ESG framework and adoption of DLT by regulators among biggest impacts for 2019

Supervisory technology (SupTech) is being explored by some regulatory bodies to overcome challenges of divergent reporting models between countries.

By Charles Gubert

The application of disruptive technologies by global regulatory agencies, and a buy-side framework on environmental, social and governance (ESG) investing are touted to be among the biggest changes to impact the industry next year, according to regulatory experts.

Christiane Muyldermans, counsel for regulatory affairs and corporate public affairs at KBC Asset Management, said at the Global Custody Forum in London one of the biggest challenges facing the industry concerned data reporting whereby multiple regulatory authorities – even within the EU – request that information be supplied in different formats.

The absence of harmonisation in regulatory reporting creates additional costs for the industry, resulting in significant inefficiencies.

Annex IV reporting under the AIFMD (Alternative Investment Fund Managers Directive) is a prime example. Some EU jurisdictions allow managers to submit Annex IV via a web portal, but others insist it is emailed to them. Even the report’s contents are different across individual markets with the UK, Belgium, Ireland and Luxembourg demanding non-EU AIFMs distributing non-EU feeder funds provide information on their master funds in the Annex IV.

Such divergences are not just a burden on the industry, but they also pose problems for regulators as it prevents them from adopting a joined-up approach to market supervision.  Muyldermans suggested big data analytics could help regulators manage this risk. Supervisory technology (SupTech) is being explored by some regulatory bodies and is seen by many as a sensible shift away from the formulaic template-based approach to reporting.

Using SupTech, regulators could gather unstructured information reported by financial institutions, store it on a cloud, and use artificial intelligence to go through it and identify any anomalous trends in real-time. Through blockchain or distributed ledger technology (DLT), different agencies would share information on a cross-border basis helping to combat fraud and detect systemic risks more quickly. While some test cases in SupTech may materialise over the next 12 months, its adoption on a global basis is a long way out.

Equally pressing is the EC’s Action Plan on Sustainable Finance, which Muyldermans said would bring about significant governance changes across the buy-side. The rules could see asset managers being forced to integrate ESG into their investment processes and disclose their policies to clients. In addition, the EC has taken it upon itself to come up with a classification system for ESG, a move some believe could be counterintuitive as interpretations and applications of ESG are anything but formulaic and standardised.

Some providers disagree. In its study – “ESG Investing: Setting a Course for a Sustainable Future” – BNY Mellon said that while ESG was gaining considerable momentum across financial services, the absence of a common set of internationally agreed-upon standards for organisations to validate their ESG investment credentials was holding back its wider adoption.  A number of custodians have, however, spotted a commercial opportunity and are attempting to create data analytics and reporting platforms for clients focused on ESG.