The UK has long billed itself as the friendly home of fintechs (financial technology companies), which covers everything from money transfer apps to open-source banking and payments and supply chain finance. UK fintechs are not subject to any specific legal regulation, except where their activities fall under the responsibility of existing financial regulators.
According to KPMG, around 2,500 of these companies have established themselves in the UK, with an increasing upward drift through the funding rounds towards market listed status. In contrast to other sectors where venture capital and private equity has largely left the scene, fintechs have continued to attract decent levels of investment. According to trade statistics, the UK’s fintech industry raised the equivalent of $9.1bn (£7.9bn) in the first six months of this year, compared with $7.3bn during the same period in 2021, which itself went on to become a record-breaking year. So, despite the industry’s growth, why are investors currently wary?
The fintech industry endured a torrid summer as questions were raised about a series of companies suddenly struggling with questions over their accounts or dealing with failures to implement money-laundering protocols in certain markets. At the same time, the capital-intensive and mainly loss-making business model, is suddenly less in vogue with investors who are wary of debt-laden companies at a time of rising interest rates, but there is also a sense that growth has been helter-skelter and management control sometimes lacking.
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 likely limited the number of shares that could be issued and traded beyond the usual fund holders, so share price movements tend to move dramatically on a comparatively low trading base.
However, a lack of share liquidity is not the company’s main problem and, while embarrassing, neither is its chief executive Kristo Käärmann’s deliberate tax default issues with HMRC. Instead, Wise faces serious reputational fall-out from the activities of its subsidiary in the UAE, Wise Nuqud, which was recently fined $360,000 by regulators over failures in maintaining money-laundering protocols. To be honest, this isn’t unusual in the general finance sector; Natwest (NWG) was recently caught in a money laundering scandal that involved bin bags full of musty Scottish bank notes being accepted in branches for deposit. 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 bank-related tasks far more cheaply, such as a forex transactions, and lending institutions that must hold statutory levels of capital 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 over the underlying business model, and whether the businesses are mature enough to avoid embarrassing entanglements?
Zepz and Revolut's growing pains
Fintechs seem to run into trouble when it comes to moving on from cocky startup status to mature business. In practical terms, how to acquire the staid back office of a bank whilst 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 eschewed an IPO in London despite being based there, in favour raising of money in New York. It raised $300mn from investors in a private round giving it a potential valuation of $5bn, but since then valuations for fintechs plummeted on the private market and Zepz has become a case study of how start-ups can quickly degenerate into dysfunction if there is inadequate control over their growth.
It recently appointed a new chief executive, Mark Lenhard, after a chaotic period where the company had four executives all with the title “CEO”. The previous incumbent Breon Corcoran had proposed a plan of cost cuts so that Zepz could aim to post a profit after the company shelved plans for a $6bn (£5bn) IPO. Under new management the company recently posted a maiden profit, the new boss told The Times, but an IPO is not on the cards.
Accounting issues look set to bedevil previous fintech sector darling Revolut. The company is tangled up in an auditing nightmare after its auditors BDO were singled out by the Financial Reporting Council for having done insufficient work on revenue recognition to prevent a potential “material misstatement”, according to a Financial Times investigation. The result is the auditors are now crawling through the books under pressure from the regulator, which could delay the filing of its accounts and potentially lead to fines and penalties for management. The auditing issue could affect Revolut’s drive to get a banking licence in the UK. It has so far received 44 out of 48 approvals in different jurisdictions, with the UK licences still outstanding - more than 18 months after it filed the application.
In the meantime, Revolut is another fintech that is looking hard at its cost base. After going on a hiring spree through 2021, the company is now cutting back on graduate roles and paring back other non-essential costs.
It is not hard to see why fintech valuations are sinking in the private equity market, along with their listed brethren. Wise's most recent profit numbers show the impact of adding to back-office capabilities at the same time as maintaining marketing spend to keep new customers rolling through the doors. Its adjusted cash profit margin came down four percentage points as administrative costs went up in the first half.
Ultimately, the sector needs to decide whether it stays a relatively high-volume services/technology business, or becomes more like the banking sector, with all the aggravation and red tape that this entails. Until that conundrum is solved, investors will continue to be wary of the sector’s brash appeal.
