Regulation Strangulation

So, here’s a quick rundown of applicable regulations to registered entities based on review of four regulators (CME/CFTC/ICE/NFA):

  1. FCM: 1,457
  2. IB: 847
  3. CTA: 566
  4. CPO: 659
  5. Swap Dealer: 705
  6. DCM: 320
  7. SEF: 258
  8. MSP: 673
  9. DCO: 457

Is it any surprise that there are fewer FCMs?  If cost is a basic function of (# of regulations) x (spend per line item), it’s obvious that the clearing firm community would shrink (and will continue to do so).  We conducted a little research and concluded that the approximately $6.4-billion spend on regulatory compliance in the derivatives sector—calculated based on industry statistics—can be split amongst the 6,500 active derivatives firms and the total number of obligations we have (4,146).

Accordingly, each line item costs the industry $1.54 million, or $237 per firm per line item. In the case of a clearing firm, this means the cost is about (237) x (547 more rules than an IB) = $130,000 more in compliance costs than another firm!  (Note: These are not weighted by complexity of rule, so it’s pure numerical analysis—weighting would likely skew the numbers on a marginal basis up or down).

fcmbloggraph

While we’re careful not to draw conclusions of causation vs. correlation, the anecdotal evidence is astounding:  there are 1,457 obligations on clearing firms—far more than clearinghouses, SEFs, and actual exchanges.  By constraining these middlemen, we are placing a bottleneck on the financial services supply chain:

fcm

By isolating that single entity and not being thoughtful about regulation and the implicit costs (which should be aggregated here based on our calculation), there is little surprise that the number of clearing firms is decreasing at an alarming rate.  That’s why we do what we do:  our software helps these firms track and manage their regulations more efficiently—saving time, saving money, and reducing risk.

Ascent Raises $1.2 Million Seed Round

We’re so thrilled to announce the successful close of our oversubscribed $1.2 million seed funding round!

The funding will be used to operationalize and streamline our platform, to invest in the continued growth of our proprietary data set, and to make a few key hires that will help us develop the best possible product.

Additionally, we’re pleased to announce that Paul R. Wood (retired partner at Madison Dearborn Partners), Fred Hatfield (Chairman of the Board, ICE Futures U.S., and former CFTC Commissioner), and Jim Gray (Current CEO of proprietary trading company G-Bar LP and founder/former CEO of OptionsXpress, acquired by Charles Schwab in 2011) will be joining the Board of Directors alongside CEO Brian Clark and COO Aaron Droba.

“What excites me about Ascent is how they’re using technology to shape the future of the derivatives industry by bringing simplicity and efficiency to the compliance process,” said Hatfield. “Regulators have adopted a ‘broken window’ policy for reporting and compliance requirements for every market participant. Ascent offers a cost-efficient solution that can alert users to problem areas that cost firms both financial and reputational harm.”

We’ve also recently signed a licensing agreement with another registered self-regulatory organization (“SRO”) that permits us to centralize their current sets of rules and documents on our platform–simplifying the processes and procedures required for their customers to comply with applicable regulations.

It’s a privilege to gain the experience and insight of Paul, Fred, and Jim as we continue to execute on our strategic vision for Ascent.  We know our platform can dramatically simplify compliance processes for firms, and we’re eager to build upon this momentum to continue constructing the most comprehensive solution possible for our clients.

Regulatory Complexity: In Numbers

Statistics and pundits—those oft-maligned liars—share the same stories: we are more highly regulated than ever before. While the Federal Register has hovered around 80,000 pages per year, the Code of Federal Regulations has added nearly 45,000 pages since 2010. Unsurprisingly, confusion abounds in this tangled web of regulations. Imagine a simple regulatory “sandbox,” having four corners in which you can play (that is, legal spots in which companies can operate). Facing regulation from as many as 12 bodies (and often more!), how can the average financial services broker find a safe spot to play in a sandbox that now has 3,972 sides?

