LLM INTERNATIONAL BUSINESS LAW 2016-2017

Master’s thesis

Analysis of the FinTech ecosystem: what regulatory and corporate responses could foster the innovation whilst not threatening the financial stability and the consumers’ interests ?

by Clément Bourdon (ANR646456)

Research conducted under the supervision of :

Vladimir Mirkov

Defended on the 12nd of June 2017

TABLE OF CONTENTS

Introduction 4

Chapter 1 : The FinTech genesis 6

I. The banking (over)regulation and its side effects on the banking industry 6

A. Customers relations: the era of suspicion and simple mind. 7

1. ‘Know Your Customer’ and its presumptive suspicion 7

2. Consumer protection and information duties 9

B. Prudential regulations: complexification of capital requirements and risk management 10

C. The apparent banking monopoly 11

II. The FinTech opportunity resulting from the banking regulations 13

III. A Primer on interactions between regulation and innovation 14

Chapter 2: The FinTech opportunity 16

I. The Origin of… Financial Species 17

II. Technologies reshaping the financial services 18

A. The rise of new technologies 18

1. The Blockchain Technology 19

2. RegTech 20

3. Smart Contracts 22

4. Internet of Things 22

5. Artificial Intelligence 23

B. New species of Financial Services 24

1. Peer to peer lending & crowdfunding 24

2. Robo-advisors 25

3. Mobile payments 26

III. A Disruptive Business Model 27

A. ‘Uncorporate’ the corporate culture 28

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B. Horizontal approach v. Vertical approach 29

IV. Too linked to fail and too fast to save 31

Chapter 3: The regulatory and corporate responses urged by the rise of

FinTech companies 33

I. The corporate responses: The unavoidable adaptation of the incumbents 33

A. Open innovation vs. Closed innovation 34

B. The Corporate venturing strategies 36

II. An innovative environment calls for an innovative policy framework 37

A. The EU Digital Market Strategy vs. The FCA Project Innovate 38

1. The EU FinTech Task Force and other initiatives 38

2. The FCA’s creative responses 40

3. The investments data’s at a global level: the illustration of a deep contrast between UK and the rest of Europe 43

B. The Regulatory Sandbox approach 44

C. Cyber financial security 46

Conclusion 48

Bibliography 49

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Introduction

The society is radically changing under the impulse of new technologies. This is the digital revolution. New technologies such as Blockchain, Artificial Intelligence or the RegTech are disrupting many industries and sectors making them irrelevant or less attractive for a new type of customers, namely the Millenials. With this new category of customers came new consuming habits that match with what these new technologies offer.

The banking and financial sector is one of these sectors facing this disruption wave.

However, this disruption cannot be isolated as the sole result of the emergence of new technologies and the change of consumers’ habits. The heavy financial regulations increased the compliance costs forcing thereby financial entities to focus on compliance instead of innovation. The combination of the rise of new technologies and the heavy and stringent banking/financial regulations concurred to leave a free path for a brand new financial entity: the FinTech’ companies.

FinTech is the term describing the intersection between financial services and technologies. New start up companies are relying on new technologies to deliver innovative financial services that better capture the consumers’ needs. Besides the use of disruptive technologies, FinTech start up companies are based on an innovative business model that enables them to focus on the innovation instead of the traditional short term profit vision.

The appearance and growth of these new players changed the financial ecosystem. The traditional players - the incumbents- are feeling threatened and struggle to endorse a successful and innovative strategy that could allow them to compete with the FinTech start up companies. Banks are actually facing -what Charles Darwin would call- variations under nature. In order to survive, the incumbents therefore need to adapt their strategy and their model. In such high regulated environment this new ecosystem also needs a rational framework to set safeguards for consumers and that ensure the financial stability. The FinTech sector is therefore challenging both the incumbents and the policymakers.

This paper intends to focus on those challenges. It will provide a critical analysis of the FinTech ecosystem before focusing on the following problematic:

What regulatory and corporate responses could foster the innovation whilst not threatening the financial stability and the consumers’ interests ?

This thesis will be divided in three parts. The two first chapters will explain two important components of the ecosystem that allowed the FinTech sector to grow and the concomitant threats for the incumbents. These two parts are important to set the ‘big picture’ of the ecosystem. The third

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chapter will address the corporate and regulatory responses that could foster the innovation while saving the consumers’ interests and the financial stability.

Chapter 1 focuses on the banking regulations and the actual regulatory trends which systematically tended to increasing stringency and compliance duties in order to respond to corporate and financial scandals. The over regulation of the banking and financial sectors contributed to bureaucratize the profession and to increase the compliance costs. The side effect of these regulations leads the banks to focus more on the compliance duties than the customer relationship which is essential to the banking profession. As a result, this field has been left abandoned by the banks. This therefore left a free field that FinTech companies are now invading (Chapter 1).

Chapter 2 intends to explain the other component that made the emergence of FinTech start up companies: the disruptive technologies on which they are relying and the innovative corporate strategies they embraced. It is important to stress out that disruption is not only about new technologies but is also related to innovative business models. However, disruptive financial firms also bring risks of a new type. This will lead to underline cyber financial security issues (Chapter 2.).

Finally, based on the analysis of the FinTech ecosystem, Chapter 3 will provide both corporate and regulatory responses to capture this new ecosystem. On one hand, the banks need to change their strategies and endorse strategies that enable them to renew their services and innovate in order to remain competitive in this new environment. On the other hand, the policymakers must be vigilant regarding the consumers’ interests and the financial stability while fostering the innovation: a complex equation for the regulator. A comparative analysis between the EU model and the UK strategy will emphasize the issue of regulating financial innovation (Chapter 3).

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Chapter 1 : The FinTech genesis

FinTech industry is not any more a trend but has become a reality. Hundreds of companies are offering financial services to customers whose habits have radically changed at an internet and mobile era. The FinTech ecosystem include mainly two major entities: The incumbents - the traditional financial and banking institutions, share this ecosystem with new players, namely the start up companies. One might wonder why so many young start up companies with few resources (or even none) decide to launch an activity in one of the most regulated sector which is Finance and Banking. What exactly encourages those hundreds companies to literally rush on the financial and banking sector ? What stimulates those entrepreneurs to compete with these collosus companies ?

A first answer to this question might reside in the public policy framework encompassing the banking industry. Banking regulations have become more and more rigid and successively tended to more stringency and a bureaucratisation of the profession (I.). While consumers’ habits radically changed, banking sector progressively neglected its customers’ relations and instead chose to adopt a product-centric vision. The rigidity of the regulatory framework of the banking sector encourages other entities to circumvent these regulations -shadow banking system- or take up new activities focused on a client-centric vision. Banking (over)regulation contributed to create the FinTech opportunity (II.).

Regulation might be regarded as a two edged sword while attempting to capture innovation. It might stimulate innovation as it might hinder it. FinTech is relying not only on innovative technologies but also on innovative business models as Chapter II will address it. The third section of this chapter intends to deliver a primer on the interactions between regulation and innovation while Chapter III will address in depth the regulatory responses to the FinTech industry. Depending on the regulation tool and regulatory approach used, innovation might be positively or adversely impacted. The effect on innovation is mainly assessed on a case by case study following a trade-off between incentive effect and compliance costs notably resulting from the regulation (III.).

I. The banking (over)regulation and its side effects on the banking industry

Banking regulations are constructed around three pillars: prudential control (supervision), relations with customers and activities. The compliance function has become the core of banking regulations. This trend dramatically changed the banking profession and tended to increase the complexity of these regulations and the compliance costs. 1

Tom C.W. LIN, “Compliance, Technology, and Modern Finance”, The Brooklyn Journal of Corporate, Financial and 1

Commercial Law, 2016, p.164.Page ! of !6 53

Since the past decades, the political response to corporate scandals has always tended to the implementation of stricter regulation . The recent regulations characterised by increasing rigidity 2

and bureaucratisation had a poor side effect on the banking industry. If it is obvious that such regulations purported to ensure financial stability and security in response to tragic events , it 3

contributed as well to denature and standardise the profession itself leaving thereby a freeway for 4

FinTech companies.

While the initial banking activity was built upon a trust relationship between the bank and the customer, the policy framework regarding customer relationships had the side effect to set an atmosphere of suspicion (A.). The supervision regulations in the aftermath of the financial crisis of 2007/2008 had far reaching consequences on the sector that now can be observed. Basel III fixed a rigid supervision and risk management framework leaving a poor leeway to innovation (B.). Finally, the banking license regulation could let think that banks actually enjoy a monopoly regarding banking activities. However, the banking monopoly appears to rather be a mockery and therefore did not impede FinTech companies to rise (C.). The following developments shall assess and emphasise the side effect these regulations had on the banking environment related to each ‘regulatory pillar’. This section as a whole intends to describe the regulatory environment of the incumbents.

A. Customers relations: the era of suspicion and simple mind. The customers relations are regulated through two different types of policies. On one hand, compliance duties (‘Know Your Customer’ principle) resulting majorly from the Anti-Money Laundering regime oblige banks to proceed to a customer due diligence (1.). On the other hand, consumer protection regime sets numerous information duties on behalf of the banks vis-à-vis the customers (2).

1. ‘Know Your Customer’ and its presumptive suspicion The anti-money laundering reforms purported to ‘protect financial institutions from liability and to prevent laundered money from entering the legitimate economy, thereby encouraging further criminal activity’ . Many regulations and legislations reinforced the anti-money 5

laundering regime after the terrorist attack of 9/11. The purpose of such policies is ultimately to

Mark FENWICK and Erik P.M. VERMEULEN, “The Future of Capitalism - ‘Un-corporating’ Corporate Governance”, Lex 2

Research Topics in Corporate Law & Economics Working Paper No. 2016-4, 2016, p.6. The terrorist attack of 9/11 was followed by a massive reform of Anti Money Laundering regime while the financial 3

crisis of 2007/2008 and subsequent corporate scandals motivated new prudential measures in order to reinforce financial stability. Hubert DE VAUPLANE, “Les FinTech et la réglementation bancaire et financière”, Banque & Stratégie, n°339, 4

Septembre 2015, p.35. Philip J. RUCE, “Anti-Money Laundering : The Challenges of Know Your Customer legislation for Private Bankers 5

and the Hidden Benefits for Relationship Management (“The Bright Side of Knowing Your Customer”)”, The Banking Law Journal, 2011, p. 548.

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mitigate the reputation risk that banks might suffer from a loss of public confidence and 6

reduce “the likelihood of banks becoming a vehicle for or a victim of financial crime” . 7

In October 2001, the Financial Action Task Force on Money Laundering (“FATF”) reviewed 8

its Forty Recommandations as initially developed in 1996. The key reform consisted in the reinforcement of customer due diligence and record keeping requirements (‘Know Your Customer, KYC).

FATF’s recommendations are mainly based on the Statements of Principles on Prevention of Criminal Use of the Banking System for the Purpose of Money-Laundering issued by the Basel Commitee in 1988. The Committee identified four key requirements in the process of 9

customer due diligence : (1) customer acceptance policy, (2) customer identification, (3) on-going monitoring of high risk accounts and (4) risk management. Furthermore the Basel Committee extends customer due diligence to the monitoring of the account activity and its conformity with the expected transactions determined for the customer of the defined account . In case of any suspicion or any reasonable grounds of suspicion, financial institution 10

has a duty to report it to the financial intelligence unit set by the Member State . 11

The customer due diligence obliges the financial intermediaries to search for and check the real identity of the customer and the origins of its funds but also evaluate the customer’s knowledge in order to ensure the adequacy of the transaction with the customer’s risk profile . 12

There is another issue related to the information and communication technologies: many business transactions are non-face-to-face transactions. As the Basel Committee already stated in 2001, “electronic banking combined with the speed of the transaction inevitably creates difficulty in customer identification and verification” . At a digital era, the regulator reinforced 13

the customer due diligence measures which got more intrusive considering that most transactions are non-face-to-face transactions..

The initial purpose of the anti-money laundering regime was an evidence especially regarding the attack of 9/11. This regime intends to establish more transparency towards customers’

X, Global Bank Regulation, p.2246

BASEL COMMITEE ON BANKING SUPERVISION, “Customer Due diligence for banks”, October 2001, p. 3.7

“The Financial Action Task Force (FATF) is an inter-governmental body established in 1989 by the Ministers of its 8

Member jurisdictions. The objectives of the FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system.” (http://www.fatf-gafi.org/about/) BASEL COMMITEE ON BANKING SUPERVISION, “Customer Due diligence for banks”, October 2001, p.59

Ibidem.10

See Recommendation 13, Financial Action Task Force, “40 Recommendations”, October 2003, p.811

Hubert DE VAUPLANE, “Les FinTech et la réglementation bancaire et financière”, p.34.12

BASEL COMMITEE ON BANKING SUPERVISION, “Customer Due diligence for banks”, p. 11.13

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identity and funding sources. It is however interesting to focus on how the customer is perceived through the compliance prism. A certain doctrine considers compliance movement as the Leviathan of modern era as it gets 14

more and more complicated and intrusive in customer’s privacy. As an insidious result, these anti-money laundering measures set a suspicious a priori on the customer: through the KYC process, the customer is perceived as a potential fraudster. This regime introduced an era of suspicion and excessive bureaucratisation.

2. Consumer protection and information duties The excessive consumer protection policies also had a poor side effect regarding the perception of the customer. To emphasise this trend, this paper will focus on the Payment Services Directive enacted by the European Union.

The Payment Services Directive of 2007 (hereafter, the Directive) and its reform (The Payment Services Directive II) contributed to reinforce the consumer protection.

