EY Compliance Management for Asset Management Survey 2012

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Compliance managementfor asset management2012 survey


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Introduction 1

Executive summary 4

Top dozen action list to achieve better compliance management 6

Survey ndings 13Summary of ndings 2012 survey vs. 2011 survey 40

Glossary of acronyms 43

Contents


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2 Compliance management for asset management 2012 survey

Although most rms were interested in how to innovate, only a

minority of respondents felt condent enough to state that they

could actually see concrete opportunities to innovate as a direct

result of forthcoming regulations. For example, measures such

as RDR and some of the UCITS IV-VI measures (featuring fund

mergers, master-feeder funds and passports for management

companies) offered possibilities for rms (or their parents) to offer

new investment products, offer new platforms or gain efciencies.

Other new regulations, such as Solvency II, AIFMD, MAD II/

MiFID II, FATCA legislation and EMIR, required more substantial

reporting obligations and record-keeping. The desire to hold abuffer of quality collateral for rms suddenly needing to clear OTC

derivatives added a further complicating factor in the case of the

latter.

Furthermore, macro-regulatory measures such as the detailed

rule-making from Dodd-Frank, Basel III/CRD and Solvency II

remained uid and incomplete at the time of writing, with the

potential to delay much-needed reform in adjacent or dependent

regulations, sometimes considerably. The G20 Summits1had

promised reform of the nancial services industry by a target date

of December 2012, but as the nish date loomed, it was only too

apparent that there was some way to go in terms of central banks

and competent authorities implementing the devil in the detail ina consistent manner.

The result of the processes among the G20 countries has created

an asset management industry confronted by a otsam of

piecemeal regulatory initiatives taking place at global, regional

and local levels. Political interventions have created measures that

sometimes appear to work at cross-purposes (e.g., EMIR/AIFMD

vs. shadow banking/CRD on collateral/rehypothecation). The lack

of congruence in some key areas such as banking and capital

markets represents an 11th hour warning of the multi-locational

free-for-all to come if divergent approaches or extraterritorial

tendencies fail to be reconciled.

It is little wonder then that we found that compliance professionalsin asset management show signs of reg fatigue, because they

are stretched as never before by the number of new measures

and constant changes. Many seem challenged to help business

and operations colleagues understand the impacts, deduce the

opportunities and manage the complexity transfers from the many

and varied measures, while trying to support their risk colleagues

in anticipating extreme events, optimizing capital and liquidity,

and minimizing the potential for reputational risk.

1 The G20 Summits that had taken place in London and Pittsburgh in April and September 2009 had proposed 58 action

areas for promoting global nancial regulatory reform in the wake of the crisis. Impressive progress was made on the

part of the IMF, the OECD and the FSB, working with bodies such as the BCBS, BIS, IAIS, IASB and IOSCO to ensure that

all G20 countries endeavored to implement the prudential or conduct of business measures into their national regulatory

frameworks by the target completion date of December 2012.

In such an environment, we believe that careful thought about

future developments and possible improvements to business

and operational processes and the compliance management

function in particular should be extremely valuable for the asset

management sector. In conducting this survey, we interviewed

42 Heads of Compliance, Heads of Legal and Chief Compliance/

Risk Ofcers representing a selection of large, medium and small

traditional and alternative investment management rms (by

AuM) operating across Europe.

One-on-one interviews conducted between July and

September 2012 gave respondents the scope to offer full opinionsonce more under conditions of anonymity. We are grateful to

them for their patience and considerable support behind this

endeavor. Once again, the result is a range of qualitative opinion

and quantitative comparison ndings that form the bulk of this

publication. Critical conclusions are featured in the executive

summary and in the 2012 vs. 2011 comparison template at the

rear of the document for ready reference by seniors, particularly

from the boards or the business.

Ernst & Young has also added our own view of the top dozen

actions that we believe will help rms to improve their compliance

management processes still further. This survey complements the

latest Risk Management for Asset Management Survey that waspublished in June 2012.

We hope that you and your colleagues in legal, risk, internal audit,

nance, business, operations, senior management and the board

enjoy reading this report and that you nd it constructive and

thought-provoking in helping your rm raise its game, mitigate

risks and attract new business. We also welcome your comments

and feedback. If you would like to discuss any aspect of the

survey, please get in touch with me and my colleagues using the

contact details at the back of the report.


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3Compliance Management for Asset Management 2012 Survey

Compliance Management for Asset Management Survey

Ernst & Youngs Compliance Management for Asset Management 2012

Survey offers revealing insight into the unique set of challenges currently

confronting our industrys compliance professionals. In comparing the

views of 42 Heads of Compliance, Heads of Legal and Chief Compliance/

Risk Ofcers from some of the most recognized asset managers in Europe,the survey provides indications about future developments and evidence of

the importance of the compliance function in the industry. It also suggests

areas where improvements must be made to effectively meet the new

challenges faced by asset management rms.


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4

A focus on governance, remuneration and innovation is making compliance

management an essential profession in 2012.

The European asset management industry has come of age since the risk and

compliance surveys were rst launched in 2009. The drivers managing complexities

from overlapping directives plus the desire to mitigate reputational impacts havent

changed, but the prioritizations have shifted to involve risk management and operational

aspects as magniers. Examples of the former include investment risk independence

and product, liquidity and duciary risk management, and examples of the latter include

front ofce controls, managing the complexities around collateral rules, and client asset/

money protections.

Just as the lines blurred between nance and compliance when managing the ICAAP

processes, the lines between compliance and operations have blurred with measures

such as EMIR and Solvency II on the horizon. Heads of compliance discovered how

aligning regulatory impact with business innovation was a stepping stone to cultural

acceptance on the part of senior management. Some rms cited opportunities to develop

new instruments, share classes, management structures, risk models or even platforms

on the back of regulations examples included LDI, GTAA, portable alpha, smart beta,

active ETFs and infrastructure assets. The leaders were not shying away from the

consequences of taking bold initiatives.

There are over 30 local and regional regulatory measures

impacting asset managers in the EU; regulatory measures are

becoming more operational, impacting trading, collateral and

outsourcing arrangements.

Gone are the days when asset management was a lightly regulated industry. TheG20 deadline of 31 December 2012 coincides with over 30 local and regional

compliance measures that need to be anticipated, understood, modeled and managed.

With high-prole nes issued for areas such as client money arrangements or mis-selling,

the consequences of the potential impacts of getting it wrong can have a severe impact

on redemptions and thus AuM, as sadly witnessed by more than one respondent in this

survey. While the amount of attention paid to ARROW and ICAAP procedures has shown

a quantum leap, there is evidence to show that rms need to show similar willingness to

address the conduct side in a similar manner. The pace has stepped up in four themed

areas when it comes to conduct regulation. Firms will need to demonstrate (via reverse

burden of proof) that they have the policies/procedures, systems/controls, reporting

tools and quality data to meet the needs in each zone:

Product regulation Covering PRIPs, RDR and local product denition/qualication/intervention approaches in each country of business

Front ofce measures Short Selling Regulation (SSR); revisions to the Market Abuseand Markets in Financial Instruments Directives (MAD II/MiFID II); and local front-ofce-themed approaches in each country

Fund regulatory measures Including UCITS V & VI following on from UCITS IV, theAlternative Investment Fund Managers Directive (AIFMD) and local approaches onmonitoring the component parts of these measures in each country

Derivative and collateral measures Dodd-Frank Title VII and EMIR as well as newerregulatory resolutions, such as shadow banking and ETF/MMF measures as required

Executive summary

The opportunity to build trust and

condence is the key benet comingout of the regulatory attentionthat our industry is getting. We arereverting to a rm that is true to itsvalues, running our agency businessmodel with transparency on fees[particularly our tax transparentfunds] and a focus on both clientservice and avoiding regulatory risk.

We have a regulatory reform presenceand a technical compliance teamwhich features six to seven FTEs

working on policies/procedures,marketing signoffs and businessguidance as part of our reformremit. You cant look at regulations inisolation we focus on CRD, MiFID II,UCITS V and AIFMD simultaneously.

There are two philosophies atwork you can either take stepsby preventing conicts of interestdeveloping with the business fromarising, or manage those conictswhen they do. In the real world

of rms with an active style ofmanagement, the former is notrealistic or practical, so we invest insystems to manage appropriately.

