journal of applied it and investment management vol 3. no. 1

#journalVolume 3 · No. 1 · April 2011of Applied IT and Investment Management

Rising to the regulatory challengeThe investment management industry prepares for new legislation

Industry experts assess regulatory changesTHE CHALLENGE OF RECONCILING GROWTH AND COMPLIANCE Dodd-Frank ActHOW WILL THE ACT AFFECT IT SYSTEMS? IFRS 9CHALLENGER MEETS REQUIREMENTS AND BUILDS COMPETITIVE ADVANTAGE WITH INVESTMENT MANAGEMENT IT UCITS IVWHAT INVESTMENT MANAGEMENT FIRMS SHOULD DO TO COMPLY AND ENSURE GROWTH Also ...SOLVENCY II, AIFMD AND SYSTEM BEST PRACTICES FOR COMPLIANCE: INSIGHTS FROM ERNST & YOUNG, TOWERGROUP, KPMG AND ALFI

2 April2011 JournAlofAppliediTAndinvesTmenTmAnAgemenT simCorp

CEO COmmEnt:

meeting the regulatory challenge

ediTor-in-ChiefLars Bjørn Falkenberg, Senior Vice President, SimCorp A/[email protected]

Co-ediTorsMichael Metcalfe, financial journalist, [email protected] Trier, Copy & Translations Manager, SimCorp A/S, [email protected]

publisherSimCorp 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: 19,000.

submissionguidelinesArticles, book reviews, new reports and information on recent research can be submitted for review to Co-Editor Mette Trier, [email protected]. For submission guidelines, please visit www.simcorp.com/journal.

legAlnoTiCeThe 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

SUBSCRIPTIONSubscription 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 [email protected].

by CEO Peter L. Ravn

meeting the challengeof reconciling regu-latory compliance with business growth intheinvestmentmanagementindustrytodaydoes not necessarily have to be a choicebetweenarockandahardplace.however,itisclearfromtherangeofarticlesappearinginthisissueoftheJournalthatcurrentandproposedregulation is irrevocablychangingthewaybusiness isdone in the investmentmanagementindustry.

Withimpositionofnewandupdatedlawsandstandards, suchasAifmd,solvency ii anduCiTsivproceedingineurope,thedodd-

frankActintheusAandifrs9internationally,itislittlewonderthatmanyofourclientsviewincreasedregulationastheprimarybarriertogrowthgoingforward.Theserequirementsarenotnegotiable.Theyaremandatoryandaprerequisitefordoing business. important for investment managers is to be able to fulfil theserequirementsandregardthemnotasaburdenimposedontheindustrybutrathertaketheoppositeview.Thisisnowtheframeworkwehavetooperateinandwehavetoseehowwecanbestturnthatframeworkintoacompetitiveadvantage.

Weareinthesituationwhereallkeystakeholdersincludinginvestorsandclientsdemand greater transparency and strong compliance with the necessary iTinfrastructure to back these up. We at simCorp acknowledge that a strongcompliancefunctionwillalsobecomeafactorofincreasingcompetitiveimportance,whichwilldefineandsetanorganisationapartfromitscompetition.

itallstartswithasounddatafoundation,asolidarchitectureofyourinvestmentmanagementsystemandyourlandscape.Youcanneverforeseeexactlywhatchangeswillappearinthefuturebutyoushouldbeabletocopewiththesechangesmuchfasterandmuchbetterifyourfoundationisingoodshape.

AndsimCorpdimension,withoneintegratedplatformandonedatabase,ensuresthatallclientshavethenecessaryconsistencyintheirdataandintheiroperationsasafoundationforalltheregulatoryreporting.Tohelpclientsrisetotheregulatorychallenge,our constantmonitoringof the regulatory scenemeans thatsimCorpdimension remains compliantandavoidsadiversionof resources fromrealisinggrowthstrategies.

in an ideal world, the investment management system is there to support thebusinessandtohelpthebusinesstoexpand,ratherthanbeingabarriertofuturegrowth.ifthesoftwareplatformismisconceived,wherethefundamentalsarenotinplace,theneventuallyitwillbecomeahindrancetogrowthratherthananimpetustohelpgrowthebusiness.Theregulatorychangesthatarecomingoverthenexttothree years not only place demands on the investment management industry intermsoftheend-userslikefundmanagementcompaniesandclientsbutalsoontheinvestmentmanagementsoftwaresolutionproviders.Theyalsoneedtostayontrackand keep up to date to avoid becoming a hurdle but rather support in securingcompetitiveadvantage.

it is our job at simCorp to remain vigilant and responsive, making sure thatsimCorpdimensionenablesourclients’investmentmanagementsystemstostayuptodateandallowsthemtoconcentrateontheircorecompetency–deliveringvalueforinvestors.

Peter L. Ravn, Ph.D., is CEO at SimCorp. Read the journal online at www.simcorp.com/journal

CONTENTS

3 regulatorychange:thechallengeofreconcilinggrowthandcompliance

8 bestpractices:theoptimalinvestmentmanagement systemforregulatorycompliance

12ifrs9:meetrequirementsandbuildcompetitive advantagewithinvestmentmanagementiT

16uCiTsiv:whatinvestmentmanagement firmsshoulddotocomplyandensuregrowth

20dodd-frankAct:howwilltheactaffectiTsystems?

23Aifmd:changesandbenefitsinstorefortheeuropeanalternativefundindustry

27solvencyii:whatitmeansforinvestmentmanagementsystems

30Challengesinthefrontoffice:newregulationsforcederivativesmarketoverhaul

33simCorpstrategylabhostsCopenhagensummit2011:high-levelindustryrepresentativesandacademicsconvenetodiscusskeychallenges

35bookreviews

36regulatoryupdate

38recentresearchandwhitepapers

simCorp JournAlofAppliediTAndinvesTmenTmAnAgemenT April2011 3

The investment management industry will have to adopt a host of regulatory leg-islation and new laws in the next few years. While working to meet client needs and growth goals, the industry must also address the impact that these regulatory changes will have on business, operational and compliance requirements. This ar-ticle presents some views on the challenges and solutions with regard to aligning compliance and growth strategies.

Acrosstheglobe,asweepingwaveofregulatoryreformandchange is redrawingthecontoursofthefinan-

ciallandscape.overthenextthreetofiveyears,alooseandoftenarbitrarysetofnewlegalprovisions,standardsandreg-ulationswillimpactawidespectrumofthefinancialservicessector,itsancillaryandauxiliaryservices, intermediariesandthird-partysuppliersandproviders,aswellasthecombinedrangeoffinancialinstrumentsandproductstheymanu-facture,processandmarket.Theimpactwillbevaried,withsomeareashardlyfeelingthepinchatallwhileotherswillbesignificantlysqueezed.

for the investmentmanagement in-dustry,by and large, the regulatoryandcompliancechallengesintheyearsaheadwillbeunprecedented.Amongthemanifoldchangestobetakenintoaccountat thestrategic, tactical, sys-temicandoperationallevelsarethenew

regulatoryframeworkanddemandsofthelandmarkWallstreetreformandConsumerprotectionAct(dodd-frankAct)intheusA,Aifmd,mifidcon-ductofbusiness,prips,solvencyiianduCiTsivintheeu,aswellasonaninternationallevelthenewtaxrulesandstandardsprimarilyembodiedinifrs9.

CommentsmichaelT.dolan,apartneraternst&YounginWashingtond.C.:“Thecombinedramificationsoflegisla-tiveandregulatoryreformincludetheadviceinvestmentmanagersofferclients,thewaytheyhandletransactions,howtheymarketthebusiness,thedisclosurestheyprovide,andultimatelythemannerinwhichtheywillhavetoreconfigureandretoolexistingoperationalandiTplatforms.”

ensuringeffective implementationofthenewregulationswillbedauntingenoughforanyinvestmentmanagemententerprise.Theyearsaheadpromiseeven

morepressingchallenges–withacceler-atedrulemakingbecomingthenormasregulators implementfinancialreformandfine-tunethelawmaking.

Atthesametime,theexpectationsofinvestmentmanagementorganisationsandtheirclientshaveneverbeenhigher.Arguesdushyantshahrawat,seniorresearchdirectoratTowergroup inthesecuritiesandinvestmentspracticeinboston:“Keyindustrystakeholdersincludinginvestors,clientsandprospec-tiveclientsareclamouringforgreatertransparencyanddisclosure, aswellasmoreassurancethat the individualmanagerhas strongcomplianceandinternalcontrolswiththenecessaryiTinfrastructuretobacktheseup.”

manyinvestmentmanagementorgani-sationshavelearnedfromthefinancialcrisisandmarketupheavalthatspawnedthe latestwaveof regulatory reform.demandsforgreatertransparency,bet-terreporting, lowerrisktoleranceandhigherpressureonfeesalreadyhaveandwillcontinuetoincreasesubstantially.however, thesehard factshavenotreducedclientexpectationsregardinggrowthandreturns–onthecontrary.

TherighTChoiCesWithunparalleledregulatoryactivityandmorestringentclientdemandsoninvestmentmanagers,achievinggrowthwill entail thatcompaniesmake theright investmentmanagementsystemchoices in thecurrentenvironment.sriramvenkataraman,anexecutiveinernst&Young’sfinancialservicesriskmanagementpracticeinnewYork,takestheview:“regardlessofwhether

Michael Metcalfe is Co-Editor of the Journal of Applied IT and Investment Management.

# Regulatory change: the challenge of reconciling

growth and compliance

“The combined ramifications of legislative and regulatory reform include the advice investment managers offer clients, the way they handle transactions, how they market the business, the

disclosures they provide, and ultimately the manner in which they will have to reconfigure and retool existing operational and

IT platforms.”Michael T. Dolan, Partner at Ernst & Young in Washington D.C.

April2011 JournAlofAppliediTAndinvesTmenTmAnAgemenT simCorp4

investmentmanagerspursuegrowthstrategiesoflow-costleadership,productdifferentiation,expansionintonewmar-ketsand/orsegmentsoracombinationofthese,itisimperativethatthetechnicalinfrastructureisinplacetosupportthedesiredgrowthstrategy.”

irrespectiveofthegrowthstrategiesem-ployedbyindividualinvestmentmanag-ers,thereisonecommonchallengefacedbyallwhendeliveringonthepromisesmade toclients toprovideattractivereturnsontheirinvestments.ifinvest-mentmanagersareforcedtodivertscarceandvaluableresources toovercomingoperational issuesanddeficiencies intheiriTplatforms,thentheirprospectsofachievinggrowthlookbleakindeed.

pressurepoinTs“Therearefivemajorcomponentsthatmakeupthewaveoffinancialreformwhichwillimpacttheinvestmentman-

agementindustry,”explainsmr.venka-taraman(seeoverviewbelow).ofthesefivekeyareasoflegislation,thedodd-frankActisprobablythemostcompre-hensiveandall-encompassingintermsoftheimpact itwillhaveonfinancialservices ingeneralandtheinvestmentmanagementindustryinparticular.Theprovisionsaretobeimplementedoveran18–24monthperiod,butmanyaspectsofthelegislationhaveyettobedefined.

inadditiontoahostofothermeasures,thedodd-frankActsignificantlyen-hancesthepowersandcapabilityofthesecuritiesandexchangeCommission(seC),CommodityfuturesTradingCommission(CfTC),andthefederalreserveandcreatesanewagencycalledtheConsumerfinancialprotectionbureau(Cfpb).notesmr.shahrawat:“dodd-frankclarif ies the roles andresponsibilitiesofregulators,whichisofspecialsignificanceinareassuchas

derivatives,whoseregulationhistoricallywas splitamongdifferent regulatorybodies.”

mr.shahrawatgoesontoexplainthatthedodd-frankAct accordsmuchgreaterpower toall regulatoryagen-cies (especially theseC,CfTCandthefederalreserve),whilecreatingnewagencies: theCfpb, theofficeoffinancialresearch(ofr),andtheofficeoffinancialstability.newpow-erstotheseCincludeoversightofthecredit-ratingsbusinessandtheabilitytoexamineandfinenationallyrecognisedstatisticalratingagencies.

inresponsetothenewregulatorypowers,greaterresources,andastrictermandategrantedtoregulatoryagenciesbythenewlaw,investmentmanagementcompanieswillneedtoenhancetheircompliancedepartments,addstafftodealwithmoreregulatoryexaminationsandimplement

Theinternationalfinancialreport-ingstandard9(ifrs9)isthelatestrevisionofinternationalaccountingstandardsissuedbytheinternationalAccountingstandardsboard.Thestandardsareintroducedtoimprovetransparencyof theprocesses inwhichvariousfinancialassetsandliabilities are valued, accountedforandreported,andspecificallydealswithnewrequirements fortheclassificationandmeasurementoffinancialassets.ifrs9replacesiAs39andconsistsofthreephases,ofwhich the last twoare still inprogress.firmshaveuntil2013tocomplywithifrs9.(foracorpo-ratecasestudyonifrs9,seearticleonpage12.)

TheAlternativeinvestmentfundmanagersdirective(Aifmd)isdesignedtoharmonisethealterna-tiveinvestmentfundmanagementmarket intheeu.itwill requirealternativeinvestmentfirmsaboveacertainsizetoregisterandprovideregulatorswithdetailed informa-tionontheprincipalmarketsandinstruments inwhichtheytrade.Aifmdimpactsallnon-uCiTsfunds:hedge funds,private eq-uity andventure capital funds,realestate fundsand investmenttrusts.Aifmdisapprovedbytheeuropeanparliament,butpendingindividualeumemberstates’leg-islation,itisexpectedtotakeeffectin2014.(foracloserexaminationofAifmdanditsimplications,seearticleonpage23.)

AIFMD IFRS 9fiveKeYAreAsoflegislATionfACingTheinvesTmenTmAnAgemenTindusTrY

# Regulatory change: the challenge of reconciling

growth and compliance


compliancesoftware(forsurveillanceofemployeesoutofinsidertrading,datase-curityandprivacyconsiderations).“Theywillalsoneedtoconductstafftraininganddevelopmentandenhanceprepared-nessforauditsandexaminationstodealwithpotentialinvestigationsofissueslikemarketabuseandinsidertrading,”addsmr.shahrawat.

CApiTAlpoolsChanges toprivatepoolsof capital(mainlyintheformofalternativefundsandprivateequityfunds)areoneoftheaspectsofthedodd-frankActthatwillhavethegreatestimpactontheindustry.dodd-frankrequiresalternativefundsandprivate equity funds to registerwiththeseCas investmentadvisers,whichmeanstheywillneedtoreportinvestmentperformance,clientassets,financial recordsandotherpertinentinformationonaregularbasis.italso

providesgreaterpowers to supervisesmalleralternativefundsandimplementspecialrulesgoverningsuchfunds.

“Collectively,all thismeansdramaticchangesforthissectoraffectingoperat-ingcosts,profitability,andthecompeti-tivestructureofthisbusiness,”observesmr.shahrawat.largehedgefundsthatalreadyhaveestablishedmaturecompli-ance,reporting,andclientservicedepart-mentswillfindthesechangesrelativelymanageableandwilltherebygainanad-vantageoverfundsthatdonot,whichwillbehitwithnewcostsanddistractions.

neWeuropeAnrulesineurope,therangeofnewregulationswillprimarilyaffect investmentfunds–mutualandalternativealike–andsig-nificantlychangethewayinwhichtheyareoperated,marketedanddistributed.Thevarious industry linksmakingup

thedistributionvaluechainwillneedtomodify theway theyoperateandinteract,bothwithinvestors,regulatorsandoneanother.

ThenewuCiTsivdirective,mifidconductofbusiness,aneudirectiveonpackagedretailinvestmentproducts(prips),andnewuK-basedregulationsfromtheretaildistributionreview(rdr)allshareanumberofcommonoverarchingobjectives,thekeybeingtorestoreandenhanceinvestorconfidenceinfinancialproductsandimproveindus-tryefficiency.

Thiswillbeachievedby improvingtransparencyandcomparabilityacrossarangeoffinancialproducts,not justuCiTs funds; eliminating real andperceivedconflictsof interestandhar-monising rules surrounding investorinformationandtheconductofbusiness

“Of these five key areas of legislation, the Dodd-Frank Act is probably the most comprehensive and all- encompassing in terms of the impact it will have on financial services in general and the investment management industry in particular.”

Thedodd-frankActisdesignedtopromoteusfinancialstabilitybyimprovingaccountabilityandtrans-parency in the f inancial system.itestablishes rigorous standardsandsupervisionstoprotecttheuseconomyandconsumers,investorsandbusinesses.Theactimpactstheentireusinvestmentmanagementindustryinvaryingdegrees,aswellas foreign investmentmanagerswith signif icantholdings inusf inancial assets.roll-outof thedodd-frankActstartedJuly2010andwillcontinueoverthenexttwo-threeyears. (foramoredetailedstudyofthedodd-frankActanditseffects,seearticleonpage20.)

TheuCiTsivdirective isare-formofpreviousuCiTsdirectivesdesignedtocontinuetomaketheinvestmentfundmarketintheeulessfragmentedandtoimproveitsefficiency.uCiTsivaimstomakefundconsolidationeasier, improvedistributionandcross-bordermar-keting.uCiTsivimpactstheeuinvestment fund industryaswellas foreignfundmanagers issuinguCiTs funds in theeu,wherefundmanagershaveuntilmid-2011tocomplywiththeprovisions.(forareportonuCiTsivanditspracti-calimpact,seearticleonpage16.)

solvencyiibuildsonsolvencyiandaimsatcreatingasingleeumarketforinsuranceservicesandtoprotectconsumersbyobliginginsurerstoupholdcertainsolvency require-ments.Theintentionistoachieveacorrelationbetweencapitalrequire-mentsandeconomicrisk.solvencyiialsointroducesrequirementsforimprovedreportingandtranspar-encyaswellasnationalsupervisionofinsurers.Thesolvencyiiframe-workremainstobefinalisedbutisduetotakeeffectbyoctober2012,bywhich timeall insuranceandre-insurancecompaniesoperatingwithintheeuwillbe impacted.(formoredetailsonsolvencyiianditsramifications,seearticleonpage27.)

Solvency II UCITS IV Dodd-Frank Act


acrosstheentireinvestmentfundvaluechain.Allthesechangeswillaltertheprocessesbywhichfundsaredistributedacrosseuropebyimpactingthecomplexrelationshipbetweenthefundmanufac-turer,distributorandinvestor.

havingbeenapprovedbytheeuropeanparliament,CouncilandCommission,Aifmdwillgoaheadinitspresentforminmid-2011.during2011Aifmdwillproceedthroughlevel2negotiationswhere substance isadded to thepro-posalsasagreed.Theeu’s27memberstatesthenhavetwoyearstotransposeAifmdintonationallaw,withAifmdprojectedtoenterintoforceinmid-2013.

Alsoaffectedby thisdirectiveonanationallevelisswitzerland,insofarasaeuropeanfundmanagermaybehead-quarteredinswitzerland,justasafundmanagerheadquarteredinswitzerlandmayofferbothswissandeuropeanfunds for sale in theeu.Commentsdr.matthäusdenotter,CeooftheswissfundsAssociation(sfA):“fromtheswissperspective, it iscrucialthateuropean fundmanagersareable todelegatecertainbusinessactivities toswiss f inancial servicesprovidersontheonehand,andthatswissfundsandfundmanagersreceivetherelevant‘eupassport’ontheother.”

reloCATionorloCATion?WhenconsideringwhetherAifmdwill actuallyhelpboost the estab-lishmentandrelocationofalternativefunds ineuropean jurisdictions likeluxembourg,anumberoffactorshavetobetakenintoaccount.AccordingtoCamilleThommes,directorgeneraloftheAssociationoftheluxembourgfundindustry(Alfi):“relocationisonequestion, locationanother.Whatseemstobeclearfromthecurrentver-sionofAifmdisthatitwillbeeasierifyouwanttodistributeyourfundsineurope tohaveeuropean funds inaeuropeanmanagementcompany.”

ifanalternativefundmanagerwishestosellnon-europeanfundsineuropeorsellfundsthataremanagedbyanon-euro-peancompany,therearespecificprovisionsthathavetobecompliedwithinregardtotheregulatorofthecountrywherethesefundsormanagersaredomiciled.“sowhatwebelieveisthatifyouwanttosellfundstoeuropeaninvestors,theeasiestsolutionistohaveyourassetmanagementcompanyineurope,”addsmr.Thommes.

inanswertothequestionwhethertheregulatorychallengecanbeturnedintoabenefitorcompetitiveadvantage forinvestmentmanagement companies,Charlesmuller, thedeputydirectorgeneralofAlfi,responds:“onehastoconsiderthatsomeoftheregulatoryimpulsescomefromthelessonslearnedfromthefinancialcrisis,likeAifmdtostartwith;butwearealsotalkingnowabout theprocessofuCiTsv,aboutmifid,aboutprips.soasapointofprincipleto lookattheseelements, it’scertainlyagoodthing.”

ifrs9doubTsifrs9maybeseenastheaccountingworld’sanswer to the f inancial crisis,buttherearedoubtsthatthestandardisenoughtopreventanothercrisis.manyexpertsarguethatthisrequiresvigilancefromallstakeholders–fromaccountantstoinvestorsandregulators.All inall, itpoints to improvedfiscal transparencyandconvergence.

