Regulatory Reality

Jun 22 2009   3:46PM GMT

Financial regulations and my crystal ball.



Posted by: David Schneier
Tags:
Audit
compliance
GLBA
obama
OTS
PCI
Regulatory Compliance
SOX

I had a great piece lined up for this week about a governance project I’m working on but was waylaid by all the news that hit the radar around regulatory reform.

In what may be the understatement of the year, the plans revealed last week by President Obama and his administration to overhaul the financial regulatory domain is stunning.   It was equal parts common sense (dissolution of the Office of the Thrift) , politics as usual (government intervention for distressed larger institutions) and forward thinking (creation of a consumer oversight body).  But for practitioners in the regulatory space such as myself the news was a warning that we all had better pay close attention to what’s about to happen.

The largest percentage of work my practice does has less to do with making sure our clients are in compliance with the broad range of regulations they operate under and more to do with educating them on what that means and how best to achieve it.  The very first step our practice takes with our clients is in understanding their profile, size and risks and then set about designing or assessing them based on what makes sense.  Take for example vendor management; not every vendor needs to be part of your vendor management program but because so many institutions form a baseline based on vendors in their accounts payable system they tend to add an enormous amount of work that’s just not necessary (a particular sticking point for my partner).  Regulatory compliance is not a one-sized-fits-all exercise and after nearly a decade of dealing with the regulatory alphabet soup of GLBA, SOX and PCI (in varying lengths of time) it’s amazing how little is truly understood about each framework and how best to apply their principles.

And now it’s all about to change… again.

Much like what occurred with the last major regulatory step forward with the Identity Theft – Red Flags law that went into effect in 2008, we’re going to need to work hard to get out in front and understand the new rules as they’re being rolled out.  Traditionally, much of what’s necessary to comply with any regulation already exists in large part within any organization.  The work that’s typically required is in identifying where it is and making sure it’s documented sufficiently so the work can be measured and assessed properly.   I’m sure that much of the work that’s going to result from the proposed changes will align with quite a bit of what’s already in place (or should have been in place).  But understanding the new rules is going to be a huge amount of work for those needing to comply and will require time and effort.  And all this at a time when headcount has already been thinned out and staff is working extra time to keep up with their day-to-day workload.

So for my fellow practitioners I’m putting it out there that we need to step it up too.  We need to make sure that we’re engaged in the dialogue early on and that we’re working quickly to interpret the new rules as they’re working their way through the system.  The current regulatory burden has proved to be challenge enough and with the likely musical chairs scenario that’s going to ensue as the rules shift around, it’s incumbent upon us to be prepared to ease the burden, flatten the learning curve, and help the affected institutions fall into line while keeping up with the speed of business.

The sad irony for me in all of this is that despite all the work that’s about to ensue, I’m somewhere close to certain that very little will improve as a result of the exercise.  I was looking through all of what’s been proposed and I mapped it back to the issues I’ve encountered over the years I’ve been toiling in the regulatory space and there’s still a gap.  The biggest problems originated from a lack of proper regulatory oversight resources in terms of both the hours and skills to conduct the necessary work.  You can have a strong set of rules that need to be followed but if the people assessing your performance against those rules either don’t understand what to look for or don’t have the time to conduct the necessary steps, what’s the point?  And consider what happened in the credit union space this year where, due to the onetime assessment, many CU’s fell below required reserve amounts and thus were considered to be at risk.  The NCUA instructed their examination teams to still assign an appropriately adjusted rating but to go easy on the report because there was a new normal (I’m paraphrasing a bit but that was clearly the gist of their message).  The rules were there for a good reason and the measurements tried and true but when circumstances called for it they were pushed to the back-burner; how is that going to change?   And finally, I offer my favorite broken control and one that’s potentially at the heart of this economic crisis we’re struggling with: real estate valuation.  When I bought my last house in New York, the appraiser conducted all his required steps (e.g. physical survey, square footage and finding recent comparable sales, etc.) and when all was said and done he declared the house was worth the purchase priced we’d offered.  I asked our real estate agent how it happened to be that his appraisal and our offer were identical and she told me that with the market so volatile it was impossible to conduct a meaningful appraisal and so they typically just went with the offer price.  How did that add any value to the process?  Will any of the new laws implement the proper checks and balances to assign accountability to lenders and their agents in the field?

Ultimately, I’m thinking the problem hasn’t been with the current regulatory rules but rather their inconsistent application and enforcement.  Regardless, change is a comin’ and it’s going to be an interesting and bumpy ride as we wend our way through it all so strap yourself in and hold on tight.

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