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With one in three bank staff now employed in compliance, and financial institutions groaning under the pressure of an ever-increasing regulatory burden, 2018 is set to be the year that RegTech rides to the rescue, stripping out huge cost from banks’ processes.

In the same way that nimble start-ups introduced FinTech to the financial sector, the stage is now set for the same tech-savvy entrepreneurs to apply the latest technology to help tame the regulation beast. 

The challenge is even more pressing now, with the arrival of an alphabet soup of blockbuster regulation including GDPR, MiFID II and PSD2, which will stress institutions like never before.

What is RegTech?

Deloitte has set high expectations for RegTech, describing it as the use of technology to provide ‘nimble, configurable, easy to integrate, reliable, secure and cost-effective’ regulatory solutions.

At its heart is the ability of ‘bots’ to automate complex processes and mimic human activity. And RegTech start-ups are already using robotic process automation to translate complex regulation into API code using machine learning and AI.

The holy grail of RegTech, however, is to strip out huge layers of cost and dramatically lower risk by developing and applying complex rules across all business processes in real-time, automating what can otherwise be an expensive and highly labour-intensive job. Simply put, RegTech promises to do the job faster, cheaper and without human error.

Behavioural analytics

Just like its FinTech cousin, RegTech is already being used for a surprisingly wide range of applications, for example banks are using behavioural analytics to monitor employees, looking for unusual behaviour patterns that may be a tell-tale sign of misconduct.

Brexit will also present a golden opportunity for agile RegTech start-ups whose tech solutions can adapt and transform quickly according to the new regulatory landscape, while traditional institutions struggle with the pace of change.

Unlike FinTech however, which has largely been focused on B2C solutions, RegTech start-ups have to work much more closely with traditional financial institutions. That’s because capital markets are a highly complex, regulated area, where institutions are cash-rich and where access to funding is critical if vendors want to disrupt.

Bespoke solutions

Traditional institutions are also more likely to need solutions that are specifically tailored to the challenges they face, rather than the one-size fits many approach developed by FinTechs. For example, they rely on many different data systems, and this torrent of data often makes it difficult to compile reports to deadline for regulators – a perfect challenge for a RegTech start-up.

RegTech could well be the cavalry, riding in to save the investment management industry from the increasing amount of data being produced that financial regulators want access to. A significant amount of this data is unstructured, making it difficult to process, which adds a greater level of complexity. The flow and complexity of this data is only going to increase, and with it the challenge for banks.

Financial institutions are increasingly pulling out all the stops to crunch data and meet the regulator’s next deadline and in this high-pressure environment teams are not necessarily developing the strategic overview needed to streamline their IT architecture in order to reduce operational risk.

Compliance at speed

RegTech promises to automate these processes, making sense of complex interconnected compliance rules at speed, making compliance more cost effective, while reducing the chance of human error.

It also promises to dispense with the current time lag between a period end, the collection of data by the institution and assessment by the regulator – a process that is always backwards looking.

Under the RegTech model, powered by data analytics and AI, information is in real-time and self-correcting to ensure the regulatory process remains dynamic and relevant.

The scale of the advantages promised by RegTech, are such that banks successfully harnessing its power will strip out huge amounts of cost from their processes, which can then be invested in business-critical innovation, giving early adopters a clear competitive advantage over the rest of the market.

-

John Cooke, Managing Director

Black Pepper Software

The below market commentary was written by Eric W. Noll, Convergex CEO.

MiFID II, an upcoming piece of legislation from European Union regulators, upends the traditional linkage between trading commissions and investment research in ways both the money management and brokerage industries have yet to fully understand. It will force both the explicit pricing of sell-side research and the defense of those expenses to asset owners by money managers. Moreover, while this is an EU directive, we expect many global asset owners to eventually embrace its core principles of explicit pricing and transparency. By virtue of our market leadership in the Commission Sharing Agreement business through Westminster Research, we stand ready to offer solutions and act as a guide to our money management clients as they face these new challenges.

"Half the money I spend on advertising is wasted; the trouble is I don't know which half." That century-old quote from John Wanamaker, one of America's most famous merchants, is as true today as it was in his time. Every business knows they have to advertise to attract new customers and retain old ones, but even in the Internet Age the advertising game remains – at best – an imprecise science.

There is a close analog living on Wall Street: the value of the sell-side equity analyst. Every Director of Research knows that half of their firm's analysts generate most (if not all) of the aggregate profitability of their team. Sometimes that is because the analyst in question has a history of great calls. Other times, it is because they run the best-attended conference in the sector. In still other instances, it is just "right place, right time" - a solid analyst who happens to cover a sector that has gotten hot of late.

On the investment management side of the business, Wanamaker's adage has similar relevancy when it comes to the research these asset managers purchase from those brokerage firms. Half – if not more – of the content a portfolio manager/analyst receives from the Street is perceived to have little-to-no value. Sometimes that perception is based on the principle that it is simply not value-added work, and sometimes that the research addresses a company or sector that is currently out of favor. That is an important difference of course, even if it does not change the 50/50 calculus.

This is all about to change, and the catalyst comes from the European Union with its Markets in Financial Instrument Directive (commonly called MiFID II). Set to take effect on January 3rd 2018, it requires investment managers to rethink how they pay for brokerage firm research. No longer will they be able to bundle commission payments for trading execution and research services. After January 3rd 2018, if they want to purchase brokerage firm research, there are just two options:

  1. Pay for it in cash from the earnings of the money management business itself.
  2. Set up a Research Payment Account (RPA), to be funded either with an explicit fee charged to the investment firm's clients or with commissions explicitly carved out of trading executions. The RPA will need to be structured strictly in accordance with the new regulations as well as require the asset manager to create a research budget for the year ahead, apply appropriate quality assessments to the research being consumed and report research expenditures to its clients on both an ex-ante and ex-poste basis.

That might all sound innocuous enough, but once you think through the ramifications it becomes clear that big changes are afoot. For example:

Take a moment and consider the ramifications of these changes. Here are just a few novel questions and issues they raise:

How does the sell-side develop a service menu to help their clients budget their research spends? Over the decades, brokerage firms have refined a dynamic pricing model that enable them to essentially charge different prices to different customers for the same product, all the while looking to capture every bit of potential revenue.  Now, clients will want to know exactly how much a report or an analyst visit or a conference will cost. It's like going from a family-style buffet restaurant to a dining establishment with a la carte pricing.

While US based asset managers may not necessarily have to comply with MiFID II, it is important to emphasize that we anticipate this directive will ultimately have a global impact as it is now virtually impossible to contain regulation within geographic boundaries. As global managers do business with European asset owners, they may ultimately make a decision to adapt their current procedures to give them the operational capacity to respond to the MiFID II Directives and err on the side of caution.

Now, if you want a playbook for how all this looks, we have it. Our Westminster Research Associates business has been around for 20+ years, helping clients with exactly the sort of challenges they will face with MiFID II. For example:

In summary, MiFID II may be an EU regulation but it will almost certainly change broker-provided investment research around the world. We see that as a positive development because with greater transparency will come more accountability and, ultimately, a more efficient research marketplace. Clients will get more of what they want – truly differentiated research that helps them perform – while tracking what that resource costs and explicitly evaluating its cost and benefits.

Will this be an easy transition? Of course not, but we are focused on making all of the necessary changes to our business model to meet the MiFID II requirements that will enable our clients to respond effectively to the new environment. The quote with which we started this note mentioned that half of all advertising is wasted. It could well be that half of all broker research is unwanted. Only time will tell. But with MiFID II on the horizon, we are on the road to finally determining which half is truly valuable. And that is a journey worth taking, both for brokers and for asset managers.

(Source: Convergex)

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