As SFTR Deadline Looms, Time to Take Control of Your Data
Looming regulatory deadlines – such as the impending roll-out of Europe’s Securities Financing Transactions Regulation (SFTR) – are rarely welcomed by compliance teams at buy- and sell-side firms. But the introduction of this complex and far-reaching regulation, starting April 2020, offers market participants a significant opportunity. Firms that have so far adopted a tactical approach to European reporting requirements can leverage SFTR to switch to a more strategic mindset.
Compliance teams know that quick fixes – third-party delegation or other regulation-specific “point solutions” – do not address the fundamental mismatch between the data generated by internal systems and that required by regulators. Those that use SFTR to take greater control of their data stand to achieve substantial long-term process improvements and cost-efficiencies.
Lessons learned?
What have we learned from the release of EMIR (2014) and MIFID II (2018), which respectively introduced standardized reporting requirements in Europe for derivatives and then a wider range of instruments across Europe’s financial markets and beyond?
First, pre-existing systems used for order generation, transaction execution and collateral management are not easy to adapt to new reporting requirements, with market participants left needing to enrich, aggregate and validate data efficiently and accurately across a diverse range of instrument types. Under deadline pressure, this problem has often been tackled by delegating reporting to a third party or buying (or even building) a regulation-specific solution. For delegators, a key risk is a loss of control, despite still being liable for reporting submitted on their behalf.
Delegated reporting services from dealers have proved to be variable in quality, while delegating firms struggle to develop the subject matter expertise to improve data and process quality over time. Continued delivery of poor quality data to outsourcing suppliers, due to inadequate feedback loops, inevitably incurs cost and risks fines. This issue is particularly acute if – as with EMIR and SFTR – double-sided reporting requires transactions need to be matched at the trade repository level.
For those buying ‘point solutions’, the downside is the lack of future-proofing, while building in-house can be highly resource-intensive. What happens when regulatory requirements evolve, as with both EMIR and MiFID II? What happens when international agreement is reached among regulators on use of a new identifier that must be incorporated into reports? Bought-in point solutions rarely offer the change management capabilities to handle these inevitably developments and it can be expensive to maintain the required resources and processes in-house.
Indeed, many firms have found themselves devoting valuable human and financial resources to handling multiple incremental changes to regulatory requirements. Due to inadequate change management, market participants have been building new features and maintaining inefficient processes, diverting attention away from activities that increase revenue and/or value to the end-client.
This is the second key lesson: regulation is an imperfect and evolving process, requiring regulated firms – and their compliance teams in particular – to oversee adjustments to their internal workflows and systems on a regular basis. This is likely to be our experience of compliance with SFTR, too. For now, European Securities and Markets Authority (ESMA) recognises that SFTR’s requirement for reports to include legal entity identifiers for collateral issuers cannot be met fully because these are not yet widely adopted in Asia and the US. But this will change over time and must be anticipated for smooth ongoing compliance. As ESMA Chair Steven Maijoor recently noted in his address to the FESE convention, the interplay between global capital markets and regional/national regulation “implies a continuous challenge” for supervisors and market participants alike.
Change of mindset
In view of the ongoing operational challenges presented by evolving regulatory reporting requirements, we believe there is merit in a change of mindset. Rather than a necessary evil, reporting obligations can be regarded as a launchpad for a more sustainable approach to data management that yields extensive improvements across the daily operations of market participants.
For any firm that has used tactical reporting solutions to date, compliance with SFTR is likely to be a painful, complex and costly experience. SFTR reporting includes a larger number of data fields, many focused on re-use of collateral, posing severe problems for firms using fragmented architecture and semi-manual processes across collateral management, repo trading and securities financing. And despite slow progress on standardization of unique transaction identifiers, ESMA is insisting on accurate data and high match rates from the outset.
Clearly, time is of the essence. But greater control of data and more streamlined reporting processes have benefits beyond compliance. The back offices of market participants have long been plagued by trade fails, breaks and costly manual intervention due to imperfect information flows and missing or incorrect data fields. A more comprehensive approach to data management and governance not only reduces these risks and costs, but offers the possibility of new insights and efficiencies. For example, firms may be able to identify and eradicate common sources of mismatches, perhaps pertaining to particular counterparties.
