There is no doubt that the future of the financial sector is digital, and this applies to both large and small companies. However, a successful digital transformation of the financial sector requires regulation. Not only to protect financial stability, but also to make consumers feel safe in using new digital and innovative services. Properly addressed, the EU Digital Finance Package can therefore be a winning formula that makes the EU financial sector highly competitive in the global race for digital and innovative services.
The EU digital finance package
On the 24th of September, the European Commission launched a digital finance package, setting a comprehensive strategy to promote a more competitive EU financial sector that gives consumers access to innovative financial products.
Innovation in digital finance, meaning the new digital technologies in the financial services industry, has accelerated during recent years. The ever-increasing speed of digitalization affects all industries, and not least the financial sector. As services, customers and corporates go online, so do the financial solutions that enable the digital movement.
The EU digital finance package includes two strategies and two legislative proposals: one strategy for payments in the retail industry and an overall digital finance strategy. These strategies are further complemented with legislative proposals for crypto assets, and not to mention, digital operational resilience. As digital dependency increases and supply chains extend, so do the inherent IT- and information security risks – a topic that will be further elaborated in an upcoming article dedicated to the legislative proposal for digital operational resilience.
The EU has identified digital finance as an enabler for innovation across all sectors, and an innovative digital financial market in Europe is believed to have a ripple effect in other industries as well. Digital financial solutions are also believed to be an important key for the economic recovery in the aftermath of the pandemic, as it would offer businesses new ways of funding.
The digitalization of finance has been moving fast over the last decade, but regulation has been lagging. The increased usage and development of digital financial services calls for more regulation and requirements within the area to ensure financial stability, which has become even more important as the on-going pandemic has accelerated the use of digital solutions globally. However, we can now see how the regulatory area of digital finance is catching up and changing quickly. We have recently seen the newly launched EBA guidelines on Information and Communication Technology, ICT (EBA/GL/2019/04), and the legislative proposal for digital operational resilience is further confirmation of digital solutions in the financial market becoming more regulated in Europe.
What will the regulation mean for the industry?
The main purpose of the EU digital finance package is to ensure financial stability while enhancing innovation, which makes cybersecurity an essential prerequisite. This is probably why the Swedish Financial Supervisory Authority (SFSA/Finansinspektionen) chose cybersecurity and the inherent risks as their main focus when commenting upon the package.
Another interesting area that the SFSA points out is the focus on third-party providers. Many of these have become crucial for the financial sector, and the increased extension and integration of the digital supply chain have significantly increased the attack surface and thereby the risks. The important aspect here is that most of these third-party providers are not necessarily financial firms to begin with, which means that much will be required from them to be able to comply to the strict regulations in the financial sector.
Firms, those already obliged to comply to financial regulations as well as those that may have to in a near future, may feel that increased legislation and stricter requirements for yet another area solely implies more administration and additional costs for the business. However, to be able to move forward and make use of the on-going digitalization, the financial market’s stability must be protected, and consumers must feel safe. The need of regulation for digital financial solutions is hence a long-term foundation for the European financial industry to be able to compete on a global level.
By launching the digital finance package, EU is also addressing the issue of fragmentation in the financial sector. While the overall market trend is that there are a few international players in each industry, and smaller companies nationally, the financial sector has remained the opposite.
However, up- and coming FinTech companies have begun to challenge the traditional banks during the last decade, specializing within certain financial niches such as payments, savings, insurance or wherever there is room for innovative solutions. The digital finance package in combination with the increasing number of FinTech companies will continue to push the European financial market towards becoming more integrated. Larger and often national or regionally oriented banks will need to go global or focus their offering towards more capital-intensive services as FinTech companies take over services with lower barriers of entry. At the same time, we predict a continued steady stream of new FinTech companies that, through new innovative and often more digital services, challenge and continue to take business from banks, insurance companies and other traditional players.
The future is digital, and regulation may be an accelerator rather than a showstopper
There is no doubt that the future of finance is digital, and so are financial companies. Likewise, we will see a significant increase in firms considered financial companies, as non-financial third parties are included in upcoming legislation. Moving forward, it will be equally important for these firms to be innovative as well as secure and proving high digital resilience through the entire supply chain. Upcoming regulation will make sure that the baseline of digital security is kept high in the financial sector, which in turn will ensure that both customers and firms feel comfortable in using digital solutions, such as cloud services and other digital enablers.
Ensuring trust for the financial system is key for financial firms to enhance innovation and continue their digital development, and firms would be well advised to look upon the regulation of digital finance as a business enabler rather than an obstacle. Correctly addressed the EU Digital Financial Package may be a winning formula making the EU financial sector highly competitive in the innovative race of digital finance.