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# journal SimCorp

Journal of Applied IT and Investment Management

of Applied IT and Investment Management

REPAIRING A FAILED SYSTEM Credit ratings IT in the spotlight Managing macro financial risks SimCorp establishes research institution

reduce cost


Volume 1 路 No. 1 路 April 2009


mitigate risk

April 2009

enable growth

2 April 2009

Journal of Applied IT and Investment Management

CEO comment:

A new paradigm in the investment management industry by CEO Peter L. Ravn Welcome to our new quarterly journal, which is part of SimCorp’s contribution to a better understanding of the strategic and tactical trends in the global investment management industry. SimCorp’s strong technological engage­ ment in the buy-side of institutional investment management enables us to offer a qualified view of what’s going on in the industry. At the same time, we want to continuously develop our own knowledge. In our view, the best way to do so is to share our ideas and experience with those of business schools, industry experts and consultants as well as with our clients, as this is not a single, but a multi-disciplinary industry development. We aim to realise this opportunity to make a genuine contribution through establishing the SimCorp StrategyLab as a significant industry thought leader. In this connection, I am very pleased to be able to announce that Ingo Walter, Professor in Finance, Governance and Ethics, of the Stern Business School, University of New York, has taken up the challenge of leading the work of SimCorp’s StrategyLab. The current market environment is one of constant and rapidly emerging challenges. Without doubt, it will lead to a tightened regulatory environment with increased pressure from governments to protect citizens’ wealth. We will also see more assets and more pension obligations being outsourced to the fund management sector. Therefore, the industry needs to take greater steps to mitigate risk. It needs to achieve greater efficiency and transparency to reduce cost. And it will need to harness scalable platforms in a way that does not entail high levels of incremental cost. These requirements are the guiding principles underpinning the work of SimCorp’s StrategyLab. In 2008, SimCorp produced very robust financial results in a challenging and changing environment. We also maintained a significant level of R&D, amounting to more than 22% of sales. This is not only a very high level for our industry, it is also our belief that making this investment in R&D will enable us to help drive our clients’ businesses forward. The work of our StrategyLab and the issues examined in this publication give us confidence that going forward we will also spend our R&D resources in the right areas. Therefore, it is our belief that we can play an important part in preparing the industry as a whole to face a new paradigm in the investment management industry.

Peter L. Ravn (Ph.D.) is CEO at SimCorp A/S.


Contents # Repairing a failed system


# Credit ratings: IT in the spotlight


# Outsourcing and risk management: time to redefine requirements?


# SimCorp establishes private research institution


# SimCorp StrategyLab research programme 2009/2010


# time to rethink risk management? Global risk management report March 2009


# Managing macro financial risks


# SimCorp Dimension Release 4.5


# New challenges for operational risk after the financial crisis


# Regulatory update


# Book review


# SimCorp StrategyLab Risk Management Excellence Award 2009


# Recent research and white papers


Read the journal online at Editor-in-Chief Lars Bjørn Falkenberg, Vice President, SimCorp A/S Editorial Assistant Mette Trier Riisgaard, SimCorp A/S Publisher SimCorp A/S, Weidekampsgade 16, 2300 Copenhagen S, Denmark, Phone: +45 35 44 88 00. Journal of Applied IT and Investment Management is a quarterly publication, which is published and distributed globally by SimCorp A/S. Print run: 7,000. Subscription to the journal is free of charge for members of the industry, associated institutions and academics. To subscribe, please visit Address changes can be mailed to SUBMISSION GUIDELINES Articles, book reviews, new reports and information on recent research can be submitted for review to Editorial Assistant Mette Trier Riisgaard, For submission guidelines, please visit http:// Disclaimer The contents of this journal is for general information and illustrative purposes only and will be used at your own risk. The articles in the publication do not necessarily reflect the view of SimCorp. SimCorp will use all reasonable endeavours to ensure the accuracy of the information. However, SimCorp does not guarantee or warrant the accuracy or completeness, factual correctness or reliability of any information in this journal and does not accept any liability for any errors or omission including any inaccuracies or typographical errors. ISSN 1903-6914. Copyright rests with publisher. All rights reserved ©SIMCORP A/S 2009.


Journal of Applied IT and Investment Management

April 2009


# Repairing a failed system

Today’s global financial problems are probably as severe as those faced in the ­early 1930s. Time will tell. But the top tier of global financial institutions are far bigger than they were back then. by Professor Ingo Walter, director of SimCorp StrategyLab


he world’s three biggest banks each have at least $2 trillion of assets on their balance sheets and most of them are in deep trouble. Banks, insurers and asset managers have written off hundreds of billions of assets, and many of them are so entangled with the rest of the financial system that they cannot be allowed to fail. Collapse of a major bank today would create financial havoc far greater even than what we have already been through in the last year. Creditors of these large financial intermediaries must be protected, or the global financial system itself will collapse. Not surprisingly, the govern­ ments of the countries hosting these ‘systemic’ institutions are currently doing all they can to save them, a task that is proving enormously expensive for taxpayers. Bottom-line: long-standing

The bubble There is almost universal agreement that the fundamental cause of the crisis was the combination of a credit boom and a housing bubble in the United States and elsewhere. There are many statistics to back this up. For example, in the five-year period from 2002 to 2007, the ratio of debt to national income in the US rose from 3.75 to 4.75 to one. It had taken the whole previous decade to accomplish a feat of similar proportion, and another fifteen years for it to double prior to that. During this same period, house prices grew at an unprecedented rate of 11% per year, in the US, with comparable developments in the UK, Spain, Ireland, Hong Kong and other markets.

“When the ‘bubble’ burst, it signaled a s­ evere economic crisis to come.”

When the ‘bubble’ burst, it signaled a severe economic crisis to come. The median family, whose home might have represented 35% of its total assets and which typically was highly leveraged, would not be able to continue as before, and in the aggregate the global economy and financial system were destined to feel the brunt of it.

implicit guarantees of financial institutions and instruments have now hardened and broadened dramatically, requiring a fundamental repricing as part of any effort to repair the financial architecture.

There is no shortage of proximate causes. Mortgages granted to people with little ability to pay them back and designed to systemically default or refinance in just a few years, depending on the path of house prices. The securitisation process

It is much less clear, however, why this combination of events led to such a severe financial crisis, that is, why we ended up with widespread failures of financial institutions and the freezing up of capital markets. The ‘systemic crisis’ that ensued reduced the supply of capital to creditworthy institutions and individuals, amplifying the effects to the real economy.

that allowed credit markets to grow so rapidly – but at the cost of lenders having little ‘skin-in-the-game.’ And there were the opaque structured products that were rubber stamped AAA by the rating agencies more interested in fees than risk assessment. When there is no trans­ parency, no one can be sure who is holding what and who is exposed to whom, causing markets to shut down in a crisis and a ‘run’ on those markets is sure to occur. What about securitisation and derivatives? Somewhat surprisingly, securitisation and transferring risk via credit derivatives is not the ultimate reason for the stresses in the global financial system we have seen. If this were the key issue, then capital markets would have effectively absorbed and distributed the losses, and the financial system would have moved forward. Instead, blame needs to be squarely placed at the large, complex financial institutions (LCFIs) – the universal banks, investment banks, insurance companies, and, in rare cases, even hedge funds – that are ‘systemic’ and today dominate the financial industry.

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Journal of Applied IT and Investment Management

# Repairing a failed system The central fault lies in the fact that the LCFIs ignored their own business model of securitisation and chose not to transfer the credit risk to other investors. The whole purpose of securitisation is to lay risks off the economic balance-sheet of financial institutions. But the way securitisation was achieved, especially during 2003-2007, was more for the

purpose of arbitraging regulation than for sharing risks with the financial markets. The reason why banks face regulatory capital requirements is that they have incentives to take on excessive risks given their high leverage. Capital requirements ensure that (1) banks find it costly to take on risks; and (2) when they get hit by a shock, there is enough of a capital buffer-zone to protect them. But that‘s not what happened.

To get around the capital rules, banks created a ‘shadow banking sector’ of special-purpose investment vehicles and conduits funded by asset-backed commercial paper that was guaranteed, often fully, by the sponsoring banks themselves through liquidity and credit enhancements. These structures were basically ‘banks without capital.’ Designing things this way allowed banks

to transform on-balance sheet loans and assets into off-balance sheet contingent liabilities, and thereby exploit loopholes in regulators’ require­ments right under their noses. Measures of risk published by the banks barely moved, even as their institutions exploded with liquidity and leverage. This lack of risk transfer – the leverage ‘game’ that banks played – is the ultimate reason for collapse of the financial system.


Compensating bankers and the responsibility of regulators It is important to acknowledge that in the period leading up to the crisis, bankers and insurers increasingly paid themselves in the form of short-term cash bonuses based on volume and marked-tomarket profits, rather than on long-term profit­ability of positions created. There was neither any discounting for liquidity risk of assetbacked securities, nor any proper assess­ment of true skills of their key ‘profit’-centres. All of this helped make regulatory arbitrage the primary business of the financial sector. The regulators were supposed to vigilantly prevent this from happening. Instead, they were the dogs that didn’t bark in the night. The regulatory archi­tecture and the political pressur­ es they operated under cannot escape blame. In fact, its cracks made the system vulnerable to bankers’ errors and short-term incentives in the first place. In a world without regu­la­ tion, shareholders and creditors of financial institutions (depositors, uninsured bondholders and others) would put a stop to excesses of risk and leverage by charging materially higher costs of funding. Instead, lack of proper pricing of deposit insurance and too-big-to-fail guarantees of ‘systemic’ institutions have distorted incentives in the financial system. For years, regulation – capital requirement in particular – has targeted individual bank risk, when in fact the justification for its existence resides primarily in managing ‘systemic’ risk. It was to be expected that financial institutions


Journal of Applied IT and Investment Management

would maximise returns from the explicit and implicit guarantees by taking excessive aggregate risks – unless, that is, these were priced properly by regulators, which they were not. Back to basics in financial regulation Current financial regulation is seriously flawed precisely because it focuses on the financial institution’s individual risk as opposed to its systemic risk. Where should the regulators start to fix the system? The integration of global financial markets has certainly delivered large welfare gains through improvements in static and dynamic efficiency – the allocation of real resources and the rate of economic growth. These achievements have however come at the cost of increased systemic fragility, evidenced by the ongoing crisis. The challenge of redesigning the regulatory overlay to make the global financial system more robust must be met without crippling its ability to innovate and spur economic growth. Four changes seem paramount, each addressing either regulatory arbitrage or the externality imposed by actions of individual institutions on systemic

1 ’Restoring Financial Stability: How to Repair a Failed System’, Viral Acharya and Matthew Richardson (Editors), New York University Stern School of Business, 2009.


