03 January 2024

The UK is home to a world-renowned fintech sector – one that contributes £11 billion to the nation’s economy, and supports more than 76,000 jobs.

But it’s a landscape marked by polarisation. ‘Winning’ businesses are flying higher and higher, but others are finding it increasingly difficult to navigate the road ahead and to secure the support they need to continue their growth journey.

Against this backdrop, we speak to Dan Conway, Restructuring Partner at FRP Advisory and Martin Cook, Partner and Head of Fintech at Burges Salmon, to review the state of play for the UK’s fintech firms, and what the year ahead might hold.

Q: What is the current state of play for the UK’s fintech sector? Who are the ‘winners’, and which businesses are finding it harder to trade?

Martin Cook: Fintech is a disparate market with a lot of different product or market subsectors – from payments to lending, from regtech to cryptoassets and from wealthtech to data products. The climate in the market depends very much on where in this broad ecosystem a particular business is located, as well as specific factors relating to a particular business.

On a macro level, a big challenge that we’ve seen for firms is access to funding.

This isn’t a problem of capital availability. While overall investment levels have fallen from the peaks seen during the Covid years, investors still have money to invest. But their attitude to investment certainly has changed. What we’re seeing now is a polarisation in the market. Quality businesses are getting good money, while weaker businesses are really struggling to secure the funds they need.

Those firms that are ‘winning’ in the funding space are increasingly those that have a good track record as a business, or those led by a team, or an individual, with a reputation for success.

Dan Conway: I’d absolutely agree with this assessment. This is perhaps an outcome of the fintech market maturing, and investors maturing with it.

The sector has developed significantly since the very dynamic environment that we saw 10 or 15 years ago. While the single ‘great idea’ that has underpinned so many fintechs is still important and is still attracting funding, this is rarely good enough on its own for investors. Funders are putting more and more emphasis on the sophistication of a business, and its credibility and pedigree.

Rising interest rates are also having an effect because it’s reshaping investors’ attitude to risk and return.

While previously an investor might have been happy to take more of a risk investing in a fintech business to try to get a higher return, it’s now a greater challenge to get an investor to speculate on an uncertain return. This links back to the reputation point – it’s easier or more appealing to invest if the business, or its founders and management have a track record of success generating returns for investors.

Martin Cook: It’s important to point out that the recent economic landscape has also created opportunities for some fintech businesses.

Neo-banks have been able to capitalise on rising interest rates to bring in significant amounts of customer deposits. And with the ongoing cost of living squeeze, there’s naturally been strong demand for financial wellbeing or saving propositions, along with wealth management solutions that help reduce the cost of advice or remove barriers to it.

We’ve also seen a trend in consolidation.

Some of this has been synergy-driven, with businesses combining in order to drive efficiencies. But other cases have been purely competitive. Fintechs have been acquiring other fintechs to ‘leapfrog’ part of their growth or development journey, for example to move faster in securing a regulated product or proposition, or even to acquire a competitor’s entire team and all of the reputation, skills and knowledge that come with it.

Dan Conway: And another factor behind this wave of consolidation has been the drive to achieve scale.

Often fintechs need scale to make money. While having lots of competition is always good for the quality of the end product, it limits how big a slice of the market one firm can secure, and therefore how large their revenue streams can be.

Consolidation is one way for businesses to address this.

Q: We’ve touched on the bifurcation of the market, and the challenges firms are facing when it comes to funding. In this environment, what’s the outlook for the fintech market in the months ahead?

Dan Conway: The UK fintech market is resilient, and we’re not seeing widespread waves of company failures.

There is also plenty of liquidity around, and where funders have been sitting on war chests, the time will soon come when they need to use it.

Pedigree will continue to be the ‘make’ or ‘break’ factor when it comes to whether fintech businesses can secure the backing they need.

Because the market has matured and interest rates are – for the immediate term – likely to remain at historically high levels (when compared to the previous 15 years), funders will need to be able to satisfy themselves that investing in a fintech business will generate more value than putting their money into another, potentially less risky and more established, sector, such as manufacturing or retail. For fintech businesses, getting to a point where they can demonstrate to funders that they are a solid bet is going to be key to success.

Martin Cook: There’s also a growing opportunity for UK fintech companies to benefit from a trend in incumbent banks expanding into the fintech space.

For the banks, acquiring, investing in, or partnering with a fintech can be a way for them to quickly secure a competitive edge against another rival. Financial institutions, by virtue of their scale and nature, are often less agile than fintech firms but this does not mean a lack of ambition to change by those setting strategic direction.

For them, getting a fintech on board can mean they can secure the technology they need to deliver new propositions and services, in a fraction of the time and money it would otherwise take them to deliver it.

This is a trend that is set to continue, and gives an exit strategy that some fintech businesses will benefit from. I know of certain businesses that have selling to an incumbent as their end goal.

Dan Conway: The landscape in terms of valuations has also changed with less bullish values being attributed to fintechs than has been seen in the past decade.

Increasingly – and again this ties to the point about reputation and pedigree – the value that investors and acquirers are seeing in fintech businesses is linked to its people, not just the tech. A founder, or ‘star’ employee who is known in the market to deliver is worth their weight in gold.

This introduces key person risk to fintech businesses, something that they’re going to need to carefully manage in order to maximise future outcomes.

The question that boards should be asking now is “what happens if this person leaves?”. If businesses would lose their edge because one person, or even a group of people, were absent from their business, then contingency plans need to be in place.

Q: Regulation is always a key consideration for financial services firms. What is on the horizon for fintechs here?

Dan Conway: The FCA’s Consumer Duty has been arguably the biggest regulatory development of this year.

It is prompting businesses across the financial services industry to take a close look at how they are delivering good value and good outcomes to customers.

For some regulated fintech businesses, this will mean a review of fees and charging structures, which may affect revenues, and will have added to the cost of meeting ongoing regulatory burdens.

Martin Cook: The good news is that fintechs are well placed to manage Consumer Duty’s arrival, often because of the more focussed target market and more limited product suite.

Consumer Duty compliance is an ongoing process, however, so any businesses feeling pressure from it now will need to have a plan for how to manage this over the long term.

We’re also starting to see the expansion of Consumer Duty from the regulated firms that are mandated to comply, to areas of the industry that are not directly FCA authorised.

This makes sense. Regulated businesses will be looking to their partners for alignment on Consumer Duty’s goals, simply to help with their own compliance efforts. In practice, this means more businesses are likely to have more regulatory considerations to deal with.

Beyond Consumer Duty, there are also new regulations coming down the line that fintechs may need to deal with. In 2024, we’re expecting new measures around data protection, artificial intelligence, cryptocurrencies and buy now, pay later (BNPL) propositions. Fintechs need to be on the front foot in each case. The use of artificial intelligence – and governance and risk management around it – is likely to be really significant and build on the momentum of 2023.

But while being subject to regulation may be seen as a burden, remember that it can also be an advantage. In areas where regulation is required to operate – such as banking or payments – going through the effort to be authorised can make it harder for not just any competitor to encroach on a fintech’s territory: a defensive strength in this highly dynamic market.

This article was originally published on FRP Advisory’s website.

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