In fast-evolving regulatory environments, ﬁnancial institutions face the uphill tasks of regulatory compliance and reporting—as failure attracts severe penalties. What can ﬁnancial institutions do to ensure they are in line and in time with these non-negotiable regulatory requirements? The answer rests in optimized infrastructure, technology, and trained personnel to ensure eﬀective, eﬃcient, accurate, and documented compliance processes. This helps business navigate regulatory environments smoothly, ensuring robust business processes, enhancing customer satisfaction, and increasing revenue and proﬁts.
Big Brother is Watching—The Premise of Regulatory Compliance
With numerous new laws, regulations, and regulatory expectations, external reporting requirements for ﬁnancial institutions are continuously evolving. In order to provide transparency within the ﬁnancial system, Banking, Financial Services and Insurance (BFSI) companies must automate regulatory reporting processes to deliver data quality and accuracy. According to a survey in 2012, only 25% of banks had an automated regulatory reporting process, while 75% still continued with manual or partially automated regulatory compliance systems. This paper elucidates key trends in regulations and discusses how technology can help ﬁnancial institutions comply with ever-evolving regulatory requirements.
Regulators face extreme challenges of collecting, processing, and reporting information eﬃciently and accurately. Ever-expanding regulatory initiatives such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, BASEL III, AML, etc. with increasing demands to report more and report, at once, intensify these challenges. These regulatory initiatives make it imperative for ﬁrms to improve the value of information collected and reported, and manage change eﬀectively and eﬃciently, staying up-to-speed with the changing economic environment.
Figure 1: Data Based on Federal Reserve Suggestion
Surveying the Regulatory Terrain: Key Regulations and Trends
In the aftermath of the ﬁnancial crisis in 2007-08, there was a pressing need to bring changes in the regulatory system. Some of the key regulatory initiatives that ushered sweeping changes in the system are:
Foreign Account Tax Compliance Act (FATCA)
FATCA is more than a regulation or a compliance requirement—it covers the entire banking value chain. It was enacted in the US in March 2010, and is intended to prevent tax evasion by US citizens by using oﬀshore accounts. This compliance requires US citizens/residents to report their overseas ﬁnancial accounts, and foreign ﬁnancial institutions to report their US customers to the Internal Revenue Service (IRS). FATCA taxes US citizens/residents on their worldwide income. However, if a person is working in a foreign country, then FATCA gives a ﬂexibility to exclude a limited amount of foreign income from the total income.
All non-ﬁnancial intermediaries and agents owning or holding US investments have to satisfy information reporting and disclosure requirements of FATCA (as of January 2014). This US legislation impacts tax functions, technology systems, operations, and business strategy of organizations.
- Harmonized with inter-governmental agreements
- Relaxed documentation and due diligence requirements
- Liberalized requirements for retirement funds and savings accounts
- imited relief for Foreign Financial Institutions (FFIs)
How Technology Facilitates FATCA Compliance
Financial institutions must make signiﬁcant changes in technology to consolidate and automate processes and procedures to be able to implement systems that can help them be FATCA compliant. They must reassess the current state of the systems and operations, conduct gap analysis, develop action plans, and evaluate the legal entities to determine whether they are covered by FATCA or not.
Data mining helps minimize the number of times information is needed from the client for data analysis. The technology partner uses business intelligence tools to customize diﬀerent types of data analyses. An important type of data analysis for FATCA is link analysis. Link analysis enables clients to bring together disparate data. Technology is used to ﬁnd out the common elements from the available disparate data, allowing ﬁnancial institutions to connect and group data to a centralized location. Technology also helps in data sharing and automating data masking
Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd Frank Act)
The Dodd–Frank Act brought signiﬁcant changes to ﬁnancial regulation in the US. To protect unsuspecting borrowers against abusive lending and mortgage practices, the Dodd Frank Act established federal ﬁnancial regulatory agencies and directed the ﬁnancial services industry to monitor banking practices and troubled ﬁnancial institutions. It contains roughly 1,500 provisions, including about 398 rule-making requirements.
