Is the UK still a hotbed for fintech innovation?

London: In early 2021, then Chancellor of the Exchequer, Rishi Sunak, announced a plan to supercharge fintech within the UK.

“Our vision is for a more open, greener, and more technologically advanced financial services sector,” he said. “The UK is already known for being at the forefront of innovation, but we need to go further. The steps I’ve outlined today to boost growing fintechs, push the boundaries of digital finance, and make our financial markets more efficient will propel us forward. And if we can capture the extraordinary potential of technology, we’ll cement the UK’s position as the world’s pre-eminent financial center.”

He wasn’t wrong. At the time, the industry was making strides toward financial innovation. The Kalifa review had been published earlier that year and more than a few of UK-founded fintechs had reached unicorn status.

The “ambitious program of initiatives” aimed at driving innovation further forward. The FCA was to launch a regulatory “scale box,” the visa system was going to be streamlined to attract the best talent, recommendations following the Kalifa Review were going to be taken forward, and the illustrious CFIT (Center of Financial Innovation and Technology) was to be formed.

Two years on, with an almost stagnant economy and a dwindling appetite for UK IPOs, the fruits of this plan are yet to be seen.

It’s not all Sunak’s fault; the aftermath of the pandemic brought a number of economic headwinds, and the political landscape had its bout of instability. The fintech industry globally has been hit with difficulties and low funding, and the UK, stumbling to find its post-Brexit footing, has felt the implications.

Deal count for H1’2023 in the UK was seen to have dropped by 53%, according to KPMG’s Pulse of Fintech Report, dragged along by several mega-raises and a multi-billion buyout of data insights firm Wood Mackenzie. While the UK still remains the strongest in the EMEA region, The US has seen growing fintech funding, and Europe has implemented strong regulatory policies to improve its future position.

In addition, home-grown challenger banks are turning their sights elsewhere. Revolut CEO Nikolay Storonsky famously said earlier this year, “In the UK, there are higher taxes to pay and an extremely bureaucratic regulator.” The comment was made soon after the company withdrew its banking license application, amongst indications it would be rejected.

While this may be the comment of a disgruntled leader smarting from a banking license rejection, criticism of the UK’s approach in other areas of financial innovation has also seen print.

The government-commissioned Kalifa Review even noted a need for ongoing development, “The trajectory of UK fintech is at an inflection point of opportunity – and risk. While the UK’s position is well established, its future is not assured.”

An area of particular concern for fintech leaders in the UK is the open banking sector. Britain, once a pioneer in open banking, was seen to be doing little to further innovation into open finance.

“The UK was ahead of the world in open banking, there’s no doubt about it,” said James Lynn, Co- Founder of Currensea. “But there’s a real danger that the UK could be resting on his laurels when it comes to open finance and really getting behind.”

In early 2023, the Joint Regulatory Oversight Committee (JROC) published its recommendations to grow open banking in the UK. The goal of the recommendations was to increase innovation and competition while lowering costs. “While significant progress has been made, there is more to be done to deliver the full benefits of open banking within retail banking markets and beyond,” they stated. However, they also said its successful implementation would take years and rely heavily on the governments’ implementation of long-term open banking regulation.

The recommendations came at a critical time. In January of the same year, the Competition and Markets Authority (CMA) announced the completion of its open banking roadmap, which, for some, left much to be desired. In July 2023, Natwest, one of the largest banks in the UK, released a report identifying a need for development in the space. According to the report, while Open Banking in the UK has been a “qualified success”, it was still only utilized by 10% of adults.

“Unless the regulator says to do something, nothing happens,” said Stephen Wright, head of regulation and standards, bank of Application Programming Interfaces (APIs) at NatWest Group. “When you look at the adoption of internet and mobile banking, which is more than 60% adoption, and the adoption of contactless, that’s up at 85–90% – it’s got a way to go.”

Elsewhere, open banking standards have gained popularity, and while in many countries, regulators are yet to implement formalized rules, private companies have driven development.

In the US, fintechs such as Plaid have driven demand for more open access to financial data. According to a Plaid survey, the ability to switch accounts and connect fintech accounts easily to their bank has become a priority for US consumers. They also found demand had gotten even stronger as consumers faced more economic challenges. The efforts of private actors like Plaid have been bolstered by a movement from local regulators to implement rules supporting a move towards open banking.

Natwest identified a need for a coherent plan to reach UK open banking objectives set out in the JROC’s report. They stated there was a lack of incentives and coordination to meet these goals and called for a regulatory prioritization for removing roadblocks to encourage innovation.

