Regulatory Change: Time to Leap Into the Breach?
In today's advancing regulatory landscape, financial services firms can no longer afford to treat regulation as a one-off race against the clock to establish business readiness. With the regulatory outlook rooted firmly in more stringent reporting, greater transparency, disclosure and protection for investors, the need to manage regulatory change efficiently is ever more apparent. Regulators are indicating larger and more regular fines for non-compliance, in a drive to make markets function more efficiently. As large-scale regulatory change looks here to stay, it may be time for firms to leap into the breach and take a firmer grasp of the regulatory nettle.
The Financial Conduct Authority (FCA) has made it clear it continues to see poor data being reported by firms; this has been evident in some recent heavy penalties for regulatory reporting breaches under EMIR (1). So how do firms ensure they are reporting everything fully, and that outsourced services are also fulfilling their regulatory obligations?
Strategies for Managing Regulatory Change and Oversight
While regulatory change is very much part of business as usual activity for financial services firms, it often manifests in tactical fixes when up against regulatory deadlines. The FCA has set store that it now expects firms to manage regulatory change as a core competency within the firm. As consultants in financial services, ISC advise firms to adopt a structured approach in managing regulatory change, so that they are better equipped to focus on risk-based activities and can target areas of regulation that will have most impact on the business.
Key challenges highlighted in an FCA market study on asset management (2) include concerns over potential market restrictions post Brexit and addressing increased disclosure requirements introduced by MIFIID II and PRIIPS.
On the regulatory challenges facing asset management specifically, the FCA's Chief Executive commented (3), "There are strong forces of change affecting asset management in the UK, some of which are global in nature, others are UK specific."
Regulators such as the FCA are likely to publish further guidance on industry concerns in due course; in the meantime, firms who are adopting a strategic and integrated approach to regulatory change can more readily evolve in response to a changing regulatory landscape.
The benefits of an integrated regulatory change function are not only better control and oversight for the firm, but the potential to reap efficiencies and drive down costs through reduced duplication, shared learning and cross-pollination between different projects.
Key elements of an effective regulatory change function comprise:
- Strategic focus. A central regulatory change function can steer the business towards strategic rather than tactical solutions to upcoming regulatory change and take a long-term view of what's important for the business. The need to fully understand upcoming regulatory changes, its impact on existing systems and processes including outsourced services, staffing requirements, cost and time implications are essential precursors to any regulatory implementation project. Through careful planning, these challenges can be more effectively managed.
- Risk-based approach. A full risk assessment and impact analysis of impending regulation, driven by both a strategic and risk-based approach, can enable the firm to drill in on the areas in which governance needs to be tightened.
- Synergies across business operations. Firms can capitalise on synergies across different areas of regulation and how it impacts business operations. A key driver for firms is the need to drive down cost through improved automation, data reuse and reduced duplication. Lessons can be learned from conducting post-implementation reviews; this can also provide opportunities for greater efficiencies and cost savings.
- Audit and compliance. Post-implementation, firms should be able to demonstrate compliance and a complete audit trail to regulators.
Regulatory Change - Pathway to Business Readiness
In addition to establishing working relationships with regulatory bodies to become better informed of upcoming regulation, a regulatory change function can signpost risk and channel the business towards areas that require increased governance.
Well-managed regulatory change ensures that firms stay ahead of the game and avoid succumbing to penalties.
The Cost of Non-Compliance
Regulatory breaches have made headline news in recent years. One of the heaviest fines levied on a single firm by the FCA at the end of 2017 amounted to £34.5 million for a breach in EMIR reporting regulation (1). It's not only a firm's in-house activities that can fall foul of regulation; outsourced services are subject to regulatory obligations and firms can incur fines where there is insufficient oversight of outsourced services. The FCA has imposed fines under the Client Assets Sourcebook (CASS) for outsourced failings. In the last 3 years, the financial cost to firms fined by the FCA for regulatory breach exceeds 56 million pounds, aggregated across different companies and regulation in financial services.
Source FCA - fines in millions (GBP), aggregated across companies in financial services 2015 - 2018
The cost of regulatory non-compliance is not just about monetary fines; the cost to a firm's reputation can be far worse in the long term. With high-profile firms having made headline news after falling foul of data privacy law and facing investigations, even established firms may struggle to repair reputational damage. Under more stringent data protection laws under Global Data Protection Regulation (effective May 2018), and a drive to extend greater data protection law to the US, more firms may come under the spotlight.
In its business plan for 2018/19 (4), the FCA confirmed that items high on the agenda for the coming year will be around recognition of regulatory standards and ensuring that trade is not unduly restricted post Brexit, along with increased oversight of obligations introduced under MIFID II. An increased focus on MIFID II will mean monitoring for compliance around best execution and gaining understanding of how high-frequency algorithmic trading (HFTs) is used across trading markets.
Some milestones for upcoming regulation, and penalties for non-compliance, are summarised below.
Table 1: Regulatory milestones
The European Union is reconsidering the role of ESMA, the key EU financial reporting body, along with other regulatory bodies; as a result, its influence could alter post 2019 and may even lean towards a more principle-based and flexible approach to how rules are applied post Brexit. However, UK firms with offices in Europe will still be subject to full EU rules; it cannot be assumed that lighter restrictions will apply.
The lessons learned from past regulatory shake-ups following the financial crisis and on the introduction of MIFIID in 2007 mean that firms can no longer be complacent about compliance with regulation.
Emerging themes for regulation over the next few years look set to focus on defining the rules around the passporting of funds post Brexit, on disclosure requirements of MIFIID II and PRIIPS, and potential costs and accountability from technological innovation. This is likely to include advances in artificial intelligence (AI) in areas such as risk management, compliance, security and client reporting.
When facing regulatory change, it's clear that planning must be meticulous. Firms that have core competencies in regulatory change management will be well-placed to assess the impact of upcoming regulation on in-house and outsourced services as well as how to manage compliance risk. The financial and reputational consequences of non-compliance are high.
ISC have an experienced team of consultants in implementing regulatory change. For further information on how ISC can advise firms in structuring regulatory change teams and implementation projects, contact firstname.lastname@example.org.
- (1) FCA fines 2017 - EMIR
- (2) FCA: Asset Management Market Study
- (3) FCA: Asset Management: A regulatory Perspective
- (4) FCA Business Plan 2018/19
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