Tech companies’ unregulated financial data business creating substantial market distortions, industry warns

Tech companies’ increasingly heavy rotation into the financial sector is creating market distortions in data service provision and pricing, leading industry players warned, calling on EU regulators to tighten scrutiny on the data space.

A chorus of incumbent, alternative and fintech players alike raised flashing red flags about unregulated data providers and distributors concentrating financial market power thanks to their ability to bypass hefty prudential requirements and dominate the digital space.

The trend would also be pushing several regulated companies to outsource data functions to unregulated entities in order to ease the burden of regulatory compliance, financial associations and groups warned responding to the European Securities and Markets Authority (ESMA)’s consultation on digital finance.

“The majority of financial market data is consumed through unregulated market data providers,” said pan-European exchange Euronext.

New types of unregulated data vendors and connectivity providers that “are not within the scope of Mifid II/Mifir” are creating “new risks in relation to the collection, use, dissemination, and consumption of financial market data,” it said. 

Central securities depository ID2S, which specialises in blockchain technology, agreed that at present “data service providers operate largely on an unregulated and unsupervised basis.” 

“Rarely is adequate due diligence carried out by the sources of Big Data, yet this very data is increasingly used (by banks, CSDs, clearing houses etc..) to support new technology applications […] where key financial decisions are made on the basis of the accuracy and validity of underlying data,” it warned.

“Many technology companies enter new fields with the objective of growing at pace at all costs” added alternative trading exchange Aquis Exchange. “In these circumstances, traditional controls and processes which can be expensive to maintain and only called upon under extreme circumstances are often compromised.”

Unlevel playing field creating the wrong incentives

Overall, “to the extent that technology providers can leverage data to influence the provision of financial services, this can potentially enable the rapid scaling of financial services subsidiaries,” the Association for Financial Markets in Europe (AFME) said.

“This highlights the importance of ensuring that, to the extent that technology providers were to enter capital markets, the principle of ‘same activity, same risk, same regulation’ is adhered to for managing any consequential conduct, prudential, and systemic risks.” 

For example the association pointed out that, while ICT third-party providers will be included in the scope of the EU’s forthcoming Digital Operational Resilience Act (Dora), “they will remain governed indirectly by obligations imposed on incumbent financial entities and will not be subject to direct requirements on risk management, resilience and governance.”

Conversely, filling the regulatory gap between regulated data users and third-party data providers or distributors would “ensure that regulated firms are able to operate within an appropriate risk appetite framework as part of their considerations in outsourcing to unregulated companies,” Aquis argued. 

The reality of the current financial services landscape, however, paints a very different picture, the respondents said – one that ends up incentivising several financial sector firms to offload some data-related functions to unregulated entities, often set up within the same group.

“Financial services companies are currently escaping potential regulatory obligations by providing services and outsourcing their business to unregulated (group) companies,” said the European Fund and Asset Management Association (EFAMA). 

“A coherent regulatory scheme should not only encompass the regulated financial market data providers, such as exchanges, but also their unregulated group financial market data companies,” said BVI, citing the cases of SIX Financial; ICE Data; LSE and Refinitiv; Deutsche Börse and Qontigo.

Deutsche Börse’s fintech data analytics subsidiary Qontigo was also listed by EFAMA as an example of how financial firms are relying on unregulated third-party entities “to outsource part of their business and circumnavigate regulatory obligations.”

“ESMA has tried, without success, to obtain detailed rating cost and product information from the above-mentioned unregulated rating data companies and we fear that similar situations may arise with data companies associated with regulated trading venues or benchmark providers,” EFAMA said.

According to BVI, a similar dynamic is taking place among “index companies belonging to exchange groups such as FTSE or STOXX, as well as other dominant data sources and market data distributors, such as Bloomberg, Factset, or, locally, WM-Daten, which are important for the proper functioning of the markets and ultimately financial stability.”

In its own response to ESMA’s consultation, Deutsche Börse stated that “there may be risks involved both in the data generation [and] the usage of the data itself” related to financial data provision by unregulated firms – but nonetheless concluded that incorporating these entities under existing or new prudential frameworks isn’t warranted at this stage.

Talking to bobsguide, the German group said: “It is too early to say at this stage whether a legislative action would be needed or not, depending on the assessment of legislators/supervisors of the associated potential risks,” adding it will “monitor the political process closely.”

At the opposite side of the spectrum, Euronext asked ESMA to “clarify the concept of ‘data service providers’ in order to understand if they would be subject to the existing EU regulatory framework or if they are left unregulated.”

EFAMA also urged that “it would be important for Markets in Crypto-Assets (Mica) to introduce similar obligations on the provision of data as those found under Mifid.”

Resurrecting monopolies and interoperability risks

Digital technology being used by financial firms include an expanding range of cloud-based activities, AI, advanced analytics and distributed-ledger technology (DLT) – areas that are continuously bolstering tech companies’ slice of the financial sector business.

In particular, in the financial data management and distribution space, lower regulatory scrutiny and a stronger digital market position would allow tech companies to impose opaque fee structures and bundle their products, several respondents said. This in turn threatens to create new monopolies that can capitalise on financial firms’ ever-increasing need for regulatory data and digital efficiency, they said.

“Large technology companies can effectively cross-subsidise new business lines while significantly undercutting regulated firms in a grab for market share, potentially damaging regulated firms’ business models,” Aquis said.

“This might then result in the exit of participants from certain business lines,” squeezing out competition and hindering “investor protection, market integrity and security in the event of a degree of monopolistic power being obtained and exercised by a technology company.”

Big Techs like Amazon and Google, for example, are ramping up their proposition in the sector through a range of interconnected or bundled services – such as Amazon AWS Data Exchange, Amazon AWS TimeStream and Google GCP Datashare – that steepen concentration risk and squeeze industry choice.

“Given technology companies interest in building up their portfolio of both data sources and tooling to support financial market data, the risks here to interoperability of financial market data from both a reference data and technological platform appear high, as do the costs of extracting market data from an unregulated firm’s systems given the costs of transmitting data and the large volume of data that exists in financial markets.”

This can lead to heftier costs to “move away from or diversify data vendors for any given regulated firm,” Aquis said.

Legacy anti-competitive issues in the financial data segment would therefore be resurrecting due to the sector’s increased reliance on tech firms.

German investment fund association BVI noted that “the use of financial market data has […] for years been associated with regular, sometimes massive price increases and the conclusion of increasingly complex data licences for the asset managers.”

Unregulated tech companies are thus behaving similarly to previous “monopolies and oligopolies such as stock exchanges and companies with a dominant market position,” in setting “one-sided conditions.”

“The issue of access to, pricing and distribution of market data has been for a long time a source of a heated debate between the market data producers on one hand, and users on the other,” said Anna Carrier, senior government and regulatory affairs adviser at Norton Rose Fulbright.

Also to tackle mounting concerns on the accessibility of market data, the European Commission is in the process of considering various changes to the market data regime – including setting up a post-trade consolidated tape for equity and equity-like financial instruments, Carrier said.

“It may also consider other changes to the market data regime.”

“The creation of a consolidated tape and other market data issues are going to be a large part of the upcoming Mifid II/Mifir review,” expected to be launched early next year, she said.

Following the close of ESMA’s consultation last month, UK and European financial groups will get another chance to pitch in to regulators’ digital finance debate at a hearing on preliminary findings on Friday.

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