August 14, 2017
The UK is undergoing one of the greatest politico-economic shifts ever attempted. How can the government best defend and promote one of the UK’s most promising sectors? FTI Consulting’s Public Affairs Team looks at the industry’s direction of travel and what measures the government can take to position FinTech as a driving force for the post-Brexit economy.
In June 1967, the world’s first cash machine opened in Enfield, North London. It was concomitant with the UK’s leadership in financial services and placed the UK at the forefront of technological advances. Fast forward fifty years and the UK remains a world leader in using innovative technology to improve customer experience. Financial technology – “FinTech” – is the latest example of this, already contributing up to £7 billion each year to the UK economy and employing 60,000 people.
Traditional FinTech encompasses the obvious examples of technological advances in the way we use our money such as contactless payments. Emergent FinTech, on the other hand, is the disruptors to the market, producing innovative products which undercut established market players. TransferWise is a prominent example, allowing people to buy foreign currency without the costly charges imposed by banks and bureaux de change.
Low corporation tax, government initiatives such as the roll out of super-fast fibre optic broadband and DCMS’s digital strategy, and other measures outlined in the 2017 Budget have propelled the UK as a pioneer in FinTech. London especially stands out where finance, technology and innovation are brought together in one place. But the UK’s recent vote to leave the European Union is changing the industry’s priorities. Notable threats such as trade barriers might kill off the industry. Others see great opportunity as the UK establishes its own set of regulations and fosters deeper relations with emerging markets.
Brexit-related uncertainty is posing challenges for financial services in general. Stories of banks relocating their European operations to Dublin or Frankfurt are common business news headlines, but FinTech has so far managed to weather this storm: the first half of 2017 saw £433 million’s worth of investment in the FinTech sector, over half of which originated from overseas. Importantly, this is an increase of one third compared to the same period in 2016 (which was the six-month period up to the Brexit vote).
Investor confidence may decline as negotiations progress. If overseas investors believe the likelihood of the UK achieving a good deal with the EU is falling, then they’ll be more reluctant to invest equity. On the other hand, if there is increased confidence of a deal that’s beneficial to the UK, foreign direct investment may soar. Investors might not seem spooked just yet, but sentiment can change quickly, and there’s still over a year and a half of negotiations to come. FinTech’s expansion needs a stable and certain investment environment.
Open Banking, an initiative spearheaded by the Competition and Markets Authority to encourage greater diversity in the banking sector, is the greatest change in financial services and likely to significantly aid FinTech’s growth. It marries with similar rules contained in the EU’s second Payment Services Directive (PSD2), which the UK must implement by January 2018. Rivals to the big banks will be able to build services on the back of customers’ existing accounts, using data provided by those big banks. As Greg Baxter, global head of digital strategy at Citibank, said: “Industrialists need innovation, innovators need industrialisation”.
The first challenge stems from this data access. Firms will need to find ways of storing it safely as the rate of cyber-attacks increases. Far more problematic is UK FinTech’s access to European data after Brexit. Depending on the agreement reached with the EU, the UK may no longer be subject to PSD2. Good news for Leave supporters who want to claw back sovereignty, but in practice it might mean the UK missing out on business opportunities with European consumers. Open Banking has demonstrated the government’s support for the aims of PSD2, but it is more limited in scope and is only applicable to the UK. Without access to European data, UK firms may be on the back foot compared to their continental competitors.
Crucial for the FinTech industry is its access to skilled labour; the sector relies on EU migrants to a much greater extent than the financial services sector in general. STEM skills (science, technology, engineering and mathematics) are particularly valued. For non-EU migrants, government currently runs the Tech Nation Visa Scheme, which grants entry to the UK to 200 migrants with exceptional technological talent. Indian nationals receive about one fifth of these visas. Brexiteers might argue that leaving the EU will liberate our immigration system to the benefit of these workers, but investors will be watching closely how government intends to operate a skills-based visa system.
In a separate initiative, the Department for International Trade is releasing £500,000 per year to attract FinTech specialists to come to the UK, illustrating Liam Fox’s commitment for the sector to drive the UK as “a proud champion in the cause of global free trade”. But there is a chasm between Brits seeing the economic benefits of immigration and those who want it curtailed. One sub-sector likely to lose out if labour is restricted is WealthTech, which seeks to replicate or enhance the processes currently undertaken by a finance professional. Nutmeg is a UK-based digital asset manager with no physical presence, yet the app-based firm has approximately $1 billion of assets under management. A company with a product based on complex software needs employees with the relevant know-how, and the UK can’t provide them all.
