In most heavily regulated sectors, it is commonplace to complain about the regulator. Too much intrusion; too much compliance; stifling innovation. Therefore, at a recent Fidelio Board Breakfast on “FinTech, Governance and Growth” it was striking to hear leading Non-Executive Directors recognise the contribution of the regulator to the health of the sector. FinTech is known for its iconoclasm and for providing very real challenge to the incumbents. But trust is essential to its success and for Boards, investors and customers, the regulator plays a pivotal role. Indeed, as FinTechs grow they will need an effective capability at Board and Executive level to engage with the regulator. This is typically in the shape of former bankers, as well as former regulators, who are familiar with what good looks like in larger, more complex and systemically important organisations. But equally, effective regulators recognise that one size does not fit all, and in this Table Talk, Fidelio looks at how Financial Services regulators are looking to nurture a major industry of the future. Our Search, Evaluation and Development assignments suggest that successful FinTech Boards and Executives are also keenly aware of the importance of this symbiosis between the industry and the regulator.
The Backdrop
Since the Financial Crisis the financial sector has been driven by three main forces: technology, evolving customer expectations, and increasing regulation. Using state of the art technology to provide improved financial services for consumers is simple enough in concept, but clearly complex in execution given the scale, intricacy, and security requirements for the software systems involved. The challenge for regulators is to ensure that consumers are protected, without killing the “golden goose” of innovation, for example by ensuring that smaller fledgling institutions – and important, innovative technologies – are not confronted with a disproportionate regulatory burden. With profitability and financial sustainability a significant challenge for many FinTech firms, it’s vital that the costs of regulatory compliance are proportionate and that the regulatory regime does not wind up inadvertently benefiting incumbents. The recently updated UK’s Senior Managers and Certification Regime was felt at Fidelio's breakfast to make a positive contribution in that it fosters clarity as to precisely who is accountable for each key function. There was also agreement that the UK regulators are sensitive to the need to balance consumer protection and innovation. The PRA (Prudential Regulation Authority) and FCA (Financial Conduct Authority) understand both challenger and incumbent firms, and grasp what they are trying to achieve: they want to see that FinTech Boards are holding management and founders to account, while allowing important technologies to flourish.
The Sandbox Option
The regulatory mandate to foster innovation has given rise to the concept of “Regulatory Sandbox” which has become popular across a number of countries and is applicable to many regulated industries. In general the rationale for a Regulatory Sandbox is strongest in industries where innovation may inadvertently cause harm to consumers, whether financial or even physical, as in healthcare. In the UK the Regulatory Sandbox run by the FCA provides for a participant in each cohort to develop and try out their financial product or service on consumers in controlled conditions.
Sandbox Positives
For Boards and Executives the Sandbox has clear advantages:
Familiarises FinTech business leaders with the regulatory mindset and objectives
Creates bespoke regulatory solutions for new business concepts
Reduces barriers to entry by lowering costs of regulation
Reduces the time and, potentially, the cost of getting innovative ideas to market
Enables greater access to finance for innovators by reducing regulatory uncertainty
Enables more products to be tested and potentially introduced to the market
In effect the Sandbox allows the regulator to work with innovators to ensure that appropriate consumer protection safeguards are built into new products and services.
Sandbox Issues
There are people and technology implications to the Sandbox approach, including potential pitfalls:
It is resource-intensive from the regulator’s point of view and may require dedicated, specially trained teams
Sandbox space is typically limited and oversubscribed – in a competitive industry not all firms will qualify, and the regulatory playing field will therefore not be level
Startups may incorrectly use acceptance on a Sandbox programme to imply regulatory approval for marketing and fundraising purposes
Consumer safeguards may inadvertently be weakened within the Sandbox, with potential for actual harm
What works in the Sandbox may not work at scale in the broader market
Notwithstanding, the Non-Executive Directors participating in Fidelio’s breakfast including with FinTechs that had already achieved size and scale felt the regulatory approach in the UK was contributing to the sector’s success. In their view the Sandbox concept is a strong one and the UK’s approach effective; this perspective is shared by the FCA, whose October 2017 report on its experience to that point is generally positive.
What the future brings for Boards and regulators?
For the UK FinTech industry the terms of the UK’s departure from the EU could well impact regulation. The overnight decisive election outcome will now shift the focus to terms of departure. While uncertainty has not been helpful for the UK FinTech industry, the regulatory framework including the Sandbox has been recognised as an advantage in attracting capital and nurturing innovation.
The UK also benefits from co-location of the financial innovation cluster with the relevant regulators in London – this is not the case in the US, for example, with the regulators in Washington and the innovators typically elsewhere. Germany is already home to significant FinTech activity, but does not have equivalent Sandbox provisions, while in the EU more broadly the ECB’s position on such measures to foster financial innovation is less clear.
With complexity and many moving parts, it is evident that FinTechs benefit from Boards and Executives with a good understanding of and capacity for the regulatory/industry symbiosis. Fidelio has a track record in developing highly effective Board and Executive teams who engage proactively with critical stakeholders including regulators.
To learn more about Fidelio’s approach to Search, Evaluation and Development, contact Gillian Karran-Cumberlege on gkarrancumberlege@fideliopartners.com or Steve Cheetham on scheetham@fideliopartners.com.
