Clearing the fintech market presents new challenges for compliance officers

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

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

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

Economic uncertainty

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

Furthermore, the prices of fintech solutions may well increase as the number of fintech companies decreases and the ability to innovate decreases. Such a development would be distasteful to potential investors and buyers.

In recent years, TRRI’s fintech surveys have highlighted the popularity of applications in many disciplines. This year’s survey showed that the most popular areas of use include credit risk analysis, information and data security and customer management.

The demand to automate operations has not disappeared, but the challenges for implementation have grown. The economic environment has made it more difficult for companies to deploy fintech applications in a cost-effective manner, and fintech firms have become less able to innovate, reducing the range of available applications.

Other reasons why fintech has slowed

Susceptibility to fraud is another of the main reasons why fintech has become less attractive. Fintech applications’ exposure to fraud has increased in recent years; and this, combined with an increase in the number of cyber security breaches, has put pressure on fintech firms to consider security and control elements. Victims of fraud lost £1.3 billion in 2021 alone due to a rise in online fraud, with a nearly 40% rise in approved push payment fraud, according to UK finance.

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

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

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

Finally, the availability, or otherwise, of skilled employees and indeed the ability of companies to afford employees with relevant knowledge can also act as a brake for the development of new fintech solutions or the purchase of existing applications.

The 2023 Fintech/Regtech survey identified skills shortages as one of the biggest challenges to the growth of fintech, with half of company boards surveyed reporting that they had had to expand their companies’ skill sets to accommodate developments in innovation and digital disruption. The need for additional skilled resources was balanced by the fact that some fintech firms were laying off workers.

Challenges for risk and compliance officers

For compliance officers, it is a different perspective on the risks that companies are exposed to, and underlines the need to develop comprehensive but flexible governance arrangements. This, of course, puts greater focus on companies’ risk management frameworks, making it more important to get third-party onboarding processes right. Risk and compliance officers must ensure that the risk of fintech failure is fully investigated when onboarding a supplier.

The onboarding process should also consider the skills and resources available to the fintech firm and its plans to recruit or develop the necessary skills. Furthermore, compliance officers must ensure that, where there is a regulatory reason to engage with a fintech application, all relevant rules are covered and that output from fintech solutions can be used to demonstrate compliance both internally to senior management and externally to regulators.

In addition, the adequacy of business continuity arrangements and exit strategies must be fully evaluated to ensure that if fintech is no longer available, the damage to customers, shareholders and the wider financial services sector is offset.

Companies that have solid risk and governance frameworks that ensure regular review and updating of risks may already have managed the risks associated with a changing fintech marketplace. However, it would be prudent for firms to reassess their relationships to prevent the market downturn from disrupting the provision of services and putting the firm at greater risk of financial loss, customer harm and regulatory scrutiny.