Regulation or Innovation: Which Will Win Out in 2017?

Does regulation drive innovation or vice-versa? Or is it more important to have both working in tandem?

John Brazier, deputy editor, Buy-Side Technology

With regulatory compliance and technology innovation key focus areas for asset managers in the coming year, John wonders which will be the winner in terms of industry focus in 2017.

Momentum is a tricky thing to manage: Once you have it how do you keep it under control or handle the speed bumps that may thwart your progress? What if those speed bumps are unavoidable and are in fact much higher than first imagined?

You’d be hard pressed to find many people willing to speak out against the ways in which technological progress has improved the asset management industry.

Regulators, while not willing to stall that progress, have attempted to introduce an element of caution to the adoption of new technologies and to fix historic problems within the industry.

This leaves asset managers at a crossroads: Do they continue to embrace new technology to improve returns while only doing the bare minimum to remain compliant, or put the brakes on new projects in order to give complete attention to new regulatory demands?

With the continued issues around Dodd–Frank in the US, the arrival of Mifid II in Europe next year, and numerous other regulations to contend with, asset managers face something of a paradoxical quandary.

The “regtech” movement may not be particularly new but its momentum has gathered considerable steam recently.

Problematic Position

The heart of the issue lies in the relationship between regulatory oversight and technology innovation, in that it is unclear which is driving which. While regulation is informed by developments in technology adoption and its impact upon the market, it is also reactionary and cannot, by definition, be ahead of the market.

For example, much of the Dodd–Frank and Mifid II rules are focused on fixing systemic issues that caused the global credit crisis of 2008, but that was almost a decade ago and Mifid II won’t even come into effect for another year. A lot can happen within 12 months, let alone 10 years.

Technology innovation, for its part, is a difficult beast to tame. Regulators are more than aware of the damage that can be done through the implementation of untested or unstable systems, as evidenced by the downfall of Knight Capital back in 2012.

For their part, regulators are also aware that they would face a huge backlash by implementing stricter impediments on the pace of innovation that has, for the most part, served the asset management industry well.

It seems that these two forces are driving each other in tandem and without the other, either one would be detrimental to the continued development of the market. Asset managers, however, are now stuck in the middle and must choose which side to place most faith in.

Real Winners

The purpose of these numerous regulatory initiatives is to improve transparency and market stability, but more importantly, to better protect end-investors from historic calamities and malpractices. Whether regulation such as Dodd–Frank or Mifid II will eventually fulfill the aims of the regulators will only become clear with time—and even then it will be hard to quantify exactly how the industry will benefit.

There is, however, another group of clear beneficiaries from the new regulatory-focused markets: technology vendors. While regulators take stick from the asset managers, who in turn face the inevitable consequences of getting their decisions wrong, it’s the vendors who stand to gain the most.

The “regtech” movement may not be particularly new but its momentum has gathered considerable steam recently, as opportunistic solutions providers have taken heed of the way in which the wind is blowing to position themselves as indispensable utilities to asset managers that lack either the technology know-how or capabilities to ensure compliance with regulatory mandates.

It’s an impossible question to answer. Regulation will continue to dominate the asset management landscape throughout the year and beyond, hitting new highs once Mifid II is introduced next year. At the same time, technology progress will continue apace, with buy-side firms seeking to improve returns and get a competitive edge on the rest of the market through whatever new systems might be available.

Whatever approach asset managers might adopt to address this issue, declaring a winner between regulation and innovation is largely irrelevant if the industry can benefit from these two forces working in harmony. 

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