Fatca Tests Buy Side’s Compliance Readiness

Terry Flanagan

With the publication of final regulations implementing the information reporting and withholding tax provisions commonly known as the U.S. Foreign Account Tax Compliance Act (Fatca), investment managers need to make sure that their investors are not using abusive tax shelters or other questionable activities.

The Fatca regulations, which were published on January 17, target U.S. tax dodgers using foreign accounts, stipulate that every foreign financial institution must undertake a search of its client base to identify clients containing U.S. indicia—address, residency, nationality, phone number etc.—and classify each of these clients appropriately.

“Under Fatca, it’s going to be necessary to conduct due diligence with a focus on identifying potentially fraudulent activities,” said Jeff Mulligan, head of due diligence research and reporting at HedgeOp Compliance, an IMS Group Company. “They have to make sure that people are who they say they are.”

HedgeOp Compliance works with fund of hedge funds and other institutional investors to create a due diligence infrastructure and record-keeping system for researching and evaluating potential hedge fund managers. The company also helps develop and/or review the AML and KYI controls for investment managers as it relates to their investors.

While the final regulations will be effective when published in the Federal Register, which were published yesterday, the timelines for the various due diligence, reporting and withholding provisions incorporate the delayed deadlines set out by the Internal Revenue Service, and are being phased in to allow firms to develop the necessary systems and procedures and to align them with any intergovernmental agreements.

For example, withholding agents, which may be U.S. or non-U.S. entities, will not be required to implement U.S. account verification procedures prior to January 1, 2014, and the deadline for foreign financial institutions, generally including offshore investment vehicles, to file any required Fatca reports for fiscal years 2013 and 2014 will be March 31, 2015.

“The 544-page release with the final regulations is very comprehensive and responds point by point to many comments that had been received, including many comments about collective investment vehicles and their investment managers,” said Mulligan.

Investment firms have had their hands full with regulations such as the U.S. Dodd-Frank Act and the similar Emir rules in Europe, which deal with OTC derivatives.

“We treat regulatory obligations as a catalyst for business growth rather than as an obstacle,” said Benita Warmbold, senior-vice president and chief operating officer of Toronto-based Canada Pension Plan Investment Board (CPPIB), Canada’s biggest pension fund, at an online forum sponsored by investment management technology company SimCorp.

“Fortunately, there’s a fair amount of synergies between our approach to managing data complexities and the regulatory changes that are happening in the OTC derivatives processing space,” said Warmbold, who is responsible for treasury, investment risk, operations, investment finance and technology functions.

For instance, the legal entity identifier—the G20’s initiative to attach a barcode to all financial trades—required for each of the entities and securities processed fits in perfectly with CPPIB’s data strategy.

“Having a unique identifier allows us to know our true exposure across all the asset classes, enabling us to quickly drill down into specific portfolios, sectors, geographies and product types,” said Warmbold. “This is where regulation in some ways acts as a business catalyst for expansion and innovation.”

Utilizing a variety of online resources combined with its experience with fund documentation, structures, and operations, HedgeOp Compliance performs extensive non-investment due diligence on potential hedge fund managers, said Mulligan at HedgeOp Compliance.

The scope of its due diligence reports covers offering document review, public record research (e.g., civil and criminal records, judgments, liens, bankruptcy filings, etc.) and news articles research.

“We add value to the non-investment due diligence process by reviewing the offering document materials of the underlying fund and preparing a report summarizing the fund’s investment terms, while drawing attention to terms that may not reflect industry standards,” said Mulligan. “We also focus on highlighting any inconsistencies between the funds’ various disclosure documents.”

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