Building a resilient investment management business
Covid-19: something we should have seen coming, or a true Black Swan event?
Ever since Covid-19 hit, there’s been a lot of discussion – not just in the investment fund sector, but everywhere – as to whether or not the pandemic qualifies as a ‘Black Swan’ event. As an event, they are extremely rare, and classified as an event where nothing in the past could convincingly point to its possibility – meaning there’s no way to be fully prepared for it. It’s an event that’s highly improbable, but if it does occur, the impact will be severe.
There are those who believe Covid-19 meets that criteria, even though there have been global pandemics in the past… and those who would point to a zombie apocalypse as really the only example of a genuine Black Swan event.
For the investment industry, funds have had to adapt to rapidly changing operating conditions, new policy settings, and unpredictable member behaviour in response to the evolving health and economic crisis caused by Covid-19 and the global reaction to it. It’s fair to say that many organisations have been ill-prepared for this, and they’re firmly in the Black Swan camp.
The Australian Prudential Regulation Authority (APRA) disagrees. In 2013, they issued the Cross-industry Practice Guide (CPG) 233 – Pandemic Planning. In essence, CPG 233 classified a global pandemic as something that was likely to occur, and that being unprepared for it doesn’t make it a Black Swan.
“The guide aims to assist regulated institutions in considering and prudently managing the risks posed by a potential influenza pandemic, or any other widespread outbreak of contagious disease that could affect their operations.”
In other words, APRA considered a global pandemic an anticipated event, which is why they published CPG 233 to help APRA-regulated institutions prepare for it and maintain business continuity as much as possible. It outlines key aspects of pandemic plans and how pandemic planning differs from traditional business continuity planning. Most importantly, CPG 233 makes it clear that APRA expects all its regulated institutions to consider pandemic risks.
Like all financial institutions, investment management businesses have a risk management register. This is a list of what a business considers to be the major risks facing them, and how they intend to mitigate those risks. Since the publication of CPG 233 in 2013, ‘global pandemic’ would have been on that list. However, the details of how to deal with the impact of an event like Covid-19 would have been cursory at best, because there was simply a widely-held belief that it wouldn’t come to pass.
Now that Covid-19 is upon us, and we’re continuing to navigate the ‘new normal’, no-one can afford to maintain the ‘ostrich approach’. The worst has happened. How did investment funds respond and more importantly, what insights can we take away from the experience to build a resilient investment management business?
How have investment management businesses reacted to Covid-19 around the world?
For the most part, funds responded quite well, although it’s still too soon to gauge the whole of the impact. And one of the most valuable lessons they learned was that they were capable of rapid and effective decision-making – more so than they had been in the past. Like all organisations worldwide, they had to work swiftly to relocate staff to home offices, with the necessary equipment to maintain business continuity in the virtual world. A lot of off-shoring has also taken place as well. Mostly, these are to locations such as the Philippines and India, and generally involve investment administration operations.
Liquidity was also tested, with Governments around the world allowing people to access their retirement savings prematurely.
Unit pricing and valuation processes also faced challenges; for example, how can a commercial city building be valued if there may no longer be a future for it, because more people are working from home – a situation that’s likely to be ongoing? Covid-19 placed significant stress on valuation policies, with many reviews of those policies occurring as a result.
And of course, like so many other industries, digital transformation accelerated as businesses closed their physical doors while opening virtual ones. Financial advisors who previously wouldn’t have thought about meeting investors online, are now using online video communication platforms to engage with investors.
What lessons can be gleaned from Covid-19 to strengthen investment risk management?
What the pandemic has taught us is the need to be flexible, transparent, and ensure a full understanding our supply chains. For example, if an investment fund is using a third-party administrator located in a different country, it’s essential they’re aware of this. Covid-19 has, by necessity, forced a greater level of communication between funds managers and their service providers. This, of course, helps to improve visibility over the fund and how it’s managed.
It’s important to revisit risk management plans and business continuity plans, and that starts with becoming familiar with historical events – both global and local. This means investment management businesses need to be more imaginative and thorough when planning for hypothetical situations. What this means is that just having one line in a risk management plan on how to deal with a pandemic is not effective or useful; there
needs to be more scenario planning, with each one being thought through in detail. And not just for a pandemic, but any crisis that could threaten business continuity or even survival. Although they’re unlikely to occur, we must always consider what the impact would be if they did, and be ready to meet the subsequent challenges.
What other risks do investment fund businesses face? Spreadsheets can be a major concern – download our white paper on spreadsheet risk to find out more.