As we did in 2021 and 2022, we've crowdsourced some fintech predictions for the year ahead from the Freshfields Fintech team, with a couple of longer-term trends for fun. So you can skip ahead (should you choose to), the topics for these predictions are:
- Cryptoasset regulation
- AML - increasing focus on fintechs
- Regulating BNPL
- AI in fintech finally delivers
- Servicing financial institutions - regulation in its own right?
- A future beyond stablecoins?
- Central bank digital currency (CBDCs)
- The Metaverse
Following a turbulent year for cryptoassets, we expect legislators around the world to re-examine their approach to businesses operating this space. In the EU, MiCA is expected to be adopted in the first half of 2023, establishing a harmonised set of rules for cryptoassets. The question for 2023 is whether other regulators will follow suit and if so, how will that impact their relative attractiveness to the industry.
We also think 2023 will see a quickening of the pace of legislative reform, as lawmakers finally grasp the difficulty of fitting digital assets into existing legal frameworks. For example, in the US, the Uniform Commercial Code may be amended to address questions of property rights in digital assets and the creation and perfection of security interests. In the UK, consultation around a third type of property ("data objects") is continuing and there is a consultation underway on the legal characterisation of decentralised autonomous organisations (DAOs). Finally, the taxation of cryptoassets remains complicated - our snapshot from earlier this year sets out some of the complexities.
AML - increasing focus on fintechs
AML has been a priority for financial services authorities for the past decade and scrutiny of fintech businesses in this area is likely to increase. The range of AML risks is broadening to include criminal enforcement and a potential tsunami of third-party follow-on litigation. We expect that regulators will flex their muscles in this area, for example by restricting fintechs and challenger banks from taking on new customers where they see weaknesses and appointing special auditors to monitor AML implementation in the most serious of cases.
Crypto in particular will be subject to significant scrutiny in this area. Over the last few years we’ve seen tightening of the AML rules in the UK, EU and across Asia, bringing cryptoasset service providers into scope of the AML regime, and this trend is set to continue.
With the cost of living crisis affecting more and more people, and the widening use and availability of “buy now pay later” (BNPL) (e.g., to buy takeaways and groceries), we predict that 2023 will be the year that legislators and regulators clamp down on BNPL. In the UK, many providers are not currently regulated due to an exemption from the consumer credit regime. However, this exemption will be narrowed and many providers will need to become authorised and comply with extensive requirements. BNPL products have also been included within the scope of the EU’s updated Consumer Credit Directive which we expect to become law in the first half of 2023 (for more information, see our podcast).
It will be particularly interesting how legislators balance accessibility of credit with ensuring that consumers are appropriately protected, and how debt management will work at a time where defaults are expected to increase. We will also be keeping an eye on how the industry reacts – some BNPL businesses may need to consolidate to survive.
If 2022 was a challenging year for cryptoassets, it also saw a growing consensus that the underlying distributed ledger technology works and is undeniably useful. Most news outlets reported Jamie Dimon’s description of Bitcoin as “a hyped up fraud” but only a few mentioned his next statement that DLT and tokenisation have clearly proved their usefulness. Yet as confidence in the technology has grown, confidence in the crypto native users of the technology has fallen as worries persist around the governance behind even the largest fintechs. We think that this opens the door for traditional banks and broker dealers to offer their existing clients the opportunity to tokenise their current fixed income and equity asset pools. In doing so they will be able to offer their clients efficiencies. For example, in respect of coupon payments, settlement times and corporate actions which can be streamlined through the use of smart contracts. In addition, tokenisation will allow access to new revenue streams available in the cryptosphere and more specifically enable their clients' tokenised assets to be used as collateral or for staking in DeFi transactions.
