The Future of Investment
Compliance for Asset Owners:
The Next Great Transformation
By: State Street Global Services – Performance Services
December 2014
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THE FUTURE OF INVESTMENT COMPLIANCE FOR ASSET OWNERS: THE NEXT GREAT TRANSFORMATION
Contents

Introduction

Structure and Workflow of Compliance Programs

Data Integration

Common Program Challenges

The Future of Compliance
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THE FUTURE OF INVESTMENT COMPLIANCE FOR ASSET OWNERS: THE NEXT GREAT TRANSFORMATION
Introduction: Getting to Today
“We want to be at the leading edge, not following.” – Large asset owner
For most of the past decade, asset owners and asset managers allocated valuable resources to establishing and
improving their investment compliance programs. Objectives have ranged from simple execution of processes
allowing them to comply with investment policy requirements, to clear demonstration for audit purposes of strong
alert and fail management procedures. In many cases clients can now easily produce reports and matrices that
encompass any breaches and their resolution. Compliance reporting has evolved from obligatory reports quickly
filed away, to “at your fingertips” information showing more comprehensive compliance results to satisfy internal
monitors, auditors, investors and owners.
The importance and growth of investment compliance programs, the need for improved risk management, and
expansion of the regulatory environment have led to the necessity of expanded and refined compliance tools;
providers — big and small — have led the charge here. Most of the larger pension funds and asset managers
are now working with custodians and with a handful of leading compliance engines and providers for outsourced
compliance processing services, while smaller asset owner organizations have chosen either to use custodians
or to perform in-house compliance.
No matter what the approach, online tools have taken on greater importance, allowing users to track and modify
actions taken for each of their breaches and to perform trend analysis across their portfolios. Simple reporting
now allows users to capture a summary of the program and share it regularly. Corporations, pension funds and
mutual funds have all moved forward in their view of compliance and its importance in their overall risk
management programs.
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This decade-long transformation, combined with recent market activity and investment instrument development,
has given way to a financial landscape that is quickly changing and highly regulated. Today’s compliance
programs need not only be auditor- and investor-ready, they must be able to prove themselves against current
and future regulations as well.
The Exercise: Getting to Tomorrow
We spoke with a set of North American asset owners and investment managers between May and December
2014 to get an idea of how they are managing their compliance programs to align themselves with new and everchanging market requirements. These conversations gave us a view into our clients’ existing compliance
programs and their plans to transform those programs to meet future requirements.
Specifically, our research sought to gain insight into the following:

Role of Compliance in the Organization

Daily Operational Workflow

Use of Online and Proprietary Tools

Reporting Needs

Audiences for Compliance Results

Asset and Instrument Coverage

Regulatory Requirements

Support Networks – Peer to Peer
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To give us a more complete view of the investment compliance landscape, clients interviewed for this initiative
encompassed both current State Street Investment Compliance subscribers and clients using other services
and/or performing compliance in-house.
The initiative gave clients a unique opportunity to share their views on investment compliance services, influence
the future direction of our product offering, and provide input on best practices.
Based on the responses received, we’ve organized this report into four sections:
Section I
Structure and Workflow of Compliance Programs
Team structure, roles and responsibilities, testing frequency, reporting uses and consumers of
information
Section II
Data Integration
Performance information, alternatives and illiquids, risk statistics and derivatives data
Section III
Common Program Challenges
Section IV
The Future of Compliance
I. Structure and Workflow of Compliance Programs
While each organization interviewed presented a unique story, we found one interesting similarity: most were in
the process of overhauling or significantly tuning their compliance programs.
In the process, organizations are looking at the areas of:

