A common language is needed for RegTech to flourish

RegTech is being held back by a ‘linguistic disparity’ between regulated firms and technologists according to Gareth Malna, funds and financial regulation solicitor at Burges Salmon.

The global RegTech is continuing to rise in prominence, with the banking and other parts of the financial services industry undergoing an all-encompassing digital transformation.

Since the 2008 financial crisis, the sheer number and volume of regulations has forced organisations to expand their compliance teams to fulfil compliance and manage risk. With technogoly promising to ease the burden, investment in RegTech companies has grown consistently quarter on quarter, increasing 10x between Q2 2017 and Q2 2018, according to data by RegTech Analyst.

“I don’t know if that is a trend which is going to continue, however, for the foreseeable future we will continue to be in a state of regulatory flux, notably because the outcome of Brexit and where things move in that direction,” said Malna. “It is possible that at the end of the negotiating period we end up with an equivalent plus model where our regulations mirror that of the EU for a while, and then overtime, we do our own thing to benefit the UK Market.”

Three years ago, Burges Salmon decided to take a new direction and appointed a dedicated new head of FinTech. Its focus has been on looking at the market from a policy level, working closely with the FCA and Think Tanks. Based in Bristol, the law firm has also focused on building a hub of knowledge and people to showcase what the Southwest of the UK has to offer.

“The Southwest is a different proposition to likes of Manchester, Liverpool, Edinburgh, Leeds etc.  They are all doing very good things, but their primary focus has been to effectively copy what is happening in London. The cool front end of FinTech,” Malna added. “Whereas the focus in the southwest has always been on the back end, on the pipes that make everything work.”

Despite all of the early promises that RegTech has offered, Malna doesn’t see the sector replacing ‘the interpretive piece’ of the jigsaw because it is hard to code that into binary. “You are dealing with shades of grey and binary is largely dealing with black and white.”

However, Burges Salmon has been heavily involved with the FCA on the digital regulatory reporting call for input. One of the key aspects of that is trying to create a lexology or a common understanding of the rules from the outset, which can then be coded and used on the blockchain to validate to consensus on that basis.

“That is a really interesting approach to regulatory interpretation. If that takes off, the role of the regulator will change dramatically.”

The FCA, Bank of England and a number of other interested parties hosted a tech sprint last year to prove the concept could work. They took one field from a standard regulatory report (from SUP 16.12) and they coded a bit of kit to mine the data and find the relevant information according to Malna.

Whilst that was a success it was only one field in one report. “Reports have hundreds of fields and they picked a very simple field to start with, one they thought they couldeasily answer. As soon as they started to tackle the problem they realised they couldn’t even concretely define the type of firm that rule applied to.

“The concept was proven, but in practice I think we are a few years away from something that would work even on a reporting basis, let alone for overall regulatory compliance.”

For overall regulatory compliance, Malna argues there is a long way to go before the handbook can be made completely digital. The key is developing the technologies that underlie the process, however, there are a number of problems associated with that in the current market and in the process.

“They utilise a lot of semantic technologies which are in their infancy at the minute. If you are going to use the blockchain to validate the consensus of the interpretation of rules, then you need to understand the limitations of blockchain itself.

“Each of those blocks is super small, so you can store a very small of text in each one. If you need to store more information, maybe files or bits data which are broader than those cells can cope with, you need to utilise alternative blockchains. Even understanding which blockchain is going to be right for this kind of project is a big challenge.

“Then there is the issue of the amount of energy that the blockchain uses, in terms of pure electricity, to verify each block, which would be unsustainable in the context of the huge numbers of transactions that you would be trying to verify based on existing technologies.”

In terms of the RegTech market, Malna admits to seeing a number of solutions which focus on the hard requirements i.e. one that have no interpretative element to them.  However, while these platforms have a good place to work in, the industry is still in desperate need of something broader.

“There are loads of different RegTech vendors which are offering niche solutions. To truly utilise technology for regulatory compliance we need to create a simplified, global and political regulatory world where everyone agrees to the same standards, and the same could be said for the tech.”

Citing a report by JWG CEO PJ Di Giammarino, Malna said the RegTech market is full of ‘little bits of technology’ like blockchain, DLT, robo advisory, Ai, risk analytics, payment processing, computer learning. “All of that is sitting in separate little silos and it needs to be strategically applied. There needs to a common understanding”

However, one of the main issues around this is the disparity between the regulated firms and technologies according to Malna. The technologists can code whatever is needed or whatever they told, but firms cannot always tell the technologists what they want because of those ‘shades of grey’. He stressed the importance of creating a common understanding or language.

“It needs to be simplified so people can talk in a common language i.e. regulated firms are not just taking the language of MiFID II or AFIMD, and the technologists are not just taking in tech jargon.

“People need to be able to talk in a collaborative way and understand each other. As soon as technologists talk about semantic technologies, you can very quickly lose an entire room full of people. However, that technology is crucial in understanding, identifying and translating those regulations into computer codes.”

There needs to be more of a platform for collaboration in general according to Malna. “Regulators and regulated firms need to go away and think about how they can rationalise all of this. That doesn’t mean cutting back on regulations because that would be a bad thing. We have got to the current state of regulation because of what happened in 2008.

“We clearly need to have laws in place to make sure that firms are kept in check, but the current pace of change is completely unstainable.”

Adoption of RegTech has been seen by many as slow, with more people talking the tech than actually applying it.  In terms of banks, it’s a slow-moving industry and they are not comfortable making fundamental changes over night, meaning change takes time. Despite seeing a lot of regulatory change they already have a big spend on and their compliance, with costs ballooning every year.

“RegTech providers are promising to solve a host of problems for an extra cost. They can promise cost savings, but ultimately in the short term there are integration costs. Banks already have a big compliance team doing the work, they don’t want the cost of someone trying to integrate a new system on top of that.

“It comes down to selling longer term compliance savings against a short-term increased compliance costs. The problem is I don’t think anyone wants those short term increases in compliance costs.”

Copyright © 2018 RegTech Analyst

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