Due diligence is one of the first issues that comes to mind when talking about the fund industry, but what does it really involve?
Distributor due diligence is the process of evaluating a fund distributor’s operations and processes to confirm that they are competent and capable of effectively marketing and selling the fund to investors. Fund managers need to ensure that the distributor has the necessary expertise and resources to distribute the fund to investors in accordance with prevailing regulatory obligations.
The areas covered during distributor due diligence include:
- Client and investor identification: the process of verifying the identity of clients and investors in order to comply with legal and regulatory requirements. This process is typically required for financial institutions, including fund managers and distributors, in order to prevent financial crimes such as money laundering and terrorist financing.
- Compliance, risk management, and internal controls, that is, evaluating the company’s compliance and control framework, as well as risk management practices to confirm that they are effective and in place.
- Oversight of sub-distribution network which ensures that the distributors’ standards are, in turn, applied at the level of sub-distributors.
- Product governance, to ensure an appropriate framework is in place to avoid mis-selling of the product.
- ESG, to determine whether the distributor is equipped to advise investors on ESG matters.
So, how to meet changing compliance and reporting obligations?
This has, traditionally, been very challenging. We see many investment managers, before joining ume, not being able to just assemble a comprehensive list of who their distributors are, define proper set of questions, let alone obtain information from them, or report on them in a consistent way. The ume platform changes that completely. The process is now digitized and investment managers can slice and dice their data, create deep insights and comprehensive reports for their management boards, auditors, and regulators.
In 2017, you launched a due diligence platform specifically designed for investment managers and distributors. Are we to understand that there was no other solution to collect and evaluate due diligence information back then – or at least, not that efficient?
Until recently, fund managers collected due diligence information by sending questionnaires via emails to distributors, asking them to complete these. Distributors would receive dozens, sometimes hundreds, of different request, asking the same information, but in a slightly different way with different questions. This was more work than distributors could handle, and fund managers would therefore only receive responses to a fraction of their request. When the fund managers did receive information, they would manually have to go through it all. It was virtually impossible to comprehensively, and consistently evaluate the distributors. The consequence was that managers did not understand, and could therefore not manage, their distribution risk.
Could you further explain what your solution is about?
ume standardises and mutualises due diligence information. The leading investment managers using the platform collectively agree the information they require. Distributors complete the information once, and that then satisfies all the fund managers’ requirements. What is more, the ume platform automatically evaluates distributors’ responses according to the individual risk appetite that the investment fund managers have themselves defined. The ume platform makes the information collection possible in the first place and saves the industry tens of thousands of man-days of effort.
The ume due diligence information requirements now set the compliance standard for the industry. These high compliance expectations reduce money laundering, terrorist financing, sanctions breaches, and mis-selling of investment products – as the regulators intended, for the greater good of investors and society overall.
What about Artificial Intelligence (AI)? Do you believe it will – or may already – be one of the main challenges in due diligence?
AI will probably become an enabler over time. Machine text understanding will further evolve and help humans understand and evaluate the information they receive. Due diligence is required to help investment managers better understand the risks they take when working with a counterparty, so that they can pair that up against the rewards they reap from the relationship. AI will help investment managers understand distribution risks even better so that they can manage them according to their risk appetite.