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TAMING THE WOLF: MANAGING RISK IN A REGULATORY ENVIRONMENT

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James Keenan

The Wolf of Wall Street highlighted the excesses of the financial services industry. LOC Consulting’s James Keenan examines how investment banks can address complex issues arising around culture, risk management, and transparency, at a time of significant regulatory reform.

Martin Scorsese’s portrayal of the rise and fall of Jordan Belfort of brokerage firm Stratton Oakmont, is said to have stretched beyond the realm of possibility. Audiences loved it, more circumspect financial services professionals hated it, and film critics described it as ‘the rigging of the American game unveiled’.

Nevertheless, several elements of the film ring true.  The crux of the story is that Stratton Oakmont’s success was built on the fraud known as ‘pump and dump’ – a technique that works by buying up the stock of worthless companies through nominees, selling it on a rising market to genuine investors, and then unloading all of it. This practise eventually saw Belfort jailed.

Systemic risk

James Keenan

James Keenan

The Wolf of Wall Street serves as a cautionary tale. Certainly it can be hard to see the wood from the trees with highly complex products being traded. Moreover, investors need to be cautious when the wood (i.e. the bourse) happens to be inhabited by wolves.

Likewise, the latest regulation sweeping the financial services industry is necessary to protect the wealthy one per cent of potential investors that Belfort urges his ‘wolf pack’ to ‘harpoon’, or to guard against rogue traders committing securities fraud by pricing derivatives portfolios in a way that reduces reported losses.

Derivatives are contracts between banks and other investors. Linked to corporate debt, commodities, currencies, and other assets, they are a major source of credit exposures between the largest global institutions. The collapse of Lehman Brothers in 2008, came about because Lehman’s portfolio was tied up in highly complex and opaque OTC derivatives.

Lehman was just one of many major banks and financial institutions bundling complex OTC derivative instruments together such that the true risk inherent in transactions was not obvious. Due to this high complexity, lack of transparency, and a culture focused on financial gain, banks failed as things went wrong, bailouts ensued, and the leveraged debt around certain trades had a disproportionate effect on financial systems and the global economy.

Exponential problem

Recognising that comprehensive OTC derivatives regulatory reform regulators are introducing numerous rules including EMIR, Dodd Frank and MiFID. These aim to reduce counterparty risk, improve transparency, and enable regulators to better assess, mitigate and manage systemic risk. They present substantial challenges for financial institutions.

Implementation is problematic as regulators are putting in different obligations at different times which can be contradictory. The new rules also continue to evolve and expand to eventually encompass all relevant OTC derivative asset classes.

Inherently complex

Delivering business change to ensure compliance in these circumstances is inherently complex. Employing a conventional project structure and approach to address regulatory change is not an option. There is a diversity of internal and external stakeholders involved, and the fact that mandatory delivery timelines can move makes scheduling difficult.

Furthermore, the interdependency of rules calls for fundamental system changes, many of which will need to be delivered concurrently, and without impacting on ‘business as usual’ activities. The core concern for financial institutions is that regulations cannot be delivered to the required quality through existing organisational structures, leaving significant areas to address.

Ongoing analysis of the evolving market, deep industry knowledge and interpretation of the in-coming regulation will be essential in ensuring that new central clearing and e-trading platforms are delivered in a compliant way. It will be vital to clearly set out and communicate the new workflows and technical capabilities necessary to execute the electronic trades, and ensure that all members of staff have a full understanding of the behaviours no longer permitted.

The rationale for the workflows is important given the complexity of the often competing regulations cross-jurisdiction, such that key workflow aspects are not inadvertently removed leading to a regulatory breach, or obsolete elements left in place leading to inefficiency.

Strategic delivery capability

With substantial financial and reputational implications attached to any instance of non-compliance or breach, it’s essential that senior decision-makers are engaged in the implementation of any rules. A strategic delivery capability is therefore required and can be achieved by establishing a governing committee to span all regulatory delivery. Led by a senior chair under which design authority committees can sit, this enables financial institutions to manage operational risk arising from regulatory change.

Taming The WOLF: Managing Risk In A Regulatory Environment

Taming The WOLF: Managing Risk In A Regulatory Environment

A dedicated business project team should also be established to provide an effective conduit between programme sponsors managing trading sales activities and the IT teams making system changes. This way, aims are understood and requirements clearly defined before being fed into the IT teams. A defined methodology is recommended covering the following:

  • Rule interpretation by legal, compliance and business experts
  • Impact analysis by business experts
  • Definition of IT requirements
  • Dependency management and implementation scheduling (with integration in to change management roadmap)

It must be recognised however, that project teams are temporary by nature, thus the financial institution itself needs to embed the required responsibilities within the organisation. This is where many organisations opt to engage an experienced external provider to drive the structural change required and ensure that the necessary level of in-house competency is achieved to sustain the capability going forward.