1. Reflect that financial institutions have become large and complex, governing them from the outside has become almost impossible; their high performance groups have bargained for increasingly short-term compensation that has led to excessive leverage- and risk-taking. It is therefore important to change the incentives of traders and key profit centres at large financial institutions with bonus-malus reserve accounts, which penalise employees whose ­actions trade current profit for future losses. This would essentially bring ‘clawbacks’ into the compensation system. 2. Prevent obvious regulatory arbitrage (privatising, for example, the financial investments of government-sponsored enterprises) and charge for guarantees – deposit insurance, too big to fail, loan guaran­tees and the bailout – using marking-to-market that reflects leverage and risk in a continual manner. 3. Recognise the systemic risk exposure associated with large, complex financial institutions. Then it is important to quantify the systemic risk associated with these institutions and ‘tax’ it through higher capital requirements or deposit insurance fees in proportion to each firm’s contribution to systemic risk rather than individual risk. This is hard to do, but current financial regulations do not even claim to address this central problem. The need for such systemic risk regulation, possibly by augmenting central bank agendas, is only underscored by the growing size of the few remaining players in the financial arena.

“The challenge of redesigning the regulatory overlay to make the global financial system more robust must be met without crippling its ability to innovate and spur economic growth.” stability. In the recent title, ‘Restoring Financial Stability: How to Repair a Failed System’1, my co-authors and I argue that the future regulation should:

April 2009

4. Enforce greater transparency of OTC derivatives ­positions and off-balance-sheet transactions, employing centralised clearing for standardised products and, at a minimum, centralised registries for customised ones so that counterparty risk can be assessed.

Some say these regulatory changes will inevitably inhibit financial innovation. But this gets the whole issue wrong. The goal is not to have the most advanced financial system, but a financial system that is reasonably advanced but robust. That’s no different from what we seek in other areas of human activity. We don’t use the most advanced aircraft to move millions of people around the world. We use reasonably advanced aircraft whose designs are proven reliable and robust. The same is the case with ethical drugs - although we are now in a golden age of biomedical research, our goal is to have only extensively tested products widely used in the market.

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Journal of Applied IT and Investment Management

# Repairing a failed system Moving forward There are many cracks in the financial system, some of which we now know

about, others no doubt will be discovered down the road. The eighteen white papers contained in ‘Restoring Financial Stability: How to Repair a Failed System’ describe a relevant issue at hand and corresponding regulatory proposals. A common theme is that fixing all the cracks in the system will shore up the financial house, but at great cost. Instead, by fixing a few major

“There are many cracks in the ­financial system, some of which we now know about, others no doubt will be discovered down the road.”


ones, the foundation can be stabilised, the financial structure rebuilt, and innovation and markets can once again flourish. Ingo Walter (Ph.D.) is director of SimCorp StrategyLab, Seymour Milstein Professor of Finance, Corporate Governance and Ethics and serves as the Vice Dean of Faculty at the Stern School of Business, New York University.


Journal of Applied IT and Investment Management

April 2009


# Credit ratings: IT in the spotlight

When Schroders Investment Management received a rating upgrade, the strength of its technology platform was a key factor in the rating agency’s opinion. by Richard Willsher


n November 2008 Fitch Ratings revised the London-based asset manager’s rating from M2 to M2+. It noted, “The rating also factors in the extent of Schroders research resources and the solid risk management framework. The addition of the ‘+’ modifier emphasises strength in the company’s investment infrastructure and the technological platform with notable progress being made in data management and integration (...)”2.

actuaries and consultants Lane Clark & Peacock explains, “Data and information is the oxygen of any kind of insurance or asset management business. If you don’t know what business you’re running then how can you expect to run it well or to react to changing environments and situations? The ability to know what your business is and to know what your business is doing quickly is, we think, vital. And that in the end comes down to IT systems, most of all because there are vast amounts of information that any asset manager will need about all the holdings of different individuals, contracts that they’ve got in place etc. So the ability to be able to turn that vast amount of very detailed information into usable and useful summaries in a matter of days rather than weeks is pretty important.”

“The stakes however have become considerably heightened in light of the recent volatility in financial markets.” Other recent upgrades where Fitch made specific reference to technology as a determining factor included Groupama Asset Management, RFM Investment Management, Rothschild & Cie Gestion and Robeco.

2 “…Schroders has achieved key milestones in its London operations with respect to its technological platform ­following implementation of SimCorp Dimension as the main accounting and repository tool. Risk management routines have been responsive to the volatile market environment and included heightened surveillance of certain risks…”. 3 ‘Reviewing and Rating Asset Managers,’ Fitch Ratings report, 29th May 2007. 4 ‘Approach to Evaluating and Assigning Investor Manager Quality Ratings to Asset Management Companies’, Moody’s Investor Service, 31st August 2005.

The oxygen of asset management That Fitch should include technology in its set of five rating categories3 - company & staffing, risk management & controls, portfolio management, investment administration and technology - is not altogether surprising. As Andrew Cox, partner, and head of regulatory capital at

Moody’s Investors Service takes this into account when evaluating and assigning its Investor Manager Quality ratings. “Moody’s believes,” it explains, “that the successful operation of an investment management firm relies also on the ability of the firm to set up an appropriate investment infrastructure, including the use of real-time portfolio management systems and various external data service providers to deliver targeted levels of portfolio management, accounting, shareholder services, and legal/control functions. In this area, faceto-face discussions are reinforced by onsite reviews.

It is also recognised that the failure of IT operations could threaten an investment management company’s ability to manage and monitor efficiently its offerings and provide adequate client services. For this reason, while stopping short of an assessment of enterprise-wide operations risk, we review the content and frequency of back-up systems as well as the tests of reliability of the key information feeds.”4 A spokesman for Standard & Poor’s notes that, “For financial institutions ratings, technology is not a major area of focus [for us]. Rather, we are more interested in the broader enterprise risk management of the firm (risk governance, credit risk etc.) and the degree to which senior management can answer our questions and present credible, timely management reports. Within this, we do also focus upon operational risk, which is important to asset managers, for example disaster recovery, how management monitor operational risk etc.” Basel II / Solvency II The rating agencies then do not offer themselves as detailed analysts of data systems and technology platforms. It is quite clear however that they do attach a significant degree of importance to the technological underpinning of an asset management or fund management business when apportioning ratings. With hindsight it was inevitable that IT’s role in risk management and capital adequacy would become more important, even before the financial crisis beginning with the US sub-prime fiasco. Information and the efficiency of systems lie just below the surface of the criteria of Basel II for non-life business and Solvency II for insurance and asset managers with a life insurance aspect to them. There is a strong emphasis on risk management and controls and on operational risk in Basel ‘Pillar 1.’ And

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Journal of Applied IT and Investment Management

Credit ratings: IT in the spotlight quality information and robustness of systems falls within the view of regulatory oversight in ‘Pillar 2.’ The stakes however have become considerably heightened in light of the recent volatility in financial markets. Anything other than a rapid response to

With the current pressure from regulators, pressure from markets and pressure on the models applied by rating agencies in arriving at their ratings, it looks inevitable that IT will be further thrust into the spotlight. Ratings criteria will have to place increased emphasis on technology, even more than they currently do and

“ is remarkable how difficult it is to get information or even to find someone who actually understands what the information means.” marking assets to market and speedy quantifying of positions poses a reputational risk to an institution. “Both Basel II and Solvency II are, in the end, about risk management,” says Andrew Cox, “and the first step to managing risk is identifying risk. The only way you do so is by knowing what your business is doing, what risks it’s running and what its exposures are and this derives from the IT system. There at the heart of it a good data system is a prerequisite for good risk management.” He goes on to say that the UK’s Financial Services Authority is particularly keen to focus upon the integrity of data. “From my personal experience in working with clients to help them with both regulatory capital and Solvency II,” concludes Cox worryingly, “it is remarkable how difficult it is to get information or even to find someone who actually understands what the information means. There is a lot of room for improvement. Different companies are at different levels. Above all people must not think that this is a solved problem.”

anything less will again draw criticism of the rating agencies themselves. In the rating process there will be winners and losers. Ratings will go up or down depending on how flexible, scalable, robust and quick their systems are in the way they respond to the stresses placed on their asset managers’ businesses. Richard Willsher is a London-based financial journalist and former investment banker.



Journal of Applied IT and Investment Management

April 2009


# Outsourcing and risk management: time to redefine requirements?

Recent events have focused the minds of asset managers not only on the benefits but also on the risks of outsourcing. It may be time to revisit and recalibrate the strengths, weaknesses, opportunities and threats inherent in the business model. In this article, the author suggests six IT-architectural considerations for future risk mitigation in an outsourced back office environment. by Vice President Marc Schröter


ver the last few years, there has been a trend for asset managers to move towards outsourcing part of their operations to their custodian or Third Party Administrators (TPAs). Initially, these offerings covered back office processes such as asset servicing (corporate actions, income processing, tax services etc.), clearing services (actual settlement, fails management, clearing

etc.), treasury services (cash and currency management) as well as fund services (fund administration, fund accounting, transfer agency etc.) and securities financing (lending and collateral management). Recently, TPAs have started to offer additional services such as performance and risk reporting as well as post-trade compliance reporting. Most common and successful outsourcing areas

Figure 1 shows a categorisation of some of the main functions of an asset management organisation. Some functions span front, middle and back offices and, in addition,



FRONT OFFICE • • • • •

Research Portfolio management What-if scenarios Order management Order execution/ allocation • Pre-trade compliance

• • • • •

Post-trade compliance Performance attribution Risk management Client reporting Trade confirmation and settlement instructions • Reconciliation • Data management • Mark-to-market valuation

• Securities finance • Fund accounting and administration • Corporate actions, income processing • Cash/currency management • Investment accounting and tax • Legal reporting • Safekeeping • Transfer agency



IN-HOUSE Figure 1. Definition of front, middle and back office business processes and various degrees of outsourcing

It is generally believed that the most common and successful outsourcing areas are fund accounting and corporate events, whereas areas like pre-/post-trade compliance, investment analysis and performance are less likely to be outsourced.




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Journal of Applied IT and Investment Management


# Outsourcing and risk management: time to redefine requirements? there are often different definitions of what middle and back office cover.

