‘Fintech’ – which is a combination of the words financial and technology – is a term used to describe a new technology that aims to automate and improve the delivery and use of financial services. Fintech is used as a tool in order to help companies, as well as consumers, manage their financial operations by using specialized software and algorithms. The term describes a wide range of financial activities, from money transfers to managing investments, generally without being assisted by another person. Financial technology is already a popular tool, as according to a statistic from 2017, a third of consumers are using 2 or more fintech services.
Many fintech companies are operating in an environment that is highly regulated. Fintech companies should analyze early in their venture whether or not the business model is regulated. The issue of regulation is critical due to the fact that regulated business activity generally needs a license from the local regulator. In order to apply for the license, skilled managers are required, as well as enough capital, and submitting a business plan that shows the setup of the organization.
In order to assess the regulatory risk, there are certain steps that fintech companies need to go through – these steps will need to be done regularly, as the environment changes constantly, and businesses that were previously unregulated might end up requiring a license at one point:
- Identifying key jurisdictions
- Narrowing down the analysis to a handful of countries
- Developing a business model as well as alternatives (as a safety net in case it turns out that the initial model requires a license)
- Figuring out a basic legal model – answering legal questions
- Finding out whether or not the model is regulated – there is the possibility that this can be done by contacting the regulator
Finding out whether or not a business model is regulated can be done, in some cases, by studying competitors. Attention to detail will be necessary, as small details that are part of a business model might end up having a big impact when it comes to regulation. In case a fintech company at the end of the whole process is unsure if their model is regulated, a clear answer can be gained by having a feasibility study prepared by a law firm – this will require a small investment, but it might be worth it in the long run.
In case it turns out that the business model of a fintech company is regulated, and the company chooses to not apply for a license, then changes will be necessary if avoiding regulation is preferred. Small changes can end up going a long way, as there are certain triggers of regulation. In order to stay outside the scope of regulation, the company should try to:
- Not handle customer money or assets
- Not deliver services such as loans, deposits or brokerage activities
- Focus on aggregation models or distribution
- Focus on providing the financial solution, as opposed to the financial service
While there are no guarantees, tweaking these areas can end up helping avoid regulations. Alternatively, partnering with an institution that is regulated might help the fintech company, due to the fact that the license might cover their activities. Methods that have worked in the past are:
- Providing technical infrastructure, while the partnering entity offers the service itself under its own name
- Handling most of the services under the banner of outsourcing, while the partnering entity legally provides the service
- Operating as an agent of the partnering entity
Depending on the model they opt for, fintech companies might have to face certain regulations when they operate with a regulated institution. This is all a part of the required private equity due diligence of operation. However, partnering with a regulated entity will help the fintech company avoid applying for a license that would have put a hole in their budget – or for which they might not have the budge at all. On the flipside, an obvious result of partnering with a regulated institution is the fact that earnings will be shared.
If regulation cannot be avoided, an alternative that fintech companies can take into consideration is moving to a different jurisdiction that might have a regulatory environment that is lighter. The company can choose a country where the service is not regulated, or where the regulator offers a form of temporary exemption when it comes to small startup companies. Another option, is choosing a jurisdiction where the regulator is less strict, as opposed to the markets which are more developed.
Companies should keep in mind the fact that the strategy of avoiding regulation can end up being harmful to an extent, as business partners might not look positively at institutions that take minimalistic approaches when it comes to regulations. In addition, companies that operate in a regulatory “sandbox” or if they are offered an exemption might not be able to offer their services across the border.