The Three R's of the Investment Management Industry


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  • Liquidity stress tests with more stringent variables
  • Previously used code dated Trading systems more complex, latency more of a factor Require development, testing and integration No previous framework and further clarity required Will require coding to recognize, maintain & revert the state of a specific stock Potential to exponentially increase trade message traffic
  • Compliance Statement – As part of the GIPS compliance statement, investment firms will be required to disclose whether their firm has been verified. Fair Value – The proposal requires firms to report portfolio performance based on fair value accounting. Risk Disclosures – As part of the composite description, firms will be required to disclose sufficient information to allow a prospective client to understand the relevant risks of the composite strategy. Verification – The scope and purpose of verification, as well as the required verification procedures that must be followed by verifiers have been clarified in Section III in order to increase the understanding and consistency of verification. Non-fee-paying Portfolios – Investment firms will be required to include all discretionary non-fee paying portfolios in at least one composite. Standard Deviation – Investment firms will be required to disclose the three-year annualized ex-post standard deviation of the composite and benchmark. Proprietary Portfolios – Firms will be required to disclose the percentage of composites composed of proprietary assets (e.g., “seed” capital or “house” money). Real Estate External Valuation – For periods beginning January 1, 2012 or after, real estate investments must be valued by an independent external valuer or appraiser at least once every 12 months.
  • Liquidity stress tests with more stringent variables
  • Recent TG survey shows that 58% of small to mid-sized global asset managers are using some sort of remote or hosted application. Need to address Data privacy System security
  • The Three R's of the Investment Management Industry

    1. 1. The Three R’s of the Investment Management Industry Risk. Regulation. Reinvention. <ul><li>Dayle Scher </li></ul><ul><li>Research Director </li></ul><ul><li>Investment Management </li></ul><ul><li>July 16, 2009 </li></ul>
    2. 2. Risk Management Changes
    3. 3. Important areas of risk <ul><li>Credit (losses due to the deterioration of a debtor’s credit quality and ability to repay an obligation) </li></ul><ul><li>Counterparty (counterparty to a transaction will be unable to meet its future payment obligations) </li></ul><ul><li>Liquidity (inability to raise capital or inability to sell instruments due to a lack of buyers) </li></ul><ul><li>Market (financial losses due to changes in the market value of securities held on a balance sheet) </li></ul><ul><li>Operational (losses due to compliance failure or due to the lack of robust processes and procedures) </li></ul>
    4. 4. Important areas of risk (continued) <ul><li>Portfolio (aggregation of the risks in the individual components that make up the portfolio) </li></ul><ul><li>Regulatory (regulation will affect the value of a holding or impede the ability to earn revenues) </li></ul><ul><li>Reputational (negative publicity will cause a decline in the customer base, revenue or incur litigation) </li></ul><ul><li>Settlement (settlement failure due to counterparty inability to deliver securities or cash) </li></ul><ul><li>Sovereign (foreign countries take actions that reduce the value of assets held in that country) </li></ul>
    5. 5. Significance of various risks differs across Securities and Investments firms Hedge Funds European Universal Banks Settlement Operational Counterparty Liquidity Market Portfolio Credit Sovereign Source: TowerGroup Registered Investment Advisors Institutional Broker-Dealers Execution Venues Traditional Asset Mgrs Retail Broker-Dealers Regulatory Reputational Low Significance High Significance Key:
    6. 6. Risk will be one of the few areas where CIOs will spend more money in 2009 <ul><li>Where will CIOs spend their risk dollars? </li></ul><ul><li>Accurate and timely data for securities valuation (Derivatives, illiquid instruments) </li></ul><ul><li>Upgrade data management infrastructure </li></ul>Data Management <ul><li>New risk applications </li></ul><ul><li>Data warehouse </li></ul><ul><li>Improve risk models (greater robustness) </li></ul><ul><li>Alternate approaches: Scenario analysis, etc. </li></ul><ul><li>Infrastructure for enterprise-wide risk mgmt </li></ul>Apps/Infrastructure <ul><li>Hire risk personnel </li></ul><ul><li>Raise profile of risk function: incentives, reporting structure </li></ul><ul><li>Greater training and reporting </li></ul>Organizational
    7. 7. Regulatory Changes
    8. 8. 10 Regulatory Initiatives and their Impact <ul><li>Oversight of derivatives, structured products </li></ul><ul><li>Hedge fund registration </li></ul><ul><li>Valuation of illiquid instruments </li></ul><ul><li>New standards for leverage; capital adequacy </li></ul><ul><li>Reinstatement of uptick rule, limits on short selling </li></ul>
