Asset Managers have been subjected to significant changes in the way that they are required to manage risk

within their business. Some of these relate to Basel 2, but there is a responsibility to implement and evidence an enterprise wide risk framework that supports ICAAP. This can be complicated by the evolving approach to regulation of complex groups resulting in changing regulatory relationships for asset managers. This talk will address the issues involved in achieving this wider risk framework.

Neil Brown Managing Director NoteWell Associates Ltd.

NoteWellMail@aol.com

Mitigating Risk by Evidencing Risk Control

..we will scrutinise proposals for new UCITS III funds and conversions of existing funds and will engage in a thematic review of the risk management of firms that are proposing to operate or are operating UCITS III funds.

Hector Sants, 19th September 2005

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Mitigating Risk by Evidencing Risk Control

.financial services regulators around the world are rightly concerned that the business and affairs of financial services firms are responsibly and effectively organised and controlled at senior management level and that firms senior management take responsibility for this a firm is required to establish, implement and maintain adequate risk management policies and procedures which identify and set the tolerable level of risk relating to its activities and effectively manage those risks. A firm also has to have a separate risk control function, where this is proportionate depending on the nature, scale and complexity of its business. This function will be responsible for assessing the risks that the firm faces and for advising the firm's governing body and senior managers on these risks. Christine Sinclair 15th May 2006
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Generic Risk Process

Define Risks the firm is prepared to take (Risk Appetite)

Identify risks the firm owns (to capital, reputation, earnings, brand.)
Categorise and identify the drivers of these risks (investment performance, market, credit, operational, event.) Agree measurement techniques (attribution, VaR, stress testing, scenarios, other)

Agree limitations of these techniques (Correlations, Fat Tails, model validity under stress)
Design / Build / Implement systems and processes to capture this information Set and operate appropriate controls (limits, delegated authorities, escalation processes Apportion responsibility for managing these risks Business management to own them Risk management to provide oversight
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Objective of the ICAAP

How much and what composition of internal capital the firm considers it should hold as compared with the capital resource requirement (CRR) pillar 1 calculation , and
the adequacy of the firms risk management processes

with respect to capital adequacy.

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Risk Framework
What are the risks?

Strategy
Earnings Reputation (Brand?) Investment Performance Failure to deliver mandated product Includes TCF, Advertising

Operational Risks Legal & Compliance Risks

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What Risks Should Be Considered for ICAAP?

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Other issues?

Group Structures strengths and weaknesses.

Outsourcing (and insourcing!)

Where applicable, details of any other business-unit-specific or business plan stress tests selected

Differentiation between ICAAP requirements and good business management.

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ICAAP

Annual? Risk types considered to justify exclusion? Capital required to mitigate worst case occurrence Not a process to manage the business.

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An Appropriate Risk Management Infrastructure

Who owns this and why will it happen?

Senior Management CEO/SEO / Apportionment Officer SIAPs

If you dont understand it, you shouldnt be responsible! Others

Line Management
All staff

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What Is Involved?
Company Risk Framework TABLE OF CONTENTS

Overview Governance Roles and responsibilities Definition of risks and risk appetite

Risk Management Framework Risk and Control Assessment processes Incident Management processes

Reporting and Monitoring

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Example: Roles and Responsibilities

Senior Management are responsible for implementing An effective and appropriate operating structure that has transparent and formal responsibilities including: implementing risk management frameworks within their part of business.

developing and implementing processes and procedures for measuring and managing risk in all of the material products, activities, processes and systems of their part of the business.
understanding and evaluating the risk profile and ensuring appropriate risk mitigation within their part of the business. producing reporting to demonstrate the effectiveness of the risk mitigation they have applied
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What Does This Mean?

Much of this will exist, some is documented. Document from the top down, pull all existing frameworks together Quality not Quantity (substance not form) Ensure that Management Information produced by all areas can support the risk framework (evidences management control)

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Reporting Structure
Board of Directors

Management / Board / Risk Committee

Chief Executive Officer

Business area Heads / Senior Management Monthly / Quarterly Reporting

Risk Management Monthly / Quarterly reporting

Line Management Monthly / Quarterly Reporting Business Activity Daily/ Weekly/Monthly /Quarterly Reporting
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Example - New Product Process Risks?

Strategy Earnings Reputation Investment Performance Failure to deliver mandated product Includes mis-selling,TCF, advertising

Operational Risks Legal & Compliance Risks

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Example - New Product Process

Initial idea - (Marketing?) product, marketplace, competition, asset target, costs, profitability....

Management support Front Office design (Portfolio Management?)

Middle/Back Office ability to support proposal

Legal/Compliance/Risk review Is the proposal legal and are we allowed to build/distribute? Do all areas of the business understand what is required of them?

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Product Marketing Responsibilities

Internal

External

Clearly defined product characteristics objectives, sources of alpha / absolute return risk controls & characteristics fees and commissions

Compliant marketing materials Brochures / Applications IFA materials Advertising

TCF considerations Place in market Place in portfolio Family/friends..

Clearly defined target marketplace Clearly defined target sales and timescales Clearly defined product review process

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Product Investment Management Responsibilities

Through what clearly defined investment process and risk controls & characteristics will they capture the alpha / absolute return to deliver the clearly defined fund objectives ..........

Credibility of how they will deliver consistent product/performance.

Ability to explain/demonstrate sources of absolute and relative performance (Attribution) Ability to explain demonstrate current portfolio positioning/bets (risk analysis)

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Middle/Back Office Responsibilities

What new systems or people are required? On what platform / how will you
price account risk measure report

What processes change as a result of this? What manual processes are introduced? What processes are special/different for this product? Ensure continuity and disaster recovery
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Risk Management Process

Investment Risk

Review proposed product characteristics versus proposed objectives / market / clients for goodness of fit
Ongoing review of the performance, attribution and risk analysis of product using appropriately designed statistics and techniques still true to label?

Operational Risk
Ensure

specific accountability, policies & controls, reporting at launch & ongoing segregation of duties at launch & ongoing Key Risks, Key Controls, Control Enhancements identified and addressed Integrate into ongoing OpRisk reporting enhance where necessary
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Additional/Enhanced Processes.?

Instrument / portfolio pricing Instrument / portfolio risk analysis Risk Management oversight Management oversight Board reporting

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Who Owns What?

Product design Investment delivery Product support Product launch Oversight

Marketing / Distribution (/ Investment Management) Investment Management Middle/Back Office CEO Senior Management/CEO Legal/Compliance/Risk Management

Ongoing product life

All of above but ultimately, CEO..

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Conclusions

Senior Management resolve is key Dont build the Bugatti Veryon * Model Bugatti Veyron 16.4 Engine type 7993cc, 16 cylinders in a W Power/Torque 1001bhp @ 6000rpm / 922 lb ft @ 2200rpm Performance 0-62mph: 2.5sec / Top speed: 253mph Price 810,345 Verdict Blows away all the other supercars

Set senior responsibilities and deliverables to drive framework down through the business
Ensure reporting is appropriate and evidenced Having created this framework, be ready for internal/external review
* Source: Times Online
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