Top 10 Operational Risks: The ninth and tenth risk areas in a 10-part series

Operational risk within investment management firms can stem from many sources. Firms also have varying tolerance levels for accepting or handling such risk. SEI believes virtually every firm can benefit from taking a fresh look at common areas of risk and consider the variety of relatively straightforward risk management measures that can readily be deployed. In that spirit, SEI put together a 10-part guide as an effective risk management tool to set the foundation for operational excellence. Below are excerpts from chapters nine and ten, now available for download at

9) READING THE FINE PRINT: Know Thy Legal Entities

Pressured by the sheer volume and complexity of work in a high-velocity business, investment managers and their attorneys don’t always give key documents and agreements the attention they require.

Common pitfalls: Relying solely on attorneys to review important documents, such as ISDA, prime brokerage, custodial and administrative agreements, is a recipe for trouble. Hazards also crop up when authorized signatories simply follow the “sign here” stickers, assuming that their subordinates have scrutinized the details or that the agreement is the same as the last one they signed.  Significant business issues are often buried within legal documents; yet they are too often executed and filed without a careful review by the very people responsible for managing the operational risks the agreements may entail.

What can firms do?

Provide for both legal and operational review of key documents. It is crucial that key agreements be examined from both perspectives.  Workflow tools may help in determining who should review which documents.

Scan contracts with key service providers and make them available to staff throughout the organization.  This simple step can help firms raise awareness concerning contractual terms and obligations.

Clearly identify which entities are counterparties. It is also vital to know the regulators to which those entities are subject. When assessing counterparty risk, firms should continuously monitor counterparties’ net exposure as well as their creditworthiness.

To be sure, poring over and deciphering byzantine legal documents is neither easy nor enjoyable.  Ensuring adequate review of documents takes state-of-the-art data management, know-how and perseverance.  It is up to each of us, in our respective roles, to take responsibility for getting it right.

10) POOR PLANNING AND SLOW RESPONSE TIMES: Changes in the Firm, the Marketplace and the Regulatory Environment

Neglecting to plan ahead is source of operational as well as business risk. A lack of advance planning can throw operational teams into a frenzied, hurry-up mode in which mistakes multiply.  In the worst cases, failing to anticipate changing conditions can jeopardize the entire enterprise.

Common pitfalls:
Clients, competitors and regulators are pushing the industry to create new alpha-generating products, increase transparency, provide more timely reporting, adopt key industry standards and reduce investment and operational risk—and do it all for lower fees.  Firms that underestimate these environmental shifts may sustain huge business and operational impacts.    Risks also arise from failing to anticipate cost structures and needs for organizational expansion.

What can firms do?

Place a high priority on effective long-term business planning. Firms that care about their long-term profitability and survival can’t afford to procrastinate.  They need to take time to consider what may lie ahead and mobilize the resources to manage change at both the firm and industry level.

Use operational benchmarking to help analyze cost structures. Benchmarking can also help firms quantify the financial impact of changes in key drivers.

Do not focus solely on expected AUM growth. Firms also need to anticipate their numbers of accounts, a factor that increases resource needs as well as operational risk.

Anticipate resource needs. Each budget cycle should include consideration of the resources needed to match expected AUM, account or product growth.  Firms should also factor operational staffing and systems needs into planning for new product and sales initiatives.

Take the time to absorb and discuss industry group analyses of new regulations and requirements. Firms should also begin getting ready to comply with new operational performance and due diligence standards.

One effect of the changing industry environment is to place greater emphasis on operational excellence through best-practice processes, improved data management, more effective controls and appropriate investment in staff and infrastructure. Rapid industry change has its upside, and firms that want to manage and reduce their operational risk will make the most of it.

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