With the annual compliance spending of the financial institutions exceeding hundreds of billion dollars and the growing number of financial regulations, it’s no surprise that RegTech, or regulatory technology, has emerged to respond to a broad range of compliance issues. Here is all you need to know about RegTech in 2020.
As with all emerging technologies, two viewpoints exist on RegTech adoption. While some businesses are rushing to embrace the innovation, others treat RegTech with skepticism and suspicion. Many businesses don’t know much about RegTech and prefer to use what they presume to be their good-old strategies to meet regulatory demands.
If you fall into the latter bucket, let me leverage my fintech expertise to clear the fog and outline what RegTech is. You can understand how RegTech helps you address all kinds of risk and regulatory challenges, and where RegTech is headed.
What is RegTech?
RegTech implies the use of technology for supervising, reporting, and ensuring compliance mostly for the financial industry (essentially the most regulated one) while also covering the needs of pharmaceutical and medicine manufacturing, the oil and gas sector, transportation, etc. Besides сompliance solutions, RegTech is aimed at financial crime surveillance, focusing on fraud, money laundering, and insider trading.
History of RegTech
The history of RegTech goes back to the 2008 financial crisis that led to an increase in government regulations. Additionally, technological advancements in the financial domain spurred the appearance of numerous fintech solutions that aimed to serve customers differently.
The use of customers’ data for these fintech products caused regulators’ concerns about maintaining data privacy.
In particular, the General Data Protection Regulation appeared to handle how customers’ data was collected and managed.
Other regulations, such as the Payment Services Directive and the Markets in Financial Instruments Directive, came about to manage the payment and investment sectors accordingly.
RegTech’s Response to Challenges
RegTech came as a response to those challenges, promising to help banks avoid billion-dollar penalties for non-compliance and become more cost-efficient with the nascent-state RegTech solutions. However, many banks were reluctant to adopt the innovation, relying upon their legacy technology and processes, disconnected IT systems, and siloed data.
The 2020 Mess of Uncertainty
In 2020, with a new wave of economic uncertainty and recession, we can expect more regulations appearing to prevent bankruptcies, unemployment growth, and other crisis phenomena. All of these 2020 issues may help RegTech take center stage and spur the wide adoption of maturing RegTech solutions to facilitate compliance, risk management, and regulatory reporting.
The RegTech Landscape in 2020
Currently, there are more than 250 RegTech companies in the market. The market is expected to grow from $4.3 billion in 2018 to $12.3 billion by 2023 at a CAGR of 23.5%. The list of the most innovative RegTech companies is spearheaded by 4Stop, Ascent, Dathena, Trunomi, and others.
Interestingly, startups, as well as incumbents choose to cooperate on the RegTech market, and the absence of competition typical of, for instance, Fintech, spurs the emergence of new RegTech solutions.
In 2019, RegTech broke a record in the number of global deals (145). The stat can be partially attributed to the General Data Protection Regulation (GDPR), the second Payment Services Directive (PSD2). Both the GDPR and the PSD2 have been applicable since 2018, and the California Consumer Privacy Act (CCPA) is coming into effect in 2020.
However, there’s been a recent investment market drop ($2,5 billion in 2019 compared to $4 billion in 2018). The stat maybe because of the doubts individual investors have about the maturing technology and the downturn.
Key Benefits of RegTech
Besides the increasing regulatory burden and enormous non-compliance fines, another factor contributes to the growth of RegTech. Benefits brought by RegTech solutions are substantial and account for the rising RegTech demand. Among the key benefits achieved with process digitization are:
- Ensuring continuous compliance with various regulations due to their automated real-time monitoring and keeping track of changes
- Reduced compliance costs (physical infrastructure expenses of banks may account for over 40% of their total IT spending)
- Efficient fraud detection, know-your-customer procedures, and anti-money laundering controls
- Improved risk management
- Effective regulatory reporting
- Real-time transaction monitoring and auditing
Still, many financial organizations refrain from adopting RegTech solutions regardless of their growing popularity and tangible benefits. Let’s explore the reasons for it in more detail.
Major RegTech Challenges
Among the main obstacles that RegTech companies face are:
Varied Regulations in Different Jurisdictions
Despite a unified approach to regulation taken by financial centers after the 2008 crisis, various laws set different standards. For instance, U.S. banks abide by the Dodd-Frank Act, while the EU issued MiFID II for businesses under its jurisdiction.
Besides, there may be regional interpretations of the main provisions of these laws, so RegTech providers should keep this in mind and stay on top of the laws and local peculiarities of their implementation. In this case, they’ll be able to provide a solution that’s efficient for different jurisdictions.
Manifold regulations such as GDPR, MiFID II, and others coming into effect at the same time bring potential inter-regulation conflicts that may affect businesses of all industries substantially. RegTech companies have a significant amount of work to elaborate solutions that help their clients abide by these requirements and spot the issues that may cause a conflict.
Consumer Data Privacy
Being a hot issue, especially in the face of the GDPR that has come into effect, the privacy of consumer data becomes even more critical for any company, and RegTechs is no exception. They must ensure the secure management of customer data and enhance the protection of clients’ info from data breaches, loss, and other cyber threats.
The Quality of Data
RegTechs are heavily dependent upon the quality of the data provided to them. For instance, getting duplicated, inaccurate, or incomplete data from an insurer may result in output that lacks accuracy and insightful value.
