Samuel Riding, Regulation Asia, December 15, 2015

Fintech start-ups need to know how regulators are welcoming innovators.

Even as large financial institutions fear or doubt regulation’s impact on their business, start-ups in often face a shortage of practical advice. Lawyers and venture capital investors suggest they should first decide precisely their sustainable competitive advantage within financial services. Then, they need to seek a dialogue with regulators themselves about how best to proceed with their businesses.

Many fintech start-ups don’t yet have an idea of where they fit into the financial regulation landscape, according to Adrian Fisher, Singapore-based TMT lawyer at Linklaters.

Addressing fintech start-ups and investors at the Finnovasia 2015 conference in Cyberport, Hong Kong, he noted they should have a clear idea which elements of financial services they fall under – ‘core’ which includes lending, payments, and financial advice; or ‘peripheral’ including customer authentication mechanisms and data analytics.

Core fintech providers need to be fully aware of regulation, and in many cases require a license to operate, “which brings with it the compliance burdens traditional banks face today,” Fisher said.

Peripheral fintech providers, on the other hand, typically have to worry less about their own compliance because they do business with already heavily regulated third parties.

Know where you stand
“You might not come under those regulations, [but] as a supplier to banks or fintech companies you will likely have a lot of these requirements imposed on you,” he explained.

In a separate interview with Regulation Asia, Emily Reed, head of the commercial and retail banking practice at Hogan Lovells, outlined some of the dangers in start-ups not having a clear idea of where they stand at the outset.

“Over the past eight years in the UK we have seen start-ups quite often obtain authorisation for activities they don’t actually carry out,” she said. “We have seen distortion, with people subjecting themselves to regulation when they don’t need to be or thinking they are a payment service when they are not and then building a business on that.”

“If you are going to be the next unicorn you are going to want to make sure your understanding of regulation is correct at the outset.”

Regulators were partially to blame for this, she believed, as they had introduced rules which were complex and difficult to understand.

However, Fisher noted, they could be as much in the dark as fintech providers on which regulations should be applied.

“Regulators are not necessarily equipped to deal with things like new currencies, [or] lending where there is no banking intermediary,” he said.

Both he and Reed pointed out that ‘sandboxing’ – where fintech providers and banks hive off innovative businesses and conduct test runs before opening up them to customers – was being encouraged by regulators to foster innovation in a secure environment.

“We have been helping start-ups launch on an unregulated basis – how you can operate within existing rules to test your product idea without having to wait for authorisation, which takes a minimum of six months,” Reed said.

However, she noted, individual jurisdictions could often be hampered in these efforts by overarching regulatory structures, including the federal system of government in the US and EU regulations in Europe.

“US entrepreneurs are coming to London to start up because the complicating factor of having both state and federal laws is a problem,” she explained. “[For the UK] the impact of Europe on the desire of the FCA (Financial Conduct Authority) to promote innovation by relaxing its rules is clearly an issue.”

At Finnovasia 2015, Melissa Guzy, co-founder and managing partner of Arbor Ventures, noted that even if regulators have not yet worked out how to regulate fintech, more typical start-up issues such as business model, staffing and finance remain the biggest barriers to success.

At the same time, she suggested, fintech providers themselves had a part to play in helping to develop regulatory tools – or regtech – that would help the financial services industry.

“[Hong Kong] is very important when it comes to financial trading technology, and KYC, AML – it probably has the toughest regulation around opening a bank account,” Guzy said.

“FATCA and compliance is where we will start to see the rise of fintech start-ups in Hong Kong who really have a chance to become regional leaders.”

Befriending the innovators
There is increasing competition among global financial centres to be seen at the forefront of fintech innovation.

Hong Kong has set up a fintech steering committee to look at how regulation can work to support the sector, and MAS (the Monetary Authority of Singapore) has created a fintech innovation group with a USD225 million finance pot available to start-ups.

However, according to Fisher, mainland China arguably has the most advanced thinking on fintech of any jurisdiction in Asia.

“In China the fintech environment has developed rapidly and before there was fintech there was shadow banking. The rules they have introduced are about ensuring those entities are properly regulated,” he said.

“Financial regulation will remain about ensuring stability of the financial system and protecting customers, and you will see behaviour of regulators reflect these things.”

This is particularly true in regulating smaller transactions, where Chinese regulators have made it easier for crowdfunders and P2P to develop their businesses relatively unencumbered by regulation.

Scott Robinson, founder and director of the Plug and Play fintech accelerator, noted that Southeast Asia was likely to be fertile ground for fintech start-ups.

“There is a user base growing its ability to spend money, buy apps, and use the internet. One of the reasons banks have not entered certain markets is [difficulty creating bricks and mortar networks in somewhere like] Indonesia, where there are roughly 18,000 islands.”

However, he noted there can also be regulatory barriers in the region: “Working with regulators, specifically in the fintech space, can be a very risky investment if they are in bed with a corrupt entity.”

Saeed Hassan, managing partner at Grow Advisors (Grow VC Group), suggested Japan and Australia were the best examples of fintech regulation in Asia Pacific.

“The reason Japan and Australia as well are moving forward in terms of regulation is because they are not waiting for the perfect regulation and coming to the market [with it],” he said.

“The regulatory process should be just the same as [it is with] innovation and technology – come up with something and then adapt and change it.”

Development of the internet itself was founded on the concept of “permission-less innovation” noted Robinson, however it was not so easy to apply this to the fintech paradigm.

“You have to ask permission in certain areas [whereas] Uber when it enters a new market prices in the cost of legal fees for that market,” he said.

“[However], the model we have seen in Singapore is incredible. Nowhere else can a start-up take a meeting with [the regulator] with less than 24-hours’ notice.”

In some jurisdictions, regulators have typically been wary of providing advice to financial services providers because they believe it could compromise their authority.

However, she said: “This is changing somewhat and if you look at recent consultations they are more willing to engage in discussions with innovators.”

In some cases, however, this had annoyed incumbent banks. The major financial institutions have been doing a huge amount in the innovation space and been somewhat concerned that the FCA (UK’s Financial Conduct Authority) has been favouring the fintech industry somewhat.”

Although regulatory input is a positive for fintech start-ups, it was no guarantee of success, Guzy noted.

“We haven’t seen huge successful companies coming out of Singapore. Governments do not make start-ups successful,” she said. “One of the things that happens is [start-ups] tend to run out of money. HKMA (the Hong Kong Monetary Authority) needs to find USD100 million to put into local VC firms that can help mentor them, which makes a huge difference at an early stage between success and failure.”

However, Hassan noted, money alone would not solve the problem, given fintech was increasingly becoming an area of competition between global financial centres:

“One of the things people forget is we should try and nurture and grow talent in our cities, because otherwise all we are doing is competing with others.

“It’s about culture and not just about money.”

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