The ESA publishes report on innovation facilitators

On 7 January 2019, the European Supervisory Authority (“ESA”) (consisting of the European Securities and Markets Authority, the European Banking Authority and the European Insurance and Occupational Pension Authority) published a joint report on “innovation facilitators” that have been established across the European Union (“EU”).

The report provides:

• a comparative analysis of innovation facilitators established to date within the EU;
• the challenges cited by competent authorities;
• a set of best practices recommended by the ESA regarding the design and operation of innovation facilitators; and
• options that the ESA will consider in the context of future EU-level work on innovation facilitators.

1.1 Innovation facilitators

The report states that innovation facilitators usually take the form of ‘innovation hubs’ and/or ‘regulatory sandboxes’. In summary, innovation hubs provide a dedicated point of contact for regulated and unregulated entities to raise enquiries with competent authorities on FinTech-related issues to seek non-binding guidance on regulatory and supervisory expectations. Regulatory sandboxes, on the other hand, are schemes set up by a competent authority that provide regulated and unregulated entities with the opportunity to test innovative products and services that relate to the carrying out of financial services. This is pursuant to a testing plan agreed and monitored by a dedicated function of the competent authority.

Through a comparative analysis of 25 EU and European Economic Area (“EEA”) jurisdictions, the report concludes that innovative facilitators are similar in their overall objectives and scopes across the European financial sector. However, the report also cites certain challenges that have been raised by the competent authorities.

1.2 Challenges cited by competent authorities

Competent authorities noted that enquiries raised through innovation hubs, and propositions tested in regulatory sandboxes, often involved issues that went beyond their direct scope of responsibility (for example, giving rise to data protection and regulatory perimeter issues) or involved cross-border issues going beyond the legislative competency of the authorities. This posed a challenge in providing complete and prompt responses in these contexts.

With regards to innovation hubs specifically, some competent authorities noted that firms could potentially mistake indicative guidance from competent authorities as being binding and final, resulting in a legal challenge against the competent authority if the authority shifts its view.

On the other hand, concerns were raised about propositions being tested in regulatory sandboxes being perceived by consumers as being ‘endorsed’ by the competent authority. They stated that such a view posed the risk of potential preferential access to financing and/or market positioning of the firm in the sandbox and/or a legal risk to the competent authority in the event that consumers were to suffer detriment because of the services provided from the sandbox.

In relation to general operational matters, some competent authorities cited difficulties in finding and retaining staff with the appropriate knowledge and experience of FinTech as a challenge.

1.3 The ESA’s best practices

Against this background, the ESA has set out a range of best practice measures to provide support to competent authorities who are considering the establishment of innovation facilitators. Competent authorities can also use them when reviewing existing innovation facilitators.

The best practice measures are split into four sub-headings, which are summarised below:

• Pre-establishment principles – Prior to the establishment of innovation facilitators, the competent authority should carry out a rigorous analysis to identify the appropriate expertise, powers, processes and structures required in light of local market conditions.
• General operating principles for innovation facilitators – The competent authority must ensure that information about the innovation facilitators are suitably visible to relevant market participants, alongside points of contact for firms. The scope of entities eligible for the innovation facilitator should be clearly defined and made public. Furthermore, appropriate internal records relating to the operation of the innovation facilitator should be maintained and where appropriate, communications should be made to the market on the regulatory and supervisory approaches to issues identified in the context of interactions via innovation facilitators, for example, in the form of published frequently asked questions/FAQs.
• Operating principles for innovation hubs – The competent authority should clearly define the key information required from firms submitting enquiries via the innovation hubs, whilst making clear that additional information may be required. Enquiries made via the innovation hub should be responded to within a reasonable time and where enquiries fall outside the remit of the competent authority (for example, data protection issues), a referral should be made to the other relevant authorities.
• Operating principles for regulatory sandboxes – There should be specific and clear entry conditions/criteria against which applications are assessed and these should be made public. All applications to participate in regulatory sandboxes should be acknowledged in writing and responded to within a reasonable timeframe. Firms participating in regulatory sandboxes should disclose to consumers that the services are being provided in the sandbox and should explain the implications of this to the consumers (for example, of what would happen on exit from the sandbox). Participating firms should be required to develop plans for a controlled exit from regulatory sandboxes, including providing appropriate degrees of protection for consumers. Lastly, competent authorities cannot introduce regulatory sandboxes to disapply regulatory requirements under EU law. However, levers of proportionately imbedded in EU law, for instance, concerning systems and controls, may be applied to firms participating in the regulatory sandbox in the same way as to firms outside the sandbox.

1.4 Future developments

The report states that the innovation facilitators analysed operate only on a national level and cites this as being a potential impediment to the scaling up of financial innovation across the EU. The ESA has therefore proposed to:

• develop joint ESA own-initiative guidance on cooperation and coordination between innovation facilitators; and
• suggested to establish an EU-wide network of innovation facilitators open to all competent authorities in the EU, which could serve as a forum for sharing knowledge cross-border.

The report confirms that the ESA will continue to monitor developments regarding national innovation facilitators in the EU and take further steps that are considered appropriate to promote an accommodative and common approach towards FinTech in the EU. The ESA states that it will define these further steps, as appropriate, in 2019.

Co-authored by Fatima Butt.