Compliance
GUEST COMMENT: Babel Systems On How To Beat Soaring Regulatory Costs

In this article, the founder and CEO of Babel Systems, a securities processing platform, examines how firms can succeed despite rising regulatory costs.
Steve Wise is founder and chief executive of Babel Systems, a
securities processing platform for online trading providers,
including platforms, new D2C propositions, stockbrokers and
wealth managers. He addresses how firms, faced by rising
regulatory burdens, can deal with the issue and remain profitable
and focus on business growth, rather than simply dealing with the
latest set of rules. As always, this publication does not
necessarily endorse all the views expressed but is delighted to
share these insights with readers and invites responses.
One of the main legacies from the economic crisis is much
stricter regulation, which has become an expensive albatross for
many firms. As a result, even though many wealth managers are
benefiting from the recovery and increased investor confidence,
the market is still being held back by these extraordinary cost
pressures.
Not only is regulatory compliance a time-consuming and costly
exercise in its own right, but it is made even harder by the fact
that many of these new rules are retroactive. As a result, firms
now have to review data from as far back as seven or eight years
ago in some cases to ensure compliance with new Financial Conduct
Authority regulations.
Unsurprisingly, this extra analysis throws up a lot of complex –
and costly – issues, as firms can’t simply apply new rules into
what they are doing right now. A lot of wealth managers seem to
think about emerging regulations as quite separate from any work
they had performed previously, but that can be a costly
mistake.
The transparency that is needed to meet the FCA’s regulatory
demands requires a much broader approach, which can result in
significant administrative efforts (and expense) unless managed
properly, with the right processes and supported by the right
systems.
This is especially true when it comes to the “Big Three”
regulatory behemoths of client money, client suitability, and the
transparency requirements set out by the Retail Distribution
Review. Firms that are forced to address these areas often wonder
whether there is a way for wealth managers to reduce the cost
pressures of these regulations while still remaining fully
compliant. The answer is yes – but only if firms have the right
tools for the job.
CASS and client money segregation
The protection and segregation of client money is vital to
investor confidence in the wealth management market and is
closely watched by the FCA. As such, the Client Asset Specialist
Unit (CASS) has forced wealth managers to improve the
traceability of their transactions considerably, from initial
transaction through to settlement, as every order made has to be
traced back to the specific funds provided by the client.
This has become increasingly important in the last few years with
the increase in client portfolios, as well as the need to bridge
the gap between what is owed to the market and what is owed to
the client. This has extended to the processing of cheques -
where a client has deposited a cheque, the firm has to cover the
liability while the cheque is in clearing. Not only are the
amounts of these cheques high, the fines are as well: one firm
has been fined £5 million ($8.4 million) for not segregating
client money effectively.
The problem is that most of the IT systems that support this
process were put in place many years ago, and therefore do not
allow for the level of precision and transparency that is needed
today, especially when data needs to move from one system to
another.
This situation is particularly precarious when wealth managers
use older systems that cannot be changed to accommodate new
regulatory requirements, as these firms will need to have
numerous people checking through multiple spreadsheets to verify
all the information required by the FCA. Not only will these
manual processes increase operational risk, but the cost of
additional staff will also be significant.
The good news is that these can be reduced if wealth managers
choose a modern back office system that is able to automate these
processes, not only for the transactions that are being performed
today, but also with archived financial data that hasn’t been
reviewed in years. This approach will not only reduce risk -
which is a vital goal in its own right - but will also reduce the
extra costs associated with time-consuming manual processes and
additional staffing requirements.
Suitability of client profiles
Wealth managers are responsible for ensuring that their clients’
profiles are suitable for whatever investments they choose to
make. This is often a process that wealth managers tend to
dismiss if clients portfolios are already familiar to them,
without checking if all of the client details they have on file
are up to date. The problem is that client profiles may have
changed due to job loss or a number of other factors, which can
affect their suitability for a particular type of investment
and/or the scale on which they would like to invest.
As with client money, this process is currently under a great
deal of scrutiny by the FCA. Along with these regulatory
pressures, established wealth managers are also increasingly
being challenged by new entrants who have the tools and
mechanisms in place to make sure that their client profiles are
consistently up to date and that any advice given is suitable for
the individual in question.
These firms have the advantage of building their platforms to
accommodate new regulation much more easily, whereas more
established wealth managers need to dedicate a large proportion
of their resources to retracing their steps over a span of many
years to ensure that they are compliant.
Again, technology is likely to provide the answer here, as
purpose-built processing platforms can enable wealth managers to
configure their systems to prompt clients to confirm various
details every time they log in. More modern systems also have the
ability to automatically validate all of the data that is being
passed to the back office so that firms can be sure that all of
this information is clean. In addition, because these new systems
have document storage built in, it is much easier to search the
database to see exactly when and where any advice has been
given.
RDR requirements for transparency
As a direct result of the RDR, wealth managers need to
demonstrate to their clients that they are compliant with strict
rules related to transparency. Compliance in this area is
determined by the much-debated Skilled Person Review, also known
as the section 166 review, whereby the FCA commissions reviews by
Skilled Persons to obtain an independent view of a firm’s
activities.
If firms do not have the appropriate back office systems in
place, they are likely to spend a significant amount of time
collating this information through spreadsheets and other manual
processes, which will entail additional costs and time
requirements. The FCA recently rejected calls to clarify the
circumstances under which the section 166 review would take
place, which means that wealth managers need to be constantly
prepared for this type of review.
A number of top UK firms have already been sanctioned for lack of
transparency and the cost of fixing these problems afterwards can
reach as much as £2 million, largely because the FCA employs
large consultancies for this work and then passes these costs
onto the firms being investigated. This expense could be greatly
reduced, however, if companies were able to store all of the
information required for a section 166 review in one single
database, complete with a clear and detailed audit trail. This
way, if the firm does receive a visit from FCA inspectors, the
length of the review will be much shorter, and therefore far less
costly. There is an argument that using these types of
systems in the first place would mean that the Review would not
be enacted.
The threat of being left behind
Rising regulatory costs are a serious issue for wealth management
firms that do not have the right systems to tackle them. However,
forward-looking firms in the wealth space are now able to deploy
purpose-built systems that are able to cater for both new and
emerging regulation. As a result, fewer resources need to be
spent on the administrative and operational procedures that are
needed to demonstrate compliance for both current and legacy
transactions. The cost of regulation can never be avoided
completely, of course, but firms that embrace technology that has
been designed for the future will discover that there are ways to
reduce make this expense significantly.