The Directive set an extensive set of informations to be disclosed to the consumer. The payment service provider has the duty to provide the consumer with the information that takes into account the ‘needs of the latter as well as practical technical aspects and cost-efficiency depending on the situation with regard to the agreement in the respective payment service contract’ . 15

Furthermore, the financial education and awareness principle encourage Member States to develop appropriate mechanisms ‘to help existing and future consumers develop the knowledge, skills and confidence to appropriately understand risks, including financial risks and opportunities, make informed choices, now where to go for assistance, and take effective action to improve their own well-being’ . 16

The enactment of these policies translate into an excessive bureaucratisation. Before proceeding a transaction the customer has to answer to a set of standardised questions, interrogations and tests. From a human resources perspective as well, the consequence is likely to be adverse : client service managers spend more time to fulfil formulas rather than 17

delivering personalized advices to customers. As Mark Fenwick and Erik Vermeulen rightly underline it, “a paradoxial effect of regulation might be that corporations (…) become more depersonalized and associated with finance and

Hubert DE VAUPLANE, “Les FinTech et la réglementation bancaire et financière”, 34.14

Directive (EU) 2015/2366 of 25 November 2015 on payment services in the internal market, amending Directives 15

2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC, preambule, p.8, (26).

EU PARLIAMENT,DIRECTORATE GENERAL FOR INTERNAL POLICIES, “Consumer Protection - Aspects of Financial 16

Services, Study”, p.112 Hubert DE VAUPLANE, “Les FinTech et la réglementation bancaire et financière”, p.35.17

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greed, rather than delivering the kind of new product, services and experiences that made them a success in the first place” . 18

B. Prudential regulations: complexification of capital requirements and risk management

The financial crisis had two major impacts regarding respectively the public perception and the supervision reforms. The financial crisis was followed by an increasing public mistrust in the financial services industry. As the origins of the economic cataclysm have become “widely more understood the public perception of banks deteriorated” . As a premonitory sign, a 2015 survey 19

shows among American people that their confidence in trust technology firms has even exceeded their confidence in banks . The policymakers responded to the crisis by setting more stringent 20

rules and compliance requirements.

In the aftermath of the financial crisis of 2007/2008, the Basel Committee on Banking Supervision issued the Basel III framework reforming former Basel II framework. Basel III contains a set of measures aiming at promoting a more resilient banking sector in response to deficiencies observed in the financial regulation. The framework is built around three pillars which purport to reduce systemic risk: a) the capital requirement, b) the leverage ratio and c) the liquidity requirements.

Basel III raises “both the quality and the quantity of the regulatory capital base and enhances the risk coverage of the capital framework” . The purpose here is mainly to set an efficient backstop 21

for the banks in case of an eventual bailout. Under the leverage ratio requirement, Basel III promotes “the short-term resilience of the liquidity risk profile of banks” . This requirement 22

ensures that banks dispose sufficient and high-quality liquid assets that can be converted into cash on the private markets to meet exceptional needs in case of a liquidity stress scenario . 23

Finally, the net stable funding ratio (NSFR) requires “banks to maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities” . The NSFR 24

refrains then banks to rely on unstable funding sources or illiquid and weak assets.

Mark FENWICK and Erik P.M. VERMEULEN, “The Future of Capitalism - ‘Un-corporating’ Corporate Governance”, p.18

9. Douglas W. ARNER, Janos Nathan BARBERIS and Ross P. BUCKLEY, “The Evolution of Fintech: A New Post-Crisis 19

Paradigm?”, University of Hong Kong Faculty of Law Research Paper No. 2015/047; UNSW Law Research Paper No. 2016-62, October 2015, p.15.

Ibid., p.14.20

BASEL COMMITTEE ON BANKING SUPERVISION, “Basel III: A Global regulatory framework for more resilient banks 21

and banking systems”, December 2010, p.2 BASEL COMMITTEE ON BANKING SUPERVISION, “Basel III : The Liquidity Coverage Ratio and liquidity risk 22

monitoring tools”, January 2013, p.1 Ibidem.23

BASEL COMMITTEE ON BANKING SUPERVISION, “Basel III : The net stable funding ratio”, October 2014, p.124

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Basel III thereby sets a strong regulatory framework ensuring more stability among the traditional banking sector. This reform tends toward a heavier supervision and a complexification in terms of capital requirements and risk management . Therefore this prudential reform is 25

characterised by strong rigidity and stringency.

The prudential reform through Basel III has lead to the growth of the unregulated shadow banking system -which is sometimes depicted as the devil incarnate . Carrying systemic risks 26

the shadow banking system has been deeply involved in the financial crisis of 2007/2008. Until recently, the shadow banking system was not encompassed through any regulatory scope. This regulatory failure naturally lead stakeholders to a regulatory arbitrage. Many entities (investors and banks) saw herein the perfect opportunity to circumvent the heavy prudential regulations of the traditional banking sector.

However, the Financial Stability Board filled this regulatory gap with its policy framework in 2013 (Strengthening Oversight and Regulation of Shadow Banking - Policy Framework for Strengthening Oversight and Regulation of Shadow Banking Entities). The measures herein were implemented by at the EU level in the Regulation Regulation (EU) 2015/2365 of 25 November 2015 on transparency of securities financing transactions (SFT) and of reuse and amending Regulation (EU) no 648/2012. This regulation promotes transparency on such transactions by introducing a reporting obligation. Any counterpart to a SFT shall report the details of the transaction to a registered trade repository that meets the requirements defined by the regulation . In the name of essential transparency - and consumer protection considerations, the 27

regulator set new requirements to ensure financial stability. This regulation basically promotes more information in the market and imposes a compliance burden on the counterparts to SFT.

The combination of the prudential regulation of the traditional banking system and the transparency regulation of the shadow banking system have as an effect to build up a constraint on the banking profession. They both tend toward a heavy bureaucratisation of the sector. The rigidity and the stringency of the prudential reforms provide a poor leeway to adapt the services. In a figurative way the weight of prudential regulations asphyxiate the banking sector . 28

C. The apparent banking monopoly The third pillar pillar of banking regulation relates to the requirements to meet in order to carry on traditional banking activities. So called banking activities are exclusive to holders of a

Hubert DE VAUPLANE, “Les FinTech et la réglementation bancaire et financière”, p.34.25

David. T LLEWELLYN, « Shadow banking : A valuable role or the devil incarnate ? », Forum financier/Revenue 26

bancaire et financière, 2015/5, pp. 337 à 342 Art. 4, Regulation REGULATION (EU) 2015/2365 of 25 November 2015 on transparency of securities financing 27

transactions (SFT) and of reuse and amending Regulation (EU)No 648/2012 Hubert DE VAUPLANE, “Les FinTech et la réglementation bancaire et financière”, p.34.28

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banking license delivered by the national banking regulator. The national laws set requirements to meet in order to obtain the banking license.

The European Union did an attempt to harmonize this field of law among the Member States while enacting the Directive 2006/48/EC of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions (recast). The Directive sets a minimum of mandatory requirements to be enacted by Member States at a national level notably in terms of minimum 29

capital required to take up the business of credit institutions. 30

These banking license requirements create an apparent banking monopoly and a ‘black or white’ framework within which only the holder of a banking license might provide banking services. These requirements therefore may be regarded as entry barriers for potential new competitors. 31

For these reasons, any new competitor -namely FinTech’ companies- should obtain first a banking license before delivering financial and banking services. However, this first assumption is misleading at least for two reasons according to Hubert De Vauplane. First, in certain countries such as France some ‘statuts au rabais’ offer a less restrictive framework. These ‘statuts au rabais’ enable FinTech start ups to provide financial services restricted to advisory services delivered to customers while the execution of the core financial operations is left to traditional actors. Each of these regulated statutes matches with a specific type of activities performed by FinTech’ start ups from the asset management to the investment services and the lending activities under the supervision of the competent financial prudential authority . 32

FinTech’ companies precisely took the advantage of this situation to focus on customer advices while enjoying a less regulated framework . It makes it easier for FinTech companies to 33

appropriate the customer relations field since it was left abandoned by the banks which rather preferred to focus on products.

The banking monopoly described above is therefore ‘apparent’ since it paradoxically created an opportunity for FinTech’ start ups to invade a field of activities left abandoned by the banking network: the customer relations. However, depending on each national legislation, some activities such as Peer to Peer Lending might face regulatory barriers (see infra.).

Article 7.29

Articles 9 and 10.30

Hubert DE VAUPLANE, “Les FinTech et la réglementation bancaire et financière”, p.34.31

AMF website: http://www.amf-france.org/Acteurs-et-produits/Prestataires-financiers/FinTech.html?32

Ibid., p.3433

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II. The FinTech opportunity resulting from the banking regulations The FinTech opportunity raised from the combination of the heavy regulations following financial crisis and the rise of the digitalisation of society illustrated by disruptive technologies (see 34

Chapter II that will address the impact of new technologies).

As argued above, the recent banking regulations denatured the banking environment and profession.

The three types of regulations exposed above were characterised by rigidity, transparency and stringency. These three pillars of banking regulation share a same pattern characterised by stricter compliance rules. This has a direct impact on the banking profession since these regulations incite the entities “to make a much more significant investment in compliance and the management of legal risk” . By considerably enhancing the compliance costs these regulations concurred to an 35

excessive bureaucratisation of the profession and the standardisation of the services provided. The layers of regulations responding to corporate scandals introduced complex and bureaucratic processes and practices that are “focused on formalistic, ‘check the box’ compliance and short-term financial goals” 36

Hence, it restricted the area of customer relations and thereby created an opportunity for FinTech’ companies to enter a new market while focusing first on the customer’s expectations before delivering an optimal service. The different banking regulations failed to capture the changes of consumers’ habits subsequent to the rise of new technologies. At the opposite, banks endorsed a product-centric vision and tended to a standardisation of the products offered to the customers listed in categories.

FinTech’ sector took the advantage of the overregulation and standardisation of the traditional banking sector to build on new activities driven by a client-centric approach and provide a new offer on this highly regulated market.

These assessments already emphasise an interesting and disruptive pattern of FinTech’ companies. These companies endorse a horizontal approach (client-centric vision) instead of a vertical approach (products-centric vision) shared by traditional banks. Chapter II intends to deliver a precise and critical analysis of the innovative and disruptive patterns proper to FinTech companies.

Hubert DE VAUPLANE, “FinTech : les nouveaux acteurs de la finance”, available at: https://medium.com/@maitrehub/34

fintech-les-nouveaux-acteurs-de-la-finance-fa44d732a74d. Mark FENWICK and Erik P.M. VERMEULEN, “The Future of Capitalism - ‘Un-corporating’ Corporate Governance”, p.35

7.Ibid., p.9.36

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III. A Primer on interactions between regulation and innovation The digitalization of the banking industry is not a trend any more but has become a reality. It radically changed the banking and financial environment: “The changing habits of consumers and the new competitive environment are forcing banks to address their digitalisation process as a matter of urgency” . Moreover, the rise of these FinTech’ start up companies came up to prove 37

that the actual banking policy frameworks are not relevant anymore to address the new consumers’ habits.

The rise of FinTech’ industry brings at least two regulatory challenges which will be addressed in depth in Chapter 3. On one hand, banks must adapt their structure to these new changes to remain competitive. This adaption entails at least three processes: a) a response to the new competition, b) a technological adaptation and c) a strategic positioning (infra., Chapter 3). 38

On the other hand, it raises the issue of an efficient public policy framework and the optimal methodology to encompass the changes of the banking environment embodied by the FinTech industry. This part is aiming to give a first abstract insight about the interactions between regulation and innovation on a broad scale.

A regulation or public policy may impact the three components of what makes innovation to occur: 1) willingness of entrepreneurs, 2) opportunity/motivation, 3) capacity to innovate . 39

Regulation may therefore be regarded as a two edged sword regarding those components: it might encourage innovation as it might hinder it. Pursuing this statement, two important patterns of the regulation must be beard in mind while evaluating the impact on innovation: the incentive impact and the compliance cost of the regulation . Ultimately, the regulatory effect on innovation entails a trade-off between the 40

incentive effect and the compliance cost.

After having delivered a critical analysis of the regulatory framework of banking industry, it is interesting to tackled it down in the light of those two patterns. It is assessed that the compliance costs entailed by the banking regulations are overwhelming (customer due diligence, compliance policies under Basel III etc.), while the incentive effect of these policies seems to be unexpectedly neglected. Moreover, the heavy prudential regulations and the capital requirements did not encourage new entrants and to the contrary refrain them from taking up a banking activity.

X., “The digital transformation of the banking industry”, BBVA Research Paper, 16 July 2015, p.1.37

Ibid., p.4.38

Ashford, N. (2000) “ An Innovation-based strategy for a sustainable environnement’ in J. HEMMELSKAMP, K. 39

RENNINGS and F. LEONE, Innovation-Oriented Environnmental REgulation: Theoretical Approach and Empirical Analyzis, ZEW Economic Studies, Heidelberg: Springer Verlag, 2000, pp.67-110.

Stewart (2010), Carlin and Soskice (2006) in Jacques PELKMANS and Andrea RENDA, “Does EU regulation hinder 40

or stimulate innovation?”, CEPS Special Report, November 2014, p.5.Page ! of !14 53

The trade-off between the incentive effect and the compliance cost generated by banking regulations (through the ‘three pillars’) seems easy to perceive: a low incentive effect for high compliance cost. It therefore provides a poor environment for innovation.

Recent working papers also emphasised three other dimensions that may impact the innovation 41

on a market : a) flexibility , b) information , c) stringency . 42 43 44

Rigid regulations can actually hinder innovation activity “by reducing the attractiveness of engaging in R&D, constraining modes of commercialisation, and creating lock-in-effects that force the economy into suboptimal standards” . 45

The overregulation clearly refrain the innovation within the banking industry itself or the entrepreneurship. However, the rise of internet and mobile devices created new consumer expectations . Start up companies therefore responded to this new demand by providing financial 46

services relying on new technologies and took the advantage of the excessive rigidity of the sector.

