By Mark Weir, Head of Data Management, Maples Fund Services, and Andrea Peratitis, Head of Regulatory Reporting, PointNine Limited
Regulatory compliance has become a top priority for the financial services industry due to the increasing requirements of global regulators. Compliance with these mandates has become quite onerous and as financial services firms gather more data for regulatory reporting, they are presented with greater operational and technological challenges.
The Growing Compliance Burden
According to Thomson Reuters’ 2016 Cost of Compliance Report, firms worldwide are experiencing “regulatory fatigue” as a result of the sheer volume and scope of regulation and subsequent increased compliance requirements. The speed and breadth of regulatory change is creating the biggest challenges for firms. According to the survey, 69 percent of respondents expect an increase in the volume of information published by regulators, all of which will need to be reviewed and much of which will require action. Additionally, the remit of compliance functions is expanding with firms needing to place a greater focus on technology, IT risk and the issues regarding cybersecurity. Beyond simply looking at regulation, compliance functions are being forced to be more engaged than ever in the consideration of myriad risks to the business.
Mark Weir, Maples Fund Services
Another key challenge is the rising cost of staffing and human capital resources. While over two-thirds of firms expect the costs of skilled staff will continue to rise, the growing issue is in the availability of high-quality skills and experience. Not only will firms need to invest significant resources in identifying and attracting top talent, they will also need to contend with the rising costs of retaining these individuals to remain competitive in this changing environment.
Similarly, a 2015 report from the European Association of Corporate Treasurers on the cost of EMIR compliance for non-financial counterparties measures costs incurred due to EMIR implementation and ongoing compliance. For the initial implementation, roughly 70 percent of respondents indicated the costs to be €50,000 or below, 20 percent indicated costs were between €50,000 and €200,000, and 10 percent indicated they have spent more than €200,000. As to the annual compliance costs – which include IT, staffing, audit services and bank fees, among others – approximately half of the respondents stated costs of €10,000 or below, 40 percent spent between €10,000 and €100,000, and 10 percent over €100,000. Beyond these costs, there are a number of non-financial burdens imposed by EMIR.
Regulation on the Horizon
The financial crisis exposed weaknesses in the functioning and transparency of the financial markets. As a result, the G20 summit made a commitment to take measures to improve transparency, mitigate systemic risk and promote overall financial market stability. In particular, it was intended to ensure supervision of over-the-counter (“OTC”) trading of derivatives which were considered to have played a central role in causing the financial crisis. Regulators have followed suit and have introduced various reporting regimes. Whereas the initial phase of regulation post-financial crisis – Form PF, AIFMD, CPO-PQR – focused on periodic reporting, the next phase focuses on near real-time transaction reporting and is designed to give regulators even deeper visibility into the risk that trading activity poses to the broader market.
Over the last few years, the European Commission has revamped its regulatory framework with the introduction of both the Regulation on Transparency of Securities Financing Transactions (“SFTR”) and the Market Abuse Regulation. SFTR, originally proposed in January 2014, aims to improve the transparency of securities financing transactions in the shadow banking sector. With the new rules helping to identify the risks associated with these financial transactions, as well as their magnitude. This regulation is in line with the G20 leaders’ commitment. Similarly, the Market Abuse Regulation aims to increase investor protection and confidence by allowing deeper and more integrated financial markets. The new framework will help combat market abuse across commodity and related derivative markets, ban the manipulation of benchmarks and reinforce the investigative and sanctioning powers of regulators. The Market Abuse Regulation also ensures that rules keep pace with market developments, such as the introduction of new trading platforms or new technologies.
Perhaps most significant is the European Market Infrastructure Regulation (“EMIR”) which came into effect in 2012 to provide authorities with a comprehensive overview of the market with the goal of reducing counterparty and systemic risk and to increase transparency in the OTC derivatives market. In addition, and complementary to EMIR, The Markets in Financial Instruments Directive (“MiFID”) introduced a transaction reporting regime across the EU and this is set to expand significantly in the next few years when MiFID II and the Markets in Financial Instruments Regulation (“MiFIR”) come into effect. MiFID II and MiFIR are designed to enable regulators to detect potential instances of market abuse and monitor the fair and orderly functioning of markets and investment firms’ activities with the goal of strengthening the regime’s overall transparency framework to further bolster investor protection and confidence and promote overall market stability.
