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This article from
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Meeting the compliance challenge
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RICHARD CAMPBELL
Strategy director, Milvus Business Development
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Governments and regulators around the world are working hard to stop money-laundering, tax evasion and generally improve the governance of corporations and financial institutions.
This has resulted in an exponential growth in compliance costs and procedures. These pressures are changing the structure of the global financial services sector, and the wealth management sector in particular.
Financial institutions may be at the sharp end of the regulatory challenge, but the regulators themselves face a dilemma: How to maintain the balance between providing a well-regulated banking environment, so that bodies such as the OECD do not blacklist the region, while not placing too heavy a burden on financial institutions that operate in that jurisdiction.
The Bahamas reacted to being blacklisted by the OECD in 2001 by increasing its regulatory procedures for organisations operating financial services from within the territory. The effect of this increased burden, combined with the downturn in the global markets, has resulted in the Bahamas becoming a jurisdiction in which profits have been hit hard. In 2003 financial institutions including Lloyds TSB closed down their operations in the Bahamas, quoting the increasing costs of compliance as a critical issue.
In 2004 Jersey gained a commitment to be taken off the OECD tax blacklist after it agreed to become involved in the tax information exchange initiative. Jersey-based institutions now face the challenge of meeting this regulatory obligation, along with others such as the EU Savings Directive and the Basel II capital accord, while controlling their costs and defending their service quality to avoid a similar situation to that in the Bahamas.
Industry-wide figures on the cost of complying with the regulatory burden are hard to find, but Milvus’s research suggests that between 20% to 25% of total operational overheads are spent on compliance-related activity. For all wealth management companies, compliance is a large and growing challenge. In 2003 HSBC reported to have spent $400m on global compliance and a medium sized Channel Islands private bank now employs 22 full time compliance personnel, whereas five years ago one person performed this role, part-time. That is an average growth of over 800% per year.
The burden of compliance weighs heavily on all wealth management organisations. Each institution is left with a need to make a decision on which strategy to pursue to cope with the burden of compliance.
However, compliance can be viewed as an opportunity, not merely an obligation. It is an opportunity to improve the reputation of the company. Further, since investment or, at the very least, increased operational cost is required to comply, surely it is better to invest positively and see this as an opportunity to improve the competitive position. The Gartner Group goes further and suggests that those organisations that invest proactively in what they refer to as a ‘compliance management architecture’ will halve their overall compliance costs by 2006.
A major source of compliance cost incurred by wealth management organisations is due to the internal labour and third-party consultancy required when responding to regulatory changes. These costs are largely unplanned and are reactive to the situation often brought about by an acute emergency. Such emergencies remain the norm until a proactive approach is undertaken. Such an approach has in-built flexibility to provide a well-managed response to regulatory change by employing suitable technology in an integrated compliance management architecture. Security policy can demonstrate compliance with many different regulations. Control of access to data, audit trail of access and of transactions can show compliance, and resilience to internal and external data tampering.
The computer platform upon which the system is based can have a profound impact on overall security and, correspondingly, the cost of compliance. A lack of fine-grained control over access to files and programmes leaves processes and systems open to abuse which again can threaten the ability to comply in a cost effective way to audit and control requirements.
Information should be available to senior management to alert them of all threats to the business, whether from within or externally. The business should be proactive in understanding threats that it faces and be prepared in its response to these threats. Regular practice in contingency planning also builds corporate flexibility in responding to unforeseen events, enabling the organisation to put new processes in place more rapidly. An increasingly important aspect of business continuity is the ability to reconfigure the business systems quickly in response to a need for organisational change driven by regulatory compliance. Much regulation is concerned with the management and movement of documents through the organisation and with third parties. To be compliant with many regulations, a financial institution must be able to find, track and report on huge amounts of data, while at the same time keeping tight control on costs and delays in doing so. Modern document management technologies and strategies can significantly reduce total costs of compliance.
Many new regulations are concerned with verifying that core processes are in line with current regulations and that the business management team is in control of its core processes. Systems must have a full audit and management facility for all transactions across wealth management processes. Internal workflows are also essential and capabilities to support flexible responses to process changes and modern integration technology allow a complete process view for management and auditors. The effective management of data across the organisation is critical to a cost-effective compliance management architecture. Data warehousing and business intelligence technologies are best employed to collate diverse data and enable analysis and reporting to meet a wide range of compliance and business management requirements. Compliance reporting has traditionally been a significant source of cost to wealth management companies. Integrated Regulatory Reporting is a move to reduce manual report collation, improve analysis and reduce total costs, through the automatic production of electronic reports by regulated firms and their submission in electronic format to the regulator. This strategy for reporting is being mandated by the International Accounting Standards Board and the UK FSA, with many other regulatory bodies considering the adoption of this approach in the medium term. Wealth management companies incur high costs in complying with ever-changing regulatory requirements. The response can be piecemeal and reactive, or based upon a flexible compliance management architecture. Milvus argues that significant cost savings, reduced operational and reputational risk can be gained by employing the latter approach. Milvus has made significant internal investment and works with ‘best of breed’ application providers to help its customers deploy an effective compliance management architecture. We would argue it is only by doing this that wealth management businesses can continue to operate profitably.
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