Investment based crowdfunding and crypto assets – Challenges ahead

Crowdfunding Regulation

With the aim to overcome existing divergences in national frameworks on crowdfunding, in October 2020 the EU has adopted and published the long awaited final text of the Regulation on crowdfunding service providers (Regulation (EU) 2020/1503), the European Crowdfunding Service Provider Regulation “ECSPR”). The ECSPR provides a level-playing field for crowdfunding platforms in the EU, by introducing a harmonized set of rules that will be enable European crowdfunding service providers (CSPs) to explore the full potential of the EU single market.

The ECSPR covers two main types of practices used by crowdfunding platforms:

  1. Facilitation of granting loans (lending based crowdfunding)
  2. Placement of transferable securities within the meaning of Art. 4 para. 1 Nr. 44 MiFID II and/or instruments admitted for crowdfunding purposes that basically refer to shares in private limited companies that are not subject to restrictions that would effectively prevent them from being transferred (investment based crowdfunding)

Offers of financial instruments, either transferable securities or above-described instruments admitted for crowdfunding purposes under national law, of a single project owner whose total consideration is not exceeding 5.000.000 EUR will be eligible to be treated as crowdfunding offers and thereby will be exempted from more onerous requirements stipulated by EU and national rules on securities prospectus and securities issuing requirements.

The ECSPR will start to apply as of 10 November 2021. Crowdfunding service providers operating already under national regimes are provided with a 12-month transitional period within which they will have to ensure compliance with new rules.

Given that the ECSPR is primarily aimed to regulate crowdfunding service providers, the exact scope of application of the investment based crowdfunding in respective EU Member State can only be assessed based on relevant provisions of national law that implement MiFID II definition of transferable securities and define instruments that may fall under the definition of instruments admitted for crowdfunding purposes.

Investment based crowdfunding with crypto-assets – the new frontier?

In the wake of the ever increasing use of crypto-assets for fund raising, the legitimate question that can be raised is whether the crypto-assets can also be used for the purposes of fund raising in accordance with the new regime on investment based crowdfunding under the ECSPR.

Currently, most EU Member States do not stipulate de jure the possibility of issuing transferable securities via DLT or similar technology. However, majority of supervisory authorities across the EU tend to assess the legal status of each crypto-asset on a case by case basis by assessing its features based on various criteria like the level of standardization, tradability on financial markets etc.

  • Debt securities

In relation to crypto-assets with features of debt financial instruments (bonds, derivatives etc.) most supervisory authorities in the EU have taken pragmatic approach by assessing their legal status on a case by case basis and by treating them in accordance with applicable rules on issuance of financial instruments within the meaning of MiFID II. Nevertheless, there are also certain potential impediments to the issuance of debt transferable securities in tokenized form. These are particularly related to requirements under CSDR (e.g. requirement for transferable securities to be registered with CSD in book-entry form) as well as potential obstacles in national legislation like requirement for transferable securities to be represented in the form of a global certificate in physical form.

  • Equity securities

In addition to above mentioned challenges to tokenization of debt securities, the issuing of equity securities in tokenized form (in their literal meaning) has been prevented in most EU Member States due to open legal questions arising from company law that is barely harmonized at the EU level. Therefore, the possibility of using the new crowdfunding regulatory framework for the issuance and placement of equity based transferable securities depends largely on provisions of company law and securities law at national level. The recently published German Act on Electronic Securities (eWpG), which has for the first time allowed the issuing of securities in Germany in electronic or even crypto-form, is also one good example of how the issuing of tokenized shares can hardly be enabled by amendments of securities legislation. Due to related company law issues, German legislator has decided to make new provisions of eWpG solely applicable to debt instruments and units in investment funds, by leaving companies shares out of the scope of its application for the time being.

  • Reform of the MiFID II definition of financial instruments

With the intention to overcome the regulatory uncertainty around the application of MiFID II framework to crypto assets with features of financial instruments the European Commission has proposed in September 2020 a Directive that shall, among other, amend the MiFID II definition of financial instruments.

The new definition will be covering all types of financial instruments under MiFID II (including transferable securities) issued via DLT or similar technology as well. Due to the fact that MiFID II is a Directive, the revised definition will still need to be implemented into national law and currently significant divergences exist in national definitions of financial instruments across the EU. Last but not least, previously mentioned company law issues that prevent issuance of tokenized shares in many EU Member States and new laws on issuance of crypto-securities that fall short of covering all types of financial instruments in certain Member States (like in Germany) will represent challenges that will still need to be addressed. Until the new regime based on the expanded MIFID II definition becomes operational prospective the issuers of security tokens will still need to rely on national laws and the wide interpretative discretion of national supervisory authorities.

