UK-RUSSIA FINTECH WORKING GROUP Insights and recommendations

April 2020 @thecityuk www.thecityuk.com TheCityUK

TheCityUK is the industry-led body representing UK-based financial and related professional services. In the UK, across Europe and globally, we promote policies that drive competitiveness, support job creation and ensure long-term economic growth. The industry contributes over 10% of the UK’s total economic output and employs more than 2.3 million people, with two thirds of these jobs outside London. It is the largest tax payer, the biggest exporting industry and generates a trade surplus greater than all other net exporting industries combined.

Moscow Innovation Cluster

Moscow Innovation Cluster (MIC) has been designed as a platform for innovation and interaction between business, industry, science and the city. Russian President Vladimir Putin signed the establishment decree on 26 November 2018. In September 2019, MIC launched its own digital platform for Moscow companies to get the necessary services and information for business development in one place. Today, the platform includes a space lease service; a navigator through the support efforts the city administration and other government institutions can provide; a service to find partners, including investors, customers and clients; a service to find pilot sites to test products; contracting capacities exchange to facilitate interaction between customers and contractors, and a patent exchange, where you can easily find the necessary technologies in the e-database.

2 www.thecityuk.com Contents

Foreword 4

Working Group Recommendations 5

Why a FinTech strategy? 7

Recent trends in FinTech development 10

How FinTech Hubs Create New Value through RegTech 12

How Blockchain can support RegTech 14

An industry perspective on promoting and encouraging Fintech and Blockchain projects 16

Developing the skills, knowledge and behaviour to create a sustainable FinTech ecosystem 18

Transformation and innovation: A guide to partnerships between financial services institutions and FinTechs 22

Launching a FinTech in the United Kingdom 29

Contributors 31

3 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS FOREWORD

Across the world, FinTech is breathing new life into financial services, opening new markets, giving customers more freedom and choice, and including more people in the financial system than ever before. The FinTech revolution has been diffused and decentralised. There is no one centre from which innovation flows. Financial services firms who pioneer innovative technology solutions, non-traditional financial services firms and start-ups have clustered in FinTech hubs which have proceeded to connect with each other like nodes in a network. The UK and Russia are both prominent FinTech hubs. UK FinTech hubs employ some 76,000 people and generate approximately £6.6bn of revenue. Their success is underpinned by the UK’s world-leading financial services ecosystem. Russia, meanwhile, is renowned for its depth of technology talent and expertise. The country is facing strong consumer demand for FinTech solutions: 82% of Russian citizens use various FinTech services on a daily basis. FinTech clusters are called hubs because they are centres for interaction and exchange, made stronger by their connectivity with other hubs. FinTech companies benefit from constant cross-border flows of people, ideas and capital. In the UK, for example, early stage FinTech companies are often founded by international entrepreneurs and benefit from international talent; and, in the first six months of 2019 alone, the sector attracted $2.9bn in funding, largely from international sources. The origins of this UK-Russia FinTech project lie in our joint conviction that while the UK and Russia have achieved much independently in developing FinTech capabilities, we can achieve so much more by working together. TheCityUK and Moscow Innovation Cluster with support from the British Embassy, Moscow, have brought together a range of UK and Russian FinTech experts to share insight and expertise. We have gathered representatives from banks, early stage FinTech companies, legal and consultancy firms, stock exchanges, regulators and trade associations to share perspectives on how the UK and Russia can develop areas of mutual interest. This is why, as part of the UK-Russia FinTech project initiative, we have complied this report which summarises insights from members of the working group, and we hope it will help deepen FinTech cooperation between Russia and the UK. We hope that the range of issues discussed throughout the paper will shine a light on some of the key strategic and commercial opportunities for both countries. This paper has been made possible by the financial support of the British Embassy, Moscow and with input from UK and Russia-based FinTech stakeholders participating in the UK-Russia FinTech Working Group. We would like to thank everyone who has directly and indirectly contributed to the work of the Working Group.

Marcus Scott Anatoly Valetov Chief Operating Officer, TheCityUK Director, Moscow Innovation Cluster

4 www.thecityuk.com Recommendations of the UK-Russia FinTech Working Group

The UK-Russia FinTech Working Group set out some recommendations in the following four core areas:

How to create a FinTech Hub The starting point for any aspiring FinTech hub is to link its FinTech development strategy to the broader needs of the particular economy that it operates within. Beyond this, FinTech hubs need to make sure they can develop funding pipelines for early stage FinTech companies. Public funding can have a role in catalysing private investment although any FinTech hub will also need strong connections with established financial institutions that are ready to test and implement innovative solutions. Good regulation is also needed: the ’test and learn‘ model of regulation adopted in the UK (and Singapore) is a good example of pro-innovation regulation. FinTech hubs are only as strong as the people within them, and so they need to develop training institutions which encourage an entrepreneurial mind set in practitioners. This is every bit as important as helping people acquire technical knowledge. Finally, a FinTech hub needs good governance to bring all of these factors (regulation, finance and talent) together. Governance requires coordination between the hub authority, regulators, the central bank and relevant ministries.

How to create right-touch FinTech regulation Regulatory sandboxes, as pioneered in the UK and now implemented in many other jurisdictions, are frameworks that offer a testing environment for new technologies within controlled regulatory environments. These are a good model for regulatory approaches that seek to encourage FinTech growth while protecting consumers. However, there is no one-size-fits-all regulatory solution to approaching FinTech and different countries have to account for various factors while implementing innovative regulation to meet the needs of their economies. Typically, regulatory sandboxes support firms that fall within scope of the regulator’s remit and can also be suitable for firms that do not require licenses to operate. RegTech firms are an example of this. In addition to regulatory sandboxes, it may also be worth FinTech hubs considering other regulator-led innovation mechanisms such as tech sprints and industry proofs of concepts which are neutral between technology providers but which endorse the use of particular technologies, such as RegTech and AI, that allow vendors providing solutions around those technologies to benefit from an innovative regulatory environment.

How to help FinTechs scale internationally Companies that attract capital are far more likely than others to expand internationally and so FinTech hubs should work hard to develop accelerators and incubators and other sources of capital. But FinTechs looking to expand internationally often hit an early barrier when they have to cover the costs of adapting to the new market’s regulation. Many law firms are exploring innovative ways of working with FinTechs to help them cover these compliance costs and FinTech hubs should look to develop platforms that bring FinTechs into contact with such firms and associations (for example, the FinTech Association of Russia). The availability of international talent in a particular FinTech hub can help give its FinTechs a more global outlook. Authorities should consider how their migration policies support the growth of the FinTech sector. Finally, the Global Financial Innovation Network (GFIN), which is an organisation made up of many financial regulators looking to develop common solutions to regulating FinTech, is helping FinTechs navigate regulatory barriers to entering many jurisdictions and regulators that are engaged with FinTech hubs should consider the merits of joining GFIN.

5 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS

How to support partnerships between FinTechs and financial services institutions As there are many cultural differences between FinTechs and financial services institutions, it is important that both kinds of organisations develop a strong understanding of each other as a prelude to commercial partnerships. To this end, we suggest that:

Financial Services Institutions should consider: • creating a playbook for successful FinTech collaboration

• publishing a set of guidelines for FinTechs entering into partnership with the financial services institutions (FSIs)

• streamlining internal processes

• creating a collaborative culture.

FinTechs should consider: • understanding the legal and commercial structures entailed in working with a financial services institution

• ensuring the other party’s data and sensitive information will be safe

• comparing the technology infrastructures of each party

• knowing the size and composition of the team who will take this forward

• creating a dynamic map of their innovative solutions and projects to provide an easy and comfortable navigation for financial institutions.

