Amba White Paper - Implementing a Successful Compliance Outsourcing Program_2011 Aug

Priti Parekh

COO and Global Head of Delivery, Amba Research

August 2011

Implementing a Successful Compliance Outsourcing Program

Amba White Paper

© AMBA HOLDINGS INC. 2011

This document contains information confidential and proprietary to Amba Holdings Inc. (“Amba”)

and may not be reproduced or distributed in whole or in part without the prior written consent of Amba. 2

How can Asset Managers make their Compliance Outsourcing Programs a Success?

Summary

The use of “outsourcing”, to help the Compliance function accomplish more while keeping costs under control, is a relatively new phenomenon. While many other functions in asset management firms began outsourcing much earlier (back-office: 1990s; investment research 2000s), the Compliance function is playing catch-up.

In the past three years, several large sell-side and buy-side firms have begun using legal and para-legal staff out of India in increasing volumes. As with research, investment banks have led the way, but a few large asset management firms have followed suit too. Most of them started off by „offshoring‟ work to their captive centers in India and other locations. The emergence of capital markets specialist vendors, who also now provide Compliance outsourcing services, has helped to build confidence in this space.

The combined pressure of rising regulations and budgetary restrictions will drive asset management businesses to increasingly resort to outsourcing more middle office functions. Compliance managers need to learn how to successfully run outsourcing programs. Merely replicating an onshore approach in an offshore location neither works well nor delivers optimal results.

In this paper, we provide some practical guidelines on how to make a Compliance outsourcing program a success. The first section focuses on the business case for outsourcing and the second section focuses on how you can evaluate and execute a good outsourcing program.

Priti Parekh




Section A: The Business Case for Outsourcing Compliance activities

Increased regulations mean more is expected from the Compliance function

Stricter and newer regulations imposed by FINRA, the Dodd Frank Act, the MiFID, the UCITS Directive, etc. are driving capital market firms to look at the Compliance function from a new perspective. Increasing transparency, disclosure norms, and focus on corporate governance are leading businesses to review their Compliance functions in an attempt to assist their respective Boards of Directors in delivering robust and demonstrable risk management.

Worldwide, senior executives face common concerns on this front:

Is the Compliance division of my company adequately staffed to meet the increasing workload driven by newer regulatory requirements?

Is my company‟s Chief Compliance Officer empowered to make strategic contributions to the firm?

How can I improve the efficiency of my Compliance team?

To what extent will the cost of compliance increase with the growth and expansion of my company‟s operations? Will this lead to an unsustainable increase in the compliance budget?

Have the outsourcing and offshoring options been effectively tapped in my organization?

Thomson Reuters Governance Risk & Compliance surveyed 337 Compliance practitioners in the global financial services space around the world over November 2010 to January 2011 to estimate the average cost of Compliance for 2012. As many as 79% of respondents expected the cost of senior compliance staff to increase in 2012, while 73% expected the total compliance budget to increase in 2011 compared with just 43% two years ago.

Nearly 83% of respondents believe that the flow of regulatory information would increase significantly, demonstrating the sharply higher volumes, accelerated speed of change and new requirements that firms need to stay on top across sectors and jurisdictions. About 71% of respondents also foresee an increase in time spent interacting with regulators and exchanges, highlighting the growing intensity of supervision and interaction required.

Another survey by the Society of Corporate Compliance and Ethics and the Health Care Compliance Association published in February 2011 confirms that both compliance budgets and staffing will increase in 2011.




26%

32%

46%

27%

14%12%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2009 2010 2011 Projected

Change in Budget

Increase Decrease

24%

31%

27%

18%

10%8%

0%

5%

10%

15%

20%

25%

30%

35%

2009 2010 2011 Projected

Change in Staffing

Increase Decrease



and may not be reproduced or distributed in whole or in part without the prior written consent of Amba.

5

Outsourcing vs. Offshoring

Increasing regulation has also meant that corporations have been driven to „offshore‟ work to their captives in low-cost destinations particularly if it is a repeatable process that can be measured and monitored remotely. However, the recent trend we see in the industry is to directly „outsource‟ work to third-party vendors than merely „offshore‟. This is because offshoring to their own captives does not take away the pain of talent, attrition, career management, and rising people costs that plague the industry as well as the overall management costs associated with running these processes offshore. In many cases the Compliance function may want to offshore 20-30 heads with specialist skill sets and managing of such a small team at a remote in-house location can become a headache.

There is now a new crop of capital market outsourcers who will take away the burden of running these repeatable and measurable Compliance activities and provide you with significant cost and quality advantages. Going directly to a third-party vendor provides better value because the cost savings relative to mere offshoring can be as high as 30%. Economies of scale at an external vendor can provide talented offshore staff with a career path as well as better training and supervision than may not be cost effectively delivered in house. In many cases the perception that an in house solution is the lowest risk option may not be accurate.

Compliance advisors/consultants are playing an important role; but there is a large gap in day-to-day implementation

Consultants and advisory firms, who have a wealth of experience in compliance and regulatory affairs, are an increasing favorite with corporations. Consultants are supporting businesses by reviewing their compliance procedures, providing interpretation and implementation assistance on new regulations, providing training for FINRA/SEC exams, conducting mock audits, and more. They also help with sudden surges in compliance workload driven by Form ADV submissions, anti-money laundering (AML) checks, insider trading scrutiny, as well as investigating and dealing with actual incidents of breach. Advisors provide practical insights and best practices and play a crucial role in balancing and interpreting the diktats of regulators. Many consultants have good relationships with regulators and their counsel helps with approval processes.

Often, however, it is with routine day-to-day tasks that brokerage and asset management firms find themselves behind the clock, over-budget, and understaffed.

Best practice in day-to-day compliance can be greatly enhanced by leveraging the productivity of onshore compliance officers. Firms that focus their onshore teams on tasks that require judgment, managerial insight, and regulatory interaction and move tasks that require application of routine practices over larger volumes on an ongoing basis offshore are able to deliver breadth and depth of compliance oversight within an acceptable budget.

Internal senior managers in the Compliance function and external consultants/advisors are best employed exercising judgment but they need to be confident that routine processes are conducted with adequate rigor and that reporting is accurate. Outsourcing of routine tasks can be the solution.

Outsourcing is emerging as the favorite option, especially to India

We believe the Indian subcontinent will be the preferred destination and will command the lion‟s share of outsourced or offshored compliance volumes in terms of headcount. This is due to the availability of English speaking legal and capital markets talent, a strong process and work ethic, and a new breed of capital market specialist vendors who have developed the capability to run outsourced programs.

A number of Institutional Asset Managers, fund-of-funds, and investment banks have already set up Compliance offshoring programs in lower cost locations such as Bangalore in India, Birmingham in the UK, and Jacksonville in the US. Latin America and Eastern Europe have also been considered by firms




seeking specific language capabilities. As in the case of investment research outsourcing and legal process outsourcing – which were considered exotic and difficult a decade back, but have now become fairly commonplace – we feel Compliance outsourcing is now maturing. Compliance offshoring requires team with dual skill sets as successful execution requires both “capital markets” domain orientation and some legal skills. The emergence of vendors who are capital markets specialists who take on Compliance outsourcing programs has helped build confidence among Asset Managers that the risks of outsourcing are quite low.

Among those who have already offshored portions of Compliance work to their captives in India are:

– 3 of the top 5 investment banks

– The asset management arm of a top 5 Insurance major

– 2 of the top 5 institutional asset management firms

The nascent outsourcing market for Compliance work to third-party vendors in India includes:

– A small number of Institutional & Retail Money Managers with multiple asset classes

– A bulge bracket investment bank




Section B: How to Evaluate and Execute a Successful Compliance Outsourcing Program

1) Deciding „what‟ to outsource/offshore – Sequencing the program

Outsourcing or offshoring is a multi-year program that cuts across multiple activities. Correctly sequencing the activities that are done offshore and planning for skills management is critical to the overall success of the program.

The figure below maps the processes that have been migrated to date, specifically to India, by various Asset Managers.

E-mail Surveillance

AML Checks

Client SuitabilityChecks

Sales & Marketing Material Reviews

Regulatory Filings

Guideline Monitoring

Insider Trading Surveillance

Ava

ila

bility o

f m

an

po

we

r in

Ind

ia

Level of complexity

Compliance processes that can be Offshored

The diagram reflects Amba‟s assessment of the level of complexity of some of the Compliance tasks and the ready availability of manpower in India for these task types. The size of the bubble indicates the potential volume of offshore-able tasks.

We would advice firms to first draw their own map based on their in-house assessment of complexity (talent availability will remain the same). The outsource/offshore program should ideally be sequenced in the following order:

1. Kick-start the process with activities that are both simple and where manpower is available in abundance. Assign a 2-3 month timeline to set this up

2. Once Step 1 stabilizes, add activities that are large in volume, irrespective of whether they are complex or not and irrespective of whether talent is abundant or not. Allow these to stabilize for another six months before you start to move the more complex activities.

Often there are other considerations while identifying the right sequence. Here is one such example: A large Asset Manager decided to outsource its Institutional Sales and Marketing Material Review processes first and the non-institutional processes were migrated four months later. The reason was that since institutional sales material is distributed only to institutional investors, it does not require regulatory approval and filing. In contrast, any sales material that is available to the general public is considered advertisement or sales literature. There are stringent norms for the filing of such material with the US SEC prior to first use and require stronger due diligence before they are finalized. As such, the Asset Manager transferred the non-institutional review processes only after it was confident that the vendor‟s team was fully trained and had acquired the necessary skills to handle such literature.




2) Deciding „how‟ to effectively outsource - Use simple flow charts to identify and resolve issues

Here is an example of outsourcing one of the key Compliance processes listed – Sales & Marketing Material Review. Also listed are some of the issues a company may encounter along with some suggested resolutions.

Sales & Marketing Material Review – Sample of a task type

Vendor‟s compliance team reviews the document for reasonability checks and compliance adherence. The checks are conducted in accordance with the respective regulations for marketing material review and information disclosures. For instance, no recommendation is made for purchase or sale of securities, no guarantees are made as to the performance of securities, disclosures are consistent with the asset type/fund type.

Client‟s compliance team assigns new task to the vendor‟s compliance team through a software application

Mark the errors in the document and re-assign to the submitter

Submitter makes the suggested changes and uploads the clean document.

Any changes required in the

document?

Assign the documents to Compliance Officer for final sign-off

Issue – Access to client information.

Resolution – Access to the vendor can be provided through remote gateways such as CITRIX. Hence, no client information is stored on vendor‟s local systems.

Issue – Strong domain knowledge required.

Resolution – A vendor with strong capital markets knowledge can provide such resources.

Issue – The vendor cannot provide final signoff

Resolution – Final sign-off is provided by the Compliance officer at the client‟s end.

YES




Bring the team together around a common plan

After the C-level decision is made, getting the Compliance team behind an outsourcing or offshoring plan is important for its success. There are three elements to communicating the program effectively to onshore team members:

– Explain the objectives clearly

– Explain the rationale behind selection of tasks that are moving out

– Explain the overall timeline

Given below is an example of a typical 12-week transition plan.

Analyze, plan, and design

solutionsStaffing, setting

up infrastructure

Live work

execution

Go live – client

sign off (BAU)CKT

• Measure

performance against

SLAs, final client

sign-off and handover

to delivery for

business as usual

• Develop a holistic

view of client

requirements

• Understand

compliance

functional

processes/

products

• Identify most

suitable activities to

outsource

• Design and plan

processes in

accordance with

client

requirements

• Set up infrastructure,

IT, governance,

supervisory structure,

identify skills

required, and

commence staffing

• Start delivery,

incorporate client

feedback, improve

processes and

finalize SOPs, and

activity timelines

• Client

transfers

knowledge

through class

room, web,

or through

on-the-job

training

transfer

• Create initial

SOP

(Standard

Operating

Procedure)TIMELINES

Monitor and control using a strong transition Dashboard

CLIENT SIGN-OFFCLIENT SIGN-OFF

INITIAL SOP

CLIENT SIGN-OFF

FINAL SOP

ONGOING 3 WEEKS 5 WEEKS3 WEEKS 1 WEEK

Key steps in transitioning Compliance processes

Communicating such a plan to the entire Compliance team helps bring them all on to a common program and sets the right expectations for the implementation phase.

3) Implementation – Making it a success

Once you have identified an appropriate outsourcing partner, by applying the right level of rigor, the majority of Compliance processes can be transitioned flawlessly over 12-14 weeks, and the rest can be sequenced over a 3-12 month period.

An outsourcing program will have three components that need to work hand-in-hand: a) Goals & Ownership; b) Work scoping & Transition, and c) Governance.

A partner who understands the capital markets space and speaks the same financial markets language can help to smooth this process and reduces the burden on your team making successful execution more likely.




a) Goals & Ownership: Ensure that both your team and the offshore partner‟s team are on the same page in terms of their understanding of the goals for the program. Demarcate ownership for specific deliverables and communication lines between different levels in the two teams.

b) Work scoping & Transition: One area to guard against is a „one-size-fits-all‟ knowledge transfer methodology for the different processes that Asset Managers want to offshore. In some areas like AML checks, where the scope of work is likely to be permanent and easy-to-define, a process-centric approach will work (“Rules-led” work). In such areas, the key to successful transition is for the vendor to document the process very well based on your input. At the other end of the spectrum, “Expertise-led” or domain-oriented processes, such as Guidelines Monitoring, require an implementation methodology that emphasizes continuous learning, wherein talent & knowledge would trump process. In such areas, the vendor needs to staff the leadership of the team with people who come with relevant experience and can learn the nuances of the work with occasional guidance from your team without expecting you to document every aspect of the activity. Other activities are in between (“Judgment-led”), wherein there needs to be some degree of initial documentation, but through frequent exchange of notes between the onshore and offshore teams, the offshore team‟s ability to make judgment calls is kept in line with onshore thinking.

The following chart illustrates how knowledge transfer works in different contexts

Knowledge Transfer Framework from Client to Vendor

LOW

HIGH

Analytics/Judgment-led work (Eg. Sales & Mktg Material Reviews, Email reviews)

• Jointly develop SOPs

• Onsite visit by vendo’rs supervisors to learn the key processes

• Client goes offshore for supplementary training during the process go-live phase

• Iterative feedback and guidance

• Daily interaction with vendor team is preferable

Rules-led work (AML Reviews, FinraFilings)

• Transfer of client SOP which might be available

• Agree on well-defined SLAs

• Invite few vendor supervisors to client Onsite and conduct a train-the-trainer model

• Weekly interaction

• Sample quality checks on output

• Keen focus on IT/Software Mapping/access issues

Expertise-led work (Eg. Guideline Monitoring)

• Understand and document client’s end objectives

• Onsite training with the client is a good practice to learn such a highly judgmental process

• Review & understand sample outuputs with the client

• Start work offshore and encourage terativefeedback and guidance

• Bi-weekly interaction

Tim

e ta

ke

n fo

r kn

ow

led

ge

tra

nsfe

r

Interaction with the client team

c) Governance: Ensure there is a mechanism for multiple layers of communication with different frequencies to assess performance, provide feedback, identify new objectives, make structural and execution changes to the program, and re-prioritize activities.




Conclusion

a) We expect rapid adoption of outsourcing programs by Compliance functions at asset management firms and brokerages driven by both regulatory and cost pressures. India remains the chief destination for this initiative. While Compliance offshoring will be much smaller than the USD4bn Finance & Accounting offshore industry, similar cost savings of 40-50% can be achieved. The most important difference though would be that Compliance leadership will prefer to use (and be better served by) specialist capital markets firms, offering structured outsourcing programs that provide better overall value than merely offshoring work to their own captive locations.

b) Both outsourcing and offshoring is best suited for day-to-day ongoing activities. The guidelines provided in this paper can help sequence these programs appropriately, as well as to frame an overall timeline and bring the entire team together to work towards successful implementation. The terms outsourcing and offshoring have been used interchangeably in some places because most of the outsourcing vendors would in any case move the work to low-cost offshore locations. The main difference with the outsourcer is that he takes the overall responsibility for the tasks and is expected to deliver greater value.

c) Further, the paper suggests that using the right approach to scope out work and manage the transition, based on the nature of each task, will reduce risks and make the program implementation smooth. In this regard, it will help to have a specialist vendor who already understands Compliance in the capital markets space. For sustained benefits, multi-level communication and governance will keep the outsourcing program on the right track.

IMPORTANT NOTICE

This information in this article has been compiled or arrived at from sources believed to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Amba has not verified the factual accuracy, assumptions, calculations or completeness of the information. Accordingly Amba accepts no liability whatsoever for any direct or consequential loss or damage arising from the use of this communication, reliance on any information contained herein, any error, omission or inaccuracy in any such information or any action resulting there from.

THIS COMMUNICATION DOES NOT CONSTITUTE INVESTMENT ADVICE OR COUNSEL OR SOLICITATION FOR INVESTMENT IN ANY SECURITY.

About Amba

Amba Research provides investment research, analytics, marketing, and middle office support services to the global capital markets industry. Over 70 companies, including six of the top 15 global asset managers and six of the top 15 global investment banks use Amba to differentiate and outperform. All Amba services are customized, exclusive, and proprietary to each client. Amba was founded in 2003 by senior directors of research from Goldman Sachs, Deutsche Bank, and JPMorgan. Amba has offices in New York, London, Singapore, Bangalore, Colombo, and San José (Costa Rica).

Amba Research is the highest ranked Investment Research outsourcing services firm in the 2010 Black Book of Outsourcing report.

For more information, please visit www.ambaresearch.com

Amba Investment Services Ltd. or Amba Research is not associated with the Association of MBA Executives Inc. All Amba trademarks shown in this communication are held by Amba Investment Services Limited. © Amba Holdings Inc. 2010

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Amba White Paper - Implementing a Successful Compliance Outsourcing Program_2011 Aug

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