Why is FinTech so hard to regulate?

5 challenges for financial regulators

Why is FinTech so hard to regulate?

The growth of UK FinTech in recent years has been sensational. Amazingly, as many as 7 in 10 Brits use the services of at least one FinTech business and the sector employs many thousands up and down the country. In 2021, UK FinTech investment soared to $37.3bn, up from $5.2bn in 2020, according to a KPMG report. The UK currently accounts for around 10% of global FinTech revenue worldwide.

But that success is proving a challenge for UK regulators as a system designed for traditional financial services companies adapts to the fast moving world of tech.

5 challenges for financial regulators

So why is the FinTech sector so hard to regulate? We’ve set out the 5 main challenges currently facing financial regulators and the UK government.

1. Growth of the FinTech sector


The FinTech sector is booming. In 2020 there were around 2,500 FinTech companies in the UK and between 2011 to 2016 the number of FinTech companies grew by 21% year on year. 

The diversity of the FinTech sector is a success story for UK businesses, but it can be a headache for regulators. The high street big banks and financial companies of yesteryear have been joined by hundreds of smaller niche FinTech businesses. The Financial Conduct Authority (FCA) is now responsible for overseeing over 59,000 businesses and their sister organisation, the Prudential Regulation Authority (PRA), watches over 49,000 firms.

The sheer volume of online transactions and the number of small, niche financial services companies means that the regulators are stretched thinner than ever before. 

2. New FinTech products


The success of FinTech businesses comes from their ability to innovate, problem solve and come up with new financial products and solutions. In many ways, their freedom to operate outside of the regulatory framework has allowed innovation to flourish. But this innovation can also pose a challenge for regulators.

New financial products may fall outside the existing regulatory framework or regulators may need to adapt existing legislation. New financial products and services include the following:

  • 2021, found the use of Buy-Now Pay-Later (BNPL) products nearly quadrupled in 2020 to £2.7 billion. The Government plans to change the law to bring some of the current forms of unregulated buy-now-pay-later products under FCA regulation.

  • Cryptocurrency: since January 2020, crypto businesses in the UK have had to comply with the 2017 money laundering regulations but specific crypto legislation is currently thin on the ground and more specific regulation is expected in the near future.

  • Open banking: new online banks and existing banks taking their business online has opened up new risks for consumers. Robust processes are needed to prevent money laundering, identity theft, data protection violations, cybercrime and financial terrorism.

  • Robo advisors: robo advisors that give guidance to investors are increasingly common. The FCA warns that, “imported robo advice models may not meet UK regulatory requirements such as suitability, pensions switching and anti-money laundering requirements” and may therefore need to be adapted to the local environment.

3. Additional risks for consumers


For consumers, the rise of FinTech companies gives them more choice but there are also new financial risks. The financial regulators need to respond quickly to ensure that those risks are mitigated, and consumers are protected: new regulations may be needed.

Here are some examples of those additional risks for consumers:

  • New financial providers: this makes it harder for consumers to work out which providers are regulated, and which are offering legitimate products and returns.

  • Quick decisions: consumers may make quicker financial decisions online as products can be bought more quickly with no face-to-face contact. This means that potentially vulnerable customers may take on financial risks they don’t understand or make quick decisions without taking time to consider their suitability.

  • Increased complexity: the array of available choices can cause consumers to sign up to multiple financial products and to lose sight of their overall financial position.

  • Tech risks: there are more security risks as sensitive data is held by even more businesses. Data and passwords can be stored on mobile phones or laptops and customers may be tempted to duplicate passwords, leaving them open to identity or other financial fraud.

  • Accessibility and exclusion: some consumers without access to new technologies may not be able to access new financial products. Others might be access new technologies but may not have the funds or income to support their spending choices.

  • Social media: research shows that new investors with under 3 years’ experience are more than twice as likely to rely on YouTube or other social media for researching new investments.

4. Keeping regulations in proportion to risks


The regulators often walk a tricky tightrope between keeping and creating regulations that are proportionate to financial risks, while still protecting consumers. There is a danger that increasing financial regulation may stifle the pace of change, potentially dampening foreign investment in the UK financial sector and making the market less attractive.

Complying with financial regulations is also a big cost for businesses and it’s important that they are not, therefore, loaded with unnecessary compliance costs. A 2019 European Commission study on the costs of compliance for the financial sector found that survey participants spent an average of 3.23% of operating costs on financial compliance.

Financial regulators need to ensure that new regulations are as slimline as possible and don’t hit businesses with large compliance bills.

5. Promoting collaboration


 

With such a complex industry to regulate and monitor, financial regulators and the UK government rely on collaboration with the FinTech industry. They need industry input to ensure regulations are workable, proportionate and promote competition.

In February 2021, the Government-commissioned Kalifa report highlighted the need for collaboration between the regulators and FinTech businesses. Its recommendations included the following:

  • FinTech task force: this government led group should be set up to provide a ‘single customer view’ of the government’s regulatory strategy on tech and a single touchpoint for the private sector to engage.

  • Scalebox: this regulatory nursery should be set up by the FCA as an extension of the successful Sandbox programme and will enable new FinTech businesses to gain help and support from the FCA in their early growth phases.

  • Trade policy: the UK Government should engage with FinTech businesses to make sure that future trade agreements will benefit the FinTech sector.

What’s next for FinTech Regulation?

Governments and financial regulators across the globe face numerous challenges that make the FinTech sector hard to regulate, but regulations will come – with many in the pipeline. In the UK, the FCA has acknowledged that gaps and malpractice is starting to occur because of gaps in regulation.

The FinTech sector is booming and has pioneered innovative technology and new financial products. The financial regulators need to protect consumers from additional risks, work with FinTech businesses to develop workable new regulations and also oversee a burgeoning number of new businesses.

For global regulators, FinTech regulations should be a priority. An agile regulator that works in collaboration with the industry will allow the FinTech sector to remain competitive and continue to grow into the future.


CUBE solves complex regulation for regulated institutions of all shapes and sizes. We know what’s on the horizon for regulatory change, and implement that change when it happens.



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