Concerns around money laundering and disruption of financial services markets by blockchain shouldn’t shut out fintech start-ups from the banking system.
The UK Financial Conduct Authority is generally known for being measured and careful in the language it uses in its releases and publications unless it is particularly keen to make a point. Eyebrows have therefore been raised by the recent release of the FCA’s “Regulatory Sandbox Lessons Learnt Report”, providing an update on the progress of the FCA’s regulatory sandbox initiative after its first year of operation.
What is the sandbox?
The sandbox was established principally to allow start-up businesses an opportunity to test new and innovative products, services and business models that might otherwise require FCA regulation in a live market environment under the supervision of the sandbox team. The sandbox has been a welcome and popular initiative by the FCA to encourage innovation and experimentation in the financial services market here in the UK.
Blockchain in the sandbox
A significant number of firms entering the sandbox in the first two cohorts have been involved in using distributed ledger, or blockchain, technology (the same technology which powers cryptocurrencies like Bitcoin). A majority of firms so far are using blockchain technology for electronic money and payment projects. This is unsurprising given the rapidly developing nature of blockchain and the huge opportunities it offers to disrupt traditional financial services models.
Access to banking services for blockchain firms
While the report is generally upbeat on progress of the sandbox, it does raise an issue with which many firms working in the cryptocurrency space (including BitcoinBro) will be wearily familiar – the inability of most firms to obtain access to wholesale banking facilities from UK banks.
The FCA is quite direct in its assessment of the problem:
We are concerned that denying certain customers bank accounts on a wholesale basis causes significant barriers to entry and could lead to poor competition in certain markets
The fact that the FCA devote a whole page in their report to this issue suggests that there is a serious problem. The question is, why are crypto firms finding it so hard to access banking facilities? The FCA suggests a number of reasons.
An association in banking circles between cryptocurrencies and the risks of money laundering and terrorist financing.
In truth, it cannot be denied that, in the past, cryptocurrencies have sometime been used to facilitate transactions in illegal or illicit products or services over portals like the Silk Road or the dark web. The very nature of cryptocurrency transactions, that they are peer-to-peer, do not involve traditional banking processes and are very difficult to link to individuals makes them a potentially attractive means of laundering money.
The association between cryptocurrencies and money laundering has not been helped by (unbelievably) the failure of existing UK anti-money laundering regulation to incorporate cryptocurrency trading within its scope. This will change once the Fifth Anti-Money Laundering Directive, which does incorporate cryptocurrency trading, comes into force at some point in 2018.
Although the reputable cryptocurrency trading firms (including BitcoinBro) do operate in compliance with UK AML regulation as if they were regulated, cryptocurrencies’ existence outside the regulated environment must only exacerbate their negative perception within the UK banking fraternity. However, bringing cryptocurrencies into the existing UK AML regulatory regime, which is now one of the most robust in the world, should do much to ease these concerns.
…strategic business decisions, the profitability of certain business relationships, credit risk assessments and overall compliance costs.
This is a more serious charge – the FCA appears to be suggesting that some banks are deliberately shutting out a whole category of businesses for “strategic business” reasons.
Banks may not be wrong to be concerned about the reputational, regulatory or even financial risks they run in banking what they perceive higher risk clients, but could there be something else driving the decision not to bank these businesses?
A threat to incumbents
Blockchain technology offers exciting possibilities in innovative electronic payment systems which could significantly reduce the time and cost of payments for business and consumers, but they also represent an undeniable threat to the incumbent operators of existing systems, namely high street banks and financial institutions. Banks would have to be blind not to recognise this risk as potentially existential, and would be acting rationally if they responded accordingly.
BitcoinBro offers no view on whether this interpretation of the FCA’s comments is fair or not. In our experience, the principal barrier to being accepted by the UK high street banks has been one of understanding, particularly at branch level. Too many account opening teams simply do not understand the cryptocurrency or blockchain industries at client take-on stage, which makes progressing applications extremely difficult.
It would be unfortunate, however, if misplaced concerns about money laundering risks continued to hinder the progress of this exciting, and potentially transformational, technology. The UK has a wonderful opportunity to lead the world in blockchain and crypto fintech, which the FCA appears keen to encourage. If businesses are forced to look overseas to jurisdictions that are prepared to offer banking facilities (and countries like Germany, Estonia and Slovenia appear keener to do so than their UK counterparts), this opportunity risks being lost.
We are aware of the risks this may pose to innovation and competition and intend to continue to focus on this issue.
Interestingly, the FCA show no sign of letting the matter lie.