Financial services regulation and COVID-19 video diaries: Issues affecting asset and fund managers – part 2: operational risks

My name is Iona Wright and this is the second instalment of our video diaries relating to impacts of COVID-19 on asset and fund managers.

My focus today is on the operational risks that managers may be exposed to as a result of COVID-19. Putting aside general business continuity and operational resilience considerations, which will be common to all firms, I will be focussing, in particular, on three areas of relevance to managers. These are:

1. Service providers
2. Investments and trading
3. Risk management

Turning first to service provider risk: managers rely on a network of service providers essential to 'their business as usual' operations. Yet, to date, they may not have had deep insight into crisis management plans for these providers.

This is particularly the case given the breadth of service providers relied on by managers which can include: depositaries and custodians; valuation and transfer agents; distributors and fund administrators, to name just a few.

At this time, it is important for managers to be performing an operational risk assessment on their service providers and consider which will be strained by COVID-19 impacts and what BCPs these providers have in place. Managers should be focussing, in particular, on whether service levels are being maintained by key providers and reviewing SLA terms with a view to considering what processes are in place if something goes wrong. Ultimately, this all feeds into managers' wider business continuity planning which is a key priority for the FCA at the moment.

Turning to our second area of focus, investments and trading: clearly the potential for significant market instability stemming from COVID-19 is likely to be in place for months and predictions of a downturn are increasing. The challenge to managers is therefore how to be responsive and realistic in the face of these market stresses while continuing to comply with their regulatory obligations.

In particular, managers will need to be considering whether there have been breaches of investment restrictions and keeping forecasts, models and assumptions under regular review for the purpose of business planning and analysis.

How to continue with reporting and recording in the current environment is also a concern with most managers having moved to alternative sites or working-from-home arrangements. The key message for the FCA, so far, has been to acknowledge that difficulties may arise in this context but firms are expected to maintain appropriate records and submit transactional data as soon as possible, with enhanced monitoring and retrospective reviews to be built in where deficiencies have been identified. 

Managers should also ensure that they are not forgetting about their market counterparties and look to reviewing their ISDA, prime brokerage and other counterparty agreements for potential events of default, termination events or requirements to provide additional margin.

Our third and final focus area is risk management which has the potential to be significantly impacted by COVID-19. For example, some authorised fund managers have experienced issues ensuring compliance with the limits at value at risk as part of their risk limit systems. In this respect, the FCA has been clear that its expects managers to already have plans in place to deal with such events and to take appropriate remediation action, considering market conditions and the best interests of customers.

Another point to flag is that valuation of less liquid and private investments has become more challenging with increased COVID-19 related market volatility. As a result, managers may need to reassess their valuation processes, policies and controls including those of third-party valuation agents, with clients, investors and other stakeholders being informed when any of these divert from the norm.

Managers should also be keeping a close eye on the monitoring of liquidity and consider whether they anticipate any challenges in meeting redemption requests or striking now at quarter-end. This is particularly the case for passive products where significant liquidity is largely untested. It may also be appropriate to consider suspending redemptions or invoking gates to introduce limits. Also clear investor and regulatory communication of this will be essential. 

Just to draw together these areas of operational risk: the key takeaways for managers are really threefold. The first is to perform an operational risk assessment on material service providers, including counterparties, as part of managers' wider BCP reviews. The second is to keep investment restrictions of forecasts and assumptions under regular review while focussing on maintaining well recorded business as usual, transaction reporting and recording processes; and the third is for managers to be keeping a close eye on their risk management systems, in particular, to ensure compliance with value at risk limits, reassess valuation procedures as and when needed and closely monitored liquidity, as any material diversions in these respects will likely to be communicated to investors, clients and the FCA.

I hope that this has been helpful and thank you very much for watching. Please do join us for further video diaries to be published in due course.