In Part 1 of our FinTech series, our Technology team examined what FinTech (‘financial technology’) is and why technology is driving the rapid change in the financial services sector. While money may make the world go round, there are a variety of legal and business risks that FinTech companies need to be aware of. In this Part 2 we will analyse some of those risks in relation to start-up issues, financial regulation, big data analytics and commercial contracts, and consider strategies for FinTech companies to mitigate and manage them.
As is generally true for start-ups across all industries, funding is critical for FinTech start-ups. For this reason, FinTech start-ups need to address a number of strategic issues at the beginning of their journey to help make their company attractive for investors. These include choosing the right corporate structure to enable continued growth, putting in place appropriate shareholder agreements that clearly define share ownership, and employing an efficient tax structure. Having these items in place will show potential investors that the company has considered the various legal and operational issues that are often at the core of why so many start-ups fail. Other important tasks are drafting employee share incentive plans to ensure the company can retain key staff, putting in place necessary confidentiality materials to safeguard the company’s ideas, negotiating and signing directors’ service contracts, and getting essential supply chain contracts in order.
Financial services regulation
Arguably, the financial industry is the first highly-regulated sector to be subject to major change through technological innovation. With the introduction of a range of new European and local regulations in recent years, along with corresponding penalties for non-compliance, it is critical for FinTech companies to have qualified experts to help them navigate these legal ‘grey areas’.
One of the fundamental obstacles for FinTech companies is accurately determining if, and how, these financial services regulations and licensing requirements apply to their products, services and business governance. A FinTech company in Ireland, for example, should understand what criteria differentiate a non-regulated entity from one which requires approval or licensing by the Central Bank of Ireland.
A further challenge here is that, as regulations in matters such as payment services and consumer protection continue to evolve, FinTech companies need to stay up-to-date on the developments and have processes in place to effectively implement the necessary regulatory changes within the required deadlines.
The good news is that factors such as efficiency, technology and innovation that make FinTech start-ups more attractive than traditional bricks-and-mortar banks and investment advisors, also make them well-suited to view regulation as an opportunity rather than an insurmountable challenge. If addressed correctly, regulation tends to bring with it legitimacy that can be a market differentiator which elevates FinTech companies above competitors and go a long way towards more sustainable growth. Get it wrong, however, and a FinTech company can face difficulty raising funding, criminal and regulatory sanctions, and damage to the value of the business and reputation of the brand.
Commercial Contracts, Licensing, and Terms & Conditions
Commercial contracts play a vital role in the expansion of FinTech because they record the collaborations and commercial partnerships that underpin FinTech companies and their legal relationships. The variety of companies that are entering into strategic agreements with one another in the FinTech industry is a mixed blessing. On the one hand, having the right commercial partnerships in place can steer a FinTech company into the next stage of growth. However, a FinTech company should remember when entering contract negotiations that the commercial drivers and appetite for risk of an online start-up in a commercial contract negotiation will be very different from that of a major bank or established technology corporation and it should tailor its approach accordingly. An added challenge at the negotiating table is the degree of regulatory uncertainty in the FinTech industry. Including a robust change control process in the contract along with a shorter contract term may help to overcome this obstacle.
Licensing agreements that allow the FinTech company to lawfully use and exploit the IP and technology of other companies are valuable resources that can help the FinTech company capitalise on what’s already available in the market without having to invest valuable seed capital in creating new IP that ‘reinvents the wheel’. Few things in the technology industry are as damaging from a financial, legal and public relations perspective as being suspected of infringing on someone else’s IP. For this reason, it is crucial to have the right licensing agreements in place with suitable contractual protections in case of an IP claim.
By putting in place appropriate terms and conditions for the supply of their goods and services, FinTech companies can introduce a level of clarity to their customer relationships. In particular, if the FinTech company deals with individual consumers, it is vital that the terms comply with applicable financial regulation and consumer protection law in each jurisdiction where the FinTech company offers its goods and services. This is not only important to avoid legal and regulatory sanctions, but is also vital for obtaining and maintaining consumer trust.
‘Big data’ analytics and artificial intelligence
As more and more of the financial services industry moves online there is a tremendous amount of digital data being created and stored every day. This ‘big data’ presents an opportunity that FinTech companies can exploit through new business models that sift through the data and identify possibilities for new products or manage existing risk. For example, a FinTech company can analyse big data sets in a way that is customer facing, such as by providing end-customers with visibility on their spending habits so that they can better organise their savings goals. Another potential opportunity is for FinTech companies to create tools that enable financial institutions to analyse big sets of data in the ‘back end’ to understand the types and degree of risks and consequently make better-informed decisions about such risks.
In any case, the confidentiality, privacy and security of any personal data (including sensitive personal data) is paramount for any FinTech company processing any form of personal data. From a competition law point of view there is also an emerging risk that control of extremely large sets of big data may raise market share or other anti-trust concerns from EU regulators. Big data comes with great benefits but also real risks that are multiplying as the volume of data being collected grows. In Part 3 of this series, we will examine the data protection issues becoming apparent from the rise of FinTech and how FinTech companies can ensure that their business complies with the various legislative and regulatory requirements.
The area of artificial intelligence will play a growing and related role in big data analytics in the near future. While robotics and A.I. are still in their infancy, FinTech products and recommendation engines are already leveraging data and analytics to automate decision making processes. In such cases, FinTech companies need to carefully assess the relevant data protection legislation to ensure that their product complies with the applicable notice, consent and processing requirements now and in the future.
Undoubtedly, FinTech is reshaping and improving finance and money in a fundamental way. The race is on for technology and financial services companies to create faster, cheaper and more efficient solutions that integrate with our modern lifestyles. The challenge for FinTech companies remains staying on the right side of legislation and regulators in the highly scrutinised industry of financial services. In Part 3, we will look at further challenges that need to be addressed by FinTech companies as well as a strategies to manage these in respect of mobile payments, data protection and security, cyber-attacks and protecting intellectual property.
How we fit in
We believe that FinTech is an exciting industry sector with a wealth of opportunity. Our team consists of lawyers who are experts in a broad range of areas that affect FinTech, including technology, intellectual property, outsourcing, payments and financial services regulation. We are strong negotiators with comprehensive industry knowledge and strong business acumen. Given our experience and understanding of FinTech business models, risks and challenges we are ideally placed to guide market participants through the legal and business issues. Please contact one of our team members below if you would like to learn more about how we can help.