Journal of Applied IT and Investment Management Vol.3 No. 2 by SimCorp

# JOURNAL of Applied IT and Investment Management

John Crocker, President and CEO, HOOPP

Successful pension formula Control cost and manage risk while spurring growth Solvency II

TURNING FINANCIAL REGULATION INTO BUSINESS OPPORTUNITY Dodd-Frank Act

A SHIFT TO LIQUIDITY RISK PUTS NEW DEMANDS ON IT SYSTEMS Cost imperative

INVESTING TO REDUCE OPERATIONAL COSTS Business Process Management

A PRAGMATIC APPROACH TO REDUCING COSTS AND MITIGATING RISK Client centricity

THE NEW INVESTMENT MANAGEMENT BUSINESS MODEL? SimCorp StrategyLab Copenhagen Summit 2011

KEY INVESTMENT MANAGEMENT INDUSTRY CHALLENGES ANALYSED

Volume 3 路 No. 2 路 September 2011

September 2011

JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

CONTENTS

CEO COMMENT:

Rising to the future

SimCorp

Successful pension formula: control cost and manage risk while spurring growth

Solvency II: turning financial regulation into business opportunity

Dodd-Frank Act: a shift to liquidity risk puts new demands on IT systems

Cost imperative: investing to reduce operational costs

Business Process Management: a pragmatic approach to reducing costs and mitigating risk

Client centricity: the new investment management business model?

However, other changes are emerging, including a greater appetite for more sophis ticated financial instruments, a sharper focus on improving workflows, as well as the technology applied. While SimCorp has an obligation and also a strategy to absorb these changes, it is important to underline that when we extend our product’s scope to meet market requirements, it is not just in response to regulatory changes but also to what is currently happening in the industry.

SimCorp StrategyLab Copenhagen Summit 2011: key investment management industry challenges analysed

- Investment fund insights

- Pension and insurance fund insights

- Asset management insights

CXO Corner: Marc van den Berg, COO at PGGM

Our clients expect us to have a product and a solution to fulfil their needs – not only today but tomorrow as well. They want us to think ahead. It is a question of striking the right balance between here-and-now needs and preparing for the future. Key to staying on top of industry trends is our research arm, SimCorp StrategyLab. Following the successful SimCorp StrategyLab Copenhagen Summit 2011, three white papers were produced that identify and assess some of the key challenges facing the industry. These challenges include the vital role that the right kind of investment management system plays to ensure that business and IT strategies are in alignment.

Book reviews

Regulatory update

Recent research and white papers

by CEO Peter L. Ravn Meeting the regulatory challenge remains one of the most pressing items on the investment management industry’s agenda. The rapidly changing requirements are very tangible and have to be complied with – today rather than later when it may prove too late.

Aligning theory with practice cannot be done by investment management companies without examining the type of IT infrastructure currently in place and how well this is capable of absorbing the constantly changing requirements that have become a permanent characteristic of the industry landscape. Whereas on the one hand research is key, on the other the operational aspects need to be considered as well. For this reason, while analysing some of the latest regulatory changes impacting the industry today, including the Dodd-Frank Act in the USA and Solvency II in Europe, this issue contains a new feature in the form of a regular column called ‘CXO Corner’, where top executives look at operational challenges and solutions from a front-line perspective. SimCorp also provides a unique opportunity to discuss these issues at the SimCorp Dimension International User Community Meeting (IUCM) taking place this year in Stockholm on 28-30 September. Theme of the 14th consecutive annual conference is ‘Rising to the future’, and the agenda includes seminars, workshops and breakout sessions, all of which will focus on how the industry – and of course SimCorp – is preparing to meet the challenges of tomorrow while dealing with the requirements of today. As SimCorp turned 40 on 2 September, our goal over the years has always been the same: releasing the power we have within the organisation and realising that we remain a knowledge-based organisation. Developing knowledge is vital for our success in the marketplace – this is the foundation of our business. That has been SimCorp’s creed in the first 40 years of its existence and will remain so going forward. Peter L. Ravn, Ph.D., is CEO at SimCorp.

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: 20,000. 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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# Successful pension formula: control cost and manage risk while spurring growth

Minimising risk and maximising return is often easier said than done in the pension fund industry. In this article, HOOPP President and CEO John Crocker describes how an integrated asset management software system supports the liability-driven investment model of the leading Canadian pension fund, which bases its success on non-traditional portfolio structures and alternative investment.

I John Crocker is President and CEO, HOOPP, Toronto, Canada.

n the harsher post financial crisis environment, increased market volatility, financial instability and regulatory change are impacting business risk, cost and growth respec tively, and creating challenges as well as opportunities that are not necessarily always in equal measure. For the pension fund industry, the hallmarks of success will be flexibility in implementation and adaptability in operation of investment strategies. Aiming to maximise pension benefits, one of the main challenges will be choosing the right investment man agement system to successfully support investment strategies while minimising risk and controlling costs. When looking for a new operational platform at the Healthcare of Ontario Pension Plan (HOOPP), the set of cir cumstances and challenges were much the same as in the rest of the industry – only the point of departure was differ ent. Since its creation in 1960, HOOPP has developed into one of the leading pension funds in Canada. Serving as the main provider of pension services to the Ontario healthcare sector, HOOPP is not only structured differently compared with other Canadian pension funds but also has a unique way of delivering its services. In 1993, it went from being an employer-sponsored benefit scheme to becoming a jointly sponsored scheme, and is now the largest private pension fund in Canada with assets under man agement totalling around C$36 billion. Also a little unusual is the fact that the fund’s Board of Trustees controls both the pension benefits and the pricing of these benefits. The Board of Trustees is

made up equally of union representatives and hospital appointees. In the case of other pension funds, the actual pricing is negotiated separately in a different structure. The board is responsible for controlling both the investment and administrative aspects of the business, which helps provide a 360° perspective on all the key pension issues, including the assets managed by the fund and the liabilities underlying the pensions to be paid out in the future. DEFINED BENEFIT PENSION PLAN The HOOPP fund pays out a defined benefit pension and believes that this is the best type of pension for ensuring people obtain an adequate pension in retirement. The pension is calculated based on two elements: years of service and earnings. By comparison, defined contribution plans, on the other hand, do not provide a pension at all, but rather are a savings vehicle promoted by the bank ing industry and insurance companies to offload responsibility for retirement sav ings to the individual. Defined contribu tion plans do not have a savings target. Corporate entities like this approach because essentially they are transferring the risk of providing the pension from the company to the employee. For their part, defined benefit pension funds have not traditionally allocated large resources to promoting the model. When a defined benefit pension plan is thoroughly examined, it is actually the most effective way of turning a dollar of earnings into a dollar of pension income. HOOPP’s cost of managing the fund is around 25 basis points; by contrast, the

investment cost for many retail mutual funds is roughly 10 times that amount. So the fee impacts on individual savings over a 20-30 year period are huge. HOOPP’s costs not only include in centives and direct compensation for professional investment management expertise but also include the cost of its investment management system, i.e. the IT platform on which operations are based. The approach to running this op eration is fairly lean; the investment team has only around three dozen members. Overall, each of the fund’s investment professionals is responsible for around C$1 billion in assets. LIABILITY-DRIVEN MODEL AS INVESTMENT APPROACH For the past few years, the HOOPP fund has implemented a liability-driven investment (LDI) approach involving non-traditional portfolio structures and alternative investment strategies. The liabilities are modelled in terms of calculating what the cash flows look like, what interest-rate sensitivities are built into the liabilities, what inflationrate sensitivities are involved, and also the demographic profile of our pension membership. Against this is placed what we term as a liability-hedge portfolio. One of the main parameters considered in this approach is interest rates: the lower they go, the more they drive up the liabilities – a 0.25 percentage point move in interest rates amounts to a difference of C$1-2 billion in shifting valuations. The benefit of the liability-hedge port folio is that most of the assets and liabilities move together so that if inter

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# Successful pension formula: c ontrol cost and manage risk while spurring growth est rates go up or down, the assets move accordingly and in tandem. This has been the central element of our fund’s new investment philosophy. On top of this, the fund has what we describe as a return-seeking portfolio, which includes data and risk overlays, hedges, alpha strategies, various equity-based strategies, private-equity instruments, cross-market arbitrage, etc. The fact that our pension fund made money while others lost money owed much to the success of this liability-driven investment model. One of the main explanations why funds like HOOPP have fared better than many of their counterparts in recent times was an early decision to pursue a more actively managed ap

lost 10% and was 25% down. That was basically the wakeup call needed to conclude that the fund had too much risk in its asset mix and in its invest ment approach. MOVING INTO A NEW ASSET MIX To correct this state of affairs, HOOPP’s Board of Tr ustees decided in the mid-2000s to move away from the traditional asset mix to an asset al location of 46% in equities and 54% in fixed income. That strategy led to a key decision in the fourth quarter of 2007. We sold around C$6 billion worth of equities and moved that money mainly into the bond market. This move to reduce the assets in equities dampened volatility a little.

“For the past few years, the HOOPP fund has implemented a liability-driven investment (LDI) approach involving non-traditional portfolio structures and alternative investment strategies.” proach to the investment portfolio. In the 1980s and ’90s, it was traditional for the North American pension fund industry to divide portfolios into an asset mix comprising 60% equities and 40% fixed income. This approach worked f ine coming out of the 1982 recession, but stopped working when the Internet bubble burst in 2001-02. In those two years com bined, HOOPP lost a total fund value of around 10% when it was targeting an annual return of 7.75% in each of those years. Instead of making 15-15.5%, it

Then in the fourth quarter of 2008, the financial crisis erupted, the bank ruptcies began to occur and the chaos became palpable. The payoff for our decision to reduce exposure to equities translated that year-end losses were limited to less than 12% of the fund’s value. Compared to this, the average pension fund account lost around 18% and some of the bigger funds lost as much as 20 to 30% or even more. In fact, some of HOOPP’s total loss was artificial because we were obliged to adopt some mark-to-market accounting

to record the loss. Subsequent events proved this move to be correct in the sense that the markdowns that were taken in 2008 returned to full-market value in 2009, allowing the fund to gen erate a return of well over 15% in that year. We were probably one of the few funds to report a positive return – albeit a small one – in the two-year period of 2008-09. NEW ASSET MANAGEMENT SYSTEM FOR NEW ACTIVITIES At the time when the fund was in creasingly moving into the area of derivatives and other non-traditional portfolio compositions, we were using an old investment management system as our core operational platform. We found ourselves in a situation where, with business processes increasingly dominated by the use of derivatives, the software system was just not ca pable of keeping up with the growing complexit y of portfolio structures and alternative investment vehicles. Consequently, we were ending up with hundreds of spreadsheets, control ling and risk-managing them, and involving time-consuming and costly workarounds. These error-prone manual processes were no longer acceptable, as in our business errors can translate into hundreds of millions of dollars. It became increasingly apparent to us that the existing portfolio manage ment and accounting system would not support the types of activities that we wished to undertake, both now and in the future. What was needed was a portfolio management and accounting system that could handle all of the vari ous investment products and strategies that we needed to employ. In addition, that system needed to be flexible enough to absorb new products and strategies in the future and provide timely and adequate reporting and accounting to support investment decision-making.

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HOOPP President and CEO John Crocker outlines how the support of non-traditional portfolio structures and alternative investment strategies applied by the Canadian pension fund requires an extremely robust and flexible investment management system infrastructure. This imperative led us to start a search to replace our system with one geared towards reducing risk and enabling us to obtain more functionality in terms of the type of products our investment team generates. Following a rigorous selection process, the SimCorp Dimen sion investment management system was chosen because of its ability to provide a fully integrated, front-to-back office architecture with robust capabili ties including derivatives management and accounting. The support of diverse investment in struments and strategies requires an ex tremely robust and flexible investment management system infrastructure. Adopting the new system has allowed the investment team to engage in more and different types of transactions and really test the functionality of the asset management solution. With the new system in place and up and running, the year-end financial and accounting work proved also faster and more efficient,

both for our internal personnel and the external auditors. Running a very sophisticated portfolio made it a high priority to find and de ploy a single solution that could support the operation. The investment manage ment system serves as a primary means of processing every transaction on the books and is the system of record. It is able to support the complex derivatives book, all existing instruments as well as potential ones to come in the future. All instruments are processed through

the system, including bonds, equities and derivatives. As such, it acts as the single, integrated system of choice to support the fund’s investment strategy. Choosing the new software solution was a strategic decision to support the investment team, which manages all of the fund’s assets in-house. It would without a doubt have been extremely difficult for us to do this effectively without the power, functionality and flexibility of the new portfolio man agement soft ware which has been

“What was needed was a portfolio management and accounting system that could handle all of the various investment products and strategies that we needed to employ.”

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# Successful pension formula: c ontrol cost and manage risk while spurring growth

absolutely mission-critical in terms of us being able to move forward. The highly integrated and automated investment workflow is anchored in an integrated platform, which allows us not only to reduce manual involvement but also to further increase the integration and automation of workflows. MATCHING INVESTMENT MODEL AND SYSTEM The implementation of an LDI strategy at HOOPP ref lects success in every respect. The plan stands today in its strongest position ever: it has more assets under management and more members than at any time in its history. HOOPP is fully funded. By combining the right kind of investment model – in this case, a liability-driven investment model – with the right kind of invest

ment management system – such as the one we have now – you have the mak ings of a great marriage. In a business partnership like this, there is every rea son for us to believe that we can achieve the kind of competitive advantage that is needed to stay ahead in ensuring HOOPP can deliver on its pension pay ments for generations to come. By way of summary, implementing the type of applied asset management software HOOPP has found with its current provider gives us a platform which enables us to mitigate operational and financial risk, while at one and the same time supporting and enabling our investment growth strategy. Utilising this system, our investment team is able to respond more swiftly to

“By combining the right kind of investment model – in this case, a liability-driven investment model – with the right kind of investment management system – such as the one we have now – you have the makings of a great marriage.”

changing market conditions and come up with fresh investment ideas, thereby creating a competitive advantage over other players in the same space. This gives HOOPP speed and flexibility and yet maintains a good risk-control culture. Finally, our investment management platform also enables HOOPP to keep operations lean which in turn helps us to maintain a high degree of control over costs. These are all critical build ing blocks that combined, help us to ensure that our fees are kept to the minimum, and that the pension benefits are maximised. John Crocker, CFA, has held the post of President and Chief Executive Officer at HOOPP since 2001. Joining HOOPP in 1998 as Chief Investment Officer, he had more than 30 years experience in the investment industry, having managed large funds in the insurance, trust, and banking industries. He reports directly to HOOPP’s Board of Trustees and is responsible for overall leadership and management of the organisation. He is also responsible for developing, implementing, and overseeing – in consultation with the board – performance measurement programmes, long-term strategies, and annual work plans to ensure the organisation meets the needs of plan beneficiaries. John Crocker is a member and former director of the Toronto Society of Financial Analysts, a member of the CFA Institute, and a member of the Pension Investment Association of Canada (PIAC). He holds a bachelor of commerce degree from McGill University and is a Chartered Financial Analyst (CFA).

HOOPP The Healthcare of Ontario Pen sion Plan (HOOPP) is the lead ing pension plan for Ontario’s healthcare sector with over 370 participating employers and more than 260,000 plan members and retirees. On their behalf, HOOPP invests the assets of its C$35.7 billion fund, administers the plan and pays out C$1.2 billion in pension benef its annually. Created in 1960 and now one of the largest and most respected pension plans in Canada, the HOOPP def ined benef it plan provides eligible members with a retirement income based on a formula that takes into account a member’s earnings history and length of service in the plan. HOOPP’s assets are actively man aged using a diversified, long-term investment strategy. Governing HOOPP is a Board of Trustees with representation from labour and management. The unique governance model provides rep resentation from both employ ers and members in support of the plan’s long-term interests. More information can be found at www.hoopp.com.

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JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

http://compliance.simcorp.com

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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. To determine your system challenges, take our self-assessment and receive a personalised impact quick guide that outlines: • which regulations will affect you • what impact these regulations will have on your investment management system • which areas of your software platform you should focus on • what actions to consider regarding each regulation.

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# Solvency II: turning financial

regulation into business opportunity The Solvency II regime is here to stay. European pensions and insurance companies have no other choice but to absorb and align the new legal framework within their IT systems and infrastructure. This article examines how Danish pension fund ATP used its operational platform as a point of departure to embrace the regulatory challenges embodied in Solvency II, transforming legislative requirements into a business opportunity rather than treating them as an obstacle.

I Jacob Elsborg is Head of Technology, ATP Investment Area, Hillerød, Denmark.

In this article, only Solvency II’s Pillar 1 (i.e. the risk management of investments) is discussed. 1

n July 20 01, the Danish Fi nancial Supervisory Authority (FSA) introduced new financial regulations, which fundamen tally changed the rules of the game for Danish pension funds, including the country’s largest – ATP. The cen trepiece of the financial reform was the introduction of mark-to-market valuation of pension liabilities. The FSA also tightened required standards of risk management, risk assessment, and transparency. A key element was the requirement to conduct resilience tests, or so-called traffic lights. The net effect of this new procedure was to tighten the overall solvency requirements for all Danish financial institutions, includ ing ATP.

allows ATP to turn Solvency II into a business opportunity.

