage with fintechs at all stages of development, and to facilitate engagement and pragmatic flows of information and advice, as well as the infrastructure to provide fintechs with a testbed for their innovations. The best example of this is the Regulatory Sandbox, established in 2016, which gives selected groups of fintechs an opportunity to test their services with real customers in a controlled environment, thereby smoothing the path to full authorisation and roll out, and providing the FCA itself with valuable insights into the innovation landscape. Other initiatives include the FCA’s Innovation Hub which helps firms to understand the regulatory framework and guides them through the application process; and a move towards creating machine-readable rules which could help to automate certain aspects of regulatory reporting. All these examples are evidence of the UK regulatory infrastructure recognising the difficulties for start-ups in breaking into established markets and taking practical steps to level the playing field and encourage growth in the sector.
Risks to the industry
The most obvious risks revolve in some way around Brexit. This is not least because of the uncertainty around what any new deal will look like (at the time of writing this is still a matter of ongoing debate) and the resultant hesitancy that this may bring for those looking to invest from abroad. We have not as yet seen a significant slowdown in the pace of innovation or investment – in fact if anything we have seen the reverse – but many of the potential shapes of deal, or in particular no deal, could well trigger one.
In the financial services sector more generally, one of the risks that Brexit certainly does pose is the loss of passporting rights across the EU. These emanate from the EU-wide framework that allows a financial services firm authorised in one Member State to provide services into another Member State without separate authorisation, and without having to have an established base of operations there. The loss of these rights has of course been of great concern to firms that operate internationally. However, the potential loss is perhaps not as significant to the fintech market as a whole, since a large proportion of fintechs either operate only domestically, or do not carry out regulated activities and therefore do not need authorisation at all. For those that do currently use passporting rights, it will undoubtedly mean additional cost and operational complexity, but arguably no more than if they were to make moves into other major markets such as the US.
A related risk is around regulatory divergence: if the UK ends up operating under different rules from the rest of Europe, then it will naturally be harder for businesses operating internationally to meet both sets of requirements, which could operate as a barrier to international expansion. As with passporting, this divergence would logically only affect the proportion of fintechs that operate across borders into mainland Europe, and the scale of the burden will again be similar to the burden of expanding into any other non-EU jurisdiction.
However, perhaps the most significant risk in real terms is around immigration. Access to talent is frequently cited as a key barrier to growth in fintech, as a wide range of advanced skills is often needed to build and scale such innovative business models, and the industry is heavily reliant on overseas talent: it is estimated that 28% of employees in the tech sector are from within the EEA, and 42% are from outside the UK – and even then experienced software engineers are in short supply. The concerns in this area fall into two distinct branches. The first is that if post-Brexit immigration policy does not adequately cater for the many and various skills that the industry requires, both in terms of the numbers allowed and the currently very high skills bar for obtaining a visa, then the industry will be left with skills gaps that cannot readily be filled domestically and these gaps will therefore stifle growth. The second is that, almost regardless of the numbers or skills criteria, if the process for obtaining a visa is too cumbersome, time-consuming or expensive, fintechs with little time or money will be dissuaded from or simply unable to get hold of the skills they need to grow effectively. Action is already being taken to deal with these issues (for instance an increase in the number of visas allowed under the Tier 1 Exceptional Talent programme). However, regulators need to continue to push for the expansion or removal of quotas and the implementation of streamlined processes that will allow the UK fintech industry to continue to flourish: “taking back control” of our borders could be highly counterproductive if it damages our competitive advantage in the process.
Trends into 2019 and beyond
Cryptocurrency and blockchain. The feverish excitement around anything with either “coin” or “chain” in the name has already started to be tempered by a healthy level of scepticism. This is marked by more thorough examination of the real benefits of blockchain against the practical and operational costs of implementing and operating it, be they the energy costs, the time lag or the implementation risk. The effects of economic Darwinism will continue to take hold – much to the chagrin of many participants in poorly constructed initial coin offerings – such that the blockchain and crypto projects remaining will be those that really do make use of the technological advantages that blockchain has to offer, rather than the vague panacea-like promises that have dominated so many headlines over the past few years. Regulatory intervention may well arrive at some point – not least as a result of the work of the Cryptoassets Taskforce which issued a report in October 2018; this is most likely to involve the extension of the regulatory perimeter to include some types of crypto-related activity.
Investment. Investment in fintech firms has continued in significant volumes, largely at the lower-level, early stage end of the market (as there are many new entrants). However, one noticeable trend is that the size of seed and Series A investments has increased in many instances, with Series A rounds happening at around the £10m to £15m mark rather than the more traditional £5m and lower level. This is likely a vote of confidence by investors in the ability of early stage companies with the right ideas, tech and people to break into the mainstream market; and an acknowledgement that such businesses are able to scale incredibly quickly – something which is helped greatly by the positive “environmental” factors outlined above.People and HR. As with other employers in the financial services space there will be a few things for fintechs to bear in mind over the next twelve months from a people perspective. Any fintech regulated by the FCA and operating under FSMA will be focusing on preparation for the implementation of the Senior Managers and Certification individual accountability regime - with work to be done on mapping across existing roles and accountabilities, assessments of fitness and propriety for intended senior managers and certified staff, and training at all levels. Separately, they are unlikely to escape the ongoing focus on culture and conduct led by the regulators and increasingly required by employees, government and society as a whole. #metoo, together with ongoing concerns at the under-representation of women in financial services and technology generally, continues to present a stark reminder of the need to address both recruitment and retention and the management of the working environment so as to minimise the risk of issues and claims.
2019 will also give fintech businesses time to review their workforce models and the basis on which they secure services from consultants and contractors. The Treasury has confirmed that from 2020 the current public sector IR35 model will apply to the private sector, placing responsibility for deducting tax and NI on the end user rather than the individual consultant when IR 35 applies. This is likely to increase hiring costs and lead to some re-evaluation as to the benefits of the contractor model more generally.
Data and open banking. The proliferation of data usage in financial services will continue, primarily but not exclusively through improvements in and further adoption of open banking, both within and outside the parameters of the Open Banking Implementation Entity project. In September 2019 the entry into force of the rules on strong customer authentication – which include an obligation to allow fintechs to use whatever authentication mechanisms a bank uses for itself – should boost the usability and therefore adoption of open banking solutions. We predict these will gain most traction first in the SME space before they become widely used by consumers, as the majority of solutions have so far focused on pain points for small businesses.
IP and patents. Whilst currently relatively limited, it is likely that the number of patent filings in relation to fintech will increase, as fintech companies become more savvy as to the ways they can protect the value in their solutions. The number of patent filings in relation to technology generally and software in particular has increased over the past few years, and correspondingly this is likely to take hold in fintech as well. Over time, this will increase the likelihood of patent litigation arising in the sector.
A further significant issue for fintechs is the risk of employees leaving a business and taking valuable IP or other commercially sensitive information with them. Young businesses are often not as careful in the way they guard their information with regard to their own employees, but in the early stages of a business that type of information is often one of the most valuable assets the business has. As the market continues to mature, the movement of employees between fintechs will become more common, and even the youngest businesses will need to make sure that they have their houses in order to prevent any damaging dilution of their competitive advantage.
Fintech for incumbents. We predict that 2019 will see big incumbent businesses continue to get involved in fintech. This will span not only financial services institutions – not just banks but also trading platforms and insurance companies – using technology more efficiently, partnering with fintechs and even getting new regulatory licences to engage in “fintech” activities. It will also involve big technology companies branching out into financial services of various kinds, not least retailers starting to take advantage of open banking structures to overhaul the processes they use to take payments.
Insurtech. The insurance industry is generally considered to be lagging behind banking and other areas of finance in its use of technology. However that is now finally starting to change, as more insurtech providers come to market and – more significantly – incumbent insurers start to engage in the process of updating their technology. There have already been some significant partnerships in this area; we foresee significant further development in 2019.
Digital identity. Digital identity is a growing theme, as the number and maturity of digital KYC providers increases and incumbent institutions and fintechs alike become more trusting of their solutions. This will not only be of great benefit to regulated businesses in decreasing the overhead and operational burden of manual KYC checks, thereby increasing their customer conversion rates; it is also likely to have a positive effect on financial inclusion, by making it easier for people not accustomed to traditional finance structures to sign up to app-based financial services. The Fifth Anti-Money Laundering Directive has recognised the use of an “electronic identification process” that is accepted by national authorities; further regulatory guidance in relation to the use of such solutions would be very welcome as a means of encouraging their further adoption.
Looking back to look forward. The UK’s fintech market is thriving, varied and fascinating. It has succeeded in becoming so largely because innovators, regulators and incumbents have learned from the mistakes and failings of the past and made changes to shape the future. By breaking down regulatory and commercial barriers to harness the power of technology, the fintech industry is bringing material benefits to businesses and individuals on a daily basis and contributing to the growth of the UK economy as a whole. Long may it continue.