They’re hot and don’t take risks

Greater regulation, following the financial crash, has increased financial services firms’ focus on risk management, writes James Dean

Armies are being raised in the City. Not of champagne-quaffing traders, nor Rolex-bling brokers, but of a new breed of worker with the hottest skill in the Square Mile – compliance officers.

Compliance, according to a recent report, is where it’s at. Demand for compliance officers is at a record high, as the financial services industry begins to accept that strong internal controls are essential in an age of intensifying regulatory pressure. The demand is expected to fuel the biggest hiring spree in the City since records began in 1989, according to the Confederation of British Industry and PwC, the professional services firm.

The demand for ranks of compliance officers is borne from the deluge of rules and regulations that followed the financial crisis. After years of toing and froing between lawmakers and industry at home, in Europe and even further abroad, many reforms are becoming reality.

“We’re going through unprecedented regulatory change coming off the back of the financial crisis,” says Julie Coates, head of financial services risk and regulation at PwC, “yet there’s so much more to come over the next few years. Some of these reforms are so far reaching that businesses will have to rethink how they make money in the future and perhaps even change the way they work completely.”

On the horizon is the possibility of new European rules based on the US Volcker reforms, clamping down on banks’ use of depositors’ funds for speculative trading. British banks, on the orders of the Basel Committee for Banking Supervision, have long been increasing their capital reserves. “Ring fences” between the retail and investment sides of too-big-to-fail banks are still on the cards.

There’s much greater engagement with senior management about the way in which risk is managed

Not all the changes of the last six years have come from new rules, though. Nik Kiri, a partner in the financial regulation group at Linklaters, the law firm, says that while “black-letter regulatory reform” has increased financial services firms’ focus on risk management, more significant, perhaps, is the way that regulators’ expectations have changed when it comes to the way firms and their senior management teams address risk.

“Regulators are asking much more searching questions of institutions,” he says. “There’s much greater engagement with senior management about the way in which risk is managed. Regulators are asking senior management, on an individual basis, to take responsibility for certain risks, to focus their minds on the importance of risk management and to make it easier to hold them accountable if there is a subsequent failure.

“It’s at least partly a reaction to the fact that regulators have struggled to hold individuals accountable for the problems a number of large firms faced during the financial crisis.

“The legal changes will have a very significant impact in terms of firms’ business models, structures and capital arrangements. But in terms of day-to-day risk management and governance, it’s not so much about legal changes as the way that regulators are using existing rules to get management to focus on the way risk is being managed in their businesses. There has been a step-change in the dialogue between regulators and firms.”

Because regulatory scrutiny has intensified, company boards must be able to respond. “Broadly speaking, the role of the chief risk officer has changed from analysing credit risk to understanding compliance in a much wider sense,” says PwC’s Ms Coates. “It’s now about looking at company-wide procedure even to the extent that they might recommend a comprehensive restructuring of the business.”

Responding to new data streams is a challenge, she says. “Long gone are the days that ‘technology’ meant ‘minimise IT spend’. In the digital age, companies need to respond quickly to customers, suppliers, government – anyone in the chain.

“Management information systems used to stream lagging indicators, but that’s just not the case any more; it’s all real-time data, or at least it should be. Having more up-to-date information at your fingertips allows you to be more responsive. Then the key is to filter out the most important indicators from the myriad of data – customer complaints or breaches of internal controls, perhaps – in order to best inform decision-making.”

Despite the benefits, technology also presents its own risks. For years, Britain’s top banks have been grappling with the problems that arise from having IT operations that are of such a big scale. In the last two years, Lloyds, Halifax, the Co-operative Bank, Royal Bank of Scotland, NatWest, Ulster Bank and Nationwide have all had to fix issues with transactions from customers’ current accounts.

Problems often arise when IT systems have to be bolted together; for example, after a merger. “Legacy systems are a major hazard when it comes to putting everything together,” says Ms Coates. Also, increasingly, regulators want to ensure that management know how their computer systems work. They ask when they look at a business: ‘Do senior managers understand the complexity?’”

Companies have a lot of work to do, but getting to grips with the new regulations and making changes early on will make it easier to navigate the choppy waters, she advises. As the reforms bed down, customers should get “more inventive, better tailored” products and better service.

In time, and with continued effort, customers should start to trust financial services again – lack of trust perhaps being the biggest barrier to success. And once the customers are happy, the shareholders will also be happy because improved sales tend to mean stronger earnings.

ANALYSIS

THE TAXMAN COMETH FROM AMERICA

They once provided a haven for the inestimable wealth of the Western elite. “If you can’t trust a Swiss banker, what’s the world come to?” asked James Bond in 1999’s movie The World Is Not Enough. Now, though, the allure of the Swiss bank account appears to be fading among wealthy Americans and Europeans.

Credit Suisse and UBS, Switzerland’s two biggest banks, have long reported that Western money is flowing out of their private accounts, (they’re not worried, though, because money from the Middle and Far East is flowing in). The outflows have come as Western governments crack down on tax evasion and avoidance by citizens using offshore bank accounts.

The Americans have been leading the charge. Last year, the US Internal Revenue Service (IRS) won a case against Wegelin, Switzerland’s oldest private bank, which pleaded guilty to helping American clients shelter $1.2 billion from the taxman. As the bank was forced to close, one Zurich-based newspaper screamed “gunboat diplomacy”. Four years before, UBS paid a $780-million fine to US authorities in relation to tax evasion charges, also agreeing to disclose details of the Americans holding money at the bank.

To aid the clampdown, American lawmakers passed the Foreign Account Tax Compliance Act (FATCA) in 2010, which requires every US citizen to disclose the existence of bank accounts held abroad. Unusually, it also requires foreign financial institutions to tell the IRS about their American account holders. It is all part of a bid to reclaim an estimated $100 billion in taxes withheld from the Federal Treasury every year.

Such sweeping changes to accounting systems have presented big challenges in the recent past. After the Enron scandal, financial reporting standards were radically overhauled by the passing of the Sarbanes-Oxley Act. From the off, companies struggled to accurately calculate tax across their operations.

“Those rules were the single biggest driver behind audit qualifications for some time,” says Alan MacPherson, leader of the global tax governance, risk and compliance practice at Deloitte, the professional services firm. As a result of the complications, companies spent huge amounts on updating their systems.

Businesses impacted by the FATCA rules – and perhaps also mindful of the increasingly adversarial nature of international tax authorities – might do well to overhaul their tax-calculating systems ahead of the changes, which come into effect in July.

The complexities brought about by American lawmakers can, to some extent, be assuaged with the help of computers. Generally, the idea is to use technology to automate small, repetitive processes that have a high error rate and standardise the process of taking data from one place to another.

Many companies are also choosing to outsource certain tax functions to specialist centres, in part for cost-savings and in part because it frees up management to concentrate on other issues. India, of course, is a leader in this field, with its highly educated workforce and increasing levels of business experience.

FATCA is looming. Any institution that fails to update their systems is likely to receive an unwelcome visit from the American taxman – and financial penalties to boot.