Compliance

02:22 PM
Senthil Radhakrishnan, Virtusa Consulting
Senthil Radhakrishnan, Virtusa Consulting
Commentary
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Capital Markets Regulatory Labyrinths Require Different Thinking

Developing measurable and repeatable processes for regulatory compliance is a must for financial service compliance experts.

Regulatory impact and related compliance changes can be thought of as labyrinths, and investment banks and other capital market firms are constantly playing catch up. In some situations, compliance adherence is controlled and methodical, while in others its ad-hoc and a scramble to meet deadlines.

Recently there have been certain events that have spurred the creation of cumbersome regulations, including:

  • Trading System Errors: A big trading glitch in the front-office of Knight Capital that sent more than four million accidental stock orders that shook the market and eventually resulted in a $460 million loss for the firm
  • Risk Management: Poor risk supervision in JPMorgan leading to their Chief Investment Office, which was supposed to hedge counterparty risks, operated like an internal hedge fund, taking big bets on the direction of market movements. The desk was making such large investments that it breached JPMorgan's internal risk guidelines for the entire bank. Despite such breaches it was only noticed after losses emerged.

Focusing on regulation and compliance is now pervasive within and across investment banks. It's no longer just a back-office function.

So how can firms deal with the increasing amount of regulatory complexity? One was is to look at regulatory compliance from a holistic process perspective.

Although the following isn't news, most business and technology leaders in financial services are dealing with some of these basic issues when it comes to regulatory compliance:

  • Too many regulations. There are many regulations which are distinguished by regional and/or regulatory authorities. Keeping track and being compliant with all these regulations puts a significant burden on the operations of an institution. Many of these regulations across regions are similar yet differ in a few subtle ways. For example, MIFID and EMIR in Europe and Dodd-Frank in U.S. cover similar areas, but are implemented differently.
  • Requirements are not always clear. There are multiple departments or entities involved in the process, such as legal, tax, accounting, trading and IT. Navigating different groups when matters are vague makes the implementation more challenging, so much so that the original intent of the regulation itself is forgotten. For example, in the Volcker rule on separating proprietary trading divisions from broker dealers, the clauses on how to demarcate market making from proprietary trading are unclear. Broker dealers have a market making function to quote two sided (buy-sell) prices and in this role it's difficult to distinguish if the trader was serving a client trade request or was trading voluntarily.
  • Regulations can be simpler. The general feeling is that the regulations are more complicated and wordy than they need to be. For instance, when Dodd-Frank was released there was a lot of criticism around the 800+ page document, as some of the main points got buried in the document.

Most regulations are actually beneficial in the long term, as they help organizations evaluate business (like Basel III, Swap Data Repository) and provide management and the government with data points to take corrective measures where necessary. They also provide investors, employees and shareholders some stability and protection. Over a period of time regulations get embedded in the normal business process and their "overhead" perception goes away.

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NJ_trader
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NJ_trader,
User Rank: Moderator
12/3/2013 | 2:36:19 PM
re: Capital Markets Regulatory Labyrinths Require Different Thinking
Formulating a standard procedure to respond to new regulations is important, but it should be noted that the procedures need to be flexible enough to account for different requirements from regulators. But a standard approach is needed. Financial firms should not continue with the status quo (basically running around and gathering data and building one-off systems to respond to regs).
senthilr14
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senthilr14,
User Rank: Apprentice
12/2/2013 | 9:38:32 AM
re: Capital Markets Regulatory Labyrinths Require Different Thinking
In regulation (most of the times) US leads and others follow with some variations. Its important to define a standard procedure for similar compliance requirements.e.g reporting a OTC trade. There are going to be minor changes in the fields, etc. for different instruments and markets, but the process applied should be the same. The standard/template process will also evolve with time due to changing market needs or new technology, etc. But changing the process will be done by a specialized group taking different interests or concerns as a part of quarterly or six-monthly release( not in an ad-hoc or knee jerk manner)
IvySchmerken
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IvySchmerken,
User Rank: Author
11/28/2013 | 5:36:44 PM
re: Capital Markets Regulatory Labyrinths Require Different Thinking
With so many different regulators in the US and overseas it's difficult to establish repeatable processes for compliance, unless, as you say, there are definitions that are accepted at a global level. One recent sample is what's going in with derivatives reforms. The CFTC is close to finalizing its rules for SEF trading covering credit index swapssand interest rate swaps. But the SEC has not yet begun to work on the regs for single-name credit default swaps. The CFTC has pledged to harmonize with the SEC, but the two-step approach means that market participants will have to work on compliance with the SEC's credit derivatives in the future.
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