Like brakes to a bicycle, fintech must exist within the realms of regulation if it is to ditch its ‘wild west’ persona. Indeed, the adoption of various elements of the industry, like cryptocurrency, has ultimately suffered due to the lack of regulation that surrounds and supports them. Throughout the entire month of May, The Fintech Times will be dedicating its focus to highlighting the most current developments in this ever-perplexing and constantly-changing foundation of regtech.
Having spent this week delving into the latest regulations, including what the industry believes will be the most impactful regulations of 2022 and how new regulations are shaping the future of the technology, today we’re rounding off the opening segment of our regtech coverage with a look into some of the most current problems faced by regulators.
Harder to catch
Opening our discussion, Taavi Tamkivi, CEO and founder of the Estonian-based regtech company Salv, provides a comprehensive view of some of the hurdles that need to be crossed by regulators in the anti-money laundering (AML) sector: “Regulators are doing their best to create a level playing field for all financial institutions and halt money laundering and terrorist financing. However, with the rapidly developing sector, they often end up playing catch-up.
“Unfortunately, most of the new regulations have minimal effect on preventing and stopping financial crime – according to the global regulator FATF, almost all countries score poorly on the effectiveness of their AML/CFT measures.
“The increasing amount of new regulations paired with a shortage of AML and compliance talent and massive growth of new regulated companies, such as fintechs and VASP, has vastly increased financial institutions’ workload and compliance spending. Even though two-thirds of the annual global compliance spending is done in Europe, very little has been achieved to improve the overall issue. Companies have entire teams to make sure that they adhere to the regulations but have no capacity to improve their financial crime-fighting efforts.
“Criminals work in well-functioning, sophisticated, international networks, and it’s hard for regulators (and financial institutions) to keep up. These networks spend vast resources identifying and exploiting regulatory loopholes and use the latest tech to make ‘their’ funds flow incredibly fast and harder to catch. Banks often operate in silos with no proper means to efficiently collaborate and share intelligence to detect and manage suspicious behaviour. Unfortunately, the law-abiding regular citizens are most affected by the regulatory burden whilst the criminals remain untouched.
It’s not all doom and gloom – significant improvements are starting to happen in that space. The global regulator FATF recommends that countries push their financial institutions to create private-to-private fincrime data exchange networks to battle crime.
“The banks in Estonia are already using Salv’s AML Bridge, a private data exchange platform. As the financial industry is beginning to understand it needs to adhere to a collaborative approach to beat financial crime, more and more financial institutions worldwide are open to engaging with service providers capable of offering similar solutions. Furthermore, industry research bodies like FFIS/RUSI provide valuable data and support progress across the sector.”
Lack of guidance
Amrit Midha, chief regulatory officer at Stacked Invest, provides an insight into the issues that regulators, and specifically those within the US market, are finding themselves running into: “The regulatory regimes surrounding digital asset management businesses in cryptocurrencies continue to be of heightened interest in 2022.
“Global regulatory agencies need to issue definitive guidance in a harmonised manner for the asset class that has quickly become significantly mainstream. This is critical for the protection of consumers as well as effective and continuous management of fraud, financial crime risks and market integrity globally.
“The US guidance remains bifurcated at best, granted with some overlap, but mostly with differences in viewpoints amongst its agencies. The Securities and Exchange Commission views it as a security, whilst Commodity Futures Trading Commission sees bitcoin as a commodity, and at the same time, the Financial Crimes Enforcement Network have issued its own differing interpretations.
“The most significant direction has indeed been the Executive Order from President Biden calling for expedited coordination amongst the agencies and establishing clear regulatory guidelines for cryptocurrencies that foster innovation while protecting consumers. It remains imperative that regulations are crafted based on input from the crypto industry and experts. Collaboration is crucial in building an effective regulatory regime, especially in such a new and technical market.
“It is also of paramount importance to protect the growing interests of the consumers and make the United States remain competitive in this space. The US offers some of the best securities and safekeeping laws in the world, with high regard to its regulatory agencies in aggressively preventing bad actors from operating against the consumer principle and ensuring fair, clear and not misleading practices in banking and financial services. Today it is still home to the largest number of crypto investors, which is now progressively seeing Wall Street lean towards adoption along with its institutional money.
“Time is now of the essence to produce a best in class Crypto Regulatory Framework that showcases the strengths of our well-founded laws and regulations and fosters governance in this positively disruptive space in a meaningful and sustainable manner.”
Joe Higginson, chief commercial officer at Identitii, identifies the anonymity of cryptocurrency as one of the main issues that regulators have when trying to rectify compliance in the world of digital assets: “Countries around the world have made, or are considering, regulations that require banks and other organisations that handle cryptocurrency transfers to update their know-your-customer (KYC) and know-your-transaction (KYT) compliance and reporting procedures.
“US President Joe Biden signed an executive order that directs federal government agencies to work together to better understand and ultimately regulate digital assets. Whatever rules the Treasury Department, or any other regulator, comes up with, they are likely to mean more work for any business that deals in cryptocurrency. Banks already are required to have stringent KYC and AML procedures in place when dealing with fiat transfers, but crypto exchanges do not.
“The requirements have not been there, and neither has the desire to implement such procedures. It would entail costs and inconvenience for the exchanges, and their customers certainly have not been clamouring for it. Indeed, one of the key attractions of cryptocurrencies has been the anonymity available to both parties in a transaction, the amount and time of which are incorporated into the blockchain that records it, but not information about the participants.
“It’s almost certain now that crypto exchanges will have to compile this information to comply with the U.S. rules, and other similar ones, and the exchanges will have to update their KYC and AML processes. There is also the possibility they will have to go back over old transactions and uncover the parties, which will not be a simple task.
“If there is a silver lining, it is that crypto exchanges are new and nimble entities, built on digital foundations, so they can respond more quickly and with less disruption to their organisational structures and operations when changes, in this case to their payment and fraud monitoring systems, are called for. Banks, by contrast, often labour under hidebound attitudes, organisational silos and legacy data systems, impeding progress.”
Time for a complete overhaul
Nick Payne, banking services, customer advisory at SAS UK & Ireland, consolidates many of the comments of his predecessors and suggests that environmental and social governance (ESG), as well as cryptocurrency, will come increasingly into the main focus for regulators this year.
He comments: “In 2022, firms will need to revisit their governance frameworks as they tackle the challenges of overseeing a more complex business environment and address heightened regulatory and social expectations. These changes will focus on operational resilience, climate, diversity and inclusion.
“The regulatory focus will undoubtedly focus on the banks’ climate pledges and whether or not they are delivering on these promises. Regulators will develop ESG disclosure and increase inspection of greenwashing and liability risk management.
“Financial service providers will need to deepen their climate-related risk management capabilities, including scenario analysis, as the supervisory focus will broaden beyond climate to capture nature-related risk.
“Continuing progress made in 2021, there will be a sharp focus on the risks stemming from digital innovation in 2022, with cryptoasset and digital payment providers needing to prepare for increased management of their risk frameworks. Weaknesses in banks’ AML processes have gained more attention from the regulators and I expect greater levels of inspection in 2022.: