Published on May 11, 2018 by Manish Gupta
The burden of meeting investment guideline requirements has grown rapidly in recent years. Portfolio managers (PMs) perform numerous activities to ensure their portfolios comply with regulations and client guidelines, but the most vital and critical activity is investment guideline monitoring (IGM), which helps to manage and mitigate key risks or breaches. Breaches lead to reputational and financial loss that hurt an organization’s bottom line. Considering the complexity of an organization’s data management, trade processing, technology and regulatory control, it becomes difficult to completely eliminate risk of a breach, but the number of errors can be reduced.
Focus areas to enhance IGM:
1. Lack of connectivity in systems
Generally, a breach can be prevented prior to a trade by verifying trade details such as quantity, price, and identifiers in the Order Management System (OMS), investment compliance systems and Execution Management System (EMS). The OMS has a strong link to investment compliance systems, but the lack of connectivity between the OMS and the EMS may be an issue. Most asset management companies use in-house EMSs for trade execution and processing, leading to data discrepancies in their OMS and EMS, and to breaches of investment compliance regulations.
Steps to overcome it:
Instead of using a separate OMS and EMS, organizations could use a one-size-fits-all system, i.e., an Order and Execution Management System (OEMS) – a combination of the OMS and EMS that enhances trade and post-trade monitoring in numerous ways, as mentioned below:
Eliminates risk of staging the order between two applications: the OMS and EMS. Traders no longer have to switch systems and can manage trade-execution strategies that will not only save time but also reduce errors to a large extent
Provides a consistent view across the trade lifecycle. PMs can reduce errors and risks by identifying potential issues before trade execution
Provides effective management of FX forward rolls and rebalancing benchmarks
Facilitates easy splitting, cancelling and replacing of orders
Flags breaches for review
Enables faster resolution of exceptions
2. Discrepancies in interpretation
Most breaches are due to discrepancies in interpretation of guideline language. Effective management of interpretation issues requires a well-defined approach to identify and analyze an issue and to take preventive action.
Another example is “primarily investments in equities”. The word “primarily” does not have a specific definition. It is used differently in different organizations. Some asset managers define it as a “minimum of 80% in equities”, whereas others consider it to be a “minimum of 90%” or a “minimum of 67%”. Investment guidelines provide no explicit minimum investment level; PM and investment compliance department interpretations may therefore vary.
Steps to overcome it:
If investment agreements carry clear definitions, it will not be a concern. The US Mutual Funds Act of 1940 defines “primarily investments” as a “minimum of 80% in equities”, whereas UCITS and OEIC define it as a “minimum of 67% in equities”. However, this term is sometimes not defined, and standard practice mentioned below may be followed organization-wide:
The definition should be finalized by the organization’s functional teams, including the legal, sales, client relationship management, portfolio management and accounts departments, and should be implemented in all the organization’s accounts. If in doubt, the best approach would be to consult with the client.
After discussion with the functional teams, a centralized issue log should be created to ensure consistency. This would contain detailed information, such as potential issues and how to resolve them.
3. Lack of accurate and sufficient data
Investment compliance systems depend heavily on data for coding investment restrictions. Each organization has a data management team that is responsible for building data points and maintaining data quality in all related systems from which data flows into investment compliance systems.
Compliance systems should be mapped with all data required to monitor exceptions or breaches. If not, manual monitoring will be required, necessitating more time to resolve a breach.
Steps to overcome it:
Create a data dictionary of all data points that flow from the security master database to the investment compliance system. The data dictionary is a repository of all data points, such as data point name, source, region for which it is created, and usage. All data related to a security – from multiple vendors, such as Bloomberg, Thomson Reuters, and Telekurs – should be collected into a centralized database. This data should then be validated before moving it to a calculation platform, where a data point is created using numerous pieces of information.
Periodically assess the data dictionary to check whether it could be enhanced to monitor investment restrictions and to avoid breakage of data flow into compliance systems.
If a breach is identified due to data limitation, raise the issue with the relevant departments for timely resolution.
Key to safeguarding data integrity is centralizing it, so that all job functions rely on the same set of data.
Enhancing investment compliance monitoring not only assists the PM to manage the portfolio effectively, but also helps the organization stay ahead of peers.
Any view or opinion represented in this blog is published in good faith and for informational purposes only. The owner of the blog does not make any representation about the completeness, reliability or accuracy of this information. Any action you take upon the information you find in this blog is strictly at your own risk. The owner will not be liable for any error or omission in this information nor for the availability of this information. The owner will also not be liable for any loss, injury, or damage resulting from the display or use of this information.
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About the Author
Delivery Lead, Compliance_Ops
Manish has over 8 years of experience in investment management industry and specializes in investment management compliance. At Acuity Knowledge Partners, he is responsible for successful migration, implementation, ongoing maintenance of global clients’ investment guidelines which includes guideline interpretation, rules coding, testing compliance rules, list update and post trade monitoring. Prior to Acuity Knowledge Partners Manish worked at AXA, Infostep India and a prominent chartered accountant’s firm. He holds an MBA in Finance and International Business form Kohinoor Business School.
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