Fintech – technology-enabled financial innovation – continues to gain in importance.
To create an environment in the EU that will enable fintech to continue flourishing, competent authorities have adopted various initiatives. These include the establishment of innovation facilitators, the number of which has grown rapidly in recent years.
What are innovation facilitators?
Innovation facilitators aim to encourage greater engagement between authorities and firms about financial innovations – not only to support firms in understanding regulatory and supervisory expectations but also to increase authorities' knowledge about innovations, and the risks and opportunities they present.
They may take one of the two following forms:
1. Innovation hubs
Innovation hubs provide dedicated points of contact (eg telephone or electronic interfaces, online or physical meetings) for firms to raise enquiries and initiate a dialogue with authorities on fintech matters.
For example, a business might want to know whether a certain activity requires licensing, whether anti-money laundering issues arise or which other regulatory requirements apply. The guidance given by authorities via hubs is non-binding, except in Poland, where the hub is mandated to render binding advice.
Beneficiaries are usually:
- established financial market players;
- (potential) new financial market entrants; and
- other firms, such as technology providers, that offer solutions to financial market participants.
An exception is Austria, where regulated entities are requested to direct their fintech-related queries to their usual contact at the Finanzmarktaufsichtsbehörde, Austria's financial markets regulator, rather than the hub.
2. Regulatory sandboxes
Regulatory sandboxes offer a framework through which firms can test innovative financial products, services or business models in a "live" context, monitored by competent authorities.
Testing occurs during a testing period, pursuant to a testing plan and within specific parameters (eg limitations on the number of customers).
Similar to innovation hubs, sandboxes are typically open to:
- established financial market players;
- firms considering to enter the financial market or having done so recently; and
- other (eg technology) firms – but only if they partner with regulated entities.
To participate, firms have to meet further conditions defined by competent authorities and/or national law. These usually include the proposition having a minimum level of novelty and a certain nexus to regulated activities.
What is the current situation?
According to a January 2019 report on regulatory sandboxes and innovation hubs by the European Supervisory Authorities (ESAs), 24 European Economic Area states had hubs. Sandboxes were less common, with only five EU member states – Denmark, Lithuania, the Netherlands, Poland and the UK – having such a system.
Since then, further innovation facilitators have been set up, including a hub in Bulgaria and a sandbox in Hungary. In Norway, preparations are ongoing to make a sandbox operational this year. In Spain, legislation on a sandbox is underway.
There is also draft legislation in Austria for implementing a sandbox but it is currently on hold following the government's termination in June. It remains to be seen whether the endeavour will be revived after national elections on 29 September 2019.
Some authorities are less keen on regulatory sandboxes. For example, in a forthright statement, the New York Department for Financial Services said that: "Toddlers play in sandboxes. Adults play by the rules." (For more on this, see Claire Harrop's blog.)
In its digitalisation strategy, the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), Germany's financial regulator, said that it would not use a sandbox approach, arguing that the principle "same business, same risk, same regulation" demands that fintech firms be supervised just like any other regulated financial institution. According to BaFin, only the intensity of supervision can differ depending on the risk, in application of the proportionality principle.
Interestingly, the concept of a sandbox as promoted by the ESAs seems not necessarily to entail anything to the contrary, depending on its concrete implementation. In their report, the ESAs make it clear that firms participating in sandboxes are required to comply with applicable laws and regulations, and that no "light touch" approach applies. This includes that, to the extent firms carry out a regulated activity in the sandbox, they are required to hold an appropriate licence (ie if they do not have it already, they have to obtain it before testing starts).
The ESAs take the view that competent authorities may exercise discretionary powers and apply levers of proportionality embedded into law. This might concern licensing processes – for example, authorities might issue a temporary licence for the duration of the testing or impose further limitations reflecting the restricted scope of the activities to be conducted in the sandbox. It might also be relevant for ongoing supervision – such as in terms of expectations regarding internal governance processes.
However, according to the report, whenever discretion or proportionality is applied, this should occur in line with "normal" practice as per firms not participating in the sandbox.
Thus, it seems that even adults in a sandbox have to play by the rules that apply to those outside the sandbox. But if this is so, why have a sandbox at all?
The key advantage of a sandbox seems to be that it is a space, limited by the testing parameters, where firms and authorities can (quickly) find out whether a proposition works and, if so, whether it meets the necessary regulatory requirements. By testing an application before a full market launch, firms still have time to change their proposition before committing to a broader roll-out. Hence, for firms, the sandbox is, in the end mainly, about saving costs and time.
In addition, sandboxes and innovation hubs may make it easier for firms to identify the regulatory and supervisory expectations applicable to them and to demonstrate compliance therewith.
Further, for the authorities, sandbox testing allows them to better understand financial innovations and what the regulatory framework means when applied to them. The insights obtained from innovation facilitators might even influence future regulation and supervisory approaches, as the European Securities and Markets Authority recognised in its July 2019 report on the licensing of fintech business models.
The success of innovation facilitators will further depend on how they are used and operated.
In April 2019, the ESAs and the European Commission launched the European Forum for Innovation Facilitators (EFIF). Through the EFIF, the ESAs and national competent authorities will exchange experiences from engagement with firms through innovation facilitators, share fintech-related know-how, and exchange views on the regulatory and supervisory treatment of innovative products, services and business models.
The expectation is that the EFIF will help to boost cross-border co-operation, co-ordination and potentially convergence, and thereby contribute to the number-one objective of the Commission's fintech action plan: to enable innovative business models to scale up across the EU.