Check against delivery.

Ladies and Gentlemen,

There are fairly precise accounts of what happened on the evening of 28 December 1895 in the Grand Café on the Boulevard des Capucines in Paris. The Lumière brothers brought moving pictures to the big screen for the first time. According to reports, 33 onlookers gathered in the Salon Indien in the basement of the café. It is said that the organisers were not exactly thrilled by the lack of interest. After all, they had gone to the trouble of setting up seating for 100 people in the converted billiard room especially for the occasion. Nevertheless, it was to be a memorable evening.¹ The audience were present for the turn of an era: the birth of cinema. Here in Paris.

We are currently experiencing the turn of an era in the financial sector, too. New, digital technologies are changing the industry and thereby the capital markets at an unprecedented rate. Indeed, many people expect these technologies to cause a major transformation, with traditional intermediaries – such as banks or central counterparties in securities transactions – being driven out by open networks, such as open blockchain technologies, for example.

Those who are particularly eager for such a development to occur take exception to the power they feel these intermediaries wield. They believe that the trust required for financial transactions should in future be ensured by technology – like blockchain – rather than by institutions. Whatever you might think of these ideas, one thing is clear: if a blockchain economy, i.e. decentralised ecosystems, really were to largely come to pass, the financial world would look very different from the one we know today. The same is true for your jobs and the work processes you interact with on a daily basis. But not just yours! Regulation and supervision would certainly require an update too.

As yet, nobody can say whether the dreams of a financial world free of intermediaries are nothing more than hype or are actually realistic scenarios for the future. Alongside technological developments, much will depend on the direction politics takes over the next few years. At the moment, the trend is leaning towards “more regulatory intervention” in the trading and distribution of cryptoassets.

Even from within the blockchain scene there are calls for regulators to redouble their efforts in dealing with the increasing number of market abuse cases that come up time and again in, for example, the area of money laundering. Although I personally believe that the financial markets will never manage to do without intermediaries completely, there is one thing that we must not turn a blind eye to: financial markets will change – one way or the other. These changes will be propelled in particular by the increasing use of artificial intelligence (AI) and distributed ledger technology (DLT), which we have already mentioned.

What does this mean specifically for you as an industry and for us as supervisors and regulators? We all need to carry out a full review of our structures and processes. Companies need to consider which business models and processes will allow them to be successful in the long term in an increasingly digital financial word. Regulators and supervisors, in turn, need to ensure the continued stability and integrity of the financial markets under completely different conditions. Let me reflect on three basic but quite fundamental supervisory and regulatory issues.

1. Who is supervision targeted at?

First of all, let us think about the questions of who supervisory measures are targeted at and who we can address future supervisory communication to. At present, there is a comparatively low level of outsourcing in financial services. This means that the majority of the work is still carried out in-house, and – to a limited degree - processes are outsourced to third parties. However, outsourcing is becoming increasingly important in the financial industry too. This is a development that will accelerate even further in the future. And in extreme cases this could lead to many of the services in the financial sector being performed by just a small group of technology companies.

And when I look at securities trading specifically, it is clear that even now vast amounts of data are processed and analysed by automated systems on a very large scale – and in a very sophisticated manner. But the end of the road is not yet in sight. The use of automation and algorithms will rise at an increasing rate, both in organisation and in trading. The corresponding processes will thereby become even more efficient and even more effective. At the same time, we will witness new players arriving on this market too, such as small, agile fintech and technology companies.

What does all this mean for regulation and supervision? New types of risks could develop under the supervisory radar, and in extreme cases these risks could jeopardise financial stability itself. For instance, the emergence of major platforms run by very large technology firms could create new data monopolies upon which financial institutions are increasingly dependent. Equally, disintermediation in traditionally integrated value chains in the provision of financial services will continue and an ever-increasing number of service providers could fall outside the scope of financial regulation. We would therefore be well advised to consider whether and to what extent we should formulate specific requirements for certain service providers, in particular cloud service providers, focusing on relevant activities as opposed to supervising whole entities. The supervisory toolbox has to be adjusted to serve both stability and a level playing field.