6 www.thecityuk.com Why a FinTech strategy?

FinTech has become a cornerstone of the global financial The role of curricula combining tech and business via services landscape. Simply stated, FinTechs are innovative partnerships with other hubs and academia is another companies with technology enabled business models that major component of a successful FinTech ecosystem. cut across a broad spectrum of the financial services value For example, in India, several universities are introducing chain. The success of FinTechs is driven by their ability FinTech focussed courses and centres of excellence to improve customer experience, to bring innovation at in emerging technologies. Due to the availability of a faster pace and to serve clients that are not profitable local technology talent along with cost advantages, enough for legacy financial institutions. Being mostly several international organisations are setting up their small sized companies, FinTechs strongly depend on their innovation labs in India. To attract and retain talent, ecosystem that includes financial institutions, regulators, Singapore simplified its work visa requirements for foreign support infrastructure and financing sources. Despite this, entrepreneurs; resulting in an influx of foreign talent to the results are impressive: with about $160bn invested start or join FinTech start-ups. over the last five years, global FinTech turnover has Finally, it is essential that a FinTech hub has a flagbearer reached $120bn in 2017 alone and is expected to reach who can orchestrate the ecosystem and promote $265bn in revenue in 2025. The job creation potential collaboration. Singapore’s membership-based association of the FinTech sector (more than one billion jobs across (the Singapore FinTech Association) facilitates cooperation developing markets) and its instrumental impact on among ecosystem players; bridging between the private financial inclusion is demonstrated by the impact of mobile sector and the relevant regulator, the Monetary Authority money expansion in Kenya. In this market, FinTech has of Singapore. Mumbai FinTech Hub, a subdivision of the lifted 2% of Kenyan households out of extreme poverty. state government, is another example of a flagbearer as Capturing this potential and creating a successful FinTech it supports its local FinTech community and represents the ecosystem is not easy. There is a need to align very diverse ecosystem at local and international events. stakeholders (FinTechs, banks, regulators, investors, etc.) across several dimensions that include demand, Bridging the national ambitions governance, policy, talent and financing. While each and the market participants needs: ecosystem has its own features, benchmarking is a good the strategy starting point to understand what can work and what cannot work. System architects designing a proper vision and strategy for a FinTech hub need to understand their current Policy and governance appear to be critical aspects to ecosystem situation, monitor relevant learnings from promote growth. Public funding can catalyse private benchmarks and align those benchmarks with the investment and finance shared infrastructure. Singapore country’s national vision for financial services and digital. has a proactive regulatory regime engaged in multiple As shown below, many of the strategic choices will relate infrastructure efforts such as a local and regional to the expected trajectory of the FinTech economy; others regulatory sandbox, a national know your customer (KYC) will relate to the role of the FinTech regulator and the hub utility pilot and blockchain for interbank payments. It is flagbearer. Choices around all of these areas are equally essential to keep the right balance between a regulator’s critical for success. role in enabling innovation while appropriately managing associated risks.

7 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS

Figure 1 System architecture for a FinTech hub Source: EY

Dimensions Choices

Target client segments Unbanked Underserved FSIs/Corporates All Demand Priority focus areas See figure 2

Source Local Private Local Public Foreign Funding Use Marketing & Development Infrastructure Local FinTechs Foreign FinTechs

Approach Passive Conservative Risk based Permissive Regulation Role of CB Regulatory only Catalyst for change Involved in all projects

Personal background Locals Repats Foreign Talent Professional background Entrepreneurs Professionals Students

Decision process Siloed Consultative based Committee based Top-down Governance FinTech Hub State linked Collaboration with private sector Independent/private

A key dimension of the strategy design is to understand possible remediations. Once a mapping (such as the one the market appetite for FinTech solutions, whether B2C or below) is ready, the next step is to prioritise the Hub’s tasks B2B ones. The strategy should reveal a clear understanding based on needs of existing and potential new FinTechs. of potential barriers to FinTech adoption in the market and

Figure 2 Demand for FinTech services and potential barriers to their adoption Source: EY

Segments Demand area for FinTechs Adoption barriers

Payments and cards Deposits and Lending Insurance and value • Fees accounts added services • Financial literacy Remittance/ P2MP2G – Deposit Brokerage Micro- Durable Health/life PFM • Indebtedness fear Retail P2P G2P pooling accounts lending goods loans insurance tools • Device without data • Limited trust in Digital Financial Services

Payments and cards Deposits and Lending Insurance and value • Visibility and taxation accounts added services • Credit and acceptance SME and M2G – Investment Saving Short term Trade Micro- Market cost Acceptance Corporate M2Supplier accounts accounts loan finance insurance place • Fear of complexity • KYC and onboarding processes

Digital enablers & RegTech Cybersecurity Productivity enabler • Lack of strategy to Financial and outsourcing outsource core FSI Shared KYC Alternative Transaction Data Chat functions to FinTechs services API Cloud AI utility credit scoring security sharing bots • No knowledge of institutions handling FinTechs (FSIs) • Unclear regulatory framework 1st wave 2nd wave

8 www.thecityuk.com

To enable the transition to the desired future state, a Conclusion full set of initiatives is required on all domains related to While there is strong potential for FinTech hubs to develop, demand, financing, regulation, talent and governance. the sector remains relatively nascent. The effective Properly documenting, resourcing, monitoring and implementation of a FinTech strategy can accelerate coordinating these initiatives is essential given the growth, create a strong pipeline of local FinTechs, diverse nature of the initiatives themselves and of the catalyse innovation in the financial sector and improve stakeholders involved. Examples of typical initiatives the provision of financial services to the population. A include: setting up a FinTech unit, setting up FinTech funds, compelling strategy should at least cover the following: launching regulatory sandboxes, setting up a FinTech Hub, developing local FinTech licenses, mobilising capital from • Current ecosystem assessment, including stakeholder public and private stakeholders to finance infrastructure, expectations, mapping of current demand and offering. revising or developing regulations, developing equity • International benchmarks, with a deep dive in the compensation frameworks to attract and retain talent, lessons learnt from successful FinTech ecosystems. deploying virtual market places for FinTechs, creating innovation labs and creating investor toolkits to name • Vision and strategy, including the key choices for the a few. design of the ecosystem. • Key Performance Indicators, that will measure the Bringing all the pieces of the success of the initiative on all the five key domain ecosystem together critical areas. To foster ecosystem growth and the development of • FinTech unit operating model, including structure, innovative FinTech solutions, many stakeholders must be manpower levels and governance. involved. The FinTech Hub, acting as the flagbearer, can • Implementation roadmap supporting initiative cards that help orchestrate the ecosystem, enabling collaboration include relevant details to execute the initiatives. among key players and promoting FinTech locally and globally. The FinTech Hub builds networks and bridges with • Guidebook for FinTech entrepreneurs, providing other global hubs to enable international partnerships, guidelines to on demand areas for FinTech locally, resource and knowledge sharing. information on the ecosystem and enablers.

A FinTech Hub usually covers marketing and • Financial institutions guidelines covering key activities communications, ecosystem enablement and hub to be conducted by financial institutions to support the operations functions. The hub is often hosted outside of growth of the FinTech sector. the regulator and acts as a one stop shop for all FinTech • Governance guidelines to enable effective project related matters including hosting industry events and management and governance in implementing the programmes and working with regulators, financial strategy roadmap. institutions, media, academia, global hubs, FinTech matchmaking and financing. A FinTech Hub should work in tandem with the regulator and its FinTech unit, which could be a department within a Central Bank which handles FinTech strategy, governance, digital solutions enablement and digital solution marketing. FinTech hubs also sometimes providing licensing coordination and regulatory support to FinTechs.

