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How to Best Address Rising Regulatory Risk in 2023

As featured in TabbFORUM
By Brock Arnason, Founder and Chief Executive Officer of Droit


Financial firms have plenty on their plate on the regulatory front across the globe, and this year the regulatory burden will only intensify, explains Brock Arnason, founder and CEO of Droit. In this article, Mr. Arnason highlights what’s in store regulation-wise for firms and explains that they need to step up their compliance infrastructure to achieve transparency and responsiveness in the new regulatory environment.


As the new year dawns, a heightened sense of uncertainty due to geopolitical tensions, rising interest rates and a slowing economy continues to persist. Further, the year 2023 shows no sign of abatement to regulatory changes – from market reform rewrites, to digital assets and sustainability reporting. Against the backdrop of a decade of dealing with financial regulatory reform, how can financial institutions best prioritize and prepare for the careful management of these numerous and varying risks?


Volumes of regulatory complexity
Since the 2008 recession there has been a myriad of financial regulatory reform of which the Dodd-Frank and MiFID II legislations represent the best known examples. Firms across the financial services industry have had to develop robust compliance strategies as a result. For the most part, compliance with these regulations has by now been bedded down, representing a maturity of the situation amongst market participants.


Looking forward, however, compliant decision-making nevertheless still has the potential to be fraught with errors, risk and inefficiencies due to the sheer volume of complex, ever-changing regulations across a number of different spheres. One of the areas that gives most cause for concern is the numerous wide-ranging market reforms, including the EMIR refit, the new SEC reporting and business conduct rules, and rewrites in Europe of MiFID II/MiFIR, in Australia of the ASIC Derivative Transaction Rules (Reporting), and in the UK of the Financial Services and Markets Bill 2022-23.


The ultra-dynamic digital assets space, reeling from recent scandal, has also had a new impetus for more regulatory clarity likely taking effect by 2024. On a global level, the Financial Stability Board (FSB) regulatory guidelines for capital requirements represent the continuation of a meta standardization of regulatory efforts to control digital assets (the first of such methods of standardization was initiated by the FATF’s ‘Travel Rule’ in 2019 requiring financial institutions to pass along information to one another for certain electronically-facilitated transfers). Within the US, a number of different initiatives, including Biden’s Executive Order ‘Ensuring Responsible Development of Digital Assets’ (E.O.14067), will hopefully provide a meaningful determination of responsibility and control between the various regulators such as the CFTC and FCC. In Europe, the Markets in Crypto-Assets (MiCA) Regulation will continue to have a significant effect on the cryptoasset market.


The fast-growing environmental, social and governance (ESG) sector is also facing increased regulation in a bid to stamp out greenwashing accusations due to confusion over standards. The EU is leading the charge on writing rules for this sector through its Sustainable Finance Disclosure Regulation (SFDR), which will categorize investment funds to ensure that environmental investing delivers its advertised ambitions. It is yet to be seen how effective these new sustainability rules will be, however, they will certainly require significant and ongoing investment in technology and operational processes for European financial institutions and insurers. In the US, meanwhile, work continues on the impending SEC Climate Disclosure mandate, as well as implications regarding disclosure itself and potential categorization.


It is clear from the above that financial institutions face increasing challenges to consolidate fragmented reporting architecture across regions and asset classes while responding to rapidly evolving regulation. This, paired with an opaque and inconsistent decision-making process, can lead to over and under reporting and extensive reconciliations from poor, missing data elements.


Drive effective risk management
The ability to drive effective risk management in an environment of heightened uncertainty is undoubtedly down to the data – and can best be mitigated by quantification through a regulatory compliance platform. In today’s data-driven world, firms specifically require the ability to codify complex regulatory requirements into intelligent actionable decisions.


Because firms are dealing with a constantly evolving environment, they can best manage this on a consistent basis by implementing a visible, evidence-driven decision process which automatically reflects the latest “best industry” consensus and adherence to underlying regulatory texts.


Complete transparency in report eligibility decision-making can be realized if it is based on comprehensive knowledge of rules and regulations governing transaction reporting. This includes from-the-source text digitized in a machine-readable format to a visualization framework for the logic path of the regulatory evaluation, to the audit record of the trade input data required to perform the evaluation.


Quick decisions, with confidence

In order to maintain resilience during these uncertain times, firms not only need an easier, more automatic way to interpret, understand and correctly implement regulation at a singular point in time, they need to be able to respond to the changing environment on a continually updated basis.


By having the logic implied by regulatory obligations represented as data, firms can then receive a constantly updated, visual decision process that is traceable to the underlying text. This means that these organizations can then better understand the aspects and respond to the changing environment, safe in the knowledge that they are getting a feed of the latest consensus interpretation as regulatory obligations change.


Firms wanting to achieve transparency and responsiveness to regulatory change ultimately need to prioritize investment in their compliance infrastructure. Only then will they be best positioned to scale, operate efficiently, and address regulatory risk with confidence.