Improving investment compliance through process management
Workflow and process management can be extremely helpful as a means of managing investment compliance for hedge funds and other financial organizations.
Hedge funds and financial institutions need bulletproof compliance workflows. Here is how we approach compliance management.
Compliance Management Made Easy
Summary
- Trade flow requires multi-step approval workflows - Every trade involves placing orders, execution, confirmation, and payment across portfolio managers, brokers, and counterparties, with approval workflows minimizing reconciliation discrepancies and catching errors quickly
- Cash handling prevents fraud through multiple checks - After Madoff and Lehman Brothers incidents, no single individual should control cash movement, requiring at least two agents to sign off on fund transfers to prevent Ponzi schemes and fraudulent activity
- Automated reporting maintains investor confidence - Monthly net asset value reports to partners, tax reporting, and audit processes need automation with approval workflows that trigger next steps, reduce processing lag, and ensure unbiased parties conduct audits
- IT infrastructure security requires process monitoring - Hedge fund managers must establish information security policies for applications, databases, systems, hardware, and networks, with audit logging, user authentication controls, and incident tracking preventing severe impacts on trades and investor relations. See how Tallyfy manages compliance workflows
Hedge funds were already a fairly complex financial service organization and it has been that way for decades. This means there is a strong need to improve compliance through process management in this sector.
Maybe we should teach schoolchildren probability theory and investment risk management.
— Andrew Lo, Professor at MIT
In the wake of financial crisis that occurred in 2008 there have been further complexities and requirements put in place to protect investors and ensure investment compliance. Many of these revolve around improved planning and execution of trades.
What you have now is a great emphasis on infrastructure and with it a far more complex process that must be carefully managed.
This infrastructure includes general business management as well as cash management and trade flow, reporting and legal compliance.
Those who deal with and allocate capital to hedge funds demand more accountability and improved processes. Financial services teams represent about 17% of our conversations at Tallyfy, and we’ve found that institutional investors now ask about process controls before they ask about returns. In our conversations with wealth management firms and asset managers, the due diligence questionnaires have become increasingly detailed, with questions about data security, incident response plans, and disaster recovery testing appearing in every vendor assessment we complete.
Because of the many hands involved throughout the process of trade flow and cash management, it’s necessary for processes to be improved, and for approval workflows to be in place so that each party is measured and accountable.
There are a number of areas in which processes can be improved not only for compliance but for improved workflow and accountability.
This includes general business operations, the flow of trades being made, cash handling, reporting and audits and investment compliance.
Every business requires sound process management
Every business incorporates workflows to efficiently manage tasks and general operating processes whether you are talking about project management at Facebook HQ, deployment of new products in a retail chain or a digital marketing agency managing content deployment.
A hedge fund, while at its core being an investment property, is still a business.
You could say that the purpose of the business is to generate a distribution of returns from the raw inputs that are being fed into it.
Like any business then you are dealing with a majority of the same operational requirements from simple office management and administrative tasks to accounting, IT, communications and HR.
And like any business when you have failures and missteps due to poor process management then the attention is shifted.
It’s difficult for the business as a whole to focus on managing the investments and the hedge fund when you are putting out fires due to missed takes, poor deployment, and paperwork that was not properly handled or filed.
The people who work within a hedge fund need to manage and lead appropriately but they also need to be given the tools that allow them to work efficiently and productively.
Process management tools that help with maintaining investment compliance on one side of the business can also offer the same process tracking and efficient workflows on the operational side.
All departments need to work and communicate effectively in order for the business to effectively manufacture returns for the clients.
Hedge funds are driven by trades
Compliance is critical and every trade must be executed and processed without error. No exceptions. This is the core of any hedge fund.
Every single trade that occurs involves multiple steps and while it’s a tech-heavy process there is still room for human error. Those steps typically involve:
- Placing a trade order
- Execution of the trade order either through an order management system or direct negotiation
- Confirmation of the transaction
- Payments being made and housing the security positions
The execution of those trades involves portfolio managers, brokers, counterparties and more at various stages.
The more frequently a hedge fund engages in trading the greater the potential for error.
When you create approval workflows to ensure investment compliance you can better control the operational process and minimize discrepancies in reconciliation.
If errors do still occur within an approval workflow they are more readily caught and can be fixed quickly to reduce the risk of distractions impeding the team ability to monitor and trade on opportunities.
An efficient workflow with carefully tracked processes is the only way for a hedge fund to stay competitive.
Cash is the heart of hedge fund investments
After major incidents like Madoff and Lehman Brothers, many are probably more careful about how cash is being handled.
