Looking at the FinTech and RegTech conversations in 2017 we find that there is considerable confusion about some basic terms, definitions and relationships amongst policy makers, academics and practitioners alike. The now much more popular term is being used to describe many things.
When you say RegTech, do you mean it to be a subset of FinTech, its own domain within FS, or even a domain that extends beyond FS? We have settled on the Ouroboros dragon eating his own tail as the appropriate symbol to provide some context for the semantics in this short article.
Finance, FinTech and Regulation
Financial services are the business of money and markets. Money and markets are about prices, and prices are about expectations. Buyers and sellers commit capital based upon expectations of the rule of law, enforceability of contracts, coherency of governmental and monetary policies, and sound regulatory principles. Indeed, financial services depend on five core regulatory principles:
- Consumer protection
- Computational integrity
The first four are widely talked about in regulatory circles, but the fifth one is a new by-product of the post-2008 wave of regulatory reforms across the globe. We believe this fifth principle is now integral to the healthy functioning of the system which depends on very granular detailed data prescribed by many different sets of regulatory obligations.
In part due to this new principle, financial technology (Fintech) companies have erupted into early growth cycles. They are fueled by significant funding, the ongoing $400 billion of technology costs in financial services, and the promise of disrupting the production and distribution of credit, payments, insurance, wealth management, and market infrastructure. By challenging legacy industry verticals, the companies are also changing the application of these regulatory principles.
FinTech, the Economy and Regulation
In 2016, Thomas Philippon evaluated The FinTech Opportunity for the National Bureau of Economic Research and concluded that a new regulatory framework was required. He defined FinTech as:
“FinTech covers digital innovations and technology-enabled business model innovations in the ﬁnancial sector. Such innovations can disrupt existing industry structures and blur industry boundaries, facilitate strategic disintermediation, revolutionize how existing ﬁrms create and deliver products and services, provide new gateways for entrepreneurship, democratize access to ﬁnancial services, but also create signiﬁcant privacy, regulatory and law enforcement challenges.”
While we like the definition, and agree with his conclusion about the need to revisit the regulatory framework to accommodate it, we see three important operating disruptors also driving decision making for those faced with our Ouroboros:
- Fintech is also giving rise to new definitions of money and price discovery
- The complexities of the regulatory burdens are fueling the demand for intelligent systems to manage compliance
- The uncertainty of the legal environment is driving a requirement to link detailed business processes to a constantly changing body of law.
Fintech may be thought of as an agent of creative destruction—it seeks to supplant legacy financial services with greater economies of scale at better points of distribution. Established financial services companies come with legacy architectures around data, technology, and regulation.
JWG has been at the forefront of tracking the mountain of regulatory reform that, when printed is measured in Eiffel Towers. Alongside regulators, we have proven tools can be employed to make sense of the technology implications of regulation. However, we also know that without a common view of the artefacts which help technology know it is acting in a compliant way, the computing power is not going to be smart enough to deliver meaningful benefit to the economy.
Consider MiFID II, one of a dozen regulatory implementation programmers going on now. Can the business models it changes be articulated? Does anyone (including the regulators) have a data model for it? Is any of the code being developed for regulatory purposes able to be shared between firms? Despite the billions being spent this year alone on all the tech, sadly only a few pockets of RegTech excellence exist to help the industry manage the operating disruptions from this major restructuring of a global marketplace.
Moreover, Fintech in lending has additional regulatory burdens (such as Basel III) which relate to leverage and credit. The operating disruption here is in the dynamic between the business model, regulators, and technology.
Legacy regulatory concerns are over leverage, while firms are at risk of being consumed by the advent of operating innovation around machine learning and less encumbered business models/technology architecture.
Turning our attention briefly to the third disruptor, as JWG’s 2016 Brexit analysis showed, and our 2017 review of the CHOICE act indicated political and legal uncertainty is higher than it has been in decades. In today’s environment of high change for the rule book this means that it is not good enough for businesses to get the changes done to stay in business next year. If they want to remain competitive, they need to adopt RegTech to be able to manage the changes coming later this decade.
Framing the debate
This is part of the larger historical shift of financial services from risk intermediation, to risk information processing, and now to risk information production. Risk intermediation (leverage and credit) and risk information processing (market architecture and payments) are now augmented and even disintermediated by risk information production (computation).
The disruption is caused by secular advances in technology and innovation. However, basic concepts of leverage (and therefore capital) are regulatory mandates. This means that efficiencies at both a balance sheet and income statement level from legacy companies are supporting disruption from companies based in the first–but without the second.
Regardless of whether you sit in a ‘FinTech company’ a ‘financial institution’, or a ‘regulatory agency’ you have a common interest: understanding the opportunities presented by the disruptors in front of us. Learning from both FinTech and RegTech successes will help to establish a solid basecamp from which to lead the charge up the FinTech and RegTech mountains in parallel.
Dan Orlow has a broad background in financial services and technology. He started as a payments economist at the Federal Reserve Bank of New York, worked in the securities markets as a portfolio manager, a founder of a predictive analytics start up, and most recently as the founder of Game Sports Network, a fin-tech based events market platform for fantasy and sports gaming. He has U.S. and EU Citizenship (Germany), completed graduate study in Mandarin and finance, and is admitted before the Bar in Pennsylvania, Washington, D.C. Court of Appeals, and the U.S. Supreme Court.