Alan Halfenger is a Managing Director in Treliant’s New York office. A former Chief Compliance Officer from the securities and investment management industry with experience in Anti-Money Laundering (AML), anti-corruption, sanctions, and know-your-customer compliance, Alan advises clients on regulatory risks related to global securities and commodities dealings, as well as…
The bank securities business is once again undergoing a period of dramatic growth and change, driven both by long-term trends affecting the entire financial services industry and by significant short-term, tactical issues. Banking organizations engaged in the securities sector are rethinking their supervisory, compliance, risk management, and audit infrastructures to capitalize on new opportunities and meet new challenges.
The market and regulatory forces shaping the bank securities business can be exceedingly complex to manage, as banks increasingly compete with, or at times partner with, traditional broker-dealers and FinTechs to address this changing market. The long-term trends that banks and their securities affiliates are dealing with include market forces, such as historically low interest rates, the move from traditional commission-based brokerage relationships to fiduciary investment management activity, the growth of FinTech and online businesses, the globalization of the securities and investment industry, significant political developments such as Brexit, and the growth of private investment funds. Their shorter-term issues include COVID-19 and remote working, recent shifts in regulatory oversight, social and generational movements, and the impact of the U.S. elections.
This article highlights the compliance, risk management, and audit implications of today’s shifting landscape by looking at how banks engaged in the securities business are responding in three areas:
- Business and Product Expansion
- Staffing and Technology Pressures
- Regulatory Oversight and Change
Business and Product Expansion
As a general matter,we see many banks taking a broad approach to securities activities and
expanding their capabilities – whether in-house, through a subsidiary/ affiliate, or with a
third-party marketing firm – while others may stiII be expanding, but in a narrower approach
There are a number of specific examples demonstrating this expansion, including:
- lnsourcing the retail sales of securities to bank branch customers;
- Expanding asset management and securities sales to private banking clients;
- Broadening institutional asset management for proprietary mutual funds and institutional clients;
- Adding capabilities to the investment banking business (including trading, M&A, and underwriting of securities); and
- In some cases, utilizing trust and custody powers to provide some of the services above on a narrower basis.
While the first four of these approaches can be broadly defined and include a wide range of
activities, they aII generally involve broker-dealers or registered investment advisers, either
at an affil rate or third party if not in-house. The fifth example provides ba n ks a stepping
stone toward a broader business through the use of existing bank permissions.
A number of banks, especially established players in private banking, are expanding their securities offerings, including hiring teams of brokers/investment advisers to significantly increase their business’s assets under management. These acquisitions bring existing books of
business and clients that often trade more varied securities (equities, derivatives, private
funds, and leverage) and in more sophisticated and complex ways. This materially adds
complexity and risk to aII aspects of the broker dealer and investment advisory affiliate, as
well as the overall organization. Banks need to address this increased complexity by adding
technology and oversight processes and expanding the experience and skill sets of their control
teams, including compliance, legal, audit, risk management, and supervisory controls. In addition to reactively adding staff in these areas, banks need to get ahead of these issues and address their increased need for sophisticated infrastructure and their growing risk during the new product approval process.
Other banking organizations focus on retail solutions by exploring the establishment of an affiliate broker-dealer, in order to capture additional revenue currently flowing out to a registered third-party marketing firm. While this approach often offers increased revenue opportunities, the issues and risks are obvious. Prior to expanding in this direction, best practice is to engage in detailed business planning that addresses not only the business opportunities, but the infrastructure and control requirements and costs. All too often the lure of increased revenue overshadows the need for specialized infrastructure and staff.
The current bank securities business expansion involves not only retail and private banking, but
institutional banking as well. Here, bank-affiliated securities businesses are investing in prime
brokerage services to drive custody and trading revenues, complex lending and trading to attract credit funds, a nd even the development of investment management-sponsored “fund of funds” products investing in private equity and hedge funds. The size of these businesses combined with their complexity is what creates the potential for large missteps,controversy, and regulatory issues in the future. While investing in staffing and technology for the first line of defense is critical , banks are increasingly also staff ing the compliance, risk, and audit teams with professionaIs with relevant securities experience. Banks looking to deepen their exposure and revenue from the alternative asset management industry must continue to expand the risk infrastructure to balance risk and reward.