In this definition, the front office covers investment decision and trade execution processes, whereas compliance control and risk management are considered an integral part of the investment decision process. Middle office covers post-trade activities such as trade confirmation, settlement and reconciliation as well as compliance, risk measurement and return and attribution analysis to form the basis


DATA VENDORS Figure 2. Typical (simplified) best of breed system enterprise architecture

1 An operating model shows the operating units for a business and the relationships between these operating units. ‘Target operating model’ is used as a term de­scribing a transition period when a new ‘target’ operating model is introduced. 2 An enterprise architecture is the business, technology, information/data and applications supporting the operating model.


model to a new scenario where parts of the operations are no longer carried out in-house. Accordingly, they have adjusted their enterprise architecture2 to reflect the new operating model. A typical result of this model is an enterprise architecture with a number of trading systems in the front office and one or more TPAs taking care of all the back office operations. The front office system typically only holds minimum (intra-day) information which is


FRONT OFFICE SYSTEM(S) of internal and external reporting (client, regulatory etc.). This information is also used intra-day as input for portfolio managers to support investment decisions and by managers to overview the total risk. These front and middle office functions are generally considered less likely to be outsourced since they are core to the investment decision process and corre­ sponding management. On the other hand, back office processes like corporate action processing, net asset value (NAV) calculation and fund accounting typically may be considered better suited to outsourcing, depending on the client’s target operating model1 (TOM). As a result of outsourcing certain back office processes, many asset managers have now re-defined their operating



uploaded on a daily basis from the TPA. In addition, there are typically a number of specialised systems covering specific middle office functions. Each of these systems are based on data fed from the TPA, the front office systems or other sources, see figure 2. When banks file for bankruptcy what you want is overview At the end of business Friday 12 September 2008, most financial institutions knew that Lehman Brothers was in trouble. On Saturday 13, the US Federal Reserve (FED) called for a meeting on the future of Lehmans and, on Sunday 14, the International Swaps and Derivatives Association (ISDA) offered a special trading session to allow market participants to offset positions in various derivatives. On Monday 15,

Lehman’s announced it would file for bankruptcy. The recent financial crisis has highlighted other connected events similar to these. Moving into 2009, Citibank and Bank of America announced additional losses and with second phase bank rescue packages all over the world, there is a market situation where practically all financial institutions are at risk, no matter how large or small. In this situation it is evident that financial institutions are very aware of the need to manage risk; counterparty risk, issuer risk, liquidity risk, market risk, operational risk etc. However, risk management is not solely about access to systems with the correct theoretical models. Trans­ parency and timely access to consistent information to produce a full overview of exposure are as critical. Asset managers who have outsourced back office processes to a TPA rely on the services provided by the TPA as well as the quality of data provided to feed downstream systems. One of the main issues with an enterprise architecture, as shown in figure 2, is the duplication of data, which creates ambiguity in results produced. There is no guarantee that the same market data has been used for calculations, there is no guarantee that the same formulas have been applied and there is no guarantee that the results are produced with the same input parameters. This makes it very hard to have a consistent and consolidated reliable view across asset classes, portfolios, portfolio managers and TPAs. And if there is no consistent, consolidated view of exposure it is not possible to manage risk efficiently. When ISDA opened up for that extra­ ordinary trading session on Saturday 14,


Journal of Applied IT and Investment Management

it was a unique opportunity for financial institutions to reduce their exposure towards Lehmans. However, to do so, required a full overview of their agreements and risks with Lehman. There was no time to manually consolidate data across systems and asset classes and there was no time to wait for the TPA opening up Monday morning to get access to the latest updated positions. The problem boils down to the essential question asset management organisations should ask themselves: “Does our enterprise architecture provide the necessary information to manage invest­ ments and associated risk in a timely manner?” The following sections discuss some of the critical issues that asset managers should be considering when reviewing their enterprise architecture. Six IT-architectural considerations from a post-crisis perspective 1. Innovation and growth For any asset manager an infrastructure that enables innovation and growth is a

but also analyse exposure, risk and performance key ratios on these products. Moving into new markets means that the asset manager must comply with local tax and accounting standards and regulatory requirements. The organisation should establish an enterprise architecture that gives suitable flexibility in these areas to support rapid time-to-market for new products and ensure they retain competitive advantage. 2. Information details level Another key point to consider is the access to detailed portfolio information. Requirements differ across departments. The level of detail needed to match and settle a trade is very different from the requirements for handling portfolio accounting, which is again different from the requirements for performance attribution or risk management. For example, if a global equity fund is managed by several external asset managers, the accounting department would need to see all trades in the same stock as one position, whereas the performance department would want to calculate return on each manager, hence splitting the stock position by manager.

Pressure on returns has over recent years been the driver of a trend where many asset managers have started separate securities lending businesses, which brings a need for management of collateral. The recent market turmoil


means that agency lending is changing as companies look to limit their risk from agencies and handle lending/collateral themselves. Further, the market situation has led to a situation where collateral is involved in almost all OTC contracts. This brings a significant requirement for asset managers to keep track of securities and cash at a much more detailed level than ever before. Another example is the requirements for performance reporting according to time-weighted return (TWR). Whereas most portfolio key ratios (duration, market value etc.) can be calculated and reported based on the current holdings on the portfolios, carrying out a performance calculation requires details of any historic transactions in the portfolio as well as a full history of security classifications both for the benchmarks and the portfolios (for instance for Global Investment Per­ formance Standards (GIPS) reporting). All of these requirements may change over time. Given special circumstances, as witnessed during the recent market turmoil, there are likely to be new requirements for analysing portfolio risk for worst case market scenarios.

“Does our enterprise architecture provide the necessary information to manage investments and associated risk in a timely manner?” business critical requirement. Paramount is the flexibility to launch new products or move into new markets when desired. Launching new products means that the enterprise architecture must be able to handle all the administrative processes

April 2009

Asset management organi­ sations must choose an enterprise architecture that gives access to portfolio information at whatever detailed level is required across different departments and business processes.

3. Timely information Another aspect to consider is whether information is available in a timely manner. Is it possible to get access online to updated positions and market prices? In situations such as the default of Lehman Brothers, it is not sufficient to know the exposure to Lehman’s as of last night – it is about knowing the exact exposure now.

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# Outsourcing and risk management: time to redefine requirements? Access to timely information is critical for both making investment decisions and managing risk. Asset management organisations should consider the implications of this when deciding on their operating model.

4. Consolidation and consistency Once all the information is available at the required level of detail, the next task is to consolidate all the information. The calculation of exposure to another financial organisation should include every business with that organisation ranging from equity positions in the organisations stock, unsettled trades, derivatives contracts with the organi­ sation as well as derivatives contracts with underlying assets issued by the organisation, lending agreements, cash and security collateral, bond issues and so on. It is necessary for risk assessment purposes to have a consolidated view of all these and at the same time ensure that there is consistency in valuation, using the same market data and price models.

For example, it is important to be able to consolidate across asset classes that are managed in different systems, across different external portfolio managers that are managing different portfolios, or a sub-strategy within a portfolio, and across different custodians or TPAs that are each administrator of a part of the assets. In solutions using different systems it can be difficult to ensure that the prices used for P&L calculations are based on the same input data as is used for the key ratio calculations. An example is to apply the same price haircut derived from liquidity risk in the P&L account as well as risk key ratio calculations.

secure foundation as the basis for investment decisions.

5. Quality and transparency Much of the information used by asset managers as the basis for their investment decisions, assessment of risk and validation of compliance contains advanced calcu­ lations and these rely on the quality of underlying security, reference and market

“...there are likely to be new requirements for analysing portfolio risk for worst case market scenarios.”

The asset management organisa­ tion needs an enterprise architecture that ensures con­ sistency in underlying data and valuation as well as the ability to consolidate information across the company. This addresses operational risk and provides a

data. For example, if a stock split is missed or an equity re-classification not made (for instance from large cap to small cap) the performance attribution will be


Journal of Applied IT and Investment Management

wrong. The decomposition of returns on structured products cannot be made, or trusted, unless the underlying security and market data are of the highest quality. This information is very sensitive to the underlying market data as well as the calculations used to get to the data. Even in the best process, errors can sometimes occur. In that event it is important to have valida­tion procedures and the necessary transparency to identify and correct the error. This includes full transparency of the input data used as well as the calculation models. If this is not the case, the system becomes a black box where the asset manager needs to trust the output data with little chance of validating if it is correct or not without a significant effort. The more advanced analysis the asset manager requires, the higher the demands on data quality and transparency.

April 2009


(from competitors) their services to their clients. While SLAs describe exactly the terms of the services to be delivered, there are nevertheless these two underlying forces pulling in opposite directions. The asset management organisation should implement an operating model that on the one hand may benefit from cost efficient services delivered by a TPA

“The more advanced analysis the asset manager requires, the higher the demands on data quality and transparency.”

It is therefore key for the asset management organisation to implement an operating model that ensures sufficient quality in the underlying data as well as transparency as to how the information has been derived. 6. Flexibility The implementation of an outsourcing arrangement is typically a large project for any organisation. This creates a barrier to change in that once the outsourcing infrastructure is in place it is not easily changed. The requirements of an asset manager evolve over time and there is then a question as to whether the current TPA can meet these new requirements and if so whether it is covered within the service level agreement (SLA). The TPAs typically scale their business by standardisation of services, whereas asset managers may need customised services (data feeds and others) to obtain sufficient flexibility to scale their business by differentiating

and at the same time delivers the flexibility needed to diversify their own business.

What is clear is that the turmoil in financial markets over the last several months has thrown into sharp focus the vulnerabilities in risk management, data handling and business models across the asset management industry. Asset managers are wiser now than they were before and all are playing catch-up to enable IT capabilities to match what is now known in a world where the unthinkable happens. Marc Schröter (M.Sc. EE, BA Finance) is Vice President and Head of Strategic Research at SimCorp A/S. More information on how the challenges can be met from an IT operational perspective can be found in the author’s white paper, ‘Extended Enterprise Data Management’.

Download the full white paper at

April 2009 14

Journal of Applied IT and Investment Management


# SimCorp establishes private research institution

Professor Ingo Walter at Stern School of Business, New York University takes on the position as director of the new institution. In light of the financial crisis and the resulting increasingly complex strategic challenges arising in the investment management industry, SimCorp has established an independent research institution. The institution, SimCorp StrategyLab, is headed by Ingo Walter, Seymour Milstein professor in finance, governance & ethics at Stern School of Business, New York University. SimCorp StrategyLab aims to build thought leadership in applied IT and investment management and to contribute to the development and future growth of the industry in general.


he past two years of events in the global investment management industry has given us reason to believe that we and the rest of the industry could

Mission It is the mission of SimCorp StrategyLab to contribute to identifying ways to mitigate risk, r­ educe cost and enable growth in the international investment management industry. Vision It is the vision of SimCorp ­StrategyLab to become a renowned and trusted thought leader in the i­ nvestment management industry through contribution of applicable research and knowledge within matters of strategic importance for IT and investment management. benefit from qualified input as to how to address the severe strategic challenges the entire industry is facing. We want to demonstrate a strong industry commit­ ment by contributing to risk mitigation, to enabling growth and to reducing cost in the future environment of the investment management industry. We wish to do this through research, industry expertise and best practise,” says Executive Vice

President of SimCorp Group, Torben Munch. The scope of the research work of SimCorp StrategyLab is centred around identifying, understanding and suggesting solutions to issues pertaining to mitigating risk, reducing cost and enabling growth which are of relevance to the highest strategic levels of institutions in the investment manage­ment industry. In addition, the work aims to suggest solutions from an IT perspective. “The three themes, miti­gating risk, enab­ling growth and reducing cost, are in our view fundamental drivers of value crea­tion in the industry. Indeed this can be said to be what investment manage­ment is all about. Business cycles deter­mine the weight of each driver in a mutually ­interdepen­dent relation­ ship. For the time being, miti­gating risk and reducing cost are the predominant drivers. Hopefully, in the near future, growth will return as a strong driver to the investment management market. Regardless of the current environment, our working hypothesis is that good governance is about addressing all three drivers concurrently. And as organisations seek to reduce the trade-off between them, they gain greater scalability and become less ‘error-prone’,” continues Torben Munch.