Passporting is an issue at the heart of every financial institution’s Brexit plans. Passporting allows a bank or other financial services company to sell its products and services across the European Economic Area, whilst still only being regulated in its host country. One report by a House of Lords committee envisages a loss of £20 billion to the FinTech industry alone if no agreement on passporting is reached. Contrarily, Innovate Finance, a FinTech membership body, forecasts only 20% of its 300 members being affected. That’s because as a new and blossoming industry, FinTech tends to be regulated by individual member states with little harmony between each one – in this case passporting is irrelevant. Many FinTechs also haven’t yet reached a size where passporting would come into play. The mechanism is more beneficial to companies with overseas expansion plans.
Nonetheless, banks like Monzo will be wondering whether in a few years’ time their banking licence covers 65 million people or 500 million people, as will the Department for International Trade. Losing these rights affects not just FinTech specifically, but also the entire financial sector on which the FinTech thrives. In March, it was reported that the EU may attempt to undercut London as FinTech capital by introducing a new passporting regime for FinTech firms across the remaining nations – but this isn’t yet official EU policy. London’s status as hub for financial start-ups will be diminished by Brexit if passporting ends.
These challenges are not definitive, however. The UK voted to leave the EU in part to control its own migration policy, so there’s nothing to stop a future government allowing residency to every FinTech expert it wants. Similarly, there are ways for the UK to retain passporting rights, subject to compromise. The sector’s concerns can be allayed if there is the political will. Providing FinTech overcomes the obstacles that Brexit has presented then there’s no reason UK FinTech cannot still become the lifeblood of the UK economy and a template for economic innovation the world over.
The UK is traditionally seen as being more liberal with its regulatory practices than other EU member states. Indeed, while opposition from the UK has long been cited by countries favouring the EU taking a more federalist direction as a drag on their ambitions, successive British governments have been among the strongest advocates for the deepening of internal market cooperation. The lack of a UK voice in these negotiations post Brexit will pose a number of challenges for the FinTech sector.
For credit companies, opportunity presents itself more than risk because they are subject to patchwork regulation, rather than one EU-wide policy. There is little harmonisation, too, in peer-to-peer lending, another important strand of FinTech. Leaving the EU, then, presents the UK with the opportunity to develop a pro-FinTech regulatory regime, specific to the needs of the UK-based sector. A regulatory environment that reacts efficiently is particularly important for an industry that thrives off innovation and fast-moving transformation.
With political and economic upheaval come new business opportunities. The UK won’t be starting from scratch – it will have a more EU-aligned regulatory regime than any other country in the world. But, as already mentioned, it will adjust the rules to suit its needs. RegTech is the latest sub-sector currently taking the UK FinTech industry by storm. Defined by the FCA as “the adoption of new technologies to facilitate the delivery of regulatory requirements”, RegTech is increasingly in demand as companies look for more efficient ways of adhering to industry rules. This is truer now that those rules will change, as well as the ever-digitalised nature of our economy placing greater requirements on companies to protect consumer data.
Leaving the EU means Britain forging a new economy, and FinTech has a role to play in project “Global Britain”. Theresa May has indicated her intention to withdraw from the EU customs union – despite calls from both within her party and from the opposition backbenches to retain access. Assuming the UK does leave the customs union, the UK will be able to strike free trade agreements (FTAs) – the raison d’ être of Liam Fox’s Department for International Trade. Much of Africa and Latin America remains untouched by FTAs, yet both are enormous markets which would benefit hugely from the technological advances that FinTech offers. Developed nations, too, are still without formal trading agreements with the EU, such as Australia and the United States. The UK stands to benefit if it can negotiate deals with those countries conducive to FinTech growth.
The Brexit vote has precipitated attempts by other European cities to poach jobs and investment from London. Amsterdam, Frankfurt and Paris are all competing for large international banks considering relocating their European operations, and they’re succeeding too. But London’s status as a technology and financial centre in one place, its loose regulation, pro-business culture and the English language make it a hard city to match.
Challenges include access to employees with specific skills; the ability to sell a product or service to the rest of the EU and, in the short term, whether the sector can continue attracting investment. If the government makes a success of Brexit and FinTech manages to navigate those challenges, then it can reap the benefits of forging deeper relations with emerging markets; more reactive regulation to suit its needs and encourage the prioritisation of immigrants with the requisite skills.