Banking Risk in the Digital AgeMay 2016

parker-fitzgerald.comQuarterly Outlook

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Scott vincent ceo & Founder, parker fitzgeraldI’m delighted to introduce Parker Fitzgerald’s Quarterly Outlook. This is the first in a regular series of forward-looking reports, examining some of the key challenges that the financial services sector faces as it continues to evolve in a world of rapid technological, operational and regulatory change.

These reports will provide insights from our

senior team of economists, former regulators

and technical experts and are underpinned

by research from our recently announced

strategic partnership with University College

London (UCL).

This first Quarterly Outlook focuses on the

emergence of FinTech and the impact of digital

transformation on both the banking sector and

the risk management function. In this report we

examine how the risk profile of organisations

changes as they adopt new digital business

models and the evolving regulatory landscape

in response to innovation within the industry.

This includes viewpoints from leading

economist Dr Gerard Lyons, Paul Rippon,

the deputy CEO of the new challenger bank,

Mondo, Dr Colin Lawrence, former regulator

and adviser to the Bank of England, and

Michael Soppitt, Digital Risk specialist.

I hope you enjoy these insights and viewpoints

and I look forward to sharing further Quarterly Outlook reports later in the year.

Scott Vincent CEO and founder, Parker Fitzgerald

Digital risk needs to be a priority for boards, regulators and policy makers

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CALCULATING THE ECONOMIC IMPACT OF TECHNOLOGYFor the bulk of the post crisis era, regulation has dominated the banking and wider financial services sector environment. It remains important, but now there is a new central issue to focus attention on: technology and the digital world.

While technology has always had an influence

on banking, the current phase is dramatically

different, in both its scale and pace of change.

The banking sector is in the early stages of a

digital transformation.

The combination of technology and digital has

the potential to change everything. It provides

access to new products and services and

changes the way traditional things are done.

In an industry like banking and finance, where

the barriers to entry can sometimes be high,

this is transformative and disruptive at the

same time.

The digital economy is estimated to be about

5.3% of global GDP and accounts for 12.4%

in the UK1, making it the largest internet

economy in the world, followed by South

Korea at 8% of GDP and China at 6.9%. The

average in the rest of the EU is 5.7%. While

the biggest use in the UK is for online retail,

the willingness of people here to embrace

the digital economy suggests it may be able

to make greater inroads elsewhere, such

as finance. Perhaps therefore it is also no

surprise that the UK, led by London, is at the

forefront of the ‘FinTech’ revolution, combining

financial expertise with technical innovation.

1 Boston Consulting

The banking sector is in the early stages of a digital transformation

12.4%Digital economy as proportion of UK GDP

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For banks, the biggest challenge may be that

digital allows multiple competitors to emerge in

different areas. From a regulatory perspective

the issue is what impact this has on the stability

of the financial system. Provided regulators

do not protect the incumbent with too high

a regulatory barrier to new entrants, while

safeguarding customers through a minimum

regulatory threshold, then a larger number of

finance providers should help the stability of

the system. Thus it is to be encouraged.

It will undoubtedly destroy some of the old ways

of doing things, while at the same time forcing

banks and others to reinvent themselves in

the face of new products and new, smaller,

more nimble competition. There are a number

of areas where these disruptive impacts are

likely to be felt, including the following:

● Sustainability of profits and earnings for incumbents: New entrants, including tech

companies and big internet providers have been

enviously eyeing profitable parts of banking,

including the payments system (which is guarded

closely by the banks, as access to this would

provide a rich vein of information on how people

receive and spend money that could be used in

many other ways and is estimated to account

for between 37% to 40% of bank revenues).

● Job losses: Staffing levels in European

and US banks are unlikely to return to

their pre-crisis peak and further losses are

expected as a result of competitive pressures

and branch closures brought about through

digital transformation. Some financial services,

however, may be ‘distinctive’, to use the word

of Deputy Governor Andrew Bailey, meaning

that the customer would find it hard to replace

without an unacceptable loss and cost.

