Given the long list of regulations that organisations need to comply with – CECL, IFRS9, MiFID II, SOX, CCPA, BCBS 239, SR 11-7, Solvency II, GDPR, CCPA, among others – investment by organisations in Regulatory Technology (RegTech) is estimated to grow by a whopping 45% annually on average over the next five years. This represents a six-fold increase by 2023. The risk of hefty financial penalties because of non-compliance looms and so, clearly, institutions are wisely resorting to technology to meet regulatory demands efficiently and cost-effectively. At the same time, they are mitigating any reputational risk that accompanies non-compliance, the effects of which are potentially longer lasting than any monetary fine, says Henry Umney, CEO of ClusterSeven.
RegTech can be quickly deployed, replaces expensive manual processes, delivers flexibility and facilitates dynamism to enable financial institutions to deliver against the evolving compliance requirements. When used concurrently with existing legacy systems, such platforms can help drive innovation too.
As financial institutions make investments in RegTech capabilities – typically considered to be big data analysis, artificial intelligence, biometrics, blockchain and chatbots – the widespread use of spreadsheets in core business processes means that spreadsheet risk management must be a major consideration in these efforts. If overlooked, these risks could well be the ‘chink in the armour’ that leads to accidental non-compliance, as well as potential business impact and reputational harm.
Spreadsheet risk is genuinely a risk to the business
A large portion of regulatory compliance requirements involve complex data processing and spreadsheets often serve as the ‘go to’ tool for managing several vital business processes. For instance, spreadsheets are widely used for final mile reporting, pricing models, economic/financial models, or data manipulation. With spreadsheets feeding information to many core enterprise systems and RegTech platforms, accuracy of the data inputs in many instances is dependent on the integrity of the spreadsheet applications that store the material. Hence, incorrect inputs into any system will skew the outcome, to either cause compliance breaches or indeed impact decision-making, completely negating the value of these latest technologies to the business.
With spreadsheets feeding information to many core enterprise systems and RegTech platforms, accuracy of the data inputs in many instances is dependent on the integrity of the spreadsheet applications that store the material.
Spreadsheet risk is genuinely a risk to the business for several reasons. Not only is it easily accessible (it’s available on every desktop), it is easy to use and so, used without training and often in the absence of formal usage policies. All this combined means that there are little or no checks on data sources used to populate business critical spreadsheet-based processes.
Automation of spreadsheet risk management key to RegTech success
Spreadsheet risk can be overcome with the adoption of a best practice approach to this function. Like RegTech solutions, spreadsheet risk management is underpinned by automation.
Automated spreadsheet management enables financial institutions to have complete visibility and an understanding of the organisation’s spreadsheet environment. The technology exposes the data lineages of individual files across the spreadsheet environment to accurately reveal the data sources and relationships between the applications. Every identified critical spreadsheet can be tiered based on the risk it poses to the business. Today, spreadsheet risk management solutions facilitate an enterprise-strength model that dovetails with the larger RegTech environment to establish a seamless process that supports everything from creation of new spreadsheets through to their adoption into the relevant corporate applications and ultimate retirement from the business’ application landscape.
A considered approach to spreadsheet risk management must be an integral part of any RegTech initiative.
Spreadsheet risk management minimises compliance execution risk. Fundamentally, one of the objectives of the various regulatory regimes collectively is that they want organisations to build in operational resilience into their business to ensure commercial flexibility and strength in tougher economic times. This kind of approach helps design-in operational resilience by providing intrinsic safeguards for things like attestation management. It provides automated processes for attestation by employees for the most critical spreadsheets, ensuring that changes are made in line with the company policy – critical for regulations such as the Senior Managers and Certification Regime, where the onus of good business practices and accountability rests with the senior executives themselves.
Good data underpins business operation, decision-making and commercial success, and compliance. Stringent and ‘business as usual’ style management of these end-user computing tools where unstructured, yet business-critical data resides, is essential not merely for compliance, but for efficient running of an organisation. A considered approach to spreadsheet risk management must be an integral part of any RegTech initiative. It will ensure that financial institutions fully maximise the value of their investments in the associated technology platforms.
About the author
Henry Umney is CEO of ClusterSeven. He joined the company in 2006 and for over 10 years was responsible for the commercial operations of ClusterSeven, overseeing globally all sales and client activity, as well as partner engagements. In July 2017, he was appointed CEO and is strongly positioned to take the business forward. He brings over 20 years’ experience and expertise from the financial services and technology sectors. Prior to ClusterSeven, he held the position of Sales Director in Microgen, London and various sales management positions in AFA Systems and ICAP, both in the UK and Asia.
Website: https://www.clusterseven.com/
Your experience encompasses assisting companies with growing their businesses – what attracted you to this area of specialism? How rewarding is this?
With China’s economic development and growth over the last 20 years, more and more foreign companies have been expanding their businesses into China, either through direct investment or through increasing numbers of cross-border transactions. However, doing business in China has distinctive challenges that must be considered, not only because of the potential language barriers, but also because of various business-related regulations and tax requirements that are unique to the country.
Our consultants at Nexia TS (Shanghai) Ltd provide business and tax advisory services to global clients investing in and/or doing business in China. Our service offerings range from planning, structuring and the setting up of foreign-invested businesses, as well as a focus on tax consulting and advisory for all aspects of Chinese taxation. Chinese company and employment law advisory services are also offered. We are able to provide compliance work that caters to assurance and other statutory needs.