ThenextphaseoftheiAs39replace-mentwillfocusonliabilitiesandimpair-ment,andisduetobecompletedlaterin2011.heretheimplicationswillbewiderforfinancialinstitutions,manyofwhichhavebeensettingasidemillionsofdollarsasprovisions forbaddebt.The largerfinancial institutionshavethe technology tohelp themcapturethenecessarydataandcalculatecreditrisk.butsmallercompaniesmayhavetoinvestinmoreiTresources.

“inourexperience,datamakesup70%ofanifrsproject.itisakeycomponenttotheworkbeingdone,”estimatesJohnfoulley, thehongKongriskmanage-mentpracticeheadforsAsinstituteAsiapacific.moreover,accountantsneedtobemoreattunedtoriskmanagementthathastypicallybeenhandledbyaseparatedepartment.

fATCAimpACTAnothertaxregulationthatcouldhaveafar-reachingimpactallovertheworldisthenewuslegislationembodiedintheusforeignAccountTaxCompli-anceAct(fATCA).passedbytheusCongressinmarch2010,itisdesignedtoensuretheidentificationof(andre-portingon)uspersonswithbankingrelationshipsoutsidetheusA.

Theuslegislationenvisagestheimpo-sitionofawithholdingtaxamountingto30%onspecificpaymentsfromussources(particularlyinvestmentincomeandcapitalgains)paidtoanyforeignf inancial intermediary foreither itsownaccountor thatofaclient.Theforeignfinancialintermediarycanavoidthisprocedureonlybyconcludinganagreementdirectlywith theustaxauthorityirs.

givenitssignificantinternationalactivity,particularlywiththeusA,switzerlandishighlyaffectedbyfATCA.Commentsdr.denotter:“ifnon-usfinancialin-termediarieswishtoinvestintheuscapi-talmarketandlookafterusclientsoncefATCAentersintoforce,theywillhavetoconcludethecorrespondingagreementwiththeustaxauthorities.Anyaffectedfinancialintermediarieswouldhavetobepreparedtotakeonacomparativelyhighadministrativeburdeninordertocomplywiththisagreement.”

butluxembourgtooislikelytofeeltherepercussionsoffATCA.Commentsmr.Thommes:“dependingonhowthatwillendupindetail–weinluxembourgandalsothroughoureuropeanassocia-tionefAmAarestillindiscussionswiththeustaxauthoritiesastohowexactlyfATCAshouldbe interpreted– thiscouldhaveanoutstandinglyimportantimpactintermsofinvestmentmanage-mentsystemapplicationsandcouldproveextremelycostlytoimplement.”

WinningWAYsheightenedregulatoryexpectationswillplaceadditionalpressuresontheinvest-

mentmanagement industryat large.inthewordsofmr.dolan: “investmentmanagementfirmshavedealtwithchang-ingregulations,accountingpoliciesandrisk trends.but this time it’sdifferent.Complyingwith emerging ruleswillrequirefundamentalchangesinbusinessmodelsandstrategies.Theimpactwillbeenterprise-wide.Werecommendthatfirmsleverage their compliance investmentsintoagrowthagendabystreamliningandenhancingsystemsportfolios, improvingdatagovernanceandmanagement,andenhancingcustomermanagement.”

Thechangesareat thestrategic level,theyarenotat thebusinessunit levelanymoreorattheproductlevel.Whereasin thepast, the approachwasmoretactical inorientation,thepresentcir-cumstancescallformoreofastrategicre-appraisaltotakeaccountofnotonlyone aspectof regulatory change, ifdodd-frankistakenasanexample,butawholehostofregulatorymeasures(i.e.Aifmd,mifid,solvencyii,uCiTsiv,etc.).

Asaconsequence,andinviewofthisall-encompassingandwide-rangingchange,regulators expect to see, and indeeddemand,acomprehensive,custom-builtandsophisticatedcomplianceprogrammewithfull testing,useof technologicaltoolsandiTexpertise.Theconsequencesofnon-compliancearenotworththink-ingabout,andacompliancefailurecanproveterminaltoabusinessoperation.

Asoundsystemofcompliancecontrols–backedupwiththenecessaryiTar-chitecture–isessentialinprotectingtheorganisationfrombusiness,regulatoryandreputationalrisks.Astrongcompli-ancefunctionwillalsobecomeafactorof increasingcompetitive importance,whichwilldefineandsetanorganisationapartfromitscompetitors.intheend,thewinningwaywillprevail.

Michael Metcalfe is Co-Editor of the Jour-nal of Applied IT and Investment Man-agement. A financial journalist by profes-sion, he has worked for such publications as The Economist, Financial Times and In-ternational Herald Tribune. Based in Germany, he also worked in the Luxem-bourg financial sector for 10 years, includ-ing tenures with Nordea Investment Funds S.A. and Lombard International Assurance S.A.

“… regulators expect to see, and indeed demand, a comprehensive,

custom-built and sophisticated compliance programme with full testing, use of technological tools

and IT expertise.”

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.

Assess regulatory impact today at

http://compliance.simcorp.com

compliance.simcorp.com

Assess the impact of new regulations on your investment management system

Regulatoryimpact assessment - get a personalised

quick guide


New financial legislation being passed across the globe will have sweeping repercus-sions on the technical and IT structures of investment management organisations. Based on interviews with three global consultancies, Michael Metcalfe, Co-Editor of the Journal of Applied IT and Investment Management, discusses the choice of IT platform when it comes to gearing up to meet the regulatory challenge in a post-crisis environment.

sincethecollapseofanumberofglobalfinancial institutionsin2008unleashedthefull forceofaglobalfinancialcrisis,the

rippleeffectsofwhicharestillbeingfelt,thefinancialservicessector ingeneralandtheinvestmentindustryinparticularhavewitnessedsweepingchangesinthewaytheydobusiness.boththebuy-sideandthesell-sideoftheindustryhavehadtocontendwithawiderangeofpressingissues,rangingfromdepressedinvestorconfidenceanddecliningassetpricestocorporaterestructuringandbusinessre-alignment.

Althoughmuchoftheinvestmentman-agement industryhasreboundedoverthepast18months,principallythroughrisingstockmarkets,thishasoccurredagainstacontinuingbackdropofradi-cal industrychange,muchofwhichiscontradictoryinnature.overthepasttwoyears,regulatorsand, increasinglyinvestors,haveprogressivelydemandednewandimprovedlevelsofserviceandtransparencyfromindustryplayers.

Atthesametime,manyofthesesamebusinesseshaveneededtofocusoncostreductionandcontrolinanattempttoremaincompetitiveandmaintainprofitmargins.forthemajority,lessinternalresourceshavebeenavailabletosatisfynewclientdemandsandtodevelopnewproductsandprocesses tocopewithincreasinglyfiercemarketcompetition,especially fromthe largerplayersandnewentrantstothemarket.

notwithstanding improvingmarketconditionsacrosstheglobe,theinvestorpopulationatlargeremainscircumspect

andriskadverse.Thesemarketdynamicshavemaintainedpressureonbusinessprocesses.Asa result,manyplayersarere-assessingtheirexistingbusinessmodels,technicaloperationsandthere-lationshipsthatsupporttheseprocesses,atthesametimeasseekingtoimproveriskmanagementoversightandcontrol.

neWWAveofregulATionsAndsTAndArdsWhereasindustrychangesoverthepasttwoyearshavestemmedprimarilyfrom

theprevailingmarketconditions, thenextthreetofiveyearswillseeawaveofnewregulationsandstandardsthathavebeeninthemakingforsometimefinally implementedacross theglobe,butprincipallyineuropeandtheusA.Combined,thisnewregulatorypatch-workwill impactthefullspectrumofbankingandfinancialservices,trickling

downtoinvestmentandsecuritiesopera-tionsandsignificantlychangingthewayinwhichtheseareundertaken,withtheresultthatparticipantsacrossthevaluechainwillneedtomodifythewaytheyoperateandinteract.

in thecaseofeurope, theprincipaleu-wideregulatorymeasures includethenewuCiTsivdirective;mifidconductofbusiness, including rulesregardingpointofsaleordistributionoffinancialproductsandthewayinwhich

thisdirectivewill interactandsupportthenewuCiTsdirective;apotentialeudirectiveonpackagedretailin-vestmentproducts (prips);andnewuK-basedregulationsfromtheretaildistributionreview(rdr).

intheusA,thenewregulationsbe-ingpassedwillhaveafar-reachingand

# Best practices: the optimal investment management system for regulatory compliance

Michael T. Dolan is a Partner, Ernst & Young LLP, Washington D.C., USA.

Sriram Venkataraman is an Executive, Financial Services Office, Ernst & Young LLP, New York, USA.

Dushyant Shahrawat is Senior Research Director, Securities and Investments, TowerGroup, Boston, USA.

“… many players are re-assessing their existing business models, technical operations and the relationships that support these processes, at the same time as seeking to improve risk management oversight and control.”


profoundimpactonthesecuritiesandinvestments industry,affectingcom-petitivepositioningof f irms,marketstructure,revenuegrowth,profitabilityandiTbudgets.newregulationscre-ateopportunitiesforserviceproviderstohelphedgefundsmeetregistrationrequirements, assistwithover-the-counter (oTC)derivativesvaluationandclearing,monitorcapitaladequacyand leverage limits,andpromoteriskmanagementandcompliance.

uCiTsivAsdriveroftheregulatorymeasuresbeingen-actedineurope,uCiTsivisprobablytheonehavingthemostimpactontheinvestmentmanagementindustryintheimmediatefuture.Whilecostsavingsisakeydriverattheindustrylevel,theincreasedcomplexityandtheensuingoperationalchallengesbroughtaboutbyuCiTsivmayactuallyleadtosomeadditionalcostpressuresattheorganisa-tionallevel.forstarters,firmswillneedthenecessaryiTexpertiseandsystemstohandlemultiplelanguagesandtaxissues.

Additionally,themanagementcompanypassportisstillsubjecttotaxissuesthatwillhavetobecloselyconsideredbeforemakingrestructuringdecisions.frag-mentedtaxregimescouldmeanthattheuseofthemanagementcompanypassportandcross-borderfundmergersposerisks,suchasdoubletaxationtoinvestors.

TorisetothechallengeofuCiTsiv,investmentmanagerswillhavetobuildintotheiriTbestpracticesthenecessarytechnicalandoperationalfunctionalitiestodealwith:1)sellingacrossmultiplecountries;2)administeringacrossmulti-

plelegislations;3)copingwithtaxissuesacrossmultiplemarkets;4)remainingcompliantinthefaceofgrowingregula-torycomplexity.

understandingtheintricaciesandnu-ancesofuCiTsivwillbeimportantaswell to ensure theorganisation’stechnologyandoperationalprocessesarealignedsuccessfully.Whilefundmanag-ersconcentrateontheircorecompetencyofmanagingmoney,outsourcingopera-tionalsolutionsoffersonewaytomeetchallengesonthemanager’sownterms.europeanassetmanagersshouldtakethetimenowtobetterunderstanduCiTsiv’sarrayofoperationalchallengestodeterminewhichcanbemetbyinternalversusexternalresources.

uCiTsivbesTprACTiCesAsuCiTsivwillbethefirstofmanyeuregulatorychanges tobe imple-mentedinthenextfewyearsand,whilethemajorityofthenewprovisionsareoptionalratherthanmandatory,itwillhaveamajorimpactonthechoiceofbestpracticesinvolvedintheadministrationanddistributionofuCiTsfunds.nowthatlevel2implementingregulationshavebeenpublished,thefundindustryislookingtofullyassessthebusinessandiTimplicationsofuCiTsiv.

ofparamount importancewillbe todeterminethestrategicandbest-practicedecisions,whetherregardingproduct,process,administrationordistribution,thatwillberequiredagainstabackdropof increasingcompetitioninamarketthatmaynotexperiencethesamelevelsofgrowthintheforeseeablefutureashasbeenthecaseoverthepastdecade.

Thekeybest-practicequestionaskedbymanyinvestmentmanagersis:howcanthedifferentpartsofuCiTsivbeutilisedtomaximiseadministrativeand technologyeff icienciesandyetenhancedistributionandnetsales inordertopromotegrowth?WhilesomeofthecompulsorymeasuresofuCiTsivarecurrentlyperceivedasadditionalburdens (i.e.Kidandmanagementcompany-relatedharmonisedorgani-sationalandconductofbusinessrules),thismaynotnecessarilyprovetobethecase,especially inthe long-termperspective.otheruCiTsivmeasures(i.e.mergers,master-feederstructures,themanagementcompanypassportandstreamlinedproductnotification)havethepotentialtoboosteconomiesofscale,enhanceefficienciesandimple-mentbest-practiceinvestmentmanage-mentsystemsolutions.

mAJorusreformissuesTurning to theusA, six issueswillbecomemajorbusinessprioritiesowingtoregulatoryreform.Theseareinturn:

Risk management Thelargestopportunitythatthenewregulatoryenvironmentcreateswillbeinhelpinginvestmentorganisationsretooltheirriskmanagementdepart-ments.Anintensefocusonriskwillbedrivenbypressurefromshareholderstobettermanagecompany-widerisk,whether arising from the expectedrequirementsofbaseliiitothemanyprovisionsof thedodd-frankActthatrelatetoriskmanagementandthedemandsplacedbythenewofficeoffinancialresearch(ofr).

forexample,investmentcompanieswillbeassisted inmanagingriskby inte-gratingtheiraccountingcollateralandreportingsystems,improvingattributionanalysis,andcleansingandstandardisingdata.provenexpertisewillberequiredinhelpinginvestmentcompaniesaddresstheirriskmanagementneeds.

OTC derivatives reform Thedodd-frankActwillbringinflu-entialchangestotheoTCderivativesmarket,creatingopportunitiesforsolu-tionsrelatedtocollateralmanagement,centralisedclearing,real-timereportingandmonitoringofpositions.underthereform,manyoTCderivativeswillhavetobeshiftedtoacentralclearingmodelowingtomoretransactionvolumesandrelatedservices.AmajoroverhauloftheoTCderivativesbusiness is thereforeinevitable,bringingwithitimplicationsforchoiceofbest-practiceiTsolutions.

Hedge fund registration newrulesaffectingthealternativefundsectorwillmakefundmanagersdemandservicesrangingfromseCauditsandcompliance checks toperformancereportingandvaluation.overthenextfewyears,regulatorychangeswillobligethealternativefundsectortoprepareiTplatformsforseCregistration,moretransparencyanddisclosure require-ments,greaterregulatoryscrutiny,andastrongerinternalriskmanagementandcompliancedepartment.

Thisreformcallsforexpertisealternativefundaccounting,reportingandclientmanagementsystems.systemsintegra-tionandexpertisewillberequiredonthepartofinvestmentmanagementcompa-

“To rise to the challenge of UCITS IV, investment managers will have to build into their IT best practices the necessary technical and operational functionalities …”


niesinrelationtotheiralternativefundoperations,complianceandreporting.

Leverage and capital adequacy Acommonandunifyingthemerunningacrossseveralregulatoryrequirementsisstricterlimitsontheamountofleveragethatinvestmentmanagementoperationscanassume,greatercapitalrequiredtobeheldonthebooksandfrequentandmore

comprehensivereportingofleverageandcapitalheld.

Tomeetthesedemands,institutionswillneedtoundertakeathree-stepprocess.Theywillneed tomonitor securitiespositionsmoreandmoreinrealtime,aggregatetheirexposureacrossalllinesofbusinessandbeable toreportandmanage it in linewith requirementsembodiedintheCollinsAmendment.investmentmanagementorganisationswillrequiresupportforallthesetasksforoneofseveralreasons:inmostcases,they

simplydonothavethein-houseskillstodothiswork, they lacktheskilledpersonneltodoit,orexternalsupplierscandoitmorecost-effectively.

Asset valuations severalnewaccountingrulesaffecttheprocessandmethodologythat invest-mentmanagementcompaniesuse tovaluesecuritiespositions,particularly

illiquid instruments.newfinancialAc-countingstandardsboard(fAsb)rules,aswellasnewinter-national Account-ingstandardsbody(iAsb)rulesgovern-ingsecuritiesvalua-tion,willrequirecom-panies toalter theiraccountingandgen-eral ledger systems,use third-partypro-vidersforindependentvaluationsandbetterreport valuations tooutsideparties.

i n a dd i t ion , t hedodd-frankActwillnotonlyrequirepubliccompanies to reportsecurities positionsto shareholders andregulators but also

requireprivateequityandalternativehedgefundstobeginreportingpositions(togeneral/limitedpartners,toregula-tors,totheofrandeventoprospectiveclients).Thiswillmeandemandforinte-gratedsolutionsthatprovidekeyinputsintothevaluationprocess.

Audit and compliance investmentmanagement companieswill feel theheat frommorefrequentand invasiveauditsandmuchgreaterregulatoryoversight from theseC,CfTC,federalreserve,andConsumer

financialprotectionbureau.seCin-vestigationsofalternativehedgefundshavesteadilyrisenoverthelastfewyearsfrom776in2007to944in2009andanestimated1,050in2010.newpowers,aus$100millionbudgetincrease,andtheauthoritytohire1,000newemployeeswillmeanthatinvestmentorganisationswillbecontendingwithamuchmoreempoweredseC.

Thefederalreserveandtheofrwillalsoexertgreaterregulatoryoversightandinfluenceoninfluentialinvestmentcompanies likemorganstanleyandgoldmansachsand largealternativefundsthataredeemedtobesystemicallyimportant.Thiswill increasetheneedforcompliancesoftware,auditprepara-tion,employeesurveillanceandrelatedservices.

groWThChAllengesAs regulatory requirements and cli-entdemanddrivechange, investmentmanagementorganisationswillneedtore-appraise their investmentmanage-mentsoftwaresystemsinordertoadoptbestpractice.Amongthemostimportantpointsforconsiderationincludethewaydataisstored.ifdataisstoredinseveraldatabasesorsystems, includingspread-sheets, itbecomesdifficult toobtainatrueindicationofriskexposure,aswellastogaininsight intoliquidity,valuationsandsimilarmetrics.valuable timeandresourcesarespentontryingtoconsolidatedisparatedatasourcesintoacleanandtruepictureofthebusiness.

inaddition,companieswillfindthatdueto limitations intheir investmentmanagementsystemplatforms,thereisanabundanceofmanualprocessesandduplicatedataentries,whichconsumeresources and result inhigher errorrates.further,manymonths–orevenyears–maylapsebetweennewreleasesorupgradestotheplatform;whichforcesdiversionofiTandotherresourcesto

“A common and unifying theme running across several regulatory requirements is stricter limits on the amount of leverage that management operations can assume, greater capital required to be held on the books and frequent and more comprehensive reporting of leverage and capital held.”

# Best practices: the optimal investment management system for regulatory compliance


creatingworkaroundsinordertocomplywithnewlegislationandregulation.

Thecompanythenfinds itself in thesituationofswimmingagainstthecur-rentjusttokeepupwiththetideofnewregulation,ratherthandedicatingtimetogrowing thebusiness.finallyandperhapsmostimportantly,theplatformdoesnotsupportallassetclassesandfinancial instruments,therebylimitingtheopportunitiestogrowthroughex-pandinginvestmentofferings.

sYsTemsoluTionsAnoptimaliTplatformembeddedinthetechnologyprocessesof the indi-vidualinvestmentmanagementorgani-sationaddressesalloftheabovepointsbyprovidingacoresystembasedonasingledatasource,combinedwithashighadegreeofautomationasispossible.Thesystemshouldbefrequentlyupdatedandprovidecoverageofallassetclassesandfinancialinstruments.

fromatechnologypointofview, theinvestmentmanagementsystemmustbeabletoincorporateregularchangestoworkflowsandprocesses,aswellasscaletoaccommodatehighertransactionvolumes,newassetclassesandnewfundsandportfolios.suchabest-practiceinvestmentmanagementsystemallowsinvestmentmanagementorganisationstofocusontheircorecompetencyofaddingvalueforclientsratherthandevotinganinordinateamountofresourcestoopera-tionsandiTworkarounds.

Withunprecedentedregulatoryactivityandmorestringentclientdemandsoninvestmentmanagers, ithasbecomecategorically imperative that invest-mentmanagementorganisationshavethe rightandevenoptimal technicalinfrastructureinplacetosupporttheirdesiredgrowthstrategy.CompaniesneedtofeelconfidentthattheiTplat-formstheyadoptorhave inplacecan

handleongoingregulatorycompliance.onlyinthiswaycantheyensurethatcorecompetenciesaredirectedatrealis-ingtheorganisation’sgrowthpotential.

Michael T. Dolan is a Partner at Ernst & Young LLP and is based in Washington DC. He is part of the organisation’s Advi-sory practice where he helps clients improve the overall performance of their operations, accounting and financial reporting processes. Michael Dolan specialises in implementing new portfolio accounting and analytical re-porting systems for portfolios of investments, debt, and derivative products. He holds a Masters degree in Quantitative Finance and is a Certified Public Accountant (CPA).

