Fintech trends and updates

An update on the latest fintech trends, including blockchain, open banking, PSD2 and initial coin offerings

19 June 2020

FCA confirms that it is still available to support innovative firms

21 May 2020

By Ciara Davies.

On 14 May 2020, the FCA updated its webpage to confirm that, through its Innovation Hub, it is still available to support innovative firms looking to launch financial services products and services. The FCA is keen to assist firms that are focussing on helping people and the financial systems they rely on to deal with the effects of COVID-19.

The FCA wants to hear from firms that are developing innovative solutions, including those intended to:

improve access to credit or funding for consumers or small businesses.
help improve access to cash, charitable donations, government aid or other financial help.
help increase the speed or efficiency in assessing and resolving insurance claims.
improve the identification of scams from, for example, phishing or push payment fraud.

This is not an exhaustive list and the FCA will consider other credible proposals designed to help with the consequences of COVID-19 or which are innovative and show clear consumer benefit.

FCA’s Digital Sandbox

4 May 2020

By: Ciara Davies

The FCA has announced that it intends to collaborate with key strategic partners and the industry to pilot a ‘digital sandbox’. The FCA welcomes initial expressions of interest as it develops this pilot and plans to open applications later in the summer.

The FCA believes that developing a permanent digital testing environment would provide significant value to the financial services sector. The FCA, therefore, is accelerating its plans and will pilot aspects of the digital sandbox on a modular basis to provide support to innovative firms during the crisis.

The FCA outlines features that could be the foundations of a digital sandbox:

Access to high quality data assets including synthetic or anonymised data sets to enable testing and validation of technology solutions
Identification of areas of regulatory interest where innovation could play a greater role
A collaboration platform for idea sharing
An observation deck to enable regulators and other interested parties to observe in flight testing at a technical level
Application programming interface (API) or vendor market place – FinTech, RegTech and other vendors can list solutions and APIs
Access to regulatory support

The FCA will be updating its webpage with further details on the specific proposals for the launch of the coronavirus pilot of the digital sandbox.

In the meantime, if you would like to express your interest please email the FCA at digital.sandbox@fca.org.uk.

The Payment Systems Regulator (PSR) published an updated version of its COVID-19 website

1 May 2020

By: Ciara Davies

The PSR has acknowledged that this has been a challenging time for people and business. It is closely monitoring the situation and the impact that coronavirus may have on its work now and in the future.

The PSR has stated that during the pandemic, it will not hesitate to take necessary steps to ensure that payment systems continue to work for everyone. Organisations are expected to review their current arrangements and to take reasonable steps to ensure that they are prepared to meet the challenges posed by coronavirus. In addition, the PSR asks regulated parties to report immediately if they believe they are or will be in financial difficulty or if circumstances could lead them to being unable to offer the full range of services.

Updates to PSR work or requirements will be included on the PSR COVID-19 update webpage.

HSBC considering the transfer of $20bn worth of paper trails of private investments on blockchain

Update posted: 11 December 2019

By Paschalis Lois

Late last month, HSBC indicated its intention to digitise $20bn worth of paper trails relating to private placements and to store it on a blockchain platform. The aim of the shift is to make it easier for investors to track private placements, make enquiries of the data, and effectively assess the placements’ veracity before entering into a transaction. To achieve this, HSBC will be moving the data relating to these placements on a blockchain platform named ‘Digital Vault’.

The need for efficiency in private placements stems from the fact that there is currently no clear standardisation of data, and a lack of transparency as private placements are not made over public exchanges. This means that investors often spend too much time checking the status of holdings. As such, blockchain technology, which can allow for the safe storing of immutable records of information, and by extension easy verification of an information trail, can cut down time of investors seeking to confirm the status of a private placement.

This is not the first time HSBC has experimented with the benefits of blockchain technology. It previously executed its first live trade finance transaction involving a Letter of Credit, on R3’s Corda Blockchain platform in May 2018 over a timespan of 24 hours, where an equivalent transaction using the traditional methods would have taken 5-10 days. These moves potentially signal greater practical use of blockchain technology by established financial services businesses, especially where speed, veracity, and immutability are key criteria of the economic activity concerned and comes at a time where blockchain technology and smart contracts are already gaining greater recognition and better legal status.

Is Cryptocurrency Property?

Update posted: 28 November 2019

By Tom Whittaker and Charlotte Mallin Martin

On Monday 18 November 2019, Sir Geoffrey Vos, Chancellor of the High Court, launched the Law Tech Delivery Panel’s ‘Legal Statement on the Status of Cryptoassets and Smart Contracts’. It is essential we get to grips with the legal implications of using crypotassets because, as Sir Geoffrey Vos said “[t]here is an endless spectrum of types of cryptoasset and cryptocurrencies, many of which already are or certainly will be designed for use in wholesale and retail payment mechanisms” (see paragraph 3).

The Legal Statement concludes that, as a matter of English legal principle, cryptoassets should be treated as property. The “novel and characteristic features” of cryptoassets, such as their intangibility or the fact that cryptographic authentication is used to control their use and transfer, are not fatal to this finding.

The conclusion reached in the Legal Statement should not come as a surprise to those involved in litigation which concerns cryptoassets. The English High Court in Elena Vorotyntseva v Money-4 Limited t/a Nebeus.com and Others [2018] EWHC 2596 (Ch) did not appear troubled by the parties’ agreement that cryptocurrency is a form of property (see paragraph 14). In B2C2 Ltd v Quoine Pte Ltd [2019] SGHC (I) 03, a decision of the Singapore International Commercial Court, Simon Thorely IJ held that cyrptocurrencies “have the fundamental characteristic of intangible property as being an identifiable thing of value” (see paragraph 142).

Sir Geoffrey Vos said that the Law Commission will now explore the possibility of introducing legislation to regulate this area. We know that freezing orders (Elena Vorotyntseva) and asset preservation orders (Robertson v Persons Unknown (Unreported)) can be granted by the courts in cases which concern the possible dissipation of cryptoassets. The Legal Statement says, however, that only some types of security can be granted in these cases. For those involved in, or considering, litigation involving cryptoassets, they might be helped by further guidance on what orders they can and cannot seek from a court.

“With great power comes great responsibility” – the FCA examines technological evolution

Update posted: 6 November 2019

By Christopher Walker

On 6 November the FCA’s Director of Innovation, Nick Cook, gave a speech to the CDO Exchange Financial Services conference in relation to the FCA’s innovation strategy.

In particular, Mr Cook focussed on future initiatives in relation to the FCA’s regulatory sandbox (the Sandbox).

General innovation efforts

The Sandbox has been in use for 5 years and has been used by 700 firms; 47 firms have completed Sandbox testing, with around 80% now operating in the market.

Whilst new players have entered into retail banking in recent years, Mr Cook identified that there have been ‘significantly fewer offerings’ in ‘asset management and retirement savings’. Additionally, he noted that ‘big and mid-size players’ do not particularly engage with the Sandbox, as it does not currently offer services relevant to their needs.

As part of an effort to recalibrate its initiatives, the FCA is looking to diversify the Sandbox’s offering by encouraging “developments in certain areas of regulatory interest – trying to ensure that the Sandbox helps to produce certain desirable outcomes” which the FCA considers important.

In particular, the FCA is seeking propositions that:

make finance work for everyone through addressing issues such as access, exclusion and vulnerability
support the UK in the move to a greener economy by responding to the challenges posed by climate change, or
use technology to overcome regulatory challenges – by helping regulated firms comply with their obligations.

These ‘3 outcomes’ are part of the FCA’s efforts to ensure that financial services are ‘a force for good’ in society in relation to protecting consumers or the impact of climate change.

Regtech developments

Mr Cook also identified Regtech as a ‘key ‘underserviced’ area of the Sandbox’. One key challenge identified by the FCA during their engagement with firms looking to gain market access “is the lack of access to high-quality synthetic data assets against which to test new technology solutions”. Consequently, the FCA is looking to generate further discussions around the digital testing landscape and the role the FCA should play in supporting its creation, as well as potential for cross-jurisdictional utilisation of a digital testing environment.

