An academic has warned that even the smallest error in RegTech solutions can create systematically erroneous outcomes, leading to large scale liability risks.

Veerle Colaert, a professor of financial law at KU Leuven University and a member of the European Securities and Markets Authority stakeholder group, published a paper this week looking at how technological solutions have emerged to help with regulatory compliance requirements.

“In recent legal doctrine, RegTech is almost unequivocally hailed as holding the promise of substantial gains in terms of increased efficiency and reduced risk of human errors and resulting administrative fines,” she stated. However, the risks and challenges inherent in many RegTech solutions are yet to be exposed in legal doctrine and regulatory reports.

“When a RegTech solution contains even a small error, this may create systematically erroneous outcomes, leading to large scale liability risks,” Colaert argued. “In addition, building watertight systems tailored to the needs of a specific financial institution comes with a hefty price tag, which may be prohibitive, especially for smaller players.”

In order to contain these costs, financial institutions can buy ‘one size fits all’ RegTech solutions, or open-source solutions may be developed which supervisors could be requested to endorse.

Colaert pointed out that when this leads to a single RegTech solution being widely used in the marketplace, an error in this solution may result in systemic compliance failures and systemic risks. “RegTech also creates new challenges in the areas of cybersecurity and data protection,” she continued, adding that the “dehumanisation resulting from RegTech solutions may necessitate particular risk management efforts”.

Despite the risks, RegTech seems to be one of the very few successful answers to the current compliance challenge, according to Colaert, especially since both legislators and supervisors increasingly require or presuppose automation to ensure compliance.

Earlier this year, the Financial Conduct Authority's Business Plan for 2018/19 laid out plans to take forward work to deliver cost savings via RegTech, both for firms submitting regulatory returns and how this information is used.

The paper presents several strategies to manage each of the RegTech risks and challenges, while also looking at the role of supervisors as the RegTech industry emerges.

Colaert stated that supervisory support of RegTech should at least include the provision of sufficiently long implementation periods for new regulation, to allow for the development of adequate RegTech systems.

“Of equal importance is swift supervisory feedback on interpretation difficulties in the implementation process, sandboxes allowing for trial and error of new RegTech solutions in a safe environment, and the development of RegTech solutions for reporting to the supervisor,” read the paper.

She concluded by suggesting that RegTech accelerates the evolution towards a cooperative supervisory model, in which regulators guide financial institutions in their search for adequate and correct compliance, and financial institutions in turn deliver essential input to the supervisor for the development of efficient guidelines and best practices.

“In the complex maze of today’s financial regulation, the supervisor increasingly takes up the role of intermediary between the legislator and financial institutions, between rules and compliance,” Colaert added.

Share Story: