Financial institutions are turning away from single product vendors as they look to consolidate their regulatory compliance requirements with specialist RegTech firms that offer a suite of solutions, according to John Lee, President at Compliance Solutions Strategies (CSS).
New and evolving regulations seem to be landing in the ‘in-tray’ of financial services firms with alarming regularity. Implementation is hampered by financial firms’ legacy systems and the fact that regulatory compliance, while a prerequisite to conducting business delivers zero return in terms of shareholder value and remains a cost centre. In this environment, more and more companies are turning to third-party RegTech solutions to comply with their mandatory regulatory requirements.
The challenge facing financial firms is that many of these so-called RegTech vendors are start-ups that focus on delivering a single piece of the regulatory jigsaw. As a result, financial services firms are often left to project manage and onboard a number of products, unable to interact with one another, to comply with a single regulation. For example, MiFID II has aspects around corporate governance, transaction cost analysis, trade and transaction reporting and data management, all of which can depend on a separate technology solution, but a financial institution would find it easier if it was all connected together.
This is what led John Lee to found CSS. Having market mapped more than 150 RegTech providers globally he noted that many were built around a single solution and exhibited poor cash flow dynamics, leading to a risk of failure. CSS is backed by private equity and has brought together four leading and highly synergistic businesses to support the buy-side vertical of traditional asset managers, hedge funds, fund administrators, and third-party providers to the funds industry.
The company operates across three distinct business channels. The first is the regulatory reporting, and regulatory data management space. With its Consensus reporting platform CSS can cater for a wide range of financial institutions’ periodic reporting requirements and in the process standardise workflow, ensure accurate data collection and data validation. This covers a wide range of essential compliance requirements from MiFID II and Solvency II through to AIFMD Annex IV, PRIIPs and the SEC Reporting Modernization Program.
Channel two revolves around trade and transaction monitoring, analytics and compliance. It brings together the reporting requirements of EMIR, MiFIR and SFTR, among others, through its TradeChannel solution. Multi-jurisdictional substantial shareholding threshold disclosure and position limit monitoring is provided via the company’s Signal product. And all aspects of trading compliance from best execution and market surveillance through to trade sequencing and cross trades is provided by Sentry.
The final business channel focuses on enterprise-wide compliance through its Manager compliance workflow tool, which not only centralises policies and procedures and provides alerts but also offers additional modules for Code of Ethics / Personal Account Dealing monitoring.
In bringing this suite of solutions together under the CSS banner, it serves to mitigate the risk inherent in relying on a single product vendor.
Lee said, “By using a vendor without breadth and depth you run the risk of introducing a single point of failure. This ‘weakest point’ scenario is very much top of mind for regulators. In the process of evaluating the universe of RegTech providers I rapidly concluded that many were no more than ‘opportunistic FinTech’ not invented for the regulatory need they purported to meet. What we wanted to do with CSS was to move from offering a single tactical response to the mandatory regulations that FIs face and to position ourselves as a strategic partner of depth and breadth who is intent on working with our clients across a full range of compliance requirements.”
As so many of these small, one-product companies are living invoice to invoice it leaves firms at risk of the solution collapsing, Lee said. An institution needs to make sure it is always compliant, or it is at risk of being fined. However, if the provider no longer exists, they’d have to find another offering, and sharpish. When looking into the market, they need to assess whether the service they are using is for the long-term or not. This challenge is only accentuated if an FI is using multiple single-product solutions in their compliance process.
Lee said, “If you look at MiFID II alone, while there is a pressing best execution requirement, there is also a need for trade and transaction reporting, as well as product governance which extends to cost and charges calculations. A TCA provider alone focused on best execution cannot even get close to covering half of the compliance needs captured within a single regulation. And that doesn’t even touch on the cost and charges calculations and template creation requirements of PRIIPs and Solvency II, or the latest reporting protocol stemming from SFTR. By operating as a strategic partner, around a set of solutions, across geographies, we are effectively a ‘one stop shop’ for many buy-side clients, large and small.”
The RegTech sector has been growing year-on-year since 2014 and the record level of investment volume last year shows this is not stopping anytime soon. RegTech Analyst data shows the total amount of capital to be invested into RegTech companies around the globe reached $4.4bn in 2018, 2.5-times higher than the levels in 2017. 2019 looks set to continue the upward trend, with Q1 already seeing $1.3bn invested, just $400m shy of 2017’s total.
Despite this increase in funding, the number of transactions is not increasing at the same pace. In 2017, there were 161 transactions and 164 the following year – so while investment sizes are going up, the number of companies funded is not.
Lee has noticed that while there is a lot of capital entering the market, start-ups are increasingly struggling to find early series funding, because there are so many solutions out there now. “The next stage of growth for RegTech will see existing providers investing in organic growth and thereby deepening their value proposition in order to meet new regulatory demands as they appear,” Lee said.
“I think you’re going to see more investment taken on by the existing providers of RegTech as they look to support the regulatory compliance needs of their customers and in the process build deeper relationships. In return we’ll see the financial services industry look to consolidate vendor relationships, moving from single tactical providers into strategic partnerships with specialist compliance firms such as CSS.”
Interest in the RegTech sector from private equity firms is pronounced but the opportunities to invest in RegTech providers of size such as CSS remain limited. While the wider FinTech space has numerous unicorns, such as Monzo and Revolut, there are not as many on the RegTech side. In the meantime, CSS will continue to grow both organically and through adjacent ‘tuck in’ acquisitions that deepen its value proposition as the strategic partner of choice for the global financial services industry.