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Straight From The Source

michael-o-brienBy Michael O’Brien, Vice President, Head of Product Management, Global Risk & Surveillance, Nasdaq

Results from Nasdaq’s annual survey on compliance trends is a wakeup call for firms that are unprepared for new regulations.

In today’s environment, compliance officers in financial services firms face an array of short-term and long-term challenges. They play a multi-faceted role not only in protecting their organization’s reputation, but also in avoiding legal and regulatory fines and penalties. Going forward, their role will become even more important, so they will need to keep up a high profile. And with regulations getting tougher, and attempts at manipulating markets becoming more sophisticated, they need to leverage advanced technology to accomplish their objectives.

These are some of the trends Nasdaq and Aite Group uncovered in Nasdaq’s 2016 Global Compliance Survey: Inside the Mind of the Compliance Officer. For the second year, Nasdaq reached out to senior compliance officers in hundreds of firms to try to understand their objectives, organizational structure, budget, regulatory concerns and surveillance processes. The results are based on 114 responses from 82 sell-side firms, buy-side firms and corporates in the U.S., Asia-Pacific, the U.K. and Canada. Most of the respondents concentrate on general compliance or trade surveillance and monitoring, but other areas include anti-money laundering (AML), front-office business, compliance IT/technology and electronic communications.

The survey verifies that the compliance role has become more visible, and compliance officers are providing input into strategic decision making. Many respondents – especially those in sell-side and buy-side firms – noted that they report directly to the CEO. They frequently collaborate with executive management and have a seat at the table in executive discussions.

Moreover, compliance teams are collaborating with other departments including the front office, risk management, legal and executive management. Sell-side firms are more likely to collaborate with the front office on trade monitoring or with business departments, while buy-side firms are more likely to collaborate with the legal department. Vertical collaboration was found to be more common among corporate entities than in investment banks/brokerages and buy-side firms/advisors.

From respondents’ perspective, the compliance department’s most important function is upholding and protecting the reputation of their firm. However, they also believe their firms’ management to be slightly more concerned with regulatory fine avoidance, overall. Interestingly, sell-side firms are most likely to be concerned with reputational risk, whereas corporations are most likely to be concerned with avoiding regulatory fines.

Rising regulatory challenges
Yet, compliance officers clearly face major challenges when it comes to fully understanding regulation and how it impacts the firm.  Only 16% of survey respondents said that they believe their firm is completely prepared for regulatory changes and implementations to come into effect over the next 12 months, which is extremely worrying considering the amount of investment in compliance resources during the last year. Buy-side firms, in particular, were notably more concerned about new reporting and requirements associated with regulations than both sell-side firms and corporates.

Since the financial services industry is global, firms look at regulatory procedures holistically, but the survey reveals that specific areas of concern have shifted. In 2015, it was mainly Dodd-Frank that was consuming compliance officers’ resources. But in 2016, the focus shifted to Markets in Financial Instruments Directive (MiFID) II and Market Abuse Regulation (MAR), which are in the beginning phases of implementation and include several new requirements that are much more stringent and explicit compared to past regulations.

One would expect compliance budgets and spending to have increased significantly at most firms across the board. But it is surprising by how much: in percentage terms, spending often exceeded the increase in the firm’s revenue. Budgets are forecasted to increase even more over the next 12 months, albeit at a slightly lower rate. Sell-side compliance budgets are expected to increase slightly less than buy-side firms and corporations over the next year, probably because they are farther up the maturation curve.

So how are they going to be spending their budget in the next 12 months? The results indicate that firms will likely become more focused on trade surveillance, AML, regulatory alerts and Know Your Client (KYC). Surveillance technologies, followed by staffing, are expected to be the top areas of investment. About three-quarters of respondents already utilize automated processes and specialized technology for trade surveillance, and they will likely continue to implement both technology and systematic processes in this area.

Interestingly, 49% of respondents from the buy-side reported that their traders are executing more trades directly and relying less on their sell-side partners for execution. In addition, 74% reported that they are satisfied or very satisfied with their ability to monitor trading activity in listed securities and OTC instruments.

However, the survey found that trade supervision, employee/personal trade compliance and electronic communications surveillance are less likely to be automated, so we can expect increased investment in these areas. Currently, sell-side firms are far ahead of corporations and buy-side firms when it comes to automating electronic communications surveillance and AML, so those types of firms will likely be playing a game of catch-up. Notably, buy-side firms are lagging in monitoring electronic communications.

Overall, we see increased visibility and collaboration as a positive trend. Financial firms of all types need to do their part to prioritize compliance and make it a strategic initiative, because it is so critical to ensuring fairness, market integrity and investor confidence. Collaboration helps to break down the silos that tend to undermine the effectiveness of compliance programs. One could argue that it will be essential as new regulations come into effect.

Clearly compliance officers are taking their job of managing reputational risk and avoiding regulatory fines very seriously – as they should. No one wants to see their firm’s name in a news headline associated with a scandal or, perhaps even worse, be subjected to a regulatory investigation.

Still, the results of this year’s survey should be a call to action for firms – sell-side, buy-side and corporations alike – that are unprepared to cope with new regulations in the next 12 months. Now is the time to work with regulators, partners, peers and vendors to educate themselves and stay informed. Those that do not already have automated processes and specialized technology need to get onboard because humans cannot possibly keep up with the volumes and speed of today’s markets.

If you would like to read the full report, you can download it at http://nasdaqtech.nasdaq.com/2016-GCS-IB

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