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See discussions, stats, and author profiles for this publication at: From FinTech to RegTech: How have European countries responded to the development of FinTech through regulation? Research December 2019 DOI: 10.13140/RG.2.2.20178.09928 CITATIONS0 READS525 1 author: Anthousa Agathokleous University of Nottingham 1 PUBLICATION0 CITATIONS SEE PROFILE All content following this page was uploaded by Anthousa Agathokleous on 10 December 2019. The user has requested enhancement of the downloaded file. University of Nottingham, Dissertation for the Degree of Master of Laws (LLM), LLM in International Commercial Law 2018/19 From FinTech to RegTech: How have European countries responded to the development of FinTech through regulation? Anthousa Agathokleous I hereby declare that I have read and understood the regulations governing the submission of postgraduate dissertations, including those relating to length and plagiarism, as contained in the Handbook for Taught Masters Students, and that this dissertation conforms to those regulations. i TABLE OF CONTENTS TABLE OF CONTENTS . i ABBREVIATIONS LIST . iii INTRODUCTION . 1 PART I FinTech: Evolution and Innovations . 3 FinTech evolution . 3 FinTech 1.0 . FinTech 2.0 . Early regulatory response to FinTech . FinTech 3.0 . FinTech 3.5 . FinTech innovations . 7 Crowdfunding and peer-to-peer lending . Robo-advisors . Cryptocurrencies and blockchain technology . Artificial Intelligence and Machine Learning . From FinTech to RegTech . 11 PART II FinTech: Evolution and Services . 12 What are the risks associated with FinTech? . 13 Financial stability risks . Other risks associated with FinTech . What are the challenges in regulating FinTech? . 17 Regulatory response to FinTech . 18 Some considerations for regulators . 19 Principles-based or rules-based regulation? . Engagement or enforcement? . Pro-active or re-active regulation? . A global regulatory approach to FinTech? . What has been done so far in the context of the EU? . 21 Payment services . Crowdfunding and P2P lending . Blockchain, crypto-assets and/or cryptocurrencies . Automated services and robo-advice . Data and consumer protection . Innovation facilitators . ii PART III Specific regulatory approaches to FinTech: UK, Germany and Cyprus . 27 General regulatory framework for FinTech businesses . 28 Crowdfunding and P2P lending . 30 Robo-advisors and automated advice . 32 Blockchain, crypto-assets and/or cryptocurrencies . 33 Innovation facilitators . 37 Non-financial regulation . 40 RegTech. 42 CONCLUDING REMARKS . 43 BIBLIOGRAPHY . 46 iii ABBREVIATIONS LIST ABBREVIATION EXPLANATION (5)AMLD (Fifth) Anti-Money Laundering Directive AI Artificial Learning AML/CFT Anti-Money Laundering/Combatting the Financing of Terrorism API(s) Application Programme Interface(s) ATM(s) Automatic Teller Machine(s) BaFIN Bundesanstalt fr Finanzdienstleistungsaufsicht (translated as: Federal Financial Supervisory Authority) BARAC Blockchain Technology for Algorithmic Regulation and Compliance BCBS Basel Committee for Banking Supervision BIS Bank for International Settlements CFD(s) Contracts-for-Difference(s) CHIPS Clearing House Interbank Payment System CySEC Cyprus Securities and Exchange Commission DLT Distributed Ledger Technology EBA European Banking Authority EBF European Banking Federation EBP European Blockchain Partnership EC European Commission ECB European Central Bank EFIF European Forum for Innovation Facilitators ESAs European Supervisory Authorities ESMA European Securities and Markets Authorities EU/EEA European Union/European Economic Area FATF Financial Action Task Force FCA Financial Conduct Authority FinTech Financial Technology iv FSB Financial Stability Board FSMA 2000 Financial Services and Markets Act 2000 FTTF Financial Technology Task Force G20 Group of Twenty (international forum) GDPR General Data Protection Regulation GFIN Global Financial Innovation Network ICB Inter-Computer Bureau ICO Initial Coin Offering IDD Insurance Distribution Directive IMS Internet Media Services IOSCO International Organisation of Securities Commissions IT Information Technology KYC Know-Your-Client LTCM Long-Term Capital Management MiFID (II) (Second) Markets in Financial Instruments Directive ML Machine Learning NASDAQ National Association of Securities Dealers Automated Quotations NBS Nottingham Building Society P2P (lending) Peer-to-peer (lending) PRA Prudential Regulation Authority PSD2 Second Payment Services Directive PSP(s) Payment Service Provider(s) RegTech Regulatory Technology RTGS Real-time gross settlement RTS Regulatory Technical Standards SaaS Software-as-a-Service SEC Securities and Exchange Commission SME(s) Small to Medium Size Enterprise(s) v SWIFT Society of Worldwide Interbank Financial Telecommunications UK United Kingdom US United States (of America) WWI First World War 1 INTRODUCTION Technology is everywhere, all the time, and growing1. That is also the case for the financial services, a