Regulatory Compliance in the Financial Industry and Blockchain Technology. Part I

 

Introduction

Regulatory compliance refers to the act of adhering to laws, regulations, standards, and guidelines established by the governing bodies of various industries.

The objective of regulatory compliance is to ensure that organizations operate in a manner that protects the following:

  • The public interest.

  • The environment.

  • Promote fairness and transparency in business practices.

Let's look at some examples:

  • In the payment card industry, the Data Security Standard.

  • In the healthcare industry, the Health Insurance Portability and Accountability Act.

Organizations that fail to comply can face significant penalties and reputational damage. In this article we will focus on the issue in the financial industry.

 

The financial industry and regulatory compliance

The financial sector is subject to a wide range of regulations and, as a result, there are eight potential compliance issues that financial institutions may face, including:

  • Anti-money laundering (AML) compliance.

  • Know Your Customer (KYC) compliance.

  • Know Your Transaction (KYT) compliance.

  • Data privacy and security.

  • Market conduct and consumer protection.

  • Capital and liquidity requirements.

  • Risk management.

  • Derivatives and Complexa Instruments.

We will focus the article on the first four listed compliances.

 

Money laundering (AML): Money laundering is the process of disguising illegal income as legitimate funds through a series of transactions, making it difficult for law enforcement agencies to trace the source of funds.

AML regulations vary from country to country, but include provisions for:

  • Customer identification and due diligence assesses the risk of money laundering and terrorist financing.

  • Transaction monitoring: Look for suspicious activities and report them to the relevant authorities.

  • Record keeping: Maintain records of your processes and transactions.

  • Reporting to authorities: such as the Financial Crimes Enforcement Network (FinCEN) in the United States.

Know Your Customer (KYC): Involve organizations collecting and verifying specific information about their customers, to comply with KYC regulations, financial institutions typically implement the following measures:

  • Customer Identification: Identify their customers, usually by verifying government-issued identification documents.

  • Client due diligence: Assess their source of funds and the purpose of their relationship with the institution.

  • Continuous monitoring: look for changes or anomalies that may indicate increased risk.

  • Record keeping: Keep records of your KYC compliance processes and customer information.

KYC regulations vary by country, but compliance goals are the same for all authorities: to prevent financial fraud and protect against money laundering.

 

Know Your Transaction (KYT): A set of processes and procedures designed to ensure that financial institutions comply with anti-money laundering (AML) and counter-terrorist financing (CFT) regulations.

KYT processes generally involve the monitoring and analysis of financial transactions to determine the source and destination of funds, as well as the persons and entities involved in the transactions.

 

Privacy and data security: To comply with privacy and data security regulations, financial institutions must implement robust measures to protect personal and financial information, as well as comply with industry-specific regulations, such as the Gramm-Leach-Bliley Act: in the States and the Payments Act or Card Industry Data Security Standard (PCI DSS).

 

Three of the key measures include:

  • Data confidentiality or encryption: Encryption of sensitive data both in transit (transmission) and at rest (database), so that if intercepted, it cannot be easily read by unauthorized people.

  • Authentication or access control: Limit access to sensitive information to only those who have a legitimate need to access it and use strong authentication methods to ensure the identity of users.

  • Employee Training: Provide regular training to employees on data protection best practices and ensure that they understand the importance of protecting sensitive information.

 

Blockchain technology and compliance in the financial industry

Blockchain technology has the potential to bring significant benefits to the financial industry, such as:

  • Increased transparency, security, and efficiency in financial transactions stored on the blockchain.

  • Integrity and authenticity in the transmission of transactions between participating nodes in the network.

Financial institutions must be proactive in addressing these challenges and ensure that their use of blockchain technology is consistent with the compliance standards already outlined in this article.

 

Blockchain technology (TB) and regulatory compliance

A.   TB, Know Your Customer (KYC) and Anti-Money Laundering (AML): Automated Enforcement: Smart contracts can be programmed to automatically enforce compliance with anti-money laundering and financial authority rules and regulations.

To know how this regulation is complied with, we must identify where cryptographic assets are bought and sold, cryptocurrency exchanges, or online markets (websites or applications). A. TB, privacy, and data security:

It keeps immutable records, transactions recorded in a blockchain are permanent and cannot be modified, which makes it easy to keep a record to audit the stored data.

B.   The TB and know your transaction (KYT): The TB allows its blocks that store transactions to be considered as a ledger, shared among thousands of nodes or computers. Each user has an account or user address such as:

0x0a8E3D8953d52138C827B03CF0e747031E5c2906

With this address, we can follow the transactions from its creation until the last one in which I participate through the browsers or blockchain browsers.

C. TB is decentralized and highly secure against attacks: The blockchain protocol reduces the risk of fraud and manipulation because altering a transaction or a block involves attacking all the nodes that have the blockchain protocol and databases.

 

Closing remark:

In the following articles, we will explain in detail how TB meets the requirements to comply with the 4 regulations listed above.

 

 
Carlos Sampson