● Tax receipts: The financial services sector

is a major and vital source of public revenues,

particularly for the UK where the tax contribution

totalled £66.5 billion in 2015, representing 11%

of total tax receipts2. This total incorporates

contributions through corporation tax, the

bank levy, VAT and employment taxes. Any

significant change to banks’ profitability and

staffing levels is likely to have a major impact

on public finances and will represent a serious

challenge to public policy makers.

● New data challenges: In finance, assessing

risks properly is key and information is central

to this. Perhaps therefore it is no surprise

that financial services allocate a greater

proportion of spending to IT, followed by the

telecommunications industry. Information is

king, especially if used in the right way. Think

of the future potential application to banking

of artificial intelligence software that exhibits

human-like intelligence.

It may help provide new, innovative solutions

to, as yet, unmet client demands. Banks will

not only need to retain this edge in information

access, but now they will also need to think

more about how to use it, because of the advent

of big data, and also about how to store it

because of the regulatory environment. This will

force banks to allocate more resources to the

storage and analysis of client and market data.

2 City of London Corporation Research Report: Total Tax Contribution of UK Financial Services Eighth Edition

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Responding to these disruptive effects will be

a major challenge. Where should banks invest

their resources, as the technology space

is vast and fast moving? Surveys of where

financial firms wish to invest in the digital and

technology area suggest mobile technology

tops the list, and in a survey by Oxford

Economics this was followed by business

intelligence, cloud computing, collaborative

technologies, telepresence technology and

only then social media, although this can help

bring brand awareness and customer loyalty.

Of course, one size will not fit all. Not just

in terms of banks, but also across different

product areas. There are some parts of the

financial industry where costs and profit

margins are high, and in which technology

can be the catalyst for change, increasing

competition, lowering margins, ensuring greater

productivity and lower costs for the consumer.

Examples might include retail banking and

discretionary wealth management.

An age old adage has been to cut out the middle

man. Seen in other industries it is now impacting

finance. Digital is allowing new platforms to

emerge across a host of areas, such as peer-to-

peer lending. There is increased business risk.

Banks should identify the areas most at risk, as

well as those where there is a competitive edge

that might be exploitable by early movers.

While user-friendly client systems and increased

automation bring change, they also raise

issues such as access to information and the

security of financial transactions. This is already

evident in terms of the increased attention on

cyber security. Regulations, too, will change,

as technology forces the business model to

change. An important part of the new supervisory

approach is business model analysis.

Banks should embrace change. If positioned

correctly from a strategic perspective, greater

technology should provide banks with an

opportunity to transform financial services.

Dr Gerard Lyons is a senior

adviser to Parker Fitzgerald and

Chief Economic Adviser to Boris

Johnson, the Mayor of London.

Understanding where banks should invest their resources is critical, given the pace of technological advancements is complex

For banks, the biggest challenge may be that digital allows multiple competitors to emerge in different areas

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A CHALLENGER BANK’S PERSPECTIVE ON THE FINTECH REVOLUTIONPaul Rippon explains the opportunities and risks arising from launching a new UK digital bank, Mondo, which will provide customers with personal current accounts on their smartphones.

The concept of Mondo was developed by

a group of individuals who felt that current

technological innovation and greater digital

connectivity could transform retail banking and

address some of the longstanding frustrations

that customers experience with their personal

current accounts.

In a digital world of Uber, Netflix and Facebook,

personal banking feels remarkably analogue

and unresponsive in comparison. For instance,

the management of your current account can

involve long and inconvenient phone calls or

queues in branches, transactions can take days

to appear on statements and obtaining an

up-to-date balance is often difficult.

Both high street and challenger banks are

responding to this challenge and many providers

have moved to incorporate more digital services

in retail banking. We feel, however, that there are

limitations to models which rely on integrating

digital banking with legacy IT systems or from

purchasing off-the-shelf packages.

Here at Mondo, we are building a core digital

banking system from scratch. This approach

allows us to utilise the latest modern technology

and put all our focus into designing a product

that caters to the needs of today’s consumers.

We plan to launch later this year on obtaining

our full banking licence, which is currently

being considered by the PRA and FCA.

We are building a core digital banking system from scratch

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Of course, launching a new retail bank into

the marketplace is not free of challenges or

risk. Arguably the number one challenge for

us is to ensure that we develop a product

that consumers actually want and would

use. Mondo has therefore put considerable

focus and energy into the design and testing,

including the process of receiving feedback of

our ‘Alpha’ version ahead of our full launch.

