7th May 2021
Why is Regtech Adoption Important?
As money laundering and terror financing methodologies keep pace with advances in technology, financial institutions must work harder to ensure they are aligned with their regulatory environments and are able to stop criminals misusing their services. The increasingly complex data demands of the financial landscape mean that firms must seek suitable technology and software solutions to detect the threats they face and to adapt to evolving regulations: this aspect of financial technology is known as regtech.
With potentially significant financial and even criminal penalties at stake, it is important that service providers understand how regtech can help them meet their regulatory compliance obligations and protect the financial system from harm.
What is RegTech?
The term ‘regtech’ was coined in 2015 by the UK’s Financial Conduct Authority (FCA) and was defined as ‘a subset of fintech that focuses on technologies that may facilitate the delivery of regulatory requirements more efficiently and effectively than existing capabilities’. While fintech involves some innovation in, or enhancement of, the products and services that a company offers, regtech is not customer-facing and instead is implemented to improve a firm’s compliance performance, helping to address AML vulnerabilities, increase the cost effectiveness of compliance, or adapt to incoming legislation. Regtech is often associated with the financial sector but is applicable in a range of industries and business contexts (such as healthcare) where compliance is an important consideration.
From a practical perspective, regtech has a wide range of potential applications, adding automated speed, efficiency, and accuracy to important compliance processes that would otherwise need to be completed manually. In the financial sector, regtech may serve the following purposes:
- Customer Identity verification
- Transaction monitoring
- Customer risk assessment
- Data storage and record-keeping
- Automated suspicious activity reporting
- Data analysis
- International sanctions screening
- PEP screening
- Adverse media monitoring
By automating essential compliance processes that would otherwise have been completed manually, regtech offers banks and financial institutions significant benefits, enables them to keep pace with competitors, and helps to reduce human error. Specific regtech compliance advantages include:
- Efficiency and accuracy: The administrative burden of manual compliance is a significant time and resource drain and carries the risk of human error (along with any subsequent need for remediation). Regtech enables firms to manage a high volume of compliance tasks quickly and with greater accuracy than human compliance employees.
- Data management: The vast amounts of data required by financial compliance are often unwieldy and inefficient, while siloed data can create blindspots or delays in the compliance process. Regtech facilitates a comprehensive approach to data management, bridging gaps in siloed data and streamlining access.
- Risk assessment: In a risk-based AML compliance environment, firms must capture a wide range of data points in order to build accurate customer risk profiles. Regtech enables firms to capture risk data with much greater scope and detail and organize customers into risk categories in order to reduce friction during the due diligence process.
- Adaptability: The regulatory landscape evolves constantly to keep pace with technological innovation. Regtech allows firms to adapt quickly when new legislation such as the EU’s Sixth Anti-Money Laundering Directive (6AMLD) is introduced, or when new criminal methodologies emerge.
AI and machine learning: One of the most significant developments on the fintech landscape is the integration of artificial intelligence (AI) and machine learning (ML) tools. Beyond their speed and efficiency benefits, AI and ML systems allow firms to manage the vast amounts of data involved in modern financial compliance and use it to make more informed decisions about risk. In practice, regtech solutions that integrate AI and ML may be able to spot suspicious patterns in customer behavior that conventional monitoring may miss, and even anticipate changes in customer risk profiles.
Beyond practical benefits for day to day compliance, regtech also offers specific advantages in addressing unique, contemporary challenges faced by service providers in the financial sector. These include:
Customer experiences: Onerous compliance requirements often compromise the speed and efficiency benefits of fintech innovation, adding administrative friction during onboarding and negatively affecting customer experiences. Regtech addresses this challenge by enabling firms to streamline compliance, passing the time and cost benefits onto customers and ensuring better experiences.
Innovation and competition: As a subset of fintech, regtech is a way for firms to integrate and explore the application of cutting edge technology within their business infrastructure. By declining to implement innovative regtech tools, firms not only risk introducing compliance blindspots but falling behind competitors that embrace advances in technology such as AI and ML systems.
Regulatory penalties: As authorities introduce legislation to manage new criminal threats, firms must ensure they continue to meet their risk-based AML compliance obligations or face significant regulatory penalties. Regtech tools allow firms to easily scale up their AML response for higher risk customers quickly, satisfying their obligations under a risk-based system and avoiding costly penalties.
The increasing data demands of regulatory compliance in jurisdictions around the world have made regtech tools an indispensable part of AML/CFT.
When financial technology advances, so too do the methodologies of criminals and the legislative responses from authorities. Regtech enables firms to keep pace with cybercrime threats and the new regulations introduced to deal with them. Recent examples of data-focused legislation include the General Data Protection Regulation (GDPR), which introduced new data privacy requirements for businesses, and 6AMLD, which introduced new AML reporting and record-keeping rules for cryptocurrency service providers.
Regtech has also been an important tool in the fight against criminal activity related to the Covid-19 pandemic, which has seen a sharp increase in incidents of cybercrime, medical fraud, and money muling. As financial institutions came under pressure to manage the effects of the pandemic and a surge in customers seeking to use online financial services, regtech solutions played an important role in helping to manage the increased compliance burden.