Oxford Seed Fund

By Oxford Seed Fund

A Fintech-Cambrian Explosion

The Cambrian explosion was an event that occurred approximately 541 million years ago and resulted in the divergence of most modern metazoan phyla – basically caused the separation for species that led to modern day humans. Before the Cambrian explosion, most organisms were simple, composed of individual cells occasionally organized into colonies. Over the following 70 to 80 million years the rate of diversification accelerated, and the variety of life began to resemble that of today. Scientists hypothesize that a rapid increase of oxygen, mainly caused by a somewhat settled atmosphere and foliage that could convert inhospitable carbon dioxide to oxygen, spurred the events that led to the explosion that forever changed our earth.

This an apt analogy when thinking about what caused the Fintech revolution in the UK, eventually spreading across the globe. Let’s think about this in 3 stages:

  1. Pre Fintech-Cambrian Explosion (FCE)
  2. The global financial crisis (GFC) and FCE
  3. Post FCE and Future

Figure 1. – A timeline of the FCE

Unlike the traditional Cambrian Explosion, we can say, with some certainty, that the FCE started post the GFC in 2007.  Now while the regulation set in place post-GFC is akin to the rapid increase in oxygen, we need to ask ourselves what entity caused this regulatory change?

The UK FCA is the regulatory authority that protects the general public from the predatory companies that cook up financial schemes for their own benefit. Pre-GFC the FCA had a simple mandate – protect the little old lady who has been working her whole life so she can be comfortable when she retires. This seems like an over exaggeration, but it lay at the core of the FCA’s operations. To protect this little old lady the FCA was strict, with policies that forbid seemingly innovative companies from accessing FCA data to test innovative market hypothesises. These innovative companies were simply told to go away, and even if these companies had a war chest to fuel legal battles, in the end the FCA had the final say… which was inhospitable to say the least. This acted as a major bottle neck to innovation, especially within the realm of fintech.

The proliferation of cheap data, increase in mobile computation capabilities, masses of young millennials who wanted (on both the demand and supply side) to understand the implications of this data on their financial wellbeing, large corporations that wanted to act on this data, and a thriving East London tech startup scene imbued a sense of unused potential energy that was waiting to let loose. This is the frustrating state of the fintech world pre FCE – full of energy and capabilities but no place or regulatory mechanisms in play to act – or in the terms of our analogy, there was no oxygen.

Collateralized debt obligations (CDO) and credit default swaps (CDS), mouthful derivatives that are responsible for the GFC are the exact types of instruments that played on that little old lady we mentioned earlier and are the prime catalysts of the GFC. So, after the GFC, why did the FCA relax regulations to allow companies and startups to access FCA data, data that could be used to construct similar instruments to CDOs and CDSs? Well simply put, the UK government realized that in order to stay competitive on the global stage of this emerging fintech scene it needed to break the regulatory bottle neck that limited access to FCA data – in other words, to add oxygen to the ecosystem. The UK government probably also realized that innovation often happens outside the walls of a red-tape-laden institution and that this innovation could act to protect that little old lady and every other consumer like her. To do this, the FCA instituted what is now known as the regulatory sandbox initiative – which took some time post the GFC, the first sandbox initiative was in 2016. This sandbox is the Fintech-Cambrian Explosion (FCE) that spurred the modern fintech revolution in the UK.

The sandbox seeks to provide firms with:

  • The ability to test products and services in a controlled environment
  • Reduced time-to-market at potentially lower cost
  • Support in identifying appropriate consumer protection safeguards to build into new products and services
  • Better access to finance

The sandbox also offers tools that mimic that firms would go through in the real world, but within a controlled environment by providing limited access to restricted data, mentorship and legal guidance. Through this regulatory mechanism the FCA oversees tests using a customised regulatory environment for each test – including safeguards for consumers. Additionally, sandbox tests are expected to have a clear objective (e.g. reducing costs to consumers) and to be conducted on a small scale, so firms will test their innovation for limited duration with a limited number of customers.

Clearly this is what those frustrated individuals with masses of built up potential energy needed. Now I’m not saying that this was the primary catalyst for the fintech revolution in the UK, but many lectures at the University of Oxford and the Saïd Business School and many of my MBA cohort who worked in this space agree it was a crucial contributor.

So, what does the future hold post this FCE? Well to really understand that we will need to wait, measure and understand the data that is coming out of this initiative – much like the 10 million years post the initial Cambrian explosion that were stages of iterative changes based on lessons learnt (hopefully we won’t need to wait that long). I see this initial stage as very similar to the early internet days, or more recently the current blockchain era. We don’t know how the technologies that are spurred post this FCE will change the day to day lives of people, corporations or startups or how it will solve some of the worlds biggest and smallest problems until we test, build, measure, fail, rebuild and repeat.

And like the Cambrian Explosion, the effects of the FCE are spreading. We live in a globalised world and scaling ideas and companies means cross-regional movement. The UK FCA understands this, as do the regulatory authorities of other countries. To this effect, the sandbox initiative is going global, with the creation of the Global Financial Innovation Network (GFIN). GFINs mandate is simply to protect little old ladies all over the globe by providing a more efficient way for innovative firms to interact with global regulators, helping them navigate between countries as they look to scale new ideas.

Time will only tell if this yields the next FCE, but I’m optimistic that through testing, building, measuring, failing, rebuilding and repeating, the Fintech renaissance will move from strength to strength making all our lives easier, far more exciting and giving us more time to dwell on the business worlds next Cambrian explosion.

This blog post was written by Nikul K. Roshania – 2018-19 MBA Candidate, Dean’s Scholar, and Director of the Oxford Seed Fund –  as part of the Oxford Seed Fund blog series.

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