How Can Regulation Keep Up as Technological Innovation Races Ahead?
Technology advances have 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 and analytics, have delivered huge opportunities to radically improve the efficiency and effectiveness of risk management, while reducing costs and better meeting the needs of customers.
However, these advances have also raised fundamental questions around how regulation should adapt. For an industry still finalizing reforms introduced after the global financial crisis, financial technology and innovation present a new round of challenges. That’s why it’s time for financial institutions and regulators to ask: How can we build a regulatory environment fit for a digital future? Below Kara Cauter, Partner, Financial Services, Advisory Ernst & Young LLP UK, answers the hard question.
Technology’s potential to make financial markets safer
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 inadvertently disguise criminal behavior. But new technologies also offer significant opportunities to improve risk management and enhance the efficiency, safety and soundness of markets and convenience to consumers.
As a result, financial services firms are constantly tapping into new tools to improve the customer experience and strengthen risk management and compliance:
- Open banking, enabled by application programming interface (API) platforms, allows multiple firms to interact, 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, transacting and new mediums of exchange.
- AI, combined with other tools, is enhancing the scope and effectiveness of monitoring and surveillance tools that seek out fraud, market abuse and money laundering, 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, while others (including governments) are incorporating centralized digital records of individual and company identities (i.e. digital passports to accelerate the onboarding of new clients to new services).
- Many regulators 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.
- New products such as cryptocurrenciesare also being analyzed to determine whether they should be covered by existing regulations for other financial activities or products, or defined as a new asset and subject to new rules.
Time to ask new questions about old risk principles
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 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: Traditional risk management is built around quantifiable factors such as market, credit and liquidity risks. However, 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: 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.
Ultimately, as regulators and market participants navigate the FinTech landscape, they’ll need to consider how to best use and regulate the use of digital tools to deliver effective risk management and compliance – without stifling the innovation that can help deliver better and secure financial services.