9 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS Recent trends in FinTech development

In response to the rapid developments in the FinTech However, authorities should be aware that there is no sector, many authorities have implemented so-called one-size-fits-all solution and different countries have to ‘regulatory sandboxes’, which can be defined as account for various factors while implementing innovative frameworks that offer a testing environment for new regulation to meet the needs of their economies. technologies within controlled environments. Taking a closer look at more recent events, it is clear The UK has been a pioneer in the use of accelerators and that regulators around the world are rethinking their sandboxes as part of its regulatory process. The Financial approaches and adopting models that are agile and Conduct Authority (FCA), as part of its broader Project collaborative in order to face the challenges posed by Innovate, launched the first regulatory sandbox in June emerging technologies. 2016. This sandbox allows business to test innovative The limited success and utilisation of its current products and services in a safe, live environment, with the sandbox has made the Australian Government revise its appropriate consumer safeguards and, when appropriate, regulatory sandbox regime in 2019. They have increased is exempt from some regulatory requirements. the number of financial services and products eligible to After its implementation in the UK, the regulatory take part in their sandbox and extended the duration of sandbox approach has been spreading rapidly not only in their testing period from 12 months to 24 months. The developed countries but also in developing economies. regulator believes that these changes will help to enhance Different countries all over the world have been working Australia’s FinTech ecosystem and attract more companies to implement this mechanism for piloting new FinTech to the market. approaches in a low-risk environment. Australia, The Monetary Authority of Singapore has recently Singapore, Switzerland, Canada, Hong Kong, Malaysia, introduced a new Sandbox Express, which is aimed to Thailand, Indonesia are just some examples of countries improve the accessibility of its sandbox platform and to that have chosen to form their own regulatory sandboxes. test ideas quicker. The approval process has become easier The number of regulatory sandboxes continues to grow. and simpler for businesses with low or well understood Many countries believe that this sandboxing concept risks as all the conditions and restrictions that could apply can not only help them to develop appropriate rules and in such cases are now pre-determined. regulations for emerging products, services and business Recent studies have shown that legal and regulatory models, but also to promote innovation and to make their initiatives in innovative areas may be less efficient if they economies more appealing for foreign companies and are narrowed to one jurisdiction. This is especially true for start-ups. countries with similar legislation (e.g. within the EU). It is helpful if regulators in different jurisdictions can embrace a collaborative approach so that FinTechs in a sandbox environment can test products internationally.

10 www.thecityuk.com

The FCA, a leader in FinTech regulation, therefore initiated Aiming to build successful FinTech ecosystem, many the creation of a global sandbox on the understanding countries (including the majority of European states) that the linking together of influential supervisory choose to create innovation hubs, which help FinTech bodies can build a network that provides a comfortable players to access regulators easily by providing a point environment for innovative firms to interact with of contact to raise concerns and seek advice. There are regulators and to allow the trial of cross-border solutions. studies highlighting that in some cases innovation hubs In addition, the network not only acts as a common forum should be chosen over regulatory sandboxes as they for joint work and discussions, but also helps regulators to bring similar benefits while minimising the drawbacks collaborate and share experiences, business models, new of the latter. However, many studies suggest that these ideas and approaches. Initially launched by an international instruments are more effective when they complement group of 12 regulators, the network now comprises about each other rather than being used as substitutes. 50 organisations. In conclusion, while the relevance and importance of It is important to note that the sandboxing concept has the sandbox approach shows no sign of diminishing, its challenges. It should not be regarded as the only viable there is still room for improvement. Creating a regulatory tool to promote an innovative environment in a country. environment for FinTechs to be truly cross-border Given its many constraints (such as the limited number of businesses is rightly the next challenge for regulators to participants and restrictions on testing time), a regulatory overcome. sandbox alone cannot accommodate all the needs of the emerging FinTech industry.

Furthermore, some companies that choose to participate in this initiative may pursue objectives that differ from those highlighted by regulators. For example, a Deloitte survey of current and past participants in the FCA’s sandbox found that most firms highly regarded its promotional value: they are sure that acceptance into the sandbox increased their credibility with investors and customers alike. This raises the possibility of an unintended, yet perhaps inevitable, consequence: a sandbox can create an uneven playing field between the start-ups that are accepted in the system and those which are not.

11 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS How FinTech Hubs Create New Value through RegTech

Data from Juniper Research forecasts global Regulation FinTech Hubs play a critical role in supporting the Technology (RegTech) spending will exceed $127bn by development of RegTech by providing the ecosystem to 2024, up from $25bn in 2019.1 And it is easy to see why bring together all the stakeholders required to understand, numerous organisations predict such substantial growth, test and adopt RegTech solutions at scale. This is evidenced given the scale of the regulatory burden facing the in multiple jurisdictions where RegTech has been integrated financial services industry. into the financial services innovation process enabled by regulators, including the UK, Singapore, Australia and the Estimates for the industry’s annual cost of compliance Middle East. For example, RegTech solutions were in the have exceeded $100bn, with major banks spending very first FCA sandbox and now in the first cohort for the between 15%-20% of their costs on governance, risk and Global Financial Innovation Network sandbox run by over compliance. Despite all this spending, billions of dollars 50 regulators. in fines are still being incurred for failures of systems and controls in managing compliance. Other innovation mechanisms used to test the impact of RegTech include the use of TechSprints and Proof of RegTech promises to reduce this burden and risk by Concepts. In the UK, these mechanisms are delivered automating processes through new digital technologies through a dedicated RegTech unit within the FCA’s that improve both efficiency and effectiveness. For Innovation team. The RegTech unit facilitates interaction example, it can help companies shift compliance from with financial institutions, policymakers and other manual processes to data driven systems enabled regulators in strategic areas for RegTech development such by analytics and machine learning; and lead to the as digital regulatory reporting and the application of new fundamental re-design of current processes facilitated by technologies to enable greater data sharing to combat Cloud and Distributed Ledger Technologies (DLT). financial crime across jurisdictions. However, the key for RegTech adoption lies in the Despite the success of these innovation initiatives, significant opportunities it provides to create new value in there remain challenges in accelerating the adoption of financial services. Reducing companies’ regulatory burden RegTech at scale. Overcoming these challenges requires means that more capital can be allocated to providing policymakers, regulators, institutions and solution finance by existing institutions and reduces barriers of providers to collaborate and co-create through existing entry for FinTechs. Ultimately, foundational RegTech frameworks, new mechanisms and industry assets. solutions such as digital KYC enables greater access, choice and control for consumers and businesses and A blueprint for this industry collaboration model is set out greater trade between jurisdictions. in the International RegTech Association’s (IRTA) global market study on the urgent need for digital optimisation These new opportunities are delivering openings for of KYC conducted with Protiviti.2 We interviewed new RegTech companies, and a range of providers of stakeholders in multiple financial centres where significant data, analytics and AI capabilities who combine their work was underway to digitally enable the KYC process, technologies with advisory services that support new including by creating new industry shared services such as digital system design and change. For example, Juniper utilities for digital identity and verification. estimates the use of AI in KYC checks will result in cost savings of $1bn by 2024 combined with greater consumer access, faster response times and satisfaction.

