Opinion: The future of fintech
Jeremy Glen and Erin Findlay take a look at the state of the UK fintech sector and discuss its future potential.
The UK fintech sector is the largest in Europe, second only to the United States globally. As the UK Government aims to strike a balance between innovation and the maintenance of a secure financial system, the UK financial services regulatory regime has achieved global respect, asserting itself as an attractive option for start-ups, innovators, and investors alike.
We examine the new regulations and developments that are on the horizon for the fintech sector in 2023 as the law continues to play catch up with innovation.
The Edinburgh Reforms
Set to be ‘the biggest overhaul of banking rules in 30 years’, Jeremy Hunt has announced that the Edinburgh Reforms - a regulatory package consisting of 30 proposed measures - will be introduced alongside the Financial Services and Markets Bill (FSM Bill), expected to receive royal assent in spring 2023. The Reforms relate to four key themes:
- the maintenance of a competitive marketplace that promotes the effective use of capital;
- an aim to become a world leader in sustainable finance;
- the maintenance of a sector that is at the forefront of technology and innovation; and
- the introduction of reforms that are aimed at both consumers and businesses.
The Reforms, therefore, propose key changes to the fintech sector.
Central Bank Digital Currency (CBDC)
In a bid to maintain trust and certainty in the UK’s financial system in light of the increase of alternative digital currencies and the move to an increasingly digital world, the Bank of England and HM Treasury have stated that “on current trends it is likely that a retail, general purpose digital central bank currency - a digital pound - will be needed in the UK.”
Rather than a new form of currency, such as cryptocurrency, the CBDC would be a digital version of the pound as we know it. It purports to be more stable than other digital currencies in that ten pounds worth of digital pounds would always equate to the value of ten pounds of ‘real’ pounds, avoiding the price volatility witnessed by other digital currencies, such as Bitcoin. It is intended that a CBDC would be for everyday use, and no interest would be payable to account holders on their funds. CBDC transactions would be completed instantaneously without the need for a commercial bank to act as an intermediary.
It is proposed that the Bank of England would issue the digital pounds, but individuals and businesses would open a ‘wallet’ with a private provider, not the Bank of England. This would allow companies within the fintech sector to develop innovative financial products for the public whilst maintaining the Bank’s central infrastructure for stability and certainty.
A House of Lord’s debate was held on the case for a CBDC on 2 February 2023, although no conclusive position was reached by the Lords on whether the currency should or should not be introduced. On 7 February 2023, the Bank of England, in conjunction with HM Treasury, produced a Consultation Paper titled “The digital pound: A new form of money for households and businesses?” alongside a Technology Working Paper. In their Consultation Paper, the Bank and HM Treasury highlight that given the likelihood of the introduction of a digital pound, despite no final decision being taken on its introduction, the move to the next phase of their process – development and design – will now proceed. It is hoped that if the decision is made to launch a CBDC, this will reduce the time it takes to move to the ‘build’ phase.
The consultation is open until 7 June 2023 for views on the case for a CBDC and any potential design proposals. Any decision on whether a CBDC will be introduced can be expected around 2025. Similar initiatives are also currently being discussed in the European Union and United States.
The Government also intends to provide more robust regulation regarding cryptoassets to provide confidence and clarity to consumers, with an aim for the UK to become a global hub for cryptoasset technology. Proposed changes will focus on strengthening the regulation of crypto trading platforms and providing a ‘world-first regime’ for crypto lending. A consultation opened on 1 February 2023 which aims to seek views on how this can be achieved and ways to improve market integrity and consumer protection.
The Edinburgh Reforms and FSM Bill also outline certain provisions that, if passed in their current form, would result in the inclusion of cryptoassets as a ‘regulated activity’, and therefore extend the regulatory powers of the Financial Conduct Authority and Prudential Regulation Authority to include those firms responsible for such cryptoassets. It is hoped that this will provide greater consumer protection and will introduce a prohibition on financial promotions by crypto firms. In addition, the FSM Bill proposes to establish a safe regulatory environment for stablecoins, a cryptocurrency that pegs its value to an external reference, such as US Dollars or gold, and has increased in popularity for its perceived stability over other cryptocurrencies.
Designated cryptoassets are also now included in the list of investment transactions that qualify for the Investment Manager Exemption. This allows non-UK resident investors to appoint UK-based investment managers to conduct certain investment transactions on their behalf, without bringing them into the scope of UK taxation.
Financial Market Infrastructure Sandbox
In technology, sandboxes are isolated virtual environments, separated from live systems and networks, that allow users to experiment and test new technologies in a controlled setting. In 2023, as part of the Edinburgh Reforms, it is proposed that a Financial Market Infrastructure Sandbox will be established which will enable certain firms to test and adopt new technology and innovations, such as distributed ledger technology (DLT), with the ability to disapply certain regulatory and legislative provisions for a limited period. It is hoped that this sandbox will promote innovation and the outcome of the sandbox will be examined to determine whether permanent changes should be made to UK legislation if the results suggest that this would be beneficial to the sector. A similar concept focusing specifically on DLT was launched by the European Commission on 14 February 2023.
The Fintech sector shows promise of being a UK-wide success story. On 1 February 2023, US financial reporting services company, Mirador, announced that it will base their European operations from a new hub to be opened in Edinburgh. In addition, US identity decisioning platform, Alloy, has also recently announced the opening of their first UK branch.
Predicted areas of growth in the sector include digital lending, digital banks, digital payments, (including blockchain technology payments) and digital wealth management. In addition, there are opportunities for cross-sector collaboration, as demonstrated by the recent ‘FinTech meets Space’ event held by FinTech Scotland and Space Scotland. This event represented the start of an Accelerator programme to be funded by the UK Space Agency, which aims to create cross-sector solutions and prototypes for challenges faced by, and opportunities available to, the sectors. Similar collaboration initiatives are also occurring in Scotland with the legal sector, public sector and the development of social enterprises.
Jeremy Glen is corporate law partner and Erin Findlay is a trainee solicitor at BTO Solicitors LLP