Doing regtech right
Regulation is likely to be a hot topic at Sibos, both inside and outside of conference sessions. We assesses the main regulatory themes for this year’s event.
So far 2016 has been one of the most contentious years since the G20 agreed the regulatory reform agenda seven years ago. With ever-rising costs, increasingly severe penalties and continued issues with data quality, it would be easy to claim the plans conceived in the wake of the crisis are not going to get us to safety.
As politicians, courts, regulators and firms wrestle with the same issues, we see a rare window of opportunity for 2017 to become the year we all started to work together.
Why? Well, when we step back and look at all the dynamics, everyone should understand by now that their only hope is to work towards alignment and use new regulatory technology (regtech) to deliver what is required to meet key challenges including Brexit, Mifid II, Regulation on Packaged Retail and Insurance-based Investment Products (Priips) and the Benchmarks Regulation.
The voting public of the UK have made their decision and the country will leave the European Union (EU). Where do financial services firms stand now? The threat of Brexit represented a major exercise in project management and speculative forecasting.
As a starting point, in May JWG published a 26-page research paper, Brexit: changing out the engine of finance, within which we discussed the operational and procedural implications of Brexit on the financial services industry.
This report included a ten-point action plan that every firm should implement to successfully manage the ‘mother of all change programmes’:
- Organisational gap management. The process of mapping future rules to the current operating model and identifying the gaps will be a complex task that must be started early
- Regulatory change management capability check-up. The board should ask senior managers to flex their change management muscles and see if they are strong enough to withstand even the worst-case scenario
- Brexit risk tracker review. Senior management should be creating a comprehensive impact assessment to account for the many types of risk: market, counterparty, liquidity, operational, vendor and legal
- Regulatory change portfolio management. The way change programmes are run across business and functional silos will need to be reviewed and gaps filled quickly
- Rule interpretation factory. Establishing a system for interpreting the obligations will be essential, as new rights and responsibilities, which were previously guaranteed under the EU’s regulatory regime, come in to play
- Collaborative working groups. As the entire market faces the same obstacles, a collective response could allow firms to develop a clear and unified voice in dealing with Brexit issues
- Regtech strategy. Developing a comprehensive strategy for regtech will be essential in managing the rewiring effort
- International standards management. Reconciling international standards, along with equivalence requirements, will necessitate continuous efforts by businesses
- Professional services lock-in. Obtaining high-quality advice is essential. Therefore, getting commitment from the top legal, physiological and change management professionals early will be key
- P&L revision. Firms should prepare to spend more. Costs will increase across all departments, so budgets and forecasts will need to be amended to account for a worst-case scenario
Ultimately, we must conclude that this decision makes regulatory change management more complex and more difficult. In the wake of Brexit, the industry must review how it manages regulatory change and the need for a regulatory change management platform has never been greater.
The revised European Markets in Financial Instruments Directive (Mifid II) looms over the regulatory horizon like an oncoming storm.
Aiming to improve the safety and transparency of financial markets, Mifid II reaches far beyond investment banks, affecting asset managers, commodity firms and OTC brokers and dealers. In terms of depth, the regime will fundamentally reshape the way business is done, from requiring comprehensive audit trails and full surveillance of the trading lifecycle to assessing the suitability of clients before any marketing takes place.
It is for these reasons that the industry must together adapt and evolve to comply with Mifid II. The current legacy systems favoured by most institutions will not be able to cope with the changes ahead. Indeed, even the regulators have had to delay Mifid’s implementation due to the sheer scale of the IT system restructuring required.
A key area the industry should collaborate on is transaction reporting, where the duplicity and inconsistency of fields and formats will surely cause the greatest headaches on implementation day. JWG analysis of the 687 transaction reporting fields used across Mifid II, the European Market Infrastructure Regulation, Regulation on Energy Market Integrity and Transparency and Securities Financing Transactions Regulation suggests that about 40 per cent of these fields are related to the same facts, of which field definitions are similar for around 63 per cent and formats broadly align for 58 per cent of these common fields. Clearly, if the industry were to work with the regulators to produce a common reporting format for all these regulations, it would save time and resources on both sides; let alone achieving the desired goal of enhancing financial stability through reducing the occurrence of the ‘garbage in, garbage out’ phenomenon.
But it is not only Mifid II that compliance professionals must worry about. The relentless march of change continues in Europe, with Priips, Market Abuse Regulation and Benchmarks Regulation all disrupting business models and introducing tough new standards. The buy side too continues to wrestle with its own waves of reform: Ucits V, Alternative Investment Fund Managers Directive, regulation on European venture capital funds, European social entrepreneurship funds and, of course Mifid II and Priips – all of which are on the 2016 work plans.
In recent months, there has been a great deal of lobbying by the industry to delay the implementation date of the Priips regulation. The aim of the regulation is “to encourage efficient EU markets by helping investors to better understand and compare the key features, risk, rewards and costs of different Priips, through access to a short and consumer-friendly key information document”. The formal request for postponement by representative bodies of EU banking, insurance and asset management industries in late April 2016 was rejected on 18 May 2016 by the European Commission (EC).
This refusal to delay the implementation deadline means that firms providing investments or investment services to retail markets within the EU must quickly get to grips with the regulatory technical standards that recently have been adopted by the EC. They must continue with their implementation programmes if they are to meet the 31 December 2016 deadline.
Considering the upcoming application deadline of the Priips regulation and the overlap of this with Mifid II, many firms are looking to see whether they can align their regulatory change programmes between the two regimes.
Benchmarks and indices are vital tools for assessing the underlying price of financial instruments and contracts as well as for measuring the performance of investment funds. Despite this, recent Libor and Euribor scandals have exposed how vulnerable to manipulation these instruments are.
In the light of these events, the EC produced a benchmark regulation, which seeks to re-establish reliability of benchmarks by providing a consistent approach to their creation, improvement in the quality of input data and the introduction of adequate controls to avoid conflicts of interest. This is likely to create huge definitional and reference data challenges for firms across the industry. The implementation deadline of January 2018 places the Benchmarks Regulation right in the middle of the Mifid II implementation timeframe.
The regtech solution
This huge strain demands new and dynamic solutions, old strategies of a project by project sticking plaster approach look increasingly out of date. In this light regtech stimulated by the regulator has a real opportunity to provide a path to safety:
- The regulators’ engagement. The participation of regulators is critical to overcoming the current regtech market failure and reducing the billions that will be spent on Brexit. At a recent JWG conference 70 per cent of those present said their participation was critical to overcoming the current regtech market failure
- Collaborative appetite at an all-time high. The sharing of code, data models, emerging practices and standards must be top of the agenda for senior management as this will be needed to overcome the complexity of meeting overlapping requirements and unclear interpretations
- Data standard working groups. Collaborative working groups backed by the regulators represent the best path forward for the development of data standards
A real risk remains that regulatory appetites are too low for meaningful participation in the crucial foundational efforts. Without them at the regtech working parties, the market will take years to come together and we will miss the opportunity afforded by spending tens of billions on G20 reform over the next 24 months.
Looking ahead we have a real 2017 opportunity. If we come together to do regtech right, politicians can appease their constituents, regulators can sustain their massive rulebooks and firms can comply with these rules in a better, faster and cheaper manner.
By Dan Simpson, head of research at JWG, an independent analyst firm specialising in financial regulation