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A New Era of Compliance Is Dawning. It’s Overdue.

A New Era of Compliance Is Dawning. It’s Overdue.

As the world resets from the pandemic - and all the change and disruption (and innovation) that came with it - we wanted to discuss innovation and disruption in investment management and compliance. Compliance is not typically viewed through the lens of innovation or disruption, but we think that’s all about to change.

A conversation with Mark Strefling, an accomplished investment management lawyer and compliance expert, and Neil Visnapuu, CEO of TradeLlama, with over a decade of experience in Fintech, brings some fresh perspective to the once-straightforward role of compliance.

Q: What does the term ‘disruption’ mean to you, in practical terms?

MS:  True disruption, in my view, occurs when a process, system, or product so significantly alters the market such that adoption provides a competitive advantage, either in terms of efficiency, effectiveness, or market perception.

In practical terms, disruption in compliance involves embracing a new view where:

  1. Compliance is an integrated function of the business, and compliance tools integrate with (and dare I say, compliment) investment decision making, operations, and surveillance/forensics.
  2. Innovative compliance solutions are recognized as an alpha driver - to borrow from the SEC 'tone at the top, recognizing compliance as a catalyst to growth.’
  3. CCO’s are empowered in the organization - armed with information, analytics, and tools to contribute at all levels of the organization.

... And the reason for the ‘disruptive’ effect (and no, I’m not going to lead with the typical scare tactic warning of SEC enforcement): Effective and efficient compliance and risk control provides a competitive advantage attracting and retaining clients and investors who are increasingly sophisticated and focused on compliance and risk controls.

NV: Change that either is thrust upon you, or you seek out, in order to substantially change your position, relative to your peers.

Q: What are some of the challenges you see facing investment management firms, and specifically CCOs today?

MS: CCOs face numerous challenges - both in terms of regulatory complexity and business effectiveness. The role (necessarily and appropriately) has become elevated in recent years. Compliance professionals are responsible for creating efficient solutions with respect to compliance regulations, policies and procedures, but also to do so in a way that differentiates an organization. They are increasingly responsible for not just understanding and mitigating risks, in real-time, across the firm, but also representing the firm in connection with diligence and maintaining efficient and effective organizational control.

The days of pulling the old CCO compliance manual off the shelf are gone. The ‘tone at the top’ culture of compliance has changed the landscape. It is now putting together patterns, consuming that data, and making sense of it.

NV: How a business operates is becoming much more important to investors these days. Add to that, an overwhelming amount of data to sift through, and a bunch of tech ‘solutions’ that are siloed and not actually tuned to the ongoing and changing business needs. All that data becomes noise when you don’t have a way to turn it into something meaningful and applicable to the business.

There is a gap in most compliance technology. It is missing the overlay of ‘real-time’ compliance, forensic testing for risk assessment, and education - yes, even for CCOs - in an increasingly complex regulatory environment.

Q: Why are compliance departments often viewed as both inefficient and ineffective?

MS: I would suggest these misperceptions arise because there is often limited understanding about the value of compliance functions and the roles they perform to protect and improve organizations.

In my view, lawyers (and compliance professionals) often contribute to this problem: Despite some urging from the SEC, compliance policies and procedures are often poorly tailored to organizational risks, compliance manuals and procedures are seldom in plain English, and compliance training is designed to scare rather than educate.  To make matters worse, compliance teams also tend to look at the world through a rearview mirror, and often with lackluster access to information, analytics, and tools.

NV: At a very high level, it’s likely to do with incentives.  The more correlated work is to comp, the more you’ll see impactful changes.  We’re not in a position to advocate that, but our tools enable a CCO to make a better case on incentives.

Q: There is so much noise these days. How does a CCO sort through what's important? How can CCOs meet the constant barrage of changing regulations and stay ahead of regulators while balancing the needs and risk appetite of their firm?

MS: Technology (to provide visualization and analytics), process (to continuously improve), and oversight (to identify issues early before they become a serious issue). While it is tempting to believe that unless or until a regulator issues a risk alert or identifies a deficiency in your organization, that all is well or there is no benefit to finding problems - the truth, however, is that a CCO and the manager are both much better served by not putting on blinders. By accepting that there are compliance risks that may not be adequately monitored or controlled - or even identified as a risk (the CCO’s ‘blind spot’) a compliance team anticipates (rather than responding reactively.  Avoiding the identification of unique or emerging risks, or following the pack by employing a checklist-type approach seldom results in value creation - or even effective risk mitigation.

NV: You either hire a team to help, you use tools, or both. Bots can’t do your job, but tools can help you do your job better and more efficiently. By using the right tools you can elevate the level of work that gets done.  I’m a big believer in context.  Context brings focus to bear on that which is important and offers reasonable assurance on that which can be ignored.  Machine learning is a great enabler of context.

Q: What does the next generation of AI regtech look like?

MS: The next generation of AI regtech is much more than a bot - it empowers CCO’s, focusing compliance professionals on value creation and risk mitigation rather than simply administration and maintenance of rules-based systems.  Compare, for example, the tools, analytics, and systems deployed for investment risk management against current regtech which often focuses solely on automation and scheduling - next-generation regtech systems need to provide compliance teams with information, visualization, and analytics on a real-time basis - allowing compliance professionals to manage the complexity of regulation and effective management of current and emerging risk.

