Client Mandates Create Compliance Issues

Terry Flanagan

Asset managers ranging from small hedge funds to global institutions need to be cognizant of three different types of pre-trade compliance areas, according to Matt Gibbs, product manager for investment systems provider Linedata.

Regulatory compliance and internal compliance are #1 and #2. “This is very common in some of our larger client base, where they’re involved in takeovers and acquisitions,” said Gibbs. “Because of that they will have to enforce stop lists across their entire client base and their current stock.”

The third and most important are client mandates, which can change more quickly than either regulations or internal compliance.

“If you were going to give me a big chunk of money, you’re going to give me some areas that I’m supposed to be investing that in and you’re going to put some restrictions around how you want me to invest that money,” Gibbs said.

All three compliance types need to be factored into every trade, which creates challenges for larger companies running multiple asset classes across multiple systems, such as fixed income, foreign exchange, and derivatives. “All of a sudden it starts to get quite complicated when you’re looking at individual client mandates,” Gibbs said. “How can you across multiple systems determine where your true exposure is before going to market? This really is the crux of the problem.”

The challenge in pre-trade compliance is ensuring that from the moment that an order idea is conceived by a portfolio manager, there is a check that makes sure that idea and that concept, if executed, will still leave the firm in a state of compliance.

For a hedge fund which is running a very niche pool of money, the compliance rules might exist within the fund manager’s head, while across a large fund manager where the pools of money have been split up, individual rules might reside within each pocket of the company, without encompassing the whole.

That effectively precludes pre-trade compliance, and limits the firm to post-trade compliance. “At the very end of the day your accounting system will be informed of all the trading activity, and at that point they would run a compliance check to ensure everything is in place,” said Gibbs.

Linedata has taken the approach of providing a single layer of pre- and post-trade compliance, which can be applied across an entire firm’s portfolio.

“We have to make the assumption that you’re not always going to be using our order-management system to input orders,” Gibbs said. “You will be having people using spreadsheets. You will have people using perhaps competitors systems. They will be a particular niche in a certain industry asset class.”

Linedata with then create “adapters” to ensure that no matter what method is used, the rules can be checked “quickly and efficiently, and we will have that adapter with built-in two-way logic. Everything we send out is going to be audited and everything we get back in is going to be audited.”

If a manager wants to override a particular compliance warning, if they can force the trade through, “but we want their reasons for doing it and we want to store that in a database so that in six months time, when the SEC come in and has a conversation with us, we will have that entire audit history and the entire process behind that particular transaction.”

Featured image via Dollar Photo Club

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