Artificial intelligence in financial services - new report by Finance Watch

Today, Finance Watch, a non-profit association dedicated to reforming finance in the interest of European citizens, published a new report: 'Artificial intelligence in finance: how to trust a black box?' authored by its Chief Economist Thierry Philipponnat.

As AI-powered systems increasingly drive financial decision-making in areas such as creditworthiness assessments, insurance pricing and investment products, the report asserts that the core principles of financial regulation accountability, responsibility, and transparency are being tested.

Against this backdrop, the report identifies several critical concerns: 

• Lack of transparency: AI models operate as “black boxes”, generating outputs without clear explanations of their reasoning, making human oversight and intervention impossible.
• Consumer protection under threat: In retail finance, the deployment of AI could lead to opaque creditworthiness assessments (see for an example here), pricing discrimination, discriminatory lending, and misleading financial advice. 
• Supervisors face AI challenges: Supervisors tasked with enforcing regulation face challenges in keeping pace with financial institutions' deployment of AI and delivering on their mandates.
• Market stability is at risk: Increasingly dependent on third-party AI providers, financial institutions face operational risks from unregulated external systems and concentration risks, where a handful of dominant AI firms control critical models and infrastructure, creating systemic vulnerabilities. 

As a response, the report urges a reassessment of the financial regulation framework: 

1. Expand the scope of the AI Act to cover all financial services
2. Establish a clear liability regime that holds providers of AI-powered services accountable for damages caused by an output of an AI system
3. Conduct a regulatory gap analysis to ensure all AI-driven financial activities are adequately regulated.

Financial expertise does not preclude qualification as consumer – CJEU in Petruchová (C-208/18)

Yesterday, the CJEU issued a judgment in the case C-208/18 Jana Petruchová v FIBO Group Holdings Limited (the case has not yet been published in English; the link refers to the French version). The case concerns an individual contract for difference (CfD) concluded between the claimant and the defendant and, particularly, the definition of a ‘consumer’ in the context of financial investments under Article 17(1) of the Brussels Regulation. The preliminary question referred to the CJEU was whether Article 17(1) of the Brussels Regulation should be interpreted as meaning that a person who engages in the trade of foreign currency exchange is a consumer or whether the individual’s financial knowledge and expertise, the complex nature of the contract, and the risks involved determine that that person is not a consumer. A summary of the facts of the case and an analysis of AG Tanchev’s opinion can be found here.

It is noteworthy that the defendant never argued that the claimant was acting in the sphere of her professional activities (para 46). In fact, the claimant was, at the time of the conclusion of the contract, a university student, which leads the CJEU to immediately ascertain that the contract was not concluded within the scope of the claimant’s professional activities. Instead, the argument is that the professional nature of the contract is not the only criterion that matters when determining whether a party qualifies as a consumer. However, just like AG Tanchev, the CJEU rejected this argument. The CJEU declared that factors such as the amounts involved in the financial transactions, the risks of financial losses associated with such contracts, the financial knowledge or expertise that the person might have or its active engagement in such financial operations are irrelevant in the qualification of a person as a consumer (para 59). In this sense, the CJEU reaffirmed that the crucial test is whether the contract relates to the person’s professional activities or whether the contract’s goal is to satisfy the individual’s personal needs (para 56).

This conclusion is not surprising, since the CJEU had already established (for example, in the Schrems case) that the concept of consumer has an objective character and that it is not connected with subjective aspects such as the particular knowledge that the individual has about the object of the contract (para 55).

Furthermore, the CJEU concluded that even though the definitions of a ‘consumer’ present in other EU legislative instruments are interpretively relevant (para 61), the fact that financial instruments are excluded from the scope of the Rome I Regulation is irrelevant in this case, since the two Regulations pursue different goals (para 64). The qualification of an individual as a ‘retail client’ is also irrelevant for the qualification as a consumer (para 77).

