Post-financial crisis, the SEC shifted focus from investor protection toward systemic risk, fundamentally changing what filings are required and how asset managers and funds are examined.
Rulemaking at the SEC went from looking at information to be viewed by potential and current investors to collecting large chunks of data to be loaded in some future database and processed by analytics software. The SEC wants access to the data behind the old, viewable reports so that they can load and analyze that data too. In addition to the changes in format, the type of information has also changed. Funds and asset managers now have to report on collateral, securities lending, borrowings, counterparties, guarantors, and a whole host of derivatives information.
These changes have supurred the rise in importance of Form PF, Form N-MFP, Form N-PORT and Asset Manager SIFIs and Money Market stress testing, and created four distinct challenges for the industry.
First, the new data is much harder to source and use than the old data. There are many new source files to merge and aggregate into a combined, single filing, and those new sources, especially on the collateral and derivative side, tend to be of a lower quality than the (relatively) clean records used pre-crisis.
For derivatives, even when the data is in a good format and sourced directly from an accounting system, there can be a lot of variations in how the data shows. Does the derivative show as a single investment or is each leg shown? Does the accounting system have the reference information necessary to determine exposure?
For newer financial products, is the derivative set up in the accounting system as the nearest approximation, since an actual security type option has not yet been created?
So just because the SEC is looking for data to analyze rather than reports to view, it does not mean that the data requires less scrubbing. In fact, with the need to merge data from many sources of widely varying quality and because of all the variations in data presentation, there is more effort than ever required to extract, load, aggregate, scrub, reconcile, and calculate the data before filing. Add in the need to trace back to the multiple sources of data to provide the provenance of your answers to the SEC and the challenge becomes even more daunting.
Secondly, the data behind viewable filings like ADV Part 2 and N-CSR will need to be kept separate from the style template so that the underlying data can be automatically compared to other filings. You see a mini-version of this with the current use of Form PF data by OCIE, but in the future, this shift will likely be felt primarily by mutual funds who remove annual report data from a controlled system, send it to a typesetter, and then modify it in a medium that cannot be used in data format reporting, making it all the more challenging to report that data.
Third, in the future the SEC will be analyzing the data provided, and during examinations will be asking questions about the results of their analysis. Once the SEC has improved their infrastructure, as briefly described in their Fiscal 2014 to 2018 plan, they will start using it.
In the past, asset managers worked with legal counsel to do a mock examination as preparation for a real examination. This process provided an advance look at what the SEC might find so that they could prepare a quick and effective response. Once the SEC begins incorporating the results of their data analysis into examinations, it will be prudent to change the mock exams as well, conducting a mock data analysis to predict the likely questions and prepare those quick and effective responses.
Fourth, today the SEC is mandating stress testing and portfolio analytics in the case of money market funds, and strongly suggesting it in the case of fixed income funds. There is also an initiative pending to require stress testing for large asset managers and investment companies. It is likely these trends will continue, extending the mandated stress testing to the industry at large.
Since the financial crisis, the impact to the asset management industry of the SEC's shift to systemic risk evaluation and management has steadily expanded, starting with 600 money market funds in 2010, adding 5,000 private fund advisors in 2012, and with the recent enhanced reporting proposal, adding in the 9,000 advisers to separately managed accounts and 13,000 mutual funds that make up rest of the asset management industry.
As the SEC shifts away from human viewable disclosures and towards machine readable, systemic risk data, as they perform an analysis on that data and require asset managers to answer for the results of that analysis, and as they mandate that asset managers conduct portfolio analytics, regulatory filers really will need to "change everything" about how they approach regulatory reporting.
Paul Soltis is North America Product Manager at Confluence.