Regulation may actually appear as a two edge sword regarding innovation: it may stimulate it as it might hinder it. The way on how a regulation shall treat innovation actually depends on the type of regulation and the regulatory approach used . 47

Jacques PELKMANS and Andrea RENDA, “Does EU regulation hinder 41

or stimulate innovation?”, p.5. Flexibility describes the number of implementations paths firms have available for compliance.42

Information refers to how the regulation “promotes more or less complete information in the market”.43

Stringency measures the degree to which a regulation requires compliance innovation and imposes a compliance 44

burden on a firm, industry or market. Jacques PELKMANS and Andrea RENDA, “Does EU regulation hinder or stimulate innovation?”, CEPS Special Report, 45

November 2014, p.26.X., “The digital transformation of the banking industry”, p.246

Ibidem.47

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Chapter 2: The FinTech opportunity

As stated by Geoffrey Moore, “without big data analytics, companies are blind and deaf, wandering out onto the web like deer on a freeway” . This quote perfectly illustrates the FinTech opportunity. 48

FinTech start up companies understood that big data’s analysis gives power. The rise of new technologies allow FinTech entities to perform such analysis and address personalized financial services to customers thereby creating value for both the company and its customers.

The paradoxical effect of the “sledge hammer” banking regulations combined with the rise of new technologies has been to create an opportunity for FinTech start up companies to entirely reshape the banking/finance profession. Even more, this opportunity lead those to disrupt the financial and insurance sector as the recent and many reorganisations of the “too big to fail” institutions depict 49

it. Those big players are suffering from -what Charles Darwin would name - variations under 50

nature leading them to struggle for their existence.

The Financial Services delivered by the FinTech start up companies include mainly five categories of services: Payments, Wealth/Asset management, Insurance, Deposits and Lending. FinTech players usually focus their activities on one category of services. Each of these areas have been revolutionised by the FinTech industry which brought new developments sharing common patterns such as improved interoperability, simplicity and added value for the consumer . This FinTech 51

movement is disturbing/disrupting the today’s financial landscape but must be grasped as a part of a broader movement which must certainly not be regarded as a brand new phenomenon proper to the 21st Century and the emergence of the Internet (I.).

This chapter will discuss the different disruptive patterns of FinTech companies. It can be argued that FinTech companies are disrupting the incumbents players at least on two sides. On one hand, start up companies successfully combine new technologies with financial services to deliver new types of services (II.). On the other hand, FinTech companies are characterised by an innovative business model proper to the sharing economy. We illustrate the shift from the hierarchical and vertical approach that characterises the traditional players to a horizontal approach which is focused on consumers’ needs and expectations rather than products and short term rentability (III.).

Geoffrey MOORE, The Business Book, Dorling Kindersley Ltd, 2004, p. 31648

See the recent news with the restructuring of ‘big players’: BNP Paribas http://www.lemonde.fr/economie-francaise/49

article/2017/03/20/bnp-paribas-va-fermer-200-agences-d-ici-a-2020_5097387_1656968.html, ING http://www.lesoir.be/1470513/article/economie/2017-03-28/ing-syndicats-approuvent-plan-restructuration, Monte Paschi http://www.lefigaro.fr/flash-eco/2017/03/09/97002-20170309FILWWW00382-monte-dei-paschi-enterine-son-plan-de-restructuration.php.

Charles DARWIN, On The Origin of Species, 1859. 50

DEUTSCHE BANK, “FinTech 2.0: creating new opportunities through strategic alliances”, White Paper Series, 2016, p.51

4.Page ! of !16 53

The exponential potential of FinTech entities and activities must however not lead to forget the eventual systemic risks inherent to high tech financial industry (IV.). Systemic risks shifted from a “too big to fail” logic to a “too linked to fail” and “too fast to save” assumption. Regulators shall also remain attentive regarding cybersecurity concerns.

I. The Origin of… Financial Species As mentioned above FinTech is not a new specimen within the financial and banking environment. It is important to bear in mind that new technologies did not suddenly pop up from nothing but are part of a historical progress proper to human mankind. The linkage between finance and technology has been everlasting. A certain doctrine identifies thus three main eras of FinTech evolution. 52

In the late 19th century the combination between technology such as telegraph, railroads, canals and steamships enabled financial linkages beyond the borders allowing thereby rapid transmission of financial information, transactions and payments around the world . These technologies illustrate a 53

first step in the financial globalisation process. The early post war period was marked by considerable achievements in the field of information technology: IBM integrated first code-breaking tools in its computers, the first handheld financial calculator was produced in 1967, the issuance of credit cards in the 1950’s and the establishment of the Interbank Card Association in the U.S. in 1966. Finally, 1967 saw the birth of the first ATM by Barclays in the UK. This event closed the first era of the FinTech revolution, namely the FinTech 1.0.

FinTech 2.0 covers the period from 1967 until 2008 and is characterised by the digitalisation and globalisation of finance. Three major events displayed this era. The Society of Worldwide Interbank Financial Telecommunications (SWIFT) was established in 1973 with the “vision of creating a global financial messaging service, and a common language for international financial messaging” thereby facilitating interconnection between cross-border 54

payments. Then the setting up of NASDAQ and the end of fixed securities commissions marked the “transition from physical trading of securities dating to the late 1600’s to today’s fully electronic securities trading” . It was then followed by the introduction of online banking which increased the 55

use of Information Technologies in the banking sector . It goes without saying that these evolutions 56

triggered many regulatory works to encompass the risks proper to cross-border financial interconnections.

Douglas W. ARNER, Janos Nathan BARBERIS and Ross P. BUCKLEY, “The Evolution of Fintech: A New Post-Crisis 52

Paradigm?”, p.6. Ibid., p.7.53

Socierty of WorldWide Interbank Financial Telecommunciations, SWIFT History -https://www.swift.com/about-us/54

historyDouglas W. ARNER, Janos Nathan BARBERIS and Ross P. BUCKLEY, “The Evolution of Fintech: A New Post-Crisis 55

Paradigm?”, p.9. Ibidem.56

Page ! of !17 53

Finally, the emergence of the Internet set the development of FinTech industry to a next level. As described in the former Chapter, the Internet and mobile devices radically changed consumers’ habits and therefore the entire face of the banking profession.

The financial crisis of 2007-2008 expressed a turning point in the FinTech evolution. As argued in Chapter 1, the post-crisis regulations asphyxiated the banking and financial environment allowing thereby a new generation of market players to establish a new paradigm of FinTech as known as FinTech 3.0..The next sections will only address the so called FinTech 3.0..

II. Technologies reshaping the financial services FinTech is basically expressing the intersection between new technologies and financial services. Start up companies rely on those technologies to innovate and deliver a new offer of products and services competing those provided by the incumbents . 57

These technologies share a common pattern which leads to more automation, disintermediation and process efficiencies. The following developments intend to analyse and understand the far reaching implications of those technologies on the financial landscape and how these new technologies disrupt the financial industry.

This section will deliver an accurate analysis and description of what makes the DNA of FinTech industry: the rise of the new technologies (A.) and the emergence of new financial services resulting from the application of the new technologies to the financial sector (B.).

A. The rise of new technologies Five technological developments are playing a key role in the digitalisation of the Financial industry: Blockchain, RegTech, Smart contracts, the Internet of Things and Artificial Intelligence. The Blockchain technology offers a distributed ledger platform characterised by a public key cryptography and a shared data storage. It therefore leads to a disintermediation (1.). The RegTech process could provide an efficient response to the enormous compliance costs emphasised in Chapter 1 resulting from the overwhelming compliance burden (2.). These two technologies lead to the development of ‘Smart contracts’ which allows the performance of a contract without any human intermediaries, similarly to a vending machine (3.). The Internet of Things provides hybrid products/services combining both a conventional physical function and information services. It ultimately sets an immediate interaction between the FinTech entity and the customer (4.). Finally, the recent developments of Artificial Intelligence may also enhance the data’s analysis (5.).

PRICE WATERHOUSE COOPERS, ‘Blurred Lines: How FinTech is Shaping Financial Services’, Pwc Global FinTech 57

Report, March 2016, p.4Page ! of !18 53

1. The Blockchain Technology The Blockchain technology finds many diverse applications and disrupted many industry sectors entailing thereby far reaching implications. As instance, Blockchain technology is underlying the virtual currency Bitcoin but cannot be limited to this application though. The 58

following developments intend to stress how the FinTech industry is taking advantage of the Blockchain Technology.

The Blockchain can be defined as “a ledger or, more simply, a chronological database of transactions recorded by a network of computers” . A distributed ledger is basically “a record 59

of information, or database, that is shared across a network” without any central authority . 60 61

Furthermore, “the term ‘blockchain’ refers to these transactions being grouped in blocks, and the chain of these blocks forms the accepted history of transactions since the inception of the blockchain” . It is relying on two technological components: a public-key cryptography and a 62

peer-to-peer or shared data storage . 63

As Vitalik Buterin stresses it out in his definition , the essence of blockchain technology is 64

informational and processual and not strictly limited to the financial sphere . 65

One of the major advantages of the blockchain technology resides in the absence of a centralised entity gathering the information and the automatic updating of the record of 66

information. This decentralised structure provides security guarantees making potential cyber-attacks less potential and effective . Another strong pattern of blockchain is the suppression of 67

See Satoshi NAKAMOTO, “Bitcoin: A Peer-to-Peer Electronic Cash System”.58

Gareth W. PETERS and Efstathios PANAYI, “Understanding Modern Banking Ledgers through BLockchain 59

Technologies: Future of Transactions Processing and Smart Contracts on the Internet of Money”, arXiv:1409.1451 (2014) in Lawrence J TRAUTMAN “Is Disruptive Blockchain Technology the Future of Financial Services ?”, 69 the Consumer Finance Quarterly Report, 2016, p.237.

EUROPEAN CENTRAL BANK, “ Distributed Ledger Technology”, In Focus-Issue , 2016, p.1.60

Satoshi NAKAMOTO, “Bitcoin: A Peer-to-Peer Electronic Cash System”61

Ibidem.62

Michael MAINELLI and Alistair MILNE , “The Impact and Potential of Blockchain Technology on Securities 63

Lifecycle”, SWIT Working Papers 2015-007, p.3. “a magic computer that anyone can upload programs to and leave the programs to self-execute, where the current and 64

all previous states of every program are always publicly visible, and which carries a very strong cryptoeconomically secured guarantee that programs running on the chain will continue to execute in exactly the way that the blockchain protocol specifies.”

Marc PILKINGTON, “Blockchain Technology: Principles and Applications” (September 18, 2015), p.8. Research 65

Handbook on Digital Transformations, edited by F. Xavier Olleros and Majlinda Zhegu. Edward Elgar, 2016. Available at SSRN: https://ssrn.com/abstract=2662660g.

Michael MAINELLI and Alistair MILNE , “The Impact and Potential of Blockchain Technology on Securities 66

Lifecycle”, p.18. EUROPEAN CENTRAL BANK, “ Distributed Ledger Technology”, p.267

Page ! of !19 53

intermediaries within a transaction and the subsequent automation of contracts and 68

transactions.

Blockchain technology has such potential to change the whole structure of the Financial Services industry but also the Insurance sector by erasing intermediaries. First of all, it provides process efficiencies by avoiding a third party for a validation/reconciliation purpose and it automatically updates the information related to a transaction. 69

Moreover, it also brings large gains of transparency which is certainly a positive point from a regulatory perspective . It therefore improves the regulatory reporting and facilitates the 70

tracking of securities ownership . Blockchain also underlies the development of 71

cryptocurrencies. As of 24 March 2015, Nasdaq concluded an agreement with the start-up Noble Markets to build up a market for cryptocurrencies . 72

The potential of automation and self-executing transactions delivered through Blockchain technology enables the development and exploitation of other disruptive technologies such as smart contracts and Regtech (see infra.).

As this subsection has emphasised it Blockchain underlies many strong evolutions of the Banking and Finance sectors. It is leading towards more automation while enhancing security and transparency of the platform it generates.

2. RegTech The rise of RegTech must be read and understood in parallel of the expansion of compliance duties and prudential regulations enacted in the aftermath of the financial crisis of 2007/2008 as discussed in Chapter 1. The use of automated systems to facilitate compliance with law is a common practice within the financial spectrum . The immediate response to the complexification of the compliance 73

regime supervision regulation is to be found in ‘RegTech’.

