Reporting and Governance

As the number of rules increases, along with their interpretations by individual regulators, firms are having to turn to digital solutions so as not to become completely overwhelmed. By Randeep Buttar, founder of Compliance as a Service.

Regulators across the globe continue to enforce ever tighter constraints on financial activity, such as the trading of derivatives, the management of capital, liquidity and financial risk, which is creating real challenges for firms. 

The challenge of compliance is further heightened because of the difference in regulators’ requirements from one jurisdiction to another. This makes regulatory interpretation very difficult. The ability to report on compliance accurately is severely impeded as a result, and so we must level off the regulatory landscape and embrace technological advances to be able to report on compliance in a more effective and accurate manner. 

In 2013, the Basel Committee on Banking Supervision stated that “many banks lacked the ability to aggregate risk exposures and identify concentrations quickly and accurately at the bank group level, across business lines and between legal entities”. This was mainly due to the lack of common data definitions. It was imperative to address this so that enhanced regulatory reporting requirements could be met.

Since 2007/8, institutions have faced an ever-increasing regulatory burden. Consider the fact that the Markets in Financial Instruments Regulation (MiFIR) and Directive (MiFID II) contain more than 500 pages of information. The volume of new regulation has increased significantly, as has the rate of change to existing regulation, including a 492% increase in regulatory changes between 2008 and 2015. Simply keeping abreast of these changes is a significant challenge, in that all this needs to be interpreted and aligned to a compliance delivery plan which is likely to affect many areas, such as services, products, metrics, policy, processes and systems.

Complicating matters, the industry faces a high level of fragmentation. Regulators, central banks, government bodies and the legal industry are not aligned. Regulations can be discretionary, principles-based or rules-based. “Consistency in reporting to regulators across banks depends hugely on definitions: clear and consistent data dictionary that is agreed by all participants, which just doesn’t exist at this time,” said Anastasia Dokuchaeva from compliance software specialist ClauseMatch. 

The cost of fragementation

Differing local regulatory requirements and guidelines increase complexity, meaning that in some cases different processes must be implemented in different jurisdictions making operations costly. It is estimated that regulatory divergence of this nature costs the industry $780bn per year.

“A single directive can lead to lead to 28 different variations, with EU member states ‘gold-plating’ the transposition into national laws and regulations. That’s a nightmare for digital banks to mitigate regulatory risk and maintain compliance,” wrote Professor Tom Butler at the University of Cork.

To keep up with demand, compliance departments have grown. Large banks in the US and the UK are allocating between 10% and 15% of their workforce to compliance functions. By increasing headcount, operational expenditure rises and yet the desired outcome of becoming compliant is not achieved.

“Most regulatory reporting obligations are met by leveraging significant manual effort. The Catch-22 is that companies are using highly skilled resources that could be leveraged for preventative control measures or risk management to generate reports on compliance outcomes after the fact,” wrote Karl Viertel, founder and CEO at risk analyst Alyne.

Against this backdrop, the ability of institutions to report on their compliance state in an accurate, granular and timely manner has become a priority for senior managers. An example of where technology helps in a simple yet effective way is identifying regulatory overlaps. Some 50% of a compliance officer’s time is spent aligning global compliance requirements, evaluating compliance costs, implementing and ensuring compliance with new regulations, regulatory reporting and remediation programmes. 

To arrive at this point, however, a timely approach is required to distil regulations. This means regulation needs to be digitised. Text analytics can then be used to structure text in a way that enables classification, tagging or annotation. Semantic analytics can take this and match and sort it against a set of terms, which in turn provides meaning. This gives institutions the ability to effect compliance implementation as a data-driven exercise. 

Technology will need to take into account the reality of calculations which vary, such as value at risk, which can be calculated in many ways including variance-covariance, historical simulation and Monte Carlo. ‘Tagging’ can be used to link to all of these ‘instances’, the benefit being the ability to compare the approaches but also model the benefits of a unified calculation approach.

Regulators require the ability to aggregate submissions across multiple institutions. The Prudential Regulation Authority oversees 344 banks in the UK; the European Central Bank oversees 744 monetary financial institutions across Europe; and the Office of the Comptroller of the Currency oversees 852 banks in the US; hence the need to standardise in making comparisons. Attempts are ongoing but challenges remain, such as industry classification codes, country codes, product codes and so on.

Regulators are seeking equivalence, but they are still divergent. Considering Brexit, the UK’s Financial Conduct Authority is seeking ‘mutual recognition’ rather than equivalence with the EU. Nevertheless, institutions operating in multiple jurisdictions must satisfy reporting requirements according to different interpretations. The cost of achieving this manually is high, and therefore a good combination of technology and regular interaction with regulators is necessary to keep up.

Whether it is capital and liquidity reporting, structural reporting or market-driven reporting, the need to ascertain an interpretation, deliver to a standard plan, demonstrate compliance at multiple levels and then report is fundamentally the same. 

For institutions and regulators, it is vital that this challenge is shared. There will always be competing perspectives: the growth agenda versus the control agenda, for example, or harmonising regulation globally versus geopolitical considerations. However, it is important that transparency and alignment are achieved. This can only happen by truly getting a handle on the data definitions. Implementation and scaling are challenges that require commitment and management focus. 

A Speakers’ Corner is an area where open-air public speaking, debate and discussion are allowed. The original and most noted is in the north-east of Hyde Park in London

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