Operational Resilience 2021: The Human Factor

Operational resilience will replace business continuity as the mantra for operations, IT and risk managers at fund management firms, banks and brokers in 2021 requiring a whole new combination of procedures, human interactions and even a bit of technology spend.

Operational resilience goes far beyond business continuity. “Operational resilience takes a much broader approach to risk management and its various disciplines, including business continuity,” says Joseph Giunta, a partner at New York-based financial services consultancy New Bridge Consulting Group. “Practically speaking it is the ability to recover from any type of disaster and continue to offer services to customers in a rapidly changing environment,” With the COVID-19 pandemic making remote working the new norm, the goal of front, middle and back-office operations and IT professionals at buy-side and sell-side firms can no longer be about quickly recuperating from even short or even medium-term fires, such as natural disasters or computer glitches, which might affect a particular city, region or business unit. They must now be prepared to deal with a full-blown mishap which can quickly take out multiple critical technology platforms and people concurrently.

Fund management firms, broker-dealers and banks were put to the test in 2020 when they could no longer work from the office or even backup locations as most countries entered a period of lock-down with only essential workers going about their business as usual. Trading and post-trade professionals had to adapt to working from home in quick makeshift environments. As a result, say operations, compliance, and technology managers who spoke with FinOps Report over the past month, they realize that the siloed way of doing business– sticking to one’s knitting in one’s own unit– no longer works. There are more far more conversations between front, middle and back office folks who hardly ever spoke with one another unless to point fingers about a trade processed or booked incorrectly. The COVID-19 pandemic has proven that correctly duplicating an office IT configuration for work from home won’t always prevent trading and post-trade operations problems. That is just half the solution. The other half is knowing what to say and when to colleagues, subordinates and C-level management to get trades executed and processed correctly on time every day.

Human interactions will come in handy now that several US banking regulators have issued a seven-tiered approach to ensure operational resilience which will apply to at least a dozen of the US’ largest banks based on the value of assets under management. The recommendations– which will likely be interpreted as regulation — encompass everything from business continuity and cybersecurity to scenario testing and third-party risk management. The guidance, which parallels that issued by the Basel Committee on Banking Supervision and the UK’s Financial Conduct Authority, will require a change from the historic piecemeal approach of addressing different regulatory requirements separately. A hodgepodge of prescriptive measures and principles has now been turned into a single overarching mandate. “There will now be a holistic end-to-end view of resiliency programming encompassing all of the critical functions from customer onboarding and interfacing, to trading and post-trade processes,” explains Hamish Wynn, a managing director of the risk and resiliency practice for global consultancy Accenture in New York. “Therefore, any stress calculations or other measures of resiliency made by individual business lines, such as scenario testing, will have to be rolled up into a single view.”

Some mega banks have already created the official role of operational resilience director to coordinate data collection and analyze the separate reports to make any necessary changes to procedures and technology, according to Wynn. However, the need for a single enterprise-wide view of operational resilience across business lines will likely not be limited to mega banks. Fund management firms and broker-dealers are expected to follow suit as best practice. The only difference is that they might not generate formal operational resilience reports for regulators or assign someone the official title of operational resilience director. Nonetheless, it will take a village to figure out the weakest links in the chain of front, middle, and back-office functions and how to correct them as some financial firms are quickly finding out. “We created a new task force comprised of operations, technology, trading, cybersecurity, customer service and human resources to report to the CFO/COO,” says Michael Aldrich, global head of operational strategy for Brown Advisory, a Baltimore, Maryland-based fund management firm with over US$106 billion in assets. “Any changes to a process or new technology now requires enhanced training and employee certification to validate an understanding of the new process or new technology.” That doesn’t mean checking off a yes box to acknowledge the change exists. All front, middle and back-office employees who have a part to play in the process or have access to the related technology system are required to show how the change occurred and what it means to their everyday work. Those changes can occur in a monthly or even quarterly basis.

The new communication skills needed in more interactive environment go far beyond following a Miss Manners guidebook on social etiquette. They require knowing how to reduce the time it takes to complete tasks without jeopardizing personal relationships. Gone are the days when the portfolio manager and trading desk managers could holler across the room or walk down the hall to see each other. The same applies to middle and back office operations managers. Weekly if not daily Zoom meetings, daily pre-arranged email communications, and status reports have become the norm. Aldrich says that his firm has encouraged one-to-one virtual check-in meetings and socially- distanced get -togethers, such as outdoor team building activities to help business line managers and team members understand their tasks and address their concerns. Business line managers at Brown Advisory have even been given additional training by its human resource department on how to communicate with team members working remotely to take into account additional family responsibilities. “It requires a whole new skill set in management,” says Aldrich. About 85 percent of Brown Advisory’s 730 employees, including about 75 hired since March, have returned to the office working in rotating shifts with two weeks in the office followed by a mandatory two weeks at home. Operations managers at several US brokerages tell FinOps Report say that their firms are also relying on rotating shifts and have come up with rules for when and how Zoom and other social chatrooms are to be used. “Our weekly Zoom meeting addresses any minor glitches that might have occurred and preventative steps to take to avoid any mistakes,” says one operations manager at a US brokerage.