  • Instruments admitted for crowdfunding purposes

Looking into the issuing of instruments admitted for crowdfunding purposes (shares in private limited companies) in tokenized form, the picture doesn’t seems to be brighter either. The ECSPR stipulates explicitly that its definition and scope of application in relation to admitted instruments for crowdfunding purposes applies without prejudice to requirements under national laws that govern their transferability, such as the requirement for the transfer to be authenticated by a notary. To that end, EU Member States have a final say when it comes to deciding whether shares in private companies will be eligible to be used for crowdfunding purposes under the new regime. There is a fairly big chance that certain Member States will exclude shares in private limited companies from the scope of application of the new regime at national level by stipulating gold-platting provisions in national law. For instance, heavily criticized national transposition law in Germany, which was published in March this year, stipulates such an exclusion that will prevent shares in private limited companies of being used for crowdfunding offers under the new regime. Despite the fact that such measure would most probably just result in incorporation of fund raising SPVs in other EU jurisdiction (whose shares can still be offered on crowdfunding platforms anywhere in the EU) it cannot be excluded that some other EU Member State will follow similar approach.

Conclusion

Against the backdrop of everything mentioned above, it is fair to conclude that prospective fund raisers intending to leverage the new regime on crowdfunding as a less onerous regulatory framework comparing to regime under Prospectus Regulation will still largely need to ensure compliance with national laws in respective Member States from where they are intending to operate / set up an SPV for fund raising. The proposed EU Regulation on markets in crypto-assets (MiCAR) doesn’t seem to provide any further clarity to this topic either, because its scope of application will be limited solely to crypto assets that do not qualify as financial instruments under the MiFID II framework.

Therefore, despite the fact that the ECSPR has achieved significant progress in harmonization of rules on crowdfunding in the EU, there are still many challenges ahead that will need to be addressed before the crowdfunding as an alternative finance model starts to leverage DLT and crypto-assets in full capacity.

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Sustainable Finance Package

Finalisation of the regulatory framework on sustainable finance in sight

The EU has taken major steps over the past number of years to build a sustainable financial system. On this blog, we have repeatedly given updates on the EU Taxonomy Regulation, the Sustainable Finance Disclosure Regulation and the Benchmark Regulation that form the foundation of the EU’s work to increase transparency and provide tools for investors to identify sustainable investment opportunities. We are now steering toward a final regulatory framework on sustainable finance.

Sustainable Finance Package in a nutshell

On 21 April 2021, the European Commission has adopted a comprehensive package of measures (the Sustainable Finance Package) as part of its wider policy initiative on sustainable finance, which aims to re-orient capital flows towards more sustainable investments and enable the EU to reduce its carbon-footprint by at least 55% by 2030 and reach carbon neutrality by 2050.

The Sustainable Finance Package is comprised of:

  • Corporate Sustainability Reporting Directive (CSRD), which amends the existing reporting requirements under Directive 2014/95/E (Non-Financial Reporting Directive, NFRD) by expanding the scope of sustainability-related reporting requirements to more corporate entities;
  • Taxonomy Climate Delegated Act, which provides technical screening criteria under which an economic activity qualifies as environmentally sustainable, by contributing substantially to climate change mitigation or climate change adaptation while making no significant harm to any of the other environmental objectives;
  • Six Delegated Acts that amend requirements under UCITS, AIFMD, and MiFID II framework by incorporating new rules on consideration of sustainability risks, factors and preferences by investment managers and investment firms.

Corporate Sustainability Reporting Directive (CSRD)

With the aim to capture a wider group of companies and to bring sustainability reporting over time on a par to financial reporting, CSRD expands the scope of the existing NRFD, which currently applies only to companies with over 500 employees (even though national law in certain EU Member States stipulates lower thresholds).

The CSRD expands the scope of application of sustainability-related reporting requirements to all large undertakings (whether listed or not) that meet two of the following three criteria:

  • balance sheet total of EUR 20,000,000,
  • net turnover of EUR 40,000,000,
  • an average of 250 employees during the financial year.

In addition to large undertakings, the CSRD reporting requirements will apply to all companies listed on the EU regulated market as well, with the exception of listed micro companies.

