UK FinTech: Regulating for innovation

Speech by Christopher Woolard, FCA Director of Strategy and Competition, delivered at the FCA’s event on UK FinTech: Regulating for innovation on 22 February 2016. This is the text of the speech as drafted, which may differ from the delivered version.

Introduction

Good evening everyone.

It’s a pleasure to be hosting you all this evening, it is very good to see so many of you here at the start of UK Fintech week.

Fintech week is looking at innovation in the round. This evening, I want to focus on just one aspect. How can regulation foster innovation in financial services? And as part of that how can we ensure that we have a regulatory environment fit for future innovation?

I’d like to start with the question, why does the FCA care about innovation? Primarily because of our duty to promote competition in the interests of consumers. One of the best ways we can promote competition is to foster disruptive innovation.

Disruptive innovation drives a number of dynamics in the market. A few firms will emerge as genuine competitors at scale to the existing incumbents. Many will be sufficiently interesting business models that they may find themselves purchased by bigger players and their technologies adopted in the mass market. And both of these developments may drive other incumbents to compete harder to retain or gain customers.

Getting these competitive conditions isn’t something that only the regulator is interested in. That’s why we have diverse representation here tonight from a cross-section of financial services firms, including start-ups, incumbents, as well as trade bodies, consumer groups and government.

Whilst we come to this event with different viewpoints, business models, and perspectives, one thing that we can agree on is that the environment in which we are operating is significantly different from just 18 months ago.

The 2015 EY Fintech adoption Index that surveyed six markets around the world found that on average 15.5% of digitally active consumers are users of fintech. The survey suggests that the average rate of adoption could double in the next 12 months.

It’s a sobering reminder of the pace at which the digital landscape is evolving and the scale of the challenge for us as a regulator to bear in mind when we think about both the risks that financial innovation may bring and how to balance that against creating unnecessary barriers to the many opportunities. 

Our main way of addressing this set of issues has been Project Innovate and I wanted to say a little more about this now.

The Project Innovate story

As the Innovation Hub matures we are seeing firms that we supported being authorised. Out of the first wave of firms we supported, 18 have been authorised, and 21 are in the process of going through our authorisations process.

We launched Project Innovate in October 2014.

It has two main strands of work. The first is providing direct support to innovative firms and the second is policy and process improvement.

What does direct support mean? It’s born out of the recognition that extended periods in development can burn cash for innovators. It isn’t free consultancy or picking winners. Instead, we assist innovative firms to work with us. Some tech start-ups are completely unfamiliar with financial regulation which can be daunting; larger firms are more familiar with regulation but often have complex questions about their new propositions. We are here to help both types of queries as long as propositions meet our criteria that they are innovative and we can see benefits to consumers.

The Innovation Hub team also offers guidance pre-authorisation and gets the firm to think about how to best prepare for this. This year we want to make Project Innovate’s service work end-to end. Firms that have received initial support from the Hub will have their applications handled by a specialised Project Innovate authorisation process. After authorisation we will provide dedicated supervisory support, normally for one year.

The key to success here is an early engagement model that results in a better understanding of risks and benefits from both our perspective and also the firms progressing through this regulatory process.  We don’t just want firms to learn from us, but we want to capture their experience too in evolving markets.

Take for example one start-up firm who are here in the audience today. WealthKernel is a provider of automated wealth management solutions to institutional clients and in particular they want to use technology to change how smaller institutional clients receive financial advice.The Innovation Hub helped with their thinking before authorisation and they are currently going through that process now. At the same time we were able to explore the pros and cons of automated advice with comparison to the US market where this has gained a huge amount of traction and WealthKernel was able to play a role in our robo-advice forum. Engaging early on was as much as a discovery journey for us as it was for them.

In regards to new products, we have been able to be at the forefront of seeing these come into the market.  For example, the insurance firm, CUVVA is a business that provides ultra-short term car insurance, allowing users to buy car insurance covering a period of a few hours, and allowing people to borrow or pool friends’ cars. The Innovation Hub helped the firm think carefully about how their business model may fit into regulation. The firm has now been authorised by the FCA and is open for business.

To put these examples in a bit more context, through the Hub model, we have now received 413 requests for support and supported 52% of these firms. It is important to note that the 48% of firms we did not provide support to was because in most cases the idea was already established, in which case they can still take a standard route to authorisation, or more rarely we did not think it was likely to be in the interest of consumers.

As the Innovation Hub matures we are seeing firms that we supported being authorised. Out of the first wave of firms we supported, 18 have been authorised, and 21 are in the process of going through our authorisations process. That is about a 30% conversion rate. The firms that have been authorised include investment firms consumer credit firms and insurance intermediaries.