sector reputable of being resistant to change and suspicious to technological disruption2. In the digital era we live in, technology is increasingly used to support or provide financial services, which has led to the emergence of FinTech. FinTech, a contraction of financial technology and a term originating in the early 1990s, is generally perceived as describing the use of technology to deliver financial solutions3. Although financial services and information technology have long been intertwined and arguably mutually reinforcing4, worldwide interest for FinTech has only been significantly increasing for regulators, industry participants, consumers and academics, as of 2014 onwards5, with the application of rapidly developing technology to improve and automate the delivery and use of financial services in the 21st century6. Nowadays, FinTech embraces various sectors and industries, including retail and wholesale banking, and encompasses both start-ups and traditional financial institutions such as banks and credit agencies7. FinTech will democratise financial services, generating benefits for banks, businesses and consumers through increased competition and cost effectiveness8. Innovations such as peer-to-peer lending and crowdfunding, blockchain technology and cryptocurrencies, artificial intelligence, machine learning and data analytics, are all central to FinTech as it exists today. Such technologies can ameliorate the monetary and financial system, but 1 David Hodes, Information Technology Everywhere, All The Time (BXJ, 28 March 2019) accessed 04 July 2019. 2 Robert G. Fichman, Brian L. Dos Santos and Zhiqiang (Eric) Zheng, Digital Innovation As A Fundamental And Powerful Concept In The Information Systems Curriculum 2014 38 MIS Quarterly 329. 3 Thomas Puschmann, Fintech (2017) 59(1) accessed 02 July 2019. 4 Douglas W. Arner, Janos N. Barberis and Ross P. Buckley, The Evolution of Fintech: A New Post-Crisis Paradigm? 2015 University of Hong Kong Faculty of Law Research Paper No. 2015/047 1271. 5 Google Search Trend, FinTech interest over time accessed 03 July 2019. 6 Julia Kagan, Financial Technology Fintech (25 June 2019) accessed 02 July 2019. 7 Ekaterina Kalmykova and Anna Ryabova, FinTech Market Development Perspectives 2016 EDP Sciences. 8 Mark Carney, The Promise of FinTech Something New Under the Sun? (Deutsche Bundesbank G20 Conference, Wiesbaden, 25 January 2017) accessed 01 July 2019. 2 they may also disrupt existing industry structures, distort industry boundaries, and most significantly create privacy, regulatory and law-enforcement complications9. Part I of this dissertation briefly explores FinTechs evolution and its rapid expansion, largely induced by the 2008 global financial crisis impact on the financial services sector. It then explores the application of technology in regulatory processes to facilitate and expedite regulatory compliance, a concept known as RegTech. Part II focuses on financial regulation and the regulation of FinTech, inquiring into the need for countries to regulate it, the challenges they might face, and some issues regulators should consider. It then concludes by identifying how the European Union (EU) responded to the rise of FinTech. With FinTech innovations having both benefits and complications, it is essential that policymakers enact regulation that maximises FinTechs opportunities, safeguards innovation, and minimises risks to society10. The need for appropriate regulation is exacerbated by the immense influence FinTech has on the functioning of the financial sector and the fact that it is continuously developing and expected to grow exponentially over the next years, fundamentally altering the way financial services are delivered and used globally. Despite its cross-border element, a global regulatory approach for FinTech has not emerged yet, although countries have commenced regulating FinTech through various tools in accordance with their FinTech sector importance and regulator mandates. The discussion brings us to Part III, which tackles the main question this paper pursues to answer: How have European countries responded to the development of FinTech through regulation? Part III discusses and draws parallels and comparisons between specific EU Member States regulatory attempts: the United Kingdom (UK), which has followed an active regulatory approach; Germany, which has been more passive in embracing FinTech; and Cyprus, which is only now, tentatively, seeking to explore the FinTech opportunity. 9 Thomas Philippon, The Fintech Opportunity (2016) NBER accessed 03 July 2019. 10 Mark Carney (n 8). 