In March 2017, the European Commission issued a public consultation document on Fintech. The goal of the European Commission (EC) document is to further the objective of a digital single market within Europe. This will be done by supporting the development of digital infrastructure, improving access to goods and services, and ensuring rules foster technological development.
The European Banking Authority (EBA) published its response to the public consultation in June 2017. The EBA response is significant because it sheds light on how European banks are approaching the areas of artificial intelligence, roboadvisors, crowdfunding, and big data. Institutions in other countries, including Canada, could benefit from careful analysis of the European approach to these issues as they craft their own Fintech strategy.
Artificial Intelligence and Roboadvisors – Potential Areas of Concern
Artificial Intelligence and big data analytics are areas where the European Commission is aiming to strike a delicate balance between fostering innovation and controlling risk. Automated artificial intelligence applications, such as roboadvisors, have the potential to provide enhanced and more personalized service to customers. However, these applications are not without risk.
The EBA identified several areas of concern in its response paper:
- Access to Information and Transparency – Customers have both limited access to the underlying algorithms underlying roboadvice, and limited understanding of how the algorithms work. European regulators such as the European Commission and the UK Financial Conduct Authority have expressed concern that customers could receive sub-optimal advice from a robadvisor without being aware this is the case due to lack of visibility into the underlying algorithm. This could lead to poor investing decisions by customers.
- Cybersecurity Risk – Algorithms could be compromised by malicious actors or software error. This exposes customers to the risk of financial loss. Best practices in data security should be maintained at all times to protect against unauthorized data access, as well as data misuse without customer consent.
- Market Distortions Caused by Widespread Automation – Large scale use of passive investment vehicles based on similar algorithms could result in customers taking the same actions en masse. This opens markets up to distorted pricing and in extreme cases to algorithm-influenced "flash crashes" brought on by sudden mass selling. Such events could be particularly problematic for investors because the allocation of liability is unclear.
- Limited Data Portability – Machine Learning Algorithms, which improve based on their interactions with a customer, may be able to offer a more personalized customer experience. In many cases these algorithms are proprietary, and financial institutions are reluctant to share them with competitors. If individuals cannot take their data with them when they transfer to another financial institutions, there is a risk their new institution may employ a different algorithm which may not be suited to their data. This could result in a lower quality customer experience.
These concerns are not jurisdiction-specific and could apply to artificial intelligence applications in a Canadian context as well.
The EBA takes the position that the robo-advice industry is still developing and that, at this stage, careful monitoring, rather than full-scale regulation is needed. Furthermore, since most Fintech services are provided online, the EBA argues regulators should be considerate of cross-border commerce and seek to avoid stifling innovation. In the event that such regulation is introduced, the European Commission has committed to ensure that it will be based on the principles of technological neutrality, proportionality to business size and significance, and promotion of market transparency and integrity.
Crowdfunding Regulation – Call for Harmonisation
The European Commission requested public comment on the impact of national regulatory regimes for crowdfunding on the development of social funding platforms in Europe. In January 2017, the European Crowdfunding Network issued a report on Crowdfunding calling for EU wide minimum standards for alternative finance legislation in member states. The EBA raised the concern that national regulatory regimes create room for regulatory arbitrage between nations and increase the likelihood of regulatory gaps. Since complying with different regulatory systems is quite costly, disparate national regulation of crowdfunding is a particular burden to Fintechs who do not have the same access to capital as established players.
The EBA suggests the introduction of an EU wide regime on Crowdfunding. This would facilitate cross border alternative financing which would make crowdfunding easier for smaller European economies. Harmonisation of regulations could also be helpful in prevention of terrorism financing or money laundering using alternative finance platforms.
The EBA also recommends harmonisation of the disclosure requirements for crowdfunding platforms. At a minimum, crowdfunding platforms should conduct a risk assessment and publish it to potential investors or lenders. A risk assessment should include a report on the creditworthiness of the issuers as well as disclosure documents on the risk of the investment being illiquid, the risk of loss, or the risk of unrealized return. These concepts are sensible ways to reduce the likelihood of fraud or marked risk in alternative finance forums. They are also consistent with the EC principle of encouraging market transparency.
The concerns in Europe are not unlike those expressed by Fintechs operating in Canada. Although Canadian securities regulators have, over the last couple of years, made a number of changes to provincial exempt market regimes, which changes are intended to facilitate greater access to capital (in particular, for start-ups and small and medium-sized businesses), market participants have expressed similar concerns over the lack of a harmonized regime across all Canadian jurisdictions.
Conclusion
The EC consultation aims to ensure European regulators balance fostering Fintech innovation with minimizing risk, particularly with respect to roboadvisors, crowdfunding and artificial intelligence. In this respect, the EBA has strongly argued in favour of harmonisation of standards across Europe. Developments in European Fintech regulation could potentially impact contractual arrangements of Canadian entities (either Fintechs or incumbents) engaged in cross-border activity within the European Economic Area. In addition, European regulatory developments will be particularly relevant to Canadian Fintechs who are considering expanding to Europe.
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