RegTech & the Future of Regulations

RegTech on the Cusp of Exponential Growth?

As the world continues to witness a tremendous surge in financial technologies, RegTech is set to mature into a driving force for change in the financial services industry. In particular, the convergence of data analytics with RegTech and the evolution of regulatory structures have the potential to create unprecedented change in this space.?

1. What is RegTech?

RegTech, short for Regulatory Technology, is the use of new technologies in the financial services industry to address compliance and regulatory challenges. Simply put, RegTech refers to innovative technology that assists regulated companies to meet the increasing number of complex regulatory compliance requirements they must adhere to.

?In fact, rising compliance costs along with a growing interest in automation have created an environment ripe for disruption by RegTech. For instance, while many banks already have regulatory and compliance-focused technology in place, RegTechs help banks become more competitive by providing sustainable and efficient solutions that automate the processes banks use to meet their regulatory expectations.

?Additionally, the 2008 financial crisis increased regulatory scrutiny around the world, making it a primary concern throughout the financial services industry. RegTech developments to date are partly a response to the new institutional demands by regulators and policy-makers.

2. What are some of the key focus areas for RegTech??

Against this backdrop, new RegTech companies have emerged to help firms address risk and regulatory challenges. From sharpening surveillance against fraud, money laundering, and insider trading, to tools for regulatory monitoring, transaction reporting, and product governance, the use cases for RegTech are increasing.?

Three areas, in particular, have typically dominated RegTech services.?

A. Risk Management and Fraud

According to a PwC survey covering 99 countries, nearly 47% of companies experienced fraud in the past 24 months; in contrast, investing in fraud prevention led to a 16% reduction in costs associated with fines and/or penalties alone. It is not surprising, therefore, that several innovative RegTech companies have emerged to help detect fraud, assess risk exposure and anticipate future threats for companies.?

B. Compliance

?Another key area for the development of RegTech has been compliance. A global survey of financial services executives in 2020 highlighted that a third of banks spend more than 5% of their revenue on it. In 2019,?the total projected cost of financial crime compliance across all financial institutions in the key markets of APAC, EMEA, LATAM and North America was estimated to be $180.9 billion.??

C. KYC, Digital Identity and Digital Onboarding

Prevalent across banking, investment, asset management, wealth management, and other financial services segments, KYC ensures financial service providers know detailed information about their clients'?identity, their risk profile and financial position.?KYC standards are designed to?protect financial institutions against fraud, corruption,?money laundering?and?terrorist financing.

According to research, digital onboarding and KYC checks are set to drive RegTech spending to exceed $130b in 2025 largely on the back of a proliferation of digital-only financial services that require KYC (including gambling, cryptocurrency exchanges and some elements of eCommerce).

3. What is next for RegTech?

While these traditional areas remain extremely important, the future evolution of RegTech is marked by two important developments.?

A. Convergence of data analytics and machine learning with RegTech

A new inflection point in RegTech is being ushered by the convergence of data analytics and machine learning with RegTech. With this convergence, RegTech, goes beyond the digitalisation of risk and compliance solutions and becomes truly transformational.?

Firstly, many emerging RegTechs are using cloud technology to deliver solutions involving machine learning, big data analytics, and natural language processors to aggregate and analyze financial data and to detect, predict, and mitigate risks to the organization.

Secondly, financial institutions are using alternative data to add to their armory. Specifically, some common alternative data sources being used today are geolocation data, phone usage data, and spending patterns. Other common alternative sources are biometric data, psychometric data, and social media data. The combination of these alternative sources of data with traditional sources is leading to new innovations in RegTech.

For instance, some banks are using biometrics (body measurements and calculations) to verify identities; machine learning to prevent money laundering by analyzing customer behavior and transactions; and anomalies in data patterns or transactions to detect fraud.?

As one example, Barclays now offers finger vein biometrics for its corporate clients. Developed in collaboration with Hitachi, the infrared technology scans users’ unique finger vein patterns, eliminating the risk of PIN capture, identity fraud, or the sharing of account details.

In another case, Goldman Sachs is leveraging drone technology to give prospective M&A clients a bird’s-eye view of what they are bidding on—be it a shipping port, factory, warehouse, retail location, or any other site.

Looking to the future, we anticipate that the convergence of data analytics and machine learning with RegTech and the use of alternative data, will provide organizations with a significant competitive advantage and mitigate risk along the whole value chain of their business.

B. Regulations are evolving into platforms

A second important development is the changing nature of regulation itself. From being rule based (with an emphasis on detailed rules, clarity and certainty, tick-in-the-box, high-compliance costs etc), regulatory structures evolved to being principles-based (with an emphasis on desired outcomes, dialogue with regulators, flexibility and freedom).?

And the latest stage of evolution is marked by insight-based regulatory structures that are increasingly data driven, focused on real-time insights and shift from ‘know your customer’ to ‘know your data’ with an emphasis on increased experimentation in a controlled environment.

Another trend, though still at a proof-of-concept stage, is the evolution of regulations as a platform.?

For instance, Australia based company Data61 is working with government stakeholders to transform their rules into digital logic. It is a multi-stage process that involves:

• Changing regulatory rules into machine-readable logic that captures the intention and operation of regulation
• Reviewing the quality of these rules and endorsing them for publication on an open platform;
• Enabling anyone to leverage the regulation data via an open platform API to allow anyone to develop tools and services to simplify end-user interactions with regulation to reduce costs, time and complexity.

The eventual goal is to provide free and open access to legislation and regulation via public APIs, which will allow users to access the database of endorsed logic rules and a reasoning engine to process rules and data into accessible digital logic.

Throughout this process, Data61 collects feedback about the Platform’s usability, utility and capabilities to drive further prototype development for developers and end users.

?To conclude, we are set to witness an exciting new phase in RegTech which will further drive innovation across the whole regulatory ecosystem. More importantly, this will pave the way for a paradigm shift in the way regulations are conceptualized, designed and implemented in line with the most disruptive technologies.??