In addition to the ‘3 outcomes’ for Cohort 6 above, the FCA has flagged two types of technologies it is interested in receiving applications in relation to:

Federated learning or travelling algorithms - enabling entities to develop performant algorithms ‘which are trained on multiple data assets without bringing those assets together’, and
Complex scenario modelling and scenario simulation - in essence, whether ‘graph analytics, behavioural science and deep learning can be used to better model relationships, connections and behaviours in financial markets’, before simulation and scenario-testing can be undertaken against these complex scenario models.

Mr Cook noted that the outcome for regulators would ‘could mean understanding with greater precision the impact of planned or potential policy interventions. For firms, this could help them ensure that the products they are developing don’t pose any unintended risks to certain customer groups, such as vulnerable consumers, before they are released into the market’.

The speech builds on continuing efforts by the FCA to address issues around vulnerable consumers, facilitate a greener UK economy and manage the data-rich financial services ecosystem.

Sandbox Cohort 6 applications will remain open until 31 December 2019.

Financial Action Task Force publishes statement on virtual assets

Update posted: 18 October 2019

By Christopher Walker

The Financial Action Task Force (FATF) has published a statement on 18 October in relation to money laundering risks from “stablecoins” and “other emerging assets”.

A stablecoin is generally accepted to be a token which is backed by fiat currency, a basket of cryptoassets, other types of assets, or algorithms – their “stability” stems from their backing of one of these mechanisms (for further information, page 18 of FCA PS19/22 provides analysis in relation to this area).

The statement provides details as to how FATF will assess countries’ implementation of global standards introduced in June 2019 in relation to money laundering and terrorist financing risks of virtual assets.

In particular, FATF will assess (as part of its mutual evaluation process) how well countries are implementing these measures; countries that have already completed a mutual evaluation assessment will be required to report back to FATF during the follow-up process as to any actions they have taken.

FATF’s main concerns surround:

Prospective mass-market adoption of virtual assets; and
person-to-person (“P2P”) transfers without the need for a regulated intermediary.

FATF’s first concern, following the recent surge in the possibility of mass-market virtual assets such as Facebook’s Libra Cryptocurrency, further demonstrates high-level interest in the regulation of cryptoassets at an international level – the FATF are keen to ensure that stablecoins and their respective service providers are subject to their standards and do not fall outside of AML controls.

For full details as to FATF’s June recommendations, please see the link here.

Update posted: 16 October 2019

By Christopher Walker

The Bank of England and FCA publish their joint report on machine learning in UK financial services

The Bank of England (‘BOE’) and FCA published their joint report on machine learning (ML) in UK financial services (the ‘Report’) on 16 October.

The Report defines ML as ‘the development of models for prediction and pattern recognition from data, with limited human intervention’ and a sub-category of artificial intelligence (‘AI’) – in the financial services industry, ML use cases currently include anti-money laundering, fraud detection and customer-facing applications.

Surveying the industry

The Report is the outcome of a survey sent to around 300 firms in order to further develop regulatory understanding around the ways ML processes are being utilised by financial institutions.

Broadly, the survey asked firms questions such as:

Whether ML is used in their business;
If so, the nature of ML usage; and
How developed are the lifecycles of the respective ML applications deployed.

Key findings

The Report’s insights (non-exhaustively) include:

ML use is ever increasing in financial services, with two thirds of survey respondents indicating they already use it in some form and 52% stating that they have a dedicated ML strategy in place;
Regulation is not seen as a barrier but firms would increasingly like to see further guidance in relation to its use and current regulations – key limitations include legacy IT systems and data issues;
ML is currently being developed largely in-house with third party providers instead used for underlying platforms and infrastructure, such as cloud computing;
Firms believe that ML could amplify existing risks rather than generate many new risks, with firms’ primary concerns surrounding their model validation and governance frameworks keeping pace with technological development; and
Safeguards currently employed by firms include ‘human-in-the-loop’ mechanisms – human oversight is used to spot and correct ML models that veer off-course from an initial set of goals over time due to drift caused by regular updates. However, the Report highlighted that ‘black box’ ML models, insufficient staff training and poor quality data sets were all areas of concern that will need to be addressed.

Comment

As discussed within our analysis of the BOE’s Future of Finance report, there is a great deal of work that remains to be conducted in relation to AI in financial services.

The Report indicates that the majority of firms simply use their existing risk management frameworks in relation to ML applications, but that they expected a need for these frameworks to evolve in relation to increasingly sophisticated ML techniques; the FoF report also acknowledged this challenge.

As a prelude to a future joint public-private sector working group on artificial intelligence, the Report continues important engagement with the financial services sector in relation to the evolving AI ecosystem; as such, the BOE and FCA have described the report as a research project rather than one which will immediately generate a policy response. Ensuring that AI systems and their respective ML components are aligned with a firm’s and wider society’s conduct and ethics rules will continue to be an ongoing area of interest to the regulators and wider industry.

Update posted: 15 October 2019

By Christopher Walker

FCA opens consultation on costs recovery as new AML/counter-terrorism financing cryptoasset business supervisor

The FCA published ‘CP19/29: Recovery of costs of supervising cryptoasset businesses under the proposed anti-money laundering regulations: fee proposals’on 15 October 2019.

Key changes

The consultation is part of the UK’s implementation of the Fifth Money Laundering Directive, implemented through amendments to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.

Cryptoasset businesses (i.e. currently those identified as undertaking cryptoasset activities within the HM Treasury’s 2019 consultation paper, although this is subject to final confirmation) must:

Register with the FCA from 10 January 2020 where intending to carry out new cryptoasset business after this date, or by 10 January 2021 if already carrying out cryptoasset business before this date;
Be subject to the FCA’s supervision in relation to AML and counter-terrorist financing (‘CTF’) from 10 January 2020 – the FCA may conduct enforcement action against firms for non-compliance following this date whether registered or not;
Pay the relevant registration fee (which is currently proposed as £5,000); and
Following the implementation of the new regime, pay an annual periodic fee to cover the FCA’s regulatory costs and the project set-up costs incurred to date.

As part of the registration process, cryptoasset business will need to prepare their AML/CTF policies, controls and procedures before submitting their applications; the FCA is looking for applicants to demonstrate that they are able to identify, assess, monitor and effectively manage the financial crime risks to which the applicant may be exposed.

The FCA is seeking a three-month period to make registration assessments following receipt of the required information and is encouraging early applications to ensure applicants meet the relevant deadline. All applications must be made through the FCA’s Connect system.

The consultation questions

The FCA asks for responses in relation to two questions:

Do you have any comments on the proposed registration fee of £5,000 for crypto-asset businesses?
Do you have any comments on the proposals for periodic fees, including minimum fees, the minimum fee threshold and the draft definition of income?

Response timescales

The deadlines for responses in relation to (1) registration fees and (2) periodic fees are due on the 11 November 2019 and 10 December 2019 respectively.

Feedback will then be published on the registration fee in the FCA’s Handbook Notice in December 2019, and on periodic fees in the FCA’s consultation paper on fee-rates in April 2020.

Update posted: 10 October 2019

By Christopher Walker

Artificial Intelligence, Accountability and the Future of Finance

Introduction

Alan Turing, described by Mark Carney as the 'father of computer science and artificial intelligence', was unveiled as the new face of the £50 note earlier this year.

Much like Turing, the Bank of England (BoE) has also recognised that Artificial Intelligence (AI) has the potential to radically transform society. For instance, the BoE’s Future of Finance Report (the Report) notes that within financial services, AI could significantly improve the sector’s working hours and efficiency, provide innovative insights into consumer behaviour, greatly improve lending decisions, and reduce instances of fraud.

We previously assessed cloud computing within the Report – we now look at its assessment of the future of AI within the UK financial services sector.

What is AI?

This is a source of an ongoing, contested debate which the Report does not appear to engage with. Stanford’s 'One Hundred Year Study on Artificial Intelligence' cites one definition of AI as:

“[…] that activity devoted to making machines intelligent, and intelligence is that quality that enables an entity to function appropriately and with foresight in its environment.”

The European Commission’s High-Level Expert Group on AI have also produced a 'Definition of AI' document which usefully expands on the starting point above.

