Navigating the complexities of Fintech

In a recent interview on the London Fintech podcast, Alistair Cotton, CEO and Co-founder of Integrated Finance sat together with Host Mike Baliman.
Topics focused around the complexities of the financial services industry and how Fintech has evolved since its birth. They explore how societal processes often lead to unexpected outcomes and how regulatory challenges continue to reshape the finance landscape.

Alistair provides insights into the operations side of Integrated Finance, and how it is revolutionising the embedded finance and Fintech infrastructure space.

Listen to the full episode here!

What is Integrated Finance, and how did it come about?

Alistair starts with where it all began, the origin of Integrated Finance.

The origin story

• Integrated Finance was conceived by co-founders with a rich foreign exchange and sales background.
• The company stemmed from the difficulties of building and scaling a regulated business.
• The primary challenge was managing multiple providers, each with its unique APIs.
• This struggle of getting all distinct systems to work together smoothly led to the formation of Integrated Finance.

What does Integrated Finance do?

Integrated Finance aims to simplify the Fintech landscape for businesses. Here's how:

1. Platform connectivity: Integrated Finance provides a single platform connecting multiple providers. This unique feature negates the need for businesses to manage separate connections with each provider
2. Single API access: Integrated Finance offers its customers access to all providers through a single API, simplifying the process further.
3. Supporting rapid scaling: the company allows businesses to quickly build and scale financial products. This service is vital for companies seeking to grow in the fast-paced Fintech environment.

By offering these services, Integrated Finance aids businesses to navigate the financial landscape more efficiently, saving time and resources. This innovative approach was born from the first-hand experiences of Alistair and his co-founders with the complexities of scaling a regulated business.

Understanding business ideas: painkillers vs. vitamin tablets

Painkillers are products or services that alleviate an immediate pain point or problem. They provide instant relief, just like a painkiller does for a headache.
Vitamin tablets: these products or services are meant to improve situations over time but might not address an immediate need. They work subtly, like taking vitamins might improve your health over an extended period, but they don't offer instant relief.

It is easier to sell painkillers than it is to sell vitamins. A quick solution is always more attractive when dealing with an immediate issue - a point both Mike and Alistair painstakingly agreed upon.

The importance of understanding nuance

Alistair holds a strong opinion on the importance of understanding the nuances within an industry as the key to finding the best business ideas. He believed you need to go down the rabbit hole of your problem and to understand the core challenges that many people within the industry face.
If you can identify a widespread problem, you're on to a potentially successful business idea. It's akin to discovering a common headache you can alleviate with your solution.

Exploring the journey of Fintech and its regulatory challenges

The Fintech industry has significantly evolved over the past decade, originating as a novelty term and blooming into a dynamic sector filled with a myriad of innovative companies. Nevertheless, this rapid expansion has not been without hurdles, particularly regarding regulatory compliance and scaling operations.

The boom in Fintech and regulatory developments

Around 2010-2012, Alistair recounts that the Fintech sector witnessed a surge in growth. This was spurred on by a lack of specific rules, which prompted the introduction and ongoing adjustment of regulations to ensure a secure and fair environment for all stakeholders.

Stepping stones: E-Money and payment institution licences

Regulators rolled out e-money licences and payment institution licences intended as preliminary steps. This allowed companies to launch financial products without the burdensome cost and complexity of obtaining a full banking licence.

Successful regulatory cases: Revolut and TransferWise

Revolut and TransferWise serve as prime examples of success under this regulatory approach. Despite the likely unexpected vast scale of growth, these companies have managed to cater to millions of customers globally, showcasing the effectiveness of this regulatory framework.

Scaling challenges

However, operating on such a grand scale introduces new challenges. Companies must ensure smooth operations while remaining compliant with different jurisdictions' regulations. Existing 'baby' financial licences may not sufficiently detail risk and control procedures necessary for large-scale operations, leading to potential issues in regulatory adherence.

The exciting leap from Peer-to-Peer to banking: the journey and its hurdles

Our financial world is changing quickly - Alistair provides a strong example in companies like Zopa which are leading the way. They're shifting from peer-to-peer models to classic banking structures. Alistair acknowledges it sounds like the wrong direction, but explains why.

Zopa's big move

In the last 20 years, Zopa has evolved from a peer-to-peer lending trailblazer to a traditional bank. This change is a complex dance with banking rules that have only become stricter over time.

Regulation: too much of a good thing?

Some argue that strict banking regulations might not improve the industry's health. Despite the Federal Reserve's rigorous stress tests, reports suggest possible instability in many US banks. These concerns also extend to policies like Quantitative Easing (QE) and large-scale government borrowing.

Joining the big league

Becoming a bank means playing by the same rules as heavyweights like HSBC and Citigroup. These rules aim to ensure financial stability. However, they can also lead to the risk of collapse due to policy errors or unexpected events.

