Why Regulation is so Important for the Fintech Sector

Fintech harnesses AI, blockchain, cloud computing, big data and other technologies to improve and streamline the provision of financial services.

While most countries now regulate fintech, it took time for national laws and policies to catch up with this emerging and dynamic sector. This is important, as an unregulated fintech sector poses risks, specifically with regard to increased levels of financial crime.

Why is regulating fintech a challenge?

The emergence of the financial technology (fintech) sector presents regulatory challenges for several reasons.

For example, most countries’ existing regulations covering the financial services sector were created for traditional banking, so were unsuited to the emerging technologies used in the fintech sector. This means countries have had to adapt existing rules or create specific fintech regulations.

In addition, fintech companies are generally smaller and operate cross-border, and therefore must comply with the rules of each jurisdiction in which they operate. A third factor is the diversity of activities which fall under the definition of “fintech”.

These activities can cover everything from crowdfunding and cryptocurrency to full-service digital banking. As a result, the sector strays into several areas, each of which has different regulatory requirements.

How is fintech regulated in the UK?

Fintech businesses that operate in the UK are supervised by the Bank of England’s Financial Conduct Authority and Prudential Regulation Authority. These bodies monitor fintech regulations and have the powers to deal with any breaches of the rules.

Fintech firms are also subject to the provisions of the Proceeds of Crime Act 2002 and money laundering regulations. Among other things, firms are required to conduct customer due diligence, including the “Know Your Customer” process to verify new customers’ identities.

As noted, any UK-based fintech firms operating in other countries will also be subject to the rules relating to the other jurisdiction(s), such as the EU Anti Money Laundering framework.

What are the risks of unregulated fintech?

Given that it concerns banking and financial services, an unregulated fintech sector poses far-reaching risks. However, the main reason why it is important to regulate fintech is to combat the increased opportunities for financial crime. The rise of fintech has led to a rise in money laundering and other types of so-called “fincrime”, such as fraud, cybercrime, and market abuse. The potential risks will only increase as further developments impact the fintech sector.

In particular, the increased use of decentralised finance (DeFi) has brought cryptocurrency and blockchain technology under the spotlight of regulators across the world. DeFi operates outside the traditional central bank structure and offers users a layer of (but not full) anonymity. While this has advantages, it also presents opportunities to carry out fincrime.

Overall, an unregulated fintech sector has wide implications for governments, companies and consumers. By regulating fintech, countries can ensure companies know the rules of doing business in that jurisdiction. It also provides a guarantee to customers that the fintech company operates within the law. This helps fintech to establish customer trust, as well as levelling the playing field for the whole banking and financial services industry.