Ensuring Robust Monitoring: Best Practices for Guideline Coding

Published on September 4, 2024 by M Amarnath Rao

Introduction

Guideline coding refers to capturing any client-related restrictions in a compliance engine. Coding restrictions/rules in the compliance engine is the very first step in the investment compliance process, in line with an investment management agreement (IMA) strategy. For example, the guidelines may restrict/prohibit certain investments based on asset class and contain exposure-related restrictions for maintaining a diversified portfolio.

Why guideline coding?

Guideline coding is the foundation of investment compliance. To monitor client investments/requirements, the entire guideline needs to be defined on a compliance engine to capture the requirements appropriately. We provide more details below:

Supports the management of restrictions throughout the client contract lifecycle. Guideline coding helps monitor client restrictions on a compliance engine (e.g., Bloomberg AIM, Sentinel, Charles River) in line with their specific investment requirements.

Ensures a governed and centralised workflow process to optimally manage investment restrictions. Guideline coding is the most appropriate way to track and manage client requirements on an authorised system. It ensures a centralised platform for managing IMA restrictions.

Monitors and detects. Guideline coding helps a company deploy internal control systems to locate and monitor risk.

Prevents loss of brand/reputation. Guideline coding is always compliant, boosting confidence in investing in a company while avoiding any reputational loss.

Guideline coding best practices

The guideline coding process commences as soon as the client relationship manager (CRM) forwards the client guidelines and restrictions to the compliance team. Some best practices are outlined below:

Leverage expertise of the compliance team. The guideline coding process should start with this, to optimise the coding.

Document exceptions received from the client. Documentation plays a major part in guideline coding. Any related information should be documented to capture client restrictions effectively.

Use appropriate rule templates. For example, the “do not invest” rule should use the prohibition template and the exposure-related requirement should use the exposure template that captures the NAV of any given portfolio.

Utilizing the value-added features of any Compliance system. To standardise and enhance the guideline coding, compliance engines have their own pre-defined/in-built value-added features, for e.g., Bloomberg AIM is equipped with set of attributes/custom groups. Using these would result in accuracy,consistency and efficiency.

Adhere to appropriate rule logic. Rule logic plays a key role, and a slight change in logic could lead to breach of requirements. Understanding the IMA requirement and applying the logic in the compliance engine is critical.

Rule testing. This plays a major role in ensuring accuracy and consistency. After completing the coding process, any newly coded rule is tested by placing test trades and using model portfolios.

Why is it imperative to consider the above listed best practices?

The intention of rule coding best practices is to avoid any active breaches caused due to rule coding errors. The below case study of rule coding error is one of the examples which led to an active breach.

Case study:

Region	United States
Date on which the exception was triggered	August 2024
Source of the requirement	Investment guidelines
Rule requirement	Maximum 5% of securities in the BBB range at the time of purchase
Root cause	A newly issued unrated security with an expected rating of BBB was excluded from the test due to rule coding logic not considering unrated securities in the test bucket. The rule started flagging only after the security was rated as BBB.
Observations	The exception was not triggered at the pre-trade level due to rule coding error, i.e., the rating logic was not capturing for unrated securities. The exception was triggered above 5% during Post trade monitoring due to the purchased security being assigned the rating of BBB at a later point in time.
Steps taken	Acuity Knowledge Partners captured the breach immediately (rule flagging above the 5% limit) along with the rule coding error and escalated the issue to the respective stakeholders.
Rectification action/steps taken	1) Rule coding was updated to capture unrated securities, as suggested by Acuity Knowledge Partners 2) The portfolio manager sold one of the existing holdings from the portfolio’s BBB bucket, retaining the new security to bring the rule back into compliance 3) The client was notified immediately on the day of identification of active breach and related fine/loss incurred due to non-identification and related transaction cost was paid back to the client account.

How Acuity Knowledge Partners can help

We are pioneers in investment services offerings. We create tailor-made dynamic functions with a robust, responsive and proficient control framework and process delivery. Our highly experienced tool-agnostic team provides support in investment compliance, trade surveillance and corporate, forensic and crime compliance. These services are supported by our proprietary suite of Business Excellence and Automation Tools (BEAT), which offer domain-specific contextual technology.

Our team of experts have a unique combination of skillsets. They have extensive experience in order management/compliance systems such as Bloomberg AIM, Ion’s Latent Zero Sentinel, Charles River Database (CRIMS), LDC, ThinkFolio and BlackRock’s Aladdin.

Sources:

https://www2.deloitte.com/us/en/pages/advisory/articles/investment-compliance-monitoring.html

Tags:

What's your view?

Thank you for sharing your Comments

Share this on

About the Author

M Amarnath Rao

Know More

Amarnath carries a total work experience of 14 years and is currently working as an investment compliance specialist in pre-trade & post-trade monitoring. He has worked for various firms including Thomson Reuters & Capgemini. At Acuity Knowledge Partners, he is working as a Delivery Manager supporting both post & pre-trade compliance services. He is a BBM graduate in Finance from Garden City college, Bangalore.