Many professional asset managers exceed their own risk exposure limits because of inadequate computer systems and compliance controls, according to a new survey conducted by Arthur Andersen.
This underscores perils faced by banks dealing in derivatives, experts said, noting that customers who are unaware of contracts risks are the likeliest to come in conflict with dealers.
"It's pretty obvious from a people, technology, and automation perspective that very few resources have been dedicated to compliance and risk management," said Stephen D. Callahan, a partner in Arthur Andersen's investment management consulting group.
"Given the complexities of today's securities products, the regulatory environment mutual funds are subject to and the reputational and financial risk that can result from any kind of misstep, you would think more attention would be paid to these issues."
In its survey of 250 asset managers, the accounting and consulting firm found the lack of automated risk management tools the most common reason investment professionals violated risk exposure limits. According to the survey, 77% of managers overseeing institutional and retail funds cited this as a cause for this problem, compared with the 71% who cited lack of process controls.
The survey suggested that similar problems led to violations of regulatory, internal, or customer compliance guidelines. Nearly all mutual fund respondents cited lack of tools as a cause for these problems, compared with the 67% who said resource limitations had caused problems.
The survey respondents suggested the best way for fund managers to overcome these problems is to integrate their compliance and trading systems. Only about 15% of the fund managers said they already do this.
Mr. Callahan said the need for these kinds of controls are necessary to avoid highly public blunders.
"If this area is not managed correctly, it can only deliver bad news," he said. "It could just take one little trading error to pay for an investment in training or systems."
Heinz Binggeli, a managing director at Emcor, an Irvington, N.Y., risk management consulting company, said banks should avoid rushing into this business, however.
Confusion over Bankers Trust New York Corp.'s role in derivatives sales led to the legal problems it faced in its dealings with Proctor & Gamble Co., he said. In that case, Proctor & Gamble sued the bank for violating its fiduciary duty to the company.
Even though the judge overseeing the case ruled that Proctor & Gamble could not sue the bank for breach of fiduciary duty before the two parties settled, banks and other derivatives dealers have sought to ensure their derivatives dealings are conducted at arms' length.
Indeed, Mr. Binggeli pointed out that J.P. Morgan & Co. took a step away from the business last week. It signed an agreement that gave Reuters the right to use its RiskMetrics data in Reuters' risk management systems.
"I think banks are better off to stay out of the business of giving advice," he said. "It almost inevitably leads to conflict-of-interest situations."