An understanding watchdog makes for a ‘go-to’ place for new Fintech business

Use of virtual currencies and the blockchain to ease and make more secure a raft of financial services and other applications is expected to be given a boost with Gibraltar’s plans to introduce a world-leading regulatory regime

New technology companies will be drawn to the jurisdiction by promises of encouragement and support rather than having an overly cautious and restrictive approach, according to a group of business professionals attending an end-2016 roundtable discussion organised by accountancy firm, KPMG (Gibraltar) and Gibraltar International Magazine.
But major obstacles remain for innovative entrepreneurs: acceptance by banks to provide initial project finance and operational bank accounts; awareness of support services; and having a watchdog that also seeks to protect consumers and investors.
All of which provides an opportunity for Gibraltar to become the go-to financial technology (Fintech) jurisdiction, with the intervention of government, marketing of the advantageous business environment and support services, and having an understanding financial services regulator.
A blockchain is a distributed ledger of unchangeable, digitally recorded data that provides full transparency in virtual currencies applications like Bitcoin and for land title transfer and accountancy, for example.
Micky Swindale, who is head of advisory for KPMG’s Gibraltar and Isle of Man operation, told the eight sector guests:  “As an advisor, just about everyone I’m dealing with on just about anything they are doing at the moment, is asking whether we think they should be doing it on blockchain!
“It’s not an automatic, one size fits all”, she declared, “however, whilst it may not work for all applications, I think there will be a very quick evolution [of the technology].”
Siân Jones, founder of UK virtual currency consultancy Coinsult, taking part by remote video connection, submitted: “The market capitalisation of bitcoin is about £10-12bn, small beer compared to wider currencies, but when you look at the much, much wider range of blockchain use cases, you start to see massive potential.”
Having worked for the last three years in virtual currency and distributed ledger technology, and on public policy in Brussels, Jones reported: “There has been a huge shift in the last year on thinking just in terms of virtual currencies, which is dominated by Bitcoin and accounts for around 94% of the value of all those blockchain-based digital assets.

Vast potential predicted

“The potential in other use cases – financial and non-financial – is vastly bigger in my opinion than the virtual currency and payment related stuff, which itself will become much bigger in time.  In that context, when you look at the broad terms and say Gibraltar wants a piece of that, it starts to make some very significant sense,” Jones observed. “My crystal ball prediction is that that space will account for less than 10% of all the uses and value of use cases for the wider underpinning technology.”
As an example, a recent report on insurance by accountancy firm, PwC, foresaw a US$5-10bn opportunity in the wholesale insurance market from the use of distributed ledger technology.
But as the roundtable participants quickly identified, having a sound, safe regulatory environment to protect investors, the public and a jurisdiction’s reputation was necessary if virtual currency and blockchain initiatives are to flourish.  Yet, New York State – where a regulatory regime launched in 2015 and two years in the making – had been “a spectacular failure” resulting in just two or three licences being granted, “because it is a significant, comprehensive, all-encompassing, highly burdensome piece of regulation”, Jones declared.
At over 45 pages long, the BitLicence had caused a flight from NY State of innovative start-ups, “simply because the burden and cost has been so significant; they moved out to other parts of the US, or to Europe and elsewhere”, she said. “That [approach] is certainly not something we in Gibraltar would want.”
With Jones as an advisor, it was revealed that Gibraltar Financial Services Commission (GFSC) has been actively looking into the possibility of developing its own ambitious regulatory solution designed to create the right environment for new technology companies to settle and grow in the jurisdiction.  The new licence-type is likely to be the first in the world to present a practical solution for users of virtual currencies and the blockchain.
Nicky Gomez, GFSC risk manager and one of five involved in the regulator’s year-old specialist Innovate & Create team, explained: “The team’s purpose is to support start-up Fintech companies who want to establish in the jurisdiction.
“One of the things that we are very much aware of is that these kinds of firms are not used to working within a regulatory environment, so it is important that we adopt a supportive approach to working with them to get a better understanding of what it is that they want to offer, what the risks are, and to manage those risks to a level that falls within our risk appetite in an environment that will benefit consumers and the jurisdiction.”
As Sian Jones pointed out: “New York State shows exactly what can go wrong if you try and regulate a new technology that is still being developed. The businesses, activities, business models and use cases are all still evolving, and too early, too prescriptive regulation is detrimental to innovation.

