Investment guideline review – a strategic approach

Published on May 27, 2024 by Usha Prasad

Compliance is crucial in the investment compliance sector, as it ensures adherence to regulations and internal policies. To stay compliant and optimise investment strategies, it is essential to regularly review investment guidelines. This review process involves developing a framework, analysing consistency and validating guidelines – an effective and resource-saving approach to evidence-based guideline development. Non-compliance can lead to severe penalties, fines and reputational damage, and erode investor trust.

Enforcement actions and fines:

• 462 new standalone enforcement cases, representing a 6.5% increase from fiscal year 2021.

• Monetary penalties and disgorgement ordered in SEC actions reached a record-breaking 439bn. Civil penalties alone accounted for USD4.194bn, also the highest on record. While disgorgement decreased slightly from the previous year, fiscal year 2022 witnessed the SEC’s second-highest year ever in whistleblower awards.

As regulations evolve swiftly, organisations must adjust to ensure compliance and seize untapped opportunities. Guideline reviews play a crucial role in demonstrating a business's dedication to sustainable practices and achieving success through understanding its elements, adopting optimal strategies, using technology and keeping up with trends and regulations to foster sustainable long-term growth.

Interpretation and annotation of investment guidelines

The use of guideline interpretation and coding has empowered investment compliance functions to achieve greater efficiency. This approach safeguards clients from potential risks associated with guideline breaches and regulatory losses, minimising financial loss and damage to goodwill.

Differing interpretations of guidelines may result in inaccurate or false violations and disrupt compliance systems. A client document comprises an Investment Management Agreement (IMA), a Statement of Additional Information (SAI), single mandates and a prospectus. Converting client documents into an annotation template is advisable, to minimise discrepancies during rule coding by compliance rule writers. This process enables them to leverage existing rules in the compliance system’s library, reducing the risk of duplication.

Why conduct compliance rule and portfolio reviews?

• Regulatory requirements: Due to regulation updates or changes

• Document amendment: On instruction from client or portfolio manager

• Proof of concept: Untouched rule libraries, and stale rules not reviewed in the past 5-10 years

• Violations: Increasing data exceptions or compliance violations due to incorrect coding

• New investment class or security: Addition of a new asset class or security type

• Manual or redundant: Depends on manual and redundant processes that can be automated and consolidated

Designing an annotation template involves the following recommended methods and techniques:

• An Excel table format is required for the annotation sheet, while the guideline document should be extracted from a document in PDF format. If there are restrictions mentioned in the guideline documents, they should be incorporated into the template format.

• It is essential that the annotation sheet be written in a clear and easily understandable manner, incorporating all relevant information such as rule ID, rule name, comments and observations.

• The rule coder should strive for a consistent interpretation of key phrases using either the existing rules or universal rules, while avoiding redundant rules in compliance systems.

• Existing portfolios should be scrubbed to incorporate new logic or enhancements.

• The annotation template should be updated frequently to ensure that it reflects all recent regulatory changes.

• Enhancing system capabilities may require revising rules to improve efficiency and effectiveness. This process involves optimising existing rules or implementing new rules to align with the updated system functionalities.

• It is essential to keep the Standard Operating Procedures (SOP) document updated through regular revisions or by organising frequent team meetings to discuss regulatory modifications.

Compliance rule review could be enhanced by leveraging key compliance capabilities:

• Reviewing rule construction for investment mandates and regulatory requirements.

• Submitting an evidence document of changes to the universal rule library to the client for review and documenting approval.

• Validating compliance results for pre-trade, overnight/batch and trade compliance rules using a validation process or a what-if analysis.

• Unit testing and validation using positive and negative scenarios to ensure that the rule is working appropriately.

• Documenting the testing scenarios for audit purposes, preventing trade errors and avoiding compliance violations.

Conclusion

Against the constantly changing backdrop of investment regulations and market dynamics, ensuring adherence to investment guidelines is crucial for managing risk and maintaining integrity. Taking a proactive stance in reviewing investment guidelines can guarantee compliance across essential areas, enhancing performance, productivity and alignment with regulatory standards.

How Acuity Knowledge Partners can help

We pinpoint deficiencies and suggest tailored solutions for improvement. Our compliance team provides continuous advisory services, conducting thorough assessments of best practices and advising on data-sourcing strategies.

We perform thorough analyses to create effective investment compliance operational frameworks for assessing regulatory changes and implementing adjustments to enhance efficiency and effectiveness in all compliance settings. Our range of expertise is diverse, we are tool-agnostic and we have extensive experience in working with order management and compliance systems such as Bloomberg AIM, (LZ) Sentinel, Charles River Database (CRIMS), Think Folio and BlackRock’s Aladdin. We have in-depth knowledge of investment compliance monitoring functions and a deep understanding of global regulations such as the Investment Company Act of 1940, UCITS, ERISA, FINRA, the Securities Act of 1933, SFC, MPFA, FSA and APRA.

Source:

• SEC.gov | SEC Announces Enforcement Results for FY22

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