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A Regulation Revolution In Financial Services

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Forbes | | Dec 2, 2018

If your professional interests take you to the crossroads of financial services, regulation, compliance, and digital - especially data analytics and machine learning - which altogether is known as regtech, you are in the right place. You are part of statistically small and very geek-oriented professional community, but you know this, and though you might choose not to admit this to strangers at this year's festive parties for fear of causing great pain by boredom, you are in good company with this Contributor and my interviewee.

I first met Jo Ann Barefoot when I was chairing the U.K. Financial Conduct Authority (FCA) Industry Sandbox Consultation, where she provided excellent guidance and insights. Jo Ann is one of the most dedicated and busiest advocates of the regtech space on the planet and is truly outstanding in both her knowledge and passion in this area.

She dedicates her time to a number of global bodies and initiatives related to regtech: she is a Senior Fellow Emerita at the Harvard Kennedy School Center for Business & Government, a Senior Advisor to the Omidyar network, sits on the fintech advisory committee for FINRA, is an Executive Board Member of the International RegTech Association (IRTA), is a member of the Milken Institute U.S. FinTech Advisory Committee, and chairs the boards of the Center for Financial Services Innovation and FinRegLab.

See:  Exploring cryptoasset regulation

A former Deputy Comptroller of the Currency and staff member at the U.S. Senate Banking Committee, she is the CEO of Barefoot Innovation Group, the Co-Founder of Hummingbird Regtech, an angel investor, advises financial companies and governments worldwide, delivers a regular podcast with global industry specialists on RegTech, and if all of that is not enough, she is writing a book on financial innovation and regulation.

If you want to understand how technology and the digital revolution will impact regulation and compliance in financial services, Jo Ann Barefoot should be one of your global gotos.

Jo Ann is in London speaking at the RegTech Rising Summit this week so I took the opportunity to get her views on this often technical subject and get us excited about where retech is going.

Lawrence Wintermeyer:  Jo Ann, you do a lot of work in the new field of “regtech.” Can you give us a simple definition of regtech, and tell us who is excited about it?

Jo Ann Barefoot: You’re right about the excitement, which is notable since most people don’t find financial regulation exciting. Something truly new is happening.

“Regtech” is new-generation technology that’s transforming financial regulation and compliance. The same technologies that are remaking everything else, like big data, artificial intelligence, blockchains, cloud computing and voice interface, are revolutionizing the regulatory realm too. They offer the tantalizing prospect of improving regulatory results and cutting costs, at the same time.

Both regulators and regtech firms are attacking pain points in the regulatory chain. Examples include creating “machine-readable” regulations; automating reporting interfaces to enable continuous monitoring of risk; using AI to scan securities market information for signs of misconduct; and equipping mobile phones with chatbots so consumers can report financial scams.

Wintermeyer: I know you’re a former bank regulator. How did you find yourself involved in the regtech space?

See:  Crypto Bear Market Gives UK Regulators Breathing Space to Finalize Crypto Regulation

Barefoot: I’ve been a regulator, Senate staffer, and consultant. About five years ago, I started immersing in new technology, partly through a senior fellowship at the Harvard Kennedy School Center for Business and Government. I realized that current regulation is failing in areas like consumer protection and anti-money laundering and that new technology could do better. I now focus on helping convert financial regulation to “digitally-native” design, and I’ve co-founded a regtech firm, Hummingbird, which combats money laundering.

Wintermeyer: Anti-money laundering, or AML, is one of the most advanced regtech use cases, and the statistics are frankly shocking. The UN says we currently catch less than 1 percent of global financial crime because of technology which is out of date and unscalable. What are the most promising changes emerging?

Barefoot: AML is probably the most expensive and risky regulatory area for banks -- the industry spends at least $30 billion a year to catch that minuscule fraction of cases. And remember, the crimes funded with laundered money are violent -- terrorism and global trade in drugs, weapons, endangered animals, and human beings. A million children are trafficked every year. This is easy money, highly profitable, with low chance of being caught.

Technology can change that. Financial crimes have data typologies, distinctive patterns that become easy to spot if we can consolidate and analyze enough information. Today’s machine learning tools can find the patterns, while new encryption techniques can make it safe to share data much more widely while safeguarding privacy. Technology can also fix the AML “Know-Your-Customer” rules, which currently block millions of innocent people from financial access because they lack traditional identity documents. New digital identity techniques can screen nearly everyone, cheaply and accurately.

We have the technology to do all this well. We need to update the regulations.

Wintermeyer: Regulators currently seem preoccupied with decentralized cryptocurrency exchanges as platforms for money laundering and terrorist financing, which appear marginal next to what is going on in the real global banking system. Does regtech have a role to play here?

Barefoot: Crypto bedevils policymakers because it breaks the molds and because it’s mutating too fast for traditional regulation to keep up. Blockchains arguably have higher promise, and higher risk, than any other innovation except maybe AI. They can accelerate financial processes and reduce costs, whether by moving payments on the internet or enabling new ways to raise capital. Most regulators aim for a balance between over- and under-regulating, but the learning curve is daunting. The road will be bumpy.

Wintermeyer: There is a movement globally toward financial regulators adopting “regulatory sandboxes” to assess fintech innovation in products and processes. Will we soon see regtech sandboxes where regulators could experiment with new technologies like artificial intelligence, machine learning and blockchains? Will we see more regulatory sandboxes being launched by US regulators?

See:  UK banks publish fintech collaboration toolkit

Barefoot: I hope so! Traditional regulatory change is slow. Technology change is fast, and accelerating. The widening gap between the two is loaded with risk for consumers, the financial system, and regulators themselves. One official has said that if regulators hold still today, they’re actually “accelerating backward.”

We can’t speed up regulatory change, soundly, unless regulators can learn faster, and that requires letting them do small-scale experimentation. Regulators throughout the world are creating sandboxes, greenhouses and reglabs: safe, risk-controlled spaces where they can try things out, study how new products and practices really work, and learn hands-on. In the US, the Bureau of Consumer Financial Protection has launched a sandbox-type program, as has the Commodity Futures Trading Commission (CFTC). All the federal US regulators and several states have innovation initiatives launched or planned. Most focus more on testing fintech than trying regtech, but both are coming.

Wintermeyer: You often highlight a remarkable initiative of the UK’s Financial Conduct Authority to test “machine-executable regulation” -- issuing some regulations in the form of computer code rather than words. Is this possible? If so, what changes will it bring?

Barefoot: The FCA is the world’s most innovative regulator and they’ve taken a breathtakingly creative step, running a test of whether some regulations could be issued in the form of code and become, in effect, self-implementing. That could drastically reduce compliance costs, mistakes, and time lags.

The experiment was held under an FCA-invented process called a “tech sprint,” which is essentially a hackathon. Experts in financial regulation and technology teamed up to translate a regulatory reporting requirement from words into code and run it against a set of test data. When the computer produced a correct report -- in ten seconds -- the participants jumped up and cheered. Think about that. When was the last time we saw banks and regulators cheering together?

Wintermeyer: US regulators participated in one of these FCA tech sprints this year, and I know some have regtech initiatives on the drawing board. What path do you see the US taking along with regtech?

See:  5 ways regulation can be a competitive advantage to British business

Barefoot: America has a uniquely fragmented regulatory structure which, for all its strengths, impedes innovation. We can’t readily change it, so we need to make it work better through more innovation and more interagency collaboration.

That’s happening. The Treasury Department issued a fintech report this year that calls on the federal financial agencies both to innovate and to coordinate. There’s a lot of momentum developing.

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