Journal of Applied IT and Investment Management Vol 3. No. 1

# journal of Applied IT and Investment Management

Rising to the regulatory challenge The investment management industry prepares for new legislation

Industry experts assess regulatory changes

THE CHALLENGE OF RECONCILING GROWTH AND COMPLIANCE Dodd-Frank Act

HOW WILL THE ACT AFFECT IT SYSTEMS? IFRS 9

CHALLENGER MEETS REQUIREMENTS AND BUILDS COMPETITIVE ADVANTAGE WITH INVESTMENT MANAGEMENT IT UCITS IV

WHAT INVESTMENT MANAGEMENT FIRMS SHOULD DO TO COMPLY AND ENSURE GROWTH Also ...

SOLVENCY II, AIFMD AND SYSTEM BEST PRACTICES FOR COMPLIANCE: INSIGHTS FROM ERNST & YOUNG, TOWERGROUP, KPMG AND ALFI

Volume 3 路 No. 1 路 April 2011

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SimCorp

CEO comment:

Contents

Meeting the

regulatory challenge

3 Regulatory change: the challenge of reconciling growth and compliance

by CEO Peter L. Ravn

Meeting the challenge of reconciling regulatory compliance with business growth in the investment management industry today does not necessarily have to be a choice between a rock and a hard place. However, it is clear from the range of articles appearing in this issue of the Journal that current and proposed regulation is irrevocably changing the way business is done in the investment management industry.

With imposition of new and updated laws and standards, such as AIFMD, Solvency II and UCITS IV proceeding in Europe, the DoddFrank Act in the USA and IFRS 9 internationally, it is little wonder that many of our clients view increased regulation as the primary barrier to growth going forward.

These requirements are not negotiable. They are mandatory and a prerequisite for doing business. Important for investment managers is to be able to fulfil these requirements and regard them not as a burden imposed on the industry but rather take the opposite view. This is now the framework we have to operate in and we have to see how we can best turn that framework into a competitive advantage.

We are in the situation where all key stakeholders including investors and clients demand greater transparency and strong compliance with the necessary IT infrastructure to back these up. We at SimCorp acknowledge that a strong compliance function will also become a factor of increasing competitive importance, which will define and set an organisation apart from its competition.

It all starts with a sound data foundation, a solid architecture of your investment management system and your landscape. You can never foresee exactly what changes will appear in the future but you should be able to cope with these changes much faster and much better if your foundation is in good shape.

And SimCorp Dimension, with one integrated platform and one database, ensures that all clients have the necessary consistency in their data and in their operations as a foundation for all the regulatory reporting. To help clients rise to the regulatory challenge, our constant monitoring of the regulatory scene means that SimCorp Dimension remains compliant and avoids a diversion of resources from realising growth strategies.

In an ideal world, the investment management system is there to support the business and to help the business to expand, rather than being a barrier to future growth. If the software platform is misconceived, where the fundamentals are not in place, then eventually it will become a hindrance to growth rather than an impetus to help grow the business. The regulatory changes that are coming over the next to three years not only place demands on the investment management industry in terms of the end-users like fund management companies and clients but also on the investment management software solution providers. They also need to stay on track and keep up to date to avoid becoming a hurdle but rather support in securing competitive advantage.

It is our job at SimCorp to remain vigilant and responsive, making sure that SimCorp Dimension enables our clients’ investment management systems to stay up to date and allows them to concentrate on their core competency – delivering value for investors.

Peter L. Ravn, Ph.D., is CEO at SimCorp.

8 Best practices: the optimal investment management system for regulatory compliance

12 IFRS 9: meet requirements and build competitive advantage with investment management IT

16 UCITS IV: what investment management firms should do to comply and ensure growth 20 Dodd-Frank Act: how will the act affect IT systems?

23 AIFMD: changes and benefits in store for the European alternative fund industry 27 Solvency II: what it means for investment management systems 30 Challenges in the front office: new regulations force derivatives market overhaul 33 SimCorp StrategyLab hosts Copenhagen Summit 2011: high-level industry representatives and academics convene to discuss key challenges 35 Book reviews 36 Regulatory update 38 Recent research and white papers

Subscription Subscription to the Journal is free of charge for members of the industry, associated institutions and academics. To subscribe, please visit www.simcorp.com/journal.

Change of address should be e-mailed to journal@simcorp.com.

Editor-in-Chief Lars Bjørn Falkenberg, Senior Vice President, SimCorp A/S larsbjorn.falkenberg@simcorp.com CO-EDITORS Michael Metcalfe, financial journalist, michael.metcalfe@gmx.de Mette Trier, Copy & Translations Manager, SimCorp A/S, mette.trier@simcorp.com Publisher SimCorp A/S, Weidekampsgade 16, 2300 Copenhagen S, Denmark, phone: +45 35 44 88 00.

Journal of Applied IT and Investment Management is a financial industry periodical, published and distributed globally by SimCorp A/S. Print run: 19,000.

SUBMISSION GUIDELINES Articles, book reviews, new reports and information on recent research can be submitted for review to Co-Editor Mette Trier, mette.trier@simcorp.com. For submission guidelines, please visit www.simcorp.com/journal.

LEGAL NOTICE The contents of this publication are for general information and illustrative purposes only and are used at the reader’s own risk. SimCorp uses all reasonable endeavours to ensure the accuracy of the information. However, SimCorp does not guarantee or warrant the accuracy or completeness, factual correctness or reliability of any information in this publication and does not accept liability for errors, omissions, inaccuracies or typographical errors. The views and opinions expressed in this publication are not necessarily those of SimCorp. © 2011 SimCorp A/S. All rights reserved. Without limiting rights under copyright, no part of this document may be reproduced, stored in or introduced into a retrieval system, or transmitted in any form, by any means (electronic, mechanical, photocopying, recording or otherwise) or for any purpose without the express written permission of SimCorp A/S. SimCorp, the SimCorp logo, SimCorp Dimension and SimCorp Services are either registered trademarks or trademarks of SimCorp A/S in Denmark and/or other countries. Refer to www.simcorp.com/trademarks for a full list of SimCorp A/S trademarks. Other trademarks referred to in this document are the property of their respective owners.

ISSN 1903-6914

Read the journal online at www.simcorp.com/journal

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# Regulatory change:

the challenge of reconciling growth and compliance The investment management industry will have to adopt a host of regulatory legislation and new laws in the next few years. While working to meet client needs and growth goals, the industry must also address the impact that these regulatory changes will have on business, operational and compliance requirements. This article presents some views on the challenges and solutions with regard to aligning compliance and growth strategies.

A

Michael Metcalfe is Co-Editor of the Journal of Applied IT and Investment Management.

cross the globe, a sweeping wave of regulatory reform and change is redrawing the contours of the financial landscape. Over the next three to five years, a loose and often arbitrary set of new legal provisions, standards and regulations will impact a wide spectrum of the financial services sector, its ancillary and auxiliary services, intermediaries and third-party suppliers and providers, as well as the combined range of financial instruments and products they manufacture, process and market. The impact will be varied, with some areas hardly feeling the pinch at all while others will be significantly squeezed.

For the investment management industry, by and large, the regulatory and compliance challenges in the years ahead will be unprecedented. Among the manifold changes to be taken into account at the strategic, tactical, systemic and operational levels are the new

regulatory framework and demands of the landmark Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) in the USA, AIFMD, MiFID conduct of business, PRIPs, Solvency II and UCITS IV in the EU, as well as on an international level the new tax rules and standards primarily embodied in IFRS 9.

Comments Michael T. Dolan, a Partner at Ernst & Young in Washington D.C.: “The combined ramifications of legislative and regulatory reform include the advice investment managers offer clients, the way they handle transactions, how they market the business, the disclosures they provide, and ultimately the manner in which they will have to reconfigure and retool existing operational and IT platforms.”

Ensuring effective implementation of the new regulations will be daunting enough for any investment management enterprise. The years ahead promise even

“The combined ramifications of legislative and regulatory reform include the advice investment managers offer clients, the way they handle transactions, how they market the business, the disclosures they provide, and ultimately the manner in which they will have to reconfigure and retool existing operational and IT platforms.”

Michael T. Dolan, Partner at Ernst & Young in Washington D.C.

more pressing challenges – with accelerated rulemaking becoming the norm as regulators implement financial reform and fine-tune the lawmaking.

At the same time, the expectations of investment management organisations and their clients have never been higher.

Argues Dushyant Shahrawat, Senior Research Director at TowerGroup in the Securities and Investments practice in Boston: “Key industry stakeholders including investors, clients and prospective clients are clamouring for greater transparency and disclosure, as well as more assurance that the individual manager has strong compliance and internal controls with the necessary IT infrastructure to back these up.”

Many investment management organisations have learned from the financial crisis and market upheaval that spawned the latest wave of regulatory reform.

Demands for greater transparency, better reporting, lower risk tolerance and higher pressure on fees already have and will continue to increase substantially.

However, these hard facts have not reduced client expectations regarding growth and returns – on the contrary.

THE RIGHT CHOICES With unparalleled regulatory activity and more stringent client demands on investment managers, achieving growth will entail that companies make the right investment management system choices in the current environment.

Sriram Venkataraman, an Executive in Ernst & Young’s Financial Services Risk Management practice in New York, takes the view: “Regardless of whether

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# Regulatory change:

the challenge of reconciling growth and compliance investment managers pursue growth strategies of low-cost leadership, product differentiation, expansion into new markets and/or segments or a combination of these, it is imperative that the technical infrastructure is in place to support the desired growth strategy.”

Irrespective of the growth strategies employed by individual investment managers, there is one common challenge faced by all when delivering on the promises made to clients to provide attractive returns on their investments. If investment managers are forced to divert scarce and valuable resources to overcoming operational issues and deficiencies in their IT platforms, then their prospects of achieving growth look bleak indeed.

PRESSURE POINTS “There are five major components that make up the wave of financial reform which will impact the investment man-

FIVE KEY AREAS OF LEGISLATION FACING THE INVESTMENT MANAGEMENT INDUSTRY

agement industry ,” explains Mr. Venkataraman (see overview below). Of these five key areas of legislation, the DoddFrank Act is probably the most comprehensive and all-encompassing in terms of the impact it will have on financial services in general and the investment management industry in particular. The provisions are to be implemented over an 18–24 month period, but many aspects of the legislation have yet to be defined.

In addition to a host of other measures, the Dodd-Frank Act significantly enhances the powers and capability of the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), and the Federal Reserve and creates a new agency called the Consumer Financial Protection Bureau (CFPB). Notes Mr. Shahrawat: “Dodd-Frank clarifies the roles and responsibilities of regulators, which is of special significance in areas such as

derivatives, whose regulation historically was split among different regulatory bodies.”

Mr. Shahrawat goes on to explain that the Dodd-Frank Act accords much greater power to all regulatory agencies (especially the SEC, CFTC and the Federal Reserve), while creating new agencies: the CFPB, the Office of Financial Research (OFR), and the Office of Financial Stability. New powers to the SEC include oversight of the credit-ratings business and the ability to examine and fine nationally recognised statistical rating agencies.

In response to the new regulatory powers, greater resources, and a stricter mandate granted to regulatory agencies by the new law, investment management companies will need to enhance their compliance departments, add staff to deal with more regulatory examinations and implement

AIFMD

IFRS 9

The Alternative Investment Fund Managers Directive (AIFMD) is designed to harmonise the alternative investment fund management market in the EU. It will require alternative investment firms above a certain size to register and provide regulators with detailed information on the principal markets and instruments in which they trade.

AIFMD impacts all non-UCITS funds: hedge funds, private equity and venture capital funds, real estate funds and investment trusts. AIFMD is approved by the European Parliament, but pending individual EU member states’ legislation, it is expected to take effect in 2014. (For a closer examination of AIFMD and its implications, see article on page 23.)

The International Financial Reporting Standard 9 (IFRS 9) is the latest revision of international accounting standards issued by the International Accounting Standards Board. The standards are introduced to improve transparency of the processes in which various financial assets and liabilities are valued, accounted for and reported, and specifically deals with new requirements for the classification and measurement of financial assets. IFRS 9 replaces IAS 39 and consists of three phases, of which the last two are still in progress. Firms have until 2013 to comply with IFRS 9. (For a corporate case study on IFRS 9, see article on page 12.)

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“Of these five key areas of legislation, the Dodd-Frank Act is probably the most comprehensive and allencompassing in terms of the impact it will have on financial services in general and the investment management industry in particular.” compliance software (for surveillance of employees out of insider trading, data security and privacy considerations). “They will also need to conduct staff training and development and enhance preparedness for audits and examinations to deal with potential investigations of issues like market abuse and insider trading,” adds Mr. Shahrawat.

provides greater powers to supervise smaller alternative funds and implement special rules governing such funds.

“Collectively, all this means dramatic changes for this sector affecting operating costs, profitability, and the competitive structure of this business,” observes Mr. Shahrawat. Large hedge funds that already have established mature compliance, reporting, and client service departments will find these changes relatively manageable and will thereby gain an advantage over funds that do not, which will be hit with new costs and distractions.

the distribution value chain will need to modify the way they operate and interact, both with investors, regulators and one another.

The new UCITS IV Directive, MiFID conduct of business, an EU Directive on Packaged Retail Investment Products (PRIPs), and new UK-based regulations from the Retail Distribution Review (RDR) all share a number of common overarching objectives, the key being to restore and enhance investor confidence in financial products and improve industry efficiency.

CAPITAL POOLS Changes to private pools of capital (mainly in the form of alternative funds and private equity funds) are one of the aspects of the Dodd-Frank Act that will have the greatest impact on the industry.

Dodd-Frank requires alternative funds and private equity funds to register with the SEC as investment advisers, which means they will need to report investment performance, client assets, financial records and other pertinent information on a regular basis. It also

NEW EUROPEAN RULES In Europe, the range of new regulations will primarily affect investment funds – mutual and alternative alike – and significantly change the way in which they are operated, marketed and distributed.

The various industry links making up

This will be achieved by improving transparency and comparability across a range of financial products, not just UCITS funds; eliminating real and perceived conflicts of interest and harmonising rules surrounding investor information and the conduct of business

Solvency II

UCITS IV

Dodd-Frank Act

Solvency II builds on Solvency I and aims at creating a single EU market for insurance services and to protect consumers by obliging insurers to uphold certain solvency requirements. The intention is to achieve a correlation between capital requirements and economic risk. Solvency II also introduces requirements for improved reporting and transparency as well as national supervision of insurers. The Solvency II framework remains to be finalised but is due to take effect by October 2012, by which time all insurance and re-insurance companies operating within the EU will be impacted.

(For more details on Solvency II and its ramifications, see article on page 27.)

The UCITS IV Directive is a reform of previous UCITS directives designed to continue to make the investment fund market in the EU less fragmented and to improve its efficiency. UCITS IV aims to make fund consolidation easier, improve distribution and cross-border marketing. UCITS IV impacts the EU investment fund industry as well as foreign fund managers issuing UCITS funds in the EU, where fund managers have until mid-2011 to comply with the provisions. (For a report on UCITS IV and its practical impact, see article on page 16.)

The Dodd-Frank Act is designed to promote US financial stability by improving accountability and transparency in the financial system.

It establishes rigorous standards and supervisions to protect the US economy and consumers, investors and businesses. The act impacts the entire US investment management industry in varying degrees, as well as foreign investment managers with significant holdings in US financial assets. Roll-out of the Dodd-Frank Act started July 2010 and will continue over the next twothree years. (For a more detailed study of the Dodd-Frank Act and its effects, see article on page 20.)

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“… regulators expect to see, and indeed demand, a comprehensive, custom-built and sophisticated compliance programme with full testing, use of technological tools and IT expertise.” across the entire investment fund value chain. All these changes will alter the processes by which funds are distributed across Europe by impacting the complex relationship between the fund manufacturer, distributor and investor.

Having been approved by the European Parliament, Council and Commission, AIFMD will go ahead in its present form in mid-2011. During 2011 AIFMD will proceed through Level 2 negotiations where substance is added to the proposals as agreed. The EU’s 27 member states then have two years to transpose AIFMD into national law, with AIFMD projected to enter into force in mid-2013.

Also affected by this directive on a national level is Switzerland, insofar as a European fund manager may be headquartered in Switzerland, just as a fund manager headquartered in Switzerland may offer both Swiss and European funds for sale in the EU. Comments Dr. Matthäus Den Otter, CEO of the Swiss Funds Association (SFA): “From the Swiss perspective, it is crucial that European fund managers are able to delegate certain business activities to Swiss financial services providers on the one hand, and that Swiss funds and fund managers receive the relevant ‘EU passport’ on the other.”

