Contributed By Fox Williams LLP
FinTech (financial technology) is the term for any technology applied to financial services. This dynamic and fast-growing sector is a key component of the UK’s financial services industry.
FinTech start-ups use technology to deliver financial services to customers, usually at a lower cost than traditional providers, and often resulting in better client service for customers. Established financial services firms are exploring either acquiring or working with FinTech start-ups to drive innovation within their own culture.
FinTechs may be providers of technological solutions which bring innovation to traditional financial services companies, or they may be companies delivering innovative financial services offerings which disrupt an existing financial services market. However, ultimately, many FinTechs are simply financial services companies using technology, and an improved customer service proposition, to create an offering more in line with the expectations of the Facebook generation.
The UK FinTech market can be roughly divided into the following main areas: (i) payments; (ii) lending/crowdfunding; (iii) blockchain; (iv) digital wealth; (v) InsureTech; (vi) RegTech; (vii) challenger banks or 'neo-banks'; and (viii) TradingTech.
Banks, cards schemes and acquirers and payment processors are the traditional players in the payments landscape. New entrants usually focus on taking the 'friction' out of the payments process and include providers of mobile payments, contactless and e-wallets. Trends in this important area include further advances in biometric identification and greater use of big data and artificial intelligent (AI) to halt fraudulent payments.
The introduction of PSD2, the European Union’s second Payment Services Directive, in January 2018 has made an impact on the UK payments industry. PSD2 is the European Union’s second Payment Services Directive. Its aim is to revolutionise the payments industry, affecting everything from the way we pay online, to what information we see when making a payment. PSD2 breaks down the bank’s monopoly on their user’s data. It allows ‘merchants’ – businesses like Amazon – to retrieve a user's account data from their bank, with the user's explicit permission. This means that when a consumer buys something, the merchant can make the payment for the consumer, without having to redirect them to another service (such as PayPal or Visa). PSD2 also caters for ‘open banking’ whereby customers will be able to hold all of their accounts with various providers in the same app and, as a result, innovative firms will be able to collate useful data about their customers’ spending habits in order to provide more tailored products to their user base. The FinTechs that facilitate this are known in the legislation as 'Account Information Service Providers'. PSD2 also requires stronger identity checks when paying online.
After the financial crisis of 2008, some of the traditional banks reduced their lending to entrepreneurial or start-up businesses, thus creating an opening for new and innovative financing platforms. We have since seen the emergence of peer-to-peer (P2P) or marketplace lenders who ‘crowdsource’ funds from both institutional and retail investors in order to provide finance to small- and medium-sized businesses or to consumers. These platforms combine technology-driven underwriting with superior customer service to compete successfully in a market traditionally dominated by the UK’s high street banks.
Crowdfunding has grown substantially, not only as a debt offering but also as a means of raising equity, particularly for start-up companies looking to raise funds and gain brand recognition at the same time. A good example of the power of crowdfunding in the UK was challenger bank Monzo, which used crowdfunding platform Crowdcube to meet its crowdfunding target of GBP20 million through effective marketing and advertising to its core base of customers.
However, consumer confidence has dropped due to some high-profile issues in the market, particularly in relation to P2P lending. Some platforms have had higher than expected defaults, some due to poor underwriting and others due to fraud, leading to lenders on the platforms losing capital. Such issues are likely to lead to consolidation in the market. The Financial Conduct Authority, the UK’s financial services regulator, has recently released a consultation paper proposing various amendments to the existing peer-to-peer lending rules, including limiting the scope of investors that P2P products can be marketed to and mandating higher levels of disclosure to investors.
Blockchains (decentralised, cryptographically secure, trustless shared ledgers) and digital assets (tokens measuring forms of value, the transfers of which are recorded on blockchains) received widespread mainstream attention in late 2017, with bitcoin reaching a price of nearly USD20,000 in December 2017 and initial coin offerings (ICOs) raising more than USD6.5 billion across 453 ICOs throughout that year.
However, while 2018 saw a rapid decline in price across all crypto-currencies – with bitcoin reaching a low of USD3,192 in December 2018 – ICOs grew exponentially, raising more than USD21 billion across 1,082 ICOs, peaking in June 2018. Despite this, regulatory uncertainty, a number of high-profile ICO scams and a failure by some ICO projects to meet development deadlines led to a perception of ICOs being less attractive in the second half of 2018, both as an investment proposition and a means of capital formation.
