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Risk Management Looks For Guidance


Firms attempting to prepare and strengthen their risk management systems in this rapidly changing regulatory landscape are finding it's a bit like trying to hit a moving target.

Flexibility will be the key to adapting to a new financial regulatory authority and new risk oversight rules that have yet to be formally established.

"We are seeing regulatory updates almost day to day," said Elizabeth Krentzman, a principal at Deloitte & Touche. To prepare for the unknown, firms like Deloitte are trying to stay abreast of all the proposals floating around.

The Obama Administration's new proposal, "A New Foundation: Rebuilding Financial Supervision and Regulation," calls for the Federal Reserve to serve as a systemic risk regulator, supported by the creation of a new Financial Services Oversight Council, as well as the creation of a new Consumer Financial Protection Agency.

Many people initially supportive of the idea of creating a new agency or merging agencies like the Securities and Exchange Commission and the Commodities Futures Trading Commission are becoming increasingly skeptical that the Congressional committees that oversee these agencies will be willing to share or surrender their power.

Instead, agencies like the SEC and CFTC are being asked to "harmonize" and "sharpen their pencils to come up with a list of all the instruments they regulate," Krentzman said, so authorities can locate any gaps in coverage or areas where resources may overlap.

Super Fed Superbad?

There are growing concerns among industry leaders that making the publicity-shy Federal Reserve serve as the systemic risk regulator would give too much power to the Fed and fall short of providing the regulatory transparency such a move requires.

In testimony before the Senate Committee on Banking, Housing, and Urban Affairs last Thursday, Paul Schott Stevens, president and CEO of the Investment Company Institute, said the Financial Services Oversight Council, as proposed, would have at best an advisory or consultative role.

"The lion's share of systemic risk authority would be vested in the Federal Reserve, and that approach strikes the wrong balance," Stevens said. "Most importantly, it fails to make meaningful use of the expertise and viewpoints of other regulators, and it represents a worrisome expansion of the Federal Reserve's authority over the nation's entire financial system. I would urge Congress instead to create a strong Systemic Risk Council-one with teeth."

Stevens said the interagency council should be comprised of financial regulatory leaders from the Treasury Department, Federal Reserve, SEC, CFTC, Federal Deposit Insurance Corporation and the Comptroller of the Currency.

"This approach offers several advantages," he said. "The Council would enlist expertise across the spectrum of financial services. It would be well-suited to balancing the competing interests that often arise, and it would engage the functional regulators as full partners in the task of identifying emerging risks or gaps. At the same time, its independent staff could serve as a check on the functional regulators and avoid the 'regulatory capture' that could result if one agency were set over all institutions deemed 'systemically risky' or 'too big to fail.'"

Stevens said an interagency council could be formed quickly, compared to the years it could take for any existing agency to assemble the skills needed to oversee all areas of the financial system.

The Treasury's recently proposed a requirement for all hedge funds and private capital pools with $30 million or more of assets under management to not only register with the SEC, but to reveal their assets under management, whether they engage in leveraging or borrowing, and if they have any off-balance sheet exposure. If passed, hedge funds would also have to comply with strict capital, liquidity and risk management rules.

The intention of these proposals is not to drive away legitimate investments to shady offshore locations, but rather to ensure that hedge funds develop and implement the tools that will allow them to monitor and manage a broad array of risks in a manner that can be quantified, said Ricardo Martinez, a senior manager at Deloitte & Touche.

"Not all risks can be quantified," he said, but "those that can be measured need to be grouped together."

Martinez said investors should expect and require their hedge fund manager to employ a risk management framework with the following key features:

* Identification of material risks

* Measurement of the principal categories of risk

* A regular process of risk monitoring, appropriate for the size of the fund, its portfolio management process and the complexity of its investment strategies

* Policies and procedures establishing measurement and monitoring criteria

* Knowledgeable personnel to measure and monitor risk

The hiring of a chief risk officer who aspires to balance risk and return expectations can help a firm manage investment decisions consistent with the firm's investment guidelines, Martinez said.