FinTech Report: Parliament sets the tone for regulating innovative financial services

Technology is transforming practically all aspects of life, and financial services are no exception. Examples of innovative Financial Technologies (FinTech) are becoming more and more mainstream, like crowdfunding platforms or virtual currencies such as Bitcoin. By making transactions and administration faster and smoother, these technologies have the potential to improve efficiency significantly; no wonder investment in FinTech is growing exponentially. At the same time, this sort of disruptive innovation contains many inherent risks, such as data and consumer protection challenges, cybercrime, and so on. Legislation in such areas is difficult, since being excessively cautious has the potential to shackle innovation, while leniency can lead to enhanced risk levels and legal uncertainty.

On 17 May, the European Parliament adopted an own-initiative Resolution on FinTech, which represents the first real step towards regulating electronic financial services such as cashless payments, crowdfunding platforms, virtual currencies, and many more. A non-legislative document, the Resolution aims to start a comprehensive discussion on the future of FinTech, while encouraging the Commission to thoroughly analyse the nature of digitalisation in the financial sector and propose actions to bolster innovation while enhancing security.

Commission Vice President Valdis Dombrovskis described the report as timely, as the FinTech sector is growing rapidly and the economic potential in the digitalisation of financial services is enormous; but benefits can only be reaped effectively if there is both security and legal certainty around these new services. At the end of 2016, the Commission set up a Financial Technology Task Force (FTTF) in order to help FinTech reach its full potential, and this Resolution by the Parliament will further intensify the debate on how to regulate the area without hampering its potential. Currently there is also an ongoing public consultation on FinTech which will close on 15 June, and which is open to all citizens and organisations.

This briefing will first give a short introduction to the area of FinTech and the specific challenges lawmakers face when trying to regulate it, and will subsequently summarise the seven main areas of the Resolution to paint a comprehensive picture of a complex field.

What is FinTech?

Financial Technology (FinTech) is a broad term that mainly refers to the digitalisation of traditional financial services such as lending, stock trading, and other transactions, for the purpose of providing these services (more) directly, or to enhance their efficiency. For example, peer-to-peer (p2p) lending allows consumers to borrow money without the need of an intermediary (a traditional bank), while cashless payments have already made buying and selling more efficient across practically all sectors.

Regulatory change in the financial sector is a sensitive issue, since it can affect companies from the smallest start-ups to the largest multinational banks. Several Directives already cover parts of FinTech, such as the e-Commerce Directive, the Payment Services Directive or the E-Money Directive, but there isn’t one that would cover all aspects. Since previous pieces of legislation were mostly designed for “classical” financial institutions, they may not fit well with new innovative models, and this can lead to legal uncertainty and an uneven playing field.

The Resolution is therefore a reaction to a pressing need for safe and effective regulation that can both strengthen financial integration and enhance the EU’s important global role with regards to financial services.

Seven key areas

The Resolution is divided into seven parts, according to the main areas FinTech touch upon as well as the most relevant issues to stakeholders, lawmakers and consumers.

1. Defining an EU framework for FinTech

First of all, the Resolution attempts to clarify its overall stance towards FinTech and the areas relevant to it. It welcomes the creation of the task force (FTTF), but emphasises that the Commission should draw up a comprehensive action plan, which could further reduce the regulatory uncertainty and contribute to a more efficient, competitive and integrated European financial system.

The Parliament believes that FinTech could contribute to the success of the Capital Markets Union (CMU) project as well, for example by providing more funding opportunities, and therefore the Commission and the Member States should take this into account when advancing the CMU or revising financial services legislation.

More generally, the “level playing field” principle should be observed at all times, ensuring that legislation and supervision are both based on the principles of “same services and same risks”, technology neutrality, and a risk-based approach. At the same time, as with all innovative areas, some experimentation in legislation should be encouraged, provided that it happens in a controlled environment – for example, in a so-called “regulatory sandbox”. This will not only help to identify good practices, but will also contribute to an adequate level of technical expertise for regulators and supervisor, necessitated by the ever-increasing complexity of FinTech services. For this reason, the Parliament proposes setting up a so-called “one-stop shop”, where service providers and users could find all relevant information on the regulatory and supervisory aspects of FinTech in the EU.

The Parliament emphasises that innovative service providers should be able to access funds easily to boost innovation, but reiterates the fact that FinTech – for all its enormous potential – could create new risks for financial stability. Therefore, it is pivotal that European Supervisory Authorities (ESAs) collect as much information as possible, and use it to impose a degree of regulatory constraint on companies’ balance sheets – but without hindering them from progress, especially with regards to supplying cross-border services within the EU. The Parliament believes that FinTech can prove to be an invaluable tool that could further raise the effectiveness of the Single Market, but only if consumers, who are the main driving force behind the rise of innovative financial services, can be supported and protected via national and EU-level legislative measures.

