What is set to change in RegTech in 2023?


As the RegTech industry evolves, the sector looks towards new trends and developments that may impact it going forward. What are these? 

In a recent post by Saifr, Mark Roszak – regulatory and compliance advisor to Saifr – outlined a number of key trends the RegTech industry could expect to see in 2023 and beyond and what this may mean.

Roszak said, “As we look further into 2023 and beyond, we can expect the regulation of broker-dealers and investment advisors to continue to evolve with the shifting business practices. Specifically, we expect that the regulations will be shaped by a number of factors, both past and present, including the increase of virtual currency activities within the traditional financial services ecosystem, continued focus on ESG, and the implementation of the SEC’s new marketing rule.

“Beyond those, we look at the potential for AI and ChatGPT to revolutionize certain aspects of broker-dealer and investment advisors and with-it regulations will have to keep pace.”

On the topic of the new marketing rule, Roszak explained that he expected to continue to see guidance and potentially enforcement actions that clarify certain elements. With the SEC updating its frequently asked questions (FAQs) regarding the marketing rule in early January – while the FAQs are currently short and non-controversial, it sets a promising precedent and a basis on which the SEC can choose to expand, Roszak said.

The Saifr advisor also highlighted the publishing of the SEC’s Division of Examinations 2023 examination priorities that underline the focus on the new marketing rule in future examinations.

He said, “Specifically, the SEC’s Division of Examinations noted its focus on whether investment advisors have adopted and implemented policies and procedures designed to comply with the new marketing rule. It doesn’t take much foresight to see coming fines in this area in 2023 and beyond.”

Roszak also cited another key RegTech trend as changes in crypto. He said, “Earlier this year, the SEC proposed rules to enhance custodial protections of customer virtual assets managed by registered investment advisers.

“One point regarding the proposed regulation, underscored by SEC Chair Gary Gensler, is that it “covers a significant amount of crypto assets.” In order to comply with the proposed rule, an investment adviser with custody of client crypto assets would need to ensure such assets are maintained with a qualified custodian.”

A great deal of crypto asset trading volume occurs on platforms that directly settle trades. Its not uncommon, Roszak claims, for crypto trading platforms to require investors to pre-fund trades and to transfer their crypto assets to such an exchange prior to the execution of any trades.

Roszak quipped, “Under the proposed rules, this practice would likely be barred for any exchanges not also qualified custodians (i.e., most crypto exchanges). Consequently, this proposal could effectively prevent many investment advisers from investing client funds in crypto assets. Pushback from the crypto industry is likely over the next year; however, it is likely that new regulations will be promulgated to the nascent virtual currency industry.”

The Saifr advisor highlighted that the Lummis-Gillibrand Responsible Financial Innovation Act has made little progress since introduced in the Senate in June last year. With crypto scandals abound, however, he said, “Expect to see the Lummis-Gillibrand bill dusted off and revisited during 2023, or other comprehensive crypto legislation proposed; however, it is unlikely that any comprehensive crypto legislation is passed in the near-term.”

Another area of RegTech to watch out for is GPT3 Investment Advice and the like. Roszak said, “In theory, the rise of GPT3 and other artificial intelligence-based language models are the logical next step for the “robo-adviser” space. But in some ways, AI language models are qualitatively different from what’s currently on offer.

“For one thing, GPT3 and similar language models can have trouble actually “understanding” their input or output in the conventional sense – they’re usually designed to produce textual outputs based on their massive bodies of training text, to provide likely follow-ups to a given prompt. As such, they can “mix-and-match” their training data to produce a probable response to a given query, but lack the ability to verify the truth or falsity of the result.

“The popular ChatGPT system, for instance, lacking any outside context for the words it uses, is known for its tendency to occasionally fabricate factual information, a phenomenon popularly referred to as “hallucinating.”

Roszak explained that while the ability to synthesise large amounts of information is promising, the potential consequences for fabricated information provided to a client could keep GPT3 and similar language models away from mainstream robo-advisers for at least the next several years.

“Nevertheless, the rapid progress in the development of such systems suggests that it may not be long before personalized marketing copy, background briefs, or even investment advice are routinely the province of GPT3’s successors,” said Roszak.

The final RegTech topic outlined was the hot button topic of ESG. Roszak explained, “ESG factors are becoming increasingly important for investors, and regulators are responding by proposing new requirements to make ESG disclosures more consistent and comparable. In May of 2022, the SEC proposed a rule that would require the enhancement and standardization of climate-related disclosures.

“Later last year, the SEC proposed rules that would require asset managers to provide more information about their ESG-related investment products. Given the controversy surrounding the topic of ESG, it remains unclear whether either of these rules will be finalized in the near term.”

Read the full post here.

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