We believe the importance of this process

reflects broader trends in the sector. One of

the major ways that technological innovation

or FinTech is making an impact, is through

the disaggregation and disintermediation of

financial services. Over the past few years,

you have seen that the most successful new

entrants in financial services (for example,

FundingCircle or Nutmeg) are those that focus

on doing one thing really well. Mondo’s focus

is to ensure that our ‘one thing’ – the provision

of a smartphone-based personal current

account – is as good as possible before

we consider expanding. This represents a

significant opportunity and challenge for us.

As a new market entrant, we face a range of

other operational and business risks. As a

mobile-only banking provider, cyber-security is

something we take incredibly seriously. Mondo

has invested heavily in internal expertise to

ensure the robustness of our systems, which

has been subsequently validated by external

parties. As well as systems security, there is

also the issue of customer security. For this,

we have developed new features to combat

fraud and ID theft, such as a phone app to

freeze and unfreeze your account, and we will

continue to ensure that we are on top of any

emerging cyber threats to provide the highest

levels of fraud and identity protection.

As a prospective bank, we are subject to a

high level of prudential regulations and the

usual risk management concerns in respect

of capital and liquidity. We are in very strong

position in terms of capital. To date, our capital

raising has been incredibly successful, with

our latest crowdfunding campaign raising £1

million in just 96 seconds. In terms of liquidity,

we are adopting a conservative approach to

managing our assets and liabilities.

The most successful new entrants are those that focus on doing one thing really well

£1M/96seconds

Capital raised by crowdfunding in just

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Our lending is limited to the provision of

customer overdrafts, with the rest of our deposits

being placed with the Bank of England. We

have the advantage of low operational costs,

with no significant overheads associated with

an expensive branch network, which means we

do not have to participate in high risk lending.

Obtaining a banking licence is a significant

undertaking that we take incredibly seriously and

so far we have completed the ‘pre-application’

stage and submitted our banking licence. There

are undoubtedly, and understandably, barriers

to entry for prospective new challengers in

the retail banking sector, whether they are

considered FinTech or conventional.

Despite these risks and challenges, there

are many reasons to be very excited about

the opportunities ahead for Mondo and those

introducing technological innovation into

banking. The digitalisation of financial services

and the emergence of FinTech has the potential

to completely transform the sector on a global

basis. Much of this innovation is currently taking

place in the UK and, in particular, London.

From Mondo’s perspective, being based in

London offers unparalleled advantages due

to its position as a global financial centre, its

regulatory and market infrastructure and its

ability to attract the brightest talent.

Perhaps one of the most exciting aspects of

Mondo’s product offering is that it is completely

scalable. While we are very much focused on the

UK market at present, there may be opportunities

to expand to Europe and elsewhere in future.

We consider this ‘scalability’ to be an important

aspect of FinTech and we fully expect a ‘Google

of banking’ to emerge at some point in future...

and naturally we hope it is us.

This will of course depend on effective

coordination of international financial

regulations and removal of cross-border

restrictions in banking and financial services.

We would encourage policy makers to provide

more leadership and support for UK firms in

order to ensure these opportunities are seized.

Paul Rippon is Deputy CEO of

Mondo, a new UK digital bank

www.getmondo.co.uk

The digitisation of financial services and the emergence of FinTech has the potential to completely transform the sector on a global basis

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WHAT DOES THE FINTECH REVOLUTION MEAN for THE RISK PROFILE OF BANKS?

1. Digital DisruptionInvestment in financial technology (FinTech)

has grown exponentially from just $2 billion

in 2010 to $19 billion in 20151. At the current

rate of growth this could exceed $100bn within

the next 10 years. Yet so far only 1% of the

consumer banking wallet has been disrupted

by new digital banking models2. We estimate

that the loss of traditional banking revenue

through digital disruption will rise to 30% by

2026. When compared with other digitally

disrupted industries such as music and travel

booking, this figure could easily exceed 50%

before it plateaus.

