In the first part of this three part blog, I looked at the concept of ‘enterprise regulatory change’ and considered whether regulatory change initiatives, at the enterprise level, are even achievable, whilst in the second part, I looked at the implementation models for enterprise regulatory change and what this means at the programme level. In this final part, I want to look at the practical realities of implementing regulatory change and what this might mean to an enterprise-wide initiative.
It’s kind of clear that the implementation-model-piece-of-the-jigsaw is the “in theory” part of the decision making process – great on paper, but not necessarily so great in practice – and that when you have to drill down into the level of thinking required to factor in the shape and size of the organisation, the decision making process really becomes a two dimensional one.
Such will be the case in a large scale organisation – like a big bank – where rarely are systems and processes either integrated or aligned, meaning that a regulatory change initiative will struggle to benefit from the sort of efficiencies that may be available to a smaller firm. Holistically, these organisations will need to be asking the following sort of questions:
- How many business lines are we trying to implement the regulation across?
- Do they all share the same data architecture?
- How many trade execution or order management platforms are we dealing with?
- What risk architecture platforms are we using?
- What systems are being used for pricing?
- Is there a common platform for accounting and valuation?
- How many parts of the business do we need to tap into for reporting, and so on.
Once you have drilled down into this level of granularity, you start to define the many hurdles that will challenge an enterprise-wide initiative for regulatory change, right from the start.
In practice, the size of these hurdles are pretty much correlated to the size of the organisation and so there is likely an inverse relationship between a firm’s size and the complexity of the implementation strategy that it can deploy.
The European Market Infrastructure Regulation (the Europeans’ answer to global OTC swap reform) is an interesting example of a regulation that requires implementation across multiple asset classes as well as multiple business lines. In particular, the peculiarities of individual asset classes such as credit, rates, equities, FX and commodities make an enterprise-wide initiative extremely difficult to do.
To highlight the complexities of implementing this particular regulation, I thought about some simple examples of what a project team might have to tackle:
- How many different systems do we need to manage / extract data from?
- e.g. different asset classes will typically use different systems for processing trades, matching, confirmation, accounting and valuation, pricing, collateral, reconciliation and so on. There is rarely a common platform.
- What corporate and life cycle events do I need to build for? Do I need to build for coupons and payments?
- e.g. equity swaps will need to accommodate for corporate actions and life cycle events whilst interest rate swaps will need to accommodate for different coupon and payment cycles.
- What are the underlying pricing methodologies?
- e.g. What data sources are used for pricing? What interest rate curves are used for discounting? What data sources are used to maintain these curves?
- What are the valuation methodologies?
- e.g. do the valuation methodologies deploy discrete pricing models, discounted cash flow models or risk based models?
- What non-linear pricing structures do I need to build for?
- e.g. interest rate swaps may embed callable features, equity swaps may embed convertible features into underlying stocks or baskets whilst FX swaps may embed optionality to convert across currencies.
- What benchmarks or indices are used in pricing methodologies?
- e.g. interest rate swaps using LIBOR or EURIBOR benchmarks, credit default swaps using iTraxx indices, commodity swaps referencing cash fixings or equity swap baskets referencing indices.
- What data is required for trade reporting?
- e.g. trade reporting requires different data fields for different asset classes.
- Is the derivative cash settled or can I take physical delivery?
- e.g. interest rate swaps are typically cash settled but commodity swaps may be physically settled. New innovations such as CME deliverable swap futures that can be delivered into OTC interest rate swaps will significantly complicate workflow.
- Are there multiple variations of the same product?
- e.g. CDS indices have multiple series, whilst commodity swaps may be constructed against different reference data, and so on.
When I look at this kind of level of thinking, I can’t help but wonder if the idea of an enterprise-wide initiative for regulatory change may just be too big of an ask for a complex organisation trying to implement a complex regulation?
We love to talk about digging up the road once and I touched on this idea in the second part of this blog where I introduced the concept of ‘Portfolio Implementation’ as a possible model for implementing regulatory change, but when you drill down into how you are actually going to do it, the practical realities may just make this impossible.
To understand this, consider another example – ‘client classification’. This is a requirement across multiple regulations for firms to classify their clients into a discrete set of categories – FATCA, AMLD IV, EMIR, CRD IV and MiFID II all come to mind.
A forward thinking firm would clearly have a choice here: build multiple projects across each regulation to classify clients or take a holistic approach to align the build across a portfolio of regulations and build just once.
Again, at least on paper!
But in practice, the build is likely to be driven by “time is short”, “the project is already behind schedule”, “the budget is already stretched”, “it’s too complicated” and so solutions often tend to be tactical ‘fire-fights’ rather than strategic.
Just how we should approach enterprise-wide initiatives for regulatory change is, relatively speaking, chartering new territory because there is not a time in history where financial institutions have been bombarded with such a tsunami of back-to-back regulations.
And so in summary, I’m not particularly convinced that enterprise initiatives are that achievable for certain regulations, but there may be partial components that are common across a build and so any strategy that can help should probably be embraced with both hands as firms attempt to contain the soaring cost of implementation.