Growth and expansion are essential to any banking organization, and the growth of the securities business makes strategic sense given the macro trends in the world But this growth cannot be done at the expense of the control environment We are currently seeing many organizations exploring the expansion and growth of their securities affiliates. The most successful ones are investing in the second and third line of defense and identifying the risks, finding the resources to mitigate them, and continuing to monitor their exposure.
Staffing and Technology Pressures
Having the right team with access to the right tools is criticaI to any successfuI organization.
The rise of online and FinTech businesses has put a great deal of pressure on the securities
businesses of many banks. While this trend long predates the pandemic, more and more financial services firms are trying to reach customers through the internet. The many FinTech startups have driven this trend, and the pandemic has accelerated it Many banks have responded not only by expanding their online banking and credit offerings, but their securities offerings as well.
Online and FinTech growth has required banks to develop not only new client and business
technology, but additionaI processes and controIs for oversight, risk compliance, and supervision. Online tools need to be developed for client information gathering and disclosures,
account and activity monitoring, and electronic communications. Banks often lack staff with the multifaceted expertise to successfully develop and deploy these tools, requiring them to source a nd hire candidates with technology, regulatory, and product expertise from the securities industry. These individuals are often highly sought after by hedge funds and FinTechs, so they often command higher compensation packages,which can cause internal staffing and budgeting pressures. Additionally, banks often have to integrate these systems into existing bank client infrastructure, which forces them to build rather than buy system solutions, causing additional staffing and budgetary pressure.
The banking industry has gone through severaI cycles of consolidation, regionalization, and
headcount reduction. This has had direct impact on the staff supporting affiliate broker-dealers. We frequently talk to audit and compliance teams that are extremely understaffed, and
this problem is compounded by the fact that securities-related backgrounds are not common in banks. Many of them are turning to part-time and co -sourcing arrangements to supplement their teams and fill the knowledge gap. This option often provides organizational flexibility and cost management,while enhancing available staffing options. However, banking organizations need to stay focused not only on their growth areas, but on areas where they are cutting costs. Amid cost cutting, the risks and issues never seem to go away.
New emerging technologies across the industry, but especially in compliance and risk, are
requiring banks to expand the technical capabilities of their teams. Whether it is the latest in
artificial intelligence, trade surveillance tools, or return and performance calculators, specialized RegTech securities technology is required. As are staff members familiar with these tools.
Finally, working from home has changed how many of us do business, and the bank securities
industry is no exception. Banks are developing new controls that address remote working by their sales people, especially as regulators focus on supervisory oversight as well as protecting older customers and others from sales practice abuses in the current environment.
Regulatory Oversight and Change
Although industry commentators often say we are in a deregulatory period, many of our bank
broker-dealer clients continue to feel the pressure of expanding regulations. Examinations and
reviews continue to cause stress on compliance programs. These examinations include significant attention to bank securities activities from federal and state banking regulators, as well as the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) It is common to hear chief compliance officers say that they have multiple exams going on simultaneously, from different regulators, while also trying to implement new regulations and controls, handle internal audits, respond to changes due to the pandemic, and prepare for the wave of customer complaints they are expecting as the economy shakes out.
Adding more pressure, FINRA and the SEC have both begun examinations focused on the implementation of the new Regulation Best Interest (Reg Bl), which reemphasizes clients’ interests over their financial advisors’. Many bank-affiliated securities and investment management firms are trying to get ahead of these exams by conducting internal reviews to test the compliance of their newly implemented programs. Because of the many inherent conflicts, this exercise has been especially hard in bank branch based retail organizations that market proprietary mutual funds. The Reg Bl changes are significant, and bank securities businesses need to be conducting independent testing and audits of their implementation before facing regulators.
Finally, one of the areas of focus that has been mentioned by severaI regulators and ex-regulators is the duty of the banking organization to oversee the activities of non affiliated
broker-dealers marketing in their branches. Many banks do not have the audit staff to test these
securities activities, but reguIators are clear in their expectations for management and audit
oversight Banks must develop programs that address these risks and protect their clients or face severe criticism from the reguIators.
Recently, we were reviewing information from a bank securities working group, and it became very clear from the industry data that the securities business has become a strong and vibrant part of the banking industry Often, bank management, despite enjoying the increased revenue, does not fully appreciate the infrastructure and risk issues related to the securities industry These issues and trends are daunting, and frankly, this article only scratches the surface of the challenges banks face. It does, however, underscore a fundamental point: Going forward, how banks staff and develop their securities businesses will be centraI to their overall health and success.