NV: Again, back to the idea that operational outperformance not only gets clients closer to the ideas that brought them to the house, but it also is a form of comparative advantage in a very competitive landscape.

There’s always the idea that you can automate something - filing forms, for example.  There’s plenty of software that does that sort of thing, though it’s not driven by any learning systems  Firms that service that market, I think they’re also the drivers of legacy surveillance tools that again, are taking human behavior (pivot tables in spreadsheets), and streamlining as such.

The coming changes will be in how tech helps the user identify, at scale, that which was not being done in the first place.  Automation in forensics.  At TradeLlama, we’re really focused on trading itself, so we have mental models that help translate to our engineers these concepts.

We often tell our people, the floats (decimals - say price, quantity, commission) feed your statistical toolsets, the strings (strategies, tickers, PM names) are both aggregations, and links to the compliance stalwarts - namely, policies, procedures, knowledge exchange archives, etc.  Learning systems will facilitate the process of leveraging strings in a trade, against their statistical merit (the decimals they carry) and the ecosystem from which firm behavior is meant to be aligned.

The end is familiar though - change behavior, or change the rules.  This newer approach should make the identification of conflict easier.  A CCO should get to that decision tree even faster, with tools like ours.  Do I change my PM or my policy on style drift?

Driving that discussion (our tech), really highlights the impact to the business that a CCO will have.  That’s why we really want to relate these tech concepts to their real-world impact.

I doubt these frameworks will ever resolve conflict on their own, and in that regard, I would say that’s a good thing.  But someone out there is probably pitching that too!

Q: How do you see the industry shifting as we move forward? What do you see as the role of compliance?

MS: As we enter the new Biden administration and a likely shift towards more examinations and more enforcement; the CCO role will continue to evolve and shift to an even more all-encompassing one. The CCO will (or should) begin engaging with broader teams in the manager in order to be successful. And the organizations that recognize this and become early adopters are going to be the ones that quickly emerge as the leaders. Automation and the ‘set it and forget it’ mentality creates a false sense of security. In the past, that may have worked, but there is a new paradigm coming. I think that arming CCO’s with a tool to get the data that they’ve been largely deprived of in the past, in a meaningful way, is a game-changer.

NV: Our belief is that box-checking creates bad tech.  We use machine learning (ML) to help our clients tell the story. We accept that the concept of single and multi-tenant use must go hand-hand. And, to top it off, in order to ensure client success, we tailor our offerings to work within existing productivity tools (like Teams, Slack, etc.) Compliance will be the bridge that connects the entire organization and will need tools that evolve with it. By providing tools that allow CCO’s to be more impactful, we’ve aligned them with other senior officers in the organization in a meaningful way.  And hopefully, engendering a conversation on incentives.

Q: Tell us more about your views on how effective and integrated compliance can be the next generator of ‘business alpha’ for an RIA.

MS:  On a relative basis, Compliance and internal/ operational control only recently became a serious focus for institutional allocators.  In fact, many RIA’s operate compliance processes solely out of necessity, rather than opportunistically.

My view (and my experience) is that compliance and operational risk controls provide effective differentiation (particularly in the alternatives space) in a competitive market, and effective integration of compliance with investment and operational processes can yield not only efficiency but alignment in direction.

NV: I think operations are best understood, in asset management, as implementing ideas on behalf of clients.

Conflicts of interest, for example, in many ways are operational deficiencies that get in the way of providing the client the closest thing to the actual ideas that the business is providing.  If you can better your peers operationally, you’re not just getting closer to the very things that draw your clients to your firm, you’re differentiating yourself in a very competitive chase for comparative advantage.  Specifically, around trade surveillance and behavioral modeling, there’s no excuse not to do this - the data is already there.

Q: Tell us a bit about yourselves, your backgrounds, and how you've gotten to where you are today.

MS: At my core, I’m a lawyer and accountant.  Originally introduced to the world of investment management during my years at KPMG, I later joined a law firm, ultimately leading its hedge fund practice.  However, many of my views result from my experience as a general counsel (and later Chief Executive Officer) of a significant multi-strategy hedge fund.  Through this experience I was fortunate to learn practices and approaches which elevate compliance beyond what is, quite honestly, a largely ministerial role in many organizations to an integrated and value-add position that creates meaningfully contributes to the success of a manager - something I call ‘business alpha’.  With a JD, MBA and Accounting/ finance education and my operational and business experience I am able to bring an understanding of the complex challenges facing CCOs and investment management firms today. I would say I am uniquely qualified to help firms tie it all together in a meaningful way.

NV: I’ve worked at a hedge fund, and at a large traditional asset manager.  I’ve covered hedge funds on an equities desk, seeded hedge funds, and for the last decade, serviced hedge funds and asset managers in the surveillance space.  Somewhere in that, I wrote a fair bit of code as well.  TradeLlama is ultimately my bringing together all of that, with my favorite people from those prior experiences.  I hope I can bring some of the best things I saw at DE Shaw, at UBS, at Accenture, at a few nameless start-ups, and avoid any of the trappings as well.

Q: What brought the two of you together? How did your paths cross?

NV: We met almost a decade ago when early work our team produced for surveillance was leveraged by Whitebox, under Mark's supervision.

The relationship developed over time, with ideas around improving the technology driving much of the discussion that eventually led to this current assessment and related business opportunities.

Neither of us has yet to extinguish the other’s ability to discuss the future of FinTech, or where our respective ambitions fit in that marketplace.

MS: Ditto.