The challenges of regulating technological innovation in the financial services sector

The financial services sector, in its constant quest for development, speed, efficiency and optimisation, is a fertile ground for the emergence and development of new innovative solutions, such as those based on artificial intelligence ("AI") and machine learning, which already have many applications in the markets with a rapid and growing development.

Indeed, financial institutions are encouraged to adopt AI and new technologies because of the numerous benefits they can derive from them: cost reduction, process automation, risk management optimization, productivity improvement and increased profitability. On the other hand, innovative firms, Fintechs, are developing new technologies to optimise and rethink the provision of financial services.

Many applications of AI are already a reality in financial markets, notably regarding investment services (algorithmic and high frequency trading, robo-advisors), banking services (neo-banks, credit scoring) or financial crime (AML (KYC, transaction monitoring), fraud detection).

Beyond the emergence of new business models, financial technological innovation also offers other opportunities for regulated institutions in terms of compliance with regulatory and prudential requirements (Regtech) but also for financial authorities for regulatory, supervisory and control purposes (Suptech). The rise of Regtech and Suptech has been driven by the significant increase in the availability and granularity of data, as well as by the development of new technologies such as AI and infrastructures such as cloud computing and application programming interfaces (APIs) which together make it possible to collect, store, and analyse large data sets more quickly and efficiently.

The application of new technologies in the financial sector, however, affects the risks inherent in the financial system and itself introduces new risks, for example in relation to data protection, consumer and investor protection in cyberspace and market integrity, or in terms of cyber risks. 

From a legal perspective, the emergence of disruptive technologies in the financial services sector poses a challenge to traditional regulatory methods. The Fintech ecosystem, which brings new players alongside regulated financial institutions, is changing the dynamics of the financial system. This emergence, combined with the emergence of new disruptive financial services, has challenged the application of existing financial regulations to new Fintech activities.

This explains why, in recent years, the European Union has introduced a series of new regulations specifically aimed at regulating digital financial services, such as the Markets in Crypto-Assets Regulation (MiCA), the Digital Operational Resilience Act (DORA), the Instant Payments Regulation or the long-awaited Regulation on artificial intelligence (AI Act). On the other hand, existing financial regulations (AML regulations, Consumer Credit Directive,..) are being amended to take account of new digital products offered by financial institutions (virtual IBANs, buy now pay later solutions,..).

There is also the question of whether using innovative solutions has an impact on regulatory obligations. In this respect, it should be noted that most European financial regulations (MiFID II, PSD II, the AI Act, MiCA,..) are technology-neutral. This means that they will apply equally to regulated financial services, regardless of the type of underlying technology used. This "technology-neutral" approach should ensure that the emergence of new technologies developed to provide a financial service does not affect the need to comply with the regulatory framework applicable to the provision of that service. However, this approach may itself also be a source of legal uncertainty due to the difficulty of applying traditional regulatory requirements to disruptive business models. 

On the other hand, another challenge for regulators is to identify and monitor new emerging market dynamics, which also requires them to have a deep understanding of the technologies used to deliver innovative services or products. In response to the development of innovation in the markets, regulators themselves are therefore seeking to develop innovative regulatory strategies to respond to technological developments and to improve their understanding of new fintech activities and their disruptive business models. To this end, several Member States have set up innovation facilitators, including regulatory sandboxes and innovation hubs.

Our Financial Services & Fintech team of specialist lawyers is a top-tier firm advising a range of financial institutions, global technology companies and FinTech disruptors on their most innovative and strategic FinTech projects globally. We advise on all aspects of technology in relation to FinTech projects, with particular expertise covering regulations, product development, blockchain, crypto-currencies, platforms, strategic collaboration arrangements and digital transformation. We pride ourselves on having a market-leading global FinTech practice with a strong EU and Belgian footprint, which is also recognized as a top-tier law firm in legal directories.

For any question, please contact Pierre Berger (Pierre.Berger@dlapiper.com) or Nicolas Kalokyris (Nicolas.Kalokyris@dlapiper.com).