Tecnoservice judgment (C-245/18): Payment services providers not liable for payer's incorrectly provided IBAN

On the 21st of March, the ECJ published its judgement in the Tecnoservice case (C-245/18) on the Payment Services Directive (PSD1), which can have interesting repercussions for everyday payments. The case revolved around a payment made to a wrong payee, an occasion feared by most consumers when making a payment in a bank, even though it is not as common. Should the bank warn you about such a mistake, if it is clear that the name of the payee and the account number do not match, and would it be hold liable if it does not but simply proceeds with a transaction?

A debtor of Tecnoservice, an Italian company in liquidation, made an order for payment via a bank transfer in a branch of Poste Italiane. The transfer order stated the name of the account holder, as well as the international bank account number (‘IBAN’).

The transfer was made to the IBAN number provided, which, however, did not correspond with Tecnoservice, meaning the payment went to another account. Tecnoservice proceeded to bring an action against Poste Italiane for failing to check whether the IBAN provided corresponded to the account holder's name. Poste Italiane argued they transferred to the IBAN provided and were not required to conduct any additional checks.

Articles 74 and 75 of Directive 2007/64, which were in force at the time of the dispute (now replaced by Directive 2015/2366), regulate such errors.

Article 74 of Directive 2007/64, entitled ‘Incorrect unique identifiers’, provides:

‘1. If a payment order is executed in accordance with the unique identifier, the payment order shall be deemed to have been executed correctly with regard to the payee specified by the unique identifier.

2. If the unique identifier provided by the payment service user is incorrect, the payment service provider shall not be liable under Article 75 for non-execution or defective execution of the payment transaction.

However, the payer’s payment service provider shall make reasonable efforts to recover the funds involved in the payment transaction.

3.      If the payment service user provides information additional to that specified in Articles 37(1)(a) or 42(2)(b),he payment service provider shall be liable only for the execution of payment transactions in accordance with the unique identifier provided by the payment service user.’

Article 75 of the directive, entitled ‘Non-execution or defective execution’, provides, in essence, in paragraphs 1 and 2, that the liability established by those paragraphs is ‘without prejudice to ... Article 74(2) and (3)’ of the directive.

The referring court asked whether articles 74 and 75 must be interpreted as being applicable only to the payment service provider of the person who ordered the payment, or as being applicable also to the payee’s payment service provider?’

As the main question of the referring court related to the interpretation of art. 74(2), namely the case where the unique identifier provided (IBAN) is incorrect, the Court focused on that provision. According to the Court, the use of the term 'payment service provider' in that article should include both providers involved (payer's and payee's) as no other distinction is being made (para. 25). This means the limitation of liability applies to both.

Conversely, the second subparagraph of art. 74(2) states that it is only the payer’s payment service provider that shall make reasonable efforts to recover the funds. Therefore, if there was an intention to limit the applicability of also the first subparagraph of art. 74(2), it could have specified only the payer's payment service provider, as well (para 27).

Following that, the Court decided that the limitation of liability provided for by art. 74(2) of Directive 2007/64 in the case of a payment order executed where the unique identifier and the payee name provided do not match, applies to both payer’s and payee’s payment service providers. (para 31).

However, the Court made sure to point out that thet MS can require payment services provider of the payer to act with due diligence in order to correct such mistakes.

So, you've been warned, payment services providers will not be held accountable for mismatching IBAN and account holder names!

FCA report on debt management firms: A long way to go to address consumer vulnerabiltiy

On 15^th March 2019, the UK regulator for financial services, the Financial Conduct Authority (FCA) published a report on consumers and debt management firms. The report focused on the impact of advice provided by debt management firms to vulnerable consumers. This report comes shortly after the publication of the Access To Cash review report on the declining use of cash in Britain and its impact on vulnerable consumers (you can read the blog post on that report here.  

This publication is a follow-up on the 2015 review of the sector conducted by the FCA. The FCA is a newly established authority and these reviews have the dual aim of assisting the FCA in gaining a better understanding of the sector as well as an nudge to traders to increase their standards (though the report does not set any goals). For the report a sample of 12 firms was selected including both commercial debt management firms and not-for-profit debt advice bodies.

