IMPACT OF TECHNOLOGY ON THE FINANCIAL SECTOR
Written by Lucy Frew from Kemp Little
All lawyers with financial sector (FS) clients need to focus on how technology is revolutionising the financial industry and truly reflect that in their practices. Understanding both the regulatory drivers and the regulatory response to this revolution is also key.
The massive changes currently taking place present challenges, as well as opportunities, for FS businesses and now, more than ever, the right legal support can make all the difference.
Nowadays financial services businesses really need a law firm that truly understands the interrelationship between technology, regulation and the FS, and can provide integrated expertise in all these areas.
Technology’s impact on business models
Technology is revolutionising the way that the financial industry operates. Rapidly accelerating technological advances are creating entirely new business propositions, such as crowd-funding, peer-to-peer lending, digital currencies, mobile banking, online investment and new payment systems.
Technology has created a massive increase in the availability and use of data and social media, shaping customer expectations and the ability of financial institutions to use consumer data to price, target and market their products and services.
FS businesses are adopting new technologies to compete. Client demand for online access is causing a shift towards more direct and immediate interaction with financial products and services. Technological changes increasingly allow consumers to manage their own savings and investments and firms need to demonstrate how they add value.
However, in its Risk Outlook 2014, the FCA acknowledges a risk that consumers will make “impulsive or ill-informed decisions due to more direct, more frequent and faster interaction with financial services”. Lawyers need to help firms navigate between serving client demand and mitigating risk.
Regulatory drivers for innovation
Regulators need to grapple with how to respond to the impact of technological advances on the financial sector. For the moment, at least, the UK FCA is embracing the technology revolution. Martin Wheatley, the FCA’s Chief Executive, has announced that the FCA is considering “sweeping change” with a major consultation into how the FCA can encourage innovation in the financial services market. This will look at whether it does enough to promote competition and create room for new entrants into the market, particularly those with novel business models, and whether FCA regulation serves the needs of innovative businesses.
The FCA is also consulting on some “big ticket, advice-related” changes. It raises the possibility for new online business models where the firm might not have to comply with full regulatory safeguards.
This could have major implications all round and is an area where lawyers need to keep a close eye on developments.
Technology’s impact on regulatory compliance
Firms are increasingly relying on technology in adapting to regulatory reforms. The bar is much higher than it was and demonstrating regulatory compliance is challenging.
This trend is increasingly pronounced as firms across the globe work out how to meet the challenges of the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US and the European Market Infrastructure Regulation (EMIR), which focus on the trading of derivatives and the clearing of trades, and incoming MIFIR/MIFID II reforms of the framework for the investment sector in the EU. Businesses, with the assistance of their lawyers, already need to plan how best to comply with, and capitalise on, the changes ahead of the finalisation of the EU implementing legislation.
The timelines for regulatory reforms frequently mean that firms are being required to commit significant resources to implement changes speedily while navigating potential uncertainty around the requirements and determining what the requirements actually are in practice.
Also, firms’ compliance needs to run through their businesses in an integrated manner, so that all aspects from IT and operations through senior management to front office and marketing and outsourced functions communicate with each other and understand what is required of them.
While some existing businesses and new challengers are already well along the path to executing business plans that capitalise on technological advances and current and incoming regulatory changes, others are grappling with how best to position themselves and allocate resources in the most efficient way. This is an area where lawyers offering combined technology and regulatory foresight can really help.
Risks as well as benefits
Although technology undoubtedly brings benefits, high-profile technical failures in the financial sector in recent years are alarming, with adverse implications on market integrity, consumer outcomes and firms’ reputations.
The FCA is concerned that technological advances increase firms’ dependence on underlying systems, resulting in exposure to the disruption in ways that can prove costly. Lawyers need to help firms implement effective oversight and controls for increasingly complex systems. The controls themselves need to be constantly reviewed to ensure they keep up with changing technology and regulatory requirements such as EMIR and MIFIR/MiFID II to ensure issues are minimal and can be resolved quickly.
Another major issue is that despite the publicity which cybersecurity has garnered, the risk has still not been countered effectively. Most institutions are vulnerable and do not have effective controls and frameworks in place to mitigate these risks. The rise of cybercrime requires firms to invest significantly to improve controls. The adequacy of businesses’ cybercrime prevention measures are firmly within the sights of regulators.
Another area of regulatory focus is the increasing interconnectedness of regulated and non-regulated activities (for example, firms outside the regulatory perimeter providing technological solutions or platforms for services that are regulated).
The FCA, in its Risk Outlook 2014, has identified technological developments as a key risk to its objectives. Meanwhile, at EU level, the Joint Committee of the European Supervisory Authorities has identified IT-related operational risks as key risks to the stability of the European financial system in its report published on 2 April.
The key message for firms is that the impact of technology on the financial sector is increasingly a central focus for regulators. The FCA expects firms to look at their business models, strategies and structure to ensure they can identify and manage the root causes of technological risk. It will make judgements about senior management and firms and intervene, including by taking enforcement action, where appropriate.
Lawyers offering integrated technology and financial regulatory expertise will be those best-placed to help businesses minimise exposure to potential regulatory, financial and reputational issues while capitalising on the benefits that technology brings.