1 Juniper Research, ‘FinTech Payments’, (September 2019), available at: https://www.juniperresearch.com/researchstore/fintech-payments/regtech 2 IRTA, ‘An Urgent Call for KYC Optimization’, (November 2019), available at: https://regtechassociation.org/news/new-report-an-urgent-call-for-kyc- optimization/

12 www.thecityuk.com

We found common factors that prevented wider adoption Our report sets out practical next steps for adopting tech of digital solutions and shared platforms. Notably, a lack activism through new mechanisms and the creation of of shared understanding around the impact of different digital assets that facilitate regulators and institutions technologies on the KYC process, lack of clarity on roles in overcoming key challenges to KYC optimisation. We and responsibilities in mandating standards and owning believe this digital optimisation blueprint applies to other and operating industry assets such as utilities, and conflict areas of RegTech that support SME finance and trade, between KYC and data privacy requirements. These factors broader Social Development Goals, and reduce some have a number of knock on effects, such as providing of the burdens that accompany regulatory change and barriers to RegTech partnering with financial institutions. reporting.

It is significant that a separate report by the Alliance for These digital optimisation principles can be adopted in Financial Inclusion identifies Russia as one of the few the design of FinTech hubs’ collaboration and co-creation states to have defined the concept of identity for AML/CFT models and services, including the delivery of new assets purposes. The report describes how this ground-breaking such as data trusts, testing facilities that operate at work is being used to extend financial services to excluded production scale, especially for machine learning. populations through tiered access and is connecting with The development of digital optimisation policy frameworks faster payments initiatives. by supra national bodies the Financial Action Task The IRTA report recommendations set out how more Force (FATF), International Organization of Securities effective collaboration in KYC optimisation can bring Commissions (IOSCO) and the Financial Stability Board about the kind of broader social impact and new value (FSB), linked to standards development will enable creation we are seeing in Russia. We suggest adopting the scalability and interoperability of solutions, across multiple concept of ‘tech activism’ set out by Nick Cook, Director jurisdictions. of Innovation, the FCA. This concept involves regulators Developing this common model for design and adoption identifying where innovation will deliver public value, will help ensure that the forecast industry spend of and also being informed and active in understanding the $127bn on RegTech will create exponentially new value role of specific technologies in delivering that value. Tech with connected FinTech Hubs delivering better outcomes, activism requires regulators to remain vendor neutral for individuals, business and society. while specifying leading technologies that help tackle longstanding problems, rather than being tech-agnostic about the role of technology in achieving better outcomes.

13 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS How Blockchain can support RegTech

Regulatory technology or RegTech is a term used to define unprecedented scale on firms that have failed to meet a wide range of technology concepts and systems that regulatory standards. Meanwhile, regulators around the can be used to help organisations comply with regulatory world have been joining together to create more powerful and statutory processes. While the term RegTech is most frameworks for international regulatory cooperation which frequently encountered in a financial services context, restricts opportunities for regulatory arbitrage. the underlying technology is applicable across a range of Compliance, therefore, continues to consume more and regulated business areas. more resources, time and spend in an already highly RegTech helps businesses attain regulatory outcomes by competitive financial services market. While the FinTech providing additional transparency and consistency to their industry has boomed recently by providing its tech-minded reporting and enabling the standardisation of regulatory clientele with new innovative products, regulators across processes. This is why RegTech is a buzz word not just for the world are yet to fully grasp this phenomenon and regulated businesses but for regulators too. Regulators are looking for insight to help them understand how are pleased that technology empowered systems and best to regulate the sector. Regulators want to promote processes now allow them to proactively monitor industry competition by levelling the playfield for new entrants who participants rather than just relying on retrospective are competing with incumbents with far more resources. forensics when things go wrong or are reported as having RegTech is the only solution that can help that can help gone wrong. Even more importantly, regulators are now FinTechs comply with regulations without having to bear starting to come to the view that there is little point in prohibitive compliance costs. issuing regulations if their implementation cannot be RegTech is the ‘innovative use of technology’ as actively monitored by regulators. well as use of ‘innovative technology’ for regulatory Parties on both sides of the regulatory divide have now compliance. come to understand that it is only through RegTech that they can operate efficiently or regulate effectively as the Blockchain/Distributed Ledger case may be. Technology for RegTech One such innovative technology for regulatory compliance Regulations in financial services is blockchain or DLT. Although the financial services sector has been viewed DLT facilitates an expanding, chronologically ordered list as one of the world’s most regulated industries, the of cryptographically signed, time stamped, tamper proof financial crisis of 2008 forced a powerful rethink of how transactional records shared by relevant participants in a it is regulated. The post-mortem that followed the crisis network. DLT can also create ‘smart contracts’ which are resulted in imposition of enhanced regulatory scrutiny pieces piece of deterministic computer code that make it aimed at preventing a repeat of the meltdown. This possible for the same input (for example, the delivery of a scrutiny came in form of new wide-ranging set of rules certain good) to provide the same output (for example, a and regulations for service providers. Regulators have payment of a certain sum) every time. increasingly made it clear that non-compliance would not be tolerated but would be met not just with financial DLT has rapidly become embedded in RegTech solutions penalties but also with public naming-shaming which with several recently launched DLT RegTech projects can have a disastrous impact on a firm’s brand value. around the world that are highly promising. Regulators in recent years have imposed penalties on an

14 www.thecityuk.com

Using DLT to create template-based The benefits of such a scenario would be enormous: contracts that eliminate the burden regulators could receive in near real time data from of periodic reporting and the need to the complete market. They would be able not just to predict but also to thwart undesirable market outcomes. investigate market behaviour: Meanwhile, service providers will no longer need to Using DLT to bring an end to standard regulatory provide periodic regulatory reports and will be able reporting may sound too good to be true and, given to focus more on their core business. International where regulators and market participants are currently cooperation will help governments better align their positioned, it may seem a distant goal, but something like regulations, reducing inappropriate arbitrage and the this is certainly within the realm of the possible. overall system would become fairer for all. Needless to As an example of how this could work, a regulator could say, this would only be possible if there were constructive set up a DLT network and require that each market dialogue between market participants and regulators participant joins this network when it grants a licence as well as an open collaborative dialogue between to conduct a regulated activity. The regulator could also international regulators, all willing to consider innovative publish a set of contract templates which are basically the ways of using RegTech for mutually beneficial outcomes. regulations encoded as DLT smart contracts. Whenever a Chainvine is a blockchain/DLT company at the forefront service provider does business with a customer, it chooses of creating solutions for a wide range of partners from the relevant contract, based on the product, and fills in law firms to governments to large and small corporations. appropriate parameters specific to that customer. This Chainvine solutions are agnostic to the underlying DLT and information about parameters is communicated back to could therefore not just interact with different types of DLT the regulator through the smart contract in an anonymised networks but can also work as an interchange between way. DLT can ensure that this information is only made different DLT networks that could be based on different available to the regulator and is not available to other technologies. One project that Chainvine is currently market participants or competitors. delivering is about reducing friction in international In this scenario the regulator will always know the type of trade. This is achieved by working in collaboration with parameters being used by regulated market participants, governments, regulators and statutory bodies to securely and could perform simple analytics to get an accurate make data between the exporters, transporters, insurers sense of how each of the regulated entities are engaging and importers of goods. with its customers for ensuring that such contracts are In another project, Chainvine are helping a national fair to consumers. In a more advanced implementation of government develop a ‘National Asset Management this scenario, the regulator could run machine learning System’ that will digitise government processes in the algorithms to monitor general ‘market behaviours’ and fishing industry. The system aims ”to bring efficiency sense when certain patterns which are known to create and promote transparency without compromising upon distressing market conditions are starting to emerge. At the sovereignty of the government departments.” These the same time, the regulator would be better able to seemingly conflicting goals are only achievable with the identify ‘ethical’ market participants and certify them use of a technology like blockchain/DLT. as such, making it easier for ‘good’ participants to issue ethical bonds. The ultimate potential of such a system can’t be underestimated.

This scenario can easily be extended internationally if regulators start to collaborate more closely and agree upon the ‘parameters’ themselves as well as agree to inform and learn from each other about the patterns that have led to suboptimal market outcomes.

