Are the Baltics the ideal marketplace for developing FinTech companies?
As a result of the United Kingdom (“UK”) exiting the European Union (“EU”) on 1 January 2021, a number of financial institutions in the UK lost their “exclusive” right of access to utilize the European Economic Area (“EEA”) passporting rules.1 These changes have also been felt by financial institutions based in Gibraltar.
Back in 2016, it was reported around 5,500 UK companies with licensed activities which have passported their authorization (i.e., a licensed activity) into the EEA are impacted as a result of the UK exiting the EEA bloc.2
While the UK certainly has a more favorable corporate tax regime when compared to other Member States, wider access to a larger marketplace seems to be the more favorable option in the long-run for most companies. It is also without a word of doubt, the UK’s focus on retaining its presence as a financial services leader is ever strong, for example, the recent relaxation of some of the eligibility requirements for companies seeking to IPO.3
Following the recent memorandum of understanding agreed between the EU-UK, concerning financial services cooperation, no visible guarantee was given to hold UK rules as equivalent to EU rules.4 While this mist of uncertainty hovers above the UK financial services industry, institutions are gearing up for plans B and C.
Seeking the necessary permissions and compliance via each individual Member State’s national regimes adds complexity and substantial costs for FinTech companies based in the UK. This is something which all FinTech companies would ideally like to avoid or circumvent.
In the last couple of years, the Baltic states (i.e., Latvia, Lithuania and Estonia) have geared up and responded by implementing favorable regulatory frameworks for all FinTech institutions. With this FinTech focus and benefits stemming from the passporting rules, the Baltic states are slowly driving the industry and attracting all the major market players, including Revolut.
In this article, we outline the important practical considerations one needs to consider for each of the Baltic states; their regulatory advancements, licensing benefits, stock options, capital markets and alternative financing mechanisms. These tools provide a beneficial and attractive environment for financial service institutions to either start out in life or continue growing their business.
1. Lithuania’s regulatory adaptation and transparency
Since early 2017, the Bank of Lithuania has instigated the rapid development of a FinTech-conducive regulatory and supervisory ecosystem, which continually fosters innovation in the financial sector. The two most notable events were:
- first, by opening a regulatory sandbox in late 2018 to allow startups and FinTechs to test their innovative products in a live environment under the guidance and supervision of the Bank of Lithuania.5
- Second, as a result of UK’s EEA departure and in the absence of an agreement on financial services cooperation between the EU and the UK, some UK companies with licensed activities subsequently passported into the EEA not wanting to be locked into only one single market. Lithuania has led by example, by inviting financial service institutions under their roof with an appealing and easily understood regulatory regime, attractive marketing plan, convincing regulatory supervision, as well as rapidly adapting national regulations for FinTechs, InsurTechs, RegTech and other startups.
One of the most recent examples is Revolut, which transferred its EU customers from its UK based company to a Lithuanian company. After setting up a Lithuanian company and acquiring a license for its activities, Revolut’s Lithuanian company has passported its licensed activities based on the provision of services without a branch in the other 29 EEA Member States, providing clients uninterrupted services. Revolut went even further by establishing and acquiring a Special Purpose Bank (“SPB”) license. The latter license permits Revolut to receive deposits and other repayable funds from its clients (Revolut currently provides this service in a total of 13 Member States).6
In terms of numbers, Lithuania edges ever closer each year to the level of the UK within The World Bank Ease of Doing Business rankings.7 While Lithuania continues to improve its regulatory regime, in some areas (ahead of the EU), the existing transparent regulator and ‘easy on the eye’ regulations, Lithuania is leaning towards becoming the dominant “Fintech Hub” in the EU.
