Pillsbury
Sam Pearse
13 October 2015
Financial technologies simultaneously help with regulatory compliance and breed unregulated activity, but Sam Pearse of Pillsbury says the authorities will catch up, and that might not be a bad thing
Image: Shutterstock
How important is technology in helping financial services firms comply with regulation?
Technology is essential to enable financial services firms to meet their regulatory requirements. Firms are presented with increasing regulatory obligations as regulators seek to achieve multiple aims, ranging from transparency for clients through to greater clarity and accountability to the supervisors. For example, the Foreign Account Tax Compliance Act and the EU’s revised Administrative Cooperation Directive to improve international tax compliance create due diligence and reporting obligations for UK financial institutions.
Whatever the business line, financial services firms face a growing need to accumulate data and satisfy reporting obligations. Meeting these obligations can consume valuable staff hours if adequate technology is not in place.
The UK Financial Conduct Authority (FCA) launched Project Innovate at the end of October 2014 in response to the growing number of innovative firms whose businesses might fall within the regulatory regime. The Innovation Hub’s stated aims include supporting new and established innovator businesses by helping them assess if and how the UK regulatory regime applies to them.
The existence of Project Innovate, and the number of businesses that have approached them for help, is strong evidence of the relevance of technology in the financial services area. If there were not opportunities in the sector then technology business would not be looking at it.
What are the risks of getting this wrong?
A failure to comply with applicable regulation could have potentially business-ending consequences. Breaches could result in a revocation of the relevant permissions to undertake the regulated activity and, even at the lower end of the scale, a fine or public censure could have substantial reputational risk.
What do firms need to look out for when dealing with new payment technologies, like digital currencies and block chain?
The sensitivities of firms to digital currencies and technology like block chain depend on the nature of their dealings.
In the UK (in contrast to Germany), digital currencies are not categorised as money, electronic money or funds. As such, firms can treat digital currencies as an asset class without falling within the regulatory regime. That could perhaps result in such firms lacking credibility in the eyes of the client, and that is where increased regulation and guidance would be beneficial.
The value of digital currencies is extremely volatile and this will raise issues for firms trading in them or accepting them as a method of payment. Note that accepting digital currencies as payment for goods or services does not itself give rise to regulatory obligations.
Then of course there is the question of how or where the currency is stored. There are a range of companies offering digital wallets, which may not be regulated for their activities.
With regard to block chain, the first challenge for firms is to ensure they understand what it is and how it works. Once that is achieved, block chain offers a tremendous range of potential applications beyond financial transactions. For example, of interest to financial services firms might be smart contracts, which can be created to continually assess and monitor the conditions of a contract relating to, say, bonds or derivatives.
The anonymity afforded by crypto-currencies and block chain technology may prevent some firms from taking full advantage of the potential of the technology, and firms must be careful to assess whether they can meet their regulatory obligations if using such currencies and platforms. Again, focused regulation on this area, such as regulating exchanges, might assist.
Do you think these types of payments will become more strictly regulated, and do you think they should be?
It is inevitable that we will see greater regulation in this area and in the UK, the FCA and HM Treasury, to name but two, have launched consultations and calls for evidence. This is consistent with the UK government’s statement in the 2015 budget of intending to position the UK as a thought-leader in financial technology.
Outside of the UK, the European Securities and Markets Authority has also launched a call for evidence on investment instruments using or relying on digital currencies and the distributed ledger concept. Furthermore, the well-publicised frauds and thefts of digital currencies, or the use of them to fund illegal activities, has meant that both digital currencies and block chain technology are firmly in the sights of the lawmakers.
The potential use of the technology is vast and for that potential to be given the best opportunity to develop and mature, businesses and consumers need to have confidence in it. Well-considered regulation would help build that confidence.
Sam Pearse is a partner in the corporate and securities practice at Pillsbury
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