The FSA regulations rather than the Solvency II regime were the catalyst that led ATP to rethink its mission and its strategy for accomplishing it. Looking back, the process ATP started would be very similar if the Solvency re gime1 had come prior to the challenges mentioned above. The consequence has been that adoption of the Solvency regime has been aligned with the busi ness process re-engineering (BPR) that has been undertaken over the last years.

Rethinking the business model entailed a multi-year BPR involving 12 elements organised into four categories. First, on the overall business side, ATP adopted a new and integrated view of pension management, created a new business area called liability hedging, and re newed its risk management practices to provide timely warnings of changes in risk patterns. Second, on the investment side, the overall strategy was redesigned by adopting an absolute return strategy, separating beta and alpha portfolios, and entering into strategies to hedge tail risk. Third, on the liability side, ATP developed and implemented a new pension accrual model preserv ing important features from the old model, while designing the new model to continually balance the accrual of new pension rights with economic re alities and the investment policy. Also, a new mortality model was designed to

The integration of the requirements stipulated by Solvency II is seen as a natural extension of developing the ATP business model, and engendering a competitive advantage rather than a regulatory burden. This is also the reason why we start by taking a closer look at the development of the ATP business model and the BPR, which has led to an operational platform that

THE ATP BUSINESS MODEL At the start of the millennium, the challenges of increased market tur bulence and repeated financial crises together with a fair value disclosure regime led ATP to conclude that its approach to pensions needed to be re appraised. The change was not a minor tweaking in investment strategy - it was to rethink the organisation’s busi ness model from the ground up. The goal was to reconcile a return-seeking investment strategy with safeguards to pensions and pension pledges through sustainable guarantees and effective risk management.

capture and address the longevity risk, and a daily valuation of the liabilities was introduced. The fourth category involved strategic management of the operational platform, def ining the operational platform, setting up the organisation and responsibilities, and developing an operational framework. An integrated view of assets, liabilities and objectives A pension fund’s overall objectives and risk tolerance, investment policy, and pension policy constitute the three key focus areas of pension fund manage ment (see Figure 1, page 9). Integrating decisions in these three areas is a critical governance challenge. For example, changes on the liability side can impact investment policy. The most dominant example of this is that life expectancy increases, pension li abilities increase and reserves decrease, and thereby threaten the solvency degree. This in turn reduces the ability to act. Overall, a risky long-term invest ment strategy makes little or no sense if a fund’s tolerance for a red-light risk 2 is low, while the policy of indexation on the other side of the balance sheet involves expedient consumption of the reserves. The challenge is to design and imple ment strategies and policies that are consistent with the overall objectives and that take into consideration the relationship between the asset and liability side of the business model. ATP’s reaction to this challenge was to develop an in-house asset and liability management (ALM) model, which

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“The challenge is to design and implement strategies and policies that are consistent with the overall objectives and that take into consideration the relationship between the asset and liability side of the business model.” One of the biggest threats facing funds takes the form of severe losses, because such losses reduce reserves. This again reduces the ability to increase pension benefits in the future, and having a solvency margin to protect it can force the fund to sell off risky assets at an inconvenient time.

Objective and risk tolerence

Investment policy

Pension policy

Figure 1: The interdependence of the three key focus areas in pension management. Source: ATP. ensures that allocations to risky assets are dynamically controlled as a function of the size of the reserves and ATP’s risk tolerance. This approach includes a total (assets and liabilities) mark-to-market valuation on a daily basis. In brief, the four guiding principles of the ATP business model are defined as: • e nsuring an appropriate risk level -> the investment risk is defined in view of ATP’s free reserves; • a voiding uncompensated risk -> liabilities are hedged in full; • d iversifying aggressively -> the port folio should do well in any circum stances; • hedging tail risks -> solvency should be protected by hedging against black swan events. Investment objectives ATP’s two main investment objectives are to protect reserves against adverse developments in the financial markets and to create excess return in order to ensure the purchasing power of the pensions. These objectives have led ATP to divide assets into two independent

portfolios – a hedge portfolio and an investment portfolio. The hedge portfolio’s aim is to elimi nate mark-to-market risk of the ATP liabilities. This portfolio is not expected to generate excess return. In contrast, the investment portfolio is designed to generate excess returns, which in turn requires taking on investment risk. As the hedging portfolio predominantly consists of derivatives, it does not in itself consume liquidity. So in principle, all ATP assets are avail able for the investment portfolio. Both portfolios are managed through risk budgets defined as dynamic risk budgets. These are set up to handle the trade-off between the aim of producing higher pensions for the members against the risk of losses, and thereby compromising further pension payments. The essence of dynamic risk budgeting is that the risk is reduced before a threat materialises. A central challenge for an asset manager in the pension industry is the quest to produce high stable returns in order to secure the purchasing power of pensions.

Along with adopting a new approach towards risk management, ATP changed the concept of return target from a rela tive return target to an absolute return target. As a consequence, the new definition differs from the traditional benchmark-based framework, where the focus is on creating a return above a benchmark portfolio. The absolute goal ATP has defined for the investment portfolio is to achieve a return net of taxes that is at least equal to liability hedge funding costs, changes in longev ity, and indexation of pensions and pen sion rights in line with inflation. The liability side of the coin Changes were also made on the liability side. ATP developed a new pension ac crual model that was able to adapt more readily to the complex realities of market fluctuations and mark-to-market valua tion. It has to be noted that the social objectives and values from the old pen sion models were maintained. The new model provides for a lifelong guaranteed pension, with accruals based on collec tive insurance principles. In effect, ATP will remain a defined contribution model in the sense that benefits reflect individual contributions made, while resembling a defined benefit scheme through the applied guarantee. The new model was designed in respect to valuation within the framework of the mark-to-market valuation. Since 2001, ATP has on a daily basis calculated a full valuation of its assets, and since 2003 has on a daily basis calculated a valua tion of the entire reserves defined in the balance sheet. The new pension model made valuation of the reserves even more specific and in line with valuation of the assets. From 2010 on, a full valuation was made based on daily updated data.

ATP’S OPERATIONAL PLATFORM AND ITS STRATEGY Along with the overhaul of the busi ness model, the operational platform of ATP and its strategy were defined as integrated parts of the business strat egy. The definition included a strategic framework for the operational platform to redefine and establish data, processes, information and system management within operations in order to ensure quality and performance in each area. Besides this, the challenge was to create an operational platform that was flexible and scalable while reducing the total costs of operations. The creation of a new operational platform and its strategy comprised: defining the operational platform and its implementation within the overall business strategy; setting up the or ganisation and responsibilities; and developing an operational framework. For ATP, implementation of the opera tional platform strategy thus became an integrated part of the business strategy (see Figure 2, page 10). Some asset managers define an opera tional strategy as the strategy that in corporates the tactics and processes that support the investment strategy. The operational platform strategy expands the operational strategy by including the functional setup of the platform as a part of this strategy. Sometimes the functional setup is defined within the Red-light risk refers to the traffic light stress test applied under the Danish mark-to-market regime. The traffic light stress test involves current monitoring of the individual pension fund’s risk situation and its ability to withstand a set of well-defined capital market shocks. A red-light situation signifies a situation where a pension fund fails to meet the red-light resilience test. Consequently, the FSA will move to enforce tight supervision of the fund and demand drafting of a reconstruction plan. 2

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“Due to this approach, the Solvency II implementation project only demanded minor extensions concerning the new data needed, and the existing framework could easily handle these new tasks.”

Figure 2. Schematic illustration of an operational platform strategy as an integrated part of the business strategy. Source: ATP. framework of the IT strategy, but, far too often, the functional definition is left in no-man’s land (i.e. not forming part of any strategy). Further, ATP has decided to define an operational platform in the following way: “An operational platform in the asset management industry is where management of the organisation’s data and information together with the ex ecution of decisions take place.”

A NEW OPERATIONAL FRAMEWORK FOR SOLVENCY II Having defined an operational platform and its strategy, Solvency II now pre sented ATP with the need to develop an operational framework which could han dle its requirements, and here the main tasks constituted: preparing data for the calculations; implementing calculations and processes; and reporting. The first step to be considered was gathering and washing of data, by many described as an

As early as 2000, ATP had taken a strategic decision to store all investment data within the investment manage ment system SimCorp Dimension. The decision in practice made this system function partly as a data warehouse for ATP. The approach has been fol lowed consistently, and today the data management team ensures that all data from various vendors are entered into this data warehouse and that the data has the right quality. The setup ensured that the Solvency II implementation project only demanded minor extensions concerning the new data needed, and the existing framework could easily handle the new tasks. In the past several years, ATP has worked on integrating the liability and investment sides of its business which includes a total (assets and liabilities) mark-to-market valuation on a daily basis as described earlier. As a conse quence, the data on the liability side was available prior to implementation of the Solvency II regime, executed on a shared operational platform, and therefore it was not a question of how to produce or access data. The second step is the development and implementation of the calculation processes. One part of the calculations is handled by an external partner al ready implemented on the operational platform at ATP. The second part is the

Besides handling the automated flow, the data model has made it possible to incorporate non-automated processes in scheduled flows. In order to incorporate a non-scheduled task in a flow, the nonscheduled task has to be defined as an event, and when the task is done, the result (success or failure) is written into the status table in an Oracle data ware house. In this way, the non-scheduled tasks are represented on equal terms with the scheduled tasks. The third step in implementing Sol vency II is the internal reporting. Also with regard to handling this challenge, ATP’s operational platform already has a setup in place, as ATP has a portal where all information shared within the Pension and Investments area is pre sented. Therefore the task was to define the reports based on the data stored by the Solvency II application within the Oracle data warehouse.

F. Decision-making

E Portal Business Intelligence

H. Order execution

Besides defining the operational plat form and its strategy, the organisation was aligned in order to ensure that only one team handled all functions (see Figure 3). Many teams in ATP’s Risk and Operations department had been working with data quality, however, during development and implementa tion of the operational platform, the data management function was set up – ensuring that only one group was handling the entire dataflow for users of the operational platform.

overwhelming burden. However, ATP was well prepared for this.

With the development of the ATP op erational platform, process management was defined as critical for the opera tions. Accordingly, the way automated processes were operated changed, and a group within the Risk and Operations department was made responsible for operating all automated processes in the Pension and Investments area as a whole. For these operations, ATP has built a data model handling both the data and process flow. In brief, all data entries and processes are defined as events. When an event happens, the result can be either a success or a failure. This leaves the daily quantitative data management (i.e. managing incoming files and data) and daily process management as exception handling; if an event fails, the process management or the data management

team takes care of this. When an event fails, the process flows are set up to wait until the event is defined as ‘OK’, and then the flows continue which is crucial for the time spent on daily operations.

D. Reporting repository Information management

C. Data processing / Calculation Bloomberg

Other systems

Liv.Net

Business strategy

Risk manager

Investment strategy

SimCorp Dimension

Operational platform strategy

G. Process management

IT strategy

liability side, and this application was already in place as concerns fulfilling Solvency II requirements. Data from both applications are then used within an ATP-developed Solvency II ap plication. The programme is developed as an executable programme and the functional flow is set out in Figure 4 (see page 11).

Strategic alignment

Functional alignment

A. Data management

B. Transaction management

Figure 3. Functional setup of ATP’s operational platform. Source: ATP.

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Data storage

Calcualtion

Oracle datawarehouse in SimCorp Dimension

Risk manager calculation

Information storage

Solvency II application

Liability data

Oracle data warehouse

Reporting

Solvency II reports Portal

Liability calculation

Figure 4. Solvency II functional flow on ATP operational platform. Source: ATP. OPPORTUNITY SURMOUNTS OBSTACLE By way of summary, ATP’s implemen tation of Solvency II has underpinned the strength of its new business strategy and the operational platform. ATP has absorbed Solvency II within its overall risk management, and due to the man agement and development of the new operational platform, the focus of the im plementation of the Solvency II require ments has been on the definition and development of the calculation engine, not the processes surrounding them. In terms of business strategy and the operational platform, it is clear that Solvency II implementation is merely a step in the direction that ATP has taken in the last years. Due to the work of the previous years, where ATP management has worked closely with the board in developing the business model, the Sol vency II regime has been based on this, and therefore the conceptual framework is basic knowledge.

The way risk is measured in the risk budget model means that the ATP risk manage ment protocol avoids solvency traps, such as being forced to reduce unhedgeable risks in times of high volatility and negative returns, or being unable to take on addi tional risk when risk decreases and mean reversion sets in. The focus of measurement is not on absolute solvency, but on the risk of ex periencing a red-light situation within a three-month period. So even under severe adverse conditions sufficient reserves are available to take on additional risk. The aim of implementing an internal model under Solvency II is – so to speak - to replace the former red-light model with the model used for solvency calculation, and thereby to use the model in the daily risk management. Implementation of the Solvency II require ments as a part of the operational platform was a perfect match. Platform operations were prepared for the change. The main

SimCorp

processes and responsibilities were in place in order to support a daily production. No changes within the area of responsibili ties were made in order to support the daily production of Solvency II. The data gath ering and quality assurance were already in place, and with a few changes to the existing framework the data production was also in place. Processing the calcula tion and reporting went equally smoothly due to the flexible setup defined as engines on the platform. Implementing the Solvency II regime has therefore focused on the definition and development of calculation and report ing, and ATP has not experienced any operational challenges implementing daily calculation in the organisation. All in all, the main part of the work already done in respect to implementing a Solvency II regime has enhanced ATP’s risk manage ment and therefore ATP perceives the implementation as a business opportunity and not as a regulatory burden.

“Implementing the Solvency II regime has … focused on the definition and development of calculation and reporting, and ATP has not experienced any operational challenges implementing daily calculation in the organisation.”

Jacob Elsborg, MBA, M.Sc., is Head of Technology for ATP’s investment department, a position he has held since 2000 and is responsible for the department’s operational platform. He holds a Master’s degree in Economics and Mathematics from the Copenhagen Business School and an MBA from the Henley Management College in the UK. Jacob Elsborg has worked in the financial industry for much of his professional life, starting his career as an IT economist for Danmarks Nationalbank, the central bank of Denmark, from 1995 until 2000.

ATP Established as an independent entity in 1964, ATP is a statutory pension fund with over 4.6 mil lion members – virtually the en tire adult population in Denmark – and the country’s largest fund. Together with the tax-financed state pension, ATP provides in come security in old age for the Danish population. ATP pensions are life-long, with profit annuities. Members accrue pension rights based on a collective insurancebased defined contribution model. Group assets totalled around DKK760 billion at year-end 2010. ATP invests in a wide variety of domestic and foreign assets. In its investment practice, ATP dem onstrates a long-standing com mitment to codes on corporate governance as well as corporate social responsibility. ATP strives to increase awareness among fi nancial investors and companies of the financial and economic risk and opportunities associated with climate change. More informa tion at www.atp.dk.

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SimCorp

# Dodd-Frank Act: a shift to

liquidity risk puts new demands on IT systems New US legislation embodied in the Dodd-Frank Act will have a direct impact on over-the-counter (OTC) derivatives, clearing and counterparty risk and exposure. This article discusses the paradigm shift in investment management workflow processes arising from the new regulations, examining settlement flows and liquidity issues, and the type of investment management software system architecture that will be required.

assage of the Wall Street Reform and Consumer Pro tection Act, more popularly known as the Dodd-Frank Act, signifies the biggest US regulatory change in several decades and will have a profound impact on the investment management industry across its entire spectrum of business, software system and financial processes – not least in the area of central clearing and counterparty risk and exposure.

Ebbe D. Kjaersbo is Chief Business Consultant at SimCorp, New York, USA. Justin McBride is Chief Business Consultant at SimCorp, New York, USA. Arne E. Jørgensen is Domain Manager at SimCorp, Copenhagen, Denmark.

While Dodd-Frank encompasses a wide range of financial provisions, this article confines itself to the new regulations that specifically relate to the central clearing of OTC derivatives as outlined in sec tion 7 of the Act, and the repercussions for settlement flows, liquidity and risk management. The main purpose here is to address these issues by listing the principal functionalities an investment management institution must consider when choosing a software system to meet these challenges. INVESTMENT SYSTEM CAPABILITY CHECKLIST This article should be read as a catalogue of the potential challenges and issues, which asset managers may face in rela tion to the business processes linked to a particular investment management system. In other words, the points made in this article can be used as a checklist for a self-assessment of software system capabilities. First, we examine the scope and scale of Dodd-Frank, identifying the main provisions related to OTC derivatives, clearing and counterparty risk and expo sure. We seek to define the main issues to address, applying a pragmatic approach

to assessing technology considerations, risk and counterparty exposure, central clearing and various key points such as initial and variation margin. We then go on to identify the main data management parameters necessary to support compliance with the reporting requirements for payment transpar ency and disclosure as contained in the rules related to central clearing of OTC derivatives, drilling down into the fol lowing areas: • • • • • •

valuation; automation; quality; transparency; scalability; reporting.