Compliance management for asset management 2012 survey


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5Compliance management for asset management 2012 survey

The compliance function has moved beyond its former image of ex-

post box-ticking toward ex-ante horizon risk management, helping

rms avoid the reputational effects.

As regulation becomes more comprehensive, consistent, invasive and potentially even

activist, the best recourse would be for rms to demonstrate tness for purpose by way

of skill-sets, future exibility when it comes to systems design, and above all, reinforced

evidence of good intent in serving their clients. Sound management information, coupled

with sound behaviors, will be an important means to sustain business models. There

is normally a trade-off given the level of compliance resourcing. As more attention

is diverted to administering governance, responding to requests for information

by regulators and facing up to clients, the traditional functions of policy work and

compliance monitoring are getting squeezed.

For the rst time, the survey recorded how regulators had started posing deeper

questions about skill-sets and bench strength to cover all the countries where a rm

did business. Firms would do well to agree to a modus operandi of where critical

functions should reside such as compliance monitoring, guideline monitoring, branch

monitoring, client onboarding/KYC, AML/sanctions, special investigations, whistle-

blowing, marketing, product development, regulatory reform and lobbying. Firms should

also redesign their systems to cope with single-portfolio view or single-legal entity

look-through requests. Almost all would benet from exploring the means to transfer

complexity by working in partnership with asset servicers to examine the case for

managed middle as well as back ofce requests.

Engaging with Heads of Compliance and Regulatory Reform, who are working

hard to create a holistic approach to compliance, was the primary rationale

for running this survey.

There are big opportunities to be hadfrom regulation examples includerunning LDI strategies from our QIFstructures, running ETFs from Dublinand Paris, and Solvency II durationmatching products. Our parent is alsoplanning to run platforms, new vendorservices and potentially even trade

venues.ABC and AML is a huge area ofthematic interest for the FSA rightnow. Apart from client money, wevehad to redouble our efforts aroundABC, nancial crime, fraud and AML.Weve also formed a GIFA (groupinvesting forensic accounting) teamwho are tasked with overseeing thisactivity.

Compliance ofcers need tounderstand the products to be fully

accepted by the business. Manycompliance ofcers look as if theyvejust graduated from complianceschool as business prevention ofcers.They can quote you the rule from theregulation but they havent a clueabout the implications for the businessand cant keep a calm head in a storm.

Weve spent a lot of effort in settingthe right tone from the top in termsof positioning ourselves mostappropriately given that we are a

poster child for what happens in thissector.

Based on the results of the survey and the experience of our

own Ernst & Young practice professionals, we have identied

the top dozen actions to help rms better manage the risks

they face. This list is not a denitive action plan, but we hope

it will offer a useful starting point for identifying the steps that

would most benet your rm.


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6 Compliance management for asset management 2012 survey6

Top dozen action list to achieve bettercompliance management

1Task a regulatory reform function/PMO to anticipate

future measures, lobbying, strategy, business development

and product development

Three years ago, when compliance managers in asset management focused

on one signicant regulatory change per year, the notion of a regulatory

reform function was rare. Now, as rms are confronted with incremental

regulatory changes each month, it is vital, and 45% of respondents in this

survey indicated that the rm had either tasked a global regulatory reform

(GRR) function/individual or could rely on a comparable function at the

parent level to help manage the risks on the horizon. Asset managersshould evaluate the likely future costs of trying to dig up the road

regulation by regulation on an ongoing basis. They should try to determine

how future opportunity costs from meeting requests from local/regional

regulators and from signicant clients such as pension funds/SWFs could

be managed down. A minority of rms have begun to design their systems

and controls (SYSC), their reporting or their data structures to meet the

needs of multiple regulations, or by transferring complexities to third-party

servicing companies (reversibly, if that is possible). Fewer than 5% of the

leading rms have tasked a project management ofce (PMO) function to

do this but interest is growing!

2Where a majority of respondents see adverse impacts, aminority see opportunities to be developed

Heads of Compliance discovered how aligning regulatory impact with

business innovation was a stepping-stone to cultural acceptance on the

part of senior management. Virtually all respondents grumbled about the

impacts of some of the measures remuneration at the fund level, liability,

treatment of letter boxes, uncertainties over inducements and extra-

territoriality all drew sharp criticism. But some rms cited opportunities

to develop new instruments, share classes, management structures, risk

models or even platforms on the back of regulations such as UCITS IV,

RDR/PRIPs and MiFID II, which could be regarded as more opportunistic.

Seventy-six percent of respondents claimed to be exploring/designing new

products or services in order to take advantage of the regulatory measures examples included LDI, GTAA, building block QIFs, portable alpha,

alternative beta, active ETFs and infrastructure assets such as farmland.

One extremely effective strategy practice by several rms in Scotland, the

Netherlands and Scandinavia was to build greater levels of trust by focusing

on ethics and/or repositioning their reputational proles.

There is denitely a ight to qualityin the Eurozone and its driven notso much by regulation but by politicsand macroeconomics. And yes, thesetrends could become structural.

Regulatory risk is the big issue theworlds of UCITS, AIFMD, MiFID II,EMIR and FATCA especially plusthe increased interest from localregulators. We have a great deal of

interest shown from the DNB andAFM here in the Netherlands, theCSSF have doubled their headcountin Luxembourg, and in France, theMadoff issue means that the AMF aremuch stricter on monitoring.

We are moving to take advantage ofnew opportunities by creating new JV-arrangements for RDR.

The biggest opportunities for ourrm right now are central clearing

opportunities, offering greater rangesof ETFs and the launch of more RDRshare classes.


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3Smoother ARROW visits show that good rms get more

time off for good behaviors

The FSAs ARROW visits are often electrifying. But compliance departments

and other control functions have spent time reacquainting their business

colleagues with the ner points about their rms policies and procedures.

The evidence from this survey suggested that regulators right across

Europe were placing a great deal of focus on behaviors and managing

conicts of interest in the Nordics, for example, there was renewed focus

on TCF, and in Germany, on Musterbaustein Kostenregelung for portfolio

management. In the UK, there was growing interest in rms setting outtheir compliance strategy and ensuring that it was fully embedded (the

USE test). Respondents were keen to share their experiences around

culture, behaviors and ethics. Several rms were able to demonstrate how

their code of ethics linked to their risk appetite, TCF outcomes, periodic

disclosures and reinforcement by means of training, acceptable case

practices and sometimes mentoring. Leading rms explained how these

measures could extend beyond the rm to include branches, outsourcing

agents, key clients or shareholders.

4

Capital might still be king, but evidencing good governance,

controls and behaviors is equally important

The positive news for rms in this survey was that four asset managers

were awarded lower ICG scores by the FSA. In effect these rms made

careful preparations to manage their capital requirements downwards

per Pillars 1 and 2 and the treatment of cost/time and commerciality of

unwind. The natural momentum of travel might still be an upward trend

in ICG scores (to a range of 130% to 170%), but clearly, some rms have

worked hard to buck that trend. Asset managers should continue to

model their capital requirements with a goal of optimization in mind and

conduct capability maturity modeling exercises on what other rms are

doing as part of their ICAAP/SREP processes, bearing in mind the type

and combination of factors that might give the regulator cause for setting

elevated ICG uplifts. This applies particularly to rms running platforms,

rms operating multiple or complex investment styles featuring leverage,or rms expecting to take full advantage of waivers. Firms are strongly

encouraged to focus on corporate governance, unwinding provisions,

reverse stress testing (killer super-scenarios), and especially the USE

test (linking risk qualitative and quantitative risk appetite statements and

frameworks to strategy and behaviors).

The expectations around CoB havemoved the fundamental challengeis supplying the regulator with anopen-ended reverse burden of proof.Cultural drivers now span discussinga mission statement, a statement ofcorporate values and a code of ethicsand may even extend to performing aroot cause analysis tied to culture andvalues in 2013. The regulator wants

to know how a CoEs values might beconsistently applied so as to preventpoor customer outcomes.

The changes to the CASS rules/CASS-RP are the biggest worrybecause of the need to address all theagreements. We have an ARROW visitin October and a need to evidence lackof conicts around our outsourcingarrangements with XXX and YYY.We have a standard remunerationagreement with our outsourcers

but we think the FSA will wish to seesomething more robust.

Solvency II will impact asset allocationmovements as rms replace theirexposure in equities with assets in thepassive space such as index funds,ETFs and alternative beta, all of whichare relatively easy to handle from atransparency perspective.


