Patrick Armstrong, Senior Risk Analysis Officer in ESMA's Innovation and Products team, has published a speech given on 27 September at FMA’s FinTech conference. The speech highlighted the issue of regulatory risk in FinTech, in particular in the issue of identifying the ‘tipping point’ between issues which are ‘too small to intervene’ and which are ‘too large to ignore.'

As part of determining this point, ESMA has put in place a framework to analyse of financial innovation using a balanced principles-based approach guided by the three core objectives:

  • investor protection;
  • financial stability; and
  • orderly markets.

This framework informs of the range of innovation ESMA tracks as well as the tools it employs. The speech set out in general terms the regulatory challenges which ESMA sees in FinTech, before giving an update on the regulatory work being undertaken in the areas of robo-advice, Big Data and artificial intelligence, crowdfunding and distributed ledger technology.

The challenges

The speech highlights five challenges to financial innovation across the EU:

  • a lack of heterogeneity of the financial markets Member States;
  • unexpected risks from what has been designed and targeted to a given segment of sophisticated market participants over time migrating to a market segment home to less informed investors
  • being able recognize and inhibit growth of flawed products before they become widely distributed;
  • dealing with weaknesses that are only become apparent during periods of extreme illiquidity or economic crisis;
  • the limitations in classical risk management tools, e.g. the lack of time series information to measure volatility and tail risk; and
  • dealing with the incentives for the private sector to seek to circumvent the intended regulation.

Automated advice (robo-advice)

In December 2015, the Joint Committee of the three European Supervisory Authorities (ESAs) published a discussion paper onautomated advice, highlighting its benefits and risks to consumers and to financial institutions. The aim was to assess what, if any, action is required to mitigate potential risks and how best to harness the potential benefits of this innovation.

Benefits included:

  • greater and cheaper access to more consistent service; and
  • more consistent service.

Risks included:

  • the potential for consumers to misunderstand advice provided;
  • the potential for limitations or errors in automated tools; and
  • the potential risks associated with the widespread use of automated advice tools (e.g. “herding risk” if a significant volume of consumers end up transacting in the same way in relation to the same financial products and services).

The three ESAs have analysed the responses received in relation to the discussion paper and are in deciding whether further cross-sectoral action is warranted or needed at this stage, although from a securities regulators standpoint, it appears that robo advice can exist within the technologically neutral MiFID framework.

Big Data/artificial intelligence (AI)

Big Data is the processing and use of high volumes of different types of data from various sources, using IT tools, in order to generate ideas, solutions or predict certain events or behaviours. This, in particular, allows for increasingly powerful search techniques to support behavioural analytics and collect and manipulate information from many different sources to identify and measure risks, trends, and customer preferences more comprehensively than ever. In turn, AI software largely relies on data to discern patterns, identify trends and make accurate predictions.

The ESAs have noted the continued increase in the use of Big Data across the banking, insurance and securities sectors, and are working to better understand it relative to the relevant regulatory frameworks. Potential benefits include improved quality of services/products, more efficient processes or better management of risks or fraud situations. Potential risks include the impact on access to products/services for certain consumers, the lack of transparency around the processing of data and the firms’ decision-making using Big Data technologies, the potential limitations or errors in the data and analytic tools, and security and privacy concerns. The ESAs will analyse whether any actions are required to mitigate the risks whilst harnessing the benefits.


Crowdfunding is as a new means of providing financing and an alternative investment solution that provides a complementary source of funding for small businesses. Member States and National Competent Authorities (NCAs) have been working on how best to respond to crowdfunding and, NCAs in many member states approached ESMA to clarify how crowdfunding fit into existing legislation. As the tipping point had been reached, ESMA published:

  • an Opinion to National Competent Authorities on how to supervise crowdfunding. The Opinion provides clarity on the rules likely to apply to investment-based crowdfunding to mitigate the risk of divergent interpretations of existing legislation within the EU. ESMA stresses that the regulatory burden under legislation such as MiFID need not be as great as some in the industry seemed to think at the time;
  • advice to EU Parliament, Council and Commission on how they may wish to regulate crowdfunding. The Advice highlights ESMA’s concerns that strong incentives currently exist for crowdfunding platforms to structure their business to fall outside the scope of regulation, particularly the rules on prospectuses. ESMA advises the institutions to consider possible policy options to reduce these incentives; and
  • Q&As specifically regarding pertinent risks in relation to money laundering and terrorist financing in relation to investment-based crowdfunding.

Distributed ledger technology (DLT)

ESMA is analysing DLT and its potential applications across the securities markets investment life-cycle, ESMA publishing a discussion paper on the potential uses, benefits and risks of DLT applied to securities markets in June 2016. For more information and a summary of this discussion paper, please see our previous publication, available here. More than 60 stakeholders responded to the consultation, which has now closed, and ESMA is using this feedback to develop its position on the use of DLT in securities markets and assess whether a regulatory response is needed.


Mr. Armstrong concludes that the topic of innovation differs in magnitude from the vast majority of work ESMA does in the policy space, and that the types of and need for innovation differs greatly across Member States. ESMA’s framework needs to remain flexible and adaptive to market events and to know when to respond in a supportive as opposed to a protective manner. ESMA intends to revisit the framework on a regular basis to ensure it remains effective and relevant.

Next Steps

Our dedicated FinTech team is experienced in working with market participants to bring innovative FinTech products to market, both through the FCA sandbox and outside of it. We are also hosting a Digital Financial Services Conference at our London office on 1 November 2016, covering a wide range of FinTech issues with presentations by leading industry specialists.