Team Structure

Roles and Responsibilities

Measurement Frequency

Reporting Requirements

Consumers of Compliance Information
Based on our research, it seems that most organizations have similar goals, but are executing differently based
on their individual needs, circumstances and resources.
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Team Structure. The size and shape of compliance programs continue to evolve. Some are small, with only a
single full-time employee responsible for day-to-day duties and program oversight. Others have spread oversight
across individuals that have compliance responsibilities along with other performance and risk-based duties. A
few have dedicated investment compliance teams with little or no non-compliance responsibilities. Common
among the participants we interviewed: a very small subset of clients said they had brought compliance
monitoring totally in-house; the rest had outsourced responsibility to a custodian or provider. The most standard
practice is that program oversight and alert management functions are held at the asset owner or manager, with
rules construction, maintenance, and daily and/or monthly compliance processing and reporting outsourced to
servicing entities.
Roles and Responsibilities. These days, chief executive officers (CEOs) are more closely tracking their
compliance programs and investment officers are making regulatory compliance a top priority. All of the
organizations interviewed listed their chief investment officers (CIOs) as the final reviewer of their compliance
reporting. Even five years ago, that was not the case.
If we use a public pension plan that has outsourced its compliance operations to a custodian or provider as an
example, typical roles and responsibilities might look like this:
Program Oversight and Authorization:
Pension Plan
Guideline Analysis:
Provider
Rules Construction and Maintenance:
Provider
Rule Signoff:
Annual/Semiannual Rule Review:
Daily/Monthly Compliance Monitoring:
Pension Plan
Provider with Pension Plan signoff
Provider
Alert Management:
Pension Plan
Board/Management Reporting:
Pension Plan
Measurement Frequency. In the asset manager space, daily compliance testing is the norm, and asset owners
are quickly moving in that direction. When looking at State Street’s North American investment compliance client
base, in 2010 about 60 percent of clients received monthly measurement and 40 percent received daily. In 2014,
that proportion has reversed. Today about 70 percent of our clients are on daily service while 30 percent receive
monthly monitoring.
Reporting Requirements. As noted earlier, the stature and role of compliance within organizations has
changed. Many interviewees mentioned strong interest and oversight coming from either their CIO or CEO.
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Almost all compliance programs in the study stated a need for reporting that summarized the current status of the
compliance monitoring, complete with alert management details and trend analysis over a given time period
(often a 2-3 month historical period).
Consumers of Compliance Information. The position of users of this information within the organization has
also changed, with CIOs, CEOs, boards and committees consuming high-level reporting, with internal monitoring
teams and portfolio managers using next-generation reporting containing further details and trend analysis.
II. Data Integration
The provision of new information and next-generation reporting cannot be successfully implemented without
better and more comprehensive data. Organizations are making efforts to include more granular types of data
into their compliance testing and overall reporting. Unfortunately, they are running into roadblocks — more on
that shortly. For now, let’s focus on what organizations are including and what’s to come next.
Over the past few years, compliance professionals have been working to expand their testing to encompass
more investment types such as commingled and pooled funds. In the past, these were treated as line items in a
portfolio and were either excluded from testing or treated as a single security. Today, organizations are pulling
third-party data into their testing to account for the underlying holdings of that single line item; this gives them a
more granular look into what they truly own. Test results more accurately reflect the true weighting of an industry,
sector, issuer or security.
Many organizations aren’t able to secure all the data they need to accurately test
compliance as comprehensively as they would like. Firms are turning to custodians to help
them acquire more of what they need and working with their portfolio managers and other
providers to acquire more detail on private assets, hedge funds, and for risk and liquidity
information.
Compliance professionals are attempting to challenge their data requirements by going through this same
exercise again; performance analytics, alternatives and risk information are the next set of information that
programs wish to incorporate into their testing and reporting. Performance statistics are now being included in
tests with limits placed on each; many tests only treat these limits as warnings rather than true alerts, with most
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clients looking at them as “information only” type rules. The same cannot be said for the inclusion of risk
statistics. Tracking error, for instance, is a key risk indicator that more compliance officers are including in their
testing. Some risk platforms and services are able to set limits around certain figures; however, they lack the
ability to add commentary to a breach or create an audit trail to close out or explain a breach. Compliance
systems do a superior job of this and provide a level of comfort to compliance officers that is unavailable on other
systems. Organizations are now asking, “When does a risk limit become a compliance rule?” and risk and
compliance functions are blending when organizations construct or retool their investment oversight.
Alternatives are also a complex data component that some organizations are beginning to include in their
compliance assessment. In most cases clients interviewed are still evaluating exactly what and how they want to
test private and illiquid assets. The unique data timing and transparency challenges presented by these assets
are becoming the next frontier for the most rigorous programs.
As noted, regulators are playing their part in transforming
compliance programs as well. The complexities and
leverage associated with derivative investments have led
regulators to try to surface and quell portfolio risk.
Regulators have instituted reporting requirements in many
Best Practices Learned from the
Study

Use of centralized teams with
clear responsibilities

Data integrity focus, workflow
orientation (clear roles)

Compliance measurement
across public and private
assets

Rules and measurement at
portfolio, position, strategy
levels

Use of control rules (warnings)

Frequency – migrating to
weekly/daily

Collaboration with peers
(Council of Compliance
Pension Officers)

