RegTech startups: Living in a Dream World?

‘RegTech’ is the hottest buzzword finding a prominent place in financial services lingo in recent times. In absence of a clear and more specific understanding of the term, it has added to the list of myriad coinages floating around disruption / innovation theme in FinTech arena and creates a disproportionate sense of awe and curiosity.

While the term has been in use in recent years – articulated in different sense by different groups, it came into popular awareness around Nov 2015 when FCA (UK) used it in more specific sense for inviting views from the industry on fostering innovation and technology for managing regulatory requirements (so-called ‘RegTech’)[1]. As a part of its Innovate initiative, FCA elaborated key ideas of RegTech as:

A sub-set of FinTech that focuses on technologies that may facilitate the delivery of regulatory requirements more efficiently and effectively than existing capabilities.

Regulatory Landscape and Traditional Compliance Approach

Before looking further through the horizon of RegTech, let’s underline on some of key factors dominating the present regulatory landscape:

Ongoing spate of regulations covering different business segments remains unabated across jurisdictions.
Added to it, emerging regulatory stance indicates towards formulation of further more regulations by the regulators to manage the hyperbole of disruptive business changes.
With each new twist in regulatory requirements firms would continue struggling to keep pace with such regulatory change, besides coping with involved costs and complexities.
While facing challenges of compliance at the one hand, firms have been facing equally onerous regulatory penalty regime in case of non-compliance or failure. A related news suggests that big US banks alone paid out more than $ 200 billion in fines and penalties to the regulators during 2009 – 2015.[2]

Regulatory compliance practice in its traditional form has remained beleaguered with ever-changing, complex and overlapping requirements. Subjectivity and contextual interpretation of requirements as well as bespoke reporting essentially require locking down of regulatory requirements before evaluation of compliance technology solution. Added to that long-drawn, repetitive and incremental approach for each specific regulatory change increases compliance efforts and technology solution costs significantly.

Against this backdrop, necessity of a radically different yet simplistic and cost-effective solution approach towards regulatory compliance has been felt all along. However, under the continuous pressure of compliance timeline, investment constraints as well as fear of error/failure in compliance had kept firms away from any form of experimentation and exploration – either in terms of compliance technology options or business approach. Proliferation of innovative technologies in recent times – e.g. artificial intelligence, natural language processing, RPA, big data and data mining, cloud, biometrics, APIfication, distributed ledger/blockchain, have opened up new opportunities of exploring solution options as well as its deliverance approach.

RegTech: Potential and Promises

Market observers identify RegTech as the fastest growing area in the FinTech world in recent years. Some market estimates indicate presently more than 100 RegTech startups[3] have been offering regulatory compliance services covering AML/KYC, CDD, Capital and Liquidity Management, Risk Modelling and Simulation, Trade Surveillance and Regulatory Reporting areas. Please also see some of key RegTech startups dominating the current landscape.[4]

Building on foundational possibilities of emerging genre of technologies and adopting a non-traditional solution approach, RegTech startups promise to radically transform the core compliance management function. With agility and speed as the core mantra and moving away from case-by-case and incremental way, RegTech ventures have come up with innovative solution offering covering key aspects of compliance management lifecycle. These encompass intelligent regulatory interpretation and impact analysis, data and process standardization/alignment, contextual and integrated reporting, extensive testing and validation as well as effective control of risks through dashboard monitoring.

As a part of core offering of RegTech solutions, much of immediate focus is directed towards automation, standardization and simplification of compliance tasks and data processes, enabled with speedy implementation and delivery through cloud based platforms. Leveraging on above foundational base, new automation tools, data insights and redesigned processes supporting intelligent compliance planning and monitoring becomes the logical progression in the offering. Besides streamlining compliance processes and mitigating involved risks, these solutions attempt to realize shorter adaptation cycle and reduced costs in managing compliance as a natural and most sought after outcome.

RegTech Solution Focus

Without generalizing the unique and innovative solution proposition brought by individual RegTech startup, a high level snapshot of key solution offerings and its likely stages of evaluation has been summarized in below exhibit.

Adoption and Implementation Issues

While possibilities from RegTech solutions have been claimed to be immense, there are few fundamental questions relating with adoption and implementation aspects. These need to be suitably answered to bring basic clarity about potential capabilities of RegTech in the minds of financial services firms.

Agglomeration of different solution components: RegTech solutions being narrow and uniquely focused (e.g. targeted to specific business process or functional area) rather than covering entire spectrum of compliance management, it possibly requires agglomeration of different solution components rather than one unified solution base.

Immediacy and solution maturity: Much of RegTech solution offerings being at early stages of formulation/implementation, it brings question about readiness and maturity of solutions for mass scale adoption by the market in immediate future.

Early adoption risk: The very nature of innovativeness involves continuous re-conceptualization and exploratory formulation. Against this backdrop, evolving maturity level of solutions and high business delinquency rate (of startups) pose new risks to early adopter firms.
Integration, synchronization and orchestration: Given potentially disjointed solution components, it highlights the need of effective means of integration, synchronization and orchestration to handle disjointed systems acting in unison.

Disparate technical and architectural standards: Considering disparate and proprietary technical standards and architectural approach adopted by different RegTech startups, it would require cohesive integration with firms’ business model, technological infrastructure and processes to derive optimal efficiency.

Cyber security and data privacy: With multiple incidences of cyber-security and data violation taken place in recent times, financial services firms have been extra conscious to safeguard against these risks. To evoke required confidence amongst the user firms, RegTech solution providers (more so cloud based services) need to lay out formidable and forwarding looking safeguard plan measures.

Cost and efficiency: Without unduly sounding conservative and discounting the fascinating level of potential benefits, key questions regarding feasibility of promised efficiency in compliance efforts and costs reckoning the above factors needs to be suitably substantiated.

Preparing to move in a new direction

As being observed in case of adoption of any other emerging technology, RegTech solution is expected to have its own hype cycle[5] – from initial curiosity, to inflated expectations, disillusionment, enlightenment and finally stable stage of adoption and productivity.

Current level of industry engagement with RegTech firms appears to be still in lower thresholds. To create a wider level of awareness and consequent adoption by the industry would require increased collaboration and knowledge sharing amongst involved stakeholders, namely – RegTech firms, industry participants, regulators, regulatory experts, existing technology service providers and others.

An unusually higher rate of mortality being observed for startups as well as their basic limitation in quickly able to scale up – in terms of size, scope and location, will certainly act as serious deterrent for big banks to consider RegTech solution options. While RegTech solution could be appealing in terms of its innovativeness and favorable to overall business case, firms may not like to take extra risk in compliance matters, which remain subject to closer regulatory supervision as well as potential reputational loss.

So in the immediate future, we can witness a muted take off with financial services firms preferring to stick with their old practices and tools, keeping firm belief in the old adage – If you want a thing done well, do it yourself!

*A moonshot, in a technology context, is an ambitious, exploratory and ground-breaking project undertaken without any expectation of near-term profitability or benefit and also, perhaps, without a full investigation of potential risks and benefits.

[1] https://www.fca.org.uk/news/news-stories/call-input-supporting-development-and-adoption-regtech

[2] http://www.cnbc.com/2015/10/30/misbehaving-banks-have-now-paid-204b-in-fines.html

[3] https://www.cbinsights.com/blog/regtech-regulation-compliance-market-map/

[4] https://letstalkpayments.com/21-hottest-regtech-startups-that-are-defining-the-industry/

[5] http://www.gartner.com/technology/research/methodologies/hype-cycle.jsp

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