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It is common knowledge that ESMA is now focusing on the European securities market. Its major goal is to help protect investors, streamline market practices & guarantee financial stability. Innovation wise, ESMA is responsible for ensuring a coordinated approach to regulating & supervising innovative financial activities in the securities markets. 

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Monitoring Financial Innovation

A framework that ESMA has put in place is most favorable for conducting financial innovation analysis. It ensures a principles-based approach in terms of the range of innovations being monitored. While developing this structure, ESMA was pursuing three main goals: 

  • protection of investors 
  • financial stability 
  • streamlining rules for market participants 

FinTech Innovation Engines

Let’s look at some of the factors that have influenced FinTech revolution. They can roughly be divided into supply factors (i.e. those encouraging innovators to come up with new products or services), and demand factors (i.e. those encouraging customers to use innovation).

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Supply Factors

Firstly, there has been a sharp increase in the capacity of technological capabilities and a concomitant reduction in costs. We are now witnessing an increase in the ability to process large amounts of data, combined with a sharp reduction in hardware and software costs and data storage.

Secondly, there is a phenomenon called the “innovation spiral” whereby several new products or services may arise from a simple innovation and it is not yet known whether it will be successful. We can see it in the way certain financial services (e.g. payments, budget planning & investments) are being implemented in smartphones nowadays.

Thirdly, the entry of traditional financial firms from certain markets has paved the way for new entrants. Often, these new participants come up with new ways of providing services that the already existing ones have overlooked. These participants are using new technologies to quickly enter the market. They are often not burdened with regulatory requirements, complying with the law, and meeting capital requirements. 

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Demand Factors

The post-financial crisis has led to a marked decrease in confidence in traditional financial institutions. As a result, consumers can now use the services of new market participants, and they can now use a la carte service providers, such as payment systems and savings mechanisms that were previously offered only by banks.

Secondly, increased expectations, Internet access and real-time online transaction capabilities ensure enhanced customer service. This has led to higher customer expectations regarding convenience, speed & cost of financial services, which, in turn, has become one of the most important factors in making purchasing decisions. 

Thirdly, demographic factors drive demand. Generation Z or as they are also called “the indigenous people of the digital space” have different expectations from technology than previous generations.

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Regulatory Challenges

FinTech & acceptable regulatory measures is an important subject for regulators & market players alike. The main challenge here is to understand when regulators need to interfere. 

While interacting with a financial innovation, regulators is free to select one of the below approaches, each of them being more “proactive” than “reactionary":

  • Prohibiting or restricting goods/processes due to attendant risks
  • Adopt the “wait & see” attitude
  • Promoting & regulating products or processes due to their potential benefits

The 1st approach centers around powers which ESMA has been granted since the entry into force of new MiFID/MFIR Directives.

The 2nd approach is the one that ESMA has used in relation to DLT. 

The 3rd approach can be exemplified by the investigation ESMA conducted into investment crowdfunding and which resulted in the identification of a potential threat to investors in the event if crowdfunding platforms operate outside the MiFID rules. 

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Cryptoassets & DLT

According to ESMA, DLT can bring a number of advantages to the securities markets, including, but not limited to after-sales processes. However, before these benefits can be realized, a number of problems will need to be addressed. It is important to note that DLT is still at an early stage of development, and we still do not have a clear idea of ​​how DLT can overcome all these obstacles. In addition, ESMA understands that although DLT may one day reduce or mitigate certain risks, it can also aggravate others.

In securities transactions, the temporary difference between the purchase of securities and the receipt of funds leads to business risks between counterparties and / or their intermediaries. To the extent that DLT technologies are designed to replace traditional reliance on trusted intermediaries to provide a settlement, they will need to demonstrate their ability to eliminate transaction risks. This becomes even more important when the purchase of securities and financing takes place on two different platforms.

ESMA will be continuing to keep track of the latest developments in the field of cryptoassets & DLT as long as regulatory actions are required. 

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While looking into ways in which FinTech is capable of improving the functioning of the financial system, we realize that they are attendant with certain risks. Therefore, regulators should come up with new and effective methods of responding to these challenges.

ESMA stated that its legal framework for monitoring financial innovation is based on principled approaches. In turn, its structure must remain flexible and adapted to market events. It also needs a meaningful base to know when to react supportively and when to respond defensively. Its is planning to regularly review this structure to ensure that it remains effective and relevant.

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