Erik P.M. Vermeulen, “There Is No Escpe From Blockchains and Artificial Intelligence”, https://medium.com/68

@erikpmvermeulen/there-is-no-escape-from-blockchains-and-artificial-intelligence-lawyers-better-be-prepared-2d7a8221c627#.gpp8yxqbp

ALLEN & OVERY, “FinTech”, Working paper, 2016, p.5.69

PRICE WATERHOUSE COOPERS, ‘Blurred Lines: How FinTech is Shaping Financial Services’, p.1770

EUROPEAN CENTRAL BANK, “ Distributed Ledger Technology”, p.471

Casey, M (2015), Nasdaq to privde trading technology for Bitcoin Market place, The Wall Street Journal, 23 March, 72

Retriev from http://www.wsj.com/articles/nasdaq- to-provide-trading-technology-for-bitcoin-marketplace-1427140006 in Marc PILKINGTON, “Blockchain Technology: Principles and Applications” p.27

Arner et al (note 5) at 16: “financial institutions and the financial industry, particularly large financial institutions in 73

developed markets, are increasingly applying technology to meet the demands of regulators, especially demands arising from new post-crisis regulations.”; Institute of International Finance, ‘RegTech: Exploring solutions for Regulatory challenges’ (Oct 2015); Institute of International Finance: ‘RegTech in Financial Services: Technology solutions for compliance and reporting’ (March 2016) in Veerle COLAERT, “RegTech as a Response to Regulatory Expansion in the Financial Sector”, March 2017, p.6. Available at SSRN: https://ssrn.com/abstract=2677116

Page ! of !20 53

Most commonly RegTech refers to the use of new technologies “to facilitate the delivery of regulatory requirements” but it cannot be restricted to a subpart of FinTech as the UK’s 74

Financial Conduct Authority (‘FCA’) argues . The latter definition would excessively narrow 75

down the true potential of RegTech which can be viewed as the “next logical evolution of financial services regulation and should develop into a foundational base underpinning the entire financial services sector” . It therefore finds an application in a wide array of 76

situations . 77

To seize its potential from a regulatory perspective, RegTech should be referred as the process enabling the “prospect of continuous monitoring that would improve efficiency by both liberating excess regulatory capital, and decreasing the time it takes to investigate a firm following a compliance breach” . 78

A complete definition would identify RegTech as encompassing “all technological solutions that facilitate compliance with and monitoring of regulatory requirements” . 79

Two practical examples might illustrate the use of RegTech for the purpose of facilitating compliance. Chapter 1 discussed the KYC principle enacted by the Anti-Money Laundering framework. This regime requires financial entities to report suspicious transactions (see supra.). Such transactions are tested against a selected number of criteria. RegTech finds an application in the computer softwares enabling to detect and flag suspicious transactions facilitating thereby the monitoring . In a second phase, member staff shall assess whether or not the alert should be 80

followed by an effective report to the competent financial intelligence unit. RegTech can also play a key role in data’s reporting to the supervisor. “Data mining and cloud-based systems can streamline and automate such reporting obligations and render them much more efficient” . 81

FINANCIAL CONDUCT AUTHORITY, “Call for Input: Supporting the development and adoption of RegTech”, 74

November 2015, https://www.fca.org.uk/publication/call-for-input/regtech-call-for-input.pdf, at 3. Institute of International Finance, “REGTECH: Exploring solutions for regulatory challenges” at 2; Institute for International Finance, “Regtech in financial services: Technology solutions for compliance and reporting” (March 2016) at 2 in Veerle COLAERT, “RegTech as a Response to Regulatory Expansion in the Financial Sector”, p.6.

FINANCIAL CONDUCT AUTHORITY, “Feedback Statement-Call for Input on Supporting the Development and Adopters 75

of RegTech”, 3 July 2016.Douglas W. ARNER, Janos Nathan BARBERIS and Ross P. BUCKLEY, “The Evolution of Fintech: A New Post-Crisis 76

Paradigm?”, p.14. These situations may include “monitoring corporations for environmental compliance to monitoring trucking 77

companies for speed infractions to tracking the global location of airliners on a real time basis” as assessed in Douglas W. ARNER, Janos Nathan BARBERIS and Ross P. BUCKLEY, “The Evolution of Fintech: A New Post-Crisis Paradigm?”, p.15.

Ibid., pp.14-15.78

Veerle COLAERT, “RegTech as a Response to Regulatory Expansion in the Financial Sector”, p.779

Ibid., p.7.80

Ibidem.81

Page ! of !21 53

RegTech then appears to be an optimal answer to the bureaucratisation and the strengthening of compliance burden on financial entities. Similarly to the Blockchain technology it provides process efficiencies and lower compliance costs while offering a “possibility of more accurate compliance efforts, and better reporting to supervisory authorities” . 82

3. Smart Contracts Most commonly, contracts are enforced by the parties to the contract and subsequently end with the performance enacted by the parties. The concept of smart contracts go beyond this conception of performance.

Such contracts can be defined as “agreements where execution is automated, usually by computers” and therefore ensure the contract execution/performance without any human 83

action. The main feature of smart contracts is actually similar to Blockchain technology and RegTech since these three technologies are in keeping with a trend driven by automation and decentralisation. Smart contracts are relying on two major technological components which are respectively the ‘contractware’ and the ‘decentralised ledgers’ which were tackled down in the subsection dedicated to blockchain technology. The ‘contractware’ technology is an important feature regarding the automation of the performance. The ‘contractware’ can be defined as the “physical instantiation of a computer-decipherable contract” . 84

Combined with a distributed ledger such as Blockchains, it could have a high degree of immutability and security, guaranteeing contract execution based on coded terms . Smart 85

contracts could radically reshape the insurance sector. These could bring insurers, customers and third parties on a single platform leading thereby to process efficiencies and a reduction of claim processing time and costs . 86

4. Internet of Things The Internet of Things (IoT) has also acquired a high attention over the past few years and has reached a high potential regarding its diverse applications : Smart Cities, Smart Car, Smart 87

Mobility, Smart Home… The Internet of Things illustrates “a vision in which the Internet extends into the real world embracing everyday objects. Physical items are no longer

ALLEN & OVERY, “FinTech”, p.5.82

Max RASKIN, “The Law of Smart Contracts”, Georgetown Technology Review, September 22, 2016. p.2. Available at 83

SSRN: https://ssrn.com/abstract=2842258 or http://dx.doi.org/10.2139/ssrn.2842258 Max RASKIN, “The Law of Smart Contracts”, p.10.84

CAP GEMINI CONSULTING, “Smart Contracts in Financial Services: Getting from Hype to Reality”, October 2016, p.4.85

Ibid., p.12.86

Ovidiu VERMESAN and Peter FRIESS, Internet of Things: Converging Technologies for Smart Environments and 87

Integrated Ecosystems, River Publishers, Aalborg, 2013, p.153.Page ! of !22 53

disconnected from the virtual world, but can be controlled remotely and can act as physical access points to Internet services” . The goal of the IoT is to “to enable things to be connected 88

anytime, anyplace, with anything and anyone ideally using any path/network and any service” . 89

As many other sectors, the IoT is expected to have an enormous impact on the financial life and customer’s experience. Practically this innovative process gives rise to “hybrid products” that have both a physical function and information services . This technology enhances the 90

customer experience by delivering more information about a product or a service. Through the data’s collecting and analysis, FinTech platforms can deliver accurate and personalised information regarding the customer on a day-to-day basis . Further, it allows a 91

constant interaction between the services provider and its customers.

The IoT perfectly illustrates this new ‘client centric’ vision endorsed by the FinTech industry and previously emphasized. It allows the customer to have an immediate access to its advisor while allowing a customer’s data’s collection in order for the advisor to deliver a relevant customer support . It therefore creates value for both the customer but also the FinTech actors 92

since the IoT offers a way to remain close to the customer and retain them.

5. Artificial Intelligence For the present purpose, the thesis will only deliver a brief primer on AI and focus on the impact of such technology on the financial sector.

Although there is not a single definition on which experts agree, Artificial Intelligence can be defined as “the science and engineering of making intelligent machines, especially intelligent computer programs” and “is related to the similar task of using computers to understand 93

human intelligence, but AI does not have to confine itself to methods that are biologically observable” . The difficulties met by experts struggling to define AI are related to the 94

Friedemann MATTERN and Christian FLOERKEMEIER, “From the Internet of Computers to the Internet of Things”, 88

Springer- Volume 6462 of the Series Lecture Notes in Computer Science, Berlin, 2010, p.242. Ovidiu VERMESAN and Peter FRIESS, Internet of Things: Converging Technologies for Smart Environments and 89

Integrated Ecosystems, p.8. Friedemann MATTERN and Christian FLOERKEMEIER, “From the Internet of Computers to the Internet of Things”, p.90

246. DELOITTE, “Financial Services in the Age of The Internet of Things”, 2015, p.2.91

Yvon MOYSAN, “Les objets connectés dans le secteur bancaire : révolution ou simple évolution ?”, Revue Banque 92

(FR), 2014, p.80. John MCCARTHY, “What is Artificial Intelligence?”, John Mc Carthy’s Home Page, Nov. 12, 2007, p.2. Available at: 93

http://www-formal.stanford.edu/jmc/whatisai.pdf [https://perma.cc/U3RT-Q7JK]. Ibidem.94

Page ! of !23 53

ambiguous conceptualisation of “intelligence” . These conceptual barriers may set a huge 95

obstacle for policymakers willing to identify the object of any such regulatory framework.

There are basically four types of AI: type I (purely reactive), type II (limited memory), type III (theory of mind) and type IV (self-aware). FinTech industry uses the type II which “considers pieces of past information and adds them to its preprogrammed representations of the world” : 96

it is using its memory to take proper decisions and undertake appropriate actions. Robo advisors (see infra.), are relying on this process to deliver asset management and investment strategies advices to consumers . 97

B. New species of Financial Services Once a critical development and description of the new technologies made, it is required to expose the impact of these technologies on the financial services or the translation of those technologies within the financial spectrum. The rise of Blockchain, IoT, AI, RegTech radically changed this sector and gave rise to new types of services that are currently disrupting the incumbents. This part intends -in a non exhaustive way- to briefly expose these new types of services classified in three categories: funding activities, advisory activities and payment activities.

Each of these activities may however, on a case-by-case basis, face regulatory obstacles since it involves strongly regulated activities. The Peer to Peer lending offers a new type of funding that can be analysed as a consuming credit (1.). The robo advisors relying on Artificial Intelligence offer new types of advisory services regarding investment/asset management strategies (2.). Finally, the mobile financial services enable the inclusion of less deserved populations within the formal economy (3.).

1. Peer to peer lending & crowdfunding As stated in the former section, the rise of new technologies leads to the disintermediation and automation of the financial sector. The peer to peer lending is an illustration of this trend. Peer to peer lending refers to the internet platform allowing individuals to lend to other individuals or small businesses without requiring any financial intermediary . In other words it covers two interesting patterns: the 98

loan involves two individuals and the absence of any financial intermediary. The loans are then used to fund whatever project such as the acquisition of a car, studies, medical operation,

Matthew U. SCHERER, “Regulating Artificial Intelligence Systems: Risks, Challenges, Competencies, and Strategies”, 95

Harvard Journal of Law & Technology, Vol. 29, No. 2, 2016, p.359. Available at SSRN: https://ssrn.com/abstract=2609777 or http://dx.doi.org/10.2139/ssrn.2609777.

Erik Vermeulen, IBLII lecture 1, Semester II. 96

ALLEN & OVERY, “FinTech”, p.2.97

A. MATEESCU, “Peer to Peer Lending”, Data& Society - Research Institute, 2015, p.2.98

Page ! of !24 53

travel… Zopa is the first peer-to-peer lending platform that has been established in 2005 in the UK . 99

If the general public often combines P2P lending with crowdfunding, these activities are however different. The crowdfunding involves generally individuals who fund a specific project held by professionals while the peer to peer lending targets only transactions between individuals and does not aim to fund a peculiar project . 100

Peer to peer lending shares many similitudes with the lending activities held by traditional players regarding notably the duration, the amounts, the terms and the legal nature (consuming credit) of the loan . However, the essential difference between P2P and traditional credits is 101

the origins of the funds and the burden of the credit risk. Credits issued by banks are funded through the deposits made by its customers while the P2P lending does not rely on such deposits since this activity is part of the banking monopoly (see supra.). Then, the lender relying on a P2P platform exclusively supports the burden of the credit risk while banks assume this credit risk . Therefore, P2P platforms usually advise lenders to divide the original loan in 102

smaller loans with different terms in order to reduce such risk. Since peer to peer lending involves a credit. This activity is exposed to the same risks: liquidity risk, counterpart risk, interest rate risk, operational risk… 103

This activity involves the receiving of deposits from the public and the granting of credits for its own account within the meaning of Article 1.1 (a) of the Directive 2000/12/EC amending Directive 2000/12/EC relating to the taking up and pursuit of the business of credit institutions. It is raising many issues from a national regulatory perspective since lending activities are strictly regulated. Public policies generally only allow credit institutions to perform lending and deposits activities. In some countries (e.g.: Belgium), such regulatory obstacle prevents therefore the establishment of a P2P lending market and therefore requires a legislative modification.

2. Robo-advisors The robo-advisors -also named digital advisors- “incorporate computer-based technology into their portfolio management processes – primarily through the use of algorithms designed to optimise various elements of wealth management from asset allocation, to tax management, to

A. MATEESCU, “Peer to Peer Lending”, p.2.99

C. HOUSSA, “Le peer to peer lending : un disrupteur innovant à l’avenir encore incertain”, Forum Financier / Droit 100

Bancaire et Financier, 2016, p.75 à 84. C. HOUSSA, “Le peer to peer lending : un disrupteur innovant à l’avenir encore incertain”, p.76.101

Ibid., p.77102

Ibidem.103

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product selection and trade execution” . In a few words, robo-advices offer computer-based 104

investment recommendations. Without any human interaction, robo-advisors intend to rank or match consumers with certain types of products/investments on a personalised basis . These 105

products include deposits, mortgages, consuming credits and securities.

Concretely, the customer is asked to answer targeted questions assessing its risk appetite, financial situation and investment preferences . Then the computer based technology will 106

configure investment and asset management strategies based on the answers delivered by the customer . This system therefore delivers a customer-tailored advice addressing its specific 107

needs and requirements. It it important to bear in mind that all digital advices are not the same. While some of them are focused on a single portfolio strategy others may endorsed a multi-complex strategy relying on multi-strategy algorithms . 108

Investment advisory is commonly considered as a regulated activity and therefore conditioned to an aggregation given by the prudential authority. Therefore, regulations might set entry barriers to these new players. The specific regime emphasised in Chapter 1 enable FinTech start up companies to endorse a specific statute allowing them to perform such activities in a less regulated framework (see supra.).

