New legislative initiatives implemented since the global financial crisis have pushed the asset management industry further into the regulatory spotlight. Since 2008, regulators in the US, Europe and Asia have implemented many new regulations targeted at managing systemic risk and enhancing transparency and investor protection. Asset managers and institutional investors now face a global torrent of continually evolving and granular regulatory requirements. The introduction of the Alternative Investment Fund Manager Directive (AIFMD) Annex IV, the European Market Infrastructure Regulation (EMIR) in Europe and Dodd Frank’s Form PF and CPO-PQR in the US, has created increased transparency in every aspect of the investment management process. In addition, managers are quickly learning that they are under the regulators’ microscopes in every jurisdiction in which they operate.
The on-going globalization of financial regulatory policy is accompanied by fragmentation – creating challenges for the industry as it seeks to develop seamless, firm-wide, and universal regulatory systems. The only certainty is that the enhanced global regulatory environment will continue for the foreseeable future, mandating that managers develop, implement, and maintain Regulatory Enterprise Risk Management (RegERMTM) systems. For many firms, the cost of compliance has become a primary focal point. Legacy data management and reporting systems are overburdened and managers’ internal resources are overwhelmed by the challenge. When faced with the prospect of engaging third-party service providers to alleviate the burden, many firms focus more on the cost rather than addressing the fundamental need for, and overall benefit of, a holistic solution. Ironically, this approach is ultimately likely to be more expensive and less efficient.
Transforming systems and procedures can be expensive if approached incorrectly. Managers are well advised to shift their focus from the cost of compliance to the cost of noncompliance for lapses in RegERM, which can cause unwanted scrutiny and catastrophic operational results. By implementing a robust RegERM strategy, institutions of all sizes can benefit from accurate and timely compliance toregulatory reporting as well as significant synergies with existing operational processes including creating increased flexibility and economies of scale in portfolio analytics, due diligence processes, and client reporting. Most importantly, effective RegERM mitigates the types of lapses that can compromize the firm. The best hedge to this risk is a holistic RegERM approach to operations and compliance.
Traditionally, compliance has been approached by dealing with each regulation in isolation and regulatory reporting has been treated as a narrowly defined support function. This siloed approach may have been successful in the past with the more generic type obligations of annual filings, for example Form ADV. Significantly, the US Securities and Exchange Commission proposed new rules expanding the data required in ADV for registered investment advisers and promulgated new detailed regulatory reporting for investment companies and ETFs. This comes on top of a dramatic increase in recent years of the quantity of data communicated to regulators and the frequency of communication. Form PF, CPO-PQR, Annex IV, EMIR, and the European Short Selling Regulation materially altered the reporting landscape making regulatory reporting a monthly, if not daily, exercise. Additionally, the level of granularity in the transparency mandates a much more deliberate approach to data governance.
Filing requirements, while diverse, also realize significant areas of overlap that makes data management very challenging. The simplest enforcement case for a regulatory body can just involve allegations of disparate and inconsistent reporting. The best way to prevent this is a RegERM system of data governance that aligns all third-party reporting.
Regulatory Enterprise Risk Management System
An effective RegERM system should seek to achieve at least three primary goals: the alignment of all firm data and third-party reporting, the development of a repeatable process to meet the perpetual demands of reporting, and the establishment of a process for maintaining a detailed audit trail to ensure repeatability and to efficiently respond to any inquiries relating to the reporting. It is important to keep in mind that while regulatory reporting aims to provide global regulators with “a finger on the pulse” of systemic risk, this oversight is the job of the regulators not the manager. Rather, the manager’s responsibility is to use its best efforts to comply with the obligations it is subject to, while mitigating the possibility that it becomes the focus of a regulatory inquiry.
Owning the process
The first step is to identify the RegERM team that should be a combination of both internal and external resources. Given the importance of the exercise and the sensitivity of the data, firms are well-advised to have a strong leader from within the organization head up the process. Regulators have made it clear that while they recognize that firms will outsource some of the process, the liability remains with the regulated entity and as such, they expect the firm to “own” the reporting process.
Efficiently leveraging service providers
Investment firms pay significant fees to prime brokers, custodians, counterparties, and administrators. Many firms are also engaging outside technology service providers to assist with data flow and overall risk management. The right RegERM system should ensure coordination among these providers to create efficiencies and align all relevant data.
The Role of the administrator
Administrators typically hold the most holistic data sets. Proactive administrators have been working with asset managers for a number of years to consolidate this information to provide value and insight beyond the pure net asset value (NAV) calculation. These administrators have created dedicated data management and reporting teams that harness the extensive array of data they are provided to create a value proposition that extends beyond just the fund vehicles that managers establish for investors, and focuses on the provision of services that directly enhance the operations of managers themselves.
By coupling the processes and technology required to ensure maximum data integrity, both inbound and outbound, with seasoned data, analytical, and regulatory professionals, administrators can now be called upon to provide reporting that complies with regulatory standards as well as to provide the analytics underlying such reports.
Technology’s growing importance
It is also crucial to engage the right technology provider to effectively effectuate a RegERM system. Regulatory reporting requires expertise from multiple disciplines and managers will require a robust technology firm with deep knowledge of legal and regulatory, operations, finance, risk, and alternative fund management. In addition, the technology firm should have sufficient gravitas within the industry.
Having access to regulatory bodies for inquiries on behalf of clients – for prognosticating what the regulators are looking for in the requisite reports can be a large part of the challenge.
