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Thought Leadership Perspectives
A Culture of Compliance: The Relationship between Trading and Compliance
Compliance on the buy-side is changing. As hedge funds become increasingly regulated, the question of how best to achieve effective and efficient compliance lurks ominously ahead. This is a challenge that institutional asset managers have had to address for several years, and their path to compliance is strewn with stories of both overwhelming success and debilitating failure. As a result, these seasoned veterans have plenty of examples and experience to offer hedge fund managers when it comes to developing compliance best practices.
What has become clear is that trading compliance is more than simply a technological challenge. Trading compliance systems are readily available to deliver highly sophisticated pre and post-trade reviews, adaptable rules engines and analyses of trades across all asset classes, including derivatives. But these systems deliver their best when a true culture of compliance is established.
Challenges of Building a Culture of Compliance
Where a culture of compliance exists, traders and compliance officers enjoy a highly collaborative and consultative partnership. The difficulty is, of course, that compliance officers and traders do not always enjoy that type of relationship. In many cases, they are politely distant at best and actively antagonistic at worst. Compliance managers are often regarded as the people who like to say ‘no’ and present unnecessary impediment to generating alpha. At the same time, compliance officers sometimes see traders as unresponsive and uncooperative barriers to their efforts to keep the firm within the limits of the law.
As institutional fund managers have proven, developing this relationship is essential to effective compliance management and, as the consequences of regulatory breaches become more severe, paramount to ongoing profitability. Bridging the gap of understanding between the two departments is critical if compliance is to be achieved in a way that minimizes costs but continues to maximize profits.
Getting Started: Forging a Partnership
To develop a culture of compliance successfully, the heads of both departments need to be aware of each other’s needs and then build those needs into their own operations. A partnership in which compliance officers understand all facets of the trading process and in which traders factor in the goals of their compliance colleagues is the foundation of a functional compliance environment. Where that partnership exists, traders are no longer faceless, nameless, and distinctly separate, but instead become real people with real personalities and it is understood that they have their own individual goals as well as corporate aims.
Regulatory Impact at the Firm Level
A critical element of that partnership is ensuring that traders understand and acknowledge the requirements of and potential impact of relevant legislation. Aside from keeping their traders up to date with the unfolding developments and implementations of the Dodd-Frank Act, there are a number of requirements of which traders need to be aware.
As an example, everyone on the trading desk needs to know the differences between reporting and disclosure requirements under schedule 13g and schedule 13d of the 1934 Securities Act and in which circumstances each should be applied. They need to know what the proscriptions on short-selling outlined in Rule 105 of Regulation M are and how to modify their behavior in light of those regulations. When dealing with investors on the international bond markets, they need to understand the differences between Rule 144a and Regulation S. These are fundamental to their daily activity, and while traders don’t need to become experts on these regulations, they do need to understand how and when to tailor their trading and processes in response to these requirements.
Understanding Internal Policies and Procedures
Equally important as the requirements established by regulatory bodies, traders also need to be aware of internal compliance procedures. Compliance, therefore, has a role in educating traders on what the policy is on trader error, for example, and how allocation deviation processes and disclosure are handled. Compliance is at the forefront of interpreting trading regulations for the firm and designing policies and procedures that address them as well as advising software engineers on how the regulations affect technology processes.
Developing Internal Relationships and Alliances
Building a compliance culture is also about developing internal relationships and alliances with other groups that support trading. That effort will almost certainly include operations, fund accounting and risk management. It will also require actively involving head traders and chief compliance officers and senior compliance personnel in the same internal committees and decision-making forums. The ultimate goal is to break down many of the internal barriers between different functions by focusing on greater transparency and ensuring the fundamental interests of different groups are aligned.
Firms with a culture of compliance also recognize that there is more that unites traders and compliance officers than divides them. They often require the same skills and need access to the same tools. As institutional investors have embraced the concept of a compliance culture, their head traders can frequently be found at the industry’s leading regulatory conferences. At the same time, their risk and compliance colleagues will be among the attendees at the equivalent trading seminars and symposia.
Leveraging Trading and Compliance Technology
Trading and trading compliance tools and technologies are also starting to adopt similar characteristics to aid cross-channel sharing, disclosure and reporting. Traders receive the same reports as their compliance colleagues and they have access to the same compliance solution so that they can find out if they are close to any regulatory or client mandated limits. They can also be proactively notified of potential compliance breaches and the repercussions of each proposed order. At the same time, compliance teams have access to the trading platform so they can investigate and conduct trend analyses.
In a successful culture of compliance, both traders and compliance officers share the risks that could have an impact on the firm. They have a collaborative approach to identifying and managing those risks in recognition of the fact that they cannot do it alone; they work jointly on committees to define risk policies; and they are recognized as equals – or at least peers – in the success of the overall business. The antagonistic relationship of the past is replaced with a much more consultative approach and the ability to participate in this partnership model is recognized.
Achieving a Culture of Compliance
After years of wrestling with the increasing demands of regulators and clients, compliance continues to be the thorniest of issues for the buy-side. Regulators have been alternatively flirting with and threatening hedge funds with greater scrutiny for some time. But the moment is here, and the spotlight is now unavoidable.
Hedge funds are now where institutional managers were ten years ago. Fortunately, they have that decade of precedence from which to explore and learn, which enables them to reject the more costly and unwieldy compliance programs that have littered less successful buy-side institutions. Instead, they can rapidly move to a compliance culture that gives them the flexibility needed to retain the innovative and precision strategies that separate them from their competitors and deliver for their investors.
About Fidessa group
Fidessa group plc (LSE: FDSA) provides high-performance trading, investment management and information solutions for the world’s financial community.