Digital Transformation – Foot Anstey's Islamic Finance Virtual Roundtable highlights

On 8 May 2024, Foot Anstey hosted the latest in their Islamic Finance Roundtable series. In this virtual instalment, industry leaders came together to discuss digital transformation and the opportunities and challenges presented for financial institutions and their operations. Hosted by Imam Qazi and Paolo Sbuttoni from Foot Anstey and joined by Andrew Parsons and John Taylor from Version1, discussion centred around:

1. Technology trends in financial services in 2024.
2. Legal and technology hurdles to navigate when implementing technology (in particular, Cloud Adoption, Artificial Intelligence (AI) and Blockchain).
3. The key technology and legal challenges in building a digital bank.
4. Whether the Islamic finance sector is keeping pace with other sectors.

Technology trends in financial services in 2024

Expansion of Artificial Intelligence & Machine Learning

Andrew Parsons (Digital Advisor for Financial Services at Version 1) opened the discussion noting that "it is difficult to have any conversation these days without the words AI being used". It was clear from the discussion that financial institutions consider use of AI for an ever-increasing number of new purposes. An example is using AI to conduct credit analysis on customers to reduce the time from application to acceptance. Of particular interest is the growth in use of generative AI as a tool to produce content. There is a trend towards democratisation of generative AI, with an increasingly diverse range of users.

"Gen AI is clearly today's talking point" – John Taylor, Global Lead for Cloud Transformation at Version1

Machine learning (as a tool for analysing data) was also highlighted as a growing area with more neural networks and large language models (LLMs) entering the market. These models however come with a large price tag and, as a result, it was noted that there is an emerging trend amongst businesses to instead employ smaller language models (SLMs which are more streamlined versions of LLMs) particularly those with more limited budgets.

Move to multi, hybrid and industry cloud

There has been an increasing trend and preference towards industry clouds (for cost and security purposes), and there is a general consensus that this could have significant impact on the market, shifting some data centre spend to cloud services.

John Taylor (Global Lead for Cloud Transformation at Version1) explained that they are seeing more interest in "Multi-bank Clouds" and starting to hear the term "Poly-cloud" come to the fore, stating, "I think we are going to see a rise in hybrid, multi and poly-cloud scenarios going forward".

Sustainability

Paolo Sbuttoni (Commercial, Tech and Data Partner at Foot Anstey) raised that there is an increased focus on sustainability in technology, particularly how (1) cloud services can increase sustainability of businesses and (2) a focus on energy efficiency in data centres. There is a package of European climate related legislation (the EU Green Deal) which will impact cloud suppliers and customers alike, who will need to track and report on their supply chains and develop policies around environmental impact and sustainability.

Growing complexity managing cloud spend

Pricing of cloud services can be complex. It was noted that the sector is seeing an increased interest from financial operations and management teams on cloud related spending. It is expected that this will continue to grow with an increasing focus on cost-optimisation and return-on-investment. Managing cloud costs is rising and the top challenge for those adopting cloud and the evolving area of FinOps is going to gain strategic importance, as well as go hand-in-hand with sustainability where delivering optimal and efficient use of resources will optimise cost and carbon emissions.

Increased interest in Data Centres

Imam Qazi (Partner and Head of Islamic Finance at Foot Anstey) noted that businesses within the sector are starting to show a renewed interest in Data Centres due to their comparative reduced cost. It was considered that we may see them come back into favour in 2024 as rising costs see banks re-evaluating their data storage solutions. The challenge for financial institutions, as for many other organisations is the flexibility of cloud vs. on-premise (e.g., access to the latest gen-AI services in cloud) and this is likely to contribute to more hybrid operating models, where workloads are balanced between on-premise and cloud.

Legal and technology hurdles to navigate when implementing technology (in particular, Cloud Adoption, Artificial Intelligence (AI) and Blockchain)

Increasing regulation

"We are seeing increasing regulatory requirements in the cloud – they are likely to become more stringent and specific" – Paolo Sbuttoni, Technology and Data Partner at Foot Anstey

Paolo Sbuttoni explained that we are generally seeing an increased amount of regulation in this space, Whether that is general requirements, like the EU's Network and Information Security (NIS) Directive on cybersecurity or here in the UK we have sector specific changes on the horizon with the Bank of England, the Prudential Regulation Authority and Financial Conduct Authority (FCA) jointly raising concerns about the cloud computing market being concentrated with a few big tech suppliers – there has been an ongoing consultation with a proposal to strengthen oversight of cloud providers to the financial sector.

There is a clear trend towards increased regulation of AI, for example with the recent passing of the EU's AI Act (the Act). The Act categorises AI into 4 levels of risk for AI systems – for AI considered to be "high risk" the Act imposes a wide range of obligations on providers. The first provisions of the Act will take effect in October 2024 and the rest of the Act will be staggered, with most of the requirements coming into force by May 2026. The Act is highly prescriptive, whereas the UK has chosen not to pass a similar law and currently opted for a more pro-innovation light-touch approach. However, the Act does not just apply to businesses in the EU. It has extra territorial effect and can catch UK businesses placing AI systems into the market in the EU, regardless of where they are established. Businesses using AI should start to assess whether and how the AI Act may apply to them.