RELOCATION OR LOCATION? When considering whether AIFMD will actually help boost the establishment and relocation of alternative funds in European jurisdictions like Luxembourg, a number of factors have to be taken into account. According to Camille Thommes, Director General of the Association of the Luxembourg Fund Industry (ALFI): “Relocation is one question, location another. What seems to be clear from the current version of AIFMD is that it will be easier if you want to distribute your funds in Europe to have European funds in a European management company.”

If an alternative fund manager wishes to sell non-European funds in Europe or sell funds that are managed by a non-European company, there are specific provisions that have to be complied with in regard to the regulator of the country where these funds or managers are domiciled. “So what we believe is that if you want to sell funds to European investors, the easiest solution is to have your asset management company in Europe,” adds Mr. Thommes.

In answer to the question whether the regulatory challenge can be turned into a benefit or competitive advantage for investment management companies, Charles Muller, the Deputy Director General of ALFI, responds: “One has to consider that some of the regulatory impulses come from the lessons learned from the financial crisis, like AIFMD to start with; but we are also talking now about the process of UCITS V, about MiFID, about PRIPs. So as a point of principle to look at these elements, it’s certainly a good thing.”

IFRS 9 DOUBTS IFRS 9 may be seen as the accounting world’s answer to the financial crisis, but there are doubts that the standard is enough to prevent another crisis. Many experts argue that this requires vigilance from all stakeholders – from accountants to investors and regulators. All in all, it points to improved fiscal transparency and convergence.

The next phase of the IAS 39 replacement will focus on liabilities and impairment, and is due to be completed later in 2011. Here the implications will be wider for financial institutions, many of which have been setting aside millions of dollars as provisions for bad debt.

The larger financial institutions have the technology to help them capture the necessary data and calculate credit risk. But smaller companies may have to invest in more IT resources.

“In our experience, data makes up 70% of an IFRS project. It is a key component to the work being done,” estimates John Foulley, the Hong Kong risk management practice head for SAS Institute Asia Pacific. Moreover, accountants need to be more attuned to risk management that has typically been handled by a separate department.

FATCA IMPACT Another tax regulation that could have a far-reaching impact all over the world is the new US legislation embodied in the US Foreign Account Tax Compliance Act (FATCA). Passed by the US Congress in March 2010, it is designed to ensure the identification of (and reporting on) US persons with banking relationships outside the USA. The US legislation envisages the imposition of a withholding tax amounting to 30% on specific payments from US sources (particularly investment income and capital gains) paid to any foreign financial intermediary for either its own account or that of a client. The foreign financial intermediary can avoid this procedure only by concluding an agreement directly with the US tax authority IRS. Given its significant international activity, particularly with the USA, Switzerland is highly affected by FATCA. Comments Dr. Den Otter: “If non-US financial intermediaries wish to invest in the US capital market and look after US clients once FATCA enters into force, they will have to conclude the corresponding agreement with the US tax authorities. Any affected financial intermediaries would have to be prepared to take on a comparatively high administrative burden in order to comply with this agreement.”

But Luxembourg too is likely to feel the repercussions of FATCA. Comments Mr. Thommes: “Depending on how that will end up in detail – we in Luxembourg and also through our European association EFAMA are still in discussions with the US tax authorities as to how exactly FATCA should be interpreted – this could have an outstandingly important impact in terms of investment management system applications and could prove extremely costly to implement.”

WINNING WAYS Heightened regulatory expectations will place additional pressures on the invest-

SimCorp

ment management industry at large. In the words of Mr. Dolan: “Investment management firms have dealt with changing regulations, accounting policies and risk trends. But this time it’s different.

Complying with emerging rules will require fundamental changes in business models and strategies. The impact will be enterprise-wide. We recommend that firms leverage their compliance investments into a growth agenda by streamlining and enhancing systems portfolios, improving data governance and management, and enhancing customer management.”

The changes are at the strategic level, they are not at the business unit level any­more or at the product level. Whereas in the past, the approach was more tactical in orientation, the present circumstances call for more of a strategic re-appraisal to take account of not only one aspect of regulatory change, if Dodd-Frank is taken as an example, but a whole host of regulatory measures (i.e.

AIFMD, MiFID, Solvency II, UCITS IV, etc.).

As a consequence, and in view of this allencompassing and wide-ranging change, regulators expect to see, and indeed demand, a comprehensive, custom-built and sophisticated compliance programme with full testing, use of technological tools and IT expertise. The consequences of non-compliance are not worth thinking about, and a compliance failure can prove terminal to a business operation.

A sound system of compliance controls – backed up with the necessary IT architecture – is essential in protecting the organisation from business, regulatory and reputational risks. A strong compliance function will also become a factor of increasing competitive importance, which will define and set an organisation apart from its competitors. In the end, the winning way will prevail.

Michael Metcalfe is Co-Editor of the Journal of Applied IT and Investment Management. A financial journalist by profession, he has worked for such publications as The Economist, Financial Times and International Herald Tribune. Based in Germany, he also worked in the Luxembourg financial sector for 10 years, including tenures with Nordea Investment Funds S.A. and Lombard International Assurance S.A.

compliance.simcorp.com

Assess the impact of new regulations on your investment management system Dodd-Frank Act, UCITS IV, IFRS 9, Solvency II and AIFMD: legislation sweeps the industry with new requirements. The right investment management system can help you meet the challenges.

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# Best practices: the optimal

investment management system for regulatory compliance New financial legislation being passed across the globe will have sweeping repercussions on the technical and IT structures of investment management organisations.

Based on interviews with three global consultancies, Michael Metcalfe, Co-Editor of the Journal of Applied IT and Investment Management, discusses the choice of IT platform when it comes to gearing up to meet the regulatory challenge in a post-crisis environment.

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ince the collapse of a number of global financial institutions in 2008 unleashed the full force of a global financial crisis, the ripple effects of which are still being felt, the financial services sector in general and the investment industry in particular have witnessed sweeping changes in the way they do business. Both the buy-side and the sell-side of the industry have had to contend with a wide range of pressing issues, ranging from depressed investor confidence and declining asset prices to corporate restructuring and business re-alignment.

Michael T. Dolan is a Partner, Ernst & Young LLP, Washington D.C., USA. Sriram Venkataraman is an Executive, Financial Services Office, Ernst & Young LLP, New York, USA. Dushyant Shahrawat is Senior Research Director, Securities and Investments, TowerGroup, Boston, USA.

Although much of the investment management industry has rebounded over the past 18 months, principally through rising stock markets, this has occurred against a continuing backdrop of radical industry change, much of which is contradictory in nature. Over the past two years, regulators and, increasingly investors, have progressively demanded new and improved levels of service and transparency from industry players.

At the same time, many of these same businesses have needed to focus on cost reduction and control in an attempt to remain competitive and maintain profit margins. For the majority, less internal resources have been available to satisfy new client demands and to develop new products and processes to cope with increasingly fierce market competition, especially from the larger players and new entrants to the market.

Notwithstanding improving market conditions across the globe, the investor population at large remains circumspect

and risk adverse. These market dynamics have maintained pressure on business processes. As a result, many players are re-assessing their existing business models, technical operations and the relationships that support these processes, at the same time as seeking to improve risk management oversight and control.

NEW WAVE OF REGULATIONS AND STANDARDS Whereas industry changes over the past two years have stemmed primarily from

down to investment and securities operations and significantly changing the way in which these are undertaken, with the result that participants across the value chain will need to modify the way they operate and interact.

In the case of Europe, the principal EU-wide regulatory measures include the new UCITS IV Directive; MiFID conduct of business, including rules regarding point of sale or distribution of financial products and the way in which

â€œâ€Ś many players are re-assessing their existing business models, technical operations and the relationships that support these processes, at the same time as seeking to improve risk management oversight and control.â€? the prevailing market conditions, the next three to five years will see a wave of new regulations and standards that have been in the making for some time finally implemented across the globe, but principally in Europe and the USA. Combined, this new regulatory patchwork will impact the full spectrum of banking and financial services, trickling

this directive will interact and support the new UCITS directive; a potential EU Directive on Packaged Retail Investment Products (PRIPs); and new UK-based regulations from the Retail Distribution Review (RDR).

In the USA, the new regulations being passed will have a far-reaching and

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“To rise to the challenge of UCITS IV, investment managers will have to build into their IT best practices the necessary technical and operational functionalities …”

profound impact on the securities and investments industry, affecting competitive positioning of firms, market structure, revenue growth, profitability and IT budgets. New regulations create opportunities for service providers to help hedge funds meet registration requirements, assist with over-thecounter (OTC) derivatives valuation and clearing, monitor capital adequacy and leverage limits, and promote risk management and compliance.

UCITS IV AS DRIVER Of the regulatory measures being enacted in Europe, UCITS IV is probably the one having the most impact on the investment management industry in the immediate future. While cost savings is a key driver at the industry level, the increased complexity and the ensuing operational challenges brought about

by UCITS IV may actually lead to some additional cost pressures at the organisational level. For starters, firms will need the necessary IT expertise and systems to handle multiple languages and tax issues.

Additionally, the management company passport is still subject to tax issues that will have to be closely considered before making restructuring decisions. Fragmented tax regimes could mean that the use of the management company passport and cross-border fund mergers pose risks, such as double taxation to investors.

To rise to the challenge of UCITS IV, investment managers will have to build into their IT best practices the necessary technical and operational functionalities to deal with: 1) selling across multiple countries; 2) administering across multi-

ple legislations; 3) coping with tax issues across multiple markets; 4) remaining compliant in the face of growing regulatory complexity.

Understanding the intricacies and nuances of UCITS IV will be important as well to ensure the organisation’s technology and operational processes are aligned successfully. While fund managers concentrate on their core competency of managing money, outsourcing operational solutions offers one way to meet challenges on the manager’s own terms.

European asset managers should take the time now to better understand UCITS IV’s array of operational challenges to determine which can be met by internal versus external resources.

UCITS IV BEST PRACTICES As UCITS IV will be the first of many EU regulatory changes to be implemented in the next few years and, while the majority of the new provisions are optional rather than mandatory, it will have a major impact on the choice of best practices involved in the administration and distribution of UCITS funds. Now that Level 2 implementing regulations have been published, the fund industry is looking to fully assess the business and IT implications of UCITS IV. Of paramount importance will be to determine the strategic and best-practice decisions, whether regarding product, process, administration or distribution, that will be required against a backdrop of increasing competition in a market that may not experience the same levels of growth in the foreseeable future as has been the case over the past decade.

The key best-practice question asked by many investment managers is: how can the different parts of UCITS IV be utilised to maximise administrative and technology efficiencies and yet enhance distribution and net sales in order to promote growth? While some of the compulsory measures of UCITS IV are currently perceived as additional burdens (i.e. KID and management company-related harmonised organisational and conduct of business rules), this may not necessarily prove to be the case, especially in the long-term perspective. Other UCITS IV measures (i.e. mergers, master-feeder structures, the management company passport and streamlined product notification) have the potential to boost economies of scale, enhance efficiencies and implement best-practice investment management system solutions.

MAJOR US REFORM ISSUES Turning to the USA, six issues will become major business priorities owing to regulatory reform. These are in turn: Risk management The largest opportunity that the new regulatory environment creates will be in helping investment organisations retool their risk management departments. An intense focus on risk will be driven by pressure from shareholders to better manage company-wide risk, whether arising from the expected requirements of Basel III to the many provisions of the Dodd-Frank Act that relate to risk management and the demands placed by the new Office of Financial Research (OFR).

For example, investment companies will be assisted in managing risk by integrating their accounting collateral and reporting systems, improving attribution analysis, and cleansing and standardising data. Proven expertise will be required in helping investment companies address their risk management needs.

OTC derivatives reform The Dodd-Frank Act will bring influential changes to the OTC derivatives market, creating opportunities for solutions related to collateral management, centralised clearing, real-time reporting and monitoring of positions. Under the reform, many OTC derivatives will have to be shifted to a central clearing model owing to more transaction volumes and related services. A major overhaul of the OTC derivatives business is therefore inevitable, bringing with it implications for choice of best-practice IT solutions.

Hedge fund registration New rules affecting the alternative fund sector will make fund managers demand services ranging from SEC audits and compliance checks to performance reporting and valuation. Over the next few years, regulatory changes will oblige the alternative fund sector to prepare IT platforms for SEC registration, more transparency and disclosure requirements, greater regulatory scrutiny, and a stronger internal risk management and compliance department.

This reform calls for expertise alternative fund accounting, reporting and client management systems. Systems integration and expertise will be required on the part of investment management compa-

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# Best practices: the optimal

investment management system for regulatory compliance

nies in relation to their alternative fund operations, compliance and reporting.

Leverage and capital adequacy A common and unifying theme running across several regulatory requirements is stricter limits on the amount of leverage that investment management operations can assume, greater capital required to be held on the books and frequent and more

simply do not have the in-house skills to do this work, they lack the skilled personnel to do it, or external suppliers can do it more cost-effectively.

Asset valuations Several new accounting rules affect the process and methodology that investment management companies use to value securities positions, particularly illiquid instruments.

New Financial Accounting Standards Board (FASB) rules, as well as new Internationa l Accounting Standards Body (IASB) rules governing securities valuation, will require companies to alter their accounting and general ledger systems, use third-party providers for independent valuations and better report valuations to outside parties.

“A common and unifying theme running across several regulatory requirements is stricter limits on the amount of leverage that management operations can assume, greater capital required to be held on the books and frequent and more comprehensive reporting of leverage and capital held.” comprehensive reporting of leverage and capital held.

To meet these demands, institutions will need to undertake a three-step process.

They will need to monitor securities positions more and more in real time, aggregate their exposure across all lines of business and be able to report and manage it in line with requirements embodied in the Collins Amendment.

Investment management organisations will require support for all these tasks for one of several reasons: in most cases, they

In add it ion, t he Dodd-Frank Act will not only require public companies to report securities positions to shareholders and regulators but also require private equity and alternative hedge funds to begin reporting positions (to general/limited partners, to regulators, to the OFR and even to prospective clients). This will mean demand for integrated solutions that provide key inputs into the valuation process.

Audit and compliance Investment management companies will feel the heat from more frequent and invasive audits and much greater regulatory oversight from the SEC, CFTC, Federal Reserve, and Consumer

Financial Protection Bureau. SEC investigations of alternative hedge funds have steadily risen over the last few years from 776 in 2007 to 944 in 2009 and an estimated 1,050 in 2010. New powers, a US$100 million budget increase, and the authority to hire 1,000 new employees will mean that investment organisations will be contending with a much more empowered SEC. The Federal Reserve and the OFR will also exert greater regulatory oversight and influence on influential investment companies like Morgan Stanley and Goldman Sachs and large alternative funds that are deemed to be systemically important. This will increase the need for compliance software, audit preparation, employee surveillance and related services.

GROWTH CHALLENGES As regulatory requirements and client demand drive change, investment management organisations will need to re-appraise their investment management software systems in order to adopt best practice. Among the most important points for consideration include the way data is stored. If data is stored in several databases or systems, including spreadsheets, it becomes difficult to obtain a true indication of risk exposure, as well as to gain insight into liquidity, valuations and similar metrics. Valuable time and resources are spent on trying to consolidate disparate data sources into a clean and true picture of the business.

In addition, companies will find that due to limitations in their investment management system platforms, there is an abundance of manual processes and duplicate data entries, which consume resources and result in higher error rates. Further, many months – or even years – may lapse between new releases or upgrades to the platform; which forces diversion of IT and other resources to

SimCorp

creating workarounds in order to comply with new legislation and regulation.

The company then finds itself in the situation of swimming against the current just to keep up with the tide of new regulation, rather than dedicating time to growing the business. Finally and perhaps most importantly, the platform does not support all asset classes and financial instruments, thereby limiting the opportunities to grow through expanding investment offerings.

SYSTEM SOLUTIONS An optimal IT platform embedded in the technology processes of the individual investment management organisation addresses all of the above points by providing a core system based on a single data source, combined with as high a degree of automation as is possible. The system should be frequently updated and provide coverage of all asset classes and financial instruments.

From a technology point of view, the investment management system must be able to incorporate regular changes to workflows and processes, as well as scale to accommodate higher transaction volumes, new asset classes and new funds and portfolios. Such a best-practice investment management system allows investment management organisations to focus on their core competency of adding value for clients rather than devoting an inordinate amount of resources to operations and IT workarounds.

With unprecedented regulatory activity and more stringent client demands on investment managers, it has become categorically imperative that investment management organisations have the right and even optimal technical infrastructure in place to support their desired growth strategy. Companies need to feel confident that the IT platforms they adopt or have in place can

Journal of Applied IT and Investment Management

“As regulatory requirements and client demand drive change, investment management organisations will need to re-appraise their investment management software systems in order to adopt best practice.” handle ongoing regulatory compliance.

Only in this way can they ensure that core competencies are directed at realising the organisation’s growth potential.

