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Earlier today the Government published the Kalifa Review of UK Fintech, led by Ron Kalifa OBE (the “Review”).

Amongst its progressive recommendations the Review recommends the expansion of the EIS, SEIS and VCT tax reliefs to regulated fintechs.

Digital technology enables financial markets to acquire, process and communicate data at much greater speeds than ever before, to much wider audiences and at a greatly reduced cost.

The acceleration of decision making by artificially intelligent systems is only likely to increase with the advent of quantum computing and there is a pressing need to keep secure the vast amounts data that is now collected about who we are and what we do. This calls for a new type of regulation capable of addressing the new problems that now emerge; problems that rarely if ever had to be considered when the systems of our financial institutions simply relied on paper records and paper communications.

It is important that global markets have confidence in the regulated systems and processes of UK fintech companies if we are to remain in the vanguard of change in the new digital world of fintech activity, change that has so far catalysed the UK into a fintech hub where so-called “unicorns” such as Wise, Onfido, Checkout.com and Revolut have chosen to base themselves.

 

Here is my brief summary of the Review’s findings.

Fintechs find it difficult to access the growth capital to transition beyond the start-up phase. Unregulated fintechs that wish to scale need to be capable of competing at a global level both with the mega technology companies and similar rival fintechs based out of other jurisdictions. They need to cater to an international market which brings with it the requirement to export early. The rate of technological development and speed of other markets to react and develop fintech products and services places particular pressure on the fintech sector. Regulated fintechs face the requirement for regulatory capital in order to become a substantial national and international business. This requirement is specific to financial institutions and creates difficulties for their smaller firms looking to develop an offering in this space.

At present, investment into the UK fintech sector has been made by international sources of capital and foreign investors are now enjoying the proceeds. Encouraging domestic investment and in particular that of institutional capital would allow us to retain these proceeds and could also go some way towards plugging the UK pension shortfall that has reached approximately £5 trillion.

The opportunity is clear, that more domestic sources of funding backing the fintech sector would drive UK economic growth. Unlocking a fully-fledged fintech ecosystem delivers job creation, skills and talent development; overall market attractiveness; export potential and tax revenue benefits.

Tax incentives such as R&D tax credits and tax relief schemes can accelerate UK fintech growth by providing entrepreneurs with more reassurances that they can secure funding. There was more than £150 million raised in 2018 under the EIS scheme alone, giving many UK fintechs the funds necessary to scale at the early stage.

The government proposes to expand R&D tax credits and the Enterprise Investment Scheme and Venture Capital Trusts so there is more clarity that regulated fintech businesses qualify for investment as well as unregulated fintech businesses.

Expanding the Enterprise Investment Scheme and Venture Capital Trust tax reliefs and redirecting the low risk investment supported by the reliefs is expected to unlock over £7bn per the UK Research and Development Roadmap.

The UK has an impressive scorecard:

  • representing 10% of the global market share an £11 billion in revenue, the UK is a dominant force in fintech.

  • total tech spend by UK financial services firms was £95 billion in 2019.

  • SMEs and corporates are all keen users of fintech. UK citizens are becoming digitally active and the 71% are now using the services of at least one fintech company.

  • investment into UK fintech stood at $4.1 billion in 2020 – more than the next five European countries combined.

There are three broad threats to our fintech leadership position.

Competition: Overseas centres are seeking to emulate the UK’s success. Competitor jurisdictions such as Singapore, Australia and Canada are investing heavily across many of the areas we have looked at including capital, and skills and direct support for fintechs.

Brexit: Brexit has created regulatory uncertainty in specific areas relevant to fintech. Firms must navigate the immigration system for European Union talent for the first time – whilst rival jurisdictions are rolling out aggressive attempts to lure talent in.

Covid: The pandemic has accelerated digital adoption globally in a way that marketing or policy never could. This is creating opportunities for jurisdictions that are quickest to diagnose what’s happening and nimblest to capitalise on the opportunities for fintech.

If we can overcome these threats fintech will create many more high income tech based employment opportunities across the UK; fintech will be a core asset enabling UK fintech companies to lead international markets fintech will support citizens and SMEs to access more, better and cheaper financial services and in a sustainable way to help “build back better”.

The Review recommends:

  • a new regulatory framework.

  • a Scalebox that supports firms focusing on scaling innovative technology.

  • a Digital Economy Taskforce (DET) drawn from cross government departments and regulators that would speak with a single customer view on the government’s regulatory strategy on tech and provide a single touch point with which the private sector might engage.

  • the development of a global trade policy in relation to fintech.

  • that the competition and markets authority CMA should be more flexible in its assessment of mergers and investments in order to facilitate the growth oh UK fintechs.

The government also proposes to enhance fintech skills within the UK workforce by ensuring access to short fintech courses from high quality education providers at low cost and new visas that will enable fintech companies to recruit overseas talent more easily.

Broadening the application of existing UK state aid tax incentive schemes would further encourage early stage investment, which can be surprisingly capital intensive. According to a survey commissioned by the review both founders and investors but particularly 89% of investors highlighted the significance of financial data sets to their business model and the level of investment required to develop these. This is because data permeates financial services, whether it is analysing payment flows, credit scoring mechanisms, understanding overall risk and more. A tax credit relating to the costs of such data sets would provide a valuable source of cash/capital for critical investment to accelerate their R&D and successfully scale and grow.

The same survey showed that 97% of fintech founders have utilised state aid schemes, including EIS and VCT yet 56% highlighted that they faced a level of difficulty in accessing these schemes.  47% of founders were concerned over the ability to qualify for tax reliefs if the business models of their company pivoted from unregulated to regulated in the future .

Expanding the tax reliefs to regulated fintechs will level the playing field for fintechs relative to other technology companies.  Whilst the UK has some brilliant tax incentive schemes to encourage angel investment in early stage start-ups, many fintechs are excluded from the concessions available for SEIS, EIS and VCT investment due to their involvement in finance provision. Changes are needed to ensure that the fintechs can at least compete on a level playing field with other start-ups in those early embryonic years of raising early stage capital.

There is a growing consensus that there is a private market funding gap for several high growth sectors in the UK and European market. Whilst good progress has been made by using government funds to catalyse the creation of domestic VC managers, the gap still exists. Importantly UK private institutions have yet to participate in fintech funding.

Accordingly, the government proposes to unlock institutional capital with a £1 billion fintech growth capital fund, modelled on the Business Growth Fund – there is £6 trillion in UK private pension schemes alone a small portion of which could be diverted to high growth technology opportunities like fintech. This is likely to fall within the remit and interests of the Productive Finance Working Group.

The government also proposes to improve the listing environment through free float reduction, dual class shares, a relaxation of pre-emption rights and the creation of a global family of fintech indices to enhance sector visibility so that once enough UK fintech companies have listed and formed a sub-sector, a UK index can become a bellwether for all UK fintech stocks and cement the country’s reputation as a listing destination.

Various international initiatives are planned as well as a  new government backed Centre for Finance, Innovation and Technology (CFIT) led by the private sector which will coordinate targeted fintech policies. In particular the CFIT will launch an International Fintech Credential Portfolio (FCP) enabling fintechs to demonstrate an international sign of quality, resilience trust and standing to participants in international markets.

 

Roger Blears

26th February 2021