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Establishing a Risk Appetite in Asset Management
“If it looks like a duck, quacks like a duck, it might just be a duck”(Merk, 2012).*
Christopher B GrixAsset Management Forum12th March 2013
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Contents1. Aim/ Scope of Review2. Method
• Overview or Research• Portfolio Risk descriptions• Business Risk descriptions• Operational Risk descriptions
3. Results• Governance• Portfolio Risk• Business Risk• Operational Risk
4. Conclusions
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Aim/ Scope of Review• Aim:– “To understand if there is a benchmark risk
appetite or holistic control limit framework for Asset Managers, that has been agreed by firms’ senior management, separate to any mandatory regulatory, legal or client driven requirements.”
• Scope: – UK based Asset Management Companies, via Risk
Management Departments.
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Questionnaire – An online questionnaire was sent to members of the following Risk Professionals:
• IMA Risk Working Group.• Asset Management Risk Forum.
The questionnaire was broken into the following sections:
• Governance – focusing on how Risk Appetite is defined and reviewed.
The research then reviewed how the relevant risk types are enforced/ embedded within asset managers:
• Portfolio Risk – risk in the portfolios managed on behalf of clients.• Business Risk – risk in the Asset Manager itself that may affect its capital or
financial position.• Operational Risk – risk in the Asset Manager itself as a result of people, processes,
systems or external events.
Method – Overview of Research
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Method – Risk Descriptions
Portfolio Risk Types Description
Market Market volatility impacting performance.
Investment Performance
Performance of investments against a benchmark, usually on a 1, 3 or 5 year basis.
Liquidity Ability to turn portfolio assets to cash.
Counterparty/ Credit
Portfolios’ exposure to counterparties and risk of their default.
Investment Guideline Breaches
Failure to meet client, legal or regulatory restrictions on portfolio investments.
Portfolio Risk
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Business Risk Types Description
Profitability Profitability of overall business or sub units.
Product Concentration Profit, Revenue or AUM dependence on one or a few product types/ strategies.
Client or Intermediary Concentration(s)
Profit, Revenue or AUM dependence on one or a few client(s) or intermediaries.
Counterparty Risk Asset managers’ exposure to counterparties and risk of their default.
Liquidity of Own Assets Ability to turn own company assets to cash.
Business Risk
Method – Risk Descriptions
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Operational Risk
Operational Risk Types Description
Legal/ Tax/ Regulatory Failure to adhere to legal, tax or regulatory requirements.
Compliance/ Fraud/ Corruption
Ethical breaches resulting in fraud or corruption.
Information Security Adequacy of IT security standards.Business Continuity Preparedness to continue business
through a range of disaster events.Outsourcing Degree of reliance and quality of
outsourced services.Personnel Key person risk, attrition levels.Manual Models Reliance on non-standard or manual IT
tools.Errors/ Losses Volume and size of errors or
operational losses.
Portfolio Risk
Business Risk
Method – Risk Descriptions
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Results - Governance1.1. Does your firm have an explicit Risk Appetite Statement? Total of 46
Responses
Total of 46 Responses
1.2. If you do have a Risk Appetite statement, how frequently is this reviewed (firms could select multiple answers for this question e.g. quarterly and annually)?
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1.3. How is your firm’s Risk Appetite defined or reviewed?
Results - GovernanceTotal of 46 Responses
1.4. Do you feel the organisation’s risk appetite acts as a practical tool to help steer or limit the organisation’s business plan within agreed risk tolerances?
Total of 46 Responses
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Results – Portfolio Risk2.1 Does your firm include Portfolio Risk for third party/ clients’ assets in its Board/ Executive approved Risk Appetite statement?
Total of 41 Responses
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Results – Portfolio Risk2.2 Please select which areas of Portfolio Risk have a Hard Limit applied to them across your organisation - these are defined by the Company separate to any regulatory minimums or client guidelines and must not be breached (firms could select multiple answers for this question). Total of 41
Responses
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2.3 Please select which areas of Portfolio Risk have a Soft Limit applied to them across your organisation - where key risk indicators or other measures are in place, but no absolute limits are enforced (firms could select multiple answers for this question).
Results – Portfolio Risk
Total of 41 Responses
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Results – Business Risk3.1 Does your firm include Business Risk in its Board/ Executive approved Risk Appetite statement?
Total of 39 Responses
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3.2 Please select which areas of Business Risk have a Hard Limit applied to them across your organisation - these are defined by the Company separate to any regulatory minimums or client guidelines and must not be breached.
Results – Business Risk
Total of 39 Responses
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Results – Business Risk3.3 Please select which areas of Business Risk have a Soft Limit applied to them across your organisation - where key risk indicators or other measures are in place, but no absolute limits are enforced. Total of 39
Responses
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Results – Operational Risk4.1 Does your firm include Operational Risk in its Board/ Executive approved Risk Appetite statement?
Total of 38 Responses
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Results – Operational Risk4.2 Please select which areas of Operational Risk have a Hard Limit applied to them across your organisation - these are defined by the Company separate to any regulatory minimums or client guidelines and must not be breached.Total of
38 Response
s
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Results – Operational Risk4.3 Please select which areas of Operational Risk have a Soft Limit applied to them across your organisation - where key risk indicators or other measures are in place, but no absolute limits are enforced. Total of 38
Responses
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Conclusions• Disconnect remains between strategic planning and formation of Risk
Appetite.
• Larger firms more “visibly” able to evidence documented risk appetites than smaller firms.
• The key trend that appears to have been the driver for the most prevalent risk limits identified in the survey are likely to be:
• Regulatory pressure, via rules or enforcement actions;• Client pressure, through increased requests for information or client
led due diligence;• Changes in market practice, where control improvements quickly
become expected industry standard.