Advent Software

Uncovering the true cost of compliance – And how to control it

By Advent Software – Although the financial markets have largely recovered from the crisis of 2008, investment managers worldwide are still feeling the fallout in one very important regard: the unprecedented wave of reform that has washed over the shores on both sides of the Atlantic.

It’s a confounding “alphabet soup” of regulation: AIFMD, FATCA, MIFID II, RDR II, UCITS, EMIR – the acronyms go on and on. Five years in the making, many of these new or revised regulations, combined with the provisions of the US DoddFrank act, have begun to take effect or will soon.

Meanwhile, in the UK, two more new acronyms have been added to the investment lexicon. The oversight responsibility formerly held by the Financial Services Authority (FSA) has been divided between two entities dubbed the “twin peaks” of regulation: the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority (PRA). The FCA is primarily concerned with consumer protection, fair play and compliance among investment firms. The PRA, overseen by the Bank of England, is keeping its eye on the health and stability of large institutions that could pose systemic risk.

Clearly, regulators everywhere are under substantial political pressure to do a better job of preventing abuses. This means stricter rules and more stringent enforcement, which in turn puts pressure on firms to demonstrate that they have a culture of compliance and the controls to prove it.

Most firms would agree that the compliance burden has increased in recent years, along with its cost. Yet few have actually taken the time to measure that cost. What is the true cost of compliance? Where and how does it affect firms the most? And, perhaps the most important question, how can it be controlled? Only after measuring the cost of compliance and understanding its sources, both direct and indirect, can firms take steps to keep it from spiralling out of control.

Uncovering the Costs – Seen and Hidden

In an effort to uncover the costs of compliance, London-based researchers ComPeer Ltd., best known for their wealth management performance benchmarking service, surveyed 147 UK firms, including investment managers, full-service and execution-only stockbrokers, and private banks. The survey included 30 wealth management firms that account for 35% of the industry’s assets in the UK. Based on their findings, ComPeer estimated the true cost of regulatory compliance for the UK investment industry at GBP420 million (USD659 million, EUR494 million) in 2012. By 2015, the firm projects the cost to rise to GBP500 million (USD784 million, EUR588 million).

While these numbers are just for the UK, they give firms in the US and continental Europe a sense of the magnitude of the cost of compliance. What makes the survey findings globally relevant is uncovering how and where the costs add up in a firm’s operations – and it’s not just in the compliance office.

ComPeer analysed compliance costs from five different perspectives:

  • Regulatory fees, levies and fines
  • Direct compliance costs (department staffing, systems, resources)
  • Indirect compliance costs (including senior and non-senior staff time and resources spent on compliance)
  • “Business as Usual” (or everyday) compliance costs
  • Compliance project costs (associated with preparing for specific regulatory initiatives)

The firm also compared the indirect costs for both senior and non-senior staff. Among the key findings:

A staggering 39% of total compliance costs were attributable to FSA fees and levies. This amounts to 3.6% of the industry’s revenue and 17.2% of profits. (Many observers expect compliance costs to rise under the “twin peaks” regime.)

  • Investment managers, private banks and full-service brokers all saw increases in compliance staff headcount between 2007 and 2011. Compliance staff costs rose by 12.5% in the same period, most of that coming in the last two years.
  • Because compliance is becoming increasingly complex and burdensome, compensation and seniority of compliance officers continue to rise.
  • Because of the number of regulatory initiatives currently underway, compliance project costs are higher than “business as usual” compliance costs.
  • The costs of the compliance department alone do not reflect true compliance costs. Direct compliance costs account for only 31% of the total. True compliance costs (excluding fees and levies) are about twice as large as direct compliance costs.
  • Time spent on compliance issues by front office and senior management – a firm’s most highly compensated professionals – is responsible for more than 50% of indirect compliance costs.

The survey concluded that wealth management firms lack reliable information about their own compliance costs, which makes it more difficult to manage them—and to stand up credibly to regulators. Firms need to gain a better understanding of how compliance affects the bottom line and where they need to focus their efforts to improve efficiency.

Building a Best-Practice Infrastructure for Compliance

If the cost of compliance extends beyond the office of the CCO, so too must the controls needed to ensure cost-effective compliance. The risk of compliance breaches is not isolated to any one area, but pops up at a variety of points in any firm’s processes and procedures. What’s needed is not a compliance “tool,” but rather a firm-wide technology infrastructure that supports compliance at any point.

An integrated, end-to-end technology solution should be able to help firms meet compliance requirements more efficiently by:

  • Reducing business risk: Faced with increased capital requirements, coupled with demands for more frequent and detailed client communication, firms find their business risks becoming more complex. Technology can help by streamlining operations, improving transparency and enabling you to communicate your strategies and results more effectively with clients, in a more timely manner.
  • Reducing operational risk: A comprehensive, integrated technology infrastructure reduces your operational risks by eliminating internal manual processes, providing secure connections with counterparties, and making regulatory compliance part of your everyday processes.
  • Reducing investment risk: A sound portfolio management and trading platform enables you to perform more rigorous due diligence, with accurate and current data that enables you to analyse exposure, make informed decisions and execute them quickly.

In order to achieve effective risk reduction and compliance cost reduction simultaneously, a best-practice solution would need to incorporate the following:

  • Workflow automation: A significant opportunity exists to reduce the hidden cost of compliance by increasing the efficiency of noncompliance staff, both senior level and operations. This can be achieved by maximising automation and straight-through processing, which reduces operational risks by minimising manual intervention and eliminating workflow gaps where breaches can occur. This frees both front and back office staff from time spent on compliance issues to focus on their actual jobs.
  • Data integrity: By building the platform around a core system based on a single data source, a firm can reduce the risk of errors arising from inconsistent data and manual reentry of data across multiple applications. The right solution will protect the integrity of portfolio and client data by keeping it organised, clean, secure and easily retrievable for regulatory reporting.
  • Consolidated reporting: The system should be able to aggregate data from multiple sources and enable consolidated reporting. By eliminating the need to compile required reports manually, firms can cut hidden labor costs and redirect staff to more productive activity.
  • Pre- and post-trade compliance: The optimal solution will include flexible functionality that automates pre- and posttrade checking for compliance with regulatory investment constraints, client mandates and restrictions, and internal policies. This relieves compliance staff of having to check each trade manually with spreadsheets, which is not only tedious and time consuming but also runs the risk of errors.
  • Global portfolio management: Much of the new regulation is aimed at gaining some control over the inherent risks in investing internationally. Firms that invest in multiple markets need a truly global, multi-currency portfolio management system that supports cross-border portfolio diversification, with coverage of all asset classes and financial instruments.
  • Client relationship management: Ideally, portfolio data and client relationship data would be integrated on the same platform. Among other benefits, this enables firms to more efficiently address “Know Your Client” requirements.
  • Flexibility and scalability: Finally, considering that regulatory requirements are constantly changing, firms will need technology with the flexibility to adapt as changes occur. It should have the scalability to handle growing transaction volume, new asset classes and new portfolios without straining resources or adding significantly to staff.

The cost of compliance is the cost of doing business these days, and like any such cost, it needs to be managed. Ultimately, compliance is not simply about meeting the letter of the law, but about safeguarding your organisation from business, regulatory and reputational risk. An efficient operational infrastructure goes a long way toward satisfying regulators that you have the controls in place to protect your clients and their assets. By making the compliance burden easier and less labour-intensive to manage, it also helps drive down the cost of compliance.

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