New legislation on the European financial markets, MiFID II, is expected to come into force on January 3rd 2018 and will impact Fintech’s future. Through regulating trading activities and enhancing investors protection, it will aid the creation of more transparent and robust financial markets. It will also extend the regulatory coverage to non-equity products, including cash and derivative instruments in fixed income, foreign exchange and commodities.
The amended directive will also apply to more industry stakeholders engaged in investment services, such as investment banks, portfolio managers, brokers and market makers.
Impact of New Rules
The new rules will impact existing financial markets’ practices as well as the rapidly evolving field of financial technology. Currently, the general classification of FinTech includes a plethora of aspects. These include automated advice, high-frequency trading, blockchain and cryptocurrencies, digital payments, peer-to-peer lending, crowdfunding, artificial intelligence and big data analytics.
Some of these activities already follow a harmonised regulatory framework, such as the Payment Services Directive (PSD2) for digital corporate payments. Furthermore, some of the services such as blockchain, cryptocurrency, P2P and crowdfunding follow national laws, while some activities such as AI and big data analytics are unregulated.
Among the variety of services, robo advisory and high-frequency algorithmic trading will be directly influenced by the new directive and thus will be regulated at the EU level. Hence, the investment firms engaging in these activities will adopt new rules and follow new guidelines for their innovative technologies in order to deliver their services, while ensuring investor protection.
The increasing use of robo advisory services has created a need for enhanced suitability guidelines to ensure that firms provide suitable personal recommendations to their clients or make suitable investment decisions on behalf of their clients. In addition, the European Securities and Markets Authority (ESMA) believes that automated robo advisors might endanger investors protection and has identified three main areas where specific needs for protection may arise:
- The quality of and manner of providing the information (electronic disclosure or human interaction) to clients of the automated investment advisor or portfolio manager
- The assessment of suitability with specific attention to the use of online questionnaire with limited, or without, human interaction
- The organisational arrangements that firms should implement when providing robo advice.
MiFID II has reinforced the existing MiFID I requirements on the assessment of suitability. The updated suitability rules have recently been incorporated in the more detailed consultation paper named ‘guidelines on certain aspects of the MiFID II suitability requirement‘ before a final report is released by the second quarter of 2018.
The consultation paper, which aims to enhance clarity and foster convergence in the implementation of certain aspects of the new suitability requirements, is intended for firms and institutions engaging in fields such as investment advice and portfolio management services. The paper replaces the existing 2012 guidelines on suitability requirements, taking into consideration the results of supervisory activities conducted by National Competent Authorities (NCAs) on the application of suitability requirements, the development in the financial technology markets and recent studies on behavioural finance.
Automated Robo Advisory
According to the updated suitability requirement under MiFID II, firms engaging in robo advisory services will have to consider additional regulatory requirements. ESMA has proposed 12 general guidelines which relate to:
- Information for the clients on the purpose of suitability assessment
- Knowledge of the client and product
- Matching clients with suitable products
- Other requirements for staff and record keeping.
ESMA has included robo advice examples to its draft guidelines which are intended to help companies better understand the regulatory environment.
High-frequency Algorithmic Trading
Algorithmic trading is already an established activity in numerous financial institutions, investment firms and trading venues, with little or no human interaction. These can cause risks, excessive volatility and market distortions unless they are regulated. According to MiFID II, investment firms that engage in algorithmic trading should have effective systems and risk controls suitable to the business in order to ensure that the trading systems are resilient. The investment firms should also have effective business continuity arrangements to deal with the failure of their trading systems.
In order to enhance the resilience of markets in an environment with rapid technological developments, the regulatory measures should build on the technical paper issued by ESMA in 2012, which details guidelines on systems and controls in an automated trading environment. Moreover, it is preferable that all high-frequency algorithmic trading firms are authorised, which would ensure that such firms are subject to the MiFID II organisational requirements and are properly supervised.
Investment firms and trading venues should have robust measures to prevent algorithmic or high-frequency algorithmic trading techniques from creating disorderly markets or engaging in abusive activities. Moreover, the structures of algorithmic trading venues should also be fair, transparent, non-discriminatory and should not lead to disorderly market conditions.
The use of advanced financial technologies such as algorithmic trading, automated investment advisory and portfolio management brings a variety of services to clients, with different levels of human engagement, need for interaction and assistance. The complexity that arises from the unique nature of the technologies will create a requirement for thorough understanding of the new MiFID II rules and universal adherence to the guidelines published by ESMA, which will secure investor protection and market efficiency.
Venezuelan Digital Currency Backed by Oil
Venezuela has announced plans to launch a digital currency, “the petro”, backed by the country’s oil and mineral reserves. The petro aims to help ease the country’s monetary crisis but sceptics claim the proposal has no credibility and will not help those in extreme need.