Tactical solutions for EMIR and MiFID II have typically offered users neither short-term fixes nor long-term benefits. For market participants willing to adopt a positive mindset to regulatory reporting, SFTR offers an opportunity to take control of data and to build a strategic platform that will deliver both low-effort compliance and high-impact benefits year on year. To find out more about how CSS can help you take control of your data, please visit our TradeChannel page or contact us.
Data Quality the Key to Meeting Challenge and Opportunity of Cost Transparency
Technology has done much to increase cost transparency in recent years, yielding considerable power – and savings – to consumers. Price comparison websites, for example, make it easy for us to weigh the costs of regular household expenditure items – from holidays to utility services to home insurance – across multiple providers. Behind the technology of course, many workflows must operate efficiently to deliver on the promise of a good deal. Without robust data governance and management processes, the quality and completeness of information cannot be guaranteed, which undermines consumer choice.
These challenges are no doubt familiar to compliance teams at asset management firms. It’s fair to say there has been a revolution in transparency in the industry in recent years, with transaction costs very much in the spotlight. Europe has led the way, with MiFID II and the Packaged Retail and Insurance-based Investment Products (PRIIPS) Regulation spelling out specific requirements for how information on costs and charges should be collected, calculated and presented to end-investors.
But the direction of travel is common across major jurisdictions. All asset managers need to ensure that they meet disclosure requirements on transaction costs wherever they market their funds, ensuring their internal data management processes are sufficiently flexible to accommodate nuances in regulatory obligations.
In truth, we’re still in the early stages of this revolution, despite the Herculean efforts of compliance teams ahead of MiFID II’s introduction in January 2018. While deadlines undoubtedly drive change, every compliance officer knows compliance is a process, not a single event. As such, the industry is still working its way to the stage at which end-investors can make informed choices between providers based in part on accurate and comparable information on transaction costs.
This much was made clear earlier this year when the Financial Conduct Authority published the findings of its review of disclosure costs by asset managers. Acknowledging that the interaction between MiFID II, the PRIIPs Regulation and the UCITS Directive “is not seamless,” the UK regulator pointed to shortcomings in the calculation and disclosure of transaction costs, concluding: “Asset managers may be communicating with their customers in a manner that is unfair, unclear or misleading and as such investors can be confused and misled as to how much they are being charged.”
Nevertheless, much progress has been made. Compliance teams have collaborated closely with their colleagues on trading desks and investment operations to take or share ownership of best execution. Compliance officers have come to grips with the information and transaction flows across multiple markets, extending their skillset in support of evolving transparency requirements.
But there are still significant barriers to efficient and effective disclosure, meaning workflows are still highly manual and prone to error, and data outputs are often incomplete or inaccurate.
In many cases, over-burdened compliance staff have had to refocus on myriad other compliance process challenges once they found a way of meeting the initial MiFID II deadline. Ideally, any compliance process should be reviewed and refined periodically, to identify opportunities for improvement and automation. Too often the temptation is to repeat a process once established, no matter how imperfect, throwing bodies at the challenge if necessary to mask inefficiencies. A further fly in the ointment is the need to supply different levels of disclosure across jurisdictions. A process designed to meet one regulator’s requirements can require substantial, costly manual intervention to support compliance elsewhere.
In part, labor-intensive approaches are reluctantly accepted by asset managers large and small because their existing data management infrastructure is not set up to support the necessary data flows. Due to past M&A activity and/or a reluctance to replace trusted legacy technology, many firms still rely on a spaghetti of systems and connections. Historically, the focus has been on getting information to the front office, with little afterthought for how transaction inputs and outcomes can be stored and shared downstream for compliance purposes. Some firms are re-examining and re-engineering their data management infrastructure to take account of new realities, but these initiatives are not simple, quick or cheap to implement.
The limitations of incumbent system architectures can make it particularly difficult to handle the MIFID II/PRIIPS methodology for calculating implicit transaction costs. While arrival price is the specified measure for liquid, electronically traded instruments, asset managers can draw on a list of acceptable proxies for various over-the-counter instruments, e.g. last close or a benchmark value. On the one hand, it is no trivial task to build and automate the connections, routines and calculations to follow this waterfall systematically; on the other, it is not the best use of a highly trained and valuable human resource to keep this responsibility in the hands of a compliance officer.
In a highly regulated industry, compliance teams have to be cross-functional, working with colleagues in multiple business lines and departments to assess regulatory requirements and identify the most cost-effective and efficient methods and mechanisms for delivering the necessary data in an accurate and timely fashion. Increasingly, this means designing and overseeing processes, using the most suitable tools available in the marketplace, rather than compliance staff rolling up their sleeves and digging out their information themselves. At Compliance Solutions Strategies, we stand ready to work with buy-side compliance teams to supply the tools and solutions that complement in-house capabilities and resources.
