The EBA’s discussion paper considers how fintech is changing financial services and the opportunities and risks this brings for the industry.

The European Banking Authority (EBA) has increasingly come to recognise the growing prevalence of fintech and its potential across the financial services industry. The EBA's enthusiasm for the benefits of fintech for consumers and businesses has been balanced by the unknown risks associated with new technologies.

With pervasive changes to financial services on the horizons, the EBA has launched a discussion paper to better understand these developments. What changes do the EBA see on the horizon?

The fintech mapping exercise

In the spring, the EBA undertook a ‘mapping exercise’ to identify how fintech was affecting or being applied across the financial services industry. The EBA received feedback from regulators in 22 member states and two EEA states on a sample of 282 fintech firms.

What were the key observations?

The EBA's main observations from its mapping exercise were as follows:

  1. Fintech is pervasive and becoming increasingly significant to financial services.
  2. The regulatory status of fintech firms appears to be very varied (31% of the fintech firms sampled were not regulated).
  3. A firm’s regulatory status does not appear to correlate with the technology used. The same or similar innovations are being applied by both regulated and unregulated fintech firms.
  4. Fintech firms mostly target consumers and financial institutions (34% of unregulated firms and 49% of firms of unidentified regulatory status targeted consumers).
  5. A significant proportion of fintech firms appear to hold funds, including customer funds (63% of EU regulated firms held customer funds compared with 12% for firms subject to unidentified regimes or no regulated regimes).
  6. There are considerable differences between the regulatory regimes of member states (with some member states having specific regimes in place for lending-based crowdfunding platforms and financial intermediaries). Similarly, member states have different policies in place for supporting the development of fintech (such as sandboxing regimes or innovation hubs).

What is the EBA’s view?

The EBA has identified a number of areas which it is looking to investigate further. In summary, these areas are:

Authorisation/Registration regimes. The EBA is concerned that there is a lack of harmonisation over the treatment of fintech firms by member state regulators. The EBA has expressed concern that some member state’s sandboxing regimes or innovation hubs are not in compliance with EU directives. Discrepancies in the regulatory treatment may lead to firms 'forum shopping' for states with the most lenient regimes.

Additionally, the high number of unregulated firms could be an indicator of a lack of consistent approach over which firms require authorisation. The EBA wants to ensure there is a 'level playing field' so that regulated firms are not being treated unfairly against unregulated firms which provide the same or similar services.

Risks and opportunities for credit institutions. The EBA notes that fintech presents opportunities to benefit consumers, credit institutions (CIs) and regulators alike, primarily by increasing competitiveness in the industry. At the same time, however, fintech may amplify certain risks for established CIs, like banks. There are growing risks around, for example, cyber security and data protection. CIs may also face new commercial pressures due to increasing competition and loss of traditional revenues which may, in turn, lead to instability in the market.

Fintech’s impact on CI business models. The EBA recognises that the traditional business models of CIs will change in the next few years to adapt to the opportunities available through fintech, whether these are streamlining back office functions to reduce operational and compliance costs, improving consumer engagement through digital interfaces or expanding products and services so that they are better suited for individual consumer needs.

Consumer protection and conduct of business. The EBA has previously looked into and considered the risks which technological innovations bring for consumers. The EBA has prepared the following ‘longlist’ of areas of risk for consumers:

  1. Consumers may be unclear of their rights due to confusion around the regulatory status and nature of the fintech firm they are dealing with.
  2. Differences in regulation and supervision by regulators may lead to differing levels of consumer protection across the Single Market. This is particularly pertinent for fintech firms due to their ability to use technology to engage with consumers remotely.
  3. Fintech firms (particularly where unregulated) may have unsuitable or non-existent complaints handling procedures. This might be through failings in their complaints procedures themselves, such as not reporting complaints, or due to uncertainties around the allocation of responsibilities where fintech firms interact with other firms to provide a service.
  4. Insufficient information may be being disclosed to consumers. Some firms are able to circumvent outdated legislation which has not been brought up to date with developments in digitalisation. This is exacerbated by the fact that there may be reduced opportunities for consumers to seek clarification where they are interacting with automated tools.
  5. There is a lack of financial literacy amongst consumers in member states which, together with the introduction of technological innovations, may result in consumers lacking risk awareness.

Fintech’s impact on firms’ resolution. There is at present a disconnect between fintech firms which are unlikely to be subject to resolution-related requirements and the increased risks that their technology may bring to the resolvability of transactions. For example, during financial crises, bank runs may be exacerbated by faster payment transfers through digital innovations. Decentralised technologies also pose questions of responsibility and enforceability for regulators.

Fintech and AML. Not all fintech firms will be 'obliged entities' for the purposes of the EU AML Directive, although they may provide similar services. This discrepancy between the AML requirements of fintech firms may lead to increased risk of fraud as well as unfairly affecting competition.

What are the next steps?

The EBA invites any responses to the 23 questions raised in its discussion paper. The deadline for responses is 6 November 2017. Contributions received by the EBA will be published following the close of the consultation.

Our final thoughts

We applaud the EBA’s increasing engagement with fintech and its pursuit of a clearer regulatory framework for a rapidly changing financial services industry. There will certainly be significant legal obstacles to overcome in order to develop an EU wide framework.

The thinly veiled swipe at member state sandbox regimes not complying with EU directives, however, could indicate a political agenda as well as lack of harmonisation. With considerable competition for becoming the global leader of fintech, member states will fight for the fintech crown.

This discussion paper asks important questions for the future EU regulation of fintech, the answers and member state consensus will not come easily.