•	 20-20 InsightsVolcker Rule Compliance: Preparing forthe Long HaulWith the final version of the rule set to arrive on Ju...
do away with any methods that may generate                 Post-trade compliance relates to measuring                 prof...
efficient channels of communication. Mapping the                                      processes are graduating from being ...
2.	Determine counterparties distinctly in a            detect “disguised” proprietary trades (directional             trad...
Point-of-arrival Architecture for Risk and Compliance Reporting                                                           ...
About the AuthorsJaydeep Chakraborty is a Senior Consultant with Cognizant Business Consultings Banking and FinancialServi...
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Volcker Rule Compliance: Preparing for the Long Haul


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For financial institutions, compliance with the Dodd-Frank Volcker Rule is a matter of urgency, and we provide a roadmap for preparation, analysis, and implementation with respect to systemic risk management, market making, underwriting, hedging, avoidance of proprietary trading, reporting infrastructures and more.

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Volcker Rule Compliance: Preparing for the Long Haul

  1. 1. • 20-20 InsightsVolcker Rule Compliance: Preparing forthe Long HaulWith the final version of the rule set to arrive on July 21, financialinstitutions must devise and implement dynamic structures that canensure ongoing compliance with key provisions. Executive Summary clients by separating traditional banking func- The nebulous nature of key provisions of the tions from activities such as proprietary trading, Volcker Rule has banking and financial services which are prohibited or severely restricted. organizations in the U.S. devoting an enormous amount of time and resources to determine the Not surprisingly, the banking industry has best way to comply with this new regulation frequently sought clarifications about the of the Dodd-Frank Wall Street Reform and Con- interpretation of the rule and challenged many of sumer Protection Act. The challenge is to balance its provisions. The final version of the rule is due the cost of compliance with the ability to drive on July 21, 2012. revenue growth. Most financial entities in the U.S. are affected by This white paper provides guidelines for organiza- this rule to varying degrees. These institutions tions seeking to plan for and achieve conformance need to reorganize their businesses to balance efficiently and effectively. Determining the poten- compliance with revenue streams. tial impact on various business functions through a detailed analysis is key for any affected orga- Importantly, the regulation will affect various nization. A detailed roadmap towards compliance trading functions of financial services enter- and empowering end-users with tools to detect prises. The affected companies will need to assess and preempt noncompliance are among other and redefine their strategies, especially for: important components of an effective strategy. • Market making: Although allowed under the Paradigm Shift rule, a banking entity must monitor this activ- The Volcker Rule as proposed under the ity to ensure that it is indeed market making Dodd-Frank Act1 seeks to reduce systemic risks, and not disguised proprietary trading. while allowing trading and other security-related activities that support liquidity in the U.S. finan- • Hedging: Prohibition of certain risk-taking cial markets. It aims to prevent a conflict of activities under hedging may prompt banks interest between financial entities and their and dealers to evaluate their strategies and 20-20 insights | july 2012
  2. 2. do away with any methods that may generate Post-trade compliance relates to measuring profit beyond the prescribed thresholds. Pre- the retained risk, recognizing the breakup of vention of hedging losses arising out of direc- the revenue earned, etc. tional trades will have to be considered as well. Achieving Compliance • Covered funds: The rule will limit finan- As organizations prepare to assess the true cial entities’ sponsorship of covered funds. impact of the rule in light of the reshaped A covered fund is essentially a hedge fund or regulation set to emerge on July 21, 2012, it is a private equity fund that does not offer its imperative that they: services to retail clients. The extent to which Organizations a banking entity can sponsor a covered fund • Identify and analyze all should devise will be determined based on its Tier-1 capital- trading activities that ization, the potential loss it will need to take on come under the purview an assessment and the total size of the covered fund. of the regulation. framework leveraging • Other activities: Some other activities related • Identify and analyze statistical methods to lending and underwriting may also be exposure to covered affected to varying degrees. Internal controls funds and the criteria for and analytics to map must be put in place to ensure such activities investment decisions. the impact (P&L, do not cross over into proprietary trading. • Assess the financial business processes The rule will affect the way risk management impact on the top line and and technology) from and compliance functions are carried out. The bottom line after consid- Key provisions of existing risk management and compliance ering all