NOVEMBER 7, 2023
10 min read
Are you starting your own fintech business in the UK but getting tangled in the web of ever-changing rules and regulations? It’s always a dark forest for everyone who wants to step into this field, and I’m here to guide you through it.
As a CEO with over 15 years of experience and a fintech expert who helped launch over 20 fintech products, I will try to gain your trust and demonstrate that navigating the UK regulations is easier than you think.
Now, let’s talk about you. Imagine you’re starting a fintech business in the UK. The fintech rules might seem complicated, but they’re crucial for you and your startup. My goal is to help you understand the regulations better.
You’ll navigate them effectively, which ensures your success in the UK’s dynamic fintech investment area. Becoming a global leader in the vibrant and ever-growing UK fintech world and international markets won’t be a challenge to you anymore.
The UK Fintech Regulations for Startups Are Not a Monster
“Fintech regulations” usually sounds scary for new companies and startups entering the industry. Yet, understanding how these rules work is as essential as learning the multiplication table in the first grade. Regulations are vital for your business growth.
It’s critical to take regulations into account when establishing your business. Building a company based on these guidelines is akin to laying the foundation of a secure and successful fintech venture.
Ignoring these regulations might lead to stagnation, hindering your entry into the market and stunting your competitive edge against industry counterparts. Though some wish for fewer restrictions, solid rules lay a foundation for your progress.
Adhering to rules, like knowing your customers (KYC) and obtaining the proper licenses, is the bedrock for faster growth. As your company expands, you can face more scrutiny and work toward advanced licenses.
Regulators focus on protecting the market’s honesty, which is vital in our connected world. They encourage innovators, as they could shape the industry’s future.
The regulatory process primarily emphasizes teamwork, forming a solid fintech sector to encourage innovation and investor confidence.
The Financial Conduct Authority (FCA), which stands for a financial services regulator in the UK, has the responsibility of safeguarding consumers, maintaining industry stability, and encouraging fair competition among financial service providers. And this institution isn’t just about following rules; it actively nurtures innovation. Programs like the Regulatory Sandbox let businesses test new ideas before launching them, ensuring regulations are followed and new products or services are introduced quickly.
The main point to understand here is that following the UK’s regulations doesn’t mean everyone tries to make your path in fintech harder. On the contrary, they try to protect you and your business in the future and provide you with opportunities to grow.
- For example, the FCA’s active role in regulating new tech, such as cryptocurrency, emphasizes the need for protection. They aim to support new companies in the competitive field of fintech.
What are the Opportunities for Fintech Firms in the UK?
To establish a company and develop a fintech business, you can choose any niche you prefer. Yet, according to the UK Department of Business and Trade, there are five key areas where fintech companies can expand:
- Payment technology (Paytech). The UK leads the payment technology revolution, offering investment opportunities in digital commerce, cross-border payments, mobile POS payments, and more.
- Wealthtech. This sector is transforming investment and asset management. Opportunities lie in robo-advisors, portfolio management tools, micro-investment, social trading platforms, and business-to-business (B2B) software solutions.
- Credit and lending tech. Solutions in this area enhance lenders’ payment processing time, providing personalized experiences for loan and mortgage customers. This field is expected to see high growth.
- Digital banking. Nearly a quarter of British adults have accounts with digital-only banks. The Global Survey says that around 54% of people in the United Kingdom (including all generations) use digital wallets and mobile banks. Moreover, 66% of banking customers aim to transition to digital banks fully.
- Distributed ledger technology (DLT) and digital currencies. The application of blockchain technology in finance is anticipated to reach a global market size of £16.7 billion by 2026. Cryptocurrencies, trading platforms, non-fungible tokens (NFTs), alternative asset trading, and related support structures are forecasted to dominate the market soon.
In the UK, wealth tech and payment technology are standout strengths, constituting more than 50% of all UK fintech companies.
Fintech Regulations in the Pre-Brexit UK vs Present-Day Regulations
Before the UK’s separation from the EU, fintech regulations were primarily aligned with EU standards, encompassing the following:
- Passporting Rights: UK-based fintech firms enjoyed the privilege of passporting rights, enabling seamless operations across the EU without additional authorizations.
