Forward-Looking Compliance Practices in Wealth ManagementIn a market of rapidly mushrooming regulatory requirements, wealth management firms need to adopt proactive practices by allocating resources with a long-range aspiration for compliance.

Executive SummaryGlobal wealth today has crossed $241 trillion, up a $10 trillion from last year and nearly $100 trillion from 2003, with the U.S. contributing to about three-fourth of the latest increase. Average wealth per adult is also touching new highs. Although the post-crisis growth of wealth management indus-try has been resounding, the industry has been facing more challenges than ever before such as stringent regulations, unstable financial markets, demanding investors and cut-throat competition.

Global wealth management firms are battling tighter margins due to various challenges. A key challenge is regulatory compliance, which calls for the need to adopt a strategic vision. Regulatory action typically stems either from revelations of fraudulent practice or from a crisis in the past. So what can change? The answer lies in becoming proactive rather than reactive towards compliance.

Simply put, firms need to put automated con-trols in place to prevent any one individual from affecting the way the firm conducts business. At the same time, controls and restrictions should

not be enacted to an extent that hampers the achievement of business objectives and under-mines employee morale and action. Designed systems should also be intelligent enough to have analytical capability to generate reports and help in finding the firm’s internal noncompliance.

Introduction In the wake of the recent financial crisis, regulators have become more focused on protect-ing investors, ensuring that firms have enough regulatory capital and practice timely reporting. Many new regulations have come to the fore to address issues that were earlier overlooked. To leap the regulatory hurdles, wealth management firms should reexamine their business and oper-ating models, adhere to the regulations and also anticipate upcoming regulations by setting their own standards of noncompliance.

This white paper analyzes the key themes of the regulations: Reporting, Investor Protection, Marketing and Distribution, Transparency, Risk Management, Client Onboarding, Capital Require-ments, Remuneration and Business Conduct. And these themes are mapped (Figure 1, next page)

cognizant 20-20 insights | december 2013

• Cognizant 20-20 Insights

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Key Regulatory Themes

Figure 1

against the global regulations and IT systems (Figure 2, next page). The regulations impact the following areas in IT system the most: Trade Settlement, Risk Management, Sales, Portfolio Accounting and Portfolio Management. They play a crucial role in adapting to the regulatory changes and also to be prepared for the future regulations by setting high standards for compliance.

Key ThemesThe regulations in the wealth management domain touch across the following key themes.

Client Onboarding

• Background checks for clients. In a bid to curb the money laundering and other financial crimes (such as fraud, tax evasion, etc.), client onboarding process has become more strin-gent. Anti-money Laundering and Know Your Customer norms ensure that the firm collects all the necessary information about its clients before providing services to them. In addition

to these regulations such as Foreign Account Tax Compliance Act (FATCA) and OEC Offshore Tax agreement address the tax evasion issue.

Capital Requirements

• Financial strength of the firms. The recent financial crisis brought to the fore a major flaw in the system. The dearth of capital in finan-cial services firms led to many firms becoming insolvent. As a result, many regulations have cropped up to ensure that the firms have suf-ficient capital consistent with the risk profile of the firm. Regulations such as Undertakings for Collective Investment in Transferable Secu-rities (UCITS), Alternative Investment Fund Managers Directive (AIFMD), European Market Infrastructure Regulation (EMIR) and Basel address the capital requirement issues.

Delegation

• Reason for transferring responsibility. There are certain guidelines concerned with

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the kind of activities that can be delegated by a fund manager, which are covered in the UCITS and AIFMD regulations. These regula-tions state that there must be an objective reason to delegate an activity to someone and also limit the extent to which an activity can be delegated to ensure that the ultimate responsibility of the delegated activity still lies with the fund manager.

Valuation

• Consistency in evaluating fund. In order to reflect a true picture of the fund, it is impera-tive that the fund managers employ the cor-rect valuation methods for valuing the fund. Regulations like AIFMD and UCITS lay empha-sis on the procedures used for valuing the fund to ensure that the funds are valued indepen-dently and the methods used are consistent.

Marketing & Distribution

• Insistence on plain language. With the finan-cial products becoming increasingly complex, there are regulations that mandate the firms to market their products in a comprehensible

manner for investors. Hence, the firms will need to upgrade, reprint, and distribute new market-ing materials and product information sheets that comply with the new mandates. Some key regulations in this area are UCITS, Retail Distribution Review (RDR), Packaged Retail Investment Products (PRIPs), AIFM, and Mar-kets in Financial Instruments Directive (MIFID).

Remuneration

• Standards for fair incentives. Under a set of new stringent rules covering remuneration, managers are expected to ensure that sound and prudent practices are in place, which are con-sistent with risk profiles. The regulations such as AIFMD state that at least a portion of the vari-able remuneration must be in the form of non-cash variable payments such as shares/units of AIF so that the incentives are aligned with the interests of AIFM. Other regulations that focus on remuneration issues are UCITS, RDR.

