By Brian Clark,  Founder and CEO, Ascent
By Brian Clark, Founder and CEO, Ascent

Guiding FX through the complex maze of Regulatory Compliance with RegTech

Today’s FX traders are faced with a conundrum. The massive wave of regulatory oversight rolling over financial services has also landed on the shores of FX. It’s brought with it an enormous number of regulatory requirements, which are growing at superhuman speed and carry increasingly severe repercussions for non-compliance.

Today’s FX traders are faced with a conundrum. The massive wave of regulatory oversight rolling over financial services has also landed on the shores of FX. It’s brought with it an enormous number of regulatory requirements, which are growing at superhuman speed and carry increasingly severe repercussions for non-compliance.

A few statistics help bring this point home: 

  • As reported by Medici research, regulatory rule changes have increased 500% since 2008.
  • Effectively, a new regulatory update goes into effect every seven minutes.
  • Last year, the Securities and Exchange Commission (SEC) filed 95 enforcement actions against public companies. According to the NYU Pollack Center for Law & Business and Cornerstone Research, this is the highest number in over a decade.
  • These actions against public companies are but a fraction of the SEC’s broader enforcement activities. In 2019 alone, the SEC published a whopping 2,754 enforcement actions.

The SEC is not the only regulator taking this route. The Financial Conduct Authority (FCA) in the United Kingdom recently levied its largest personal fine ever, as reported by the National Law Review. And the Commodity Futures Trading Commission (CFTC), one of the regulators overseeing FX markets in the U.S., signaled in a recent enforcement manual that its approach to enforcement would be moving more in line with that of 
the SEC’s.

Our current era of onerous regulatory oversight coupled with debilitating enforcement actions leaves FX traders in a bind. Today, for any given transaction, traders risk higher non-compliance fines for the regulations they know about and also risk not knowing about all of the regulations that may apply. 
This is where regulatory technology, or RegTech, can help. Often slated as the growing sister of FinTech, RegTech solutions leverage machine learning, natural language processing, blockchain, AI, and other technologies to help improve the way businesses manage regulatory compliance.

The RegTech industry currently sits at an exciting crossroads. A few years ago, many of the promises made by RegTech providers seemed too good to be true, and financial firms were hesitant to take a risk on something like regulatory compliance, which is vast, complex, and has a non-existent margin of error. But a wellspring of funding has helped bring those RegTech solutions to life, pushing them past pilots and out of the innovation phase so that they can begin operationalizing benefits in a production environment.

In short, RegTech is no longer just for early adopters. We’re starting to see the actual, tangible benefit these technologies can provide.


The RegTech universe

But what are those benefits, specifically, and how might they help FX traders on both the buy and sell side?

To help answer that and to make sense of the vast and growing RegTech universe, we group solutions into three distinct buckets: Knowledge Automation, Workflow Management, and Point Solutions.

Knowledge Automation: Compliance made smarter

Knowledge automation solutions sit right at the very beginning of the compliance process. They are meant to solve one of the most complex and intractable issues of compliance: regulatory change management. 

How are FX traders supposed to keep up to date on the constant flow of new regulatory updates being released? When towering new regulations like GDPR are released onto the marketplace, how can FX firms assess which aspects relate to their business in a quick and accurate manner? In short, how can FX traders have confidence that they’re trading compliantly?

These are the challenges of regulatory change management, and in one form or another they plague all sectors of the financial industry. Big banks try to take them on by hiring small armies of compliance analysts, consultants, and lawyers to find and sift through the dense legalese of regulatory updates, but smaller firms usually can’t afford such a hit to their bottom line. Instead they’re left with a few exhausted Risk and Compliance officers, pouring over documents day-in and day-out while traders put trades in with fingers crossed.

Change management solutions leverage technology to help solve this. Some of these solutions act essentially like a news feed, aggregating all relevant information — from new regulatory obligations to proposed rule, enforcement actions, and speeches — into one place. This automates the time consuming horizon scanning aspect of change management, leaving it up to Compliance and Risk teams to sift through this collected information and determine where and how it might affect policies and procedures.

But recently, advancements in AI have helped push RegTech capabilities forward. The opportunities provided by neural networks — deep learning systems that are taught how to complete a task by being fed large data sets — have exploded over the last few years, powering everything from image recognition software to self-driving cars.

This same technology can be used in RegTech to help automate the sifting as well as the collecting of regulatory change management. By treating the vast troves of regulatory knowledge that are out there as big data, running that data through a trained AI which can then determine which obligations and rule changes apply to a business, it is possible to automate the transformation from data to knowledge. We at Ascent believe that this process, knowledge automation, is the next frontier in RegTech as well as one of the most powerful manifestations of how technology can help regulatory compliance.


Workflow Management: Compliance made smoother

Workflow management solutions sit downstream of knowledge automation solutions. Once Compliance and Risk teams understand what their obligations are, they have to reconcile them with their policies and procedures, communicate relevant changes to senior management and other team members, and track their actions in case of an audit. Historically, this has often been completed through Excel spreadsheets and email chains, leaving open huge opportunities for error and creating a massive lift whenever an auditor comes asking for information. Workflow management solutions, specifically through governance, risk management, and compliance (GRC) platforms, offer a faster and safer route.

