Innovation in technology plays a critical role in the efficient operation and stability of the financial markets. However, the risks associated with technology can destabilise the entire financial market if proper safeguards and guardrails are not in place to contain these risks.
Before technology is accepted and implemented, a thorough and comprehensive analysis of the following factors must be undertaken:
Benefits and costs
Financial market infrastructures should weigh the benefits against costs. If the costs are exorbitant, then the technology should not be implemented unless it’s for the public good and subsidized by the government. In some cases, organizations collaborate under one umbrella to contribute toward funding, thereby lowering costs.
Legal issues
Financial markets are governed by rules and obligations that participants must abide by. New technology must fit into existing legislation, or new laws must be passed to safeguard and protect end users from market abuse and scams emanating from unregulated activities. The core functions of market regulation are efficiency, confidence and stability, and protection of investors and end users. Any technology that does not support these functions cannot be accepted. Issuers or owners of the technology should be registered with relevant statutory bodies.
Network effects
The mass adoption of technology drives efficiency and lowers transaction costs for end users.
Anti-Money Laundering and Counter Financing of Terrorism
The Financial Intelligence Centre Act (FICA) safeguards the financial system from money laundering by requiring accountable institutions to report suspicious activities and follow Know Your Customer (KYC) procedures when initiating client relationships. This includes continuous monitoring of client business activities. New technology should be capable of catering to anti-money laundering and counter-financing of terrorism requirements. The Financial Action Task Force (FATF) places countries on a grey list if they lack adequate laws to counter terrorism financing and money laundering. The costs of grey listing are felt across respective countries, as some countries may withdraw investments due to mandate specifications. The withdrawal of foreign investments can cause volatility in debt, exchange, and forex markets and may lead to devaluation of the host country’s currency.
Scalability
The ability to expand capacity to meet increased demand is a prerequisite for good technology.
Speed
The rate at which transactions can be completed should surpass that of traditional technology.
Security
Data and access must be resilient to breaches. If network governance is breached, investors may lose confidence and withdraw their funds.
Complaint resolution
The technology should include methods to resolve customer queries when needed to build confidence.
Ease of use
End users should experience an intuitive human interface with the technology, as complex systems can drive away investors and end users.
New Technology in Global Financial Markets: Distributed Ledger Technology (DLT)
Distributed Ledger Technology is underpinned by peer-to-peer validation of transactions using a consensus mechanism, cryptography, a shared database, and immutability of records in the ledger. All people with nodes and access to the common ledger can validate transactions, which are then chained or recorded using blockchain technology.
Cryptography creates digital signatures for transactions by generating private and public keys. Private keys belong solely to the cryptocurrency owner within the native domain, while public keys are available to all nodes in the domain for transaction verification.
Immutability of transactions on the common ledger creates a permanent record that cannot be altered.
Shared database provides all network participants access to the common ledger, as in the Bitcoin network. Developers determine whether a ledger should be permissioned or permissionless based on desired functionality and security requirements.
- Permissioned access: Only a select few have access to specific points on the network, with restricted access rights.
- Permissionless access: All nodes can access the network without restrictions, as seen with Bitcoin.
Smart Contracts
These allow paper contracts to be coded into the system, with pre-defined triggers to fulfill contractual obligations. If covenants are breached, early contract termination is triggered automatically by the system.
Tokenization
Tokenization represents real-world assets on digital platforms. This technology may disrupt exchanges, debt markets, and real estate trading after legal processes are amended to accommodate it. However, custody and depository institutions continue to play an essential role, ensuring that dematerialization processes are modified but not eliminated. Settlement and payment systems remain crucial to the economy under strict regulations.
Risks
Since digital technologies emerged, billions of dollars have been lost due to limited investor knowledge of the digital ecosystem and the delayed response from regulatory authorities to protect consumers. The Financial Sector Conduct Authority (FSCA) has a duty to educate the public on risks in the digital economy. Their website is full of resources for consumer education. Additionally, all providers of financial services are registered on the FSCA’s website, making it easy for investors to check and confirm before committing funds.
Visit FSCA’s website for more information
Opinion and Suggestions
To mitigate the effects of security breaches and data loss, organizations, including those in financial markets, must prioritize data security and control. Disclosure policies on data handling should be provided within financial statements to assure investors. Under data privacy policies, mechanisms for compensation should be in place for data loss through negligence. Severe penalties should apply for misuse of client data, with penalties expected to be legislated soon. Data companies will likely be held accountable for data losses, as stolen data is often used for fraudulent purposes.
Decentralized technology alone will take time to mature enough for mass adoption to lower transaction costs for users and businesses. Scalability of systems infrastructure is vital to support dynamic environments and consumer needs. Additionally, the integration of new technology with legacy systems is essential, as decentralization alone will not be possible without interoperability due to existing legal and regulatory requirements. Full adoption of distributed ledger technology will take years as laws and regulations must adapt first. The speed of adoption will vary by country and company, depending on resources and preparedness.
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