Ross CuddebackPresident of the GARP-BSRMF, Head of Asset Management Risk – AmericasDeutsche Asset & Wealth Management

Ken WinstonFounder of the GARP – BSRMF, Chief Risk OfficerWestern Asset Management

December 2015

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Webcast SeriesBuy Side Risk Management Principles

SpeakersRoss D. Cuddeback, CFA, FRM

Head of Asset Management Risk for the Americas and Member of the Deutsche AWM Americas Extended Executive Committee for Deutsche Asset & Wealth Management which manages €1.2 trn globally.  Mr. Cuddeback also serves as the President of the GARP – Buy-Side Risk Managers Forum.

Mr. Cuddeback joined Deutsche Bank in 2006. Prior to his current role, Mr. Cuddeback served in Deutsche Bank's Corporate Investment Bank, where he was responsible for overseeing counterparty credit risk to hedge fund clients. Prior to joining, he worked at Barclays Capital within the Hedge Fund Credit Group, at Risk Capital Management, at a boutique energy risk management consultancy and at Crédit Agricole Indosuez within the Financial Institutions Credit Risk Management Department

Dr. Kenneth Winston

Kenneth Winston is chief risk officer of Western Asset Management Company, which manages $450 billion of fixed income assets globally. He is also a Lecturer in Economics at the California Institute of Technology. Prior to Western Asset, Dr. Winston was the chief risk officer of Morgan Stanley Investment Management and an Adjunct Professor in the Financial Mathematics program at New York University. He began his financial career as a quantitative equity portfolio manager. He holds a PhD in pure mathematics from MIT and is the author or editor of a number of publications, including The Oxford Handbook of Quantitative Asset Management.

Agenda• Background of the GARP – Buy-side Risk Managers

Forum

• Buy-Side Risk Principles Publication• Purpose• Governance• Investment Risk• Operational Risk

• Questions & Answers

GARP – Buy-side Risk Managers Forum

GARP – Buy-side Risk Managers Forum Background

Industry group of 40 Chief Risk Officer or equivalent practitioners from major ($100bn+) Bank-owned, Independent and Insurance-owned Asset Managers*

The forum conducts semi-annual meetings where relevant topics relevant to the asset management industry and risk management are discussed among members

The overall mission is to determine and promote sound practices for risk management for asset management activities

History

2003 – Recognizing the lack of industry groups specific for risk management for the buy-side, Ken Winston (Western Asset Management) and Sarah Collins (formerly of Dreyfus) formed the Buy-side Risk Managers Forum with 30 member firms

2008 – The first Risk Principles for the Buy-side document was published 2013 – Recognizing shared goals of reinforcing sound risk management practices with the industry, the Buy-side Risk Managers Forum affiliated with GARP to form the GARP – Buy-side Risk Managers Forum

2015 – Revision and republication of the Buy-side Risk Managers Principles document* GARP-BSRMF membership is by invitation only; group membership is capped at 40 firms

Risk Principles for the Buy-side

GARP – Buy-side Risk Managers Forum Principles set high-level standards for Risk management for Buy-side firmsGovernance Principles – addresses both fiduciary & proprietary risks

Rationale for Risk Framework Establishment of the Fiduciary Principle Risk Culture Segregation of Duties Importance of Risk Measurement & Transparency

Investment Risk Principles – primarily fiduciary risk principles, processes/tools for managing risk better

Mutual agreement & understanding of Risk expectations

Estimation of Investment Risk Measurement of Investment Performance Liquidity Risk Management Concentration Risk

Operational Risk Principles – covers a wide variety of risk, most of which owned ultimately by the firm

Types of Operational Risk Execution, Process and Delivery Risks Outsourcing / Service Provider Risk Financial Reporting Risk Legal and Regulatory Compliance, including

Regulatory

Managing Proprietary Risk on the Buy-side Seed Capital Co-investment Guarantees

Leverage Valuation Stress Testing Credit/Counterparty Risk

Elements of an effective operational risk framework

Operational event recording & review Use of risk assessments Use of KRIs to proactively identify risks Coordination between control functions Operational risk quantification

Governance

• Whether you take a consultative or prescriptive the approach will depend upon the organization’s ownership structure, size, complexity and culture

• Definitions of risk and risk tolerances should be mutually agreed upon

Tone at the Top & Mutual

Understanding

• Defined decision making structures & escalation procedures provide basic foundation for putting risk management into action

• Risk management must have access to senior management• Segregation of duties• Risk Management roles and responsibilities should be clearly defined and

governance supported by written policies and procedures

Organizational Structure

• Risk reporting should inform decision-making• Escalation should follow the natural flow of informationReporting &

Escalation

A governance framework centered around the core fiduciary obligation foundation of effective risk management

Principles of Governance• Common understanding of the methods used and metrics

measured• Applied uniformly across the enterprise• Clearly defined terminology

Framework

• Appropriate checks and balances• Segregation of duties between investment decision makers,

risk management and operational support functions• Segregation of control functions from line functions

