An acronym-heavy set of regulatory obligations such as FATCA, MiFID, 5MLD, EMIR, and SFT define stringent frameworks for firms to follow. Onboarding new clients while adhering to regulatory guidance is a significant challenge – one that Chris Foye, Senior Director of Market Planning at LexisNexis Risk Solutions, is familiar with.
“Decentralised markets allow participants to get information and conduct trades using a variety of providers, which means no single provider is likely to have a complete view of a participant’s trading activity or behaviour,” he says. “Furthermore, the nature of the FX market means firms are invariably exposed to multiple regulatory regimes, which increases operational complexity.”
This complexity often presents itself during onboarding where KYC analysts face considerable challenges. So how are firms coping with these challenges, and how are RegTech service providers helping them?
“The nature of the FX market means firms are invariably exposed to multiple regulatory regimes, which increases operational complexity.”Chris Foye
Simplifying compliance and lessons from other markets
When quizzed about the role regulation plays in the FX market, Ben Richmond, CEO and Founder of CUBE, a global RegTech provider specialising in Automated Regulatory Intelligence (ARI), begins by explaining that regulation does much more than protect just clients. “It also helps to protect brokers as it sets aside trustworthy brokers from those that have less than desirable security measures,” he says.
“However, in recent years, there has been an increase in the number and complexity of regulations and the risk has been more diverse,” he continues. “In the FX market, which not only relies on speed and high volumes but also is decentralised and transcends borders, the risks associated increase ten-fold.”
Echoing Foye’s point about increased operational complexity, Richmond explains that a mix of budget pressures, increasing complexity, and difficulty in recruiting talent is creating significant challenges in compliance departments. “Compliance teams are being asked to understand and interpret new rules and guidance and put adequate measures in place,” he says.
“But at the same time, compliance budgets remain the same or are being reduced. Finding and retaining compliance talent is also an issue – particularly in areas like FX which are highly technical. Regardless, given the volume, velocity, and complexity of regulatory change, it is extremely difficult for humans alone to manage.”
Foye points out that these conditions make technology adoption a no-brainer, with ease of use a primary factor. “Firms are looking at the ease at which risk orchestration platforms can respond to business needs i.e., the platform’s configurability and how easily new content can be ingested to support the KYC process across multiple countries,” he says. “The result for FX firms is time to onboarding is greatly reduced whilst making the KYC process more robust.”
This robustness occurs thanks to teams accessing audit trails on a single, centralised system and letting go of legacy tech that required them to jump between several systems during the onboarding process. In addition to these advantages, both Foye and Richmond note that increasing regulatory complexity across markets is boosting the adoption of such technologies in FX.
Richmond says, “Across the board, financial firms are becoming attuned to applying RegTech to key areas of compliance and are reaping the benefits. Adoption has been strongest in the areas of Anti-Money Laundering, Counter Terrorist Financing, and Information Security. Having seen the advantage that RegTech brings to these areas, firms are now open to seeing how the same benefits can apply in other industries – and FX is no exception.”
He further stresses that compliance is now viewed by buy and sell-side teams as not just necessary paperwork, but as a competitive advantage in the markets. Foye points to the lessons RegTech providers learned by supporting participants in other markets means FX firms can hit the ground running.
“Although there are nuances across sectors, the fundamental steps in a KYC process are very similar,” he says, “and so RegTech’s experience of serving financial institutions, especially challenger banks and payment companies, means that all the key components are already in place for FX firms.”
“Finding and retaining compliance talent is also an issue particularly in areas like FX which are highly technical.“Ben Richmond
Factors to consider and steps to implementing a RegTech solution
While every firm in FX recognizes the need for a robust RegTech framework, implementing a solution is a tough task. What factors should they consider, and what combination of solutions do they need? Richmond lays out a few basics.
“The main thing FX firms should look for is a product that only provides the regulatory data that is relevant to their firm or, even better, a product that creates, maintains and maps a customer regulatory inventory to relevant internal, controls policies and procedures,” he says. But what if a firm operates in multiple jurisdictions?
“It can be more complicated,” he says. “FX firms must look for a RegTech provider that can identify which rules apply to them and which ones to ignore. Most importantly, integrating this information with their compliance program and ensuring everyone is correctly notified when something in the rule changes is essential. CUBE is currently the only provider that can satisfy the complex requirements and scale of global, diversified financial institutions.”
But regulatory monitoring is only half of the equation. Firms must also be able to quickly and effectively incorporate rule changes into their workflow with minimal impact on operations or intrusion on the customer journey. Foye points out that workflow configurability is an essential factor that firms must insist on.
He also lists ease of integration via a single API, range of content, and the service provider’s standing as critical points to evaluate. “Firms should look for a strong and reputable partner, with whom they can work for the foreseeable future, ” he says.
With these preliminary factors in place, what should firms look at when evaluating a service provider?
Given the diverse regulatory needs each FX firm has, Richmond suggests starting by identifying the areas of regulatory change management that a firm finds the hardest to manage. Ease of product use is also a critical factor.
“Firms can evaluate this during a product demonstration or proof of concept,” he says. “It is also a good idea to ask for references from other users and read any available company case studies. For larger organisations, the solution should be scalable, allowing access for multiple users and with collaboration tools that help distributed employees work together. Coverage of regulations and jurisdictions is important here. If a key regulator or regulation is missing – then this creates a potential compliance gap and associated risks.”
