The evolution of the regulatory landscape alongside the rise of FinTech.
(Speech by Gilbert van Roon, founder of FinTech Compliance, given at CASS Business School FinTech Event on 2nd April 2016)
Traditionally, compliance isn’t seen as the most innovative or exciting area, but hand in hand with FinTech, and other innovative businesses it becomes much more interesting.
Basically once you have done one Stockbrokers, you have done them all, but I find that nearly all FinTech clients are different. Whether in their business model, their mindset, or their approach. Or all 3!
So I am here today, to talk to you a little bit about the development of the regulatory environment over time alongside the rise of FinTech.
By way of a brief overview of the History of compliance:
– Before 1986 it was completely self regulated. The financial services industry was argued to have a common set of values, and so those persons who would breach those values would simply be ostracised. Unfortunately, it emerged over the course of time that this was not quite robust enough. so……
– Then came the “Financial Services Act 1986”. This covered Investment activites only and set out a statutory framework for self regulating organisations such as the Securities and Futures Association. Unfortunately, it emerged over the course of time that this too was not quite robust enough. so……
– “Real regulation”, or at least, something which had a semblance to what we have today, came about with the introduction of the “Financial Services and Markets Act 2000”. This set out a more thorough Statutory Framework, and established a Quango regulator to oversee the sector.
What is now the Financial Conduct Authority Covers:
– Investment Business
– Insurance Business
– Consumer Credit Business (Including P2P lending)
– Payment Services
– Electronic Money
With regard to what effect having lax, or non existent regulations would have, I need only point at Consumer Credit. The FCA has only been responsible for the oversight of Consumer Credit firms since 2015 where previously, it was the Remit of the Office of Fair Trading. Obtaining an FCA licence involves several tens of thousands of pounds of expenditure (on lawyers, accountants, Compliance Consultants, and the fee payble Directly to the FCA), and up to a year waiting for the FCA to complete processing an application. But the methodology to obtain a Consumer Credit Licence, was to register with the OFT, and make a one off fee payment of £150. That’s correct – £150 for perpetuity and no further fees payable. You were subject to the Consumer Credit Act 1977 and the Consumer Credit Act 2006, but there were no visits from regulators, no financial reporting, and really – no compliance or oversight of any kind.
For a moment, I would like you to hold a number in your thoughts. That number is 20,000. That is the number of regulated Investment Companies that we have in the UK. This high number makes sense, when you bear in mind, that London is a world leader in financial services. In fact, Global Financial Centres Index rated London as being the Number 1 financial services centre in the world, in March 2016. Source: http://www.longfinance.net/global-financial-centre-index-19/976-gfci-19-the-overall-rankings.html
In terms of the number of consumer credit firms, there are in excess of 50,000 of them. That is of course, an insane figure, especially when you take a look at Sweden (where I was doing some Regulatory Research last year) which has less than 20 Consumer Credit firms in total! Now part of this is down to the UK’s “Spend culture” as well as Sweden’s “save culture”. However, there could not have been that many Consumer Credit firms in the UK if there would have been proper controls put in place and effective oversight. Without proper regulation, the number of Consumer credit firms has exploded over the years (to the extent that they now outnumber the number of investment firms two and a half times!), and some have become predatory. You only have to think of Payday lenders with their extortionate rates and their questionable practices to recover monies lent (for example, one such lender getting in trouble with the FCA for falsifying letters which purported to be from Law firms trying to recover the money – of course the law firms didn’t even exist).
Of course, never having been subject to any regulations means that the vast majority of these firms will fall flat on their face when faced with a real regulator with real teeth. All of those 50,000 firms will have to go through an authorisation process with the FCA, and though I think around half will not be pass muster with the FCA, others I have spoken to in industry suggest I am being generous.
Coming back to FinTech within Compliance specifically. (Of course there are always exceptions to the rule, but…)In my mind, there are two ways in which I can break down FinTech. One of the FinTech revolutions happened years ago. That is, The back office FinTech revolution. Computers were introduced into the financial services as they became viable in a business context. This allowed the enormous rise of the now ubiquitous Bloomberg, specialising in the technological delivery of information systems, as well as many other trading systems, information retention systems, reporting systems etc.
The Second FinTech revolution is the one we are seeing at the moment. This FinTech Revolution is using technology to solve the problems and issues which exist in actually delivering financial services to clients (As well as coming up with new services which were not previously possible without high technology). It began in the late 90’s, with the first internet banking service introduced by the Nationwide Building Society in 1997. The rise of the smartphone has been a blessing, as now we have a substantial portion of the populace who is walking around with a small computer in their pocket, powerful enough to process complex programmes. I even have Fifa on my Smartphone! And Angry birds of course, which seems to come as standard on Smartphones now.
Whilst the Industrial Revolution was powered by coal and raw materials, this FinTech Revolution is being powered by Smartphones and Mobile High-Speed internet.
So, this revolution, spurred on by the delivery medium of SmartPhones has very much picked up pace over the last few years.
Now, we bring this all back to the FCA and compliance again. (sorry!)