Finally, and in relation to these main parameters, we describe the type of bestpractice software system architecture in vestment management companies need to support the transparency of transac tion flow and reporting requirements to comply with the specific provisions related to central clearing. Identified are the various investment management system functionalities and processes that are required. These include data main tenance, trading and settlement, initial and variation margins, and finally the verification of, and processes related to, software system outputs such as valua tions and reports. SCOPE AND SCALE OF DODD-FRANK Signed into law in July 2010, the DoddFrank Act covers a wide spectrum of financial reform, but has a clear goal of reducing, or at least controlling, the amount of systemic risk in modern

markets. The main thrust of the legal provisions embodied in Dodd-Frank seeks to correct structural weaknesses in the US financial industry, such as the risk posed by activity that falls outside direct regulatory supervision (i.e. trad ing in OTC derivatives), the systemic risk posed by very large financial entities failing, and the dangers of not requiring underwriters and securitisation compa nies to maintain some exposure to the assets they securitise. While the goal of reducing systemic risk may be clear, the timing of these changes is not – creating an ongoing challenge not only for market par ticipants but also for those who manage the software systems as new ways of assessing and settling margin calls are adopted and new reporting requirements are absorbed. Sweeping as it may be, the legislation is still a work in progress. Many crucial details remain unclear and the industry will have to await details of the rules with which it must comply. Changes in the area of OTC derivatives are to be phased in over a period of time. Yet the precise timing for implementation re mains uncertain. The first of two phases related to OTC derivatives for central clearing initially limited to Credit De fault Swaps (CDS) and Interest Rate Swaps (IRS) was set to take effect from July 2011. However, the timeline is under revision. What is already clear is that the DoddFrank Act will have a major impact on the investment management systems and operational processes of asset man agement institutions. Among the areas most affected will be OTC derivatives,

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clearing and counterparty risk and ex posure. A related challenge derives from the continued use of OTC derivatives during the transition to a new market structure and as the goal of a stable, ro bust and liquid market is realised. To use OTC derivatives appropriately now and in the future, investment management companies working in this space will need tools that offer a clear understand ing of exposure to risk, leverage, and counterparties, given the complexity and inter-connected nature of the modern financial markets. INVESTMENT MANAGEMENT SYSTEM CONSIDERATIONS 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 investment management company have all the tools necessary to determine its various exposures to risk? Does the company use disparate systems to man age investments leading to an inability to holistically review risks? An increased focus on risks, and lessons learned, will lead to a push for IT departments to provide tools that allow for a greater understanding of current risks. The old standards sought to measure weights in classifications such as cur rency, 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 nonlinear returns and specific risk-exposure characteristics of certain security types. RISK AND 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 po tential payment of profits will directly involve their ability to pay, or even, as after the bankruptcy of Lehman Broth ers, 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. But now, financial accounting standards

SimCorp

“What is already clear is that the Dodd-Frank Act will have a major impact on the investment management systems and operational processes of asset management institutions. Among the areas most affected will be OTC derivatives, clearing and counterparty risk and exposure.” are driving the demand for transpar ency by incorporating a Credit Value Adjustment (CVA) directly into the reported fair value of derivatives, mean ing 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 administrative task; pre-deal calculation of CVA affects valuation of current holdings, modifies collateral requirements and dictates preference in trading partners. Exposure is also a factor of leverage, as any derivative – either exchange traded or OTC – will increase exposure to cer tain risks without a cash outlay to actu ally purchase the underlying security. A key tool to assess the degree of leverage is Virtual Cash – the amount of capital saved by transacting in a derivative ver sus a direct purchase of the underlying security, index or risk factor. CENTRAL CLEARING Another aspect of Dodd-Frank for con

sideration is a move away from collateral bilateral trading into a margin-based model using Swap Execution Facilities (SEFs) for execution and price discovery, and exchange-style Central Counter parties (CCPs) to limit the exchange of collateral and mitigate systemic risk. Regulators will also have to determine what must be cleared through a CCP, and therefore traded through an SEF, in order to meet transparency requirements as dictated by Dodd-Frank. The CCP-based trading and clearing process is illustrated in Figure 1. The clearing of trades via a central coun terparty is a well-known and established practice for exchange-traded instruments – it was basically one of the functions the exchanges were originally created to handle, although specialisation entered only later, creating a space for dedicated CCPs. Typically, these trades are very short-lived, stretching just from trade date to settlement date, which limits the operational risk, the counterparty risk, as well as the market risk.

Futures are different. They live longer, typically 3-18 months. Upon maturity, they are usually cash settled by paying the difference between the original price of the underlying and its market price at maturity. To minimise the risk, this difference is paid in instalments (i.e. the variation margin as described below) as the price develops over time; at the end, the accumulated variation margin will be the f inal settlement amount. As security against market changes in the period between the investor’s failure to pay and the bro ker’s ability to unwind the position, an initial margin (as also described below) is made up front, to be returned at maturity. OTC DERIVATIVES Perhaps the greatest change 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.

OTC customer

IDB/ECN/Confirmation service

OTC dealer

Clearing member

Clearing house (e.g. CME)

Clearing member

Figure 1. CCP-based trading and clearing process

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Under Dodd-Frank, the initial scope for central clearing is limited to CDS and IRS instruments. With maturities of typically 5-30 years, they are both very long lived. The CDS bears a strong resemblance to an insurance contract. Described simply: if you own a bond and take out a CDS on it, your counterparty pledges to buy the bond at par value in case the issuer defaults. Like an insur ance contract, you pay a periodic fee for your certainty and this fee is basically a sunk cost at maturity. An IRS is simpler in construction, with merely the periodic (i.e. yearly, quarterly, monthly) exchange of f ixed- versus floating-rate interest payments (or the net difference thereof). An IRS at mar ket terms starts with the value zero and ends upon its maturity with the value zero (or the net value of the last interest payment). However, given its very long lifetime, its market value can fluctuate dramatically in between. While Dodd-Frank attempts to reduce the systemic risk inherent in the trading of OTC derivatives, it only sets the foun dations for this new structure, not the specific details. It does not specify execu tion method or price discovery mechan ics of the Swap Execution Facility (SEF), nor if this is simply a new name for exist ing providers. As the rules governing an SEF are clarified, the pricing definition will become clearer as well. In terms of price discovery, the method chosen will have a direct impact on current systems if straight-through-processing (STP) is an organisational goal, as indeed it must be where implementation of Dodd-Frank is concerned. INITIAL MARGIN Given the long lifetime of CDSs and IRSs and the extensive, albeit tempo rary, fluctuations in market value this can cause, CCPs will require substantial amounts of high quality, highly liquid collateral as initial margin for these contracts. This makes collateral manage ment a central function. It will serve no good purpose to have liquid government bonds out on repurchasing agreements

(repos) and plenty of lower grade bonds in the inventory when collateral has to be posted for the next OTC derivatives transaction. It will be crucial for the collateral man ager (whether internal or external) to have the full picture on which to base decisions and measure the efficiency of the collateral management process. It also means that the trading desk will have to consider the collateral implica tions of their trades – before making them. The costs and consequences of not having the necessary collateral at hand could turn out to be substantial. VARIATION MARGIN Again in terms of the variation margin, the long life times of CDSs and IRSs will make their market values very vola tile. By way of example: the worst day in 2008 saw long swap rates move by 40 basis points from one day to the next. For a pension fund hedging its combination of 10-year government bonds and 40year pension obligations with $50 billion notional of long, centrally cleared IRS, such a move would trigger a variation margin (cash) payment of over $2 billion. Hence liquidity management can sud denly take on completely new and po tentially huge proportions for investment management companies. The CCP may have taken over the counterparty risk, but the new liquidity risk has become just as critical as credit risk was earlier – except that company personnel may have much less experience in dealing with liquidity risk in their business and in vestment management system processes. MAIN DATA MANAGEMENT PARAMETERS Turning to an examination of the main data management parameters necessary to support compliance with the reporting requirements for payment transparency and disclosure in the Dodd-Frank Act’s provisions related to central clearing of OTC derivatives, the areas for consid eration include valuation, automation, full data quality and transparency, scal ability, and reporting.

Valuation Standing behind valuation is obviously data sourcing. Investment management companies having to deal with the Dodd-Frank Act’s provisions related to central clearing of OTC derivatives should have or look for a platform that can consolidate disparate data sources to obtain a true and accurate snapshot of risk exposure, as well as gain insight into liquidity, valuations and other important metrics. In relation to Dodd-Frank, the main purpose of valuation is to use it for both initial and variation margin calculations.

SimCorp

Quality An appropriate data system accom modating the Dodd-Frank provisions should provide near real-time updates to ensure robust data quality for informed decision-making. The updates must be able to encompass the settlement pro cess, variation margin settlement, as well as exposure calculation. Access to timely information is critical for both making investment decisions and managing risk. Investment management organisations should consider the implications of this when deciding on their operating system.

“… liquidity management can suddenly take on completely new and potentially huge proportions for investment management companies. The CCP may have taken over the counterparty risk, but the new liquidity risk has become just as critical as credit risk was earlier ...” Automation An optimal IT system to meet DoddFrank requirements will offer a high degree of automation to support a full straight-through-processing (STP) workflow across different functions in order to minimise any manual processing errors that can lead to financial loss and reputational damage. The system should be sufficiently automated to deal with real-time communication with the CCP and the counterpart, including automatic handling of rejects. Automatic settling of daily variation margin balances in relation to processing of CDS and IRS instruments is also a key ingredient here.

Transparency When gearing up for regulatory com pliance with Dodd-Frank, investment management companies should select a solution that can provide and process all the necessary information required. Even in the best process, errors can sometimes occur. In that event, it is important to have validation procedures and the necessary transparency to iden tify and correct the error. This includes full transparency of the input data used as well as the calculation models. The more advanced analysis the investment company requires, the higher the de mands on transparency. It is therefore

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“As the requirements of Dodd-Frank in the area of central clearing of OTC derivatives become clearer, and as the legislation is expanded to include more and more OTC derivatives, a system is required that has the necessary scalability to adapt and include the new instruments as they are added.” key for the organisation to choose and implement a system that ensures trans parency in how the information has been derived. Scalability As the requirements of Dodd-Frank in the area of central clearing of OTC derivatives become clearer, and as the legislation is expanded to include more and more OTC derivatives, a system is required that has the necessary scalabil ity to adapt and include the new instru ments as they are added. The system also needs to scale to ensure the organisation’s growth potential. Reporting The system must be able to contain reporting mechanisms that identify, monitor and absorb new Dodd-Frank re quirements that arise in connection with any new central clearing mechanisms and structures as and when they come on stream. Using a common integrated platform for as many calculations as possible, whether related to valuations,

margins or whatever, streamlines the reporting process, increases transparency and mitigates risk. INTEGRATED INVESTMENT MANAGEMENT SOFTWARE By way of summary, the Dodd-Frank Act’s provisions stipulating central clear ing of OTC derivatives will force greater transparency in transaction flows, which in turn will require a centralisation of data sources to provide a 360° view in order to ensure that the best investment decisions are made. These obligations, in combination with the all-encompassing need to accom modate greater diversity in the market as well as regulatory reform along the lines of Dodd-Frank, will drive investment management companies to adopt a more integrated approach in their long-term strategy for software system architecture. An overhaul of the system that drives the OTC derivatives market, through Dodd-Frank and associated rules, of

fers an opportunity to review, and possibly retool, the applications invest ment management companies rely on to process OTC derivatives. At this stage, more is unknown than known, and the main focus in the coming months 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. To meet these new and emerging re quirements, an integrated investment management software system provides the best enterprise solution. An inte grated yet modular configuration has the scope and scale to embrace all the instruments covered by the Dodd-Frank provisions in all the areas examined in this article. Whether valuation, automa tion, full data quality and transparency, scalability, or reporting, a one-stop solu tion that is capable of addressing all these points offers the best way to proceed.

Want to learn more about Dodd-Frank? Read more about Dodd-Frank and its implications in the white paper ‘Impact of Dodd-Frank on OTC derivatives: supporting central trading and clearing’. The white paper discusses: • Dodd-Frank’s provisions relating to OTC derivatives • The business systems required to support OTC derivatives as they migrate from bilateral to central trading and clearing arrangements • How an investment management solution can help asset managers work towards Dodd-Frank compliance Download the white paper at http://www.simcorp.com/compliance

SimCorp

Ebbe D. Kjaersbo is Chief Business Consultant at SimCorp North America. With over 11 years of experience at SimCorp, he is an expert in trade settlement processing and in other areas of automating investment management processes. In his current role, Ebbe Kjaersbo leads a team of specialists who implement SimCorp Dimension. He works with SimCorp’s buy-side clients to streamline and automate complex frontto-back office processes, ranging from settlement via central clearing to regulatory compliance reporting. His diverse skills extend from the development of SimCorp standard interfaces to third-party applications such as Bloomberg and SWIFT, to managing multi-million dollar on-time/ within–budget projects. He holds a Masters in Mathematics and Economics. Justin McBride is Chief Business Consultant at SimCorp North America. With over 14 years of industry experience, his areas of specialisation span a wide area of front-toback office operations including trade lifecycle processing and settlement. In his current position, Justin McBride leverages his previous consulting experience with buyside firms in access of US$100 billion in assets under management to support proofof-concepts, requests-for-information and product demonstrations. Before joining SimCorp in 2003, Justin McBride worked for Thomson Financial Investment Management Systems. He began his career at Financial Times Information, where he consulted on the implementation of Extel fundamental data products. Justin McBride is a graduate of the University of Edinburgh, with an honours degree in Economics & Business Studies. Arne E. Jørgensen is Domain Manager at SimCorp. With wide experience in the development and implementation of investment management systems, ranging from central banks over pension and insurance to discretionary asset management, spanning three continents, he has combined business knowledge and IT knowledge. Arne E. Jørgensen was pivotal for both the business and the technical aspects of the solutions SimCorp provided to its clients for the introduction of the Euro in 1999, of IFRS 1999-2005, and of the EU Savings Directive in 2005. The role as domain manager includes monitoring and analysing regulations and legislation like IFRS 9, US-GAAP, NAIC, FATCA, and he is currently heading the Central Clearing Task Force (Dodd-Frank and EMIR) at SimCorp’s Copenhagen headquarters. He holds an M.Sc. and a Diploma in Finance.

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SimCorp

# Cost imperative:

investing to reduce operational costs In the wake of the global financial crisis, many investment management firms have responded to declining client loyalty, downward pressure on margins and an unprecedented wave of new regulatory requirements by sharpening the focus on operational costs and ways to trim IT budgets. Those with a more strategic approach to cost management are assessing a range of other alternatives to introduce long-term cost savings, while at the same time attempting to leverage these investments to better position themselves for growth. This article reviews some of the more common initiatives designed to help reduce operational costs and assesses their benefits and drawbacks.

C Robert Olsson is Research Consultant at SimCorp StrategyLab, Copenhagen, Denmark.

ost cutting has been high on the investment man agement agenda ever since the global financial crisis broke. This is evidenced by a recent SimCorp StrategyLab survey (‘Global Investment Management Growth Sur vey 2010’), where 71% of the investment management industr y participants surveyed ranked growth as their first or second priority, with managing costs following closely behind (67%).1 Industry observers have continued to confirm this trend through 2011; with some glimpse of light at the end of the tunnel, however, cost cutting has taken on a more strategic aspect. A common response to the crisis was to implement quick fixes to reduce costs and improve short-term profitability. Many firms simply stopped or deferred expenditures, while others mandated

cost reductions across the organisation. Such measures will of course reduce costs in the short term, but research has shown that they are typically not sustainable and may even harm future growth potential by cutting long-term investments. COST CUTTING FROM THE TOP When implementing strategic cost management initiatives, it is crucial to have a holistic and forward-looking view that is grounded in future revenue growth, increased prof itability and shareholder value. With an increased focus on growth, a long-term perspec tive is needed. To be able to run a successful cost management initiative over time, it is also vitally important to first determine where the major costs are, find ways to

“To be able to run a successful cost management initiative over time, it is also vitally important to first determine where the major costs are, find ways to manage these costs, and finally, follow up if the cost management initiative actually had the intended effect.”

manage these costs, and finally, follow up if the cost management initiative actually had the intended effect. While the focus of this article is not on project managing cost-cutting ini tiatives, it is notable that SimCorp StrategyLab’s ‘Global Investment Man agement Cost Survey 2009‘ indicated that 48% of participants found that they did not know what the expected savings were on their cost-cutting initiatives. 2 To find the most effective cost management strategies, expenditures first need to be broken down into different areas in order to gain an understanding of the underlying cost structures. For example, the typical breakdown between noncompensation and direct compensation expenses for asset managers is shown in Figure 1 (see page 17). DIRECT COMPENSATION EXPENSES Even though direct compensation ex penses account for more than 50% of total expenses, cost cutting in this area must be carefully considered. To cut the staff and then rehire the same individu als on contract at a higher cost is not un common; yet counter effective to cost. 3 During a downturn in the economy, cutting staff is a common way to adapt to the new level of activity, but as business once again picks up, acquiring the right talent in order to spur growth is typi cally done in a highly competitive labour

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SimCorp

Others 2%

Noncompensation expenses 45%

Direct compesation 53%

market with increased salary demands that may hinder the pace of growth and profitability. Centralisation and reorganisation As a way to trim the organisation, some functions (e.g. sales and marketing) that have previously been handled locally in each business unit could be centralised. The important thing here is to ensure that local variations are not lost due to the centralisation. Another common way to cut costs is to reduce the number of hi erarchical levels in the organisation and push activities down in the organisation. This could produce savings in the range of an estimated 5-10% of the cost base.4 Automation of processes One of the most effective ways to reduce staff costs and at the same time improve organisational productivity is to increase the level of process automation. A fully automated workflow from front to back office (and vice versa), also known as straight-through-processing (STP), is able to reduce staff costs considerably, while enabling growth. An automated flow also provides the organisation with more flexibility and agility. This in turn means that the organisation is more likely to be a first mover for new initia tives, which can help gain market share and ultimately lead to higher growth potential. However, there are three major in hibitors to achieving true STP: internal systems fragmentations, inf lexible systems and inconsistent data.5 And as organisations strive to implement STP, which typically involves strategic, multiyear projects, IT spending patterns indicate that these areas are currently in focus, with systems integration and modernisation of legacy systems being two of the top 10 priorities for 2011.6 In fact, there appears to be a trend towards better enterprise data management and STP, driven by both the weaknesses of a fragmented system architecture exposed by the global financial crisis, and more recently, by the demands of the acceler ating rate of new regulations. In sum

mary, this means that in today’s market, it is critical that investment management firms select an IT platform that not only provides consistent data among front-, middle- and back-office functions, but also is flexible enough to handle future demands, providing highly automated workflows in both directions. NON-COMPENSATION EXPENSES In order to understand the most ap propriate areas in which to focus cost management initiatives for non-com pensation expenses, an understanding

Figure 1. Breakdown of asset managers’ expenses. Source: Cruz, Marcelo 2010, SimCorp StrategyLab.4

which traditionally receive a great deal of attention when cost management ini tiatives are underway and the remaining sections of this article look at some of the more recent alternatives available.

