The Rise and Development of FinTech

Accounts of Disruption from Sweden and Beyond

Robin Teigland, Shahryar Siri, Anthony Larsson, Alejandro Moreno Puertas, Claire Ingram Bogusz, Robin Teigland, Shahryar Siri, Anthony Larsson, Alejandro Moreno Puertas, Claire Ingram Bogusz

• Publisher: Taylor & Francis
• Year: 2018
• eBook ISBN: 9781351183604
• Edition: 1
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

This comprehensive guide serves to illuminate the rise and development of FinTech in Sweden, with the Internet as the key underlying driver. The multiple case studies examine topics such as: the adoption of online banking in Sweden; the identification and classification of different FinTech categories; process innovation developments within the traditional banking industry; and the Venture Capital (VC) landscape in Sweden, as shown through interviews with VC representatives, mainly from Sweden but also from the US and Germany, as well as offering insight into the companies that are currently operating in the FinTech arena in Sweden. The authors address questions such as: How will the regulatory landscape shape the future of FinTech companies? What are the factors that will likely drive the adoption of FinTech services in the future? What is the future role of banks in the context of FinTech and digitalization? What are the policies and government initiatives that aim to support the FinTech ecosystem in Sweden? Complex concepts and ideas are rendered in an easily digestible yet thought-provoking way.

The book was initiated by the IIS (the Internet Foundation in Sweden), an independent organization promoting the positive development of the Internet in the country. It is also responsible for the Internet's Swedish top-level domain.se, including the registration of domain names, and the administration and technical maintenance of the national domain name registry. The book illustrates how Sweden acts (or does not act) as a competitive player in the global FinTech arena, and is a vital addition to students and practitioners in the field.

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Part 1

New regulations

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1 A regulatory innovation framework

How regulatory change leads to innovation outcomes for FinTechs

Åke Freij

Introduction

While regulatory change is a most pressing challenge for firms in numerous industries, for example automobiles (Liker, 2015; Schrage, 2015) and life sciences, the difficulty in successfully handling regulatory requirements is most challenging for financial services companies (Wessel, 2012; Moreno, 2014). The difficulty is present both for incumbent players as well as for FinTech startups. Regulatory requirements are seldom seen as an engine for innovation, but rather as an obstacle to creativity and customer satisfaction. At the same time as pressure for digital transformation continues to increase, regulatory changes should be seen as an opportunity for FinTech startups and incumbents alike.

In this chapter, my aim is to present a framework that enables both FinTechs and incumbents to consider an innovation strategy that leverages regulations. To do so, I first present four areas where regulatory changes have been found to influence a firm: product design, service processes, customer relationships, and technology platforms, illustrating each with an example of a regulatory change. I then present the four opportunities that I have found emerge in connection with these regulatory changes: dominant designs, firm collaboration, technical requirements, and legal protection. Combining the four areas of regulatory changes with the four opportunities builds the basis for my regulatory innovation framework through which I have identified six innovation strategies for dealing with any given regulatory change and corresponding opportunities. To illustrate the strategies, I provide examples of how both incumbents and FinTech startups have implemented innovation as a result of a regulatory change.

In addition, I further articulate the helpfulness of the framework by relating it to the FinTech industry. First, I discuss the relevant sets of activities emerging within FinTech: peer-to-peer, customer intimacy, payments, personal financial management, and underbanked innovation. I then apply the framework to a current regulatory change with a potentially strong influence on the FinTech sector, PSD2 (the Second Payment Services Directive), before positioning selected FinTech startups within the framework based on their business model. I then conclude with recommendations for FinTechs, incumbents, and regulators.

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About the research

The research behind this chapter was performed over a time span of six years as part of my PhD thesis research project and includes empirical data from the Swedish financial services industry. Fifty personal interviews were performed concerning one regulatory change over the time period 1990–2005, and a study of 10 regulations in the Swedish life insurance industry with a historical perspective from 1903 until today was based on archival data and additional interviews (Freij, 2017). These data were supplemented with studies of firms implementing 10 other global financial services regulations. In addition, an analysis of 100 academic innovation articles plus 20 industry trade publications was performed. Extensive source data analysis was made to find the reported patterns and strategies. Data about FinTech firms were collected with a focus on the Swedish entrepreneurial ecosystem by listing all available FinTechs and categorizing them relative to a regulatory innovation framework. FinTechs with the most relevance for one selected regulatory change were identified along with innovation opportunities connected to each FinTech.