International update

While these examples and statistics illustrate successes domestically, the international context is just as important. In the past year, we have had over 25 non-UK innovators approach the Hub either for support or to learn more. Furthermore, if we want disruptive innovators at scale we need to think about how they can expand internationally with the minimum of friction.

This year through Project Innovate we aim to ramp up our international engagement. We are looking to have cooperation agreements in place with some key regulators to reduce some of the barriers to UK authorised firms looking to grow scale overseas and to assist non-UK innovators interested in entering the UK market. I am off to Australia next month to exchange views and ideas with ASIC, which in March 2015 launched its own “Innovation Hub”.

A number of overseas regulators have also introduced initiatives to promote innovation in financial services. Last year the Japanese FSA has launched a “FinTech Support Desk”. The Monetary Authority of Singapore has also formed a FinTech & Innovation Group responsible for regulatory policies and development strategies to facilitate the use of technology and innovation in the financial sector. And the CFPB in the US has Project Catalyst aimed at small firms. So we are not the only ones in this space and we can stand to benefit from learning from each other along the way.

Regulatory Sandbox

While we have made great progress to date with Project Innovate, it’s essential we don’t stand still.  Our coming area of focus will look at policy and process improvement. We set ourselves an ambitious goal to create something practical and useful to foster innovation and are opening up the possibility of answering regulatory uncertainties through testing in a live environment.  This will be known as the sandbox. 

The Sandbox will allow businesses to test out new, innovative financial services without incurring all the normal regulatory consequences of engaging in those activities. It is safe to say that we have been inundated with interest about the sandbox.

We will offer a range of options for firms such as authorisation for testing; no enforcement action letters, and individual guidance and waivers for all firms. Safeguards for consumers and the financial system while testing will be agreed between the businesses and the FCA. One thing that we won’t compromise is lower standards of protection for consumers.

We also recommended options, the virtual sandbox as a testing environment and an umbrella scheme to allow one or more bodies to act as a sponsor for innovation. We see industry leading these working together and with the regulators in a more collaborative way.

In December 2015 we held a Sandbox event to elicit feedback from industry on FCA and industry recommendations made in our report. We had Innovate Finance, BBA, and ABI present their thoughts on industry recommendations outlined in the report. We are currently reviewing the feedback received on FCA options and plan to have the sandbox unit up and running later this Spring.

RegTech

In addition to this, we are also looking at ways of encouraging firms to be innovative with technology and helping them to help identify ways to integrate these new technologies into their business models. Most people refer to this as regtech – thinking about solutions to issues that already sit squarely within the sphere of regulation.

Since our initial discussions with industry, we have launched a call for input to seek broader views on how we should progress our RegTech work. There are some key opportunities here, which include managing regulatory requirements more efficiently, and, an opportunity for us to understand how we can best support developments and potentially adopt some RegTech solutions ourselves. 

One example could be distributed ledger technology, sometimes more popularly known as ‘block chain’. There have been countless column inches devoted to this subject. The current development of distributed ledger technology has the potential to revolutionise financial services; whether it is the panacea of all ills in the financial world is yet to be seen. However it’s clear that there are a lot of regulatory and consumer issues that will need to be discussed as the technology evolves. For example, how individuals gain access to a distributed network and who controls this process, along with what data security exists for users are vital considerations for us as a regulator.

Innovation can be an iterative process and the development of a digital solution is therefore unlikely to be perfect first time round. During the phase of any digital development, it’s crucial that innovators are allowed the space to develop their solutions. The FCA continues to monitor the development of this technology but is yet to take a stance until its application is clearer.

In the meantime, we continue to work with firms developing distributing ledger technology solutions via the Innovation Hub to ensure consumer protections are being factored in during the development phase of this technology and the Hub liaises with the rest of the organisation to ensure a coordinated and informed approach.

We are particularly interested in exploring whether block chain technology can help firms meet know your customer or anti-money laundering requirements more efficiently and effectively. We are engaged in discussions with government and industry on this issue.

Close

The key challenge for government, industry and regulators is to continue to ensure the regulatory environment fosters the best of financial innovation. Our ultimate goal is that the benefits of competition can be realised in the interest of UK consumers.

So in conclusion, as the regulator we want to see a thriving market for financial innovation in the UK.

We only have to look at the fact that Project Innovate has been copied around the world to know that we operate in a competitive international environment.

Project Innovate has had a good introductory phase, what we need to do is keep pushing forward and not rest on our laurels. 

The Sandbox is the logical next step and offers us, industry and consumers a good opportunity to test business models and products in a controlled environment.

The key challenge for government, industry and regulators is to continue to ensure the regulatory environment fosters the best of financial innovation. Our ultimate goal is that the benefits of competition can be realised in the interest of UK consumers.

We all have a part to play in that, and I look forward to our discussion this evening.