Five actions to take five years into Dodd-Frank
By Jim Low, KPMG
While just under two-thirds of its provisions have been implemented, the Dodd-Frank Act remains one of the more controversial pieces of legislation five years in. Dodd-Frank requires private equity (PE) investment advisers with more than $150 million in regulatory assets under management to register with the Securities and Exchange Commission (SEC) and comply with numerous requirements associated with registration including increased fiduciary responsibilities, maintenance of records, restrictions relating to fees and custody of assets, as well as submit to periodic examination by the SEC. The SEC also requires PE firms to focus on portfolio valuation.
With the U.S. 2016 elections coming up and with Congress having already made some legislative changes to Dodd-Frank, private equity awaits a confluence of events to determine the law’s ultimate impact. In the meantime, here are five actions to take, no matter what the future holds.
1. Incorporate compliance policies into your business model
Regardless of enforcement velocity or future legislative changes, firms that get ahead of regulatory concerns and evolve their business model to include regulatory transformation place themselves in a position to grow. Having monitoring and surveillance in place will assist in identifying potential areas of non-compliance and observe on a risk basis areas for improvement. Potential gaps can only be addressed by implementing a holistic approach to managing regulatory demands and ensuring that compliance programs are fully integrated into the strategic objectives of the firm. The resulting fuller vision may also reveal new opportunities.
2. Adopt a culture of compliance
The private equity industry has not been impacted to the extent that banks have, but the potential costs of non-compliance, both in fees and reputation can motivate behavioral change nonetheless.
With their limited resources, regulators look favorably upon firms’ efforts to voluntarily examine their practices and make changes to address regulatory discrepancies. Firms that successfully enact compliance programs and maintain a working relationship with regulators, lead others who see the benefits of working with the system.
3. Keep a pulse on advocacy efforts
As lobbying expenditures in the financial sector have increased significantly in the last few years, with a 2.5 percent uptick in 2014 alone, financial institutions have met with some sympathy from Congress in their efforts to roll back certain provisions of Dodd-Frank. Bipartisan Congressional concern could ultimately lead to rolling back or modifying the Investment Adviser Act registration requirements for PE advisers, but change remains far from guaranteed. Results of upcoming elections may also impact the likelihood of changes in the PE registration regime, given ongoing criticism from Republicans that Dodd-Frank overreached and from some Democrats that it didn’t go far enough.
4. Analyze big data to manage risks
The SEC has been able to sift through massive amounts of data using tools to better understand the PE industry. It makes sense that the industry follow suit, and use tools that harness and analyze data to help identify gaps and manage risks better. Using data is integral to the way we all will do business in the future, so firms should consider investing in the tools to manage data now.
5. Plan ahead based on size of firm
Complying with the provisions of the Dodd Frank Act could range from $1,400,000 to more than $2,700,000 in just legal and other fees surrounding initial paper work. The costs for designing, implementing, and maintaining a compliance program, including hiring talent and employee training, are comparatively higher for smaller firms as compared to larger firms. Annual ongoing compliance costs often exceed $584,000, even for advisers to mid-sized and smaller funds.
As a result, small and mid-size firms may be further behind implementing compliance policies than larger ones and may have to consider how they will continue to operate with the regulatory burden. Consolidation of these firms is something to consider and may become a trend in the near future.
Large firms should keep in mind that the Financial Stability Oversight Council (FSOC), the Financial Stability Board and the International Organization of Securities Commissions (IOSCO) continue to review whether various asset management activities present any potential systemic risk concerns, but those efforts appropriately do not appear focused on private equity. While designation of large firms as Systemically Important Financial Institutions seems unlikely at this time, firms will want to monitor developments in this space carefully in the future.
As noted above, Republican success in the 2016 elections, if it occurs, may help ease some of the regulatory burdens associated with Dodd-Frank; however, firms that proactively set up and maintain a comprehensive compliance program will be better positioned to identify and address areas of concern, therefore avoiding severe penalties. Additionally, if they use that program to identify areas of growth, they will be able to use this set of regulations to their advantage.
Jim Low is the U.S. and global leader for Regulatory Change at KPMG LLP and is based in New York.
