#27 – RegTalks with Pablo Montes, KPMG

Episode Notes

During his interview with Know Your Customer’s Claus Christensen, KPMG’s Pablo Montes discusses:

• The RegTech sector’s key drivers, both historically and currently
• What countries are leading the pack in both RegTech investment and adoption
• Unexpected applications of RegTech bound to become increasingly important in the future

The KPMG report quoted during this episode is available for download at the following link: https://kpmg.com/ie/en/home/insights/2023/02/unlocking-the-potential-of-regtech.html

Pablo Montes is part of KPMG’s global strategy group and he is the strategy fintech lead in KPMG Ireland. His experience includes working with leading fintechs, global tech players and large retail banks on the delivery of strategic and regulatory programmes. Currently Pablo’s focus is on advising FinTechs on their business strategy in areas such as product-market fit and go-to-market planning. Pablo has also worked with government agencies to help them define a strategy to grow RegTech ecosystems.

RegTalks is a podcast produced by Margherita Maspero for Know Your Customer.

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Episode Transcript

Claus: Welcome to RegTalks, a podcast dedicated to the latest trends from the world of RegTech, fintech and financial regulations. My name is Claus Christensen and I’m the CEO and co-founder of award-winning RegTech provider Know Your Customer.

Today it’s my great pleasure to welcome Pablo Montes as my guest. Pablo is part of KPMG’s global strategy group and he is the strategy fintech lead in KPMG Ireland. His experience includes working with leading fintechs, Global Tech players and large retail banks on the delivery of strategic and regulatory programmes. Currently, Pablo’s focus is on advising fintechs on their business strategy in areas such as product-market fit and go-to-market planning. Most recently, Pablo has also worked with government agencies to help them define a strategy to grow RegTech ecosystems.

Pablo, thanks so much for being here.

Pablo: Thank you for having me. It’s a real pleasure and I look forward to the discussion.

Claus: As you know, RegTech is the key focus of our podcast here. As KPMG, you and your team have a very privileged vantage point over RegTech trends and RegTech adoption. What is your view on the current state of RegTech, both in Ireland and globally?

Pablo: Yes, at KPMG we are fortunate enough to have the opportunity to support clients across many industries and verticals, and RegTech is no exception. I think in Ireland we have seen a massive growth of RegTech in recent years. If we look at the Irish fintech sector perhaps it has been historically dominated by the payments sub-sector, but now over the last couple of years we have really seen RegTech take off. As a matter of fact, if we compare the number of indigenous firms across both subsectors, we can see that they are almost on par now. Some of the Irish RegTechs have now gained traction internationally in areas such as KYC, AML and fraud, with obviously your company being one of them.

Then if we look at a global macro level, I think the global pandemic has caused problems for many industries but has also contributed to the acceleration of the digital economy across all regions, which has put pressure on both regulators and the regulated entities. In response, we have seen that many financial institutions have started using RegTech solutions. However, in broad terms, I believe RegTech adoption today is still far from what it could be. As financial markets continue to develop new regulations and guidelines come into play, I think we will start seeing greater adoption and also more use cases for RegTech solutions.

Claus: I certainly agree there, there’s a lot more to come. This brings us nicely to the next question and the main topic of this episode. You are the main author of a new report by KPMG Ireland titled “Unlocking the potential of RegTech”. Myself and our Head of Marketing, Margherita Maspero, had the pleasure of contributing some of our experience and insights to it. We thought we’d invite you onto this podcast specifically to discuss some of the key findings. For anybody interested, we will also include a link to the full report in the description of this episode (LINK TO REPORT).

To get started, can you tell us what are the key objectives of this report and who would benefit most from reading it?

Pablo: Yes, from the conversations we had with clients, we felt that RegTech is currently an area of great interest and opportunity. But at the same time, we feel that there are still significant challenges that are slowing RegTech adoption. At KPMG, we believe in the benefits that RegTech solutions can bring to the table and with this thought leadership paper, our intention was to encourage key ecosystem stakeholders to consider the business challenges that RegTech is solving today and comment on some of those barriers that are slowing RegTech adoption and ultimately our goal was to produce a set of actions that each key stakeholder could consider to accelerate the adoption of RegTech solutions. We believe our report is relevant to all key players in the RegTech ecosystem, this being financial services institutions, RegTech vendors, regulators, policymakers, industry associations and also investors. Any of these groups will benefit from reading the report.

Claus: How far back can we trace the origins of RegTech?

