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INNOVATION & PRODUCTS

INNOVATION & PRODUCTS

The objective of ESMA’s work in financial innovation is to achieve a co-ordinated approach to the regulatory and supervisory treatment of new or innovative financial activities, and provide advice to the European Parliament, the Council and the Commission.

Organisation

According to Article 9(4) of ESMA’s founding Regulation, ESMA shall establish a Committee on financial innovation. Within this framework, ESMA’s Financial Innovation team monitors financial activities in general and financial innovation in particular.  The main objectives are to ensure that supervisors, policy makers and market participants are aware of innovations that may undermine investor protection, give rise to financial instability or threaten market integrity. This work is achieved through the Financial Innovation Standing Committee  of ESMA.  

At the same time, a key premise of this work is the realisation that financial innovation has beneficially contributed to some of the key economic pillars through which finance operates and has brought investors and consumers material improvements in their quality of life.

Our work in this area relies on market intelligence from the FISC, its Consultative Working Group, ESMA staff, meetings held with non-EU regulators and market participants and from research undertaken by the department itself.

Crowdfunding

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’s work on investment-based crowdfunding, which included an article in ESMA Trends, Risks and Vulnerability report in September 2014, culminated in the publication of an Opinion to NCAs and Advice to the EU Parliament, Council and Commission in December 2014.

To accompany ESMA’s response to the Commission’s consultation on CMU, which asked questions about crowdfunding, ESMA published our analysis of a survey of the NCAs about regulated investment-based crowdfunding platforms in the EU. ESMA has also published Q&A on money laundering and terrorist financing in relation to investment-based crowdfunding.

Virtual Currencies

Virtual Currencies (VCs), like Bitcoins, have been monitored by ESMA even before the EBA warning on VCs was published in 2013. ESMA has published in 2015 a call for evidence in order to gather more information on the topic in order to understand recent market developments and outline potential benefits or risks for investors.

Contingent Convertibles

Contingent Convertibles (CoCos) are unsecured bonds with specific features that enable them to be converted or written down at a certain trigger event or at the discretion of the supervising authority. An initial article on CoCos was published in the Trends, Risks and Vulnerabilities report in 2013. In July 2014, ESMA published a statement to institutional investors to clarify the risks of investing in CoCos

Loan Participation Funds

Loan Participation funds provide investors with exposure to a diversified portfolio of secured bank loans. ESMA published a background articleon the more mature loan participation fund market in the United States, to describe its features, regulatory performance and risks.

Alternative indices

Alternative index products have grown rapidly since the financial crisis. While they minimize certain weaknesses of traditional market cap indices they expose investors to different potentially risks. For example, in order to construct an index that seeks to minimize risk, index providers may weight securities according to their volatility instead of weighting them according to market capitalization. This can have the side effect of a more concentrated sector exposure which may introduce other risks. While alternative index products are not necessarily more risky than traditional index products, they are frequently more opaque. A low level of transparency around construction methodology and simulation makes it difficult for investors to understand the risk and return profile of alternative indices.

Structured Retail Products

ESMA published an opinion on Structured Retail Products, providing good practices for product governance arrangements. These good practices that product providers could put in place to improve their ability to deliver on investor protection in particular focus on:

  • the complexity of the structured retail products they manufacture and distribute;
  • the nature and range of investment services and activities undertaken in the course of business; and
  • the type of investors they target.

ESMA expects national competent authorities to embed these good practices in their supervisory approaches to structured retail product providers.

Other activities

  • Financial Innovation Day

The Financial Innovation Day is a primary source of knowledge in helping us monitor innovation. The Day provides us with a unique perspective on developments in the EU financial markets and acts as a forum to share insightful ideas with peers, academics and practitioners. Its audience is composed of regulators from the 28 Member States.

We held our first Financial Innovation Day on 8 April 2014 and our second on 16 December 2015, about which you can read more on our website.