2. The most popular licenses in Lithuania
Almost half of the FinTech companies in Lithuania hold an Electronic Money Institution (“EMI”), Payment Institution (“PI”) or SPB license. A majority of these companies can also issue prepaid cards and digital wallets for the benefit of their clients, in addition to making money transfers.8
3. E-money and payment licenses
The respective provisions of the Lithuanian Law on Electronic Money Institutions defines “electronic money” as a monetary value as represented by a claim on the issuer which is issued on receipt of monetary funds by the electronic money issuer from a natural or legal person and has the following characteristics: (i) stored electronically (incl. magnetically); (ii) is issued for the purpose of making payment transactions; and (iii) is received by persons other than electronic money issuers.
For any FinTech company to be able to accept money from clients in the ‘electronic domain’ and to hold it in payment accounts for a relatively long time, issuing electronic money and then redeeming it, prior to being able to do, it is first necessary to become an electronic money issuer.
The Bank of Lithuania supervises and authorizes electronic money and payment institutions within Lithuania. The authorization process usually includes: (i) submitting an application for an EMI license to the Supervision Service of the Bank of Lithuania; (ii) an assessment of the application for a license of an EMI and attached documents; and (iii) an issuance of a license or refusal to issue a license.
The entire authorization process, depending on the completeness of the documents submitted, usually takes around 6 to 12 months.
If, however, a FinTech company already holds an EMI license and respective documentation in the UK it is considered to be an advantage in producing the necessary documents, as well as saving time during the authorization process.
4. A SPB license
A key feature of a SPB is minimum capital requirement of EUR 1 million, while for traditional banks, it is EUR 5 million.
In terms of timing, it is possible to acquire a SPB license within 9 to 12 months.9
A SPB differs from a traditional bank and comes with a number of restrictions attached to the services which a SPB can provide. A SPB is subject to limitations in investment and other financial services of a similar nature. The respective services a SPB can provide are the following:
- acceptance of deposits and other repayable funds;
- lending (including mortgage loans);
- financial lease (leasing);
- payment services;
- issuance and administration of travelers' checks, bills of exchange and other means of payment, if these activities do not include payment services;
- provision of financial sureties and financial guarantees;
- financial intermediation (agent activities);
- money management;
- creditworthiness assessment services;
- rental of safe deposit boxes;
- currency exchange (in cash); and
- issuance of electronic money.
One of the notable benefits of holding an a SPB license, is the deposits of any one individual may reach up to EUR 100,000 and are insured under the deposit insurance scheme.10 SPBs are participants of the deposit insurance system and are obligated to make regular (ex-ante) and special (ex post) deposit insurance contributions to the Deposit Insurance Fund of Lithuania.
Importantly, a SPB license is valid across the EEA and activities can be passported to other Member States enabling access to the EEA financial services market. As previously mentioned, a good example is Revolut.
The Bank of Lithuania operates a CENTROlink system designated for processing and executing payment orders between Single Euro Payments Area (“SEPA”) participants.
The Bank of Lithuania provides technical access to SEPA schemes (credit transfers (“SCT”), direct debit (“SDD”) and instant payments (“SCT”)) for all types of payment service providers – banks, credit unions, e-money, or payment institutions – licensed in the EEA.11
Any EEA licensed payment service provider has an option to access CENTROlink, given there is no mandatory requirement to establish an entity in Lithuania to access CENTROlink.
A recent example of a financial service institution accessing CENTROlink is TBI Bank EAD. The latter is registered in Bulgaria and has passported its activity to Lithuania and the Bank of Lithuania has approved its access to CENTROlink system.12
6. Employee Stock options
On 1 February 2020, new tax-favorable legislation for the treatment of employee stock options came into effect in Lithuania.
Employee stock options can be exercised at no cost or for lower than their fair market value price, but no earlier than three years of holding stock options, from the date they were granted, are treated as non-taxable income for personal income tax purposes.13
7. Access to capital markets and alternative sources of financing
To encourage the development of capital markets in Lithuania, micro, small and medium sized enterprises (“SMEs”) can reimburse the costs incurred in acquiring third-party advisory services necessary exclusively for the listing of shares and/or bonds.