Michael T. Dolan is a Partner at Ernst & Young LLP and is based in Washington DC. He is part of the organisation’s Advisory practice where he helps clients improve the overall performance of their operations, accounting and financial reporting processes.

Michael Dolan specialises in implementing new portfolio accounting and analytical reporting systems for portfolios of investments, debt, and derivative products. He holds a Masters degree in Quantitative Finance and is a Certified Public Accountant (CPA).

Sriram Venkataraman is an Executive in the Financial Services Office of Ernst & Young LLP and is based in New York, USA. He is part of the organisation’s Advisory practice and has experience in market risk management, financial derivative pricing models and trading system implementation.

Sriram Venkataraman’s client base covers major money centre banks and financial institutions.

Dushyant Shahrawat is a Senior Research Director at TowerGroup in the Securities and Investments practice, Boston, USA. With over 15 years of experience in financial services, he is a Chartered Financial Analyst (CFA) and a member of the Boston Security Analysts Society. Dushyant Shahrawat researches strategic issues facing asset managers, hedge funds and brokerage firms globally, and advises clients about strategy, marketing, regulation, technology and product development. He has shared his opinions on financial industry trends at over 100 events across the USA, Europe and Asia and has appeared on various television and radio channels. He has also been widely quoted in printed publications such as the Wall Street Journal, New York Times, Fortune, and the Financial Times.

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ERNST & YOUNG Nearly 35,000 Ernst & Young financial services professionals around the world provide integrated assurance, tax, transaction and advisory services to asset management, banking, capital markets and insurance clients. In the Americas, Ernst & Young is the only public accounting organisation with a separate business unit dedicated to the financial services marketplace. Created in 2000, the Americas Financial Services Office today includes more than 4,000 professionals at member firms in over 50 locations throughout the USA, the Caribbean and Latin America.

Practitioners span many disciplines and provide a wellrounded understanding of business issues and challenges, as well as integrated services. For more information, visit www. ey.com/US.

TOWERGROUP TowerGroup is a leading research and advisory services company focused exclusively on the global financial services industry. For more than a decade, it has provided the world’s top financial services, technology, and professional services companies with advice and information. Its team of analysts and specialised advisers covers the business and technological issues impacting the entire financial services sector. More information at www.towergroup.com.

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# IFRS 9: meet requirements and build competitive advantage with investment management IT

Investment management companies worldwide have to consider the impact of the new IFRS 9 accounting standard on their financial reporting and accounting procedures. This article describes how one Australian company is prepared to meet the IFRS 9 challenge head-on with the support of its financial software solution.

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David Mackaway is General Manager, Operations, Challenger, Sydney, Australia.

h e I nt e r n at ion a l A ccounting Standards Board (IASB) issued International Financial Reporting Standard (IFRS) 9, Financial Instruments, to simplify the classification and measurement of financial assets effective 1 January 2013. IFRS 9 permits adoption for financial statements starting from 2009, and requires that financial assets are classified into one of two measurement models: (1) the amortised cost model, or (2) the fair value model. The classification requirement is based on an entity’s business model for managing financial assets.

The new IFRS standard is designed to remove many of the complex and rulebased provisions of tainting, reclassification and impairment requirements of the current International Accounting Standard (IAS) 39. Moving on in October 2010, the IASB issued additions to IFRS 9 to include accounting for financial liabilities. The additions retain

“IFRS 9 aims to achieve just that – make the accounting of financial instruments simpler, clearer and easier to use.” many of the provisions of IAS 39, except that fair value changes of liabilities due to an entity’s own credit risk are to be recognised in other comprehensive income.

Furthermore, there shall be no recycling or subsequent recycling to profit or loss even when the liabilities are derecognised.

As the investment management industry continues to become more of a global market place in search of alpha, fund complexes are considering adoption and implementation of IFRS 9 is more appropriate for their ever-growing global investor base. At a certain point, a fund management company is bound to select IFRS financial reporting for one or another of its funds.

But many corporate treasurers and chief financial officers remain uncertain about how and when to adopt IFRS 9. The new standard is partially a consequence of the financial crisis of 2008-09, as investors and regulators demanded to know what kind of assets and liabilities companies have in their books at any given time, what they were worth 'in the market', the risks involved and the gains or losses in the value of those items, and they want that shown in the financial statements.

IFRS 9 aims to achieve just that – make the accounting of financial instruments simpler, clearer and easier to use. Companies were given the option of adopting the standard as early as November 2009 but are not required to do so until 2013.

However, the common argument is that the stakes are high and that companies should prepare for the standard as early as possible.

A DIFFERENT STORY In Challenger’s case, the story is a little different. Like everyone else, Challenger has to consider the impact of IFRS 9, but for other business reasons had already moved on to the stage of needing to account on both an amortised cost and fair value basis long before the IFRS changes were introduced. Using the right asset software solution in the form of SimCorp Dimension was a key factor

allowing us to already be in a position where adoption of IFRS 9 will not be a significant operational issue.

A key advantage for us is that we use one software solution as our primary source of truth for asset valuations across the entire business. The system also has the essential flexibility we need to be able to value assets in multiple ways for varying parts of our business.

Challenger was fortunate to have strategically made the decision to have a centralised and very flexible asset system to cater for its business needs and the SimCorp Dimension system met that need. Over the past five to six years a great deal of effort has been put in to the implementation of this system; and this has meant that a very limited amount of additional effort will need to be put into implementing IFRS 9, which was precisely why we wanted a system giving us a high degree of flexibility.

HISTORY IN THE MAKING Challenger is a large Australian financial services company and the foremost issuer of retail annuities in Australia. Challenger is the only financial services company in Australia dedicated to providing guaranteed, certain-return income stream products to both institutional and retail clients.

Today, the investment team in Challenger‘s life company, Challenger Life, which is regulated by the Australian Prudential Regulation Authority (APRA), manages over A$7 billion in assets to secure income for approximately 60,000 clients.

Challenger also operates a funds management business of approximately A$20 billion (see Figure 1), applying a multi-boutique strategy with 10 boutique partners within the organisation servic-

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5,146 4,547

Rainmaker forecast a CAGR of 13.4%

1,466

2010

1,689

2011

1,912

2012

2,163

2013

ing over 55,000 investors in managed funds and 75 institutional clients. The boutiques cover a diverse range of asset classes, ranging from Australian and international equities, traditional fixedincome products, all the way through to alternative funds. We have a diverse range of asset classes and a diverse range of client needs, effectively servicing 11 distinct businesses. Having one core asset system affords us a lot of efficiencies and control.

Challenger has used the same software solution for assets since 2003. At that time it effectively transitioned the entire business so that all of its assets are administered through the same system.

We use the system in a holistic way for investment administration; trade entry and execution, portfolio valuation and unit pricing, performance and attribution and compliance. With it all carried out within the one system, we gain a lot of operational efficiency and strong management control over our entire book of assets.

A GOLDEN OPPORTUNITY There is little doubt that conversion to IFRS represents a golden opportunity for investment management to revise its accounting policies. Present standards require financial assets to be classified as one of the following: • • • •

at fair value through profit or loss; held-to-maturity investments; loans and receivables; or available-for-sale financial assets.

Alternatively, investment management companies can adopt IFRS 9 early with only two financial asset categories. Debt instruments can be held at amortised

2,449

2014

2,771

2015

4,017 3,136

2016

cost if the fund’s business model is to hold debt to maturity and the payments received are solely for principal and interest. Debt not at amortised cost and all equity and derivatives would be at fair value.

Gains or losses on debt instruments at amortised cost are recognised in profit or loss when sold, impaired, reclassified to fair value and through amortisation.

Gains or losses on financial assets held at fair value are generally recognised in profit or loss (comprehensive income for certain equities).

Financial liabilities will be classified as a) at amortised cost using the effective interest method, b) fair value through profit or loss, c) financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies, d) certain financial guarantee contracts, or e) commitments to provide a loan at a below-market interest rate.

Financial asset and liability classifications, which define measurement and profit or loss recognition, are made using IAS 39 or IFRS 9 requirements. Management will also be able to define and document valuation methods, inputs and levels within the IFRS fair value hierarchy for different types of investments.

Financial instruments held as assets or liabilities will be tagged by specific categories for aggregation and disclosure in the statements of financial position and comprehensive income. Statement notes will include IFRS 9 fair value hierarchy disclosures with levels based on the observability of inputs and valuation

3,550

2017

2018

2019

2020

Fig. 1.

Australian industry FUM growth projections (A$ billions).

Source: Rainmaker Roundup, December 2009.

methods, as well as risk disclosures for financial instruments.

The costs of financial instruments at fair value through profit or loss will have to be segregated from transaction or commission costs, which will be expensed.

Management and the administrator will want to track activity over a period of time using IFRS indicators and prepare sample financial statements to be assured that IFRS reporting is accurate and comprehensive.

“We use the system in a holistic way for investment administration ...

With it all carried out within the one system, we gain a lot of operational efficiency and strong management control over our entire book of assets.”

REDUCING COMPLEXITY To date, IFRS 9 covers financial assets and represents only the first phase of the overhaul of IAS 39; the treatment of liabilities and hedge accounting remain under consideration. The most benefit from IFRS 9 is really to simplify the classification of different categories of financial assets. According to a global survey of financial professionals released by the CFA Institute, half of

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# IFRS 9: meet requirements and build competitive advantage with investment management IT

the respondents indicated that IFRS 9 improves decision-usefulness of financial reports; 38% believed it reduced the complexity of financial instrument accounting.

IFRS 9 narrows down financial instruments into two measurement categories: amortised cost or fair value, thus eliminating the held-to-maturity, available-for-sale, and loans and receivables categories. The classification hinges on two criteria: the entity’s business model for managing its financial instruments and the contractual cash flow from that instrument.

An instrument is measured at amortised cost only if the entity’s objective is to hold the asset to collect cash flows and if the contractual cash flows are solely payments of principal and interest. Assets that fail to meet the two criteria (for example, equities, convertible bonds, forwards or swap contracts) should be measured at fair value through profit or loss.

STATUTORY REPORTING In Challenger’s case, IFRS 9’s requirement of either treating financial instruments on an amortised cost basis or a fair value basis has been one effectively in place for many years.

“ ...we were looking for a contender with a proven ability to be highly flexible in accounting for and running assets for different businesses within one system.”

As the regulator overseeing Challenger’s annuity business, APRA requires the assets and liabilities held in the life company to be valued on a mark-tomarket basis and this forms the statutory reporting for the business. In addition, Challenger for management reporting purposes looks at cash operating earnings on an amortised cost basis to show the level of cash flow being generated to support the payments made to its annuitants.

In relation to Challenger’s managed funds’ business, there has always been a requirement to value these portfolios on a fair value basis. It’s fundamental to the business: many of the funds operate with the idea of buying and selling securities on an ongoing basis to generate performance and there is a constant need to have assets valued at their current fair value to ensure equitable treatment of all unitholders and to deal with the ebb and flow of investors applying for and redeeming into the funds.

Whereas with IAS 39 everything had to be treated on a security-by-security basis, now the focus is on the entire business.

The whole idea is to generate a return for the investor, and typically managed funds – and certainly the ones Challenger operates – operate in a trust structure. What this means is that unit-holders can apply and redeem from the trust at any point in time and we need to ensure this is done at the fair value of the assets.

In view of all these diverging requirements in a complex statutory environment, it is very hard to be in a scalable position if you require five or six systems to deal with all these requirements. And so strategically for Challenger, when it was going through the process of picking a new asset software system, we were looking for a contender with proven ability to be highly flexible in accounting for and running assets for different businesses within one system.

This type of flexibility is extremely valuable and very powerful. What it meant for Challenger is that it could have these diverse business models all operated off one central system and not have to worry about managing multiple versions of the same system doing different things.

BEEN THERE, DONE THAT For many years we have had the requirement of valuing according to a fair value method while also needing a reporting framework based on amortised costs.

About three years ago, we undertook a project to fully achieve this within our software solution. As we now move forward in our investigation of IFRS 9, we take a great deal of comfort in the fact that from an operational perspective, the exercise amounts to no more than just looking back to the future because we had already been there and done it.

If we have parts of our business that may need to move to amortised costs from a statutory perspective, our view is that this will not be a significant operational hurdle because we know the system can do it – the system has actually been operating this way already – and for those particular assets or portfolios that are affected, we can just literally switch the methodology back.

CASH FLOWS AS BUILDING BLOCKS One of the fundamental strategic building blocks that Challenger believes its investment management solution has right was to build a system that thinks about securities based on their cash flows. Securities in the system are literally made up of a bundle of cash flows, and once all these cash flows are gathered and assembled, each and every one can then be valued at varying rates. That is a real strategic difference compared with some of the other systems that are available in Australia.

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David Mackaway, Challenger’s General Manager, Operations, outlines how an optimal software solution can improve an investment management company’s ability to meet the needs of being innovative, adaptable to change and responsive in speed-to-market.

“The ability to slice and dice a security and break its valuation down into cash flow components clears the way to proceed along many different paths.”

The ability to slice and dice a security and break its valuation down into cash flow components clears the way to proceed along many different paths. This has allowed inordinate amounts of flexibility in our business, not only to deal with legislative changes but also to effectively handle the complexities of some of the instruments we trade in.

For example, Challenger administers numerous complex structured assets, but here again they all boil down to a bundle of cash flows that need to be broken up into their constituent parts to decide how to value them. Because the software is able to break down securities in this manner, it is possible to represent very complex securities using standard bond functionality and associated customised cash flows to the extent that the system represents a very real competitive advantage for us.

THE HOLISTIC WAY One of the important features in using the system in a holistic way is that we

do not run into the problem of having to duplicate work processes. For example, if the underlying value given to a security has to be changed in one system and then different changes have to be made within the compliance system, this requires duplicate effort and workload.

For Challenger, having it all in one system – while it does not remove the need to make changes as instruments change – it does allow us to do it in a streamlined and efficient way.

In Australia there is always the debate whether investment management companies should conduct their administration in-house or outsource to a third-party provider, which is larger and can potentially add the economies of scale that may not otherwise be present. We have carried out the function in-house for many years, and one of the key reasons for that is retaining control and having a high degree of flexibility to be able to work with our investment teams in designing and structuring new products.

Challenger considers itself as somewhat of an industry leader in being innovative and designing product that meets the needs of its clients, and we also consider ourselves as being responsive in speed-tomarket. Being innovative, dealing with constant change and being able to bring that to the market place very quickly means that you need a lot of control, not only in terms of the investment management perspective but also the administration and operation of the product as well. With the type of software solution we have, it really increases our ability to support all these needs and is a key reason we retain the function in-house.

David Mackaway has held the post of General Manager, Operations, at Challenger since 2007 and is responsible for all investment and registry operations supporting the Challenger business. He has worked in the industry for over 17 years and prior to joining Challenger was an Executive Director of MMC Asset Management Limited and Chief Financial Officer of ASX-listed MMC Contrarian Limited. Prior to MMC, David was based in the USA as Global Head of Operations for Principal Global Investors. He also worked in Australia for BT Funds Management for over 10 years in various operational roles, including running BT’s fixed interest and currency business.

CHALLENGER Challenger Limited (Challenger) is an investment management firm established in 1985 and listed on the Australian Securities Exchange (ASX:CGF) in 1987. The foremost issuer of retail annuities in Australia, Challenger is the only financial services company dedicated to providing guaranteed, certain-return income stream products to both institutional and retail clients. Today, Challenger Life manages over A$7 billion in assets to secure income for approximately 60,000 clients. In addition, Challenger operates a successful funds management business across various asset classes managing over A$20 billion and servicing 55,000 retail and 75 institutional clients. This is operated via a multi-boutique strategy whereby Challenger partners with boutique investment management firms offering both administration and distribution capability. Currently there are 10 boutiques in the Challenger stable. More information at www.challenger.com.au.

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# UCITS IV: what investment anagement firms should do m to comply and ensure growth

With UCITS IV coming into force from 1 July this year, the main objective is to make the fund industry more efficient while still maintaining a high level of investor protection. Windows of opportunity will be opened for those firms deploying the right investment management software solutions but disparate tax regimes tend to overshadow the benefits of the directive.

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Peter E. Hertel is Domain Manager for Fund Accounting, SimCorp.

he UCITS framework, originating from 1985 and updated several times since then, was intended to allow a real single market in investment funds to develop – since the funds all complied with the same rules, consumers could invest with confidence across EU borders.

The rules increase investor protection and cost transparency, and set out basic requirements on organisation, management and oversight of funds.

Undertakings for Collective Investment in Transferable Securities (UCITS) have proved very successful over the past 20 years, emerging as an essential cornerstone in the development of the European investment funds industry.

