Intended audience: Boards and senior management leading innovation and strategic partnerships of regulated financial services (FS) firms. It will also interest heads of risk, compliance, and regulatory affairs of FS firms considering or adopting embedded finance.
Embedded finance allows any business to integrate third-party financial services or products into their own digital customer journey at the point of need. Buy-Now-Pay-Later and payments are well-known examples. However, other banking, insurance, and embedded investment use cases are starting to emerge, driven by consumers' growing demand for integrated online experiences, and enabled by digital and technological innovation. [Download our full report for a more detailed definition of embedded finance and how it works].
Some of the most promising opportunities for FS firms lie in partnerships with non-financial business brands, including digital platforms. But as more regulated FS firms explore such partnerships, EU and UK financial services and cross-sector regulatory authorities are also taking an increasingly active interest in the risks and opportunities they present for markets and consumers.
We set out four thematic regulatory areas of focus – consumers, data, resilience, and governance and accountability. Considering existing and emerging regulatory pressures and enablers from the outset of any embedded finance journey will be critical to its success and long-term viability.
Navigating regulatory requirements: embedded finance vs traditional business models
Embedded finance offers attractive benefits for all ecosystem participants. It can remove friction in the consumer experience while creating growth opportunities, competitive advantage, and operational efficiencies for both regulated FS firms and business brands.
However, embedded finance also harbours some complex risks. While these risks are not new per se, they are exacerbated – or made more challenging to manage – by some of embedded finance's unique characteristics compared to traditional FS business models.
A prime example is the critical role that business brands will play in the embedded finance value chain and their control over the customer journey, relationship, data and technology stack. Yet, business brands will typically be entities that are unfamiliar with FS regulatory requirements. This may put pressure on embedded finance partnerships where there are challenges in reconciling customer experience, commercial priorities, and compliance.
FS firms will have to review and enhance their risk appetite, governance, and risk management frameworks (RFM) to ensure they remain fit for purpose in an embedded finance environment and can ensure the firm fulfils all applicable regulatory requirements.
The latter will depend on the exact embedded FS offering, as no single embedded finance regulatory framework exists. Instead, regulatory and supervisory demands will increase in line with embedded finance's potential to harm consumers and threaten market integrity. In practice, this means that the complexity of the regulatory environment will directly correlate to the business complexity of embedded finance use cases and the scale of their adoption.
The four thematic regulatory areas that we expect FS and cross-sector authorities to primarily focus on when scrutinising the risks and opportunities associated with embedded finance business models are set out below:
Regulatory considerations as a critical factor in strategic business choices
We believe current and emerging regulatory focus areas across the above four themes, as well as policy enablers (e.g., Open Finance or Digital ID), should inform a firm's strategic choice about who to partner with, which products to offer, and when to enter the market.
Regulation will also influence the firm-level capabilities FS firms need to build or enhance. For example, firms should review and update their risk appetite to address the risks arising from the shared responsibilities with business brands and other material TPPs around the customer journey, technology, and personal data.
Strategic choices around the Target Operating Model will also be required. For example, whether to integrate embedded finance into their existing core business or create a stand-alone entity. The integrated approach would allow the firm to leverage existing people, expertise, processes, and technology and integrate channels more efficiently where it benefits its customers. However, a separate entity may make it easier to create an innovative culture, adopt development methodologies, attract digital talent, and avoid the limitation of legacy systems.
Embedded finance has the potential to reshape access to financial services, meet consumer financial needs in the most relevant context, and give FS firms access to new markets and customers through strategic partnerships.
However, designing and implementing successful embedded finance strategies will require FS firms to carefully navigate tensions between prioritising commercial priorities, achieving the right regulatory outcomes, and delivering a seamless customer journey while operating within their risk appetite.
For more details and our full analysis, please download our report.