Balancing new regulations on the rise of FinTech : a cross-country analysis

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Balancing new regulations on the rise of

FinTech: A cross-country analysis

Thesis Joint Master Entrepreneurship 2015/2016 Supervisor: dr. R. Perez Ribas

Name: Guilaine Pouw

Student number: 2109654 (VU) / 11095911 (UvA)

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Abstract

This thesis investigates the balance between two forces concerning the new regulations in the FinTech industry: entrepreneurs’ access to capital, and investors’ protection. By adjusting the model of trust and control (Das and Teng, 1998) an attempt is made to connect the identified incentives to balancing access to capital and investor protection in a cross-country analysis. The United Kingdom is heading in the right direction in balancing the two forces by using a “right touch” from the government. By facilitating a proper balance, the government

facilitates an environment supporting the growth of the FinTech industry.

The United States has to regain trust by the implementation of the Jobs Act. Finally, the Netherlands still has to find a proper balance between trust and control in the FinTech industry. By introducing the new regulations, barriers to capital are lowered, but with the implementation of the investor-test the investor protection is not considered sufficiently.

Introduction

Global investments in the Financial Technology, FinTech, have more than tripled during the last five years, from $930m to $2.97bn globally in 2013 (Accenture, 2015). Arner, Barberis and Buckley (2015) define Financial Technology as the technology enabling financial

solutions. They state that FinTech today is seen as the new marriage of financial services and information technology. FinTech nowadays is led by startups. This FinTech era poses

challenges for regulators and market participants, particularly in balancing the potential benefits of innovation with the possible risks of new approaches (Arner, Barberis and Buckley, 2015). Due to the broad spectrum included in the FinTech sector this research will focus mainly on the equity-based crowdfunding and peer-to-peer business lending. The foundation of this choice lies in the developments in regulation concerning these FinTech partials, as well as their presence among sectors. To define equity-based crowdfunding and peer-to-peer business lending the definition by Wardrop et al. (2015) will be used. Equity-based crowdfunding is the sale of registered securities by mostly early stage firms to investors (Wardrop et al., 2015). Peer-to-peer business lending is defined by Wardrop et al. (2015) as debt-based transactions between individual/institutional investors and existing businesses who

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are mostly SMEs. Figure 1 shows the overall global growth of the FinTech industry through the years.

Figure 1: The global growth of FinTech

Source: Accenture and CB Insight (2015)

The spur in growth in the FinTech sector has three underlying occurrences. One of these occurrences is the financial crisis. The financial crisis led to the demand of more supervision and control in the financial market, together with the innovation occurring in a range of financial products, has led to constant changes in financial legislation (Schotsman, 2012). With people losing their trust and jobs in the banking industry, people moved to the underutilized FinTech industry.

Another reason may be the existent non-fit regulations and procedures for FinTech companies. The existent non-fit legislation was designed for other financial institutions, namely banks (Roland Berger, 2016). A new framework must ensure that it is able to manage any systematic risks that may arise from technological change without stifling the innovation in the FinTech industry (Financial Times, 2016). A third reason for the rise of FinTech is the accelerating pace of developments in the fields of mobile devices, the modern methods of data analysis, the shifting of this data into the virtual “cloud,” the personalization of online services and the growing convergence to ICT (Dapp et al., 2014).

With the growth of the FinTech industry new associated risks arise. With the fear of fraud and possibly creating a new bubble in the financial market, governments are refining the

regulations concerning the financial market, especially the FinTech industry. By making an adjustment to the control and trust model by Das and Teng (1998) this research contributes to

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the effects of the new regulations on the relationship between startups and investors. By evaluating the access to capital and investor protection cross-country, this research aims to create an overview on how to balance these two forces within the United Kingdom, the United States and the Netherlands.

The spur in growth of the FinTech industry is becoming a danger for the banking system and calls for new regulations in setting proper boundaries. Previous literature has mainly focused on the trust in (electronic) banking systems in a business-to-customer relationship. This research focuses on the business-to-business relationship between investors and startups In order to gain insight into the effects of the new FinTech regulations a desk research will be conducted for the United Kingdom, the United States and the Netherlands. An attempt is also made to provide a comprehensive overview of the developments in the overall FinTech industry, while focusing on equity-based crowdfunding and peer-to-peer business lending. By reviewing the literature on entrepreneurs’ access to capital and investors’ protection a balance is sought between trust and control. By adjusting the antecedents proposed by Das and Teng (1998) the model fits in creating a balance from a startup and investor perspective. Through the new regulations countries seek to find a balance between trust and control.

The United Kingdom has aimed to be the leading European FinTech country. By providing a stimulating environment a proper balance has been found. The United States still has to find this balance, it first has to regain trust due to the impact of the financial crisis. The

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1. Hypothesis

1.1 The effects of FinTech

“We have the opportunity to make finance more cost efficient, consumer friendly and transparent. All of the things banks have ceased to be” (Mackenzie, 2015)

This quote by the Founder of the Lending Club shows the expected impact of the FinTech industry. The Lending Club was the first to offer loans on a secondary market and has grown out to be the largest peer-to-peer platform. They saw the opportunity to compete with banks and have the opportunity to disrupt the market. Since the success of the Lending Club, it has faced some difficulties since the beginning of 2016. Scandals have been taking place in the providence of loans. This shows that with the rapid growth of the FinTech industry, risks are being taken. It is of importance that the market has set boundaries.

