Speech by Mary Starks, Director of Competition, FCA, delivered at the OECD (Organisation for Economic Cooperation and Development), Paris. This is the text of the speech as drafted, which may differ from the delivered version.
Good afternoon everyone, I would like to thank the OECD for inviting me here today to the competition meeting to discuss disruptive innovation in financial services.
I think everyone in this room would agree that the pace of technological change has been and continues to be rapid.
The world is moving towards using digital solutions. Banking by smartphone and tablet has become the leading way customers manage their finances, as mobile banking overtakes branches and the internet is the most popular way to bank in UK. Customers moved £2.9 billion a week using banking apps in 2015 - up from £2 billion in 2014.
Anyone of my generation had a smile last Wednesday about Back to the Future day – the day Marty McFly travelled forwards to in 1985. Back then the hoverboard was the ultimate in futuristic technology. Now the Lexus Hoverboard has been created and brought from concept to market in 18 months.
The question is whether financial services is keeping up with, making the most of, or being turned upside down by technological innovation. The first internet revolution brought us online banking, in much the same way as it brought us online shopping – a new platform for a familiar service. The current wave brings a more diverse set of new ideas, for example peer to peer lending, whereby borrowers and lenders are directly connected by a platform rather than intermediated by a bank. This new wave of ideas goes by the buzzword Fintech.
Today I would like to give you an overview of the Fintech sector in the UK and elsewhere, where the regulator fits into all of this, and what disruption we have seen so far.
Overview of the Fintech sector
Global investment in Fintech tripled to $12bn in 2014 from a year earlier. The US takes the biggest share of this, but Europe is experiencing the fastest growth, particularly in the UK and Ireland.
The UK Government has been extremely supportive of innovation in financial services, for example appointing Eileen Burbidge as a special envoy for Fintech, tasked with championing innovation in financial services at home and on a global level.
Competition in retail banking and other financial services was an issue pre crisis, and in mainstream banking at least the picture is even gloomier post crisis, with concentration up and many of the former challenger banks wiped out. However, the emergence of Fintech in this landscape is cause for hope – Fintech is driving not only the new generation of challenger banks, but also a range of businesses looking to challenge traditional banking in more disruptive ways. A shake-up that many would argue is long overdue.
Role of the regulator
This sets the scene for me to talk about how the FCA fits into this.
The traditional view of a regulator’s role in innovation is basically 'stay out of the way, and don’t try to pick winners'. We don’t try to pick winners, but our competition mandate does give us a role here. The FCA is unusual amongst financial regulators for having a competition mandate. Promoting competition in the interests of consumers has been a statutory objective for us since April 2013. So we see our role as empowering consumers to make good choices, and encouraging new entry and innovation - to drive value in financial services.
Fintech firms often struggle with how to start a conversation with the regulator – the Innovation Hub provides such an avenue, with an approach tailored for these firms.
In common with many other conduct regulators we take a risk-based approach – targeting our resources where the potential for detriment is highest. This naturally leads us to spend time on those firms who have a lot of customers – the large incumbents – and we understand their outlook reasonably well. Our competition mandate however requires us to stand in the shoes of a very different population – new entrants and challengers. How do they experience regulation? Do our frameworks provide the right kind of protection, giving customers confidence in these new businesses? Do they allow enough room for innovation?
One of the ways in which we sought to explore this was by launching Project Innovate in October 2014, and within that establishing the Innovation Hub, a unit within FCA geared entirely towards working with innovative businesses.
The Innovation Hub does two things. One is to provide direct support to innovative firms. Fintech firms often struggle with how to start a conversation with the regulator – the Hub provides such an avenue, with an approach tailored for these firms. New business models may not fit easily into regulations designed around the last generation – we can advise individual firms on navigating the regulatory framework, and take soundings about which aspects of it we may need to review.
Building on that, the second strand of work is about us as a regulator listening to the industry. We want to hear if innovation is stymied by regulatory barriers, and ensure our frameworks remain fit for purpose in an evolving world.
In this regard we issued a call for input in June this year asking firms to tell us about the specific regulatory barriers they face when innovating using digital and mobile solutions. The Innovation Hub is currently analysing the responses we received and will provide feedback later this year.
The Innovation Hub is also exploring the feasibility of a regulatory ‘sandbox’ – a safe space in which businesses, new entrants and established players alike – can experiment with innovative products, services, business models and delivery channels without immediately incurring all the normal regulatory consequences. We will report the results of the feasibility study to the Government this autumn.
In the first nine months of operation, the Innovation Hub has provided or is in the process of providing ongoing assistance to 144 firms. We’ve had requests for assistance from many more and have established criteria to help us target our assistance where it matters most. The criteria include the firm having to be innovative, having done some regulatory research already, having a genuine need for support, and lastly providing consumer benefit - we are not here to support 'innovative' tax planning!
Our competition mandate requires us to stand in the shoes of...new entrants and challengers.
Out of the 144 firms supported, the Hub provided 51 informal steers. Informal steers are different from individual guidance which is legally binding – instead they are fast and frank feedback to firms about the regulatory implications of their business model. Informal steers are provided based on the information provided and are relied on at their own risk.
The Innovation Hub is also mounting a series of themed events. The first three-day forum took place earlier in the autumn and focused on the nascent 'robo advice' or automated advice market. The forum involved presentations and panel discussions with firms such as Nutmeg, Money on Toast as well as big players such as BlackRock, exploring the provision of low cost, mass-market financial advice.