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Top dozen action list to achievebetter compliance management

We invest in ETCs and ETNs ourselvesbut we are very aware of the mis-selling potential of ETFs and the risk ofa bubble developing, particularly in thecommodities space.

Theres a big focus on the front ofceright now focus on PM visits, focuson automated TCA, and ensuringadequate segregation of dealingand fund management. We are also

engaged on managing market abuseand weve run an internal developmentto drive our diagnostics usingBloomberg as a platform.

We used an external provider forgetting our KIIDs up to speed anddidnt experience anything like thesame degree of issues that we did forthe registration Form PF.

Master/feeder could be oneopportunity but only the future will tell;

there is the advantage of a passportbut there are costs to apply to funds.

5Product management is no longer just Know Your Client

its also Know Your Product (KYC, KYP)

The current climate is a hot one for product development, promotion

and investor protection. Recent mis-selling scandals, nes, product

demarcations into simple vs. complex and the promise of greater

product activism next year (around intervention and suitability) make this

one of the hardest areas for asset managers to manage. More than one

respondent noted the divergent approaches being adopted across Europe

color-coding in Portugal; prescriptive regulation in France and Belgium;

SRRI approaches in Luxembourg and Denmark; product intervention inFrance, Italy, Spain and the UK; a focus on inducements/kickbacks in the

Netherlands, UK and Germany; TCF approaches in the UK, Ireland and the

Nordics; and prescriptive approaches to distribution in the UK, Italy and

Greece. Firms must design their product manufacturing and distribution

capabilities to focus on multiple outcomes. Client onboarding/KYC must

be combined with Know Your Product (KYP) and applied as a product

in every case. Particular areas for focus regarding the latter elements

included rms offering guaranteed return products and absolute return

products, so rms should ensure that they are condent of evidencing the

correct classication of products, clients and processes if they offer these

products.

6Control frameworks must withstand the heat of the

front ofce

The next two years will see a signicant focus being placed on front

ofce environments across several EU Member States such as the UK,

Germany and France. Many rms will need to retool their front ofce

control frameworks, their OMSs/PMSs and their policies accordingly. Firms

featuring shorting as part of their investment or hedging strategies will

need to be ready to respond to requests from regulators for information

concerning shorting activities in cash or derivative instruments at relatively

short notice, with the prevailing model increasingly that of a reverse

burden of proof (Spain) or even proving a negative (Italy). Measuring and

monitoring conicts will be a central theme for rms wishing to satisfynew market abuse measures, including whether this relates to sanction

checking, monitoring company visits by fund managers, sounding out, soft

commissions, segregation of fund managers from dealers, demonstrating

fairness monitoring on order aggregation or allocations, or demonstrating

why an adverse situation or conict could not develop if a rm operates

algorithms, as well as the more traditional areas. Firms should also press

their sell-side dealers to co-model the potential impacts on liquidity,

collateral and market microstructure for non-equities under MiFID II.


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7UCITS V/VI a big step up from UCITS IV

Most respondents understandably didnt wish to dwell on their experiences

under UCITS IV, preferring to focus on the concerns and opportunities

under UCITS V/VI. But rms might wish to reect on whether the KIID/

SRRI program was delivered to planned timescales, and whether they

had implemented a mechanism for gaining assurance over the probity of

production, life cycle management and effective translation into all client

languages. Firms might also wish to revisit whether full use was made of

opportunities of ManCo passporting, cross-border mergers or master/

feeder structures over the next three years, and if not, why not, whileassessing the merits of any benets that were realized. As for UCITS V, it

is logical that rms conduct their impact analyses with AIFMD and ideally

MiFID II in mind, particularly when it comes to aligning remuneration

policies or applying these at the appropriate levels. Given the depository

liability measures, rms might consider the terms of their service provider

provisions and initiate a review of any performance fee calculations to

ensure that they are compliant.

8On AIFMD, rms cant afford to wait for the draft

measures to be nalized

There is growing acceptance that AIFMD wont merely be game-changing

for hedge funds but will likely have direct and indirect impacts ontraditional rms managing real estate, infrastructure funds or investment

trusts too. There is little that rms can do to soften the impacts, although

one or two advocates forecast that the AIFM brand could become just

as accepted as a strong quality brand as UCITS for marketing purposes.

Firms should model the impacts on ManCo letter-box entities to evaluate

the potential impact if a proportionality threshold is applied consistently by

every Member State. Firms should also look at their legal entity structures

to evaluate where they would need to operate AIFM activities (if they

operate MiFID branches, this should be a top priority as it is understood

that rms cannot maintain both AIFM and MiFID branch activities). Asset

managers should press both the global custodians and prime brokers

on how they would address liabilities arising from loss of assets throughfraud or insolvency, and they should press for an audit of how client assets

would be ringfenced at the sub-custody network level at each investment

destination under stressed or extreme market conditions.


We are delaying investments in P/E inview of the unforeseen consequencesunder AIFMD.

AIFMD is the largest impact becauseit impacts our investment trust model.The letter-box provision in the draftleaked L2 text is particularly unhelpful.We will be looking to extend the broadcoverage of our OEICs and NURSfunds model by taking in investment

trusts into our external managermodel and we will look to convert ourUCITS manager into a AIFM, and keepour MiFID activity separate.

We established an inter-dealingentity as an AIFM and are nding theprospect of applying remunerationmeasures at a fund level to be mostintrusive.


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Top dozen action list to achieve bettercompliance management

9On Dodd-Frank and EMIR, the devil will be in the details

each side of, and across, the pond

Both the Dodd-Frank Title VII and EMIR measures are due to take effect at

the end of Q4 2012, but some of the devil in the detail might be applied

over the forthcoming months, including measures such as substituted

compliance and extraterritoriality that are applicable to US persons.

The Dodd-Frank measures that apply to swap dealers/major swap

participants for swap reporting and record-keeping are understood to

take effect from October 2012 for IRS/CDS and January 2013 for EQS/

XCS. In Europe, ESMA will post the products eligible for CCP clearingfrom January 2013, with reporting measures issued after Q3 2013, the

margin requirements nalized later. (We advise you to check those dates,

which may have changed since this was written.) Asset managers should

begin to adapt their business models for signicant change accordingly,

focusing on documentation, valuation, STP, counterparty risk monitoring

and (especially) collateral management systems. Firms should conduct

an immediate beauty parade in order to evaluate the collateral

management/transformation as well as derivative clearing capabilities

of all the counterparties, and they may consider the merits of industry

efforts to address the shortfalls in collateral provisioning if relevant to their

investment strategy.

10Stress testing applies to regulations, not just risks

The notion of next generation regulation is somewhat puzzling, but

is taken in this context to signify measures on the horizon that could

substantially affect on the business or operating environment for an asset

manager. Many of the measures are political in scope or somewhat diffuse

and may or may not impact asset managers and their clients directly.

But several of the proposed measures have the weight to create tectonic

shifts. Asset managers should remain vigilant to these relatively known

unknowns and begin scenario modeling in the same manner as they might

model for extreme market scenarios. Known measures with unknown

effects include the Shadow Banking Resolution (impacting ETFs, MMFs

and SBL/repo practices), EU Banking Union/Liikanen (single supervisoryand structural impacts on banks), CSD-Regulation (affecting settlement

cycles, compulsory buy-ins and disintermediation of agent banks in the

EU), Financial Transaction Tax (in France, Italy and at least 10 other EU

countries at the time of going to press), plus recovery/resolution planning

(or living wills) impacting the capital structures of not only global SIFIs

but, over time, the treatment of capital at clearinghouses as well.

We are focused very much on theDodd-Frank interpretative guidance,which will create a new kind ofindustry. We are positive because ofthe emphasis on two-way collateraland portfolio netting.

We see opportunities arising from theVolcker Rule as prop desks are takenapart and rendered into their movingparts. We also see opportunities

to hire more staff. But the costsof new measures far outstrip theopportunities.

The regulations are working atcross-purpose. EMIR would favorrehypothecation and collateralexpansion, whereas shadow bankingresolution and CRD are working theother way.

We are watching the shadow bankingresolutions closely to see the impact

on haircuts and general collateralrequirements. The effect of thesemeasures can only have a negativeimpact on collateral and closeopportunities for growth in the EUleverage space.


