Forget about praise for all the hard work in 2014. Everyone now has to roll up their sleeves to address a host of new regulatory and investor requirements while meeting even tighter budgets. And let’s not forget the need to execute new business strategies for bottom-line growth.
Given so many changes, just what should the operational priorities be? Speaking with ten global fund management firms, broker-dealers and banks as well as external software providers and consultants, FinOps Report offers the following list of five challenges which financial firms should embrace if they want to remain competitive and compliant.
1. Find Risk Data
Do you know where you’re data is and can you put it to work for you? Large global financial organizations aren’t the only ones who will have to deal with new regulatory requirements aimed at reducing systemic risk and ensuring investor protection. Individual fund management firms may have escaped from the onerous designation as systematically important financial institutions, but they will fall more closely under the US Securities and Exchange Commission’s radar for what Chair Mary Jo White described as portfolio composition risk and operational risk.
Do they have sufficient liquid assets to fulfill a potential tsunami of redemptions; can they manage to stay afloat during extreme market downturns; and can they handle “transition planning” in the event of their financial demise are just three of the tough questions an SEC examiner will want answered, according to Ron D’Vari, chief executive of New Oak, a New York based financial advisory firm, whose clients include fund managers. “With the significant increase in the use of derivatives to adjust or obtain exposure to a market sector more efficiently, leverage must also be correctly addressed,” he says.
2. Operate in Real or Near Real-Time
Eliminating delay is going to be increasingly important in the middle and back office. Can you locate the necessary securities or cash — not later, not tomorrow, but right away — when a financial firm needs them to meet requirements for margin calls, redemptions, or even settlement deadlines? “In a new world of higher collateral requirements, potential redemptions, and a shorter timetable to settle transactions in Europe, financial firms will need to have far quicker access to cash and securities,” says Michael Zimits, a partner at Capital Markets Advisors, a New York financial services consultancy specializing in risk management and operations. “Middle and back-offices won’t be able to wait until the end of the day to track down where cash and financial instruments are located to make the necessary transfers to counterparties, clearinghouses and securities depositories.”
3. Reduce Operational Risk
There are plenty of areas where financial services firms could stand some improvement, but operational risk could end up being top of the list in 2015 as cost constraints are balanced against the demands from regulators and investors for reassurance that correct procedures are in place. A central issue will be making sure that front, middle and back offices have access to the same information at the same-time. Spreadsheets will be out as will any manual re-keying of data between applications, operations directors at several US fund management firms tell FinOps. “We’ve been directed to review how quickly and how consistently data flows from the front office to the middle and back-offices and vice versa,” says one operations manager. “Once that task is completed, we shift focus to our interactions with broker-dealers and custodians.”
Topping the list of priorities for two fund management firms and two of their broker-dealers contacted by FinOps — ensuring that allocations and confirmations are handled on the evening of the day trades are executed, rather than the following day. Yet another must-do for the same firms — handling any exceptions or discrepancies in the details of executed trades also on trade-date. “Waiting until T+1 [the day after the trade is completed] doesn’t give us enough time to meet Europe’s two-day settlement cycle,” explains one US fund management operations specialist.
4. Think Smarter
The pressure of new regulation has a ripple effect, which may cause a lot of old working assumptions to be questioned. New capital and leverage ratios introduced by the Basel Committee for Banking Standards could require prime brokers to increase the regulatory capital they must reserve against the bites of their in their balance sheets hedge fund managers are consuming. Those higher requirements, starting in 2015, will ultimately prompt prime brokers to be more selective about which hedge fund managers they accept as clients and to charge those they pick higher fees, according to Radi Khasawaneh, a fixed-income analyst in London with global research firm TABB Group. Hedge fund managers, in turn, may be smarter to reduce their number of prime brokerage relationships to maximize their importance to their service providers, which must balance the revenues they earn from clients to the net exposure and leverage used by each underlying hedge fund.
5. Stay Clean
Although much of the attention on whistleblowers in 2014 has been on alleged accounting fraud at large global banks and corporations, the ranks of those blowing the whistle and being called out will be on the rise, predicts Deborah Prutzman, managing director of The Regulatory Fundamentals Group (RFG), a New York-based regulatory and legal compliance specialist. Compensation for tattling could amount to anywhere from several hundred thousand dollars to multimillions depending on the amount of any fine the SEC imposes.
Of course, tattle-worthy problems aren’t usually unintentional run-of-the-mill glitches, but rather outright corruption. Operational areas where compliance expert expect a rise in enforcement actions are improper controls on investor assets, including transfers of funds into personal accounts, and breaches of sanctions against foreign governments, individuals, and companies. “Fraudulent wire transfers are becoming a big area of concern; therefore, strict policies have to be implemented, including increasing the number of signatures required for any large sum to our leave a bank account and verifying just where the monies are headed,” says one UK fund management operations manager. Yet another US fund management operations specialist tells FinOps: “We will be reviewing our control and oversight policies to ensure that no single individual is entirely responsible for cash receipts and payments.”
Shopping for Solutions
With all five of these best practices coming down to better controls through improved data management and process automation, the pressure on financial firms to get their operational houses in order will intensify in 2015. The higher the number of front-office trading and back-office systems handling multiple asset classes, the more persuasive the arguments in favor of a methodology called investment book of record of record (IBOR), says Duncan Cooper, a director at investment technology specialist Sapient in London. Regardless of which software platform is used, the ultimate benefit of IBOR is enabling a common view of reference, counterparty, position and transactional data throughout front, middle and back offices.
Other software which may be on the shopping list in 2015 are post-trade trade matching and reconciliation platforms, automated collateral management platforms, and corporate actions workflow management tools. The reason: no one can afford the operational risk of failing to settle trades on time,overlooked margin calls, delayed corporate action information, or missed deadlines for decisions involving corporate reorganizations. Besides the drag on administrative time for cleaning up these failures, explicit costs include compensating counterparties, clients, and even market infrastructures such as clearinghouses and securities depositories. Just one mistake could wipe out millions of dollars worth of hard-earned profits.
For hedge fund managers looking for a better way to forecast how their trading strategies will affect their prime broker’s capital charges and ultimately fees, analytic tools are available. One such platform –Blacklight from S3 Partners — will help them aggregate the necessary data quickly, explains Robert Sloan, managing partner of the New York-based firm. Yet another benefit: evaluating current or future prime brokers.
With the focus of the asset management industry shifting in 2015 from data collection to data aggregation, data analysis, and regulatory reporting, chief data officers are going to be rising in prominence in fund management shops. No longer will the inclusion of CDOs in top management be limited to the world’s largest banks. “CDOs will become the C-suite member who has the single greatest ability to transform how the asset management business operates in the year ahead,” says Todd Moyer, executive vice president at Pittsburgh-headquartered Confluence. The reason: he or she will convert Big Data into actionable business decisions and opportunities. Doing so, of course, will require the CDO to successfully bridge the gap between business lines and information technology units.
Although shoring up middle and back office operations in 2015 will likely continue to be heavily driven by enhancements to technology resources and data governance, one significant aspect can only be handled by an overarching cultural change. Whistleblowers are often motivated by the desire to implement necessary change, rather than greed; therefore, developing enterprise-wide governance standards around legal and regulatory issues would be a good idea. Such a task requires senior management to match up applicable laws and requirements with responsibilities for each employee.
It would also be a good idea for the C-suite to view users and developers in the front-lines as sources of critical feedback. “Empower all staff, including operations professionals, to speak up and discuss any concerns with compliance directors,” says Prutzman.