The rise of Regtech: how technology can lighten the regulatory load for banks
Regtech: the result of regulatory inflation and technological innovations
“Regtech,” a portmanteau of regulation and technology, refers to the use of new technologies to more effectively comply with regulation. By extension, it also means the start-ups that are responding to the difficulties faced by major financial institutions in designing an effective compliance approach with their existing IT systems.
Over these past few years, the stream of new regulation imposed on financial institutions is not so much drying up as speeding up: MiFID 2, MAD 2/MAR, PRIIPs, AMLD 4, CRD 4, EMIR, UCITS 5, FRTB, BCBS 239… On average, the costs of complying with regulation represent approximately 20% of major financial institutions’ “run-the-bank” costs and up to 40% of their “change-the-bank” costs.
At the same time, recent technological progress in data processing is opening up new horizons. Data can now be analyzed in a much more sophisticated manner with artificial intelligence (AI), and in particular, machine learning (ML). It can also be aggregated and managed more efficiently, thanks to blockchain, shared-use platforms, cloud-based services, biometrics, cryptography and more.
Regtech can be applied to many fields, including modeling, scenario analysis and forecasting; risk data consolidation and reporting; transaction monitoring; know-your-customer (KYC) compliance; and regulation monitoring and implementation (compliance as a service or CaaS). Technologies and initiatives in these last three fields are discussed below.
Transaction monitoring
Machine learning offers banks a powerful behavioral analysis tool. For example, a system that has been fed traders’ transaction data will develop detailed negotiating profiles for each of them and be much more accurate at identifying any suspicious behavior that deviates from their usual patterns. It will also be able to detect false positives.
Sybenetix, Behavox and RedOwl have developed monitoring tools based on sophisticated behavioral analysis algorithms, enabling compliance managers to detect and investigate suspicious transactions in real time, in line with the suspicious transactions and order reporting (STOR) regime included in EU market abuse regulation (MAR).
Know-your-customer (KYC) controls
To more efficiently meet client identity and verification requirements, banks can use automated data validation solutions that help organize client data in a standardized manner and then compare it with public information (credit databases, company registers, police records, etc.) for a more accurate assessment. Machine learning significantly increases the efficiency of checks made during client onboarding, particularly since it quickly learns to detect false positives and therefore make less frequent but more relevant alerts.
Numerous KYC utilities, such as Contego, Onfido, Tradle and Trulioo, enable banks to make the client onboarding processes faster (with near real-time checks), more user-friendly (accessible from any device) and above all less expensive (since the costs are shared between all the banks using the utility, which conducts KYC checks once on behalf of all member institutions).
Compliance-as-a-Service
Largely based on machine learning, natural language processing (NLP) can also help banks monitor and implement regulation. Identifying new laws and regulations and understanding the implications can be particularly difficult for global financial institutions that operate in many countries.
Suade, Fortia and Corelytics enable financial institutions to stay up to date with the latest regulation and analyze their compliance needs through real-time regulatory databases and predictive analytics tools.
While the regtech trend remains in its infancy, it is fast growing: the number of regtech companies doubled to more than 100 in 2017. The number of deals has also risen sharply, with more than 30 mergers, acquisitions and initial public offerings in 2016. Continued growth will require harmonious collaboration between regulators, financial institutions and regtech companies, as well as productive dialogue between technology developers and regulation experts. Financial institutions have every incentive to include regtech in their regulatory strategy, since it will considerably improve the way they manage compliance for the foreseeable future.
First published in FinTech Mag