This article appears courtesy of Global Investor.
As recently as 2004, it was rare to find an asset management firm or financial institution with a chief risk officer sitting on the board. Just two years later, the thinking has moved on and asset managers recognise that strategic management of risk is an essential and differentiating component in a compliant, healthy and successful business. Most companies either have in place, or are considering appointing a chief risk officer or equivalent role at board level.
The speed of change, increasing complexity, and breadth of competition in the market requires an ever more flexible and pro-active approach to risk management. The train is coming and only the most nimble will be on it!
The key drivers for the asset management industry and its main players are the re-emergence of liability-driven investment and the rejection of long-adhered-to asset benchmarks; the focus on the customer rather than the company; the creation of solutions not products; and the ever increasing framework of global regulation that surrounds our business.
In deciding how to react to these drivers, companies will need to consider how adequately they have embedded risk management into their culture, systems and processes; how to identify and leverage opportunities brought by the rapid change in the regulatory environment; and how to prioritise and mobilise resources to benefit from the increasing complexity of investment solutions.
Effective risk management will be a key differentiator. Customers will want to understand the risks inherent in their portfolios and in the businesses that they entrust their money to. They will want to know how those risks are identified, controlled and mitigated. They will want to have confidence that we shall deliver on our promises to them in a manner consistent with their specific risk tolerances.
Risk management has always been an integral part of an investment business and includes elements as diverse as strategic asset allocation and stock selection through to detailed operational controls and the development and testing of robust disaster recovery plans. In the most successful organisations, risk management is part of the business – not something separate from it. It is part of the fabric and carried out by everyone as part of their daily role. The risk team's role is to support the business in managing its risks.
Articulating risk
The future will see more pro-active application and communication of risk management strategy at the business development and client acquisition stage. Pension fund trustees and consultants are already demanding more insight into every area of an asset manager's risk policy at the request for proposal stage. Companies need to demonstrate an understanding of the key risks for the customer and articulate how they are identified, measured, monitored and mitigated. Doing this well will be a differentiator and will become a vital component in convincing customers (or future customers) that their money is in safe hands and that consistent delivery is assured.
As a well-regulated industry, asset management has traditionally coped well with regulatory changes. However, as the EU continues to play a more dominant role in policy formulation, companies are watching their national regulators with an ever closer eye. Cross-border competition will bite harder if new rules are not interpreted and implemented in the same way andwithin the same timescale in each country.
Before even considering new European regulation, issues for many UK-based asset managers include the alignment of regulations between existing products, such as OEICs and insurance-linked funds, or the fact that current regulation forces the launch of new innovative products offshore rather than onshore. Perhaps there remains an opportunity for work to be done at a national level in the shorter term that could be of benefit to businesses looking at the global marketplace over the longer term.
Derivative capabilities
The development of more complex solutions, utilising liability-driven investment and absolute return strategies, brings with it an equivalent need for comprehensive and robust derivative capabilities in order to manage and mitigate risk most effectively and deliver returns with certainty and precision. The combination of this, together with first-class capabilities in the management of core bond portfolios and a spread of uncorrelated returns will provide more of the key differentiators for successful business in the future.
This new thinking requires significant change and targeted education for pension scheme trustees and company directors (who, in the UK at least, are also coming to terms with complex new rules designed to offer greater protection to scheme members). Asset managers wishing to stay at the vanguard will need to help clients understand what options are available, which risks can be mitigated and which cannot.
The risk landscape will continue to change in many ways. Companies that can look beyond merely managing risk to ways of genuinely utilising this capability for the benefit of customers will generate competitive advantage and be clear winners.
Keith Lovett is chief risk officer of Insight Investment.