Post-trade realities hit home on the buy-side

By Virginie O’Shea, senior analyst at Aite Group

The ongoing global regulatory debateabout the Tier-one asset management community’s systemic significance reflectsthe dramatic shift in attitude toward the buy-side over the last 24 months.Though it continues to be fiercely debated, the potential impact of a largeasset manager’s failure on the financial markets is at the forefront of theregulatory crackdown on non-bank financial institutions. The buy-side communityhas already faced a gamut of new regulatory requirements, and it is confronted withthe prospect of many more in the coming years. Buy-side-focused regulation maybegin to rival that focused on the sell-side in five years if nonbank reformcontinues to be drafted at this pace.

All of these requirements have alreadyimpacted the buy-side’s middle- and back-office operations, and firms that puttechnology purchases on hold during the 2008 economic and market crisis are evaluatingtheir internal technology environments. Systemic and operational risk concernshave also heightened these firms’ scrutiny of third-party outsourcingrelationships, leading to an uptick in reconciliation processes and theintroduction of additional reporting layers between firms and their serviceproviders.

The regulatory burden has increasedsignificantly for these firms overall and several regulatory items are top ofmind for the 58 buy-side firms we surveyed as part of our recent researchincluding the Foreign Account Tax Compliance Act (Fatca), the AlternativeInvestment Fund Managers Directive (AIFMD), and the upcoming Undertakings forCollective Investment in Transferable Securities (Ucits) regulations. Potentialchallenges or issues are even related to the interconnectedness of regulationsin one region; for example, there is some concern about the interaction betweenfund regulations Ucits V and AIFMD and the over-the-counter derivativesclearing requirements under the European Market Infrastructure Regulation (Emir).

Given regulatory change’s wide scope, itis no surprise that the buy-side community is still somewhat divided betweenthose adopting a firefighting approach versus those that are able to approach complianceprojects strategically. Not all firms are looking at compliance requirementsholistically; some firms are focusing on implementing specific technologyprojects aimed at meeting individual regulations’ requirements. Others areexamining a strategic, more centralized data framework from which to draw datafor reporting purposes; hence, these firms have multi-year technology projectsin flight.

It is commonly recognized, however, thatdata sets are being heavily impacted by regulatory change, especially risk andvaluations data. Firms are much more aware of the data management process’shortcomings than they were before due to data-quality issues’ increasedvisibility when aggregating required data for reporting or risk measurementpurposes. Regulators are probing portfolio data in unprecedented ways, whichrequires more systematically centralized client and portfolio data in a worldstill clinging to spreadsheets for valuation modeling and record keeping.

It is not just a case of buy-side firmsmeeting their regular reporting obligations; they must also deal with a wholeslew of ad hoc reporting requirements and, sometimes, on-site visits byregulators, which are likely to increase if systemic importance is designated.The pace of regulatory change has not helped matters, since firms are oftenreliant on manual processes and therefore cannot scale to meet an uptick indemands on a daily or weekly basis.

Our research indicates that the majority offirms are reliant on at least some manual processes to respond to regulators’ad hoc requests for information, and only 12% of respondents to our survey feelthat they are in a good place to respond in a largely automated fashion.Moreover, regulators are not the sole issuers of ad hoc reporting requests;external clients, internal audit teams, and risk management teams are alsodemanding information about certain data items or sets on a more frequentbasis.

Middle- and back-office desires to reducecosts and improve efficiency is reflected in respondents’ operationalpriorities: 86% of firms indicate that they have prioritized reducing costs viavendor rationalization programs and process industrialization. The introductionof workflow processes, which is deemed very important by 76% of firms andsomewhat important by 24%, is also aimed at increasing staff productivity andreducing manual effort. Along with the reduction of costs and manual processes,firms are focusing on bringing down operational risks and retiring oldersystems that may pose technology risk or key person risk, as a limited numberof staff members are likely to know how to operate such systems. Firms’post-trade priorities also reflect support for expansion into new assetclasses.

Overall, the buy-side is still a long wayfrom optimally efficient post-trade processes. Firms continue to grapple withcore operational issues, which is not a surprise given the many regulatory andmarket infrastructure changes over the past few years. The efficiency andautomation improvement process is ongoing and will continue to be an area of painfor the foreseeable future and Aite Group expects increased evaluation andinvestment in the middle- and back-office for some time to come.

The report, Buy-Side Post-Trade Realities:Keeping Cool While Under Fire, is posted on Aite Group’s website here: http://www.aitegroup.com/report/buy-side-post-trade-realities-keeping-cool-while-under-fire