I therefore welcome the work of the Joint Committee of the European Supervisory Authorities (ESAs) and the European Commission to develop an appropriate oversight framework for monitoring third-party providers that are critical for relevant entities.²

2. Is the principle of human responsibility safeguarded?

Ladies and Gentlemen,

The increasing displacement of human decision-makers by algorithms or other forms of artificial intelligence also presents us with a range of additional fundamental questions. One of these questions concerns the integrated analysis and portfolio management platforms that are already being used on the capital markets. If portfolio analysis ends up using algorithms with little or no transparency, there is a serious danger of delays in the discovery of errors and of mistakes in the assessment of models.

Depending on how integrated these systems are, errors could have far-reaching repercussions resulting in severe losses.

But what are the consequences of errors caused by algorithms in such complex, integrated systems? Can the manager of a company then say, “it wasn’t me, it was the algorithm”? In my view: no! As German supervisors, we at BaFin will do everything we can to uphold the principle that humans must bear responsibility, even when innovative technologies are used in complex, integrated systems. But this brings with it the difficult question of how we can ensure the traceability and explainability of algorithms if they are based on artificial intelligence. The more complex the underlying artificial intelligence is, the more difficult it becomes to actually achieve the goal of explainability.

3. How is the time frame changing?

The last aspect I want to highlight relates to the question: How long will supervisory approvals be valid in future if artificial intelligence and machine learning increasingly determine the pace of events in the financial world as well?

Let’s explore, to pick an example, what this would mean in the context of internal models for determining regulatory capital requirements that are subject to approval. Self-learning elements that continuously evolve may change the functioning of a model that we have just approved into something quite different, even while the ink of our signature on the approval letter is still drying.

We will therefore have no choice but to re-define principles we use to decide whether a modification is enough to constitute a model change in the supervisory sense, in a world dominated by Artificial Intelligence. And we have to define how much a model has to change before a bank or insurer has to get straight back to us again. It will not be easy to find answers to these types of questions. At a very general level, we may have to develop assessment procedures in the future that focus more on the outputs or output corridors of models rather than on their design or input factors.

Ladies and Gentlemen,

The digitalisation of the financial markets by way of artificial intelligence and DLT, and the way in which these technologies have penetrated the industry, is a game changer for companies and for supervisors and regulators alike. Frequent communication and discussion, for instance at our regular BaFin Tech conferences, has proven invaluable.

It is with great interest that I have observed a number of authorities, both in Germany and abroad, joining forces with private companies over the past year or two to form public-private partnerships in order to get projects to experiment with artificial intelligence underway. And this is a path we have also taken here at BaFin: around two months ago, we launched the Anti Financial Crime Alliance (AFCA) together with the Financial Intelligence Unit (FIU), the Federal Criminal Police Office (Bundeskriminalamt) and 14 banks. As a public-private partnership, we are seeking to strengthen and coordinate the fight against money laundering and terrorist financing. Here too, we believe that exchanging and evaluating information on an ongoing basis and on a large data pool is perhaps the decisive factor for success.

Ladies and Gentlemen,

To conclude, let us now turn back to the Lumière brothers and to the chain of events that started here in Paris around 125 years ago: the success story of cinema. The film industry has experienced its share of upheavals since then too – and occasionally a major transformation. The first film made by the Lumière brothers was short, silent, simple and in black and white. Modern blockbusters have sound, of course. And they are much longer and in full colour, and often have an abundance of special effects. All of it – the past and the present – is still cinema, without a doubt. But the protagonists who were part of that world had to constantly evolve in order to continue their success.
And the situation is the same in the world of finance, which is likewise undergoing a transformation. Only those who evolve with the times will be able to stay on the road to success.

Thank you for your attention. I look forward to your questions.

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