The results of the 2015 review were grim, exposing an unacceptably low standard of services, especially by commercial fee paying firms and a high risk of detriment for vulnerable consumers. Has the situation improved since then?

The 2019 report shows that there has been an improvement, and commercial firms tend to be more customer-focused now, compared to a few years ago. However, there is still a long way to go for improving standards in the area. The two main areas identified for improvement are:

1) Debt advice given to customers seeking help together or who are already on a joint debt management plan.

Firms often treat consumers as a unit and fail to provide them with options that apply only to one of them, meaning they may lose out on a more favourable solution.

2) The identification and treatment of vulnerable customers. 

While most firms have good intentions, they do not have the proper procedures in place, quality assurance and staff training for identifying and assisting vulnerable consumers in an appropriate manner. Consumers’ vulnerability or vulnerabilities may go unnoticed or unrecorded. Worse yet, it may be identified only to later be buried under a pile of documents or processes and not accessible to the next person handling the case. 

Identifying consumer vulnerability has a severe impact on the advice that should be provided to these consumers and how they will respond to it. Firms need to take the circumstances of each consumer into account, also in the advice provided.

Furthermore, the report point out that there is no one-size-fits-all when addressing vulnerability and firms should be flexible and be able to adapt to the needs of vulnerable consumers where necessary. Some firms have done that successfully by creating specialist units that receive further training and had greater autonomy within the company on how the communicate with customers. Such specialist units could be key in addressing the needs of vulnerable consumers.

The report is a welcome development to bring attention to the needs of vulnerable consumers of financial services and the FCA is showing its commitment to pursue this agenda further by taking action against firms as well as publishing a new guidance on vulnerable consumers.

National courts are not obliged to review unfair practices during mortgage enforcement proceedings - CJEU in Bankia

On 19th September 2018, the ECJ issued its ruling on the Bankia case (Case C‑109/17). The case concerned the application of the Unfair Commercial Practices Directive in mortgage enforcement proceedings and gave the Court the opportunity to comment on the different mechanisms used by the Unfair Commercial Practices Directive and the Unfair Contract Terms Directive (hereafter UCPD and UCTD respectively).

This blog has previously covered also the AG opinion on this case. You can find the previous post here.

Facts of the case

In 2006 Mr Marí Merino, Mr Gavilán and Ms Marí Merino took out a loan with Bankia secured by a mortgage in respect of a capital of EUR 166 000, repayable over a 25-year period. That agreement set the amount of the ‘starting price’ of the mortgaged property at EUR 195 900.

In 2013,  after a second novation, the amount of the starting price of the property was reduced to EUR 57 689 and the period for repayment of the outstanding loan capital of EUR 102 750 was extended to 40 years. In addition, the extrajudicial sale of the property was authorised and the agreement now states that that property is the habitual residence of Mr Marí Merino, Mr Gavilán and Ms Marí Merino.

Bankia used that novated loan agreement secured by a mortgage to initiate mortgage enforcement proceedings. Mr Marí Merino, Mr Gavilán and Ms Marí Merino lodged an objection to those proceedings claiming that the agreement contained unfair terms. First, the amount of the starting price was reduced to their detriment, with the extension of the period for repayment being merely a means of inducing the borrowers to accept the novation of the agreement. 

Furthermore, they argued that Bankia acted in a way that was contrary to the requirements of professional diligence inasmuch as it took advantage of restructuring the debt in order to alter the valuation of the property in question, meaning that Bankia employed an unfair practice.

Finally, Bankia was not adhering to the Code of Good Banking Practice, by which it is bound, by not allowing the borrowers to discharge the debt by giving the property in payment while remaining there as tenants, even though they satisfied the conditions set in the Code for doing so. 