Ultimately, the goal is to ensure that no single individual has sole control of cash. By maintaining a system of multiple checks and balances, and approval processes around reconciliation, investors can be put at ease that there won’t be any potential issues of fraud that impact operations and investments.
In a properly designed system, there is no one agency responsible for the movement of cash. Rather, approval workflows include at least two or more agents to sign off on the transfer of funds.
Access review and certification template
A system lacking this kind of process is what enabled the Ponzi scheme created by Madoff.
Automated reporting keeps investors at ease
Hedge fund administrators typically file reports on a monthly basis, sending the net asset values out to the partners within the fund.
If a hedge fund uses a 3rd party data house or analytics provider then they would also receive a copy of the report. Their role is to check and reformat data while also maintaining a database of the hedge fund returns.
Additional reports include tax reporting for individual partners and the general partner.
Depending on the structure of the fund, whether it includes onshore and offshore, there may be separate accounts for those and may also have separate administrators for each.
Investors require these regular reports and because they change hands and must occur at specific times it is important to automate the process as much as possible.
While individuals are still involved, automation can take place through approval workflows that indicate reports were appropriately sent and received. This can trigger the next step in the process to reduce lag in processing and ensure no reports are omitted or inappropriately handled.
That approval process can also include the audits that are intended to maintain compliance.
With appropriate approval in place, a fund can ensure that an appropriate unbiased party is utilized for the audits.
This was another issue that allowed Madoff to misappropriate, as the audits of his funds were done by a related party and not a reputable unbiased one.
Templates for Investment Compliance Workflows
Ready-to-use templates for investor relations, financial reporting, and reconciliation
Managing processes around responsibilities to investors
A hedge fund manager must provide prospective and existing investors with information regarding investment objectives and strategies, permissible investments, risk factors and material terms of investment in the fund.
Typically this information is provided as, a result of investor due diligence, and having processes defined for the dissemination of disclosures can ensure that information is provided on a timely basis, without compromising proprietary information regarding the fund trading positions.
It’s not uncommon for fund managers to create standardized answers to investor questions and queries.
Because objectives and strategies, as well as permissible investments and terms, can change, it’s important to update any workflows or processes that use documentation and standardized answers or responses.
This ensures that any approval workflows incorporate documents with the correct information and disclosures.
Those workflows should also be updated to provide fund investors with relevant performance data and risk information regarding the strategy and terms of the fund.
With the right approval workflows and triggers in place, those managing the fund can ensure that the right information is being submitted to investors at the right time to meet its responsibilities to investors.
Maintain a secure IT infrastructure
A hedge fund manager should establish information security policies and procedures in order to define the controls required to secure the data and systems used in its operations.
In its policies and procedures, a manager should address the security and usage of computer applications, databases, operating systems, hardware, and networks.
Process management helps with audit logging and monitoring, internal controls, smart employee onboarding and user authentication controls to govern access, tracking personnel responsibilities in IT and tracking data transfer including backup and recovery, problem management etc.
Improving processes in this area means developing procedures for executing programs including data transmission.
With monitored processes in place, a fund manager can more readily identify, resolve, review and analyze IT-related incidents and adjust processes appropriately to prevent issues in the future as these can have a severe impact on trade and investor relations.
Process management is critical to improving infrastructure and investment compliance
Like any business, a hedge fund manager can’t grow the business without a strong infrastructure and the right processes in place. From what I’ve seen, the funds that invest in process early tend to outperform those that scramble to add controls after problems arise. In discussions we have had with financial services operations teams, the pattern is clear: firms that complete their SOC-2 or similar compliance certifications ahead of client requests close deals faster than those who promise to get certified later.
Those processes ensure accountability at multiple levels, both internally and with 3rd parties.
Also, having approval workflows and carefully managed processes reduce operational errors and administrative fatigue that prevent managers from focusing on effective trades.
It’s impossible for a manager to invest competitively under the weight of constant operational issues. The math just doesn’t work.
To ensure better performance and investment compliance, evaluate where processes can be approved and where the fund would benefit from an approval workflow.
How does your organization use approval workflows to manage critical areas of operation and compliance? Let us know down in the comments!
About the Author
Amit is the CEO of Tallyfy. He is a workflow expert and specializes in process automation and the next generation of business process management in the post-flowchart age. He has decades of consulting experience in task and workflow automation, continuous improvement (all the flavors) and AI-driven workflows for small and large companies. Amit did a Computer Science degree at the University of Bath and moved from the UK to St. Louis, MO in 2014. He loves watching American robins and their nesting behaviors!
Follow Amit on his website, LinkedIn, Facebook, Reddit, X (Twitter) or YouTube.
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