Success rate of the ‘nanny state’ approach in consumer protection and financial system stabilisation regulation – does it work?

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Report on the above session presented at the IBA Annual Conference 2020, via Zoom 5 November 2020

Alfred Page
Borden Ladner Gervais, Toronto
apage@blg.com  

Judit Budai
Szecskay Attorneys at Law, Budapest
judit.budai@szecskay.com

Committee(s)

Financial Services Section (Lead)

Capital Markets Forum

Banking Law Committee

Insurance Committee

Asset Management and Investment Funds Committee

Securities Law Committee

Session/Workshop Chair

Alfred Page  Borden Ladner Gervais, Toronto and IBA LPD Council Member and Financial Services Section Liaison Officer

Speakers

Alejandra Naughton  Grupo Supervielle, Buenos Aires

Alix d’Anglejan-Chatillon  Stikeman Elliott, Montreal and Diversity and Inclusion Officer, IBA Asset Management and Investment Funds Committee

Avimukt Dar  IndusLaw, New Delhi

Judit Budai  Szecskay Attorneys at Law, Budapest and Senior Vice Chair, IBA Securities Law Committee

Massimiliano Danusso  BonelliErede, London and Conference Quality Officer, IBA Capital Markets Forum

The session employed a discussion-style format to ensure that the panellists could engage in a lively and dynamic dialogue. The five expert panellists shared perspectives and comments on the following four topics: the current state of effectiveness of regulators regarding consumer protection in capital and financial markets; using technology to protect the markets and control abuse; diving into financial literacy; and data gate-keepers.

Current state of effectiveness of regulators regarding consumer protection in capital and financial markets

Alfred Page set the scene. Regulatory intervention to date has generally been balanced against the risk of excessive protections for consumers and non-financial parties. Financial services businesses and their business counterparts have both experienced unfair results and disinformation. Digital asset regulation has been sporadic, and spread across many regulators and many jurisdictions, even though the use and functionality of the assets are a global phenomenon. This has led to forum shopping (for example, there have been initial coin offerings in Switzerland and Gibraltar, but these are prohibited in many other jurisdictions; the United States Securities and Exchange Commission has repeatedly refused to permit Bitcoin exchange-traded funds, yet a Canadian sponsor took staff regulators to a hearing before the Ontario Securities Commission, and won).

Massimiliano Danusso pointed out that sporadic regulatory coverage and inconsistent judicial approach also create governing law shopping issues, for example, over-the-counter derivatives being governed by English law, and also forum shopping issues. He also highlighted that, in continental Europe, consumer protection is often expanded by case law beyond that which the applicable laws effectively state from a linguistic point of view.

This ‘exasperated nanny’ approach creates dangers as it introduces an element of great uncertainty in a world (that of financial services) that requires utmost certainty. European courts may attempt to protect counterparties, sometime showing very little attention to the provisions of the contractual agreement between the parties. He cited a recent Italian Supreme Court case^[1] to support that view. In London, the courts have a completely different approach, giving paramount importance to the contractual provisions agreed between the parties.

Avimukt Dar stated that internet transactions are generally more visible than offline transactions since every transaction is traceable and on the books. Ironically, because of such visibility, he stated that regulatory scrutiny is also greater in digital transactions in India.

Within the context of crypto assets, Dar mentioned that, in India, there was a benign neglect of the concept of cryptocurrency initially, and the Reserve Bank of India prevented the banks from dealing in crypto. However, this was eventually set aside by the Supreme Court of India. At present, the Reserve Bank of India, as well as the Government of India, continue to project that they will soon propose a framework to regulate cryptocurrency in India.

Judit Budai added that due to the online availability of various investment services, and when interest rates are low, consumer demand moves towards risky investment products, such as options and futures. To save consumers from themselves, and limit possible losses, particularly in a crisis, and disincentivise service providers to launch overly complex products to consumers, via MiFIR transaction reporting, the European Union introduced the power of product intervention measures as of 3 January 2018 to the European Securities and Markets Authority and the European Banking Authority as well as EU Member States' financial supervisory authorities, which means that they may impose temporary or permanent limits on the retail distribution of risky investment products. In 2018 and also in 2020, national authorities in the EU effectively applied such power and restricted the distribution by service providers of binary options and contracts for differences to retail investors. Within the context of crypto assets, Budai also mentioned that the EU digital finance package, announced in September 2020 by the European Commission, contains a digital finance strategy and legislative proposals on crypto assets for a competitive EU financial sector, while ensuring consumer protection and financial stability.

The panellists then discussed some other global examples in various financial sectors before Alejandra Naughton highlighted the need to educate consumers more fully about financial products. Alix d’Anglejan-Chatillon made the case for global regulatory convergence given the lighting speed of technological changes that have been exponentially accelerated by the Covid-19 pandemic and the borderless nature of new technologies and digital assets.

