Regulatory Compliance in the Financial Sector

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1 BT for Regulatory Compliance Meeting the needs of an increasingly regulated environment

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3 BT for Regulatory Compliance For financial institutions, adapting to an increasingly regulated environment means changing their internal business processes, changing the way that they interact with market regulators and changing the way that they do business with their customers. Some of these regulations even limit the availability of capital to fund the necessary changes. In these situations, the technology that supports your business can also affect your ability to achieve regulatory compliance cost-effectively. But it s unlikely that all of the technology approaches you took to meet old-world regulations will be able to meet your new-world requirements. So you ll need to review those approaches with your service providers. And one of those service providers is BT. Regulations are changing the shape of the financial services sector The financial services sector covers a broad and deep set of business and operational processes everything from accepting a card payment from a retail customer at a point of sale to transferring electronic money between commercial banks and central banks; or from a broker s retail client purchasing a couple of shares in a new company to a central bank issuing government bonds to fund a national debt. Some organisations, such as universal banks, are active in many different aspects of this broad market, while others may address only a niche segment even if that niche segment may be of critical economic importance, eg stock exchanges, automated clearing houses, equity brokers, etc. The sector also includes a vast range of service providers to the financial community, including providers of financial market data, matching systems, hardware, software and network services. But a key characteristic of the financial services sector is that it is regulated in a way and to a degree that is seen in almost no other market sector in the world. Individual financial organisations have many different business drivers, but three key drivers are probably common to all: 1. increase revenue 2. achieve regulatory compliance 3. reduce operational costs...and in that order of importance. Over recent years regulation has moved further up the list of priorities for both senior management and operational management within financial institutions. Regulations are changing the shape of the financial sector, not merely as a simple by-product of their introduction but with the specific intention of changing that shape. Whether legislators and regulators are taking the most appropriate approach is not a business-operational question: financial institutions have to comply with the regulations of the countries in which they operate, or otherwise face penalties or closure. At the same time, many operational processes and technology systems within financial institutions are creaking through old-age and their inappropriateness for bearing the burden of achieving today s and tomorrow s business and compliance goals, while delivering the service levels that customers now expect to receive. These systems can often hinder financial institutions attempts to achieve the primary goals above, and in some cases they can absolutely stop institutions achieving them. 3

4 Taking a new approach to technology Too often financial institutions are using IT approaches that do not reflect the advances in technology usage across industrial and retail sectors approaches that are hard to justify in terms of delivering better service to customers. Continuing to take conventional approaches to technology while expecting to achieve major positive change is clearly ineffective. Institutions need to take a new look at where better and more appropriate solutions may lie, starting at the foundations of their operations and building upwards from there. Networks are the foundation of information technology. They have changed the way that businesses operate, financial services are delivered and people live their lives. Personal computers were first introduced into business in 1981, and networking them to mainframes led to distributed processing. The public internet went commercial in 1993 and changed forever the way that we look at networks, information and technology. As one of the world s largest providers of network-centric services to the financial community globally, BT can provide an insight into how new approaches to network-centric functions can help meet the primary goals of increasing revenue, achieving regulatory compliance and reducing operational costs. Keystones of regulatory change Regulations in recent years have varied in size and scope, from the massive documentation behind the US Dodd-Frank Act to the many individual directives and regulations of the European Union. However, out of the plethora of individual regulations there are three common themes: 1. Operating in the client s best interest This comes in many shapes, whether it is about treating your client fairly or achieving best execution in financial markets. The business impacts of this are many, from gathering and storing more information about individual customers to accessing more execution venues, clearing houses and securities depositories in order to get the best overall outcome for a customer. Improving transparency means making more information available to the outside world and to regulators, accessing more information from the outside world, and managing all of that information effectively to make the right business decisions and maintain regulatory compliance. 3. Reducing risks The financial sector operates on the basis of making profits from taking measured risks. There is a general regulatory drive internationally to try to remove unnecessary and inappropriate risks from the sector. Processing transactions faster can help reduce the time delay during which risks can turn into dangers. Knowing more about customers can help reduce the risks of doing the wrong kind of business with the wrong kind of customer. Having a more real-time picture of the risks that the organisation currently has on its books helps to allow for corrective action before damage is done. And understanding and managing operational risks appropriately can keep systems working even when there are disruptions requirements that are already addressed by guidelines and regulations including Basel II and the EU MiFID directive. No matter what aspect of the sector a firm may be active in as a financial institution or as a service provider to financial institutions capital is tighter and competition is tougher. And business is even tougher for financial institutions that are also faced with the ever-more stringent capital adequacy requirements of new regulations. It s unlikely that the financial sector can get to where it needs to be in the future if it continues to approach its goals of increasing revenues, achieving regulatory compliance and reducing operational costs as though they are separate, independent challenges. It s even more unlikely if the sector continues to take a siloed approach siloed within the organisation and siloed between external activities. The times call for enterprise-wide changes in order to achieve enterprise-wide profitability with enterprisewide compliance. 2. Transparency Regulators have begun to recognise that they do not necessarily understand and cannot see the way that financial markets are working. Financial institutions have recognised the same, with the problem becoming even greater as the range of execution venues, asset classes, countries, counterparties and clients that they are involved with increases. And clients are less willing to take part in markets or buy services where they perceive that there is insufficient transparency. 4

