Why is RegTech investment around the world growing?

Investment in RegTech companies has reached record levels in the first six months of 2019. The question is why that is and if the growth will continue.

The RegTech sector is booming. The industry has just experienced a record-breaking first six months of the year with $3.7bn having already been injected into the industry. That’s almost four times as much invested in the entire industry in 2014. And the year is not over yet. But that begs the question as to why RegTech is having a moment. More importantly, are there any challenges threatening to halt its momentum?

Let’s start by looking at the numbers. Having analyzed data from our own database, FinTech Global’s latest research reveals that the RegTech sectors has netted almost $13.3bn across over 900 deals since 2014. More impressively, close to two-thirds of that was raised in the past 18 months. The research also revealed the annual global RegTech investment had jumped from $923.4m in 2014 to $4.48bn in 2018. “The RegTech sector is maturing,” says Russell Perry, co-founder and CEO of kompany, the Austrian RegTech company providing real-time access to official and audit-proof commercial register information.

Indeed, the sector has come a long way since the UK’s Financial Conduct Authority, the financial regulator, first coined the term officially in 2015. Since then, Perry argues that two things have led to the rise of the sector: technological advancements and a stricter regulatory framework in regards to things like anti-money laundering (AML), risk management and data privacy. The first factor can help businesses alleviate the pressures of the second. “For the first time, the cost of compliance is lower than the fine that will be associated if you are not compliant,” Perry continues.

Indeed, RegTech vendors are helping companies ensure compliance with real regulatory changes. So unsurprisingly, the most recent surge occurred just after the EU introduced the Markets in Financial Instruments Directive (MiFID II) and the General Data Protection Regulation (GDPR) in 2018. Indeed, 22.5 per cent the RegTech investments in the first six months of 2019 has been in regards to compliance management. That is a significant uptick from previous years. From 2014 to 2018, the compliance share of the sector dropped from 29.7 per cent to just six per cent.

Moreover, 21.3 per cent of all RegTech investment between 2014 and 2019 have been injected into cybersecurity companies. In the RegTech space, this means that they are providing solutions specifically targeted at overcoming obstacles of financial regulations such as know your customer (KYC) and GDPR.

Given the situation, Perry argues the rise of the RegTech sector should not shock anyone. “RegTech is solving real problems,” he says. “We’re talking about real businesses – not about applications. We are not talking about consumer products where if something goes offline, nobody cares. It might just be a Twitter complaint, right? We have clients who rely on our platform to verify 100,000 funds on a constant basis. Just imagine that those funds can’t be verified. That they can’t fulfil their data compliance. Then they won’t be able to sell their products. That’s putting billions at risk. [That’s not] 100 million people that can’t log in to Instagram, you know.”

Another reason is that business leaders are realising that the evolution of the market is catching up with them. “[Compliance] and executive teams are recognizing that their legacy compliance technologies are not up the modern regulatory and compliance challenges, and that is driving more adoption of new technologies and RegTech,” suggests Devin Redmond, co-founder and CEO of Theta Lake, the RegTech built for modern video, audio and chat communications.

Moreover, some corporate head honchos have also seen the uncertainty on the global markets – think the US-China trade war and Brexit as two examples – and have accordingly began to get worried. “Many clients are anticipating an economic downturn over the coming years, resulting in an increasing cost focus,” says Niclas Nilsson, founder and CEO of Capnovum, the London-headquartered company offering cognitive compliance management platform for horizon scanning and regulatory change management.  “Inflated compliance departments, in response to more comprehensive regulation over the past decade, become obvious targets.”

As the business teams around the world are recognising the value of being compliant, transparent, efficient and auditable, it has become evident that there is a need for RegTech startups, scaleups and incumbent companies’ solutions. And where there is a demand, there is always going to be people ready to bet on the companies meeting that demand. “Shrewd investors can see that RegTech is still in its infancy and yet to break-through to mainstream usage across the hundreds of millions of regulated entities worldwide so this is why we are seeing interest in RegTech firms,” argues Anthony Quinn, founder and CEO of Arctic Intelligence, the Australian RegTech company providing financial crime audit, risk assessment and compliance solutions.

And the RegTech industry is not just catching the eye of venture capitalists. “We are already seeing private equity funds marking funds for RegTech because it is assumed that the RegTech market itself will be go to a $100bn a year just in 2022, 2023 depending which report you follow,” Perry suggests.

However, the uptick in investments does not meant the RegTech sector is not facing its fair share of challenges. Capacity is one of them. “The increased focus on cost optimization has caused an enormous raise in inbound opportunities for many RegTech providers,” Nilsson says. “Even those with truly scalable technology feel the pain, since few startups are prepared to handle the volume of commercial interactions.”

On a similar note, some RegTech toolkits are still “immature”, according to Redmond. “These are companies and technologies that don’t have true products versus toolkits with smart people to do custom implementations with organizations,” he continues. “These can be dangerous as firms can underestimate the total cost of ownership and the opportunity cost [and] time lost trying to implement overly bespoke approaches.”

Although, Redmond believes this issue may be dealt with over the next year and a half with these projects being either scrapped or redone “with more standardized and market ready products, tools, and solutions.” Still, he fears that those “abandoned and not entirely successful toolkit projects will ‘taint’ perceptions of the space, challenge acceptance of ROI and impact budget availability from customers unnecessarily.”

Additionally, even though many corporate chieftains recognize the value of enlisting the services of RegTech enterprises, it can still be difficult to convince them to trust a new startup. “The biggest challenge facing RegTechs is the trust gap between major firms, who are quite conservative in their thinking and behaviours ingrained over decades – sticking to major providers, the ‘nobody got fired for hiring IBM’ mentality,” argues Quinn.

He continues. “Many traditional technology providers have become complacent and have outdated and often stale technology that is far from agile or leveraging the latest technology innovations, but it is often still hard to convince traditional financial institutions that there are now better ways of doing things – the change is gradual and sometimes glacial, but it’s coming.”

Just like some companies may be slow to accept the RegTech sector, Perry also suggests that some regulators may feel much the same way. “They have been very slow in accepting technical solutions because there is not enough transparency,” he says.

The solution to this particular dilemma, according to Perry, is to ensure the RegTech industry can work closer with regulators in the future. By doing so, he believes they can help make the sector seem more transparent. For instance, they can provide data and insights on things like AML “so that the regulators can do more regulation and supporting rather than just fining.” “Regulators’ buy-in is required but the buy-in comes only through the transparency of the RegTech solutions and only through an outreach with the regulators,” Perry says.

Despite these challenges, the people FinTech Global spoke with seem optimistic about the sector’s future. “In the next few years, we expect RegTech to break through to the mainstream,” predicts Quinn. “Regulators are now aware of and encouraging regulated entities to experiment and adopt RegTech solutions so whilst adoption at this point is largely early adopters we expect there to be a shift such that RegTech solutions rather than manual outdated excel models for managing risk and compliance become the norm and laggards that fail to adopt will be the ones having to answer the question why they are not utilising technology to help them manage risk and compliance more effectively.”

So what’s next? If you ask Redmond, the answer is that the “market will start to segment into broader categories beyond use cases like AML, KYC, SupTech, communication monitoring and into categories such as new initiatives, replacement initiatives, and augmentation.”

He continues. “Specifically, you will begin to see RegTech that is designed for new FinTech initiatives around banking, lending, wealth management, etcetera. You will see RegTech that is designed to replace aging compliance technologies. And, you will see a variety of RegTech solutions designed to augment legacy compliance technologies as well has help bridge gaps between old compliance technologies and new RegTech and compliance technology.”

Copyright © 2019 FinTech Global

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