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What Regulation?

Mon 07 Nov 2016

The FCA stated that Anti Money Laundering will remain their top strategic priority in 2016/17

That regulation is good for consumers but inimically harmful to business growth is an accepted truth but how detrimental, or even counterproductive, the regulation generally depends on the type of activity being regulated.

A 2012 report commissioned for the Department for Business, Innovation and Skills concluded that, from studies available, that product market regulation was most damaging to market growth. Broad-ranging and covering all aspects of a business involved in the creation and selling of anything that may be defined a ‘product’, product market regulation limits growth in several ways. Most notable however is how it limits market entry and therefore stifles competition.

The FCA’s unprecedented interest in the field of RegTech is therefore no surprise. They are naturally keen to see regulations adhered to but also increasingly conscious not to see the market dominated by a few large players or the value of financial services as an economic driver snuffed out. The emergence of RegTech, as a sub branch of FinTech or through the evolution of regulation-specialist third party providers, has been seized on by the regulator.

Perhaps in the knowledge that the relationship between regulation and negative growth is not always a linear one, where by limited deregulation in the most regulated market sectors can have a disproportionately greater effect on growth, the FCA set up Project Innovate.

The project, which has encouraged RegTech start-ups, appears to be aimed at negating the growth-impacting element of regulation while ensuring that the FCA meets its statutory requirement.

This is both a blessing and a curse for financial services. A blessing because the automation of regulatory
requirements leaves businesses more time to concentrate on revenue-generating areas. But a curse because all regulation, no matter its scope, involves change and indeed has its own associated entry and exit costs. If regulation is seen to be more easily dealt with and simpler to adhere to and not a drag on growth, then greater and more wide-ranging regulation might be encouraged. Indeed, using the supposition that the financial services market is lightly regulated – only Holland has fewer regulatory restrictions amongst OECD countries – the development of RegTech could be seen as giving a green light to further regulatory action.

So what types of regulation might emerge as a result of the RegTech world? The vote to leave the European Union on 23rd June will see the UK adopt one of three currently existing models with regards to our relationship with the EU. The demonstration of ‘equivalence’ in legislation may be a prerequisite to entry into EFTA or the EEA, to varying degrees. However, a third-country option which will work on the basis of a trade deal with the European Union will mean the UK withdrawing fully from EU legislation but with the possibility existing that equivalence will still need to be demonstrated in bilateral agreements.

Without being fully aware of which model is to be adopted then it is difficult to know how the regulatory landscape will look in five years.

However, assuming either the EFTA or EEA arrangement which at this point in time seems to be the most
likely, it looks as if large swathes of the EU’s regulatory platform will have to be adopted, particularly, as if expected, the UK doesn’t trigger Article 50 until 2017, meaning an EU exit in 2019.

These include the Central Securities Depositories Regulation (CSDR), Securities Financing Transactions Regulation (SFTR), the Packaged Retail and Insurance-Based Investment Products Regulation (PRIIPs), the Benchmarks Regulation, Payment Services Directive II (PSD II), Insurance Distribution Directive (IDD) and the General Data Protection Regulation (GDPR), all of which are due to go live before the earliest possible date the that UK could leave the European Union. Directives, of course, do not need to be converted into national law to be in force so will presumably, apply any way. Regulations will need to be adopted however and it stands to reason that they simply won’t be.

Assuming the need to demonstrate equivalence however, fraud and data breach protection will remain major challenges going forwards.

The FCA have already stated that AML will remain their top strategic priority in 2016/17. With the current
AML regime developed prior to most of the technological developments in banking we now take for granted, the refresh intends to remove the overwhelming conception that KYC checks are a barrier to doing business effectively.

The FCA has already indicated that it is anticipating the use of RegTech solutions to streamline due diligence, anti-impersonation and transaction checks but quite how they will structure this willingness into guidance remains to be seen.