Regulation overtakes reputation as biggest risk concern for asset management CROs
London, 14 June 2010 – Increased regulatory interest has overtaken reputation as the biggest risk concern for asset management chief risk officers (CROs) with the desire to optimize capital and liquidity springing into third place, according to Ernst & Young’s second annual industry risk management study.
This year’s research, which surveyed in detail 29 heads of risk and CROs from several leading asset managers in the UK and continental Europe, also found that most organizations were likely to launch a product from scratch in two to three months or up to six months compared to just two months last year.
Roy Stockell, leader of Ernst & Young’s Europe, Middle East, India and Africa Asset Management business, comments: “The asset management industry is in a very different place to this time last year. It has wrestled with a number of new regulations in the past 12 months, from the Walker Review to UCITS IV through to the controversial alternative investment fund manager (AIFM) directive and Internal Capital Adequacy Assessment Processes (ICAAPS). It is clear there will be radical changes to the shape and focus of the industry in the near future and access to capital has become a fast-growing issue for our respondents this year.”
Firms are paying careful attention to their ICAAPs and are looking to optimise capital provisioning, particularly in light of continued challenges around liquidity.
Dr Anthony Kirby, director in the Ernst & Young regulatory and risk management practice, comments: “To a large extent, the G20, the central banks and the prudential regulators are all acting in a concerted manner to manage liquidity risk and avoid pro-cyclicality at all costs. However, the current evidence is that the FSA in particular is placing more focus on risk appetite and linking the risk framework to strategic decision making. This includes requiring managers to provide a sufficiently detailed explanation of (and justification for) the methodology adopted and the conclusions reached.”
The results of the survey showed a definite direction of travel towards greater regulatory scrutiny plus a desire by firms to optimise the amount of capital they must set aside to meet Pillar II challenges, also known as individual capital guidance.
Kirby continues: “The ‘trust me’ approach has given way to a ‘show me’ approach and the FSA is increasingly keen to see evidence of reverse stress testing and more detailed unwinding costs and what this would mean. This is not just a feature in the UK, but gaining greater attention across other European jurisdictions as well. As capital becomes more scarce and more of a binding constraint for firms, the issue of pricing for risk capital will assume a relatively higher importance."
Elevating the CRO
The greater worth of the CRO has been recognized by the industry this year. Unlike the 2009 survey, there were no instances where a CRO was not involved in any stage of the product development process. The survey also highlighted the fact that more CROs are reporting to chief executive officers than last year with an equal number reporting to either the group CRO or COO.
Kirby comments: “The role and remit of the risk function has elevated from a ‘risk monitoring’ function reactive to events, towards more of a strategic enabler of the business. The CRO now looks at a multitude of new risks, such as investment, fiduciary and client mandate risks, in addition to more traditional risks such as liquidity, valuation, counterparty and operational. It is clear from our survey this year that businesses are better valuing the role of the CRO. CROs must persist in driving risk management through the business and continue with essential reporting to the board,” he adds.
Improving management information
If there was a silver lining for the industry in light of the financial crisis, it was that managers recognized the need for good quality operational risk data in order to meet stress testing requirements – such as stress testing to destruction scenarios. “Most firms need between five to seven years of historic data featuring both incidents and near misses to carry out meaningful analysis”, Kirby comments. “They must record all the data from errors in their firm’s favor as well as bad news data to ensure they have the most complete picture possible to hand for assessing future scenarios.”
Kirby concluded: “CROs are not always afforded the luxury of being able to sit back and study the bigger picture of the business. However, for the newly-elevated risk management function to maintain its seat at the table, CROs must be armed with the relevant management information and historic data for back-testing. It also makes sense to dust-down older contracts and service level agreements to make sure that they are still appropriate.”
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