This is a paper submitted by Innovate Finance to the House of Lords European Affairs Committee on 1 April 2022, setting out views on post-Brexit opportunities to build a UK regulatory system to support the next wave of financial innovation.
Contents
About Innovate Finance
Post-Brexit opportunities for the UK financial services sector, including in relation to possible areas of future growth
Table 1: Principles for regulators to consider for their approach to FinTech
About Innovate Finance
Innovate Finance is the independent industry body that represents and advances the global FinTech community in the UK. Innovate Finance’s mission is to accelerate the UK’s leading role in the financial services sector by directly supporting the next generation of technology-led innovators.
The UK FinTech sector encompasses businesses from seed-stage start-ups to global financial institutions, illustrating the change that is occurring across the financial services industry.
Since its inception in the era following the Global Financial Crisis of 2008, FinTech has been synonymous with delivering transparency, innovation and inclusivity to financial services. As well as creating new businesses and new jobs, it has fundamentally changed the way in which consumers and businesses access finance.
Post-Brexit opportunities for the UK financial services sector, including in relation to possible areas of future growth
Financial technology (FinTech) is a fast-growing element of the UK’s financial services sector.
FinTech companies have emerged since the global financial crisis of 2008, bringing new technology to bear, putting consumers and small businesses at the forefront of their business models.
To provide a sense of the growth of FinTech in the last decade:
- In 2021, $11.6bn was invested into UK FinTech companies - a record number. By way of comparison, in 2014 $929m was invested into UK FinTech. Last year, only the United States attracted more capital into FinTech than the UK; on this measure Britain is well ahead of its European neighbours. This chart shows that in 2021 investment in the UK was equivalent to the next six countries in Europe’s Top 10 combined.
Data compiled by Innovate Finance in September 2021 shows that alternative FinTech lenders and banks increased their contribution of the total amount lent to all UK SMEs from 50% in 2014 to 65% in 2019 (from £69bn to £83bn). Despite initial obstacles and delays to obtaining accreditation for the Coronavirus Business Interruption Loan Scheme (CBILS), FinTech lenders and banks provided around 30% of all CBILS Loans to businesses in 2020.- During the pandemic FinTechs have continued to support individuals and businesses, accelerating the adoption of FinTech products which are now being used by 8 out of 10 UK citizens.
- British FinTech firms are challenging and overtaking incumbent banks, with Revolut valued at $33 billion last year. Other UK FinTech “unicorns” in the UK include: Checkout.com (valued at $40bn in January 2022), OakNorth Bank (valued at $5bn in 2021), Monzo (valued at $4.5bn in December 2021), Starling Bank (valued at $1.9bn in February 2021), and GoCardless (valued at $1bn in March 2022)
The growth of new technologies such as cloud computing, blockchain and artificial intelligence, together with a greater consumer use of digital platforms for engaging with financial services and shopping (ecommerce) has powered the expansion of FinTech.
Another crucial element behind the UK FinTech success story is the UK’s unique and proactive approach to FinTech regulation.
Initiatives such as the rollout of Open Banking, the FCA’s regulatory “sandbox”, and an overall desire to take a proportionate approach to regulating new business models has led to the UK taking the position as global leader for FinTech regulation. The success of the regulatory “sandbox” was such that it has now been replicated by nearly 50 other jurisdictions around the world.
Brexit is an opportunity for an even more forward-thinking UK regulatory system, one that protects the consumer and enables innovation and competition in financial services to thrive. This is crucial, because it is innovation and competition that ultimately leads to benefits for end users - consumers, citizens and small businesses.
In its recent paper on the benefits of Brexit, the Government set out guiding principles for regulation which include a desire to “lead from the front” to develop new technology and ‘proportionality’. However, many FinTech founders (including members of Innovate Finance) are concerned that these positive objectives are not always reflected in the actions of regulators like the FCA. FinTech firms fear regulators may take a more risk-averse approach.
Innovate Finance’s view is that the UK requires a new wave of regulatory innovation to unlock and nurture the next generation of FinTech innovation for the benefit of consumers and small businesses.
Principles for regulators to consider for their approach to FinTech
We would recommend that as regulators face new technology, their post-Brexit regulatory approach should be guided by three principles.
This is summarised in Table 1, below.
- Fit-for-purpose regulation
- Out-of-date rules need to be removed or updated, and new products should be brought into the regulatory perimeter faster.
- The FCA is proposing a new ‘outcome-based’ consumer duty. This could support innovation, but only if it replaces existing tick-box regulation, some of which (like the Consumer Credit Act) is 50 years old and no longer serves to provide positive outcomes for consumers. Outcome-based rules will not promote innovation if they are superimposed on top of existing prescriptive rules. The FCA is proposing to remove two existing handbook principles, but aside from that there is no indication of other regulatory requirements being removed in favour of outcome-based requirements. In advance of the introduction of the new Consumer Duty, we recommend that there be a thorough, post-Brexit review of FCA retail consumer regulation to identify existing prescriptive rules which could be removed when the Consumer Duty is introduced.