proprietary trad- infrastructure will need to be modified to ing activities. the rule on various accommodate increased monitoring and tracking functions and of trading activities: Organizations should devise business units. an assessment framework • Risk management: For the most part, the leveraging statistical methods and analytics to industry’s existing risk management frame- map the impact (P&L, business processes and works help financial entities predict and technology) from key provisions of the rule on mitigate losses. Following various functions and business units. They should: The existing risk the new regulation, the risk management methods management will also have to predict • Analyze the nuances of permitted trading activities that need to be tracked and moni- and compliance and restrict proprietary tored to ensure compliance, focusing on: infrastructure will trading. Firms will need > Revenue generation sources and patterns to formulate policies and in trading activities. need to be modified procedures to prevent > Sources of trades and strategies from to accommodate the noncompliance. This will various trading desks and traders.increased monitoring require identifying areas > Financial instruments traded by the trading of potential noncompli- desks and the associated revenue risks. and tracking of ance and devising internal > Hedging strategies and positions. trading activities. controls for regular audits to identify loopholes in the • Assess gaps in risk management and com- compliance process. The Volcker Rule also pliance tests and define all the metrics that imposes new reporting requirements — both will be needed to monitor trading activities. internal and external. A multiphase project-oriented roadmap towards • Compliance: Banking entities will be mandated Volcker Rule compliance should be drafted by to implement both pre- and post-trade compli- organizations that may want to continue with ance measures to ensure conformance to the the permitted trading and sponsorship activities. provisions of the rule. Pre-trade compliance Establishing a project governance model, before relates to the account from which the trade an organization starts identifying gaps, will ensure is placed, identifying the counterparty, etc. clear ownership of responsibilities and establish 20-20 insights 2
  3. 3. efficient channels of communication. Mapping the processes are graduating from being detection- needs for compliance to existing business models based to becoming prevention-oriented. of trading, risk management and compliance can help identify gaps quickly. A detailed analysis of An important component of this strategy is to the identified gaps can be undertaken based on provide responsible end-users with tools that the organization’s priorities. Once the gaps are can help them preempt and prevent noncompli- identified, the next step will be to develop efficient ance. Such an approach can go a long way toward and accurate solutions ensuring compliance with the Volcker Rule. The A multiphase that reflect the data needs designated business process and technology project-oriented andlandscape. Thebusiness- IT the existing volume capabilities must develop and track the various metrics and measures that the Volcker Rule roadmap towards of business and the suggests. Some of these requirements are: Volcker Rule associated risk of noncom-compliance should pliance driving the choice factors will be important 1. Distinguish customer-initiated trades. be drafted by of solution. This distinction may not be currently made and/ organizations or tracked in the absence of regulation prohibit- Finally, a detailed imple- ing proprietary trading. that may want to mentation plan will need to continue with the be drawn up. It should not Workflows in the order-cap- Mapping the needs permitted trading only target the gaps identi- ture-to-settlement process for compliance to fied but also conform with may be required. These work- and sponsorship the target operating model flows must tie the order origi- existing business activities. for the planned new busi- nation (it may be as simple models of trading, ness processes in the organization. Figure 1 pres- as recording the phone call ents a sample roadmap for achieving compliance. the client makes asking for a risk management and trade to be executed) to the compliance can help Speeding Up Conformance settlement of the trade in the identify gaps quickly. Given the wave of regulatory changes as well as the customer’s account. increasingly sophisticated nature of frauds being committed, compliance and risk management This will also create audit trails to support the audit program mandated by the Volcker Rule. Compliance with Volcker Rule: Roadmap Volcker Rule-Compliant Banking Entity • Define detailed specs and system requirements. ss • Develop high-level & low-level designs. Implement & ce • Data mapping and dependency identification. ro Operationalize • Design, develop, test and implement. eP • Operationalize proposed recommendations based on target operating model. nc ia pl m • Define target state business processes. Detailed Co • Develop detailed business requirements for metrics to serve as early warning system Analysis le for noncompliance. Ru and Process • Develop detailed guidelines for future policies and procedures related to er Definition lck risk management and compliance. (24–30 Vo • Define target operating model. weeks) • Product evaluation (if required). • Concentrate on market making, underwriting, hedging, investments in covered funds, lending. • Understand revenue-risk appetite for the affected LOBs. • Identify risk measures. Identify Gaps • Identify gaps in risk management framework and policies and procedures. (6-8 weeks) • Identify business process changes. • Understand IT landscape supporting relevant risk & compliance functions. • Define a high-level data model to support any solution for gaps identified. Noncompliant Banking Entity • Understand the changes and how these impact business functions. Get Prepared • Identify impacted business and relevant stakeholders. (1-2 weeks) • Identify SMEs from relevant LOBs. • Define project governance framework. Figure 1 20-20 insights 3
