The raft of new regulatory requirements currently being rolled out in jurisdictions throughout the global financial markets will have a significant impact on post-trade processing, affecting activities such as clearing and reporting. In addition, the intensification of investor due diligence processes in the aftermath of the financial crisis means hedge funds must now adhere to increasingly stringent checks on their investment strategies and operating models.
Creating and maintaining a robust, all-encompassing compliance strategy in response to these new rules and requirements should be a top priority for hedge funds, both now and in the future. Technology will play a key role in this effort. But while many organisations will establish and manage such a strategy in-house, outsourced solutions are becoming increasingly popular as hedge funds strive to satisfy regulatory requirements and investor expectations in an efficient and cost-effective way.
In this webinar, sponsored by the Depository Trust & Clearing Corporation (DTCC), Hedge Funds Review has convened a panel of industry experts to consider the likely evolution of post-trade requirements in this new regulatory environment. The discussion explores the potential impact on hedge fund operating models and the ways that firms are looking to manage and improve their compliance processes. The participants also highlight important questions that managers must ask when deciding whether to keep such processes in-house or outsource their company’s compliance functions. Which areas of regulatory change are likely to have the greatest impact on hedge fund operating models? What role can technology play in addressing these changes? How can outsourcing certain compliance activities help, for example, in effectively addressing different rules across multiple jurisdictions at the same time?
Legislation designed to tighten oversight of the financial markets flooded the financial services industry in the aftermath of the global financial crisis. As a result, hedge funds will be affected by a range of new rules under developing regulatory regimes, including the US Dodd-Frank Act, the European Market Infrastructure Regulation (Emir), the Central Securities Depositories Regulation, the Markets in Financial Instruments Directive (Mifid) II and the Securities Financing Transactions Regulation. However, the impact of each regime on the hedge fund industry will vary, as will the timeline over which managers must establish a compliance strategy, leaving many searching for strategies that will remain robust, but flexible over time.
Mandated central clearing is already underway for derivatives transactions in the US under Dodd-Frank and will be phased in from early 2015 in the European Union under Emir. “While not immediately affected, hedge funds will need to ensure they have the appropriate middle- and back-office systems in place to comply with the initial and variation margin requirements for centrally cleared trades, and increased margin requirements for non-centrally cleared derivatives trades,” explains Leigh Walters, managing director, global head of sales and partners at DTCC. He adds that it is important for hedge fund managers to take the time to ensure the right reporting model is in place at their organisation, as more reporting requirements come into effect for hedge funds and other financial organisations under new regimes such as Emir. A direct reporting model allows hedge funds to retain more control over the process and, as a result, the accuracy of the data reported. However, by delegating these activities to a third party, hedge funds can avoid the cost of building or overhauling a reporting infrastructure so that it adheres to current regulations. Managers must examine the likely costs and benefits of each method in relation to a hedge fund’s individual business model.
Leigh Walters, managing director, global head of sales and partners, DTCC
The recent introduction of shorter settlement cycles as part of the European Commission’s efforts to harmonise securities settlement periods will also affect compliance strategies and the use of technology as a risk management tool. The new rules will cap settlement periods for certain transactions at a maximum of two business days after trading (T+2). “By decreasing the amount of time assets are tied up in the settlement process, hedge funds are now able to better manage counterparty risk and capital more efficiently, but they need to have fully automated systems and processes in place to ensure compliance with the new rules, even in times of market stress,” Walters says.
Technology will play a major role in addressing the changes that have already started to happen under many of these new regulatory regimes. “The investor due diligence process is becoming ever more stringent and new regulation increasingly onerous. Therefore, to remain competitive and compliant, hedge funds must meet these new requirements by implementing robust operational processes and risk management controls,” says Walters. “In particular, automating the entire trade life cycle – from the front office, through to the middle and back office – is an effective way for hedge funds to assure both investors and regulators that they are adopting best practices.”
By automating the trade life cycle, hedge funds can increase transparency, reduce the potential for processing errors and seamlessly connect with counterparties. This will enhance the trade process by establishing robust systems for the collection, management, storage and exchange of transactional data with both clients and regulators.
There are other benefits to post-trade automation. In addition to underpinning a strong regulatory compliance function, it can also streamline day-to-day operations, increasing a hedge fund’s overall efficiency and reducing costs. Furthermore, for hedge funds that trade in more than one region, automation can be used to increase operational efficiency across all asset classes, regions, and counterparties. “Hedge funds that operate in multiple jurisdictions can meet many of their regulatory obligations in the middle and back office through the automation of post-trade processes,” Walters says.
Managers operating throughout the Asian markets, for example, are subject to a patchwork of requirements and regimes within the region, as well as in relation to other jurisdictions such as the US and Europe. Levels of post-trade automation are also not standardised across the different countries that comprise the Asian markets. As a result, formulating a compliance strategy and implementing technology solutions that can be applied throughout the region is a complex process. It would also require considerable resources to establish and maintain any solutions that are developed.
The webinar will explore the major concerns for hedge funds currently grappling with this issue, including how to assess the potential effects of global regulations, such as the US anti-tax-evasion law Fatca and the Global Account Tax Compliance Act, as well as local regulations, such as those covering electronic trading in Hong Kong. The panellists will also discuss the key issues for managers operating in the region to keep in mind, including capital requirements, short selling and margin trading restrictions, as well as the technology options currently available to managers from vendors operating in the region.
As the global regulatory burden continues to grow and funds become subject to more stringent investor due diligence, outsourcing has become a topic of interest to managers. According to Walters, there has been an uptick in interest in post-trade processing services among hedge funds as a direct result of new financial market rules. He adds that outsourcing these functions will allow hedge funds to provide proof of compliance with the new rules to regulators and demonstrate best practice in the middle and back offices to investors.
“As firms look to increasingly automate and streamline these processes, we are seeing them turn to providers such as the DTCC and Omgeo in the post-trade space, because our services can help clients improve their operational processes and assist them in complying with local regulatory requirements,” Walters adds. If thorough research shows a particular middle- or back-office function can be performed more efficiently and effectively by a third party, a hedge fund should consider outsourcing, he says. These third-party services can alleviate some of the compliance burden arising from the growing regulatory and investor requirements that today’s financial organisations are subject to, while still allowing overall operational control to remain in-house.
Careful consideration of the costs and benefits of such a solution is important. The webinar will feature a range of industry experts who will outline the likely impact of new regulations on the hedge fund sector, how post-trade processing will be affected and whether demand for outsourcing is expected to increase among hedge funds as a result. Tune in to find out how your business could be affected and how to prepare as regulatory changes continue to transform the dynamics of financial markets worldwide.