- GDPR Compliance: Compliance with the General Data Protection Regulation (GDPR) was pivotal, ensuring comprehensive data protection and privacy.
- Strong Consumer Protection: Robust consumer protection regulations were in place, fostering trust within the fintech industry.
Following Brexit, the UK implemented various alterations in its fintech regulations:
- End of Passporting: The loss of passporting rights prompted UK fintech companies to establish a physical presence or seek authorization in EU countries to continue their operations, leading to many setting up offices in EU member states.
- Data Protection: While much of GDPR was retained, companies now navigate both GDPR and UK GDPR, leading to a dual regulatory environment. Understanding these nuances is crucial for data-driven fintech firms.
- Regulatory Innovation Sandbox: The introduction of a Regulatory Innovation Sandbox encourages fintech firms to test innovative products in a controlled environment, fostering growth and compliance.
- Financial Services Bill: The Financial Services Bill introduced regulatory changes, including a new prudential regime for investment firms and the establishment of the Financial Services Regulatory Initiatives Forum.
The UK Regulations that Fuel Fintech Innovation
#1. EMI vs. PI — The Right Choice for Your UK Startup
In the late 2000s, pivotal decisions set the stage for considerable changes. The European Commission introduced two directives focused on electronic money and payment services. These directives have reshaped how companies can enter the fintech market. As with Electronic Money Institution (EMI) or Payment Institution (PI), you don’t have to get a license to conduct official fintech activities.
Electronic Money Institution
EMI stands for Electronic Money Institution. It’s a licensed entity specialized in issuing electronic money, known as “e-money.”
With EMI, you can provide the following services:
- Issuance of e-money
- Facilitation of electronic payment services
- Management of digital financial transactions
- Ensuring compliance with regulated guidelines.
EMI is advantageous for fintech and startups because it allows for streamlined online transactions, offering clients the flexibility to utilize e-money for secure digital transactions. This institution provides an easy way for businesses to access electronic payment services while still following specific regulations.
Payment Institutions (PI) cater to handling a range of payment services, ensuring smooth financial transactions:
With PI, you can provide the following services:
- Payment processing services
- Facilitation of seamless money transfers
- Offering payment options such as cards
- Credit services.
PIs are instrumental in managing the flow of payments and financial transactions. Unlike Electronic Money Institutions (EMIs), PIs do not issue electronic money. Instead, they efficiently manage funds within regular bank accounts, facilitating secure and effective payment operations.
Comparing Services of EMIs and PIs
The choice between the two depends on your business needs. Both EMIs and PIs offer payment services, currency exchange, and more, but only EMIs issue electronic money.
If you can’t understand which model fits you best, look at the popular example:
Wise, formerly TransferWise, transitioned from a PI to an EMI to expand its capabilities.
In the beginning, Wise was operating as a PI. However, as Wise’s popularity surged, they encountered a hurdle. A company couldn’t issue payment cards or effectively manage customer funds without having specific payment orders for each transaction. This limitation prompted a crucial decision.
Wise became an EMI, recognizing the need for a more universal framework. As an EMI, the organization gained the power to issue payment cards and operate multi-currency accounts.
Hence, now you may apprehend that when you are only beginning your journey in fintech and don’t have many users and significant capital turnover — PI is enough. In contrast, EMIs have broader services, acting like digital banks.
#2. Simplifying and Enhancing Path to Obtaining Banking Licenses
Gaining a banking license faces a hurdle: starting a bank requires substantial capital to absorb potential losses and ensure financial stability. However, acquiring a banking license demands the existence of this capital. The UK found an innovative solution. They divided the process into two parts.
Digital challenger banks like Starling and Monzo obtained a banking license labeled “with restrictions,” tailored for startup firms lacking the necessary regulatory capital.
This process is called Mobilization (you can learn more about this in the report by FCA and Bank of England), and it offers newly established banks additional time to complete the development of their infrastructure, such as IT systems, governance structures, and risk management frameworks, after obtaining authorization. This extension allows these banks to fine-tune their operations before full operation commences.
