As the legal sector undergoes a digital transformation, law firms grapple with cybersecurity challenges, prompting a shift towards third-party payment providers
Although previously considered to be behind the curve, the legal sector is now actively embracing digital transformation. The legal tech market has surged over the past few years as law firms embrace new digital tooling to drive innovation and stay competitive.
Digital transformation in the legal sector
However, new data generation and management requirements are embedded within this technology transformation. With law firms now responsible for an unprecedented volume of sensitive data, they are grappling with its greatest vulnerability: the challenge of cybersecurity.
Recent studies have highlighted this reality, revealing that a staggering 75% of UK law firms have grappled with cyberattacks at some point in the past year, with over three-quarters of these incidents directly impacting client accounts.
Law firms find themselves navigating a landscape where concerns about security and risk profiles have reached new heights. There are calls across the legal sector for the implementation of meticulous protocols for handling sensitive client data. At the same time, there is a collective shift toward adopting secure digital solutions for financial management.
Spearheading this transformation is the Solicitors Regulation Authority’s (SRA) enhanced fining powers. Regulations are tightening, compelling law firms to reassess their operational frameworks, with intensified scrutiny on payment processes and managing client funds.
As risks increase, the conventional penalties prescribed by the SRA for breaches of its Accounts Rules are no longer sufficient. Whether it involves preventing money laundering or improper asset concealment, the SRA recognises the importance of strengthening its regulatory powers by addressing vulnerabilities within firms and improving public trust. As a result, a proactive clampdown on managing client funds is beginning to take place.
Navigating the SRA regulatory challenges ahead
As of August 2023, the UK’s base interest rate has soared from 0.1% in 2021 to a staggering 5.25%. This substantial increase has opened new opportunities for law firms to earn significant interest by holding large residual balances in their client accounts. However, the financial landscape shift is closely accompanied by the watchful eye of the SRA, which has warned firms that they must pay a ‘fair’ sum of interest back to customers or face being investigated.
The SRA’s revised regulations encompass a dynamic framework of Anti-Money Laundering Regulations (AML) and Know-Your-Customer (KYC) rules. These aim to guide law firms to protect their clients and prevent financial crime and are enforced by the authority to penalise firms with substantial fines or even more severe consequences, such as criminal charges.
While these rules have been in place for several years, the latest AML annual report from the SRA clarified that law firms still need to be in line with the requirements. Only 30% of law firms are fully compliant, with 51% only partially compliant. There is a growing knowledge gap in the legal industry regarding financial crime as increasingly complex criminal activity continues to occur – especially with the aid of technologies such as AI.
However, due diligence is a very standard procedure for a law firm, whether at the point of onboarding a client or at the end of a deal for verifying transactional parties. With this being a mainstay of a law firm’s BAU activity, it is concerning that over two-fifths of UK law firms (42%), reported that due diligence is one of the most time-intensive aspects of managing client funds and payments.
Completion processes must be rigorous to ensure the correct governance and precautions prevent money laundering or cyber risks. However, legal teams should be applying themselves to delivering legal work rather than completing administrative paperwork.
With the new regulations now set, a crucial question comes to mind – how can law firms navigate the evolving boundaries set by regulators whilst meeting the pressing needs of clients who seek both swiftness and security in their legal dealings?
The rise of third-party allies
Partnering with a payment provider has become an attractive solution for many law firms to help ease the burden of completing complex transactions and making deal payments. Nearly half (49%) of top law firms in the UK now report that they engage a paying agent/escrow provider (25%) or banking partner (24%) to manage client payments.
While facilitating payments via a paying agent or holding funds in escrows have been long-standing options for legal teams to handle deal payments, they are now becoming even more common for UK-based law firms in light of the SRA regulatory updates.
Departments such as M&A, real estate, litigation and supply chain have been the first to see real benefits, but there are far-reaching applications across the legal sphere.
A key component of these transactions that builds complexity in the deal flow is the international spread of transactional parties. Not only do these global deals require enhanced due diligence, but they also need FX.
By partnering with third-party payment providers, legal teams gain access to global payment networks and financial expertise, streamlining international fund flows for them and their clients.
With the risk landscape only becoming increasingly fraught, law firms must update their payment processes and outsource client money management. The shift reduces the administrative burden of tasks like governance and supervision, risk assessments, transaction monitoring, and suspicious activity reporting but also allows legal teams to reduce risk and time-consuming tasks that drain precious resources.
Embracing the digital shift
The legal sector has upheld tradition and time-honoured practices since its inception. However, with the evolution of technology and the escalating intricacies of client expectations, law firms now find themselves at the intersection of legacy and transformation. There are risks of stagnation for those who don’t embrace the shift into a digitised legal landscape, so to thrive, firms need to pivot towards operational efficiency and resource optimisation through technology.
Regulatory changes are casting a glaring spotlight on legal professionals, emphasising that the customary approaches of the past are now inadequate for the increasingly meticulous management of client accounts.
The digital age has ushered in a wave of cybersecurity threats, the danger of fraud, and the ever-increasing complexity of deal fund flows, forcing law firms to re-evaluate their processes. The challenge lies in finding a balance – streamlining time-intensive procedures while consistently meeting clients’ evolving demands.
As such, law firms need to see third-party payment providers as instrumental allies in simplifying the process of client money management. Technology emerges as the catalyst for a transformation in the operational nature of legal services. It’s a call for law firms to bid farewell to antiquated practices and embrace the possibilities presented by the digital era.
This piece was written and provided by Andrew Hawkins, CEO UK & Europe at Shieldpay.