In such a way, SMEs can access alternative sources of financing with initially lower cost, for example, by receiving advisory services on setting set up a compliant and viable structure and on the respective financial instruments to be provided in the marketplace.14
In recent years, the government has paid a lot of attention to the development of capital markets. Legislation has been adopted to develop alternative sources of financing: (i) a legal framework for crowdfunding and peer-to-peer lending has been established; and (ii) private limited companies have been allowed to issue bonds publicly.
1. Latvia’s regulatory regime supporting FinTechs
In terms of numbers, one in five new Latvian startups belong to the Financial Technology sector.15
The Latvian Financial and Capital Market Commission (“FCMC”) has made available the Innovation Hub and Regulatory Sandbox to any market player for professional support and consultancy services in relation to existing and upcoming regulation.16
A good example of highlighting the FCMC’s readiness and competence to supervise the financial services industry, is in relation to the upcoming EU crowdfunding rules. The European Parliament has recently adopted the Regulation on European Crowdfunding Service Providers (“ECSP”) for businesses.17 The ECSP is already in force and is applicable from 10 November 2021. The ECSP is binding in its entirety across the EU and will provide a new and comprehensive set-up for crowdfunding platforms to operate under. In Latvia, the FCMC has already begun working and consulting with companies establishing or established to correspond with the upcoming rules in the ECSP.
Several of the largest European peer-to-peer marketplace platforms have originated in Latvia, such as Mintos and Twino, which are currently adapting to the recently adopted regulatory changes, by either acquiring an investment firm license and/or electronic money institutions license.18
2. E-money and payment licenses
In order to obtain a license to operate an electronic money institution or for the operation of a payment institution, the company must submit a complete application to the FCMC.
Depending on the licensed activities, the minimum capital requirement for an EMI is EUR 350,000 and for PIs starting from around EUR 20,000 up to EUR 125,000.
The FCMC shall take a decision on the issuance of a license or refusal to issue a license and inform the applicant within three months after receipt of all the necessary documents, as well as detailing the reasons in the event of a refusal. If all relevant documents are not submitted or submitted incomplete, the FCMC can prolong the duration for an additional three months, and therefore the licensing process can take up to 6 months (and as we have seen in practice, sometimes even longer).
In the event, a FinTech company already holds the respective documentation for a UK issued EMI or PI license, it could save time in adapting the documents and reduce the assessment period before the FCMC.
For FinTechs who intend to provide innovative payment service FCF reduces state fees for the examination of documents submitted for respectively chosen license of either electronic money institutions or payment institutions. Following the registration or authorization the annual charge is also set lower than average for the first three years.19 In other words, these instruments assist with limiting the financial burden (i.e., licensing and maintenance costs) at the early stage.
3. Attractive employee stock options
The main demand for employee stock options originates from FinTechs and other start-ups, which attract strong and high-level candidates for skyrocketing their ideas into a profitable company with promising equity.
Employee stock options, if developed thoughtfully, can attract employees for the long-term and set the ownerships’ mindset. Especially within the startup community, stock options are also used in cases when a company is not able to afford the increases in employees’ salaries at the time.
At the beginning of 2021, the Latvian Personal Income Tax Law and Commercial Law brought about favorable changes. These changes expanded the possibilities to grant stock options not only to joint stock companies, but also to limited liability companies’ employees, board and supervisory board members and other related companies’ employees.
The minimum holding period has been reduced from 36 months to 12 months and in addition, it is possible to exercise the option within 6 months after employment is terminated without losing the tax exemption.
4. Access to capital markets and alternative sources of financing
The FCMC has undertaken (until 31 December 2021) to create a development and support model enabling enterprises to prepare for their participation in the capital market in case of the issuance of share and/or bonds.20
Similar to Lithuania, Latvian SMEs can apply to reimburse the costs incurred by acquiring third-party advisory services necessary exclusively for the listing of shares and/or bonds.