Pablo: I think financial services institutions have been using technology to improve their compliance and risk functions long before the term RegTech became popular. For example, regulations such as Basel 2 in the early 2000s drove a substantial amount of technology change in financial institutions to do all the required calculations and reporting. But I believe RegTech really emerged from the aftermath of the 2008 global crisis, which brought a dramatic shift in focus towards all the regulatory compliance aspects of the financial services industry. Since then, we have seen how regulators around the world have been imposing on financial institutions a vast amount of new regulation to essentially prevent another financial crisis. And then, naturally, for many financial institutions, compliance becomes a major source of cost. And to stay compliant and within cost budgets, many financial institutions began turning to technology.

Claus: The whole discussion also reminds me of our own origins. When we founded Know Your Customer in 2015, we thought of ourselves as financial technology. The term RegTech wasn’t established at that point, and we even used fintech in the very beginning. Not sure exactly when we switched, but it must have been 2018 and 2019, those years, until we finally used the term RegTech consistently in our own communications. Based on your analysis, what were some of the sectors, key drivers and do these drivers still apply today?

Pablo: I think some of the key initial drivers were the regulatory pressures derived from these new regulations and the fact that regulators started to ask for more frequent and detailed data requests. I believe these drivers still applied today, but now in recent years key drivers have also been the rising need for faster transactions and the fact that financial institutions have been focusing not only on delivering on the cost agenda but also on improving customer experience through the adoption of new digital business models. And we’re all familiar with those low-click digital customer journeys when we consume new financial products through digital channels. But in a big part this is only possible because there are RegTech solutions that are powering those back-end processes, reducing the time for customer verification and enabling it to be virtually.

Claus: I very much agree there, especially in the RegTech as the secret sauce for fintech companies. Are there any particularly interesting or maybe surprising numbers you could share with us about the growth of RegTech in recent years that you found in your report?

Pablo: Yes, all these drivers that we mentioned, I think they have contributed to a solid double-digit growth over the past years. We expect that to continue in the near future. We believe grow at a CAGR of around 19% between now and 2027 and reach a total market value of around 20 billion euros in revenue by then. With these numbers, it’s no surprise that we’re also seeing a strong interest in the investor community. Last year, despite all the macro headwinds, we have seen a total investment across venture capital, private equity and M&A that remain quite strong in RegTech. If you look at the numbers, global investment in RegTech was near €11 billion. As we analyse those numbers, we are seeing consolidation in the market and the key driver is the fact that certain segments are starting to be saturated. In addition, we’re also seeing a large portion of RegTech vendors that are in a growth phase with advanced rounds of venture capital funding and that are competing on the same product categories, which probably is not sustainable in the long term.

From the conversations we have with financial institutions, we also see how these are starting to demand solutions that can solve a wider set of their compliance needs. And we see many RegTech vendors offering solutions that are still focused on niche problems. However, we think that the market is moving away towards more modular platforms that can offer multiple solutions amid a wider range of compliance needs for institutions and we think this will also drive more consolidation this year. In response to these demands by financial institutions, we have also seen an increased amount of partnerships between RegTech vendors and other third parties, as some have come together to create joint go-to market offering. Again we have seen some of the largest Irish RegTech vendors announcing partnerships last years and also this year.

Claus: I think that paints a really fascinating picture. The current state of RegTech, especially from investors’ perspective and so on, is so interesting. It’s so dynamic at the moment. There’s so much happening and for the next few years it will be really interesting to see consolidation happening among vendors. We certainly experienced some of that growth that you cited over the past few years. From what I see in our own pipeline, I also still think we are just at the beginning of the adoption here. There’s a lot more happening. So that, in turn, leads us to the next question… Who are actually the main stakeholders that can benefit from a more generalised RegTech adoption?

Pablo: I think RegTech is solving many pressing challenges for multiple stakeholders and can be applicable to many sectors and verticals. But obviously the financial sector is one that generates a unique volume of data and is subject to an extraordinary degree of regulation. So ,if we focus on the financial services sector, I believe RegTech solutions can play a crucial role in helping regulators, financial services institutions and ultimately the consumer in many ways. For financial services institutions, RegTech has many implications, not only in the form of reduced regulatory cost and improved customer experience, but also other areas such as enhancing risk management and transaction monitoring processes as well as facilitating predictive analytics in the organisation.

