0. Buy-side risk management
PRMIA / ISDA presentation
Steve Farrall
Chief Risk Officer
Schroders
August 2009

1. Contents Thoughts on Buy Side Risk Management Schroders
Internal priorities
External priorities
Investment risk
Operational risk
Liquidity in funds
Market Transparency
Forward-looking risk measures – stress testing
Capital requirements and ICAAP
Implementation
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2. 1. Schroders
Asset Management (£113bn AUM) and Private Banking (£11.2bn AUM)
Operating in 26 countries across UK, European, Asia-Pacific, US, Americas regions
From Global products to Local-Local products
Institutional and Intermediary distribution
Operate across asset classes – Equity, Fixed Income, Commodities, FX, Property, Structured, LDI, Multi Asset, Property, Private Equity, Hedge Funds, Funds of Funds
Operational Centres eg: Luxembourg for UCITS funds and Zurich for private banking operations
Outsourcing with key partners
Listed FTSE 100 company, also with Family ownership
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3. 2. Internal Priorities Executive requirements for risk management
Clear scope and mandate
Cover investment risks, market and liquidity risks, principal and agency risks. What could really damage us?
Proactive, forward-looking (people and reporting)
Increase business understanding (include wider range of experience)
Focus on actions – the risk process should lead to identifiable actions taken to mitigate or accept risk
Be proactive during crises, providing mitigation advice
Keep costs manageable and minimise burden on business
No duplication with Audit and Compliance
Follow a principles-based approach that can adapt to new business or one-off situations
Ensure clear accountability in the governance process
Escalate and advise rapidly when there are issues – good advice early may be more useful than complete and validated advice too late
Provide enough bench strength that key processes are not dependent on single individuals 3

4. 3. Industry priorities
Term credit risk, completeness of counterparty risk
Due diligence around third party funds and funds of funds
Liquidity – and shift in investor preferences
Walker and shareholder activism – process and practice
Risk culture –escalation
Risk culture – involvement at new products stage
Risk culture – forward looking and identifying tripping points, rather than reactive
Bringing risk into the strategic debate
Truly defining and articulating risk appetite
Stress testing and stability analysis
Need to reconcile independence of the risk function with proximity to the business
Clearer and more focused management reporting
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5. 4. Investment Risk
Recognise a key fact: Investment managers are the primary risk managers –but: independent challenge and oversight is vital
Mandate compliance and performance attribution tools strong
Risk decomposition and concentration risk tools strong
More needed on stress and scenario testing – forward looking measures under defined conditions
Group Risk team to focus on independent review and challenge:
Stress and scenario testing
Leverage and illiquidity
Independent price verification
Review of outlier P&L
New products
Testing wider industry concerns
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6. 5. Operational Risk
Historical issue: Comprehensive processes but little value added
Divorced from the business
Need to show an impact, as well as meet regulatory requirements – the real use test
Refocus the Group Operational Risk team:
Clear allocation of end-to-end process responsibility
Risk mapping to be driven by business mapping –not a detached exericise
More rapid escalation of errors, issues and losses - resolve first, then document.
Analysis of trends and exceptions – ensure lessons learned are shared
Comprehensive record of controls – but driven from what actually happens in the business.
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7. 6. Liquidity in Funds
The industry has provided liquidity as a free option in many cases
Markets have thoroughly tested this
At product design stage –what would be the liquidity of this product under stress market conditions?
Design a product or pricing method that reflects this
Stay on top of the issue with regular stress testing.
Stress testing needs to consider potential cash outflows, as well as the ability to get product into market under stress conditions – how lumpy is the client side?
Also consider from the start the need to protect the ongoing investor –clearer guidance over use of bid/offer spread and side pockets.
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8. 7. Market Transparency
Historically the market has accepted little transparency in the hedge fund and fund of funds space
Changing perceptions post Madoff
Requirement to be clear over the due diligence that fund managers should be expected to undertake, and what the hedge fund or fund of fund provider should provide
Reliance on external indicators such as UCITS
Auditors, pricing agents, regulators
Provision of information – articulation of strategy
Ability to backtest – transparency and execution of performance: proprietary strategies and reticence in data provision.
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9. 8. Forward looking measures – stress testing
Risk appetite should be defined from board level – across all risk factors
High level stress tests as well as detailed risk limits (eg: mandates)
Credit risk – counterparty stress tests and collateral stress tests
Market/Investment risk – macro stress tests on markets, micro stress tests on individual investment strategies (eg: cash/futures basis)
Liquidity risk - macro tests such as withdrawal of capital from an asset class, micro tests such as loss of the most significant investors in a fund
Operational risk – resilience tests such as withdrawal of a major service provider or failure of a market system
Engagement at the highest level – the most significant should be discussed with the Board –who should be engaged in the process
Actions taken based on the results
Keep the scenarios relevant to the business and up to date
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10. 9. Capital Requirements and ICAAP
These risk measures should feed the ICAAP
Stress and scenario testing under Pillar II
Need to ensure that they are considered appropriately - not simple addition
Senior management of the firm should be engaged in the development and testing of the ICAAP – not just something for risk or finance
Builds credibility, and a more proactive consideration for the need for capital
Amend for material transactions
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