Welcome to Vilnius: Regulatory Competition in the EU Market for E-Money
If you google ‘Lithuania e-money’, the auto-fill function will suggest that you search for ‘Lithuania e-money license’. If you accept the tip, the first result will be Ecovis, which describes itself as ‘the most experienced finance institution and FinTech licensing advisor’ for Lithuanian licences. The second Google result is SB-SB Legal Services, which has a more global reach and boasts of being ‘capable of proposing a wide choice of countries suitable for the registration of payment systems. We offer electronic money licenses in European countries, including Lithuania, Malta, Czech Republic, Cyprus, Estonia, Bulgaria, Switzerland, Great Britain and Gibraltar’, in addition to other (small) countries across the world. And then your Google search will retrieve a third licensing services provider, also suggesting Lithuania (after the UK) for any EMI licence, and a fourth, and so on. What is going on?
In the words of Ecovis’ pitch:
‘Fintech companies, banks, electronic money institutions, payment service providers, insurance companies, investment managers and investment funds, forex dealers, securities brokers and other finance institutions in Europe are subject to higher regulation and risk management requirements. Licensing of a finance institution in one of the member states within the European Economic Area (EEA)/European Union (EU) opens up business opportunities to provide services in all other EEA/EU states, enjoy benefits of a Common Market of almost 500 million wealthy consumers and over 20 million businesses.
Fintech company or other finance institution registered and licensed in Lithuania provides significant competitive advantage and opens up European financial market at a significantly lower incorporation and operational costs. Favourable regulatory environment, excellent infrastructure, the fastest internet and quality talent pool make Lithuania and primarily its capital Vilnius attractive for large international finance institutions as well as Fintech start-ups.
The official policy of the Bank of Lithuania (regulator) and the Government is a creation of regulatory environment and favourable ecosystem for foreign Fintech companies, in order to attract foreign finance institutions and FinTech start-ups into Lithuania. Regulatory behaviour and significantly lower finance institution incorporation, licensing and maintenance costs is what makes Lithuania preferred jurisdiction for the finance business people from around the world, seeking licensing for their European and global activities’ [sic; italics added].
And favourable the regulatory environment must be. As Carly Minsky noted in a Sifted article earlier this year, e-money institutions have been flocking not only to the UK (155), but also to Lithuania (53), Cyprus (16) and Malta (15): these are higher numbers than for the largest EU economies (France, 11, Germany, 7, Italy, 3). It is fair to say that, the UK aside (ça va sans dire…), these are not countries known for a venerable tradition of safe and sound financial regulation and supervision. What we see here is a conspicuous example of regulatory arbitrage in action within the European financial services market.
Regulatory arbitrage is not necessarily a bad thing. But some caution is warranted in this case: what we observe here is not just regulatory arbitrage, but rather full-blown regulatory competition, ie pro-active efforts to attract businesses by some jurisdictions. In addition, at the receiving end of this competitive effort are financial services firms.
Regulatory competition in markets for financial services, especially when coming from smaller jurisdictions, can be particularly dangerous: as the Iceland banking crisis reminds us, the harm that a financial institution collapse can cause outside the jurisdiction in charge of supervising it can be much higher than the harm caused domestically (although the latter may itself be huge). Ex ante, the expected (short-term) political and economic benefits accruing locally, especially in terms of higher tax revenues, highly paid jobs, etc, from attracting foreign firms and exporting financial services may well be higher than the expected domestic systemic harm that can derive from a badly supervised financial sector; the cross-jurisdictional externalities will not even enter the political equation (see J Armour et al, Principles of Financial Regulation (OUP:2017) 565-66).
Does the presence of EU-harmonised rules for Electronic Money Institutions (Directive 2009/110/EC), including prudential requirements (own funds rules), make such concerns less serious? Again, the experience of the European banking sector, which also operated under an umbrella of common rules, yet got to the brink of a systemic crisis in the second half of the 2000s, would suggest that rules harmonisation may be insufficient.
While the business model of e-money institutions is not as risky as banks’, we are still talking about financial firms receiving money from individuals for future use as a means of payment. Especially in a zero-interest rate environment, the EU prohibition on interest payments on such e-money accounts may not be enough to dissuade consumers from using them as substitutes for deposit accounts. They may have read the usual warning that e-money accounts are not covered by deposit insurance, but the innovative features of these payment products, in terms of reduced fees and ‘customer experience’, will possibly outweigh concerns about the risks of losing their money. To be sure, as the Lithuanian central bank reports, ‘[t]o protect funds of electronic money holders, EMIs … follow the funds separation method, i.e. h[o]ld them in accounts opened with credit institutions as safe, liquid low-risk assets (time deposits, cash)’. But, once again, e-money institutions, like any other firm, may be tempted to draw from such accounts when they face the threat of insolvency. And, risks of fraud aside, in the event of the insolvency of the e-money institution, customers may have to wait before they get their money back (see D Awrey and K van Zwieten, ‘The Shadow Payment System’ (2018) 43 J Corp L 775, 814).
Only time will tell whether the EU internal market’s ‘almost 500 million wealthy consumers and over 20 million businesses’ will be well served by Lithuanian, Cypriot and Maltese e-money institutions. In the meantime, European Supervisory Authorities, whose goals include ‘preventing regulatory arbitrage’, may perhaps consider questioning the merits of regulatory competition to attract the players of an increasingly important component of the financial services industry.
Luca Enriques is the Allen & Overy Professor of Corporate Law at the University of Oxford Faculty of Law.