A digital revolution has been taking place in the financial services sector. Although global investments in FinTech ventures have tripled in the year 2014, it is still unclear whether this revolution is a challenge or more of an opportunity for the industry (CB Insight, n.d.). SMEs are highly influenced by the rise of FinTech. One positive effect occurs when SMEs are funded via FinTech when banks are unwilling or unable to do so. This can lead to an overall increase in the loan volume in SMEs (World Economic Forum, 2015). Another positive effect associated with FinTech is the increasing speed in access to funding. Applications can be completed within a few hours; physical meetings are not necessary anymore. This advantage is associated with convenience. Loan applications via marketplace platforms are in some cases easier to obtain than through banks. The process is handled faster and fewer visits are required. In some cases it is possible to issue credit at a lower interest rate, which enables a lower cost structure.

Besides influencing SMEs, FinTech benefits the national economy. One key concern after the financial crisis is the safety of deposits. With marketplace platforms, no depositor money is used in order to finance SMEs. Equity is directly from (risk-interested) investors. FinTech financing can potentially drive economies and employment in the long run (World Economic Forum, 2015).

FinTech is in most parts of the world still unregulated, this nature of this rising sector is expected to come back to bite (Financial Times Alphaville, 2015). As mentioned by the

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Standard & Poor’s report in the FT Alphaville article, the rise of FinTech could raise industry risks. Another downside to the rise of FinTech is the expectation that startups associated with FinTech will end badly. Although the World Economic Forum (2015) claims that risky loans come directly from investors, the FinTech market is currently jumping into unsecured

consumer loans, which may indicate the creation of a new bubble.

1.2 An investor and startup perspective on FinTech

To enable the rise of marketplace platforms, as part of FinTech, three main factors are of importance to make it work. Firstly, the environment must provide a supportive institutional and technological context (World Economic Forum, 2015). Providing supportive regulation, availability of data, rule of law, and a payment and banking infrastructure. Second, three central actors are a must, namely: risk-taking investors, educated borrowers and effective platforms. Thirdly, process facilitators must be existent. These intermediating parties have the ability to consolidate the offerings of lending sites towards SMEs (World Economic Forum, 2015). These intermediating parties can potentially bring additional liquidity to the market. The latter increases productivity from both an investor perspective as well as from a startup perspective.

An existent challenge concerning the rise of FinTech is to make regulation and reporting transparent, efficient and effective. In regulating FinTech, a need exists to find a balance. Regulations most of the time burden financial institutions by stringent and detailed

requirements, leading to discouraging innovation in new financial products (EY, 2013). This could lead to a decreasing interest in the FinTech industry by investors. When upcoming FinTech industry would become overregulated, it may lead to higher regulative burden for startups, thereby pushing the FinTech industry into the same direction of banks and their stringent regulation.

So, finding a right balance between trust and control needs to encourage startups as well as investors in the FinTech market, but this emerging financial industry needs to be regulated. This research will zoom in on the influence of the new regulations on the supportive

institutional and technological context. The following research question will be aimed to answer:

What are the effects (cross-country) of the new regulations on FinTech from a startup and investor perspective and how can these two forces be balanced?

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First of all, focus will be on the effect of the new regulations on access to capital from a startup perspective, thereby also discussing the developments with regard to access to capital. Thereafter, a cross-country comparison will be provided. Secondly, the effect of the new regulations on investor protection and access to capital will be presented. Lastly, a discussion will be presented will be presented regarding balancing these forces with the use of an

adjustment on the model by Das & Teng (1998).

2. Literature Review

In the attempt to connect and balance access to capital and investor protection in a cross-country analysis, first the literature will be reviewed on these topics.

2.1 Access to capital

One of the main obstacles for entrepreneurs and startups is the inability to access and acquire the capital necessary for starting a new business (Hurst and Lusardi, 2003; Kerr and Nanda, 2009). This inability to raise capital may stem from information gaps or an inability to contract on the outcomes of a venture. It is suggested that capital constraints impact not only the entry of a startup, but also the ability of firms to transition and grow, particularly in lesser-developed markets (Desai et al., 2003).

Europe and the rest of the world are becoming more integrated; small firms will continue to rely on the conditions of the local financial system. Developed financial markets grant easier access to external funds for individuals and firms (Guiso, Sapienza and Zingales, 2004). A research conducted by Robb and Robinson (2012) state that startups lack access to form capital markets, and thus are forced to rely on an informal network of family, friends and other financing sources to bootstrap their initial financing. Having credit market access has important impact on firm success (Robb and Robinson, 2012).

The literature is supporting the difficulty for startups in requiring access to capital. Regulative burdens as well as formal credit providers, like banks, are examples of the burdens

experienced by startups. FinTech may be the right solution for startups in providing capital. But with the rise of the FinTech industry the banks, which are most reliant on lending and trading, will feel the most pain (Financial Times Alphaville, 2015). This indicates that the FinTech industry is partly taking over the funding mechanisms of banks. For now, FinTech

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companies are able to avoid much of the regulatory burdens. But, will the new regulations higher the burden for startups in accessing capital? An attempt will be made to answer this question for each of the discussed countries.

2.2 Investor protection

Typically, when investors finance firms, they are generally protected through enforcement of laws and regulations. Regulations are in most countries enforced by market regulators, partly by courts, and partly by market participants (La Porta et al., 2000).