Regulatory activities on the Dodd Frank Act in 2013 included:
- Financial Stability Reform
- Resolution Planning
- Securitization Reforms
- Derivatives Regulation
- Investor Protection Reform
- Credit Rating Agency Reform
- Volcker Rule
- Compensation, Corporate Governance and Disclosure
- Capital Requirements
- Foreign Bank Regulation
- Consumer Protection Reform
- Origin of Mortgage and its Servicing
- Specialized Corporate Disclosure
Figure 2: DFA Rulemaking Progress as on July 1, 2013
- Protects US citizens from abusive ﬁnancial service practices
- Eliminates the ‘too-big-to-fail’ concept to ensure that taxpayers do not bear the consequences of the failure of ﬁnancial institutions
- Ensures that advanced warning systems are created in order to deal with any economic crisis
- Brings transparency in the derivatives and instruments market, and avoids chaos
- Increases accountability of credit rating agencies for debt instruments
- Ensures top executive decisions are aligned with the interests of the ﬁnancial institution
How Technology Facilitates Dodd-Frank Act Compliance
The Dodd-Frank Act impacts diﬀerent lines of business in the ﬁnancial services industry. To comply eﬃciently and eﬀectively, the technology partner must assess the new rules and regulations, tools, and processes it currently has—and build new IT systems integrating old processes within the existing platforms. New IT systems will contain measurable, transparent, and predictable processes that reduce costs across the diﬀerent business lines. The technology partner
- Implements pre-trade compliance checks enforcing system restrictions
- Rationalizes and consolidates to achieve true copy of the data, and supports regulatory reporting
- Places special emphasis on data management, business intelligence, risk analytics, and knowledge management
Basel III (or the Third Basel Accord) builds on Basel I and Basel II documents by the Basel Committee on Banking Supervision. Basel III enhanced the banking regulatory framework and dealt with ﬁnancial and economic stress, risk management, liquidity in the market, and banks’ transparency. The two liquidity ratios—the short-term Liquidity Coverage Ratio (LCR) and the longer-term Net Stable Funding Ratio (NSFR)—increase the high-quality liquid assets of banks and obtain stable sources of funding. These liquidity ratios ensure adherence to sound principles of liquidity risk management. LCR Basel III (or the Third Basel Accord) builds on Basel I and Basel II documents by the Basel Committee on Banking Supervision. Basel III enhanced the banking regulatory framework and dealt with ﬁnancial and economic stress, risk management, liquidity in the market, and banks’ transparency. The two liquidity ratios—the short-term Liquidity Coverage Ratio (LCR) and the longer-term Net Stable Funding Ratio (NSFR)—increase the high-quality liquid assets of banks and obtain stable sources of funding. These liquidity ratios ensure adherence to sound principles of liquidity risk management. LCR incorporates amendments in the expansion of the assets considered as High Quality Liquid Assets (HQLA) and net cash outﬂows to reﬂect experience in times of stress. The new LCR was implemented in a phased manner, starting January 2015. Implementing LCR on an ongoing basis helps monitor and manage liquidity risk. An LCR of 60% should be maintained in the ﬁrst year of its implementation, gradually climbing by 10% each year until it is implemented at 100% in January 2019
Figure 3: MiFID related regulations
- Improves the ability of ﬁnancial institutions to deal with issues arising from ﬁnancial and economic stress
- Improves risk management and governance
- Strengthens transparency and disclosures of banks
How Technology Facilitates BASEL III Compliance
The technology partner focuses on improving the data management practices that require ﬁnancial institutions to aggregate, standardize, and analyze data to derive high quality information and reports. When the data management levels required by Basel III are achieved, the technology partner deploys advanced analytics to achieve process eﬃciency
In the past, data was managed in silos. To comply with Basel III, ﬁnancial institutions need to manage the quality of the data extracted from the ageing infrastructures. There is a need to develop the IT systems that produce and manage consistent, accurate, and true copy of the data from disparate systems. The technology partner installs IT infrastructure that is ﬂexible and robust, and quickly integrates data from disparate systems and builds quick interfaces.