For regulators, first and foremost, RegTech helps protecting the financial markets for the simple reason that RegTech solutions can reduce residual risk at an institutional level, and therefore in aggregate will lead to a reduction of risk in the financial system. Another benefit that regulators, such as the Financial Conduct Authority in the UK, have experienced over the past year is having access to more data and improve visibility on the market as a result of offering regular support programmes such as regulatory and digital sandboxes. Through these programmes, they’ve been able to gather key data that has helped them with their supervision activity, but also to understand what is coming into the market and ultimately that gives them the information that they need to continue to implement the required actions and programmes that protect the financial system and facilitate innovation in the interest of the consumer.

And finally, I think RegTech also brings many benefits for the consumer too. Firstly, in the form of better service quality, driven by allowing financial institutions to have more effective compliance and risk management processes. Secondly, I think reactive solutions play a key role in accelerating financial inclusion. For example, in emerging markets, the digital wave of financial services that we have seen in recent years has led to an increased access for previously unbanked populations. And for this part of the society, access to services like bank accounts, micro credits and remittances are made possible by the use of RegTech solutions, which help banks and fintechs find that perfect balance between cost and security.

Claus: As a RegTech vendor, we work for our clients. We work mostly for financial institutions, but we do this so we can enable them to provide a better service to their customers. Ultimately, the idea that lowering the barriers to accessing these financial products by making onboarding more seamless and digital and,  ultimately, cheaper is good for society as a whole. That is something I love about our products and our interactions with financial institutions. On top of that, I think one overlooked stakeholder to benefit is really the regulators. It’s not something we concentrate on and our customers are often seen as consumers of regulations only and the regulator as emitting the stream of regulations. But there is a potentially virtuous feedback cycle for more RegTech adoption, freeing the regulators from concerns of overloading the industry with regulatory requirements and thereby enabling the regulator to strategically tighten regulations further, where matters in the next cycle.

If we look at the map of RegTech adoption around the world, which countries or regions do you think are leading the pack?

Pablo: I believe the US will be the leading RegTech group in terms of investment and vendor concentration and there are a couple of reasons for that. But first and foremost, it has the world’s largest financial market and an abundant, mature ecosystem of financial services institutions. Another big driver of adoption in this market is that perhaps there is a bit more harmonisation in the regulatory environment compared to other markets.

The UK then will be the second largest market from an investment and better concentration point of view. London has obviously the world’s largest cluster of financial services and that provides a vast opportunity for RegTech vendors in terms of clients, partners and also talent. Then if you look at the numbers, there are more than 3,000 Fintechs headquartered in London alongside 240 foreign banks. And the success we have seen by some of the challenger banks and fintechs in this country is very much linked to the adoption of RegTech solutions that enable the low-click needed for onboarding new customers in a seamless way.

In terms of the European market, I think Ireland is leading the pack and other countries such as Lithuania have emerged in recent years. For Ireland, the key driver of its success as a RegTech hub has been targeted government policy, which included grants, tax incentives and funding. In addition, Ireland has also one of Europe’s more competitive corporate tax rates and also offers a strong talent pool for RegTech thanks to the presence of global tech giants and the fact that there is a large financial service sector in Ireland too. Lithuania is quite different from other RegTech hubs. Probably what makes it quite unique is that a lot of activities that financial services institutions and other FinTechs have in Vilnius are around compliance and risk management. They are also very well regarded in areas such as AML. They also have an open-door policy, so if you are looking to establish a new company in the fintech industry or you have some ideas or questions, you can actually reach out to the Central Bank of Lithuania and arrange a meeting as part of their newcomer programme, where they will essentially give free advice, which is something that is not so common among regulators.

And then if you look at APAC, Australia is a big market, but in general regulatory regimes across the APAC region are very different. However, I think it presents an opportunity for RegTech vendors as a result of the recent growth of the Asian digital economy, in particular in places such as Singapore and Hong Kong, where regulators are actively encouraging the adoption of RegTech.

Claus: That’s very interesting, Pablo. Here actually our views are different. My first thought was Singapore and Hong Kong, which you just mentioned there, because of how much they support the adoption of RegTech from the regulator. And we’ve seen a lot of successes in our own company in that region for that reason, I’d say. But you are of course right, and I see that as the CEO of our company, that one of the main drivers in any region or country is the availability of good funding and an environment that lets RegTech companies flourish. And yes, the US is certainly the biggest financial market. It might not be the most advanced in regulations, but it is certainly in the availability of funding and that makes everything easier.

We’re all very familiar with more immediate RegTech applications, such as the ones around client onboarding, transaction monitoring or periodic reviews. But what are some of the unexpected applications you predict will become increasingly important in the future?

