European Supervisory Authorities Recommendations on Digital Finance

Recommendation 1 - take a holistic approach to the regulation and supervision of fragmented value chains

Digitalisation is increasing reliance by financial institutions on third-party providers for the provision of services through outsourcing and other arrangements. Critical third-party providers may result in concentration risks and financial stability risks.

Recommendation 2 - enhance consumer protection to address risks of mis-selling (in particular for tied and bundled products)

New financial services business models may harm consumers, especially those with lower levels of financial and/or digital literacy and the disclosure requirements across the EU must be fit-for-purpose for the digital age.

Recommendation 3 - prevent financial exclusion and promote a higher level of digital and financial literacy to help consumers make effective use of financial services provided via digital means

Increasing digitalisation should not become an inhibitor to accessing financial services. Therefore, prevention of financial exclusion in addition to informing consumers about responsible choices that meet their expectations, increasing confidence and trust in the digital financial system as well as their personal financial outlook is important.

Analysis of the use of data in AI/Machine Learning models and potential bias leading to discrimination and exclusion should be monitored.

Recommendation 4 - address the issue of borderless financial services and the definition of cross-border services in a digital context

Digital financial services are inherently borderless and therefore raises questions as to whether the obligation to notify of ‘cross-border provision of services’ is necessary and if so, how to classify these services under the ‘right of establishment’ or ‘freedom of services’.

Borderless financial services present challenges both to the regulators, but also to consumers who may not be able to determine which authority is the relevant authority to address recourse.

Recommendation 5 - strengthen supervisory skills and resources available to relevant authorities to monitor digitalisation

Digitalised financial services evolve rapidly and in some instances with increasing complexity. Consequently, regulatory authorities may lack the necessary expertise and resources to effectively monitor the market. The work on the Digital Finance Supervisory Academy will be invaluable in supporting the deepening of regulatory expertise.

Recommendation 6 - clarify data protection obligations in the customer due diligence (CDD) and wider AML/CFT context

Notwithstanding the possible benefits, fragmentation of financial services might complicate AML/CFT compliance for financial institutions, especially when they outsource some or all of their compliance tasks to external service providers.

Some participants in the digital financial services market might also lack adequate AML/CFT systems and controls which prompts a need for clarity in related AML/CTF obligations across digitalized financial services.

Recommendation 7 - potential expansion of consolidation rules to consider in light of Mixed Activity Groups (MAG’s)

Digital finance has unlocked new synergies between financial and non-financial activities that potentially introduce systemic risk into the market for financial services. The associated prudential risks may be managed by drawing reference to the Financial Conglomerates Directive.

Recommendation 8 - three complementary frameworks are proposed to enable cooperation that would promote information-sharing on policy developments in each authorities’ respective sector and strengthen market monitoring coverage

The growing digitalisation and datafication of financial services necessitate closer cooperation between financial and relevant non-financial authorities. The ESAs see merit in the Commission exploring possible ways to foster an enhanced cooperation framework between financial data, cyber, consumer protection and competition authorities.

Recommendation 9 - ESAs should look into possible ways to enhance cooperation between home and host authorities

The ESAs should develop guidance on notification requirements, discussions of practical cases in supervisory forums, or procedures to follow in situations in which a financial firm infringes on the rules of other Member States.

Enhanced coordination with third-country authorities may also be necessary in the form of a review of existing Memoranda of Understanding (MoUs) to ensure they reflect specific issues related to digital finance.

Recommendation 10 - monitor the growing use of social media in relation to financial services

Digitalised financial services have coincided with new trends through social media, such as ‘social trading’, or investment advice shared over social media—which brings new opportunities but risks as well.

Increased effective communication with consumers who seek information predominantly through digital channels including social media, will become necessary as digitalisation has seen a growth in ‘self-directed’, often non-sophisticated and adopting a ‘do it yourself’ approach. Consumers are therefore turning to digital means to access investment products and services, making investment decisions based on emotion rather than informed decision making.

Related Concerns

Risk of Cross-mis-selling

Cross-mis-selling can also be observed for example in the context of digital platforms where a number of products or services may be offered in combination, to target new customers or to retain them, or in so-called ‘embedded finance’.

Fund Management Platforms

There is also a shift in the range of services provided from a mere intermediary function to a wider set of services, including trade execution, custody, corporate action processing, reporting, compliance and so-called value-added services, such as the provision of data analytics, this is seen across fund management platforms.

The phenomenon deserves monitoring as it may have implications for investor protection. In particular, lack of transparency in the fees charged by fund distribution platforms to asset managers, which could in turn affect the cost of investing in funds for end users

Cyber security and Operational Resilience Risk

The increased digitalisation of financial services can exacerbate certain ICT and cyber risks and risks in relation to the operational resilience and business continuity of financial entities, especially with the increasing exposure to and dependency on third-party service providers, including unregulated ones.