To that end, the CSRD aims to capture nearly 50,000 companies in the EU in comparison to only 11,000 companies that are currently subject to reporting requirements under NFRD. This should provide financial institutions that are subject to Regulation (EU) 2020/2088 (Sustainable Finance Disclosure Regulation, SFDR) with more relevant sustainability-related data about prospective investee companies, based on which they will be able to fulfil disclosure requirements under the SFDR.

As a next step, the Commission will engage in discussions on the CSRD Proposal with the European Parliament and Council.

Taxonomy Climate Delegated Act

The Taxonomy Climate Delegated Act represents the first set of technical screening criteria that are intended to serve as a basis for the determination which economic activities can be deemed as environmentally sustainable under the Taxonomy Regulation. Developed based on the scientific advice of the Technical Expert Group (TEG), the Delegated Act provides technical screening criteria for determination whether an economic activity contributes significantly to either climate change mitigation or climate change adaption while making no significant harm to any other environmental objective under Article 9 of the Taxonomy Regulation.

Final Draft of the Delegated Act still needs to be officially adopted by the Commission, after which the European Parliament and the Council will have 4 months (which can be extended by additional 2 months) to officially adopt it.

Amending Delegated Acts

As part of the Sustainable Finance Package, the Commission has also published six long-awaited final versions of the draft amending delegated acts under MiFID II, UCITS and AIFMD framework with the aim of incorporating additional requirements on consideration of sustainability risks, factors and preferences by investment managers and investment firms.

The proposed changes introduced by delegated acts, which are expected to apply from October 2022, can be summarized as follows:

Product Governance: changes to MiFID II Delegated Directive (EU) 2017/593 put the obligation on manufacturers and distributors of financial instruments to take into consideration relevant sustainability factors and clients’ sustainability objectives in the process of product manufacturing and distribution.

Suitability assessment: changes to MiFID II Delegated Regulation (EU) 2017/565 require investment firms to take into account clients’ sustainability preferences in the course of suitability assessment. Given that requirements on suitability assessment apply only to firms providing investment advisory and portfolio management services, ESMA is separately considering (ESMA Consultation on appropriateness and execution only under MiFID II) whether the consideration of sustainability risks and factors shall be taken into account in the case of provision of other investment services for which requirements on appropriateness assessment apply.

Integration of sustainability risks and factors: amendments to MiFID II Delegated Regulation (EU) 2017/565, UCITS Delegated Directive 2010/43/EU and AIFMD Delegated Regulation (EU) 231/2013 impose new obligations on investment firms and asset managers, by requiring them to take into account sustainability risks and factors when complying with organisational requirements, including requirements on risk management and conflict of interest requirements.

Further, UCITS and AIF management companies that consider principal adverse impacts of their investment decisions on sustainability factors under SFDR (e.g. impact of an investment in a fossil fuel company on climate and environment), will be required to consider this when complying with due diligence requirements stipulated under UCITS and AIFMD framework.

The Sustainable Finance Package also includes similar changes to Delegated Acts under IDD, which affect insurance distributors.

Conclusion

The proposals published as part of the Sustainable Finance Package represent some of the last pieces in the puzzle of the EU regulatory framework on sustainable finance, which aims to support the EU on its way towards creation of a more sustainable economy. These latest efforts by the Commission provide some further clarity to corporate entities and financial institutions that have been facing with new regulatory challenges for quite some time now.  In the meantime, on 7 May 2021 the Commission has also published one additional Delegated Act under the Taxonomy Regulation, which outlines requirements on the content, methodology and presentation of key performance indicators (KPIs) that entities, which are subject to reporting requirements under Article 8 of the Taxonomy Regulation, need to comply with.

Nevertheless, there are some other important legislative proposals that still need to be published, like the final version of regulatory technical standards under the SFDR that is essential for compliance of financial institutions with disclosure requirements stipulated by this Regulation.  Those regulatory initiatives show that aiming at a sustainable financial market in Europe is more than a fancy trend but rather a new effort which needs to be taken seriously and is not to be underestimated. If you have any questions about the EU regulatory framework on sustainable finance and its impact on your business, please get in touch with us.

ESMA updated AIFMD and UCITS Q&As

On June 4, 2019 ESMA published updates questions and answers on the application of the AIFM Directive (available here) and the UCITs Directive (available here). ESMA’s intention of publishing und regularly updating the Q&A documents ensures common supervisory approaches and practices in relation to both the AIFM Directive and the UCITS Directive and their implementing measures.