3. Mobile payments Mobile financial services are probably the first activities that have taken the advantage of Information and Communication Technologies within the financial industry. Mobile financial services include two broad category of services which are mobile banking and mobile payments.

Mobile banking “allows bank customers to check balances, monitor transactions, obtain other account information, transfer funds, locate branches or ATMs, and, sometimes, pay bills” 109

whereas mobile payments describe the process allowing individuals to execute transactions through the use of their mobile phones . Mobile payments encompass three types of 110

BLACKROCK, “Digital Investment Advice: Robo Advisors Come of Age”, Septermber 2016, p.1.104

Tom BAKER and Benedict G. C DELLAERT, “Regulating Robo Advice Across the Financial Services Industry”, U of 105

Penn, Inst for Law & Econ Research Paper No. 17-11, March 2017, p.8. Available at SSRN: https://ssrn.com/abstract=2932189 or http://dx.doi.org/10.2139/ssrn.2932189

DEUTSCHE BANK, ”Robo advice - when machines manage your assets (Fintech #8)”, 23 August 2016, p.1.106

Ibid., p.1.107

BLACKROCK, “Digital Investment Advice: Robo Advisors Come of Age”, p.3.108

Julia S. CHENEY, “An Examination of Mobile Banking and Mobile Payments: Building Adoption as Experience 109

Goods?”, FRB of Philadelphia - Payment Cards Center Discussion Paper No. 08-07, 2008, p.6. Available at SSRN: https://ssrn.com/abstract=1266809 or http://dx.doi.org/10.2139/ssrn.1266809.

Chris Jay HOOFNAGLE and Jennifer M. URBAN and Su LI, “Mobile Payments: Consumer Benefits & New Privacy 110

Concerns”, BCLT Research Paper, 2012, p. 2. Available at SSRN: https://ssrn.com/abstract=2045580 or http://dx.doi.org/10.2139/ssrn.2045580

Page ! of !26 53

transactions : 1) C2C transactions through a mobile device, 2) purchases of goods and 111

services over the Internet on a mobile device and 3) “mobile payments as a point of sale (POS)” . Several technologies underly mobile payments but the description of these go 112

beyond the framework of this section . 113

Mobile financial services are delivered by two categories of players: the existing players (banks and card companies) and the challenging players (telecoms operators , process innovators and 114

technology innovators).

These mobile financial services grant many advantages to the consumers and allow the inclusion for less deserved populations in the formal economy . 115

Mobile payments system and the technologies underlying it present many benefits for both 116

the consumers and the merchants: reduction of transaction costs, better payment security , it 117

could offer a digital wallet, storage of coupons, computing and storage capacity of the mobile phone enables the set of repositories for customers’ purchases… Furthermore, it allows faster transaction and enable the consumer to monitor finances and control spending . 118

At the opposite of the two other kinds of services, regulatory barriers within the EU are less meaningful since the Payment Services Directive and the EU Directive 2000/46/EC on the taking up, pursuit of and prudential supervision of the business of electronic money institutions set a framework regarding the performance of mobile payments activities.

III. A Disruptive Business Model If the technologies mentioned and described in former section demonstrate their potential disruptive effect on the incumbents firms, these also suffer from their inability/difficulty to adapt their existing business model to the societal changes.

Fumiko HAYASHI, “Mobile Payments: What’s in It for Consumers?”, Federal Reserve Bank of Kansas City - 111

Economic Review - First Quarter, 2012, p.37. Fumiko Hayashi describes this third category as “payments initiated from a mobile device 112

at physical locations, such as a grocery store, restaurant, or gas station”. See Footnote above. For further information, refer to Fumiko HAYASHI, “Mobile Payments: What’s in It for Consumers?”, p.38.113

As of July 6, 2017, the French telecom company Orange launched “Orange bank”, its new branch of activities 114

entirely dedicated to banking services. http://www.lemonde.fr/economie/article/2017/04/20/orange-joue-la-carte-du-gratuit-dans-la-banque_5114165_3234.html

WORLD ECONOMIC FORUM, “The Mobile Financial Services Development Report 2011”, vii.115

Chris Jay HOOFNAGLE and Jennifer M. URBAN and Su LI, “Mobile Payments: Consumer Benefits & New Privacy 116

Concerns”, p.3. Rather than a single Personal Identification Number as security warranty, “mobile payment technologies could 117

leverage information about the consumer, location information, security features on the device, and one-time account identifiers to more effectively verify buyers’ identifies, thereby achieving more secure transactions.” in Chris Jay HOOFNAGLE and Jennifer M. URBAN and Su LI, “Mobile Payments: Consumer Benefits & New Privacy Concerns”, p.3.

EUROPEAN PARLIAMENTARY RESEARCH SERVICE, “Consumer protection aspects of mobile payments”, Briefing - 118

June 2015, p.4.Page ! of !27 53

As emphasised in chapter 1, public attitudes to consumption -and work- have radically changed. Facing these changes, companies need to adapt their business model in order to capture adequately these changes. Sharing economy is disrupting the usual business model designed as such by the traditional capitalism. What is part of success of FinTech companies -and what makes them disruptive- is their ability to provide an offer which is adapted to new consumers’ expectations. These new players share a same vision which consists in ‘uncorporating’ the corporate culture (A.). They’re also built around an innovative business model displayed by a horizontal approach, a flat-hierarchy and openness (B.) allowing thereby to focus on customers’ needs.

A. ‘Uncorporate’ the corporate culture The banking regulations considerably increased the burden of compliance leading towards stringent agency-based rules. In a similar way, it can be argued that the usual ‘corporate attitude’ of large firms is not relevant any more and has even become a threat for the 119

incumbents. The purpose of this subsection is to critically analyse the disruptive patterns displayed by this business model while underlying the parallel threat for the incumbents.

Large multinationals firms used to adopt the traditional governance model characterised by rigidity and hierarchy which marginalise and inhibit innovation and proactivity. The over regulation emphasised in chapter 1 and this corporate culture endorsed by large multinational companies are interconnected on two sides at least.

Firstly, the regimes regarding the customers’ relations and the supervision strengthened the compliance duties on behalf of the banks. As a result, companies are “obliged to spend more time and money on managing the rising costs associated with navigating the mosaic of overlapping legal rules that now constitutes the contemporary regulatory landscape” . As 120

previously emphasised, the direct effect of these policies was to drastically enhance the compliance costs. However, the real problem linked to these regulations does not lay dow in the direct compliance costs -which are manageable for these large firms, but rather in the indirect costs arising : bureaucratisation of the company, ‘one-size-fits-all’ corporate culture, box 121

thicking compliance… The indirect costs display a ‘depersonalisation’ of the company as mentioned in chapter 1 while ignoring the changes in public attitudes to consumption.

Defined by Vermeulen and Fenwik as : “ a corporate culture in which conservative decision-making, a short term 119

perspective and formalistic compliance are over-emphasized’, in Mark FENWICK and Erik P.M. VERMEULEN, “The Future of Capitalism - ‘Un-corporating’ Corporate Governance”, p.4.

Mark FENWICK and Erik P.M. VERMEULEN, “The Future of Capitalism - ‘Un-corporating’ Corporate Governance”, p.120

8. Ibid., p.9.121

Page ! of !28 53

The second effect resulting from these policies is to give incentives to focus -almost exclusively- on short term financial gains . Although an emphasis on financial gains is not damageable on a 122

short term basis, it may however be damageable on the long term since it draws the company away from long-term product-development and innovation . Corporate culture also shaped the 123

relationships amongst investors, managers and employees: these relationships are agency-based/hierarchical and these various stakeholders encourage this short-term strategy since they do not commit to the company for a long time . 124

The combination of these two consequences lead towards a unpersonalised company less responsive to innovation and rather “focused on formalistic, ‘check the box’ compliance and short-term financial goals” .Traditional banks are getting less competitive and this can be 125

observed in the news of the past months: BNP Paribas, ING, Monte dei Paschi, Crélan etc are facing strong reorganisation while FinTech start up companies are popping up at a worldwide level.

This depicts rightly the failure of this business model to capture new consumers’ expectations and the lack of both an innovation and a long-term strategy . In order to remain competitive, 126

banks should reconsider the core elements of any firm expressed by the tryptic product/people/process and maybe get inspiration from the FinTech companies’ organisation. 127

While giant companies’s organisation display rigidity, hierarchy and short-term vision, the FinTech start up companies are built around flexibility, flat hierarchy and openness getting therefore more responsive to innovation . In other words, FinTech companies share a 128

decentralised platform.

B. Horizontal approach v. Vertical approach Incumbents traditionally adopt a vertical approach regarding their activities: the entity that supplies a product/service and the one that produces the product/service is the same . The 129

company is therefore entirely organised around the product from the conception to the

Mark FENWICK and Erik P.M. VERMEULEN, “The Future of Capitalism - ‘Un-corporating’ Corporate Governance”, p.122

9. Ibidem.123

Erik P.M VERMEULEN, “Corporate Governance in a Networked Age”, Tilburg Law School Legal Studies Research 124

Paper Series, No 16/2015, p.5. idem.125

Dariusz KRALEWSKI, “Bottom-up decentralized approach to innovation strategy”, p.1. Available at: http://ceur-126

ws.org/Vol-864/paper_7.pdf. Mark FENWICK and Erik P.M. VERMEULEN, “The Future of Capitalism - ‘Un-corporating’ Corporate Governance”, 127

p.14. Erik VERMEULEN, Mark FENWICK, J.William CALLISON, Joseph A. MCCAHERY, “Corporate Disruption: The Law 128

and Design of Organizations in the 21st Century”, TILEC Discussion Paper, October 2016, p.19. Hubert DE VAUPLANE, “FinTech : les nouveaux acteurs de la finance”129

Page ! of !29 53

distribution to the client. This vertical dimension can easily be understood under the light of the standardisation and bureaucratisation of the banking profession.

Rather, FinTech companies endorsed an horizontal approach which is focused on clients’ needs and expectations . Horizontality is built around autonomy and decentralisation while intending 130

to reduce hierarchy within the company . 131

This organisational structure is inspired from the sharing economy model within which the clients define their own needs and not the bank who used to do so by proposing preformated products to specific ranges of customers defined by abstract criteria . Another distinctive 132

feature regarding this approach is that FinTech companies do not take in charge both production and supply of the product/services . They usually distribute a product/service produced by a 133

specialist firm in order to adequately respond to customers’ expectations.

This horizontal structure issued from sharing economy and adopted by FinTech companies is characterised by three features . First the horizontal approach leads the company to set a 134

decentralised structure without any centralised decisional process. It therefore reduces the hierarchical structure proper to giant firms while expanding autonomous and decentralised human activity . This logic therefore encourages flat-hierrachy. Then, the horizontal structure 135

enables the mutualisation of knowledges and expertise leading towards a better use of the resources . It concurs thereby to the conception of a platform through which users get free 136

access to those resources. Finally the crowdsourcing approach entails an extensive sharing approach which fosters and relies on creativity, intelligence and know-how of the members of this platform to achieve specific tasks . 137

While banks felt under pressure due to the regulatory constraints (see supra.), FinTech actors take the advantage of their essential flexibility and agility to provide a new offer that matches with new consuming habits inferred by the digital revolution . As any other disruptive 138

company, FinTech catches precisely these new expectations and offer in return the suitable service.

Hubert DE VAUPLANE, “FinTech : les nouveaux acteurs de la finance”.130

Jacques RODET, “Verticalité, horizontalité et changement dans les organisations. Pensée disjonctive, pensée 131

conjonctive et pensée complexe”, February 2009, p.3.. Available at: http://jacques.rodet.free.fr/vhchgt.pdf. Hubert DE VAUPLANE, “FinTech : les nouveaux acteurs de la finance”.132

Ibidem.133

Ibidem.134

Delphine MASSET and Eric LUYCKX, “L’économie collaborative: une alternative au modèle de la compétition”, 135

Analyses Etopia, Mars 2014, p5. Ibidem.136

Ibidem.137

Hubert DE VAUPLANE, “FinTech : les nouveaux acteurs de la finance”.138

Page ! of !30 53

IV. Too linked to fail and too fast to save However, the FinTech opportunity must not occult the emerging risks and vulnerabilities inherent to the incursion of new technologies within the financial industry. Financial Technology could pose systemic risks of a new genre for the financial system . Since 139

the financial crisis, policy makers have been more bothered by systemic risks associated with the ‘too big to fail’ institutions but much less with those associated with the rise of new technologies . 140

Tom C.W. Lin uses the expressions of “too linked to fail” and “too fast to save” to emphasise these new risks related respectively to links and speeds proper to new technologies. It also may raise concerns regarding cybersecurity.

The high-tech interconnection and interdependence proper to FinTech companies may cause serious damages and systemic distress dissimilar to the systemic risk related to “too big to fail” institutions which concerns important banking institutions. In the present case, the “too linked to fail” institutions are namely smaller financial intermediaries that do not need to be banking institutions while still remaining an important component of the today’s high tech financial system . 141

For instance, the Depositary Trust & Clearing Corporation, which processes trillions of dollars of securities transactions on a daily basis , occupies an important place within global markets -142

without being a banking institution- and “any malfunction in its computer system could cause serious disarray to the financial system” . 143

In 2015 Bloomberg terminals suffered from a temporary technical impairment that affected 144

billions of dollars in transactions . Bloomberg plays an important role in today’s financial 145

landscape since many investments are relying on informations provided by the informations services provider.

