Eliminate Manual Processes with Built-In Compliance by Design

Increasingly, regulators are adopting more principle based compliance regulations.  Most recently in the UK, PROD 4 regulations for Insurers have come into force and in Australia, the Design and Distribution Obligations (DADO) are now in effect for any financial service firm.   In the past, regulations were more prescriptive; requiring firms to provide certain information to regulators or customers.  Now, as manufacturers of product, firms are required to ensure their products provide “fair value” and  they must identify target markets for each product and monitor who buys them to ensure the product being purchased is “appropriate” for the customer and their circumstances.

 This is a very different approach from the more traditional mandates around disclosing risks and providing data.  That approach put the responsibility on the consumer to read and understand what the risks and data meant to them.  Now, the onus is on the firm creating the product to ensure that the customer is not only getting what they pay for, but also that what they buy and how they buy it is appropriate for their situation and their means and financial sophistication.   

And while these principle based regulations can be considered by some to be a bit ambiguous, that has not stopped regulators from using them to inflict heavy fines.  In 2020, the latest year with data available, global regulators levied fines totaling over USD 10.4billion for regulatory breaches.

Report: Fines against financial institutions hit $10.4B in 2020

Those numbers have gotten the attention of CEO’s and their Boards worldwide.  According to a Deloitte survey, 87 percent of executives rate reputational risk as more important than other strategic risks.  And reputation is not just a regulatory compliance issue.  It is a cultural issue.  In many cases, the cost of a blunder goes far beyond any fine that could be assessed. Most recently, we saw Credit Suisse punished by the market for lax risk management.  Its’ share price fell by nearly 25% when details of the Archegos portfolio came to light; not to mention the two C-suite executives who stepped down.

Financial Service Firms find themselves at an uncomfortable intersection of increasing and constant principles based regulation; Board and C-Suite pressure to avoid reputation risk; and their traditional organizations that make “compliance” a box-ticking problem for the legal silo alone. 

This new paradigm is at odds with how most firms have organized their compliance departments.  There are not really boxes to ‘tick” anymore.  To be compliant with these new principles requires firms create a culture of compliance that permeates the entire firm.  For example, Sales and Distribution professionals are now “on the hook” for understanding what the end consumer pays and the profit margins of their distributors.  Product managers need to do more than just create an attractive new service or feature.  They now need ensure that product is sold to the “appropriate” target consumer years after it leaves the drawing board.  This requires a new level of collaboration and ownership that can only come from a new set of tools and solutions. 

To succeed in this new environment, financial firms can learn from industries like aerospace and defense and the automotive industries.  These sectors have had to deal with exacting product specifications throughout the lifecycle of a product for decades.  Every individual in the process owns compliance and knows the ramifications of not meeting specifications.    These industries incorporate compliance throughout the product creation, management and even the sunsetting process of a product.  That means everyone owns compliance and everyone collaborates on a single platform,  The result?  Efficiency, compliance, speed to market and auditable, traceable decisions.

There are 1.4 million paragraphs in the revamped version of the EU’s ‘Markets in Financial Instruments Directive’ (MIFID II) – making it a tad over 7,000 pages long. That’s roughly seven times longer than Tolstoy’s War and Peace. Staggeringly, MIFID II is just one of 80 regulatory reforms that came into effect since the 2008 financial crisis, demanding more transparency, reporting and collaboration in the design and sale of financial products. Meanwhile, in the USA, there are rumours that the Dodd-Frank Act, which spells out numerous financial provisions over its 2,300 pages, is about to be amended significantly.

Crucially, MIFID II introduces the principle of ‘Product and Sales lifecycle’ – something that’s already well-established in other industries such as aeronautics, automotive and life sciences. Our industry is clearly behind the times. 

“To manage product and commercialization lifecycles, these industries have put in place built-in compliance by design.  This involves collaborative approaches that are efficient, help to handle the complexity of development, manufacturing and distribution of highly regulated products, and enable adoption of a global strategy for the whole product lifecycle.” Explains the whitepaper ‘MIFID II: opportunity or constraint?’

“In the aeronautics industry, for example, an aircraft is subject to certification throughout its development cycle. Product lifecycle management records and manages the process from the early architectural design stage to how the product is manufactured, operated and maintained. It also considers how information is recorded from operations, tracing and demonstrating development throughout the process. This provides greater security and protection of the ‘consumer passengers’. These activities are so important that they account for 20 percent of the non-recurring development costs for an aircraft program.”