Specifically, Artificial Narrow Intelligence (ANI or weak AI), aligned with achieving a single complex goal or problem, is the current focus for financial regulators; for instance, when set a single complex goal, a successful ANI might comfortably become world-champion across various board games, but when asked to achieve other goals, is ineffectual – a good chess playing ANI would likely struggle to meaningfully review the latest film.

Nonetheless, companies are already using ANI to detect fraud more effectively, provide robo-advisory services, conduct algorithmic trading, triage large volumes of customer data quickly, and conform with their regulatory obligations.

Recommendations

The Report recommends the establishment of a public-private financial sector working group with the FCA to promote the responsible use of machine learning in AI, which would:

monitor developments in the use of machine learning to understand possible micro and macroprudential implications of widespread adoption
develop principles, and share best practice, for the responsible, explainable and accountable use of machine learning in finance
explore the intersection with current rules (including Senior Managers Regime) and where old rules need updating
feed into the Centre for Data Ethics and Innovation’s work on maximising the benefits of artificial intelligence and managing the risks in finance.

Next steps

The BoE has responded to the Report, noting that as part of its priority to build resilience and deliver 'a world-class regtech and data strategy', it will:

identify and implement improvements in the BoE’s/PRA use of data in the next 1-3 years, including better tools for peer analysis, and beginning to exploit the benefits of machine learning and AI for regulation and supervision; and
establish a public-private working group with the FCA and firms to further the dialogue on AI innovation; and explore whether principles and guidance could support safe adoption of these technologies.

Additionally, on 1 August the FCA published the article 'Artificial Intelligence (AI) in the Boardroom' – this details further issues with ethics, explainability, transparency and liability. These four key issues are likely to be at the heart of any future AI financial services frameworks.

One of the central challenges for firms will be effectively auditing AI decision-making, focussing on ensuring that systems are in place to generate an audit trail to understand how decisions have been made by ANI systems. In particular, regulators will need to understand how a system’s algorithms, design processes and data function altogether. To that end, the FCA has partnered with the Alan Turing Institute, the national institution for data science and AI, to explore a year-long project in on 'ethical and regulatory issues concerning the use of AI in the financial sector'.

It seems that, as Turing concluded in his seminal paper, 'We can only see a short distance ahead, but we can see plenty there that needs to be done'.

Update posted: 30 September 2019

By Paschalis Lois

DLT moves in the payment sector – If you can’t beat them, join them?

We have recently seen two announcement from some big names in the banking and payment services sector joining up distributed ledger initiatives.

For starters, MasterCard has announced a strategic partnership with R3, a blockchain software consortium company comprising of members from an array of sectors such as payment, insurance, and banking.

R3 was set up in order to promote blockchain based solutions across industries, such as financial services, healthcare, digital assets etc. R3’s notable blockchain solution, Corda, is a distributed ledger whereby different participants can receive different access to parts of the ledger depending on necessity, while all parts of the ecosystem can work together to provide a reliable and fast-paced transfer of value across the entire ecosystem. This allows for participants from different sectors to all use the same ledger while potentially providing different services across it.

MasterCard’s strategic partnership will aim at providing fast cross-border payment solutions to its customers which will initially 'focus on connecting global faster payments infrastructures, schemes and banks supported by a clearing and settlement network operated by Mastercard'.

On a similar note, Deutsche Bank has signed up to JPMorgan’s Interbank Information Network (IIN). IIN is a blockchain project developed by JPMorgan which provides banks on the network with information that can help streamline transfers, such as KYC related information, or payment detail confirmations. JPMorgan considers this addition a benefit for the system itself, as most of its useE

Update posted: 18 September 2019

By Christopher Walker

The French Resistance: France Says No to Facebook’s Libra

Facebook’s Libra cryptocurrency project faces yet another regulatory roadblock in the form of France’s Finance Minister, Bruno Le Maire.

In his opening remarks to an OECD conference, Le Maire stated that the 'monetary sovereignty of states was at stake' due to Facebook’s proposed cryptocurrency.

In particular, the Finance Minister highlighted that the creation of a virtual currency with a userbase of potentially two billion could pose a 'systemic risk' to economic stability.

The position presents a stark development from previous comments on cryptocurrencies, such as those made by Mark Carney in 2018, which downplayed the risks to financial stability due to 'crypto-assets [small size] relative to the financial system'.

The Libra project continues face ongoing challenges, such as:

Concerns surrounding the threat posed to fiat currency: in particular, Libra would pose challenges to governmental control of monetary policy – in times of crisis, abandonment of the state’s currency could further exacerbate economic woes and undercut the control of central banks
Money laundering and terrorism: U.S. Treasury Secretary, Steven Mnuchin, has previously 'expressed very serious concerns that Libra could be misused by money launderers and terrorist financiers'
Consumer protection: Facebook’s corporate governance in light of the Cambridge Analytica scandal still clearly sits within the minds of lawmakers – importantly, regulators are looking for clarity over the systems that will be put in place to protect Libra’s users.

Global regulators will question Facebook in Basel on 16 September over concerns surrounding the digital currency’s scope and design.

Until these concerns have been addressed, Libra’s likely launch will continue to be delayed.

Update posted: 16 August 2019

By Paschalis Lois

German Regulator approves a €250 million real estate bond token sale

Last July, the German Regulator, BaFin, approved a sale of €250 million tokenised real estate backed bonds to be issued by a blockchain start-up Fundament. This is not the first tokenisation of real estate value, as an technology space. Addressing the third Annual Fintech Conference this week, the Commission’s Vice President Valdis Dombrovskis shared his enthusiasm for the scheme’s potential to create 'a pan-European, fast bank-to-bank payment network.' The lack of adoption within the market, however, is both surprising (given how great this technology is) and a cause for concern.

Keen to promote uptake of TIPS, the Commission is toying with the possibility of a 'stronger regulatory push', which may be included in its review of the Payments Account Directive later this year. Whether this will bring about the Commission's ambitions for the EU's Fintech future will be an interesting development to watch.

The vice president’s full speech can be found here.

Up in the cloud: the Bank of England looks to future proof fintech

Update posted: 9 August 2019

By Christopher Walker

The Bank of England (the BoE) has called on “financial services to embrace cloud technologies” in a key report on the “Future of Finance”. The BoE has raised concerns that financial institutions are slower at adopting the public cloud than other industries. This, the BoE argues, can be explained by cautious regulators, management teams taking time to gain trust and visualise use cases, as well as the cost of migrating systems.

However, with providers such as AWS underpinning the IT systems of companies like Monzo, Coinbase or Stripe and JP Morgan’s recent blockchain with Microsoft Azure, the financial world is arguably already welcoming cloud computing.

Conservative estimates reported by McKinsey have placed a combination of software as a service (or “SaaS”) and public cloud as hosting at least 40% of banks’ workloads globally within the decade. With cloud computing set to perform a critical function within finance infrastructure, we briefly note the BoE’s comments on the potential benefits to the finance industry, as well as the challenges on the horizon.

Opportunities

Current cloud infrastructure presents a series of advantages as identified within the report, such as:

Quality: externally maintained cloud systems by dedicated providers are often beyond their in-house equivalents in terms of power, security and service maintenance.
Speed: data analysis tools allow firms to examine and respond to customer demand and relevant trends quickly.
Value: the report cites research that cloud computing may reduce IT infrastructure costs by between 30-50%, freeing up a businesses' funds for deployment elsewhere.
Innovation: cloud technology provides flexible and agile infrastructure, reducing barriers to entry for small players who might not be able to invest in their own secure solutions. It offers ready-made platforms for early stage companies, including fintechs, to cut their time (and cost) to market.

Challenges

However, future challenges include:

Cyber security and resilience: although their strength provides a deeper level of threat resilience than many companies would be able to source internally, external cloud services are not impenetrable (a recent example being the hack into Capital One’s cloud affecting more than 100 million of its customers). A combination of vendor concentration risk and the spread of reliance on these platforms for service delivery may increase the risk of a successful cyber-attack affecting a wider range of companies’ systems.
Control: there are concerns that cloud infrastructure will reduce regulatory ability to scrutinise banks’ IT systems e.g. in relation to access and audit rights.
Privacy: privacy, consent, data security and encryption of cloud services, as well as key questions surrounding liability in the event of a data breach or fair usage of the data, were noted by the BoE as critical areas where further evaluation is required.
Regulatory: according to a Finastra survey cited by the report, 43% of UK firms stated that “complex regulatory requirements” were a key barrier to cloud uptake. Consequently, further clarity will be needed within this field. The BoE will be following up on their report in light of the concerns above, publishing a supervisory statement this year that “[describes] the PRA’s modernised policy framework on outsourcing arrangements” with a focus on cloud computing. Alongside the September implementation of EBA’s guidance on cloud outsourcing arrangements, this will hopefully broaden regulatory comprehension within the sector.

