Regtech to safeguard fintech's massive growth

Hong Kong is harnessing technology to help financial institutions comply with a surge in new regulations worldwide and thwart online scams. Chai Hua reports from Hong Kong.

Banks and other global financial institutions last year published more than 61,000 regulatory alerts concerning new trade policies and rules, or 234 updates on business regulations per work day. Complying with new regulations has been a laborious process.

But adopting technology in regulations compliance — which is also known as regulatory technology (regtech) — as part of efforts to facilitate business and fight financial fraud, has emerged as a game changer worldwide.

The Hong Kong Special Administrative Region, as an international financial technology center, has made significant strides in embracing regtech, particularly in the financial sector.

According to the Hong Kong Monetary Authority (HKMA) — the city's de facto central bank — more than 80 percent of banks surveyed have adopted regtech as a standard procedure. It is expected that by 2025 regtech's adoption rate will have reached 89 percent, and it will be one of the top three most commonly used tools in financial technology.

Benefits for end-users

Regtech is not limited to government compliance requirements aimed at anti-money laundering. Its application, in fact, is closely intertwined with people's daily lives. "Know Your Customer" is also a mandatory responsibility for banks. When a new customer opens an account with a bank, it is required to conduct a background check on the client to ensure their legitimacy. The process has to be repeated when the same client opens an account with another lender, which makes for an unnecessary effort.

"Banks and other financial institutions need to spend a significant amount of time and effort to comply with these regulations, and this raises transaction costs," says Professor Tam Kar-yan, dean of the Business School at The Hong Kong University of Science and Technology.

A growing number of financial institutions are applying technologies to simplify the process, or offering remote services for opening accounts. This type of regtech application not only enables banks to meet the regulatory requirements for the "Know Your Customer" procedure, but also makes it easier for customers to open accounts by eliminating the need for cumbersome manual procedures like providing documents for personal identification and proof of address, says Tam.

"It may seem quite complicated. But, regtech can, in fact, create value for both financial institutions and end-users of financial services by automating compliance processes and enabling innovative customer services," he added. Bank of China (Hong Kong) has been using the Hong Kong Special Administrative Region government's mobile application "iAM Smart" — a one-stop personalized digital services platform that enables users to use online services through their mobile phones for authentication to open accounts remotely. If the technology could cover more financial institutions, Tam believes it would be more convenient for end-users.

Detecting fraudulent transactions in real time is another formidable task. Transaction abnormalities characterized by mismatch of transaction patterns and profiles of the transacting parties need to be swiftly identified. The sheer volume of transactions and the myriad suspicious patterns have made manual monitoring unfeasible. Tam believes regtech can be precise in identifying potentially fraudulent transactions, and reducing false alarms that may inconvenience clients.

Pushed by fintech

Hong Kong has emerged as a pioneer in developing a regulatory framework for new financial technology solutions, such as blockchain, Web3 and virtual assets. "The new products are technology-based. So, regulations also need to be revised to become relevant. The regulations have to catch up with technology," says Tam.

As Hong Kong's new licensing regime for virtual asset service providers came into force in June, there will be greater focus on regulatory compliance requirements, including anti-money laundering and on-chain transaction monitoring. Consequently, technological products tailored to meet these demands are gradually entering the market.

OKG Technology Holdings — a Hong Kong-listed blockchain technology company — is one of the technology service providers meeting the demand by launching OKLink's on-chain anti-money laundering solution, which helps regulators to identify and combat crypto-related crimes with panoramic compliance analysis tools, on-chain security detection, situational awareness, early warning monitoring, data modeling and labeling.

Jeff Ren, chief executive officer of OKG Tech, believes regtech will greatly facilitate the growth of the virtual assets industry. The company also provides an on-chain data monitoring tool called Chaintelligence for global law enforcement agencies to track suspicious online deals.

The company plans to launch more regtech products soon to help regulators monitor the market, as well as insurance licensing.

Fight against fraud

Deloitte China Partner Tony Wood has found that besides reducing costs and improving efficiency, there has been increased focus of regtech on data analysis in past five years to spot patterns of existing data to deal with complicated issues like internet-based scams and financial fraud, which is becoming a pressing social problem.

