The Year in Compliance; What Happened and What Lies Ahead

Blog Post by Osvaldo Berrios on 10 February 2023 in category Regulations

As we kick off the new year, let’s catch up on the year that was. Saying that 2022 was a difficult year is an understatement. The Global Markets sustained significant losses. We experienced rising inflation, supply change issues, war, and a pandemic after a pandemic. Yet here we are in 2023 continuing to push on through the adversity. The year in compliance was no different. 2022 heralded some of the largest regulatory fines on record, along with new regulatory requirements, reorganizations, and so on.

Compliance News

Despite all of the regulatory upheaval, though, one thing remained constant – regulators doubled down on their focus of protecting consumers. This was evident in several major regulatory developments from around the globe, including:

For those who may be unfamiliar here is some background on each.

Canada: New Self-Regulatory Organization (SRO)

The MFDA and IIROC recently merged their regulatory duties/responsibilities into one organization which has been rebranded under the umbrella of the New Self-Regulatory Organization (SRO). The combined entities will now assume joint responsibility for executive management and governance of SRO, and their prior individual areas of oversight involving mutual fund products and investment advisors will be merged seamlessly.

The unification of the MFDA and IIROC will ensure a smoother and more effective way of overseeing compliance for financial services businesses in Canada. Prior to this, the two organizations acted independently of each other, with the demarcation line being between products and practitioners. The MFDA oversaw compliance issues affecting mutual funds products while IIROC had jurisdiction over practitioners who sold and marketed these products, namely advisors and investment advisory firms.

The merger will fundamentally streamline the way business gets done. A case in point is the way that new products are registered today. Previously, when IIROC and MFDA functioned as independent organizations, this required multi-layered processes that spanned organizations and teams. Now, for example, the registration process for both products and advisors will be streamlined and consolidated within one organization, which will eliminate back and forth questions and delays.

Exams and audits will also be consolidated into one organization as well, which should save time, resources and headaches, both from a regulatory standpoint (for SRO) and for regulated firms as well.

US: Regulation Best Interest (Reg BI)

2022 marked the first Reg BI fine on record (handed down by FINRA to a Californian firm for failure to train and educate advisors). The firm was also penalized for selling illiquid and high-risk investment products to conservative and moderately conservative clients.

Another big Reg BI change in the last quarter of 2022 came in the form of amendments to marketing rules and Form CRS requirements. Firms are now required to review and elaborate on their conflicts of interest, compensation, and marketing, and share these details with consumers.

After a number of audits, FINRA also found that a large number of firms were still not satisfying the requirements under Reg BI. Specifically, FINRA found that many firms had inadequate processes in place, or did not have a clear understanding of what was required.

These shortcomings tend to be commonplace with any new regulation, but the FINRA findings do signal concerns because the industry is now two years past the required deadline for Reg BI compliance, and many firms still seem unsure as to what is needed from both process and technology standpoints.

At last year’s FINRA conference, regulators from both the SEC and FINRA reaffirmed their stances on client best interest. Firms need to employ a holistic approach when providing investment recommendations to consumers. This means that an advisor can’t just sell what’s available in their firm’s product portfolio, or what’s most profitable or beneficial to their firms or themselves, at the expense of what’s best for their clients. Advisors must act in the best interest of their client, given that client’s unique, individual financial objectives and profile. And this appropriate investment advice must happen before any trade is executed.

UK: FCA Consumer Duty

Consumer Duty is another regulation which will go into effect in 2023.

Just this past July, the FCA published its Handbook for guidance for its new Consumer Duty. Consumer Duty is an overhaul of suitability requirements for the UK’s financial services industry and its handling of retail clients.

In contrast to Reg BI (which requires firms to put clients’ interests ahead of their own), Consumer Duty requires firms to look through the lens of their clients and put their well-being ahead of their own, and more importantly to act in a manner that delivers “good outcomes for retail customers.” This is a nuanced but fundamental difference from prior regulations. It’s also important to note that the new rules under Consumer Duty will supersede prior rules around suitability.