Regulatory change drives the evolution of financial services

In the financial services industry, there is no single issue that currently takes so much attention, time, investment, and management energy as the changes in regulations. There is no indication that this development will slow down at any point in the future, but rather it could escalate further. Regulations (together with technology) have been identified as a significant source for radical innovation in the industry (Bieck and Freij, 2010). Hence, I argue that actions connected to these changes are the best way to develop a competitive advantage, in opposition to seeing them as a burden of mandatory compliance. The argument is based on and guided by tangible research findings and analysis, as well as from business practice experience. Applying a more positive strategy toward regulations is of benefit for both existing firms but also for the growing FinTech population.

Regulations are exponentially increasing in frequency and impact

In the beginning of the twentieth century, regulations were introduced with slow intervals. A new regulation was considered a long time before implementation, and the industry was generally well prepared for the implications of this change. Currently, entering the twenty-first century, the pure number of regulations to be implemented within the near future by any financial institution is approaching 50. Not only is the complexity and volume of each single regulation increasing, but there are also variations depending on local jurisdiction, as well as different implications for different business units, for example insurance, retail banking, and investment management. The end result is that a major financial services company can have well over 100 regulatory implementation projects currently in progress. These implementation projects for regulatory changes are seldom seen as a source of innovation. Rather, businesses tend to have a negative view at the outset. A new entrant that pursues a strategy to embrace rather than avoid or minimize regulations may have opportunities to establish a strong position in the evolving market.

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Business managers are usually (very) negative toward new regulations

Executives act relative to changes in regulations in a conservative way and make more effort to avoid these changes rather than to embrace them (Levitt, 1968). This approach stands in stark contrast to the progressive and innovative approach taken by businesses when it comes to “regular” business innovation activities that are driven by internal ideas or customer requirements. Firms that adopt their strategies in a proactive way when regulations change are likely to experience more success than those firms that do not adapt (Smith and Grimm, 1987). On the other hand, negligence to adapt to regulatory change can lead to increased risk that organizations fail.

Implementations of regulatory change are not efficient

Due to the increasing frequency, volume, and complexity of regulatory changes, there is a practical approach of implementing these changes in a less than efficient way. Implementations are made in silos (i.e., both concerning individual regulations and for each organizational unit), which leads to a multitude of tasks performed by uncoordinated resources. The implementations are almost always reactive in mindset, meaning that the approach taken is to do the minimal effort possible to just pass the compliance threshold. Many times, the solutions implemented are “tick-box”-oriented or “forms-centered.” The main purpose is to deliver a set of information to a corresponding regulator without much thought of the value of the information contained. In addition, there is a weak connection between the compliance organization responsible for the projects and the capabilities concerning acquisition of technology solutions. When adding these circumstances together, the picture is that of limited innovation and considerable investments.

Four areas of regulatory change impact

Based on my empirical data and analysis, four different areas of impact from regulatory change emerged. Asking firms what they did after a regulatory change derived the picture of impact. The four areas signify the main impact from any single regulation, but any regulations in addition also influence the other three areas over time. Below, I briefly illustrate the four impact areas of product design, service processes, customer relationships, and technology platforms, and how they influence companies when a regulatory change occurs.

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Product design

The products designed and sold by financial services firms are an important area of impact from regulatory change. Regulators can target transparency of products by demanding improved disclosure (Richard and Devinney, 2005). Products are designed to define firms’ offerings to the market and customers (Fixson and Park, 2008). A regulatory change can present requirements for new products, as in the cars developed toward zero-emission rules (Dyerson and Pilkington, 2000). The company needs to understand the regulatory change and how it creates demand for new products, and also how it influences the existing products.