For many, the UK’s success in fintech innovation lies in the supportive regulatory structure.

The Financial Conduct Authority (FCA) has been at the forefront, sparking a significant shift in 2016 when the entity launched its regulatory sandbox for fintechs. Working with regulators, startups could work to find solutions that were innovative while remaining compliant.

Initially starting with accepted “cohorts,” the FCA opened out the sandbox in 2021 to any startup at any time, driving the pace of innovation.

For a lot of startups, this marked the beginning of their success story.

“When we initially set up, we went through the FCA sandbox,” said Lynn. “Staying really close to the regulator is important. For me, I think the most important approach there is being proactive and actually thinking through regulatory angles and working with the regulator, as opposed to just sort of coming up with ideas and waiting for someone to knock on the door.”

Currensea then grew to be valued at “just under £20million” last year before valuations across the industry plummeted. This was despite their launch “at the worst possible time in history” for a travel debit card – just before the COVID-19 pandemic grounded planes for months.

Despite the encouraging start and the subsequent regulatory “scale box” for growing startups promised by Sunak in 2021, momentum has dwindled. Leaders in the UK fintech sphere have voiced their concerns.

“Over the last decade, the UK has been the leading hub for fintech globally, supported by regulators who have embraced innovation,” said Janine Hirt, CEO of Innovate Finance. “However, as other countries are catching up, we risk falling behind unless our regulators continue to innovate.”

The Financial Services and Markets Act 2023 (FSMB 2023), given the Royal Accent in June, marked a pivotal step to improve the UK’s financial market competitiveness post-Brexit.

“The Act is central to the Government’s vision to grow the economy and create an open, sustainable, and technologically advanced financial services sector,” stated HM Treasury. The Treasury wrote in their statement that the FSMB2023 allowed for the UK to take advantage of post-Brexit freedoms and “rocket boost” the sector.

It allowed for a number of steps to be made towards regulatory innovation.

“This landmark piece of legislation gives us control of our financial services rulebook, so it supports UK businesses and consumers and drives growth,” said Economic Secretary to the Treasury, Andrew Griffith. “By repealing old EU laws set in Brussels, it will unlock billions in investment – cash that can unlock innovation and grow the economy.”

In response to HM Treasury’s call for proposals regarding financial services regulation, running May to July 2023, Innovate Finance outlined its vision for regulation that would drive further innovation.

“As technology, and the fintechs who enable it, become central to financial services, we need to see new regulatory approaches that support innovation,” said Hirt. “We also welcome new policies that can create more agile regulators that can protect both consumers and market competitiveness and enable innovation in financial services”.

Central to their proposal was the move away from a “one size fits all” approach. “The application of the same rules for start-up and scale-up fintechs as traditional financial institutions has a disproportionate impact..when compared to incumbents,” they stated.

They explained that the current financial regulation framework can be difficult for startups with limited resources to navigate and understand. They also posed the idea for a “RegTech test” when new regulation is implemented to check the technology sector’s ability to remain compliant.

A particular area of the FSMB 2023 that was deemed progressive was its focus on enabling the “safe adoption” of digital assets and blockchain. Perhaps in direct response to the landmark MiCA bill introduced by the European Commission a month prior to the FSMB’s royal ascension, it provided guidelines for encouraging the establishment of regulated digital asset companies in the UK.

“The Act now gives regulators the powers to develop and apply rules for crypto assets, and we encourage the FCA and Bank of England to engage directly with industry on how existing rules can be tailored to crypto assets and stablecoin,” said Hirt.

“We would encourage rapid progress on (a sandbox for innovation in financial market infrastructure from the FCA), ensuring it is open to as wide a variety of technology and markets as possible – and with regulators tweaking their rules alongside firms testing the use of digital assets to improve efficiency and operational capability.”

The introduction of these allowances run in accordance with Sunak’s desire to “make Britain a global hub for crypto assets,” stated during his time as Chancellor of the Exchequer. This same desire led Sunak to announce plans for the creation of a government-backed NFT, which were subsequently dropped a year later.

In addition to the FSMB, various regulators have put forth proposals that could nurture the digital asset space. The Law Commission proposed the creation of a new personal property category that would allow for the ownership of digital assets.

“The use and importance of digital assets has grown significantly in the last few years,” said Sarah Green, law commissioner for commercial and common law. “The flexibility of the common law means that the legal system in England and Wales is well placed to adapt to this rapid growth.”