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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

Global dividend payouts forecast to revive in 2021

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Global dividend payouts forecast to revive in 2021 1

By Joice Alves

LONDON (Reuters) – Global dividend payments could rebound by as much as 5% this year, a new report estimated on Monday, after the coronavirus caused the biggest slump in payouts since the financial crisis more than a decade ago.

Companies’ payouts to shareholders plunged more than 10% on an underlying basis in 2020 as one in five cut their dividends and one in eight cancelled them altogether.

A total of $220 billion worth of cuts were made between April and December, based on investment manager Janus Henderson’s Global Dividend Index. But there are signs companies are beginning to reinstate at least some of them.

Janus Henderson’s report warned that dividends could still fall 2% this year, in a worst-case scenario. But its best-case scenario sees 2021 dividends up 5% on a headline basis.

“It is quite likely we will see companies pay special dividends in 2021, utilising strong cash positions to make up some of the decline in distributions in 2020”.

Banking dividends will be likely to drive the rebound in payouts in 2021, the report said, after the European Central Bank and Bank of England eased blanket bans for lenders on dividends and buybacks. These were imposed during the first wave of the crisis to prepare for a potential increase in bad loans.

UK lenders Barclays and NatWest resumed payouts this month.

Last year, dividend bans meant banks cut or cancelled $70 billion of payments globally, according to the report.

But the overall global dividend cuts proved less dramatic than expected. In August, Janus Henderson had expected the virus to drive corporates to cut $400 billion worth of dividends, nearly double the eventual outcome.

A resilient fourth quarter of 2020 helped, said Janus Henderson. The likes of German car maker Volkswagen and Russia’s largest lender Sberbank restored payments.

Mining and oil companies cut dividends after a slump in commodity prices, while consumer discretionary companies also took a hit following lockdowns.

European dividends, not including Britain, fell by 28.4% on an underlying basis in 2020 to $171.6 billion. “This was the lowest total from Europe since at least 2009,” Janus Henderson said.

(GRAPHIC: Dividend cuts by region –

Global dividend payouts forecast to revive in 2021 2

In contrast, North American payouts rose 2.6% for the full year, setting a new record of $549 billion, the report said. Canada had the fewest dividend cuts anywhere in the world, the index showed.

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Former Bank of England Governor Carney joins board of digital payments company Stripe

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Former Bank of England Governor Carney joins board of digital payments company Stripe 3

By Kanishka Singh

(Reuters) – Mark Carney, former head of the UK and Canadian central banks, has joined the board of U.S. digital payments company Stripe Inc, days after the company was reported to be planning a primary funding round valuing it at over $100 billion.

“Regulated in multiple jurisdictions and partnering with several dozen financial institutions around the world, Stripe will benefit from Mark Carney’s extensive experience of global financial systems and governance”, the company said on Sunday, confirming a report by the Sunday Times newspaper.

Forbes magazine had reported on Wednesday that investors were valuing Stripe at a $115 billion valuation in secondary-market transactions.

A senior Stripe executive told Reuters in December that the company plans to expand across Asia, including in Southeast Asia, Japan, China and India.

The company offers products that allow merchants to accept digital payments from customers and a range of business banking services.

Stripe raised $600 million in April in an extension of a Series G round and was valued back then at $36 billion.

Consumer-facing fintechs have seen a boost to their businesses during the COVID-19 pandemic, as people have been staying at home to avoid catching the virus and have increasingly been managing their finances online.

Carney, who headed the Bank of England and the Bank of Canada, had a 13-year career at Wall Street bank Goldman Sachs Group Inc in its London, Tokyo, New York and Toronto offices.

He is the United Nations special envoy on climate action and finance.

(Reporting by Kanishka Singh in Bengaluru; Editing by William Mallard)

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The potential of Open Finance and the digitisation of tax records

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The potential of Open Finance and the digitisation of tax records 4

By Sudesh Sud, Founder of APARI 

The world is undergoing huge changes at the moment. Between coronavirus pushing the economy to the limit and a group of Redditors challenging the financial market hegemony, people are questioning the role of established institutions. If finance doesn’t work to enable the economy, businesses or individuals, then who is it for?

Before the digital revolution, financial experts were seen as a necessity. They knew how things worked, what everything meant, could provide good advice and were employed to sit at the heart of the action. Now, trading can be done by anyone online through established platforms, with a wealth of information available to hand.

Yet, as the 2008 financial crisis proved, established financial institutions have made themselves too big to fail. Simply tearing down the existing financial system would leave many ordinary people, along with businesses and government treasuries, in ruin.

However, as legendary futurologist, Buckminster Fuller, once said: “You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.”

Traditional banking models are already being upended by technology. Through Open Banking, challenger banks are able to connect services digitally, cutting inefficiencies and costs while speeding up transactions. Now, Open Finance is seeking to build on this model to connect financial services via technology, potentially making the existing financial model obsolete.

Just as Open Banking led to greater democratisation of money, Open Finance has the potential to transfer power back to individuals. Not only would this benefit society as a whole, but it would help minimise the boom-bust cycles that cripple entire economies. No individual would be too big to fail, and bailing people out would cost far less, having minimal impact on the economy overall.