What next?

In its report, the BoE refers to the work of UK Finance to develop a series of practices that might enable cloud computing to scale in finance. The BoE concludes that, as part of this process for encouraging the adoption of cloud technologies, it should work with the private sector to help firms realise the benefits of public cloud usage without compromising resilience by:

understanding and mapping concentration risks and interoperability, as well as building expertise within the BoE;
testing operational resilience, including to cyber-risk;
setting standards and guidelines for cloud usage; and
collaborating with international regulators on a longer-term approach to cloud oversight.

Conclusion

On balance, whilst current progress in the uptake of cloud technologies in financial services may seem slow for some, the forecast ahead looks promising.

Update posted: 11 March 2019

By Alex Fallon and Nathan Dudgeon

Mastercard and HSBC bet that jingles will retain customers

Recently, Mastercard announced 'the sound equivalent of our iconic red and yellow circles'. Mastercard's audio-only press release described how the changes will add a new dimension to their brand identity and reflect the changing way consumers interact with the world around them.

They are not the only financial heavyweights moving into audio branding. HSBC launched its own sonic brand in January which is said to represent the next stage in its own global refresh.

Might there actually be an industry shift in the way financial services market themselves? Why?

What is sonic branding?

The practice itself is not new, and had enjoyed varying success. One indisputable triumph is Intel Technology - you probably even hummed it in your head as you were reading this. Audio is a powerful way to connect to customers, and quite underused in comparison to the visual medium. But it is the growing prevalence of smart shopping which has made financial heavyweights such as Mastercard and HSBC sit up and take notice.

It is estimated that by 2022, conversational commerce (i.e. buying something through voice controlled devices) is going to be worth $40bn+ across the US and UK alone. This has been fuelled by the growing ubiquity of IoT devices and voice-controlled speakers such as Amazon Echo and Google Home.

Sonic branding in the financial services market

These developments are particularly interesting in the cases of HSBC and Mastercard as they indicate a shift in focus. Previously, financial companies, especially banks, could rely on customers’ continuing loyalty (aka ‘stickiness’) but there is a lot that threatens it: from Open Banking, to massive simplification of the current account switching service. Incumbents need to 'up their game' and focus on retaining their customers through brand recognition and familiarity (among other things – one would hope that they also focus on customer UX, product quality and customer service!).

Sonic branding has been historically overlooked in this sector. However, the two brands have fully committed to the new approach and Mastercard, for example, intend to use the sounds in advertisements, logos, ringtones, musical scores and hold music.

Interestingly, Mastercard is also trialling the use of a shortened version of its new sonic brand at the point-of-sale. As contactless payments become increasingly frequent it seems Mastercard has set the ball rolling on a more personalised point-of-sale experience. A similar feature is also available on Monzo where customers are alerted to account activity by a cash-register style 'Kerching' noise. This may seem frivolous but companies are desperate to stand out in a crowded market. Traditionally this was done through financial incentives and, while this remains important, low interest rates and growing commoditisation of financial services have created a new focus on brand identity. This is particularly true of the credit/debit card market where banks have switched the orientation of cards, changed the material or even, in the case of the UK-based business account app 'Anna', introduced a card which 'meows' when you make a purchase.

The fact your bank card makes a unique sound when you use it does not offer any practical benefits. But it does say something about your provider. It says that they embrace innovation (or just ‘being different’) and that, by association, so do you.

Mastercard and HSBC cards won't meow, sadly, but they don’t have the same brand objectives as start-ups like Anna. They have huge established customer bases and their branding is therefore focused on encouraging a familiarity and loyalty amongst existing customers which will discourage them from switching.

Time will tell whether sonic branding is the new frontier for customer loyalty, or whether it’s just the latest attempt to avoid becoming ‘the dumb pipes’.

Update posted: 7 February 2019

By Nathan Dudgeon

SWIFT and Corda announce partnership

Although distributed ledger tech may have lost the mainstream limelight to the likes of AI, that doesn’t mean there isn’t anything interesting happening. On 30 January, SWIFT gpi and R3’s Corda announced a collaboration that will get the two techs working together, with a live demo to be shown in September 2019.;

The SWIFT gpi is built to disrupt correspondent banking, which solves the problem of how a UK bank can deal with transactions in, say, New mber 2018

By Alex Gillespie

ESMA stakeholder group reports on Initial Coin Offerings and Crypto-Assets

On 19 October, ESMA released an own-initiative report from its Securities and Markets Stakeholder Group advising ESMA on how to address the risks of ICOs and Crypto-Assets. It provides an overview of recent market developments and the regulatory treatment of ICOs and crypto-assets across 36 European jurisdictions.

The group’s advice to ESMA is to provide level 3 guidelines or create supervisory convergence on the following areas:

1. Interpreting the MIFID definition of 'transferable securities'

This includes clarifying whether transferable asset tokens which have features typical of transferable securities are subject to MiFID II and the Prospectus Regulation. The group was of the view that payment tokens and utility tokens are not covered, however, since they share similar risks to securities traded on capital markets, the group recommended that ESMA raise this with the EBA and European Commission.

On the other hand, transferable asset tokens may already be subject to MiFID II and the Prospectus Regulation depending on their characteristics and the group recommends that ESMA:

provides guidance (in the form of Level 3 Guidelines) as to whether they should be considered transferable securities under MiFID II, and

asks the Commission to add asset tokens which share characteristics with derivatives to the list of MiFID financial instruments.

2. Interpreting the MiFID definition of 'commodities'

This concept is crucial to determine whether an asset token with features typical of a derivative is a MiFID financial instrument or not. The group recommends that ESMA clarifies this in level 3 guidelines together with the circumstances in which asset tokens giving a right to a commodity are to be considered MiFID financial instruments;

3. Interpreting multilateral trading facilities (MTFs) and organised trading facilities (OTFs)

The group was of the view that the organisation of a secondary market in asset tokens should be covered either within the concept of an MTF or OTF and urged ESMA to clarify the definitions of MTF and OTF under MiFID II to make it apparent if this was the case and that, if so, the Market Abuse Regulation should then apply.

4. Authorisation/Licence requirements

Regulatory convergence/guidelines on the fact that, in all situations where an asset token is to be considered a MiFID financial instrument, persons giving investment advice on those asset tokens or executing orders in those asset tokens are to be considered investment firms and should be licenced as such unless they qualify for an exemption under MiFID II.

5. Sandboxes

The group also recommends that, whilst sandboxes should not be 'overly coordinated' at the European level, some coordination is necessary and it advises ESMA to set minimum criteria for the:

scope, operating conditions and measures to ensure investor protection
transparency to the public in relation to the same
regular reporting to ESMA and to the public on the experience and operation of the sandbox and the initiatives tested within it.

For further details, including the recommendations made by the group for the regulation of ICOs and crypto-assets, read the full report.

Update posted: 22 October 2018

By Nathan Dudgeon

FCA announces fifth cohort for the Regulatory Sandbox

The Sandbox has been a great success for the FCA’s Project Innovate – it has been emulated by financial regulators across the world, and there are various ‘global sandboxes&rsquo%ns (including intended use) and the jurisdiction.

High-risk areas where crypto-related activities might be carried out include:

offering services to cryptoasset exchanges

carrying out trading activities for clients or with counterparties whose source of wealth derives from cryptoassets

arranging, advising or otherwise taking part in ICOs.

The FCA also elaborates that following a risk-based approach does not mean banks should approach all clients operating in these activities in the same way. Instead, because the risks associated with different business relationships in a single broad category can vary, the FCA thinks it appropriate to manage those risks appropriately.

