Last week IBM announced they had entered into a definitive agreement to acquire strategic consultancy Promontory Financial Group. Promontory is not exactly a household name, but they are one of the very top tier of global banking consultancies, with a particular focus on regulation and compliance.
The Wider Landscape
IBM cite a McKinsey figure of $270 Billion costs related to compliance, which consists of direct compliance spend of $99 Billion, with the remainder accounted for with other forms of compliance leakage (fines, damage to goodwill etc.). For clarity we must state that there is no public data available for this figure, but it seems in-line with other research that is available.
In many ways the figures are somewhat irrelevant, if we look at, for example, the destruction to shareholder value that can occur when a financial institution is not in compliance with relevant rules and regulations. Over the last number of years, we have seen a number of major banks being hit with fines for breaching compliance rules and/or misleading actions, such as the ongoing controversy with Deutsche Bank, or the Libor issues that engulfed Barclays and others. These in turn have a material impact on share prices.
The burden of regulatory compliance is, in all likelihood, going to increase in coming years. On the political front we are going through a period of increased uncertainty, as demonstrated by results such as that of the recent Brexit referendum in the United Kingdom. While it is impossible to predict the exact outcome of the changes that will come from events such as Brexit, the only certainty we can have is that it will increase, rather than decrease the amount of, and disparity in, regulations worldwide. More importantly public opinion is such that the underlying trust in the global financial system needs to be bolstered and reinforced by regulators and governments alike.
Cognitive Risk and Compliance
When technologists approach a problem such as risk or compliance it generally tends to be in the form of a binary either/or approach. The issue with this approach is that when we have combinations of rules, regulations and legislation there will be grey areas that are subject to interpretation. These areas can, and do, evolve over time. More importantly most of this regulation and associated documents appear in very unstructured forms.
A regulation may appear to some to be very black and white. A court judgement about its application in specific context may completely change how it should be interpreted. The location in which a firm is domiciled, where it trades, where a transaction begins, where the transaction completes, who initiated the transaction, who discussed it and so forth all have impacts.
This disconnect, between a very black and white rules based approach and the realities of what needs to be done, combined with the sheer volume of unstructured legislation, has ultimately left the wider financial industry in a position where most compliance and regulatory efforts are highly manual, and in general something that occurs after an event, e.g. a transaction, has completed.
What makes the Promontory acquisition interesting is the focus on understanding the rules in a manner that can link together context and precedence. Some of the initial focus will be on training Watson, IBM’s Cognitive Computing Platform, on how to absorb regulations, and validating the results. But the longer term goal is clearly on helping institutions embed risk management and regulatory compliance into their day to day processes with as much automation as possible.
The idea of a wider platform, which financial institutions could use on say a per transaction basis to validate compliance, but always holding a wider context, while taking into account evolving rules is definitely of significant value. And that is also where developers come in, integrating this platform across various components within a financial institution will be key.
The Human Element
It is important to note, however, the human element in all of this work. Companies are ultimately responsible themselves for being in compliance. Technology can assist, but there is still a human judgement call that needs to be made.
From a market perspective IBM has had slowing growth in much of its traditional business for a number of years, and at the same time it has spent significant time investing in Watson and associated platforms. This is part of a larger transition. As we have noted before some macro trends in the technology industry are shifting, which has direct consequences for a number of lines in business across all the incumbents.
Over the last year a number of IBM acquisitions have been focused on data (e.g. The Weather Channel), which can then be combined with various models to make intelligent decisions. This acquisition is somewhat in reverse, it is the intelligent decisions and understanding of the rules that is coming first, the data will then come from the customers. Either way on a strategic front the potential upsides of this acquisition are significant, but as always the proof will be in the products offerings that follow.
Disclaimer: IBM are a RedMonk client.