Mutual fund and ETF Managers have faced a barrage of new regulatory reforms during the last few years, particularly since the passage of the Dodd-Frank Act in July 2010. Recent election results have brought the proposed Volcker Rule back into the conversation and signaled that Dodd-Frank is here to stay. Despite these rapidly evolving regulatory requirements, one critical fact has remained consistent for managers of the thousands of active mutual funds in the market: new technology is key to ensuring full compliance and achieving full-circle transparency with investors.
Fund managers must embrace technology to help them meet new regulatory demands and achieve and maintain required levels of transparency. To ensure full compliance, managers would do well to approach their technology initiatives according to three distinct areas, each of importance to managers and investors alike. First, develop rules in legacy systems to prevent prohibited trades. This is especially necessary in the current environment of easy money and increased market liquidity, due to central bank activity.
Second, implement technology tools that deliver greater pre-trade compliance checks, system-enforced restrictions and better post-trade reporting. Morningstar estimates that September 2013 saw the largest monthly outflow of U.S. equity funds to date this year, underscoring the need for a full view of fund activity, both before and after trades. Finally, facilitate increased tracking and reporting requirements to en- sure asset and fund managers completely disclose assets under management.
The 2008 market collapse and subsequent volatility have led both institutional and retail investors alike to demand increased transparency into their portfolio exposures and holdings. Title VI of Dodd-Frank requires improvements to the regulation of bank holding companies, savings and loan holding companies, and depository institutions to ensure that they do not threaten financial stability in the U.S.
Beyond just requiring stringent regulation of trading activities, Title VI of Dodd-Frank puts strict constraints on the securitization business. That will increase regulatory monitoring and reporting for all mutual fund and ETF managers. By setting parameters and automating adherence funds will be able to focus on testing, tracking and monitoring trades to ensure all prohibited activities are avoided and audit trails are preserved.
Dodd-Frank's Title IV primarily affects investment advisor registration under the Investment Advisers Act of 1940 and, in order to ensure compliance with the registration requirements and additional investor protections, firms are required to adhere to additional reporting for advisors. Firms must also limit the ability of financial advisors to exclude information while reporting to various federal government agencies, and develop and enforce a code of conduct for investment advisors, fund managers and broker-dealers. Key areas for firms to consider include: portfolio transparency, business model transparency and "know your client" fiduciary responsibilities. To best support the industry-wide efforts toward greater transparency, managers should urge their firms to invest in technology tools that deliver stringent pre-trade compliance checks, greater system-en-forced restrictions and tougher post-trade compliance reporting.
A prominent objective of Dodd-Frank is to protect whistleblowers, shareholders and retail investors. The law's Title IX includes sections related to shareholder approval of golden parachute payments, compensation ratio disclosures, payback policies in the case of wrongdoing, hedging disclosures and transparency of a firm's leadership structure. Fund managers must be able to track and prove that they have processes in place to provide equal treatment to all retail investors. These demands require technology that can facilitate increased tracking and advisor reporting requirements related to disclosing assets under management. Here are five tips for mutual fund/ETF managers to embrace technology to comply with regulations.
1. Develop rules to prevent prohibited trades. Update legacy systems to best support efforts toward greater transparency. Ensure all prohibited activities are avoided and audit trails are preserved.
2. Enhance pre-trade compliance checks. Deliver stringent pre-trade compliance checks as Dodd-Frank has increased regulation of trading activities and put strict constraints on the securitization business.
3. Increase tracking requirements related to disclosing AUM. Accurately measure and report a firm's leverage, including off-balance sheet items, trading policies and counterparty exposures.
4. Streamline reporting requirements. Produce more frequent attribution reports and conduct correlation analyses to ensure that portfolios are as diversified as analytics models indicate.
5. Enforce a code of conduct. Firms must limit the ability of managers and advisors to exclude information while reporting to various federal government agencies.
Improved performance reporting and portfolio insight for the end client is imperative to achieving greater transparency. Dodd-Frank has mandated fund managers to provide more transparent and meaningful information in SEC disclosures to help regulators and clients understand their business models, compensation and fee structure as well as levels of service. Managers should frequently produce attribution reports and conduct correlation analysis to ensure that their portfolios are as diversified as their analytics models indicate.
Steve Steinberg is VP of product management and investment services at Fiserv.