Challenges and Risks for WealthTech Startups

WealthTech startups are getting a considerable funding boost year after year. As per the research report by CBInsights, global WealthTech startups have received a total funding of $15,890 in the year 2021, with a deal count up by 27% from the previous year. The growth of innovative services and wealth solutions like robo advisors, digital platforms, algorithmic trading, WealthTech applications, etc., is accelerating. The adoption of technological advancements has not only enhanced productivity and competence but also boosted cost efficiency.

While these WealthTech solutions hold immense growth potential for the future, they also pose significant risks and challenges to the industry. Let’s explore some risks and challenges in the WealthTech space.

Cyber security risk

With FinTech innovations in wealth management, cybersecurity concerns are also evolving. Cybercriminals mainly target  WealthTech companies for the sensitive information they hold about investors and the market. Ransomware attacks, identity theft, DDoS (distributed denial of service) attacks, payment fraud, etc., are some of the prime cybercrime trends in WealthTech.

As per the IMF (International Monetary Fund) survey, the financial sector is the prime target for cyber attackers due to the lack of strategies and resources to enforce cybersecurity regulations. This survey by the IMF also highlights the state of cyber risk in the financial sector. 

As cybersecurity risks and challenges rise with technological innovations, artificial intelligence-based tools are becoming practical for fraud detection and can strengthen cybersecurity.

As per the market report by Markets and Markets, artificial intelligence in the cybersecurity market is currently valued at $22.4 billion. This is projected to grow at a compound annual growth rate (CAGR) of 21.9% and reach $60.6 billion by 2028.

Investing in risk management measures and  AI-based cybersecurity tools can help WealthTech companies manage cybersecurity challenges effectively. Financial supervisors can boost FinTech compliance by investing in robust cybersecurity regulations to reduce cybersecurity concerns in the financial sector.

Flawed Advice Risk

FinTech innovations in wealth management have benefited the industry and helped it grow exponentially. However, they also encounter various challenges; flawed financial advice is one of the main challenges. 

In a WealthTech space, many factors lead to flawed investment advice. Some critical factors can lead to flawed decisions:

• Heavy reliance on automated systems leads to unsupervised decisions. 
• Overreliance on past data can lead to flawed advice.
• Algorithmic or automation bias is another critical factor influencing unfair investment recommendations. 
• Rapid changes in the market dynamics can also become a challenge for algorithms to make fair and accurate predictions.

However, WealthTechs can tackle these challenges by focusing on the accuracy of algorithm designs involving human expertise, data quality, and constant monitoring mechanisms. 

Complex regulatory environment

WealthTechs are grappling with challenges posed by a complex regulatory environment as their service involves handling investors’ sensitive data and giving crucial financial advice. With the adoption of FinTech innovations in wealth management, regulators are changing their guidelines for advanced operations, innovative products, and services in the market. 

Cross-border operations pose the challenge of operating in multiple jurisdictions, various regulatory requirements, and increased regulations and compliance costs.

The financial services industry is heavily regulated and focuses mainly on investor protection. Hence, WealthTech companies must stay updated and compliant with the constantly evolving regulations for advanced technologies and market developments. Here are the regulatory challenges faced by WealthTech companies:

WealthTechs can tackle these challenges by training employees, seeking guidance by collaborating with regulators, implementing robust compliance measures, and leveraging the technology to automate and streamline the compliance process. RegTech companies can play a crucial role in wealth management to address regulatory challenges.

Element of trust and customer adoption

Digital models offered by many WealthTech companies may struggle to replicate the level of trust element from human interaction. Customers may become hesitant to share sensitive information with the automated systems. Mishandling of data or incidence of data breaches can erode trust. Data security concerns are rising with the adoption of advanced technology.

Strong security measures, personalization, incorporation of the human element in the digital wealth management offerings, transparency, real-time customer support, and educating the investors on this can help WealthTech companies get to grips with these challenges.

Navigating market volatility

As WealthTechs rely on automated processes and data-driven algorithms, they encounter the challenges of navigating market volatility. Here are some of them:

• Market volatility can disrupt algorithms caused by geopolitical tensions and sudden economic shifts, leading to imprecise predictions. 
• The rapid change in market data can also lead to inaccurate predictions as WealthTechs rely on real-time processing of large volumes of data. Effectively managing the risk is also essential. 
• As algorithms rely heavily on historical data, they may need help accessing rare market events, which can result in poor investment recommendations.
• WealthTechs may struggle to access emotional investor behaviour in a highly volatile market, which can impact investment decisions. 

WealthTechs can navigate the challenges by combining the hybrid approach with automation, integrating real-time data, backtesting algorithms, and constantly monitoring market conditions. 

Integration with existing systems

With the increasing adoption of Fintech innovations in wealth management, well-established players in the industry are also investing heavily in technological infrastructure and WealthTech solutions. In this, some WealthTechs may face challenges in integrating with existing systems. Some challenges can be compatibility with legacy systems due to technical complexities, the time-consuming process of data standardization, and security concerns. 

However, many WealthTech companies are navigating these challenges by developing a well-documented application programming interface (API), data mapping, pilot testing, and continuous monitoring of successful integration.

Conclusion

WealthTechs can overcome challenges and thrive by adopting strategies like a robust risk management framework, RegTech solutions for regulatory compliance, strong cybersecurity measures & tools, transparency, data privacy, human oversight, contingency planning, continuous monitoring, and a combination of such strategies. 

As the emergence of WealthTech companies is in its nascent stage, it is vital to have a proactive approach to help them effectively tackle all the challenges and roadblocks. The ultimate focus of the wealth management industry is to provide reliable and trustworthy services to their customer base; WealthTechs need to adopt effective strategies.