Questions referred

The following questions were referred to the ECJ:

1)    Must Directive 2005/29 be interpreted as meaning that national legislation such as that currently regulating Spanish mortgage enforcement — Article 695 et seq. in conjunction with Article 552(1) of the [Law of Civil Procedure] — which does not provide for the review by the courts, of their own motion or at the request of one of the parties, of unfair commercial practices, is contrary to Article 11 of that directive because that national legislation hinders or prevents review by the courts of contracts or acts which may contain unfair commercial practices?

(     2)    Must Directive 2005/29 be interpreted as meaning that national legislation such as the Spanish law which does not ensure actual compliance with the code of conduct if the party seeking enforcement of a debt decides not to apply that code (Articles 5 and 6 of Royal Decree-Law No 6 of 9 March 2012, read in conjunction with Article 15 thereof) is contrary to Article 11 of that directive?

(     3)    Must Article 11 of Directive 2005/29 be interpreted as precluding Spanish national legislation which does not allow a consumer, during mortgage enforcement proceedings, to request compliance with a code of conduct, in particular as regards the giving of a property in payment and extinguishment of the debt — Point 3 of the Annex to Royal Decree-Law No 6 of 9 March 2012, Code of Good [Banking] Practice?’

Review of unfair practices in mortgage enforcement proceedings

The first question is asking whether national law which prohibits the review of unfair commercial practices is contrary to art. 11 UCPD. The Court pointed out that the UCPD prohibits unfair practices, but leaves it to the discretion of the Member States to decide what measures to use to combat unfair practices. Such national measures need to be adequate and effective and that the penalties thus laid down are effective, proportionate and dissuasive (para 31). Furthermore, the Court underlines that the UCPD is without prejudice to national contract law and individual legal action, as set out in art. 3(2) UCPD.

Therefore, the ECJ found that it is not necessary for national courts during mortgage enforcement proceedings to be able to review whether the enforceable instrument breaches the UCPD, as the UCPD does not place such an obligation on the Member States (para 34).

The Court elaborates on the differences between the well-known Aziz case, also concerning mortgage enforcement proceedings in Spain and the present one, as well as the differences between UCTD and UCPD. It states that both the UCTD and the UCPD aim to ensure a high level of protection; however, each one pursues that objective using different means (para 36).

The reasoning put forward by the Court is that the UCTD clearly sets out in art.6 UCTD that unfair terms are not to be binding on the consumer, while the UCPD merely prohibits unfair practices (paras 37, 41). The UCTD seeks to address the inequality of power between the parties which is created by the unfair term, while the UCPD only seeks to put an end to unfair practices, without an impact on the validity of the contract. 

Contrary to Aziz, where compensatory protection was found to not meet the requirements of art. 7(1) UCTD, in the case of unfair practices, compensatory protection can be sufficient (paras 45-46). Still, the Court clarifies that it is possible for the unfairness of practices to be considered during mortgage enforcement proceedings in the context of review of unfair terms. As established in Pereničová and Perenic the finding of an unfair practice doesn't have a direct effect on the validity of the contract (paras 49-50).

For the first question, the court agrees with the AG opinion that the answer to the first question should be negative.

Codes of Conduct

The second and third questions referred to codes of conduct, and whether national law which does not confer a legally binding nature to a code of conduct is contrary to art. 10 UCPD. The Court notes that it is not up to them to establish whether the Code in question falls under the definition of code in art. 2(f) UCPD.

The court stated that even though non compliance with a code may constitute an unfair practice, the UCPD does not require for the Member States to provide for direct consequences when the traders do not adhere to the code they subscribed to (para 58). This decision undermines the effect of codes of conduct, if traders face no consequences when they do not adhere to them. More precisely, it transfers that responsibility to the Member States, even though the UCPD is a maximum harmonisation directive and intended to strengthen the relevance of codes of conduct.

This judgement appears to weaken the importance of the UCPD, making it clear that it is less able to protect individual consumers than the Unfair Contract Terms Directive. While the judgement is firmly based in the letter of the law, it shows the resulting gaps in protection and the need for individual remedies for the UCPD, in order to achieve the proposed aim of a high level of consumer protection.