Fintech regulations in Latin America could fuel growth or freeze out startups

May 31, 2020
Cofounder & Chief Business Developer Officer en Prometeo OpenBanking
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techcrunch.com
It may have entered the game later than other leading regions such as Europe and North America, but Latin America’s fintech industry is dynamic and growing fast. The sector was recently given a valuation of more than $150 billion and continues to expand year-on-year.

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And while the longer-term impact of COVID-19 on the sector is yet to be determined, there’s no doubt that the demand for certain fintech solutions is on the rise. As smaller financial institutions across the region are under pressure to digitize, many are calling on fintechs to help them along this journey. In addition, a number of SMEs are seeking out digital loan services to help them get through the crisis.

The sector’s speedy expansion has meant that regulators in LatAm are under increasing pressure to enact legislation that addresses the murky waters of fintech activity, providing confidence to consumers and investors alike. However, regulation across the region must be careful to not quash innovation, while startups must figure out how to be agile in an environment which is becoming increasingly regulated. Let’s take a closer look at what impact regulation has had so far in LatAm, and what needs to happen to strike a balance between sector growth and public trust.

The development of fintech regulation across LatAm

Mexico is currently leading the way when it comes to fintech regulation in LatAm, thanks to its comprehensive 2018 fintech Law. The law covers most fintech activities, including crowdfunding, virtual wallet, transactions carried out with cryptocurrencies and open banking. In addition, Mexico has certain financial laws that regulate financial entities in their execution of transactions using fintech. The law also provides a regulatory sandbox for both licensed and non-licensed companies.

Brazil is the furthest ahead after Mexico, as it individually legislates crowdfunding and peer-to-peer lending, while a special congressional commission is working on a broader legislative strategy. Brazil’s Central Bank also endeavors to make open banking legislation effective by the third quarter of 2020, which will pave the way for a thriving open banking ecosystem.

The majority of initiatives in Brazil come from its Central Bank, which has been attempting to reduce the influence of certain players in the payment services chain. The results of this have been encouraging for smaller acquirers and fintech startups, with the goal to stimulate competition in the segment.

While it doesn’t yet have overarching, comprehensive fintech legislation, Colombia has recently adopted new regulations addressing financial markets, which specifically addresses roboadvisors. The country has also developed a sandbox model for the fintech industry, but does not yet regulate peer-to-peer lending.

Clearly, Mexico’s fintech law is having a spillover effect across the rest of the region: Chile and Peru are also pushing toward more comprehensive legislation. However, the development of regulation remains inconsistent across markets, and those lagging behind should look to Mexico and Brazil for lessons learned on the impact of legislation on the startup ecosystem.

Regulatory consistency across countries will facilitate growth

While there’s no doubt that Mexico’s legislation influenced the trajectory of other countries in LatAm, notably to start addressing open banking, regulation has on the whole been very local in nature. As evidenced, each country has managed its own set of regulations regarding fintech.

Going forward, if regulators want to facilitate startup growth and innovation, they should work together to build regulations that match up across borders. While Mexico and Brazil are huge markets in themselves, it is likely that fintechs coming from smaller ones such as Colombia or Ecuador will want to scale and export their products to other countries soon after launch.

An example where regulatory consistency would hold huge benefit for fintech startups is in open banking. Countries in LatAm can look to the European model of PSD2 as an example for successful regional open banking legislation that facilitates scaling operations for fintechs from country to country. While such an achievement would be more impressive in LatAm as it isn’t an economic or political bloc like the EU, that doesn’t mean that there cannot be a push for more regulatory collaboration between countries.

Regulators must be careful to not push out smaller players

While regulation is no doubt necessary to instill confidence in both consumers and potential investors, there’s no doubt that it has created serious barriers to entry for new players in fintech. For example, Uruguay’s 2018 regulation made it impossible for peer-to-peer lenders to stay afloat. The entire peer-to-peer sector was forced to stop operations due to the insurmountable demands of compliance.