Why It’s Important
Hyperinflation has eroded the Venezuelan bolivia’s value by 97% this year, making imports incredibly expensive and causing many to abandon trust in the currency. The country’s oil reserves made up 95% of its exports in 2016, while oil and gas extraction accounted for 25% of GDP. Rich supplies of resources provide some initial credibility to the proposal, but President Maduro’s questionable track record when it comes to monetary policy is making many sceptical about the proposal. His currency controls and money printing have only added to the monetary crisis. Maduro has not announced when the digital currency would come into use or any details regarding how the country would create such a system.
Opposition leaders argue the country’s shortages of food and medication are far more pressing and that the digital currency will not address this. The digital currency may provide a more trusted medium of exchange, but it is unlikely to help those in excessive poverty.
Venezuela’s Inflation Is at 4000%. Here’s Why
Venezuela’s currency, the bolivar, has lost 96% of its value this year. As the currency becomes near worthless, imported food and medicine are in short supply. A humanitarian crisis is unfolding.
The government and state-owned oil company, PDVSA, owe bondholders $60bn alone and have recently defaulted on debt repayments. More defaults could mean investors seizing their stake in Venezuela’s oil.
Why Is Venezuela in Debt?
Acting upon the country endowment of natural resources made it an economic success in the mid-2000s.
Yet, while the price of oil skyrocketed during the late-2000s, former President Hugo Chávez matched this with Venezuelan public debt.
Once the price of oil dived in June 2008, lenders stopped extending credit to the country.
Defaults on government bonds are largely to blame for this inflation.
In 2016, OPEC found that oil reserves accounted for 95% of the country’s exports, while the oil and gas extraction combined made up 25% of its GDP.
Venezuela’s overdependence on oil and lack of saving during its heyday are the leading causes of the current crisis.
The Psychology Behind Saving
The idea that the poor do not save enough money just because they are simply “too poor to save” is wrong.
Gambian farmers have in the past saved in cash (wooden lockboxes with savings were smashed open in an emergency or once the savings goal was reached), stored crops, and consumer durables. Saving in livestock and jewellery enabled other farmers to convert cash into less liquid assets to prevent unwarranted and frivolous spending. A detailed household survey conducted in 13 countries found that for many people in the developing world saving may be counter-intuitive. The poor and the extremely poor, those living on less than $2 a day and on less than $1 a day, respectively, do have a significant amount of choice in regards how to spend their money.
The Developing World
The poor do not use all of their income to buy calories, but only allocate between 56% to 78% to food. Spending on tobacco and alcohol (considered non-essential and nonfood items), and festivals (weddings, funerals or religious events) plays a significant role in household budgeting. For example, the poor in rural areas of Mexico spent slightly less than half the budget on food, and 8.1% on alcohol and cigarettes. The poor and the extremely poor spend about the same on food, which suggests that the extremely poor feel no extra compulsion to purchase more calories. Instead, the remaining income is often saved across a variety of informal saving groups, including peer-to-peer banking and peer-to-peer lending.
It is often the poor, women and the rural communities who are the least banked (those without an access to formal banking services). Not surprisingly, without an access to savings accounts or other formal financial services, it is difficult for families to manage unexpected risks, like illnesses, or plan children’s education. But the desire to save and engage with financial services is still there, as shown by a large uptake in the savings plans in Kenya despite high-interest costs, high withdrawal fees, and close to negative interest rates.
Yet, inchoate financial infrastructure in the developing world cannot on its own explain undersaving. Behavioural economists argue that the poor are no different to the rich in their saving habits: both groups are subject to cognitive biases and inherent human irrationalities and face self-control problems. When it comes to saving, “present bias” (or procrastination, proverbially) occurs when people give stronger weight/preference to an earlier option or purchase that provides instant gratification, rather than setting some funds aside for emergency use. Due to income uncertainties, however, the consequences of this “live for today” behaviour are far more detrimental to the poor than on the rich.
The Developed World
Undersaving is not exclusive to the developing world. Household saving rates, the difference between disposable income and consumption, vary greatly across the world. In 2017, Switzerland and Luxembourg, closely followed by Sweden, are the three countries with the highest savings rates. However, a higher GDP per capita does not necessarily equate to a higher savings rate.
In other words, people with higher income in the developed world countries do not always save more. Consider the US with GDP per capita $57,466 and savings rate of 5.3% and the Czech Republic, GDP per capita $35,127 and a savings rate of 6.7%. Similarly, with GDP per capita of over $43,000, the UK’s household savings rate was 3.3% in 2016, the lowest level since 1963, while in Hungary ($27,008 GDP per capita) the savings rate has been on average 4.5% in the past three years.
Is it possible to fully comprehend the monetary hurdles of low-income families? Undoubtedly, consuming today might be a rational choice and a necessity to survive. But, biases deserve context. For many in the developing world saving at home still remains hard. Technological innovation in finance and growth of electronic wallets have already alleviated some of the hurdles of saving money, but technology is not the silver bullet that will address undersaving. An active and conscious commitment to saving and awareness of biases could have a strong beneficial impact on the lives of the poor.
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