Distribution oversight – Challenges of global distribution

By Pino-Sun Becker LL.M

Similar to “Know your customer” (KYC) principles, “Know you distributor” (KYD) has paved its way into global markets with the aim to ensure products are distributed in the jurisdictions agreed with the product manufacturer using suitable sales channels to attract appropriate investors. Thus, to know your distribution partners is essential in today’s fund industry, not only for regulatory reasons, but above all to avoid reputational damage or legal consequences.

What is Distribution oversight?

Distribution oversight is defined as the practice of monitoring, assessing, and reviewing the respective distribution channels within a network to ensure compliance with oversight requirements posed by regulators.

This requires a system comprised of specific tools and procedures to continuously assess, monitor, and review a distribution network, whilst being capable of responding to events triggered by changes in regulation, market development or within the network itself.

Basic requirements are:

  • A complete and comprehensive understanding of the laws, regulations guidelines and standards applicable to the countries in which the network operates.
  • A method of obtaining the necessary information. i.e.: what regulators require and the specific information of importance to the clients using the network – not only for regulatory, but also strategic purposes.
  • Consider the client impact – conducting a full audit on a distributor may give the security of having done everything possible with regards to distributor vetting, however it is costly, inefficient and a hindrance to market access. The challenge is to find a balance between the detail and type of information you require, whilst minimizing the burden for the client and your own resources in providing the data to you.
  • An assessment method: Obtaining a great deal of raw data from a distribution network is only the first step. You then must be able to distil the vital points from the data and highlight what is essential and come to reasoned conclusions.

Over the past years one could see a growing trend towards specialized outsourcing, as opposed to the development of inhouse solutions. Especially when talking about distribution.

  • In recent years, regulators have enforced ever more strict requirements for IFMs when engaging in distribution activities. In reaction, these aim to mitigate their risks whilst trying to minimize expenses by turning to specialized service providers.
  • Service Providers which have had a chance to establish themselves within their playing field, obtained the necessary experience and know how – are aware of trends within the market and know how to respond to clients and their respective regulators requests are highly sought-after.
  • ACOLIN was lucky enough to spearhead many distribution oversight efforts for its clients when it started to become an issue of real importance back in 2015. Having not only an established network of distributors and partners, but also engaging in ongoing oversight activities and reporting back to our clients using our network, thereby giving them the insight and especially the security that their products were being distributed over a transparent network.
  • After all, the IFM retains the responsibility for the distribution of his products.

What can you tell us about the risk-based approach and its importance within distribution oversight?

The risk-based approach is a key principle within distribution oversight, which has really taken on form through the implementation of the European AML directives and their effect upon our industry.

It requires responsible entities, competent authorities and also countries to assess, and understand the (specifically) AML and CTF risks to which they are exposed in order to take appropriate mitigating measures in accordance with their specific level of risk.

  • In its core, this means that you must be able to understand not only the risks you are currently exposed to, but also how your profile changes through your business activities, especially – how your risk profile changes when doing business with others.
  • Translated to fund distribution this means an IFM must be able to assess and understand his own risk but also be capable of assessing and understanding the risks associated with selecting specific distribution channels. A well thought out method of distribution oversight is the answer – conducting a detailed risk assessment on the respective distribution channels and displaying these in a clear and transparent method to enable the IFM to reach the necessary conclusions regarding his risk profile.

The risk-based approach is a principle which gives ACOLIN the flexibility to efficiently use its resources and take actions to mitigate the greatest threats with regards to AML &CTF head-on.

Having mentioned before the impact AML law has had on distribution oversight – have you noticed any impacts with regards to the stricter UBO Identification requirements?

We noticed the impact these stricter requirements had not so much when they were implemented into the respective national laws, but we saw much more of a reaction by IFMs when it became apparent how these requirements were being enforced by regulatory bodies.

When we started of really building a system of distribution oversight, conducting a due diligence on a regulated entity could be a real challenge. We were viewed as mistrusting our own clients – doubting their reputation and adherence to law. Slowly a shift became apparent and there was a period in which entities appeared to surrender to their fate, having recognized that bowing to this formalistic hassle had become inevitable – a sentiment which often still resonates in the background.

So, the question remains: how do you view these requirements?

  • As an administrative burden to keep regulatory authorities off your back?
  • Or do you view them as a tool to help you understand, where your products land, who is ultimately profiting from them and what risks you are incurring from doing business with them?

Whilst some EU Member States have been more or less successful in implementing the necessary mechanisms for proper UBO identification, verification and monitoring, I believe we are nevertheless seeing a shift in the way we understand and use this data, to better understand the business we are conducting.

You mentioned the importance of transparently and clearly reporting the information obtained through distribution oversight. Could you elaborate on this?

The priority of the IFM is to understand what is going on with the distribution of his products.

This is the basis of oversight reporting – understanding what the IFM needs to know in order to understand the distribution network and oversight measures exercised upon it.

Now recently we have seen a shift through a specific reporting duty introduced in Luxembourg through the supervisory authority CSSF by their circular 18/696. Effectively, IFMs had now been asked by their regulator: “Show us specifically where and how you have distributed your products, how you have identified and monitored your distribution channels and applying the risk-based approach, what this means to you.”

It would be a lie to say most IFMs and respective global /main distributors in Luxembourg were not panicking at least a little bit at these new requirements.

The onus now lies on those engaging in distribution oversight to report on their risk-adjusted monitoring measures, considering where specific distribution activities took place of a specific product.

Resulting from this and observing the challenges our clients face, we were able to leverage our oversight reporting capabilities to also meet the specific requirements imposed by the CSSF Circular 18/698.

How do you see distribution oversight changing in the upcoming years?

Right now, we are seeing a lot of initiatives being taken. We are seeing regulators interpreting provisions differently, we are seeing service providers popping up trying to take a piece of the cake and we are seeing a lot of insecurity and uncertainty.

To counter this effect, standardization and harmonization measures are being deployed.

  • On the one hand side we are seeing industry associations trying to standardize the way we monitor distribution.
  • Regulatory authorities are closely looking at each other’s initiatives and we will have to see which come out on top.
  • On a European level, the dispersion caused by regulatory initiatives has been recognized resulting in a strong push towards harmonized measures across Member States whilst minimizing their potential for gold-plating.

I expect the topic of distribution oversight to remain of great importance, I believe we might see a continued shift of standardized measures and a common understanding of how we recognize and assess risk in distribution. I believe transparency and reporting will continue to grow. However, whilst this trend and the initiatives which carry it are clearly meant to be beneficial, it is important to keep in mind how these are to be realized, working to minimize uncertainty and unnecessary burden.

About the Author

Pino-Sun Becker LL.M., is Head of Group Compliance & Risk at ACOLIN Europe AG. In this function he is responsible, together with his team to manage distribution oversight on the ACOLIN DNM Network, comprised of over 400 distribution partners. His team is responsible for the group-wide KYC activities as well as all compliance and risk management tasks within the ACOLIN Group. Having studied at the universities in Maastricht and Lyon, where he obtained his LL.M, he went on to the Frankfurt School of Finance and Management to obtain a professional compliance degree (CCP).

While studying in Germany, he started his career at ACOLIN in 2015 where he was leading in the development of the due diligence/KYC process and the risk assessment method. Taking on more responsibility, he moved on to Deputy Head Compliance. In the period 2018 to 2020, Pino changed to a S&P500 listed US Asset Manager before returning as Group Head of Compliance and Risk to ACOLIN in 2020.