Sriram Venkataraman is an Executive in the Financial Services Office of Ernst & Young LLP and is based in New York, USA. He is part of the organisation’s Advisory practice and has experience in market risk management, financial derivative pricing models and trading system implementation. Sriram Venkataraman’s client base covers major money centre banks and financial institutions.

Dushyant Shahrawat is a Senior Research Director at TowerGroup in the Securities and Investments practice, Boston, USA. With over 15 years of experience in finan-cial services, he is a Chartered Financial Analyst (CFA) and a member of the Boston Security Analysts Society. Dushyant Shah-rawat researches strategic issues facing asset managers, hedge funds and brokerage firms globally, and advises clients about strategy, marketing, regulation, technology and prod-uct development. He has shared his opinions on financial industry trends at over 100 events across the USA, Europe and Asia and has appeared on various television and radio channels. He has also been widely quoted in printed publications such as the Wall Street Journal, New York Times, Fortune, and the Financial Times.

TOWERGROUP

Towergroup is a leading re-search and advisory servicescompany focused exclusively onthe global financial services in-dustry.formorethanadecade,ithas provided the world’s top fi-nancialservices,technology,andprofessional services companieswithadviceandinformation.itsteamof analysts and specialisedadvisers covers the business andtechnological issues impactingthe entire financial servicessector. more information atwww.towergroup.com.

ERNST & YOUNG

nearly 35,000 ernst & Youngfinancial services professionalsaround the world provide inte-gratedassurance,tax,transactionand advisory services to assetmanagement, banking, capitalmarketsandinsuranceclients.intheAmericas,ernst&Youngisthe only public accounting or-ganisation with a separate busi-nessunitdedicatedtothefinan-cialservicesmarketplace.Createdin2000,theAmericasfinancialservices office today includesmorethan4,000professionalsatmember firms in over 50 loca-tions throughout the usA, theCaribbean and latin America.practitioners span many disci-plines and provide a well-rounded understanding of busi-ness issues and challenges, aswell as integrated services. formoreinformation,visit www.ey.com/us.

“As regulatory requirements and client demand drive change, investment management organisations will need to re-appraise their investment management software systems in order to adopt best practice.”


T he internat iona l Ac-countingstandardsboard(iAsb) issued interna-tionalfinancialreporting

standard(ifrs)9,financialinstru-ments,tosimplifytheclassificationandmeasurementoffinancialassetseffective1January2013.ifrs9permitsadoptionforfinancial statementsstartingfrom2009,andrequiresthatfinancialassetsareclassifiedintooneoftwomeasure-mentmodels: (1) theamortisedcostmodel,or(2)thefairvaluemodel.Theclassificationrequirement isbasedonanentity’sbusinessmodelformanagingfinancialassets.

Thenewifrsstandardisdesignedtoremovemanyofthecomplexandrule-basedprovisionsoftainting,reclassifica-tionand impairment requirementsofthecurrent internationalAccountingstandard(iAs)39.movingoninoc-tober2010,theiAsbissuedadditionsto ifrs9 to includeaccounting forfinancialliabilities.Theadditionsretain

manyoftheprovisionsofiAs39,exceptthatfairvaluechangesofliabilitiesduetoanentity’sowncreditriskaretoberec-ognisedinothercomprehensiveincome.furthermore,thereshallbenorecyclingorsubsequentrecyclingtoprofitorlossevenwhentheliabilitiesarederecognised.

Astheinvestmentmanagementindustrycontinuestobecomemoreofaglobalmarketplace insearchofalpha, fundcomplexesareconsideringadoptionandimplementationofifrs9ismoreap-propriatefortheirever-growingglobalinvestorbase.Atacertainpoint,afundmanagementcompanyisboundtoselectifrsfinancialreportingforoneoran-otherofitsfunds.

butmanycorporatetreasurersandchieffinancialofficersremainuncertainabouthowandwhentoadoptifrs9.Thenewstandardispartiallyaconsequenceofthefinancialcrisisof2008-09,asinvestorsandregulatorsdemandedtoknowwhatkindofassetsandliabilitiescompanieshaveintheirbooksatanygiventime,whattheywereworth'inthemarket',therisksinvolvedandthegainsorlossesinthevalueofthoseitems,andtheywantthatshowninthefinancialstatements.

ifrs9aimstoachievejustthat–maketheaccountingoffinancialinstrumentssimpler,clearerandeasiertouse.Com-paniesweregiventheoptionofadoptingthestandardasearlyasnovember2009butarenotrequiredtodosountil2013.however,thecommonargumentisthatthestakesarehighandthatcompaniesshouldprepareforthestandardasearlyaspossible.

AdifferenTsTorYinChallenger’scase,thestoryisalittledifferent.likeeveryoneelse,Challengerhastoconsidertheimpactofifrs9,butforotherbusinessreasonshadalreadymovedon to the stageofneeding toaccountonbothanamortisedcostandfairvaluebasis longbefore theifrschangeswere introduced.using therightassetsoftwaresolutionintheformofsimCorpdimensionwasakeyfactor

allowingustoalreadybeinapositionwhereadoptionofifrs9willnotbeasignificantoperationalissue.

Akeyadvantageforusisthatweuseonesoftwaresolutionasourprimarysourceoftruthforassetvaluationsacrosstheentirebusiness.Thesystemalsohastheessentialflexibilityweneedtobeabletovalueassetsinmultiplewaysforvaryingpartsofourbusiness.

Challengerwasfortunatetohavestra-tegicallymadethedecisiontohaveacentralisedandveryflexibleassetsystemtocaterfor itsbusinessneedsandthesimCorpdimensionsystemmetthatneed.overthepastfivetosixyearsagreatdealofefforthasbeenputintotheimplementationofthissystem;andthishasmeantthatavery limitedamountofadditionaleffortwillneedtobeputintoimplementingifrs9,whichwaspreciselywhywewantedasystemgivingusahighdegreeofflexibility.

hisTorYinThemAKingChallengerisalargeAustralianfinancialservicescompanyandtheforemostissuerofretailannuitiesinAustralia.ChallengeristheonlyfinancialservicescompanyinAustraliadedicatedtoprovidingguaran-teed,certain-returnincomestreamprod-uctstobothinstitutionalandretailclients.Today,theinvestmentteaminChallenger‘slifecompany,Challengerlife,whichisregulatedby theAustralianprudentialregulationAuthority(AprA),managesoverA$7billioninassetstosecureincomeforapproximately60,000clients.

Challengeralsooperatesafundsman-agementbusiness of approximatelyA$20billion(seefigure1),applyingamulti-boutiquestrategywith10boutiquepartnerswithintheorganisationservic-

Investment management companies worldwide have to consider the impact of the new IFRS 9 accounting standard on their financial reporting and accounting procedures. This article describes how one Australian company is prepared to meet the IFRS 9 challenge head-on with the support of its financial software solution.

# IFRS 9: meet requirements and build competitive advantage with investment management IT

David Mackaway is General Manager, Operations, Challenger, Sydney, Australia.

“IFRS 9 aims to achieve just that – make the accounting of financial instruments simpler,

clearer and easier to use.”


ingover55,000investors inmanagedfundsand75institutionalclients.Theboutiquescoveradiverserangeofassetclasses, ranging fromAustralianandinternationalequities,traditionalfixed-incomeproducts,all thewaythroughtoalternativefunds.Wehaveadiverserangeofassetclassesandadiverserangeofclientneeds,effectivelyservicing11distinctbusinesses.havingonecoreas-setsystemaffordsusalotofefficienciesandcontrol.

Challengerhasusedthesamesoftwaresolutionforassetssince2003.Atthattimeiteffectivelytransitionedtheen-tirebusinesssothatallofitsassetsareadministeredthroughthesamesystem.Weusethesysteminaholisticwayforinvestmentadministration;tradeentryandexecution,portfoliovaluationandunitpricing,performanceandattribu-tionandcompliance.Withitallcarriedoutwithintheonesystem,wegainalotofoperationalefficiencyandstrongmanagementcontroloverourentirebookofassets.

AgoldenopporTuniTYThereis littledoubtthatconversiontoifrsrepresentsagoldenopportunityforinvestmentmanagementtoreviseitsaccountingpolicies.presentstandardsrequirefinancialassetstobeclassifiedasoneofthefollowing:

• atfairvaluethroughprofitorloss;• held-to-maturityinvestments;• loansandreceivables;or• available-for-salefinancialassets.

Alternatively, investmentmanagementcompaniescanadoptifrs9earlywithonlytwofinancialassetcategories.debtinstrumentscanbeheldatamortised

cost if thefund’sbusinessmodel is toholddebttomaturityandthepaymentsreceivedare solely forprincipal andinterest.debtnotatamortisedcostandallequityandderivativeswouldbeatfairvalue.

gainsorlossesondebtinstrumentsatamortisedcostarerecognisedinprofitorlosswhensold,impaired,reclassifiedtofairvalueandthroughamortisation.gainsorlossesonfinancialassetsheldatfairvaluearegenerallyrecognisedinprofitorloss(comprehensiveincomeforcertainequities).

financialliabilitieswillbeclassifiedasa)atamortisedcostusingtheeffectiveinterestmethod,b)fairvaluethroughprofitorloss,c)financialliabilitiesthatarisewhenatransferofafinancialas-setdoesnotqualify forderecognitionorwhen thecontinuing involvementapproachapplies,d)certainfinancialguaranteecontracts,ore)commitmentstoprovidea loanat abelow-marketinterestrate.

financialassetandliabilityclassifica-tions,whichdefinemeasurementandprofitorlossrecognition,aremadeusingiAs39orifrs9requirements.man-agementwillalsobeabletodefineanddocumentvaluationmethods,inputsandlevelswithintheifrsfairvaluehierar-chyfordifferenttypesofinvestments.

financial instrumentsheldasassetsor liabilitieswillbetaggedbyspecificcategoriesforaggregationanddisclosureinthestatementsoffinancialpositionandcomprehensiveincome.statementnoteswillincludeifrs9fairvaluehi-erarchydisclosureswithlevelsbasedontheobservabilityofinputsandvaluation

methods,aswellasriskdisclosuresforfinancialinstruments.

Thecostsoffinancialinstrumentsatfairvaluethroughprofitorlosswillhavetobesegregatedfromtransactionorcom-missioncosts,whichwillbeexpensed.managementandtheadministratorwillwanttotrackactivityoveraperiodoftimeusingifrsindicatorsandpreparesamplefinancialstatementstobeassuredthat ifrsreporting is accurateandcomprehensive.

reduCingCompleXiTYTodate,ifrs9coversfinancialassetsandrepresentsonly thefirstphaseoftheoverhaulofiAs39;thetreatmentof liabilities andhedge accountingremainunderconsideration.Themostbenefitfromifrs9isreallytosimplifytheclassificationofdifferentcatego-riesoffinancialassets.AccordingtoaglobalsurveyoffinancialprofessionalsreleasedbytheCfAinstitute,halfof

2010

1,466

2011

1,689

2012

1,912

2013

2,163

2014

2,449

2015

2,771

2016

3,136

2017

3,550

2018

4,017

2019

4,547

2020

5,146

Rainmaker forecast a CAGRof 13.4%

Fig. 1. Australian industry FUM growth projections (A$ billions).Source: Rainmaker Roundup,December 2009.

“We use the system in a holistic way for investment administration ... With it all carried out within the one system, we gain a lot of operational efficiency and strong management control over our entire book of assets.”


therespondentsindicatedthatifrs9improvesdecision-usefulnessoffinan-cial reports;38%believed it reducedthecomplexityoffinancial instrumentaccounting.

ifrs9narrowsdownfinancialinstru-ments intotwomeasurementcatego-ries:amortisedcostorfairvalue,thuseliminatingtheheld-to-maturity,avail-able-for-sale,andloansandreceivablescategories.Theclassificationhingesontwocriteria:theentity’sbusinessmodelformanagingitsfinancial instrumentsandthecontractualcashflowfromthatinstrument.

Aninstrumentismeasuredatamortisedcostonlyiftheentity’sobjectiveistoholdtheassettocollectcashflowsandifthecontractualcashflowsaresolelypaymentsofprincipalandinterest.Assetsthatfailtomeet the twocriteria (forexample,equities,convertiblebonds,forwardsorswapcontracts)shouldbemeasuredatfairvaluethroughprofitorloss.

sTATuTorYreporTinginChallenger’scase,ifrs9’srequire-mentofeithertreatingfinancialinstru-mentsonanamortisedcostbasisorafairvaluebasishasbeenoneeffectivelyinplaceformanyyears.

AstheregulatoroverseeingChallenger’sannuitybusiness,AprArequires theassets and liabilitiesheld in the lifecompany tobevaluedonamark-to-marketbasisandthisformsthestatutoryreportingforthebusiness.inaddition,Challengerformanagementreportingpurposeslooksatcashoperatingearningsonanamortisedcostbasistoshowthelevelofcashflowbeinggeneratedtosup-portthepaymentsmadetoitsannuitants.

in relation toChallenger’smanagedfunds’business,therehasalwaysbeenarequirementtovaluetheseportfoliosonafairvaluebasis.it’sfundamentaltothebusiness:manyofthefundsoperatewiththeideaofbuyingandsellingsecuritiesonanongoingbasistogenerateperform-anceandthereisaconstantneedtohaveassetsvaluedattheircurrentfairvaluetoensureequitabletreatmentofallunit-holdersandtodealwiththeebbandflowofinvestorsapplyingforandredeemingintothefunds.

WhereaswithiAs39everythinghadtobetreatedonasecurity-by-securitybasis,nowthefocusisontheentirebusiness.Thewholeideaistogenerateareturnfortheinvestor,andtypicallymanagedfunds–andcertainlytheonesChallengeroper-ates–operateinatruststructure.Whatthismeansisthatunit-holderscanapplyandredeemfromthetrustatanypointintimeandweneedtoensurethisisdoneatthefairvalueoftheassets.

inviewofallthesedivergingrequire-ments inacomplexstatutoryenviron-ment,itisveryhardtobeinascalablepositionifyourequirefiveorsixsystemstodealwithalltheserequirements.AndsostrategicallyforChallenger,whenitwasgoingthroughtheprocessofpickinganewassetsoftwaresystem,wewerelooking foracontenderwithprovenabilitytobehighlyflexibleinaccount-ingforandrunningassetsfordifferentbusinesseswithinonesystem.

Thistypeofflexibilityisextremelyvalu-ableandverypowerful.WhatitmeantforChallengeristhatitcouldhavethesediversebusinessmodelsalloperatedoffonecentralsystemandnothavetoworryaboutmanagingmultipleversionsofthesamesystemdoingdifferentthings.

beenThere,doneThATformanyyearswehavehadtherequire-mentofvaluingaccordingtoafairvaluemethodwhilealsoneedingareportingframeworkbasedonamortisedcosts.Aboutthreeyearsago,weundertookaprojecttofullyachievethiswithinoursoftwaresolution.Aswenowmovefor-wardinourinvestigationofifrs9,wetakeagreatdealofcomfortinthefactthat fromanoperationalperspective,theexerciseamountstonomorethanjustlookingbacktothefuturebecausewehadalreadybeenthereanddoneit.

ifwehavepartsofourbusinessthatmayneedtomovetoamortisedcostsfromastatutoryperspective,ourviewis thatthiswillnotbeasignificantoperationalhurdlebecauseweknowthesystemcandoit–thesystemhasactuallybeenop-eratingthiswayalready–andforthoseparticularassetsorportfoliosthatareaffected,wecanjustliterallyswitchthemethodologyback.

CAshfloWsAsbuildingbloCKsoneofthefundamentalstrategicbuild-ingblocksthatChallengerbelieves itsinvestmentmanagementsolutionhasrightwastobuildasystemthatthinksabout securitiesbasedon their cashflows.securitiesinthesystemareliter-allymadeupofabundleofcashflows,andonceallthesecashflowsaregatheredandassembled,eachandeveryonecanthenbevaluedatvaryingrates.Thatisarealstrategicdifferencecomparedwithsomeoftheothersystemsthatareavail-ableinAustralia.

“ ...we were looking for a contender with a proven

ability to be highly flexible in accounting for and running

assets for different businesses within one system.”

# IFRS 9: meet requirements and build competitive advantage with investment management IT


Theabilitytosliceanddiceasecurityandbreakitsvaluationdownintocashflowcomponentsclearsthewaytoproceedalongmanydifferentpaths.Thishasal-lowedinordinateamountsofflexibilityinourbusiness,notonlytodealwithlegislativechangesbutalsotoeffectivelyhandlethecomplexitiesofsomeoftheinstrumentswetradein.

forexample,Challengeradministersnumerouscomplexstructuredassets,buthereagaintheyallboildowntoabundleofcashflowsthatneedtobebrokenupintotheirconstituentpartstodecidehowtovaluethem.becausethesoftwareisabletobreakdownsecuritiesinthismanner,it ispossibletorepresentverycomplexsecuritiesusingstandardbondfunctional-ityandassociatedcustomisedcashflowstotheextentthatthesystemrepresentsaveryrealcompetitiveadvantageforus.

TheholisTiCWAYoneoftheimportantfeaturesinusingthesysteminaholisticwayisthatwe

donotrunintotheproblemofhavingtoduplicateworkprocesses.forexample,iftheunderlyingvaluegiventoasecu-rityhastobechangedinonesystemandthendifferentchangeshavetobemadewithin thecompliance system, thisrequiresduplicateeffortandworkload.forChallenger,having itall inonesystem–whileitdoesnotremovetheneedtomakechangesasinstrumentschange–itdoesallowustodoitinastreamlinedandefficientway.

inAustraliathereisalwaysthedebatewhetherinvestmentmanagementcompa-niesshouldconducttheiradministrationin-houseoroutsourcetoathird-partyprovider,whichislargerandcanpoten-tiallyaddtheeconomiesofscalethatmaynototherwisebepresent.Wehavecar-riedoutthefunctionin-houseformanyyears,andoneofthekeyreasonsforthatisretainingcontrolandhavingahighdegreeofflexibilitytobeabletoworkwithourinvestmentteamsindesigningandstructuringnewproducts.

Challengerconsidersitselfassomewhatofanindustryleaderinbeinginnovativeanddesigningproduct thatmeets theneedsofitsclients,andwealsoconsiderourselvesasbeingresponsiveinspeed-to-market.beinginnovative,dealingwithconstantchangeandbeingabletobringthat to themarketplaceveryquicklymeansthatyouneedalotofcontrol,notonlyintermsoftheinvestmentmanage-mentperspectivebutalsotheadminis-trationandoperationoftheproductaswell.Withthetypeofsoftwaresolutionwehave,itreallyincreasesourabilitytosupportalltheseneedsandisakeyreasonweretainthefunctionin-house.

CHALLENGER

Challengerlimited (Challenger)is an investment managementfirmestablishedin1985andlistedon the Australian securities ex-change(AsX:Cgf)in1987.Theforemostissuerofretailannuitiesin Australia, Challenger is theonly financial services companydedicated to providing guaran-teed, certain-return incomestream products to both institu-tional and retail clients. Today,Challenger life manages overA$7billioninassetstosecurein-come for approximately 60,000clients. in addition, Challengeroperatesa successful fundsman-agement business across variousassetclassesmanagingoverA$20billionandservicing55,000retailand 75 institutional clients. Thisis operated via a multi-boutiquestrategy whereby Challengerpartners with boutique invest-mentmanagementfirmsofferingbothadministrationanddistribu-tion capability. Currently thereare 10 boutiques in the Chal-lenger stable. more informationatwww.challenger.com.au.

“The ability to slice and dice a security and break its valuation down into cash flow components

clears the way to proceed along many different paths.”

David Mackaway has held the post of General Manager, Operations, at Chal-lenger since 2007 and is responsible for all investment and registry operations sup-porting the Challenger business. He has worked in the industry for over 17 years and prior to joining Challenger was an Executive Director of MMC Asset Man-agement Limited and Chief Financial Of-ficer of ASX-listed MMC Contrarian Limited. Prior to MMC, David was based in the USA as Global Head of Op-erations for Principal Global Investors. He also worked in Australia for BT Funds Management for over 10 years in various operational roles, including running BT’s fixed interest and currency business.

David Mackaway, Challenger’s General Manager, Operations, outlines how an optimal software solution can improve an investment management company’s ability to meet the needs of being innovative, adaptable to change and responsive in speed-to-market.


T he uCiTs framework,originatingfrom1985andupdatedseveraltimessincethen,wasintendedtoallow

arealsinglemarketininvestmentfundstodevelop–sincethefundsallcompliedwiththesamerules,consumerscouldin-vestwithconfidenceacrosseuborders.Therules increase investorprotectionandcosttransparency,andsetoutbasicrequirementsonorganisation,manage-mentandoversightoffunds.

undertakingsforCollectiveinvestmentinTransferablesecurities (uCiTs)haveprovedvery successfulover thepast20years,emergingasanessentialcornerstoneinthedevelopmentoftheeuropean investment funds industry.Although intended foreumemberstates, theuCiTsbrandhasbecomeglobalandrecognisedasawell-super-visedretailfinancialproduct–uCiTs

fundshavebecomesuccessfulinoverseasmarketssuchasAsiaandlatinAmerica.

uCiTsiv is the latest reformof theuCiTsdirectives–aseriesofefficiencyandconsolidationmeasures(seefigure1)thatwillallowtheindustrytoaddresslackofscale,experiencecostsavingsandimprovetheefficiencyoftheireuropeanoperations.itwasapprovedbytheeuro-peanCommissioninJuly2010and,pend-ingeumemberstates’legislativeapproval,itwilltakeeffecton1July2011.