Although intended for EU member states, the UCITS brand has become global and recognised as a well-supervised retail financial product – UCITS

“The directive foresees that the investment fund market will be able to consolidate funds and reduce the number of local management companies, resulting in cost savings and efficiencies.”

funds have become successful in overseas markets such as Asia and Latin America.

various EU member states still stand as a barrier for attracting foreign investors.

UCITS IV is the latest reform of the UCITS directives – a series of efficiency and consolidation measures (see Figure 1) that will allow the industry to address lack of scale, experience cost savings and improve the efficiency of their European operations. It was approved by the European Commission in July 2010 and, pending EU member states’ legislative approval, it will take effect on 1 July 2011.

One thing is to gain the needed tax knowledge, but just as important is to make sure that players have the right IT investment management platform to implement this knowledge. To obtain the necessary economy of scale, the trick is to sell the same fund to as many investors as possible, but still include their various preferences in respect to special distribution needs, risk preferences (hedge classes), large- or small-scale investments (various fee constructions), performance fees and tax support.

The directive foresees that the investment fund market will be able to consolidate funds and reduce the number of local management companies, resulting in cost savings and efficiencies. In addition, UCITS funds will become more competitive, and, with easier access to new EU markets, this will result in increased market shares.

The larger industry players by now are well prepared in respect to the mandatory changes (i.e. introduction of the Key Investor Information Document), which will also be in force by July this year. However, they are only beginning to prepare for the new consolidation opportunities.

WINDOW OF OPPORTUNITY The directive really does open the window for increased cross-border operations. But once the window is opened, investment management firms face big challenges in respect to various tax-regime support and local regulatory specialities. Without a huge extra effort, the 27 different tax regimes of the

One of the main features of UCITS IV is the master-feeder structure, which provides for pooling of assets. This new fund opportunity adds an additional dimension to the complex tools for modelling structures that can target a larger investor group. Fund management companies have to invest time and/or money gaining the needed multiple taxregime and regulatory knowledge. Then they have to ensure that this knowledge can be implemented in an IT investment management platform, where via a flexible definition and design of fund structures, pricing and fees they can put these changes to good effect. Without this the benefits on offer cannot be utilised.

The UCITS IV directive applies to practically all of Europe and the new master-feeder structure as well. For a long time fund administration centres like Luxembourg have operated with advanced fund structures in the form of multi-class funds and pooling structures.

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Journal of Applied IT and Investment Management

Mandatory changes

New opportunities

– Key Investor Information Document (KID)

– Management company passport (MCP)

– Supervisory co-operation

– Cross-border UCITS mergers

– (Simplification of the cross-border notification procedure)

– Master-feeder UCITS structures

However, UCITS IV has pushed many other member states into removing restrictions in respect to more advanced fund structures. It is therefore also expected that local fund managers in more member states in general will consolidate their funds and gain economies of scale as a spinoff of UCITS IV. So even the fund manager who only focuses on the local market should also look into the new opportunities in order to stay competitive.

The directive does open new opportunities but also forces changes in respect to cross-border investor communications and investor reporting. But even though this initially will increase costs for fund operations, it also marks an opportunity for the industry to standardise operations and investor communications.

NEW KID ON THE BLOCK The Key Investor Information Document (KID) will replace the simplified prospectus existing up to now and will ensure a highly standardised and easily understandable form of information for investors that can be used to compare all UCITS funds.

Fund companies must provide this document at least once a year for every fund and for each class fund in a multi-class structure (although some exceptions exist). Furthermore, the document has to be translated into every language of jurisdictions where the fund is sold.

KID is a compact document covering several investment management platform disciplines. It obliges the fund to have risk, performance and charges information integrated in one document and, as in more frequent fact-sheet reporting, displays the need to have an IT investment management platform that can do this type of integrated reporting in a smooth, well-reconciled, auditable and reliable way. This will put stress on IT platforms with multiple systems and different release cycles and incur high

costs to keep interfaces up to date and reconciliation up to scratch.

There are several technical challenges in the recurring event of providing the information but the overall challenges can be summarised as follows.

The way things stand at present, many fund management companies simply do not have all the KID information housed or stored in one system (i.e. performance, risk, charges, explanatory texts, etc.).

Should the required data be stored in a data warehouse or should one of the given systems be used as the central data holder for the information? Can any of the systems available contain this information? And, in general, how does a company make sure that the information used is internally consistent?

New KID reporting is not an annual event, as certain funds need to be updated more often in a year. Several events can cause this, and as an example, the Synthetically Risk and Reward Indicator (SRRI) has to be monitored weekly or at least monthly.

The existing IT setup must be able to accommodate this, as the data and calculation methods behind the KID information must be available and auditable over a passage of years. Calculations approximating spreadsheets in this area will normally not be acceptable by auditors.

Even though the document is very strict in context and form, guidelines from the Committee of European Securities Regulators (CESR) contain provisions for non-standard information in respect to certain advanced fund types (i.e. structured funds). Many players in the market, while advocating support for KID reporting, have very few remarks as to how or if they support special needs for advanced funds.

Some of the key figure calculations can be handled via an external partner, but the basic data supply has to come from

April 2011

Figure 1. Most important amendments introduced by UCITS IV. The new directive comprises five new basic elements: two new mandatory changes and three new opportunities. core operations; in several instances, the calculations cannot be outsourced but need to have internal special treatment (i.e. in the case of Value at Risk calculations and return scenarios).

In the short run, it might be an easier solution to outsource part of the calculations and reporting. One question

“The way things stand at present, many fund management companies simply do not have all the KID information housed or stored in one system (i.e. performance, risk, charges, explanatory texts, etc.).” is whether this setup will have support for the advanced funds. But in any case, responsibility cannot be denied for the data, the auditibility required or the general data quality, not to forget monitoring of the key figures.

Using a broader perspective, the KID requirement should be seen as just one of many reporting requirements. The frequent fact-sheet reporting and annual year reporting does include similar information and a technical solution could be applied in connection to this.

CROSS-BORDER SHOPPING MADE EASIER The UCITS IV changes will result in increased cooperation between supervisory authorities. The notification procedure will be applied according to a regulator-

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# UCITS IV: what investment management firms should do to comply and ensure growth to-regulator principle instead of today, when each fund company needs approval directly from local authorities. This will allow a UCITS fund to begin marketing its units in another member state (the ‘Host Member State’) no later than 10 working days after the date of receipt of the required standard notification letter.

Although it will now be quicker to apply the notification procedure, the products offered in the foreign markets still need to be attractive to foreign investors. With the European market being strengthened over many years via the introduction of UCITS funds and the common IFRS accounting standard, the EU still consists of 27 different tax regimes where specialised tax treatment often requires special detailed reporting in order to be tax efficient. The latest example of this is found in new Austrian taxation where specific Austrian rules have been introduced.

To utilise this improved access to new investor groups, investment management companies need – in the current tax-regime landscape – to have an IT system platform that can support the local required tax transparency – and thereby avoid penalty taxation.

MANAGEMENT COMPANY PASSPORT A UCITS funds management company may be authorised to carry out its activities for funds domiciled in any member state.

If a fund company wants to carry out activities for funds domiciled in another

country, it still needs to comply with the local regulatory requirements, and it is therefore important to have a systems platform that can support the specific requirements of the targeted countries.

CROSS-BORDER UCITS MERGERS The new legal framework to facilitate cross-border UCITS mergers will open up for consolidation across borders and thereby enhance the economies of scale.

With the average fund size in Europe as measured in terms of assets under management six times smaller compared to the average US fund, this amendment is seen by many as an important efficiency booster.

Unfortunately the guidelines do not include any common tax rules. Open questions in relation to the move of assets in relation to any merger, and existing investors’ tax position after the merger, have created major uncertainty in the market.

A July 2010 survey entitled ‘UCITS IV and Asset Servicing’ from Ernst & Young states that “... the view of many in the industry is that new requirements such as the Key Investor Information Document (KID) will push up fund costs, with no guarantee that asset managers will rush to merge funds, adopt master-feeder or rationalise management company structures.”

And a merger between UCITS funds will therefore have to be individually conducted as the rules very much depend on the member states of the outgoing and ingoing UCITS fund.

“UCITS IV has highlighted the importance of having an integrated investment management software system that in a flexible way can help design funds targeting large investor groups in a cost-efficient way.”

SimCorp

Specific challenges can also arise in a cross-currency merger when cross-currency conversions and resulting residuals have to be handled.

MASTER-FEEDER UCITS STRUCTURES The new option for creating master-feeder structures under UCITS IV has proved one of the larger discussion elements of the directive. The benefits of having this option are obvious, as it allows the fund management company to centralise the investment platform in one state and still have local funds with a national flavour.

Or alternatively, instead of establishing new local funds with their own asset management functions, it can enhance the distribution channel of larger master funds by establishing simple feeder funds investing into the master.

Previously, due to UCITS compliance rules (investor protection), one UCITS fund could not invest more than 10 or 20% (depending on the member state) into another UCITS. This rule still applies with the master-feeder structure proving an exception where the feeder must invest at least 85% in the master.

Several fund managers have opted for less restricted rules where a feeder fund can have several masters. This makes it theoretically possible in a flexible way to define various feeder funds with the proper ‘mix’ of master funds, thereby offering a larger palette of risk profiles for investors. This is a structure widely seen in the pension and life insurance business. However, this has been viewed as being in conflict with diversification requirements (investor protection).

The master and the feeder funds are separate legal entities and akin to a fund-of-fund construction with specific links in respect to pricing, transparency, timing and accounting.

MISSING TAX FRAMEWORK The missing tax framework in the UCITS directive has raised a number of

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Peter E. Hertel, SimCorp, urges fund management companies to ensure their IT platform can address the increasingly complex fund structures with the required tax transparency. unanswered questions for cross-border mergers. For master-feeder funds there are additional open questions such as: ow should the transfer of assets from • h a migrated feeder fund (from normal fund to feeder) be handled fiscally?

• h ow should withholding ta x be treated by the feeder side when originating in the master fund?

h

ow should transparency be treated • in respect to security?

• how should transparency be treated in respect to income statement details?

As long as these questions remain open or cause issues on the investor side, we will not see a substantial amount of master-feeder funds in Europe.

FAIR TREATMENT Another more general issue is the question of fair treatment of the feeders. According to the CESR, the feeder should be handled equitably, but there is no clear statement that the feeders should be handled equally. This actually makes it easier to treat the master fund as a multi-class fund with class-specific fees. If certain costs or market conditions can justify different fee structures, the various feeders can therefore invest in separate classes without any of them being ‘discriminated’.

TRANSPARENCY NEEDS As mentioned above, the master-feeder construction is similar to a fund-of-fund

construction with a link in respect to pricing transparency, timing and accounting. CESR Level 2 requirements (‘Box 2’) state that a master and a feeder must define the terms of agreement the feeder must have to ‘Access to information’, thereby enabling the feeder to perform its exposure, compliance and other risk management functions.

The CESR also states that the feeders should receive period P/L figures. For a simple fund-of-fund construction the period P/L figures in the fund-of-fund will be limited to the P/L directly on the fund certificate. But is this sufficient for the investors in the master fund? For tax reasons, it is likely that some investors will request that income is broken down into more details (i.e. dividend income, interest income or capital gain).

However, the question is how detailed these should be? And how can the master fund make sure to inform the feeders about their share of the period P/L when the ownership ratios have recorded changes over the last period?

Furthermore, how will tax authorities consider realisation within this concept?

When the fund realises capital gain, there is no direct realisation in the feeder fund. Should the feeder receive a share of the realisation in the master? And how should the share be defined? Should the share be a pure pro rata share according

to the current ownership ratio? Or will tax authorities request that the feeder should realise P/L as if the feeder had invested directly? This would imply requesting more advanced partnership accounts like P/L allocation according to accumulated unrealised P/L. To be able to service the needs arising in the tax area, these various fund pooling techniques with P/L allocation features will be important tools to design the right level of transparency, thereby utilising the benefits that UCITS IV presents.

The master-feeder option should therefore not only be seen as a new fund structure type but as an additional tool to design a fund that can address a large number of investor groups. The question is: can the IT investment platform include this design element, and at the same time offer the required transparency?

WINDOW AJAR UCITS IV opens the window for easier access to new investors and includes a series of much-needed efficiency and consolidation measures. The required investor reporting exposes the power of an integrated investment platform.

But to really benefit from the opening window, fund management companies have to examine tax regime requirements and make sure that the IT platform can address the increasingly complex

fund structures with the required tax transparency.

UCITS IV has highlighted the importance of having an integrated investment management software system that in a f lexible way can help design funds targeting large investor groups in a costefficient way.

Peter E. Hertel is Domain Manager for Fund Accounting in SimCorp’s Strategic Research department. He holds an M.Sc. in Economics from Copenhagen University. He joined SimCorp in 1988 and over the years has been involved in development, sales, support, project management, implementation and internal and external training. In the past five years he has been heavily involved in implementing fund accounting in Denmark, Finland and Luxembourg, heading up the global fund accounting domain in SimCorp’s Strategic Research department. Here he has worked on enhancing global support for complex fund structures and multiple tax regimes with a focus on optimising daily workflows, thereby helping to achieve growth with general risk control in a cost-efficient way.

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SimCorp

# Dodd-Frank Act:

how will the act affect IT systems?

New US regulations as embodied in the Dodd-Frank Act will have a farreaching and profound impact on the investment management industry, not only in the USA but elsewhere, affecting competitive positioning of firms, market structure, revenue growth, profitability, and IT budgets. The industry will have to overhaul five investment management system areas: risk management, compliance, reporting, analytics, and data management.

T

Dushyant Shahrawat is Senior Research Director, Securities and Investments, TowerGroup, Boston, USA.

he passage of the Wall Street Reform and Consumer Protection Act (also known as the Dodd-Frank Act) signifies the biggest US regulatory change since the 1930s and will have an enormous impact on the securities and investments business. In our belief, the reforms will have a substantial influence on over 4,000 brokerage firms, an estimated 8,500 investment managers, and all the 10–12 US exchanges and alternative execution networks.

The Dodd-Frank Act became law in July 2010. It is the most sweeping piece of financial regulation passed in the USA in decades. All types of financial firms will feel its impact, from banks to investment firms, from brokers to insurance companies.

The legislation has special significance for the securities and investments indus-

“The Dodd-Frank Act and other regulation related to securities and investments will collectively have a major impact on the technology and operational decisions of financial institutions.”

try, with brokerage firms being affected the most among all financial firms and traditional investment managers being affected the least. The impact on brokers will include lower revenues, higher costs, and a change in the competitive environment and market structure.

The law seeks to correct structural weaknesses in the US financial industry like the risk posed by activity that falls outside direct regulatory supervision i.e. trading in over-the-counter (OTC) derivatives, the systemic risk posed by very large financial entities failing, and the dangers of not requiring underwriters and securitisation firms to maintain some exposure to the assets they securitise.

Sweeping as it may be, many crucial details of the Dodd-Frank Act remain unclear – the legislation is still a work in progress and securities firms will have to await details of the rules with which they must comply. Changes in areas like derivatives and new capital requirements will be phased in gradually, the first phase being expected in 12–16 months and the second phase over the next two to three years.

IMPLICATIONS FOR IT The Dodd-Frank Act and other regulation related to securities and investments will collectively have a major impact on the technology and operational decisions of financial institutions. Old priorities will be sidelined (i.e. the need to amend investment management systems to support new financial products will be dampened as financial innovation slows), while new priorities will emerge (i.e. supporting transparency and disclosure). Below are

five implications of new regulation on the industry's technology and operations.

Key areas for consideration Not surprisingly, the passage of the Dodd-Frank Act and other regulations will mean greater investment management system requirements in certain areas: risk management, compliance, reporting, and analytics. It is our belief that IT spending in the risk and compliance business will grow 8–9% between 2010 and 2011, led by the largest institutional brokerage firms. Hedge funds must initiate IT projects to comply with registration requirements and enhance overall transparency and disclosure of operations (albeit quite hesitantly). And data management will also necessitate great improvements in risk management, compliance, reporting, and analytics.

Renewed focus on cost savings and efficiency As regulation impacts the industry's economics, pressing down revenue (from proprietary trading, OTC derivatives) and pushing up costs (of risk management, compliance, reporting), pressure on cost savings and efficiency will revive.

There will be overall cost pressure on the entire IT budget, particularly in areas like agency brokerage and OTC derivatives.

Even if economies improve dramatically in 2011 and beyond, chief financial officers will continue to pressure heads of IT and operations to seek ways to trim costs in response to continued market uncertainty and reduced profitability.

Supplier ties A re-assessment of suppliers will be driven by the shift in business and IT

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EXCLUSIVE VIDEO INTERVIEW Watch our interview with TowerGroup Senior

Research Director, Dushyant Shahrawat, to hear more about how the Dodd-Frank Act and other regulations will affect the investment management industry.

www.simcorp.com/compliance

needs due to changed regulations, the drive to trim costs, and the need to become more technologically nimble and enhance business flexibility and agility to respond to new regulations.