The Price of Going Digital
Staying compliant with regulations without technology support requires a huge manual workload and a seamless process of audit and reporting.
However, the cost of digital transformation may be too high on the pocket for some of the traditional financial services companies, so they refuse to adopt RegTech innovations.
The Potential for Algorithmic Bias
The algorithmic bias may occur when an AI-based RegTech solution incorporates existing human biases into its relationship model and produces wrong outcomes. These outcomes may happen due to flawed or prejudiced source data or when an algorithm learns bias in the process of data analysis.
Such biases are infrequent and inadvertent, but they pose outstanding lending and reputation risks to companies and cause great resistance to RegTech products.
Regulatory Technologies and Their Use-cases
The list of mature technologies used in RegTech solutions includes:
Cloud Computing for Data Security and Cost-efficiency
RegTech products are typically cloud-based and offered using the Software as a Service (SaaS) distribution model. It allows for lower data storage costs and no expenses on IT infrastructure and regular data backups and efficient disaster recovery.
Natural Language Processing (NLP) for Supervising and Managing Regulatory Change
With natural language processing algorithms, manual and laborious reviewing of financial documents and processes prone to regulatory change has become obsolete.
Using NLP in RegTech products allows them to read and analyze numerous regulatory sources, identify any changes made to them, and notify financial institutions about those changes or additions.
More sophisticated solutions can also identify internal stakeholders (e.g., compliance officers) who need to stay in-the-know and notify them about regulatory changes.
Machine Learning (ML) to Improve Transaction Monitoring
Machine learning algorithms can help with transaction monitoring and alerting about suspicious transactions and cases.
Supervised ML algorithms trained on prior suspicious activities, can compare current rules and investigation results, and recommend rules refinement to reduce the number of false-positive alerts.
Robotic Process Automation (RPA) to Facilitate KYC and AML Processes
The Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations resulted in tedious manual processes of customer onboarding.
Employees of financial organizations have to review customer information and manually enter it in numerous internal systems.
RPA solutions eliminate manual effort and reduce the risk of human error by automating standard and repeatable processes of data input into numerous internal systems, screening automation, reports generation, and more.
Big Data Analytics to Improve Decision-making
RegTech solutions based on data analytics bring financial organizations deeper insights, 15-20 times quicker analysis of multiple data sets, and powerful reporting that helps make informed business decisions, uncover risks quicker, and manage them more efficiently.
The following technologies are still evolving in their RegTech application:
Blockchain for Better Deals’ Transparency
Blockchain can be used for document tracking to streamline deals and ensure increased transparency, which is essential for regulatory compliance.
Additionally, blockchain facilitates KYC procedures that are typically paper-based and siloed. Implementing a blockchain solution for KYC allows sharing customers’ data across a bank’s divisions and even different financial organizations.
Thus, clients wouldn’t need to resubmit their info when applying to additional financial products, and their onboarding process for a new account in another bank would be made much more manageable.
The distributed ledger technology also helps to automate information collection processes for AML. What’s more, blockсhain-based records can facilitate validation of the documents collated for AML reporting.
Biometrics for Better Identity Management
Biometrics helps enhance identity management using face scanning, fingerprint scanning, iris scanning, voice recognition, and other identification methods.
Besides helping to decrease identity fraud, biometric solutions can be paired with behavioral analytics to prevent illicit transactions and other financial frauds, thus saving companies from enormous financial and reputation losses.
Where’s RegTech Headed
The increasingly complex regulatory landscape makes compliance a weary load for businesses of all sizes. It spurs greater interest in automating the supervision of regulatory change, reporting, and financial fraud detection.
Besides, due to the ballooning amount of regulations, the cost of compliance continues to grow. According to recent estimates, it may take up to 20% of the entire financial firm’s budget just to stay in business and avoid fines from regulators.
Therefore, companies (in particular, those that operate across multiple jurisdictions) will have to keep up with current and emerging regulations, manage their compliance costs more wisely, and increase the efficiency of compliance processes.
For that, embracing the tech that eliminates manual paper-based workflows and reduces the risk of human error seems indispensable.
Thus, RegTech solutions addressing the ever-evolving compliance needs will be increasingly in demand. The same refers to compliance officers with deep domain expertise who can handle complex cases unmanageable without human judgment.
As for regulators, they’ll be encouraging RegTech adoption by leveraging RegTech solutions for more efficient and careful supervision over banks, insurance companies, and other financial institutions. Another reason for regulators to favor RegTech startups is the absence of licensing, facilitating regulators’ work.
One Final Note
For every company wishing to adopt RegTech innovation, I suggest following the 3-step approach. First, it’s crucial to spot the problems addressed with RegTech and analyze possible solutions in terms of the ROI and efficiency metrics.
Secondly, it’s necessary to summon an on-site dedicated RegTech team, accountable for elaborating solutions, supervising their implementation, and assessing efficiency.
Alternatively, if your local talent market lacks RegTech professionals, you may find a third-party provider that’ll make your RegTech project an endeavor, which brings its dividends.
Finally, it’s required to assess RegTech’s long-term sustainability by making sure that the RegTech you’re working with has a viable operating model, strong leadership, stable funding, and resources to manage any unexpected issues that may appear.