So now it’s our turn. These regulations are clearly overdue and serve an honorable purpose: to offer greater protection for investors and more transparency into all asset classes. But they do present a major headache for compliance departments around the globe and the way they manage data.

What’s more, over the next few years, even more expensive regulations with indisputable deadlines will come into being, building on the ones before. The cost – in both cash and time – of meeting their combined demands using current practices would be even more exorbitant than they are now.

“The average bank spends approximately 40% to 60% of its change budget on regulatory compliance – but squanders a significant portion of this investment on inefficiencies. As regulations continue to expand, companies need to fundamentally change their approach.” So says the article ‘When Agile Meets Regulatory Compliance’ by Norbert Gittfried, Dr. Erik Lenhard, Walter Bohmayr and Claus Helbing.  

They’ve hit the nail on the head. Many organizations are still working with disjointed technologies and processes across departments and geographies. Their investment management relies on manual processes that hamper collaboration, innovation and product governance. That’s why financial institutions often outsource their compliance workload to law firms or consultancies, hiring enormous teams on equally enormous wages to handle projects. But even then, compliance is not guaranteed.

The mistake they are making is in treating change – and the way their business adapts to it – as the exception not the rule. Change should be considered ‘business as usual’.

They should put in place permanent but flexible processes – embedding governance and control in the business culture, not hired in on a random basis. This should then be supported by a sustainable platform that can be updated to fit future regulations as laws evolve. A digital platform that has the agility to deal with regulatory changes such as product revision.

That’s the theory but as the whitepaper ‘Digitization of asset and wealth management: promise and pitfalls’ points out, the reality is a bit different: “Lately, much has been written about the revolutionary potential of digital technology... But there is little information available on the actual practices on the ground. The rhetoric of technology has run ahead of reality. It’s time for a stock take.”

“Senior executives have become preoccupied with the day-to-day running of the business (cited by 48% of the respondents), while there has been inadequate forward spend on digital skills (38%) and regulatory issues have been slowing things down (35%).

In particular, the day-to-day pressures on senior management have been all the more intense, at a time when investment returns remain driven more by politics than economics due to central bank action. When business leaders are always fighting yesterday’s problems, it is hard to get on the front foot and envision a new future.”

But, whatever the excuse for not doing the right thing, it still has to be done. So, what’s the next step? The same whitepaper points out that digitalization in itself is not the be all and end all. It is simply an enabler in the delivery of business strategy.

“Without a clear strategy and a group of far-sighted people committed to deliver it, no digital tool can make much difference – no matter how sophisticated.” Its interviews with money managers who were early adopters of digitalization confirmed one truth above all others: “Strategic change is as much about mindset shifts as about bright business ideas or shiny new gizmos.”

“A PLM approach helps us structure our offering while keeping operating costs in check… We are pioneering the use of the PLM technology that has been so successful in traditional industries, such as the aerospace or automotive sectors, to design and market new, across-the-line financial instruments.”

Innovation Factory provides BNP Paribas Securities Services with its own tailored dashboard that displays internal and external data: product ideas from its clients, partners and employees around the world; market, competition and regulatory data; up-to-date product data; client proposals and associated Requests for Proposal, as well as profitability, billing and contractual information.

The result? “We have a consolidated, instantaneous view of each project and its evolution over time… 360° traceability.” Said Philippe Ruault, Head of Clearing, Settlement & Custody Products.

So, what should be on their solution shopping list?

Multi-disciplinary collaboration across one integrated platform is the basic ‘must-have’. This will break down the silos between people, processes, data and systems.

And, in addition to automating regulatory rules enforcement, it’s important to maximize the reuse of information via well governed, templatized processes.

Companies also need to establish internal processes and controls to perform comprehensive due diligence and ongoing assessments of service providers. Such a controlled, process-based culture can massively cut compliance costs.

Furthermore, the capability to gather, align, enrich and most important of all, interpret Big Data will provide valuable information and customer insights. All of which should be delivered in a user-friendly manner – ideally by real-time dashboards and analytical views of the entire product lifecycle.

With this in place, regulatory changes can, at last, be treated as ‘business as usual’. So instead of starting from scratch with each new reform, these businesses will be able to maximize the re-use of information, build on already-established processes and templates to automate their obligations to regulators and investors – improving transparency and accountability. What used to take weeks in tedious manual entries and random sampling will be completed in megabytes per second, freeing up time to be invested more profitably.