The latest update refers to the depositories and the possibilities to delegate the safekeeping of assets of the funds. ESMA clarifies that supporting tasks that are linked to depositary tasks such as administrative or technical functions performed as part of the depositary tasks could be entrusted to third parties where all of the following conditions are met:

  1. the execution of the tasks does not involve any discretionary judgement or interpretation by the third party in relation to the depositary functions;
  2. the execution of the tasks does not require specific expertise in regard to the depositary function; and
  3. the tasks are standardised and pre-defined.

Where depositaries entrust tasks to third parties and give them the ability to transfer assets belonging to AIFs or UCITS without requiring the intervention of the depositary, these arrangements are subject to the delegation requirements, in Germany subject to Para. 36 KAGB.

Another question relates to the supervision of branches of depositories. The AIFM Directive, the UCITS Directive, the CRD and the MiFID II do not grant any passporting rights for depositary activities in relation to safekeeping assets for AIFs or UCITS. Branches of depositories located in the home Member State of the AIF or UCITS that is not the home Member State of the depositary’s head office may also be subject to local authorisation in order to perform depositaries activities in relation to AIFs or UCITS. In this case, the competent authority for supervising the activities in relation to AIFs or UCITS is the one located in the Member State of the depository’s branch.

The guidance provided by ESMA in the Q&A documents for AIFs and UCITS regarding the depository function do not contain any surprising elements but further strengthen the harmonized interpretation and application of the AIFM and UCITS Directives in Europe.

Germany is paving the way for an informal transition period for the financial market in case of hard Brexit

On 20 November 2018, the Federal Ministry of Finance of Germany published a Draft Act on Tax-Related Provisions concerning the withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union.

The Draft Act proposes amendments to the German Banking Act (Kreditwesengesetz) and the Insurance Supervision Act (Versicherungsaufsichtsgesetz) and aims to avoid any harm to the functioning or stability of financial markets in case of a hard Brexit, i.e., the withdrawal of the UK from the EU by the end of March 2019 without an agreement.

BaFin will be allowed to grant a transition period until the end of 2020 for passporting financial services into Germany

The proposed amendment to the KWG will allow the German Federal Financial Supervisory Authority (BaFin) to permit firms based in the UK, which have been providing cross-border banking or financial services based on a European passport before Brexit, to continue to operate financial transactions in Germany until the end of 2020 at the latest. The proposal reads:

In the event that the United Kingdom of Great Britain and Northern Ireland withdraws from the European Union at midnight on 29 March 2019 without having concluded an agreement on withdrawal from the European Union […] the Supervisory Authority may determine, in order to prevent disadvantages for the capacity of financial markets to function or for their stability, that the [passporting] provisions […] are to be applied accordingly, fully or partially, for a period of up to 21 months following the time of withdrawal, to companies based in the United Kingdom of Great Britain and Northern Ireland that on 29 March 2019 conduct banking business or provide financial services in Germany through a branch in Germany or by providing cross-border services [under the passporting regime]. [This] only applies to financial transactions that are completed after 29 March 2019 insofar as these transactions are closely connected to transactions that existed at the time of withdrawal.

As already mentioned here the FCA has been planning to take similar precautions for a hard Brexit. Now Germany is following.

The Draft Act, which needs to go through parliament before entering into force, authorises BaFin to extend the current passporting regime at its own discretion. BaFin may adopt a generally applicable rule for all institutions concerned or restrict it to individual supervisory areas that are highly affected. The transition period can also be shortened by BaFin. In addition, BaFin may attach conditions to its permission regime and abolish its measures at any time.

According to the currently proposed wording of the Draft Act, the transition period only applies to financial transactions concluded before Brexit. New financial transactions are only included if they are closely related to existing ones.

During the transition period, the companies concerned must prepare themselves to either apply for a respective license in Germany in order to to submit their German business to the supervisory regime for third countries, or to bring their German business to an end.

Transition period also proposed for the insurance sector

The Draft Act authorises BaFin to adopt a similar transition period for insurance undertakings in order to avoid disadvantages for policyholders and beneficiaries. This will enable insurance companies based in the UK to either transfer or terminate existing contracts within a reasonable timeframe, or meet the necessary prudential requirements for an orderly run-off of such contracts, where this is not possible.

Draft Act subject to European law

In case the EU comes up with a similar and uniform transition rule to protect the financial markets from any chaotic disruption due to Brexit, the EU rule will prevail.