Thedirectiveforeseesthatthe invest-mentfundmarketwillbeabletocon-solidatefundsandreducethenumberoflocalmanagementcompanies,resultingincostsavingsandefficiencies.inaddi-tion,uCiTsfundswillbecomemorecompetitive, and,witheasier accesstoneweumarkets,thiswillresult inincreasedmarketshares.

Thelargerindustryplayersbynowarewellpreparedinrespecttothemanda-torychanges (i.e. introductionof theKeyinvestorinformationdocument),whichwillalsobeinforcebyJulythisyear.however,theyareonlybeginningtoprepare for thenewconsolidationopportunities.

WindoWofopporTuniTYThedirective really does open thewindow for increased cross-borderoperations.butonce thewindow isopened,investmentmanagementfirmsfacebigchallengesinrespecttovarioustax-regimesupportandlocalregulatoryspecialities.Withoutahugeextraef-fort,the27differenttaxregimesofthe

variouseumemberstatesstillstandasabarrierforattractingforeigninvestors.

one thing is togain theneeded taxknowledge,but justas important istomakesurethatplayershavetherightiTinvestmentmanagementplatformtoimplementthisknowledge.Toobtainthenecessaryeconomyofscale,thetrickistosellthesamefundtoasmanyinves-torsaspossible,butstill includetheirvariouspreferencesinrespecttospecialdistributionneeds, riskpreferences(hedgeclasses), large-or small-scaleinvestments(variousfeeconstructions),performancefeesandtaxsupport.

oneofthemainfeaturesofuCiTsivis themaster-feederstructure,whichprovidesforpoolingofassets.Thisnewfundopportunityaddsanadditionaldimension to the complex tools formodellingstructuresthatcantargetalargerinvestorgroup.fundmanagementcompanieshaveto invest timeand/ormoneygainingtheneededmultipletax-regimeandregulatoryknowledge.ThentheyhavetoensurethatthisknowledgecanbeimplementedinaniTinvestmentmanagementplatform,whereviaaflex-ibledefinitionanddesignoffundstruc-tures,pricingandfeestheycanputthesechangestogoodeffect.Withoutthisthebenefitsonoffercannotbeutilised.

TheuCiTsivdirective applies topracticallyallofeuropeandthenewmaster-feederstructureaswell.foralongtimefundadministrationcentreslikeluxembourghaveoperatedwithadvancedfundstructuresintheformofmulti-classfundsandpoolingstructures.

With UCITS IV coming into force from 1 July this year, the main objective is to make the fund industry more efficient while still maintaining a high level of inves-tor protection. Windows of opportunity will be opened for those firms deploying the right investment management software solutions but disparate tax regimes tend to overshadow the benefits of the directive.

# UCItS IV: what investment management firms should do

to comply and ensure growth

Peter E. Hertel is Domain Manager for Fund Accounting, SimCorp.

“The directive foresees that the investment fund market will

be able to consolidate funds and reduce the number of

local management companies, resulting in cost savings

and efficiencies.”


however,uCiTsivhaspushedmanyothermemberstates intoremovingre-strictions inrespecttomoreadvancedfundstructures.it isthereforealsoex-pectedthatlocalfundmanagersinmorememberstatesingeneralwillconsolidatetheirfundsandgaineconomiesofscaleasaspinoffofuCiTsiv.soeventhefundmanagerwhoonlyfocusesonthelocalmarketshouldalsolookintothenewop-portunitiesinordertostaycompetitive.

Thedirectivedoesopennewopportuni-tiesbutalsoforceschangesinrespecttocross-border investorcommunicationsandinvestorreporting.buteventhoughthisinitiallywillincreasecostsforfundoperations,italsomarksanopportunityfortheindustrytostandardiseoperationsandinvestorcommunications.

neWKidonThebloCKTheKeyinvestorinformationdocu-ment(Kid)willreplacethesimplifiedprospectusexistinguptonowandwillensureahighlystandardisedandeasilyunderstandableformofinformationforinvestorsthatcanbeusedtocomparealluCiTsfunds.

fundcompaniesmustprovidethisdocu-mentatleastonceayearforeveryfundandforeachclassfundinamulti-classstructure (althoughsomeexceptionsexist).furthermore,thedocumenthastobetranslatedintoeverylanguageofjurisdictionswherethefundissold.

Kidisacompactdocumentcoveringseveral investmentmanagementplat-formdisciplines. itobliges the fundtohaverisk,performanceandchargesinformationintegratedinonedocumentand,asinmorefrequentfact-sheetre-porting,displaystheneedtohaveaniTinvestmentmanagementplatformthatcandothistypeofintegratedreportinginasmooth,well-reconciled,auditableandreliableway.ThiswillputstressoniTplatformswithmultiplesystemsanddifferentreleasecyclesandincurhigh

coststokeepinterfacesuptodateandreconciliationuptoscratch.

Thereareseveral technicalchallengesintherecurringeventofprovidingtheinformationbuttheoverallchallengescanbesummarisedasfollows.

Thewaythingsstandatpresent,manyfundmanagementcompaniessimplydonothavealltheKidinformationhousedorstoredinonesystem(i.e.performance,risk,charges,explanatory texts,etc.).shouldtherequireddatabestored inadatawarehouseorshouldoneofthegivensystemsbeusedas thecentraldataholder for the information?Cananyofthesystemsavailablecontainthisinformation?And,ingeneral,howdoesacompanymakesurethattheinformationusedisinternallyconsistent?

newKidreportingisnotanannualevent,ascertainfundsneedtobeupdatedmoreofteninayear.severaleventscancausethis,andasanexample,thesyntheticallyriskandrewardindicator(srri)hastobemonitoredweeklyoratleastmonthly.TheexistingiTsetupmustbeabletoac-commodatethis,asthedataandcalcula-tionmethodsbehindtheKidinformationmustbeavailableandauditableoverapas-sageofyears.Calculationsapproximatingspreadsheetsinthisareawillnormallynotbeacceptablebyauditors.

eventhoughthedocumentisverystrictincontextandform,guidelines fromtheCommitteeofeuropeansecuritiesregulators(Cesr)containprovisionsfornon-standardinformationinrespectto certainadvanced fund types (i.e.structuredfunds).manyplayersinthemarket,whileadvocatingsupport forKidreporting,haveveryfewremarksastohoworiftheysupportspecialneedsforadvancedfunds.

someofthekeyfigurecalculationscanbehandledviaanexternalpartner,butthebasicdatasupplyhastocomefrom

coreoperations;inseveralinstances,thecalculationscannotbeoutsourcedbutneedtohaveinternalspecialtreatment(i.e.inthecaseofvalueatriskcalcula-tionsandreturnscenarios).

intheshortrun, itmightbeaneasiersolutiontooutsourcepartof thecal-culationsandreporting.onequestion

iswhetherthissetupwillhavesupportfortheadvancedfunds.butinanycase,responsibilitycannotbedeniedforthedata, theauditibility requiredor thegeneraldataquality,nottoforgetmoni-toringofthekeyfigures.

usingabroaderperspective, theKidrequirementshouldbeseenasjustoneofmanyreportingrequirements.Thefrequentfact-sheetreportingandannualyearreportingdoesincludesimilarinfor-mationandatechnicalsolutioncouldbeappliedinconnectiontothis.

Cross-bordershoppingmAdeeAsierTheuCiTsivchangeswillresultinin-creasedcooperationbetweensupervisoryauthorities.Thenotificationprocedurewillbeappliedaccordingtoaregulator-

– Key Investor Information Document (KID)

– Supervisory co-operation

– (Simpli�cation of the cross-border noti�cation procedure)

Mandatory changes

– Management company passport (MCP) – Cross-border UCITS mergers

– Master-feeder UCITS structures

New opportunities

Figure 1. Most important amendments introduced by UCITS IV.The new directive comprises five new basic elements: two new mandatory changes and three new opportunities.

“The way things stand at present, many fund management companies simply do not have all the KID information housed or stored in one system (i.e. performance, risk, charges, explanatory texts, etc.).”


to-regulatorprincipleinsteadoftoday,wheneachfundcompanyneedsapprovaldirectlyfromlocalauthorities.ThiswillallowauCiTsfundtobeginmarketingitsunits inanothermemberstate(the‘hostmemberstate’)nolaterthan10workingdaysafterthedateofreceiptoftherequiredstandardnotificationletter.

Althoughitwillnowbequickertoapplythenotificationprocedure,theproductsofferedintheforeignmarketsstillneedtobeattractivetoforeigninvestors.WiththeeuropeanmarketbeingstrengthenedovermanyyearsviatheintroductionofuCiTsfundsandthecommonifrsaccountingstandard,theeustillconsistsof27differenttaxregimeswherespecial-isedtaxtreatmentoftenrequiresspecialdetailedreportinginordertobetaxef-ficient.ThelatestexampleofthisisfoundinnewAustriantaxationwherespecificAustrianruleshavebeenintroduced.

Toutilisethis improvedaccesstonewinvestorgroups, investmentmanage-mentcompaniesneed–inthecurrenttax-regimelandscape–tohaveaniTsystemplatformthatcansupport thelocal requiredtaxtransparency–andtherebyavoidpenaltytaxation.

mAnAgemenTCompAnYpAssporTAuCiTsfundsmanagementcompanymaybeauthorisedtocarryoutitsactivitiesforfundsdomiciledinanymemberstate.

ifa fundcompanywantstocarryoutactivitiesforfundsdomiciledinanother

country,itstillneedstocomplywiththelocalregulatoryrequirements,andit istherefore importanttohaveasystemsplatformthatcansupportthespecificrequirementsofthetargetedcountries.

Cross-borderuCiTsmergersThenew legal framework to facilitatecross-borderuCiTsmergerswillopenupforconsolidationacrossbordersandtherebyenhancetheeconomiesofscale.Withtheaveragefundsizeineuropeasmeasuredintermsofassetsundermanage-mentsixtimessmallercomparedtotheav-erageusfund,thisamendmentisseenbymanyasanimportantefficiencybooster.

unfortunately theguidelinesdonotincludeanycommontax rules.openquestionsinrelationtothemoveofassetsinrelationtoanymerger,andexistingin-vestors’taxpositionafterthemerger,havecreatedmajoruncertaintyinthemarket.

AJuly2010surveyentitled ‘uCiTsivandAssetservicing’fromernst&Youngstatesthat“...theviewofmanyintheindustryisthatnewrequirementssuchas theKeyinvestorinformationdocument (Kid)willpushup fundcosts,withnoguaranteethatassetman-agerswill rushtomergefunds,adoptmaster-feederorrationalisemanagementcompanystructures.”

AndamergerbetweenuCiTsfundswill thereforehavetobe individuallyconductedastherulesverymuchdependonthememberstatesoftheoutgoingandingoinguCiTsfund.

specificchallengescanalsoarise inacross-currencymergerwhencross-cur-rencyconversionsandresultingresidualshavetobehandled.

mAsTer-feederuCiTssTruCTuresThenewoptionforcreatingmaster-feederstructuresunderuCiTsivhasprovedoneofthelargerdiscussionelementsofthedirective.Thebenefitsofhavingthisoptionareobvious,asitallowsthefundmanagementcompanytocentralisetheinvestmentplatforminonestateandstillhavelocalfundswithanationalflavour.oralternatively,insteadofestablishingnew local fundswith theirownassetmanagementfunctions, itcanenhancethedistributionchanneloflargermasterfundsbyestablishingsimplefeederfundsinvestingintothemaster.

previously,duetouCiTscompliancerules(investorprotection),oneuCiTsfundcouldnotinvestmorethan10or20%(dependingonthememberstate)intoanotheruCiTs.Thisrulestillap-plieswiththemaster-feederstructureprovinganexceptionwherethefeedermustinvestatleast85%inthemaster.several fundmanagershaveoptedforlessrestrictedruleswhereafeederfundcanhaveseveralmasters.Thismakesittheoreticallypossible inaflexiblewaytodefinevariousfeederfundswiththeproper ‘mix’ofmaster funds, therebyofferingalargerpaletteofriskprofilesforinvestors.Thisisastructurewidelyseeninthepensionandlife insurancebusiness.however,thishasbeenviewedasbeinginconflictwithdiversificationrequirements(investorprotection).

Themasterandthe feeder fundsareseparate legal entities andakin toafund-of-fundconstructionwithspecificlinksinrespecttopricing,transparency,timingandaccounting.

missingTAXfrAmeWorKThemissing tax framework in theuCiTsdirectivehasraisedanumberof

“UCITS IV has highlighted the importance of having an integrated investment management software

system that in a flexible way can help design funds targeting large investor groups in a cost-efficient way.”

# UCItS IV: what investment management firms should do

to comply and ensure growth


unansweredquestionsforcross-bordermergers.formaster-feederfundsthereareadditionalopenquestionssuchas:

• howshouldthetransferofassetsfromamigratedfeederfund(fromnormalfundtofeeder)behandledfiscally?

• how should withholding tax betreatedbythefeedersidewhenorigi-natinginthemasterfund?

• howshouldtransparencybetreatedinrespecttosecurity?

• howshouldtransparencybetreatedinrespecttoincomestatementdetails?

Aslongasthesequestionsremainopenorcauseissuesontheinvestorside,wewillnot seea substantial amountofmaster-feederfundsineurope.

fAirTreATmenTAnothermoregeneralissueisthequestionoffairtreatmentofthefeeders.AccordingtotheCesr,thefeedershouldbehan-dledequitably,butthereisnoclearstate-mentthatthefeedersshouldbehandledequally.Thisactuallymakesiteasiertotreatthemasterfundasamulti-classfundwithclass-specificfees.ifcertaincostsormarketconditionscanjustifydifferentfeestructures,thevariousfeederscanthere-foreinvestinseparateclasseswithoutanyofthembeing‘discriminated’.

TrAnspArenCYneedsAsmentionedabove,themaster-feederconstructionissimilartoafund-of-fund

constructionwitha link inrespect topricing transparency, timingandac-counting.Cesrlevel2requirements(‘box2’)statethatamasterandafeedermustdefinethetermsofagreementthefeedermusthaveto‘Accesstoinforma-tion’, therebyenabling the feeder toperformitsexposure,complianceandotherriskmanagementfunctions.

TheCesralsostatesthatthefeedersshouldreceiveperiodp/lfigures.forasimplefund-of-fundconstructiontheperiodp/lfiguresinthefund-of-fundwillbelimitedtothep/ldirectlyonthefundcertificate.butisthissufficientfortheinvestorsinthemasterfund?fortaxreasons, it is likelythatsomeinvestorswillrequestthatincomeisbrokendownintomoredetails(i.e.dividendincome,interestincomeorcapitalgain).

however,thequestionishowdetailedtheseshouldbe?Andhowcanthemasterfundmakesureto informthefeedersabout their shareof theperiodp/lwhentheownershipratioshaverecordedchangesoverthelastperiod?

furthermore,howwill taxauthoritiesconsiderrealisationwithinthisconcept?Whenthe fundrealisescapitalgain,thereisnodirectrealisationinthefeederfund.shouldthefeederreceiveashareoftherealisationinthemaster?Andhowshouldthesharebedefined?shouldthesharebeapureproratashareaccording

tothecurrentownershipratio?orwilltaxauthoritiesrequestthatthefeedershouldrealisep/lasifthefeederhadinvesteddirectly?Thiswould implyrequestingmoreadvancedpartnershipaccounts likep/lallocationaccordingtoaccumulatedunrealisedp/l.

Tobeabletoservicetheneedsarisinginthetaxarea,thesevariousfundpoolingtechniqueswithp/lallocationfeatureswillbe importanttools todesigntheright levelof transparency, therebyutilisingthebenefits thatuCiTsivpresents.

Themaster-feederoptionshouldthereforenotonlybeseenasanewfundstructuretypebutasanadditionaltooltodesignafundthatcanaddressalargenumberofinvestorgroups.Thequestionis:cantheiTinvestmentplatformincludethisdesignelement,andatthesametimeoffertherequiredtransparency?

WindoWAJAruCiTsivopensthewindowforeasieraccesstonewinvestorsandincludesaseriesof much-neededefficiencyandconsolidationmeasures.Therequiredinvestorreportingexposesthepowerofanintegratedinvestmentplatform.buttoreallybenefitfromtheopeningwindow,fundmanagementcompanieshavetoexaminetaxregimerequirementsandmake sure that the iTplatformcanaddress the increasinglycomplex

fundstructureswiththerequiredtaxtransparency.

uCiTsivhashighlightedtheimpor-tanceofhavinganintegratedinvestmentmanagementsoftwaresystemthat ina f lexiblewaycanhelpdesign fundstargetinglargeinvestorgroupsinacost-efficientway.

Peter E. Hertel is Domain Manager for Fund Accounting in SimCorp’s Strategic Research department. He holds an M.Sc. in Economics from Copenhagen Univer-sity. He joined SimCorp in 1988 and over the years has been involved in develop-ment, sales, support, project management, implementation and internal and external training. In the past five years he has been heavily involved in implementing fund ac-counting in Denmark, Finland and Lux-embourg, heading up the global fund accounting domain in SimCorp’s Strategic Research department. Here he has worked on enhancing global support for complex fund structures and multiple tax regimes with a focus on optimising daily work-flows, thereby helping to achieve growth with general risk control in a cost-efficient way.

Peter E. Hertel, SimCorp, urges fund management companies to ensure their IT platform can address the increasingly complex fund structures with the required tax transparency.


T he passage of the WallstreetreformandCon-sumerprotectionAct(alsoknownasthedodd-frank

Act)signifiesthebiggestusregulatorychangesincethe1930sandwillhaveanenormousimpactonthesecuritiesandinvestmentsbusiness.inourbelief,thereformswillhaveasubstantial influ-enceonover4,000brokeragefirms,anestimated8,500investmentmanagers,andall the10–12usexchangesandalternativeexecutionnetworks.

Thedodd-frankActbecamelawinJuly2010.it isthemostsweepingpieceoffinancialregulationpassedintheusAindecades.Alltypesoffinancialfirmswillfeelitsimpact,frombankstoinvest-mentfirms,frombrokersto insurancecompanies.

Thelegislationhasspecialsignificanceforthesecuritiesandinvestmentsindus-

try,withbrokeragefirmsbeingaffectedthemostamongallfinancialfirmsandtraditional investmentmanagersbeingaffectedtheleast.Theimpactonbrokerswillincludelowerrevenues,highercosts,andachangeinthecompetitiveenviron-mentandmarketstructure.

The law seeks to correct structuralweaknessesintheusfinancialindustryliketheriskposedbyactivitythatfallsoutsidedirect regulatory supervisioni.e.tradinginover-the-counter(oTC)derivatives, thesystemicriskposedbyverylargefinancialentitiesfailing,andthedangersofnotrequiringunderwritersandsecuritisationfirmstomaintainsomeexposuretotheassetstheysecuritise.

sweepingas itmaybe,manycrucialdetailsofthedodd-frankActremainunclear–thelegislationisstillaworkinprogressandsecuritiesfirmswillhavetoawaitdetailsoftheruleswithwhichtheymustcomply.Changesinareaslikederivativesandnewcapitalrequirementswillbephased ingradually, the firstphasebeingexpectedin12–16monthsandthesecondphaseoverthenexttwotothreeyears.

impliCATionsforiTThedodd-frankActandotherregula-tionrelatedtosecuritiesandinvestmentswillcollectivelyhaveamajorimpactonthetechnologyandoperationaldecisionsoffinancial institutions.oldprioritieswillbesidelined(i.e.theneedtoamendinvestmentmanagementsystemstosup-portnewfinancialproductswillbedamp-enedasfinancialinnovationslows),whilenewprioritieswillemerge(i.e.supportingtransparencyanddisclosure).beloware

five implicationsofnewregulationontheindustry'stechnologyandoperations.

Key areas for considerationnot surprisingly, thepassageof thedodd-frankActandotherregulationswillmeangreater investmentmanage-ment systemrequirements incertainareas: riskmanagement, compliance,reporting,andanalytics.itisourbeliefthatiTspendingintheriskandcompli-ancebusinesswillgrow8–9%between2010and2011,ledbythelargestinsti-tutionalbrokeragefirms.hedgefundsmustinitiateiTprojectstocomplywithregistrationrequirementsandenhanceoverall transparencyanddisclosureofoperations(albeitquitehesitantly).Anddatamanagementwillalsonecessitategreatimprovementsinriskmanagement,compliance,reporting,andanalytics.

Renewed focus on cost savings and efficiencyAs regulation impacts the industry'seconomics,pressingdownrevenue(fromproprietary trading,oTCderivatives)andpushingupcosts(ofriskmanage-ment,compliance,reporting),pressureoncostsavingsandefficiencywillrevive.TherewillbeoverallcostpressureontheentireiTbudget,particularlyinareaslikeagencybrokerageandoTCderivatives.evenifeconomiesimprovedramaticallyin2011andbeyond,chieffinancialoffic-erswillcontinuetopressureheadsofiTandoperationstoseekwaystotrimcostsinresponsetocontinuedmarketuncer-taintyandreducedprofitability.