For many startups, regulation will mean becoming compliant before officially launching and operating in the market. If a startup is already operating while the regulation is enacted, it will often be forced to freeze its operations and concentrate on compliance. This means a serious halt to cash flow as the company cannot take on new customers and provide the service to their existing ones. Without hefty funding, many startups are simply pushed out of the market.

In fact, 53% of startups surveyed by Fintech Radar Mexico 2019 said that the fintech law will create strong barriers to entry for new players. In addition, 46% of those startups said the high costs associated with compliance will generate inefficiencies, while 41% said the regulation is rigorous. Only 24% of startups surveyed said they are ready to comply with the regulation.

Clearly, there is a disparity between comprehensive regulation and the capabilities of startups to comply with new rules. Regulators must become more in-tune with the conditions needed to facilitate a dynamic startup ecosystem if countries are to see further innovation and growth in the sector.

How should fintech startups in LatAm behave in this regulatory climate?

With more regulation ahead, there are certain things that LatAm-based fintechs can do to raise their chances of success. The youngest ones should find ways to get creative and operate outside of regulation where possible, so they can avoid being hit with the many demands of compliance.

Those startups looking to scale and enter new markets must ensure maximum contact with that market before they officially launch. Once their product is operational in a new country, they must be agile and quickly test the responsiveness of the market to the product to be able to determine its potential for success.

Finally, it is being revenue-driven in the LatAm fintech ecosystem that will boost resiliency for startups. While funding from VCs can certainly help cover initial base costs — and interest from global VCs is growing (notably SoftBank’s $5 billion Latin America fund) — those startups that chose to bootstrap will have more flexibility to be nimble and adapt according to changes in the regulatory landscape.

The foundations for further growth and dynamism in the LatAm fintech ecosystem will not be laid by one single actor. A careful balance between regulatory consistency, legislation that tunes in with sector capabilities and forward-thinking agile startups will give continued growth and innovation the biggest chance of success.

Las opiniones compartidas y expresadas por los analistas son libres e independientes, y de ellas son responsables sus autores. No reflejan ni comprometen el pensamiento u opinión de Latam Fintech Market, por lo cual no pueden ser interpretadas como recomendaciones emitidas por la platafomra. Esta plataforma es un espacio abierto para promover la diversidad de puntos de vista sobre el ecosistema Fintech.

And while the longer-term impact of COVID-19 on the sector is yet to be determined, there’s no doubt that the demand for certain fintech solutions is on the rise. As smaller financial institutions across the region are under pressure to digitize, many are calling on fintechs to help them along this journey. In addition, a number of SMEs are seeking out digital loan services to help them get through the crisis.

The sector’s speedy expansion has meant that regulators in LatAm are under increasing pressure to enact legislation that addresses the murky waters of fintech activity, providing confidence to consumers and investors alike. However, regulation across the region must be careful to not quash innovation, while startups must figure out how to be agile in an environment which is becoming increasingly regulated. Let’s take a closer look at what impact regulation has had so far in LatAm, and what needs to happen to strike a balance between sector growth and public trust.

The development of fintech regulation across LatAm

Mexico is currently leading the way when it comes to fintech regulation in LatAm, thanks to its comprehensive 2018 fintech Law. The law covers most fintech activities, including crowdfunding, virtual wallet, transactions carried out with cryptocurrencies and open banking. In addition, Mexico has certain financial laws that regulate financial entities in their execution of transactions using fintech. The law also provides a regulatory sandbox for both licensed and non-licensed companies.

Brazil is the furthest ahead after Mexico, as it individually legislates crowdfunding and peer-to-peer lending, while a special congressional commission is working on a broader legislative strategy. Brazil’s Central Bank also endeavors to make open banking legislation effective by the third quarter of 2020, which will pave the way for a thriving open banking ecosystem.

The majority of initiatives in Brazil come from its Central Bank, which has been attempting to reduce the influence of certain players in the payment services chain. The results of this have been encouraging for smaller acquirers and fintech startups, with the goal to stimulate competition in the segment.

While it doesn’t yet have overarching, comprehensive fintech legislation, Colombia has recently adopted new regulations addressing financial markets, which specifically addresses roboadvisors. The country has also developed a sandbox model for the fintech industry, but does not yet regulate peer-to-peer lending.