The Financial Industry Regulatory Authority (FINRA)
FINRA is a self-regulatory organization that oversees ﬁnancial regulations of member brokerage ﬁrms and exchange markets. It oﬀers regulatory services to all the security ﬁrms that publicly conduct business; organizations that oﬀer professional training, testing, and licensing of registered persons, arbitration and mediation, market regulation by contract for the NYSE, the NASDAQ Stock Market, Inc., the American Stock Exchange, LLC, and the International Securities Exchange, LLC; and industry utilities, such as Trade Reporting Facilities and other over-the-counter operations. and exchange markets. It oﬀers regulatory services to all the security ﬁrms that publicly conduct business; organizations that oﬀer professional training, testing, and licensing of registered persons, arbitration and mediation, market regulation by contract for the NYSE, the NASDAQ Stock Market, Inc., the American Stock Exchange, LLC, and the International Securities Exchange, LLC; and industry utilities, such as Trade Reporting Facilities and other over-the-counter operations.
FINRA uses Internet, media, and public forums to help investors build ﬁnancial knowledge. It also provides essential tools to improve the understanding of the market and principles of investing. In 2013, FINRA considered the following for heightened scrutiny: Business Development Corporations, Leveraged Loan Products, Commercial Mortgaged-Backed Securities, High Yield Debt, Structured Products, Exchange Trade Notes, Non-Traded Real Estate Investment Trusts (REITs) and Closed Funds.
- Regulates trading in equities, corporate bonds, and security futures
- Licenses individuals and admits ﬁrms to the industry, writes rules to govern their behavior and examines them for regulatory compliance
- Sells regulatory products and services to stock markets and exchanges
- Provides educational and qualiﬁcation examinations
How Technology Facilitates FINRA Compliance
FINRA guidelines require ﬁnancial institutions to partner with ﬁrms that help them establish a strong social media policy that evolves with the changes in industry regulations and technology. The partner helps the organization build a social media policy by identifying the social media platforms aligned with the organization’s business goals.
Anti-Money Laundering Laws (AML)
AML is a set of procedures, laws or regulations used in the ﬁnancial and legal industries to prevent, detect, and report illegal money laundering actions. According to a survey in 2012, 41% of organizations have integrated AML in the business strategy of new products/services.
AML came into eﬀect after the Financial Action Task Force (FATF)—an intergovernmental body—was formed and anti-money laundering standards were laid out. New government regulations and ever-evolving laundering techniques keep AML compliance departments constantly on their toes, trying to deal with change.
The Anti-Money Laundering and Countering of Financing of Terrorism (AML/CFT) was amended on a makeover, eﬀective from June, 2013.
Key Highlights of the Amended AML Regulation
- Amendments to the ordinary course of business exemption that applied to accountants and others, including directors,employees, agents and other personnel.
- New Regulation 5A required enhanced customer due diligence to be carried out for transactions requiring Suspicious Transaction report
- Changes were made to the customer due diligence exemption and extended to client funds account
How Technology Facilitates AML Compliance
Financial institutions are reacting to regulatory demands and investing in automated systems that can monitor every single ﬁnancial transaction, discover unusual behavior, and discover transactions that seem to be money-laundering ones. Automated systems leverage data from disparate systems and can help verify new customer identities and perform link analysis to understand the background of the customer. These systems must learn and adapt to the situations, while analyzing client proﬁles and their transactions, improving cost and operational eﬃciencies
Financial institutions need to partner with technology ﬁrms that can provide technology platforms based on the product- and risk-speciﬁc requirements. There is no need to replace existing systems. The new platforms must integrate tightly with the existing applications maximizing previous technology investments. As risks and rules change, the designed platform must be agile enough to adapt. Changes may include product changes, mergers and acquisitions, and working in a new geography. A technology partner helps in maintaining these new systems and supports the business in achieving cost eﬃciencies and customer satisfaction.
Know Your Customer (KYC)
KYC regulation is important for both ﬁnancial institutions and regulators to ascertain relevant customer information. These policies help prevent identity theft, ﬁnancial fraud, money laundering and terrorist ﬁnancing. Seven out of 10 Indian ﬁnancial services ﬁrms do not regularly update the know-your-customer (KYC) details, as per a KPMG survey of 2012 on anti-money laundering.