Benefits of SaaS One of the most visible benefits of a SaaS solution is that it provides po tential cost savings compared to an on-premises solution. This means that some maintenance costs and the costs for server rooms are eliminated and there is also a reduced need for fulltime helpdesk, hardware and operations support.

OUTSOURCING AND CLOUD COMPUTING One growing trend in cutting IT costs is to use IT outsourcing and cloud com puting, which includes Software-as-aService (SaaS). With cloud computing considered to be one of the top priorities of 2011,7 it definitely qualifies for further discussion.

Drawbacks of SaaS The main issue with utilising SaaS as a cost-cutting strategy is that in the long term, say three to four years, the compounded SaaS payments generally exceed the cost of an on-premises solu tion.8 This can be acceptable for invest ment management firms, since much of the operational risk of driving a com

“… in today’s market, it is critical that investment management firms select an IT platform that not only provides consistent data among front-, middle- and back-office functions, but also is flexible enough to handle future demands, providing highly automated workflows in both directions.” of the cost structure in needed. Figure 2 (see page 18) shows the typical break down of these expenses for the asset management industry. With the two largest costs indicated as being ‘Real estate and rents’ and ‘IT expenses’, it is therefore reasonable to as sume that these two areas have the great est potential for cost reductions overall. But here the focus is on IT expenses,

Cloud Computing and SaaS Cloud computing can basically be structured in four layers, starting at the lowest level with hosted services and then Infrastructure-as-a-Service (IaaS), offering virtualisation to simulate hardware on-premises, Platform-as-aService (PaaS), offering a computing and development platform, and finally SaaS where a full end-user application is provided in the service.

plicated systems environment is trans ferred to the vendor, which allows them to price their services at a premium to the traditional software on-premises model. While a SaaS strategy provides some relief on the balance sheet, in the long run, the actual cost savings are at least questionable and this needs to be carefully considered against the value of the solution and the level of operational risk transferred to the vendor.

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Real estate and rents IT expenses

Non-tech temporary labour

Market data services

Advertising and marketing

26%

20%

Travel and entertainment Postage

Legal fees

Other fixed expenses

Other professional fees

10%

15%

20%

25%

30%

Figure 2. Breakdown of non-compensation expenses. Source: Cruz, Marcelo 2010.4

One major concern with SaaS has been the security of the business data. This is the most serious risk with using a SaaS deployment strategy and it has many facets. The most crucial problem related to business data is of course a permanent data loss. When the business data crosses in ternational borders to some offshore data centre, problems with legislative compliance could also arise. This means that cost savings by means of cheaper labour at some SaaS vendor’s offshore operation might not be feasible. PROCESSES A logical way to cut costs long term is to look at the processes in the organisa tion and then try to optimise or at least improve these processes. This could take the form of either improving the existing internal process or to simply hire some external organisation to take over the whole process, using for example Business Process Outsourcing or Managed Services.

Business process improvement Many companies around the globe use business process improvement as a means to reduce costs. Among investment management firms it is reported to be the most common cost-cutting meth odology. 2 As part of the business process improvement initiatives, strategies like Lean, Six Sigma or Lean Six Sigma are used to reduce waste and reduce variation in processes. Six Sigma Around since the mid-1980s, Six Sigma was originally developed by Motorola to improve manufacturing processes and eliminate defects. The core concept of Six Sigma is to 1) define the problem; 2) measure the problem by quantifying the current state and analysing it to reveal the root cause; 3) eliminate the problem by improvements; and then 4) control the result of the change9. In a newer itera tion, Six Sigma is combined with lean to become Lean Six Sigma. Lean originates from the Japanese car industry of the late-1980s and is similar to Six Sigma. Even though both Six Sigma and Lean Six Sigma stem from the production industry, both strategies can be applied to other industries as well. All organisa tions have processes and there is always potential to improve these processes; it is only a matter of what kind of processes that are improved in each organisation. By the late-1990s, around two-thirds of Fortune 500 companies had some Six Sigma initiatives in play. In the investment management industry, top performers in terms of their ability to generate profit review their cost structure every six months and use BPI or Lean Six Sigma as cost-cutting methodolo gies. 2 Drawbacks of Six Sigma Six Sigma’s strong focus on optimising individual processes can mean that the individual processes are optimised at the expense of overall enterprise efficiency.

“A logical way to cut costs long term is to look at the processes in the organisation and then try to optimise or at least improve these processes.”

SimCorp

An alternative to Six Sigma that can help to overcome this sub-optimisation is to focus on strategic cost drivers. These strategic cost drivers could be: • • • • •

business configuration; organisational structure and design; business and process complexity; external spending; benefits.

By focusing on the above strategic cost drivers, improvements across business lines and international borders can be achieved over both the short and long term.10 Business process outsourcing An alternative to improving internal processes is to simply outsource the entire process, i.e. using business pro cess outsourcing (BPO). Here BPO is defined as when a company outsources the labour part of a process and retains systems and IT in-house. Although still small in absolute terms, this is one of the fastest growing segments in the invest ment management industry, according to a recent TowerGroup survey.11 Benefits of BPO The advantage with BPO is that it pro vides the company with flexibility. BPO moves some fixed costs, i.e. staff costs, to variable costs and it also enables the company to focus on its core competen cies and thereby slim the organisation. This in turn can enable the company to become more agile to changing business needs. In a recent SimCorp client survey, the expenditure on own staff in the IT department was reported to make up an average 27% of the total IT budget. The big proportion of staff costs means that BPO potentially can have a substan tial influence on the entire IT budget and suggests that vendors that gain from relatively high economies of scale can provide a cost-efficient alternative to inhouse staff for investment management organisations. Compared to full outsourcing of different business functions including outsourc ing of the IT systems, BPO to a greater extent also enables the company to be in possession and control of all business data. To be in control of the business data can be crucial as already discussed.

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“An important point is that any cost management programme involves both cutting costs as well as ensuring that the initiative helps the company to achieve a stronger and more competitive position in the market.” Drawbacks of BPO Even if BPO allows the company to be in possession and control of all business data, the major issues with BPO are risks like: • o perational risks – possible slippages in quality, cost or speed of process execution; • strategic risks – such as protection of intellectual property, security and privacy; • composite risks – longer-term risks, such as inability or difficulty in re placing the outsourcing vendor with internal resources at a later stage due to loss of knowledge.12 Naturally, the risks as cited above have to be carefully considered and analysed before deciding to use BPO to cut costs. However, these risks are very much related to the BPO vendor and to a great extent can hence be eliminated by thorough due diligence during the vendor selection. Managed Services A form of outsourcing very similar to BPO is Managed Services. There are many def initions of what Managed Services actually includes, but a reason able definition is a standardised service, with a relatively small labour component, delivered by a third party for monitoring and maintaining computers, networks and software. It is also common that the Managed Service is delivered as an addon to an already existing engagement with an IT vendor.

Benefits of Managed Services The main benefits of Managed Services from a cost-cutting perspective are, as with BPO, that the organisation can focus on its core strategic initiatives and also that the vendor can bring best prac tices into a project and thereby provide process improvements. In an organisa tion focusing on growth, an increased focus on strategic initiatives can help the organisation become more agile and possibly also shorten the time-to-market for new offerings. These benefits are very closely related to the benefits provided by BPO. Another benefit of Managed Services takes the form of efficiencies for one-off tasks or regularly recurring but inter rupted tasks like regulatory updates or

system upgrades. In these cases, the company buying the service does not have to staff up for these peaks in the workload or maintain the skills for these tasks. Drawbacks of Managed Services On the negative side, a Managed Ser vice agreement can be difficult to fulfil if it proves hard for the vendor to fully understand the client’s pain points and the scope of the project, maybe due to a cultural mismatch between the vendor of the service and the client. In an envi ronment with several vendors providing different services, it can also happen that the vendors blame each other when something goes wrong. Finally, it may prove difficult to exit an existing vendor relationship if the vendor turns out to be uncooperative. It is important to select a trustworthy vendor but also to ensure that the vendor actually understands the processes and pain points of the organisation. Without this understanding of processes and pain points it is hard, if not impossible, for the vendor to provide any useful business process improvements. Managed Services also include the kind of operational, strategic and composite risks applying to BPO but possibly to a lesser extent since the scope of a typical Managed Service is smaller than a fully outsourced process using BPO.

SimCorp

MAIN CONCLUSIONS In this article a number of different strategies have been presented to po tentially help investment management organisations better manage costs while positioning themselves for growth. Some look very promising at first, but do not necessarily help to manage costs in the medium to long-term timeframe. From the discussion it is also clear that some cost-cutting strategies have issues that could produce sub-optimisations and potentially endanger the organisa tion’s existence. An important point is that any cost management programme involves both cutting costs as well as ensuring that the initiative helps the company to achieve a stronger and more competitive position in the market. Quick fixes can actually prove to be very costly solutions when the figures are finally added up. Robert Olsson, M.Sc., is Research Consultant at SimCorp StrategyLab. He has been working within the IT industry for some 10 years and four years within the financial industry. Robert Olsson has held a number of different positions ranging over software development, training, professional services and marketing. He holds a Master’s degree in Informatics as well as a Master’s degree in Business and Economics earned from Lund University in southern Sweden.

Notes

1. SimCorp StrategyLab (2010), ‘Report on Global Investment Management Growth Survey 2010’. 2. SimCorp StrategyLab (2009), ‘Report on Global Investment Management Cost Survey 2009’. 3. Ernst & Young (2010), ‘From cost reduction to cost optimisation’. 4. Cruz, Marcelo (2010), chapter 6 in Pinedo, Michael (ed.), ‘Operational control in asset management: Processes and costs’, SimCorp StrategyLab. 5. Celent (2006), ‘European Post-Trade Processing: STP in the Back and Middle Office’. 6. Aite Group (2011), ‘2011 Capital Markets Technology Spending: Risk, Compliance, and Uncertainty Abound’. 7. Gartner (2011), ‘2011 CIO Agenda survey’. 8. Gartner (2010), ‘SaaS vs. Software: The pros and cons of SaaS pricing’. 9. Arfelt, Klaus (2010), chapter 4 in Pinedo, Michael (ed.), ‘Operational control in asset management: Processes and costs’, SimCorp StrategyLab. 10. Deloitte (2004), ‘Six Sigma’s role in enterprise cost reduction’. 11. TowerGroup (2011), ‘Rodney Nelsestuen: Sourcing, Resourcing, or Outsourcing? Globalizing Operations by 2015’. 12. Kannan, Nari (2011), ‘Reducing operational risk in business process outsourcing’, www.sourcingmag.com.

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# Business Process Management:

a pragmatic approach to reducing costs and mitigating risk

Controlling processes is a key tool to reduce cost and mitigate risk in the investment management industry, with both cost reduction and risk mitigation having been common themes since the recent financial crisis starting in 2008. Business Process Management (BPM) tools and methodologies provide one good alternative to control investment management processes.

I Anders Kirkeby is Domain Manager for System Architecture at SimCorp, Copenhagen, Denmark.

nvestment management organi sations are complex businesses. Mounting demands from ever more complex regulatory regimes help create an increasingly transparent and level playing field for all parties involved. However, these initiatives add little clarity for the organisation itself, as the regulatory requirements mostly cover the external view and not the internal intellectual property, which is frequently the raison d’être and differentiator for a particular organisation. In a recent report on 2011 trends, re search and analyst agency Ovum cites BPM as one of the key priorities for this year. Over the last several years many companies have embarked on enterprise BPM (EBPM) projects, attempting in this way to tie up all processes with a sin gle standard solution. These are valiant

Model and design

Develop and deploy

and useful efforts, but large enterprisewide solutions may have inherent issues when applied to investment management operations. This is especially the case in the level of complexity they can control, project ownership and change agility, not to mention project cost and risk, which may not be acceptable in the current economic climate. AUTOMATION FOR EFFICIENCY AND CONSISTENCY Arguably the most important driving force behind IT investments over the past decades has been automation – the wish to reduce cost or free up resources through automation of specific processes. Lessons from other industries, such as the highly process-driven and automated Japanese car industry in the 1970s, show how large market shares were quickly captured, not just with lower prices but also with higher quality, both of which can largely be ascribed to clear processes and ever increasing levels of automation. Automation was literally turned into a competitive advantage. The value of these earlier lessons today is evident in business-process improvement method ologies such as Six Sigma.1 Automation relies on well-defined pro cesses describing workflows to control who or what does what or when and

Analyse and optimise

Manage and interact

Gathering operational data during process execution, often called Business Activity Monitoring (BAM), is critical. The data is used to continuously opti mise the processes, but also to report on metrics relevant to the specific processes. The ability to report is as important as the automation itself. The data may be used for internal and external Service Level Agreements (SLAs) to make in volved parties more accountable. SLAs are widely viewed as an effective tool for improving efficiency in medium to large enterprises where departmental separa tions may otherwise cause substantial overhead. 2 Taking another lesson from manufactur ing, the investment management indus try is increasingly divesting parts of its

See the chapter ‘Lean Six Sigma’ in asset management: a way to cut costs? by Klaus Arfelt in ‘Operational Management and Control: processes and costs’ (2010), published by SimCorp StrategyLab. 1

SLAs have been used since the late 1980s by fixed-line telecom operators as part of their contracts with their corporate customers. This practice has spread and it is now common for a customer to engage a service provider by including a service-level agreement in a wide range of service contracts in practically all industries and markets. 2

Figure 1. Business Process Management: a continuous process. Source: Microsoft.

under which circumstances. There are several useful definitions of BPM, but here we will define it as the continuous process (see Figure 1) of analysing and optimising the processes required, then to model and design the actual work flows, subsequently to actually develop and deploy the workflows, and lastly to manage the workflows and interact to carry out the workflow tasks. Data gath ered automatically during that last step is then used to facilitate the next cycle of process analysis and optimisation.

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vertical integration stacks. Outsourcing aspects of IT operations is very common and may be very close to the individual organisation’s business services and at arm’s length in other cases. But more recently we see a trend towards Busi ness Process Outsourcing (BPO) of back-office functions, reference data management and traditional middleoffice reporting needs. The outsourced functions, which are deemed not to be core competencies, are still businesscritical. Hence there is a need for clear reporting on how well stakeholders are living up to expected service levels. LET PRAGMATISM RULE BPM PROGRAMMES Many organisations have considered or even begun enterprise-wide BPM programmes to tie all business processes together using a single methodology and software tool support. While this certainly has merit, it is costly and risky, and does not provide immediate results. This makes it a hard sell in the current economic climate. It may not always be feasible from the tool aspect due to a combination of time, risk, cost and technical constraints. The fully unified approach typically requires that all software components across the entire enterprise architecture adhere to one of a small set of defined generic interfaces, typically in the form of Service-Oriented Architecture (SOA). Despite substantial interest in this type of architecture, we are still far from hav ing generally accepted SOA-interfacing standards at anything but perhaps the technical protocol levels. As a result, it would require a substantial amount of standard and custom mid

dleware components to establish a single orchestration interface to all components. The unified approach is a useful longterm enterprise architecture strategy, but many require a more progressive approach to deliver value from a BPM initiative sooner than the unified all-ornothing approach would allow.

SimCorp

The gist of this can be summarised as follows: be pragmatic and apply the enterprise BPM strategy to discrete processes to deliver immediate value. The most likely conclusion is that investment management systems would ideally be fully integrated on a single BPM plat form, but that it is more cost-effective to

“Arguably the most important driving force behind IT investments over the past decades has been automation – the wish to reduce cost or free up resources through automation of specific processes.” Thus the winning approach is to proceed with the analysis work across all business processes to identify the ones with the most potential for cost and risk reduction and procure or evolve the enterprise soft ware environment accordingly to ensure that each of these individual processes can be orchestrated in a single tool. The multi-platform approach is a prag matic choice, but may also be required to control software licence and configu ration costs. Organisations employing pure best-of-breed enterprise architecture strategies accept the cost of integrating and configuring at fairly low levels. Other organisations seek to minimise software costs by employing larger component sets from fewer vendors, which entails them using the workflow tools supplied by the vendor to leverage default configurations as the workflows might be very granular and quite software-specific.

