Regulatory Reporting: It’s All About the Process

As the regulatory reporting mandates keeping coming, there is no question fund management shops are feeling overwhelmed. But they are also realizing that offloading the management of the tsunami of reporting tasks onto third-party service providers isn’t working out as well as they expected.

Both sides are on a steep learning curve in handling the mission-critical function and fund managers are learning the hard way that if planned incorrectly even the most well-intentioned help from some of the world’s largest financial institutions could turn into unanticipated headache and unnecessary expense. “We have belatedly come to the conclusion we should have thought more carefully before leaping into external relationships to ensure the correct division of labor and workflow,” says one US East Coast fund management operations manager. “Our blind leap of faith turned out to be costly.”

AIFMD, EMIR, FATCA, Dodd-Frank and Solvency II are just a sampling of the estimated two dozen or so measures which will require fund management firms to research hundreds, if not thousands of data points. They have options as to how much work they will outsource and to which type of service providers. Whichever path they choose, the risk of incorrect data, inconsistent information between regulatory reports, and the wrong formatting are turning out to be the most common problems, fund management operations specialists tell FinOps Report.

“Outsourcing is a broad term and defines a range of workflow models,” explains Gary Kaminsky, managing director of regulatory compliance for reporting software firm ConceptOne in New York City. “It could spell anything from providing some of the data for fund management firms need to populate the appropriate fields to completing the entire report and filing it with a regulatory agency.”

Regardless of how much or how little help fund management firms receive, the regulatory buck ultimately stops at their desks for any mistakes. Granted, the same applies to other types of outsourcing agreements, but regulatory reporting takes the legal onus to a higher level. Determined to reduce systemic risk and protect investor interests through detailed monitoring efforts, regulators are less likely to forgive reporting errors than unintended middle- and back-office glitches. The reason: depending on the size of the error and how important it is to understanding a fund management firm’s risk profile, a regulator may interpret any misrepresentation as intentional fraud.

The potential for regulatory fines or even reprimands aside aren’t even the worst of it. Investors are also not keen on being misled, even accidentally. “It’s the perfect storm of regulatory demands, investor demands, and the usual business needs to add product lines or increase volume,” says Todd Moyer, senior vice president of regulatory reporting firm Confluence in Pittsburgh.

As a result, just doing more of the same thing — scrambling through multiple databases or spreadsheets in multiple departments to cobble together whatever one can as quickly as one can to meet a deadline — will not cut it. Where does that leave fund management firms? Making some tough decisions as to how they will aggregate the necessary data, ensure its accuracy, divide responsibilities and sign off on the final documentation.

Fund Admins Stepping Back

Fund administrators — often large banks or other financial institutions with deep pockets — appear to be a natural choice for taking on the task of regulatory reporting. They already have much of the necessary information. There is just one catch. Like other financial services firms, their data is likely to be stored is the databases of multiple applications. The report data must then be converted to a common format and even researched and reconciled, if the databases don’t agree. The risk of errors, let alone costly manual work, is daunting.

Facing the same workflow and data management challenges as their clients, many fund administrators are stepping back from the opportunity to take on regulatory reporting for the fund clients. In fact, only a handful of fund are offering full-fledged regulatory reporting services. More are offering partial solutions, attempting to avoid levels of risk that can’t be adequately priced for any agreement.”They [fund administrators] are taking on the work begrudgingly as a way of servicing the largest panic-stricken fund managers who have dumped the worry on their lap,” acknowledges one operations specialist at a US East Coast fund management firm. “However, they aren’t necessarily doing all of the work.”

At a minimum, fund management companies can turn to their fund administrators for some of the necessary data, and go on to populate the forms and file them themselves. But many fund managers are looking for the reverse scenario — where they send the data they have to the fund administrator, which will then complete the reports and forward them to the regulatory agency.

When fund managers obtain that higher level of service, how well are fund administrators doing at providing it? It depends on who one asks. “Regulatory reporting consists of far more than filling in the boxes,” points out Kaminsky, whose firm competes with fund administrators in regulatory reporting work. “It requires an understanding of exactly what a regulator might want to know and why.” Case in point: reporting on market, credit and counterparty risk for fund management firms wanting to comply with Europe’s Alternative Investment Fund Managers Act (AIFMD) requires some interpretation of the methodology and inputs the European Commission and local regulators want.

