The U.S. Foreign Account Tax Compliance Act (FATCA), signed into law on March 18, 2010, poses serious operational and systemic challenges for foreign financial institutions (FFIs). One of the most complex challenges is the need for financial institutions to gather sensitive client data to identify accounts for the purpose of reporting to the Internal Revenue Service.
While FATCA does not come into effect until January 2013, the Act may require wholesale changes to the type of customer and transaction data captured and stored in an organization. Understanding the classification requirements of FATCA, identifying what data is available and is "electronically searchable," as well as developing the best approach to the correct treatment of the customer base on a global basis will require planning and preparation. Once the required changes and impacts are fully understood, implementing the systems and legal arrangements to gather and process the data could take an extensive amount of time. The industry generally considers 18 months as the timeframe necessary to implement major system enhancements, so financial institutions need to begin planning now.
FATCA is part of a longer-term trend; changing regulations are altering the financial landscape and increasing the focus on the quality of data held by financial institutions, data that is of increasing interest to the wider community for identifying systemic risk and understanding the economic impacts originating from the financial system. With regulation moving in this direction, many FFIs are discovering that the client information they have historically gathered, and the controls that are in place to maintain the quality of that data may be insufficient.
FATCA's data reporting requirements go beyond the current information collected through existing Client Identification Program (CIP) and Know-Your-Customer (KYC) processes. The Act will require FFIs to be able to classify their customers on a global basis under U.S. tax principles relying on a range of information such as U.S. Tax Status, U.S. Citizen/Residence Status, Place of Birth, U.S. account directions. Account balances may also be used to determine certain thresholds and for reporting to U.S. accounts. Industry classification codes and ownership hierarchies may also be used to correctly classify organizations.
In addition, there will be a range of documentation requirements post-January 2013 that institutions may have to be prepared to capture and report on:
- U.S. documentary evidence.
- FFI EIN & FFI Certification.
- Non Financial Foreign Entity (NFFE) documentation.
- U.S. Tax Forms W-9 andW-8s.
Given the reliance on this type of information to determine FATCA status, existing client data will likely require cleansing and/or enhancement. When organizations start to look at their customer data in light of the FATCA requirements across their range of global data stores, the systemic impact of this piece of regulation will quickly become apparent.
Also, with mandates stemming from Dodd-Frank, Basel III and other post-financial crisis financial regulatory changes gaining momentum, FFIs that act now can integrate FATCA work into other compliance requirements, capturing crossover between projects and moving FATCA preparations forward as efficiently as possible.
The FATCA data gathering and capture process, if not handled appropriately, could become a bone of contention with clients. FFIs' attempts to comply with the data requirements will require a careful balancing of privacy and client relationship management considerations. In particular, client patience may be strained by FFIs' need to obtain clarification on U.S. tax status and privacy waivers. If internal FFI data sharing is not possible, related entities in different jurisdictions may each have to approach clients with information requests. In a worse case, organizations with poor client data face the risk of misclassifying clients and inadvertently withholding on them. Organizations that have multiple business units need to ensure that this data-gathering process is managed in a coordinated fashion across all their global operations.
The initial preparation for compliance is expected to be costly. The European Banking Federation pegged the price tag at nearly $150 million for one large cross-border bank. These costs are in large part driven by the fact that complying with FATCA will usually require new systems infrastructure to support data identification, aggregation and reporting.
Making It Happen
Preparing to identify, analyze and report the data that FATCA requires will involve a number of tasks, some of which can be done simultaneously:
- The initial identification of sources of "electronically searchable" client data across global operations;
- Development of the classification schema and the data available to support initial classification;
- Analysis of existing clients, counterparties, products and data;
- Development of a strategy based on that analysis;
- Development and sizing of client communication strategies based on the initial classification;
- Impact analysis of existing processes and systems to enable classification of new clients and counterparties;
- Data remediation and client communications for the existing client base;
- Additions to the existing control framework to support the increased data requirements; and
- Training, education and awareness.
Firms can begin by developing a single global view of their products and clients across divisions to glean some idea of the scope of the challenge. Financial institutions can ascertain whether their KYC, Client ID, trading systems or other systems will handle the data gathering, analysis and reporting tasks, or whether they need to be modified.
Most importantly, developing this view across their global client portfolios will enable organizations to understand the implementation challenges they face based on the availability and robustness of existing data. This view will aid executive management in the strategic decision making process, particularly implementation decisions across an organization’s global footprint. The result will be an organization that is well-prepared to respond when the IRS issues Regulations.
The cost of implementation and the belief that the U.S. is unfairly and unilaterally dictating regulatory terms may rankle non-U.S. firms and their clients. However, the resulting attention firms must pay to increasing the quality of the customer data may also offer an enhanced understanding of the customer base, allowing for a more efficient deployment of capital and the ability to be well-positioned for the changing regulatory landscape.
About the Author: Doug Nixon is a Senior Manager in Ernst & Young LLP's Financial Services Advisory practice, specializing in assisting large financial institutions adapt their environments based on changes in the regulatory, compliance, risk and market environments. Doug leads Ernst & Young LLP's Data Quality and Data Governance solution for Financial Services.