On the other hand, “the high-tech, high-speed nature of modern finance increases the risks that normal financial accidents could cause significant systemic harm so quickly that prevention and

Kristin N. JOHNSON, “Cyber Risks: Emerging Risk Management Concers for Financial Institutions”, Georgia Law 139

Review, 2015, p.137. Tom C.W. LIN, “Compliance, Technology, and Modern Finance”, p.169.140

Ibidem.141

DTCC website, http://www.dtcc.com/en/about, Page consulted on 29 March, 15:44.142

Tom C.W. LIN, “Compliance, Technology, and Modern Finance”, p.170.143

Bloomberg is an informations services provider with about 325 000 terminals used by financial traders and not a 144

large banking institution. Nathaniel POPPER and Neil GOUGH, “Bloomberg Data Crash Puts Market in Turmoil”, N.Y. Times, Apr. 18, 2015.145

Page ! of !31 53

intervention is not feasible” . New technologies such as supercomputer programs allow on a 146

daily basis massive transactions measured in billions of dollars enacted in a fractions of a second . A glitch within a computer system could have far reaching consequences regarding 147

financial stability resulting in cascading and spill-over adverse effects as other computer systems would react instantly to that glitch. As the financial system is getting ever more invaded by new technologies, it seems that many volatile market events occurred for no reason and are likely to happen in the near future . 148

The rise of the ever evolving financial technology is raising many concerns in terms of cybersecurity and it confronts policymakers to new types of systemic risks. They must remain vigilant regarding the evolution of the systemic risks related to cyber risks.

See FRANK PARTNOY, WAIT: THE ART AND SCIENCE OF DELAY 43 (2012); Andrew G. Haldane, Exec. Dir. Fin. 146

Stability, Bank of Eng., Speech at the International Economic Association Sixteenth World Congress: The Race to Zero 15 (July 8, 2011), http://www.bankofengland.co.uk/ archive/Documents/historicpubs/news/2011/068.pdf; Floyd Norris, In Markets’ Tuned-Up Machinery, Stubborn Ghosts Remain, N.Y. TIMES, Aug. 23, 2013; Matthew Baron et al., The Trading Profits of High Frequency Traders (Nov. 2012) (unpublished manuscript) (on file with the National Bureau of Economic Research) http://conference.nber.org/ confer//2012/MMf12/Baron_Brogaard_Kirilenko.pdf (finding that high-frequency traders profit at the expense of ordinary investors) referenced in Tom C.W. LIN, “Compliance, Technology, and Modern Finance”, p.170.

Tom C.W. LIN, “Compliance, Technology, and Modern Finance”, p.170.147

Ibid., p.171.148

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Chapter 3: The regulatory and corporate responses urged by the rise of FinTech companies

The previous chapters described the complex FinTech ecosystem. This ecosystem involves entities conducted by different or sometimes opposite interests.

The policymaker willing to set an adequate framework on this ecosystem shall take into account all these interests: financial stability, consumers’ interests and the innovation . This appears as a 149

complex equation for the regulator. Facing this radical evolution of the financial industry, the incumbents also have no choice than to adapt themselves to this new offer. This chapter therefore intends to analyse both the corporate and regulatory responses that might capture and anticipate the disruption carried by the FinTech industry.

As a result from the rise of FinTech start up companies on the financial marketplace, the incumbents are threatened in this new and innovative environment. These ‘variations under nature’ call for an adaptation of their strategy. The incumbents have the duty to evolve and adapt in order to remain relevant for the consumers (I.).

On the other hand, policymakers have the duty to encompass this new environment and set an adequate framework allowing these new start up companies to develop innovative ideas while protecting the consumers’ interests and ensuring the financial stability. This section will deliver a comparison between the conservative EU regulatory approach and the innovative policies implemented by the UK. The rise of new technologies and high tech finance also increased the cyber financial threats (II.).

I. The corporate responses: The unavoidable adaptation of the incumbents

The innovation -when it succeeds- gives a considerable competitive advantage to the company who embraced it: it lowers down the transaction costs, enhances the customer relationship, reduction of R&D costs… Before the rise of FinTech, the banks were not part of a high competitive marketplace . However, the emergence of disruptive technologies radically changed 150

this paradigm and gave rise to a new ecosystem within the banking and financial marketplaces. Innovation is not any more an option but a duty to remain relevant.

The innovation was first conceptualised by Joseph Schumpeter in 1930 and he distinguished 151

five different scopes where innovation could find an application: a) the introduction of a new

Catherine HOUSSA, “Le droit bancaire et le défi de la finance numérique”, p.1. Available at: http://149

www.simontbraun.eu/images/CHO_le_droit_bancaire_et_le_d%C3%A9fi_de_la_finance_num%C3%A9rique.pdf. Due to the banking monopoly as discussed in Chapter 1.150

Joseph SCHUMPETER, The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest and 151

the Business Cycle, Harvard University Press, Harvard, 1934, p.66.Page ! of !33 53

good/services, the b) introduction of a new method of production/supplying, c) the opening of a new market, d) the conquest of a new source of supply of raw materials and e) the carrying out of the new organisation of any industry. Following these principles, FinTech are innovating at least on three points: they introduced new services based on new technologies, they also introduced a new way of supplying financial services since they are much closer to the client and finally their organisation is also innovative. FinTech start up companies brought what Charles Darwin would call ‘variations under nature’ as already evoked in Chapter 2. In order to survive to these variations under nature, the incumbents have to adapt themselves to the new environment shaped by the FinTech revolution and to endorse strategies that will allow them to innovate.

This issue brings to the following question: What banks should do to avoid their disruption? An open innovation space would allow the banks to gain access to innovation and implement new strategies at a low cost compared to the closed innovation model (A.). Another strategy which is very popular in the United States is a corporate venturing strategy (B.).

A. Open innovation vs. Closed innovation The incumbents struggle to innovate but lack the talent necessary to endorse the digital revolution. Banks have basically three options: a) build up partnerships with FinTech start up companies, b) building its own R&D strategy (closed innovation) or c) rely on an open innovation model.

A first solution that would allow banks to be part of the digital revolution and avoid a -threatening- competition is to join hands with FinTech start up companies and build up a productive collaboration in certain fields such as customer experience, products, efficiency and security . This solution does not involve public policymakers. 152

However, bank partnerships on the online marketplace lending must be arranged in a way that addresses efficiently the regulatory, enforcement and litigation risk . 153

Collaboration can take many forms: a merger/acquisition, a partnership, launch of its own FinTech subsidiaries, startup programs to incubate FinTech companies or joint ventures to fund FinTech companies . Such strategy rests upon the assumption that banks lack the talent needed 154

to sustain innovation. They therefore need to acquire it. As instance, Capital One acquired Level

CURRENCYCLOUD, “Banks and the FinTech Challenge: How disruption has been a catalyst for collaboration and 152

innovation”, Currencycloud White Paper, 2016, p.11. GOODWIN, “Bank partnership or go it alone?”, August 23, 2016, p.1. Available at: http://www.goodwinlaw.com/153

viewpoints/2016/08/08_23_16-bank-partnership-or-go-it-alone. CURRENCYCLOUD, “Banks and the FinTech Challenge: How disruption has been a catalyst for collaboration and 154

innovation”, p.11.Page ! of !34 53

Money (start up based in San Francisco), BBVA acquired Simple in February 2014 for the 155 156

amount of $115 m., Context 360, Motion Savvy and Bracket Computing joined Wells Fargo’s incubator program and MasterCard is also relying on M&A strategy to build customer loyalty, 157

safety, security and data analytics. The following subsection will deeply address the corporate venturing strategy as a way to unlock the innovation chain (see supra.). The corporate venturing model can be depicted as a form of partnerships but will be analysed in a distinct section as mentioned above.

In some countries, a collaboration between both actors could also be beneficial for FinTech start up companies regarding the banking license requirements that may prevent them to carry on certain types of activities such as P2P lending or deposits activities or even investment advisory which may also be conditioned to strong requirements. Moreover, in most cases, FinTech companies do not produce the goods and services they offer to their clients . This form of 158

partnership therefore provides ‘win-win’ opportunities for both players.

Collaboration may bring talent and allow the incumbents to increase their capabilities in terms of innovation. The changes of customers’ habits make the business model of traditional banks less relevant (see supra.). Therefore, they also have to adapt their own services and endorse a horizontal and client-centric approach . 159

A second solution might be found in what is called the ‘open innovation’ which goes beyond the simple collaboration. The ‘open innovation’ model suggest a sharing of data’s and information with all the stakeholders of the natural -external or internal- ecosystem of the company . It 160

therefore might involve other companies or even industries. The ‘open innovation’ underlies the idea to give to a company all the tools (data’s, knowledges, ideas…), available within the relevant ecosystem in order to enable the latter to sustain a relevant innovation strategy . The 161

‘open innovation’ entails a process in two steps: a) a sharing of knowledge/ideas and know-how among the stakeholders of the same ecosystem and b) the implementation of such ideas/know-how in the undertaking.

https://www.americanbanker.com/news/capital-one-acquires-pfm-provider-level-money. Page consulted on May 1st, 155

2017, 10:00. https://techcrunch.com/2017/04/14/simple-account-closures/, Page consulted on May 1st, 2017, 10:01.156

https://accelerator.wellsfargo.com/, Page consulted on May 1st, 2017, 10:02.157

Ronan LE MOAL, « Les banques ont tout intérêt à nouer des partenariats », Revue Banque et Finance, n°339, 2015, 158

p.16-20. Available at: http://www.revue-banque.fr/banque-detail-assurance/article/les-banques-ont-tout-interet-nouer-des-partenariat.

Ibidem.159

Ibidem.160

Ibidem.161

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This approach allows the banks to avoid strong R&D costs, share the risks related to the uncertainty of the evolution of the markets and gain time . 162

However it raises risks from both a prudential/regulatory and/or management/operational perspectives that might result from the loss of control of the innovative service/product. On one hand, banks could misuse the open innovation model and only focus on the profits generated by financial innovations resulting therefrom while sacrificing business ethics . This practice may 163

recall the fraudulent Ponzi schemes set by financial institutions and revealed by the subprimes crisis of 2007/2008. From a prudential perspective, the financial innovation appears as a two edged sword regarding the financial stability. Furthermore, considering the proximity between the partners of the ecosystem -including other banks- a problem encountered by a bank could be easily transferred to another bank increasing thereby the systemic risk . 164

Finally, banks could also build their own innovation strategy which would result in increasing expenses in Research & Development. This type of strategy is called the ‘closed innovation’ where the company is only relying on its own resources to innovate . However, R&D units 165

usually focus on a narrow range of projects and therefore neglect ‘outside’ technological advances . 166

B. The Corporate venturing strategies The corporate attitude and the vertical business model were emphasized in Chapter 2. In many cases, this complex, hierarchical and bureaucratized structure prevent the company to endorse an efficient innovation strategy. Large companies could first try to deconstruct this mainstream business model and set an innovative model that allows the company to capture the technological and business model changes and innovate.

However, this deconstruction is a difficult task and has poor chance to succeed . Another 167

strategy is to implement a corporate venturing strategy. A corporate venturing strategy might enable large companies to create “an open and inclusive ecosystem through which large firms

Haouat ASLI, MERIEM. « Open innovation : quels enjeux pour le secteur bancaire ? », Innovations, vol. 39, no. 3, 162

2012, p.38. Ibid., p.40.163

Ibid., pp.41-42.164

Thierry DINARD, “Les banques en route vers l’open innovation”, Revue Banque et Finance, n°672, 2013, pp.34-38. 165

Available at: http://www.revue-banque.fr/banque-detail-assurance/article/les-banques-en-route-vers-open-innovation.Josh LERNER, “Corporate Venturing”, Harvard Business Review, October 2013. Available at https://hbr.org/2013/10/166

corporate-venturing. Erik VERMEULEN and Mark FENWICK, “Seven 'Corporate Venturing' Strategies to Foster Innovation (and Create an 167

Environment of Long-Term Growth)”, TILEC Discussion Paper, October 2016, p.12.Page ! of !36 53

can change the corporate attitude and capture some of the important innovation characteristics that are usually being attributed to startups, such as speed, passion and efficiency” . 168

Corporate venturing could basically be defined as “a process of creating businesses” . These 169

ventures then offer new business opportunities to the company that launches the venture. For a more complete definition, “corporate venturing is usually understood as a corporation making an investment in external startups either directly (off the balance sheet through a corporate venturing unit) or indirectly (through an independent and separately managed venture capital fund) for strategic and/or financial gain. The strategic benefits usually imply the further stimulation of the innovative capacity and potential of large corporations” . 170

Corporate venturing often allows large companies to be more agile, move faster with more flexibility and more cheaply than traditional R&D strategy in order to respond to technological and business model changes . As it gives the ability to the company to respond faster to 171

technological changes, it also allows the latter to easier disengage “from investments that seem to be going nowhere” . 172

Finally, corporate venturing allows the company to have a better visibility on emerging competitive threats and disruptive advances outside the company . 173

II. An innovative environment calls for an innovative policy framework The FinTech environment is characterised by a fast and exponential growth while the traditional legislation process is reactive, slow and linear. Such regulatory approach is not relevant any more to address such fast evolving ecosystem. The regulator should embrace a proactive flexible approach rather than a rule-based and rigid approach. As stated in Chapter 1, the rigidity and the stringency of a policy might hinder innovation. However, policymakers must set an adequate balance between innovation, consumers’ interests and the financial stability.

This section analyzes two radically different regulatory processes to capture the FinTech ecosystem. The European Union endorsed a reactive and traditional legislation process while the UK endorsed a more flexible approach through the Project Innovate (A.).

