FATCA: joining the KYC dots?

The recent high profile decision by the board of Wegelin, Switzerland’s oldest bank, to close after helping US citizens evade taxes of $1.2 billion in offshore holdings, has ensured that Foreign Account Tax Compliance Act is on the 2013 compliance agenda for all. But how big a deal is it?

It’s no secret that complying will be confusing, difficult and costly. However, if we look at the FATCA requirements in the larger context of EMIR, AMLD IV, the FTT, MiFID and the Retail Distribution Review, we see that similar requirements can be delivered by one thematic programme.

While the implications are not exactly the same, in general they require dynamic, flexible client data systems that can produce reference information to the granularity required by regulators.

Even though FATCA is the first regulation of its type requiring KYC upgrades of this scale, it certainly won’t be the last. EMIR offers strong examples of how these demands are not unique to FATCA. For instance, the classification demands for non-financial counterparties under EMIR require systems that can differentiate between financial (FCs) and non-financial counterparties (NFCs).

We were therefore surprised to see a recent Fenergo survey showing that 71% of firms are building new FATCA classification solutions and engaging in extensive data mining to identify US clients.

Customer data quality and maintenance is central to complying with FATCA. Identification of whether or not a customer can be considered ‘US’ means customer data systems will have to trawl through the entirety of their customer accounts for US ‘indicia’. Passports, place of birth, addresses and even residence information will have to be checked, while any incriminating ‘US’ data must be assessed, verified, and reported. New linkages between customer data systems will be required to adequately ensure the entirety of your customer data is fit for purpose. Firms will need to be able to prove that their data, showing an account for John Smith, who is a US citizen by birth and citizenship, but not a resident for tax purposes and, thus FATCA exempt, is accurate.

If a piecemeal, regulation-by-regulation approach is taken to managing client data, firms will be forced to self-certify each requirement, leading to an increase in costs, suboptimal solutions and annoyance for the customer. In the instance of FATCA, this means physically contacting each client to find out if they are a US or non-US citizen, updating and ‘re-papering’ these records, causing customer dissatisfaction and creating data that is costly to refresh.

With the final US regulations having been released in December, and HMRC publishing its draft regulations and guidance in January, the industry now has line of sight as to what exactly needs to be accomplished. But, there is still very little detail on the report formats, the registration requirements and the transmission protocols – and that remains a pressing concern. However, key provisions that would have required wholesale customer self-certification have been softened to allow firms to ‘pre-classify’ identified accounts. But, despite the additional detail the problems remain the same: FATCA requires a big step up for the management of client data.

Having set the reporting deadline at the end of this year, the IRS is pursuing bilateral intergovernmental agreements (IGAs) with 50+ countries, exempting firms in those countries from reporting client information directly. Differing bilateral standards have led to divergences across borders and, with over 37 possible FATCA account classifications now in existence, tracking data in this way is a new and tall order for any firm’s KYC framework. This is especially true when operating across multiple jurisdictions, and with requirements for both high and low levels of detail. Client systems must be able to judge whether their counterparty participates in a FATCA IGA, is ‘non-financial’ or is US based. Not being able to make an accurate classification may mean being forced to apply the FATCA 30% withholding tax.

The real difficulty here is in linking your databases to identify and maintain this information, something never before required to this level in other regulations. While providing ‘single customer views’ across regulation is nothing new, adding fields for tax tracking purposes is. Not only must this data be linked across a domestic institution, but also across borders and group levels. For instance, firms that fall under the same national IGA are no longer ‘foreign’ to each other and consequently do not have to report to the US. This means that if firms are trying to get a single FATCA view of a customer across a group, systems must be aligned.

There are plenty of unknowns to be discovered, and we won’t have all the answers this year. Regardless, joining the dots now will pay big dividends to your future KYC agenda. Who knows, it might even be good for business.