Regulatory compliance is an ongoing, escalating cost that is stifling profitability. Today, the “cost of compliance” is now 85% of a financial institution’s average operational budget, leaving a mere 15% available for programs like business development and customer acquisition. Many institutions continue to rely on disconnected, incomplete approaches to regulatory compliance, preventing them from gathering accurate, up-to-date, comprehensive information about clients. Worse, in many cases the status quo approach of asking clients repeatedly for the same information is also damaging relationships, creating a customer experience crisis and loss of business.
Mounting pressures such as the Foreign Account Tax Compliance Act (FATCA), are presenting yet another outreach and data management burden for financial institutions. Because of these challenges, the industry is increasingly looking for better ways to collect customer information, then validate, report and provision it to counterparties, clients and regulatory agencies to avoid customer defection and remain in compliance.
By adopting a proactive, client-driven approach to FATCA, institutions will be better positioned to quickly and predictably achieve regulatory compliance, while driving long-term customer satisfaction and business growth, even as requirements evolve amidst the tsunami of new regulations.
FATCA: Deadlines, data and due diligence
Enacted by the U.S. Congress in 2010, and enforced through regulations promulgated by the U.S. Department of the Treasury, the Internal Revenue Service and a growing number of intergovernmental agreements (IGAs), FATCA aims to stop Americans from using offshore accounts to evade tax by requiring foreign financial institutions (FFIs) to report information about financial accounts held by U.S. taxpayers. However, it is not simply a U.S. regulation. It applies worldwide and assumes all customers are U.S. taxpayers until the customers have certified under penalties of perjury that they are not. Adding to the complexity are FATCA equivalents from other countries which are often referred to as "Sons of FATCA”) and the Automated Exchange of Information (“AEoI”).
The word ‘tax’ in the Foreign Account Tax Compliance Act can also be misleading. A more accurate representation of the regulation would be to substitute the word ‘tax’ with ‘data’. After all, central to FATCA is customer due diligence (CDD) outreach and documentation, which depends on the institution's ability to efficiently collect, validate and report client data. If financial institutions get this right, they’ll have a well-run FATCA program; if they get it wrong, it will nosedive into a remediation program.
Unfortunately, many are taking a last-minute approach to FATCA compliance which is woefully impractical given that the process requires iterative customer outreach, combined with status quo data management solutions. Customers l inevitably take their time responding and many responses will likely be incomplete or unreliable. Dismal response rates will also disrupt the flow of business and lead to additional, intrusive customer outreach.
As many institutions have already decided, it may make sense to begin CDD outreach on June 2, 2014 which is the date in which the IRS list of registered foreign financial institutions (FFIs) will be available. However, laying the foundation and preparing for CDD must start immediately.
The earlier the outreach and education to customers is started, the higher the conversion rate by the deadline date. Equally important is that there will be fewer recalcitrant accounts simply because the customer did not understand the requirement and the consequences of non-compliance. By embarking immediately on a systematic approach to FATCA compliance, financial institutions will be better prepared to avoid fines, reduce operational costs and eliminate repeat requests to customers, all of which drives client retention and business growth.
The client due diligence problem
Current approaches to client due diligence (CDD) regulatory compliance are expensive, difficult to manage and unstructured; they are also slow, disjointed, error-prone and lack transparency. A myriad of challenges are inhibiting institutions’ ability to effectively manage compliance. These include:
-- Too many new and changing regulations to keep track of and adhere to, resulting in repetitive requests for regulatory information from clients. Some regulations also require a “periodic review” on a calendar basis.
-- Limited data reliability since new regulations require gathering of more non-public data from trading partners. Existing processes for requesting data and documentation directly from clients typically involve a combination of communications via telephone, fax, mail and email which severely limits accountability and auditability.
-- Too many broken processes for gathering customer information, requiring a huge dependency on accurate legal entity and product data. Financial institutions often have to buy legal entity data from multiple vendors and then consolidate the information.
-- Too many points of contact, spanning both the front office and back office, each asking the client repeatedly for the same information. This results in chaotic data management with distributed spreadsheets, lack of insight into data, and little to no accounting for what data exists and what doesn’t.
Financial institutions need a new way to facilitate communication, validation and reporting of information between their clients, counterparties and regulators that will enable them to meet regulatory compliance deadlines on time and on budget with minimal client disruption.
Haydon Perryman is Director of Compliance Solutions at Strevus.