Investing Through a Downturn: RegTech and Customer Onboarding (Part 1)

By Peter Johnson

While many venture capital firms are on Twitter proclaiming that they are “open for business” and still making investments, at Jump Capital, we are not only making new investments, we’ve been busy prioritizing areas where we’d like to be particularly active in the coming months.

One of these areas is the regtech sector, where we’ve invested in several great companies including LogicGate and Eventus Systems. Broadly, we believe regulatory technology is a market ripe for new and better solutions. We also believe that demand for solutions in this market will not only be resilient in a down market but will accelerate as downturns often lead to a flurry of new regulation, as we saw coming out of both the 2001 and 2008-2009 downturns.

Within regtech, one of the areas we find particularly promising is customer onboarding. The onboarding of customers by financial institutions continues be a slow, onerous, and manual process – as highlighted by this fact: In the initial days of the Paycheck Protection Program, the largest lenders in the U.S. are only accepting applications from existing customers because they lack the ability to efficiently onboard and service the onslaught of businesses looking to apply.

One of the key elements in onboarding new customers (and major contributor to the above issue) is AML/KYC compliance, which in an area of particularly high risk and spending, and the numbers below demonstrate:

  • $25 billion — Annual U.S. AML/KYC compliance costs
  • $26 billion+ — Global AML/KYC fines in 2018 and 2019
  • $8.9 billion, ~$2 billion, ~$2 billion — Size of individual AML/KYC fines issued against BNP Paribas, HSBC and JP Morgan Chase

A Very Brief History

Anti-Money Laundering (“AML”) and Know Your Customer (“KYC”) laws have been in effect since the Bank Secrecy Act (“BSA”) of 1970 first addressed the issue of financial impropriety. At a high level, it required all financial organizations to develop AML compliance programs complete with internal controls, customer due diligence and monitoring systems, and screens of customers against watchlists. The Patriot Act of 2001 built on the BSA, requiring KYC and enhanced due diligence protocols, as well as formalizing the Foreign Corrupt Practices Act.

Historically, compliance functions have been largely manual and time intensive, requiring significant increases in headcount to ensure regulatory requirements are met and the threat of punitive fines is reduced. Corporate executives are attuned to these trends — approximately 50% worry about current technological adaptability to regulatory requirements, the impact of legacy systems and antiquated architectures, and the lack of flexibility with current systems. In fact, the UN reports that less than 1% of global financial crime is caught because of technology which is out of date and unscalable.

The Opportunity For RegTech

Current solutions have been rendered insufficient by the following trends which add complexity to the onboarding process:

  1. Siloed data within legacy systems
  2. Siloed businesses as a result of consolidation of financial institutions and unintegrated acquisitions
  3. People, rather than technology, thrown at the problem
  4. Growth in new products and geographies serviced

RegTech startups add value by replacing legacy systems with automated solutions, leveraging data, and adapting to regulatory changes. Broadly, our expectation is that solutions that are predictive rather than reactive, enable sharing of data across regulators and organizations while maintaining strict customer data privacy rules, streamline workflows, and are adaptable to the ever-changing regulatory landscape will win the day. At a minimum, a solution must address at least one of the following categories, freeing compliance officers to focus on the most important processes and customers.

  1. Time and Cost: Time spent on customer onboarding processes increased 22% in 2016 and 18% in 2017, reflective of increasing regulatory burdens. Additionally, financial organizations spend $25 billion per year on KYC/AML compliance, with the largest banks spending upwards of $500 million. According to Bain, governance, regulation, and compliance represents 15% to 20% of “run the bank” costs for financial organizations. RegTechs add value through automation — streamlining workflows, and decreasing the time, number of steps, and labor required to onboard a client. A legacy client onboarding process requires multiple employees to manually receive and input data, check that data against lists, create a risk scoring, and flag the client for further review. With an automated solution, this process can be completed in a matter of seconds using a single API integration.
  2. Accuracy: Systems used by financial organizations are largely manual, thus error prone and subject to regulatory scrutiny. Additionally, they are poorly equipped to handle regulatory changes and to share information across borders in an environment with global regulatory bodies legislating independent standards. As such, only 21% of banks believe their current technology solutions are flexible enough to handle rapidly changing requirements. RegTech Artificial Intelligence/Machine Learning applications continuously train screening tools as the system ingests more data. A more automated and accurate process limits the touch points for manual error and reduces the number of false positives flagged by compliance teams.
  3. Agility: The regulatory environment is dynamic, particularly in new markets such as crypto and sports betting. Advanced systems are adaptable to incorporate any major changes so compliance officers are not exposed to periods of regulatory uncertainty.
  4. Integration: Integration comes in two forms: plugging directly into a financial organization’s compliance function, and securely (with consent) sharing customer data across organizations and regulatory bodies. The latter is a potential game changer for the industry, driving immense time and cost savings if the information collected on a client onboarded by one financial organization could be easily transmitted to another, where allowable.
  5. Burden on Customer Onboarding Experience: Customers are dissatisfied with the onboarding process. According to a 2017 Deloitte study, 38% of customers drop out of the onboarding process due to frustration with the volume of physical information required. Digital automated solutions make this process simpler and faster.

Clearly, there are many areas where innovative new companies can add value by improving onboarding and AML/KYC processes. In Part 2 of this series, we’ll dive deeper into these areas, and some of the companies offering innovative solutions.

Thanks to Kirk Manoogian for his assistance with this research and post.

By Peter Johnson

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