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11Appropriate resourcing is key, but so is how FTEs are

counted

For the rst time, the survey recorded how regulators had started posing

deeper questions about skill-sets and bench strength to cover all the

countries where a rm did business. The rate of growth of compliance FTEs

was not consistent across all rms it didnt vary by style, AuM or size of

existing team, and for some rms it remained resolutely at. Businesses

should take a look at the appropriateness of all the control function

FTEs and ask whether regulators and signicant clients would judge that

to be adequate given the slew of regulatory reforms under way. Firmsshould agree to plan regarding the location of critical functions, such as

compliance monitoring, guideline monitoring, branch monitoring, client

onboarding/KYC, AML/sanctions, special investigations, whistle-blowing,

marketing, product development, regulatory reform and lobbying. There

is no right answer to this exam question, but sufce to say that rms

should benchmark themselves and be ready to evidence their total control

footprint spanning the 1/2/3LD when called upon to do so.

12Systems quality is what counts, not just data quantity

Most rms in this survey made reference to their systems and data

remaining t for purpose, but the overall gures alluded to a marked

deterioration in the number of rms experiencing signicant issues withsystems exibility/IT change requests. The more advanced rms were

fortunate to be able to redesign their systems to cope with single-portfolio

view or single-legal entity look-through requests, as demanded by their

investment risk colleagues or compliance colleagues needing to comply

with measures such as FATCA, Solvency II or Dodd-Frank US persons

reports. Other smaller and more local asset managers were not so lucky.

Many were unable to cope with multiple client-driven or regulatory change

requests; some were challenged to compile sufcient data to support their

SRRI, ETF or ICAAP provision at will. Others struggled to integrate their

OMS/PMS/GL systems and controls, ensuring compliance all the way up

the chain of product distributors across all the countries where they did

business. Almost all would benet from exploring the means to transfercomplexity by working in partnership with asset servicers to examine the

case for managed middle as well as back ofce requests.


We operate via a hub and spokesmodel here regional hubs and localcoverage in terms of spokes. Weprobably have too many FTEs basedin the hubs and not enough in thespokes. We need a lot more spokesto face off to the regulators in eachof the major markets where we dobusiness and one of the key benetshas to be that you need language

skills to understand the pitfalls in eachmarket center.

We have good KPIs for our dealersand portfolio managers, with visitsto public companies logged centrallyso we can evidence proof to theregulators if we need to.

We have practiced sound guidelinesfor compliance management and havegood data taxonomies here. We havebeen working hard on data quality andwe reckon weve made something like

a 70% improvement rate over the pastthree years.


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Compliance management for asset management 2012 survey12

Managing complexity from overlapping regulatory

directives, complying with regulatory interest

and mitigating the potential for reputational

risk continued to be the top key motivations forcompliance.


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Survey ndings

The high-level drivers were similar (see Figure 1), but the difference this time around

was the proportionality and the appearance of several new areas of awareness for assetmanagers. In 2011, 69% of respondents were concerned about the sheer volume of

regulations on the horizon and the challenge in nding the time to keep up with all the

changes. In the current no stone unturned regulatory climate, that gure had climbed

to 90% of respondents. This years respondents felt challenged to keep abreast of all the

material while performing their day job. Possibly given record levels of nes over the

2011-12 period, the corresponding gure for rms wishing to avoid reputational damage

also showed a steep increase from 58% in 2011 to 81% in 2012.

To manage complexity from overlapping directives or avoid reputational impact, 45% of

respondents had either appointed a Head of Regulatory Reform (often reporting to the

Head of Compliance or Head of Legal function) or were specically relying upon their

parent bank, insurer or asset managers strategic program management ofce (PMO)

function in order to formalize this process nearly six times as high as the 8% gurerecorded in 2010. Firms employed this function for varying purposes, ranging from

anticipating future measures, lobbying, strategy, business development and product

development. The factor ratio for proof of delivery was 56% business-led and 44%

compliance-led.

Figure 1: High-level justication for the compliance management function

The 2012 survey also revealed new areas that need to be on the radar screens of the

Heads of Compliance: a need to support offering differentiated and personalized services

to clients mentioned by 29% of respondents; a specic desire to comply with client

asset/money protection rules (41%); a desire to stay abreast of future shadow banking

rules (45%); a focus on recovery and resolution planning (9%); and for UK rms at least,

avoiding a referral to a 166 process (or the equivalent) (29%). The primary new concern

was a redenomination focus in the light of developments in the Eurozone (60%). Having

modeled various extreme event scenarios and the ability to move into new currencies

at will, respondents mentioned an uncoordinated euro breakdown as their primary worry.

Desiretooptimizecapitalandliquidity

Increasedshareholderpressurefortransparency

Increasingclientinterestandscrutiny

Inc

reasingconcernswiththird-partyarrangements

Increasingregulatoryinterests/concerns

Businesscontinuityissues(e.g.,

terrorism/fraud)

Keepupwithmarketpracticese.g.,

ISDA,

IMA

Desiretoavoidreputationalimpact

Formerfineorregulatorysanction

MeasuresrecommendedbyEUCorp.

GovernanceGreenPaper

Financialaccountingconcerns

ManagingG20divergencesand

regulatoryrisk

Managingcomplicationsarisingunder

TwinPeaksmeasures

RedenominationfocusintheEurozone

Supportingdifferentiatedand

personalizedservicestoclients

Firm

needingtoavoidareferraltoa

166process(orequivalent

Desiretocomplywithclient

asset/moneyprotectionrules

Compliancewithfutureshadowbankingrules

FocusonRRP(riskappetite/stress

testing/recoveryandresolutionplanning)0

Tomanagecomplexityfrom

overlappingdirectives

123

3 4 2 1 5

Key:

CM4AM Survey 2011

CM4AM Survey 2012

1 2 3

Ranking:

CM4AM Survey 2011

CM4AM Survey 2012 1 2 3

Relative

score

The primary driver is the need to

design products for the long-terminvestor and to help build trust inwhere the environment is going.

The biggest driver for compliancehas been the drive towards clientcentricity. We closed some strategies,for example, where contracts wereprejudicial.

In the future, we will be very muchfocusing on the reputationalconsequences, given that ourselling points are conservatism,trustworthiness and maintainingregulatory discipline. The institutionalmandates in JP/TW and CN are veryhot on the latter if you receive aregulatory discipline notice, you dontget awarded a mandate for threeyears in these countries.

Regulatory reform is a key componentof what we do, and it accounts forsome 10% of compliance time. Wewould like to broaden the team and

carve it out from compliance as awhole.

The motivation is the volume ofregulatory change combined withno meteoric growth in assets, plusthe degree of increasing regulatoryoverlap and encroachment. We donthave a formalized reg reform presencehere but do maintain a strong focuson governance and stewardship.

The volume and level of complexity ofregulatory changes, potential changes

and drafting issues are greater thananything we have ever experiencedbefore.


16/48


Survey ndings

Compliance functions need to help their rms understand the rules against which they

will be judged and to help them to align their strategic objectives with customers thathave been sold products. This survey showed a growing percentage of respondents (78%)

indicating that they operated within a united one compliance culture spanning business

lines and geographies (see Figure 2).

Figure 2: Slight return of the star fund manager culture among asset managers

Yes

Partly

No

We have a one complianceculture in evidence

Does a "star culture" existwithin the firm?

2012: 26%

2011: 23%

2012: 38%

2011: 38%

2012: 36%2011: 39%

2012: 78%2011: 76%

2012: 22%2011: 24%

The notable difference was the growing evidence of a star culture creeping back

into the business since the failures of New Star and Gartmore in 2010, with 26%of

respondents indicating its presence by way of signicant or excessive portfolio manager

conviction (up from 23% in 2011 and 18% in 2010) and only36% attesting to its absence

(down from 39% in 2011 and 48% in 2010). Even in cases where there was not a strongfund manager conviction culture, many houses were contemplating a move into active

strategies, active indexing or OTC derivatives, involving a relatively high degree of

specialism portfolios in order to add outperformance at greater levels of risk.

Impacts galore, but innovation opportunities are more rare

Heads of Compliance were queried on their top three/top ve risks keeping them awake

at night, and the results are shown in Figure 3.

The top risk category by far (unsurprisingly) related to the sheer number of global,

regional and local regulations to manage. However, the subsequent breakout patterns

showed interesting groupings. The next four risk issues consisted of changes in

regulatory issues and priority; fund monitoring/investment risk issues, front ofce

order issues (e.g., market abuse), and a focus on US issues specically (includingextraterritoriality).

