The Promise Of Regtech

As mandates grow in number, severity and complexity, wealth management firms increasingly look to technology for help.

Ten years ago, it wasn’t even a word. Now, “regtech” is big business.

A Deloitte report last year identified more than 150 start-ups in regtech—that is, technology designed to facilitate regulatory compliance. A Citi study named 24 know-your-customer startups alone. Reuters sees the global demand for regulatory, compliance and governance software approaching $20 billion by 2020.

Thus far, however, wealth management and private banking have shown less interest than traditional and investment banking firms. “The applicability of regtech to private banking and wealth management would seem to be very limited,” says Indra Chourasia, senior business architect for Capital Markets, Consulting and Service Integration at Tata Consultancy Services. “Customer engagement in this space is very sensitive owing to the significant customer confidentiality and privacy issues involved, and none of these firms want to lay off the delicate part of this business to any outside party.”

Going forward, however, that’s likely to change. Regulation will only get tougher as tax agencies push for greater transparency, and wealth managers expand to serve clients who are increasingly mobile—and hold assets around the world. In recent years, private banking has spread far beyond the traditional core of clients served by banks in Switzerland, Luxembourg and a few other countries. Today’s wealthy come from East Asia, Eastern Europe and Latin America, as well as developed markets, and their wealth is growing in complexity. Cross-border capability is an absolute necessity.

Particular urgency stems from MiFID II, which went into effect in January and added a regulatory structure to the EU’s Markets in Financial Instruments Directive. It goes beyond the original directive, which aimed to create a single EU financial market, to cover virtually any kind of financial instrument and virtually any user, from traders to fund managers to pension funds.

Most important from a wealth management perspective, MiFID II aims to create better audit trails by requiring institutions to report trade data, including price and volume, immediately—time-stamped, sometimes as finely as every 100 microseconds. Transaction-reporting data must be saved for at least five years. Banks and brokers must be able to show customers they are receiving the best available price.

Allende, CaixaBank: We expect regulations to become even more stringent in the future.

“It’s the main regulatory issue for us in Europe,” says Víctor Allende, executive director of Private and Premier Banking at CaixaBank, one of the largest wealth managers in Spain. “And we expect such regulations to become even more stringent in the future.”

GlobalData’s 2017 Global Wealth Managers Survey found that 75% regard local regulatory changes as a big concern. A 2016 Deloitte study found that private banking firms counted regulatory compliance and accompanying reputation risk among the biggest obstacles they face. Unless they can master the details (and cost) of regulatory compliance in multiple nations, firms will have trouble taking advantage of cross-border business.

In the post-MiFID II era, “regulators’ primary concerns are transparency, reducing costs for the client and eliminating conflicts of interest,” says Allende. Regtech helps achieve all of these, he adds. By making data easier to access, it facilitates greater transparency, which makes conflicts of interest easier for banks to detect and, hopefully, eliminate. It also reduces reporting costs, which can be passed along to clients or used to enhance margins.

Regulators are pushing financial institutions to advance digital advisory tools, “because they want to reduce the cost of the customer’s investment in these kinds of products,” Allende says—essentially, giving clients “the same tools as the manager in terms of analyzing and making independent decisions relating to their assets.” At the same time, automating the client-adviser relationship “makes transactions traceable,” improving the quality of reporting and rendering “the customer decision-making process more transparent and objective.”

Still Working It Out

Regtech is still very much a work in progress, however, and the most exciting innovations may lie ahead. Much of the effort in development thus far has focused on digitization of manual processes, but the larger objective is to meet increasingly strict know-your-customer (KYC), anti-money laundering (AML) and counter-terrorist financing (CTF) requirements. AI applications, especially, have the potential to help firms detect compliance risks and make better-informed decisions about how to mitigate them. Above all, they help firms deploy their data more efficiently and respond quickly to new mandates.