Risks arise with the rapid rise of the FinTech industry. One of the risks related to investor protection is the occurrence of expropriation. La Porta et al. (2000) state that outside investors are more vulnerable to expropriation, and are more dependent on the law, than either the employees or suppliers. One way to limit the risk of expropriation is by corporate governance. Corporate governance can be divided into market-centered governance and bank-centered governance. Definitions of these governance forms are provided in table 1.

Table 1: Two types of corporate governance Market-centered

governance

Finance is provided by large numbers of investors and in which takeovers play a key governance role;

Bank-centered governance A main bank provides a significant share of finance and governance to each firm.

Source: La Porta et al. (2000)

However, when a legal system does not protect outside investors, external finance and corporate governance will not work well (La Porta et al., 2000). Reforming the corporate governance of a country has several benefits: expansion of financial markets, facilitation of external financing of new firms, move away from concentrated ownership, improvement of efficiency of investment allocation, and facilitation of private restructuring of financial claims in a crisis (La Porta et al., 2000). To achieve these benefits, for most countries radical changes in the legal system are required.

La Porta et al. (2000) concludes that financial markets need some protection of outside investors, whether by courts, governments, or market participants. Although this is seen as a difficult task, the roots of the investor protection lie in the legal structure of a country and the origin of the laws.

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2.3 Partner cooperation by Das and Teng (1998)

In the approach to find a balance between investor protection and access to capital by startups, the model of partner cooperation of Das and Teng (1998) will be used. The FinTech market is known for the possibility of risky situations occurring. With a lack of governance the investor fears of expropriation. And with a lack of regulations the startup fears for the intentions of the investor. This shows that there is a need of minimum level of both trust and control in order to have confidence in a partner (Das and Teng, 1998). Figure 2 shows the antecedents which influence the level of trust and control, which creates a confidence in partner cooperation. Figure 2: The model of trust and control in strategic alliances

Source: Das and Teng (1998)

First, the trust perspective will be discussed and the associated antecedents in trust building. Second, the control perspective will be discussed and the associated antecedents concerning control mechanisms.

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2.3.1 Defining trust

One factor influencing the confidence in partner cooperation is trust (Ring and Van de Ven, 1992). In the literature several backgrounds of research fields find it difficult to define trust, which has led to disagreement about this concept. Mayer et al. (1995) have identified the following five issues that summarize the root of the disagreement about trust:

o The difficulty of defining trust;

o Confusing trust with its antecedents and outcomes;

o Failing to clearly understand the relationship between trust and risk;

o Confusing the levels of analysis due to lack of specificity of trust referents; o Failure to consider both the trusting party and the party to be trusted.

Before focusing on trust in the Business-to-Business relationship, a few well-known trust definitions in the literature will be presented in table 2. Although these definitions are relatively old, they are still seen as very useful in the concerning literature.

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Table 2: Definitions of trust

Author(s) Definitions of trust

Mayer et al. (1995) “The willingness of a party to be vulnerable to the actions of another party based on the expectation that the other will perform a particular action important to the trustor, irrespective of the ability to monitor or control that other party”

Rotter (1967) “The belief that a party’s word or promise is reliable and that a party will fulfill his/her obligations in an exchange relationship” Anderson and Narus (1990) “The firm’s belief that another company will

perform actions that will result in positive outcomes for the firm, as well as not take unexpected actions that would result in negative outcomes for the firm”

Rousseau, Sitkin, Burt and Camerer (1988) “A psychological state comprising the intention to accept vulnerability based upon positive

expectations of the intentions or behavior of another”

Gambetta (1988) “The probability that an individual will perform an action that is beneficial or at least not detrimental to us is high enough for us to consider engaging in some form of cooperation with this individual” Zucker (1986) “A set of expectations shared by all those in an

exchange”

What comes forward in all these definitions is the interaction between individuals based on expectations from each side. To facilitate collaboration, trust can play a defining factor (Mayer, Davis, Schoorman, 1995; Smith, Carol and Ashford, 1995). Trust can help in reducing agency and transaction costs (Jones, 1995), and improve a firm’s ability to adapt to complexity and ambiguity (Korsgaard, Schweiger and Sapienza, 1995).

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In this research the focus lies on the effects of new FinTech regulations on the access to capital and investor protection. Trust between an investor and entrepreneur is essential to help overcome control problems, especially in an environment with severe agency risks and

incomplete risks, an occurrence in the FinTech industry discussed earlier (Manigart, Korsgaard and Folger, 2002).

Trust is believed to be a source of confidence because, by definition, trust is the degree to which the trustor holds a positive attitude toward the trustee’s goodwill and reliability in a risky exchange situations (Gambetta, 1988; Nooteboom, Berger and Noorderhaven, 1997; Ring and Van de Ven, 1992). As Lane and Bachmann (1996) state, trust may be the right instrument in reducing the uncertainty. Which is crucial in innovative occurrences in the financial market.

Antecedents of trust building

In order to build a trust-based relationship, some techniques have been found to play a significant role.

Risk taking

The relationship between trust and risk taking can be seen as reciprocal. Trust leads to risk taking, while in turn, risk taking can lead to a sense of trust in relationship (Boon and Holmes, 1991; Madhok, 1995; Rempel, Holmes and Zanna, 1985). Although the literature states that risk taking leads to trust, in practice, firms do not just take a risky decision in the hope of building a trust-based relationship. In the FinTech industry the same could be expected. Investors and startups may be apprehensive in the relationship at first, but when fear of fraud and fear of wrong intentions diminishes, a trust-building relationship could occur.

