The digital revolution in the financial sector will get a helping hand from EU regulators later this year when the European Commission tables new proposals for retail financing, with a clear objective: let the revolution flourish.
By the end of 2016, or in early 2017, the EU executive will unveil an action plan on retail financial services. The aim is to overcome barriers to the creation of a deeper Single Market in the fields of banking, pensions, and investment products.
Technology-driven financial products and services (FinTech) are expected to play an important role in this, according to a public consultation held earlier this year by the European Commission.
Despite all the hype around the FinTech world, the Commission is not willing to rush in its response. Officials explained that it is too early to regulate this nascent sector, especially since it is hard to come up with one-size fits all solutions for the different products and services powered by the digital revolution, such as crowdfunding or blockchain, the much talked-about technology behind virtual currencies.
On 14 September, the European Commission gave a hint of its hands-off approach in its effort to relaunch the Capital Markets Union:
“The Commission will continue to promote the development of the FinTech sector and work to ensure the regulatory environment strikes an appropriate balance between building confidence in companies and investors, protecting consumers and providing the FinTech industry the space to develop,” the communication said.
The executive has been also sympathetic to the digital disruptions seen in other fields such as the transport sector.
“The single market must keep up with the times: innovative business models must be encouraged and welcomed,” Commission Vice-President Jyrki Katainen said last October.
The Commission believes that FinTech can bring companies and investors closer to capital markets, and offer more convenient and accessible financial services to consumers, including new ones that better meets their needs. And it also fuels competition, one of the top concerns in Brussels.
“This innovative potential should be harnessed,” the CMU communication said.
EU officials added that the upcoming framework would be technology neutral, and should help to spur the sector’s growth, while addressing some of the risks that could emerge, such as cyber attacks or money laundering.
In January, ten people were arrested in the Netherlands as part of an international investigation into money-laundering through sales of bitcoins, the virtual currency.
The Dutch prosecution office warned that virtual currencies are “an attractive way for criminals to launder funds” since “it is not regulated or monitored by financial authorities”.
Striking the right balance
Numerous working groups have been set up across Europe in order to strike the right regulatory and supervisory balance “between a supportive approach and a protective approach”, said Verena Ross, Executive Director of the European Securities and Markets Authority (ESMA).
“The balance between the two is at times a challenge, but one that we consider most carefully, especially in light of our future product intervention powers,” she told a conference in London last March.
But Commission officials noted that not all EU bodies share this laissez-faire approach.
In its last report about the risks and vulnerabilities in the EU Financial System, published in August 2016, the European Supervisory Authorities (ESA) agreed with the Commission about some of the expected benefits of FinTech. However, the joint committee of the three regulators warned that FinTech providers are “likely to challenge the sustainability of current business models” while representing cybersecurity risks and privacy issues.
The European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority said they were considering new regulation “to warrant adequate levels of investor protection, financial stability, and market integrity”.
On top of the “individual risk features”, the EU supervisory bodies stressed that the technological innovations’ impact on market structure needs to be monitored as well, “in order to ensure that competitive forces create a continuous and smooth diffusion processes avoiding abrupt and disruptive industrial reorganisation”.
ESA announced that it will look at FinTech in a more “holistic” way in 2017. Its efforts will be coordinated with those of the Commission, the ECB and other authorities in member states to come up with an “appropriate” regulatory environment, the EU executive said.
While the digital revolution triggered a response from EU institutions, national capitals have only just started to wake up.
And still, only a few member states are seriously looking at how to deal with the digital revolution in the financial sector. Arguably, the best efforts so far have come from Britain. Last spring, the authorities established a regulatory sandbox, where innovators were able to test products without the normal regulatory constraints for two months.
This ‘sandbox approach’ has been advocated by companies and the IMF. During a panel discussion at the World Economic Forum in Davos, Christine Lagarde supported Paypal chief Dan Schulman’s idea of a sandbox, as this would help to experiment with new ideas while limiting any potential damage to consumers.
The banks get on board
While banks have embraced the opportunities brought by new technologies, they are also calling for a level-playing field.
“Digitalisation cannot overcome the statutory obstacles alone,” the European Banking Federation said in its opinion to the upcoming action plan on retail financial services.
“Banks willing to provide digital financial services across the EU still face the burden of having to comply with divergent consumer protection requirements in the 28 Member States. In most of the cases, even on-line banks have to set up a subsidiary in every country and adapt their products to local regulation and context,” the opinion said.
As the banking industry recalled, “far from blocking competitive initiatives, banks engage in Fintech partnerships, and finance innovative startups”.
Some large banking corporations like Citigroup have set up entire divisions to surf the digital wave. And others are thought to be doing the same.
Such moves come against the backdrop of a bank’s report for investors called “Digital Disruption”. According to the document, FinTech newcomers made $9 billion in revenues today, but are expected to multiply this by 10 before the end of the decade, to reach $100 billion. By 2023, FinTech could double again its business to reach $203 billion in North America, or 17% of retail banking, the report said.
In Europe, BBVA has invested heavily in the digital revolution. CEO Francisco Gonzalez shared the digital transformation of Spain’s second largest bank across the planet over the last few months, from the Davos forum to Harvard.
As “technology will be the driver of a dramatic improvement of productivity and efficiency in banking,” he aimed at turning the firm into the first Big Data-driven bank.
Some fear the digital disruption could lead to further concentration in the banking sector, in a winner-takes-all approach seen for example in the pharmaceutical world where nimble biotech startups were eaten up by large pharma groups.
“The key question here is whether FinTech will help the financial sector to serve citizens better or worse than it does now,” said Christophe Nijdam, secretary general of Finance Watch.
The Capital Markets Union (CMU), part of the third pillar of the Commission’s Investment Plan for Europe, seeks to better connect savings to investment and to strengthen the European financial system by enhancing private risk-sharing, providing alternative sources of financing and increasing options for retail and institutional investors.
The CMU Action Plan of September 2015 set out a comprehensive programme of actions to put in place the building blocks for the CMU by 2019.
But the first initiatives are progressing at snail pace. In order to relaunch the legislative process, the Commission presented on 14 September a communication to revive the CMU efforts.
As part of the agenda, the executive will present an action plan on retail finance services to overcome barriers to the creation of a deeper Single Market in the fields of banking, pensions and investment products.
- End 2016-beginning 2017: action plan on retail finance services
- European Commission: Communication 'Capital Markets Union - Accelerating Reform'
- European Supervisory Authorities: report on risks and vulnerabilities in the EU Financial System
- European Banking Authority: Consumers Trends Report 2016
- European Securities and Markets Authority: Financial Innovation: towards a balanced regulatory response, speech by its Executive Director Verena Ross
International Monetary Fund
- European Banking Federation: Response to the consultation on retail financial services
- Finance Watch: Summary of the conference "Between a rock and a hard place: The future of traditional banking"