How can regulation keep up as technological innovation races ahead?

By

Kara Cauter

EY EMEIA Capital Markets Advisory Partner

Capital markets regulatory leader. Technology led transformation of compliance and control. Committed advocate of women and children. Open minded and outspoken. Gourmet gardener. Runner. Wife. Mother.

5 minute read 1 Aug 2018

As technology disrupts financial services, regulators and the industry must ensure customer safety without stifling innovation.

The technology revolution has changed every aspect of financial markets. For consumers, this transformation has made financial services more affordable, accessible and tailored to our individual needs. For financial institutions, digital tools, including emerging technologies such as artificial intelligence (AI), robotics, analytics, and distributed ledger technology, have delivered huge opportunities to radically improve the efficiency and effectiveness of risk management, while reducing costs and better meeting the needs of customers. Digital platforms have also allowed traditional players to adapt old business models, offering new products and services, while also allowing an entirely new tranche of nontraditional competitors to accelerate the disruption of the sector.

But while the technological changes sweeping the financial markets have brought clear benefits to both industry players and consumers, they’ve also raised fundamental questions around how regulation should adapt. For an industry still finalizing reforms introduced after the global financial crisis, the rise of FinTech presents another a new round of challenges. It’s time for financial institutions and regulators alike to ask: How can we build a regulatory environment fit for a digital future?

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Chapter 1

Technology offers potential to make financial markets safer

New tools and technology for improved risk management and customer experience

It’s inevitable that new technologies introduce new risks, and new twists on old risks, as well as different ways of working. Systems can fail and undermine market stability; machines can make decisions with unintended consequences that harm customers and markets; and the almost limitless data that is the lifeblood of the digital world can be manipulated, misused, stolen or, because of its sheer volume and complexity, even inadvertently disguise criminal behavior. But new technologies also offer significant opportunities to improve risk management and enhance the efficiency, safety, and soundness of markets.

Financial services firms are tapping into new tools to strengthen risk management and compliance, while improving the customer experience:

  • Open banking enabled by application programming interface platforms (APIs) allows multiple firms to interact and access and update data to deliver new customer services.
  • A combination of algorithms and natural language processing (NLP) delivers financial advice. These advanced machines can also “read” news and digital information sources to evolve strategies, initiate trades and analyze market and customer activity.
  • Distributed ledger technologies (DLT) are underpinning new methods of record-keeping and transacting and even new mediums of exchange.
  • Artificial intelligence combined with other tools is enhancing the scope and effectiveness of monitoring and surveillance tools that seek out fraud, market abuse and money laundering, and extending the scope and quality of controls application and testing.

Regulators are also exploring how to use technology in their role:

  • Using machine learning to enhance surveillance of market activity and check the validity and accuracy of reports and models that firms submit to them.
  • Some are considering how digitization and automation could change the way regulations are written, distributed and complied with.
  • Others, along with governments, have or plan centralized digital records of individual and company identities, i.e., “digital passports,” which can accelerate onboarding of clients to new institutions and services.
  • Regulators are also doing what they can to facilitate new technology-driven business as well as supervise it. Many are establishing regulatory “sandboxes” – innovation hubs – to test new, technology-led services in safe environments where possible harm to markets or consumers can be limited.

Finally, regulators are also analyzing new products such as cryptocurrencies to determine whether these products should be covered by existing regulations for other financial activities or products, or defined as a new asset and subject to new rules.

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Chapter2

Time to ask new questions about old risk principles

Requirements for a transparent, balanced, and connected risk management ecosystem

But despite positive moves to deploy technology to improve the security and efficiency of global financial markets, it’s still early days. Both industry and regulators are struggling with fundamental questions around how to identify and describe the risks posed by new technologies and new ways of doing business.

Delivering regulatory answers fit for a digital future will call on all market participants to revisit old principles, ask new questions and work together. Building a transparent, balanced, and connected risk management ecosystem will require:

  • Collaboration in compliance: Scale, consistency and investment create conditions that encourage technological improvements, and support market-wide benefits, as well as greater risk management. But, scarce resources, limited reach and fragmented processes constrain investment by individual firms. Collaboration across the sector can overcome these issues.
  • Standardization to speed the path: Digital tools are built on rules and algorithms, fed by data. But inconsistent and unclear definitions and standards for data, which is nearly always held in silos or defined under different taxonomies, are hampering opportunities to deploy new technology where it could be most effective: in providing market-wide services and solutions.
  • Rethinking accountability and transparency to share the load: Senior bankers have no doubt that they will be held accountable for their organizations’ failings, large and small. But it’s time to rethink the parameters of accountability. When third parties have access to outsourced services data and when more decisions are made, or influenced, by AI, who is responsible for breaches?
  • Reassessing risk management to accelerate progress: New technologies are generating both new risks and new ways in which old risks can arise. But traditional risk management is built around quantifiable factors such as market, credit and liquidity risks. Digitized financial markets require a reimagining of these basic principles now that risks can manifest in milliseconds and multiply exponentially, sometimes outside the control of any single person, firm, or function.
  • Governing, not just mining, data: The growing volume of data presents financial institutions with both opportunity and risk. Customers see the benefits of faster, customized services enabled by open access to data, but their wariness of possible abuse is growing, and cloud solutions are adding a new dimension to the data ecosystem. Technology-led solutions to monitor, analyze, and protect data can match the scale and magnitude of these risks and enable their management.

We’ll explore each of these issues in greater detail in future articles.

Balancing regulation with innovation

Technological advances offer opportunities to improve the efficiency and outcomes of financial markets. But they also create new challenges in meeting regulation’s unchanging objectives: managing market instability and avoiding poor outcomes for customers and counterparties. As regulators and market participants navigate this new technological landscape, they’ll need to consider how best to both use and regulate the use of digital tools to deliver effective risk management and compliance – without stifling the innovation that can help deliver better financial services.

 

This is the first in an EY series around how the digital transformation of the financial markets offers both regulatory challenges and solutions. Watch for future articles that explore specific issues in depth.

Summary

As regulators and industry players respond to new technologies, they’ll need to balance regulation and innovation.

About this article

By

Kara Cauter

EY EMEIA Capital Markets Advisory Partner

Capital markets regulatory leader. Technology led transformation of compliance and control. Committed advocate of women and children. Open minded and outspoken. Gourmet gardener. Runner. Wife. Mother.