Equity preservation

Another way to build a relationship among partners is ensuring that equity and fairness is preserved (Korsgaard, Schweiger and Sapienza, 1995; Sheppard and Tuchinsky, 1996). This trust-building antecedent would especially important from an investors’ perspective. Without any proper governance existent in a startup, an investor will fear for expropriation. Equity preservation would be a way to diminish mistrust.

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Communication

Communication and proactive information exchange can be seen as another tactic in building trust in a partner cooperation (Macneil, 1980; Thomas and Trevino, 1993). With open

communication in a partner relationship a party can collect evidence about the partners, credibility and trustworthiness (Das and Teng, 1998). As prescribed earlier, to facilitate the rise of the FinTech industry it is highly important to create a transparent communication about regulations, in order to work efficiently and effective. Transparency creates set boundaries and may benefit the communication between startups and investors.

Interfirm adaptation

This antecedent refers to the adjustment of one’s own behavioral pattern in order to bring about a fit between the partners (Hallen, Johanson and Seyed-Mohamed, 1991). Research suggests that a willingness to adapt is essential for trust building (Macneil, 1980). Although an investor and a startup have different incentives in collaboration, adaptation seems crucial for a successful relationship.

2.3.2 Defining control

Another influencing factor on the confidence in partner cooperation is control (Ring and Van de Ven, 1992). The article by Das and Teng (1998) considers control as “a regulatory process by which the elements of a system are made more predictable through the establishment of standards in the pursuit of some desired objective or state” (Leifer and Mills, 1996: 117). Control mechanisms and level of control are seen as two important concepts of control. Control mechanisms are the organizational arrangements designed to determine and influence what organizational members will do. Level of control is the direct outcome of the controlling process, that is, the degree to which an individual believes that proper behavior of the other party is ensured (Das and Teng, 1998). The objective of a control mechanism is to help in achieving an adequate level of control.

Most firms use control in the aim to make the organizational goals more predictable, which may ensure more predictive outcomes in the future. So, firms expect that adequate and effective control help generate a sense of confidence in a partner cooperation (Das and Teng, 1998). There are three antecedents of control mechanisms that will be discussed.

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Antecedents of control mechanisms

Goal setting

Goal setting emphasizes the importance of establishing specific goals in organizations (Locke and Latham, 1984). Goals are an important formal control mechanism, because they can specific what is expected from the startup as well as the investor.

Structural specifications

Structural arrangements, including rules and regulations, are an important occurrence of formal control (Das and Teng, 1998). This antecedent is highly important for the FinTech industry. To set boundaries, the new regulations try to diminish risky investment and the creation of a new possible “bubble” in the financial industry.

Cultural blending

Organizational culture has been defined as “a system of shared values…and norms that define appropriate attitudes and behaviors for organizational members” (O’Reilly and Chatman, 1996: 160). Organizational culture may provide a sense of control. Because people are guided by their shared values and norms, behavior may be voluntarily positive for both sides of the relationship. When regulations lack guidance in certain areas of the FinTech industry, startups and investors may rely on the culture’s norms and standards.

This research is moving in another direction than the model proposed by Das and Teng (1998). Instead of using the proposed antecedents of the level of trust and control the

antecedents used in this research will show a better fit to discuss the level of trust and control. Previous research has mainly focused on the level of trust in business-to-consumer

relationships in the banking sector. This research focuses more on creating and balancing a level of confidence in the relationship between a startup and investor in the FinTech industry. After reviewing the literature on access to capital for startups and investor protection, it became clear that the level of trust and control depends mostly on: regulative history, past occurrences in the financial market, new regulations and governance. This introduction of the adjusted model will be presented in the Discussion. For each country an analysis will be presented.

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In this literature review an attempt has been made to create an overview on the discussed variables in this research and how they are discussed in the literature. Access to capital has been identified by the literature as one of the burdens experienced by startups. One of those burdens is the regulative burden concerning accessing capital by startups. Investor protection is highly dependent on the legal form and origin of governance in a country. To balance these variables the model of trust and control by Das and Teng (1998) has been discussed. This model creates guidance in the manner to find confidence in a partner cooperation.

Trust and control are widely discussed in the literature, but the obstacle experienced is that most of these models focus on a business-to-consumer relationship and traditional financial markets. Regulation has not been a focal point in balancing trust and control in business relationship. This research tries to fill up this gap by focusing on

business-to-business relationships in the alternative financial market with new regulations as a focal point in finding a balance between trust and control.

3. Regulative developments per country

In this research a cross-country analysis will be provided on the new regulations in the FinTech industry. Three countries are considered. First, the United Kingdom (UK), a leading FinTech country. Second, the United States of America (USA), a country that introduced new legislation concerning crowdfunding and peer-to-peer lending in 2015 as part of the FinTech industry. Third, the Netherlands, where recently new guidelines and legislation have been introduced by the AFM.

In this section the new regulations, focusing on peer-to-peer business lending and equity-based crowdfunding, concerning the FinTech sector will be discussed. In the end, an overview of the motivations, goals and outcomes of these new regulations will be presented.

3.1 United Kingdom

The UK is leading in the rapid growth and developments in the FinTech sector. Figure 3 shows a growth of 161% in alternative finance between 2013 and 2014. Peer-to-peer business lending has the largest share is this market and has grown 250 percent between 2012-2014. While the share of equity-based crowdfunding is considerably smaller than P2P business lending, it has an average growth rate of 410 percent between 2012-2014. To support and

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enhance this rapid growth the government has taken a stand in the approach of the FinTech industry, as new regulations seem a necessity.