How to Handle Brexit as a Fund Manager

By Dr. Verena Ritter-Doering of Curtis, Mallet-Prevost, Colt and Mosle LLP and Uwe Lill of GFD FINANZKOMMUNIKATION

The good old days seem to be over. Once Brexit gets real, the current passporting rules will no longer be available and new rules will apply for UK fund managers with EU clients. With or without equivalence, the UK will become a third country from an EU perspective, which raises three key questions that you will need to answer in order to chart the path forward: 1. Where is your fund located? 2. Where is your fund manager located? And 3. Where are you undertaking sales activities to address your EU clients?

To put it simply, there are seven different ways to serve your existing EU clients after Brexit, or to build new relationships with EU clients. We will show you in this Brexit map which route you will need to take to remain successful. In addition to considering the legal setup , it will be equally important to evaluate the way you communicate if you want to grow your EU customer base. For example, you must consider what should be taken into account when informing media in the unique German-speaking market.

For background information and details on this ongoing process (which may change on a daily basis!), please do not hesitate to contact us. We are very happy to share our expert knowledge with you.

Please click on this link to view the Brexit Tube Map for Fund Managers

FCA re-confirms temporary permission regime for inbound passporting EEA firms in case of a hard Brexit – the EU stays strict for now

Brexit will have an impact on the European and the UK financial market. Cross-border services will still be possible but the legal set-up will change and will get more complicated than the current passporting regime. Anyone who provides banking business or financial services in Germany without the appropriate license is committing a criminal offence. If charged, the person committing the criminal offence can become subject to a prison sentence (up to 5 years in case of intention and up to 3 years in case of negligence) or a monetary fine.

Outbound from the UK

If there is no implementation period when the UK withdraws from the EU, the UK will become a ‘third-country’ in relation to the EU and the current passporting regime will no longer cover the provision of financial services, payment services or the management and distribution of funds on a cross-border basis between the UK and continental Europe. Any UK person then providing any such business in Germany without the appropriate license, i.e., without a licensed set-up in Europe, will commit a criminal offence on a personal level.

The current political will in Europe does – at least at this stage – not cater for any easing of the strict criminal regime once the passporting rights of UK firms end due to Brexit.

Inbound to the UK

The FCA (backed by the UK Government) on the other hand just confirmed on October 10, 2018 that they are willing to protect the UK market by offering a transition period in case of a hard Brexit without a transition period. This will allow inbound EEA firms to continue operating in the UK within the scope of their current permissions for a limited period after the exit day, while seeking full UK authorisation. It will also allow funds with a passport to continue temporarily marketing in the UK while seeking UK recognition to continue to market in the UK.

The FCA expects the temporary permissions regime to come into force when the UK leaves the EU on March 29, 2019 and expects the regime to be in place for a maximum of three years, within which time, firms and funds will be required to obtain authorisation or recognition in the UK.

The FCA is currently consulting details of the rules they propose should apply to firms and funds during the temporary permissions regime.

What to do?

Firms will need to notify the FCA that they wish to use the temporary permissions regime.  This will be an online process and the FCA expects to open the notification window in early January 2019.  The notification window will close prior to exit day. Once the notification window has closed, firms that have not submitted a notification will not be able to use the temporary permissions regime. The FCA will then allocate firms a period (‘landing slot’) within which they will need to submit their application for UK authorisation.  After exit day, the FCA will confirm firms’ landing slots so they can start to prepare their applications. The first landing slot will be from October to December 2019 and the last will be from January to March 2021.

The regime will work in a similar way for EEA investment funds with fund managers notifying the FCA of the funds they want to continue to market in the UK.  As with firms, the FCA expects to start accepting notifications in early January 2019 and the notification window will close prior to exit day. Once the notification window has closed, fund managers that have not submitted a notification for a fund will be unable to use the temporary permissions regime for this fund and will not be able to continue marketing the fund in the UK.

It needs to be seen if the EU will align its supervisory authorities to a similar practice to ease disruption of the financial markets, should no deal be reached, and the UK will leave the EU on March 29, 2019.

Who is Who? European Supervisory Authorities – How they Cooperate and Interact

If you are looking for guidance from national and European supervisory authorities, it is not easy to see at first glance how they work together and whose guidance is most relevant. We want to shed some light on the ‘Who is Who?’ of German and European regulators.

