Asset Management: Climbing the Asset Maturity Curve
ConceptOne - Whitepaper - Achieving Regulatory Alpha Through Regulatory Risk Management - June 2015
1. Achieving Regulatory Alpha through
Regulatory Enterprise Risk Management
ConceptONE and Maples Fund Services Whitepaper
2. 2
Overview: The New World of Enhanced Global Regulatory
Requirements
New legislative initiatives implemented since the global financial crisis have pushed the asset
management industry further into the regulatory spotlight. Since 2008, regulators in the US, Europe and
Asia have implemented many new regulations targeted at managing systemic risk and enhancing
transparency and investor protection. Asset managers and institutional investors now face a global
torrent of continually evolving and granular regulatory requirements. The introduction of the Alternative
Investment Fund Manager Directive ("AIFMD") Annex IV, the European Market Infrastructure Regulation
("EMIR") in Europe and Dodd Frank's Form PF and CPO-PQR in the US, has created increased
transparency in every aspect of the investment management process. In addition, managers are quickly
learning that they are under the regulators' microscopes in every jurisdiction in which they operate.
The ongoing globalization of financial regulatory policy is accompanied by fragmentation – creating
challenges for the industry as it seeks to develop seamless, firm-wide, and universal regulatory systems.
The only certainty is that the enhanced global regulatory environment will continue for the foreseeable
future, mandating that managers develop, implement, and maintain Regulatory Enterprise Risk
Management ("RegERMTM
") systems. For many firms, the cost of compliance has become a primary
focal point. Legacy data management and reporting systems are overburdened and managers' internal
resources are overwhelmed by the challenge. When faced with the prospect of engaging third-party
service providers to alleviate the burden, many firms focus more on the cost rather than addressing the
fundamental need for, and overall benefit of, a holistic solution. Ironically, this approach is ultimately likely
to be more expensive and less efficient.
Transforming systems and procedures can be expensive if approached incorrectly. Managers are well
advised to shift their focus from the cost of compliance to the cost of noncompliance for lapses in
RegERM, which can cause unwanted scrutiny and catastrophic operational results. By implementing a
robust RegERM strategy, institutions of all sizes can benefit from accurate and timely compliance to
regulatory reporting as well as significant synergies with existing operational processes including creating
increased flexibility and economies of scale in portfolio analytics, due diligence processes, and client
reporting. Most importantly, effective RegERM mitigates the types of lapses that can compromise the
firm. The best hedge to this risk is a holistic RegERM approach to operations and compliance.
Traditionally, compliance has been approached by dealing with each regulation in isolation and
regulatory reporting has been treated as a narrowly defined support function. This siloed approach may
have been successful in the past with the more generic type obligations of annual filings, for example
Form ADV. Significantly, the US Securities and Exchange Commission proposed new rules expanding
the data required in ADV for registered investment advisers and promulgated new detailed regulatory
reporting for investment companies and ETFs. This comes on top of a dramatic increase in recent years
of the quantity of data communicated to regulators and the frequency of communication. Form PF, CPO-
PQR, Annex IV, EMIR, and the European Short Selling Regulation materially altered the reporting
landscape making regulatory reporting a monthly, if not daily, exercise. Additionally, the level of
granularity in the transparency mandates a much more deliberate approach to data governance.
Filing requirements, while diverse, also realize significant areas of overlap which makes data
management very challenging. The simplest enforcement case for a regulatory body can just involve
allegations of disparate and inconsistent reporting. The best way to prevent this is a RegERM system of
data governance that aligns all third-party reporting.
3. 3
Regulatory Enterprise Risk Management System
An effective RegERM system should seek to achieve at least three primary goals: the alignment of all
firm data and third-party reporting, the development of a repeatable process to meet the perpetual
demands of reporting, and the establishment of a process for maintaining a detailed audit trail to ensure
repeatability and to efficiently respond to any inquiries relating to the reporting. It is important to keep in
mind that while regulatory reporting aims to provide global regulators with "a finger on the pulse" of
systemic risk, this oversight is the job of the regulators not the manager. Rather, the manager's
responsibility is to use its best efforts to comply with the obligations it is subject to while mitigating the
possibility that it become the focus of a regulatory inquiry.
1 RegERM Team
(a) Owning the Process
The first step is to identify the RegERM team which should be a combination of both internal and external
resources. Given the importance of the exercise and the sensitivity of the data, firms are well advised to
have a strong leader from within the organization head up the process. Regulators have made it clear
that while they recognize that firms will outsource some of the process, the liability remains with the
regulated entity and as such, they expect the firm to "own" the reporting process.
(b) Efficiently Leveraging Service Providers
Investment firms pay significant fees to prime brokers, custodians, counterparties, and administrators.
Many firms are also engaging outside technology service providers to assist with data flow and overall
risk management. The right RegERM system should ensure coordination among these providers to
create efficiencies and align all relevant data.
(c) The Role of the Administrator
Administrators typically hold the most holistic data sets. Proactive administrators have been working with
asset managers for a number of years to consolidate this information to provide value and insight beyond
the pure net asset value ("NAV") calculation. These administrators have created dedicated data
management and reporting teams that harness the extensive array of data they are provided to create a
value proposition that extends beyond just the fund vehicles that managers establish for investors, and
focuses on the provision of services that directly enhance the operations of managers themselves. By
coupling the processes and technology required to ensure maximum data integrity, both inbound and
outbound, with seasoned data, analytical, and regulatory professionals, administrators can now be called
upon to provide reporting that complies with regulatory standards as well as to provide the analytics
underlying such reports.