Clearly, Mexico’s fintech law is having a spillover effect across the rest of the region: Chile and Peru are also pushing toward more comprehensive legislation. However, the development of regulation remains inconsistent across markets, and those lagging behind should look to Mexico and Brazil for lessons learned on the impact of legislation on the startup ecosystem.

Regulatory consistency across countries will facilitate growth

While there’s no doubt that Mexico’s legislation influenced the trajectory of other countries in LatAm, notably to start addressing open banking, regulation has on the whole been very local in nature. As evidenced, each country has managed its own set of regulations regarding fintech.

Going forward, if regulators want to facilitate startup growth and innovation, they should work together to build regulations that match up across borders. While Mexico and Brazil are huge markets in themselves, it is likely that fintechs coming from smaller ones such as Colombia or Ecuador will want to scale and export their products to other countries soon after launch.

An example where regulatory consistency would hold huge benefit for fintech startups is in open banking. Countries in LatAm can look to the European model of PSD2 as an example for successful regional open banking legislation that facilitates scaling operations for fintechs from country to country. While such an achievement would be more impressive in LatAm as it isn’t an economic or political bloc like the EU, that doesn’t mean that there cannot be a push for more regulatory collaboration between countries.

Regulators must be careful to not push out smaller players

While regulation is no doubt necessary to instill confidence in both consumers and potential investors, there’s no doubt that it has created serious barriers to entry for new players in fintech. For example, Uruguay’s 2018 regulation made it impossible for peer-to-peer lenders to stay afloat. The entire peer-to-peer sector was forced to stop operations due to the insurmountable demands of compliance.

For many startups, regulation will mean becoming compliant before officially launching and operating in the market. If a startup is already operating while the regulation is enacted, it will often be forced to freeze its operations and concentrate on compliance. This means a serious halt to cash flow as the company cannot take on new customers and provide the service to their existing ones. Without hefty funding, many startups are simply pushed out of the market.

In fact, 53% of startups surveyed by Fintech Radar Mexico 2019 said that the fintech law will create strong barriers to entry for new players. In addition, 46% of those startups said the high costs associated with compliance will generate inefficiencies, while 41% said the regulation is rigorous. Only 24% of startups surveyed said they are ready to comply with the regulation.

Clearly, there is a disparity between comprehensive regulation and the capabilities of startups to comply with new rules. Regulators must become more in-tune with the conditions needed to facilitate a dynamic startup ecosystem if countries are to see further innovation and growth in the sector.

How should fintech startups in LatAm behave in this regulatory climate?

With more regulation ahead, there are certain things that LatAm-based fintechs can do to raise their chances of success. The youngest ones should find ways to get creative and operate outside of regulation where possible, so they can avoid being hit with the many demands of compliance.

Those startups looking to scale and enter new markets must ensure maximum contact with that market before they officially launch. Once their product is operational in a new country, they must be agile and quickly test the responsiveness of the market to the product to be able to determine its potential for success.

Finally, it is being revenue-driven in the LatAm fintech ecosystem that will boost resiliency for startups. While funding from VCs can certainly help cover initial base costs — and interest from global VCs is growing (notably SoftBank’s $5 billion Latin America fund) — those startups that chose to bootstrap will have more flexibility to be nimble and adapt according to changes in the regulatory landscape.

The foundations for further growth and dynamism in the LatAm fintech ecosystem will not be laid by one single actor. A careful balance between regulatory consistency, legislation that tunes in with sector capabilities and forward-thinking agile startups will give continued growth and innovation the biggest chance of success.

Las opiniones compartidas y expresadas por los analistas son libres e independientes, y solamente sus autores son responsables de ellas. No reflejan ni comprometen el pensamiento o la opinión del equipo de Latam Fintech Hub y, por lo tanto, no pueden interpretarse como recomendaciones emitidas por la plataforma. Esta plataforma es un espacio abierto para promover la diversidad de puntos de vista en el ecosistema Fintech.

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