The financial crisis of the last decade has been a tough learning experience for the financial services industry. In response, strict regulatory compliance is now demanded and enforced. Financial compliance requirements have evolved over the years, and are currently highly complex and continuously changing. The risks and penalties associated with failure to meet compliance requirements are severe. Innovative strategies and supporting technology have been introduced to help businesses succeed in today’s regulatory environment. Let’s take a look at this evolution.
What is compliance?
According to the International Compliance Association (ICA), the term compliance describes the ability to act according to an order, set of rules or request. In the context of financial services, it refers to compliance with the external rules that are imposed upon an organization as a whole, as well as compliance with internal systems of control that are imposed to achieve compliance with the externally imposed rules.
Brief history of compliance regulations
In 2002, the Sarbanes-Oxley Act (SOX) was passed by the U.S. Congress to protect investors from the possibility of fraudulent accounting activities by corporations. SOX mandated strict reforms in financial disclosures from corporations in an effort to prevent accounting fraud and overhaul regulatory standards. SOX was created in response to public accounting scandals in the early 2000s, when companies such as Enron Corporation, Tyco International and WorldCom shook investor confidence.
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in an effort to further reduce risks in the U.S. financial system. The financial reform legislation placed limitations on activities banks and other financial service organizations could and could not do in relation to consumers. President Donald Trump pledged to repeal the Dodd-Frank Act, and in June 2017, the House of Representatives voted to replace it with the Financial CHOICE Act, which is expected to revoke significant pieces of the Dodd-Frank Act.
Over the years, other compliance areas have emerged, including underwriting for all types of lending areas: fair lending processes, default and foreclosure processing, anti-money laundering, collections practices, operations risk, and vendor management. Financial institutions have had to explore avenues to ensure compliance under this new regulatory reality. For example, the Consumer Financial Protection Bureau was established to abolish predatory mortgage lending practices, but also to govern other types of consumer lending – such as credit/debit cards, credit unions and payday loan companies – as well as to serve as an address for consumer complaints. It requires lenders to disclose information in a form that is easy for consumers to read and understand; for example, the simplified terms currently found on credit card applications.
The dangers of non-compliance
Government institutions and federal regulators are determined to create a reality where all companies are compliant. To this end, non-compliance penalties and fines are becoming increasingly heavy and drastic. In addition, the negative effects of non-compliance can damage the future growth of a business.
Beyond monetary penalties, non-compliance with new laws about financial transactions has led to social punishment by publicly disclosing a company’s lack of compliance. This negative publicity has adversely impacted the brand reputation of many organizations, causing far greater repercussions than a one-time financial fine.
Some countries have enacted strict laws to encourage full compliance by local companies. For example, late filing in Denmark can lead to the company being dissolved, Venezuelan companies must keep their accounts up to date in Spanish with sanctions if the books are more than one month behind, and Estonian companies can find their credit ratings reduced if they file late. In some countries, non-compliance can result in mandatory closure of operations, or even imprisonment of the directors. In the United States, Federal Sentencing Guidelines have played an influential role in contemporary financial compliance practices.
Barriers to compliance
With such high stakes, why would a company remain in non-compliance with regulatory laws?
According to an in-depth study by BDO Outsourcing, there are four main models that a global business can choose to ensure local compliance: utilizing an in-house compliance function, local outsourcing, centralized outsourcing with central delivery, and centralized outsourcing with local delivery. Each of these models has advantages and disadvantages. Choosing the wrong model for a company’s business operations could result in non-compliance due to a range of factors, including lack of visibility, dearth of expert knowledge, lack of cooperation across entities, inefficient human resources or an incompetent outsourcing team.
Lack of a compliance culture
As senior leadership and board members may not be as informed about the rules and regulations as individuals on the front lines, it is critical that company leaders become educated about regulations and are kept up to date with changes in the field– and liability – with regard to compliance. For compliance to be truly embedded in an organization’s culture, sufficient resources must be dedicated to the compliance function, an adequate reporting structure must be in place, regular risk assessments must be conducted, and a clear process must be documented for investigating possible areas of non-compliance. If these activities are not a priority, non-compliance is likely not far behind.
Operating in multiple countries means having to comply with many local regulations – for tax returns, VAT reclaims, statutory filing, payroll, and many more. Compliance regimes vary from simple to complex, and local regulations are often updated frequently. Without strong and reliable local knowledge, businesses can find themselves in non-compliance – even unintentionally – but still be liable for any consequences.
The financial burden of bringing all systems and processes into compliance is complex and costly. Many smaller companies typically do not have the requisite in-house resources and experience to meet regulatory requirements while larger financial services firms face staggering compliance costs to ensure all necessary tasks are completed. These costs, and those of obtaining local expert knowledge, the integration of new systems, or the total replacement of a company’s current internal structure, can be a strong barrier to ensuring compliance.
Intention to fraud
As in any industry, some companies may attempt to hide under the government radar in an effort to save money. They may engage in such practices as tax fraud and evasion, such as not reporting certain income, particularly cash, which illegally deprives public budgets of money; establishing off-shore havens, which facilitate tax evaders and avoiders by storing money offshore, where it is unreported and untaxed; or engaging in tax dodging, often in the form of aggressive tax planning by big businesses or individuals, which exploits the limits of the law with the aim of minimizing taxes paid.
Steps to compliance
Despite the rise of artificial intelligence, where automation is increasingly replacing human resources and becoming the core of many financial operations, Compliance Officers have become just as critical to financial institutions as traders, bankers and analysts. This in-house leadership position was created in response to the growing levels of compliance now required, especially in the banking industry. The Compliance Officer works with management and staff to identify and manage regulatory risk, ensuring that the organization has systems of internal control that adequately measure and manage the risks that it faces.
Corporate compliance programs
A key step in establishing an overall culture of compliance is to institute corporate programs that aim to raise awareness about the importance of compliance across the entire organization. These formal programs specify an organization’s policies, procedures and actions to help prevent and detect violations of laws and regulations. Corporate compliance programs may advise staff about the risk of non-compliance, design and implement prevention controls, monitor and report on the effectiveness of these controls, resolve any compliance difficulties, and take an advisory role in instituting new internal rules or policies.
Technology as an enabler to compliance
Financial technology (Fintech) has been instrumental in helping financial services companies address the increased burden of compliance via innovation. The masses of data and mounting regulatory pressures facing financial institutions demands that they leverage the power of technology and automation to enhance their monitoring, analytical, and processing capabilities.
FinTech continues to develop tools for financial compliance, including data governance, artificial intelligence to manage risk, and the use of cloud-based tools to protect financial data. Focus has turned to developing solutions for regulatory management that involve automated processes that eliminate human error, enhanced visibility, and sophisticated reporting.
The regulatory outlook illustrates that financial compliance is not only a matter of following a static list of rules. Financial services organizations must be proactive in establishing a compliance culture, ensuring full transparency in their financial transactions, avoiding any risks of non-compliance, and building trust amongst their customers and stakeholders.
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