I get a lot of questions about starting various types of financial services businesses. In this article I will go through the basics and – for most of you – shatter your dreams.
What is a Financial Service?
A financial service is an activity where funds are being handled on behalf of another party.
Companies used for personal gain, such as personal investment companies or companies set up to manage one’s own wealth otherwise, are not technically financial service providers since the funds belong to the owners.
Now, this doesn’t mean you can form a company and hand out ownership left and right to skirt financial services regulations. There are controls in place for how ownership can be assigned and intentionally abusive or evasive behaviour is regulated.
To keep things simple for this article, I will assume that financial services refer to money-related services rendered to third-parties.
Different Activities, Different Regulations
Although many have realized that the activity they have in mind will require a license, a common confusion I come across is that these would-be financial service providers fail to realize that different activities have different regulations.
Investment services are different from foreign exchange services which are different from deposit taking services which are different from credit services which are different from remittance services which are different from prepaid card services, and so on and so forth.
Insurance is also a type of financial service, often covered by its very own act of law – as opposed to just being a chapter in an act.
This is a service where customers deposit money into your company, which you then take and invest on behalf of the customer. Profits are shared between you and the customer.
It can also be investment advisory.
This activity requires a high degree of skill but a license is not always required, for example if the amounts or number of customers are very low.
Licensing requirements vary between jurisdictions but are generally easy to obtain if you have the credentials and can show at least 100,000 USD in share capital.
This can be a type of investment, where you invest in currencies and currency-pairs on behalf of clients.
It most often refers to the selling and buying of currencies. Customers who deposit USD to buy GBP are given GBP at an exchange rate you determine based on how much GBP other customers have deposited.
To make this work, you need a lot of initial capital and good banking connections.
License is usually required for any meaningful size of operation.
This is probably the easiest service to offer. There are a number of entities suitable for deposit taking, from various bank-like entities such as the north European sparkasse/sparkassa (savings treasury), New Zealand FSP, Panama, Costa Rica, or specially-licensed IBCs.
License is not always required but, again, for any meaningful size of operation, a license may become necessary. For one, to satisfy banking partners.
Issuing of Credit
Banks are often called credit institutions because that is what separates them from purely deposit taking institutions.
Issuing credit to individuals will often require a license but smaller operations may not always need one. Lending to businesses can be done under the guise of investment and may as well not always require a license.
So you want to compete with Western Union, Xoom, Ria, Transferwise, and Transfast?
Get a license or become an agent of them.
Unlicensed money remittance businesses are punished severely.
If you want to offer prepaid cards, you have three options:
- Partner with a licensed issuer.
- Partner with a partner of a licensed issuer.
- Become a licensed issuer.
Number 1 does not necessarily require a financial services license but the licensed issuer will prefer that you hold some form of accreditation. Being an experienced business professional can suffice.
Tonnes of service providers have partnered with a couple of Polish and Belizean banks that act on the very limit of the law. The Polish ones have ramped up their due diligence process as of late, though.
Number 2 is the easiest and is how nearly all these “anonymous prepaid card no ID free IBAN” operators operate, or used to operate. The entry requirements are almost nonexistent. These schemes used to get shut down a lot but things seem to have improved somewhat in recent times; either because I don’t keep enough of a close eye on that sector nowadays or because compliance has actually finally tightened.
Number 3 requires a license; often a full, unrestricted banking license.
Why Offshore License?
Why even a license?
Because one is needed – quite simply.
An offshore license is – or was – perceived as a way to satisfy the need to be licensed with tax advantages and relaxed license requirements.
Times have changed. Enforcement of laws is getting better, interpretations stronger, and authorities more diligent.
For reasons relating mostly to taxation but also to accountability and customer protection, having an offshore license to conduct financial services won’t be enough unless you are also operating in that jurisdiction. Even so, there may be constraints that prevent certain activities to be conducted or offered remotely or outside of economic trading zones such as the EU.
Offshore financial service licensees are or were often used to dodge tax and obfuscate ownership. This left customers with little to no recourse and security in case of bankruptcy or failure.
Similar to how gambling was once a free-for-all online, it has since shifted to regional licenses , and – in recent years – to per-jurisdiction licensing. Although not as strict, this has been happening in financial services, too.
So before you pay thousands upon thousands for a license, make sure the license is actually useful and that your structure is compliant. It would be unfortunate if your partner banks and brokers closed your accounts for fear of regulatory reprisal.