To date, nearly three quarters of FinTech

investment has been focused on user

experience, driven by a consumer demand for

convenience and connectivity. The change in

consumer behaviour, coupled with increasing

pressure on profitability, has also led to

incumbents replacing much of their physical

assets with automation. This has resulted in an

industry-wide reduction of full time employees

(FTE) by c.25% since the global economic

crisis3. Digital disruption will only continue to

facilitate this trend. We predict FTE figures to

fall by a further 30% over the next 10 years.

1 CB Insights: The Pulse of FinTech in Review, March 2016 2 Citi GPS: Digital Disruption, How FinTech is Forcing Banking to Tipping Point, March 2016 3 Business Insider: UK Banks Cut Jobs, July 2015

$19bGlobal FinTech investment in 2015

$100+bGlobal FinTech investment expected by 2020

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Operational rationalisation at this scale has

already been achieved across much of the

Nordic region. Operating with a similar cost

to income ratio, the European banking system

could add 40% to pre-tax profits4. Yet even

this addition to the bottom line would not be

sufficient to counter the potential revenue loss

through disintermediation.

To stem the threat to revenue, banks must

become innovative before FinTech companies

get the scale to truly compete. Banks have

responded promptly to the challenge,

developing various strategies to leverage

process automation, partner ecosystems,

outsourcing and IT agility to bring innovative

services to market at speed.

Many firms have also begun working directly

with new start-ups and FinTech providers

through so-called ‘Innovation Labs’. Through

collaborations, banks hope to control change

to ensure they are the net winners of digital

disruption. In this new interconnected and

modular financial economy, services will no be

longer delivered by just one organisation, but

by many different firms operating across the

value chain.

This new look banking enterprise requires

a review of enterprise risk. Technology

integration and increased connectivity

will expose firms to a new set of threats.

Managing these risks will require a detailed

understanding of constituent technologies

such mobile, cloud, security and big data.

This must be combined with a broad

knowledge of business processes, regulatory

issues and risk management. The mandate

and skillset is distinctly different from the

traditional roles of Chief Risk Officer (CRO) or

Chief Information Security Officer (CISO) and

in response to the skills gap, we will see the

rise of the Digital Risk Officer (DRO). By 2017

a third of all organisations will have a DRO

responsible at an executive level for managing

the risks across the digital business5.

So what are the challenges the DRO will need

to bring to the board?

4 Citi GPS: Digital Disruption, How FinTech is Forcing Banking to Tipping Point, March 20155 Gartner: Digital Business Innovation Risk Will Bring About the Rise of the Digital Risk Officer, June 2014

Banks must become innovative before FinTech companies get the scale to truly compete

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2. Strategic Risks 3. Financial RisksSelecting the right business model is key. From

outsourcing, to technology and partnership

selection, an evaluation of the benefits and

risks is required. Whilst on the one hand

outsourcing may limit costs, provide access

to skilled resource and enable flexibility and

agility, it also brings the challenge of integration,

control and third party risk management. Firms

will also need to assess their digital strategy

against more than 250,000 pages of new

regulation and legislation to ensure a viable

and sustainable digital operating model.

Reputational risk will be closely coupled with

these decisions, from ensuring regulatory

compliance to selecting complementary

partnerships. New external factors, such as

social media, also pose a reputational risk.

Twitter has been shown to be a powerful

predictor of stock market sentiment and

individual Tweets can significantly impact

stock price values6.

In 2013 the business magnate Carl Icahn

announced his Apple position over Twitter,

causing the Apple stock to rise $17bn in market

capitalisation within minutes7. In 2015 Hilary

Clinton vowed to take on the pharmaceutical

industry, which sent the 144 member Nasdaq

Biotechnology Index down 4.7%8.

The financial risks of becoming a digital

enterprise are significant and the adequacy of

a firms’ IT architecture to support the operating

model will be key. Over recent years RBS,

Barclays, the Bank of England and most recently

HSBC, have all been subject to major IT outages.

In 2014 RBS was fined £56m by the FCA for

the incident, with the cost of remediation also

expected to stretch into the millions9. Incidents

such as these not only have a financial impact

but strengthen the position of new entrants

who offer a counterpoint to traditional banking.

