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2012 Operations Survey: The Two Rs of Basic Concern: Risk & Regulation


Risk management and regulatory reporting.

These are the two areas that worry managers at mutual fund companies, asset management companies and support providers as being the greatest potential sources of errors in their operations.

Driving the concern are the "potential loss related to litigation, regulatory risk as well as reputational risk,'' as the vice president for compliance of a mutual fund company in Simsbury, CT, put it,

Indeed, in each case, risk management and regulatory reporting were each cited by 50% of the 110 respondents to the core question of what concerned them most about the potential for area in their fund company's basic functions.

All told, 175 of the top business and operations executives in the fund industry took part in the second annual Money Management Executive Operations Survey. The survey was conducted in July and August by Lodestar Research and sponsored by J.P. Morgan Worldwide Securities Services.

The worries exemplify the increasing pressure that operations executives in the fund business feel as regulators worldwide step up their scrutiny of financial firms, not just from the Dodd-Frank Wall Street Reform Act or new Internal Revenue Service rules on cost-basis accounting or the Foreign Account Tax Compliance Act.

Of those reforms, top of mind clearly was the Dodd-Frank act. Fully 60% of respondents said that response to the credit crisis of 2008 was either an "important" or "very important" driver of change in their funds' operations. Of big firms with more than $51 billion in assets under management, that rose to 76% who felt Dodd-Frank was going to be a big driver of change.

Indeed, 93% of big firms cited in some fashion the Dodd-Frank Act, which emphasizes additional disclosure on how financial firms, including investment funds, as driving change in their operations. Also playing a role are new proxy disclosure rules which require boards to describe how risks are managed.

Next up are the new IRS rules on cost-basis accounting, cited by 50% of respondents as important drivers of change. FATCA was cited by 34% as driving change. A similar percentage of respondents cited European regulations, such as the fourth round of the Undertakings for Collective Investment in Transferable Securities, the third round of the Basel Accord and the second edition of the Markets in Financial Instruments Directive.

But lawmakers and their requirements took second seat to a more important constituency that is driving the change, according to the respondents.

The biggest driver of change, overall?

Investor demands, cited by 77% of executives polled.

Also a big driver of change-and concern: cost. Nearly three-fourths of respondents-74%-said cost reductions were driving them to find new ways to operate.

Which is leading to closer tracking, according to the senior vice president of operations for an investment servicing firm in Columbus, Ohio, of the accuracy of net asset values as they are compiled, the speed of answering shareholder calls for services, abandonment rates on those calls and the number of accurate filings produced during a year.

Risk assessments are performed on each area of the business on a continual basis and reviewed annually by senior business leaders, in the case of the operations of a separately managed account business in New York. Its chief operating office for investment management says all risks "are self-identified and controls are documented and residual risks are assigned. Internal audit performs reviews on all risk identified along with the controls that are documented. Additional recommendations may follow to strengthen controls.''

Quantitative means of tracking risks are proliferating. Daily and monthly reports on trades that cannot be matched, known as "out-trades,'' as well as processing times, systems capacity, margin calls, risk alerts and customer complaints, are now being watched closely, according to a fund industry consultant in San Francisco.

Also being graphed are "frequency" and "severity" distributions with an effort to find what causes correlate to the errors that surface. Severity, often, gets ranked by the financial impact. And regulatory changes are reviewed with an eye toward what the "loss events" and penalties could be and are prioritized accordingly.

To manage all this regulatory, operational and regulatory risk, 44% of respondents said their firms employ a dedicated "chief operational risk officer" or a C-level executive specializing in operational risk. That compares to 49% a year ago.

Only 7% of the remaining respondents said their firms planned to add such an officer. Forty-five percent said their firms had no such plans.

Such officers are in smaller supply in firms that manage under $50 billion in assets. Of those firms, only 30% have a top officer dedicated to overseeing operational risk, compared to 59% of the larger firms. And only 2% expect to add one in the next 18 months, compared to 11% of firms with more than $51 billion under management.

With cost reduction an ongoing challenge, the survey asked respondents how automated key functions had become.