The three themes are, as a consequence of their fundamental nature, also those of the research mandate of SimCorp Strategy­ Lab. In practise, the research work of the institution will lead to research, publishing and seminar activities in the investment management sector within the sphere of finance and information technology. The institution will, under the direction of Professor Walter, conduct research work of its own. However, a significant part of the research will draw upon leading industry and academic input as well as affiliations with industry associations and world leading universities and business schools. “The challenge of SimCorp StrategyLab is not only to remain focused on the research mandate. Additionally, it is a key objective that the outcome of the research work can be applied in practise by the industry as well as serve as input for innovative product development strategies and well-founded consulting services at SimCorp. I am extremely confident that Professor Ingo Walter, with his huge practical and academic experience in the global asset management industry, is the right person to make this happen,” concludes Torben Munch. The first result of the research work of SimCorp StrategyLab is the Global Investment Management Risk Report 2009 (read more on pp. 17-20).


Journal of Applied IT and Investment Management

April 2009


Professor Ingo Walter, director of SimCorp StrategyLab.

Professor Ingo Walter holds the Seymour Milstein Professorship of Finance, Corporate Governance and Ethics and serves as the Vice Dean of Faculty at the Stern School of Business, New York University. He has been on the faculty at New York University since 1970. From 1971 to 1979 he was Associate Dean for Academic Affairs and subsequently served a number of terms as Chairman of International Business and Chairman of Finance, as well as Director of the New York University Salomon Center for the Study of Financial Institutions from 1990 to 2003 and Director of the Stern Global Business Institute from 2003 to 2006. He has had visiting professorial appointments at the Free University of Berlin, University of Mannheim, University of Zurich, University of Basel, the Institute for Southeast Asian Studies in Singapore, and various other academic and research institutions. He also held a joint appointment as Professor of International Management from 1986 to 2005 and remains a Visiting Professor at INSEAD in Fontainebleau, France. Ingo Walter’s principal areas of academic and consulting activity include international trade policy, international banking, environmental economics, and economics of multinational corporate operations. He has published papers in various professional journals in these fields and is the author, co-author or editor of 26 books. In addition to his new position as a director of SimCorp StrategyLab, Professor Walter has served as a consultant to various corporations, banks, government agencies and inter­national institutions, and has held a number of board memberships.

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# SimCorp StrategyLab research programme 2009/2010 In line with the mission of the SimCorp StrategyLab, the institution’s research programme is divided into three tracks. To answer key questions in relation to the theme of each track, three surveys will be conducted in cooperation with

The Nielsen Company, followed by individually published survey reports. In addition, leading scholars and business executives will scrutinise the issues behind each theme, contributing to three planned book publications.

Track I Mitigating risk Survey

Global Investment Management Risk Survey 2009: past, present and future Publication: March 2009

The survey builds on interviews with 90 global investment management industry professionals specialising in risk management. The survey was conducted in cooperation with The Nielsen Company.

The survey searched for answers to questions such as: What is the role of risk management in the global investment management industry? How is the discipline perceived and how is it positioned and prepared for future requirements? What role does risk management play in the financial crisis?


Understanding the Financial Crisis: investment, risk and governance Planned publication: June 2009 The severity of the financial crisis has left academics and practitioners around the world in a state of confusion. Questions abound: What happened? What are the prospects for the next few years? Is new financial regulation required to combat future crises? Should banks and companies change their risk management and governance practices? To stimulate discussion and intelligent policy responses to these questions, contributions by leading academics and executives will be collected in an edited volume. The book is edited by scholars from the Centre for Corporate Governance at Copenhagen Business School.

Track II Reducing cost Survey

Global Investment Management Cost Survey 2009 Planned publication: October 2009

The survey builds on interviews with 100 global investment management industry professionals on management C-level. The survey will be conducted in cooperation with The Nielsen Company. The survey seeks answers to questions such as: What kind of role do costs play in the current market environment in the investment ­management industry? What are the primary drivers of cost? How are costs reduced? What role does IT play in the reduction of costs? What kind of processes are applied to evaluate and decide on different cost-cutting initiatives?


Cost Management During the Downturn in the Investment Management Industry (working title) Planned publication: October 2009 To stimulate discussion and to identify ways to reduce the level of cost in the investment management industry, contributions by leading academics and executives will be collected in an edited volume. The book will be edited by scholars from a world-leading business school.

Track III Enabling growth Survey

Global Investment Management Growth Survey 2009 Planned publication: January 2010

The survey builds on interviews with 100 global investment management industry professionals. The survey will be conducted in ­cooperation with The Nielsen Company. The survey searches for answers to questions such as: What are/will be the key drivers of growth in the investment management industry? Are industry players prepared for growth? What are the post-crisis learnings from a growth perspective?


Post-Crisis Growth in the Investment Management Industry Planned publication: January 2010 To stimulate discussion and to identify ways to enable growth in the investment management industry, contributions by leading academics and executives will be collected in an edited volume. The book will be edited by scholars from a world-leading business school.


Journal of Applied IT and Investment Management

April 2009


# Time to rethink risk management? Global risk management report March 2009

Risk management has been on the top of the international regulatory agenda for some years already and as a consequence, many investment management institutions have established procedures for mitigating risk. However, the recent years’ financial crisis has toughened the focus on risk management from many angles. As a part of the research programme for 2009, and in order to clarify the state of risk management in a mid-/post-crisis perspective, SimCorp StrategyLab conducted in cooperation with The Nielsen Company in February/March 2009 a global risk management survey across the investment management industry. This article outlines and discusses the predominant findings of the survey and questions whether the time to rethink risk management has come.

by Editor-in-Chief Lars Bjørn Falkenberg


een in the light of the financial crisis, it is fair to assume that the risk management function has gained attention and recognition as a strategic discipline. However, this assumption cannot without modifications be confirmed by the results of the risk management survey.

Board of Directors CEO Executive Management level Senior Management level Other Don’t know

Risk function decline in status The SimCorp StrategyLab survey reveals that 50% of risk management func­ tions report to RISK function reporting line organisa­tio­nal levels 36% from exe­cu­tive ma­ 31% 31% na­ge­­ment and down­ 19% wards and the vast 18% majority of the 18% 18% institutions have no 20% intention of chang­ 18% ing this in the future. 23% 28% In fact there seems to 28% have been a slight 2% Past tendency to move 2% Present the risk function Future 1% 1% Base reporting line down­ 3% (n=90) wards in the organi­ 0% 5% 10% 15% 20% 25% 30% 35% 40% sation from the board of directors (-5% risk Q6A. Please state where the risk function reported in the past? Q6B. Please state where the risk function reports now? reports), CEO (-1% Q6C. Please state where the risk function will report in the futura? risk reports) to

executive manage­ment level (+2% risk reports) and to the senior management level (+5% risk reports) during 2008. This, despite the fact that 76% of respondents said that the primary key to improving risk management functions was to increase the strategic influence of the risk function. And an additional 62% of respondents stated that executive management involvement is a primary key to improvement of risk management in the future. Further, directly questioned, 37% pointed at insufficient strategic understanding of the risk function when identifying reasons of financial losses in the industry over the last two years. Finally, almost one in four of the risk management functions seem to be so poorly positioned that they can only to a lesser degree or not at all be said to contribute to the efficient use of or allocation of capital and resources in the institution they work for. One could consider whether the above findings are a significant contributor to the fact that 56% of all respondents called for a redefinition of the scope of the risk discipline, an integrated view on risk management (57%), stricter regulatory requirements (59%) and increased budget allocation (58%).

Improvements take place on tactical levels - more staff and competencies requested Regardless of reporting line, 58% of the institutions questioned increased the role and responsibility of the risk function during 2008. In line with this, the survey confirms that various categories of risk are being consolidated under the risk function. Strategic risk, operational risk, financial risk, compliance risk and reputational risk are all types of risk that are covered by the risk function in at least 76% of institutions. In addition, for the majority of respondents (min. 66%), all these types of risk are actively monitored on a frequent and systematic basis. Most (69%) of respondents believe that the financial crisis will result in increased investment in staff and in competencies (60%) in the industry per se. This is supported by the fact that 63% claim that compe­tence development/education is critical when it comes to improving the risk function. However, despite this relatively high percentage, only 32% believe that the financial crisis will give rise to a higher level of use of external consultants. This could indicate that improvements in the risk manage­ment area through competence develop­ment

April 2009 18

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# Time to rethink risk management? Global risk management report March 2009 do not necessarily include bringing in outside expertise. On the contrary, com­ petencies seem meant to be developed within the organisation.

Report on


Must be ‘made here’? The vast majority of the financial institutions surveyed, process financial risk calculations/calculate key risk figures internally and for those that process the data internally, 93% intend to keep it that way. Only 10% of those that rely on an outsourced service intend to internalise the calculations in the future.


Key figures derived from risk management systems SUMMARY: IN THIS REPORT kEY PERSONS FROM A WIDE RANGE OF MARkET LEADING FINANCIAL INSTITUTIONS are primarily used for OFFER THEIR vIEW ON THE PAST, PRESENT AND FUTURE OF RISk MANAGEMENT IN LIGHT OF THE FINANCIAL CRISIS. THE SURvEY INCLUDES SEvERAL INTERESTING FINDINGS IN REGARDS TO internal management re­ SITUATIONAL, STRATEGIC, TACTICAL AS WELL OPERATIONAL ASPECTS OF RISk MANAGEMENT. porting (49%), 12% also use the figures for asset and liability management, in­ vest­ment decisions (11%), Download the full report at: regulation/compliance re­ porting (8%) and 14% of the respondents use the key figures for client reporting as well. It is fair to assume that there will be an increase in the importance attached to risk reports and their general usage in the future and, at the same time, that the investment manage­ment industry’s ability to produce reliable reports will be subject to scrutiny. AUTHOR: SIMCORP STRATEGYLAB IN COLLABORATION WITH THE NIELSEN COMPANY

Real time issue When it comes to the ability to process real-time data, there seems to be an issue in the industry. Close to one out of five of the respondents use systems and applications that are developed and maintained internally for management of market, credit, counter­party and operational risk (average 18.5%).

However, quite a few respondents stated that they are not familiar with the brand names of the risk management software in use in their institutions (average 32.5%) and roughly 20% prefer­red not to disclose the brand names of the software they used. This adds to the assumption that the proportion of systems and applications that are developed and maintained internally for management of various types of risk are larger than 18.5% on average across risk types. Of those that state that their risk management software cannot process real-time data, an average of 39.5% across risk types rely on internal systems. Another 25% of those that cannot process real-time data across risk types have best of breed, standalone risk management installations. When it comes to market risk, these installations are to a large degree represented in the very lower end of the rating scale (represent 40% of those that practically do not have the ability to work with real-time data). In addition, those institutions using best of breed and in-house systems, as well as those that did not know their risk management software brand names or were not prepared to reveal them, faced efficiency challenges. These applications are all represented in the lower end of the rating scale, when it comes to efficiency.

years. In addition, 24% point out that insufficient data quality has caused financial loss during the same period of time. Risk management functions that report directly to the board of directors seem to realise this unfortunate correlation to a higher degree than those reporting to lower organisational levels. This tallies with the findings that 48% expect increased investments in IT applications, 46% in IT platforms as well as that 58% see these investments as key to improving risk manage­ment. As seen from a regulatory point of view, 48% directly state that they believe that authorities will, in the future, formulate requirements when it comes to the financial industry’s IT systems, data quality and applications in general. However, requirements are also expected from the shareholder side when it comes to IT in the investment management industry:

“24% point out that insufficient data quality has caused financial loss...”