We conducted a lexical analysis of financial service regulatory rulebooks to see where they rank on a spectrum from simplicity to cross-rule complexity. After removing basic words (like “the”, “a”, etc.), we tested for the number of unique words, with more unique words indicating greater clarity. The results were not surprising:

rulebook simplicity

Admittedly, the Exchanges’ rulebooks that show the highest level of simplicity were calculated based on trade practice rules. Nonetheless, all calculations were done on a ratio basis. The higher the number, the smaller the regulatory sandbox. In other words, the higher percentages mean a higher degree of certainty and, thus, a higher ability of customers to manage their compliance risk.

The certainty of a smaller sandbox means lower regulatory costs for companies—a result that is clearly better for everyone.

Number Crunch

We’ve crunched the numbers: the average US-based clearing firm needs to comply with nearly 2,000 unique, affirmative, regulatory obligations.1 Trading derivatives outside of the US? You can effectively double that—and adding another clearinghouse with its own set of unique rules imposes a significant cost on firms.

But there’s hope! Last week, CME Group’s Clearing house received permanent approval from the European Securities and Markets Authority (ESMA) to offer central counter party (CCP) services in the EU2 — a step that allows for cross-border derivative trading and simplifies the clearing process for many of the clearing members and industry participants who rely on CME’s services. This development stems from a recent MOU between European and US regulatory authorities (respectively, ESMA and the Commodity Futures Trading Commission, or CFTC) that allows CFTC-approved clearinghouses to operate legally in the European Union.

So what does this mean for US market participants?

Allowing US-based organizations to be recognized by European entities eliminates the need for duplication. Like CME, US entities can use their US-registered clearinghouses in Europe, thus avoiding the extremely expensive and lengthy process of setting up a second clearinghouse. These reduced costs will be passed down to clearing firms and, ultimately, to the end users that benefit from these efficiencies.

industry costsThe ultimate benefit, however, is that users won’t need to grapple with regulations of a new clearinghouse in a different country because the efficiencies created through EU-US cooperation will keep the regulatory count stable . . . for now.

At Ascent, we know it’s a challenge to keep up with the ever-evolving regulatory landscape. That’s why we’ve developed solutions that can quantify all of your firm’s compliance obligations on an easy-to-use, modularized platform. To learn more about how Ascent can help you more effectively manage and report on your regulatory risks, please visit us at http://www.Ascent.is.

1 Our data-driven process estimates this figure at 1,993, which may increase or decrease depending on the regulatory bodies with which a given firm must comply.
2. http://www.cmegroup.com/notices/clearing/2016/06/Chadv16-231.html#pageNumber=1

A Regulatory Heatmap

At Ascent, we take pride in providing intelligence via our research and reporting functions to help you streamline your compliance processes, and manage your firm’s regulatory risk. The data and intelligence we provide can help a compliance team allocate resources more efficiently and improve its data-driven decision-making processes.

We’ve reviewed the various violations from the Commodity Futures Trading Commission and aggregated this data into a heatmap for ensuring you stay compliant with the most troublesome regulations and laws.

CFTC ENFORCEMENT ACTION HEATMAP

heatmap table

For more information, or to have us build you a targeted compliance and risk management platform specific for your needs, please contact us at contact@Ascent.is.

It’s a Shield, Not a Sword

Businesses on the wrong side of the law often feel as if they’d been bludgeoned by instruments of jurisprudence, bearing a distinct scarlet letter from the administration of executive-based (re: administrative) and judicial-based (re: State/Federal Court) actions. Gone are the days of quiet settlements, and second chances: regulators in all industries increasingly look for large and small regulatory violations alike. Playing defense is more important than ever before. Creating a “culture of compliance” is a blunt phrase, the efficacy of which is up there with “it’s always in the last place you look”

However, the conflict between allocating resources to a cost-side employees rather than its revenue-facing employees need not be well-documented to be understood. The latter, representing the traders, brokers, engineers, product ideators, and strategists, often find themselves directly juxtaposed with the former, those who attempt to minimize costs: lawyers, compliance, finance, accounting, and a host of other others preventing commercial ills.