The Fintech balancing act

Fintech firms often enjoy lighter regulations than traditional banks, which fosters growth and innovation. However, growth can bring surprises. Companies like TransferWise and Revolut have outgrown their initial E-Money Institution (EMI) licences. This shows some Fintech firms can scale beyond what their original regulations planned for.

The ripple effect

While we often talk about big names, these issues affect the wider Payment Institution (PI) and EMI industry. The UK's Financial Conduct Authority (FCA) has issued warnings about companies in these sectors. They emphasise protecting client money and fulfilling customer duties.

The FCA has voiced concerns about firms not separating client funds from operational funds - where Alistair hints at the famous case of FTX. He also highlights potential customer service issues, especially for rapidly growing firms that may struggle to handle customer concerns promptly.

The Fintech regulatory landscape: who is playing catch-up?

Mike and Alistair discuss the dynamic tug-of-war between swift innovation and regulatory compliance that marks the current state of Fintech.

The regulatory cycle in Fintech

Initially, Fintech innovators had the upper hand, outpacing the regulators. However, the situation has evolved. Now, some Fintech companies are racing to meet regulatory standards, particularly concerning the fair treatment of clients.
Regulations continue to grow more complex, reflecting the increasing sophistication of the industry. This evolving complexity brings challenges, not least of which is adapting to an ever-thickening rule book.

The role of Regulatory Technology (RegTech)

Many Fintech companies turn to Regulatory Technology, or RegTech, solutions to help them navigate the regulatory labyrinth. RegTech services can offer solutions such as APIs or software to help manage these business challenges.
However, Alistair adds the caveat that the effectiveness of these solutions isn't a given. Simply purchasing software or integrating a new API won't necessarily resolve all issues. Therefore, while RegTech can be part of the solution, it shouldn't be viewed as a magic wand that can erase all regulatory complications.

Investor influence on Fintech growth

Investor priorities have a significant impact on the direction of Fintech companies. In recent years, there has been a growing emphasis on "growth at all costs," driven by investors and VCs. This approach often prioritises acquiring new customers over refining internal processes. It is assumed that once the company achieves considerable scale, it can focus on improving processes and meeting regulatory requirements.
However, Alistair warns that this mindset can result in a regulatory gap. While the company is focused on rapid customer expansion, it may fall behind in meeting regulatory expectations. This catch-up game can lead to challenges in the future, highlighting the importance of striking a balance between growth and regulatory compliance for long-term sustainability. By adopting a more sustainable, long term, strategy - companies can avoid potential difficulties.

Fintech's priority on robust engineering

Unlike the broader tech sector, where a minimum viable product (MVP) might be acceptable, Fintech demands a more robust approach. This distinction arises because, in Fintech, an MVP that results in financial loss for clients can severely damage a company's reputation. Thus, Mike and Alistair agree that Fintech places considerable importance on robust engineering before seeking aggressive growth.

Traditional banks and rising fintechs facing funding challenges

In 2023, both traditional banks and Fintech companies experienced challenges. Famous headlines of institutions like UBS or JP Morgan buying banks which have defaulted missed no one. The same financial burdens have translated to troubles securing funding for many Fintech’s, such as RailsBank.
Alistair provides a couple reasons for these funding difficulties. One is the increasing complexity of compliance regulations, which can strain resources. The other is the rise in interest rates, making funding less accessible. The current public market situation for tech companies, including major Fintech firms, is somewhat grim, trickling down and affecting investment rounds at various stages.

Strategies for surviving the tough climate

In these challenging times, Alistair’s advice is for companies to become strategic in their resource allocation. Prioritising customer experiences is vital as it can distinguish you from your competitors. Additionally, the importance of regulatory compliance is increasing. Companies must allocate resources wisely to meet compliance requirements without neglecting other important areas like user interface (UI) development.

To achieve this, a tactical approach to resource allocation is recommended. Alistair says companies should ensure their services are compliant, their interfaces are user-friendly, and they avoid wasting resources on non-essential areas. By adopting this balanced strategy, Fintech firms can navigate the challenging climate and lay a foundation for future success.

The role and impact of Regulatory Technology (RegTech) in the financial sector

Navigating the complex world of regulatory compliance can be like choosing the best robot vacuum cleaner. There's no perfect answer, but the context may determine how useful or not a solution might be. In the financial sector, a debate exists over the efficacy of regulatory technology, better known as RegTech.

The two Extremes of the RegTech debate

On one side of this debate, some believe RegTech will solve all compliance and regulatory issues. These proponents suggest that technology is smart enough to handle these tasks efficiently. On the other side, sceptics argue that regulatory compliance is a massive burden that no amount of technology can mitigate. Mike Baliman points out that even large corporations like Citigroup have a significant portion of their workforce dedicated to regulatory tasks. Plus, the mere task of handling numerous computer programs can bring its own set of challenges.