Erik VERMEULEN and Mark FENWICK, “Seven 'Corporate Venturing' Strategies to Foster Innovation (and Create an 168

Environment of Long-Term Growth)”, p.13. J Henri BURGERS and Chintan M. SHAH, “Corporate Venturing: Unlocking the Innovation Chain”, 2009. Available at 169

SSRN: https://ssrn.com/abstract=1442543 or http://dx.doi.org/10.2139/ssrn.1442543, p.5. Erik VERMEULEN and Mark FENWICK, “Seven 'Corporate Venturing' Strategies to Foster Innovation (and Create an 170

Environment of Long-Term Growth)”, p.5 Josh LERNER, “Corporate Venturing”.171

Josh LERNER, “Corporate Venturing”.172

Ibidem.173

Page ! of !37 53

The Regulatory Sandbox is seducing more and more public authorities. Initially launched by the Financial Conduct Authority in the UK, the sandboxing approach provides creative measures and processes that adequately take into account the diverse interests at stake (B.). The cyber security is another concern that must be addressed by policymakers at a digital age (C.).

A. The EU Digital Market Strategy vs. The FCA Project Innovate As a part of its Digital Market Strategy, the European Union (EU) launches different efforts in order to lead to an integrated digital market. The Digital Single Market Strategy for Europe follows three policy objectives: (i) support digital infrastructure development; (ii) improve access to digital goods and services; and to (iii) design rules that foster technological development. Regarding the FinTech ecosystem, the EU recently launched a FinTech Task Force and published a consultation addressed to the stakeholders of such ecosystem (1.).

On the other hand, the Financial Conduct Authority (FCA) seem to be more in advance on the EU. The high rate of FinTech start up companies established in the UK marketplace can assess it. This success is strongly linked with the creative initiatives conducted by the FCA through its Project Innovate (2.).

The comparison between both EU and FCA models reveal essential differences regarding the core role of the supervision authorities and the regulatory approach. Investment data’s clearly show that the UK policy provides positive incentives for FinTech start up companies (3.).

1. The EU FinTech Task Force and other initiatives Taking into account the new technologies, the EU reformed the Payment Services Directive and enacted a Directive to set a framework regarding the Electronic Money institutions (1.). Both legislations are linked. Regarding the proper FinTech industry, the EU set both an action plan and a FinTech Task Force that purport to foster innovation and address the challenges posed by the FinTech ecosystem (2.).

a. The Payment Services Directive II and the Electronic Money Directive The EU reformed the payment services regime and set a new framework regarding the e-money institutions. The Payment Services Directive II aim at adapting and strengthening the payment services regime set in the first Directive while promoting innovative mobile and internet payment services. This Directive will become applicable in January 2018.

The PSD2 intends to deliver strict security requirements for electronic payments and for the protection of consumers’ financial data . It also set rules regarding the transparency of 174

Art. 5, Directive (EU) 2015/2366 of 25 November 2015 on payment services in the internal market, amending 174

Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC.

Page ! of !38 53

conditions and information requirements for payment services . Finally the directive 175

enhances the consumers’ rights and set new rules regarding the rights and obligations . The 176

Directive must be read in parallel with the Directive related to the business and supervision of electronic money that modernises EU rules on e-money.

b. The EU FinTech Task Force In March 2017, the European Commission published an action plan in order to strengthen the EU Single Market for retail financial services. It also intends to harness the true potential of the digital revolution within the financial industry. This initiative follows a consultation that has been addressed to the stakeholders concerned by the emergence of FinTech. The Commission rightly underlies the delicate balance between the support of innovation across the whole financial sector, the consumer and personal data protection and the financial stability . 177

The Commission stresses out two types of concerns. On one hand, the innovative firms expressed their concerns regarding the EU and national regulations that might refrain their ability to offer innovative services. They are indeed uncertain regarding the application of over-cautious, disproportionate or inconsistent regulatory requirements . On the other hand, 178

citizens are concerned about security and cyber-fraud issues that might result from these new types of financial services. The future regulatory framework has to address both concerns in order to satisfy all the interests at stake.

Further, the Commission seems aware of the inefficiency of traditional regulatory approaches and encourages “new regulatory and supervisory approaches and cross-border co-operation when dealing with innovative firms, as long as consumers remain well protected” . In the 179

communication, the Commission mentions the Regulatory Sandbox approach that might be relevant to address the issues resulting from the innovation within the financial marketplace. Following the Action Plan strategy, the European Commission launched a public consultation addressed to the stakeholders in order to collect inputs in order to further develop its strategy regarding the Financial Technologies . As stated in the consultation paper, the public 180

Title III, Directive (EU) 2015/2366 of 25 November 2015 on payment services in the internal market, amending 175

Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC.

Title IV, Directive (EU) 2015/2366 of 25 November 2015 on payment services in the internal market, amending 176

Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC.

EU COMMISSION, Communication from the Commission to the European Parliament, the Council, the European 177

Central Bank, the European Economic and Social Committee and the Committee of the Regions - Consumer Financial Services Action Plan: Better Products, More Choice, March 23, 2017, p.11.

Ibid., p.12.178

EU COMMISSION, Communication from the Commission to the European Parliament, the Council, the European 179

Central Bank, the European Economic and Social Committee and the Committee of the Regions - Consumer Financial Services Action Plan: Better Products, More Choice, p.12.

Ibidem.180

Page ! of !39 53

consultation is articulated around four policy objectives depicting the main opportunities related to FinTech:

* Fostering access to financial services for consumers and businesses; * Bringing down operational costs and increasing efficiency for the industry; * Making the single market more competitive by lowering barriers to entry; * Balancing greater data sharing and transparency with data security and protection

needs. The consultation process will end on the 15th of June 2017 and will be followed by recommendations based on the outcome of the public consultation.

On the other hand, the Commission launched the Financial Technology Task Force (FTTF). The FTTF “involves all relevant services working on financial regulation, technology, data and competition to ensure that our assessment reflects the multi-disciplinary approach that FinTech developments ask for” . It further “aims to assess and make the most of innovation 181

in this area, while also developing strategies to address the potential challenges that FinTech poses. The work of this Task Force builds on the Commission's goal to develop a comprehensive strategy on FinTech” . 182

The description of the regulatory works carried by the Commission emphasises the linearity and the slowness of the EU regulatory process: while the rise of FinTech start up companies started in 2014, the EU authorities launched a public consultation only three years later. Further, it means that a proposal of regulation will probably be adopted in late 2017 and based on the outcome of the consultation. Then a final regulation will finally be enacted even later. By essence, a regulation intends to apply for a long term and not on a short term, it thus intends to encompass the FinTech industry on a long-term basis. However, how can it be certified that the FinTech landscape of 2017 as depicted by the consultation will remain the same in the next three or 5 years ? This interrogation illustrates well the tension between the exponential trend of Financial Technologies and the slowness of the legislation process.

2. The FCA’s creative responses The FCA launched the ‘Project Innovate’ that aims to modernise the actual regulatory processes and set a creative framework encompassing innovative and creative services/products on the financial marketplace (a.). As part of this initiative, the FCA launched the Innovation Hub (b.) and a call for input regarding the RegTech field (c.). The UK therefore seems more advanced than the EU.

Ibidem.181

EU COMMISSION, “PRESS RELEASE: European Commission sets up an internal Task Force on Financial 182

Technologies”, 14 November 2016.Page ! of !40 53

a. Project Innovate The United Kingdom seems to have endorsed a better regulatory approach that is more FinTech friendly and that attract many start up companies. This thus explains that UK is considered a world leader in Financial Technologies . It is therefore interesting to have a 183

look on the regulatory approach endorsed by the UK in order to tackle the FinTech issue.

The UK government set an innovative regulatory environment consisting in a flexible and principle based approach. These reforms succeeded by promoting the FinTech industry as a new engine of growth in the UK . In 2013, the UK government drove a reform that divided 184

the financial regulatory and prudential system in two branches. On one hand, the Prudential Regulatory Authority (PRA) as a part of the Bank of England is responsible for the supervision of large banks, building societies, credit unions, insurers and major investment firms . On the other hand, the Financial Conduct Authority (FCA) which “is the conduct 185

regulator for 56,000 financial services firms and financial markets in the UK and the prudential regulator for over 18,000 of those firms” . The latter is playing an important and 186

innovative role regarding the conduct and the development of the FinTech environment.

This section will focus on the key role played by the FCA regarding the FinTech ecosystem in the UK. The developments following intend to illustrate a clear rupture between the conservative rule-based approach of the EU and the innovative principle-based approach conducted by the UK. After the global crisis, the FCA focused on the potential of FinTech companies regarding the innovation and the benefits for consumers. It therefore actively supported the FinTech sector while introducing innovative products and creative ways of regulation . A first point to 187

emphasise the creative regulation process is the role played by the FCA. Whereas any traditional financial supervision authority has their core role limited to the overseeing of any illegal conduct of companies, the FCA endorsed an interactive approach with the businesses involved in the financial market . The Project Innovate Initiative is based on this interactive 188

approach and has been considered as one of “the most successful policies in support of innovative FinTech businesses” . The Project radically changed the role of financial 189

GOVERNMENT OFFICE FOR SCIENCE.”FinTech Futures: The UK as a World Leader in Financial Technologies”, 183

March 2015, p.4. Hyoeun YANG, “The UK’s Fintech Industry Support Policies and its Implications”, World Economy Brief, Vol.7 No.184

5, 17 February 2017, p.3. PRUDENTIAL REGULATORY AUTHORITY website: http://www.bankofengland.co.uk/pra/Pages/default.aspx. Page 185

consulted on 4th May, 10:25. FINANCIAL CONDUCT AUTHORITY website: https://www.fca.org.uk/about/the-fca. Page consulted on 4th May, 10:28.186

Caroline BINHAM, “UK regulators are the most fintech friendly,” Financial Times (12 September 2016).187

Hyoeun YANG, “The UK’s Fintech Industry Support Policies and its Implications”, p.3.188

Ibidem.189

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supervisory authorities from a rigid supervisors to creative supporters of innovative businesses . The Innovation Hub launched in 2014 is part of this Project Innovate. 190

b. The Innovation Hub The Innovation Hub intends to facilitate and enable new businesses -regulated or non regulated- to introduce innovative financial products and services in the market with less 191

regulatory costs or burden . Only businesses that meet the criteria established by the FCA 192

can benefit from the Innovation Hub program. To be eligible for the Innovation Hub program, the company “must prove that the specific product or service includes innovative factors significantly different from existing ones and that the innovation offers considerable benefit to consumers” . 193

The Innovation Hub includes a Direct Support that purports to offer particular services to 194

the businesses that meet the criteria: a) a dedicated team and contact for innovator businesses, b) help for these businesses to understand the regulatory framework and how it applies to them, c) assistance in preparing and making an application for authorisation, to ensure the business understands our regulatory regime and what it means for them and e) a dedicated contact for up to a year after an innovator business is authorised. The Project also intends to identify areas where the regulatory framework need to be adapted in order to enable further innovation for the benefits of the consumers . Then, the support provided by the Innovation 195

Hub consists of three stages: pre-authorisation, authorisation and after-authorisation. At the pre-authorisation stage, regulators help “the FinTech start up companies to understand the risk and the cost of acquiring the authorization” and help the companies to prepare the 196

authorisation by offering a dedicated support . Then, starts a special authorisation process 197

whereby the regulators accompany the business making sure the autorization application is successful. Once authorised, the regulators will keep on supporting the business for a period up to one year . 198

The Innovation Hub illustrates the creative and innovative role of the supervision authority. Within this framework, the direct consulting and assistance provided by the regulator to

Speech by Christopher WOOLARD. 2016. “UK FinTech: Regulating for innovation,” FCA. (February 23).190

“Innovate and Innovation Hub”, https://www.fca.org.uk/firms/innovate-innovation-hub. Page consulted on 4th May, 191

11:04.Hyoeun YANG, “The UK’s Fintech Industry Support Policies and its Implications”, p.4.192

Idem.193

“Innovate and Innovation Hub”, https://www.fca.org.uk/firms/innovate-innovation-hub. Page consulted on 4th May, 194

11:04. Idem.195

Hyoeun YANG, “The UK’s Fintech Industry Support Policies and its Implications”, p.4.196

Request Innovation Hub support, https://www.fca.org.uk/firms/innovate-innovation-hub/request-support, Page 197

consulted on 4th May, 11:58. Request Innovation Hub support, https://www.fca.org.uk/firms/innovate-innovation-hub/request-support, Page 198

consulted on 4th May, 11:58.Page ! of !42 53

FinTech start up companies allow them to reduce the regulatory risk and any compliance costs. In many cases, young start up companies struggle to truly understand the complex financial regulations. In some cases, it might even discourage start up companies to take up a business in such high regulated market. Hence, the financial supervision authority provides the support and assistance needed that encourage FinTech start up companies to carry on their activities.

Furthermore, this flexible approach and the close relationship between the financial supervision authority and the start up companies allow a perfect balance between the financial stability and the fostering of innovation that benefits to consumers.

c. RegTech The FCA is also involved in the development of RegTech (see supra.) as a way to facilitate the delivery of regulatory requirements. In November 2015, the FCA issued a call for input that has been followed by a feedback statement published in July 2016.

3. The investments data’s at a global level: the illustration of a deep contrast between UK and the rest of Europe

Investments in FinTech start up have known a deep increase. In 2014, worldwide investments tripled in a one year period to attain the amount of 12,2 billion dollars . This illustrates the 199

understanding of the far reaching implications of the digital revolution within the financial sector.

The investments data’s at a European level are interesting because they illustrate a certain dichotomy between the UK and Ireland and the rest of Europe. Even if the Europe has known the highest investments growth with a total of 1,48 billion dollars in 2014, the UK and Ireland still represent together 42% (m. 623 $) of the total of the European investments made in 2014. In second position, comes the Nordic countries with an amount of m. 345 $ investments followed by the Netherlands (m. 306$), Germany (m. 82$).

