IAFE releases op risk white paper for buy-side firms

The International Association of Financial Engineers (IAFE) yesterday released a white paper on operational risk for buy-side institutions, which concludes that business reputation rather than Basel-inspired regulation is the real driver for implementing robust operational risk management systems.

According to Zurich Financial Services’ database of operational risk events, losses associated with operational risk in the fund community were estimated to be about $9 billion during the past 10 years. But the actual amount of losses – which includes those events that never reach the public domain – is likely to be significantly higher, the IAFE said.

“Although it is generally agreed that operational risk does not lend itself to measurement in the same way as market or credit risk, there are models and methodologies used by banking and insurance communities that can be adopted by fund companies,” the IAFE said. “[The] establishment of a progressive operational risk culture by the use of communication and educational techniques... along with self-assessment questionnaires and operational risk models and scenario testing, comprise an important marketing cache for an operational risk manager,” the association added.

The impending Basel II capital requirements mean that several buy-side operations within major global banks are currently working on establishing operational risk cultures within their institutions, and pushing out “ownership” of risk to the business managers, the IAFE added. But the professional body claimed that these institutions are focusing beyond modelling and regulatory issues by establishing programmes that have strong business and client relationship justifications.

“Ultimately, managing operational risk within a buy-side organisation means upholding promises to clients. Breach of fiduciary trust is a major operational risk within this community, and what ultimately leads to lawsuits and ‘headline risk',” the paper continued. “One important method for managing fiduciary risk is to learn from the failings of other firms in order to avoid similar mishaps within one’s own firm.”