Regulatory Lag & Drag – Are There FinTech Solutions?

The RegTech, SupTech, and FinTech communities are focused on developing new technologies to speed up, simplify, and streamline financial institutions’ ability to implement new rules, regulations, and regulatory guidance. But there are two other stages of the regulatory life cycle that may be longer and more problematic for financial institutions than implementing new regulations: these are the time it takes for new regulations to be written and published (“Regulatory Lag”), and the time it takes to enforce those regulations (“Regulatory Drag”).

Time to Regulate – or “Regulatory Lag”.

This lag occurs where a new risk emerges, or a new product is introduced, or an existing product is used in new ways. There is always a lag between that new risk or product and the resulting legislative and/or regulatory response. In the meantime, institutions have to begin addressing the new risks when they first emerge – they can’t wait for new rules, regulatory guidance, and regulations to begin the multi-year people, process, and technology changes necessary to address the requirements of the regulation. Those early, pre-rule and pre-regulation efforts at building controls to address new risks can be expensive, and institutions run the risk of missing the mark and having to re-do much of what they’ve built. The best example of regulatory lag in the AML space is 9/11, which saw legislation passed in 45 days (October 2001), regulations published two years later (2003), and regulatory guidance in the form of the BSA Exam Manual two years after that (2005). Although it was only 45 days that financial institutions knew about the new information sharing provisions in section 314 of the USA PATRIOT Act, it was almost another four years before financial institutions knew how their regulators would examine their compliance with those information sharing provisions. It was this “regulatory lag” that led to my written statement (in December 2006) that “we’ll be judged tomorrow on what we’re building today, based on regulations that haven’t yet been written and best practices that haven’t been shared.”

Time to Enforce – or “Regulatory Drag”

Public enforcement actions (and prosecutions) drive a lot of compliance-related behavior in financial services. Yet there are multi-year delays between when the impugned behavior occurred and when a public enforcement action (and/or prosecution) makes them known to the industry. FinCEN’s December 2014 action against MoneyGram’s former BSA Officer is a good example: that action was made public in December 2014, and alleged violations of the Bank Secrecy Act that occurred from 2003 through May 2008, or more than 6 ½ years from the last day of the impugned activity and when the public action was taken.

What Can Technology Do To Address Regulatory Lag and Drag?

Regulatory lag and drag have been around for as long as there have been regulators. But with the world speeding up as much as it is, with new products and services, and new providers, being rolled out and created much faster than regulatory bodies can manage, there must be changes made in the entire regulatory life cycle.

FinTech providers and their customers demand a fast revolution. Regulators prefer a slow, deliberate evolution. There has to be a better way to identify new and emerging risks, to draft and communicate regulations to address those risks, and to implement the needed controls to manage those risks.

I’m not sure what can be done from a purely technology perspective to speed up regulators (and prosecutors), but the proponents of FinTech, RegTech, and SupTech solutions shouldn’t just focus on digitizing the implementation of new regulations, but on digitizing the entire regulatory life cycle: the regulatory lag between new risks and new regulations, the regulations themselves, and the regulatory drag from regulatory problem to public resolution.

Posted on LinkedIn on January 28, 2019