Who pays the cost of regulation?

Written by: Dave Waller Posted: 30/08/2017

Cost of reg illoAs the compliance burden on financial firms keeps on rising, it seems that businesses and their clients are both having to shoulder the increased costs

When news of the Panama Papers broke back in April 2016, it sparked a very clear chain of events – first came the headlines, then the public outcry, and then politicians scrambling to be seen to be doing something about it.

All this filtered down into a couple of tangible results – greater regulation of the financial services sector and, for those individuals working in compliance, an even busier in-tray. 

Not that they weren’t used to it by now. Ian Murphy had become Head of Compliance and Risk at Volaw Group in October 2015 and, even pre-Panama, his workload was all too apparent. 

“My first job was to produce a paper and go to the board and say: ‘Right, this is what the regulation means, and here’s what we need to do.’ And the reaction was: ‘Wow, there’s a lot to do’.” 

Indeed. Murphy had arrived as financial services were still getting to grips with a wave of new directives: the Foreign Account Tax Compliance Act (FATCA) in the US; the Alternative Investment Funds Managers Directive (AIFMD) in Europe; and the Common Reporting Standard (CRS) and Base Erosion and Profit Shifting (BEPS) initiative on a more global scale. 

And let’s not forget MiFID II, which comes into play in January 2018. It’s as if the regulators are set on dishing out woeful Scrabble hands. But if the jumble of letters can be befuddling, it spells one thing clearly for companies looking to compete in an increasingly dog-eat-dog wealth market – vastly increased costs. New regulations mean additional reporting.

Clients need to be told what has to be done and why. Processes and procedures have to be amended, staff trained to ensure they’re collecting the right data, systems adjusted to cope with the additional information required, records kept… 

And this isn’t just the initial structuring. Many of these costs are ongoing. “It’s taking more time from directors and senior managers, to make sure everything’s being complied with,” says Craig Cordle, a Partner at law firm Ogier. “And it’s not a one-off. There are service providers who need to do this on a day-to-day basis.” 

Cordle says the biggest regulatory shift in the past five years was AIFMD, which required a fundamental overhaul of how service providers looked at their organisation’s work and the advice they gave. It even changed the way they structured their funds. 

CRS brings a similarly onerous burden, requiring the automatic exchange of information on a vast range of financial transactions right across each firm’s client base, from trusts to bank accounts. Firms had to adjust their systems to capture it, and to a high spec. 

Murphy reckons it’s not unusual for compliance and risk regulation to add 10-12 per cent to a firm’s overall expenses. Twenty years ago, it would have been around five per cent. 

Technology leads the way

While some firms may opt to outsource the compliance function in order to minimise costs, others will handle all compliance in house. Outsourcing itself isn’t without issues – Channel Islands firms can’t risk someone sitting in another jurisdiction letting standards slip. But the choice generally comes down to whichever is the most cost-effective solution.

A more viable option may lie in technology and the birth of ‘regtech’ – tools that enable companies to instantly capture, verify and transmit information such as recurring client details and identities, instead of having to dig out these records manually every time.  

“One of our clients found that the cost of administering the FATCA process was £70 per transaction,” says Chris Clark, Founder and CEO of Jersey-based tech provider Prosperity 24.7.

“They were charging their client £50. So, while their client had to pay £50 for the honour of filling out a 14-page mandate to answer all the questions, our client was losing £20 per transaction. If they had 10,000 clients, that’d be a lot of money.”

Clark’s solution was to build an online portal offering those end-clients secure access to upload their own information to a system that could process in seconds what would have taken people several weeks, and at a far lower cost. It’s a shift that was, apparently, very welcome. 

“Companies do seem to come to us in a fairly stressed fashion to start with,” says Clark. “When they’re sending 14-page mandates, cross-checking everything coming back, it’s mad. It’s about creating a symbiotic relationship between your data team and your compliance team. They can use the data that the compliance team collects for the regulation to give them that 360º view of their business, and using it intelligently to derive insights on changes in client behaviours. We’ve seen it in three clients – going from regulation being a burden to making it profitable.”

It’s early days, and tech solutions are still really only an option for larger firms. Smaller companies will need people to handle their processes, and probably won’t have a large and experienced compliance team in-house. It’s not surprising, then, that many smaller companies have been absorbed by larger rivals because they can’t afford to keep up with the changes. 

The road ahead

Clark isn’t the only one to point out that regulation can be an opportunity – and it may as well be, given that companies have no choice in going along with it. Murphy says it’s given Volaw the opportunity to “look at our systems and training and record keeping”.

Ultimately, however, for any company looking to remain in business, some cost has to be passed to the end user. “In the real world, and in any area of the market, firms will always try to pass the cost on to the client,” says John Harris, Director General of the Jersey Financial Services Commission. 

“For high-net-worth individuals and private trust management structures, where there’s a high level of service at high cost, that’s feasible. For retail clients, if there are enough of them, it’s reasonable. But for others it might be a problem, and they’ll look to reduce their profit margins and pass some cost on to the client.”

Charging clients

Murphy says Volaw charges clients an annual flat fee to cover the admin time spent reporting them to the requisite systems, but that’s a relatively small proportion of the real cost to his firm. “What we’re not doing is adding on the £2,000 per client in extra training costs that the regulation has brought,” he says. 

But while clients stew at extra costs, and compliance professionals at the extra work, it has at least had a positive effect on the value of their experience. Someone who went into compliance 10 years ago may well find themselves in high demand now. 

“If you’re in compliance and experienced, there are a lot of opportunities in the Channel Islands and beyond,” says Cordle. “Compliance people will always be regarded internally as cost centres – they don’t make money for a business. But salaries have probably gone up, and if anything they’re more defensible now.” 

Murphy describes understanding FATCA as a “little bit of a black art”. But he says there’s learning to be made along the way, and highlights five lessons. “Make sure your data is up to date, and that your systems are current and capable,” he says. “Recruit the best. Ensure you have good regulatory frameworks and procedures, so you don’t have to rip it up each time a new regulation slots in. And plan for the future – you’re going to get more of it, so don’t be surprised when it comes along.” 

Indeed, the regulatory burden isn’t about to get any lighter. “No one can see a natural logical end to this,” says Harris. “The industry bears the costs, and ends up saying it can’t take much more of it. But the world moves very fast, the clamour for change is quick, and no one has a wand to stop it.” 

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