15 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS An industry perspective on promoting and encouraging Fintech and Blockchain projects

The Russian Association of Crypto-economy, Artificial was heavily edited: for example, definition of e-money Intelligence and Blockchain (RACIB), is an active player in was removed. This and other amendments lead RACIB Russian digital economy. It sees Blockchain as a technology to withdraw its support from the draft legislation. that forms the basis for many sectors of economic Also, the decline in the value of cryptocurrencies and development including FinTech. subsequent decline in public interest in cryptocurrencies generally removed some of the urgency from the issue. RACIB’s view is that in order to facilitate growth of FinTech Therefore, the draft legislation was deprioritised and sector, including facilitation of further use of Blockchain not progressed through the parliament. However, based products, there needs to be: consultations on the draft legislation were renewed in (i) clear and simple regulatory framework late 2019 and second reading is expected to take place (ii) easy access to funding for start-ups sometime this year.

(iii) access to markets. 2. RACIB was actively involved in preparing a draft of the law ’On Amendments to the Federal Law’, ’On the Development of Small and Medium-Sized Enterprises in Clear and simple regulatory the Russian Federation’ and other legislative acts of the framework Russian Federation, which regulates the cryptocurrency RACIB has been an active supporter of achieving a market. clear and simple regulatory framework. By simple, we 3. RACIB prepared an expert analysis of the bills: ’On understand that the regulatory framework needs to be Amending Part One, Two and Four of the Civil Code easily understood and that it should avoid conflicts with of the Russian Federation’, ’On Digital Financial Assets’ other legislative norms. and ’On Alternative Methods of Attracting Investments In its efforts to achieve this objective, RACIB has been (crowdfunding)’, at the request of the Expert Council of actively informed in drafting various legislative acts and the State Duma Committee on the Financial Market. provided expert analysis of draft legislation introduced to the Russian parliament. Examples of RACIB’s involvement are outlined below.

1. In early 2018, RACIB actively engaged in consultations that led to the draft legislation ‘On Digital Financial Assets’ being put before the State Duma, the lower house of the Federal Assembly of the Russian Federation, in January 2018. Unfortunately, the draft legislation did not proceed to the second reading. It

16 www.thecityuk.com

Access to funding Access to markets RACIB wants to encourage investment from big RACIB believes that access to markets is key in institutional investors into Blockchain and Cryptocurrency. encouraging FinTech and Blockchain projects. In order It believes that this could be done by increasing to achieve this, RACIB has set up representative offices transparency and removing certain negative perceptions in more than 50 regions of the Russian Federation and attached to Cryptocurrencies. abroad. It currently has foreign representative offices in Switzerland, Estonia, Kazakhstan, and Serbia. In the near It also wants small investors to feel safe when investing future, RACIB has plans to open representative offices into Blockchain projects and Cryptocurrencies. in Germany, Austria, France, Latin America and Africa. In order to achieve these objectives, RACIB initiated the RACIB believes that our network of representative offices creation of an international fund for the protection of will facilitate access to funding for its members’ projects by investors` rights in ICOs. The first task of the fund was the attracting investors to them. crypto investors’ collective lawsuit against the prohibition of cryptocurrency advertising in Google, Facebook and Other steps Twitter. FinTech hubs could increase their cooperation with law Furthermore, RACIB will soon introduce affordable tools firms in order to facilitate international growth for FinTech that would enable any cryptocurrency user to check and Blockchain start-ups. For example, many London law whether the cryptocurrency it owns or intends to buy is firms run bootcamps for start-ups where they provide grey or white. advice and template documents at no cost or on reduced fee basis. However, these bootcamps are not widely promoted and start-ups are often unaware of them or other support they can receive from law firms. FinTech hubs could promote information about legal services available to start-ups and encourage law firms to offer help and assistance to start-ups. This could be done, for example, by creating space on FinTech hubs’ webpages or creating a separate platform where law firms in various jurisdictions could offer legal support and services to start-ups.

17 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS Developing the skills, knowledge and behaviour to create a sustainable FinTech ecosystem

A successful FinTech ecosystem depends on several factors The biggest challenge in developing this pipeline is often such as fair regulation, and sufficient access to finance. a lack of coordination between the different stakeholders. However, no ecosystem can flourish unless its participants Globally, education policy at primary and secondary have the appropriate skills, knowledge and behaviours. education often lacks context, with very little consideration And the requirements of each participant in these areas for financial literacy. This creates a problem for central will vary depending on their needs. banks and ministries of finance, who are often responsible for ensuring consumer protection within the financial Broadly, the participants fit into four constituent groups: services system. The Central Bank of Russia’s Financial i) the talent pipeline Culture website is a very good example of how to improve ii) consumers and society financial literacy, but this needs to be built into primary school curriculum. iii) regulators iv) supporting professional services such as accountants and finance professionals. Figure 4 Drivers of change and future skills Source: ACCA

The talent pipeline Technical skills and ethics quotient (TEQ): In the previous TheCityUK UK-Russia FinTech report, we The skills and abilities to perform activities consistently looked at what motivates the next generation of workers to a defined standard while maintaining the highest standards of integrity, independence and scepticism. and how to make future careers attractive. In this report, we’re going to take a step backwards and look at how to Intelligence quotient (IQ): ensure ecosystems can benefit from a sufficient pipeline The ability to acquire and use knowledge: thinking, of talent and equip themselves with the right skills, reasoning and solving problems. knowledge and behaviours for the future. Creative quotient (CQ): The ability to use existing knowledge in a new situation, to make connections, explore potential outcomes, and generate new ideas. Figure 3 Ethics and trust in a digital age Source: ACCA Digital quotient (DQ): The awareness and application of existing and emerging 1. cybersecurity digital technologies, capabilities, practices and strategies. Emotional intelligence quotient (EQ): 2. platform-based business models The ability to identify your own emotions and those of others, harness and apply them to tasks, and regulate 3. big data and analytics and manage them.

4. cryptocurrencies and distributed Vision quotient (VQ): ledgers The ability to anticipate future trends accurately by extrapolating existing trends and facts, and filling the 5. automation, artificial intelligence gaps by thinking innovatively.

and machine learning Experience quotient (XQ): The ability and skills to understand customer 6. procurement of technology expectations, meet desired outcomes and create value.

18 www.thecityuk.com

These two organisations working together would previously have been enough. However, with an increasing Figure 5 Emotional quotient in a digital age Source: ACCA rate of digitalisation, and greater crossover between financial products and technology, more coordination is Examples of EQ impact needed with technology ministries to inform the direction • Change readiness: empathy is needed to deal with of travel. And lastly, universities, employers, industry technology-related job losses and a growth mindset helps to bodies and innovation clusters all need to be part of the overcome fear of change. conversation to ensure real life relevance. • Increased diversity: perspective taking enables one to understand the viewpoints of a wider pool of stakeholders in Collectively, these organisations working together will a digital age. ensure the right skills and knowledge for the future, • Ethics and beliefs: these influence advocating an ethical however it is also important to focus on encouraging approach to technology adoption, and self-knowledge helps the right behaviours and ensuring a diverse talent pool. in setting boundaries and ensuring quality of life in an ‘always- on’ environment. The ecosystem needs interventions at young ages to • Cognition and learning: a growth mindset enables one to ensure diversity within the industry, which means greater challenge tribalism and self-knowledge helps to cut out the encouragement of young women and girls, and children ‘noise’ and know one’s priorities in an era of fast reactions and from lower economic backgrounds into continued high volume. education and into STEM subjects. There also needs to be • Human–machine interaction: EQ enables one to prevent loss of control amid the increasing role of machines, and engagement with creative and social science specialists to a growth mindset facilitates extracting value and potential ensure innovation supports society. insights from interactions. • Shifting power: softer (rather than directive) forms of influencing are needed in a less hierarchical, digital, workplace, Emotional Quotient and a growth mindset enables the ability to navigate new ways

