As a relatively new sector, fintech still requires some ‘fine-tuning’ to develop into a more robust, stable, and profitable industry. Frank Wessely, a managing director in our Restructuring and Insolvency team looks at the most pressing issues facing the sector.
A promising new sector, with an alternative business model and a focus on innovation, tends to generate a buzz − and anticipation of positive outcomes. However, the fintech sector’s growth rate has averaged zero in the last five years, with a 10-year average of -1.8%. So, it is an understatement to say that its progress has not reflected expectations.
Fintech is an enormously broad sector, with many subdivisions and niches. However, there are challenges facing the sector. The Financial Conduct Authority (FCA), the primary regulator for the sector, is very keen to see fintech businesses achieve profitability – and quickly. Underlying this aim is the regulator’s fundamental concern, which is to minimize the harm caused to consumers.
Obviously, when you have stable, robust, profitable fintech firms, there is less likelihood of their causing harm to consumers, in circumstances where these companies struggle or face challenges – or in the worst-case scenario, where they get into serious financial difficulty.
Given the potential fall-out where fintech firms fail, the FCA and the Treasury have issued consultation papers, seeking comments and input, not only from the insolvency profession but also from stakeholders with similar interests. The aim is to ensure that when fintech firms do get into financial difficulty, there are clear pathways and frameworks for them to refer to, and guidance for insolvency practitioners, to enable them to address the issues accordingly.
This reflects the Treasury’s concerns about the lack of insolvency processes for these fintech businesses and it is therefore seeking to set up a special administration regime for them. While these businesses are FCA-regulated, there is currently no specific insolvency regime to manage the challenges if they get into financial difficulty.
Payment institutions and electronic money institutions
Disintermediation of banking services means that services generally provided by banks in the past, have been split up and are being dealt with more efficiently, by smaller, more focused entities, such as these new payment institutions.
So, while previously we would just have used our bank to make payments, we can now use a range of platforms and fintech businesses that are not banks, for this same purpose. And because they are not traditional banks, they are not covered by the special administration regime for banks. Therefore, the Treasury is looking to draw opinions and comments from stakeholders as to how such a regime for these firms could be set up and how it would work.
After all, where you have consumers entrusting their money to payment institutions and money institutions, the regulators want to make sure that consumers’ money is safe, in the event of the company getting into difficulty.
For example, there’s currently very little regulation governing the rapidly growing ‘buy now pay later’ category of the fintech sector. So, if the fintech sector is going to stabilise and be robust and credible, it needs to be properly regulated, so that customers feel comfortable in dealing with these businesses.
Funding and other issues
As well as ensuring there are processes in place for fintech businesses in financial difficulties, there is also the need to consider investment and funding for fintech challenger banks (small, retail banks) and ‘neo’ banks (similar to traditional banks but offering services online only). This issue has only been exacerbated during the pandemic as many firms focus on moving back towards profitability as quickly as possible.
There are some thorny issues for the peer-to-peer lending sector too, such as managing default rates; obtaining equity investment to enable platforms to grow; managing their cost base; considering whether to repurpose to institutional funding; and their image in the marketplace (having been described by the FCA as a high-risk financial product). These platforms will have to do their best to reassure customers and investors that they are being managed effectively and that their products are as clear, safe, and well understood as they can be.
Brexit has brought other issues into sharp focus too, including how firms will provide their services to customers in the EU in the future – something known as ‘passporting’. Many fintech companies have taken the decision to establish bases within the EU to overcome this specific issue now we have left the EU. All fintech firms will be eagerly awaiting further regulations and legislation to help their sector operate more easily in the EU to satisfactorily address all challenges.
Clarification for consumers
Last but by no means least, the sector must make sure that consumers understand what kind of fintech business they’re dealing with. From the average consumer’s perspective, it might seem that all businesses providing payment services and banking services are the same. But they’re not. They’re managed differently, regulated differently, operate differently and there are different risks for customers, depending on what type of institution they are dealing with. Fintech firms must make it clear to the marketplace and their customers what type of institution they’re dealing with, and what risks consumers face.
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