This huge contrast between the UK/Ireland and the rest of Europe might find an explanation in the different regulatory responses offered by those. The “Project Innovate” conducted by the FCA clearly fostered the innovation at a national level encouraging the new FinTech start up companies. It also offers a gain of time and reduces the legal uncertainty proper to long legislative preliminary works. The Sandbox initiative (see infra.) is also expected to build FinTech bridges with other States who also enacted a Regulatory Sandbox and thereby enhancing and strengthening the regulatory collaboration at a greater scale . On the other 200

ACCENTURE, “Communiqué de presse -Les investissements dans les Fintech en Europe enregistrent la croissance la 199

plus rapide, selon une nouvelle étude Accenture”, 26 mars 2015, Paris. KPMG, “The Pulse of FinTech Q4 2016 - A Global Analysis Of Investment in FinTech”, 21 February 2017, p.72.200

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hand, the Brexit could however change this landscape and adversely impact the leading position of the UK regarding FinTech industry in case of a ‘hard Brexit’.

Finally, the implementation of the Payment Services Directive 2 intends to bring more investments according to a report delivered by KPMG as it is expected to be a “game changer” in the European Union . New FinTech solutions will emerge to align with the new regime of 201

the PSD2 - “from the development of cross industry platforms in which banks can play a role to the offering of specialized products and services that make use of the open banking model” . 202

B. The Regulatory Sandbox approach The United Kingdom has implemented a regulatory sandbox as a part of its Project Innovate. The Monetary Authority of Singapore also launched the same initiative while the European 203

Banking Federation recommended as well the creation of a Europe-wide FinTech sandbox . 204

“A regulatory sandbox is a ‘safe space’ in which businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of engaging in the activity in question” . This initiative intends to 205

identify the regulatory barriers faced by businesses whilst testing new ideas and then see how and at what extent these barriers might be lowered. On the other hand, the sandbox provides safeguards to ensure the protection of consumers and the financial stability . The regulatory 206

sandbox offers a flexible and well balanced regulatory model regarding the innovation, the consumers’ interests and the financial stability.

The idea beyond the regulatory sandbox is to allow FinTech experimentation within the market while setting safeguards that contain the risks that may arise therefrom . This experimentation 207

allows authorities to get a better and practical knowledge of this ecosystem and the impact of financial technologies it may have on the regulatory landscape. It is also important to add that the regulatory sandboxes are open to both incumbents and start up companies, considering the fact that innovation is not the monopoly of start up companies . 208

KPMG, “The Pulse of FinTech Q4 2016 - A Global Analysis Of Investment in FinTech”, p.74201

Idem.202

MONETARY AUTHORITY OF SINGAPORE, “FinTech Regulatory Sandbox Guidelines”, November 2016, p.3.203

EUROPEAN BANKING FEDERATION, “Press Release: EBF presents vision for banking in the digital single market”, 14 204

November 2016. FINANCIAL CONDUCT AUTHORITY, “Regulatory Sandbox”, November 2015, p.2. Available at: https://205

www.fca.org.uk/publication/research/regulatory-sandbox.pdf. FINANCIAL CONDUCT AUTHORITY, “Regulatory Sandbox”, p.3.206

MONETARY AUTHORITY OF SINGAPORE, “FinTech Regulatory Sandbox Guidelines”, p.4.207

Pavel SHOUST, “Regulations and FinTech: Influence is mutual ?” , p.5. Available at: http://pubdocs.worldbank.org/208

en/770171476811898530/Session-4-Pavel-Shoust-Regulatory-Sandboxes-21-09-2016.pdfPage ! of !44 53

The following developments will focus on the Regulatory Sandbox enacted by the FCA since it is the pioneer of this approach.

The FCA identifies a typical ‘firm journey through the Sandbox’ in its recommendations from the application to the end of the testing of the innovative products/services. This firm journey starts with the application form. Similarly to the Innovation Hub (see supra.), the FCA introduced prerequisites to be met by businesses in order to take part to the regulatory sandbox. The FCA set five different key criteria for any firm willing to apply to take part to the regulatory sandbox: 209

* Scope: the firm must look to deliver innovation which is regulated business or supports regulated businesses established within the UK financial market.

* Genuine innovation: The innovation must consist in a ground breaking innovation or must constitute a new offering in the marketplace.

* Consumer benefit: the innovation must provide consumer benefits. * Need for a sandbox: the firm must prove a genuine need to test the innovation on real

customers and in the FCA’s sandbox. * Ready for testing: The firm must be ready to test the innovation.

Alongside these criteria, the FCA provides positive and negative indicators that suggests whether the criteria are fulfilled or not. The successful applicant will then start a close partnership with the FCA. The supervision authority will discuss with each successful firm and agree on the testing parameters, the safeguards for customers on a case-by-case analysis . 210

The FCA will then allow the firm to start testing its innovation and will engage on the terms agreed with the FCA. Once the test is completed, the firm will submit a final report assessing the outcome of the test to the FCA who will review the report. After the completion of the review of the final report, the firm must then decide whether or not to offer the innovative product/service at a wider scale and out of the sandbox . 211

During the testing, the firm enjoys a certain comfort regarding any regulatory risks and sanctions exposure as a result of the sandbox activities. The FCA provides three different options that help the firms to manage this risk:

* no enforcement action letters by which the FCA commits not “to take any enforcement action during the testing as long as the firm follows the conditions agreed” . 212

* waivers “to particular rules as long as the rule and the exception fall within the FCA’s waiver powers” . 213

FINANCIAL CONDUCT AUTHORITY, “Regulatory Sandbox”. Available at: https://www.fca.org.uk/firms/innovate-209

innovation-hub/regulatory-sandbox. Page consulted on 6 May 2017, 10:04. FINANCIAL CONDUCT AUTHORITY, “Regulatory Sandbox”, p.9.210

FINANCIAL CONDUCT AUTHORITY, “Regulatory Sandbox”, p.11.211

BBVA Research, “Regulatory Sandboxing”, Financial Regulation Outlook, March 2016, p.1.212

Ibidem.213

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* individual guidance on “the interpretation of applicable rules in respect of testing activities the firm maybe carrying out” . 214

These solutions provide legal certainty to the firms during the testing period and allow them to focus on the innovative product/services rather than regulatory risks. This approach clearly fosters the innovation and the entrepreneurial spirit.

In its recommendations, the FCA identified two types of legislative changes that would better address the challenges brought by the FinTech market. The first solution would be to introduce a new “regulated activity of sandboxing”. The FCA believes that the creation of a new sandbox regime that would incorporate new requirements and rules would lead to a more flexible regime . However, the main disadvantage is that firms would still require an authorization in 215

order to be allowed to start testing. This option might neither apply to activities that are not regulated under FSMA’s requirements . The other solution would be to amend the waiver test. 216

The FCA suggests that a modification of the current waiver conditions could make it easier for the FCA to waive its rules for firms in the sandbox. This solution is also correlated to the EU legislation and FSMA’s requirements. However the Brexit will change this situation since the European requirements regarding the FSMA supervision and authorization regimes will not apply any more to firms established in the UK marketplace.

The regulatory sandbox clearly offers a proper framework to both companies willing to test innovative products/services and the supervision authorities to observe the impact of FinTech at a smaller scale. It therefore allows prudential authorities to observe and eventually identify any eventual risks for the financial stability during the testing period. The sandbox program offers considerable learning opportunities for the prudential authorities. The FCA sets a perfect balance between the consumers’ interests, the financial stability and the innovation. Such framework allows firms to test innovation while offering a legal certainty regarding the regulatory risks. The role of the FCA is not limited to a rigid supervision authority but is extended to an assistance function for these innovative businesses. The regulatory sandbox encourages the financial supervision authorities to rethink their role and functions.

C. Cyber financial security The FinTech emergence was accompanied by new types of risks that could threaten the financial stability. Chapter 2 evoked the “too linked to fail” and “too fast to save” risks. The finance’s dependency on computerized systems and new technologies makes it more vulnerable to cyber-security issues. As rightly emphasized by Tom C.W. Lin , “the emergence of the Internet of 217

FINANCIAL CONDUCT AUTHORITY, “Regulatory Sandbox”, p.9.214

Ibid., p.14.215

Ibidem.216

Tom C.W. LIN, “Compliance, Technology, and Modern Finance”, p.172.217

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financial things is also the emergence of the Internet of financial threats”. Firms are facing new types of risks and threats that can be internal or external to the company.

External threats might involve cyber hackers and criminals trying to steal sensitive information while the internal threats and vulnerabilities are related to data breaches made possible by rogue, misguided employees or independent contractor . These threats and vulnerabilities involve at 218

least three key implications as stated by Tom C. Lin : the rising importance of financial 219

cybersecurity, the closer integration of compliance and technology functions, and the human factor in the future of finance. This paper will only focus on the cybersecurity issue.

The cybersecurity has become a major concern for many policymakers as a direct consequence of the rise of technologies and information technologies . The purpose here is to suggest some 220

proposals that could enhance the cybersecurity on the financial marketplace.

Financial Cybersecurity is not an easy topic to address for policymakers since the financial cyberspace operates in a largely privately held technological infrastructure controlled by financial intermediaries . Considering that such private firms that control the cyberspace are 221

mainly motivated by short term profits (see Chapter 2 about the traditional and vertical business model), strong incentives set by national authorities might foster them to implement measures enhancing their cybersecurity systems . In such conditions, a pure market-based approach 222

would be inefficient to set better defences against such dynamic and changing threats . Tax 223

Law could serve this incentive orientated policies and encourage private firms to enhance their cyber defences. The financial technological infrastructure also entails a more concerted work between the public authorities and the private firms . 224

Another solution would be for policymakers to design advanced technological tests to assess the information technology structure . These tests would allow to assess the vulnerabilities and 225

weaknesses of the structure similar to how banking regulators imposed a capital stress on large financial institutions.

Ibid., p.173.218

Ibid., p.175.219

See CCDCOE, “National Cyber Security Framework Manual”, 2012 ; EUROPEAN COMMISSION, “Cyber Security - 220

Report”, February 2015. Tom C.W. LIN, “Financial Weapons of War”, Minnesota Law Review, Vol. 100, 2016, p.1427;, Available at SSRN: 221

https://ssrn.com/abstract=2765010 Tom C.W. LIN, “Financial Weapons of War”, p.1427.222

Joel BRENNER, “America The Vulnerable: Inside The New Threat Matrix of Digital Espionage, Crime and Warfare 223

239 (2011)” in Tom C.W. LIN, “Financial Weapons of War”, p.1428Tom C.W. LIN, “Compliance, Technology, and Modern Finance”, p.176.224

Tom C.W. LIN, “Financial Weapons of War”, p. 1431.225

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Conclusion This thesis analyzed the complexity of the FinTech ecosystem that gathers different parties with diverse interests leaving thereby a complex equation to be solved. Two responses might offer optimal solutions to avoid the disruption of the incumbents whilst encouraging FinTech start up companies.

From a corporate perspective, the incumbents cannot escape from the risk of disruption. The FinTech start up companies are changing the financial nature. The traditional players need to embrace an innovative strategy and try to attract this invaluable asset that makes these start up companies successful: talent. A partnership between the incumbents and the FinTech start up companies such as a corporate venturing strategy or the open innovation model could allow the incumbents to embrace innovation and therefore remain competitive. Technologies such as RegTech could also help the incumbents to easily face their compliance duties.

On the other hand, the policymakers must be vigilant and avoid stringent regulatory frameworks to encompass this new environment at the risk to asphyxiate the innovation pulse. The ideal regulatory framework must set incentives to attract FinTech start up companies and allow them to experience innovation and grow in a safe realm. The Regulatory Sandbox and the Innovation Hub illustrate a proactive and flexible approach. These initiatives offer legal certainty, flexibility and allow the new players to experience new products and services without facing strong regulatory risks. The role of the prudential authorities is more cooperative within this framework and goes beyond the traditional supervision and sanction function. The next step would be for policymakers to set a flexible regulatory framework based on the lessons learned from these proactive initiatives and experiences. This policy shall be reviewed on an annual basis depending on the changes of the FinTech industry that could be observed during the sandboxing experiment.

At the opposite, the EU endorsed a conservative approach characterized by slowness and reactivity. This linear approach is not relevant any more and the final legislative outcome resulting from the preparatory works is likely to be obsolete considering the exponential development of the FinTech industry.

Another consideration is related to cyber financial security and financial stability. At a high tech era, an efficient cyber security policy must be implemented by each State and also at a supranational level to reprimand what appears to be ‘high tech’ crimes that brings new systemic risks. However, something new does not mean that it should be treated differently. Policymakers must be vigilant regarding the potential impact of FinTech on financial stability.

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- WORLD ECONOMIC FORUM, “The Mobile Financial Services Development Report 2011”.

Legislation and recommendations - Directive (EU) 2015/2366 of 25 November 2015 on payment services in the internal market,

amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC.

- Regulation REGULATION (EU) 2015/2365 of 25 November 2015 on transparency of securities financing transactions (SFT) and of reuse and amending Regulation (EU)No 648/2012

- Financial Action Task Force, “40 Recommendations”, October 2003.

Websites - AMF website: http://www.amf-france.org/Acteurs-et-produits/Prestataires-financiers/

FinTech.html?. - DTCC website, http://www.dtcc.com/en/about, - FINANCIAL CONDUCT AUTHORITY website: https://www.fca.org.uk/about/the-fca. Page consulted

on 4th May, 10:28. - SOCIETY of WORLDWIDE INTERBANK FINANCIAL TELECOMMUNCIATIONS, SWIFT History -

https://www.swift.com/about-us/history - The PRUDENTIAL REGULATORY AUTHORITY website: http://www.bankofengland.co.uk/pra/Pages/

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