As an offshoot of the thriving fintech industry, regtech, which uses new technologies like big data and cloud to help financials deal with the post crisis regulatory tsunami, hasn’t quite enjoyed the limelight accorded its parent. Yet demand for its novel offerings is growing fast globally, in turn encouraging strong investor interest in the potential of regtech startups: respected research firm CB Insights reckons the sector has raised $3bn across more than 400 deals since 2012 with deal activity hitting a new high last year.
But with the US having accounted for nearly 80% of all those deals since 2012 (the UK is second most dominant at 9%) it’s not surprising President Donald Trump’s promise to roll-back post-crisis financial regulation, Dodd-Frank in particular, has led to worries across the sector, with firms and investors busy trying to assess how such a move might impact its development. There are fears in some quarters, for instance, that Trump’s attack on rulebooks could dampen demand for regtech, undermine what up to now looked a rather bright outlook for the sector.
Pamela Perdue, executive vice president and chief regulatory officer at Connecticut-based Continuity, a provider of automated compliance management solutions to institutions, says several factors need to be taken into account when trying to gauge the impact from any Trumpian reform of rulebooks, the evolution of the regulatory burden on institutions being among them. The dramatic change in the nature of this burden post crisis can be clearly seen from data on the physical volume and velocity of new US rules. Based on an analysis of the Federal Register – the daily publication of changes proposed or made to the US Code of Federal Regulations – Perdue notes that since 1995 regulatory velocity has actually remained fairly steady: even with the onset of the Dodd-Frank era the velocity of new rules has remained pegged at 50-75 regulatory changes per quarter or roughly 300 regulatory changes per year. And, interestingly, that pattern held regardless of which political party controlled the White House and/or Congress.
Change is inevitable… except from a vending machine.
What really changed dramatically after Dodd-Frank was the volume of regulatory pronouncements. Over 2003-2008 rules averaged 1600 pages per quarter but by 2016 this had doubled to 3300 pages per quarter.
Dodd– Frank itself is a prime example of rulebook page creep. When it was passed into law in 2010 it had 2,300 pages. Now it boasts over 22,000 pages prescribing nearly 400 rules. Another is the Volcker Rule, which bars banks from engaging in proprietary trading. It started off as just three pages and ended up a 800 page plus heavyweight.
At the global level, meanwhile, Thomson Reuters Regulatory Intelligence Feeds reckons the major banks are now bombarded by nearly 200 regulatory updates daily compared to around 10 a day in 2004. TRRI Feeds, which provides firms with daily automated regulatory alerts from a database covering over 750 global watchdogs, says the regulatory burden now is such that it demands new rule interpretation and implementation every 12 minutes.
While figures vary there’s no dispute that the cost industry-wide of addressing continuous and complex regulatory change runs into billions annually. And it is rising fast, with consultant Celent, for one, seeing financial firms hiking their spend on compliance technology to $72 billion by 2019 from $50bn in 2015. Research platform Lets Talk Payments, meanwhile, predicts the global market for regulatory, compliance and governance software will be worth nearly $120bn by 2020.
It’s no wonder then, as Perdue points out, that as early as 2010 a new job title had emerged: regulatory change manager. She says: “When it comes to regulatory burden, volume is a proxy for complexity. Today there are over 14,400 citations in the US Code of Federal Regulations pertaining to the business of banking. That’s tens of thousands of discrete requirements that financial institutions have to identify, manage, and monitor. Traditional methods involving human effort and antiquated tools such as documents and spreadsheets are bound to fail in this type of environment.”
Off with the old and on with the new
As it stands then, there has never been a greater need among financials for regtech, with its promise to bring new technologies to bear on groaning rulebooks. So how feasible is it for Trump to roll back the red tape and what might the impact be of any such change on regtech? Armed with more than 20 years of regulatory expertise that includes a stint as senior examiner at the Federal Reserve Bank of Kansas City, Perdue is well placed to comment on Trump’s chances of pushing through his plans. She says: “The strong actions of Trump’s first few weeks in office have brought some surprises already and although the likelihood of a complete rollback of Dodd-Frank is slim it is not impossible.”