Unlike regulatory mandates, there is no deadline for streamlining and automating the transaction cost transparency processes of asset management firms. But CEOs, CIOs, heads of trading and heads of compliance should be in no doubt that time is running out. In parallel with warnings from national competent authorities such as the FCA, the European Securities and Markets Authority has already issued fines to firms that have not met expected standards of data completeness and quality.
Transaction cost data from asset management firms may not have found its way onto price comparison websites. But it’s worth remembering that a core objective of MiFID II is to provide greater transparency and clarity to consumers, in order to encourage increased personal ownership of savings and investments decisions. Asset managers that can use technology to deliver cost transparency both efficiently and effectively will be best positioned to grow market share as new generations take greater responsibility for their investments. CSS can help. Explore our data management and reporting solutions, and contact us.
Tips to Prevent an SEC OCIE Investment Adviser Exam from Going Bad
Strategies to employ when an SEC OCIE adviser exam goes bad drew a great crowd at the recent CSS Ascendant Fall Compliance Conference. Proactively pointing an exam in the right direction was a consistent theme, summarized by the familiar refrain: “There is no substitute for preparation.”
A few keys to note if you find your firm in this situation:
- Understand the SEC’s time frame as well as its scope – What kind of exam is it?
- Call in your helpers. This is a time when you should have compliance counsel and legal counsel as a partner.
- Keep the right attitude in the process – Be polite, responsive and timely.
- Keep track of all your conversations
The importance of understanding the type of exam, time frame expectations and scope gets your arms around the exam expectations and keeps you organized. It is absolutely acceptable to ask for clarification, but as panelist Stephanie Monaco, a Partner at Mayer Brown, LLC in Washington DC, pointed out, it’s crucial to be responsive to document requests.
Eugenie Warner and Jacqueline Hallihan, Senior Consultant and Executive Director, CSS Ascendant compliance services, respectively, discussed six ways firms can improve the exam process. Knowing where you stand in relation to the Rules and Best Practices, and type of exam and particular focus is critical. Monaco guided the audience through important steps when responding to an SEC deficiency letter, such as adjusting and implementing new procedures, and attaching those policies and procedures as exhibits in the response to the deficiency letter.
Warner discussed actions to prevent problems and tips for going forward, such as planning new business and planning lines with compliance having a seat at the table. In the end, all parties agreed that setting the stage with the right culture, preparedness and responsiveness are turning points that continue achieving good exam results.
If you need help with preparing for SEC scrutiny, please explore our compliance management services and contact us.
Giving Voice to Values: A New Approach to Ethics
The “Giving Voice to Values” program grew out of Professor Mary Gentile’s frustration of what was going on in both the financial industry and in higher education. She was frustrated and angry about the poor way that ethics was being taught in universities and applied in real-world scenarios. What developed out of her frustration is now an award-winning ethics program that is being used in many industries, including various types of businesses as well as the military.
So what makes this approach to teaching ethics more impactful? The program is focused on values-driven leadership. In her studies, Professor Gentile recognized that after each corporate scandal that hit the news (e.g., Equifax, Wells Fargo, the recent college entry scandal, etc.), a series of things always happen. First, there are the negative comments about the failure in how they are teaching people ethics in MBA programs. Then it’s the reaction and criticism from alumni that the teaching of ethics and values is not effective within MBA programs. Then the university administration will pull together a task force to brainstorm how to attack the issue. In her experience, there was a lack of real meaning and impact of these task forces. She also noticed that when students were working on ethics case studies, their thinking became more complex and they struggled with the right choice; they started to justify the case studies and the sense of what was right. A common theme in case study evaluations by students was, “I know what the right answer is, but in the real world, that is just not possible.”
The turning point of her values-based program grew from her participation in a Columbia University study that asked all incoming MBA students to tell about a time they were asked to do something in a job that conflicted with their ethics. Interestingly, very few students said they never had that type of situation. In fact, the majority of students had a story to share. Examples included inflating their billable hours, inflation of valuation, exaggerating the enhancements of a new product to maximize sales revenues, corruption, bribes, HR issues, etc. Though it was not really empirical data in the education sense, it was good data to analyze.
