In a joint report (the “Report”) published on 7 January 2019, the EU’s three financial industry watchdogs considered the need for potential strategies to help coordinate and promote innovation in the EU fintech space.
The Report by the European Securities and Markets Authority (“ESMA”), European Banking Agency (“EBA”) and European Insurance and Occupational Pensions Authority (“EIOPA”) (together the European Supervisory Authorities or “ESA”) sets out (i) a comparative analysis of the role of innovation hubs and regulatory sandboxes (together referred to as “Innovation Facilitators”) at national level; and (ii) best practices regarding the establishment and operation of Innovation Facilitators in the furtherance of financial innovation and the interaction between fintech companies and supervisory authorities.
Innovation hubs seek to provide a forum for regulators and fintech companies to raise issues, seek guidance on compliance matters and discuss ideas. The first innovation hubs were established in 2014 with the majority becoming operational in the course of 2016 and 2017. Currently they are relatively widespread, with innovation hubs reported in over twenty-one Member States and three EEA States.
Regulatory sandboxes allow for a controlled environment in which new products and applications can be tested on real customers. Such sandboxes were first launched by the UK’s Financial Conduct Authority in May 2016 and have been attributed as a key factor in helping London become a major hub for financial technology. Other UK regulators, such as the Information Commissioners Office have also sought to use sandboxes to ensure compliance in the design of data-driven products (the subject of another Covington blog post available here). At present, only five Member States have operational sandboxes, with a further four having preparations for establishment under way.
As recognised in the Report, these Innovation Facilitators offer a range of benefits in helping supervisory authorities to keep pace with rapidly developing technologies in the financial sector. This includes offering such authorities the ability to anticipate regulatory and supervisory issues and to respond proactively. Further, it allows fintech companies easy access to regulators, allowing for early clarification on regulatory and supervisory matters and to act as a platform to raise policy matters.
However, the Report also notes that one of the potential impediments to the scaling of financial innovations across the EU is that Innovation Facilitators currently only operate on a national level. This approach can potentially result in different regulatory and supervisory stances being adopted towards the same innovation. Furthermore, risks are identified in terms of ‘forum shopping’ and ‘regulatory arbitrage’ that would compromise the level regulatory environment. In practice this may result in firms who have successfully tested innovations in one Member State having to repeat the processes of concept explanations, risk-mitigation and testing, with the risk of different outcomes.
To try and address the issues outlined above, ESA has proposed two measures at the EU-level:
- The development of ESA guidance on cooperation and coordination between Innovation Facilitators. Such guidance would seek to ensure that where authorities choose to agree on bilateral or multilateral collaboration arrangements, that a common approach is adopted to allow for the exchange of information in the context of information hubs and regulatory sandboxes.
- Network of Innovation Facilitators. Intended as a complementary measure to the ESA guidance, this network would be open to all competent authorities in the EU and provide a platform for practitioners/experts to support said authorities in arriving at common approaches to questions about regulatory and supervisory expectations. In addition, the network would also seek to enhance financial innovation and technical capacity through acting as a forum of authorities to share their knowledge on the operation of innovation facilitators.
At present these measures remain no more than early-stage proposals, but they do indicate that the ESA are actively considering methods to stimulate pan-European fintech innovation. For now, the Report uses its comparative analysis to outline best practices at a national level by way of principles for the establishment and operation of Innovation Facilitators. These principles are intended to promote convergence and ‘protect the level playing field’.
The ESA will continue to monitor developments regarding Innovation Facilitators at the national level within the EU and will take appropriate steps to promote a common approach towards fintech, as well as continuing to exploring strategies for cross-border coordination and cooperation. Further steps are to be outlined in the course of 2019.
The team at Covington will continue to monitor developments and keep you informed.