What does regtech collaboration across the regulatory ecosystem involve? Get our take here.
Welcome to the third installment of our 2022 regtech series. In my first post, I talked about how regtech adoption in financial services has lagged the adoption of other forms of fintech, despite 50 percent of customers using fintech daily. I discussed industry data on how compliance departments continue to rely on hiring people to manage business growth, despite static budgets and increasing labor costs. More recent statistics, however, suggest the tide is turning in favor of regtech adoption.
In my second post, I talked about the regtech funding market, which has favored a few large regtech companies. In fact, I noted that most regtech firms have raised little to no money from investors. Interestingly, regtech firms that succeed in raising two or more rounds were able to capture large funding rounds from investors.
In this post, I pivot away from focusing on compliance and markets and instead look toward the legal industry. Why the legal industry? Because lawyers have long had strong relationships with heavily regulated industries, and financial services is no exception.
Why Financial Services Lawyers Need to Stay Current on Regtech Developments
There are a few reasons why lawyers need to keep up with the available regtech products and understand how they work. First, lawyers will need to advise on how to conduct adequate due diligence on software vendors, with special emphasis on these issues:
- Vendor capability and stability
- Vendor alignment
- Ease of integration with the client’s business
- The risks and consequences of a proliferation of solutions
- Third-party risk management
- Error management
Before advising on such vendors and their underlying technology, lawyers need some basic understanding of the vendor’s infrastructure, data models, and algorithms. They also need to understand the legal risks of using manual and automated processes, along with the legal risks related to the regtech product itself. Other areas such as data protection and privacy laws are also critical to effectively serving legal clients.
Similarly, lawyers (like their compliance brethren) need to stay current on regulatory developments. Thomson Reuters estimates that the financial industry spends at least a day per week staying current on regulatory shifts. Lawyers spend even more time tracking regulatory changes. And clients often ask lawyers about various products and vendors. The more a lawyer knows about these products, how they work, and which are the best in class, the better counsel the lawyer can give.
Additionally, lawyers need to understand regtech developments so they can work with regulators to shape applicable rules and with clients to implement those rules. A prime example is cryptocurrency and blockchain technology. As more innovators leverage blockchain technology to deliver services to financial firms or their customers and more financial services firms open up to using cryptocurrencies, regulation of these products will be needed to prevent fraud and other market abuses. As a regulatory intermediary, lawyers can help innovators engage with regulators to develop smart regtech solutions.
Participating in the Regulatory Ecosystem
Lawyers play a key role in the regulatory ecosystem. They both advise clients on the development and application of rules and work with regulators to help shape those rules. The cross-collaboration between regulators, regulated firms and their employees, and law firms is important in maintaining competitive markets and establishing regulatory compliance.
Source: RegTech and the Law
Source: RegTech and the Law
In addition to advising clients on regtech products, lawyers need to understand how regtech will change the practice of law. This question recently came up at the American Bar Association’s Financial Services Technology Joint Subcommittee Meeting in Atlanta. A few legal areas are going to be impacted by regtech in the near term.
- Due diligence in venture, private equity, and mergers and acquisitions. Technology works best in repeatable situations that manage standardized data sets. When it comes to venture investments, private equity deals, and mergers and acquisitions, firms tend to request the same information, and this process is repeated thousands of times a year. Rather than manually requesting and reviewing these large data sets, a seasoned lawyer could leverage software and natural language processing (NLP) tools to request information, review the initial response for completeness, and perform an initial analysis.
- Document review. A similar process could be used for document review in litigation and transactional deals that require copious amounts of data and documents to be uploaded to a data room. Imagine a machine embedded in today’s online data rooms that could review materials in real time as they're uploaded. Imagine further a machine that could produce a daily or weekly status report along with initial assessments.
- Contract creation and review. Given recent advances in natural language processing, lawyers can expect to leverage NLP products for contract creation and review, especially with standardized contracts such as those used in real estate. While lawyers will still be responsible for crafting customized contractual terms, much of the standard (i.e., "boilerplate") provisions, formatting, and structure will be managed by machines.
- Pleadings and disclosure documents. The same is true for pleadings and disclosure documents such as regulatory and shareholder filings. Again, machines will perform the role of paralegals and associates, but with the considerable risk of liability, experienced lawyers will still need to review final drafts.
In sum, I believe machines will have the biggest impact on the number of paralegals and new lawyers needed in the industry. Today, these roles handle much of the administrative and repetitive work (e.g., document review) where machines can add the most value. Going forward, the industry will need to deal with the dilemma of hiring fewer associates while maintaining long-term subject matter expertise.
Like the financial services industry, the legal industry is ripe for technological disruptions because of the sheer amount of data it processes, and the high volume of repetitive tasks done by law firms today. Other businesses (e.g., eDiscovery and fund administrators) have already started to intrude on the historic role played by law firms. Today, firms outsource or use contract lawyers to manage certain tasks. In the future, I believe firms will leverage technology, particularly NLP, to make the practice of law more efficient, less costly, and scalable—and, just as importantly, to provide a better client experience.
But the transition will create issues that the industry must deal with, including product and malpractice liability, cybersecurity, and data privacy. It will also require lawyers and firms to learn new skill sets as they deal increasingly with technology both in their own practice and in their clients’ operations.
In our next blog post, I’ll discuss some of the strengths and weaknesses of regtech, including how to evaluate such products and conduct initial due diligence on vendors.