Financial market supervision in Germany

The first go-to regulator in Germany is the Federal Financial Supervisory Authority (BaFin), which is entrusted with the tasks of banking, insurance and securities supervision and acts as a universal financial supervisory authority. BaFin is also responsible for ensuring that financial services, banking and insurance transactions are not conducted without a license and can also sanction any violations against the regulatory regime – and does so regularly. One of the newest additions to the list of tasks of BaFin is supervising compliance with consumer protection rules within the financial market. This primarily concerns cases in which regulated institutions violate regulatory provisions that protect consumers. If these infringements go beyond individual cases, they are pursued in the public interest by BaFin. BaFin, together with criminal enforcement authorities, is also responsible for pursuing money laundering and terrorist financing and supervising compliance with AML requirements. BaFin’s banking and insurance supervisory office is based in Bonn, the office responsible for securities supervision, asset management and bank resolution is based in Frankfurt am Main.

In Germany, the task of banking supervision is shared by BaFin and the German Central Bank (Deutsche Bundesbank). BaFin and Deutsche Bundesbank, e.g., oversee whether the banks have sufficient financial resources and whether business operations are properly organised. BaFin and Bundesbank receive the necessary information from the banks themselves or obtain it through on-site audits. The Bundesbank is responsible for the majority of operational banking supervision, namely the reporting and evaluation of audit reports submitted by the institutions and the performance of special audits. Guidelines for ongoing supervision and interpretation of legal requirements are mainly issued by BaFin.

The supervision of insurance policies by BaFin is intended to ensure that the insurance companies are capable of providing the benefits to which they are obliged. To this end, BaFin checks, for e.g., whether the insurance companies have sufficient financial resources and assess risks correctly.

BaFin’s supervision of securities serves the purpose of ensuring the availability of sufficient information and transparency for all market participants by monitoring the proper publication of relevant information. BaFin also monitors insider trading and price manipulation.

European financial market supervisory regime

BaFin and Deutsche Bundesbank are not the only regulators you have to keep up with when you are a regulated institution. At the European level, the European Securities and Markets Authority (ESMA), the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) have their say and the European Central Bank (ECB) is also responsible for financial market supervision within the Eurozone.

The Single Supervisory Mechanism (SSM) has entrusted the ECB with the direct supervision of significant financial institutions in the Eurozone. These are about 120 banks and banking groups. To fall within the ECB’s responsibility, a bank must either have a balance sheet total of more than €30 billion or more than 20% of its home country’s GDP. If these thresholds are not met, the ECB monitors the 3 largest banks in each of the countries participating in the SSM (which are 19 countries in the Eurozone). All other banks will continue to be supervised by the national supervisory authorities.

If the ECB is in charge, the ECB cooperates with the national supervisory authorities of the banks’ home countries. Joint Supervisory Teams (JSTs) are set up by the ECB for coordination. These are composed of staff from the ECB and the national supervisory authorities. In Germany JSTs consist of members of the ECB, BaFin and Deutsche Bundesbank. A consistent supervisory practice can be established through the JSTs, taking into account national standards and a uniform standard within the Eurozone.

In contrast to the day-to-day supervision of the national regulators and the ECB, the European supervisory authorities EBA, ESMA and EIOPA (together ESAs) generally do not act directly vis-à-vis individual financial institutions, but ensure uniform standards within the EU. They also monitor the application of EU law by national supervisory authorities and the market. For this purpose, they use convergence instruments such as guidelines and Q&As (Questions and Answers), which aim at a consistent application of EU law by the national supervisory authorities. In practice, however, European directives are not always implemented equally in each Member State since the directives also leave a scope of interpretation for the national legislator on certain aspects of regulatory law.

The guidelines issued by EBA, ESMA and EIOPA are binding for the national regulators in Europe. They are not directly binding for the institutions but become directly binding when adopted by the national regulators. BaFin publishes on its homepage whenever it adopts guidelines, and also when guidelines are specifically not integrated within the German administrative practice. The advantage of the ESA’s approach of having a single rulebook and consistent rules throughout the EU for the market is that the provision of cross-border services becomes easier if just one set of rules apply.

EBA, ESMA and EIOPA are also actively involved in the European legislative process by supporting the European Commission in drafting legislative proposals based on their knowledge of the European financial market and its supervisory mechanisms.

Although the ESAs do not act directly vis-à-vis the majority of the regulated institutions, it is worth monitoring their publications to get an early grip on regulatory developments. The European administrative practice is essentially formed through the ESAs. It is also worth noting that the ESAs usually publish drafts of their envisaged guidelines for consultation purposes. For lobbying purposes it is essential to participate in such consultations.

