Is the Buy-Side Risk Function Losing Status?

Are buy-side institutions paying enough attention to risk management in light of the ongoing financial crisis? A recent study of 90 investment management organizations raises some alarm bells.A 2009 global survey of investment management risk carried out by SimCorp Strategy Lab,a private research lab based in Copenhagen, in March together with The Nielsen Company, revealed that the risk function has lost status in the reporting hierarchy. What the study found is that since 2007, the number of organizations that have the risk management functions reporting into the board of directors dropped by 5 percent from 36 percent to 31 percent, which amounted to a fall of 14 percent within the group. I spoke with Professor Ingo Walter, director of SimCorp Strategy Lab, who holds the Seymour Milstein Professorship of Finance, Corporate Governance and Ethics at New York University's Stern School of Business, about the research findings.

"What I had hoped to have seen is that is had moved up given the crisis in the financial markets," said Professor Walter. "One would think this would be a golden opportunity for the risk side to be moved up in the hierarchy of the key strategy and formulation and execution process of companies," said Walter. But it didn't move up. "It moved the other way a bit," said Walter.

Usually there is a chief risk officer and this individual reports somewhere to line management, usually to chief operating officer and sometimes to the chief financial officer of the firm. Usually there's an executive committee or management board and one would think the chief risk officer would be part of that, suggested the professor. For instance, at Goldman Sachs, the chief risk officer David Viniar is the same person as the CFO, he noted. "If the risk function is at the top of the organization then it's difficult for the risk management function to be rolled over by the deal guys," he said.

However, despite the slight decline in reporting status, 58 percent of the respondents had extended the role and responsibility of the risk management function during 2008. Looking to the future, 76 percent of the respondents cited "increased strategic influence of the risk function" as the way to improve risk management.

Respondents believed that investments in the risk management area will mostly come from staff and least will be in external consultants. They also cited increased investments in competencies, implementation of new models and methods.

Though many industry studies have shown that risk management technology is an area that investment firms are prepared to spend money on, almost half of the respondents (49 percent) answered they are more than satisfied with their risk management software. They are least satisfied with the ability to process real-time data, according to the study.

In terms of what went wrong with risk analytics and measurement approaches, 38 percent of respondents blamed insufficient risk methods and techniques, 37 percent cited insufficient strategic understanding of the role of the risk function and 36 percent cited insufficient training/competencies in the risk management function as significant causes of financial losses in the investment industry.

Professor Ingo noted that reliance on standard deviations and volatility coefficients are all historically based. "When you look at the metrics that have been used commonly and you hit a tail event like we had, especially with the disappearance of liquidity, every risk model is based on time continuous markets and time continuous liquidity and when you saw that disappear you are subject to model risk," said Ingo.

But in terms of using external inputs to carrying out risk assessments, the predominant one was regulatory as opposed to consultants or shareholders or external auditors, noted Ingo. "To me that shows a sort of reactive results as opposed to proactive. You would think in today's world, one would try to get a little ahead of the curve and think of improving risk management in terms of techniques as opposed to waiting to hear" when something is noticed by regulators, said Professor Ingo in the interview.

Another issue that organizations need to address is compensation. "One of the problems with risk management, is you really ought to be rewarded for things that didn't happen, whereas on the return side, they have hard numbers to come up with, which is what gives them a lot more power in the organization," he said.A 2009 global survey of investment management risk carried out by SimCorp Strategy Lab revealed that the risk function has lost status in the reporting hierarchy. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio