The evolution of Regulatory Technology (RegTech) has gained momentum as FinTechs pass the baton in the race to reimagine more nuanced financial ecosystems. With the global RegTech market growth rate at CAGR of 22.5% this is anything but a storm in a tea cup. The three events that led to this shift include the growth of FinTechs, assortment of global financial crises over the past years and, post-cold war changes in political economics.
While the 1997 Asian crisis revealed the need for sound regulatory practices. The domino effect of 2008 financial crisis, not very long back, exposed the vulnerabilities in the complex global business network. The international cascading effect following these events was unprecedented and forced the regulators to impose greater checks and balances. This has spiked the cost of regulatory implementation and maintenance and is visible in the increased volume of implementation content from 20/30 pages to thousands of pages today.
Regulations have been after-the-fact game so far, applying patchwork after the event has occurred. This costly traditional approach amounts to billions of dollars in losses. There is an urgent need to fundamentally realign the approach towards containing the complexity and cost while fostering the financial systems towards a more inclusive economic landscape. Blockchain and Artificial Intelligence (AI) together can help redesign the regulatory ecosystem.
Blockchain can potentially open new frontiers for supervision and help integrate regulations organically. The decentralized distributed nature of blockchain-based business network will help regulators become an integral part of the system. Blockchain brings in smart contracts as intuitive building blocks of regulatory ecosystem. For example, when we use permissioned blockchain to set up cross border remittances, one can codify the regulations through smart contracts. This would cut out the need to release bulky regulations as thousands of pages of text and instead codify it into smart contracts.
The initiatives towards creating an ecosystem of codified law are catalysts for change. The core idea is to reimagine the ecosystem of business in a way that the business transaction network is a ‘codified’ interconnected network of business partners. This is not just a technology connection via the internet but also a route to establishing AI-based supervision.
In the current highly disjointed set up, we look at a report, conduct months of analysis and come back with insights. AI, specifically machine learning (ML) aspects, will change the fundamental approach to the way regulators tap into financial events. Using ML mechanics of unsupervised, supervised and reinforcement learnings, it can become intelligence driven, real time and collaborative. This will be a synchrony of efforts, where unsupervised models will learn new patterns, drive actions and decisions through incentivized reinforcement learning while checking against the history of parameters using supervised models. Today, AI has already started playing a bigger role in several areas primarily in systems monitoring. Going forward, we see AI integration at the business network level.
The road ahead
Regulators are transforming their approach to play the role of enablers in the financial ecosystem. In a bid to experiment and perfect the potential models for wider application, the idea of sandboxes has come into play. Sandboxes promote an agile approach at scale and are globally gaining traction from Kenya to the State of Arizona, US. Some big initiatives already under way were shaped at Financial Conduct Authority (FCA), Hong Kong Monetary Authority (HKMA), while more are starting to emerge. This is no longer a localized effort with global interests taking shape. The Global Financial Innovation Network running across 20 countries, is one such initiative.
Nevertheless, there are many challenges and some of them are more foundational than others. The legal framework has operated in a certain way since inception. The same can be said of computers. We have used computers to execute rules, with humans as the learning agent. However, now we are looking at a future where this is set to change. The foundation of AI is not new, but with recent innovations it has proven its capability exponentially. Additional challenges are expected to emerge in blockchain network adoption and it still needs to be seen if smart contract based laws are ready to meet all scenarios. Wider adoption of these technologies will in turn drive greater innovation to solve the challenges.
We are at the precipice of a complete re-imagination of RegTech ecosystem. The needs are right here. The traditional approaches of rolling out regulations and envisioning technology solutions are not sustainable in a complex and connected global economy. The future that is emerging is based on building a codified business network using blockchain and reimagining supervision using AI. The sandboxes, in this regard, are the right approach to grow in a small and very organic way, by leveraging the ecosystem.