How better regulation can power up UK fintechs

by Omar Salem, general counsel, Algbra

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How regulatory reforms and increased capital can drive UK fintech expansion

One of the first questions any fintech founder or investor asks is how it will be regulated. Regulation affects every aspect of a fintech’s business, from how it interacts with customers to the amount of capital it needs to hold. Financial regulation is also expanding to cover not only firms providing financial services but also technology firms that provide infrastructure to them.

The UK’s strong and globally respected regulatory framework has helped launch and attract some of the world’s leading fintechs. UK Finance boss David Postings recently indicated that he would like to see more risk-taking in the UK, but there is much to do to improve how regulation works without increasing risk. Nonetheless, there is significant scope to improve the UK’s regulatory architecture to protect consumers better and support fintechs. If we want the UK to continue to be a global leader in fintech, we must continually work to optimise our regulatory framework.

There are major improvements to the UK’s regulatory system that could be needed across three stages in the life cycle of a fintech. Firstly, the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA) authorisation process should be improved. Secondly, a more consistent approach to regulation should be put in place. Thirdly, the pools of capital available to high-growth firms should be expanded.

Improving the PRA and FCA authorisation process

The UK rightly has a rigorous process for authorisation of new financial services firms. This is vital to protecting the integrity of the UK’s financial sector, ensuring financial prudence and protecting consumers. It is partly because the process is so well regarded that fintechs seek authorisation in the UK as a stamp of approval. However, there is scope to speed up the process and include more accountability without weakening the effectiveness of the authorisation process.

The slow pace of the PRA and FCA’s authorisation process stems not solely from an intrinsic need to take so long but because there is a lack of accountability in the authorisation process. This originates partly from different interpretations of the statutory provisions that are supposed to ensure applications are processed within certain time frames but, in practice, are ineffective. In addition, the mechanisms for challenging regulators’ decisions are unsuitable. For example, it would make sense for firms to be able to request a quick review, at the informal feedback stage, of a case officer’s plans to recommend that an application be refused. This would bring greater accountability and support greater confidence in the regulators’ decision-making concerning authorisation applications even when an application is refused. It is possible to have both an effective and prompt authorisation process – but we need to revise the statutory framework to tighten the process. Of course, we must also ensure that the regulators are sufficiently resourced and staffed to process applications effectively.

A more consistent framework for regulation

Associated with the issue of authorisation is the patchwork nature of the UK’s licensing and regulatory regime. Separate licensing gateways apply to:

  • Banks, insurers, investment firms, mortgage lenders, consumer credit firms and certain crypto asset issuers and service providers (FSMA 2000);
  • Electronic money institutions (Electronic Money Regulations 2011);
  • Payment institutions (Payment Services Regulations 2017);
  • Central security depositories (UK CSDR)
  • Consumer buy-to-let mortgage providers (Mortgage Credit Directive Order 2015); and
  • Benchmark administrators (UK Benchmarks Regulation).

This smorgasbord of regulatory regimes should be consolidated into a single licensing framework, with the core authorisation requirements standardised with additional bespoke requirements where necessary. Besides simplifying the authorisation process, this would have the key benefit of allowing authorised firms to add new regulatory permissions without needing to go through another full authorisation process again, saving resources for regulators and firms.

The Government has indicated through the Future Regulatory Framework that it is heading towards a more consolidated regulatory system, with regulatory requirements pushed into the regulators’ rulebooks rather than being prescribed in legislation. In a policy paper published in July 2023, progress was promised by the end of the year, but so far, this seems to have been limited.

Expanding pools of capital for high-growth firms

Key to the successful development of fintechs is access to the right capital at the right time. The fintech sector, along with other high-growth sectors, is strategically important to the UK and has the potential to provide highly rewarding returns to investors. There is, therefore, a strong argument from a public interest perspective for using regulation to support early-stage high-growth companies.

While positive steps have been taken through the UK Government’s Khalifa Review of UK FinTech to support funding for the fintech sector and the Mansion House Pensions Compact to support greater investment by pension funds in high-growth companies, more needs to be done. One option would be to require all pension funds to invest a minimum proportion of funds in early-stage high-growth companies, either directly or through a specialised fund that could be developed. A relatively small percentage of UK pension fund investments are steered toward early-stage high-growth companies, which could have a massive positive catalytic event, potentially encouraging other investments into these companies.

Regarding listing, it is recognised that the UK market faces challenges, although these should not be exaggerated. Nevertheless, a radical reset of the UK’s promised listing regime is underway, including introducing a new single listing category for equity shares in commercial companies (ESCCs). This removes certain restrictions to listing and allows dual-share classes, meaning it should be particularly attractive to fintechs. It has been gratifying that the FCA has moved to reform the regime following feedback, and it should take a similar approach to authorisation and the broader regulatory framework.

London is rightly a leader in financial services and the fintech sector. The quality of our regulation is an important factor in this. However, we must be at the cutting edge to maintain this position. For the fintech sector, critical developments should include improving our authorisation process, implementing a more consistent regulatory framework and increasing the pools of capital available to high-growth companies.

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