One behaviour which shouldn’t be overlooked is emotional of working that may challenge the status quo. intelligence. Technology should create value for society, but we’ve already seen ways in which that theory can fail, either actively through criminal intent, or passively by excluding parts of society. There are also plenty of Consumers and society examples from everyday life where new technology Much of the above applies to consumers in both a B2B solutions have negatively impacted labour rights or created context and B2C. Businesses need digitally aware talent biases against different genders and races. Developing to understand how technology can support internal strong emotional intelligence within an organisation transformation, as well as how to engage their own will be essential to ensuring the sustainability societal customers with new products. contribution of future businesses. Thinking about society, there are a number of issues which need to be considered. It’s all too easy to believe FinTech solutions will bring about beneficial changes for the masses, but that belief requires making several assumptions, including that there will be widespread access to internet and mobile technology, financial literacy, and even a basic understanding of new technologies. Different generations will respond and behave in different ways, as will those living across urban and rural environments. With new financing solutions comes greater risk of misuse or irresponsible use, and so all elements of society need to be considered and educated.

19 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS

Figure 6 Building the legal framework to help businesses succeed Source: ACCA

Enabling business Maintaining Supporting an Providing Dispute resolution to be the driver of stability and ethical approach encouragement for mechanisms society’s prosperity confidence to business business enterprise for business

Regulators Figure 7 Economic crime in a digital age Regulators arguably face the greatest challenge when Source: ACCA it comes to understanding new technology solutions. Governments and regulators often lose the war for talent as they can seldom match private-sector salaries. They do, International however, retain those that want to contribute to society cooperation and deliver public value. That said, regulators need to be at least aware of the capabilities of new technologies, and the risks that surround them. This is necessary for Public and private consumer protection purposes, i.e. protecting consumers sector cooperation from themselves, but also because with the advent of new technologies, comes new ways and means of exploiting the system. Hence regulators need to be prepared to combat these new forms of economic crime, while maintaining stability, and not hampering innovation. Organisational Regulators cannot combat these crimes in isolation, and cooperation so need to cooperate with the private sector, but also with international counterparts as the financial system becomes more globally interconnected.

20 www.thecityuk.com

Supporting professional services well as fostering entrepreneurship, ecosystems need accountants and finance professionals that can understand You would not take your brand-new sports car, loaded their businesses and products and support them to grow with the latest digital technologies, to your outmoded sustainably. In addition to the essential technical skills and mechanic to be serviced. You would take it to a specialist. knowledge, they need a blend of behaviours – ethics, Both the mechanic and the specialist understand the creativity, digital, vision, emotion, intelligence – which will fundamentals of how a car works, but one will provide enable them to provide strategic advice. ACCA recognises much more relevant support than the other. The same this, and so ensures that our qualifications remain relevant applies to businesses. You would not take your highly for the future. We support our students and members to innovative business to an outmoded advisor who could not understand these new developments. understand your work. A challenge for governments is helping those outmoded Nurturing talent, innovation and creativity is important mechanics (or accountants) to gain the skills that will allow for developing new technology ideas into products and them to stay relevant and economically active. Otherwise, solutions, and into new business models. But those ideas it is likely that new technologies will automate or replace a and businesses will struggle to survive, let alone grow, lot of their work. As such, governments need to work with without the support of specialist professional services the private sector to invest in re-skilling existing workforces firms that understand how they operate. And so, as for the future.

Figure 8 Future ready – accountancy careers in the 2020s Source: ACCA

Technica l

e c n e ig l C l The r e e t assurance a IN t i advocate v e

The The

sustainability business

trailblazer transformer

D Sustainable

i g organisations

i t

a l l a

n

o The The i t

digital data o

playmaker navigator m e

v i si on e nc rie Expe

21 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS Transformation and innovation: A guide to partnerships between financial services institutions and FinTechs

Note: TheCityUK and its members have spent much time considering how FinTechs can best partner with financial institutions. The following article is an excerpt from a broader report TheCityUK co-authored with Santander and Shearman & Sterling called ‘Transformation and innovation: a guide to partnerships between financial services institutions and FinTechs’. The report is from 2017, however, its findings remain highly relevant to the discussions of the UK-Russia FinTech Working Group, as several group members highlighted many of the forms of collaboration between FinTechs and financial institutions discussed in this paper as being of critical importance for the development of the industry.

For the UK’s established financial services institutions (FSIs), and stringent regulations, and lack an established internal the importance of innovation for future success has long process for working with small, agile companies. On the been recognised. This is reflected in the way in which the other hand, FinTechs are usually working on much industry has set out in recent years to become a world leaner, shorter lifecycles for decision making and product leader in the adoption of FinTech. The drive to innovate development, so they cannot afford to go through the will strengthen UK competitiveness and help to tailor complex processes required of established and regulated financial services more closely to the needs of consumers financial services’ systems. in future.

Meanwhile, on the edges of the financial services sector, Key collaboration models and legal agile start-ups in the FinTech, InsurTech and RegTech issues to consider sectors – referred to simply as FinTechs in this section – are To smooth the journey to collaboration, this section innovating ahead of many of their FSI counterparts. The outlines the common pain points for FSIs and start-ups range of new ideas and pioneering technologies being from the point of view of choosing the right collaboration explored and developed has the potential to overhaul how model, and highlights some key legal concerns. It outlines financial services are delivered, enhancing accessibility and the first steps that FSIs and FinTechs should take when consumer choice. beginning discussions, and highlights ways successful For both FSIs and FinTechs, collaboration will be a key partnerships can be made while avoiding these pitfalls. component to future success. By combining their By using these guidelines as a starting point, both FSIs respective strengths, FSIs and FinTechs can not only secure and FinTechs can understand the issues faced by potential their own future and provide superior service to their partners, and avoid the customers, but also help to secure the UK’s position as a common setbacks that global centre of finance and financial innovation. can derail otherwise Many FSIs are already working with FinTechs, but there promising collaborations. are often barriers that need to be negotiated for effective collaboration. FSIs are often tied into legacy processes

For a more comprehensive version of the guide, please refer to ‘Transformation and innovation: a guide to partnerships between financial services institutions and FinTechs’ published by TheCityUK in collaboration with Santander and Shearman & Sterling.3

3 ‘Transformation and innovation: a guide to partnerships between financial services institutions and FinTechs’ published by TheCityUK (20 November 2017), available at: https://www.thecityuk.com/research/transformation-and-innovation-a-guide-to-partnerships-between-financial-services-institutions- and-fintechs/

22 www.thecityuk.com KEY CONSIDERATIONS

By working together, FSIs and FinTechs can combine their On bringing these partnerships into practice, the section respective strengths to drive innovation and reinforce the also identifies a number of key legal hurdles to address. UK’s position as a global leader in the financial industry. These range from data protection and IP ownership, This section outlines two key areas of consideration that to risk allocation and costs control, and finally to exit FSIs and FinTechs need to agree upon: common legal mechanisms. concerns that have the potential to hold up projects, and Deciding which model, or combination of models, outlined the nature of the collaboration model itself. By having in the report to adopt, while having regard to the legal these discussions at the beginning of a project, both checklist flagged within, will help enable both parties to parties can ensure that their interests are protected while take the steps below. These should ensure that the two bringing their expertise together to innovate. sides of the financial services ecosystem are getting off This section highlights seven possible ways in which on the right foot and able to most effectively bring to to structure such a partnership (see box below). These market the many widely recognised benefits of FinTech permit for a varying degree of proximity between the two innovations. entities, and allow for leadership on certain aspects to be split, equally, unequally or to sit with one party altogether. It would also be possible for an FSI and FinTech to agree to a tailored partnership which amounts to a hybrid of those outlined.