Which takes us nicely on to our next prediction for 2023 and that is the growth of DeFi. If you are less familiar with DeFi you may want to read our insights piece. Initiated readers will know that, at its simplest, DeFi essentially describes the financing transactions carried out entirely on the Blockchain without a central intermediary. DeFi did not escape the difficulties of 2022. Genesis, which was one of the largest DeFi lenders and had gained membership of ISDA, was very publicly dragged down amidst the FTX wreckage, filing for insolvency earlier this year. Others had similar but less high profile fates. Issues of circular collateral (lending to a fintech and holding coins issued by that fintech as collateral) and worries over AML and KYC checks remain and some difficult lessons will need to be learnt quickly. If they are, the benefits of the technology remain and the growth in DeFi will be fuelled by the twin forces of challenging traditional debt markets and the increase in tokenisation of assets.
AI in fintech finally delivers
As discussed in our recent blogpost, the insurance industry should be a natural fit for AI, but the big break-through has not yet happened. We predict 2023 will change that. As insurers race against the cost-of-living crisis to deliver competitive pricing, AI may be used to decrease costs, streamline the customer experience (e.g., reducing claims times), and increase the efficiency and accuracy of risk assessments. We may also see the increased use of automated services, e.g., further automation of the underwriting and claims handling process. Implementation of AI solutions is not without its challenges and much will depend on the age-old balancing act that regulators face between innovation and customer protection.
On the topic of AI more generally, we expect to see increased regulation in the UK, as foreshadowed by the Digital Markets, Competition and Consumer Bill which is due to be published in Q1 2023 and is expected to contain new powers for the CMA to test and verify whether the use of algorithms by companies complies with competition laws.
Servicing financial institutions - regulation in its own right?
Legislators and regulators have recognised that financial institutions are becoming increasingly dependent on third parties to provide services that are vital to the stability of the financial system. Given the increasing number of partnerships between incumbent institutions and BigTech (e.g., LSEG-Microsoft) and the proliferation of “banking as a service” providers, these new regimes will have a significant impact on a previously unregulated space.
The EU is certainly leading the way, having published the Digital Operational Resilience Act (DORA) towards the end of 2022, although its provisions won’t apply until January 2025. So the trend for 2023 is that firms and service providers will need to digest the impact and start preparations for potentially significant changes. Other jurisdictions are perhaps slightly behind, but are moving in the same direction - for example, the UK has published a discussion paper setting out a “critical third party” regime that will similarly apply to significant service providers.
Any service provider that satisfies the criteria to be designated under DORA or the UK proposals will be subject to supervision of one or more financial services authorities - which might be quite a daunting prospect to those not ready for it.
A future beyond stablecoins?
It seems clear that 2023 is the year that activities relating to stablecoins will be regulated in many jurisdictions. At the time of writing, stablecoins are the only new type of cryptoasset which the UK government plans to bring into scope of regulation and there remain no plans to regulate cryptoassets like bitcoin or ether. The HKMA consulted on stablecoins in early 2022 and the Singapore MAS consulted on a specific regulatory regime for stablecoin-related activities towards the end of 2022.
The policy rationale for regulation of stablecoins was that these types of cryptoassets were viewed as the most likely to become a widespread means of payment, including by retail customers. In our view, this has not happened and appears to be an example of the difficulty of regulating in such a fast-moving area. If anything, the events of 2022 have raised more questions about the viability of stablecoins and at the time of writing, it feels like we are a long way from there being a stablecoin that is trusted sufficiently to be used as an everyday means of payment.
In a world where CBDCs are likely to be introduced over the next few years, we query the relevance of stablecoins and whether regulatory time might be better spent on a wider range of cryptoassets. Given the risks of investing in cryptocurrencies where the allure of getting rich quickly remains strong and the recent failures of cryptoasset businesses, that suggests to us that regulators may have backed the wrong horse in seeking to protect consumers.
CBDCs and the Metaverse
Finally, we will leave you with two longer-term trends about which we will undoubtedly hear more of in 2023.
Central banks will continue to explore and develop their CBDC solutions and we expect more public announcements in the year ahead. We might also see some central banks piloting their solutions and others rolling theirs out for use more widely.
In terms of the Metaverse, we think this will be the year that legislators start to grapple with new (and existing) legal issues arising from new applications. In 2023, the European Commission is expected to take steps to ensure that virtual worlds are developed in a human-centric way (similar to the aims of its recent regulatory intervention on AI) and that European industries and citizens are able to benefit from the associated opportunities.