Governments doing little

“Relatively little is being done by governments to support innovation, in spite of noises suggesting that it is happening.  The UK, for example, makes a lot of noise about supporting Fintech, but in reality, there is little government support.”
One significant development is the UK Financial Conduct Authority’s (FCA) regulatory ‘Sandbox’ approach, which aims to “create a ‘safe space’ for businesses to test innovative financial products, services, business models and delivery mechanisms in a live environment without immediately incurring all the normal regulatory consequences of engaging in the activity in question”, Jones related.  During 2016, around 20 jurisdictions have launched or are developing sandboxes.
The European Commission has also published a draft amendment to the 4th Anti Money Laundering Directive that includes bringing virtual currency exchanges and custodian wallet providers, into the realm of regulation by defining them as ‘obliged entities’.
Swindale, now also head of digital ledger services for KPMG’s Islands Group [of seven financial services territories, including Gibraltar], interjected: “We have sounded this note of caution about putting in place a restrictive framework and the need to take time to stand back to allow these companies to develop and to understand how these technologies are being applied.”
She suggested: “This is a sector that while swift regulation might not be the wisest course, people are hungry for that certainty it gives potential customers.”
Tim Connal, GFSC’s senior legal advisor, reminded:  “The remit of Innovate & Create is not just related to Fintech and virtual currencies.  Like a lot of things, it links back to our strategic business plan 2014-17, which includes support of innovation in Gibraltar, businesses coming in and the reputation of the jurisdiction.
“It is just a happy coincidence that a lot of the innovation going on in the financial services sector surrounds Fintech. We are looking also to help businesses that are not necessarily regulated, but that want to provide services to business in the jurisdiction that are regulated and provide support to licencing Fintech products.”
The World Economic Forum published a report in August that gave a ringing endorsement of the ability of blockchains to transform modern financial technology, Swindale underlined. In addition to increasing the speed and security of transactions worldwide by using cryptology, blockchain technology also can be used to reduce costs by leveraging cloud technology, she clarified, adding: “Blockchain can also improve regulatory compliance by offering detailed factual evidence and a solid trail of transactions for auditors and regulators.”
But some small entrepreneurs and other enterprises not experienced in operating in a regulated environment were put off by the envisaged responsibility and workload involved.
Peter Howitt, founding partner of local law firm Ramparts concurred: “We definitely have a divergence in the crypto space between those who are very pleased to carry on without supervision and those who take a more strategic long-term view, and probably have experience in other sectors where they can see there is a need for regulation and it is helpful if they do things in the right way.”
As someone deeply involved in eCommerce – electronic payments, electronic money – and eGaming, he disclosed: “I have a pension fund and I’d love to have a Bitcoin Exchange-Traded Fund (ETF), but I can’t; I’ve got an ISA. Those thinking more strategically realise that regulation is not a no-no, but there has to be thoughtful, sympathetic regulation.
“The bigger operators that I have spoken to seem to be intelligent about the need to find a good home for crypto companies, and also the difficulties of accessing the wider system – bank accounts, having relationship with card schemes – are not going to get better by staying out in the cold.”

Creating a bridge

Cue Brent Almeida, chief executive of WaveCrest Group, a Gibraltar-based digital payment solutions company, who stated: “Our solutions create a bridge between more traditional payment networks and the emerging Fintech ecosystem.  We have seen this business vertical grow by over 600% in the last 12 months, but that success would never have been possible without a regulator here that – even in the absence of explicit legislation on virtual currencies – displays an appetite for that type of financial services innovation.”
However, as Philip Vazquez, a lawyer at Triay Stagnetto Neish and one of the organisers of Gibraltar Start-up, a voluntary body that aims to help Gibraltar’s entrepreneur and smaller innovative start-up companies, disclosed: “We are not experiencing notable interest from start-ups in this [Fintech] sector at this stage.  Bitcoin and crypto businesses are a new and growing area, for example.
“We are not sure why more innovative businesses are not coming to us, maybe they are coming into the jurisdiction at a higher level in Gibraltar, but we might in the next 12 months see Fintech and distributed ledger technology be the base of more smaller businesses.”
Micky Swindale recounted the IoM experience where “the regulator moved fairly quickly to extend aspects of financial and personal regulation to include virtual currency companies, but the initial flood of business attracted was rather cut off at source by the fact that local banks wouldn’t support those companies and became very nervous about dealing with them, even via businesses that were already customers.  That can be a big issue.”
Howitt went further. “We see it here in Gibraltar too, it is a massive issue,” but he and Almeida both saw a big opportunity for the government to intervene and encourage the Gibraltar International Bank (GIB) it owned, to provide support, subject to sufficient regulatory and risk control. Swindale intervened to warn: “There is a danger that all of that [effort to encourage entrepreneurs] will go to waste if there isn’t a bank to support it.”

