Fri. Nov 15th, 2019

Planet Compliance

Innovation & Regulation in Finance

Brexit, Passporting for Financial Firms and what all the fuss is about

5 min read

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When talking about Brexit, the UK’s decision to leave the European Union in a way and at a point in time yet to be determined, one of the key discussion points is that financial firms fear to loose their passporting rights.

As with many Brexit discussions before and after the vote, there always seems to be an element of unawareness when talking about specifics. So, what does it actually mean and what really is at risk? As for the first part of this question, the single passport is a system, which allows financial services operators legally established in one Member State to establish/provide their services in the other Member States without further authorisation requirements. Hence, UK financial firms risk loosing this right and will have to establish a presence in at least one of the remaining EU member states if whatever solution that will be agreed on following Brexit does not include this right. For sake of completeness, this would also mean that financial institutions from other EU member states like France or Germany, which do not have a presence in London or somewhere else in the United Kingdom, face the same dilemma.

Still not entirely clear what’s so bad about it? Let’s use a practical example then to demonstrate how the passporting works and its importance for financial firms in general and FinTechs in particular: Seedrs is an equity crowdfunding platform founded in the UK in 2009. It let’s businesses raise funds from investors who in exchange receive shares in the company. These companies are often early stage growth-focused businesses, which might find it difficult to find the money required to run their operations and finance necessary investments in, for example, machinery or staff. It’s a riskier investment than traditional ones, but there is the upside for investors that it potentially can generate higher returns though that is often only one of the reasons for investing in start-ups. Given the low interest environment and a general shortage of funding for small and medium sized enterprises (SMEs), it’s a very useful structure. Equity Crowdfunding is a regulated activity and Seedrs has received approval from the FCA. Now, Seedrs like other crowdfunding platforms has managed to establish a foothold in its country of origin, i.e. the UK, but naturally the people in charge must have been thinking that there are limits to the amount of companies and investors they could provide their services to in the UK. Like any good company that growth, they will have considered accessing other markets with their proven model, so they looked abroad. Thanks to the FCA authorisation they did not need to apply for additional approval from the other regulators in EU member states. Other than its UK office, Seedrs also has offices in Lisbon and Amsterdam (it is also in the process of opening in Berlin and has one in New York, but that’s a different story). These offices might be useful to deal more directly with businesses and investors in the respective countries, but they are not necessary for regulatory purposes. Investors could come from Bulgaria and firms from Italy, for instance, as long as they comply with the requirements for investing and raising money on crowdfunding platforms.

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If the UK were to loose its passporting rights, as indicated above, Seedrs would have to apply for its regulatory authorisation in one of the other EU countries it already has or will have an office. In order to receive this, certain functions must be present in that office though, which is likely to lead to additional staff being added or staff transferred. In any case additional costs for application, staffing and other aspects will occur for Seedrs and it will not be able to accept businesses and investors from other EU member states for its UK arm. As a result, UK SMEs will be deprived of foreign funds while UK investors will be limited to investments into UK firms. Some people might think that the latter isn’t such a bad thing after all, but in practice it means less money and less growth for everyone. While for a large international bank the additional costs and administrative burden will be painful, for comparatively small FinTechs it could be fateful: like all companies equity crowdfunding platforms like Seedrs only work if they are profitable, which they can only be achieved through scalability though, i.e. a significant number of projects and investors. In any case, life will be much more difficult.

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A solution that may have found its problem: Trade Finance and BlockchainThe honeymoon for Blockchain is over. Excitement has turned into disillusion and disappointment. Coined (no pun intended) a solution looking for a problem, the application of the technology in Trade Finance is a silver lining in times of Blockchain gloom. Let’s face it: Blockchain has seen better times! Cryptocurrencies have been in a slump even though Bitcoin recovered half of the value of the heydays in 2017. The majority of cryptos though are still far away from such heights. Initial Coin Offerings are basically dead: While 2018 with a total of almost $11.4 billion still exceeded the previous year against little more than $10 billion, representing a growth of 13%, it needed 2,284 ICOs to do that as opposed to only 966 in 2017. However, this is nothing compared to this year, which with little more than a month to go has only seen 204 ICOs raising a mere $3,175 billion. Security Token Offerings have somewhat taken over the baton, it is nothing of the sort when Blockchain was hailed as the solution to everything. But then the reality set in. The realisation about the limitation of distributed ledger technology and the amount of work that is required to implement it paired with the understanding that a blockchain is not for everyone has driven down its standing. Denounced as a solution looking for a problem, it seems that following the drop from the peak of inflated expectations we are now securely in the trough of disillusionment to borrow from the Gartner hype cycle. Regulators, too, have come down hard on token offerings, which in turn has led to the misled perception that blockchain technology is rather synonymous with fraudulent ICOs. Regulatory action like the financial watchdog of HK issuing a warning against investing in Security Tokens at first glance supports such a perception even if it is only a regulator being spooked by previous slackness. But if you think these events spell the end for Blockchain technology in Finance you are mistaken. Despite the many negative news of the past months, the implementation of Blockchain solution has progressed nonetheless. Many solutions simply need more time than overly optimistic tech aficionados forecasted. It’s work in progress and while some areas might take longer, others have made great progress. One such example is Trade Finance. An area that is full of inefficiencies, the use of distributed ledger technology means trade finance can be monitored in real-time and by multiple parties, Because of the exchange of documents in a digital, secure and decentralized manner, international transactions across borders are streamlined, become much more efficient and are better protected against fraudulent activities. Given past predictions that turned out to overestimate the potential of Blockchain, you need to be careful with these numbers, but Bain & Company estimated last year that digitalizing the documentary trade finance process by using Blockchain technology could increase global trade volumes by $1.1 trillion by 2026, from the current base of $16 trillion. So, the obvious question is where are we one year on? Well, there are still plenty of issues to be honest. Regulation, while less dominant in the field of trade finance than in other heavily regulated areas of finance, is, as you would have expected, a bit of an obstacle. Like anywhere else, regulators have to catch up with innovation and they only have started to do so. For example, in the USA, naturally one of the biggest players in international trade negotiable instruments in trade finance are only recognized if they are on paper and signed – not exactly how Blockchain works. The big elephant in the room is the lack of standards though and its segregation in the form of about thirty different consortia made up of banks and technology firms that are working on their own solution. This means different platforms and different standards. And if we have learned anything from history and examples from other industries, it is that fragmentation of standards can seriously hinder innovation or at least delay adoption significantly. You remember the format war between Blu-ray and HD DVD? Well, there you go, and that’s why – almost on the day four years ago – we gathered the courage to announce that Blockchain isn’t the Silver Bullet for everything. We promised you though a resort from all the Blockchain gloom and recently some of the players in the race to develop the one trade finance solution have made tangible progress. For instance, UBS announced in October that is has gone live starting full-fledged transactions on we.trade, the blockchain-based trade finance platform that claims to be close to wide adoption by its member banks as according to we.trade, financial institutions like Société Générale, HSBC, Santander, UniCredit, Nordea, KBC Bank, Rabobank, and Deutsche Bank already use the platform settle trade contracts. At the same time, dltledgers, another platform, announced in July that it had processed more than $1 billion in trade finance on its blockchain trade platform in the last 18 months. Clearly, these only represent singular examples of success stories that also highlight the fact that there lies a meaningful chunk of road ahead, but it’s a silver lining, isn’t it?

