The growth of FinTech and RegTech in financial services

The financial technology (FinTech) and regulatory technology landscapes (RegTech) are booming, on the back of the growing opportunities they are offering financial services institutions. FinTech is helping players improve their customer propositions while bolstering the efficiency of their operations, and RegTech is enabling financial services institutions to radically improve the way they run their compliance processes. Experts at boutique consultancy CDCA reflect on the evolution of the FinTech and RegTech in the UK marketplace. 

The Financial Conduct Authorities business plan for 2019/2020 states that the UK financial sector is one where the possibilities and risks are still unknown. This is the third instalment to the UK financial regulation bodies efforts to mitigate risks for consumers and firms from the leave process. The FCA has pledged to “make UK regulation smarter, focusing on the outcomes we want to achieve” and indeed, has stressed the importance of cooperating more with international regulatory bodies. This is ironic, given the fact that the UK is set to leave one of the biggest regulators globally. FCA chair Charles Randell, aims to ‘continuously’ update the leading bodies within the UK financial scene and claims that this is important for the future of financial regulation.

The existing scene is one where FinTech has reached a rate where it needs to be understood and regulated suitably. The UK currently houses most of the world’s upcoming and largest FinTechs, averaging £20 billion in revenue this year. Furthermore, the UK has seen the largest amount of funding in FinTechs, beating the US and China with approximately £14 billion in investments, notably during the first six months of this year. In retrospect, the revenues generated now is over seven times that back in 2015.

As the industry continues to grow, competitors such as Monzo have continued to receive strong backing from investors and venture capital firms. Last year, the company was valued at $1.5 billion and eyes ambitious plans to grow its consumer base in the future. The so-called ‘bank of the future’ aims to keep the company away from bigger institutions, notably, those who have been building their FinTech presence at a rather fast pace.

BigTechs into FinTech?

Regulating the FinTech industry compared to the larger financial institutions proves a problem for regulatory bodies such as the FCA. While these technologies remain relatively new; many suffer from asymmetric information between the consumers and the tech itself. With many other multinationals entering this space, such as Apple, the future of FinTech regulation is still quite uncertain. Apple’s bold move into the FinTech space could require further regulatory measures and testing.

It is bold that technology companies are breaking into the financial services industry. Their collaboration with Goldman Sachs to release the much anticipated Apple Card may pose this very threat and may require regulatory bodies to assess more aspects into its launch, such as user and consumer data protection, clearer terms and services. 

However, the FCA have outlined a scheme to assess the impacts these new technologies are having on the industry. Through pilot phase 1 and phase 2 testing, these firms will be given the authority to test them in the real market – known as ‘sandbox’ testing, where the companies involved can gain an idea of what the wider implications of this technology are. These impacts will mostly be examined on the effect it will have on consumers. The incumbents involved in this, who have a strong FinTech presence are the likes of Morgan Stanley, HSBC, Barclays, and Santander. Anything uncovered as a key issue in the pilot phase 1 testing will be readdressed in phase 2, ensuring complete coverage of the sector and it might improve existing ones, affecting key areas such as retail banking.

The discoveries so far have been revealing, with over 146 applicants who were involved in the ‘sandbox’ testing phase. Most of the testing was dominated by retail banking, with over 50% in the cohort and the second largest being general insurance and protection. Over 65% of these candidates were startups, something we might expect given the majority of UK FinTechs who are relatively new on the scene and haven’t gone through any formal incubators. Despite this, a survey from Industry Sandbox Consultation has shown that top financial institutions have increased their usage of FinTech services, particularly in the business development side of their firms. Most of these results detail retail banking clients using technologies to streamline their business to become more efficient and build infrastructure to support a ‘better financial system’.

To conclude, the question remains whether the environment in which these FinTech services can operate, considering the potential reveal that some safeguards must be in place if the aforementioned pilot phases reveal damaging effects to consumers. If indeed the future of FinTech looks feasible from a regulatory standpoint, what could the benefits be? A conclusive report from Accenture found that when interviewing the top calibre FinTechs exceeding market capitalisations of $1 billion, common themes such as openness, collaboration, and investment lay at the core of these companies and their visions for a future that not only transforms financial institutions but the world economy through connecting previously unrelated industries together. 

