Latest great guest post by Paul Rohan, author: PSD2 in Plain English and his latest book Open Banking Strategy Formation, available from Amazon here

There is a strong consensus amongst commentators and investors that Platform Ecosystems seem to build better businesses. With that in mind, can we reasonably describe Platform Ecosystems as potentially an “Irresistible Force” in an Open Banking world?

There does seem to be significant opportunities for Non-Bank Platforms arising from the use of PSD2 APIs. Platforms enable Platform Owners to innovate on a scale that they could not by themselves. Innovation is massively distributed (innovation that would otherwise be done far more slowly in-house by traditional banks) to a diverse pool of outsiders with deeper expertise in narrow market segments. Doing this allows capturing of the under-exploited long-tails of the Platform’s core market, transferring the costs of developing new innovations to App developers.

That said, will App Developers flock to Platforms that use the PSD2 APIs? Platforms enable Developers to use the baseline capabilities of the Platform as the foundation for their own work. In the Open Banking era, it will be interesting to see if Platforms regard PISP/AISP capabilities as precisely the type of baseline capabilities (used by Consumers and Businesses, used by all economic sectors) that will allow Developers to focus on the specific financial and non-financial needs of very narrow market segments. Instead of replicating the functionality that their Apps share with other Apps, Developers can limit their investment to functionality that their Apps do not share with others. This makes it economically viable to target very small market segments that would otherwise have been difficult to justify targeting. Platforms also provide access to an existing pool of customers, who can more easily find the App Developer’s work and more efficiently transact with them.

Of course, the ultimate arbiters of the desirability of an Open Banking Ecosystem will be the End Users. There does seem to be significant opportunities for End Users from Non-Bank Platforms using PSD2 APIs. The End Users can uniquely customise their experience of a Platform to their idiosyncratic needs by mixing-and-matching from a diverse pool of Apps that augment the utility of a Platform. End Users also benefit from the accelerated pace of innovation around the Platform, with the prospects of increasing value over time. End Users also benefit from the network effects that are also in the best interests of Platform Owners and App Developers in competitive Platform markets. This is a big challenge for Incumbent Banks with monolithic code bases. We seem to be heading for a world where Platforms compete with Platforms, rather than product versus product. If banks want to continue to build balance sheets with net interest margins, they may need to have Apps serving deposit taking services on the Platforms that pensioners use, generating money that is lent to the pensioners’ children through Apps on the Platform that their children use (the same could hold true for the banking needs of mature businesses and immature businesses).

The opportunities for Platform Owners, App Developers and End Users from PSD2 APIs look like they could make Platform Ecosystems an “Irresistible Force” in an Open Banking era. However, how might these irresistible Platform Ecosystems collide with the “Immovable Object” of Regulation? What could cause Regulators to dig in their heels and intervene in the Open Banking Ecosystem?

Regulators will try to ensure that market conditions and structures support the conditions for sustained innovation, the source of durable advantage for trading blocs. The elements necessary for sustained innovation were set out in the “Competitive Advantage of Nations” by Michael Porter in 1990.  Regulators focus on the “Factor Conditions” need to support sustained innovation. The trading bloc’s needs factors of production, such as skilled labour or infrastructure, to compete in a given industry. “Demand Conditions” also need to be healthy. Strict and modern product standards in the home-market provides a springboard for global competitiveness. “Related and Supporting Industries” need to be healthy. The presence (or absence) in the trading bloc of supplier industries impact international competitiveness. “Firm Strategy, Structure and Rivalry” also influence sustained innovation, as the conditions in the trading bloc governing how companies are created, organised and managed, as well as the nature of national competition. We can see this thinking underpinning the policy development that led to PSD2.

There are natural tensions and trade-offs between policy goals on deregulating competition, enforcing strict product standards and limiting direct cooperation between industry rivals. The Access to Account provisions of PSD2 aim to deregulate competition and enforce strict product standards; however, the PSD2 RTS are deliberately not specific on technologies or business models, thus limiting direct cooperation between industry rivals. Regulators want to see some incumbent banks trying to steal a march on others. They want to see some banks have far better Developer communities than others, thus accelerating innovation and competition.

