Did you know that every seven minutes a regulatory update is issued somewhere in the world?*
In the time it will take you to read this article the regulatory landscape will have changed, probably only slightly, but still, that's a lot of new information on a daily basis.
The outsource trend
The regulatory and compliance burden of operating in the financial industry is nothing new, but as we've passed the 10 year anniversary of the financial crisis and reflect on its real impact on the funds industry, one of the, perhaps unsurprising, trends has been the increase in outsourced compliance.
As the costs of compliance continue to rise, leveraging economies of scale have become a necessity for survival. As the big become bigger (we have seen some high profile mergers in the last two years and that trend is expected to continue) what does that mean for those at the other end of the scale and perhaps even more importantly those in the middle?
We all need some assurance
New launches, sub-threshold Alternative Investment Fund Managers (AIFMs) and private equity funds are increasingly reaching out to their providers for support in achieving compliance. The regulatory obligation here in some instances is reduced and sub-threshold AIFMs/AIFs are exempt from most of the real burdensome requirements of AIFMD. In addition, private equity funds have special treatment under the AIFMD annex IV reporting as well as the obvious lack of complexity when compared with, for example, a hedge fund. Outsourcing for these structures is therefore usually driven not only by cost, but also by a requirement for assurance. Especially with new regulations, there are often many different interpretations of requirements and there's an inherent comfort to knowing that your provider is servicing other similar structures and you're not an outlier; safety in numbers, you could say.
Cost, cost, cost
Unlike banks, for whom compliance can be a source of competitive advantage (e.g. the development of advanced RWA models for BASEL), for funds there are no such additional benefits to be gained from investing in compliance.
Therefore, for mid-sized structures the outsourcing decisions are driven by more obvious reasons such as high costs for compliance professionals and IT infrastructure requirements. As they're in scope of the most burdensome regulations ranging from AMLD 4/5 AIFMD, MIFID II, MIFIR, EMIR, and SFTR depending on the fund type, in addition to the jurisdiction specific requirements, the costs of investing in technology in many cases simply don't make economic sense. To that end, the potential of leveraging a best-of-breed technology application and gaining specific regulatory expertise through a partner makes a compelling argument for the outsource model.
More on the way
With the BEPS (Base Erosion Profit Shifting) OECD initiatives continuing to impact the financial world, the economic substance requirements are anticipated to bring local needs for designated persons, such as compliance officers.
Another obvious example here is the Cayman Islands' Anti money laundering officer role, which becomes mandatory for all Cayman domiciled funds this year (deadline of 30 September has been pushed out to the end of the year). In this situation, due to the size of the recruitment market in Cayman, the choice of outsourcing this role is not an option, but in fact a necessity.
Finally
Historically, the arguments against the outsourcing of compliance functions, roles and support have been centred on the loss of control and transparency, but with the provision of client portals with advanced functionality allowing access to your data on demand, this argument begins to fall away.
When the outsource model makes sense, then by partnering with a global best–in-class provider you gain more than just support, you also gain the knowledge that you at least don't need to read a regulatory update every seven minutes!
*The 2018 Reuters Outsourcing Compliance Study
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
