Kalifa Review - A revolution for FinTech?

The Government has published a report on FinTech in the UK containing some significant and far- reaching proposals for the financial services industry. Ultimately, the review focusses on how the UK can solidify itself as the global leader for FinTech and avoid talent and capital leaving the UK for other jurisdictions (yes, in light of Brexit!). The proposals are focused on bolstering the UK fintech ecosystem by providing a pro-innovation regulatory environment, making the UK an attractive place for leaders in the field to study and work, improving conditions for the UK's private and public capital markets to incentivise local growth and investment (rather than seeking more hospitable overseas venues), and positioning UK FinTechs at the centre of international ecosystems. The proposals are welcomed and needed. They build on FinTech developments already seen in the market. Implementing the proposals is now critical. Over to the Government…

Background

At the 2020 Budget, the Chancellor Rishi Sunak announced that the Government would be carrying out a review of the UK FinTech sector. The review, launched in July 2020, was led by Ron Kalifa OBE and the report outlines priority areas for industry, regulators and policy makers. It contains a number of proposals for how the UK can build on its existing strengths and produce an effective regulatory framework.

The report looks at the considerable growth and development of FinTech in the UK and notes the role played by regulatory initiatives such as the FCA's regulatory sandbox as well as the Bank of England's New Start Up Unit, in transforming the UK into a FinTech Hub. The report highlights three broad challenges to the UK's position that must be addressed: Brexit; competition; and the COVID-19 pandemic. It notes that overseas centres are hoping to emulate the UK’s success and states that Brexit has created regulatory uncertainty. It also notes that COVID-19 has accelerated digital adoption globally. It calls for immediate action in the areas of: jobs; trade; and inclusion and recovery. It then sets out a series of recommendations and sub-recommendations. We look at the key ones below.

Centre for Finance, Innovation and Technology

The report calls for the creation of the Centre for Finance, Innovation and Technology. Indicative targets will include:

• increasing FinTech adoption rate;
• increasing percentage of SMEs making use of external finance;
• doubling number of UK domiciled FinTech unicorns;
• increasing the number of FinTech listings on the London Stock Exchange;
• increasing the number of FinTech jobs; and
• Growing UK FinTech market share.

A coalition on SME finance

The report argues that there is a need for alternative providers beyond incumbent banks and calls for solutions that respond better to the specific finance needs and characteristics of different SMEs. It states that the coalition will use advanced analytics and data science to (among other things) assess barriers to growth and develop proofs of concept for new products.

Comprehensive FinTech strategy

The report calls for a comprehensive FinTech strategy covering a range of matters that also encompasses cross-sectoral matters not specific to financial services (such as data). The report states that the strategy should have clear objectives, actions and timescales. As part of this, the report states that the Government should consider whether any key areas should be identified for particular support. It states that these areas of focus could be particular sub-sectors (e.g. cyber security) or specific topics (e.g. financial inclusion).

Digital Finance Package

The report calls for a UK digital finance package, perhaps in light of Brexit and in light of the EU's own Digital Finance Package (see our briefing here). The report refers to the current regulatory framework, noting a lack of cohesion in mandates, policy direction and objectives and calls the current framework "vertically-focused". It proposes a regulatory framework that promotes co-ordination in relation to cross-cutting issues such as digitisation.

UK Digital Finance Package – key aspects

• Data strategy. This would include a digital ID trust framework to be established by the Government and would include, among other things, a corporate digital ID.
• Develop and adopt common data standards. The report argues that common data standards are crucial and that progress needs to be made in relation to the coverage and adoption of financial data standards.
• Prioritising smart data. The report argues that this could be achieved by using a "citizen-centric approach" allowing people to use, share and revoke their access to data. To achieve this, the report advocates: a cross-sectoral approach to Smart Data; mandating the sharing of data within sectors (such as Open Banking) and between sectors; and continuing to progress Open Finance as a mandatory regime.
• Artificial Intelligence. The report calls for the regulatory implications of AI to be considered and calls for clarity on the application of the PRA and FCA rules in the context of AI on issues such as governance and accountability.
• Central Bank Digital Currency. The report argues that a Central Bank Digital Currency (CBDC) could help support the adoption of new technologies (e.g. blockchain) in financial services. The report looks at the merits of a retail CBDC and a wholesale CBDC and suggests a hybrid model.
  Supporting the digitisation of Financial Markets Infrastructure. The report argues that this could be done by: fully dematerialising securities, in line with the requirements of Central Securities Depositories Regulation (CSDR); reviewing the CSDR, Financial Collateral Regulation and Settlement Finality Directive legislation; embracing digital technology in post-trade processes; looking at how the trading of tokenised securities can be facilitated on investment exchanges; and looking at whether digitised systems could lessen operation burdens of transaction reporting under MiFID and EMIR.
• Introduce a new UK regime for the regulation of cryptoassets. The report refers to the EU legislative proposal for a Markets in Crypto-Assets MICA (see our briefing here) and calls for the UK to act quickly. It proposes a bespoke regime with a "functional and technology-neutral approach". The report also welcomes initiatives in relation to stablecoins, such as HM Treasury's consultation paper and the call for evidence in relation to the UK’s regulatory approach to cryptoassets and stablecoins (see our briefing here).
• ESG. The report argues that FinTech has an important role to play in relation to ESG in terms of collection and processing of relevant ESG data. It sets out a number of proposals including the following: the UK should develop a framework to encourage sustainability-linked investments (e.g. sovereign bond or commercial debt); promotion of uniform sustainable reporting standards and terminology; and creation of a centralised electronic register for ESG data.

Adjusting certain aspects of FinTech regulation

• Payments regulation. The report highlights concerns in relation to the impact of the existing regulatory framework and asks whether change is needed in some areas (e.g. strong customer authentication and capital and liquidity).
• FinTech, new technologies and markets. The report notes that there are many areas of existing financial services law that could be updated in line with technological and market developments and calls for regulations to be technology-neutral.

Financial inclusion

The report advocates the use FinTech to support financial inclusion and capability. Proposals for regulators include the following:

• expanding financial education programme, to include financial education in schools, benefits of digital products and climate risks;
• incentives to FinTech companies to focus on particular demographics or areas to improve financial inclusion;
• encouraging incumbents to engage in financial inclusion and facilitating a retail lending referral scheme; and
• looking into whether FinTech could be used to tackle specific financial inclusion issues (e.g. the delivery of the Post Office Card Account) and whether cashback without a purchase (currently prohibited under PSD2) should be allowed under the Payments Review.

Digital Economy Taskforce

The report proposes a new Digital Economy Taskforce framework to deliver the FinTech strategy and sets out a number of features it should have, including the following:

• the taskforce should be established and mandated by the Government;
• the taskforce should have its own, clearly specified objectives (such as assisting in the development of the UK FinTech strategy);
• the taskforce should be temporary i.e. it should only exist until the FinTech strategy has been fully developed and the taskforce’s objectives implemented; and
• the taskforce should be required to have regard to certain specified matters when undertaking its role (such as the promotion of financial inclusion objectives).

Scalebox

The report calls for a “scalebox” arrangement to be introduced to businesses in the FinTech sector. Aspects of this include the following:

• enhancing the existing FCA regulatory sandbox (e.g. being available on a rolling basis, rather as opposed to time-limited windows);
• a new, permanent “digital sandbox” to encourage collaboration focusing on so-called Priority FinTech Areas and allowing for digital collaboration; and
• partnering with FinTech and RegTech firms (this would involve, for example, regulators encouraging regulated firms, as part of their operational risk assessment, to think about the potential benefits of technology).

Co-author: Bisola Williams, Expertise Legal Manager