Despite the decline in digital asset prices and use of ICOs, technological development has continued steadily throughout 2018, while use cases of blockchains, particularly in financial services, has increased. Financial services use cases range from forex, trading and settlements, payment systems, decentralised loans (known as 'borrowing from the blockchain'), wallet-service providers, investment management platforms, tokenisation/digital representation of traditional financial assets to effect faster transactions and development of tokenised securities.
During 2018, government, regulatory and monetary policy authorities began to formulate the foundations for incorporating digital assets into the wider economy. In October 2018, the Crypto Assets Task Force, consisting of HM Treasury, the Bank of England and the Financial Conduct Authority, published its final report on digital assets, which set out the path forward for regulation in the UK, with a view to making the UK the world’s most innovative economy, and maintaining its position as one of the world’s leading financial centres. In January 2019 the FCA published the first of several consultations relating to digital assets in order to formulate the regulatory perimeter for digital assets, with further consultations on specific aspects of the digital assets space to follow. The FCA also continues to operate its ‘regulatory sandbox’, which provides innovative businesses scope to test FinTech products and services in the real market, and sees a large proportion of participants operating businesses in the digital assets space. Meanwhile, the Law Commission is undertaking a scoping study to consider whether changes in the law are required to accommodate 'smart contracts' (self-executing computer code which can hold and deal with digital assets, and often an integral part of blockchain-based offerings). Additionally, the FCA is co-ordinating globally with 11 other regulators as part of the Global Financial Innovation Network for the creation of a global sandbox for regulators and tech innovators to share their experiences and concepts to develop the framework needed for better cooperation.
2019 is likely to see further legal and regulatory consultations and the development of law and regulation to provide greater certainty and facilitate innovation in this space as well as provide the regulatory certainty required for increased investment and use case development. Data protection regulation and the immutable nature of blockchains will also prove a key factor influencing blockchain development and use.
Once regulatory certainty and appropriate balance with data protection regulation begins to emerge – together with the launch of projects in development during 2017 and 2018 demonstrating the validity of certain use cases – there may be an increase in investment in both start-ups and in-house technologies, particularly at an institutional level, and more widespread use and adoption of both the technology in general and digital assets in particular.
A fast growing trend in the trading and investments space is the use of ‘robo-advice’ and ‘robo-advisers’. Robo-advice involves replacing face-to-face savings and investment advice with online, automated guidance and execution that have the ability to deliver advice in a more cost-efficient way. Nutmeg, founded in 2011, was an early pioneer of the online investment model in the UK, although it is much less automated than newer start-ups entering the space. Interfaces are becoming increasingly intuitive, easy to understand, accessible at any time and on mobile devices, and are relatively cheap. They seek to put the power in the user’s hands, without the need for a human adviser.
Even with their superior customer-centric digital wealth offering, robo-advisers have struggled to gain market-share over the incumbents, leading some new players to look almost exclusively to B2B arrangements with more traditional wealth managers and private banks, where their product is white-labelled and provided directly by the wealth managers to their clients. Interestingly, one of the largest wealth managers in the UK, Hargreaves Lansdown, have yet to make any moves into this space by updating their customer proposition.
Of all the FinTech sub-sectors, InsureTech is the one lagging behind the others. Challengers have found it incredibly difficult to break into the B2C market, as becoming a regulated insurer is an extremely capital intensive challenge. Not surprisingly, we have seen the incumbents partnering with start-ups in this space, particularly where the proposition is customer-centric. Other incumbents have taken a corporate venturing approach, providing incubators, such as the Aviva Digital Garages, as well as investing in and acquiring start-ups, such as AllianzX. However, there are opportunities for start-ups to go it alone. Zego is one such start-up which focuses exclusively on the so-called gig economy, targeting Uber and Deliveroo drivers by providing them with pay-as-you-go insurance. Zego (and others in this market space such as Cuvva and Laka) utilise AI to provide hyper-personalised products to consumers, thereby overcoming the problems of traditional insurers.
RegTech (regulatory technology) has been one of the biggest growth areas within FinTech in the last couple of years. As regulations become ever more onerous and complex, RegTech is seen as the only option if financial services providers are to cope. While some larger financial institutions build their own bespoke systems, most mid-tier players use third-party software, particularly in the areas of KYC and AML. Indeed, the topic of financial crime is very high on the UK regulator’s agenda (as it is for many other of the world’s regulators). Such providers have seen unprecedented growth and are seen as challengers to the incumbent credit information providers. Indeed, ClearScore, a RegTech start-up, was recently acquired by Experian for GBP275 million.
