05.14.2014
By Terry Flanagan

Risk Management Activates

Increased use of alternative investments, calls for greater transparency, and the burdens of regulation are forcing asset managers to change their approach to risk management from a passive exercise to one that’s tied to investment and trading decisions.

“Risk management needs to become actionable,” said Samuel Won, founder and president of Global Risk Management Advisors, during a panel discussion on Tuesday hosted by risk management technology provider FinCad. “The financial crisis has inexorably changed the way institutions behave. They are trying to connect risk measurement to management and governance of risk. The linkage between measurement and management of risk is being brought about by regulation, pressure from investors, and fiduciary risk.”

As the investment process is becoming more complex, there is evidence that institutional investors are becoming less tolerant of products with poor transparency, where investment processes are not well defined, said Cubillas Ding, senior research director at Celent Research.

Citing an upcoming study by Celent on buy-side risk management, Ding said that the use of alternative investments by asset managers is being driven by quantitative easing, investor search for yield, and an upturn in traditional funds and alternatives in general. “Forward-looking surveys of institutional investors as well as historical composition changes in portfolios indicate that alternatives are going mainstream and becoming a permanent fixture of portfolios,” he said.

The ability to be consistent, flexible and robust from an operational perspective underpins the opportunities of investment firms to attract capital, Ding added.

The Basel Committee on Banking Supervision has published a final standard that sets out a supervisory framework for measuring and controlling large exposures, which will take effect from January 1, 2019.

The large exposure standard includes a general limit applied to all of a bank’s exposures to a single counterparty, which is set at 25% of a bank’s Tier 1 capital. This limit also applies to a bank’s exposure to identified groups of connected counterparties (ie counterparties that are interdependent and likely to fail simultaneously).

This places the onus on institutions to take a holistic approach to risk management. “Firms need to think about how trading and investment decision making and risk activities can be more seamless,” said Ding. “They need to demonstrate a total risk monitoring and governance approach. This is especially important for an asset manager that works with both internally and externally managed portfolios, especially if there are substantial amounts of derivatives.”

Feature image via Flickr/William Hook under CC

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