If you are a bank and consider that your clients may be holding or trading cryptoassets (this may be discovered by enquiring about the source of a deposit), then existing requirements for checking the source of wealth and funds are still risk sensitive. Firms should assess the risks posed by a customer whose wealth or funds derive from the sale of cryptoassets. If a firm identifies a customer is using a ‘state-sponsored cryptoasset… designed to evade international financial sanctions’, then this should be seen as high risk.

Update posted: 05 June 2018

By Nathan Dudgeon

Google bans crypto advertising

Google announced in May that it was updating its ‘new restricted financial products policy’. The policy came into effect at the start of this month, and bans the adverts of ‘Cryptocurrencies and related content (including but not limited to initial coin offerings, cryptocurrency exchanges, cryptocurrency wallets, and cryptocurrency trading advice)’.

Facebook and Twitter made the same move earlier this year, with consumer protection as the clearly stated aim. Scott Spenser, Google’s director of sustainable ads, told CNBC in March:

‘We don’t have a crystal ball to know where the future is going to go with cryptocurrencies, but we’ve seen enough consumer harm or potential for consumer harm that it’s an area that we want to approach with extreme caution’.

Most people can agree that consumer protection is positive, so trying to prevent regular people from investing in extremely volatile products without being fully aware of the risks is also positive. On the other hand, this development is worrying because this action could be seen as going beyond Google's remit.

It may seem like regulatory language is not developing at the same pace as technological innovation or the commercial exploitation of recent interest in crypto and token offerings. It is clear though that regulators are not just sitting idle. In the USA, the U.S. Securities and Exchange Commission actively pursues potentially fraudulent initial coin offerings. In the UK, although there is no specific regulatory framework to catch crypto assets, the Financial Conduct Authority continues to keep a watchful eye over developments. It considers that the existing regulatory perimeter is currently enough to catch those activities that are likely to be troubling from a consumer protection standpoint.

This is why Google’s decision to act as a quasi-regulator in this context, is a potentially troubling development. Stepping in and blocking the crypto market may sound like consumer protection, but it is potentially overstepping its perceived role as gatekeeper to information.

Update posted: 29 May 2018

By Harry Tiara

Rewriting the insurance policy

Like much of the financial world, the insurance industry has been slow to recognise the growth of fintech (financial technology), regtech (regulatory technology), paytech (payment technology) and everything else ‘tech’. This is why those in the ‘insurtech’ area are making a seriously big impact.

For example, Lemonade (an American insurer aimed at individuals) automates pretty much everything that they do, such as using Chatbots and AI to run everything from the process of purchasing a policy, through to cl0target="_blank">Open Banking regimes.

Streamlining the process for fintechs trying to expand internationally

There will be plenty of collaborations in the private sector too; events, conferences, networking and so on.

Update posted: 21 March 2018

Storing (illegal) data on blockchain

By Nathan Dudgeon

You may have seen in the news over the last couple days how researchers have found that the Bitcoin blockchain is being used to store illegal content, like images of child abuse or hacker code you can use to break encryption on DVDs. Using a blockchain to store files other than transactions is entirely possible; in fact some tokens deliberately exist to be an alternative file storage system (like Filecoin), despite the Bitcoin blockchain not being created for this.

How to store data on the blockchain

When you send money using your bank, there is often a little section for you to put a description of the transaction – as long as it is just a few characters. There is a function called ‘OP_RETURN’ that does the same thing with Bitcoin, which means that people can use it to post short messages. This is a deliberate function of the network. In fact, the first ever transaction has a message that reads "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks". It is almost like a cryptic clue to blockchain’s mission statement.

Storing much larger amounts of data was not part of the design however, and it most often involves fragmenting. This is where you have to make many transactions, each with a different piece of the data, before some clever software stitches it all together at the end.

There is another way to store larger amounts of data where you essentially send your Bitcoin to a made up recipient (in Bitcoin language this means replacing the valid receiver keys with arbitrary data). This comes at a cost however, as there is no bank to ask for your money back. This is why it is called ‘burning your Bitcoin’.

A 21 KB image of Nelson Mandela (which is already on the chain, by the way) would burn about $380 of Bitcoin at the current price of $8,400.

Why you would want to store data

While there are valuable uses for blockchain data storage, people would usually choose a chain specifically designed for that purpose. For example, there is a notarisation industry that will certify that a document exists. For larger pieces of data, you could post content free from censorship (e.g. whistleblowers) or archive memorable/historical data (e.g. there are at least six wedding-related photos currently on the Bitcoin chain).

On the other hand, people can spread copyright infringements or commit blackmail with threats of posting private information. Interpol and Kaspersky Labs started warning years ago that you could use similar methods to embed malware into the blockchain. This has not happened yet with Bitcoin, but it only seems a matter of time.

What has already happened however (and is all over the news), is the appearance images (and links to more) of child abuse on the chain. The consequences of this is that possession of the Bitcoin blockchain could be a very serious criminal offence, although we will have to see how the police or courts respond to this.

Update posted: 14 March 2018

Google bans cryptocurrency ads

By Alex Gillespie

At 4am this morning, Google announced that, as of June 2018, it would no longer permit advertisements which service cryptocurrencies and related content (including initial coin offerings, cryptocurrency exchanges, cryptocurrency wallets and cryptocurrency trading advice). The ban will cover both Google’s AdWords as well as Youtube.

No reasons were given in Google’s announcement, however, the ban follows a similar ban from Google’s rival Facebook in January. At the time, Facebook explained that this was due to the fact that many companies that advertised ICOs and cryptocurrencies were not “operating in good faith”.

It also follows the IMF’s announcement on Tuesday about the ‘peril’ of crypto-assets and calling for greater consumer protection internationally. The value of bitcoin fell 4.1% to below $9,000 following the announcement.

This is the latest example of an established firm distancing itself from cryptocurrencies (another recent example being Lloyd’s ban on the use of its credit cards to buy cryptocurrencies) to protect themselves against commercial or reputational damage by association with the technology. It is unlikely that Google will be the last firm to do so.

Update posted: 9 March 2018

Cryptocurrencies and the future of money

By Alex Gillespie

In a speech (PDF) last week, Mark Carney set out his views on the future of money and how, in his view, this will change with the development of cryptocurrencies. Here are some key high-level takeaways from Mr Carneys speech:

The role of cryptocurrencies as money: Mr Carney was upfront about the fact that in his view cryptocurrencies are “failing” as a currency and explored three key problems with the technology, namely that cryptocurrencies: (a) are poor stores of value due to the extreme volatility caused by their lack of intrinsic value or external backing, (b) are inefficient media of exchange due to their generally being slower and more expensive than payments in sterling and (c) because of these problems are virtually unused as units of account.
The Bank of England’s policy towards cryptocurrencies: In addition to cryptocurrencies’ shortcomings as money, the Bank of England has wider concerns around consumer and investor protection, market integrity, money laundering, terrorism financing, tax evasion and the circumvention of capital controls and sanctions. However, the Bank of England does not wish to avoid stifling innovation or preventing the implementation of technologies that will bring future benefits to the financial system.
The regulation of cryptocurrencies: In view of the potential technological benefits, Mr Carney was against general bans on the use of cryptocurrencies but instead targeted regulation so that cryptocurrencies are held to the same standards as the rest of the financial system. Mr Carney gave the following examples that the Bank of England are looking into: (a) regulating crypto-asset exchanges according to the same standards as security exchanges, (b) introducing regulations to prevent ICO’s being allowed to “use semantics” to avoid regulations and (c) clarifications to the regulatory requirements, such as for capital, of institutions which engage with or have exposure to cryptocurrencies.
The future of money: Perhaps most interestingly, Mr Carney shared his thoughts on how, if cryptocurrencies as we know them are not the future, money and payment systems will change in the future as a result of the technology such as: (a) the diminished role of financial institutions as society’s preference changes towards decentralised peer to peer interactions (b) the role of distributed ledger technology and the benefits this will have on the efficiency, reliability and flexibility of payments and (c) the adoption by central banks of their own digital currencies (however, Mr Carney was of the view that this was unlikely to take place in the short term due to the technology’s existing shortcomings).

It is interesting to hear the views of such a senior policymaker on how a not-so-distant financial system might look based on market conduct to date. It also raises an important debate about how our financial system may need to change for the benefit of society and how traditional financial institutions will fit into that given the recent advances in cryptocurrency technology. Mr Carney’s speech will interest anyone engaged with this technology or financial services as a whole.

