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.