However, should a serious operational failure occur, quicker escalation policies take effect which involve more than a single phone call or email to a single person. It is about contacting all affected parties depending on the function involved through emails, followed up by phone calls, and virtual meetings in record time. Having  multiple back-up contacts is also part of the gameplan. Although going the extra mile started in during the early stage of the COVID- 19 pandemic, the practice is now set in stone for future use, say brokerage operations managers in the US and Europe. They recall some unfilled trades, higher rates of settlement fails, missed margin calls and overlooked deadlines for decisions on corporate action entitlements during March and April when trading and operations managers were still adjusting to working from home. A combination of insufficient technology capacity and limited staff to handle higher trading volumes created the perfect storm and no one wants the same scenario to occur in the future. “Our middle and back-office systems became overloaded and we didn’t have enough backup staff to handle exceptions as some folks became unavailable due to illness or family commitments,” quips one operations manager at a US broker-dealer. “We now have a process of sending out escalation emails and making calls more rapidly, closer to the time of the exception rather than at the end of the day. We are also backing up the first-line of defense escalation team so that there are several parties to contact in case someone is out of pocket.”

However, improved escalation policies can only go so far in ensuring operational resilience. An ounce of prevention is even better. Fund management firms and broker-dealers need to make certain that all trades are executed, cleared and settled properly and booked correctly in the first place. Problems with trading and post-trade functions appear to have subsided over the past few months as snafus in connecting to trading venues and broker-dealers have been fixed and post-trade applications added capacity. However, remote staff must still count on their proprietary networks which link to the necessary platforms and people to function well even under duress.  Financial firms are taking some extra precautions to make sure their employees are always connected to the necessary systems and individuals. Stephen Farnsworth, head of operations, and IT for San Diego-based asset management firm Brandes Investment Partners, says that his firm’s employees are relying on one of three network providers monitored daily. A 24 -by-7 help desk is available to assist staff with moving from one network to another quickly in case of an outage.

Heightened oversight of third-party vendors has become even more critical to ensuring operational resilience than ever before. No longer are the perfunctory questions of “do you have a back-up system working and tested” sufficient. Financial firms want to know just what the procedures are in detail and what happens if they don’t work. Instead of annual reviews, monthly or even weekly updates have become mandatory. As firms often rely on at least several dozen if not hundreds of vendors, developing a risk model applies with the most critical applications receiving the most attention. Chicago-based software firm Sterling Trading Tech, which offers trading, compliance, and risk management technology to banks and brokers, says it is receiving a lot more questions on the who, when, where and how of their business continuity planning. The questions are coming not only from large bank clients, but also small to mid-tier brokers which would previously be satisfied with a brief mention of business continuity in their contracts. “Instead of a few pages of basic questions to answer we now have to explain in detail about warm and hot backup sites, location of data centers, and testing,” says Sterling Trading Tech’s president Jim Nevotti. “Discussions once limited to technology managers are now including business and compliance directors.” The detailed questions apply not only to new clients but also existing ones who want to review the firm’s policies and procedures in the wake of the COVID-19 pandemic.

Prime brokers, custodians, and fund administrators which handle securities lending transactions, credit lines and strike net asset valuations, are also experiencing more frequent monitoring. “Our clients are now requiring us to provide quicker updates on the status of trade confirmations, clearance and settlement, lending, corporate actions, and margin calls,” says one operations manager at a US prime broker. As a result, fund managers are using proprietary portals of service providers more often than usual for real-time rather than end-of-day updates. One operations manager at a global custodian banks estimates that the frequency of intraday views on his bank’s portal has more than doubled since the COVID-19 pandemic started. As a result, his bank has decided that its customer-interfacing network management staff will implement weekly virtual meetings for the largest clients and quarterly meetings for small to mid-tie clients. Updates on overseas regulatory changes or changes in policies affecting local agent banks in overseas markets will occur as quickly as they happen.

