RegTech as a response to regulatory expansion in the financial sector

Paper by Veerle Colaert (KU Leuven)

In the aftermath of the financial crisis, the financial sector was hit by a tidal wave of new legislation. The question of how financial institutions can remain compliant with this ever expanding financial legal framework has however been largely neglected. A recent paper (see ssrn or by Professor Veerle Colaert (KU Leuven) explores the potential of RegTech in this respect – the use of technological solutions to facilitate compliance with and monitoring of regulatory requirements.

The author examines the substantial gains or RegTech in terms of increased efficiency and reduced risk of individual errors and liability. On the other hand, she also identifies considerable risks and challenges of RegTech solutions, including new types of systemic risk, high costs, data protection concerns and problematic side-effects of “dehumanization”.

“When a RegTech solution contains an error (even a small one), this leads to liability risks at a far larger scale than when an individual employee makes an individual mistake. If the same RegTech solution is widely used in the market – because successful RegTech companies gain a considerable market share, because open-source solutions are widely used or because the supervisor endorses a certain RegTech solution – an error in the RegTech solution may even cause systemic compliance failures and result in systemic risk. In addition, building watertight systems tailored to the needs of a specific financial institution has a high price tag, which may be prohibitive especially for smaller players. Privacy and data protection, as well as the dehumanization that results from RegTech solutions also raise new challenges.”

As RegTech nevertheless seems to be one of the very few answers to the compliance challenge, the author presents several strategies to remedy or contain each of these challenges.

Finally, the contribution emphasizes the crucial role of financial supervision as an intermediary between legislator and financial institutions in a RegTech era. RegTech accelerates the evolution towards a cooperative supervisory model, in which the supervisor guides financial institutions in their search for adequate and correct compliance and in which financial institutions in turn deliver essential input for the development of efficient guidelines, best practices and RegTech solutions.

Author: Joeri Vananroye

Professor of economic analysis of law (KU Leuven), attorney (Quinz)

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