The RegTech ecosystem: in depth analysis (part 3 of 3)

In our two previous articles, we mentioned that, despite the technology existing to enable ‘good regulatory practice’, the market has failed to overcome the four main barriers.  Why?

In short, while we have a strong chorus of support from the side-lines, the regulators are only just now beginning to take on the job of making it safe for the ecosystem to engage.  We applaud the many efforts underway which could provide the mandate to stimulate the innovation, investment and dialogue required.

Building on lessons learnt from FinTech initiatives, we are now seeing increasing movement in the policy objectives in defining RegTech as a separate and distinct space.  The long awaited ‘good news’ is that interest from the authorities in RegTech is now alive and kicking as the snapshot below shows.

The birth of RegTech

20160310 Fixing the ecosystem with a RegTech commons v1.2P GRAPHIC

The bad news, however, is that we are heading into a part of the economic cycle in which one rarely sees ‘academic’ initiatives succeed.  Every day we hear reports of front, middle and back-office culls in a way that we haven’t since 2009.  Not good news for RegTech – unless we find a crystal clear motive and business case.

The question this article poses then is, how do we pool together these efforts in an attempt to drive a coherent and targeted response to fix the ecosystem?  Indeed, as we enter into discussions with 20 top firms about their views, we are finding that overcoming all of the barriers is paramount to facilitating the adoption of RegTech.

We believe the regulators’ role in the ecosystem is crucial.  But the view has always been that the regulators’ job is not to dictate ‘how’ things are done and, hence, they are typically absent from the implementation discussions at which ‘tech’ is paired with Reg.

The lessons learnt from FinTech have proven that this need not be the case; there is real value in having the regulator at the party.  And, reflecting on our views on the tribal nature of regulatory implementation, it might well be the case that we need a bit of the ‘change’ tribe to join the regulatory community as well.

In the UK – recognised as a FinTech hub – the FCA has made good progress in building a supportive environment for innovation and is now focused on breaking down the barriers that hold RegTech development back.  It’s a tall order.  We are spending tens of billions every year, costs are constrained and the rules are going to be in flux through to the end of the decade.  The ‘how’ to tackle the RegTech system will either make or, perhaps in some cases quite literally, break the banks.

The RegTech commons

JWG’s response to the FCA’s call for input provided a number of recommendations to help bring down these barriers.  These centred around the role of the regulator in establishing the supporting infrastructure and dialogue and ensuring that the right conversations about what RegTech is needed are happening with the right people at the right time.  We referred to this as a ‘RegTech commons’.

We believe the commons are necessary to segment the dialogue by focusing on key regulatory problems that can be solved – and, in doing so, creating value.  The domains can  build the tools and standards necessary for development and work to integrate RegTech into the specific implementation agendas that are attracting the billions from the ‘change the bank’ budgets to immediately start lowering the cost income ratio.  Think your boss would be interested in this?  Read on …

Building the RegTech domains

Firstly, JWG recommended the establishment of an industry committee to prioritise the key RegTech domains and their requirements, and an implementation steering group for each domain.  Concentrating on the domains of solution for different applications of RegTech would help the conversation by pairing the right technology to the right challenges at the right time.  These domains would also bring in the smaller, agile and innovative companies and larger well-established firms who could to work together and use their complementary advantages to identify specific solutions.

For example, regulatory reporting could be considered one RegTech domain.  Trade and transaction reporting rules require large financial institutions to track millions of products and thousands of trading systems, resulting in a system with billions of reports that are a challenge to manage well.  In a similar way, prudential, statistical and systemic risk reporting are also big tasks.

Here, a committee could help curate a common canonical data model that could accelerate the adoption of solutions across the sector (e.g., open source data validation rules).  It could link regulations to the wider legislative initiatives and external standards that parent them, and could perform sophisticated gap analysis to make regulation simpler and more effective.  The primary benefit of this approach would be to investment firms who would no longer need to rely on multiple vendors for their compliance strategy.