Over time, the re-assessment of supplier relationships could cause a dislocation in the provider market with suppliers with strong functional knowledge and competitive pricing winning out over competitors that have generic solutions not customised to the industry’s needs.

Greater pressure to outsource New regulations will also push some firms to re-examine their attitude toward outsourcing. Renewed cost pressures and the need to bolster capabilities in certain areas may cause investment managers to seek more relationships in both business process outsourcing (BPO) and information technology outsourcing (ITO). Brokers will also further expand outsourcing relationships in securities processing, causing the few remaining firms that self-clear to consider using correspondent clearing providers.

Organisations will further outsource functions such as custody, trade settlement, cash management, and investor services, which are already largely outsourced; that is, a higher proportion of activities will be outsourced. Areas such as valuation of illiquid instruments, administration of OTC derivatives, and collateral management, which are currently outsourced in a limited way, will be offered up for outsourcing bids. However, some functional areas – including supplier management, risk management, compliance, and order management –

will remain off the outsourcing agenda for the most part.

Changes in service delivery Regulatory pressure will also have an impact on investment management firms' attitude toward the way they consume software, influencing their perception of concepts such as application service provider (ASP)-based delivery, software-asa-service (SaaS), and cloud computing.

For the last five to seven years, there has been a clear trend in the industry toward thin-client computing and accessing software through a web-based interface.

The new regulations will push this trend further as companies grapple with three demands: the need to reduce costs, enhance flexibility, and report in real time. The need to cut costs and enhance flexibility will drive up demand for cloud computing, with the initial focus being on pushing generic services like storage and computing power into the cloud soon followed by more business functions like data management.

OPPORTUNITIES In response to these changes in the IT and operational priorities of investment management companies, what should they be doing and what opportunities do they have in this changing environment?

It is our belief that the collective weight of US regulatory reforms will greatly affect the technology-related and operational decisions of securities and investments firms in particular. Pressure will be greater on chief technology officers to cut costs, drive greater efficiency, better articulate return on investment on new

projects, be more accountable to business users, and be more flexible in responding to business needs and regulatory requirements.

In addition to demands for investment management technology improvements, there will be opportunities for institutions that service asset managers and broker-dealers. These include custodian banks, sub-custodians, prime brokers and hedge-fund administrators. Major financial institutions such as State Street and Bank of New York are already rapidly bolstering their capability in areas such as collateral management, derivatives processing and securities valuation.

“Pressure will be greater on chief technology officers to cut costs, drive greater efficiency, better articulate return on investment on new projects, be more accountable to business users, and be more flexible in responding to business needs and regulatory requirements.”

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OTC derivatives

– Collateral management – Central clearing – Real-time reporting

Leverage and capital adequacy

– Real-time positions monitoring – Regulatory reporting – Leverage management

Hedge fund registration

– Audits and compliance – Performance reporting – Investor eductation and disclosure

Valuations

– Data management – Intraday valuation – OTC valuation

Risk management

– Data management – Attribution analysis – Systems integration

Audit and compliance

– Compliance management – SEC audit preparation – Employee surveillance

Figure 1 illustrates six issues that will become major priorities for the institutional securities business due to US regulatory reform and presents examples of investment management system focus areas driven by regulatory challenges.

POINTS TO CONSIDER In response to the new regulatory powers, greater resources, and a stricter mandate granted to regulatory agencies by the new laws, securities firms will need to enhance their compliance departments, add staff to deal with more regulatory examinations, and implement compliance software (for surveillance of employees for insider trading, data security, and privacy). This means that

investment management organisations will have to overhaul their systems to support needs in five application areas: risk management, compliance, reporting, analytics, and data management.

It is clear then that the Dodd-Frank Act will have a profound impact on the technology departments of securities and investment firms, requiring them to make changes to processing, accounting, risk management, and compliance software applications. Lower revenue in areas such as OTC derivatives and agency trading will put pressure on IT budgets, but green shoots will emerge in areas such as risk management, reporting, and data management.

“It is clear then that the Dodd-Frank Act will have a profound impact on the technology departments of securities and investment firms, requiring them to make changes to processing, accounting, risk management, and compliance software applications.”

SimCorp

Figure 1. Investment management system focus areas driven by regulatory reforms of the securities industry.

Source: TowerGroup.

Dushyant Shahrawat is a Senior Research Director at TowerGroup in the Securities and Investments practice, Boston, USA. With over 15 years of experience in financial services, he is a Chartered Financial Analyst (CFA) and a member of the Boston Security Analysts Society. Dushyant Shahrawat researches strategic issues facing asset managers, hedge funds and brokerage firms globally, and advises clients about strategy, marketing, regulation, technology and product development. He has shared his opinions on financial industry trends at over 100 events across the USA, Europe and Asia and has appeared on various television and radio channels. He has also been widely quoted in printed publications such as the Wall Street Journal, New York Times, Fortune, and the Financial Times.

TOWERGROUP TowerGroup is a leading research and advisory services company focused exclusively on the global financial services industry. For more than a decade, it has provided the world's top financial services, technology, and professional services companies with advice and information. Its team of analysts and specialised advisers covers the business and technological issues impacting the entire financial services sector.

More information at www.towergroup.com.

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23

# AIFMD: changes and benefits in

store for the European alternative fund industry

Alternative fund managers face changes but also opportunities arising from the AIFM Directive. This article aims to address the main implications and challenges for alternative investment firms in implementing the directive, focusing on the practical aspects in gearing up IT processes to accommodate the legislative provisions.

O

n 11 November 2010 the European Parliament and EU Commission approved the proposed Alternative Investment Fund Managers Directive (AIFMD). Having taken 19 months to negotiate, the directive represents a major step in the regulation of the alternative investment industry within Europe. From mid-2011, when AIFMD is officially published, member states have two years to implement the directive.

Camille Thommes is Director General of the Association of the Luxembourg Fund Industry (ALFI), Luxembourg.

Charles Muller is Deputy Director General of ALFI, Luxembourg.

From the outset it was clear that the directive would substantially change the rules applying to managers of alternative investment funds in the EU domain. But much of the hard work – the Level 2 implementation phase – still lies ahead.

The way in which AIFMD came into being was not a procedure that is normally used, however. Normally a consultation phase is gone through, resulting in a draft directive. Here the EU Commission was under pressure due to decisions by the G20 that were motivated by the 2008 financial crisis to immediately come up with a proposal, which was then extensively debated and criticised during the entire process.

What emerged from this process was a directive at a very high political level and where many of the more technical elements were left to be resolved at Level 2.

And the Level 2 measures are currently under discussion and in the preparation phase with the European Securities and Markets Authority (ESMA formerly known as CESR). A first consultation has been published by ESMA asking for feedback and information from the alternative investment fund industry stakeholders and many of them, located in and outside the EU, have answered.

THE BIG PICTURE There remain outstanding quite a number of question marks as to the details of some rules, or the influence and the rise of third-country funds to be distributed in Europe, etc. Put another way, we have the big picture but not the details as yet.

What we at ALFI have stated from the start is that we understood the willingness by EU authorities to try and regulate non-UCITS funds as well.

This could be viewed not necessarily as a burden but also as an opportunity to create a second fund category to match the success of the Undertakings for Collective Investment in Transferable Securities (UCITS) category, which has proved very successful over the past 20 years, emerging as an essential cornerstone in the development of the European investment funds industry.

Despite the claimed technical successes of AIFMD, the implementation phase is likely to be fraught with difficulties. Whereas UCITS was a voluntary quality brand offered to managers who wanted to benefit from it, AIFMD stems from the G20 and does not have that element of voluntary approach.

How to combine them and make them work certainly represents a mediumterm challenge.

Subject to a very limited set of exemptions, the provisions of AIFMD affect all managers of non-UCITS investment funds, such as hedge funds, real estate or venture capital and private equity funds, which are located in Europe (or even outside Europe if they are managed by an EU manager or distributed in Europe) and which fall outside the scope of the UCITS Directive, irrespective of their legal form and regime.

AIFMD will, for the first time, introduce a harmonised European regulatory regime for managers of alternative investment funds. The AIFM Directive is designed to address a number of risks identified by the EU Commission relating to alternative investment funds, including systemic risk. It will require from the managers of alternative investment funds above a certain size to register and provide regulators with detailed information on the principal markets and activities of the funds that they manage.

The directive also contains provisions on capital maintenance, risk management, valuation, delegation, depositary, reporting, leverage, remuneration policies, etc.

It also regulates the EU management of third-country alternative investment funds and EU market access for thirdcountry alternative investment funds and their managers.

PRACTICAL IMPLICATIONS In addition to subjecting alternative investment fund managers to compulsory regulation in the EU, AIFMD will require significant modifications to the structures, strategies and operations of fund managers and funds in the nonUCITS sphere and will also directly and materially affect those that service this industry.

AIFMD will oblige service providers to the industry (i.e. depositaries, custodians, prime brokers, administrators, and other outsourced services) to adapt to a very different market for alternative investment funds.

As a consequence, AIFMD substantially redefines the relationships between fund managers, alternative funds and their

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service providers, who will need to adapt their product offerings effectively to the new requirements.

“IT suppliers will have to assure that the reporting they provide is fully compliant with the level of detail expected, and that their systems are able to produce the required data.”

In addition, AIFMD presents major operational, compliance and reporting challenges for fund managers. For one, depositary and (where used) prime brokerage arrangements will need to be re-aligned.

For the second, products and services will need to be designed (or reconfigured) to provide for a greater flow of information, either to allow a depositary to perform its required functions under AIFMD or where administrators are asked to cope with the increased demand for reporting capacity by managers who now have reporting obligations to both regulators and investors. For the third, valuation processes and procedures will require modification.

And finally, demand for third-party assistance and assurance will almost inevitably increase as a result of AIFMD. In order to find practical, integrated solutions to the challenges posed by these multiple regulatory developments, alternative investment management organisations will need to consider their strategic positioning, identify areas for change, and plan for implementation. They will need to understand the issues they are facing and undertake an adaptation process through

practical, economic, financial and IT solutions that are fully compliant with AIFMD requirements.

DEPOSITARY REQUIREMENTS One of the key areas alternative investment managers will have to consider when adapting to AIFMD will be depositary requirements. For banks that offer depositary facilities (and many of them do), AIFMD in its current form is likely to have a huge impact on their ability to service funds and assets at the riskier end of the investment spectrum.

In the wake of the Lehman collapse and Madoff scandal, AIFMD has been framed to considerably tighten the unharmonised rules under which depositary banks operate for the moment.

For a start, all funds – traditional and alternative alike – must now provide custody of their assets.

For the depositary banks, the extent of their fiduciary duties is now clearly laid out at a European level. Some of the more important duties they must now perform include: monitoring cash flows; safekeeping assets and monitoring the day-to-day transactions of a fund, including the accurate and timely valuation of assets in a fund.

AIFMD contains extensive provisions on the depositary’s role and responsibilities, its ability to delegate and its liability to the fund and investors. The harsher strict liability provisions previously proposed have been modified to better take into account the effective business conditions, developments, structures and variety of assets to be safe-kept by a depositary. There is now potential scope for a discharge of that strict liability, notably in the case of the use of a sub-custodian if certain conditions are met, and if the fund managers can demonstrate that the local depositary satisfies certain quality criteria (due diligence process).

SimCorp

Alternative investment managers will need to ensure they have the resources (people and systems) to meet the AIFMD requirements, and pro-actively demonstrate their preparedness to clients. Contractual arrangements will need to be revised to ref lect the new regime and ensure appropriate information flows. Alternative investment management organisations need to assess the impact on their business model, operations, product offerings and pricing, to work out what is done by whom, for whom and in what business area, in order to start evaluating what changes may need to be made, both in response to obligations imposed directly on them and to respond to client-driven demand.

VALUATION PROCESSES Another key area to consider when adapting to AIFMD provisions takes the form of valuation processes and procedures.

Alternative investment managers may need additional assistance to comply with the detailed requirements on these processes and procedures under AIFMD. Each fund’s assets will have to be valued and the net asset value (NAV) calculated at least on an annual basis. Open-ended funds will be required to carry out more frequent valuations and NAV calculations at a frequency appropriate to the assets they hold and their issuance and redemption frequency, whereas closedended funds have to carry them out each time the capital of the fund increases or decreases. More details on valuation requirements will come in the Level 2 implementing measures.

Many alternative fund managers have traditionally carried out valuation activities in-house, and will be able to continue to do so under AIFMD. But regulators are now enabled to require that an external valuer or auditor verifies the internal valuation. They will be required to ensure and demonstrate that valuation functions are independent from the

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“… AIFMD presents major operational, compliance and reporting challenges for fund managers.” portfolio management function and the persons responsible for implementing the firm’s remuneration policy. Some fund managers may simply not have the personnel or organisational structure to permit them to do this; others may choose to outsource as a more convenient and cost-effective option.

Alternative investment managers will need to revisit their valuation services, and factor this and their increased liability exposure into their business models and product offerings. They will need to revise valuation processes and procedures to comply with AIFMD. IT systems may require upgrading, and fund documentation and suppliers will need to be updated to reflect the new requirements.

DISCLOSURE REQUIREMENTS Alternative investment managers will a lso require more assistance w ith AIFMD’s extensive disclosure and reporting requirements. IT suppliers will have to assure that the reporting they provide is fully compliant with the level of detail expected, and that their systems are able to produce the required data.

Compliance and legal departments will need to ensure that all contractual arrangements are appropriate in case the data provided is deemed to be insufficient by the regulator.

Under AIFMD, alternative investment fund managers will be obliged to make full disclosure to investors (before they invest), including a description of the investment strategy and objectives of the fund, the types of assets the fund may invest in, the techniques it may employ, and the procedures to be used to alter the investment strategy. In addition, they will have extensive ongoing reporting requirements to investors. To help meet these obligations, suppliers will be required to assist fund managers with their increased reporting workload for investors.

Alternative investment fund managers will also be obliged to make extensive disclosures to regulators in areas such as gearing, liquidity, risk management, trading activity, and information about portfolio investments. In addition, further ad-hoc reporting may be necessary for effective monitoring of systemic risk.

Many fund managers simply will not have the capacity to do all this in-house, and will need technical assistance with planning around the presentation of information as well as reporting services to cope with these increased disclosure requirements.

COMPLIANCE FUNCTION AIFMD will oblige alternative fund managers to review their compliance functions, particularly in relation to the way conflicts of interest and risk management are handled. They are likely to require more compliance resources to cope with the burden of ensuring compliance with AIFMD. In many instances, the compliance function will be ramped up and will assume a far more important role in the practical operations and administrative tasks of the individual alternative fund manager.

When dealing with a set of asset classes considered as not being plain vanilla, but rather hedge funds, real estate, private equity and the like, obviously the operational and administrative capabilities will have to be adapted to the specific needs of servicing these types of products. These include NAV calculations, managing portfolio registrations, portfolio holdings, and specific reporting requirements of a compliance nature.

LOCATION OPPORTUNITIES In addition to creating opportunities for the alternative fund management industry, AIFMD also presents benefits and advantages for certain European fund industry locations and hubs. A case in point is Luxembourg. It was the first country to implement the latest version

of UCITS – UCITS IV – and it has announced its ambition to be very early in the process of transposing AIFMD. Over the years, Luxembourg has gained experience in fund structuring and distribution, and developed an extensive fund-servicing infrastructure. It is familiar with concepts like capital maintenance, risk management, valuation rules, reporting obligations, etc. and their implications in terms of fund structuring and supervision - many of them inspired by the UCITS legislation. And due to its regulated structure, Luxembourg has been able to build the competencies needed in setting up and administering alternative structures, i.e. private equity funds, real estate funds and hedge funds.

With its Specialised Investment Fund (SIF) vehicle introduced in 2007 and now accounting for almost a third of all Luxembourg-registered funds, the Grand Duchy has in place most of the provisions laid down in AIFMD. Regulated by law, SIF is an operationally flexible and fiscally efficient multipurpose investment fund regime for an institutional and qualified investor base.

“Alternative investment fund managers will also be required to make extensive disclosures to regulators in areas such as gearing, liquidity, risk management, trading activity, and information about portfolio investments.”

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“For their part, those investment managers that react swiftly and effectively to the strategic and operational opportunities created by AIFMD will be in a position to capitalise on the changing environment to gain competitive advantage by adjusting their business models.”

Luxembourg’s current SIF legislation offers promoters the option of establishing investment structures, which comply with the main features of AIFMD. Luxembourg also has the know-how to use and apply an investment management passport enabling alternative fund managers to offer their services and market their funds throughout the EU. AIFMD, then, will more likely than not increase the establishment and relocation of alternative investment funds in European jurisdictions like Luxembourg and Ireland. The challenge in Luxembourg’s case will be to replicate UCITS’ success and know-how in the alternative investment world. The support of a local government authority, the pro-active approach of a domestic financial regulator, and the capacity of a country to anticipate and quickly adapt itself to any new requirements make a strong case for a country like Luxembourg or Ireland as a location for alternative investment funds and their managers.