7 Models of Collaboration

1.  Application programming interfaces / sandbox 2. Hackathon / Entrepreneur in residence 3. Startup corporate accelerator 4.  FinTech product sourcing 5. FinTech joint venture / venture builder 6. Corporate venture capital 7. Mergers and acquisitions

23 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS

Recommendations for FSIs

Create a playbook for successful FinTech collaboration

Publish a set of guidelines for FinTechs

Streamline internal processes

Create a collaborative culture

Guidance for FinTechs

Understand the legal and commercial structures entailed

Ensure the other party’s data and sensitive information will be safe

Compare the technology infrastructures of each party

Know the size and composition of the team who will take this forward

24 www.thecityuk.com Choosing the right collaboration model

Application programming Hackathon/Entrepreneur in residence interfaces/sandbox Hackathons are limited-time development events, where In this model, FSIs offer FinTechs limited access to some of FSIs present a business or technology challenge and invite their infrastructure or services through public Application FinTechs to come up with a solution, often through a team Programming Interfaces (APIs), sandbox development that has formed specifically for the project. environments, or anonymised samples of customer data. Popularised in recent years by several high-profile success For the FSI, this represents a relatively hands-off approach stories, hackathons focus on rapid innovation and fast to innovation, with FinTechs able to build and test new prototyping to test early-stage concepts, rather than products and services without impacting the FSI. producing a polished product.

Open APIs are becoming more common in financial In this model, teams participating in the project are often services, particularly as 2018 will see the introduction of given access to internal expertise and resources by the FSI, the EU’s Revised Payment Service Directive (PSD2), which which can raise questions about intellectual property rights, will allow banking customers to enlist third parties to particularly as solutions are co-created during these events. manage their finances without leaving their existing bank. FSIs will need to establish how their own existing intellectual An API or sandbox model will often not include a property can be used during the hackathon, and who commercial agreement about how a product will be used, ultimately owns the rights to products or services that are or who owns it. developed by FinTechs or entrepreneurs in residence.

Key Key considerations for considerations for application programming hackathon/entrepreneur interfaces/sandbox in residence

FSIs and FinTechs will need to set out FSIs and FinTechs will need to set out guidelines around: guidelines around: • intellectual property rights • intellectual property • exclusivity • exclusivity • development costs for everything produced • data protection within the API/sandbox structure. • costs and control • regulatory compliance.

25 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS

Start-up corporate accelerator FinTech product sourcing This model usually sees many FinTechs submitting In this model, the product or service is already complete applications to FSIs for support with new products or and market ready. An FSI will select a specific product services that they are already developing. By selecting a developed by a FinTech company to test with limited small batch of these applicants, an FSI can identify and sections of its customer base, either as a white-label or co- capitalise on the most promising innovations, while the branded product. If this process is successful, the FSI then selected FinTechs gain access to expertise, support, and a scales the use of the product to its entire business. This captive customer base. allows the FSI to easily trial new propositions and products without putting their own capital and development time Corporate Accelerator programmes may operate on into building them. equity agreements, rather than simple collaboration, with the FSI usually taking a stake in the FinTechs it selects. This is a commercial model, with each party sharing risk That means FinTechs will need to ensure they are clear and growth opportunities without equity changing hands. and comfortable with the amount of equity they are However, issues can surface around intellectual property offering and the terms it is issued on. As shareholders rights and exclusivity. FinTechs will need to understand will expect a higher level of control, governance upfront if entering into an agreement for the use of their rights and exclusivity than commercial partners, legal product with one FSI will prevent them from also selling agreements will need to be made early in the process to the product to other companies. prevent the FinTechs and FSI operating under different This exclusivity concern can affect the FSI, too. It will commercial models. Each side should be aware of the need to establish whether it is tied to a single provider, rights of the other under such arrangements and ensure and assess the operational risks associated with relying they are documented upfront if necessary. on one product. As with most of these models, there are also discussions to be had about the legal ownership and control of intellectual property. Key considerations for start-up corporate accelerator Key considerations for

FSIs and FinTechs will need to set out FinTech product sourcing guidelines around: • intellectual property FSIs and FinTechs will need to set out • exclusivity guidelines around: • costs and control. • exclusivity • regulatory compliance • data protection

26 www.thecityuk.com

FinTech joint venture/venture builder Corporate venture capital Rather than hiring or acquiring an existing start-up, in This model is one of the simplest. An FSI will take a this model an FSI sets up its own stand alone start-up minority stake in one or more up-and-coming FinTechs, in to address a specific market niche. This company sits order to secure insider access to new innovations as they alongside its core business channels, and can have a come to the fore. separate branding. As a straightforward investment, much of the legal By setting up this stand alone start-up in partnership considerations here are standard for large businesses. The with a FinTech or Venture Builder, FSIs are able to bring in FSI will need to assess the risk profile of the investment specialised skills and investment, bolstered by shared equity. and the stability of the FinTech’s value. Exclusivity, in this context, means establishing whether the service being The main legal concern for a joint venture is ownership developed will be provided solely to the FSI investor. and control of the new company. Questions around who will own the rights to any new products created and whether this agreement is exclusive will need to be settled at the outset. It’s also vital that the stakeholders are able to agree on the value that will be given to technical Key expertise against financial investment. considerations for corporate venture capital

Key FSIs and FinTechs will need to set out considerations guidelines around: for FinTech join venture/ • growth and risk venture builder • exclusivity • costs and control FSIs and FinTechs will need to set out • exit mechanisms guidelines around: • intellectual property. • growth and risk • exclusivity • costs and control • exit mechanisms • intellectual property • outsourcing rules.

27 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS

Mergers and acquisitions Hybrids This is one of the most complex models, both practically It is possible for FSIs and FinTechs to agree to a tailored and legally. Through mergers and acquisitions, FSIs buy partnership framework, which will likely be a hybrid of the out specific FinTechs to secure access to new innovations, above models. This may provide for a greater degree of or speed up strategic transitions. flexibility and could enable the partnership to reap a wider range of benefits. Naturally, this approach may conversely Commercially, the key item is usually valuation. The FSI result in greater complexity and in an increased number and FinTech need to agree on a valuation. An FSI will of legal issues to consider and address. Over time some often acquire a FinTech when it has an established product hybrids may become standardised, and could be easily but may lack a stable or clear track record, and have replicated in copycat format by other firms. In practice, an uncertain growth prospects. In these circumstances, there FSI and FinTech can amalgamate a number of the models may be a valuation gap, which can be bridged by agreeing laid out in this report, and this process can be integrated to deferred consideration, which is paid only when certain into the rest of the business. milestones are reached (known as an ‘earn out’). This can also provide a useful incentive to selling owners to ensure As FinTech continues to evolve and progress from its that the FinTech is left in good condition, or to continue to initial disruptive phase into a more mature and diversified grow the business. market, the creation of new models should also be expected. Ensuring that a firm’s business practices and legal structures are open and flexible to future innovation may help secure a competitive advantage in this high Key growth area. considerations for mergers and acquisitions Key

FSIs and FinTechs will need to set out considerations guidelines around: for hybrids • intellectual property • risk and revenue The list of key considerations will be a variation of those listed in the previous models, • additional investment needs depending on the nature of the hybrid. • employee agreements

28 www.thecityuk.com Launching a FinTech in the United Kingdom

Note: In our UK-Russia working group meetings, participants often discussed how Russian companies can launch FinTech initiatives in the UK, whether through founding new FinTech start-ups, acquiring existing FinTech start-ups or partnering with UK institutions. In the following paper, which TheCityUK co-produced with Allen & Overy, we explain how a foreign business can launch a FinTech in the UK. The paper was initially written for a US audience, and launched in San Francisco, but it is highly relevant to our group discussions and so we have included an excerpt of our report ‘Launching a FinTech in the United Kingdom’, in this paper below.

