Transparency is a way of life in financial services today. The wave of regulation that started building after the global financial crisis of 2008-9 shows no sign of peaking; instead, the list of requirements just keeps growing. The thread running through almost all of the transparency regulations is the regulators’ insistence that clients should have a clear view of their overall position which captures exposure to every intermediary that handles the investment along the way.
Providing the level of look-through that regulators now demand is a major challenge for asset managers and insurers; data must be assembled from multiple sources and aggregated in the right way to arrive at the answers that regulators require. But solving this challenge delivers huge benefits for financial services companies. The trick is to translate the complexity of the problem into the biggest possible opportunity.
Take the complexity of reporting on costs as an example. Given the way that many investments are structured – as funds of funds or sets of segregated accounts with different investment managers – assembling the information that must be disclosed can be extremely laborious. The fund in which the client has invested often owns holdings in several underlying funds that in turn have holdings in a further layer of funds and so on – a pyramid of funds, in effect.
To deliver a comprehensive view of costs for the top-level fund, firms must gather data from every level of the pyramid, starting with the funds at the base and calculating how costs are allocated to funds in the layer above until they reach the fund at the top of the pyramid. Then they must calculate how the top-level costs are allocated to each client that has invested in that fund and share the information.
MiFID II and IDD requires asset managers and insurers to set out clearly all the costs and charges their clients have incurred during the previous reporting period (typically 1-year), while the UK’s Cost Transparency Initiative (CTI) imposes similar requirements on pension funds. However, costs are far from the only area in which look-throughs are now required. Insurers must perform the same process for the credit ratings on their fund holdings under the Solvency II regime. Most recently, fund providers have had to start disclosing information on the ESG ratings of the underlying companies in their portfolios.
Join the dots - a holistic approach to regulatory reporting processes
Firms have no choice but to find a way to overcome the complexity of these processes. Historically, they have relied on Excel spreadsheets and manual inputs for most of their reporting. Excel is a great tool for some jobs, but it struggles to carry out the multi-layered calculations for complex chains of investments that look-throughs depend on.
Financial services groups are turning to so-called 'point solutions' for their reporting, solving different look-through problems in isolation. They buy MiFID II calculators and CTI Cost Disclosure engines. Insurers use credit analysis engines to comply with Solvency II. And when they have to start making ESG disclosures, they implement a further specialist solution.
But in concentrating on trying to meet their obligations under each separate regulation, they risk losing sight of the bigger picture.
These look-through requirements all involve essentially the same process – aggregating information upwards through the pyramid, level by level, until you have a master set of data that applies to the top level and captures everything beneath it. Assembling the data and walking it up through the layers to the top is an extremely complex problem, but it also represents a big opportunity. If you can solve the look-through problem in a way that is not limited simply to data on costs, for example, but will work no matter what type of information you feed it - you have solved multiple problems instead of one isolated challenge.
Today, different teams in separate departments must perform look-throughs for various types of information: costs, asset valuations and prices, credit ratings, geographical and sectoral exposures, ESG ratings and so on. Currently, they each use different tools to carry out their own versions of the same basic process. If instead everyone used a single, standardised tool to do look-throughs, the firm would gain big benefits in terms of efficiency, as well as reducing operational risk and improving the quality and speed of its reporting.
Translate complexity into opportunity
But that’s not all. Once firms have an efficient way of performing look-throughs of all kinds, they can start to offer new services. It becomes possible to create client profit & loss accounts and balance sheets aggregated from accounting data for each fund they are exposed to - showing where their returns have been generated from and how their exposures have changed over time. The look-throughs that firms currently perform are backwards-looking because they are part of the reporting requirement. But the same tool could be used to model future scenarios, by pushing data down from the top level rather than extracting it from the bottom up. Modelling like this would be extremely complex to do with the tools firms currently use.
Look-throughs are a fact of life for financial services companies and are giving many of them a nasty headache. In their haste to make the pain go away, they should be careful not to miss the huge opportunity right in front of them. Solve that problem correctly and the benefits will touch every part of their business.