For their part, those investment managers that react swiftly and effectively to the strategic and operational opportunities created by AIFMD will be in a position to capitalise on the changing environment to gain competitive advantage by adjusting their business models.

Camille Thommes is Director General of the Association of the Luxembourg Fund Industry (ALFI). Prior to joining ALFI in 2007, he worked for Banque et Caisse d’Épargne de l’État, Luxembourg, where he held senior positions in the Securities Department before heading the bank’s Investment Fund Department in 2001.

Camille Thommes started his professional career in 1986 at Banque Générale du Luxembourg (now BGL-BNP Paribas) where he held various positions in the custody area. He is a member of several advisory committees to the Supervisory Commission for the Luxembourg Financial Sector (CSSF) and represents ALFI at the Board of Directors of the European Fund and Asset Management Association (EFAMA), Finesti S.A., Profil S.A. and XBRL asbl. Camille Thommes holds a Master’s degree in Economics (section Business Administration) from the University Louis Pasteur in Strasbourg, France.

Charles Muller has been Deputy Director General of ALFI since 2003 and is also responsible for Legal Affairs, Promotion, Communication and Press Relations. After studying law in Paris („maîtrise en droit“ at the Sorbonne) and London (LLM at University College), Charles Muller became a Luxembourg barrister („avocat à la Cour“). In 1994 he joined Banque Générale du Luxembourg, where he held various legal positions in the retail, corporate and private banking departments, before being appointed the bank’s Deputy Secretary General. Charles Muller is also a former Board member of the International Investment Fund Association (IIFA), a Board member of the European Federation for Retirement Provision (EFRP) and a member of the Management Committee of the European Fund and Asset Management Association (EFAMA).

SimCorp

ALFI The Association of the Luxembourg Fund Industry (ALFI) is the official representative body for the Luxembourg investment fund industry. Set up in 1988 to promote fund development, the association now includes a wide selection of service providers: custodian banks, fund managers and administrators, transfer agents, fund distributors, law firms, consultants and tax advisers, auditors and accounting firms, IT services companies, etc. More information at www.alfi.lu.

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# Solvency II: what it means

for investment management systems

Solvency II requirements and their practical implementation pose a number of issues for investment management organisations – currently and in the near term up to 2013. This article outlines how and in what ways investment management companies will need to prepare their IT infrastructures and investment management systems for Solvency II.

S

olvency II brings a fundamental change to the regulation of insurance companies in the EU. The requirements of the new principles-based regime, which are proving to be a hot topic for debate and discussion, can be broadly divided into three pillars. The first pillar sets the requirements for the capital adequacy models. Companies can choose whether to use a standard model or to develop a full or partial internal model.

Dr. Thomas Varain is a Partner and Swiss Insurance Head at KPMG, Zurich, Switzerland.

Dr. Peter Ott is a Partner at KPMG, Munich, Germany.

The second pillar defines risk management requirements for insurance companies, including risk management for investments. Pillar 3 covers in detail the reporting and disclosure requirements regarding risk to the regulator and the public. Insurance companies need to demonstrate to the regulator and to their clients that they have a comprehensive and appropriate risk management system in place that is integrated in their decision-making processes and strategy.

“Also in the short and medium term, the data management and data quality requirements resulting from Solvency II will be a huge challenge for insurance companies and their asset management.”

IMPLICATIONS FOR INVESTMENT MANAGEMENT From an investment management perspective, all three pillars are relevant for insurance companies: • t he first pillar covers standard and

internal models to measure investment risk;

t

he second pillar covers risk manage• ment of investments; • the third pillar sets out the disclosure requirements for investment allocation and investment risk.

The f ifth Solvency II Quantitative Impact Study (QIS 5) raised the awareness of the fundamental revolution in the regulatory requirements. The broad spectrum of possible consequences of the regulatory changes, in areas such as products, investment management and the structure of the insurance market, is beginning to become clear. One of the most obvious consequences is the effect on asset allocation.

Solvency II replaces the current investment categories and limits; in particular, it replaces national investment regulations with investment categories, limits and solvency requirements defined by the EU Commission. In contrast to the old system, the new guidance is sensitive to the structure of the investment portfolio.

The proposal of the EU Commission in Omnibus II Circular in January 2011 is not very clear on the actual effective date of Solvency II. Omnibus II specifies the harmonisation of supervision in Europe; in particular the new European insurance regulator founded on 1 January 2011, the European Insurance and Occupational Pensions Authority EIOPA.

Also, the binding effective date for Solvency II is fixed as 1 January 2013, which should end discussions on a further delay.

However, the EU Commission’s circular allows maximum transition periods for core areas of the directive. For example, the suggested transition periods for topics such as regulatory reporting, governance system requirements and the valuation of assets, technical reserves and solvency capital range between three and 10 years.

Standard model For pillar 1, insurers can use the standard model to determine their Solvency Capital Requirement (SCR). In many EU countries, the majority of insurance companies will use the standard model, because smaller and mid-sized insurers lack the capability to develop a full or a partial internal model. However, within its overall structure, the standard model takes only limited account of the actual investment risk profile of the company.

In addition to the risk module for insurance risk, the QIS 5 standard model contains modules for market risk, default risk, risk from intangible assets and operational risk. The market risk module is one of the most important modules in the standard model. The key elements are interest-yield curves and stresses thereon and market risk for equities.

The interest risk is based on two predefined yield curves to which a steep increase or decrease in interest rates is applied. Insurance companies have to consider both: investments that are sensitive to interest-rate changes and technical reserves that are valued based on yield curves. The market risk for

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The Berlaymont building hosts the EU Commission,s headquarters in Brussels equities is based on percentage declines in market value and takes account of correlations.

Investments in real estate require capital of 25% of the market value derived from the IPD Total Return Index for the UK. Listed shares in the EU or in an OECD country require capital between 39% and 49% of the market value, depending on the historic development of the MSCI World for the valuation date.

ASSET MANAGEMENT CHALLENGES Basically, all three pillars are relevant for the investments of an insurance company and Solvency II therefore sets demands on asset management companies. Initially, the implications of Solvency II for asset management were not entirely clear. Therefore, it is all the more important for the industry to adjust to the coming developments and be able to make the necessary changes.

Insurance companies will generally aim for low investment risk, as higher risk requires higher solvency capital. This will change the asset allocation strategy and

“Solvency II has multiple im­plications for the systems, processes and controls within the infrastructure of asset management.�

will also have an impact on the investment management industry. Also in the short and medium term, the data management and data quality requirements resulting from Solvency II will be a huge challenge for insurance companies and their asset management.

The complexity of models in the insurance industry has increased significantly.

Whereas in the past, the models focused on insurance risk and actuarial reserves, today, assets are becoming more and more important. Insurance companies are forced to develop their own models for investments if the standard model does not adequately ref lect their risk profile.

The calculation of the SCR requires large amounts of input and data that of course have to be available for investments as well. Here the asset management companies are challenged because they have to provide most of the data. Due to the importance of data, IT systems and technology in Solvency II requirements, it is important that they are considered from the beginning, even though the implementation of the market and credit risk models is not yet fully completed.

The asset management industry should not neglect this important factor and should not rely on the insurers needing a certain time until the models are fully implemented. In addition, the requirement for data is not limited to companies that develop an internal model.

The standard market risk model under Solvency II requires certain information

which asset management is often not yet able to provide.

Biggest challenge The biggest challenge for asset management is that companies have to be able to manage and provide all the data that feeds into the calculation of solvency requirements as well as financial and regulatory reporting. This includes, in particular, the data quality requirements and data being up to date. Solvency II requires that the data used is complete, appropriate and accurate and emphasises how important the quality of data is for the effective implementation of Solvency II. This goes for both internal and external data.

Solvency II expects companies to develop guidelines and standards for data quality, as well as for the updating and validation of data. Regulators will check compliance with the directive in the course of their approval of the internal models.

Data quality Data quality will also be of high importance in areas looked at by the regulator, such as the input and output data for the Own Risk and Solvency Assessment (ORSA), the Use-Test and the data that is required for disclosures, e.g. Solvency and Financial Condition Report (SFCR), Report to Supervisor (RTS) and Quantitative Reporting Templates (QRT). It is unavoidable that data used is validated and subject to a quality assurance process and that all data and its sources are documented and archived.

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As insurance companies must demonstrate their compliance with Solvency II, they will also have to obtain confirmation of compliance from their asset managers, as they may have to show this to the regulator. Insurers will also probably want to perform their own checks on asset managers to ensure that the Solvency II requirements have been met.

High complexity The complexity of asset management for insurance companies is high due to the differences in the individual investment portfolios of insurance companies and the resulting different levels of granularity of the requirements. Examples of data required include: quoted market prices and yields of bonds and equities; detailed information on derivatives; geographical data on the individual assets; and information on guarantees.

As a result of Solvency II and the new disclosure guidance, it is also possible that insurance companies will require certain data more often than has been the case until now.

IMPLEMENTING THE REQUIREMENTS The administration of investment data will be more complex for companies under Solvency II compared to the previous regulatory regimes. This includes, for example, the comprehensive documentation of data flows. Data management will also have to be adapted to ref lect the new environment. We expect that the importance and use of data-repositories and data warehousing systems will increase significantly.

Smaller and mid-sized asset managers will probably not be able to meet the new requirements without a comprehensive data management system.

Solvency II has multiple implications for the systems, processes and controls within the infrastructure of asset management. Because of the wide-ranging changes required, companies should start to address the challenges soon.

Companies need to be aware that higher costs and resource requirements may result from the necessary changes.

Journal of Applied IT and Investment Management

Apart from Solvency II, asset managers will face additional legal and regulatory requirements, which increase the importance of an early response. An efficient, timely and structured approach can save costs and resources. This topic also affects the asset services sector. Companies in this area should also assess on a timely basis where changes are required to meet the demands of Solvency II. INTEGRATED SOLUTION Prior to the start of a large and expensive project to implement the changes required, companies in the asset and investment management industry need to clearly understand their position with regard to the governance, definition, quality and reporting of data and what is expected of them in the future.

This relates to the requirements from Solvency II and also to the needs of clients, i.e. what kind of data and reports insurance companies will require. In the future, it will be unavoidable for companies to maintain a comprehensive and consistent data management system, including appropriate governance. Investment managers should check in which areas adaptations and enhancements are required, including relevant processes, controls and governance guidelines.

In addition, appropriate data quality and validation, as well as documentation and governance guidelines, should not only be in place because they are a regulatory requirement. Data and IT systems are key building blocks of the asset management business, and companies should place a high value on being able to build on an appropriate and solid foundation.

Last but not least, investment management companies should be made aware that they also stand to benefit from the situation. Insurance companies will prefer asset managers who have demonstrated that they are well equipped to meet the Solvency II requirements.

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“Data and IT systems are key building blocks of the asset management business, and companies should place a high value on being able to build on an appropriate and solid foundation.”

Dr. Thomas Varain is a Partner and Swiss Insurance Head, Audit Financial Services, KPMG, Zurich, Switzerland. He is in charge of the KPMG insurance audit practice and co-ordinates KPMG’s service offering towards insurers. With 14 years of experience providing audit and advisory service to international insurance companies, he started his career with KPMG Cologne. Thomas Varain has extensive experience in the audit of international insurance companies and is specialised in accounting and regulatory issues, as well as in insurance asset management. A Certified Accountant (D), he holds a business administration degree from the University of Passau, Germany, and a Ph.D. from the University of Goettingen, Germany.

Dr. Peter Ott is a Partner at KPMG in Munich, Germany. Specialising in Solvency II and risk management for insurance, he has been a Partner in Financial Services at KPMG in Munich since 2005, where he has headed KPMG’s Solvency II projects and initiatives since 2006. With 15 years of experience providing audit and advisory services to insurance companies, he started his career with KPMG Munich.

Peter Ott has extensive experience in the audit of insurance companies and is specialised in accounting and actuarial issues, as well as in insurance asset management.

A Certified Accountant (D) and an actuary he holds a Ph.D. in business administration and a Master’s degree in business research (MBR) from the University of Munich, Germany.

KPMG KPMG is a global network of professional services firms providing audit, tax and advisory services. With 140,000 professionals working together to deliver value in 146 countries worldwide, KPMG operates as an international network of member firms, working closely with clients, and helping them to mitigate risks and grasp opportunities. More information at www. kpmg.com.

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# Challenges in the front office: new regulations

force derivatives market overhaul

Evident during the recent financial crisis, and in the context of current regulatory reform, is the high level of systemic risk that exists as a by-product of the use of over-the-counter (OTC) derivatives. This article assesses the front-office tools needed to effectively manage their use, and previews the potential effects of changes in market structure on the IT demands of the front office.

W

Brent Rossum is Domain Manager, North America Front Office, SimCorp NA.

hile much maligned given their role during the crisis, OTC derivatives, when used properly, will continue to be powerful tools to manage investment risks and structure portfolio strategy. While OTC derivatives did not cause the crisis, the inter-connected financial obligations between organisations due to their use did cause a near financial system meltdown.

The Dodd-Frank Act, signed into US law in 2010, covers many aspects of financial reform, but has a clear goal of reducing, or at least controlling, the amount of systemic risk in modern markets. By June 2011, US agencies affected by the legislation, notably the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) but also in concert with international agencies such as the UK’s Financial Services Authority (FSA), must add substance by putting into place rules and structure to underpin the legislation.

tion risks brought to light since 2006.

While the effects on the sell-side are more drastic, the buy-side can expect more direct changes as Swap Execution Facilities (SEFs) and Central Counter Parties (CCPs) come on line. The goal of reducing systemic risk may be clear, but the timing of these changes is not.

This creates an ongoing challenge not only for market participants but also for those who manage the IT systems that participants will use as the market adopts new styles of trading and absorbs new reporting requirements.

Another key challenge for IT managers in 2011 comes from the continued use of OTC derivatives by the front office during the transition to a new market structure and as the goal of a stable, robust and liquid market is realised. To use OTC derivatives appropriately now and in the future, the front office needs tools that offer a clear understanding of exposure to risk, leverage, and counterparties, given the complexity and inter-connected nature of the modern financial markets.

“An increased focus on risks, and lessons learned, will lead to a push for IT to provide tools that allow for a greater understanding of current risks.”

Most of the efforts made by global regulators are meant to instil confidence in the system and boost transparency and liquidity. Many reforms try to reduce the opacity of sell-side trading operations and mitigate counterparty concentra-

Key items to address in 2011 for those who manage IT platforms that support frontoffice OTC derivative operations are: • Transparency and control over ap-

plications that describe exposure,

provide valuation and calculate risk;

• Flexibilit y in on-boarding new

workflows into existing front-office applications.

EXPOSURE TOOLBOX OTC derivatives are indeed complex, both in their structure and in their impact on the investment portfolio. The basic assessment to make is: does the front office have all the tools necessary to determine their various exposures to risk? Does the front office use disparate platforms to manage investments leading to an inability to holistically review risks? An increased focus on risks, and lessons learned, will lead to a push for IT to provide tools that allow for a greater understanding of current risks.

The old standards sought to measure weights in classifications such as currency, credit ratings and issuer exposure.

With the increased complexity of the markets, that definition must extend to include counterparty and leverage, but also measures that capture non-linear returns and specific risk-exposure characteristics of certain security types.

Counterparty exposure Counterparty exposure is not as simple as keeping track of those with whom you trade. Any OTC transaction will involve counterparty risk, as the potential payment of profits will directly involve their ability to pay, or even, as after the bankruptcy of Lehman Brothers, to retrieve pledged collateral against trading activity. Before the crisis, counterparty exposure analysis aggregated all exposures due to trading activity, performed stress tests on likely profits expected, then assessed if any party was overexposed. The

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front office would then be instructed on future actions to lessen this risk.

systematic risk present in equities, just as entering into a Pay Fixed Interest Rate Swap lowers exposure to rising interest rates. The challenge for the front office (assuming the OTC market continues to offer the current breadth of products) comes from the complexity of intelligently representing the single risk factor directionality of multi-leg OTC derivatives.

But now, financial accounting standards like IFRS 7 and Topic 820 (formerly FAS 157) are driving the demand for transparency by incorporating a Credit Value Adjustment (CVA) directly into the reported fair value of derivatives, meaning all fair market or exit values must expressly capture the monetised value of the counterparty credit risk. With this move, counterparty risk is no longer a pure middle-office task; pre-deal calculation of CVA affects valuation of current holdings, modifies collateral requirements and dictates preference in trading partners.