“... be pragmatic and apply the enterprise BPM strategy to discrete processes to deliver immediate value.”

take a pragmatic incremental approach to avoid costly and risky BPM projects which are not particularly welcome in the current economic climate. AVOID STALE PROCESS DIAGRAMS Where BPM tooling is applied, it is par amount to seek platforms where work flow model and execution platform are one and the same. Workflow modelling should not be done in one tool, only to be implemented in another. This creates an all-too-common disparity between process documentation and process ex ecution, which inevitably leads to issues around keeping both synchronised. Many software implementation projects begin with workflow analysis, and lovely diagrams are drawn up in, for instance, Visio and later implemented in the actual operational software. After that point, the diagrams turn stale when subse quent workflow changes are applied to the operational platform but not to the documentation. BPM is not a one-off activity, but rather a continuous programme of process op timisation – both to improve efficiency but also to adapt to changes in the busi

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“BPM is not a one-off activity, but rather a continuous programme of process optimisation – both to improve efficiency but also to adapt to changes in the business environment.” ness environment. The process models should be maintained and optimised continuously. The best way to ensure workf low models are maintained is to have them form part of the system as opposed to simply documentation. The workflow should not be a series of diagrams and protocols maintained as separate documents but rather be data residing within the very tools they are supposed to control. WHO OWNS BPM? Customer Relationship Management (CRM) systems share many character istics with BPM. One is that successful projects to introduce seek to make the most of existing tacit process knowledge in end-users. An effective approach is to put the configuration and modelling tools in the hands of end-users. A good example of the value of empowering end-users rather than relying on tech nologists to introduce new CRM systems is salesforce.com. When it launched the market’s first powerful easy-to-use hosted CRM solution sales departments the world over jumped at the opportunity to deploy a CRM solution quickly on their own without involving their IT departments. The fast-growing market share of salesforce.com demonstrates the value of end-user empowerment. The lesson here is not to bypass ‘IT’ but that some enterprise-component change projects may gain agility and reduce fric tion through end-user empowerment. In BPM terms, business analysts and power users should therefore be the owners of the process modelling and execution. Technologists should support this by providing the necessary integration on demand. Especially the incremental ap proach advocated here would not benefit from being owned by technologists. REDUCE COSTS WITH BPM An investment in BPM can contrib ute to achieving cost-reduction aims. Modelling the processes incurs a cost

but may be done as part of the imple mentation of software to support the business processes. However, the tooling and maintenance will carry additional costs. Nevertheless, the process models supported by BAM data will support analysis with a view to optimising the processes further. The ability to leverage BPM to con tinuously optimise business operations is important. Sufficiently rich models, which are always in synch with actual operations and a steady trickle of op erational data, should provide the tools to continually look for ways to optimise processes. The models provide overview, the data provides statistics on actual us age. Both may change, but in combina tion they provide insights into the actual processes that are taking place. Processes governing human workflows may be used to improve operational ef ficiencies to ensure appropriate responses within expected timeframes along with the tracking tools to generate quality of service (QoS) metrics for performance evaluation of both individuals and teams, possibly through SLAs between teams. RISK AND AGILITY BPM may also be used to help reduce operational risk. Well-defined process models will immediately bring more clarity and an increased ability to com municate the processes and workflows to others who might be able to spot weaknesses. Institutionalising the defined processes should help reduce the occurrence of errors by reducing the set of possible outcomes in any given situation. Trans parency in processes will allow more workflow participants to better under stand the processes they contribute to and how these fit into the larger picture. Greater process transparency also pro vides greater agility to react faster to op portunities and changes in the business

environment. Business process models, which are actively used by supporting software tools running daily operations, should empower business units to do their own ‘what-if ’ analyses and deploy changes without necessarily requiring cross-functional change projects. BPM AND THE INVESTMENT MANAGEMENT INDUSTRY Using BPM to ensure consistency in cli ent interaction is a classic use of BPM in other industries, which applies equally well in investment management. With increasing regulatory requirements for client reporting for investment perfor mance purposes, it makes sense to wrap not only the actual client interaction in defined workflows, but also to model and control the processes leading up to client interaction. One instance of this is found in the regularly scheduled report production tasks where some parts are completely automated, other parts require manual task such as a fund manager’s com mentary, and where at several stages there will be different persons signing off parts of the finished report before it reaches clients. Everything must be seen to be audited and executed in a timely fashion, and that is precisely what BPM can provide by tasking users to take a specific action within a defined timeframe. Many back-office functions are already quite efficient through investment in straight-through-processing (STP) systems. Many organisations have well-defined key performance indica tors (KPIs) and metrics to track STP rates – the rate of transactions processed without human intervention. The cost of transaction processing varies greatly with the nature of the instruments and the involved parties, so even a high overall STP rate does not preclude scope for further optimisation.

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SimCorp

Interest Rate Swap < 20M Own currency Portfolio Manager (PM) can execute < 20M Foreign currency PM needs approval from his manager < 20M < 50M Own currency PM needs approval from his manager < 20M Foreign currency via central dealing desk < 50M Own currency via central dealing desk

Figure 2. Example of possible order handling rules based on order characteristics.

All non-market convention executions via central dealing desk

BPM IN THE FRONT OFFICE TOO? Traditionally BPM has not played much of a role in the front office characterised by more room for individual preferences and proprietary processes. But again, increasing regulation and cost pressures make it highly relevant to look at frontoffice areas where BPM may add value. Smart Order Routing has gained popu larity over the last several years. Some aspects are relevant for BPM, such as rule-driven aggregation of orders and differentiated handling of orders based on specific order characteristics. Work flow models may define the full flow of orders between functional roles in the organisation, e.g. between portfolio manager, compliance officer, dealer, and supervisors. The workflow model may then be en riched with business rules to directly en force compliance or supervisory approval thresholds, which may trigger different workflow paths. Overall workload can then be reduced by allowing portfolio

managers to release orders without supervisory approval if the order value is lower than a certain amount and the risk is deemed sufficiently low. Similarly, some orders may need to trigger valida tion workflow paths to ensure appropri ate roles get their say when necessary (see Figure 2). Without easily configurable workflows, such rules would have to be enforced in a more static and general manner, result ing in unnecessary validation tasks. This carries increased operational risk because a user who routinely has to ignore some elements is likely to occasionally ignore more than intended. BPM TAKEAWAYS Like any other technology under review, it is important to stress that BPM is not a panacea. It is a tool, which is implemented at a certain cost and, if handled well, can be used to achieve demonstrable benefits. Ap plying BPM strategically in discrete areas will help to deliver value in the short to medium term rather than long term only.

“Automation is the driver behind BPM to reduce cost and mitigate risk through fewer possible outcomes in any given business process and process step.”

Automation is the driver behind BPM to reduce cost and mitigate risk through fewer possible outcomes in any given business process and process step. BPM can be applied more widely across the business functions in investment management, including areas that may not have had much BPM attention in the past, of which only a few are mentioned in this article. BPM should be viewed as a continuous cycle of process optimisation, which requires process model and deployment to be one and the same to preserve a single version of the true picture. Such a single version provides agility to make changes to follow shifting business needs fast and safely. Anders Kirkeby is Domain Manager for System Architecture in the Strategic Research department at SimCorp. He leads a team charged with setting and executing strategically focused changes in the SimCorp Dimension investment management software product. His specific focus areas include scalability, enterprisewide cross-functional consistency and overall user experience. Prior to joining SimCorp, he served in software architecture and consultant roles focused on the Microsoft technology stack as well as a three-year IT start-up engagement as technologist and product owner for a SaaS product. He earned his degree in Computer Science and Human-Computer Interaction from the University of Aarhus, Denmark.

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SimCorp

# Client centricity: the new investment management business model?

As investment management companies seek to differentiate themselves from their competitors in the new post-financial crisis environment, many are turning to a more client-centric approach. This article seeks to define the business model, examine some of the reasons behind the approach and highlight some of the ways in which an investment management organisation can deepen client understanding and enhance profitability.

C Lupus Maltzahn is Head of Accenture Wealth and Asset Management for the UK and Ireland, London, UK.

lient centricity is not a new concept; before the finan cial crisis it was mostly a vague one, but issues of trust, as well as economic and regulatory pressures, have made it a more tangible part of the strategy of investment man agement businesses. Companies are considering ways to move away from siloed, product-driven businesses to ones that are focused on what clients want. This is a good thing not only for re-establishing consumer trust and the industry’s relevance but also in terms of its economics and technologies. However, there are reasons to question whether the large-scale client relation ship management (CR M) projects already underway or about to be started at many investment management com panies are the best way to address this issue. To design, build and implement a CRM solution that works for a busi ness as large, varied and complex as are most investment management businesses today, without f irst simplifying the problem, is in our view very hard to do or get right. Rather, we believe that there are sig nificant advantages to a more pragmatic approach that: • m akes best use of the fact that the number of clients an investment management business has is com paratively low; • recognises that some of the present peculiarities of investment manage ment businesses, such as high com

plexity, silos, departmental ‘fiefdoms’ and regulatory and technological issues, make it very hard for large CRM projects to succeed. The approach set out in this article does not seek to define the dream world that CRM solutions suggest from the outset. Instead, it looks to create the basis for simplifying the problem and approach ing the question of client centricity, starting with the client rather than with a CRM solution that can never be more than a tool to support the client-centric business. Specifically, we would suggest that businesses: • s tart with a relatively simple analysis of existing data on clients and their behaviours, which is possible as the number of investment management source systems and clients is relatively small; • create an initial segmentation based on economic value and potential of clients, their behaviours and needs; • look at ways to align product offer ing and the channels to these client segments; • use the outputs of these three steps to map out a future model where the business serves its clients in a way that is profitable and at the same time creates relevance and trust, thereby strengthening the corporate brand. In our experience, such an approach has enabled businesses to control costs in re lation to both value created and certainty of successful outcome, and created the momentum and focus required to turn

investment management businesses supported by the appropriate and nec essary software systems infrastructures into high-performing, client-centric organisations. CLIENT FOCUS: BACK TO BASICS In the wake of the financial crisis, many leading investment management busi nesses including investment banks, as set managers and wealth managers are re-establishing a clear focus on client relationships. They are right to do so. In the years leading up to the crisis, investment management businesses moved away from their traditional role as client-focused intermediaries, and instead began concentrating on developing products. In doing so, many firms effectively turned themselves into product factories, selling to a broad and diverse portfolio of clients. Moreover, the different silos of the product factories have become increasingly complex and separated, making it very hard to see and serve clients in a unified manner. Today, the shortcomings of this productdriven approach have become increas ingly evident. With capital requirements rising and profit margins declining, a combination of client demands, regula tory changes and commercial pressures is shifting the emphasis away from prod ucts, and back towards client intimacy and satisfaction. Why? Because, in turning themselves into product factories, investment man

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“With capital requirements rising and profit margins declining, a combination of client demands, regulatory changes and commercial pressures is shifting the emphasis away from products, and back towards client intimacy and satisfaction.” agement businesses have endangered their relevance to clients, and under mined their economic focus. Going for ward, those firms that can truly under stand clients’ behaviours and needs – and thereby align their service offerings with what their clients seek and value – will stand out from their competitors, and be better placed to grow revenues and client profitability over time. MAJOR FAULT-LINES TO SIDESTEP In our view, refocusing on the client is not just a smart thing for investment management businesses to do, but also a prerequisite for future high performance. Over a prolonged period of ‘fat’ years, firms neglected investment in client service in favour of developing ever more highly engineered products from within different silos. As a result, they have undermined the value and loyalty upon which long-term client relationships depend, while simultaneously losing any unified or consistent views of each client’s needs, and also profitability. Today, in the colder post-crisis environ ment, this legacy has resulted in two major fault-lines in firms’ client relation ships. The first fault-line is a crisis of rele vance and trust. The focus on developing and selling products has made clients feel that firms are pushing different products through separate parts of their organisa tion, with little all-round understanding of the client’s requirements. Experience shows that clients trust firms that they feel understand them to provide them

with solutions that meet their needs. The widening gap between the products on offer and clients’ real needs – coupled with underperformance by some of the products themselves – has critically un dermined this trust. The second fault-line is the economic unsustainability of the product range, the business, the operational and IT complexity it involves, and the sales and client service model. By effectively becoming factories churning out prod ucts through siloed, product-focused sales teams, investment management businesses have made it very hard to create and maintain an integrated and unified all-round view, not just of client needs but also of client profitability. And conversely, this also means that it is very hard – if not impossible – to evaluate the degree to which a signifi cant amount of the complexity and cost in a modern investment management business actually creates value. At the same time, reduced client willingness to buy complex, high-margin products has forced firms to refocus on some of their more commoditised offerings, driving down margins still further. Taken together, the combination of these two fault-lines with firms’ rising complexity and cost means leaving things as they are is not an option. Post-crisis, it is increasingly clear that what key segments of an investment management business’s client base now value – and will pay for – is not products for products’ sake. Instead, they want

a service that is aligned to and serves their specific business needs for an ac ceptable price. Delivering this in a world of tighter margins and higher capital requirements is the challenge now fac ing investment management businesses worldwide. CLIENT CENTRICITY: FOUR KEY FOCUS AREAS There is a way in which firms can si multaneously address both the crisis of relevance and the economic unsustain ability of their product and sales model. By putting the client’s behaviour and needs at the core of everything they do, and aligning every aspect of their service and product offering with these, firms can rebuild relevance and trust and regain visibility and control over client profitability. Once client centricity is embedded, the sales and marketing teams can increase the benefits still further by using the new client insight to identify and target high-potential clients with the optimal combination of compelling product, ser vice, technology and channel. Equally importantly, the firm will have clear sight of the return on investment from these efforts. In seeking to achieve client centricity, investment management companies need to take into account two ongoing shifts on the client side. One is that today’s clients are more diverse than ever before, with more specialised needs and preferences, so understanding them requires correspondingly more insight and precision. The other is that customer expectations are rising as fast as their sense of loyalty declines, with the result that satisfying clients’ requirements now demands more focus and consistency than in the past. So, how can investment management businesses achieve the benefits of client centricity in a way that takes account of these challenges? Getting client cen tricity off the ground does not require a large upfront investment. Instead, a firm can make real and substantial progress by extracting its existing client data, and applying relevant, targeted analytics quickly and at low cost. The momentum behind the resulting ongo ing improvement in client relationships and profitability can then be built up progressively over time.

SimCorp

A firm that focuses successfully on four key areas will find it can build deeper, more durable and more profitable client relationships based on mutual trust and value. These four areas are: 1. Conduct basic analytics to understand clients’ buying needs In many cases, efforts to impose a clientcentric culture from top-down through a massive investment management systems implementation project fail because of three challenges. The first is the siloed structure of much of the legacy IT infrastructure, with different business units unable to share information easily or effectively. The second is issues around data protection and client privacy, again preventing sharing of data. The third is that embedded ‘fiefdoms’ in the busi ness may be unwilling to share client information and relationships that they feel belong to them individually, rather than to the firm as a whole. These same barriers have the effect of impeding cross-selling and a 360° view of client profitability. Given these issues, a ‘large’ systems im plementation effort from the ground up is usually not the best way forward, and will struggle to deliver. Client data may exist at many points across the business, in many formats. The challenge is to identify and integrate the data. A more workable and effective solution may be to pull together these disparate elements of data into one place, and then conduct analytics to identify and understand the patterns in clients’ behaviour and needs. Launching a small initial pilot pro gramme of client data analytics also brings several additional benefits. By fostering deeper client understanding, it can help to highlight not just patterns of client behaviour, but also the most pertinent elements of data that will help to shed light on those patterns. As more and better data is pulled in, the analytics can be iterated to progressively sharpen the insights. And the early findings can be used to produce ‘quick wins’ that de liver good returns in a short timeframe, helping to sell the idea of analytics-based segmentation to the sales team and across the business as a whole. Once the iterative analytics programme is embedded and gaining momentum, the insights generated can be incorpo rated into the firm’s management infor