Consumers include portfolio
managers, risk team,
management team, board
arenas. And those funds not directly required to report
under these regulations have often instituted their own
leverage and exposure testing. Both movements have
required compliance professionals to challenge their data
providers to include more underlying data and issuer
information to allow their compliance testing to accurately
reflect holding concentrations, leverage and exposures.
Board reporting and investment committee presentation
materials are also changing. The majority of clients
interviewed have begun to include performance and
compliance in all standing material delivered to their
boards, committees and senior management.
Performance, risk and compliance are being viewed as
one in a complete risk management program.
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THE FUTURE OF INVESTMENT COMPLIANCE FOR ASSET OWNERS: THE NEXT GREAT TRANSFORMATION
III. Common Program Challenges
Most of the gaps our interviewees identified center on data. Whether third-party data, private equity, performance
characteristics, risk statistics, liquidity information or alternatives, many organizations aren’t able to secure all the
data they need to accurately test compliance as comprehensively as they would like. Firms are turning to
custodians to help them acquire more of what they need and working with their portfolio managers and other
providers to acquire more detail on private assets, hedge funds, and for risk and liquidity information.
Investment compliance and risk professionals are finding themselves linked when constructing or refining the
organization’s overall risk management program. The result of these conversations puts compliance
professionals in a new situation: their investment officers now want to see the “riskiness” of their portfolios and
how they measure up against current or anticipated limitations. Measures such as liquidity, tracking error and
VaR are all beginning to surface in compliance testing. Most organizations that are including them in their testing
are doing so using vendor data or custodial data from those that offer a risk-based service. Some of the risk tools
in the market are able to place limits around certain statistics; however, getting those tests incorporated into the
overall compliance results is often a manual process that sits in the client’s operations or the contracted
compliance back office.
A few interviewees mentioned that one area of manual calculation or testing lacking sufficient coverage was
Substantial Shareholder testing. This type of monitoring requires an entity to look across all of its investments
and ensure that they do not exceed foreign ownership limits in any one country. These limits often differ by
country; maintaining accurate limits information and executing required testing can be quite cumbersome. Some
firms are offering Law Cards supporting the maintenance of these limits; however, updating the restrictions in a
compliance engine is a manual process and normally not done by the same firm. There is appetite for a service
offering where both the maintenance of and measurement against country limits are executed by a single
provider.
Alternatives bring new challenges, with many organizations trying to figure out how they want them included in
their testing. The study seems to show that of those using alternatives in their investment portfolios, all have
begun to try to obtain more granular level detail on underlying holdings. The issues many are running into are
that it is extremely difficult to secure the needed information, and they are unsure of what they want to test. Early
best practices place the responsibility on the portfolio managers (often, external managers) to provide accurate
holdings data with underlying information in a flat file and delivered to the client. Currently, most organizations
testing these assets are using offline calculations, with a few able to directly upload the data to their compliance
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monitoring system. There are no official common best practices when dealing with alternatives and many
organizations are curious as to what their peers are doing to fill the gap.
“We have a small team – we’re reliant on third-party support.” – Global asset owner
Collaboration with peers was another item that came up often in discussions. A small proportion of respondents
expressed little or no interest in sharing information with their peers or in identifying what others are doing in the
compliance space. The greater majority were keen on finding and using forums where compliance, investment
and risk management professionals could compare their programs and measurement concepts to expert peers.
Rules, new regulations and their treatment, data gathering techniques, compliance program composition and
reporting are all points of interest where collaboration is viewed as beneficial. Some organizations are part of the
Council of Compliance Pension Officers, but it is limited to the pension space; areas like insurance and mutual
funds, for instance, appear to lack the same type of forum.
These challenges and how they are met will drive the investment compliance industry through its next phase of
change.
IV. The Future of Compliance
The last decade has shown us many changes and evolutionary shifts in the investment compliance space. Based
on these findings and related conversations, we are in store for another transformation. Whether it’s driven by
organizational needs, gaps in data integration, an increase in the audience for breach results, the importance of
compliance in an overall risk program or a need for more information sharing within the industry, we begin to see
an emerging vision of the future compliance landscape.
Although a few respondents have pulled or kept their compliance back-office work in-house, the majority have
contracted it out to custodial firms or providers that supply a full back-office service. This continues to be the
trend and will be a key assumption in our model for how the compliance landscape is changing.
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From the responses and content we have gathered, it is clear that the organizational structure of an entity’s
compliance team is the foundation on which the compliance program is created. As compliance has grown from
a small piece of an investment oversight program to one of the more important elements, compliance activity will
be less of an organization’s part-time focus and more a core function. Within this core function, compliance
teams will have greater authority, report to higher levels within the organization and comprise a greater share of
investment-related staff.
Given more authoritative roles, compliance teams will be empowered to ensure investment managers close out
or sign off on their alerts without the intervention of a CIO. Compliance testing will continue to move to daily
testing, with most organizations replacing the monthly testing schedule. The results will often be incorporated into
a daily/weekly report with officer signoff and CIO review; all alert management details will be documented online
and secured for audit.
The next component in building a strong compliance program will be augmenting the data required for testing.
Data needs are driven by markets, strategies and the regulatory environment; with the lines between risk and
compliance beginning to blur and the increased complexity of investment instruments, organizational data needs
are being driven further. Liquidity testing, which has normally been contained within a risk service, is becoming
more important to compliance professionals, increasingly testing limits placed on the level of liquidity in a
portfolio. Mutual funds are seeking to ensure their portfolios can be liquidated quickly enough if faced with
potentially aggressive redemption demands. Once these liquidity rates are calculated, programs are looking to
test how close they are to regulatory and/or self-imposed tolerance levels. Tracking error and VaR are also
making their way into regularly scheduled compliance monitoring. This will lead firms to include alternatives and
illiquid securities, with the responsibility falling to investment managers to provide more granular information to a
compliance back office (custodian, provider or in-house).
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Regulatory requirements, risk management, expanded and more senior consumers,
new and more complex data integration, proactive testing and a collaboration effort
by both service providers and clients themselves will drive the continued
transformation of investment compliance.
For the greater part of the past 10 years, compliance programs have been focused on post-trade results. As
firms’ need for “real time” information increases and they move to get ahead of trading before it happens, pretrade compliance for asset owners may become more commonplace. The need for post-trade results will still
exist, with the trend analysis, alert management and audit trails it brings. However, being proactive with
managing the risk to a portfolio will become an important step in the compliance process.
The transformation of investment compliance will be driven by increased collaboration between peers. There are
a few forums to share information and best practices; however, strides can be made to fully connect firms with
one another. New regulatory requirements should help push this along. The fact that many organizations will
have similar responsibilities should generate the need for a common place to discuss how to construct testing,
reports and necessary filings. Custodians, law firms and even the organizations themselves can play a part in
creating more online committees, conferences and community forums. These will give compliance and risk
professionals an opportunity to plan for and work with coming investment restriction.
Regulatory requirements, risk management, expanded and more senior consumers, new and more complex data
integration, proactive testing and a collaboration effort by both service providers and clients themselves will drive
the continued transformation of investment compliance.
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Comparison of Compliance Capabilities Over Time
2004