Update posted: 16 February 2018

Will artificial intelligence take our jobs?

By Nathan Dudgeon

We looked at a PwC report on the impact of AI over the next 15 years. The results were a bit more nuanced than most – discussing which industries, which job types, and which demographics are at risk to artificial intelligence, why, and when.

Read the full article here.

Update posted: 8 February 2018

FCA confirms (again) that cryptocurrencies may be regulated

By Nathan Dudgeon

In October last year, the Treasury Select Committee asked the FCA’s Chief, Andrew Bailey, to explain the limits of the FCA’s powers. This week they published a letter with the FCA’s detailed response (PDF).

In it, Mr. Bailey explains a number of areas that fall on the border of the FCA’s powers, one of which is cryptocurrencies.

The summary is that nothing has changed – crypto is still borderline.

Why? At a very high level, the existing regulated activities and financial promotions regimes were not originally drafted with ICOs in mind. The laws point to exhaustive lists to determine whether something is regulated or not, and digital tokens are not expressly referred to in the lists. We think this is partly why so many people (mistakenly) believe that all ICOs are not regulated in the UK.

Remember, however, that tokens’ functions vary widely. Many digital tokens perform the same or similar functions to financial instruments which do fall within the list of regulated investments.

The FCA has previously warned that “depending on how they are structured, some ICOs may involve regulated investments and firms involved in an ICO may be conducting regulated activities”. They noted that some ICOs show parallels with IPOs, private placement securities, crowdfunding, futures, options, or collective investment schemes. All of which are very much regulated.

This latest letter from the FCA merely confirms the status quo, for now.

Update posted: 2 February 2018

Lessons on building cyber resilience from the FCA

By Alex Gillespie

Cyber security has become an increasing concern both for individuals and businesses over the years. We have already seen one large cyber security scare in 2018 with the threat posed by ‘Meltdown’ and ‘Spectre’ both being widely reported in the media. With Open Banking coming into effect it is unsurprising that cyber security is very much in the FCA’s focus.

On Friday, Robin Jones, Head of Technology, Resilience and Cyber at the FCA, gave a speech setting out some salutary lessons the FCA has drawn from previous cyber attacks over the years and offering guidance to firms around improving their cyber resilience. By way of illustration of the dangers, according to the National Cyber Security Centre there were over 1,100 reported attacks in the last 12 months alone (590 of which were regarded as ‘significant’) and there are more than 10 cyber attacks in the UK every week.

Consequently firms should understand the dangers and make efforts to build their resilience against such a threat. The FCA expects firms to follow the basic principles of ‘resilience’ – being not only that firms can protect themselves against attacks and identify potential threats and their own vulnerabilities, but also that they can detect attacks that have been successful and know how to respond and recover from them.

According to Mr Jones, there are three key lessons that firms can take away from some of the last year’s high profile cyber attacks. These are:

Address the basics: Cyber attacks typically exploit well-known vulnerabilities in systems. Wannacry is one example of where the attack could, for the most part, have been prevented if the NHS had carried out some basic security practice.
Detect attacks, stop them spreading and have robust contingency plans: The best way to mitigate an attack is to have a back-up. Firms should consider and identify their tolerance for the systems or data being made unavailable due to a cyber attack.
Ensure any contingency plan includes a communications plan: Know how to get hold of key people and contact staff, consumers, suppliers and authorities. Firms should ensure that they have plans in place prior to any attack, rather than trying to create plans at the same time as reacting to an attack.

Ultimately, the FCA expects firms to have strong governance procedures in place and show visible leadership in the event of an attack. According to the FCA, firms should understand their key assets and their back-up arrangements. They should be in a position to know what is important and the means for protecting their customers from any theft (most attacks exploit the simplest vulnerabilities and therefore following basic cyber-security practices will go some way to addressing this).

Firms should exhibit a good security culture whereby senior leaders and staff alike are alert to potential threats and trained to follow good security practices. Systems should also be put in place whereby passwords are regularly changed, systems access limited to only those that require it, etc.

Of course, this speech will be helpful both on a practical level and, for authorised firms, to help better understand the FCA rules pertinent to cyber-security. Read the full speech.

Update posted: 19 January 2018

Baidu releases blockchain as a service platform

By Nathan Dudgeon

Baidu aren’t the first huge company in China to launch blockchain as a service. In fact, both Tencent and Ant Financial (part of Alibaba) already have blockchain services in the market.

What is blockchain as a service? Firstly, you’ll need to understand blockchain – start with our article, or this YouTube video.

Blockchain as a service is, generally speaking, where a company (like Baidu) creates its own blockchain system and hosts it on the cloud. This blockchain is a foundation, or a template – and you can build stuff on top of it.

So instead of setting up your own blockchain, which costs a lot of time and resources, you might go to a blockchain service provider, like Baidu, and use theirs for a subscription fee. Companies will come in, use Baidu’s technology, and shape it into whatever specific purpose they choose. Baidu will no doubt have plenty of their own pre-made models to allow you to start immediately.

It’s the same idea as Dropbox – for many companies this is far cheaper, better-made, secure, and easy-to use than creating their own in-house file sharing system.

So what is Baidu actually offering? “Efficient and low cost traceability and trading, ideal for digital currency, payment and settlement, digital ticketing, bank credit management, equity proof and exchange-traded securities, insurance management, financial auditing and more.” Elsewhere, Baidu have said they want to use blockchain in AI, driverless cars and distributed computing.

People have noted that this is fairly generic, but that’s a common practice in the market at the minute. Apparently the whole platform has been built in-house, which is different to most other providers – commentators wonder whether this means it’s a private ledger (i.e. it is invitation-only, but probably also takes less of your computer power to run).

Update posted: 17 January 2018

PSD2 and Open Banking: finally here

By Nathan Dudgeon

The Payment Services Directive (PSD2) came into force this week. You might have noticed news stories about how credit card surcharges are ending, or an increase in ‘strong customer authentication’.

Open banking is probably the biggest change brought by this new law. Banks can now share your data with third parties (on receipt of your permission), and these can ‘plug in’ to your bank via an API to bring extra value. Interesting times are ahead; will the banks adapt or just become ‘dumb pipes’? (See this article in The Times. Please note, you will need to register/login to view.)

You can also read our Guide to Open Banking or Understanding the new Payment Services Regulations

Update posted: 15 January 2018

Lessons from the KodakCoin

By Alex Gillespie

On Tuesday 9 January 2018, Kodak became the latest firm to seek to raise capital from an initial coin offering (ICO). At the CES2018 convention, Kodak announced plans to use the Ethereum blockchain to create a digital platform for photographers to monitor and protect their photographs from IP infringement. Once launched, customers will be able to purchase photographs over the platform using its own digital currency, the ‘KodakCoin’. According to Kodak, the platform will record a cryptographic record of all photographs purchased through it.

On the day it was announced Kodak’s share price rose by 119% but it has also faced criticism from many commentators on the proposal, particularly because KodakCoin and Global Blockchain Technologies Corp made an immediate $2 million investment into the cryptocurrency (subscribing for all 8 million KodakCoins available at the first stage of the pre-initial coin offering).

Many commentators have expressed concern at the considerable interest shown by investors in a platform that has not even been launched yet, akin perhaps to the frenzy shown by investors during the 17^th century TulipMania, and an aspect of ICOs that the FCA has already expressed concern about in the UK. We have previously noted the FCA’s concerns about ICOs after it publically voiced concerns about a general lack of investor understanding in the products and a lack of substance behind many ICOs.

Commentators have criticised the proposal for being vague and even flawed. For example, the ICO will only be available to ‘accredited investors’ earning more than $200,000 in income or with a net worth of £1 million (to avoid the ICO being registered with the SEC) creating considerable problems for a platform allegedly intended to be used by the mass market. Other commentators have argued that there is no need at all for the use of cryptocurrencies and blockchain for what is, after all, a proposal for a central database to record ownership supported by a web-trawler to identify cases of IP infringement.