Challenger banks or 'Neo-banks'
Perhaps the most striking development in the UK’s FinTech market over the last 12 months has been the rise of challenger banks or 'neo-banks'. These may or may not be deposit-taking institutions, but their modus operandi is to provide customer-centric consumer products to a millennial audience. The best examples of these in the UK are Monzo and Revolut, both of which have reached 'unicorn' status with valuations above USD1 billion. Monzo is a deposit-taking, fully licensed bank, with a raft of current account features such as account management and transaction characterisation. The Revolut proposition centres around a pre-paid card that can be used abroad for purchases at a much cheaper rate than traditional banks – but recent additions include travel insurance (a text reminder is sent when you are in an airport to check whether you have insurance), credit products and business accounts. By the end of 2018, Monzo had over one million users, while Revolut had over three million users. The key driver for these firms is to gain market share as quickly as possible, even if this is at the cost of short-term profitability.
Investment banks are under constant pressure to improve profits, and one such way to achieve this is to invest in cutting-edge trading technologies, in particular aimed at reducing the overall cost of trading and issuing financial instruments. This area has not received much press coverage in the UK, as it is purely a B2B sector, but activity has still been buoyant. Origin Financial Markets, a capital markets platform which connects issuers and dealers from around the world in one place, has started to gain traction, as has eToro, a trading platform which rode the wave of the crypto-currency boom with its crypto-currency trading facility.
Public Market Listings
For some UK FinTechs, the holy grail is to become a publicly listed company, and ultimately make it into the FTSE 100. The only B2C FinTech to do so in 2018 was Funding Circle, a UK-headquartered international SME-lending platform. Funding Circle listed in September 2018, with a market capitalisation of GBP1,173.05 million and a share price of GBP3.346. Trading subsequently became turbulent but has recently settled after better than expected results were released. More UK and European FinTechs are likely to list over the coming years, particularly where the brand is key to success.
Rise of Accelerators
We have also seen the rise of FinTech accelerators and incubators in the UK.
Accelerators are schemes that offer start-ups the opportunity (if accepted) to spend anywhere from a few weeks to a few months working with a group of mentors to build out their business and avoid problems along the way. Some accelerators are structured in the form of a competition whereby the winner receives an equity investment and branding benefits at the end of the programme. One of the most well-known accelerators in the UK is Barclays’ accelerator powered by Techstars. This accelerator offers guidance from key Barclays staff, mentoring from leading entrepreneurs in FinTech, access to technical expertise and up to USD120,000 of investment (depending on location).
Incubators often provide a co-working space whereby many different FinTechs can work in the same space and have the opportunity to share ideas and collaborate. Incubators often have good relationships with venture capitalists and early-stage investors to help FinTechs get off the ground. An example of a successful incubator in the UK is Level39, a three-floor, 80,000-square-foot community space located at One Canada Square in Canary Wharf, one of London’s main financial districts.
Partnerships and Mergers
As early-stage FinTechs have expanded into the market, many have used partnerships within the FinTech community in order to grow their customer base further. We are now seeing many FinTechs pairing up in innovative ways in order to offer a variety of products to their customers. For example, Revolut, a ‘banking-style’ platform used to send and manage money around the world has partnerships with online mortgage broker Trussle and P2P lender Lending Works in order to offer its customers mortgage advice and consumer credit opportunities.
We have also seen established players, such as banks, buying, investing in or partnering with FinTechs. Santander Bank set up an investment fund in London, Santander Innoventures, to invest in FinTechs such as Kabbage and Ripple. Santander Innoventures’ most recent investment (along with Barclays) was in the short-term finance provider, MarketInvoice.
Last year also brought the collaboration between HSBC and anti-money laundering technology provider, Quantexa. HSBC is set to spend a further USD2.3 billion on improving its AI technology, USD200 million of which has reportedly been allocated for investments in FinTech and enterprise start-ups.
It is anticipated that in the coming years there will be increased co-operation and collaboration between FinTechs and established players in the market. With banks looking to retain their customer user base and FinTechs looking to grow theirs, it seems that the two may merge in interesting ways in the near term.
Brexit has been a key theme in the UK – not only the FinTech sector but also the financial services sector in general. The main concern has been around the loss of passporting rights for UK companies, who – under the rules of the single market – had the right to ‘passport’ their regulatory permissions into another Member State without having to seek fresh permissions from that Member State's regulator. FinTechs in the UK have dealt with this by setting up subsidiaries in another EU Member State (typically Ireland or Luxembourg), obtaining full regulatory permissions in that jurisdiction, and then passporting their rights across Europe. As yet, we have not seen many, if any, FinTechs move their UK-based headquarters elsewhere.