RegTech: A new maturity level

Today, I love to share with you my contribution to the RegTechBlackBook "The sequel". I thought it was the right moment because it is about opportunity, potential and reflection. #RegTech is alive and kicking. Good things are happening, and I'm already super excited by some early 2022 updates. Stay tuned!!! #collaboration

We are at that time of the year when it is a perfect moment to push the pause button and spend some time with your family.

Season's greetings and happy holidays!

Wikipedia: Regulatory technology, RegTech, is a new technology that uses information technology to enhance regulatory processes. With its main application in the Financial sector, it is expanding into any regulated business with a particular appeal for the Consumer Goods Industry. Often regarded as a subcategory under FinTech , RegTech puts a particular emphasis on regulatory monitoring, reporting and compliance and is thus benefiting the finance industry. The objective of RegTech is to enhance transparency as well as consistency and to standardize regulatory processes , to deliver sound interpretations of ambiguous regulations and thus to provide higher levels of quality at lower cost.

In our first RegTech Blackbook, released back in 2019, I started with the most recent definition from Wikipedia as well. There are some important changes within this definition that I would like to walk you through and I will provide you with the latest state of RegTech.

Regulatory technology, RegTech, is a new technology that uses information technology to enhance regulatory processes.

The definition was updated from a relatively new field in financial service to a matured and established version of technology. Back in 2019, we predicted that RegTech was the new kid on the block and was here to stay. This was also the reason why we wrote a book to inform people about its potential. The FCA in the UK stated in 2020 that investments in RegTech more than doubled between 2017 and 2018, with estimates predicting the global market to be worth $55 billion by 2025. The RegTech market is dominated by start-ups. Globally, there are around 1000 active RegTech firms, with an estimated 70% of these firms less than 5 years old. While estimated predicted growth within the sector is strong (23%–25% year-on-year), it is thought that this is likely to be driven more by the organic growth of existing firms than new market entrants.

RegTech is on the rise, which could be explained by the increasing number of fraudulent activities, such as money laundering, taking place in the financial sector. The United Nations Office on Drugs and Crime (UNODC) estimates that between 2 and 5% of global GDP is laundered each year. That’s between EUR 715 billion and EUR 1.87 trillion each year. Fighting crime requires a need for risk and compliance management systems for all kinds of financial organizations. But RegTech can also effectively reduce compliance costs by streamlining business processes and using technology to optimize efficiency. A survey conducted by the FCA revealed that all financial firms in the UK either currently have RegTech or are planning to implement it in the next 2 years.

With its main application in the Financial sector, it is expanding into any regulated business with a particular appeal for the Consumer Goods Industry.

Yes, this is right. RegTech is no longer serving just the financial industry and has managed to enter other industries that are typically also highly regulated. A complete chapter later in the book has been dedicated to this trend and it was covered in our earlier book too. Regulators or supervisors are also non-financial organizations and RegTech is starting to be introduced there too. But we tend to name this SupTech, supervisory technology. SupTech refers to the technology that supports supervisors, which is often no different to the technology used by RegTechs. The Bank for International Settlements (BIS) defines SupTech as the use of innovative technology by supervisory agencies to support supervision.

Regulators set the rules and will have to check compliance. It is later on where technology can help to deal with the vast amount of data that regulators have been requesting since the financial crisis of 2008. Who knows, we may write a book about SupTech in the future too. You will notice that the topic pops up several times throughout this book.

Often regarded as a subcategory under FinTech , RegTech puts a particular emphasis on regulatory monitoring, reporting and compliance and is thus benefiting the finance industry.

The definition has been enriched with the statement that RegTech is a subcategory under FinTech. I believe this is correct. However, RegTech goes so much further. Let me take you back to the previous RegTech Blackbook, where I wrote about the birth of RegTech.