    9. 9. 10 Regulatory Initiatives and their Impact <ul><li>Executive compensation </li></ul><ul><li>Strengthening mortgage regulations </li></ul><ul><li>Changes in accounting rules </li></ul><ul><li>Revamping of credit rating business </li></ul><ul><li>Amendments to money market funds </li></ul>
    10. 10. Regulators Will Enact New Derivatives Rules at the Organizational and Industry Level Organization Derivatives Industry <ul><ul><li>Client qualification </li></ul></ul><ul><ul><li>Segmentation of collateral </li></ul></ul><ul><ul><li>Off-balance-sheet accounting </li></ul></ul><ul><ul><li>OTC position reporting </li></ul></ul><ul><ul><li>Capital requirements </li></ul></ul><ul><ul><li>OTC clearing </li></ul></ul><ul><ul><li>Infrastructure improvements </li></ul></ul><ul><ul><li>Information reporting </li></ul></ul><ul><ul><li>Exchange listing </li></ul></ul><ul><ul><li>Ratings agency reform </li></ul></ul>
    11. 11. Count on more accounting change <ul><li>Fiduciaries to independently value illiquid instruments instead of solely relying on third parties </li></ul><ul><li>Debate on mark-to-market versus fair-value accounting </li></ul><ul><li>Conversion from US GAAP to IFRS </li></ul>Source: TowerGroup
    12. 12. And while not regulatory, GIPS changes are unavoidable Error Correction <ul><li>2010 Exposure Draft </li></ul><ul><li>Compliance Statement </li></ul><ul><li>Fair Value </li></ul><ul><li>Risk Disclosures </li></ul><ul><li>Verification </li></ul><ul><li>Non-fee-paying Portfolios </li></ul><ul><li>Standard Deviation </li></ul><ul><li>Proprietary Portfolios </li></ul>
    13. 13. Emboldening of regulators has four key technology implications <ul><li>Data Integrity </li></ul><ul><li>Data Models </li></ul><ul><li>Data Governance </li></ul>Data Management <ul><li>Stress Tests </li></ul><ul><li>Models </li></ul><ul><li>Scenario Analysis </li></ul>Valuations <ul><li>Confirmations </li></ul><ul><li>Affirmations </li></ul><ul><li>Performance measurement </li></ul>The Basics! <ul><li>Credit Risk </li></ul><ul><li>Market Risk </li></ul><ul><li>Operational Risk </li></ul>Risk Management
    14. 14. Reinvention in a capital-constrained environment
    15. 15. Securities and Investments Firms’ IT Spending by Region (2007–12P) <ul><li>Source: TowerGroup estimates </li></ul><ul><li>(USD in Millions) </li></ul>CAGR = –1.7% CAGR = –1.7% CAGR = 6.1%
    16. 16. Restructuring of market practices in OTC derivatives Source: TowerGroup Issue Business Impact Regulation Firms will have to improve automation to comply with regulatory demands. Regulators will demand better reporting and more transparency. Market structure evolution As the battle between pure OTC, OTC with clearing, and exchange listing heats up, brokers have to prepare for all scenarios. Central clearing Regulators will force certain contracts to be cleared centrally. Brokers will have to manage collateral with central clearing parties in addition to counterparties. Product and process standardization Product standardization is a prerequisite for the process automation demanded by regulators. Buy-side firms will gravitate to standard, transparent products. Pricing, valuation, and risk Enterprise risk management becomes a competitive differentiator. Best practices for pricing and valuations will include multiple independent price points.
    17. 17. Consolidation is underway <ul><li>Combination of Credit Agricole and Societe Generale asset management businesses </li></ul><ul><li>BlackRock acquisition of BGI </li></ul>
    18. 18. IT Spending shifts to external development… Source: TowerGroup estimates (USD in Millions) 2007–12P CAGR ($) % Internal – 4.0% External-Hardware 1.1% External-Software 0.1% External-Professional Services – 4.4% External-Outsourcing Services 2.0%
    19. 19. … and a growing shift to hosted software Internal <ul><li>Why? </li></ul><ul><li>Variable cost model </li></ul><ul><li>Technology advances </li></ul><ul><ul><li>continuous enhancements </li></ul></ul><ul><ul><li>common user interface </li></ul></ul><ul><ul><li>flexible administration </li></ul></ul><ul><ul><li>security </li></ul></ul><ul><ul><li>privacy </li></ul></ul><ul><ul><li>business continuity </li></ul></ul>External
    20. 20. Conclusions <ul><ul><li>Investment management firms face daunting objectives of client focus, operational excellence, and risk management. </li></ul></ul><ul><ul><li>Firms ranging from the most traditional to the most alternative face new regulation to address investor protection, market practice, and accounting standards. </li></ul></ul><ul><ul><li>The reinvention of the industry started with the dissolution of two brokerage stalwarts and continues to evolve with technology needs hampered by an environment of strict cost control. </li></ul></ul><ul><ul><li>Smart spending today on flexible technology will determine a firm’s future success </li></ul></ul>
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