In the future, blockchain will acquirea bigger presence among private-banking and wealth advisories looking to ease the expense of compliance and reporting while maintaining security, anticipates Benjamin Collette, a partner at Deloitte in EMEA Wealth Management and Private Banking. “The single most important issue in compliance and reporting is the cost of legacy systems, since this industry has a tremendous investment in these,” he says. “The cost of technology development with blockchain is a fraction of the cost of keeping legacy systems up-to-date, because you don’t have to build it yourself.”

Collette, Deloitte: The cost of technology development with blockchain is a fraction of the cost of keeping legacy systems up to date.

Firms are already applying blockchain solutions to order routing, register maintenance and similar back-office tasks, but have only just begun using them for front-office operations more closely linked to portfolio management. “We’re starting to see more application to KYC, as opposed to pure regulatory reporting,” says Collette.

The definition of regtech may be changing as well. Allende suggests that it ought to be expanded to include efforts to automate interactions with private-banking clients, since these can also make data collection and reporting easier.

CaixaBank, for example, recently introduced an omnichannel advisory platform called Time that directs the financial-planning process, generating a financial plan to meet the client’s financial needs at each stage of life. The client can do this either in conjunction with an adviser, or online through the private-banking segment of the banking home page, starting by filling out and digitally signing a suitability test for products regulated by MiFID II.

“Forty-eight hours later, the manager will send them a personalized proposal in response to this assessment,” Allende says. The platform includes an online customer alert that informs clients immediately of any deviations from their financial plan. CaixaBank also launched a robo-advisor called Smart Money that gives clients access to an assortment of markets and assets through a low-fee managed portfolio.

Who’s Adopting It?

Not all firms are adopting regtech at the same pace, if at all. Geography is a factor.

“It depends on how international their funds are and how frightening the regulators that they face in different markets are, and how concerned they are about negative publicity,” says Virginie O’Shea, research director at Aite Group in London. Since social media rapidly spreads information, reputational damage looms even larger for global firms facing an increasingly complex regulatory landscape.

Smaller firms have generally been slower to spend on regtech than larger ones, O’Shea adds, in part due to cost. “They only invest in technology when they are faced with scalability challenges or unexpected attention by regulators,” she says. “Most firms don’t automate unless they absolutely have to.”

Larger firms, on the other hand, are forging ahead. “We see a lot of larger managers evaluating and investing in surveillance to track employee behavior and patterns of activity, to make sure internal compliance is on track,” O’Shea says. That suggests a regtech divide could develop, as smaller firms find themselves less able to control regulatory costs than larger ones.

Whatever their profile, private-banking firms need to be cautious moving forward with regtech, Chourasia advises. Many solutions have not yet reached maturity, and may not prove out: Early adopters beware. Many solutions are narrowly focused on specific processes or functions; developers may need to find a way to integrate and synchronize them before a unified solution covering the entire spectrum of compliance management can be said to exist. The challenge is even greater given that different regtech start-ups have different proprietary technical standards and architectural approaches.

“These all require more involved and enhanced levels of human analysis, interpretation and judgment,” says Chourasia. “Despite the hyped talk of AI, ML, and other cognitive abilities of regtech, in the present form of these technological tools, this appears less feasible in the near future.”

Forward Momentum

Despite these complexities and sensitivities, few predict the trend to automate will end soon. These issues may affect regtech’s direction, however.

Since every high-net-worth individual has accounts with multiple institutions, “much greater efficiency and cost savings can be achieved if regtech moves out from under the control of individual firms,” Collette argues. “That means moving from every bank having its own KYC systems to a market utility” that can authenticate each client; make sure he or she is not laundering money; maintain an identity card, or, in the case of a company, articles of incorporation; and store all of this data in a centralized location.

Collette suggests a market utility that could fulfill this function for any private bank or wealth manager could be modeled on Swift, which enables secure, standardized communication between financial institutions and is owned by the member institutions themselves.

Whether regtech coalesces around a collective solution or remains in the hands of individual firms, expect cost to remain the driving force—and the direction to remain in the hands of the regulators.