Since we established our practice in China in 2001, we have assisted many international companies with their inbound investments into China, setting up direct presence and fulfilling the domestic regulations. Overall, we find that our experience and expertise with the Chinese regulations and business environment have also benefitted our clients.
How should foreign companies structure their business operations to be as tax efficient as possible when considering expansion into China?
In our experience, we have found that the simplest structures are often the best. It is potentially useful for foreign parent companies to own their Chinese subsidiaries through offshore holding companies in low tax jurisdictions that also had favorable tax treaties in place with China. In many cases, multinational groups use layers of holding companies in their structures. Related party transactions between sister companies and the ultimate parent company were essentially designed to extract profits out of Chinese operations without being taxed. Things have changed since 2008 though, and China has implemented many new regulations intended to ensure that the country receives its fair share of taxes. Where a foreign company sets up and registers a subsidiary in China, it is now usually most tax efficient when the subsidiary autonomously performs its business functions. The more control the China subsidiary has over its operations, the better - especially with respect to participation in the VAT system. Furthermore, more autonomy from the parent company generally results in fewer issues with respect to expense deductibility for corporate income taxes. It is true that profits dividends paid to the subsidiary shareholders are taxed at 10%, or less in some cases, but there is tax savings over attempting to extract profits through royalties or cross-border services that are subject to both withholding tax and VAT. Foreign companies operating in China nowadays must take these issues under consideration.
For foreign companies operating in China without setting up a registered entity, there are also tax-related considerations. It is important to properly structure these transactions. For those that simply sell goods into China, the buyer of the goods handles all of the China-related issues. However, for those that sell services, or a combination of goods and services, into China, it is crucial to minimize the risks associated with being recognized as permanent establishment for corporate income tax purposes, and also to ensure that tax treaty benefits are applied to and recognized by the respective tax authorities. Likewise, VAT now applies to all cross-border service transactions, so proper structuring of the service agreements is essential.
What potential pitfalls face foreign companies who wish to set up a Chinese operation - in terms of staying compliant with regulation whilst wishing to operate under a tax efficient structure? What are the potential consequences of non-compliance?
Many foreign investors assume that setting up an entity in China that relies heavily on related party transactions may be very simple when using special purpose entities. For example, a US company might set up a holding company in Hong Kong, to take advantage of lower withholding tax rates on royalties obtained by selling IP usage rights to its China subsidiary. However, China has closed many loopholes with tax officials scrutinising royalty and other similar agreements. If certain criterias are not met, the royalty payments may not be deductible for the China subsidiary.
Another area often overlooked is how China’s tax rules have changed with respect to the indirect equity transfer of Chinese entities by offshore parties. Considerable paperwork must now be filed in China during such transactions, even if no tax will be assessed on the transfer. Penalties can be quite severe if the offshore transferer and transferee do not comply with the documentation filing requirements.
Since the introduction of the Corporate Income Tax Law in 2008, China’s State Administration of Taxation has implemented many new General Tax Anti-Avoidance Rules that allow the country to pursue foreign companies doing business in China and purposefully setting up the businesses or transactions to avoid Chinese taxation. With the advent of BEPS and increasing global cooperation between countries, it has become much easier for China to pursue such cases.
What tax incentives are in place for foreign companies who may want to establish business operations in China?
Companies within certain specific industries can enjoy corporate income tax breaks, and these industries are normally associated with high-tech manufacturing and R&D. In addition, Chinese local municipal governments attempt to attract foreign investments by offering tax exemption or tax rebates on the portions of VAT or corporate income taxes to which they are entitled. There are also incentives for companies investung in energy-saving and environmental protection facilities, which they can deduct a certain amount of their investments for corporate income tax purposes.
How can multinational companies move finances in an efficient way between their international offices?
Foreign companies with regional headquarters in China’s free trade zones have a few options for moving funds between China and other countries. However, China generally has strict foreign exchange rules in place that limit the movement of funds via profit dividends, loans, or other genuine transactions between the parties. Capital usually cannot be moved out of the country without closing and liquidating the business in China. Companies should plan exit strategies at the time of business setup. However, regulations are always subject to change, so such strategies should be analyzed continuously and updated as needed.
What are your thoughts on China’s One Belt One Road initiative? What’s been the impact of the concept on commodity demand thus far?
Unveiled in October 2013, the One Belt One Road initiative is a development framework aimed at enhancing trade and investment connections between Central and Eastern European countries and Asian countries. It not only plays a role as an important economic link between countries, that also helps to relieve some of the issues that were caused by China’s economic development during recent years, such as overcapacity, falling demand for commodities like steel, investment bubbles, lower rates of return on investment and so forth. The key to success of this initiative also depends on joint participation from other countries to bring in high technology to increase the rate of return on investments, instead of just building roads and bridges and ports, which are the key strengths of China in leading this initiative. The collaborative stance that China places on this initiative is very helpful. For example, it acts like entrepreneurs who would like to set up business with existing infrastructures and available financing.
According to the futures prices on steel and copper traded on the Shanghai Futures Exchange, the dominant Futures prices on steel and copper have been rising since 2016, which means that demand for domestic commodities has been gradually recovering. With more deals and projects announced in the future, we foresee that the demand for domestic commodities will continue to rise further.
What do you think the future impact of the initiative will be?
This initiative in the long run will benefit the global economy as a whole, and help rebuild economic interactions between countries that were in existence before the 2008 economic crisis. It not only increases the routes by which transported goods can reach destination countries around Asia and Europe, but also revitalizes the economies and unlocks potential demand from the One Belt One Road countries.
Website: https://nexia.com