The Current Approach to Transaction Reporting
The concept of near real-time transaction reporting of derivatives trades is new for many firms and poses huge challenges to almost all market participants. With MiFID II, MIFIR and other impending regulation on the horizon, firms will grapple with even more comprehensive reporting requirements as well as the resulting challenges this will pose with respect to technology and governance.
Current practices for transaction reporting include a heavy reliance on counterparties and manual processes. With many existing reporting mechanisms supported by manual processes, there is high risk for error and compromised data quality. This can result in low confidence on what is being reported to the regulators and therefore increase the potential of receiving fines for noncompliance. In addition, organisations may face other potential threats that can have significant reputational, regulatory or legal ramifications.
Andrea Peratitis, PointNine
A recent survey by Sapient Global Markets found that 72 percent of firms are using in-house systems, 16 percent are using a third-party vendor solution and 6 percent are using a managed service solution to manage trade reporting. Among those using an in-house system, more than a quarter (26 percent) expect their trade reporting costs to increase by 50 percent or more over the next two years. Despite these statistics, there is still a sense of pessimism among market participants with few believing that these systems will truly deliver the adaptability, scalability and flexibility needed to meet new requirements.
The Future State
The influx of new regulation is forcing firms to look at trade reporting and data in a much wider capacity. MiFID II, in particular, has become a catalyst for this. Current tactical approaches will not scale for real-time transaction reporting and organisations will need to reframe their approach to regulatory reporting to be both compliant and strategic in meeting these obligations.
One key element of this is the decision to continue doing reporting in-house or to explore alternative solutions. There are a number of tangible costs, as well as overall opportunity costs, associated with either upgrading or building a trade reporting solution and managing it in-house that should be considered.
As regulation demands more detailed reporting, firms will undoubtedly be grappling with more and more data from disparate sources. This lack of data standardisation poses a significant challenge for firms tackling reporting in-house and the infrastructure can be extremely expensive to build and maintain as regulatory change continues. Additionally, current transaction reporting regulations require the reporting of both economic and legal information which is not traditionally captured in front office or back office systems and is reliant on manual processes. Automation of close to real time transaction reporting will depend to some extent on the clever use of data enrichment tools targeting the legal subset of the information required, something that can be difficult to achieve via an in-house system. Existing service providers who house much of the required data are best placed to fulfil the reporting requirements assuming such providers invest into new processes and technology that capture all the required data elements and develop integration with the regulators and trade repositories.
Given the pressures firms today are facing to both remain compliant and realise efficiencies in their operations, outsourced solutions offer an ideal alternative to in-house reporting. Particularly, as the role of technology grows with respect to regulatory compliance, outsourcing can provide firms with access to more robust, scalable and cost-effective solutions.
It is however, crucial for firms to properly evaluate the services and services providers they may choose to engage. There is no one size fits all approach and it is important for firms to find solutions that are flexible, customisable and can deliver real business results. Additionally, there should be seamless coordination across all data providers to both create efficiencies and ensure that all relevant data is aligned. When approached in a measured and strategic way, regulatory compliance is a natural extension of corporate governance and can add real value – not just cost – to firms and their investment operations.
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About Maples Fund Services
Maples Fund Services, a division of MaplesFS, is a leading independent global fund services provider operating in key onshore and offshore financial centres across the Americas, Europe, Asia and the Middle East. Maples Fund Services offers a wide range of services, including accounting, middle office, risk reporting and administration services to onshore and offshore hedge funds, fund of funds, private equity and real estate funds, family offices and managed account platforms. Its clients include investment management firms, institutional investors, pension plans and global financial institutions. Maples Fund Services’ expert teams and innovative technology provide clients with high quality service, consistent and timely reporting and adaptable solutions to address their ever-changing needs.
About Point Nine Limited
Point Nine is one of the industry leaders in post-trade execution, operation, processing and reporting. Founded in 2002, we collaborate with both buy and sell side financial firms and corporations to help them meet the ever-expanding challenges of post-trade processing. Circle, our in-house proprietary technology, provides a real-time solution to all our customers and their trading relationships.