Banks are already making large investments in

new IT infrastructure. In 2017, European banks

are expected to spend 21.9% of their IT budget

on new investments, this compares to just 13.7%

four years ago10. Transitioning legacy platforms to

new infrastructure is in itself fraught with risk and

will require careful consideration and planning.

Digital architectures, once implemented, also

create new financial risks that must be managed.

The speed of data transmission, the ease of

service switching, straight-through processing

and increased connectivity, will all impact the

bank’s ability to manage its capital position

and control liquidity. A run on the bank, like

that seen during the financial crisis, could

happen in minutes without the right controls.

This risk threatens not just the firm, but the

industry and the financial system itself.Transitioning legacy platforms will require careful consideration and planning

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4. Operational RisksThe impact of digital transformation for

operational risk will be significant. As firms

transform, it will become increasingly important

to avoid mismatches between the vulnerabilities

of the sector, the business model and the risk

management capability. Digital transformation

shifts the balance from traditional operational

risks to new risk types such as cyber security,

digital conduct and fraud. These risks build on

traditional risk definitions and require firms to

evolve their risk framework to improve controls

and policies, governance and culture. Digital

disruption is already impacting fraud, with the

cost of losses through mobile channels costing

companies 3% of revenue on average11 and by

2018 mobile is expected to account for 54% of

total online sales, an increase of 184%12.

Compliance programmes such as PCI and PII

will continue to be important, as will the use of

analytics and information sharing services such

as the Fraud Intelligence Sharing System (FISS)

provided by the UK Cards Association. The

growth of the digital ecosystem will continue to

work in favour of the fraudster. Social media and

an exponentially growing volume of data, creates

rich pools of information for criminals to utilise.

In the two years to 2015, the cost of social

engineering fraud has already doubled to $1bn

as a result13. Interconnectivity will also increase

the attack surface of the digital enterprise – a

major challenge for organisational security.

Today’s attack strategies employ patient multi-

step processes that blend social engineering,

exploits, malware and evasion into on-going

co-ordinated attacks.

The JP Morgan breach in 2014 is but one

example, resulting in the compromise of

84 million accounts. Mitigating this type of

threat requires more than an IT solution. It

encompasses issues of management and

ownership across the IT, operational and third

party domains. Understanding anomalous

user behaviour will also be critical, with 75% of

security risk attributed to just 1% of users. To

combat this the DRO will need to rely on new

advanced analytical tools. Risk and regulatory

technology (RegTech) such as this will become

increasingly important. Unlike FinTech, RegTech

is not in competition with the banks’ supply

chain but integral to it – helping to mitigate the

unique risks that digital disruption creates.

As well as protecting the bank, the DRO will also

need ensure that technology-led improvements

do not adversely impact the customer. The FCA

already requires firms to identify consumer biases

and avoid taking advantage of them. In a digital

world, customer biases can be exacerbated

by the ‘framing effect’ in which people react

differently depending on how information is

presented. Banks must therefore analyse how

customer biases impact digital decision making.

Furthermore, digital environments change

the paradigm of financial conduct, but once

understood can also enhance conduct risk

mitigation. Each bias is predictable and their

drivers are known, so it is possible to design

digital channels that avoid consumer bias and

to adapt monitoring mechanisms so they can

detect when consumer bias is a problem.

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ConclusionPolitical, economic and regulatory ambition

will ensure that digital disruption is here to

stay. In August 2014, the Chancellor of the

Exchequer, George Osborne, announced the

UK Government’s goal to make the UK the

‘global capital of FinTech’. The FCA, through

Project Innovate, is actively addressing many

of the regulatory barriers to digital innovation.

This has been supported by new regulatory

policy such PSD II, XS2A and legislation from

the European Commission aimed at creating

a Digital Single Market.

For incumbents, digital transformation will be

critical for survival, but managing the digital

risk will be critical for success. Successful

firms will need to operate alongside new

FinTech, service providers and suppliers of

capital and infrastructure. This will create new

sets of risks that extend across the strategic,

financial, operational and regulatory domains.

To ensure sustainability of earnings and return

on equity, firms will need to proactively identify

these risks and develop appropriate mitigation

strategies. These challenges will extend

beyond the historical experience of many risk

practitioners and will require a fundamental

upskilling across the business, including

new board level representation to provide a

consistent and unified approach to digital risk.

