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Short Reads

A digital transition in the financial services sector

A digital transition in the financial services sector

A digital transition in the financial services sector

30.09.2020 EU law

On 24 September 2020, the European Commission (the “Commission”) adopted the Digital Finance Package (the “Package”). The aim of this initiative is to create a competitive EU financial sector that gives consumers access to innovative financial products, while ensuring consumer protection and financial stability. The package includes a digital finance strategy, a legislative framework for crypto-assets, a legislative framework for digital resilience and a retail payments strategy.

The Commission mentions that the announced measures will be crucial for the EU’s process of economic recovery because the initiative provides European companies, in particular small and medium enterprises, with new ways to access funding. The package also links to other initiatives of the Commission, including the European Green Deal and the New Industrial Strategy, by helping to mobilise funding to these initiatives.

The package is built on previous measures in this field, including the FinTech Action Plan of 2018.

Digital finance strategy

The Digital Finance Strategy gives a general overview of the approach towards Europe’s digital transformation in finance in the coming years. The strategic objective is to embrace digital finance for the good of consumers and businesses. To ensure this, the strategy sets out four main priorities and related actions to enable consumers and businesses to enjoy the benefits of digital finance, while at the same time mitigating risks.

1. Removing fragmentation in the Digital Single Market

The first priority of the Commission under the digital finance strategy is removing fragmentation in the Digital Single Market. In this regard, key actions from the Commission include proposals to harmonise rules on customer on-boarding, and implementation of an interoperable cross-border framework for digital identities. Other key actions for the Commission include exploring the need to introduce additional harmonised licensing and passporting regimes and establishing an EU digital finance platform to foster cooperation between private and public stakeholders.

2. Adapting the EU regulatory framework to facilitate digital innovation

Adapting the EU regulatory framework to facilitate digital innovation is a second priority following from the Digital Finance strategy. In this regard, the Commission proposed a new EU legislative framework for crypto-assets, which is discussed later in this short read.

Furthermore, the Commission will ensure that potential regulatory obstacles to innovation (following new legislation on financial services) are removed, by performing regular reviews. Finally, the Commission will provide interpretative guidance on a regular basis on how existing legislation on financial services is to be applied to new technologies.

3. Promoting data-driven innovation in finance by establishing a common financial data space

The third priority is promoting data-driven innovation in finance by establishing a common financial data space. EU legislation will be amended to ensure that information that is publicly disclosed is available in standardised and machine-readable formats, and an infrastructure for public disclosure will be set up. Secondly, the Commission will present a strategy on supervisory data in 2021. Thirdly, a legislative proposal for a new open finance framework will be published in mid-2020.

4. Addressing the challenges and risks associated with digital transformation

The fourth and final priority is addressing the challenges and risks associated with digital transformation and enhancing the digital operational resilience of the financial system. By mid-2022, the Commission will propose the necessary adaptations to the existing financial services legislative framework with respect to consumer protection and prudential rules. In this way, end-users of digital finance, financial stability, and the integrity of the EU financial sector will be protected and a level playing field is ensured. In addition, the Commission presented a proposal for a new EU framework for strengthening digital operational resilience, which is will be explained later in this short read.  

A legislative framework for crypto-assets

As part of the Digital Finance Strategy, the Commission has proposed a legislative framework on crypto-assets (digital representations of values or rights that can be stored and traded electronically). This framework includes a proposal for a Regulation on markets in crypto-assets and a proposal for a Regulation on a pilot regime for market infrastructures based on distributed ledger technology. The aim of this framework is to stimulate innovation and possibilities offered by crypto-assets and at the same time mitigate risks to investors and financial stability.

Some crypto-assets qualify as financial instruments as defined in MiFID II. The majority of crypto-assets, however, currently fall outside of the scope of EU legislation on financial services. The Commission makes a distinction between crypto-assets already regulated by EU legislation, and other crypto-assets.

With the proposal for a regulation on markets in crypto-assets, the Commission proposes a regime for those crypto-assets that were previously unregulated, including ‘stablecoins’. This regulation contains strict requirements for issuers of crypto-assets, and for crypto-asset service providers wishing to apply for an authorisation to provide their services in the EU. Under this regulation, operators authorised in one EU Member State are allowed to passport their services in another EU Member State. Protection is built in (for example) by demanding capital requirements, a mandatory complaint holder procedure available to investors, and investor rights against the issuer.

Crypto-assets that are already subject to union legislation (i.e. that qualify as financial instruments as defined in MiFID II) will remain subject to existing EU legislation. However, in the proposal for a regulation on a pilot regime for market infrastructures based on distributed ledger technology the Commission proposes a pilot regime for market infrastructures that wish to try to trade and settle transactions in financial instruments in crypto-asset form. The pilot regime represents a controlled environment, which allows temporary derogations from existing rules so that regulators can gain experience on the use of distributed ledger technology in market infrastructures, while ensuring that they can deal with risks to investor protection, market integrity and financial stability. This should enable market participants and regulators to gain experience with the use of distributed ledger technology exchanges that would trade or record shares or bonds on the digital ledger.

A legislative framework for digital resilience

The second framework following from the Digital Finance Strategy is the regulatory framework on digital operational resilience. This framework is divided into a legislative proposal for a Regulation on digital operational resilience for the financial sector, and a legislative proposal for a Directive amending several other directives, including the UCITS Directive, Solvency II Directive and AIFMD. The financial sector depends on software and digital processes, and this dependency is increasing, which can result in ICT risks materialising. Therefore, the overall aim of these proposals is to prevent and mitigate cyber-attacks and other cyber-related problems.

With the legislative proposals, the Commission intends to create resilient financial firms that are sufficiently able to cope with all types of various ICT problems and cyber threats. Therefore, banks, stock exchanges and FinTechs (for example) will need to conform to strict standards as set out in the proposals to prevent and limit the impact of ICT-related incidents. In addition, service providers providing cloud computing to financial institutions will be subject to an oversight framework.

Retail payments strategy

Lastly, the digital finance package contains a retail payments strategy. The aim of the retail payments strategy is to ensure modern and safe retail payments. The focuses of this strategy are providing safe EU-wide payment solutions and instant payments, protecting consumers, and reducing dependency on large market parties domiciled outside of the EU.

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