Figure 3: The growth of alternative finance in the United Kingdom (2012-2014)

Source: Nesta (2015)

The UK Government has chosen an open approach to the FinTech growth and has provided a range of tax subsidies and direct investments to the FinTech sector (Gov. UK, 2014). Two of these tax measures highly influence startups. One is the Enterprise Investment Scheme (EIS). The EIS is designed to help smaller higher-risk trading companies to raise finance by offering several tax reliefs to investors (Gov. UK, 2013). The other, the Seed Enterprise Investment Scheme (SEIS) offers great tax efficient benefits to investors in return for investments in small and early stage startups in the UK (SEIS, n.d.).

The government provides sufficient regulation to maintain existent investors as well as giving possible new players the freedom to innovate (Roland Berger, 2016).

The UK government has introduced April 1st, 2014 a new regulatory body: the Financial Conduct Authority (FCA). This body carries the responsibility for regulating loan-based crowdfunding platforms (P2P) and investment-based crowdfunding.

Lending individuals and businesses have access to clear information, which allows them to assess the risks associated. This way investor protection is enhanced. The FCA is currently protecting against insufficient consumer demand, platform failure, the risk of cyber-attacks, fraud and credit and/or investment risk being mispriced (FCA Innovate, 2015).

To decrease the possibility of these potential threats to occur, the FCA has introduced two key policies. One of the key policies of the FCA is Project Innovate. The aim of this project is to

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encourage innovation in the interests of consumers as well as promoting competition through disruptive innovations. To do this, the project engages constructively with innovative

businesses and seeks to remove unnecessary barriers (FCA Project Innovate, 2015). The Regulatory Sandbox is another key policy created by the FCA. These ‘sandboxes’ are safe spaces where businesses can experiment with innovative products, services and for instance business models. With this experiment business can test their ideas without immediately incurring the normal regulations engaged with the particular activity (FCA Project Innovate, 2015).

Although the FCA is aiming for the right approach concerning legislation, dangers are expected for the governments’ flexible approach. The FCA is aiming for the “right touch.” Some say that there is a thin line between the “right touch” and a “light touch” regulation. This “light touch” preceded the financial crisis years ago. Than an arising question remains: is the UK Government creating a FinTech bubble? (Financial Times, 2016).

3.2 United States

In 2012 President Obama signed the new Jumpstart Our Business Startups (JOBS) act. Only recently (2015) the bill passed voting in the Congress and Senate. As the title of the Act already mentions, this law was designed to jumpstart the American economy and (restore) opportunities for primary job creators, such as small businesses, startups and entrepreneurs. The American Government anticipates several outcomes of the Jobs Act: increase in capital formation, growth of startups and small businesses, opportunity to go public and create more jobs. This will mainly be achieved by reopening the American capital market, allowing small companies and entrepreneurs to access capital in an easier manner, making it easier for small companies to go public, raising the number of shareholder registration (500 to 1000), and capital expansion (Press Release, n.d.). Each of these effects will be discussed shortly. Access to capital

A regulatory ban from the SEC prevents small businesses from using advertisements to solicit investors. This part of the law allows small companies to utilize advertisements or solicitation to reach investors, a manner to obtain capital USA SEC, (2016).

Entrepreneurial access to capital

Allows companies to pool up to $1m form investors without registering to the SEC, or up to $2m when the company provides investors with audited financial statements.

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This has a limitation to an individual contribution of $10,000 or 10% or the investor’s annual income USA SEC, (2016).

Small company capital

This part makes it easier for small businesses to go public by increasing the threshold from $5m to $50m. Amending this regulation makes it a viable channel for small companies to access capital, which may lead to economic growth and job creation USA SEC, (2016). Private company flexibility

This regulation removes barriers to capital formation for small companies by raising shareholder registration from 500 to 1000 shareholders USA SEC, (2016).

Capital expansion

Increases the number of shareholders permitted to invest in a community bank, from 500 to 2000. This regulation would enable banks to better deploy capital USA SEC, (2016). The opportunity to go public is the one consequence, which shows a large change.

Accounting firm EY has made a mid-year (2015) update on the consequence of the American Jobs Act. Figure 4 shows that from the year 2012 to 2014, the year in which the Jobs Act was introduced, the IPOs in the USA have more than doubled. This shows that the government has created an environment in which going public is more accessible.

Figure 4: The number of IPOs in the United States after introducing the Jobs Act (2012-2014)

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Although all the proposed benefits of the Jobs Act seem to have positive effects on the national economy, the FSA has raised concerns about the possibility of inadequate investors’ protection in place. It is crucial for investors to realize that the firm’s ‘approval’ only covers the marketing side. A partner at law firm Herbert Smith Freehills claims the there is no ‘approval’ of the investment or what happens to the investors’ money (Financial Times, 2013).

Another potential negative associated with the Jobs Act is the increased risk involved. With the regulatory requirements lowered for new public businesses could possibly lead to

manipulation and fraud (BDO IPO Halftime Report, 2015). It is argued that this is one of the main reasons for the delay in passing the Jobs Act bill.

It is still a big question mark if these new regulations will benefit the market and economy as described above. Although the belief in this new Act has risen, still 51% of the bankers expect a positive impact on the number of businesses going public (BDO IPO Halftime Report, 2015).