- Some examples of rules and guidance that could be replaced by the Consumer Duty include (non-exhaustive list):
- Various sections of the Consumer Credit Act (1974) (“CCA”), including prescriptive rules on communication with customers, contract forms and communication of late payments. In many cases, better outcomes can be achieved for consumers by reliance on the Consumer Duty and scrapping ineffective, prescriptive ‘tick box’ rules. While we recognise that making amendments to the CCA is not within the FCA’s gift, we note that when Parliament repealed some CCA requirements they were then replaced by rules within the FCA Handbook.
- Related to the CCA rules on notices of sums in arrears (“NOSIAs”), for example, sections of the FCA’s consumer credit sourcebook (“CONC”) could be removed such as CONC 7.17. Where consumers have entered into a forbearance arrangement with their lenders, the application of NOSIA rules can cause confusion and distress. In this scenario, firms compliance with prescriptive NOSIA rules is ostensibly at odds with the consumer understanding and good customer outcomes promoted under the Consumer Duty regime.
- Financial promotion obligations where the consumer duty obligations apply.
- Outside of the EU, the UK now has the ability to move quickly. However, as has been seen in the example of Buy Now, Pay Later, new providers are ready and willing to be regulated but the process has been slow, creating unnecessary uncertainty.
- Reform capital requirements to remove the minimum requirement for own funds and eligible liabilities (MREL) burden on smaller new banks and revise SME capital ratios. This would level the playing field for FinTech or “challenger” banks and EMIs, remove disincentives for global investors into UK FinTech by improving the landscape and growth opportunity for FinTech companies, and unlock further lending to SMEs by allowing more capital to be made available for borrowing. EY estimates MREL rules will reduce SME lending by £42bn over 5 years (20% of lending). The Bank of England should raise the threshold for MREL and clarify some of the transition arrangements. MREL is a scheme designed to prevent the ‘too big to fail’ approach but applied to many banks that are not big and where any corporate failures would be absorbed by the wider market. The PRA should also make it easier for the Challenger banks to use IRB (the internal ratings-based approach to capital requirements for credit risk- large banks are allowed to use a ‘modelling approach’ which enables more efficient capital provisions) for their SME loan risk weightings, and where IRB isn’t permitted/used, the PRA should reduce standard risk weightings for SME loans to reflect the underlying risk of the asset class. At present these increase capital requirements which challenger banks could otherwise put to productive use by lending to small firms.
- Fit-for-the-future regulation.
- Introduce a consumer data right to create an economy-wide Open Data ecosystem. FinTech companies want to see the rollout of Open Finance to unlock new uses of Smart Data that go above and beyond Open Banking. This could see the emergence of far more holistic personal financial management platforms, where consumers can have a really clear, up-to-date and accurate picture of their financial life. The majority of contributors to the Kalifa Review of UK Fintech, and many Innovate Finance members (which include Third Party Providers and Technical Service Providers), agree that Open Finance is worth pursuing within the context of wider Smart Data projects.
- Legislation for Digital ID. As highlighted in the Kalifa Review, being able to determine an individual’s identity and that “you are who you say you are” is critical to accessing financial services. Government and regulators must work with the industry to achieve the outcome detailed in the Kalifa Review, namely to secure the “effective development of the future digital ID architecture and ecosystem [which] will provide more safe and secure financial transactions for all UK citizens.”
- The UK needs a coherent, joined-up strategy for regulating digital money, to include cryptocurrencies, central bank digital currency (CBDC), decentralised finance and blockchain-enabled market infrastructure. Regulators must recognise that (aside from anti-money laundering rules) squeezing new products into old rules often does not work. The FCA’s current proposals for extending financial promotion rules to crypto-assets would create a situation where there is no viable route for a crypto-asset firm to obtain approval for otherwise compliant financial promotions or marketing. The UK has the opportunity to be the leading G7 country for blockchain-enabled financial services, including payments systems, environmental, social and governance (ESG) assurance and capital markets infrastructure. To capitalise on this, we now need a strong vision from the UK government, a joined-up strategy and a regulatory system that can evolve in collaboration with industry and other nations.
- Regulators need to continue to engage with and support the RegTech and Supervisory technology (“SupTech”) providers to design technology-based compliance that achieves better outcomes at lower cost.
- Regulators must develop better understanding of technology across regulatory functions and include a “RegTech test”, assessing whether and how the proposals enable RegTech solutions for compliance. This also means a shift to greater adoption of RegTech, including a timetable for implementing machine-readable regulatory rulebooks.
- Reform of regulators
We need reform of regulators themselves. The government’s Future Regulatory Framework is a good start, with its proposal for regulators to have a statutory secondary objective to promote the competitiveness of UK financial services.