For those organisations that overcome these

challenges, the opportunity is significant. It will

not be possible to generate the quantum of

pre-crisis profits, however through optimisation

and by limiting the impact of disintermediation,

we estimate that European banks could add

40% to their pre-tax profits in the next 5 years.

Michael Soppitt is a Director

within Parker Fitzgerald’s Global

Digital Practice.

6 Business Insider: The ECB says Twitter can Predict the Stock Market, July 20157 Forbes: Does Social Media Affect Capital Market, September 20138 Bloomberg: Clinton’s Tweet on High Drug Prices Sends Biotech Stocks Down, Sep 20159 FCA: FCA Fines RBS, Natwest and Ulster Bank Ltd £42 million for IT Failures, Nov 201410 Celent: IT Spending in Banking, A Global Perspective, February 201511 Pymnts.com: Rising Mobile Commerce Fraud Costing Retailers, February 201512 Verifi: Mobile Channels Risk. Booming M-Commerce Comes with Elevated Risk13 BBC: Vishing and Smishing: The Risk of Social Engineering Fraud, January 2016

Digital transformation will be critical for survival, but managing the digital risk will be critical for success

40%Potential addition to European banking pre-tax profits in the next 5 years

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DIGITAL INNOVATION: THE REGULATORY HORIZONWhile financial regulators often struggle to keep pace with rapid technological change, it is clear that innovations in financial technology and the growth of FinTech are increasingly on the radar of global and national regulators.

This comes at a time when they seek to

manage concerns about financial stability,

payment infrastructures, cyber security, data

protection, privacy and wider conduct risks.

It is clear, however, that there is currently no

global comprehensive regulatory framework

in place for the digital revolution, with many

international regulators still learning about

FinTech and how innovation impacts on

financial stability and benefits consumers.

Some initiatives are very focused on the

FinTech sector itself, such as the FSB’s

consideration of financial stability ramifications

and the FCA’s initiative to explore how FinTech

works in a sandbox. Other regulators, such

as the OCC, are more focused on linking any

digital transformation with a broader scope of

financial services innovation which might or

might not involve FinTech.

It is not desirable for any financial institution to invest heavily in any digital infrastructure without ensuring that it is consistent with the EU regulatory guidelines

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Some key current and future regulatory

developments are illustrated below:

1. The Actions and Intentions of the Regulators

• Financial Stability Board (FSB) Measures:

In February, the Financial Stability Board (FSB),

led by Mark Carney, announced that they

are looking at the potential financial stability

implications of emerging financial technology

and ensuring that global regulatory frameworks

can manage any systemic risks that may arise

from technological advancements. The FSB are

expected to outline further details on this shortly.

• FCA Project Innovate and Regulatory Sandbox:

Given the UK Government’s desire for the

UK and London to be the leading FinTech

centre in the world, it has launched initiatives

to incorporate the digital financial sector into

the legislative and regulatory framework.

The FCA’s Project Innovate and Regulatory

Sandbox are attempts to provide new FinTech

companies with sufficient support to achieve

regulatory authorisation.

• HKMA FinTech Facilitation Office (FCO):

FinTech is driving innovation in financial services

globally and changing the nature of commerce

and end-user expectations for payments and

financial services. And in order to support the

sustainable development of the FinTech industry

in Hong Kong and to keep the public confidence

in FinTech services and the banking system, it

is crucial for the banking sector to maintain a

high level of cyber security and data security.

In terms of regulatory compliance, there is a

significant amount of legislation in place or

currently being developed at EU level. The

EU has implemented critical frameworks

for the adoption of digital markets and

payment systems. PDS2 is the DNA of the

digital payments directive, the Single Digital

Market of the EU sets out three pillars on the

implementation of the entire digital market

whilst MIFID II is focused on securities trading

and will set up compliance frameworks on

activities including High Frequency Trading

and the transparency of Dark Pools. Finally,

the EU Data Protection Act is focused primarily

on privacy issues.