Examples of other domains would be the application of distributed ledgers and smart contracts to clearing and settlement rules, or the use of big data and artificial intelligence in trade surveillance requirements.

Standards and tools

Parallel to these committees, we recommended the regulator works towards building common methodology for applying RegTech to the policy lifecycle.  Not all regulations are created equal and some are not worthy of much technology investment.  For those that are, clear guidelines for checking in with the right tribes should be established from ‘cradle to grave’.

These guidelines should spell out how technology artefacts should be developed, deployed and maintained.  This could well be a whole new class of regulatory toolkit with the specific objective of enabling technologists to sit at the table with policy makers, consultants, academics and stakeholders.

The premise of these tools is to remove the complexity and timing barriers which, in turn, provide the motive for engagement and investment.  For example, it is possible to create a dictionary that links the words used across regulations to describe the specific classes of requirements and how they apply to a particular regulation.  This can be combined with a classification system that provides technologists with a segmented dialogue specifically on the type of solution that they wish to provide.

RegTech development also relies upon standards that foster an environment conducive to RegTech and, moreover, a common and holistic understanding of the regulatory landscape.  On this topic, we recommended the FCA facilitate the establishment of an international taskforce to develop the common language for regulation, working with current data providers such as ISO.  Off the back of this should be a taskforce for the standardising of regulatory publications in machine-readable formats, and the engagement of well-established groups of regulatory data specialists which we will, no doubt, explore further on these pages in the coming months.

In turn, we suggested the FCA provide a cloud for the testing of these new standards and reference datasets.  This cloud could bring benefits to the regulators (using impact assessments and agent-based modelling to assess policies), the regulated (such as traders now obliged under MiFID II to test their algorithms) and also potential RegTech providers (through the provision of a ‘RegTech sandbox’ for virtual testing of new products and applications, similar to the FCA’s planned virtual sandbox).

Integrating with the wider implementation agenda

Dialogues about applying technology to regulation, and improving the regulatory process in general, should not be separated from each other.  If we truly wish to define a methodology that takes RegTech into consideration during the policymaking process – another one of our recommendations – then these conversations need to be happening together.

There has been a huge push from EU Commissioner, Jonathan Hill, to focus on regulatory design and implementation, and look into how to improve the policymaking process.  The inter-institutional agreement on better law-making between the Commission, parliament and council in December 2015 centres implicitly on new tools for better design, such as regulatory impact assessments.  In our response, we refer to using RegTech tools and standards to design a broader scope impact assessment that includes a clear stocktake of the current operating model, the future operating model required and, most importantly, the transition paths between these two states.  Harnessing the power of next generation impact assessments and obligation modelling would signal the required support for banking technology, leading to innovation in the right areas.

The final advice to the FCA covered reducing the timing and complexity barriers with a greater emphasis on implementation, using RegTech tools and standards to facilitate this.  This involves the creation of a taskforce, including top academics and industry experts, to formulate a resource optimisation model to balance the implementation workload and to put the case forward for an EU taskforce on the implementation of regulation.

These would run hand in hand with the dialogue on the RegTech domains and the collaborative development of tools and standards for a common understanding of regulatory rules, with attention to leveraging RegTech during the design of the regulation and its implementing measures.  This would bring the market together in a much needed implementation dialogue, and RegTech’s value in streamlining, simplifying and harmonising the infrastructure will play a central role in this.

Conclusion

When a RegTech solution is made clear to academics, investors, vendors and firms, and it has the backing of the authorities, there will be a much higher incentive for the ecosystem to contribute to its growth.  Many potential RegTech supporters have been looking for a common, cost-saving solution, but either do not have the time or the wide level of expertise needed to develop it.  By bringing the market together to have this conversation, regulators can create the preconditions for successful uptake of RegTech.

We discussed these recommendations with the FCA and a number of top firms during our RegTech roundtable in March.  To stay up to date with ongoing developments, watch this space and sign up to our alerts here. You can also find the agenda for our 5 July RegTech conference here.

 

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