Pablo: I think it’s important to look at the regulatory pipeline and analyse those regulations and guidelines that are coming down the line. For example, with legislation such as MiCA coming into play, crypto could be an area of great opportunity. In particular, the boarding process might become a bit longer for crypto exchanges as these will need to figure out how suitable a user is for certain kinds of products. So, I think digital asset compliance could be an area of opportunity for RegTech to step in.

Another area of opportunity for RegTech could be the metaverse, in particular for those solutions that are focused on digital identity verification. Consumer duty is also an area where we see regulators to increase their focus. For example, the introduction of regulatory reforms like the FCA Consumer Duty will fundamentally improve how firms serve consumers by setting higher standards for consumer protection. And that could lend itself to a new range of RegTech solutions that focus on areas such as customer communication monitoring to address all the challenges that these new rules will create.

Other regulations such as DoRA will also require institutions to do testing every year and make sure that they meet certain thresholds around research scenarios and report on that. So that will be another area to expand all those RegTech solutions that are currently focused on risk analytics, calculations and reporting.

And then the evolving ESG regulatory framework would also generate more opportunities not only to support institutions on the disclosure of regulatory requirements, but we are also seeing solutions emerge in other areas such as identification of ESG red flags in possible investment assets. I think also a further increase of regulation into other regulated sectors such as life sciences, real estate, energy and utilities could also create more opportunities for RegTech solutions.

Claus: I love your take on ESG and the metaverse. I totally agree. The Metaverse is an interesting question… It will turbocharge global communication if it’s done right. And that means we need identity to be secured in there. And ESG is already a big part of many financial investment decisions and will play an even greater part in the future. This translates from the listed companies down to the next layers beyond them of the private companies that supply them, obviously. So it will be a big thing for everybody.

In the last section of your report, your focus on key hurdles to adoption that still remain and provide some suggestions on how to overcome these. Can you select two of the most significant barriers to adoption? And how would you suggest getting past them in practice?

Pablo: It’s hard to pick only two when we see many barriers across the different ecosystem stakeholders, but I think one of the most significant ones is lack of awareness. RegTech is still an industry that suffers from a lack of awareness, and this is what I think is generating a significant drag on adoption by some financial services institutions, as some of them lack an understanding of RegTech solutions and the challenge that RegTech can solve. The second most significant barrier I think has to do with the actual implementation of RegTech solutions. Many financial services institutions face the challenge of integrating RegTech solutions with legacy systems, and on the other hand, for RegTech vendors is also a challenge to identify financial institutions that have the required technical capabilities to enable the deployment of their solutions. In terms of solving these two challenges, I think regulators could have a big role to play here. For example, in relation to the awareness issue, I think it would help to have more official declarations, roundtable discussions and events that bring together all the different players in the ecosystem. To overcome the implementation barrier, I think the key would be to establish a global API framework similar to what the Hong Kong Monetary Authority has published in recent years to encourage financial institutions to share their API infrastructure with third parties.

Claus: An interesting question that I always think of when I see standards from the regulator is: are they able to foresee enough use cases and special features, or would the standards be too restrictive for the most innovative company?

Right, I know this has been a slightly different format compared to the other episodes that we record here, but I would like to still ask that last question that I ask all my guests at the end of the interview… If tomorrow, Pablo, you woke up and somehow you had become the global financial regulator, what would be the first thing you would do? And of course why?

Pablo: OK, that’s a really interesting question. I think I would probably seek to harmonise rules within each of the economic regions as much as possible and make sure that those rules are produced in a machine-readable format. I believe we have reached a point where it’s challenging to sustain the level of regulatory change only with people and most financial institutions are convinced that utilising data is essential to ensure a continuously compliant business. But in order for them to use more data, regulations need to be written in a way that can be consumed into tooling. So, in my view, having rules that are produced in a machine-readable format will cut out a lot of interpretation and manual processes. But more importantly, it will also make the financial markets safer.

Claus: Love that take. The different implementations of rules, especially in Europe, is something we all struggle with. The other part – having machine-readable regulations – I have thought about that many times actually, and I was wondering when it would actually become truth. I have a new idea there, just now when you said it. Maybe we have already arrived, Pablo. What about we let ChatGPT just read the regulations for now and interpret that for us? Then we might have machine-readable regulations already because ChatGPT can read them.

Pablo: Yeah, that would be great.

Claus: Anyway, that is a great note to end on. Pablo, thank you so much. This has been packed with insights. Thank you so much for compiling this report. It’s a really valuable industry resource and I’d say a lot of people will be studying that. Thanks so much for coming on. It has been a pleasure.

Pablo: It’s been my pleasure. Great to chat with you, Claus.

 

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