Bridget Van Kralingen: the collaborative solution to regulatory compliance

There was a time when marketers talked enthusiastically about reaching to 'segments of one', but the promise was just that – the technology at the time could do nothing more than segment to fairly general market categories. That day has passed, and today true personalisation is the new quest of every chief marketing officer. 

Now, just like personalised marketing before it, a new possibility is at hand, and it is materialising in financial services first, as an answer to the dilemma of regulatory compliance. While this set of activities is the very basis of trust in global financial markets, at the same time it is also expensive, labour-intensive and virtually undifferentiating for any individual enterprise.

The science of compliance

Compliance accounts for nearly $270bn in annual spending – or roughly $1 out of every $10 of operational spend at major banks – according to industry estimates. The sheer number of regulations is staggering, comprising some 3 million pages. A global bank can expect to absorb 40,000 changes in regulation per year, each with several individual stipulations that must be met. And with every change comes the complexity and expense of understanding how each one affects thousands of other regulations.

And yet despite the high cost, compliance is not a four-letter word. The financial services industry learned important lessons coming out of 2008, one of which is that the mandate for transparency is the foundation for trust in the global financial markets. Regulatory compliance builds that transparency and trust, which is good for banks, good for customers and good for the integrity of the system.

How should banks be addressing this dilemma of reducing costs, while building trust and improving stability in the system? There are three things:

• Adopt new technologies, such as cognitive computing and blockchain, and then aim them at this specific challenge;

• Fractionalise costs for the industry by setting up platforms/utilities/consortia to reduce compliance costs in areas where there is no competitive differentiation; 

• Improve stability across the industry by ensuring regulators are better equipped as change agents, as compared with their historic role as watchdogs.

Shared infrastructure

The second recommendation, in particular, has strong appeal. But why would this concept of a shared capability platform be viable now? After all, market players have talked before about industry platforms – open yet secure, available to multiple clients in an industry, while holding out the promise of dramatically reduced costs for a basic process, such as loan origination or customer onboarding. But each time, banks came up against the reality of collaboration, trust and, perhaps, even sharing some costs for the promise of a new outcome – and then turned away.

What is different in 2017? First is industry motivation. The economics of the industry now demand this level of innovation. As just one of many indicators, investment banks across Europe saw return on equity of just 6.7% in 2015, down from 9.2% the year before, and well below the mid-teen returns that investors expect.

Add the capital requirements related to dealing with cyber threats, as well as the agility and disruption of 'asset-free', born-on-the cloud entrants, and it becomes evident that industry incumbents need to consider new approaches.

Second is the technical possibility. There is technology available now – specifically blockchain and the 'cognitive' systems that are trained rather than programmed and that continue to learn and get better the more they are used. Specific to compliance, it is now possible to break the linear relationship between labour and the escalating volume of financial transactions.

Unstructured information in the form of regulation, rulings and examiner notes, for example, must all be understood to operationalise sustainable practices in regulation management, risk management and compliance. This unstructured information is projected to grow from today’s 3 million pages to a staggering 300 million pages by 2020. Its growth is far outstripping any human ability to deal with it.

Together these factors merge to create both incentive and opportunity for multiple financial services firms to tap into a centralised, cloud-based platform in order to cope with the regulatory environment. In the process, they will discover the promise of cutting the cost of these activities by 50% or more: IBM’s modelling shows that this is the magnitude of what is possible.

It is an idea whose time has come: a burning-platform issue in the form of reg-tech; new economics driving an unavoidable need for new alternatives; and the arrival of advanced technologies to solve a problem that has blown past the traditional capacity of people and institutions.

The new face of artificial intelligence

There are examples to draw on. The parsing of hundreds of thousands of pages of regulatory compliance mandates, for example, is a workload ideally suited for cognitive computing – applying the same basic approach that has already been deployed in several of the world's leading cancer research and treatment centres.

In the same way that IBM is working with researchers and oncologists to train our cognitive system, Watson, on medical literature, population health trends, patient histories, genetics and an array of data, variables and correlations that no human could master, we will also train Watson on the inner workings and complexities of compliance in financial services and other industries.

Experts in risk management and regulatory compliance will teach Watson, since it learns by continuously ingesting regulatory information as it is created, and through interaction in real-world applications. Watson, in turn, will extend and enhance these professionals’ expertise. This is the new face of artificial intelligence – man and machine working together to tackle serious challenges, and will become especially important as areas such as consumer protection command new attention.

That work is a driver behind IBM’s acquisition of Promontory Financial Group, a risk management and regulatory compliance consulting firm, which gives access to 600 of the world-leading experts to whom the industry turned in the aftermath of 2008.

Fundamental change

Then, to an intelligent, secure cloud platform, add blockchain. The World Economic Forum estimates that 80% of banks are currently working on blockchain projects, while a recent study by IBM shows roughly 65% of banks expect to have blockchain solutions in production in the next three years.

The financial services industry is still in a period of rampant experimentation, but one very interesting implication and shift is coming into view. By making transactions far more transparent and visible to both regulators and to banks themselves, blockchain will illuminate property exposures in ways that traditional ledger-based accounting does not.

This has the potential to revolutionise the illiquidity of property used as collateral. Imagine that kind of clarity about the funding stress on certain banks in 2006/07, and it is easy to see that the role of regulators themselves could be transformed. With real-time access to data creating real-time influence from the start, it is a chance for regulators to be more of a dynamic and positive change agent, and less of a watchdog.

The case for why this industry is ready for a new model is clear: prevailing economic pressures; the availability of cloud-based utilities or platforms that are based on expert, learning systems; and the opportunity to adopt a rather radical new approach – a collaboration that fractionalises the costs of a vital but non-differentiating set of activities for all participants.

A single cognitive platform serving clients across financial services, beginning with one of this industry’s greatest challenges – regulatory compliance – is a concept whose time has come.

Bridget Van Kralingen is the senior vice-president at IBM Industry Platforms.