While much ink has been spilled on the funding and valuation reset over the past two years, we sense the beginnings of a recalibration among regulators that will have important consequences for the development of financial services, and the engagement between fintech entrepreneurs and traditional financial services providers. This is a global recalibration happening across varying regional regulatory baselines with important distinctions for entrepreneurs and investors.
As investors, we would like to think that talent and technology will always prevail. But this is rarely sufficient for ambitious fintech entrepreneurs who must contend with a challenging regulatory environment and powerful financial services incumbents. Against this backdrop over the past decade, many regulators were slow and reluctant to provide a regulatory compliant roadmap (understandable) and many incumbents were unable or unwilling to engage in good faith owing to bureaucratic failings and competitive angst (inexcusable). This dynamic, however imperfect, still managed to provide sufficient oxygen for meaningful innovation as regulators generally sought to lean in and engage with entrepreneurs amidst a multi-decade secular shift in the technology underpinning the entire financial services marketplace.
Needless to say, in the wake of the spectacular collapse of FTX and other misadventures within and outside digital assets, regulators have rightly grown more cautious. The political winds are shifting, and we expect a recalibration of regulatory engagement that will comparatively underweight innovation as a core policy KPI.
First, some context on the regulatory backdrop for fintech innovation. Regulators generally take a multi-layered lens when thinking about market structure and oversight. As a general rule, the closer an institution is to retail investors, the more scrutiny of the market and the market participants (e.g., listed equities and retail banking). Whereas, markets that are the domain of institutions, like the interdealer FX or interest rate swaps market, there is more of a buyer-beware mentality, and the focus is on making sure an institution is properly capitalized to manage risks. More broadly, across all markets, regulators endeavor to understand potential systemic risks from the potential failure or disruption of an institution or market.
Alas, fintech does not always fit neatly into certain customer or market verticals that often provide the default regulatory lens for oversight. Thus, regulators have long sought to balance the secular need for innovation with ensuring adequate customer and market protections. In reality, the nature of fintech innovation over the past decade has often represented developing models and business concepts in the absence of true oversight or rules of the road. To mix a few metaphors, this was often a delicate dance, although regulators were generally inclined to lean in and promote innovation, albeit at a slower and more measured pace than entrepreneurs may have preferred.
However, in the midst of today’s global regulatory recalibration, past is prologue to some extent, as it relates to the comparative strengths in the EU’s regulatory innovation infrastructure. While there has been significant progress globally in recognizing the shortcomings in the legacy regulatory structure and movement to correct and advance the necessary rules and regulations to provide for a healthier and more technologically advanced financial system, we believe the breadth and depth of the assorted regulatory initiatives across the EU is laying the groundwork for a truly modern financial system, one that is also better equipped to weather a near-term recalibration that involves a more cautious steer among regulators.
While being slow is more of a feature than a bug for regulators worldwide, it is noteworthy that Europe has been a comparative global leader in finding a lane for innovation, by defining that persistent grey area where innovation is seeded. European initiatives related to the issuance, transaction and reporting of digital assets (such as MiCA and the complementary DAC8), and Open Banking, which provides the rails for data and information sharing across financial intermediaries, are two notable examples. But there are many more. Europe is now moving beyond Open Banking to Open Finance (see FiDA Open Finance), which will enable consensual data sharing across a broader range of financial products, helping cement and advance data standards under GDPR. Indeed, the “alphabet soup” of various EU legislative and regulatory initiatives is boiling over…SFDR, MiFID II, CMU (Capital Markets Union), IDD (Insurance Distribution Directive), etc.
As investors in European fintech, we believe that these and other initiatives provide business model support for founders to innovate around greater transparency and less friction in previously siloed or undefined marketplaces, whether it is providing B2B services to incumbents or enhancing compliant use-cases around customer and business data.
We believe this backdrop, albeit not without its challenges, compares favorably to other regions. For example, the US has been hampered by a matrix regulatory structure for different institutions and asset classes. Further afield, MENA has less indigenous financial services to innovate around, and China is now looking inward, a complicator for securing a meaningful lane for multinational cross-market innovation.
In the midst of the current environment, we see a back-to-basics emphasis on the investment journey and the role of venture investors. Just as the days of investment rounds paced by the biggest check at the highest valuation from cross-over funds are thankfully behind us, we view the ongoing regulatory recalibration as underscoring the comparative advantage from our European fintech focus at MiddleGame Ventures.
We remain as optimistic as ever on the secular opportunity across fintech in general and the ability to innovate around new business models in Europe in particular. As former operators, investors, and regulators, our remit is to help talent persevere by navigating the regulatory and market crosscurrents that encompass the often messy middle or indeed, middlegame, of an entrepreneur’s journey. And while hurdles may be steeper in certain business lines, the rewards will be greater for those founders that persevere.
