RegTech: What is it and where should you focus?
Regulatory technology (“RegTech”) broadly encompasses software solutions that help companies identify regulatory requirements or assist companies in complying with said requirements. While RegTech solutions exist across multiple industries (e.g., healthcare, pharmaceuticals, transportation), they stand to benefit the financial services industry the most due to this industry’s complex supervisory environment and ever growing list of regulatory requirements.[1] This post will further examine the specific areas within the financial services industry ripe for disruption and the corresponding types of RegTech solutions that are most likely succeed within the space.
The scope of RegTech solutions for financial institutions is diverse and ever growing, ranging from consumer compliance to stress testing and capital requirements. Within RegTech, three subcategories in which investors should focus are anti-money laundering (“AML”)/sanctions compliance, know-your-customer (“KYC”), and third-party and vendor management. There are two primary drivers for the selection of these subcategories. First, each subcategory corresponds with large compliance/risk management teams and a high degree of manual, low value-add processes and procedures. Second, according to the 2018 Risk Survey conducted by Bank Director, bank executives identified AML/sanctions, KYC, and vendor management as the top areas in which their banks are deploying technology to improve the compliance function.
After defining the specific subcategories within RegTech in which investors should focus, the final portion of this post examines the specific types of technology solutions that will be the most disruptive. Specifically, investors should target RegTech startups with the following offerings:
- Scalable artificial intelligence (“AI”) and machine learning (“ML”) solutions that supplement (i.e., not replace) the existing tech stack;
- Automation-of-Work (“AoW”) software that augments or automates a desktop analyst responsibilities; and
- Third-party and vendor management marketplace
Scalable AI/ML Solutions Supplementing the Existing Technology Stack
The banking industry is notoriously slow at investing in new technology, and the decision-making process to do so is fragmented and tedious. It is not uncommon for sales cycles in the banking industry to range from 10 to 18 months (and that is not even including an initial proof-of-concept). Furthermore, the back and middle office are riddled with legacy technology systems that required significant time and money on the bank’s part to implement. Banks are thus reluctant to replace legacy systems with newer, more sophisticated technology platforms, even if the latest solutions provide meaningful operational efficiencies or cost reductions. One example is a bank’s legacy AML transaction monitoring system. Startups offering next-generation transaction monitoring platforms to replace incumbent technology are likely to find lukewarm interest from customers due to 1) high switching costs/stickiness of the existing system; and 2) limited incentives to invest in the latest technology, particularly if not under regulatory pressure (i.e., if it’s not broken, don’t fix it).
Rather than chase startups seeking large ACV contracts to replace incumbent bank systems, investors should back startups offering scalable, easy-to-implement SaaS solutions that supplement or bolt onto the existing technology stack. Intelligo is an example of a RegTech startup whose SaaS-based customer due diligence product (Clarity) is a low-cost, scalable offering that supplements existing technology and provides meaningful operational efficiencies in the form of lower false positive alerts.
Automation-of-Work Software
AoW software refers to technology solutions that enable a desktop analyst to either complete a given process/procedure more efficiently or automate the process/procedure entirely. Such applications typically incorporate supervised machine learning techniques to automate or replicate the actions taken by an analyst (e.g., if A do B, if C do D). The possible applications of AoW software within the RegTech space (and more broadly the back/middle office of banks) are numerous due to the prevalence of paper-based records/transactions, lack of system-to-system communication, and sequential, well-defined work procedures.
The most successful AoW companies in the RegTech space will be those focused on industry-specific solutions that train their machine learning models on proprietary datasets (e.g., bank transaction data, customer profiles, trade finance documents). These companies build natural moats by improving the accuracy of their models and developing domain expertise on complicated, industry-specific process flows. TraydStream is a prime example of an industry-specific application of AoW software that provides meaningful operational efficiency to a bank’s back/middle office trade department. TraydStream automatically digitizes trade finance documents (think Letters of Credit, Bill of Lading, Commercial Invoice), automates sanctions and export control checks on the parties to the transaction, and manages the distribution of documents within the internal process flow by recognizing the type/nature of the document.
Third-Party and Vendor Management Marketplace Solutions
Regulatory expectations require banks to conduct extensive due diligence and ongoing monitoring of their third-party service providers and vendors, particularly those providing “critical” products/services to banks. In the current environment, bank vendors complete lengthy due diligence questionnaires and document requests (e.g., proof of Information Security Policy, Compliance Policy, Data Protection Policy) for each bank. The due diligence questionnaires and document requests are often similar, but not exactly the same, requiring vendors to repeat this time-consuming task for each bank.
A marketplace solution leveraging a common due diligence questionnaire would address the enormous inefficiencies in the current vendor due diligence environment (See Exhibit 1). Rather than complete redundant due diligence questionnaires, a vendor could upload a single instance of its due diligence responses to the centralized marketplace and control which banks could access the information. There is also a strong incentive for banks to adopt a marketplace approach, as they could reduce the length of the procurement lifecycle, while maintaining robust oversight of their vendors. Centrl is an example of a startup tackling the inefficiencies of vendor due diligence through a single platform on which banks/vendors create, distribute, and complete questionnaires. However, Centrl lacks the marketplace functionality to share results across banks. To date, no such marketplace solution exists on which vendors can exchange/share due diligence results across multiple parties.
Exhibit 1: Vendor Due Diligence Environment and Marketplace Solution

[1] Henceforth, all references to RegTech are specific to its application within the financial services industry.
