The Rising Influence of Reg-Tech in Financial Services Compliance

With the ever-increasing number of tightening regulatory demands to follow, financial institutions are now investing heavily in regulatory technology, such as cloud-based systems and artificial intelligence. The HKMA defines regulatory technology, or reg-tech as it has come to be known, as the use of innovative technologies to achieve regulatory compliance in an efficient and automated manner. According to the HKMA, investment in reg-tech companies reached US$1 billion in 2017.

Current Challenges in Financial Services Compliance

To explain the growing role of reg-tech in financial institutions in Hong Kong, we must first account for three main challenges compliance teams are currently facing. Firstly, there are now nearly five times as many regulations for compliance professionals to familiarise themselves with in comparison to the pre-2008 financial crisis era, including more stringent requirements in relation to Basel III, GDPR, and AML.

Secondly, with as many as 70 major digital banking & fintech initiatives being undertaken by banks in Hong Kong since 2017, compliance teams need to contend with rapidly expanding volumes of transactions. While the financial system is now more efficient because of such advanced technologies, these developments are also susceptible to an increase in the number and impact of financial crimes.

Finally, it is not solely compliance teams that offer their inputs on regulatory issues. For example, as a result of stringent private banking regulations, relationship managers have had to spend up to half their working time covering off compliance-related issues and client due diligence using cumbersome IT systems. There is a need for transparent and efficient collaboration between different teams.

The Benefits of Reg-Tech

The use of reg-tech in compliance alleviates the three challenges mentioned above. Reg-tech includes cloud-based systems, whereby data is maintained and updated in a central storage point. Hence, when input is required from different teams for regulatory reasons, reg-tech provides compliance teams with digital trails and an enhanced document management system.

Additionally, by processing machine-readable regulations, reg-tech provides a streamlined process that can consolidate multi-jurisdictional demands in a single platform. This supports compliance professionals who need to review large numbers of regulations.

Lastly, reg-tech has already had a substantial influence in AML/CFT and transaction monitoring, areas that are traditionally time-consuming. Between 2017-18, there was a 40 percent increase in the number of suspicious transaction reports in comparison to five years back. Reg-tech can be hardwired to eliminate low-risk issues through AI, thereby freeing up time for compliance teams to appropriately investigate high-risk cases involving serious financial crimes.

Implications in Hong Kong

With these benefits of reg-tech in mind, it is no surprise that the HKMA and SFC have wholly embraced its use in Hong Kong. Arthur Yuen, deputy chief-executive of the HKMA, has emphasised the importance of reg-tech in “supporting the interface between banks and regulators”. The growing number of fintech initiatives entails a need to amalgamate large volumes of data in a transparent manner in communication between financial institutions and regulators. Hence, in order to further facilitate the adoption of reg-tech within financial services, regulatory authorities have launched schemes to “complete the smart banking ecosystem”. For example, the HKMA and the SFC have opened sandboxes which allow partnered banks and trading units to conduct trials of innovative fintech projects in a confined regulatory environment, so that they may implement experimental ideas to detect systemic risks to eventually polish future technological initiatives from a regulatory standpoint.

The growing use of reg-tech in the compliance landscape in Hong Kong is already having a trickle-down effect on hiring trends. It is no longer just the communication skills and regulatory knowledge of a certain candidate that will be considered during an interview process. Compliance professionals will also need to be able to highlight their competence in handling reg-tech software. Moving forward, compliance professionals will need to adapt to rapidly developing technologies, particularly for data-heavy areas such as transaction monitoring and AML/KYC.

Moreover, lawyers interested in moving into banks or the buy-side will find new challenges awaiting them. If a lawyer decides to gain in-house commercial exposure by specialising in compliance, they will need to quickly acclimatise to technological developments that would be unfamiliar territory for a professional who has worked in private practice. As reg-tech advances further, there will be more demand and lucrative career prospects available for those with the capability to adapt to new software, so lawyers must pay attention to developments in this field if they are considering switching career tracks in the long-term. Similarly, mid- to senior-level lawyers who move into compact in-house legal & compliance teams will need to acquaint themselves with the functions of reg-tech as they will work closely with compliance specialists for regulatory purposes.

Additionally, just as compliance teams require input from other teams within banks for regulatory reasons, there will be implications from the adoption of reg-tech on other teams as well. IT and change management teams will need to ensure that there is a seamless transition in adopting and maintaining reg-tech, whilst front office staff would also need to adjust to new regulatory software.

The Way Forward

While there is no doubt that reg-tech offers a centralised solution to the jigsaw puzzle of keeping up with frequent and fragmented regulatory changes, there is still a degree of anxiety around these new technologies. Financial institutions are cautious about the fact that they will be accountable for the decisions made by AI, and there are concerns around the potential for data tampering and breaches of privacy in cloud computing. However, given that the the HKMA and the SFC are sanctioning pilot trials and expressly endorsing the use of reg-tech in internal compliance and regulatory liaison, in addition to the exposure that technology firms are gaining to regulatory frameworks, these fears should be assuaged as reg-tech refines itself further. As these developments take effect, compliance specialists and lawyers, to a smaller extent, need to prepare themselves to handle evolving technologies to stay competitive in middle office functions in the financial services industry. 

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Consultant, Lewis Sanders