The industry criticism should also be viewed in the general context that Kodak was only recently saved from bankruptcy and since the announcement had an ever falling share price. Kodak’s business and the problems that led to its falling share price (principally its failure to keep up with digital technology) do not appear to have changed beyond speculative proposals for the KodakCoin.

Of course, time will tell and the resurgence of a fading household branch is a great thing. However, it is clear that Kodak has a long way to go to convince its detractors (and perhaps the regulators) as to the viability of this project. We wait to see whether this could be the next KodakMoment.

Update posted: 27 December 2017

Tandem gets a banking licence, again

By Nathan Dudgeon

Earlier this week, the PRA gave Tandem permission to acquire 100% of Harrods Bank Limited.

This is big news. Tandem will finally have a banking licence, again – they did have one at the start of 2017, but lost it after failing to secure funding from a Chinese conglomerate in March (as reported in the Financial Times).

The deal is due to complete sometime in the new year, and Tandem will get £80 million of capital, access to a full banking licence and 10,000 savings and mortgage customers (plus tens of thousands of Tandem co-founders are already on the waiting list). The licence means Tandem will be able to offer their current accounts and finance other business activities with the deposits (such as offering loans).

Buying a banking licence is a fairly unusual way to get one – banks are rarely put up for sale and there are still regulatory hurdles to jump before you can buy one, which is why this news comes months after Tandem’s announcement of the deal. Another alternative is to become an ‘appointed representative’ – where someone who is already authorised agrees to take responsibility for your performance of that regulated activity, usually for a considerable fee.

To find out more about setting up a bank, have a look at the Bank of England’s new bank start-up unit, or you can always reach out to us.

Update posted: 18 December 2017

The FCA gives feedback on DLT

By Alex Gillespie

There was, I think, little to surprise in the FCA’s feedback statement (PDF) to its discussion paper on distributed ledger technology (DLT) which, in the rapidly changing world of fintech is arguably a surprise itself! There were no radical new policies or initiatives or proposed changes to the FCA Handbook just a confirmation that “our current regulatory requirements appropriately reflect our strategic objectives” and a commitment for further engagement with fintech, both domestically and internationally.

Despite the lack of any headline changes, the statement itself had the quiet confidence of a Regulator that is slowly getting to grips with the rapid changes to financial services brought about by fintech and DLT. The FCA engaged with participant feedback on topics ranging from digital currencies, smart contracts, regulatory reporting and financial crime (among others). Most of all, the statement primary reaffirmed the FCA’s ongoing commitment to engage with UK fintech as a ‘technology-neutral’ observer and highlighted the benefits which DLT offers to financial services as well as the shortcomings that need to be resolved.

My main take away from the statement, is that the FCA has rightly identified initial coin offerings (ICOs) as requiring closer scrutiny. The FCA mostly reiterated the concerns it gave in its consumer warning from September 2017 – that these are high risk investments little understood by the average investor – but also included a ‘regulatory considerations on ICOs’ annex to address widespread confusion as to the regulatory requirements behind an ICO (including when they are ‘regulated’). This should be compulsory reading for anyone considering launching an ICO.

Update posted: 12 December 2017

Madrec, MiFID II, and Ethereum: both complicated and excellent

By Gareth Malna

There is only a matter of weeks until the date that MiFID II takes effect, bringing with it the swingeing changes to the regulatory landscape that many compliance officers in the financial services sector have been working towards (and, perhaps, dreading) for the better part of two years. But, with a sense of inevitability, the world continues to turn and the big winners from the changes are likely to be those institutions that provide the tools to ensure compliance.

Step forward UBS, which with help from Barclays, Credit Suisse, KBC, SIX and Thomson Reuters has launched the Massive Autonomous Distributed Reconciliation platform (Madrec); an initiative based on the Ethereum platform to make the reconciliation of counterparty data a much simpler, automated, process.

From a brief review of articles and blog posts reporting on the launch of Madrec it is clear that media commentators are struggling to understand exactly what the project does and why it is important, so we have set out our take on it below.

Without Madrec, banks (such as UBS) which make transactions in financial instruments for their clients are required to clear transactions on trading venues. This is done on a transaction-by-transaction basis and requires a physical review of the trading contracts in order to check the veracity of data being reported by the counterparties before the transaction can be cleared and regulatory reports filed. In order to effect that checking process banks rely on their own processes and data sources, taking external reference data from a number of sources without any agreed standard.

As of 3 January 2018, MiFID II will require all parties to the majority of financial transactions to obtain and maintain a unique identification code for the purposes of increasing transparency about exactly who is actively participating in transactions in the market. That unique code is a Legal Entity Identifier (LEI), which has to date only been required of trading venues under certain European regulations – notably the European Market Infrastructure Regulation (EMIR – which imposes requirements on derivatives transactions) and the Market Abuse Regulation (MAR – dealing with illegal trading behaviours).

Pre-Madrec, banks acting for counterparties will be able to use the LEIs of the counterparties to identify and carry out checks on those counterparties using the bank’s standard data sources – a manual and potentially time-consuming process.

In a post-Madrec world, banks will be able to use the permissioned platform (which is based on smart contract technology) to automatically reconcile in real-time the information pertaining to each LEI against consensus baseline information. Any deviations in the reported information from the consensus could then be highlighted and resolved where necessary.

Suddenly the compliance burden is reduced and firms are free to use their resources to focus on the business of running their business rather than relying on inefficient processes to meet their regulatory obligations.

This is clearly what the times should look like – use of available technologies in a manner that facilitates regulatory compliance and transparency at a reduced time and cost burden. The only question is, who else will step up to the plate to benefit from the regulatory changes that are afoot?

Update posted 8 December 2017

Bitcoin benefits: save hay while the sun shines?

By Nathan Dudgeon

Every news agency on the planet is talking about how bitcoin passed the $16,000 mark last week. The articles are full of people lamenting the fact that they deleted their bitcoin, or spent it all years ago and didn’t become millionaires. The pages are also full of dire warnings against bubbles.

Something from CoinDesk caught our attention this week, because it argues for bitcoin benefits beyond simple profit.

Marc Hochstein says:

“Off the top of my head, I can name three social useful functions of bitcoin: its censorship-resistance; its judgment-resistance; and the topic of this essay, its deflationary quality, which rewards saving for tomorrow rather than splurging today.”

In short, he argues:

"Bitcoin encourages people to be wiser with their money, to think before they spend, to plan ahead and not act so much on impulse."

Why? Because there are a finite number of bitcoins – once we’ve finished mining them all there will be no more. As bitcoin becomes more popular/widespread, the price rises, and a government can’t ‘print’ more money to water down value. If the value of your money increases as you hold it, you’re going to think a lot more carefully before spending it, and are incentivised to think long-term. The article argues that this will cause a shift away from “the culture of conspicuous consumption, of shopping as therapy”.

This is especially so for young people, whereas in contrast:

“More typical is the short-termism that, at its most destructive, led Wells Fargo to set impossible sales quotas for its retail bankers, motivating them to create millions of unauthorized accounts and ultimately resulting in massive fines and brand damage.”

We enjoy a good debate here at Burges Salmon so we think it’s important to highlight ‘a reasoned response from the other side’, regardless of whether we agree or not. If you’re interested in reasoned arguments against what some call ‘ICO mania’, take a look at Preston Byrne’s content.

For me, it is easy to say that you are patiently waiting for long term gains when your investment’s value rises meteorically every week. A more worrying thought is if bitcoin is a bubble, then when it bursts and those who bought high lose out, you’ve instead taught the exact opposite – they should have made the most of the short term gains while the sun was shining. That’s a point we can definitely agree on; short termism is rarely a good thing.

Update posted: 8 December 2017

FCA regulatory sandbox: Cohort 3 announced

By Nathan Dudgeon

The FCA have published an update on the third and fourth cohorts of their very successful regulatory sandbox.

There were 61 applications for cohort 3, and 18 made it through the selection process. They’re all listed on the website for you to have a look, but big players include Nationwide (robo-advice) and Barclays (regtech), and the rest cover everything from cybersecurity and insurance to investment management and AML.