Using technology to protect the markets and control abuse

The panellists considered the effectiveness and various merits of regulatory sandboxes. Naughton re-emphasised the challenges from a financial authority perspective, namely trying to maintain a delicate balance between protecting and spreading information but without affecting the pace of innovation, fostering financial supervision capabilities (information technology and artificial intelligence (AI)) and supporting digital financial literacy. She also observed that sandbox effectiveness largely depends on how a regulator understands FinTech disruptions, for instance, are they a revolution or an evolution of financial services as we know them? Practices vary from country to country. Dar noted that the sandbox regime is very new in India and appears to be an intelligence gathering tool at present, while d’Anglejan-Chatillon explained that the situation in Canada is fairly developed, although crypto-trading platforms are still shoehorned into the existing securities and derivatives regulatory framework, which does not capture the specificities and unique risks of this asset class. Budai observed that, in Europe, start-ups pursuing new technologies that might be the subject of regulatory sandboxes are often acquired by banks at an early stage, even before getting to the necessity of licensing.

The discussion then turned to how cryptocurrencies may evolve in future. d’Anglejan-Chatillon stated that the Bank of Canada, as with other central banks, is contingency planning for a Central Bank Digital Currency to preserve control over national monetary policy and regulatory oversight over national payment systems as the use of cash declines precipitously. She also mentioned that, given the challenges of managing the risks posed by the widespread use of multiple private digital currencies, the regulatory response also needs to be globally coordinated.

Regarding the use of AI, Dar explained the approach in India, which is two-pronged: first, in taking small steps towards getting companies with large data to share their non-personal data in a manner which allows for better competition and potential machine learning for the regulator as well as the regulated; second, by adopting a big data approach to all filings and incidents in order to detect patterns. This is particularly important for a developing economy as replicating the regulatory workforce of advanced economies on a per capita basis is both undesirable and unworkable.

Finally, the panellists briefly highlighted a few other protections including technology-neutral risk assessment-based regulation of anti-money laundering/'know your customers’ (AML/KYC) procedures for regulated investment and financial institutions, and automated balance alerts.

Diving into financial literacy

As a former banking regulator, Naughton was then invited to give a few comments on financial literacy. First, she observed that things should always be kept simple; that way, it is easier to engage with stakeholders. Also, such initiatives should be tied to ‘teachable moments’, for example, a first transaction, a first mortgage, etc. Naughton also reminded the participants that there is no one-size-fits-all approach. While some emerging countries could be aiming at reaching a deeper financial inclusion, others could be empowering consumers. Another thing to consider is focusing on key target audiences: youths, women, migrants, low income, etc. Naughton cautioned that, unfortunately, crises tend to repeat faster than our ability to move forward in financial education.

Data gate-keepers

Dar gave an overview of India’s approach to data gate-keeper regulation. He revealed that India’s regulatory approach to data is increasingly focused on data sovereignty, rather than personal data privacy. There is now a deeper emphasis and focus on sharing data (including analytics, insights, trends, etc) with other local players to level the playing field, and also a strong push to share all kinds of data with the government generally – this also extends to personal data in some circumstances.

Conclusion

Finally, Budai asked the other panellists for their opinions about the adequacy of the role that the FAANGs (referring to the five most popular technology companies: Facebook, Amazon, Apple, Netflix and Alphabet (formerly known as Google)) play in protecting consumers from fraud. Dar again observed that the FAANGs do assist consumer protection because the transactions on their platforms are much more transparent than those taking place in the offline world, thus regulators generally see these types of market players as easier to regulate.

Budai also asked the panellists for their views on the possible role that AI could play in further securing the security and safety of online transactions in the future. d’Anglejan-Chatillon highlighted a Financial Stability Board paper (from October 2020) entitled 'Use of Supervisory and Regulatory Technology by Authorities and Regulated Institutions’, which cites examples such as the Banque de France’s ‘Le Lab’ and the European Central Bank’s ‘SupTech Virtual Lab’ for regulatory reporting, ‘misconduct’ analysis and ‘macroprudential supervision’. It raises the obvious concerns over cyber risks, data quality and ownership and consent issues and discusses the fair and transparent use of data for regulatory decision making and the consent and ethics of using predictive AI models and inherent bias issues. It also explores how cloud-based services facilitate information sharing but increase strategic and operational dependence on large third-party providers and highlights the critical need for globally consistent data standards and rulemaking approaches.

In conclusion, Page repeated a question from the audience: did panellists believe that regulators can rely on the FAANGs to protect consumers going forward? Panellists articulated sceptical opinions but would not entirely exclude that conclusion!

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