By Jenine Ellappen – Compliance Product Manager at Infovest
Consolidation is often perceived as a positive goal. Software companies are continuously making acquisitions and trying to merge products and services to create an ‘all-inclusive’ package. Is this dream really possible though? Is it feasible for one solution to be the best at everything? The investment industry is enormous and has many components including portfolio management, performance, risk and compliance to name a few. For a single product to master all of these requires extreme flexibility, domain expertise and a well-designed architecture. Therefore the question is: given the choice, should one choose an all-in-one solution or a specialised product?
In investment compliance, this choice gives rise to heated debate between the business and compliance teams. While integrated order management systems seem to offer an all-in-one solution, which includes pre and post trade compliance, there are certain limitations on the post trade functionality resulting from the fact that the system was not specifically designed for post trade compliance. Consequently, there are many arguments to support the case for a dedicated investment compliance system.
One of the main reasons that compliance teams need a dedicated compliance system is to allow them to have compliance centric data which is independent from other business units.
Data is vast and in every organisation the instrument universe, data attributes and data needs are constantly growing and evolving. In addition, compliance regulation is also evolving and becoming ever more demanding.
There are various regulations and investment policies in place to protect investors. These stipulate investment restrictions across various data attributes such as asset type, sector, country and issuer. The difficulty is not in obtaining data but in obtaining clean and consistent data. A prime example is finding clean issuer data as there is no international naming convention. If a fund has exposure to an issuer named ‘US Treasury N/B’ and another issuer named ‘US Treasury FRN’ the system will identify them as different issuers, not aggregate the exposures and as a result potentially not report a valid breach. This is a major risk. In addition compliance may require additional data on unlisted instruments or alternative asset type classifications. Certain regulations refer to the term ‘transferable securities’ instead of ‘bonds’ or ‘equities’. With a compliance centric database, the compliance team is able to clean, classify and supplement data without being concerned about the impact on other business units.
Investment compliance rules can be complex and a flexible rule builder is essential. While many systems have rule templates it is never the case that one size fits all.
Best of breed systems have a combination of templates and base rule components, such as calculators and aggregators, to allow the compliance team to create their own custom rules via a rule wizard. This provides them with flexible tools and insight into the detail of the rule calculation. It also empowers the compliance team to take full ownership of their rulebooks.
Consider the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive which provides investment guidelines for Collective Investment Schemes (also known as Mutual Funds) which has the 5/10/40 rule that restricts investments in transferable securities or money market instruments issued by the same body to 5%. This 5% is however raised to 10% provided that the sum of all exposures greater than 5% is less than 40%. This rule may appear to be simple but it actually requires conditional logic and a mix of aggregators. In South Africa the Collective Investment Schemes Control Act (CISCA) Board Notice 52: Determination on the Requirements for Hedge Funds has a similar rule. This complexity demonstrates the importance of having a flexible rule building platform.
Breach management is also a significant component of any compliance system. Once compliance breaches are identified by the system the compliance team require tools to investigate and manage these breaches.
Breaches may occur for a host of different reasons such as market value movements, cash investments or disinvestments, purchases or sales of instruments or portfolio transitioning. The compliance team may choose to take different approaches depending on the underlying cause of the breach. In most cases though, the portfolio manager will need to be contacted with the details and calculation of the breach.
This communication should be executed from the compliance system and all comments should be saved for auditing purposes. Should a fund incur major losses and the regulator looks for those accountable, the compliance team needs to have the fund compliance history and comments at their disposal.
The system should also be able to automatically send daily compliance reports and escalation emails. If a breach age exceeds a certain number of days the system should highlight this by sending a notification to the compliance users, risk manager and portfolio manager.
In summary, to operate effectively, the compliance team requires a dedicated investment compliance system with all the necessary tools to fulfil their mandate. They need a system that provides them with compliance centric data, a flexible and simple rule wizard, sophisticated breach management and automated reporting. To settle for anything less will compromise compliance capability with far-reaching consequences for investors and the firm itself.