  4. 4. 2. Determine counterparties distinctly in a detect “disguised” proprietary trades (directional trade. trades disguised as market-making or hedging). Currently, generic identification processes may Rules-based analytics models fed with data points be in place to determine counterparties at a par- to detect proprietary trades, risk exposure, etc. ent company or issuer level. can ensure that noncompliant trades and trading desks are detected in the The new regulation requires establishing and pre-trade stage. Data points Rules-based tracking additional attributes that can help that need to be tracked analytics models determine the true nature of the counterparty and modeled include finan- (or issuing entity) to cial instrument type, vari- fed with data points Given the wave decide if the trade can be ous risk measures, asset to detect proprietary of regulatory placed. Derivative instru- size, revenue, fees, bid-ask trades, risk exposure, changes as well as ments with counterpar- securities and underlying spread and so on. etc. can ensure that the increasingly ties need to be examined Such a capability will ensure noncompliant trades sophisticated and tracked appropriately. conformance with the Vol- and trading desks cker Rule provision mandat- nature of frauds This will also support ing identification of poten- are detected in the being committed, audits and reporting on tial nonconformance. pre-trade stage. compliance and traded counterparties. 5. Enhance data management and reporting risk management 3. Compute metrics infrastructure. processes are under revenue relative to graduating from risk at the trading desk The current risk and compliance reporting infra- level. structure at various organizations may not be being detection- geared toward collecting data and reporting based to becoming Currently, it is easy to for the several new metrics that may need toprevention-oriented. measure and attribute be developed (e.g. VaR exceedence, Skewness revenue and risk at the and Kurtosis of portfolio P&L, etc.) and tracked trade/book level. The challenge is to implement post-Volcker. these metrics at the trading desk level in the pre-trade placement stage. The data management infrastructure will need to be enhanced to ensure that appropriate systems Risk attribution at the trading desk level prior to consume the data that is required to generate trade placement will require software that can all the metrics and associated metadata needed model payoff scenarios for the trade and a risk for risk and compliance processes to adhere engine that can integrate the risk and return of to Volcker provisions (see Figure 2, next page). the trade with the risk and return of the portfolio The extent of the augmenta- that it is a part of. tion will depend on the orga- Noncompliance nization’s business volume, Modeling the risk of the trade along with its risk future growth plans, etc. was never an option. attribution to the portfolio in the pre-trade stage Now even the will allow the trading entity to ascertain the capi- Conclusion intent to conform tal required to cover the risk. It can therefore The evolving regulatory envi- determine whether the trade would add to the ronment calls for augment- to regulations profitability of the desk without increasing its ing and implementing capa- must be clearly uncovered risk. bilities that can orient risk demonstrated. and compliance functions 4. Establish early warning systems to detect from detection to prevention. To achieve this, noncompliance. exceptional business intelligence and/or visual analytics tools are necessary. This, in turn, Existing risk management practices and systems requires data creation and aggregation for effec- at trading desks come into the picture post-trade. tive reporting on various risk metrics and other Such systems and processes will not be able to statistical measures for monitoring of trading 20-20 insights 4
  5. 5. Point-of-arrival Architecture for Risk and Compliance Reporting Areas that may potentially be affected V due to the Volcker Rule Mobile and Tablet Client’s Web Site Default Web Portal Data Transfer Protocols Distribution Data Management Business Activity Governance & Control Framework SLA Tracking Operational Efficiency Enhancers Audit trail / Monitoring Workflow Tools Data Access Business V Online Data Analyzer Extracts via MS Excel Data Intelligence Visualization Operational Reporting V Investor Statements E-mail Integration Business Rules Integrated Issue Entitlements Management Engine V Configurable Data Extraction and Validation V V V V V Trade Processing Performance & Accounting Security Master Client Master Configuration Attribution Data Supplementary Unstructured Corporate Actions Reconciliation Custody Product Master Security Info Data