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“A more workable and effective solution may be to pull together these disparate elements of data into one place, and then conduct analytics to identify and understand the patterns in clients’ behaviours and needs.” mation system and incentives, thus fa cilitating the cultural shift required. One approach for extending the programme is to adopt an appropriate software system architecture that collects and analyses the client data from various sources — thereby replicating many of the benefits of rebuilding the CRM infrastructure. In the longer term, the benefits of better client understanding will be felt through out the organisation. By providing senior management with insights into why customers buy particular product and service offerings, it enables the business to regain control of client understanding. Furthermore, aligning, unifying and in tegrating the client data across products and sales teams enables individual client profitability to be tracked, managed and improved. And if regulators ask why a particular product was sold to a particular client, true and accurate data is available to show why the product purchase was in line with the client’s needs and behaviour. 2. Group clients into segments based on behaviour and need Having gained a better understanding of clients, the next step is to segment them into groups or clusters sharing similar behaviours and needs. This provides the basis upon which to develop and deliver a specific blend of products, services and technology that meets the requirements and expectations of each client segment. To restore relevance and trust, firms need to return to a clear view of how their clients behave, and of the attributes that shape that behaviour. This means view ing the customer base as a structured portfolio of clients, each with specific needs and requirements that place them in particular segments. 3. Re-align product offering and delivery channels to support need Having identified segments based on clients’ behaviour and needs, the next step is to develop a hypothesis about the overall value proposition – including

service model, product offering and chan nels – that will best satisfy the specific customer. This will include the definition of clusters and categories showing what some clients buy and others do not, tak ing into account the relative importance of multiple customer values, including speed, reliability and convenience, as well as price. Through this approach, the firm can assemble the right service elements to optimise the client’s experience – and the resulting buying behaviour – consistently across customer channels and touchpoints. In this way, the firm can move its offering to each client to the point where the right client behaviour, experience and economics intersect, giving the client and the firm itself every reason to continue doing business together. By tailoring client contact as part of a structured overall offering, businesses are able to reach the right clients at the right times in the right places, and engage in a two-way exchange of information. This offering dovetails with the client’s preferred behaviour to deliver a consistent and highly relevant customer experience and offering that breeds trust and loyalty. The result is differentiation and growth for the business. 4. Initiate actions to enhance brand over time Brands are built up in people’s minds mostly through their personal experience of interactions with the brand itself. One key factor in trust creation is the cred ibility that stems from consistent delivery of solutions that show insight into, and concern with, client needs. In combination, the first three building blocks of client centricity that we have described will enable the business to reach the right clients with the right mes sages for the right products via the right channels at the right time. They will also enable the firm to keep clients at the cen tre of strategic decision-making, process

design and management, technological sophistication, organisational design and talent management. In achieving these goals, the fourth building block becomes possible: fulfill ing the brand promise in a way that can be continually improved through ongoing client feedback and behavioural analytics. When an investment management busi ness builds trust through relevance to cli ent’s behaviour and needs, this trust does not just apply to the immediate products being bought, but to its wider brand of fering and values. This enables the firm to embed its brand with clients, boost client cross-sell and profitability, and optimise sales and marketing investment in new opportunities. TRUST AS ENABLER While it is impossible to gauge how all the factors affecting the investment man agement industry – financial, economic, commercial, technological or regulatory – will play out in the coming years, what is clear is that a client-centric organisation will stay very close to its clients during these uncertain times. It will do this by maintaining a clear 360° view of what each client wants from it, and of how successfully the company is fulfilling that specific client’s behavioural and business requirements. A client-centric investment management business will differentiate itself from its competitors by ensuring that it stays rel evant to its clients in difficult times and that its investment management system continuously meets the client-centric demands embedded in achieving the relevance. Its clients will appreciate and remember this relevance, coming to trust the company and its brand in a way that is both intimate and professional. This in turn will open up opportunities for profitable growth. The critical enabler for capitalising on these opportunities is trust. A product

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can be commoditised. A trusted rela tionship, however, will always remain a unique differentiator. The successful investment management businesses over the next few years will be those that make it their first priority to help clients achieve their long-term aspira tions in the way they want to achieve them as opposed to simply convincing them to buy more products. Investment management companies can embark on this journey speedily, pragmatically and at reasonable cost. The data and insight needed to support greater client understanding should already exist at various points within the organisation and the challenge is to reshape the organisation around such understanding and quickly identify the patterns and segments involved. The first step is to bring the disparate data together, and then, supported by the right investment management software system, to act on the findings to build momentum from there. Lupus Maltzahn leads Accenture´s Wealth and Asset Management practice in UK/ Ireland as well as the company’s UKI Capital Markets Management Consulting business. He has more than 15 years of experience in the wealth and asset management area, having worked as a consultant to the industry as well as in the wealth management and private equity space. His specialist areas include business strategy, operating strategy and operating models in private banking, wealth and asset management. Lupus Maltzahn holds a degree in Modern History from Oxford University.

Accenture Accenture is a global management consulting, technology services and outsourcing company, with approximately 211,000 people serving clients in more than 120 countries. Accenture’s Global Capital Markets practice serves more than 275 clients worldwide, including 14 of the world’s top 15 investment banks, 8 of the top 10 global custody companies, 16 of the top 20 money managers, and 14 equity, commodities, and futures exchanges. More informa tion at www.accenture.com.

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# SimCorp StrategyLab Copenhagen Summit 2011: key investment management industry challenges analysed

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Thought leaders representing the investment management industry convened with renowned academics at the SimCorp StrategyLab Copenhagen Summit 2011 to discuss key investment management industry challenges in the post financial crisis environment. They articulated their findings in three thought-provoking white papers now published and which are summarised in the following article.

W Professor Ingo Walter, Seymour Milstein Professor of Finance at the Stern School of Business, New York University is Director of SimCorp StrategyLab.

ith the passing of the global financial crisis of 2008-09, many things have changed for global f inance and for the asset management industry in particular. As we now know all too well, major finan cial shocks can no longer be contained. They spread with amazing speed, both geographically and across asset classes and financial intermediaries. Financial interconnectedness can bring great ben efits, but it also generates large systemic risks, and there are few places to seek refuge from its consequences. As expected, the asset management in dustry is one area of the global economy that has not been spared. Massive losses at the apex of the crisis in late 2008 af fected assets under management (AUM) in all but a few hedge funds that cor rectly bet against the asset classes in question – losses that would have been even larger had not the financial inter mediaries involved invested in the same assets that proved to be toxic and that otherwise would have been fully passed on to asset managers. As it turned out, most investment managers took some very large hits, impairing pension funds’ ability to meet their defined benefit obligations, forc ing large losses on defined contribution clients, and eroding accumulated assets in investment funds. The crisis has led to fewer and larger, even more complex and interconnected financial intermediaries,

and its aftermath has increased rather than decreased the world’s exposure to systemic risk. Living in this new world poses a whole new set of challenges for investment managers, both in serving their clients well and in devising new business models. BEYOND ‘BUSINESS AS USUAL’ It is hardly surprising that global finance is again facing a new regulatory environ ment, something that has characterised the aftermath of every significant finan cial shock in modern history. Taxpayers continue to show very little patience with behaviour they regard as posing new risks to the system and, worse, ‘privatising returns and socialising risk’. The memory of taxpayer losses and risks borne at the height of the crisis remains fresh in people’s minds and underpins the political will to move beyond ‘busi ness as usual’ toward a more robust fi nancial infrastructure. Bolstering capital is the centrepiece everywhere, with few reminders needed how undercapitalised major financial intermediaries were at the height of the crisis. Beyond that, key initiatives focus on asset origination, assessing asset qual ity and the role of rating agencies, incentive-compatible approaches to compensation, car ve-outs or ringfencing of activities that do not belong in systemically-sensitive financial inter mediaries, and reaching into consumer protection in asset origination. The task is to significantly bolster the safety and

soundness of financial intermediation, while at the same time preserving as much as possible of the industry’s effi ciency, innovativeness and competitive ness. As this effort proceeds, no part of the banking or shadow-banking system, including asset management, will be spared the need to respond in a sensible and sustainable way. For asset management, these challenges focus from a functional and technologi cal perspective on managing risk, con trolling costs and enabling growth, and from a sectoral perspective on invest ment funds, pension funds and alterna tive investment funds. The immediate impact of the turbulence in all three sec tors involved dramatic declines in assets, affecting clients as well as revenue based on AUM and investment performance. This clearly stressed existing business models, with much greater pressure on both risk management and cost control on the part of asset management com panies. Many clients have become much more risk-sensitive as well as expensesensitive in an environment in which asset management outperformance is hardly assured. RISK, COST AND GROWTH MANAGEMENT REBUILD TRUST The importance of convincing clients that cost control – and the investment management soft ware system sup porting it – lies close to the heart of an asset manager’s strategy, and that risk

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“The importance of convincing clients that cost control – and the investment management software system supporting it – lies close to the heart of an asset manager’s strategy, and that risk management techniques are as close to the state of the art as possible, is surely more crucial today than before the financial turbulence.” management techniques are as close to the state of the art as possible, is surely more crucial today than before the financial turbulence. Both dimensions of asset management lie at the core of any credible and durable strategy in this industry, and one that will translate into an equally convincing growth profile. To be sure, global assets under man agement in all sectors of the industry will continue to show disproportionate growth, but that growth will have a dif ferent geographical profile than before and will require serious progress on the risk management and cost management fronts to be harvested.

MISSION AND VISION As one of the main activities of the SimCorp StrategyLab research pro gramme 2010-11, the Copenhagen Summit 2011 and its deliverables are directly aimed at supporting the mission and vision of SimCorp Strat egyLab. To find appropriate solutions and to gather relevant best practices for the top strategic institutional levels of the investment management in

SIMCORP STRATEGYLAB PER FORMS THOUGHT LEADERSHIP In its capacity as an independent re search institution, SimCorp Strat egyLab earlier this year undertook a major effort to bring together leading academics and practitioners in a series of thoughtful and lively debates in the form of the SimCorp StrategyLab Co penhagen Summit 2011. Each of the meetings addressed each of the follow ing three industry sectors: investment funds; pension and insurance funds; and asset management. The meetings were based on the observation that each of these sectors follows its own dynamic

dustry, 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. STRATEGYLAB PROFILE SimCorp StrategyLab is formally organised under the management of

and faces some unique challenges. The objective of the SimCorp StrategyLab research programme for 2010-11 was to identify and analyse these challenges and to draw some conclusions of strate gic value to the industry. Up for discussion were 12 key challenges facing the three individual industry sectors, related respectively to risk, cost and growth issues. Three esteemed aca demics headed up teams of high-profile academics from renowned research in stitutions, such as INSEAD and Stern School of Business, NYU, as well as sen ior executives from major international

a board of directors. The chairman of SimCorp StrategyLab’s board is the CEO of SimCorp, Peter L. Ravn (Ph.D.). Heading SimCorp Strategy Lab is Ingo Walter, Seymour Milstein Professor at the Stern School of Busi ness, New York University, who is in charge of the research institution’s academic affiliations and oversees the quality of its research work and re lated activities. Along with SimCorp StrategyLab’s partners, and building bridges between theory and practice, are leading academics, industry ex perts and executives who contribute to its research programme and other activities.

associations, consulting and investment organisations, including the European Fund and Asset Management Associa tion (EFAMA), TowerGroup, Danske Capital, Nordea Investment Manage ment & Life and Schroders. Each of the three academics pre sents the main conclusions drawn from the three meetings in three white papers that form one of the main deliverables of the SimCorp StrategyLab research programme for 2010-11. The white papers combine the consensus reached in each of the discussions, as well as on-going research among academics, policymakers and industry associations. We believe each white paper is both definitive and de fensible in its analysis and implications for firms in the global asset management industry. Ingo Walter, Director of SimCorp Strategy- Lab, is Vice Dean of Faculty and Seymour Milstein Professor at the Stern School of Business, NYU. Professor Walter has had visiting professorial appointments worldwide and remains a Visiting Professor at INSEAD in Fontainebleau, France. Professor Walter‘s principal areas of academic activity include international trade policy, international banking, environmental economics and economics of multinational corporate operations.

OTHER ACTIVITIES Among SimCorp StrategyLab’s other activities for the 2010-11 period and following up on the SimCorp Strat egyLab Risk Management Award 2010, SimCorp StrategyLab is seek ing applicants for the SimCorp Strat egy 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 28-30 September 2011 at the SimCorp Dimension Inter national User Community Meeting 2011 in Stockholm.

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# Investment fund insights:

COPENHAGEN

SUMMIT

2011

post-crisis hindrances to growth pose key industry sector challenge

T Martin J. Gruber (Ph.D.) is Professor Emeritus of Finance and Scholar in Residence at the Leonard N. Stern School of Business, New York University, New York, USA.

he biggest challenge facing the investment funds sector today is the challenge to growth as triggered by the financial crisis of 2008-09. The crisis resulted in money flowing out of funds (although it has started to flow back in), and people switching funds both within and between fund complexes, reacting rapidly to short-run moves in the market. The crisis has also increased the threat of new regulation as to how investment funds can or should function. All of this has increased the uncertainty for invest ment fund management. One way investment funds can start to meet this challenge is to work on their public relations. The investment fund industry has a really good track record, and if the last three financial crises are examined, we find that while the industry suffered temporary losses as a result of each crisis, when the crisis was a year past the industry bounced back to previous levels. While there is a threat of increased regulation, the point also has to be made that regulation is a cost but also one of the biggest advantages for the industry, because regulation in combination with the industry’s self-determination has led to a tremendous transparency in the investment fund business; more transparency than is offered by any other financial intermediary. This is one of the

major advantages of investment funds that has to be promoted. The biggest opportunity facing the in dustry today comes out of a very large social challenge. If we look around the world today, the demographics in every country mean that we have fewer working people supporting more retired people. This means that we have to have better and better schemes for retirement planning. In the USA, 70% of the people owning investment funds, when asked why they own such funds, the principal reason they gave was retirement. The private retirement system has to grow all over the world, but particularly in Europe. Investment funds are a natural product for the retirement industry and can also be crafted into a platform that will actu ally help people plan for retirement. We see this as representing a tremendous opportunity for the development of products and systems and one that the industry finds advantageous. The four main conclusions in the Invest ment funds white paper are: • B usiness issues related to risk, cost and growth factors are intercon nected and impact investment funds in varying degrees of significance. • Increased market volatility, financial instability and regulatory change

Download the ‘White paper on Investment funds’ and watch the interview with Professor Gruber at: www.simcorpstrategylab.com/summit

have become permanent features of the global industry landscape, creat ing challenges as well as opportuni ties for industry players. Although the outlook for the investment funds industry remains broadly optimistic, the ability to manage risk, cost and growth respectively will separate the winners from the losers. • Changing demographics (i.e. ageing population) will alter investment funding patterns, creating new cost challenges but also growth opportu nities for the investment management industry as a whole. • S cale, internationalisation and the right choice of investment manage ment system are key determinants in controlling risk of both a market and a regulatory nature, curbing costs whether in the IT or operational sphere and spurring growth in terms of both business and product. Martin J. Gruber (Ph.D.) is Professor Emeritus of Finance and Scholar in Residence at the Leonard N. Stern School of Business, New York University. He is a director and member of the executive committee and the investment committee of the National Bureau of Economic Research. He is a Past President of the American Finance Association and a Fellow of the American Finance Association, Financial Management Association and Institute for Quantitative Research in Finance. Marty Gruber is a director of the Daiwa Closed End Funds and has been a Director of DWS Investment Funds, SGCowen Investment Funds, TIAA-CREF. He has published six books and over 100 articles on investment analysis and portfolio management. Marty Gruber holds an S.B. degree and Chemical Engineering from MIT and a Ph.D. in Finance and Economics from Columbia University. He was also awarded the degree of Docteur ‘ honoris causa’ by the University of Liege, Belgium.

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JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

# Pension and insurance fund insights:

SimCorp

COPENHAGEN

SUMMIT

2011

demographic pressures on fund returns top industry sector challenges

T Massimo Massa (Ph.D.) is the Rothschild Chair Professor of Banking and Finance at INSEAD, Fontainebleau, France.

he biggest challenge facing pension and insurance funds today is the rapidly ageing population. This will force funds to provide participants with pay-outs for a longer period of time. Pension and insurance companies will be required to provide high returns and at the same time stable cash flows for the retiring population. In other words, the industry is under pres sure to provide higher returns, presumably adopting an increasingly client-centric ap proach with more customised services, and, at the same time, lower risk and greater dependability. This will increase demands on the companies. In the next 10-20 years, the entire industry has to restructure itself in order to simultaneously better manage risk, provide stable cash flows and meet more and more the tailored needs of their corporate sponsors and participants. One of the key factors that could lead the in dustry to a successful future is consolidation. The simultaneous requirement of higher performance, lower risk and more stable cash flows can be met in a better way mostly by bigger financial groups that can invest across many different asset classes and per form stable and reliable risk management by acquiring the right asset management system to enable and support this. No doubt, the biggest opportunity facing the industry is the switch from a pay-asyou-go system to a new one based on three

pillars. Pillar I is mainly pay-as-you-go, usually defined benefit and redistributive; Pillar II is the private funded, almost always defined contribution; and Pillar III is the private funded, voluntary, supplementary, preferably defined contribution. Next to the government-provided funds, private funds will participate in the growing business of providing coverage to an increas ingly aging population. Both the companysponsored plans and the employee-funded funds will be mostly in the private domain. Private pension funds and insurance com panies will be competing to exploit this new opportunity. The four main conclusions in the Pension and insurance funds white paper are: • C hanging demographics (i.e. ageing population) will alter pension funding patterns, creating new cost challenges but also growth opportunities for the pension and insurance funds industry as a whole. • Greater market volatility, increased financial instability and more regulatory change are creating challenges as well as opportunities that are not necessar ily always in equal measure. The main drivers for success in the pension and insurance funds industry will be flexibil ity in implementation and adaptability in operation. • Scale, internationalisation and the right choice of investment management

Download the ‘White paper on Pension and insurance funds’ and watch the interview with Professor Massa at: www.simcorpstrategylab.com/summit

software system are key determinants in mitigating risk, controlling costs and promoting growth. It is not only the investment side of handling assets under management that is to be con sidered but also a software system for handling assets and liabilities; therefore an appropriate investment management system for the entire business should be considered. • The investment management software system is the common denominator running through all the themes dis cussed. It is beneficial in ways to reduce cost, promote flexibility and create a huge barrier to entry for others intent on entering the industry. If sufficient resources are forthcoming and the com pany big enough, the right operational platform (operational setup, procedures, staff as well as IT solutions) effectively helps create a special niche and to fend off competition. Massimo Massa (Ph.D.) is the Roths child Chair Professor of Banking and Finance at INSEAD, where he teaches international finance, corporate finance, information financial economics and behavioural finance in MBA, Ph.D. and Executive programmes. He has obtained an MBA from the Yale School of Management and an M.A. and Ph.D. in Financial Economics from Yale University. His research interests include portfolio theory, theory of information in financial markets, behavioural finance, market microstructure and investment funds. His articles have been published in academic journals such as the Review of Financial Studies, Journal of Finance, Journal of Financial Economics, Journal of Business, Journal of Financial and Quantitative Analysis, Journal of Financial Markets, Review of Finance, and European Journal of Financial Management. Massimo Massa has previously worked in the Bank of Italy in its Banking Division (1989–92) and in the Research Department of its Monetary and Financial Markets Division (1993–97).

