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Compliance Monitoring Needs a Breakthrough

New Regulations Have Compliance Departments Spread Thin


With new global regulations forthcoming, corporate compliance departments will need to upgrade aging systems and expand automation technology just to keep up. The time for little fixes may be over, and firms cannot use the recession as an excuse for putting investments off.

Compliance departments are increasingly concerned with the growing complexity of innovative and synthetic instruments and the components that go into them, said Michael Fay, a principal at Deloitte & Touche, during a webinar last week titled "Investment Portfolio Compliance Monitoring: Challenges in a Changing Environment."

Increased regulatory scrutiny and reporting requirements are straining compliance offices, as are increased complexity in legal structures, domiciles and jurisdictions, he said.

"These have implications that can span the organization from IT, operations, legal, compliance, client services, marketing, trading and portfolio management," Fay said.

Like everything else right now, most compliance departments are typically spread pretty thin, but even robust programs are struggling to keep up with all the growth in the compliance arena.

"Technology will be a key facilitator for new regulations," said Jack Wiener, executive vice president at Linedata Services. "A lot of our clients are still dependant on spreadsheet engines. Upgrading them to newer systems won't be easy, but it's very doable."

"Many systems are showing signs of their age," said Susan Waters, a senior manager at Deloitte & Touche. "In many cases, rule interpretations may have changed, and the availability of data has increased exponentially."

It's usually unnecessary and far too costly to continually upgrade compliance systems, so firms often make small fixes, like patching a hole.

"The longer you have a system, the more fixes you have," she said. After a while, though, small fixes are no longer enough and major upgrades are needed.

"As firms start to bring on more accounts, they have realized that many of the older rules are obsolete," said John O'Neill, a senior manager at Deloitte & Touche. "You may need to dip into the actual coding to make sure it serves the purpose it was intended to serve and that your documentation is complete and up-to-date," he said. "Many of these programs have layers of rules that were intended to do the same thing."

Going back and fixing all those layers can be very costly and time-consuming. Thus, it makes more sense to start over with something altogether different.

"New rule architecture is needed on the technology front," Wiener said. "What might have been compliant a few years ago might not be anymore, and probably needs to be upgraded."

The compliance front is looking for a technological breakthrough in new rule architecture that has the ability to change not only the core rule, but have it ripple through and change related rules, Wiener said.

As regulatory scrutiny continues to increase both in the U.S. and globally, firms must take steps to make sure that information sharing is consistent among regulators, O'Neill said. Firms will need to look for ways to automate their processes that won't harm their effectiveness.

O'Neill said it is often difficult to combine systems that use different back-office environments, though certainly not impossible.

"Compliance departments should make sure automated rules are properly aligned for complex systems," he said. Asset managers should diligently test automated rules to make sure any issues are documented. "Testing shows weaknesses with rules and with the data being brought in," he said. Compliance offices can use automation to analyze possible bankruptcy trends among their firm's holdings, assess trade reconciliation and confirmation processes, and assess the implication of market stress events on the value of the collateral in case of prime broker relationships, among other things.

Many of these tasks are becoming increasingly difficult as data becomes more abundant.

In order to stay compliant, firms must make sure that investment restrictions are captured completely and accurately, and that documentation that needs to be analyzed is complete and up-to-date, Waters said. Additionally, firms must confirm that coding in automated investment compliance monitoring systems is done appropriately-particularly with respect to complex instruments.

For rules that can't be automated or are only partially automated, firms must determine that manual monitoring procedures are sufficient, she said.

As companies continue to expand their global product reach and capital flows, Fay said the need for transparency becomes more apparent.

"Regulatory concerns are spreading across the globe," O'Neill said. "The globalization of investment management firms and the convergence of trading and back-office systems have created challenges, particularly for those reluctant to change."

There is a natural clash between local privacy requirements and global information sharing, but compliance departments must seek to find a common ground.

"There is a risk of treating clients with the same guidelines differently," he said. "Your compliance officers need to ensure you are keeping up with changes in regional regulations that may impact your global business."

The financial crisis is causing more and more investors to take an interest in how their investments are managed and regulated. As a result, more sophisticated investors are increasingly expressing their concerns over credit risk and their uncertainty about how to evaluate those risks.

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