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Podcast

Asset Managers: Highlighting the gaps between perceived and actual operational risks

All Eyes on FIs Podcast: Season 1 – Episode 5

December 5, 2023

In our fifth instalment from the All Eyes on FIs series, the Financial Institutions team, and Operational Risk Solutions team collaborate to provide insights into perceived and actual risks for asset managers.
Financial, Executive and Professional Risks (FINEX)
N/A

The host and guests from our Financial Institutions, Operational Risk Solutions and, Clients Insights & Analysis teams take you through the perception of risk from speaking to clients compared to the information and data our proprietary database can provide.

The aim in episode five of All Eyes on FIs is to highlight the gaps and identify areas of alignment between the data and the people.

Asset Managers: Highlighting the gaps between perceived and actual operational risks

Transcript for this episode:

RICHARD LANGDON: Looking ahead really to upcoming challenges facing the industry, I think the transition to T plus 1 settlement for US securities, which is due to come into effect in May next year, I think that will present significant operational pressure on firms.

NARRATOR: Welcome to All Eyes on FIs, a podcast series from the WTW financial institution's team. Our experts have their eyes on risk management, regulatory changes, and coverage challenges faced by financial institutions of all kinds and sizes, from professional liability to crime and everything in between.

LAURA KELLY: Hello, and welcome to our All Eyes on FIs podcast series I'm Laura Kelly, Associate Director in the FINEX Operational Risk team here at WTW in London. And I'm joined by my colleagues Richard Langdon and Thijs Butterman from our London and Amsterdam offices.

Today we're going to discuss operational risk trends within the asset management industry. We will look at the risk trends from both an organizational perspective, i.e. what our clients are saying, but also by comparing this to data within our proprietary claims database to give us an indication of what claims are actually being experienced. Our aim here is to identify where there are areas of alignment between the two or indeed if there are gaps. Richard and then Thijs could I ask you to introduce yourselves?

RICHARD LANGDON: Yes. Sure. Thanks, Laura. My name is Richard Langdon. I'm based out of WTW's London office. I'm part of WTW's FINEX financial institution's team where I lead our coverage of the wealth and asset management sector in the UK for risk and insurance solutions. I've worked with asset management firms for 20 years now and joined WTW in January this year. Thijs over to you.

THIJS BUTTERMAN: Thanks, Richard. My name is Thijs Butterman I work in the financial lines client insight and analysis team here at WTW. And I've been with the company for nearly 10 years now, mainly focusing on the operational risk database that we are discussing today, which has operational losses that have been notified to us as claims in it. There's some 30,000 losses in there now with some $55 billion worth of operational losses.

LAURA KELLY: Thank you both, and welcome. Before we begin, I think it's probably worthwhile emphasizing that no two firms are exactly the same but there will be themes that run through all organizations, whether global or regional, large or small. Let's start with a question for you Richard. What challenges are asset managers talking to you about? And is it pretty static from year to year?

RICHARD LANGDON: Yes. Thanks, Laura. I think that the operational makeup of many asset managers has changed significantly over the last few years in response to the current inflationary environment and high levels of competition amongst peers as well. Managers have been forced to find efficiencies across their businesses as well as reduce cost, protect their margin, as well as delivering a more robust approach to operational risk management in general.

This has happened in a number of ways really. Firstly, through improvements to the operating model, which is an area that's taken up a lot of focus across the industry over the last couple of years. Firms have really sought to streamline their operating models, including the incorporation of innovative technology, such as AI. Many firms have outsourced a number of key functions and have also leveraged their use of data as well. This has really enabled firms to streamline processes to maximize their use of data and analytics, reduce operational overheads, and also manage costs through efficient use of technology.

LAURA KELLY: So challenging times, all of which come with associated risks for asset managers. Are you seeing any other changes?

RICHARD LANGDON: Absolutely. I think another big change we've seen in particular for larger managers is a push to diversify their product offering away from the traditional asset classes. By that I mean equities, bonds, credit, global macro, and so on. And more into private markets and other alternatives such as real estate, infrastructure, digital assets and so on.

As private and alternative markets have started to open up to a wider audience, I'd say this has been an important opportunity for managers to capitalize on in order to broaden their appeal, but also as a way of maintaining their management fees in a world where passive products have continued the downward pressure on fees generally. So a lot of the growth we've seen within asset managers in the alternative space it has been in organic as well. So that's put pressure on integrating new platforms quickly and efficiently into the operating model.

LAURA KELLY: And that in and of itself would lead me to assume that working at pace and with new technology carries additional risks with it. Are you seeing anything else?

RICHARD LANGDON: Yes. And I think the last point to note here is the way that firms, especially those with a retail audience, such as wealth managers in particular, it's the way they interact with their clients, which, again, is an area that's moved on and developed significantly in the last few years. Direct engagement with clients through digital channels has been a big area of focus and it's really transformed the way-- it's transformed the distribution strategies of managers as a way to access younger demographics and improve the user experience.

