FinTech is easy to define: any technology that seeks to improve, enable and/or automate the delivery and use of financial services. But the precise origin of this portmanteau word is hard to pinpoint: Wells Fargo became the first bank to offer online accounts in 1995, PayPal launched in 1999, and Zopa became the world’s first peer-to-peer lending company in 2005 – regularly cited as a pivotal FinTech event.

And then there is crypto, which securely transfers assets by dispensing with intermediaries altogether thanks to blockchain technology. The Bitcoin network only came into existence in 2009. Some define the FinTech sector by including crypto; others do not – it depends whom you ask. In the crypto Venn diagram, although a large subset is FinTech, this does not apply universally. But what all FinTech companies have in common is a mission to challenge traditional financial services by providing a faster, often cheaper and invariably better service or product.

Unicorns everywhere

FinTech innovation has certainly developed apace – from new mobile payment technology such as Apple Pay and Google Wallet, to the use of AI and biometrics. Globally, there are now around 200 FinTech unicorns (valued at $1bn+), of which 20+ are UK-based, including Revolut, Wise, Monzo, Zego, and Starling Bank. Most have only achieved unicorn status in the past three years – an indicator of how nascent the sector is, and how far it has to go.

So where next? As technology drives FinTech forward, regulation sits firmly on the radar of every startup: despite their collective desire to disrupt, it is an inevitable sign of the sector’s maturity. Even though no UK or US regulations have yet exclusively targeted the sector, which is subject to existing financial services regulation, increased compliance and anticipation of new regulation take centre stage. ‘The problem that FinTechs have faced is not a lack of regulation, it’s an abundance of regulation which wasn’t written for FinTechs,’ says Emily Reid, who leads the FinTech practice at Hogan Lovells.

‘But that’s also been an opportunity for the more creative startups which have ensured that they understand the regulatory framework and then used innovative ideas to deliver a compliant service focused on the quality of the customer experience and the cost of delivery,’ she says. ‘That was the dream: to put those two things together and deliver a really compelling proposition that could be taken up widely.”

Starling flies

An exemplar of this approach is Starling Bank, a UK-based digital challenger bank that has no physical branches and serves customers via mobile banking apps. Starling has a possible IPO in its sights, potentially in late 2022 or early 2023, but when Matt Newman joined as general counsel in December 2015, the embryonic bank had only ten people. ‘It was like the Dutch football team used to be: total football,’ he says. ‘This was total law: everyone had to do everything. We weren’t a bank until July 2016 – the journey since has been one of expansion.’

Today, the legal team comprises nearly 20 lawyers while Starling has 1500+ employees. ‘We’ve developed a divisional structure because a lot more zeros have been added to everything,’ he explains. ‘Our CEO, Anne Boden, believes in lawyers; she loves lawyers.’ Starling’s main panel law firms include Linklaters, Norton Rose Fulbright and TLT.

Newman praises the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). ‘Working with regulators on processes and mechanics has been great,’ he says. ‘They were very helpful because FinTech is important for them, particularly in terms of competition from other financial centres. Early on, we were almost less of a risk to them from a financial perspective; we were more of a risk from a reputational perspective. But as we’ve grown, the level of scrutiny has become greater.’

On how UK FinTech regulation might develop, Newman is understandably circumspect. ‘I’m not going to profess to be a visionary,’ he says. ‘It’s hard to anticipate how things are going to impact us. By the time GDPR came in – they originally started talking about it in 2008 – but by 2018, we had a completely different infrastructure in terms of how we use the internet and digital systems. Now they’re starting to look at it again. Our drivers are all about customers and the customer experience, making them safe and giving them better banking in a number of ways. And UK regulation generally does a good job in supporting that.’

Advantages of regulation

Reid echoes the point. ‘Zopa was my first FinTech startup client,’ she says. ’Our focus was to enable them to launch entirely outside the regulatory perimeter, which we found a way to achieve. But they encountered problems of credibility, trust, and the lack of a level playing field. Rather than it being a great advantage to be unregulated, the general view turned out to be that regulation would actually help them. The UK is known for a regulatory environment that encourages entrepreneurialism, and that is also safe for consumers.’

