Financial regulation

Regulatory initiatives have demonstrated that successful investment managers are those able to manage regulatory change efficiently. Key is actively dealing with the inherent uncertainty and utilizing asset management software solutions that are easily adaptable. In this article, we look at ways to build efficient monitoring into the investment management system and competitively master regulation’s impact on the operating model.¹

Investment managers currently face a host of regulatory initiatives that have different regional origins. Regulatory development always comes with a high degree of uncertainty as the interpretation of requirements may change on the way from law to real-world operations. This requires closely tracking regulations over time to ensure your fund management system’s regulatory compliance.

One of the most important areas to monitor are the related requirements of your operating platform, because the right timing and steering of the ensuing implementation efforts can have a direct impact on your business performance.

Cost-efficient implementation of changes in your operating platform can only ensue when uncertainties in or changes to the regulation are identified early on. Research shows that if investment managers do not master this challenge, they may face increases in costs of between 200 and 10,000%.²

The key question remains: how can you ensure that you detect and monitor relevant regulatory topics efficiently and in good time?

Regulatory affairs – strategic optimization

In order to identify important regulatory initiatives at an early stage, a Regulatory Affairs unit must be in place, charged with monitoring the national and international regulatory environment relevant for the firm at a strategic level.

Some, mostly larger, firms do not limit themselves to monitoring the regulatory space, but also integrate a regulator-liaison function into this unit. The overall monitoring process performed by the Regulatory Affairs unit results in strategic advice on the single regulations delivered to the executive management team (see Figure 1).

Regulatory compliance – efficient implementation

The key task of the equally important Regulatory Compliance unit is to ensure cost-efficient regulatory compliance in line with the regulatory deadlines (see Figure 2).

Even though the Regulatory Compliance unit works in close contact with the Regulatory Affairs unit, it must focus on the tactical and operational issues of regulatory requirements, leaving the strategic angle to the Regulatory Affairs unit.

Suitable regulatory monitoring tools

The tools suitable for monitoring and steering the regulatory project portfolio are closely related to commonly known project management tools. As an example, the SimCorp Regulatory Center of Excellence manages SimCorp’s regulatory requirements portfolio using the self-designated ‘Magnitude of regulation’ and ‘Time to regulation’ as parameters to prioritize between different regulations (see Figure 3).

Due to the more operational nature of its responsibilities, which entails foremost the responsibility for cost-efficient and timely implementation of regulatory requirements, the Regulatory Compliance unit is highly dependent on the delivery capabilities of an investment manager’s IT department. In order to satisfy this unit’s growing demand, it requires systems that support regulatory change by design.

Investment managers can choose between two fundamentally different approaches to handle the mostly cross-organizational regulatory requirements and to ensure timely delivery of new solutions. You can:

• either build up and/or maintain large-scale business analyst, development, and test organizations, or
• collaborate with solution providers who ensure that their software is constantly updated to meet the diverse regulatory requirements.

Implications for the investment manager

Against the background that a fair share of regulations are impacting the entire IT architecture or at least one IT solution, it is recommended that investment managers:

• monitor regulatory change actively and steer the project portfolio efficiently with a Regulatory Compliance function;
• ensure that their IT solutions are adaptable to regulatory change; either by investing internally or by choosing the right solution provider, ensuring that regulatory solutions are defined and deployed with short time-to-market.

Regulatory change – a real world example

As an aftermath of the global financial crisis, the G20 countries initiated tighter regulation of the global derivatives markets with a common statement concluding the summit of Pittsburgh 2009. The actual regulatory efforts were then undertaken at a regional or national level. This produced a flurry of regulations across the globe, i.e. Dodd-Frank in the USA or EMIR in the EU. These derivatives processing regulations exemplify two things:

1. Despite the same source, regulation still differs from region to region and hence must be monitored on an individual basis.
2. All regulations related to the investment management industry have a direct impact on the investment manager’s IT infrastructure.

EMIR’s impact as a case in point

In the case of the EU’s European Market Infrastructure Regulation (EMIR), it features three elements that have a direct bearing on your IT infrastructure:

• Introduction of Central Clearing Parties (CCP) to reduce counterparty risk
• Optimizations in processing OTC derivatives
• Increased market transparency by introducing trade repositories

Even though there is no uniform penalty scheme across countries and regions, regulators gave clear guidance that non-compliance with the requirements would result in severe penalties.^3-4

Combined with the extremely short time-to-market of the regulations, this high level of regulatory pressure created an enormous market demand for quick-to-implement solutions in 2013.

Regulatory compliance and its impact on system infrastructure

The key requirements related to all trade repository regulations are:

• All types of derivatives have to be reported – across all different underlying asset classes.
• Near-time reporting schedules must be adhered to (under EMIR in the EU, all information has to be reported on the following workday).