With more information available to them, Open Finance businesses will be able to use technology to make better decisions instantly. Many people struggle to get onto the housing ladder due to a poor credit score, for example, yet they have been paying rent every month of their adult lives. Why, then, can they not access mortgages? A company called Credit Ladder is addressing this through Open Banking, reporting rent payments via challenger banks like Starling to credit agencies, helping good renters to access mortgages.

While it is still very early days for Open Finance, there seems to be an endless raft of possibilities to benefit individuals, businesses and national economies. Faster, more secure, and less risky access to credit can help grow the economy, transforming finance from something that benefits a few wealthy capitalists to something that enables growth in the real economy.

So how else could Open Finance benefit society?

Using Tax Information

Every working adult pays income tax. Some of us via self-assessment while others are enrolled in PAYE. Regardless, we all have tax records with a wealth of financial information that has been verified, at least in part, by HMRC.

This centralised repository of financial information could be put to better use, such as allowing credit reference agencies to better understand an individual’s risk profile or helping to prove income as part of a mortgage application. Unfortunately, HMRC is a black hole of information ‒ its sheer size and power sucks information in, but nothing comes back out again.

However, by Making Tax Digital (MTD), HMRC are effectively allowing individuals to keep validated tax records on the software of their choice. Software providers may then be able to use this information to enable certain aspects of Open Finance. The information doesn’t need to be protected by HMRC, it is the individual’s choice and responsibility over how to use their own information.

As MTD software develops, we will see it connected to Open Banking, allowing self-assessed taxpayers to connect their business account directly to the software, effectively getting their tax return completed for them by an AI program. They would simply check the details, add any adjustments, and click submit. HMRC would then validate the records, providing assurance for any financial institutions using that financial information.

More Growth, Lower Risk

With access to complete and validated financial information, lenders would be able to more quickly and accurately assess individual risk when considering a loan or mortgage application. This would greatly speed up the process of applying for a loan, whether for a business venture or property purchase, for example.

Take residential landlords, for example. They may own a few properties already, with equity coming out of their ears. If that landlord wants to obtain another property, they would need to get their accountant to assemble their financial information, complete a SA302, and send everything off to their mortgage advisors who would then validate the information before submitting the mortgage application.

The application can then take months to approve, slowing down the process and potentially leading to missed opportunities. Since property sales usually occur in a chain (the owner of the property you are purchasing is usually purchasing another property, and so on), these inefficiencies slow the process down for everyone and can have major impacts.

If, however, mortgage applicants could simply share validated financial/tax records, mortgage providers could use that information to make quick decisions with reduced risk. What’s more, applicants could share only relevant, high-level information, rather than expose their entire financial history.

Individual Risk Management

Currently, individuals can manage their credit score/risk profile via third party providers like Experian, Equifax and TransUnion. These credit reporting agencies use limited information, such as credit cards, store cards and loans to assess risk. Individuals need to understand what factors each agency uses in order to ‘game’ the system.

For example, someone who has always been careful with their money, kept to a strict budget and never taken out a loan or credit card will have a far worse credit rating than someone who regularly uses debt to finance their lifestyle. So, even though they may have amassed a good deal of savings, they cannot get a good deal on a loan or mortgage.

With Open Finance, these individuals would be able to quickly prove their earnings, spending, and savings, decreasing their risk profile in line with reality. Rather than crude measures of creditworthiness, financial institutions would be able to use accurate and validated information to make quick decisions based on realistic risk. This both transfers more power to individuals and contributes to faster growth while reducing overall risk.

As a centralised repository for validated financial information, MTD providers will be in a unique position to develop a two-sided marketplace for finance, allowing credit providers to match products to individuals’ risk profiles. When a customer needs a loan, credit card or mortgage, they can simply browse products for which they have already been approved, applying and receiving finance instantly.

Empowering PAYE Taxpayers

Currently, PAYE taxpayers have little, if any, visibility or control over their tax contributions. They will see the amount paid in tax and national insurance, but to claim any allowances requires them to submit a self-assessment tax return. For most PAYE taxpayers, this simply doesn’t seem worthwhile.

Yet, self-employed taxpayers can claim for things like travel to their place of work, a proportion of living expenses when working from home, even their lunch. These things are necessary for productive work yet, for PAYE taxpayers, come out of their already taxed income. Meanwhile, businesses tend to make use of every tax allowance available to them.

This imbalance could be rectified with Open Finance connected to tax software. As MTD becomes a validated system for self-assessed taxpayers, a new version could be developed for PAYE taxpayers, putting them in control of their tax and finances. Not only would they be able to benefit from Open Finance in the same way as self-assessed taxpayers, but they will also be able to claim for reasonable allowances. What’s more, HMRC/the Treasury/the government would be able to hold employers accountable for pay disparities and unreasonable tax avoidance.

Open Finance, then, has the power to speed up and reduce the cost of obtaining and providing finance. It would make the finance system fairer and most transparent while distributing financial power, and help to avoid the creation of too big to fail financial institutions and the boom-bust cycle that has become unfortunate features of modern capitalism.

Ultimately, Open Finance has the potential to help the UK and other nations recover from the seemingly unending series of crises that have plagued the early 21st century by allowing people to access finance quicker in order to grow their business and personal finances while reducing risk, inefficiencies, and costs.

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