Quantumrun

IMAGE CREDIT:

iStock

Financial data localization: Data privacy or protectionism?

Some countries are promoting data localization to protect their sovereignty and national security, but are the hidden costs worth it?

Author:
Author name
Quantumrun Foresight
July 18, 2023

Insight highlights

Data localization regulations, which mandate data storage and transmission methods within and across territories, introduce increased complexity for global businesses by restricting cross-border data transfer and enforcing unique operational models. While designed to enhance privacy, cybersecurity, and local competition, these rules can result in high costs, hinder counterterrorism efforts, and compromise market competitiveness.

Financial data localization context

Data localization regulations dictate the methods of data storage and transmission within and across geographical boundaries. These legislations stipulate the in-territory data handling requirements (domestic storage) and the permissible data outflow (domestic processing). As these laws continue to evolve, they are leading to more fragmentation regarding what is permitted and what is not with data at the national and economic zone levels. While data localization may foster customized solutions, it often compromises scalability.

Data localization introduces an escalating level of complexity, making it difficult for businesses to function globally by restricting the transfer of data and insights across different jurisdictions. To continue operations and service delivery in these areas, companies are often forced to adapt to unique business models. Such market distortions are particularly prevalent in countries with a more nationalist and protectionist political environment, such as China, Russia, and India, which have some of the strictest regulations. Notable instances include Tesla and Volkswagen group partnering with local Chinese entities to penetrate the domestic market and the ongoing discussions around creating a TikTok US, where all US-based data would be confined within US systems.

Following the invasion of Ukraine, Visa and MasterCard suspended their services in Russia, leading to an increased dependence on Mir, Russia’s national payment card scheme, due to localization requirements boosted by international sanctions post Russia’s annexation of Crimea. Although most of these rules are intended to bolster privacy, cybersecurity, and local competition, they also impact financial institutions.

Disruptive impact

Data localization, despite its intentions, can often be burdensome and counterproductive. It imposes high costs, such as mirroring, where providers are required to invest in both cross-border cloud services and domestic data storage facilities for storing duplicate data—expenses that are often passed onto customers. Furthermore, it can hamper anti-fraud and counterterrorism measures by restricting the sharing of financial transaction data across borders, potentially increasing customer vulnerability to fraud.

Broad restrictions on cross-border data transfer could lead to missed business opportunities, reduced international trading capabilities, decreased geographical footprint, and a loss in market competitiveness. From a broader perspective, studies suggest that data localization can negatively impact national productivity, trade output, and employment, and even lead to price increases.

Nonetheless, McKinsey thinks that organizations willing to face the challenges of data localization are likely to reap substantial benefits. One notable advantage of data localization is the mitigation of risk. With more stringent enforcement measures in place, non-compliance penalties can be hefty. Regulatory bodies can also limit corporate activities, such as prohibiting the onboarding of new clients.

Furthermore, data privacy isn't only a regulatory concern but also a significant matter for consumers. With the rising expectations around the use and transmission of their data, digital trust has become a serious consideration for consumers. While the benefits of risk reduction are tangible, they are a defensive measure.

Implications of financial data localization

Wider implications of financial data localization may include:

Companies facing high entry costs in new markets if they are required to establish local data centers or use local services, which might discourage new entrants, leading to reduced competition and possibly higher prices.
Stifled innovation in the financial sector since cross-border data flows play a significant role in the global development of innovative financial services and products.
Data localization giving more control to national governments over their financial data. This feature could be seen as strengthening national sovereignty, but it can also potentially lead to misuse of power and censorship.
A perceived increase in privacy and security for consumers if they believe their information is more secure within their national borders. However, this perception might not always align with reality, as data breaches can happen anywhere.
Financial data localization impacting the demographic distribution of access to financial services. If certain regions or countries impose strict data localization laws, it may result in the withdrawal of international financial service providers from these markets, reducing access to these services for the population.
Jobs in the information technology sector within countries enforcing data localization. However, a skills gap may emerge if the local labor force isn't trained to manage and maintain these data centers.
Increased demand for local data centers escalating energy consumption and having a negative impact on the environment.
Strained international trade relations, mainly if seen as a form of digital protectionism. This development could potentially lead to trade conflicts or retaliation from other countries.