In the UK, the Financial Conduct Authority (FCA) has followed up on its rhetoric that the regulatory framework wants to accommodate innovation in financial services. We discuss the definite green signal and several welcome initiatives from the regulator that should deliver in 2016.
Green lights from the regulator
In the UK, the Financial Conduct Authority (FCA) is, with increasing frequency, delivering on initiatives to better enable innovation and the net effect of these is certainly a green light to the international FinTech sector. In some cases, the initiative itself represents an innovative way in which the FCA uses its own resources (for example, its idea of enabling a regulatory 'sandbox' – see below). While many initiatives invite the industry to provide input as to which rules and policies apply a disproportionate brake to innovation, in some cases the FCA provides its own thought leadership, as with its recent draft guidance on cloud-related outsourcing (see below).
Christopher Woolard, the FCA's director of strategy and competition, has made it clear that it is a priority to ensure that regulation does not interfere with progress, saying in a speech in November: "we run the risk of seeing the problems and challenges of technology and innovation without valuing sufficiently the benefits they can bring. We may be potentially too risk averse. [A ] danger is we ignore the needs of consumers and those firms that could bring the disruptive innovation we need in markets...". We expect to see more from the FCA to encourage the growth of FinTech over the coming year.
From spring 2016, the FCA's Project Innovate will expand, using the concept of a regulatory sandbox as "a ‘safe space’ in which businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of pilot activities", (Read more detail in our blog here.)
As part of this, the FCA envisages a process of enabling innovators to apply to the FCA to use the sandbox regime. If permission is given, firms will agree a basis of testing and reporting to the FCA, within a tailored rule-based regime and with benefits that may include a 'no enforcement' promise. The sandbox could be delivered through private virtual sandboxes or through umbrella incubator companies.
Start ups, multipliers and established businesses should welcome the sandbox framework. The sooner innovators test for viability and get their projects authorised, the sooner these initiatives can have a positive impact on the real economy in terms of staff hires and operational implementation, as well as in terms of the market benefits they are designed to bring.
There are signs that the regulator will continue to ask questions of itself and the market in terms of whether current regulations are supportive of innovation. In summer 2016, interim findings will be released from the FCA's Asset Management Market Study (MS 15/2.1) and a question asked under this study is whether there are any barriers to innovation or technological advances which prevent new ways of doing business to the benefit of investors.
The FCA's recent draft Guidance Consultation 15/6 on firms outsourcing to the ‘cloud’ and other third-party IT services, gives a clear steer as to the regulator's view on whether firms should be using the cloud, "We see no fundamental reason why cloud services (including public cloud services) cannot be implemented, with appropriate consideration, in a manner that complies with our rules".
While this certainly hits a positive note, the FCA's draft sets out a number of steps it expects firms to takes as part of a decision process. Some of the steps are of a practical nature, such as the need for operational and security risk assessments and due diligence on issues such as the supply chain, concentration risk and jurisdictional control. Others are of a governance/legal nature, such as the requirement for a data residence policy, documented business case and contract addressing a range of issues. The shopping list of steps to jump through is extensive, so hopefully the finalised guidance (expected in Q2 2016) will allow for proportionate application.
Payment services developments
EU legislation in the form of the recast Payment Services Directive (PSD2) will introduce new regulated activities in the payment space known as payment initiative services and payment account services. While at first glance, this might be seen as a negative step – creating a barrier by bringing additional activities into the fold of regulation – the consequence will, in fact, be permissive as Member States will need to facilitate their delivery.
PSD2 also adds in protective measures that will require existing payments business, such as banks, to recognise and deal competitively with newcomers providing these services. It will be interesting to see the pace at which existing players or technology-rich newcomers launch platforms and products in this space and just how disruptive this will be.
Competition and efficiency in the financial services sector
Many of the FCA's initiatives relate to whether or not the market is working efficiently. Other recent examples can be seen in the FCA's Call for Input papers: Big Data in retail general insurance and Supporting the development and adoption of RegTech. These papers recognise emerging or necessary trends in terms of market change and seek input with a view to enhancing the regulator's decision-making on the way ahead. A common factor to these papers is that the underlying technology and solutions are still emergent and the process of achieving market consensus on the way ahead, in turn, drives adaptation.
Sectors in which we expect to see increasing change throughout 2016 are the investment advisory and asset management sectors. This should be propelled by proposals from the Financial Advice Market Review (FAMR), set to emerge ahead of the Budget, early in 2016. FAMR was launched in August 2015 to consider whether the current regulatory and legal framework governing the provision of financial advice to consumers effectively ensures that all consumers have access to the support necessary for effective financial decision-making. The FCA's November 2015 Asset Management Market Study also focuses on efficiency and value for money in that sector.
Regulatory change will doubtless follow these initiatives and given the added stimulus of MiFID II implementation projects, it will be interesting to see whether firms take the opportunity to refresh their operational models in a way that embraces greater use of technology.