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PA OPINION

Re-thinking regulation to help capital markets support innovation

PA Consulting spoke with Kerstin Hermansson, Monika Bergström and Vigg Troedsson about why regulators need to adapt to the digitalised age

Capital markets regulation is increasingly a barrier to entry for new FinTech firms. PA Consulting spoke with Kerstin Hermansson, Monika Bergström and Vigg Troedsson about why regulators need to adapt to the digitalised age.

A well-functioning capital market is central to every financial system, as it offers good investments and ensures that enterprises have access to capital and liquidity. Sweden is a good example where capital markets have enabled growth and increased in wealth. Capital markets in Sweden have become a natural part of long-term savings – by March 2018, Swedish households had almost five times more assets in equities, funds and insurance than in deposits and cash. This has undoubtedly benefitted entrepreneurship and living standards in Sweden.

A broad ownership structure and access to capital via public markets is good for the economy and for corporates. However, the fact that society is dependent on sophisticated capital markets also makes it sensitive to financial crises and massive change. For these reasons, the capital markets industry has been the centre of attention for regulators during the last decade – and the regulatory pressure continues.

To gain insight into the development of regulatory compliance and how RegTech could help financial institutions (FIs) to keep up, PA spoke with Kerstin Hermansson, Managing Director of the Swedish Securities Dealers Association, Monika Bergström, Senior Vice President and Head of Compliance of Handelsbanken Capital Markets, and Vigg Troedsson, Senior Vice President of the Swedish Securities Dealers Association.

There are a number of positive outcomes of new regulation. Vigg explains: “There are clear positive effects of regulatory changes in the industry. For instance, fees for equity trading have decreased from about 0.45 per cent to literally zero.” But the group’s common view is that future regulatory development must embrace market practice and digital perspectives from the start, in a much more collaborative and agile process than today. “The capital markets industry has become very sophisticated and complex, much like an ecosystem or the human body,” says Vigg. “All parts of the system have important roles to play to provide value to clients living and prospering in the real economy”. PA’s UK regulatory survey found 92 per cent of organisations think they will feel a negative impact if regulators fail to evolve within three years. The traditional models of regulation are no longer sustainable.

Regulations create barriers to entry

One objective for regulators has been to increase competition in the industry. But they’ve created barriers to entry higher than ever before. Today it’s hard for entrepreneurs to enter financial services and compete in the market. “We need to come to more outcome-based regulation that facilitates for firms to understand the requirement in them” says Kerstin. “Today, regulations put the same requirements on small players as the very large ones – and that is very complicated since the firm needs to understand with a myriad of requirements. The sheer number of detailed requirements require advanced capabilities and scale efficiencies that smaller firms simply don’t have.”

In some markets, regulatory bodies are creating new initiatives to decrease entry barriers while retaining their influence. In 2016, the UK Financial Conduct Authority, supported by PA, launched its first regulatory sandbox in the UK. The sandbox lets businesses test products, services and business models with real consumers. It gives support to quickly kick-start FinTechs and get the right licences. This is an excellent way to improve competition and decrease time to market for new players.

As well as helping new entrants in the short term, it’s also key to simplifying regulatory implementation going forward. It gives regulatory support for firms to identify safeguards to build into new products and services, rather than having to retrofit them or come under regulatory scrutiny later. For some firms, this could also mean better access to capital by setting standards sooner to provide greater clarity.

Regulatory compliance in financial markets has become cumbersome since the financial crisis. It’s forecast that by 2020 there will be around 30 million pages of regulation. Thus, it’s hard to test or predict the full outcome of a new regulation, especially the cost of implementation. “Often, new regulations are unclear and technical standards are typically set very late in the process. This creates unnecessary room for interpretation,” says Monika. For example, the technical standards for the EU Payment Service Directive (PSD2) aren’t expected to be finished until late 2018, about a year after the legislation was supposed to be adopted.

Artificial intelligence (AI) might address these problems. “In the future, we might use advanced analytics and AI to understand the impact of proposed changes before finalising them,” says Vigg. The challenge is to make regulation a natural part of the value chain rather than an unwanted add-on so industry isn’t spending time and money developing responses to regulations based on predictions. “Regulators need to bring in digitalisation engineers early in the process together with a broader set of industry experts from the start,” says Kerstin.

"The capital markets industry has become very sophisticated and complex, much like an echosystem or the human body."

Vigg Troedsson,
Senior Vice President of the Swedish Securities Dealers Association

A clearly defined regulatory framework designed with digital capabilities and market practice from the start will also enable RegTechs to enter the scene and reduce cost and time to market. Further, 93 per cent of UK businesses think regulators can support innovation by creating a stronger sense of predictability and certainty for their sector. Without clearly defined and marketdriven information standards, there will be limited use for RegTechs. Standards would create strong incentives to collaborate in the industry and reduce the total cost of regulatory compliance.

Without a revised approach, regulators risk stifling the innovation, competition and even stability of the markets that they protect. “Going forward it is important to take a broader perspective on the overall market impact when changing regulations,” says Monika. We should reuse information from the market and refine it, instead of starting from a blank sheet of paper.

"Going forward it is important to take a broader perspective on the overall market impact when changing regulations."

Monika Bergström,
Senior Vice President and
Head of Compliance of Handelsbanken Capital Markets

The fast pace of technology today is not just a challenge for businesses, it’s a challenge for regulators as well. Regulators must innovate and re-examine how they work internally by breaking down internal siloes, investing in technology and becoming more vocal and collaborative. “Cross-functional teams with lawyers, bankers, economists and digital engineers should be used both when setting the regulatory framework and when National Competence Authorities (NCA) are implementing it into their operating models,” says Kerstin. The result will be better, more cost efficient for the industry and create greater value in the market.

Explore further insights on InsurTech and RegTech in our latest publication Next Wave of FinTech

Find out more

Contact the financial services team

Gavin Neilson

Gavin Neilson

Celia Larkin

Celia Larkin

Scott Paton

Scott Paton

Jason Hill

Jason Hill