(d) Technology's Growing Importance
It is also crucial to engage the right technology provider to effectively effectuate a RegERM system.
Regulatory reporting requires expertise from multiple disciplines and managers will require a robust
technology firm with deep knowledge of legal and regulatory, operations, finance, risk, and alternative
fund management. In addition, the technology firm should have sufficient gravitas within the industry.
4. 4
Having access to regulatory bodies for inquiries on behalf of clients – for prognosticating what the
regulators are looking for in the requisite reports can be a large part of the challenge.
2 RegERM Process
By implementing a RegERM platform that consolidates data from multiple sources into a single system
and provides the required advisory services, the path to successful reporting becomes more predictable
and streamlined.
The following are recommended "best practice" steps to developing, implementing, and maintaining a
robust RegERM system for compliance and reporting requirements:
Step 1: Data Source Identification
The required data is typically not available from one source. Whether the source is front office, middle
office, back office, fund administrator, prime broker, counterparty or custodian, or whether data is
domiciled in Dublin, New York or Hong Kong, the right RegERM system must identify and subsequently
integrate, reconcile and validate all necessary data sources.
The data elements required can vary widely depending on factors such as the specified regulation and
the fund's strategy. Examples of the data elements required may include positions, transactions, NAV,
assets under management, collateral, borrowing and credit support details, cash details, risk and
performance metrics, investor information, investment liquidity, investment ownership, and service
provider information.
Step 2: Data Aggregation
Once identified, the source data needs to be synthesized, reconciled, and validated. Optimal data
aggregation requires a secure, customizable data warehouse that allows manager, fund, position,
transaction, performance, risk, and investor level information to be managed side by side regardless of
data source, investment strategy, and investment asset class. In addition, the platform should allow the
technology and data management personnel to accept data in any system-digestible formats and to
review and reconcile disparate data. Ultimately, a clean data set must be generated, which can then be
leveraged for any regulatory report.
Step 3: Data Transformation
Transformation of the data into the correct protocol is frequently the most difficult and time-consuming
part of the exercise. Understanding the various regulations and how they apply to particular asset
managers as well as comprehending the extensive array of regulatory calculations and mappings
required can be challenging for any investment firm. A strong RegERM automatically computes most of
the required calculations but access to experienced advisors who can work alongside the investment
manager to determine their regulatory obligations, data requirements, and data discrepancies is another
necessary element.
Step 4: Centralized Data Warehouse and Calculation Engine
Once the data has been appropriately transformed, it must be aggregated into a centralized data
warehouse. This step is essential to the overall alignment of third-party reporting. While the data sources
5. 5
for Form PF, CPO-PQR, Annex IV and other reports may be the same, the output requirements are
different. Aggregation of the underlying data into one warehouse ensures consistency and facilitates the
population of reporting protocols. The most efficient means of answering reporting questions is the use of
a proprietary calculation engine which can aggregate the transformed data from the warehouse and
populate the reporting template per the requisite protocol.
Step 5: Review and XML Transformation
The final step prior to transmission is the review of the output. This involves both a technological
validation as well as manual checks for unexplained disparities and required explanations. A strong
RegERM system provides full workflow capabilities allowing the investment manager to track the entire
process. The RegERM system should provide an interface for validation, review, approval, and
submission of the filing as well as capabilities to store submissions and filings and provide an audit trail
for future reference.
Critically, the platform must perform a series of systematic checks on the filing. Finally, a team of
regulatory professionals should review the report question by question to confirm responses.
Step 6: Electronic Transmission
Once the review is complete, the RegERM system should have the capability to prepare the electronic
filing. Different regulators require different mechanisms for submission. Most require XML but some
accept Excel and rarely are the formats identical between regulators. In addition, some allow direct
transmission while others require the reports to be uploaded via a portal or submitted by e-mail. A strong
RegERM system will ensure that the filing is prepared and submitted in the manner required by the
applicable regulator.
Conclusion
Regulatory reporting has generated significant new challenges for the investment management industry.
There is no question that regulatory requirements have been and will continue to be refined as the
regulators harness the new information at their disposal and enforce different risk profiles on the market.
Investment managers who choose to directly confront these challenges can mitigate serious risks that
have the potential to compromise their firms. Such firms generate regulatory alpha through their RegERM
systems. These systems harness service providers, technology, and advisors and follow a stringent
reporting process. Successful implementation of such systems can help investment managers avoid
large expenditures of time and money from botched processes, poor systems, and regulatory scrutiny.
An effective system is designed to be flexible and agile to accommodate evolving requirements. The best
system will be at the forefront of change, liaising with regulators, and enhancing processes to ensure that
the investment management firm has access to the best technology available in the industry.
On top of continuing to demonstrate compliance with global regulations, the RegERM system should be
leveraged for other functions. As regulators require more reporting that demands detailed interactive data
management systems, firms can opportunistically take advantage of using this new platform to support
their investment operations, sales, marketing, and client communications. As investors become
increasingly sophisticated so do their requirements and any errors, slowness, inconsistency in reporting
