The Risks They Are All Changing!

The major NEMA Europe conference takes place in Athens this coming week and, as chairman of the NEMA Risk Forum day, I realised that many of the risk issues being tackled are quite new to our industry.

The major NEMA Europe conference takes place in Athens this coming week and, as chairman of the NEMA Risk Forum day, I realised that many of the risk issues being tackled are quite new to our industry.

There is, for example, a renewed focus on geopolitical risk. It has always been relevant to markets, but the emphasis has been on its impact on market values rather than asset safety or shareholder rights. With the growing role of depositories in assessing the risk in markets, there is concern that they are expected to guide on geopolitical as well as market structural risk.

The idea of possible interference in the ownership structure of companies started with the manipulation of Russian share registers some years ago. It has been heightened, in many countries, by the political concept of promoting national champions as cause to over-rule the rights of corporate owners. And it has been exacerbated by dubious decisions on foreign exchange risk in countries like Argentina and Hungary or the cavalier use of fines and fiscal penalties in the financial sector in several other countries.

In reality, share owners are a class that can be penalised if that is the will of the so called Court of Public Opinion. And the new question has to be whether the results of such a scenario can be laid at the door of the asset guarantor, or depository.

NEMA will also look at the concept of contingency networks. I remember coming across this as a serious issue around Y2K. Certain broker dealers, especially, decided that they needed an alternative to their supplier in the event that their Y2K development failed. I had a tough time, especially with one of the more vocal broker-dealers, in suggesting that moving assets to a new provider in markets where a major player was delinquent, was a palliative to the problem rather than a solution.

#Contingency networks are still dangerous concepts unless we are talking of genuinely active contingencies. Moving assets to a new provider, even where stand by arrangements are in place, is challenging. Over and above changing everyone’s static data, the reality is there are relationship and operational aspects of each custodian in each jurisdiction that need to be embedded. Why else does transition to a new custodian take so long? Moving assets from one active provider to another active provider in a market is simpler although there is still a challenging market side communication process.

Custodian liability has changed beyond all recognition. AIFMD and UCITS have changed the landscape well beyond the fund brands they have launched. Acting as a depository is a genuine risk business. The ratio of assets under custody to capital is overpoweringly high. Event risk now has the power to destroy major custodial banks. There are too many accepted risk elements that have to be better managed in a world of total liability.

Regulators will not tell us what best practice is and where liability lies. We need to codify it and agree it across our industry. We need to do it in a rational way. I recall work on risk being undertaken by different interested parties in the past and the focus was always on the “get out of jail” card. We need now a careful analysis of known risks and an assessment of those carried, those beyond scope and those that are debateable. And we need a genuine assessment of the latter to at least understand them and, if possible, to categorise them more clearly. The aim of the exercise has to be to ensure a more open debate. And if ever there is dispute on liability, to have a knowledge repository that could serve at least as a guideline. Without more clarity, the pressure is on the depository to articulate an instant opinion at a time of crisis. It would be far better that they can quote one agreed by their peers and hopefully discussed in broader forums.

The NEMA risk day will also examine the role of utilities. So many operational risks in our industry are driven by poor data quality or poor data management. How many suppliers really operate off a single client and securities database? How many firms are behind the curve on legal entity identifiers? How many times do we as an industry individually search for the golden copy of a securities price or a corporate event? There is excellent work being started in the KYC world on common databases. But this needs to be extended and tackle the risks and costs of all the duplicative data and information effort across our industry.

The last subject we will tackle at the Risk Forum is liquidity. It will inevitably be bound up with collateral. And hopefully it will cast light on the mess the industry and regulators have created. RTGS with central bank money, promotion of CCPs for an ever wider (and often less liquid) group of instruments or the quite logical demands for more capital for each type of risk is pushing the industry into new ground. The reality is that there will never be enough prime collateral. The reality is that liquidity providers usually favour the same type of collateral in exchange for their assets. And the danger is that liquidity will be there in the good days but will dry up in times of crisis. Liquidity has also become a visible game with liquidity problems likely to be apparent in quick order and with potentially grave consequences. Should we slow down demand? Do we need new safety nets? Will there be a lender of last resort and will they provide solvency or liquidity support for both are the same thing albeit separated by sentiment. And will they support the markets in their jurisdiction or just their national players?

Risk management across our industry has changed. It is more exciting. That implies the next major risk event will be dangerous. Will we perhaps then be looking back at the good old days of Lehman risk with feelings of nostalgia?