Attempting to turn a cost-minimizing function into one of profit maximization is not only misguided, it’s fundamentally dangerous. It would be quite difficult for an accountant, lawyer, or compliance officer (“Risk Reducers”) to prove how much money they saved the company because of things that didn’t happen (often to the chagrin of these individuals when year-end raises and bonuses are announced). Those that do attempt to commercialize their safety net might find it missing when it’s most important: when a potential regulatory infraction occurs.

This is, of course, intended to prove a single point: Compliance is a Shield, not a Sword. The programs and processes you introduce are designed to safeguard you from the significant tail-risks on the cost side of your commercial equation, not capture you margin on your productivity side, or use for the threatening of fellow market participants.

compliance word graph

Figure 1, above, represents a standard distributed model of a firm’s risk/reward (which I’ve modeled as normally distributed and directly correlated, that is 1 unit of risk = 1 unit of reward or loss). The Marginal Revenue (“A”), gained by attempting to monetize your “Risk Reducers,” is always significantly outweighed by the Marginal Cost (“B”). Specificity of numbers asides, the chart illustrates a basic premise, regardless of the level of kurtosis: Protecting all you do have with your “Risk Reducers” is far more important than using them as a weapon to gain a marginal advantage: Swords may fight debt, but shields save equity.

Compliance 101

The word “compliance” used to elicit chuckles and groans from management as recently as the mid 2000s. The word itself, which originated in the 1640s, colloquially signaled a career arc with a negative trajectory and, for many, brought to mind professionals plying their trades in damp, dark corners of offices vacated by revenue generating staff. The explosion of (and focus on) regulations have outstripped demand for compliance jobs, a result of the increase in complexity and volume of regulations following the financial crisis and impropriety that sent the economy into a tailspin. Indeed, the very word itself has staged a comeback for the ages.

compliance word graph

The promulgation and implementation of the Dodd-Frank Act and its associated requirements cut sharply across institutions large and small alike. At a base level, regulations and rules are an additional cost imposed on any business. Some are necessary (without which we’d have pure anarchy) and some are unnecessary (without which we’d have efficiency), they increase the costs of operating a firm both internally and externally. The rules put in place following the financial collapse of 2008 have imposed extraordinary costs on small and large businesses alike across the entire of the financial services sector.

The labor shortage in financial services compliance has led to difficult choices when a firm is unable to in-house such work: (1) pay tens of thousands, hundreds of thousands, or even millions of dollars to external consultants on a regular basis, or (2) roll the dice of non-compliance. Note: The CFTC and SEC alone collected $3.14 Billion and $4.20 Billion in civil penalties alone in its 2015 fiscal year. Honeymoon periods in place during the creation of these regulations are now ending, and the chance of penalty on a noncompliant entity is nearly guaranteed. Regulators are swifter and keener to enforcing many of the rules that have been implemented over the past seven years. Firms must grapple with rules and regulators at:

  1. Government institutions (CFTC, SEC)
  2. Quasi-governmental agencies (NFA, FINRA)
  3. Self-regulatory organizations (CME, ICE)
  4. Financial services supply chain requirements (Clearing firms, ISV’s, and a host of private enterprises)

This cost of compliance is accelerating, much to the delight of external consultants. At Ascent, we find this cost prohibitive for businesses attempting to compete honestly, and our goal is to decrease the cost of compliance. By lowering barriers to entry for the financial services marketplace, competition will flourish. This, in turn, lowers the cost of financial services for all. Ascent, at its baseline, is creating a platform solution that will help you streamline your compliance requirements and workflows and give you back the competitive edge blunted by the regulatory gavel.

As we undertake this journey to disrupt the existing model of compliance services, we invite you to comment, contact, disagree, cheer, or ideate via the comments below, or via our website at http://www.ascent.is. The cost of compliance is causing businesses to shut their doors. This is something we find unacceptable. A more competitive marketplace with more consumer surplus is beneficial for all parties involved.

Ascent Technologies Inc.: Compliance. Simplified.