Organizations begin to outsource their
compliance operations

Basic data sources: Holdings based with
few derivatives or complex measures
included

Testing done using spreadsheets and
early version compliance systems

Reporting is summary based with little
underlying detail displayed

Compliance for external managers is
mostly monthly certification signoff
based


2014

Majority of large organizations outsource
some or most compliance operations

Holdings, transactions, derivatives and
complex data are included in testing

Multiple software and service programs
available and most custodians have
automated online solutions

Reports include a summary along with
underlying alert details

Alert management available online with
commentary, attachments and signoffs
Testing reports are delivered via email or
mailed in hard copy

Full audit capabilities available for both
regulatory and internal organizational use
Little to no online reporting and fail
management capabilities

Reporting, fail management and results
detail stored and delivered via online tools
Study Characteristics

Sample Pool: 15 organizations with over $850 billion in total net assets

Size of Organizations: Less than $10 billion to over $150 billion

Type of Organizations: Asset owners, asset owner/manager hybrids

Regional Location: North America

Length of Study: May through December 2014

Staff Sizes: 1 to 4
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Disclosures:
Research method/Source: Reference material taken from client responses during interview process (described in the Introduction) along with general
observations of industry trends and client behavior over time.
Views and opinions expressed herein are those of the author(s) and they are subject to change based on market and other conditions and in any event may not
reflect the views of State Street Corporation and its subsidiaries and affiliates (“State Street”). This information herein is for marketing and/or informational
purposes only and it does not constitute investment research or investment, legal, or tax advice, and it is not an offer or solicitation to buy or sell any product,
service, or securities or any financial instrument, and it does not constitute any binding contractual arrangement or commitment of any kind. This information has
been prepared and obtained from sources believed to be reliable at the time of publication; however. it is provided “as-is” and State Street makes no guarantee,
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the information herein. No permission is granted to reprint, sell, copy, distribute, or modify any material herein, in any form or by any means without the prior
written consent of State Street. Copyright © 2014 State Street Corporation, all rights reserved.
State Street Global Services® is the investment servicing business of State Street Corporation (NYSE: STT), one of the world’s leading providers of financial
services to institutional investors.
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