Cybersecurity risk is increasing and data protection compliance is more important than ever, particularly with the use of AI and its access to large data sets. With AI needing data in the cloud to learn, this of course means that data protection compliance is more in focus for cloud suppliers and users of cloud. Due to the above and the EU AI Act, there is an increasing trend from more mature businesses in this area to focus on AI governance.

Level of oversight required

It was raised by Imam Qazi that, from a legal perspective, the implementation of AI is something that Foot Anstey are looking into all the time, particularly in the realm of due diligence. There is now a variety of software on the market which can, for example, review documents and produce summaries. There are lots of advantages to this, however the associated risks must also be considered.

Paolo Sbuttoni expanded on this. There are lots of tools available to law firms, but as a provider of legal advice and content, the firm need take responsibility for the output.

"We don't think AI will be replacing lawyers any time soon, however the lawyer of the future (and increasingly of the present) is without doubt becoming "AI enabled"" – Paolo Sbuttoni, Technology and Data Partner at Foot Anstey

Legacy technology challenges

It was raised that traditional banks often have legacy technology with data across many incompatible technologies – this is often a challenge when looking to use AI. It was commented that before being able to utilise AI effectively, data needs to be centralised into a cloud environment. This first step of moving data to the cloud is a key strategic decision businesses need to take – and this is often the foundation for digital transformation. John Taylor raised the increasing role of AI in aiding legacy code refactoring and development, as well as in software development more generally, likely to support more financial organisations in beginning to tackle legacy tech, where they have tended to back away from modernisation previously.

The key technology and legal challenges in building a digital bank

Outdated core systems

It was observed that one of the challenges facing established banks in their digital transformation is their legacy systems. Banks may need to consider replacing their core banking system before their digital transition can fully gather momentum. However, it was noted that in doing so this raises opportunities, with a clearly defined strategy and purpose in place, to jump ahead of others in the sector.

Unique service offerings

Ferheen Parkar (Head of Credit Administration at UBL) also highlighted that, where banks offer unique service lines, it is difficult to apply a "one-size-fits-all" approach to technology and this can make development and implementation of technology challenging. This can result in processes remaining manually intensive for either the bank or the customer.

Bespoke or off-the-shelf software

A number of approaches within the industry were noted, each with their own advantages and limitations. Andrew Parsons explained that there are lots of options currently available on the market, both using fin-core and modular software. He noted however, that even if you buy off-the-shelf, you will likely still need to add some developments to the product and that you may have to "sit in a queue" for these to be implemented.

David Tweedy (Chief Commercial and Operating Officer at StrideUp) expanded upon this, noting that if you buy off-the-shelf then there is a good chance you will have the same underlying technology as most of your competitors, leaving little scope to gain a competitive advantage and forcing you to instead compete on brand, price criteria and service.

As a result, some have chosen to adopt an approach of developing their own bespoke software using in-house engineering and development teams. This may result in a more agile product which can integrate unique service propositions for both internal users and customers. However, even with significant investment, this approach is unlikely to deliver a significant competitive advantage based purely on the technology. In the process, opening host of other potential issues and management challenges, mainly around costs and management focus. Ultimately, these are strategic questions and the answer will depend on the focus and strategy of the individual business.

"In my opinion, the real secret behind success isn't so much the technology itself, it's how you deploy it and what you do with it" - David Tweedy, Chief Commercial and Operating Officer at StrideUp

Outdated legal processes

It was raised that the way that banks operate their legal compliance is perhaps lagging behind other sectors within the market and it was considered whether this could be linked to a measured approach to digital adoption by law firms supporting banks. This is something that many law firms are actively focusing on addressing by implementing technologies, including client portals, and undergoing their own digital transformations.

"From my perspective, one of the things that needs to transform digitally is the legal aspect" – Abdulrahman Al-Husari – Head of Real Estate Finance at Nester

Is the Islamic finance sector keeping pace with other sectors?

Faisal Nisar (Senior Counsel at BLME) explored this question noting that he felt the Islamic finance industry was on a par with other industries in its journey to digitisation, a feeling the general consensus on the roundtable echoed. Although there are a few notable examples of innovation in the mainstream bank space in the UK, the industry as a whole is getting to better grip with the advantages that can be achieved from technology. It is anticipated that, in the next few years, we could see Islamic digital banks grow their digital offerings and make an even greater impact on the market.

"The Islamic finance sector, as a whole, is getting to better grip with the advantages that can be achieved from technology" – Faisal Nisar, Senior Counsel at BLME

For further information regarding Version 1 please contact John Taylor on [email protected] or Andy Parsons on [email protected].

For more information from Foot Anstey, please contact Imam Qazi on [email protected] or 0117 915 4913 or Paolo Sbuttoni on [email protected] or 0117 403 8980.

Foot Anstey's Islamic Finance Roundtable series is set to continue with its next meeting centred on Fraud and its impact on Islamic banks and financial services.