The drive for global tax transparency continues to gain speed while financial institutions (FIs) also grapple with emerging disruptive financial technology innovations and growing threats to data security. Building on the U.S.-led FATCA regulations, the first wave of reporting for the OECD-led initiative, the CRS, includes 49 jurisdictions undertaking the first exchange of financial information this year, with the second wave of 53 countries to follow as second wave adopters. They now have a significantly larger number of requirements to track, issues to solve and compliance rules to follow. FIs and governments have been under a time crunch to prepare.
Meanwhile, the converging tax transparency rules and innovations in big data, analytics and security have profound implications for how FIs are harnessing technology to stay compliant.
There are three global trends that are driving FIs to seek innovative ways to reduce costs, invest in automation efficiency and shift from a tactical view to looking at both tax and technology through a more strategic lens:
- Accelerating advances in infrastructure, communications, software and hardware are disrupting traditional business models and providing new opportunities for FIs with enhanced abilities to collect and process more data and interact with clients remotely. Data transmission technology and the adoption of mobile devices and applications have also changed the behavior of customers and interactions with them forcing even traditional, change-resistant organizations to evolve in order to survive.
- Regulators worldwide have not been blind to these changes. They now demand electronic audit trails and are eager to collect huge amounts of data — sometimes more than they can process. The last few years have shown a steep inflation in the regulatory requirements FIs are obligated to comply with through multiple tax regimes. The regulators have also increased the pressure through audit crackdowns, widely-publicized penalties on offending FIs and increasing emphasis on the personal responsibility of senior managers in FIs. Their efforts have effectively ended secret foreign bank account practices and have motivated them to regulate tax compliance with global standards, like the CRS and Base Erosion and Profit Sharing (BEPS).
- Demography and culture are also strong agents for change. FIs are increasingly mindful of public opinion, now formed and fueled in online environments as well as traditional press, and the increasing intolerance toward tax evasion. They are now willing to invest more resources to avoid adverse news and reputational risks associated with it.
Responding to these fast-evolving changes presents FIs with difficult and costly challenges to upgrade and maintain their data and technology on a consistent basis:
- Collecting and managing data. FIs are facing serious challenges with the sourcing, volume and accuracy of their data. These issues derive from data existing in legacy systems and distinct data structures across multiple systems, businesses and jurisdictions. Such issues affect customer experience and the accuracy of reporting, in addition to increasing internal risks — and fixing them requires a large investment in robust data infrastructure, as well as a painstaking process of data clean-up, standardization and remediation.
- Data analytics. Regulatory pressures demand stronger ownership and control over the data and maintenance of more detailed audit trails. FIs now need to improve their data analytics capabilities, extract information from various sources, filter reportable data and perform calculations on account activities which were not previously required.
- Data protection. PwC, a professional services firm, found in its Global Economic Crime Survey 2016 that cybercrime has risen to the second most reported economic crime — affecting 32% of organizations. FIs are prime targets for cybercrime with risks including theft of financial or personally identifiable information (PII), money laundering and financial fraud. These risks worsen with the increasing pressure from clients to provide more services through digital channels and from regulators to report electronically.
In its 2016 Financial Industry Cybersecurity Report, SecurityScorecard also points out that “IT systems are increasingly becoming a risk factor, especially in the financial industry. Many financial organizations rely on legacy IT systems that are expensive to maintain, prone to more unpatched vulnerabilities and the general challenges of software integration and architecture upgrading compound when mergers and acquisitions are in place.” FIs are required to invest significant resources in improving the security of their systems, as well as to comply with new regulations and standards for cyber security.
How do FIs respond?
For many FIs, the first year of CRS still relies on manual labor due to data quality issues and short implementations time frames. Some FIs have begun investing in new automation technologies and flexible robust data infrastructures. FIs are also increasingly focused on standardizing and centralizing the data throughout their organizations in data warehouses and employing new data management tools to facilitate large-scale data remediation and clean-up projects — as well as utilizing machine learning and big data technologies to identify patterns and facilitate reporting.
Some FIs have resorted to outsourcing parts of the reporting process as an interim step, in order to complete the ongoing IT projects or to avoid the build and maintenance of new technologies altogether.
What can we expect to see in the future?
A survey by Thomson Reuters, The Cost of Compliance 2016, determined that “The rise of financial technologies such as virtual currencies, robo-advice and digital ledger technology (such as Blockchain) will continue to challenge FIs to adapt to new forms of digital technology.”
FIs are also likely to progress to using technology to leverage new information acquired and machine learning to identify complex nonlinear patterns in large data, in order to generate new business. This will enable them to shift the increased investment in compliance from a cost center to a revenue generator and relieve some of the pressures on their operational margins.
Every year, and with the passing of new regulations, the financial industry is coming to grips with the fact that more changes are on the way. FIs are increasingly viewing CRS and global tax regulations as strategic issues requiring the global alignment of tax, technology and organizational strategies to ensure compliance.