Is Regulator Innovation Coming to the Boil? - Lombard Risk

Is Regulator Innovation Coming to the Boil? By James Phillips, Regulatory Reporting Strategy Advisor, Consultant to VERMEG

Regulator Innovation

As a leader in the provision of Regulatory Reporting solutions, VERMEG is at the forefront of innovation in this area.  VERMEG has an active innovation agenda which is both invested in and influences the evolution of how reporting is done.  But, what about how regulation is done, what Regulator Innovation is being enabled by technology changes?  This is the Supervisory Technology “SupTech” phenomenon, and SupTech is going to increase capacity and enable more to be done with the same or less resources.

What’s being regulated, and the FinTech impact

It can have escaped no-one’s attention that transformative technology has generated FinTech innovations on every dimension.  These innovations have brought new services to consumers, disrupted how payments are done, created mobile wallets, automated capital markets and institutional trading and core banking infrastructure and have digitalised banking services.  Regulators have not been blind to the consequent new risks arising in the financial system, but the pace at which they have needed to adapt has been challenging.

The Regulator Innovation response

In response, there is now an explosive array of regulator initiatives from sandboxes to techsprints (coined as regulator-friendly language for a hackathon) and proofs of concept with academia and industry RegTech providers all probing how the new paradigm might work.  What is next, and imminent, is the coming together of these, as regulators themselves now collaborate.

Regulator’s tools

In the run-up to where we are now, there have been evolving phases of technology available to regulators.  Existing legacy tooling includes 1st generation data management and workflows, requiring careful manual intervention.  Then at the 2nd generation there is a layer of innovation which digitises existing workflows, making life easier and a little less manual, but this does not break new ground.  More recently, 3rd generation solutions are focussing on collecting data (i.e. Big Data technologies, coming of age for Cloud, substantive use of APIs and Robotic Process Automation) and 4th generation, to analyse data (i.e. leaning now on Artificial Intelligence, Machine Learning, and multiple other technology innovations including e.g. practical applications for natural language processing, image recognition and neural networks).  These 3rd and 4th layers are the breakthroughs that will open up a more actionable supervisory environment.  There are others too, not least machine-readable regulation which I will place in a 5th generation, to come – but to come soon.

Regulator project work

In terms of what’s actually happening, a recent report [FSI Insight 9 1] by the Financial Stability Institute (hosted by BCBS at Basel, to foster international regulatory coordination and development of best practice) includes a mass of evidence of SupTech projects.  Almost half the regulators in FSI’s study already have or are developing a SupTech strategy.  So this means half have not, presumably still making do with 1st generation tooling.  Of those embracing SupTech strategically, some have roadmaps targeting data collection, data de-duplication and data analysis.  Others have a proactive but sometimes ad hoc attitude to the use of regulator tools such as labs, accelerators and techsprints.  For these, regulators have leveraged their convening power to harvest significant input from financial institutions and the private sector.  VERMEG has participated in innovation tracks such as this, in the case of the UK regulator’s Digital Regulatory Reporting (DRR) project.

The use cases that are now capturing industry attention are those underpinned by Big Data (BD) and Artificial Intelligence (AI) technologies, with emphasis on gaining wins in misconduct analysis, reporting, and data management.  Huge amounts of unstructured data can now be handled by BD and AI tools, assisting with conduct supervision, potentially leading to outcomes which will define a new normal, where risk and compliance supervisory insight become predictive and proactive, as opposed to having to be informed only by looking backwards.

Regulator collaboration is rapidly bringing this all to the boil

But there are barriers now holding up these willing regulators.  Firstly, SupTech solutions remain largely experimental and are the ongoing subjects of the current roadmaps and PoC programs.  Some innovative solutions are live already, for example regulatory reporting by data pull in Rwanda 2.  Secondly, many SupTech solutions have so far been originated in collaboration with universities, with vendors less engaged.  Vendors have been involved with only around a quarter of the projects in the Financial Stability Institute review, and even when engaged, there are challenges such as the ownership of IP and of governance accountability.  Thirdly, functional requirements are not clean (for example even in VERMEG’s specific sphere of reporting, there are many operating models by which regulatory reporting can be digitised). Fourthly, many requirements have been developed on the fly, on a fail fast and learn basis.  Indeed, this lack of uniform requirements from one regulator to the next has restricted the emergence of a vendor market.

However, there is now a significant acceleration in the extent of collaboration between regulators and this is going to change the game.  Everyone is getting in touch with everyone else: this international coordination and collaboration will help innovation coalesce around common requirements and use cases, so eliminating the need for individual regulators to work on the same problem, and then vendors can and will step up.  We have the BIS Innovation Hub 3, designed to identify and develop in-depth insights in FinTech trends impacting central bank operations, working to be a focal point for a network of central banks on innovation.  This year, it has established bases in Hong Kong, Singapore and Switzerland, with EU and US to follow.  Launched in January 2019 following a 2018 UK FCA global sandbox proposal, the Global Financial Innovation Network 4 now has 50 regulators, central banks and international organisation members, including this October four US regulators (SEC, CFTC, OCC and FDIC).  GFIN is a collaborative forum on emerging business models and for joint RegTech work and to trial cross-border solutions.  Then there are industry collaboratives, including the RegTech Council 5 which has recently established new missions with meaningful regulator involvement, and the recently launched Alliance for Innovative Regulation 6, and many other accelerators including those specifically for regulators as opposed to the regulated.

Market impact and ‘Always On’

All this activity is instrumental to opening the doors to a great joining up, with the information relationship between the regulated and the regulator defined by data, and flowing more or less on-demand, if not literally real time.  In VERMEG’s world, with respect to digital regulatory reporting, there are a mix of available models including machine readable reporting rulebooks and push and pull solutions.  These lend themselves to different objectives – granular data or computed totals, prudential, statistical or transactional data.  What will be thematically the same across all these, is the move to a much more automated ‘Always On’ world.

The big prize for all industry participants will come when vendors are engaged with both the upstream work in the data world of regulated firms, as well as providing solutions to regulators.  There will be new solutions to include reporting (automated, real-time, transactional), data management (consolidation, validations, exception handling), and an array of compliance automation arenas from market surveillance, misconduct analysis (AML, fraud, mis-selling etc), and all the supervisory mainstays of prudential ratios, stress testing and forecasting, all with far less data problems, duplication and manual handling.  The rapid acceleration in regulator collaboration being seen now in 2019, especially, is what brings Regulator Innovation to the boil in 2020.

 

References:

  1. FSI Insight 9 “The SupTech Generations”: https://www.bis.org/fsi/publ/insights19.pdf
  2. Leveraging ‘suptech’ for financial inclusion in Rwanda http://blogs.worldbank.org/psd/leveraging-suptech-financial-inclusion-rwanda
  3. BIS Innovation Hub: https://www.bis.org/topic/fintech/hub.htm
  4. Global Financial Innovation Network: https://www.fca.org.uk/firms/global-financial-innovation-network
  5. RegTech Council: https://jwg-it.eu/regtech-council
  6. Alliance for Innovative Regulation: https://www.regulationinnovation.org/