Though the fintech industry is getting more and more mainstream globally, there is still a learning curve for many people as to what fintech actually is, and a lot of jargon which can be hard to understand if you’re not in the know. In this new series of articles, The Fintech Times plans to breakdown all aspects of fintech to help those interested to learn and understand the industry, making it more accessible for all.
Regtech, like most of the other portmanteaus in the fintech universe, is exactly what it says on the tin – regulatory technology. Simply put, this technology is used to achieve and manage regulatory requirements in the financial industry, with Regtech companies helping businesses comply with the relevant regulations efficiently and cost-effectively.
After the 2008 financial crisis there was a global surge in financial sector regulation. Eager for the economy to recover and to ensure it never hit rock bottom again, regulators put new rules in place to improve risk management and safety in the industry. These rules, regulations and requirements are changing constantly with banks and financial institutions under continuous pressure to keep up. Between 2008 and 2016 there was a 500% increase in regulatory changes in developed markets. Not only is the regulatory landscape moving rapidly but fines for non-compliance are costly and constant, and something companies are going to want to avoid. Global financial institutions have been fined over $36 billion since 2008, with about $10 billion of those non-compliance fines awarded in 2019.
This is where Regtech comes in, as its products and services facilitate the compliance of businesses to these various regulatory requirements. Rising to particular prominence in around 2015 when the actual term “Regtech” was created by the Financial Conduct Authority, Regtech has a particular emphasis in regulatory monitoring, reporting and compliance, which are all facilitated through technological advancements. These tech companies often use cloud technology through software-as-a-service (SaaS), as well as utilising big data for reporting.
Generally speaking, regulations for financial institutions fall into one of four categories:
- Regulatory: Data distribution and regulatory reporting through big data analytics and real-time reporting.
- Identity management: revolving around Know-Your-Customer (KYC), Customer-Due-Diligence (CDD) and Anti-Money Laundering (AML) requirements.
- Compliance: Real-time monitoring of compliance and any upcoming regulations
- Risk management: detecting risks in compliance and anticipating any future issues.
There are many benefits to financial institutions that engage in Regtech, mainly – and perhaps most obviously- the ease of complying with necessary regulations. Another big draw of Regtech is that they can offer this compliance at a relatively low cost, usually by automating processes and reducing the need for manual intervention. Regtech can streamline processes through these automated solutions, allowing users to access data for reports where they may not have been able to previously. This allows both its users and the regulatory bodies themselves to look forward in risk management as better insights are available through the “big data” the tech can provide, even being able to sniff out market abuse and financial crime. By using automated processes, they enable compliance staff to take up other activities rather than manually checking, compiling and analysing.
Regtechs aren’t only applicable to financial institutions either but can also be utilised in other regulation heavy industries like health care. Some examples of Regtechs include cleversoft, who optimise and automate business processes for regulatory documents and back-office processes; Enveil, a data security company protecting Data in Use; and token, an open banking and PSD2 compliance platform.
Why is Regtech important?
Regtech is important because it allows companies to meet regulatory requirements and reporting obligations they have. As stated, compliance can also be incredibly costly, with HSBC spending $2.2 billion on their regulation and compliance in 2015. It can be even more expensive on the other side though, with fines and penalties costing companies and arm and a leg should they fail to comply. In 2019 alone global banks amassed over $10 billion dollars in fines due to violations, with US Goldman Sachs fined $3.97 billion, and Wells Fargo $2.96 billion. This makes Regtechs a crucial commodity in the industry, and near essential to the ongoing operation of banks and financial institutions.
Regtech can also prove useful in the ongoing Covid-19 pandemic, as it plays a role in security through analytics. With an increase in remote working, there is also a potential increase in the amount of “opportunistic” cybercriminals looking to exploit people through scams, schemes and laundering money through legitimate financial institutions. With regulatory technology in place, financial institutions can flag suspicious activity and combat financial crime.
UK Regulation Compared to Elsewhere
When it comes financial regulation in the UK, there are two key regulators: the Prudential Regulation Authority, responsible for the financial safety of banks; and the Financial Conduct Authority, responsible for how banks treat their clients and behave in financial markets. The main framework followed is the Financial Services and Markets Act 2000 (FSMA) that prohibits a financial service business being created without having the relevant permissions. Regulated activities include deposit-taking, consumer credit and investment funds amongst others. UK financial regulation benefits from the reporting and analytics that technology can provide it, as it supports risk management and security.
When compared to other countries, the UK’s regulations are comparatively light according to a report by the UK government. Investigating other regulatory regimes to feedback into UK policy, the study found that some of these countries applied a “heavier regulatory touch”, contributing to stronger business practices and better risk management by regulated entities. This leads to better protection and fewer significant failures in the regulated market. It also noted that heavier regulation did not lead to less innovation, with tech companies thriving despite the need for stricter compliance. This is where technology can also be of use, as Regtech can support companies through tighter regulations, allowing for the same amount of creativity and competitivity in a market. If the UK were to adopt a similar system, it is likely Regtech would see a surge in uptake.
A digital sandbox, or regulatory sandbox as they are also known, is a framework created by a regulator that allows fintech’s, start-ups and other innovators to test their product or solution in a controlled environment under the supervision of the regulator. Rather than a physical place where kids can make sandcastles, these sandboxes are testing grounds for new business models that not only help emerging start-ups get closer to releasing their solutions to the world but also helps regulators adapt their rules to the growth and evolution of the market, ensuring new companies stay compliant.
The UK financial conduct authority, in 2015, published a report as to why sandboxes were needed, coining the term itself. Their sandbox began in 2017 and was required to have a clear objective and to be conducted on a small scale, with a limited duration and a limited number of customers.
In addition to these sandboxes, there are other systems that some countries have put in place to support financial innovation, such as fintech hubs, incubators and accelerators. These all provide similar support levels to fintech start-ups, all with the goal of getting them off the ground.
Sandboxes are established for various reasons, but often the main goal of their creation is to promote competition and innovation within financial service markets. They can also foster relationships between financial services providers and the regulators themselves, leading to communication and possible collaboration on future regulations. Sandboxes encourage fintech regulation as well as for Regtechs, creating a vast, competitive market with a variety of solutions for financial institutions to choose from, in addition to creating a safer market through sandbox programmes.