2017 AIMA Forum Sydney: Operational Due Diligence

Alex Wise, Executive Consultant to Castle Hall across Asia Pacific, yesterday led a panel discussion at the 2017 AIMA Australia Forum. This year’s flagship AIMA event attracted more than 400 participants across asset managers, investors and service providers.

The panel, “The DD Canary: Operational Due Diligence from the Front Line” focused on the role of operational due diligence (“ODD”) to enhance investment decision making and provide greater protection for asset owners when allocating to external asset managers.

Castle Hall was also proud to be the lead sponsor for the AIMA Operational and Regulatory sessions during the Forum.

Speakers were:

  • Damien Jasczyk, Deutsche Bank AG, Australia/NZ
  • Jonathan Green, NSW Treasury Corporation (TCorp)
  • Criag Roodt, APRA

Key takeaways from the panel:

  1. Operational Risk is “Risk Without Reward”. There is no return upside to taking on additional operational risk: as such, investors should focus on understanding and mitigating operational risks when allocating to third party managers.
  2. The starting point for an effective operational diligence process is a clearly defined governance framework. Jonathan explained that, at TCorp, the organization’s Board has established a policy which governs both investment and operational diligence, for both proposed and incumbent managers. The Investment DD and ODD processes rank equally and are complementary, not competitive: both must be satisfied for an investment proposal to proceed.
  3. Craig agreed that an asset owners’ due diligence policy should be written, enabling each organization to have a clear and unambiguous understanding as to their Board’s expectations around the due diligence process. An effective due diligence policy will establish the Board’s risk appetite and what gates a manager should pass through to meet each organization’s acceptance criteria.
  4. It is critical that operational due diligence have a veto power. Frauds and financial losses across the Australian financial sector can often be traced to a “story” around a front office over-rides of due diligence and risk recommendations.
  5. Effective ODD can be a value add, and should not focus only on the bare minimum, “hygiene factor” criteria. ODD provides the opportunity to develop deep relationships with managers and service providers, gathering bilateral information which can also assist the asset owner organization.
  6. Due diligence is not one size fits all. The more the asset class depends on individual skill and management, the greater the operational risk.  As such, it is to be expected that investors will place greater diligence emphasis on more complex asset classes, such as hedge funds and private equity.
  7. ODD should consider all external asset managers, not just hedge funds. The ODD process should also evaluate and document manager changes over time through an effective monitoring program.
  8. Manager pays due diligence reports now coming available in Australia will be helpful as an input to the due diligence process, but cannot be considered to be a “single source” solution to a superannuation or insurance company’s due diligence obligations. Over time, the market will decide whether investors find manager pays diligence information to be sufficiently useful to offset the inherent conflict of the manager pays model, and will continue to provide feedback to managers’ diligence providers as to scope and content. However, in all cases, asset owners will remain responsible for the final investment decision, and must make their own determination as to the suitability of a manager for their portfolios. Diligence must consider both objective facts as well as subjective questions of people and culture: the “soft issues” will remain a diligence challenge for investors, irrespective of manager commissioned diligence information.