Supplier tiesAre-assessmentof supplierswillbedrivenbytheshift inbusinessandiT

New US regulations as embodied in the Dodd-Frank Act will have a far-reaching and profound impact on the investment management industry, not only in the USA but elsewhere, affecting competitive positioning of firms, market structure, revenue growth, profitability, and IT budgets. The industry will have to overhaul five investment management system areas: risk management, compliance, reporting, analytics, and data management.

# Dodd-Frank Act: how will the act affect IT systems?

Dushyant Shahrawat is Senior Research Director, Securities and Investments, TowerGroup, Boston, USA.

“The Dodd-Frank Act and other regulation related to

securities and investments will collectively have a major

impact on the technology and operational decisions of

financial institutions.”


needsduetochangedregulations,thedrivetotrimcosts,andtheneedtobe-comemoretechnologicallynimbleandenhancebusinessflexibilityandagilitytorespondtonewregulations.

overtime,there-assessmentofsupplierrelationshipscouldcauseadislocationintheprovidermarketwithsupplierswithstrongfunctionalknowledgeandcompetitivepricingwinningoutovercompetitorsthathavegenericsolutionsnotcustomisedtotheindustry’sneeds.

Greater pressure to outsourcenewregulationswillalsopushsomefirmstore-examinetheirattitudetowardoutsourcing.renewedcostpressuresandtheneedtobolstercapabilities incertain areasmay cause investmentmanagerstoseekmorerelationshipsinbothbusinessprocessoutsourcing(bpo)andinformationtechnologyoutsourcing(iTo).brokerswillalsofurtherexpandoutsourcingrelationships insecuritiesprocessing,causingthefewremainingfirmsthatself-clear toconsiderusingcorrespondentclearingproviders.

organisationswill furtheroutsourcefunctions suchascustody, trade set-tlement,cashmanagement,andinves-torservices,whicharealready largelyoutsourced;thatis,ahigherproportionofactivitieswillbeoutsourced.Areassuchasvaluationofilliquidinstruments,administrationofoTCderivatives,andcollateralmanagement,whicharecur-rentlyoutsourcedinalimitedway,willbeofferedupforoutsourcingbids.how-ever,somefunctionalareas–includingsuppliermanagement,riskmanagement,compliance,andordermanagement–

willremainofftheoutsourcingagendaforthemostpart.

Changes in service deliveryregulatorypressurewillalsohaveanim-pactoninvestmentmanagementfirms'attitudetowardthewaytheyconsumesoftware,influencingtheirperceptionofconceptssuchasapplicationservicepro-vider(Asp)-baseddelivery,software-as-a-service(saas),andcloudcomputing.forthelastfivetosevenyears,therehasbeenacleartrendintheindustrytowardthin-clientcomputingandaccessingsoftwarethroughaweb-basedinterface.

Thenewregulationswillpushthistrendfurtherascompaniesgrapplewiththreedemands: theneed to reduce costs,enhanceflexibility,andreport inrealtime.Theneedtocutcostsandenhanceflexibilitywilldriveupdemandforcloudcomputing,withtheinitialfocusbeingonpushinggenericserviceslikestorageandcomputingpower into thecloudsoonfollowedbymorebusinessfunc-tionslikedatamanagement.

opporTuniTiesinresponsetothesechangesintheiTandoperationalprioritiesofinvestmentmanagementcompanies,whatshouldtheybedoingandwhatopportunitiesdotheyhaveinthischangingenvironment?

itisourbeliefthatthecollectiveweightofusregulatoryreformswillgreatlyaffectthetechnology-relatedandopera-tionaldecisionsofsecuritiesandinvest-mentsfirmsinparticular.pressurewillbegreateronchieftechnologyofficerstocutcosts,drivegreaterefficiency,betterarticulatereturnoninvestmentonnew

projects,bemoreaccountabletobusinessusers,andbemoreflexibleinrespond-ing tobusinessneedsandregulatoryrequirements.

inadditiontodemandsforinvestmentmanagementtechnologyimprovements,therewillbeopportunitiesforinstitu-tions thatserviceassetmanagersandbroker-dealers.Theseincludecustodianbanks, sub-custodians,primebrokersandhedge-fundadministrators.majorfinancialinstitutionssuchasstatestreetandbankofnewYorkarealreadyrap-idlybolsteringtheircapabilityinareassuchascollateralmanagement,deriva-tivesprocessingandsecuritiesvaluation.

“Pressure will be greater on chief technology officers to cut costs, drive greater efficiency, better articulate return on investment on new projects, be more accountable to business users, and be more flexible in responding to business needs and regulatory requirements.”

EXCLUSIVE VIDEO INTERVIEWWatchourinterviewwithTowergroupseniorresearchdirector,dushyantshahrawat,tohearmoreabouthowthedodd-frankActandotherregulationswillaffecttheinvestmentmanagementindustry.

www.simcorp.com/compliance


figure1illustratessix issuesthatwillbecomemajorpriorities for the insti-tutionalsecuritiesbusinessduetousregulatoryreformandpresentsexamplesofinvestmentmanagementsystemfocusareasdrivenbyregulatorychallenges.

poinTsToConsiderinresponsetothenewregulatorypow-ers,greater resources, anda strictermandategrantedtoregulatoryagenciesbythenewlaws,securitiesfirmswillneedtoenhancetheircompliancede-partments,addstafftodealwithmoreregulatoryexaminations,andimplementcompliancesoftware(forsurveillanceofemployees for insider trading,datasecurity,andprivacy).Thismeansthat

investmentmanagementorganisationswillhavetooverhaultheirsystemstosupportneedsinfiveapplicationareas:riskmanagement,compliance,report-ing,analytics,anddatamanagement.

it isclear then that thedodd-frankActwillhaveaprofoundimpactonthetechnologydepartmentsof securitiesandinvestmentfirms,requiringthemtomakechangestoprocessing,account-ing,riskmanagement,andcompliancesoftwareapplications.lowerrevenueinareassuchasoTCderivativesandagencytradingwillputpressureoniTbudgets,butgreenshootswillemergeinareassuchasriskmanagement,report-ing,anddatamanagement.

Dushyant Shahrawat is a Senior Research Director at TowerGroup in the Securities and Investments practice, Boston, USA. With over 15 years of experience in finan-cial services, he is a Chartered Financial Analyst (CFA) and a member of the Boston Security Analysts Society. Dushyant Shah-rawat researches strategic issues facing asset managers, hedge funds and brokerage firms globally, and advises clients about strategy, marketing, regulation, technology and product development. He has shared his opinions on financial industry trends at over 100 events across the USA, Europe and Asia and has appeared on various tel-evision and radio channels. He has also been widely quoted in printed publications such as the Wall Street Journal, New York Times, Fortune, and the Financial Times.

TOWERGROUP

Towergroupisaleadingresearchand advisory services companyfocusedexclusivelyontheglobalfinancial services industry. formore than a decade, it has pro-vided the world's top financialservices, technology,andprofes-sional services companies withadviceandinformation.itsteamofanalystsandspecialisedadvis-erscoversthebusinessandtech-nological issues impacting theentire financial services sector.more information at www.tow-ergroup.com.

“It is clear then that the Dodd-Frank Act will have a profound impact on the technology

departments of securities and investment firms, requiring them to make changes

to processing, accounting, risk management, and compliance software applications.”

– Collateral management– Central clearing– Real-time reporting

– Real-time positions monitoring– Regulatory reporting– Leverage management

– Audits and compliance– Performance reporting– Investor eductation and disclosure

– Data management– Intraday valuation– OTC valuation

– Data management– Attribution analysis– Systems integration

– Compliance management– SEC audit preparation– Employee surveillance

OTC derivatives

Leverage and capital adequacy

Hedge fund registration

Valuations

Risk management

Audit and compliance Figure 1. Investment management system focus areas driven by regulatory reforms of the securities industry. Source: TowerGroup.


on11november2010theeuropeanparliamentandeuCommissionapprovedtheproposedAlternative

investmentfundmanagersdirective(Aifmd).having taken19monthstonegotiate,thedirectiverepresentsamajorstepintheregulationofthealter-nativeinvestmentindustrywithineu-rope.frommid-2011,whenAifmdisofficiallypublished,memberstateshavetwoyearstoimplementthedirective.

fromtheoutset itwasclear that thedirectivewouldsubstantiallychangetherulesapplyingtomanagersofalternativeinvestmentfundsintheeudomain.butmuchof thehardwork–thelevel2implementationphase–stillliesahead.

ThewayinwhichAifmdcameintobe-ingwasnotaprocedurethatisnormallyused,however.normallyaconsultationphase isgonethrough, resulting inadraftdirective.heretheeuCommis-sionwasunderpressureduetodecisionsbytheg20thatweremotivatedbythe2008 f inancial crisis to immediatelycomeupwithaproposal,whichwasthenextensivelydebatedandcriticisedduringtheentireprocess.

Whatemergedfromthisprocesswasadirectiveataveryhighpoliticallevelandwheremanyofthemoretechnicalele-mentswerelefttoberesolvedatlevel 2.Andthelevel2measuresarecurrentlyunderdiscussionandinthepreparationphasewiththeeuropeansecuritiesandmarketsAuthority (esmAformerlyknownasCesr).AfirstconsultationhasbeenpublishedbyesmAaskingforfeedbackandinformationfromthealternative investment fund industrystakeholdersandmanyofthem,locatedinandoutsidetheeu,haveanswered.

ThebigpiCTureThereremainoutstandingquiteanumberofquestionmarksas tothedetailsofsomerules,ortheinfluenceandtheriseofthird-countryfundstobedistributedineurope,etc.putanotherway,wehavethebigpicturebutnotthedetailsasyet.

WhatweatAlfihave stated fromthe start is thatweunderstood thewillingnessbyeuauthorities to tryandregulatenon-uCiTsfundsaswell.Thiscouldbeviewednotnecessarilyasaburdenbutalsoasanopportunitytocreateasecondfundcategorytomatchthe successof theundertakings forCollectiveinvestmentinTransferablesecurities (uCiTs)category,whichhasprovedvery successfulover thepast20years,emergingasanessentialcornerstoneinthedevelopmentoftheeuropeaninvestmentfundsindustry.

despitetheclaimedtechnicalsuccessesofAifmd,theimplementationphaseis likely tobe fraughtwithdifficul-ties.WhereasuCiTswasavoluntaryqualitybrandofferedtomanagerswhowanted tobenefit from it,Aifmdstemsfromtheg20anddoesnothavethatelementofvoluntaryapproach.howtocombinethemandmakethemworkcertainlyrepresentsamedium-termchallenge.

subjecttoaverylimitedsetofexemp-tions,theprovisionsofAifmdaffectallmanagersofnon-uCiTsinvestmentfunds,suchashedgefunds,realestateorventurecapitalandprivateequityfunds,whichare located ineurope(orevenoutsideeuropeiftheyaremanagedbyaneumanagerordistributedineurope)andwhichfalloutsidethescopeoftheuCiTsdirective, irrespectiveoftheirlegalformandregime.

Aifmdwill,forthefirsttime,intro-duceaharmonisedeuropeanregula-toryregimeformanagersofalternativeinvestmentfunds.TheAifmdirectiveisdesigned to address anumberofrisks identifiedby theeuCommis-sionrelatingtoalternativeinvestmentfunds, includingsystemicrisk.itwillrequirefromthemanagersofalternativeinvestmentfundsaboveacertainsizetoregisterandprovideregulatorswithdetailed informationontheprincipalmarketsandactivitiesofthefundsthattheymanage.

Thedirectivealsocontainsprovisionsoncapitalmaintenance,riskmanagement,valuation,delegation,depositary,report-ing,leverage,remunerationpolicies,etc.italsoregulates theeumanagementofthird-countryalternativeinvestmentfundsandeumarketaccessforthird-countryalternativeinvestmentfundsandtheirmanagers.

prACTiCAlimpliCATionsinadditiontosubjectingalternativein-vestmentfundmanagerstocompulsoryregulation in theeu,Aifmdwillrequiresignificantmodificationstothestructures,strategiesandoperationsoffundmanagersandfunds inthenon-uCiTssphereandwillalsodirectlyandmateriallyaffectthosethatservicethisindustry.

Aifmdwillobligeserviceproviderstothe industry(i.e.depositaries,cus-todians,primebrokers,administrators,andotheroutsourcedservices)toadapttoaverydifferentmarketforalternativeinvestmentfunds.

Asaconsequence,Aifmdsubstantiallyredefinestherelationshipsbetweenfundmanagers,alternative fundsandtheir

Alternative fund managers face changes but also opportunities arising from the AIFM Directive. This article aims to address the main implications and challenges for alternative investment firms in implementing the directive, focusing on the practical aspects in gearing up IT processes to accommodate the legislative provisions.

# AIFmD: changes and benefits in store for the European alternative fund industry

Camille Thommes is Director General of the Association of the Luxembourg Fund Industry (ALFI), Luxembourg.

Charles Muller is Deputy Director General of ALFI, Luxembourg.


serviceproviders,whowillneedtoadapttheirproductofferingseffectivelytothenewrequirements.

in addition,Aifmdpresentsmajoroperational, complianceand reportingchallengesforfundmanagers.forone,de-positaryand(whereused)primebrokeragearrangementswillneedtobere-aligned.forthesecond,productsandserviceswillneedtobedesigned(orreconfigured)toprovideforagreaterflowofinformation,either toallowadepositary toperformitsrequiredfunctionsunderAifmdorwhereadministratorsareaskedtocopewiththeincreaseddemandforreportingcapacitybymanagerswhonowhavere-portingobligationstobothregulatorsandinvestors.forthethird,valuationprocessesandprocedureswillrequiremodification.Andfinally,demandforthird-partyassist-anceandassurancewillalmostinevitablyincreaseasaresultofAifmd.

inordertofindpractical,integratedsolu-tions to thechallengesposedby thesemultipleregulatorydevelopments,alter-nativeinvestmentmanagementorganisa-tionswillneedtoconsidertheirstrategicpositioning,identifyareasforchange,andplanforimplementation.Theywillneedtounderstandtheissuestheyarefacingandundertakeanadaptationprocessthrough

practical, economic, f inancial and iTsolutions thatare fullycompliantwithAifmdrequirements.

deposiTArYreQuiremenTsoneofthekeyareasalternativeinvest-mentmanagerswillhave toconsiderwhenadaptingtoAifmdwillbede-positaryrequirements.forbanksthatofferdepositaryfacilities(andmanyofthemdo),Aifmdinitscurrentformislikelytohaveahugeimpactontheirabilitytoservicefundsandassetsattheriskierendoftheinvestmentspectrum.in thewakeof thelehmancollapseandmadoffscandal,Aifmdhasbeenframed to considerably tighten theunharmonisedrulesunderwhichde-positarybanksoperateforthemoment.forastart,all funds–traditionalandalternativealike–mustnowprovidecustodyoftheirassets.

forthedepositarybanks,theextentoftheirfiduciarydutiesisnowclearlylaidoutataeuropean level.someof themoreimportantdutiestheymustnowperforminclude:monitoringcashflows;safekeepingassetsandmonitoringtheday-to-daytransactionsofafund, in-cludingtheaccurateandtimelyvaluationofassetsinafund.

Aifmdcontainsextensiveprovisionsonthedepositary’sroleandresponsi-bilities, itsability todelegateand itsliabilitytothefundandinvestors.Theharsherstrictliabilityprovisionsprevi-ouslyproposedhavebeenmodifiedtobetter take intoaccounttheeffectivebusiness conditions,developments,structuresandvarietyofassets tobesafe-keptbyadepositary.Thereisnowpotentialscopeforadischargeofthatstrictliability,notablyinthecaseoftheuseofasub-custodianifcertaincondi-tionsaremet,andifthefundmanagerscandemonstratethatthelocaldeposi-tarysatisfiescertainqualitycriteria(duediligenceprocess).

Alternative investmentmanagerswillneedtoensuretheyhavetheresources(people and systems) to meet theAifmdrequirements,andpro-activelydemonstrate their preparedness toclients.Contractualarrangementswillneedtoberevised toref lect thenewregimeandensureappropriate infor-mationflows.Alternative investmentmanagementorganisationsneedtoas-sesstheimpactontheirbusinessmodel,operations,productofferingsandpric-ing,toworkoutwhatisdonebywhom,forwhomandinwhatbusinessarea,inordertostartevaluatingwhatchangesmayneedtobemade,bothinresponsetoobligationsimposeddirectlyonthemandtorespondtoclient-drivendemand.

vAluATionproCessesAnotherkeyareatoconsiderwhenadapt-ingtoAifmdprovisionstakestheformofvaluationprocessesandprocedures.Alternative investmentmanagersmayneedadditionalassistance tocomplywiththedetailedrequirementsontheseprocessesandproceduresunderAifmd.eachfund’sassetswillhavetobevaluedandthenetassetvalue(nAv)calculatedatleastonanannualbasis.open-endedfundswillberequiredtocarryoutmorefrequentvaluationsandnAvcalcula-tionsatafrequencyappropriatetotheassetstheyholdandtheirissuanceandredemptionfrequency,whereasclosed-endedfundshavetocarrythemouteachtimethecapitalof the fund increasesordecreases.moredetailsonvaluationrequirementswillcomeinthelevel2implementingmeasures.

manyalternativefundmanagershavetraditionallycarriedoutvaluationactivi-tiesin-house,andwillbeabletocontinuetodosounderAifmd.butregula-torsarenowenabledtorequirethatanexternalvaluerorauditorverifies theinternalvaluation.Theywillberequiredtoensureanddemonstratethatvalua-tionfunctionsareindependentfromthe

“IT suppliers will have to assure that the reporting they provide is fully compliant with the level of detail

expected, and that their systems are able to produce the required data.”


“… AIFMD presents major operational, compliance and reporting challenges for fund managers.”

portfoliomanagementfunctionandthepersonsresponsible for implementingthefirm’s remunerationpolicy.somefundmanagersmaysimplynothavethepersonnelororganisational structuretopermitthemtodothis;othersmaychoosetooutsourceasamoreconvenientandcost-effectiveoption.

Alternative investmentmanagerswillneedtorevisittheirvaluationservices,andfactorthisandtheirincreasedliabil-ityexposureintotheirbusinessmodelsandproductofferings.TheywillneedtorevisevaluationprocessesandprocedurestocomplywithAifmd.iTsystemsmayrequireupgrading,andfunddocumenta-tionandsupplierswillneedtobeupdatedtoreflectthenewrequirements.

disClosurereQuiremenTsAlternative investmentmanagerswilla lso require more assistance withAifmd’sextensivedisclosureandre-portingrequirements.iTsupplierswillhavetoassurethat thereportingtheyprovideisfullycompliantwiththelevelofdetailexpected,andthattheirsystemsareable toproducetherequireddata.Complianceandlegaldepartmentswillneedtoensurethatallcontractualar-rangementsareappropriateincasethedataprovidedisdeemedtobeinsufficientbytheregulator.

underAifmd,alternativeinvestmentfundmanagerswillbeobligedtomakefulldisclosuretoinvestors(beforetheyinvest), includingadescriptionof theinvestmentstrategyandobjectivesofthefund,thetypesofassetsthefundmay invest in, the techniques itmayemploy,andtheprocedurestobeusedtoaltertheinvestmentstrategy.inad-dition,theywillhaveextensiveongoingreportingrequirementstoinvestors.Tohelpmeettheseobligations,supplierswillberequiredtoassistfundmanagerswiththeirincreasedreportingworkloadforinvestors.

Alternativeinvestmentfundmanagerswillalsobeobligedtomakeextensivedisclosurestoregulators inareassuchasgearing,liquidity,riskmanagement,tradingactivity,andinformationaboutportfolioinvestments.inaddition,fur-therad-hocreportingmaybenecessaryforeffectivemonitoringofsystemicrisk.manyfundmanagerssimplywillnothavethecapacitytodoallthisin-house,andwillneedtechnicalassistancewithplanningaround thepresentationofinformationaswellasreportingservicestocopewiththeseincreaseddisclosurerequirements.

CompliAnCefunCTionAifmdwillobligealternativefundman-agerstoreviewtheircompliancefunctions,particularlyinrelationtothewayconflictsofinterestandriskmanagementarehan-dled.Theyarelikelytorequiremorecom-plianceresourcestocopewiththeburdenofensuringcompliancewithAifmd.inmanyinstances,thecompliancefunctionwillberampedupandwillassumeafarmoreimportantrole inthepracticalop-erationsandadministrative tasksof theindividualalternativefundmanager.

