How Covid-19 has impacted regulation and compliance

A Funds Europe webinar, in association with Backstop Solutions, discussed how fund managers are using technology to adapt to problems as diverse as capital raising and operational due diligence in the absence of face-to-face meetings.

If there is a consensus that the investment management industry has managed the operational impact of the coronavirus pandemic, it could be because previous events such as the financial crisis of 2008 and Hurricane Sandy in 2012 forced the industry to become more resilient, says Gregory Worsfold, founding partner of compliance advisory firm Optima Partners.

“Technology has played a huge part in this and most firms have used the cloud and sophisticated systems to keep their data safe and to enable their staff to work from home,” he says.

Worsfold took part in the Funds Europe/Backstop Solutions webinar along with Mitchee Chung of Mercer and Peter Rigg of Sagar Partners.

Regulators will, however, continue assessing the risks of working at home. “There are concerns around security flaws and the lack of end-to-end encryption in communication tools like Zoom and WhatsApp. Technology can help firms operate in new working environments but it also creates new risks which firms have to document and monitor and adapt their controls and policies accordingly,” says Worsfold.

In the UK, the Financial Conduct Authority (FCA) is looking at behavioural risks, he says. For example, are employees as connected to the compliance process as they should be when they are not in the office? Or is compliance culture being watered down when staff are now “working alongside flatmates rather than office colleagues”.

For operational due diligence, a large part of the process such as documentation review and other tasks that can be performed remotely have remained unchanged since the pandemic, says Chung, who is the European Director of Mercer Sentinel, Mercer’s specialist operational risk consulting group. “It is only the on-site visits that have changed. These visits are a core tenet of validating a company’s systems – but when you look at all the hours spent on a due diligence programme, it amounts to one day in an eight-week process.”

This raises the question of whether the importance of face-to-face meetings or office-based working will be diminished. Chung does not believe they will. 

“Across the world, we are seeing people return to the office and most businesses want to retain some form of office environment, especially for processes like trading. So, I think there will be a mixture of virtual and face-to-face meetings.”

The risk that comes from the absence of on-site visits varies among managers. Chung says: “A large percentage of the managers that we assess are well-known to us and we have assessed them and their strategies many times in the past. When changes are made to the fund, we can call them, so it is a way of working that we are already familiar with and that has given allocators a lot of confidence.”

However, for some managers, the change to remote working is very new, says Chung. “Some have adapted well and others did not and are still uncomfortable with video calls which can create risks. But in many circumstances it is just a case of making adjustments. For example, whereas in the past we would have a full day of on-site meetings with 30 different people, we have had to break that down into a series of virtual meetings.”

The specific topic of discussion for a meeting is relevant to how a meeting is staged, says Chung. Trading processes for asset classes like equities and bonds will require a video call, “but if it is HR processes, we don’t necessarily need a video demonstration,” says Chung.

Challenges of capital raising
A lack of physical meetings does carry challenges for capital raising. Peter Rigg, director at Sagar Partners, an advisory firm which works with family offices’ alternative investment mandates, says: “If your client is a family office, it can be difficult to recommend a new fund or investment when you have never met in person. So hopefully the lockdown will ease and people will go back to the office.”

Fund managers are seeing flows reallocated to existing funds more than they are seeing new money, says Rigg. However, he adds: “It has opened up significantly in recent weeks. Investors still need to make a return. Interest rates have gone even lower and equity markets have rallied, so conditions are quite good right now for alternative funds.”

There are pockets of value in areas like structured credit and asset with idiosyncratic returns, including real estate and commodities. Distressed assets are also of interest, says Rigg.

“It has been a great opportunity to upgrade portfolios … but it is harder for new groups because of the communication challenges and the due diligence difficulties, which is a shame because it continues the trend for larger asset managers to get larger at the expense of the smaller ones,” says Rigg.

Thoughts are turning to what aspects of the pandemic response may become permanent operational changes. For example, might the funds industry become a more prolific adopter of new technology?

“The pandemic has changed the work environment and even when things return to normal there will be an increase in the use of remote working and the technology you need for that,” says Worsfold, adding that regulators are now more comfortable with cloud for safe data storage.

Cyber security and two-factor authentication is now more important, says Rigg, who adds: “Everything must move to digital record-keeping. It is not good enough to have an expensive headquarters with paper files that you can’t go into because of a pandemic.”

And perhaps one of the best blessing in disguise of the pandemic is, as Chung says, that technology investment has ascended budgetary agendas, meaning firms will find money not just for short-term ‘patches’ – such as a pandemic – but for technology needed to make long-term changes to operating models.

You can watch the recorded ‘How Covid-19 has impacted regulatory and institutional due diligence’ webinar on the Funds Europe’s webinar channel.

© 2020 funds europe

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