The FCA conducted a thorough review process prior to rolling out its Handbook and has set an implementation date of July, 31, 2023, which was extended from the original proposed date of April 2023. In doing so, the FCA is providing ample time for firms to begin preparing and setting forth processes to comply with the regulation.

Consumer Duty will require more oversight than previous suitability approaches, and the FCA has stated that how firms handle and care for their clients’ financial well-being will be of utmost importance. Companies located outside of the UK that do business in the UK will be required to comply with Consumer Duty as well.

Complying with the new regulation could prove difficult for firms that are reliant on antiquated surveillance systems and processes. For example, demonstrating good outcomes will be a challenge. To produce a good outcome, advisors first have to be able to envision what a good outcome for a particular client would look like. Of course, the FCA does not expect firms to be fortune tellers or psychics, but the regulator does expect firms to truly know their clients and to make professional recommendations that will help each consumer thrive, while also providing proper disclosures and excellent customer service.

Another key challenge for firms will be how to evidence compliance during FCA conduct audits. Some firms seem equipped to do so, while many others find the idea of evidencing ‘good outcomes’ to be difficult.

In my conversations with compliance professionals from leading financial institutions, when posed with this challenging new mandate, many seem like deer in the headlights. That’s because the new regulation, while somewhat loosely defined, is a total mind shift from other regulations, and it’s broad and sweeping.

Before I get too far ahead of myself talking about audits, there are other bigger questions. Where to begin? First, one must define what good outcomes are, how they’ll be delivered, specify any new training required, and identify the data and technology necessary to monitor, manage, track, measure and prove compliance. As the date fast approaches for Consumer Duty to take effect, this is where technology partners, like NICE Actimize can help.

Wealth Management

More Changes in Store for 2023

With 2022 now behind us, what new developments will 2023 bring? If I had to guess, I’d w wager more of the same – more regulatory fines, more regulatory requirements.

The global regulatory pendulum continues to swing toward benefitting consumers though. While the key mandate of regulatory agencies is ensuring market integrity, and making sure financial services firms are playing by the rules, regulators are also under immense pressure to do another very important job: protect consumers.

It’s a difficult job, but one where intelligent surveillance technology can definitely help. That’s why in 2023, I expect to see technology playing an increasing role, not only in simplifying compliance for regulators, but also in helping financial services firms comply with the many ever-changing regulations that govern their day-to-day dealings with consumers and investors.

If the immediate past is any guidance for the future, I also expect fines in 2023 to continue to grow. Regulators have given firms plenty of time to get their processes in order. If firms have not taken advantage of the opportunity yet and fail to comply, it will likely be seen as a sign of negligence.

Additionally, the global markets have and will likely continue to go through difficult times. During these times, firms are setting out budgets for projects, development, expansion, and other key things. While firms are typically budget conscious when the economy sputters, I would hope they will consider what the cost of non-compliance really means for them. Often it is possible to solve compliance challenges with technology at a much lower cost than the larger costs that could otherwise be incurred in the form of reputational damage and fines, as a result of compliance shortcuts.

Another area where I expect to see major compliance changes is in the crypto space. Following recent events, like the alleged fraud on the part of market maker FTX, regulators have made it clear that enforcement actions and new regulations are on the horizon. In fact, such event have served as a catalyst for global regulators to start looking at regulations in the digital asset space more seriously. It will be interesting to see how this all plays out. After all, how can one effectively regulate a market predicated on anonymity and decentralization?

Lastly, if history is any indication, we should all expect existing regulations to continue to adapt and evolve in 2023 and beyond. After Reg BI was introduced, the SEC made a number of adjustments over time. I would expect the FCA’s Consumer Duty to follow suit. Once the FCA starts conducting reviews, I fully expect that they’ll identify areas of improvement and adjust Consumer Duty accordingly. These constant adjustments and revisions are nothing new, but they do mean that financial services firms need to be ever-vigilant, have a flexible mindset, and should consider leveraging knowledgeable technology partners to learn, adapt, and stay ahead of the compliance curve.

Interested in learning more about how the regulatory landscape is changing, and the positive role that technology can play? Reach out to me at Osvaldo.Berrios@nice.com.