The RegTech Imperative: Addressing the Rising Cost of Non-Compliance

Jun 12, 2018

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Compliance technology has clearly grown in prominence in recent years and the reason for that is simple. Not only has the industry’s regulatory framework become more complex and difficult to navigate, but the cost of non-compliance has also risen significantly.

Together, this has served as a driving force for firms to invest in technology that not only helps meet compliance obligations more efficiently, but also more effectively. In order to appreciate the challenge that RegTech is looking to solve, it is important to look at the cost of non-compliance and how that has evolved in recent years.

The Regulatory ‘Stick’ is Reaching Farther

Perhaps one of the biggest impacts of technology is that it has made it easier for individuals and institutions to store records. When it comes to regulation, this basic technical capability has provided the means to expand powers of surveillance and enforcement. Greater transparency obligations have armed regulators with the information with which to investigate cases of non-compliance. Equally, new rules signed into law over the last ten years – covering everything from market abuse, best execution, inducements, anti-money laundering, bribery and corruption – has provided them a broader remit with which to do so.

Although the pendulum may have started to swing away from overly prescriptive rules towards more principles-based regulations, this will not reverse the demand for RegTech solutions. Looking at regulatory fines and investigations over the last couple of years unveils a number of examples on both sides of the Atlantic that demonstrate regulators are only just starting to enforce new areas of responsibility.

Anecdotal Evidence

For example, towards the end of last year, the FCA issued a statement of objection against four asset managers alleging that they had colluded by sharing information on the price they intended to pay for an initial public offering (IPOs)[1]. According to its own statement, this was “the first case the FCA is bringing using its competition enforcement powers.”

Those competition enforcement powers look set to be flexed further. Earlier this month, the FCA finished its investigation and announced measures to improve competition in the UK’s asset management industry[2]. It has also signalled that it is looking to promote fee transparency and competition between private equity and hedge funds[3].

The SEC has also found new ways to exercise its powers in recent years. Its case against Och-Ziff Capital Management demonstrated how wide-ranging their powers have become. It was the first time a hedge fund had been charged under the Foreign Corrupt Practices Act (FCPA). Even after agreeing to pay hundreds of millions of dollars to settle initial charges made against the company and its senior management[4], the SEC still came after two of the fund’s former executives who allegedly masterminded the bribery of government officials across a number of African countries[5].

In another first-of-its-kind case, although less newsworthy, BlackStreet Capital Management agreed to settle SEC charges in 2016 that it had brokered a deal and charged fees but failed to comply with registration requirements to be registered as a broker dealer[6]. This demonstrates that non-compliance does not need to be malicious. Even simple administrative obligations like registrations and attestations incur significant penalties if overlooked.

A Broader Trend

Although many of the previously-mentioned examples could be seen as anecdotal when viewed in isolation, combined they paint a clear picture across the investment industry. Investment management firms face broader obligations, closer scrutiny and harsher enforcement than ever before.

This trend is backed by aggregate statistics. From the start of 2017 to September 30, 2017, the SEC announced it had conducted 2000 examinations of investment advisers, up by 30% from the prior year, having reassigned an additional 100 staff members to its examinations unit.

What the Future Holds

Globally, there are still many newly-introduced rules whose impact has not been fully realized across the investment management industry. In Europe, in particular, far-reaching regulations like MiFID II and GDPR have yet to be tested when it comes to enforcement. Both are not only far-reaching in the breadth of their rules, but also their extra-territorial nature and potential severity of penalties.

At the same time, initiatives such as the senior managers and certification regime in the UK (which is due to be extended to cover investment management firms) will further emphasize the need for individual accountability and professional competence. And while the current US administration has signalled its desire to reduce the regulatory burden on firms, it has not made a material difference with regards to the obligations facing investment management firms.

Participants in the capital markets across the globe – individuals and institutions alike – face a higher bar when it comes to the standards of behavior. To enforce those standards, regulators continue seeking greater transparency (through rules such as MiFID II) and are introducing new surveillance systems (such as the consolidated audit trail in the US). They broadly see technology as a key part of the industry’s roadmap (as detailed by the FCA’s business plan).

With IT contributing to the closer regulatory scrutiny of investment firms, it is only natural that those firms turn to technology as a means to meet their regulatory responsibilities. IT clearly has a role to play in compliance. From helping to capture and disseminate the impact of new rules, train and monitor employee behavior, capture records, submit reports, manage certifications, registrations and attestations – RegTech is set to continue evolving its capabilities with a simple goal – to make compliance more efficient and effective. However, in order to achieve that goal, the industry will need to continue investing in this kind of technology.

[1] https://www.fca.org.uk/news/press-releases/fca-issues-first-statement-objections-four-asset-management-firms

[2] https://www.fca.org.uk/news/press-releases/fca-sets-out-next-steps-improve-competition-uk-asset-management-industry

[3] https://www.ft.com/content/cbb6d6d0-a777-11e7-93c5-648314d2c72c

[4] https://www.sec.gov/news/pressrelease/2016-203.html

[5] https://www.sec.gov/news/pressrelease/2017-34.html

[6] https://www.sec.gov/news/pressrelease/2016-100.html

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