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Blockchain…The Answer to the Financial Service Industry’s Prayers?

Published May 15, 2018

Category: Innovation | Sourcing

Written by: Andrew Frost
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Andrew Frost

Andrew leads the Lawson Conner Investment Management practice where he is responsible for the launch of asset management businesses and their associated investment funds. He works very closely with prospective launches across hedge, private equity, real estate, venture capital and corporate finance and covers a diverse range of entrepreneurs looking to establish their businesses under the FCA regulatory environment. Andrew spent 10 years at Man/GLG, holds a degree in Economics from the University of Technology in Sydney and is a CAIA charter holder.

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Since the financial crisis of 2008, the financial services industry has been inundated with new rules and regulations that have consumed resources and increased spend on compliance. All of this is occurring at a time when the industry has also been under increasing competition from financial technology (fintech) firms. Whilst the fintech industry is booming by providing new innovative products at a rapid pace, traditional incumbents have appeared less agile at adopting these. It is worth noting that these same disruptive technologies can also be used to the advantage of the financial services industry. “RegTech” refers to clever, disruptive, technology that will service (and no doubt revolutionise) the regulatory sector. This type of technology will continue to flood the market over the next few years but how will firms use it? Will they embrace it? Will they feel held back by the unknown? Or will they see the benefits of it and outsource these functions to third-party experts? 

Blockchain, a critical fintech innovation, appears to be on every conference and panel debate and is slowly creeping in to boardroom discussions. Blockchain has moved on from simply being the technology used for cryptocurrencies into other areas such as the movement of information and identity, the movement of commodities and securities and the digital execution of contracts. The world of blockchain has moved forward at an incredible speed; but what exactly is it? 

To put things simply, blockchain is a type of Distributed Ledger Technology (DLT). DLT is a system of digital data that is duplicated, shared and synchronised across multiple locations. Whilst a type of DLT, blockchain uses unchangeable, encrypted, packages of data stored in a connected chain as the ledger of data. Here, each new piece of data is verified by all locations and is then added to the existing chain of previous data making it virtually impossible to defraud. It thus provides users with a trustworthy source of information. 

Complying with regulators is becoming a larger burden than ever before. Using blockchain can help ease these pressures and will, no doubt, play an important role in the Know Your Customer (KYC) and Anti-Money Laundering (AML) processes of the future. 

Blockchain has the ability to inexpensively verify an individual’s identity in a time-efficient manner. Today, KYC tasks are repetitive in nature which result in data inconsistencies, mistakes and a duplication of processes. These tasks are often carried out using a number of different systems, both internal and external, which inevitably lead to the implementation of manual solutions with the purpose of bridging end-to-end operational procedures. AML compliance also requires extensive documentation requests and verification, as well as proof of identity. All together, these outdated processes are not only highly frustrating but also create an environment prone to many risks. These processes can take days, weeks, or even months in some jurisdictions, to fulfil and satisfy the regulators’ requirements. As a result, the cost of being compliant is escalating rapidly as financial institutions try to stay ahead of terrorists and fraudsters. 

The use of a shared ledger is of most importance here. With this, the processes can be monitored and adjusted in a more efficient way than they currently are. Due to the shared nature of the ledger, a comprehensive database of client activity and background information would be available to all on the network. This would mean that any changes to this information would be communicated and updated in real time; making it much more likely to detect a potential scam or fraudulent transaction. Giving all departments access to a shared ledger would give them all the client background information and account activity that would result in a seamless stream of knowledge and make the KYC process as efficient as possible. 

Another luring aspect of blockchain from a compliance perspective is its practical immutability. As soon as data is input and saved into the ledger it can never be changed or deleted. For this reason alone, blockchain has been used as the document of proof for the transferring of digital assets; and by the same token can lend itself to the application of proof-of-process for compliance. The shared ledger can be used to keep track of the many steps required by the regulators. By recording actions and their outputs, an audit trail for regulators to verify compliance would have been created. Due to the immutability of the records there would be no reason to dispute them at any point. 

Navigating the ever-changing plethora of regulatory rules and obligations is challenging and costly. Several of the new regulations now require structured, well-defined and complete risk data reporting which places extra strain on those being regulated. These strains are exacerbated since there is still a heavy reliance on manual processes and archaic partially automated processes. On the other side of the coin, some regulators receiving these mandatory datasets are ill-equipped to manage them, impacting their ability to provide effective data analysis, surveillance and a timely and effective review process. 

Using blockchain for regulatory reporting, could take away several pain points for both the financial institutions and the regulators. Since the data is shared by design, regulators would not have to collect, store, reconcile and aggregate the information for themselves. All transactions are documented immutably on the distributed ledger providing a comprehensive, secure, precise, irreversible and permanent audit trail. Introducing one shared platform would remove the requirement for each to hold its own replicated records. It could also mean the records would be updated in real time. A blockchain could vastly improve the speed and quality of any regulatory review process since there would no longer be a need for reconciliation. 

Financial firms would benefit from a more efficient regulatory reporting process since the distributed ledger would act as both an execution platform and a mechanism to store transactional information. The use of blockchain would significantly improve their ability to resolve compliance issues, react to new regulatory and compliance obligations and address internal audit requirements in a timely and cost-effective manner; as well as improve the quality, accuracy and confidence of and in the process. 

Global reporting and compliance on blockchain will not be adopted overnight. Setting up and managing an infrastructure to support these kinds of solutions takes time and can prove to be disruptive. However, the technology has an overwhelming potential to revolutionise and improve many of the processes within financial services, particularly those that are regulated. Populating a database is all well and good and certainly a first step, but using the algorithms to extract data, check and update it, analyse and communicate it efficiently requires all-important expert know-how. A trusted service provider can not only set up the shared ledger facility but also manage it to ensure that all regions communicate with one and other by sharing the same analysed information. As a relatively new system, particularly in relation to KYC and financial crime prevention, it is yet to be seen how regulators will adapt and embrace the possibilities before the industry-wide benefits can be really felt… but there is no denying how beneficial these can and will be

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