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Understanding Investment Compliance Risk in Finance and Banking

The market cap of the global banking sector was around EUR7.3tn in the first quarter of 2020, and the global financial services market is predicted to reach USD26.5tn by 2022. As the financial services sector continues to grow rapidly, it also remains exposed to risks. With financial institutions being an integral part of most investment portfolios, investment compliance monitoring becomes vital for asset managers.

The Emergence of Risk in Financial Services

The global financial services space has been evolving rapidly. A number of innovations, including cloud computing, bring your device to work (BYOD), fintech applications, blockchain, and cardless ATM cryptocurrencies have transformed financial services over the past decade. However, the large-scale adoption of these innovations has been mirrored by the emergence of different forms of risk. Compliance risk is arguably the most critical form of risk that financial institutions have to deal with.

A survey shows that 40% of organizations do not conduct annual risk assessments. It could be a compliance risk if a financial institution shares recordings of calls between a customer and customer service personnel with an external vendor for the purpose of analyzing the calls. According to regulations, call recordings can be maintained only in the financial institution’s servers.
To manage this risk, a virtual work environment would have to be created that offers the external vendor access to the call recordings and ensures those call recordings would not be leaked.

Investment Compliance Risk in Finance and Banking

Traditionally, financial institutions have managed risk assessment in two ways: through enterprise risk management and internal audit. However, such methods cannot detect legal or compliance risks. Compliance regulation requires banks and other financial institutions to adhere to external regulations and internal controls. For instance, a global bank could face up to 350 regulatory assessments a year.

If they do not adhere to these requirements, errors arising from unmonitored compliance risks in investment management could lead to reputational, monetary, and regulatory damage. Compliance risk management is part of the collective governance, risk, and compliance (GRC) framework.

The GRC framework is a set of practices and technologies that ensures an organization adheres to its mission, values, and risk tolerance. Thus, it forms an essential component of investment compliance monitoring. The impact of investment compliance risks could be substantial and have severe repercussions for financial institutions.

The Impact of Risks

  • Reputational: Damage caused to the firm’s reputation and credibility in the form of negative press across print, television, and social media. It can damage employee morale, and customers would lose confidence.
  • Business: Offices or branches may shut down, affecting day-to-day operations.
  • Legal: Banks and other financial institutions across the world were fined around USD27bn from 2008 to 2018 for not complying with anti-money-laundering (AML) and know your customer (KYC) regulations. This indicates the number of penalties that could be imposed on financial institutions. There could be also prison terms for leadership and decision-makers from the risk and finance departments.
  • Financial: Penal action could result in lower share prices and a loss of future earnings and investor confidence, and have a long-term impact on a financial institution’s standing.

How to Manage Compliance Risk

While practicing investment compliance monitoring, it, therefore, becomes critical to understand how to manage compliance risks across financial services.

Identify, Assess and Mitigate

Management of compliance risk is a continuous process that involves identifying, assessing, and mitigating potential losses that could arise due to non-adherence to investment compliance regulation.

Create Frameworks

Financial institutions would have to create robust management practices, policies, and procedures that form a framework to manage compliance risks. These policies and procedures would have to be revisited and, if necessary, revised to keep up with the latest compliance requirements.

Invest in Training

Financial institutions must train their workforce on compliance risk extensively. It is highly recommended to have quarterly training sessions for those employees who could be exposed to such risk.

Finally, asset managers understand that by outsourcing risk management-related activities to a credible partner, they could reap the benefit of cost arbitrage while they focus on their core competencies.

Michael Brown is working as a marketing consultant at AcuityKP, a leading provider of high-value research, analytics and business intelligence to the financial services sector.

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