Whendealingwithasetofassetclassesconsideredasnotbeingplainvanilla,but ratherhedge funds, real estate,privateequityandthe like,obviouslytheoperationalandadministrativeca-pabilitieswillhavetobeadaptedtothespecificneedsofservicingthesetypesofproducts.TheseincludenAvcalcula-tions,managingportfolioregistrations,portfolioholdings,andspecificreportingrequirementsofacompliancenature.

loCATionopporTuniTiesinadditiontocreatingopportunitiesforthealternativefundmanagementindus-try,Aifmdalsopresentsbenefitsandadvantagesforcertaineuropeanfundindustry locationsandhubs.Acaseinpoint isluxembourg.itwas thefirstcountrytoimplementthelatestversion

ofuCiTs–uCiTsiv–and ithasannounceditsambitiontobeveryearlyintheprocessoftransposingAifmd.

overtheyears,luxembourghasgainedexperience in fund structuring anddistribution,anddevelopedanexten-sive fund-servicing infrastructure. itis familiarwithconcepts likecapitalmaintenance,riskmanagement,valuationrules,reportingobligations,etc.andtheirimplicationsintermsoffundstructuringandsupervision-manyoftheminspiredbytheuCiTslegislation.Andduetoits regulated structure,luxembourghasbeenabletobuildthecompetenciesneededinsettingupandadministeringalternativestructures,i.e.privateequityfunds,realestatefundsandhedgefunds.

Withitsspecialisedinvestmentfund(sif)vehicle introduced in2007andnowaccountingforalmosta thirdofallluxembourg-registeredfunds, thegrandduchyhas inplacemost oftheprovisions laiddowninAifmd.regulatedbylaw,sifisanoperation-allyflexibleandfiscallyefficientmulti-purposeinvestmentfundregimeforaninstitutionalandqualifiedinvestorbase.

“Alternative investment fund managers will also be required to make extensive disclosures to regulators in areas such as gearing, liquidity, risk management, trading activity, and information about portfolio investments.”


luxembourg’scurrentsif legislationofferspromoterstheoptionofestablish-inginvestmentstructures,whichcomplywith themain featuresofAifmd.luxembourgalsohastheknow-howtouseandapplyaninvestmentmanagementpassportenablingalternativefundman-agerstooffertheirservicesandmarkettheirfundsthroughouttheeu.

Aifmd,then,willmorelikelythannotincreasetheestablishmentandreloca-tionofalternative investmentfunds ineuropeanjurisdictionslikeluxembourgandireland.Thechallenge inluxem-bourg’scasewillbetoreplicateuCiTs’successandknow-howinthealternativeinvestmentworld.Thesupportofalocalgovernmentauthority,thepro-activeap-proachofadomesticfinancialregulator,andthecapacityofacountrytoantici-pateandquicklyadaptitselftoanynewrequirementsmakeastrongcase foracountrylikeluxembourgorirelandasalocationforalternativeinvestmentfundsandtheirmanagers.

fortheirpart,thoseinvestmentmanag-ersthatreactswiftlyandeffectivelytothestrategicandoperationalopportu-nitiescreatedbyAifmdwillbe inapositiontocapitaliseonthechangingenvironmenttogaincompetitiveadvan-tagebyadjustingtheirbusinessmodels.

Camille Thommes is Director General of the Association of the Luxembourg Fund Industry (ALFI). Prior to joining ALFI in 2007, he worked for Banque et Caisse d’Épargne de l ’État, Luxembourg, where he held senior positions in the Securities Department before heading the bank’s In-vestment Fund Department in 2001. Camille Thommes started his professional career in 1986 at Banque Générale du Luxembourg (now BGL-BNP Paribas) where he held various positions in the cus-tody area. He is a member of several ad-visory committees to the Supervisory Commission for the Luxembourg Finan-cial Sector (CSSF) and represents ALFI at the Board of Directors of the European Fund and Asset Management Association (EFAMA), Finesti S.A., Profil S.A. and XBRL asbl. Camille Thommes holds a Master’s degree in Economics (section Business Administration) from the Uni-versity Louis Pasteur in Strasbourg, France.

Charles Muller has been Deputy Director General of ALFI since 2003 and is also re-sponsible for Legal Affairs, Promotion, Communication and Press Relations. Af-ter studying law in Paris („maîtrise en droit“ at the Sorbonne) and London (LLM at University College), Charles Muller be-came a Luxembourg barrister („avocat à la Cour“). In 1994 he joined Banque Géné-rale du Luxembourg, where he held vari-ous legal positions in the retail, corporate and private banking departments, before being appointed the bank’s Deputy Secre-tary General. Charles Muller is also a former Board member of the International Investment Fund Association (IIFA), a Board member of the European Federation for Retirement Provision (EFRP) and a member of the Management Committee of the European Fund and Asset Manage-ment Association (EFAMA).

Alfi

TheAssociationof theluxem-bourgfundindustry(Alfi) istheofficial representativebodyfortheluxembourginvestmentfundindustry.setupin1988topromotefunddevelopment, theassociationnowincludesawideselectionofserviceproviders:cus-todianbanks,fundmanagersandadministrators, transferagents,funddistributors,lawfirms,con-sultantsandtaxadvisers,auditorsandaccountingfirms,iTservicescompanies,etc.moreinformationatwww.alfi.lu.

“For their part, those investment managers that react swiftly

and effectively to the strategic and operational opportunities created by AIFMD will be in a position to capitalise on the

changing environment to gain competitive advantage by

adjusting their business models.”


s olvencyiibringsafundamen-talchangetotheregulationofinsurancecompanies in theeu.Therequirementsofthe

newprinciples-basedregime,whichareprovingtobeahottopicfordebateanddiscussion,canbebroadlydividedintothreepillars.Thefirstpillar sets therequirements for thecapitaladequacymodels.Companiescanchoosewhethertouseastandardmodelortodevelopafullorpartialinternalmodel.

Thesecondpillardefinesriskmanage-mentrequirementsfor insurancecom-panies, includingriskmanagementforinvestments.pillar3coversindetailthereportinganddisclosurerequirementsregardingrisktotheregulatorandthepublic. insurancecompaniesneed todemonstratetotheregulatorandtotheirclientsthattheyhaveacomprehensiveandappropriateriskmanagementsys-teminplacethatis integratedintheirdecision-makingprocessesandstrategy.

impliCATionsforinvesT-menTmAnAgemenTfromaninvestmentmanagementper-spective,allthreepillarsarerelevantforinsurancecompanies:

• thefirstpillarcoversstandardandinternalmodelstomeasure invest-mentrisk;

• thesecondpillarcoversriskmanage-mentofinvestments;

• thethirdpillarsetsoutthedisclosurerequirementsforinvestmentalloca-tionandinvestmentrisk.

The f ifthsolvency iiQuantitativeimpactstudy(Qis5)raisedtheaware-nessof thefundamentalrevolutionintheregulatoryrequirements.Thebroadspectrumofpossibleconsequencesoftheregulatorychanges,inareassuchasproducts, investmentmanagementandthestructureoftheinsurancemarket,isbeginningtobecomeclear.oneofthemostobviousconsequencesistheeffectonassetallocation.

solvencyiireplacesthecurrentinvest-mentcategoriesandlimits;inparticular,itreplacesnational investmentregula-tionswithinvestmentcategories,limitsandsolvencyrequirementsdefinedbytheeuCommission.incontrasttotheoldsystem,thenewguidanceissensitivetothestructureoftheinvestmentportfolio.

TheproposaloftheeuCommissioninomnibusiiCircular inJanuary2011isnotveryclearontheactualeffectivedateofsolvencyii.omnibusiispeci-fiestheharmonisationofsupervisionineurope;inparticulartheneweuropeaninsuranceregulatorfoundedon1January2011,theeuropeaninsuranceandoc-cupationalpensionsAuthorityeiopA.

Also,thebindingeffectivedateforsol-vencyiiisfixedas1January2013,whichshouldenddiscussionsonafurtherdelay.

however,theeuCommission’scircularallowsmaximumtransitionperiodsforcoreareasofthedirective.forexample,the suggested transitionperiods fortopics suchas regulatory reporting,governancesystemrequirementsandthevaluationofassets,technicalreservesandsolvencycapitalrangebetweenthreeand10years.

Standard modelforpillar1,insurerscanusethestand-ardmodeltodeterminetheirsolvencyCapitalrequirement(sCr).inmanyeucountries,themajorityofinsurancecompanieswillusethestandardmodel,becausesmallerandmid-sizedinsurerslackthecapabilitytodevelopafullorapartialinternalmodel.however,withinitsoverallstructure,thestandardmodeltakesonlylimitedaccountoftheactualinvestmentriskprofileofthecompany.

inadditiontotheriskmodulefor in-surancerisk,theQis5standardmodelcontainsmodulesformarketrisk,defaultrisk,riskfromintangibleassetsandop-erationalrisk.Themarketriskmoduleisoneofthemostimportantmodulesinthestandardmodel.Thekeyelementsareinterest-yieldcurvesandstressesthereonandmarketriskforequities.

Theinterestriskisbasedontwopre-definedyieldcurvestowhichasteepincreaseordecrease in interest ratesisapplied.insurancecompanieshavetoconsiderboth:investmentsthataresensitiveto interest-ratechangesandtechnicalreservesthatarevaluedbasedonyieldcurves.Themarket risk for

Solvency II requirements and their practical implementation pose a number of issues for investment management organisations – currently and in the near term up to 2013. This article outlines how and in what ways investment management companies will need to prepare their IT infrastructures and investment manage-ment systems for Solvency II.

# Solvency II: what it means for investment management systems

Dr. Thomas Varain is a Partner and Swiss Insurance Head at KPMG, Zurich, Switzerland.

Dr. Peter Ott is a Partner at KPMG, Munich, Germany.

“Also in the short and medium term, the data management and data

quality requirements resulting from Solvency II will be a huge challenge

for insurance companies and their asset management.”


equitiesisbasedonpercentagedeclinesinmarketvalueandtakesaccountofcorrelations.

investmentsinrealestaterequirecapitalof25%ofthemarketvaluederivedfromtheipdTotalreturnindexfortheuK.listedsharesintheeuorinanoeCdcountryrequirecapitalbetween39%and49%ofthemarketvalue,dependingonthehistoricdevelopmentofthemsCiWorldforthevaluationdate.

AsseTmAnAgemenTChAllengesbasically,all threepillarsarerelevantfor the investmentsof an insurancecompany andsolvency ii thereforesetsdemandsonassetmanagementcompanies.initially,theimplicationsofsolvencyiiforassetmanagementwerenotentirelyclear.Therefore,itisallthemoreimportantfortheindustrytoadjusttothecomingdevelopmentsandbeabletomakethenecessarychanges.

insurancecompanieswillgenerallyaimfor lowinvestmentrisk,ashigherriskrequireshighersolvencycapital.Thiswillchangetheassetallocationstrategyand

willalsohaveanimpactontheinvest-mentmanagementindustry.Alsointheshortandmediumterm,thedataman-agementanddataqualityrequirementsresultingfromsolvencyiiwillbeahugechallengeforinsurancecompaniesandtheirassetmanagement.

Thecomplexityofmodelsintheinsur-anceindustryhasincreasedsignificantly.Whereasinthepast,themodelsfocusedoninsuranceriskandactuarialreserves,today,assetsarebecomingmoreandmoreimportant.insurancecompaniesareforcedtodeveloptheirownmodelsfor investments if thestandardmodeldoesnotadequately ref lect their riskprofile.

ThecalculationofthesCrrequireslargeamountsofinputanddatathatofcoursehave tobeavailable for investmentsaswell.here theassetmanagementcompaniesarechallengedbecausetheyhavetoprovidemostofthedata.duetotheimportanceofdata,iTsystemsandtechnologyinsolvencyiirequirements,itisimportantthattheyareconsideredfromthebeginning,eventhoughtheimplementationofthemarketandcreditriskmodelsisnotyetfullycompleted.

Theassetmanagementindustryshouldnotneglect this important factorandshouldnotrelyontheinsurersneedingacertaintimeuntilthemodelsarefullyimplemented.inaddition,therequire-mentfordataisnotlimitedtocompa-nies thatdevelopan internalmodel.Thestandardmarketriskmodelundersolvencyiirequirescertaininformation

whichassetmanagementisoftennotyetabletoprovide.

Biggest challengeThebiggestchallengeforassetmanage-mentisthatcompanieshavetobeabletomanageandprovideallthedatathatfeeds intothecalculationofsolvencyrequirementsaswellasfinancialandregulatoryreporting.Thisincludes, inparticular,thedataqualityrequirementsanddatabeinguptodate.solvencyiirequiresthatthedatausediscomplete,appropriateandaccurateandempha-siseshowimportantthequalityofdatais for theeffective implementationofsolvencyii.Thisgoesforbothinternalandexternaldata.

solvencyiiexpectscompaniestodevelopguidelinesandstandardsfordataquality,aswellasfortheupdatingandvalidationofdata.regulatorswillcheckcompliancewiththedirectiveinthecourseoftheirapprovaloftheinternalmodels.

Data qualitydataqualitywillalsobeofhighim-portance in areas lookedatby theregulator,suchastheinputandoutputdatafortheownriskandsolvencyAssessment(orsA),theuse-Testandthedatathatisrequiredfordisclosures,e.g.solvencyandfinancialConditionreport(sfCr),reporttosupervisor(rTs)andQuantitativereportingTemplates (QrT). it isunavoidablethatdatausedisvalidatedandsubjecttoaqualityassuranceprocessandthatalldataanditssourcesaredocumentedandarchived.

The Berlaymont building hosts the EU Commission,s

headquarters in Brussels

“Solvency II has multiple im plications for the systems,

processes and controls within the infrastructure of asset management.”


Asinsurancecompaniesmustdemon-stratetheircompliancewithsolvencyii,theywillalsohavetoobtainconfir-mationofcompliancefromtheirassetmanagers,astheymayhavetoshowthistotheregulator.insurerswillalsoprob-ablywanttoperformtheirownchecksonassetmanagers toensure that thesolvencyiirequirementshavebeenmet.

High complexityThecomplexityofassetmanagementforinsurancecompaniesishighduetothedifferencesintheindividualinvestmentportfoliosof insurancecompaniesandtheresultingdifferentlevelsofgranular-ityoftherequirements.examplesofdatarequiredinclude:quotedmarketpricesandyieldsofbondsandequities;detailedinformationonderivatives;geographicaldataontheindividualassets;andinfor-mationonguarantees.

Asaresultofsolvencyiiandthenewdisclosureguidance, it isalsopossiblethat insurancecompanieswill requirecertaindatamoreoftenthanhasbeenthecaseuntilnow.

implemenTingThereQuiremenTsTheadministrationofinvestmentdatawillbemorecomplex forcompaniesundersolvency ii compared to thepreviousregulatoryregimes.This in-cludes,forexample,thecomprehensivedocumentationofdataflows.dataman-agementwillalsohavetobeadaptedto ref lect thenewenvironment.Weexpectthattheimportanceanduseofdata-repositoriesanddatawarehous-ingsystemswillincreasesignificantly.smallerandmid-sizedassetmanagerswillprobablynotbeabletomeetthenewrequirementswithoutacompre-hensivedatamanagementsystem.

solvencyiihasmultiple implicationsforthesystems,processesandcontrolswithintheinfrastructureofassetman-agement.becauseofthewide-rangingchanges required, companies shouldstart toaddress thechallenges soon.Companiesneedtobeawarethathighercostsandresource requirementsmayresultfromthenecessarychanges.

Apartfromsolvencyii,assetmanagerswillfaceadditionallegalandregulatoryrequirements,whichincreasetheimpor-tanceofanearlyresponse.Anefficient,timelyandstructuredapproachcansavecostsandresources.Thistopicalsoaf-fectstheassetservicessector.Companiesinthisareashouldalsoassessonatimelybasiswherechangesarerequiredtomeetthedemandsofsolvencyii.

inTegrATedsoluTionpriortothestartofalargeandexpen-siveprojectto implementthechangesrequired,companies in theassetandinvestmentmanagementindustryneedtoclearlyunderstandtheirpositionwithregard to thegovernance,definition,qualityandreportingofdataandwhatisexpectedoftheminthefuture.

Thisrelates to therequirements fromsolvencyiiandalsototheneedsofcli-ents,i.e.whatkindofdataandreportsinsurancecompanieswillrequire.inthefuture, itwillbeunavoidableforcom-paniestomaintainacomprehensiveandconsistentdatamanagementsystem,in-cludingappropriategovernance.invest-mentmanagersshouldcheckinwhichareasadaptationsandenhancementsarerequired, includingrelevantprocesses,controlsandgovernanceguidelines.

inaddition,appropriatedataqualityandvalidation,aswellasdocumenta-tionandgovernanceguidelines,shouldnotonlybeinplacebecausetheyarea regulatory requirement.dataandiTsystemsarekeybuildingblocksoftheassetmanagementbusiness,andcompaniesshouldplaceahighvalueonbeingabletobuildonanappropriateandsolidfoundation.

lastbutnotleast,investmentmanage-mentcompaniesshouldbemadeawarethattheyalsostandtobenefitfromthesituation. insurance companieswillpreferassetmanagerswhohavedem-onstratedthattheyarewellequippedtomeetthesolvencyiirequirements.

Dr. Thomas Varain is a Partner and Swiss Insurance Head, Audit Financial Services, KPMG, Zurich, Switzerland. He is in charge of the KPMG insurance audit prac-tice and co-ordinates KPMG’s service of-fering towards insurers. With 14 years of experience providing audit and advisory service to international insurance compa-nies, he started his career with KPMG Co-logne. Thomas Varain has extensive expe-rience in the audit of international insurance companies and is specialised in accounting and regulatory issues, as well as in insurance asset management. A Certi-fied Accountant (D), he holds a business administration degree from the University of Passau, Germany, and a Ph.D. from the University of Goettingen, Germany.

Dr. Peter Ott is a Partner at KPMG in Munich, Germany. Specialising in Sol-vency II and risk management for insur-ance, he has been a Partner in Financial Services at KPMG in Munich since 2005, where he has headed KPMG’s Solvency II projects and initiatives since 2006. With 15 years of experience providing audit and advisory services to insurance companies, he started his career with KPMG Munich. Peter Ott has extensive experience in the audit of insurance companies and is spe-cialised in accounting and actuarial issues, as well as in insurance asset management. A Certified Accountant (D) and an actu-ary he holds a Ph.D. in business adminis-tration and a Master’s degree in business research (MBR) from the University of Munich, Germany.

KPMG

Kpmg is a global network ofprofessional services firms pro-viding audit, tax and advisoryservices. With 140,000 profes-sionals working together to de-liver value in 146 countriesworldwide, Kpmg operates asan international network ofmember firms, working closelywithclients,andhelpingthemtomitigaterisksandgraspopportu-nities.moreinformationatwww.kpmg.com.

“Data and IT systems are key building blocks of the asset management business, and companies should place a high value on being able to build on an appropriate and solid foundation.”


W hilemuchmalignedgiventheirroledur-ingthecrisis,oTCderivatives, when

usedproperly,willcontinuetobepower-fultoolstomanageinvestmentrisksandstructureportfoliostrategy.WhileoTCderivativesdidnotcausethecrisis,theinter-connectedfinancialobligationsbe-tweenorganisationsduetotheirusedidcauseanearfinancialsystemmeltdown.

Thedodd-frankAct,signedintouslaw in2010, coversmanyaspectsoffinancial reform,buthasacleargoalofreducing,oratleastcontrolling,theamountofsystemicriskinmodernmar-kets.byJune2011,usagenciesaffectedbythelegislation,notablythesecuritiesandexchangeCommission(seC)andtheCommodityfuturesTradingCom-mission(CfTC)butalsoinconcertwithinternationalagenciessuchastheuK’sfinancialservicesAuthority (fsA),must add substancebyputting intoplacerulesandstructure tounderpinthelegislation.

mostoftheeffortsmadebyglobalregu-latorsaremeanttoinstilconfidenceinthesystemandboosttransparencyandliquidity.manyreformstrytoreducetheopacityofsell-sidetradingoperationsandmitigatecounterpartyconcentra-

tionrisksbroughtto lightsince2006.While theeffectsonthesell-sidearemoredrastic, thebuy-sidecanexpectmoredirectchangesasswapexecutionfacilities(sefs)andCentralCounterparties(CCps)comeonline.Thegoalofreducingsystemicriskmaybeclear,butthetimingofthesechangesisnot.ThiscreatesanongoingchallengenotonlyformarketparticipantsbutalsoforthosewhomanagetheiTsystemsthatparticipantswilluseasthemarketadoptsnewstylesoftradingandabsorbsnewreportingrequirements.

AnotherkeychallengeforiTmanagersin2011comesfromthecontinueduseofoTCderivativesbythefrontofficeduringthetransitiontoanewmarketstructureandasthegoalofastable,ro-bustandliquidmarketisrealised.TouseoTCderivativesappropriatelynowandinthefuture,thefrontofficeneedstoolsthatofferaclearunderstandingofexpo-suretorisk,leverage,andcounterparties,giventhecomplexityandinter-connectednatureofthemodernfinancialmarkets.

Keyitemstoaddressin2011forthosewhomanageiTplatformsthatsupportfront-officeoTCderivativeoperationsare:

• Transparencyandcontroloverap-plications thatdescribeexposure,

providevaluationandcalculaterisk;• flexibility in on-boarding new

workflowsintoexistingfront-officeapplications.

eXposureToolboXoTCderivativesare indeedcomplex,both in their structure and in theirimpactontheinvestmentportfolio.Thebasicassessmenttomake is:does thefrontofficehaveallthetoolsnecessarytodeterminetheirvariousexposurestorisk?doesthefrontofficeusedisparateplatformstomanageinvestmentslead-ingtoaninabilitytoholisticallyreviewrisks?Anincreasedfocusonrisks,andlessonslearned,willleadtoapushforiTtoprovidetoolsthatallowforagreaterunderstandingofcurrentrisks.