The next breakout consisted of several items with current topical interest, such as

managing the complexity of collateral management issues; regulators/investors

retrenching toward home territory; product risk, including prevention of mis-selling;

plus a focus on retail, MMFs, ETFs and their incoming regulations.

The FSA is clearly maintaining its

approach of regulatory intrusivenessand the number of informationrequests has increased. The FSA arenot listening or wanting to listen theyseem to know the best way to dothings. They want to be respected butthat hope is unrealistic as they cannotbe penal in approach on the one handand expect rms to conde in them onthe other.

The new style of the FSA hasdispatched the concept of relationship

management out of the window. Ifit exists at all these days, its verysparing and themed visits are notvery realistic. The new FSA approachin terms of proving the negative is adesign around failure and not a designbased on cooperation with the rms.

The Board understand the need forinvestments behind regulatory reformand compliance but theres only somuch tolerance around regulatorybandwidth. They understand the point

of the capital measures such as BaselIII or Solvency II because they get PnLand capital, but they dont really getwhat measures such as AIFMD are allabout.

We are concerned at the newregulatory powers at the FCA andthe tone of the regulatory dynamic,which is likely to be more aggressivethan pragmatic. We are concerned atthe direction of travel of the ARROWprocess and whether the FCA will

construct a brand-new framework orprocess.

The regulatory changes are drivinghot and cold, and investors areasking very detailed and penetratingquestions.

Measures such as AIFMD, FATCA andthe MiFID II proposals are the mostpressing right now, but we are hopefulof an intergovernmental agreementon FATCA in the Nordics.


17/48


Figure 3: Top compliance risks keeping Heads of Compliance awake at night

79%

63%

45%

18%

5%

Sheer number of global, regional and local regulations to manage

Changes/variety of regulatory issues and prioritizations

Fund monitoring/investment risk issues

Front office order issues (e.g., market abuse or order aggregation issues)

Focus on US issues specifically including extraterritoriality

Complexity of collateral management issues

Regulators/investors retrenching toward home territory

Product risk including prevention of mis-selling

Front office trade issues (e.g., best execution or allocation handling)

Client asset/client money protections and complexity of the CASS rules

ARROW/ICAAP in sights during 2012-13 and FCA response

Impact of regulations on specific illiquid asset classes (e.g., property focus)

Focus on retail, MMFs, ETFs and their incoming regulations

Policy and procedural complexities (and revisions of the same)

Need to mitigate possibility of being served with a 166 notice

Compliance monitoring/systems and controls

AML/ABC/financial crime and sanctions checking

Governance issues

Transaction monitoring and reporting

Recovery and resolution planning for parent, etc.

40%

26%

12%

11%

49%

50%

31%

30%

37%

38%

38%

37%

37%

29%

25%

The list also included several items of interest to asset managers operating in the UK and

thus regulated by the FSA. These items were client asset/client money protections and

complexity of the CASS rules, front ofce trade issues such as late trade allocation

handling, ARROW/ICAAP in sights during 2012-13, and the need to mitigate thepossibility of being served with a 166 notice.

There were also interesting results when it came to respondents grading the overall

importance of specic regulatory measures by priority and by impact on the rm in terms

of extra due diligence, reporting and general cost to the rm (see Figure 4).

Figure 4: Top regulation categories receiving special attention in 2012

Ms

iori

tyforI

Pr

Medium MLD III

CliBribery

Act

SS(new

C

PRIPs

MLD III

UCITS IV/V

AIFMDBribery ActFATCA

AIFMD

UCITS IV

EMIR. MiFID IIRDRClientoneyProduct

Reg.

RDREMIR

ShadowBanking

MAD II

Dodd Frank

S II

ent Money

ProductRe .

PRIPsS II

MiFID II

CRD III/IV

MAD II(new!)

!)

Dodd Frank

RD III/IV

Key:

Large priority shifts are shown by the blue arrows.

Large priority and impact shifts are shown by the gray arrows.

Thin lines signify lowered priorities and/or impacts, andthick lines signify raised ones.

Note: The analysis does not include mandatory areas of importance such as

166 notices or ARROW/ICAAP, which are high priority by definition.

The Bribery Act is a huge thematicfocus with the FSA right now andwe worry about FSA nes. The FSAalways had powers to intervene, andnow the other European regulators arefeeling the desire to do so as well.

Our policies cover AML and willneed to cover ABC as well over thenext six months because the BaFINare showing much more interest inhospitality payments than before.

The Dear CEO letters issued by theFSA asking questions on what rmswould do if their outsourcing partycollapses has posed difculties. It iscommercially unrealistic to expectrms to be able to repatriate thefunctions theyve outsourced to thirdparties or to maintain a second set ofarrangements on hot standby.

We heard that the FSA have writtento rms to inquire about theiroutsourcing arrangements and

specically the contingency plans incase of insolvency. But weve lost thepeople and would nd it impossible torepatriate what we do.

Our strategy is to be disruptive to themarket. We already have SRI fundsand plan to land more from our Irishplatform, plus plans to move into theactive business, and not just for ETFs.But the ratio of opportunity to threatis rapidly diminishing under the weightof overregulation at global, regional

and local levels.

RDR creates the opportunity for newshare classes, and our custodian armwill be interested in developing newplatform services with AIFMD in mind.There will be opportunities to createnew products for insurers underSolvency II e.g., duration matchingswaps, or other products which dontentail large capital requirements.


18/48


Survey ndings

The main areas of focus in terms of priority and impact1were AIFMD, UCITS IV/V and

FATCA,although there was evidence that the signing of the recent model intergovernmental

agreement (IGA) on 26 July 2012 reassured some rms that the impact would be lessthan feared. Measures growing in priority (often correlating with impact) included CRD,

Solvency II, MAD II, MiFID II, EMIR, Client Asset/Money Protectionand (especially) Product

Regulation. Shadow banking(and the cross-impacts on the supply of ETFs/MMFs and on

stock-lending/repo) was a new entrant in 2012. Measures slipping back in terms of priority

and impact consisted of Bribery Act (largely implemented) and particularly PRIPs(possibly

correlated against the risk of Product Regulation with each EU Member State following its

own course).

Although most rms were interested in how to innovate, only a minority of respondents felt

condent enough to state that they could actually see concrete opportunities to innovate

as a direct result of forthcoming legislation (see Figure 5) as European regulators insist that

strategic objectives must align with how customers have been sold products.

Figure 5: Top opportunity categories cited by respondents in 2012

Newsectors

Newalternatives

New shareclasses

New customproducts

New x-assetproducts

SRI/ESG

New tradingtools/venues

Newdistribution/

master-feeder

New collateralmgmt./repo

Newplatforms

Newvendors/services

Opportunityto reposition

0

2

4

6

8

10

12

14

Although the number of rms looking to develop new fund ranges, new products or new

services was not high in terms of strict innovation, 76%of respondents (up from 72% in 2011)

claimed to be exploring/designing new products or services in order to take advantage of

the regulatory measures. Specically, 33%of rms indicated that they were open to the

opportunities to build greater levels of trust by focusing on ethics and/or repositioning their

reputational prole.

Opportunities included:

Almost all asset managers considered the creation of new products as innovation. LDI,portable alpha (transferring portfolio outperformance from one investment category toanother) and variants of ETFs (e.g., strategy) were mentioned.

Other examples included entering emerging markets; developing farmland, infrastructureor property funds; developing new OTC instruments such as variance swaps; ESG/SRI; orfocusing on specic types of distressed assets such as packaged loan repayments. RDRshare classes were also mentioned.

Creative solutions tailored to meet the needs of each client were cited by somerespondents in terms of dening innovation. Examples included pooled LDI funds,building-block QIFs, tailored ETFs and custom liquidity swaps.

New cross-asset opportunities included regulated and derogated products

(e.g., parallel structured loans).

1 The scores reect the average priority/impact scores of all the rms in the survey where the item was cited, scored H/MH/M/LM/L and then normalized per the number

of respondents where the measure was relevant. For example, AIFMD was cited as relevant by 38 respondents, but Solvency II by only 20 respondents in 2012s sample

We are taking stock of Solvency IIbecause we feel this will create

changes in duration matching andopportunities to move into newcollateral and derivative areas, givenboutiques increase their exposure toinsurance assets.

