The UK boasts of a mature and globally reputable financial industry, consisting of both financial service providers that fall under regulatory oversight and those that do not. Both ‘regulated’ and ‘unregulated’ finance contribute to the ecosystem and economy, however, unregulated finance is often misconceived as unethical or irresponsible finance. With evermore innovative financial services solutions being offered to meet changing market needs, it is imperative that unregulated players set a robust customer ethical standard with customer outcomes at the forefront.

With alternative finance gaining recognition in the financial sector, and increasingly filling a void for the SME market where traditional financial institutions cannot adequately cater to customers, consumers must be educated on the distinction between regulated and unregulated finance, the opportunities that both present, and how and why unregulated finance providers should be held accountable, as well as the broader impact of ensuring this.

Regulated vs. unregulated finance

In the context of financial regulation, “regulated finance” refers to financial services governed by regulatory bodies, such as the Financial Conduct Authority (FCA) in the UK. This body enforces a specific set of standards and regulations aimed at protecting consumers, maintaining industry stability, and fostering healthy competition among financial service providers of covered financial products. Regulated financial services encompass institutions such as banks, credit unions, and other financial entities that are required to obtain a banking license.

Unregulated finance, on the other hand, refers to financial services that are not subject to regulation by the FCA. Some examples include peer-to-peer lending platforms, crowdfunding sites, crypto exchanges, and certain types of exempt lending, factoring, and mini-bonds. It’s crucial to note that even if a firm isn’t conducting a “regulated activity” under the Financial Services and Markets Act, it may still be subject to specific requirements, such as registration for anti-money laundering purposes, not to mention being subject to a whole host of other legal and regulatory obligations, such as data protection under the GDPR.

There’s a misconception that “unregulated” finance equates to “unscrupulous” or “unaccountable” finance. While there will always be dishonest individuals who exploit the lack of regulation, many unregulated firms actually adhere to the FCA’s codes of conduct, guidance, and principles. These businesses are well aware that customers trust regulated firms, so adopting best practices is not just a good idea but also a competitive advantage.

With great power comes great responsibility

There is an opportunity, indeed a responsibility, for finance providers operating in the unregulated space to set a precedent. The new financial products and services that are being introduced should be commended for broadening access to financial products for underserved market segments.

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However, any gains here will be eroded if trust is broken, potentially prompting regulatory bodies to reconsider whether their regulatory scope is sufficiently broad. Failing to implement appropriate governance and oversight structures not only jeopardises customers but can also destabilise broader economic progress.

What does good look like for unregulated finance providers

Even when not bound by formal regulatory frameworks, an unregulated financial services provider can still act responsibly and demonstrate good conduct by adhering to a set of self-imposed ethical standards and best practices. These can include:

Transparency: Be transparent about the services offered, the associated costs, and the potential risks. Providing clients with clear, understandable information helps build trust and avoid misunderstandings. Treating customers fairly should be at the heart of all financial services providers’ offerings, regardless of regulatory status.

Privacy and Data Protection: Safeguard client data with strong cybersecurity measures and data protection policies, ensuring that personal and financial information is kept confidential and secure.

Fair Treatment: Treat clients fairly and equally, offering the same level of service and attention to all clients, without discrimination.

Honesty and Integrity: Avoid misleading clients about the benefits and potential returns of services or products. Maintain honesty in all marketing, advertising, and communication.

Compliance with Applicable Laws: Even if not regulated by a specific financial authority, ensure compliance with all applicable local, national, and international laws, including anti-money laundering (AML) and combating the financing of terrorism (CFT) regulations.

Training: Ensure the wider business is trained on all key risk areas such as anti-money laundering, data protection, and vulnerable customer treatment.

By adopting these practices, an unregulated financial services provider can demonstrate a commitment to integrity and professionalism, which can help in building a reputable brand and a loyal client base. Moreover, these practices can prepare the provider for future regulation and make the transition smoother if the regulatory landscape changes.

Even if a firm is not regulated by the FCA, there are several self-regulating bodies designed to promote best practice and customers’ best interests such as, CIFAS and the Association of Alternative Business Finance. These organisations set standards and members hold one another to account.

The future of unregulated finance

As new financial services and products increase their prominence in the financial services ecosystem, whether that be Buy Now Pay Later, EMI and digital money transmission providers or embedded finance, the regulators in turn become interested.

In January 2022, HM Treasury confirmed that it intends to bring buy now pay later (BNPL) into the consumer credit regime.  We are currently waiting for a further Consultation Paper to be published by HM Treasury that sets out its proposals in more detail.  What we do know is that the changes are likely to mean that currently unregulated fintechs offering ‘exempt’ embedded finance to consumers, sole traders, partnerships of up to three partners and unincorporated associations will need to apply to the FCA for authorisation.

What this means for affected unregulated fintechs is:

  • Adjusting their products, customer-facing documentation and business model to comply with the CCA and conduct of business requirements and Principles for business and documenting those changes in policies and procedures.
  • Ensuring that they comply with the UK financial promotions regime.
  • Giving customers a right to take complaints to the Financial Ombudsman Service.
  • Giving connected lender liability protection in relation to goods/services funded, and
  • Building a compliance, governance and risk framework that satisfies FCA compliance.

Where unregulated fintechs don’t offer ‘exempt’ embedded finance to consumers, sole traders, partnerships of up to three partners, and unincorporated associations, they may nonetheless need to respond to market changes as their competitors’ businesses change.

The Consumer Credit Act is being reviewed more broadly over the next few years, and one of the areas up for review is whether its application should be extended—for example, whether it should extend to SME lending and/or to lending worth more than £25,000. These risks are further away than the BNPL changes but, if they come to pass, would have similar impacts on unregulated Fintechs.

Regulation is not a bad thing. In fact, it tends to reflect and respond to growth in a particular product or service that is meeting a key customer need. Unregulated firms would be wise to embed regulatory principles in the way they operate, not because they have to but because they should want to: it makes business sense as well as being the right thing to do for their customers.

Alexis Alexander is Chief Legal & Compliance Officer, Liberis

Alexis joined Liberis in 2019 and is Chief Legal and Compliance Officer having helped the business build and scale its legal, regulatory, compliance and security functions globally