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Compliance & Risk

Deflating fintech market provides renewed challenges for compliance officers

Mike Cowan  Senior Regulatory Intelligence Expert / Thomson Reuters

· 5 minute read

Mike Cowan  Senior Regulatory Intelligence Expert / Thomson Reuters

· 5 minute read

As the market for fintech innovation stalls out, how can compliance officers make sure their investments in certain fintech solutions remain viable?

After several years of sustained growth, investment in the fintech marketplace declined during 2022 as the uncertain economic climate and fears of recession, inflation, and climbing interest rates contributed to increases in operating costs for potential investors who may now need to use their capital for other priorities.

This downturn was reported in Fintech, Regtech and the role of compliance in 2023 report, published by Thomson Reuters Regulatory Intelligence (TRRI). The report quoted statistics from Innovate Finance’s 2022 Summer Investment Report, which found that in the first half of 2022 the total capital invested in fintech worldwide reached $59 billion. This was flat year-on-year, with 3,045 deals completed; fewer than the 3,401 deals in the first half of 2021.

The 2023 Fintech/Regtech survey found further evidence of a financial downturn in the sector, reporting that enthusiasm for fintech was waning, with a fall in the number of people feeling extremely positive about the sector. Overall, this year’s survey reported that 15% of respondents were extremely positive about fintech, compared with 31% last year.

Economic uncertainty

The profile of the fintech marketplace appears to be changing as smaller operators are more likely to fail, leaving larger firms with a greater market share. Fintech firms are making employees redundant, losing vital skills and experience, as the economic situation remains unstable.

Further, prices of fintech solutions may well increase as the number of fintech firms declines and the capability to innovate diminishes. Such developments will be unpalatable to potential investors and buyers alike.

In the last few years, TRRI’s fintech surveys have highlighted the popularity of applications in many disciplines. This year’s survey showed the top uses include credit risk analysis, information and data security, and customer relationship management.

Demand to automate operations has not dissipated, but the challenges to implementation have grown. The economic environment has made it harder for firms to deploy fintech applications in a cost-efficient way, and fintech firms have become less able to innovate, reducing the choice of available applications.

Other reasons why fintech has diminished

Susceptibility to fraud is another of the main reasons why fintech has become less attractive. Fintech applications’ exposure to fraud has increased in recent years; and this, coupled with a rise in the number of cyber-security breaches, has placed pressure on fintech firms to consider security and control elements. Fraud victims lost £1.3 billion in 2021 alone amid a surge in online fraud, with a nearly 40% rise in authorized push payment scams, according to UK Finance.

Fintech applications can be powerful tools which help reinforce money laundering controls, although fraudsters also see fintech applications as conduits for laundering activities. The greater number of transactions that fintech applications can promote, coupled with the continuous flow of money, especially across borders, and the potential for anonymous account-holding, are all characteristics which hold huge appeal for money launderers.

Financial services regulators have placed the onus on firms to have effective anti-money laundering (AML) controls in place, including for many of the disciplines that fintech applications purport to address, such as customer due diligence, know-your-customer checks, and transaction-monitoring arrangements. In fact, regulators have fined several financial services firms for failures in these areas. Regulators are also concerned that fintech applications may increase the risk of harm to customers and investors or reduce firms’ operational resilience or systemic financial stability.

Crypto-assets, cloud computing, and payment systems have all been identified as needing to be brought inside the regulatory perimeter. These areas are now subject to regulations or are in the process of being regulated. This imposes another level of complexity on fintech applications.

Finally, the availability, or otherwise, of skilled staff and indeed firms’ ability to afford staff with the relevant knowledge may also be acting as a brake on the development of new fintech solutions or the purchase of existing applications.

The 2023 Fintech/Regtech survey identified a dearth of skills as one of the greatest challenges to the growth of fintech, with half of corporate boards surveyed reporting that they had had to widen their firms’ skill sets to accommodate developments in innovation and digital disruption. The need for additional skilled resource was balanced by the fact that some fintech firms were laying off workers, however.

Challenges for risk & compliance officers

For compliance officers, there is different perspective on the risks to which firms are exposed, highlighting the need to develop comprehensive yet flexible governance arrangements. This places greater focus on firms’ risk management frameworks, of course, making it more important to get third-party on-boarding processes right. Risk & compliance officers need to ensure that the risk of a fintech failing is fully explored when on-boarding a supplier.

The on-boarding process should also assess the skills and resources available to the fintech firm, and its plans to recruit or develop the necessary skills. Further, compliance officers need to ensure that, where there is a regulatory reason for engaging with a fintech application, all the relevant rules are covered and that the output from fintech solutions can be used to demonstrate compliance both internally to senior management, and externally to regulators.

Also, the adequacy of business continuity arrangements and exit strategies needs to be fully evaluated to ensure that, should the fintech no longer be unavailable, the detriment to customers, shareholders, and the wider financial services sector is offset.

Firms that have solid risk and governance frameworks that provide for the regular review and updating of risks may already have managed the risks associated with a changing fintech marketplace. It would, however, be prudent for firms to reassess their relationships to prevent the market downturn from disrupting the supply of services and placing the firm at greater risk of financial loss, customer detriment, and regulatory scrutiny.

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