March 21, 2019
RegTech is a concept that creates a lot of buzz and holds many promises. Many players join the bandwagon; advisors, lawyers, risk managers and consultants all have an opinion and try to contribute and benefit from the momentum.
Very few real solutions have been successful so far though, so let us try to shed some light on RegTech in general and some criteria for a successful RegTech solution and application.
What is RegTech
In a broad sense and without nitpicking, RegTech is the entire field of developing and applying technology to support achieving compliance with regulations. RegTech is often linked to the financial services industry in general and FinTech more specifically. Although strictly speaking RegTech is not limited to any particular industry, we will focus on the financial services industry in this article.
Technology in financial services
Given the data intensity of the financial services industry, technology and automation have played a major role in the development of the sector for decades. On the back of CRM systems, transaction processing, deal capture and risk management systems, banks have implemented client and transaction monitoring systems since late last century. Some of these systems play a major role in complying with regulation but only recently RegTech is recognized as a separate and new field.
What is the purpose of RegTech
Applying technology needs to serve a purpose, although sometimes technology is applied just because it’s there. In financial services, technology needs to improve quality, decrease costs, increase transparency and speed or a combination of these aspects. RegTech usually promises improvements along all three dimensions.
Standardization of processes could lead to better quality and customer service but likely, improvements will in the short run be limited, hard to measure and hard to justify. More likely – and a frequently heard argument – RegTech will be implemented to save costs. That being the case, it’s important to understand where the costs of compliance actually sit. And that’s mostly in the 1st Line of Defense; client onboarding is done by the business, handling false positives and running scripts on trade transactions are done in operational departments, obtaining client documentation is done by customer service staff and relationship managers. All these are first line activities over which the 2nd LoD – the compliance department – has little influence.
The pain of complying with regulations usually follows an 80/20 rule… 80% of the work goes into 20% of your clients. Retail and wealth clients are usually not the pain points and neither are listed MNCs; most work to comply with regulations is often related to commercial clients and family owned companies.
Needless to say that technical solutions that focus on the true pain points are most likely to succeed.
Some trends and characteristics of promising tools
Without going into specific companies and solutions let me give a few criteria for potentially successful solutions:
- RegTech solutions with zero footprint will me more easily adopted over solutions without. The easier a technical solution can be implemented the likelier it will be adopted and the faster it can be deployed and prove its value.
- Add-ons will be popular. Replacing legacy systems is usually cumbersome, difficult and costly. Solutions that can be added to an existing system stack, are more likely to be adopted than RegTech solutions that require replacement of systems.
- Open solutions that can be easily interfaced via APIs to the legacy systems of the FI will be preferred.
- Single function solutions will be easier to fit into the overall architecture of FIs and as a result will be adopted faster.
- Especially larger institutions will prefer proven technology. It is therefore imperative for RegTech companies and their solutions to build up a track record, starting with smaller customers.
- Solutions that focus on painful and expensive processes will have a high chance at being effective.
- Banks have been experimenting with AI since the 80s and 90s of the last century with limited progress. AI can only deliver value if and when sufficient data is available and that is often a bottleneck. AI engines exist and have demonstrated to be able to add value in regulatory compliance processes. Given the fact that data in FIs is usually dispersed, not standardized and often not even available in digital form, solutions that have the required AI functionality and can deal with different and incomplete sources of data will have a high change of success.
- Distributed Ledger Technology is only in the first chapter of likely a long and successful story. In itself though it is ‘just’ a replacement for the widely used relational database model. It’s therefor more a tool enabling technological solutions than a solution in itself.
- In line with the above, RegTech solutions that automate, streamline and standardize manual and peripheral processes are most likely to succeed on a short notice.
Only talking about cost savings and achieving compliance will not lead to immediate and enthusiastic adoption. Senior management will need to see the potential of RegTech in improving the customer experience and creating commercial opportunities for RegTech to be truly successful.