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Risks and rewards of fintech in Singapore
The term "fintech" has seen widespread use since the 2000s, but some of the technologies it encompasses have existed for decades. For example, the science of cryptography has been fundamental to the financial system since the early days of electronic transactions.
In the modern sense, today's fintech innovations range from distributed ledger technology (DLT) - blockchain being the most widely known - and cloud computing to robotics, artificial intelligence, machine learning and quantum computing. Two of these technologies in particular are currently in the spotlight: DLT and cloud computing. Both are expected to fundamentally transform the financial industry in the coming years, each at its own pace.
Broadly defined, DLT provides a decentralised peer-to-peer network that maintains a consensus of replicated, shared and synchronised digital data. The potential for DLT to reduce or eliminate operational inefficiencies has generated great interest from financial services firms since, in essence, DLT could provide every trusted party with a copy of an asset's complete transaction history. This provides users with a common, shared version of the truth, potentially resolving the siloed nature of financial industry infrastructure today.
Cloud is another important fintech offering. Many large financial firms continue to operate inhouse IT infrastructure that was custom-designed to meet the specific needs of their businesses. However, cloud computing is now providing cost-savings and benefits to challenge the dominance of individually owned and managed IT infrastructures.
What do these innovations mean for Singapore's financial markets?
Singapore is well-positioned to take advantage of the benefits of new financial technologies, including DLT and the cloud. As a hub for global trade and finance, the city-state offers a robust ecosystem of financial and fintech firms that are helping to foster innovation by leveraging its well-educated, technologically adept workforce. Furthermore, Singapore's regulators are working hard to make the island nation an even stronger fintech capital, as we saw at the Singapore FinTech Festival organised by the Monetary Authority of Singapore (MAS).
For financial firms, implementing cloud-based IT solutions is likely to cost less than upgrading or replacing bespoke legacy IT systems across most applications and configurations. The flexibility and scalability of cloud infrastructure allows for instant experimentation, immediate results and efficient exits. This essentially eliminates the need to go through long cycles of purchasing, installing and managing server equipment, empowering companies of all sizes to create new applications when they need them, scale them as appropriate and turn them off when no longer necessary.
DLT innovation, for example, is possible in part because of the cloud. Without the cloud, every DLT experiment would require new equipment, storage and system. The cloud makes it possible to easily experiment with the technology, creating a dynamic experience where the user can test scenarios and tools without sourcing equipment and integrating systems. Proof-of-concept initiatives have already convinced many that DLT has the potential to address some of the key limitations of today's financial markets, including:
- Multiple versions of the truth: Financial markets are largely siloed by asset class or geography, meaning there is often limited insight to the overall state of the wider market. This lack of transparency means that most banks maintain large, costly IT resources designed to reconcile transactions to determine what the true status of transactions are. As mentioned previously, DLT has the potential to provide a common, shared version of the truth. In theory, every user could have a single copy of the same history of all transactions across asset classes.
- Vulnerable to technology threats: The legacy IT systems currently in use were not designed to protect against today's technological threats, such as the growing sophistication of cyberattacks that can compromise data. With DLT, however, all data is encrypted according to modern standards and can only be decrypted and inspected by the owner of the required keys.
- Unnecessarily complex: Today's financial IT systems are complex due to their evolution over the course of decades. There are few widely used standards, systems are not well integrated and many manual processes persist. But a shared ledger used by every party involved in the trading of an asset could change this, if the industry works toward network and data standards that are integrated using common tools and workﬂows.
- Not equipped for 24/7 processing: Today's systems were mostly designed before the industry became globalised and markets needed to operate 24 hours a day. A DLT-based transaction distribution model could enable always-on processing, which is more resilient to local database corruption than many of the existing hardware replication models.
Are there hidden dangers in fintech innovation?
It is too early to fully appreciate whether fintech innovations such as DLT and the cloud will ultimately be systemically beneficial. For all the expected benefits, fintech adoption could also have negative consequences, such as exacerbating cybersecurity threats or amplifying third-party risks.
As a result, there is a need to monitor unanticipated risk as fintech adoption grows. Regulation is an important part of ensuring that fintech delivers more rewards than risks. It is encouraging to see that the MAS is working with the industry to promote this by establishing innovation sandboxes and proactively working with the financial community to develop guidelines.
Examples of this proactive approach include:
- In July 2016, the MAS issued new guidelines specifying that public cloud computing is a form of outsourcing. Accordingly, the guidelines state that financial institutions must perform due diligence when selecting cloud services providers and are required to apply sound governance and risk management practices. Similarly, the guidelines require cloud service providers to take active steps to address risks associated with data access, confidentiality, integrity, sovereignty, recoverability, regulatory compliance and auditing.
- In October 2017, the MAS announced that it was participating in an experiment to explore how DLT could be used for the local clearing and settlement of payment and securities. The project, known as Project Ubin, is being conducted in phases in collaboration with a group of local and international financial institutions. The prototypes resulting from this collaboration could ultimately be used by the Singapore Exchange to enhance the efficiency of securities trading and settlement cycles.
While the overall impact of fintech on the financial ecosystem remains limited at this time, potentially disruptive innovations will likely unfold quickly and somewhat unpredictably in coming years. These developments could impact financial stability in both positive and negative ways. As a result, fintech developments must be closely monitored to help ensure that implementations take advantage of all of the benefits of new technology while keeping a close eye on potential risks.
- The writer is managing director and Chief Technology Architect at The Depository Trust & Clearing Corporation (DTCC)