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Hong Kong increases focus on fintech and regtech

New wave of innovation aims to boost ambitions as a global financial hub

Hong Kong, which is dominated by large and established financial institutions, is also seeking to lower barriers for startups to drive innovation in the booming fintech and regtech sectors. Regulatory changes could also offer opportunities for nimble disruptors, although the need to balance innovation with investor protection will remain a key priority.

Breaking down barriers

Key insights

  • Fintech startups face a challenge for traction in Hong Kong, with the market dominated by large and established financial institutions
  • Banking incumbents plan to increase their fintech spending but overall investment lags global peers
  • Hong Kong's commitment to a safe and robust regulatory environment could offer more opportunities for regtech specialists

Although a sophisticated and diversified economy, Hong Kong's financial sector has proven to be a difficult market for fintech startups to penetrate largely due to its fragmented and sector-specific regulatory regime. Innovation has been driven largely through collaboration and partnerships between established banks and fintech specialists, rather than by smaller market disruptors.1 More than 80 percent of Hong Kong's banking incumbents plan to increase partnerships with fintech companies over the next three to five years, according to PwC.2 The model has set Hong Kong apart from other jurisdictions, but also fuelled concerns that such partnerships could slow the pace of disruption and potentially leave the Asian hub behind the technological curve.

Challenges for fintechs

Hong Kong has launched a range of initiatives to stimulate the fintech sector but they have tended to reflect the dominance of incumbent firms. The Hong Kong Monetary Authority (HKMA) established interoperable fintech sandboxes in 2017, with the intention of driving a lighter-touch regulatory environment. However, the program was restricted to banks and their partnering technology firms. Singapore, by contrast, provided a more inclusive sandbox initiative in June, 2016, with startups accounting for 80 percent of applications.3

The need to develop a regulatory framework specific to fintechs is seen as paramount for Hong Kong's competitiveness

Hong Kong's incumbents have not been idle with banks such as HSBC, Standard Chartered and Singapore's DBS establishing fintech accelerators to foster new talent. Yet their investment in fintech is below the global average for peers and behind its Asian neighbours. Hong Kong's financial institutions allocated 14 percent of their annual turnover to “fintech matters," compared with 15 percent globally and 32 percent in China, according to PWC's 2017 fintech survey.4 "The concern is that, while this approach is savvy and sustainable, the pace is just not nimble enough," the survey said. The need to develop a regulatory framework specific to fintechs is seen as paramount for Hong Kong's competitiveness with most of the hub's financial services legislation written before the fintech revolution began, according to legal experts.5  

However, Hong Kong has been actively building bridges overseas in a bid to ease pathways for innovative fintechs. Agreements are now in place with the United Kingdom and Australia, which enable Hong Kong fintechs to expand their business offshore while making it easier for foreign fintechs to gain footholds onshore.

Seeking leadership in regtech

The focus of regulators on anti-fraud and counter-terrorism financing legislation is also in the spotlight

Regulatory changes that will keep pace with the dynamic fintech sector are expected to create more opportunities for startups specializing in regtech as compliance demands increase and become more complex. Hong Kong's desire to become a safer and more transparent financial centre may also spur innovation.

“To be able to lead in regtech may be our best possible opportunity to cement our leadership status," said Dr Winnie Tang, a fintech expert at the University of Hong Kong.6 Regulators will also be key to establishing ecosystems that can allow regtech firms to flourish and they have shown a direct interest in setting the agenda. Hong Kong has taken the lead in a number of regtech initiatives, including partnering with Singapore in the use of distributed ledger technology to create a platform for cross-border trade finance. The project, which includes Deloitte and a consortium of banks, is intended to build an “information highway" between Hong Kong and Singapore to make cross-border trade financing cheaper, safer and more efficient.7

Focus on fraud

The focus of regulators on anti-fraud and counter-terrorism financing legislation is also in the spotlight and could provide further niches for regtech firms to exploit with innovative compliance solutions. The international Financial Action Task Force (FATF) is due to publish its latest evaluation of Hong Kong in October 2018, and is likely to highlight the success of its Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) since its introduction in 2012.Amendments to the legislation were unveiled in February 2018, harmonizing it with international standards set by the FATF, which demand enhanced customer due diligence and record-keeping obligations from Hong Kong's non-financial businesses and professions. The amendments also include provisions to reinforce the transparency of beneficial ownership of Hong Kong companies through the creation of a Significant Controllers Register (SCR), which companies must be able to produce on demand. While adding a layer of compliance, the SCR should foster greater confidence in Hong Kong's commitment to the rule of law.9

Striking the balance between a robust regulatory regime and a business environment that can nurture the fintech industry will be a key challenge for regulators. Hong Kong may have been slow to lower barriers to entry for smaller entrants to the sector but a flurry of initiatives to build a regulatory framework for fintech should offer niche opportunities for nimble regtech firms.

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Sources

  1. PwC Hong Kong Fintech Survey (2017) Banking partnerships with fintechs
  2. Ibid.
  3. South China Morning Post (June 28, 2017) Hong Kong makes progress on fintech
  4. PwC (2017) Ibid.
  5. Hogan Lovells (December, 2017) Regtech in HK
  6. EJInsight (February, 2018) Regtech opportunities
  7. Hong Kong Monetary Authority (November, 2017) DLT trade finance platform with Singapore
  8. Clifford Chance (March 1, 2017) Hong Kong Eyes International Best Practices with 2018 Amendment to AML Ordinance
  9. Ashurst Legal Update (March, 2018) Significant Controllers Register