For Brandes Investment Partners the timing of the COVID-19 pandemic’s start required more frequent communications with the fund management firm’s new middle and back-office service provider SEI hired in October 2019. “Since we were in the first quarter of the transition period we had our content experts speak with their experts either weekly or twice a week,” says Farnsworth. The crossover was seamless with the exception of one technological glitch, which was unrelated to working remotely due to the COVID-19 pandemic. That snafu, which was quickly fixed, involved transmitting data from Brandes’ systems to SEI’s and required an exercise in reformatting. Brandes initially incorrectly formatted an API call from SEI’s system into Brandes’ portfolio management system. Although the portfolio management system temporarily slowed down, trading was not affected, according to Farnsworth. All of Brandes’ 240 employees were shifted over to working remotely with all the necessary technology within a weekend in March as the firm’s traders were already accustomed to working from home. The employees will work remotely until at least June 1, 2021.

Nothing beats the right technology when it comes to striking a required end-of-day valuation. Phone calls, virtual meetings and emails won’t do the trick for fund managers. Neither will depending solely on their fund administrators. Instead of counting on fund administrators to have effective business continuity plans in place, fund management firms are taking matters into their own hands, depending on a combination of internal staff and platforms designed for creating a contingency NAV. “Fund managers will now have access to two NAVs– the NAV that will be published and another NAV that is used in case the first administrator can’t strike the NAV,” says Geoff Hodge, president of Sydney, Australia-headquartered Milestone Group whose pControl platform provides back-up NAVs, contingency NAVs and oversight of fund administrator’s NAV operations. So far, no fund management firms or fund administrators have publicly admitted to having difficulties striking NAVs on time during the pandemic, but some fund operations managers tell FinOps Report they are considering implementing technology for contingency NAVs just in case. State Street, Brown Brothers Harriman, and MUFG have also released proprietary NAV contingency platforms, while BNY Mellon is using Milestone’s pControl platform to offer a third-party oversight and contingency NAV service to any fund manager regardless of its fund administrator. It could not be determined how many clients BNY Mellon has nabbed for the recently launched service.

Yet another area where technology could go a long way to ensuring a glitch-free post-trade environment is in the processing of exchange-traded derivative trades. If one were to believe the findings of a report issued by London-based derivatives analytics platform operator Acuiti, there were some bottlenecks in the early days of the pandemic related to the inability of some futures commission merchants (FCMs) to process higher volumes. “The exact details of what happened during those frenzied days in March has not yet been written, but what is clear is that several major FCMs temporarily stopped accepting trades, creating huge issues with broker give-ups and trades that were executed with one broker and cleared with another,” says Acuiti’s report sponsored by New York-based business outsourcing and technology giant Broadridge Financial. The report doesn’t identify the FCMs, but the largest ones include JP Morgan, Goldman Sachs, Morgan Stanley, BankofAmerica, Societe Generale, and Citi. “The reason behind the failure of certain FCMs to accept trades is understood to be in the back-office, which at some FCMs was unable to deal with the higher volumes.” says the Broadridge-sponsored report. Rather than risk relying on flawed data from risk, margin and other systems, some FCMs opted to stop accepting trades until the problems were fixed.

The bottlenecks caused by processing more trades has hit home for some mega firms which now understand they can no longer avoid investing in back-office technology for exchange-traded derivatives (ETDs). About forty percent of Tier One and Tier Two banks will be spending at least US$5 million over the next three years in back office systems to address ETDs, says the Broadridge-sponsored report. “When you are dealing with trade processing failures due to higher volumes, the problem can’t be solved by moving employees around as they are not familiar with different applications and it takes too much time for them to resolve exceptions,” explains Justin Llewellyn-Jones, head of capital markets for North America at Broadridge. “Large-scale transformational projects are also too complicated to manage, hence firms will start with the highest pain points first and for FCMs that is in their back-office systems.”

Although the new mantra of operational resilience will likely affect all operations and technology managers at fund management firms, broker-dealers and banks, risk managers could often end up with the heaviest burden, predicts Llewellyn-Jones. The reason: they must come up with the metrics to ensure that the people and processes used don’t exceed a firm’s risk appetite and those metrics will vary by business line. “Rather than constantly calling employees to ask about how they are going about their work, business line managers will be implementing metrics on performance as it relates to exceptions — not performing the work on time or making errors,” says New Bridge Consulting Group’s Giunta. “For technology platforms, the exceptions will refer to the number of outages, their severity, and the actual time to recovery.”

Operational resilience, which took center stage in 2020, will remain the financial industry’s buzzword in 2021 even if a vaccine for COVID-19 succeeds in reducing the rate of transmission, agree operations managers and consultants. No one is willing to take any chances as regulators require reassurance and customers need continuity. “There will be a continued emphasis on risk appetite with a continued evolution of metrics which will in turn affect systems and procedures,” says Giunta. “The lessons learned from the COVID-19 pandemic in 2020 will be with us for some time to come.”