Innovate Finance’s full response to the Future Regulatory Framework Review can be seen here, but to summarise, Innovate Finance thinks that:
- The proposed framework should be expanded in scope to include all financial services regulators: including the Bank of England (“BoE”) and Payment Systems Regulator (“PSR”), as well as the Prudential Regulation Authority (“PRA”) and Financial Conduct Authority (“FCA”). While we recognise that there is a forthcoming consultation on the regulation of payments firms by the BoE and PSR, which aims to ensure alignment with the broad principles of the Future Regulatory Framework Review, we remain concerned that this may lead to a fragmented and sectoral approach taken by the regulators.
- Regulators must have specific consideration of the impact of regulation on start-up and scale-up entities. This should include statutory requirements for a more comprehensive approach to cost benefit analysis methodologies — and specifically all new regulations should include a start-up and scale-up test (assessing proportionality of the proposals).
- Reform of the Financial Ombudsman Service (“FOS”) must be included: given the FOS’ quasi-regulatory role and impact on industry, we recommend that an independent review take place to check whether it remains fit for purpose. We would recommend that the governance and accountability mechanisms are reviewed, and the Future Regulatory Framework measures on accountability and scrutiny should be applied to FOS, as well as our additional recommendations on culture change and capacity building. Further, we recommend that the independent review should consider whether the introduction of ‘have regards’, which the FOS must take into account while exercising its functions, would be beneficial.
- Accompanying culture change and capability building must take place: the new objectives will only be successfully applied if accompanied by a culture (behaviours and incentives, at all levels of the organisation) that supports them, and culture change to achieve these; and the right capability, in terms of skills, knowledge and resources. Industry interchange should be encouraged and measured, technology skills and understanding should be rolled out across all supervisory and policy teams, and the resourcing of regulators should be assessed to identify whether they have sufficient capacity, as well as capability, to respond in an agile manner to new market developments. A regular independent benchmarking study should be used to provide additional accountability and organisational support for the international competitiveness and growth objectives. The benchmarking exercise should also monitor domestic competition in financial services to ensure the focus on international competitiveness does not inadvertently entrench incumbents’ dominant position across key industry verticals.
Table 1: Principles for regulation to strengthen the UK’s leading position in financial innovation
| 1. Fit for purpose: updating existing rules | 2. Fit for the future: Enabling innovation | 3. Innovative, agile regulators |
| Bring new technology and services into the regulatory perimeter, with proportionate regulation that protects consumers and supports innovation including BNPL and crypto regulation. | Introduce Consumer Data right to create economy wide open data – unlocking new Fintech solutions including NetZero, financial inclusion and SME lending. Support this with legislation for Digital ID. | Reform regulators’ capability, capacity and culture to underpin proposed competitiveness objectives. Including statutory benchmarking reports, capability reviews and industry interchange. |
| Reform out of date legislation that provides poor consumer outcomes and/or fails to reflect technology: including Consumer Credit Act. And review regulation to remove barriers to Net Zero solutions. | Digital currencies: Introduce CBDC – possibly starting with wholesale currency and regulation for asset backed stablecoin – to establish the UK as the centre of the next phase of payment technology. | A consistent approach – across all regulators including FOS, Bank of England and PSR. New Future Regulatory Framework should be extended to these regulators and ‘quasi regulators’ and action taken to ensure FOS and FCA have the same interpretation of rules. |
| Reform capital requirements to remove MREL burden on smaller new banks and revise SME capital ratios - to level the playing field for challengers, remove disincentives for global investors, and unlock lending. | Enable RegTech solutions. Launch machine readable regulatory rule books. Enable machine readable ESG data. Introduce a RegTech test: requirement for all new regulations to consider how best to enable SupTech/ RegTech solutions | Support start-ups and scale ups: extend the FCA scalebox to the PRA; introduce start-up and “scale-up test” as part of Cost Benefit Analysis. |
Concluding comments
Regulation can bring many positives. It can:
- create trust and confidence for consumers and investors, supporting adoption and growth of innovation and attracting innovative firms to the UK as a trusted jurisdiction;
- open up market opportunities for innovation and new services;
- enable technology-based compliance solutions, whether RegTech or SupTech;
However, regulation can also bring negatives and hinder innovation if it:
- applies analogue approaches to digital solutions;
- fails to understand current customer behaviours;
- fails to appreciate how digital customer journeys can be designed to achieve better outcomes;
- has built-in bias in favour of incumbents and larger firms; and / or fails to keep up with market and technology developments.
Maintaining and strengthening UK competitiveness means both supporting innovation and protecting consumers and financial stability; it is not an ‘either, or’ equation.
The UK is home to some of the largest global players in FinTech, is a world leader in FinTech investment, and is in many ways driving the international financial innovation agenda.
However, if we – government, regulators, and industry - rest on our laurels, the innovators who are making financial services more democratic, more effective, and more inclusive will go elsewhere, taking jobs and economic growth with them. Consumers will miss out on beneficial services and may even be left unprotected from unscrupulous players.
But if the government, regulators and industry come together to seize the clear opportunity that lies before us, in supporting a new wave of effective regulation, we can secure the UK’s position as the trusted global centre for financial services.
We would be pleased to discuss our response in more detail with the members of the Committee, and facilitate discussions with our members and the wider FinTech ecosystem