3.3 The Netherlands

Besides growth in the FinTech industry in the UK and the USA, the growth in the

Netherlands is quite impressive as well. Figure 5 shows that the overall Dutch growth in the alternative finance market has been 59 percent between 2012 and 2014. This research focuses only on the peer-to-peer business lending and equity-based crowdfunding which both have been marked in figure 5. The equity-based crowdfunding sector has grown 44 percent between 2012 and 2014, while P2P business lending has grown a staggering 257 percent in those years. As a consequence of this growth, the Dutch government and the AFM have taken action in regulating the rise of the FinTech industry with introducing the crowdfunding-investor test. .

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Figure 5: The growth in alternative finance in the Netherlands (2012-2014)

Source: EY (2013)

A research conducted by the FCA and Roland Berger has shown that this non-fit results in ambiguity within decision-making authority or inconsistent rulings from the Dutch

supervisor, AFM and DNB (Roland Berger, 2016). These constant changes have led to the Dutch Authority Financial Markets (AFM) and the Dutch Bank (DNB) to follow three

supervisory regimes: a permit to mediate in credit; exemption to mediate in claimable money; and permits for the transmission of orders in financial statements (AFM, n.d.).

In December 2015 a Dutch meeting was organized by the AFM. During this meeting a new meaning was given to the regulations concerning crowdfunding in the Netherlands.

These new rules (pilot version) became operative at April 1st, 2016 for all crowdfunding platforms with a permit or exemption. Market participants have made their concerns clear about the crowdfunding-investor test. With its over repeating character it is expected to be a great burden for investors. Before revising the characteristics of this test, each investor’s capital had to be checked. Luckily, negative signals from the FinTech environment have led to revisions from the AFM and DNB.

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With practicability and reducing unnecessary administrative burdens in mind, the AFM adjusted the crowdfunding-investors test at three parts. First of all, investors are only “tested” when the investment is higher than 500 euros. In the past each investment was checked irrespectively the amount invested. Second, the AFM conducts a limited test. This limited test may suffice with asking with raising questions about capital as well as pointing out the risks of investing in crowdfunding mechanisms. Thirdly, the limited test is only conducted of each subsequent 5000 euros. In the past tests where repeated with each new investment,

irrespectively the amount invested (AFM, 2016). The goal of this test is to make investors conscious of the possible risks associated with investing in a crowdfunding platform. With the results of the test, which are not binding, the investor can choose whether or not to invest. Although this helps in possibly decreases fraud in the sector, it does not protect the investor in a binding manner.

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3.4 Cross-country table

Table 3 presents an overview of the motivation, goals and consequences of the new regulations concerning FinTech for each of the discussed countries. Each of the countries takes a different approach in setting new boundaries in the FinTech industry.

Table 3: A cross-country comparison concerning new regulations

Country Netherlands UK USA

Motivations for regulation Non-fit regulations Financial innovation in the market Make the UK a leading FinTech country

As a remedy for the dot-com burst and economic recession;

9/11 lowered investor trust, which led to a decrease in invested capital.

Goals of regulation

Create fitting legislation for crowdfunding platforms

Give new players freedom

‘Right touch’ to maintain existent investors

Create more jobs

Increase capital formation Growth of startups and small businesses

Opportunity to go public

Outcome An investor test

(decrease fraudulent investors)

Less restrictive

regulation for investors with small investments

Investor protection enhanced

Tax subsidies

Companies possibly stay private longer (from 500 to 2000

shareholders)

Rules are less restrictive for small companies

Source: Roland Berger (2013), Financial Times, Financial Times Alphaville, UK government, USA government, AFM, EY.

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4. Discussion

With the regulation of FinTech a proper balance is needed. Over regulation could damage the rise of the FinTech sector and under regulation could probably lead to higher risks, for

instance fraud. With these concerning risks the fear exists that another bubble is being created in the financial market.

The effects of investor protection and access to capital have been widely researched for the traditional financial market. (Perotti and Volpin, 2006). Perotti and Volpin (2006) state that (i) better access to finance does favor entry and competition and (ii) effective investor protection is better in more politically accountable countries, where countries may be subject of scrutiny of informed citizens. This paper suggests that improving formal investor protection laws, while ignoring the enforcement, may not improve access to finance (Perotti and Volpin, 2006). The article concludes that entry rates and competition are affected by investor

protection in sectors, which depend more on external finance. This shows that an unbalanced act in investor protection and access to capital does not spur competition as well as the financial market.

To find the right balance countries need to facilitate easier access to capital for startups on the one hand. On the other hand, investor protection needs to be enhanced, lowering potential risks in the up rise of the FinTech sector. The need to balance these two variables will be discussed later. Both sides, access to capital and investor protection, will be discussed and a comparison will be made between the three discussed countries.

4.1 A cross-country comparison concerning access to capital

The UK sees the potential growth of the FinTech industry as an opportunity. Access to capital is being loosened and encouraged by tax subsidies provided by the UK government.

FinTech platforms could help non-FinTech SMEs in growing by gaining access to capital that has not been available before. It can be stated, that with a relatively low regulative burden in accessing capital, the UK is able to attract higher (outside) investments, which contribute to the economic growth (Gov. UK, 2015).

The USA has recently alleviated the burden for startups in accessing capital. A regulation has been banned by the SEC, which prevented small businesses from using advertisements to solicit investors. Now, small companies are allowed to utilize advertisements or the

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solicitation of investors, a manner to obtain capital USA SEC, (2016). This shows that with the rise of FinTech and new regulations, the Jobs Act does not create new burdens in accessing capital, it enhances it.