It is most unfortunate, that with both law and regulation, it is difficult, and nigh on impossible to be forward looking. The way Laws and regulations traditionally are drafted is that an event takes place or thing happens. People look at this event or thing and think “hmmm….this is wrong, we should make a law/regulation to prevent that happening to people in the future”. It is typically event driven and retrospective. It is very difficult to look into a crystal ball, with a fruitful imagination and come up with laws and regulations to protect people from things which have never happened yet, and may never happen!
A recent example of Law trying to be forward looking (and failing thus far) is the very recent Psychoactive substances Act 2016. This defined all Psychoactive substances as illegal, unless specifically legal and subject to exclusions. Whilst exclusions were applied for the most commonly known legal psychoactive substances (Alcohol, Nicotine, Caffeine), it seems as if there are a great many things which have mild Psychoactive effects, and therefore under this legislation, will become illegal! Unfortunately, this would include things such as Nutmeg, or pure oxygen, both of which have mild Psychoactive properties. This bill is having trouble justifying itself!
With this type of issue in mind, when FinTech entrepreneurs were first trying to do things differently in the financial services, the world was a much less friendly place, FinTech Compliance wise.
As an example. Take a Stockbrokers. Most of us will have seen “Boiler Room”, “The Wolf of Wall Street” or “The Big Short”, and so at least have a Hollywood idea of what a Stockbroking office would look like. Only with less shouting and less fraud. No, seriously – there is actually less fraud.
So, the laws and regulations which dictate the manner in which Stockbroking is to be conducted and monitored have been designed with this situation in mind. That there will be a room, full of brokers at desks with telephones and computers. The laws and regulations deal with the specific issues which would arise in this scenario. Compliance Professionals at this point have dealt with and monitored such businesses for many years.
Then, you have a software developer (FinTech Entrepreneur) who steps forward with an app that can do stockbroking without stockbrokers! Clearly, both a different set of rules, and a compliance professional with a different skill set is needed.
Note that certain issues will always arise, and as such, will always need to be dealt with whether you are a FinTech or traditional firm. Carrying on from the stockbroking concept, “Best Execution” would be a good example. This is the rule that enforces the responsibility on the Financial services or FinTech firm to ensure they purchase (or sell) an investment instrument on behalf of their client to ensure the best possible result taking into account (Generally):
– Characteristics of Client
– Characteristics of order (Such as Fill or Kill)
– Characteristics of the Financial Instrument
– Charateristics of the execution venues
– Perhaps most importantly……price!
In traditional stockbroking, this manifests itself by the broker reaching out to market participants in order to get an array of prices, and range of possibilities for execution. That broker then takes all the factors into account holistically, and then exercises their discretion as to where and how to execute the trade, and therefore meet the obligations of Best Execution. There is specific human intervention / discretion exercised here.
If a FinTech firm engages with a compliance firm at an early stage however, requirements such as these can be considered and assimilated. I think it’s actually going to be very interesting to see what creative software systems could do for actually helping with compliance, and especially solving problems such as meeting the requirements of Best Execution.
Over time, the interaction between the Regulator and FinTech has become a friendlier one. This is partially stemming from the stated aim of the Chancellor, for the UK to become a global centre of FinTech Innovation. However, a ship as big as the FCA takes a long time to turn, so we are yet to see the situation to be as friendly as we would like.
Other drivers for the FCA to be friendlier towards FinTech firms include one of their crucial Statutory objectives: that they have a duty to promote competition in the interests of consumers. One of the best ways the FCA can promote competition is to foster disruptive innovation.
The FCA has launched several initiatives which, in their infancy had a lot to learn, but over time, they themselves are developing their understanding too. Initiatives include:
– The “Sandbox”. This allows FinTech or Innovative firms to operate in a test environment with strict controls, and clear compensation available to particiants, to mitigate any fallout. Note that this is strictly a testing environment – you will not be able to do this permanently.
– The Innovation Hub. The FCA is reaching out to try and help businesses. But only if they meet 2 criteria. That they are innovative and the FCA can see benefits to consumers.
Outside of the FCA, Compliance Professionals such as myself have now dealt with enough FinTech startups as to allow us to develop a more specific understanding. This of course allows us (as it does the FCA) to assist and work with them more effectively.
Outside the world of Compliance and the FCA, Lawyers too are growing with their understanding. Investment professionals are genuinely starting to see the potential of some of these firms. The scope for scalability. The scope for putting the FinTech revolution at the fingertips of millions of people, not only in the UK, but in Europe.
And this is an example of how Compliance can help your business, and in fact compliment it. Depending on exactly what it is you are doing, and how you are doing it, you may be able to avail yourself of what are referred to by us in compliance as “Passporting Rights”. What this means is, having gone through the painful process of burning time and money with: Software developers, lawyers, Accountants, professionals, Compliance Consultants, and the FCA themselves – you won’t actually have to do it all over again, in every single last jurisdiction in the EU where you want to launch your product. What I am getting at, is that getting Authorised as a FinTech firm in the UK, does not just open up this country of 64 million people, but the entirety of the EU, with 508 million people.
I would say by way of a general conclusion, that the environment and culture for FinTech firms has improved dramatically, even if we just take the last two years. The FCA is getting friendlier, although it has some way to go, and the network of professionals in London in particular, has assimilated a huge amount of knowledge in a short space of time, and is now well prepared to offer the support and guidance to this current crop of disruptors and innovators.