Cutting through the KYD Paper Trail

The Financial Conduct Authority’s (FCA) recent Business Plan brings to light the ongoing regulatory focus on minimising the impact of operational disruption and reducing harm from firm failures. This spotlight underscores a critical challenge within the UK’s financial services sector: how can investment managers effectively manage and monitor their long and complex distribution chains?

The FCA’s review in 2021 of the MiFID Product Governance application revealed significant variability in the quality of Due Diligence (DD) conducted by providers, such as Asset Managers and Portfolio Managers. Notably, some providers perceived the DD process as offering little to no added value. This sentiment hints at a broader issue within the industry—how traditional, questionnaire-based DD processes, often seen as burdensome paper trails, may not be the most efficient way to ensure compliance and manage risks.

The question then arises: Is there a better way to navigate the extensive paper trail of Know Your Distributor (KYD) processes? Advances in technology, particularly in artificial intelligence (AI), offer promising solutions. AI’s ability to swiftly analyse vast amounts of data from open databases presents an opportunity to revolutionise the DD process. By harnessing AI, firms can assess whether their distributors have:

• Appropriate authorisation and permissions for their business activities.
• Any conflicts of interest, such as through director shareholdings.
• Sufficient capital resources for their ongoing activities.
• Any history of data breaches or cyber incidents.
• A concerning track record of client complaints to the Financial Ombudsman Service (FOS).

This approach could drastically reduce the time and resources spent on KYD processes, transforming them from a cumbersome obligation to a strategic advantage.

The benefits of adopting more sophisticated due diligence processes extend beyond regulatory compliance. They offer a pathway to better understand and manage the risks associated with distribution chains. In an era where operational resilience is paramount, having detailed insights into the financial health, regulatory compliance, and operational stability of distributors can make a significant difference.

Moreover, this approach can aid in uncovering hidden opportunities within the supply chain. By identifying potential risks or areas of non-compliance early, firms can proactively address these issues, avoiding the costly repercussions of regulatory fines or operational disruptions

The financial services industry stands at a crossroads, with evolving regulatory expectations and the increasing complexity of global supply chains. The adoption of AI and data analytics in due diligence processes is not merely a trend but a strategic imperative for firms aiming to navigate this landscape successfully.

As we look to the future, the ability to leverage technology to enhance operational efficiency, reduce costs, and mitigate risks will distinguish leaders in the financial services sector. In doing so, firms will not only meet regulatory expectations but also build more resilient and competitive businesses in an ever-changing market.

The conversation around due diligence and KYD is evolving, with technology playing a central role in shaping its future. As the financial services industry continues to adapt to these changes, the adoption of AI-driven due diligence processes will undoubtedly become a cornerstone of effective risk management and regulatory compliance strategies.