The purpose of financial regulation is ultimately to protect the consumer. There are hundreds of global financial regulations created by a myriad of regulatory bodies both in response to, and as a means to avoid, financial crisis, and to create stability and security in the financial systems. The proliferation of financial regulation has intersected with innovations in technology to create a category of solutions dubbed “RegTech.” But how did we get here?
The October 1929 stock market crash led to the failure of over 10,000 banking institutions and the Banking Act of 1933 (the Glass Steagall Act), which separated commercial and investment banking to protect depositors from the speculation that occurred prior to the crash. The Federal Deposit Insurance Company (FDIC) followed, along with early regulatory bodies.
More recently, decades of deregulation of the financial industry caused the near collapse of the global banking system in 2008. This deregulation produced both aggressive lending practices (that many say were caused by the Community Reinvestment Act) and complicated new financial instruments that packed many mortgages together to create “safer securities,” along with complex derivative products whose value is tied to other instruments. Investors bought these mortgage-backed securities and derivatives without understanding the full impact of the underlying loans. Inevitably, the regulatory pendulum swung wildly the other way.
More than a decade later, financial institutions navigate over 350 global regulations from 292 regulators mandating capital retention, disclosures, pre-trade transparency, post-trade reporting, disclosures, know-your-customer, know-your-counterparty, data protection, accounting practices, and third-party risk management, just to name a few of the actionable regulations. It is now a full time job to keep track of the regulations, mandates, and rules associated with being a bank, investment bank, insurance company, pension fund, mutual fund, hedge fund, or any other regulated financial institution. This is exacerbated for global institutions, which must comply in each region where they do business.
Vendors have stepped in with products and services, RegTech, designed to help the financial services industry understand and manage these risks. But what is RegTech today? Is it more than just a new buzzword like “Big Data,” “Blockchain,” “Artificial Intelligence,” or “The Cloud?” Is it the vendors that build technology to monitor for risk factors as defined by regulations? Is it vendors whose services are used downstream to help financial institutions meet regulatory requirements? The answer is “all of the above.” A plethora of companies are building solutions to help address regulatory issues such as Anti-Money Laundering (AML) and Know Your Customer (KYC), essentially helping identify personnel at institutions; or, Enterprise Risk Management issues such as fraud. There are also companies that offer fintech services that already comply with regulations, or have made adjustments to existing products to meet current regulatory standards, whether pre-trade discovery or the ability to prove best execution, or understanding the underlying loan level data in a Mortgage Backed Security. Following the swing of the regulatory pendulum, many companies that provided existing solutions created new ones to assist the financial institutions they serve.
Many vendors will mention that their solutions meet certain regulations. With some of these regulations reaching hundreds of pages in length with numerous sections and even more articles, the question becomes: which services within these products meet each specific regulatory criteria? And, are there other vendors that offer similar products? For example, our company, VendEx Solutions, offers VReg, a product that helps financial institutions understand their vendor reliance, allowing institutions to perform risk assessments on companies on which they rely to meet regulatory requirements.
These recent innovations have brought to market hundreds of companies leveraging technology to make a difference. According to Deloitte, there are currently 378 RegTech companies in five categories: Regulatory Reporting, Risk Management, Identity Management and Control, Compliance, and Transaction Monitoring. This does not include existing fintech companies that offer RegTech solutions. As the pendulum continues its swing toward more stringent regulatory standards, there is a high likelihood that we will see this number double in the next five years.