Making reporting for a host of new mandates more chaotic — and error-prone — for both fund management firms and their administrators is the tendency to fragment the workload. Not only is the data dispersed in multiple applications, but the work is divided among dedicated teams tasked with different reporting obligations, separate service providers to help out and even separate software platforms to support them. Such a scenario elevates the risk that inconsistent answers are given to the same or similar questions to different regulatory reports.

Doing the Work Twice

The top complaint among three fund managers contacted by FinOps Report: having to do the same work twice, because of incorrect or inconsistent answers in prepared reports. “There were inaccuracies in our Form PF which required us to redo some of the answers,” gripes one US fund management operations specialist which had delegated the work to its fund administrator. Alternative investment funds registered with the US Securities and Exchange Commission must file the comprehensive Form PF either annually, semi-annually, or quarterly to report on their holdings, operations and in some cases risk profiles.

Yet another operations specialist was only too ready to complain that his firm had outsourced reporting to a “prominent” fund administrator, only to ultimately discover that the fund administrator had farmed out the work to another regulatory reporting firm. “It’s not that they were outsourcing that was the problem. It was that the liability for errors got lost in this mess,” he says. “We should have known something was wrong from the beginning when the pricetag was so low.”

What do fund administrators say? Naturally, they aren’t happy about taking the fall for any errors. “We’re being scapegoated by fund management firms and sometimes other regulatory reporting firms who profit,” says one operations manager at a fund administrator. “We aren’t always receiving the data we need from fund management firms on time. In other cases, we’re having to correct errors.”

The reason for the inaccuracy, according to the fund administration specialist: either the client sourced raw data from a different application than the fund administrator, had incorrect information in the first place, or relied on a different interpretation of the question to be completed than the administrator. Hence, the methodology and inputs used didn’t match. Of course, fund management firms are no more likely than the administrators to accept these blame for these problems.

Regardless of who does most of the work, it is still likely fund administrators will play a critical role in the regulatory reporting process. “Fund administrators aren’t necessarily doing a poor job,” explains Larry Wagner, a principal in the financial services department of consultancy Navint in New York City. “They are just doing the best with what they have to work with.”

So what’s a fund management firm to do? If relying completely on a fund administrator isn’t necessarily the best option, there are less drastic alternatives. “Consolidate or reduce the number of third party service providers or software systems used to aggregate and report the data,” recommends Moyer. The reason: it could easily reduce potential data discrepancies between regulatory documents.

Fund administrators aren’t the only outsourcing option available to fund managers. Third-party providers, such as Confluence and ConceptOne, offer a range of regulatory reporting technology and services — from sourcing the data from the fund manager’s internal applications and enriching the data from fund administrators, up to completing the forms themselves. Both Confluence and ConceptOne also license software to firms that prefer to maintain in-house control of all of the work. They also offer consultants to help fund managers understand how to populate specific data fields for specific reports. ConceptOne goes a step further and actually files the reports with regulators.

Managing Expectations

Whatever outsourcing solution is chosen, the potential for unreasonable expectations and poorly constructed process is always present. Fund administrators can’t promise to track down the answer to every question, nor should fund management firms expect them to. They also can’t expect them to produce flawless results. What they can — and should count on — is serious up-front planning time discussing what each question in each regulatory form means, potential conflicts among data sources, assignment of responsibility for data verification, and who is responsible at the end for signing off on the report.

While data quality is a critical factor in all processing of fund management operations, the rubber really meets the road in regulatory reporting. Fund managers that have not yet committed to data quality and governance initiatives are going to have a harder time pulling together the data and cleaning up discrepancies. That mean they will need more people to dedicated to verifying, if not completing reports.

Waiting until the last minute isn’t going to work when the deadlines are coming so fast. Nor will delegating different staff in different departments — finance, operations and compliance — to be responsible for each regulatory report, says Wagner.

A far better approach now under review by some fund management firms: assigning the same staff to multiple reporting mandates, organized by the amount of data overlap. Such could be the case with completing Form PF in the US and reporting for AIFMD in Europe where at least thirty percent of data fields are closely aligned.

Bottom line: despite the temptation to look at the avalanche of regulatory reporting obligations as just a requirement to work harder, fund managers are learning the hard way that it’s really a demand and an opportunity to work smarter. Better data management. Better planning. Better allocation of responsibility whether they do it in-house or with some third-party help.