In particular, the FCA has given some encouraging news regarding the location of the latest cohort:

“In the sandbox’s first phase, a majority of the firms were London-based with only a few from other parts of the UK. As the FCA continues to increase its regional engagement in emerging FinTech hubs, encouragingly, the proportion of regional firms has increased in each subsequent cohort. Over 40% of firms invited to test in cohort 3 are based outside London, compared to 35% in cohort 2 and 25% in cohort 1.”

Cohort 2 includes Bristol-based Moneyhub.

The sandbox is very popular and applications are being accepted for the fourth cohort now. Deadline is 31 January.

23 November 2017

The Autumn Budget and fintech

By Alex Gillespie

For those of us engaged with the UK’s burgeoning fintech scene, there was much to be pleased by in the Autumn Statement. Fintech and new technologies as a whole are increasingly seen by the government as part of the answer to the UK’s future and the uncertainties of Brexit. If you didn’t manage to catch the budget itself, one of the key policies (for fintech at least) was the government’s plan to unlock over £20 billion of investment to support the growth of innovative firms over the next 10 years. This, the Chancellor said, will be achieved by:

Establishing a new £2.5 billion investment fund incubated in the British Business Bank and designed to co-invest with the private sector to generate £7.5 billion of investment.
Doubling the annual allowance for those investing in knowledge-intensive companies through the Enterprise Investment Scheme (EIS) and the annual investment those companies can receive through the EIS and the Venture Capital Trust scheme. The government expects this will unlock £7 billion of investment.
Investing in fund of funds in the private sector, with the initial wave of investment seeded by the British Business Bank. There will be up to three waves of investment to support up to £4 billion investment.
Backing new and emerging fund managers through the Enterprise Capital Fund programme established by the British Business Bank, expected to unlock £1.5 billion.
Backing overseas investment in UK venture capital through the Department of International Trade, which is expected to unlock £1 billion of investment.

On top of this, the government has announced several other policies to support UK fintech, such as to invest £21 million of the next four years for the expansion of Tech City UK and to support regional tech companies. Other benefits include supporting challenger banks by making PRA capital requirements more proportionate for eligible smaller banks as well as the creation of a new £10 million Regulator’s Pioneer Fund to help regulators develop innovative approaches to help get new products and services to the market.

Of course (as with any Budget), the devil will be in the detail and execution of the proposals – we look forward to seeing them in action.

20 November 2017

Artificial Intelligence and ethics: just because we can, should we?

By Nathan Dudgeon

Just a couple weeks ago, a panel at Bristol TechFin 2017 led a discussion on the ethics of creating AI which might evolve into something you can’t understand. Just a few days ago, New York University officially launches ‘AI Now’ an institute dedicated to understanding the social implications of artificial intelligence. Creepy coincidence or a sign of the times?

We think it’s a sign of the times, and one of the biggest for us was that the keynote was from a lawyer (a Supreme Court Justice, no less) – someone whose job is to be risk-averse.

“At its most ambitious, AI’s promise is to serve as a framework for improving human welfare to make the world more educated, more interesting and full of possibility, more meaningful, and more safe. But once we overcome some technical problems that are more likely than not to get easier to deal with every day, we’re in for more than just a world of change and evolution. We’re in for some discussion of what it means to be human.”

“Tonight we gather not because we know how to answer that question, but because we realize – using different words, perhaps – that change is coming.”

An adaptation of the keynote was can be found on Quartzy.

It will be interesting to see what, if anything, the Institute covers on the financial services industry specifically. We definitely think that more discussion and more awareness is good – after all, collaboration and transparency are (often) hallmarks of the fintech world.

It may also provide useful assistance for politicians and regulators when making proactive and proportionate laws or regulations for the future. Here in the UK, the FCA are especially innovative and proactive when it comes to working with industry and understanding new technologies and industries – for example, the FCA’s foray into Model Driven Machine Readable regulation (yes, based on R3’s Corda distributed ledger tech) that Burges Salmon is taking part in as a legal Subject Matter Expert.

15 November 2017

UK Financial Services after Brexit – ECB criticises bank relocation plans

By Alex Gillespie

The European Central Bank (ECB) released an article on the Brexit-related relocation plans of UK banks. The article criticised the relocation plans of banks to EU member states as setting up ‘empty shells’ or ‘letter box banks’ and stressed that banks within the EU needed to have sufficient substance locally. The ECB warned that:

Banks should not seek to transfer all market risk to a third-country group entity. Some risk should be managed by the EU bank locally, with local trading capabilities and risk committees. The EU bank should also trade and hedge risks with diversified counterparties not just with their own group.
It was concerned by banks’ plans for ‘dual hatting’ whereby employees carry out roles for multiple group entities, particularly where the employees would be primarily located outside the EU. This would have the effect of diluting the local governance and autonomy of the EU bank.
In the event of a transitional period being agreed, banks must nevertheless set out clearly what their plans will be, commit to them and explain how and when they will be carried out.

Comment: Almost immediately following David Davis’ call the day before for greater collaboration and a new partnership between the UK and EU, the EU has announced plans to exert greater authority over UK banks operating in Europe than had initially been expected. The most immediate issue for UK banks will be committing to contingency plans before the outcome of the Brexit negotiations have been determined.

14 November 2017

UK Financial Services after Brexit – David Davis makes a speech

By Alex Gillespie

The travails of the UK financial services industry continued this week as the UK and EU jostled over the industry’s future relationship with Europe after Brexit. On Tuesday, David Davis, the embattled Secretary of State for Exiting the European Union gave a speech on the financial services sector post-Brexit relationship with the EU. The speech was positive and optimistic for the future of the industry as Mr Davis reminded the audience of London’s historic strengths and that it was the world’s leading financial centre.

Mr Davis warned of the potential risk to Europe of the Brexit negotiations leading to the fragmentation of its financial services sector. To avoid this the UK and EU should look for a ‘new balance’ between both sides, which should achieve three things:

protecting financial stability
ensuring consumer protection
supporting the existing co-operative system for cross-border financial services.

These objectives were in the interests of both sides and would give clarity and certainty to businesses across Europe.

Mr Davis also disclosed that the government sought to include UK financial services in its two year transition period, during which UK firms would remain subject to EU regulators and agencies. A ‘carrot’, widely publicised by the media, was the government’s plans to introduce an Immigration Bill intended to give UK businesses greater flexibility over the mobility of their workers across the continent.

14 November 2017

FCA warns consumers of risks of cryptocurrency CFDs

By Guinevere Wentworth

The FCA has released a consumer warning on contracts for differences (CFDs) with cryptocurrencies, which are being heavily marketed at consumers. CFDs allow a consumer to speculate on the price of an asset by investing only a portion of its value. Both the potential profit and the risk are large and money can be lost very quickly so that money may end up being owed.

Cryptocurrency CFDs are extremely high-risk, speculative investments and the FCA highlights four main concerns:

the price volatility of cryptocurrencies
the large levels of leverage
the high charges and funding costs
the likelihood of pricing not being transparent.

It warns that only experienced and sophisticated investors with knowledge of the risks should invest.

Comment: CFDs are regulated and investors should check that the firm is authorised if offered the opportunity to invest in a CFD or are considering one. This does not mean that losses from trading, however, are protected. Firms offering CFDs should make sure that they are authorised and prepared for MiFID II while also making sure that they only promote CFDs to appropriate investors.

13 November 2017

Concerns over ICOs raised by ESMA

By Guinevere Wentworth

The European Securities and Markets Authority (ESMA) has released two statements on the risks of initial coin offerings (ICOs). Read our introduction to ICOs.

The first statement (PDF) reminds firms involved with ICOs that they need to assess if their activities are regulated. If they are then they need to ensure that they comply with relevant EU legislation, such as the Prospectus Directive, the Markets in Financial Instruments Directive, the Fourth Money Laundering Directive and the Alternative Investment Fund Managers Directive, and any relevant UK law.

The second statement (PDF) is aimed at investors. It flags the key risks associated with ICOs, such as the risk of losing the whole of an investment, that there may be flaws in the technology, the lack of information provided to investors, that there may be no exit option and that there is no protection offered to the investor if the ICO is unregulated.

Next steps: Firms involved with ICOs should make sure that they are aware of the regimes in place and what their obligations are, while investors should carefully consider where they invest. If you have any questions on this area, please contact our fintech team or your usual Burges Salmon lawyer.

Update posted:

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