INNOVATION & PRODUCTS
INNOVATION & PRODUCTS
ESMA monitors financial activities and retail investor trends, with a particular focus on financial innovation including Fintech and crypto-assets. It identifies issues and/or risks connected to such activities and trends and helps to co-ordinate NCAs initiatives on market monitoring and facilitating exchanges of best practices, including providing advice or suggesting proposals to take relevant action when needed.
Risk identification and monitoring is based on ESMA qualitative and quantitative risk metrics, market intelligence, interaction with the Financial Innovation Standing Committee (FISC), its Consultative Working Group, and the ESMA Financial Innovation Scoreboard.
Financial innovation scoreboard
ESMA uses a framework that provides a ranking relating product features to ESMA’s objectives to prioritise which financial innovations require deeper analysis and potential policy responses.
Crypto Assets, Initial Coin Offerings and Distributed Ledger Technology
Crypto-assets (CAs) are a type of private asset that depends primarily on cryptography and Distributed Ledger Technology (DLT). There are a wide variety of crypto-assets ranging from so-called cryptocurrencies or virtual currencies to digital tokens issued through Initial Coin Offerings (ICOs). Crypto-assets are relatively new and the market is evolving, which raises specific challenges for regulators.
ESMA has monitored and analysed risks related to CAs since 2013. In November 2017 and February 2018 ESMA issued two Statements on Initial Coin Offerings (ICOs) and a joint ESA’s Warning on the risks of Virtual Currencies (VCs) respectively, to address concerns related the speculation around these instruments. ESMA had previously published a Report on DLT applied to financial markets, which highlighted the potential benefits and risks of DLT as of February 2017.
In January 2019, ESMA published Advice to the EU Institutions on Initial Coin Offerings (ICOs) and Crypto-Assets (CAs). The Advice sets out the issues that exist in the current EU regulatory framework when applied to CAs. It clarifies the rules that apply to those CAs that qualify as financial instruments and the challenges that arise when applying the existing rules to those instruments. In addition, it highlights the important risks that remain unaddressed when CAs fall outside of the regulated space. ESMA advises the European Commission, Parliament and Council to consider and, if relevant, address these issues.
Following the publication of our Advice, ESMA continues to actively monitor market and analyse risks including potentially significant developments in stablecoin markets, which require scrutiny because of the specific risks that it may raise, including in relation to financial stability.
Crowdfunding is a means of raising finance for projects from ‘the crowd’ often by means of an internet-based platform through which project owners ‘pitch’ their idea to potential backers, who are typically not professional investors. It takes many forms, not all of which involve the potential for a financial return. ESMA’s focus is on crowdfunding which involves investment, as distinct from donation, non-monetary reward or loan agreement
ESMA published an Opinion to NCAs and Advice to the EU Parliament, Council and Commission in December 2014. Following the Advice, in March 2018 the European Commission presented a proposal for a regulation on crowdfunding service providers. Once adopted at EU level, the new regulation will allow platforms to apply for an EU passport based on a single set of rules.
RegTech and SupTech
ESMA carries out analyses of the regulatory (RegTech) and supervisory technologies (SupTech) currently being developed in response to various demand and supply drivers in the financial markets. RegTech describes technology, particularly information technology, used in the context of regulatory compliance, including tasks such as risk management. SupTech is technology used by supervisory authorities.
ESMA finds that on the demand side, regulatory pressure and budget limitations are pushing the market towards an increased use of automated software to replace human decision-making activities. This trend is reinforced by supply drivers such as increasing computing capacity and improved data architecture. Market participants are increasingly using new automated tools in areas such as fraud detection, regulatory reporting and risk management, while potential applications of new tools for regulators include greater surveillance capacity and improved data collection and management.
With these new tools come challenges and risks, notably operational risk. However, with appropriate implementation and safeguards, RegTech and SupTech may help improve a financial institution’s ability to meet regulatory demands in a cost-efficient manner and help regulators to analyse increasingly large and complex datasets. More analyses are available in a dedicated to this topic article of TRV
AI and Big Data
ESMA, jointly with EBA and EIOPA, has consulted on the use of Big Data by financial firms and published a Report on Big Data. The Big Data phenomenon encompasses the use of machine learning techniques, which are a form of Artificial Intelligence (AI). Markets participants and financial institutions are increasingly using AI and machine learning in a range of applications across the financial system. AI technologies are used to find signals for higher returns and optimising trade execution or for regulatory compliance, surveillance, data quality assessment and fraud detection. ESMA monitors and evaluates how Big Data sources and tools, with AI techniques, are used in the financial sector and the risks associated
Retail investors and products
As part of its mandate, ESMA monitors and assesses retail markets. Data-based monitoring is a key part of its approach. ESMA has developed a range of demand-based indicators, such as measures of income, sentiment, and asset allocation. Other indicators relate to costs, performance and detrimental outcomes. Combined with retail market intelligence from various sources, these indicators help ESMA to assess retail market trends and developments, including with respect to ESMA’s investor protection objective. ESMA also carries out in-depth analyses of retail markets. Topics studied in recent years include the EU market for structured retail products and the use of complaints data to identify key sources of consumer detriment
ESMA has begun work on guidelines for outsourcing to cloud service providers, which will be addressed to NCAs and to financial market participants in its remit. ESMA’s work will follow recommendations and guidelines by the other ESAs in this area. It will also consider ESMA’s direct supervision work around outsourcing to cloud service providers, which has included sending a letter in July 2018 to all its supervised entities setting out its expectations for cloud-based outsourcing. ESMA also hosted a workshop with NCAs in July 2019 on the topic of cloud computing to inform the subsequent development of the guidelines
ICT risks, including cybersecurity risks, undermine confidence and represent a threat to the stability of the financial system. Furthermore, cyber-attacks are a growing concern because of their increasing frequency and potential impact.
In response to a request in the European Commission’s 2018 FinTech Action Plan, ESMA and the other ESAs published joint Advice in April 2019 on two cybersecurity-related topics: Advice on legislative improvements relating to ICT risk management requirements in the EU financial sector; and Advice on the case for a coherent EU-wide cyber resilience testing framework for significant market participants and infrastructures within the whole EU financial sector.
ESMA continues to work closely with international authorities and NCAs on cybersecurity-related matters. For example, ESMA hosted a workshop with NCAs in July 2019 to promote supervisory convergence on cybersecurity
European Forum for Innovation Facilitators (EFIF)
The EFIF provides a platform for supervisors to meet regularly to share experiences from engagement with firms through innovation facilitators (regulatory sandboxes and innovation hubs), to share technological expertise, and to reach common views on the regulatory treatment of innovative products, services and business models, overall boosting bilateral and multilateral coordination.
The EFIF was established further to the January 2019 Joint ESA report on regulatory sandboxes and innovation hubs which identified a need for action to promote greater coordination and cooperation between innovation facilitators to support the scaling up of FinTech across the single market.