As the saying goes, when it rains, it pours, which couldn’t be any truer for buy-side firms when it comes to the perfect storm of new regulations going live this year. On top of rules that have already come into force in recent years, the buy-side faces an unprecedented degree of financial and operational challenges in 2020 and beyond.
How will they respond? From my many conversations with hedge funds, asset managers and other clients, we can expect another year of scrutinizing budgets, difficult resource allocation decisions and added costs for staffing, reporting systems and technology upgrades. Some firms are so overwhelmed, they’re planning on outsourcing their regulatory-related functions.
The Compounding Impact of New Regulation
On tap for 2020 are Uncleared Margin Rules (UMR), along with key provisions of the Securities Financing Transaction Regulation (SFTR) and Central Securities Depositories Regulation (CSDR). UMR impacts firms globally and SFTR and CSDR, although European in origin, will impact any firm with transactions executed in Europe. Financial institutions are also feverishly readying for Libor transition and Brexit adjustments. Needless to say, it’s going to be an intense period of regulatory change for the financial sector.
For the buy-side, this regulatory tsunami is challenging traditional operating models and introducing new costs and regulatory reporting requirements. For instance, UMR’s waves 5 and 6, taking effect in 2020 and 2021, respectively, will predominantly impact funds and institutional investors, requiring buy-side firms to acquire skills to perform functions they’ve never done before.
Many firms are expected to make securities lending a key element of their liquidity management strategies to offset the operational and funding costs of UMR. However, this reliance on securities lending will increase reporting obligations under SFTR and could have an adverse effect as firms look to mitigate settlement risk under CSDR. This illustrates the compounding impact of these multiple regulations and reinforces the law of unintended consequences.
Acute Challenges for the Buy-Side
As a result, buy-side firms, which are already grappling with intense cost-cutting pressure and tight operating margins, now find themselves in the difficult position of having to also upgrade in-house systems or perform major overhauls of out-of-date platforms to meet their regulatory mandates and grow their client-service capacity. Increasingly, many buy-side firms are instead looking to outsource some compliance functions to third parties to avoid the investment needed to modernize their infrastructure.
One client told me that with regulation moving so quickly, it’s more cost-effective to have a vendor take on the responsibility of implementing constant technology revisions. In their view, a service provider has the subject-matter expertise and capacity to monitor ongoing developments in the regulatory environment, such as timetable revisions, expansion of scope and extension to new jurisdictions, to quickly make the required and costly system changes for their clients to maintain compliance. I expect this trend to continue well into the future as the buy-side is forced to manage a host of new regulations amidst a diverse set of business demands.