Technology is revolutionising the way that financial services and markets operate. Moreover, regulatory reforms are resulting in a profound shift in how firms go about meeting their regulatory obligations and the increasingly technical nature of regulatory compliance. Simply put, technology is taking on a much greater role and becoming inextricably interwoven into the financial industry. Rapidly accelerating technological advances are creating entirely new business propositions, such as crowd-funding, digital currencies and new payment systems. Evolving client expectations mean that businesses need to adopt new technologies to compete.

Changing regulatory compliance

New regulatory requirements across the globe for financial services and markets imply a profound shift in how firms go about meeting their regulatory obligations and the increasingly technical nature of regulatory compliance.The convergence of regulation and technology is part of a regulatory trend that can be observed across all financial sector reforms. However, major changes in the wake of the financial crisis have focused on the trading of derivatives and the clearing of trades, notably the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US and the European Market Infrastructure Regulation (EMIR) in the EU.

Meanwhile, the Markets in Financial Instruments Directive (MiFID), the EU framework since 2007 for investment services and markets is being comprehensively revised to improve the functioning of financial markets and strengthen investor protection with the changes, known as MIFID II, expected to take effect in 2016. MiFID II is wide-ranging and likely to affect a number of a firm’s functions depending on business model. Businesses need to start strategic planning now to comply with and capitalize on the changes ahead of the finalisation of the EU implementing legislation. Firms are increasingly relying on technology in adapting to new regulatory conventions. The bar is much higher than it was and demonstrating regulatory compliance is challenging.

Risks as well as benefits

Although technology undoubtedly brings benefits, high-profile technical failures in the financial sector in recent years are alarming, with adverse implications on market integrity, consumer outcomes and firms’ reputations. The UK Financial Conduct Authority (FCA) in its Risk Outlook 2014 has identified technological developments as a key risk to its objectives. At EU level, the Joint Committee of the European Supervisory Authorities has also identified IT-related operational risks as key risks to the stability of the European financial system in its report on risks and vulnerabilities in the EU financial system published on 2 April.

The FCA is concerned that technological advances increase firms’ dependence on underlying systems, resulting in exposure to the disruption in ways that can prove costly. It is crucial that firms are able to implement effective oversight and controls for increasingly complex systems. These will need to improve in line with technological changes and MiFID II and EMIR requirements to ensure issues are minimal and can be resolved quickly. 

Increased availability and connectivity of personal and financial data has increased the potential profits that criminal elements can extract from financial services to the detriment of consumers, firms and market integrity. The rise of cyber-crime requires firms to invest significantly to improve controls. The adequacy of businesses' cyber-crime prevention measures are firmly within the sights of regulators.

Another area of regulatory focus is the increasing interconnectedness of regulated and non-regulated activities (for example, firms outside the regulatory perimeter providing technological solutions or platforms for services that are regulated).

Central focus for regulators

The key message for firms is that the impact of technology on the financial sector is increasingly a central focus for regulators. The FCA expects firms to look at their business models, strategies and structure to critically assess whether they are effectively identifying and managing the root causes and drivers of technological risk. It will make judgements about senior management and firms and intervene, including by taking enforcement action, where appropriate.

Lucy Frew is a partner at the recently launched Financial Regulatory practice of Kemp Little