Distributed Ledger Technology (DLT) is currently a hot topic for financial services, and with good reason, as banks are looking for efficient solutions to costly and cumbersome regulatory burdens and this is exactly what DLT promises to deliver. One of the key areas where there is clear application for this is in meeting Know Your Client (KYC) and Anti-Money Laundering (AML) requirements which can be expensive and lengthy processes. Although there are certainly challenges ahead for integrating DLT into financial services, and it is not a magic formula that will solve all issues with no drawbacks, it is clear that the industry is heading towards a future that contains DLT, and we must therefore prepare for it.
We need to stop talking about DLT … and just do it
One of the key features of DLT is that it is a decentralised database, a system that allows non-trusting counterparties to directly share in the database, without a single controlling entity or intermediary. Transactions are immutable and cannot be tampered with – another key aspect of the technology. Also, the concept of digital identity, a firm’s identity on the system is verified and usable by all on it, is especially useful, particularly for meeting KYC requirements.
KYC is an expensive part of business, a pricy process to implement and it can come with damaging fines if not done correctly. In some cases, it can take a significant amount of time to establish, present a poor experience for the customer and make for much work on the part of the banks. However, KYC is crucial in the movement against money laundering and terrorist financing and adequate compliance to due diligence and client onboarding requirements is necessary and failure to comply can be harshly punished with hefty fines.
One of the most obvious advantages is the cost saving element; there would be huge savings on operational costs after the initial set-up for, once a digital identity has been established for a customer, banks do not need to re-perform the same checks. This lack of duplication also means KYC checks could be performed just once, by one entity, and then be accessible, through a digital identity, to all on the system, reducing the effort involved. This would lead to a better customer experience as the client would only have to submit documentation once, security would be increased as the opportunity for identity theft would be minimised and fewer transactions would be falsely flagged. There will also be increased security and transparency through almost real-time distribution of information, which will help regulators in their supervisory efforts.
Is DLT worth the effort?
The initial efforts and costs would be significant and it is important to weigh up the long-term benefits against this. Although the savings over time would be tremendous, the high start-up costs could be a deterrent, especially when taking a leap with a new technology with challenges still to be resolved.
Perhaps more worryingly, there are privacy and security risks. While there are options that can increase security, such as private and permissioned DLT with strong encryption, clients will want to ensure that their details remain private from those institutions with which they are not involved. Also, if all information is contained in a known system, despite the increased security it entails, it might carry risks of cybersecurity failure.
Another concern might be standardisation, for different KYC requirements across jurisdictions could decrease the efficiency and usefulness of this technology, as well as banks having various onboarding checks. There would need to be an entire culture shift to a decentralised network and standardisation. Additionally, liability needs to be addressed. If one bank performs checks inaccurately for a client’s digital identity, and this is then used by multiple banks … who is liable?
Despite the initial cost and effort, DLT could be incredibly important for long-term efficiencies. Many regulators and institutions are investigating this technology as a source of challenge, innovation and identifying the issues to be resolved, as well as the areas, such as KYC, in which it could bring most advantage. Standardisation is a step that the financial sector certainly IS contemplating as a part of many efficiency solutions and, through collaboration and the teamwork of regulators, institutions and a variety of firms, new innovative technologies, such as DLT, could eventually be integrated smoothly into the sector.
A collaborative approach to using DLT to make KYC processes more efficient seems likely, but it is important that it is introduced safely into the system – and this takes time. Regulators and firms need to work on the security, privacy and technical issues which DLT poses before being able to reap the benefits. KYC does seem like an ideal place to start this introduction and, hopefully, it is something that the sector will see introduced in the next few years, and its usefulness can be utilised.
Many open questions still underpin today’s KYC regime and DLT’s part in it, as well as in other regulatory areas. JWG will be exploring these issues in more depth at our 300+ person RegTech Capital Markets Conference on 28 February 2017. A roundtable session on KYC/DLT will explore the issues mentioned in this article in greater depth, including the need for a collaborative approach, the efficiencies that DLT could bring to the KYC sphere and its introduction to the sector.
If you would like to join over 50 firms and talk to industry leaders about these problems and their solutions, you can sign up here.
JWG are following all developments in the KYC/DLT space very closely, and we will be launching a Client Management SIG (CMS) in March, to focus on KYC regulations and client data from an end-to-end perspective.
If you would like to find out more about this group, please contact email@example.com.