This enabled these startups to access further funding as they grew, backed by venture capital.
#3. Granting Fintech Access to the Central Bank
In the UK, fintech companies can obtain accounts with central bank’s and have access to their payment systems. This approach minimizes risk for fintech company deposits and fosters competition in pricing with the banking and financial services sector. Companies such as Wise, Modulr, and Form3 have utilized this capability, benefiting both fintech and non-finance companies.
One notable player in this field is Clear Bank, a UK-based clearing bank that provides clearing and agency banking services to fintech companies. Clear Bank’s innovative approach has helped numerous fintech startups navigate the complex regulatory landscape. By partnering with Clear Bank, these companies gain access to central bank money and payment systems, ensuring the safety of their deposits and facilitating seamless transactions.
This partnership with Clear Bank is a testament to the collaborative nature of the UK’s fintech ecosystem. It not only eases the burden of regulatory compliance for startups but also promotes healthy competition and innovation in the financial sector.
#4. Establishing a Defined Standard for Open Banking
- The U.S. follows a market-led approach for Open Banking, which has its limitations, especially with lower conversion rates in many cases.
- In contrast, the EU enacted the Payment Services Directive (PSD2) in 2018, which set rules for third-party access to payment account data. Lately, they updated it to PSD3 that includes the key aspects of PSD2, like transparency, liability, and open banking. But PSD3 has stricter rules about customer authentication and accessing payment systems, which helps make payments safer and fight fraud.
- The UK’s Open Banking Implementation Entity established a model and API standards, clearly defining how Open Banking would operate.
For an insight into how fintech regulations can vary based on different authorities and countries, I suggest reading an article on regulations in the MENA region. It highlights the diverse nature of open banking and its application in various countries.
In the UK, one can pay tax bills with HM Revenue and Customs using open banking-initiated payments. Moreover, along with Open Banking updates, the UK introduced Variable Recurring Payments (VRP), allowing secure one-click subscriptions directly from a user’s bank account.
This move from unofficial “screen scraping” to officially secure Open Banking benefited companies like Truelayer, Yapily, Credit Kudos, and other UK payment service startups.
#5. Developing a Regulatory Sandbox for Early Financial Innovation
The UK initiated the world’s first regulatory sandbox, aiding early-stage firms by providing guidance on regulations and waivers for novel or innovative tests. Diverse companies such as Zilch, Bud, the London Stock Exchange, and Barclays have benefitted from this Sandbox.
Recently, the sandbox has evolved digitally, enabling companies to access synthetic data from real bank customers, allowing them to make innovative solutions and validate their effectiveness beforehand. The UK has also launched a digital assets Sandbox for tokenized securities, simplifying the complex requirements around securities for innovators.
#6. Enacting Legislation for Digital Asset Guidelines and Consumer Protections
In June 2023, the UK implemented the Financial Services and Markets Act, categorizing crypto as a regulated financial activity. The act defines consumer rights, sets capital requirements for Stablecoin issuers, and provides legal certainty for consumer protections.
Over the past decade, the UK has seen the emergence of influential global brands in its market. The forward-thinking strategies of UK regulators, such as establishing a permanent digital sandbox, facilitating licenses for digital asset businesses, and advancements like VRP, are key drivers behind the current momentum.
Moreover, the success of neobanks in a market with low card transaction revenue demonstrates the efficacy of regulations developed in the previous decade.
The inventive drive of UK entrepreneurs has and will persist in challenging traditional financial services, fostering an environment of disruption and evolution with the mix of new technologies and established regulations.
To thrive as a fintech company and become a leader not only in the UK but worldwide, understanding the whole regulation process is critical. A competent team of professionals can be the most effective approach to tackle this challenge. Establishing a compliance team is intricate, but having one could ensure your business is maintained.
If you have an innovative fintech concept or product, DashDevs can be your ideal partner. Our experts are well-versed in the technical intricacies of business banking and can guide you through acquiring essential licenses and ensuring compliance with the UK regulatory framework.