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The dangers of allowing compliance to become a “black box”

This article originally appeared in WealthBriefing's Technology Traps Wealth Managers Must Avoid 2020 report

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A growing number of regulations discourage financial institutions from doing business globally and increase costs and risks for ambitious wealth managers. Apiax provides answers to wealth managers' most pressing regulatory questions, enabling them to realise more business opportunities, while keeping costs low and risks under control.

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by Apiax
| 04/05/2020 13:40:28

Ralf Huber is Co-Founder of Apiax, a regtech focused on transmuting complex regulations into digitised compliance rules. Here, he outlines the dangers of compliance becoming a “black box” and explains how a rules-based system is the key to future-proofing in a fast-changing environment

In the turbulent space between wealth technology and the law, change can happen overnight. With digital toolkits and automated processes, wealth managers can go from compliant to non-compliant at the flick of a switch. Like in most industries, technology was introduced to take the manual burden off employees while ensuring efficiency and accuracy. Over time, the heavily data-driven wealth industry has become dependent on its capabilities. But although it is designed to optimise the investment advisory process, technology and automation may also expose businesses to huge compliance risks, if they are not watchful.

Here, I will identify the steps of the journey most prone to regulatory change while highlighting the essence of how integrated compliance mechanisms help wealth managers address common and - costly - traps.

Client relationship management (CRM)
Research (1) has highlighted personalisation as the main differentiator for wealth managers. Compared to other financial services, the wealth industry is lagging behind, with associations of poor customer service and simplistic or ill-fitting product recommendations.

Developing a stronger understanding of your current (and future) client base is a key way to address any shortcomings and gain competitive advantage. Adequate client data is key when developing personalised and viable investment strategies and proposals. Capturing such information in the requisite detail encourages a client-first approach and a commensurately detailed advisory process, both supported by a solid CRM system.

Fit-for-purpose CRM software records information ranging from customer profile, investment goals and risk appetite through to interaction history and communication preferences, using all these datapoints to in turn define appropriate action points. Fully leveraging client information is vital, yet at the same time there are significant risks associated with the recording of data and nurturing of customer relationships. As many firms aim to transition their businesses to cloud-based environments, new rules apply to the storage and handling of personal data. Usually installed within the back-office, changes may appear subtle to those not immediately familiar with the technology or its implications.

Servicing an international client base, there are also countless rules governing the interaction between an investment firm and its customers. These rules vary significantly between countries - even in supposedly harmonised markets such as the European Union - and add complexity not recognisable to CRM or portfolio management software that enable client actions through either automated workflows or individual commands. Relying on technology and automation in such business-critical moments requires a smart compliance layer attached.

So far, attempts have been made to install compliance rules directly into the CRM software. In theory, this might seem like an adequate solution to institutions able to identify and articulate relevant rules. In reality, however, the implementation and maintenance of these rules may prove challenging over time. This is due to the level of complexity and overwhelming amount of compliance rules involved, often adding up to thousands per country. Managed in a CRM environment, rules may become inconsistently maintained, resulting in supervisory issues or costly client complaints.

By decoupling the compliance function from the CRM environment, legal and compliance officers can build, maintain and alter compliance rules on a separate, dedicated platform - without system downtime or interference with client-facing processes. Instead, the two divisions work jointly together through Application Programming Interface (API) connections to exchange information. Through identifying and acting on regulatory requirements, the compliance plug-in blocks or permits actions based on their accordance with the law and informs the user about risks and requirements whilst operating within the CRM system. Efficiency is seen as a mere bonus compared to the significant risk reducing benefits involved in the implementation of compliance by design in CRM.

Market research and model portfolios
Just like understanding your clients, recognising market behaviours is essential when planning reliable investment proposals. Dedicated research teams spend hours daily monitoring these activities to identify market trends and trigger points for activity. Combined with investment themes and trends, research findings are compiled into model portfolios representing the firm’s main customer segments.

Despite being thoroughly market-oriented, many portfolio modelling tools overlook or simplify regulatory requirements - one of the main factors impacting the viability of investment portfolios. It is a dynamic and geographically diverse element, making its implications unpredictable if we are not paying close attention. Once taken into account, investment strategies can take many different turns - or get rejected altogether - due to its impact. As such, model portfolios usually require personalisation and long processes of configuration before being presented to the client in the form of tailored investment proposals.

In a competitive environment, these preparatory efforts may consume valuable time and resources from client advisors which would be far better spent on analysing the markets or understanding client needs.

Introducing digital compliance assurance at a model portfolio stage means analysts get early notifications of key regulatory impacts directly in their tools and can incorporate them into comprehensive and market-specific opportunity overviews. Connected to the internal compliance system, legal guidelines and policies appear where relevant and harmonise interpretation across jurisdictions for clear instructions within their environments.

Portfolio management tools
Planning a compelling investment proposal is a complex and data-intensive process. Joining together the external regulatory (and business) environment with clients’ individual needs creates countless combinations of criteria and data points to take into account.

To facilitate this process, wealth managers use digital tools to better build portfolios and strategies reflecting this information. Research (2) indicates that almost half of wealth managers now regularly employ data analysis and insights generated from the use of AI to refine customer advice. Even if comprehensive and sensitive to market trends, portfolio management tools may at times struggle to fully process all compliance requirements - especially in a cross-border context. In a sector prone to constant regulatory change, best practices enabled in wealth management software may become outdated overnight, making affected proposals less profitable, poorly suited to investors’ needs or even outright non-compliant.

Tax can be another trap
Once executed, tax deductions are another element that can make or break any investment strategy. Local and international tax standards can be simplified or overlooked by inadequate wealth management software and may therefore be challenging to predict. As a result, tax-related miscalculations and under-performance can break trust and weaken the relationship between the firm and its clients, potentially causing broader reputational damage.

Replacing the software’s own pre-installed default settings with company-specific compliance assurance aligns the wealth advisory process with the broader internal compliance frameworks. Operating behind the scenes of the internal infrastructure, and maintained by the internal compliance experts, the plugged-in assurance layer permits or rejects investment strategies based on their correspondence with local and international standards, as well as internal policies and risk appetite.

Technology is a key enabler for wealth managers wanting to deliver a competitive product offering and personalised client experiences. The data-intensive advisory process is reliant on careful processing of business-critical criteria while automation optimises efficiency across entire workflows, including market research, portfolio planning and CRM.

Although essential to firms worldwide, wealth technology does also carry significant compliance risks. In particular, digital investment management tools may fail to fully reflect the implication of complex regulatory standards involved in cross-border investment strategies. Over-reliance on default settings and automated workflows in such programmes generates loss of control and lack of transparency to compliance departments in their efforts to meet international compliance standards. In addition, dynamic regulatory frameworks add layers of complexity to an already challenging compliance landscape.

Integrating a digital and standalone compliance layer, maintained and supervised by regulatory experts, into the wealth advisory environment is an effective way to align processes with international regulatory standards as well as internal policies. By replacing wealth management programmes’ default compliance assurance functions, wealth managers will benefit from the ability to provide predictable and viable investment advice – rather than it becoming a “black box”, with all the risks that implies.


1. BCG Global Wealth 2019: Reigniting Radical Growth

2. Forbes Report - The Next Generation Wealth Manager