Investment Billing Accounting Middle Office Bank Office Reference Data Custom DataSource: Cognizant Business Consultings Asset and Wealth Management PracticeFigure 2activities. Considering the continuing economic The Volcker Rule is only emblematic of the currentturbulence that has roiled the financial services forces driving financial services organizationsindustry worldwide, the cost of noncompliance is to proactively detect anomalies and protect theirclearly sky-rocketing.2 Noncompliance was never clients’ interests and assets.an option. Now even the intent to conform toregulations must be clearly demonstrated.Footnotes Dodd–Frank Wall Street Reform and Consumer Protection Act: a federal financial regulatory reform1 signed into an act in 2010 in the United States.2 Litigation involving major banking and financial services organizations such as JPMC, Peregrine Financial and Barclays are some recent examples.References• Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds, Financial Stability Oversight Council, Jan. 2011. www.treasury.gov• Dodd-Frank Act document: One Hundred Eleventh Congress of the United States of America, Jan. 5, 2010. www.sec.gov• Final Rules Regarding Further Defining “Swap Dealer,” “Major Swap Participant” and “Eligible Contract Participant,” Commodity Futures Trading Commission. www.cftc.gov• Dodd-Frank Act Regulations, Report to Congressional Addressees, United States Government Accountability Office, Nov. 2011. www.gao.gov• Volcker Rule Resource Center. www.sifma.org 20-20 insights 5
  6. 6. About the AuthorsJaydeep Chakraborty is a Senior Consultant with Cognizant Business Consultings Banking and FinancialServices Practice. He has nine years of experience in implementing IT solutions for financial servicesclients in the U.S. and Europe. Jaydeep has been focusing on the regulatory changes affecting financialinstitutions in the U.S. and has developed and implemented solutions to help such institutions staycompliant with changing regulations. He can be reached at Jaydeep.Chakraborty@cognizant.com.Jayanta Das is a Consulting Manager with Cognizant Business Consultings Banking and FinancialServices Practice. He has 11 years of experience in sectors such as oil and gas, BPO, retail banking,asset and wealth management and risk management and compliance in financial services in bothemerging markets and the U.S. In financial services, Jayanta has worked on several consultingengagements at diversified asset and wealth management organizations in the U.S. He can be reachedat Jayanta.Das2@cognizant.com.Cognizant Business Consulting ContactsBalaji Subramanian is a Consulting Director with Cognizant Business Consultings Banking and FinancialServices Practice. He has more than 14 years of experience in consulting in the area of asset and wealthmanagement in financial services. Balaji can be reached at Sbalaji@cognizant.com.Anshuman Choudhary is a Consulting Senior Manager with Cognizant Business Consultings Bankingand Financial Services Practice. He has 14 years of experience in asset and wealth management and riskmanagement and compliance in financial services. Anshuman has been instrumental in implementingseveral programs on anti-money-laundering, counterparty credit risk and clearing and settlement forclients across the globe. He can be reached at Anshuman.Choudhury@cognizant.com.Raghvendra Kushwah is a Consulting Manager with Cognizant Business Consultings Banking andFinancial Services Practice. He has nine years of experience in implementing IT solutions for financialservices clients in the U.S. Raghvendra focuses on risk and compliance projects in the financial servicesspace and has modeled innovative solutions that lowered clients’ turnaround time to be compliant withregulations. Raghvendra can be reached at Raghvendra.Kushwah@cognizant.com.The team would like to acknowledge the research contribution of Souvik Kumar Biswas from CognizantResearch Center to this report.About CognizantCognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business processoutsourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquarteredin Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deepindustry and business process expertise, and a global, collaborative workforce that embodies the future of work.With over 50 delivery centers worldwide and approximately 140,500 employees as of March 31, 2012, Cognizant is amember of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among thetop performing and fastest growing companies in the world.Visit us online at www.cognizant.com for more information. World Headquarters European Headquarters India Operations Headquarters 500 Frank W. Burr Blvd. 1 Kingdom Street #5/535, Old Mahabalipuram Road Teaneck, NJ 07666 USA Paddington Central Okkiyam Pettai, Thoraipakkam Phone: +1 201 801 0233 London W2 6BD Chennai, 600 096 India Fax: +1 201 801 0243 Phone: +44 (0) 207 297 7600 Phone: +91 (0) 44 4209 6000 Toll Free: +1 888 937 3277 Fax: +44 (0) 207 121 0102 Fax: +91 (0) 44 4209 6060 Email: inquiry@cognizant.com Email: infouk@cognizant.com Email: inquiryindia@cognizant.com©­­ Copyright 2012, Cognizant. All rights reserved. No part of this document may be reproduced, stored in a retrieval system, transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording, or otherwise, without the express written permission from Cognizant. The information contained herein issubject to change without notice. All other trademarks mentioned herein are the property of their respective owners.