Suitability headache: under the bonnet of DFMs' compliance battle
Compeer's annual compliance survey, which was produced in co-ordination with fintech firm JHC, investigated the challenges wealth firms face against the backdrop of increased regulation.
The survey results were generated from interviews with chief operating officers and compliance staff, responsible for a combined £100 billion in assets under management.
The findings were illuminating, showing that suitability remained a significant challenge and that compliance is no longer a role undertaken by a specific department, engaging the whole firm.
We highlight 15 important charts from the survey, which shed light on the challenge facing wealth firms.
Wealth managers were asked how much they envisage growing assets under management in the next five years.
A fifth of firms fell into the smallest growth bracket expecting a little over 5% compound annual growth rate (CAGR).
At the other end of the scale was the small number of firms who envisaged CAGRs in excess of 14%, some of which were looking to at least double their AUM. The majority of firms were on a more steady path, predicting annual growth of between 6% and 10% across the next five years.
These two graphs highlight the change in regulation expectations in 12 months. The graph on the left shows how wealth firms rated the pace and volume of regulatory change compared to the previous five years in 2015. The graph on the right shows how they rated the pace and volume of regulatory change across 2015 and 2016.
'In 2015 a third of firms thought the regulatory landscape was beginning to look like a ‘new normal’ and were adapting to the volume of compliance work required of them,' the survey noted.
This year 71% of participants think the pace and volume of regulatory change is high and that despite some improvement in their processes, it feels as though the rate is increasing once again.
The role of technology
'The large majority of firms have used technology to help them deal with regulation by, for instance, implementing new CRM systems that aid the challenges brought about by suitability,' the survey highlighted.
'Many said that they were trying to go paperless, again something that helps meet the challenges of suitability and allows them to use technology wherever possible.
Firms also found ways to ensure their current technology setup was used most effectively, and automation was an often cited example of this, where firms tried to convert large volumes of repetitive manual tasks into work done by a computer.
The respondents were then asked if they believed it was possible to get a competitive edge by dealing with regulation in different way to their competitors.
'A rather large 65% however, said that regulation is something that can be used to gain an advantage over your peers.'
Two frequently cited examples include:
• Using technology to aid efficiency gains, shortening the time needed to deal with regulation and
therefore controlling/cutting costs
• Embracing regulation and building it into the culture of your business so that costly mistakes are not
made in the future
Data from the report found that the compliance department’s share of total costs since 2009 remained almost static, hovering between 5% and 4%.
Wealth firms were asked why this appears to be the case considering the belief that regulation is heavily pressuring margins?
'Could it be that firms are passing the costs onto clients,' one respondent mused. Another highlighted: 'Managing risk is the responsibility of the entire business, so the costs of compliance are now spread out across the whole firm, hiding the real effect when looking at the compliance department alone.'
Absorbing the cost
Most firms said compliance costs had remained static when measured as a percentage of total costs because the real cost of compliance was very difficult to quantify as it was built into the entire business, appearing as, for example, opportunity costs of front office staff filling in suitability forms or IT developers working on regulatory projects.
Time spent on regulation
Individuals were then asked what proportion of their usual working hours various departments spend on regulatory work.
41% of firms' IT departments spend less than 20% of their time in regulatory work, while those that spent 20-40% stood at 35%.
Elsewhere 58% of senior management staff typically spend between 20-40% of their time on regulatory work, versus 24% who spend less than 20% of their time in this area.
How this compares to five years ago
82% said IT departments have seen their regulatory workload increase over the last five years.
'In fact a large majority of firms said both the Front Office (FO) and senior management have also had to increase the amount of time they now commit to regulatory work, though it was the FO who suffered most,' the survey noted.
This is because 41% of firms said the FO spend between 20% and 40% on regulatory work, and 29% said the FO can spend up to 60% of their time doing regulatory work.
Why is suitability still a challenge
Wealth firms were asked why they thought the suitability issue is so ‘current’ given the fact that the underlying issues and regulations have been around for so long?
'The industry is still not getting it' came out as the top reason, while increased pressure from the FCA was the second reason cited.
Some of the greatest suitability challenges mentioned included: 'Getting the front office to buy into it, fully
embracing the ethos of suitability' and 'Getting around the ambiguities surrounding what the regulator requires of a firm.
Record keeping and using the information correctly was highlighted as another challenge.
Reviewing suitability processes
'It was rare to hear a firm speak of a time-structured process review when speaking about suitability,' the report noted.
'Most firms, 71%, said reviewing suitability processes was something that evolved as they went along, learning new
things about what the FCA expects, about how effective their internal procedures were at serving clients, and
building systems that allowed them to better match client requirements with suitable investments.
How suitability reviews are handled
'While many firms recognised the benefits associated with technology and the automation that it could
bring, many admitted that the manual element could never be extinguished, since suitability was often an ‘art and not a science’ where personal relationships and understanding came into play. 76% said they used a mixture of systems and manual processes to do the review.'
Have suitability assessments increased compliance costs?
'It is positive to see that half of firms have not seen costs move as a result of the drive to ensure ongoing suitability assessments are done.
'In fact, a very small number of firms said costs had fallen because suitability had allowed them to introduce a lot of automation that streamlined processes and costs.
However, 44% said costs had increased. Some firms said the increase was minimal, though the average increase was over 10%. One firm cited costs increasing by 400% due to the quadrupling of time now needed to carry out such assessments.
The debate then moved on to Mifid II, with wealth firms being asked if FCA consultation papers and ESMA Q&As had added to the previous ambiguities surrounding the regulation.
'Ambiguity was a running theme throughout this year’s research process as it appears ever greater volumes of regulation increases the amount of possible ambiguities around the edges of initiatives such as Mifid II, Suitability and GDPR (General Date Protection Regulation),' the survey said.
'Firms are crying out for more information so that they can feel confident that the road they are now on is the right one.'
One respondent said: 'There’s a hell of a lot of ambiguity still there. We actually rely much more on our lawyers than on the FCA, while another said 'They’ve provided some additional clarity but I’m probably being a bit generous there.'
However, some think it may not be such a bad thing that there's not more clarity: 'In a weird way, it’s actually good that there’s not been a lot of new information as it allows us to carry on with what we’re doing,' the commented.
Hitting the Mifid deadline
The study was rather concerned by how unprepared wealth firms are to meet the Mifid deadline.
'Perhaps one of the most worrying findings in this year’s research is how close the percentages are between those who think it’s very likely that they’ll hit the deadline of January 2018 (53%) and those who think they could struggle (41%),' it noted.
'Projects rarely come in ahead of deadline so it could be argued that the 41% is to be expected. However, this is after the deadline has already been extended by 12 months. Will we see a further extension?
Finally wealth firms were asked how prepared they were for General Data Protection Regulation (GDPR), which will be enforced from May 2018.
Almost a fifth of firms were still very much in the early stages of preparing for the GDPR. For the 44% of firms
that had already started implementing changes, many were focusing on the staff training required to ensure
employees understood the implications of the regulation.
'This is understandable since the weak points in any data leak are likely to be human,' the study suggested.
Interviewees also recognised that GDPR will have an impact on their IT systems and since such work often has long lead times associated with projects, firms were assessing the work required from their technology departments.
Contraventions of GDPR could result in fines of up to 4% of global turnover, so the 31% of firms who are yet to look at GDPR would do well to at least begin their gap analysis.