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Q&A with Bart McDonough: The Cost of Compliance

Agio Technology chief executive Bart McDonough explains which platforms companies are going to need to comply with new regulations and why these changes will cost more for smaller hedge funds.

Related: McDonough discusses hedge fund trends for 2011.

How much are the new compliance requirements -- and hiring new compliance officers -- going to cost hedge funds?

McDonough: The cost of the chief compliance officer is just one part of that cost. The CCO is going to come in and implement systems and policies that drive system selection. So the cost is really going to depend on the complexity of the firm. It's tough to give a number. A five-person firm is going to be very different than a 20-person firm with offices in three different countries.

Your compliance needs go up as you increase your complexity around your counterparties, the markets and the geographic diversity your firm is located in. Those pivot points will determine how much the firm needs to spend.

What does this mean for hedge funds deemed systemically important by regulators? Will their compliance bill be higher than smaller firms'?

McDonough: The cost is going to be more significant. However, if you're looking at new costs from pre-Dodd-Frank to post-Dodd-Frank, most of the firms that are likely to be tagged "systemically significant" have already spent a tremendous amount on a lot of their systems. So they're not going to see that incremental Dodd-Frank impact. A smaller firm that wasn't regulated is going to see a much greater incremental cost as a result, in percentage terms and flat dollars.

Within that investment, what new platforms will hedge funds need in order to comply with Dodd-Frank's various rules?

McDonough: There's what people think of as your traditional compliance suite of email capture, instant messaging and text messaging. But there are a lot of document management systems that also need to be implemented to get all of the unstructured data into structured form. And then you have things like Internet security and monitoring so that you can control and police your information.

Then there's integration with all of your straight-through processing systems -- from your transactional systems and execution systems to your accounting platforms. And you need to be able to have that visibility and flexibility within your risk systems. So when the SEC requires extracts from your risk system, it needs to be flexible enough to handle the request. And that's what we're stressing with our clients: Build flexible systems.

Even though Dodd-Frank is written the way it is right now, if you build really flexible, dynamic systems, regardless of how those regulations change over time, you can keep up with that change. You really need to have flexible systems that can really cover the gamut of everything I talked about.

How much is that going to cost?

McDonough: A lot of our larger clients have already spent that money. The big ones are ahead of that curve. For some firms it ranges from $250,000 to many millions. It's just going to depend on what investments they've already made. And the ones that already made investments have spent millions to build these dynamic, interconnected systems, allowing you to trade different asset classes across many counterparties with a diverse investor base. They need to have a variety of reporting requirements with the geographic diversity of office locations and market trading. All of those factors are going to drive the cost base for hedge funds.

How will data management evolve because of Dodd-Frank?

McDonough: Data management needs to be open. I go back to the word "flexible" -- that's what we keep stressing. You don't want a lot of proprietary technologies that you can't get access to. And we're seeing a lot of work in the integration of System A to System B. The key there is to have a nice, open and flexible integration that allows you to swap out System A for System X, or add System X into the mix and everything continues to go.

Can hedge funds trust the cloud? Will they rely more heavily on it to rein in data storage costs?

McDonough: We already have clients that are using the cloud. Some of the top-tier hedge funds in the world are using the cloud, and that's even public clouds for things in which security matters a little less. If it's market data and you need to run some algorithms against it -- putting that market data into the cloud, it's not proprietary. That's in the public domain.

But then there's the idea of the cloud, the private cloud and the hybrid cloud -- to be able to have your own cloud in someone else's data center, managed on a consumption basis in which you get charged for what you use, but it's dedicated to you. So without question the technical flexibility and the economic benefits of the cloud in whatever form that is -- be it private, hybrid or public -- will evolve. And we're already seeing it.

Are hedge funds still turning to the sell side for the latest technology?

McDonough: They look to the sell side for advice on the latest technology. They certainly are using sell-side consulting services to give them advice. Are they looking for them to deliver the latest technology? I don't see that as much.

Especially post-Madoff and post-crisis, you're seeing the increasing importance of multipriming. Hedge funds are just not going to rely on one firm's technology because it makes the multipriming that much more difficult. So they're looking at third-party systems. As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

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