...and we have lift off: the EU Digital Finance Strategy

On 24 September 2020, the European Commission published its Digital Finance Strategy (alongside a package of other proposals summarised in our briefing). Like us, the European Commission considers the future of finance is digital. Europe also wishes to be fully prepared in order to harness the benefits of digital finance for consumers and businesses. The initiative builds on the EU's 2018 Action Plan on Fintech (see our briefing here). The European Commission also considers its Digital Finance Strategy would play a crucial role in supporting Europe’s strategy for a post-COVID-19 social and economic recovery, as well as helping to open up channels of funding for existing EU existing initiatives, such as the EU Green Deal and the New Industrial Strategy. The Digital Finance Strategy follows public consultations and the Digital Finance Outreach. It is linked to a number of EU initiatives, such as the EU's Payments Strategy and the EU's 2020 Data Strategy. Needless to say, it is a big deal and its tentacles spread far and wide.

The Digital Finance Strategy sets out four key priorities and is underpinned by the following aspects.

• Europe and its financial sector must embrace trends and all the opportunities offered by the digital revolution. 
• Europe must drive digital finance with strong European market players in the lead.
• Europe's aim is to make the benefits of digital finance, available to European consumers and businesses.
• Europe should promote digital finance based on European values and a sound regulation of risks.

Interoperable KYC checks: making onboarding seamless

Europe's first priority is to tackle fragmentation in the Digital Single Market for financial services so that consumers in the EU can access cross-border services and European financial firms can scale up their digital operations. The European Commission refers to the absence of a framework for EU Fintech firms to provide services cross-border and considers that its proposal for a Crowdfunding Regulation and its new proposal for a Regulation on markets in cryptoassets will improve matters.

The European Commission feels that more needs to be done to ensure that "on-boarding" of financial services works effectively and seamlessly.

Proposals

• By 2024, the EU should introduce a legal framework providing for the use of interoperable digital identity solutions so that new customers can access financial services quickly and easily. This framework would be based on more harmonised anti-money laundering (AML) and counter-terrorism financing (CTF) rules and a revised framework for electronic identification and trust services for electronic transactions (e-IDAS Regulation).
• The EBA should prepare guidelines with European Supervisory Authorities by Q3 2021 on converging aspects related to identification and verification needed for "on-boarding" purposes and should consider how much reliance financial service providers place on third parties to carry out customer due diligence (CDD) processes (including other financial service providers).
• Enlisting the European Data Protection Board (EDPB) to provide further detail on data protection aspects in the context of reusing "onboarding" information for other purposes/.
• Use the upcoming review of AML/CTF framework through technical standards focusing on reliance on third parties to meet CDD requirements, including issues associated with liability and , transparency and ethical use.
• Work with the ESAs to strengthen the innovation network provided by the European Forum of Innovation Facilitator (EFIF) to build a new EU digital finance platform
• Promote national innovation facilitators, e.g. through the structural reform support programme . In particular, the Commission will work with the EFIF to ensure that it offers, by mid-2021, a procedural framework for launching cross-border testing and other mechanisms helping firms to interaction with supervisors from different Member States,

Facilitating digital innovation, while ensuring operational resilience

The second priority is to ensure the EU regulatory framework facilitates digital innovation in the interest of consumers and market efficiency. The Commission wants ensure that regulatory frameworks promote the responsible use of digital ledger technology and artificial intelligence in financial services. It also wants to look deeper into collaborative innovation circles.

The European Commission cites the benefits cloud services can provide to the financial sector and refers to its proposal for a Regulation on operational resilience and how it will provide oversight in this sector. It hopes its Data Strategy will improve access to alternative cloud service providers in the financial services sector. It also refers to ongoing initiatives, such as the cybersecurity certification scheme that is being developed by the EU cybersecurity agency (ENISA) and confirms that future initiatives may include promoting the move towards modular IT architecture.

Proposals

• The Commission plans to carry out a Digital Finance Outreach to give guidance on the interpretation of the EU regulatory framework and plans to issue an "interpretative communication" in 2021 to clarify treatment of cryptoassets to complement legislative proposals.
• The Commission plans to enlist the ESAs and the ECB to look into creating regulatory and supervisory guidance on the use of AI in line for the forthcoming legislative proposal on AI in 2021 The work by the ESAs will be informed by advice promoted by the Expert Group on Digital Ethics. The Commission wants the work to focus on supervisory expectations and mitigating risks.
• By 2024, the Commission wants a comprehensive EU framework in place enabling the uptake of distributed ledger technology and crypto-assets in the financial sector. The framework would also address the risks associated with these technologies.
• By 2024, the Commission, working together with the ESAs, aims to ensure clarity as regards supervisory expectations about how the legislative framework on financial services should apply AI applications.

Open data and Open Finance - Promoting data-driven innovation in finance by establishing a common financial data space

The third priority is to create a European financial data space to promote data-driven innovation, building on the EU's Data Strategy, including enhanced access to data and data sharing within the financial sector. The European Commission refers to the Second Payment Services Directive and developments in financial data sharing, as well as developments in data protection.

Proposals

• The European Commission will set up a common financial data space (and will enlist the help of data experts working with European Supervisory Authorities) via a number of measures.
• The European Commission is proposing that by 2024, information that is publicly released under EU financial services legislation should be disclosed in standardised and machine-readable formats. The Commission is planning to implement the necessary infrastructure as part of its Capital Markets Union Action Plan.
• By 2024, the EU aims to put in place the necessary conditions to enable the use of innovative technologies, including RegTech and SupTech tools, for supervisory reporting by regulated entities and supervision by authorities.
• The Commission, together with the ESAs will develop a strategy on supervisory data in 2021 covering harmonisation of supervisory reporting requirements, promoting the use of available international standards and identifiers (including the Legal Entity Identifier).
• The European Commission is proposing that by 2024, the EU should have an Open Finance framework in place, in line with the EU Data Strategy, the upcoming Data Act, and Digital Services Act. The Commission confirms this will be coordinated with the review of the Payment Services Directive.

Same activity, same risks, same rules

The fourth priority is to address new challenges and risks associated with the digital transformation. The Commission notes that while digital finance has many benefits, it could also undermine financial stability. The Commission also notes the increasing role played by technology companies in provision of financial services (sometimes serving as intermediaries and sometimes providing hardware, software and cloud-based solutions for the financial industry) and expects this trend to become more pronounced in the future.

Proposals

• The Commission wants EU prudential and conduct regulation and supervision to be "future proofed" by 2024 to fit what it considers will be the new financial ecosystem (including traditional regulated financial institutions and technology providers offering financial services).
• The Commission will review the Payment Services Directive and the E-Money Directive. Second, it will assess how to ensure comprehensive supervision of the more fragmented value chains and the new providers of financial services.
• The Commission will review the prudential supervisory perimeter to consider whether it captures risks arising from platforms and technology firms providing financial services and risks arising from techno-financial conglomerates and groups. This will involve looking at the existing provisions concerning group supervision in EU financial services legislation, such as the Financial Conglomerates Directive.
• The Commission plans to obtain advice from the ESAs on how to address “same activity, same risk, same rules” issues, fragmented value chains, the scope of the supervisory perimeter and prudential risks related to non-bank lending, and will decide on the necessary legislative amendments by mid-2022.

Co-author: Bisola Williams