3 PART I FinTech: Evolution and Innovations The application of technology to finance is not novel. There is a long history of interlinkage between finance and technology, with FinTechs evolution within the financial services sector traced over three distinct eras: FinTech 1.0, FinTech 2.0 and lastly FinTech 3.011. This latest evolution of FinTech poses most challenges for market participants, and most importantly regulators, necessitating the emergence of adequate regulation to balance FinTechs innovation and risks. Before dealing with the regulatory aspect of FinTech, we will explore FinTechs evolution and some of its most significant financial innovations. FinTech evolution FinTech 1.0: The use of information technology has a long history in the financial services industry, but in FinTech 1.0 which lasted from 1866 to 1967, although interlinked with technology, financial services were at least in the public viewpoint, largely an analogue industry12. What provided the foundation for further FinTech evolution was the rapid progression of technological developments in the aftermath of the First World War13. By the end of this era, a global telex network was in place, the fax machine succeeded the telex and code-breaking tools were introduced in computers14. By the second half of the 19th century, the use of the telephone and printed paper revolutionised the functioning of financial markets15. The first credit cards introduced by the Diners Club in the 1950s revolutionised payments globally and led to the establishment in the US, of what is now known as MasterCard16. Lastly, ATMs, one of the most remarkable financial innovations17 were installed, in 1959 in Ohio, and in 1967 in Europe by Barclays Bank in London18. 11 Douglas W. Arner, Janos Nathan Barberis and Ross P. Buckley, Fitech and Regtech in a nutshell, and the future in a sandbox 2017 CFA Institute Research Foundation 3(4). 12 ibid. 13 Douglas W. Arner, Janos N. Barberis and Ross P. Buckley, 150 Years of FinTech: An Evolutionary Analysis 2016 JASSA The FINSIA Journal of Applied Finance 3(6). 14 Douglas W. Arner, Janos N. Barberis and Ross P. Buckley (n 4) 15 Bhavya Bhasin, Evolution of technology in financial markets 2018 5(8) IJIRR. 16 Douglas W. Arner, Janos N. Barberis and Ross P. Buckley (n 4) 17 Paul Volcker, The only thing useful banks have invented in 20 years is the ATM (NYpost, 13 December 2009) accessed 03 July 2019. 18 Thomas Puschmann (n 3). 4 FinTech 2.0: The above developments led to FinTech 2.0, lasting from 1968 to 2008, throughout which financial services moved to a large extent online19. The late 1960s and 1970s saw the speedy advancement of electronic payment systems, enhancing domestic and international payments and financial flows and attracting great attention to the FinTech sector20. Technological advancements in this area include the establishment of the Inter- Computer Bureau (ICB) in the UK, the Clearing House Interbank Payments System (CHIPS) in the US, as well as the introduction of Fedwire and the Society of Worldwide Interbank Financial Telecommunications (SWIFT)21. Throughout FinTech 2.0, traditional financial institutions embraced FinTech, adopting technology to replace paper-based operations and thereby facilitating transactions and managing internal risks, whilst from a consumer perspective, financial transactions were simplified through the introduction of online banking, as in the case of the Nottingham Building Society (NBS) in the UK22. This paved the way for e-banking and banking applications (or apps) as we know them today. In the area of securities, the creation of NASDAQ in the US, the end of fixed securities commissions and the development of the National Market System, marked a move away from the physical trading of securities23. A significant FinTech novelty which is ultimately one of the very first FinTech start-ups and possibly the most successful start-up to date, is the Internet Media Services (IMS) started by Bloomberg in 198124. The number of FinTech start-ups has ever since been increasing, reaching globally the number of around 12,500 by 201925. With the financial services becoming increasingly digitalised throughout the 1980s, by the early 21st century banks internal processes and interactions with outsiders and retail customers became almost fully 19 Douglas W. Arner, Janos Nathan Barberis and Ross P. Buckley (n 11). 20 Douglas W. Arner, Janos N. Barberis and Ross P. Buckley (n 4). 21 ibid. 22 ibid. 23 ibid. 24 ibid. 25 M. Szmigiera, Number of FinTech startups worldwide 2019, by region (Statista, 9 August 2019) accessed 03 July 2019. 5 digitised26. The advent of the internet in the 1990s was perhaps the principal revolution of all innovations, leading to the rapid development of online consumer banking27. Early regulatory response to FinTech: The evolution in technology throughout FinTech 2.0 went hand-in-hand with a change in the financial services structure and called for a wholly different regulatory approach by governments. Most importantly, regulators themselves began using technology to fulfil their mandates, leading to a complete digitalisation of information regarding market dynamics and movements28. The first major regulatory response to FinTech was the establishment of the Basel Committee for Banking Supervision (BCBS) by the Bank for International Sett
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