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5 min read

A solution that may have found its problem: Trade Finance and BlockchainThe honeymoon for Blockchain is over. Excitement has turned into disillusion and disappointment. Coined (no pun intended) a solution looking for a problem, the application of the technology in Trade Finance is a silver lining in times of Blockchain gloom. Let’s face it: Blockchain has seen better times! Cryptocurrencies have been in a slump even though Bitcoin recovered half of the value of the heydays in 2017. The majority of cryptos though are still far away from such heights. Initial Coin Offerings are basically dead: While 2018 with a total of almost $11.4 billion still exceeded the previous year against little more than $10 billion, representing a growth of 13%, it needed 2,284 ICOs to do that as opposed to only 966 in 2017. However, this is nothing compared to this year, which with little more than a month to go has only seen 204 ICOs raising a mere $3,175 billion. Security Token Offerings have somewhat taken over the baton, it is nothing of the sort when Blockchain was hailed as the solution to everything. But then the reality set in. The realisation about the limitation of distributed ledger technology and the amount of work that is required to implement it paired with the understanding that a blockchain is not for everyone has driven down its standing. Denounced as a solution looking for a problem, it seems that following the drop from the peak of inflated expectations we are now securely in the trough of disillusionment to borrow from the Gartner hype cycle. Regulators, too, have come down hard on token offerings, which in turn has led to the misled perception that blockchain technology is rather synonymous with fraudulent ICOs. Regulatory action like the financial watchdog of HK issuing a warning against investing in Security Tokens at first glance supports such a perception even if it is only a regulator being spooked by previous slackness. But if you think these events spell the end for Blockchain technology in Finance you are mistaken. Despite the many negative news of the past months, the implementation of Blockchain solution has progressed nonetheless. Many solutions simply need more time than overly optimistic tech aficionados forecasted. It’s work in progress and while some areas might take longer, others have made great progress. One such example is Trade Finance. An area that is full of inefficiencies, the use of distributed ledger technology means trade finance can be monitored in real-time and by multiple parties, Because of the exchange of documents in a digital, secure and decentralized manner, international transactions across borders are streamlined, become much more efficient and are better protected against fraudulent activities. Given past predictions that turned out to overestimate the potential of Blockchain, you need to be careful with these numbers, but Bain & Company estimated last year that digitalizing the documentary trade finance process by using Blockchain technology could increase global trade volumes by $1.1 trillion by 2026, from the current base of $16 trillion. So, the obvious question is where are we one year on? Well, there are still plenty of issues to be honest. Regulation, while less dominant in the field of trade finance than in other heavily regulated areas of finance, is, as you would have expected, a bit of an obstacle. Like anywhere else, regulators have to catch up with innovation and they only have started to do so. For example, in the USA, naturally one of the biggest players in international trade negotiable instruments in trade finance are only recognized if they are on paper and signed – not exactly how Blockchain works. The big elephant in the room is the lack of standards though and its segregation in the form of about thirty different consortia made up of banks and technology firms that are working on their own solution. This means different platforms and different standards. And if we have learned anything from history and examples from other industries, it is that fragmentation of standards can seriously hinder innovation or at least delay adoption significantly. You remember the format war between Blu-ray and HD DVD? Well, there you go, and that’s why – almost on the day four years ago – we gathered the courage to announce that Blockchain isn’t the Silver Bullet for everything. We promised you though a resort from all the Blockchain gloom and recently some of the players in the race to develop the one trade finance solution have made tangible progress. For instance, UBS announced in October that is has gone live starting full-fledged transactions on we.trade, the blockchain-based trade finance platform that claims to be close to wide adoption by its member banks as according to we.trade, financial institutions like Société Générale, HSBC, Santander, UniCredit, Nordea, KBC Bank, Rabobank, and Deutsche Bank already use the platform settle trade contracts. At the same time, dltledgers, another platform, announced in July that it had processed more than $1 billion in trade finance on its blockchain trade platform in the last 18 months. Clearly, these only represent singular examples of success stories that also highlight the fact that there lies a meaningful chunk of road ahead, but it’s a silver lining, isn’t it?

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