Sweden – a flourishing Fintech start-up scene in spite of regulatory hurdles

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Mattias Anjou
Hammarskiöld, Stockholm
mattias.anjou@hammarskiold.se

Johan Löfquist
Hammarskiöld, Stockholm
johan.lofquist@hammarskiold.se

Isabelle Vinterskog
Hammarskiöld, Stockholm
isabelle.vinterskog@hammarskiold.se

Introduction

Fintech has developed successfully in Sweden, with companies such as Klarna, recently declared the most valuable fintech company in Europe at USD $5.5bn,^[1] and iZettle, acquired by PayPal for USD $2.2bn in May 2018, receiving international acclaim.

The development of the Swedish Fintech sector is driven by three important factors. The first is the entrepreneurial drive among young professionals from Sweden’s top universities, opting to start their own companies or taking employment in start-ups rather than joining established financial institutions. The second is good access to seed and venture capital and an advanced financial infrastructure. The third is that Swedes are fast to adapt to new technology and rarely use cash to make payments.

To boost this development, the Swedish Financial Supervisory Authority (SFSA) has been tasked by the Government to support innovation and businesses wanting to provide new financial services and products. This governmental objective, however, stands in bright contrast to the SFSA’s supervisory duties and its practices regarding authorisations and licences which, traditionally, have been focused on the applicant being able to show regulatory knowledge, rather than the SFSA providing guidance as to how existing regulation should be applied in relation to new business models. In our experience, this dual and somewhat contradictory role has not worked as well as one could hope. Start-ups that are unfamiliar with the financial regulatory environment will often find little guidance from the SFSA and the application process has become lengthy and costly.

Payment services

One area in which the development has been particularly visible is the payment services industry. With only 13 per cent of total payments in Sweden being made with cash in 2018,^[2] Sweden has gone far in its transition to a cashless society. This has made it a suitable greenhouse for new digital payment services. In recent years, a large number of start-ups have been set up in the payment services sector, including third-party services providers (TPPs) and, among them, fast-growing companies such as Tink AB and Trustly Group AB.

TPPs allow the customer to aggregate data from payment accounts held with banks or other payment service providers and to initiate payments from such accounts. Fintech start-ups have found a variety of ways to make use of customers’ account data, for example, through tools for personal financial management, budgeting, subscription management and invoice payments. Such services were already provided on an unregulated basis before the entry into force of the EU Payments Services Directive (PSD2).^[3] Following the Swedish implementation of PSD2 and, more recently, the European Commission’s Regulatory Technical Standards (RTS)^[4] on strong customer authentication and common and secure open standards for communication, the TPPs have become subject to stricter requirements on risk management, data protection and secure communication standards. While TPPs have previously used ‘screen-scraping’ techniques to gain access to the customer’s account, they must now identify themselves to the account servicing institutions, which in turn are obliged to provide interfaces that give TPPs access to user accounts.

The PSD2 only covers payment accounts (as defined in PSD2) and it is uncertain if and how third-party providers may aggregate information on and initiate payments from non-payment accounts such as saving accounts and securities accounts. Some Fintech companies have offered such services since before the PSD2 and the RTS came into force and are likely to continue to do so. At present it appears that many of the public interfaces provided by the account servicing institutions will not allow information to be collected from non-payment accounts, which means that Fintech companies that wish to provide such services may have to continue to rely on the previously used screen-scraping techniques in relation to non-payment accounts. It remains to be seen how Swedish and European regulators respond to such services.

Loans and financing

Other sectors in which incumbent companies have had to face increasing competition from start-ups are the loan and financing markets. New technological solutions and regulatory developments have enabled Fintech start-ups to offer unsecured consumer credits, mortgage loans and loans to small and medium-sized business. By offering their services mainly online, applying instant credit processes and using fast digital tools to quickly process credit applications, they can provide swift access to financing to consumers and businesses on competitive terms.

After the Swedish implementation of the EU Mortgage Credit Directive,^[5] which introduced a new authorisation, ‘mortgage credit institutions’, a number of specialised mortgage credit providers have emerged. Since the institutions are not allowed to take deposits from the public, they are not subject to as extensive regulation as credit institutions, something that has lowered the barriers for market entry. The mortgage credit institutions’ total share of the Swedish mortgage market is still quite small, but with customer-friendly, digitalised processes and a low-cost base, companies such as Hypoteket and Stabelo have taken up the competition with the banks. Since they cannot take deposits from the public, their business must be financed through other means, including mortgage-backed bonds.