The UK tech environment locations with some 1.6 million members. Of these groups the overwhelming majority (91%) are open to all. The UK’s multi-billion-pound tech sector is a world leader on the international stage. It is a major employer and plays The UK, and London in particular, is seen as a leading a leading role in the development of new and innovative global FinTech hub supported by a large financial services technologies. market, forward-looking government and a regulatory environment that facilitates and supports innovation. The UK’s digital economy is growing more than twice FinTech has been one of London’s standout success stories, as fast as the wider economy, with an estimated value with the sector attracting a record £1.34bn of 2017’s of £184bn ($240bn) in 2017. Over the past five years, bumper investment. These are exciting times for UK London has attracted more digital tech investment FinTech and it is easy to see why the sector is attracting than Paris, Berlin and Amsterdam combined, and tech such international attention. has become an integral part of the city’s economy, infrastructure and society. The sector’s relentless pursuit of innovation has driven a remarkable growth trajectory. Getting started 2017 saw venture capital investment into the UK tech sector reach an all-time high, totalling £2.99bn, almost No restrictions on US investments double that of 2016. The UK now has 25 of Europe’s 57 In principle, there are no restrictions on US ownership or tech unicorns (businesses valued at $1bn or more), the investment in the UK. Authorisation may be required for vast majority of which are based in the capital. In addition investment in certain regulated areas, including financial to these, some 102 UK emerging companies are fast- services. The specifics of the authorisation (if any) will approaching a billion dollar valuation. The trend of growth depend on, among other things, the proposed investor, therefore looks set to continue. the nature of the business of the underlying company and the level of control which the investor may exercise. The Tech sector in the United Kingdom is also the most international of any Tech ecosystem outside Silicon Valley. Regulatory considerations 33% of UK Tech company customers are based outside the United Kingdom and 25% of entrepreneurs across A number of businesses may also need specific consents or the world report having a significant relationship with authorisations before they will be eligible to do business, two or more entrepreneurs in London. While Brexit poses particularly companies operating in the financial sector. challenges, the government has a stated aim to maintain Whether a FinTech will need specific authorisation in order the sector’s position as a leading digital economy on to do business in the United Kingdom will depend on the the global stage and has set out a number of initiatives nature of the product and/or services it offers. designed to achieve this (including special regulatory A FinTech will fall within the scope of UK regulation if regimes and visa programmes targeting the Tech industry). it carries out certain regulated activities for which an The various elements of the UK ecosystem are also highly exemption does not exist. Details of these activities (and interconnected, fostering collaboration, growth and the exemptions) are specified in legislation and cover more sharing of ideas. Data provided by meetup.com reveals the traditional financial services as well new products such as presence of 3,527 established UK tech groups over 283 crowdfunding.

29 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS

Most FinTech companies will therefore undertake a Directors thorough analysis of their business model against UK A private limited company must have at least one director. It is regulations to fully understand what can be achieved common to have at least two (and a public limited company is without becoming a regulated entity or, conversely, to help required to have two directors). There is no upper limit (unless one is included in the articles of association) and no need for them seek appropriate licences or approvals. the directors to be British nationals or resident in the United Kingdom (subject to any relevant tax considerations). Choice of entity Registered Address A US company which wants to do business in the UK The company must have a “registered office” in the United through a subsidiary company will usually establish a Kingdom to which any official notices or communications may limited company with share capital. This means, if the be sent. The registered office need not be the address from business is unable to pay its debts, the shareholders are which the company operates – for example, it could be an address provided by a service provider (there are numerous generally only liable for the amount outstanding on their companies who provide this service in the UK). subscribed shareholdings. Shareholders Other forms of entity may be established (e.g. a branch, a A company is required to have at least one shareholder. There company limited by guarantee, a public limited company, is no requirement for a shareholder to be a UK national or a limited liability partnership or a partnership). Minimum resident in the United Kingdom. share capital requirements, restrictions on rights attaching to shares and other relevant considerations (e.g. tax) will Ongoing Compliance Companies must generally file a set of annual accounts together influence a US company opting for one entity or another. with a return confirming, among other things,the directors and shareholders of the company. Both filings are a matter of Liability of directors public record. The public register must also be updated to reflect certain significant events in the life of the company (e.g. new As in the US, directors of companies may be liable to the issuances of shares and changes to the board of directors). In company and third parties for damages which result from practice, these obligations are not onerous. the infringement of the law or the company’s constitution and, in certain circumstances, may be criminally liable. D&O insurance in respect of such risks is widely available. The PSC Register Most UK companies are required to keep an up-to-date Setting up a limited company register of people with significant influence or control over in the UK the company (a PSC register) and the existence of a person The process of incorporating a limited company in the with significant influence or control must be declared at UK is generally straightforward and can be achieved on a the time of incorporation. The register is a matter of same day basis, if necessary. public record. This ultimately requires the identification of shareholders Share Capital who either: There are no requirements as to the size of a company’s issued share capital, and a company can be incorporated with a • hold (directly or indirectly) > 25% of the shares share capital of as little as a penny. There is no tax or duty payable on an issuance of shares. • hold (directly or indirectly) > 25% of the voting rights

• hold (directly or indirectly) the right to appoint or remove Constitution The constitution of an English company (its articles of a majority of the board association) is binding upon each shareholder of the company. • have the right to exercise or actually exercise ‘significant It must be filed with the registrar of companies and is a matter of public record. influence or control’ • have the right to exercise or actually exercise significant influence or control over the activities of a trust/firm, the trustees/members of which meet one of the other conditions. 30 www.thecityuk.com Contributors

TheCityUK and Moscow Innovation Cluster would like to thank everyone who has contributed to the report and to the UK-Russia FinTech Working Group discussions. We would especially like to thank the British Embassy, Moscow for their generous support of our project.

UK-side members Russia-side members • ACCA • API Bank • Bivonas • Credit Europa Bank • Chainvine • DBrain • Deloitte • FinTech Association • EY • Forum Analytical Centre • Innovate Finance • Intellect Dialog • International RegTech Association • Moscow Agency of Innovations • Law Society of England and Wales • Moscow Stock Exchange • London Stock Exchange Group • NAUFOR • PwC • OZ Forensics • Sberbank 500 Startups • SWiP • View App • Yandex

31 UK-RUSSIA FINTECH WORKING GROUP: INSIGHTS AND RECOMMENDATIONS

TheCityUK, Fitzwilliam House, 10 St Mary Axe, London, EC3A 8BF www.thecityuk.com

MEMBERSHIP To find out more about TheCityUK and the benefits of membership visit www.thecityuk.com or email us at [email protected]

This report is based upon material in TheCityUK’s possession or supplied to us from reputable sources, which we believe to be reliable. Whilst every effort has been made to ensure its accuracy, we cannot offer any guarantee that factual errors may not have occurred. Neither TheCityUK nor any officer or employee thereof accepts any liability or responsibility for any direct or indirect damage, consequential or other loss suffered by reason of inaccuracy or incorrectness. This publication is provided to you for information purposes and is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or as the provision of financial advice. Copyright protection exists in this publication and it may not be produced or published in any other format by any person, for any purpose without the prior permission of the original data owner/publisher and/or TheCityUK. © Copyright April 2020