Learning to love industry regulation

There is no single business, organisation or individual in the financial services industry that is not affected by compliance.

It is accepted that compliance is necessary, but many hate the complexity and its intrusion into doing business.

There is also a fear of compliance and, to be more exact, the regulators.

A number of fund managers and dealer groups would not talk to Money Management about the subject, citing fear of reprisals from regulators.

Others were prepared to talk about the pluses and minuses of compliance, as long they or their company were not mentioned.

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However, others were willing to talk openly about the benefits and some of the negatives that compliance creates in their organisations.

After very public problems with companies such as HIH and Westpoint, the financial services industry must be seen to be regulated, otherwise clients will lose confidence in the system.

Bank collapses in Australia in the 1890s saw people taking money out of financial institutions and stashing it under their beds.

The loss of confidence in financial institutions is not something in the distant past either. The collapse of companies such as Estate Mortgage, OST Friendly Society and Pyramid Building Society in the early 1990s shook the public’s faith in financial institutions and funds were withdrawn.

Interestingly, the collapse of Westpoint did not see investors rushing to withdraw their money.

It could be argued that investors had confidence in the system and that the greater level of scrutiny the industry has come under, since the implementation of Financial Services Reform (FSR), is paying off, although critics may disagree.

IOOF head of group strategy Tony Hodges said the complexity of the financial services industry has led to a greater level of diligence and an increase in the monitoring of compliance issues.

“There have been extensive layers of laws and regulations, and there is an argument for meeting these challenges in different ways,” he said.

“We are all spending a lot more time and effort meeting all those challenges.”

Hodges said compliance is now a necessary part of doing business in today’s environment. It is also necessary to protect the public.

“In financial services there is a lack of financial literacy among the public, which is not good, so there is a justifiable need for good regulation to protect people,” he said.

“Collapses such as HIH, Westpoint and Enron show we must be regulated, but you can’t regulate for all managements.

“These collapses have to be put in perspective, and we need to return to corporate morality.”

Hodges argues that the mutual structure worked in Australia for many years and delivered good outcomes.

There have been complaints about the level of compliance in financial services and some feel it has become too onerous.

Certainly, the amount of work and staff resources that now have to be devoted to compliance in organisations has risen dramatically since the introduction of FSR.

Tower Australia chief executive officer, retail life, David Callander said the compliance team in his organisation has doubled since the introduction of FSR.

“At Tower, the compliance area is a growing department and continues to grow,” he said.

For organisations such as Tower, which has to deal with multiple regulators, the overlap in regulations creates more work for compliance officers.

“The collective compliance role in Tower has doubled since FSR, as there is still overlap on regulations.

“However, the industry is working to smooth this out.”

Callander said there is no problem with regulation and he believes the level of regulation is about the right balance.

“There has been a marked emphasis on the content of the regulations, rather than the process, but again we are working through these issues,” he said.

“We are still going through the development phase as we find better ways to meet the regulations.”

Callander said compliance at present “just needs fine tuning” rather than major revision.

“Everybody was over cautious, but the financial services industry is still learning and working towards the right balance of meeting the requirements of the regulations and running a workable compliance structure.

“The challenge is how to get better value from the compliance process and make it cost effective.”

For overseas fund managers, the Australian rules and regulations still have to be applied to products imported from parent organisations.

Invesco Australia chief executive officer Mick O’Brien said the local operation brings in a lot of product from its American parent, but it is still put through the same due diligence as with a fund sourced from an external party.

“We have got to apply the same levels of compliance to these products as with any other, and we still have to disclose to the market what we are doing with that product to make it suitable for local distribution,” he said.

“We go through due diligence on the product through questionnaires, discussions and, if necessary, somebody visiting the US to ensure the product is compliant.”

O’Brien said Invesco has an internal system for meeting compliance regulation and it is used for the Australian operation when creating a product or when taking one off the shelf from one of the overseas subsidiaries.

“We complete the due diligence for them as part of the service of launching the product here,” he said.

Some overseas fund managers outsource areas such as compliance and distribution to a third party based in Australia.

Australian Funds marketing director Paul Pickering said his organisation can spend up to six months going through every thing for a manager coming to Australia.

“We have an internal compliance team and our clients assume everything is happening, so the levels of compliance don’t really impact on them,” he said.

It is accepted that larger organisations such as fund managers have the staff and resources to deal with compliance on a daily basis, but financial planners argue the compliance system is too onerous.

Financial Planning Association (FPA) manager of policy and government relations John Anning believes there is an argument that compliance has become too onerous, especially for smaller practices.

“I would agree compliance has become onerous and smaller practitioners are finding it hard, but we don’t have any firm data,” he said.

