Fifty years ago, banking was a relationship business. Bank managers collected information about depositors and borrowers from all sorts of sources, formal and informal. In recent decades, credit decisions have become far more data-driven, with companies like Amazon and the Alibaba-affiliate, Ant Financial, taking the lead in the U.S. and China. This paradigm shift in finance, however, is only just beginning. We are entering a period in which the leaders in finance will have to focus intensely on data and its analysis. Banks and traditional financial institutions around the world are in the process of building ever-more sophisticated IT systems while new FinTech competitors seek to apply technology to finance in new and innovative ways, with the objective of disrupting the industry. At the same time, however, the greatest existential threat to both probably lies elsewhere: with the large platform technology firms. BigTech is entering finance, heralding the dawn of the era of TechFins, companies that start with data and tech and add financial services to their product offerings.
A robust debate is underway around the world over how best to regulate this interaction of data and finance. This is going on in parallel with the far more heated debate over the role of data and data platforms and their impact on the future of economies and societies around the world.
In our new paper, The Future of Data-Driven Finance and RegTech: Lessons from EU Big Bang II, we analyze the interaction of major European initiatives in the areas of financial and data regulation in 2018, arguing that together these have triggered a new Big Bang in European finance, comprising the rise of RegTech (regulatory technology) and of data-driven finance.
The groundwork for this Big Bang was laid by the extensive reporting requirements imposed after the Global Financial Crisis to control systemic risk and change financial sector behavior. The process was then completed by the reforms of 2018, including: (1) MiFID2; (2) strict data protection rules reflecting European cultural concerns about dominant actors in the data processing field (GDPR); (3) facilitation of open banking to enhance competition in banking and particularly payments (PSD2); and (4) the legislative framework for digital identification imposed to further the European Single Market (eIDAS).
We suggest that the parallel reform processes culminating in 2018 were each designed independently and for very specific objectives, which did not include spurring the development of RegTech and data-driven finance. This, however, is exactly the effect they are having. Furthermore, because their application is often extraterritorial, this impact is global. This is even more so because countries around the world are focusing on similar issues: How to design systems to regulate data and finance and their interaction?
We argue that the European Union’s financial services and data protection regulatory reforms have unintentionally driven the use of RegTech by intermediaries, supervisors, and regulators, thereby laying the foundations for the digital transformation of EU financial services and financial regulation. These four pillars are underpinning the rise of RegTech, and our analysis suggests that together they will underpin the future of data-driven financial services in the European Union. Although unrelated and uncoordinated, these four regulatory strategies – interacting together – are fueling a Big Bang transition to data-driven finance. These pillars bolster an emerging ecosystem that aims to promote a balance among a range of sometimes conflicting objectives, including systemic risk, data security, and privacy, efficiency, and customer protection.
The full outcomes of this experiment in Europe are as yet unclear. Their impact in terms of the very rapid development of RegTech and its use by the financial industry and regulators is very clear. It also seems clear that eIDAS will bring finance and data even more closely together, particularly with anticipated changes in the area of anti-money laundering rules. However, the full impact on both the financial and data industries, particularly from GDPR and open banking under PSD2, are very much at early stages of development.
Furthermore, these legal changes in Europe are already having global implications. First, their extraterritorial impact has meant that financial and data firms around the world have already spent large amounts of time and money on RegTech in building IT and compliance systems to implement the new requirements.
Second, the experiences of the European Union provide insights for how other societies may develop regulatory approaches to the intersection of data, finance, and technology, and also financial inclusion. Societies around the world are looking very closely at issues surrounding data regulation, with GDPR being a major influence in discussions in the U.S., China, India, and elsewhere. Likewise, many around the world are watching very closely to see how Europe’s experiment with open banking progresses. To the extent that Europe’s experiment is positive, it will be emulated elsewhere. To the extent that it fails, the idea will be shunned around the world.
What is clear everywhere though is that the interaction between finance and data – a long-term process of digitization and datafication combining into new business models and competitors – is now permanent; and regulating data-driven finance requires not only careful thought and appropriate policy choices but also RegTech. As we have seen already in Europe, digital finance requires RegTech, which in turn supports further digitization and datafication, accelerating the transition to data-driven finance. The challenge for societies is determining what role data and data companies will be allowed to play and the nature of the societies that will evolve as the result.
This post comes to us from professors Dirk A. Zetzsche at the Universite du Luxembourg and Heinrich Heine University Dusseldorf, Douglas W. Arner at the University of Hong Kong, Ross P. Buckley at the University of New South Wales, and Rolf H. Weber at the University of Zurich. It is based on their recent paper, “The Future of Data-Driven Finance and RegTech: Lessons from EU Big Bang II,” available here.