Faculty Commentary

The Rise of FinTech and Compliance

An important transformation is happening in the financial industry. The rise of new technology and compliance has dramatically altered many of the key functions and functionaries of modern finance. Artificial intelligence, algorithmic programs, and supercomputers, instead of human actors, now constitute the core of many financial operations. At the same time, compliance officers have become just as critical to financial institutions as traders, bankers, and analysts. Finance as we knew it has changed and continues to change.

My recent article, Compliance, Technology, and Modern Finance, offers a detailed commentary on these unfolding changes—the crosscutting developments in compliance, technology, and modern finance. It examines the concurrent and intersecting ascents of new financial technology and compliance as well as the potential perils linked with their ascents. It also highlights the larger implications of the changing financial landscape due to the growing roles of new technology and compliance. In particular, it focuses on the challenges of financial cybersecurity, the integration of technology and compliance, and the role of humans in modern finance.

The modern financial industry is ostensibly a tech industry. In the financial industry, human labor and intelligence has been displaced by computerized automation and artificial intelligence. Technology is now at the heart of many core financial operations. Most established, sophisticated financial firms are essentially high-tech companies, and some of the most promising startups in the financial industry are so-called “FinTech” firms. Many financial firms now use artificially intelligent programs to assess risk, allocate capital, and trade securities with little or no human intervention.

Almost concurrent with the emergence of new financial technology has been the rise of compliance in the financial industry. This rise has been fueled in part by increased regulatory scrutiny of financial firms, particularly in the post-Enron and post-financial crisis eras, as well as increased complexity in these regulatory frameworks and the markets themselves.

In the modern financial marketplace, regulators and firms face new systemic risks and threats as a result of the industry’s growing reliance on technology. Complex, high-tech systems invariably malfunction and suffer from so-called normal accidents. Because of the complex, high-speed, and high-tech nature of modern finance, normal financial accidents will be inevitable and could cause substantial strains on the entire financial system. Beyond these systemic risks, the modern, high-tech financial industry also faces a variety of discrete threats. Computers have become the weapon of choice and cyberspace the preferred locale for many attacks against financial firms. The hacker with a laptop has replaced the robber with a gun. The emergence of the Internet of financial things is also the emergence of the Internet of financial threats.

In the face of these developing changes, risks, and threats, I believe we will likely see three larger trends emerge in the financial industry: (1) greater investments in financial cybersecurity (2) closer integration of compliance and technology functions, and (3) a renewed emphasis on the human factor in finance.

First, we will likely see financial firms making greater investments to better confront the challenges of financial cybersecurity. Part of what makes financial cybsecurity so difficult is that the industry operates on a largely privately held technological infrastructure controlled by disparate firms. As such, timely, coordinated, security-enhancing actions could prove particularly difficult as businesses place other priorities, such as short-term profits and secrecy, over financial cybersecurity. Because of the linked nature of the modern financial system, it is not enough for a firm to have strong financial cybersecurity; its vendors and counterparties also need to have strong cybersecurity practices in place to safeguard against the multitude of threats in the marketplace.

Second, we will likely see a closer integration of the compliance and tech functions at financial firms. In order to be more effective, compliance departments will need to better leverage the power of new information technology, just as firms have done so on their business-side operations. The deluge of data and regulations that compliance departments now oversee simply demands the monitoring, analytical, and processing power of new information technology. In the near future, compliance strategy will be technology strategy; and technology strategy will be compliance strategy. Moreover, the tech savvy lawyer or compliance officer is going to be one of the most valuable creatures in the modern financial ecosystem.

Third, we will likely see a renewed emphasis on the human factor in the financial industry. Despite all their advances, smart machines still lack the judgment and sophistication of smart humans. The human factor will likely remain the critical factor in in the future of finance. Machines, no matter how artificially intelligent, are still not as smart as humans (yet). The human brain, with its billions of neurons and trillions of synaptic connections, remains one of the most sophisticated and powerful of all analytical machines. Human interactions that implicate persuasion, values, empathy, culture, and emotion remain key ingredients in any successful financial, legal, or compliance practice. More and more, smart machines will complement—but not yet replace—smart financiers, lawyers, and compliance officers in their work.

In sum, the rise of new financial technology and compliance are causing major changes in the financial industry. My recent article highlights some of the key implications of these changes, and hopes to serve as a studied account for how to think anew about the future of compliance, technology, and modern finance.

The full article is available for downloading from SSRN here.

This post first appeared on the Compliance and Enforcement blog of NYU Law School’s Program on Corporate Compliance and Enforcement. The original post can be viewed here

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