Aside from the fact that PSD2 and Open Banking came from Regulators in the first place, there are several other reasons for thinking that Regulators will let this structural change in financial services take root and grow.

Firstly, the Regulators need to have authoritative research that generates credible evidence of economic or social harm from certain market activities or market positions. If we assume that wise regulation follows an in-depth analysis of the economic and social benefits and costs of particular ways of doing business, the research base on Open Innovation in Financial Services is pretty small and new. Economic analysis of this arena is still developing, both in theory, in lawsuits and in case studies. PSD2 and Open Banking is designed to accelerate financial services competition and innovation, reaching market segments that are currently under-served. This environment needs time to develop and be studied, before Regulators reach for the statute book again. As things stand, EU Regulators can have no philosophical objection to a business model based on “Platform economics”. Recital 33 of PSD2 explains that EU policy is that there should be “continuity in the market, enabling existing and new service providers, regardless of the business model applied by them, to offer their services with a clear and harmonised regulatory framework.”  The research has also to attempt to capture an explosion of lots of new competitive activity. Platforms are evolving very quickly. Platforms compete with entrenched Incumbent Product-led businesses and also compete with other Platforms. Platforms compete with Apps in their Ecosystem. Apps compete with Apps. Studies of these interactions are in their infancy.

Secondly, Regulators cannot just “shoot from the hip”. New law has to reconcile with existing law. How could new definitions of “Platforms” reconcile with old definitions? How can legal definitions take into account the economic effects of the various Platforms that seem to demonstrate very dynamic network effects? A too broad definition of digital Platform may lead to counterproductive regulation. Any new approach has to reconcile with the current legal approaches. There are already Laws for Intermediaries, Laws on Competition and Laws on Data.  Articles 101 and 102 of the Treaty on the Functioning of the European Union Article (TFEU) prohibit the abuse of market positions fixing prices, limiting supply, sharing supply, attaching unfair conditions to contracts or limiting the technical development of a market. EU Competition law does not prohibit a firm from having a dominant position; it only prohibits the abuse of that position. A market actor would be considered to be dominant if it can act without first considering the reaction of customers or rivals. All of these categories of conduct rules already apply to all business models. The behaviour of fast-growth Platforms may challenge the law but there is no legal framework called ‘Platform law’.

Thirdly, Regulators need a sustained and credible set of complaints from market actors about unfair market dominance and unfair market practices. Regulators have been conducting public consultations about the activities of Platforms. What did Developers complain about when Regulators consulted them about the commercial behaviour of Platforms? They complained that Platforms could apply terms and conditions which Developers found unbalanced and did not have the possibility to negotiate. In certain circumstances, Developers were unhappy that Platforms were refusing access to its services unless Developers accepted specific restrictions. A Platform could decide that it would promote its own services to the disadvantage of services provided by Developers. However, complaints can be rebutted. Platforms won’t be without ammunition to defend themselves from Developer complaints to Regulators. To govern their ecosystems, Platforms have to have gatekeeping, pricing and process controls for App Developers. If Developers don’t like it, there is fierce competition between Platforms, they can go elsewhere. Furthermore, Apps can develop on multiple Platforms serving their target market segments. Developers can and will complain about Platforms, but Platforms will have solid grounds to argue their case.