Other start-ups act as credit intermediaries and provide comparison platforms, where consumers have the opportunity to compare the terms and interest rates for loans, mortgages and insurances. The emergence of such platforms has made Swedish consumers very prone to transfer existing loans and mortgages to the creditor that offers the best terms and interest rates, on a regular basis.

There are some Swedish examples of lending platforms that use crowdfunding arrangements where investors are matched with consumers or businesses seeking loans or investments. Such services are offered on a business-to-business basis as well as a consumer-to-business or peer-to-peer basis. The market for these types of crowd lending platforms is relatively small but is growing. However, many start ups have struggled to find profitable business models, hoping instead to scale-up eventually and achieve network effects. Depending on to whom the credit is provided and the services that the intermediary provides, they will be regulated and supervised differently. In some uncertain cases, the SFSA has opted to sort them into an existing and reasonably close regulatory category to ensure some element of consumer and investor protection. Accordingly, lending platforms like these still have an unclear regulatory status.

Difficulties in obtaining a licence as a credit institution

Consumer lending firms and mortgage credit institutions that wish to fund their business through deposits see it as a natural next step to apply for a licence as a credit institution. In the past four to five years, however, the SFSA has only granted licences to a handful of applicants, and many others have either been subject to non-approval or have voluntarily elected to withdraw the application following the SFSA indicating that the application is unlikely to be approved. This development is mainly connected to the SFSA’s practice not to provide guidance to the applicants in guidelines and practice statements. This has made it difficult for applicants to know what is required to obtain a licence and how to put together an application of sufficient quality. The development has also created hurdles to market entry and made it difficult for start-ups that provide credit to grow quickly. It has also meant that a licence application is a lengthy and costly procedure, which requires expert advice from consultants, such as lawyers with regulatory expertise and capital adequacy experts.

Fintechs and incumbents

The technological development in Sweden is not only driven by start-ups. Joint initiatives by Sweden’s major commercial banks have resulted in innovations such as BankID, the most widely used and recognised authentication software in Sweden both in and outside the financial sector, as well as Swish, an invention that enables instant payments and money transfers through the use of mobile phone numbers, used to pay both the babysitter as well as to purchase a hot dog from a food truck. BankID and Swish have created an important infrastructure which has been fundamental for many Fintech start-ups in Sweden.

The interplay between start-ups and incumbent banks takes a variety of forms in Sweden. While some start-ups only seek to challenge the banks, others have opted to co-operate and integrate their technical solutions into the banks’ existing services. There are also examples where start-ups license their technical solutions to banks, while simultaneously providing their own competing services. Many start-ups have also received significant investments from credit institutions.

The regulatory and supervisory approach to Fintech companies

In 2017 the SFSA was tasked by the Government to investigate how the authority could better accommodate for businesses wanting to provide new financial services or products.

Unlike some jurisdictions, Sweden opted not to introduce a ‘regulatory sandbox’ for start-ups, where new technologies and services may be tested for a limited duration under close guidance and supervision from the authority, but without being subject to full authorisation and all requirements otherwise applicable. Start-ups in the Swedish Fintech industry are subject to the same authorisations and regulatory requirements as incumbent companies.

Instead, the SFSA introduced an Innovation Centre, for the purpose of providing a first point of contact for start-ups seeking regulatory guidance. The Innovation Centre is also supposed to be a forum for discussions between the authority and the industry. However, it does not offer advisory services and does not provide preliminary binding decisions to provide certainty that a licence is required or if certain regulations would apply in relation to a particular service or product. Start-ups that contact the SFSA before an application is submitted, therefore, will find little guidance from the SFSA. Despite the governmental assignment to support innovation and new businesses, the SFSA is foremost a regulatory authority and the two tasks have proven difficult to balance for the authority.

As many of the companies in the Fintech sector find themselves in a complex regulatory environment, a number of regulations and guidelines on both the EU level and the national level must be taken into account when seeking authorisation or a licence. The SFSA tends to use a formalistic approach to regulation and may often question many of the interpretations that have been made in the application with respect to the legal implications of the new product or service, often without providing a clear view on their own interpretation.

This has led to difficulties in obtaining authorisation without extensive help from legal consultants, which, in combination with the large number of applications filed with the SFSA in recent years, has led to relatively lengthy and costly application procedures for start-ups that want to obtain authorisation or a licence.

The future ahead

As the financial industry advances more quickly than the national and European regulators, we expect more challenges and legal uncertainties ahead, despite the effort to make regulations neutral with respect to new business models and new technical solutions. While there certainly is a need to ensure sufficient consumer protection and adequate risk management at these start-ups, we hope to see a more communicative and pragmatic approach from the SFSA in the future. That would reduce the time and costs for market entry to the benefit of competition in the financial industry and ultimately the consumers.

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