The True Cost of Compliance

Damned if you do, damned if you don’t. Financial firms are caught up in a seemingly unwinnable paradox. Permission to operate requires meeting regulatory compliance laws and policies as defined by the national and global financial authorities by which the firms are governed. The global pandemic spiked compliance costs as Compliance Officers and regulators grappled with how to manage an overnight shift from traders operating in secured environments – to working from their kitchens. As it is often the case with technology advancements, the true cost of those advances should not be measured in currency, it should be measured in jobs.

Adding insult to injury

Although regulators temporarily relaxed reporting and some other aspects of compliance following the arrival of COVID, all firms recognized that the day of reckoning would eventually come and enforcement was non-negotiable. At first, at the onset of the coronavirus, Compliance Officers were initially stunned and overwhelmed by the unexpected paradigm shift in how and where traders work and communicate. However, there is nothing quite like a necessity to spur innovation and change.

Heroically, those tasked with ensuring that operations met compliance guidelines rose to the challenge of COVID, swiftly enacting new policies and identifying solutions to meet the unexpected reliance on personal devices and unapproved Communications modes like WhatsApp, Facebook Messenger and Instagram. The trend towards replacing repetitive actions with robotics, software and artificial intelligence (AI) had already begun in other industries but was just beginning in banking. COVID accelerated digital transformation catalyzing a workplace practice from one that was an emerging trend into a best practice within less than six months of a global pandemic. As we’ve entered “the new normal” phase as a society, using software instead of human capital is on-trend.

Software solutions in RegTech offer greater accuracy and can better pinpoint potential transgressions by interpreting nuance, even in strings of multi-lingual texts punctuated with emojis. Here’s the rub. Despite the effort by Compliance Officers to stabilize their firms’ operations in a COVID crisis, their jobs are now on the chopping block. Experts are forecasting a 25% reduction in compliance staff in London’s banks over the next twelve months.

Crippled by diminishing returns and burdened with skyrocketing costs for compliance in a COVID era, banks are forced to cut costs. HSBC plans to strip $4.5 billion in costs over the year ahead which includes a reduction in force targeting 35,000 workers. In a double-whammy, banks aren’t hiring either: job vacancies in London have declined by 55% versus this time last year.

A closer look at the costs of compliance

In 2013, KPMG reported on the hedge fund industry’s challenges of managing change and uncertainty – and that was in a pre-pandemic era. Increased institutionalization at that time was putting pressure and a greater focus on risk management, due diligence and transparency as it related to operations, transactions and those who brokered them. Compounding the challenges was a shifting regulatory environment which further exacerbated the complexity – and drove up the costs of compliance.

Deloitte recently analyzed how the costs of compliance have changed since the financial crisis of a decade ago. They found that operating costs for compliance rose dramatically: up 60% since pre-financial crisis spending levels. Their report highlighted how the increasing costs of compliance, in combination with low-interest rates, stagnant revenue growth and a slow economy puts downward pressure on returns. The Dodd-Frank Act of 2010 alone spiked compliance costs by $50 billion per annum. Today, with the added pressure of COVID, many economies are in free-fall, unemployment rates are at levels not seen since The Great Depression, and many countries are in the midst of a recession.

LexisNexis published its analysis of compliance spending earlier this year (April 2020): globally, financial institutions will spend $181 billion on compliance. Communications monitoring are among the most expensive aspects of compliance efforts. Over the past two years alone, compliance costs worldwide have risen 7% annually. Not surprisingly, the US and Europe hold the unwelcome badge of spending the most on compliance; $10,000 per employee on average. As for spending on crime compliance, the mid- to large-sized financial firms in the Netherlands, UK, Germany, Italy and France hold the dubious distinction of spending the most.

The option of non-compliance isn’t feasible. The delta is 2.71 times greater costs for those organizations that do not meet regulatory compliance requirements according to a 2019 report by Ponemon and Globalscape. On average, when financial institutions of all sizes are considered, the annual cost of compliance is ~$5.5 million for those who comply and ~$15 million for those who do not. Between the years 2008-2018, banks paid more than $321 billion on enforcement actions including settlements and related fines. An estimated 10+%, potentially increasing to 20% by the year 2022, of banks’ operating budgets are dedicated to compliance.

Slipping through the cracks

Everyone upholds the value of technology – until they’re negatively impacted by it. Insofar as we know, members of society have victimized others since time began. There is always someone, somewhere, who has nefarious intentions and figures out how to game the system to his/her/their advantage. Although advances in RegTech, particularly around the increasingly complex and utilized engagement practice involving e-Comms, may be regarded as an essential evil by those who have been displaced, there is no denying the value that it can bring to financial firms with respect to managing compliance costs and reducing risks. Recognizing that the true cost of compliance is at the level of the people impacted by the advances in RegTech, employers need to consider upskilling, training and other initiatives to lessen the blow.