Over the last few years, the market has seen the volume of investments in FinTech companies increase significantly from 3 billion dollars to more than 40 billion dollars in 2015, and that is quite easy to understand why. FinTech has taken over the world and is everywhere these days, besides having completely disrupted all financial services industries involved with wealth management, payments, financing, insurance, banking and even customer service.
As the market becomes more used to the term, and FinTech becomes more accessible and easy to understand (and use) as it evolves, it won’t be something strange to people as it is today, just as credit cards were when they first came out. The market should not expect the FinTech revolution to slow down any time soon, and that has brought an issue for the companies that are now working with FinTech: regulations. The increasing levels of regulation and the growing challenging regulatory expectations are having operational impacts throughout companies, requiring people, process and technology-based solutions.
In order to meet and respect new legislation and regulation this can create challenges around understanding, implementing and embedding the new requirements whereas for existing legislation there can be challenges around understanding, managing and mitigating risks, and finding the balance to address the regulatory challenges is far from straightforward as the strategic versus tactical solution debate rages on.
But what does “RegTech” really mean? RegTech goes beyond the simple development and adoption of new technologies to facilitate the delivery of regulatory requirements, but it is a technological advancement that assists those focused on compliance and regulatory-related activities in their professions, making it easier, faster, more complete and more efficient to monitor compliance and regulatory obligations, once it is known that successfully complying with the multitude of financial services industry regulations can be a complex, time-consuming and costly activity for companies. At the end of the day, it’s possible to say that RegTech is the missing link connecting technology, regulations, financial services and FinTechs, enhancing their strengths and bringing them all together in a simple and fast way, as shown on the chart below:
Just like FinTech, InsureTech, PayTech, and any other combinations of XTech, RegTech is another great example of an industry that is being deeply and significantly changed by software. The usage of technology to within the regulatory space has been happening at different levels for the past 15 to 20 year, so that isn’t something new, however, what the new RegTech mandate recognizes is that the gap between software and non-software enabled services has widened significantly within many different industries, specially the financial services industry, and despite the fact that technology has been used to address regulatory requirements. According to a recent Deloitte study, RegTech should be seen as an exciting advance in the industry that can provide companies with the following capabilities:
- Process and data agility: Cluttered and intertwined data sets can be unbundled and organized through ETL (Extract, Transfer Load) technologies
- Reporting speed: Reports can be configured and generated quickly, even when a specific rule changes, offering a great capability of adapting to the fast and ever-changing regulation environment
- System integration: It offers short timeframes to get solution up and running within any existing or legacy ecosystem.
- Analytics: RegTech uses analytic tools to intelligently mine existing “big data” data sets and unlock their true potential e.g. using the same data for multiple purposes.
- Cloud-based solution: RegTech solutions using the cloud mean that data is remotely maintained, managed and backed up. Cloud based solutions provide many advantages, such as cost control, infrastructure flexibility, scalability and security
In order to provide a better understanding on why the financial services industry sees so much importance in the RegTech world, after the recession, banks in the US alone have spent more than 160 billion dollars as fines, penalties and settlements for non-compliance of regulations. A good example is the London-based HSBC Bank, which has spent 2.2 billion dollars on regulation and compliance in the first nine months of 2015, an increase of 33 percent YOY according to the institution.
On average, the annual spending on compliance of regulations for banks and other financial institutions is estimated to be around 70 billion dollars. Unlike the incumbents, RegTech solutions are agile while those developed by traditional players are robust. A good data that shows that RegTech investments will continue to grow is that the increasing regulatory requirements and expectations is the most challenging topic for financial institutions globally when managing risks, as shown on the chart below:
Further to that, the global demand for regulatory, compliance and governance software is expected to reach 118.7 billion dollars by 2020, which represents a great opportunity for RegTech. Investments in regulatory software can lead to an ROI of 600 percent or even more with a payback period of less than three years. Yet, most financial institutions and banks have not subscribed to RegTech solutions due to the sensitivity of the information they hold and eventual security doubts.
The RegTech companies that are currently operating in the market are performing different roles such as content aggregators and providers, which mean that regulations are properly interpreted and understood by experts, and then decoded and delivered as simple rules, all done through a SaaS methodology. Such companies also support clients in developing reports as per the jurisdiction’s requirement, thereby saving a lot of time and resources.
Simply put, the RegTech framework hinges on understanding what works and what won’t, from manual procedures to unnecessary redundant or antiquated systems that need to be eliminated. And opportunities are not only concentrated on regulators, for they aren’t the only ones demanding transparency and compliance. Savvy institutional investors want all or part of the same data to improve decisions on asset allocation. Fund managers may leverage the data to eliminate unprofitable business lines and add revenue-generating ones more efficiently as well.
The fact is that RegTech companies are becoming more numerous every day around the world, and each one of them promise to offer radically advanced solutions to solve existing problems or new value propositions. The challenge upon those companies now is to find the right solutions that offer true added value and will pass the test of time. No wonder investments in RegTech have skyrocket since 2012, both in volume and number of deals, reaching an average CAGR of 38.5 percent, as shown on the chart below:
Looking ahead, in a timeframe of 5 to 10 years, it possible to list the way RegTech technologies can improve the regulatory management and compliance process:
- Regulatory changes: Regulators usually communicate changes throughout documentation or website updates, which creates the need for regulated companies to monitor multiple jurisdictions and regulators in order to keep compliant. RegTech service providers will enable the full replacement of this inefficient system with a central database and even compare new regulations with financial institutions’ current compliance processes, identifying needed changes and allocating any obligations to the right business units.
- Analysis:Normally, the regulatory authority studies the regulated company’s reports, which usually involves a human resource personally going through a Word or Excel file built on a mandatory template. By using RegTech services, financial institutions and banks may submit their raw data only and regulators could then use analytics to extract the information needed and identifying anomalies for further evaluation or processes improvement.
- Compliance and reporting:Regulated companies need to update their practices and reporting, which currently is a significant manual effort that requires coordination across various functions. RegTech can enable companies to bypass a significant amount of this work through digital identity systems that eliminate the need for physical records to establish identity.
- Examination:In the end of a process, the regulator must decide whether there is the need of taking any further action regarding the regulated company. If so, the result is an onsite documentation review. A labor-intensive effort like this raises risks like identifying a non-issue, failing to identify a real issue, and possibly even regulatory capture. A good solution would be a blockchain consortium in which global financial institutions and banks belonged to, where regulators would be able to get examination evidence and scan it automatically.
RegTech will certainly continue to build on the gains it made in 2016, and this growth will come from new technologies being built to serve the specific needs of regulated firms both within and outside the financial services industry. It’s safe to say that a special attention will be given to the Insurance sector, likely to be among the first industry to embrace RegTech in 2017.
The companies that develop and commercialize RegTech solutions will continue to mature their products by incorporating lessons learnt from the past year, making their products more efficient and user friendly. There will be a greater level of collaboration between next generation technology providers and incumbent financial service institutions, supporting an atmosphere of enhanced innovation, which will lead an even greater growth within the next few years.
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