Portfolio > Asset Managers

Avoiding Mismatches

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The director of the SEC’s Division of Investment Management mentioned derivatives in particular at the ICI’s Operations and Technology Conference last October:

“. . . one growth mismatch that comes to mind is fund firms’ increasing investment in highly complex investment products, such as over-the-counter derivatives, and the capability of firms’ back office operations to handle the processes that firms rely on to conduct these trades.

According to recently reported data, there was $34 trillion outstanding in credit default swaps at the end of last year [2006], their value having grown 240% in 18 months. From a risk standpoint, a notable aspect of this incredible growth is that these complex instruments are becoming more widely traded, with traditional long-only asset managers increasing their exposure to them. Firms’ traders and portfolio managers may have the sophistication to invest in these products.

However, a firm relatively new to this area may not have enough experienced personnel in other areas, particularly in back-office operations, to perform their necessary functions with respect to these trades. As a result, we are seeing operational risks arise as constraints in the back office threaten the important functions, such as managing the documentation, settlement, valuation and confirmation processes, that this part of the firm performs.”

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