In conjunction with her work on the Columbia Study, she discovered the work of another professor related to the simple question of “What would you do if….?” This was the question that was asked of young individuals by a mentor, parent, teacher, leader, etc., which caused them to verbally voice their position out-loud. The studies showed that individuals that verbally voice their moral position to another went on to do good things, like rescuers in WW II. “If you want to have an impact on people’s behavior, it’s more impactful to have them act that way to be more successful.” the study concluded.
In short, it recognizes that most of us already want to act on our values, but that we also want to feel that we have a reasonable chance of doing so effectively and successfully.
Next comes the science aspect of the discussion. Professor Gentile studied the science of muscle memory and found that if you keep practicing something in the same way, your body will remember the movement. Thus, muscle memory is developed. So why not bring that concept into ethics training. Why can’t a moral muscle memory be created? This is the basis of Giving Voice to Values and the development of ways to voice concerns in a certain way to be more successful. Herein lies the three A’s to building ethical thinking:
- Awareness-building – Attempts to familiarize you with the challenges you are likely to face in your industry, in your position, in your job. Awareness is important but that’s not the only part of it.
- Analysis – Familiarize people with the policies, rules and regulations. Then present people case studies to test their analysis of it.
- Actions – The last piece of the puzzle that helps people react in ethical ways.
When we are faced with a dilemma, humans tend to act emotionally, react unconsciously and then rationalize it afterwards. Professor Gentile wants to rewire that response cycle! The Giving Voice to Values program provides the forum to actually speak up and voice concerns about the moral situation. It focuses on the values-driven leadership process. It focuses on giving a forum to employees to voice concern and attempt to remediate issues before they escalate. A culture change can occur when employees are not just permitted, but encouraged to speak up.
Giving Voice to Values is about asking the questions: ‘Here is the information about what is right, and now knowing what is right, so how do you have an impact in a positive way? What if you are going to act on your values? Does it change the conversation?’
In short, it is about empowering people to speak up and act morally.
Everyone will be faced with a values conflict within their lifetime. How you respond to these situations needs to be based on your moral compass. So speak up!
Need ethics credits or want to learn more about ways to promote ethics within your organization? Register now for our October 17 ComplianceCast, How Organizations Can Promote Ethics.
Tips for Developing a Tailored Private Fund Compliance Calendar
As regulatory concerns proliferate and become more complex, developing and monitoring your “to-do” list becomes of paramount importance. John Gentile, the Director of Private Fund Manager Services for Compliance Solutions Strategies and Michael Emanuel, a Partner at Stroock & Stroock & Lavan LLP provided attendees of the recent CSS 2019 Fall Conference some insight into compliance calendaring for private fund advisers, specifically, how to identify, complete, and track progress throughout a private fund adviser’s fiscal year.
Some key takeaways:
- Stay the Course – This means: establish and implement a testing program that is spread throughout the year and well-documented.
- Outline Your Calendar – In other words, divide the compliance tasks by frequency: weekly, monthly, quarterly, semi-annually, annually, or similar divides.
- Consider all Sources of Dates and “To Do’s” – Here, calendar all applicable regulatory requirements as well as best practices. But do not forget other sources of obligations such as Compliance Manual procedures; advisory, vendor, and other contracts; side letters; non-United States laws and regulations; remediation tasks from prior reviews and testing; and prior SEC Deficiency Letters.
Once you have your compliance calendar complete, as the experienced panelists reminded the audience, keep the analyses and documentation flowing. For example, utilize attestations; delegate certain activities; assign in writing responsibilities to utilize appropriate personnel and clarify who is responsible for implementation; and set up friendly reminders for yourself and others. To develop your knowledge of the advisory business and all of the adviser’s activities, and in turn to develop adviser-wide awareness of compliance perspectives, sit in on committee meetings and find time to engage with staff.
Finally, analyze your compliance calendar on at least an annual basis. Ask yourself about its overall effectiveness and whether it assisted you in managing your many responsibilities. If not, feel free to reach out to the panelists or others at Compliance Solutions Strategies to obtain additional support for enhancing your compliance calendar, as well as any other aspect of your Compliance Program. Check out our consulting services and contact us.
Brexit: Implications for Shareholders with Threshold Interests
As yet another deadline approaches for the United Kingdom to either leave the European Union with a withdrawal agreement in place or else exit effective immediately in a “no-deal” scenario, it is worth examining how this would affect asset managers subject to the UK regimes for major shareholdings, short selling, and dealing disclosures.
