Facing FATCA: Unravelling the IT solution confusion

Despite initial belief that the Foreign Account Tax Compliance Act (FATCA) requires just enhanced data checking and storage capabilities, it is clear that the regulations affect multiple areas of one’s business. As such, FATCA demands a four-stage response, which can be summarised as follows:

• Identification of relevant clients by checking data against specific indicia for both existing and new accounts.
• Remedial case management for identified accounts and/or missing data, including document storage.
• Calculating withholding tax as required.
• Amalgamated reporting on transactions and balances to the IRS and other tax bodies and clients.

These requirements place significant pressure on the processes and workflows throughout financial institutions’ (FIs) businesses. Institutions have a number of options available to them and must decide which will offer them the best route to meeting the new and complex demands of FATCA.

The first option is to continue with manual search, identification and remediation processes. For smaller FIs with a relatively homogenous client base, this appears attractive at first look; but even for these institutions, the manual effort involved will be extensive. FATCA requires that every new and existing client be checked against every indicia on an iterative basis and all findings must be confirmed, proved and recorded in an auditable fashion. When performed manually, there is a real risk that large amounts of confidential information could be shared improperly. Furthermore, recording auditable data is expensive, thus the costs and risks outweigh any perceived cost-benefit associated with manual processing.

The second option is to update existing client systems. As with manual processing, there appears to be cost benefits - in terms of capital outlay and operational expenditure - to this approach. However, given that FATCA touches numerous aspects of one’s workflow, multiple systems will need to be updated to support FATCA compliance. As the regulation will inevitably be adjusted over time, this will attract significant maintenance overhead in the longer term. It will also be difficult to support regulatory audits with data spread throughout multiple legacy systems.

The third option is to use current anti-money laundering (AML) infrastructure. However, although AML systems may be capable of meeting the identification stage of FATCA compliance, they offer little support for remediation and ongoing case management. They will therefore require significant development and integration with additional systems supporting the withholding and reporting requirements. FACTA’s reporting demands alone mean that this is a sub-optimal arrangement. To be effective, FIs will need to have all relevant data in a single system able to manage the various report formats, reporting media and reporting parties mandated by FATCA, and be able to handle incoming queries from regulatory bodies on reported data.

The fourth option is to outsource FATCA certification. Again, this looks like an attractive option for FIs that have embraced outsourcing in other areas of their businesses. But outsourcing still comes with management responsibility and financial institutions will still need to provide support for withholding and reporting in the future. In addition, investment interfaces will still be required. Outsourcing certification also runs the risk of duplication of data. In particular, FIs with global clients will need to address their data-security concerns and ensure providers are able to address data protection issues across multiple jurisdictions. Indeed, FATCA certification is too close to an FI’s core business to be outsourced fully with confidence.

The reality is that FATCA presents one of the biggest challenges to established systems, processes and workflows that most FIs have ever faced. It touches almost every aspect of their business, demands iterative processes, and has extensive reporting and auditing requirements. It is emphatically not KYC-plus or enhanced AML – although these are nonetheless an important aspect of the regulations.

For the majority of FIs affected by FATCA, a cost-benefit analysis will show that a packaged, specialist solution delivers the best outcomes over the long term. FATCA isn’t going away. Moreover, with the international community’s move towards a collaborative approach to taxation and the trend for additional supra-national legislation, FATCA can be viewed as the harbinger of a future in which financial institutions are subject to ever-more stringent demands for data.

In this light, deploying the right systems now represents a wise investment in the future.

*Colin Camp is managing director, products and strategy for Dion Global Solutions. Camp has over two decades of experience within the financial software industry and nearly fifteen years’ experience in the Investment Banking and Broking industries. He has been based in Asia for 17 years and has previously held other senior positions including with Religare Technova/Capital Market Solutions and Misys Securities Trading Systems.