FinTech Action Plan versus Global Financial Innovation Network

As outlined in Part 3 of this series of posts giving updates on the European FinTech regulation agenda, the envisaged harmonized regulatory framework for financial innovation within the Single Market will be based on a comprehensive understanding of the innovative landscape within the financial market. Building the knowledge takes time and effort. It took EBA three and a half months after laying out its FinTech Road Map to publish the first analyses which form part of the FinTech Knowledge Hub.

The Knowledge Hub aims at fostering a better understanding of the innovative landscape within the financial market through facilitating the exchange of information between European and national regulators, innovators and technology providers. On this basis, a regulatory framework can be built that will fit the market’s demands and will support new innovative business models.

In contrast to the European approach, the Financial Conduct Authority (FCA) in London approaches the support for FinTechs in what seems to be at a first glance a more rapid way. Already in February 2018 the UK regulator encouraged the idea of a “global sandbox.” A regulatory sandbox allows the provider of innovative technology to offer his or her idea to a certain number of potential clients within the financial market for a limited period of time without the application of the full set of compliance, license and capital requirements. During this time the provider can assess if his or her innovative approach is worth the investment of full regulatory compliance. In the UK the possibility for FinTechs to approach the market via a regulatory sandbox has been successfully established in 2016.

Driven by the understanding that major emerging innovation trends (such as big data, artificial intelligence and blockchain based solutions) are increasingly global, rather than domestic, in nature, in February 2018 the FCA started an international dialogue with firms doing business, or looking to do business, in the UK or overseas, regulators, consumers, or any other interested party to assess what a global sandbox could look like. The FCA received 50 responses to their call in February with an overall positive feedback. Key themes to emerge in the feedback were:

Regulatory co-operation: Respondents were supportive of the idea of providing a setting for regulators to collaborate on common challenges or policy questions that firms face in different jurisdictions.

Speed to market: Respondents saw as one of the main advantages for the global sandbox that it could be reducing the time it takes to bring ideas to new international markets.

Governance: Feedback highlighted the importance of the project being transparent and fair to those potential firms wishing to apply for cross-border testing.

Emerging technologies/business models: A wide range of topics and subject matters were highlighted in the feedback, particularly those with notable cross-border application. Among the issues highlighted were artificial intelligence, distributed ledger technology, data protection, regulation of securities and Initial Coin Offerings (ICOs), know your customer (KYC) and anti-money laundering (AML).

Building on the FCA’s proposal to create a global sandbox, on 7 August 2018 the FCA has, in collaboration with 11 financial regulators and related organisations, announced the creation of the Global Financial Innovation Network (GFIN). The FCA is the only European regulator within GFIN. The other members are the Abu Dhabi Global Market (ADGM), the Autorité des marchés financiers (AMF, Canada), the Australian Securities & Investments Commission (ASIC), the Central Bank of Bahrain (CBB), the Bureau of Consumer Financial Protection (BCFP, USA), the Dubai Financial Services Authority (DFSA), the Guernsey Financial Services Commission (GFSC), the Hong Kong Monetary Authority (HKMA), the Monetary Authority of Singapore (MAS), the Ontario Securities Commission (OSC, Canada) and the Consultative Group to Assist the Poor (CGAP).

The idea of GFIN is to:

  1. act as a network of regulators to collaborate, share experience of innovation in respective markets, including emerging technologies and business models, and communicate to firms;
  2. provide a forum for joint policy work and discussions; and
  3. provide firms with an environment in which to trial cross-border solutions (business-to-consumer (B2C) or business-to-business (B2B)).

With the announcement of the creation of GFIN, the FCA also published a consultation document laying out a mission statement for GFIN and the idea of a global sandbox which is still based on the FCA’s concept thereof published in February. The consultation is addressed to innovative financial services firms, financial services regulators, technology companies, technology providers, trade bodies, accelerators, academia, consumer groups and other stakeholders keen on being part of the development of GFIN and will be running until 14 October 2018.

Although the knowledge centered approach of the EU for a regulatory framework for FinTechs within the Single Market surely is a reasonable approach, an international approach could have the advantage of providing speedier solutions and create a competitive advantage. With Brexit on the horizon, the FCA’s approach seems sensible and certainly a good move to keep their financial market up to date.