Measured against six criteria (adaptability to change, scalability, transparency, efficiency, ability to process real-time data and cost of ownership) only under half (47.8%) claimed to be satisfied with their risk management software instal­lations. To put this in perspective, 17% of respondents also claimed that insufficient support by IT platform and by applications generally in use has caused direct financial loss over the last two

Almost half of the respondents (47%) recognise the influence that the ability to store, process and report high quality, real-time data on risk exposure will have on the market value of financial institutions in the future. Given the fact that 17% of respondents assign responsibility for direct financial loss in the investment management industry throughout the last two years to insufficient support by IT-platform and by IT-applications in use as well as insufficient data quality, the relationship between IT, data quality and market value seems to be beyond doubt.


Journal of Applied IT and Investment Management

Q15: To which degree do you believe that the ability to store, process and report high quality, real-time data on risk exposure calculation will influence financial institutions’ market value in the future? 1 = Not at all 10 = To a very large extent

Don’t know 3%

1+2 6%

3+4 7%

5+6 38%

8+9 10% 7+8 37%

Base (n=90)

Q17A. On a scale of 1 to 10, please state to which extent financial loss during the past 2 years in your organisation was caused by insufficient data quality. 1 = Not at all 10 = To a very large extent

1+2 28%

3+4 23%

Prefer not to disclose 3% Don’t know 2% 9+10 2% 7+8 17% 5+6 24% Base (n=90)

1 ATP™ (Advanced Port­folio Technologies) is a registered trademark of SunGard and is used under license.

Thus, the fact that slightly more than one out of five respondents are very dis­ satisfied with the ability of their current risk management software to process real-time data supports a sense of urgency when it comes to improving or replacing installations. Waiting for the regulators... At present, multi-factor/statistical approach (APT™(1)-like) is the most commonly used method to measure market risk used by 49% of the respondents. Another commonly used measure is multi-factor/fundamental approach (Berra-like) used by 43%. Both approaches are often labelled ‘black boxes’ by market participants with a relatively low degree of transparency and customisation since the risk calcula­tions are run by more or less closed, standard statistical models develop­ed, maintained and supplied by external third party service providers.

However, it was the general perception among respondents that the measures and methods used at present are insufficient. 67% of the respondents state that a key to improving risk management is to redefine risk assessment models and methods. There seems to be a strong reason for this: 38% of respondents say that insufficient risk methods and techniques are a direct cause of financial loss in the investment management industry. As a consequence 52% of all respondents also state that they expect an increase in investment in implementing new risk assessment models and methods.

April 2009


of risk management. An additional 32% of respondents do not deny that regulators are a key to improving risk management in the investment management industry. Conclusions Due to the recent years’ financial crisis, the huge fall in asset values and the unprecedented defaults among highly rated financial institutions, it would be reasonable to assume that the investment management industry would reposition the risk management function to give an improved shelter for themselves and the assets they are mandated to manage.

“38% of respondents say that insufficient risk methods and techniques are a direct cause of financial loss in the investment management industry.”

The granular approach came third, used by 30% of respondents as the primary measure to monitor market risk. This approach enables a 100% customised composition of measures and methods.

When it comes to market risk indicators, Value at Risk comes in as the primary indicator used by 44% of respondents, exante volatility is primarily used by 9% and stress scenarios are primarily used by 16% of respondents. Considering recent market turmoil, the use of stress scenarios is surprisingly limited. Also a bit worrying is that in total 12% of the respondents either do not know what risk indicators are most commonly used in their institution (6%) and that 6% use none of the above listed measures and methods as their primary indicators.

Since the use of external consultants is thought likely to increase by only 32% of respondents, the primary input to establish better risk assessment models and methods has to derive from the institutions themselves or from other parties. Since at present the regulators are the investment management institutions’ predominant primary risk management advisor (29%), it is fair to assume that at least a part of the industry awaits for their regulators to drive future development when it comes to new risk assessment models and methods. This assumption is backed by the 38% of respondents who believe that tighter regulation of the financial sector will improve the quality

However, the result of this survey raises a question as to whether the right measures have been/will be put in place by the investment management industry itself in order to alleviate the range of risks that are facing the industry now and which will do so the future.

The findings of the survey point to the fact that the risk management function shows a slight tendency of moving downwards within institutions, with as many as 28% of the respondent institutions’ risk functions reporting in to the senior management level, well below the level of the board of directors. This is a fact despite the widespread perception

April 2009 20

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# Time to rethink risk management? Global risk management report March 2009

Distribution of investment management sectors in the survey. Asset Manager 50% Pension 7% Insurance 10% Fund 13%

Other 20%

that the risk management function should be much better affiliated with the strategic levels of the institutions for quite a few good reasons, (such as direct financial losses as a result of poor strategic understanding, among other things, etc.) to support this perception. Moreover, it seems that quite a few of the risk management functions do not create value for their institutions. Additionally, risk management functions generally request for additional human resources, training and competencies, increased budget allocation, better data, improved reporting, improved support by IT systems and applications, new risk management models and methods, just to mention some of the findings of the survey. More importantly, lack of meeting these requirements earlier are claimed to have caused direct financial loss through the last two years. Despite this crossindustry picture of a largely rather weak and vulnerable risk management platform, the role and responsibility of the majority of the risk management functions was extended during 2008. This could indicate a tendency to seek to manage and alleviate risk by attempting to isolate it to the risk management function rather further down in the engine rooms of the investment manage­ ment institutions. At the same time, managements request that the ‘risk management engines’ run even faster than they did before - despite the fact that there is now more work to do with the same amount of resources and competences.

Perhaps it is time to track if increased or improved governance of institutions is practicable. And at the same time it could be the moment to consider whether risk manage­ment is a strategic and integrated management discipline that entails all functions and systems in and outside of investment management institutions. And perhaps institutions should not wait for regulators to define and enforce new requirements on their industry. Perhaps the work to improve risk management should rather start now.

Global investment Management Risk Survey 2009 Methodology

• This survey is based on 90

CATI interviews with respond­ ents from around the world.

• The interviews were conducted during February and March

2009 by The Nielsen Company.

• Respondents were randomly selected



management institutions.

• Only one contact person per company was interviewed.

• All contact persons had risk management as their primary field of work, and/or strategic responsibility and/or decision-

making with risk management and executive or general man­ agement.

• The questionnaire of 30 ques­ tions was created by SimCorp

StrategyLab and was examined

by The Nielsen Company prior to fieldwork.

• SimCorp StrategyLab was not disclosed as the initiator of the study unless prompted by the respondent.

• All respondent answers are anonymous unless they specifi­

cally agreed to have their ­answers attributed.


Journal of Applied IT and Investment Management

April 2009


# Managing macro financial risks One of the most fundamental characteristics of the economy is the business cycle, that is, the considerable fluctuations of GDP around its long-term growth path. by Professor Ole Risager


e call it the business cycle because it is associated with large fluctuations in companies’ earnings and turnover.1 The business cycle is also associated with considerable movements and shifts in other macro


forecasting the cycle. Table 1 briefly reviews a short list of indicators that are useful in predicting the US business cycle.2 The first indicator, and probably the most important, is the term structure spread. The signal arising from a decline in longterm interest rates relative to short-term


Term structure spread Prior to both recessions, long-term interest rates fell sharply relative to short-term rates Stock market

Sharp declines in equity prices also consistent with recession

Initial claims

Sharp rise provided a signal, in particular in 2001

Capital goods orders

Sharp fall in orders and hence a signal in 2001, but not in 2008

Housing starts and building permits Clear signal prior to the 2008 recession as housing starts plummeted, but not in 2001

1 Some companies like utilities and pharmaceuticals have low macroeconomic betas but many industries actually have peak-to trough declines in earnings between 30-70 percent, see ’Mapping decline and recovery across sectors,’ McKinsey Quarterly, January 2009. Besides aggregate indicators, each industry has specific 2 indicators that are important for understanding industry trends and risks, which, however, goes beyond the purpose of this article. In the anticipation of lower inflation associated with 3 declining growth. See also J.H Stock and M.W. Watson, 2003, ‘How did 4 leading indicator forecasts perform during the 2001 recession’ Federal Reserve Bank of Richmond Economic Quarterly 89/3. 5 Treasury spread is the difference between the 10 year treasury yield and the 3 month treasury yield. Shaded columns are recession periods. Source: Federal Reserve Bank of New York.

variables like interest rates, stock prices and commodities, including oil, gas, metals, grain, and so forth. Correctly positioning a company in the cycle often makes the difference between good and bad performance. Moreover, evi­ dence also shows that the right 1,0 management of business cycle risks, including the right timing of investments and acquisitions, 0,8 is important for CEO and company reputation, and in some cases even for the survival of the 0,6 top-management team. Leading indicators and early warning signals It is therefore important for most companies to try to spot significant changes in growth including turning points in the business cycle. There are by now also a large number of economic indicators that can be used in

rates prior to recessions has been a useful early-warning indicator prior to the 2001 and 2008 recessions.3 This is also true if we go further back in the history of the US. Figure 1 shows that spikes in the term

Reading leading indicators: be aware of the psychological biases Risk managers, including topmanagement and the executive board, who on a regular basis address key risks, will therefore always have to engage in discussions on the validity of the signals from these and other indicators. In this context, it is important to be aware that many studies in behavioral finance show that decision-makers often have expectations that are too optimistic if




1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Table 1. Signals from leading indicators prior to the 2001 and 2008 recession

structure have preceded the majority of recessions since 1960. Careful monitoring of the term structure is therefore a ‘must’ in macro risk management, but experience also shows that one should ‘listen’ to a whole battery of indicators since there is seldom one variable that tells the whole story.4 I have therefore also listed a sample of other indicators that are used in forecasting cycles. However, while leading indicators offer useful guidance on where the economy is likely to be heading, indicators are unfortunately not right all the time.

Figure 1. Probability of US recession predicted by treasury spread 5 twelve months ahead (monthly averages)

April 2009 22

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# Managing macro financial risks the boom has lasted over an extended period. In such an environment, individuals tend to make simple extrapolations of expectations and hence believe that the party will last for a long time, if not forever.6 Signals from leading indicators are therefore often ignored. And people who issue skeptical views about the sustainability of the boom are often considered to be out of touch with the modern world and addicts to outdated paradigms. The rhetoric is often like “this time is different – is it not?” This explains why many businesses tend to repeat the same mistakes business cycle after business cycle. The pig-cycle is a

6 The same holds in deep recessions. We should therefore now be careful not to become too pessimistic in our outlook. 7 It is much easier to predict broad movements in GDP and other macro variables than to predict asset prices which behave almost in a random fashion in the short term.

famous model that explains this all too well. The model originates from agriculture but is equally relevant in construction, in real estate, in shipping, in banking, and in many other businesses. The story is simple: in good times with high prices, business leaders think that markets will continue to

be strong going forward. Companies therefore often engage in ambitious expansion strategies through organic growth or through acquisitions. Such strategies are also facilitated by strong cash flows and therefore easy to get through the executive board. In many cases companies do not properly analyse the consequences for the whole market of massive investments. So what could be a good idea for a single company often turns out to be a disaster for the industry because the market gets flooded with too much capacity with a strong negative effect on market prices and returns. And the more so if the downturn of the market goes hand in hand with a deep recession in the macro economy as is the case right now.

undertaken in close cooperation with topmanagement because risk management is not only about identifying all the bad things that could happen but also

“To facilitate a balanced treatment of upside and downside risks, top-management could take the lead in the internal company risk meetings.”

