Open finance is expected to be regulated over the next few years, leading to a new open data ecosystem
Open finance is making its way into the legal system through the consolidation of several initiatives that will lend it legal protection. Once this is complete, customers will have an open finance framework that protects their data and interests in a regulated environment, and the financial sector will change forever.
What is open finance and what is its purpose?
Open finance refers to third party access to personal financial data. Although open banking is already regulated under the PSD2 regulation, in terms of open finance there is still no regulatory umbrella for this market.
In the words of the Expert group on European financial data space, which wrote the Report on open finance in 2022:
“Open finance refers to the sharing, access and reuse of personal and
non-personal data for the purposes of providing a wide range of financial services.”
According to this group:
“The objective of open finance is to promote innovative financial products and services to the direct benefit of consumers and firms.”
As is currently the case in open banking, it is expected that in open finance the consent of customers will be necessary for this transfer of information, from which in turn they can benefit by becoming users of services that would not exist if it were not for this new data flow.
How will open finance work?
The basic workings of open finance are expected to be relatively simple, although
new -and in a sense exotic- properties emerge, which will transform the current financial system just as open banking transformed traditional banking. The original idea is that the customer can transfer their data to third parties and, consequently, access new services.
In one example, a customer has transferred their financial data to an open financial service provider (they will be key players in this universe in a similar way to banking service providers), so that this can design an application for the customer to view all the insurance or pension products that he or she has with the different providers. They have access to a richer and more informative dashboard.
In another example, a customer has transferred the financial data to another company, which is responsible for the sustainability of personal finances in the long term. Analyzing the profile of this woman, the system recommends several points of action to balance some of the long-term financial vulnerabilities, pointing out the key points still unresolved, depending on the customer’s chosen strategy.
The differences between open finance and open banking
If we have to make a difference between open finance and open banking, it lies in the scope. While open banking refers to the initiation of payments and account information services -at least as regulated in PSD2- open finance goes a step further and aims to establish regulations beyond the payment area and even banking services by ‘traditional’ players.
Generally, to engage in open banking it will be necessary to have a banking license as stipulated in the PSD2 Directive, or to work for companies that operate under this umbrella, whereas open finance could extend the regulatory umbrella to companies outside the current ecosystem, although in practice the services remain under the protection of services known to customers. This is precisely what is happening with open banking: the new players can operate autonomously, although within the banking ecosystem traditional institutions work with values such as security and trust.
In a sense, open finance can be understood as the next step of open banking, and the next iteration in open data regulation of banking services is likely to include both. Of course, one difference at the moment is the regulation of open banking versus the deregulation of open finance.
Main advantages of open finance
The advantages of open finance are similar to open banking. For example, consumers will be able to access their financial data more easily and will be able to better understand their finances, so they can make better decisions in this area.
An increased transparency is expected in this sector as the ecosystem is deployed in the same way as open banking, which at the same time will be useful for different companies that will work with data. The financial sector is expected to grow as a result of consumer protection.
This will be the biggest beneficiary, as they will have more control over their information (personal data) and the information generated as they use the sector. This is one of the core points of the European Union: empowering citizens.
Competition is also expected to increase in the sector, leading to new services and a Darwinian system whereby the companies that offer the best services will be the ones leading the transition.
Keys to a secure customer-oriented open finance
In the same way as open banking regulations, open finance will require a legal security framework that protects customers and their interests. Some of the key aspects to ensure a healthy open finance system as raised by the Expert group on European financial data space of the European Commission include:
- Customer experience
- Financial inclusion.
- Give customers control
- Horizontal approach
Which includes ease of use and customization.
Improved access and use for all consumer segments, with a focus on SMEs and vulnerable individuals often excluded from financial services.
Give customers control
They must have the power over their data, as well as the utmost protection.
This group of experts stresses the use of artificial intelligence and machine learning for the benefit of consumers, reducing the risk intrinsic to these systems.
Integration of open finance in a cross-sectoral framework. In other words, make it compatible.
In addition to these recommendations by the European Commission, there are others worth mentioning:
- Same business, same risks, same rules. According to BBVA Research, it is also imperative to work with a framework so that open finance is treated in the same way as open banking to safeguard security and ensure a level playing field.
- A definition of ‘open financial service providers’ with their respective authorization, evaluation system and assignment of responsibilities. In other words, an authoritative list of who can work with this vulnerable data so that all guarantees for customers are met.
- A standardization of data and normalization of interfaces, so that it is possible to automate processes and maximize security in data access. For example, the customer always follows a similar procedure when authorizing the assignment. This regulation could be the equivalent of the PSD2 for finance.
- Coordination of competent authorities in matters of regulation, legislation or supervision, so that there are no loopholes that give rise to lawless situations or legal cracks in the system regulations that could put personal data at risk.
- Avoid oligopolies (and of course a monopoly) through a level playing field for all suppliers. Systems like ‘winner-takes-all’ that lead to serious power imbalances and disproportionate market shares, very keenly felt in digital environments, must be discouraged.
A legal framework for open finance
How is it applied in Europe?
In Europe, it is increasingly important for people to decide to whom, when, how and, most importantly, why, they disclose their data. Access to data plays a key role in promoting innovation and competition, which is why the European Commission plans to create a framework to promote data sharing between companies in the financial sector.
“This initiative aims to enable the exchange of data and access by third parties to a wide range of financial sectors and products, in accordance with data protection and consumer protection rules”
This initiative is called the Open Finance Framework and it may still take a few years to become consolidated. When it does, the financial market is expected to ‘explode’ just as the banking market did with open banking.
Timeline of European open finance
- In 2020, the European Commission established the need for open data in this sector in its Digital Finance Strategy.
- In 2021, the Expert group on European financial data space was set up.
- In 2022, the Report on open finance was published which led to a series of public consultations.
- During 2023, negotiations similar to those that led to the GDPR in 2016 and PSD2 in 2015 are expected to take place.
- By 2024 a binding and mandatory Open Finance Directive is expected to be published for all member countries.
How is it applied in LATAM?
Unlike the European Union, LATAM does not have consistent regulations, but many countries have shown an interest in laying the foundations for the open finance model:
- In 2018, Mexico included open finance in its Fintech Law.
- In 2020, Brazil initiated the legal framework, underpinned in 2021 by equating open finance with open banking.
- In Colombia, regulation remains voluntary, although the Superintendency of Banks is working for a more solid framework.
- In Chile it is a deregulated market and, therefore, risky. Companies can use systems such as financial APIs, but they do not have legal backing.
- Peru is in a similar position, although they are working for a nationwide Open Banking law that includes, among others, rural populations.
- In Argentina there is no regulation, and at the moment it is not expected as a priority. However, this is likely to change soon.
There is movement in Uruguay, where the Central Reserve Bank is setting up a Financial Innovation Plan that will see the light in a few years.