In the Netherlands, the AFM created lower boundaries to invest in for instance crowdfunding platforms. A consequence is alleviating the burden for investors to invest as well as for startups to access capital.

After discussing the potential benefits for each country it became clearer that each

government is taking a different approach. The USA and the Netherlands are more focused on alleviating the burdens in accessing capital. While the UK is encouraging startups by

providing tax subsidies and direct investments.

4.2 A cross-country comparison concerning investor protection

Investor protection is highly dependent on the legal form and history of a certain country. Two legal “families” are considered: the common law (UK and USA) and the French civil law (the Netherlands). Common law countries are known for their strong protection of outside investors, meanwhile the French civil law countries have the weakest protection. But where do these positions stem from? It has a “judicial” explanation. In common law countries the legal rules are mainly made by judges. When new situations occur, it is expected that judges apply the countries’ principles even when a specific conduct is not yet described in the statutes (Coffee, 2000; Johnson et al., 2000b). Oppositely, in the French civil law countries the system rests on legislatures and judges whom are not supposed to go beyond the

countries’ statutes (La Porta et al., 2000). In this situation it is possible for a corporate insider to find a way to expropriate, which is not explicitly forbidden by the statutes and can precede the expropriation. Thus, the common law system is more protective of outside investor than the rules in the French civil law. Table 4 provides an overview on the legal historical form of each country, the investor protection and the origin of governance.

Table 4: Investor protection cross-country

UK USA The Netherlands

Legal form Common law Common law French civil law

Investor protection Strong Strong Weak

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The UK has introduced reformed regulations concerning FinTech. By providing tax subsidies and direct investments in the market by the government, it aims to be a top European FinTech country. Although the literature supports the common law legal system as highly protective of outside investors, the UK aims to protect outside investors by providing transparency on the FinTech market. This may help in lowering the risks of FinTech without legislative

consequences.

Recently the Jobs Act has been introduced in the USA. The new law aims to encourage small businesses and startups by loosening the federal regulations and letting individuals become an investor. Due to the market-centered nature of the USA, finance is provided in large numbers of investors, the Jobs Act enhances the American legal system and encourages further

investments by individual investors. But, there is also friction between a fear of fraud and the American legal system. The articles by Coffee (2000) and Johnson et al. (2000b) state that most common law countries have a high protection of outside investors. Still the SEC fears an increase in fraudulent actions on the financial market. A possible reason for this friction might be the new nature of the FinTech industry, which has not yet been fully described in the statutes. The SEC fears that the rise of the FinTech industry will possibly lead to riskier unregulated investments where investor protection cannot be guaranteed.

The Netherlands aims to reduce unnecessary burdens and has therefore introduced the investor test. This tool screens investors as well as pointing out the risks of the investments for startups. Being a French civil law country, the literature states that the Netherlands would have a poor protection of outside investors. The new regulations enhance this view. It seems that the investor test does not include a protection for investors; there is no protection against expropriation by insiders.

4.3 Balancing the forces

Due to the financial crisis it can be stated that trust was lost, partly due to a lack of control. This led to startups and investors moving to a new market, the FinTech sector. With the rise of the FinTech sector a fear of creating another “bubble” in the financial market exists. Therefore it is highly important that with the use of new regulations, access to capital and investor protection is to be balanced. This research proposes a balance between these two forces with the use of the model of confidence in partner cooperation by Das and Teng (1998).

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After reviewing the literature it became clear that other antecedents were influencing the level of trust and control proposed by Das and Teng (1998). To make it suitable for this research the antecedents have been corrected and are presented in figure 6.

Figure 6: The model of trust and control (adjusted)

Source: Das and Teng (1998)

Trust building

Regulative history

After reviewing the literature on investor protection, it became clear that the historical legal form of a country is highly influential on investor protection. Which leads to influence the trust level positively or negatively.

Past occurrences in financial market

Due to past occurrences in the financial market the level of trust has changed significantly. As a consequence of the financial crisis and the bursting bubble in the financial market the level trust was historically low. This is influencing both the level of control as to level of trust. When the financial crisis hit, the trust in the financial market was at an all time low. Next to that, the financial crisis led to governments sharpening the regulations. The level of trust is slowly increasing with the new level of control.

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Control mechanisms

New regulations

New regulations are highly influential for both the level of trust as well as the level of control. When setting new boundaries in the FinTech industry the level of trust may increase for both the investor as well as the startups. New regulations may diminish fraud or decrease the boundaries of accessing capital. When the level of trust increases this may influence the control mechanisms, these may be adjusted to the perceived level of trust. New regulations may increase the level of control, which in turn may lead to a higher trust level.

Governance

With the fear of expropriation, governance is the tool to diminish this risk. With governance existent in a startup the level of control increases, but at the same time the level of trust increases as well from an investor perspective. This may in turn lead a lowering barrier in accessing capital for a startup. Trust may be increasing with this level of control.

When a balance is found between the level of trust and the level of control, a positive effect may exist on the confidence in partner cooperation between the startup and the investor. After reviewing the adjustments made on the model of Das and Teng (1998) an analysis can be made for each country.

United Kingdom

The UK has a legislative history of common law. This form of legislation is known for its strong investor protection (La Porta et al., 2000). This leads to higher level of trust from an investor perspective and a lower demand of control.

Like every other country the financial crisis had influence on the UK economy. This lowered the level of trust from an investor perspective and startups perspective as well.

