ALASTAIR MAJURY Chartered MCSI
Majury Change Management
Alastair Majury found the below article in the Chartered Institute for Securities & Investment's S&I Review, which I believe is worth sharing.
With fintech investment in full swing, all eyes are on the next golden opportunity within the booming sector. ‘Regtech’ could be just that
Finding a solution to a problem is always satisfying. It’s even more satisfying, though, when that solution presents a considerable commercial opportunity: an innovation that financial firms across the globe could adopt to make complying with increasingly complex regulation easier, faster and cheaper.
Enter ‘regtech’: defined by the Financial Conduct Authority’s (FCA) Project Innovate as “any technological innovation that can be applied to or used in regulation, typically to improve efficiency and transparency”.
Most people have by now heard of fintech (financial technology); its meteoric ascent has been exhaustively documented in the media. One minute, economists ponder its limitless possibilities; the next, they warn of its potential for untold market disruption.
Sir Mark Walport, the UK Government’s Chief Scientific Adviser, recently praised fintech as a tool with which financial services could “re-establish trust… while opening up financial services to a vast number of unserved or under-served consumers”. Sir Mark went so far as to say: “In short, fintech can democratise financial services.” Part of his rationale for the bold claim is that technology frees up surplus capital and time for investment in small businesses and philanthropy.
The article in which he is quoted, however, is titled ‘Chief Scientific Adviser warns on dystopian future of fintech’, which demonstrates the concerns that surround the sector. Namely these worries relate to technological innovation having the potential to outrun the necessary regulations to protect the sector from financial crime and safeguard against the destabilisation of mechanisms that provide monetary stability.
“Traditional human regulators will no longer be able to keep up, but it’s clear that the need for regulation is only going to increase in importance”
For background’s sake, it is worth noting the scale of the fintech sector. According to a report by management consultancy company Accenture, fintech is the fastest-growing area of investment in Europe. Global investment in the sector’s ventures trebled from $4.05bn in 2013 to $12.2bn in 2014, which is no mean feat, so the extensive coverage is likely warranted.
Wide spectrum of innovation
But what commentators often gloss over in opinion pieces is that fintech is a vast umbrella term and the arena itself is multifaceted, covering a wide spectrum of technological marvels. For instance, CodeBase in Edinburgh, Britain’s biggest tech start-up hub, is using its links with the University of Edinburgh’s informatics department – itself Europe’s biggest by some way – to develop fintech offerings like photo-imaging cash, while SecureKey allows online businesses to rid themselves of the need for passwords.
Regtech is one area that has caused regulators, financial firms and technology startups alike to take notice. The term regtech was coined by Fintech Circle Innovate CEO Nicole Anderson, who summed up this promising commercial opportunity with the line “the regulators’ pain is the sector’s gain”.
Engineers in this sub-field hope to create technology to automate regulation and compliance, removing the need for firms to spend time and capital on meeting an exhaustive list of regulatory requirements, a list that will only grow this year once regulation such as the second Directive on Payment Services comes into force. Software aims to scan automatically companies’ data files with a fine-toothed digital comb to pinpoint the requested information and collate it into custom-made reports that match the regulators’ checklists. Instead of the company installing the software, the regtech firm would typically sell the service, so the company’s costs remain fairly low.
At a recent technology summit, Dr Michael Lynch OBE, Founder of Invoke Capital, described regtech as: “Perhaps the biggest fintech opportunity in London.” Dr Lynch told the S&IR: “The financial system has become rapid, complex and innovative at the same time as a tsunami of new information from emails to trading data has become available in real time.
“In this new microsecond and terabyte world, it’s clear that traditional human regulators will no longer be able to keep up. However, it is also clear that the need for regulation and stability monitoring is only going to increase in importance. Consequently, we see the automation of regulation, so-called regtech, as one of the most interesting emerging technology areas.”
Lisa Moyle, Head of Programme at technology industry trade body techUK, also sees the potential benefits of this relatively untapped segment. “Regtech lowers the cost of compliance and, from a government policy management perspective, it improves the picture you’re getting from financial institutions. It’s more accurate and it’s in machine-readable format, which increases efficiency,” Moyle enthuses.
In short, regtech could facilitate real-time surveillance of messages, trades, market movements, exposures and hedging.
Governments are taking note
Not surprisingly then, the UK Government is getting on board. According to the ‘Fintech Futures Report’ published recently by the Government Office for Science, the FCA’s Project Innovate is working with HM Treasury and the Prudential Regulation Authority to explore ways of supporting the adoption of new technologies to facilitate the provision of regulatory requirements.
Two types of innovation appear to underlie regtech. First up is text analysis, which Dr Lynch explains is “the ability to read messages, emails or listen to phone calls and understand what they mean in real time, so they can instantly be checked against compliance”.
The second form of technology, says Dr Lynch, is machine learning and big data analytics, “which can sort through large numbers of transactions, spotting those which pose a threat to an organisation in some way.”
Michael Backes, Managing Director of Hamburg-based Liquid Labs, goes further and suggests that, in the not-too-distant future, financial services could be at a point where “intelligent algorithms point out dangerous patterns in the markets where regulators can be better informed or make better decisions.”
Looking to cut costs
One area of regulation that has already seen the benefit of this new compliance wizardry is ‘Know Your Customer’ (KYC). Following investigations into banks allegedly involved in money laundering, regulators have been calling for institutions and financial firms to implement tougher policies to detect dubious client accounts. Not surprisingly, this is driving up IT overheads and institutions are looking for ways to reduce the cost.
This is where regtech can take centre stage.
Backes explains: “There has been a wave of KYC technologies that are usable inside the regulatory framework. The German authorities have halfway given in on allowing remote KYC. It hasn't been completely sorted yet, but it would allow companies to take on new customers at much lower costs and allow them, in turn, to create trust quicker.
‘Trust’ is a word that players in the fintech field are acutely aware of. It is one of the biggest challenges that startups will need to overcome in order to dent the market; or at least, the banking market. Startups will have to prove that they can establish a solid client base and generate enough revenues for their offering to be attractive to investors.
Backes ponders why this is the case: “Am I willing to let a robo-advisor manage a part of my wealth? Yes, but I would be hard-pressed to let it manage 100%. The risk of letting a new company touch a significant part of my financial life is difficult. Even if I hate the banks or brokerages, I know that they are held to certain rules that are meant to provide stability or security.”
Starting with the digital natives
For now, the most tangible commercial opportunity for fintech and regtech startups, and in turn their investors, is the small and midsize enterprise market. As banking and innovation expert Dr. Hansjörg Leichsenring wrote in a recent blog, “It is here that fintech startups can establish a presence in territory already occupied by digital natives.”
And the results should, in theory, free up compliance officers to focus on recognising and acting on potentially much bigger threats to their firms. Contrary to the warnings, perhaps fintech, and specifically regtech, could truly mean ‘win-win’ for the financial services sector.
Watch this space.
Note: Global investment in fintech ventures trebled from $4.05bn in 2013 to $12.2bn in 2014. - Source: Accenture