FIs are increasingly challenged on their ability to understand, manage and mitigate risk exposure, with regulators asking that additional capital be held where firms are unable to demonstrate this. Simultaneously, unprecedented levels of complex tech change have increased the need for assurance over outcomes, whilst the pressure to curb or reduce costs remains. The outcome? A massive boom in regulatory technology solutions, otherwise known as ‘RegTech’; best defined as new technology that facilitates the delivery of regulatory requirements. So what areas of business is RegTech having most impact?

Multiple business compliance issues for RegTech to impact

There are at least seven issue areas according to the IIF (Institute of International Finance), as follows:

  • Risk data aggregation as required for capital and liquidity reporting and for stress testing. This involves the gathering and aggregation of high quality structured data from across an FI. It is complicated by the use of incompatible and often outdated IT systems.
  • Modelling, scenario analysis and forecasting required for stress testing and risk management. This is increasingly complex and demanding in terms of computing power, labour and intellectual capacity, due to the vast array of risks, scenarios, and variables that need to be included.
  • A bottleneck in monitoring payments transactions (particularly in real-time) is the low quality and massive incompatibility of transaction metadata produced by payments systems. This complicates the automated interpretation of transactions metadata to recognize things like money laundering and terrorism financing.
  • Identification of clients and legal persons, as required by ‘know-your-customer’ regulations. This becomes much more efficient through the use of RegTech automated identification solutions such as fingerprint and iris scanning, blockchain identity and so on. (The Money Laundering Regulations of 2017 are now the underlying rules that govern KYC in the UK).
  • Monitoring a financial institution’s internal culture and behaviour and complying with customer protection processes. This frequently requires the analysis of qualitative information conveying the behaviour of individuals, such as e-mails and the spoken word. Automated interpretation of these sources enables enormous leaps in efficiency, capacity, and speed of compliance.
  • Trading in financial markets requires participants to conduct a range of regulatory tasks such as margin calculations, choice of trading venue, choice of central counterparty and assessing the impact of a transaction on their institution’s exposures. Automating these tasks via RegTech will ensure compliance and increase the speed and efficiency of trading.
  • Identifying new regulations applying to a financial institution. Interpreting their implications and allocating the different compliance obligations to the responsible units in an organization is currently a labour-intensive and onerous process, which could be enhanced through automated interpretation of regulations.

Regtech is about tech innovation

So what are the main tech innovations that fall under the umbrella of RegTech and that are tackling these compliance issues? They include:

  • Machine learning, robotics and artificial intelligence. Data mining algorithms based on machine learning can organize and analyse large sets of data, even if this data is unstructured and of a low quality, such as e-mails, pdfs and the spoken word. It can also improve the interpretation of low-quality data outputs from payments systems. Machine learning can create self-improving and more accurate methods for data analysis, modelling and forecasting as needed for stress testing. Artificial intelligence could even be applied in software automatically interpreting new regulations.
  • Improvements in cryptography are leading to a more secure, faster and more efficient data sharing within financial institutions, especially for more efficient risk data aggregation processes. Data sharing with other financial institutions, clients and supervisors could also benefit.
  • Biometrics, which is already allowing for massive efficiency and security improvements by automating client identification. This too is required by know-your-customer (KYC) regulations.
  • Blockchain and other distributed ledgers are allowing for the development of more efficient trading platforms, payments systems and information sharing mechanisms in and between financial institutions. When paired with biometrics, digital identity could enable timely, cost efficient and reliable KYC checks.
  • Application programming interfaces (APIs) and other systems allowing for interoperability make sure that different software programs can communicate with each other. APIs could, for example, allow for automated reporting of data to regulators.
  • Shared utility functions and cloud applications allow financial institutions to pool some of their compliance functions on a single platform, allowing for efficiency gains.
  • So there’s a heck of a lot going on at all levels of IT infrastructures in the name of better regulation and compliance. Interestingly, according to The Business Insider journal, many of the companies actually offering these RegTech solutions haven’t scaled as might have been expected from the initial hype and have failed to follow the trajectory of firms in other segments of fintech. This unexpected inertia is likely to resolve over the next 12-24 months as other factors come into play that shift FIs approach to RegTech solutions and as the companies offering them evolve. External factors driving this change include regulatory support of RegTech solutions and consultancies offering more help to FIs wanting to sift through solutions. Start-ups offering RegTech solutions will also play a part by partnering with each other, forming industry organizations and taking advantage of new opportunities.

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