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Compliance demands spur firms to invest in ‘regtech’ — and more


Amid increased state and federal financial regulation, firms are stocking up on tools to help them stay compliant, avoid sanctions, and measure financial risk more precisely.

The increase in regulation that began after the financial crisis of 2008 – 09 spurred a measurable increase in spending: Operating costs spent on compliance have increased by more than 60% for retail and corporate banks, compared to pre-financial crisis spending levels, according to one estimate from Deloitte.

Enter “regtech,” short for regulatory technology, which uses information technology to achieve regulatory compliance and enables improved record keeping, better data management, and more robust reporting solutions. Spending on regtech is expected to increase 35% per year, according to Juniper Research.

What sort of compliance-driven investments are financial institutions making, and how do these investments affect financial services?

New research co-authored by MIT Sloan accounting professordelves into how regulations have both direct and indirect effects on technology adoption. The direct effect relates to significant improvements in data collection and information systems made for compliance purposes; the indirect effect stems from these improvements enabling complementary investments in customer analytics tools.

The research

The authors examined the 2014 amendments to Securities Exchange Act Rule 17a-5, which introduced new internal control requirements for broker-dealers who maintain custody of customer assets. The amendments were developed in response to large Ponzi schemes and bankruptcies in the prior decade. Non-custodian broker-dealers were not subject to the rule, providing a control group for the study. 

To track technology adoption, the authors constructed a dataset of software and hardware investments, IT budgets, IT-related labor demand, and website technologies from multiple sources. The software tools they examine include Oracle ERP, Salesforce, and HubSpot; the website technologies include ThreatMetrix (fraud detection), Pardot (sales engagement), and goMoxie (live chat).

To examine how technology adoption affects operations and financial services, the authors collected data from BrokerCheck, which tracks customer complaints about misrepresentation, churning, investment suitability, and negligence.

Regtech’s effect on technology adoption

Firms affected by the amendment made significant investments in regtech. They expanded their IT budgets, and added data management and enterprise resource planning software tools that helped ensure compliance with the amendment. They also added computers and servers.

These investments led to indirect effects on technology adoption at regulated firms. According to Sutherland, the intuition is that regtech investments involved information system improvements and digitization efforts that marketing and customer analytics functions could leverage. For example, customer relationship management tools demand a certain level of data availability and accuracy that regtech investments helped achieve.

Broker-dealers subject to the amendment increase the number of CRM and business intelligence software programs by over 13% following the amendment. They also increase the number of distinct technologies employed on their websites by over 11%. These increases were pronounced for firms making larger regtech investments. 

Improved monitoring

These technology investments had spillover effects on non-compliance functions. Firms affected by the amendment experienced a decline in customer complaints filed with the regulator (FINRA), particularly those most easily detected by technological monitoring. The likelihood of a complaint declined by 2.3%, the number of complaints fell by 3.5%, and customer-alleged damages dropped by 29%.

The results illustrate how data and information systems can create synergies throughout an organization, leading to improved customer service. For example, a broker-dealer could decide to implement enterprise resource planning software to comply with internal control regulation, and this software also allows a supervisor to monitor an employee’s interaction with a customer.

The authors concluded that technology will continue to play an important role in compliance amid continued regulation, help facilitate the adoption of complementary tools, and improve the quality of financial service that customers receive.  

RegTech” is co-authored by Ben Charoenwong, assistant professor of finance at the National University of Singapore; Zachary Kowaleski, assistant professor of accounting at the University of Notre Dame; and Alan Kwan, assistant professor of finance at Hong Kong University.

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For more info Tracy Mayor Senior Associate Director, Editorial (617) 253-0065