1. Estonia’s e-government and embrace on digital platforms
In 2014, Estonia became the first country in the world to offer electronic residency to individuals from outside the country. The E-residency program equips e-residents with a digital identity and the status provides individuals access to Estonia’s transparent digital business environment.
With the e-residency kit, an e-resident can sign documents and can establish a company online from anywhere in the world, access banking, payment processing, as well as settle tax related obligations.21
A great benefit which comes with e-residency is the network of already existing e-residency entrepreneurs ready to share their experiences to outside companies who are interested in joining the community.
2. E-money and payment licenses
In order to obtain a license to operate an EMI or for the operation of a PI, the company must submit a relevant application to the Estonian Financial Supervision Authority (“EFSA”).
Depending on the licensed activities, the minimum capital requirement for an EMI is EUR 350,000 and for PIs starting from EUR 20,000 to EUR 125,000.
The EFSA shall take a decision on the issuance of a license or refusal to issue a license and inform the applicant within three months after receipt of all the necessary documents, as well as detailing the reasons in the event of a refusal, but not later than within six months after receipt of the application.
The seat and the principal place of business of a PI or EMI entered in the commercial register shall be located in Estonia.22
3. Start-up status and visa
Once a startup has decided to relocate their founders and/or employees to Estonia, the first step would be to apply for the ‘Startup Status’.
Once the startup holds the Startup Status, the company can hire global talent with ease and the founder can apply for a visa or a temporary resident permit.23
Estonians are open to attract non-EU founders via the startup visa, which is also designed for start-ups to ease process to hire non-EU talents.
To be eligible for the startup visa a founder must have a technology based, innovative and scalable business in mind, at least EUR 160 per month available for day-to-day needs and to receive approval from the Startup Committee.
In light of recent amendments, if approved, as of 19 February 2021 the same visa will be granted to family members – spouses and children.24
4. Stock options
Currently Estonia does not hold any specific incentive scheme for start-ups and issuance of employee share options are provided based on existing general regulations.
Rules regarding the offerings of transferrable securities are used to facilitate the need and together with the tax regime currently in force (applicable to all private companies), there are favourable options.
Tax exemptions for share options can be applied if an employee holds stock options for at least for three years. Most of the terms and conditions attached to stock options are established within a stock option agreement between the company and the option holder.
5. Access to capital markets and alternative sources of financing
While the issuance of bonds and/or shares is a regulated market in Estonia (similarly as in Latvia and Lithuania), Estonians have taken a big leap and in late 2017 passed legislation with the aim to regulate cryptocurrency trading. The latter gained popularity in the amounts of initial coin offerings (“ICOs”) and token generation events (“TGEs”).25
The structures of ICOs and TGEs vary and may be used to raise capital for different kinds of projects, for example, creating new coin, app or service launches. These structures provide for an alternative source of financing and are more frequently used for seed/early-stage financing, instead of the ‘traditional’ initial public offering (“IPO”) where the financing is company-based and usually are used as an exit after venture capital funding.
Any ICO or TGE should be assessed on its substance to define whether they should be treated as an issuance of a security instrument or not and which corresponding regulation should be applied.26
Where to go…?
Well, it depends. There is no right or wrong answer.
With certain limitations now visible for certain UK-based FinTech businesses trying to reach EU customers, detailed and clear thought needs to be given as to how to potentially widen the options in a fast growing and developing industry.
In the event the EU holds UK rules as equivalent to EU rules, as a result of further discussions, passporting considerations may not be necessary.
Without access to the EU marketplace, it significantly reduces the actual or potential customer headcount and therefore limiting prospective growth opportunities.
The Baltic States are leaning towards providing somewhat of a City ‘complement’ for FinTech businesses who wish to services customers throughout the EEA.
Regardless of the vision taken, it is important to carry out the necessary due diligence and preparations before engaging any of the regulators in either of the Baltic States.
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