Over the last decade, the FinTech industry has experienced significant growth. The global market was valued at around $7.3 trillion in 2020 and is projected to grow at a compound annual growth rate (CAGR) of 26.87 percent up to 2026, according to Research and Markets, on the back of increased investments in technology-based solutions, supportive government regulations and the rising adoption of internet of things (IoT) devices, among other factors.
Prior to the coronavirus (COVID-19) pandemic, FinTech adoption was doubling every two years, according to the Global Fintech Adoption Index 2019. It swelled from 16 percent in 2015 to 64 percent in 2019 – and growth continued throughout the crisis. The pandemic was a game changer, with FinTech acting as a core enabler of digital payments as consumers rapidly migrated to contactless and online shopping. As the global economy shifts from ‘respond’ to ‘recover’, new opportunities will arise.
How, then, can FinTechs leverage their unique assets and skills to capitalize in the post-COVID-19 era, particularly considering the increased exposure to regulatory requirements, sanctions, and legal action likely to shadow the industry?
Growth factors
A variety of factors have contributed to the advancement of FinTech over the last decade. Technological advancements have changed how we do nearly everything in our day-to-day lives. Some technologies such as IoT, artificial intelligence (AI), blockchain, and cloud computing, have been major drivers of FinTech innovation. Where incumbent financial players have been unable to maintain pace with shifting consumer habits, FinTechs have stepped in to gain significant ground.
Barriers to entry have reduced as technology has flourished, forcing traditional financial institutions (FI) to change or be left behind. According to Dorothy R. Auth, a partner at Cadwalader, Wickersham & Taft LLP, FinTech is the natural progression of how financial services will evolve, and the COVID-19 pandemic has only accelerated its development. “FinTech will make transactions faster and more efficient. Blockchain in particular will be a disruptive force and threatens traditional banking if they do not integrate it into their systems,” warns Dr. Auth.
Already, many banks are partnering with FinTech firms to enhance their service offerings. FIs are realizing that consumers’ brand loyalty is decreasing, while demand for speed, accuracy, transparency and more technology is rising. According to the Swiss Finance Institute, during the COVID-19 pandemic, the daily average rate of FinTech app downloads increased from 29.2 percent to 32.8 percent.
Adapting to market demands will be crucial in the post-COVID-19 digital age. “We have seen sustained rapid growth in the FinTech sector over the last 12 months,” observes Gabriel Lakeman, an associate at Latham & Watkins. “On the payments side, COVID-19 has had a continued impact on the rise of payments services. On the crypto side, we have seen a significant broadening of the ecosystem with new technological developments being deployed in real-world use cases.
“Already, many banks are partnering with FinTech firms to enhance their service offerings. FIs are realising that consumers’ brand loyalty is decreasing, while demand for speed, accuracy, transparency and more technology is rising.”
“Decentralised finance is a clear example – trading volumes on DeFi platforms are up significantly, there is increased interest in DeFi protocols, and non-fungible tokens (NFTs) are opening new avenues for intellectual property monetization,” he adds.
Regulatory frameworks
Alongside the exponential growth of the industry, the regulatory landscape for FinTechs has also evolved in recent years. “We have seen heightened regulatory certainty and scrutiny, increased institutional adoption, and market consolidation,” says Sonia Struthers, a partner at McCarthy Tetrault. “Securities regulators have clarified how securities laws apply to crypto-asset trading and taken enforcement action. For example, the Ontario Securities Commission in Canada has been particularly active in enforcing requirements applicable to the trading of crypto-assets.
“In the payments space, Canada’s new Retail Payment Activities Act, which will apply to ‘retail payment activity’, was passed,” she continues. “The Advisory Committee on Open Banking released its final report, calling for an open banking system to be implemented within 18 months. Since the world’s first bitcoin exchange-traded fund (ETF) was authorized, cryptocurrency funds have been flourishing in Canada. The Canadian FinTech industry has been consolidating, with larger players growing and launching new products.”
Though the outlook for the industry appears positive, increased exposure to regulatory requirements, sanctions, and legal action will be an area of concern for FinTechs. “Legal certainty is a key issue for market participants as we have seen regulators starting to move to a more active role, particularly in the retail and crypto space,” suggests Mr. Lakeman. “Proposed new regulatory frameworks offer the possibility of greater legal certainty in the medium term and provide the opportunity for early players to establish their positions.
“However, we have seen increased regulatory action through enforcement and supervisory intervention in the meantime – and this has increased the level of legal uncertainty. Continued close engagement by regulators with the industry is vital to support innovation while ensuring consumer protection,” he adds.
The sandbox approach
In the UK, the Financial Conduct Authority (FCA) has demonstrated its commitment to encouraging innovation in the interest of consumers. Since 2016, it has been running ‘regulatory sandboxes’, allowing firms to test innovative products, services, business models, and delivery mechanisms with real consumers in a safe environment under FCA supervision.
