Tsering Namgyal , Contributor , MLex | Oct 2016

 

A new breed of technology startups that offer novel solutions to better comply with regulations — often known as RegTech — is gaining increasing traction in Asia.

Often seen as a part of the growing financial technology, or fintech, sector, RegTech is currently most commonly used by financial institutions to better comply with the post-crisis rules foisted on them by global standard-setters such as the Financial Action Task Force, or FATF, and the Basel Committee on Banking Supervision, or the Basel Committee.

The rising cost of compliance and big fines imposed on banks for non-compliance have put them on the defensive, setting them on a drive to reduce exposure to higher risk customers, a process known as de-risking. With annual cost of compliance estimated at $70 billion, they have also begun to look for smart technology solutions that might help them reduce costs and automate some of the labor-intensive and expensive compliance processes, thereby driving the growth of RegTech.

Asian regulators have been supportive of this subcategory of fintech, suggesting how technology might help big banks prevent fraud and avoid future penalties. (see here) Global banks have paid more than $200 billion in fines since the last financial crisis for violating various rules.

What is RegTech?

Yet, RegTech — just like fintech — is a broad category, having become a catch-all term for any technology solution that deals with customer data in the context of regulatory compliance. As the application of technology has broadened to encompass every sphere of the regulatory eco-system, and as it has come to be embraced by banks as well as regulators themselves, so has the meaning of RegTech.

The RegTech label is put on anything from the use by banks and fund managers of software solutions to help confirm the identity of their clients to regulators relying on technology to automate the processes by which they deal with data sent to them by financial institutions. In its broadest sense, the work of governments such as India and Singapore — the latter under its GovTech initiative announced on Oct. 1 — to create centralized vaults of identity information on their citizens is also part of RegTech.

A key part of the RegTech space, however, is primarily involved in the area of fraud prevention and customer due diligence. One Singapore-based startup involved in enhanced due diligence, or EDD, provides easy-to-use customized databases and suave data analytics, known in tech parlance as good user interfaces. For instance, what was once a 50-page due diligence report done by a risk consultancy firm at a king’s ransom has made way for a smart chart on a laptop that would display, say, a Jakarta-based company’s ties with a well-known Indonesian politician.

While much has been made of the potential application of big data, machine learning, or even artificial intelligence, in automating processes and getting rid of inefficiencies, the actual adoption of such sophisticated technologies in the area of compliance is still some time off, MLex has learned.

Indeed, some form of automation and digitization of data is long overdue, because compliance still remains very much a manual process, with a lot of background checking and reporting to regulators done manually. Such modifications could lead to tremendous cost savings and free up a lot of human resources, especially for big banks with large compliance teams.

Apart from the big global banks, these RegTech solutions are perhaps even more relevant for smaller and boutique regional financial institutions, asset managers and professional service providers such as law firms and accounting firms that are also increasingly coming under pressure to conduct their own customer due diligence. These organizations might not be able to afford full compliance teams, and in the case of some, are quite new to the field.

And unlike most tech firms offering banking solutions, RegTech startups are not regulated, and need not comply with traditional banking rules because they do not directly handle money.

Fintech firms will have to either get licensed, or go through the so-called regulatory sandbox, where they would be exempt from banking rules for a set period of time. Except for those that are offering unique solutions, many are not likely to qualify for either.

Fintech needs RegTech

In fact, it is the fintech companies — which are aiming to overturn the traditional model of banking with the use of smart technologies such as blockchain — that will probably need RegTech solutions most.

For one, they typically lack regulatory expertise, so they could turn to RegTech solutions to help them better familiarize themselves with the rules and ensure they are compliant with regulations, especially those governing client onboarding and anti-money laundering. The ability to fulfill these rules — which are applicable across-the-board — will be critical for their success in getting licensed, or being elected into a sandbox program.

These solutions could also be used by regulators themselves. One Asian regulator, for instance, has already signed up with a startup providing customized enhanced due diligence on companies in Indonesia mentioned earlier, MLex has learned.

Over the longer term, RegTech solutions — in their more sophisticated and newer incarnations — could be very useful for regulators scrambling to make sense in a timely manner of rivers of data sent to them by financial institutions on a daily basis.

This is, however, an area that remains very much at an evolutionary stage. The theory is that rather than still relying on old technology such as Excel spreadsheets, as some regulators are doing, they could opt for other more advanced solutions to make better sense of data at their disposal, and potentially prevent market misconduct, and hopefully, even help stave off financial crises.

Still, there are limits to what computers can do. More specifically, for instance, regulators still require firms to meet their customers face-to-face before onboarding them, and questions exist, for good reasons, as to how effective computers will be for that job.

In addition, when it comes to the use of technology in regulation, there is one important fact to remember: Since regulations are mainly principle-based, they require constant interpretation to tease apart nuances, and whether computers could replace human discretion and judgment remains very much to be seen.

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