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New regulations

The new regulations of the UK government are aimed to being a “right touch” in delivering a proper level of control. The right level of control has led to a safe feeling in the FinTech sector, which leads to a higher level of trust.

Governance

The governance of the UK is market-centered (La Porta et al., 2000). With most investments coming from the market, the barriers in accessing capital from a startups perspective are relatively low. With the strong investor protection the need for governance may be low from market participants. Table 5 shows the level of trust and control after reviewing the literature and connection this to the FinTech industry in the United Kingdom.

Table 5: The level of trust and control in the United Kingdom

Trust level Control level

UK High Relatively low

After reviewing the elements influencing the level of control and level of trust, it became clear that with a high level of trust and relatively low level of control by the government, the UK is on its way in creating a proper balance between access to capital and investor

protection. When a proper balance exists, the confidence in partner cooperation will exist. To mention, with the UK inhabitants deciding to leave the European Union (Brexit), there is a possibility that the Brexit negatively influences the FinTech growth. Further research could provide new insights into the effects of Brexit.

United States

Like the UK, the USA has a Common law legislative history (La Porta et al., 2000). Known for its proper investor protection, the level of trust from an investor perspective is relatively high.

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downturn in the trust level by the American citizens. This in turn led to a higher level of control by the US government, which increased the barriers in accessing capital by startups. New regulations

With the new regulations the government aims to regain the trust in the financial market, in this case the FinTech industry. By implementing these new rules the investor protection became better and granting loans to startups became relatively easier. This has led to an increase in the level of trust but will need time to reach a proper level again. The level of control still stays relatively high due to the fear of creating another “bubble.”

Governance

Governance plays a more important role in the USA than in the UK. Although the governance is market-centered, the level of trust is lower than in the UK. The low level of trust due to mostly the financial crisis may be a reason for a higher demand for governance from both the investor as well as the startup. Table 6 shows the results on the level of trust and control for the United States.

Table 6: The level of trust and control in the United States

USA Low High

It became clear that the past occurrences in the financial market play a big role in the low level of trust in the FinTech sector. Although the level of trust is sure but slowly increasing, the level of control of the government remains high. It can be stated that the balance between investor protection and access to capital is a bit out of balance. In order to create a stimulating FinTech industry the investor protection must be high and barriers must be relatively low to increase the level of trust. A high level of trust will lead to a lower need of a high level of control.

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The Netherlands

With the French civil law regulative history of the Netherlands the investor protection is weak (La Porta et al., 2000). This may implicate that the level of trust in the Netherlands is

relatively low.

The influence of the financial crisis exists in the Netherlands as well. The Netherlands has a bank-centered governance (La Porta et al., 2000). During the financial crisis the trust in banks diminished and the granting of loans became more difficult, accessing capital became a large burden. The financial crisis increased the level of control and at the same time the level of trust was lowered.

New regulations

With the growth of the FinTech industry the barrier of accessing capital has been lowered from a startup perspective as well as the possibilities for investors to invest. Although the investor-test presented by the AFM aims at lowering the risks on the FinTech market, the investor protection is not considered sufficiently with these new regulations. Due to the new regulations the demand for a high level of control has been lowered.

Governance

Although the Dutch governance is shifting slowly from a bank-centered governance to a market-centered governance, the demand for governance is still existent. Table 7 shows the level of trust and control of the Netherlands after reviewing the literature and the adjustment on the model of Das and Teng (1998).

Table 7: The level of trust and control in the Netherlands

The Netherlands Relatively low Moderate

It became clear that the Dutch government still has some work to do in balancing the new regulations in the FinTech industry to positively influence the investor protection and assess

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to capital by startups. Having a good look at the investor protection and the efficiency of the investor test may lead to a balancing act.

5. Conclusion

Finding a proper balance is essential to enhance and further develop the growth of the FinTech industry. Via the model of Das and Teng (1998) the effects of the new regulations have been analyzed cross-country. After studying the literature on entrepreneurs’ access to capital and investors’ protection it became clear that the regulative history, past occurrences in the financial market, new regulations and governance are the identified antecedents influencing the level of trust and control. With the fear of fraud and the creation of a new bubble in the financial market, the new regulations burden possible risks arising. Each of the three countries discussed show a different approach in defining the new regulations for the FinTech industry.

This differing approach of each country is highly dependent on the context, the historical legal form. The United Kingdom has a legal form of common law and market-centered governance, which is seen as stimulating the FinTech rise. With the enhanced investors’ protection, relatively low barriers in access to capital and a “right touch” approach by the government for a now a stable balance between trust and control exists. Leading to a confidence in partner cooperation.

The United States has a historical legal form of common law and a market-centered governance, which is stimulating the FinTech growth. Past occurrences in the financial market were highly influencing the level of trust. The introduction of the Jobs Act is a tool to regain trust by lowering the entrepreneurs’ access to capital as well as enhancing the

investors’ protection.

The Netherlands has a legal history of French civil law and a bank-centered governance, which has shown as not highly stimulating for the FinTech industry. Besides a differing context, the new regulations are enhancing the entrepreneurs’ access to capital, but lacks consideration of investors’ protection. By redefining the newly introduced regulations both forces should be enhanced to find a proper balance.

For further research it could be interesting to look into more sectors that are included in the FinTech industry. Due to a lack of data, future research could analyze the rise of FinTech in emerging markets.

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Balancing new regulations on the rise of FinTech : a cross-country analysis