How fintechs innovate: introducing the regulatory nursery

Build­ing on the momen­tum cre­at­ed by Ron Kalifa’s inde­pen­dent review of the fin­tech indus­try in Feb­ru­ary, the Finan­cial Con­duct Author­i­ty (FCA) is set to open what it’s call­ing a reg­u­la­to­ry nurs­ery before the end of the year. The aim of this scheme is to bet­ter equip fin­tech firms in their infan­cy by offer­ing them men­tor­ing and oth­er guid­ance, while pro­mot­ing com­pe­ti­tion and effec­tive reg­u­la­tion in the sec­tor. 

Partnering innovation and regulation

Since its cre­ation in 2015, the so-called sand­box licence award­ed by the FCA has enabled fin­tech enter­pris­es to test poten­tial new prod­ucts and ser­vices on a small group of con­sumers in a con­trolled envi­ron­ment before releas­ing these on a com­mer­cial scale. 

There is evi­dence to sug­gest that it has been suc­cess­ful. Accord­ing to research pub­lished last year by the Bank for Inter­na­tion­al Set­tle­ments, firms using the sand­box sys­tem raise on aver­age 15% more cap­i­tal there­after than those that don’t, while “their prob­a­bil­i­ty of rais­ing more cap­i­tal increas­es by 50%”.

But the sandbox’s one-size-fits-all approach to licence approvals sub­ject­ed both cal­low and expe­ri­enced fin­tech com­pa­nies to the same rig­or­ous reg­u­la­to­ry pro­to­cols. This left many of the for­mer out of their depth. Indeed, of the 24-firm cohort that entered the sand­box in 2018, nine busi­ness­es went on to fail. 

In cre­at­ing the reg­u­la­to­ry nurs­ery, the FCA aims to address this prob­lem by equip­ping the par­tic­i­pants with bespoke guid­ance that stress­es how impor­tant it is for them to meet reg­u­la­to­ry stan­dards. 

The head of the FCA’s inno­va­tion divi­sion, Maha El Dimach­ki, explains: “Our aim is to ensure that fin­techs have the tools to suc­ceed and con­sumers have as much choice as pos­si­ble. By set­ting stan­dards ear­li­er on in the fin­tech ‘jour­ney’, we can work col­lab­o­ra­tive­ly in build­ing a stronger sec­tor.”

It’s not only the nurs­ery that’s paving the way for more robust and sus­tain­able fin­tech solu­tions for con­sumers. Under­stand­ing the vital role that inno­va­tion plays, the FCA has per­mit­ted star­tups to enter the sand­box at any point of their choos­ing, rather than at a set time each year.

The ‘journey’ of a fintech sandbox 

Zee­shan Uppal is a co-founder and non-exec­u­tive direc­tor at Yield­ers, the first Islam­ic fin­tech firm to be reg­u­lat­ed by the FCA. He recalls that a “great aspect of the sand­box for us was the lev­el of trans­paren­cy award­ed by the FCA. We were assigned a case­work­er who was able to give us hon­est feed­back.” 

But Uppal adds that there were also set­backs. “It was a lengthy and metic­u­lous process that last­ed two years. Although we gained vital expe­ri­ence through­out this peri­od, we found the time­lines hard to work with. And it can be hard to become oper­a­tional with­out the rub­ber stamp from the FCA.” 

Since obtain­ing such approval, the six-year-old invest­ment plat­form has gone on to serve more than 8,000 users in 45 coun­tries, set­tling invest­ments worth £12.5m to date. 

Uppal and co-founder Irfan Khan, who is now head­ing MMOB, had amassed a com­bined 10 years of expe­ri­ence in the finan­cial ser­vices sec­tor before set­ting up Yield­ers.

“We were lucky to have reg­u­la­to­ry and bank­ing expe­ri­ence, but it was still dif­fi­cult to nav­i­gate through the process, as reg­u­la­to­ry stan­dards were geared towards a tra­di­tion­al bank­ing sys­tem at the time. It’s great to hear the Reg­u­la­to­ry Nurs­ery will be pro­vid­ing ded­i­cat­ed guid­ance and men­tor­ship to infant fin­techs who may lack oper­a­tional expe­ri­ence.”

The impact of regulation on financial innovation

The Reg­u­la­to­ry Nurs­ery is encour­ag­ing. It pro­vides a back­drop to an even play­ing field for emerg­ing fin­techs. While it is the role of the FCA to remain impar­tial with regards to push­ing trends, El Dimach­ki explains it’s about ensur­ing the “right bal­ance of reg­u­la­tion to sup­port inno­va­tion, com­pe­ti­tion and eco­nom­ic growth.” 

While this may be true, future trends can­not be ignored. Mon­zo recent­ly launched ‘Mon­zo Flex’. a prod­uct com­bin­ing the best of  ‘Buy Now, Pay Lat­er’ (BNPL), cred­it loans and over­drafts, enabling it to  com­pete with the likes of Klar­na, Clear­Pay, Rev­o­lut and Pay­Pal. And it seems like a strong busi­ness move, with a loy­al cus­tomer base of 5 mil­lion, and the Woolard Review esti­mat­ing 5 mil­lion peo­ple in Britain used BNPL in 2020, Mon­zo could prof­it sub­stan­tial­ly as BNPL prod­ucts con­tin­ue to grow in pop­u­lar­i­ty, despite the lack of reg­u­la­tion in the area at present.

The rapid growth of a “mar­ket­place” approach to bank­ing dur­ing COVID-19 has cer­tain­ly spurred com­pe­ti­tion and choice in the mar­ket, democ­ra­tis­ing finance for retail con­sumers. How­ev­er, while prod­uct offer­ing is essen­tial to com­pe­ti­tion, finan­cial lit­er­a­cy is not. In a recent sur­vey by invest­ment app Free­trade, of the 2000 British respon­dents, near­ly 50% couldn’t answer sim­ple ques­tions regard­ing per­son­al finance. This lack of finan­cial aware­ness means while fin­techs con­tin­ue to inno­vate, now more than ever, reg­u­la­tion remains crit­i­cal in pro­tect­ing every­day con­sumers. 

The future of fintech innovation

In estab­lish­ing the Reg­u­la­to­ry Nurs­ery, the FCA hopes to jump­start reg­u­la­tion as a core oper­a­tional point for infant fin­techs, embed­ding the impor­tance of long-term sus­tain­abil­i­ty in the sec­tor. Con­sumer trust is a con­tentious point, as data col­lec­tion con­cerns and fear of the unknown play a huge role in mis­trust of tech­nol­o­gy. Despite this, the mass adop­tion of fin­tech across the UK shows promise of an upward trend. It is how­ev­er, up to fin­techs to build trust with­in their oper­a­tional mod­el – with FCA approval being a secure way in. 

As fin­techs con­tin­ue to evolve and expand their prod­uct offer­ings, the inten­tion of the Nurs­ery is to pro­vide advice and assis­tance, giv­ing rise to inno­va­tion by pro­vid­ing reg­u­la­to­ry sup­port. It is through this over­sight the Nurs­ery plays a cru­cial role in allow­ing fin­techs to build their own solu­tions. As fin­techs con­tin­ue scal­ing towards becom­ing full-ser­vice banks, it is the con­sumers who are at the helm. It is their needs that ulti­mate­ly enable fin­techs to cre­ate inno­v­a­tive solu­tions, demon­strat­ing that when it comes to inno­va­tion and reg­u­la­tion, the con­sumer remains on top.