In Part 1 of our short series, we discussed the need for standards, particularly in the world of finance and here with regard to interface technology, and presented the two most common concepts for their development, the regulatory and market-driven approach. In our second part, we will now look at the tangible advantages and disadvantages of the two ways of establishing standards and what we can deduce from this comparison.
Part two: Regulatory versus market-driven – the pros & cons
Regulatory standards: stability and consumer protection
What are the arguments in favour of regulatory standards in the area of open finance? A key benefit is their ability to create stability and trust in the financial sector. Through clear guidelines and specifications, regulatory standards can help to maintain the integrity of the financial system and protect consumers, who benefit greatly from open banking applications such as multibanking, from potential risks. In the EU, for example, PSD2 has paved the way for improved security and transparency in payment processing. This is because the opening up of payment transactions to third-party providers and the associated provision of access to account data is associated with security risks such as data leaks or the misuse of customer data, to name but a few. With PSD2, important steps have been taken to improve security, such as the introduction of Strong Customer Authentication (SCA). Regulatory standards can also promote competition by facilitating market access for new players and thus driving innovation.
Market-driven standards: Flexibility and innovation in the implementation of new technologies
Market-driven standards are characterised by their flexibility and adaptability to rapidly changing market requirements. In an environment without strict regulatory requirements, companies can react more agilely to technological developments for open finance and introduce innovative solutions more quickly. This also promotes competition and enables standards to emerge organically based on the needs and requirements of market participants, i.e. banks, third-party providers and end customers.
The example of Switzerland: the challenges of market-driven standards.
In Switzerland, for example, there is currently a lack of specific regulatory requirements for open finance, which on the one hand leaves room for innovation, but on the other hand brings with it a number of challenges. Without clear guidelines, interoperability problems and security risks can arise, as each financial organisation can implement its own standards. It may also be difficult to ensure a harmonised approach to consumer data protection. These uncertainties could potentially affect consumer confidence in open finance. Furthermore, as the Swiss banks themselves determine the pace of implementation and the group of late adopters outnumbers the field of fast movers many times over, there is a risk that Switzerland will fall behind in international comparison. As a result, the Federal Council (Bundesrat) addressed the development of open finance in Switzerland at the end of 2022. It instructed the Federal Department of Finance (FDF) to submit measures to it by June 2024 in the event that the financial sector is not sufficiently committed to opening up its interfaces. We see this as a clear disadvantage of the market-driven approach.
Definition of standards in unregulated markets
However, the lack of legislative initiatives does not mean that a market is not actively endeavouring to define and introduce standards. Switzerland once again serves as an example: Several initiatives have been formed here that have taken up the cause of standardising the various aspects of financial processes. These initiatives are not (yet) driven by legislation, but by the market participants themselves, often the banks.
For example, the Swiss Bankers Association (SBA) has developed guidelines for payment transactions and interbank communication in order to improve efficiency and security in the financial sector. In addition, the SIX Group, which operates the national financial centre, has introduced various standards for payment transactions and the processing of financial transactions. The introduction of ISO 20022 as the standard for data exchange in payment transactions and thus the basis for Open Finance is a significant step that promotes interoperability between different financial institutions and at the same time helps to facilitate integration into international financial markets.
The SFTI (Swiss Fintech Innovations), an association that is primarily backed by Swiss banks and insurers, was founded in April 2016. It has set itself the goal of strengthening Switzerland as a financial centre and educational location by networking financial service providers, academia and fintechs and supporting the joint processing of specific topics and tasks. The development of API standardisation recommendations is an important part of its portfolio of tasks.
All these examples highlight the crux of an unregulated market: despite all these initiatives and endeavours, there is still no central authority that defines the rules for the development and release management of standards as part of a governance process supported by all stakeholders. As a result, various initiatives have taken up the cause of standardising APIs for open banking and open finance over the years. However, as many cooks spoil the proverbial broth, the further development is not surprising: as a result of an unavoidable concentration process, the SFTI’s Common API initiative now has by far the largest number of participants and the widest reach. This is not least due to the intensified cooperation with SIX, which, as a joint venture of the Swiss banks, is not only a founding member of the SFTI, but has also realised the only Swiss open banking platform to date with bLink.
Initiatives in regulated markets
However, there are also mergers and initiatives in regulated markets that are dedicated to standardising interfaces for open banking, among other things. In the EU area regulated by PSD2, the Berlin Group is one example.
Founded in 2004, the organisation consists of the German banking industry and over 20 other key players in the field of card-based payment transactions from more than 15 different countries in and outside the eurozone. It focuses on the standardisation of interfaces in the area of payment transactions. Its main objective is to develop uniform and interoperable standards for European payment transactions. By creating common standards, the Berlin Group facilitates the smooth exchange of payment data between different players in the financial sector and thus contributes to the harmonisation of payment transactions in Europe.
Final consideration
There is no doubt that standards in financial services, especially in the emerging field of open finance, are crucial. The need for clear standards in open finance spans various aspects, including interoperability, security, usability, fostering innovation and regulatory compliance. In this context, regulatory standards set by government institutions and market-driven standards resulting from the dynamics of market participants play a central role.
The example of Switzerland shows the current challenges and opportunities of the market-driven approach: The lack of specific regulatory requirements creates room for innovation, but also brings with it uncertainties regarding interoperability and security. The initiatives presented by the Swiss Bankers Association, the SIX Group and the SFTI association show that, despite the lack of legal requirements, efforts are being made towards standardisation. However, the importance of a central authority for the governance and development of standards, which is necessary to ensure an efficient and standardised approach, becomes clear.
The comparison with the Berlin Group in the PSD2-regulated EU area makes it clear that standardisation initiatives also exist in regulated markets in order to promote interoperability in payment transactions beyond the legal requirements.
For FinTechs such as Qwist, this heterogeneous situation means that a high degree of flexibility is required when developing solutions in order to adequately adapt to the challenges and special features of the different markets. The expertise that Qwist has acquired as an EU-wide company in the regulated markets ultimately also benefits customers from non-regulated countries.
Ultimately, the balance between regulatory and market-driven standards must be carefully weighed up. While regulatory standards offer stability and consumer protection, market-driven standards allow for flexibility and innovation. The future of open finance will depend heavily on the successful integration and coexistence of these two approaches.
Are you interested in the basics of Open Finance and the role of standards? Read part 1 of our series.
Read part 1 now