5 IP and Clouds are changing the financial world The Internet Protocol (IP) has changed our world, though perhaps more-so at home than within financial institutions. IP is used over communications links by financial institutions, but the approach to those communications links has remained largely unchanged over the last hundred years or more. Whereas at home we are used to accessing multiple services and communicating with multiple separate counterparties simultaneously, using data, voice and video down the same IP link our home internet connection at work, in financial institutions, there is still massive use of oneto-one communication links, with a separate link for each counterparty, each client, each service provider, etc. While we have all reaped great benefits from IP at home, those same benefits have too frequently not been obtained, or even reached for, by financial institutions. The three primary drivers of financial institutions and in particular regulatory changes are now making firms review if they re using technology in a way that supports those drivers or that hinders the firm from achieving its business goals. Cloud approaches, using shared IP-based network platforms that include multiple service providers and service users, are visibly changing the use of services and technology by retail customers. But over the last nine years, analysts have been producing reports indicating that conventional do-it-yourself, point-to-point networks operated by financial institutions are doubling their total cost of operation of communications as compared to the cost of community cloud approaches. And private community clouds have already been built and are interconnecting banks, brokers, investment managers, exchanges, ECNs and MTFs, CCPs and CSDs around the world. Identity management, security and risk management Whether the topic is KYC, AML, FATCA or LEI, ensuring that you know who you re communicating with and that your communication is secure is a critical aspect of financial services. It s such a major issue that some of the world s largest banks each operate several thousand different and separate systems for identifying counterparties and clients. Implementing federated identity management approaches can help firms deal with today s problems and help with migrating to a more rationalised approach to identity management that can increase security while reducing operational costs and risks. Security can mean many things, and you can be sure that all of those things have to be addressed by financial institutions. Many transactions and messages have to be secured from prying eyes through the encryption of data. In Payments and Post-Trade operations, having non-repudiable proof of message delivery and receipt is often considered missioncritical. Systems have to operate reliably so that firms can be secure in the knowledge that they can continue to serve their customers even when there is disruption in the outside world a compliance requirement from guidelines such as Basel II and regulations such as MiFID. Business Continuity Planning also has to include security and redundancy of hosting centres and communications links. All of this environment, both technical and operational, has to be included within the risk management practices of the organisation, and risk management is becoming more and more a real-time practice that has to assure the overall financial security of the organisation. 5

6 Recording, audit and reporting When reporting transactions to regulators, non-repudiable message exchange can be a vital factor for proving compliance, both internally and to the regulators. But it s not only data messages that need to be recorded: more regulations are now requiring the recording of all communications with clients, whether by voice, or instant messaging, and whether personnel are mobile, working from home or in the office. The aim of these regulations can be to check on whether customers are being treated fairly or whether firms are complying with best-execution requirements, but underlying this is the need for firms to be able to reconstruct intelligently not only the situation around a single trade but the whole, overall picture of what was happening in its customer-facing operations involving all media. Reach Today, to meet best-execution regulatory requirements, more firms need to connect to more execution venues and data sources. To meet de-risking regulatory requirements, more firms have to link to more central counterparties and clearing houses for trading across more asset classes. New regulations are causing new infrastructures to be built, such as trade repositories, consolidated tape market data systems and Legal Entity Identifier systems all of which can create new communications requirements for financial institutions. With the impacts of the economic crash and business downturn across North America and Europe, more firms need to address market opportunities in the BRICS economies and other new markets, whether that means accessing new market infrastructures or new clients, or both. And reaching into more markets and regulatory jurisdictions can often mean having to link and report to more market regulators. For many financial institutions, when they started building private networks decades ago it was to link primarily to their own domestic operations, interlinking buildings and branches. With increasing internationalisation of business their networks often were extended abroad, not just within the firm but also to connect to market infrastructures in other countries, and then to connect to clients both domestically and internationally. What was a relatively small-scale communications operation became significant, in terms of both its size and its cost to the firm. Some firms saw this in-house building and ownership of network and IT infrastructure as also building competitive edge. But in the meantime, the internet went commercial and, for many firms, changed competitive edge technology into costly legacy. 6

7 Getting to where you need to be depends on where you re starting from Communications is a volume business, whether your firm is a telco, a financial institution or a service provider. It s based on economies of scale and optimal use of capital: install the connection, then fill it, then make it bigger, then fill it again and so on ad infinitum. If you re not filling your connections and your competitor is then you re not being as capitalefficient as your competitor. The world s airlines have proved this model for the last 60+ years: by sharing the same infrastructure, the sum of the data volumes that all the airlines generate works to the costbenefit of all of them. Every new firm that joins in and shares the infrastructure adds to the volumes that everyone benefits from. Together, through sharing infrastructure, the users create a virtuous spiral the same kind of virtuous spiral that has made the public internet expand so rapidly in reach and capacity and reducing so rapidly the end-user cost over the last 20 years. The time of financial clouds is already with us, and to paraphrase, nothing can stop an idea whose time has come. Financial regulations are not going to get lighter in the future or easier to comply with, and legacy approaches to network and IT infrastructure are more likely to be a weight that drags a firm backwards rather than being a generator of operational efficiency and competitive edge. 7

8 Visit for more information on BT for Financial Services Offices worldwide The telecommunications services described in this publication are subject to availability and may be modified from time to time. Services and equipment are provided subject to British Telecommunications plc s respective standard conditions of contract. Nothing in this publication forms any part of any contract. British Telecommunications plc 2013 Registered office: 81 Newgate Street, London EC1A 7AJ Registered in England No: Designed by Westhill.co.uk Printed in England PHME 66891