Strong and collective desire

For an industry often accused of gaming the system, regulation is the only game in town for the next five years, making it imperative that financial institutions enshrine compliance and transparency firmly within corporate culture. Regulation cannot ever eliminate risk completely, but it can improve the way risk is managed provided it is approached with the appropriately level of gravitas.

Without a strong and collective desire to not only follow the letter but the spirit of the rules, organisations will always find ways to work with those rules to their competitive advantage – those then become industry accepted norms and the circle starts again. Industry-level cultural change is the only way to avoid such a circle, and requires strong, prohibitive action from regulators at individual and corporate level.

With a strategic delivery capability for managing business change built on a robust governance structure, strong senior-level buy-in to drive towards greater compliance and including a communications programme embracing both internal and external parties, financial institutions will be better equipped to successfully transform their business with minimal operational disruption.

Importantly, they can employ the same mechanics and structure to respond rapidly and appropriately to further regulatory shifts, engage with trading partners compliantly, and intervene in a rapid and appropriate manner should issues arise.

Finance

One third of money management tools face closure by the end of the year if they do not embrace open banking

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One third of money management tools face closure by the end of the year if they do not embrace open banking 1
  • New research from Yolt Technology Services shows 35% of Personal Finance Managers aren’t using any open banking technology
  • Imminent screen scraping ban set to cause major disruption for consumers and businesses with just two months to go
  • 1 in 5 PFMs have never even considered using open banking
  • 28% cited data privacy as a reason for not adopting open banking technology

An international study of over 1,000 senior professionals in the banking, lending, PFM, investment, and retail sectors by leading open banking provider Yolt Technology Services has revealed that over a third (35%) of Personal Finance Management (PFM) platforms aren’t using open banking technology. These businesses will face an urgent transition when screen scraping is phased out in Europe at the end of 2020 if they are to avoid major service disruptions.

The final leg of PSD2, Stronger Customer Authentication (SCA), comes into effect in Europe on 31st December 2020 and will add an extra layer of security to log-in processes. This will force many banks to withdraw screen scraping facilities, which are currently used by PFMs to automatically extract on-screen data from the bank’s online banking page or app. This data is then used as raw text in the PFM to generate spending insights for users, but is less secure, less efficient, and creates a more cumbersome log in process.

As a result, many PFMs will have to look for alternative methods to gather customer data efficiently and securely, but despite being early pioneers of open banking, the survey showed that 35% of PFMs are not using open banking products and services such as AIS systems. In fact, nearly 1 in 5 respondents (19%) stated that they have never even considered using open banking.

More surprising still is that among those who were using open banking, only half (55%) were using Account Information Services, while over three quarters (77%) were using Payment Initiation Services (PIS). While PIS can deliver significant value for users, enabling settling between accounts or payment into regular savings accounts, its functionality is not a core part of the PFM offering in the same way as AIS.

Among those who haven’t yet adopted open banking technology, 35% of PFMs said it was too early to invest, and 28% named data privacy as the chief reason for not adopting. Despite this, PFMs do still show an above average adoption rate (68%) after being one of the first sectors to take advantage of the technology, compared with the banking and retail sectors, the next highest, on 63% and 62% respectively.

And the adoption of open banking technology is proving to be lucrative for those PFMs that do make the switch. Over 90% of PFMs who keep track of the monetary gains of open banking said that it is worth between £1m – £5m to their business each year, compared with 70% of respondents across all sectors, so there are financial gains to be had. This may be because open banking is central to service delivery for the majority of PFMs, but in other sectors it is a differentiator and its use is optional.

For all of this promise to be realised, there are clear issues to be addressed, but PFMs stand to benefit if they lead the charge.

Leon Muis, Chief Business Officer at Yolt Technology Services, comments:

“As pioneers of open banking, Personal Finance Managers have incredible potential to propel the technology even further – but only if steps are taken now to address the issues our survey reveals. That starts with more adoption – platforms which rely on manual methods of information gathering like screen scraping are not only less efficient, they deliver a worse service for users. To see a third of all PFM platforms using no open banking technology at all is a concern, and one that they will have to deal with sooner rather than later, with the upcoming ban on screen scraping.

