Financial technology (fintech) is strategically important to each industry. In line with this belief, on 8th March 2018, the European Commission published a fintech action plan that was designed to boost fintech innovation across Europe. In this article, Moey Li, representative of Beijing at Dewit Law Office, will outline the current developments to fintech rules and regulations at the European Union (EU)-level and will explain what is being proposed in the latest iteration of Europe’s fintech action plan.
Fintech refers to the technology-enabled innovation of financial services that are spurring new business models, applications and processes. Fintech is having a transformative effect on financial markets and institutions and on the provision of financial services in general.
Technological innovation in finance is not new, but the amount of investment and the pace of innovation has increased significantly. There has been rapid advancement in artificial intelligence, mobile applications, cloud computing, big data analytics and distributed ledger technology like blockchain. This has changed the business models of established financial institutions, technology companies and new market entrants, while affecting services for both consumers and markets.
For this reason, public authorities around the world have started to investigate the impact fintech has on financial services. For instance, the European Commission has already attempted to regulate the activities of fintech firms by enacting Payment Service Directive (PSD 2) and the Financial Instruments Directive (MiFID II), and recently on 8th March 2018, the European Commission (EC) published an action plan on fintech being used in the European financial sector.
Crowdfunding is an innovative way to raise funds that allows entrepreneurs to make an ‘open call’ for financial support that goes to a specific business project. This is generally done through an internet-based platform, which matches the amount of funding to the public’s demand for the project. Crowdfunding is vital as it helps companies tap into new sources of funding, while at the same time providing new investment opportunities.
Although there is currently a lack of EU-level legislation or regulation in this area, the fintech action plan pays special regulatory attention to this type of funding. In the action plan, the European Commission proposes a new regulation on investment-based and lending-based crowdfunding service providers (ECSP). This will create a European cross-border passporting regime for market players that choose to apply for the ability to operate as an ECSP, under the supervision of the European Securities Markets Authority (ESMA).
Crypto/virtual currencies and ICOs
Cryptocurrency or virtual currency is a digital representation of value that is: not issued or guaranteed by a central bank/public authority; does not have to be backed by a legally established currency; and does not possess the legal status afforded to currency or money. Cryptocurrency is accepted as a legal means of exchange that can be transferred, stored and traded electronically.
An initial coin offering (ICO) is an innovative way of raising money from the public by using ‘coins’ or ‘tokens’ and can also be called an ‘initial token offering’ or ‘token sale’. In an ICO, a business or individual issues coins and tokens for sale in exchange for fiat currencies, like the euro, or virtual currencies, like Bitcoin and Ether.
Currently, virtual currencies and exchanges used to trade ICOs are not regulated under EU law. Therefore, the European Banking Authority, the ESMA and the European Insurance and Occupational Pensions Authority has issued a series of warnings regarding the risks of buying and/or holding virtual currencies. They make it clear that these virtual currencies are generally not backed by any tangible assets and are unregulated.
Other actions are being undertaken to minimise risks associated with virtual currencies, specifically money laundering and the financing of terrorism. The European Commission will continue to assess the challenges and opportunities of Crypto-assets and ICOs and consider if the EU should take further regulatory action.
Open banking refers to an emerging idea in fintech where banks allow third-party companies to build applications and provide services using a bank’s data. It involves the use of application programming interfaces (APIs) to create a connected network of financial institutions and third-party providers (TPPs).
For open banking, the PSD2 is the main focus, although, regulations that include the EU General Data Protection Regulation (GDPR), the fourth Anti-money Laundering Directive and the EBA Standard on Secure Customer Authentication should also be considered. According to the PSD2, banks must use API technology that will grant third-party service providers, account information service providers and payment initiation service providers (PISP) open access to a customer’s bank accounts.
The TPPs will have to follow the same rules as traditional payment service providers when it comes to registration, licensing and supervision by the competent authorities. Additionally, the PSD2 will oblige payment service providers to step up security around online payments.
Robo-advisors are online platforms that automate investment advice using financial algorithms and aim to replicate many of the activities, at a (supposedly) lower cost, performed by wealth or insurance managers.
