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Erin McKnight
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Interconnectivity of buy-side institutions forces change in risk management

Buy side forced to adopt more sophisticated risk management as interconnectivity between buy-side stakeholders grows, says Algorithmics, an IBM Company

White paper analyses impact, requirements and opportunities of buy-side interconnectivity

Buy-side institutions – including insurers, pension funds, asset managers, hedge funds, wealth managers and asset services – are now more interconnected than ever before. Two key factors have combined to bring this about – the tide of new regulation and the low-yield market environment. Increased regulation requires asset owners to report on risk at a more granular level and this detail will need to come from their asset managers and servicers. The low-yield market has forced asset owners to look to higher risk investments to meet their investment goals and to demand greater transparency and risk awareness from their managers.

In a new white paper, Algorithmics, an IBM Company, together with 13 senior executives predominately from the buy side, explore this interconnectivity, particularly in the context of risk, to understand the dependencies, vulnerabilities and also to identify opportunities.

Dr Andrew Aziz, Executive Vice President of Buy-Side Risk Solutions at Algorithmics, an IBM company, commented: “Our clients are adjusting to doing business in an environment beset with new regulation and investor wariness. All agree that attention is focused on the quality of risk management which is forcing change in their risk functions. For example, regulators are now pushing asset owners to assess risk from a full balance sheet perspective, changing the demands placed on their external asset managers and the types of services required. In our view, interconnectivity presents an opportunity for the buy side to develop new solutions and innovative ways of doing things, such as providing Solvency II compliance services, expanding liability driven investment (LDI) vehicles as well as supplying liability proxying capabilities.”

Key findings of the white paper, ‘The Buy Side Ecosystem: The Interconnectivity of Risk’, include:

1. Drivers for interconnectivity of risk:

  • Regulation
  • Market factors:

o Prospering in a low yield environment

o Dealing with volatility

2. Key implications of the interconnectivity of risk

  • Asset owners are more demanding

o Transparency to stay in the game

o Asset owners are paying closer attention to asset manager activity

o More stringent due diligence is the order of the day

3. A change in behavior is required

o Integration and interaction between portfolio managers and risk management as the risk and return functions become more interconnected and risk moves from the middle to the front office

o Risk shifts to the boardroom

o Some organizations will choose to dispose of businesses

4. The risk management function is changing

o Experience counts

o Transition from a passive to a pro-active function with influence

o Increased investment in risk technology

o Dealing with increased complexity.

Dr Andrew Aziz concludes: “Buy-side institutions, especially asset managers, need to be cognizant of the domino effect created by the interconnectivity of risk. Just because regulation is not directed specifically at them, it does not mean that they are immune to its effects. Potentially, the knock-on effect of demands from the regulator, to the asset owner, to the asset manager, to the asset servicer will present both challenges and opportunities. Being attuned to these implications and taking action as a result will dictate how successful they are in the future. It is not just a question of risk management for a single enterprise but more a case of risk flows and management right across the buy side.”