The data management challenge ahead of asset managers and fund administrators became clear as they were handed final rules from the SEC this month on liquidity risk management and reporting modernization.
For fund administrators, new Form N-PORT filings will present a two-fold requirement of having to collect more information from disparate resoruces, and having to determine where the sources of information orginate, says Paul Soltis, global market manager for fund administration service provider Confluence. "There's going to be a lot more raw data that firms will have to collect, relay and transform to get the necessary answers in the form," he tells Money Management Executive.
Though a challenge, the requirements do present an opportunity for self-analysis, Soltis adds, so that firms can better understand what regulators will be asking them about in exams.
What were your overall takeaways on the SEC's ruling on reporting?
There wasn't much in the way of surprises. The proposal was largely intact. There were some odds and ends that were changed. Some were interesting and will have a decent amount of implications, especially around some of the back office elements, such as Regulation S-X.
To clarify, these reporting modernization rules are going to have much more of an impact on the administrator. They are going to impact the back office. There will certainly be some impact on the front office as well. The administrator and the asset manager are going to have to coordinate their efforts. Neither is going to be able to do reporting alone. Especially Form N-PORT; getting that filing done is going to fall on the fund administrator, rather than the asset manager.
What's the challenge that you can see for firms?
We see the challenges in three different areas for Form N-PORT. Data management is the biggest challenge. This is a systemic risk report that the SEC is collecting. This is for information on mutual funds, primarily for the SEC to evaluate systemic risk in the market. It's going to inform exams and it's going to inform rule-making too.
With these different types of information the SEC is gathering, it means there's going to be a lot more raw data that firms will have to collect, relay and transform to get the necessary answers in the form. By way of comparison, for financial reporting, which is what the back office is most familiar with, you need six to eight different data sources. For a systemic risk filing like Form N-PORT, you're going to need probably 20 to 30, and that's based on our experience.
Also, a lot of the information is more complex because of the nature of what these filings are asking for. There's a lack of consistency in the transformation. So a counterparty might have once source of information if you're examining options; another may another source if you're talking about swaps. So there's this need to have more complex data transformation for a hierarchy of information. But it's harder to relate that information, it's harder to organize that information, in order to answer the questions.
Does the fund industry need more standardization in how it records such information?
I don't know if that's feasible. To some degree, N-PORT is a way to get that level of information. I would also add the efforts of other organizations, such as Morningstar, which has its advanced portfolio template. It has very similar information. There's been attempts on the private fund side called OPERA (Open Protocol Enabling Risk Aggregation).
There's all this raw data that comes from the transaction and the markets you're trading in, and its going to have to get cleaned up and organized, and transformed into a standardized model. It seems that the industry will have to work toward that goal, since its easy to see how a firm could be inundated by having to deal with all this data.
I think so. If you look at N-PORT from a perspective of regulatory complexity, it's not that complicated. There are some elements, notably duration and the liquidty buckets that will come into play. But primarily, this is a data management and reporting challenge that firms will have to face to complete the N-PORT.
There's not a lot of regulatory complexity, that you have to analyze what it is you're doing. The problem is more of an operational complexity, which is what we've been discussing. It's about managing all that data, organizing it and having it standardized, related, scrubbed and ready for use.
Are fund administrators prepared for the technical challenge of this new requirement?
For most firms, the impetus to put effort toward Form N-PORT reporting was the final rule. It varies a bit, though. Firms have different levels of comparitiveness and organization. For most firms, now that there is certainty about what is going to be required, the intensity of effort and preparations will go way up. For some they may just be starting, but certainly it will take off now that there's a final rule.
We're curious as to whether there's a paralell here to how wealth management firms have been making changes as a result of the Department of Labor fiduciary rule.
There's some history here. Most of these administrators have had to file what's called a Form N-MFP. It's very similar, but it didn't cover as many funds. Now, this is going to be a new problem to be solved on the mutual fund side of the back office.
You've noted the SEC's decision to delay a vote on Rule 30e-3, which would have permitted funds to default to the electronic delivery of financial statements. What are your expectations regarding the rule?
It's a matter of whether they can reconcile with some of the opposition around Rule 30e-3. There are points for it and against it. It didn't seem like they had enough time for analysis and wanted to move forward with other aspects of the proposal. I thought there were some good arguments for moving forward with 30e-3. Hopefully that's the direction that they are moving in. There's a big benefit to investors and the industry if the rule passes.
With the final rule, where do firms need to upgrade or increase their technical ability at this point?
Data management is big. It's a new challenge for many firms, especially the mutual fund back office. Another is XML filing. Not so much in the filing itself - people are familiar with the formate from Forms N-MFP and PQR - but rather its the need to have a system that can be quickly updated when the XML schema changes, and firms will have to expect that to happen quite a bit.
Certainly with N-MFP there were a number of changes, and you can expect the same thing to happen with N-PORT. In fact, with the liquidity risk management effort, because it didn't necessarily align with the SEC modernization intiative, you could have the case where they have one form of N-PORT that an admin files on June 30th, and another version that is filed on December 31st.
So that's the other challenge: Just make sure that within whatever system you've got, to create that XML filing, so that you have the ability to very quickly and easily make changes to the XML schema in the system.
Who in management needs to be spearheading this effort?
It's going to be the person in operations who's going to take the lead. That's been our experience. I'm sure on the technology side they'll also be involved, since there is software that will need to evolve in order to support the changes. There are other systems involved that are going to be sourcing the data.
If you were advising a firm, what amount of resources need to be allocated to this effort?
Much of this effort will involve operational resources that are in the business domain. A lot of effort will be toward determining where are you going to be sourcing this information, going line by line down the form to understand what are the ultimate sources of the inputs for a particular item.
Is it something that I source today, or is it going to be something new? You'll need to answering where is it - is it coming from the portfolio management team, the risk management team, is it coming from a market data provider or the securities lending agent. Determining who's going to provide this information. Knowing that something is coming out of the accounting system and I'm using it today for financial reporting; to analyze that data and then figure out how to use the data.
Again, we've talked about creating a hierarchy of transformation, basically a decision tree that I need to go to in my data management process. Much of this is less technical and more within the business domain. The harder process is going to be how do I create those logical rules, rather than how do I put those logical rules into practice in some automated system.
What's the expected cost of this effort for mid- to large adminstrators?
We have our proprietary estimates. But it's going to be a significant investment in terms of getting the readiness together and then the ongoing cost of the resources and the software that it's going to take to continue to file Form N-PORT every month.
Should firms be examining their software and systems for potential upgrades or even replacement?
That will depend on the nature of the softare and the systems themselves.
For regulatory reporting in general, given the frequency of change in the XML schema and the layout of information filing, it really calls for a hosted solution. I don't think IT would want to bog themselves down with that sort of fat client-type of situation. A thin client hosted is what the business problem calls for, instead of a heavy installed fat client that you're going to have to update every month.
You've touched upon how the new filing will inform SEC exams. Will regulators be scrutinizng firm filings and potentially flagging them for review?
They're analyzing the information. The real implication is, what are they going to use that information for? They've got all your information, all of your data - what are they going to find? Being able to do that self-analysis is going to be the next dimension of a lot of this reporting, so that you know what the SEC is going to ask you about.