Legislation that pertains to robo-advisory services differs depending on the product and distribution model. Broadly speaking, robo-advisory services for insurance would be subject to registration requirements, information requirements and conduct of business obligations under the Insurance Distribution Directive. Whereas similar services provided for investment advice and portfolio management are subject to the MiFID II and future guidelines on assessing suitability (finalised in the first half of 2018).
About the fintech action plan
On 8th March 2018, the European Commission published a fintech action that will help the financial industry make use of the rapid advances in technology such as blockchain. This will benefit consumers, investors, banks and new market players.
This plan is part of the European Commission’s efforts to build a capital markets union and a single market for consumer financial services and is an integral part of the drive for a digital single market. The European Commission wants to have a set of EU-rules that are more future-oriented and aligned with technological development in the financial sector.
The action plan sets out steps for innovative business models to scale up, it supports the uptake of new technologies, it increases cybersecurity and it improves the financial system’s integrity. The new action plan is looking to achieve its goals by doing the following:
Licensing crowdfunding and monitoring the ICO development
- The European Commission is presenting a proposal for an EU-regulation on investment-based and lending-based crowdfunding service providers. The proposal aims to ensure an appropriate and proportionate regulatory framework that allows crowdfunding platforms to operate across borders with a comprehensive passporting regime under unified supervision.
- The European Commission will also monitor developments in crypto-assets and ICOs and assess whether regulatory action is required at the EU-level.
Institute guidelines on regulatory sandboxes/innovation facilitators
- The European Commission invites the European Supervisory Authorities (ESAs) to conduct further analysis and identify best practices by the fourth quarter of 2018 and, where appropriate, issue guidelines on sandboxes.
- It will present a report with the best practices for regulatory sandboxes by the first quarter of 2019 based on the work of the ESAs.
Put in place standards for increasing competition and cooperation
- The EC will help to develop a more coordinated approach by establishing standards for fintech in the fourth quarter of 2018, and it will support joint efforts by market players to develop standardised application programming interfaces that are compliant with the PSD and the GDPR for a European, open-banking ecosystem.
Host an EU fintech lab
- The European Commission will host an EU fintech lab where European and national authorities will be invited to engage technology solution providers in a neutral, non-commercial space during targeted sessions started in the second quarter of 2018.
Follow through on the EU blockchain initiative
- The European Commission will consult the public on the further digitisation of regulated information in EU-regulated market listed companies in the second quarter of 2018 and will continue to work on a comprehensive strategy that addresses distributed ledger technology and blockchain.
Enhance the security and integrity of the financial sector
- The European Commission will organise a public-private workshop in the second quarter of 2018 to explore and assess barriers that limit information sharing on cyber threats between financial market participants.
- The European Commission also invites the ESAs to evaluate, by the fourth quarter of 2018, the costs and benefits of developing a coherent cyber-resilience framework for market participation within the EU financial sector and to map, by the first quarter of 2019, existing supervisory practices across financial sectors based on information, communications technology and governance requirements.
Review its applicability
- An expert group will be established by the second quarter of 2019 to review the current regulatory framework’s applicability to financial innovation.
- The European Commission will have the ESAs explore the need for guidelines on outsourcing to cloud service providers by the first quarter of 2019.
Fintech is rapidly evolving, not only in Europe, but around the world. Understanding what the EU is doing to try and regulate and utilise these advanced changes to financial services is important for businesses if they hope to operate throughout the region. This new action plan will not only have long-term effects on European firms, but Chinese businesses as well.
Dewit Law Office, established in 1945, is headquartered in Brussels, Belgium. Dewit Law Office has always provided professional legal services to clients and dealt with a number of cases throughout Europe. As a member of SILFA, Dewit Law Office has a long-term relationship with law firms spanning the Netherlands, Luxemburg, France and Germany and provides efficient legal services to clients there.
Dewit Law Office established their Beijing office in 2009, where they not only provide legal services for European clients, but also assist Chinese firms when it comes to developing their business in Europe.