The UK continues to be ranked amongst the most ‘fintech-friendly’ countries worldwide and remains second only to the United States as a destination for fintech investment.

In the past 12 to 18 months, however, investment and M&A activity in the sector has been in decline.

In this article, we consider the reasons for that downward trend and argue there is reason to approach 2024 with cautious optimism.

Investment Trends
From the collapse of FTX, Celsius and BlockFi, the significant drop in cryptocurrency value to widespread redundancies, the Wirecard scandal and the cost of borrowing at record highs, 2022 was a challenging year for innovators in the financial services sector.

In the second half of the year, market volatility and the accompanying reluctance to invest in new projects led to previously readily available funding opportunities drying up and the M&A market slowing, making it an increasingly hazardous landscape for startups and established fintech companies alike.

This trend continued into 2023, evidenced in figures published by Innovate Finance in July reporting a 37% decrease in funding in the first half of 2023 when compared to the second half of 2022, as investors and large financial institutions err on the side of caution and remain conservative with their funding decisions; with an increased focus on the growth of their existing investment portfolios.

Perhaps unsurprisingly, there has been a clear prioritisation of profitability and favouring of fintech businesses able to demonstrate swift revenue growth coupled with a departure from investments in (initially) loss-making, high-growth startups.

Industry giants have also not been immune to these market challenges, with PayPal amongst those announcing a layoff of 2,000 staff and, less than a year after gaining ‘unicorn’ status, UK payments infrastructure company Paddle announcing it was downsizing its workforce by 8%.

These examples only scratch the surface of the well documented challenges faced by the global fintech market, largely due to high inflation, higher interest rates, the war in Ukraine and a drop in company valuations. Macroeconomic factors and global political tensions have been accompanied by fintech-specific difficulties such as the fallout from the collapse of numerous crypto firms in 2022, followed by the collapse of prominent banks in the sector, including Silicon Valley Bank (SVB).

According to the recent KPMG Pulse of FinTech H1 ’23 Report, across the EMEA region, fintech funding dropped from $27.3 billion across 963 deals in H2’22 to $11.2 billion across 702 deals in H1’23 although the US showed more resilience, accounting for two-thirds of fintech funding. Key trends internationally were identified as:

– An increasing focus on operational efficiency, sustainable cash flows, and profitability (from fintech companies and investors alike);
– Declining funding for crypto in the wake of sector challenges, combined with
– Increasing focus on real world asset tokenisation and institutional blockchain solutions from a TradFi perspective;
– Continued resilience of the payments sub sector, particularly payments infrastructure;
– Rapidly growing interest in potential uses for generative AI, particularly in cybersecurity, insurtech and wealthtech.

Current Fintech Financing Opportunities
In the face of the current uncertain economic environment, a key question fintechs are asking themselves is where and to whom they can, or in some cases should, turn to raise funds.

Traditionally, the UK has had accessible debt and equity capital markets. As a result, raising finance on the public markets has been a popular avenue for fintechs in recent years (Wise, PensionBee and LendInvest, amongst others), but for those not yet in a position to raise finance through listing, or those apprehensive to as a result of (in our view misguided) fears that London’s public markets may have lost their international appeal, there are alternatives.

Many fintech startups have combined crowdfunding finance with traditional sources, such as securing cash from venture capital and private equity. Incubators offering funding for startups in return for equity are also becoming increasingly prevalent in the UK and may present an alternative funding option to small and growing fintech businesses.

More recently, the UK Government has launched the FinTech Growth Fund, worth up to £1 billion, to back growth-stage fintechs, with a view to competing with Silicon Valley. The fund, backed by leading financial institutions including Mastercard, Barclays and the London Stock Exchange Group, aims to address the issue of fintechs struggling to scale and reverse the trend of tech firms pursuing a listing outside the UK.

It is a welcome shot in the arm to the sector, showing the UK government’s continued commitment to its development and growth. And, closer to home in Scotland, FinTech Scotland has recently launched the Financial Regulation Innovation Lab in partnership with the University of Strathclyde and the University of Glasgow to seek to revolutionise and shape the future regulatory landscapes in the UK and around the world by delivering a wide-ranging, ambitious research agenda to help advance the understanding and adoption of new and emerging technologies.

M&A Trends
While there are reasons to look forward with optimism for the fintech investment landscape, the M&A market remains slow. From 409 transactions closing in EMEA during 2021, deal flow has significantly dropped since (344 closing in 2022, while only 115 have closed in the region in 2023 to date – KPMG Pulse of FinTech H1 ’23 Report).

The UK has, however, been an outlier in the region, attracting the majority of fintech funding in EMEA in H1’23 and accounting for half of the region’s ten largest deals, including the $3.1 billion buyout of data insights firm Wood Mackenzie by Veritas Capital.

The divestiture of the Edinburgh headquartered firm evidences the credentials of the UK and Scotland as a key player on the global fintech stage.

We consider the current market challenges will continue for the remainder of 2023 and into early 2024. Lower valuations of companies and assets may encourage M&A deals from private equity and challenger firms, in each case looking to support fundamentally strong businesses with great management teams.

Whilst AI (especially generative AI) is expected to attract significant funding and attention, fintech activity is likely to remain subdued until global markets steady. There is a positive outlook for payment technology, insurtech and wealthtech, with significant interest in these sub-sectors.

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The payments field remains the most lucrative globally, with its perceived resilience, broad everyday applicability, and high growth potential, particularly in embedded finance.

We expect investment and M&A activity to rebound when global uncertainty eases. Whilst this uncertainty casts a shadow over the M&A and investment outlook, the long-term prospects for the fintech market in the UK and its attractiveness for investors and dealmakers remains positive.

The majority of fintech businesses have been disruptors in their sectors in the first instance, and typically have the ability to adapt and flex to changing circumstances, society and market conditions.

There is hope on the horizon for the sector, despite recent challenges!