Slides by Steve Farrall, Schroders 11 Aug 09


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Slides by Steve Farrall, Schroders 11 Aug 09

  1. 1. Buy-side risk management Steve Farrall Chief Risk Officer Schroders August 2009 PRMIA / ISDA presentation
  2. 2. Contents <ul><li>Thoughts on Buy Side Risk Management </li></ul><ul><ul><li>Schroders </li></ul></ul><ul><ul><li>Internal priorities </li></ul></ul><ul><ul><li>External priorities </li></ul></ul><ul><ul><li>Investment risk </li></ul></ul><ul><ul><li>Operational risk </li></ul></ul><ul><ul><li>Liquidity in funds </li></ul></ul><ul><ul><li>Market Transparency </li></ul></ul><ul><ul><li>Forward-looking risk measures – stress testing </li></ul></ul><ul><ul><li>Capital requirements and ICAAP </li></ul></ul><ul><ul><li>Implementation </li></ul></ul>30441
  3. 3. 1. Schroders <ul><ul><li>Asset Management (£113bn AUM) and Private Banking (£11.2bn AUM) </li></ul></ul><ul><ul><li>Operating in 26 countries across UK, European, Asia-Pacific, US, Americas regions </li></ul></ul><ul><ul><li>From Global products to Local-Local products </li></ul></ul><ul><ul><li>Institutional and Intermediary distribution </li></ul></ul><ul><ul><li>Operate across asset classes – Equity, Fixed Income, Commodities, FX, Property, Structured, LDI, Multi Asset, Property, Private Equity, Hedge Funds, Funds of Funds </li></ul></ul><ul><ul><li>Operational Centres eg: Luxembourg for UCITS funds and Zurich for private banking operations </li></ul></ul><ul><ul><li>Outsourcing with key partners </li></ul></ul><ul><ul><li>Listed FTSE 100 company, also with Family ownership </li></ul></ul>30441
  4. 4. 2. Internal Priorities <ul><li>Executive requirements for risk management </li></ul><ul><ul><li>Clear scope and mandate </li></ul></ul><ul><ul><li>Cover investment risks, market and liquidity risks, principal and agency risks. What could really damage us? </li></ul></ul><ul><ul><li>Proactive, forward-looking (people and reporting) </li></ul></ul><ul><ul><li>Increase business understanding (include wider range of experience) </li></ul></ul><ul><ul><li>Focus on actions – the risk process should lead to identifiable actions taken to mitigate or accept risk </li></ul></ul><ul><ul><li>Be proactive during crises, providing mitigation advice </li></ul></ul><ul><ul><li>Keep costs manageable and minimise burden on business </li></ul></ul><ul><ul><li>No duplication with Audit and Compliance </li></ul></ul><ul><ul><li>Follow a principles-based approach that can adapt to new business or one-off situations </li></ul></ul><ul><ul><li>Ensure clear accountability in the governance process </li></ul></ul><ul><ul><li>Escalate and advise rapidly when there are issues – good advice early may be more useful than complete and validated advice too late </li></ul></ul><ul><ul><li>Provide enough bench strength that key processes are not dependent on single individuals </li></ul></ul>
  5. 5. 3. Industry priorities <ul><ul><li>Term credit risk, completeness of counterparty risk </li></ul></ul><ul><ul><li>Due diligence around third party funds and funds of funds </li></ul></ul><ul><ul><li>Liquidity – and shift in investor preferences </li></ul></ul><ul><ul><li>Walker and shareholder activism – process and practice </li></ul></ul><ul><ul><li>Risk culture –escalation </li></ul></ul><ul><ul><li>Risk culture – involvement at new products stage </li></ul></ul><ul><ul><li>Risk culture – forward looking and identifying tripping points, rather than reactive </li></ul></ul><ul><ul><li>Bringing risk into the strategic debate </li></ul></ul><ul><ul><li>Truly defining and articulating risk appetite </li></ul></ul><ul><ul><li>Stress testing and stability analysis </li></ul></ul><ul><ul><li>Need to reconcile independence of the risk function with proximity to the business </li></ul></ul><ul><ul><li>Clearer and more focused management reporting </li></ul></ul>30441
  6. 6. 4. Investment Risk <ul><ul><li>Recognise a key fact: Investment managers are the primary risk managers –but: independent challenge and oversight is vital </li></ul></ul><ul><ul><li>Mandate compliance and performance attribution tools strong </li></ul></ul><ul><ul><li>Risk decomposition and concentration risk tools strong </li></ul></ul><ul><ul><li>More needed on stress and scenario testing – forward looking measures under defined conditions </li></ul></ul><ul><ul><li>Group Risk team to focus on independent review and challenge: </li></ul></ul><ul><ul><li>Stress and scenario testing </li></ul></ul><ul><ul><li>Leverage and illiquidity </li></ul></ul><ul><ul><li>Independent price verification </li></ul></ul><ul><ul><li>Review of outlier P&L </li></ul></ul><ul><ul><li>New products </li></ul></ul><ul><ul><li>Testing wider industry concerns </li></ul></ul>30441
