Risk. Compliance. Regtech. These umbrella terms are becoming increasingly important in FinTech today, which has been a driver of innovation and development in the financial world for some time now. Risk management is a practice (or series of practices) intended to reduce the likelihood or magnitude of negative outcomes experienced by an individual, organization, or society from taking risks in any given situation. Regtech is a term coined to describe the application of risk management and compliance tools to financial markets.
Risk and compliance has become more important in FinTech as well, especially in the world of crypto currency, ICO’s, cryptocurrency exchanges, traders and the blockchain industry. Today, FinTech companies are facing a multitude of regulations with new ones coming out every day. The Financial Conduct Authority (FCA), the European Union’s equivalent to the SEC in the US – which recently released its crackdown on ICOs – has been leading this charge at both EU and national levels across Europe. But there are also other regulatory bodies around the world. For example, The Securities and Exchange Commission (SEC) in the United States is also constantly updating its rules for cryptocurrency exchanges as well as other ICO companies.
Regtech is the innovation of applying risk management and compliance tools to financial markets. Some of this progress has been driven by FinTech start-ups, but also by financial institutions that have been eager to create a competitive edge. In the case of banks, it’s important to manage their regulatory burden so they can remain competitive. In addition, many banks are in the process of developing blockchain technology and smart contracts to automate processes while at the same time applying their own risk management practices to these new developments.
Regtech is also being applied to other financial markets, such as the insurance industry and credit rating agencies. Risk and compliance has become a top concern – especially in the world of cryptocurrencies. Many crypto exchanges are regulated, but it’s becoming more difficult to determine just how to apply regulatory guidelines in this area. Some of these exchanges are seeking licenses under the EU’s new AML (Anti-Money Laundering) laws. Others are going through the process of having their third-party service providers approved. One example is Coinbase, which wants its suppliers in-house so they can be more efficient, responsive and transparent in their approach with authorities.
In the world of finance, risk means predictability. Regtech companies and organizations today are working to take advantage of the fact that predictability and transparency are not often associated with financial markets. For example, blockchain technology offers the ability to store information about a transaction in a permanent and transparent way. This means that this information cannot be changed (and can be revealed so no one can fake their data). Regtech companies offer tools to make predictions – based on transaction history – about whether an individual or organization will choose to take a certain action or not. The hope is that this will allow regulators to better understand risks and better manage them in some cases.
One of the challenges in this area is that regulators face not only financial risks, but reputational and political ones as well. Regulators must balance their responsibility to investors, consumers, the market itself and stakeholders with one another. These issues are being addressed by a variety of organizations and teams. For example, B3i (Blockchain Insurance Industry Initiative) was launched in March 2016 by Swiss Reinsurance Company Ltd., Allianz SE and Zurich Insurance Company Ltd to share information regarding blockchain technology in the area of insurance. This includes research on the use of smart contracts as well as potential applications for distributed ledger technologies and how these can be used for underwriting, claims processing or risk analysis. Major industry players (insurance) get together on a regular basis to share information about this innovative technology.
Meanwhile, FinTech companies are responding to the regulatory challenges they face by developing new tools and adding staff to help them address regulatory compliance. For example, in October 2017 eToro, which is regulated by the FCA in the UK as a payment services provider, was among the first startups to introduce a dedicated regtech team. The group will develop automated solutions for regulatory requirements and also oversee anti-money laundering compliance, know-your-customer checks and other tasks. As the regulatory requirements involved in the cryptocurrency space are becoming increasingly complex, such measures are critical to their success.
As these types of regtech solutions become more commonly available to financial services across the board, more companies and organizations will benefit from greater predictability, transparency and better management of risks. This will help improve FinTech and industry as a whole.