We are excited by the product designopportunities post-RDR. Thereare corporate treasurers who areinvesting in inappropriate CNAV fundsand we see opportunities to deliverproducts which are more suitable perUCITS V/VI. We see opportunities in

moving into the LDI space as well.The opportunities we would expect tosee from regulation include: 1) realestate debt coming out of SolvencyII; 2) new UCITS IV ManCos; 3) fundrationalization/new distribution;and above all, 4) positioning aroundbeneting the client to rebuild trust.

We launched new RDR share classesto be in the game. But we seebetter opportunities under UCITSVI to create hybrid funds with long-

term investment managementcharacteristics, such as more property,multi-asset or infrastructure funds, allof which must be launched with hugecare.


19/48


20/48


This survey illustrated how the focus on customer/product/market controls was

mentioned by 67% of respondents, a signicant rise on the 2011 and 2010 gures(mentioned by 58% and 42% of respondents, respectively). Particular areas for focus

regarding the latter elements included rms offering guaranteed return products and

absolute return products, as well as the correct classication of products, clients and

processes relating to these products. Also given uncertainties in the Eurozone and

constant regulatory changes, 32% of rms cited environmental risk (external risks

impacting their business models), a signicant increase compared with 2011.

Another area of departure on the part of regulators concerned questions in two specic

areas relating to culture. The rst line consisted of deeper questioning around areas

such as compliance strategy and consistency, perhaps echoing the direction of travel that

was adopted by the US within the Sarbanes-Oxley legislation (specically Article 404):

Evidence of a compliance mission/vision statement in place (identied as used in

some form by 35% of respondents) Evidence that the strategy was consistent with functional and regional objectives and

consistent with ExCo attention and appropriate risk committees

Evidence that the strategy was supported by appropriate monitoring and surveillance,showing a one compliance culture in terms of stated aims, reinforcement,challenge, reporting and best practice aspiration

Survey ndings

The second line of deeper query was more ad hoc, consisting of selective questioning

around areas such as the following (see Figure 7):

Figure 7: Responses concerning selected areas by way of Critical Governance/Culture

The tone from the top percolates

the business to do the right thingfor clients. We survey every clienton a rolling three-year basis, and ourCoE is imbued within our partnershipculture which maintains a long-term(decades) view. The measures aretied into the Risk Appetite and six TCFoutcomes, and we feature mentoringfor the business and control functionsand adopt a partnership liabilityapproach to risk as appropriate, sowe tick most of your boxes. This

plays very well to the exacting NorthAmerican client base.

The rm has linked our compliancemanagement policies to TCF and riskappetite, with training sessions in boththe UK and Netherlands. We also gotour outsourcing agent to sign up toour policies.

Elements of the areas for management, governance and culture

Environmental Business model ControlsOversight andgovernance Mitigants Net Risks

Customers,products

and markets

Businessprocess

Prudential issues

Customer

Treatment &

Market Conduct

Operating

Business risks Oversight andgovernance Total

Customer, product

and market controls

Financial and

operating controls

Prudential risk

controls

Environmentalrisk

Enterprise-wide

riskmanagementand

controlfunctions

Management,

governanceand

culture

Financial

Soundness

Controls

79%

Excesscapital /liquidity

Theme: Critical governance/culture elements

Center of excellence/code of ethics (CoE) ownerOwner has point of presence with linkage to key committees

Challenge culture; appreciation of business conduct risk

Statement of ethics (SoE) in direct company-level controls (e.g., US parent)

CoE/SoE linked to a company-level control framework

CoE/SoE sensitivity analysis and risk appetite derived

CoE/SoE linked to measurement and management of control function staff

CoE/SoE risk appetite extended per the six TCF outcomes

CoE/SoE extends beyond the firm to subs, branches, etc.

CoE/SoE extends beyond the firm to outsourcing agents or third parties

CoE/SoE values discussed with shareholders or critical clients

CoE/SoE communicated and reinforced periodically by means of training

CoE/SoE linked to periodic disclosures or attestations to avoid CoI

MI for tracking qualitative and quantitative results in evidence

Tone from the top; examples of acceptable/non-acceptable case practices

New professional employees sign up on entry and appraised

New business/ops professionals mentored

68%71%

76%

59%

59%

45%

57%

53%

21%

14%

35%

50%

63%

55%

54%

65%

19%

68%of respondents claimed to have a code of ethics (CoE) of some description,sometimes emanating from the parent company (bank, insurer, US parent, etc.).

59%of respondents claimed to have an actual statement of ethics (SoE) of somedescription, again either resident at the parent entity/US parent or as a stand-alonedocument in use by control functions, HR departments, etc.

Only 45%of respondents could claim that these documents could be linked to acorporate risk appetite and only 53% to the six TCF outcomes, for example.

Only 21%of respondents could claim that the scope of these documents extendedbeyond the rm to subsidiaries and branches, and only 14% to outsourcing agents orother third parties.

While 50%of respondents mentioned that these documents were communicated/

reinforced by means of appropriate training, with 65% claiming that new businessprofessionals signed up, only 19% claimed that these very same professionals werementored.

Only 55% of respondents could claim that there was appropriate MI for tracking thesedocuments.


21/48


The US code of ethics is posted and

keeps us in good stead; its no longergood enough to have a conicts register

the regulators are looking for rmsto show more creativity in terms ofexploring how conicts can arise in thecourse of the broader business.

We see that the SEC-style code of ethicsas becoming prevalent during 2013 andwe have a statement of ethics whichis reinforced through HR practicesand training/mentoring, although wehavent formally coupled it to TCF

outcomes just yet.

There is a CoE policy (one of the keyUS requirements) which extends todetailing conicts of interest and PAdealing. There is a new focus on tonefrom the top and identifying non-ethicalbehavior.

The code of ethics is scary, American,but the direction of travel. We havealready taken the steps to move ontoa more transparent framework of

key policies and procedures such asmanaging conicts and other keypolicies centrally plus featuring NEDs atthe board and verifying that compliancecan provide suitable challenge.

The code of ethics was completed forour US operations congruent with ourUK manual. There is nothing to beat atone from the top where the CEO haszero tolerance of malfeasance.

We kicked off a compliance vision inEMEA and we are looking to roll it out

into our other global regions. The FSAare increasingly talking about thecustomer experience.

Capital remained king, with more rms paying attention to managing

ICAAPs given the direction of travel across Europe

The results from the 2012 suggested that the Internal Capital Adequacy Assessment

Process (ICAAP) continued to pose signicant challenges for rms located in the UK,

Ireland, Germany and Luxembourg. The survey evidence suggested that regulators such

as the FSA, IFSA and BaFIN were placing much more emphasis on governance, unwinding

provisions over a 9- to 12-month period, reverse stress testing (RST), and the USE test

(linking risk appetite statements and frameworks to strategies, cultures and behaviors).

Regulators in the UK and Germany were keener in seeing evidence of advanced,

externally validated capital modeling and RST procedures made specic to rms, not just

proportionate to market conditions. Here were some of the specic factors that were

mentioned by respondents in relation to their ICAAP modeling:

Modeling extreme event risk arising from exposure to a counterparty impacted by aEurozone member default or implosion of critical investor or investment destinations in theportfolio

Loss of portfolio management team, loss of start fund manager(s) or the latter underinvestigation by the regulator

Reputational scandal, such as mis-selling of guaranteed products, a major fraud scenarioor failure to manage client money (FSA CP12/22 & CASS Money rules in the UK)

Modeling around stock market down by more than 40%, or AuM down by more than 20%and/or 10% client redemptions by number

Lack of provision to prepare for failure/instability of parent (e.g., bank or insurer ormaterial counterparty collapse, such as a Lehman or MF Global type)

Failure to model for a lockdown of the repo or collateral markets under conditions ofmarket stress (elevated VIX index, high spreads in OIS swap curve, high CDS spreads forcounterparty)

Signicant front or back ofce error(s) as in, greater than seven gures such asneeding to reverse out trade or corporate action error(s), respectively

Insufcient consideration in evidence when modeling liability in the event of a majoroutsourcing failure, claim on liability or the extent of indemnication

Litigation action by major SWF investor or the result of class action, howsoever arising

The results from the survey also showed the spread in ICG gures recorded for 39 rms

between 2011 and 2012 (see Figure 8). Although four rms in the survey managed to

lighten their ICG scores from previous levels, the trend remained upwards, with a new

normal set at between 130% and 170% of uplift vs. the highest of Pillar 1, Pillar 2 and

unwinding capital with some hedge funds, multi-style managers and platform distributors

particularly impacted. The greater the uplift in ICG scores, the less expected were the

results by some rms, particularly for those running platforms or multiple investmentstyles, or expecting to take full advantage of waivers.