Further to this, we have also seen the development of FinTech and its arrival on the UK financial sector, with the Chancellor of Exchequer, Phillip Hammond stating in his 2019 Mansion House piece that “as the first wave of FinTech innovation matures, [they] must now evolve [their] policy and regulation too, to make sure it remains fit for purpose”. 

RegTech

The Financial Conduct Authority (FCA) has already outlined multiple issues within the FinTech space, which may explain the creation of RegTech. The industry aims to build upon its largest ever financial technology body, which is the RegTech space, which will track and identify firms’ abilities to harness consumer data. A move much needed given that 17% of incidents last year were linked to external IT providers. The need for surveying these firms, most of which are SME’s, could help reinforce the confidence of firms to reinforce their existing IT services and even build upon them. 

RegTech has been on the rise since 2015 and has been dubbed the “new FinTech”. It acts as a bridge or facilitator to use new technology to comply with existing or future regulatory requirements. Its purpose is to address the fast-growing pace of FinTech in the market, which has been favoured by many leading institutions for being faster and efficient in their business processes. Hence, it is not surprising that RegTech growth figures are as high as they are now, with the market expected to be worth $12.3 billion by 2023, up from its current market value of $4.3 billion.

The compounded annual growth rate (CAGR) is expected to be 23.5% until 2023. This is comparable to the considerably higher CAGR value for the global FinTech market through 2019 to 2025, standing at 74%. Further to this, studies from KPMG have shown that by 2020, RegTech will make up to 34% of all regulatory spending.

The aims of RegTech have been mostly to assist financial services firms to better understand regulation, through the focus of driving digital transformation with the promise to; strengthen compliance and mitigate risk, reduce the costs of compliance and improve protection for consumers. RegTech can, however, offer more. Since we are now in RegTech 3.0, allowing for the potential to provide business insight, provide customers with faster service, and drive new products to market. 

RegTech, however popular it is now, is not a new technology. It has evolved from multiple versions, with the core idea to help business deal with regulations.

• 1990: Financial services use the first version of RegTech 1.0 to help analyse the risks of specific processes. 
• 2000: RegTech 2.0 was developed to focus on the need for KYC (Know Your Consumer). These allowed financial services firms to improve upon their supervision.            
• 2010: The new RegTech aimed to allow firms to innovate and grow, but since the financial crisis of 2008, financial services firms experienced increasing regulatory pressures and law changes. It becomes important to focus on KYD (Know your Data) and KYC to be the focus.
• 2020: The industry now moves from KYC to KYD, given the rise of FinTechs and crucial data infrastructure that make up many FS firms.

RegTech 3.0 remains the focus of many financial services firms going into the future. Indeed, a study by Data Driven Investor showed that over 60% of institutions believe that it is likely that RegTech will have an increased budget in their internal compliance costs and business development plans. Upon further surveying of the top global RegTech start-ups, over 50% stated that they would most likely use and develop RegTech 3.0 for artificial intelligence and data analytics.

To conclude, as a result of this increase in RegTech in the financial services industry, we can already realise some of the efficiencies of using this type of technology. Examples such as Capital Regulation has already changed with the advent of RegTech 3.0. For example, financial firms had to previously hold a capital requirement to mitigate risk, but in the advent of RegTech, this is about to change. Algorithmic compliance will now be at the core of many financial services firms to control Capital Regulation. Of course, the regulatory bodies will now sandbox these technologies before they are to be released to market. 

With the possible disruption of these technologies on the traditional business models, RegTechs may have the potential to not only serve more institutional clients in the financial services sector but also act as a technology vendor elsewhere. It may lead to more sector work in education, public services, and technology firms who are also aggressively entering the financial markets. While the technology is there and has been proven to work in financial services; the question remains as to how far can FinTech and RegTech go and whether the future regulatory bodies may deem them as an essential need for consumers protection. 

Data used in this article has been sourced from several publications and research reports including from Accenture, Alvarez & Marsal, Deloitte, FCA and KPMG.