Risk management is also about identifying opportunities Because a thorough under­ standing of leading indicators and macro­economics in general requires experience, companies that are signifi­ cantly exposed to macro­ economic risks should not only allocate junior staff to this task. Competent risk management requires experienced staff also because business cycle analysis should be accompanied by a thorough knowledge of markets and economic history, including an understanding of what is ‘normal’ and what is not ‘normal.’ Moreover, it is also important that risk management is

about identifying opportunities, cf. below. Unfortunately, in many companies risk management is associated with routinely, often quarterly, ‘bad risk’ identification exercises plus some discussion of mitigation possibilities. However, since risk also entails upside risks, risk management could potentially be much more rewarding. To facilitate a balanced treatment of upside and downside risks, top-management could take the lead in the internal company risk meetings. Work with explicit scenarios and try to do some numerical calculations Sometimes business leaders argue that because macroeconomists and finance gurus can never with certainty tell whether we will have a recession or not, we should not spend time on such exercises. In my view this is wrong because the business cycle is not a random event; recessions and recoveries can to some extent be predicted though seldom with complete accuracy.13 Many companies can therefore do much better if they try to get ahead of the curve. To be more concrete, suppose leading indicators are telling us that it is likely that we will have a recession or a significant


Journal of Applied IT and Investment Management

downturn within the next 12 to 24 months. The first scenario we therefore start to characterise is the recession scenario. To this end we make assumptions about the depth and length of the downturn. Next we stress test the current strategy against this scenario and try to report likely quantitative effects on sales, earnings, and so forth. How much will we lose if we maintain business as usual and how can we mitigate the downturn? What can we do in terms of capital budgets, hiring decisions, loan facilities, and so forth? Which actions could we take now? How can our company get ahead of our rivals in the industry? Following this, we also start thinking about opportunities in case the recessionary scenario actually materialises,

Economic history is informative about likely scenarios Since we cannot be sure that we will have a recession we also outline other scenarios. In this process we should also assess probabilities of different scenarios. On the basis of this analysis, top-management including the executive board can decide what the appropriate strategy should be given all the information we have at this juncture. Suppose the company is convinced that a recession is likely, moreover, suppose the company decides to adjust its strategy to make it compatible with this scenario. In this case the company is running the risk that the leading indicators could have sent a false signal. However, it is important to bear a number of simple facts in mind: First, booms are always followed by recessions. It is possible to get the timing wrong, but a long upswing is always followed by a downturn. History teaches us that ‘this time is never different’.8 Second, the length of a typical cycle, defined as the time from trough to trough or peak to peak, is about five to six years. This is a simple yet important piece of evidence that should help anchor our expectations and hence prevent us from flying away from macroeconomic realities. Because we had the last recession in 2001, this tells us that we should have watched out for a recession in 2006 or 2007. And that was also what serious macroeconomists started to do but most companies did not take much notice. Instead, many firms actually maintained business as usual and some firms even geared up for more aggressive investments. Now we know that in most cases it would have been wiser to have changed course and prepared for a

“The recession scenario does not only have to deal with downside risks; it entails a lot of opportunities for those who carefully plan for it.” 8 Sounds trivial right now but many were in serious doubt about this just a few years ago. Business rhetoric sometimes dismisses this basic fact of life; a recent example is the ‘New-Economy Paradigm’ that popped up in the late 1990s claiming that the business cycle is something that belonged to the past. Yes: there were ­people who believed in that and who at the same time made public commitments to the New Economy World. There were also people employed in well known investment banks who wrote books telling us that the Dow Jones index would soon reach 36000. Right now it stands at around 8000!

as downturns normally are associated with bargains, that is, investment opportunities that do not exist at the peak of the cycle. Which of our rivals could get into serious trouble and hence become bargains? And can we otherwise benefit from the downturn? The recession scenario does not only have to deal with downside risks; it entails a lot of opportunities for those who carefully plan for it.

April 2009


April 2009 24

Journal of Applied IT and Investment Management

# Managing macro financial risks slowdown. I am not saying that we could have forecast the magnitude of the current recession in 2006 or in 2007 but it is not surprising that a downturn was just around the corner. And in some sectors of the economy this was pretty obvious. The current crisis is not going to last forever: be prepared for a recovery Likewise it is important to realise that the current deep downturn eventually will come to an end. A recovery is therefore bound to happen. A trough is reached when housing prices have stabilised and when the banking sector has been sufficiently recapitalised.9 It is likely that it will get worse before it gets better, but some recovery will take place when the stimulus packages start to work. At that time it will be important for companies to start

“Likewise it is important to realise that the current deep downturn eventually will come to an end.”

9 Useful a on housing stabilisation includes the ratio of unsold new homes to existing sales and the volume of starts, that is, the increase in housing supply.

thinking about the likely nature of the recovery. In which parts of the world will it come first? Which industries will lead and which industries will lag? What is the outlook for interest rates and the cost of capital? Is it likely that interest rates will increase to new plateaus in response to current massive government borrowing to fund the stimulus packages? And should this affect our company’s scheduled funding strategy including the company’s capital structure policy? The current very difficult macroeconomic situation and the

high uncertainty as regards the timing and nature of the recovery pose lots of important questions to company risk management that we should not forget to address. In other words, at this juncture companies should not only focus on cost cutting and efficiency gains but also devote qualified manpower to address important future business issues. Ole Risager (Ph.D.) is professor at Copenhagen Business School, Department of International Economics & Management. He has extensive experience on monitoring and managing macroeconomic risks from his previous positions as Senior Economist at the International Monetary Fund, USA, and as Vice President - Chief Economist at AP Moller – Maersk, Denmark.



Journal of Applied IT and Investment Management

April 2009


# SimCorp Dimension Release 4.5: sophisticated technology meets market challenges SimCorp helps clients mitigate enterprise risk in a response to market turmoil. The increasingly complex investment management environment as well as the current financial crisis both underline that improved risk management is crucial for financial institutions to stay competitive in ever-changing markets. Releasing the new version of the investment management software solu足 tion SimCorp Dimension, SimCorp responds to this challenge across the front, middle and back office. Within the front office, all signs point to an increasingly transparent and restrictive market environment that will require a Go to release45 to view an on-demand presentation of release 4.5

1 Financial Information eXchange.

more sophisticated use of technology. Reduced equity returns have obliged investment management firms to better manage costs and operational risk with the implementation of electronic trading. As electronic trading continues its explosive growth rate and displaces outmoded trading models, the need for cutting-edge technology has never been greater. To cater for this, SimCorp offers a seamlessly integrated, feature-rich front office suite that covers portfolio management, trading and compliance.

Sophisticated technology allows trading executives to optimise the trading function with electronic trading via the FIX1 protocol. SimCorp Dimension provides accurate real-time positions and instrument valuation to better manage risk and improve portfolio returns. Moreover, SimCorp is continuously improving the front office suite, and Release 4.5 is another important step towards refining the offering with the cutting-edge technologies, tools and functionality that will enable clients to improve the entire front office investment process workflow.

April 2009 26

Journal of Applied IT and Investment Management

# SimCorp Dimension Release 4.5: sophisticated technology meets market challenges Improved risk monitoring and performance measurement The investment process has become increasingly complex, incorporating investment strategies (alpha/beta) and exotic instruments (derivatives and structured products). Accordingly, fi­ nancial institutions need to put more emphasis on risk monitoring and investment performance measurement. Also, the current “A significant proportion of the 100,000 man-hours financial crisis has spent over the last six months in preparing SimCorp further stressed the Dimension Release 4.5 has been dedicated to importance of the transparency of risk developing front, middle and back office functionality positions and riskthat enables clients to mitigate enterprise risk.” adjusted performance, especially for structured Leen Kuijken, products. SimCorp Vice President and Head of Product Management, SimCorp A/S recognises these chal­ lenges in its continued effort to improve risk management and performance measurement functionality across the middle office. As an example, SimCorp Dimension extends its risk monitoring capability by introducing multi-factor models powered by Advanced Portfolio Technologies (APT™(2)). Plugged into the SimCorp Dimension risk flow, this solution allows a broader range of clients to reduce operational risk, using SimCorp Dimension as their central operating and intelligent data warehouse platform. Also, new performance measurement functionality has been introduced to ease and reduce the risk of transferring historical client performance data to SimCorp Dimension from thirdparty software. As a result, historical client portfolio returns can now be automatically included in the account reporting for improved investment performance overview.

2 ATP™ is a registered trademark of SunGard and is used under license. 3 FINCAD™ is a registered trademark of FinancialCAD Corporation and is used under license.

Automated back office processes To remain profitable in a market characterised by pressured margins, financial institutions with global

operations are facing increasing demands, such as meeting new regulations, increasing operational efficiency and reducing the extensive risk and costs that can be associated with back office processes. SimCorp Dimension covers all the operational processes that naturally go with maintaining holdings, and version 4.5 releases new functionality especially targeted at catering for the increased back office operations requirements. For instance, to ensure investment strategy execution based on correct data, top level reconciliations functionality is now offered. Moreover, to assist the fund industry, the new scalable Fund STP Server cuts operational risk and costs by eliminating labour intensive and manual controls and processes. Furthermore, calculation of theoretical prices and key ratios for credit derivatives are now available, based on market-tested, proven models and functions from FINCADTM(3). Stay competitive: mitigate enterprise risk across the front, middle and back office Acknowledging the need for sophis­ ticated technology to meet industry challenges, SimCorp will continue its bi-annual releases of new versions of SimCorp Dimension as a tailor-made tool kit to help clients mitigate enterprise risk across the front, middle and back office. Read more in the Release 4.5 pre­ sentation which can be ordered at, where you are also offered an online guided tour of the release.



Journal of Applied IT and Investment Management

April 2009


# New challenges for operational risk after the financial crisis

Managing operational risks efficiently has become crucial, especially in times of crisis and financial turmoil. Operational risks are encountered in several areas of business operations, and financial institutions are facing a continuous ­increase in related regulations. by Professor Caspar Rose


he Capital Requirements Directive (CRD) was formally adopted on 14 June 2006, building on the new Basel Accord. It affects banks and building societies and certain types of investment firms. The new framework consists of three ‘pillars’. Pillar 1 of the new standards sets out the minimum capital requirements firms will be required to meet for credit, market, and operational risk.

While the management of operational risk has always been a fundamental element of banks’ risk management programmes, Basel II introduced a new dimension in the form of separate capital requirements and heightened expectations for the management of operational risk. Improvements in the internal governance and other aspects of a bank’s risk management and measurement frame­ work are expected to coincide with the increased focus on operational risk. The nature of operational risk Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk. Legal risk is included, but is not limited to, exposure to fines, penalties, or punitive damages resulting from supervisory actions, as well as private settlements. The generic causes cover: people, processes, systems and external events.