She explains what routinely still happens in advising FinTech startups. ‘We spend considerable time helping them to understand the nature of the product they are offering from a regulatory perspective,’ she says. ‘Once launched, there is so much ongoing compliance and it’s complicated – rarely a single set of regulations, but multiple different, sometimes conflicting, pieces of legislation to contend with. What tends to happen is that your startup says: great, we can’t afford to speak to lawyers from now on, but it’s okay as we know everything and we understand it all.

‘Then they grow and want to raise more funds or have investors lined up. The first thing they find is that someone’s doing due diligence on every aspect of their business, including their regulatory compliance. They find it’s wanting in numerous respects and have to come back and say: we need your help. Cutting costs and cutting corners is an endemic problem.’

According to Reid, the democratisation of investment services in pure FinTech has a long way to go. Post-Brexit, she suggests, the UK no longer wants equivalence in many areas because we would rather do our own thing. ‘The payments industry is an example of where we might want to conform enough to have continued access to global payment systems, but diverge enough to eliminate some pointless regulations that exist,’ she adds.

‘Engagement is imperative’

‘Our clients are troubled by how much time they’re going to have to spend engaging with the UK government and regulators to get the balance right between conforming in order to assist trade with the EU, and diverging, in order to assist trade generally. That is a mammoth task for anyone in the sector. If you don’t lobby, if you don’t engage in the debate, there’s a huge risk that regulators and governments will do something that is really damaging to your future. Although hugely time consuming and costly, the requirement to engage is imperative.’

Reid suggests that crypto will eventually become subject to specific UK regulation. ‘It will be regulated somehow,’ she says. ‘Most likely, it will either be a form of security or electronic money. But it will take a lot of time and effort to devise a regulatory regime.’

For Alan Konevsky, interim CEO and Chief Legal Officer of tZERO in New York, these words ring true. Formerly a lawyer at Sullivan & Cromwell, a managing director at Goldman Sachs and a senior VP at Mastercard, he has been immersed in FinTech for many years. ‘tZERO is a longstanding innovator in digital and blockchain solutions for the capital markets,’ he explains.

‘As part of our journey, we’ve had a big focus on advocacy and education with policymakers and regulators. Regulatory issues present a headwind, but we think that, as a result of our advocacy and the advocacy of other industry players, they have recently turned into a tailwind in many respects, including with a number of important developments coming out of the SEC for trading digital asset securities.’

The industry is maturing to the point where it’s attracting an increasing amount of attention, suggests Konevsky, including at a legislative level. In a recent interview with the FT, the SEC chair, Gary Gensler, warned that as a $2tn global industry, cryptocurrency trading platforms are putting their own survival at risk unless they heed his call to work within the US regulatory framework. Such platforms are big business – Coinbase reported a $1.6bn profit in the second quarter, for example.

Clarity needed

Konevsky accepts that change is coming. ‘From a regulatory perspective, it is going to be incremental – there will be a period of time where there will be a mix of traditional and new. But at some point, neighbourhood banks will fall away, or look very different. What people want is regulatory clarity so they can make business decisions and deploy capital efficiently to develop and commercialize scalable consumer products with real-world benefits. It’s very important in this space because there’s a lot of uncertainty which deters innovation. There’s a conversation to be had about regulatory clarity versus regulatory flexibility. But as an industry we must also become a lot crisper with specific products vs macro narratives that are much harder to regulate efficiently.

‘Of course, the crypto industry wants clarity, business wants clarity, and the regulators say: “Look, we want it too, but it takes time for us to get through the (political) process.” This space is global by nature – and then you have the potential of Central Bank digital currencies and what China and other countries are going to do with digital currencies and impact on a range of activities. Digital cash is critical, including for securities settlement. When implementing these regulations, however, we will need to do it in a way that’s consistent with our values as a society, including with respect to privacy and related matters as well as ensuring that private cryptocurrencies remain as viable products.’

If the future of FinTech is driven as much by regulation as by technology, then regulators seem set to become far more active in identifying and mitigating the technology and operational risks posed to financial institutions, their customers and clients, and to financial stability. Inevitably, that will mean more regulatory and supervisory intervention. This may not be what many FinTech startups want to hear, but it is perhaps the price of their success.

Get your ticket to the Legal Geek Conference

Written by Dominic Carman