What next for the UK’s fintech sector?

According to KPMG, around 2,500 of these companies have established themselves in the UK, with an increasing trend upwards through the financing rounds towards market-listed status. Unlike other sectors where venture capital and private equity have largely left the scene, fintech has continued to attract decent levels of investment. According to trade statistics, the UK fintech industry raised the equivalent of $9.1bn (£7.9bn) in the first six months of this year, compared to $7.3bn in the same period in 2021, which itself was a record-breaking year. So, despite the industry’s growth, why are investors now wary?

The fintech industry endured a torrid summer as questions were raised about a number of companies suddenly grappling with questions about their accounts or dealing with failures to implement anti-money laundering protocols in certain markets. In other words, the capital-intensive and mainly loss-making business model is suddenly less popular with investors wary of debt-laden companies in an era of rising interest rates, but there is also a sense that growth has been hellish. -Skelter and management control are sometimes missing.

A word to the wise

Wise (WISE) is currently the best-known and largest fintech to list on the London Stock Exchange via the unusual route of a secondary listing. While this undoubtedly saved costs at the time, it probably limited the number of shares that could be issued and traded beyond the usual fund owners, so share price movements tend to move dramatically on a relatively low trading base.

However, a lack of share liquidity is not the company’s main problem, and while embarrassing, neither is CEO Kristo Käärmann’s conscious tax non-compliance issues with HMRC. Instead, Wise faces serious reputational fallout from the activities of its UAE subsidiary, Wise Nuqud, which was recently fined $360,000 by regulators for failing to maintain anti-money laundering protocols. To be honest, this is not uncommon in the general financial sector; Natwest (NWG) was recently caught up in a money laundering scandal involving bin bags full of moldy Scottish notes being accepted at branches for deposits. However, the affair gives ammunition to those critics who demand that fintechs are essentially banking entities that should be subject to the same level of regulatory oversight.

Part of the problem for Wise, and similar payment transfer firms, is that they fall somewhere between a technology provider that can perform banking-related tasks far more cheaply, such as foreign exchange transactions, and lending institutions that must have regulatory capital levels to safeguard their balance sheets. The question now is whether trying to remain a technology service provider is profitable enough on its own to avoid questions about the underlying business model, and whether the businesses are mature enough to avoid embarrassing entanglements?

Zepz and Revolut’s growing pains

Fintechs have apparently run into trouble when it comes to progressing from cocky start-up status to mature business. In practical terms, how to acquire the permanent office of a bank while maintaining the free-spirited culture of a new company. Take money transfer specialist Zepz (random use of consonants is a feature of the sector), as an example. It avoided an IPO in London despite being based there, in favor of raising money in New York. It raised $300 million from investors in a private round that gave it a potential valuation of $5 billion, but since then valuations of fintechs have plummeted in the private market, and Zepz has become a case study of how startups can quickly degenerate into dysfunction if there is insufficient control over their growth.

It recently appointed a new CEO, Mark Lenhard, after a chaotic period during which the company had four managers, all with the title “CEO”. Former incumbent Breon Corcoran had proposed a cost-cutting plan so Zepz could aim to post a profit after the company scrapped plans for a $6bn (£5bn) IPO. Under new management, the company recently made a first profit, the new manager said The timesbut an IPO is not on the cards.

Accounting problems seem to bedevil previous fintech sector darling Revolut. The company is embroiled in an audit nightmare after its auditors BDO were singled out by the Financial Reporting Council for doing insufficient work on revenue recognition to prevent a potential “material misstatement”, according to a Financial Times investigation. The result is that the auditors are now crawling through the books under pressure from the regulator, which can delay the submission of the accounts and potentially lead to fines and penalties for the management. The audit issue could affect Revolut’s efforts to obtain a banking license in the UK. It has so far received 44 out of 48 approvals in various jurisdictions, with UK licenses still outstanding – more than 18 months after it submitted its application.

Meanwhile, Revolut is another fintech looking hard at its cost base. After going on a hiring spree through 2021, the company is now cutting back on graduate roles and reducing other non-essential costs.

It’s not hard to see why fintech values ​​are declining in the private equity market, along with their listed brethren. Wise’s latest profit numbers show the impact of adding back office functions while spending enough on marketing to keep new customers rolling through the doors. The adjusted cash profit margin decreased by four percentage points as administrative costs increased.

Ultimately, the sector must decide whether it remains a relatively high-volume service/technology business, or becomes more like the banking sector, with all the aggravation and bureaucracy that entails. Until that conundrum is resolved, investors will continue to be wary of the sector’s cheeky appeal.