Four key elements are incorporated by ﬁnancial institutions while framing their KYC policies:
- Customer Acceptance Policy
- Customer Identiﬁcation Procedure
- Transaction Monitoring
- Risk Management
Identity information helps ﬁnancial institutions understand the capacity of individuals to engage in money laundering or identity theft. Daily transactions of individuals are monitored against their expected behavior and recorded proﬁle
How Technology Facilitates KYC Compliance
Global footprints of ﬁnancial institutions necessitate the need for global KYC hubs with data to cater to various regulations. The data in these hubs must be reusable to enable better ﬂexibility and scalability. Reusable data reduces the overall cost for ﬁnancial institutions. Global KYC hubs help in automating business processes, improving eﬃciency, enabling rapid turnaround and reducing operational risk. Automated processes ensure all required and correct data is captured—managing the risk of regulatory non-compliance.
Markets in Financial Instruments Directive (MiFID)
MiFID is a European Union Law that aims to increase cross-border investment orders. Its main objective is to increase competition, create harmonization across jurisdictions, enhance ﬁnancial transparency, and protect customers of investment services. MiFID covers investment banks, portfolio managers, corporate ﬁnance ﬁrms, and some derivative and commodity ﬁrms.
Key Highlights of MiFiD
- Authorized ﬁrms regulated in their home states can provide services to customers in other EU member states
- Clear procedures are adapted to categorize customers as ‘eligible counterparties,’ professional clients or retail clients
- While taking trade orders, detailed client information needs to be captured
- New post-trade transparency and capital requirements in transactions are extended to ﬁnancial instruments
- Firms need to publish price, volume, and time of all trades of the listed shares
- Firms must obtain results in the client order execution
- MiFID treats Systematic Internalisers as mini-exchanges for pre- and post-trade transparency requirements
How Technology Facilitates MiFID Compliance
To comply with MiFID, a technology ﬁrm has to alter its marketing practices, rewrite customer contracts, and deeply assess the client needs. To do so, it must be capable of retaining and integrating information to plan for and implement technology requirements. The ﬁrm manages the information lifecycle to easily access information and include indexing for faster and accurate searching. To implement the MiFID regulation for a ﬁnancial institution, the technology ﬁrm upgrades the network infrastructure and communication lines to enable acceptance of data from multiple sources. The upgradation is ﬂexible enough to handle the new, evolving business rules and data elements. Along with the infrastructure, the technology ﬁrm also upgrades the storage systems. Storage infrastructure ramps up signiﬁcantly to handle increase in data ﬂow and manage the data exchange mechanisms.
Emergency Economic Stabilization Act (EESA)
The Emergency Economic Stabilization Act of 2008 is a US ﬁnancial system law enacted to regulate international credit and subprime mortgage crisis. The regulation authorizes the United States Secretary of the Treasury to disburse more than $700 billion for the purchase of distress assets and for supplying cash directly to banks. It also allows companies to insure their troubled assets.
EESA has authorized the Secretary of the Treasury to establish a Troubled Asset Relief Program (TARP) to protect consumers and businesses when securing credit. The purchase of illiquid assets by the Secretary of the Treasury under TARP increases the conﬁdence of banks in the credit market.
- Provides authority and facilitates restoration of liquidity and stability in the ﬁnancial system
- Allows TARP to purchase troubled assets from ﬁnancial institutions
- Imposes limits on executive compensation of participating ﬁnancial institutions
- Monitors the activities of the Secretary of the Treasury
- Protects homeowners
Technology Makes All the Diﬀerence
Leading ﬁnancial institutions evaluate their current regulatory infrastructure and think of reﬁning tools and capabilities to adjust to the current regulatory landscape. Institutions are progressing from regulation to transformation to position themselves and achieve success. Control functions must be used to ensure compliance and support transformation change in key business processes. To support transformational change, it is mandatory to identify and assess inter-relationships between regulatory initiatives, develop business and structural models in compliance with new regulations, and changing customer needs through innovation and investment.