Operational risks cover a wide range of different events such as: • IT disruptions or failure of external service/product providers • fraud (both external and internal) • theft of confidential data and hacking/insider trading • external robbery and theft • erroneous credit models/input data • rogue trading and self-dealing • errors in legal documents/ compliance processes • loss of key personnel • mis-selling/incorrect advice or failure to assess product suitability. Operational risks are calculated by three different methods in a continuum of increasing sophistication and risk sensitivity: (i) the Basic Indicator Approach; (ii) the Standardised Ap­ proach; and (iii) Advanced Measurement Approaches (AMA). Banks are encour­ aged to move along the spectrum of available approaches as they develop more sophisticated operational risk measure­ ment systems and practices. Under the AMA, the regulatory capital requirement will equal the risk measure generated by the bank’s internal operational risk measurement system using both the quantitative and qualitative criteria. Use of the AMA is subject to supervisory approval. To illustrate the magnitude of capital allocated to operational risk, Deutsche Bank reported in its annual accounts for year-end 2007 that capital for credit,

market and operational risks, including diversification benefits across risks, amounted to €13.310 billion in total. Operational risks accounted for €3.974 billion, which demonstrates how signifi­ cant it is. Key operational risks in times of crisis In times of economic recession or financial crises, there is a higher risk that certain operational risk events materialise such as rogue trading, fraud and mis-selling / incorrect advice. For instance, asset managers may be tempted to manipulate their earnings and financial statements to avoid reporting huge losses. To illustrate, Société Générale, one of the largest banks in Europe, was thrown into turmoil in January 2008 after the chairman revealed that a rogue employee had executed a series of ‘elaborate, fictitious transactions’ that cost the company more than $7 billion, the biggest loss ever recorded in the financial industry by a single trader. Further, on December 10, 2008 FBI agents arrested the former chairman of NASDAQ Bernard Madoff and charged him with one count of securities fraud. According to federal charges, Madoff said that his firm has “liabilities of approximately US$ 50 billion.” Banks from outside the U.S. have announced that they have potentially lost billions in dollars as a result. Moreover, customers who have seen their returns diminish substantially due to an economic recession may sue financial institutions claiming that they have received incorrect advice from asset managers, including failure to assess product suitability. In times of an

April 2009 28

Journal of Applied IT and Investment Management

# New challenges for operational risk after the financial crisis economic recession where the likelihood of default increases, recovery from collaterals becomes pivotal. Therefore it is important that the internal legal processes that are in placed to ensure security over collateral are robust and checked carefully. A small legal technica­ lity may be crucial as recovery may turn out to be legally impossible. As a consequence, the governance of operational risks involves more than just calculating the yearly operational risk capital. As economies and financial

management lowers the operational capital requirements, but it also facilitates a more efficient internal risk allocation. In other words, those units that are associated with high operational risks are charged accordingly, whereas other units, for instance retail banking, may observe that their operational risk capital is lowered. This means that capital is allocated more precisely to the risk owners, which face the largest operational risks. From the perspective of the risk owners, group OR consumes their time (oppor­ tunity costs), and they may ask “what’s in it for me?” The value of their input is not immediately recognised or associated with any positive bottom-line impact from their immediate perspective. There­fore, the main chal­ lenge when seeking to implement an efficient operational risk framework is to motivate and incentivise the various risks owners to participate actively in the process. As a consequence, in communi­ cating with the risk owners, group OR should focus on the benefits. A consistent group-wide framework will deliver better insight and reporting on:

“Efficient risk management lowers the operational capital requirements, but it also facilitates a more efficient internal risk allocation.” conditions change over time, so does the operational risk exposure. This entails that a number of specific operational risk events may become even more likely, which in times of crises requires the attention of top management. Tailoring the operational risk management framework The focus is on how to optimise the value of the risk owners’ input, meaning that each business unit / platform delivers a comprehensive description of their own major risks. Optimisation entails tailoring the communication from group opera­ tional risk department (group OR). Managing operational risk efficiently requires that the financial institution aims for AMA although it should be recognised that the best AMA model is no better than the input supplied by the bank’s risk owners. Efficient risk

• top risks within the business unit (BU) subsidiary or platform • top risks owned by platforms but affecting the BU / subsidiaries. This allows the BU/subsidiary to get greater assurance that for risks with a big impact on them: critical processes across the group are working at the right standard; mitigation is in place across the group and is regularly checked. Risk owners are not only supposed to identify their key risks but also to do so



Journal of Applied IT and Investment Management

on a continuous basis to report to the group on how these risks evolve over time. As a consequence, there is often a need to appoint a liaison person. When tailoring the operational risk framework, communication is vital: • balancing the need for a comprehensive risk description versus information overloading; •

preparing the meeting participants’ expectations prior to a meeting when sending out material in advance (distinguishing ‘nice to know’ from ‘need to know’ information);

• making sure that the bank’s top management actively communicates that OR is of high priority for the group; •

ensuring that the risk owner is able to observe some clear advantages of the project – even if this means that more capital must be allocated.

Managing operational risks efficiently when services are outsourced Outsourcing is increasingly used as a means of both reducing costs and achieving strategic aims. Its potential impact can be seen across many business activities, including information technology (for instance applications development, programming and coding), specific operations (for instance aspects of finance and accounting, back office activities and processing), administration and contract functions (for instance call centres).

Industry research and surveys by regulators show financial firms outsourcing significant parts of their regulated and unregulated activities. These outsourcing arrangements are also becoming increasingly complex. For instance, IT disruptions may impact the entire group if a financial institution relies on a single common IT platform. To illustrate, Danske Bank experienced severe IT integration problems when it in 2007 acquired the Finnish Bank Sampo. Failure to integrate a different IT system into the single platform concept had severe negative impacts on the bank’s ability to serve its customers and facilitate trans­ actions in the entire Danske Bank group.

April 2009


As a consequence, national banking supervision authorities all have requirements as well as issued guidelines on outsourcing. For instance, in early 2005, new provisions were introduced in France in regulation 97-02 relating to internal control in credit institutions and investment firms. These provisions cover both material and non-material out­ sourcing and set up specific requirements for outsourcing core activities. Out­ sourcing has to be established in a written contract which must explicitly allow for on-site visits by the financial

“As a consequence, national ­ banking ­supervision authorities all have ­requirements as well as issued guidelines on outsourcing.”

Outsourcing has the potential to transfer risk, management and compliance to third parties who may not be regulated, and who may operate offshore c.f. ‘Outsourcing in Financial Services’ issued by the Basel Committee (2005). The increased reliance on the outsourcing of activities may impact on the ability of regulated entities to manage their risks and monitor their compliance with regulatory requirements. Among the specific concerns raised by outsourcing activities is the potential for over-reliance on outsourced activities that are critical to the ongoing viability of a regulated entity as well as its obligations to customers.

institution and by the Commission Bancaire. Outsourced activities and their related risks must be a specific part of the reporting to the board of directors. In addition, the UK Financial Services Authority (FSA) sets out its guidelines for banks and in the Interim Prudential Sourcebook for banks where it states that a firm should always notify the FSA prior to entering into a material outsourcing arrangement.

April 2009 30

Journal of Applied IT and Investment Management


# New challenges for operational risk after the financial crisis The Basel Committee has formulated a number of specific recommendations that address outsourcing by financial institutions, specifically: •

The board of directors or equivalent body retains responsibility for the outsourcing policy and related overall responsibility for activities undertaken under that policy.

The regulated entity should establish a comprehensive outsourcing risk management programme to address the outsourced activities and the relationship with the service provider.

The regulated entity should ensure that outsourcing arrangements neither diminish its ability to fulfil its obligations to customers and regulators, nor impede effective supervision by regulator.

Outsourcing relationships should be governed by written contracts that clearly describe all material aspects of the outsourcing arrangement, including the rights, responsibilities and expectations of all parties.

• T  he regulated entity and its service providers should establish and maintain contingency plans, including a plan for disaster recovery and periodic testing of backup facilities. Outsourcing services may offer sound financial benefits due to economics of scale or specialisation. However, a prerequisite is that top management is aware of the increased operational risks that are associated with outsourcing, especially if the services are performed in other parts of the world, for instance when an European bank outsources some of its IT services to firms located in Asia. The following case study illustrates that regulators may issue specific instructions when outsourcing fails.

Caspar Rose (M.LL., Ph.D.) is professor at Copenhagen Business School, Department of International Economics & Management and Centre for Corporate Governance. He holds a background as a lawyer as well as a financial economist. Caspar Rose has served as special legal advisor for the Confederation of Danish Industries (Dansk Industri) as well as for Danske Bank where he worked as chief analyst in the Operational Risks Group.

Case study outsourcing unit pricing for managed funds

In 1999, a major Australian institution outsourced its unit pricing and custody arrangements to a custodian that was

part of the overall group. The custodian was eventually sold

to another party but the outsourcing arrangement remained in place. In January 2004, it was discovered that tax credits

had not been claimed for the relevant funds over a number of years and that unit prices had been underestimated as a

result. When the problem was discovered, the institution

had to compensate investors, costing approximately AUD $90 million, and the regulators instructed the institution to

carry out an overall review of its systems and processes to ensure that the problem did not recur (generic example on outsourcing risks illustrated in the Basel Committee’s report on outsourcing, 2005).

General lessons for operational risks after the crisis Financial institutions have always been exposed to operational risk events as failure in people, processes, systems and external events are an inherent part of conducting financial services. However, there is strong reason to believe that the exposure to operational risks in the future will increase. The reason is that systems, financial products and IT solutions tend to become increasingly complex and interconnected, especially if financial institutions decide to outsource vital parts of their services. One of the main reasons for the occurrence of the current crisis is the widespread use of complicated and nontransparent financial products that were developed during the last decade. Often they were structured as synthetic products that were bundled and resold several times to investors on a global scale. However, this has important consequences for the governance of operational risks. The key message is that when financial engineering increases in complexity, management needs to be focused on the management of operational risks. If top management neglects this task or accepts inefficient operational risks controls, this may lead to fatal consequences for any financial institution.




Journal of Applied IT and Investment Management

April 2009


Regulatory update This quarterly regulatory update covers major new regulatory requirements and substantial developments that affect the investment management industry.



Convergence of the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB)

In September 2008, FASB and IASB issued the latest progress report and timetable for completion for their convergence project begun in September 2002. Copies of the report can be downloaded at

§ §

Federal Information Security Management Act

The National Institute of Standards and Technology (NIST), part of the U.S. Department of Commerce, has published the first major update, since December 2005, of its Special Publication 800-53. Revision 3 of its ‘Recommended Security Controls for Federal Information Systems and Organizations’ was published in February 2009 and is an initial public draft on which respondents are asked to comment. The full text of this 200page document can be found at index.html

Financial Accounting Standard No. 157

On 10 October 2008, FASB issued a FAS Staff Position to clarify FAS 157, ‘Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.’ FAS 157-3 became effective upon issuance and affects all entities that had not by 10 October 2008 issued financial statements for the reporting period ending 30 September 2008.

§ § § §

Global Investment Performance Standards (GIPS)

A new GIPS 2010 exposure draft was published 23 January 2009 and is now available for industry comment. Interested parties have until 1 July to file their comments via the GIPS website It is planned that the new standard will be adopted in early 2010 and will take effect from 1 January 2011.

Money market Rule 2a-7.