Depositary

• Appointment of a scrutineer for assets. Regulations like AIFMD, UCITS also mandate

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Reporting to Investors

Disclosure about Fund Managers EmployedFirm Level and Portfolio Level Disclosures

IT Systems Potentially Impacted by Regulatory Changes

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that the fund managers appoint a depositary for cash flow monitoring, safekeeping of the assets and oversight of certain operational functions. The regulations also specify who can act as a depositary.

Risk Management

• Setting up a robust risk-control system. Risk management function can play a crucial role in the decision making as it helps a firm identify and monitor the key risks. The regula-tions such as Basel, EMIR, AIFMD, and UCITS state that firms must implement adequate risk management systems to identify mea-sure, mitigate and monitor all risks. This would include the use of appropriate stress-testing procedures. It is also required that the risk management systems be subject to an annual review by the senior management.

Transparency

• Need for crafting transparent content. The regulators emphasize on in the need for more transparency in the firms. There are many mandates that regulate the content and the format of annual reports published by the firms. Key regulations addressing the theme of transparency are RDR, PRIPS, EMIR, FATCA, AIFMD, and UCITS.

Business Conduct

• Employing fairness in trading. Regulations such as AIFMD also propose guidelines for conducting the business in a fair manner, which includes fair and equal treatment of all the investors and fair resolution of conflicts of interest. Other key regulations that address the business conduct are RDR, UCITS.

The Road AheadComplying with the ever-increasing number of regulations can be a daunting task for the

wealth management firms. Firms need to take into account, not just the cost of noncompliance, but also the cost of compliance. While noncompliance may lead to penalties, loss of business, the cost of compliance is no less harsh. To analyze the

tradeoff between the cost of compliance and con-tinuing in a particular line of business or with a particular product battling high compliance costs,

we need to do scenario analysis. For this purpose, the information backbone of the business needs to be shared with the compli-ance department. This will also help business in gaining analysis from the compli-ance, which can be used for cross-selling and upselling. The new approach of shar-ing the transactional analy-sis results will help business in going one step ahead in doing behavior analysis for cross-selling and upselling. For example, in India a lot of retailers encourage custom-ers to do cash transactions instead of using debit or credit card. Compliance will track these trans-action trends and business can use the informa-tion to design a new product (new type of debit or credit card) or modify existing products to encourage retailers to embrace card transactions.

Given the instability of the market, the regula-tions are much more likely to change in future. The industry must be prepared to tackle those challenges by focusing on strategic transforma-tion. Firms can allocate a part of its discretionary budget every year to be future-proof rather than responding to existing regulatory changes. This discretionary budget can be utilized in analyzing its business, practices and systems,identifying weak-nesses from the firms’ internal compliance per-spective, and coming up with process and system solutions to avoid huge compliance expenditures in the future. One of the examples for the internal compliance could be related to portfolio churn-ing in an individual portfolio. Internal compliance can supervise the extent of portfolio churning and analyze the case internally. At the same time client should be reported on the fees and commis-sions charged and how it has impacted the port-folio value. Reverse churning is also something that needs to be analyzed and reported internally.

A firm’s existing analytics can be used to generate reports about its internal compliance failure and tracking the patterns. These noncompliance pat-terns can be discussed with regulators to make standard compliance requirements in the market. In a market where competitors grapple with new compliance requirements, the firm can utilize the budget on its newer business strategies, giving it a clear edge over the rest.

Firms can allocate a part of its discretionary budget every year to be future-proof rather than responding to existing regulatory changes.

Firms need to take into account,

not just the cost of noncompliance,

but also the cost of compliance.

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About Cognizant

Cognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process outsourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquartered in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industry and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 50 delivery centers worldwide and approximately 166,400 employees as of September 30, 2013, Cognizant is a member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top performing and fastest growing companies in the world.

Visit us online at www.cognizant.com or follow us on Twitter: Cognizant.

About the AuthorsRakesh Singh is a Manager with Cognizant’s Banking and Financial Services Consulting Group. He has more than 14 years of experience in leading business and IT consulting engagements, mainly in the risk and compliance, capital markets and private wealth management domains. He can be reached at Rakesh.Singh3@cognizant.com.

Sumeet Gupta is a Consultant with Cognizant’s Banking and Financial Services Consulting Group, focusing on risk and compliance. He can be reached at Sumeet.Gupta2@cognizant.com.

Acknowledgements The authors would like to acknowledge the review assistance provided by Anshuman Choudhary, Consulting Director within Cognizant’s Banking and Financial Services Consulting Group.

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