Credit ratings: IT in the spotlight

When Schroders Investment Management received a rating upgrade, the strength of its technology platform was a key factor in the rating agency’s opinion.

by Richard Willsher, financial journalist

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In November 2008 Fitch Ratings revised the London-based asset manager’s rating from M2 to M2+. It noted, “The rating also factors in the extent of Schroders research resources and the solid risk management framework. The addition of the ‘+’ modifier emphasises strength in the company’s investment infrastructure and the technological platform with notable progress being made in data management and integration (...)”. Other recent upgrades where Fitch made specific reference to technology as a determining factor included Groupama Asset Management, RFM Investment Management, Rothschild & Cie Gestion and Robeco.

THE OXYGEN OF ASSET MANAGEMENT

That Fitch should include technology in its set of five rating categories - company & staffing, risk management & controls, portfolio management, investment administration and technology - is not altogether surprising. As Andrew Cox, partner, and head of regulatory capital at actuaries and consultants Lane Clark & Peacock explains, “Data and information is the oxygen of any kind of insurance or asset management business. If you don’t know what business you’re running then how can you expect to run it well or to react to changing environments and situations? The ability to know what your business is and to know what your business is doing quickly is, we think, vital. And that in the end comes down to IT systems, most of all because there are vast amounts of information that any asset manager will need about all the holdings of different individuals, contracts that they’ve got in place etc. So the ability to be able to turn that vast amount of very detailed information into usable and useful summaries in a matter of days rather than weeks is pretty important.”

Moody’s Investors Service takes this into account when evaluating and assigning its Investor Manager Quality ratings. “Moody’s believes,” it explains, “that the successful operation of an investment management firm relies also on the ability of the firm to set up an appropriate investment infrastructure, including the use of real-time portfolio management systems and various external data service providers to deliver targeted levels of portfolio management, accounting, shareholder services, and legal/control functions. In this area, face-to-face discussions are reinforced by on-site reviews.

It is also recognised that the failure of IT operations could threaten an investment management company’s ability to manage and monitor efficiently its offerings and provide adequate client services. For this reason, while stopping short of an assessment of enterprise-wide operations risk, we review the content and frequency of back-up systems as well as the tests of reliability of the key information feeds.”

A spokesman for Standard & Poor’s notes that, “For financial institutions ratings, technology is not a major area of focus [for us]. Rather, we are more interested in the broader enterprise risk management of the firm (risk governance, credit risk etc.) and the degree to which senior management can answer our questions and present credible, timely management reports. Within this, we do also focus upon operational risk, which is important to asset managers, for example disaster recovery, how management monitor operational risk etc.”

BASEL II / SOLVENCY II

The rating agencies then do not offer themselves as detailed analysts of data systems and technology platforms. It is quite clear however that they do attach a significant degree of importance to the technological underpinning of an asset management or fund management business when apportioning ratings. With hindsight it was inevitable that IT’s role in risk management and capital adequacy would become more important, even before the financial crisis beginning with the US sub-prime fiasco. Information and the efficiency of systems lie just below the surface of the criteria of Basel II for non-life business and Solvency II for insurance and asset managers with a life insurance aspect to them. There is a strong emphasis on risk management and controls and on operational risk in Basel ‘Pillar 1.’ And quality information and robustness of systems falls within the view of regulatory oversight in ‘Pillar 2.’

The stakes however have become considerably heightened in light of the recent volatility in financial markets. Anything other than a rapid response to marking assets to market and speedy quantifying of positions poses a reputational risk to an institution.

“Both Basel II and Solvency II are, in the end, about risk management,” says Andrew Cox, “and the first step to managing risk is identifying risk. The only way you do so is by knowing what your business is doing, what risks it’s running and what its exposures are and this derives from the IT system. There at the heart of it a good data system is a pre-requisite for good risk management.” He goes on to say that the UK’s Financial Services Authority is particularly keen to focus upon the integrity of data.

“From my personal experience in working with clients to help them with both regulatory capital and Solvency II,” concludes Cox worryingly, “it is remarkable how difficult it is to get information or even to find someone who actually understands what the information means. There is a lot of room for improvement. Different companies are at different levels. Above all people must not think that this is a solved problem.”

With the current pressure from regulators, pressure from markets and pressure on the models applied by rating agencies in arriving at their ratings, it looks inevitable that IT will be further thrust into the spotlight. Ratings criteria will have to place increased emphasis on technology, even more than they currently do and anything less will again draw criticism of the rating agencies themselves. In the rating process there will be winners and losers. Ratings will go up or down depending on how flexible, scalable, robust and quick their systems are in the way they respond to the stresses placed on their asset managers’ businesses.



Richard Willsher is a London-based financial journalist and former investment banker.