2013: the year of compliance

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Asset management is now one of the most highly regulated industries in the entire economy, and the scope and complexity of regulations continue to increase. Like the regulatory revolution that reshaped the airline and telecommunications industries in decades past, this evolving compliance environment will be a game changer for asset management – particularly for smaller firms.

Regulators are not the only ones raising the bar. Potential investors are focusing on the same pointed questions as examiners regarding risk, expense allocation, performance reporting and valuation.

In our 2012 Global Hedge Fund and Investor survey, 56% of institutional investors surveyed indicated that operational risk concerns (separate from performance) would cause them to redeem assets. Further, when asked where they think fund managers should direct capital investments in technology, 68% said risk management.

Facing this juncture, asset management firms require a strategy that can help them navigate the current regulatory environment, adapt to inevitable regulatory changes, remain cost-competitive and stay focused on their core business strengths.

Waves of regulation

Regulators are proposing new rules at a fast and furious pace – and many regulations have yet to be clearly explained. For an in-depth look at the intricacies of the compliance landscape, download the full report “2013: the year of compliance”.

Here are highlights of the areas in which asset management firms face pressure:

  • SEC
    The SEC has thoroughly reviewed and revamped its systems, operations, internal communications and examination processes. Simply put, the agency has started aggressively looking at risk like never before and implementing a new, more comprehensive methodology to select firms to review.
  • Form PF
    The scope and complexity of Form PF will shape firm-wide data strategies. Small private funds, in particular, may now fall under the filing umbrella due to the methodology used to calculate assets under management subject to regulation.
  • Commodity Futures Trading Commission (CFTC)
    The CFTC has assumed new supervisory powers over many registered funds that perhaps have never dealt with CFTC regulation before. The CFTC operates a parallel and separate regulatory regime from the SEC, and the respective rules and review procedures can be frustratingly different for asset managers.
  • National exams
    Starting this year, the SEC will likely visit and conduct presence examinations on most new firms that initially registered by 31 March 2012. Two other types of exams will also be conducted: routine exams and sweep-based exams. Taken as a whole, the exams will make setting up a new advisory firm more onerous than ever.
  • Alternative Investment Fund Managers Directive (AIFMD)
    The AIFMD is one of the most encompassing pieces of financial legislation to come from Brussels since the creation of the EU, and its reporting requirements are widely seen as more onerous than even the SEC’s voluminous Form PF.

The end of the entrepreneur?

Some argue that the overwhelming number of new regulations will stifle entrepreneurship. The largest firms command the scale, headcount and compliance budgets to implement new internal procedures and systems at far lower marginal costs than smaller firms.

Making bigger firms even bigger is exactly the opposite intention that policymakers had in mind when drafting the new regulations. More concentration in the industry implies more systemic risk.

Re-emphasis on outsourcing

Given the regulatory landscape, strategic outsourcing of key compliance-related functions will become increasingly important for small fund managers. Fund administrators, prime brokers, compliance specialists and firms that provide middle- and back-office functionality have responded quickly to the new environment.

For example, most fund administration service providers have created data aggregation and reporting services to address a wide variety of regulatory filings. More than a dozen outsourced fund administrators are aggressively marketing their outsourced services in preparation for Form PF alone.

By implementing a smart outsourcing plan, the classic business model of a small fund – starting with little more than an office, a telephone, a prime brokerage account and a Bloomberg terminal – is by no means dead and buried.

Download the full report “2013: the year of compliance” for key steps to smart outsourcing and much more on dealing with the new regulatory landscape.

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