First, the latest political developments. The deadline date is 31 October 2019. By that date, if the UK and EU haven’t come to agreement on the terms of the UK’s departure, the UK leaves the EU effective immediately, unless a deadline extension is provided for in the interim. The possibility of such a no-deal scenario caused enough concern in the UK Parliament that it recently passed a law requiring the UK Government, led by the Prime Minister Boris Johnson, to formally request from the EU another extension of the deadline by 19 October 2019 if a withdrawal deal is not struck by that time. That extension would push the new Brexit deadline date to 31 January 2020. But there is no guarantee that the EU would grant the extension. Moreover the Prime Minister is reportedly searching for procedural ways in which to avoid requesting the extension in the first place, having proclaimed repeatedly that the UK will leave the EU by 31 October 2019 “with or without a deal,” despite his apparent legal obligation to request the extension.
Alternatively, if a withdrawal agreement is in fact struck between the UK and the EU before 31 October, its terms would provide for a transition period during which EU laws would continue to apply in the UK. Under the provisional withdrawal agreement agreed to in principle between the UK and the EU in March 2018, that transitional period lasts until 31 December 2020 and may be extended by two years beyond that date. (It remains to be seen whether the UK will decide to formally accept that form of withdrawal agreement.) EU laws that would continue to apply in the UK would include the EU Transparency Directive, the EU Short Selling Regulation, MiFID II and the rest of the pertinent EU financial legislation affecting asset managers and other market participants.
For shareholders with interests subject to UK threshold reporting obligations, the following is what they can expect in the event that the UK departs the EU without a deal in place on 31 October, based on statements made by ESMA and the UK’s FCA:
Long holdings
Applicable rules including the thresholds (at 3% and greater interests) and notification form will be retained, but the scope of issuers that trigger filings will change. The FCA has stated that issuers trading on relevant UK markets will be in scope. This will be the case even for such issuers that currently have their EU Home Member State outside of the UK, and even if that would subject their threshold shareholders to notification requirements in both the UK and a separate EEA jurisdiction. (Currently with the UK still part of the EU, the only issuers in scope are those with the UK as their Home Member State).
As for UK-registered issuers trading on relevant EEA markets outside the UK – typically these issuers currently have the UK as their Home Member State – ESMA has urged them to declare a new Home Member State within three months, or else a Home Member State would be declared for them. (Such new Home Member State would in principle be an EEA jurisdiction in which their securities are trading, and according to ESMA could even result in an issuer assuming multiple Home Member States if its securities happen to be cross-listed in multiple such jurisdictions.)
Short holdings
The relevant rules such as thresholds (at 0.2% and higher) and notification procedures will continue, but the list of “Exempted Shares” not subject to UK short position filings will cease to be published by ESMA. Instead the FCA will publish its own list of Exempted Shares, which will require asset managers and other short position holders to use that data source instead. Moreover, the FCA will no longer be required to provide ESMA with information about relevant net short positions on UK markets. Additionally, the EU’s “FIRDS” database, which according to previous ESMA guidance may be relied upon to understand where to file short position notifications (and which provides other useful data about ISINs listed on EEA markets), will no longer receive information fed by the UK.
Holdings in issuers within an offer period
For long holdings in issuers that are subject to a takeover bid and within an “offer period,” the threshold filing requirement (at 1% interest and subsequent dealings) will remain, but the scope of relevant issuers will change. While most such issuers based in the UK (as well as in Guernsey, Jersey and the Isle of Man) will still trigger filing requirements, “shared jurisdiction” issuers will cease to be relevant. “Shared jurisdiction” issuers can include UK-registered companies trading on a regulated market in another EEA country, or else an issuer registered in the EEA (outside of the UK) that trades on a regulated market in the UK. (When in November 2018 the UK’s Takeover Panel outlined this change to occur upon Brexit, it listed 36 issuers as falling within this “shared jurisdiction” category that will no longer trigger such filings.)
The above is based largely on what ESMA, the FCA and the Takeover Panel have stated in the run-up to prior deadlines, which came and went on 29 March and 12 April 2019 pursuant to extensions granted by the EU. In case any of that guidance changes or further updates published, leading into the next deadline date of 31 October, market participants are urged to monitor the latest developments at ESMA, the FCA and the Takeover Panel. (Consult for example the FCA’s Brexit-related web pages accessed here, or its dedicated Brexit phone line at 0800 048 4255.)
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