“Data privacy concerns are a key reason behind this adoption rate, but this is built on fundamental misunderstandings not only about the technology, but the rules which govern its use. That over a quarter of PFM platforms don’t understand how open banking legislation works is a signal that we need to do better as an industry to champion the benefits of the technology, but also showcase the core safeguards and secure foundations upon which it is built.

“What is also clear is the power open banking has to differentiate platforms, and those which can most effectively implement it stand to benefit the most, both financially and in service delivery. And, with the phasing out of screen scraping coming into effect at the end of the year, PFMs need to act now to better support their customers and avoid being left behind.”

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Accountants have become critical to the survival of businesses and their reputations during Covid-19

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Accountants have become critical to the survival of businesses and their reputations during Covid-19 2

The opportunity for fraudulent activity to flourish as finance departments operate remotely with less oversight in these extraordinary Covid-19 times is inevitable. Government loans and financial support have been given out with little or no accountability to businesses that are struggling with the change in their trading environment and as a consequence businesses find themselves in financial need. 

There is already evidence of corporations handing back furlough grants as HMRC offers a 90-day amnesty, but without rapid data-driven insight and risk stratification, businesses may not know the extent of their exposure. Indeed many businesses face the daunting prospect of repaying loans at the same time as paying deferred VAT early next year in a far from certain trading environment. Stuart Cobbe, Director of Growth, Europe, MindBridge explains that the role of the accountant has now become critical to businesses and their reputations. 

Unlocking transparency

The Covid-19 landscape is fluid and ever-changing, and businesses require accurate visibility of all aspects of their business in order to plan effectively for the future and to understand their financial position. As the economy continues to recover to a new ‘normal’, companies need to focus on the next 6 months. How many ‘zombie’ businesses are only operating due to deferred VAT payments? How many companies will fail when they cannot repay loans? The role of the accountant is vital in unlocking this transparency to provide data-driven, actionable insights.

After all, there are many questions around how government financing has been used, from grants to loans, furlough payments to VAT deferments. As of the 20th September, the total cost of furlough claims has reached a staggering almost £40 billion, despite 30,000 applications being rejected, with many likely to have been attempts to defraud the taxpayer. Research by economists from Cambridge, Oxford and Zurich universities found that as many as two thirds of furloughed workers continued to work.

For businesses that do not understand the extent of their exposure, they risk facing a HMRC-imposed tax charge equivalent of up to 100% of the grant to which any recipient was not entitled and was not repaid. It is, therefore, interesting to see the number of large organisations now publicly revealing plans to repay all furlough payments. For many, this is an opportunity to boost corporate reputation and demonstrate a commitment to rediscovering business as usual. However, given the huge pressures businesses have been under in recent months, many CFOs and FDs may not have the full visibility they require to effectively manage this without the power of audit.

Financial Risks

This is about far more than reputational damage, the potential misuse of furlough is far from the only financial risk. The extraordinary shift in every business’ modus operandi over the past few months has opened the door for opportunistic fraud. New sources of income; staff working from home with limited oversight; the financial pressures – both business and personal – created by the recession. The misappropriation of assets should be a very real concern for businesses of every size.

For organisations that have relied upon grants and loans to survive, an employee exploiting the lack of oversight to syphon funds for personal use could tip the company into failure. Companies must determine how – or whether – deferred VAT payments and loan repayments can be made. Is the company truly solvent or no more than a ‘zombie’ business operating with a balance sheet propped up by short term government finance?

Actionable data 

Business resilience and reputation is a priority in this era, and CFOs or FDs may be struggling to establish trust across businesses now operating under a whole new range of pressures, from slimmer margins to a disjointed, remote workforce. There is an obvious need for complete visualisation of financial risks, and accountants play a crucial role in unlocking this data.

The rapid identification of mistakes in government support applications, potential fraud and the analysis of which deferred payments and loan repayments can be made and when – whilst ensuring other risk factors do not jeopardise business stability – is essential to futureproof the business, and accountants can assess data to provide this information in a complete and actionable format to lead smarter company decisions. This is the data insight CFOs and FDs need today.

Traditional financial risk assessment models will not be adequate. At best, problems will be revealed months after the fact. Companies need rapid identification of areas of unexpected activity today. This is where accountants and finance departments using sophisticated machine learning and artificial intelligence techniques can deliver real business value by rapidly assessing financial data and surfacing unexpected activity. Armed with this information, finance teams will know where to focus activities, the questions to ask and the remedial action to take. This information will drive departments and remedial action to ensure business success and growth as the nation gets back to its feet.

