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Holly H. Miller
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Holly H. Miller is a partner at Stone House Consulting, LLC, providing strategic, operational and IT consulting services to investment managers and hedge funds. Prior to founding Stone House Consulting, she was Chief Operating Officer at M.D. Sass, managing $15 billion in hedge funds, private... More
My company:
Stone House Consulting, LLC
My blog:
Stone House Consulting
My book:
The Top Ten Operational Risks: A Survival Guide for Investment Management Firms and Hedge Funds
  • Top Ten Areas of Operational Risk 0 comments
    Aug 10, 2010 10:28 AM

    Operational risk is a serious concern not only to traditional and alternative investment managers, but also to their clients and the organizations that regulate buy-side firms. In worst-case scenarios, an investment firm’s failure to identify and mitigate operational risk can result in significant direct costs and a devastating loss of reputation. It may take years to reassure investors, regulators, and trading partners that the firm is well-managed.

    So what exactly is operational risk? Some call it “risk without reward.” The Basel Committee on Banking Supervision (Basel II) defines operational risk as “the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events,” and states that the definition is intended to include legal risk but exclude reputational risk, and lists as examples events ranging from data entry errors to earthquakes.[1] But operational risk is not something that can be easily identified by a generic checklist, nor is there a single, universally applicable approach to mitigating the operational risks to which a given firm is exposed. Different organizations will have different exposures (depending, for instance, upon their investment strategies, the markets in which they operate, and the instruments they employ) as well as varying tolerance levels for operational risk, just as they have with regard to investment risk.

    Nonetheless, there are key areas to look for risk within an investment management organization. In addition, there are some straightforward approaches to mitigating operational risk that can be deployed by large and small organizations alike. Many of these approaches will address several key risk areas at once.

    During the next ten weeks, Stone House Consulting will be covering our 'top 10' areas of operational risk with a short article on each one, including suggestions for identifying whether these risks exist within your organization and steps to mitigate them. Although there is no one-size-fits-all solution for operational risk management, we hope these articles will help many organizations reduce their operational risk profile.

    Click here for our top ten list.

    We remarked that operational risk may be seen as “risk without reward.” In this view, there is no upside for the firm, and operations managers are compensated on the pinball model: if they do very well, they get to play again. We’d like to suggest another perspective. Operational excellence, which starts with risk management, can create value by reducing costs, increasing client satisfaction, and maintaining sound business relationships with trading partners. We hope you will enjoy reading these articles and that you find them to be both thought-provoking and practical. Please feel free to share them with your colleagues and encourage others to subscribe to our mailing list.

    [1] “Sound Practices for the Management and Supervision of Operational Risk,” February 2003, p. 2. The definition as given here originally appeared in “Working Paper on the Regulatory Treatment of Operational Risk,” September 2001, p. 8. Stone House Consulting accepts the exclusion of reputational risk from the definition but postulates that internal operational risk entails reputational risk.  We maintain that the reputational consequences arising from “inadequate or failed internal processes, people, and systems” should be captured in a comprehensive measure of operational risk. For instance, the firm might model the loss of investment management fees as assets are withdrawn. 

    Disclosure: No positions

    Disclosure: no positions
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