It is, therefore, not desirable for any financial

institution to invest heavily in any digital

infrastructure without ensuring that it is

consistent with the EU regulatory guidelines.

Given the rapid pace of technological change

and the process of learning by international

regulators with regards the potential impacts of

digital innovation, the precise future regulatory

landscape will be difficult to predict. Banks

and financial firms, however, should have

appropriate digital risk strategy and control

systems in place, thereby ensuring they are well

positioned for current and future regulations.

This will mean that all aspects of operations

comply with sensible standard risk practice,

such as good governance, transparency,

disclosure, flexibility and efficiency.

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• Office of the Comptroller and Currency (OCC):

In a document advocating safe financial

services innovation (March 2016), the OCC

includes digital-based products as one of

many innovations in lending and security

markets. The key requirement is effective risk

management and control frameworks;

‘At the Office of the Comptroller of the Currency

(OCC), we are making certain that institutions

with federal charters have a regulatory

framework that is receptive to responsible

innovation along with the supervision that

supports it.’

2. Digital Compliance

PSD2/XS2A:

The Payment Services Directive II defines the

architecture of the payment systems in the EU by

enhancing consumer protection, introducing strict

security requirements and promoting innovation.

Key Considerations:

• New rules designed to open up access of

payment account information to Third Party

Providers (TPPs). These types of providers,

which have already offered services to

consumers for some time, without being

regulated, are defined and regulated by PSD II.

• Customers are allowed to give permission

to retailers to use their bank details. This

direct connection between retailers and banks

is enabled by an Application Programming

Interface (API) for which the European

Banking Authority (EBA) has been given

the responsibility for defining the Regulatory

Technical Standards (RTS).

• Prohibition to use the same payment

instrument within more than one limited

network or to acquire an unlimited number of

goods and services.

• ‘One-leg’ transactions (where the payment

service provider of either the payer or the payee

is outside the EEA) and transactions in any

currency (not just EU Member States currencies)

come under regulations relating to transparency

and the supply of information to users.

• The rules introduce and define the concept of

‘stronger customer authentication’ and require

Payment Services Providers to apply strong

customer authentication when accessing their

online account or initiating a payment transaction.

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MIFID II:

The delayed Markets in Financial Instruments

Directive II (MIFID II) is a comprehensive piece

of financial services legislation, extending

transparency and competition in Financial

Markets and especially trading activities. This

looks set to impact on technological innovations

in financial markets, as the Directive contains

provisions to regulate high-frequency algorithmic

trading and dark pools, by placing effective

systems and risk controls to ensure its trading

systems are resilient and fair.

Network and Information Security Directive:

The European Parliament and the Council

reached an agreement on December 2015 (still

to be finalised) on the Commission’s proposed

measures to increase cyber security in the EU.

This new Directive is the first piece of European

legislation on cyber security aiming to make

digital environment more trustworthy. Under

this regulatory initiative, Member States are

required to adopt a national strategy that sets

out concrete policy and regulatory measures

to maintain a level of network and information

security. This includes designating a national

competent authority for information security.

Dr Colin Lawrence is Head

of Strategy & Research at

Parker Fitzgerald.

Single Digital Market:

This is an EU initiative, aimed at removing

the complexity and multiplicity of current EU

regulations creating a single digital market and

enable cross-border e-commerce to flourish.

The Digital strategy was adopted on 6 May

2015 and includes 16 initiatives to be delivered

by the end of 2016 based on 3 Pillars:

• Pillar I: Better access for consumers and

businesses to digital goods and services

across Europe.

• Pillar II: Creating the right conditions and

a level playing field for digital networks and

innovative services to flourish.

• Pillar III: Maximising the growth potential of

the digital economy.

EU Data Protection Regulations:

The key theme of this regulation agreed by the

EU at the end of 2015 is to ensure:

• Privacy

• The ‘right to be forgotten’

• The design of monitoring and control systems

to cope with burgeoning innovation such as big

data usage with predictive analytics.

Indeed, each firm must perform a ‘Privacy

Impact Assessment’ which is a design of a

framework to ensure that the intention of usage

of data pertaining to privacy is not altered

(i.e. with predictive analytics). In the event of

non-compliance the new regulations include

provisions for fining companies up to 20 million

Euros or 4% of their total global annual revenue.

