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- Context: the fintech revolution
The term fintech, in the broadest sense, refers to the groundbreaking application of new developments in information and communication technologies in the financial sector. Some examples include online payment and credit services, digital wallets, blockchain and the use of crowdfunding for financing projects.
The European Commission (“EC”) has pointed out that, in addition to promoting innovation in the financial sector, fintech solutions are a key tool for strengthening the capital markets union in Europe and improving financial services. To promote the opportunities offered by fintech solutions, the EC has proposed measures to expand the innovative models and to strengthen cybersecurity and the financial system in its Fintech Action Plan of March 8, 2018.
Several competition authorities have identified fintech as a groundbreaking market and have published reports on this sector: in Spain (the Spanish competition authority or “CNMC” and the Catalan competition authority), the Netherlands, Portugal, Mexico, the US and Canada. In July 2018, the European parliament published a study on competition issues in the fintech sector.
Other authorities have already carried out substantive actions. In July 2016, the German competition authority declared the restrictions imposed by the German banking industry for online payment services to be in violation of competition law, as they did not allow payments to be made through third-party systems.
In general, competition authorities have received fintech solutions positively. Along these lines, the CNMC report published on November 13, 2018, suggests regulatory recommendations to maintain the improvements in competition and efficiency promoted by the fintech phenomenon.
- CNMC: Is a new regulatory approach necessary?
In its report (available here), the CNMC analyzes the specific opportunities and risks involved in various applications of the financial sector: (i) payment services and systems; (ii) distributed ledger technologies (DLTs), such as blockchain; (iii) asset management and advisory services; (iv) crowdfunding; and (v) insurtech, expressing the need to reconsider traditional financial regulation.
Of the opportunities presented by fintech solutions, the study highlights the improvements in efficiency brought about by process and product innovations as a result of these applications, which enable better and more differentiated services to be offered.
The CNMC also indicates the potential of fintech solutions to promote competition, as they can offer prices that are more affordable to consumers and reduce transaction costs.
Fintech solutions may also mitigate certain market failures. Fintech solutions enable new competitors to enter the market, particularly small businesses and startups, which do not necessarily operate in the financial sector. In addition, the use of platforms increases transparency (to win the trust of both sides of the market), therefore reducing the information asymmetries between the user and the service provider. The increased transparency of the platforms, together with the verification and monitoring of the transactions integrated in the network itself, in the case of DLTs, also reduces moral hazard as ex post conflicts of interest are mitigated.
Accordingly, the CNMC highlights the following risks: (i) the possibility of fintech solutions gaining market power as a result of indirect network effects (which leads to concentration dynamics); (ii) the emergence of new issues regarding access to data information (particularly, the potential application of the essential facilities doctrine); (iii) the role of algorithms, which may facilitate collusive behavior; (iv) the possibility that big techs, based on their experience in big data, gain market power if they expand their market downstream or in other areas, such as the online advertising sector; and (iv) the effect of greater competition on taking risks and the stability of financial intermediaries, which continues to be a matter open for debate.
The CNMC has also identified problems regarding potential price discrimination and taking surpluses from consumers and, lastly, has raised concerns regarding cybersecurity.
Accordingly, the CNMC proposes the following recommendations to implement a suitable regulation:
- The regulation must avoid deterring fintech innovations: The increased efficiency results from increasing competition with the entry of new agents in the market, but also because fintech is an innovation in itself, which enables costs to be reduced (process innovation) and the variety of services to be broadened (product innovation). In addition, the CNMC reiterates that “the changes arising from the fintech revolution are structural and reflect social and technological trends that are positive and unstoppable” and, therefore, regulations and incumbent operators are forced to adapt.
- Reevaluate the need and proportionality of the various regulatory requirements for entering the market and carrying out financial activities. An example of an entry barrier is the need to have physical location (with headquarters or branches, or both) and specific internal organizational requirements for financial institutions. These barriers may be reduced by taking advantage of technology, which enables many of these functions to be carried out without a physical presence, therefore reducing physical location and organizational costs. These innovations may be accompanied by secure remote identification measures and the use of DLTs.
- Activities, not entities, should be regulated, as market failures result from a certain activity and not the legal form of the entity’s organization. The regulation should also avoid activity restrictions that prevent certain entities from expanding their range of services.
- The regulation should take advantage of new technologies for regulatory compliance (regtech) to reduce the charges linked to regulatory and supervisory activities. The authorities can use interoperable open source platforms and automatic data reporting for supervision. However, the authorities must regulate the ex ante regulation burden by taking advantage of technologies that facilitate subsequent follow-up and control. For example, potential fraud detection with the assistance of artificial intelligence.
- A regulatory testing ground (sandbox) should be adopted so that more innovative models can be developed and their impact on the market can be assessed. The sandbox allows entry requirements that are lighter or nonexistent to be applied for certain innovative and smaller business models for at least a certain period of time. Regulators may therefore design an ex post regulatory response that is based on the actual impact of these projects. This mechanism can be supplemented with an innovation center that acts as a safe harbor for companies. This would be a place where regulators and operators would be in contact with each other.
- Open-banking and open-insurance initiatives should be supported to ensure the application of technological neutrality and non-discrimination principles, where data can be accessed under reasonable terms. Open-banking applications reduce the control of data by financial institutions in favor of customers, granting them greater power regarding access by third-party suppliers to their accounts.
In conclusion, the CNMC, as is the case with the EC and other authorities, recognizes the positive impact of the technological innovations of the financial sector on competition, to the benefit of the consumer, and suggests developing an appropriate regulatory framework that considers the opportunities and risks involved in the fintech phenomenon.
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