Segregation of Functions

• Clearly defined roles and responsibilities:• risk and assessment; and,• control and identification mitigation within risk tolerances

• Policies and procedures, code of ethics, guidelines and escalation procedures should be clear, unambiguous, accessible and achievable

Roles & Responsibiliti

es

• Risk conscious culture:• risks are well-understood• tolerances are clearly defined; and,• risk / return trade-offs are considered

Culture

• Risk management function must be independent• A skilled Chief Risk Officer provides leadership and an

independent view on:• evolving practices• whether risk is being taken intelligently and strategically

with a reasonable expectation of being rewarded

Independence of Risk

Management

• Meaningful and actionable reporting is a continual improvement effort

• Risk Reporting should be tailored to the audience• Mutual agreement is not expected or required, but the risk

manager’s role as an objective observer includes effective communication to peers

Measurement and

Reporting

• Certain activities require special risk governance when the asset manager’s assets are exposed to investment risk.

• Conflict Avoidance• Proprietary versus client investment activities to provide

transparency, accountability and control• Clearly defined allocations of profit and loss

Proprietary Investment Managemen

t

Principles of Governance

Investment Risk

• Client Risk Tolerances and Expectations Should be Known, Communicated, and Monitored

• Different procedures for separately managed and collective investment portfolios• Sometimes relative to benchmark• Many measures – tracking error, VaR/Expected Shortfall, stress tests

• Investment Risk Should be Estimated and Monitored• Ex Ante (forward-looking) vs. Ex Post (backward-looking)• Should assess statistical accuracy of forward-looking measures

Investment risk

estimation

• Investment Performance Should be Measured and Monitored• Both performance measurement (“what happened”) and performance attribution

(“why it happened”)• Many reasonable attributions are possible – if feasible, should be aligned with

investment risk estimate factors

Investment performance measuremen

t

Asset managers are fiduciaries investing money on behalf of clients, receiving a fee for their services. The manager has an obligation to make investment decisions in the best interest of its clients.

Client Risk Tolerances

Investment Risk, #2

• Liquidity and Capacity Risk Should be Estimated and Monitored• Take into account liquidity demand; liquidity supply; and liquidity options• Both normal and stressed market behaviors should be estimated• Capacity should be tied to ability of liquidity supply & options to meet demand

Liquidity Risk and Capacity

• Concentration Risk Needs to be Tracked and Understood• Large percentage holdings, large risk contributors, a large group of similar securities –

all can weaken the benefits of portfolio diversification• Common concentrated holdings across portfolios for different clients can cause

problems with maneuverability

Concentration

• Risks Attributable to Leverage Should be Tracked and Understood• Leverage shortens the horizon over which an investment thesis must prove correct and

increases volatility• Many definitions – clear communication is necessary

Leverage

• Valuation Methodologies Should be Fair and Consistent• Always important to have fair and accurate valuations, but especially important for

collective investment vehicles• Third party vendors and well documented procedures necessary; the confidence in the

value of a security goes down as its market depth goes down

Valuation

Investment Risk, #3

• Stress Testing is an Important Tool in Analyzing Risk• Risk models that only take into account behaviors in normal markets are necessary but

not sufficient• Various historical and hypothetical market scenarios are necessary to shed light on

what might happen in extreme conditions

Stress Testing

• Issuer and Counterparty Credit Risk Should be Estimated and Managed• Credit exposure occurs both through direct means (buying a company’s bond) and

indirect means (being exposed to a derivatives contract with the company, for example an f/x forward

• Procedures for approving appropriate counterparties; estimating and possibly limiting net credit exposures; proper legal documentation; and robust collateral exchange are tools to manage credit and counterparty risk

Credit Risk

Operational Risk

• Events with financial impact and near misses• Internal as well as external events• Include events from outsourced services and sub-advisory relationships• Consider developing an operational events database

Recording of Operational

Events

• Top-down and a bottom-up approach to identifying and prioritizing risks• Monitor remediation of any identified issues• Strong consideration to IT related controls• Consider conducting controls testing

Risk and Control

Assessments

• Should allow to measure the effectiveness of key controls• Effective implementation requires a structured approach, with metrics derived from

the Risk Assessment and a process that includes thresholds for monitoring and escalation

Key Risk Indicators

• Allows quantification of operational risks• Two approaches:

a) use operational risk event data orb) scenario based approach

Operational Risk

Quantification

Q&A

Creating a culture of risk awareness®

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About GARP | The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to preparing professionals and organizations to make better informed risk decisions. Membership represents over 150,000 risk management practitioners and researchers from banks, investment management firms, government agencies, academic institutions, and corporations from more than 195 countries and territories. GARP administers the Financial Risk Manager (FRM®) and the Energy Risk Professional (ERP®) exams; certifications recognized by risk professionals worldwide. GARP also helps advance the role of risk management via comprehensive professional education and training for professionals of all levels. www.garp.org