Redesigning the EU regulatory framework for fintech and digital financial services

The Pinsent Masons financial services sector team bring you insight and analysis on what really matters in the world of financial services.

The European Commission is conducting a review of the way financial services are regulated. This is overdue, and presents an opportunity for the Commission to make regulation more efficient, less costly and more forward-looking.

Overlaps, inconsistencies and gaps in laws and regulation continue to increase the cost and complexity of financial services. Regulated firms and technology providers have good reason to get involved in the review process to advocate regulation that deals with the way that business is actually conducted.

Through an initial consultation, the Commission asked for evidence from industry on whether some regulations are unnecessary and whether they have had unintended consequences.

The consultation is closed, and the Financial Conduct Authority (FCA) in its response highlighted that a new regulatory framework is needed, one that enables digital financial services. The FCA's response also highlights areas of regulation which could be improved to better accommodate the many ways in which 'fintech', new financial technologies, are transforming the sector. 

There is a need to reduce complexity in EU legislation

The FCA is responsible for over 40 pieces of EU legislation together with 'level 2 and 3' measures and standards which set out a lot of the detail around how financial services firms should comply with regulations. The sheer number of these sector-based rules creates a pressing need for EU law makers to think more broadly about reducing the overall compliance burden, especially aspects of it that result from constant change.

The EU itself knows this. It has a Better Regulation agenda designed to improve the law-making process and deals with the process of assessing the impact of introducing new rules.

In its consultation response the FCA said that much work is to be done in adapting the financial services regulatory framework if it is to reflect these principles of better regulation and reduce complexity within the regulatory system.

A starting point may be for impact assessments for new proposals to take into account the broader picture. Impact assessments typically focus on the overall cost to a business required to comply with a specific new law, but often do not pay enough attention to the cost of making changes necessary to deal with a series of new laws.

The introduction of uncoordinated new rules that require changes to technology and IT systems, documentation and processes is costly. That problem would be solved if more thought was given at the design stage to how these many changes could be better aligned to reduce the impact they will have on regulated businesses.

Aligning implementation dates to save cost

More thought should be given to coordinating implementation dates for new financial services rules in order to save cost. For example banks, card issuers, telecoms providers, technology companies and consumers will all be affected by changes that will result from the introduction of the Payment Services Directive 2, the Payment Accounts Directive and the Regulation on Interchange Fees.

Had the implementation dates for each of these pieces of legislation been coordinated, firms could have sought to have a more standardised approach to the changes needed. The reality is however, that each of these pieces of legislation has a different implementation date stretching across nearly two years. As businesses plan to respond to these changes as efficiently as they can, they will also have to bear in mind underling changes that the European Banking Authority will introduce as it drafts regulatory technical standards and submits those standards to the Commission.

This lack of coordination means that financial services businesses must focus more of their time and resources on adapting systems for compliance rather than on innovating to provide better customer outcomes.

Building trust and avoiding confusion

But reducing cost is not the only benefit that would come from better aligning implementation dates for new EU laws. Better alignment would also build greater investor and consumer confidence in the regulatory system.

Trust is eroded when investors and consumers are constantly having to cope with updated terms and conditions or other changes in regulation. As the FCA's response highlights, behavioural economics suggests that people get overwhelmed with too much information.

Aligning implementation dates would mean that financial services businesses could communicate regulatory change more effectively to their customers.

More effective communication would happen if consumers were told about changes when it mattered to them, such as at the most critical point during a decision making process, and in a way that is effective, one that accounts for the use of mobile devices. As we have all known for a long time, tension between the benefits of full disclosure needs to be balanced against the limitations of 140 character platforms and small screens.

Future-proofing laws

In its consultation response the FCA said that rules must be future-proofed to account for changes in technology. There is a clear need to update a number of outdated concepts, such as references in the Distance Marketing Directive to fax machines and floppy disks.

The Commission and regulators need help with this. To create rules that are flexible enough to deal with new technologies they need to work with those who understand the financial services technology of today and its future direction.

For example, in a number of pieces of EU law the concept of a 'durable medium' has superseded references to paper. But as we move towards cloud environments, the durability of a storage medium is less important than the medium's accessibility and the authentication of the data's integrity. Those with the greatest knowledge of future technologies will be able to best assist law makers in drafting definitions that do not create unnecessary barriers to their use.

While the call for evidence has closed, this is only the beginning of the review process for the Commission. There is therefore a good opportunity now for regulated firms and technology providers to provide an evidence-based approach to support a vision for changing regulation in a way that reduces cost and provides better outcomes for investors and consumers.

There is also an opportunity for established financial services businesses to address difficulties in the regulatory framework which make it difficult to make greater use of financial technologies and collaborate with fintech providers.