Hong Kong's overall crime rate soared in the first half of this year, with the number of criminal acts hitting 42,923 — a 36.5-percent increase over the same period in 2022 — according to the Hong Kong Police Force. The number of deception cases rose 52.1 percent, with more than 75 percent of them being internet-related.

"The definition of regtech has evolved with the emergence of new technologies and capabilities. Fundamentally, through the application of regtech, we've strengthened confidence in the financial system," says Wood.

In view of the sharp increase in financial crime globally, especially digital fraud, there's increasing concern about the potential harm to victims and consumer confidence in new digital financial services, as well as the wider possible impact on the banking system's integrity and stability, the Hong Kong Monetary Authority told China Daily.

The authority says it will continue to promote the adoption of technology, data and network analytics to boost the innovative capability of banks in combating fraud and financial crime. It will promote adopting a consistent and coordinated approach to real-time fraud monitoring by all retail banks before the end of September.

The HKMA will also expand its pilot bank-to-bank information-sharing platform, and financial intelligence evaluation sharing tool, which was rolled out in June, covering more retail banks and personal accounts.

The HKMA hosted the fourth Anti-Money Laundering Regtech Lab (AMLab) in June, bringing together retail banks, technology companies and industry experts to innovate and develop a sector-wide approach to real-time fraud monitoring. The AMLab series covered solutions, including experiments with network diagrams for identifying suspected money mules, and learning how to integrate alternative data into more traditional data sets for analysis.

With enhanced information sharing and data analytics, lenders have so far identified more than 21,000 previously unknown accounts, according to the HKMA. As a result, the number of intelligence-led suspicious transaction reports climbed by 319 percent last year, compared with 2021, leading to an increase of 113 percent in criminal proceeds restrained or confiscated.

According to Wood, two-thirds of the banks that had yet to adopt regtech two years ago have now done so. Moreover, 60 percent of Hong Kong's retail banks now deploy network analytics — an advanced form of regtech — and the number has more than doubled from three years ago.

"What we're trying to achieve is to encourage all banks to consider other areas where they can enhance their operations by applying some form of technology. But, there isn't a universal set of solutions that will work for all of them because it's such a diverse sector," Wood says.

New direction for small banks

One way of giving full play to regtech in an integrative ecosystem would be to get more banks and companies, especially small enterprises, to adopt the practice.

Tam believes launching more pilot projects and industry alliances would be useful. "Just like Jetco, a bank consortium that helps more than 30 banks with ATM services in Hong Kong and Macao, we can also set up similar platform for smaller institutions and provide them with regtech tools," he explains.

"The setting-up and operating costs of regtech tools, and a lack of regtech knowledge and support teams may deter small Hong Kong banks from using the technology," says Tony Petrov, chief legal officer of Sumsub, a full-cycle verification service provider.

Petrov suggests that small enterprises should use all-in-one regtech solutions and develop their expertise in the field through increased collaboration with peers or regtech solution suppliers.

He believes the government can play a crucial role in promoting the adoption of regtech for smaller financial institutions. "It can provide more precise regulatory guidelines specifically for these institutions, including streamlined compliance structures and thorough recommendations. Programs for financial support, such as grants, subsidies or low-interest loans, can reduce the cost of applying regtech. Additionally, knowledge exchange and training will allow banks to understand regtech's benefits and provide hands-on experience in regtech solutions."

According to Petrov, Singapore will commit up to US$112 million over three years under its renewed financial sector technology and innovation program to promote the adoption and development of advanced capabilities in key sectors, including regtech. The program will specifically focus on and support the needs of less technologically mature businesses aiming to acquire regtech solutions.

The HKMA developed a two-year roadmap in 2020 to promote the adoption of regtech in the local banking sector. As part of the roadmap, it has launched a "regtech knowledge hub" to encourage greater sharing of regtech adoption experience and expertise within the city's regtech ecosystem.

In addition, various initiatives have been launched to promote regtech's adoption, including "global regtech challenge", a "regtech adoption practice guide" series, a "regtech skills framework" and a "regtech use case video" series.

Li Xiaoyun contributed to this story.

Contact the writer at grace@chinadailyhk.com