FinTech Action Plan and EBA Road Map: Part 3

As outlined in Part 1 and Part 2 of this series of posts giving updates on the European FinTech regulation agenda, there is a political will to create a comprehensive and harmonized regulatory framework for financial innovation within the Single Market. Part of the Road Map to a regulatory framework is a FinTech Knowledge Hub, which is meant to facilitate the exchange of information between European and national regulators, innovators and technology providers. The Knowledge Hub will foster a better understanding of the innovative landscape within the financial market.

Three and a half months after laying out its FinTech Road Map, EBA delivers first products that form part of the FinTech Knowledge Hub.

The two documents published on 3 July 2018 are reports on the impact of FinTech on incumbent credit institutions’ business models  and on the prudential risks and opportunities arising for institutions from FinTech . Both reports contain an analysis of the impact of FinTechs on the current financial landscape and aim to raise awareness within the supervisory community and the financial industry of potential prudential risks and opportunities from current and potential FinTech applications. EBA wants to convey an understanding of the main trends that could impact incumbents’ business models and pose potential challenges to their sustainability.

The first report, on the impact of FinTech on incumbent credit institutions’ business models, is an overview of the current market situation. It identifies four drivers for changes in current business models which are i. customer expectations and behaviour, ii. profitability concerns in the current low interest rate environment, iii. increasing competition and iv. regulatory changes such as PSD2 and GDPR. EBA identifies two main trends among the different digitalisation projects of the established institutions, namely digital transformation of internal processes and digital disruption by use of innovative technologies that aim to enhance customer experience. In the current FinTech ecosystem the prevailing model of interaction between FinTechs and incumbent institutions is one of collaboration and establishment of new relationships. In this way FinTechs can provide knowledge and ideas incumbent institutions have yet been too reluctant or too slow to establish themselves.

The second report, on prudential risks and opportunities arising for institutions from FinTech, is intended to raise awareness of and to share information on current and potential FinTech applications. The report focuses on seven use cases without making recommendations. The seven use cases are:

  1. Biometric authentication using fingerprint recognition,
  2. Use of robo-advisors for investment advice,
  3. Use of big data and machine learning for credit scoring,
  4. Use of Distributed Ledger Technology (DLT) and smart contracts for trade finance,
  5. Use of DLT to streamline Customer Due Diligence processes,
  6. Mobile wallet with the use of Near Field Communication (NFC),
  7. Outsourcing core banking/payment systems to a public cloud.

EBA focuses mainly on operational risk aspects, but also considers opportunities that may arise from the seven applications. The report is informative and provides a good overview for competent authorities and institutions alike of the current landscape and the inherent prudential risks that the market should be aware of.

MiFID II: Fundraising in the EU for Non-EU Fund Managers

The revised Directive 2014/65/EU on markets in financial instruments (MiFID II) took effect throughout the EU on 3 January 2018. MiFID II and the corresponding Regulation (MiFIR) intend to enhance investor protection and improve the operations of financial markets, their efficiency, resilience and transparency. It aims to make European financial markets safer, thereby restoring investor confidence following the fallout from the financial crisis, and covers the majority of the financial services industry including banks, brokers, investors, asset managers and exchanges.

MiFID II generally does neither apply to fund managers nor to third country entities. In a recent Client Briefing my London colleagues explained why MiFID II may yet be an issue for third country fund managers.

If non-EU fund managers market and distribute their funds through intermediaries located within the EU some requirements introduced in MiFID II will indirectly also apply to the non-EU fund managers (non-EU AIFM). This is mainly due to the fact that the EU intermediary himself is subject to the regulation and needs to ensure compliance with MiFID II and the corresponding national implementations in the relevant EU Member States.

For example, when addressing the European market each non-EU fund manager in his role as manufacturer of the fund product will be required to define an intended target market for the interests in the fund distributed in the EU. Specifically, manufacturers of financial products are required to specify a target market of end clients/investors for whose needs, characteristics and objectives the product is intended, as well as a distribution strategy that is consistent with the identified target market. The manufacturers should then make available to any distributor information on the product, including the target market and distribution strategy. If the distributor is an EU investment firm acting as intermediary between the non-EU fund manager and investors located in the EU, the intermediary can only offer the interest in the fund to the defined end investors according to the manufacturer’s target market and distribution strategy.

Non-EU fund manager should also be aware that the implementation and enforcement of MiFID II rules may vary somewhat between the various EU member states.

You can download the full Client Briefing here