One example of a regulation affecting product design is the fund-based life insurance introduced in Sweden in 1990 and in several other countries in the late 1900s. The regulation presented requirements for new components to be assembled into innovative products with a higher degree of flexibility than before.

A second example is the regulations concerning securities funds (Undertakings in Collective Investments in Tradable Securities, UCITS). This regulation defines the role of the financial product called “investment fund.” When the UCITS regulation was updated to version 5 in 2016, products were influenced due to changes in the ability to remunerate providers of funds.

Service processes

Service processes are necessary to deliver the promise of functionality offered in products. Due to the visibility of processes, regulators target them to increase efficiency in an industry. Processes are required over the entire life cycle of the product (Jacobides, 2005). A change in regulations influences how firms modify their internal processes (Cabigiosu and Camuffo, 2012). A proactive company can offer services to customers whereby the requirements from regulations are supported as a process delivered to the market.

An example of a regulation influencing service processes is Foreign Account Tax Compliance Act (FATCA) for reporting on US tax status for customers in non-US banks. The regulation implied that new information was captured in the process of establishing a customer account.

A second is the implementation of “best execution” regulations concerning trading of securities in the EU regulation Markets in Financial Instruments Directive (MiFID). New processes were required to analyze the consequence of buying and selling specific securities across multiple markets.

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Customer relationships

A key rationale for regulators to address regulatory change is to strengthen the protection of customers. Regulations can contain requirements for increased transparency, and clarification of roles in connection with the customers. Such regulations are prominent in, for example, the building industry (Cacciatori and Jacobides, 2005) and in the airline engine industry (Brusoni, Prencipe, and Pavitt, 2001). Thereby, the roles of actors interfacing the customer, across the processes of sales, advice, distribution, and maintenance, are often changed as a result of new regulations.

One example of a regulation influencing the customer relationship is the European Union directive MiFID2 (the second Markets in Financial Instruments Directive), including requirements for Know Your Customer (KYC). Demands are presented in this new regulation of how the advisory relationship with the customer is to be documented. In addition, there are instructions for the use of external intermediaries, and how such partners are remunerated. Numerous variations of regulations concerning financial advice exist in different countries.

Another example of a regulatory change that will alter customer relationships is PSD2, which will be addressed later in the chapter.

Technology platforms

Regulatory changes with impact on technology can be either technical specifications, where requirements are infused to certify a new technology (Teece, 1986), or a broad regulation, which puts entirely new obligations onto the platforms of an industry (Tee and Gawer, 2009). Technology also plays a role in addressing the requirements of regulations across products and processes. The use of platforms to manage regulatory requirements has proven viable in the financial services industry (Meyer and Dalal, 2002).

The Payment Card Industry Data Security Standard (PCI DSS) is an example of a detailed and specific requirement for technology. Even if it is formally not a government regulation, it can be regarded as a de facto regulation for payment cards.

An example of regulatory change with impact on technology is Solvency 2 for insurance. This regulation covers capital requirements, risk management, and reporting, and thereby drives new technical foundations for information management. A corresponding regulation is the existing Basel 2 rules for banks, which is currently superseded by the Basel 3 framework.

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Opportunities when regulations change

Discontinuities due to an external source, such as regulatory changes, can lead to significant changes in how an industry organizes itself, with important implications for the control or profitability of a firm. The results of regulatory evolution can lead to different outcomes in the ownership of assets (Tee and Gawer, 2009). Evidence of the innovation effects from regulations has been presented by contributions from previous research (see e.g. Ferraro and Gurses, 2009). For example, firms that are in possession of production assets, such as platforms, can leverage these to create new services that support common regulatory compliance processes across ...

Table of contents

• Cover Page
• Post-Conflict Archaeology and Cultural Heritage
• Title
• Copyright
• Contents
• List of Figures
• List of Tables
• List of Contributors
• Acknowledgments
• Foreword
• Introduction: Fintech and Shifting Financial System Institutions
• Part 1 New Regulations
• Part 2 Cognition: Legitimacy and Views
• Part 3 New Norms Enabled By New Technologies and Standards
• Part 4 a View of the Actors
• Conclusion: Implications for Actors as Institutions Evolve
• Index