Regulation: an innovation killer? Not necessarily!

Challenges & Opportunities for the FinTech Hub Europe

Regulation creates legal security and trust for our financial ecosystem. But what does good regulation need? Why is the dialogue between industry and politics becoming more and more important? Which major issues are currently being addressed for the digital financial market?

European Champions - wanted and found? Germany as a digital location has immense potential to produce the long-awaited new champions. Alongside the successful model of small and medium-sized enterprises, digital, scaling business models are establishing themselves and are thus also becoming increasingly important for the overall economic development of the country. This is especially true for fast-growing FinTechs.

However, the successful development of FinTech innovation requires a suitable regulatory framework that understands innovative business models, reduces intra-European fragmentation (catchword: scalability) and has recognised the importance of financial innovation for the real economy and society. In this sense, regulation is never just an - often unloved - necessity, but must always be seen in the light of location-based competition policy.

The Regulator and the Financial Centre - State of Play

Anyone who has studied the coalition agreement of the Ampel-coalition will first read a lot of positive things: "Germany is to become one of the leading locations in Europe for FinTechs, InsurTechs, platforms, neobrokers and all other idea generators," is how the chapter on digital financial services is introduced. The proclamation of the European Tech Champions Initiative - a fund to be managed by the European Innovation Fund with a total volume of 10 billion euros - was one of the first official acts of the government. So far so good? Almost!

On paper, much reads flawlessly, but there are also places that show that financial innovation is not yet sufficiently understood in depth. This can be seen, for example, in the fact that the topic of blockchain is de facto non-existent in the coalition agreement and that the focus in the context of crypto assets is primarily on risk assessment and money laundering (more on this later). This means that we need a closer exchange between political decision-makers, supervisors and market participants. This is where associations like the digital association Bitkom come into play, driving knowledge transfer and providing a platform for politics, industry and society.

The key point: In the end, it must not remain just an exchange. An understanding must be developed in order to create an innovation-promoting and competitive framework in Germany and Europe.

Big planks, big wheels: regulatory principles for the digital financial centre

Three challenges arise for Germany as a digital financial centre:

  • Overcoming boundaries and breaking down silos,
  • Meeting innovation with innovation, and
  • Modernising and digitalising supervision.

Overcoming boundaries and breaking down silos

The primary goal must be to achieve competitiveness, scalability and equal opportunities for all players in the digital finance industry - and to do so on an European scale. There is still too much fragmentation and differences in legislation and supervising practices are still very apparent. This already starts with the topics of eID and KYC and different interpretations within the member states. This means that the scalability of financial innovations is already significantly impeded at the starting point of verifying new customers in a money laundering-compliant manner. A uniform European framework for easy-to-use digital identities must therefore be a key priority for European and German legislators.

With the further development towards an Open Finance Framework through vertical processes (PSD2 Review) and horizontal initiatives (Data Act), there is an opportunity to create a uniform framework for data exchange for all players along the value chain of the financial ecosystem, thus enabling further innovation under fair competitive conditions. This would be a real locational advantage that could be achieved with regulatory measures.

Countering innovation with innovation

Everyone knows the problem: regulatory processes are long. This means that it is not unusual for four years to pass between the publication of a draft by the EU Commission and its implementation, which can often take another 12 to 18 months. This is a long time in which the world of technology continues to change rapidly. While regulation should be launched with foresight, no one knows what the world will look like in four, six or eight years until an act is perhaps revised again.

Moreover, it is essential to understand innovations and then adjust rules rather than transfer existing rules 1:1. We currently see this approach heavily in the context of crypto assets with regard to the implementation of money laundering regulations. Opportunities based on the immutability of the blockchain and the use of chain analysis tools to detect fraudulent behaviour are not considered enough. The crypto industry is already working on standards between central service providers for the secure exchange of personal data relevant to money laundering. For unhosted, i.e. "private" wallets, however, there are impediments on the EU level that could, in the worst case, mean a de facto end for unhosted wallets and thus DeFi applications in Europe.

Modernisation and digitalisation of supervision

The planned modernisation of financial supervision, which must above all result in a stronger digitalisation of processes, must be accelerated. This includes the dismantling of the paper form as well as the use of technology within supervision. This is the only way to reduce bureaucracy at the faster pace promised in the coalition agreement, e.g. for start-ups. Through optimised processes and the use of technological tools, BaFin would have significantly higher capacities to concentrate on the supervision and monitoring of the market. This also includes a stronger examination of the business models of digital market participants, which have different functionalities than incumbents, which should also be reflected in supervisory practice. At the very least, a BaFin branch in Berlin as a tech and FinTech hub would be a first step towards promoting better exchange.

It depends on the execution

The will is as strong as ever and the right understanding on the part of political decision-makers seems to be largely in place. In the end, however, it comes down to concrete measures and implementation that reach the market, because: Regulatory framework conditions are crucial for a successful location policy. The exchange between innovation drivers, politics and supervision is therefore becoming increasingly important, especially as the complexity of the ecosystem increases. It is therefore important that all stakeholders pull together here, in the interest of a positive overall economic development in Europe!

This text first appeared in German on