Foye stresses the importance of evaluating how each step of the KYC process is connected. “One common issue we see with firms is they have lots of systems in place,” he says, “but little inter-connectivity between them, which is why so many firms are now adopting a risk orchestration platform to manage this.”
“They should capture the data sources they currently use or would like to use,” he continues, “to help fulfil those requirements, for instance, identity verification providers to verify the identity of individuals against various databases like the electoral roll, etc.” He also adds that firms must take future growth into account.
“It is all well and good to buy a solution to meet current needs,” he says, “but if that solution cannot meet future needs, it could end up being a costly exercise.”
Richmond recommends building a workflow that is simple to adjust and integrates with the rules and regulations databases “That way, if the rules change, it is very easy to see the policies, procedures, and workflows that may also need to be reviewed and modified,” he says.
Both Foye and Richmond point out that the regulatory solution landscape is diverse. Firms must understand the nuances of each solution to determine whether they need certain features.
“Given the pace of regulatory change, compliance departments need a workflow that notifies them of relevant regulatory changes,” Foye says. “But compliance departments also have a range of policies and procedures that they need to ensure are constantly updated. They need to be aware of how a regulatory change may impact those policies so they can quickly change them accordingly.”
Given the pace of change, firms need a system that helps them manage relevant changes seamlessly. This is where an integrated workflow management system, like RiskNarrative, comes into its own, Foye suggests; “A platform that allows rule and policy changes to be implemented with minimal impact on operations and by compliance teams themselves in natural language, rather than requiring technical support, means firms never need to greet regulatory changes with dread.”
Richmond says that service providers explaining their products in clearly understood language goes a long way toward clarifying any confusion about a platform’s abilities. “It is important that vendors describe their products and capabilities clearly and simply,” he explains. “They should focus on the benefits, the problem that is being solved, and the product’s overall purpose.”
“Providing examples, case studies, and setting up user communities can all help ensure that the potential benefits of introducing a RegTech solution can become apparent for firms who have not yet adopted solutions.”
Artificial intelligence, machine learning, and advanced technology
No talk of tech solutions is complete these days without discussing the impact AI has on a field. RegTech is no different. Regulatory data is highly unstructured and typically, regulatory bodies do not cross-reference rules with each other. As a result, automating RegTech workflows using machine learning is challenging.
However, this doesn’t mean AI cannot play a significant role. “FX regulations are not standardised across issuing bodies or regulated entities, making the task of interpreting data even harder,” Richmond says. “That’s where natural language processing (NLP) steps in. NLP allows firms to make sense of complex FX market regulatory data and accelerates three different stages of the regulatory change management journey: Information retrieval and filtering, content understanding, and semantic modelling.”
Foye points to other areas of the regulatory process where AI is also playing a significant role. “With machine learning, both supervised and unsupervised models are being used to help FX firms streamline the onboarding process.,” he says. “There are also RegTech companies looking to drive the adoption of blockchain given the FX market is a decentralised market.”
“An example of this is RiskNarrative’s virtual agent,” he continues, “which models the behaviour of KYC analysts within the FX firm and then helps automate decisions and/or augment existing KYC teams at peak times.”
Foye further notes that adopting new tech for the sake of it might be counterproductive. “FX firms need to assess the adoption of new capabilities in terms of how effective they are at mitigating risk as well as whether they are explainable to regulators and other stakeholders.”
While AI usage in RegTech is currently restricted to a few use cases, its ability to learn will likely see its role expanding. Richmond agrees with this view wholeheartedly. “The best thing about AI is that it becomes more intelligent over time when deployed through human-in-the-loop systems that take both regulatory expert and user feedback into account.”
“AI is inherent and a critical part of the RegTech solution – and will act as the backbone for monitoring FX market regulation. More specifically,” he explains, “it can accelerate every stage of the regulation change process: from the content collection, normalisation, and translation to classification and entity extraction, to recommendations and predictions.”
Recent market volatility has quelled a lot of talk about blockchain for RegTech. However, the immutability it brings along with transparency (when implemented correctly,) means DLT solutions are never out of the question. The post-trade environment particularly offers several use cases.
For instance, banks can use a DLT network to process regulatory reports automatically, eliminating the need to manually match transactions. Counterparties will always have identical and live data on their ledgers, backed by smart contracts that prevent errors.
Currently, these DLT solutions are nascent, however, progress is promising. Service providers are currently developing prototypes to address SFT and EMIR reporting requirements of vanilla interest rate swaps via smart contracts.
Ensuring regulatory coverage
Both Richmond and Foye are optimistic about the role automation, and sophisticated RegTech solutions will play in the future. Richmond singles out automation as an example of the benefits tech brings to the compliance role. “Automated workflows can ensure the right people are notified of relevant changes at the right time. These capabilities can free up compliance teams to perform higher-value activities including applying their expertise, identifying new opportunities, or promoting compliance, culture, and ethics within their organisations.”
“Robotic Process Automation (RPA) is now widely used in financial services to automate a range of processes that were formerly performed by employees,” he continues. “CUBE uses RPA and other proprietary technologies to automate the collection, standardisation, aggregation, and categorisation of regulatory content. We can map regulatory content to a specific business, business line, or product, even down to an individual policy or procedure.”
Foye recommends that firms evaluate how the output from one solution feeds into another workflow. “A RegTech may be strong in one area e.g., tracking regulation, policy management, or orchestration,” he says. “So where multiple providers are chosen then firms need to assess how the output from one solution feeds into another.”
Time will tell how RegTech will evolve, but on current evidence, there’s undoubtedly a lot to get excited about.