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Underlying Data and Overall Governance are Central to Surviving the Regulatory Tsunami

Financial services firms must tackle underlying data issues and enforce top-down governance strategies if they are to survive the regulatory tsunami, argued Anthony Kirby, director of Ernst & Young’s regulatory and risk management practice, at last week’s International Securities Association for Institutional Trade Communication (ISITC) conference in London.

Addressing the operational impact of upcoming regulations, Kirby and a panel of capital markets participants discussed the problems caused by increasing regulation and some potential solutions. After reviewing market crises from Black Monday to the collapse of Lehman and the Flash Crash, Kirby considered the global, regional and local scope of regulatory reform, pointing particularly to the scale of measures such as Basel III, the Dodd-Frank Act and Solvency II.

“This isn’t just a compliance issue,” he said. “Regulators are no longer just engaging with risk and control departments, they are also visiting C-suite members, such as the CFO and CEO these days. If the current pace continues, meeting the requirements of regulation could cause banks to double or triple the size of their compliance and risk teams over the coming five years, but where will these people come from? Combined regulations could also elevate a bank’s cost/income ratio by anything up to 1% to 2% a year.”

With many regulations having overlapping time horizons, transparency is becoming ‘the mood music of regulation’ and financial services firms are facing rising costs, but not always rising revenues. Kirby argued that more damage will be done if regulation is not addressed with operational executives around the table that already hosts politicians and regulators.

“Over the next few years, European regulations, such as Basel III and EMIR [the European Market Infrastructure Regulation] will challenge business models, revenue and balance sheets. The need is to sort out the top and bottom of the problem, from overall governance down to fundamental market and reference data,” he said.

“Firms should try not to dig up the road again and again to automate systems for multiple regulations, and they should try not to focus on individual regulations in isolation, but on a broader business approach. For example, banks could defray anything up to 20% to 40% of future regulatory cost by not digging up the road over and over again. There are innovators in the market, but only about 5% of firms are looking at regulation in an operationally holistic way.”

Kirby noted the disciplines needed to manage regulatory intervention, including transparency, disclosure and robust documentation, and emphasised that the regulatory environment is no longer about ‘trust me’, but about ‘prove to me’. He added: “There is much to do, but it is possible to save money and time by recognising regulations as a common problem and bringing operations and data management to the attention of politicians and legislators from the word go.”

A vox pop question on the burden of regulation showed 92% of audience members expect the regulatory workload to increase in 2013, while 8% expect it to remain the same. Andrew Gibbons, chief operating officer at Thomas Murray, commented: “Things will only get worse next year. There are a lot of regulations in flight now, but in 2013 there will be more implementation. Operations is about change and regulation has a big impact on operations. Then add issues such as the euro crisis and libor investigation and the burden will only increase.”

Panellists noted the difficulty of securing budget and planning change when regulations are not finalised and information is incomplete, as well as the operations challenge of working with many regulations that are not consistent in areas such as terminology. “Until we have standardisation across regulations, implementing them will continue to be very difficult. We need market standards and best practice,” said Gibbons.

Presenting a vendor perspective, Gary Brackenridge, senior vice president of strategic initiatives at Linedata, said: “It seems the market is living with decisions it didn’t make and is stuck with infrastructure it can’t change. If a systems provider could say it had a solution to the regulatory problem that would be great, but it is not possible to replace core systems immediately. Infrastructure remains rickety and systems providers must plug gaps and put wrappers around systems. This is difficult for vendors as every situation is unique, which means we can’t get scale and drive down replacement costs. More shared market infrastructure would help drive costs down. Meantime, vendors are in a race to develop solutions to plug and wrap existing systems”.

While shared infrastructure does not yet play a significant part in the industry, Gibbons suggested shared utilities, initially supporting post-trade models, could support the market in the next two to three years. Meantime, Geoff Harries, global head of asset servicing solutions at DST Global Solutions, said customers are increasingly looking at outsourcing the regulatory problem, in part because the cost of compliance is astronomic compared to the value add. But he warned: “It is possible to outsource responsibility, but not accountability, leaving a lot of work on issues such as the interpretation of regulation and the oversight model for compliance in house.”

Audience responses to a second vox pop question asking how firms would respond to regulatory overload reflected the panel’s views. A large number suggested resources would be diverted to do just what was necessary to comply with regulation. Others said spending would be increased to cover both new initiatives and regulatory compliance, some said business models would be simplified to support only core functions, and one or two suggested it was time to run for the hills.

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