The Observer


Keep using the rear view mirror….

by Sudha Datta and Jim Harris, Soterium Inc.

Although it seems a long time ago, the financial crisis in 2008 continues to highlight the need to understand both Operational and Reputational risk in an increasingly regulated world. Outside of Canada, several significant financial institutions closed their doors with most others taking severe financial impacts to their bottom lines.  Here at home, despite our more intensive regulatory environment, Canadian Banking firms were also subject to significant losses, which reduced their quarterly returns for investors. With this in mind it is critical to any Pension Plan that continuous independent oversight and maintenance takes place to ensure risk mitigation and a successful outcome for all parties.

It is commonly agreed that Pension Plan (Plan) Trustees have a fiduciary responsibility to their members. In other words, members must rely on the Trustee’s knowledge and experience to keep their contributions safe, their benefits invested and disbursed correctly, and to mitigate risk while reaping best yield for the Plan.

It is also true that with the increased trend to global investments, the term ‘risk’ has expanded to encompass concerns with regards to protection and recoverability of assets invested outside of North America, and the corresponding regulation/compliance requirements. With that in mind, let’s summarize the risks a plan can face in three broad categories:

  • Investment Risks: Include Asset, Credit, Market, Currency and Interest rate.
  • Operational Risks: Include Asset Servicing, Asset Safety and Accessibility risk. It may include key-person risk and technology risk.
  • Reputation Risks: Include Compliance, Regulatory, Processing and Fraud.

In many cases, the primary focus of Trustee/Administrator meetings and/or Investment Committee meetings is to ensure that, whether managed internally or externally, that the Plan yields/returns and overall performance, continues to grow in line with stated Plan objectives and within investment guidelines. In turn, where management fees/bonuses are linked to performance, any risk taken should be quantified and explained to the Trustees/Administrators on a continuous basis.  

With regard to Operational and Reputation Risk, a common refrain is ‘That’s OK, but isn’t that the Custodian’s responsibility?’  While it’s true they play a pivotal role by providing Trade Settlement, Asset Servicing and Ancillary services, the bottom line is that Trustees need to continually evaluate all aspects of the relationship with their Custodian(s).

On that same subject, Custodian risk also exists through limitations of liability in legal agreements, Agent Bank selection/RFP reviews/Due Diligence processes, Operational and concentration risk, to name but a few.
That said, what should a Plan be looking at with regards to oversight/maintenance? To help with an evaluation, here are a few sample questions:   

  1. Is the safekeeping/custody agreement and securities lending agreement less than five years old?
  2. Is the chain of custody clearly documented and asset recovery, including time frames understood and agreed?
  3. Does the Plan actively manage and have benchmarking processes in place?
  4. Have there been any issues with regards to asset settlement/servicing over the last year?
  5. Has the plan carried out a review to quantify operational risks lately?

To be clear, it doesn’t follow that the style and depth of assessment can be fully addressed through a service review with your Relationship Manager at your Custodian. By conducting a regular custodian Health Check an independent consultant will be able to assess, review and report on the following areas:
  • Documentation
  • Asset Safety
  • Asset Recovery
  • Agent Bank Due Diligence
  • Fee Tariffs/Revenue
  • Securities Lending Benchmarking
  • Compliance/Regulation

Please note that this is not an exclusive list and will be dependent on the type of Plan or Fund.

There is no doubt however, that the Trustee/Administrator’s roles, already complex, continue to grow more challenging over time as new investment classes and opportunities arise putting additional strain on the existing structures and resources, requiring greater flexibility and/or review to ensure best practices remain in place.

Plans of all shapes and sizes, quite rightly, look to the road ahead to ensure their beneficial owners are catered to both in terms of the returns/yield needed today and in the future. It is critical to ensure that the platform on which the investment program is built is appropriate, mitigates risks, and remains compliant.

Finally, as the rubber hits the road, the challenge for all Plans is to ensure that all aspects of their responsibilities are continually fit for purpose, with the need to evaluate all aspects of your Plan administration on a regular basis.  This is not only a prudent approach, but one that can provide a more confident course forward.

 Sudha Datta

Worked as Head of Operations with Sovereign Wealth fund Abu Dhabi Investment Authority (ADIA) where he was responsible for custody, securities lending and investment operations for over 20 years. Datta is a recipient of the “industry Legend Award” from Global Custodian magazine.

 Jim Harris

With over 40 years international Finance experience, Harris headed Global Custody and UK Settlements teams in his career with a UK Clearing Bank and is responsible for the Continuous Risk Assessment Model at RBC, having joined the Network Management team in London in 1994 and moved to Canada in 2010.