FATCA: A US Regulation That's Having a Global Impact

FATCA has raised the stakes for data quality and the need for "clean data."

Enacted as part of the Hiring Incentives to Restore Employment Act of 2010, the US Foreign Account Tax Compliance Act (FATCA) has been one of the most widely discussed pieces of regulation in recent years. In simple terms, it aims to thwart tax avoidance by US citizens by preventing them from hiding income and assets in other countries. However, the impact is truly global, encompassing most foreign financial institutions (FFIs) and investment firms with US clients.

FATCA requires participating FFIs to identify and report certain information about US accounts to the Internal Revenue Service. The reporting measures are considered so complex that policy makers agreed to extend the compliance deadline. The FFI reporting deadline is now fixed at July 1, 2014, but the Treasury Department announced in May that the IRS will adopt a soft approach to enforcing the rules. As a result, penalties for failing to comply with the rules are unlikely to be in full force until next year. That said, the IRS has stated in no uncertain terms that it fully expects firms to make every effort to comply with the requirements and iron out any issues.

This temporary relief does not mean FFIs can slow down their preparation. Institutions not only need to develop action plans for implementation, but they must also pay attention when enforcing these measures. Here are several areas that FFIs must consider.

Legal entity identification
FFIs must identify and classify entities in order to comply with the regulation. To be compliant, they will need to identify US and non-US persons and create new US accounts. This classification is based on a number of legal entity criteria related to geography, industry sector, and ownership. The legal entity data required includes global intermediary identification number (GIIN) codes, entity types (and exemptions), affiliation, public listing data, and ownership information -- to 10% shareholding in some cases.

Considering the thousands of entities that institutions have on their books, FFIs face a significant administrative and financial burden to source, validate, and maintain this legal entity data. An effective sourcing of accurate legal entity data can streamline this effort and remove multiple unnecessary requests for client documentation.

Due diligence and onboarding
Institutions must continue to strengthen their know-your-customer processes in order to meet more extensive requirements. FATCA compliance is an ongoing process requiring proactive monitoring of client information, and FFIs are required to report any changes to the IRS.

Though typical know-your-customer rules require some accounts to be reviewed periodically (depending on customer risk ratings), FATCA compels institutions to identify any changes in circumstance for all clients on a continuous basis in order to ensure these changes do not trigger a review of the US or non-US status for that specific customer.

Auditing and monitoring
Many institutions do not store customer data and documentation centrally. Privacy considerations and complex architecture often mean that data is stored across technology silos and operational processes, leading institutions to have multiple and partial views of a customer. This invariably increases complexity, costs, and risk of errors.

Functions across institutions must share their understanding of how FATCA will impact their use of client data in order to optimize budgets and resources and increase overall efficiency. FFIs need to develop and execute an institution-wide action plan that takes into account each function's client data requirements and how they can be leveraged across the business.

Accurate data
FATCA has raised the stakes for data quality and the need for clean data. Many FFIs will tackle FATCA data sourcing together with other pieces of regulation, such as EMIR, the Dodd-Frank Act, MiFID, and AIFMD. The level of field overlap can be significant, while the need for efficiency and consistency is increasing.

Data quality is critical to meeting FATCA requirements. Any flawed information likely will directly impact the accuracy and validity of the reporting itself. To ensure full compliance, FFIs must validate the data they use on an ongoing basis. Despite perceptions, automated data processing alone is not enough. It requires dedicated teams with solid expertise and knowledge of data sources and languages and, ultimately, human oversight to find the definitive answer where sources conflict. For these reasons, firms are turning to external providers to help with this process.

Though this regulation is undoubtedly complex, the burden of FATCA compliance both today and in the future can be reduced by adopting the right strategy at the outset. And if that strategy has quality data management practices at its core, then the benefits can flow through to other initiatives and tax regulations that will follow this. As it is with all regulations, when it comes to reporting client data, it is essential that institutions ensure there is a full understanding of the requirements and opportunities across the organization while keenly focusing on timeliness, accuracy, and momentum.

Mark Davies joined Depository Trust and Clearing Corporation (DTCC) in 2012 to lead its European efforts around the development of the legal entity identifier, a global initiative created in response to new regulations for reducing systemic risk. In January 2013, in addition ... View Full Bio