Both requirements have a direct impact on implementation and production costs when comparing the two fundamental system infrastructure options investment managers commonly choose between to ensure compliance:

• Best-of-breed approach
• IBOR-based approach

Reporting across all underlying asset classes

Due to different reasons, some investment managers run multiple IT systems to support their entire derivatives portfolio. Deciding on a best-of-breed architecture has a direct impact on potential solutions for a trade repository reporting solution because:

• Information from different source systems has to be consolidated in a data warehouse (DWH) in order to enable one consistent data upload to the trade repository, or
• Each derivatives system has to be enhanced with a direct uplink to the trade repository.

Both scenarios imply additional costs compared to a situation in which an investment manager runs an integrated solution covering all derivatives based.

When running all derivatives operations on a system utilizing an investment book of record (IBOR) as its core, there is neither a need for additional data unification nor multiple interfaces in implementing and maintaining the Trade Repository.

Near-time reporting schedule

When comparing the DWH-based best-of-breed approach to the IBOR-based reporting approach, one can spot another challenge for the best-of-breed approach in the form of reporting availability.

In nearly all cases, today’s data warehouses are based on nightly batch runs loading day T data from the operational systems into the data warehouse, making it available for reporting on T+1. This approach, which decouples reporting data from the operational source systems, reduces the available time for data verification and exception handling before data is uploaded to the trade repository.

Is outsourcing the solution?

Some market participants choose to outsource their reporting requirements. However, even though delegation of the reporting obligation is allowed, the EU’s ESMA regulating authority holds individual firms responsible for the data that is reported on their behalf. This means that every investment manager has to be able to reconcile the actual book positions with the information prevailing at the trade repository, or in the worst case, the multiple trade repositories that their outsourcing providers have selected.

In order to cater for efficient reconciliation processes, the investment manager has to prepare data in such a way that it matches the reports of the relevant trade repositories. This may sound simple on paper. However, what it means in practice is that it is required to implement and run the trade repository interface to a large extent in order to be able to produce the reports.

EMIR Trade Repository Reporting: a successful solution experience

In a demonstration of best practice in action, between July 2013 and August 2014, SimCorp delivered its EMIR Trade Repository Reporting solution to more than 30 of its clients across Europe – all driven by the SimCorp Regulatory Center of Excellence as the professional services solution provider.

This shows that not only investment managers but also solution providers in the regulatory space benefit from operating a regulatory compliance function. This is because a unit like the SimCorp Regulatory Center of Excellence continuously provides up-to-date information about the regulation at hand, ensuring that solutions are built based on the right information.

From an IT architecture and solution perspective, Trade Repository Reporting underlines that investment managers using multiple systems for their derivatives processing can find themselves in a situation in which they face significantly higher costs when it comes to fulfilling their regulatory requirements.

Drawing the necessary conclusions

The recent implementation of regulations globally, for which EMIR Trade Repository Reporting can be seen as a role model, has proven that these kind of processes come with a high level of uncertainty. In order to deal with these challenges efficiently and ensure their timely implementation, investment managers must:

• Manage the portfolio of relevant regulations carefully and proactively;
• Operate their IT department in forward-looking mode, i.e. IT must be closely involved in monitoring regulations; and
• Have an investment management platform that is prepared to adjust to new regulatory challenges at short notice and that enables cost-efficient implementation.

For an investment management firm to succeed in an increasingly regulated market, it needs to leverage a regulatory change program, targeting both the business and technology aspects of legislative change. Such a program must be able to identify last-minute changes in regulations and integrate them into solutions that are already in deployment.

Although it is assumed that business departments detect and analyze the impact of these changes, the key to success is for firms to transform such regulatory requirements into working IT solutions before the regulation kicks in.

The bottom line is that if you adhere to this approach, you stand in a good position to use regulatory change to gain competitive advantage over peers by ensuring cost- and time-efficient regulatory compliance.

1. For a full outline of the ideas and concepts featured in this article, see the co-author’s chapter ‘The Asset Manager’s Guide to Sustainable Regulatory Advantage’ in ‘Global Asset Management: Strategies, Risks, Processes, and Technologies’, Ingo Walter and Michael Pinedo (eds.), Palgrave Macmillan and SimCorp StrategyLab, published September 2013.

2. http://en.wikipedia.org/wiki/Software_testing#Economics

3. http://regtechfs.com/e250000-fine-for-breaching-emir-too-good-to-be-true/

4 http://www.fxweek.com/fx-week/news/2323407/regulators-take-differing-views-on-reporting-fines