Figure 8: Comparison of known relative ICG uplifts (2012 and 2011 data)

to size, nature,

complexity...

Key:

Medium entities

Large entities (by AUM)

Strong brand

Retail footprint

Complex/illiquid products

Strong distribution/platform dependency

M&A/integration candidate/weak SYSC

Black box methodology/valuations

1 00 1 10 1 20 13 0 14 0 150 16 0 1 70 1 80 1 90 20 0 210 2 20 23 0 2 40 25 0 30 0 40 0 5 00

Unexpectedscore

Expectedscore

Relative % ICG UpliftThe new normal

10 firms 19 firms 10 firms


22/48


Survey ndings

Weve developed a compliance

strategy since January 2012 and ourplans are proportionate to the FSAsrisk outlook, with H/M/L prioritieslinked to monitoring.

We are OK with the practices ofcompliance strategy, but not the

mission, vision or linkage of theobjectives to functional and regionalobjectives and/or committees whichis work in progress. We are ne withthe CoE and try to link it with our TCFprinciples and dont have shareholders,

but we are woolly on factors such asrisk appetite and we can do betteron the MI. Ninety-ve percent of theoutsourcing is internal so the sameprinciples apply.

Culture-wise, weve come to realizethat transparency doesnt cure all ills.Salespeople like easy conversationswith clients and dont feel comfortablepointing out the aws or regulatorypitfalls. They focus on making thecustomer feel happy and take on

aspects where we cannot deliver. Werecognize that more education anddisclosure is needed to correct this.

The FSA were critical of us claimingthat our committees didnt keepminutes. This has now been remediedbut it illustrates that everything wedo within the theater of compliancemust be evidenceable.

Weve always run an ethical biashere with a focus on SRI and running

engagement surveys with our clientson a rotational basis.

Our ARROW/ICAAP featured 36interviews involving 6 FSA staff overthe course of two weeks. Were a

close and continuous rm but even so,we felt that to be excessive.

The shifting of the CRD timetable hascaused concerns, particularly how themeasures will operate with COREP inthe UK.

As some elevated ICG scores were recorded from mid-tier or alternative asset manager

rms, clearly other factors were at work, several of which were product- or client-related,such as the following:

Third country or offshore governance; ineffective interview process with NEDs, boardmembers, senior managers or control function representatives; or poor SYSC in evidence

Distributors with a strong platform or client money presence, carrying products targetedat retail-classied consumers

A strong brand or reputation coupled with a signicant retail footprint in the countryconcerned

Firms offering guaranteed or absolute return products, exacerbated if offered to retail-classied consumers or there was lack of challenge on suitability

Complex, illiquid or non-fungible products being manufactured or distributed, or modelsbeing operated; compounded if the rm operates a black box methodology for valuations

or is too reliant on specic third parties

A relative lack of rigor or challenge surrounding the amount of capital provisioned forunwinding or insufcient commercial logic behind the same

The rm was operating a black box methodology when it came to valuations or was tooreliant upon any third party, particularly if there was insufcient evidence of t and proper

due diligence

Whether a rm should participate in a signicant corporate event such as a merger oracquisition

There were signs in the UK, Germany and Italy which have a strong culture of

independent distributors of regulators linking prudential measures such as capital

provisions with conduct of business measures around duciary duties. The direction of

travel would require asset managers, and other market participants that feed into the

sale and distribution of nancial products, to act in their customers best interests, avoidconicts of interest and behave in a way they would hope to be treated themselves.

Most rms were aware of evolving product regulation measures across

the EU such as product intervention and PRIPs, while the UK was

focused on the rollout of RDR

In the UK, the Financial Conduct Authority (FCA), the new regulatory body created from the

current FSA, will be focusing on the distribution of products as well as the responsibilities

of wholesalers as part of a comparatively interventionist approach. Martin Wheatley, who

will be heading up the new body in January 2013, commented at the FSAs asset managers

conference on 25 September that the FCA would not be authorizing businesses if they

could not deliver good outcomes for consumers:

Asset managers in the UK should treat their customers fairly and could be subject to

more onerous professional obligations. Asset managers have a role to play in educating

customers nd what they need and should work closely with intermediaries who sell

products to consumers. Such expectations should be at the center of how all regulated rms

operate.

The formation of the FCA coincides with the introduction of the Retail Distribution Review

(RDR) in the UK,2which is designed to help consumers achieve a fair deal from the nancial

services industry and have greater condence in the products they buy and in the advice

they take. The FSA has set out when trail commissions can continue to be paid on advice

given on existing products after the deadline of 31 December 2012. The rollout will

coincide with the introduction of the Provisieverbod (client interest measures that focus

on achieving greater transparency, fairness and accountability in the Netherlands) and

similar moves in Denmark.

2 Retail Distribution Review (RDR) will come into force in the UK at the start of January 2013. Under RDR, product providers will not be allowed to pay commissions

and advisors wont be allowed to receive commissions. The FSA feels that product providers should not be allowed to buy distribution, hence platforms will no

longer be paid by product manufacturers and will need to be paid by the parties receiving the services (i.e., the IFA and investor per the FSAs CP12_12). Proponents

of RDR reckon that the measure will simplify the landscape by bringing about greater fee transparency and a greater sense of a level playing eld between product

manufacturer, product distributor platforms, IFAs and clients


23/48


Feedback from this years survey from the 37 asset managers impacted by RDR was as follows:

Only 19%of respondents felt positive that the introduction of RDR would mean more cost-effective ways of delivering investments, products and services and would make adviceavailable to a wider range of consumers.

32%of respondents believed that the move toward unbundled pricing would be nancially

viable for the majority of players.

Only 30% of recipients felt that the introduction of RDR would really simplify the landscapeor require new controls to evidence unbundling and TCF; 43%of respondents held theopposite view.

62%of respondents expected to see an increase in platform use and/or dependencyunder the RDR.

74%of respondents expected to see a signicant degree of industry consolidation

under RDR.

43%of respondents felt that removing commissions could give a boost to exchange-traded

fund (ETF) product classes and passive investments such as trackers.

28% of respondents agreed with the assertion that the future charging model underRDR will see margins accruing to the advice section of the value chain, and 22% ofrespondents completely disagreed.

57%of respondents were relatively comfortable with the differentiation between offeringunbiased, unrestricted advice and restricted advice.

Despite the fact that RDR took effect 31 December 2012, respondents made mention of

several unanswered questions:

Per CP12_12, the FSA is offering platform service providers time to make thenecessary changes until a proposed implementation date of 31 December 2013.How will the transition be managed?

If unit rebates to consumers is still permitted (by means of units allocated), thenpresumably this would not prevent rebates from being made through additionalinvestment into the product (unit rebating)? Would this be easy for investors tounderstand?

Might some fund managers retain their most expensive share classes for direct toinvestor business with completely different share classes/rate books for institutionalclients?

Respondents suggested that not all rms had publicized how they would treatadvisor payments on individual retail legacy products after RDR takes effect. Somerespondents were exemplary in specifying precisely how they would treat commissionpayments on legacy products. For instance, when trail commissions would remain,treatment of commissions on the original investments/increments would be on a non-advised/advised top-up basis. Would this be compulsory post-RDR?

Respondents from other continental European Member States (as well as the UK)also made repeated but more tentative references to the Packaged Retail Investment

Product Directive,3a suite of measures due to take effect in 2015 that will be applicable

to products that provide for capital accumulation where an element of packaging is a

feature (see Figure 9).

3 The Directive is a series of proposals to overhaul the marketing, sales and d istribution of retail investments marketed directly to consumers, broadly falling into

four groups: investment funds, insurance-based investment products, retail structured securities and term deposits. It represents a shift of emphasis toward the

regulation of products as simple vs. complex and the reclassication of clients. There will be formalized procedures concerning pre-contractual disclosures, product

life cycle information and continuing obligations, denitions of execution-only (and complex vs. non-complex products), fee disclosures and cost transparency,

disclosure of conicts of interest in the sales and advice process, and details of insurance policies. PRIPs would be structured under a single common framework to

allow comparisons between products featuring a high level of standardization, allowing responsibilities to be apportioned between product provider and product

distributor.