The current impact and future of RegTech

Alistair’s opinion is that the truth likely lies somewhere in the middle of these extremes. RegTech is undeniably a positive force, making it easier for businesses of all sizes to manage compliance more automatedly. However, scaling regulatory compliance remains a significant challenge. For instance, the rise of new forms of money, such as cryptocurrencies, over the past decade has added more complexity to the regulatory landscape.

RegTech is still in its early stages, and much more work remains. One strategy to improve the effectiveness of RegTech is increased collaboration. This collaboration could take the form of industry consolidation, merging different firms and their respective data sets to provide a broader base for decision-making.

Another strategy involves companies combining RegTech with their proprietary customer information to get a more accurate picture of what people do with their money. This strategy could provide more specific and customised solutions to regulatory challenges. Ultimately, the future of RegTech depends on its adaptability and the industry's willingness to collaborate and innovate.

How should regulators and fintech founders approach Electronic Money Institutions (EMIs)?

Several parts of the financial sector constantly move and evolve. Regulators and Fintechs have to adapt and find solutions to these changes. Alistair highlights two important perspectives: how regulators approach Electronic Money Institutions (EMIs) and his best advice for Fintech founders or management teams under such circumstances.

From a regulator's perspective

If you were in the shoes of a regulator, you might be wondering why EMIs, designed for a small number of customers, are now servicing millions. If a large-scale provider with an EMi such as Revolut encountered problems, it could inconvenience many people. As a result, there could be a need to limit the scope of EMI licences based on transaction volume or customer count.

Alistair’s advice for regulators is to encourage standardisation. Standardisation, in this case, means having a shared way of communicating, allowing both the regulator and the firms to share information about problematic actors more easily. These bad actors can move from one firm to another, causing repeated problems. It would make the sector more secure if such individuals could be easily identified and blocked from joining new firms.

From a Fintech founder's perspective

As for those working in Fintechs, Alistair suggests a shift in perspective. Firstly, understand that although your company is in financial services, you are also in the compliance game. Accepting this from day one can set your business on the right track. Invest in compliance, take it seriously, and it will pay off in the long run.

The other piece of advice is not to try and build everything yourself. There are plenty of effective software solutions out there. Select what works best for your business and focus on your strengths. Accept that you may not know everything, and harness the power of these tools to help you.

Alistair emphasises the point that today's Fintechs are built by people who understand their customers deeply, not just finance experts. Embrace this perspective, and your business will be on the right track to success.

The unpredictability of outcomes in human society and financial regulations

The journey of life and policy-making is not always a straight path. Alistiar explains that we often think of processes linearly; we aim to move from point A to point C simply by passing through point B. However, human societies have many feedback loops that are not straightforward or linear.

He takes the example of the UK's education policy. The goal of abolishing grammar schools was to increase education, providing equal opportunities for all students. Instead, evidence shows that the policy has been levelling it down, thus producing the opposite effect of what was intended.

The complexity of financial regulations

The world of finance isn't any less complicated. Banks, especially larger ones, juggle a multitude of functions and operations, making regulation a challenging task. Alistair breaks it down as follows:

• A regulatory body is attempting to manage this vast and complex network of operations that even the bank's management struggles to fully comprehend.
• Large banks are often considered "too big to fail," leading us to bail out these institutions to prevent larger, potentially more damaging crises.

The evolution of financial services and the impact of technology

A major turning point in financial history came in 1971 when the gold standard was suspended. Before this, money was backed by precious metals, and complex financial products like derivatives didn't exist. Since then, financial services have evolved, becoming increasingly complex, and regulators' jobs continue to grow more challenging.

Alistair provides the following ideas on how the financial services industry might approach these challenges:

• Narrow banking: this involves banks focusing on specific services, such as mortgages and car loans, to reduce complexity.
• Refactoring finance: he also proposes a more radical approach, calling for a complete overhaul or "refactoring" of finance itself.

The evolution of financial services is a continuous process with no definitive answers. It's a journey that will keep us all guessing and adapting.

Integrated Finance: a key player in this landscape

Businesses like Integrated Finance are carving out their own path amid this evolving landscape.

Integrated Finance offers a platform for businesses that wish to build Fintech solutions. This includes financial service companies or brands that want to add financial services to their product offering. Our platform provides the needed infrastructure, saving businesses from creating everything in-house.

Conclusion

The world of financial services is a complex, ever-evolving landscape that continually presents new challenges and opportunities.

From the unpredictability of societal outcomes to the intricacies of financial regulation, the path isn't always clear. However, with the ongoing advancement of technology and innovative platforms like Integrated Finance, the financial sector continues to reshape itself.