13 April 2018. Technological development has enabled the creation of new financial products, in particular derivatives and structured products, which are now commonplace and minimise or even intensify risk depending on their use. Subsequently, the use of software and outsourcing solutions has standardised, accelerated and facilitated the backup processes of financial intermediaries. Timely and global payment and settlement systems would not have been possible without extensive use of IT systems. The stock exchanges and other trading platforms have developed in an equally revolutionary way. Floor trading has been abandoned worldwide in favour of electronic trading platforms. In addition to traditional stock exchanges, various over-the-counter trading platforms have developed. Finally, growing demands placed on "know your customer" clarifications, which are required for combating money laundering as well as for proper customer service under MiFID II (Markets in the Financial Instruments Directive), are no longer possible without IT-supported research and algorithm-based databases.
Networking and acceleration
These developments were accelerating and innovative. New products, stock exchange transactions and other transactions can be processed more quickly and in larger volumes. At the same time, the interconnectedness of financial intermediaries and markets is becoming more apparent, leading to bank runs or, as in 2008, liquidity crises spreading faster and globally. This poses new challenges for system stability efforts.
New fintech environment
However, banks and other financial intermediaries are also affected internally by technology development. They are increasingly becoming de facto software houses, forced to either develop software themselves or purchase it from third parties. These third-party software and IT systems have established themselves as new players in the market. They develop stock exchange systems, but also settlement systems and general IT-supported back and mid-office functions. Sometimes these are joint undertakings by banks, but they can also be companies and platforms that have nothing in common with the traditional financial intermediaries. Since these companies also require a lot of expertise, market concentration, if not market power, makes them stand out, as a large number of banks ultimately use the same or similar IT systems from the same providers. At the same time, since there are economies of scale in IT implementation, this development is causing market concentration in the banking market to further increase. It remains unclear whether and to what extent these market participants, collectively referred to as fintech companies, themselves need to be regulated. The Swiss Financial Markets Infrastructure Act, governing stock exchanges and trading platforms, has been in force since 2015, and the circular issued by the Swiss Financial Market Supervisory Authority FINMA regarding outsourcing has been adapted for the modern age. Conversely, legislators and supervisory bodies have deliberately exercised restraint when it comes to regulating crowdfunding and, more recently, initial coin offerings.
Exploit opportunities and manage risks
Burgeoning information technology has enabled new business areas, operations and trading techniques. Thanks to IT, fintech's smaller unregulated financial market participants are now able to operate in capital markets without licensing requirements (e.g. crowdfunding platforms). The banking business is now closer to its customers thanks to the digitisation of client relationship management with customer-friendly interfaces for digital handheld devices. Finally, information technology in the area of regulatory compliance, also called regtech, performs an otherwise impossible task. This is today almost entirely IT-based, meaning that the development of regulation can be automated to a certain extent and the efficiency-based cost management of over-regulation is counteracted. Bank management and boards of directors are faced with the big challenge of managing the risks that occur in the financial sector and at the same time understanding the methods and technology with which the identified risks can actually be managed. It is still open as to where development is headed.
This text is an abridged version of the article published in 2015. It was first published in 2015 in the anthology entitled "Recht im digitalen Zeitalter (Law in the Digital Age), Festschrift Schweizerischer Juristentag in St.Gallen, Zurich".
Prof. Dr. Sabine Kilgus is a titular professor of private and business law, in particular financial market law, at the Law School of the University of St.Gallen.
Photo: Photocase/Nuchylee