GRC platforms are known for their extreme flexibility, allowing users to customize their experience to their needs. At their most basic level they act as a container, just as a customer relationship manager like Salesforce or Oracle does. But the specific components of each GRC platform helps determine how it may address a firm’s individual operational risk management needs.

Some GRC platforms are known for their vastness and complexity while others may be built around one specific aspect of risk management, such as facilitating internal audits, or even one specific regulator. Some are focused on improving collaboration and alignment across business functions — so that users in IT, operations, legal, and upper management can all access the same data within the same framework. Others are known for their ability to integrate seamlessly with existing systems within an organization, and to cleanly and efficiently absorb legacy data into their own platform.

As FX firms evaluate various GRC platforms, their flexibility and variety may seem like a barrier, but it can ultimately allow for firms to find a GRC that is the right fit for them.

Point Solutions: Compliance executed

Point solutions solve one specific regulatory compliance need for FX traders. They are more limited in functionality than knowledge automation or workflow management solutions, but when they meet the right need they can provide substantial value.

Below are just a few examples of how point solutions can help the FX market:

  • Improving laborious Know-Your-Customer (KYC) procedures: FX brokers are required to abide by stringent KYC policies in order to ensure they know the customers they are dealing with and to weed out bad actors. RegTech solutions provide electronic identity verification tools that can help determine where prospective customers are who they purport to be and can significantly increase the speed at which customers can be on-boarded.
  • Making Anti-Money Laundering (AML) processes easier: AI can also help FX brokers in identifying suspect transactions. Leveraging machine learning, AML solutions can automatically flag dubious transactions and trading behaviour at a pace and level of accuracy that wouldn’t be possible for humans. 
  • Streamlining MiFID II reporting requirements: When the MiFID II legislation went into effect in early 2018, it markedly stepped up the pre- and post-trade transparency requirements FX traders have to abide by. This created a heavy burden on FX traders, especially in regard to reporting required disclosures of trade details and, even more importantly, in reporting the right trade details to the right regulator. RegTech point solutions can automate and meaningfully streamline this process. 
  • Improving transparency through voice-to-text translation: The high volume of FX transactions conducted via voice can make it difficult to track trade corrections and maintain record keeping. But natural language processing tools can convert those voice recordings to text — and can now even decipher the thick jargon traders are known for. This turns those recordings into a searchable database and allows other machine learning algorithms to crawl them and highlight problematic transactions.
  • Easily aggregating data: Data management can be a laborious and costly project for firms, as they take on the herculean task of trying to collect their data from instant messaging, emails, phone calls, etc., in order to monitor for market abuse and meet regulatory requirements. RegTech tools can capture all this data from its various forms and collect it in one singular place, in order to better monitor and analyze it.

Creating a RegTech Stack

As firms try to determine which RegTech solutions are right for them, they will need to reconcile with a difficult truth. Considering the massive complexity and scope of regulatory compliance, there will likely not be one singular RegTech solution that meets all of their needs.

While this may seem disheartening at first, other industries demonstrate how, actually, this can be to a firm’s advantage. 

Both the marketing and shipping industries have embraced automation and technology in pursuit of more streamlined processes — just as regulatory compliance is beginning to — but in both marketing and shipping no singular one-size-fits-all solution dominates the market. Instead, as in RegTech, there are a wide variety of solutions. Instead of causing chaos, this has allowed marketing and shipping companies to build a fully integrated technology stack that is unique and optimal for their specific business needs.

FX firms can do the same. They can find a knowledge automation solution that will easily plug into a legacy GRC platform, for example, and then hand select point solutions that are specific to their business challenges. 

By connecting up complementary solutions like this, firms will be able to take a giant step closer to achieving End-to-End Compliance: a fully traceable process that connects external regulatory events to a business’ specific obligations, then all the way through to that business’ internal controls, policies, and procedures. 

The Unique and challenging needs of FX

RegTech has relevance for all sectors of financial services, but its opportunities for FX traders are of special importance. FX, by its very nature, is operating within a global marketplace. This means that FX traders can be subject to even more rules and regulations than, for example, an RIA focused only on domestic operations — giving even more importance to the role of RegTech in the FX market. Through AI and machine learning, RegTech has the ability to simplify the impact of multi-jurisdictional compliance.  

But FX is also a decentralized marketplace. Outside of the country-based regulators that oversee FX — like FCA and CFTC — there are two organizations that are globally-focused on  “governing” or “guiding” organizations within the FX trading marketplace: FX Global Code and BIS Markets Committee. 

Both organizations provide guiding principles instead of rules due to the decentralized nature of the FX marketplace. The lack of formality in this regulatory framework has led to a lack of adoption and enforceability. But, given the direction the regulatory environment is heading in, FX firms shouldn’t expect this to be the situation for long. 

Sell-side firms have gradually been adopting the principles laid out by FX Global Code and BIX Markets Committee, with buy-side firms trailing behind some. Both would be wise to get ahead of the regulatory curve so as to avoid trying to catch up from behind. 

This, ultimately, is the power of RegTech. It can liberate FX firms from the conundrum of how to operate in a climate where they can’t keep pace with the superhuman rate of regulatory change. Technology offers firms a path forward, so that firms can feel empowered rather than restricted by the rule of law.