Theoldstandardssought tomeasureweights inclassificationssuchascur-rency,creditratingsandissuerexposure.Withthe increasedcomplexityof themarkets,thatdefinitionmustextendtoincludecounterpartyandleverage,butalsomeasuresthatcapturenon-linearreturnsandspecificrisk-exposurechar-acteristicsofcertainsecuritytypes.

Counterparty exposureCounterpartyexposureisnotassimpleaskeepingtrackofthosewithwhomyoutrade.AnyoTCtransactionwillinvolvecounterpartyrisk,asthepotentialpay-mentofprofitswilldirectlyinvolvetheirabilitytopay,oreven,asafterthebank-ruptcyoflehmanbrothers,toretrievepledgedcollateralagainsttradingactiv-ity.beforethecrisis,counterpartyex-posureanalysisaggregatedallexposuresduetotradingactivity,performedstresstestsonlikelyprofitsexpected,thenas-sessedifanypartywasoverexposed.The

Evident during the recent financial crisis, and in the context of current regula-tory reform, is the high level of systemic risk that exists as a by-product of the use of over-the-counter (OTC) derivatives. This article assesses the front-office tools needed to effectively manage their use, and previews the potential effects of changes in market structure on the IT demands of the front office.

# Challenges in the front office: new regulations

force derivatives market overhaul

Brent Rossum is Domain Manager, North America Front Office, SimCorp NA.

“An increased focus on risks, and lessons learned, will lead to a push for IT to provide tools that

allow for a greater understanding of current risks.”


frontofficewouldthenbeinstructedonfutureactionstolessenthisrisk.

butnow,financialaccountingstandardslike ifrs7andTopic820 (formerlyfAs157)aredriving thedemand fortransparencyby incorporatingaCreditvalueAdjustment(CvA)directly intothe reported fair valueofderivatives,meaningallfairmarketorexitvaluesmustexpresslycapturethemonetisedvalueofthecounterpartycreditrisk.Withthismove,counterpartyriskisnolongerapuremiddle-officetask;pre-dealcalculationofCvAaffectsvaluationofcurrenthold-ings,modifiescollateralrequirementsanddictatespreferenceintradingpartners.

Directionality of exposureexposureisalsoafactorofleverage,asanyderivative–eitherexchange-tradedoroTC–willincreaseexposuretocer-tainriskswithoutacashoutlaytoactu-allypurchasetheunderlyingsecurity.AkeytooltoassessthedegreeofleverageissyntheticCash(alsoknownasvirtualCash)–theamountofcapitalsavedbytransactinginaderivativeversusadirectpurchaseof theunderlying security,indexorriskfactor.

forexample,apurchaseofabondfuturewilladdsensitivitytointerestrateswhileonlyrequiringmargintogainthatex-posure.virtualisationofthecasheffectismoreeffectivethansimplyaggregat-ingnotionalamountssincefairvalues,non-linearmeasures(suchasdelta),andcontractdetails,willaffecthowmuchcashreplicatestheexposure.bymeasur-ingthetotalamountofsyntheticCash,thedegreeof leverageintheportfoliocaneasilybecomparedtoassetsundermanagementtounderstandhowaggres-sive,orhedged,theportfolioactuallyis.

directionalityofderivatives isalsoakeyaspectofunderstandingriskandexposure.sellinganindexfuturehasadirect impactonloweringexposureto

systematicriskpresentinequities, justasentering intoapayfixedinterestrateswap lowersexposure to risinginterest rates.Thechallenge for thefrontoffice(assumingtheoTCmarketcontinuestoofferthecurrentbreadthofproducts)comesfromthecomplexityofintelligentlyrepresentingthesingleriskfactordirectionalityofmulti-legoTCderivatives.

ThefundinglegofaTotalreturnswap(Trs)orCreditdefaultswap(Cds)mustbecapturedsincetheyhaveadi-rectaffectoncashflows(andtheyield)of theportfolio;but theexposure legmustclearlyaffectachangeinexposuretospecificrisk factors.buyingcreditprotectionthroughaCdshasonlyasmallexposure tochanges in interestrates(throughthefunding leg),butalargeeffectoncreditexposure,justasaninflationswapoffersexposuretofuturelevelsof inflation.True transparencyintoexposurecomes fromagranularapproachtoriskprofiles,andproperag-gregationintospecificrisksthataffecttheinvestmentportfolio.

Credit ratings and credit spreadsAnothereffectof the financialcrisisconcerningallmarketparticipants,andalsocoveredby thedodd-frankAct,isregulationandtheroleofratingagencies,theirbusinessmodelandtheefficacyof theircreditanalysis.evenabovetheapparentconflictofinterestofhavingissuerspayforbondratingsishowusefulthesemeasuresare.marketsmovefaster thanrevisionsofcreditratings,so incorporationofmeasuresofcreditworthinessmustcomedirectly frommarket sentiment as representedbyspreadlevelsinthecreditmarkets.

Assessingrelativevalueofbondsviaobservedspreadsisacorecomponentoftradingcreditandisastapleofanyfront-officesystem.Whatwillchangefrom2011onwardsistheuseofspreadsand

ratingsinanincreasinglycomplemen-taryfashion.moreandmore,spreadswillofferadynamicassessmentatwhatlevelacreditshouldtrade,ratherthan

where theagenciesbelieve it should.bondsandCdsstradeinrelated,butdistinctmarkets.Thecrisisbroughtto lighthowquicklytheCdsmarketassesseschangesincreditcomparedtotheslowprocessofreviewingcreditrat-ings.measuressuchasimpliedCdsparspreadsbridgethisgapbymeasuringthecreditspreadofabondimpliedbytrad-ingactivities intheCdsmarket,andincreasestheabilityofthefrontofficetorespondtochangesinmarketsentimentacrossissuersandindustries.

WorKfloWmAnAgemenTperhapsthegreatestchangepossibleforthosewhotradederivativeswillcomeasrulesrelatedtothedodd-frankActandsimilarmandatesoverhaulthewayswapsaretraded,movingfromopaquebilateraltradingintoatransparent,centralisedandstandardisedmodel.

“The challenge for the front office (assuming the OTC market continues to offer the current breadth of products) comes from the complexity of intelligently representing the single risk factor directionality of multi-leg OTC derivatives.”


Overhaul of the marketWhiledodd-frankattemptstoreducethesystemicriskinherent inthetrad-ingofoTCderivatives,itonlysetsthefoundationsforthisnewstructure,notthespecificdetails,asseeninthisexcerptfromthedodd-frankAct:

“...anelectronic tradingsystemwithpre-tradeandpost-tradetransparencyinwhichmultipleparticipantshavetheabilitytoexecuteortradeswapsbyac-ceptingbidsandoffersmadebyotherparticipantsthatareopentomultipleparticipantsinthesystem...”

it is tobenotedthatdodd-frankdoesnotspecifyexecutionmethodorpricedis-coverymechanicsoftheswapexecutionfacility(sef),norifthisissimplyanewnameforexistingproviders.AstheCfTCclarifiestherulesgoverningsefs,itwillbedefinedhowpricesarenegotiated.intermsofpricediscovery,themethodchosenwillhaveadirecteffectoncurrentfront-officesystems if straight-throughprocessing(sTp)isanorganisationalgoal.forexample,a‘requestforquote’issimilartohowbondstradeelectronicallyandis

supportedbymessagingprotocolssuchasfiX.butsupportingsTpforswapsmeanseitheradoptingahybridcommunicationmodel(usingfiXforexecutionandfpmlforsecuritystructure)orsupportinganewversionoffiXthatdirectlysupportsthisprocess(i.e.fiXml).

Central clearingAnotheraspectof the legislation isamove away fromcollateralbilateraltradingintoamargin-basedmodelusingsefsforexecutionandpricediscovery,andanexchange-styleCentralCoun-terparty(CCp)to limit theexchangeofcollateralandmitigatesystemicrisk.regulatorsmustalsodeterminewhatmustbecleared throughaCCpandtherefore traded throughansef inordertomeettransparencyrequirementsdictatedbydodd-frank.

Theofficeoffinancialresearch(ofr),anewusTreasuryofficecreatedthroughdodd-frank,holds themandate formonitoringsystemicriskandwillrelyonthedepositoryTrustandClearingCorporation’s (dTCC)globalreposi-tory foroTCderivativesdatastoredin itsTradeinformationWarehouse(TiW).forswapstradedthroughsefsandclearedthoughCCps,thistransferwilldependontheabilityofeithertheCCp,orthetradeprocessingsegmentofthesef,topassdatatodTCC.foroTCtradesoutside that framework,investmentmanagerswillcontinuetopass thatdatadirectly to thedTCC(seefigure1).

Margin managementWhetherornot investmentmanagerswillacceptusingcashasmargininlieuofinvestmentopportunities,areviewofsystemsusedtomanagemarginiswar-ranted.oftendifferentassetclassesusespecifictoolsthattakeintoaccounttheintricaciesof thatmarket.Abespokesystemthatmanagescollateralduetorepo tradingmaynotbe suitable for

handlingcollateralfromtradingoTCderivatives.Themoreasset-specif icsystemsareused,thegreaterthechal-lengeofobtaininga truecross-asset,cross-function,firm-wideperspectiveoncollateralandmargin,andtheslowerthefrontofficewillbeinrespondingtodynamicmarketevents.

ThedevilisinThedeTAilsAnoverhaulofthesystemthatdrivestheoTCderivativesmarket, throughdodd-frankandassociatedrules,offersanopportunitytoreview,andpossiblyretool,theapplicationsthefrontofficereliesupon tomanage investments.At this stage,more isunknownthanknown,andthemainfocusoverthenextyearwillbetostandreadytoadoptthechangesinmarketformandstructure,whilecontinuing tomanage the riskinherentinthecurrentsystem.

investmentmanagersmustkeenlyre-gardtherenovationsneededasworkinprogressanddetermineifthetradingofoTCderivativeswillbetoocomplex,cumbersomeandcostlytocontinuetotakeadvantageof theirusefulness inportfolio strategyandhedging, andwhetherornottheirfront-officeiTplat-formisreadyforthisbrave,newworld.

Brent Rossum, CFA, is Domain Manager for Front Office in SimCorp North Amer-ica. He holds a B.Sc. in Economics from the University of Minnesota, USA, and an M.Sc. in Finance from the ICMA Centre, University of Reading, UK. Prior to join-ing SimCorp in 2010, he worked in front-office product management at Bloomberg, TradeWeb and Charles River Develop-ment.

CCP (Central Counter Parties)

Buy-side Dealer

DTCC (Depository Trust and Clearing Corporation)

Exchangetrading Negotiation

Processing and con�rmation

SEF(Swap Execution Facilities)

Figure 1. Proposed OTC

framework.

“An overhaul of the system that drives the OTC derivatives market,

through Dodd-Frank and associated rules, offers an

opportunity to review, and possibly retool, the applications

the front office relies upon to manage investments.”


i n2010–11,thesimCorpstrategy-labresearchprogrammefocuseson the threemajor sectorsoftheglobal investmentmanage-

mentindustry: investmentfunds;assetmanagement;andpensionandinsurancefunds.Alltheserespectivesectorsfaceauniquesetofstrategicandtacticalchal-lenges.focusingonthesechallenges,simCorpstrategylab in itscapacityasanindependentresearchinstitutiongathered leading industryrepresenta-

tivesandacademicsforthreetwo-daymeetings intheformofthesimCorpstrategylab Copenhagen summit2011,withonemeetingaddressingeachindustrysector.

Withtheaimofidentifyinganddiscuss-ing12keychallengesfacingthethreeindividual industrysectors,relatedre-spectivelytorisk,costandgrowthissues,threeesteemedacademicsweredesig-natedtoheadupteamsofhigh-profileacademics from renowned researchinstitutions,suchasinseAdandsternschoolofbusiness,nYu,aswellassen-iorexecutivesfrommajorinternationalconsultingandinvestmentorganisations,includingTowergroup andnordeasavings&Assetmanagement.

missionAndvisionTheCopenhagensummit2011isoneofthemainactivitiesofthesimCorpstrat-egylabresearchprogramme2010–11,anditsdeliverablesaredirectlyaimedatsupportingthemissionandvisionofsimCorpstrategylab.

To findappropriate solutionsand togather relevantbestpractices for thetop strategic institutional levels ofthe investmentmanagement industry,simCorpstrategylabcarriesout itsownresearchandanalysisoftrendsandchallenges inthefinancialsector.Theresearchprogrammeiscarriedout inclosecollaborationwithinternationallyrecognisedacademicsandestablishedindustryexperts.Asaresult,simCorpstrategylabisabletocontributecompe-tentsuggestionsforbestpractices,whichare intendedtominimiserisk, tofindwaystoachievesustainablecostsavingsandtoenablegrowth.

ThoughTleAdershipTheaimofthesimCorpstrategylabCopenhagensummit2011wastogener-ateandcontributesubstantialknowledgeabout key investmentmanagementindustrychallengesandtoannouncerecommendedsolutionsofvaluetotheindustry.Amongthedeliverablesareanumberof forthcomingarticlesandthreewhitepapers tobepublished inseptember2011.

With the purpose of identifying and examining key investment management in-dustry challenges, thought leaders representing the industry and renowned academic institutions gathered at the SimCorp StrategyLab Copenhagen Summit 2011 meetings in February and March.

# SimCorp StrategyLab hosts Copenhagen Summit 2011: high-level industry representatives and academics convene to discuss key challenges

Lars Falkenberg is Assistant Director at SimCorp StrategyLab

“The aim (...) was to generate and contribute substantial knowledge

about key investment manage-ment industry challenges and to

announce recommended solutions of value to the industry.”

Members of the Pension and insurance funds group discuss key industry challenges under the guidance of group head Professor Massimo Massa, INSEAD.


seCTorgroupsThree teamsof thought leaders fromacademicinstitutionsandtheindustrywerecreated,withdesignatedsectorleadersteamingupwithadistinguishedacademicconductingresearchintheareaaswellasindustryspecialists.Thesespe-cialistsincludedoneormorerepresenta-tivesfrommajorsimCorpclientsandonethoughtleaderfromsimCorpitself.

At the individual sectorgroupmeet-ingsinCopenhagen,thethreegroupsdiscussed thekey issuesof risk,costandgrowthspecificallyrelatedtoeachofthethreesectorsunderexamination:investment funds;assetmanagement;andpensionandinsurancefunds.

fromasuggestionpresentedbytheheadofgroup,basedonlistsofproposedkeychallengessentinadvancebythegroupmembers,eachsectorgroupagreedon12keychallengesfacingtheindividual in-dustrysector.Aguidingprincipleforthediscussionswasthat–inlinewiththeaim

ofsimCorpstrategylab’sresearchpro-gramme–qualifiedconsiderationsonthesolutionsproposedshouldbeputforwardfromaniT-architecturalperspective.

mAinConClusionssomeofthemainconclusionstoemergefromtheindividualdiscussionswere:

• industryissuesassociatedwithrisk,costandgrowthareinterrelatedandimpactthethreeexaminedsectorsofinvestmentfunds,assetmanagement,andpensionandinsurancefundsinvaryingdegreesofmagnitude;

• increasedmarketvolatility,financialinstabilityand regulatorychangeareheretostay, impactingbusinessrisk,costandgrowthrespectively,andcreatingchallengesaswellasopportunitiesthatarenotnecessarilyalwaysinequalmeasure;

• changingdemographics(i.e.ageingpopulation)willalterasset, invest-

mentandpensionfundingpatterns,creatingnewcostchallengesbutalsogrowthopportunitiesfortheinvest-mentmanagementindustryasawhole;

• scale, internationalisationandtherightchoiceofinvestmentmanage-mentplatformarekeydeterminantsincontrollingrisk(marketandregu-latory),curbingcosts(iTandopera-tional)andspurringgrowth(businessandproduct).

oTherACTiviTiesAmongsimCorpstrategylab’sotheractivities for the2010–11periodandfollowingupitsexcellenceAwards2010,simCorpstrategylabisseekingappli-cantsforthesimCorpstrategylabex-cellenceAwards2011,whichwillawardoutstandingandinnovativeleadersintheabilitytomitigaterisk,reducecostandenablegrowth.Thethreewinnerswillbeannouncedataceremonyon29sep-tember2011atthesimCorpdimension

internationaluserCommunitymeeting2011instockholm.

followtheactivitiesoftheindustrysectorgroupsatwww.simcorpstrategylab.com.

Lars Falkenberg (MA) is Senior Vice Pres-ident, Head of Global Product & Market-ing Management at SimCorp and Assist-ant Director of SimCorp StrategyLab. Before his role at SimCorp, Lars Falken-berg gained international senior manage-ment experience in asset management from one of Europe’s top 12 financial institu-tions. Executive education and training in international banking and finance at e.g. INSEAD and the Swiss Finance Institute supplements his theoretical background.

QuAlifYforsimCorpsTrATegYlAbeXCellenCeAWArds2011

submityourcontributionstoqualifyforsimCorpstrategylabrisk,CostandgrowthmanagementexcellenceAwards2011.readmoreaboutsimCorpstrategylab,itsexcellenceAwardsandthesubmissionguidelinesatwww.simcorpstrategylab.com.111111

INDUSTRY SECTOR GROUPS AND MEMBERS

Asset management

marnoverbeek,professor,rotterdamschoolofmanagement

lestergray,Ceo,schrodersAsia(basedinsingapore)

larseigenmøller,executivevicepresident,danskeCapital

dr.ralfschmücker,managingdirector,simCorpCentraleurope

peterengel,seniorsalesmanager,simCorpCentraleurope

dr.matthäusdenotter,Ceo,swissfundsAssociation,sfA

michaelJarzabek,generalbevollmächtigter,lbbWAssetmanagementinvestmentgesellschaftmbh

dushyantshahrawat,seniorresearchdirector,Towergroup

Pension and insurance funds

Anthonyneuberger,professor,Warwickuniversity

ingoWalter,professor,directorofsimCorpstrategylab,sternschoolofbusiness,nYu

marcvandenberg,Coo,pggm

Arnee.Jørgensen,domainmanager,Accounting,simCorpgroup

Jacobelsborg,headofTechnology,ATpinvestmentArea

dr.Annukkapaloheimo,Ceo,scandinavianfinancialresearch

dr.frankWellhöfer,Coo,meAgmuniChergoAssetmanagementgmbh

Investment funds

martinJ.gruber(head),professor,massimomassa,professor,inseAd

ulrikmodigh,headofAssetmanagementoperations,nordeasavings&Assetmanagement

brians.Jensen,headofbusinessprocesses,nordeasavings&Assetmanagement

peterhertel,domainmanager,fundAccounting,simCorpgroup

bernarddelbecque,directorofresearchandeconomics,europeanfundandAssetmanagementAssociation(efAmA)

mereleA.may,seniorvpinvestmentoperations,AmericanCenturyserviceCorporation

martinJ.gruber(head)professor,sternschoolofbusiness,nYu

massimomassa(head)professor,inseAd

stephenJ.brown(head)professor,sternschoolofbusiness,nYu


A sanassetmanagerorpen-sion trustee,you shouldworrylessaboutthestocksandproductsyoupickfor

yourclientsandmoreaboutgettingyour fundamental investmentbeliefsright.Afterasteepdeclineintheglobalstockmarketsanda recovery that isstilluncertain, it issimplynotenoughtohaveagoodorganisation,goodstaffandawell-definedmission.Youneedtoformulateyourownsetof investmentbeliefs:aclearviewonhowyouperceivethewaycapitalmarketswork,andhowyourfundcanaddvalueandstriveforexcellence.funds thatestablishandimplementawell-defined investmentphilosophyhavebeenshowntoearnconsistentlybetterresults.

Thispracticalbookprovidestheframe-workfordeterminingyourowninvest-

mentbeliefsandguidanceonhowtoimbed,communicateandmonitorthem.itsresearchisbasedonasurveyoftheworld‘sleadingfundmanagers,viewedasexcellentcompaniesintheassetman-agementindustry.

Thebookprovidesatimelyoverviewof themajordebates in the industryandanintroductiontotheissuesthatmatterforlong-termsurvivalinfinan-cialmarkets.Withinvestmentbeliefsfirmlyinplace,youwillbeabletomoreeasilynavigatetheinvestmentoptionsavailable,knowingthatyourchoicesanddecisionsare inaccordancewithyourvaluesandobjectives.successfulimplementationof investmentbeliefsmightwellbeoneofthedecisivefac-torsinbecomingawinneror loserintheinvestmentmanagementindustryin2020.

KEES KOEDIJK is Professor of Financial Management and Dean of the Faculty of Economics and Business Administration at Tilburg University, the Netherlands. He has won several awards for his research on sustainable development. He has published extensively on finance, European integra-tion, and monetary policy.

ALFRED SLAGER is Chief Investment Officer at Stork Pension Fund and affiliated to Tilburg University, the Netherlands. His expertise includes international financial services, with a particular interest in asset management, pension fund and banking strategies. He publishes regularly on pen-sion and investment management subjects.