Following the 2008 financial crisis, there has been increased regulation in the financial sector. At the same time, there has been an increase in the disruptive use of technology in the sector. Traditional banks often still run on late nineties legacy systems that are not easily adapted to modern customer requirements. Technological advances have resulted in an increased number of financial technology (FinTech) companies whose purpose is to develop technology-driven products that enhance customer experience and end-customer engagement with Financial Institutions. It seems like a well-executed marketing plan that after the financial crisis, start-ups began claiming that they would bring change into the industry and would be much better than the incumbent banks. Better service, more transparency and the same level of trust as banks.

FinTech companies focused on a particular part of the banking value chain, leading to new solutions. But these solutions didn’t always fulfil the full spectrum of end-customer financial needs. As such, end customers couldn’t leave their bank completely even if they wanted to. Both FinTechs and incumbents worked hard to close this gap.

Over the years, many FinTech start-ups couldn't convince enough clients to become viable long-term business partners to keep their businesses alive. It has been difficult for many start-ups to survive. Gradually, the banks recovered from the initial impact of the financial crisis, which allowed them to look forward again. They started to interact with what was once their worst nightmare: FinTech. It was the birth of several incubation initiatives and in-house innovation cells within the banks, ultimately leading to financial investments into FinTech. For the first time, this new collaboration mode started to emerge. Both parties learned a lot from each other and started to collaborate more and more. Digitalization of our sector lifted off.

At the same time, with the increased reliance on consumer data in the creation of digital products, concerns grew among regulators over the distribution and usage of data privacy. It is the coupling of increased regulation with a greatly technology-oriented financial sector and its new collaboration mindset that birthed the need for regulatory technology. Hence, RegTech was born.

In hindsight, RegTech also became a movement of people from all over the globe collaborating to solve regulatory issues, exchanging views and best practices. Several regions formed RegTech organizations to bring like-minded together, and together we are stronger. These organizations performed research and insights into regulators, banks and also start-ups. Recently, you start to see these organizations cross-fertilizing with another. RegTech has become a global movement and is highly motivated by financial inclusion and global equality. Within the book, several authors are passionate about this topic and dedicated their contribution to this.

I noticed another small but important difference in the definition. The definition now confirms the benefit of RegTech for the financial industry. Yet another sign that RegTech is here to stay and has proven its right to exist.

The objective of RegTech is to enhance transparency as well as consistency and to standardize regulatory processes , to deliver sound interpretations of ambiguous regulations and thus to provide higher levels of quality at lower cost

It is also interesting to look at the unique selling points presented by RegTech companies. A report by the Australian RegTech Association revealed the following USPs stated by RegTech companies. Clearly in line with the demand of the banking industry and the definition above. They also demonstrate the willingness of RegTech companies to collaborate and work with Financial Institutions (FI).

Providing higher levels of quality at lower costs is a real issue for the industry, worsened by the COVID-19 pandemic, wherein FIs are confronted by a landscape that looks and feels very different from before. There is a real risk of global or national recessions, even depression, and an ultra-low interest rate environment means that net interest margins are wafer-thin.

In short, banks’ top-line revenue is under pressure. This makes it more imperative than ever to bring costs down. You can’t jeopardise compliance with laws and regulations. Many banks have now gotten their compliance back in good order after the avalanche of new regulations following the 2008 crisis. The first years after the crisis were challenging for compliance departments and institutions invested heavily in resources. Coping with regulation was usually done by heavy lifting and manual work. As we are now more stabilised, rationalisation of compliance resources is not a strange idea. Banks are looking at running efficiency programs within the departments. RegTech provides the digital tooling to support this digital transformation.

Conclusion:

RegTech is not at the top of the hype cycle yet, but there are a lot of opportunities to realize collaborative objectives between banks, start-ups and regulators. It takes three to tango. The RegTech topics mentioned in the previous book by FINRA (surveillance and monitoring, customer identification and AML compliance, regulatory intelligence, reporting and risk management, investor risk assessment) are still relevant, but the world has changed drastically due to the COVID-19 pandemic and because of the regulator's different focus points, such as KYC and AML. The future for RegTech is bright and is an opportunity to become relevant for many sectors.