Problem with banks

With that in mind, Howitt declared: “We have just described a global banking infrastructure that is starting to break – the politicians have no control over it since the [2008 financial] crisis – that largely, is why so many of us are passionate about Bitcoin.  It all feeds into most of us thinking that this situation is an amazing opportunity.”
Siân Jones observed: “The problem of banking is not in any way unique to virtual currency businesses; it is part of a much bigger problem of wholesale de-risking, which has been going on across the banking sector. One factor is that so many of the banks are owned by other much larger banks, so those de-risking policies filter down through to the smaller banks, many of which are reliant on their correspondent banking relationships to function.”
Gomez concurred. The GFSC had identified the issue of access to banking facilities: even when local banks showed interest, their [larger] correspondent banks might not be comfortable with the risks around Fintech companies. He stated: “It shows the dynamics here.  No one is going to resolve it simply by having a good regulatory environment; we need to see how that interacts with banking policies and Board risk appetite.
“What we can do is provide a strong responsive regulatory framework that supports the right controls being in place whilst not stifling development.  Ultimately, we would approach any new business with the same regulatory objective of ensuring consumers’ and Gibraltar’s reputations are protected.  How this is done needs to be proportionate to the circumstances” the Commission’s risk manager concluded.
Yet Brent Almeida saw “a huge opportunity still ahead of us as a jurisdiction”, sighting the general benefits of Gibraltar – “why we are all here as individuals and businesses – favourable corporate tax regimes, no capital gain, no VAT – which also eliminate some of the operational complications with regulating virtual currencies.”
The jurisdiction, he judged, had experience in building support infrastructure for a new innovative industry.  “We have seen what has happened with online gaming here, where there are very similar dynamics to those of the virtual currency world”, Almeida observed.
“Now [with virtual currencies and other blockchain applications] we are talking about a much larger potential market. All the ingredients are there for Gibraltar to be as well-positioned as any other jurisdiction to take advantage of this growth, it really comes down to some better marketing of the jurisdiction and execution across the board on government support of innovation and start-ups. There are clearly a lot of inter-dependencies still to be managed, but we are certainly moving in the right direction”, he submitted.

Ground breaking

One significant development occurred when Ransu Salovaara, chief executive of Revoltura, moved to the jurisdiction to launch last summer his ground-breaking BitcoinETI product, a traded security backed by a portfolio of bitcoins, listed on GSX (Gibraltar’s Stock Exchange), the first in Europe to do so.
“Many institutional investors are demanding a stock-listed product so that they can get exposure to bitcoin. We fixed this by having BitcoinETI listed in Gibraltar and trading out of Frankfurt Stock Exchange,” Salovaara said, adding: “We plan to do more. We get approached by crypto currency and digital asset companies very interested to see that the whole crypto currency space will get better here if there are regulated products supporting them.”
Nick Cowan, GSX managing director, devised the product with listing member, Argentarius that had a prospectus with regulatory approval to passport across the EU and in a structure suitable for UCITS funds.
“The challenge was to engage with the regulator at an early stage, to articulate clearly the opportunity as well as the risks associated with a securitisation structure, and to recognise that everyone was going to be taken out of their comfort zone,” Cowan recalled.
“Structuring Europe’s first asset backed security listed on a regulated market was something that no-one had seen before in virtual currency and offered a whole new learning exercise on how this would work regarding liquidity, execution and, particularly, the risks surrounding security,” Cowan admitted.  “There was an intensive risk matrix process – including the potential reputational risk to Gibraltar if we got it wrong.”
The GFSC signed off on the project within six months. “That was a huge accomplishment from a regulatory basis, because with other products the Commission can approach other regulators as a point of reference for advice if required, but with the advent of the Bitcoin ETI, the GFSC had to take the lead showing an appetite for innovation,” Cowan declared.
Howitt saw the development as an opportunity to market Gibraltar as a centre of excellence in this technology, “making it clear that we are a place in the world where you want to come to gain support as a start-up and receive help through the process. There is a really good chance that whilst everyone is focusing on blockchain and exciting things around it, bitcoin is going to keep building as the internet money alongside Fiat currency.”
He was pragmatic: “It’s a win-win situation. If there is growth in virtual currency there’s a regulatory regime to support that, and if there is growth in blockchain, we have the regime to support that too, so whichever part is the one to grow we can benefit as a jurisdiction.  In 12-24 months we may see that virtual currencies and blockchain are separated in their application and the key for Gibraltar is in having a flexible regulatory regime that can support either or both of those applications.”
As Sian Jones perceived: “We are working hard in Gibraltar to address the challenges of a rapidly evolving, brand new technology.  We know it’s a bad idea to try to regulate a technology, rather focus on the business activities that might use that technology.  We are looking into something that is outcomes focused, principles-based, that addresses the very broadest spectrum of the use of distributed ledger technology”.