Over the past few years, various financial authorities in the EU have adopted various initiatives to facilitate financial innovation, including setting up so-called innovation facilitators (regulatory sandboxes and innovation hubs). These initiatives were designed to promote greater engagement between competent authorities and FinTech parties about financial innovations with a view to enhancing the understanding of regulatory and supervisory expectations of FinTech parties on the one hand and increasing the knowledge of the competent authorities about innovations and the opportunities and risks on the other.
On 7 January 2019, the European Supervisory Authorities (ESAs) (namely the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the the European Insurance and Occupational Pensions Authority (EIOPA)) published a joint report setting out a comparative analysis of the innovation facilitators established to date within the EU. The ESAs also set out best practices for the design and operation of innovation facilitators.
The analysis covers innovation hubs in 21 EU Member States and 3 EEA states and regulatory sandboxes in 5 EU Member States.
In short, innovation hubs provide a dedicated point of contact to ask competent authorities questions on FinTech-related issues, obtain non-binding guidance on how innovative financial products, financial services or business models relate to licensing or registration requirements and understand regulatory and supervisory expectations.
Regulatory sandboxes go a step further than that and provide a framework to enable firms to test innovative financial products, financial services or business models. Such frameworks require a specific testing plan to be agreed and monitored by a dedicated function of the competent authority. Regulatory sandboxes will not entail the disapplication of regulatory requirements.
We focus in on some of the observations set out in the ESA's joint report.
Innovation facilitators offer opportunities for FinTech firms to better understand the regulatory and supervisory expectations against the backdrop of rapid technological advancement and help enhance the accessibility of competent authorities, enabling participants to obtain clarifications regarding regulatory and supervisory issues at an early stage and within a reasonable timeframe.
On the other hand, competent authorities gain a better understanding of innovation in financial services, which ultimately also benefits FinTech firms: the savvier the regulator, the easier it will be for them to understand the issues that FinTech firms run into in their day-to-day business and find ways to deal with them. Their insights may enable the authorities to adopt a preventative approach, identifying supervisory issues early on, such as emerging risks to consumer protection, but also acquire a good understanding of potentially undue regulatory barriers to financial innovation. This also identifies a critical issue when it comes to innovation/FinTech: in practice it is challenging for the authorities to keep pace with the FinTech industry and find and retain skilled and experienced staff.
Other observations relate to the importance of good coordination between the various domestic authorities, but also internationally. This is obviously not exclusive to FinTech, but innovations aren't developed within the competence area of one regulatory authority and are not limited to particular borders. This will require the data protection, competition, financial services and/or consumer protection authorities to coordinate their approaches and views, both domestically and internationally, and to share knowledge.
In this context, the ESAs set out options, to be considered in the context of future EU-level work on innovation facilitators:
- the development of Joint ESA own-initiative guidance on cooperation and coordination between innovation facilitators;
- the creation of an EU network to bridge innovation facilitators established at the Member State level.
However, as the report rightfully points out: the limitations and challenges observed regarding the scaling of financial innovations across the EU may not be solved through guidance or networks, but may stem from barriers developing from, for instance, variations in regulatory requirements which cannot be solved via innovation facilitators.
In this respect, the ESAs believe it is important that a common approach is adopted to support collaboration between the various innovation facilitators to allow for the exchange of information about the emergence of specific financial innovations. Accordingly, the ESAs could promote a common approach by developing guidance in these areas. The report suggests the creation of an EU network of innovation facilitators, with participation open to all competent authorities in the EU. This could provide a platform for practitioners/experts to support participating authorities in reaching common approaches to firm-specific questions elevated to the network about regulatory and supervisory expectations regarding the treatment of financial innovations.
The potential difficulties of a shared EU regulatory approach
Whether the suggested approaches are going to be meaningful and effective remains to be seen. As the ESAs joint report also concludes: many reported impediments to scaling are the result of national legislation that determine definitions of financial instrument/services which are based on the directives transposed differently into national Member State laws, or conduct of business requirements that may differ across Member States. These differences may make it difficult to have a shared approach when it comes to the applicable regulatory and supervisory requirements.
Having said that, one may argue that ultimately the different stakeholders in the financial industry will benefit the most from a high-quality, open (minded) and frequent interaction between competent authorities and innovators, as by working together it is more likely that parties will come to a balanced approach than if we would leave it to a more reactive approach, where the regulator merely reacts to malpractices or crises.