It's important to consider the effect of these changes on the operational risk profile of managers, especially in the context of a dynamic risk environment where threats to cyber security in particular have evolved so quickly. Structural changes to the way asset managers operate, combined with adapting a more-- adapting to a more remote and hybrid working pattern post-COVID, I think have all led to a number of different considerations for operational risks.

LAURA KELLY: In summary, a constantly evolving landscape. We obviously carry out the WTW annual global directors and officers survey. What does the survey indicate are the key risks being faced by those responding for comparison purposes?

RICHARD LANGDON: From the directors and officers survey, I think we can really see that across financial institutions, many of the top risks relate to cybersecurity. In fact, three of the top five that were highlighted by the survey came from cyber attacks, cybercrime, and cyber extortion. So we can say this is definitely a top priority across the industry.

On top of this, 74% of respondents indicated data loss as a big area of concern. Now this obviously can be linked to cybersecurity in certain instances and the next big concern that came out of the survey was bribery and corruption, which 67% of participants indicated was a top priority for them.

I feel that the structural changes that I mentioned that we've seen have led to increased vulnerabilities to these threats and this is also coincided time-wise with a much greater prevalence of hacking and online attacks generally, but this is clearly a key area of concern, a key area of concern in asset management boardrooms at the moment.

LAURA KELLY: Thank you so very much, Richard. We obviously now have the client perspective. At this point, I'll pass over to Thijs Looking for further comparison, what does our claims database say in terms of risk losses actually being experienced currently?

THIJS BUTTERMAN: Yeah. Thank you, Laura. So it's interesting when you put together these kind of side by side expectation versus reality moments. Although, one is probably a bit more forward-looking and the other probably a bit more backward-looking, but the database shows us that still for asset managers, the largest part of claims is made on the professional liabilities policies. Directors and officers liability claims are second most frequently notified, followed by crime, employment practices liability, and only then cyber.

LAURA KELLY: Right. So in the data, we are not yet seeing the cyber concerns highlighted by the survey and clients being reflected in actual losses. That would be right.

THIJS BUTTERMAN: No. No. There's definitely correlations between the survey and the data. Take, for instance, the bribery and corruption concerns that Richard just noted from the survey. These events would generally be covered under directors and officers policies, which is the second most frequent in terms of claims notifications. But in terms of cyber notifications, although it has been increasing over the last few years for asset managers really, they're very relatively low still and the ones that we are seeing being notified by asset managers largely relate to data breaches of a malicious nature, so hacking or ransomware attacks. But a factor in the claims that we are seeing for asset managers to cyber claims is that a lot of these are actually occurring in the supply chain rather than at the insured. So for asset managers, for instance, it's a roughly a third. 32% of all notified cyber claims actually relate to a breach that occurred at somewhere in the supply chain that effects are insured.

So this could perhaps help to explain a bit the increased sense of awareness around cyber events as we're, not only vulnerable to them ourselves within our own organization, us being hacked, but if our supplier or someone further down the supply chain gets hacked, then it affects us as well. So that might help to explain the increased awareness of these events.

LAURA KELLY: Thank you for that. That's really interesting, Thijs Do we think there's a possible reason behind this absence of claims?

THIJS BUTTERMAN: I think the absence of claims is always just as strong of a trend as a presence of claims. You could look at the D&O survey and take a positive twist from it and say this awareness of cyber event has led to firms strengthening their procedures and their IT security, and that is actually what is keeping these types of losses low.

I also think on the whole asset managers are probably not the most data heavy firm. So they might just be less of a target for hackers. Although, could change-- that could change if you move slightly more into the retail space obviously. Or it's possible that asset managers don't carry cyber insurance yet as a core insurance cover. But I'm sure Richard will have thoughts on that one.

RICHARD LANGDON: Yes, that's an important-- yeah, an important one to pick up on that. Thijs thank you. I think insurance against cyber losses is becoming one of the core financial lines of cover for asset managers. That said, there's still many that don't have cyber cover in place. I think a less accessible market one or two years ago meant that there was limited capacity available and pricing was often prohibitively expensive.

I would say that the changes we've seen in 2023 increased competition amongst insurers, price reductions generally, and greater capacity in the market, which has led to more managers looking to take out dedicated cyber cover for sure. There are still, however, many without cover, which, as you say, could explain some of the disconnect here.

LAURA KELLY: OK and just to circle back, what are your thoughts on the changing approach towards operational resilience generally?

RICHARD LANGDON: I think asset managers have and still are taking great steps to deliver a more robust approach to operational risk management with far greater regulatory focus on operational resilience and business continuity through the upcoming DORA legislation in Europe and also the Critical Third Party regime in the UK. Managing risks associated with third party technology, outsourced service providers, digital engagement, for example, it's all gained a lot more focus and we've seen managers placing much greater emphasis on this part of their planning and governance processes.

LAURA KELLY: Thank you. We will circle back to you Thijs on the actual claims being experienced shortly, but firstly Richard, what does the landscape look like in terms of the wider priorities that asset managers have?