By implementing a RegERM platform that consolidates data from multiple sources into a single system and provides the required advisory services, the path to successful reporting becomes more predictable and streamlined.
The following are recommended “best practice” steps to developing, implementing, and maintaining a robust RegERM system for compliance and reporting requirements:
Step 1: Data source identification
The required data is typically not available from one source. Whether the source is front office, middle office, back office, fund administrator, prime broker, counterparty or custodian, or whether data is domiciled in Dublin, New York or Hong Kong, the right RegERM system must identify and subsequently integrate, reconcile and validate all necessary data sources.
The data elements required can vary widely depending on factors such as the specified regulation and the fund’s strategy. Examples of the data elements required may include positions, transactions, NAV, assets under management, collateral, borrowing and credit support details, cash details, risk and performance metrics, investor information, investment liquidity, investment ownership, and service provider information.
Step 2: Data aggregation
Once identified, the source data needs to be synthesized, reconciled, and validated. Optimal data aggregation requires a secure, customizable data warehouse that allows manager, fund, position, transaction, performance, risk, and investor level information to be managed side-by-side regardless of data source, investment strategy, and investment asset class. In addition, the platform should allow the technology and data management personnel to accept data in any system-digestible formats and to review and reconcile disparate data. Ultimately, a clean data set must be generated, which can then be leveraged for any regulatory report.
Step 3: Data transformation
Transformation of the data into the correct protocol is frequently the most difficult and time-consuming part of the exercise. Understanding the various regulations and how they apply to particular asset managers as well as comprehending the extensive array of regulatory calculations and mappings required can be challenging for any investment firm. A strong RegERM automatically computes most of the required calculations but access to experienced advisorswho can work alongside the investment manager to determine their regulatory obligations, data requirements, and data discrepancies is another necessary element.
Step 4: Centralized data warehouse and calculation engine
Once the data has been appropriately transformed, it must be aggregated into a centralized data warehouse. This step is essential to the overall alignment of third-party reporting. While the data sources for Form PF, CPO-PQR, Annex IV and other reports may be the same, the output requirements are different. Aggregation of the underlying data into one warehouse ensures consistency and facilitates the population of reporting protocols.
The most efficient means of answering reporting questions is the use of a proprietary calculation engine, which can aggregate the transformed data from the warehouse and populate the reporting template per the requisite protocol.
Step 5: Review and XML transformation
The final step prior to transmission is the review of the output. This involves both a technological validation as well as manual checks for unexplained disparities and required explanations. A strong RegERM system provides full workflow capabilities allowing the investment manager to track the entire process. The RegERM system should provide an interface for validation, review, approval, and submission of the filing as well as capabilities to store submissions and filings and provide an audit trail for future reference.
Critically, the platform must perform a series of systematic checks on the filing. Finally, a team of regulatory professionals should review the report question by question to confirm responses.
Step 6: Electronic transmission
Once the review is complete, the RegERM system should have the capability to prepare the electronic filing. Different regulators require different mechanisms for submission. Most require XML but some accept Excel and rarely are the formats identical between regulators. In addition, some allow direct transmission while others require the reports to be uploaded via a portal or submitted by e-mail. A strong RegERM system will ensure that the filing is prepared and submitted in the manner required by the applicable regulator.
Regulatory reporting has generated significant new challenges for the investment management industry. There is no question that regulatory requirements have been and will continue to be refined as the regulators harness the new information at their disposal and enforce different risk profiles on the market.
Investment managers who choose to directly confront these challenges can mitigate serious risks that have the potential to compromise their firms. Such firms generate regulatory alpha through their RegERM systems. These systems harness service providers, technology, and advisors and follow a stringent reporting process. Successful implementation of such systems can help investment managers avoid large expenditures of time and money from botched processes, poor systems, and regulatory scrutiny.
An effective system is designed to be flexible and agile to accommodate evolving requirements. The best system will be at the forefront of change, liaising with regulators, and enhancing processes to ensure that the investment management firm has access to the best technology available in the industry.
On top of continuing to demonstrate compliance with global regulations, the RegERM system should be leveraged for other functions. As regulators require more reporting that demands detailed interactive data management systems, firms can opportunistically take advantage of using this new platform to support their investment operations, sales, marketing, and client communications. As investors become increasingly sophisticated so do their requirements and any errors, slowness, inconsistency in reporting or apparent lack of control can trigger significant doubts in the mind of the client or potential client. Beyond simply reacting to regulatory requirements, prepared firms are taking a holistic view to redesigning data architecture.
It is becoming more rational and cost effective to combine multiple reporting systems into one platform, allowing for consistent reporting and reduced marginal costs for significantly more robust, customizable, and powerful institutional reporting platforms.
Gary Kaminsky has over 27 years of experience in the securities industry. At ConceptONE, he continues his career in the financial services sector that began as an attorney with the Enforcement Division of the US Securities and Exchange Commission. Gary has also served as a co-founder, COO, CCO, and general counsel for two alternative investment management companies. Prior to launching those funds, Gary was CCO and counsel for Susquehanna Investment Group, a leading proprietary trading firm, preceded by a position as a securities and regulatory attorney with Dechert, LLP.
Mark Weir is responsible for the Global Data Management and Middle Office team at Maples Fund Services. Prior to joining Maples Fund Services, Mark worked in Citi's funds and custody outsourcing departments and at Investors Bank and Trust in fund administration. Mark holds a First Class Honors Degree in International Business from the Dublin Institute of Technology.