17

About the authors

Dr Gerard Lyons is a senior advisor to

Parker Fitzgerald, and is a member of the

Advisor Board. Since January 2013 he

has been the Chief Economic Advisor to

Boris Johnson, the Mayor of London. Before that he spent

27 years in senior roles in The City, at Chase Manhattan,

Swiss Bank Corporation, DKB International and at

Standard Chartered. His publications include The Europe

Report: A Win-Win Situation (2014), London: The Global

Powerhouse (2016) and The Consolations of Economics,

which was a Daily Telegraph Book of the Year and

released in paperback by Faber & Faber (2015). He has

testified to committees of the US Senate and Congress

and of both Houses of the UK Parliament, and has spoken

at the EU-China Forum in Beijing, as well as at other

international fora, including the Institute of International

Finance, and at many high profile events in the City.

Paul Rippon is co-founder and Deputy

CEO of Mondo. A banker, entrepreneur

and learning coach, Paul has over 23

years’ experience working in the UK and

Ireland’s financial sector across six banks and building

societies. He has held a variety of roles, covering most

aspects of retail banking in particular risk and operations.

As an entrepreneur, he has co-founded businesses across

agriculture, manufacturing and digital services. Paul has an

MBA, is a qualified banker holding the ACIB and is a Fellow

of the Chartered Institute of Bankers. For the past 14 years

he has coached hundreds of students at the ifs University

College across a variety of subjects, most recently for the

MSc in Banking Practice and Management.

Michael Soppitt is a Director within Parker

Fitzgerald’s Global Digital practice. He

has over 15 years’ experience advising

leading financial institutions on technology

strategy relating to cyber-security, data privacy and fraud

analytics. Michael’s primary mandate is to help clients

adapt their risk management capabilities to support new

digital business models. This includes how new technology

can be leveraged to increase the efficiency and integrity of

the risk management function.

Prior to joining Parker Fitzgerald, Michael held several

leadership roles at Santander, Lloyds Banking Group and

American Express. Michael holds an MSc in human-centred

computer systems and a BSc in neuroscience from the

University of Sussex and is a visiting lecturer at Warwick

University on the topic of Digital Risk.

Dr Colin Lawrence is Head of Strategy &

Research at Parker Fitzgerald, overseeing

the firms’ Strategy and Research practice.

He is also the Chairman of Parker

Fitzgerald’s Global Regulatory Network. A recognised

expert in all areas of financial risk management, Colin

has more than 30 years’ experience in financial services

and strategy consulting. From 2008 to 2013 Colin was the

Director of the Risk Specialist Division at the Prudential

Regulatory Authority (PRA), and senior adviser to the

Deputy Governor of the Bank of England on a number

of systemic issues. Additionally, Colin has held senior

positions in academia (Columbia University, Cass Business

School, City University of London) and was formerly

the Vice-Chairman of the International Professional

Risk Association, PRMIA. Colin holds a BA and MA in

Economics from The Hebrew University in Jerusalem,

and a PhD in Economics from the University of Chicago.

About Parker Fitzgerald

Parker Fitzgerald is a specialist management

consultancy focused exclusively within the

finance sector.

The firm provides strategic advice, assurance

and consulting solutions to the world’s leading

financial institutions, in all areas of risk

management, regulation and financial technology,

leveraging a global network of senior industry

practitioners and recognised technical experts.

Additionally, Parker Fitzgerald reports on various

matters for regulatory authorities and central

banks in the UK, Europe and US.

Disclaimer The information contained in this document has been compiled by Parker Fitzgerald and includes material which may have been obtained

from information provided by various sources and discussions with management but has not been verified or audited. This document also

contains confidential material proprietary to Parker Fitzgerald. Except in the general context of evaluating our capabilities, no reliance may

be placed for any purposes whatsoever on the contents of this document or on its completeness. No representation or warranty, express

or implied, is given and no responsibility or liability is or will be accepted by or on behalf of Parker Fitzgerald or by any of its partners,

members, employees, agents or any other person as to the accuracy, completeness or correctness of the information contained in this

document or any other oral information made available and any such liability is expressly disclaimed.

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