RICHARD LANGDON: I think the priorities I mentioned previously continue to apply. Managers are continually looking for ways to deliver efficiencies to manage cost, leverage technology and data, all within a rigorous risk management framework I'd say. Managers continue to evolve their businesses based on the challenges of the current environment and the needs and wishes of the next generation of investors too and all of this will no doubt continue.

Other things to touch on from an operational perspective, I'd say that asset managers are having to focus much more on the relationships with service providers and the third parties in the context of their business continuity planning. Withdrawal of provision of certain services can have a material impact on firms who rely on service providers. By that, I mean prime brokers, technology providers, and so on. I think recent examples of business failures have highlighted really how important it is for firms to have backups in place and be able to continue operations under extreme scenarios.

Just the last thing to mention, looking ahead really to upcoming challenges facing the industry, I think the transition to T plus 1 settlement for US securities, which is due to come into effect in May next year, I think that will present significant operational pressure on firms to manage their resources, technology, liquidity and this is going to be an area that will attract a great deal of attention over the next few months.

LAURA KELLY: Thank you, Richard. I'd now like to circle back to the claims data, Thijs. What are the claims actually being experienced, and what type of losses are they?

THIJS BUTTERMAN: Yeah. So as I mentioned earlier, professional indemnity claims make up 60% of the claims that we see for asset managers. They're still, by far, the number one policy type that's being notified. When we look at more in depth into these professional indemnity claims, we tend to really see them in two distinct categories, which is essentially linked to stock market performance really.

So when stock markets are up, the typical-- and returns are being made to typical professional indemnity claim that we tend to see for asset managers are trading error type losses. So what we mean by those is you buy instead of sell or you buy 100 instead of buying 10 is what you really meant to do. And yeah, that's a very typical loss and good coverage for those and they kind of resolve quite quickly.

LAURA KELLY: OK. So that's one aspect. Does it differ when market conditions are not as favorable?

THIJS BUTTERMAN: Yes. Yes, it does really. So when the stock market takes a turn for the worst or whatever the underlying asset is and the returns are not being made, we see a different type of loss emerge, which is breach of mandate type losses, so when you've invested outside of your mandate. Now these types of losses are generally being reported as a result of investors scrutinizing the assets that were invested when the returns are not so favorable and it's important to highlight these ones because they are the most expensive types of claims that we see for asset managers on average by quite a stretch.

D&O losses, however, which I mentioned were the second most frequent for asset managers, they don't really carry a correlation to stock market performance. Asset managers operate in a highly regulated market, so D&O notifications are a bit more of a constant and tend to be connected to regulatory investigations.

LAURA KELLY: OK. Does the data allow us to see who brings claims against asset managers?

THIJS BUTTERMAN: Yes, it does actually and, well, not surprisingly, direct investors or customers of the insured or underlying investors in a fund, they tend to make up the largest proportion of claims notified followed by claims from regulators and other government entities. So it really matches very well to the professional indemnity and D&O notifications being high in frequency as well. So I think it's important to highlight the continued presence of these types of claims as they still make up, by far, the largest cost and frequency for asset managers.

LAURA KELLY: Thank you, Thijs. That's incredibly interesting. Richard, do you have a comment to make on this?

RICHARD LANGDON: Yes. Thanks. Yeah, I mean, just to note really that how important it is to have a full understanding of the operational risk profile of your business and what the likely financial impact is of the exposures you have. I think fully quantifying the risks you face is crucial in order to tailor the governance you have around them. So for example, the amount of insurance cover you buy to transfer these risks off your balance sheet. I think using data and analytics to support decision-making in these areas is a very effective way of building your risk management framework around the actual risks that are present and this is an important feature of WTW's approach to structuring insurance programs certainly for our clients.

LAURA KELLY: Thank you. And thank you both for joining me for this podcast, which we do hope listeners have found informative. Thijs and then Richard, do you have any final thoughts before we close?

THIJS BUTTERMAN: Yeah. So my message would be based on the data that we're seeing is that cyber is rightly in everyone's front of mind. We see it in the news, in our supply chain, in our own organizations, but it's important not to forget about the core operational risk, which have not gone away.

RICHARD LANGDON: Exactly. I agree. And also, to always consider how changes to the operating model and the structure of your business will impact your risk profile and by extension then, how your insurance covers should adapt in line with these over time is also super important.

LAURA KELLY: Perfect. Thank you very much indeed both.

RICHARD LANGDON: Thank you.

THIJS BUTTERMAN: Thanks.

LAURA KELLY: In closing, I would say please do look out for our asset management operational risk workshops, events, and thought leadership for further insights and as ever, do speak to your insurance broker if you want to discuss this topic further. Alternatively, please do reach out to any of this team and we'd be happy to discuss our insights with you. Thank you for listening.

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Podcast host

Associate Director, Sales and Client Management, ORS – FINEX GB

Podcast guests

Director, Financial Institutions -FINEX

Associate Director, Client Insights & Analysis

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