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JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

SimCorp

# Asset management insights: rebuilding trust is

COPENHAGEN

SUMMIT

2011

the main challenge facing global asset managers

T Stephen J. Brown (Ph.D.) is David S. Loeb Professor of Finance at the Leonard N. Stern School of Business, New York University, New York, USA.

he greatest challenge for the asset management industry since the global financial crisis is to rebuild confidence. Confidence has been shaken, regulators have been stirred, an increasing ground swell of regulation is in the pipeline, and the industry has to get to grips with these issues. Last but not least, clients are concerned and the industry must develop procedures and techniques to deal with this crisis in confidence. What clearly emerged from our group discussions was the need for asset manage ment companies to increase transparency at all levels: transparency in terms of the cost structure as many companies do not fully comprehend their own individual cost structures; transparency in business processes – if the companies fail to fully understand some of the products they are selling, how can they explain them to the clients? In the period before the crisis the asset management enterprise was very different from what it is today. Businesses were able to survive with very high cost structures. Now we are seeing a need to control costs and a need to be transparent within the organisation on the nature of the products being sold and the magnitude of the costs necessary to provide those products. For the asset management business as a whole, the most pressing challenge is

the crisis in confidence resulting from the financial crisis. On top of this, there is increased competition from low-cost providers as well as increased government regulation and intervention in the markets. The opportunity for growth lies with those enterprises that are most able to meet these challenges by providing transparency to their clients, their stakeholders and in particular their regulators. Those enter prises that can meet this challenge will be the ones that will be the most effective in meeting future challenges. They will be the winners in this new and different environment. The four main conclusions in the Asset management white paper are: • Th e main conclusions to emerge from the discussions were the importance of rebuilding investor trust, the important role of increasing transparency at all levels as a means to that end, the dif ficult challenge posed by increasing competition from low-cost providers, and finally the extent to which the fac tors that influence risk, cost and growth interrelate. • Clearly, the greatest challenge since the global financial crisis is to rebuild confidence. Confidence has taken a severe knock, regulators have been put on notice, and there is an increas ing groundswell of regulation in the pipeline. The industry has to come to

Download the ‘White paper on Asset management’ and watch the interview with Professor Brown at: www.simcorpstrategylab.com/summit

grips with this reality. Last but not least, clients are concerned and the industry must develop procedures and techniques to deal with this crisis in confidence. • We believe that the most effective way in which to rebuild lost confidence is for asset management companies to ensure that their investment manage ment systems embrace transparency at all levels: transparency in terms of really understanding and comprehending their own individual cost structures as well as the need to increase transparency in business processes and products for sale. • The crisis in confidence is also associ ated with increased competition from low-cost providers as well as increased government regulation and related chal lenges. Those enterprises that are best equipped to meet these challenges will benefit the most in terms of exploiting their growth opportunities. Stephen J. Brown (Ph.D.) is David S. Loeb Professor of Finance at the Leonard N. Stern School of Business, New York University, USA. He graduated from the University of Chicago with an MBA and a Ph.D. in 1976. On his first appointment at Bell Laboratories, he spent time on assignment as District Manager in the AT&T Pension Fund where he was responsible for the asset management function. Steve Brown has served as President of the Western Finance Association and is a Managing Editor of the Journal of Financial and Quantitative Analysis. He has published extensive research on asset management issues. This research won the prestigious Graham and Dodd Award in 2010 for the best paper published in the Financial Analysts Journal. He has been retained as an advisor by asset management companies in Australia, China, Japan and the United States and is currently retained by Russell Investments as a member of their Academic Advisory Board. Steve Brown has testified on his asset management research before the US Congress in March 2007.

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JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

SimCorp

# Marc van den Berg, COO at PGGM: how to navigate the regulatory rapids

funds market, it was decided to partition the pension fund itself and the services organisation providing administration and asset management. The services organisation retained the name PGGM and the pension fund itself was given a new name – PFZW. This acts as a pen sion fund for the healthcare and welfare sector, managing assets of around €105 billion for 1.5 million contributors to the compulsory scheme.

# Journal: Please describe briefly PGGM and its business model.

PGGM, then, serves as the administra tive organisation for collective pension schemes and operates through a number of subsidiaries. The group provides pen sion administration, management support and policy advice as well as integrated asset management. At the end of 2010,

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eading off our new regular column, the ‘CXO Corner’, is Marc van den Berg, Chief Operating Officer at PGGM Investments, who takes a look at opera tional challenges. In our conversation, he shares some of his thought-provoking insights into how a major Dutch pension fund administrator stays on top with its investment management system in a harder regulatory climate.

Marc van den Berg: Founded in 1969, PGGM was a pension fund until the start of 2008. Then, due to regulations and increasing transparency in the pension

Marc van den Berg, MBA, has held the post of Chief Operating Officer at PGGM Investments since 2006 and is responsible for all operations support ing the Dutch pension fund’s business. Joining PGGM Business Development & Innovation in 2005 before becom ing COO, he played a major role in the transformation of PGGM from a pension fund to a service provider with a prominent position in the industry, managing more than €100 billion in assets under management. (More in formation at www.pggm.nl.)

Prior to that, Marc van den Berg worked at KPMG and Nolan, Nor ton & Co. He began his career as a consultant in the field of business and IT strategy at KPMG, becoming a Partner in 1996 with a focus on the financial sector. Marc van den Berg studied Business Management at the State University of Groningen in The Netherlands.

PGGM managed the assets on behalf of over 2.3 million current and former employees of five Dutch pension funds. # Journal: How does PGGM strive for competitive advantage from an operational perspective? Marc van den Berg: One of the actions PGGM undertook when the split took effect was to enter the market to look for other clients to do their asset management for them. This is because we think we have a competitive edge in the sense that we have a pension fund’s board perspective, having lived under the same roof with a pension fund board for 30 years. Our strength lies in integral balance-sheet management of a pension fund.

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SimCorp

With this issue of the Journal of Applied IT and Investment Management, we launch a recurring column called CXO Corner where we ask top global executives from the investment management industry for their opinion on challenges and best-practice solutions impacting the business.

To maintain this competitive advantage, while at the same time meeting the wave of new regulations sweeping the invest ment management industry, PGGM is gearing up its operational structure and processes. First, it has teamed up with other pension fund managers to form a common front and try to inf luence decision-making. Then, internally, it has a tax, legal and compliance department to report on regulatory developments and their likely impact on the business. Main legislative areas for consideration include AIFMD, central clearing of OTC Derivatives and UCITS IV in Europe, and the Dodd-Frank Act in the USA.

# Journal: What kind of impact will central clearing of OTC derivatives have on operational processes at PGGM?

# Journal: What is PGGM doing operationally to meet the regulatory challenge?

As a Dutch-based pension fund, PGGM is required to examine the Dodd-Frank related aspects of central clearing and counterparty requirements, because the same regulatory trend is developing in the European sphere under the UCITS framework of legislative provisions for funds domiciled in Europe and also be cause PGGM adopts a global approach.

Marc van den Berg: PGGM has set a roadmap to define the main contours of legislation as it emerges and the appro priate response this will entail. As much of the legislation applies to the fund management side of the business, the fact that PGGM is divided into pension fund and asset management components means that its operational structure can accommodate and absorb new regula tions more effectively and transparently. This also has repercussions in terms of improved cost efficiencies, as synergies and economies of scale can be derived from the use of either internal or ex ternal managers in the fund selection process.

One of the main regulatory issues up for review at present is central clearing of over-the-counter (OTC) derivatives. In the USA, it is the Dodd-Frank Act that is driving an overhaul of central clear ing procedures and processes, as well as counterparty risk and credit exposure. For pension funds this means that they will have to deposit an initial margin at the central clearing repository, a stipula tion that does not currently apply. With all our OTC derivatives contracts, we now only post the variation margin as we know the counterparty and we are not required to deposit an initial margin.

Marc van den Berg: This regulatory change is going to have a detrimental impact on returns. So we have examined the options, asking what does it mean in terms of performance and what has to be done on the operational side to meet this challenge. What is the administra tive impact of moving from variation to initial margin and what do we have to do in terms of record keeping? And on the risk side, who are the counterparties we are using?

# Journal: What role does financial software play in this?

Marc van den Berg: If we relate this to the type of asset management software we are using, it has to support what we are trying to achieve in this area and how we keep our records. The first step is that we have to have a transparent way of working that clearly identifies and monitors key checkpoints in the business process. So if we look at the central clearing aspects of this, we have to identify the counterparties we wish to use, what combinations of counterparties we can draw on and then to pick and choose the right ones. Once we have this, then we know how to set up the administrative side. And here we need help in deciding on the best way to proceed. # Journal: What course of action are you pursuing to meet the regulatory challenge?

Marc van den Berg: We are currently in discussions with our investment management solution provider on the best courses of action to adopt – how to set up the system, how to work with the central clearing parties, how to get the information from them and to them, what formats to use, what instruments to apply, etc. We have established a user group to examine the main aspects of the new central clearing requirements with the aim of identifying the functional speci fications that are needed to deal with the changes in the system arising from the new requirements. These specifications relate to the instruments used in post ing collateral with the central clearing party; how to account for the f lows generated in order to keep track of posi tions; how to measure the counterparty risk and assess rating; what counterpar ties and clearing houses should be used; and the composition and generation of reporting devices and reports.

One of the challenges involved in assess ing counterparty risk and exposure is to find and define all the underlying and of ten disparate assets and liabilities behind each position. Having one integrated and unified investment management system is a key advantage here, because the definition is always the same. It provides us with a holistic way to have all this information available on a daily basis, where a report calculating all the precise compositions of the various positions in the investment portfolio is generated. # Journal: What are the major system architecture considerations here?

Marc van den Berg: A key consideration here is a keen awareness of the type of architecture the enterprise’s operating structure is built on. Having a onesystem architecture as we do helps a lot, particularly in the area of data defini tion, as you then know that a position registered in your portfolio is a position registered everywhere else in your sys tem. So any change made in the position

only has to be applied once and that is absolutely a benefit in terms of cost, ease of use and transparency. A checklist for what we regard as the key criteria in selecting an enterprise-driven asset management solution to ensure operational success would include: an adept system that has the capacity to grow with the business; a need for the software to keep up with all new developments; an integrated one-stop solution as opposed to best of breed; and flexibility and adaptability to deal with manifold changes. # Journal: What is the ideal software system for today’s global investment managers?

Marc van den Berg: The ideal invest ment management software system should provide the key cornerstone for a resilient yet flexible operational platform with which to keep costs under control while not jeopardising business growth prospects.

Even if there will be greater costs in volved in the implementation of all the new regulatory requirements coming our way, we have built-in systems of checks and balances that enable us to cap these costs. Hence the need for a flexible and adaptable asset management software system that can be implemented as an enterprise-wide solution. # Journal: Thank you for your penetrating insights. With a view to taking the discussion a step further in the next issue of CxO Corner, whom would you like to hand over the word to and what would you like the Journal of Applied IT and Investment Management to ask this person to talk about?

Marc van den Berg: I would like to hand over the word to my German colleague, Dr. Frank Wellhöfer, COO at MEAG MUNICH ERGO Asset Management GmbH, who I would like to share his ex periences on the best means of ensuring technical support to promote continued business growth.

September 2011

JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

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BOOK REVIEW:

# The Risk Controllers: Central Counterparty Clearing in Globalised Financial Markets Peter Norman, Wiley Business & Finance Publishing, 2011

learing houses, or CCPs, were among the very few organisations to emerge from the global financial crisis with their standing enhanced. In the chaotic aftermath of the bankruptcy of Lehman Brothers, they successfully completed trades worth trillions of dol lars in a multitude of financial instru ments across listed and over-the-counter markets, and so helped avert financial Armageddon. That success transformed the business of clearing. Governments and regulators around the world gave CCPs and the clearing services they provide a front-line role in protecting the global economy from future excesses of finance. CCPs, which mitigate risk in

financial markets, responded by greatly expanding their activities, notably in markets for over-the-counter deriva tives, and often in fierce competition with one another. In the book, Peter Norman describes how CCPs operate, how they handled the Lehman default, and the challenges they now face. Be cause central counterparty clearing is a complex business with a long history that continues to influence decisions and structures even in today‘s fast changing world, The Risk Controllers explores the development of CCPs and clearing from the earliest times to the present. Written in non-technical language, The Risk Controllers provides a unique and accessible guide to CCPs and clearing.

It is essential reading for clearing profes sionals, legislators and regulators whose job it is to take this vitally important business into the future. PETER NORMAN is a London-based journalist and writer. The Risk Controllers: Central Counterparty Clearing in Globalised Financial Markets is his second book explaining the workings and history of an important financial infrastructure. Plumbers and Visionaries: Securities Settlement and Europe‘s Financial Market, his pathbreaking account of the history and prospects of the securities settlement industry in Europe, was published by John Wiley & Sons in December 2007.

BOOK REVIEW:

# Financial Origami: How the Wall Street Model Broke Brendan Moynihan, Wiley Business & Finance Publishing, 2011

he si mpl ic it y of Wa l l Street‘s business model is often masked by the sup posed complexity of its innovations. While the “financially engineered” products that Wall Street peddles to investors may seem different, in reality, they are nothing more than fi nancial origami—where the attributes of stocks, bonds, and derivatives are folded and refolded to form something that seems new. This is the perfect metaphor for how Wall Street works, and ulti mately proved to be the underlying cause of the recent financial crisis. In the book, Brendan Moynihan describes how the Wall Street business model has evolved from a method to transfer risk into a method for manufacturing risk. Page by page, he skillfully dissects financial engineering and addresses how financial

origami, along with its inherent conflicts of interest, have allowed individuals as well as institutions to skirt regulations or taxes, sometimes meet investor needs, and always boost their profits. Along the way, the author explains the events that have shaped financial markets, firms, and products over the past 40 years, and have hurt Wall Street over the past three. It also explores the evolution of Wall Street, shows the logical sequence of events that brought us to this point, and offers insights on how to fix some of the problems we face. The Wall Street busi ness model effectively broke. But there are many lessons to be learned from what has transpired, and this book shows what they are – helping to avoid getting caught up in financial origami and the extreme of taking good ideas and running them into the ground.

BRENDAN MOYNIHAN is an editorat-large for Bloomberg News, where he manages the popular column “Chart of the Day” and writes about the economy and Wall Street. He has been with the company since 2006, after spending more than 20 years on Wall Street as a trader and risk manager. Moynihan is the author of Trading on Expectations (Wiley) and co-author of What I Learned Losing a Million Dollars.

September 2011

JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

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BOOK REVIEW:

# Sovereign Debt Crisis: The New Normal and the Newly Poor Dimitris N. Chorafas, Palgrave Macmillan Studies in Banking and Financial Institutions, 2011

his book is about sovereign debt, f iscal def icits, the newly poor and the deceit of the State Supermarket. The issues confronting the global economy, particularly America, Europe and Japan, are inseparable from the current lack of social and political leadership as well as of a credible plan to deal with the moun tains of debt amassed by sovereigns, households and companies, particularly banks. The many practical examples in the book expose the situation into which western society has cornered itself. It of fers advice on how to rise up from this, even if it means slaughtering unafford

able endowments, unwarranted govern ment rescues, and other proliferating but unsustainable big spending projects. Sovereign Debt Crisis considers the risks of losing sight of past failures, and our society‘s ability to solve its problems, with debt heading the list.

DIMITRIS N. CHORAFAS has advised financial institutions and industrial corporations in strategic planning, risk management, computers and communications systems, and internal controls since 1961. More than 8,000 banking, industrial and government executives have participated in his seminars in the USA, the UK, Germany, Italy, Asia and Latin America. Dimitris N. Chorafas is the author of more than 150 books, all critically well-received, and some of which have been translated into up to 16 languages.

BOOK REVIEW:

# Minding the Markets: An Emotional Finance View of Financial Instability David Tuckett, Palgrave Macmillan, 2011

he 2008 f inancial crisis showed that human emo tion has a critical impact on financial markets. Until now, economic theories have failed to take this into account. At the heart of the worst financial crisis in world his tory was a failure to organise markets in a way that adequately controls the very human emotion and behaviour which trading unleashes. The newly estab lished discipline of ‘emotional finance’, pioneered by David Tuckett, draws on principles of psychoanalysis to enable financial markets to be understood in a completely new way. By recognising the crucial role played by unconscious needs and fears, the influence of groups and the nature of uncertainty in all invest

ment activity, Minding The Markets provides a deeper understanding of the markets and timely ideas about how to incorporate that understanding into policies to make markets safer. Based on candid and in-depth interviews with over 50 fund managers internationally, this groundbreaking book not only pre sents a fresh academic theory, but also reveals the truth about what happens in the emotionally-charged real world of financial trading.

DAVID TUCKETT is Fellow of the Institute of Psychoanalysis and Professor at University College London, UK. David Tuckett has brought together his initial training as an economist with his subsequent work in sociology and psychoanalysis to initiate a new line of research, the significance of which has been recognised with recent invitations to speak at the Global Economic Symposium and the Global Risks Network of the World Economic Forum. He is the author of many papers and several highly successful books.

