Home Policy & Governance European supervisory authorities recommend steps to improve ‘innovation facilitators’

European supervisory authorities recommend steps to improve ‘innovation facilitators’

European fintech innovation: the 57-page report examines the operation and use of innovation hubs and regulatory sandboxes across the European Economic Area | Credit: NakNakNak; Pixabay

A report recommending improvements to the operations of innovation hubs and regulatory sandboxes – increasingly used by public authorities across the world to encourage fintech innovation – has been published by three European supervisory authorities.

The ‘Update on the functioning of innovation facilitators – innovation hubs and regulatory sandboxes’ report – the first such analysis for four years – has been compiled by the European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and European Securities and Markets Authority (ESMA).

As of October 2023, there were 41 innovation hubs across the European Economic Area (EEA – the 27 European Union member states, plus Iceland, Liechtenstein and Norway) and 14 regulatory sandboxes, according to the report. Most innovation hubs were established between 2016 and 2019, while most sandboxes were launched between 2020 and 2021. Ireland is among the EU member states planning to introduce a sandbox.

The 57-page analysis assesses how existing innovation hubs and sandboxes have been functioning, and presents recommendations aimed at national competent authorities (NCAs), the three European supervisory authorities (ESAs) themselves and the European Commission to ‘further enhance’ their ‘role and efficiency’.

Among their conclusions, the ESAs propose that the Commission launch what is described as a ‘comprehensive reflection’ on EU strategy to support financial innovation and the operation of ‘innovation facilitators’, in particular sandboxes.

Innovation hubs’ activity: big differences

In respect of innovation hubs, the ESAs write that – overall – they ‘have achieved a certain degree of maturity and that the fintech sector perceives hubs as positively contributing to regulatory and supervisory clarity’.

The report notes significant differences between innovation hubs’ activity levels, with some receiving just ‘1-10’ inquiries per year. Most hubs receive ‘11-50’ inquiries per year while a ‘handful’ receive 100-500 questions per year. One self-reported activity in the range of ‘500-1,000’ inquiries per year.

The ESAs observe that NCAs face various challenges in operating innovation hubs, including the ‘perception of risk of misalignment between the fintech sector’s expectations and the purpose of the hubs’ and NCAs not being able to provide ‘prompt and precise’ responses to companies’ queries.

The ESAs find that the innovation hubs’ main benefits for NCAs are to improve their awareness of new emerging innovations in the financial sector and recognise cases where a reassessment of the relevant regulatory perimeter may be required.

Overall the ESAs observe that ‘all but one’ surveyed NCA running a sandbox consider that their cost/benefit perception justifies their continuation.

That said, the report notes that specific metrics to measure their success or usefulness are typically lacking. ‘As a result, this does not allow NCAs to objectively assess the functioning of their regulatory sandboxes,’ the report states. ‘Looking ahead, some adjustments may be needed to keep regulatory sandboxes attractive for firms and able to respond to the changing needs of the market,’ the ESAs caution.

RELATED ARTICLE EU Digital Finance Platform to map fintech growth and support cross-border testing – an article (11 April 2022) on the launch of a European Commission-hosted website with the ultimate aim of helping private-sector innovators to ‘scale up’ fintech solutions

EU cross-border testing framework: ‘re-evaluation’ due

The ESAs’ previous joint-report spurred the creation of the European Forum for Innovation Facilitators (EFIF) in 2019. This new report, published on 11 December 2023, was compiled on the basis of ‘relevant surveys answered by EFIF members and discussions during EFIF meetings in 2023’, as well as bilateral discussions with NCAs.

Sustaining the theme acknowledging a relative lack of critical analysis, the ESAs observe that ‘only a small number of NCAs actually collect feedback from participants in the activities of innovation facilitators or establish indicators to track their performance,’ adding that ‘as a result of these limitations, the findings mainly reflect the views of the regulatory and supervisory community, and not necessarily of the fintech sector’. The report notes that ‘around one fifth of innovation hubs keep information and activity reports for internal use only’ and ‘the majority of innovation hubs do not have metrics to assess their functioning’.

In respect of regulatory co-operation, the report states that cross-border collaboration ‘seems to work well’ while also acknowledging that ‘there is room for improvement’.

EFIF published a ‘procedural framework for innovation facilitator cross-border testing’ in 2021. ‘The ESAs highlight that actual cross-border activities of regulatory sandboxes have not yet been tested in practice,’ the report states, pointing out that ‘actually, as of now, [no] firms have participated in the EU cross-border testing framework established by EFIF’. The three supervisory authorities recommend ‘re-evaluating’ the framework. As a broader priority, they also recommend formalising an EFIF process to ‘raise co-legislators’ attention’ to issues identified via innovation hubs or sandboxes. 

As a separate point, the report acknowledges the trend towards EU-wide initiatives that include experimentation clauses, or directly promote the establishment of regulatory sandboxes for specific fields. Examples includes the European Blockchain Sandbox, the DLT pilot regime regulation (which allows financial market infrastructure operators to test distributed-ledger technology in the issuance, trading and settlement of tokenised financial instruments) and the relatively high-profile proposed EU Artificial Intelligence (AI) Act, which includes measures to encourage member states to establish AI regulatory sandboxes.

‘While it may be necessary for financial sector regulatory sandboxes to co-ordinate with new sandboxes in other fields, most of the NCAs have not yet formed views on how they plan to coordinate their sandbox activities with those initiatives,’ the report notes. ‘Some NCAs intend to add additional services into the scope of existing financial sector sandboxes, while others expect to have projects in the regulatory sandbox that could start application processes in parallel, for example, to the DLT pilot regime.’

RELATED ARTICLE Sandboxes could ‘amplify problems’: IMF analysis questions many test-spaces’ impact – our news story (11 September 2023) based on an IMF paper titled ‘Institutional Arrangements for Fintech Regulation: Supervisory Monitoring’

IMF analysis: think carefully

A global analysis published by the International Monetary Fund (IMF) last year (2023) urged authorities to think carefully about whether devoting resources to new mechanisms such as sandboxes to help with private-sector engagement is worthwhile, stating that for most authorities existing structures will likely do a better job.

‘There are several ways to strengthen surveillance and respond to the challenges of fintech,’ noted the 58-page ‘Institutional Arrangements for Fintech Regulation: Supervisory Monitoring’ analysis. ‘For most authorities, existing supervisory structures will allow them to effectively monitor new fintech developments and respond to challenges. Using existing resources and infrastructure can allow authorities to monitor new fintech developments and identify risks while saving cost and time on the design and implementation of new structures.’

‘Sandboxes may not be the most effective way for many authorities to monitor fintech developments because they are resource-intensive and costly, and engagement extends to a relatively smaller number of firms over a longer period,’ the report concluded.

It went on to add that ‘sandboxes are not a sensible fix to underlying problems with supervisory structures and could amplify existing problems as well as allow authorities to carry out risk-washing’.

The paper also included a typology of sandboxes, specifying six types: product-testing sandboxes; policy sandboxes; digital sandboxes; thematic sandboxes; cross-sector sandboxes; and cross-border sandboxes.

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