IBM RegTech Innovations

Cognitive Technology: A shelter in the storm of regulatory change

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Turbulence and disruption have been the mainstay of the financial services industry for more than a decade and there is little to suggest that a long calm is in the offing.

Quite the contrary, the industry had to adapt to an onslaught of new regulations in the aftermath of the Global Financial Crisis. A decade later, it may have to adapt to the dismantling of those same regulations but remain keyed up for the not-unrealistic possibility of another regulatory assault in a few years. But regardless of whether there is increased or decreased regulation, the one certainty is that there will be change.

Adapting quickly and efficiently to the compliance obligations brought about by changing regulations is a business requirement that demands urgent attention. It is also an opportunity to implement technology that can facilitate change. However, traditional technology is not the answer. Companies require cognitive systems that can learn and adapt.

The financial services industry was forced to spend significant money, time and resources to adopt the increased compliance requirements brought about by the Dodd-Frank Act, along with the Know Your Customer and Anti-Money Laundering regulations that have continued to grow since 9/11 and the Global Financial Crisis. And today there are several other regulations requiring the focus of the industry, whether it is increased data security and privacy requirements being driven by General Data Protection Regulation (GDPR), incremental monitoring and surveillance requirements for the Market Abuse Directive (MAD) and Market Abuse Regulation (MAR), or additional reporting requirements of the Markets in Financial Instruments Directive (MiFID) and the Home Mortgage Disclosure Act (HMDA).

Practical experience suggests cognitive systems can be extremely effective facilitators of change in managing risk and compliance, whether it is to understand the constantly changing regulations, or to address the compliance requirements.

Estimates suggest the financial services industry spends over $270 billion every year on regulatory compliance. This is capital that cannot be deployed elsewhere or used to create value. Interestingly and surprisingly, the application of technology has been fairly limited in several areas, while many of the areas where technology has been applied continue to only leverage older, less advanced approaches.

More effective use of technology is key to better adapt to regulatory changes, cut costs and free up much of that locked-up capital.

In one practical case, an IBM Watson system had 82% accuracy detecting obligations on 15,000 structured training samples, which led to a 30% increase in the productivity of legal and compliance teams. The financial services industry is expected to have to deal with more than 300 million pages of regulation by 2020, all of it provided only as unstructured information.

When the Watson-powered IBM Safer Payments system went online in France, it was fed 4.7 billion transactions in real time, including approximately 75% of annual credit card transactions in the country. The system can learn. It can detect and halt fraud in milliseconds. When it came on line, the credit card fraud rate in France fell for the first time in a decade.

For the financial services industry, the next set of changes are just around the corner courtesy of the policy changes being driven by the new US administration, along with continued desire internationally for increased protection, security and fairness in financial markets and with personal information.

While we know there will be change, there remains much uncertainty in exactly what that change will be, and how it will impact the obligations of financial institutions. As an example, President Trump signed an executive order to repeal vast tracts of Dodd-Frank regulations on February 3. The Dodd-Frank Wall Street Reform and Consumer Protection Act have created an increased burden on the financial services industry since 2010, driving increased capital requirements, along with additional tracking and reporting mandates. While reduced requirements will be welcomed from the banks, there will still be a lot of effort to determine what exactly they will need to still do.

Another example is the Department of Labor (DOL) fiduciary rule that requires brokers and financial advisers to act in their clients’ best interest. The DOL Fiduciary Rule was set to take effect in April and would expand the “investment advice fiduciary” definition of the Employee Retirement Income Security Act of 1974. In short, it would raise the legal and ethical requirement for all professionals that work with retirement plans or give retirement advice. In effect, the rules would bar advisors from accepting payments that create conflicts of interest and require them to put the interest of customers first. This has been a very heated topic and required a lot of focus and resources from firms involved in wealth management, even driving some firms to stop taking on some business. Once again, we see a situation that has these same firms stopping in their tracks, with no clear view of exactly what regulatory requirements will ultimately need to be addressed.

Our experience working with thousands of financial institutions, both large and small, makes it clear that managing regulatory change, compliance and related risks can be a real struggle. The implementation of changes, whether they are increases or decreases in regulatory requirements, across the entire operational scope of a firm is both time-consuming and expensive. The fact that firms are more likely than ever before to either have global operations, or at least deal with clients that do business internationally, only makes adapting harder.

The velocity of change in the regulatory burden and the need to understand nuance and appreciate the intention behind regulations makes the use of available technology a necessary choice. Watson can learn and adapt quickly to a changing landscape, facilitating change.

The process of training technology to facilitate financial regulatory change, identify obligations and compliance risk is similar to the one that some of the world’s top doctors at Memorial Sloan Kettering, the top-ranked MD Anderson Cancer and the Cleveland Clinic used to train the technology to facilitate oncology treatment.

As Watson ingests more information and expertise about a constantly changing environment it becomes more effective at helping financial services companies transform all aspects of their operations. And now, IBM has the expertise and regulatory background of the Promontory Financial Group to accelerate the training and capabilities of Watson regulatory compliance solutions.

In the past, the only way to reduce risk and increase compliance has been to dedicate additional resources and spend more money. However, cognitive technology has potential to fundamentally transform this equation, enabling organizations to actually increase their compliance capabilities and reduce risk, while at the same time reducing related costs. Over the next couple of years, banks will be able to leverage cognitive systems to streamline and improve most of their major compliance activities. Technology could reduce costs while improving compliance and facilitating adaptations to change, in effect freeing up capital.

Effectively used, technology is a port and shelter in the constant turbulence and the never-ending storm of change that has become the norm for the financial services industry.

Vice President, Financial Crimes & Conduct Risk

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