RIAs, Hedge Funds to Pay Up for Compliance Help
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Registered investment advisors, broker-dealers and hedge funds are spending more money on compliance software than ever before. This according to a report released on Tuesday by research firm Celent, which predicts that the U.S. wealth management compliance solutions market will reap $178 million in sales in 2007, growing to $318 million by 2011. The overall market is expected to grow steadily at a 15 percent compound annual growth rate, but the kinds of purchases made and the amount spent by different firms will vary by market segment.
Granted 15 percent annual growth is not an outrageous pace, but the study shows that more and more firms are looking to automate their compliance operations to cut costs and keep pace with an expanding set of rules. “Compliance continues to be an ever-growing responsibility for senior managers in a variety of financial services firms, especially those with a significant retail business component,” says Isabella Fonseca, senior analyst and co-author of “Automated Wealth Management Compliance Solutions.”
The very cost of compliance for securities firms has skyrocketed, nearly doubling in the past three years. Total compliance spending by securities firms reached an estimated annual total of more than $25 billion in 2005, up from $13 billion in 2002, according to a February report from the Securities Industry and Financial Markets Association (SIFMA). Over 93% of total compliance costs were staffing-related.
To take advantage of the increasingly rigorous regulatory environment, product manufacturers have been busy rolling out automated compliance products that allow chief compliance officers to monitor and track their firms and individual employees.
But not all segments of the wealth management business will spend the same amount of money on compliance, nor will they spend it on the same things. RIAs will spend the most money, increasing spending from $88.4 million in 2007 to $183.1 million in 2011, the Celent report says. “The largest opportunity for compliance solutions is the RIA segment because [RIAs are] the most heavily regulated, they’re experiencing the fastest growth and represent the largest segment of the [wealth management] market,” Fonseca says. Similarly, hedge funds will pony up more dough on compliance IT than in the past as a result of increased investor and regulatory pressure, ramping up spending from $41.5 million to $78.8 million in 2011, according to the report. Broker/dealers will spend a more modest $43 million in 2007 and experience slower growth over the next four years. Trust companies will spend very little.
The use of third-party vendors for compliance functions is expected to lighten the load for CCOs, other senior managers and financial advisors. Some of the tasks these vendors will tackle include tracking trade orders, soft dollars, 12b-1 fees, employee licensing, continuing education, suitability, gifts and entertainment, email surveillance and retention, manager selection and sales transaction evaluation. Complying with Sarbanes-Oxley and Anti-Money Laundering rules and other recently enacted laws also would fall under their bailiwick.
However, it is difficult to find a third-party vendor who can manage all the disparate functions needed to run a wealth management firm. “It’s a very confusing market. There are not many choices for firms to choose from. Few firms can handle everything under one roof,” Fonseca says. “We looked at 50 providers but only eight of them were proficient” in all areas of compliance.
Two of the vendors, Actimize and SunGard, offer compliance tools that readily integrate into large financial operations systems, the report says. Actimize compliance tools can be tied to a trade order management system to develop real-time compliance alerts. SunGard’s compliance tools are set up either as stand-alone products or as part of a product suite. Five of the other products highlighted by the study are stand-alone compliance systems: Automated Compliance Systems, Compliance11, Iconium, TurboCompliance, and TerraNua. The three firms that received the highest rankings based on Celent’s evaluation were Activize, SunGard and Compliance 11. These firms excelled at the four main criteria: Advanced Technology, Breadth of Functionality, Customer Base, and Depth of Client Services.
Despite the small number of full-service vendors and the hassle of a la carte compliance functionality, it’s still more cost effective than building it in-house, according to Fonseca’s research. “The trend of outsourcing will continue,” she says. What does this mean for RIAs and broker/dealer employees? “It definitely makes life easier for the financial advisors. They will have more control and spend less time on compliance paperwork.”
Ultimately, smaller firms, RIAs for example, provide the bulk of the selling opportunities in the wealth management compliance space. This will benefit the stand-alone product vendors that lack integration to complex larger systems, Celent says. Additionally, there may be opportunities for vendors to license their stand-alone technology as modules to larger systems. While smaller firms will probably go the standalone route, larger firms will increasingly add on compliance services as needed. Eventually, compliance will become a built in component of back office systems for all but the smallest firms.
