Top 400: Balancing compliance with business growth

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Flexibility is the key to overcoming the threat to growth caused by an abundance of new legislation, argues John Mayr of SimCorp

An unprecedented barrage of new legislation is raining down on investment managers. While much is aimed at improving control and transparency, reducing various forms of risk, a subtler yet significant consequence is to constrain business growth. A 2009 KPMG report revealed that "81% of investment management companies surveyed see regulatory interference as the biggest hindrance to growth", while a SimCorp StrategyLab survey last year found that "86% of investment management companies surveyed see increased regulation as inhibiting growth".

So what are the regulatory challenges causing asset management organisations so much grief? The box below gives a brief overview of the impact of some of the new rules more directly applicable to those offering investment expertise in Europe. Even from this small sample, new business and operational needs are identifiable, which must be satisfied to stay legal. For example, in investment management business processes there are implied changes in: product design; portfolio construction; risk analysis and management; performance measurement; pre and post-trade compliance and trading itself; portfolio valuation; client, management and regulatory reporting; and accounting. In short, there will be impact across the entire operation of an investment business.

Inevitably, this will affect short-term growth capability of investment firms, as resources and attention are diverted to change programmes required to meet these challenges. It will also affect the long term, as firms operate on the new regulatory playing field. Not only that, but even with all the legislation on the table now there will be much more to come.

Flexibility is key
An investment management business's ability to cope with all this change, both known and as yet unknown, is dependent upon the flexibility of its operational platform. Over the past decade or so there has been a variable trend towards operational outsourcing. However, outsourcing is no panacea, bringing with it challenges of its own, such as inflexibility, cost of change, the need to have internal processes that mirror and monitor the activities of the service supplier, the establishment and maintenance of interfaces and interactions between the firm and the service supplier and many others. Furthermore, outsourcing cannot solve the whole problem: firms still need some internal operations and systems. Changing these means co-ordinating the firm's own activities with a service supplier that may have many clients with diverse, competing requirements; requirements it may prioritise higher.

The alternative, running operations in-house, of course presents other issues, but it does have the attraction that control is retained within the firm, which is of course where responsibility for compliance remains whether processes are outsourced or not.
These days, any operational process is almost completely dependent upon the software systems upon which it is based. So, since new regulation is forcing change across the entire operation, most of that change will be reflected somewhere in system requirements. The flexibility of an investment management business's systems is therefore critical to its ability to cope with regulatory change and to adapt with minimum negative impact on business growth. This applies to the functionality of individual system components, such as those to support master-feeder fund constructions under UCITS IV, but also to system-wide requirements, such as ability to consolidate all the information required to produce a key investor information document (KID) under the same legislation.

The trouble with KIDs
To examine this last by way of example, a KID contains, among other elements, an explanatory text on fund investment objectives and risk-taking and some core key figures. These last include fee charges, past performance measures and the ‘synthetic risk and reward indicator', a risk measure based mainly on the volatility of the fund's historical returns. So KID production requires fully auditable information from performance, risk and fund accounting processes, along with text, all of which must be combined into a finished document. Given that so many business functions are involved, the ease with which such a process may be created and operated clearly depends upon the degree to which systems used, whether supporting internal or outsourced operations, work together.

Some investment management organisations have created a set-up comprised of many disparate systems interfaced together into a functionality patchwork. So there are different systems for, say, portfolio management, dealing, compliance, settlement, risk, performance, accounting, client reporting and so on. At the other end of the spectrum, others have sought a single system providing all required functionality in a seamless whole.

The multi-system approach proposes that the most functionally superior software can be used at every point in the operation. However, even if the proposition was delivered upon, hitching together systems with different design principles, different technologies and different data format requirements creates a very complex overall ‘solution', which is difficult and risky, and therefore costly, to change. Workarounds become ubiquitous and the investment management process becomes a series of operational silos. As amply evidenced by the requirements of the current new legislation, this is not a realistic basis on which to operate long-term.

Reduced complexity
The seamless system approach, on the other hand, starts from the premise that the investment management operation's purpose is to support the firm as a whole and that business functions will therefore operate together cohesively. In practice this means that a seamless processing system comprises a central, single store of data used by all operational areas, each of which uses system functionality that makes communication of information to other areas a natural outcome. So, again using the KID example, results of calculations made in the performance or risk departments do not have to be extracted from those silos, interpreted, massaged into new formats and passed on for document assembly. Instead, the KID production process fetches the data it requires from the common data store and compiles it. While effort is still necessary to effect changes to such a seamless processing system, and there is dependency on the supplier of that system to keep it current, it is inherently highly flexible thanks to its relative simplicity: changed requirements do not result in new or changed internal interfaces or data conversions.

Despite the sense that the investment management industry is already gripped by extreme regulatory change, further legislation, such as UCITS V and MIFID II, is even now on the horizon. It is impossible to predict what future operational impact will be, so the growth-minded investment management COO is best served by ensuring flexibility is a built-in characteristic of the in-house infrastructure. As Charles Darwin deduced: "It is not the strongest of the species that survive, but rather the most adaptable to change."

John Mayr is marketing and development partner at SimCorp


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