Digital resilience: How digital technology supports financial markets

Digital technology continues to drive the financial sector forward. Last year alone, investors around the world invested more than $200 bln into innovative products and services for the financial industry. In the turbulent world of today, digital technology not only remains an important competitive advantage for the financial market, offering a window of opportunity for future growth, but also serves as protection against sanctions and respective restrictions. The capabilities of innovative digital tools on the financial market, restrictions and risks related to their use were in the center of discussion at the 4th Transformation of Financial Markets and Financial Systems Within the Digital Economy. The international conference was organized by the Department of Financial Markets and Financial Engineering and the Department of Banking and Monetary Regulation of the Finance Faculty of the Financial University under the Government of the Russian Federation, with support from the Central Bank of Russia, the Russian Chamber of Commerce and Industry and the National Financial Association. Key aspects of the expert discussion are covered below.

Digital shield

Digital tools are what can ensure stability to the financial market amid the global turbulence and, most importantly, prevent the technological decline of the financial sector. The technology resistant to external challenges is particularly important, notes Artem Genkin, President of the Center of Protection of Bank Clients and Investors.

“Effective and successful technologies in the financial sector must be able to resist geopolitical shocks,” Artem Genkin explains.

A good example is DeFi, or decentralized finance, a tool on the conventional financial market that helps improve basic services and consistently wins over new niches.

“It is not a coincidence that DeFi is often called ‘LEGO money.’ They do help build enhanced and more customized financial products based on open-source protocols, to meet all sorts of customer demands. It is a strategy used by major financial service providers on the financial market as they compete for clients,” Artem Genkin adds.

In addition to optimizing transaction costs, DeFi offers more effective and transparent products and services to the financial sector that can be accessed by a wide range of users.

“Inclusivity is one of the key benefits of this technology as anybody with internet access can enter the DeFi market,” Artem Genkin notes.

Investment booster

Regaining retail investors’ trust in the financial market is important in current conditions. It is also one of the priorities of the Russian Central Bank, according to Mikhail Kovrigin, Director of the Central Bank’s Department of Strategic Development of the Financial Market.

Digital financial instruments can become another driver of investment activity. For instance, private investors are currently showing an active interest in the DeFi sector, Artem Genkin says. Due to the staking mechanism, they can open analogues of crypto deposits, while DeFi protocols provide access to direct crediting on the crypto market.

Digital financial instruments can also make attracting investment in the real sector easier, for instance, for the purposes of industrial renovation whose importance was emphasized by Vladimir Gamza, Chair of the Council on Financial, Industrial and Investment Policy under the Russian Chamber of Commerce and Industry.

Industrial renovation is a radical transformation and modernization of the outdated industrial facilities. According to the estimates of the chamber, there are currently thousands of facilities that require renovation.

In addition to such tools as offset and special investment contracts and industrial mortgage, digital instruments such as tokens and utility digital rights could be used to fund such projects. It can help to expand the circle of funding participants due to small and medium-sized businesses and retail investors.

“The main objective is to involve the financial sector in the industrial renovation. If we fail to provide the financial support of the area, it would be difficult to deal with the import substitution tasks,” Vladimir Gamza notes.

Digitizing the back office

Until recently, the active use of digital instruments on the financial market has been restricted by an entire range of “analogue” barriers, including those related to the regulations. For instance, in 2017, the Bank of Russia proposed an initiative to launch a marketplace for financial services. And even though the first pilot deals were made a year after, the launch keeps getting postponed due to the specifics of the regulation.

“The infrastructure was ready, but to make the platform work, it was necessary to make amendments to the regulatory framework, including laws on securities and financial platforms,” says Alexei Zhinkin, vice-president of the National Finance Association self-regulatory organization.

And this is only one of many examples. Thus, the order of the Federal Service for Financial Markets on the interaction between registrars with the Federal Agency for State Property Management is still in force. According to the document, under certain circumstances, for instance, when announcing a buyback, the registrar must inform the federal agency about it via a certified mail, that is, in hard copy. Also, due to the specifics of the regulatory framework, it is impossible to include digital assets to an open-end fund. There are many such things that hinder a comprehensive digitalization of the financial market, Alexei Zhinkin notes.

Doubts that professional market players have regarding the efficiency of digital instruments are also a challenge. For instance, a discussion is still underway on the advantages of digital financial assets (DFA) over traditional securities, notes Sergei Titov, Director of the Money Markets Department of the Moscow Exchange. It is not entirely clear whether the costs of DFA operations will actually be significantly lower. As regards speed of operations, the traditional commercial infrastructure still stays ahead of blockchain platforms. The emission procedure appears simpler with DFA – yet, according to Sergei Titov, new regulations may neutralize this advantage in the future. He also mentions difficulties which will persist during DFA circulation between financial market participants due to an underdeveloped regulatory framework.

Investor protection

Obviously, greater use of digital tools may pose new challenges for market participants, which should also be considered. According to Stanislav Volkov, managing director of the NCR rating agency, such technologies as big data and machine learning allow banks and insurance companies to detect fraudulent transactions, improve interaction with clients, and simplify client scoring. However, these technologies pose a threat of personal data leaks for financial services consumers, including biometric data breaches, apart from risks of reduced competition and price discrimination.

The risks in the DeFi sector include cyberattacks, high volatility, and unaudited smart contracts that may result in unscheduled asset withdrawals. Legal risks for mass investors raise concern as well.

“Unlike the traditional financial market, the DeFi market lacks deposit insurance system and compensation funds. The risks of a highly profitable high-tech product, with no restrictions on participants’ competencies, are quite an explosive mix,” Artem Genkin emphasizes.

Yet, the market already has numerous protective mechanisms to mitigate such risks. Those include, among others, information transparency as well as the opportunity for users to evaluate projects, including through feedback on social media and marketplaces.

Restricting non-qualified investors’ access to complex high-risk products, including to DeFi protocols, may be efficient as well, Artem Genkin notes. Eventually, digital financial instruments and technologies will receive detailed regulations to minimize the risks of use. As to DeFi, such regulations may include integration of KYC procedures for identifying clients, elements of control from developers, as well as software solutions to prevent risky transactions.

“The combination of these methods could well be implemented in legislative acts, meaning it will become a reality,” Artem Genkin concludes.

By Olga Blinova

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