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Financial technologies at the crossroads. Where will Estonia lead it?

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A recent report and discussion on the FinTech sector in Estonia point to crucial questions and potential for development for this dynamic and profoundly significant field in Estonia, the EU, and the world. 

Fintech, or “technologically enabled financial innovation,” is a rapidly evolving field that merges technology and financial services. The field encompasses companies involved directly in providing financial services – such as digital currencies, payments, and insurance and providers of technology that supports those services – such as analytics and digital identity. 

Current State and Future Direction for Estonian Fintech Ecosystem. 

Emphasizing one of the report’s key findings, the leading author Laivi Laidroo, Associate Professor and Vice-Dean of School of Business and Governance at TalTech, brings out that the fintech landscape in Estonia is very diverse and growing fast. The report listed 215 fintech companies as of the end of 2020, which refers to an increase of 131 companies (1.5 times) compared to 2018. 

Distribution of the number of Estonian FinTechs by type of activity

“This is a clear indication that good opportunities exist for developing different types of fintech companies in Estonia,” said Ms. Laidroo. “The ecosystem of companies, public sector, universities, and accelerators and incubators is supportive of new ideas and enterprises.”

Distribution of average net profit of Estonian FinTechs by type of activity.

Such productivity in the sector relies strongly on informal communication between industries and individuals (something mentioned in many other articles regarding Estonian IT success). Most key ecosystem players know each other personally, making it easy to connect with the public sector. This is further amplified by the participation of globally known companies (e.g., Wise, Veriff) in the ecosystem.

This brings us to find the appropriate model for inducing further development. In Estonia, companies and the public sector are currently debating should someone take the lead in creating the vision and determining the goal for the sector or if the openness of the system is the source of its strength.

However, what can be agreed upon is the necessity of keeping the smooth interaction and coordination going. In general, the Estonian business environment is supportive of newcomers and with its large ecosystem of accelerators and incubators with good contacts to established actors. In the public sphere, the Ministry of Finance, Bank of Estonia, and Financial Supervision Authority have become more open in communication with entrepreneurs in recent years. However, there have been several cases of money laundering in the financial sector in recent years, fraud in co-financing, and explosive growth of virtual currency service providers, which can be seen as ill-considered and inadequate regulation. The cases mentioned above have made state agencies more cautious in their decisions. As the report suggests, this could make the sector more closed.

Finding the right regulative balance

This brings to the question of regulation. The financial sector is known to be heavily regulated. In the EU, the single market is the cornerstone of all economic regulation. However, according to the report, the dynamism of mixing tech with finance is challenging for regulators, and there is a lack of detailed coverage for new business models. For the companies, regulative and regulatory-related factors are the most pressing issue regarding future developments, according to the survey. Hence, the second key question is how regulation balances the security required in the financial world and the openness of innovation needed to boost the economy.

Estonia’s regulation provides an excellent example of the dynamical oscillation between these two considerations. As a digital leader, Estonia recognized the potential of fintech early. In 2017, Estonia became one of the first countries in the EU to start issuing activity licenses to companies operating in the field of virtual and cryptocurrencies. This led to a boom of licensed virtual currency service providers in Estonia, with 1308 unique applicants receiving their licenses between 2017 and 2019. When significant money laundering emerged on the public radar that had relied on cryptocurrencies, the regulation had to react. In response, the regulation tightened the control. Since 2020, all holders of a virtual currency license must have their registered headquarters in Estonia and operate through a company established in Estonia. The amendments resulted in voiding 1296 licenses held by 705 unique companies. Estonia is looking further into regulating crypto-assets and introducing regulations for crowdfunding and other alternative investments. In 2021, the Ministry of Finance of Estonia introduced draft legislation intended to implement the rules on crowdfunding locally set out in the European legislation (ECSPR, see below) and broadened it to include, for example, P2P lending service providers in its scope. At the time of writing the report, the exact fate of the draft is still unknown.

Currently, there are similar ongoing processes in the EU because, according to Taavi Tamkivi, CEO of Salv and Financial Technology Area Head in FinanceEstonia, “The top political players of EU have understood the importance of the fintech sector.” 

As an example of this, a new regulation on European Crowdfunding Service Providers (ECSPR), which entered force in 2021, aimed at harmonising rules across the single market so that crowdfunding service providers need to apply for a license in one home member state and will then be allowed to operate in all other member states. Or, Markets in Crypto-assets regulation (MiCA) only mildly intervenes with business development by requiring providers to conduct self-reporting of fair, honest, and professional conduct; however, it reacts more strictly to e-money and asset-referenced tokens who will have to apply for a licence, and a regulator must approve the contents of their white paper before the offering can proceed. 

Reimagining financial purpose for sustainability and beyond

Although sector-specific concerns are significant and need to be solved, the stakes are higher. According to Luukas Ilves, deputy secretary-general for digital development at the Ministry of Economic Affairs and Communications, we should consider the architecture of moving value for tomorrow, and how this relates to people’s overall well-being.

“Blockchain and DLC make transparency available for the regulators, so fintech is not just replacing old banks. It expands the scope of financialization and allows using money as a tool in areas not currently affected by it, be it achieving sustainability or increasing wellness of people,” says Mr. Ilves. 

The role of regulators, therefore, is paramount in considering what are the values that we base our regulations on, and how they will direct the market. In the field of sustainability transition, this carries special weight in the light of recent disappointing news from top US banks which rejected going green in their investments. Sustainability issues will not disappear but will come back stronger. Innovation in both the private and public sector need to contribute more. Strong ideas relying on digitalization, such as carbon coins, are already proposed, and they need not remain in the area of science fiction. 

As also pointed out by Mr. Ilves, Estonia is in a good place to lead innovation because of our interdisciplinary culture and the opportunities for digital governance. Regulating FinTech towards sustainability is an opportunity not to be missed.

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Written by
Peeter Vihma

social scientist at the university of helsinki and the estonian university of life sciences

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