Directionality of exposure Exposure is also a factor of leverage, as any derivative – either exchange-traded or OTC – will increase exposure to certain risks without a cash outlay to actually purchase the underlying security. A key tool to assess the degree of leverage is Synthetic Cash (also known as Virtual Cash) – the amount of capital saved by transacting in a derivative versus a direct purchase of the underlying security, index or risk factor.

For example, a purchase of a bond future will add sensitivity to interest rates while only requiring margin to gain that exposure. Virtualisation of the cash effect is more effective than simply aggregating notional amounts since fair values, non-linear measures (such as delta), and contract details, will affect how much cash replicates the exposure. By measuring the total amount of Synthetic Cash, the degree of leverage in the portfolio can easily be compared to assets under management to understand how aggressive, or hedged, the portfolio actually is.

Directionality of derivatives is also a key aspect of understanding risk and exposure. Selling an index future has a direct impact on lowering exposure to

The funding leg of a Total Return Swap (TRS) or Credit Default Swap (CDS) must be captured since they have a direct affect on cash flows (and the yield) of the portfolio; but the exposure leg must clearly affect a change in exposure to specific risk factors. Buying credit protection through a CDS has only a small exposure to changes in interest rates (through the funding leg), but a large effect on credit exposure, just as an Inflation Swap offers exposure to future levels of inflation. True transparency into exposure comes from a granular approach to risk profiles, and proper aggregation into specific risks that affect the investment portfolio.

Credit ratings and credit spreads Another effect of the financial crisis concerning all market participants, and also covered by the Dodd-Frank Act, is regulation and the role of rating agencies, their business model and the efficacy of their credit analysis. Even above the apparent conflict of interest of having issuers pay for bond ratings is how useful these measures are. Markets move faster than revisions of credit ratings, so incorporation of measures of credit worthiness must come directly from market sentiment as represented by spread levels in the credit markets.

Assessing relative value of bonds via observed spreads is a core component of trading credit and is a staple of any frontoffice system. What will change from 2011 onwards is the use of spreads and

April 2011

ratings in an increasingly complementary fashion. More and more, spreads will offer a dynamic assessment at what level a credit should trade, rather than

“The challenge for the front office (assuming the OTC market continues to offer the current breadth of products) comes from the complexity of intelligently representing the single risk factor directionality of multi-leg OTC derivatives.” where the agencies believe it should.

Bonds and CDSs trade in related, but distinct markets. The crisis brought to light how quickly the CDS market assesses changes in credit compared to the slow process of reviewing credit ratings. Measures such as implied CDS par spreads bridge this gap by measuring the credit spread of a bond implied by trading activities in the CDS market, and increases the ability of the front office to respond to changes in market sentiment across issuers and industries.

WORKFLOW MANAGEMENT Perhaps the greatest change possible for those who trade derivatives will come as rules related to the Dodd-Frank Act and similar mandates overhaul the way swaps are traded, moving from opaque bilateral trading into a transparent, centralised and standardised model.

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CCP (Central Counter Parties) SEF (Swap Execution Facilities) Buy-side

Exchange trading

Negotiation

Dealer

Processing and confirmation

DTCC (Depository Trust and Clearing Corporation)

Figure 1.

Proposed OTC framework.

Overhaul of the market While Dodd-Frank attempts to reduce the systemic risk inherent in the trading of OTC derivatives, it only sets the foundations for this new structure, not the specific details, as seen in this excerpt from the Dodd-Frank Act:

supported by messaging protocols such as FIX. But supporting STP for swaps means either adopting a hybrid communication model (using FIX for execution and FpML for security structure) or supporting a new version of FIX that directly supports this process (i.e. FIXML).

“... an electronic trading system with pre-trade and post-trade transparency in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the system ...”

Central clearing Another aspect of the legislation is a move away from collateral bilateral trading into a margin-based model using SEFs for execution and price discovery, and an exchange-style Central Counterparty (CCP) to limit the exchange of collateral and mitigate systemic risk.

Regulators must also determine what must be cleared through a CCP and therefore traded through an SEF in order to meet transparency requirements dictated by Dodd-Frank.

It is to be noted that Dodd-Frank does not specify execution method or price discovery mechanics of the Swap Execution Facility (SEF), nor if this is simply a new name for existing providers. As the CFTC clarifies the rules governing SEFs, it will be defined how prices are negotiated.

In terms of price discovery, the method chosen will have a direct effect on current front-office systems if straight-through processing (STP) is an organisational goal.

For example, a ‘request for quote’ is similar to how bonds trade electronically and is

“An overhaul of the system that drives the OTC derivatives market, through Dodd-Frank and associated rules, offers an opportunity to review, and possibly retool, the applications the front office relies upon to manage investments.”

The Office of Financial Research (OFR), a new US Treasury office created through Dodd-Frank, holds the mandate for monitoring systemic risk and will rely on the Depository Trust and Clearing Corporation’s (DTCC) global repository for OTC derivatives data stored in its Trade Information Warehouse (TIW). For swaps traded through SEFs and cleared though CCPs, this transfer will depend on the ability of either the CCP, or the trade processing segment of the SEF, to pass data to DTCC. For OTC trades outside that framework, investment managers will continue to pass that data directly to the DTCC (see Figure 1).

Margin management Whether or not investment managers will accept using cash as margin in lieu of investment opportunities, a review of systems used to manage margin is warranted. Often different asset classes use specific tools that take into account the intricacies of that market. A bespoke system that manages collateral due to repo trading may not be suitable for

handling collateral from trading OTC derivatives. The more asset-specific systems are used, the greater the challenge of obtaining a true cross-asset, cross-function, firm-wide perspective on collateral and margin, and the slower the front office will be in responding to dynamic market events.

THE DEVIL IS IN THE DETAILS An overhaul of the system that drives the OTC derivatives market, through Dodd-Frank and associated rules, offers an opportunity to review, and possibly retool, the applications the front office relies upon to manage investments.

At this stage, more is unknown than known, and the main focus over the next year will be to stand ready to adopt the changes in market form and structure, while continuing to manage the risk inherent in the current system.

Investment managers must keenly regard the renovations needed as work in progress and determine if the trading of OTC derivatives will be too complex, cumbersome and costly to continue to take advantage of their usefulness in portfolio strategy and hedging, and whether or not their front-office IT platform is ready for this brave, new world.

Brent Rossum, CFA, is Domain Manager for Front Office in SimCorp North America. He holds a B.Sc. in Economics from the University of Minnesota, USA, and an M.Sc. in Finance from the ICMA Centre, University of Reading, UK. Prior to joining SimCorp in 2010, he worked in frontoffice product management at Bloomberg, TradeWeb and Charles River Development.

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# SimCorp StrategyLab hosts Copenhagen Summit 2011:

high-level industry representatives and academics convene to discuss key challenges With the purpose of identifying and examining key investment management industry challenges, thought leaders representing the industry and renowned academic institutions gathered at the SimCorp StrategyLab Copenhagen Summit 2011 meetings in February and March.

Lars Falkenberg is Assistant Director at SimCorp StrategyLab

Members of the Pension and insurance funds group discuss key industry challenges under the guidance of group head Professor Massimo Massa, INSEAD.

I

n 2010–11, the SimCorp StrategyLab research programme focuses on the three major sectors of the global investment management industry: investment funds; asset management; and pension and insurance funds. All these respective sectors face a unique set of strategic and tactical challenges. Focusing on these challenges, SimCorp StrategyLab in its capacity as an independent research institution gathered leading industry representa-

“The aim (...) was to generate and contribute substantial knowledge about key investment management industry challenges and to announce recommended solutions of value to the industry.”

tives and academics for three two-day meetings in the form of the SimCorp Strateg yLab Copenhagen Summit 2011, with one meeting addressing each industry sector.

With the aim of identifying and discussing 12 key challenges facing the three individual industry sectors, related respectively to risk, cost and growth issues, three esteemed academics were designated to head up teams of high-profile academics from renowned research institutions, such as INSEAD and Stern School of Business, NYU, as well as senior executives from major international consulting and investment organisations, including TowerGroup and Nordea Savings & Asset Management.

MISSION AND VISION The Copenhagen Summit 2011 is one of the main activities of the SimCorp StrategyLab research programme 2010–11, and its deliverables are directly aimed at supporting the mission and vision of SimCorp StrategyLab.

To find appropriate solutions and to gather relevant best practices for the top strategic institutional levels of the investment management industry, SimCorp StrategyLab carries out its own research and analysis of trends and challenges in the financial sector. The research programme is carried out in close collaboration with internationally recognised academics and established industry experts. As a result, SimCorp StrategyLab is able to contribute competent suggestions for best practices, which are intended to minimise risk, to find ways to achieve sustainable cost savings and to enable growth.

THOUGHT LEADERSHIP The aim of the SimCorp StrategyLab Copenhagen Summit 2011 was to generate and contribute substantial knowledge about key investment management industry challenges and to announce recommended solutions of value to the industry. Among the deliverables are a number of forthcoming articles and three whitepapers to be published in September 2011.

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INDUSTRY SECTOR GROUPS AND MEMBERS Investment funds

Pension and insurance funds

Asset management

Martin J. Gruber (Head), Professor, Massimo Massa, Professor, INSEAD

Anthony Neuberger, Professor, Warwick University

Marno Verbeek, Professor, Rotterdam School of Management

Ulrik Modigh, Head of Asset Management Operations, Nordea Savings & Asset Management

Ingo Walter, Professor, Director of SimCorp StrategyLab, Stern School of Business, NYU

Lester Gray, CEO, Schroders Asia (based in Singapore)

Brian S. Jensen, Head of Business Processes, Nordea Savings & Asset Management

Marc van den Berg, COO, PGGM

Lars Eigen Møller, Executive Vice President, Danske Capital

Arne E. Jørgensen, Domain Manager, Accounting, SimCorp Group

Dr. Ralf Schmücker, Managing Director, SimCorp Central Europe

Jacob Elsborg, Head of Technology, ATP Investment Area

Peter Engel, Senior Sales Manager, SimCorp Central Europe

Dr. Annukka Paloheimo, CEO, Scandinavian Financial Research

Dr. Matthäus Den Otter, CEO, Swiss Funds Association, SFA

Dr. Frank Wellhöfer, COO, MEAG MUNICH ERGO Asset Management GmbH

Michael Jarzabek, Generalbevollmächtigter, LBBW Asset Management Investmentgesellschaft mbH

Martin J. Gruber (Head) Professor, Stern School of Business, NYU

Massimo Massa (Head) Professor, INSEAD

Peter Hertel, Domain Manager, Fund Accounting, SimCorp Group Bernard Delbecque, Director of Research and Economics, European Fund and Asset Management Association (EFAMA) Merele A. May, Senior VP Investment Operations, American Century Service Corporation

Stephen J. Brown (Head) Professor, Stern School of Business, NYU

Dushyant Shahrawat, Senior Research Director, TowerGroup

SECTOR GROUPS Three teams of thought leaders from academic institutions and the industry were created, with designated sector leaders teaming up with a distinguished academic conducting research in the area as well as industry specialists. These specialists included one or more representatives from major SimCorp clients and one thought leader from SimCorp itself.

At the individual sector group meetings in Copenhagen, the three groups discussed the key issues of risk, cost and growth specifically related to each of the three sectors under examination: investment funds; asset management; and pension and insurance funds.

From a suggestion presented by the head of group, based on lists of proposed key challenges sent in advance by the group members, each sector group agreed on 12 key challenges facing the individual industry sector. A guiding principle for the discussions was that – in line with the aim

of SimCorp StrategyLab’s research programme – qualified considerations on the solutions proposed should be put forward from an IT-architectural perspective.

ment and pension funding patterns, creating new cost challenges but also growth opportunities for the investment management industry as a whole;

MAIN CONCLUSIONS Some of the main conclusions to emerge from the individual discussions were:

• s cale, internationalisation and the

• industry issues associated with risk,

cost and growth are interrelated and impact the three examined sectors of investment funds, asset management, and pension and insurance funds in varying degrees of magnitude;

• increased market volatility, financial

instability and regulatory change are here to stay, impacting business risk, cost and growth respectively, and creating challenges as well as opportunities that are not necessarily always in equal measure;

• c hanging demographics (i.e. ageing

population) will alter asset, invest-

right choice of investment management platform are key determinants in controlling risk (market and regulatory), curbing costs (IT and operational) and spurring growth (business and product).

OTHER ACTIVITIES Among SimCorp StrategyLab’s other activities for the 2010–11 period and following up its Excellence Awards 2010, SimCorp StrategyLab is seeking applicants for the SimCorp StrategyLab Excellence Awards 2011, which will award outstanding and innovative leaders in the ability to mitigate risk, reduce cost and enable growth. The three winners will be announced at a ceremony on 29 September 2011 at the SimCorp Dimension

International User Community Meeting 2011 in Stockholm.

Follow the activities of the industry sector groups at www.simcorpstrategylab.com.

Lars Falkenberg (MA) is Senior Vice President, Head of Global Product & Marketing Management at SimCorp and Assistant Director of SimCorp StrategyLab. Before his role at SimCorp, Lars Falkenberg gained international senior management experience in asset management from one of Europe’s top 12 financial institutions. Executive education and training in international banking and finance at e.g.

INSEAD and the Swiss Finance Institute supplements his theoretical background.

QUALIFY FOR SIMCORP STRATEGYLAB EXCELLENCE AWARDS 2011

11

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Submit your contributions to qualify for SimCorp StrategyLab Risk, Cost and Growth Management Excellence Awards 2011. Read more about SimCorp StrategyLab, its Excellence Awards and the submission guidelines at www.simcorpstrategylab.com.

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bOOK REVIEW:

# Financial Markets and Organizational Technologies: System Architectures, Practices and Risks in the Era of Deregulation Alexandros-Andreas Kyrtsis (Ed.), Palgrave Macmillan, July 2010

P

rogressive financial deregulation following abolition of the Bretton Woods System in the early 1970s changed the use and configuration of technologies in the organisational contexts of finance.

Information systems and financial engineering have led to an unprecedented reinvention of the business of banking.

of crises with systemic consequences, requires an understanding of the complex techno-organisational landscapes which emerged from this evolution. It shows the interconnection between the difficulty of overcoming the financial and operational risks we are facing, and the global webs of organisational and technological complexity.

Written by experts from the social studies of finance, information systems specialists, and historians and sociologists of technology, this book explains why the management and the regulation of financial organisations, especially in periods

This volume is published in the Palgrave Macmillan Studies in Banking and Financial Institutions series.

ALEXANDROS-ANDREAS KYRTSIS is Professor of Sociology at the University of Athens, Greece. Previously, he worked as an adviser for banks and IT firms. His current research focuses on the analysis of the techno-organisational backstage of financial markets.

bOOK REVIEW:

# I nvestment Beliefs: A Positive Approach to Institutional Investing Kees Koedijk and Alfred Slager, Palgrave Macmillan, December 2010

A

s an asset manager or pension trustee, you should worry less about the stocks and products you pick for your clients and more about getting your fundamental investment beliefs right. After a steep decline in the global stock markets and a recovery that is still uncertain, it is simply not enough to have a good organisation, good staff and a well-defined mission. You need to formulate your own set of investment beliefs: a clear view on how you perceive the way capital markets work, and how your fund can add value and strive for excellence. Funds that establish and implement a well-defined investment philosophy have been shown to earn consistently better results.

This practical book provides the framework for determining your own invest-

ment beliefs and guidance on how to imbed, communicate and monitor them.

Its research is based on a survey of the world‘s leading fund managers, viewed as excellent companies in the asset management industry.

The book provides a timely overview of the major debates in the industry and an introduction to the issues that matter for long-term survival in financial markets. With investment beliefs firmly in place, you will be able to more easily navigate the investment options available, knowing that your choices and decisions are in accordance with your values and objectives. Successful implementation of investment beliefs might well be one of the decisive factors in becoming a winner or loser in the investment management industry in 2020.

KEES KOEDIJK is Professor of Financial Management and Dean of the Faculty of Economics and Business Administration at Tilburg University, the Netherlands. He has won several awards for his research on sustainable development. He has published extensively on finance, European integration, and monetary policy.

ALFRED SLAGER is Chief Investment Officer at Stork Pension Fund and affiliated to Tilburg University, the Netherlands. His expertise includes international financial services, with a particular interest in asset management, pension fund and banking strategies. He publishes regularly on pension and investment management subjects.

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Regulatory update This regulatory update covers major new regulatory requirements and significant developments that affect the investment management industry.