“These sandboxes have been hugely successful and led to regulators worldwide adopting sandboxes of their own,” notes Sushil Kuner, a principal associate at Gowling WLG. “By testing products under the supervision of the regulators, this potentially accelerates the authorization process and the route to market for many firms.”
In January 2019, an international group of financial regulators and related organizations formally launched the Global Financial Innovation Network (GFIN) to create a global sandbox. “The GFIN, chaired by the FCA, seeks to provide a more efficient way for innovative firms to interact with regulators, helping them navigate between countries as they look to scale new ideas and launch in new jurisdictions,” explains Ms. Kuner. “This includes the ability to conduct a cross-border test which is crucial in the FinTech sector where products, services, and business models can operate cross-border in multiple jurisdictions.
“Currently, applications are open for the FCA’s ‘Green FinTech Challenge’ and the ‘Second Digital Sandbox’ as part of a program of work to assist firms and regulators to overcome some of the challenges that moving to a net-zero economy will raise in the area of sustainability and climate change,” she continues. “It is through more initiatives like these, and the FCA’s Techsprints where it holds workshops with industry, academics, and other professionals to find innovative solutions to challenges in the financial services sector, that regulators can encourage innovation in this space.”
Balancing the regulatory burden
According to Alison Manzer, a partner at Cassels Brock & Blackwell LLP, there are two distinct aspects to regulation in the FinTech space: firstly, the use of FinTech as a solution for regulatory compliance with existing regulations in the sector, and secondly, the regulation of activities not currently under regulatory control. “The evolution of regulation of activities under current regulation, such as anti-money laundering (AML), can assist the sector by adapting to accept digital solutions to the regulatory needs,” she says. “Shifting compliance standards to accept the FinTech solutions being developed will assist in the growth of the sector and protect the existing regulated activities.
“Reducing the regulatory burden on FinTechs by recognizing what is uniquely an aspect of digital approach rather than adding financial services activities to the regulatory regime will assist by not overreaching the compliance requirements. An activity not currently regulated does not necessarily need regulation because it moves to digital delivery,” she adds.
Going forward, it will be important for FinTechs to get their compliance right. “The approach to effective regulatory compliance can differ between the portion of the sector that is providing applications to support regulatory compliance and those that are operating in a sector that is regulated or becomes regulated,” says Dr. Manzer. “But both need a basis for assessment that uses the global incentives as a base and then applies an understanding of the aspects of the FinTech service that reflect the policy concern – usually protection of customers, depositors, or the financial system.
“Monitoring in that manner allows adaptation of the product to meet regulatory interventions on a real-time basis while minimizing the need for retrofit to meet the specifics of regulation. The global discussion signals the issues of concern and the sectors that need to prepare to respond,” she adds.
With customer and regulatory expectations increasing and evolving simultaneously, there will be many challenges ahead, particularly in areas such as AI, which will be integral to creating new FinTech solutions. “One significant area which regulators will likely focus on is the governance around AI and ensuring that AI is working to deliver good outcomes for both consumers and markets, with a clear understanding by organizations of how decisions made by AI solutions are being reached,” asserts Ms. Kuner.
Prospects in Canada
In Canada, current trends are consistent with the global approach to increasing the digital aspect of the delivery of financial services, according to Dr. Manzer. “It is expected this will continue, with Canada firmly supporting international approaches to the intervention of technology in the sector and its regulation,” she says.
Ms. Struthers agrees. “Continued innovation and institutional interest in the FinTech space remains strong in Canada,” she says. “The number of companies offering new and novel services, including embedded finance and banking-as-a-service, continues to increase. We also note an increased focus from investors on environmental, social, and governance (ESG) impacts, and the selection of Montreal, Canada as the second location of the International Sustainability Standards Board, as well as the recent announcement by the CSA of regulation of climate-related disclosure. We expect this to lead to the FinTech space being scrutinized with this lens in the future.”
In addition, the Canadian Securities Administrators (CSA) has published a number of regulatory notices clarifying that entities facilitating the trading of crypto-assets may be subject to securities legislation. “As a result, we expect to see regulatory scrutiny increase in Canada as compliant players take additional steps to become or stay in compliance, while non-compliant players enter into discussions with regulators, review their business models or exit the Canadian market,” suggests Ms. Struthers.
The road ahead
Financial services, like so many other aspects of the global economy, have been dramatically impacted by the pandemic. Since the outbreak, FinTechs have had to learn to lead, navigate and disrupt the financial services industry during a time of considerable upheaval.
Increased reliance on technology has spurred consumers to gravitate toward FinTech services to meet their financial needs. As the world begins to move beyond the pandemic, the industry is set to continue shaping the financial landscape into the future.
