Top 10 Operational Risks: The first two risk areas in a 10-part series

20 Sep 2012

Operational risk within investment management firms can stem from many sources. Firms also have varying tolerance levels for accepting or handling such risk. SEI believes virtually every firm can benefit from taking a fresh look at common areas of risk and consider the variety of relatively straightforward risk management measures that can readily be deployed. In that spirit, SEI put together a 10-part guide as an effective risk management tool to set the foundation for operational excellence. Below are excerpts from the first two chapters, now available for download at

1) COMPLACENCY: Trivializing and Disregarding Risks

In the relentless press of daily tasks, it’s all too easy for investment firms to fall into a passive, reactive mode of operating. But deeming spotty recordkeeping “good enough” and promising to deal with business continuity planning “later” exposes firms to myriad risks.

Common pitfalls: Firms sow the seeds of dysfunction when they hire inexperienced or under-qualified staff, neglect to train new employees, and disregard potentially vital feedback from middle- and back-office staff.  Failing to check employees’ work is another major source of risk.  Firms also court potential disaster when they lag behind in technology investments or limp along without electronic document management.

What can firms do?

Better training – Skills of operational staff should align with the complexity of the products and financial instruments handled.  Firms need to hire and train employees accordingly.

Tighten up internal procedures – Ensuring that critical documents are always backed up should be a priority, and is easy to accomplish with today’s tools.  Maintaining error logs (including near misses) and reviewing them regularly will help managers to spot weaknesses in operational systems and procedures.

Improve communications – It takes little cost or effort to keep staff informed of business changes that affect operations.  To help staff stay abreast of new requirements, firms should also have a new product committee that includes participation from compliance, operations and IT.

Develop appropriate checks and balances – Operational staff members should not be put in the position of being solely responsible for the accuracy of their work; they deserve to work with effective oversight. The same point applies when it comes to managing service providers.

Firms that assume disasters won’t happen leave themselves vulnerable. They need to take the time to think about what go wrong – and then take steps to make sure it never does.

2) THE BLIND LEADING THE BLIND: Overextended and Underqualified Managers

Supervision is a major area of operational risk because breakdowns occur so often and in so many different forms—especially when mid-level and senior managers are unfamiliar with investment operations. The larger the firm, the greater the challenge of directing and supervising others.  Outsourcing can help, but poses added demands for due diligence and oversight.

Common pitfalls: In this era of tight budgets, many firms are understaffed for the volume of activity their operational departments must handle. This may lead employees to shortcut tasks or push them aside – a more common problem than rogues with malign intent. Managers are often overstretched, too, with so many responsibilities they cannot possibly keep track of all their direct reports.  Executives unfamiliar with operations may delegate responsibility to managers not suited for the task – for example, assigning all responsibility for operational risk to a compliance team composed entirely of attorneys and paralegals.

What can firms do?

Help managers understand – Process mapping and workflow documentation can illuminate middle- and back-office functions for those unfamiliar with them. Developing detailed, comprehensive job descriptions that spell out essential skills and competencies can support more effective hiring, employee development, and training.

Beef up external reviews – Measures such as mock regulatory examinations, peer benchmarking and operational due diligence reviews can help pinpoint areas of organizational risk.

Apply best practices when outsourcing – That means adhering to due diligence procedures – from initial RFPs to annual on-site visits.  Reading all the fine print is critical.

Preserve institutional knowledge – Robust training and cross-training programs can reinforce departmental competencies.  Firms should also implement succession planning for all key positions (which may include junior staff).

Consider increased automation or outsourcing – This may offer a viable long-term solution for investment managers who want to keep staffing lean as they grow.

Senior executives and managers need to recognize that their knowledge of middle- and back-office functions may have gaps they’re not aware of, with potentially major repercussions.

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