2. Increase the quality and quantity of data

Technology neutrality, which – from a regulatory point of view – means that the same laws or principles should apply to all technologies within a field, has become one of the EU’s principles when regulating electronic businesses. The Resolution stresses the need of staying technologically neutral when applying existing data legislation (e.g. GDPR, PSD2, eIDAS, AMLD4), as well as the importance of ensuring a free flow of data within the EU.

The openness and accessibility of data ensures that all business models can reach their full potential, therefore the report highlights the need for clear rules on ownership, access, and transfer of data – whether raw or pre-processed. At the same time, it emphasises the importance of better informing consumers concerning the value of their personal data.

One of the latest trends with regards to financial services is the appearance and spread of algorithms, which, combined with personal data, can provide financial advisory services such as “robo-advice”. Although these may have many positive implications for financial inclusiveness, they also have the potential to cause harm to consumers and pose systemic risk; therefore the Parliament advises close monitoring in order to establish whether further legislation is needed in this area.

3. Cybersecurity and ICT risks

The Resolution emphasises that there is a need for end-to-end security across the whole value chain of financial services, while encouraging the Commission to make cybersecurity its top priority in its upcoming Action Plan. To further enhance security, it calls for the ESAs (and the ECB) to supervise the banks, review their operational standard requirements and provide guidelines on how to mitigate such risks. In addition, all stakeholders (supervisors, regulators, governments, researchers, market participants, etc.) should strive to achieve effective information exchange, potentially through a single contact point.

The document asks the Commission to develop new concrete initiatives in order to make FinTech businesses more resilient against cyberattacks, as well as to better educate consumers and businesses about security risks. This being said, the report warns that companies’ safety measures should not be completely uniform, since in that case one breach can put the whole field in jeopardy.

4. Blockchains

There is a huge potential in the application of blockchain technology for transfers (cash or securities), as well as for smart contracts. The latter is a sort of computer protocol that executes the terms of the contract (replacing traditional contractual clauses), leading to more efficient arrangements in lending, trade finance, etc.

The Parliament also highlights both the benefits and risks of “unpermissioned” blockchain applications (which have no single owner and are open to everyone), such as Bitcoin. It calls on the Commission to identify the issues through multi-stakeholder meetings and address them in a report.

5. Interoperability

APIs (application programming interfaces) provide methods of communication between software components, which are crucial for interoperability. The report underlines that interoperability is a key precondition to a well-working and efficient FinTech sector; it therefore acknowledges the importance of APIs and calls for the standardisation (although with the opportunity left to vendors to develop their own) of both APIs and data formats.

MEPs also call on the Commission to coordinate between the relevant actors (Member States, market participants, etc.) to ensure that newly created FinTech systems are interoperable with remote identification systems, with special regards to the e-IDAS, the EU-level personal identification scheme. The Commission is also asked to identify ways of remote identification in connection with the second Payment Services Directive (PSD2), to determine whether “strong customer authentication” is suitable for banks as well, not only for average customers.

6. Financial stability and the protection of consumers and investors

Since the threats related to new, innovative financial services are not yet completely understood, the Resolution highlights the need to pay specific attention to both the needs and potential vulnerabilities of investors and retail consumers, especially because of the expansion of FinTech in services to non-professional clients. European Supervisory Authorities (ESAs) are encouraged to partner with private-sector players and intensify the monitoring and analysing of new technological developments to better understand their implications.

With regards to new technologies in insurance (unfortunately named “InsurTech”), the Report highlights the large amount of uncertainty surrounding the area, and thus calls for more legal certainty which could enhance security and privacy and lead to more overall financial stability.

7. Financial education and IT skills

If consumers are to use FinTech safely and efficiently, they need to acquire adequate skills in both financial and digital literacy. The Report emphasises that, without proper financial education, new technologies will not be able to fulfil their potential, and therefore the Commission and the ESAs need to work together to ensure an appropriate level of education accessible to everyone.

Finally, the text warns that the Commission itself forecasted a shortage of almost one million ICT professionals by 2020, and subsequently calls for the Member States to better prepare for the accelerating labour market changes.

Next Steps

The Resolution was adopted by the European Parliament at the plenary meeting of 17 May 2017. The Public Consultation is still open to citizens and businesses until 15 June, after which the Commission will evaluate the results and decide if further action is required at EU-level.

Additional Facts:

Official Title: European Parliament resolution of 17 May 2017 on FinTech: the influence of technology on the future of the financial sector

Adopted: 17 May 2017

Procedure: Parliament Own-Initiative