The pressure on ﬁnancial institutions is to ensure that they meet regulatory requirements at an appropriate time. To meet these requirements, they need to carefully plan for improved economic conditions that generate balance sheet growth and reduce provision of liquidity. Financial institutions also need to invest in technology to be on top of regulatory requirements. The current IT infrastructure is only capable of supporting earlier regulatory requirements. There is an urgent need to bring signiﬁcant architectural changes to adapt radically to the evolving regulatory landscape and exercise control over the key individual business functions.
Regulatory compliance programs generate considerable data into disparate silos. To properly manage and generate intelligent data, there is a need to have a uniﬁed data management system to reduce risk and maintain regulatory compliance, and use appropriate technology and tools for fast access to granular information. Without appropriate technology and tools it is diﬃcult to understand the background of data, measure, and monitor compliance programs, and generate the right kind of reports for higher management. Technology, thus, implemented appropriately to monitor and manage compliance programs not only drives down cost but also drives up revenues.
Banks and ﬁnancial institutions that use technology are real winners in the capital markets as technology helps build stronger relationships with the client. Continued investment in technology, user-friendly channels such as mobile, Internet, and social media help these institutions provide excellent customer service.
Managing Risk and Compliance Challenges
Financial institutions that choose state-of-the-art technology to manage regulatory requirements keep deﬁning their business by:
- Automating regulatory reporting processes to minimize the manual work
- Building a team that can handle changing requirements and help train the personnel
- Optimizing governance structure and control environment within the regulatory function
- Enhancing and evolving business processes with changes in the regulatory environment to enhance ﬂexibility, eﬀectiveness, and keep pace with the regulatory demands
Three steps that a ﬁnancial institution must consider overcoming the challenges in areas of risk management and regulatory compliance are :
- Uniﬁed Data Management Platform: Uniﬁed Data Management Platform delivers data integrity and quality to support regulatory compliance. With an integrated and uniﬁed platform, ﬁnancial institutions can perform data mining, data proﬁling, and monitoring. It also helps in transforming data silos maintained in disparate systems into reliable, accurate, and trusted data.
- Optimization: Optimizing regulatory structures enables ﬁnancial institutions to implement changes in the regulatory landscape within a speciﬁed timeframe and aligned with short- and long-term objectives. This can be achieved through incremental and innovative improvement to the supporting technology.
- Standardization: Regulators everywhere face the challenge of collecting, processing, and reporting information accurately and eﬀectively. In order to overcome this challenge, e-ﬁlling is a standard tool that regulators must choose to improve the entire end-to-end regulatory reporting process. Financial institutions achieve greater transparency and eﬃciency while collecting relevant information. This standardized reporting tool can easily support the changing needs of the regulators.
The Coforge Thought Board:
Digitalize Reporting - Master the Changing Regulatory Environment
Partners in Change
Banks and ﬁnancial institutions need to invest in the infrastructure and leverage technology to ensure eﬀective, accurate, and documented compliance processes. The investment should be timely, aligned with the current regulatory environment and periodically monitored so that ﬁnancial institutions are able to keep pace with the changing needs.
Our service areas address business processes, data quality, and technology architecture to support the regulatory reporting processes. We manage the regulatory reporting requirements and accuracy of numbers quickly and easily. We help simplify the processes required to produce clients’ ﬁnancial views besides facilitating the production of fully reconciled ﬁnancial reports at all levels of granularity.
Building technology infrastructure and business systems to manage regulatory compliance are complex tasks, and best achieved in partnership through an experienced IT solutions provider having a grasp of leveraging technology to manage regulatory environments.
Our domain expertise, thousands of person-hours of experience, and a proven track record of eﬃciently and eﬀectively mobilizing technology will help you match pace with the regulatory environment. As preferred technology partners, our clients values us for:
- Understanding and foreseeing regulatory changes, technological advancements, and process limitations
- Understanding the needs of ﬁnancial institutions to be regulation-compliant, and analyzing the challenges they face with compliance as well as with using technology to manage them
- Designing and delivering systems and tools that not only help compliance but also leverage the investment to deliver value across diﬀerent business functions