With the increasing EU emphasis on regulating digital financial services and a growing market for them in the Czech Republic, CEE Legal Matters spoke to Noerr Attorneys-at-Law Filip Murar and Ludek Chvosta about the local regulatory framework, the pace of its development, and the ways in which the market has responded.
CEELM: What are the recent key developments in terms of financial services digitalization in the Czech Republic?
Chvosta: First of all, digitalization is an everchanging process. Rather than talking about digitalized finance per se, we need to accept that what we consider digitalized finance today will become just finance in the future. The digitalization of financial services is not something new, but rather a trend that has been witnessed in the past decade, and earlier, and manifested in services such as internet banking and smart applications.
Interestingly, what has happened is that the COVID-19 pandemic has accelerated certain trends. In fact, technology has developed so fast that, at times, there is a noticeable trend of certain regulations lagging behind. Even relatively new players in the fintech market are slowly accepting that they are primarily financial entrepreneurs and are perceived as such by national central banks. This represents an identity shift from individuals and companies primarily seeing themselves as inventors and creators of digital and crowdfunding solutions and – yes, sometimes even providers of loans – yet retaining an expectation that they were somehow exempt from regulations. This attitude has now definitely started to change, causing a bit of “cultural shock” as digital players now know they cannot “have their cake and eat it too” – at a certain point you are a financial services provider and will be regulated as such.
Murar: One specific example where regulation is catching up with technical development, both on the European and local levels, is crowdfunding. In the Czech Republic, until 2021, it was rather unclear whether financial regulation applied to crowdfunding and, if so, to which types and to what extent. It was difficult to determine whether specific crowdfunding activities constituted, for example, investment services, public offerings of investment instruments, or licensed provision of consumer credit. In practice, to provide our clients with maximum legal certainty, we had to both formally and informally communicate with our local regulator and determine, on a case-by-case basis, whether a specific issue was regulated or not. Today, we have a clear EU Crowdfunding Regulation which explicitly stipulates that investment- and lending-based crowdfunding are regulated and sets down clear rules and guidance about licensing and obligations toward customers. This really is one of the good examples of how regulation catches up with technological innovation, and I believe it will gradually happen in many other areas, most visibly in connection with crypto assets.
CEELM: How do digital financial services operate in the absence of a relevant regulatory framework?
Chvosta: Historically, one of the primary rationales behind the regulation of financial systems was to ensure the protection of investments. That is why financial services are subject to very strict regulatory requirements, as they deal with “somebody else's money”. Thanks to rapid technological development, people now have access to a diverse set of digital financial services – and it only requires having a laptop and software applications. However, this does not change the fact that service providers are still playing around with other people’s money. Notwithstanding any legislative gaps, the courts in the Czech Republic take a conservative, measured approach, looking at the core of the matter which invariably revolves around the need to ensure the protection of someone else’s money. Therefore, old rules are interpreted by analogy in a way that they still apply to new technological developments, even if there is no specific regulatory framework for the moment.
Murar: As we already mentioned, there is still a gap between technological evolution and financial regulation in the Czech Republic. However, we see a positive trend of the regulator wanting to make decisions while taking into account the stance of fintech companies. In addition, the Czech National Bank has established a fintech contact point where digital startups have – in a much less formalized manner – the opportunity to ask questions about specific legal issues and the applicable regulation. This kind of regulatory guidance is very helpful for digital finance businesses, even more so in absence of relevant regulatory frameworks.
CEELM: How did fintech companies react to heavy regulations coming online in the past few years?
Chvosta: There is no reason whatsoever for regulators and fintech companies to be on opposing sides. Fintech has slowly realized that it is in its best interests to cooperate with regulators and to treat the development of its products – from the outset – as being subject to future regulation. At the same time, regulators are coming down from pedestals and communicating more. Notably, our regulator is not shying away from going with the times while looking especially at Germany’s BaFin and Luxembourg’s CSSF for guidance.
Initially, the technology sector had younger people with rather free-market ideas, seeing themselves as low-threshold innovators not necessarily subject to regulation. However, sooner or later, everyone comes to terms with the fact that if a business community wants to expand, they need to grow in terms of credibility – one of the ways of telegraphing that you’ve “made it to the big leagues” is to embrace the fact you have crossed the border into regulated territory. Nowadays, the initiative of being regulated often comes from the business sector itself. Even though meeting certain requirements might be related to additional costs, there are, definitely, more benefits to it.
Murar: We can see both negative and positive reactions on part of fintech companies. Naturally, regulation brings administrative and operational obstacles and challenges, such as the need to obtain a license, drafting a robust set of internal regulations, supervision of the regulator, or increased obligations for the protection of the customer. On the other hand, being regulated gives fintech companies higher credibility, legal certainty, and comfort, “scrubbing” the market of dishonest or fraudulent competitors – who do not meet the criteria for obtaining a license – and thus may lead to attracting more customers. We saw a similar trend five-to-six years ago in connection with consumer credit regulation. Before 2016, there were thousands of providers offering consumer credit under a basic trade license, without the supervision of the regulator, and frequently in a very dishonest manner. New regulation put these dishonest providers outside the market while, on the other hand, it provided businesses that did obtain a new license with a certain reputational credibility.