The US Securities and Exchange Commission is planning to overhaul money market funds Rule 2a-7, part of the Investment Company Act, according to its investment management division director Andrew Donohue. The possible changes are likely to focus on liquidity, disclosure and risk in short-term investments. They seem likely to have an impact on investment managers in the coming year and may require a change in technology.

Solvency II

Negotiations in Brussels over the draft of Solvency II, the ‘Basel II for insurance companies,’ are reported to be progressing well. The aim is for a final draft to be ready for approval by the European Parliament in April 2009. Meanwhile, the Committee of European Banking Supervisors and the Committee of European Insurance and Occupational Pensions Supervisors in January announced a set of agreed principles aimed at improving cooperation between national regulators through so-called colleges of supervisors.


The European Parliament approved the UCITS IV draft Directive on 13 January 2009. EU member states are expected to finally approve the directive in March which will lead to national implementation by July 2011. The key achievement of the current step in the UCITS legislation is that it effectively gives the go-ahead for a pan-European management company passport whose adoption had previously been in doubt.

April 2009 32

Journal of Applied IT and Investment Management


# Restoring Financial Stability: How to Repair a Failed System Viral Acharya and Matthew Richardson (Editors), New York University Stern School of Business, 2009. reviewed by Editor-in-Chief Lars Bjørn Falkenberg Acharya Richardson


t o r i n g Fi n a n c i a l S ta b i l i t y


rom different angles, investment managers, scholars and private citizens have witnessed and felt the effects of the financial School faculty is making an important contribution to the needed debate crisis which began unfolding in to go about reforming our broken financial system. Plainly, the insights of 2007. We have seen how the eory need to be better adapted to the practical requirements of maintaining turmoilHow hastocompletely changed stability of markets and institutions. Restoring Financial Stability: our economies and financial led System helps point the way.” Grimly, we have aul Volcker, chairman of economic Recovery advisory Board and systems. former chairman of the Federal Reserve (1979–1987) followed the news about banks collapsing as well as political steps for action and government we are yet in the midst of a gigantic global financial crisis, the academics rescue us packages. buted to this timely and comprehensive compendium have provided with Praise for

—Myron Scholes, chairman of Platinum Grove asset Management to and reduce

How to Repair a Failed System

n excellent analysis on each topic, but also timely recommendations as to All agree that it is critical to e forward responsibly to develop the next generation of our financial-service hitecture.” consider what action is required

the damage entailed. Likewise, we recognise the importance of finding ways of preventing rs provide important perspectives on both the causes of the global financiala fatal repetition. spurred l as proposed solutions to ensure it doesn’t happen again. AEqually must-read for by these motives, rested or involved in the financial markets.” and bringing their expertise from —John Paulson, President and founder of Paulson & co, inc. the fields of finance, economics and accounting, a group of 33 academics at New York able economic recovery can take hold until our tattered financial system is aired but, more importantly, until its institutional frameworkUniversity’s is restructured Stern School of set out to scrutinise the es of financial behavior are put in place. This book, the workBusiness of prominent ns from a leading school of business, makes an important contribution to complex problems behind the of the problems and provides specific recommendations for their grimsolutions. scenes. As a result, the s this book especially valuable is its detailed evaluations and analyses coveringhave produced 18 professors ums of the marketplace.” white papers that all suggest —Henry Kaufman, President of Henry Kaufman & co., inc. market-oriented solutions to the problems which have caused what they define as a ‘systemic’ financial crisis. winner of the 1997 nobel Prize in economics




‘Restoring Financial Stability: How to Repair a Failed System’ is aimed at policy-makers and business executives. Discussing financial policy options from the perspectives of a free market, the authors point to a number of opportunities as well as suggest specific steps of action which range from modest regulatory changes to more fundamental ones. To avoid future ‘systemic’ financial damage, recurring and devastating changes to competitive conditions as well as an unproductive distribution of capital,

How to Repair a Failed System Vi ra l A c h a rya M at t h e w R i c h a r d s o n editors the authors put forward a number of ideas for change. In addition to the urgent need for re-establishment of market liquidity and solvency of financial institutions, risk in the system needs repricing. The changes require both special regulatory remedies and additional capital claims on financial firms causing ‘systemic’ risks. Based on their insights into individual areas of financial theory, the authors have

addressed the practical requirements of reconstructing the financial services industry. Pinning down and putting into perspective the problems as well as suggesting specific recommendations for their solutions, they make a timely and substantial contribution to the discussion of the means to a recovery and reformation of the financial system, also recom­ mending new rules of financial behavior.

The financia 2008 transfo economies. A of bank failu drawn and historic pres seemed to be proposed, a g York Univer tackling the Representing accounting, t Cooley and V independent focused solut framework. I sent hand-bo

This book, Repair a Fail work. For p alike, the b policy alterna to deal with crisis. Their potential of regulatory in practice to its

To better un financial cris financial hea timely work. Richardson, the best thin from one of t

Qualify for the

SimCorp StrategyLab Risk Management Excellence Award 2009

Risk management excellence award 2009 SimCorp StrategyLab invites investment management institutions to participate in an assessment of their ability to mitigate market risk, operational risk and governance risk. The assessment will be based on their achievements and developments accomplished in the period from 1 August 2008 to 31 July 2009. The international jury consists of well-known specialists and academics within finance, governance and risk management. Submission deadline is 31 July 2009. The Risk Excellence Award 2009 will be announced on 17 September 2009, at a ceremony in Luxembourg. The result of the competition will also be announced in the October issue of the Journal of Applied IT and Investment Management.

Learn more about the award and find submission guidelines on

April 2009 34

Journal of Applied IT and Investment Management


Recent research and white papers #

A European Mandate for Financial Sector Supervisors in the EU


by Daniel C. L. Hardy, International Monetary Fund

The EU is deliberating the introduction of an explicit ‘European mandate’ for financial sector supervisors to supplement national mandates. Suggestions are made on (i) the formulation of a European mandate; (ii) the policy areas to which it should apply; (iii) which institutions should be given a European mandate; (iv) the legal basis for the mandate; (v) how to implement the mandate in practice; and (vi) how to achieve accountability for fulfilling a European mandate. Decisions on these issues are needed if the introduction of a European mandate is to have a substantive positive effect.

Global megatrends 2009

International Monetary Fund, 30 pages, 2009

by Priti S. Rajagopalan, Deloitte Research

The use of International Financial Reporting Standards (IFRS) is on the rise across the globe. The transition to new accounting policies under IFRS requires a change in mindset, presenting companies with both challenges and opportunities. In some markets, IFRS will likely contribute to substantial changes in: • • • • •

Insurance product design, price and offerings Investment strategy Risk management practices Securitisation Mergers and acquisitions activity

These changes will give rise to pressure for both convergence and divergence across insurance lines, thereby adding complexity and dynamism to the market structure of the insurance industry. By taking a proactive approach to understanding the impact of IFRS implementation on key business strategies, insurers can avoid the risk of being unprepared for the industry-wide shift, while seizing on emerging opportunities for differentiation from competition. Deloitte Research: The IFRS Journey in Insurance Deloitte, 20 pages, 2008

Globalisation The power shift from West to East Energy and commodities Talent retention

These are just a few of the important topics that are discussed in the publication ‘Global megatrends 2009.’

The IFRS Journey in Insurance: A Look Beyond the Accounting Changes

The financial crisis is causing a considerable amount of uncertainty about the future. Yet, we still need to think about the trends that were unfolding before the crisis and question how they will evolve and what new directions they might follow, as well as consider new trends that are now emerging: • • • •

IMF Working Papers, no. 09/5


Global megatrends 2009

Ernst & Young, 20 pages, 2009


World Economic Forum 2009: shaping the post-crisis worLD How best to reform the world’s financial system? That was the hot topic at this year’s World Economic Forum (WEF) in Davos, where leaders discussed possible solutions to global problems ranging from the economic downturn to climate change.


Top 10 strategic risks for business What strategic challenges are likely to affect your company in 2008 and beyond? This publication identifies ten of the most critical risks, including regulatory and compliance, financial shocks, and aging consumers and workforce, faced by some of the world’s most important industry sectors. The 2009 Ernst & Young business risk report: The top 10 risks for global business Ernst & Young, 40 pages, 2009



Journal of Applied IT and Investment Management

2009 insurance industry outlooks In a continually evolving economic climate, there is a greater need for insurance companies to work strategically to achieve their growth objectives. Ernst & Young discusses the key issues facing the insurance industry this year in these reports.


Solvency II: Information systems as a major challenge Ernst & Young, 4 pages, 2009

The impact of tax treaty trends in the Asia-Pacific funds sector

The impact of tax treaty trends in the Asia-Pacific funds sector KPMG, 50 pages, 2009


Finance of the future looking forward to 2020 A decade ago, KPMG International made a series of predictions on the future of finance in 2010. Reflections on these predictions and thoughts on where finance will be a decade from now are set out in this publication. Finance of the future - looking forward to 2020

Trends in the European Investment Fund Industry in the Fourth Quarter of 2008 and Results for the Full Year 2008 2008 has been a very difficult year for European investors and fund managers. The global financial crisis, which started in the United States in the summer of 2007 had a severe impact on investment funds in Europe and other regions. The impact of the crisis in the financial markets on the banking sector and the real economy explains why investment funds were severely hit. The report puts the crisis into perspective.

Ernst & Young, 40 pages, 2008

This publication provides an overview of the basic tax rules applying to funds and other international investment structures across 17 Asia-Pacific countries. It considers how tax treaties are being applied across the region and what tools countries increasingly have at their disposal in order to be able to deny treaty relief to funds. The report also discusses how the funds industry should be responding to these challenges.


by Bernard Delbecque, Director of Economics and Research, EFAMA

Insurance Finance 2010: Taking a broader view


April 2009

Trends in the European Investment Fund Industry, Quarterly Statistical Release, no. 36 EFAMA, 11 pages, 2008


2009 Global Survey of Investment and Economic Expectations: expert views on capital markets, economy, investment and governance In the continuing uncertain economic environment, it’s of growing interest to hear how experts view the short and medium-term investment landscape. In November and December 2008, Watson Wyatt conducted a global survey of 104 investment managers to gauge their views on macroeconomic predictors, capital market expectations and where they see investment and governance going in the future. 2009 Global Survey of Investment and Economic Expectations Watson Wyatt, 76 pages, 2009 KPMG, 20 pages, 2009

New reports published and information on recent research which could be relevant for listing can be submitted for review to Editorial Assistant Mette Trier Riisgaard,

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SimCorp is a leading provider of highly specialised software and financial know-how for the financial sector. Established in 1971, with approximately 1,000 employees, SimCorp is listed on the NASDAQ OMX Copenhagen A/S. The SimCorp system, SimCorp Dimension, is sold, implemented and supported by the head office in Copenhagen and the subsidiaries and branches in Amsterdam, Brussels, Frankfurt, Helsinki, Hong Kong, Kiev, London, Los Angeles, Munich, New York, Oslo, Paris, Singapore, Stockholm, Sydney, Vienna and Zurich.

Journal of Applied IT and Investment Management Vol.1, No.1  

Journal of Applied IT and Investment Management is an industry periodical, published and distributed globally by SimCorp A/S. The aim of the...

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