Fourthly, Platforms don’t fit easily into patterns of behaviour that Regulators have traditionally disliked and prevented. Many Platforms are offering free services to consumers, which means that the standard competition criterion of excessive pricing cannot apply. On those Platforms, asymmetric/skewed prices or cross-­?subsidies might drive network effects. This might make Regulators uncomfortable but the skewed pricing complicates the economic analysis necessary to assess the anti-competitive behaviour. The criterion for abusive conduct (required for the application of Article 102 of the TFEU) does not focus on the impact on prices only, but also take into account the reduction in the freedom of choice for the users of the Platform, However, most Platforms increase the choice of users, reaching micro-segments and exploiting untapped resources. Defining “market abuse” requires Regulators to define both “markets” and “abuse”. As markets blend into each other and the functions in Platform ecosystems envelop other software functions, multi?sided digital Platforms complicate market definition and market power analysis, making the determination of the optimum level of competition far trickier. Traditional market definition tests only look at the effects of a price change on the demand in one side of the market/Platform(s), without taking into account the effect on the demand for the other side(s) of the market. The “SSNIP test” that the EU Commission uses to identify the smallest relevant market within which a hypothetical monopolist or cartel could impose a profitable significant increase in price was devised in 1997, when was 2 years old. Anti-trust regulators cannot act against market dominance if they cannot easily define markets. When US Regulators broke up AT&T into “Baby Bells” in 1984, life was simpler as we were in an Industrial Economy with divisionalised companies in clear market sectors. Even after that intervention, something like the old AT&T started to merge together again.

Given these factors, can we identify Open Banking Scenarios where the “Irresistible Force” of Platform Ecosystems could collide with the “Immovable Object” of Regulators? Where will Regulators be attentive and intolerant in the world of Open Banking? What specific outcomes could attract fines and sanctions? Given the immaturity of PSD2 and new rules on Open Banking Platforms, we can only look at the principles of good regulation and how they could impact. In the UK, the FCA has 11 principles for businesses offering financial services.

1.      Integrity – A firm must conduct its business with integrity

2.      Skill, care and diligence – A firm must conduct its business with due skill, care and diligence

3.      Management and control – A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.

4.      Financial prudence – A firm must maintain adequate financial resources

5.      Market conduct – A firm must observe proper standards of market conduct

6.      Customers’ interests – A firm must pay due regard to the interests of its customers and treat them fairly

7.      Communications with clients – A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading

8.      Conflicts of interest – A firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client

9.      Customers: relationships of trust – A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment.

10.  Clients’ assets – A firm must arrange adequate protection for clients’ assets when it is responsible for them

11.  Relations with regulators – A firm must deal with its regulators in an open and cooperative way, and must disclose to the appropriate regulator appropriately anything relating to the firm of which that regulator would reasonably expect notice.

In crude conclusion, Principle 6: Customers’ interests (or “Treating Customers Fairly – TCF”) may be where the “Irresistible Force” collides with the “Immovable Object”. Unlike unproven and radical new measures (probably requiring a global political consensus) like breaking up giant platforms or preventing them making multiple acquisitions of potential challengers, this area of potential conflict arises from laws already enacted and conduct principles in place for all business models. Customers being treated fairly should fully understand the features, benefits, risks and costs of the financial products they buy.  TCF also aims to minimise the sale of unsuitable products by encouraging best practice before, during and after a sale. The FCA sets out six core customer outcomes that it wishes to see as a result of the TCF initiative. These are:

Outcome 1 – Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture

Outcome 2 – Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly

Outcome 3 – Consumers are provided with clear information and kept appropriately informed before, during and after the point of sale

Outcome 4 – Where consumers receive advice, the advice is suitable and takes account of their circumstances

Outcome 5 – Consumers are provided with products that perform as firms have led them to expect, and the associated service is of an acceptable standard and as they have been led to expect

Outcome 6 – Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint

In an Open Banking Ecosystem, customers may start browsing the market on a Platform and conclude that process with the purchase of a financial product from an App Developer on that Platform. Conversely, the journey could start on an App and end on the Platform. With customer consent, data could be shared between Platforms and Apps. Platforms Owners could compete with Apps on their Platforms to sell to the same customer. While this will create the dynamic innovation and competition that Regulators seek, this environment will inevitably blur the boundaries of regulated organisations and create new conduct risk/ethical dilemmas. Regulators don’t want innovative ecosystems or fair outcomes for customers, they want innovative ecosystems and fair outcomes for customers. If this new market structure doesn’t consistently produce the desired outcomes set out under principles such as TCF, the “Irresistible Force” and the “Immovable Object” are likely to collide in the shorter term.

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