For Perdue several big hurdles face Trump on his regulatory reform mission. The legislative appetite to tackle too many broad reforms may flag quickly and push financial services out of the spotlight. “Even if the President decides to attempt an executive order to overturn existing rules the move will be subject to and may not withstand judicial scrutiny. He’s already issued an executive order stating that for one new rule written two must be abolished but the edict has left lawmakers scratching their heads over how to implement its nonspecific guidance. Identifying a regulation as a candidate for elimination does not automatically signal repeal; the rulemaking agency still has to follow proper protocols for removal.”
It is also uncertain how any rollback of regulation would be beneficial: “The challenge that most lawmakers fail to understand is that it’s not the stringency or leniency of the rules that causes banker heartburn. It’s the mere change itself. Each time a rule is enacted, changes or is removed, it sets in motion a chain of events inside a financial institution that commands resources. Risks must be identified and addressed. Policies and procedures must be updated; systems must be upgraded and staff must be trained on the “new” way of doing things.
“Every one of these implementation steps consumes organisational energy in the form of time, money and people. Resources that could be better applied toward innovating new products or services, attracting new business, or economic development, are instead poured into staffing regulatory teams and performing compliance functions. It’s a situation where no one wins. But it’s also an opportunity for those who have the foresight to maximise their efficiency by using modern technology to alleviate some of the burden.”
There seems little doubt that regtech is here to stay and holds considerable potential but Perdue is keen to manage expectations of the sector: “Specifically in the United States, regtech sector has gained a toehold the past couple of years but it’s still not in full bloom like its parent, fintech. A primary obstacle to greater success of the sector in the US is the complex regulatory schema. Regulations tend to lack standardisation or prescriptions for action, making automation difficult to apply. Regulations follow traditional models of legal jargon: a host of complicated definitions, followed by vague or subjective descriptors or modifiers – words like adequate, generally or regularly – that require interpretation and are therefore harder to throw at technology to deal with.
“Where efforts [by regtech startups and institutions themselves] have made headway they are focused on the more traditional regulatory software, like anti-money laundering and interdiction software [which helps firms ensure they do not become involved with the wrong people or entities]. Very few innovators have tried to tackle the bigger problems of automating entire compliance management systems. And even fewer have focused on the challenge of getting machines to read and analyse regulations.
A rolling stone gathers no moss
More broadly for Perdue it’s not clear how a Trump administration could really affect regtech going forwards considering there seems to be little appetite in the new administration for the tech sector and greater emphasis on traditional manufacturing and energy sectors such as coal power. At the same though, Trump’s election did lead to a rally on Wall Street as investors looked favourably upon his plans to rollback regulation, slash corporate taxes and spend $1trillion on infrastructure. Banking stocks in particular sparkled, gaining around 20% at one point. If that advance can be sustained, she believes corporate capital may loosen, resulting in more investment in the regtech sector by financials.
Irrespective of how policy is prioritised Perdue is clear regulatory challenges will remain and need to be addressed: “Those in the sector would be wise to understand that the political implications of any regulatory moratorium or rollback do not change the mechanics: change is change, and change must be managed somehow.”
CB Insights analyst Lindsay Davis echoes Perdue’s analysis: “Regardless of political tides, regtech will continue to be a growing trend because of the efficiencies it creates. Regtech is solving critical pain points that existed in regulatory compliance long before major pieces of regulation like Dodd-frank, such as automating manual processes and centralising traditionally disparate pieces of information. All of which creates efficiencies, frees up time, and creates cost savings. The boost for banks [on markets] coupled with potential loosening in regulatory mandate will only help free up both time and capital within institutions to either buy, build, or invest in new technology including regtech.”
At the more global level it might appear any regulatory reform in the US would have little impact on regtech activity elsewhere. But Perdue believes those regtech companies wanting to gain the greatest traction fast would be wise to look at countries where regulatory regimes are newer and simpler: “An unintended consequence of US regulatory uncertainty could be an atmosphere that drives investment dollars outside the US. More generally, the more complex regulatory regimes in the US and UK inhibit somewhat the pace and intensity of regtech efforts in these jurisdictions while uncertainties caused by Brexit make it tough to call how supportive of the sector the rest of Europe might be going forwards. With several already mature consortia available elsewhere, such as the Singapore Fintech consortium and the Fintech & Payments Association of Ireland, innovation centres are developing that could well prove a bigger magnet for [regtech] investment from around the globe.”