September 2011

JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

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

IV ENTERS INTO FORCE IN §UCITS THE EU – AT LEAST ON PAPER

On 1 July 2011, UCITS IV came into force in the EU. However, detailed implementation rules which are necessary to bring into effect the new aspects of UCITS IV are still missing in many jurisdictions. Of the 27 EU member states, Luxembourg, Germany, Ireland, Malta, Denmark and the UK have transposed the directive into national law and were ready for the 1 July deadline. France, Austria, the Netherlands, Romania, Cyprus, Italy, Spain, Sweden and Finland are still at the draft legislative stage. Norway, Belgium and Portugal are still waiting on their respective administrations to issue a draft of the law. The longer the disjointed implementation process continues, the greater the possibility of regulatory arbitrage. It also places investment management firms operating in jurisdictions that have not transposed the directive at a competitive disadvantage with their more compliant counterparts. The problems associated with implementing directives like UCITS IV uniformly across 27 member states have influenced the European Commission’s decision to use mainly so-called ‘Regulations’ in the future, which are automatically binding on member states. http://www.pwc.com/gx/en/financial-services/issues/regulation/ european-fs-regulation-update/updates/july-11-2011.jhtml#1

ADOPTS NEW RULES IN §SEC CONNECTION WITH DODD-FRANK ACT

On 23 June 2011, the USA’s Securities and Exchange Commission (SEC) voted in favour of adopting several new rules and amendments in order to effect certain provisions of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the Dodd-Frank Act. Most of the changes involve the amount of assets under management (AUM) a USregistered investment adviser (RIA) must have under its auspices. But there’s another important change: For the purposes of determining whether a firm needs to register at the SEC or state level, the term ‘assets under management’ is being replaced with the term ‘regulatory assets under management.’ Under the new rules, advisers currently registered with the SEC will have until 30 March 2012 to certify that they are qualified for SEC registration – e.g., that they have registered AUM of at least US$100 million. Advisers that fall short of the new threshold (the old threshold was US$25 million) are required to register with the appropriate state authorities and withdraw from SEC registration by 28 June 2012. http://www.riabiz.com/a/7152478

AGREEMENT ON OVERALL § BROAD DESIGN OF BASEL III REFORM

On 26 June 2011, the Group of Governors and Heads of Supervision (‘the Committee’), the oversight body of the Basel Committee on Banking Supervision (BCBS), reached broad agreement on the overall design of the Basel III capital and liquidity reform measures. In terms of defining capital, the Committee recognises that certain deductions in previous proposals could have resulted in adverse consequences on some business models and processes. Therefore, it has capped recognition of the following items at 10% of the bank’s common equity component (the aggregate of the three items are capped at 15%): investments of more than 10% of issued share capital in unconsolidated financial institutions; mortgage servicing rights; and deferred tax assets that arise from timing differences. It has also agreed to recognise minority interest supporting ‘the risks of a subsidiary that is a bank’ and removing the counterparty credit restriction on hedging of investments in other financial institutions. http://www.pwc.com/gx/en/financial-services/issues/regulation/ european-fs-regulation-update/updates/july-11-2011.jhtml#1

EU PROPOSAL ON BANK § NEW CAPITAL REQUIREMENTS

On 20 July 2011, the European Commission adopted a legislative package to strengthen the regulation of the banking sector. The proposal replaces the current Capital Requirements Directives (2006/48 and 2006/49) with a Directive and a Regulation and constitutes another major step towards creating a sounder and safer financial system. The directive governs the access to deposit-taking activities while the regulation establishes the prudential requirements institutions need to respect. http://ec.europa.eu/internal_market/bank/docs/regcapital/CRD4_ reform/IA_directive_en.pdf

PUBLISHES RESULTS OF FIFTH § EIOPA QUANTITATIVE IMPACT STUDY (QIS5)

The European Insurance and Occupational Pensions Authority (EIOPA) published the QIS5 report on 14 March 2011. QIS5 is the fifth and last full quantitative impact study before the Solvency II regime is implemented and the publication of the QIS5 report represents a key milestone in finalisation of the Solvency II project. https://eiopa.europa.eu/fileadmin/tx_dam/files/publications/reports/ QIS5_Report_Final.pdf

September 2011

JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

CENTRAL COUNTER § DERIVATIVES, PARTIES AND TRADE REPOSITORIES

This compilation of briefing papers deals with two crucial questions related to the European Commission’s Proposal for a Regulation on OTC derivatives, central counterparties (CCPs) and trade repositories (also known as the European Market Infrastructure Regulation (EMIR). QIS exercises are crucial to the development of EU regulation. QIS5 is the fifth in the sequence and probably the last fully comprehensive exercise. The QIS exercises are essential to strive to ensure that Solvency II is designed in the most appropriate manner, with sufficient evidence of the impact of the regime proposed. http://www.europarl.europa.eu/document/activities/cont/201103/201103 24ATT16422/20110324ATT16422EN.pdf

SUMMARY OF KEY FATCA PROVISIONS

The Foreign Account Tax Compliance Act (FATCA), enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, is an important development in US efforts to combat tax evasion by US persons holding investments in offshore accounts. Under FATCA, certain US taxpayers holding financial assets outside the USA must report those assets to the IRS. In addition, FATCA will require foreign financial institutions to report directly to the IRS certain information about financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest. IRS here provides a summary of the key FATCA provisions. http://www.irs.gov/businesses/corporations/article/0,,id=236664,00.html

PROPOSES ADJUSTMENT TO § IASB EFFECTIVE DATE OF IFRS 9

The International Accounting Standards Board has published this exposure draft of proposed amendments to IFRS 9 Financial Instruments to propose changing the mandatory effective date of IFRS 9 so that entities would be required to apply them for annual periods beginning on or after 1 January 2015 rather than being required to apply them for annual periods beginning on or after 1 January 2013. Early application of both would continue to be permitted. http://www.ifrs.org/NR/rdonlyres/8C0E16FF-1512-4D879413F4FEDA24EE34/0/EDAmendmentstoIFRS9_August2011.pdf

CONSULTATION PAPER (DRAFT) § ESMA’S ON POSSIBLE IMPLEMENTING MEASURES OF AIFMD

On 13 July 2011, The European Securities and Markets Authority (ESMA) sent a consultation paper to the European Commission on possible measures for implementation of the Alternative Investment Fund Managers Directive (AIFMD). This paper will be of interest to managers, depositaries and prime brokers of alternative investment funds, investors in those funds, as well as associations or other bodies representing such entities. http://www.esma.europa.eu/popup2.php?id=7625

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REPORTED BURDENED § CUSTODIANS BY REGULATORY CHANGES IN GERMANY

New domestic and Europe-wide regulations for the financial sector are putting pressure on custodians operating in Germany, consultancy kommalpha has found. In its annual survey – conducted on behalf of the Financial Times’ German pension magazine dpn among custodians and custodian banks operating in Germany – kommalpha said the so-called ‘Depotbankrundschreiben‘ by German supervisor Bafin had caused the most strain. This circular on custodians and custodian banks has sharpened some regulations regarding reporting and verification. Clemens Schürhoff, board member at kommalpha, said the obligation to verify legal and bespoke exposure caps for various asset classes in investment managers’ portfolios, based on independent data warehousing, would lead to an increase in demand for IT solutions among custodians. http://www.ipe.com/news/custodians-burdened-by-regulatory-changesin-germany-says-kommalpha_41292.php?s=regulatory%20changes

III AND ITS CONSEQUENCES: § BASEL CONFRONTING A NEW REGULATORY ENVINRONMENT

Recent fiscal crises demonstrated numerous weaknesses in the global regulatory framework and in banks’ risk management practices. As a result, regulatory authorities have discussed several new measures to increase the stability of the financial markets. One central focus is strengthening global capital and liquidity rules (Basel III) with the goal of improving the banking sector’s ability to absorb shocks arising from financial and economic stress [Source: Basel Committee on Banking Supervision (Dec. 2010) - Basel III: A global regulatory framework for more resilient banks and banking systems]. http://www.accenture.com/SiteCollectionDocuments/PDF/Accenture_ Basel_III_and_its_Consequences.pdf

REPORT: OVER-REGULATION MAY § ‘DESTROY’ GLOBAL SAVINGS CULTURE

There is a danger over-regulation could ‘destroy’ the savings, protection and investment culture, according to a new report published by software consultancy company Focus Solutions. The report, authored by Focus Solutions’ Martin McKenna, said in pre-1988 UK, when the regulatory environment was much more relaxed, the savings and investments culture was healthy, with past generations often pressuring the younger generations to save. It also said that, in the majority, customers understood the products they were buying and the sales process, which was often done face to face as profit margins were sufficient for companies to sustain a larger sales force. He added that, while the profitability was much larger for these companies, this in turn often benefited the customers who would periodically receive bonuses. http://www.international-adviser.com/article/report-overregulationmay-destroy-global-savings-culture

September 2011

JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

SimCorp

Recent research and white papers #

ASSET MANAGEMENT IN EUROPE – FACTS & FIGURES

The report ‘Asset Management in Europe - Facts & Figures’ from EFAMA gives a snapshot of the European asset management industry covering both the retail and institutional landscape. Its focus is on the value of assets professionally managed in Europe, rather than on the domiciliation of assets, and with a distinction made between investment fund and discretionary mandate assets. Among the findings are that asset management is a vital source of economic growth; however, it is concentrated in a limited number of countries. AUM in Europe recovered in 2009 to reach € 12.4 trillion at year-end. Institutional investors represent the largest client category of the European asset management industry and the dominant asset classes managed are bond and equity. Asset Management in Europe - Facts & Figures’, EFAMA 2011 http://efama.org/index.php?option=com_docman&task=doc_download&gid=1412 EFAMA, 49 pages, May 2011

HARNESSING THE FORCES OF CHANGE - SURVEY OF CLOSE TO 200 GLOBAL FINANCIAL SERVICES EXECUTIVES ON THE FUTURE OF THE INDUSTRY

Emerging from the global turmoil of the financial crisis, financial services companies face a multitude of external forces that continue to change the industry and impact individual companies. While the forces impacting the financial services industry appear random in nature, they fall into a set of common themes: compliance, capital, customers, and competition. These four forces of change are affecting the decisions made in all areas of business, from risk management to product development to operating models and strategy. Deloitte surveyed 175 financial services executives globally to get their feedback on how these forces are impacting their business, as well as to sound respondents’ views on where the financial services industry is headed. ‘Harnessing the forces of change’, Deloitte, 2011 http://www.deloitte.com/view/en_GX/global/industries/financial-services/4237452c54bbf210VgnVC M2000001b56f00aRCRD.htm Deloitte, 49 pages, May 2011

RISK MANAGEMENT FOR ASSET MANAGEMENT SURVEY 2011

The financial industry in Europe faces the greatest regulatory transformation ever. All industries, banking, capital markets and insurance, and the parties that support them, are affected simultaneously. The European Commission itself has singled out no fewer than 30 measures affecting the financial markets, where political agreement must be reached by the end of 2011. Asset managers, who were not per se the causes of the financial crisis of 2007-08, have nonetheless learned the lesson that efficient risk monitoring does not equate to effective risk management. Ernst & Young’s ‘Risk Management for Asset Management 2011 Survey 2011’ consolidated the views of 30+ heads of risk and chief risk officers at several leading asset managers in the UK and continental Europe on risk management, and from these interviews has developed a 12-point plan on how investment management organisations can optimise their risk management efforts going forward. ‘Risk Management for Asset Management Survey 2011’, Ernst & Young, 2011 http://www.ey.com/Publication/vwLUAssets/Risk_management_for_AM_2011Survey/$FILE/ Risk_management_for_AM_2011Survey.pdf Ernst & Young, 48 pages, May 2011

PwC - ASSET MANAGEMENT CEO SURVEY 2011

This report by PwC asks the CEOs of 31 large global asset management institutions for their thoughts on the state of the industry, tackling key challenges such as regulation and risk management, as well as their outlook on corporate and industrywide growth. PwC’s 14th Annual Global CEO Survey found that CEOs are optimistic about growth. But after the worst economic crisis in 75 years, new strategies are needed to create growth. Emerging markets and industry innovations (new products) are seen as the primary drivers of growth. ‘CEOs on sustainable growth.’ 14th Annual Global CEO Survey, PwC, 2011 http://www.pwc.com/en_GX/gx/sustainability/research-insights/ceosurvey-sustainability/CEO_ Sustainability_GLOBAL_online.pdf PwC, 10 pages, November 2010

BUILDING ON SUCCESS – STATE OF THE GLOBAL ASSET MANAGEMENT INDUSTRY 2011

This report is BCG’s ninth annual study of the global asset management industry. The assessment gives its take on the global asset management industry, with a comprehensive series of industry and market statistics to bolster its claims. Highlights include an increase of 8% in global AUM versus 2009, the impacts of regulation and tougher client demands. The report concludes that “Clearly, the global asset management landscape remains an enormously challenging one. But along with great challenges come great opportunities.” ‘Building on Success – Global Asset Management 2011, BCG, 2011 http://www.bcg.com/expertise_impact/Industries/Financial_Institutions/PublicationDetails. aspx?id=tcm:12-81072&mid=tcm:12-81043 Boston Consulting Group, 32 pages, 2011

EVOLVING INVESTMENT MANAGEMENT REGULATION – MEETING THE CHALLENGE

KPMG assesses how the tidal wave of regulation is impacting the investment management industry and what companies must do to meet client demand, achieve their growth ambitions and remain profitable while complying with regulations. The publication addresses issues from systemic risk to investor protection, transparency, governance, and taxation, while also stressing that balancing the competing demands of various regulatory agencies is a huge challenge. Regional and industry segment viewpoints are offered. ‘Evolving Investment Management Regulation - meeting the challenge’, KPMG 2011 http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Pages/evolvinginvestment-management-regulation.aspx KPMG, 44 pages, 2011

September 2011

JOURNAL OF APPLIED IT AND INVESTMENT MANAGEMENT

GETTING UP TO SPEED – SOLVENCY II DATA AND SYSTEMS

Streamlined information technology systems and effective data management are core components of a Solvency II implementation and key to the success of any business-driven programme. It is clear that data quality issues continue to represent a major challenge and risk to many insurers’ ability to meet compliance deadlines. Ernst & Young outlines the issues at hand and makes recommendations on what steps must be taken and which investment management software system requirements must be met to comply with Solvency II, as well as with IFRS 4 Phase II.

ALTERNATIVE FUNDS – MEET DODD-FRANK AND THE EU DIRECTIVE

The global financial crisis has left its mark in both the USA and the European Union (EU), with major legislation passed and in process of implementation. In the USA, the Dodd-Frank Wall Street Reform and Consumer Protection Act (DoddFrank Act), represents the most comprehensive overhaul of US financial regulation in decades. The act applies to many areas of the financial services industry. This report focuses on regulation that affects hedge funds and private equity funds – also collectively referred to here as private or alternative funds. The EU’s Directive on Alternative Investment Fund Managers (AIFMD) is also discussed in this report.

‘Getting up to speed – Solvency II data and systems, Ernst & Young, 2011 http://www.ey.com/Publication/vwLUAssets/Solvency_2_Data_and_Systems/$FILE/Solvency_2_ Data_and_Systems_GL_IFRS.pdf Ernst & Young, 12 pages, 2011

‘Alternative Funds - Meet Dodd-Frank and the EU Directive’, Aite Group 2011 http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/FSI/US_FSI_ VolckerQA_FinancialReformInsights_102710.pdf Aite Group, 19 pages, March 2011

FATCA AND THE FUNDS INDUSTRY: DEFINING THE PATH

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

Contrary to popular opinion, FATCA is not - or not primarily - an operational tax issue. There are, of course, significant operational issues, and the tight timescale before implementation means that many companies will have to work to define and develop the necessary operational measures to ensure FATCA compliance. These will require detailed engagement by a range of operational specialists and management functions. KPMG surveyed leading fund promoters in 12 countries to look at the key challenges the industry needs to address as a matter of urgency to prepare for FATCA implementations. ‘FATCA and the funds industry: Defining the path’, KPMG, 2011 http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Pages/fatca-and-the-fundsindustry.aspx KPMG, 28 pages, June 2011

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FOREIGN ACCOUNT TAX COMPLIANCE ACT (FATCA) – OVERCOMING CHALLENGES RELATING TO OPERATIONAL IMPLEMENTATION

The wording of the FATCA has led to lots of heated debates in the banking, insurance and asset management sectors. Fundamental questions like “Which business units within our Group are in fact FFIs?” and “Can structured products also generate US source income?” were discussed. At the same time, considerable lobbying was directed at the USA’s IRS and Treasury Department, which is evidenced by the just under 80 “comment letters” received by these two institutions to date. The authors range from industry associations to large corporations and ambassadors of European countries in the USA. And it is difficult to overlook the fact that implementing the FATCA regulations is considered extremely expensive by all types of financial service providers. Accordingly, there was a huge outcry in the financial sector demanding specific and practical instructions on what to do. ‘Foreign Account Tax Compliance Act (FATCA) - Overcoming challenges relating to operational implementation’, Ernst & Young, 2011 http://www.ey.com/Publication/vwLUAssets/Foreign_Accounting_Tax_Compliance_Act_EN/$FILE/ FATCA_March_2011_en.pdf Ernst & Young, 24 pages, 2011

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