§ THE ALTERNATIVE INVESTMENT FUND MANAGERS DIRECTIVE (AIFMD)

The European Commission proposed an initial draft of a new directive introducing a harmonised EU regulatory and supervisory framework for Alternative Investment Fund Managers (AIFM) in April 2009. The AIFM Directive was approved by the European Parliament on 11 November 2010, and pending legislative approval, it is expected to take effect early 2013. The AIFM Directive is designed to address a number of risks identified by the EU Commission relating to alternative investment funds, including systemic risk. It will require alternative investment firms above a certain size to register and provide regulators with detailed information on the principal markets and instruments in which they trade. The directive affects all non-UCITS funds: hedge funds, private equity and venture capital funds, real estate funds and investment trusts. http://ec.europa.eu/internal_market/investment/alternative_ investments_en.htm

§ REGULATION ON SHORT SELLING AND CERTAIN ASPECTS OF CREDIT DEFAULT SWAPS

On 15 September 2010, the European Commission adopted a proposal for a regulation on short selling and certain aspects of credit default swaps (CDS).

Its main objectives are to create a harmonised framework for coordinated action at European level, increase transparency and reduce risks. The new framework will mean regulators – national and European – have clear powers to act when necessary, whilst preventing market fragmentation and ensuring the smooth functioning of the internal market. http://ec.europa.eu/internal_market/securities/short_selling_en.htm

SOLVENCY II MEDIUM-TERM § WORK PLAN

On 19 January 2011, the European Insurance and Occupational Pensions Authority (EIOPA), the authority replacing CEIOPS, issued a Solvency II medium-term work plan. The medium-term work plan will help to realise a shift in attention from the drafting of regulatory advice to the implementation: from regulation to supervision. Until today, the Solvency II project has focused on the development of the regulatory framework.

In view of the imminent implementation, EIOPA will increasingly focus on preparing the day-to-day supervision by member states under Solvency II. Therefore, the work plan should ensure a smooth transition to the new framework both from a policy and a supervisory practice perspective, with an appropriate balance between risk sensitivity and practicability of the new regulation. The work plan also highlights the interconnectedness of Solvency II with non-Solvency II-specific areas. https://eiopa.europa.eu/fileadmin/tx_dam/files/aboutceiops/ WorkinProgress/SolvencyII-Medium-Term-Work-Plan-2011-2014.pdf

NAIC ADOPTS A NUMBER OF MEASURES § FROM HEALTH CARE REFORM TO SOLVENCY RISK ASSESSMENT

The US National Association of Insurance Commissioners (NAIC), whose overriding objective is supporting state insurance regulators as they protect consumers and maintain the financial stability of the insurance marketplace, passed a number of regulatory initiatives during a special joint conference call on 17 December 2010. The passing of the initiatives is meant to demonstrate the organisation’s commitment to consumer protection within the context of stable markets and effective regulation. Among the initiatives passed were: The American Health Benefit Exchange Model Act, An updated model bulletin on the Use of Retained Asset Accounts, The revised Insurance Holding Company System Regulatory Act and Insurance Holding Company System Model Regulation. http://w w w.naic.org/Releases/2010_docs/naic_adopts_key_health_ provisions.htm

§ IASB & FASB ISSUE LATEST REPORT ON EFFORTS TO CONVERGE IFRS WITH US GAAP

Since the last progress report was published in June 2010, the boards have jointly issued major exposure drafts on Leases and Revenue Recognition, completed the first phase of the Conceptual Framework project and begun discussions to seek to align their respective Financial Instruments accounting proposals. The boards have also further prioritised board time available to discuss convergence projects.

http://www.ifrs.org/NR/rdonlyres/26FA84E8-631D-44A8-AAABAA60F40B647E/0/MoUStatusUpdateNov2010.pdf

§ DISCLOSURE FOR ASSET-BACKED SECURITIES REQUIRED BY SECTION 943 OF THE WALL STREET REFORM AND CONSUMER PROTECTION ACT (DODD-FRANK ACT)

The latest of many provisions to be implemented under the Dodd-Frank Act, the disclosure rules for asset-backed securities (ABS) are set to be enacted on 28 March 2011. The final rules require securitisers of assetbacked securities to disclose fulfilled and unfulfilled repurchase requests.

The rules also require nationally recognised statistical rating organisations to include information regarding the representations, warranties and enforcement mechanisms available to investors in an asset-backed securities offering in any report accompanying a credit rating issued in connection with such an offering, including a preliminary credit rating. http://www.sec.gov/rules/final/2011/33-9175fr.pdf

SimCorp

Journal of Applied IT and Investment Management

ยง FINANCIAL SERVICES REGULATION IN EUROPE TURNED OVER TO THREE NEW SUPERVISORY BODIES (ESA) IN ORDER TO HARMONISE REGULATIONS ACROSS MEMBER STATES

From January 2011, the regulation of financial services across Europe is now overseen by three European Supervisory Authorities (ESAs). The ESAs work with the newly established European Systemic Risk Board (ESRB) to ensure financial stability and to strengthen and enhance the EU supervisory framework. They will improve coordination between national supervisory authorities, such as the FSA, and raise standards of national supervision across the EU. The ESAs are the European Securities and Markets Agency (ESMA), the European Banking Agency (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA). http://www.fsa.gov.uk/pages/About/What/International/european/esas/ index.shtml

COUNTRY TO ยง LUXEMBOURG IS FIRST RATIFY UCITS IV

The UCITS brand celebrated its 25th birthday at the end of last year, as the first UCITS directive was formally adopted on 20 December 1985. Almost exactly 25 years later, on 16 December 2010, the Luxembourg Parliament ratified UCITS IV. As was the case in 1985, Luxembourg is the first country in the EU to pass this new regulation into national law. A number of provisions (such as fiscal reliefs) came into effect as soon as 1 January 2011. http://www.alfi.lu/newsletter/alfi-newsdigest

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Recent research and white papers

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AIFM DIRECTIVE HAS BEEN PASSED – CHALLENGE, CHANGES AND OPPORTUNITIES FOR THE INVESTMENT MANAGEMENT INDUSTRY

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Since the initial draft of the Alternative Investment Fund Managers (AIFM) Directive was issued, there has been a significant amount of regulatory uncertainty surrounding the alternative investment management industry in Europe. However, after 19 months of intensive debate, negotiations on the AIFM Directive reached a conclusion and the text passed during the European Parliament plenary session on 11 November 2010. The vote at the European Parliament can be seen as a major step towards closing this chapter of the AIFMD and will eliminate much of the uncertainty that has hindered the industry. The successful vote has finally permitted the global alternative investment management industry, their stakeholders, and investors to move forward and begin to prepare for the two-year implementation phase of the AIFMD. This phase will see the technical guidelines for implementation being formulated, as well as implementation laws being drafted, all of which will require close monitoring from the real estate industry to ensure that the current framework translates into sensible and appropriate measures.

‘AIFM Directive – Crossing the finish line’, Deloitte, Financial Services, 2011 http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/FSI/US_FSI_ AIFMDirective_011211.pdf Deloitte, 6 pages, January 2011

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THE SOLVENCY II CHALLENGE: ANTICIPATING THE FAR-RANGING IMPACT ON BUSINESS STRATEGY

Insurance companies are making tremendous efforts to comply with Solvency II, but to date their responses have been more mechanical than strategic. To recast Solvency II as a source of value rather than simply a driver of costs, insurers need to look beyond mere models and metrics. They must capitalise on the new rules by revisiting their business strategies, product portfolios, distribution approaches, and risk management practices. Some insurers may need to chart an entirely new course for their businesses. In this report, the Boston Consulting Group brings forward the importance for insurance companies to use the Solvency II regulation as a source of strategic value and not just as a driver of costs. The report is based on workshops and interviews with senior executives at large and mid-size insurers in Europe and North America.

‘The Solvency II Challenge: Anticipating the Far-Ranging Impact on Business Strategy’, BCG, 2010 http://www.bcg.com/expertise_impact/industries/insurance/publicationdetails.aspx?id=tcm:12-63430 Boston Consulting Group, 19 pages, October 2010

As the Solvency 2 deadline moves closer, and the framework itself becomes clearer, the strategic implications for the industry come to the forefront. This report takes the viewpoint that Solvency 2 will act as a catalyst for significant change with profound strategic impacts. Oliver Wyman, jointly with Morgan Stanley, has applied the Solvency 2 framework to the industry overall and on individual business models. Based on this proprietary analysis, the report shows among its findings that the solvency ratios of European insurers will decrease from ~200% under Solvency 1 to ~135% under Solvency 2 on average; a fundamental reappraisal and restructuring of traditional participating business can be expected; cost of capital is likely to increase in the short-term; reinsurers will be winners of Solvency 2, while geographically localised, smaller insurers – including many mutuals – may suffer; a step change in ALM capabilities and an adjustment of investment strategies is required; and European groups may need to reconsider their competitive position in markets with ’non-equivalent’ regulation, as the USA is likely to be.

‘Solvency II: Quantitative & Strategic Impact – The tide is going out’, Oliver Wyman & Morgan Stanley, 2011 http://www.oliverwyman.com/ow/ow_50350.htm?name=Solvency+2%3A+Quantitative+%26+Strategi c+Impact+%2D+The+Tide+is+Going+Out&direct=True&directemail=Info-Other@oliverwyman.com Oliver Wyman & Morgan Stanley Joint Report, 92 pages, January 2011

Two reports by major consultancies present and analyse the challenges, changes and opportunities faced by the investment management industry with the passing of the AIFM Directive.

‘A new dawn for alternative investments – Navigating the challenges and opportunities of the AIFM Directive’, Ernst & Young 2010 http://www.ey.com/Publication/vwLUAssets/aifm-A_new_dawn_for_alternative_investmentsNov10/$FILE/A%20new%20dawn%20for%20alternative%20investments%2017Nov10-secured.pdf Ernst & Young, 30 pages, November 2010

SOLVENCY II: QUANTITATIVE & STRATEGIC IMPACT – THE TIDE IS GOING OUT

LIFE INSURANCE CFO SURVEY #27

This report is based on a web-based survey among US life insurance CFOs and points out key challenges facing life insurance companies in 2011 and the likely responses to those challenges. The report highlights that the economic environment is the key challenge for companies in 2011 to achieve their growth, profit and risk objectives. Growth rates in sales, expense and cost management, and the current and future regulatory, tax and legislative environment are also important, but compared to the economic environment they are less of a challenge. In order to handle these challenges, companies are focusing on improving management discipline, enterprise-risk management and distribution productivity.

‘Life insurance CFO survey #27’, Towers Watson, 2010 http://www.towerswatson.com/newsletters/americas-insights/3251 Towers Watson, 6 pages, November 2010

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US LIFE INSURANCE OUTLOOK

In this report, Ernst & Young presents four issues that will influence the US life and annuity insurance industry in 2011. The first issue is the changing regulatory environment with, for example, the Dodd-Frank Act challenging insurers to preserve their financial strength. The second issue for organisations is to make sure to hold enough capital and also be able to control risks as a consequence of the recent financial crisis. The third issue on the list is the need to improve operational efficiency to reduce costs. Last on Ernst & Young’s list is the need to reinvent products and services and use their distribution channels to enable growth.

‘US life insurance outlook, Ernst & Young, 2011 http://www.ey.com/Publication/vwLUAssets/US_life_insurance_outlook_-_2011/$FILE/US_life_ insurance_outlook2011.pdf Ernst & Young, 4 pages, January 2011

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INCHING TOWARD PRODUCING A UCITS IV KID

With the deadline for producing Key Investor Information Documents (KIDs) looming, managers urgently need to focus on how they will be able to meet the logistical challenges of production and distribution. While transitional arrangements exist, all new funds launched after 1 July 2011 will require a KID, and therefore time is of the essence. This update from PwC indicates that, despite the fact that the KID is mandatory for all UCITS-based funds as of July 2011, many firms do not have a readiness plan in place. The article outlines the steps companies need to take in order to be compliant, as well as addressing the challenges faced by companies that outsource all or part of their investment management processing to a third party.

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TOP 10 TRENDS IN SECURITIES AND INVESTMENTS, 2011

This report from Aite Group breaks down the top 10 issues facing the investment management industry in the upcoming year. Aite Group sees regulation as a key influencer on securities and investments, with the Dodd-Frank Act, various European regulations and the move of OTC trades to exchanges among the key factors cited.

The report also discusses challenges in data management and investor-buying behaviour.

INVESTMENT MANAGEMENT: TOP 10 TECHNOLOGY INITIATIVES FOR 2011

After the wild ride that investment managers experienced in 2008 and 2009, 2010 was a better year, with mutual fund assets and hedge fund assets rising markedly. But investment firms will not forget the impact of the financial crisis on their revenues and margins, investor attitudes and asset allocations, and universal perceptions of risk. TowerGroup‘s annual Top 10 Research Note for the asset management business discusses the business drivers and strategic responses resulting from these events and lessons and focuses on the top 10 technology initiatives for investment managers for 2011. This reports shows how some of the key ramifications of the financial crisis will manifest themselves in earnest in 2011. Regulation both in the USA (i.e. the Dodd-Frank Act) and Europe (i.e. UCITS IV, IFRS 9 and AIFMD) will reshape how business is done and cause investment managers to focus as much on risk management as generating returns. Among other factors, the growing influence of mobility, social media and cloud computing for investment managers is also covered in the report.

‘Investment Management: Top 10 technology initiatives for 2011’, TowerGroup Research Note, 2011 http:\\www.towergroup.com TowerGroup, 11 pages, January 2011

2011 TRENDS TO WATCH: FINANCIAL MARKETS TECHNOLOGY – DEALING WITH VOLATILITY AND REGULATION

‘2011 Trends to Watch: Financial Markets Technology – dealing with volatility and regulation’, Datamonitor, 2010 http://www.datamonitor.com Datamonitor, 23 pages, November 2010

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FINANCIAL REFORM INSIGHTS – DODD-FRANK‘S VOLCKER RULE CHANGES LANDSCAPE FOR INVESTMENTS BY BANKS AND OTHER ENTITIES

Of all the provisions included in the 2,300 and plus pages of the Dodd-Frank Act, perhaps none has generated more attention than Section 619, more popularly known as the Volcker Rule. This briefing paper from Deloitte Touche Tohmatsu discusses the impetus for the Volcker Rule, when and how it is to be implemented, as well as what investment managers investing in US markets need to be aware of.

‘Top 10 Trends in Securities and Investments, 2011’, Aite Group, 2011 http://www.aitegroup.com/Reports/ReportDetail.aspx?recordItemID=747 Aite Group, 25 pages, January 2011

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The financial markets sector has seemingly emerged from the financial crisis in relative health, with the restoration of growth and profitability. However, the repercussions of the crisis are still being worked through and the sustainability of future growth is a key question for 2011. This report from Ovum Datamonitor weighs in with views on the trends and challenges that will shape the investment management industry in 2011. Not surprisingly, regulation and market volatility are seen as the main drivers of change going forward.

‘Inching toward producing a UCITS IV KID’, Forward thinking, PwC 2010 http://www.pwc.com/gx/en/asset-management/assets/pdf/amnews-1110-16.pdf PwC, 5 pages, November 2010

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April 2011

‘Financial Reform Insights – Dodd-Frank‘s Volcker Rule changes landscape for investments by banks and other entities’, Deloitte Touche Tohmatsu, Financial Reform Insights, 2010 http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/FSI/US_FSI_ VolckerQA_FinancialReformInsights_102710.pdf Deloitte Touche Tohmatsu, 4 pages, October 2010

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EUROPEAN FUND MANAGEMENT INDUSTRY NEEDS BETTER GRASP OF NON-FINANCIAL RISKS

This publication looks into how non-financial risks and failures have impacted the regulatory agenda in Europe and traces the management of liquidity, counterparty, compliance, misinformation, and other financial risks in the fund industry. By identifying the distribution of risks and responsibilities in this industry, the publication examines how convergence between country regulations could be achieved. Finally, the publication assesses how fund unit-holders can be protected in the best way with appropriate regulations, improved risk management practices, and greater transparency.

‘The European Fund Management Industry Needs a Better Grasp of Non-financial Risks’, EDHEC-Risk Institute Publication, 2010 http://www.caceis.com/fileadmin/pdf/Edhec/EDHEC_Non-Financial_Risks_Euro_FM_Industry.pdf EDHEC-Risk Institute, 92 pages, December 2010

New reports published and information considered worth publishing can be submitted for review to: Co-Editor Mette Trier, mette.trier@simcorp.com

Since 1971, SimCorp has been providing investment and portfolio management software and services to the world’s leading investment managers, asset managers, fund managers, fund administrators, pension funds, insurance funds, and wealth managers. SimCorp’s world-class software provides global financial organisations with the tools they need to mitigate risk, reduce cost, and enable growth. SimCorp is a global company, regionally covering all of Europe, North America, and Asia Pacific. Listed on the NASDAQ OMX, SimCorp is dedicated to supporting the global investment management industry, its clients and its investors. For more information about SimCorp’s products, please visit www.simcorp.com/products.