UK-Wide: A FinTech Legal Overview

Who Is Who in the Zoo?

FinTech has traditionally revolved around certain core themes and industries, such as crowdfunding, robo-advice, payments and consumer finance. Traditionally, the UK has positioned itself well for these innovations, having a relatively trusted and robust legal system consisting of well-understood regulation and independent judiciary. This has given start-ups comfort that the UK is a safe place to do business. The reputation of the UK as a platform for innovation has been further enhanced by the Financial Conduct Authority’s sandbox initiative, the first of its kind globally, which enabled firms to work with the regulator to explore how new business models could be integrated into the existing regulatory framework. Operating in this environment, firms benefit from certainty and guidance whilst trialling innovative products and services in real time, and with end user consumers. This builds consumer confidence, enhancing protections from the outset (with regulatory oversight to manage risks as they develop), reducing time to market, and providing certainty for firms (which do not have to operate in a regulatory-free zone).

In relation to traditional FinTech, therefore, the UK is generally considered a market leader, and any changes tend to be minor tweaks to well-established rules that work.

New FinTech species unlocked: patch notes pending

However, the status quo rarely lasts long in FinTech, and in recent years the incumbent players have met two new areas of innovation in particular: AI and blockchain.

The growth of new technologies has been particularly interesting when looked at from the perspective of the UK financial services market. Traditionally, the UK benefited from its strong position in the global financial services sector. This has been to the benefit of FinTechs, as they have had the ability to leverage off the expertise of traditional finance, and indeed a buyout by traditional finance was often seen as a success exit for founders.

However, the relationship traditional finance has with respect to blockchain and AI has been somewhat trickier.

First, there is the recognition that these innovations are genuinely new – meaning that true knowledge about how they operate can be sparse. This is impacting, for example, outsourcing arrangements – particularly since outsourcing the operation of a function to a new technology generally does not allow outsourcing of the risks if that technology does not deliver as expected. This is therefore causing a need for all businesses to upskill on new technologies so that they understand what they are dealing with, as well as careful consideration as to who to partner with and how to contract with them.

From a more general regulatory perspective, the fact that many of the risks in relation to these new technologies are in some respects difficult to determine has led to a cautious approach – for example, in terms of narrowing the types of investors who can invest in certain crypto-assets and suggestions regarding limiting the widespread use of sterling-denominated systemic stablecoins. This is leading to workarounds – for example, setting up funds as intermediary wrappers to allow certain crypto products greater access to the UK market.

Shifting philosophies

A further issue that economies globally have faced, in addition to understanding these new technologies, is deciding on the best philosophy for regulating them.

Whilst most jurisdictions wish to achieve the twin aims of encouraging innovation while protecting consumers, how that is achieved is a matter of some debate – well demonstrated by the difference in approach between the EU and the USA. On the one hand, the EU takes the approach of regulate first – arguing that by being the innovator of new regulation, the EU reacts faster to protect consumers and companies gain the advantage of having a set framework to work within. On the other hand, the USA takes in innovation first, arguing that it is best to allow unregulated innovation, and then to step in if things go wrong.

Between these two philosophies, the UK can be seen as still working out its position. The early approach has been closely aligned with the EU, in particular with respect to the focus of both jurisdictions on regulating the AML/KYC aspects of crypto-assets. However, more recently, the UK has taken an approach far more aligned with the USA, delaying specific AI regulation and explicitly stating that it wishes to align with the USA approach to stablecoin. In this respect, the UK has a very interesting role, being bound to neither approach yet incentivised to follow that which is best for the UK economy overall.

It’s a small world after all

In working out its position, the UK is by no means in isolation. Indeed, the FCA has entered into various agreements with overseas regulators, showing the FCA to be at the heart of the global approach to new FinTech industries. Indeed, we are seeing a high level of global co-ordination through networks such as the Global Financial Innovation Network, which is led and chaired by the FCA, meaning that the UK approach to FinTech has a relatively high degree of co-ordination with other jurisdictions. This is important since, to the extent that the UK aligns with the approach of other jurisdictions, firms operating in those jurisdictions will more easily be able to expand into the UK market and vice versa.

From a global perspective, therefore, the position of the UK in helping shape the approach to FinTech on the global stage is positive. It means that there is less scope for potential bad actors to switch jurisdiction simply as a means of breaking regulatory protections. It also means that, given the multinational nature of FinTech, there is an easier path towards better outcomes. Nowhere is this clearer than in the example of insolvency, where a multinational group going insolvent can trigger the need for practitioners across a range of jurisdictions – and, in the event that an insolvency becomes complicated, the only winners are the practitioners getting fees for advising on the insolvency.

Watch out for tigers…

Of course, the above assumes a generally linear path to development, and innovation is rarely linear. A recent example has been the ability of Web3 firms to move subsidiaries outside the UK so that they can then resell into the UK on a cross-border basis without needing a licence. This triggered an alteration to the UK rules on financial promotions, to effectively block the selling of unregulated transferable and fungible crypto-assets into the UK without the relevant protections being in place. The scope of these rules has been ambitious, and it is interesting to see how the FCA is going about fighting the battle of getting firms to comply with the requirements – for example, by reminding payment services providers that supporting firms in breach is potentially a criminal offence.

More change is on the horizon, with quantum computing set to galvanise processing power. While this may well benefit the use of AI, the potential impact on security systems is more concerning. It does seem that the only certainty is uncertainty – however, those who embrace and understand the new world will be in a much stronger position than those who ignore it.