RegTech vs. FinTech: Investment Banks Caught in the Middle
Why Getting the Technology Balance Right is Critical for Survival

By Warren Breakstone, S&P Global Market Intelligence

Tier one banks are spending billions of dollars a year on compliance-related activities as they have continued to ratchet-up spending on consultants, lawyers, compliance and risk staff, along with investments in regulatory technology (RegTech). This spending is designed to keep them in line with the myriad of regulations including but not limited to anti-money laundering (AML), capital structure (Basel III), market transparency (MIFID II), know your customer (KYC), and Dodd-Frank reforms that came into force following the financial crisis. By 2020, bank spending on Regulatory Technology alone is expected to reach $80 billion, as a new breed of artificial intelligence (AI)-powered screening, data visualization, reporting tools and cloud based solutions begin to gain widespread acceptance in the industry and replace many of the people driven activities and compliance consultants.

Regulatory burden has not come at a good time, as revenues for the investment banking industry have been flat and margins have fallen precipitously, with average return on equity declining from 19.5% in 2006 to under 9% today.

It does not take a freshly minted analyst to see what’s happening here. Steadily increasing compliance demands have taken a serious toll on investment banks, forcing them to spend a great deal more money – and time – managing compliance risk than they are investing in innovation to help fuel the growth of their businesses.
One senior executive at a major U.S. investment bank put the situation in stark terms: “We had to spend more on regulation in a world where we were cost cutting, shrinking what we could spend on technology, but spending more and more on regulation technology and therefore less and less on technology innovation.”

The tug-of-war between (RegTech) and Financial Technology (FinTech) spending presents challenges that become even clearer when you consider the competitive landscape for investment banks. Increasingly aggressive non-bank financial firms are encroaching on traditional banking revenue. At the same time new market innovations, such as Spotify’s upcoming NYSE direct listing which bypasses the traditional IPO process altogether, and Blockchain distributed ledger technology which threatens to dis-intermediate banks in trading and commerce, shines a spotlight on how investment banks are prone to disruption.

Against this backdrop, investment banks have few options but to evaluate serious structural changes to eliminate their undifferentiated activities. For example, one global midsize bank I recently spoke with is scaling back its underwriting business, and others are shying away from balance sheet heavy activities such as lending and trading. Another trend unfolding is that many banks are working together to consolidate back office activities. In one notable case, a global European headquartered bank shared that they have spun off their procurement arm as a “for profit” entity that will take on business from other banks and use the combined scale to gain further purchasing power.

Financial firms are also finding religion in FinTech. Many investment banks, especially the larger ones, are accelerating their efforts to automate and eliminate non-revenue producing activities. Even the prized M&A analyst pools who build financial models and pitchbooks on behalf of senior bankers are being cut back and made more efficient. While nearly every bank I have spoken with recognizes the opportunity of automation—both to free up talent to focus on higher value activities and also to reduce their expense base—no bank has fully unlocked the opportunity. One bank estimated that 70% of the work done by M&A analysts can be automated using tools and technology that is available today.

The pressure is not just on the analyst and back-office side of the house. Investment banks also have greater expectations for performance among their front office producers as well. While the acquisition of new business remains very much a relationship-driven effort, the need for more forward looking data and data on private companies as an input into the deal-sourcing process remains critical.

In some strange way, this perfect storm of investment banking challenges has forced a new technology renaissance for an industry that has historically been steeped in decades-old legacy systems, workflows and processes. With most pundits forecasting compliance spending to plateau in the coming years, and breakthroughs in automation, data science and visualization, and AI technologies coming to market almost daily, there is a great opportunity for investment banks to reorient their business investments around a streamlined approach to drive new client value and improve profitability.

The transition to a new way of doing business will not come easy. To be successful, investment banks will need to upend many of their entrenched processes. In short, they will need to start thinking a lot more like their clients, recognizing that future growth in every industry – even investment banking – is predicated on the application of new technologies that will disrupt the status quo.

About the Author
Warren Breakstone is managing director and general manager, capital markets at S&P Global Market Intelligence.