The FSA are starting to ask detailed

questions around CASS, specicallyaround how systems would operatein case of insolvency. In principle,all contracts should terminate oninsolvency, but there are differentpractices for different EU MemberStates.

Client money the resolution pack[the FSAs CASS-RP] is a real hassle.We understand that the desire isnot to have the role performed by aCompliance Ofcer but weve learned

that if this is performed by operations,you end up in a real mess becauseof the level of attendant detail thatneeds to be supplied by compliance.compliance should be involvedthroughout.

RDR is a pain working out whichdistributors to work with, trying tocommunicate with them to determineif new share classes are needed, andchecking that they are not askingcommissions for new business.

We have an established platformbusiness and we cant always affordto be at the cutting edge. The newplayers can take advantage of thelatest technology more tuned to meetthe needs of RDR, for example.

We are dotting the is and crossing thets with preparing for RDR by focusingon investment advice to retail clients,issuing RDR-accessible asset shareclasses. We were surprised to hear

that the scope of RDR might extendto cover our business model in theChannel Islands.


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Figure 10: Understanding of issues arising from applying product measures

Examples ofstyles of

product regulationacross the

EU/Switzerland

TCF

Productliability focus

Healthwarnings

Prescriptiverestrictions

Portfoliofees

restrictions

Product focus/intervention

Inducement/kickback focus

Distribution

focus

???

Leveragerestrictions

Risk indicator/labelinge.g., SRRI for UCITS

(Per

AIFMD)

Other EU Member States had introduced product safety warnings (e.g., color codings in

Portugal or risk indicator measures in Denmark and Luxembourg). Respondents spoke

about current or proposed measures that might apply to portfolio management feecharges in Sweden and Germany. On the face of it, with the spotlight increasingly turning

to the consumer investor, it seems as if short-term national responses will need to be

managed against the backdrop of regional regulation. The prediction is that business

and operating models may need to accommodate multiple ways of conducting business

across Europe over the next three years at least.

Given the short-selling regulation that took effect in November 2012

and future Market Abuse II and MiFID II restrictions, the relative

focus on front ofce issues was unsurprising

Short selling is the practice of selling assets that have been borrowed from a third party

with the intention of buying identical assets back at a later date to return to the lender.Italy, Spain, Belgium and France imposed selective bans on the short selling of nancial

stocks from 12 August 2011 in order to curb volatilities in their stock markets in a bid to

cushion bank stocks from the initial consequences of the Eurozone crisis.

When it came to the results from the survey, 44%of respondents reported issues with

short-selling restrictions being introduced in an ad hoc manner under varying thresholds

and timelines per each country. One rm commented: We are OK on preparations for

the short-selling regulations. We are positive on the regulations because we see it as a

signicant improvement on the current state of selective country bans introduced by Italy

and Spain.

The FSA are being deliberately

unapologetic, using early interventionas a tool. If the FSA anticipatethat a product would lead tofuture consumer detriment, theywill intervene earlier to preventthat product being launched andmarketed.

The Danish regulator has beengold-plating risk markers a trafclight system depending on productcomplexity and risk levels onproducts for some time now. They are

focused on the fact that changes inthe loan market affect the mortgagemarket.

Germany is going its own way now,very proud to relay what it is doingto ESMA and the BaFIN keener toregulate more directly followingstrong inuence from the Ministry ofFinance and the Ministry of ConsumerProtection. There are proposed bansagainst future launches of open-endedproperty funds, and the BaFIN are

turning their attention to closed-ended funds (effectively companies)and insurance branches as well.

We are impacted directly andindirectly by the PIB. The measuresimpact our real estate funds andwe have to make sure that ourdistributors are compliant because allmaterials will be checked by auditors.

Frances direction of travel towardprescription and even product liability

is proving to be a nightmare for us.Unlike many regulators, we dont seetransparency as a panacea. It cansometimes act to the detriment ofclient interests with regard to marketimpact, availability of liquidity, etc.

Weve had to focus on areas such asxed income fund managers runningtheir own spreadsheets and arewary to justify the use of suggestedbrokers.


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Survey ndings

Weve built our own front ofce

controls because there wasnt anoff-the-shelf system suitable for ourneeds. We prohibit our traders fromplacing or receiving orders on mobiles.We were quite careful about keepingorder data for a period greater thansix months.

Weve spent a lot of money preparingfor short-selling regulation as ourtechnical side hadnt caught up withthe regulatory requirements. In Italy,the CONSOB has an elevated sense of

expectation and weve installed an IOSsystem, whereas in Germany, we useBnext. We want to move onto a globalsystem which covers all our afliates.

There isnt centralized dealing on xedincome. Pre-sounding out was a focus

weve done work on the monitoring,training and short-selling impacts, ofboth SSR and the Spanish rules.

The AFM are not going after marketabuse to the extent that the UK is

doing and the FSA is working tothe principle of guilty until proveninnocent, the opposite from a criminalcourt procedure. Our entire frontofce performed attestations asregards market abuse prevention.

Market abuse is a signicant focus,and we are particularly interestedin changing the way that analystsinteract with companies. We areexploring going down the route ofestablishing a legal intermediary,

partly for strategic reasons (lesserdependence on sell-side research) andpartly for reasons of good practice tomanage conicts of interest.

Another added that: The CNMV approached us directly and gave us just 24 hours

to provide evidence that the rm was not operating naked shorts. This highlights theever-increasing burden from direct regulatory inquiries warranting a drop everything

response on our part.

Firms also demonstrated greater focus on monitoring and preventing forms of market

abuse, partly in anticipation of an upcoming revision to the Market Abuse Directive

(MAD II). Awareness was greatest in terms of preventing insider trading, breaches

in authorized trading, dark pool/algorithm (algo) manipulation, false/misleading

transactions and front running,in that descending order (see Figure 11).

Evidence of guarding against abuse on non-equities markets was more varied, with a

minority of rms evaluating the potential for abuse concerning inappropriate sounding

out in xed income or focusing on company visits to companies on the part of portfolio

managers as two such examples.

Figure 11: Market abuse vigilance and comparison of front ofce controls measures

0

5

15

20

30

35

25

10

Firms runningown trading

models/algosRemediationprocesses on

market abuse orbest execution

Complianceframework

oversees trading/operationalframeworks

Remediationprocesses on

fairness monitoringor late tradeallocations

Monitoringdone/desk orper desk and

overallWater-tight CSAsgiven regulatorydevelopments

Management review ofcorrelation betweenresearch spend andexecution provision

Current focus on voicerecording/electronic

communicationsrequirements (including

mobile recordings)

Adequate segregationof dealing and fund

management

Firms runningcentralized dealing

desks

Responses were highly varied in terms of the steps being taken to remediate front

ofce processes. Avoiding conicts of interest (CoI) was a big theme in 2012 and is

now on the FSAs 2013 agenda. COBs 11.3.1 & 2 require a rm to have procedures and

arrangements that allow for prompt and accurate recording and allocating of client

orders. The term prompt was interpreted very differently across rms in the survey

responses ranged from intra-day to beyond trade date plus one for certain asset classes

between different respondents, so the survey found that preventive and detect controls

could differ on this basis.

Insider trading 74%

Breaches in authorized trading 62%

Dark pool/algo manipulation 58%

False/misleading transactions 56%

Front-running 54%

Short-selling breaches 40%

OTC derivative abuses 31%

Commission/inducements fraud 29%

Separation of info b/w desks 29%

Spoong/layering 28%

Inappropriate sounding out 26%

Manipulation of splits/allocs 21%

Fiduciary breaches 17%

Asset pricing 15%

Securities lending fraud 5%

Price positioning around IPO 5%

Custodian collusion breaches 0%


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Two areas of FSA thematic activity are examined below in terms of survey responses:

Late-trade allocations Late trade bookings whereby an asset manager can givepreferential treatment to one fund over another having seen the ll/price obtained.Fourteen percent of survey respondents were paying attention to remediations in thisarea. Examples of current workings included:

Establishing a clearly dened allocations policy ensuring fair treatment for cus

Documents

EY Compliance Management for Asset Management Survey 2012