These forums are a good way to open dialogue with industry to discuss innovative ideas and regulatory nuances specific to particular areas of innovation in financial services.
Payment Systems Regulator
I’ve talked about what the FCA has been doing to encourage innovation. I must also talk about the Payment Systems Regulator ( PSR). This is a subsidiary of the FCA set up in response to ongoing challenges with payment systems in the UK, namely accessing payments infrastructure (in particular for new banks and other challengers) and concerns about the slow pace of change.
The PSR has objectives to promote three things: the interests of service users, competition, and innovation in payment systems. While the first two of these are fairly standard objectives for a regulator, the innovation objective is unusual.
There are two primary ways in which the PSR will achieve its innovation objective. First by removing barriers to competitive innovation – ensuring challengers can access payments infrastructure so their businesses can move money. And second, by ensuring collaboration delivers good results for all users of the payments system. Where collaboration is needed to facilitate innovation, for example regarding messaging standards, it is important these decisions are taken with the needs of all users, including challengers, in view.
This is really important for the Fintech community – payments innovation is one of the most active areas in Fintech, with perhaps 40% of the Fintech population operating in this segment.
What does disruption look like?
I’ll now talk about what we are seeing in the market by way of disruptive business models. It is a very diverse population, but if there’s a common theme it is that they are technology driven, well branded and looking to deliver the kind of one-click customer experience so very different from the traditional lunchtime queue at a bank branch.
Let me start with the example of crowdfunding, including peer to peer (P2P). The emergence of crowdfunding has come about as a result of banks tightening lending and small firms looking for alternative ways to borrow.
A couple of examples:
Funding Circle is one of the UK’s three major peer to peer lenders – it takes money from savers and lends it out to small businesses, claiming to cut out most of the fees charged by banks. The company launched in 2010, and has since raised more than £100m in funding.
Peer to peer foreign exchange websites are eliminating the middleman from currency conversion. They offer their customers mid-market or crowdsourced rates and charge a flat commission rate of about 0.5% a transaction. Banks typically charge a margin of 1 to 5% on mid-market rates, plus a transaction fee. In the UK, Transferwise has gained some traction in this market.
As we saw the crowdfunding/P2P market develop, we recognised this was something genuinely new and developed a tailor-made approach to regulating this market, something that other regulators internationally are looking to emulate.
We are also seeing innovation in banking. Atom Bank, for example, is looking to provide a full banking service online, with no physical branches.
In payments we have seen innovations such as the digital wallet, contactless payments and more recently Apple Pay. It is worth noting that this all operates over the existing rails – Visa/Mastercard and the interbank systems. We have not yet seen anything to challenge these systems at an infrastructure level.
Another innovation with game-changing potential is blockchain technology. Blockchain is a public ledger for virtual currency transactions and share trading, and its best known application is Bitcoin, launched in 2009. Virtual currency can be defined as a digital representation of value that is neither issued by a central bank or public authority nor necessarily pegged to a fiat currency, but is accepted as a means of payment and can be transferred, stored and/or traded electronically.
To be clear, FCA does not regulate virtual currencies, but we continue to participate in discussions with regulators internationally and the UK government, for example via the Financial Action Taskforce on virtual currencies.
I have talked through quite a bit and there’s plenty I haven’t covered – there is a lot going on in innovation in financial services.
In my view disruptive innovation does not yet threaten to drive large incumbents out of financial services, but there are some increasingly clear benefits to consumers emerging. There are six themes that I would call to your attention:
- Cheaper models, including through online only provision, but also the potential for traditional banks to reduce their cost base by getting better at multi-channel delivery, much as the retail sector has done.
- Technology changing the role of human experts – this theme goes beyond financial services into all the professions, for example teaching and medicine. In their recent book, Susskind and Susskind predict that machines will outperform humans at most tasks – what does this mean for the market for, say, financial advice?
- New markets and functions, and serving previously unserved consumers. In the UK we are seeing firms like Aire geared towards the gap in the market for financial services for people recently arrived in the UK. Aire gathers a range of data to create a proxy credit record and thus enable credit scoring for those without a UK credit record.
- Easier payments – coffee outlets are not the only beneficiaries here. The rise of text micropayments and services like Justgiving, which enable online donations to causes great and small, are hugely beneficial to charities, school fundraising and other good causes.
- Regulatory tech and ‘bank in a box’ – the idea that banks could buy some or all of their technology off the shelf (including the boring bits they need to interface with regulators), allowing capability to be built and shared effectively.
- Big data – I’ve barely touched on this, and the competition implications of big data probably merit a session of their own. But in financial services we are seeing big data impact not only on marketing and pricing, but also on credit risk assessment and insurance underwriting, whether it be through accessing information through social media platforms or attaching a black box to your car to monitor how you drive.
So – to summarise – we’re seeing lots of innovation in Fintech, and we have an important role in enabling that. We are also seeing plenty of disruption. So far though Fintech is keeping traditional financial services on its toes rather than yet posing an existential threat – in particular none of the above threatens to displace the core maturity transformation (borrow short, lend long) activity of big balance sheet banks. Traditional financial services may be facing 'Uber-style' competition but not yet 'music streaming-style' demise.