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definition can be challenging due to its complex nature. For our survey, BNY Mellon defined operational risk as the risk of loss from inadequate or failed internal processes, people and systems, or from external events. The Lehman Brothers collapse represented an excellent example of operational risk controls failing to identify underlying risks: specifically, the full extent of their sub-prime mortgage exposure, which quickly contaminated the whole financial market. Widely publicised trading losses, hedge fund scandals and, in general, much of the market collapse in 2008 could be traced to a lack of operational controls along different points in the investment process.


A close look at the events surrounding the 2008 crisis reveals the potential complexity of operational risk. Institutional investors will need to utilise a number of different solutions to safeguard their organisations from internal and external threats. These solutions need to combine qualitative and quantitative tools to tackle the different aspects of the industry’s operational risk challenges.


Operational risk management controls The survey respondents utilise a number of different controls to monitor operational risk in their organisations, varying from a culture of integrity, to internal and external fraud controls, to financial reporting. All the categories scored very high, demonstrating an understanding of the importance, complexity and resources needed to mitigate operational risk (see Fig.6). Balance sheet strength and credit rating were the two most highly rated important risk factors when evaluating global custodians. Interestingly, stress test and SIFI status did not receive high ratings, possibly suggesting the 2008 banking concerns are now well behind us.


Operational risk insurance Although the percentage of respondents actually utilising operational risk insurance went down from 35% to 26%, the number who ruled out operational risk insurance dropped much more and the number contemplating operating risk insurance rose from 5% to 18%. Furthermore, the number of respondents that now require operational risk insurance from vendors rose dramatically, from 7% to 23% since the 2005 Survey.


POLITICAL RISK


In our survey, we defined political risk as the risk that an investment’s returns could suffer as a result of political changes or instability in a country where instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policymakers, or military control. Recent examples, such as the Eurozone bailouts, the US debt ceiling debate, and the Arab Spring protests,


Fig.5 Shift in focus on operational risk during the past five years


Source: BNY Mellon


Stayed the same 29%


Decreased 1% N/A 1%


Increased 69%


Fig.6 The most important operating risk controls (% rated important or extremely important)


Culture of integrity Controls for external fraud Documented policies and procedure


Senior professional operational leadership (management) Controls for internal fraud Financial reporting


80


99% 93% 93% 93% 92% 89%


85 90 95 100


Source: BNY Mellon


Fig.7 Rating the following operating risks (% rated as challenging or extremely challenging)


Aggregating different aspects of risk (operational, market and credit risk)


Quantifying potential risks outside of market risk


Collation of appropriate data to feed the risk management process


Incorporating risk analysis results in the senior management decision-making Maintaining the pace of regulatory change Increasing costs to support risk management Creating a risk culture within the organisation Hiring experienced risk managers


Empowering the risk manager to be truly independent 0%


64% 61% 57% 55% 51% 51% 47% 36% 34%


20% 40% 60% 80% 100%


Source: BNY Mellon


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