  7. 7. 5. Operational Risk <ul><ul><li>Historical issue: Comprehensive processes but little value added </li></ul></ul><ul><ul><li>Divorced from the business </li></ul></ul><ul><ul><li>Need to show an impact, as well as meet regulatory requirements – the real use test </li></ul></ul><ul><ul><li>Refocus the Group Operational Risk team: </li></ul></ul><ul><ul><li>Clear allocation of end-to-end process responsibility </li></ul></ul><ul><ul><li>Risk mapping to be driven by business mapping –not a detached exericise </li></ul></ul><ul><ul><li>More rapid escalation of errors, issues and losses - resolve first, then document. </li></ul></ul><ul><ul><li>Analysis of trends and exceptions – ensure lessons learned are shared </li></ul></ul><ul><ul><li>Comprehensive record of controls – but driven from what actually happens in the business. </li></ul></ul>30441
  8. 8. 6. Liquidity in Funds <ul><ul><li>The industry has provided liquidity as a free option in many cases </li></ul></ul><ul><ul><li>Markets have thoroughly tested this </li></ul></ul><ul><ul><li>At product design stage –what would be the liquidity of this product under stress market conditions? </li></ul></ul><ul><ul><li>Design a product or pricing method that reflects this </li></ul></ul><ul><ul><li>Stay on top of the issue with regular stress testing. </li></ul></ul><ul><ul><li>Stress testing needs to consider potential cash outflows, as well as the ability to get product into market under stress conditions – how lumpy is the client side? </li></ul></ul><ul><ul><li>Also consider from the start the need to protect the ongoing investor –clearer guidance over use of bid/offer spread and side pockets. </li></ul></ul>30441
  9. 9. 7. Market Transparency <ul><ul><li>Historically the market has accepted little transparency in the hedge fund and fund of funds space </li></ul></ul><ul><ul><li>Changing perceptions post Madoff </li></ul></ul><ul><ul><li>Requirement to be clear over the due diligence that fund managers should be expected to undertake, and what the hedge fund or fund of fund provider should provide </li></ul></ul><ul><ul><li>Reliance on external indicators such as UCITS </li></ul></ul><ul><ul><li>Auditors, pricing agents, regulators </li></ul></ul><ul><ul><li>Provision of information – articulation of strategy </li></ul></ul><ul><ul><li>Ability to backtest – transparency and execution of performance: proprietary strategies and reticence in data provision. </li></ul></ul>30441
  10. 10. 8. Forward looking measures – stress testing <ul><ul><li>Risk appetite should be defined from board level – across all risk factors </li></ul></ul><ul><ul><li>High level stress tests as well as detailed risk limits (eg: mandates) </li></ul></ul><ul><ul><li>Credit risk – counterparty stress tests and collateral stress tests </li></ul></ul><ul><ul><li>Market/Investment risk – macro stress tests on markets, micro stress tests on individual investment strategies (eg: cash/futures basis) </li></ul></ul><ul><ul><li>Liquidity risk - macro tests such as withdrawal of capital from an asset class, micro tests such as loss of the most significant investors in a fund </li></ul></ul><ul><ul><li>Operational risk – resilience tests such as withdrawal of a major service provider or failure of a market system </li></ul></ul><ul><ul><li>Engagement at the highest level – the most significant should be discussed with the Board –who should be engaged in the process </li></ul></ul><ul><ul><li>Actions taken based on the results </li></ul></ul><ul><ul><li>Keep the scenarios relevant to the business and up to date </li></ul></ul>30441
  11. 11. 9. Capital Requirements and ICAAP <ul><ul><li>These risk measures should feed the ICAAP </li></ul></ul><ul><ul><li>Stress and scenario testing under Pillar II </li></ul></ul><ul><ul><li>Need to ensure that they are considered appropriately - not simple addition </li></ul></ul><ul><ul><li>Senior management of the firm should be engaged in the development and testing of the ICAAP – not just something for risk or finance </li></ul></ul><ul><ul><li>Builds credibility, and a more proactive consideration for the need for capital </li></ul></ul><ul><ul><li>Amend for material transactions </li></ul></ul>30441