Compliance by Design involves embedding legal mandates into both manual and automated tasks and processes during the development of a Financial Technology (FinTech)(1) offering or platform, utilizing a structured methodology.

The Significance of Compliance by Design in FinTech

Successful FinTechs integrate statutory regulations into their processes from the outset of business formation, focusing on compliance during the establishment and implementation of core company policies and IT systems. This approach can impact several compliance requirements, including:

• Stringent privacy regulations
• Regulation of securities for digital investment platforms and initial coin offerings
• Anti-terrorist funding and money laundering prevention laws
• Consumer protection statutes
• Full disclosure of lending laws

Moreover, FinTechs intending to conduct business with banking institutions and other financial establishments must consider additional compliance requirements. Even if not directly applicable to non-banking institutions, they may be indirectly subject to banking regulatory supervision. FinTechs that delay or neglect to consider regulatory requirements always face the risk of disruption and/or legal consequences.

6 Reasons FinTech Companies Should Adopt Compliance by Design

While FinTech is not a homogeneous industry and different niches, from cryptocurrency portals to instant B2B payment solutions, may require specific compliance protections, there are six universal reasons why compliance challenges need to be addressed across product types:

1. Accelerating product innovation can elevate risk

   Rapidly offering new FinTech services and offerings to the market often leads to potentially risky structural limitations.

   In addition, products powered by algorithms or artificial intelligence (AI) bring in unexpected hazards and might also alter the manner in which existing risks can manifest themselves. For instance, it can amplify prejudices that coders might not be fully cognizant of. The pressure to accelerate time to market could bring down the quality of testing methodologies, which could be addressed by compliance by design right at the development stage.

2. Non-compliant FinTech products can erode customer trust

   Amid stiff competition between FinTechs and legacy banks, conduct failures throughout the financial services industry could result in reputational damage. This could lead to a downward trend in consumer sentiment, eroding trust in FinTech companies – totally counterproductive to its promise of inclusion. Businesses that violate regulations incur significant costs for remedial procedures. This further damages consumer confidence and prompts reluctance to embrace innovative offerings.

3. Regulatory expectations are mounting to protect consumers

   Regulatory amendments in response to the COVID-19 pandemic have brought to attention a significant challenge: the need to cope with consumer protection risks that are a byproduct of accelerated and unanticipated shifts in consumer behavior.

   For example, the European Banking Authority guidelines on moratoria on loan repayments urged FinTechs and traditional lenders alike to quickly change their strategies to provide consumer relief during a difficult economic period.

   The forthcoming Individual Accountability Framework, which incorporates the Senior Executive Accountability Regime (“SEAR”), is another noteworthy update. It will necessitate greater leadership accountability and transparency. The scrutiny of pricing methods within the financial services industry has further heightened the emphasis on the appropriateness and transparency of consumer fees.

   FinTech plays an essential function in the modern era of improved consumer protection, risk mitigation, and empowerment. They have to perform automated compliance inspections prior to and commencing on the actual day or date of their market entry. Only this will offer confidence to regulators and product managers that any possible challenges will be discovered and rectified with zero delays.

4. Manual quality and compliance assurance are insufficient

   The business models for a majority of FinTechs contain manual assurance processes. However, these current assurance models usually lack end-to-end governance. In an effort to identify possible instances of consumer damage, they only focus on testing limited subsets of the broader consumer demographic.

   Specifically, consumer damage or financial loss occurs when:

   • Unfair market practices induce FinTech consumers to invest in products or services that they might not have otherwise bought.
   • They spend more than they would if they had higher-quality data.
   • They are bound by arbitrary contractual provisions.
   • Their expectations regarding the delivery and performance of the services they acquired aren’t met.

   Detriment is a very real risk in FinTech, an industry that is emerging and evolving without very strong regulatory protections to govern its evolution. Without compliance by design, manual assurance processes imply that adverse effects might not be identified until they reach the point of no return.

5. FinTechs are increasingly vulnerable to security attacks

   According to the most recent data, the financial sector is the most susceptible to phishing attempts and data intrusions, exhibiting a 27.7% incidence rate. This keeps FinTech leaders forever vigilant and on the lookout for the most effective compliance solutions to guarantee a more secure and robust data protection program.

   FinTech also struggles with legacy systems that work in a complex IT environment and lack thorough documentation. This lets them adapt to market-wide fluctuations but also leaves the door open for security threats.

   A compliance by design approach would address this by grafting security and compliance into the IT solutioning system, supporting FinTechs in their quest to build better, more secure products.

6. Delaying compliance or maintaining a reactive compliance function hinders scalability

   Compliance by design is often considered a cost driver by FinTech companies that fail to implement it. Typically, they assign it to a single staff operation, which is perceived as the “naysayer department” by the management. Then, when FinTechs begin to expand in scale, this reactionary approach appears to discourage further expansion.

   Often, manual assurance strategies ensure compliance with regulations are compartmentalized and only partially integrated into the daily activities of FinTech firms. Therefore, their level of complexity increases even as their scalability decreases.

2 Keys to Transition to Compliance by Design

A compliance-by-design approach – depends on both a product-level shift and an organizational mindset change. It starts with the following:

1. Define and enforce compliance by design principles

   Establish unique guiding principles for organizational transformation, communicated throughout the entire FinTech firm, to establish the new order from top to bottom. Some of these principles include:

   • Compliance integrated into the FinTech business and not as a separate function.
   • Engaging with compliance stakeholders when shaping product requirements.
   • Automated compliance testing methodologies embedded in the product development roadmap.
   • A scalable compliance function with outsourcing where needed.

2. Communicate the new operating model to the workforce

   After defining foundational principles, create a consistent view of the operating model to support business units and employees in understanding their role in achieving compliance goals.

Final Thought: A More Compliant and Sustainable FinTech Future

The delivery of fiscal products and services to customers and organizations is experiencing a fundamental shift that is immensely exhilarating and astoundingly creative. But while bearing this flag forward, FinTech firms also need to assess if their services and products comply with state and federal legislation and guidelines. This key consideration is anchored in minimizing risks to the financial system itself and also in looking after consumers and client entities.

Compliance by design must be necessary for the next generation of FinTech companies. It is an effective way to adhere to the high levels of consumer risk protection being espoused by regulators today, while also building organizational reputation, technological robustness, and a scalable operating model.

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