Bates News, Bates Research  |  09-20-18

FINRA Report Cites Greater Use of RegTech, Warns of Regulatory Implications



Despite RegTech’s “potential to fundamentally transform how securities industry participants perform their compliance obligations,” RegTech tools also raise “new challenges and regulatory implications” that affect “supervision, vendor management, data privacy and security.” That is the explicit assumption underlying a new FINRA white paper summarizing the results of the SRO’s extensive outreach on the subject.

It also serves as the framework for FINRA’s latest round of requests for comments on how new technologies may affect the regulator’s longstanding goals of maintaining investor protection and market integrity. Comments on the white paper are due on November 30th 2018. Bates Research takes a closer look.

FINRA Establishes a Baseline

FINRA’s white paper is significant in several ways. It serves as a baseline summary of a number of FINRA outreach initiatives underscoring the government’s priority of welcoming technological innovation in the financial marketplace (see, e.g. Bates’ News here). It serves as a marker of the current state of RegTech innovation. It also narrows the definitions of generally used terms and captures informed perspectives on concepts that have until recently been mostly aspirational.

FINRA defines RegTech as a subset of financial technology (FinTech) with an emphasis “on the development of technology tools in the financial industry linked to promoting regulatory compliance.” This is, to some extent, a limitation on the generally accepted understanding of the term, which also includes the use by regulators of technology tools such as “cloud storage and computing, big data analytics, machine learning and natural language processing to enhance its market surveillance and other regulatory functions.” That said, the white paper frames the discussion of RegTech in a way that lends itself to further parsing and possible future regulation.

The paper focuses in three areas: (i) key findings from discussions with market participants, including “broker-dealer firms, vendors, RegTech associations, academics and various other key players;” (ii) the current application of technology tools in key compliance areas; and (iii) and a listing of some of the perceived implications concerning the adoption of these RegTech tools.

Key Findings from FINRA Outreach

RegTech has arrived. That is the chief conclusion of FINRA’s outreach effort. The white paper cites one survey that found that “half (52 percent) of respondents considered that RegTech solutions were affecting how they managed compliance in their firms with almost a fifth (17 percent) reporting they have already implemented one or more RegTech solutions.” Another citation makes this point: “[t]he global demand for regulatory, compliance and governance software is expected to reach USD 118.7 billion by 2020.” FINRA concluded that the “confluence of significant regulatory and technological changes over the past few years (stemming, in part, from the post financial crisis regulation) has created incentives for firms to rethink how compliance functions operate.”

Key Current Compliance Applications

The white paper lists a variety of technologies that have been deployed to date for various compliance functions. They include artificial intelligence, natural language processing, big data and advanced analytics, cloud-based computing, robotics process automation, distributed ledger technology, application program interfaces (APIs) and biometrics.

The white paper highlights five areas where the applications of RegTech are currently used to bolster compliance programs:

  1. surveillance and monitoring - firms are utilizing cloud computing, big data analytics and AI/machine learning to obtain more accurate alerts;
  2. customer identification and AML compliance – firms are utilizing tools that use biometrics, distributed ledger technology, sophisticated data analytics and real-time transaction monitoring for KYC and other purposes;
  3. regulatory intelligence – firms are experimenting with natural language processing and machine learning to read and interpret new and existing regulatory requirements, and then offer gap analyses to help identify potential deficiencies within an organization’s compliance program;
  4. reporting and risk management – firms are automating processes concerning risk-data aggregation, risk metrics creation and monitoring for enterprise and operational risk management; and
  5. investor risk assessment – firms are experimenting with data aggregation and machine learning in combination with behavioral sciences to determine an investor’s risk appetite and tolerance.

FINRA touts the benefits of current RegTech efforts as strengthening a firm’s ability to adopt a proactive risk-based approach to regulatory compliance. It highlights the potential ability of firms to look at data across the organization that could help “break down silos” and “limit potential compliance gaps.” Further, it states that the most widely used form of RegTech today is the automation of processes that increase effectiveness and efficiencies.


FINRA also considers various implications of all this innovation. The SRO recognizes that firms will encounter risks and “operational challenges” that have implications for (i) supervisory control systems, (ii) outsourcing structures and vendor management, (iii) governance structures; (iv) customer data privacy; (v) interoperability and compatibility of multiple systems; (vi) data quality; (vii) security risk and (viii) personnel training, to name a few. In a broad cautionary note, FINRA warns that “broker-dealers may wish to consider both the benefits and risks associated with any specific tool and consider steps to mitigate risks where applicable.”


The FINRA white paper offers a peek at the challenges regulators face when trying to encourage and embrace technology innovation responsibly. It is certainly true that “RegTech tools may facilitate the ability of firms to strengthen their compliance programs, which in turn has the potential to create safer markets and benefit investors.” It is also true that these tools may present “challenges and regulatory implications” that may overwhelm a firm’s ability to have confidence in its ability to maintain compliance obligations. So, while all of FINRA’s answers seem to lie in the promise and potential of RegTech, FINRA is now beginning to ask tougher questions. Bates Group will keep you apprised.


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