# Financial markets and Organizational technologies: System Architectures, Practices and Risks in the Era of Deregulation

progressivefinancialderegula-tion followingabolitionofthebrettonWoodssystemintheearly1970schangedthe

useandconfigurationoftechnologiesintheorganisationalcontextsoffinance.informationsystemsandfinancialen-gineeringhaveledtoanunprecedentedreinventionofthebusinessofbanking.

Writtenbyexpertsfromthesocialstud-iesoffinance,informationsystemsspe-cialists,andhistoriansandsociologistsoftechnology,thisbookexplainswhythemanagementandtheregulationoffinan-cialorganisations,especiallyinperiods

ofcriseswithsystemicconsequences,requiresanunderstandingofthecom-plextechno-organisational landscapeswhichemergedfromthisevolution.itshowstheinterconnectionbetweenthedifficultyofovercomingthefinancialandoperationalriskswearefacing,andtheglobalwebsoforganisationalandtechnologicalcomplexity.

Thisvolumeispublishedinthepalgravemacmillanstudiesinbankingandfi-nancialinstitutionsseries.

ALEXANDROS-ANDREAS KYRTSIS is Professor of Sociology at the University of Athens, Greece. Previously, he worked as an adviser for banks and IT firms. His current research focuses on the analysis of the techno-organisational backstage of financial markets.

Alexandros-Andreas Kyrtsis (Ed.), Palgrave Macmillan, July 2010

BOOK REVIEW:

BOOK REVIEW:

# Investment Beliefs: A Positive Approach to Institutional Investing

Kees Koedijk and Alfred Slager, Palgrave Macmillan, December 2010

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

TheAlTernATiveinvesTmenTfundmAnAgersdireCTive(Aifmd)TheeuropeanCommissionproposedaninitialdraftofanewdirectiveintroducingaharmonisedeuregulatoryandsupervisoryframeworkforAlternativeinvestmentfundmanagers(Aifm)inApril2009.TheAifmdirectivewasapprovedbytheeuropeanparliamenton11november2010,andpendinglegislativeapproval,itisexpectedtotakeeffectearly2013.TheAifmdirectiveisdesignedtoaddressanumberofrisksidentifiedbytheeuCommissionrelatingtoalternativeinvestmentfunds,includingsystemicrisk.itwillrequirealternativeinvestmentfirmsaboveacertainsizetoregisterandprovideregulatorswithdetailedinformationontheprincipalmarketsandinstrumentsinwhichtheytrade.Thedirectiveaffectsallnon-uCiTsfunds:hedgefunds,privateequityandventurecapitalfunds,realestatefundsandinvestmenttrusts.

http://ec.europa.eu/internal_market/investment/alternative_investments_en.htm

regulATiononshorTsellingAndCerTAinAspeCTsofCrediTdefAulTsWApson15september2010,theeuropeanCommissionadoptedaproposalforaregulationonshortsellingandcertainaspectsofcreditdefaultswaps(Cds).itsmainobjectivesaretocreateaharmonisedframeworkforcoordinatedactionateuropeanlevel,increasetransparencyandreducerisks.Thenewframeworkwillmeanregulators–nationalandeuropean–haveclearpowerstoactwhennecessary,whilstpreventingmarketfragmentationandensuringthesmoothfunctioningoftheinternalmarket.

http://ec.europa.eu/internal_market/securities/short_selling_en.htm

solvenCYiimedium-TermWorKplAnon19January2011,theeuropeaninsuranceandoccupationalpensionsAuthority(eiopA),theauthorityreplacingCeiops,issuedasolvencyiimedium-termworkplan.Themedium-termworkplanwillhelp torealiseashift inattentionfromthedraftingofregulatoryadvicetotheimplementation:fromregulationtosupervision.untiltoday,thesolvencyiiprojecthasfocusedonthedevelopmentoftheregulatoryframework.inviewoftheimminentimplementation,eiopAwill increasinglyfocusonpreparingtheday-to-daysupervisionbymemberstatesundersolvencyii.Therefore,theworkplanshouldensureasmoothtransitiontothenewframeworkbothfromapolicyandasupervisorypracticeperspective,withanappropriatebalancebetweenrisksensitivityandpracticabilityofthenewregulation.Theworkplanalsohighlightstheinterconnectednessofsolvencyiiwithnon-solvencyii-specificareas.

https://eiopa.europa.eu/fileadmin/tx_dam/files/aboutceiops/Workinprogress/solvencyii-medium-Term-Work-plan-2011-2014.pdf

nAiCAdopTsAnumberofmeAsuresfromheAlThCArereformTosolvenCYrisKAssessmenTTheusnationalAssociationofinsuranceCommissioners(nAiC),whoseoverridingobjectiveissupportingstateinsuranceregulatorsastheyprotectconsumersandmaintainthefinancialstabilityoftheinsurancemarketplace,passedanumberofregulatoryinitiativesduringaspecialjointconferencecall on 17 december 2010. The passing of the initiatives is meant todemonstratetheorganisation’scommitmenttoconsumerprotectionwithinthecontextofstablemarketsandeffectiveregulation.Amongtheinitiativespassed were: The American health benefit exchange model Act, AnupdatedmodelbulletinontheuseofretainedAssetAccounts,Therevisedinsurance holding Company system regulatory Act and insuranceholdingCompanysystemmodelregulation.

http://www.naic.org/releases/2010_docs/naic_adopts_key_health_provisions.htm

iAsb&fAsbissuelATesTreporTonefforTsToConvergeifrsWiThusgAApsincethelastprogressreportwaspublishedinJune2010,theboardshavejointlyissuedmajorexposuredraftsonleasesandrevenuerecognition,completedthefirstphaseoftheConceptualframeworkprojectandbegundiscussions to seek to align their respective financial instrumentsaccountingproposals.Theboardshavealsofurtherprioritisedboardtimeavailabletodiscussconvergenceprojects. http://www.ifrs.org/nr/rdonlyres/26fA84e8-631d-44A8-AAAb-AA60f40b647e/0/moustatusupdatenov2010.pdf

disClosureforAsseT-bACKedseCuriTiesreQuiredbYseCTion943ofTheWAllsTreeTreformAndConsumerproTeCTionACT(dodd-frAnKACT)The latestofmanyprovisions tobe implementedunder thedodd-frankAct, the disclosure rules for asset-backed securities (Abs) are set to beenacted on 28 march 2011. The final rules require securitisers of asset-backedsecuritiestodisclosefulfilledandunfulfilledrepurchaserequests.Therulesalsorequirenationallyrecognisedstatisticalratingorganisationsto include information regarding the representations, warranties andenforcementmechanismsavailabletoinvestorsinanasset-backedsecuritiesoffering inany report accompanyinga credit rating issued inconnectionwithsuchanoffering,includingapreliminarycreditrating.

http://www.sec.gov/rules/final/2011/33-9175fr.pdf

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37simCorp JournAlofAppliediTAndinvesTmenTmAnAgemenT April2011

finAnCiAlserviCesregulATionineuropeTurnedoverToThreeneWsupervisorYbodies(esA)inorderTohArmoniseregulA-TionsACrossmembersTATesfrom January 2011, the regulationof financial services acrosseurope isnow overseen by three european supervisory Authorities (esAs). TheesAs work with the newly established european systemic risk board(esrb)toensurefinancialstabilityandtostrengthenandenhancetheeusupervisoryframework.Theywillimprovecoordinationbetweennationalsupervisoryauthorities, suchas thefsA,and raise standardsofnationalsupervision across the eu. The esAs are the european securities andmarketsAgency(esmA),theeuropeanbankingAgency(ebA)andtheeuropeaninsuranceandoccupationalpensionsAuthority(eiopA).

http://www.fsa.gov.uk/pages/About/What/international/european/esas/index.shtml

luXembourgisfirsTCounTrYTorATifYuCiTsivTheuCiTsbrandcelebratedits25thbirthdayattheendoflastyear,asthefirstuCiTsdirectivewasformallyadoptedon20december1985.Almostexactly25yearslater,on16december2010,theluxembourgparliamentratified uCiTs iv. As was the case in 1985, luxembourg is the firstcountryintheeutopassthisnewregulationintonationallaw.Anumberofprovisions (suchas fiscal reliefs)came intoeffectas soonas1 January2011.

http://www.alfi.lu/newsletter/alfi-newsdigest

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solvenCYii:QuAnTiTATive&sTrATegiCimpACT–TheTideisgoingouTAsthesolvency2deadlinemovescloser,andtheframeworkitselfbecomesclearer,thestrategicimplicationsfortheindustrycometotheforefront.Thisreporttakesthe viewpoint that solvency 2 will act as a catalyst for significant change withprofound strategic impacts. oliver Wyman, jointly with morgan stanley, hasapplied the solvency 2 framework to the industry overall and on individualbusinessmodels.basedonthisproprietaryanalysis, thereportshowsamong itsfindingsthatthesolvencyratiosofeuropeaninsurerswilldecreasefrom~200%undersolvency1to~135%undersolvency2onaverage;afundamentalreappraisaland restructuring of traditional participating business can be expected; cost ofcapitalislikelytoincreaseintheshort-term;reinsurerswillbewinnersofsolvency2,whilegeographicallylocalised,smallerinsurers–includingmanymutuals–maysuffer; a step change in Alm capabilities and an adjustment of investmentstrategies is required; and european groups may need to reconsider theircompetitiveposition inmarketswith ’non-equivalent’ regulation,as theusAislikelytobe.

‘solvencyii:Quantitative&strategicimpact–Thetideisgoingout’,oliverWyman&morganstanley,2011http://www.oliverwyman.com/ow/ow_50350.htm?name=solvency+2%3A+Quantitative+%26+strategic+impact+%2d+The+Tide+is+going+out&direct=True&[email protected]&morganstanleyJointreport,92pages,January2011

lifeinsurAnCeCfosurveY#27Thisreportisbasedonaweb-basedsurveyamonguslifeinsuranceCfosandpointsoutkeychallengesfacinglifeinsurancecompaniesin2011andthelikelyresponsestothosechallenges.Thereporthighlightsthattheeconomicenvironmentisthekeychallengeforcompaniesin2011toachievetheirgrowth,profitandriskobjectives.growthratesinsales,expenseandcostmanagement,andthecurrentandfutureregulatory, taxand legislativeenvironmentarealso important,butcomparedtotheeconomicenvironmenttheyarelessofachallenge.inordertohandle thesechallenges,companiesare focusingon improvingmanagementdiscipline,enterprise-riskmanagementanddistributionproductivity.

‘lifeinsuranceCfosurvey#27’,TowersWatson,2010http://www.towerswatson.com/newsletters/americas-insights/3251TowersWatson,6pages,november2010

uslifeinsurAnCeouTlooKinthisreport,ernst&Youngpresentsfourissuesthatwillinfluencetheuslifeandannuityinsuranceindustryin2011.Thefirstissueisthechangingregulatoryenvironmentwith,forexample,thedodd-frankActchallenginginsurerstopreservetheirfinancialstrength.Thesecondissuefororganisationsistomakesuretoholdenoughcapitalandalsobeabletocontrolrisksasaconsequenceoftherecentfinancialcrisis.Thethirdissueonthelististheneedtoimproveoperationalefficiencytoreducecosts.lastonernst&Young’slististheneedtoreinventproductsandservicesandusetheirdistributionchannelstoenablegrowth.

‘uslifeinsuranceoutlook,ernst&Young,2011http://www.ey.com/publication/vwluAssets/us_life_insurance_outlook_-_2011/$file/us_life_insurance_outlook2011.pdfernst&Young,4pages,January2011

AifmdireCTivehAsbeenpAssed–ChAllenge,ChAngesAndopporTuniTiesforTheinvesT-menTmAnAgemenTindusTrYsincethe initialdraftof theAlternativeinvestmentfundmanagers(Aifm)directivewasissued,therehasbeenasignificantamountofregulatoryuncertaintysurroundingthealternativeinvestmentmanagementindustryineurope.however,after19monthsofintensivedebate,negotiationsontheAifmdirectivereachedaconclusionandthetextpassedduringtheeuropeanparliamentplenarysessionon11november2010.ThevoteattheeuropeanparliamentcanbeseenasamajorsteptowardsclosingthischapteroftheAifmdandwilleliminatemuchoftheuncertaintythathashinderedtheindustry.Thesuccessfulvotehasfinallypermittedtheglobalalternative investmentmanagementindustry,theirstakeholders,andinvestorstomoveforwardandbegintoprepareforthetwo-yearimplementationphaseoftheAifmd.Thisphasewillseethetechnicalguidelinesforimplementationbeingformulated,aswellasimplementationlawsbeingdrafted,allofwhichwillrequireclosemonitoringfromtherealestateindustrytoensurethatthecurrentframeworktranslatesintosensibleandappropriatemeasures.

Tworeportsbymajorconsultanciespresentandanalyse thechallenges,changesandopportunitiesfacedbytheinvestmentmanagementindustrywiththepassingoftheAifmdirective.

‘Anewdawnforalternativeinvestments–navigatingthechallengesandopportunitiesoftheAifmdirective’,ernst&Young2010http://www.ey.com/publication/vwluAssets/aifm-A_new_dawn_for_alternative_investments-nov10/$file/A%20new%20dawn%20for%20alternative%20investments%2017nov10-secured.pdfernst&Young,30pages,november2010

‘Aifmdirective–Crossingthefinishline’,deloitte,financialservices,2011http://www.deloitte.com/assets/dcom-unitedstates/local%20Assets/documents/fsi/us_fsi_Aifmdirective_011211.pdfdeloitte,6pages,January2011

ThesolvenCYiiChAllenge:AnTiCipATingThefAr-rAngingimpACTonbusinesssTrATegYinsurancecompaniesaremakingtremendouseffortstocomplywithsolvencyii,buttodatetheirresponseshavebeenmoremechanicalthanstrategic.Torecastsolvencyiiasasourceofvalueratherthansimplyadriverofcosts,insurersneedtolookbeyondmeremodelsandmetrics.Theymustcapitaliseonthenewrulesbyrevisitingtheirbusinessstrategies,productportfolios,distributionapproaches,andriskmanagementpractices.someinsurersmayneedtochartanentirelynewcoursefortheirbusinesses.inthisreport,thebostonConsultinggroupbringsforwardtheimportanceforinsurancecompaniestousethesolvencyiiregulationasasourceofstrategicvalueandnotjustasadriverofcosts.Thereportisbasedonworkshopsandinterviewswithseniorexecutivesatlargeandmid-sizeinsurersineuropeandnorthAmerica.

‘ThesolvencyiiChallenge:Anticipatingthefar-rangingimpactonbusinessstrategy’,bCg,2010http://www.bcg.com/expertise_impact/industries/insurance/publicationdetails.aspx?id=tcm:12-63430bostonConsultinggroup,19pages,october2010

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Recent research and white papers

April2011 JournAlofAppliediTAndinvesTmenTmAnAgemenT simCorp


2011TrendsToWATCh:finAnCiAlmArKeTsTeChnologY–deAlingWiThvolATiliTYAndregulATionThefinancialmarketssectorhasseeminglyemergedfromthefinancialcrisis inrelativehealth,withtherestorationofgrowthandprofitability.however, therepercussionsofthecrisisarestillbeingworkedthroughandthesustainabilityoffuturegrowthisakeyquestionfor2011.Thisreportfromovumdatamonitorweighsinwithviewsonthetrendsandchallengesthatwillshapetheinvestmentmanagementindustryin2011.notsurprisingly,regulationandmarketvolatilityareseenasthemaindriversofchangegoingforward.

‘2011TrendstoWatch:financialmarketsTechnology–dealingwithvolatilityandregulation’,datamonitor,2010http://www.datamonitor.comdatamonitor,23pages,november2010

finAnCiAlreforminsighTs–dodd-frAnK‘svolCKerruleChAngeslAndsCApeforinvesTmenTsbYbAnKsAndoTherenTiTiesofalltheprovisionsincludedinthe2,300andpluspagesofthedodd-frankAct,perhapsnonehasgeneratedmoreattentionthansection619,morepopularlyknownasthevolckerrule.ThisbriefingpaperfromdeloitteToucheTohmatsudiscussestheimpetusforthevolckerrule,whenandhowitistobeimplemented,aswellaswhatinvestmentmanagersinvestinginusmarketsneedtobeawareof.

‘financialreforminsights–dodd-frank‘svolckerrulechangeslandscapeforinvestmentsbybanksandotherentities’,deloitteToucheTohmatsu,financialreforminsights,2010http://www.deloitte.com/assets/dcom-unitedstates/local%20Assets/documents/fsi/us_fsi_volckerQA_financialreforminsights_102710.pdf

deloitteToucheTohmatsu,4pages,october2010

europeAnfundmAnAgemenTindusTrYneedsbeTTergrAspofnon-finAnCiAlrisKsThispublicationlooksintohownon-financialrisksandfailureshaveimpactedtheregulatoryagendaineuropeandtracesthemanagementofliquidity,counterparty,compliance,misinformation,andotherfinancialrisks inthefundindustry.byidentifying thedistributionof risksandresponsibilities in this industry, thepublicationexamineshowconvergencebetweencountryregulationscouldbeachieved.finally,thepublicationassesseshowfundunit-holderscanbeprotectedinthebestwaywithappropriateregulations,improvedriskmanagementpractices,andgreatertransparency.

‘Theeuropeanfundmanagementindustryneedsabettergraspofnon-financialrisks’,edheC-riskinstitutepublication,2010http://www.caceis.com/fileadmin/pdf/edhec/edheC_non-financial_risks_euro_fm_industry.pdfedheC-riskinstitute,92pages,december2010

New reports published and information considered worth publishing can be submitted for review to: Co-Editor Mette Trier, [email protected]

inChingToWArdproduCingAuCiTsivKidWiththedeadlineforproducingKeyinvestorinformationdocuments(Kids)looming,managersurgentlyneedtofocusonhowtheywillbeabletomeetthelogisticalchallengesofproductionanddistribution.Whiletransitionalarrangementsexist,allnewfundslaunchedafter1July2011willrequireaKid,andthereforetimeisoftheessence.ThisupdatefrompwCindicatesthat,despitethefactthattheKidismandatoryforalluCiTs-basedfundsasofJuly2011,manyfirmsdonothaveareadinessplaninplace.Thearticleoutlinesthestepscompaniesneedtotakeinordertobecompliant,aswellasaddressingthechallenges facedbycompanies thatoutsourceallorpartoftheirinvestmentmanagementprocessingtoathirdparty.

‘inchingtowardproducingauCiTsivKid’,forwardthinking,pwC2010http://www.pwc.com/gx/en/asset-management/assets/pdf/amnews-1110-16.pdfpwC,5pages,november2010

Top10TrendsinseCuriTiesAndinvesTmenTs,2011ThisreportfromAitegroupbreaksdownthetop10issuesfacingtheinvestmentmanagementindustryintheupcomingyear.Aitegroupseesregulationasakeyinfluenceronsecuritiesandinvestments,withthedodd-frankAct,variouseuropeanregulationsandthemoveofoTCtradestoexchangesamongthekeyfactorscited.Thereportalsodiscusseschallenges indatamanagementand investor-buyingbehaviour.

‘Top10Trendsinsecuritiesandinvestments,2011’,Aitegroup,2011http://www.aitegroup.com/reports/reportdetail.aspx?recorditemid=747Aitegroup,25pages,January2011

invesTmenTmAnAgemenT:Top10TeChno-logYiniTiATivesfor2011Afterthewildridethatinvestmentmanagersexperiencedin2008and2009,2010wasabetteryear,withmutualfundassetsandhedgefundassetsrisingmarkedly.butinvestmentfirmswillnotforgettheimpactofthefinancialcrisisontheirrevenuesandmargins,investorattitudesandassetallocations,anduniversalperceptionsofrisk.Towergroup‘sannualTop10researchnotefortheassetmanagementbusinessdiscussesthebusinessdriversandstrategicresponsesresultingfromtheseeventsandlessonsandfocusesonthetop10technologyinitiativesforinvestmentmanagersfor2011.Thisreportsshowshowsomeofthekeyramificationsofthefinancialcrisiswillmanifestthemselvesinearnestin2011.regulationbothintheusA(i.e.thedodd-frankAct)andeurope(i.e.uCiTsiv,ifrs9andAifmd)willreshapehowbusiness isdoneandcause investmentmanagerstofocusasmuchonriskmanagementasgeneratingreturns.Amongotherfactors,thegrowinginfluenceofmobility,socialmediaandcloudcomputingforinvestmentmanagersisalsocoveredinthereport.

‘investmentmanagement:Top10technologyinitiativesfor2011’,Towergroupresearchnote,2011http:\\www.towergroup.comTowergroup,11pages,January2011

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Since 1971, SimCorp has been providing investment and portfolio management software and services to the world’s leading investment managers, asset managers, fund managers, fund administrators, pension funds, insurance funds, and wealth managers. SimCorp’s world-class software provides global financial organisations with the tools they need to mitigate risk, reduce cost, and enable growth. SimCorp is a global company, regionally covering all of Europe, North America, and Asia Pacific. Listed on the NASDAQ OMX, SimCorp is dedicated to supporting the global investment management industry, its clients and its investors. For more information about SimCorp’s products, please visit www.simcorp.com/products.

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