In short, accountants and finance professionals can provide the answers businesses need today, whilst helping managers to plan for the future effectively, despite the changes in policies and protocols as the pandemic continues to throw curveballs. An audit can quickly identify problems including but not limited to, cash flow, fraud, misuse of grants, loan repayment issues – all whilst offering the guidance and steps to safeguard the business to promote resilience and protect the solvency and reputation.

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Taking advantage of the UK’s renovation revolution

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Taking advantage of the UK’s renovation revolution 3

By Paresh Raja, CEO, Market Financial Solutions

UK property is a popular asset class because of its historical resilience to withstand periods of political and economic volatility and quickly recover its value. Domestic and international investors are aware of this general observation, which no doubt explains why investment into bricks and mortar has been rising during the COVID-19 pandemic.

As a result of tax reliefs introduced by the government to encourage buyers and sellers to return to the property market, house prices have been rising at an impressive rate. According to the UK’s biggest building society – Nationwide – house prices rose in September at the fastest annual rate since the aftermath of the EU referendum vote in 2016. Nationwide recorded annual house price growth of 5% in September.

For homeowners, this is important – house prices are a useful way of measuring the capital growth of a property. If house prices are rising, it means there is strong demand for real estate which is positive news for homeowners. House price growth also allows us to assess the overall health of the property market.

Here at Market Financial Solutions, we are regularly arranging bridging loans to support the property investment intentions of UK and non-resident buyers. From our perspective, COVID-19 has not dampened the overall need for finance to complete on real estate transactions. And importantly, we are also seeing a rise in homeowners undertaking renovation and refurbishment projects amidst the pandemic.

In August, the Renovation Nation Report revealed that the typical UK homeowner had spent over £4,000 on renovation works since the introduction of lockdown measures in March 2020, ranging from garden to living room, bedroom and kitchen upgrades. This has no doubt increased in value since then.

The rise in home improvement projects is important for a number of reasons. First, it is an effective way of increasing the value of a property. Simply updating worn furnishing and fittings, adding an extension or implementing new technologies to make a home more energy efficient can significantly enhance the appeal of a home and increase its market value.

Second, the rise in renovations and refurbishments taking place drives productivity and creates new building opportunities for SME construction firms. For example, a survey that was recently published by the Federation of Master Builders showed a marked increased interest for home improvement projects. It revealed that 42% of SMEs are predicting higher workloads during the Autumn months.

Paresh Raja

Paresh Raja

In my opinion, the COVID-19 pandemic is directly responsible for this sudden hike. People are spending more time at home, either working remotely or as part of social distancing measures. Naturally, this has compelled homeowners to consider ways of upgrading their property so that they can better enjoy their office and/or living spaces. What’s more, with the UK on the brink of second lockdown, there is a general acceptance that working from home either fulltime or part-time is something that will remain the case long after the coronavirus outbreak has been contained.

Unlocking the renovation revolution

One of the biggest challenges when undertaking a home improvement project is having the necessary finance in place. The traditional method of engaging with a high street lender for a loan has become complicated. As a consequence of COVID-19, banks are treading carefully – based on reports we’ve been hearing, loans are taking longer to be approved and the range of products available is limited.

Given how important property market activity is in driving economic productivity and growth, there is a clear need to ensure that homebuyers can access finance with minimal delay and fuss. Having witnessed current trends, Market Financial Solutions has responded by offering specialist finance loans that are tailored specifically for renovation and refurbishment projects. These are structured to the specific demands of each application, which means that construction deadlines can be met without the risk of finance being delayed.

Interestingly, the government is also keen to promote home improvements, particularly when it comes to green housing. For instance, in September the government launched the Green Homes Grant to encourage energy efficient housing. Under this scheme, grants can be accessed to pay for green home improvements. This could range from the insulation of walls and floors to the installation of double and triple glazing and the addition of low-carbon heating.

I would not be surprised if the government also considers similar grant programmes to support either types of renovation projects, particularly if more people are facing the prospect of permanent remote working. Of course, a lot of research would need to be undertaken for such a proposal but there are plenty of advantages that could be on offer as part of such a scheme. For now, we will need to wait and see.

My advice for anyone considering a home improvement project is to consider all the finance options available and applying for a loan that best meets their individual circumstances. While this might seem challenging, the fact of the matter is that lenders like Market Financial Solutions are responding to demand and creating products to support such undertakings. Finding the right type of finance will only increase the chances of work being completed on time, which ultimately works in favour of the homeowner.

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