“When we surveyed the membership at the end of 2004, it was noticeable that the cost of giving advice was going up, with resources being applied to compliance also rising.”

The initial interpretations of FSR did create a lot of compliance work and a classic example was Statements of Advice (SOAs).

The first interpretation of what an SOA should be produced documents that were in excess of 100 pages.

Certainly, the client wasn’t going to read all 100 pages and the adviser was bogged down in paperwork rather than giving advice.

Anning said this is a classic example of how the initial interpretation of the regulation was too onerous.

Another problem was when a client sought to amend their investments, such as buying more shares of a stock they already held.

The initial interpretation of the regulations meant a SOA had to be produced for every transaction, no matter how small.

Anning said lobbying has produced a more sensible outcome and made these areas of compliance easier for advisers.

“Since the introduction of FSR there have been reviews, and we have seen the record of advice being introduced as a solution to issuing SOAs for everything,” he said.

“Hopefully, in the second round of reviews we will be given more relief, and that will cut down some of the duplication in the regulations which will benefit advisers.”

Anning said while the record of advice has helped both clients and advisers, it has not replaced the SOA.

“The SOA is here to stay and we are not arguing against the principle of disclosure, just that the complexity is adding to the cost of compliance,” he said.

The cost of compliance is a significant overhead for all organisations.

According to the Investment and Financial Services Association, in its policy statement on regulation earlier this year, the cost of complying with the various financial services regulations is between 10 to 15 per cent of the total operational costs of a company.

Hodges said compliance is a major cost for IOOF.

Because the company is a fund manager, dealer group and platform provider, it is involved with many regulatory bodies.

“We have a large compliance team and compliance is probably the largest area in our corporate services,” he said.

“The question is who pays for this, and the answer is the consumer pays.”

Hodges said different interpretations also keep compliance departments busy and growing.

O’Brien said compliance at Invesco is also a major part of its operation.

“We mainly deal with ASIC [the Australian Securities and Investments Commission], although we have some involvement with APRA [the Australian Prudential Regulation Authority] over our pooled superannuation trusts,” he said.

“We pay a lot of attention to detail, and compliance is an operational capability.

“The compliance team consists of about 5 per cent of the total staff in Australia, but other staff do become involved, ranging from product managers through to myself.”

O’Brien said the company has built up its skills to manage a compliance environment, but it is always evolving.

Callander said the culture at Tower means that everybody is involved in compliance.

“We have a compliance team, but we emphasise everybody has an element of compliance in their roles in the company,” he said.

“It is a significant cost for Tower, but rather than look at the negative, we see compliance as value adding.”

After getting over the initial shock of added compliance requirements under FSR, most organisations feel they are mastering the task.

Hodges said his company has been through a significant transition period, but he sees the regulations as building more trust in the major financial services industry players.

“We are now in a mandatory reporting regime and if there are breaches we have to report them, but that is not a problem,” he said.

“We do come across breaches in some legacy products that are still running, so we have to report them, as we want to be compliant with the regulations.”

Invesco has automated a certain amount of its compliance reporting and that has made life easier, O’Brien said.

“We know what we are looking for and what to check for with our systems for reporting, so that has made compliance less onerous,” he said.

“The system is automated to send out questions and get reports.

“These are then compared, so while compliance is not getting more complicated, there are always things we are adding, such as anti-money laundering reporting.”

O’Brien said because of FSR a lot of compliance reporting has already been set up, so when a new regulation is introduced, Invesco just has to add to the reporting system, rather than build up new procedures.

An example of the levels of compliance in a large fund manager is illustrated by Invesco having to make sure sell orders on stocks from mandates are strictly handled in the order they are received to ensure nobody is disadvantaged.

“If the assets are not sold in the right order, compliance will pick this breach up,” he said.

Callander said Tower has also automated a certain amount of its compliance system using Lawlex software.

“The system prompts staff daily, weekly and monthly on compliance issues and generates reports,” he said.

“This has made managing compliance easier, and any new regulations can be added to the system.”

Callander said having economies of scale in organisations such as Tower means the company can look at introducing software systems to assist with compliance.

Anning said the expansion of the regulatory framework is a good move for the financial services industry and advisers should be looking for the positives in better compliance.

“We are working on minimising the impact of the regulations and people will recognise the need for compliance and its regard to improving client relationships,” he said.

“Advisers should not be seeing items such as SOAs as a compliance impediment, but they should be looking at how it drives benefits for the client.”

The other outcome of increased compliance is jobs. Callander said recruiting compliance specialists is hard, as there is a nationwide shortage of people with expertise in this area.

“We find compliance people a scarce resource, so if anybody is contemplating a good long-term career in financial services they should be thinking about becoming a compliance officer,” he said.

“For the right people, it will be a good career.”